77424 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR PARTS 200, 201, 230, 240, 242, 

249, and 270

[Release No. 34–50870; File No. S7–10–04] 

RIN 3235–AJ18

Regulation NMS

AGENCY: Securities and Exchange 

Commission.

ACTION: Proposed rules and amendments 

to joint industry plans. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’) is 

reproposing rules under Regulation 

NMS and two amendments to the joint 

industry plans for disseminating market 

information. In addition to 

redesignating the national market 

system rules previously adopted under 

Section 11A of the Securities Exchange 

Act of 1934 (‘‘Exchange Act’’), 

Regulation NMS would include new 

substantive rules that are designed to 

modernize and strengthen the regulatory 

structure of the U.S. equity markets. 

First, the ‘‘Trade-Through Rule’’ would 

require trading centers to establish, 

maintain, and enforce written policies 

and procedures reasonably designed to 

prevent the execution of trades at prices 

inferior to protected quotations 

displayed by other trading centers, 

subject to an applicable exception. To 

be protected, a quotation must be 

immediately and automatically 

accessible. Second, the ‘‘Access Rule’’ 

would require fair and nondiscriminatory access to quotations, 

establish a limit on access fees to 

harmonize the pricing of quotations 

across different trading centers, and 

require each national securities 

exchange and national securities 

association to adopt and enforce rules 

that prohibit their members from 

engaging in a pattern or practice of 

displaying quotations that lock or cross 

automated quotations. Third, the ‘‘SubPenny Rule’’ would prohibit market 

participants from accepting, ranking, or 

displaying orders, quotations, or 

indications of interest in a pricing 

increment smaller than a penny, except 

for orders, quotations, or indications of 

interest that are priced at less than $1.00 

per share. Finally, the Commission is 

reproposing amendments to the ‘‘Market 

Data Rules’’ that would update the 

requirements for consolidating, 

distributing, and displaying market 

information, as well as amendments to 

the joint industry plans for 

disseminating market information that 

would modify the formulas for 

allocating plan revenues (‘‘Allocation 

Amendment’’) and broaden 

participation in plan governance 

(‘‘Governance Amendment’’).

DATES: Comments must be received on 

or before January 26, 2005. Given the 

advanced stage of this rulemaking 

initiative, the Commission anticipates 

taking further action as expeditiously as 

possible after the end of the comment 

period. It therefore strongly encourages 

the public to submit their comments 

within the prescribed comment period. 

Comments received after that point 

cannot be assured of full consideration 

by the Commission.

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–10–04 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Jonathan G. Katz, Secretary, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington, DC 

20549–0609. 

All submissions should refer to File 

Number S7–10–04. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/

proposed.shtml). Comments also are 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 450 Fifth Street, NW., 

Washington, DC 20549. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Trade-Through Rule: Heather Seidel, 

Attorney Fellow, at (202) 942–0788, 

Jennifer Colihan, Special Counsel, at 

(202) 942–0735, David Hsu, Special 

Counsel, at (202) 942–0731, or Raymond 

Lombardo, Attorney, at (202) 942–8080; 

Access Rule: Heather Seidel, Attorney 

Fellow, at (202) 942–0788, or David Liu, 

Attorney, at (202) 942–8085; Sub-Penny 

Rule: Michael Gaw, Senior Special 

Counsel, at (202) 942–0158, or Ronesha 

Butler, Special Counsel, at (202) 942–

0791; Market Data Rules, Allocation 

Amendment, and Governance 

Amendment: Sapna C. Patel, Special 

Counsel, at (202) 942–0166, or David 

Hsu, Special Counsel, at (202) 942–

0731; Regulation NMS: Yvonne 

Fraticelli, Special Counsel, at (202) 942–

0197; all of whom are in the Division of 

Market Regulation, Securities and 

Exchange Commission, 450 Fifth Street, 

NW., Washington, DC 20549–1001.

SUPPLEMENTARY INFORMATION:

Table of Contents 

I. Introduction 

A. Need for Modernization of the NMS 

B. Objectives for Future NMS 

C. Overview of Reproposed Rules 

1. Trade-Through Rule 

2. Access Rule 

3. Sub-Penny Rule 

4. Market Data Rules and Plans 

II. Trade-Through Rule 

A. Response to Comments and Basis for 

Reproposed Rule 

1. Need for Intermarket Trade-Through 

Rule 

2. Limiting Protection to Automated and 

Accessible Quotations 

3. Workable Implementation of Intermarket 

Trade-Through Protection 

4. Elimination of Proposed Opt-Out 

Exception 

5. Scope of Protected Quotations—Market 

BBO Alternative and Voluntary Depth 

Alternative 

6. Benefits and Implementation Costs of 

Trade-Through Rule 

B. Description of Reproposed Rule 

1. Scope of Rule 

2. Requirement of Reasonable Policies and 

Procedures 

3. Exceptions 

4. Duty of Best Execution 

III. Access Rule 

A. Response to Comments and Basis for 

Reproposed Rule 

1. Access to Quotations 

2. Limitation on Access Fees 

3. Locking or Crossing Quotations 

B. Description of Reproposed Rule 

1. Access to Quotations 

2. Limitation on Access Fees 

3. Locking or Crossing Quotations 

4. Regulation ATS Fair Access 

IV. Sub-Penny Rule 

A. Background 

B. Commission Proposal on Sub-Penny 

Quoting 

C. Comments Received 

1. Comments Addressing Overall Proposal 

2. Response to Other Comments 

D. Exemptive Authority 

V. Market Data Rules and Plan Amendments 

A. Response to Comments and Basis for 

Reproposed Rules 

1. Alternative Data Dissemination Models 

2. Level of Fees and Plan Governance 

3. Revenue Allocation Formula 

4. Distribution and Display of Data 

B. Description of Reproposed Rules and 

Amendments 

1. Allocation Amendment 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77425

1The Commission originally proposed Regulation 

NMS in February 2004. Securities Exchange Act 

Release No. 49325 (Feb. 26, 2004), 69 FR 11126 

(Mar. 9, 2004) (‘‘Proposing Release’’). It issued a 

supplemental request for comment in May 2004. 

Securities Exchange Act Release No. 49749 (May 

20, 2004), 69 FR 30142 (May 26, 2004) 

(‘‘Supplemental Release’’).

2For small orders, the effective spread between 

bid and offer prices represents the most significant 

implicit trading cost. In addition to the implicit 

trading costs associated with the prices at which 

their orders are executed, investors must pay 

explicit costs of trading, such as broker 

commissions.

3Effective spreads declined substantially almost 

immediately after decimalization, and had declined 

an additional 40% by November 2003. Proposing 

Release, 69 FR at 11128, 11165.

4See Securities and Exchange Commission, 

Release Nos. 33–8349 (Dec. 18, 2003), 68 FR 74820, 

74822 (Dec. 24, 2003) (concept release on measures 

to improve disclosure of mutual fund transaction 

costs; notes that estimates of price impact costs 

range from 0.18% to 1.0% of the principal amount 

of transactions).

2. Governance Amendment 

3. Consolidation, Distribution, and Display 

of Data 

VI. Regulation NMS 

VII. General Request for Comment 

VIII. Paperwork Reduction Act 

IX. Consideration of Costs and Benefits 

X. Consideration of Burden on Competition, 

and Promotion of Efficiency, 

Competition and Capital Formation 

XI. Consideration of Impact on the Economy 

XII. Regulatory Flexibility Act 

XIII. Statutory Authority 

XIV. Text of Reproposed Amendments to the 

CTA Plan, the CQ Plan, and the Nasdaq 

UTP Plan 

XV. Text of Reproposed Rules

I. Introduction 

The Commission is reproposing 

Regulation NMS, a series of initiatives 

designed to modernize and strengthen 

the national market system (‘‘NMS’’) for 

equity securities.1 These initiatives 

include:

(1) A new Trade-Through Rule, which 

would establish for all NMS stocks the 

fundamental principle of price priority 

for automated quotations that are 

immediately accessible; 

(2) A new Access Rule, which would 

promote fair and non-discriminatory 

access to quotations displayed by NMS 

trading centers through a private linkage 

approach;

(3) A new Sub-Penny Rule, which 

would establish a uniform quoting 

increment of no less than one penny for 

quotations in NMS stocks equal to or 

greater than $1.00 per share to promote 

greater price transparency and 

consistency; 

(4) Amendments to the Market Data 

Rules and joint industry plans that 

would allocate plan revenues to selfregulatory organizations (‘‘SROs’’) for 

their contributions to public price 

discovery and promote wider and more 

efficient distribution of market data; and 

(5) A reorganization of existing 

Exchange Act rules governing the NMS 

to promote greater clarity and 

understanding of the rules. 

The NMS encompasses the stocks of 

more than 5000 listed companies, which 

collectively represent more than $14 

trillion in U.S. market capitalization. 

NMS stocks are traded simultaneously 

at a variety of different venues, 

including national securities exchanges, 

alternative trading systems (‘‘ATSs’’), 

and market-making securities dealers. 

Fair and efficient trading of NMS stocks 

is essential if the equity markets are to 

meet the long-term investment needs of 

the public and to reduce the cost of 

capital for listed companies. Section 

11A of the Exchange Act charges the 

Commission with facilitating the 

establishment of an NMS that links 

multiple trading centers into a unified 

system that promotes the fairest and 

most efficient equity markets possible. 

The reproposed rules are intended to 

assure that the NMS remains up to date 

and continues to serve the interests of 

investors, listed companies, and the 

public. 

A. Need for Modernization of the NMS 

The reproposed rules would 

implement a major overhaul of the 

existing structure of the NMS, much of 

which was originally designed in the 

1970s and 1980s. This overhaul is 

necessary to respond to sweeping 

changes that have reshaped the equity 

markets in recent years. First, 

communications and trading 

technologies have greatly expanded the 

available options for routing and 

executing orders in NMS stocks. 

Establishing connectivity among all 

types of securities industry participants 

has become both less costly and more 

flexible. Order-routing systems can be 

programmed to monitor prices at 

multiple trading centers, assess the most 

effective trading strategy to meet the 

needs of a particular customer, and 

instantaneously route orders to one or 

more trading centers to implement that 

strategy. Trading centers, in turn, are 

able to offer a near instantaneous 

response to incoming orders seeking to 

access automated quotations. 

Another significant change has been 

the intensified competition among 

different types of markets that 

simultaneously trade many of the same 

NMS stocks, regardless of the particular 

market where the stocks are listed. 

These include (1) Traditional exchanges 

with active trading floors, which even 

now are evolving to expand the range of 

choices that they offer investors for both 

automated and manual trading; (2) 

purely electronic markets, which offer 

both standard limit orders and 

conditional orders that are designed to 

facilitate complex trading strategies; (3) 

market-making securities dealers, which 

offer both automated execution of 

smaller orders and the commitment of 

capital to facilitate the execution of 

larger, institutional orders; (4) regional 

exchanges, many of which have adopted 

automated systems for executing smaller 

orders; and (5) automated matching 

systems that permit investors, 

particularly large institutions, to seek 

counter-parties to their trades with 

minimal publicity and price impact. 

Finally, the initiation of trading in 

penny increments in 2001 transformed 

the equity markets. The number of 

quotation updates increased, and the 

quoted size at any particular price level 

dropped. The change clearly has 

benefited many investors, particularly 

retail investors that typically use 

smaller orders. Reducing the standard 

trading increment from 1⁄16ths to 

pennies allowed effective spreads to 

narrow for small orders.2 As a result, the 

trading costs of small orders have 

dropped dramatically.3

For institutional investors that 

generally need to trade in large sizes, 

however, the results of decimal trading 

have been less clear cut. The primary 

component of trading costs for large 

orders is price impact—the change in 

stock price caused by the difficulty of 

executing large orders to buy (with 

rising prices) or to sell (with declining 

prices).4 The price impact for large 

orders, which generally will be many 

times the effective spread for small 

orders in the same stock, is largely 

determined by market depth and 

liquidity. The greater the depth and 

liquidity, the less the price impact of 

large orders. Given that millions of 

individuals invest in NMS stocks 

indirectly through these institutions, it 

is vitally important for the NMS to 

promote depth and liquidity for the 

trading of large orders.

To respond to all of these changes, the 

Commission has undertaken a deliberate 

and systematic review of market 

structure. We actively have sought out 

the views of the public and securities 

industry participants. Even prior to 

formulating proposals, our review 

included multiple public hearings and 

roundtables, an advisory committee, 

three concept releases, the issuance of 

temporary exemptions intended in part 

to generate useful data on policy 

alternatives, and a constant dialogue 

with industry participants and 

investors. This process continued after 

77426 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

5Proposing Release, 69 FR at 11126.

6A full transcript of the NMS Hearing (‘‘Hearing 

Tr.’’), as well as an archived video and audio 

webcast, is available on the Commission’s Internet 

Web site (http://www.sec.gov).

7Supplemental Release, 69 FR at 30142.

8Section 11A(a)(1)(D) of the Exchange Act.

9Although this release refers to reproposed Rule 

611 as the ‘‘Trade-Through Rule,’’ the text of the 

Rule would be named ‘‘Order Protection Rule’’ if 

adopted. The term ‘‘Trade-Through Rule’’ is used in 

this release to avoid confusion, given that the term 

has been widely used in public debate. The term 

‘‘Order Protection Rule,’’ however, better captures 

the Commission’s purpose for the Rule. 

Specifically, it is designed to protect both (1) limit 

orders represented by displayed and automated 

quotations, by prohibiting trading centers from 

executing trades at inferior prices; and (2) market 

orders and marketable limit orders (which have 

limit prices that render them subject to immediate 

execution at market prices without display), by 

requiring trading centers either to execute the 

orders at the best, immediately accessible prices or 

to route the orders to trading centers displaying 

such prices.

10The nature and scope of quotations that would 

be protected under the Trade-Through Rule are 

discussed in detail in sections II.A.2 and II.B.1 

below.

11See infra, note 38 (overview of commenters 

supporting trade-through proposal).

the proposals were published for public 

comment.5 We held a public hearing on 

the proposals in April 2004 (‘‘NMS 

Hearing’’).6 To give the public an 

opportunity to respond to important 

developments at the hearing, we 

published a supplemental request for 

comment and extended the comment 

period on the proposals.7 The public 

submitted more than 700 comment 

letters that encompassed a wide range of 

views. On one point, however, 

commenters agreed—the time has come 

to modernize the NMS.

The Commission believes that the 

insights of the commenters, as well as 

those of the NMS Hearing panelists, 

have contributed to significant 

improvements in the original proposals. 

Responding appropriately to these 

comments has caused the reproposed 

rules to differ in some respects from the 

rule text as originally proposed. As 

discussed extensively below, all of the 

changes address issues that were raised 

in the Proposing Release and 

Supplemental Release and that 

prompted substantial public comment. 

Rather than adopt rules at this point, 

however, the Commission is 

implementing a reproposal process to 

afford the public an additional 

opportunity to review and comment on 

the details of the rules. Given the 

advanced stage of rulemaking, it 

anticipates taking further action as 

expeditiously as possible after the end 

of the comment period. The 

Commission therefore strongly 

encourages the public to submit their 

comments within the comment period. 

Comments received after that point 

cannot be assured of full consideration 

by the Commission. In its evaluation of 

further rulemaking action, the 

Commission will consider, in addition 

to the comments received in response to 

this release, all comments received on 

the Proposing Release and 

Supplemental Release. 

B. Objectives for Future NMS 

The reproposed rules are designed to 

strengthen the NMS in three primary 

ways. First, they would update 

antiquated rules that no longer 

adequately serve the purposes for which 

they were adopted. Second, they would 

help level the competitive playing field 

by promoting equal regulation of 

different types of stocks and markets. 

Third, they would promote greater order 

interaction and displayed depth, of 

particular value for the large orders of 

institutional investors. 

Taken together, the Commission 

believes the reproposed rules would 

significantly improve the fairness and 

efficiency of the NMS in the future. The 

NMS is premised on promoting fair 

competition among markets, while at 

the same time assuring that all of these 

markets are linked together, through 

facilities and rules, in a unified system 

that promotes interaction among the 

orders of buyers and sellers in a 

particular NMS stock. The NMS thereby 

incorporates two distinct types of 

competition—competition among 

individual markets and competition 

among individual orders—that together 

contribute to efficient markets. Vigorous 

competition among markets promotes 

more efficient and innovative trading 

services, while integrated competition 

among orders promotes more efficient 

pricing of individual stocks. Together, 

they produce markets that offer signal 

benefits for investors and listed 

companies. 

The Commission has sought to avoid 

the extremes of (1) isolated markets that 

trade an NMS stock without regard to 

trading in other markets and thereby 

fragment the competition among buyers 

and sellers in that stock, and (2) a totally 

centralized system that loses the 

benefits of vigorous competition and 

innovation among individual markets. 

To achieve the appropriate degree of 

integration, the Commission primarily 

has relied on two tools. First, 

consolidated display of market data 

promotes transparency of the best prices 

for an NMS stock. Second, intermarket 

‘‘rules of the road’’ establish a 

framework within which competition 

among individual markets can flourish 

on terms that ultimately benefit 

investors. The reproposed rules would 

continue this strategy. They are 

designed to strengthen and enhance the 

efficiency of linkages among the various 

competing markets, but without 

mandating any particular type of trading 

model. Investor choice and competition 

will determine the relative success or 

failure of the various competing 

markets.

Some have suggested that the 

Commission should move away from 

the fundamental NMS concept of 

promoting both competition among 

markets and competition among the 

buyers and sellers in a stock. They 

believe that, instead, markets should be 

allowed to trade in isolation from one 

another. This approach, of course, was 

in effect until 1975 when Congress 

directed the Commission to facilitate the 

establishment of an NMS. After fully 

considering the matter, Congress 

specifically found that linking the 

individual markets would ‘‘foster 

efficiency, enhance competition, 

increase the information available to 

brokers, dealers, and investors, facilitate 

the offsetting of investors’ orders, and 

contribute to the best execution of such 

orders.’’ 8 The wisdom of this 

congressional finding has been proven 

by thirty years of practical experience. 

The NMS needs to be enhanced and 

modernized, not because it has failed 

investors, but because it has been so 

successful in promoting growth, 

efficiency, innovation, and competition 

that many of its old rules now are 

outdated. Since the NMS was created 

nearly thirty years ago, trading volume 

has exploded, competition among 

market centers has intensified, and 

investor trading costs have shrunk 

dramatically. The Commission 

preliminarily believes that the 

reproposed rules would contribute to 

further growth and efficiency in the 

NMS and thereby serve the interests of 

investors, listed companies, and the 

public in the future.

C. Overview of Reproposed Rules 

1. Trade-Through Rule 

The Trade-Through Rule (reproposed 

Rule 611 under Regulation NMS) 9

would establish intermarket protection 

against trade-throughs for all NMS 

stocks. A trade-through occurs when 

one trading center executes an order at 

a price that is inferior to the price of a 

protected quotation, often representing 

an investor limit order, displayed by 

another trading center.10 Many 

commenters on the proposals, 

particularly large institutional investors, 

strongly supported the need for 

enhanced protection of limit orders 

against trade-throughs.11 They 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77427

12The full title of the ITS Plan is ‘‘Plan for the 

Purpose of Creating and Operating an Intermarket 

Communications Linkage Pursuant to Section 

11A(c)(3)(B) of the Securities Exchange Act of 

1934.’’ The ITS Plan was initially approved by the 

Commission in 1978. Securities Exchange Act 

Release No. 14661 (Apr. 14, 1978), 43 FR 17419 

(Apr. 24, 1978). All national securities exchanges 

that trade exchange-listed stocks and the NASD are 

participants in the ITS Plan. It requires each 

participant to provide electronic access to its 

displayed best bid or offer to other participants and 

provides an automated mechanism for routing 

orders, called commitments to trade, to access those 

displayed prices. The participants also agreed to 

avoid trade-throughs and locked markets and to 

adopt rules addressing such practices.

13Flickering quotations are discussed further in 

section II.A.3 below.

14See infra, notes 40–42 and accompanying text.

emphasized that limit orders are the 

building blocks of public price 

discovery and efficient markets. They 

stated that a uniform rule for all NMS 

stocks, by enhancing protection of 

displayed prices, would encourage 

greater use of limit orders and 

contribute to increased market liquidity 

and depth. The Commission 

preliminarily agrees that strengthened 

protection of displayed limit orders 

would help reward market participants 

for displaying their trading interest and 

thereby promote fairer and more 

vigorous competition among orders 

seeking to supply liquidity. It therefore 

has decided to repropose Rule 611 to 

strengthen the protection of displayed 

and automatically accessible quotations 

in NMS stocks. As discussed below, 

today we are proposing two alternatives 

that would each further this goal, and 

we are seeking public comment on 

which alternative is likely best to 

advance the principle of limit order 

protection while preserving intermarket 

competition and avoiding practical 

implementation problems.

As with the original proposal, the 

reproposed Trade-Through Rule would 

take a substantially different approach 

than the trade-through provisions 

currently set forth in the Intermarket 

Trading System (‘‘ITS’’) Plan,12 which 

apply only to exchange-listed stocks. 

The ITS provisions are not promulgated 

by the Commission, but rather are rules 

of the markets participating in the ITS 

Plan. These rules were drafted decades 

ago and do not distinguish between 

manual and automated quotations. 

Moreover, they state that markets 

‘‘should avoid’’ trade-throughs and 

require an after-the-fact complaint 

procedure pursuant to which, if a tradethrough occurs, the aggrieved market 

may seek satisfaction from the market 

that traded through. Finally, the ITS 

provisions have significant gaps in their 

coverage, particularly for large, block 

transactions (10,000 shares or greater), 

that have seriously weakened their 

protection of limit orders.

In contrast, the reproposed TradeThrough Rule would only protect 

quotations that are immediately 

accessible through automatic execution. 

It thereby would address a serious 

weakness in the ITS provisions, which 

were drafted for a world of floor-based 

markets and fail to reflect the disparate 

speed of response between manual and 

automated quotations. By requiring 

order routers to wait for a response from 

a manual market, the ITS trade-through 

provisions can cause an order to miss 

both the best price of a manual 

quotation and slightly inferior prices at 

automated markets that would have 

been immediately accessible. The 

Trade-Through Rule would eliminate 

this potential inefficiency by protecting 

only automated quotations. It also 

would promote equal regulation and fair 

competition among markets by 

eliminating any potential advantage that 

the ITS trade-through provisions may 

have given manual markets over 

automated markets. 

In addition, the reproposed TradeThrough Rule incorporates an approach 

to trade-throughs that is stricter and 

more comprehensive than the ITS 

provisions. First, it would require 

trading centers to establish, maintain, 

and enforce written policies and 

procedures that are reasonably designed 

to prevent trade-throughs, or, if relying 

on one of the rule’s exceptions, that are 

reasonably designed to assure 

compliance with the exception. To 

assure effective compliance, such 

policies and procedures would need to 

incorporate objective standards that 

were coded into a trading center’s 

automated systems. Moreover, a trading 

center would be required to regularly 

surveil to ascertain the effectiveness of 

its policies and procedures and to take 

prompt action to remedy deficiencies. 

Second, the Trade-Through Rule would 

eliminate very significant gaps in the 

coverage of the ITS provisions that have 

undermined the extent to which they 

protect limit orders and promote fair 

and orderly trading. In particular, the 

ITS provisions do not cover the large 

transactions of broker-dealers acting as 

block positioners in exchange-listed 

stocks. They also exclude tradethroughs of 100-share quotations, 

thereby allowing the limit orders of 

small investors to be bypassed. The 

Trade-Through Rule would close both of 

these gaps in coverage. 

With respect to the scope of 

quotations to be protected, the 

Commission is proposing two 

alternatives, one of which would 

represent a more fundamental departure 

from the existing ITS provisions by 

potentially extending limit-order 

protection beyond the best limit orders 

on a market’s book. The definition of 

‘‘protected bid’’ or ‘‘protected offer’’ in 

paragraph (b)(57) of reproposed Rule 

600 controls the scope of quotations that 

would be protected by the TradeThrough Rule. The first alternative 

(‘‘Market BBO Alternative’’) would 

protect only the best bids and offers 

(‘‘BBOs’’) of the nine self-regulatory 

organizations (‘‘SROs’’) and The Nasdaq 

Stock Market, Inc. (‘‘Nasdaq’’) whose 

members currently trade NMS stocks. 

The scope of quotations covered by this 

alternative is comparable to the ITS 

provisions. The second alternative 

(‘‘Voluntary Depth Alternative’’) also 

would protect the BBOs of the various 

SROs and Nasdaq, but would establish 

a mechanism for a market voluntarily to 

secure protection for its depth-of-book 

quotations at prices below its best bid or 

above its best offer. These alternatives 

are discussed in more detail in section 

II.A.5 below. 

The rule text of the original proposal 

included a general ‘‘opt-out’’ exception 

that would have allowed market 

participants to disregard displayed 

quotations. Such an exception would 

have left a significant gap in protection 

of the best displayed prices and thereby 

severely reduced the proposal’s 

potential benefits. The elimination of 

any protection for manual quotations is 

the principal reason that this broad 

exception is no longer necessary in the 

Trade-Through Rule as reproposed. In 

addition, the Rule adds a number of 

tailored exceptions that carve out those 

situations in which many investors may 

otherwise have felt they legitimately 

needed to opt-out of a displayed 

quotation. These exceptions are more 

consistent with the principle of 

protecting the best price than a general 

opt-out exception. The additional 

exceptions also would help assure that 

the Trade-Through Rule is workable for 

high-volume stocks. Examples of these 

exceptions include intermarket sweep 

orders, quotations displayed by markets 

that fail to meet the response 

requirements for automated quotations, 

and flickering quotations with multiple 

prices displayed in a single second.13

Some commenters questioned the 

need to extend a trade-through rule to 

Nasdaq stocks.14 These commenters 

generally emphasized the much 

improved efficiency of trading in 

Nasdaq stocks in recent years. They 

particularly were concerned that 

extension of intermarket price 

protection to Nasdaq stocks, at least in 

77428 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

15See infra, notes 59–61 and accompanying text.

16See infra, section III.A.1.

17Private linkages are discussed further in section 

III.A.1 below.

18The comments on access fees are addressed in 

section III.A.2 below. 19See infra, section III.A.2.

the absence of a general opt-out 

exception, would interfere with current 

trading methods.

The Commission preliminarily 

believes, however, that intermarket 

price protection would benefit investors 

and strengthen the NMS in all NMS 

stocks. It would contribute to the 

maintenance of fair and orderly markets 

and, thereby, promote investor 

confidence in the markets. As discussed 

below,15 trade-through rates currently 

are significant in both Nasdaq and 

exchange-listed stocks. For example, 

approximately 1 of every 40 trades in 

both Nasdaq and NYSE stocks 

represents a significant trade-through of 

a displayed quotation. For hundreds of 

active Nasdaq stocks, approximately 1 

of every 11 shares traded is a significant 

trade-through. The routine execution of 

trades at prices inferior to those offered 

by displayed and accessible limit orders 

is inconsistent with basic notions of 

fairness and orderliness, particularly for 

investors, both large and small, who 

post limit orders and see those orders 

routinely traded through. These tradethroughs can undermine incentives to 

display limit orders. Moreover, many of 

the investors whose market orders are 

executed at inferior prices may not, in 

fact, be aware they received an inferior 

price from their broker and executing 

market. In sum, the Commission 

preliminarily believes that a uniform 

rule establishing price protection on an 

order-by-order basis is needed to protect 

the interests of investors, promote the 

display of limit orders, and thereby 

improve the efficiency of the NMS as a 

whole.

2. Access Rule 

The Access Rule (reproposed Rule 

610 under Regulation NMS) would set 

forth new standards governing access to 

quotations in NMS stocks. As 

emphasized by many commenters on 

the proposals,16 protecting the best 

displayed prices against trade-throughs 

would be futile if broker-dealers and 

trading centers were unable to access 

those prices fairly and efficiently. 

Accordingly, Rule 610 is designed to 

promote access to quotations in three 

ways. First, it would enable the use of 

private linkages offered by a variety of 

connectivity providers,17 rather than 

mandating a collective linkage facility 

such as ITS, to facilitate the necessary 

access to quotations. The lower cost and 

increased flexibility of connectivity in 

recent years has made private linkages 

a feasible alternative to hard linkages, 

absent barriers to access. Using private 

linkages, market participants may obtain 

indirect access to quotations displayed 

by a particular trading center through 

the members, subscribers, or customers 

of that trading center. To promote this 

type of indirect access, Rule 610 would 

prohibit a trading center from imposing 

unfairly discriminatory terms that 

would prevent or inhibit the access of 

any person through members, 

subscribers, or customers of such 

trading center.

Second, reproposed Rule 610 would 

limit the fees that any trading center can 

charge (or allow to be charged) for 

accessing its protected quotations to no 

more than $0.003 per share. The 

purpose of the fee limitation is to ensure 

the fairness and accuracy of displayed 

quotations by establishing an outer limit 

on the cost of accessing such quotations. 

For example, if the price of a protected 

offer to sell an NMS stock is displayed 

at $10.00, the total cost to access the 

offer and buy the stock will be $10.00, 

plus a fee of no more than $0.003. The 

reproposed rule thereby would assure 

order routers that displayed prices are, 

within a limited range, true prices. 

The reproposed fee limitation 

substantially simplifies the proposed 

limitation on fees, which, in general, 

would have limited the fees of 

individual market participants to $0.001 

per share, with an accumulated cap of 

$0.002 per share. Perhaps more than any 

other single issue, the proposed 

limitation on access fees splintered the 

commenters.18 Some supported the 

proposal as a worthwhile compromise 

on an extremely difficult issue. They 

believed that it would level the playing 

field in terms of who could charge fees, 

as well as give greater certainty to 

market participants that quoted prices 

will, essentially, be true prices. Others 

were strongly opposed to any limitation 

on fees, believing that competition alone 

would be sufficient to address high fees 

that distort quoted prices. Still others 

were equally adamant that all access 

fees of electronic communications 

networks (‘‘ECNs’’) charged to nonsubscribers should be prohibited 

entirely, although they did not see a 

problem with fees charged to a market’s 

members or subscribers. Although 

consensus could not be achieved on any 

particular approach, commenters 

expressed a strong desire for resolution 

of a difficult issue that has caused 

discord within the securities industry 

for many years.

The Commission preliminarily 

believes that a single, uniform fee 

limitation of $0.003 per share would be 

the fairest and most appropriate 

resolution of the access fee issue. First, 

it would not seriously interfere with 

current business practices, as trading 

centers have very few fees on their 

books of more than $0.003 per share or 

earn substantial revenues from such 

fees.19 Second, the uniform fee 

limitation would promote equal 

regulation of different types of trading 

centers, where previously some had 

been permitted to charge fees and some 

had not. Finally and most importantly, 

the fee limitation of Rule 610 would be 

necessary to support the integrity of the 

price protection requirement established 

by the reproposed Trade-Through Rule. 

In the absence of a fee limitation, some 

‘‘outlier’’ trading centers might take 

advantage of the requirement to protect 

displayed quotations by charging 

exorbitant fees to those required to 

access the outlier’s quotations. Rule 

610’s fee limitation would preclude the 

initiation of this business practice, 

which would compromise the fairness 

and efficiency of the NMS.

Finally, reproposed Rule 610 would 

require SROs to establish and enforce 

rules that, among other things, prohibit 

their members from engaging in a 

pattern or practice of displaying 

quotations that lock or cross the 

automated quotations of other trading 

centers. Trading centers would be 

allowed, however, to display automated 

quotations that lock or cross the manual

quotations of other trading centers. The 

reproposed rule thereby would reflect 

the disparity in speed of response 

between automated and manual 

quotations, while also promoting fair 

and orderly markets by establishing that 

the first automated quotation at a price, 

whether it be a bid or an offer, is 

entitled to an execution at that price 

instead of being locked or crossed by a 

quotation on the other side of the 

market. 

3. Sub-Penny Rule 

The Sub-Penny Rule (reproposed Rule 

612 under Regulation NMS) would 

prohibit market participants from 

displaying, ranking, or accepting 

quotations in NMS stocks that are 

priced in an increment of less than 

$0.01, unless the price of the quotation 

is less than $1.00. If the price of the 

quotation is less than $1.00, the 

minimum increment would be $0.0001. 

A strong consensus of commenters 

supported the sub-penny proposal as a 

means to promote greater price 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77429

20The comments on the sub-penny proposal are 

discussed in section IV.C below.

21The three joint-industry plans are (1) the CTA 

Plan, which is operated by the Consolidated Tape 

Association and disseminates transaction 

information for exchange-listed securities, (2) the 

CQ Plan, which disseminates consolidated 

quotation information for exchange-listed 

securities, and (3) the Nasdaq UTP Plan, which 

disseminates consolidated transaction and 

quotation information for Nasdaq-listed securities. 

The last restatements of the CTA Plan and the CQ 

Plan were approved in 1996. Securities Exchange 

Act Release No. 37191 (May 9, 1996), 61 FR 24842 

(File No. SR–CTA/CQ–96–1). The amended 

versions of the CTA Plan and the CQ Plan were 

filed as attachments to File No. SR–CTA/CQ–96–1, 

which are available in the Commission’s Public 

Reference Room. There have been several 

subsequent amendments to the CTA and CQ Plans; 

the Plans have not been republished in this 

connection. The Nasdaq UTP Plan was last 

published in its entirety in 2004. Securities 

Exchange Act Release No. 49137 (Jan. 28, 2004), 69 

FR 5217 (Feb. 3, 2004).

22H.R. Rep. No. 94–229, 94th Cong., 1st Sess. 93 

(1975).

23Trade shredding, or the splitting of large trades 

into a series of 100-share trades, is discussed further 

in section V.A below.

24Comments on the market data proposals are 

discussed in section V.A.2 below.

25Some commenters mistakenly believed that the 

level of market data fees had been left unreviewed 

for many years. In fact, the Commission 

comprehensively reviewed market data fees in 

1999, which led to a 75% reduction in fees paid by 

retail investors for market data. See infra, note 295.

26Proposing Release, 69 FR at 11177.

27The U.S. equity markets are not alone in their 

reliance on market information revenues as a 

significant source of funding. All of the other major 

world equity markets currently derive large 

amounts of revenues from selling market 

information. See infra, note 308 and accompanying 

text.

transparency and consistency, as well as 

to protect displayed limit orders.20 In 

particular, Rule 612 would address the 

practice of ‘‘stepping ahead’’ of 

displayed limit orders by trivial 

amounts. It therefore should further 

encourage the display of limit orders 

and improve the depth and liquidity of 

trading in NMS stocks.

4. Market Data Rules and Plans 

The reproposed amendments to the 

Market Data Rules (reproposed Rules 

601 and 603 under Regulation NMS) 

and joint industry plans (‘‘Plans’’) 21 are 

designed to promote the wide 

availability of market data and to 

allocate revenues to SROs that produce 

the most useful data for investors. They 

would strengthen the existing market 

data system, which provides investors 

in the U.S. equity markets with realtime access to the best quotations and 

most recent trades in the thousands of 

NMS stocks throughout the trading day. 

For each stock, quotations and trades 

are continuously collected from many 

different trading centers and then 

disseminated to the public in a 

consolidated stream of data. As a result, 

investors of all types have access to a 

reliable source of information for the 

best prices in NMS stocks. When 

Congress mandated the creation of the 

NMS in 1975, it noted that the systems 

for disseminating consolidated market 

data would ‘‘form the heart of the 

national market system.’’ 22

Accordingly, one of the Commission’s 

most important responsibilities is to 

preserve the integrity and affordability 

of the consolidated data stream.

The reproposed amendments would 

promote this objective in several 

different respects. First, they would 

update the formulas for allocating 

revenues generated by market data fees 

to the various SRO participants in the 

Plans. The current Plan formulas are 

seriously flawed by an excessive focus 

on the number of trades, no matter how 

small the size, reported by an SRO. 

They thereby create an incentive for 

distortive behavior, such as wash sales 

and trade shredding,23 and fail to reflect 

an SRO’s contribution to the best 

displayed quotations in NMS stocks. 

The reproposed formula would correct 

these flaws. It also is much less complex 

than the proposal, primarily because, 

consistent with the approach of the 

Trade-Through Rule and Access Rule, 

the new formula would eliminate any 

reward for manual quotations. It 

therefore should promote an allocation 

of revenues to the various SROs that 

more closely reflects the usefulness to 

investors of each SRO’s market 

information.

The reproposed amendments also are 

intended to improve the transparency 

and effective operation of the Plans by 

broadening participation in Plan 

governance. They would require the 

creation of advisory committees 

composed of non-SRO representatives. 

Such committees would give interested 

parties an opportunity to be heard on 

Plan business, prior to any decision by 

the Plan operating committees. Finally, 

the amendments would promote the 

wide availability of market data by 

authorizing markets to distribute their 

own data independently (while still 

providing their best quotations and 

trades for consolidated dissemination 

through the Plans) and streamlining 

outdated requirements for the display of 

market data to investors. 

Many commenters on the market data 

proposals expressed frustration with the 

current operation of the Plans.24 These 

commenters generally fell into two 

groups. One group, primarily made up 

of individual markets that receive 

market data fees, believed that the 

current model of consolidation should 

be discarded in favor of a new model, 

such as a ‘‘multiple consolidator’’ model 

under which each SRO would sell its 

own data separately. The other group, 

primarily made up of securities industry 

participants that pay market data fees, 

believed that the current level of fees is 

too high. This group asserted that, prior 

to modifying the allocation of market 

data revenues, the Commission should 

address the level of fees that generated 

those revenues.25

The Commission has considered these 

concerns at length in the recent past. As 

was noted in the Proposing Release,26 a 

drawback of the current market data 

model, which requires all SROs to 

participate jointly in disseminating data 

through a single consolidator, is that it 

affords little opportunity for market 

forces to determine the overall level of 

fees or the allocation of those fees to the 

individual SROs. Prior to publishing the 

proposals, therefore, the Commission 

undertook an extended review of the 

various alternatives for disseminating 

market data to the public in an effort to 

identify a better model. These 

alternatives were discussed at length in 

the Proposing Release, but each has 

serious weaknesses. The Commission 

particularly is concerned that the 

integrity and reliability of the 

consolidated data stream must not be 

compromised by any changes to the 

market data structure.

For example, although allowing each 

SRO to sell its data separately to 

multiple consolidators may appear at 

first glance to subject the level of fees to 

competitive forces, this conclusion does 

not withstand closer scrutiny. If the 

benefits of a fully consolidated data 

stream are to be preserved, each 

consolidator would need to purchase 

the data of each SRO to assure that the 

consolidator’s data stream in fact 

included the best quotations and most 

recent trade report in an NMS stock. 

Payment of every SRO’s fees would 

effectively be mandatory, thereby 

affording little room for competitive 

forces to influence the level of fees. 

The Commission also has considered 

the suggestion of many in the second 

group of commenters that market data 

fees should be cut back to encompass 

only the costs of the Plans to collect and 

disseminate market data. Under this 

approach, the individual SROs would 

no longer be allowed to fund any 

portion of their operational and 

regulatory functions through market 

data fees.27 Yet, as discussed in the 

Commission’s 1999 concept release on 

77430 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

28Securities Exchange Act Release No. 42208 

(Dec. 9, 1999), 64 FR 70613 (Dec. 17, 1999) 

(‘‘Market Information Release’’).

29See Proposing Release, 69 FR at 11179 (table 

setting forth revenue allocations for 2003).

30Securities Exchange Act Release No. 50700 

(Nov. 18, 2004), 69 FR 71256 (Dec. 8, 2004) (‘‘SRO 

Structure Release’’).

31Securities Exchange Act Release No. 50699 

(Nov. 18, 2004), 69 FR 71126 (Dec. 8, 2004) (‘‘SRO 

Transparency Release’’).

32Section 11A(a)(1)(C)(iii) of the Exchange Act.

33An ‘‘OTC market maker’’ in a stock is defined 

in reproposed Rule 600(b)(52) of Regulation NMS 

as, in general, a dealer that holds itself out as 

willing to buy and sell the stock, otherwise than on 

a national securities exchange, in amounts of less 

than block size (less than 10,000 shares). A block 

positioner in a stock, in contrast, limits its activity 

in the stock to transactions of 10,000 shares or 

greater.

34For ease of reference in this release, the term 

‘‘limit order’’ generally will refer to a nonmarketable order and the term ‘‘marketable order’’

will refer to both market orders and marketable 

limit orders. A non-marketable limit order has a 

limit price that prevents its immediate execution at 

current market prices. Because these orders cannot 

be executed immediately, they generally are 

publicly displayed to attract contra side interest at 

the price. In contrast, a ‘‘marketable limit order’’

has a limit price that potentially allows its 

immediate execution at current market prices. As 

discussed further below, marketable limit orders 

often cannot be filled at current market prices 

because of insufficient liquidity and depth at the 

market price. See infra, text accompanying note 49. 35 Investors generally will know the best quoted 

prices at the time they place an order by referring 

to the consolidated quotation stream for a stock. In 

the interval between order submission and order 

execution, however, quoted prices can change. If 

the order execution price provided by a market 

differs from the best quoted price at order 

submission, it can be particularly difficult for retail 

investors to assess whether the difference was 

attributable to changing quoted prices or to an 

inferior execution by the market. The TradeThrough Rule would help assure, on an order-byorder basis, that markets effect trades at the best 

available prices. 36The Commission has considered the views of 

all commenters in formulating Rule 611 as 

reproposed, as well as the other rules and 

amendments reproposed today.

market data,28 nearly the entire burden 

of collecting and producing market data 

is borne by the individual markets, not 

by the Plans. If, for example, an SRO’s 

systems fail on a high-volume trading 

day and it can no longer provide its data 

to the Plans, investors will suffer the 

consequences of a flawed data stream, 

regardless of whether the Plan is able to 

continue operating.

If the Commission were to limit 

market data fees to cover only Plan 

costs, SRO funding would have been cut 

by $386 million in 2003.29 Given the 

potential harm if vital SRO functions are 

not adequately funded, the Commission 

believes that the level of market data 

fees is most appropriately addressed in 

a context that looks at SRO funding as 

a whole. It therefore has requested 

comment on this issue in its recent 

concept release on SRO structure.30 In 

addition, the recently proposed rules to 

improve SRO transparency would, if 

adopted, assist the public in assessing 

the level and use of market data fees by 

the various SROs.31

In sum, there is inherent tension 

between assuring price transparency for 

investors, which is a fundamental 

objective of the Exchange Act,32 and 

expanding the extent to which market 

forces determine market data fees and 

SRO revenues. Each alternative model 

for data dissemination has its particular 

strengths and weaknesses. The great 

strength of the current model, however, 

is that it benefits investors, particularly 

retail investors, by helping them to 

assess quoted prices at the time they 

place an order and to evaluate the best 

execution of their orders against such 

prices by obtaining data from a single 

source that is highly reliable and 

comprehensive. In the absence of full 

confidence that this benefit would be 

retained if a different model were 

adopted, the Commission has decided to 

repropose such immediate steps as are 

necessary to improve the operation of 

the current model.

II. Trade-Through Rule 

The Commission is reproposing Rule 

611 under Regulation NMS to establish 

protection against trade-throughs for all 

NMS stocks. Rule 611(a)(1) would 

require a trading center (which includes 

national securities exchanges, exchange 

specialists, ATSs, OTC market makers, 

and block positioners)33 to establish, 

maintain, and enforce written policies 

and procedures that are reasonably 

designed to prevent trade-throughs of 

protected quotations and, if relying on 

an exception, that are reasonably 

designed to assure compliance with the 

terms of the exception. Rule 611(a)(2) 

would require a trading center to 

regularly surveil to ascertain the 

effectiveness of its policies and 

procedures and to take prompt action to 

remedy deficiencies in such policies 

and procedures. To qualify for 

protection, a quotation must be 

automated. Rule 600(b)(3) would define 

an automated quotation as one that, 

among other things, is displayed and 

immediately accessible through 

automatic execution. Rule 611 would 

not require market participants to route 

orders to access any manual quotations, 

which generally entail a much slower 

speed of response than automated 

quotations.

Reproposed Rule 611(b) would set 

forth a variety of exceptions to make 

intermarket price protection as efficient 

and workable as possible. These would 

include an intermarket sweep 

exception, which would allow market 

participants simultaneously to access 

multiple price levels at different trading 

centers—a particularly important 

function now that trading in penny 

increments has dispersed liquidity 

across multiple price levels. The 

intermarket sweep exception would 

enable trading centers that receive 

sweep orders to execute those orders 

immediately, without waiting for betterpriced quotations in other markets to be 

updated. In addition, Rule 611 would 

provide exceptions for the quotations of 

trading centers experiencing, among 

other things, a material delay in 

providing a response to incoming orders 

and for flickering quotations with prices 

that have been displayed for less than 

one second. Both exceptions are 

designed to limit the application of Rule 

611 to quotations that are truly 

automated and accessible. 

By strengthening price protection in 

the NMS for quotations that can be 

accessed fairly and efficiently, 

reproposed Rule 611 is designed to 

further the interests of both investors 

who submit displayed limit orders and 

investors who submit marketable 

orders.34 Price protection encourages 

the display of limit orders by increasing 

the likelihood that they will receive an 

execution in a timely manner. Limit 

orders typically establish the best prices 

for an NMS stock. Greater use of limit 

orders would increase market depth and 

liquidity, thereby improving the quality 

of execution for the large market orders 

of institutional investors. Moreover, 

strong intermarket price protection 

would offer greater assurance, on an 

order-by-order basis, to investors who 

submit market orders that their orders in 

fact will be executed at the best prices, 

which can be difficult for investors, 

particularly retail investors, to 

monitor.35 Finally, market orders would 

need to be routed only to quotations that 

are truly accessible.

A. Response to Comments and Basis for 

Reproposed Rule 

Rule 611 as reproposed reflects a 

number of changes to the rule as 

proposed. As discussed below, the 

Commission made these changes in 

response to substantial public comment 

on the proposed rule and on the issues 

arising out of the NMS Hearing that 

were addressed in the Supplemental 

Release. The public submitted more 

than 700 comments addressing the 

trade-through proposal.36 Although the 

comments covered a very wide range of 

matters, they particularly focused on the 

following issues:

(1) Whether an intermarket tradethrough rule is needed to promote fair 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77431

37Nearly all commenters, both those supporting 

and opposing the need for an intermarket tradethrough rule, agreed that the current ITS tradethrough provisions are seriously outdated and in 

need of reform. They particularly focused on the 

problems created by affording equal protection 

against trade-throughs to both automated and 

manual quotations. Reproposed Rule 611 responds 

to these problems by protecting only automated 

quotations.

38Approximately 138 commenters favored a 

trade-through rule that did not include an exception 

allowing market participants to opt-out of the rule. 

Commenters in this group included (1) many 

mutual fund companies and the Investment 

Company Institute; (2) approximately 24 individual 

investors and the Consumer Federation of America 

and the National Association of Individual 

Investors Corporation, (3) floor-based exchanges 

and their members, (4) approximately 29 listed 

companies, (5) a variety of securities industry 

participants, and (6) 12 members of Congress. In 

addition, many commenters supported an opt-out 

exception to a trade-through rule, but varied in the 

extent to which they made clear whether they 

supported a trade-through rule in general. These 

commenters are included in footnote 99 below 

addressing supporters of an opt-out exception.

39See, e.g., Letter from Barbara Roper, Director of 

Investor Protection, Consumer Federation of 

America, to Jonathan G. Katz, Secretary, 

Commission, dated June 17, 2004 (‘‘Consumer 

Federation Letter’’) at 2; Letter from Ari Burstein, 

Associate Counsel, Investment Company Institute, 

to Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘ICI Letter’’) at 7.

40Approximately 242 commenters opposed any 

trade-through rule. Approximately 179 of these 

commenters utilized ‘‘Letter Type C,’’ which 

primarily supported an opt-out exception to the 

proposed rule, but also suggested that no tradethrough rule would be simpler. Letter Type C is 

posted on the Commission’s Internet Web site 

(http://www.sec.gov/rules/proposed.shtml). The 

remaining commenters included securities industry 

participants, particularly electronic markets and 

their participants, a variety of local political and 

community groups and individuals, and 17 

members of Congress.

41See, e.g., Letter from Ellen L.S. Koplow, 

Executive Vice President and General Counsel, 

Ameritrade Holding Corporation, to Jonathan G. 

Katz, Secretary, Commission, dated June 30, 2004 

(‘‘Ameritrade Letter I’’), Appendix at 10; Letter from 

William O’Brien, Chief Operating Officer, Brut LLC, 

to Jonathan G. Katz, Secretary, Commission, dated 

July 29, 2004 (‘‘Brut Letter’’) at 10; Letter from Eric 

D. Roiter, Senior Vice President & General Counsel, 

Fidelity Management and Research Company, to 

Jonathan G. Katz, Secretary, Commission, dated 

June 22, 2004 (‘‘Fidelity Letter I’’) at 11; Letter from 

Edward J. Nicoll, Chief Executive Officer, Instinet 

Group Incorporated, to Jonathan G. Katz, Secretary, 

Commission, dated June 30, 2004 (‘‘Instinet Letter’’) 

at 3, 9 & Exhibit A; Letter from Edward S. Knight, 

The Nasdaq Stock Market, Inc., to Jonathan G. Katz, 

Secretary, Commission, dated July 2, 2004 (‘‘Nasdaq 

Letter II’’) at 6 and Attachment II; Letter from Bruce 

N. Lehmann & Joel Hasbrouck, Organizers, Reg 

NMS Study Group, to Jonathan G. Katz, Secretary, 

Commission (no date) (‘‘NMS Study Group Letter’’) 

at 4; Letter from David Colker, Chief Executive 

Officer & President, National Stock Exchange, to 

Jonathan G. Katz, Secretary, Commission, dated 

June 29, 2004 (‘‘NSX Letter’’) at 3; Letter from Huw 

Jenkins, Managing Director, Head of Equities for the 

Americas, UBS Securities LLC, to Jonathan G. Katz, 

Secretary, Commission, dated June 30, 2004 (‘‘UBS 

Letter’’) at 4.

42See, e.g., Letter from Kim Bang, President & 

Chief Executive Officer, Bloomberg Tradebook LLC, 

to Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘Bloomberg Tradebook Letter’’) at 

10; Fidelity Letter I at 11; Letter from Suhas Daftuar, 

Managing Director, Hudson River Trading, to 

Jonathan G. Katz, Secretary, Commission, dated 

August 13, 2004 (‘‘Hudson River Trading Letter’’) at 

1; Instinet Letter at 14; Nasdaq Letter II at 6 and 

Attachment III.

43 Instinet Letter, Exhibit A; Nasdaq Letter II, 

Attachment II. The Mercatus Center referenced 

several statistical studies in its comment letter and 

concluded that the findings of such studies are 

mixed. Letter from Susan E. Dudley, Director, 

Regulatory Studies Program, Mercatus Center, 

George Mason University, to Jonathan G. Katz, 

Secretary, Commission, dated May 24, 2004 

(‘‘Mercatus Center Letter’’) at 3.

and efficient equity markets, 

particularly for Nasdaq stocks which 

have not been subject to the current ITS 

trade-through provisions;

(2) Whether only automated and 

immediately accessible quotations 

should be given trade-through 

protection and, if so, what is the best 

approach for defining such quotations; 

(3) Whether intermarket protection 

against trade-throughs can be 

implemented in a workable manner, 

particularly for high-volume stocks; 

(4) Whether the proposed exception 

allowing a general opt-out of protected 

quotations is necessary or appropriate, 

particularly if manual quotations are 

excluded from trade-through protection; 

(5) Whether the scope of quotations 

entitled to trade-through protection 

should extend beyond the best bids and 

offers of the various markets; and 

(6) Whether the benefits of an 

intermarket trade-through rule would 

justify its cost of implementation. 

In the following sections, the 

Commission responds to comments on 

the trade-through proposal and 

discusses the basis for its reproposal of 

Rule 611. 

1. Need for Intermarket Trade-Through 

Rule 

Commenters were divided on the 

central issue of whether intermarket 

protection of displayed quotations is 

needed to promote the fairest and most 

efficient markets for investors.37 Many 

commenters strongly supported the 

adoption of a uniform rule for all NMS 

stocks as necessary to protect the best 

displayed prices and encourage the 

public display of limit orders.38 They 

stressed that limit orders are the 

cornerstone of efficient, liquid markets 

and should be afforded as much 

protection as possible. They noted, for 

example, that limit orders typically 

establish the ‘‘market’’ for a stock. In the 

absence of limit orders setting the 

current market price, there would be no 

benchmark for the submission and 

execution of marketable orders. 

Focusing solely on best execution of 

marketable orders (and the interests of 

orders that take displayed liquidity), 

therefore, would miss a critical part of 

the equation for promoting the most 

efficient markets (i.e., the best execution 

of orders that supply displayed liquidity 

and thereby provide public price 

discovery). Commenters supporting the 

need for an intermarket trade-through 

rule also believed that a trade-through 

rule would increase investor confidence 

by helping to eliminate the impression 

of unfairness when an investor’s order 

executes at a price that is worse than the 

best displayed quotation, or when a 

trade occurs at a price that is inferior to 

the investor’s displayed order.39

Other commenters, in contrast, 

opposed any intermarket trade-through 

rule.40 These commenters did not 

believe that such a rule is necessary to 

promote the protection of limit orders, 

the best execution of market orders, or 

efficient markets in general. They 

asserted that, given public availability of 

each market’s quotations and ready 

access by all market participants to such 

quotations, competition among markets, 

a broker’s existing duty of best 

execution, and economic self-interest 

would be sufficient to protect limit 

orders and produce the most fair and 

efficient markets. They therefore 

believed that any trade-through rule 

would be unnecessary and costly. These 

commenters also were concerned that 

any trade-through rule could interfere 

with the ability of competitive forces to 

produce efficient markets, particularly 

for Nasdaq stocks.

Commenters opposed to any tradethrough rule also generally cited a lack 

of empirical evidence justifying the 

need for intermarket protection against 

trade-throughs. They noted, for 

example, that trading in Nasdaq stocks 

has never been subject to an intermarket 

trade-through rule, while trading in 

exchange-listed stocks, particularly 

NYSE stocks, has been subject to the ITS 

trade-through provisions. Given the 

difference in regulatory requirements 

between Nasdaq and NYSE stocks, 

many commenters relied on two factual 

contentions to show that a trade-through 

rule is not needed: (1) Trading in 

Nasdaq stocks currently is more 

efficient than trading in NYSE stocks; 41

and (2) fewer trade-throughs occur in 

Nasdaq stocks than NYSE stocks.42

Based on these factual contentions, 

opposing commenters concluded that a 

trade-through rule is not necessary to 

promote efficiency or to protect the best 

displayed prices.

A few commenters submitted 

empirical data to support the claim that 

trading in Nasdaq stocks is more 

efficient than trading in NYSE stocks.43

77432 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

44Nasdaq and Instinet based their tables on 

statistics derived from the reports (‘‘Dash 5 

Reports’’) on order execution quality made public 

by markets pursuant to Exchange Act Rule 11Ac1–

5 (proposed to be redesignated as Rule 605 under 

Regulation NMS). Their source for these reports is 

Market Systems, Inc. (‘‘MSI’’), a private vendor that 

collects the reports of all markets each month and 

includes them in a searchable database. MSI also is 

the source of the Dash 5 Reports used in the staff 

analyses. 45Memorandum to File, from Office of Economic 

Analysis, dated December 15, 2004 (comparative 

analysis of execution quality for NYSE and 

NASDAQ stocks based on a matched sample of 

stocks) (‘‘Matched Pairs Study’’); Memorandum to 

File, from Division of Market Regulation, dated 

December 15, 2004 (comparative analysis of Rule 

11Ac1–5 statistics by S&P Index) (‘‘S&P Index 

Study’’). The Matched Pair Study and S&P Index 

Study have been placed in Public File No. S7–10–

04 and are available for inspection on the 

Commission’s Internet Web site (http://

www.sec.gov). 46Matched Pairs Study, Tables 4–10; S&P Index 

Study, Tables 2–9. 47The effective spread is a useful measure of 

trading costs, particularly for small order sizes, 

because it reflects the prices actually received by 

investors when compared to the best quotes at the 

time a market received an order. Consequently, 

unlike the quoted spread, the effective spread 

reflects any cost to investors caused by movement 

in prices during a delay between receipt of an order 

and execution of an order. In other words, the 

effective spread penalizes slow markets for failing 

to execute trades at their quoted prices at the time 

they received an order. It therefore provides an 

appropriate criterion with which to compare 

execution quality between automated and manual 

markets for comparable stocks, order types, and 

order sizes. As discussed below, however, effective 

spread statistics do not capture trading costs that 

are attributable to low fill rates—the failure to 

obtain an execution—for marketable limit orders.

48S&P Index Study, Table 1.

49Matched Pairs Study, Table 10; S&P Index 

Study, Tables 7, 9.

50An overwhelming majority of market orders in 

Nasdaq stocks are executed by market-making 

dealers pursuant to agreement with their 

correspondent or affiliated brokers.

51Matched Pairs Study at 1.

52Matched Pairs Study, Tables 4, 7; S&P Index 

Study, Tables 2, 4, 6, 8.

53See, e.g., Instinet Letter at 9; Nasdaq Letter II 

at 6. In addition to effective spread statistics, 

Instinet submitted statistics indicating that 

Specifically, they submitted tables 

asserting that effective spreads in 

Nasdaq stocks in the S&P 500 are 

significantly narrower than effective 

spreads in NYSE stocks in the S&P 

500.44 To help assess and respond to the 

views of commenters on market 

efficiency, the Commission staff 

analyzed Rule 11Ac1–5 reports and 

other trading data to evaluate the 

markets for Nasdaq and NYSE stocks.45

The staff studies indicate that the 

execution quality statistics submitted by 

commenters are flawed. The claimed 

large and systematic disparities between 

Nasdaq and NYSE effective spreads 

disappear when an analysis of execution 

quality more appropriately controls for 

differences in stocks, order types, and 

order sizes.46 The staff studies reveal 

that both the market for Nasdaq stocks 

and the market for NYSE stocks have 

significant strengths. But, as discussed 

below, both markets also have 

weaknesses that could be reduced by 

strengthened protection against tradethroughs.

First, the effective spread analyses 

submitted by commenters do not, in a 

number of respects, reflect appropriately 

the comparative trading costs in Nasdaq 

and NYSE stocks.47 They were 

presented in terms of ‘‘cents-per-share’’

and therefore failed to control for the 

varying level of stock prices between 

Nasdaq stocks and NYSE stocks in the 

S&P 500. Lower priced stocks naturally 

will tend to have lower spreads in terms 

of cents-per-share than higher priced 

stocks, even when such cents-per-share 

spreads constitute a larger percentage of 

stock price and therefore represent 

trading costs for investors that consume 

a larger percentage of their investment. 

By using cents-per-share statistics, 

commenters did not adjust for the fact 

that the average prices of Nasdaq stocks 

are significantly lower than the average 

prices of NYSE stocks. For example, the 

average price of Nasdaq stocks in the 

S&P 500 in January 2004 was $34.14, 

while the average price of NYSE stocks 

was $41.32.48

The effective spread analyses 

submitted by commenters also were 

weakened by their failure to address the 

much lower fill rates of orders in 

Nasdaq stocks than orders in NYSE 

stocks. The commenters submitted 

‘‘blended’’ statistics that encompassed 

both market orders and marketable limit 

orders. The effective spread statistics for 

these order types are not comparable, 

however, because market orders do not 

have a limit price that precludes their 

execution at prices inferior to the 

prevailing market price at time of order 

receipt. In contrast, the limit price of 

marketable limit orders often precludes 

an execution, particularly when there is 

a lack of liquidity and depth at the 

prevailing market price. For example, 

the fill rates for marketable limit orders 

in Nasdaq stocks generally are less than 

75%, and often fall below 50% for larger 

order sizes.49

Accordingly, investors must accept 

trade-offs when deciding whether to 

submit market orders or marketable 

limit orders (particularly when the limit 

price equals or is very close to the 

current market price). Use of a limit 

price generally assures a narrower 

spread by precluding an execution an 

inferior price. By precluding an 

execution, however, the limit price may 

cause the investor to ‘‘miss the market’’

if prices move away (for example, if 

prices rise when an investor is 

attempting to buy). Effective spreads for 

marketable limit orders therefore 

represent trading costs that are 

conditional on execution, while 

effective spreads for market orders 

much more completely reflect the entire 

trading cost for a particular order. 

Market orders represent only 

approximately 14% of the blended flow 

of market and marketable limit orders in 

Nasdaq stocks (reflecting the fact that 

ECNs now dominate Nasdaq order flow 

and limit orders represent the vast 

majority of ECN order flow).50 In 

contrast, market orders represent 

approximately 36% of the blended order 

flow in NYSE stocks.51 Accordingly, the 

effective spread statistics for marketable 

limit orders, and particularly for orders 

in Nasdaq stocks, must be considered in 

conjunction with the fill rate for such 

orders—a narrow spread is good, but the 

benefits are greatly limited if investors 

are unable to obtain an execution at that 

spread. The analyses presented by the 

commenters, however, did not address 

the respective fill rates for Nasdaq 

stocks and NYSE stocks or reflect the 

inherent differences in measuring the 

trading costs of market orders and 

marketable limit orders.

The analyses prepared by 

Commission staff are designed to 

provide appropriate evaluations of 

comments on the efficiency of trading in 

Nasdaq and NYSE stocks. In particular, 

they are more finely tuned to evaluate 

trading for different types of stocks with 

varying trading volume, different types 

of orders, and different sizes of orders. 

These analyses indicate that the markets 

for Nasdaq and NYSE stocks each have 

weaknesses that an intermarket price 

protection rule could help address. For 

example, the effective spread statistics 

for large, electronically-received market 

orders in NYSE stocks show significant 

‘‘slippage’’—the amount by which 

orders are executed at prices inferior to 

the national best bid or offer (‘‘NBBO’’) 

at the time of order receipt.52 Slippage 

often results in effective spreads for 

large orders that are many times wider 

than the effective spreads for small 

orders in the same NYSE stocks. By 

protecting automated quotations, the 

reproposed Trade-Through Rule should 

enhance the depth and liquidity 

available for large, electronic orders in 

NYSE stocks.

For Nasdaq stocks, the Rule 11Ac1–5 

statistics reveal very low fill rates for 

larger sizes of marketable limit orders 

(e.g., 2000 shares or more), which 

generally fall below 50% for most 

Nasdaq stocks. Contrary to the assertion 

of some commenters,53 certainty of 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77433

combined market and marketable limit orders in 

Nasdaq stocks were more likely to be executed at 

or inside the NBBO than such orders in NYSE 

stocks. Instinet Letter, Table I–C. These statistics, 

however, only reflect orders that in fact receive an 

execution—not the large volume of orders in 

Nasdaq stocks that fail to receive any execution at 

all.

54Some commenters asserted that the large 

number of limit orders in Nasdaq stocks indicates 

that sufficient incentives exist for the placement of 

limit orders in such stocks. See, e.g., Instinet Letter 

at 11; Letter from Thomas N. McManus, Managing 

Director & Counsel, Morgan Stanley & Co. 

Incorporated, to Jonathan G. Katz, Secretary, 

Commission, dated August 19, 2004 (‘‘Morgan 

Stanley Letter’’) at 14. Strengthened intermarket 

trade-through protection, however, is designed to 

improve the quality of limit orders in a stock, 

particularly their displayed size, and thereby 

promote greater depth and liquidity. This goal is 

not achieved, for example, by a large number of 

limit orders with small sizes and high cancellation 

rates.

55Memorandum to File, from Office of Economic 

Analysis, dated December 15, 2004 (analysis of 

volatility for stocks switching from NASDAQ to 

NYSE) (‘‘Volatility Study’’). The Volatility Study 

has been placed in Public File No. S7–10–04 and 

is available for inspection on the Commission’s 

Internet Web site (http://www.sec.gov).

56 Volatility Study at 1.

57See, e.g., Bloomberg Tradebook Letter at 10; 

Fidelity Letter I at 11; Hudson River Trading Letter 

at 1; Instinet Letter at 14; Nasdaq Letter II at 6 and 

Attachment III.

58Letter from Kevin J. P. O’Hara, Chief 

Administrative Officer & General Counsel, 

Archipelago Holdings, Inc., to Jonathan G. Katz, 

Secretary, Commission, dated September 24, 2004 

(‘‘ArcaEx Letter’’) at 3.

59Memorandum to File, from Office of Economic 

Analysis, dated December 15, 2004 (analysis of 

trade-throughs in Nasdaq and NYSE issues) 

(‘‘Trade-Through Study’’). The Trade-Through 

Study has been placed in Public File No. S7–10–

04 and is available for inspection on the 

Commission’s Internet Web site (http://

www.sec.gov). To eliminate false trade-throughs, the 

staff calculated trade-through rates using a 3-second 

window—a reference price must have been 

displayed one second before a trade and still have 

been displayed one second after a trade. In 

addition, the staff eliminated quotations displayed 

by the American Stock Exchange LLC (‘‘Amex’’) 

from the analysis of Nasdaq stocks because they 

were manual quotations. Finally, the staff used the 

time of execution of a trade, if one was given, rather 

than time of the trade report itself. This 

methodology was designed to eliminate manual 

trades, such as block trades, that might not be 

reported for several seconds after the trade was 

effected manually.

60Trade-Through Study, Tables 4, 11.

61 Id., Tables 3, 10.

62 Id., Tables 4, 11.

63 Id., Table 11.

64See supra, note 35 (discussion of difficulty for 

investors to monitor whether their order execution 

prices equal the best quoted prices at the time of 

order execution).

65 In October 2004, there were 3.9 million average 

daily trades reported in Nasdaq stocks. Source: 

http://www.nasdaqtrader.com. The average tradethrough rate of 2.5% for Nasdaq stocks yields 

Continued

execution clearly is not a strength of the 

current market for Nasdaq stocks. 

Certainty of a fast response is a strength, 

but much of the time the response to 

large orders will be a ‘‘no fill’’ at any 

given trading center. The reproposed 

Trade-Through Rule is designed to 

enhance depth and liquidity and 

thereby improve the execution quality 

of large orders in Nasdaq stocks.54

Effective spread statistics do not, of 

course, reflect all types of trading costs. 

They focus on the execution price of 

individual orders in comparison with 

the best quoted prices at the time orders 

are received. As a result, they do not 

capture trading costs that are associated 

with the short-term movement of quoted 

prices, or volatility. To further assist the 

Commission in evaluating the views of 

commenters, Commission staff also has 

analyzed short-term volatility for 

trading in Nasdaq and NYSE stocks.55

This analysis particularly focuses on 

transitory volatility—short-term 

fluctuations away from the fundamental 

or ‘‘true’’ value of a stock. Transitory 

volatility should be distinguished from 

fundamental volatility—price 

fluctuations associated with factors 

independent of market structure, such 

as earnings changes and other economic 

determinants of stock prices. The staff 

analysis found that transitory volatility 

is significantly higher for Nasdaq stocks 

than for NYSE stocks.56 Excessive 

transitory volatility indicates a shortage 

of liquidity. Such volatility may provide 

benefits in the form of profitable trading 

opportunities for short-term traders or 

market makers, but these benefits come 

at the expense of other investors, who 

would be buying at artificially high or 

selling at artificially low prices. Retail 

investors, in particular, tend to be 

relatively uninformed concerning shortterm price movements and are apt to 

bear the brunt of the trading costs 

associated with excessive transitory 

volatility. The reproposed TradeThrough Rule, by promoting greater 

depth and liquidity, is designed to help 

reduce excessive transitory volatility in 

Nasdaq stocks.

The second principal factual 

contention of commenters opposed to a 

trade-through rule is premised on the 

claim that there are fewer tradethroughs in Nasdaq stocks, which are 

not covered by any trade-through rule, 

than in NYSE stocks, which are covered 

by the ITS trade-through provisions.57

One commenter asserted that, outside 

the exchange-listed markets, 

competition alone had been sufficient to 

create a ‘‘no-trade through zone.’’58 To 

respond to these claims, the 

Commissions staff examined public 

quotation and trade data to analyze the 

incidence of trade-throughs for Nasdaq 

and NYSE stocks.59 It found that the 

overall trade-through rates for Nasdaq 

stocks and NYSE stocks were, 

respectively, 7.9% and 7.2% of the total 

volume of traded shares.60 When 

considered as a percentage of number of 

trades, the overall trade-throughs rate 

for both Nasdaq and NYSE stocks was 

2.5%. In addition, the staff analysis 

found that the amount of the tradethroughs was significant—2.3 cents per 

share on average for Nasdaq stocks and 

2.2 cents per share for NYSE stocks.61

The staff analysis also revealed that a 

large volume of block transactions 

(10,000 shares or greater) trade through 

displayed quotations. Block transactions 

represent approximately 50% of total 

trade-through volume for both Nasdaq 

and NYSE stocks.62 Importantly, many 

block transactions currently are not 

subject to the ITS trade-through 

provisions that apply to exchange-listed 

stocks. Broker-dealers that act solely as 

block positioners are not covered by the 

ITS trade-through provisions if they 

print their trades in the over-the-counter 

(‘‘OTC’’) market. In addition to not 

covering the trades of block positioners, 

the ITS trade-through provisions 

include an exception for 100-share 

quotations. They therefore often may 

fail to protect the small orders of retail 

investors. When block trade-throughs 

and trade-throughs of 100-share 

quotations are eliminated, the overall 

trade-through rate for NYSE stocks is 

reduced from 7.2% to approximately 

2.3% of total share volume.63 The two 

gaps in ITS coverage therefore account 

for most of the trade-through volume in 

NYSE stocks. The reproposed TradeThrough Rule, by closing these gaps in 

protection against trade-throughs, 

would establish much stronger price 

protection than the ITS provisions.

In sum, relevant data supports the 

need for an intermarket rule to 

strengthen price protection and improve 

the quality of trading in both Nasdaq 

and exchange-listed stocks. The 

arguments of some commenters that 

competitive forces alone are sufficient to 

achieve these objectives fail to take into 

account two structural problems—

principal/agent conflicts of interest and 

‘‘free-riding’’ on displayed prices. 

Agency conflicts occur when brokers 

may have incentives to act otherwise 

than in the best interest of their 

customers. Customers, particularly retail 

investors, may have difficulty 

monitoring whether their individual 

orders miss the best displayed prices at 

the time they are executed.64 Given the 

large number of trades that fail to obtain 

the best displayed prices (e.g., 

approximately 1 in 40 trades for both 

Nasdaq and NYSE stocks, or 

approximately 98,000 trades per day in 

Nasdaq stocks),65 the Commission is 

77434 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

average daily trade-throughs of approximately 

98,000.

66Proposing Release, 69 FR at 11140. 67Hearing Tr. at 90–92, 94–97, 120.

68Hearing Tr. at 57–58, 67, 142–144, 157–158.

69Supplemental Release, 69 FR at 30142–30144.

70See, e.g., Ameritrade Letter I at 8; Letter from 

Lou Klobuchar Jr., President and Chief Brokerage 

Officer, E*TRADE Financial Corporation, to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘E*Trade Letter’’) at 6; ICI Letter at 

12; Nasdaq Letter II at 9, 14; Letter from Marc 

Lackritz, President, Securities Industry Association, 

to Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘SIA Letter’’) at 15.

71See, e.g., Letter from John J. Wheeler, Vice 

President, Director of U.S. Equity Trading, 

American Century Investment Management Inc., to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘American Century Letter’’) at 3; 

concerned that many of the investors 

that ultimately received the inferior 

price on these trades may not be aware 

that their orders did not, in fact, obtain 

the best price. The reproposed TradeThrough Rule would backstop a broker’s 

duty of best execution by prohibiting 

the practice of executing orders at 

inferior prices, absent an applicable 

exception.

Just as importantly, even when market 

participants act in their own economic 

self-interest, or brokers act in the best 

interests of their customers, they may 

deliberately choose, for various reasons, 

to bypass (i.e., not protect) limit orders 

with the best displayed prices. For 

example, an institution may be willing 

to accept a dealer’s execution of a 

particular block order at a price outside 

the NBBO, thereby transferring the risk 

of any further price impact to the dealer. 

Market participants that execute orders 

at inferior prices without protecting 

displayed limit orders are effectively 

‘‘free-riding’’ on the price discovery 

provided by those limit orders. 

Displayed limit orders benefit all market 

participants by establishing the best 

prices, but, when bypassed, do not 

themselves receive a benefit, in the form 

of an execution, for providing this 

public good. This economic externality, 

in turn, creates a disincentive for 

investors to display limit orders, 

particularly limit orders of any 

substantial size.

As demonstrated by the current rate of 

trade-throughs of the best quotations in 

Nasdaq and NYSE stocks, these 

structural problems often can lead to 

executions at prices that are inferior to 

displayed quotations, meaning that limit 

orders are being bypassed. The frequent 

bypassing of limit orders can cause 

fewer limit orders to be placed. The 

Commission therefore preliminarily 

believes that the reproposed TradeThrough Rule is needed to encourage 

greater use of limit orders. The more 

limit orders available at better prices 

and greater size, the more liquidity 

available to fill incoming marketable 

orders. Increased liquidity, in turn, 

could lead market participants to 

interact more often with displayed 

orders, which would lead to greater use 

of limit orders, and thus begin the cycle 

again. The end result should be an NMS 

that more fully meets the needs of a 

broad spectrum of investors, 

particularly the long-term investors, as 

opposed to short-term traders, that 

benefit most from improved market 

depth and liquidity. 

2. Limiting Protection to Automated and 

Accessible Quotations 

The trade-through proposal sought to 

strengthen protection against tradethroughs, while also addressing 

problems posed by the inherent 

differences in quotations displayed by 

automated markets, which are 

immediately accessible, and quotations 

displayed by manual markets, which are 

not. The proposal included an exception 

that would have allowed automated 

markets to trade through manual 

markets, but only up to certain amounts 

that varied depending upon the price of 

the security. Under the proposal, a 

market would be classified as ‘‘manual’’

if it did not provide for an immediate 

automated response to all incoming 

orders attempting to access its displayed 

quotations.66

At the NMS Hearing, a significant 

portion of the discussion of the tradethrough proposal addressed issues 

relating to quotations of automated and 

manual markets. Representatives of two 

floor-based exchanges announced their 

intent to establish ‘‘hybrid’’ trading 

facilities that would offer automatic 

execution of orders seeking to interact 

with their displayed quotations, while 

at the same time maintaining a 

traditional floor.67 These representatives 

acknowledged the difficulties posed in 

developing an efficient hybrid market, 

but emphasized that they were 

committed to developing such facilities 

and that such facilities were likely to 

become operational prior to any 

implementation of Regulation NMS.

Other panelists at the NMS Hearing 

strongly believed that manual 

quotations should not receive any 

protection against trade-throughs and 

that the proposed trade-through 

amounts should be eliminated.68 They 

noted, however, that existing order 

routing technologies are capable of 

identifying, on a quote-by-quote basis, 

indications from a market that a 

particular quotation is not immediately 

and automatically accessible (i.e., is a 

manual quotation). Using this 

functionality, a trade-through rule could 

classify individual quotations as 

automated or manual, rather than 

classifying an entire market as manual 

solely because it displayed manual 

quotations on occasion.

To give the public a full opportunity 

to comment on these issues, the 

Supplemental Release described the 

developments at the NMS Hearing and 

requested comment on whether a tradethrough rule should protect only 

automated quotations and whether the 

rule should adopt a ‘‘quote-by-quote’’

approach to identifying protected 

quotations.69 The Supplemental Release 

also requested comment on the 

requirements for an automated 

quotation, including whether the rule 

should impose a maximum response 

time, such as one second, on the total 

time for a market to respond to an order 

in an automated manner. Comment also 

was requested on mechanisms for 

enforcing compliance with the 

automated quotation requirements.

Nearly all commenters believed that 

only automated quotations should 

receive protection against tradethroughs and that therefore the 

proposed limitation on trade-through 

amounts for manual markets should be 

eliminated.70 The Commission agrees. 

The reproposed Trade-Through Rule 

would protect only those quotations that 

are immediately and automatically 

accessible. Providing protection to 

manual quotations, even limited to 

trade-throughs beyond a certain amount, 

potentially would lead to undue delays 

in the routing of investor orders, thereby 

outweighing the benefits of price 

protection. If the Trade-Through Rule 

were adopted, investors would have the 

choice of whether to access a manual 

quotation and wait for a response or to 

access an automated quotation with an 

inferior price and obtain an immediate 

response. Moreover, those who route 

limit orders would be able to control 

whether their orders are protected by 

evaluating the extent to which various 

trading centers display automated 

versus manual quotations.

Commenters expressed differing 

views, however, on the appropriate 

standards for automated quotations and 

on the standards that should govern 

‘‘hybrid’’ markets—those that display 

both automated and manual quotations. 

These issues are discussed below.

a. Standards for Automated 

Quotations. Nearly all commenters 

addressing the issue believed that only 

quotations that are truly firm and fully 

accessible should qualify as 

‘‘automated.’’ 71 To achieve this goal, 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77435

Letter from C. Thomas Richardson, Citigroup Global 

Markets, Inc., to Jonathan G. Katz, Secretary, 

Commission, dated July 20, 2004 (‘‘Citigroup 

Letter’’) at 6–7; Letter from Gary Cohn, Managing 

Director, Goldman, Sachs & Co., to Jonathan G. 

Katz, Secretary, Commission, dated July 19, 2004 

(‘‘Goldman Sachs Letter’’) at 4–5; ICI Letter at 13; 

Morgan Stanley Letter at 7; SIA Letter at 6.

72See, e.g., Ameritrade Letter I at 6; Bloomberg 

Tradebook Letter at 13; Letter from Kenneth R. 

Leibler, Chairman, Boston Stock Exchange, Inc., to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘BSE Letter’’) at 7; Consumer 

Federation Letter at 3; Letter from David A. Herron, 

Chief Executive Officer, Chicago Stock Exchange, to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘CHX Letter’’) at 7–8; Citigroup 

Letter at 7; Goldman Sachs Letter at 2; ICI Letter at 

3, 10; Nasdaq Letter II at 3, 13; Letter from John 

Martello, Managing Director, Tower Research 

Capital LLC, to Jonathan G. Katz, Secretary, 

Commission, dated June 30, 2004 (‘‘Tower Research 

Letter’’) at 5.

73See, e.g., American Century Letter at 3, Letter 

from Salvatore F. Sodano, Chairman & Chief 

Executive Officer, American Stock Exchange LLC, 

to Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘Amex Letter’’), Exhibit A at 6; Brut 

Letter at 7; Letter from Matt D. Lyons, Capital 

Research and Management Company, to Jonathan G. 

Katz, Secretary, Commission, dated June 28, 2004 

(‘‘Capital Research Letter’’) at 2; Fidelity Letter I at 

8; Instinet Letter at 4; Letter from John H. Bluher, 

Executive Vice President & General Counsel, Knight 

Trading Group, to William H. Donaldson, 

Chairman, Commission, dated April 15, 2004 

(‘‘Knight Letter’’) at 5; Letter from James T. Brett, 

J.P. Morgan Securities Inc., to Jonathan G. Katz, 

Secretary, Commission, dated July 8, 2004 (‘‘JP 

Morgan Letter’’) at 3; Morgan Stanley Letter at 7; 

Letter from Darla C. Stuckey, Corporate Secretary, 

New York Stock Exchange, Inc., to Jonathan G. 

Katz, Secretary, Commission, dated July 2, 2004 

(‘‘NYSE Letter’’), Attachment at 3; Letter from David 

Humphreville, President, The Specialist 

Association, to Jonathan G. Katz, Secretary, 

Commission, dated June 30, 2004 (‘‘Specialist 

Assoc. Letter’’) at 8; Letter from Lisa M. Utasi, 

President, et al., The Security Traders Association 

of New York, Inc., to Jonathan G. Katz, Secretary, 

Commission, dated June 30, 2004 (‘‘STANY Letter’’) 

at 4; Letter from George U. Sauter, Managing 

Director, The Vanguard Group, Inc., to Jonathan G. 

Katz, Secretary, Commission, dated July 14, 2004 

(‘‘Vanguard Letter’’) at 4.

74Cf. Ameritrade Letter I at 6 (one second 

response time is appropriate); CHX Letter at 8 

(receive, execute, and report back within one 

second); Citigroup Letter at 7 (turnaround time of 

no more than one second); Goldman Sachs Letter 

at 4 (orders executed or cancelled within not more 

than one second).

75As discussed further in section II.B.3 below, a 

trading center utilizing the material delay exception 

would be required to establish specific and 

objective parameters for its use of the exception in 

its policies and procedures.

76See, e.g., Amex Letter at 5; Letter from William 

J. Brodsky, Chairman & Chief Executive Officer, 

Chicago Board Options Exchange, Inc., to Jonathan 

G. Katz, Secretary, Commission, dated July 1, 2004 

(‘‘CBOE Letter’’) at 3; CHX Letter at 7; NYSE Letter 

at 4.

77Amex Letter, Appendix A at 4.

they suggested that, at a minimum, the 

market displaying an automated 

quotation should be required to provide 

a functionality for an incoming order to 

receive an immediate and automated 

(i.e., without human intervention) 

execution up to the full displayed size 

of the quotation. In addition, they 

believed the market should provide an 

immediate and automated response to 

the sender of the order indicating 

whether the order had been executed (in 

full or in part) and an immediate and 

automated updating of the quotation. A 

number of commenters advocated a 

specific time standard for distinguishing 

between manual and automated 

quotations, ranging from one second 

down to 250 milliseconds.72 Other 

commenters did not believe the 

definition of automated quotation 

should include a specific time standard, 

generally because setting a specific 

standard might discourage innovation 

and become a ‘‘ceiling’’ on market 

performance.73

The Commission has included in the 

reproposal a definition of automated 

quotation that incorporates the three 

elements suggested by commenters: (1) 

Acting on an incoming order, (2) 

responding to the sender of the order, 

and (3) updating the quotation. In 

particular, reproposed Rule 600(b)(3) 

would require that the trading center 

displaying an automated quotation must 

provide an ‘‘immediate-or-cancel’’

(‘‘IOC’’) functionality for an incoming 

order to execute immediately and 

automatically against the quotation up 

to its full size, and for any unexecuted 

portion of such incoming order to be 

cancelled immediately and 

automatically without being routed 

elsewhere. The trading center also must 

immediately and automatically respond 

to the sender of an IOC order. To qualify 

as ‘‘automatic,’’ no human discretion 

exercised after the time an order is 

received would be permissible in 

determining any action taken with 

respect to an order. Trading centers 

would be required to offer this IOC 

functionality only to customers that 

request immediate action and response 

by submitting an IOC order. Customers 

therefore would have the choice of 

whether to require an immediate 

response from the trading center, or to 

allow the market to take further action 

on the order (such as by routing the 

order elsewhere, seeking additional 

liquidity for the order, or displaying the 

order). Finally, trading centers would be 

required to immediately and 

automatically update their automated 

quotations to reflect any change to their 

material terms (such as a change in 

price, size, or ‘‘automated’’ status). 

The definition of automated quotation 

does not set forth a specific time 

standard for responding to an incoming 

order. The Commission agrees with 

commenters that the standard should 

simply be ‘‘immediate’’—i.e., a trading 

center’s systems should provide the 

fastest response possible without any 

programmed delay. Nevertheless, the 

Commission also is concerned that 

trading centers with well-functioning 

systems should not be unnecessarily 

slowed down waiting for responses from 

a trading center that is experiencing a 

systems problem. Consequently, rather 

than fixing a specific time standard that 

may become obsolete as systems 

improve over time, Rule 611(b)(1) 

would address the problem of slow 

trading centers by providing an 

exception for quotations displayed by 

trading centers that are experiencing, 

among other things, a material delay in 

responding to incoming orders. Given 

current industry conditions, the 

Commission believes that repeatedly 

failing to respond within one second 

after receipt of an order would 

constitute a material delay.74

Accordingly, a trading center would act 

reasonably in the current trading 

environment if it bypassed the 

quotations of another trading center that 

had repeatedly failed to respond to 

orders within a one-second time frame 

(after adjusting for any potential delays 

in transmission not attributable to the 

other trading center).75 This ‘‘self-help’’

remedy, discussed further in sections 

II.A.3 and II.B.3 below, would give 

trading centers needed flexibility to deal 

with a trading center that is 

experiencing systems problems, rather 

than forcing smoothly-functioning 

trading centers to slow down for a 

problem market.

b. Standards for Automated Trading 

Centers. The trade-through proposal 

would have classified a market as 

manual if it did not provide automated 

access to all orders seeking access to its 

displayed quotations. Many commenters 

responded positively to the concept of 

allowing hybrid markets to display both 

automated and manual quotations that 

was raised at the NMS Hearing and 

discussed in the Supplemental Release. 

Most national securities exchanges 

believed that focusing on whether 

individual quotations are automated or 

manual would permit hybrid markets to 

function, thereby expanding the range of 

trading choices for investors.76 For 

example, Amex stated that hybrid 

markets would offer investors the choice 

to utilize auction markets when 

advantageous for them to do so, while 

at the same time offering automatic 

execution to those investors desiring 

speed and certainty of a fast response.77

A majority of other commenters also 

believed that the application of any 

trade-through rule should depend on 

whether a particular quotation is 

77436 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

78See, e.g., Letter from Joseph M. Velli, Senior 

Executive Vice President, The Bank of New York, 

to Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘BNY Letter’’) at 2; E*Trade Letter 

at 6; ICI Letter at 7, 13; Morgan Stanley Letter at 

6.

79See, e.g., Citigroup Letter at 6; ICI Letter at 13; 

Morgan Stanley Letter at 7; Nasdaq Letter II at 13–

14;Vanguard Letter at 5.

80 ICI Letter at 13.

81See, e.g., Hudson River Trading Letter at 3; 

Instinet Letter at 18–19; Morgan Stanley Letter at 

11–12; Letter from Edward S. Knight, The Nasdaq 

Stock Market, Inc., to Jonathan G. Katz, Secretary, 

Commission, dated September 29, 2004 (‘‘Nasdaq 

Letter III’’) at 3.

82Morgan Stanley Letter at 12.

83 Instinet Letter at 17.

84Hudson River Trading Letter at 3. This 

commenter also raised a number of quite specific 

questions concerning the operation of an 

intermarket trade-through rule. To address these 

detailed order sequencing and response scenarios, 

trading centers would be entitled to adopt policies 

and procedures that reasonably resolve the practical 

difficulties of handling fast-arriving orders in a fair 

and orderly fashion. For example, if a trading center 

routed orders to other markets to access the full size 

of protected quotations under the reproposed 

Trade-Through Rule, it would be allowed to 

continue trading without regard to a particular 

market’s quotations until it has received a response 

from such market. With respect to concern that 

traders would not be able to control the routing of 

their own orders if markets are required to route out 

to other markets, a trader’s use of the IOC 

functionality specified in Rule 600(b)(3) would 

preclude the first market from routing to other 

markets.

85Nasdaq Letter III at 3–4.

86See, e.g., Brut Letter at 10; Citigroup Letter at 

10; E*Trade Letter at 8; Goldman Sachs Letter at 7.

automated.78 They believed that such a 

rule would achieve the benefits of 

encouraging limit orders and improving 

market depth and liquidity, while 

avoiding indirectly mandating a 

particular market structure.

Although generally supportive of the 

concept of hybrid markets, several 

commenters expressed concern about 

how the ‘‘quote-by-quote’’ approach to 

protected quotations would operate in 

practice.79 The ICI noted that ‘‘[w]e are 

concerned that if it is left completely up 

to an individual market’s discretion 

when a quote is ‘automated’ or manual, 

that market could base its decision on 

what is in the best interests of that 

market and its members, as opposed to 

the best interests of investors and other 

market participants.’’ 80 These 

commenters suggested that the 

Commission should provide clear 

guidelines as to when and how a market 

could switch its quotations from 

automated to manual, and vice versa, so 

as to prevent abuse by the market.

After considering the views of 

commenters, the Commission has 

decided to include in the reproposal an 

approach that would offer flexibility for 

a hybrid market to display both 

automated and manual quotations, but 

only when such a market meets basic 

standards that promote fair and efficient 

access by the public to the market’s 

automated quotations. This approach is 

designed to allow markets to offer a 

variety of trading choices to investors, 

but without requiring other markets and 

market participants to route orders to a 

hybrid market with quotations that are 

not truly accessible. Reproposed Rule 

600(b)(4) therefore sets forth 

requirements for a trading center to 

qualify as an ‘‘automated trading 

center.’’ Unless a trading center met 

these requirements, none of its 

quotations could qualify as automated, 

and therefore protected, quotations. 

To qualify as an automated trading 

center, the trading center must have 

implemented such systems and rules as 

are necessary to render it capable of 

displaying quotations that meet the 

action, response, and updating 

requirements set forth in the definition 

of an automated quotation. Further, the 

trading center must identify all 

quotations other than automated 

quotations as manual quotations, and 

must immediately identify its 

quotations as manual quotations 

whenever it has reason to believe that it 

is not capable of displaying automated 

quotations. These requirements are 

designed to enable other trading centers 

readily to determine whether a 

particular quotation displayed by a 

hybrid trading center is protected by the 

reproposed Trade-Through Rule. 

Finally, an automated trading center 

must adopt reasonable standards 

limiting when its quotations change 

from automated quotations to manual 

quotations, and vice versa, to 

specifically defined circumstances that 

promote fair and efficient access to its 

automated quotations and are consistent 

with the maintenance of fair and orderly 

markets.

These requirements are designed to 

promote efficient interaction between a 

hybrid market and other trading centers. 

The requirement that automated 

quotations cannot be switched on and 

off except in specifically defined 

circumstances is particularly intended 

to assure that hybrid markets do not 

give their members, or anyone else, 

overbroad discretion to control the 

automated or manual status of the 

trading center’s quotations, which 

potentially could disadvantage less 

favorably situated market participants. 

Changes from automated to manual 

quotations, and vice versa, must to 

subject to specific, enforceable 

limitations as to the timing of switches. 

For a trading center to qualify as 

entitled to display any protected 

quotations, the public in general must 

have fair and efficient access to a 

trading center’s quotations. 

3. Workable Implementation of 

Intermarket Trade-Through Protection 

Several commenters expressed 

concern that the proposed trade-through 

rule could not be implemented in a 

workable manner, particularly for highvolume stocks.81 Morgan Stanley, for 

example, asserted that an inefficient 

trading center might have inferior 

systems that would delay routed orders 

and potentially diminish their quality of 

execution.82 Instinet emphasized that 

protecting a market’s quotations 

‘‘confers enormous power on a market 

* * * Such power can and will be 

abused either directly (e.g., by quoting 

slower than executing orders) or 

indirectly (e.g., not investing in more 

than minimum system capacity or 

redundancy).’’ 83 Hudson River Trading 

noted that markets sometimes 

experience temporary systems problems 

and questioned how a trade-through 

rule would handle these scenarios.84

Nasdaq observed that quotations in 

many Nasdaq stocks are updated more 

than two times per second. It said that 

these frequent changes could lead to 

many false indications of trade-throughs 

and that eliminating these ‘‘false 

positives’’ would greatly reduce the 

percentage of transactions subject to a 

trade-through rule.85 Finally, many 

commenters noted that market 

participants need the ability to sweep 

multiple price levels simultaneously at 

different trading centers. They 

emphasized that a trade-through rule 

should accommodate this trading 

strategy by freeing each trading center to 

execute orders immediately without 

waiting for other trading centers to 

update their better priced quotations.86

The Commission fully agrees with 

these commenters that intermarket 

protection against trade-throughs must 

be workable and implemented in a way 

that promotes fair and orderly markets. 

It therefore has formulated the 

reproposed Trade-Through Rule to 

achieve this objective in a variety of 

ways. First and most importantly, only 

automated trading centers, as defined in 

Rule 600(b)(4), that are capable of 

providing immediate responses to 

incoming orders would be eligible to 

have their quotations protected. 

Moreover, an automated trading center 

is required to identify its quotations as 

manual (and therefore not protected) 

whenever it has reason to believe that it 

is not capable of providing immediate 

responses to orders. Thus, a trading 

center that experiences a systems 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77437

87A number of commenters were concerned 

about flickering quotations and recommended an 

exemption to address the problem. CHX Letter at 5; 

E*Trade Letter at 9; JP Morgan Letter at 3; Letter 

from Richard A. Korhammer, Chairman & Chief 

Executive Officer, Lava Trading Inc., to Jonathan G. 

Katz, Secretary, Commission (no date) (‘‘Lava 

Trading Letter’’) at 5; SIA Letter at 10; Letter from 

Mary McDermott-Holland, Chairman & John C. 

Giesea, President, Security Traders Association, to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘STA Letter’’) at 5.

88The Commission emphasizes that reproposed 

Rule 611 is designed to facilitate intermarket tradethrough protection only. Compliance with the Rule 

would not be a substitute for meeting the best 

execution responsibilities of brokers-dealers. As a 

result, the best execution responsibilities of brokerdealers that engage in ‘‘price-matching’’ business 

practices that depend on the NBBO would not be 

affected by Rule 611’s exception for flickering 

quotations. In making a best execution 

determination, for example, a broker-dealer could 

not rely on the Rule’s exception to justify ignoring 

a recently displayed, better-priced quotation when 

experience shows that the quotation is likely to be 

accessible.

89Even with the one-second exception for 

flickering quotations, reproposed Rule 611 would 

address a large number of trade-throughs that 

currently occur in the equity markets. The 

substantial trade-through rates discussed in section 

II.A.1 above were calculated using a 3-second 

window. Rule 611 would address all of these tradethroughs, assuming no other exception was 

applicable.

90Several commenters raised questions 

concerning ‘‘clock drift’’ and time lags between 

different data sources. See, e.g., Hudson River 

Trading Letter at 2; Nasdaq Letter III at 4. These 

implementation issues would most appropriately be 

addressed in the context of a trading center’s 

reasonable policies and procedures. Clearly, one 

essential procedure would be for trading centers to 

implement clock synchronization practices that 

meet or exceed industry standards. In addition, a 

trading center’s compliance with the TradeThrough Rule would be assessed based on the times 

that orders and quotations are received, and trades 

are executed, at that trading center. In contrast, to 

comply with the locking/crossing provisions of the 

reproposed Access Rule (Rule 610(d)), a trading 

center would be required reasonably to avoid 

displaying a quotation that would lock or cross a 

quotation at the time it is displayed by a Plan 

processor in the consolidated quotation stream.

91Reserve size, in contrast, is not displayed. 

Trading centers and broker-dealers therefore would 

not be required to route orders to access reserve 

size.

problem, whether because of a flood of 

orders or otherwise, must immediately 

identify its quotations as manual. 

If the reproposed Trade-Through Rule 

were adopted, the Commission would 

monitor and enforce the foregoing 

requirements for automated trading 

centers and automated quotations. 

Nevertheless, it concurs with 

commenters’ concerns that wellfunctioning trading centers should not 

be dependent on the willingness and 

capacity of other markets to meet, and 

the Commission’s ability to enforce, 

these automation requirements. The 

Trade-Through Rule therefore provides 

a ‘‘self-help’’ remedy that would allow 

trading centers to bypass the quotations 

of a trading center that fails to meet the 

immediate response requirement. Rule 

611(b)(1) sets forth an exception that 

applies to quotations displayed by 

trading centers that are experiencing a 

failure, material delay, or malfunction of 

its systems or equipment. To implement 

this exception consistent with the 

requirements of Rule 611(a), trading 

centers would have to adopt policies 

and procedures reasonably designed to 

avoid dealing with problem trading 

centers. Such policies and procedures 

would need to set forth specific and 

objective parameters for initiating and 

monitoring compliance with the selfhelp remedy. Given current industry 

capabilities, the Commission believes 

that trading centers should be entitled to 

bypass another trading center’s 

quotations if it repeatedly fails to 

respond within one second to incoming 

orders attempting to access its protected 

quotations. Accordingly, trading centers 

would have the necessary flexibility to 

respond to problems at another trading 

center as they occur during the trading 

day. The Commission, of course, also 

would monitor a trading center’s 

compliance with the policies and 

procedures required by Rule 611(a) to 

affirm that the trading center bypasses 

quotations only when, in fact, another 

trading center is experiencing a material 

delay.

In many active NMS stocks, the price 

of a trading center’s best displayed 

quotations often can change multiple 

times in a single second (‘‘flickering 

quotations’’). These rapid changes can 

create the impression that a quotation 

was traded-through, when in fact the 

trade was effected nearly 

simultaneously with display of the 

quotation.87 To address the problem of 

flickering quotations, reproposed Rule 

611(b)(8) sets forth an exception that 

allows trading centers a one-second 

‘‘window’’ prior to a transaction for 

trading centers to evaluate the 

quotations at another trading center. 

Trading centers would be entitled to 

trade at any price equal to or better than 

the least aggressive best bid or best offer, 

as applicable, displayed by the other 

trading center during that one-second 

window.88 For example, if the best bid 

price displayed by another trading 

center has flickered between $10.00 and 

$10.01 during the one-second window, 

the trading center that received the 

order could execute a trade at $10.00 

without violating Rule 611. By 

addressing the flickering quotation 

problem in this way, reproposed Rule 

611(b)(8) would give trading centers 

added flexibility to deal with the 

practical difficulties of protecting 

quotations displayed by other trading 

centers.

The Commission believes that 

excepting flickering prices from tradethrough protection would ease the 

implementation of the reproposed 

Trade-Through Rule without 

significantly reducing its benefits.89 In 

this regard, it appears that many of the 

potential implementation difficulties 

with respect to high-volume stocks are 

related to the general problem of dealing 

with sub-second time increments. The 

Commission generally does not believe 

that the benefits would justify the costs 

imposed on trading centers of 

attempting to implement an intermarket 

price priority rule at the level of subsecond time increments. Accordingly, 

Rule 611 has been formulated to relieve 

trading centers of this burden.90

Paragraphs (b)(5) and (b)(6) of 

reproposed Rule 611 set forth 

exceptions for intermarket sweep 

orders. The exceptions respond to the 

need of market participants to access 

multiple price levels simultaneously at 

different trading centers. An intermarket 

sweep order is defined in Rule 

600(b)(30) as a limit order that meets the 

following requirements: (1) The limit 

order is identified as an intermarket 

sweep order when routed to a trading 

center, and (2) simultaneously with the 

routing of the limit order, one or more 

additional limit orders are routed to 

execute against all better-priced 

protected quotations displayed by other 

trading centers up to their displayed 

size. These additional orders also must 

be marked as intermarket sweep orders 

to inform the receiving trading center 

that they can be immediately executed 

without regard to protected quotations 

in other markets. Paragraph (b)(5) would 

allow a trading center to execute 

immediately any order identified as an 

intermarket sweep order, without regard 

for better-priced protected quotations 

displayed at one or more other trading 

centers. The exception is fully 

consistent with the principle of 

protecting the best displayed prices 

because it is premised on the condition 

that the trading center or broker-dealer 

responsible for routing the order will 

have attempted to access all betterpriced protected quotations up to their 

displayed size.91 Consequently, there is 

no reason why the trading center that 

receives an intermarket sweep order 

while displaying an inferior-priced 

quotation should be required to delay an 

execution of the order.

Paragraph (b)(6) would authorize a 

trading center itself to route intermarket 

sweep orders and thereby enable 

77438 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

92The indefinite loop scenario also is addressed 

by (1) the self-help remedy in reproposed Rule 

611(b)(1) for trading centers to deal with slow 

response times and (2) the requirement that trading 

centers immediately stop displaying automated 

(and therefore protected) quotations when they can 

no longer meet the immediate response requirement 

for automated quotations.

93Proposing Release, 69 FR at 11138.

94Hearing Tr. at 32, 58, 65, 74, 80, 84–85, 154.

95See supra, note 38 (overview of commenters 

supporting a strong trade-through rule without an 

opt-out exception).

96American Century Letter at 4.

97 Vanguard Letter at 5.

98 ICI Letter at 14 (emphasis in original).

99Approximately 367 commenters supported an 

opt-out exception. Approximately 211 of these 

commenters opposed a trade-through rule and 

endorsed an opt-out to remediate what they viewed 

as its adverse effects. Of these 211 commenters, 179 

commenters utilized Form Letter C. The remaining 

commenters supporting an opt-out exception 

included a variety of securities industry 

participants and 15 members of Congress.

100Letter Type C.

101Morgan Stanley Letter at 11–12.

102 Instinet Letter at 19.

immediate execution of a transaction at 

a price inferior to a protected quotation 

at another trading center. For example, 

paragraph (b)(6) could be used by a 

dealer that wished immediately to 

execute a block transaction at a price 

three cents down from the NBBO, as 

long as the dealer simultaneously routed 

orders to access all better-priced 

protected quotations. By facilitating 

intermarket sweep orders of all kinds, 

Rule 611 as reproposed would allow a 

much wider range of beneficial trading 

strategies than the rule as proposed. In 

addition, the intermarket sweep 

exception would help prevent an 

‘‘indefinite loop’’ scenario in which 

waves of orders otherwise might be 

required to chase the same quotations 

from trading center to trading center, 

one price level at a time.92

4. Elimination of Proposed Opt-Out 

Exception 

The rule text of the trade-through 

proposal included a broad exception for 

persons to opt-out of the best displayed 

prices if they provided informed 

consent. The Proposing Release 

indicated that the exception was 

particularly intended to allow investors 

to bypass manual markets, to execute 

block transactions without moving the 

market price, and to help discipline 

markets that provided slow executions 

or inadequate access to their 

quotations.93 The Commission also 

noted, however, that an opt-out 

exception would be inconsistent with 

the principle of price protection and, if 

used frequently, could undermine 

investor confidence that their orders 

will receive the best available price. It 

therefore requested comment on an 

automated execution alternative to the 

opt-out exception, under which all 

markets would be required to provide 

an automated response to electronic 

orders. At the subsequent NMS Hearing, 

some panelists questioned whether, 

assuming only truly accessible and 

automated quotations were protected, 

there was a valid reason for opting-out 

of such a quotation.94 To address this 

issue, the Commission requested 

comment in the Supplemental Release 

on whether the proposed opt-out 

exception would be necessary if manual 

quotations were excluded from tradethrough protection.

Many commenters opposed a general 

opt-out exception.95 They believed that 

it would be inconsistent with the 

principle of price protection and 

undermine the very benefits the tradethrough rule is designed to provide. 

American Century, for example, 

asserted that the Commission should 

focus on the limit order investors who 

have ‘‘opted-in’’ to the NMS, rather than 

on those that wish to opt-out.96

Vanguard noted that an opt-out 

exception might serve a short-term 

desire to obtain an immediate 

execution, but ‘‘without recognizing the 

second order effect of potentially 

significantly reducing liquidity in the 

long term.’’ 97 Similarly, the ICI stated 

that ‘‘while our members may be best 

served on a particular trade by ‘optingout’ from executing against the best 

price placed in another market, we 

believe that in the long term, all

investors will benefit by having a 

market structure where all limit orders 

are protected and investors are provided 

with an incentive to place those orders 

in the markets.’’ 98 All of the foregoing 

views were conditioned on an 

assumption that only accessible, 

automated quotations would be 

protected by a trade-through rule.

Many other commenters, in contrast, 

supported the proposed opt-out 

exception.99 Aside from concerns that a 

trade-through rule would be unworkable 

without an opt-out exception, which 

were discussed in the preceding section, 

the primary concerns of these 

commenters were that, without an optout exception, a trade-through rule 

would (1) dampen competition among 

markets, particularly with respect to 

factors other than price; and (2) restrict 

the freedom of choice for market 

participants to route marketable orders 

to trading centers that are most 

appropriate for their particular trading 

objectives and to achieve best execution. 

As discussed next, the Commission has 

formulated the reproposed TradeThrough Rule to respond to these 

concerns, while still preserving the 

benefits of intermarket price protection.

a. Preserving Competition Among 

Markets. Many commenters believed 

that an opt-out exception was necessary 

to promote competition among trading 

centers, particularly competition based 

on factors other than price, such as 

speed of response. For example, 179 

commenters submitted letters stating 

that, in the absence of an opt-out 

exception, ‘‘Reg. NMS will freeze 

market development and, over the long 

term, could hurt investors.’’ 100 Morgan 

Stanley asserted that allowing market 

participants to opt-out ‘‘would reward 

markets that provide faster and surer 

executions, and conversely, would 

penalize those markets that are 

materially slower or are displaying 

smaller quote sizes by ignoring those 

quotes.’’ 101 Instinet believed that, 

without an opt-out exception, a tradethrough rule ‘‘would virtually eliminate 

intermarket competition by forcing 

operational and technological 

uniformity on each marketplace, 

negating price competition, system 

performance, or any other 

differentiating feature that a market may 

develop.’’ 102

The Commission recognizes the vital 

importance of preserving vigorous 

competition among markets, but 

believes that commenters have 

overstated the risk that such 

competition would be dampened by 

adoption of a trade-through rule without 

a general opt-out exception. Even if 

reproposed Rule 611 were adopted, 

markets likely would have strong 

incentives to continue to compete and 

innovate to attract both marketable 

orders and limit orders. Market 

participants and intermediaries 

responsible for routing marketable 

orders, consistent with their desire to 

achieve the best price and their duty of 

best execution, would continue to rank 

trading centers according to the total 

range of services provided by those 

markets. Such services include cost, 

speed of response, sweep functionality, 

and a wide variety of complex order 

types. The most competitive trading 

center would be the first choice for 

routing marketable orders, thereby 

enhancing the likelihood of execution 

for limit orders routed to that trading 

center. Because likelihood of execution 

is of such great importance to limit 

orders, routers of limit orders would be 

attracted to this preferred trading center. 

More limit orders would enhance the 

depth and liquidity offered by the 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77439

103 Importantly, reproposed Rule 611 would not 

require that limit orders be routed to any particular 

market, as it does, at least indirectly, marketable 

orders. Consequently, competitive forces would be 

fully operative to discipline markets that offer poor 

services to limit orders, such as limiting the extent 

to which limit orders can be cancelled in changing 

market conditions or providing slow speed of 

cancellation.

104As discussed below in section III.A.2, a 

competitive problem could arise if a least preferred 

market was allowed to charge exorbitant fees to 

access its protected quotations, and then pass most 

of the fee on as rebates to liquidity providers to 

offset adverse selection costs. To address the 

problem of such an ‘‘outlier’’ market, reproposed 

Rule 610(c) would set forth a uniform fee limitation 

for accessing protected quotations.

105Letter Type C.

106Fidelity Letter I at 6–7.

107See, e.g., Fidelity Letter I at 9; Morgan Stanley 

Letter at 12.

preferred trading center, thereby 

increasing its attractiveness for 

marketable orders, and beginning the 

cycle all over again.103

Conversely, trading centers that offer 

poor services, such as a slower speed of 

response, likely would rank near the 

bottom in order-routing preference of 

most market participants and 

intermediaries. Whenever the leastpreferred trading center was merely 

posting the same price as other trading 

centers, orders would be routed to other 

trading centers. As a result, limit orders 

displayed on the least preferred trading 

center would be least likely to be 

executed in general. Moreover, such 

limit orders would be the least likely to 

be executed when prices move in favor 

of the limit orders, and the most likely 

to be executed only when prices are 

moving against the limit order, adding 

the cost of ‘‘adverse selection’’ to the 

cost of a low likelihood of execution. In 

sum, the lowest ranked trading center in 

order-routing preference, with or 

without intermarket price protection, 

would suffer the consequences of 

offering a poor range of services to the 

routers of marketable orders.104 The 

Commission therefore preliminarily 

does not believe that the absence of an 

opt-out exception would freeze market 

development or eliminate competition 

among markets.

b. Promoting the Interests of Both 

Marketable Orders and Limit Orders. 

Many commenters that supported an 

opt-out exception believed that an 

ability to opt-out of the best displayed 

prices was necessary to promote full 

freedom of choice in the routing of 

marketable orders, and particularly to 

allow factors other than quoted prices to 

be considered. For example, 179 

commenters submitted a letter stating 

that ‘‘[i]nvestors are driven by price, but 

prices that are inaccessible either 

because of lagging execution time 

within a market or insufficient liquidity 

at the best price point impact the overall 

costs associated with trading securities 

in today’s markets. The Trade Through 

rule may harm investors by restricting 

their ability to achieve best execution, 

and investors deserve the opportunity to 

make choices.’’ 105 Similarly, Fidelity 

asserted that ‘‘as a fiduciary to the 

mutual funds under our management, 

we should be free to reach our own 

informed judgment regarding the market 

center where our funds’ trades are to be 

executed, particularly when a delay may 

open the way for exchange floor 

members and others to exploit an 

informational advantage that arises not 

from their greater investment or trading 

acumen but merely from their privileged 

presence on the physical trading 

floor.’’ 106

The Commission agrees that the 

interests of investors in choosing the 

trading center to which to route 

marketable orders are vitally important, 

but believes that advocates of the optout exception have failed to consider 

the interests of all investors—both those 

who submit marketable orders and those 

who submit limit orders. A fair and 

efficient NMS must serve the interests of 

both types of investors. Moreover, their 

interests are inextricably linked 

together. Displayed limit orders are the 

primary source of public price 

discovery. They typically set quoted 

spreads, supply liquidity, and in general 

establish the public ‘‘market’’ for a 

stock. The quality of execution for 

marketable orders, which, in turn, trade 

with displayed liquidity, depends to a 

great extent on the quality of market 

established by limit orders (i.e., the 

narrowness of quoted spreads and the 

available liquidity at various price 

levels). 

Limit orders, however, make the first 

move—when submitted, they must be 

displayed rather than executed, and 

therefore offer a ‘‘free option’’ for other 

market participants to trade a stock by 

submitting marketable orders and taking 

the liquidity supplied by limit orders. 

Consequently, the fate of limit orders is 

dependent on the choices made by those 

who route marketable orders. Much of 

the time, the interests of marketable 

orders in obtaining the best available 

price are aligned with those of limit 

orders that are displaying the best 

available price. But, as shown by the 

significant trade-through rates discussed 

in section II.A.1 above (even for 

automated quotations in Nasdaq stocks), 

the interests of marketable orders and 

limit orders are not always aligned. 

One important example where the 

interests of limit orders and marketable 

orders often diverge are large, block 

trades. Several commenters noted that 

they often are willing to bypass the best 

quoted prices if they can obtain an 

immediate execution of large orders at 

a fixed price that is several cents away 

from the best prices.107 Yet these block 

trades often will be priced based on the 

displayed quotations in a stock. They 

thereby demonstrate the ‘‘free-riding’’

economic externality that, as discussed 

in section II.A.1 above, is at the heart of 

the need for intermarket price 

protection. To achieve the full benefits 

of intermarket price protection, all 

investors must be governed by a 

uniform rule that encompasses their 

individual trades. For any particular 

trade, an investor may believe that the 

best course of action is to bypass 

displayed quotations in favor of 

executing larger size immediately. The 

Commission believes, however, that the 

long-term strength of the NMS as a 

whole is best promoted by fostering 

greater depth and liquidity, and it 

follows from this that the Commission 

should examine the extent to which it 

can encourage the limit orders that 

provide this depth and liquidity to the 

market at the best prices. Allowing 

individual market participants to pick 

and choose when to respect displayed 

quotations could undercut the 

fundamental reason for displaying the 

liquidity in the first place.

Consequently, the Commission has 

decided to eliminate the proposed optout exception from the reproposal 

because it could severely detract from 

the benefits of intermarket order 

protection. Instead, reproposed Rule 611 

has been modified to address the 

concerns of those who otherwise may 

have felt they needed to opt-out of 

protected quotations. In particular, it 

would incorporate an approach that 

seeks to serve the interests of both 

marketable orders and limit orders by 

appropriately balancing these interests 

in the contexts where they may diverge. 

In this way, the reproposed TradeThrough Rule is intended to promote 

the overall efficiency of the NMS for all 

investors. 

First and most importantly, 

reproposed Rule 611 would protect only 

immediately accessible quotations that 

are available through automatic 

execution. It would never require 

investors submitting marketable orders 

to access ‘‘maybe’’ quotations that, after 

arrival of the order, are subject to 

human intervention and thereby create 

the potential for other market 

participants to determine whether to 

honor the quotation. Moreover, as 

discussed in section II.A.2 above, 

77440 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

108Proposing Release, 69 FR at 11136.

109See, e.g., Goldman Sachs Letter at 6; Morgan 

Stanley Letter at 8; NYSE Letter, Attachment at 4; 

Specialist Assoc. Letter at 3.

110Specialist Assoc. Letter at 3.

111Morgan Stanley Letter at 8.

112Exchange Act Section 11A(a)(1)(C)(ii) and 

11A(c)(1)(F).

113Proposing Release, 69 FR at 11136.

114 Id. The Commission does not believe that 

markets should be required to disseminate their 

DOB quotations in the consolidated data stream and 

thereby obtain trade-through protection for such 

quotations. Rather, the Voluntary Depth Alternative 

would allow each market the freedom to choose the 

course of action most appropriate for its particular 

competitive strategy.

reproposed Rule 611 includes a variety 

of provisions designed to assure that 

marketable orders must be routed only 

to well-functioning trading centers 

displaying executable quotations. 

Second, reproposed Rule 611 has 

been formulated to promote the interests 

of investors seeking immediate 

execution of specific order types that 

reduce their total trading costs, 

particularly for larger orders, by, among 

other things, minimizing price impact 

costs. Paragraph (b)(7), for example, sets 

forth an exception that would allow the 

execution of volume-weighted average 

price (‘‘VWAP’’) orders, as well as other 

types of orders that are not priced with 

reference to the quoted price of a stock 

at the time of execution and for which 

the material terms were not reasonably 

available at the time the commitment to 

execute the order was made. This 

exception would serve the interests of 

marketable orders and is consistent with 

the principle of protecting the best 

displayed quotations. 

Although reproposed Rule 611 does 

not provide a general exception for 

block orders, it seeks to address the 

legitimate interest of investors in 

obtaining an immediate execution in 

large size (and thereby minimizing price 

impact). The intermarket sweep order 

exception would allow broker-dealers to 

continue to facilitate the execution of 

block orders. The entire size of a large 

order can be executed immediately at 

any price, so long as the broker-dealer 

routes orders seeking to execute against 

the full displayed size of better-priced 

protected quotations. The size of the 

order therefore need not be parceled out 

over time in smaller orders that might 

tip the market about pending orders. By 

both allowing immediate execution of 

the large order and protecting betterpriced quotations, reproposed Rule 611 

is designed to appropriately balance the 

interests for investors on both sides of 

the market. 

The Commission recognizes, however, 

that the existence of a intermarket price 

protection, without an opt-out 

exception, may interfere to some extent 

with the extremely short-term trading 

strategies of some market participants. 

Some of these strategies can be affected 

by a delay in order-routing or execution 

of as little as 3/10ths of one second. 

Given the current NMS structure with 

multiple competing markets, any

protection of displayed quotations in 

one market could affect the 

implementation of short-term trading 

strategies in another market. This 

conflict between protecting the best 

displayed prices and facilitating shortterm trading strategies raises a 

fundamental policy question—should 

the overall efficiency of the NMS defer 

to the needs of professional traders, 

many of whom rarely intend to hold a 

position overnight? Or should the NMS 

serve the needs of longer-term investors, 

both large and small, that will benefit 

substantially from intermarket price 

protection? 

The Commission believes that two of 

the most important public policy 

functions of the secondary equity 

markets are to minimize trading costs 

for long-term investors and to reduce 

the cost of capital for listed companies. 

These functions are inherently 

connected, because the cost of capital of 

listed companies depends on the trading 

costs of those who are willing to accept 

the investment risk of holding corporate 

stock for an extended period. To the 

extent that the interests of professional 

traders and market intermediaries in a 

broad opt-out exception conflict with 

those of investors, the interests of 

investors are entitled to take 

precedence. In this way, the NMS will 

fulfill its Exchange Act objectives to 

promote fair and efficient equity 

markets for investors and to serve the 

public interest.

5. Scope of Protected Quotations: 

Market BBO Alternative and Voluntary 

Depth Alternative 

The trade-through proposal would 

have protected all quotations 

disseminated by a Plan processor in the 

consolidated quote stream. Currently, 

the scope of these quotations depends 

on the regulatory status of an SRO. 

Under Exchange Act Rule 11Ac1–1 

(‘‘Quote Rule’’) (proposed to be 

redesignated as Rule 602), exchange 

SROs are required to provide only their 

best bids and offers (‘‘BBOs’’) in a stock. 

In contrast, a national securities 

association, which currently 

encompasses Nasdaq’s trading facilities 

and the NASD’s ADF, must provide 

BBOs of its individual members. 

Consequently, the proposal would have 

protected only a single BBO of an 

exchange and not any additional 

quotations in its depth of book (‘‘DOB’’). 

For Nasdaq facilities and the ADF, 

however, the proposal would have 

protected member BBOs at multiple 

price levels. The Proposing Release 

requested comment on whether only a 

single BBO for Nasdaq and the ADF 

should be protected.108

Commenters expressed concern that 

the proposed rule text would protect the 

BBOs of individual market makers and 

ATSs in Nasdaq’s facilities and the 

ADF, but only a single BBO of exchange 

SROs.109 The Specialist Association, for 

example, believed that it would be 

unfair to offer greater protection to the 

quotations of members of an association 

SRO than to those of an exchange 

SRO.110 Morgan Stanley stated that to 

‘‘equalize the protections available to all 

market participants, we believe the 

Commission should treat SuperMontage 

as a single market for purposes of the 

trade-through rule, instead of treating 

each individual Nasdaq market maker as 

a separate quoting market 

participant.’’ 111

The Commission agrees that 

reproposed Rule 611 should not 

mandate a regulatory disparity between 

the quotations displayed through 

exchange SROs and those displayed 

through Nasdaq facilities and the ADF. 

Potentially, Nasdaq and the ADF could 

attract a significant number of limit 

orders if they were able to offer order 

protection that was not available at 

exchange SROs. This result would not 

be consistent with the Exchange Act 

goals of fair competition among markets 

and the equal regulation of markets.112

Each of the proposed alternatives for the 

definition of ‘‘protected bid’’ and 

‘‘protected offer’’ in reproposed Rule 

600(b)(57) (the Market BBO Alternative 

and the Voluntary Depth Alternative) 

therefore encompasses the BBOs of an 

exchange, Nasdaq, and the ADF. In this 

way, exchange markets would be treated 

comparably with Nasdaq and the ADF 

under either alternative.

The Proposing Release also addressed 

the issue of extending trade-through 

protection to DOB quotations, but 

questioned whether protecting all DOB 

quotations would be feasible at this 

time.113 Comment specifically was 

requested, however, on whether 

protection should be extended beyond 

the BBOs of SROs if individual markets 

voluntarily provided DOB quotations 

through the facilities of an effective 

national market system plan.114 At the 

subsequent NMS Hearing, a panelist 

specifically endorsed the policy and 

feasibility of extending trade-through 

protection to DOB quotations, as long as 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77441

115Hearing Tr. at 57 (testimony of Thomas 

Peterffy, Chairman, Interactive Brokers Group).

116American Century Letter at 2; Ameritrade 

Letter I at 4; BNY Letter at 2; Capital Research Letter 

at 2; Consumer Federation Letter at 2; Goldman 

Sachs Letter at 6; ICI Letter at 8. See also ArcaEx 

Letter at 7 (supports trade-through protection for 

exchange-listed stocks only, but for entire depth-ofbook). But see Letter from Samuel F. Lek, Chief 

Executive Officer, Lek Securities Corporation, to 

Jonathan G. Katz, Secretary, Commission, dated 

May 24, 2004 (‘‘Lek Securities Letter’’) at 7; 

Specialist Assoc. Letter at 3.

117Consumer Federation Letter at 2.

118 ICI Letter at 8.

119As a means to address capacity issues, the 

SRO participants in the applicable market data 

Plans potentially could determine to disseminate 

only those DOB quotations that were within a 

certain number of price levels away from the NBBO.

120Nasdaq UTP Plan, section XXI, Depth of Book 

Display (published in Securities Exchange Act 

Release No. 49137 (Jan. 28, 2004), 69 FR 5217, 5225 

(Feb. 3, 2004).

such quotations were automated and 

accessible: ‘‘Automatically executable 

quotes, whether they are on the top of 

the book or up and down the book, 

should be protected by the tradethrough rule, and manual quotes should 

not be. This is a simple and technically 

easy idea to implement.’’ 115

Most of the subset of comment letters 

that specifically addressed the DOB 

issue supported the approach of 

extending trade-through protection to 

all limit orders displayed in the NMS, 

not merely the BBOs of the various 

markets.116 The Consumer Federation of 

America, for example, stated that ‘‘such 

an approach would result in better price 

transparency and help to address 

complaints that decimal pricing has 

reduced price transparency because of 

the relatively thin volume of trading 

interest displayed in the best bid and 

offer.’’ 117 The ICI recognized that 

protecting all displayed limit orders 

might not be feasible at this time, but 

urged the Commission to examine the 

issue further.118

The Commission recognizes, however, 

that other commenters may have chosen 

not to address the alternative of 

protecting voluntary DOB quotations 

because it was not included in the 

proposed rule text. In this reproposal, 

therefore, the Commission has decided 

to propose rule text for two alternatives: 

(1) The Market BBO Alternative that 

would protect only the BBOs of the 

exchange SROs, Nasdaq, and the ADF, 

or (2) the Voluntary Depth Alternative 

that, in addition to protecting BBOs, 

would protect the DOB quotations that 

markets voluntarily disseminate in the 

consolidated quotations stream. The 

alternatives are incorporated in two 

alternative definitions of ‘‘protected 

bid’’ and ‘‘protected offer’’ in Rule 

600(b)(57). Comment is requested on 

which of the two alternatives would 

most further the Exchange Act 

objectives for the NMS in a practical 

and workable manner. The following 

discussion is intended to highlight 

issues that commenters may wish to 

address when evaluating the two 

alternatives. 

Comment is requested on whether 

extending trade-through protection to 

DOB quotations would significantly 

increase the benefits of the reproposed 

Trade-Through Rule. Would protecting 

quotations at multiple price levels 

further encourage the display of limit 

orders and thereby significantly 

enhance depth and liquidity in the 

NMS? Since decimalization, quoted 

spreads have narrowed substantially. 

Market participants often may not be 

willing to quote in significant size at the 

inside prices, but might be willing to do 

so at a price that is a penny or more 

away from the inside prices. Granting 

trade-through protection to such 

quotations potentially would reward 

this beneficial quoting activity. 

In assessing the potential benefits of 

DOB protection, commenters should 

consider the effect of the reserve (or 

undisplayed) size function that many 

trading centers offer investors. For 

example, Market A may be displaying a 

best offer of 1000 shares at $10.00, and 

DOB offers of 2000 shares at $10.01 and 

2000 shares at $10.02. With a reserve 

size function, however, Market A may 

have an additional 1000 shares offered 

at $10.00 and an additional 2000 shares 

offered at $10.01, neither of which is 

displayed. Assuming the displayed 

offers of $10.00, $10.01, and $10.02 

were protected quotations under the 

Voluntary Depth Alternative, Market B 

could execute a trade at $10.03 only by 

simultaneously routing an order to 

execute against the accumulated 

displayed size of the protected 

quotations at Market A. Market B 

therefore would be required to route a 

buy order, identified as an intermarket 

sweep order, to Market A with a limit 

price of $10.02 for a total of 5000 shares 

(the accumulated amount of the 

displayed size of protected quotations 

with a price of $10.02 or better at 

Market A). Under the priority rules 

currently in effect at electronic markets, 

undisplayed size has priority over 

displayed size at a inferior price. 

Accordingly, Market A would execute 

the 5000 share buy order as follows: 

2000 shares at $10.00 (1000 displayed 

plus 1000 reserve) and 3000 shares at 

$10.01 (2000 displayed plus 1000 

reserve). While Market B would have 

complied with the Rule, the displayed 

$10.02 offer at Market A would still go 

unfilled when Market B traded at 

$10.03. Comment is requested on the 

extent to which this outcome would 

detract from the benefits of the 

Voluntary Depth Alternative.

The Commission also requests 

comment on whether the Voluntary 

Depth Alternative could be 

implemented in a practical and costeffective manner. To comply, trading 

centers would need to monitor a 

significantly larger number of protected 

quotations displayed by other markets 

and route orders to execute against such 

quotations.119 The Voluntary Depth 

Alternative, however, would not 

increase the number of orders that a 

trading center would be required to 

route to other trading centers if only 

BBOs were protected. Instead, the size

of the routed orders would need to be 

increased to reflect the accumulated 

depth displayed by other trading centers 

in their protected DOB quotations.

In addition, protection of DOB 

quotations would not be feasible unless 

(1) market participants have a source of 

information that clearly identifies the 

quotations to be protected, (2) such 

quotation information is made available 

on fair and reasonable terms, and (3) 

market participants have fair and 

efficient access to the protected 

quotations at reasonable cost (i.e., 

without paying exorbitant access fees). 

Moreover, the applicable regulatory 

authorities must be able to monitor and 

enforce compliance with a rule that 

protected DOB quotations. At a 

minimum, this would require an 

objective and uniform source to identify 

the quotations that are protected at any 

particular time. Comment is requested 

on whether the Voluntary Depth 

Alternative would meet these vitally 

important requirements. 

The Voluntary Depth Alternative 

would set up a process through which 

individual markets could choose to 

secure protection for their DOB 

quotations by disseminating them in the 

consolidated quotation stream. To 

implement this approach, the SRO 

participants in the market data Plans 

would need to establish a mechanism 

for individual markets to disseminate 

their quotations through the Plan 

processor and have them designated as 

protected quotations. The participants 

in the Nasdaq UTP Plan already have 

agreed on such a mechanism.120 It 

provides that the future processor for 

the Plan should have the ability to 

collect, consolidate, and disseminate 

quotations at multiple price levels 

beyond the BBO from any participant 

that voluntarily chooses to submit such 

quotations. The participant would be 

expected to bear the costs of processing 

77442 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

121 In its discussion of the market data proposal, 

the Proposing Release requested comment on 

whether and, if so, on what terms Plan processors 

should be required to disseminate data on behalf of 

individual markets. Proposing Release, 69 FR at 

11184 n. 300. In response, one commenter was 

concerned that, at a minimum, the Plans should 

offer all participants the same opportunity on the 

same terms to disseminate additional data. Instinet 

Letter at 48. The Commission agrees that the Plans 

must act fairly and reasonably toward all 

participants. To assure that the Plans were 

responsive to individual markets that were willing 

to display DOB quotations and that they treated 

such participants fairly and reasonably, the 

Commission would monitor the deliberations of the 

Plan operating committees and, if necessary, take 

action to strengthen the NMS and promote the 

interests of investors.

122Letter from Bruce Lisman, Bear, Stearns & Co., 

Inc., to Jonathan G. Katz, Secretary, Commission, 

dated November 26, 2004 (‘‘Bear Stearns Letter’’), 

at 2.

123 Goldman Sachs Letter at 6.

124See, e.g., Bloomberg Tradebook Letter at 14; 

Fidelity Letter I at 12; Instinet Letter at 14, 15; 

Nasdaq Letter II at 2; Letter from Junius W. Peake, 

Monfort Distinguished Professor of Finance, 

Kenneth W. Monfort College of Business, University 

of Northern Colorado, dated April 23, 2004 (‘‘Peake 

Letter I’’) at 2; Reg NMS Study Group Letter at 4; 

Letter from Richard A. Rosenblatt, Chief Executive 

Officer, & Joseph C. Gawronski, Chief Operating 

Officer, Rosenblatt Securities Inc., to William H. 

Donaldson, Chairman, Commission, dated June 23, 

2004 (‘‘Rosenblatt Securities Letter II’’) at 4; STANY 

Letter at 3; UBS Letter at 8.

125See, e.g., Ameritrade Letter I at 8, 9; Brut 

Letter at 12; Citigroup Letter at 8–9; E*TRADE 

Letter at 7; Letter from W. Leo McBlain, Chairman, 

& Thomas J. Jordan, Executive Director, Financial 

Information Forum, to Jonathan G. Katz, Secretary, 

Commission, dated July 9, 2004 (‘‘Financial 

Information Forum Letter’’) at 2; JP Morgan Letter 

at 4; SIA Letter at 12–14.

126 44 U.S.C. 3501 et seq.

127The revised PRA analysis is forth in section 

VIII.A below.

128Specifically, the estimated costs of providing 

investors with disclosure necessary to obtain 

informed consent to opt-outs and retaining records 

relating to such disclosures were $100 million in 

start-up costs and $59 million annually. Further, 

the estimated costs of the proposed requirement for 

broker-dealers to provide every customer that opted 

out with the NBBO at the time of execution were 

$194 million in start-up costs and almost $148 

million annually.

its additional information. If the 

Voluntary Depth Alternative were 

adopted and any individual market 

were willing to disseminate its DOB 

quotations through the Plan processors, 

the participants in each of the Plans 

would be expected to agree on a fair and 

equitable means to disseminate such 

quotations.

As noted in section II.A.3 above, any 

intermarket protection against tradethroughs must be workable and 

implemented in a way that promotes 

fair and orderly markets. To the extent 

commenters are concerned about 

practical problems with implementing 

the Trade-Through Rule, would the 

basis for these concerns be magnified by 

the Voluntary Depth Proposal? 

Specifically, comment is requested on 

all issues relating to the feasibility and 

desirability of disseminating DOB 

quotations through Plan processors.121

For example, would the voluntary 

dissemination of protected DOB 

quotations through the Plan processors 

create a single point of failure that could 

threaten the stability of trading in NMS 

stocks?

In addition, it would be inappropriate 

to extend trade-through protection to 

any quotation unless it was publicly 

available and accessible on fair and 

reasonable terms. For example, the 

limitation on access fees set forth in 

reproposed Rule 610(c) would apply to 

any protected quotation, whether a BBO 

or DOB quotation. Moreover, any fee 

charged for DOB information 

disseminated pursuant to a market data 

Plan would have to be filed with the 

Commission for approval. The fee could 

be approved only if it was fair and 

reasonable and appropriately justified 

by Plan participants. The Commission 

requests comment on how best to 

evaluate the fairness and reasonableness 

of fees for DOB quotations if the 

Voluntary Depth Alternative were 

adopted. 

Finally, the Commission requests 

comment on the effect that adoption of 

the Voluntary Depth Alternative would 

have on competition among markets. 

One commenter, for example, suggested 

that protection of DOB quotations might 

cause increased fragmentation of 

liquidity across different markets 

because limit orders, no matter where 

displayed, would have price 

protection.122 Another commenter, in 

contrast, asserted that protecting only 

BBOs would lead to greater 

fragmentation because limit orders 

would be routed to any market where 

they would set or equal the BBO and 

thereby obtain trade-through 

protection.123 Comment is requested on 

the fragmentation issue, as well as in 

general on whether protecting DOB 

quotations would inappropriately limit 

the terms of market competition so as to 

harm investors and the efficiency of the 

NMS. For example, would adoption of 

the Voluntary Depth Alternative 

inappropriately reduce the scope of 

competition among markets to the 

payment of liquidity rebates for 

executed limit orders? Comment also is 

requested on whether adoption of the 

Voluntary Depth Alternative would 

generate forces that would lead to a 

monopolization of trading in a single 

trading facility.

6. Benefits and Implementation Costs of 

Trade-Through Rule 

Commenters were concerned about 

the cost of implementing the original 

trade-through proposal. Some argued 

that, in general, implementing the 

proposed rule would be too expensive 

and would outweigh any perceived 

benefits of the rule.124 Commenters also 

were concerned about the cost of 

specific requirements in the proposed 

rule, particularly the procedural 

requirements associated with the 

proposed opt-out exception (e.g., 

obtaining informed consent from 

customers and disclosing the NBBO to 

customers).125

In assessing the implementation costs 

of the reproposed Trade-Through Rule, 

it is important to recognize that much, 

if not all, of the connectivity among 

trading centers necessary to implement 

intermarket price protection has already 

been put in place. Trading centers for 

exchange-listed securities already are 

connected through the ITS. The 

Commission understands that, at least 

as an interim solution, ITS facilities and 

rules could be modified relatively easily 

and at low cost to enable an automatic 

execution functionality. With respect to 

Nasdaq stocks, connectivity among 

trading centers already is established 

through private linkages. Routing out to 

other trading centers when necessary to 

obtain the best prices for Nasdaq stocks 

is an integral part of the business plan 

of many trading centers, even when not 

affirmatively required by best execution 

responsibilities. Moreover, a variety of 

private vendors currently offer 

connectivity to NMS trading centers for 

both exchange-listed and Nasdaq stocks. 

Some of the commenters based their 

concerns about implementation costs on 

the estimated costs included in the 

Proposing Release for purposes of the 

Paperwork Reduction Act of 1995 

(‘‘PRA’’).126 The Commission has 

revised its estimate of the PRA costs 

associated with the proposed rule to 

reflect the streamlined requirements of 

Rule 611 as reproposed, and to reflect a 

further refinement of the estimated 

number of trading centers subject to the 

rule.127 In particular, Rule 611 as 

reproposed does not contain the 

proposed opt-out exception. Costs 

associated with this proposed exception 

represented a large portion of the overall 

estimated costs described in the 

Proposing Release, and are no longer 

applicable.128 In total, eliminating the 

opt-out procedural requirements alone 

reduces the estimate of the Proposing 

Release by $294 million in start-up costs 

and $207 million in annual costs.

The Commission also has refined its 

estimate of the number of broker-dealers 

that would be required to establish, 

maintain, and enforce policies and 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77443

129Proposing Release 69 FR at 11145 n.95.

130The estimate is described further in section 

VIII.A below.

131Trade-Through Study at 3, 5.

132 Id. at 3.

133See Trade-Through Study, Tables 4 and 11.

134World Federation of Exchanges, Annual 

Report (2003), at 86.

135 Investment Company Institute, Mutual Fund 

Fact Book (2004), at 55.

136 Id. at 64. Portfolio turnover is reported as the 

lesser of portfolio sales or purchases divided by 

average net assets. Because price impact occurs for 

both purchases and sales, the turnover rate must be 

doubled, then multiplied by total fund assets, to 

estimate the total value of trading that would be 

affected by an improvement in depth and liquidity.

137Plexus Group, Inc., Commentary 80, ‘‘Trading 

Truths: How Mis-Measurement of Trading Costs Is 

Leading Investors Astray,’’ (April 2004), at 2–3.

138The estimate of 37.4 basis points is the average 

of the total market impact and liquidity search costs 

for giant capitalization stocks (30.4 basis points) 

and the total market impact and liquidity search 

costs for large capitalization stocks (44.4 basis 

points). The much higher market impact and 

liquidity search costs of midcap, smallcap, and 

microcap stocks are not included.

procedures designed to prevent tradethroughs pursuant to the rule as 

reproposed. In the Proposing Release, 

the Commission estimated that 

potentially all of the 6,768 registered 

broker-dealers would be subject to this 

requirement, but acknowledged that it 

believed the figure was likely overlyinclusive because it might include 

registered broker-dealers that do not 

effect transactions in NMS stocks.129

After further consideration, the 

Commission believes that this number 

indeed greatly overestimated the 

number of registered broker-dealers that 

would be subject to the rule, given that 

most of those broker-dealers do not 

engage in the business of executing 

orders internally. The estimated number 

therefore has been reduced to 

approximately 600 broker-dealers.130

Taken together, these changes 

substantially reduce the estimated costs 

associated with implementation of and 

ongoing compliance with Rule 611 as 

reproposed. As discussed further in 

section VIII.A below, the estimated PRA 

costs associated with reproposed Rule 

611 are $17.8 million in start-up costs 

and $3.5 million in annual costs. In 

addition, as discussed further in section 

IX.A.2 below, the estimated 

implementation costs for necessary 

systems modifications are $126 million 

in start-up costs and $18.4 million in 

annual costs. Accordingly, the total 

estimated costs are $143.8 million in 

start-up costs and $21.9 million in 

annual costs. 

The Commission preliminarily 

believes that the benefits of 

strengthening price protection for 

exchange-listed stocks (e.g., by 

eliminating the gaps in ITS coverage of 

block positioners and 100-share quotes) 

and introducing price protection for 

Nasdaq stocks would be substantial, 

although the total amount is difficult to 

quantify. One objective, though quite 

conservative, estimate of benefits is the 

dollar amount of quotations that 

currently are traded through. The 

Commission staff’s analysis of current 

trade-through rates indicates that over 

12 billion shares of displayed quotations 

in Nasdaq and NYSE stocks were traded 

through in 2003, by an average amount 

of 2.3 cents for Nasdaq stocks and 2.2 

cents for NYSE stocks.131 These tradedthrough quotations represent 

approximately $209 million in Nasdaq 

stocks and $112 million in NYSE stocks, 

for a total of $321 million in bypassed 

limit orders and inferior prices for 

investors in 2003 that could have been 

addressed by strong trade-through 

protection.132 The Commission 

preliminarily believes that this $321 

million estimated annual benefit, 

particularly when combined with the 

benefits of enhanced investor 

confidence in the fairness and 

orderliness of the equity markets, would 

justify the one-time costs of 

implementation and ongoing annual 

costs of the reproposed Trade-Through 

Rule.

The foregoing estimate of benefits is 

very conservative because it is based 

solely on the size of displayed 

quotations in the absence of strong price 

protection. In essence, it measures the 

problem—a shortage of quoted depth—

that the reproposed Trade-Through Rule 

is designed to address, rather than the 

benefits that it could achieve. Every 

trade-through transaction potentially 

sends a message to market participants 

that their displayed quotations can be 

and are ignored by other market 

participants. When the total share 

volume of trade-through transactions 

that do not interact with displayed 

quotations reaches 8% and above for 

hundreds of the most actively traded 

NMS stocks,133 this message is unlikely 

to be missed by those who watched 

their quotations being traded through. 

Certainly, the common practice of 

trading through displayed size is most 

unlikely to prompt market participants 

to display even greater size.

A primary objective of the reproposed 

Trade-Through Rule is to increase 

displayed depth and liquidity in the 

NMS and thereby reduce trading costs 

for a wide spectrum of investors, 

particularly institutional investors that 

must trade in large sizes. Precisely 

estimating the extent to which 

strengthened price protection would 

improve market depth and liquidity, 

and thereby lower the trading costs of 

investors, is very difficult. The difficulty 

of estimation should not hide from 

view, however, the enormous potential 

benefits for investors of improving the 

depth and efficiency of the NMS. 

Because of the huge dollar amount of 

trading volume in NMS stocks—more 

than $17 trillion in 2003 134—even the 

most incremental improvement in 

market depth and liquidity could 

generate a dollar amount of benefits that 

annually would dwarf the one-time 

start-up costs of implementing tradethrough protection.

One approach to evaluating the 

potential benefits of the reproposed 

Trade-Through Rule is to examine a 

category of investors that stand to 

benefit a great deal from improved 

depth and liquidity for NMS stocks—the 

shareholders in U.S. equity mutual 

funds. In 2003, the total assets of such 

funds were $3.68 trillion.135 The 

average portfolio turnover rate for equity 

funds was 55%, meaning that their total 

purchases and sales of securities 

amounted to approximately $4.048 

trillion.136 A leading authority on the 

trading costs of institutional investors 

has estimated that in the second quarter 

of 2003 the average price impact 

experienced by investment managers 

ranged from 17.4 basis points for giantcapitalization stocks, 21.4 basis points 

for large-capitalization stocks, and up to 

35.4 basis points for microcapitalization stocks.137 In addition, it 

estimated the cost attributable to 

adverse price movements while 

searching for liquidity for institutional 

orders, which often are too large simply 

to be presented to the market. Its 

estimate of liquidity search costs ranged 

from 13 basis points for giant 

capitalization stocks, 23 basis points for 

large capitalization stocks, and up to 

119 basis points for micro-capitalization 

stocks. Assuming that the average price 

impact costs and liquidity search costs 

incurred across all stocks were a 

conservative 37.4 basis points,138 the 

shareholders in U.S. equity mutual 

funds incurred implicit trading costs of 

$15.1 billion in 2003. Based on a 

hypothetical assumption that, in light of 

the current share volume of tradethrough transactions that does not 

interact with displayed liquidity, 

intermarket trade-through protection 

could improve depth and liquidity for 

NMS stocks by at least 5% (or an 

average reduction of 1.87 basis points in 

price impact and liquidity search costs 

for large investors), the savings in 

trading costs for U.S equity funds alone, 

77444 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

139Mutual Fund Factbook, supra note 135, at 59.

140An ‘‘SRO trading facility’’ is defined in 

reproposed Rule 600(b)(72) as a facility operated by 

an SRO that executes orders in a security or 

presents orders to members for execution.

141An ‘‘alternative trading system’’ is defined in 

reproposed Rule 600(b)(2) with a cross reference to 

Regulation ATS.

142An ‘‘exchange market maker’’ is defined in 

reproposed Rule 600(b)(24).

143An ‘‘OTC market maker’’ is defined in 

reproposed Rule 600(b)(52).

144The term ‘‘regular trading hours’’ is defined in 

reproposed Rule 600(b)(64) as the time between 

9:30 a.m. and 4 p.m., unless otherwise specified.

145Protected bid and protected offer are 

collectively defined as a ‘‘protected quotation’’ in 

reproposed Rule 600(b)(58).

and the improved returns for their 

millions of individual shareholders, 

would have amounted to approximately 

$755 million in 2003.

Of course, the benefits of improved 

depth and liquidity for the equity 

holdings of other types of investors, 

including pension funds, insurance 

companies, and individuals, are not 

incorporated in the foregoing 

calculations. In 2003, these other types 

of investors held 78% of the value of 

publicly traded U.S. equity outstanding, 

with equity mutual funds holding the 

remaining 22%.139 Assuming that these 

other types of investors experienced a 

reduction in trading costs that merely 

equaled the reduction of trading costs 

for equity mutual funds, the assumed 

5% improvement in market depth and 

liquidity could yield total trading cost 

savings for all investors of over $1.5 

billion annually. Such savings would 

improve the investment returns of 

equity ownership, thereby promoting 

the retirement and other long-term 

financial interests of individual 

investors and reducing the cost of 

capital for listed companies.

B. Description of Reproposed Rule 

Reproposed Rule 611 can be divided 

into three elements: (1) The provisions 

that establish the scope of the Rule’s 

coverage, most of which are set forth in 

the definitions of Rule 600(b); (2) the 

operative requirements of paragraphs (a) 

of Rule 611, which, among other things, 

mandate the adoption and enforcement 

of written policies and procedures that 

are reasonably designed to prevent trade 

throughs of protected quotations and, if 

relying on an exception, that are 

reasonably designed to assure 

compliance with the terms of the 

exception, and (3) the exceptions set 

forth in paragraph (b) of Rule 611. These 

elements are discussed below, followed 

by a section emphasizing that a broker’s 

duty of best execution would in not be 

lessened if reproposed Rule 611 were 

adopted. 

1. Scope of Rule 

The scope of reproposed Rule 611 

would largely be determined by a series 

of definitions set forth in Rule 600(b). In 

general, the Rule would address tradethroughs of protected quotations in 

NMS stocks by trading centers. A 

‘‘trading center’’ is defined in Rule 

600(b)(78) as a national securities 

exchange or national securities 

association that operates an SRO trading 

facility,140 an ATS,141 an exchange 

market maker,142 an OTC market 

maker,143 or any other broker or dealer 

that executes orders internally by 

trading as principal or crossing orders as 

agent. This last phrase is intended 

particularly to cover block positioners. 

An ‘‘NMS stock’’ is defined in 

paragraphs (b)(47) and (b)(46) of Rule 

600 as a security, other than an option, 

for which transaction reports are 

collected, processed and made available 

pursuant to an effective national market 

system plan. This definition effectively 

covers stocks listed on a national 

securities exchange and stocks included 

in either the National Market or 

SmallCap tiers of Nasdaq. It does not 

include stocks quoted on the OTC 

Bulletin Board or elsewhere in the OTC 

market.

The term ‘‘trade-through’’ is defined 

in Rule 600(b)(77) as the purchase or 

sale of an NMS stock during regular 

trading hours,144 either as principal or 

agent, at a price that is lower than a 

protected bid or higher than a protected 

offer. Rule 600(b)(57), which defines a 

‘‘protected bid’’ or ‘‘protected offer,’’ 145

includes three main elements: (1) An 

automated quotation, (2) displayed by 

an automated trading center, and (3) 

alternative proposals for the scope of 

quotations that are to be protected—the 

Market BBO Alternative and the 

Voluntary Depth Alternative. These 

three elements are described in more 

detail below.

As discussed above, an ‘‘automated 

quotation’’ is defined in reproposed 

Rule 600(b)(3) as a quotation displayed 

by a trading center that: (1) Permits an 

incoming order to be marked as 

immediate-or-cancel; (2) immediately 

and automatically executes an order 

marked as immediate-or-cancel against 

the displayed quotation up to its full 

size; (3) immediately and automatically 

cancels any unexecuted portion of an 

order marked as immediate-or-cancel 

without routing the order elsewhere; (4) 

immediately and automatically 

transmits a response to the sender of an 

order marked as immediate-or-cancel 

indicating the action taken with respect 

to such order; and (5) immediately and 

automatically displays information that 

updates the displayed quotation to 

reflect any change to its material terms. 

Consequently, a quotation would not 

qualify as ‘‘automated’’ if any human 

intervention after the time an order is 

received is allowed to determine the 

action taken with respect to the 

quotation. The term ‘‘immediate’’

precludes any coding of automated 

systems or other type of intentional 

device that would delay the action taken 

with respect to a quotation. Although a 

trading center must provide an IOC/norouting functionality for incoming 

orders, it also can offer additional 

functionalities. Among the changes to 

material terms that require an 

immediate update to a quotation are 

price, size, and automated/manual 

indicator. Any quotation that does not 

meet the requirements for an automated 

quotation is defined in Rule 600(b)(37) 

as a ‘‘manual quotation.’’

As discussed above, an ‘‘automated 

trading center’’ is defined in reproposed 

Rule 600(b)(4) as a trading center that: 

(1) Has implemented such systems and 

rules as are necessary to render it 

capable of displaying quotations that 

meet the requirements for an automated 

quotation set forth in paragraph (b)(3) of 

this section; (2) identifies all quotations 

other than automated quotations as 

manual quotations; (3) immediately 

identifies its quotations as manual 

quotations whenever it has reason to 

believe that it is not capable of 

displaying automated quotations; and 

(4) has adopted reasonable standards 

limiting when its quotations change 

from automated quotations to manual 

quotations, and vice versa, to 

specifically defined circumstances that 

promote fair and efficient access to its 

automated quotations and are consistent 

with the maintenance of fair and orderly 

markets. The requirement of reasonable 

standards for switching the automated/

manual status of quotations is designed 

to preclude any practices that would 

cause confusion among market 

participants concerning the status of a 

trading center’s quotations or that 

would inappropriately advantage the 

members or customers of a trading 

center at the expense of the public. 

The third element of the definition of 

protected quotations in Rule 600(b)(57) 

addresses the scope of quotations 

displayed by a trading center that are 

entitled to protected status. As 

discussed above, the Commission is 

requesting comment on two alternatives. 

Under the Market BBO Alternative, only 

an automated quotation that is the BBO 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77445

146Proposing Release, 69 FR at 11137 (noting the 

problem of ‘‘false positive’’ trade-throughs caused 

by rapidly changing quotations, even when a 

trading center took reasonable precautions to 

prevent trade-throughs).

of an exchange SRO, the BBO of Nasdaq, 

and the BBO of the NASD (i.e., the ADF) 

would qualify as a protected quotation. 

The Voluntary Depth Alternative would 

protect, in addition to all of the 

quotations protected under the Market 

BBO Alternative, such additional bids 

or offers that are designated as protected 

bids or protected offers pursuant to an 

effective national market system plan. 

Thus, the minimum quotations that 

would be protected at present under 

either alternative are the BBOs of each 

exchange SRO, The NASDAQ Market 

Center, and the NASD’s ADF. In 

addition, the Voluntary Depth 

Alternative would establish a 

mechanism pursuant to which a market, 

on a voluntary basis, would be allowed 

to obtain trade-through protection for its 

DOB quotations. In particular, the 

market would need to arrange to have 

its DOB quotations designated as 

protected pursuant to one of the market 

data Plans. Section II.A.5 above 

discusses the two alternatives and 

requests comment on specific issues. 

2. Requirement of Reasonable Policies 

and Procedures 

Paragraph (a)(1) of reproposed Rule 

611 would require a trading center to 

establish, maintain, and enforce written 

policies and procedures that are 

reasonably designed to prevent tradethroughs of protected quotations in 

NMS stocks that do not fall within an 

exception set forth in paragraph (b) of 

Rule 611 and, if relying on such an 

exception, that are reasonably designed 

to assure compliance with the terms of 

the exception. In addition, paragraph 

(a)(2) of Rule 611 would require a 

trading center to regularly surveil to 

ascertain the effectiveness of the 

policies and procedures required by 

paragraph (a)(1) and to take prompt 

action to remedy deficiencies in such 

policies and procedures. As discussed 

in the Proposing Release, the 

Commission continues to believe that it 

would be inappropriate to implement a 

complete prohibition against any tradethroughs, particularly given the realities 

of intermarket trading and order-routing 

in many high-volume NMS stocks.146

The requirement of written policies and 

procedures, as well as the responsibility 

assigned to trading centers to regularly 

surveil to ascertain the effectiveness of 

their procedures and take prompt 

remedial steps, is intended to achieve 

the objective of eliminating all tradethroughs that reasonably can be 

prevented, while also recognizing the 

inherent difficulties of eliminating 

trade-through transactions that, despite 

a trading center’s reasonable efforts, 

may occur due to random and 

accidental causes. The Commission 

requests comment, however, on whether 

this approach is sufficient to address 

enforceability concerns. In this regard, 

should the Commission, instead or in 

addition, explicitly prohibit tradethroughs absent an applicable 

exception? Could a prohibition against 

trade-throughs be fashioned that would 

establish a fair, effective, and workable 

standard to govern trading center 

conduct?

At a minimum, a trading center’s 

policies and procedures must enable the 

trading center (and persons responsible 

for transacting on its market, such as 

specialists) to monitor, on a real-time 

basis, the protected quotations 

displayed by other trading centers so as 

to determine the prices at which the 

trading center can and cannot execute 

trades. In addition, a trading center’s 

policies and procedures must establish 

objective standards and parameters 

governing its use of the exceptions set 

forth in Rule 611(b). A trading center’s 

automated order-handling and trading 

systems must be programmed in 

accordance with these policies and 

procedures. Finally, the trading center 

must take such steps as are necessary to 

enable it to enforce its policies and 

procedures effectively. For example, 

trading centers will need to establish 

procedures such as regular exception 

reports to evaluate their trading and 

order-routing practices. Such reports 

would need to be examined to affirm 

that a trading center’s policies and 

procedures have been followed by its 

personnel and properly coded into its 

automated systems and, if not, to 

promptly identify the reasons and take 

remedial action. 

Of course, surveillance is an 

important component of a trading 

center’s satisfaction of its legal 

obligations. In the context of this 

rulemaking, paragraph (a)(2) of Rule 611 

would reinforce the ongoing 

enforcement requirement by explicitly 

assigning an affirmative responsibility 

to trading centers to surveil to ascertain 

the effectiveness of their policies and 

procedures. Trading centers cannot 

merely establish policies and 

procedures that may be reasonable 

when created and assume that such 

policies and procedures continue to 

satisfy the requirements of Rule 611. 

Rather, trading centers must regularly 

assess the continuing effectiveness of 

their procedures and take prompt action 

when needed to remedy deficiencies. 

3. Exceptions 

Rule 611(b) sets forth a variety of 

exceptions addressing transactions that 

may fall within the definition of a tradethrough, but which would not be subject 

to the operative requirements of the 

Rule. The exceptions primarily are 

designed to achieve workable 

intermarket price protection and to 

facilitate certain trading strategies and 

order types that are useful to investors, 

but also are consistent with the 

principle of price protection. 

Paragraph (b)(1) excepts a transaction 

if the trading center displaying the 

protected quotation that was traded 

through was experiencing a failure, 

material delay, or malfunction of its 

systems or equipment when the tradethrough occurred. As discussed in 

section II.A.3 above, the exception for a 

‘‘material delay’’ would give trading 

centers a self-help remedy if another 

trading center repeatedly fails to 

provide an immediate (within one 

second under current trading 

conditions) response to incoming orders 

attempting to access its quotes. The 

trading center receiving an order could 

only be held responsible for its own 

turnaround time (i.e., from the time it 

first received an order to the time it 

transmits a response to the order). 

Accordingly, the routing trading center 

would be required to develop policies 

and procedures that allow for any 

potential delays in transmission not 

attributable to the receiving trading 

center. Trading centers would need to 

establish reasonable and objective 

parameters governing their use of the 

material delay exemption. For example, 

a single failure to respond within one 

second generally would not justify 

future bypassing of another trading 

center’s quotations. Many failures to 

respond within one second in a short 

time period, in contrast, clearly would 

warrant use of the exception. Moreover, 

prior to disregarding quotations, a 

trading center should attempt to resolve 

the problem by contacting the other 

trading center that has failed to respond 

immediately. 

Paragraph (b)(8) of Rule 611 sets forth 

an exception for flickering quotations. It 

excepts a transaction if the trading 

center displaying the protected 

quotation that was traded through had 

displayed, within one second prior to 

execution of the trade-through, a best 

bid or best offer, as applicable, for the 

NMS stock with a price that was equal 

or inferior to the price of the tradethrough transaction. This exception 

thereby provides a ‘‘window’’ to address 

false indications of trade-throughs that 

in actuality are attributable to rapidly 

77446 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

147Such a limit order would be ‘‘marketable’’

because it would be immediately subject to 

execution at current displayed prices. 

Consequently, ‘‘limit order’’ is used differently in 

this context than elsewhere in this release, where 

it is used to refer to non-marketable orders that 

generally will be displayed, in contrast to 

marketable orders that generally will not be 

displayed. See supra, note 34 (description of 

marketable limit orders and non-marketable limit 

orders).

148An intermarket sweep order could go unfilled 

because the protected quotation at a trading center 

was accessed or withdrawn prior to the trading 

center’s receipt of the intermarket sweep order. In 

addition, the existence of undisplayed orders or 

reserve size at some trading centers could result in 

an execution at better prices than may have been 

indicated by the displayed prices and sizes. The 

router of an intermarket sweep order would only be 

responsible, however, for routing orders in 

accordance with the displayed price and size of 

protected quotations. Whether the orders actually 

execute against the protected quotations, or go 

unfilled because the quotations have been 

previously executed or withdrawn, is not within the 

responsibility or control of the router of the 

intermarket sweep order.

149The Commission preliminarily does not 

believe that ‘‘stopped’’ orders should be excepted 

from reproposed Rule 611 because their execution 

is based, at least indirectly, on the quoted price of 

a stock at the time of execution and their material 

terms are known when the commitment to execute 

the order was made. Comment is requested on the 

extent to which the proposed rule language 

appropriately designates those transactions that 

should be excepted because they are consistent 

with the price protection objectives of reproposed 

Rule 611.

150 ‘‘Regular way’’ refers to bids, offers, and 

transactions that embody the standard terms and 

conditions of a market. Thus, this exception would 

apply to a transaction that was executed other than 

pursuant to standardized terms and conditions, for 

moving quotations. It also potentially 

would reduce the number of instances 

in which a trading center must alter its 

normal trading procedures and route 

orders to other trading centers to 

comply with reproposed Rule 611. The 

exception is thereby intended to 

promote more workable intermarket 

price protection.

Paragraphs (b)(5) and (b)(6) of Rule 

611 set forth exceptions for intermarket 

sweep orders. An intermarket sweep 

order is defined in Rule 600(b)(30) as a 

limit order 147 that meets the following 

requirements: (1) when routed to a 

trading center, the limit order is 

identified as an intermarket sweep 

order, and (2) simultaneously with the 

routing of the limit order identified as 

an intermarket sweep order, one or more 

additional limit orders, as necessary, are 

routed to execute against the full 

displayed size of all protected 

quotations with a superior price. These 

additional limit orders must be marked 

as intermarket sweep orders to allow the 

receiving market center to execute the 

order immediately without regard to 

better-priced quotations displayed at 

other trading centers (by definition, 

each of the additional limit orders 

would meet the requirements for an 

intermarket sweep order). Paragraph (c) 

of Rule 611 would require that the 

trading center or broker-dealer 

responsible for the routing of an 

intermarket sweep order take reasonable 

steps to establish that orders are 

properly routed in an attempt to execute 

against all applicable protected 

quotations. A trading center or brokerdealer would be required to satisfy this 

requirement regardless whether it routes 

the order through its own systems or 

sponsors a customer’s access through a 

third-party vendor’s systems. Paragraph 

(b)(5) would allow a trading center 

immediately to execute any order 

identified as an intermarket sweep 

order. It therefore need not delay its 

execution for the updating of the betterpriced quotations at other trading 

centers to which orders were routed 

simultaneously with the intermarket 

sweep order. Paragraph (b)(6) would 

allow a trading center itself to route 

intermarket sweep orders and thereby 

clear the way for immediate internal 

executions at the trading center. This 

exception particularly would facilitate 

the immediate execution of block orders 

by dealers on behalf of their 

institutional clients.

To illustrate the operation of the 

intermarket sweep order exception, 

assume that the Market BBO Alternative 

were adopted and a broker-dealer’s 

customer wished to sell a large amount 

of an NMS stock. Trading Center A is 

displaying the national best bid of 500 

shares at $10.00, along with quotations 

in its proprietary depth-of-book data 

feed of 1500 shares at $9.99, and 5000 

shares at $9.97. The customer decides to 

sweep all liquidity on Trading Center A 

down to $9.97. Assume also that 

Trading Center B is displaying a 

protected bid of 2000 shares at $9.99, 

Trading Center C is displaying a 

protected bid of 400 shares at $9.98, and 

Trading Center D is displaying a 

protected bid of 200 shares at $9.97. The 

broker-dealer could execute this trade 

for its customer, subject to its best 

execution responsibilities, by 

simultaneously routing the following 

orders: (1) An intermarket sweep order 

to Trading Center A with a limit price 

of $9.97 and a size of 7000 shares; (2) 

an intermarket sweep order to Trading 

Center B with a limit price of $9.99 and 

a size of 2000 shares; and (3) an 

intermarket sweep order to Trading 

Center C with a limit price of $9.98 and 

a size of 400 shares. All of these orders 

would meet the requirements of Rule 

600(b)(30) because the necessary orders 

simultaneously were routed to execute 

against the displayed size of all betterpriced protected quotations. Trading 

Centers A, B, and C all could execute 

their orders immediately without regard 

to the protected quotations displayed at 

other trading centers. No order would 

need to be routed to Trading Center D 

because the price of its bid was not 

superior to the most inferior limit price 

of the order routed to Trading Center A. 

Assuming the customer obtained a fill 

for each of its orders at the displayed 

prices and sizes,148 it would have been 

able to obtain an immediate execution 

of a 9400-share trade by sweeping 

through four price levels at Trading 

Center A, while also honoring the 

protected quotations at two other 

trading centers. The trade therefore 

would have both upheld the principle of 

price protection and served the 

customer’s legitimate interest in 

obtaining an immediate execution of 

large size.

The exception in paragraph (b)(7) of 

Rule 611 would facilitate other types of 

orders that often are useful to 

investors—benchmark orders. It would 

except the execution of an order at a 

price that was not based, directly or 

indirectly, on the quoted price of an 

NMS stock at the time of execution and 

for which the material terms were not 

reasonably determinable at the time the 

commitment to execute the order was 

made. A common example of a 

benchmark order is a VWAP order. 

Assume a broker-dealer’s customer 

decides to buy a stock at 9 a.m. before 

the markets open for normal trading. 

The customer submits, and the brokerdealer accepts, an order to buy 100,000 

shares at the volume-weighted average 

price of the stock from opening until 1 

p.m. At 1 p.m., the national best offer in 

the stock is $20.00, but the relevant 

volume-weighted average price (in a 

rising market) is $19.90. The brokerdealer would be able to rely on the 

benchmark order exception to execute 

the order at $19.90 at 1 p.m., without 

regard to better-priced protected 

quotations at other trading centers. Of 

course, any transactions effected by the 

broker-dealer during the course of the 

day to obtain sufficient stock to fill the 

benchmark order would remain subject 

to Rule 611. The benchmark exception 

also would encompass the execution of 

an order that is benchmarked to a 

market’s single-priced opening, as the 

Commission would not interpret such 

an opening price to be the ‘‘quoted 

price’’ of the NMS stock at the time of 

execution.149

Finally, paragraph (b) of Rule 611 

includes a variety of other exceptions: 

(1) transactions other than ‘‘regular 

way’’ contracts; 150 (2) single-price 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77447

instance a transaction that has extended settlement 

terms.

151Rule 611 as reproposed does not include two 

exceptions that were included in the proposed rule. 

One was for trade-throughs of ‘‘non-firm’’

quotations. This exception is unnecessary because 

a quotation that is not firm would not qualify as an 

automated, and therefore protected, quotation. The 

other proposed exception was for a transaction by 

a trading center experiencing systems problems. To 

the extent such a transaction is isolated and could 

not have been reasonably avoided, it would not be 

addressed by reasonable policies and procedures. If 

such transactions occurred repeatedly, however, 

they would call into question whether the trading 

center in fact had implemented reasonable policies 

and procedures to prevent trade-throughs.

152See generally Securities Exchange Act Release 

No. 37619A (Sept. 6, 1996), 61 FR 48290, 48322–

48333 (Sept. 12, 1996) (discussion of best execution 

responsibilities).

153See, e.g., Citigroup Letter at 3, 6; Goldman 

Sachs Letter at 5–6; Morgan Stanley Letter at 7; SIA 

Letter at 7.

154Section 11A(a)(1)(C)(iv) of the Exchange Act.

155Section 11A(a)(1)(C)(i) of the Exchange Act.

156Section 11A(a)(1)(D) of the Exchange Act.

157 ITS Plan, Section 6(b)(i).

158 ITS Plan, Sections 6(b), 8(d), and 11(b).

159Were reproposed Rule 610 to be adopted, the 

Commission anticipates that SRO participants 

would be permitted to withdraw from the ITS Plan, 

assuming they had otherwise arranged to meet their 

access responsibilities.

160The modification of Regulation ATS is 

discussed in section III.B.4 below.

opening, reopening, or closing 

transactions; and (3) transactions 

executed at a time when protected 

quotations were crossed. The crossed 

quotation exception would not apply 

when a protected quotation crosses a 

non-protected (e.g., manual) 

quotation.151

4. Duty of Best Execution 

The Commission emphasizes that 

adoption of reproposed Rule 611 would 

in no way lessen a broker-dealer’s duty 

of best execution. Broker-dealers still 

must seek the most advantageous terms 

reasonably available under the 

circumstances for their customer orders. 

They must carry out a regular and 

rigorous review of the quality of markets 

to evaluate their order execution 

policies, including their decisions 

concerning the markets to which to 

route customer order flow.152 The 

protection against trade-throughs that 

would be provided by Rule 611 would 

not diminish the broker-dealer’s 

responsibility for evaluating the 

execution quality of markets, regardless 

of the exceptions set forth in the Rule. 

Moreover, Rule 611 could not be used 

to justify the internal execution of retail 

orders by a market maker at prices 

inferior to the best available quotations.

Several commenters who supported 

excluding manual quotations from 

trade-through protection also suggested 

that manual quotations should be 

excluded from the NBBO that is 

calculated and disseminated by Plan 

processors.153 Under this approach, 

market participants could disregard 

manual quotations for purposes of 

assessing the best execution of customer 

orders and calculating execution quality 

statistics under Rule 11Ac1–5 (proposed 

to be redesignated as Rule 605). The 

Commission has decided not to propose 

the elimination of manual quotations 

from the NBBO at this time. Under the 

Quote Rule, broker-dealers must honor 

their firm quotations, although the 

speed of their response may vary 

according to whether such a quotation 

is automated or manual. A common 

business practice of many market 

makers is to use the NBBO to price 

investor orders, particularly those of 

retail investors. Currently, manual 

quotations establish the NBBO in many 

NMS stocks. The Commission is 

concerned that eliminating manual 

quotations from the NBBO potentially 

would widen the spreads in many 

stocks, even though the quotations often 

may in fact represent the best indication 

of the current market price of the stock. 

Of course, broker-dealers would 

continue to be able to assess the 

availability of manual quotations in 

making their best execution analyses.

III. Access Rule 

For the NMS to fulfill its statutory 

objectives, fair and efficient access to 

each of the individual markets that 

participate in the NMS is essential. One 

of the NMS objectives, for example, is 

to assure the practicability of brokers 

executing investors’ orders in the best 

market.154 Another is to assure the 

efficient execution of securities 

transactions.155 Clearly, neither of these 

objectives can be achieved if brokers 

cannot fairly and efficiently route orders 

to execute against the best quotations for 

a stock, wherever such quotations are 

displayed in the NMS. In 1975, 

Congress determined that the ‘‘linking 

of all markets’’ for NMS stocks through 

communications and data processing 

facilities would ‘‘foster efficiency; 

enhance competition; increase the 

information available to brokers, 

dealers, and investors; facilitate the 

offsetting of investors’ orders; and 

contribute to the best execution of 

investors’ orders.’’ 156 Since 1975, there 

have been dramatic improvements in 

communications and processing 

technologies. Reproposed Rule 610 is 

intended to capitalize on these 

improvements and thereby enhance the 

‘‘linking of all markets’’ for the future 

NMS.

All SROs that trade exchange-listed 

stocks currently are linked through ITS, 

a collective intermarket linkage facility. 

ITS provides a means of access to 

exchanges and Nasdaq by permitting 

each market to send a ‘‘commitment to 

trade’’ through the system, with 

receiving markets generally having up to 

30 seconds to respond.157 ITS also 

provides access to quotations of 

participants without fees and 

establishes uniform rules to govern 

quoting practices.158 Thus, while ITS 

promotes access that is uniform and 

free, it also is often slow and limited. 

Moreover, it is governed by a 

unanimous vote requirement that 

impedes innovation.

In contrast, there is no collective 

intermarket linkage system for SROs 

that trade Nasdaq stocks. Instead, access 

is achieved primarily by private 

linkages among individual trading 

centers. This approach has 

demonstrated its advantages among 

electronic markets. It is flexible and can 

readily incorporate technological 

advances as they occur. There is no 

intermarket system, however, that offers 

free access to quotations in Nasdaq 

stocks. Nor are the trading centers for 

Nasdaq stocks subject to uniform 

intermarket standards governing their 

quoting and trading practices. The fees 

for access to quotations in Nasdaq 

stocks, as well as the absence of 

standards for quotations that lock and 

cross markets, have been the source of 

severe disputes among participants in 

the market for Nasdaq stocks for many 

years. Moreover, private linkages have 

not worked effectively with respect to 

the Amex manual trading of Nasdaq 

stocks, nor have they been successful in 

preventing intentional barriers to access, 

especially involving fees. 

Reproposed Rule 610 is based on the 

Commission’s determination that fair 

and efficient access to markets could be 

achieved without a collective 

intermarket linkage facility such as 

ITS.159 It reproposes a private linkage 

approach for all NMS stocks, but with 

modifications to address the most 

serious problems that have arisen with 

this approach in the trading of Nasdaq 

stocks. Rule 610 would address three 

subject areas: (1) access to quotations, 

(2) fees for access to protected 

quotations, and (3) locking and crossing 

quotations. In addition, the Commission 

is reproposing a modification to the fair 

access requirements of Regulation ATS 

that would extend their application to 

ATSs with 5% of trading volume in a 

security.160

77448 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

161See Rule 301(b)(3) of Regulation ATS (order 

display and execution access requirements).

162As discussed in section III.B.4 below, the 

Commission is reproposing an amendment to the 

fair access requirements of Regulation ATS that 

would extend their application to ATSs with 5% of 

trading volume in a security.

163See, e.g., Citigroup Letter at 12; Consumer 

Federation Letter at 4; Goldman Sachs Letter at 4; 

ICI Letter at 16–17; Morgan Stanley Letter at 17; 

Nasdaq Letter II at 20; NYSE Letter, Attachment at 

6; Letter from Carrie E. Dwyer, General Counsel & 

Executive Vice President, Charles Schwab & Co., 

Inc., to Jonathan G. Katz, Secretary, Commission, 

dated June 30, 2004 (‘‘Schwab Letter’’) at 17; SIA 

Letter at 16; UBS Letter at 8.

164Morgan Stanley Letter at 17.

165SIA Letter at 16.

166NYSE Letter, Attachment at 7.

167See, e.g., Letter from Brendan R. Dowd, Daniel 

W. Tandy & Ronald Zdrojeski, Alliance of Floor 

Brokers, to Jonathan G. Katz, Secretary, 

Commission, dated June 24, 2004 (‘‘Alliance of 

Floor Brokers Letter’’) at 2; Ameritrade Letter I, 

Appendix at 11; BSE Letter at 7; CHX Letter at 13; 

E*Trade Letter at 9.

168BSE Letter at 7.

169Alliance of Floor Brokers Letter at 2.

170Alliance of Floor Brokers Letter at 10; Amex 

Letter, Exhibit A at 25–26; BSE Letter at 12; CHX 

Letter at 14; Citigroup Letter at 12; Letter from Edith 

H. Hallahan, First Vice President, Deputy General 

Counsel, Philadelphia Stock Exchange, to Jonathan 

G. Katz, Secretary, Commission, dated August 10, 

2004 (‘‘Phlx Letter’’) at 2; STANY Letter at 9.

171CHX Letter at 14.

172Amex Letter, Exhibit A at 26.

A. Response to Comments and Basis for 

Reproposed Rule 

1. Access to Quotations 

Paragraphs (a) and (b) of reproposed 

Rule 610 would address access to 

quotations. Among the variety of 

services offered by equity markets, 

access to displayed quotations, 

particularly the best quotations of a 

trading center, is most vital for the 

smooth functioning of intermarket 

trading. Brokers responsible for routing 

their customers’ orders, as well as 

investors that make their own orderrouting decisions, clearly must have fair 

and efficient access to the best 

quotations of all trading centers to 

achieve best execution of those orders. 

In addition, trading centers themselves 

must have the ability to execute orders 

against the displayed quotations of other 

market centers. Indeed, the very 

existence of intermarket protection 

against trade-throughs is premised on 

the ability of trading centers to trade 

with, rather than trade through, the 

protected quotations displayed by other 

trading centers. 

Access to quotations, sometimes 

referred to as ‘‘order execution 

access,’’ 161 should be distinguished 

from a broader type of access that 

encompasses all of the different types of 

services offered by markets, such as the 

right to display limit orders or to submit 

complex order types. To obtain the full 

range of their services, markets 

generally require that an individual or 

firm become members or subscribers of 

the market. This type of access, or 

‘‘membership access,’’ subsumes access 

to quotations and is governed by 

particular regulatory requirements. 

Sections 6(b)(2) and 15A(b)(3) of the 

Exchange Act, for example, provide for 

fair access to membership in SROs. 

Similarly, Rule 301(b)(5) of Regulation 

ATS prohibits certain high volume 

ATSs from denying fair access to their 

services.162 Reproposed Rule 610(a) and 

(b), in contrast, would only address the 

responsibilities of trading centers to 

provide order execution access to their 

quotations.

The access proposal sought to achieve 

the goal of fair and efficient access to 

quotations primarily by prohibiting 

trading centers from unfairly 

discriminating against non-members or 

non-subscribers that attempt to access 

quotations through a member or 

subscriber of the trading center. Market 

participants could either become 

members or subscribers of a trading 

center to obtain direct access to its 

quotations, or they could obtain indirect 

access by ‘‘piggybacking’’ on the direct 

access of members or subscribers. These 

forms of access are widely used today in 

the market for Nasdaq stocks (as well as 

to a lesser extent in the market for 

exchange-listed stocks). Instead of every 

market participant establishing separate 

linkages with every trading facility, 

many different private firms have 

entered the business of linking with a 

wide range of trading centers and then 

offering their customers access to those 

trading centers through the private 

firms’ linkages. Competitive forces 

determine the types and costs of these 

private linkages.

Most commenters supported this 

private linkage approach for access to 

quotations.163 They frequently noted the 

success of private linkages among 

electronic markets for Nasdaq stocks 

and contrasted the speed and usefulness 

of those linkages with the ITS linkage 

for exchange-listed stocks. Morgan 

Stanley noted that ‘‘[p]rivate linkages 

are much easier to establish and operate 

and can be constructed directly between 

[order execution facilities] or through 

market intermediaries. The smooth 

operation of the market for Nasdaq 

stocks today clearly demonstrates the 

power of private linkages.’’ 164 The SIA 

stated that ‘‘for competitive reasons, 

market participants will be interested in 

the most up-to-date technology and 

routing methods available at any given 

time, and the proposed standards would 

permit such technology to evolve on an 

ongoing basis.165 The NYSE concluded 

that ‘‘[i]n the market for listed stocks, 

we believe that proposed Regulation 

NMS will provide the framework for 

alternatives to ITS for intermarket 

access.’’ 166

A few commenters opposed the 

proposed private linkages approach.167

Some questioned whether multiple 

private linkages could match the 

efficiency of a single, uniform 

intermarket linkage, although they 

generally emphasized that the current 

ITS linkage needed to be enhanced. The 

BSE, for example, stated that ‘‘[m]ultiple 

individual links to every market is not 

an economical or practical solution and 

it would enable gaming opportunities 

within the markets via technology.’’ 168

The Alliance of Floor Brokers suggested 

that problems with the ITS linkage, such 

as its slow speed and lack of structural 

flexibility, ‘‘should be addressed before 

it is determined to replace it with some, 

as yet unspecified, routing methodology 

or mechanism.’’ 169 The Commission has 

considered these views, but 

preliminarily believes that the benefits 

of private linkages, including their 

flexibility to meet the needs of different 

market participants and the scope they 

allow for competitive forces to 

determine linkages, justifies reliance on 

this model rather than a single 

intermarket linkage.

Several commenters, including some 

that otherwise supported the proposal, 

expressed concern about particular 

problems that might arise under a 

private linkage approach.170 Some were 

concerned that requiring nondiscriminatory access to markets might 

undermine the value of SRO 

membership. CHX stated that ‘‘[b]y 

requiring the Exchange to grant nonmembers access to the full capabilities 

of its order execution systems, the 

Commission’s fair access proposal 

would inappropriately require the 

Exchange’s members to help fund the 

costs of operating a market that could be 

routinely used by non-members. It 

would severely undercut the value of 

membership and enable non-members 

to free-ride on the fees paid by 

members.’’ 171 Amex stated that ‘‘to the 

extent that the proposed rule 

undermines our right to differentiate 

between members (who pay fees and 

have duties and responsibilities to the 

Exchange) and non-members in our 

charges, it could effectively remove any 

incentive for Amex membership.’’172

The Commission does not believe that 

adoption of a private linkage approach 

would seriously undermine the value of 

membership in SROs that offer valuable 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77449

173Amex Letter at 8; Brut Letter at 19; Citigroup 

Letter at 13; E*Trade Letter at 9; Nasdaq Letter II 

at 22; SIA Letter at 16; Specialist Assoc. Letter at 

12; STA Letter at 4; STANY Letter at 10; UBS Letter 

at 9.

174Hearing Tr. at 135, 138–140; Supplemental 

Release, 69 FR at 30146.

175See, e.g., Brut Letter at 13; Citigroup Letter at 

13; SIA Letter at 17 (some firms).

176Brut Letter at 13.

177SIA Letter at 16.

178See, e.g., Ameritrade Letter I, Appendix at 11; 

E*Trade Letter at 9; SIA Letter at 17.

179Letter from John M. Schaible, President, 

NexTrade Holdings, Inc., to Jonathan G. Katz, 

Secretary, Commission, dated July 29, 2004 

(‘‘NexTrade Letter’’) at 14.

services to their members. First, the fact 

that markets would not be allowed to 

impose unfairly discriminatory terms on 

non-members who obtain indirect 

access to quotations through members 

does not mean that non-members would 

obtain free access to quotations. 

Members who provide piggyback access 

would be providing a useful service and 

presumably would charge a fee for such 

service. The fee would be subject to 

competitive forces and likely would 

reflect the costs of SRO membership, 

plus some element of profit to the SRO’s 

members. As a result, non-members that 

frequently make use of indirect access 

are likely to contribute indirectly to the 

costs of the SRO market. Moreover, the 

unfair discrimination standard of Rule 

610(a) would apply only to access to 

quotations, not to the full panoply of 

services that markets generally provide 

only to their members. 

On the other hand, any attempt by an 

SRO to charge differential fees based on 

the non-member status of the person 

obtaining indirect access to quotations, 

such as whether it is a competing 

market maker, would violate the antidiscrimination standard of reproposed 

Rule 610. As noted above, fair and 

efficient access to quotes is essential to 

the functioning of the NMS. To comply 

with the Trade-Through Rule and their 

duty of best execution, trading centers 

often may be required to access the 

quotations of other trading centers. If a 

trading center charged discriminatory 

fees to competitors accessing its 

quotations, it would interfere in the 

functioning of the private linkage 

approach and detract from its usefulness 

to trading centers in meeting their 

regulatory responsibilities. 

Other types of differential fees, 

however, would not violate the antidiscrimination standard of reproposed 

Rule 610. Fees with volume-based 

discounts or fees that are reasonably 

based on the cost of providing a 

particular service would be permitted, 

so long as they do not vary based on the 

non-member status of a person 

obtaining indirect access to quotations. 

For example, a member providing 

indirect access would be entitled to 

obtain a volume discount on the full 

amount of its volume, including the 

volume accounted for by persons 

obtaining indirect access to quotations.

Another specific concern expressed 

by commenters about the private linkage 

approach was assuring efficient linkage 

to trading centers with a small amount 

of trading volume that do not make their 

quotations accessible through an SRO 

trading facility.173 Such quotations 

currently are displayed only through the 

ADF, a display-only quotation facility 

operated by the NASD, and must be 

accessed directly at the trading center. 

The proposal would have only required 

such trading centers to provide access to 

SROs and other ADF participants. At 

the NMS Hearing, several panelists 

expressed concern that this requirement 

would be inadequate to assure sufficient 

access, which prompted the 

Commission to request comment on the 

matter in its Supplemental Release.174 It 

noted that panelists at the NMS Hearing 

had suggested that relatively inactive 

ATSs and market makers should be 

required to publish their quotations in 

an SRO trading facility, at least until 

their share of trading reached a point 

where the cost of direct connections to 

those markets would not be out of 

proportion to their volume of trading. 

Alternatively, the Supplemental Release 

requested comment on whether an SRO 

without a trading facility, of which the 

NASD is currently the only one, should 

be required to ensure that any ATS or 

market maker is directly connected to 

most market participants before 

publishing its quotations in a displayonly facility.

Several commenters supported the 

approach of requiring low-volume 

trading centers to make their quotations 

available through an SRO trading 

center.175 Brut, for example, stated that 

the presence of such low-volume 

trading centers ‘‘requires vast industry 

investments to establish private 

connectivity (or utilize vendors) to 

access these markets—no matter how 

small or potentially how fleeting—to 

satisfy best execution obligations and 

avoid market disruption. The effort and 

investment to establish such 

connectivity is disproportionate to the 

liquidity on such market.’’ 176 Brut 

further noted that it had sought to avoid 

such ADF trading centers in the past, 

but that the extension of trade-through 

protection to Nasdaq stocks would 

eliminate this option.

The SIA also believed that ‘‘reliance 

solely on the SEC’s proposed market 

access rules would fail to address access 

issues related to smaller markets * * *. 

If the SEC obligates market participants 

to trade with [a smaller ADF market 

maker or ATS] by promulgating a tradethrough rule, we are concerned about 

the firms’ burden of creating many 

private linkages to many small ATSs 

that may charge exorbitant fees for the 

necessary access.’’ 177 SIA members 

were divided, however, on the best 

means to resolve the issue. Some 

favored requiring smaller trading 

centers to make their quotes accessible 

through an SRO trading center. Other 

SIA members, as well as other 

commenters, recommended requiring all 

trading centers to make their best 

quotations available through a public 

intermarket linkage facility.178

One commenter, in contrast, believed 

that access to trading centers quoting on 

the ADF should be addressed by 

requiring the NASD to add an order 

execution functionality to ADF. 

NexTrade stated that the ADF was 

created to make participation in 

Nasdaq’s SuperMontage facility 

voluntary. It believed that ‘‘the 

Commission should re-evaluate whether 

or not ’private sector’ solutions for SROs 

without an execution mechanism are 

sufficient for the investment community 

to satisfy its various obligations under 

the Act.’’ 179

After considering the various views of 

commenters, the Commission 

preliminarily has determined not to 

require small market centers to make 

their quotations accessible through an 

SRO trading facility. As discussed 

below, it believes that broker-dealers 

should continue to have the option of 

trading in the OTC market. Nor is the 

NASD statutorily required to provide an 

order execution functionality in the 

ADF. Instead, the Commission has 

reproposed Rule 610(b)(1), which 

requires all trading centers that choose 

to display quotations in an SRO displayonly quotation facility to provide a level 

and cost of access to such quotations 

that is substantially equivalent to the 

level and cost of access to quotations 

displayed by SRO trading facilities. 

The NASD, as a national securities 

association, is subject to different 

regulatory requirements than a national 

securities exchange. It is responsible for 

regulating the OTC market (i.e., trading 

by broker-dealers otherwise than on a 

national securities exchange). Section 

15A(b)(11) of the Exchange Act requires 

an association to have rules governing 

the form and content of quotations 

relating to securities sold otherwise than 

77450 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

180Under Rule 301(b)(3) of Regulation ATS, an 

ATS is required to display its quotations in the 

consolidated data stream only in those securities for 

which its trading volume reaches 5% of total 

trading volume.

181Securities Exchange Act Release No. 46249 

(July 24, 2002), 67 FR 49821 (July 31, 2002).

182A full description of the current framework for 

access fees is provided in the Proposing Release. 69 

FR at 11156.

183See, e.g., Hearing Tr. at 166, 168.

184Supplemental Release, 69 FR at 30147.

185See, e.g., BNY Letter at 4; Letter from Kenneth 

Griffin, President & Chief Executive Officer, Citadel 

Investment Group, L.L.C., to Jonathan G. Katz, 

Secretary, Commission, dated July 9, 2004 (‘‘Citadel 

Letter’’) at 9; Citigroup Letter at 14; E*Trade Letter 

at 10; Nasdaq Letter II at 3; SIA Letter (some 

members) at 18.

on a national securities exchange that 

are published by a member of the 

association. Such rules must be 

designed to produce fair and 

informative quotations and to promote 

orderly procedures for collecting, 

distributing, and publishing quotations. 

The Exchange Act does not, however, 

require an association to establish a 

facility for executing orders against the 

quotations of its members. 

ATSs and market makers that wish to 

trade NMS stocks can choose from a 

number of options for quoting and 

trading. They can become a member of 

a national securities exchange and quote 

and trade through the exchange’s 

trading facilities. They can participate 

in the NASDAQ Market Center and 

quote and trade through that facility. 

Finally, they can quote and trade in the 

OTC market. The existence of the 

NASD’s ADF makes this third choice 

possible by providing a facility for 

displaying quotations and reporting 

transactions in the consolidated data 

stream.180

The Commission preliminarily 

believes that those ATSs and market 

makers that choose to display 

quotations in the ADF should bear the 

responsibility of providing a level and 

cost of access to their quotations that is 

substantially equivalent to the level and 

cost of access to quotations displayed by 

SRO trading facilities. Although the 

Exhange Act allows an individual 

broker-dealer to have the option of 

trading in the OTC market, it does not 

mandate that the securities industry in 

general subsidize the costs of accessing 

a broker-dealer’s quotations in the OTC 

market. Under reproposed Rule 

610(b)(1), therefore, ADF participants 

would be required to establish the 

necessary connectivity that would 

facilitate efficient access to their 

quotations. As noted in the 

Commission’s order approving the pilot 

program for the ADF, the reduction in 

communications line costs in recent 

years and the advent of competing 

access providers offer the potential for 

multiple competitive means of access to 

the various trading centers that trade 

NMS stocks.181 To meet their regulatory 

requirements, ADF participants would 

have the option of establishing 

connections to these industry access 

providers, which in turn have extensive 

connections to a wide array of market 

participants. As the self-regulatory 

authority responsible for the OTC 

market, the NASD would need to assess 

the extent to which ADF participants 

have met the access standards of 

reproposed Rule 610.

2. Limitation on Access Fees

Many trading centers charge fees that 

are triggered when incoming orders 

execute against their displayed 

quotations.182 Such access fees 

particularly have characterized the 

business models of ECNs, which 

typically pass a substantial portion of 

the access fee on to customers as rebates 

for supplying the accessed liquidity 

(i.e., by submitting non-marketable limit 

orders). For Nasdaq stocks, ECNs have 

charged access fees directly to their 

subscribers, but also have charged 

access fees to non-subscribers when 

their quotations have been displayed 

and executed through Nasdaq facilities. 

Other types of trading centers, including 

exchange SROs, also charge fees that are 

triggered when incoming orders access 

their displayed quotations. These fees 

have only been charged to their 

members, because only members have 

the right to route orders to an exchange 

other than through ITS. For exchangelisted stocks, moreover, the ITS has 

provided free intermarket access to 

quotations for its participants. Finally, 

market makers have not been permitted 

to charge any fee for counterparties 

accessing their quotations under the 

Quote Rule.

The reproposed trade-through 

protection and linkage requirements 

would significantly alter the regulatory 

landscape that has shaped access fee 

practices in the past. For exchangelisted stocks, Rule 610 reproposes a 

private linkage approach that relies on 

access through members and subscribers 

rather than through a public intermarket 

linkage system. For access outside of 

ITS, markets would pay, directly or 

indirectly, the fees charged by other 

markets to their members and 

subscribers. For Nasdaq stocks, the 

reproposed Trade-Through Rule would, 

for the first time, establish price 

protection, so market participants 

would no longer have the option of 

bypassing the quotations of trading 

centers with access fees that they view 

as too high. 

The benefits of strengthened price 

protection and more efficient linkages 

could be compromised if trading centers 

were able to charge substantial fees for 

accessing their quotations. Moreover, 

the wider the disparity in the level of 

access fees, the less useful and accurate 

are the prices of quotations displayed 

for NMS stocks. For example, if two 

trading centers displayed offers to buy 

an NMS stock for $10.00 per share, one 

offer might be accessible for a total price 

of $10.00 plus a $0.003 fee and the other 

offer might be accessible for a total price 

of $10.00 plus a $0.009 fee. If each 

trading center rebated all except $0.001 

of their fees to liquidity providers (as is 

often the case), one customer submitting 

a limit order to sell at $10.00 would 

receive $10.002, while another customer 

submitting a limit order to sell at $10.00 

would receive $10.008. What appeared 

in the consolidated data stream to be 

identical quotations would in fact be far 

from identical, and market participants 

potentially would have powerful 

incentives to display their limit orders 

in high fee markets to obtain an 

economic reward beyond the quoted 

price of their limit order. 

To address the potential distortions 

caused by substantial, disparate fees, the 

access proposal included a limitation on 

fees. Trading centers would have been 

limited to a fee of no more than $0.001 

per share. Liquidity providers also 

would have been limited to a fee of no 

more than $0.001 per share for 

attributable quotations, but could not 

have charged any fee for nonattributable quotations. In addition, the 

proposal established an accumulated fee 

limitation of no more than $0.002 per 

share for any transaction. At the NMS 

Hearing, panelists displayed a sharp 

divergence of opinion on access fees, 

with some panelists arguing that agency 

markets must be allowed to charge for 

services, and other panelists arguing 

that access fees distort quotation 

prices.183 In the Supplemental Release, 

therefore, the Commission requested 

comment on all aspects of the proposed 

fee limitations, including whether it 

should adopt a single accumulated fee 

limitation that would apply to all types 

of market centers, and, if so, whether 

the proposed $0.002 per share was an 

appropriate amount, or whether the 

amount should be higher or lower.184

Commenters were splintered on the 

issue of access fees. A number were 

supportive of the Commission’s 

proposal as a worthwhile compromise 

on an extremely difficult issue.185 They 

believed that the proposal would level 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77451

186See, e.g., Brut Letter at 12; Instinet Letter at 

24; SIA Letter (some firms) at 18.

187 Instinet Letter at 27.

188See, e.g., Amex Letter at 7–8; Goldman Sachs 

Letter at 5; Knight Letter at 2; NYSE Letter at 5; STA 

Letter at 6.

189See, e.g., Instinet Letter at 24; Letter from 

Roderick Covlin, Executive Vice President, 

TrackECN, to William H. Donaldson, Chairman, 

Commission, dated May 10, 2004 (‘‘TrackECN 

Letter’’) at 1.

190SIA Letter at 17.

191For the relatively small number of NMS stocks 

priced under $1.00, fees would be limited to 0.3% 

of the quotation price per share to prevent fees from 

constituting an excessive percentage of share price.

192Section 11A(c)(1)(F) of the Exchange Act.

193Cf. Instinet Letter at 38 (‘‘there is no basis for 

adopting any limitation other than at the prevailing 

$0.003 per share level, which was arrived at 

through open competition among ATSs, ECNs, and 

SRO markets in the Nasdaq market’’).

194See supra, section II.A.4.a (discussion of 

competitive implications of trade-through 

protection).

the playing field in terms of who could 

charge fees, and provide some measure 

of certainty to market participants that 

the quoted price will be, essentially, the 

price they will pay. Other commenters 

were strongly opposed to any limitation 

on fees, believing that competition alone 

would sufficiently address the high fees 

that distort quoted prices.186 One 

asserted that ‘‘[c]ompetitive forces have 

satisfactorily dealt with the issue of 

outlier ECNs. . . [M]arket participants 

have put them at the bottom of their 

order routing tables, which means that 

orders placed on these ECNs would be 

the last to be executed at any price level, 

a position that no market participant 

wants to be in.’’ 187 In contrast, some 

commenters argued that all access fees 

charged to non-members and nonsubscribers should be prohibited, but 

believed that the proposed fee 

limitations should not apply to SRO 

transaction fees, particularly those that 

are filed with the Commission for 

approval.188 Finally, a few commenters 

questioned the Commission’s authority 

to set limitations on access fees.189

The Commission acknowledges the 

many difficult issues associated with 

access fees, but is concerned that these 

issues must be resolved to promote a 

fair and efficient NMS, particularly 

under the reproposed regulatory 

structure. As the SIA noted while 

discussing the divergent views of its 

members both opposing and supporting 

access fees, ‘‘[p]erhaps the only point of 

agreement in this debate is a desire for 

the resolution of the issue.’’ 190

After considering the many divergent 

views of commenters, the Commission 

preliminarily believes that a flat 

limitation on access fees to $0.003 per 

share would be the fairest and most 

appropriate solution to what has been a 

longstanding and contentious issue.191

The limitation is intended to achieve 

several objectives. First, it would greatly 

simplify the proposal by eliminating the 

separate limitations for trading centers 

and liquidity providers, as well as the 

associated attribution requirement. A 

single accumulated fee cap would apply 

equally to all types of trading centers 

and all types of market participants, 

thereby promoting the NMS objective of 

equal regulation of markets and brokerdealers.192

Second, the $0.003 fee limitation 

would be consistent with current 

business practices, as very few trading 

centers charge fees that exceed this 

amount.193 Based on recent inquiries, it 

appears that only two ECNs currently 

charge fees that exceed $0.003. One 

charges $0.004 for access through ADF, 

and the other charges $0.009 for access 

through the ADF. Neither of these ECNs 

currently accounts for a large percentage 

of trading volume. In addition, a few 

SROs have large fees on their books for 

transactions in ETFs that exceed a 

certain size (e.g., 2100 shares). It is 

unlikely that these fees generate a large 

amount of revenues.

Accordingly, the reproposed fee 

limitation would not reduce, much less 

eliminate, the fees that currently are 

charged by agency markets. The 

Commission recognizes that agency 

trading centers perform valuable agency 

services in bringing buyers and sellers 

together, and that their business model 

historically has relied, at least in part, 

on charging fees for execution of orders 

against their displayed quotations. 

Prohibiting access fees entirely would 

unduly harm this business model. 

Although not intended to reduce 

access fees, the reproposed fee 

limitation would be designed to 

preclude individual trading centers 

from raising their fees substantially in 

an attempt to take improper advantage 

of strengthened protection against tradethroughs and the adoption of a private 

linkage regime. In particular, the 

reproposed fee limitation would be 

necessary to address ‘‘outlier’’ trading 

centers that otherwise might charge high 

fees and pass most of the fees through 

as rebates to attract liquidity providers. 

It also would preclude a trading center 

from charging high fees selectively to 

competitors, practices that have arisen 

in the market for Nasdaq stocks, with 

limited success. In the absence of a fee 

limitation, however, the adoption of the 

Trade-Through Rule and private 

linkages could significantly boost the 

viability of the outlier business model. 

Outlier markets might well try to take 

advantage of intermarket price 

protection by acting essentially as a toll 

booth between price levels. The high fee 

market likely would be the last market 

to which orders would be routed, but 

prices could not move to the next level 

until someone routed an order to take 

out the displayed price at the outlier 

market. Because an outlier market could 

be no worse than last in order-routing 

preference, no matter how high its fees, 

it might see little downside to charging 

exceptionally high fees, such as $0.009, 

and passing most of the fee on to 

liquidity providers as rebates. In sum, 

while markets would have significant 

incentives to compete to be near the top 

in order-routing priority,194 there might 

be little incentive to avoid being the 

least-preferred market if fees were not 

limited.

The $0.003 cap would preclude the 

outlier business model. It would place 

all markets on a level playing field in 

terms of the fees they can charge and the 

rebates they can pass on to liquidity 

providers. Some markets might choose 

to charge lower fees, thereby increasing 

their ranking in the preferences of order 

routers. Others might charge the full 

$0.003 and rebate a substantial 

proportion to liquidity providers. 

Competition would determine which 

strategy was most successful. 

Moreover, the fee limitation would be 

necessary to achieve the purposes of the 

Exchange Act. Access fees tend to be 

highest when markets use them to fund 

substantial rebates to liquidity 

providers, rather than merely to 

compensate for agency services. If 

outlier markets were allowed to charge 

exorbitant fees and pass most of them 

through as rebates, the published 

quotations of such markets would not 

reliably indicate the true price that is 

actually available to investors or that 

would be realized by liquidity 

providers. Section 11A(c)(1)(B) of the 

Exchange Act authorizes the 

Commission to adopt rules assuring the 

fairness and usefulness of quotation in 

information. For quotations to be fair 

and useful, there must be some limit on 

the extent to which the true price for 

those who access quotations, and the 

true price realized by those who supply 

liquidity for quotations, can vary from 

the displayed price. Consequently, the 

$0.003 fee limitation would further the 

statutory purposes of the NMS by 

harmonizing quotation practices and 

precluding the distortive effects of 

exorbitant fees and liquidity rebates. 

Moreover, the fee limitation would be 

needed to further the statutory purpose 

of enabling broker-dealers to route 

orders in a manner consistent with the 

77452 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

195Section 11A(c)(1)(E) of the Exchange Act 

authorizes the Commission to adopt rules assuring 

that broker-dealers transmit orders for NMS stocks 

in a manner consistent with the establishment and 

operation of a national market system.

196See supra, section II.A.2.

197Supplemental Release, 69 FR at 30147.

198Amex Letter, Exhibit A at 27–28; Letter from 

Steve Swanson, Chief Executive Officer & President, 

Automated Trading Desk, LLC, to Jonathan G. Katz, 

Secretary, Commission, dated June 30, 2004 (‘‘ATD 

Letter’’) at 3; Brut Letter at 17; BSE Letter at 13; 

Citigroup Letter at 14; E*Trade Letter at 10; ICI 

Letter at 18; JP Morgan Letter at 6; Nasdaq Letter 

II at 23–24; NYSE Letter, Attachment at 9; SIA 

Letter at 19–20; STA Letter at 6; STANY Letter at 

8; UBS Letter at 9–10.

199 ICI Letter at 18.

200Amex Letter, Exhibit A at 27–28; ATD Letter 

at 3; ICI Letter at 18; Nasdaq Letter II at 23.

201Nasdaq Letter II at 23.

202Letter from Linda Lerner, General Counsel, 

Domestic Securities, Inc., to Jonathan G. Katz, 

Secretary, Commission, dated September 9, 2004 

(‘‘Domestic Securities Letter’’) at 2–3; Hudson River 

Trading Letter at 5–6; Instinet Letter at 39–41; Letter 

from Michael J. Simon, Senior Vice President & 

Secretary, International Securities Exchange, Inc., to 

Jonathan G. Katz, Secretary, Commission, dated 

June 30, 2004 (‘‘ISE Letter’’) at 7–8; Tower Research 

Letter at 6–8.

203 Instinet Letter at 39.

204For clarity, the definition of ‘‘SRO trading 

facility’’ replaces the definition of ‘‘quoting market 

center’’ in the proposal. It is consistent with the old 

definition.

operation of the NMS.195 To protect 

limit orders, orders must be routed to 

those markets displaying the best-priced 

quotations. This purpose would be 

thwarted if market participants were 

allowed to charge exorbitant fees that 

distort quoted prices.

Finally, the access fee limitation is 

narrowly drafted to cover only 

quotations that market participants 

would be required to access because of 

the Trade-Through Rule. The limitation 

would not apply to depth-of-book 

quotations (unless such quotations were 

designated as protected quotations 

under the Voluntary Depth Alternative) 

or to any other services offered by 

markets. It thereby would provide the 

necessary support for proper 

functioning of the Trade-Through Rule 

and private linkages, while leaving 

trading centers otherwise free to set fees 

subject only to other applicable 

standards (e.g., prohibiting unfair 

discrimination). 

3. Locking or Crossing Quotations 

The access proposal provided that the 

SROs must establish and enforce rules 

(1) requiring their members reasonably 

to avoid posting quotations that lock or 

cross the quotations of other markets, (2) 

enabling the reconciliation of locked or 

crossed markets, and (3) prohibiting 

their members from engaging in a 

pattern or practice of locking or crossing 

quotations. In light of the discussion at 

the NMS Hearing concerning automated 

quotations and automated markets,196

the Supplemental Release requested 

comment on whether market 

participants should be allowed to 

submit automated quotations that lock 

or cross manual quotations.197

Most of the commenters who 

addressed the issue supported the 

proposed restrictions on locking and 

crossing quotations.198 They generally 

agreed that the practice of displaying 

quotations that lock or cross previously 

displayed quotations is inconsistent 

with fair and orderly markets and 

detracts from market efficiency. One 

noted, for example, that locked and 

crossed markets ‘‘can be a sign of an 

inefficient market structure’’ and ‘‘may 

create confusion for investors, as it is 

unclear under such circumstances what 

is the true trading interest in a stock.’’199

Some commenters asserted that locked 

markets often occur when a market 

participant deliberately posts a locking 

quotation to avoid paying a fee to access 

the quotation of another market and to 

receive a liquidity rebate for an 

execution against its own displayed 

quotation.200 Nasdaq submitted data 

regarding the frequency of locked and 

crossed markets. During a one-week 

period in March 2004, it found that 

markets for Nasdaq stocks were locked 

or crossed an average of 509,018 times 

each day, with an average of 194,638 of 

the locks and crosses lasting more than 

1 second and an average duration of all 

locks and crosses of 3.1 seconds.201

Nasdaq stocks currently are not subject 

to provisions discouraging intermarket 

locking or crossing quotations such as 

those contained in the ITS Plan.

A few commenters opposed 

restricting the practice of locking or 

crossing quotations.202 They generally 

believed that the proposal would impair 

market transparency and efficiency, 

such as by prohibiting the display of 

information as to the true level of 

trading interest or information that a 

particular market’s quotations may be 

inaccessible. One commenter identified 

a number of causes, apart from access 

fees and liquidity rebates, that could 

lead to locked and crossed markets.203

These included determinations by 

market participants that quotations 

displayed by a locked or crossed market 

are not truly accessible, decisions by 

market participants that the potential 

disadvantages of routing away outweigh 

the potential advantages (e.g., loss of 

execution priority on the market place 

currently displaying the order), and 

decisions by market participants to 

exclusively use a particular market to 

run a trading strategy, even at the risk 

of missing some trading opportunities.

The Commission has decided to 

repropose restrictions on the practice of 

displaying locking or crossing 

quotations, but, consistent with its 

approach in the reproposed TradeThrough Rule, has modified the 

proposal to allow automated quotations 

to lock or cross manual quotations. Rule 

610(d) as reproposed thereby would 

address the concern that manual 

quotations may not be fully accessible 

and would recognize that allowing 

automated quotations to lock or cross 

manual quotations may provide useful 

market information. The Commission 

preliminarily believes, however, that an 

automated quotation is entitled to 

protection from locking or crossing 

quotations. When two market 

participants are willing to trade at the 

same quoted price, giving priority to the 

first-displayed automated quotation 

would contribute to fair and orderly 

markets. Moreover, the basic principle 

underlying the NMS is to promote fair 

competition among markets, but within 

a unified system that also promotes 

interaction between all of the buyers 

and sellers in a particular NMS stock. 

Allowing market participants simply to 

ignore accessible quotations in other 

markets and routinely display locking 

and crossing quotations would be 

inconsistent with this principle.

B. Description of Reproposed Rule 

Paragraphs (a) and (b) of reproposed 

Rule 610 address access to all 

quotations displayed by an SRO trading 

facility or by an SRO display-only 

facility. Paragraph (c) addresses the fees 

charged for access to protected 

quotations, and paragraph (d) addresses 

locking and crossing quotations. The 

Commission also is reproposing an 

extension of the scope of the fair access 

requirements of Regulation ATS. 

1. Access to Quotations 

a. Quotations of SRO Trading 

Facilities. Paragraph (a) of reproposed 

Rule 610 applies to quotations of an 

SRO trading facility. In reproposed Rule 

600(b)(72), an SRO trading facility is 

defined as a facility operated by a 

national securities exchange or a 

national securities association that 

executes orders in securities or presents 

orders to members for execution.204

This definition therefore would 

encompass the trading facilities of each 

of the exchanges, as well as the 

NASDAQ Market Center. The term 

‘‘quotations’’ is defined in reproposed 

Rule 600(b)(63) as bids and offers, and 

‘‘bid’’ or ‘‘offer’’ is defined in 

reproposed Rule 600(b)(8) as the bid 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77453

205As proposed, the indirect access requirement 

for ADF participants would have applied only to 

trading centers whose quotations were solely

accessible in the ADF and not through an SRO 

trading facility. As reproposed, Rule 610(b)(1) 

applies to all quotations displayed on an SRO 

display-only facility, even if the trading center also 

displays quotations in an SRO trading facility. This 

modification is needed to preclude the consolidated 

data stream from giving a misleading indication of 

available liquidity. Separate quotations displayed 

on an SRO trading facility and an SRO display-only 

facility must each be fully accessible.

price or the offer price communicated 

by a member of a national securities 

exchange or national securities 

association to any broker or dealer or to 

any customer. Reproposed Rule 610(a) 

therefore would apply to the entire 

depth of book of displayed orders of an 

SRO trading facility.

Reproposed Rule 610(a) would 

prohibit an SRO from imposing unfairly 

discriminatory terms that prevent or 

inhibit any person from obtaining 

efficient access through a member of the 

SRO to the quotations in an NMS stock 

displayed by the SRO trading facility. 

This anti-discrimination standard is 

designed to give non-members indirect 

access to quotations through members, 

but is premised on the fact that the 

SRO’s members themselves have fair 

and efficient access to the quotations of 

the SRO’s trading facility. Such access 

currently is addressed by a series of 

provisions of the Exchange Act. 

Sections 6(b)(1) and 15A(b)(2) require 

that an exchange or association must 

have the capacity to be able to carry out 

the purposes of the Exchange Act. 

Sections 6(b)(5) and 15A(b)(6) require 

an exchange or association to have rules 

designed to remove impediments to and 

perfect the mechanism of a free and 

open market and a national market 

system. Section 11A(a)(1)(C) provides 

that two of the objectives of a national 

market system are to assure the 

economically efficient execution of 

securities transactions and the 

practicability of brokers executing 

investors’ orders in the best market. 

Neither of these objectives is possible if 

an SRO’s members—those entities that 

have the right to trade directly on an 

SRO facility—do not themselves have 

fair and efficient access to the 

quotations displayed on such facility. 

Reproposed Rule 610(a) would build 

on this existing regulatory structure by 

prohibiting unfair discrimination that 

prevents or inhibits non-members from 

piggybacking on the access of members. 

In the absence of mandatory public 

linkages directly between markets, the 

ability to obtain indirect access is 

necessary to assure that competing 

markets can meet the requirements of 

the Trade-Through Rule and that all 

brokers can fulfill their duty of best 

execution. In general, any SRO rule or 

practice that treats orders less favorably 

based on the identity of the ultimate 

party submitting the order through an 

SRO member would violate reproposed 

Rule 610(a). Thus, for example, charging 

differential fees or reducing an order’s 

priority based on the identity of a 

member’s customer would violate 

reproposed Rule 610(a). 

Given the critical importance of 

indirect access to the private linkage 

approach incorporated in reproposed 

Rule 610(a), the Commission intends to 

review the current extent to which SRO 

members have fair and efficient access 

to quotations in NMS stocks that are 

displayed on an SRO trading facility, 

which term does not include the 

NASD’s ADF, as discussed below. In 

this regard, it emphasizes that the SROs 

cannot meet the access requirements of 

the Exchange Act by relying on access 

provided by trading centers that are not 

a facility operated by the SRO. Thus, if 

a trading center displays quotes on an 

SRO trading facility, but also provides 

direct access to such quotes, that SRO 

could not rely on the level of direct 

access to the non-SRO trading center to 

meet its Exchange Act responsibilities. 

An SRO trading facility must itself 

provide fair and efficient access to the 

quotations that are displayed as 

quotations of such SRO. Stated another 

way, an SRO trading facility cannot be 

used simply as a conduit for the display 

of quotations that cannot be accessed 

fairly and efficiently through the SRO 

trading facility itself. Accordingly, each 

SRO’s facilities would be reviewed to 

determine whether they were able to 

meet the enhanced need for access 

under the reproposed regulatory 

structure. 

b. Quotations of SRO Display-Only 

Facility. Paragraph (b) of reproposed 

Rule 610 would apply to all quotations 

displayed by an SRO display-only 

facility. The term ‘‘SRO display-only 

facility’’ is defined in reproposed Rule 

600(b)(71) as a facility operated by a 

national securities exchange or national 

securities association that displays 

quotations in securities, but does not 

execute orders against such quotations. 

For quotations in NMS stocks, this 

definition currently would encompass 

only the NASD’s ADF.205

Paragraph (b)(1) of reproposed Rule 

610 would require any trading center 

that displays quotations in NMS stocks 

through an SRO display-only facility to 

provide a level and cost of access to 

such quotations that is substantially 

equivalent to the level and cost of access 

to quotations displayed by SRO trading 

facilities. The phrase ‘‘level and cost of 

access’’ would encompass both (1) the 

policies, procedures, and standards that 

govern access to quotations of the 

trading center, and (2) the connectivity 

through which market participants can 

obtain access and the cost of such 

connectivity. As discussed in section 

III.A.1 above, trading centers that 

choose to display quotations in an SRO 

display-only facility would be required 

to bear the responsibility of establishing 

the necessary connections to afford fair 

and efficient access to their quotations. 

The nature and cost of these 

connections for market participants 

seeking to access the trading center’s 

quotations would need to be 

substantially equivalent to the nature 

and cost of connections to SRO trading 

facilities. In recent years, a variety of 

different types of entities have entered 

the business of providing connections 

for brokers and market participants to 

different trading centers. The 

Commission anticipates that ADF 

participants would take advantage of 

these service providers to establish the 

necessary connectivity. The NASD, as 

the self-regulatory authority responsible 

for enforcing compliance by ADF 

participants with the requirements of 

the Exchange Act, would need to 

evaluate the connectivity of ADF 

participants to determine whether it 

meets the requirements of Rule 

610(b)(1). 

Paragraph (b)(2) of reproposed Rule 

610 would prohibit any trading center 

that displays quotations through an SRO 

display-only facility from imposing 

unfairly discriminatory terms that 

prevent or inhibit any person from 

obtaining efficient access to such 

quotations through a member, 

subscriber, or customer of the trading 

center. This prohibition parallels the 

prohibition in reproposed Rule 610(a) 

that applies to the quotations of SRO 

trading facilities. Thus, a trading 

center’s differential treatment of orders 

based on the identity of the party 

ultimately submitting an order through 

a member, subscriber, or customer of 

such trading center generally would be 

prohibited. 

2. Limitation on Access Fees 

Reproposed Rule 610(c) would limit 

the fees that could be charged for access 

to protected quotations. It provides that 

a trading center shall not impose, nor 

permit to be imposed, any fee or fees for 

the execution of orders against its 

protected quotations in an NMS stock 

that exceed or accumulate to more than 

$0.003 per share or, for its protected 

quotations with a price of less than 

$1.00, that exceed or accumulate to 

77454 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

206See supra, section II.A.5 (scope of quotations 

protected by reproposed Trade-Through Rule).

207NASD Rule 4623(b)(6).

208Under Rule 600(b)(57), only automated 

quotations can qualify as protected quotations.

209 17 CFR 242.301(b)(5). 210The Regulation ATS fair access requirements 

are triggered on a security-by-security basis for 

equity securities. See Securities Exchange Act 

Release No. 40760 (Dec. 8, 1998), 63 FR 70844, 

70873 (Dec. 22, 1998). 211One commenter opposed the proposal to lower 

the threshold for Regulation ATS fair access, 

primarily because it largely acts as an agency broker 

that routes orders to other venues. Bloomberg 

Tradebook Letter at 7. The Commission 

preliminarily believes that ATSs, which by 

definition has chosen to offer market functions 

beyond mere agency routing, would appropriately 

be subject to regulatory requirements that reflect 

such functions.

more than 0.3% of the quotation price 

per share.

Thus, the scope of reproposed Rule 

610(c) would be limited to quotations 

protected by the Trade-Through Rule. 

Under the alternative definitions of 

‘‘protected bid’’ and ‘‘protected offer’’

reproposed for Rule 600(b)(57), the fee 

limitation would apply, at a minimum, 

to an automated quotation that is the 

BBO of an exchange, the NASDAQ 

Market Center, or the ADF. If the 

Voluntary Depth Alternative were 

adopted and markets voluntarily 

obtained protection for their depth-ofbook quotations, the fee limitation also 

would apply to orders accessing these 

quotations.206 When triggered, the fee 

limitation of Rule 610(c) would apply to 

any order execution at the displayed 

price of the protected quotation. It 

therefore would encompass executions 

against both the displayed size and any 

reserve size at the price of a protected 

quotation.

Reproposed Rule 610(c) would 

encompass a wide variety of fees 

currently charged by trading centers, 

including both the fees commonly 

known as access fees charged by ECNs 

and the transaction fees charged by 

SROs. So long as the fees are based on 

the execution of an order against a 

protected quotation, the restriction of 

reproposed Rule 610(c) would apply. 

Conversely, fees not triggered by the 

execution of orders against protected 

quotations (e.g., certain periodic fees 

such as monthly or annual fees) 

generally would not be included. 

In addition, reproposed Rule 610(c) 

would encompass any fee charged 

directly by a trading center, as well as 

any fee charged by market participants 

that display quotations through the 

trading center’s facilities. Trading 

centers would have flexibility in 

establishing their fee schedules to 

comply with reproposed Rule 610(c). In 

particular, trading centers could impose 

a limit on the fees that market 

participants are permitted to charge for 

quotations that are accessed through a 

trading center’s facilities. For example, 

Nasdaq has adopted such a limit for 

quotations displayed by the NASDAQ 

Market Center.207

If reproposed Rule 610(c) were 

adopted, market makers would be 

permitted to charge fees for accessing 

their quotations, so long as such fees 

met the Rule’s requirements. Market 

makers currently are not permitted to 

charge access fees under the Quote Rule. 

To promote the equal regulation of 

markets, the Commission preliminarily 

believes that, if reproposed Rule 610(c) 

were adopted, it would be consistent 

with the Quote Rule for market makers 

to charge access fees. In particular, 

market makers would be permitted to 

charge fees for executions of orders 

against their protected quotations 

irrespective of whether the order 

executions are effected on an SRO 

trading facility or directly by the market 

maker. 

3. Locking or Crossing Quotations 

Reproposed Rule 610(d) would 

restrict locking or crossing quotations, 

but would recognize that locked and 

crossed markets can occur accidentally, 

especially given the differing speeds 

with which trading centers update their 

quotations. It would require that each 

national securities exchange and 

national securities association establish 

and enforce rules that: (1) Require its 

members to reasonably avoid displaying 

quotations that lock or cross any 

protected quotation in an NMS stock, or 

of displaying manual quotations that 

lock or cross any quotation in an NMS 

stock disseminated pursuant to an 

effective national market system plan; 

(2) are reasonably designed to assure the 

reconciliation of locked or crossed 

quotations in an NMS stock; and (3) 

prohibit its members from engaging in a 

pattern or practice of displaying 

quotations that lock or cross any 

protected quotation in an NMS stock, or 

of displaying manual quotations that 

lock or cross any quotation in an NMS 

stock disseminated pursuant to an 

effective national market system plan. 

Thus, reproposed Rule 610(d) would 

distinguish between protected (and 

therefore automated) 208 quotations and 

manual quotations. Protected quotations 

could not be crossed or locked by any 

other quotations. Manual quotations, in 

contrast, could be locked or crossed by 

automated quotations, but could not 

themselves lock or cross any other 

quotations included in the consolidated 

data stream, whether automated or 

manual. Recognizing that quotations 

may on occasion accidentally lock or 

cross other quotations, reproposed Rule 

610(d) would require members to 

‘‘reasonably avoid’’ locking and crossing 

and prohibits a ‘‘pattern or practice’’ of 

locking or crossing. SRO rules could 

include so-called ‘‘ship and post’’

procedures that require a market 

participant to attempt to execute against 

a relevant displayed quotation while 

posting a quotation that could lock or 

cross such a quotation. Finally, 

reproposed Rule 610(d)(2) would 

require that each SRO’s rules be 

reasonably designed to enable the 

reconciliation of locked or crossed 

quotations in an NMS stock. Such rules 

would require the market participant 

responsible for displaying the locking or 

crossing quotation to take reasonable 

action to resolve the locked or crossed 

market.

4. Regulation ATS Fair Access 

The ‘‘fair access’’ standards of Rule 

301(b)(5) of Regulation ATS 209 require 

a covered ATS, among other things, to 

(1) establish written standards for 

granting access on its system, and (2) 

not unreasonably prohibit or limit any 

person in respect to services offered by 

the ATS by applying its access 

standards in an unfair or discriminatory 

manner. The Commission is reproposing 

an amendment to this section of 

Regulation ATS to lower the threshold 

that triggers the Regulation ATS fair 

access requirements from 20% of the 

average daily volume in a security to 

5%.210 Under the access approach 

reproposed today, the fairness and 

efficiency of private linkages would 

assume heightened importance. A 

critical component of private linkages is 

the ability of interested market 

participants to become members or 

subscribers of a trading center, 

particularly those trading centers with 

significant trading volume. As discussed 

in section III.A1 above, market 

participants then may use their 

membership or subscribership access as 

a means for others to obtain indirect 

access by piggybacking on the direct 

access of members or subscribers. The 

Commission therefore believes that it 

would be appropriate to lower the fair 

access threshold of Regulation ATS.211

Lowering the threshold for paragraph 

(b)(5) of Rule 301 also would make its 

coverage consistent with the 5% 

threshold triggering the order display 

and execution access requirements of 

Rule 301(b)(3). As a result, each ATS 

required to disseminate its quotations in 

the consolidated data stream also would 

be prohibited from unreasonably 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77455

212See Securities Exchange Act Release No. 

42194 (June 8, 2000), 65 FR 38010 (June 19, 2000) 

(‘‘June 2000 Order’’). On January 28, 2000, the 

Commission ordered NASD and the exchanges to 

facilitate an orderly transition to decimal pricing in 

the securities markets. See Securities Exchange Act 

Release No. 42360 (Jan. 28, 2000), 65 FR 5003 (Feb. 

2, 2000). In that order, the Commission set a 

timetable for NASD and the exchanges to begin 

trading some equity securities, and options on those 

securities, in decimals by July 3, 2000, and to begin 

trading all equities and options by January 3, 2001. 

See January 2000 Order, 65 FR at 5005. In April 

2000, the Commission issued another order staying 

the original deadlines for decimalization. See

Securities Exchange Act Release No. 42685 (Apr. 

13, 2000), 65 FR 21046 (Apr. 19, 2000).

213See June 2000 Order, 65 FR at 38013. The June 

2000 Order also required that at least some equity 

securities be quoted in minimum increments of 

$0.01. See id.

214See id.

215See id.

216 15 U.S.C. 78s(b).

217See June 2000 Order, 65 FR at 38013.

218See Securities Exchange Act Release No. 

46280 (July 29, 2002), 67 FR 50739 (Aug. 5, 2002) 

(‘‘August 2002 Order’’) (approving SR–Amex–2002–

02, SR–BSE–2002–02, SR–CBOE–2002–02, SR–

CHX–2002–06, SR–CSE–2002–02, SR–ISE–2002–06, 

SR–NASD–2002–08, SR–NYSE–2002–12, SR–PCX–

2002–04, and SR–Phlx–2002–05).

219Securities Exchange Act Release No. 44568 

(July 18, 2001), 66 FR 38390 (July 24, 2001) 

(‘‘Concept Release’’).

220See 66 FR at 38391–95.

221For a list of the commenters, see Proposing 

Release, 69 FR at 11165.

222See id.

223However, some commenters that opposed subpenny quoting thought that trading in sub-pennies 

should be permitted. See id.

224See id. at 11165–66.

225See SR–NASD–2003–121. Nasdaq has since 

withdrawn this proposal.

226Letter to Jonathan G. Katz, Secretary, 

Commission, from Edward S. Knight, Executive 

Vice President, Nasdaq, dated August 4, 2003 

(‘‘Nasdaq Petition’’).

227See Proposing Release, 69 FR at 11165.

228See 69 FR at 11169–70.

limiting market participants from 

becoming a subscriber or customer. 

Aside from lowering the threshold, the 

substantive requirements of Rule 

301(b)(5) would be left unchanged.

IV. Sub-Penny Rule 

The Commission today is reproposing 

Rule 612 under the Exchange Act which 

would govern sub-penny quoting of 

NMS stocks. Rule 612 would impose 

new requirements on any bid, offer, 

order, or indication of interest that is 

displayed, ranked, or accepted by a 

national securities exchange, national 

securities association, ATS, vendor, or 

broker-dealer. The reproposed rule 

incorporates the substance of the 

initially proposed rule with a few minor 

revisions, as discussed below.

A. Background 

In June 2000, the Commission issued 

an order directing NASD and the 

national securities exchanges to act 

jointly in developing a plan to convert 

their quotations in equity securities and 

options from fractions to decimals.212

The June 2000 Order stated that the plan 

could fix the minimum price variation 

(‘‘MPV’’) during the phase-in period, 

provided that the MPV was no greater 

than $0.05 and no less than $0.01 for 

any equity security.213 The June 2000 

Order also required NASD and the 

exchanges to provide the Commission 

with studies analyzing how decimal 

conversion had affected systems 

capacity, liquidity, and trading 

behavior, including an analysis of 

whether there should be a uniform 

MPV.214 The Commission stated that, if 

NASD or an exchange wished to move 

to quoting stocks in an increment less 

than $0.01, its study should include a 

full analysis of the potential impact on 

the market requesting the change and on 

the markets as a whole.215 Furthermore, 

the Commission required each SRO to 

propose a rule change under Section 

19(b) of the Exchange Act 216 to 

establish its individual choice of MPV 

for securities traded on its market.217

NASD and the exchanges complied with 

these requirements, and in August 2002 

the Commission approved rule changes 

from all of these SROs to establish 

MPVs in NMS stocks of $0.01.218

Between the June 2000 Order and the 

August 2002 Order, the Commission 

issued a Concept Release seeking public 

comment on the potential impact of subpenny pricing,219 including its effect on: 

(1) Price clarity (e.g., the potential to 

cause ephemeral or ‘‘flickering’’

quotations); (2) market depth (i.e., the 

number of shares available at a given 

price); (3) compliance with the Order 

Handling Rules and other pricedependent rules; and (4) the operations 

and capacity of automated systems.220

The Commission received 33 comments 

on the Concept Release.221 The majority 

of commenters opposed sub-penny 

pricing. Some stated that the negative 

effects of decimal trading would be 

exacerbated by reducing the MPV even 

further, without meaningfully reducing 

spreads or securing other benefits for 

the markets or investors.222 These 

commenters recommended that all 

securities have an MPV of at least a 

penny.223 A smaller number of 

commenters believed that the forces of 

competition, rather than regulation by 

the Commission or Congress, should 

determine the MPV.224 These 

commenters suggested that a smaller 

MPV could improve market efficiency 

and provide investors with greater 

opportunity for price improvement. 

They argued in general that the 

problems accompanying decimals could 

be resolved through technology 

enhancements, rather than through 

regulation.

In August 2003, Nasdaq submitted a 

proposed rule change to the 

Commission to adopt an MPV of $0.001 

for Nasdaq-listed securities.225 Nasdaq 

stated that, unless and until a uniform 

MPV is established, it believed it must 

implement an MPV of $0.001 to remain 

competitive with ECNs that permit their 

subscribers to quote in sub-pennies. 

Simultaneous with the proposed rule 

change, Nasdaq filed a petition for 

Commission action urging the 

Commission ‘‘to adopt a uniform rule 

requiring market participants to quote 

and trade Nasdaq securities in a 

consistent monetary increment * * * 

with the exception of average price 

trades.’’ 226

B. Commission Proposal on Sub-Penny 

Quoting 

In February 2004, the Commission 

proposed new Rule 612 that would 

govern quoting in sub-pennies as part of 

the overall Regulation NMS proposal. In 

the Proposing Release, the Commission 

summarized the conversion of the U.S. 

securities markets from fractional to 

decimalized trading and stated its view 

that, on balance, the benefits of 

decimalization have justified the costs. 

The Commission cautioned, however, 

that if the MPV decreases beyond a 

certain level the potential costs to 

investors and the markets might 

increase and could at some point 

surpass any potential benefits.227 To 

address this concern, proposed Rule 612 

would prohibit any national securities 

exchange, national securities 

association, ATS, vendor, or brokerdealer from displaying, ranking, or 

accepting from any person bid, offer, 

order, or indication of interest in any 

NMS stock priced in an increment less 

than $0.01. Proposed Rule 612 would 

not impose this restriction on any NMS 

stock the share price of which is below 

$1.00.

The proposed rule was designed to 

limit the ability of a market participant 

to gain execution priority by bettering 

the price of another limit order by an 

economically insignificant amount. In 

issuing the sub-penny proposal, the 

Commission cited research performed 

by OEA strongly suggesting that much 

sub-penny quoting currently taking 

place results from market participants 

attempting to step ahead of limit orders 

for the smallest economic increment 

possible.228 This conclusion was based 

on the high incidence of sub-penny 

77456 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

229See NASD IM–2110–2 (generally requiring 

that a member firm that accepts and holds an 

unexecuted limit order from its customer in a 

Nasdaq security and that continues to trade the 

subject security for its own market-making account 

at prices that would satisfy the customer’s limit 

order, without executing that limit order, shall be 

deemed to have acted in a manner inconsistent with 

just and equitable principles of trade). The impetus 

for this rule was a case brought by a customer of 

an NASD member firm, William Manning, who 

alleged that the firm had accepted his limit order, 

failed to execute it, and violated its fiduciary duty 

to him by trading ahead of the order. In the 

Manning decision, In re E.F. Hutton & Co.,

Exchange Act Release No. 25887 (July 6, 1988), the 

Commission affirmed NASD’s finding that a 

member firm, upon acceptance of a customer’s limit 

order, undertakes a fiduciary duty to its customer 

and cannot trade for its own account at prices more 

favorable than the customer’s order.

230See Securities Exchange Act Release No. 

37619A (Sept. 6, 1996), 61 FR 48290, 48322 (Sept. 

12, 1996) (adopting the Commission’s Order 

Handling Rules). A broker-dealer’s duty of best 

execution derives from common law agency 

principles and fiduciary obligations and is 

incorporated in both SRO rules and, through 

judicial and Commission decisions, in the antifraud 

provisions of the federal securities laws. See id.

231See, e.g., AFB Letter at 12; American Century 

Letter at 2; Ameritrade Letter at 10; Archipelago 

Letter at 14; ATD Letter at 3–4; Bloomberg 

Tradebook Letter at 2; BoNY Letter at 4; BSE Letter 

at 13–14; CBOE Letter at 7; Citadel Letter at 9; 

Citigroup Letter at 14–15; CSE Letter at 23; 

Denizkurt E-mail; E*Trade Letter at 11; Financial 

Information Forum Letter at 2–3; Financial Services 

Roundtable Letter at 5–6; Florida State Board Letter 

at 2; Goldman Sachs Letter at 10; ICI Letter at 19–

20; ISE Letter at 8; JP Morgan Letter at 6–7; Knight 

Letter at 7–8; Lava Trading Letter at 5; Lehman 

Brothers Letter at 5; Liquidnet Letter at 8; LSC 

Letter at 11; Morgan Stanley Letter at 3; Nasdaq 

Letter at 1–2; NYSE Letter at 9–10; NSX Letter at 

9; Peake I Letter at 13; Reuters Letter at 4; Schwab 

Letter at 17; SIA Letter at 20–21; Specialist Assoc. 

Letter at 13–15; STA Letter at 7; STANY Letter at 

13–14; UBS Letter at 10; Vanguard Letter at 6.

232See, e.g., Ameritrade Letter at 10; Archipelago 

Letter at 14; ATD Letter at 3; Bloomberg Tradebook 

Letter at 2; Citadel Letter at 9; Citigroup Letter at 

14; ICI Letter at 7–8; Tullo Letter at 8.

233See Bloomberg Tradebook Letter at 2.

234 Id.

235Ameritrade Letter at 10.

236See Tullo Letter at 8.

237See, e.g., Citigroup Letter at 14; LSC Letter at 

11; STA Letter at 7; STANY Letter at 10–11.

238Reuters Letter at 4. See also Financial 

Information Forum Letter at 2–3; Financial Services 

Roundtable Letter at 6; Knight Letter at 7; Lehman 

Brothers Letter at 5.

239See, e.g., Citadel Letter at 9; ICI Letter at 7; 

Knight Letter at 7; Reuters Letter at 4; SIA Letter 

at 20–21.

240See Brut Letter at 24; Domestic Securities 

Summary of Intended Testimony (no page 

numbers); GETCO Letter (no page numbers); 

Hudson River Trading Meeting Memo (no page 

numbers); Instinet Letter at 50; King Letter at 1; 

Mercatus Center Letter at 7; NexTrade Letter at 9–

10; Reg NMS Study Group Letter at 9; Tower 

Research Letter at 8; Vie Securities Letter at 3.

241 Instinet Letter at 50.

242E-mail from John Martello, Managing Director, 

Tower Research Capital LLC, to rulecomments@sec.gov, dated March 26, 2004.

trades that cluster around the $0.001 

and $0.009 price points.

In the Proposing Release, the 

Commission pointed to a variety of 

potential problems caused by sub-penny 

quoting, including the following: 

• 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 an infinitesimally 

small amount, important customer 

protection rules such as exchange 

priority rules and NASD’s Manning 

rule 229 could be rendered meaningless. 

Without these protections, professional 

traders would have more opportunity to 

take advantage of non-professionals, 

which could result in the latter either 

losing executions or receiving 

executions at inferior prices.

• Flickering quotations that can result 

from widespread sub-penny pricing 

could make it more difficult for brokerdealers to satisfy their best execution 

obligations and other regulatory 

responsibilities. The best execution 

obligation requires a broker-dealer to 

seek for its customer’s transaction the 

most favorable terms reasonably 

available under the circumstances.230

This standard is premised on the 

practical ability of the broker-dealer to 

determine whether a displayed price is 

reasonably obtainable under the 

circumstances.

• Widespread sub-penny quoting 

could decrease market depth (i.e., the 

number of shares available at the 

NBBO). This could lead to higher 

transaction costs, particularly for 

institutional investors (such as pension 

funds and mutual funds), which are 

more likely to place large orders. These 

higher transaction costs would likely be 

passed on to retail investors whose 

assets are managed by the institutions. 

• Decreasing depth at the inside also 

could cause such institutions to rely 

more on execution alternatives away 

from the exchanges and Nasdaq that are 

designed to help larger investors find 

matches for large blocks of securities. 

Such a trend could increase 

fragmentation of the securities markets. 

C. Comments Received 

The Commission sought comment on 

all aspects of proposed Rule 612, 

including the potential problems with 

sub-penny quoting noted above. Of the 

comments that the Commission received 

in response to the Regulation NMS 

Proposing Release, approximately 60 

separate commenters addressed the subpenny proposal. 

1. Comments Addressing Overall 

Proposal 

A majority of commenters supported 

the proposed sub-penny rule.231 Several 

commenters concurred with the 

Commission’s view that sub-penny 

quoting is widely used to step-ahead of 

competing limit orders.232 One 

commenter, an ECN, stated that it 

carried out an informal survey of its 

buy-side clients, and of the 158 

responses received 145 said that they 

opposed sub-penny quoting.233 The 

ECN concluded that ‘‘[its] clients 

believe that quoting in sub pennies is 

used, not for bona fide price 

improvement, but to jump ahead of their 

limit orders.’’ 234 Another commenter, a 

large discount brokerage firm, stated 

that it ceased allowing its clients to 

submit sub-penny orders in April 2003 

‘‘because it had determined that clients 

were using sub-pennies to step ahead of 

resting limit orders and undermining 

the Manning provision.’’ 235 A third 

commenter stated that the reduction of 

the MPV has allowed ‘‘speculators’’ to 

post quotations at small increments 

ahead of institutional trading interest, 

resulting in decreased liquidity as such 

institutional interest began seeking 

methods of execution other than the 

posting of limit orders. 236

Furthermore, the commenters 

supporting the Commission’s sub-penny 

proposal were generally of the view that 

the marginal benefits of a further 

reduction in the MPV were not justified 

by the associated costs.237 Several 

commenters argued, in essence, that 

‘‘[a]n industry-wide shift to quoting in 

sub-pennies would * * * require costly 

additional investments in systems 

capacity while producing little in the 

way of more efficient markets.’’ 238

Several commenters also believed that 

sub-penny quotations increase the 

incidence of quote flickering, which in 

turn may have adverse effects such as 

creating investor confusion or impeding 

a broker-dealer’s duty of best 

execution.239

However, a minority of commenters 

opposed the Commission’s proposal to 

prohibit sub-penny quoting.240 These 

commenters generally argued that the 

MPV should be determined by market 

forces. Two commenters believed that 

regulating quoting conventions would 

‘‘prevent marketplaces from making 

subsequent innovative changes to their 

quotation increments to respond to the 

needs of investors’’ 241 and ‘‘legislate[] a 

maximum efficiency for the market 

instead of allowing further 

improvement.’’ 242 Other commenters 

stated that quoting in sub-pennies can 

increase liquidity, lower trading costs, 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77457

243See Hudson River Trading Testimony (no page 

numbers); GETCO Letter (no page numbers).

244See Brut Letter at 24; Regulatory Studies Letter 

at 9.

245Tower Research Letter at 8.

246See id. Tower Research argued, for example, 

that the studies do not differentiate between subpenny trades and sub-penny quotations and that 

clustering of sub-penny trades around the $0.001 

and $0.009 price points could be the result of other 

activity, such as market makers offering sub-penny 

price improvement. In response to this comment, 

OEA reviewed the sources of data used in the 

original study and found that sub-penny trades 

cluster at these two price points in both markets 

where trades necessarily result from quotations, 

such as ECNs, and where that is not necessarily the 

case. Accordingly, OEA continues to believe that 

market participants frequently used their ability to 

quote in sub-pennies to step ahead of competing 

limit orders by the smallest possible amount.

247See Instinet Letter at 51; Mercatus Center 

Letter at 9.

248Tower Group Letter at 8.

249See id. at 9.

250See Instinet Letter at 50.

251With respect to the ATSs that currently do 

permit some NMS stocks to be quoted in subpennies, the Commission staff has estimated that 

the costs of widened spreads in these securities 

would be approximately $48 million annually (or 

approximately $33 million if the Commission were 

to exempt QQQQ from reproposed Rule 612). See

Memorandum to File from Office of Economic 

Analysis, dated December 15, 2004. A copy of this 

study has been placed in Public File No. S7–10–04 

and is available for inspection on the Commission’s 

Internet Web site (http://www.sec.gov/rules/

proposed/s71004.shtml).

252 ICI Letter at 20.

253See Citigroup Letter at 15.

254See Brut Letter at 25.

255 Id.

and promote efficient pricing in the 

equity markets.243

These commenters generally argued 

that regulation was not necessary to 

remedy any perceived abuses caused by 

sub-penny quoting. Two commenters 

noted that some trading markets already 

have abandoned sub-penny quoting.244

Another commenter added that ‘‘[t]he 

problems attributed to subpenny 

quoting have been largely cleared up by 

the market, and are likely to further 

improve if the Commission removes 

some uncertainty from the marketplace 

by withdrawing its proposal.’’ 245 This 

commenter also criticized the Nasdaq 

and OEA studies on which the 

Commission relied in issuing the subpenny proposal.246

Under reproposed Rule 612, the 

minimum spread for most NMS stocks 

would be $0.01. Two commenters stated 

that, as a result, investors would suffer 

harm from artificially widened 

spreads.247 Another commenter stated 

that ‘‘the primary result of eliminating 

subpenny trading would be to preserve 

a minimum profit for market makers, 

and would result in significantly worse 

realized prices for the vast majority of 

market participants not in the business 

of making markets.’’ 248 This commenter 

analyzed trading in six high-volume 

securities and concluded that proposed 

Rule 612 would have costs of over $400 

million in these securities alone due to 

wider spreads.249 Another commenter 

stated that, if all markets traded QQQQ 

solely in sub-pennies, the savings would 

be approximately $150 million per 

year.250

In summary, the comments received 

have reinforced the Commission’s 

preliminary view that there are 

substantial drawbacks to allowing subpenny quoting, and the Commission 

believes that a uniform rule prohibiting 

sub-penny quoting (except for 

quotations less than $1.00) is 

appropriate in this case. Sub-penny 

quoting generally impedes transparency 

by reducing market depth at the NBBO 

and increasing quote flickering. In an 

environment where the NBBO can 

change very quickly, broker-dealers will 

have more difficulty in carrying out 

their duties of best execution and 

complying with other regulatory 

requirements that require them to 

identify the best bid or offer available at 

a particular moment (such as the 

Manning rule and the short sale rule).

The Commission preliminarily 

believes that the $400 million and $150 

million estimates of the cost to the 

markets caused by wider spreads 

provided by commenters are inaccurate 

and excessive. These estimates appear 

to assume that all trading activity would 

occur at narrower quoted spreads. The 

Commission does not believe that the 

commenters provided any evidence to 

justify that assumption. Currently, no 

national securities exchange or national 

securities association permits quoting in 

sub-pennies; sub-penny quoting occurs 

on only a small number of ATSs. 

Because spreads on most markets 

already cannot be smaller than $0.01, 

the Commission preliminarily does not 

believe that reproposed Rule 612 would 

require these markets to take any action 

that would cause their spreads to widen. 

Therefore, the Commission believes that 

the cost to these markets of not having 

sub-penny spreads should not be 

considered costs of the reproposed 

rule.251

Finally, the Commission agrees with 

the many commenters that believed that 

prohibiting sub-penny quoting will 

deter the practice of stepping ahead of 

exposed trading interest by an 

economically insignificant amount. 

Limit orders provide liquidity to the 

market and perform an important pricesetting function. The Commission is 

concerned that, if a quotation or order 

can lose execution priority because of 

economically insignificant price 

improvement from a later-arriving 

quotation or order, liquidity could 

diminish and some market participants 

could incur greater execution costs. As 

one commenter, the Investment 

Company Institute, stated, ‘‘[t]his 

potential for the increased steppingahead of limit orders would create a 

significant disincentive for market 

participants to enter any sizeable 

volume into the markets and would 

reduce further the value of displaying 

limit orders.’’ 252 Improved liquidity 

should decrease the costs of trading, 

especially for large orders, since larger 

size should be available at fewer price 

points than would exist in a sub-penny 

quoting environment.

The reproposed rule would make only 

minor changes to the initially proposed 

rule. Reproposed Rule 612(a) would 

prohibit sub-penny quotations in NMS 

stocks over $1.00. Rule 612(b) would 

allow sub-penny quotations below 

$1.00, but only to four decimal places. 

Rule 612(c) would establish procedures 

for the Commission to grant exemptions 

from paragraphs (a) and (b). 

2. Response to Other Comments 

Beyond addressing the general thrust 

of the proposed sub-penny rule, some 

commenters discussed more specific 

matters. The Commission has revised 

the proposed sub-penny rule in 

response to certain of these comments, 

as discussed below. 

a. Restriction Based on Price of the 

Quotation not Price of the Stock. As 

initially proposed, the restriction on 

sub-penny quoting would be triggered if 

the price of the NMS stock itself were 

above $1.00. One commenter sought 

clarification of when an NMS stock 

became sub-penny eligible, suggesting a 

threshold of trading below $1.00 for 30 

consecutive business days.253 A second 

commenter suggested instead that the 

prohibition should derive from the price 

of the order, rather than the price of the 

stock; in other words, the rule should 

permit any sub-penny quotation below 

$1.00 and prohibit any sub-penny 

quotation above $1.00, regardless of the 

price level where the stock was in fact 

trading.254 The second commenter 

argued that this approach ‘‘does not 

require countless re-classifications of 

stocks as ’sub-penny eligible’ based on 

fluctuations in their valuation, stock 

splits, or other price movements.’’ 255

The Commission agrees with the 

second commenter. Basing the 

restrictions on the price of the quotation 

or order rather than the price of the 

NMS stock itself would spare market 

participants the need to track the 

77458 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

256See Archipelago Letter at 14; BSE Letter at 14; 

Citigroup Letter at 15; LSC Letter at 11; SIA Letter 

at 21; STANY Letter at 14.

257Archipelago Letter at 14.

258See Citigroup Letter at 15; SIA Letter at 21.

259See Amex Letter at 30; Angel Letter at 10; Anil 

Abraham Memo at 2; BoNY Letter at 4; Citadel 

Letter at 10; McGuire Summary of Intended 

Testimony (no page numbers); Tullo Letter at 9.

260Angel Letter at 10.

261See Tullo Letter at 9.

262NexTrade Letter at 9.

263 15 U.S.C. 78s(b). See supra note .

264See Proposing Release, 69 FR at 11172.

265See id.

266See Amex Letter, Exhibit A, at 29; ICI Letter 

at 20; Knight Letter at 8; Morgan Stanley Letter at 

21; NYSE Letter at 10; SIA Letter at 21; Specialist 

Association Letter at 14.

267See, e.g., Amex Letter, Exhibit A, at 29; ICI 

Letter at 20.

268See Instinet Letter at 51.

269 Id.

270See Brut Letter at 25; Mercatus Center Letter 

at 9–10; Tower Research Letter at 9, 14–15.

eligibility of stocks priced near the 

$1.00 threshold. Accordingly, paragraph 

(a) of reproposed Rule 612 would 

prohibit bids, offers, orders, and 

indications of interest equal to or greater 

than $1.00 in an increment smaller than 

$0.01. Therefore, a market participant 

could not, for example, accept a sell 

order in an NMS stock priced at 

$1.0025, even if the stock were trading 

below $1.00. The Commission requests 

comment on the new approach taken in 

reproposed Rule 612(a). 

b. Quotations Below $1.00. The 

Commission initially proposed a 

threshold of $1.00 below which the 

prohibition on sub-penny quoting 

would not apply and requested 

comment on whether that threshold was 

appropriate. The majority of 

commenters addressing this issue 

believed that it would be useful for lowpriced securities to trade in increments 

finer than a penny, because a penny 

would constitute a significant 

percentage of the overall price. These 

commenters viewed $1.00 as an 

appropriate threshold.256 One 

commenter stated that there is ‘‘real 

demand for sub-penny trading (and 

therefore subpenny quoting) in 

securities trading below $1.00, due to 

the low trading value of the 

security.’’ 257 The Commission agrees 

that sub-penny quotations for very lowpriced securities largely represent 

genuine trading interest rather than an 

effort to step ahead of competing limit 

orders by an economically insignificant 

amount. In such cases, a sub-penny 

increment is more likely to represent a 

significant amount of the price of the 

quotation or order. Accordingly, the 

prohibition on sub-penny quoting in 

paragraph (a) of reproposed Rule 612 

would apply only to bids, offers, orders, 

and indications of interest priced $1.00 

or greater.

Two commenters suggested that the 

Commission establish an MPV for 

quotations below $1.00; both 

recommended allowing such quotations 

to extend to four decimal places.258 The 

Commission agrees with these 

commenters and believes that it is 

reasonable to restrict quotations below 

$1.00 to four decimal places. 

Accordingly, paragraph (b) of 

reproposed Rule 612 would prohibit 

bids, offers, orders, and indications of 

interest priced less than $1.00 in an 

increment smaller than $0.0001. 

Without the ability to quote very lowpriced securities in sub-pennies, market 

participants would be forced to express 

their trading interest in increments that 

represented a substantial portion of the 

overall quotation. However, if the 

number of decimal places for quotations 

in low-priced securities were not 

limited, the problems caused by subpenny quoting of higher-priced 

securities, discussed above, could arise. 

Restricting quotations below $1.00 to 

four decimal places would avoid these 

problems. Under reproposed Rule 612, a 

quotation of $0.9987 × $1.00 would be 

permissible but a quotation of $0.9987 

× $1.0001 would not. The Commission 

requests comment on whether limiting 

quotations priced below $1.00 to four 

decimal places is appropriate.

c. Revisiting the Penny Increment. 

Some commenters, while generally 

acknowledging problems caused by subpenny quoting, recommended that the 

Commission consider increasing the 

MPV above $0.01.259 One commenter 

believed that ‘‘[t]he Commission should 

seriously consider experimenting with 

different tick sizes to help determine the 

optimal tick policy.’’ 260 A second 

commenter recommended that the 

Commission establish an MPV of a 

$0.01 for high-volume stocks, $0.05 

middle-volume stocks, and $0.10 for the 

low-volume stocks.261 A third 

commenter stated that ‘‘sub-penny 

quoting does little, if anything, to 

degrade the market from its current 

state’’ because, in the commenter’s 

view, ‘‘the true damage was done to the 

market in the shift from a fractionalized 

environment to a penny spread 

environment.’’ 262

Under reproposed Rule 612, the 

Commission would set a floor for the 

MPV, not determine the optimal MPV. 

Penny pricing was established by rules 

that were proposed by NASD and each 

of the national securities exchanges that 

trade NMS stocks and approved by the 

Commission pursuant to Section 19(b) 

of the Exchange Act.263 While some 

commenters have raised liquidity 

concerns regarding the $0.01 MPV, the 

move to decimals (and specifically the 

move to a penny MPV for equity 

securities) also has reduced spreads, 

thus resulting in reduced trading costs 

for investors entering orders—

particularly smaller orders—that are 

executed at or within the quotations. 

Therefore, the Commission did not 

propose a higher MPV as part of the 

initial Regulation NMS proposal. 

However, if the SROs in the future 

believe that an increase in the MPV is 

necessary or desirable, they may 

propose rule changes to institute the 

higher MPV. The Commission would 

evaluate those proposals under the 

requirements of the Exchange Act at that 

time.

d. Exemptions for Specific NMS 

Stocks. As initially proposed, Rule 612 

included a provision that would 

establish procedures for the 

Commission to grant exemptions to the 

rule, and the Commission requested 

comment on whether certain securities 

should be exempted from Rule 612.264

In particular, the Commission asked 

whether exchange-traded fund shares 

(‘‘ETFs’’), which are derivatively priced, 

raise the same concerns that have been 

expressed with respect to sub-penny 

pricing generally.265

Of the commenters who addressed 

this issue, the majority argued that the 

sub-penny prohibition should apply to 

all NMS stocks, including ETFs.266

These commenters generally believed 

that sub-penny quoting raises the same 

type of concerns for ETFs as for other 

types of securities.267 On the other 

hand, other commenters provided 

arguments that exemptions for at least 

certain securities would be appropriate. 

One commenter that opposed Rule 612 

argued that, if the Commission 

nevertheless did approve the rule, it 

should provide an exemption for QQQQ 

and other ETFs.268 This commenter 

argued that these securities ‘‘uniquely 

lend[] themselves to subpenny quoting 

and trading’’ because ‘‘the[ir] derivative 

nature * * * enables investors to 

determine their true value at any point 

in time by calculating the aggregate 

price of the securities constituting a 

particular ETF.’’ 269 Other commenters, 

while not explicitly recommending that 

the Commission grant particular 

exemptions, argued that sub-penny 

quoting was reasonable for certain 

securities.270 One of these commenters 

noted, for example, that quotations in 

QQQQ are not clustered around the 

$0.001 and $0.009 price points, which 

suggests that sub-penny quotations are 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77459

271See Mercatus Center Letter at 9.

272See STANY Letter at 14; STA Letter at 7; SIA 

Letter at 21; UBS Letter at 10; ACIM Letter at 2; 

E*Trade Letter at 11; Amex Letter at 12; Liquidnet 

Letter at.8.

273See ACIM Letter at 2; Amex Letter, Exhibit A, 

at 31–32; E*Trade Letter at 11; Liquidnet Letter at 

8; BSE Letter at 14; Morgan Stanley Letter at 21; SIA 

Letter at 21; STA Letter at 7; STANY Letter at 14; 

UBS Letter at 10.

274See CHX Letter at 23; Goldman Sachs Letter 

at 10; SIA Letter at 21.

275See Brut Letter at 26.

276See CHX Letter at 23.

277See Proposing Release, 69 FR at 11172. 278See Amex Letter, Exhibit A, at 32; SIA Letter 

at 21. 279 Id. 280 15 U.S.C. 78s(b). 281The Commission has previously stated that, 

‘‘[g]iven the implications of penny quoting for 

OPRA, penny quoting would require very careful 

review by the Commission.’’ Securities Exchange 

Act Release No. 49068 (Jan. 13, 2004), 69 FR 2775, 

2789 (Jan. 20, 2004) (‘‘BOX Approval Order’’). 282See CBOE Letter at 8. 283BOX Approval Order, 69 FR at 2789.

not being entered for the purpose of 

stepping ahead.271

At this time, the Commission believes 

that a basis likely may exist to grant an 

exemption from the sub-penny quoting 

prohibition for QQQQ and perhaps 

other actively traded ETFs. This 

exemption would permit a national 

securities exchange, national securities 

association, ATS, vendor, or broker or 

dealer to display, rank, or accept from 

any person a bid or offer, an order, or 

an indication of interest—in QQQQ or 

perhaps other actively traded ETFs—in 

increments smaller than $0.01. The 

Commission intends to consider this 

matter further during the phase-in 

period for Regulation NMS, if 

Regulation NMS is adopted. The 

Commission also notes that, while the 

proposed effective date for Regulation 

NMS as a whole would be [November 5, 

2005], the effective date for reproposed 

Rule 612(c), if adopted, would be 60 

days from date of publication of final 

Regulation NMS in the Federal Register. 

Therefore, the Commission could 

exercise its exemptive authority such 

that any exemptions that it may grant 

pursuant to reproposed Rule 612(c) 

could take effect simultaneously with 

the main prohibitions of Rule 612.

e. Sub-Penny Trading. The 

Commission stated in the Proposing 

Release that it did not at that time 

believe that trading in sub-penny 

increments raised the same concerns as 

sub-penny quoting. Therefore, the 

proposed rule would not prohibit an 

exchange or association from printing a 

trade in sub-penny increments that was, 

for example, the result of a mid-point or 

volume-weighted pricing algorithm, as 

long as the exchange or association or 

its members did not otherwise violate 

the proposed rule with respect to the 

trading interest that resulted in the 

execution. For example, a system that 

accepted unpriced orders that were then 

matched at the midpoint of the NBBO 

would not violate the proposed rule 

even though resulting executions could 

occur in share prices of less than one 

cent. In addition, a broker-dealer could, 

consistent with the proposed rule, 

provide price improvement to a 

customer order in an amount that 

resulted in an execution in an increment 

less than a penny so long as the brokerdealer did not accept orders that were 

priced in increments less than a penny. 

The Commission sought specific 

comment on this aspect of the proposal. 

Every commenter that addressed this 

issue agreed that any sub-penny rule 

should permit sub-penny trades that 

result from midpoint and average-price 

algorithms.272 While most of these 

commenters believed that the rule 

should permit broker-dealers to offer 

sub-penny price improvement to their 

customers’ orders,273 a few commenters 

urged the Commission to bar this 

practice.274 After considering these 

views, the Commission has determined 

not to revise the sub-penny rule in a 

manner that would prohibit sub-penny 

trading, whether that trading results 

from midpoint or VWAP algorithms or 

from broker-dealers offering sub-penny 

price improvement. The Commission 

continues to believe that trading in subpenny increments does not at this time 

raise the same concerns as sub-penny 

quoting.

f. Acceptance of Sub-Penny 

Quotations. The Commission initially 

proposed to prohibit national securities 

exchanges, national securities 

associations, ATSs, vendors, and brokerdealers from displaying, ranking, or 

accepting quotations in NMS stocks that 

are priced in sub-pennies. One 

commenter argued that the rule should 

allow a market participant to accept 

sub-penny quotations if it consistently 

re-prices such quotations to an 

acceptable increment and does not give 

the sub-penny quotations any special 

priority for ranking or execution 

purposes.275 A second commenter 

disagreed, arguing that rounding a subpenny quotation to the nearest penny 

may be confusing for investors.276 The 

Commission agrees with the second 

commenter and has determined to 

revise the proposed rule. The 

Commission believes that little purpose 

would be served by permitting market 

participants to accept sub-penny 

quotations when such quotations could 

not be displayed or considered for 

purposes of ranking. Furthermore, the 

Commission agrees that permitting 

market participants to accept sub-penny 

quotations that must be rounded to 

comply with the requirements of 

reproposed Rule 612 could cause 

confusion among investors.

g. Application to Options Markets. 

The initially proposed rule, by its terms, 

would apply only to NMS stocks, but 

the Commission requested comment on 

whether the rule should apply to 

options.277 Currently, SRO rules require 

options to be quoted on the U.S. markets 

in increments of $0.05 and $0.10. 

Therefore, the problems that could be 

created by sub-penny quoting currently 

do not exist in the options markets.

Two commenters believed that the 

rule should not apply to quoting in 

options.278 One of these commenters, 

assuming that the rule as proposed 

would allow options with a premium of 

less than $1.00 to be quoted in subpennies and options with a premium 

over $1.00 to be quoted in pennies, 

argued that this approach ‘‘would 

overwhelm the already taxed capacity of 

existing options quote processing 

systems.’’ 279 The Commission believes 

that it is not necessary or appropriate at 

this time to apply reproposed Rule 612 

to options. If a national securities 

exchange seeks to quote options in 

pennies or sub-pennies in the future, it 

would first need to propose a rule 

change to that effect under Section 19(b) 

of the Exchange Act.280 The 

Commission would have an opportunity 

to consider such a proposal at that time, 

after providing notice and obtaining 

public comment.281

A third commenter, while agreeing 

strongly with the proposed sub-penny 

rule, argued that the Commission also 

should prohibit the Boston Options 

Exchange (‘‘BOX’’), a facility of the 

Boston Stock Exchange, from using 

‘‘sub-increment’’ pricing (i.e., penny 

prices below the standard $0.05 and 

$0.10 increments used for options) in its 

‘‘PIP’’ auction.282 By initiating a PIP 

auction, a BOX market participant may 

execute a portion of its agency order as 

principal in pennies, and BOX market 

makers can match that price or offer 

price improvement to those orders in 

penny increments during the threesecond auction. The Commission 

previously has approved the BOX 

trading rules, including the rules 

governing the PIP, pursuant to Section 

19(b) of the Exchange Act.283 The PIP 

uses pennies in an auction, not in 

public quotations. Therefore, the 

Commission does not believe that the 

PIP raises the same problems caused 

sub-penny quotations of non-option 

securities and, therefore, that it is not 

77460 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

284See infra, note 21.

285See Exchange Act Rule 11Aa3–2(c)(1).

286See Proposing Release, 69 FR at 11179 (table 

setting forth revenues, expenses, and allocations of 

net income for Networks A, B, and C). 287Proposing Release, 69 FR at 11176–11179.

288See, e.g., Amex Letter, Exhibit A at 11; Angel 

Letter I at 1; CBOE Letter at 2, 9; CHX Letter at 18–

20; Financial Information Forum Letter at 4; 

Schwab Letter at 11–13; SIA Letter at 26–28; 

STANY Letter at 14.

289See, e.g., Alliance of Floor Brokers Letter at 11; 

Letter from Daniel M. Clifton, Executive Director, 

American Shareholders Association, to Jonathan G. 

Katz, Secretary, Commission, dated June 10, 2004 

(‘‘ASA Letter’’) at 2; ArcaEx Letter at 4, 12, 14; Brut 

Letter at 22; Financial Services Roundtable Letter at 

7; ISE Letter at 8–10; Nasdaq Letter II at 24–26; 

NYSE Letter, Attachment at 10–11; Letter from Phil 

Lynch, Chief Executive Officer, Reuters America 

LLC, to Jonathan G. Katz, Secretary, Commission, 

dated June 30, 2004 (‘‘Reuters Letter’’) at 2; 

Specialist Assoc. Letter at 17.

necessary to prohibit the use of pennies 

in BOX’s PIP.

D. Exemptive Authority 

Reproposed Rule 612(c) would 

establish procedures for the 

Commission to exempt from the 

provisions of Rule 612 any person, 

security, or quotation, or any class or 

classes or persons, securities, or 

quotations, if it determines that such 

exemption is necessary or appropriate 

in the public interest, and is consistent 

with the protection of investors. The 

Commission could grant such 

exemption either unconditionally or on 

specified terms and conditions. 

Reproposed Rule 612(c) also would 

provide that the Commission may grant 

an exemption from the sub-penny 

prohibition by order. 

V. Market Data Rules and Plan 

Amendments 

The Exchange Act rules and joint-SRO 

Plans for disseminating market 

information to the public are the heart 

of the NMS. Pursuant to these rules and 

Plans, investors are able to obtain realtime access to the best current quotes 

and most recent trades for all NMS 

stocks. As a result, investors of all 

types—large and small—have access to 

a comprehensive, accurate, and reliable 

source of information for the prices of 

any NMS stock at any time during the 

trading day. 

The SROs generate consolidated 

market data by participating in the 

Plans.284 Pursuant to the Plans, three 

separate networks disseminate 

consolidated market information for 

NMS stocks: (1) Network A for 

securities listed on the NYSE, (2) 

Network B for securities listed on the 

Amex and other national securities 

exchanges, and (3) Network C for 

securities traded on Nasdaq. For each 

security, the data includes (1) an NBBO 

with prices, sizes, and market center 

identifications, (2) a montage of the best 

bids and offers from each SRO that 

includes prices, sizes, and market center 

identifications, and (3) a consolidated 

set of trade reports in the security. The 

Networks establish fees for this data, 

which must be filed for Commission 

approval.285 In 2003, the Networks 

collected $424 million in revenues 

derived from market data fees and, after 

deduction of Network expenses, 

distributed $386 million to their 

individual SRO participants.286

The overriding objective of the rules 

and Plan amendments reproposed today 

would be to preserve the vital benefits 

that investors currently enjoy, while 

addressing those particular problems 

with the current rules and Plans that are 

most in need of reform. The changes fall 

into three categories: (1) Modifying the 

current formulas for allocating market 

data revenues to the SROs to more 

appropriately reflect their contributions 

to public price discovery, (2) 

establishing non-voting advisory 

committees to broaden participation in 

Plan governance, and (3) updating and 

streamlining the various Exchange Act 

rules that govern the distribution and 

display of market information.

A. Response to Comments and Basis for 

Reproposed Rules 

1. Alternative Data Dissemination 

Models 

In addition to proposing specific rules 

and amendments, the Proposing Release 

discussed and requested comment on 

the Commission’s decision not to 

propose an alternative model of data 

dissemination to the replace the current 

consolidation model.287 The great 

strength of the current model is that it 

benefits investors, particularly retail 

investors, by enabling them to assess 

prices and evaluate the best execution of 

their orders by obtaining data from a 

single source that is highly reliable and 

comprehensive. But, by requiring 

vendors and broker-dealers to display 

data to investors that is consolidated 

from all markets, the current model 

effectively also requires the purchase of 

data from all markets. As a result, the 

most significant drawback of the current 

model is that it offers little opportunity 

for market forces to determine a 

Network’s fees, or the allocation of those 

fees to a Network’s SRO participants. 

Network fees must be closely 

scrutinized for fairness and 

reasonableness, and the revenues 

resulting from those fees must be 

allocated to the SROs pursuant to a Plan 

formula. In addition, individual markets 

have less freedom to innovate in 

individually providing their quotation 

and trade data.

In the Proposing Release, the 

Commission specifically considered 

three alternative models that potentially 

could introduce greater competition and 

flexibility into the dissemination of 

market data: (1) A deconsolidation 

model, (2) a competing consolidators 

model, and (3) a hybrid model. It 

decided not to propose any of these 

alternative models after consideration of 

the benefits and drawbacks of each 

model. The Commission did, however, 

request comment on whether it should 

develop an alternative model for 

disseminating market data to the public, 

and, in particular, on its evaluation of 

the strengths and weaknesses of the 

current model and of the various 

alternative models for the dissemination 

of market data. 

In response to the Commission’s 

request for comment, a minority of 

commenters expressed their views 

regarding the appropriate structure for 

the dissemination of market information 

to the public. One group believed that 

the current model requiring the display 

of consolidated data in a stock through 

a Plan processor has produced 

significant benefits for investors and the 

markets, although they also strongly 

recommended that its operation needed 

to be improved in significant 

respects.288 Another group of 

commenters, in contrast, asserted that 

the current system has inhibited 

competition among markets and that the 

Plans should be eliminated.289 These 

commenters further suggested 

deregulation of market data by allowing 

markets to sell their own data, and by 

allowing market forces and competition 

to control the pricing of such data. They 

advocated a competing consolidators 

model or a hybrid model.

a. Competing Consolidators Model. 

Under a competing consolidators model, 

the consolidated display requirement 

would be retained, but the Plans and 

Networks would no longer be necessary. 

Each of the nine SROs that participate 

in the NMS, as well as Nasdaq, would 

be allowed to establish its own fees, to 

enter into and administer its own 

market data contracts, and to provide its 

own data distribution facility. Any 

number of data vendors or brokerdealers (i.e., ‘‘competing consolidators’’) 

could purchase data from the individual 

SROs, consolidate the data, and 

distribute it to investors and other data 

users. Of the commenters that urged the 

Commission to adopt a competing 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77461

290See, e.g., ArcaEx Letter at 12, 14; ISE Letter at 

8–9; NYSE Letter, Attachment at 10–11.

291NYSE Letter at 7 and Attachment at 10. The 

NYSE provided several reasons for the elimination 

of the Plans.

292AcraEx Letter at 14.

293See Proposing Release, 69 FR at 11178.

294Nasdaq Letter II at 26–28. 295At the NMS Hearing, a representative of 

Nasdaq stated that the current $20 fee for 

professionals to obtain market data in Nasdaq 

stocks is too high; that the fee, based on a recent 

analysis of Nasdaq’s cost structure, should be 

around $5 to $7; and that the $20 fee is a monopoly 

price ‘‘set almost twenty years ago without any 

active review of how that relates.’’ Hearing Tr. at 

223–224, 253. These remarks subsequently 

engendered some confusion among the public, 

which was reflected in many comments on the 

market data proposals addressing the level of fees. 

To put these comments in perspective and dispel 

any potential misconceptions, the following points 

should be kept in mind: (1) In 1999, the 

Commission undertook a comprehensive review of 

market data fees and revenues, which led to a 75% 

reduction in the fees paid by retail investors for 

market data; (2) Nasdaq’s suggested $5 to $7 

monthly fee for professional investors would entitle 

them to only the NBBO in Nasdaq stocks, which is 

a fraction of the data that currently is disseminated 

for the $20 monthly fee for professional investors 

for consolidated trades and quotations in Nasdaq 

stocks; and (3) Nasdaq’s $5 to $7 cost estimate 

encompassed only its own costs and therefore 

excluded the costs of other SROs that now represent 

a large percentage of trading in Nasdaq-listed 

stocks.

296Nasdaq Letter II at 27.

297The Commission also is concerned about the 

risk of compromising the quality of market 

information if the hybrid model were adopted. 

Proposing Release, 69 FR at 11178. 298Proposing Release, 69 FR at 11179. 299Hearing Tr. at 223–224, 228–229, 230–231, 

233. 300Supplemental Release, 69 FR at 30148. 301See, e.g., Ameritrade Letter I at 3, 10; ASA 

Letter at 2; Bloomberg Tradebook Letter at 8–9; Brut 

Letter at 21–23; Citigroup Letter at 15; Financial 

Information Forum Letter at 3; Financial Services 

Roundtable Letter at 6–7; Goldman Sachs Letter at 

2, 10; ICI Letter at 21–22; Morgan Stanley Letter at 

21–22; Schwab Letter at 2; SIA Letter at 22; STANY 

Letter at 14; UBS Letter at 10.

302SRO Structure Release, supra note 30.

consolidators model,290 the NYSE, for 

example, believed that allowing the 

markets to withdraw from the Plans 

would ‘‘reestablish the link between the 

value of a market’s data * * * and the 

fair allocation of costs among * * * 

users,’’ thereby ending inter-market 

subsidies and market-distortive 

initiatives created by the current 

system.’’ 291 Similarly, ArcaEx stated 

that ‘‘the best way to reform the [P]lans 

is to abolish them altogether and to 

adopt a competing consolidators 

model.’’ 292

The Commission has considered the 

comments advocating a competing 

consolidators model, but continues to 

question the extent to which the model 

would in fact subject the level of market 

data fees to competitive forces. If the 

benefits of a fully consolidated data 

stream are to be preserved for investors, 

every consolidator would need to 

purchase the data of each SRO to assure 

that the consolidator’s data stream in 

fact included the best quotations and 

most recent trade report in all NMS 

stocks. Moreover, to comply with the 

reproposed Trade-Through Rule, each 

market center would need the quotation 

data from every other market center in 

a security. As a practical matter, 

payment of every SRO’s fees would be 

mandatory, thereby affording little room 

for competitive forces to influence the 

level of fees. Consequently, far from 

freeing the Commission from 

involvement in market data fee 

disputes, the multiple consolidator 

model would require review of at least 

ten separate fees for individual SROs 

and Nasdaq. The overall level of fees 

would not be reduced unless one or 

more of the SROs or Nasdaq was willing 

to accept a significantly lower amount 

of revenues than they currently are 

allocated by the Plans. It seems unlikely 

that any SRO or Nasdaq would 

voluntarily propose lower fees to reduce 

their current revenues, and some might 

well propose higher fees to increase 

their revenues, particularly those with 

dominant market shares whose 

information is most vital to investors. 

No commenter offered useful, objective 

standards for the Commission to use in 

evaluating the separate fees of SROs and 

Nasdaq. For this and for data quality 

concerns,293 the Commission remains 

unconvinced that discarding the current 

model in favor of a multiple 

consolidator model would benefit 

investors and the NMS in general.

b. Hybrid Model. Nasdaq advocated a 

hybrid model of data dissemination as 

a compromise if the Commission 

believes that it is necessary to retain the 

Plans.294 Under a hybrid approach, 

basic elements of the current model 

(including the consolidated display 

requirement and the Plans) would be 

retained for quotations representing the 

NBBO, but all trade reports and all 

quotations other than the NBBO would 

be deconsolidated. Because much less 

consolidated data would be 

disseminated under this model, the fees 

for consolidated data would be reduced 

commensurately. The individual SROs 

would distribute their own trade and 

quotation information separately and 

establish fees for such information. To 

obtain the data eliminated from the 

consolidated system, investors would 

need to pay the separate SRO fees.

In sum, Nasdaq suggested that 

consolidated data fees should be 

reduced,295 but only in the context of 

advocating a hybrid model that would 

drastically reduce the quantity of data 

that would be disseminated to investors 

(i.e., by eliminating all trade reports and 

all quotations other than the NBBO). 

Nasdaq stated that the Commission 

should allow competitive forces to 

determine the individual SRO fees for 

deconsolidated data because trade 

reports and non-NBBO quotations are 

not ‘‘essential to investors.’’ 296

The Commission believes, however, 

that comprehensive trade and quotation 

information, even beyond the NBBO, is 

vital to investors. It remains concerned 

that an SRO with a significant share of 

trading in NMS stocks could exercise 

market power in setting fees for its data. 

Few investors could afford to do 

without the best quotations and trades 

of such an SRO that is dominant in a 

significant number of stocks. In the 

absence of a solid basis to believe that 

full trade and quotation information 

would continue to be widely available 

and affordable to all types of investors 

under a hybrid model, the Commission 

has determined that the most 

responsible course of action is to take 

such immediate steps are necessary to 

improve the operation of the current 

consolidation model.297

2. Level of Fees and Plan Governance 

a. Level of Fees. In the Proposing 

Release, the Commission emphasized 

that one of its primary goals with 

respect to market data is to assure 

reasonable fees that promote its wide 

public availability. Comment was 

requested on the extent to which 

investors and other data users were 

relatively satisfied with the products 

and fees offered by the Networks.298 At 

the NMS Hearing, several panelists 

addressed the current level of fees and 

questioned whether such fees remained 

reasonably related to the cost of market 

data.299 The Supplemental Release 

therefore noted the panelists’ views and 

welcomed comments on the 

reasonableness of market data fees and 

whether the Commission should modify 

its approach to reviewing such fees.300

Many commenters recommended that 

the level of market data fees should be 

reviewed and that, in particular, greater 

transparency concerning the costs of 

market data and the fee-setting process 

is needed.301 The Commission agrees. 

To respond to commenters’ concerns, it 

has initiated a review of market data 

fees in its concept release relating to 

SRO structure.302 The release discusses 

and requests comment on a number of 

issues raised by commenters in the 

context of SRO revenues and the 

funding of self-regulation—in particular, 

whether market data fees are reasonable, 

whether the Commission should 

77462 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

303SRO Transparency Release, supra note 31. 304See, e.g., Ameritrade Letter I at 10; Goldman 

Sachs Letter at 10; SIA Letter at 22. 305See, e.g., ASA Letter at 2; Citigroup Letter at 

16; Schwab Letter at 6; SIA Letter at 25.

306See supra, note 29. 307Market Information Release, 64 FR at 70614–

70615. 308 Data for this table is derived from the 2003 

annual reports of the various markets and from 

statistics compiled by the World Federation of 

Exchanges. The exchange rates are as of August 15, 

2004.

309See, e.g., Amex Letter at 10; Citigroup Letter 

at 17; Financial Information Forum Letter at 4; 

reconsider a flexible cost-based 

approach as described in the 1999 

Market Information Release, and 

whether market data fees should be 

used to fund SRO operational or 

regulatory costs. The Commission also 

has taken steps to promote more 

transparency with respect to market 

data fees and the use of market data 

revenues through its proposal on SRO 

transparency.303 The proposal would 

greatly increase SRO transparency by 

requiring, among other things, that 

SROs file public reports with the 

Commission detailing their sources of 

revenues and their uses of these 

revenues. Such reports would enhance 

the public’s ability to evaluate the role 

of market data revenues in funding 

SROs. For example, proposed 

amendments to Form 1, Exhibit I would 

require exchange SROs to disclose their 

revenues earned from market 

information fees, itemized by product, 

and proposed new Rule 17a–26 would 

require SROs to file electronic quarterly 

and annual reports on particular aspects 

of their regulatory activities.

Some commenters suggested that, 

instead of modifying the Plan formulas 

for allocating market data revenues, the 

Commission should impose a cost-based 

limitation on fees.304 Most, however, 

adopted a very restricted view of market 

data costs—solely the costs of the 

Networks to collect data from the 

individual SROs and disseminate it to 

the public.305 Yet nearly the entire 

financial burden of collecting and 

producing market data is borne by the 

individual markets, not by the 

Networks. If, for example, an SRO’s 

systems break down on a high-volume 

trading day and it can no longer provide 

its data to the Networks, investors 

would suffer the consequences of a 

defective data stream, regardless of 

whether the Networks are able to 

continue operating.

The commenters’ suggested approach 

to market data fees would eliminate any 

funding for the SROs that supply data 

to the Networks, which would have 

reduced SRO funding by $386 million 

in 2003.306 The Commission is reluctant 

to impose such a significant and sudden 

reduction in SRO funding without 

taking due care for the consequences it 

might have on the integrity of the U.S. 

equity markets. When the Commission 

last reviewed market data fees and 

revenues in 1999, it noted the direct 

connection between an SRO’s 

operational and regulatory functions 

and the value of its market information:

[T]he value of a market’s information is 

dependent on the quality of the market’s 

operation and regulation. Information is 

worthless if it is cut off during a systems 

outage (particularly during a volatile, highvolume trading day when reliable access to 

market information is most critical), tainted 

by fraud or manipulation, or simply fails to 

reflect accurately the buying and selling 

interest in a security.307

Moreover, the U.S. equity markets are 

not alone in their reliance on market 

data revenues as a substantial source of 

funding. All of the other major world 

equity markets currently derive large 

amounts of revenues from selling 

market information, despite having 

significantly less trading volume and 

less market capitalization than the 

NYSE and Nasdaq. To illustrate, the 

following table sets forth the respective 

market information revenues, dollar 

value of trading, and market 

capitalization for the largest world 

equity markets in 2003: 308

Data

revenues

(millions) 

Trading

volume

(trillions) 

Market capitalization

(trillions) 

London ..................................................................................................................................................... $180 $3.6 $2.5 

NYSE ....................................................................................................................................................... 172 9.7 11.3 

Nasdaq ..................................................................................................................................................... 147 7.1 2.8 

Deutsche Bourse ..................................................................................................................................... 146 1.3 1.1 

Euronext ................................................................................................................................................... 109 1.9 2.1 

Tokyo ....................................................................................................................................................... 60 2.1 3.0 

In sum, the Commission is committed 

to assuring that investors are not 

required to pay unreasonable or unfair 

fees for the consolidated market 

information that they must have to 

participate in the U.S. equity markets. 

On the other hand, we must maintain 

high standards of SRO performance, 

without which the data they produce 

would be worth little. Some 

commenters suggested that SRO funding 

should be provided through more 

specifically targeted fees, such as an 

additional regulatory fee to fund market 

regulation costs. Given the potential 

harm if vital SRO functions are not 

adequately funded, we believe that the 

level of market data fees is most 

appropriately addressed in a context 

that looks at SRO funding as a whole. 

The Commission’s review of SRO 

structure, governance, and transparency 

provides a useful context in which these 

competing policy concerns can be 

evaluated and balanced appropriately. 

The Commission does not believe, 

however, that reform of the current 

revenue allocation formulas should be 

delayed until its review of fees is 

completed. The distortions caused by 

these formulas are substantial and 

ongoing. In particular, it appears that 

market participants increasingly are 

engaging in the practice of trade 

shredding (i.e., splitting large trades into 

multiple 100-share trades) as a means to 

increase their share of market data 

revenues under the current Plan 

formulas. As discussed below, the 

reproposed formula would represent a 

substantial improvement because it is 

designed to eliminate trade shredding 

and other gaming of the current 

formulas and because it would more 

directly allocate revenues to those 

markets that contribute data to the 

consolidated data stream that is most 

useful to investors.

b. Plan Governance. The Commission 

is reproposing, substantially as 

proposed, an amendment to the Plans 

that would require the creation of nonvoting advisory committees 

(‘‘Governance Amendment’’). It 

provides that the members of an 

advisory committee have the right to 

submit their views to the Plan operating 

committees on Plan matters, including 

any new or modified product, fee, 

contract, or pilot program. Most 

commenters supported the Governance 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77463

Financial Services Roundtable Letter at 6–7; ICI 

Letter at 4 and 21 n. 35; Instinet Letter at 7, 46; 

Nasdaq Letter II at 33; Reuters Letter at 3; STANY 

Letter at 15.

310CBOE Letter at 2, 17; ISE Letter at 2; Specialist 

Assoc. Letter at 16.

311See, e.g., Letter from W. Hardy Callcott, to 

Jonathan G. Katz, Secretary, Commission, dated 

May 6, 2004 (‘‘Callcott Letter’’) at 4–5 n.10; 

Citigroup Letter at 17; Financial Services 

Roundtable Letter at 6–7; Goldman Sachs Letter at 

12–13; Instinet Letter at 46; Morgan Stanley Letter 

at 22; Schwab Letter at 8; SIA Letter at 26; STANY 

Letter at 15.

312Brut Letter at 24.

313SIA Letter at 27–28.

314Hearing Tr. at 85, 90–92, 94–97, 120–121.

315Supplemental Release, 69 FR at 30148.

316See, e.g., Amex Letter at 11; ATD Letter at 4; 

Bloomberg Tradebook Letter at 7; BSE Letter at 15; 

ICI Letter at 21; Morgan Stanley Letter at 22; Nasdaq 

Letter II at 31; NYSE Letter, Attachment at 11–12; 

313SIA Letter at 27–28.

314Hearing Tr. at 85, 90–92, 94–97, 120–121.

315Supplemental Release, 69 FR at 30148.

316See, e.g., Amex Letter at 11; ATD Letter at 4; 

Bloomberg Tradebook Letter at 7; BSE Letter at 15; 

ICI Letter at 21; Morgan Stanley Letter at 22; Nasdaq 

Letter II at 31; NYSE Letter, Attachment at 11–12; 

STA Letter at 7; UBS Letter 10; Vanguard Letter at 

6.

Amendment.309 They generally believed 

that expanding the participation of nonSROs parties in Plan governance would 

be a constructive step. Only a few 

commenters disagreed, stating that 

interested parties currently have the 

ability to communicate their views on 

Plan matters or questioning the efficacy 

of the committees.310

A number of commenters, however, 

believed that the proposal did not go far 

enough to reform the Plans and that 

even greater participation by interested 

non-SRO parties in the Plans is 

needed.311 Brut suggested that the 

Commission ‘‘consider applying SRO 

governance standards to [Network 

processors] going forward, subjecting 

their operations to the same standards of 

transparency and accountability’’ in 

order to limit their monopoly power.312

These commenters also raised concerns 

regarding several other aspects of Plan 

governance, including current 

administrative costs and burden, the 

unanimous vote requirement for Plan 

action, and the current process for 

reviewing SRO fee filings and Plan 

amendments. For instance, the SIA 

believed that inconsistencies among the 

Networks regarding administrative 

requirements and burdens (i.e., 

agreements and contracts, billing 

policies, data use policies, and annual 

audit requirements) contribute to high 

market data fees and should be reduced, 

streamlined, and made uniform.313

In many respects, the Commission 

agrees with the concerns expressed by 

commenters on the administration of 

the Plans. It believes, however, the 

Governance Amendment would 

represent a useful first step toward 

improving the responsiveness of Plan 

participants and the efficiency of Plan 

operations. Expanding the participation 

of interested parties other than SROs in 

Plan governance should improve 

transparency, as well as provide an 

established mechanism for alternative 

views to be heard. Earlier and more 

broadly based participation could 

contribute to the ability of the Plans to 

achieve consensus on disputed issues. 

Going forward, the Commission is 

receptive to additional steps that would 

improve Plan operations in general, 

particularly those that would streamline 

fee administration procedures and 

burdens. Enhanced participation of 

advisory committee members in Plan 

affairs potentially should help further 

this process. 

3. Revenue Allocation Formula 

The proposal included an amendment 

to the Plans that would modify their 

formulas for allocating market data 

revenues to SRO Participants. The 

current Plan formulas are based solely 

on the trading activity of an SRO. The 

proposed formula was intended to 

address three serious weaknesses in the 

old formulas: (1) The absence of any 

allocation of revenues for the quotations 

contributed by an SRO to the 

consolidated data stream, (2) an 

excessive emphasis on the number of 

trades reported by an SRO that has led 

to distortive trading practices, such as 

wash sales, trade shredding, and print 

facilities, and (3) a disproportional 

allocation of revenues for a relatively 

small number of stocks with extremely 

high trading volume, to the detriment of 

the thousands of other stocks included 

in a Network, typically issued by 

smaller companies, with less trading 

volume. 

To address these problems, the 

proposed formula included a number of 

elements, including a Quoting Share, an 

NBBO Improvement Share, a Trading 

Share, and a Security Income 

Allocation. The Quoting Share and 

NBBO Improvement Share would have 

provided an allocation of revenues for 

an SRO’s quotations. In particular, the 

Quoting Share would have allocated 

revenues for all quotes, both automated 

and manual, according to the dollar size 

and length of time that such quotes 

equaled the price of the NBBO. It 

included an automatic cutoff of credit 

for manual quotations, however, when 

they were left alone at the NBBO. This 

cut-off was intended to preclude SROs 

from being allocated revenues merely 

for slowness in updating their manual 

quotations. The NBBO Improvement 

Share would have allocated revenues to 

SROs for the extent to which they 

displayed quotations that improved the 

price of the NBBO. 

At the NMS Hearing, representatives 

of floor-based exchanges stated their 

intention to adopt hybrid trading 

models that would primarily display 

automated quotations.314 In response, 

the Commission, in its Supplemental 

Release, stated that the prospect of 

hybrid trading models presented an 

opportunity for simplifying the 

proposed allocation formula.315 It noted 

that the purpose of the automatic cutoff 

for manual quotations was to minimize 

the allocation of revenues for potentially 

stale quotations and requested comment 

on whether only automated quotes 

should be entitled to earn an allocation 

of revenues. The Supplemental Release 

also noted that the NBBO Improvement 

Share was significantly more complex 

than the other aspects of the proposed 

formula and that it had been proposed 

largely to counter the potential for an 

excessive allocation of revenues for 

manual quotations. Comment was 

requested on whether there was any 

need for the NBBO Improvement Share 

if manual quotations were excluded 

from the formula.

The comments generally addressed 

four broad categories of issues: (1) 

Whether the current Plan formulas need 

to be updated, (2) whether quotations 

should be considered in allocating 

revenues, (3) whether the size of trades 

should be considered in allocating 

revenues, and (4) whether the allocation 

of revenues should be allocated more 

evenly across all of a Network’s stocks. 

These comments are discussed below. 

a. Need for New Formula. Many 

commenters agreed with the 

Commission that, if the Networks were 

to continue allocating revenues to the 

SROs, the current allocation formulas 

needed to be updated.316 Many of these 

commenters also believed that the 

proposed formula should be modified in 

several respects, and their specific 

suggestions to improve the proposed 

formula are discussed below. In general, 

however, they agreed with the 

objectives of the proposal to eliminate 

much of the incentive for distortive 

trade reporting practices and to begin 

providing some allocation of revenues 

for the quotations that SROs contribute 

to the consolidated data stream.

Other commenters, in contrast, 

opposed changing the current allocation 

formulas.317 Their specific objections to 

the proposed formula are discussed 

below, but they also opposed changing 

the current formulas for more general 

reasons. First, some believed that, rather 

77464 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

318Some commenters were concerned that the 

proposed formula’s use of dollar volume 

calculations did not sufficiently allocate revenues 

to markets that trade low-priced stocks. See, e.g., 

BSE Letter at 18; CHX Letter at 16. The Commission 

preliminarily believes that dollar volume would be 

the most appropriate measure, in general, of the 

importance to investors of trading and quoting 

information. Per share stock prices, in contrast, are 

a more arbitrary measure because they are 

dependent, to a large extent, on the number of 

shares a company chooses to issue, both originally 

and through stock splits and reverse stock splits. To 

the extent the commenters were concerned about 

the less active stocks of smaller companies, the 

Security Income Allocation of the reproposed 

formula would incorporate the square root function 

precisely to more appropriately allocate revenues to 

SROs that provide a venue for price discovery in 

these stocks. See section V.A.3.d below.

319See, e.g., CBOE Letter at 14 (calculation of 

Quote Credits will ‘‘yield astronomical numbers’’

that ‘‘can be expressed only in exponential terms’’); 

NSX Letter at 7 (calculation of large number of 

Quote Credits is ‘‘particularly ludicrous’’).

320For example, assume a stock with an average 

price of $100 per share has an unusually large 

average quoted size of 200,000 shares at both the 

national best bid and the national best offer 

throughout every second of the trading year. Over 

an average 252 trading days during a year, the total 

Quote Credits in this stock would be 235.9 trillion 

($100*400,000*252*23,400 seconds per trading 

day). Quote Credits would only be calculated for 

individual Network stocks and would not be totaled 

across all Network stocks.

321See, e.g., Brut Letter at 22; CHX Letter at 21–

22; NSX Letter at 6.

than changing the formulas, the 

Commission simply should prohibit the 

particular distortive practices caused by 

the old formulas and enforce the 

existing prohibitions against such 

practices. Commenters also opposed the 

proposed formula because they believed 

it incorporated arbitrary judgments 

about the value of quotations and trades. 

Finally, those opposed to changing the 

Plan formulas also believed that the 

proposed formula was simply too 

complex to be implemented effectively 

and that its costs exceeded any benefits 

that were likely to be gained.

The Commission has considered the 

views of these commenters, but does not 

believe that they warrant leaving the 

current Plan formulas in place. First, the 

Commission intends to continue to 

enforce the existing prohibitions against 

distortive trade reporting practices. 

Rather than attempting to formulate new 

prohibitions that address every 

conceivable harmful practice, however, 

it has determined to address directly the 

ultimate source of the problem by 

reproposing revisions to the current 

formulas. As long as the allocation of 

market data revenues is based primarily 

on reporting a large number of very 

small trades, the incentive for distortive 

trading reporting will continue. 

Moreover, as discussed below, the 

current formulas are flawed in several 

important respects beyond the 

incentives they create for distortive 

trading reporting practices.

The Commission preliminarily does 

not believe that the reproposed formula 

would incorporate arbitrary judgments 

about the value of trades and quotes. In 

this regard, it is important to recognize 

that any formula for allocating market 

data revenues would reflect some 

judgment regarding the contribution of 

the various SROs to the consolidated 

data stream; otherwise, the revenues 

could simply be allocated equally 

among all Plan participants. The 

Commission’s goal in reproposing a new 

formula is to improve the judgments 

incorporated in the old Plan formulas to 

more fully achieve NMS objectives. 

For example, the current formula for 

Network A and Network B treats a 100-

share trade the same as a 20,000 share 

trade in the same stock, even though 

their importance for price discovery 

purposes clearly is not equal. All of the 

current Plan formulas treat a quotation 

as having no value if it did not result in 

a trade, even if the quotation was fully 

accessible and established the NBBO for 

a substantial period of time, thereby 

providing price discovery for trades 

occurring at other markets that 

internalize orders with reference to the 

NBBO price. Such formulas based solely 

on an SRO’s trading activity may have 

been adequate many years ago when a 

single market dominated each group of 

securities, but are seriously outdated 

now that trading is split among many 

different markets whose contributions to 

the public data stream can vary 

considerably. 

The reproposed formula would reflect 

fairly straightforward determinations 

about the kinds of data that, in general, 

are likely to be useful to investors. For 

example, a $50,000 quote at the NBBO 

in a stock is likely more useful to 

investors than a $2000 quote in the 

same stock. Similarly, a $50,000 trade in 

a stock is likely more useful to investors 

in assessing the trading trend of that 

stock than a $2000 trade; again, not 

necessarily in every case, but in general 

and on average. The reproposed formula 

would represent a substantial 

improvement on the old formulas.318

The Commission agrees with 

commenters that the proposed formula 

was very complex and may have been 

difficult to implement efficiently. They 

particularly noted that the proposed 

NBBO Improvement Share was very 

difficult to understand and had the 

potential to be abused through gaming 

behavior. Given that only automated 

quotations would be entitled to earn an 

allocation under the reproposed 

formula, the proposed NBBO 

Improvement Share can be deleted, as 

well as the proposed cutoff of credits for 

manual quotations left alone at the 

NBBO. The elimination of these two 

elements greatly reduces the complexity 

of the reproposed formula and should 

promote more efficient implementation 

of the formula. In addition, the 15% of 

the Security Income Allocation that was 

allocated to the NBBO Improvement 

Share in the proposed formula would 

now be shifted to the Quoting Share to 

establish a generally even allocation of 

revenues between trading and quoting. 

The Commission does not agree, 

however, with those commenters who 

argued that it would be overly costly 

and complex to calculate the other 

elements of the proposed formula. An 

SRO’s Trading Share, for example, 

would not be materially more difficult 

to calculate than the current Network C 

formula, which is based on an average 

of the SRO’s proportion of trades and 

share volume. The Security Income 

Allocation merely would use the square 

root function, which is a simple 

arithmetic calculation. Finally, some 

commenters believed that the Quoting 

Share, which would incorporate the 

total dollar size of the NBBO in a stock 

throughout the trading year, would 

result in astronomically high numbers 

that would be extremely difficult to 

calculate.319 In fact, the largest number 

of Quote Credits in a year for even the 

highest price stock with the greatest 

displayed depth at the NBBO would be 

very unlikely to reach beyond the 

trillions, a number well within the 

capabilities of even the most basic 

spreadsheet program.320 Moreover, it is 

the proportion of an SRO’s Quote 

Credits in relation to other SROs that 

would determine an allocation, not the 

absolute amount of Quote Credits.

Finally, a few commenters were 

concerned about the effect of modifying 

the current allocation formulas on the 

existing business models and terms of 

competition for the various markets.321

The Commission recognizes that 

reforming formulas that have remained 

unchanged for many years could affect 

the competitive position of various 

markets. Given the severe deficiencies 

of these formulas, however, it does not 

believe that the interests of any 

particular business model should 

preclude updating the formulas to 

reflect current market conditions. The 

reproposed formula is intended to 

reflect more appropriately the 

contributions of the various SROs to the 

consolidated data stream and thereby 

better align the interests of individual 

markets with the interests of investors.

b. Quotations that Equal the NBBO. 

Many commenters supported the 

proposal to allocate a portion of market 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77465

322See, e.g., Amex Letter at 11; ATD Letter at 4; 

Bloomberg Tradebook Letter at 7–8; Morgan Stanley 

Letter at 22–23; STA Letter at 7; Vanguard Letter at 

6.

323See, e.g., ArcaEx Letter at 13; Brut Letter at 22; 

CHX Letter at 19; Instinet Letter at 41.

324 Instinet Letter at 41.

325ArcaEx Letter at 13; Brut Letter at 22, Phlx 

Letter at 4.

326Brut Letter at 22.

327ArcaEx noted that top-of-book quotes make 

only a partial contribution to price discovery and 

that depth-of-book quotes are particularly important 

since decimalization. ArcaEx Letter at 13. The 

Commission agrees that depth-of-book quotes are 

important to investors, and for that reason has 

reproposed amendments to the market data rules to 

facilitate the independent dissemination of a 

market’s depth of book. The rules would not 

prevent such a market from charging fees for depthof-book quotations that are fair and reasonable and 

not unreasonably discriminatory.

328Proposing Release, 69 FR at 11181.

329See, e.g., BSE Letter at 16; CHX Letter at 19–

20; E*Trade Letter at 11.

330E*Trade Letter at 11; Instinet Letter at 42.

data revenues based on an SRO’s 

quotations, particularly if only 

automated and accessible quotations 

would qualify for an allocation.322 Some 

commenters, however, were concerned 

about the risk of harmful gaming 

behavior by market participants.323 For 

example, Instinet stated that the 

‘‘fundamental problem with the 

Commission’s proposed formula stems 

from the inherently low cost for market 

participants to generate quotation 

information and the consequent high 

potential for gaming behavior in any 

formula that attempts to reward such 

behavior.’’ 324 A specific type of gaming 

that concerned commenters was 

‘‘flickering quotes’’—quotes that are 

flashed for a short period of time solely 

to earn market data revenues, but are 

not truly accessible and therefore do not 

add any value to the consolidated quote 

stream.

The Commission recognizes that 

abusive quoting behavior is a legitimate 

concern. It preliminarily does not 

believe, however, that the reproposed 

formula would be unacceptably 

vulnerable to gaming, particularly 

because only automated and fully 

accessible quotations would be entitled 

to earn a share of market data revenues. 

The potential cost of displaying such 

quotations, in the form of unprofitable 

trades, should not be underestimated. 

Quotations would earn significant 

revenues only if they represent a 

significant proportion of the total size of 

quotations displayed at the NBBO for a 

stock throughout the trading year. The 

risk of losses that could result from the 

execution of orders against large 

quotations would be likely to dwarf any 

potential allocation of market data 

revenues. With the advent of highly 

sophisticated order-routing algorithms, 

automated quotations throughout the 

NMS can be accessed with lightning 

speed. Some of these algorithms are 

specifically designed to search the 

market for displayed liquidity and 

sweep such liquidity immediately when 

it is displayed. The market discipline 

imposed by these order-routing 

practices should greatly reduce the 

potential for ‘‘low cost’’ quotations at 

the NBBO if the reproposed formula 

were adopted. A market participant 

would need to think carefully about 

whether it is truly willing to trade at a 

price, particularly a price as attractive as 

the NBBO, before displaying accessible 

and automated quotations to earn 

market data revenues.

A few commenters also opposed the 

proposed Quoting Share because they 

believed it represented an attempt by 

the Commission to control the quoting 

behavior of market participants.325

ArcaEx stated for example, that the 

‘‘most important question is how paying 

for top-of-book quotes—on a time- and 

size-weighted basis or on any other 

basis—encourages beneficial behavior,’’

and questioned whether the Quoting 

Share would achieve this result. Brut 

asserted that ‘‘[n]ot only would [the 

proposed formula] increase the potential 

unnatural trading and quoting behavior, 

it signifies a desire to use market 

structure regulation to micro-manage 

market participant behavior * * *’’ 326

These commenters appear to have 

misunderstood the Commission’s 

objective in proposing to update the 

current Plan formulas. As noted above, 

it is unlikely that a marginal increase in 

market data revenues would 

significantly alter the quoting behavior 

of market participants, at least for those 

not already interested in trading a stock 

for separate reasons. The potential cost 

of unprofitable trades would be too 

high. Rather, the Commission’s primary 

objective would be to correct an existing 

flaw in the current formulas by 

allocating revenues to those SROs that, 

even now, benefit investors by 

contributing useful quotations to the 

consolidated data stream. Currently, 

such SROs do not receive any allocation 

for providing a venue for this beneficial 

quoting activity. Basing an allocation on 

the extent to which an SRO’s quotes 

equal the NBBO would be an 

appropriate means to correct this flaw, 

even if it does not always reflect the 

precise value of quotations.327

c. Number and Dollar Volume of 

Trades. The current Plan formulas 

allocate revenues based on the number 

of trades (Networks A and B) or on the 

average of number of trades and share 

volume of trades (Network C) reported 

by SROs. By focusing solely on trading 

activity (and particularly by rewarding 

the reporting of many trades no matter 

how small their size), these formulas 

have contributed to a variety of 

distortive trade reporting practices, 

including wash sales, shredded trades, 

and SRO print facilities. To address 

these practices and to establish a more 

broad-based measure of an SRO’s 

contribution to the consolidated trade 

stream, the proposed formula provided 

that an SRO’s Trading Share in a 

particular stock would be calculated by 

taking the average of the SRO’s 

percentage of total dollar volume in the 

stock and the SRO’s percentage of 

qualified trades in the stock. A 

‘‘qualified trade’’ was defined as having 

a dollar volume of $5000 or more. The 

Proposing Release requested comment 

on whether this amount should be 

higher or lower, or whether trades with 

a size of less than $5000 should receive 

credit that was proportional to their 

size.328

Several commenters believed that 

small trades contribute to price 

discovery and should be entitled to earn 

at least some credit in the calculation of 

the number of qualified trades.329 The 

Commission agrees and has included in 

the reproposed formula a provision that 

awards a fractional proportion of a 

qualified report for trades of less than 

$5000. Thus, a $2500 trade would 

constitute 1⁄2 of a qualified report. This 

approach would greatly reduce the 

potential for large allocations 

attributable to shredded trades, while 

recognizing the contribution of small 

trades to price discovery.

Two commenters asserted that the 

$5000 threshold was arbitrary.330 As 

noted in the Proposing Release, an 

analysis of Network A data indicates 

that approximately 90% of dollar 

volume and 50% of trades exceed this 

threshold. The Commission 

preliminarily believes that the $5000 

figure represents a reasonable attempt to 

address the problem of shredding large 

trades into 100-share trades. By 

providing only a proportional allocation 

for trades with dollar amounts below 

this threshold, the ability of market 

participants to generate large revenue 

allocations by shredding trades would 

be greatly reduced. For example, a 2000-

share trade in a $25 stock could be 

shredded into twenty trades in the 

absence of a dollar threshold for 

qualified trades, but could be shredded 

into only ten qualified trades under the 

reproposed formula—a reduction of 

50%. Moreover, when combined with 

the allocation of 50% of revenues to the 

77466 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

331Proposing Release, 69 FR at 11180.

332Amex Letter, Exhibit A at 15; Nasdaq Letter II 

at 32; NYSE Letter, Attachment at 12; Specialist 

Assoc. Letter at 16 n.21.

333Nasdaq Letter II at 32.

334ArcaEx Letter at 12; CBOE Letter at 11; 

Xanadu Letter at 2–3.

335ArcaEx Letter at 12.

336See, e.g., Brut Letter at 21, 23; CBOE Letter at 

2, 17; Citigroup Letter at 16; Financial Information 

Forum Letter at 4; Letter from Coleman 

Stipanovich, Executive Director, State Board of 

Administration of Florida, to Jonathan G. Katz, 

Secretary, Commission, dated June 29, 2004 

(‘‘Florida State Board Letter’’) at 2; Financial 

Services Roundtable Letter at 6; Goldman Sachs 

Letter at 12; ICI Letter at 4, 21 n.35; Instinet Letter 

at 45; Nasdaq Letter II at 33; NYSE Letter, 

Attachment at 12; Reuters Letter at 3; Schwab Letter 

at 13.

337See, e.g., Amex Letter at 10, Exhibit A at 13.

338Amex Letter, Exhibit A at 12.; Instinet Letter 

at 47; Reuters Letter at 2.

339 Instinet Letter at 47.

340See, e.g., Brut Letter at 21, 23; Financial 

Information Forum Letter at 3–4; Instinet Letter at 

7, 45; Nasdaq Letter II at 27, 32; Reuters Letter at 

2–3.

341See, e.g., Amex Letter at 9 & Exhibit A at 12; 

Bloomberg Tradebook Letter at 9; Callcott Letter at 

1, 2, 5.

Quoting Share and the allocation of 

another 25% of revenues based on the 

dollar volume of trades, the $5000 

threshold for qualified trades would 

eliminate much of the potential reward 

for trade shredding under reproposed 

formula.

d. Allocation of Revenues Among 

Network Stocks. The proposed formula 

included a Security Income Allocation, 

pursuant to which a Network’s total 

distributable revenues would be 

allocated among each of the Network’s 

stocks based on the square root of dollar 

volume. The square root function was 

intended to adjust for the highly 

disproportionate level of trading in the 

very top tier of Network stocks. A few 

hundred stocks (e.g., the top 5%) are 

much more heavily traded than the 

other thousands of Network stocks. The 

Proposing Release noted that an 

allocation that simply was directly 

proportional to trading volume would 

fail to reflect adequately the importance 

of price discovery for the vast majority 

of stocks.331

Of the commenters that addressed this 

issue, four supported the use of a square 

root function to allocate revenues 

among stocks.332 Nasdaq, for example, 

noted that the ‘‘methodology will 

reduce the disparity between the value 

of data of the most active and least 

active securities.’’ 333 Other 

commenters, in contrast, opposed the 

use of the square root function to 

allocate revenues among Network 

stocks.334 ArcaEx believed that the 

proposed allocation method ‘‘introduces 

a steeply progressive tax on liquid 

stocks to subsidize illiquid stocks’’ and 

that the allocation of revenues should 

remain directly proportional to trading 

volume.335

The Commission has retained the 

square root function in the reproposed 

formula to allocate distributable 

Network revenues more appropriately 

among all of the stocks included in a 

Network. Although the extent to which 

Network stocks are tiered according to 

trading volume varies among the three 

Networks, it is quite pronounced in 

each of them. The use of the square root 

function reflects the Commission’s 

judgment that, on average and not 

necessarily in every particular case, a 

$50,000 trade in a stock with an average 

daily trading volume of $500,000 is 

marginally more useful to investors than 

a $50,000 trade in a stock with an 

average daily trading volume of $500 

million. Markets that provide price 

discovery in less active stocks serve an 

extremely important function for 

investors in those stocks. Price 

discovery not only benefits those 

investors who choose to trade on any 

particular day, but also benefits those 

who simply need to monitor the status 

of their investment. Efficient secondary 

markets support buy-and-hold investors 

by offering them a ready opportunity to 

trade at any time at a fair price if they 

need to buy or sell a stock. Indeed, this 

enhanced assurance is one of the most 

important contributions of secondary 

markets to efficient capital-formation 

and to reducing the cost of capital for 

listed companies. The square root 

function would allocate revenues to 

markets that perform this function for 

less-active stocks by marginally 

increasing their percentage of market 

data revenues, while still allocating a 

much greater dollar amount to more 

actively traded stocks. 

4. Distribution and Display of Data 

Most commenters supported the 

proposal authorizing the independent 

distribution of market data outside of 

what is required by the Plans.336 They 

generally agreed that the proposal 

would allow investors and vendors 

greater freedom to make their own 

decisions regarding the data they need. 

They also believed that the 

Commission’s ‘‘fair and reasonable’’ and 

‘‘not unreasonably discriminatory’’

standards are appropriate to ensure that 

the independently distributed market 

data would be made available to all 

investors and data users. A few 

commenters, in contrast, objected to the 

proposed standards, asserting that the 

standards would not effectively protect 

investors and ‘‘weaker and newer 

markets from predatory actions by 

stronger markets or the potential loss of 

data integrity.’’ 337

The Commission is reproposing Rule 

603(a) as proposed. The ‘‘fair and 

reasonable’’ and ‘‘not unreasonably 

discriminatory’’ requirements in 

reproposed Rule 603(a) are derived from 

the language of Section 11A(c) of the 

Exchange Act. Under Section 

11A(c)(1)(C), the more stringent ‘‘fair 

and reasonable’’ requirement is 

applicable to an ‘‘exclusive processor,’’

which is defined in Section 3(a)(22)(B) 

of the Exchange Act as an SRO or other 

entity that distributes the market 

information of an SRO on an exclusive 

basis. Reproposed Rule 603(a)(1) would 

extend this requirement to non-SRO 

markets when they act in functionally 

the same manner as exclusive 

processors and are the exclusive source 

of their own data. Applying this 

requirement to non-SROs would be 

consistent with Section 11A(c)(1)(F) of 

the Exchange Act, which grants the 

Commission rulemaking authority to 

‘‘assure equal regulation of all markets’’

for NMS Securities.

Commenters were concerned about 

the statement in the Proposing Release 

that the distribution standards would 

prohibit a market from distributing its 

data independently on a more timely 

basis than it makes available the ‘‘core 

data’’ that is required to be disseminated 

through a Network processor.338

Instinet, for example, requested that the 

Commission clarify that the proposal 

would not require a market center to 

artificially slow the independent 

delivery of its data in order to 

synchronize its delivery with the data 

disseminated by the Network.339

Reproposed Rule 603(a) would not 

require a market center to synchronize 

the delivery of its data to end-users with 

delivery of data by a Network processor 

to end-users. Rather, independently 

distributed data could not be made 

available on a more timely basis than 

core data is made available to a Network 

processor. Stated another way, 

reproposed Rule 603(a) would require 

that an SRO or broker-dealer must not 

transmit data to a vendor or user any 

sooner than it transmits the data to a 

Network processor.

A majority of the commenters 

supported the Commission’s proposed 

reduction of the consolidated display 

requirements, stating that it should lead 

to lower costs for investors.340 A few 

commenters, however, opposed 

eliminating the requirement to display a 

full montage of market BBOs.341 Amex, 

for example, believed that elimination 

of the montage would confuse investors 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77467

342 In 2002, the Commission abrogated several 

SRO proposals for rebating data revenues to market 

participants. Securities Exchange Act Release No. 

46159 (July 2, 2002), 67 FR 45775 (July 10, 2002). 

The purpose of the abrogation was to allow more 

time for the Commission to consider market data 

issues. Given that the current Plan allocation 

formulas would be updated to allocate revenues for 

more beneficial quoting and trading behavior, the 

Commission anticipates that rebates would be 

permitted in the future if the reproposed formula 

were adopted, assuming their terms meet applicable 

Exchange Act standards and SROs are able to meet 

their regulatory responsibilities. Such SRO rebates 

would, of course, have to be filed with the 

Commission for approval.

343Two commenters were concerned that the new 

formula might prohibit the Network’s current 

practice of making estimated quarterly payments of 

Network revenues, with a final reconciliation at the 

end of the year. BSE Letter at 18, 19; CHX Letter 

at 22. The reproposed formula, however, merely 

tracks existing Plan language for the calculation of 

‘‘Annual Shares’’ or ‘‘annual payments.’’ Nothing in 

the reproposed formula would prohibit Networks 

from making estimated quarterly payments.

and make it more complicated for 

vendors and broker-dealers to manage 

market data.

The Commission does not believe that 

streamlining the consolidated display 

requirement would detract from the 

quality of information made available to 

investors. Reproposed Rule 603(c) 

would continue to require the 

disclosure of basic information (i.e., 

prices, sizes and market center 

identifications of the NBBO, along with 

the most recent last sale information). It 

would allow market forces, rather than 

regulatory requirements, to determine 

what, if any, additional quotations 

outside the NBBO are displayed to 

investors. Investors who need the BBOs 

of each SRO, as well as more 

comprehensive depth-of-book 

information, would be able to obtain 

such data from markets or third party 

vendors. 

B. Description of Reproposed Rules and 

Amendments 

1. Allocation Amendment 

The Commission is reproposing with 

modifications an amendment to each of 

the Plans (‘‘Allocation Amendment’’) 

that incorporates a broad based measure 

of the contribution of an SRO’s quotes 

and trades to the consolidated data 

stream.342 The reproposed formula 

reflects a two-step process. First, a 

Network’s distributable revenues (e.g., 

$150 million) would be allocated among 

the many individual securities (e.g., 

3000) included in the Network’s data 

stream. Second, the revenues that are 

allocated to an individual security (e.g., 

$200,000) then would be allocated 

among the SROs based on measures of 

the usefulness to investors of their 

trades and quotes in the security. The 

Allocation Amendment provides that, 

notwithstanding any other provision of 

a Plan, its SRO participants would 

receive an annual payment for each 

calendar year that is equal to the sum of 

the SRO’s Trading Shares and Quoting 

Shares in each Network security for the 

year.343 These two types of Shares 

would be dollar amounts that would be 

calculated based on SRO trading and 

quoting activity in each Network 

security.

a. Security Income Allocation. The 

first step of the reproposed formula 

would be to allocate a Network’s total 

distributable revenues among the many 

different securities that are included in 

a Network (the ‘‘Security Income 

Allocation’’). Paragraph (b) of the 

reproposed Allocation Amendment 

would base this allocation on the square 

root of dollar volume of trading in each 

security. Use of the square root function 

would more appropriately allocate 

revenues among stocks with widely 

differing trading volume. A small 

number of Network stocks are much 

more heavily traded than the great 

majority of Network stocks. By 

proportionally shifting revenues away 

from the very top tier of active stocks 

and increasing the allocation across 

other stocks, the Security Income 

Allocation is intended to reflect more 

adequately the importance of price 

discovery for all Network stocks. 

b. Trading Share. Under paragraph (c) 

of the reproposed Allocation 

Amendment, an SRO’s Trading Share in 

a particular Network security would be 

a dollar amount that is determined by 

multiplying (i) an amount equal to the 

lesser of (A) 50% of the Security Income 

Allocation for the Eligible Security or 

(B) an amount equal to $2.00 multiplied 

by the total number of qualified 

transaction reports disseminated by the 

Processor in the Eligible Security during 

the calendar year, by (2) the SRO’s 

Trade Rating in the security. A Trade 

Rating would be a number that 

represents the SRO’s proportion of 

dollar volume and qualified trades in 

the security, as compared to the dollar 

volume and qualified trades of all SROs. 

The Trade Ratings of all SROs would 

add up to a total of one. Thus, for 

example, multiplying 50% of the 

Security Income Allocation for a 

Network security (e.g., $200,000) by an 

SRO’s Trade Rating in that security (e.g., 

0.2555) would produce a dollar amount 

(e.g., 50% × $200,000 × 0.2555 = 

$25,550) that is the SRO’s Trading Share 

for the security for the year. 

Applying 50% of the Security Income 

Allocation to the Trading Share reflects 

a judgment that generally trades and 

quotes are of approximately equal 

importance for price discovery 

purposes. For securities with lower 

trading volume, however, this 

percentage can disproportionately 

allocate revenues for a small number of 

trades during the year, at the expense of 

those markets that aggressively quote a 

security throughout the year. For 

example, 50% of the Security Income 

Allocation for a security with 10 

qualified trades during the year might 

be $300. Rather than allocate the full 

$300 to those SROs that reported a small 

number of trades (for an average per 

trade allocation of $30), the reproposed 

formula would include a cap of $2 per 

qualified transaction report, so that a 

total of only $20 would be allocated 

pursuant to the Trading Share. The 

difference of $280 ($300 minus $20) 

would be shifted to the Quoting Share 

to allocate revenues to those markets 

that consistently displayed valuable 

quotes in the security throughout the 

more than 250 trading days during the 

year. The amount of the cap of $2 per 

qualified transaction report exceeds the 

highest amount per transaction report 

currently allocated for any of the three 

Networks.

An SRO’s Trade Rating would be 

calculated by taking the average of (1) 

the SRO’s percentage of total dollar 

volume reported in the Network 

security during the year, and (2) the 

SRO’s percentage of total qualified 

trades reported in the Network security 

for the year. A transaction report with 

a dollar volume of $5000 or more would 

constitute one qualified report. A 

transaction report with a dollar volume 

of less than $5000 would constitute a 

proportional fraction of a qualified 

transaction report. As a result, all sizes 

of transaction reports would contribute 

toward an SRO’s Trade Rating. 

c. Quoting Share. Under paragraph (d) 

of the reproposed Allocation 

Amendment, an SRO’s Quoting Share in 

a particular Network Security would be 

a dollar amount that is determined by 

multiplying (i) an amount equal to 50% 

of the Security Income Allocation for 

the security, plus the difference, if 

greater than zero, between 50% of the 

Security Income Allocation for the 

Eligible Security and an amount equal 

to $2.00 multiplied by the total number 

of qualified transaction reports 

disseminated by the Processor in the 

Eligible Security during the calendar 

year, by (ii) the SRO’s Quote Rating in 

the security. A Quote Rating would be 

a number that represents the SRO’s 

proportion of quotations that equaled 

the price of the NBBO during the year 

(‘‘Quote Credits’’), as compared to the 

Quote Credits of all SRO’s during the 

year. The Quote Ratings of all SROs 

77468 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

344Regular trading hours are defined in 

reproposed Rule 600(b)(64) of Regulation NMS as 

between 9:30 a.m. and 4 p.m. eastern time, unless 

otherwise specified pursuant to the procedures 

established in reproposed Rule 605(a)(2).

345Reproposed Regulation NMS would remove 

the definitions in former paragraph (a) of current 

Rule 11Aa3–1 and place them in reproposed Rule 

600(b). Current subparagraphs (c)(2) and (c)(3) of 

Rule 11Aa3–1 would be rescinded. As a result, 

current subparagraph (c)(4) of current Rule 11Aa3–

1 would be redesignated as subparagraph (b)(2) of 

reproposed Rule 601.

346The information covered by the amendment 

tracks the language of Section 11A(c) of the 

Exchange Act, which applies to ‘‘information with 

respect to quotations for or transactions in’’

securities. This statutory language encompasses a 

broad range of information, including information 

relating to limit orders held by a market center. See, 

e.g., S. Report No. 94–75, 94th Cong., 1st Sess. 9 

(1975) (‘‘In the securities markets, as in most other 

active markets, it is critical for those who trade to 

have access to accurate, up-to-the-second 

information as to the prices at which transactions 

in particular securities are taking place (i.e., last 

sale reports) and the prices at which other traders 

have expressed their willingness to buy or sell (i.e., 

quotations).’’).

347Reproposed Rule 600(b)(42) of Regulation 

NMS defines ‘‘national best bid and national best 

offer.’’

would add up to a total of one. 

Multiplying 50% of the Security Income 

Allocation for a Network security (plus 

any shifted allocation from the Trading 

Share) by an SRO’s Quote Rating in that 

security would produce a dollar amount 

that is the SRO’s Quoting Share for the 

security for the year. 

An SRO would earn one Quote Credit 

for each second of time and dollar value 

of size that the SRO’s automated 

quotation during regular trading hours 

equals the price of the NBBO.344 Thus, 

for example, a bid with a dollar value 

of $4000 (e.g., a bid of $20 with a size 

of 200 shares) that equals the national 

best bid for three seconds would be 

entitled to 12,000 Quote Credits. If an 

SRO quotes simultaneously at both the 

national best bid and the national best 

offer, it would earn Quote Credits for 

each quote. An automated quotation is 

defined by reference to reproposed Rule 

600(b)(3) under Regulation NMS. Thus, 

an SRO’s manual quotations would not 

be entitled to earn any Quote Credits.

2. Governance Amendment 

The Governance Amendment is 

reproposed substantially as proposed. 

Paragraph (a) would mandate the 

formation of a Plan advisory committee. 

Paragraph (b) of the Governance 

Amendment would set forth the 

composition and selection process for 

such an advisory committee. Members 

of the advisory committee would be 

selected by the Plan operating 

committee, by majority vote, for twoyear terms. At least one representative 

would be selected from each of the 

following five categories: (1) A brokerdealer with a substantial retail investor 

customer base, (2) a broker-dealer with 

a substantial institutional investor 

customer base, (3) an ATS, (4) a data 

vendor, and (5) an investor. Each Plan 

participant also would have the right to 

select one additional member to the 

advisory committee that is not 

employed by or affiliated with any Plan 

participant or its affiliates or facilities. 

Paragraphs (c) and (d) of the 

Governance Amendment would set 

forth the function of the advisory 

committee and the requirements for its 

participation in Plan affairs. Pursuant to 

paragraph (c), members of an advisory 

committee would have the right to 

submit their views to the operating 

committee on Plan matters, including, 

but not limited to, any new or modified 

product, fee, contract, or pilot program 

that is offered or used pursuant to the 

Plan. Paragraph (d) provides that 

members would have the right to attend 

all operating committee meetings and to 

receive any information distributed to 

the operating committee relating to Plan 

matters, except when the operating 

committee, by majority vote, decides to 

meet in executive session after 

determining that an item of Plan 

business requires confidential 

treatment. 

3. Consolidation, Distribution, and 

Display of Data 

a. Independent Distribution of 

Information. The Commission is 

reproposing, substantially as proposed, 

the amendment to current Rule 11Aa3–

1 (reproposed to be designated as Rule 

601), which would rescind the 

prohibition on SROs and their members 

from disseminating their trade reports 

independently.345 Under reproposed 

Rule 601, members of an SRO would 

continue to be required to transmit their 

trades to the SRO (and SROs would 

continue to transmit trades to the 

Networks pursuant to the Plans), but 

such members also would be free to 

distribute their own data independently, 

with or without fees.

Reproposed Rule 603(a) would 

establish uniform standards for 

distribution of both quotations and 

trades that would create an equivalent 

regulatory regime for all types of 

markets. First, Rule 603(a)(1) would 

require that any market information 346

distributed by an exclusive processor, or 

by a broker or dealer (including ATSs 

and market makers) that is the exclusive 

source of the information, be made 

available to securities information 

processors on terms that are fair and 

reasonable. Rule 603(a)(2) would require 

that any SRO, broker, or dealer that 

distributes market information must do 

so on terms that are not unreasonably 

discriminatory. These requirements 

would prohibit, for example, a market 

from making its ‘‘core data’’ (i.e., data 

that it is required to provide to a 

Network processor) available to vendors 

on a more timely basis than it makes 

available the core data to a Network 

processor. With respect to non-core 

data, however, Network processors 

occupy a unique competitive position. 

As Network processor, it acts on behalf 

of all markets in disseminating 

consolidated information, yet it also 

may be closely associated with the 

competitor of a market. The 

Commission believes that markets 

should have considerable leeway in 

determining whether, or on what terms, 

they provide additional, non-core data 

to a Network processor.

b. Consolidation of Information. All of 

the SROs currently participate in Plans 

that provide for the dissemination of 

consolidated information for the NMS 

Stocks that they trade. The Plans were 

adopted in order to enable the SROs to 

comply with Exchange Act rules 

regarding the reporting of trades and 

distribution of quotations. With respect 

to trades, paragraph (b) of Exchange Act 

Rule 11Aa3–1 (proposed to be 

redesignated as Rule 601(a)) requires 

each SRO to file transaction reporting 

plans that specify, among other things, 

how its transactions are to be 

consolidated with the transactions of 

other SROs. With respect to quotations, 

paragraph (b)(1) of Exchange Act Rule 

11Ac1–1 (proposed to be redesignated 

as Rule 602(a)(1)) requires an SRO to 

establish and maintain procedures for 

making its best quotes available to 

vendors.

To confirm by Exchange Act rule that 

both existing and any new SROs would 

be required to continue to participate in 

such joint-SRO plans, reproposed Rule 

603(b) would require SROs to act jointly 

pursuant to one or more NMS plans to 

disseminate consolidated information 

for NMS Stocks. Such consolidated 

information would be required to 

include an NBBO that is calculated in 

accordance with the definition set forth 

in reproposed Rule 600(b)(42).347 In 

addition, the NMS plans would be 

required to provide for the 

dissemination of all consolidated 

information for an individual NMS 

stock through a single processor. Thus, 

different processors would be permitted 

to disseminate information for different 

NMS stocks (e.g., SIAC for Network A 

stocks, and Nasdaq for Network C 

stocks), but all quotations and trades in 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77469

348The amendment would retain the exemptions 

currently set forth in Rule 11Ac1–2(f) (proposed to 

be redesignated as Rule 603(c)(2)) for exchange and 

market linkage displays. The current exemption for 

displays used by SROs for monitoring or 

surveillance purposes would no longer be necessary 

because of the limitation of the amendment to 

trading and order-routing contexts.

349See infra note 394 for a list of rules to which 

technical amendments are proposed that are in 

addition to those originally proposed.

350 In the market data rules, discussed in Section 

V., the Commission is reproposing substantive 

amendments to Exchange Act Rule 11Aa3–1 

(proposed to be redesignated as Rule 601).

351 In the market data rules, discussed in Section 

V., the Commission reproposes substantive 

amendments to the Vendor Display Rule.

a stock would be disseminated through 

a single processor. As a result, 

information users, particularly retail 

investors, could obtain data from a 

single source that reflects the best 

quotations and most recent trade price 

for a security, no matter where such 

quotations and trade are displayed in 

the NMS.

c. Display of Consolidated 

Information. Reproposed Rule 603(c) 

(currently Exchange Act Rule 11Ac1–2) 

substantially revises the consolidated 

display requirement. It would 

incorporate a new definition of 

‘‘consolidated display’’ (set forth in 

reproposed Rule 600(b)(13)) that would 

be limited to the prices, sizes, and 

market center identifications of the 

NBBO, along with the ‘‘consolidated last 

sale information’’ (which is defined in 

Rule 600(b)(12)). Beyond disclosure of 

this basic information, market forces, 

rather than regulatory requirements, 

would be allowed to determine what, if 

any, additional data from other market 

centers is displayed. In particular, 

investors and other information users 

ultimately would be able to decide 

whether they need additional 

information in their displays. 

In addition, reproposed Rule 603(c) 

would narrow the contexts in which a 

consolidated display is required to those 

when it is most needed—a context in 

which a trading or order-routing 

decision could be implemented. For 

example, the consolidated display 

requirement would continue to cover 

broker-dealers who provide on-line data 

to their customers in software programs 

from which trading decisions can be 

implemented. Similarly, the 

requirement would continue to apply to 

vendors who provide displays that 

facilitate order routing by brokerdealers. It would not apply, however, 

when market data is provided on a 

purely informational website that does 

not offer any trading or order-routing 

capability.348

VI. Regulation NMS 

To simplify the structure of the rules 

adopted under Section 11A of the 

Exchange Act (‘‘NMS rules’’), the rules 

reproposed today would designate the 

NMS rules as Regulation NMS, 

renumber the NMS rules, and would 

establish a new definitional rule, 

reproposed Rule 600 (‘‘NMS Security 

Designation and Definitions’’). Rule 

600(a) would replace Exchange Act Rule 

11Aa2–1, which designates ‘‘reported 

securities’’ as NMS securities. In 

addition, Rule 600(b) would include, in 

alphabetical order, all of the defined 

terms used in Regulation NMS. 

Regulation NMS would include 

reproposed Rules 610, 611, and 612 in 

addition to the existing NMS rules. The 

new rule series would be Rule 600 

through Rule 612 (17 CFR 242.600–612). 

Reproposed Rule 600 would provide 

a single set of definitions that would be 

used throughout Regulation NMS. To 

create a single set of definitions, Rule 

600 would update or delete from the 

existing NMS rules some terms that 

have become obsolete and eliminate the 

use of multiple inconsistent definitions 

for identical terms. In addition, Rule 

600 reproposes new terms, ‘‘NMS 

security’’ and ‘‘NMS stock,’’ to replace 

some terms that have been eliminated. 

These terms would be necessary to 

maintain distinctions between NMS 

rules that apply only to equity securities 

and ETFs (e.g., Exchange Act Rules 

11Ac1–4 and 11Ac1–5, proposed to be 

redesignated as Rules 604 and 605) and 

those that apply to equity securities, 

ETFs, and options (e.g., Exchange Act 

Rules 11Ac1–1 and 11Ac1–6, proposed 

to be redesignated as Rules 602 and 

606). Rule 600 would retain, unchanged, 

most definitions used in the existing 

NMS rules and would include 

definitions used in the new NMS rules 

reproposed today. The definitional 

changes would not affect the substantive 

requirements of the existing NMS rules. 

In addition, the reproposal would 

amend a number of other Commission 

rules that cross-reference current NMS 

rules or that use terms that Regulation 

NMS would amend or eliminate. 

The Commission received no 

comments regarding proposed Rule 600, 

the proposed redesignation of the NMS 

rules as Regulation NMS, or the 

proposed changes to other Commission 

rules. Accordingly, the Commission is 

reproposing Rule 600 and redesignating 

the NMS rules as Regulation NMS, and 

reproposing technical amendments to 

certain other Commission rules that 

cross-reference current NMS rules or 

that use terms that Regulation NMS 

would amend or eliminate, substantially 

as proposed.349

A. Description of Regulation NMS 

Reproposed Regulation NMS would 

renumber and, in some cases, rename 

the existing NMS rules, and would 

incorporate Rule 600 and the other NMS 

rules reproposed today. Where 

applicable, existing NMS rules would be 

amended to remove the definitions that 

have been consolidated in Rule 600. The 

titles and numbering of the rules in 

Regulation NMS, including the NMS 

rules reproposed today, would be as 

follows: 

• Rule 600: NMS Security 

Designation and Definitions (would 

replace Exchange Act Rule 11Aa2–1, 

which the Commission is proposing to 

rescind, and incorporate definitions 

from the existing NMS rules and the 

reproposed new rules); 

• Rule 601: Dissemination of 

Transaction Reports and Last Sale Data 

with Respect to Transactions in NMS 

Stocks (would renumber and rename 

current Exchange Act Rule 11Aa3–1, the 

substance of which would be 

modified); 350

• Rule 602: Dissemination of 

Quotations in NMS Securities (would 

renumber and rename current Exchange 

Act Rule 11Ac1–1 (‘‘Quote Rule’’), the 

substance of which would remain 

largely intact); 

• Rule 603: Distribution, 

Consolidation, and Display of 

Information with Respect to Quotations 

for and Transactions in NMS Stocks 

(would renumber and rename current 

Exchange Act Rule 11Ac1–2 (‘‘Vendor 

Display Rule’’), the substance of which 

would be modified substantially); 351

• Rule 604: Display of Customer 

Limit Orders (would renumber current 

Exchange Act Rule 11Ac1–4 (‘‘Limit 

Order Display Rule’’), the substance of 

which would remain largely intact); 

• Rule 605: Disclosure of Order 

Execution Information (would renumber 

current Exchange Act Rule 11Ac1–5, the 

substance of which would remain 

largely intact); 

• Rule 606: Disclosure of Order 

Routing Information (would renumber 

current Exchange Act Rule 11Ac1–6, the 

substance of which would remain 

largely intact); 

• Rule 607: Customer Account 

Statements (would renumber current 

Exchange Act Rule 11Ac1–3, the 

substance of which would remain 

largely intact); 

• Rule 608: Filing and Amendment of 

National Market System Plans (would 

renumber current Exchange Act Rule 

11Aa3–2, the substance of which would 

remain largely intact); 

77470 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

352 15 U.S.C. 78k–1(a)(2).

353See Securities Exchange Act Release No. 

23817 (Nov. 17, 1986), 51 FR 42856 (Nov. 26, 1986) 

(proposing amendments to Exchange Act Rules 

11Aa2–1 and 11Aa3–1).

354See id.

355See Securities Exchange Act Release No. 

17549 (Feb. 17, 1981), 46 FR 13992 (Feb. 25, 1981) 

(adopting Exchange Act Rule 11Aa2–1).

356See Exchange Act Rule 11Aa3–1(a)(4).

357See Exchange Act Rule 11Aa3–1(a)(3).

358See Exchange Act Rule 11Aa3–1(a)(2).

359See NASD Rule 4200 for the definition of a 

Nasdaq SmallCap security. The Nasdaq UTP Plan 

provides for the collection from Plan participants, 

and the consolidation and dissemination to 

vendors, subscribers and others, of quotation and 

transaction information in ‘‘eligible securities.’’

‘‘Eligible securities’’ initially included Nasdaq NMS 

securities listed on an exchange or traded on an 

exchange pursuant to a grant of unlisted trading 

privileges. See Securities Exchange Act Release No. 

28146 (June 26, 1990), 55 FR 27917 (July 6, 1990) 

(order approving the Nasdaq UTP Plan on a pilot 

basis). In 2001, the Nasdaq UTP Plan was amended 

to, among other things, revise the definition of 

‘‘eligible securities’’ to include Nasdaq SmallCap 

securities. See Securities Exchange Act Release No. 

45081 (Nov. 19, 2001), 66 FR 59273 (Nov. 27, 2001) 

(order approving Amendment No. 12 to the Nasdaq 

UTP Plan).

360The exchanges that are participants to the 

OPRA Plan are Amex, BSE, CBOE, ISE, PCX, and 

Phlx.

361See Securities Exchange Act Release No. 

17638 (Mar. 18, 1981), 22 S.E.C. Docket 484 (Mar. 

31, 1981). Exchange Act Rule 11Aa3–2 (proposed to 

be redesignated as Rule 608) codifies the 

procedures that SROs must follow to seek approval 

for or amendment of a national market system plan.

• Rule 609: Registration of Securities 

Information Processors: Form of 

Application and Amendments (would 

renumber current Exchange Act Rule 

11Ab2–1, the substance of which would 

remain largely intact); 

• Rule 610: Access to Quotations 

(reproposed in this release); 

• Rule 611: Order Protection Rule 

(reproposed in this release); and 

• Rule 612: Minimum Pricing 

Increment (reproposed in this release). 

B. Rule 600—NMS Security Designation 

and Definitions 

1. NMS Security Designation—

Transaction Reporting Requirements for 

Equities and Listed Options

Section 11A(a)(2) of the Exchange Act 

directs the Commission to ‘‘designate 

the securities or classes of securities 

qualified for trading in the national 

market system.’’ 352 The 1975 

Amendments and the legislative history 

to the 1975 Amendments were silent as 

to the particular standards the 

Commission should employ in 

designating NMS securities.353 Instead, 

Congress provided the Commission with 

the flexibility and discretion to base 

NMS designation standards on the 

Commission’s experience in facilitating 

the development of an NMS.354

To satisfy the requirement that it 

designate the securities qualified for 

trading in the NMS, the Commission 

adopted Exchange Act Rule 11Aa2–1 in 

1981.355 Exchange Act Rule 11Aa2–1 

defines the term ‘‘national market 

system security’’ to mean ‘‘any reported 

security as defined in Rule 11Aa3–1.’’ A 

‘‘reported security’’ is ‘‘any security or 

class of securities for which transaction 

reports are collected, processed and 

made available pursuant to an effective 

transaction reporting plan.’’ 356 An 

‘‘effective transaction reporting plan’’ is 

‘‘any transaction reporting plan 

approved by the Commission pursuant 

to this section.’’ 357 A ‘‘transaction 

reporting plan’’ is ‘‘any plan for 

collecting, processing, making available 

or disseminating transaction reports 

with respect to transactions in reported 

securities filed with the Commission 

pursuant to, and meeting the 

requirements of, this section.’’ 358 The 

effective transaction reporting plans are 

the CTA Plan and the Nasdaq UTP Plan.

In addition to identifying those 

securities deemed to be NMS securities, 

when adopted, the Exchange Act Rule 

11Aa2–1 designation also tacitly 

identified those securities that did not 

meet that designation (i.e., securities 

other than those that were so designated 

as NMS securities). Historically, 

securities excluded from this 

designation included standardized 

options and small capitalization equity 

securities (a subset of which has been 

identified as Nasdaq SmallCap 

securities). Trading in options and 

Nasdaq SmallCap securities has 

increased over the past three decades 

and gradually many of the rules that 

govern NMS securities have been 

applied to these securities. As a result, 

much of the terminology that has been 

used to distinguish NMS securities from 

options and Nasdaq SmallCap securities 

has become obsolete. 

For example, the Nasdaq UTP Plan 

provides for the collection from Plan 

participants, and the consolidation and 

dissemination to vendors, subscribers 

and others, of quotation and transaction 

information in ‘‘eligible securities.’’

Prior to 2001, the Nasdaq UTP Plan 

defined an ‘‘eligible security’’ as any 

Nasdaq National Market security as to 

which unlisted trading privileges have 

been granted to a national securities 

exchange pursuant to Section 12(f) of 

the Exchange Act or that is listed on a 

national securities exchange. In 2001, 

the Nasdaq UTP Plan was amended to 

include Nasdaq SmallCap securities.359

As a result, Nasdaq SmallCap securities 

became ‘‘eligible securities’’ because 

they are now reported through an 

effective transaction reporting plan (i.e., 

the Nasdaq UTP Plan), bringing them 

within the purview of the NMS security 

designation. Several definitions in the 

existing NMS rules, however, do not 

reflect the inclusion of Nasdaq 

SmallCap securities in the Nasdaq UTP 

Plan and therefore must be updated. 

Regulation NMS would do so.

In addition, transactions in exchangelisted options are reported through the 

Plan for Reporting of Consolidated 

Options Last Sale Reports and 

Quotation Information (‘‘OPRA 

Plan’’).360 Unlike the CTA Plan and the 

Nasdaq UTP Plan—transaction reporting 

plans that the Commission approved 

pursuant to Exchange Act Rules 11Aa3–

1 and 11Aa3–2 (proposed to be 

redesignated as Rules 601 and 608)—the 

Commission approved the OPRA Plan 

pursuant to Exchange Act Rule 11Aa3–

2 (proposed to be redesignated as Rule 

608).361 As such, the OPRA Plan is an 

‘‘effective national market system plan’’

but not an ‘‘effective transaction 

reporting plan.’’ While at their core the 

CTA Plan, the Nasdaq UTP Plan, and 

the OPRA Plan perform essentially the 

same function (i.e., they govern the 

consolidated reporting of securities 

transactions by Plan participants), 

because the OPRA Plan is not an 

effective transaction reporting plan, 

listed options covered by the OPRA 

Plan are technically not ‘‘securities for 

which transaction reports are collected, 

processed, and made available pursuant 

to an effective transaction reporting 

plan.’’ Therefore, listed options were 

not considered NMS securities as 

defined by Exchange Act Rule 11Aa2–

1. While the impact of this distinction 

may not be readily apparent, the 

differences in the way the Plans are 

designated dictates the securities laws 

and regulations that apply to securities 

reported pursuant to those Plans.

Further, as discussed below, some 

terms in the existing NMS rules have 

become superfluous or outdated, and 

some NMS rules define identical terms 

differently. To provide a consolidated 

set of definitions applicable to all of the 

NMS rules, Regulation NMS would 

eliminate these inconsistencies. The 

definitional changes reproposed today, 

however, are not intended to change 

materially the scope of the existing NMS 

rules.

2. NMS Security and NMS Stock 

Some NMS rules, including the Quote 

Rule (proposed to be redesignated as 

Rule 602) and Exchange Act Rule 

11Ac1–6 (proposed to be redesignated 

as Rule 606), currently apply to both (1) 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77471

362Specifically, reproposed Regulation NMS 

would define an ‘‘NMS security’’ as ‘‘any security 

or class of securities for which transaction reports 

are collected, processed, and made available 

pursuant to an effective transaction reporting plan, 

or an effective national market system plan for 

reporting transactions in listed options.’’ This 

definition is used to define a ‘‘reported security’’ in 

the Quote Rule. See Exchange Act Rule 11Ac1–

1(a)(20). For the reasons described below, the 

Commission would eliminate the term ‘‘reported 

security’’ from the Quote Rule and would not 

include it in Regulation NMS.

363Reproposed Rule 600(b)(47).

364See supra Section VI.B.1.

365The Vendor Display Rule and Exchange Act 

Rule 11Aa3–1 define the term ‘‘reported security’’

to mean ‘‘any security or class of securities for 

which transaction reports are collected, processed 

and made available pursuant to an effective 

transaction reporting plan.’’ See Exchange Act 

Rules 11Ac1–2(a)(20) and 11Aa3–1(a)(4). As 

discussed more fully below, the Quote Rule 

provides a different definition of ‘‘reported 

security.’’ 366See e.g., paragraph (a)(4) of the Vendor 

Display Rule (defining ‘‘subject security’’ to mean 

‘‘(i) any reported security; and (ii) any other equity 

security as to which transaction reports, last sale 

data or quotation information is disseminated 

through NASDAQ’’); and paragraph (a)(6) of the 

Quote Rule (defining ‘‘covered security’’ to mean 

‘‘any reported security and any other security for 

which a transaction report, last sale data or 

quotation information is disseminated through an 

automated quotation system as described in Section 

3(a)(51)(A)(ii) of the Act (15 U.S.C. 

78c(a)(51)(A)(ii))’’). 367Although the Quote Rule and the Limit Order 

Display Rule each define the term ‘‘covered 

security’’ as ‘‘any reported security and any other 

security for which a transaction report, last sale 

data or quotation information is disseminated 

through an automated quotation system as 

described in Section 3(a)(51)(A)(ii) of the Act (15 

U.S.C. 78c(a)(51)(A)(ii)),’’ the scope of the 

definitions is not identical because each rule 

defines the term ‘‘reported security’’ differently. 

The Quote Rule defines a ‘‘reported security’’ to 

mean ‘‘any security or class of securities for which 

transaction reports are collected, processed and 

made available pursuant to an effective transaction 

reporting plan, or an effective national market 

system plan for reporting transactions in listed 

options.’’ See Exchange Act Rule 11Ac1–1(a)(20). 

The Limit Order Display Rule defines a ‘‘reported 

security’’ to mean ‘‘any security or class of 

securities for which transaction reports are 

collected, processed, and made available pursuant 

to an effective transaction reporting plan.’’ See

Exchange Act Rule 11Ac1–4(a)(10). 

Exchange Act Rule 11Ac1–6 defines the term 

‘‘covered security’’ to mean: ‘‘(i) any national 

market system security and any other security for 

which a transaction report, last sale data or 

quotation information is disseminated through an 

automated quotation system as defined in Section 

3(a)(51)(A)(ii) of the Act (15 U.S.C. 

78c(a)(51)(A)(ii)); and (ii) any option contract traded 

on a national securities exchange for which last sale 

reports and quotation information are made 

available pursuant to an effective national market 

system plan.’’ See Exchange Act Rule 11Ac1–

6(a)(1).

368The Limit Order Display Rule, the Vendor 

Display Rule, and Exchange Act Rule 11Aa3–1 

define a ‘‘reported security’’ to mean ‘‘any security 

or class of securities for which transaction reports 

are collected, processed and made available 

pursuant to an effective transaction reporting plan.’’

See Exchange Act Rules 11Ac1–4(a)(10), 11Ac1–

2(a)(20), and 11Aa3–1(a)(4). The Quote Rule defines 

the term ‘‘reported security’’ to mean ‘‘any security 

or class of securities for which transaction reports 

are collected, processed, and made available 

pursuant to an effective transaction reporting plan, 

or an effective national market system plan for 

reporting transactions in listed options.’’ See

Exchange Act Rule 11Ac1–1(a)(20). As discussed 

above, this release reproposes substantial 

modifications to the Vendor Display Rule.

369The Limit Order Display Rule defines a 

‘‘covered security’’ to include both reported 

securities and other securities for which market 

information is disseminated through Nasdaq. See

Exchange Act Rule 11Ac1–4(a)(5).

370The Quote Rule defines a ‘‘covered security’’

to include both reported securities and other 

securities for which market information is 

disseminated through Nasdaq. See Exchange Act 

Rule 11Aa1–1(a)(6).

371 In paragraph (b)(1)(ii) of the Quote Rule 

(proposed to be redesignated as Rule 602), which 

requires a registered national securities association 

to disseminate quotations at all times when last sale 

information is available with respect to ‘‘reported 

securities,’’ the reference to ‘‘reported security’’

would be replaced by a reference to ‘‘NMS 

security.’’

equities, ETFs and related securities for 

which transaction reports are made 

available pursuant to an effective 

transaction reporting plan, and (2) listed 

options for which market information is 

made available pursuant to an effective 

national market system plan. To provide 

a single term that will be used in any 

provision of Regulation NMS that 

applies to both categories of securities, 

Regulation NMS reproposes a new term, 

‘‘NMS security.’’ 362

Because many rules in Regulation 

NMS, including the Limit Order Display 

Rule (proposed to be redesignated as 

Rule 604) and Exchange Act Rule 

11Ac1–5 (proposed to be redesignated 

as Rule 605), continue to be 

inapplicable to listed options, 

Regulation NMS reproposes a new term, 

‘‘NMS stock’’ that would be used in 

those provisions. Regulation NMS 

would define the term ‘‘NMS stock’’ as 

‘‘any NMS security other than an 

option.’’ 363

3. Changes to Existing Definitions in the 

NMS Rules 

Reproposed Rule 600(b) would 

provide a single set of definitions that 

would be used throughout Regulation 

NMS. To create a single set of 

definitions, Regulation NMS would 

eliminate multiple, inconsistent 

definitions of identical terms. In 

addition, Regulation NMS would amend 

some definitions in the NMS rules to 

reflect changed conditions in the 

marketplace or to modernize references. 

For example, as discussed above, 

several definitions in the existing NMS 

rules have been rendered obsolete by 

the extension of the Nasdaq UTP Plan 

to Nasdaq SmallCap securities.364

Because the Nasdaq UTP Plan includes 

Nasdaq SmallCap securities, those 

securities now are ‘‘securities for which 

transaction reports are collected, 

processed and made available pursuant 

to an effective transaction reporting 

plan’’ (i.e., they are ‘‘reported’’

securities).365 For this reason, it is no 

longer necessary to distinguish, as 

several existing NMS rules do, between 

‘‘reported’’ securities and equity 

securities for which market information 

is made available through Nasdaq.366

Accordingly, Regulation NMS would 

eliminate or revise the defined terms in 

the existing NMS rules that make this 

distinction.

a. Covered Security. Different 

definitions of the term ‘‘covered 

security’’ appeared in the Quote Rule, 

the Limit Order Display Rule, and 

Exchange Act Rule 11Ac1–6.367 In 

addition, as discussed below, the term 

has become obsolete. Therefore, 

Regulation NMS would eliminate the 

term ‘‘covered security’’ from the NMS 

rules and replaces it with the term 

‘‘NMS security’’ or ‘‘NMS stock,’’ as 

applicable, depending upon the scope of 

the particular rule.

b. Reported Security. Several NMS 

rules used the term ‘‘reported security.’’

Although the Limit Order Display Rule, 

the Vendor Display Rule, and Exchange 

Act Rule 11Aa3–1 contain identical 

definitions of ‘‘reported security,’’ the 

Quote Rule provides a different 

definition.368 Because the term 

‘‘reported security’’ is defined 

inconsistently in the NMS rules and in 

light of the reproposed changes to 

related terms, Regulation NMS would 

eliminate the term ‘‘reported security’’

from the NMS rules and replace it with 

the term ‘‘NMS security’’ or ‘‘NMS 

stock,’’ depending on the scope of the 

particular rule.

The Limit Order Display Rule uses the 

term ‘‘reported security’’ solely for the 

purpose of defining the term ‘‘covered 

security.’’ 369 Because Regulation NMS 

would eliminate the term ‘‘covered 

security,’’ the term ‘‘reported security’’

also would not be needed in the Limit 

Order Display Rule (proposed to be 

redesignated as Rule 604). Therefore, 

the term ‘‘NMS stock’’ would replace 

the term ‘‘covered security’’ in the Limit 

Order Display Rule.

Similarly, the Quote Rule uses the 

term ‘‘reported security’’ primarily to 

define the term ‘‘covered security.’’ 370

Because Regulation NMS would 

eliminate the term ‘‘covered security,’’

the Quote Rule (proposed to be 

redesignated as Rule 602) 371 also would 

not use the term ‘‘reported security.’’

c. Subject Security. The Quote Rule 

and the Vendor Display Rule both use 

the term ‘‘subject security,’’ although 

they define the term differently. To 

77472 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

372See Exchange Act Rule 11Ac1–2(a)(4).

373See Exchange Act Rule 11Ac1–1(a)(25) 

(emphasis added).

374 Id.

375See Exchange Act Rule 11Ac1–1(a)(5).

376Reproposed Rule 600(b)(73).

377This change also would impact certain nonNMS rules that define the term ‘‘consolidated 

system.’’ See, e.g., Exchange Act Rule 10b–18(a)(7) 

(‘‘consolidated system means the consolidated 

transaction reporting system contemplated by Rule 

11Aa3–1’’). As discussed below, the Commission is 

also reproposing to amend certain non-NMS rules 

that are affected by the definitional changes 

reproposed today.

378 15 U.S.C. 78c(a)(1).

379 17 CFR 240.3b–16.

380See Securities Exchange Act Release No. 

40760 (Dec. 8, 1998), 63 FR 70844 (Dec. 22, 1998) 

(adopting Regulation ATS).

381Specifically, the Quote Rule states that the 

term ‘‘exchange market maker’’ shall mean ‘‘any 

member of a national securities exchange 

(‘exchange’) who is registered as a specialist or 

market maker pursuant to the rules of such 

exchange.’’ See Exchange Act Rule 11Ac1–1(a)(9). 

The statutory requirements applicable to a national 

securities exchange are set forth in Section 6 of the 

Exchange Act, 15 U.S.C. 78f.

eliminate this inconsistency, the 

reproposed Vendor Display Rule 

(proposed to be redesignated as Rule 

603) would not use the term ‘‘subject 

security’’ and Regulation NMS would 

retain a slightly modified version of the 

definition of ‘‘subject security’’

currently found in the Quote Rule. 

The Vendor Display Rule defines the 

term ‘‘subject security’’ to mean ‘‘(i) any 

reported security; and (ii) any other 

equity security as to which transaction 

reports, last sale data or quotation 

information is disseminated through 

NASDAQ.’’ 372 As discussed above, the 

extension of the Nasdaq UTP Plan to 

include Nasdaq SmallCap securities 

renders obsolete the distinction between 

a ‘‘reported security’’ and a security for 

which market information is 

disseminated through Nasdaq. 

Accordingly, the reproposed Vendor 

Display Rule (proposed to be 

redesignated as Rule 603) would use the 

term ‘‘NMS stock’’ rather than ‘‘subject 

security.’’

The Quote Rule defines the term 

‘‘subject security’’ to mean: 

(i) With respect to an exchange: (A) 

Any exchange-traded security other 

than a security for which the executed 

volume of such exchange, during the 

most recent calendar quarter, comprised 

one percent or less of the aggregate 

trading volume for such security as 

reported in the consolidated system; 

and (B) Any other covered security for 

which such exchange has in effect an 

election, pursuant to paragraph (b)(5)(i) 

of this section, to collect, process, and 

make available to quotation vendors 

bids, offers, quotation sizes, and 

aggregate quotation sizes communicated 

on such exchange; and 

(ii) With respect to a member of an 

association: (A) Any exchange-traded 

security for which such member acts in 

the capacity of an OTC market maker 

unless the executed volume of such 

member, during the most recent 

calendar quarter, comprised one percent 

or less of the aggregate trading volume 

for such security as reported in the 

consolidated system; and (B) Any other 

covered security for which such 

member acts in the capacity of an OTC 

market maker and has in effect an 

election, pursuant to paragraph (b)(5)(ii) 

of this section, to communicate to its 

association bids, offers and quotation 

sizes for the purpose of making such 

bids, offers and quotation sizes available 

to quotation vendors.373

Because the Quote Rule (proposed to 

be redesignated as Rule 602) would 

continue to apply to both listed options 

and equities covered by an effective 

transaction reporting plan, Regulation 

NMS’s definition of ‘‘subject security’’

would revise the Quote Rule’s definition 

of ‘‘subject security’’ by replacing 

references to a ‘‘covered security’’ with 

references to an ‘‘NMS security.’’ In 

addition, for the reasons discussed 

below, Regulation NMS would replace 

the phrase ‘‘reported in the consolidated 

system’’ with the phrase ‘‘reported 

pursuant to an effective transaction 

reporting plan or effective national 

market system plan.’’

d. Consolidated System. As noted 

above, the definition of the term 

‘‘subject security’’ in the Quote Rule 

uses the phrase ‘‘reported in the 

consolidated system.’’ 374 Paragraph 

(a)(5) of the Quote Rule defines the term 

‘‘consolidated system’’ to mean ‘‘the 

consolidated transaction reporting 

system, including a transaction 

reporting system operating pursuant to 

an effective national market system 

plan.’’ 375

Regulation NMS would clarify the 

definition of ‘‘subject security’’ by 

eliminating the phrase ‘‘reported in the 

consolidated system’’ and replacing it 

with the phrase ‘‘reported pursuant to 

an effective transaction reporting plan 

or an effective national market system 

plan.’’ Thus, Regulation NMS would 

define a ‘‘subject security’’ to include, 

among other things: (1) With respect to 

a national securities exchange, any 

exchange-traded security other than a 

security for which the executed volume 

of such exchange, during the most 

recent calendar quarter, comprised one 

percent or less of the aggregate trading 

volume for such security as reported 

pursuant to an effective transaction 

reporting plan or effective national 

market system plan; and (2) with respect 

to a member of a national securities 

association, any exchange-traded 

security for which such member acts in 

the capacity of an OTC market maker 

unless the executed volume of such 

member, during the most recent 

calendar quarter, comprised one percent 

or less of the aggregate trading volume 

for such security as reported pursuant to 

an effective transaction reporting plan 

or effective national market system 

plan.376

This change would provide a clearer 

definition of ‘‘subject security’’ by 

indicating that the trading volume 

referred to in the definition is the 

trading volume in a security that is 

reported pursuant to an effective 

transaction reporting plan or an 

effective national market system plan. 

Although replacing the phrase ‘‘reported 

in the consolidated system’’ with the 

phrase ‘‘reported pursuant to an 

effective transaction reporting plan or 

an effective national market system 

plan’’ produces a clearer definition of 

‘‘subject security,’’ it would not alter the 

scope or the substance of the 

definition.377

e. National Securities Exchange. 

Section 3(a)(1) of the Exchange Act 

defines the term ‘‘exchange’’ to mean 

‘‘any organization, association, or group 

of persons * * * which constitutes, 

maintains, or provides a market place or 

facilities for bringing together 

purchasers and sellers of securities or 

for otherwise performing with respect to 

securities the functions commonly 

performed by a stock exchange as that 

term is generally understood.* * *’’ 378

Exchange Act Rule 3b–16,379 adopted in 

1998, interprets the statutory definition 

of ‘‘exchange’’ broadly to include any 

organization, association, or group of 

persons that: (1) brings together the 

orders for securities of multiple buyers 

and sellers; and (2) uses established, 

non-discretionary methods (whether by 

providing a trading facility or by setting 

rules) under which such orders interact 

with each other, and the buyers and 

sellers entering such orders agree to the 

terms of a trade. Exchange Act Rule 3b–

16 was designed to provide ‘‘a more 

comprehensive and meaningful 

interpretation of what an exchange is in 

light of today’s markets.’’ 380

The Quote Rule’s definition of an 

‘‘exchange market maker’’ defines the 

term ‘‘national securities exchange’’ as 

an ‘‘exchange.’’ 381 To avoid confusion 

between a ‘‘national securities 

exchange’’ and the broader 

interpretation of ‘‘exchange’’ set forth in 

Exchange Act Rule 3b–16, Regulation 

NMS would use the term ‘‘national 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77473

382Compare Exchange Act Rules 11Ac1–1(a)(13) 

and 11Ac1–5(a)(18).

383The reproposed definition of ‘‘OTC market 

maker’’ uses the term ‘‘NMS stock’’ because there 

is no OTC market in standardized options.

384The Quote Rule define the term ‘‘quotation 

vendor’’ to mean ‘‘any securities information 

processor engaged in the business of disseminating 

to brokers, dealers or investors on a real-time basis, 

bids and offers made available pursuant to this 

section, whether distributed through an electronic 

communications network or displayed on a 

terminal or other display device.’’ See Exchange Act 

Rule 11Ac1–1(a)(19). Exchange Act Rule 11Aa3–

1(a)(11) defines the term ‘‘vendor’’ to mean ‘‘any 

securities information processor engaged in the 

business of disseminating transaction reports or last 

sale data with respect to transactions in reported 

securities to brokers, dealers or investors on a realtime or other current and continuing basis, whether 

through an electronic communications network, 

moving ticker or interrogation device.’’ The Vendor 

Display Rule defines the term ‘‘vendor’’ to mean 

‘‘any securities information processor engaged in 

the business of disseminating transaction reports, 

last sale data or quotation information with respect 

to subject securities to brokers, dealers or investors 

on a real-time or other current and continuing basis, 

whether through an electronic communications 

network, moving ticker or interrogation device.’’

See Exchange Act Rule 11Ac1–2(a)(2).

385See Exchange Act Rule 11Ac1–2(a)(2).

386The Quote Rule states that ‘‘[t]he terms best 

bid and best offer shall mean the highest priced bid 

and the lowest priced offer.’’ See Exchange Act Rule 

11Ac1–1(a)(3). The Vendor Display Rule (Exchange 

Act Rule 11Ac1–2(a)(15)) defines the terms ‘‘best 

bid’’ and ‘‘best offer’’ as follows: 

(i) With respect to quotations for a reported 

security, the highest bid or lowest offer for that 

security made available by any reporting market 

center pursuant to § 240.11Ac1–1 (Rule 11Ac1–1 

under the Act) (excluding any bid or offer made 

available by an exchange during any period such 

exchange is relieved of its obligations under 

paragraphs (b) (1) and (2) of § 240.11Ac1–1 by 

virtue of paragraph (b)(3)(i) thereof)); Provided, 

however, That in the event two or more reporting 

market centers make available identical bids or 

offers for a reported security, the best bid or best 

offer (as the case may be) shall be computed by 

ranking all such identical bids or offers (as the case 

may be) first by size (giving the highest ranking to 

the bid or offer associated with the largest size), 

then by time (giving the highest ranking to the bid 

or offer received first in time); and 

(ii) With respect to quotations for a subject 

security other than a reported security, the highest 

bid or lowest offer (as the case may be) for such 

security disseminated by an over-the-counter 

market maker in Level 2 or 3 of NASDAQ.

387The definition of ‘‘reporting market center’’

currently in paragraph (a)(14) of the Vendor Display 

Rule and incorporated into that Rule’s definitions 

of ‘‘best bid’’ and ‘‘best offer’’ would no longer be 

necessary and therefore would be deleted.

388See reproposed Rule 600(b)(42).

389See Exchange Act Rule 11Ac1–1(a)(4). 

Paragraph (a)(6) of the Vendor Display Rule uses the 

Quote Rule’s definition of ‘‘bid’’ and ‘‘offer’’ for 

reported securities, but it defines ‘‘bid’’ and ‘‘offer’’

for Nasdaq SmallCap securities as ‘‘the most recent 

bid or offer price of an over-the-counter market 

maker disseminated through Level 2 or 3 of 

NASDAQ.’’ Because Nasdaq SmallCap securities 

now are reported securities, it is unnecessary to 

maintain the distinction between reported 

securities and Nasdaq SmallCap securities. 

Accordingly, to update and provide a single 

definition of the terms ‘‘bid’’ and ‘‘offer,’’

Regulation NMS would eliminate the definitions of 

‘‘bid’’ and ‘‘offer’’ used in the Vendor Display Rule 

and retain modified versions of the terms as they 

are defined in the Quote Rule.

securities exchange’’ rather than 

‘‘exchange’’ throughout the Regulation. 

The national securities exchange 

definition is intended to capture only 

those entities that operate as national 

securities exchanges and that are 

registered as such with the Commission. 

It is not intended to capture those 

entities that meet the ‘‘exchange’’

definition under Regulation ATS but 

that operate as something other than a 

national securities exchange. The use of 

this term would be consistent with the 

use of the term ‘‘exchange’’ in the 

existing NMS rules.

f. OTC Market Maker. The Quote Rule 

and Exchange Act Rule 11Ac1–5 define 

the term ‘‘OTC market maker’’

differently.382 Unlike the Quote Rule, 

Exchange Act Rule 11Ac1–5 defines the 

term ‘‘OTC market maker’’ to include an 

explicit reference to a securities dealer 

that holds itself out as being willing to 

buy from and sell to customers or others 

in the United States. Regulation NMS 

would retain the reference to 

transactions with ‘‘customers or others 

in the United States’’ to indicate clearly 

that a foreign dealer could be an ‘‘OTC 

market maker’’ if it acts as a securities 

dealer with respect to customers or 

others in the United States.

Accordingly, Regulation NMS would 

define ‘‘OTC market maker’’ as ‘‘any 

dealer that holds itself out as being 

willing to buy from and sell to its 

customers, or others, in the United 

States, an NMS stock for its own 

account on a regular or continuous basis 

otherwise than on a national securities 

exchange.’’ 383

g. Vendor. The term ‘‘vendor’’ or 

‘‘quotation vendor’’ is defined 

differently in three NMS rules: the 

Quote Rule, the Vendor Display Rule, 

and Exchange Act Rules 11Aa3–1.384

Although the definitions are similar, the 

definition of ‘‘vendor’’ in the Vendor 

Display Rule is the most comprehensive 

because it encompasses any SIP that 

disseminates transaction reports, last 

sale data, or quotation information, 

whereas the other definitions are less 

complete in identifying the types of 

information that vendors typically make 

available. To provide a uniform and 

comprehensive definition of the term 

‘‘vendor,’’ Regulation NMS reproposes 

to include the definition of ‘‘vendor’’ as 

it was defined in the Vendor Display 

Rule.385

h. Best Bid, Best Offer, and National 

Best Bid and National Best Offer. The 

Quote Rule and the Vendor Display 

Rule define the terms ‘‘best bid’’ and 

‘‘best offer’’ differently.386 In addition, 

Exchange Act Rule 11Ac1–5(a)(7) 

defines the term ‘‘consolidated best bid 

and offer’’ to mean ‘‘the highest firm bid 

and the lowest firm offer for a security 

that is calculated and disseminated on 

a current and continuous basis pursuant 

to an effective national market system 

plan.’’ Regulation NMS would retain the 

definitions of ‘‘best bid’’ and ‘‘best 

offer’’ used in the Quote Rule. A new 

term called ‘‘national best bid and 

national best offer’’: (1) Would replace 

the term ‘‘best bid and best offer’’ as that 

term is used in the Vendor Display Rule; 

and (2) would replace the term 

‘‘consolidated best bid and offer’’ as that 

term is used in Exchange Act Rule 

11Ac1–5. This new term refers to the 

best quotations that are calculated and 

disseminated by a plan processor 

pursuant to an effective national market 

system plan.387 The definition of 

‘‘national best bid and national best 

offer’’ also would address instances 

where multiple market centers transmit 

identical bids and offers to the plan 

processor pursuant to an NMS plan by 

establishing the way in which these bids 

and offers are to be prioritized.388

i. Bid or Offer, Customer, Nasdaq 

Security, and Responsible Broker or 

Dealer. Regulation NMS also would 

update or clarify the following terms in 

the NMS rules: ‘‘bid’’ or ‘‘offer;’’

‘‘customer;’’ ‘‘Nasdaq security;’’ and 

‘‘responsible broker or dealer.’’

The Quote Rule defines the terms 

‘‘bid and offer’’ to mean ‘‘the bid price 

and the offer price communicated by an 

exchange member or OTC market maker 

to any broker or dealer, or to any 

customer, at which it is willing to buy 

or sell one or more round lots of a 

covered security, as either principal or 

agent, but shall not include indications 

of interest.’’ 389 Regulation NMS would 

update this definition by replacing the 

term ‘‘OTC market maker’’ with the 

phrase ‘‘member of a national securities 

association’’ and call the term ‘‘bid or 

offer’’ rather than ‘‘bid and offer’’ to 

reflect the fact that the terms are not 

always used in the conjunctive. 

Modifying the definition to apply to any 

member of a national securities 

association would clarify that bids and 

offers include quotations communicated 

not only by OTC market makers but also 

by ATSs, ECNs, and order entry firms 

that are members of the NASD but that 

are not market makers.

Expanding the definition of ‘‘bid or 

offer’’ could have the unintended 

consequence of also expanding the 

scope of the Quote Rule (proposed to be 

redesignated as Rule 602) where those 

terms are used to apply to members of 

a national securities association that are 

not OTC market makers (e.g., ECNs and 

77474 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

390See Exchange Act Rule 11Ac1–1(a)(21).

391See Exchange Act Rule 11Ac1–1(a)(21)(ii).

392See Exchange Act Rule 11Ac1–1(a)(26).

393See Exchange Act Rule 11Aa3–1(a)(6).

394 § 200.800, Subpart N, § 201.101, Exchange Act 

Rules 0–10, 3a51–1(e), 3a55–1, 10a–1, and 31, and 

Rule 17a–7 under the Investment Company Act of 

1940 are in addition to those included in the 

Proposing Release.

395 17 CFR 200.30–3. In addition to conforming 

changes, the Commission is reproposing to amend 

this rule to grant the Director of the Division of 

Market Regulation the authority to grant 

exemptions to Rules 610 through 612.

396 17 CFR 200.800, Subpart N.

397 17 CFR 201.101.

398 17 CFR 230.144.

399 15 U.S.C. 77a et seq.

400 17 CFR 240.0–10.

401 17 CFR 240.3a51–1.

402 17 CFR 240.3a55–1. Section 3(a)(55)(C)(vi) 

under the Exchange Act and Section 1a(25)(B)(vi) 

of the Commodity Exchange Act (‘‘CEA’’) provide 

that an index is not a narrow-based security index 

if a future on the index is traded on or subject to 

the rules of a board of trade and meets such 

requirements as are established by rule, regulation, 

or order jointly by the two Commissions. Pursuant 

to this authority, the Commission and the 

Commodity Futures Trading Commission (‘‘CFTC’’) 

jointly adopted Exchange Act Rule 3a55–1 and CEA 

Rule 41.11. The Commission today is proposing to 

substitute ‘‘NMS securities, as defined in 

§ 242.600,’’ for ‘‘reported securities, as defined in 

§ 240.11Ac1–1’’ in Exchange Act Rule 3a55–1. The 

new term ‘‘NMS security’’ is proposed to be defined 

in § 242.600 the same as the term ‘‘reported 

security’’ is defined in current Exchange Act Rule 

11Ac1–1. Accordingly, the proposed changes to 

Rule 3a55–1 are technical. If the Commission 

adopts Regulation NMS, the changes to Rule 3a55–

1, and identical changes to CEA Rule 41.11, would 

need to be adopted jointly by the Commission and 

the CFTC.

403 17 CFR 240.3b–16.

404 17 CFR 240.10a–1.

405 17 CFR 240.10b–10.

406 17 CFR 240.10b–18.

407 17 CFR 240.15b9–1.

408 17 CFR 240.12a–7.

409 17 CFR 240.12f–1.

410 17 CFR 240.12f–2.

411 17 CFR 240.15c2–11.

412 17 CFR 240.19c–3.

413 17 CFR 240.19c–4.

414 17 CFR 240.31.

415 17 CFR 242.100.

416 17 CFR 242.300.

417 17 CFR 242.301. The Commission also is 

proposing a technical change to Rule 301(b)(3)(iii) 

of Regulation ATS to correct a cross-reference to 

Rule 301(b)(3)(ii)(A) by deleting the reference to 

subparagraph (A). This change would not have any 

substantive effect.

418 17 CFR 249.1001.

419 17 CFR 270.17a–7.

420 44 U.S.C. 3501 et seq. (‘‘Paperwork Reduction 

Act’’).

ATSs). To avoid this unintended 

expansion of the scope of the Quote 

Rule (proposed to be redesignated as 

Rule 602), Regulation NMS reproposes a 

revised version of the Quote Rule’s 

definition of ‘‘responsible broker or 

dealer.’’ 390 In particular, Regulation 

NMS would amend the portion of the 

definition of ‘‘responsible broker or 

dealer’’ found in paragraph (a)(21)(ii) of 

the Quote Rule 391 to limit its scope to 

bids and offers communicated by an 

OTC market maker.

Regulation NMS also would amend 

the definition of the term ‘‘customer.’’

The Quote Rule defines that term to 

mean ‘‘any person that is not a 

registered broker-dealer.’’ 392 To indicate 

that the scope of the definition includes 

broker-dealers that are exempt from 

registration as well as registered brokerdealers, Regulation NMS would revise 

the definition by deleting the term 

‘‘registered.’’ Thus, Regulation NMS 

would define the term ‘‘customer’’ to 

mean ‘‘any person that is not a brokerdealer.’’

Exchange Act Rule 11Aa3–1 defines 

the term ‘‘NASDAQ security’’ to mean 

‘‘any registered equity security for 

which quotation information is 

disseminated in the National 

Association of Securities Dealers 

Automated Quotation system 

(‘‘NASDAQ’’).’’ 393 This acronym is now 

outdated. Therefore, to modernize this 

definition and to ensure that any type of 

registered security that Nasdaq lists is 

covered by the definition, Regulation 

NMS would define the term ‘‘Nasdaq 

security’’ to mean ‘‘any registered 

security listed on The Nasdaq Stock 

Market, Inc.’’

4. Definitions in the Regulation NMS 

Rules Reproposed Today 

Reproposed Rule 600(b) includes a 

number of new definitions used in 

reproposed Rules 610 through 612 of 

Regulation NMS. These new terms are 

discussed in detail in Sections II 

through V above. Specifically, for the 

reasons discussed above, Regulation 

NMS reproposes the following terms: 

automated quotation, automated trading 

center, consolidated display, 

consolidated last sale information, 

intermarket sweep order, manual 

quotation, protected bid or protected 

offer, SRO display-only facility, SRO 

trading facility, trade-through, and 

trading center. 

C. Changes to Other Rules 

In addition to the changes described 

above, the rules reproposed today 

would amend a number of rules that 

cross-reference current NMS rules or 

that use terms that Regulation NMS 

would amend or eliminate. These 

amendments are intended to be nonsubstantive. Specifically, the rules 

reproposed today would make 

conforming changes to the following 

rules: 394 § 200.30–3; 395 § 200.800, 

Subpart N; 396 § 201.101; 397 Rule 144 398

under the Securities Act of 1933; 399

Exchange Act Rule 0–10; 400 Exchange 

Act Rule 3a51–1 401; Exchange Act Rule 

3a55–1; 402 Exchange Act Rule 3b–

16; 403 Exchange Act Rules 10a–1; 404

Exchange Act Rule 10b–10; 405 Exchange 

Act Rule 10b–18; 406 Exchange Act Rule 

15b9–1; 407 Exchange Act Rule 12a–

7; 408 Exchange Act Rule 12f–1; 409

Exchange Act Rule 12f–2; 410 Exchange 

Act Rule 15c2–11; 411 Exchange Act 

Rule 19c–3; 412 Exchange Act Rule 19c–

4; 413 Exchange Act Rule 31; 414 Rule 

100 of Regulation M under the Exchange 

Act; 415 Rule 300 of Regulation ATS 

under the Exchange Act; 416 Rule 301 of 

Regulation ATS under the Exchange 

Act; 417 § 249.1001; 418 and Rule 17a–7 

under the Investment Company Act of 

1940.419

VII. General Request for Comment 

In addition to any specific requests for 

comment included above, the 

Commission generally requests 

comment on all aspects of the 

reproposals described above. Interested 

persons are invited to submit written 

presentations of views, data, and 

arguments concerning the reproposals, 

including the feasibility and practicality 

of implementing the reproposals and the 

costs and benefits associated with the 

reproposals. In addition, the 

Commission will continue to accept 

comment on all issues that were 

previously raised in the Proposing 

Release and Supplemental Release. 

Finally, the Commission requests 

comment, assuming it were to adopt the 

reproposals, on the nature and length of 

implementation and phase-in periods 

that would be appropriate to allow 

market participants time to adapt to the 

new regulatory structure and implement 

the reproposals in an efficient and 

orderly manner. The Commission will 

consider all comments previously 

submitted in response to the Proposing 

Release, the Hearing, and the 

Supplemental Release, in addition to all 

comments received in response to this 

release, in evaluating any further action 

taken on Regulation NMS.

VIII.Paperwork Reduction Act 

A. Trade-Through Rule 

The reproposed Trade-Through Rule 

contains collection of information 

requirements within the meaning of the 

Paperwork Reduction Act of 1995.420

The Commission published a notice 

requesting comment on the collection of 

information requirements in the 

Proposing Release, and submitted these 

requirements to the Office of 

Management and Budget (‘‘OMB’’) for 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77475

421See supra note 9. 422 In the Proposing Release, the Commission 

used the term ‘‘order execution facility’’ to describe 

the entities that would be subject to the proposed 

rule. In the revised proposal, these entities are 

referred to as ‘‘trading centers.’’ Specifically, a 

‘‘trading center’’ would be defined to mean a 

national securities exchange or national securities 

association that operates an SRO trading facility, an 

alternative trading system, an exchange market 

maker, an OTC market maker, or any other broker 

or dealer that executes orders internally by trading 

as principal or crossing orders as agent. See

reproposed Rule 600(b)(78).

423See Section III.G.1. of the Proposing Release.

424See supra Section II.A.4.

425There are eight national securities exchanges 

(Amex, BSE, CBOE, CHX, NSX, NYSE, Phlx and 

PCX) and one national securities association 

(NASD) that trade NMS stocks and thus would be 

subject to the reproposed Rule. The ISE does not 

trade NMS stocks and thus would not be subject to 

the reproposed Rule.

426After further analysis, the Commission has 

revised the estimated number of broker-dealers that 

would be subject to the reproposed Trade-Through 

Rule. The revised number includes the 

approximately 585 firms that were registered equity 

market makers or specialists at year-end 2003 (this 

number was derived from annual FOCUS reports 

and discussion with SRO staff), as well as ATSs that 

operate trading systems that trade NMS stocks. The 

Commission preliminarily believes it is reasonable 

to assume that in general, firms that are block 

positioners—i.e., firms that are in the business of 

executing orders internally—are the same firms that 

are registered market makers (for instance, they may 

be registered as a market maker in one or more 

Nasdaq stocks and carry on a block positioner 

business in exchange-listed stocks), especially given 

the amount of capital necessary to carry on such a 

business.

427Based on industry sources, the Commission 

estimates that the average hourly rate for 

outsourced legal service in the securities industry 

is between $150 per hour and $300 per hour. For 

purposes of this Release, the Commission will use 

the highest rate of $300 per hour to determine 

potential outsourced legal costs associated with the 

proposed rule. For in-house legal services, the 

Commission estimates that the average hourly rate 

for an attorney in the securities industry is 

approximately $82 per hour. The $82 per hour 

figure for an attorney is from the Securities Industry 

Association, Report on Management & Professional 

Earnings in the Securities Industry 2003 (Sept. 

2003), adjusted by the SEC staff for an 1800-hour 

work-year with a 35% upward adjustment for 

overhead, reflecting the cost of supervision, space, 

and administrative support.

428The Commission estimates that the average 

hourly rate for an assistant compliance director in 

the securities industry is approximately $103 per 

hour. The $103 per hour figure for an assistant 

compliance director is from the Securities Industry 

Association, Report on Management & Professional 

Earnings in the Securities Industry 2003 (Sept. 

2003), adjusted by the SEC staff for an 1800-hour 

work-year with a 35% upward adjustment for 

overhead, reflecting the cost of supervision, space, 

and administrative support.

429The Commission estimates that the average 

hourly rate for a senior computer programmer in the 

securities industry is approximately $67 per hour. 

The $67 per hour figure for a senior computer 

programmer is from the Securities Industry 

Association, Report on Management & Professional 

Earnings in the Securities Industry 2003 (Sept. 

2003), adjusted by the SEC staff for an 1800-hour 

work-year with a 35% upward adjustment for 

overhead, reflecting the cost of supervision, space, 

and administrative support.

430The Commission estimates that the average 

hourly rate for an operations manager in the 

securities industry is approximately $70 per hour. 

The $70 per hour figure for an operations manager 

is from the Securities Industry Association, Report 

on Management & Professional Earnings in the 

Securities Industry 2002 (Sept. 2002), adjusted by 

the SEC staff for an 1800-hour work-year with a 

35% upward adjustment for overhead, reflecting the 

cost of supervision, space, and administrative 

support.

431The Commission anticipates that of the 270 

hours it estimates would be spent to establish the 

required policies and procedures, 120 hours would 

Continued

review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The 

Commission is resubmitting these 

requirements to the OMB for review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, an information 

collection unless it displays a currently 

valid OMB control number. The title of 

the affected collection is ‘‘Order 

Protection Rule’’ under OMB control 

number 3235–0600.421

In the Proposing Release, the 

Commission proposed to create three 

new information collections. The first 

collection of information arose from the 

proposed requirement that trading 

centers 422 adopt policies and 

procedures reasonably designed to 

prevent the execution of a transaction at 

prices inferior to prices displayed by 

other trading centers. The other two 

collections of information related to 

requirements in a proposed exception to 

the Trade-Through Rule included in the 

Proposing Release—the opt-out 

exception.423 The revised TradeThrough proposal does not contain an 

opt-out exception, and therefore, the 

collections of information associated 

with the proposed opt-out exception are 

no longer applicable.424

The Commission has revised the 

discussion below to reflect the 

requirements of the reproposed TradeThrough Rule. 

1. Summary of Collection of Information 

The reproposed Trade-Through Rule 

would require a trading center to 

establish, maintain, and enforce written 

policies and procedures reasonably 

designed to prevent the execution of 

trades at prices inferior to protected 

quotations displayed by other trading 

centers, unless a valid exception 

applies, and, if relying on such an 

exception, that are reasonably designed 

to assure compliance with the terms of 

the exception. The nature and extent of 

the policies and procedures that a 

trading center would be required to 

establish to comply with this 

requirement would depend upon the 

type, size, and nature of the trading 

center. 

2. Proposed Use of Information 

The requirement that each trading 

center establish, maintain, and enforce 

written policies and procedures 

reasonably designed to prevent the 

execution of trades at prices inferior to 

protected quotations displayed by other 

trading centers or to assure compliance 

with the terms of an exception would 

help ensure that the trading center and 

its customers, subscribers, members, 

and employees, as applicable, generally 

avoid engaging in trade-throughs, unless 

a valid exception is applicable. 

3. Respondents 

The requirement for each trading 

center to establish written policies and 

procedures reasonably designed to 

prevent the execution of trade-throughs 

potentially would apply to eight 

registered national securities exchanges 

that trade NMS stocks and the NASD,425

and approximately 600 broker-dealers 

registered with the Commission.426 The 

Commission requests comment on the 

accuracy of these figures.

The Commission has considered each 

of these respondents for the purposes of 

calculating the reporting burden under 

the reproposed Trade-Through Rule. 

4. Total Annual Reporting and 

Recordkeeping Burden 

The Commission has modified the 

estimated total annual reporting and 

recordkeeping burden for this collection 

of information to take into account 

changes made to the reproposed TradeThrough Rule. The revisions relate to 

the burden necessary to establish 

written policies and procedures 

reasonably designed to assure 

compliance with the exceptions 

contained in the reproposed Rule. Thus, 

trading centers would need to develop 

written policies and procedures for 

preventing and monitoring for tradethroughs that do not fall within an 

enumerated exception, and, if relying on 

such an exception, that are reasonably 

designed to assure compliance with the 

terms of the exception, to assure that 

they are in compliance with the Rule.

Although the exact nature and extent 

of the required policies and procedures 

that a trading center would be required 

to establish likely would vary 

depending upon the nature of the 

trading center (e.g., SRO vs. non-SRO, 

full service broker-dealer vs. market 

maker), the Commission broadly 

estimates that it would take an SRO 

trading center approximately 270 hours 

of legal,427 compliance,428 information 

technology 429 and business operations 

personnel 430 time,431 and a non-SRO 

77476 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

be spent by legal personnel, 105 hours would be 

spent by compliance personnel, 20 hours would be 

spent by information technology personnel and 25 

hours would be spent by business operations 

personnel of the SRO trading center.

432The Commission anticipates that of 210 hours 

it estimates would be spent to establish policies and 

procedures, 87 hours would be spent by legal 

personnel, 77 hours would be spent by compliance 

personnel, 23 hours would be spent by information 

technology personnel and 23 hours would be spent 

by business operations personnel of the non-SRO 

trading center.

433The estimated 1,980 burden hours necessary 

for SRO trading centers to establish policies and 

procedures are calculated by multiplying nine times 

220 hours (9 × 220 hours = 1,980 hours).

434The estiamted 96,000 burden hours necessary 

for non-SRO trading centers to establish policies 

and procedures are calculated by multiplying 600 

times 160 hours (600 × 160 hours = 96,000 hours).

435This figure was calculated as follows: (70 legal 

hours × $82) + (105 compliance hours × $103) + (20 

information technology hours × $67) + (25 business 

operation hours × $70) = $19,645 pier SRO × 9 SROs 

= $176,805 total cost for SROs; (37 legal hours ×

$82) + (77 compliance hours × $103) + (23 

information technology hours × $67) + (23 business 

operation hours × $70) = $14,116 per broker-dealer 

× 600 broker-dealers = $8,469,600 total cost for 

broker-dealers, $176,805 + $8,469,000 = $8,646,405.

436This figure was calculated as follows: (50 legal 

hours × $300 × 9 SROs) + (50 legal hours × $300 

× 600 broker-dealers) = $9,135,000.

437This figure was calculated by adding 

$8,646,405 and $9,135,000.

438This figure was calculated as follows: (2 legal 

hours × 12 months × $82) × (9 + 600) + (3 

compliance hours × 12 months × $103) × (9 + 600)) 

= $3,456,684.

439 17 CFR 240.17a–1.

440 17 CFR 240.17a–4(e)(7).

441Proposing Release, 69 FR at 11160.

442Proposing Release, 69 FR at 11172.

trading center approximately 210 hours 

of legal, compliance, information 

technology and business operations 

personnel time,432 to develop the 

required policies and procedures.

Included within this estimate, the 

Commission expects that SRO and nonSRO respondents may incur one-time 

external costs for out-sourced legal 

services. While the Commission 

recognizes that the amount of legal 

outsourcing utilized to help establish 

written policies and procedures may 

vary widely from entity to entity, it 

estimates that on average, each trading 

center would outsource 50 hours of 

legal time in order to establish policies 

and procedures in accordance with the 

reproposed Rule. 

The Commission estimates that there 

would be an initial one-time burden of 

220 burden hours per SRO trading 

center or 1,980 hours,433 and 160 

burden hours per non-SRO trading 

center 434 or 96,000 hours, for a total of 

97,980 burden hours to establish 

policies and procedures reasonably 

designed to prevent the execution of a 

trade-through, for an estimated one-time 

initial cost of $8,646,405.435 The 

Commission estimates a capital cost of 

approximately $9,135,000 for both SRO 

and non-SRO trading centers resulting 

from outsourced legal work 436 for a 

total one-time initial cost of 

$17,781,405.437

Once a trading center has established 

written policies and procedures 

reasonably designed to prevent tradethroughs in its market, the Commission 

estimates that it would take the average 

SRO and non-SRO trading center 

approximately two hours per month of 

internal legal time and three hours of 

internal compliance time to ensure that 

its written policies and procedures are 

up-to-date and remain in compliance 

with reproposed Rule 611. The 

Commission staff estimates that these 

ongoing costs would be 60 hours 

annually per respondent, for a total 

estimated annual cost of $3,456,684.438

5. General Information About Collection 

of Information 

This collection of information would 

be mandatory. The Commission expects 

that the written policies and procedures 

that would be generated pursuant to 

reproposed Rule 611 would be 

communicated to the members, 

subscribers, and employees (as 

applicable) of all entities covered by the 

reproposed Rule. To the extent that this 

information is made available to the 

Commission, it would not be kept 

confidential. Any records generated in 

connection with the reproposed Rule’s 

requirement to establish written policies 

and procedures would be required to be 

preserved in accordance with, and for 

the periods specified in, Exchange Act 

Rules 17a–1 439 and 17a–4(e)(7).440

6. General Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

the Commission solicits comments to: 

(i) Evaluate whether the proposed 

collection of information is necessary 

for the proper performance of the 

functions of the agency, including 

whether the information shall have 

practical utility; (ii) evaluate the 

accuracy of the Commission’s estimate 

of the burden of the proposed collection 

of information; (iii) determine whether 

there are ways to enhance the quality, 

utility, and clarity of the information to 

be collected; and (iv) evaluate whether 

there are ways to minimize the burden 

of the collection of information on those 

who are to respond, including through 

the use of automated collection 

techniques or other forms of information 

technology. 

Persons submitting comments on the 

collection of information requirements 

should direct them to the Office of 

Management and Budget, Attention: 

Desk Officer for the Securities and 

Exchange Commission, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, and should also 

send a copy of their comments to 

Jonathan G. Katz, Secretary, Securities 

and Exchange Commission, 450 Fifth 

Street, NW., Washington, DC 20549–

0609, with reference to File No. S7–10–

04. Requests for materials submitted to 

OMB by the Commission with regard to 

this collection of information should be 

in writing, refer to File No. S7–10–04, 

and be submitted to the Securities and 

Exchange Commission, Records 

Management, Office of Filings and 

Information Services, 450 Fifth Street, 

NW., Washington, DC 20549–0609. As 

OMB is required to make a decision 

concerning the collections of 

information between 30 and 60 days 

after publication, a comment to OMB is 

best assured of having its full effect if 

OMB receives it within 30 days of 

publication. 

B. Access Rule 

In the Proposing Release, the 

Commission requested comment on its 

preliminary view that proposed Rule 

610 and the proposed amendment to 

Rule 301(b)(5) under Regulation ATS do 

not contain a collection of information 

requirement as defined by the 

Paperwork Reduction Act.441 No 

comments were submitted that 

addressed the issue. The Commission 

continues to believe that reproposed 

Rule 610 and the reproposed 

amendment to Rule 301(b)(5) do not 

contain a collection of information 

requirement.

C. Sub-Penny Rule 

In the Proposing Release, the 

Commission stated its preliminary view 

that proposed Rule 612 does not contain 

a collection of information requirement 

as defined by the Paperwork Reduction 

Act.442 Although the Commission 

solicited comment on the PRA 

implications of the proposed Sub-Penny 

Rule, no commenters addressed this 

issue. The Commission continues to 

believe that reproposed Rule 612 does 

not contain a collection of information 

requirement.

D. Market Data Rules and Plan 

Amendments 

In the Proposing Release, the 

Commission stated its preliminary view 

that the proposed amendments to the 

joint-industry plans and to Exchange 

Act Rules 11Aa3–1 and 11Ac1–2 

(proposed to be redesignated as Rules 

601 and 603) do not impose a collection 

of information requirement as defined 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77477

443Proposing Release, 69 FR at 11186.

444Proposing Release, 69 FR at 11197.

445Proposing Release, 69 FR at 11148–11150, 

11161, 11172–73, 11186–89, 11197–98.

446See supra Section II.A.1.

447See, e.g., BNY Letter at 2; Consumer 

Federation Letter at 2; ICI Letter at 7.

448See, e.g., Consumer Federation Letter at 2; ICI 

Letter at 7.

449See supra Section II.A.1.

450See supra Section II.A.5.

by the Paperwork Reduction Act.443 No 

comments were received that addressed 

this issue. The Commission continues to 

believe that these reproposed 

amendments do not contain a collection 

of information requirement.

E. Regulation NMS 

In the Proposing Release, the 

Commission stated its preliminary view 

that proposed Rule 600, the 

redesignation of the NMS rules, and the 

conforming amendments to various 

rules do not impose a collection of 

information requirement as defined by 

the Paperwork Reduction Act.444 No 

comments were received that addressed 

this issue. The Commission continues to 

believe that these proposed 

amendments do not contain a collection 

of information requirement.

IX. Consideration of Costs and Benefits 

In the Proposing Release, the 

Commission identified certain costs and 

benefits of the Regulation NMS 

proposals, and, to help evaluate the 

costs and benefits, requested comment 

on all aspects of the costs and benefits 

and encouraged commenters to identify 

or supply any relevant data concerning 

the costs or benefits of the proposal.445

To the extent commenters discussed 

costs and benefits, the Commission has 

considered those comments. The 

Commission renews its request for 

comments on the costs and benefits of 

the Regulation NMS proposals. The 

Commission encourages commenters to 

identify, discuss, analyze, and supply 

relevant data concerning the costs or 

benefits of the reproposed rules.

A. Trade-Through Rule 

Reproposed Rule 611 would require a 

trading center (which includes national 

securities exchanges and national 

securities associations that operate SRO 

trading facilities, ATSs, market makers, 

and block positioners) to establish, 

maintain, and enforce written policies 

and procedures that are reasonably 

designed to prevent trade-throughs of 

protected quotations, and, if relying on 

an exception, that are reasonably 

designed to assure compliance with the 

terms of the exception. To qualify for 

protection, a quotation would be 

required to be displayed and 

immediately accessible through 

automatic execution. The reproposed 

Rule also would require a trading center 

to regularly surveil to ascertain the 

effectiveness of the policies and 

procedures and to take prompt remedial 

action to remedy deficiencies in such 

policies and procedures. 

Reproposed Rule 611 would include a 

variety of exceptions to make 

intermarket price protection as efficient 

and workable as possible. These would 

include an intermarket sweep 

exception, which would allow market 

participants simultaneously to access 

multiple price levels at different trading 

centers—a particularly important 

function now that trading in penny 

increments has dispersed liquidity 

across multiple price levels. The 

intermarket sweep exception would 

enable trading centers that receive 

sweep orders to execute those orders 

immediately, without waiting for betterpriced quotations in other markets to be 

updated. In addition, reproposed Rule 

611 would, among other things, provide 

exceptions for the quotations of trading 

centers experiencing a material delay 

(generally of more than one second) in 

providing a response to incoming 

orders, as well as for flickering 

quotations with prices that have been 

displayed for less than one second. 

1. Benefits 

Many commenters supported the 

adoption of a uniform rule against tradethroughs for all NMS stocks and 

discussed the benefits that such a rule 

would bring to the markets.446 These 

commenters noted that such a uniform 

rule would encourage the use of 

displayed limit orders, thus increasing 

depth and liquidity in the market.447

Some of these commenters also stated 

that the trade-through proposal would 

increase investor confidence by helping 

to eliminate the impression of 

unfairness when an investor’s order 

executes at a price that is worse than 

another displayed order, or when a 

trade occurs at a price that is inferior to 

the investor’s displayed order.448 As 

discussed above in Section II.A.1, the 

Commission preliminarily agrees with 

these commenters.

The Commission preliminarily 

believes that the reproposed TradeThrough Rule would enhance the 

overall fairness and efficiency of the 

NMS and produce significant benefits 

for investors. By providing greater 

protection for displayed prices, the 

reproposed Rule would serve to 

enhance the depth and liquidity of the 

NMS, and thus contribute to the 

maintenance of fair and orderly markets. 

By better protecting the interests of 

investors, both those that post limit 

orders and those that execute against 

posted limit orders, the reproposed Rule 

would promote investor confidence in 

the NMS. The reproposed Rule would 

be a significant improvement over the 

existing ITS trade-through rule, and 

would level the competitive playing 

field among markets by eliminating the 

potential advantage that the ITS rule 

afforded to manual markets. 

The Commission preliminarily 

believes that the proposed TradeThrough Rule is necessary to, and 

would serve to, enhance protection of 

displayed prices. Investors who post 

limit orders, and trading centers that 

quote aggressively, should not see trades 

occurring on another market at a price 

inferior to their orders, except in 

circumstances where an exception 

applies. By requiring trading centers to 

establish written policies and 

procedures reasonably designed to 

prevent trade-throughs and to comply 

with exceptions, and by requiring them 

to regularly surveil to ascertain the 

effectiveness of the policies and 

procedures and to take prompt remedial 

action to remedy deficiencies in such 

policies and procedures, the reproposed 

Rule should help ensure that displayed 

limit orders are not routinely bypassed 

by transactions occurring in other 

markets at inferior prices. By providing 

this protection for displayed prices, the 

Rule would serve to promote greater 

display of limit orders and more 

aggressive quoting. An increase in the 

use of limit orders and aggressive 

quoting should enhance price discovery 

and depth and liquidity in the markets; 

greater depth and liquidity would lead 

to improved execution quality for 

marketable orders, particularly for the 

execution of large institutional orders 

where statistics show there is room for 

improvement in both the markets for the 

trading of Nasdaq and exchange-listed 

stocks.449

Comment is requested on whether 

extending trade-through protection to 

DOB quotations 450 would significantly 

increase the benefits of the reproposed 

Trade-Through Rule. Would protecting 

quotations at multiple price levels 

further encourage the display of limit 

orders and thereby significantly 

enhance depth and liquidity in the 

NMS? Since decimalization, quoted 

spreads have narrowed substantially. 

Market participants often may not be 

willing to quote in significant size at the 

inside prices, but might be willing to do 

so at a price that is a penny or more 

77478 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

451For example, Market A may be displaying a 

best offer of 1000 shares at $10.00, and DOB offers 

of 2000 shares at $10.01 and 2000 shares at $10.02. 

With a reserve size function, however, Market A 

may have an additional 1000 shares offered at 

$10.00 and an additional 2000 shares offered at 

$10.01, neither of which is displayed. Assuming the 

displayed offers of $10.00, $10.01, and $10.02 were 

protected quotations under the Voluntary Depth 

Alternative, Market B could execute a trade at 

$10.03 only by simultaneously routing an order to 

execute against the accumulated displayed size of 

the protected quotations at Market A. Market B 

therefore would be required to route a buy order, 

identified as an intermarket sweep order, to Market 

A with a limit price of $10.02 for a total of 5000 

shares (the accumulated amount of the displayed 

size of protected quotations with a price of $10.02 

or better at Market A). Under the priority rules 

currently in effect at electronic markets, 

undisplayed size has priority over displayed size at 

an inferior price. Accordingly, Market A would 

execute the 5000 share buy order as follows: 2000 

shares at $10.00 (1000 displayed plus 1000 reserve) 

and 3000 shares at $10.01 (2000 displayed plus 

1000 reserve). While Market B would have 

complied with the Rule, the displayed $10.02 offer 

at Market A would still go unfilled when Market B 

traded at $10.03. Comment is requested on the 

extent to which this outcome would detract from 

the benefits of the Voluntary Depth Alternative.

452The Commission emphasizes that adoption of 

reproposed Rule 611 would in no way lessen a 

broker-dealer’s duty of best execution. See supra

section II.B.4. 453See supra Section II.A.1.

454 Id.

455World Federation of Exchanges, Annual 

Report (2003), at 86.

away from the inside prices. Granting 

trade-through protection to such 

quotations potentially would reward 

this beneficial quoting activity. In 

assessing the potential benefits of DOB 

protection, commenters should consider 

the effect of the reserve (or undisplayed) 

size function that many trading centers 

offer investors.451

By requiring trading centers to 

establish written policies and 

procedures reasonably designed to 

prevent trade-throughs and to comply 

with exceptions, and by requiring them 

to regularly surveil to ascertain the 

effectiveness of the policies and 

procedures and to take prompt remedial 

action to remedy deficiencies in such 

policies and procedures, the reproposed 

Rule also should help ensure that 

investors that submit marketable orders 

consistently receive executions at the 

best displayed bid or offer (or better). 

The Rule should facilitate the ability of 

a broker-dealer to achieve best 

execution for its customer orders 

because the market to which a brokerdealer routes an order would not 

execute the order at a price that is 

inferior to a protected bid or offer 

displayed on the other market (unless 

an exception applies).452 By better 

protecting the interests of all investors—

both those that post limit orders and 

those that execute against posted limit 

orders—the reproposed Rule should 

bolster investor confidence in the 

integrity of the NMS, which should 

encourage investors to be more willing 

to invest in the market, thus adding 

depth and liquidity to the markets and 

promoting the ability of listed 

companies to raise capital.

Almost all commenters agreed that 

the current ITS trade-through rule must 

be fixed to accommodate the realities of 

today’s NMS, in particular the 

differences in operation among 

automated and non-automated markets. 

Reproposed Rule 611, by providing 

protection only for automated 

quotations displayed by automated 

trading centers, would significantly 

update the ITS trade-through rule. 

Intermarket efficiency and certainty of 

execution in the NMS would be 

improved as automated markets would 

no longer need to wait for responses 

from non-automated markets and thus 

would be able to execute trades more 

quickly without regard for potentially 

unavailable quotations displayed on 

non-automated markets. The reproposed 

Rule also would level the playing field 

by eliminating the potential competitive 

advantage the existing ITS rule provides 

to manual markets. In addition, by 

providing an incentive for nonautomated markets to automate—

because market participants may be less 

likely to send their order flow to a 

market center whose orders can be 

ignored by other markets—the proposed 

Rule generally should improve the 

accessibility of bids and offers for all 

investors and increase the efficiency of 

the NMS. 

When an investor receives an 

execution in one market at a price that 

is inferior to a price displayed in 

another market, that ‘‘trade-through’’

has a cost to the investor receiving the 

inferior execution. The Commission 

preliminarily believes that the benefits 

of strengthening price protection for 

exchange-listed stocks (by eliminating 

the gaps in ITS coverage of block 

positioners and 100-share quotes) and 

introducing price protection for Nasdaq 

stocks would be substantial, although 

the total amount is difficult to quantify. 

One objective, though quite 

conservative, estimate of benefits is the 

dollar amount of quotations that 

currently are traded through. 

Commission staff’s analysis of current 

trade-through rates indicates that over 

12 billion shares of displayed quotations 

in Nasdaq and NYSE stocks were traded 

through in 2003, by an average amount 

of 2.3 cents for Nasdaq stocks and 2.2 

cents for NYSE stocks.453 These tradedthrough quotations represent 

approximately $209 million in Nasdaq 

stocks and $112 million in NYSE stocks, 

for a total of $321 million in bypassed 

limit orders and inferior prices for 

investors in 2003 that could have been 

addressed by strong trade-through 

protection. The Commission 

preliminarily believes that this $321 

million estimated annual benefit, 

particularly when combined with the 

benefits of enhanced investor 

confidence in the fairness and 

orderliness of the equity markets, would 

justify the one-time costs of 

implementation and ongoing annual 

costs of the reproposed Trade-Through 

Rule.

The foregoing estimate of annual 

benefits is very conservative because it 

is based solely on depth of quotations 

that are displayed in the absence of 

strong price protection. In essence, it 

measures the problem—a shortage of 

quoted depth—that reproposed Rule 611 

is designed to address, rather than the 

benefits that it would achieve. Every 

trade-through transaction potentially 

sends a message to market participants 

that their displayed quotations can be 

and are ignored by other market 

participants. When the total share 

volume of trade-through transactions 

that do not interact with displayed 

quotations reaches 8% and above for 

hundreds of the most actively traded 

NMS stocks, this message is unlikely to 

be missed by those who watched their 

quotations being traded through. 

Certainly, the practice of trading 

through displayed size is most unlikely 

to prompt market participants to display 

even greater size. 

As discussed above,454 a primary 

objective of reproposed Rule 611 is to 

increase displayed depth and liquidity 

in the NMS and thereby reduce trading 

costs for a wide spectrum of investors, 

particularly institutional investors that 

trade in large sizes. It is difficult, 

however, to precisely measure the 

extent to which strengthened price 

protection would improve market depth 

and liquidity, and thereby lower trading 

costs of investors. The difficulty of 

estimation, however, should not hide 

from view the enormous potential 

benefit for investors of improving depth 

and efficiency of the NMS. Because of 

the huge dollar amount of trading 

volume in NMS stocks—more than $17 

trillion in 2003455—even the most 

incremental improvement in market 

depth and liquidity could generate a 

dollar amount of benefits that annually

would dwarf the one-time start-up costs 

of implementing trade-through 

protection.

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77479

456Mutual Fund Fact Book, supra note 135 at 55.

457 Id. at 64. Portfolio turnover is measured by 

adding total fund purchases and sales, dividing by 

2, and then dividing by total fund assets. Because 

price impact occurs for both purchases and sales, 

the turnover rate must be doubled, then multiplied 

by total fund assets, to measure the total value of 

trading that is affected by price impact costs.

458Plexus Group, Inc., Commentary 80, ‘‘Trading 

Truths: How Mis-Measurement of Trading Costs Is 

Leading Investors Astray,’’ (April 2004), at 2.

459The estimate of 37.4 basis points is the average 

of the total market impact and liquidity search costs 

for giant capitalization stocks (30.4 basis points) 

and the total market impact and liquidity search 

costs for large capitalization stocks (44.4 basis 

points). The much higher market impact and 

liquidity search costs of midcap, smallcap, and 

microcap stocks are not included.

460See supra Section II.A.1.

461Mutual Fund Fact Book, supra note 135 at 59.

462See, e.g., Bloomberg Tradebook Letter at 14; 

Fidelity Letter I at 12; Instinet Letter at 14, 15; 

Nasdaq Letter II at 2; Peake Letter I at 2; Reg NMS 

Study Group Letter at 4; Rosenblatt Securities Letter 

II at 4; STANY Letter at 3; UBS Letter at 8.

463See, e.g., Ameritrade Letter I at 8; Brut Letter 

at 10–12; Citigroup Letter at 8–9; E*TRADE Letter 

at 7; Financial Information Forum Letter at 2; JP 

Morgan Letter at 4; SIA Letter at 12–15.

464See supra Section II.A.4.

465See, e.g., Citadel Letter at 6; Hudson River 

Trading Letter at 1–2; Instinet Letter at 12, 14; 

Nasdaq Letter II at 1–2, 5. 466See supra Section II.A.1. 467See supra notes 431 to 437 and accompanying 

text. As with any new Commission rule, trading 

centers also would have to take steps to educate and 

train their employees as to the scope and impact of, 

and how to comply with, the reproposed Rule and 

the policies and procedures implemented by the 

trading center.

One approach to evaluating the 

potential benefits of the reproposed 

Rule is to examine a category of 

investors that stand to benefit a great 

deal from improved depth and liquidity 

for NMS stocks—the shareholders of 

U.S. equity mutual funds. In 2003, the 

total assets of such funds were $3.68 

trillion.456 The average portfolio 

turnover rate for equity funds was 55%, 

meaning that the total purchases and 

sales of the securities they held total 

approximately $4.048 trillion.457 A 

leading authority on the trading costs of 

institutional investors has estimated 

that in 2003 the average price impact 

experienced by investment managers in 

U.S. stocks ranged from 17.4 basis 

points for giant-capitalization stocks, 

21.4 basis points for large-capitalization 

stocks, and up to 35.4 basis points for 

micro-capitalization stocks.458 In 

addition, it estimated the cost 

attributable to adverse price movements 

while searching for liquidity for 

institutional orders, which often are too 

large simply to be presented to the 

market. Its estimate of search costs 

ranged from 13 basis points for giant 

capitalization stocks, 23 basis points for 

large capitalization stocks, and up to 

119 basis points for micro-capitalization 

stocks. Assuming that the average price 

impact and search costs incurred across 

all stocks is a conservative 37.4 basis 

points,459 the shareholders in U.S. 

equity mutual funds incurred implicit 

trading costs of $15.1 billion in 2003. 

Based on a hypothetical assumption 

that, in light of the current share volume 

of trade-through transactions that does 

not interact with displayed liquidity,460

intermarket trade-through protection 

could improve depth and liquidity for 

NMS stocks by at least 5% (or an 

average reduction of 1.87 basis points in 

price impact and liquidity search costs 

for large investors), the savings in 

trading costs for U.S. equity mutual 

funds alone, and the improved returns 

for their millions of individual 

shareholders, would have amounted to 

approximately $755 million in 2003.

Of course, the benefits of improved 

depth and liquidity for the direct equity 

holdings of other types of investors, 

such as pension funds, insurance 

companies, and individuals, are not 

incorporated in the foregoing 

calculations. In 2003, these other types 

of investors held 78% of the value of 

publicly traded U.S. equity outstanding, 

with equity mutual funds holding the 

remaining 22%.461 Assuming that these 

other types of investors experienced a 

reduction in trading costs that merely 

equaled the estimated reduction of 

trading costs for equity mutual funds, 

the assumed 5% improvement in market 

depth and liquidity could yield total 

trading cost savings of over $1.5 billion 

annually. Such savings would improve 

the investment returns of equity 

ownership, thereby promoting the 

retirement and other long-term financial 

interests of individual investors and 

reducing the cost of capital for listed 

companies.

2. Costs 

Some commenters expressed concern 

over the anticipated cost of 

implementing the trade-through 

proposal.462 These commenters argued 

that proposed Rule 611 would be too 

expensive and that the costs associated 

with implementing it would outweigh 

the perceived benefits of the rule. Some 

commenters were concerned about the 

cost of specific requirements in the 

proposed rule, particularly the 

procedural requirements associated 

with the proposed opt-out exception 

(e.g., obtaining informed consent from 

customers and disclosing the NBBO to 

customers).463 As discussed above, 

however, the reproposed Trade-Through 

Rule does not contain an opt-out 

exception, as was originally 

proposed.464 Therefore, the concerns 

expressed by commenters relating to the 

costs of implementing an opt-out 

exception are not applicable. 

Commenters also expressed concern 

that applying the trade-through proposal 

to the Nasdaq market would harm 

market efficiency and execution 

quality.465 As discussed above, the 

Commission preliminarily believes that 

a uniform rule that serves to limit the 

incidence of trade-throughs would 

improve market efficiency and benefit 

execution quality.466

The Commission recognizes that there 

would be significant one-time costs to 

implement the reproposed TradeThrough Rule. Trading centers would 

necessarily incur costs associated with 

establishing, maintaining, and enforcing 

written policies and procedures 

reasonably designed to prevent tradethroughs—in other words, with 

determining a course of action for how 

the trading center would comply with 

the requirements of the Rule, including 

compliance with the exceptions 

contained in the reproposed Rule. 

Although the extent of these costs 

would vary because the exact nature 

and extent of each trading center’s 

written policies and procedures would 

depend on the type, size and nature of 

each entity’s business, as discussed 

above in Section VIII.A., for purposes of 

the PRA the Commission broadly 

estimates that each SRO trading center 

would incur an average one-time initial 

cost for establishing such policies and 

procedures of approximately $34,645, 

and each non-SRO trading center would 

incur an average one-time initial cost for 

establishing policies and procedures of 

approximately $29,116, for a total of 

$17,781,405.467

Each trading center also would incur 

initial up-front costs associated with 

taking action necessary to implement 

the written policies and procedures it 

has developed, which would include 

necessary modifications to order routing 

and execution systems to ‘‘hard-code’’

compliance with the Rule and the 

exceptions. For instance, modifications 

to order routing and execution systems 

would need to be made to route and 

execute orders in compliance with the 

requirements of the proposed Rule to 

prevent trade-throughs of protected 

quotations (which would include, for 

instance, the ability to recognize 

quotations identified in the 

consolidated quotation system as 

manual quotations on a quotation-byquotation basis). Trading centers would 

need to make sure they have 

connectivity to other trading centers in 

77480 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

468This number is an average estimated cost; 

thus, it would overestimate the costs for some 

trading centers and underestimate it for others. For 

instance, it likely overestimates the cost for ATS 

trading centers, particularly smaller ones, as 

opposed to full-service broker-dealer trading 

centers, in part because of the narrower business 

focus of some ATSs.

469 Given that floor-based market-makers and 

specialists utilize exchange execution systems, the 

Commission preliminarily believes it is reasonable 

to assume that such market-makers and specialists 

would not incur substantial systems-related costs to 

implement the reproposed Rule independent of the 

costs that would be incurred by the exchange on 

whose floor they operate to make changes to the 

exchange’s execution systems. Thus, these entities 

(approximately 160 of the 585) are not directly 

included within the cost estimates.

470See supra note 438 and accompanying text.

471The Commission acknowledges that, under the 

Voluntary Depth Alternative for protected 

quotations (see supra Section II.A.5) if a trading 

center were to choose to include its depth-of-book 

quotations in the consolidated quotation system 

and provide trade-through protection for those 

orders (to the extent they are automated quotations), 

it would be necessary for the industry to have 

access to that depth-of-book information on a realtime and historical basis, and that trading centers 

may incur additional costs associated with 

accessing and storing this data. The Commission 

requests comments on these costs.

472This figure was calculated as follows: (16 

compliance hours × $103) + (8 information 

technology hours × $67) + (4 legal hours × $82) ×

12 months = $30,144 per trading center × 609 

trading centers = $18,357,696. See supra notes 427 

to 429 for notation as to hourly rates.

473See supra Section II.A.5. for a discussion of 

the Voluntary Depth Alternative.

474See supra note 471. As a means to address 

capacity issues, the SRO participants in the 

applicable market data Plans potentially could 

determine to disseminate only those DOB 

quotations that were within a certain number of 

price levels away from the NBBO.

the NMS that could post protected 

quotations, whether through proprietary 

linkages or through use of third-party 

services. As noted below, however, the 

Commission preliminarily believes that 

most of this private linkage 

functionality already exists, particularly 

in the market for Nasdaq securities. 

Surveillance systems would need to be 

modified to assure an effective 

mechanism for monitoring transactions 

after-the-fact for ongoing compliance 

purposes. Also, trading systems would 

need to be programmed to recognize 

when exceptions to the operative 

provisions of reproposed Rule 611 were 

applicable. For example, trading centers 

would need to be able to identify 

outgoing and recognize incoming orders 

as intermarket sweep orders. Data feeds 

and market vendor systems would need 

to be modified to accommodate order 

identifiers for manual quotations and 

intermarket sweep orders, which costs 

(to the extent incurred) would likely be 

passed along to the end users of these 

systems, the trading centers. These costs 

are included within the estimates 

below. 

For non-SRO trading centers that rely 

upon their own internal order routing 

and execution management systems, of 

which the Commission preliminarily 

estimates that there are approximately 

20, the Commission preliminarily 

estimates the average cost of necessary 

systems changes to implement the Rule 

would be approximately $3 million per 

trading center, for a total one-time startup cost of approximately $60 million.468

The Commission preliminarily 

estimates that the remaining non-SRO 

trading centers that would be subject to 

the reproposed Rule would utilize 

outside vendors to provide these 

services, consistent with their current 

use of such services for order routing 

and execution management. For these 

non-SRO trading centers, the 

Commission preliminarily estimates the 

cost of necessary systems modifications 

that would be passed along to the 

trading centers to be approximately 

$50,000 per trading center, for a total 

initial cost of $21 million.469 The 

Commission also preliminarily 

estimates that the average cost to the 

nine SROs to make necessary system 

modifications to implement the 

reproposed Rule would be $5 million 

per SRO, for a total of $45 million. 

Therefore, preliminary estimated overall 

total one-time implementation costs, 

added to PRA costs, would be 

approximately $144 million.

In addition, broker-dealers that would 

not fall within the proposed definition 

of a trading center but that employ their 

own smart-order routing technology to 

route orders to multiple trading centers 

could choose to route orders in 

compliance with the proposed 

intermarket sweep exception. These 

broker-dealers would need to make 

necessary modifications to their order 

routing practices and proprietary order 

routing systems to monitor the protected 

quotations of trading centers and to 

properly identify such intermarket 

sweep orders. The Commission 

preliminarily does not believe that this 

category of broker-dealers is very large. 

The Commission also preliminarily 

believes it likely that most if not all of 

these non-trading center broker-dealers 

that employ their own order-routing 

technology already have systems in 

place that monitor best-priced 

quotations across markets, and thus 

does not believe that the changes 

necessary to implement the intermarket 

sweep order would be substantial. 

With respect to maintaining and 

updating its required written policies 

and procedures to ensure they continue 

to be in compliance with the reproposed 

Rule, for purposes of the PRA the 

Commission preliminarily estimates 

that the average annual cost for each 

trading center would be approximately 

$5,676 per trading center per year, for a 

total annual cost for all trading centers 

of $3,456,684.470 With regard to ongoing 

monitoring for and enforcement of 

trading in compliance with the Rule, the 

Commission preliminarily believes that, 

once the tools necessary to carry out ongoing monitoring have been put in place 

(which are included in the above cost 

estimates), a trading center would be 

able to incorporate ongoing monitoring 

and enforcement within the scope of its 

existing surveillance and enforcement 

policies and procedures without a 

substantial additional burden.

The Commission recognizes, however, 

that this ongoing compliance would not 

be cost-free, and that trading centers 

would incur some additional annual 

costs associated with ongoing 

compliance, including compliance costs 

of reviewing transactions. For instance, 

the Commission recognizes that access 

to a database of BBO information for 

each trading center whose quotations 

would be protected by the reproposed 

Trade-Through Rule would be necessary 

to monitor transactions for compliance 

with the Rule on an after-the-fact basis. 

The Commission believes that this 

information currently is available, at 

least with respect to the BBO of each 

trading center, and understands that 

such information currently is 

maintained by at least one industry 

vendor. The Commission preliminarily 

believes that the cost to each trading 

center to access this database would be 

incremental in relation to the cost of 

other services provided by the 

vendor.471 The Commission 

preliminarily estimates that each trading 

center would incur an average annual 

ongoing compliance cost of $30,144 for 

a total annual cost of $18,357,696 for all 

trading centers.472

The Commission also requests 

comment on whether the Voluntary 

Depth Alternative could be 

implemented in a practical and costeffective manner.473 To comply, trading 

centers would need to monitor a 

significantly larger number of protected 

quotations displayed by other markets 

and route orders to execute against such 

quotations.474 The Voluntary Depth 

Alternative, however, would not 

increase the number of orders that a 

trading center would be required to 

route to other trading centers if only 

BBOs were protected. Instead, the size

of the routed orders would need to be 

increased to reflect the accumulated 

depth displayed by other trading centers 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77481

475The Voluntary Depth Alternative would set up 

a process through which individual markets could 

choose to secure protection for their DOB 

quotations by disseminating them in the 

consolidated quotation stream. To implement this 

approach, the SRO participants in the market data 

Plans would need to establish a mechanism for 

individual markets to disseminate their quotations 

through the Plan processor and have them 

designated as protected quotations. See supra

Section II.A.5.

476Bear Stearns Letter at 2.

477 Goldman Sachs Letter at 6.

478See Securities Exchange Act Release Nos. 

50173 (Aug. 10, 2004), 69 FR 50407 (Aug. 16, 2004) 

and 50667 (Nov. 15, 2004), 69 FR 67980 (Nov. 22, 

2004) (SR–NYSE–2004–05).

in their protected DOB quotations. In 

addition, the applicable regulatory 

authorities must be able to monitor and 

enforce compliance with a rule that 

protected DOB quotations. At a 

minimum, this would require an 

objective and uniform source to identify 

the quotations that are protected at any 

particular time.

As noted in section II.A.3 above, any 

intermarket protection against tradethroughs must be workable and 

implemented in a way that promotes 

fair and orderly markets. To the extent 

commenters are concerned about 

practical problems with implementing 

the Trade-Through Rule, would the 

basis for these concerns be magnified by 

the Voluntary Depth Proposal? 

Specifically, comment is requested on 

all issues relating to the feasibility and 

desirability of disseminating DOB 

quotations through Plan processors.475

For example, would the voluntary 

dissemination of protected DOB 

quotations through the Plan processors 

create a single point of failure that could 

threaten the stability of trading in NMS 

stocks?

The Commission also requests 

comment on the effect that adoption of 

the Voluntary Depth Alternative would 

have on competition among markets. 

One commenter, for example, suggested 

that protection of DOB quotations might 

cause increased fragmentation of 

liquidity across different markets 

because limit orders, no matter where 

displayed, would have price 

protection.476 Another commenter, in 

contrast, asserted that protecting only 

BBOs would lead to greater 

fragmentation because limit orders 

would be routed to any market where 

they would set or equal the BBO and 

thereby obtain trade-through 

protection.477 Comment is requested on 

the fragmentation issue, as well as in 

general on whether protecting DOB 

quotations would inappropriately limit 

the terms of market competition so as to 

harm investors and the efficiency of the 

NMS. For example, would adoption of 

the Voluntary Depth Alternative 

inappropriately reduce the scope of 

competition among markets to the 

payment of liquidity rebates for 

executed limit orders? Comment also is 

requested on whether adoption of the 

Voluntary Depth Alternative would 

generate forces that would lead to a 

monopolization of trading in a single 

trading facility.

In assessing the costs of systems 

changes that may be required by the 

reproposed Rule, it is important to 

recognize that much, if not all, of the 

connectivity among trading centers 

necessary to implement intermarket 

price protection has already been put in 

place. For example, trading centers for 

exchange-listed securities already are 

connected through the ITS. The 

Commission understands that ITS 

facilities and rules can be modified 

relatively easily and at low cost to 

enable an automatic execution 

functionality. With respect to Nasdaq 

stocks, connectivity among trading 

centers already is established through 

private linkages. Routing out to other 

trading centers when necessary to 

obtain the best prices for Nasdaq stocks 

is an integral part of the business plan 

of many trading centers, even when not 

affirmatively required by best execution 

responsibilities. Moreover, a variety of 

private vendors currently offer 

connectivity to NMS trading centers for 

both exchange-listed and Nasdaq stocks. 

Many of the broker-dealers that are nonSRO trading centers that would be 

subject to the Rule already employ 

smart order routing technology, either 

their own systems or those of outside 

vendors, which should limit the cost of 

implementing systems changes. The 

Commission also understands that the 

cost to the Plan processors to 

incorporate the reproposed TradeThrough Rule and its exceptions would 

be minimal.

In determining these estimates the 

Commission also has considered that 

many market participants are already 

making changes to their systems to 

become more competitive. Many of the 

changes being made would assist the 

market participants in preparing for 

implementation of the reproposed 

Trade-Through Rule. For example, 

Nasdaq, which previously did not have 

an order routing system, recently 

purchased Brut, LLC in order to acquire 

access to such a system. The 

Commission preliminarily believes that 

this acquisition should reduce the costs 

that would be incurred by Nasdaq to 

implement the reproposed TradeThrough Rule. The Commission also 

notes that the NYSE is in the process of 

modifying its Direct+ System to make 

more quotations available on an 

automated basis.478 These changes that 

the NYSE has undertaken should reduce 

the cost of additional systems changes 

needed to implement the TradeThrough Rule.

Overall, the Commission 

preliminarily believes that the 

reproposed Trade-Through Rule would 

produce significant benefits that justify 

the costs of implementation of the Rule. 

B. Access Rule 

Reproposed Rule 610 of Regulation 

NMS would set forth new standards 

governing access to quotations in NMS 

stocks. These standards would prohibit 

trading centers from imposing unfairly 

discriminatory terms that would prevent 

or inhibit the efficient access of any 

person through members, subscribers, or 

customers of such trading center, and 

enable access to NMS quotations 

through private linkages, rather than 

mandating a collective intermarket 

linkage facility. In addition, in order to 

ensure the fairness and accuracy of 

displayed quotations, the reproposed 

Rule would establish an outer limit on 

the cost of accessing protected 

quotations of no more than $0.003 per 

share (or 0.3% of the quotation price per 

share for quotations priced less than $1). 

Reproposed Rule 610 also would require 

SROs to establish and enforce rules that 

would, among other things, prohibit 

their members from engaging in a 

pattern or practice of displaying 

quotations that lock or cross the 

automated quotations of other trading 

centers. Finally, the reproposed 

amendment to Rule 301 of Regulation 

ATS would lower the threshold that 

triggers the Regulation ATS fair access 

requirements from 20% to 5% of 

average daily volume in a security. 

1. Benefits 

The Commission preliminarily 

believes that the reproposed Access 

Rule would help achieve the statutory 

objectives for the NMS by promoting 

fair and efficient access to each 

individual market. By relying on private 

linkages, rather than mandating a 

collective intermarket linkage facility, 

the access provisions of reproposed 

Rule 610(a) and (b) would allow market 

centers to connect through flexible and 

cost effective technologies widely used 

in the markets today, particularly in the 

market for Nasdaq stocks. This would 

allow firms to capitalize on the dramatic 

improvements in communications and 

processing technologies in recent years, 

and thereby enhance the linking of all 

77482 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

479The Commission preliminarily believes that 

the reproposed fee limitation on protected 

quotations priced less than $1.00 would provide the 

same benefits.

480 17 CFR 242.301(b)(5).

481 17 CFR 242.301(b)(3).

482One commenter, however, felt that the 

bilateral links required for private linkages would 

be particularly burdensome to smaller market 

centers compared to an ITS-type structure. Letter 

from Donald E. Weeden to Jonathan G. Katz, 

Secretary, Commission, dated June 30, 2004, at 9–

10.

markets for the future NMS. Private 

linkages also would provide flexibility 

to meet the needs of different market 

participants and allow competitive 

forces to determine the specific nature 

and cost of connectivity. The 

reproposed access provisions of Rule 

610(a) and (b) thus would allow market 

participants to fairly and efficiently 

route orders to execute against the best 

quotations for a stock, wherever such 

quotations are displayed in the NMS. 

The Commission believes that fair and 

efficient access to the best quotations of 

all trading centers is critical to 

achieving best execution of those orders. 

The reproposed access provisions of 

Rule 610(a) and (b) also would promote 

fair and efficient access to quotations by 

prohibiting a trading center from 

unfairly discriminating against nonmembers or non-subscribers that 

attempt to access its quotations through 

a member or subscriber of such trading 

center. Such fair access to the 

quotations of other trading centers is 

critical for compliance with the 

reproposed Trade-Through Rule and 

broker-dealers’ duty of best execution. 

The reproposed fee limitation of Rule 

610(c) would address the potential 

distortions caused by substantial, 

disparate fees. As a result of the 

reproposed fee limitation, displayed 

prices would more closely reflect actual 

costs to trade, thereby enhancing the 

usefulness of market information. The 

proposed fee limitation also would 

establish a level playing field across all 

market participants and trading centers. 

A single accumulated fee limitation 

would apply equally to all types of 

trading centers and all types of market 

participants, thereby promoting the 

NMS objective of equal regulation of 

markets and broker-dealers. 

The reproposed fee limitation also 

should help address the ‘‘outlier’’

business model under which a trading 

center charges high fees for access to its 

quotations and passes most of the fees 

through as rebates to attract liquidity 

providers. These outliers might attempt 

to take advantage of intermarket price 

protection by acting essentially as a toll 

booth between price levels. Particularly 

with a trade-through rule, even though 

high fee markets likely would be the last 

market to which orders would be 

routed, prices could not move to the 

next level until someone routed an 

order to take out the displayed price at 

the outlier market. Such a business 

model would detract from the 

usefulness of quotation information and 

impede market efficiency and 

competition. The reproposed fee cap 

would preclude the outlier business 

model. It would place all markets on a 

level playing field in terms of the fees 

they can charge and ultimately the 

rebates they can pass on to liquidity 

providers. Some markets might choose 

to charge lower fees, thereby increasing 

their ranking in the preferences of order 

routers. Others might charge the full 

$0.003 and rebate a substantial 

proportion to liquidity providers. 

Competition would determine which 

strategy was most successful.479

The restrictions on locking or crossing 

quotations in reproposed Rule 610(d) 

should promote fair and orderly 

markets. Locked and crossed markets 

can cause confusion among investors 

concerning trading interest in a stock. 

Restricting the practice of submitting 

locking or crossing quotations therefore 

would enhance the usefulness of 

quotation information. Consistent with 

the approach to trade-through 

protection, however, reproposed Rule 

610(d) would allow automated 

quotations to lock or cross manual 

quotations. Reproposed Rule 610(d) 

thereby would address the concern that 

manual quotations may not be fully 

accessible and recognize that allowing 

automated quotations to lock or cross 

manual quotations may provide useful 

market information regarding the 

accessibility of quotations. The 

Commission preliminarily believes, 

however, that an automated quotation is 

entitled to protection from locking or 

crossing quotations. When two market 

participants are willing to trade at the 

same quoted price, giving priority to the 

first-displayed automated quotation 

should contribute to fair and orderly 

markets. Moreover, the basic principle 

underlying the NMS is to promote fair 

competition among markets, but within 

a unified system that also promotes 

interaction between all of the buyers 

and sellers in a particular NMS stock. 

Allowing market participants simply to 

ignore accessible quotations in other 

markets and routinely display locking 

and crossing quotations would be 

inconsistent with this principle. The 

reproposed restrictions on locking or 

crossing quotations, in conjunction with 

the reproposed Trade-Through Rule, 

should encourage trading against 

displayed quotations and enhance the 

depth and liquidity of the markets.

Finally, lowering of the fair access 

threshold of Rule 301(b)(5) under 

Regulation ATS 480 from 20% to 5% of 

average daily trading volume in a 

security would further strengthen access 

to the full range of services of ATSs 

with significant trading volume in NMS 

stocks. Such access is particularly 

important for success of the private 

linkage approach proposed for access to 

quotations. The lowering of the fair 

access threshold also would make its 

coverage consistent with the existing 

5% threshold triggering the order 

display and execution access 

requirements of Rule 301(b)(3) of 

Regulation ATS.481 As a result, each 

ATS that is required to disseminate its 

quotations in the consolidated data 

stream also would be prohibited from 

unfairly prohibiting or limiting market 

participants from becoming a subscriber 

or customer.

In reproposing Rule 610 and the 

amendment to Rule 301 of Regulation 

ATS, the Commission seeks to help 

ensure that securities transactions can 

be executed efficiently, at prices 

established by vigorous and fair 

competition among market centers. By 

enabling fair access and transparent 

pricing among diverse marketplaces 

within a unified national market, the 

Commission preliminarily believes that 

the access proposal would foster 

efficiency, enhance competition, and 

contribute to the best execution of 

orders for NMS securities. 

2. Costs 

The Commission preliminarily 

believes that reproposed Rule 610 and 

the reproposed amendments to Rule 301 

of Regulation ATS would not impose 

significant costs on most trading centers 

and market participants. The system 

changes necessary to meet the new 

access standards should be minor. 

Currently, private linkages are widely 

used in the equity markets, particularly 

for trading in Nasdaq stocks.482

Moreover, the Commission understands 

that the ITS facilities that currently 

provide intermarket access for 

exchange-listed stocks could be 

modified at minimal cost to provide an 

auto-execution functionality, at least as 

an interim measure until private 

linkages were fully established for 

exchange-listed stocks.

While commenters were generally 

supportive of the Commission’s 

proposal to employ private linkages to 

provide access between markets, some 

commenters expressed concern that the 

effort and investment to establish such 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77483

483See, e.g., Brut Letter at 13; Citigroup Letter at 

13; SIA Letter at 16–17; UBS Letter at 9.

484Under Rule 301(b)(3) of Regulation ATS, an 

ATS is required to display its quotations in the 

consolidated data stream only in those securities for 

which its trading volume reaches 5% of total 

trading volume.

485As noted in the Commission’s order approving 

the pilot program for the ADF, the reduction in 

communications line costs in recent years and the 

advent of competing access providers offer the 

potential for multiple competitive means of access 

to the various trading centers that trade NMS 

stocks. Securities Exchange Act Release No. 46249, 

supra note 181. 486As the self-regulatory authority responsible for 

the OTC market, the NASD would need to assess 

the extent to which ADF participants have met the 

access standards of reproposed Rule 610. 487Alliance of Floor Brokers Letter at 10; Amex 

Letter, Exhibit A at 25–26; BSE Letter at 12; CHX 

Letter at 14; Citigroup Letter at 12; Phlx Letter at 

2; STANY Letter at 9.

488Brokerage America Letter at 1; Oppenheimer 

Letter at 2; STANY Letter at 11.

489See supra note 193 and accompanying text.

490The Commission preliminarily believes that 

the same analysis would apply to the reproposed 

fee limitation on protected quotations priced less 

than $1.00.

connectivity to smaller markets would 

likely be disproportionate to the 

liquidity on such a market.483

Reproposed Rule 610(b)(1), however, 

would require trading centers that 

display quotations in the ADF to 

provide a level and cost of access to 

their quotations that is substantially 

equivalent to the level and cost of access 

to quotations displayed by SRO trading 

facilities.

Currently, three ATSs display 

quotations in the ADF, two of which 

also display quotations through the 

NASDAQ Market Center. Reproposed 

Rule 610(b) may require these trading 

centers to incur additional costs to 

enhance the level of access to their 

quotations and to lower the cost of 

connectivity for market participants 

seeking to access their quotations. The 

extent to which these trading centers in 

fact incur additional costs to comply 

with the proposed access standard 

would be largely within the control of 

the trading center itself. ATSs and 

market makers that wish to trade NMS 

stocks can choose from a number of 

options for quoting and trading. They 

can become a member of a national 

securities exchange and quote and trade 

through the exchange’s trading facilities. 

They can participate in the NASDAQ 

Market Center and quote and trade 

through that facility. Finally, they can 

quote and trade in the OTC market. The 

existence of the NASD’s ADF makes this 

third choice possible by providing a 

facility for displaying quotations and 

reporting transactions in the 

consolidated data stream.484 As a result, 

the additional connectivity 

requirements of reproposed Rule 610(b) 

would be triggered only by a trading 

center that displays its quotations in the 

consolidated data stream and chooses 

not to provide access to those quotations 

through an SRO trading facility.

Currently, nine SROs operate trading 

facilities in NMS stocks. Market 

participants throughout the securities 

industry generally have established 

connectivity to these nine points of 

access to quotations in NMS stocks. By 

choosing to display quotations in the 

ADF, a trading center effectively could 

require the entire industry to establish 

connectivity to an additional point of 

access. Potentially, many trading centers 

could choose to display quotations in 

the ADF, thereby significantly 

increasing the overall costs of 

connectivity in the NMS. Such an 

inefficient outcome would become 

much more likely if an ADF trading 

center were not required to assume 

responsibility for the additional costs 

associated with its decision to display 

quotations outside of an established 

SRO trading facility. Consequently, the 

reproposed access standard in Rule 

610(b)(2) would help reduce overall 

industry costs by more closely aligning 

the burden of additional connectivity 

with those entities whose choices have 

created the need for additional 

connectivity. 

To meet the standard contained in 

reproposed Rule 610(b)(1), a trading 

center would be allowed to take 

advantage of the greatly expanded 

connectivity options that have been 

offered by competing access service 

providers in recent years.485 These 

industry access providers have 

extensive connections to a wide array of 

market participants through a variety of 

direct access options and private 

networks. A trading center potentially 

could meet the requirement of 

reproposed Rule 610(b)(1) by 

establishing connections to and offering 

access through such vendors. The 

option of participation in existing 

market infrastructure and systems 

should greatly reduce a trading center’s 

cost of compliance.486

Several commenters, including some 

that otherwise supported the proposal, 

expressed concern that requiring nondiscriminatory access to markets might 

undermine the value of SRO 

membership.487 The Commission 

preliminarily does not believe that 

adoption of a private linkage approach 

would seriously undermine the value of 

membership in SROs that offer valuable 

services to their members. First, the fact 

that markets would not be allowed to 

impose unfairly discriminatory terms on 

non-members who obtain indirect 

access to quotations through members 

does not mean that non-members would 

obtain free access to quotations. 

Members who provide piggyback access 

would be providing a useful service and 

presumably would charge a fee for such 

service. The fee would be subject to 

competitive forces and likely would 

reflect the costs of SRO membership, 

plus some element of profit to the SRO’s 

members. As a result, non-members that 

frequently make use of indirect access 

are likely to contribute indirectly to the 

costs of the SRO market. Moreover, the 

unfair discrimination standard of Rule 

610(a) would apply only to access to 

quotations, not to the full panoply of 

services that markets generally provide 

only to their members.

The Commission preliminarily does 

not believe that the proposed fee 

limitation of reproposed Rule 610(c) 

would impose significant new costs on 

most trading centers. A few commenters 

were concerned about the costs to 

market participants of administering a 

fee program under the original proposal, 

which would have limited trading 

centers to a fee of $0.001 and brokerdealers to a fee of $0.001.488 The revised 

proposal, by imposing a single 

accumulated fee limitation of $0.003 

(when the price of the protected 

quotation is $1 or more), would greatly 

simplify the proposed fee limitation and 

likely would leave existing fee practices 

largely intact. Entities that currently 

charge and collect fees would continue 

to do so. Market makers likely would 

collect fees through an SRO trading 

facility or ECN through which it 

displayed limit orders or quotations, 

and the administration of such fee 

program likely would be handled by the 

SRO or ECN. Therefore, the revised fee 

limitation should not impose significant 

new administrative costs.

The reproposed fee limitation of Rule 

610(c) would, however, affect the few 

markets that currently impose access 

fees of greater than $0.003 per share that 

apply to a wide range of NMS stocks.489

These markets could be required to reevaluate their business models in light 

of the adopted fee limitation. In 

particular, they likely would need to 

reduce the rebates they currently pay to 

liquidity providers. The reproposed 

limitation also would affect a few 

trading centers that charge significant 

access fees for large transactions in 

specific types of NMS stocks, such as 

ETFs. It is unlikely, however, that such 

fees currently generate a large amount of 

revenues.490

The locked and crossed provisions of 

reproposed Rule 610(d) should not 

impose significant additional costs for 

77484 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

491See supra section IV.C.1.

492Rule 10a–1 under the Exchange Act, 17 CFR 

240.10a–1, and NASD IM–2110–2.

493 ICI Letter at 20.

494One commenter argued that a prohibition on 

sub-penny quoting should not affect institutional 

investors’ trading costs because improvements in 

trading technology (such as auto-execution and 

VWAP trading algorithms) allow them to fill large 

orders at minimal cost. See Tower Research Letter 

at 9–10. While the Commission agrees that such 

improvements have been useful, it believes that this 

commenter does not consider the costs involved in 

having to develop these technologies in response, 

at least in part, to insufficient liquidity. Moreover, 

the Commission believes that this commenter also 

does not consider the positive externalities that 

limit orders have on price discovery and price 

competition; orders that execute without being 

quoted do not contribute to price discovery and 

price competition.

495See Instinet Letter at 51; Mercatus Letter at 9.

496Tower Research Letter at 8.

497 Id. at 9.

498See Instinet Letter at 50.

the SROs. All SROs currently have rules 

restricting locking and crossing 

quotations in exchange-listed stocks to 

comply with the provisions of the ITS 

Plan. Such SROs also collect the data 

and related information required to 

monitor locked and crossed markets, 

and the Commission preliminarily 

believes that the additional surveillance 

and enforcement costs related to the 

provisions would be minor. The 

Commission recognizes, however, that 

reproposed Rule 610(d), by restricting 

locked markets with respect to 

automated quotations, could impose 

certain trading costs associated with 

widened spreads if an order that would 

otherwise have been displayed was not 

displayed. Although locked markets do 

occur a certain percentage of the time, 

they do not occur all the time, and thus, 

the average spread is between zero and 

a penny (a penny being the MPV for all 

but a very few stocks). Thus, the 

Commission preliminarily believes that 

any widening of average spreads caused 

solely by the reproposed rule would be 

limited to the difference between a subpenny and penny spread. In addition, a 

locked market often does not actually 

represent two market participants 

willing to buy and sell at the same price 

because it is likely that the locking 

market participant is not truly willing to 

trade at the displayed locking price, but 

instead chooses to lock rather than 

execute against the already-displayed 

quotation to receive a liquidity rebate. 

Finally, reducing the fair access 

thresholds of Regulation ATS would 

require ATSs that exceed the 5% 

threshold level to comply with Rule 

301(b)(5) under Regulation ATS. Rule 

301(b)(5) requires ATSs, among other 

things, to establish written standards for 

granting access to trading on its system, 

to not unreasonably prohibit or limit 

access to its services, to keep records of 

all grants or denials of access, and to 

report such information on Form ATS–

R. The Commission preliminarily 

believes that the costs to meet these 

requirements are justified by the need to 

promote fair and efficient access to 

trading centers with significant volume. 

C. Sub-Penny Rule 

Reproposed Rule 612 would prohibit 

market participants from displaying, 

ranking, or accepting quotations in NMS 

stocks that are priced in an increment 

less than $0.01, unless the per share 

price of the quotation is less than $1.00. 

It would permit sub-penny quotations 

below $1.00, but only to four decimal 

places. 

1. Benefits 

The Commission believes that the 

markets’ conversion to decimal pricing 

has benefited investors by, among other 

things, clarifying and simplifying 

pricing for investors, making the U.S. 

securities markets more competitive 

internationally, and reducing trading 

costs by narrowing spreads. The 

Commission is concerned, however, that 

if the MPV decreases beyond a certain 

point, some of the benefits of decimals 

could be lost while some of the negative 

effects are exacerbated. The Commission 

preliminarily believes that reproposed 

Rule 612, which would prohibit an MPV 

of less than $0.01 for most NMS stocks, 

would have several benefits. The 

majority of the commenters supported 

the proposal and noted various potential 

benefits of the proposed rule.491

The Commission preliminarily 

believes that sub-penny quoting 

impedes transparency by reducing 

market depth at the NBBO and 

increasing quote flickering. In an 

environment where the NBBO can 

change very quickly, broker-dealers 

have more difficulty in carrying out 

their duties of best execution and 

complying with other regulatory 

requirements that require them to 

identify the best bid or offer available at 

a particular moment (such as the 

Commission’s short sale rule and the 

NASD’s Manning rule).492

In addition, the Commission agrees 

with the many commenters that 

believed that prohibiting sub-penny 

quoting would deter the practice of 

stepping ahead of exposed trading 

interest by an economically 

insignificant amount. Limit orders 

provide liquidity to the market and 

perform an important price-setting 

function. The Commission is concerned 

that, if a quotation or order can lose 

execution priority because of 

economically insignificant price 

improvement from a later-arriving 

quotation or order, liquidity could 

diminish and some market participants 

could incur greater execution costs. As 

one commenter, the Investment 

Company Institute, stated, ‘‘[t]his 

potential for the increased steppingahead of limit orders would create a 

significant disincentive for market 

participants to enter any sizeable 

volume into the markets and would 

reduce further the value of displaying 

limit orders.’’ 493 Improved liquidity 

should decrease the costs of trading, 

especially for large orders.494 Market 

participants may be more likely to place 

limit orders if they know that other 

market participants cannot quote ahead 

of them by a sub-penny amount.

2. Costs 

The Commission recognizes that 

reproposed Rule 612 would impose 

certain costs on the U.S. securities 

markets. Currently, certain NMS stocks 

are quoted—and in the absence of the 

rule, others in the future could be 

quoted—in sub-pennies. For these NMS 

stocks, quoted spreads would be wider 

than they otherwise would be, because 

reproposed Rule 612 would not allow 

market participants to narrow the 

spread by a sub-penny amount. 

Two commenters stated that investors 

would suffer harm from artificially 

widened spreads.495 Another 

commenter stated that ‘‘the primary 

result of eliminating subpenny trading 

would be to preserve a minimum profit 

for market makers, and would result in 

significantly worse realized prices for 

the vast majority of market participants 

not in the business of making 

markets.’’ 496 This commenter analyzed 

trading in six high-volume securities 

and concluded that proposed Rule 612 

would have costs of over $400 million 

in these securities alone due to wider 

spreads.497 Another commenter stated 

that, if all markets traded QQQQ solely 

in sub-pennies, the savings would be 

approximately $150 million per year.498

This commenter, however, did not 

provide data or analysis showing how it 

reached this conclusion. No other 

commenters provided any quantitative 

analysis of the costs that a sub-penny 

quoting rule would impose by widening 

spreads to at least a full penny.

The Commission preliminarily 

believes that the $400 million and $150 

million estimates of the cost to the 

markets caused by wider spreads 

provided by these two commenters are 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77485

499See Memorandum from the Office of 

Economic Analysis, Commission, to File, dated 

December 15, 2004. This study is available on the 

Commission’s Internet Web site (http://

www.sec.gov/rules/proposed/s71005.shtml) and 

from the Commission’s Public Reference Room.

500Trades below $1.00 were excluded from the 

sample as Rule 612 would not prohibit sub-penny 

quotations priced less than $1.00.

501Executions occurring at a sub-penny price 

resulting from a mid-point, VWAP, or similar 

volume-weighted pricing algorithm would not be 

prohibited by reproposed Rule 612. For purposes of 

this study, Commission staff excluded all other 

trades that have a condition code other than 

‘‘regular way’’ (e.g., trades reported after normal 

trading hours, bunched trades, next-day trades, 

previous reference price trades, and late trade 

reports).

502For example, the cost to a sub-penny trade at 

price $25.248 for 300 shares is as follows. The 

assumption is that, without sub-penny quotations, 

this trade would have occurred at $25.25—a 

difference of $0.002 per share. At 300 shares, this 

trades incurs a cost of $0.60 ($0.002 x 300). A subpenny trade at $25.242 would incur a cost of $0.002 

per share under the assumption that, under Rule 

612, it would execute at $25.24. 503See supra note 499. 504As of December 6, 2004, one of these ECNs 

(Brut) permitted sub-penny quoting only in 

securities priced below $5.00; the other ECN (Inet) 

permitted sub-penny quoting for securities priced 

below $1.00 and also for four other securities 

(QQQQ, SMH, JDSU, and SIRI). 505See supra note 21 and accompanying text.

inaccurate and excessive. This estimate 

appears to assume that all trading 

activity would occur at these narrower 

quoted spreads. The Commission does 

not believe that these commenters 

provided any evidence to substantiate 

that assumption. Currently, no national 

securities exchange or national 

securities association permits quoting in 

sub-pennies; sub-penny quoting occurs 

on only a small number of ATSs. 

Therefore, because spreads on most 

markets already cannot be smaller than 

$0.01, these markets would not be 

required to take any action in response 

to reproposed Rule 612 that would 

cause their spreads to widen. Therefore, 

the cost to these markets of not having 

sub-penny spreads should not be 

considered costs of the reproposed rule. 

With respect to the ATSs that currently 

do permit some NMS stocks to be 

quoted in sub-pennies, the Commission 

staff performed a study of trade data in 

Nasdaq, NYSE, and Amex stocks to 

better consider commenters’ claims. 

Based on that study, the Commission 

staff estimates that the costs of widened 

spreads in these securities would be 

approximately $48 million annually (or 

approximately $33 million if the 

Commission were to exempt QQQQ 

from reproposed Rule 612).499

In this study, the Commission staff 

obtained public data from NYSE’s 

‘‘Trade and Quote’’ files for all NYSElisted and Amex-listed stocks and 

public data from the Nastraq trade file 

for Nasdaq-listed stocks, for the period 

June 7–10, 2004. Based on trading 

activity from the Nasdaq-listed 

securities, Commission staff estimated 

that 1.5% of all trades over $1.00 were 

reported in a sub-penny increment.500

These trades accounted for 4.7% of 

share volume. However, not all trades 

that were reported as having a subpenny price resulted from sub-penny 

quotations. Commission staff excluded 

VWAP trades which are marked as such 

in the Nastraq file.501 Based on this 

screened dataset, Commissions staff 

estimated that 1.4% of trades were 

reported in sub-penny increments 

accounting for 2.4% of share volume. 

Commission staff then calculated the 

dollar cost if all such trades executed at 

the near-side penny rather than at a subpenny amount. This price difference, 

multiplied by the executed volume, 

produces a dollar cost per trade.502

Summed across all sub-penny trades, 

the average daily cost for this sample 

was $80,973. At 252 trading days per 

year, this results in $20,400,235 on an 

annual basis.

Commission staff performed a similar 

analysis on the trade data for Amexlisted stocks, except that the data set did 

not permit VWAP trades to be 

excluded.503 On an annualized basis, 

Commission staff estimated that the 

gross cost resulting from slightly wider 

spreads would be $16 million (or only 

$1.2 million if QQQQ is excluded). 

Similarly, the Commission staff 

estimated that the gross costs from 

wider spreads would be approximately 

$12 million annually for NYSE-listed 

stocks.

Another potential cost of reproposed 

Rule 612 is that market participants that 

have developed systems that allow their 

users to quote in sub-pennies would, for 

most NMS stocks, lose the ability to gain 

any market advantage from such 

enhancements. In addition, any market 

participant that currently allows its 

users to display, rank, or accept orders 

or quotations in sub-pennies would 

incur costs in reprogramming its 

systems to prevent the entry of subpenny orders or quotations. The 

Commission preliminarily believes, 

however, that these costs would be 

negligible. Currently, the exchanges and 

Nasdaq do not permit sub-penny 

quoting; only two major ECNs permit 

sub-penny quoting, but only in a limited 

number of securities.504 These ECNs 

would have to take only minor steps to 

readjust their systems to comply with 

reproposed Rule 612. Finally, the 

Commission preliminarily believes that 

paragraph (b) of reproposed Rule 612, 

which would prohibit quotations below 

$1.00 from extending beyond four 

decimal places, would have negligible 

systems costs. The Commission 

currently is not aware of any market that 

quotes and trades NMS stocks in 

increments beyond four decimal places 

and preliminarily believes, therefore, 

that no market would incur systems 

costs to limit quotations below $1.00 to 

a maximum of four decimal places.

After carefully considering all the 

comments received, the Commission 

preliminarily believes that, on balance, 

the benefits of reproposed Rule 612 

would justify the costs. 

D. Market Data Rules and Plan 

Amendments 

The Commission is reproposing 

amendments to the rules relating to the 

dissemination of market information to 

the public. In particular, the 

Commission is reproposing 

amendments to the Plans 505 to modify 

the current formulas for allocating 

market data revenues to the SROs, and 

to require the establishment of nonvoting advisory committees comprised 

of interested parties other than SROs. In 

addition, the Commission is 

reproposing to rescind the current 

prohibition in Exchange Act Rule 

11Aa3–1 (proposed to be redesignated 

as Rule 601) on SROs and their 

members from independently 

distributing their own trade reports, and 

is reproposing an amendment to 

Exchange Act Rule 11Ac1–2 (proposed 

to be redesignated as Rule 603) to 

incorporate uniform standards pursuant 

to which they may independently 

distribute their own trade reports and 

quotations (outside of providing the 

requisite information to Plan 

processors). The Commission is further 

reproposing to amend Exchange Act 

Rule 11Ac1–2 (proposed to be 

redesignated as Rule 603) to make 

explicit that all SROs must act jointly 

through the Plans and through a single 

processor per security to disseminate 

consolidated market information in 

NMS stocks to the public. Finally, the 

Commission is reproposing 

amendments to Exchange Act Rule 

11Ac1–2 (proposed to be redesignated 

as Rule 603) to streamline and simplify 

the consolidated display requirements 

by reducing the data required to be 

displayed under the rule, and by 

limiting the range of the rule to the 

display of such data in trading and 

order-routing contexts.

1. Revenue Allocation Formula 

a. Benefits. The Commission 

preliminarily believes that the 

reproposed amendment to the Plans 

77486 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

506See Proposing Release, 69 FR at 11179–11180.

507See, e.g., BSE Letter at 16; CHX Letter at 19–

20; E*TRADE Letter at 11.

508See, e.g., Amex Letter at 11; ATD Letter at 4; 

Bloomberg Tradebook Letter at 7; BSE Letter at 15; 

ICI Letter at 21; Morgan Stanley Letter at 22; Nasdaq 

Letter II at 31; NYSE Letter, Attachment at 11–12; 

STA Letter at 7; UBS Letter 10; Vanguard Letter at 

6.

509See, e.g., Amex Letter at 11; ATD Letter at 4; 

Bloomberg Tradebook Letter at 7–8; Morgan Stanley 

Letter at 22–23; NYSE Letter, Attachment at 11; 

STA Letter at 7; Vanguard Letter at 6.

510See, e.g., ArcaEx Letter at 13; Brut Letter at 22; 

CHX Letter at 19; Instinet Letter at 41.

511See, e.g., Angel Letter I at 11; BSE Letter at 15, 

18; Brut Letter at 22–23; Callcott Letter at 4; CBOE 

Letter at 2, 9; Instinet Letter at 42; ISE Letter at 9; 

Nasdaq Letter II at 31; NSX Letter at 7; NYSE Letter, 

Attachment at 11; Phlx Letter at 3–4.

modifying the current formulas for 

allocating market data revenues would 

be beneficial to the marketplace because 

the new allocation formula would 

allocate revenues to markets based on 

the value of their quotations in addition 

to their trades. The current formulas 

allocate Plan revenues based solely on 

the number or share volume of an SRO’s 

reported trades, and do not allocate 

revenues to those market centers that 

generate quotations with the best prices 

and the largest sizes that are an 

important source of public price 

discovery. The new allocation formula 

also should help to reduce the economic 

and regulatory distortions caused by the 

current formulas, including wash sales, 

trade shredding, and SRO print 

facilities.506 Because the reproposed 

formula would address these distortive 

practices and would allocate revenues 

to those market centers that provide the 

most useful market information, the 

Commission preliminarily believes that 

the NMS would be benefited as a whole.

The reproposed new revenue 

allocation formula would encompass a 

two-step process. Under the proposed 

initial step, the ‘‘Security Income 

Allocation,’’ a Network’s distributable 

revenues would be allocated among the 

individual securities included in the 

Network’s data stream based on the 

square root of the dollar volume of 

trading in each security. Use of the 

square root function is appropriate to 

take into account the level of trading 

activity in each security, while adjusting 

for the disproportionate level of trading 

in the most active NMS stocks when 

distributing revenues among the various 

securities. 

Following this initial distribution of 

revenues, the next step in the process 

would be to allocate the revenues 

distributed to an individual security 

among the various SROs that trade the 

security based on each SRO’s trading 

and quoting activity. Specifically, under 

the reproposed ‘‘Trading Share’’

criterion, fifty percent of the revenues 

allocated to a particular security (subject 

to a $2 cap per qualified transaction 

report) would be allocated to SROs 

based on their proportion of the total 

dollar volume and number of qualified 

trades (transactions that have a dollar 

volume of $5,000 or greater) in that 

security. A few commenters stated that 

small trades (transactions that have a 

dollar value of less than $5000) should 

be entitled to partial credit under this 

criterion because these trades also 

contribute to public price discovery.507

The Commission acknowledges the 

benefits of small trades and has 

amended the original proposed new 

formula to provide for a proportional 

allocation of revenues for such trades. 

The reproposed Trading Share measure 

is intended to allocate revenue to those 

SROs that actively trade in the security, 

thereby providing liquidity and price 

discovery, while reducing the potential 

for the shredding of trade volume.

Under the reproposed ‘‘Quoting 

Share’’ criterion, fifty percent of the 

revenues allocated to a particular 

security under the Security Income 

Allocation measure would be allocated 

to SROs based on their proportion of 

credits earned for the time and size of 

their quotations at the NBBO in that 

security during regular trading hours. 

Many commenters agreed with the 

Commission that, if the Networks were 

to continue allocating revenues to the 

SROs, the current allocation formulas 

needed to be updated.508 In particular, 

some of these commenters noted the 

benefits of adding a quoting component 

to the new formula,509 especially if 

revenues are allocated only for 

automated and accessible quotations. 

Some commenters, however, were 

concerned that the inclusion of 

quotations in the proposed new 

allocation formula could lead new types 

of ‘‘gaming’’ of the formula, such as 

flashing quotations with no real 

intention to trade at those prices simply 

to earn more quote credits—and thereby 

more revenues—under the Quoting 

Share measure.510 The Commission 

preliminarily believes that the proposed 

requirement that quotations last at least 

one second to earn credits coupled with 

overall market discipline imposed by 

current order-routing practices 

discouraging ‘‘low-cost’’ quotations at 

the NBBO should minimize the 

potential for such gaming behavior. The 

Quoting Share criterion of the 

reproposed formula is intended to do 

what the current formulas do not—

allocate revenue to those markets whose 

quotations frequently equal the best 

prices and for the largest sizes.

The Commission received a number 

of comments regarding the potential 

cost and complexity of the proposed 

revenue allocation formula.511 The 

Commission notes that, consistent with 

the approach of the reproposed TradeThrough Rule and the reproposed 

Access Rule, it has determined to 

eliminate from the reproposed formula 

the most complex elements of the 

proposed allocation formula that were 

intended primarily to address the 

problem of manual quotation—the 

‘‘NBBO Improvement Share’’ criterion 

and the automatic cut-off for manual 

quotations left at the NBBO under the 

Quoting Share criterion. Because the 

revised formula would only allocate 

revenues for automated quotations, and 

manual quotations would be excluded 

from the any revenue allocation, the 

Commission believes that it is no longer 

necessary to include an NBBO 

Improvement Share criterion and 

automatic cut-off for manual quotations 

in the proposed new formula. As a 

result, the reproposed formula is 

substantially less complex than 

originally proposed.

In sum, the Commission preliminarily 

believes that the greatest benefit of 

allocating Plan revenues to the SROs 

based equally on the proposed Trading 

Share and Quoting Share measures is 

that such measures would allocate 

revenues to an SRO for its overall 

contribution of both quotations and 

trades, while reducing the incentive for 

distortive trade reporting practices 

caused by the current formulas. 

Investors would benefit from the 

proposed new formula because these 

broad-based measures would allocate 

revenues to those SROs that provide 

investors with the most useful market 

information, and thus that contribute to 

public price discovery, by allocating 

them a larger portion of Plan revenues. 

b. Costs. The Commission recognizes 

that the current allocation formulas 

have been used since the creation of the 

Plans and Networks in the 1970s, and 

that the SROs and the Network 

processors have become familiar with 

those formulas for purposes of 

allocating revenues and structuring their 

businesses. Because the reproposed new 

allocation formula is more detailed than 

the current formulas, the Network 

processors would have to learn the 

particular features of the new formula 

and would have to consider SRO 

quotations in addition to reported trades 

as a measure for allocating Plan 

revenues. Accordingly, the Network 

processors, or some other entity retained 

by the Networks, would be required to 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77487

512See, e.g., Brut Letter at 22; BSE Letter at 16; 

CHX Letter at 19, 21–22; E*TRADE Letter at 11; 

NSX Letter at 6–7.

513See, e.g., BSE Letter at 16; CHX Letter at 19, 

21–22; E*TRADE Letter at 11. The Commission is 

proposing a provision in the new formula that 

would provide a partial allocation of revenues for 

smaller trades that have a dollar value of less than 

$5,000. This provision should lessen impact of the 

modified formula on exchanges that handle small 

retail orders.

514See, e.g., Amex Letter, Exhibit A at 21–22; ISE 

Letter at 10; Reuters Letter at 3.

515Proposed Regulation NMS would remove the 

definitions in paragraph (a) of Exchange Act Rule 

11Aa3–1 (proposed to be redesignated as Rule 601) 

and place them in proposed Rule 600. 

Subparagraphs (c)(2) and (c)(3) of Exchange Act 

Rule 11Aa3–1 (proposed to be redesignated as Rule 

601) would be rescinded. As a result, subparagraph 

(c)(4) of Exchange Act Rule 11Aa3–1 would be 

redesignated as subparagraph (b)(2) of Rule 601.

develop a program to calculate the 

Trading Shares and Quoting Shares of 

the SRO participants. All of the data 

necessary for implementation of the 

formula would be disseminated through 

the consolidated data stream on a realtime basis. If a single entity were 

retained to handle the task for all three 

Networks, the Commission estimates 

that it would cost approximately $1 

million annually to make the requisite 

calculations under the proposed new 

formula and to disseminate the results 

to the SRO participants on a daily basis. 

This estimated cost of implementation 

and compliance represents only 1⁄4 of 

one percent of the total revenues 

collected and distributed through the 

Plans for 2003.

In addition, some SROs are likely to 

be allocated a smaller portion of Plan 

revenues under the reproposed new 

allocation formula than they would 

have received under the existing 

formulas, while other SROs would 

receive a larger portion of revenues. 

This would result if certain SROs are 

currently reporting a large number of 

trades or share volume of trades, but are 

not necessarily providing the best 

quotations or trades with larger sizes. A 

few commenters expressed concern that 

certain business models would be 

adversely impacted by the proposed 

new allocation formula,512 particularly 

for those markets that primarily handle 

small retail order flow.513 The 

Commission recognizes that reforming 

formulas that have remained unchanged 

for many years may affect the 

competitive position of various markets. 

Given the severe deficiencies of these 

formulas, however, it does not believe 

that the interests of any particular 

business model should preclude 

updating the formulas to reflect current 

market conditions. The reproposed 

formula is designed to reflect more 

appropriately the contributions of the 

various SROs to the consolidated data 

stream and thereby better align the 

interests of individual markets with the 

interests of investors. The Commission 

therefore preliminarily believes that the 

benefits of the proposed new allocation 

formula justify the costs of 

implementation.

2. Plan Governance 

a. Benefits. The Commission 

preliminarily believes that the 

reproposed amendment to the Plans 

requiring the creation of advisory 

committees would improve Plan 

governance. Under the Plans, a 

representative of each SRO participating 

in the Plan is a member of the operating 

committee that governs that Plan. The 

reproposed amendment to the Plans 

would require the establishment of nonvoting advisory committees comprised 

solely of persons not employed by or 

affiliated with an SRO participant. This 

reproposal is intended to broaden 

participation in the governance of the 

Plans. 

The proposed amendment would 

require the SRO participants to select 

the members of the advisory committee 

comprised, at a minimum, of one or 

more representatives associated with (1) 

A broker-dealer with a substantial retail 

investor base, (2) a broker-dealer with a 

substantial institutional investor 

customer base, (3) an ATS, (4) a data 

vendor, and (5) an investor. In addition, 

each SRO participant would be entitled 

to select an additional committee 

member. The Commission believes that 

the composition of the advisory 

committee would give interested parties 

other than the SROs a voice in matters 

that affect them. 

The members of the advisory 

committee would have the right to 

submit their views to the operating 

committee on Plan business (other than 

matters determined to be confidential by 

a majority of Plan participants), prior to 

any decision made by the operating 

committee, and would have the right to 

attend operating committee meetings. 

Broader participation in the Plans 

through the creation of Plan advisory 

committees would be beneficial to the 

administration of the Plans because it 

would provide transparency to the Plan 

governance process and could promote 

the formation of industry consensus on 

disputed issues. 

b. Costs. The reproposed amendment 

to the Plans requiring the formation of 

advisory committees could potentially 

result in costs to the SRO participants 

who would be required to engage in a 

selection process for purposes of 

establishing such committees. A Plan’s 

operating committee as a whole would 

be required to select a minimum of five 

committee members, while each SRO 

participant also would have the right to 

select an additional committee member. 

This selection process could potentially 

result in added costs and administrative 

burden and expense to the SRO 

participants. 

The reproposed Plan amendment also 

could potentially disrupt the current 

governance of the Plans by their 

participants. Since the creation of the 

Plans, representatives from the SROs 

have been the sole participants in the 

Plans and have been responsible for 

their administration. A few commenters 

believed that the additional 

participation of non-SRO parties could 

potentially increase the difficulty of 

reaching a consensus on Plan business, 

stating that too many members on an 

advisory committee could complicate 

and disrupt, rather than assist, Plan 

operations due to differing agendas.514

Although such a result may occur at 

times, the Commission preliminarily 

believes that this cost would be justified 

by the benefits that could be gained by 

increasing the transparency of Plan 

operations and giving parties other than 

SROs an opportunity to submit their 

views. In the past, the Plans may not 

have adequately considered the 

viewpoints of non-SRO parties on 

important issues such as fees and 

administrative burdens. Establishing 

advisory committees would address this 

problem and thereby potentially make 

the Plans more responsive to the needs 

of market participants and investors.

3. Proposed Amendments to Rules 

11Aa3–1 and 11Ac1–2 (Proposed to Be 

Redesignated as Rules 601 and 603) 

a. Independent Distribution of 

Information. 

i. Benefits. The Commission is 

reproposing an amendment to Exchange 

Act Rule 11Aa3–1 (proposed to be 

redesignated as Rule 601) that would 

rescind the prohibition on SROs and 

their members from disseminating their 

trade reports independently.515 Under 

the reproposed amendment to Exchange 

Act Rule 11Aa3–1 (proposed to be 

redesignated as Rule 601), members of 

an SRO would continue to be required 

to transmit their trades to the SRO (and 

SROs would continue to transmit trades 

to the Networks pursuant to the Plans), 

but such members also would be free to 

distribute their own data independently, 

with or without fees. The Commission 

preliminarily believes that 

independently distributed information 

could be beneficial to investors and 

other information users because depthVerDate jul<14>2003 16:34 Dec 23, 2004 Jkt 205001 PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 E:\FR\FM\27DEP2.SGM 27DEP2
77488 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

516 15 U.S.C. 78c and 15 U.S.C. 78k–1.

517Specialist Assoc. Letter at 16–17.

518The provisions proposed to be rescinded 

include requirements relating to moving tickers, 

categories of market information, and representative 

bids and offers.

of-book quotations have become 

increasingly important as decimal 

trading has spread displayed depth 

across a greater number of price points.

Reproposed Rule 603(a) would 

establish uniform standards for 

distribution of both quotations and 

trades. The reproposed standards would 

require an exclusive processor, or a 

broker or dealer with respect to 

information for which it is the exclusive 

source, that distributes quotation and 

transaction information in an NMS 

stock to a securities information 

processor (‘‘SIP’’) to do so on terms that 

are fair and reasonable. In addition, 

those SROs, brokers, or dealers that 

distribute such information to a SIP, 

broker, dealer, or other persons would 

be required to do so on terms that are 

not unreasonably discriminatory. 

Furthermore, these uniform standards 

would be based, in part, on similar 

requirements found in Sections 3 and 

11A of the Exchange Act 516 for SROs 

and entities that distribute SRO 

information on an exclusive basis. The 

Commission preliminarily believes that 

extending these requirements to nonSRO market centers, including ATSs 

and market makers, would help assure 

equal regulation of all markets that trade 

NMS stocks.

ii. Costs. The Commission recognizes 

that the rescission of the prohibition on 

independent distribution of trade 

reports under Rule 11Aa3–1 (proposed 

to be redesignated as Rule 601) could 

potentially lead to market centers 

incurring costs associated with the 

independent distribution of their market 

data if they choose to distribute such 

data without charging a fee. In addition, 

investors may have to pay for additional 

data if market centers choose to charge 

a fee for the additional data. 

Furthermore, a corollary to one 

commenter’s assertion that market 

centers could benefit from additional 

revenues if market centers choose to 

distribute their own quotation 

information 517 is that the data from one 

or more other market centers could 

potentially become more or less 

valuable than another market center’s 

data, and thereby increase or reduce that 

market center’s overall income. The 

Commission preliminarily does not 

believe that there will be any costs 

associated with the requirement to 

establish uniform standards for the 

distribution of trades and quotations 

pursuant to reproposed Rule 603(a), but 

requests comment on this issue.

b. Consolidation of Information. 

i. Benefits. All SROs currently 

participate in Plans that provide for the 

dissemination of consolidated 

information for the NMS stocks that 

they trade. Reproposed Rule 603(b) 

would confirm by Exchange Act rule 

that both existing and any new SROs 

would be required to continue to 

participate in joint-industry plans to 

disseminate consolidated information in 

NMS stocks to the public. This 

reproposed amendment would provide 

the benefit of clarifying that all SROs—

whether existing or new—would be 

required to participate jointly in one or 

more Plans to disseminate consolidated 

information in NMS stocks. The 

reproposed amendment also would 

require that all quotation and trade 

information for an individual NMS 

stock be disseminated through a single 

processor (currently, SIAC or Nasdaq). 

The Commission preliminarily believes 

that requiring a single processor for a 

particular security would help to ensure 

that investors continue to receive the 

benefits of obtaining consolidated 

information from a single source. 

ii. Costs. Given that consolidated 

market information currently is 

disseminated through a single processor 

per stock, the Commission does not 

foresee any new costs associated with 

reproposed Rule 603(b). 

c. Display of Consolidated 

Information. 

i. Benefits. Reproposed Rule 603(c) 

(currently Exchange Act Rule 11Ac1–2) 

would substantially revise the 

consolidated display requirement by 

limiting its scope. It would incorporate 

a new definition of ‘‘consolidated 

display’’ (set forth in reproposed Rule 

600(b)(13)) that is limited to the prices, 

sizes, and market center identifications 

of the NBBO, along with the 

‘‘consolidated last sale information’’

(which is defined in proposed Rule 

600(b)(14)). Beyond disclosure of this 

basic information, market forces, rather 

than regulatory requirements, would be 

allowed to determine what, if any, 

additional data from other market 

centers is displayed. In particular, 

investors and other information users 

ultimately would be able to decide 

whether they need additional 

information in their displays. 

Reproposed Rule 603(c) also would 

eliminate the burden on vendors and 

broker-dealers to display a complete 

montage of quotations from all market 

centers trading a particular security, 

which would include the price of 

quotations that may be far away from 

the current NBBO. Furthermore, 

vendors and broker-dealers would have 

the ability to decide what, if any, 

additional data from other market 

centers beyond this basic disclosure to 

display. Vendors, broker-dealers, and 

investors would benefit from this 

reduced consolidated display 

requirement through a more efficient 

use of system capacity and because the 

costs of obtaining necessary data could 

be lowered. The Commission believes 

that giving investors the ability to 

choose (and pay for) only the data they 

need and use would be beneficial. 

Reproposed Rule 603(c) would 

narrow the contexts in which a 

consolidated display is required to those 

when it is most needed—a context in 

which a trading or order-routing 

decision could be implemented. For 

example, the consolidated display 

requirement would continue to cover 

broker-dealers who provide on-line data 

to their customers in software programs 

from which trading decisions can be 

implemented. Similarly, the 

requirement would continue to apply to 

vendors who provide displays that 

facilitate order routing by brokerdealers. It would not apply, however, 

when market data is provided on a 

purely informational website that does 

not offer any trading or order-routing 

capability. Reproposed Rule 603(c) also 

would simplify the rule language to 

require that consolidated data be made 

available in an equivalent manner as 

other data and would rescind 

unnecessary provisions in order to 

update the Rule.518 Reproposed Rule 

603(c) should benefit broker-dealers and 

vendors by making compliance with the 

reproposed Rule’s more tailored 

requirements easier and more efficient.

ii. Costs. A potential cost attributable 

to reproposed Rule 603(c) could be that 

there currently may be individuals who 

use the displayed montage of quotations 

from all market centers trading a 

particular security. If vendors and 

broker-dealers determined not to 

display this additional information, 

these investors would be required to 

obtain the additional data at additional 

cost. Reproposed Rule 603(c) also could 

potentially result in an administrative 

cost or burden for vendors and brokerdealers that would be required to assess 

in what circumstances they are 

displaying market data information for 

trading and order-routing purposes and 

in what circumstances they are 

displaying such information for other 

purposes. The Commission 

preliminarily believes that such a cost 

would be minimal. 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77489

519 15 U.S.C. 78k–1.

520 15 U.S.C. 78c(f).

521 15 U.S.C. 78w(a).

522 15 U.S.C. 78w(a)(2).

523Many commenters believed that an opt-out 

exception was necessary to promote competition 

among trading centers, particularly competition 

based on factors other than price, such as speed of 

response. See supra Section II.A.4.a.

E. Regulation NMS 

The Commission is reproposing to 

redesignate the current NMS rules 

adopted under Section 11A of the 

Exchange Act 519 as Regulation NMS, 

make non-substantive conforming 

changes to various rules, and create a 

separate definitional rule, Rule 600, 

which would contain all of the defined 

terms used in Regulation NMS. 

Currently, each NMS rule includes its 

own set of definitions, and some 

identical terms, such as ‘‘covered 

security,’’ ‘‘reported security,’’ and 

‘‘subject security,’’ are defined 

inconsistently. Although reproposed 

Rule 600 would retain, unchanged, most 

of the definitions used in the existing 

NMS rules, it would delete or revise 

obsolete definitions and eliminate the 

use of inconsistent definitions for 

identical terms. Reproposed Rule 600 

would not alter the requirements or 

operation of the existing NMS rules.

1. Benefits 

The Commission believes that 

reproposed Rule 600 and the related 

proposed amendments to various rules 

would benefit all entities that are and 

would be subject to the requirements of 

the rules contained in Regulation NMS, 

including broker-dealers, national 

securities exchanges, the NASD, ECNs, 

SIPS, and vendors. By eliminating or 

revising obsolete and inconsistent 

definitions and adopting a single set of 

definitions that would be used 

throughout Regulation NMS, reproposed 

Rule 600 should make Regulation NMS 

clearer and easier to understand, 

thereby facilitating compliance with its 

requirements and potentially easing the 

compliance burden on entities subject to 

Regulation NMS. Increased compliance 

with Regulation NMS would, in turn, 

benefit investors and the public interest. 

Similarly, the related non-substantive 

amendments to various rules would 

ensure that those rules use the 

definitions provided in reproposed Rule 

600 and refer accurately to the 

redesignated NMS rules. 

2. Costs 

Reproposed Rule 600 would update 

and clarify the definitions used in 

existing NMS rules. Neither reproposed 

Rule 600 nor the related conforming 

proposed amendments to various rules 

would alter the existing requirements of 

the NMS rules or other Commission 

rules. Accordingly, the Commission 

believes that reproposed Rule 600 and 

the related amendments would impose 

few additional costs on entities subject 

to Regulation NMS. Although some 

additional personnel costs may be 

incurred in reviewing the changes, the 

Commission believes that these costs 

would be minimal.

X. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition, and Capital 

Formation 

Section 3(f) of the Exchange Act 520

requires the Commission, when 

engaging in rulemaking that requires the 

Commission to consider or determine 

whether an action is necessary or 

appropriate in the public interest, to 

consider whether the action will 

promote efficiency, competition and 

capital formation. Section 23(a) of the 

Exchange Act 521 requires the 

Commission to consider whether the 

action will promote efficiency, 

competition and capital formation. 

Section 23(a)(2) prohibits the 

Commission from adopting any rule that 

would impose a burden on competition 

not necessary or appropriate in 

furtherance of the purposes of the 

Exchange Act.522 To assist the 

Commission in evaluating the costs and 

benefits of Regulation NMS, the 

Commission solicited comment in the 

Proposing Release on whether any of the 

proposals discussed therein would have 

an adverse effect on competition that is 

neither necessary nor appropriate in 

furtherance of the purposes of the 

Exchange Act, and whether they would, 

if adopted, promote efficiency, 

competition and capital formation. The 

Commission also requested commenters 

to provide empirical data and other 

factual support for their views on these 

subjects. The Commission has 

considered comments received and has 

reproposed these rules, taking into 

account these comments. The 

Commission requests comment on these 

issues in the context of the reproposed 

rules.

A. Trade-Through Rule 

The Commission preliminarily 

believes that the price protection that 

would be provided by the reproposed 

Trade-Through Rule would encourage 

the use of limit orders and aggressive 

quoting, which should help improve the 

price discovery process, and contribute 

to increased liquidity and depth in the 

markets. The greater the number of limit 

orders available at better prices and 

greater size, the more liquidity available 

to fill incoming marketable orders. 

Thus, greater depth and liquidity should 

lead to improved execution quality, 

particularly for larger-sized institutional 

orders. The Commission also 

preliminarily believes that the 

reproposed Trade-Through Rule, by 

providing intermarket price protection 

for accessible, automated orders and not 

requiring automated markets to wait for 

responses from non-automated markets, 

would help promote efficiency in the 

markets by more effectively linking 

markets together and integrating trading 

centers with different market structures 

into the NMS, and by providing an 

incentive for non-automated markets to 

automate. Reproposed Rule 611 also 

should promote investor confidence in 

the markets by helping to ensure that 

customer orders are executed at the best 

price available and providing protection 

against limit orders being bypassed by 

inferior priced executions. Comment is 

requested on whether extending tradethrough protection to DOB quotations 

would significantly increase the benefits 

of the reproposed Trade-Through Rule. 

Would protecting quotations at multiple 

price levels further encourage the 

display of limit orders and thereby 

significantly enhance depth and 

liquidity in the NMS? 

The Commission recognizes the vital 

importance of preserving competition 

among market centers,523 and 

preliminarily believes that reproposed 

Rule 611 would promote intermarket 

competition by leveling the playing 

field between automated and nonautomated markets and, to the extent 

that the existing trade-through rule 

serves to constrain competition, by 

removing this barrier to competition. In 

addition, the Commission preliminarily 

believes that market participants and 

intermediaries, consistent with their 

desire to achieve the best price and their 

duty of best execution, would continue 

to rank trading centers according to the 

total range of services provided by such 

markets. The most competitive—i.e.

attractive—trading center would be the 

first choice for routing marketable 

orders, thereby enhancing the likelihood 

of execution for limit orders routed to 

that trading center. Because likelihood 

of execution is very important to limit 

orders, routers of limit orders likely 

would be attracted to this preferred 

trading center. More limit orders would 

enhance the depth and liquidity at the 

preferred trading center, thereby 

increasing its attractiveness for 

marketable orders, and beginning the 

cycle over again.

77490 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

524Bear Stearns Letter at 2.

525 Goldman Sachs Letter at 6.

526See, e.g., Amex Letter, Exhibit A at 23–24; 

Bloomberg Summary of Intended Testimony at 3; 

BrokerageAmerica Letter at 1; Brut Letter at 14; 

CHX Letter at 15; Domestic Securities Summary of 

Intended Testimony; Instinet Letter at 28, 33–34; 

TrackECN Letter at 3.

527Section 11A(c)(1)(F) of the Exchange Act.

528Cf. Instinet Letter at 35 (‘‘there is no basis for 

adopting any limitation other than at the prevailing 

$0.003 per share level, which was arrived at 

through open competition among ATSs, ECNs, and 

SRO markets in the Nasdaq market’’).

Trading centers that offer poor 

services, such as slow response times, 

would likely rank near the bottom in 

order-routing preferences of market 

participants and intermediaries. 

Whenever a least-preferred trading 

center is merely posting the same price 

as other trading centers, orders would 

be routed to the other, more preferred, 

trading centers. Competitive forces 

would continue to dictate that the 

lowest ranked trading center in orderrouting preference would suffer from 

offering a poor range of services to the 

routers of marketable orders. The 

Commission therefore preliminarily 

does not believe that reproposed Rule 

611 would eliminate competition among 

markets. 

The Commission requests comment 

on the effect that adoption of the 

Voluntary Depth Alternative would 

have on competition among markets. 

One commenter, for example, suggested 

that protection of DOB quotations might 

cause increased fragmentation of 

liquidity across different markets 

because limit orders, no matter where 

displayed, would have price 

protection.524 Another commenter, in 

contrast, asserted that protecting only 

BBOs would lead to greater 

fragmentation because limit orders 

would be routed to any market where 

they would set or equal the BBO and 

thereby obtain trade-through 

protection.525 Comment is requested on 

the fragmentation issue, as well as in 

general on whether protecting DOB 

quotations would inappropriately limit 

the terms of market competition so as to 

harm investors and the efficiency of the 

NMS. For example, would adoption of 

the Voluntary Depth Alternative 

inappropriately reduce the scope of 

competition among markets to the 

payment of liquidity rebates for 

executed limit orders? Comment also is 

requested on whether adoption of the 

Voluntary Depth Alternative would 

generate forces that would lead to a 

monopolization of trading in a single 

trading facility.

The end result should be an NMS that 

more fully meets the needs of a wide 

spectrum of investors, particularly longterm investors and publicly traded 

companies, by providing increased 

efficiency and improved depth and 

liquidity to our capital markets. By 

providing increased efficiency and 

promoting investor confidence in 

quality executions, investors may be 

more willing to invest in our capital 

markets, thus promoting the ability of 

listed companies to raise capital at 

lower cost. 

B. Access Rule 

Reproposed Rule 610 would establish 

standards governing access to 

quotations in NMS stocks that (1) 

prohibit trading centers from unfairly 

discriminating against non-members 

members or non-subscribers that 

attempt to access quotations through a 

member or subscriber of the trading 

center, and enable access to NMS 

quotations through private linkages, (2) 

establish an outer limit on the cost of 

accessing such quotations of no more 

than $0.003 per share, and (3) require 

SROs to establish and enforce rules that, 

among other things, prohibit their 

members from engaging in a pattern or 

practice of displaying quotations that 

lock or cross the automated quotations 

of other trading centers. The reproposed 

amendment to Rule 301(b)(5) under 

Regulation ATS would lower the 

threshold that triggers the Regulation 

ATS fair access requirements from 20% 

to 5% of average daily volume in a 

security. 

The reproposed access provisions are 

intended to bolster investor confidence 

in the markets by helping to ensure 

investors that their orders will be 

executed at the best prices and will not 

subject to hidden fees, regardless of the 

market on which the execution takes 

place. By generally imposing a uniform 

fee limitation of $0.003 per share, the 

proposed rules would promote equal 

regulation of different types of trading 

centers, where currently some are 

permitted to charge fees and some are 

not, thereby leveling the playing field 

among diverse market centers. 

Moreover, the Commission 

preliminarily believes that, by 

prohibiting a trading center from 

imposing unfairly discriminatory terms 

that would prevent or inhibit the 

efficient access of any person through 

members, subscribers, or customers of 

such trading center, the reproposed rule 

would promote competition among 

trading centers. 

The Commission preliminarily 

believes that reproposed Rule 610 also 

would increase transparency and 

efficiency in the market, thereby 

enhancing investor confidence, and thus 

capital formation. Specifically, the 

reproposed Rule would permit private 

linkages between markets, rather than 

mandating a collective intermarket 

linkage facility. Private linkages would 

permit market centers to connect 

through cost effective and 

technologically advanced 

communications networks. Such 

systems are widely utilized in the 

market for Nasdaq stocks today and 

should provide speed and flexibility to 

trading centers and their market 

participants. The use of private linkages 

should encourage interaction between 

the markets and reduce fragmentation 

by removing impediments to the 

execution of orders between and among 

marketplaces, thereby increasing 

efficiency and competition. 

Several commenters expressed 

concerns regarding the impact that the 

access fee proposal could have on 

competition.526 As discussed in detail 

in Section III, the Commission 

preliminarily believes that the flat 

limitation on access fees of $0.003 per 

share would be the fairest and most 

appropriate solution to what has been a 

longstanding and contentious issue. A 

single accumulated fee cap would apply 

equally to all types of trading centers 

and all types of market participants, 

thereby promoting the NMS objective of 

equal regulation of markets and brokerdealers.527 The $0.003 fee limitation 

would be consistent with current 

business practices, as very few trading 

centers charge fees that exceed this 

amount.528 In addition, a fee limitation 

is necessary to preclude individual 

trading centers from raising their fees 

substantially in an attempt to take 

improper advantage of strengthened 

protection against trade-throughs and 

the adoption of a private linkage regime.

In addition, the reproposed rule is 

designed to reduce the instances of 

locked and crossed quotations, which 

should promote capital formation by 

providing market participants a clear 

picture of the true trading interest in a 

stock. Moreover, the Commission 

preliminarily believes that the 

reproposed access provisions would 

encourage interaction between the 

markets and reduce fragmentation by 

removing impediments to the execution 

of orders between and among 

marketplaces, thereby increasing 

efficiency and competition. Finally, the 

Commission preliminarily believes that 

the reproposed access rule would assist 

broker-dealers in evaluating and 

complying with their best execution 

obligations. 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77491

529See, e.g., Instinet Letter at 47; Mercatus Center 

Letter at 9–10; Tower Research Letter at 8–11.

C. Sub-Penny Rule 

The Commission has considered 

reproposed Rule 612 in light of Sections 

3(f) and 23(a)(2) of the Exchange Act 

and preliminarily believes that the rule 

would not impose a burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. To the 

contrary, by preserving the benefits of 

decimalization and guarding against the 

less desirable effects of further reducing 

the MPV, reproposed Rule 612 should 

promote fair and vigorous competition. 

The Commission acknowledges that the 

Rule would, in some circumstances, 

prevent market participants from 

offering marginally better prices. Some 

commenters argued that a prohibition 

on quoting in sub-pennies, at least in 

some NMS stocks, would inhibit price 

competition and artificially widen 

spreads.529 Nevertheless, the 

Commission is concerned that subpenny quoting may be used by market 

participants more as a means of 

stepping ahead of competing limit 

orders for an economically insignificant 

amount than of promoting genuine price 

competition.

The Commission preliminarily 

believes that the reproposed Rule would 

assist broker-dealers in evaluating and 

complying with their best execution 

obligations, as well as other rules 

premised on identifying the price of a 

security at a particular moment in time. 

The Commission also preliminarily 

believes that the reproposed Rule would 

enhance depth and transparency by 

preventing trading interest from being 

spread across an increasing number of 

price points. It also would prevent 

market participants from gaining 

priority over a standing limit order 

without making an economically 

significant contribution to the price of a 

security. In these respects, the 

reproposed Rule would encourage 

market participants to use limit orders, 

an important source of liquidity. 

Accordingly, the reproposed Rule may 

promote market efficiency, competition, 

and capital formation. In addition, the 

reproposed Rule also would bolster 

investor confidence by ensuring that 

their orders, especially large orders, can 

be executed without incurring large 

transaction costs. This increase in 

investor confidence should also 

promote market efficiency, competition, 

and capital formation. 

The Commission believes that the 

reproposed Rule would establish 

common quoting conventions that 

would increase transparency in the 

markets. Moreover, the Commission 

preliminarily believes that the 

reproposed Rule would encourage 

interaction between the markets and 

reduce fragmentation by removing 

impediments to the execution of orders 

between and among markets. The 

increased transparency in the markets 

and reduction of fragmentation between 

the markets may bolster investor 

confidence, thereby promoting capital 

formation. 

D. Market Data Rules and Plan 

Amendments 

The Commission preliminarily 

believes that the reproposed Plan 

amendment modifying the current 

revenue allocation formulas would 

promote efficiency and competition in 

the marketplace by eliminating 

incentives for market participants to 

engage in distortive trading practices 

such as wash trades, trade shredding, 

and SRO print facilities to obtain market 

data revenues. Similarly, the 

Commission preliminarily believes that 

the reproposed Plan amendment 

requiring the creation of non-voting 

advisory committees would promote 

efficiency in the administration of the 

Plans by allowing interested parties 

other than SROs to have a voice in Plan 

matters, which could, in turn, 

contribute to the resolution of potential 

disputes that SRO participants would 

otherwise bring before the Commission 

or to the courts. Furthermore, 

reproposed amendments to Rule 11Ac1–

2 (proposed to be redesignated as Rule 

603) should promote efficiency and 

competition among market centers by 

helping to assure that independently 

reported trade and quotation 

information is distributed on terms that 

are fair and reasonable and not 

unreasonably discriminatory. 

Reproposed Rule 603(a) would allow 

investors and vendors greater freedom 

to make their own decisions regarding 

the data they need and thus the 

proposal should lead to lower costs to 

investors. Broker-dealers who do not 

need the data beyond the prices, sizes, 

market center identifications of the 

NBBO and consolidated last sale 

information would not required to 

receive (and pay for) such data, thereby 

promoting efficiency. Reproposed Rule 

603(b) also should promote efficiency in 

the dissemination of consolidated 

market information by requiring that all 

SROs act jointly through the Plans to 

disseminate such information to the 

public.

The Commission preliminarily 

believes that the proposed Plan 

amendments would assist in capital 

formation through a more appropriate 

allocation of the Networks’ revenues to 

those SROs that contribute most to 

public price discovery, and by 

potentially minimizing costs that may 

arise from having to resolve disputes 

relating to the administration of the 

Plans through broader representation. 

Reproposed Rule 603(c) also would 

eliminate the requirement to display a 

complete montage of quotations from all 

market centers and should therefore 

promote capital formation by reducing 

the costs to vendors and broker-dealers 

that are currently required to display 

quotations that may be far away from 

the NBBO. 

The Commission further preliminarily 

believes that the reproposed 

amendments to the Plans and to Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) 

would not impose any competitive 

burden that is not necessary and 

appropriate in furtherance of the 

purposes of the Exchange Act. Although 

modifying the allocation formula could 

shift revenues among the SRO 

participants in the Plans, the formula 

would allocate revenue to those SROs 

that contribute useful information to the 

consolidated data stream and thereby 

would promote competition on terms 

that will benefit investors. The 

Commission also preliminarily believes 

that the reproposed Plan amendment 

requiring the Plans to form non-voting 

advisory committees should enhance 

and promote competition by broadening 

Plan governance to include non-SRO 

parties, and thereby provide greater 

transparency in the administration of 

such Plans. Furthermore, the 

reproposed amendments to Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) 

should lessen the burden on vendors 

and broker-dealers from having to 

comply with certain consolidated 

display requirements. Competition 

among markets also would be enhanced 

by enabling markets to independently 

distribute their own market data. In 

sum, the Commission preliminarily 

believes that the proposed amendments 

would enhance rather than burden 

competition. 

E. Regulation NMS 

Reproposed Rule 600, the 

redesignation of the existing NMS rules 

as Regulation NMS, and the related 

proposed conforming changes to other 

Commission rules should help to 

promote efficiency and capital 

formation by making the NMS rules 

easier to understand, thereby helping to 

reduce compliance costs for entities 

subject to the rules. Enhanced clarity in 

the definitions used in Regulation NMS 

77492 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

530Pub. L. No. 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601).

531Proposing Release, 69 FR at 11151, 11162, 

11174, 11189–90, 11198.

532 5 U.S.C. 603(a).

533 5 U.S.C. 603(b).

534The Commission included an IRFA in the 

Proposing Release for proposed Rule 611. Proposing 

Release, 69 FR at 11151–53. The certificate 

contained herein is based on a further refinement 

of the number of entities that would be subject to 

reproposed Rule 611 and the impact of the 

reproposed Rule.

535A trading center would be defined as a 

national securities exchange or national securities 

association that operates an SRO trading facility, an 

alternative trading system, an exchange market 

maker, an OTC market maker, or any other broker 

or dealer that executes orders internally by trading 

as principal or crossing orders as agent.

536An intermarket sweep order would be defined 

in Rule 600(b)(30) as a limit order that meets the 

following requirements: (1) The limit order is 

identified as an intermarket sweep order when 

routed to a trading center, and (2) simultaneously 

with the routing of the limit order, one or more 

additional orders are routed to execute against all 

better-priced protected quotations displayed by 

other trading centers up to their displayed size. 

These additional orders must be marked to inform 

the receiving trading center that they are associated 

with an intermarket sweep order. Paragraph (c)(5) 

of reproposed Rule 611 would allow a trading 

center to execute immediately any order identified 

as an intermarket sweep order, without regard for 

better-priced protected quotations displayed at one 

or more other trading centers. Similarly, paragraph 

(c)(6) of reproposed Rule 611 would authorize a 

trading center itself to route intermarket sweep 

orders and thereby enable immediate execution of 

a transaction at a price inferior to a protected 

quotation at another trading center.

537See 17 CFR 240.0–10(e) and 13 CFR 121.201.

538See supra note 426.

539Pursuant to Rule 0–10(c) under the Exchange 

Act, 17 CFR 240.0–10(c), a broker-dealer is defined 

as a small entity for purposes of the Exchange Act 

and the Regulatory Flexibility Act if the brokerdealer had a total capital (net worth plus 

subordinated liabilities) of less than $500,000 on 

the date in the prior fiscal year as of which its 

audited financial statements were prepared, and it 

is not affiliated with any person (other than a 

natural person) that is not a small entity.

540 Id.

also should benefit investors and the 

public interest by facilitating 

compliance with the requirements of 

reproposed Regulation NMS. Because 

Rule 600 would clarify the existing 

definitions used in Regulation NMS 

without imposing new requirements, 

and because the redesignation of the 

NMS rules as Regulation NMS and the 

conforming changes to other 

Commission rules would create no new 

substantive requirements, Rule 600 and 

the related changes should not impose 

a burden on competition or alter the 

competitive standing of entities subject 

to Regulation NMS. 

XI. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 530 the Commission 

must advise the Office of Management 

and Budget as to whether the proposed 

regulation constitutes a ‘‘major’’ rule. 

Under SBREFA, a rule is considered 

‘‘major’’ where, if adopted, it results or 

is likely to result in:

• An annual effect on the economy of 

$100 million or more (either in the form 

of an increase or a decrease); 

• A major increase in costs or prices 

for consumers or individual industries; 

or 

• A significant adverse effect on 

competition, investment, or innovation. 

If a rule is ‘‘major,’’ its effectiveness 

will generally be delayed for 60 days 

pending Congressional review. The 

Commission requested comment in the 

Proposing Release on the potential 

impact of the proposed regulation on 

the economy on an annual basis, 

including a request for commenters to 

provide empirical data and other factual 

support for their view to the extent 

possible.531 The Commission did not 

receive any comments specific to the 

potential impact of the proposed rules 

on the economy on an annual basis. The 

Commission renews its request for 

comment contained in the Proposing 

Release.

XII. Regulatory Flexibility Act 

Section 3(a) of the Regulatory 

Flexibility Act 532 requires the 

Commission to undertake an Initial 

Regulatory Flexibility Analysis 

(‘‘IRFA’’) of the proposed rules and 

amendments on small entities unless 

the Commission certifies that the 

proposed rules and amendments, if 

adopted, would not have a significant 

economic impact on a substantial 

number of small entities.

A. Trade-Through Rule 

The Commission hereby certifies, 

pursuant to Section 603(b) of the 

Regulatory Flexibility Act,533 that 

reproposed Rule 611 would not have a 

significant economic impact on a 

substantial number of small entities.534

Reproposed Rule 611 would require any 

trading center 535 to establish, maintain, 

and enforce written policies and 

procedures reasonably designed to 

prevent trade-throughs of protected 

quotations in NMS stocks that do not 

fall within an exception to the 

reproposed Rule, and, if relying on such 

an exception, that are reasonably 

designed to assure compliance with the 

terms of the exception. Further, trading 

centers would be required to regularly 

surveil to ascertain the effectiveness of 

such policies and procedures and to 

take prompt remedial action to remedy 

deficiencies in such policies and 

procedures. Thus, only those entities 

that fall within the definition of trading 

center would be subject to the 

reproposed Rule. In addition, brokersdealers that would not be included 

within the definition of trading center 

but that employ their own order smartrouting systems to route orders to 

multiple trading centers may choose to 

(but would not be required to) use the 

intermarket sweep order functionality of 

the proposed intermarket sweep 

exception.536 In addition, vendors that 

would not be subject to reproposed Rule 

611 may need to make system 

modifications to support the operation 

of the reproposed Rule.

The current national securities 

exchanges and one national securities 

association that would be subject to the 

proposed Rule are not considered 

‘‘small entities’’ for purposes of the 

Regulatory Flexibility Act.537 The 

remaining trading centers that would be 

subject to reproposed Rule 611 are 

registered broker-dealers. The 

Commission has preliminarily 

determined that approximately 600 

broker-dealers registered with the 

Commission,538 which includes brokerdealers operating as equity ATSs, 

broker-dealers registered as market 

makers or specialists in NMS stocks, 

and any broker-dealer that is in the 

business of executing orders internally 

in NMS stocks, would be subject to 

reproposed Rule 611. Of these 600 

broker-dealers, only two are considered 

small for purposes of the Regulatory 

Flexibility Act pursuant to the standards 

of Rule 0–10(c) under the Exchange 

Act.539

With respect to non-trading center 

broker-dealers that employ their own 

smart-order routing technology and that 

would choose to route orders in 

compliance with the proposed 

intermarket sweep exception (and thus 

would need to make necessary 

modifications to their order routing 

practices and proprietary order routing 

systems), the Commission preliminarily 

does not believe that this category of 

broker-dealers would be very large, and 

also preliminarily does not believe that 

any such broker-dealer that would 

employ its own order routing systems 

would be considered small, given the 

cost of operating such proprietary 

systems.540 The Commission also 

believes it likely that, given the nature 

of their business, most if not all of these 

non-trading center broker-dealers that 

employ their own order-routing 

technology already have systems in 

place that monitor best-priced 

quotations across markets, and thus 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77493

541A vendor is defined as any securities 

information processor engaged in the business of 

disseminating transaction reports or last sale data 

with respect to transactions in reported securities 

to brokers, dealers or investors on a real-time or 

other current and continuing basis, whether 

through an ECN, moving ticker or interrogation 

device. See 17 CFR 11Aa3–1(a)(11). Rule 0–10(g) 

states that the term ‘‘small business’’ or ‘‘small 

organization,’’ when referring to a securities 

information processor, means any securities 

information processor that: (1) Had gross revenues 

of less than $10 million during the preceding fiscal 

year (or in the time it has been in business, if 

shorter); (2) provided service to fewer than 100 

interrogation devices or moving tickers at all times 

during the preceding fiscal year (or in the time that 

it has been in business, if shorter); and (3) is not 

affiliated with any person (other than a natural 

person) that is not a small business or small 

organization under this section. 17 CFR 240.0–

10(g). The Commission estimates that there are 

approximately 80 vendors, only 16 of which are 

considered small entities.

542 5 U.S.C. 603(b).

543The Commission included an IRFA for the 

access proposal in the Proposing Release. Proposing 

Release, 69 FR at 11162–63. The certification 

contained herein is based on a further refinement 

of the entities that would be subject to reproposed 

access requirements and the impact of the proposed 

rules.

544A trading center would be defined as a 

national securities exchange or national securities 

association that operates an SRO trading facility, an 

alternative trading system, an exchange market 

maker, an OTC market maker, or any other broker 

or dealer that executes orders internally by trading 

as principal or crossing orders as agent.

545See 17 CFR 240.0–10(e) and 13 CFR 121.201.

546See supra note 426.

547See supra note 539. 548Proposing Release, 69 FR at 11174–75.

preliminarily does not believe that the 

changes necessary to implement the 

intermarket sweep order would be 

significant. With respect to any vendor 

that may determine to make systems 

modifications to support the operation 

of reproposed Rule 611, only 16 of the 

approximately 80 existing vendors are 

considered small.541 Accordingly, the 

Commission does not believe that 

reproposed Rule 611 would have a 

significant economic impact on a 

substantial number of small entities.

The Commission encourages written 

comments regarding this certification. 

The Commission requests that 

commenters describe the nature of any 

impact on small entities and provide 

empirical data to support the extent of 

the impact. In particular, the 

Commission requests comment on (a) 

the number of small entities that would 

be affected by reproposed Rule 611; (b) 

the nature of any impact reproposed 

Rule 611 would have on small entities 

and empirical data supporting the 

extent of the impact; and (c) how to 

quantify the number of small entities 

that would be affected by or how to 

quantify the impact of reproposed Rule 

611. 

B. Access Rule 

The Commission hereby certifies, 

pursuant to Section 603(b) of the 

Regulatory Flexibility Act,542 that 

reproposed Rule 610 and the reproposed 

amendments to Rule 301 of Regulation 

ATS would not have a significant 

economic impact on a substantial 

number of small entities.543 Reproposed 

Rule 610 would prohibit any trading 

center 544 from imposing unfairly 

discriminatory terms that would prevent 

or inhibit the access of any person 

through members, subscribers, or 

customers of such trading center. 

Further, the reproposed Rule would 

restrict access fees imposed by trading 

centers to a maximum of $0.003 per 

share. Finally, reproposed Rule 610 

would require national securities 

exchanges and national securities 

associations to establish and enforce 

rules that, among other things, prohibit 

their members from engaging in a 

pattern or practice of displaying 

quotations that lock or cross the 

automated quotations of other trading 

centers. Thus, reproposed Rule 610 

would impact only those entities that 

fall within the definition of trading 

center. The reproposed access 

provisions also would lower the 

threshold that triggers the fair access 

requirements in Rule 301 of Regulation 

ATS from 20% to 5% of average daily 

volume in a security. This amendment 

would potentially impact the existing 

operating ATSs.

The current national securities 

exchanges and national securities 

association that would be subject to the 

reproposed Rule are not considered 

‘‘small entities’’ for purposes of the 

Regulatory Flexibility Act.545 The 

remaining entities that would be subject 

to reproposed Rule 610 and the 

reproposed amendments to Rule 301 of 

Regulation ATS are registered brokerdealers. The Commission has 

preliminarily determined that 

approximately 600 broker-dealers 

registered with the Commission,546

which includes broker-dealers operating 

as equity ATSs, broker-dealers 

registered as market makers or 

specialists in NMS stocks, and any other 

broker-dealer that is in the business of 

executing orders internally, would be 

subject to Rule 610. In addition, the 

existing operating ATSs (which are or 

are operated by registered brokerdealers) potentially could be subject to 

the reproposed amendment to Rule 301 

of Regulation ATS. Of these brokerdealers, only two are considered small 

for purposes of the Regulatory 

Flexibility Act pursuant to the standards 

of Rule 0–10(c) under the Exchange 

Act.547 Accordingly, the Commission 

preliminarily does not believe that 

reproposed Rule 610 and the reproposed 

amendments to Rule 301 of Regulation 

ATS would have a significant economic 

impact on a substantial number of small 

entities.

The Commission encourages written 

comments regarding this certification. 

The Commission requests that 

commenters describe the nature of any 

impact on small entities and provide 

empirical data to support the extent of 

the impact. In particular, the 

Commission requests comment on (a) 

the number of small entities that would 

be affected by reproposed Rule 610 and 

the reproposed amendment to Rule 301 

of Regulation ATS; (b) the nature of any 

impact reproposed Rule 610 and the 

reproposed amendment to Rule 301 of 

Regulation ATS would have on small 

entities and empirical data supporting 

the extent of the impact; and (c) how to 

quantify the number of small entities 

that would be affected by or how to 

quantify the impact of reproposed Rule 

610 and the reproposed amendment to 

Rule 301 of Regulation ATS. 

C. Sub-Penny Rule 

This IRFA relating to reproposed Rule 

612 has been prepared in accordance 

with 5 U.S.C. 603. This IRFA is 

substantially the same as the one 

contained in the Proposing Release.548

The Commission did not receive any 

comment on the IRFA contained in the 

Proposing Release.

1. Reasons for the Proposed Action 

The Commission is concerned that, 

while the conversion from fractions to 

decimals benefited investors by 

clarifying and simplifying pricing for 

investors, making our markets more 

competitive internationally, and 

reducing trading costs by narrowing 

spreads, these benefits could be 

sacrificed by decreasing the MPV from 

a penny to pricing increments finer than 

a penny. The Commission is 

particularly concerned that sub-penny 

orders can be used to step ahead of 

competing limit orders for an 

economically insignificant amount. 

The Commission believes that this 

would be an opportune time to address 

these issues by proposing a uniform 

standard of quoting in NMS stocks. The 

Commission is thus proposing to 

prohibit any vendor, exchange, 

association, broker-dealer, or ATS 

(including ECNs) from accepting, 

ranking, or displaying quotations, 

orders, or indications of interest in NMS 

stocks in sub-penny increments (except 

for quotations, orders, or indications of 

77494 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

549 17 CFR 240.0–10(e).

550 17 CFR 240.0–10(c).

551This number reflects the number of FOCUS 

filings.

552 17 CFR 240.0–10(c).

553See 17 CFR 11Aa3–1(a)(11).

554 17 CFR 240.0–10(g). 555 5 U.S.C. 603(c).

interest priced less than $1.00 per share, 

in which case the price may not extend 

beyond four decimal places). 

2. Objectives 

The reproposed rule is designed to 

fulfill several objectives. Reproposed 

Rule 612 is designed to prevent 

widespread quoting in sub-pennies, 

which could harm the markets and 

investors, by undermining a number of 

the benefits of decimalization. In 

particular, sub-penny quotation could 

impair broker-dealers’ efforts to meet 

their best execution obligations, and 

interfere with investors’ understanding 

of securities prices. In addition, the 

reproposed rule is designed to enhance 

depth by preventing quotations from 

being spread across an increasing 

number of price points, while also 

encouraging the use of limit orders—an 

important source of liquidity—by 

preventing competing market 

participants from stepping ahead of 

limit orders for an economically 

insignificant amount. 

3. Legal Basis 

Pursuant to the Exchange Act and, 

particularly, Sections 3(b), 5, 6, 11A, 15, 

15A, 17(a) and (b), 19, 23(a), and 36 

thereof, 15 U.S.C. 78c(b), 78e, 78f, 78k–

1, 78o, 78mm, 78q(a) and (b), and 

78w(a), the Commission reproposes 

Rule 612. 

4. Small Entities Subject to the Rule 

The reproposed rule would apply to 

any national securities exchange, 

national securities association, ATS, 

vender, or broker or dealer. ATSs that 

are not registered as exchanges are 

required to register as broker-dealers. 

Accordingly, ATSs would be considered 

small entities if they fall within the 

standard for small entities that would 

apply to broker-dealers. Each type of 

market participant that would be 

affected by the reproposed rule is 

discussed below. 

a. National Securities Exchanges and 

National Securities Association

Rule 0–10(e) under the Exchange 

Act 549 provides that the term ‘‘small 

business’’ or ‘‘small organization,’’

when referring to an exchange, means 

any exchange that: (1) Has been 

exempted from the reporting 

requirements of Rule 11Aa3–1 under the 

Exchange Act; and (2) is not affiliated 

with any person (other than a natural 

person) that is not a small business or 

small organization, as defined by Rule 

0–10. No national securities exchanges 

are small entities because none meets 

these criteria. There is one national 

securities association (NASD) that 

would be subject to reproposed Rule 

612. NASD is not a small entity as 

defined by 13 CFR 121.201.

b. Broker-Dealers 

Commission rules generally define a 

broker-dealer as a small entity for 

purposes of the Exchange Act and the 

Regulatory Flexibility Act if the brokerdealer had a total capital (net worth plus 

subordinated liabilities) of less than 

$500,000 on the date in the prior fiscal 

year as of which its audited financial 

statements were prepared, and the 

broker-dealer is not affiliated with any 

person (other than a natural person) that 

is not a small entity.550 The Commission 

estimates that as of the end of 2003, 

there were approximately 6,565 

Commission-registered brokerdealers,551 of which approximately 905 

would be considered small entities 

pursuant to the standard of Rule 0–10(c) 

under the Exchange Act.552

c. Vendors 

A vendor is defined as any securities 

information processor engaged in the 

business of disseminating transaction 

reports or last sale data with respect to 

transactions in reported securities to 

brokers, dealers or investors on a realtime or other current and continuing 

basis, whether through an ECN, moving 

ticker or interrogation device.553 Rule 0–

10(g) 554 states that the term ‘‘small 

business’’ or ‘‘small organization,’’

when referring to a securities 

information processor, means any 

securities information processor that: (1) 

Had gross revenues of less than $10 

million during the preceding fiscal year 

(or in the time it has been in business, 

if shorter); (2) provided service to fewer 

than 100 interrogation devices or 

moving tickers at all times during the 

preceding fiscal year (or in the time that 

it has been in business, if shorter); and 

(3) is not affiliated with any person 

(other than a natural person) that is not 

a small business or small organization 

under this section. The Commission 

estimates that there are approximately 

80 vendors, 16 of which are considered 

small entities. The Commission seeks 

comment on whether these estimates are 

accurate.

5. Reporting, Recordkeeping, and Other 

Compliance Requirements 

Reproposed Rule 612 would not 

impose any new reporting, 

recordkeeping or other compliance 

requirements on market participants 

that are small entities. 

6. Duplicative, Overlapping or 

Conflicting Federal Rules 

The Commission believes that there 

are no federal rules that duplicate, 

overlap or conflict with the proposed 

rule. 

7. Significant Alternatives

Pursuant to Section 3(a) of the 

RFA,555 the Commission must consider 

the following types of alternatives: (1) 

The establishment of differing 

compliance or reporting requirements or 

timetables that take into account the 

resources available to small entities; (2) 

the clarification, consolidation, or 

simplification of compliance and 

reporting requirements under the 

proposed rule for small entities; (3) the 

use of performance rather than design 

standards; and (4) an exemption from 

coverage of the proposed rule, or any 

part thereof, for small entities.

The primary goal of the reproposed 

rule is to provide a uniform pricing 

increment for NMS stocks. As such, 

imposing different compliance or 

reporting requirements, and possibly a 

different timetable for implementing 

compliance or reporting requirements, 

for small entities could undermine the 

goal of uniformity. In addition, the 

Commission preliminarily believes that 

it would not be consistent with the 

primary goal of the proposal to further 

clarify, consolidate, or simplify the 

reproposed rule for small entities. The 

Commission also does not believe that 

it is necessary to consider whether small 

entities should be permitted to use 

performance rather than design 

standards to comply with the proposed 

rule because the rule already reproposes 

performance standards and does not 

dictate for entities of any size any 

particular design standards (e.g., 

technology) that must be employed to 

achieve the objectives of the proposed 

rule. The Commission also preliminarily 

believes that it would be inconsistent 

with the purposes of the Exchange Act 

to specify different requirements for 

small entities or to exempt brokerdealers from the proposed rule. 

8. Request for Comments 

The Commission encourages written 

comments on matters discussed in the 

IRFA. In particular, the Commission 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77495

556 5 U.S.C. 605(b). 557Proposing Release, 69 FR at 11190–91. 558Paragraph (e) of Exchange Act Rule 0–10 

provides that the term ‘‘small entity,’’ when 

referring to an exchange, means any exchange that 

has been exempted from the reporting requirements 

of 17 CFR 240.11Aa3–1 and is not affiliated with 

any person that is not a small entity. Under this 

standard, none of the exchanges affected by the 

proposed rule is a small entity. Similarly, the 

national securities association affected by the 

proposed rule is not small entity as defined by 13 

CFR 121.201.

559See 17 CFR 240.0–10(g).

560See 17 CFR 240.0–10(e).

561 17 CFR 240.11Aa3–1 and 17 CFR 240.11Ac1–

2.

562Proposing Release, 69 FR 11190–91.

563 15 U.S.C. 78b, 78c(b), 78e, 78f, 78k–1, 78o, 

78o–3, 78q(a), 78s; 78w(a), and 78mm; 17 CFR 

240.11Aa3–2(b)(2) and 17 CFR 240.11Aa3–2(c)(1).

564 17 CFR 240.0–10(c).

requests comments on (i) the number of 

small entities that would be affected by 

the reproposed rule; (ii) the nature of 

any impact the reproposed rule would 

have on small entities and empirical 

data supporting the extent of the impact; 

and (iii) how to quantify the number of 

small entities that would be affected by 

and how to quantify the impact of the 

reproposed rule. Such comments will be 

considered in the preparation of the 

Final Regulatory Flexibility Analysis, if 

the reproposed rule is adopted, and will 

be placed in the same public file as 

comments on the reproposed rule itself. 

D. Market Data Rules and Plan 

Amendments 

1. Regulatory Flexibility Act 

Certification for the Plan Amendments 

Pursuant to 5 U.S.C. 605(b) of the 

Regulatory Flexibility Act,556 the 

Commission certified in the Proposing 

Release that amending the Plans to (1) 

modify the current formulas for 

allocating market data revenues, and (2) 

require the establishment of non-voting 

advisory committees would not have a 

significant economic impact on a 

substantial number of small entities.557

The Commission did not receive any 

comments on the certification. The 

Commission renews its request for 

comment on the certification, which is 

set forth below.

The Commission hereby certifies, 

pursuant to 5 U.S.C. 603(b), that the 

reproposed amendments to the Plans, if 

adopted, would not have a significant 

economic impact on a substantial 

number of small entities. The 

reproposed amendments to the Plans 

imposing a new net income allocation 

formula would only impact the SROs,558

SIAC (the processor for the CTA Plans 

and the CQ Plan), and Nasdaq (the 

processor for the Nasdaq UTP Plan). The 

reproposed amendments to the Plans 

requiring the establishment of an 

advisory committee would apply only to 

Plan participants. SIAC and Nasdaq 

would not be considered ‘‘small 

entities’’ for purposes of the Regulatory 

Flexibility Act.559 The Plan participants 

are either national securities exchanges 

or a national securities association and, 

as such, are not small entities.560

Accordingly, the Commission does not 

believe that the reproposed amendments 

to the Plans would have a significant 

economic impact on a substantial 

number of small entities.

2. Initial Regulatory Flexibility Analysis 

for Proposed Amendments to Rules 

11Aa3–1 and 11Ac1–2 (Proposed To Be 

Redesignated as Rules 601 and 603) 

This IRFA has been prepared in 

accordance with 5 U.S.C. 603. It relates 

to the proposed amendments to Rules 

11Aa3–1 and 11Ac1–2 under the 

Exchange Act (proposed to be 

redesignated as Rules 601 and 603 of 

Regulation NMS).561 This IRFA is 

substantially the same as the one 

contained in the Proposing Release.562

The Commission did not receive any 

comment on the IRFA contained in the 

Proposing Release.

a. Reasons for the Proposed Action 

The Commission believes that an 

overall modernization of the rules for 

disseminating market data to the public 

is necessary to address problems posed 

by the current market data rules. The 

Commission proposes to retain the core 

elements of the current rules—price 

discovery and mandatory 

consolidation—which provide 

important benefits to investors and to 

others who use market information, 

while amending other parts of the 

current rules that have resulted in 

serious economic and regulatory 

distortions. More specifically, the 

Commission reproposes to amend Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) to 

lift certain restrictions in order to 

reduce the burden on and to provide 

simplification and uniformity for those 

market centers, broker-dealers, and data 

vendors that have to comply with 

requirements under the Rules. 

b. Objectives 

The reproposed amendments to Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) are 

designed to fulfill several objectives. 

First, the reproposed amendment to 

Rule 11Aa3–1 (proposed to be 

redesignated as Rule 601) is intended to 

provide market centers, including ATSs 

and market makers, with flexibility to 

independently distribute their own 

trade reports, aside from their obligation 

to provide their trade reports to an SRO 

or to the Networks (depending on the 

type of market center). Second, a prime 

objective of the reproposed amendments 

to Rule 11Ac1–2 (proposed to be 

redesignated as Rule 603) is to provide 

uniform standards for all market 

centers, including non-SRO market 

centers and entities that are exclusive 

processors of SRO market data, for the 

independent distribution of market data. 

Third, the objective of the reproposed 

amendment to Rule 11Ac1–2 (proposed 

to be redesignated as Rule 603) 

providing that all SROs act jointly 

through the Plans and disseminate their 

consolidated information through a 

single processor is to clarify the current 

practice among the SROs and to require 

continued participation in the Plans and 

dissemination through one processor 

per security. Fourth, an additional 

objective of the reproposed amendments 

to Rule 11Ac1–2 (proposed to be 

redesignated as Rule 603) is to reduce 

consolidated display requirements on 

broker-dealers and vendors and to limit 

their consolidated display obligations to 

the disclosure of the NBBO and 

consolidated last sale information, and 

to the display of market information in 

a trading or order-routing context. 

Finally, the reproposed amendments to 

Rule 11Ac1–2 (proposed to be 

redesignated as Rule 603) are intended 

to ease the burden of compliance by 

simplifying the current consolidated 

display requirements under the Rule 

and by rescinding old provisions in the 

Rule that are outdated and no longer 

necessary.

c. Legal Basis 

The Commission reproposes 

amendments to Rules 11Aa3–1 and 

11Ac1–2 (proposed to be redesignated 

as Rules 601 and 603) pursuant to its 

authority set forth in Sections 2, 3(b), 5, 

6, 11A, 15, 15A, 17(a), 19, 23(a), and 36 

of the Exchange Act, and Rules 11Aa3–

2(b)(2) and 11Aa3–2(c)(1) thereunder.563

d. Small Entities Subject to the Rule 

The reproposed amendments to Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) 

would affect ATSs, market makers, 

broker-dealers, and SIPs that could 

potentially be small entities. Paragraph 

(c) of Rule 0–10 under the Exchange 

Act 564 defines the term ‘‘small 

business’’ or ‘‘small organization,’’

when referring to a broker-dealer, to 

mean a broker or dealer that had total 

capital of less than $500,000 on the date 

in the prior fiscal year as of which its 

77496 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

565 17 CFR 240.0–10(g).

566The reproposed amendment to Rule 11Ac1–2 

(proposed to be redesignated as Rule 603), 

providing that all SROs act jointly through the 

Plans and disseminate their consolidated 

information through a single processor would only 

apply to the SROs, which are not ‘‘small entities’’

for purposes of the Regulatory Flexibility Act. 567Proposing Release, 69 FR at 11198.

audited financial statements were 

prepared, or if not required to file such 

statements, it had total capital of less 

than $500,000 on the last business day 

of the preceding fiscal year; and is not 

affiliated with any person (other than a 

natural person) that is not a small 

business or small organization. ATSs 

and market makers would be considered 

broker-dealers for purposes of this 

definition. Paragraph (g) of Rule 0–10565

defines the term ‘‘small business’’ or 

‘‘small organization,’’ when referring to 

a SIP, to mean a SIP that had gross 

revenues of less than $10 million during 

the preceding fiscal year and provided 

service to fewer than 100 interrogation 

devices or moving tickers at all times 

during the preceding fiscal year; and is 

not affiliated with any person (other 

than a natural person) that is not a small 

business or small organization.

As of December 31, 2003, the 

Commission estimates that there are 

approximately 905 registered brokerdealers, including ATSs and market 

makers, that would be considered small 

entities. In addition, approximately 16 

SIPs would be considered small entities. 

The Commission’s reproposed 

amendment to Rule 11Aa3–1 (proposed 

to be redesignated as Rule 601) would 

enable small market centers, including 

ATSs and market makers, that 

contribute to consolidated information, 

if they so choose, to also independently 

distribute their own trade reports. The 

Commission’s reproposed amendments 

to Rule 11Ac1–2 (proposed to be 

redesignated as Rule 603) would reduce 

the compliance burden on small brokerdealers and SIPs by limiting the data 

required to be consolidated and 

displayed under the rule.566

The Commission requests comment 

on the number of small entities that 

would be impacted by the reproposed 

amendments, including any available 

empirical data. 

e. Reporting, Recordkeeping and Other 

Compliance Requirements 

The reproposed amendments to Rules 

11Aa3–1 and 11Ac1–2 (proposed to be 

redesignated as Rules 601 and 603) 

would not impose any new reporting, 

recordkeeping or other compliance 

requirements on ATSs, market makers, 

broker-dealers, and SIPs that are small 

entities. SROs that would be subject to 

these reproposed amendments would 

not be considered small entities. 

f. Duplicative, Overlapping or 

Conflicting Federal Rules 

The Commission believes that there 

are no rules that duplicate, overlap or 

conflict with the reproposed 

amendments to Rules 11Aa3–1 and 

11Ac1–2 (proposed to be redesignated 

as Rules 601 and 603). 

g. Significant Alternatives 

The Regulatory Flexibility Act directs 

the Commission to consider significant 

alternatives that would accomplish the 

stated objective, while minimizing any 

significant adverse impact on small 

entities. In connection with the 

reproposed amendments, the 

Commission has considered the 

following alternative models for 

disseminating market data to the public: 

(1) A competing consolidators model 

under which each SRO would be 

allowed to sell its market data 

separately to any number of 

consolidators; (2) a rescission of the 

consolidated display requirement and 

allowing all SROs and other market 

centers to distribute their market data 

individually; and (3) a hybrid model 

that would retain the consolidated 

display requirement and existing 

Networks solely for the dissemination of 

the NBBO, but allow the SROs to 

distribute their own quotations and 

trades independently and without a 

consolidated display requirement. 

These alternative models were all 

intended to introduce more competition 

in the marketplace and greater 

flexibility in market data dissemination. 

The primary goal of the reproposed 

amendments to Rules 11Aa3–1 and 

11Ac1–2 (proposed to be redesignated 

as Rules 601 and 603) is to retain the 

benefits of the consolidated display 

requirement, which provides a uniform, 

consolidated stream of data and is the 

single most important tool for unifying 

all of the market centers trading NMS 

Stocks, while providing market centers 

that contribute to consolidated 

information with the ability to 

independently distribute their own 

market data and reducing the 

consolidated display requirements on 

broker-dealers and SIPs. The 

Commission preliminarily believes that 

these potential alternative models pose 

an unacceptable risk of losing important 

benefits that investors and other 

information users receive under the 

current system—an affordable and 

highly reliable stream of quotations and 

trades that is consolidated from all 

significant market centers trading an 

NMS Stock. The Commission also does 

not believe that it is necessary to 

consider whether small entities should 

be permitted to use performance rather 

than design standards to comply with 

the proposed amendments as the 

amendments already propose 

performance standards and do not 

dictate for entities of any size any 

particular design standards (e.g., 

technology) that must be employed to 

achieve the objectives of the proposed 

amendments. 

h. Solicitation of Comments 

The Commission encourages 

comments with respect to any aspect of 

this IRFA. In particular, the Commission 

requests comments regarding: (1) The 

number of small entities that may be 

affected by the reproposed amendments; 

(2) the existence or nature of the 

potential impact of the reproposed 

amendments on small entities discussed 

in the analysis; and (3) how to quantify 

the impact of the reproposed 

amendments. Commenters are asked to 

describe the nature of any impact and 

provide empirical data supporting the 

extent of the impact. Such comments 

will be considered in the preparation of 

the Final Regulatory Flexibility 

Analysis, if the proposals are adopted, 

and will be placed in the same public 

file as comments on the reproposed 

amendments themselves. 

E. Regulation NMS 

Pursuant to 5 U.S.C. 605(b), the 

Commission certified in the Proposing 

Release that proposed Rule 600 and the 

redesignation of the NMS rules as 

Regulation NMS would not have a 

significant economic impact on a 

substantial number of small entities.567

The Commission received no comments 

regarding this certification. The 

Commission renews its request for 

comment on the certification, which is 

set forth below.

The Commission hereby certifies, 

pursuant to 5 U.S.C. 605(b), that 

reproposed Rule 600 and the related 

reproposed amendments, if adopted, 

would not have a significant economic 

impact on a substantial number of small 

entities. Reproposed Rule 600 would 

revise and clarify the definitions used in 

proposed Regulation NMS, thereby 

facilitating compliance with proposed 

Regulation NMS and potentially easing 

the compliance burden on entities 

seeking to comply with the regulation. 

Neither reproposed Rule 600 nor the 

related reproposed amendments of the 

NMS rules would alter the existing 

requirements of the NMS rules. 

Accordingly, the Commission does not 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77497

believe that reproposed Rule 600 and 

the re-designation of the NMS rules as 

proposed Regulation NMS would have a 

significant impact on a substantial 

number of small entities.

XIII. Statutory Authority 

Pursuant to the Exchange Act and 

particularly, Sections 2, 3(b), 5, 6, 11A, 

15, 15A, 17(a) and (b), 19, 23(a), and 36 

thereof, 15 U.S.C. 78b, 78c(b), 78e, 78f, 

78k–1, 78o, 78o–3, 78q(a) and (b), 78s; 

78w(a), and 78mm, and Rules 11Aa3–

2(b)(2) and 11Aa3–2(c)(1) thereunder, 

17 CFR 240.11Aa3–2(b)(2) and 17 CFR 

240.11Aa3–2(c)(1), the Commission 

proposes to: (1) Redesignate the NMS 

rules under Section 11A of the 

Exchange Act as Regulation NMS rules; 

(2) adopt Rules 600, 610, 611, and 612 

of Regulation NMS; (3) amend current 

Rules 11Aa3–1 and 11Ac1–2 under the 

Exchange Act and redesignate them as 

Rules 601 and 603 of Regulation NMS; 

(4) amend the CTA Plan, the CQ Plan, 

and the Nasdaq UTP Plan; and (5) 

amend various other rules to reflect the 

adoption of Regulation NMS, as set forth 

below. 

XIV. Text of Proposed Amendments to 

the CTA Plan, the CQ Plan, and the 

Nasdaq UTP Plan 

The Commission hereby proposes to 

amend the CTA Plan, the CQ Plan, and 

the Nasdaq UTP Plan to incorporate the 

new net income allocation formula into 

each Plan, which would supersede the 

existing allocation formulas in those 

Plans, and to incorporate the new Plan 

governance language into each Plan. 

Set forth below is the text of (1) the 

proposed new allocation formula to be 

incorporated into each of the Plans, and 

(2) the proposed new Plan governance 

language to be incorporated into each of 

the Plans. 

Formula Amendment 

(#) Allocation of Net Income.

(a) Annual Payment. Notwithstanding 

any other provision of this Plan, each 

Participant eligible to receive 

distributable net income under the Plan 

shall receive an annual payment for 

each calendar year that is equal to the 

sum of the Participant’s Trading Shares 

and Quoting Shares, as defined below, 

in each Eligible Security for the 

calendar year. 

(b) Security Income Allocation. The 

Security Income Allocation for an 

Eligible Security shall be determined by 

multiplying (i) the distributable net 

income of the Plan for the calendar year 

by (ii) the Volume Percentage for such 

Eligible Security. The Volume 

Percentage for an Eligible Security shall 

be determined by dividing (i) the square 

root of the dollar volume of transaction 

reports disseminated by the Processor in 

such Eligible Security during the 

calendar year divided by (ii) the sum of 

the square roots of the dollar volume of 

transaction reports disseminated by the 

Processor in each Eligible Security 

during the calendar year. 

(c) Trading Share. The Trading Share 

of a Participant in an Eligible Security 

shall be determined by multiplying (i) 

an amount equal to the lesser of (A) fifty 

percent of the Security Income 

Allocation for the Eligible Security or 

(B) an amount equal to $2.00 multiplied 

by the total number of qualified 

transaction reports disseminated by the 

Processor in the Eligible Security during 

the calendar year, by (ii) the 

Participant’s Trade Rating in the Eligible 

Security. A Participant’s Trade Rating in 

an Eligible Security shall be determined 

by taking the average of (i) the 

Participant’s percentage of the total 

dollar volume of transaction reports 

disseminated by the Processor in the 

Eligible Security during the calendar 

year, and (ii) the Participant’s 

percentage of the total number of 

qualified transaction reports 

disseminated by the Processor in the 

Eligible Security during the calendar 

year. A transaction report with a dollar 

volume of $5000 or more shall 

constitute one qualified transaction 

report. A transaction report with a 

dollar volume of less than $5000 shall 

constitute a fraction of a qualified 

transaction report that equals the dollar 

volume of the transaction report divided 

by $5000. 

(d) Quoting Share. The Quoting Share 

of a Participant in an Eligible Security 

shall be determined by multiplying (i) 

an amount equal to fifty percent of the 

Security Income Allocation for the 

Eligible Security, plus the difference, if 

greater than zero, between fifty percent 

of the Security Income Allocation for 

the Eligible Security and an amount 

equal to $2.00 multiplied by the total 

number of qualified transaction reports 

disseminated by the Processor in the 

Eligible Security during the calendar 

year, by (ii) the Participant’s Quote 

Rating in the Eligible Security. A 

Participant’s Quote Rating in an Eligible 

Security shall be determined by 

dividing (i) the sum of the Quote Credits 

earned by the Participant in such 

Eligible Security during the calendar 

year by (ii) the sum of the Quote Credits 

earned by all Participants in such 

Eligible Security during the calendar 

year. A Participant shall earn one Quote 

Credit for each second of time 

multiplied by dollar value of size that a 

firm automated bid (offer) transmitted 

by the Participant to the Processor 

during regular trading hours is equal to 

the price of the national best bid (offer) 

in the Eligible Security. An automated 

bid (offer) shall have the meaning 

specified in Rule 600 of Regulation 

NMS of the Exchange Act for an 

‘‘automated quotation.’’ The dollar 

value of size of a quote shall be 

determined by multiplying the price of 

a quote by its size. 

Governance Amendment 

(#) Advisory Committee.

(a) Formation. Notwithstanding any 

other provision of this Plan, an 

Advisory Committee to the Plan shall be 

formed and shall function in accordance 

with the provisions set forth in this 

section. 

(a) Composition. Members of the 

Advisory Committee shall be selected 

for two-year terms as follows: 

(1) Operating Committee Selections.

By affirmative vote of a majority of the 

Participants entitled to vote, the 

Operating Committee shall select at 

least one representative from each of the 

following categories to be members of 

the Advisory Committee: (i) A brokerdealer with a substantial retail investor 

customer base, (ii) a broker-dealer with 

a substantial institutional investor 

customer base, (iii) an alternative 

trading system, (iv) a data vendor, and 

(v) an investor. 

(2) Participant Selections. Each 

Participant shall have the right to select 

one member of the Advisory Committee. 

A Participant shall not select any person 

employed by or affiliated with any 

Participant or its affiliates or facilities. 

(c) Function. Members of the 

Advisory Committee shall have the right 

to submit their views to the Operating 

Committee on Plan matters, prior to a 

decision by the Operating Committee on 

such matters. Such matters shall 

include, but not be limited to, any new 

or modified product, fee, contract, or 

pilot program that is offered or used 

pursuant to the Plan. 

(d) Meetings and Information.

Members of the Advisory Committee 

shall have the right to attend all 

meetings of the Operating Committee 

and to receive any information 

concerning Plan matters that is 

distributed to the Operating Committee; 

provided, however, that the Operating 

Committee may meet in executive 

session if, by affirmative vote of a 

majority of the Participants entitled to 

vote, the Operating Committee 

determines that an item of Plan business 

requires confidential treatment. 

77498 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

XV. Text of Reproposed Rules

List of Subjects 

17 CFR Part 200

Administrative practice and 

procedure, Authority delegations 

(Government agencies), Organization 

and functions (Government agencies). 

17 CFR Part 201 

Administrative practice and 

procedure, Securities. 

17 CFR Parts 230 and 270 

Reporting and recordkeeping 

requirements, Securities. 

17 CFR Parts 240, 242, and 249 

Brokers, Reporting and recordkeeping 

requirements, Securities.

For the reasons set out in the 

preamble, Title 17, Chapter II of the 

Code of the Federal Regulations is 

proposed to be amended as follows:

PART 200—ORGANIZATION; 

CONDUCT AND ETHICS; AND 

INFORMATION AND REQUESTS 

1. The general authority citation for 

part 200 is revised to read as follows:

Authority: 15 U.S.C. 77s, 78d, 78d–1, 78d–

2, 78w, 78ll(d), 78mm, 79t, 77sss, 80a–37, 

80b–11 and 7202 unless otherwise noted.

* * * * *

2. Section 200.30–3 is amended by: 

a. Removing paragraphs (a)(62) and 

(a)(71); 

b. Redesignating paragraphs (a)(63) 

through (a)(82) as paragraphs (a)(62) 

through (a)(80); 

c. Revising paragraphs (a)(27), (a)(28), 

(a)(36), (a)(37), (a)(42), (a)(49), (a)(61), 

and newly redesignated paragraphs 

(a)(68), and (a)(69); and 

d. Adding new paragraphs (a)(81), 

(a)(82), and (a)(83). 

The revisions and additions read as 

follows:

§ 200.30–3 Delegation of authority to 

Director of Division of Market Regulation.

* * * * *

(a) * * * 

(27) To approve amendments to the 

joint industry plan governing 

consolidated transaction reporting 

declared effective by the Commission 

pursuant to Rule 601 (17 CFR 242.601) 

or its predecessors, Rule 11Aa3–1 and 

Rule 17a–15, and to grant exemptions 

from Rule 601 pursuant to Rule 601(f) 

(17 CFR 242.601(f)) to exchanges trading 

listed securities that are designated as 

national market system securities until 

such times as a Joint Reporting Plan for 

such securities is filed and approved by 

the Commission. 

(28) To grant exemptions from Rule 

602 (17 CFR 242.602), pursuant to Rule 

602(d) (17 CFR 242.602(d)).

* * * * *

(36) To grant exemptions from Rule 

603 (17 CFR 242.603), pursuant to Rule 

603(d) (17 CFR 242.603(d)). 

(37) Pursuant to Rule 600 (17 CFR 

242.600), to publish notice of the filing 

of a designation plan with respect to 

national market system securities, or 

any proposed amendment thereto, and 

to approve such plan or amendment.

* * * * *

(42) Under 17 CFR 242.608(e), to grant 

or deny exemptions from 17 CFR 

242.608.

* * * * *

(49) Pursuant to section 11A(b) of the 

Act (15 U.S.C. 78k–1(b)) and Rule 609 

thereunder (17 CFR 242.609), to publish 

notice of and, by order, grant under 

section 11A(b) of the Act and Rule 609 

thereunder: Applications for registration 

as a securities information processor; 

and exemptions from that section and 

any rules or regulations promulgated 

thereunder, either conditionally or 

unconditionally.

* * * * *

(61) To grant exemptions from Rule 

604 (17 CFR 242.604), pursuant to Rule 

604(c) (17 CFR 242.604(c)).

* * * * *

(68) Pursuant to Rule 605(b) (17 CFR 

242.605(b)), to grant or deny 

exemptions, conditionally or 

unconditionally, from any provision or 

provisions of Rule 605 (17 CFR 

242.605). 

(69) Pursuant to Rule 606(c) (17 CFR 

242.606(c)), to grant or deny 

exemptions, conditionally or 

unconditionally, from any provision or 

provisions of Rule 606 (17 CFR 

242.606).

* * * * *

(81) To grant or deny exemptions 

from Rule 610 (17 CFR 242.610), 

pursuant to Rule 610(e) (17 CFR 

242.610(e)). 

(82) To grant or deny exemptions 

from Rule 611 (17 CFR 242.611), 

pursuant to Rule 611(d) (17 CFR 

242.611(d)). 

(83) To grant or deny exemptions 

from Rule 612 (17 CFR 242.612), 

pursuant to Rule 612(c) (17 CFR 

242.612(c)).

Subpart N—Commission Information 

Collection Requirements Under the 

Paperwork Reduction Act: OMB 

Control Numbers 

3. The authority citation for Subpart 

N continues to read as follows:

Authority: 44 U.S.C. 3506; 44 U.S.C. 3507.

4. Section 200.800 is amended by 

revising paragraph (b) to read as follows:

§ 200.800 OMB control numbers assigned 

pursuant to the Paperwork Reduction Act. 

(a) * * * 

(b) Display.

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Regulation S–X ............................................................................................................ Part 210 .................................................... 3235–0009 

Regulation S–B ............................................................................................................ Part 228 .................................................... 3235–0417 

Regulation S–K ............................................................................................................ Part 229 .................................................... 3235–0071 

Rule 154 ....................................................................................................................... 230.154 ..................................................... 3235–0495 

Rule 155 ....................................................................................................................... 230.155 ..................................................... 3235–0549 

Rule 236 ....................................................................................................................... 230.236 ..................................................... 3235–0095 

Rule 237 ....................................................................................................................... 230.237 ..................................................... 3235–0528 

Regulation A ................................................................................................................. 230.251 thru 230.263 ............................... 3235–0286 

Regulation C ................................................................................................................. 230.400 thru 230.494 ............................... 3235–0074 

Rule 425 ....................................................................................................................... 230.425 ..................................................... 3235–0521 

Rule 477 ....................................................................................................................... 230.477 ..................................................... 3235–0550 

Rule 489 ....................................................................................................................... 230.489 ..................................................... 3235–0411 

Rule 498 ....................................................................................................................... 230.498 ..................................................... 3235–0488 

Regulation D ................................................................................................................. 230.501 thru 230.506 ............................... 3235–0076 

Regulation E ................................................................................................................. 230.601 thru 230.610a ............................. 3235–0232 

Rule 604 ....................................................................................................................... 230.604 ..................................................... 3235–0232 

Rule 605 ....................................................................................................................... 230.605 ..................................................... 3235–0232 

Rule 609 ....................................................................................................................... 230.609 ..................................................... 3235–0233 

Rule 701 ....................................................................................................................... 230.701 ..................................................... 3235–0522 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77499

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Regulation S ................................................................................................................. 230.901 thru 230.905 ............................... 3235–0357 

Regulation S–T ............................................................................................................. Part 232 .................................................... 3235–0424 

Form SB–1 ................................................................................................................... 239.9 ......................................................... 3235–0423 

Form SB–2 ................................................................................................................... 239.10 ....................................................... 3235–0418 

Form S–1 ...................................................................................................................... 239.11 ....................................................... 3235–0065 

Form S–2 ...................................................................................................................... 239.12 ....................................................... 3235–0072 

Form S–3 ...................................................................................................................... 239.13 ....................................................... 3235–0073 

Form N–2 ..................................................................................................................... 239.14 ....................................................... 3235–0026 

Form N–1A ................................................................................................................... 239.15A ..................................................... 3235–0307 

Form S–6 ...................................................................................................................... 239.16 ....................................................... 3235–0184 

Form S–8 ...................................................................................................................... 239.16b ..................................................... 3235–0066 

Form N–3 ..................................................................................................................... 239.17a ..................................................... 3235–0316 

Form N–4 ..................................................................................................................... 239.17b ..................................................... 3235–0318 

Form S–11 .................................................................................................................... 239.18 ....................................................... 3235–0067 

Form N–14 ................................................................................................................... 239.23 ....................................................... 3235–0336 

Form N–5 ..................................................................................................................... 239.24 ....................................................... 3235–0169 

Form S–4 ...................................................................................................................... 239.25 ....................................................... 3235–0324 

Form F–1 ...................................................................................................................... 239.31 ....................................................... 3235–0258 

Form F–2 ...................................................................................................................... 239.32 ....................................................... 3235–0257 

Form F–3 ...................................................................................................................... 239.33 ....................................................... 3235–0256 

Form F–4 ...................................................................................................................... 239.34 ....................................................... 3235–0325 

Form F–6 ...................................................................................................................... 239.36 ....................................................... 3235–0292 

Form F–7 ...................................................................................................................... 239.37 ....................................................... 3235–0383 

Form F–8 ...................................................................................................................... 239.38 ....................................................... 3235–0378 

Form F–9 ...................................................................................................................... 239.39 ....................................................... 3235–0377 

Form F–10 .................................................................................................................... 239.40 ....................................................... 3235–0380 

Form F–80 .................................................................................................................... 239.41 ....................................................... 3235–0404 

Form F–X ..................................................................................................................... 239.42 ....................................................... 3235–0379 

Form F–N ..................................................................................................................... 239.43 ....................................................... 3235–0411 

Form ET ....................................................................................................................... 239.62 ....................................................... 3235–0329 

Form ID ........................................................................................................................ 239.63 ....................................................... 3235–0328 

Form SE ....................................................................................................................... 239.64 ....................................................... 3235–0327 

Form TH ....................................................................................................................... 239.65 ....................................................... 3235–0425 

Form 1–A ...................................................................................................................... 239.90 ....................................................... 3235–0286 

Form 2–A ...................................................................................................................... 239.91 ....................................................... 3235–0286 

Form 144 ...................................................................................................................... 239.144 ..................................................... 3235–0101 

Form 1–E ...................................................................................................................... 239.200 ..................................................... 3235–0232 

Form CB ....................................................................................................................... 239.800 ..................................................... 3235–0518 

Rule 6a–1 ..................................................................................................................... 240.6a–1 ................................................... 3235–0017 

Rule 6a–3 ..................................................................................................................... 240.6a–3 ................................................... 3235–0021 

Rule 6a–4 ..................................................................................................................... 240.6a–4 ................................................... 3235–0554 

Rule 6h–1 ..................................................................................................................... 240.6h–1 ................................................... 3235–0555 

Rule 8c–1 ..................................................................................................................... 240.8c–1 ................................................... 3235–0514 

Rule 9b–1 ..................................................................................................................... 240.9b–1 ................................................... 3235–0480 

Rule 10a–1 ................................................................................................................... 240.10a–1 ................................................. 3235–0475 

Rule 10b–10 ................................................................................................................. 240.10b–10 ............................................... 3235–0444 

Rule 10b–17 ................................................................................................................. 240.10b–17 ............................................... 3235–0476 

Rule 10b–18 ................................................................................................................. 240.10b–18 ............................................... 3235–0474 

Rule 10A–1 ................................................................................................................... 240.10A–1 ................................................. 3235–0468 

Rule 11a1–1(T) ............................................................................................................ 240.11a1–1(T) .......................................... 3235–0478 

Rule 12a–5 ................................................................................................................... 240.12a–5 ................................................. 3235–0079 

Regulation 12B ............................................................................................................. 240.12b–1 thru 240.12b–36 ..................... 3235–0062 

Rule 12d1–3 ................................................................................................................. 240.12d1–3 ............................................... 3235–0109 

Rule 12d2–1 ................................................................................................................. 240.12d2–1 ............................................... 3235–0081 

Rule 12d2–2 ................................................................................................................. 240.12d2–2 ............................................... 3235–0080 

Rule 12f–1 .................................................................................................................... 240.12f–1 .................................................. 3235–0128 

Rule 13a–16 ................................................................................................................. 240.13a–16 ............................................... 3235–0116 

Regulation 13D/G ......................................................................................................... 240.13d–1 thru 240.13d–7 ....................... 3235–0145 

Schedule 13D ............................................................................................................... 240.13d–101 ............................................. 3235–0145 

Schedule 13G ............................................................................................................... 240.13d–102 ............................................. 3235–0145 

Rule 13e–1 ................................................................................................................... 240.13e–1 ................................................. 3235–0305 

Rule 13e–3 ................................................................................................................... 240.13e–3 ................................................. 3235–0007 

Schedule 13E–3 ........................................................................................................... 240.13e–100 ............................................. 3235–0007 

Schedule 13e–4F ......................................................................................................... 240.13e–101 ............................................. 3235–0375 

Regulation 14A ............................................................................................................. 240.14a–1 thru 240.14a–12 ..................... 3235–0059 

Schedule 14A ............................................................................................................... 240.14a–101 ............................................. 3235–0059 

Regulation 14C ............................................................................................................. 240.14c–1 ................................................. 3235–0057 

Schedule 14C ............................................................................................................... 240.14c–101 ............................................. 3235–0057 

Regulation 14D ............................................................................................................. 240.14d–1 thru 240.14d–9 ....................... 3235–0102 

Schedule TO ................................................................................................................ 240.14d–100 ............................................. 3235–0515 

Schedule 14D–1 ........................................................................................................... 240.14d–101 ............................................. 3235–0102 

Schedule 14D–9 ........................................................................................................... 240.14d–101 ............................................. 3235–0102 

Schedule 14D–1F ......................................................................................................... 240.14d–102 ............................................. 3235–0376 

77500 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Schedule 14D–9F ......................................................................................................... 240.14d–103 ............................................. 3235–0382 

Regulation 14E ............................................................................................................. 240.14e–1 thru 240.14e–2 ....................... 3235–0102 

Rule 14f–1 .................................................................................................................... 240.14f–1 .................................................. 3235–0108 

Rule 15a–4 ................................................................................................................... 240.15a–4 ................................................. 3235–0010 

Rule 15a–6 ................................................................................................................... 240.15a–6 ................................................. 3235–0371 

Rule 15b1–1 ................................................................................................................. 240.15b1–1 ............................................... 3235–0012 

Rule 15b6–1(a) ............................................................................................................. 240.15b6–1(a) ........................................... 3235–0018 

Rule 15c1–5 ................................................................................................................. 240.15c1–5 ............................................... 3235–0471 

Rule 15c1–6 ................................................................................................................. 240.15c1–6 ............................................... 3235–0472 

Rule 15c1–7 ................................................................................................................. 240.15c1–7 ............................................... 3235–0134 

Rule 15c2–1 ................................................................................................................. 240.15c2–1 ............................................... 3235–0485 

Rule 15c2–5 ................................................................................................................. 240.15c2–5 ............................................... 3235–0198 

Rule 15c2–7 ................................................................................................................. 240.15c2–7 ............................................... 3235–0479 

Rule 15c2–8 ................................................................................................................. 240.15c2–8 ............................................... 3235–0481 

Rule 15c2–11 ............................................................................................................... 240.15c2–11 ............................................. 3235–0202 

Rule 15c2–12 ............................................................................................................... 240.15c2–12 ............................................. 3235–0372 

Rule 15c3–1 ................................................................................................................. 240.15c3–1 ............................................... 3235–0200 

Rule 15c3–1(c)(13) ....................................................................................................... 240.15c3–1(c)(13) ..................................... 3235–0499 

Appendix F to Rule 15c3–1 ......................................................................................... 240.15c3–1f .............................................. 3235–0496 

Rule 15c3–3 ................................................................................................................. 240.15c3–3 ............................................... 3235–0078 

Rule 15c3–4 ................................................................................................................. 240.15c3–4 ............................................... 3235–0497 

Rule 15d–16 ................................................................................................................. 240.15d–16 ............................................... 3235–0116 

Rule 15g–2 ................................................................................................................... 240.15g–2 ................................................. 3235–0434 

Rule 15g–3 ................................................................................................................... 240.15g–3 ................................................. 3235–0392 

Rule 15g–4 ................................................................................................................... 240.15g–4 ................................................. 3235–0393 

Rule 15g–5 ................................................................................................................... 240.15g–5 ................................................. 3235–0394 

Rule 15g–6 ................................................................................................................... 240.15g–6 ................................................. 3235–0395 

Rule 15g–9 ................................................................................................................... 240.15g–9 ................................................. 3235–0385 

Rule 15Aj–1 .................................................................................................................. 240.15Aj–1 ................................................ 3235–0044 

Rule 15Ba2–1 ............................................................................................................... 240.15Ba2–1 ............................................. 3235–0083 

Rule 15Ba2–5 ............................................................................................................... 240.15Ba2–5 ............................................. 3235–0088 

Rule 15Bc3–1 ............................................................................................................... 240.15Bc3–1 ............................................. 3235–0087 

Rule 17a–1 ................................................................................................................... 240.17a–1 ................................................. 3235–0208 

Rule 17a–2 ................................................................................................................... 240.17a–2 ................................................. 3235–0201 

Rule 17a–3 ................................................................................................................... 240.17a–3 ................................................. 3235–0033 

Rule 17a–3(a)(16) ........................................................................................................ 240.17a–3(a)(16) ...................................... 3235–0508 

Rule 17a–4 ................................................................................................................... 240.17a–4 ................................................. 3235–0279 

Rule 17a–4(b)(10) ........................................................................................................ 240.17a–4(b)(10) ...................................... 3235–0506 

Rule 17a–5 ................................................................................................................... 240.17a–5 ................................................. 3235–0123 

Rule 17a–5(c) ............................................................................................................... 240.17a–5(c) ............................................. 3235–0199 

Rule 17a–6 ................................................................................................................... 240.17a–6 ................................................. 3235–0489 

Rule 17a–7 ................................................................................................................... 240.17a–7 ................................................. 3235–0131 

Rule 17a–8 ................................................................................................................... 240.17a–8 ................................................. 3235–0092 

Rule 17a–9T ................................................................................................................. 240.17a–9T ............................................... 3235–0524 

Rule 17a–10 ................................................................................................................. 240.17a–10 ............................................... 3235–0122 

Rule 17a–11 ................................................................................................................. 240.17a–11 ............................................... 3235–0085 

Rule 17a–12 ................................................................................................................. 240.17a–12 ............................................... 3235–0498 

Rule 17a–13 ................................................................................................................. 240.17a–13 ............................................... 3235–0035 

Rule 17a–19 ................................................................................................................. 240.17a–19 ............................................... 3235–0133 

Rule 17a–22 ................................................................................................................. 240.17a–22 ............................................... 3235–0196 

Rule 17a–25 ................................................................................................................. 240.17a–25 ............................................... 3235–0540 

Rule 17f–1(b) ................................................................................................................ 240.17f–1(b) .............................................. 3235–0032 

Rule 17f–1(c) ................................................................................................................ 240.17f–1(c) .............................................. 3235–0037 

Rule 17f–1(g) ................................................................................................................ 240.17f–1(g) .............................................. 3235–0290 

Rule 17f–2(a) ................................................................................................................ 240.17f–2(a) .............................................. 3235–0034 

Rule 17f–2(c) ................................................................................................................ 240.17f–2(c) .............................................. 3235–0029 

Rule 17f–2(d) ................................................................................................................ 240.17f–2(d) .............................................. 3235–0028 

Rule 17f–2(e) ................................................................................................................ 240.17f–2(e) .............................................. 3235–0031 

Rule 17f–5 .................................................................................................................... 240.17f–5 .................................................. 3235–0269 

Rule 17h–1T ................................................................................................................. 240.17h–1T ............................................... 3235–0410 

Rule 17h–2T ................................................................................................................. 240.17h–2T ............................................... 3235–0410 

Rule 17Ab2–1 ............................................................................................................... 240.17Ab2–1(a) ........................................ 3235–0195 

Rule 17Ac2–1 ............................................................................................................... 240.17Ac2–1 ............................................. 3235–0084 

Rule 17Ad–2(c), (d), and (h) ........................................................................................ 240.17Ad–2(c), (d) and (h) ....................... 3235–0130 

Rule 17Ad–3(b) ............................................................................................................ 240.17Ad–3(b) .......................................... 3235–0473 

Rule 17Ad–4(b) and (c) ................................................................................................ 240.17Ad–4(b) and (c) .............................. 3235–0341 

Rule 17Ad–6 ................................................................................................................. 240.17Ad–6 ............................................... 3235–0291 

Rule 17Ad–7 ................................................................................................................. 240.17Ad–7 ............................................... 3235–0291 

Rule 17Ad–10 ............................................................................................................... 240.17Ad–10 ............................................. 3235–0273 

Rule 17Ad–11 ............................................................................................................... 240.17Ad–11 ............................................. 3235–0274 

Rule 17Ad–13 ............................................................................................................... 240.17Ad–13 ............................................. 3235–0275 

Rule 17Ad–15 ............................................................................................................... 240.17Ad–15 ............................................. 3235–0409 

Rule 17Ad–16 ............................................................................................................... 240.17Ad–16 ............................................. 3235–0413 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77501

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Rule 17Ad–17 ............................................................................................................... 240.17Ad–17 ............................................. 3235–0469 

Rule 19b–1 ................................................................................................................... 240.19b–1 ................................................. 3235–0354 

Rule 19b–4 ................................................................................................................... 240.19b–4 ................................................. 3235–0045 

Rule 19b–4(e) ............................................................................................................... 240.19b–4(e) ............................................. 3235–0504 

Rule 19b–5 ................................................................................................................... 240.19b–5 ................................................. 3235–0507 

Rule 19b–7 ................................................................................................................... 240.19b–7 ................................................. 3235–0553 

Rule 19d–1 ................................................................................................................... 240.19d–1(b) thru 240.19d–1(i) ................ 3235–0206 

Rule 19d–2 ................................................................................................................... 240.19d–2 ................................................. 3235–0205 

Rule 19d–3 ................................................................................................................... 240.19d–3 ................................................. 3235–0204 

Rule 19h–1 ................................................................................................................... 240.19h–1(a), (c) thru (e), and (g) ........... 3235–0259 

Rule 24b–1 ................................................................................................................... 240.24b–1 ................................................. 3235–0194 

Rule 101 ....................................................................................................................... 242.101 ..................................................... 3235–0464 

Rule 102 ....................................................................................................................... 242.102 ..................................................... 3235–0467 

Rule 103 ....................................................................................................................... 242.103 ..................................................... 3235–0466 

Rule 104 ....................................................................................................................... 242.104 ..................................................... 3235–0465 

Rule 301 ....................................................................................................................... 242.301 ..................................................... 3235–0509 

Rule 302 ....................................................................................................................... 242.302 ..................................................... 3235–0510 

Rule 303 ....................................................................................................................... 242.303 ..................................................... 3235–0505 

Rule 604 ....................................................................................................................... 242.604 ..................................................... 3235–0462 

Rule 605 ....................................................................................................................... 242.605 ..................................................... 3235–0542 

Rule 606 ....................................................................................................................... 242.606 ..................................................... 3235–0541 

Rule 607 ....................................................................................................................... 242.607 ..................................................... 3235–0435 

Rule 608 ....................................................................................................................... 242.608 ..................................................... 3235–0500 

Rule 609 ....................................................................................................................... 242.609 ..................................................... 3235–0043 

Rule 611 ....................................................................................................................... 242.611 ..................................................... 3235–0600 

Regulation S–P ............................................................................................................ Part 248 .................................................... 3235–0537 

Form 1 .......................................................................................................................... 249.1 ......................................................... 3235–0017 

Form 1–N ..................................................................................................................... 249.10 ....................................................... 3235–0554 

Form 25 ........................................................................................................................ 249.25 ....................................................... 3235–0080 

Form 26 ........................................................................................................................ 249.26 ....................................................... 3235–0079 

Form 3 .......................................................................................................................... 249.103 ..................................................... 3235–0104 

Form 4 .......................................................................................................................... 249.104 ..................................................... 3235–0287 

Form 5 .......................................................................................................................... 249.105 ..................................................... 3235–0362 

Form 8–A ...................................................................................................................... 249.208a ................................................... 3235–0056 

Form 10 ........................................................................................................................ 249.210 ..................................................... 3235–0064 

Form 10–SB ................................................................................................................. 249.210b ................................................... 3235–0419 

Form 18 ........................................................................................................................ 249.218 ..................................................... 3235–0121 

Form 20–F .................................................................................................................... 249.220f .................................................... 3235–0288 

Form 40–F .................................................................................................................... 249.240f .................................................... 3235–0381 

Form 6–K ...................................................................................................................... 249.306 ..................................................... 3235–0116 

Form 8–K ...................................................................................................................... 249.308 ..................................................... 3235–0060 

Form 10–Q ................................................................................................................... 249.308a ................................................... 3235–0070 

Form 10–QSB .............................................................................................................. 249.308b ................................................... 3235–0416 

Form 10–K .................................................................................................................... 249.310 ..................................................... 3235–0063 

Form 10–KSB ............................................................................................................... 249.310b ................................................... 3235–0420 

Form 11–K .................................................................................................................... 249.311 ..................................................... 3235–0082 

Form 18–K .................................................................................................................... 249.318 ..................................................... 3235–0120 

Form 12B–25 ................................................................................................................ 249.322 ..................................................... 3235–0058 

Form 15 ........................................................................................................................ 249.323 ..................................................... 3235–0167 

Form 13F ...................................................................................................................... 249.325 ..................................................... 3235–0006 

Form SE ....................................................................................................................... 249.444 ..................................................... 3235–0327 

Form ET ....................................................................................................................... 249.445 ..................................................... 3235–0329 

Form ID ........................................................................................................................ 249.446 ..................................................... 3235–0328 

Form DF ....................................................................................................................... 249.448 ..................................................... 3235–0482 

Form BD ....................................................................................................................... 249.501 ..................................................... 3235–0012 

Form BDW .................................................................................................................... 249.501a ................................................... 3235–0018 

Form BD–N .................................................................................................................. 249.501b ................................................... 3235–0556 

Form X–17A–5 ............................................................................................................. 249.617 ..................................................... 3235–0123 

Form X–17A–19 ........................................................................................................... 249.635 ..................................................... 3235–0133 

Form ATS ..................................................................................................................... 249.637 ..................................................... 3235–0509 

Form ATS–R ................................................................................................................ 249.638 ..................................................... 3235–0509 

Form X–15AJ–1 ........................................................................................................... 249.802 ..................................................... 3235–0044 

Form X–15AJ–2 ........................................................................................................... 249.803 ..................................................... 3235–0044 

Form 19b–4 .................................................................................................................. 249.819 ..................................................... 3235–0045 

Form 19b–4(e) .............................................................................................................. 249.820 ..................................................... 3235–0504 

Form Pilot ..................................................................................................................... 249.821 ..................................................... 3235–0507 

Form SIP ...................................................................................................................... 249.1001 ................................................... 3235–0043 

Form MSD .................................................................................................................... 249.1100 ................................................... 3235–0083 

Form MSDW ................................................................................................................. 249.1110 ................................................... 3235–0087 

Form X–17F–1A ........................................................................................................... 249.1200 ................................................... 3235–0037 

Form TA–1 ................................................................................................................... 249b.100 ................................................... 3235–0084 

Form TA–W .................................................................................................................. 249b.101 ................................................... 3235–0151 

Form TA–2 ................................................................................................................... 249b.102 ................................................... 3235–0337 

77502 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Form CA–1 ................................................................................................................... 249b.200 ................................................... 3235–0195 

Rule 1(a) ....................................................................................................................... 250.1(a) ..................................................... 3235–0170 

Rule 1(b) ....................................................................................................................... 250.1(b) ..................................................... 3235–0170 

Rule 1(c) ....................................................................................................................... 250.1(c) ..................................................... 3235–0164 

Rule 2 ........................................................................................................................... 250.2 ......................................................... 3235–0161 

Rule 3 ........................................................................................................................... 250.3 ......................................................... 3235–0160 

Rule 7 ........................................................................................................................... 250.7 ......................................................... 3235–0165 

Rule 7(d) ....................................................................................................................... 250.7(d) ..................................................... 3235–0165 

Rule 20(b) ..................................................................................................................... 250.20(b) ................................................... 3235–0125 

Rule 20(c) ..................................................................................................................... 250.20(c) ................................................... 3235–0125 

Rule 20(d) ..................................................................................................................... 250.20(d) ................................................... 3235–0163 

Rule 23 ......................................................................................................................... 250.23 ....................................................... 3235–0125 

Rule 24 ......................................................................................................................... 250.24 ....................................................... 3235–0126 

Rule 26 ......................................................................................................................... 250.26 ....................................................... 3235–0183 

Rule 29 ......................................................................................................................... 250.29 ....................................................... 3235–0149 

Rule 44 ......................................................................................................................... 250.44 ....................................................... 3235–0147 

Rule 45 ......................................................................................................................... 250.45 ....................................................... 3235–0154 

Rule 47(b) ..................................................................................................................... 250.47(b) ................................................... 3235–0163 

Rule 52 ......................................................................................................................... 250.52 ....................................................... 3235–0369 

Form 53 ........................................................................................................................ 250.53 ....................................................... 3235–0426 

Rule 54 ......................................................................................................................... 250.54 ....................................................... 3235–0427 

Rule 57(a) ..................................................................................................................... 250.57(a) ................................................... 3235–0428 

Rule 57(b) ..................................................................................................................... 250.57(b) ................................................... 3235–0429 

Rule 58 ......................................................................................................................... 250.58 ....................................................... 3235–0457 

Rule 62 ......................................................................................................................... 250.62 ....................................................... 3235–0152 

Rule 71(a) ..................................................................................................................... 250.71(a) ................................................... 3235–0173 

Rule 72 ......................................................................................................................... 250.72 ....................................................... 3235–0149 

Rule 83 ......................................................................................................................... 250.83 ....................................................... 3235–0181 

Rule 87 ......................................................................................................................... 250.87 ....................................................... 3235–0552 

Rule 88 ......................................................................................................................... 250.88 ....................................................... 3235–0182 

Rule 93 ......................................................................................................................... 250.93 ....................................................... 3235–0153 

Rule 94 ......................................................................................................................... 250.94 ....................................................... 3235–0153 

Rule 95 ......................................................................................................................... 250.95 ....................................................... 3235–0162 

Rule 100(a) ................................................................................................................... 250.100(a) ................................................. 3235–0125 

Uniform System of Accounts for Mutual Service Companies and Subsidiary Service 

Companies, Public Utility Holding Company Act of 1935.

Part 256 .................................................... 3235–0153 

Preservation and Destruction of Records of Registered Public Utility Holding Companies and of Mutual and Subsidiary Service Companies.Part 257 .................................................... 3235–0306 

Form U5A ..................................................................................................................... 259.5a ....................................................... 3235–0170 

Form U5B ..................................................................................................................... 259.5b ....................................................... 3235–0170 

Form U5S ..................................................................................................................... 259.5s ....................................................... 3235–0164 

Form U–1 ..................................................................................................................... 259.101 ..................................................... 3235–0125 

Form U–13–1 ............................................................................................................... 259.113 ..................................................... 3235–0182 

Form U–6B–2 ............................................................................................................... 259.206 ..................................................... 3235–0163 

Form U–57 ................................................................................................................... 259.207 ..................................................... 3235–0428 

Form U–9C–3 ............................................................................................................... 259.208 ..................................................... 3235–0457 

Form U–12(I)–A ............................................................................................................ 259.212a ................................................... 3235–0173 

Form U–12(I)–B ............................................................................................................ 259.212b ................................................... 3235–0173 

Form U–13E–1 ............................................................................................................. 259.213 ..................................................... 3235–0162 

Form U–R–1 ................................................................................................................. 259.221 ..................................................... 3235–0152 

Form U–13–60 ............................................................................................................. 259.313 ..................................................... 3235–0153 

Form U–3A–2 ............................................................................................................... 259.402 ..................................................... 3235–0161 

Form U–3A3–1 ............................................................................................................. 259.403 ..................................................... 3235–0160 

Form U–7D ................................................................................................................... 259.404 ..................................................... 3235–0165 

Form U–33–S ............................................................................................................... 259.405 ..................................................... 3235–0429 

Form ET ....................................................................................................................... 259.601 ..................................................... 3235–0329 

Form ID ........................................................................................................................ 259.602 ..................................................... 3235–0328 

Form SE ....................................................................................................................... 259.603 ..................................................... 3235–0327 

Rule 7a–15 thru 7a–37 ................................................................................................ 260.7a–15 thru 260.7a–37 ....................... 3235–0132 

Form T–1 ...................................................................................................................... 269.1 ......................................................... 3235–0110 

Form T–2 ...................................................................................................................... 269.2 ......................................................... 3235–0111 

Form T–3 ...................................................................................................................... 269.3 ......................................................... 3235–0105 

Form T–4 ...................................................................................................................... 269.4 ......................................................... 3235–0107 

Form ET ....................................................................................................................... 269.6 ......................................................... 3235–0329 

Form ID ........................................................................................................................ 269.7 ......................................................... 3235–0328 

Form SE ....................................................................................................................... 269.8 ......................................................... 3235–0327 

Form T–6 ...................................................................................................................... 269.9 ......................................................... 3235–0391 

Rule 0–1 ....................................................................................................................... 270.0–1 ..................................................... 3235–0531 

Rule 2a–7 ..................................................................................................................... 270.2a–7 ................................................... 3235–0268 

Rule 2a19–1 ................................................................................................................. 270.2a19–1 ............................................... 3235–0332 

Rule 3a–4 ..................................................................................................................... 270.3a–4 ................................................... 3235–0459 

Rule 6c–7 ..................................................................................................................... 270.6c–7 ................................................... 3235–0276 

Rule 6e–2 ..................................................................................................................... 270.6e–2 ................................................... 3235–0177 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77503

Information collection requirement 17 CFR part or section where identified 

and described 

Current OMB 

Control No. 

Rule 7d–1 ..................................................................................................................... 270.7d–1 ................................................... 3235–0311 

Rule 7d–2 ..................................................................................................................... 270.7d–2 ................................................... 3235–0527 

Section 8(b) of the Investment Company Act of 1940 ................................................ 270.8b–1 thru 270.8b–32 ......................... 3235–0176 

Rule 10f–3 .................................................................................................................... 270.10f–3 .................................................. 3235–0226 

Rule 11a–2 ................................................................................................................... 270.11a–2 ................................................. 3235–0272 

Rule 11a–3 ................................................................................................................... 270.11a–3 ................................................. 3235–0358 

Rule 12b–1 ................................................................................................................... 270–12b–1 ................................................ 3235–0212 

Rule 17a–7 ................................................................................................................... 270.17a–7 ................................................. 3235–0214 

Rule 17a–8 ................................................................................................................... 270.17a–8 ................................................. 3235–0235 

Rule 17e–1 ................................................................................................................... 270.17e–1 ................................................. 3235–0217 

Rule 17f–1 .................................................................................................................... 270.17f–1 .................................................. 3235–0222 

Rule 17f–2 .................................................................................................................... 270.17f–2 .................................................. 3235–0223 

Rule 17f–4 .................................................................................................................... 270.17f–4 .................................................. 3235–0225 

Rule 17f–6 .................................................................................................................... 270.17f–6 .................................................. 3235–0447 

Rule 17f–7 .................................................................................................................... 270–17f–7 ................................................. 3235–0529 

Rule 17g–1(g) ............................................................................................................... 270.17g–1(g) ............................................. 3235–0213 

Rule 17j–1 .................................................................................................................... 270.17j–1 .................................................. 3235–0224 

Rule 18f–1 .................................................................................................................... 270.18f–1 .................................................. 3235–0211 

Rule 18f–3 .................................................................................................................... 270.18f–3 .................................................. 3235–0441 

Rule 19a–1 ................................................................................................................... 270.19a–1 ................................................. 3235–0216 

Rule 20a–1 ................................................................................................................... 270–20a–1 ................................................ 3235–0158 

Rule 22d–1 ................................................................................................................... 270–22d–1 ................................................ 3235–0310 

Rule 23c–1 ................................................................................................................... 270.23c–1 ................................................. 3235–0260 

Rule 23c–3 ................................................................................................................... 270.23c–3 ................................................. 3235–0422 

Rule 27e–1 ................................................................................................................... 270.27e–1 ................................................. 3235–0545 

Rule 30b2–1 ................................................................................................................. 270.30b2–1 ............................................... 3235–0220 

Rule 30d–2 ................................................................................................................... 270.30d–2 ................................................. 3235–0494 

Rule 30e–1 ................................................................................................................... 270.30e–1 ................................................. 3235–0025 

Rule 31a–1 ................................................................................................................... 270.31a–1 ................................................. 3235–0178 

Rule 31a–2 ................................................................................................................... 270.31a–2 ................................................. 3235–0179 

Rule 32a–4 ................................................................................................................... 270.32a–4 ................................................. 3235–0530 

Rule 34b–1 ................................................................................................................... 270.34b–1 ................................................. 3235–0346 

Rule 35d–1 ................................................................................................................... 270–35d–1 ................................................ 3235–0548 

Form N–5 ..................................................................................................................... 274.5 ......................................................... 3235–0169 

Form N–8A ................................................................................................................... 274.10 ....................................................... 3235–0175 

Form N–2 ..................................................................................................................... 274.11a–1 ................................................. 3235–0026 

Form N–3 ..................................................................................................................... 274.11b ..................................................... 3235–0316 

Form N–4 ..................................................................................................................... 274.11c ..................................................... 3235–0318 

Form N–8B–2 ............................................................................................................... 274.12 ....................................................... 3235–0186 

Form N–6F ................................................................................................................... 274.15 ....................................................... 3235–0238 

Form 24F–2 .................................................................................................................. 274.24 ....................................................... 3235–0456 

Form N–18F–1 ............................................................................................................. 274.51 ....................................................... 3235–0211 

Form N–54A ................................................................................................................. 274.53 ....................................................... 3235–0237 

Form N–54C ................................................................................................................. 274.54 ....................................................... 3235–0236 

Form N–SAR ................................................................................................................ 274.101 ..................................................... 3235–0330 

Form N–27E–1 ............................................................................................................. 274.127e–1 ............................................... 3235–0545 

Form N–27F–1 ............................................................................................................. 274.127f–1 ................................................ 3235–0546 

Form N–17D–1 ............................................................................................................. 274.200 ..................................................... 3235–0229 

Form N–23C–1 ............................................................................................................. 274.201 ..................................................... 3235–0230 

Form N–8F ................................................................................................................... 274.218 ..................................................... 3235–0157 

Form N–17F–1 ............................................................................................................. 274.219 ..................................................... 3235–0359 

Form N–17F–2 ............................................................................................................. 274.220 ..................................................... 3235–0360 

Form N–23c–3 .............................................................................................................. 274.221 ..................................................... 3235–0422 

Form ET ....................................................................................................................... 274.401 ..................................................... 3235–0329 

Form ID ........................................................................................................................ 274.402 ..................................................... 3235–0328 

Form SE ....................................................................................................................... 274.403 ..................................................... 3235–0327 

Rule 0–2 ....................................................................................................................... 275.0–2 ..................................................... 3235–0240 

Rule 203–3 ................................................................................................................... 275.203–3 ................................................. 3235–0538 

Rule 204–2 ................................................................................................................... 275.204–2 ................................................. 3235–0278 

Rule 204–3 ................................................................................................................... 275.204–3 ................................................. 3235–0047 

Rule 206(3)–2 ............................................................................................................... 275.206(3)–2 ............................................. 3235–0243 

Rule 206(4)–2 ............................................................................................................... 275.206(4)–2 ............................................. 3235–0241 

Rule 206(4)–3 ............................................................................................................... 275.206(4)–3 ............................................. 3235–0242 

Rule 206(4)–4 ............................................................................................................... 275.206(4)–4 ............................................. 3235–0345 

Form ADV ..................................................................................................................... 279.1 ......................................................... 3235–0049 

Schedule I to Form ADV .............................................................................................. 279.1 ......................................................... 3235–0490 

Form ADV–W ............................................................................................................... 279.2 ......................................................... 3235–0313 

Form ADV–H ................................................................................................................ 379.3 ......................................................... 3235–0538 

Form 4–R ..................................................................................................................... 279.4 ......................................................... 3235–0240 

Form 5–R ..................................................................................................................... 279.5 ......................................................... 3235–0240 

Form 6–R ..................................................................................................................... 279.6 ......................................................... 3235–0240 

Form 7–R ..................................................................................................................... 279.7 ......................................................... 3235–0240 

Form ADV–E ................................................................................................................ 279.8 ......................................................... 3235–0361 

77504 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

PART 201—RULES OF PRACTICE 

5. The authority citation for part 201 

continues to read as follows:

Authority: 15 U.S.C. 77s, 78w, 78x, 79t, 

77sss, 80a–37 and 80b–11; 5 U.S.C. 504(c)(1).

6. Section 201.101 is amended by 

revising paragraphs (a)(9)(vi) and 

(a)(9)(vii) to read as follows:

§ 201.101 Definitions. 

(a) * * * 

(9) * * * 

(vi) By the filing, pursuant to 

§ 242.601 of this chapter, of an 

application for review of an action or 

failure to act in connection with the 

implementation or operation of any 

effective transaction reporting plan; or 

(vii) By the filing, pursuant to 

§ 242.608 of this chapter, of an 

application for review of an action taken 

or failure to act in connection with the 

implementation or operation of any 

effective national market system plan; or

* * * * *

PART 230—GENERAL RULES AND 

REGULATIONS, SECURITIES ACT OF 

1933 

7. The general authority citation for 

part 230 is revised to read as follows:

Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 

77g, 77h, 77j, 77r, 77s, 77z–3, 78c, 78d, 78j, 

78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 78mm, 

79t, 77sss, 80a–8, 80a–24, 80a–28, 80a–29, 

80a–30, and 80a–37, unless otherwise noted.

* * * * *

8. Section 230.144 is amended by: 

a. Removing the authority citation 

following § 230.144; and 

b. Revising paragraph (e)(1)(iii). 

The revision reads as follows:

§ 230.144 Persons deemed not to be 

engaged in a distribution and therefore not 

underwriters.

* * * * *

(e) * * * 

(1) * * * 

(iii) The average weekly volume of 

trading in such securities reported 

pursuant to an effective transaction 

reporting plan or an effective national 

market system plan as those terms are 

defined in § 242.600 of this chapter 

during the four-week period specified in 

paragraph (e)(1)(ii) of this section.

* * * * *

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

9. The general authority citation for 

part 240 is revised to read as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 78c, 78d, 78e, 78f, 78g, 

78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 

78o, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, 

78mm, 79q, 79t, 77eee, 77ggg, 77nnn, 77sss, 

77ttt, 80a–20, 80a–23, 80a–29, 80a–37, 80b–

3, 80b–4, 80b–11, and 7201 et seq.; and 18 

U.S.C. 1350, unless otherwise noted.

* * * * *

10. Section 240.0–10 is amended by 

revising paragraph (e)(1) to read as 

follows:

§ 240.0–10 Small entities under the 

Securities Exchange Act for purposes of 

the Regulatory Flexibility Act.

* * * * *

(e) * * * 

(1) Has been exempted from the 

reporting requirements of § 242.601 of 

this chapter; and

* * * * *

11. Section 240.3a51–1 is amended by 

revising the introductory text of 

paragraphs (a) and (e) to read as follows:

§ 240.3a51–1 Definition of ‘‘penny stock’’.

* * * * *

(a) That is an NMS stock, as defined 

in § 242.600 of this chapter:

* * * * *

(e) That is registered, or approved for 

registration upon notice of issuance, on 

a national securities exchange that 

makes transaction reports available 

pursuant to § 242.601 of this chapter, 

provided that:

* * * * *

12. Section 240.3a55–1 is amended by 

revising paragraphs (a)(2)(ii) and 

(b)(2)(ii)(B) to read as follows:

§ 240.3a55–1 Method for determining 

market capitalization and dollar value of 

average daily trading volume; application of 

the definition of narrow-based security 

index. 

(a) * * * 

(2) * * * 

(ii) The 750 securities with the largest 

market capitalization shall be identified 

from the universe of all NMS securities, 

as defined in § 242.600 of this chapter, 

that are common stock or depositary 

shares. 

(b) * * * 

(2) * * * 

(ii) * * * 

(B) The 675 securities with the largest 

dollar value of ADTV shall be identified 

from the universe of all NMS securities 

as defined in § 242.600 of this chapter 

that are common stock or depositary 

shares.

* * * * *

13. Section 240.3b–16 is amended by 

revising paragraph (d) to read as 

follows:

§ 240.3b–16 Definitions of terms used in 

Section 3(a)(1) of the Act.

* * * * *

(d) For the purposes of this section, 

the terms bid and offer shall have the 

same meaning as under § 242.600 of this 

chapter.

* * * * *

14. Section 240.10a–1 is amended by 

revising paragraphs (a)(1), (e)(5)(ii) and 

(e)(11) to read as follows:

§ 240.10a–1 Short sales. 

(a)(1)(i) No person shall, for his own 

account or for the account of any other 

person, effect a short sale of any security 

registered on, or admitted to unlisted 

trading privileges on, a national 

securities exchange, if trades in such 

securities are reported pursuant to an 

‘‘effective transaction reporting plan’’ as 

defined in § 242.600 of this chapter and 

information as to such trades is made 

available in accordance with such plan 

on a real-time basis to vendors of market 

transaction information: 

(A) Below the price at which the last 

sale thereof, regular way, was reported 

pursuant to an effective transaction 

reporting plan; or 

(B) At such price unless such price is 

above the next proceeding different 

price at which a sale of such security, 

regular way, was reported pursuant to 

an effective transaction reporting plan. 

(ii) The provisions of paragraph 

(a)(1)(i) of this section hereof shall not 

apply to transactions by any person in 

Nasdaq securities as defined in 

§ 242.600 of this chapter, except for 

those Nasdaq securities for which 

transaction reports are collected, 

processed, and made available pursuant 

to the plan originally submitted to the 

Commission pursuant to § 240.17a–15 

(subsequently amended and 

redesignated as § 240.11Aa3–1 and 

subsequently redesignated as § 242.601 

of this chapter), which plan was 

declared effective as of May 17, 1974.

* * * * *

(e) * * * 

(5) * * * 

(ii) Effected at a price equal to the 

most recent offer communicated for the 

security by such registered specialist, 

registered exchange market maker or 

third market maker to an exchange or a 

national securities association 

(‘‘association’’) pursuant to § 242.602 of 

this chapter, if such offer, when 

communicated, was equal to or above 

the last sale, regular way, reported for 

such security pursuant to an effective 

transaction reporting plan: 

Provided, however, That any 

exchange, by rule, may prohibit its 

registered specialist and registered 

exchange market makers from availing 

themselves of the exemption afforded by 

this paragraph (e)(5) if that exchange 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77505

determines that such action is necessary 

or appropriate in its market in the 

public interest or for the protection of 

investors;

* * * * *

(11) Any sale of a security covered by 

paragraph (a) of this section (except a 

sale to a stabilizing bid complying with 

§ 242.104 of this chapter) by any broker 

or dealer, for his own account or for the 

account of any other person, effected at 

a price equal to the most recent offer 

communicated by such broker or dealer 

to an exchange or association pursuant 

to § 242.602 of this chapter in an 

amount less than or equal to the 

quotation size associated with such 

offer, if such offer, when communicated, 

was:

(i) Above the price at which the last 

sale, regular way, for such security was 

reported pursuant to an effective 

transaction reporting plan; or 

(ii) At such last sale price, if such last 

sale price is above the next preceding 

different price at which a sale of such 

security, regular way, was reported 

pursuant to an effective transaction 

reporting plan.

* * * * *

15. Section 240.10b–10 is amended 

by: 

a. Revising paragraphs (a)(2)(i)(C), 

(a)(2)(ii)(B) and (d)(7); 

b. Removing paragraph (d)(8); and 

c. Redesignating paragraphs (d)(9) and 

(d)(10) as paragraphs (d)(8) and (d)(9). 

The revisions read as follows:

§ 240.10b–10 Confirmation of transactions.

* * * * *

(a) * * * 

(1) * * * 

(i) * * * 

(C) For a transaction in any NMS 

stock as defined in § 242.600 of this 

chapter or a security authorized for 

quotation on an automated interdealer 

quotation system that has the 

characteristics set forth in section 17B of 

the Act (15 U.S.C. 78q–2), a statement 

whether payment for order flow is 

received by the broker or dealer for 

transactions in such securities and the 

fact that the source and nature of the 

compensation received in connection 

with the particular transaction will be 

furnished upon written request of the 

customer; provided, however, that 

brokers or dealers that do not receive 

payment for order flow in connection 

with any transaction have no disclosure 

obligations under this paragraph; and

* * * * *

(ii) * * * 

(B) In the case of any other transaction 

in an NMS stock as defined by § 242.600 

of this chapter, or an equity security that 

is traded on a national securities 

exchange and that is subject to last sale 

reporting, the reported trade price, the 

price to the customer in the transaction, 

and the difference, if any, between the 

reported trade price and the price to the 

customer.

* * * * *

(d) * * * 

(7) NMS stock shall have the meaning 

provided in § 242.600 of this chapter.

* * * * *

16. Section 240.10b–18 is amended by 

revising paragraph (a)(6) to read as 

follows:

§ 240.10b–18 Purchases of certain equity 

securities by the issuer and others.

* * * * *

(a) * * * 

(6) Consolidated system means a 

consolidated transaction or quotation 

reporting system that collects and 

publicly disseminates on a current and 

continuous basis transaction or 

quotation information in common 

equity securities pursuant to an effective 

transaction reporting plan or an 

effective national market system plan 

(as those terms are defined in § 242.600 

of this chapter).

* * * * *

§ 240.11Aa2–1 through 240.11Ac1–6

[Removed] 

17. The undesignated center heading 

preceding § 240.11Aa2–1 and 

§§ 240.11Aa2–1 through 240.11Ac1–6 

are removed. 

18. Section 240.12a–7 is amended by 

revising the introductory text of 

paragraph (a)(2) to read as follows:

§ 240.12a–7 Exemption of stock contained 

in standardized market baskets from 

section 12(a) of the Act. 

(a) * * * 

(2) The stock is an NMS stock as 

defined in § 242.600 of this chapter and 

is either:

* * * * *

19. Section 240.12f–1 is amended by: 

a. Removing the authority citation 

following the section; 

b. Removing ‘‘and’’ at the end of 

paragraph (a)(3); and 

c. Revising paragraph (a)(4). 

The revision reads as follows:

§ 240.12f–1 Applications for permission to 

reinstate unlisted trading privileges. 

(a) * * * 

(4) Whether transaction information 

concerning such security is reported 

pursuant to an effective transaction 

reporting plan contemplated by 

§ 242.601 of this chapter;

* * * * *

20. Section 240.12f–2 is amended by 

revising paragraph (a) to read as follows:

§ 240.12f–2 Extending unlisted trading 

privileges to a security that is the subject 

of an initial public offering. 

(a) General provision. A national 

securities exchange may extend unlisted 

trading privileges to a subject security 

when at least one transaction in the 

subject security has been effected on the 

national securities exchange upon 

which the security is listed and the 

transaction has been reported pursuant 

to an effective transaction reporting 

plan, as defined in § 242.600 of this 

chapter.

* * * * *

21. Section 240.15b9–1 is amended 

by: 

a. Removing the authority citation 

following the section; and 

b. Revising paragraph (c). 

The revision reads as follows:

§ 240.15b9–1 Exemption for certain 

exchange members.

* * * * *

(c) For purposes of this section, the 

term Intermarket Trading System shall 

mean the intermarket communications 

linkage operated jointly by certain selfregulatory organizations pursuant to a 

plan filed with, and approved by, the 

Commission pursuant to § 242.608 of 

this chapter. 

22. Section 240.15c2–11 is amended 

by revising paragraph (f)(5) to read as 

follows:

§ 240.15c2–11 Initiation or resumption of 

quotations without specified information.

* * * * *

(a) * * * 

(5) The publication or submission of 

a quotation respecting a Nasdaq security 

(as defined in § 242.600 of this chapter), 

and such security’s listing is not 

suspended, terminated, or prohibited.

* * * * *

23. Section 240.19c–3 is amended by 

revising paragraph (b)(6) to read as 

follows:

§ 240.19c–3 Governing off-board trading 

by members of national securities 

exchanges.

* * * * *

(b) * * * 

(6) The term effective transaction 

reporting plan shall mean any plan 

approved by the Commission pursuant 

to § 242.601 of this chapter for 

collecting, processing, and making 

available transaction reports with 

respect to transactions in an equity 

security or class of equity securities. 

24. Section 240.19c–4 is amended by 

revising paragraph (e)(6) to read as 

follows:

77506 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

§ 240.19c–4 Governing certain listing or 

authorization determinations by national 

securities exchanges and associations.

* * * * *

(e) * * * 

(6) The term exchange shall mean a 

national securities exchange, registered 

as such with the Securities and 

Exchange Commission pursuant to 

section 6 of the Act (15 U.S.C. 78f), 

which makes transaction reports 

available pursuant to § 242.601 of this 

chapter; and

* * * * *

25. Section 240.31 is amended by 

revising paragraph (a)(11)(v) to read as 

follows:

§ 240.31 Section 31 transaction fees. 

(a) Definitions. For the purpose of this 

section, the following definitions shall 

apply:

* * * * *

(11) * * *

(v) Any sale of a security that is 

executed outside the United States and 

is not reported, or required to be 

reported, to a transaction reporting 

association as defined in § 242.600 and 

any approved plan filed thereunder;

* * * * *

PART 242—REGULATIONS M, SHO, 

ATS, AC, AND NMS AND CUSTOMER 

MARGIN REQUIREMENTS FOR 

SECURITY FUTURES 

26. The authority citation for part 242 

is revised to read as follows:

Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 

78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l, 

78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 

78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a–

23, 80a–29, and 80a–37.

27. The part heading for part 242 is 

revised as set forth above.

28. Section 242.100 is amended by 

revising the definition for ‘‘electronic 

communications network’’ and 

‘‘Nasdaq’’ found in paragraph (b) to read 

as follows:

§ 242.100 Preliminary note; definitions.

* * * * *

(b) * * * 

Electronic communications network

has the meaning provided in § 242.600.

* * * * *

Nasdaq means the electronic dealer 

quotation system owned and operated 

by The Nasdaq Stock Market, Inc.

* * * * *

29. Section 242.300 is amended by: 

a. Revising paragraphs (g) and (h); 

b. Removing paragraphs (i) and (j); 

and 

c. Redesignating paragraphs (k), (l), 

and (m) as paragraphs (i), (j), and (k). 

The revisions read as follows:

§ 242.300 Definitions.

* * * * *

(g) NMS stock shall have the meaning 

provided in § 242.600; provided, 

however, that a debt or convertible 

security shall not be deemed an NMS 

stock for purposes of this Regulation 

ATS. 

(h) Effective transaction reporting 

plan shall have the meaning provided in 

§ 242.600.

* * * * *

30. Section 242.301 is amended by 

revising paragraphs (b)(3), (b)(5), and 

(b)(6) to read as follows:

§ 242.301 Requirements for alternative 

trading systems.

* * * * *

(b) * * * 

(3) Order display and execution 

access.

(i) An alternative trading system shall 

comply with the requirements set forth 

in paragraph (b)(3)(ii) of this section, 

with respect to any NMS stock in which 

the alternative trading system: 

(A) Displays subscriber orders to any 

person (other than alternative trading 

system employees); and 

(B) During at least 4 of the preceding 

6 calendar months, had an average daily 

trading volume of 5 percent or more of 

the aggregate average daily share 

volume for such NMS stock as reported 

by an effective transaction reporting 

plan. 

(ii) Such alternative trading system 

shall provide to a national securities 

exchange or national securities 

association the prices and sizes of the 

orders at the highest buy price and the 

lowest sell price for such NMS stock, 

displayed to more than one person in 

the alternative trading system, for 

inclusion in the quotation data made 

available by the national securities 

exchange or national securities 

association to vendors pursuant to 

§ 242.602. 

(i) With respect to any order 

displayed pursuant to paragraph 

(b)(3)(ii) of this section, an alternative 

trading system shall provide to any 

broker-dealer that has access to the 

national securities exchange or national 

securities association to which the 

alternative trading system provides the 

prices and sizes of displayed orders 

pursuant to paragraph (b)(3)(ii) of this 

section, the ability to effect a transaction 

with such orders that is: 

(A) Equivalent to the ability of such 

broker-dealer to effect a transaction with 

other orders displayed on the exchange 

or by the association; and 

(B) At the price of the highest priced 

buy order or lowest priced sell order 

displayed for the lesser of the 

cumulative size of such priced orders 

entered therein at such price, or the size 

of the execution sought by such brokerdealer.

* * * * *

(5) Fair access.

(i) An alternative trading system shall 

comply with the requirements in 

paragraph (b)(5)(ii) of this section, if 

during at least 4 of the preceding 6 

calendar months, such alternative 

trading system had: 

(A) With respect to any NMS stock, 5 

percent or more of the average daily 

volume in that security reported by an 

effective transaction reporting plan; 

(B) With respect to an equity security 

that is not an NMS stock and for which 

transactions are reported to a selfregulatory organization, 5 percent or 

more of the average daily trading 

volume in that security as calculated by 

the self-regulatory organization to which 

such transactions are reported; 

(C) With respect to municipal 

securities, 5 percent or more of the 

average daily volume traded in the 

United States; 

(D) With respect to investment grade 

corporate debt, 5 percent or more of the 

average daily volume traded in the 

United States; or 

(E) With respect to non-investment 

grade corporate debt, 5 percent or more 

of the average daily volume traded in 

the United States. 

(ii) An alternative trading system 

shall: 

(A) Establish written standards for 

granting access to trading on its system; 

(B) Not unreasonably prohibit or limit 

any person in respect to access to 

services offered by such alternative 

trading system by applying the 

standards established under paragraph 

(b)(5)(ii)(A) of this section in an unfair 

or discriminatory manner; 

(C) Make and keep records of: 

(1) All grants of access including, for 

all subscribers, the reasons for granting 

such access; and 

(2) All denials or limitations of access 

and reasons, for each applicant, for 

denying or limiting access; and 

(D) Report the information required 

on Form ATS–R (§ 249.638 of this 

chapter) regarding grants, denials, and 

limitations of access. 

(iii) Notwithstanding paragraph 

(b)(5)(i) of this section, an alternative 

trading system shall not be required to 

comply with the requirements in 

paragraph (b)(5)(ii) of this section, if 

such alternative trading system: 

(A) Matches customer orders for a 

security with other customer orders; 

(B) Such customers’ orders are not 

displayed to any person, other than 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77507

employees of the alternative trading 

system; and 

(C) Such orders are executed at a price 

for such security disseminated by an 

effective transaction reporting plan, or 

derived from such prices. 

(6) Capacity, integrity, and security of 

automated systems.

(i) The alternative trading system 

shall comply with the requirements in 

paragraph (b)(6)(ii) of this section, if 

during at least 4 of the preceding 6 

calendar months, such alternative 

trading system had: 

(A) With respect to any NMS stock, 20 

percent or more of the average daily 

volume reported by an effective 

transaction reporting plan; 

(B) With respect to equity securities 

that are not NMS stocks and for which 

transactions are reported to a selfregulatory organization, 20 percent or 

more of the average daily volume as 

calculated by the self-regulatory 

organization to which such transactions 

are reported; 

(C) With respect to municipal 

securities, 20 percent or more of the 

average daily volume traded in the 

United States; 

(D) With respect to investment grade 

corporate debt, 20 percent or more of 

the average daily volume traded in the 

United States; or

(E) With respect to non-investment 

grade corporate debt, 20 percent or more 

of the average daily volume traded in 

the United States. 

(i) With respect to those systems that 

support order entry, order routing, order 

execution, transaction reporting, and 

trade comparison, the alternative 

trading system shall: 

(A) Establish reasonable current and 

future capacity estimates; 

(B) Conduct periodic capacity stress 

tests of critical systems to determine 

such system’s ability to process 

transactions in an accurate, timely, and 

efficient manner; 

(C) Develop and implement 

reasonable procedures to review and 

keep current its system development 

and testing methodology; 

(D) Review the vulnerability of its 

systems and data center computer 

operations to internal and external 

threats, physical hazards, and natural 

disasters; 

(E) Establish adequate contingency 

and disaster recovery plans; 

(F) On an annual basis, perform an 

independent review, in accordance with 

established audit procedures and 

standards, of such alternative trading 

system’s controls for ensuring that 

paragraphs (b)(6)(ii)(A) through (E) of 

this section are met, and conduct a 

review by senior management of a 

report containing the recommendations 

and conclusions of the independent 

review; and 

(G) Promptly notify the Commission 

staff of material systems outages and 

significant systems changes. 

(iii) Notwithstanding paragraph 

(b)(6)(i) of this section, an alternative 

trading system shall not be required to 

comply with the requirements in 

paragraph (b)(6)(ii) of this section, if 

such alternative trading system: 

(A) Matches customer orders for a 

security with other customer orders; 

(B) Such customers’ orders are not 

displayed to any person, other than 

employees of the alternative trading 

system; and 

(C) Such orders are executed at a price 

for such security disseminated by an 

effective transaction reporting plan, or 

derived from such prices.

* * * * *

31. Part 242 is amended by adding 

Regulation NMS, §§ 242.600 through 

242.612 to read as follows:

Sec. 

Regulation NMS—Regulation of the National 

Market System 

242.600 NMS security designation and 

definitions. 

242.601 Dissemination of transaction 

reports and last sale data with respect to 

transactions in NMS stocks. 

242.602 Dissemination of quotations in 

NMS securities. 

242.603 Distribution, consolidation, and 

display of information with respect to 

quotations for and transactions in NMS 

stocks. 

242.604 Display of customer limit orders. 

242.605 Disclosure of order execution 

information. 

242.606 Disclosure of order routing 

information. 

242.607 Customer account statements. 

242.608 Filing and amendment of national 

market system plans. 

242.609 Registration of securities 

information processors: form of 

application and amendments. 

242.610 Access to quotations. 

242.611 Order protection rule. 

242.612 Minimum pricing increment.

Regulation NMS—Regulation of the 

National Market System

§ 242.600 NMS security designation and 

definitions. 

(a) The term national market system 

security as used in section 11A(a)(2) of 

the Act (15 U.S.C. 78k–1(a)(2)) shall 

mean any NMS security as defined in 

paragraph (b) of this section. 

(b) For purposes of Regulation NMS 

(§§ 242.600 through 242.612), the 

following definitions shall apply: 

(1) Aggregate quotation size means 

the sum of the quotation sizes of all 

responsible brokers or dealers who have 

communicated on any national 

securities exchange bids or offers for an 

NMS security at the same price. 

(2) Alternative trading system has the 

meaning provided in § 242.300(a). 

(3) Automated quotation means a 

quotation displayed by a trading center 

that: 

(i) Permits an incoming order to be 

marked as immediate-or-cancel; 

(ii) Immediately and automatically 

executes an order marked as immediateor-cancel against the displayed 

quotation up to its full size; 

(iii) Immediately and automatically 

cancels any unexecuted portion of an 

order marked as immediate-or-cancel 

without routing the order elsewhere; 

(iv) Immediately and automatically 

transmits a response to the sender of an 

order marked as immediate-or-cancel 

indicating the action taken with respect 

to such order; and 

(v) Immediately and automatically 

displays information that updates the 

displayed quotation to reflect any 

change to its material terms. 

(4) Automated trading center means a 

trading center that: 

(i) Has implemented such systems 

and rules as are necessary to render it 

capable of displaying quotations that 

meet the requirements for an automated 

quotation set forth in paragraph (b)(3) of 

this section; 

(ii) Identifies all quotations other than 

automated quotations as manual 

quotations; 

(iii) Immediately identifies its 

quotations as manual quotations 

whenever it has reason to believe that it 

is not capable of displaying automated 

quotations; and 

(iv) Has adopted reasonable standards 

limiting when its quotations change 

from automated quotations to manual 

quotations, and vice versa, to 

specifically defined circumstances that 

promote fair and efficient access to its 

automated quotations and are consistent 

with the maintenance of fair and orderly 

markets. 

(5) Average effective spread means the 

share-weighted average of effective 

spreads for order executions calculated, 

for buy orders, as double the amount of 

difference between the execution price 

and the midpoint of the national best 

bid and national best offer at the time 

of order receipt and, for sell orders, as 

double the amount of difference 

between the midpoint of the national 

best bid and national best offer at the 

time of order receipt and the execution 

price. 

(6) Average realized spread means the 

share-weighted average of realized 

spreads for order executions calculated, 

for buy orders, as double the amount of 

77508 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

difference between the execution price 

and the midpoint of the national best 

bid and national best offer five minutes 

after the time of order execution and, for 

sell orders, as double the amount of 

difference between the midpoint of the 

national best bid and national best offer 

five minutes after the time of order 

execution and the execution price; 

provided, however, that the midpoint of 

the final national best bid and national 

best offer disseminated for regular 

trading hours shall be used to calculate 

a realized spread if it is disseminated 

less than five minutes after the time of 

order execution. 

(7) Best bid and best offer mean the 

highest priced bid and the lowest priced 

offer. 

(8) Bid or offer means the bid price or 

the offer price communicated by a 

member of a national securities 

exchange or member of a national 

securities association to any broker or 

dealer, or to any customer, at which it 

is willing to buy or sell one or more 

round lots of an NMS security, as either 

principal or agent, but shall not include 

indications of interest. 

(9) Block size with respect to an order 

means it is: 

(i) Of at least 10,000 shares; or 

(ii) For a quantity of stock having a 

market value of at least $200,000. 

(10) Categorized by order size means 

dividing orders into separate categories 

for sizes from 100 to 499 shares, from 

500 to 1999 shares, from 2000 to 4999 

shares, and 5000 or greater shares. 

(11) Categorized by order type means 

dividing orders into separate categories 

for market orders, marketable limit 

orders, inside-the-quote limit orders, atthe-quote limit orders, and near-thequote limit orders. 

(12) Categorized by security means 

dividing orders into separate categories 

for each NMS stock that is included in 

a report. 

(13) Consolidated display means: 

(i) The prices, sizes, and market 

identifications of the national best bid 

and national best offer for a security; 

and 

(ii) Consolidated last sale information 

for a security. 

(14) Consolidated last sale 

information means the price, volume, 

and market identification of the most 

recent transaction report for a security 

that is disseminated pursuant to an 

effective national market system plan.

(15) Covered order means any market 

order or any limit order (including 

immediate-or-cancel orders) received by 

a market center during regular trading 

hours at a time when a national best bid 

and national best offer is being 

disseminated, and, if executed, is 

executed during regular trading hours, 

but shall exclude any order for which 

the customer requests special handling 

for execution, including, but not limited 

to, orders to be executed at a market 

opening price or a market closing price, 

orders submitted with stop prices, 

orders to be executed only at their full 

size, orders to be executed on a 

particular type of tick or bid, orders 

submitted on a ‘‘not held’’ basis, orders 

for other than regular settlement, and 

orders to be executed at prices unrelated 

to the market price of the security at the 

time of execution. 

(16) Customer means any person that 

is not a broker or dealer. 

(17) Customer limit order means an 

order to buy or sell an NMS stock at a 

specified price that is not for the 

account of either a broker or dealer; 

provided, however, that the term 

customer limit order shall include an 

order transmitted by a broker or dealer 

on behalf of a customer. 

(18) Customer order means an order to 

buy or sell an NMS security that is not 

for the account of a broker or dealer, but 

shall not include any order for a 

quantity of a security having a market 

value of at least $50,000 for an NMS 

security that is an option contract and 

a market value of at least $200,000 for 

any other NMS security. 

(19) Directed order means a customer 

order that the customer specifically 

instructed the broker or dealer to route 

to a particular venue for execution. 

(20) Dynamic market monitoring 

device means any service provided by a 

vendor on an interrogation device or 

other display that: 

(i) Permits real-time monitoring, on a 

dynamic basis, of transaction reports, 

last sale data, or quotation information 

with respect to a particular security; and 

(ii) Displays the most recent 

transaction report, last sale data, or 

quotation information with respect to 

that security until such report, data, or 

information has been superseded or 

supplemented by the display of a new 

transaction report, last sale data, or 

quotation information reflecting the 

next reported transaction or quotation in 

that security. 

(21) Effective national market system 

plan means any national market system 

plan approved by the Commission 

(either temporarily or on a permanent 

basis) pursuant to § 242.608. 

(22) Effective transaction reporting 

plan means any transaction reporting 

plan approved by the Commission 

pursuant to § 242.601. 

(23) Electronic communications 

network means any electronic system 

that widely disseminates to third parties 

orders entered therein by an exchange 

market maker or OTC market maker, 

and permits such orders to be executed 

against in whole or in part; except that 

the term electronic communications 

network shall not include: 

(i) Any system that crosses multiple 

orders at one or more specified times at 

a single price set by the system (by 

algorithm or by any derivative pricing 

mechanism) and does not allow orders 

to be crossed or executed against 

directly by participants outside of such 

times; or 

(ii) Any system operated by, or on 

behalf of, an OTC market maker or 

exchange market maker that executes 

customer orders primarily against the 

account of such market maker as 

principal, other than riskless principal. 

(24) Exchange market maker means 

any member of a national securities 

exchange that is registered as a 

specialist or market maker pursuant to 

the rules of such exchange. 

(25) Exchange-traded security means 

any NMS security or class of NMS 

securities listed and registered, or 

admitted to unlisted trading privileges, 

on a national securities exchange; 

provided, however, that securities not 

listed on any national securities 

exchange that are traded pursuant to 

unlisted trading privileges are excluded. 

(26) Executed at the quote means, for 

buy orders, execution at a price equal to 

the national best offer at the time of 

order receipt and, for sell orders, 

execution at a price equal to the 

national best bid at the time of order 

receipt. 

(27) Executed outside the quote

means, for buy orders, execution at a 

price higher than the national best offer 

at the time of order receipt and, for sell 

orders, execution at a price lower than 

the national best bid at the time of order 

receipt. 

(28) Executed with price improvement

means, for buy orders, execution at a 

price lower than the national best offer 

at the time of order receipt and, for sell 

orders, execution at a price higher than 

the national best bid at the time of order 

receipt. 

(29) Inside-the-quote limit order, atthe-quote limit order, and near-thequote limit order mean non-marketable 

buy orders with limit prices that are, 

respectively, higher than, equal to, and 

lower by $0.10 or less than the national 

best bid at the time of order receipt, and 

non-marketable sell orders with limit 

prices that are, respectively, lower than, 

equal to, and higher by $0.10 or less 

than the national best offer at the time 

of order receipt. 

(30) Intermarket sweep order means a 

limit order for an NMS stock that meets 

the following requirements: 

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(i) When routed to a trading center, 

the limit order is identified as an 

intermarket sweep order; and 

(ii) Simultaneously with the routing 

of the limit order identified as an 

intermarket sweep order, one or more 

additional limit orders, as necessary, are 

routed to execute against the full 

displayed size of any protected bid, in 

the case of a limit order to sell, or the 

full displayed size of any protected 

offer, in the case of a limit order to buy, 

for the NMS stock with a price that is 

superior to the limit price of the limit 

order identified as an intermarket sweep 

order. These additional routed orders 

also must be marked as intermarket 

sweep orders. 

(31) Interrogation device means any 

securities information retrieval system 

capable of displaying transaction 

reports, last sale data, or quotation 

information upon inquiry, on a current 

basis on a terminal or other device. 

(32) Joint self-regulatory organization 

plan means a plan as to which two or 

more self-regulatory organizations, 

acting jointly, are sponsors. 

(33) Last sale data means any price or 

volume data associated with a 

transaction. 

(34) Listed equity security means any 

equity security listed and registered, or 

admitted to unlisted trading privileges, 

on a national securities exchange. 

(35) Listed option means any option 

traded on a registered national securities 

exchange or automated facility of a 

national securities association. 

(36) Make publicly available means 

posting on an Internet Web site that is 

free and readily accessible to the public, 

furnishing a written copy to customers 

on request without charge, and notifying 

customers at least annually in writing 

that a written copy will be furnished on 

request. 

(37) Manual quotation means any 

quotation other than an automated 

quotation. 

(38) Market center means any 

exchange market maker, OTC market 

maker, alternative trading system, 

national securities exchange, or national 

securities association.

(39) Marketable limit order means any 

buy order with a limit price equal to or 

greater than the national best offer at the 

time of order receipt, or any sell order 

with a limit price equal to or less than 

the national best bid at the time of order 

receipt. 

(40) Moving ticker means any 

continuous real-time moving display of 

transaction reports or last sale data 

(other than a dynamic market 

monitoring device) provided on an 

interrogation or other display device. 

(41) Nasdaq security means any 

registered security listed on The Nasdaq 

Stock Market, Inc. 

(42) National best bid and national 

best offer means, with respect to 

quotations for an NMS security, the best 

bid and best offer for such security that 

are calculated and disseminated on a 

current and continuing basis by a plan 

processor pursuant to an effective 

national market system plan; provided,

that in the event two or more market 

centers transmit to the plan processor 

pursuant to such plan identical bids or 

offers for an NMS security, the best bid 

or best offer (as the case may be) shall 

be determined by ranking all such 

identical bids or offers (as the case may 

be) first by size (giving the highest 

ranking to the bid or offer associated 

with the largest size), and then by time 

(giving the highest ranking to the bid or 

offer received first in time). 

(43) National market system plan

means any joint self-regulatory 

organization plan in connection with: 

(i) The planning, development, 

operation or regulation of a national 

market system (or a subsystem thereof) 

or one or more facilities thereof; or 

(ii) The development and 

implementation of procedures and/or 

facilities designed to achieve 

compliance by self-regulatory 

organizations and their members with 

any section of this Regulation NMS and 

part 240, subpart A of this chapter 

promulgated pursuant to section 11A of 

the Act (15 U.S.C. 78k–1). 

(44) National securities association

means any association of brokers and 

dealers registered pursuant to section 

15A of the Act (15 U.S.C. 78o–3). 

(45) National securities exchange

means any exchange registered pursuant 

to section 6 of the Act (15 U.S.C. 78f). 

(46) NMS security means any security 

or class of securities for which 

transaction reports are collected, 

processed, and made available pursuant 

to an effective transaction reporting 

plan, or an effective national market 

system plan for reporting transactions in 

listed options. 

(47) NMS stock means any NMS 

security other than an option. 

(48) Non-directed order means any 

customer order other than a directed 

order. 

(49) Odd-lot means an order for the 

purchase or sale of an NMS stock in an 

amount less than a round lot. 

(50) Options class means all of the put 

option or call option series overlying a 

security, as defined in section 3(a)(10) of 

the Act (15 U.S.C. 78c(a)(10)). 

(51) Options series means the 

contracts in an options class that have 

the same unit of trade, expiration date, 

and exercise price, and other terms or 

conditions. 

(52) OTC market maker means any 

dealer that holds itself out as being 

willing to buy from and sell to its 

customers, or others, in the United 

States, an NMS stock for its own 

account on a regular or continuous basis 

otherwise than on a national securities 

exchange in amounts of less than block 

size. 

(53) Participants, when used in 

connection with a national market 

system plan, means any self-regulatory 

organization which has agreed to act in 

accordance with the terms of the plan 

but which is not a signatory of such 

plan. 

(54) Payment for order flow has the 

meaning provided in § 240.10b–10 of 

this chapter. 

(55) Plan processor means any selfregulatory organization or securities 

information processor acting as an 

exclusive processor in connection with 

the development, implementation and/

or operation of any facility 

contemplated by an effective national 

market system plan. 

(56) Profit-sharing relationship means 

any ownership or other type of 

affiliation under which the broker or 

dealer, directly or indirectly, may share 

in any profits that may be derived from 

the execution of non-directed orders. 

Alternative A 

Proposed Market BBO Alternative for 

Paragraph (b)(57) of This Section 

(57) Protected bid or protected offer

means a quotation in an NMS stock that: 

(i) Is displayed by an automated 

trading center; 

(ii) Is disseminated pursuant to an 

effective national market system plan; 

and 

(iii) Is 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. 

Alternative B 

Proposed Voluntary Depth Alternative 

for Paragraph (b)(57) of This Section 

(57) Protected bid or protected offer

means a quotation in an NMS stock that: 

(i) Is displayed by an automated 

trading center; 

(ii) Is disseminated pursuant to an 

effective national market system plan; 

and 

(iii) Is an automated quotation that is 

the best bid or best offer of a national 

securities exchange, the best bid or best 

77510 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

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., or such additional bids or 

offers that are designated as protected 

bids or protected offers pursuant to an 

effective national market system plan. 

(58) Protected quotation means a 

protected bid or a protected offer. 

(59) Published aggregate quotation 

size means the aggregate quotation size 

calculated by a national securities 

exchange and displayed by a vendor on 

a terminal or other display device at the 

time an order is presented for execution 

to a responsible broker or dealer. 

(60) Published bid and published offer

means the bid or offer of a responsible 

broker or dealer for an NMS security 

communicated by it to its national 

securities exchange or association 

pursuant to § 242.602 and displayed by 

a vendor on a terminal or other display 

device at the time an order is presented 

for execution to such responsible broker 

or dealer. 

(61) Published quotation size means 

the quotation size of a responsible 

broker or dealer communicated by it to 

its national securities exchange or 

association pursuant to § 242.602 and 

displayed by a vendor on a terminal or 

other display device at the time an order 

is presented for execution to such 

responsible broker or dealer. 

(62) Quotation size, when used with 

respect to a responsible broker’s or 

dealer’s bid or offer for an NMS 

security, means: 

(i) The number of shares (or units of 

trading) of that security which such 

responsible broker or dealer has 

specified, for purposes of dissemination 

to vendors, that it is willing to buy at 

the bid price or sell at the offer price 

comprising its bid or offer, as either 

principal or agent; or 

(ii) In the event such responsible 

broker or dealer has not so specified, a 

normal unit of trading for that NMS 

security. 

(63) Quotations and quotation 

information mean bids, offers and, 

where applicable, quotation sizes and 

aggregate quotation sizes. 

(64) Regular trading hours means the 

time between 9:30 a.m. and 4:00 p.m. 

Eastern Time, or such other time as is 

set forth in the procedures established 

pursuant to § 242.605(a)(2). 

(65) Responsible broker or dealer

means: 

(i) When used with respect to bids or 

offers communicated on a national 

securities exchange, any member of 

such national securities exchange who 

communicates to another member on 

such national securities exchange, at the 

location (or locations) or through the 

facility or facilities designated by such 

national securities exchange for trading 

in an NMS security a bid or offer for 

such NMS security, as either principal 

or agent; provided, however, that, in the 

event two or more members of a 

national securities exchange have 

communicated on or through such 

national securities exchange bids or 

offers for an NMS security at the same 

price, each such member shall be 

considered a responsible broker or 

dealer for that bid or offer, subject to the 

rules of priority and precedence then in 

effect on that national securities 

exchange; and further provided, that for 

a bid or offer which is transmitted from 

one member of a national securities 

exchange to another member who 

undertakes to represent such bid or offer 

on such national securities exchange as 

agent, only the last member who 

undertakes to represent such bid or offer 

as agent shall be considered the 

responsible broker or dealer for that bid 

or offer; and 

(ii) When used with respect to bids 

and offers communicated by an OTC 

market maker to a broker or dealer or a 

customer, the OTC market maker 

communicating the bid or offer 

(regardless of whether such bid or offer 

is for its own account or on behalf of 

another person). 

(66) Revised bid or offer means a 

market maker’s bid or offer which 

supersedes its published bid or 

published offer. 

(67) Revised quotation size means a 

market maker’s quotation size which 

supersedes its published quotation size. 

(68) Self-regulatory organization

means any national securities exchange 

or national securities association. 

(69) Specified persons, when used in 

connection with any notification 

required to be provided pursuant to 

§ 242.602(a)(3) and any election (or 

withdrawal thereof) permitted under 

§ 242.602(a)(5), means: 

(i) Each vendor; 

(ii) Each plan processor; and 

(iii) The processor for the Options 

Price Reporting Authority (in the case of 

a notification for a subject security 

which is a class of securities underlying 

options admitted to trading on any 

national securities exchange). 

(70) Sponsor, when used in 

connection with a national market 

system plan, means any self-regulatory 

organization which is a signatory to 

such plan and has agreed to act in 

accordance with the terms of the plan. 

(71) SRO display-only facility means a 

facility operated by a national securities 

exchange or national securities 

association that displays quotations in a 

security, but does not execute orders 

against such quotations or present 

orders for execution.

(72) SRO trading facility means a 

facility operated by a national securities 

exchange or a national securities 

association that executes orders in a 

security or presents orders to members 

for execution. 

(73) Subject security means: 

(i) With respect to a national 

securities exchange: 

(A) Any exchange-traded security 

other than a security for which the 

executed volume of such exchange, 

during the most recent calendar quarter, 

comprised one percent or less of the 

aggregate trading volume for such 

security as reported pursuant to an 

effective transaction reporting plan or 

effective national market system plan; 

and 

(B) Any other NMS security for which 

such exchange has in effect an election, 

pursuant to § 242.602(a)(5)(i), to collect, 

process, and make available to a vendor 

bids, offers, quotation sizes, and 

aggregate quotation sizes communicated 

on such exchange; and 

(ii) With respect to a member of a 

national securities association: 

(A) Any exchange-traded security for 

which such member acts in the capacity 

of an OTC market maker unless the 

executed volume of such member, 

during the most recent calendar quarter, 

comprised one percent or less of the 

aggregate trading volume for such 

security as reported pursuant to an 

effective transaction reporting plan or 

effective national market system plan; 

and 

(B) Any other NMS security for which 

such member acts in the capacity of an 

OTC market maker and has in effect an 

election, pursuant to § 242.602(a)(5)(ii), 

to communicate to its association bids, 

offers, and quotation sizes for the 

purpose of making such bids, offers, and 

quotation sizes available to a vendor. 

(74) Time of order execution means 

the time (to the second) that an order 

was executed at any venue. 

(75) Time of order receipt means the 

time (to the second) that an order was 

received by a market center for 

execution. 

(76) Time of the transaction has the 

meaning provided in § 240.10b–10 of 

this chapter. 

(77) Trade-through means the 

purchase or sale of an NMS stock during 

regular trading hours, either as principal 

or agent, at a price that is lower than a 

protected bid or higher than a protected 

offer. 

(78) Trading center means a national 

securities exchange or national 

securities association that operates an 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77511

SRO trading facility, an alternative 

trading system, an exchange market 

maker, an OTC market maker, or any 

other broker or dealer that executes 

orders internally by trading as principal 

or crossing orders as agent. 

(79) Trading rotation means, with 

respect to an options class, the time 

period on a national securities exchange 

during which: 

(i) Opening, re-opening, or closing 

transactions in options series in such 

options class are not yet completed; and 

(ii) Continuous trading has not yet 

commenced or has not yet ended for the 

day in options series in such options 

class. 

(80) Transaction report means a 

report containing the price and volume 

associated with a transaction involving 

the purchase or sale of one or more 

round lots of a security. 

(81) Transaction reporting association

means any person authorized to 

implement or administer any 

transaction reporting plan on behalf of 

persons acting jointly under 

§ 242.601(a). 

(82) Transaction reporting plan means 

any plan for collecting, processing, 

making available or disseminating 

transaction reports with respect to 

transactions in NMS stocks filed with 

the Commission pursuant to, and 

meeting the requirements of, § 242.601. 

(83) Vendor means any securities 

information processor engaged in the 

business of disseminating transaction 

reports, last sale data, or quotation 

information with respect to NMS 

securities to brokers, dealers, or 

investors on a real-time or other current 

and continuing basis, whether through 

an electronic communications network, 

moving ticker, or interrogation device.

§ 242.601 Dissemination of transaction 

reports and last sale data with respect to 

transactions in NMS stocks. 

(a)(1) Every national securities 

exchange shall file a transaction 

reporting plan regarding transactions in 

listed equity and Nasdaq securities 

executed through its facilities, and every 

national securities association shall file 

a transaction reporting plan regarding 

transactions in listed equity and Nasdaq 

securities executed by its members 

otherwise than on a national securities 

exchange. 

(2) Any transaction reporting plan, or 

any amendment thereto, filed pursuant 

to this section shall be filed with the 

Commission, and considered for 

approval, in accordance with the 

procedures set forth in § 242.608(a) and 

(b). Any such plan, or amendment 

thereto, shall specify, at a minimum: 

(i) The listed equity and Nasdaq 

securities or classes of such securities 

for which transaction reports shall be 

required by the plan; 

(ii) Reporting requirements with 

respect to transactions in listed equity 

securities and Nasdaq securities, for any 

broker or dealer subject to the plan; 

(iii) The manner of collecting, 

processing, sequencing, making 

available and disseminating transaction 

reports and last sale data reported 

pursuant to such plan; 

(iv) The manner in which such 

transaction reports reported pursuant to 

such plan are to be consolidated with 

transaction reports from national 

securities exchanges and national 

securities associations reported 

pursuant to any other effective 

transaction reporting plan; 

(v) The applicable standards and 

methods which will be utilized to 

ensure promptness of reporting, and 

accuracy and completeness of 

transaction reports; 

(vi) Any rules or procedures which 

may be adopted to ensure that 

transaction reports or last sale data will 

not be disseminated in a fraudulent or 

manipulative manner; 

(vii) Specific terms of access to 

transaction reports made available or 

disseminated pursuant to the plan; and 

(viii) That transaction reports or last 

sale data made available to any vendor 

for display on an interrogation device 

identify the marketplace where each 

transaction was executed. 

(3) No transaction reporting plan filed 

pursuant to this section, or any 

amendment to an effective transaction 

reporting plan, shall become effective 

unless approved by the Commission or 

otherwise permitted in accordance with 

the procedures set forth in § 242.608. 

(b) Prohibitions and reporting 

requirements.

(1) No broker or dealer may execute 

any transaction in, or induce or attempt 

to induce the purchase or sale of, any 

NMS stock: 

(i) On or through the facilities of a 

national securities exchange unless 

there is an effective transaction 

reporting plan with respect to 

transactions in such security executed 

on or through such exchange facilities; 

or 

(ii) Otherwise than on a national 

securities exchange unless there is an 

effective transaction reporting plan with 

respect to transactions in such security 

executed otherwise than on a national 

securities exchange by such broker or 

dealer. 

(2) Every broker or dealer who is a 

member of a national securities 

exchange or national securities 

association shall promptly transmit to 

the exchange or association of which it 

is a member all information required by 

any effective transaction reporting plan 

filed by such exchange or association 

(either individually or jointly with other 

exchanges and/or associations). 

(c) Retransmission of transaction 

reports or last sale data.

Notwithstanding any provision of any 

effective transaction reporting plan, no 

national securities exchange or national 

securities association may, either 

individually or jointly, by rule, stated 

policy or practice, transaction reporting 

plan or otherwise, prohibit, condition or 

otherwise limit, directly or indirectly, 

the ability of any vendor to retransmit, 

for display in moving tickers, 

transaction reports or last sale data 

made available pursuant to any effective 

transaction reporting plan; provided, 

however, that a national securities 

exchange or national securities 

association may, by means of an 

effective transaction reporting plan, 

condition such retransmission upon 

appropriate undertakings to ensure that 

any charges for the distribution of 

transaction reports or last sale data in 

moving tickers permitted by paragraph 

(d) of this section are collected. 

(d) Charges. Nothing in this section 

shall preclude any national securities 

exchange or national securities 

association, separately or jointly, 

pursuant to the terms of an effective 

transaction reporting plan, from 

imposing reasonable, uniform charges 

(irrespective of geographic location) for 

distribution of transaction reports or last 

sale data.

(e) Appeals. The Commission may, in 

its discretion, entertain appeals in 

connection with the implementation or 

operation of any effective transaction 

reporting plan in accordance with the 

provisions of § 242.608(d). 

(f) Exemptions. The Commission may 

exempt from the provisions of this 

section, either unconditionally or on 

specified terms and conditions, any 

national securities exchange, national 

securities association, broker, dealer, or 

specified security if the Commission 

determines that such exemption is 

consistent with the public interest, the 

protection of investors and the removal 

of impediments to, and perfection of the 

mechanisms of, a national market 

system.

§ 242.602 Dissemination of quotations in 

NMS securities. 

(a) Dissemination requirements for 

national securities exchanges and 

national securities associations.

(1) Every national securities exchange 

and national securities association shall 

77512 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

establish and maintain procedures and 

mechanisms for collecting bids, offers, 

quotation sizes, and aggregate quotation 

sizes from responsible brokers or dealers 

who are members of such exchange or 

association, processing such bids, offers, 

and sizes, and making such bids, offers, 

and sizes available to vendors, as 

follows: 

(i) Each national securities exchange 

shall at all times such exchange is open 

for trading, collect, process, and make 

available to vendors the best bid, the 

best offer, and aggregate quotation sizes 

for each subject security listed or 

admitted to unlisted trading privileges 

which is communicated on any national 

securities exchange by any responsible 

broker or dealer, but shall not include: 

(A) Any bid or offer executed 

immediately after communication and 

any bid or offer communicated by a 

responsible broker or dealer other than 

an exchange market maker which is 

cancelled or withdrawn if not executed 

immediately after communication; and 

(B) Any bid or offer communicated 

during a period when trading in that 

security has been suspended or halted, 

or prior to the commencement of trading 

in that security on any trading day, on 

that exchange. 

(ii) Each national securities 

association shall, at all times that last 

sale information with respect to NMS 

securities is reported pursuant to an 

effective transaction reporting plan, 

collect, process, and make available to 

vendors the best bid, best offer, and 

quotation sizes communicated 

otherwise than on an exchange by each 

member of such association acting in 

the capacity of an OTC market maker for 

each subject security and the identity of 

that member (excluding any bid or offer 

executed immediately after 

communication), except during any 

period when over-the-counter trading in 

that security has been suspended. 

(2) Each national securities exchange 

shall, with respect to each published bid 

and published offer representing a bid 

or offer of a member for a subject 

security, establish and maintain 

procedures for ascertaining and 

disclosing to other members of that 

exchange, upon presentation of orders 

sought to be executed by them in 

reliance upon paragraph (b)(2) of this 

section, the identity of the responsible 

broker or dealer who made such bid or 

offer and the quotation size associated 

with it. 

(3)(i) If, at any time a national 

securities exchange is open for trading, 

such exchange determines, pursuant to 

rules approved by the Commission 

pursuant to section 19(b)(2) of the Act 

(15 U.S.C. 78s(b)(2)), that the level of 

trading activities or the existence of 

unusual market conditions is such that 

the exchange is incapable of collecting, 

processing, and making available to 

vendors the data for a subject security 

required to be made available pursuant 

to paragraph (a)(1) of this section in a 

manner that accurately reflects the 

current state of the market on such 

exchange, such exchange shall 

immediately notify all specified persons 

of that determination. Upon such 

notification, responsible brokers or 

dealers that are members of that 

exchange shall be relieved of their 

obligation under paragraphs (b)(2) and 

(c)(3) of this section and such exchange 

shall be relieved of its obligations under 

paragraphs (a)(1) and (2) of this section 

for that security; provided, however, that 

such exchange will continue, to the 

maximum extent practicable under the 

circumstances, to collect, process, and 

make available to vendors data for that 

security in accordance with paragraph 

(a)(1) of this section. 

(ii) During any period a national 

securities exchange, or any responsible 

broker or dealer that is a member of that 

exchange, is relieved of any obligation 

imposed by this section for any subject 

security by virtue of a notification made 

pursuant to paragraph (a)(3)(i) of this 

section, such exchange shall monitor 

the activity or conditions which formed 

the basis for such notification and shall 

immediately renotify all specified 

persons when that exchange is once 

again capable of collecting, processing, 

and making available to vendors the 

data for that security required to be 

made available pursuant to paragraph 

(a)(1) of this section in a manner that 

accurately reflects the current state of 

the market on such exchange. Upon 

such renotification, any exchange or 

responsible broker or dealer which had 

been relieved of any obligation imposed 

by this section as a consequence of the 

prior notification shall again be subject 

to such obligation. 

(4) Nothing in this section shall 

preclude any national securities 

exchange or national securities 

association from making available to 

vendors indications of interest or bids 

and offers for a subject security at any 

time such exchange or association is not 

required to do so pursuant to paragraph 

(a)(1) of this section. 

(5)(i) Any national securities 

exchange may make an election for 

purposes of the definition of subject 

security in § 242.600(b)(73) for any NMS 

security, by collecting, processing, and 

making available bids, offers, quotation 

sizes, and aggregate quotation sizes in 

that security; except that for any NMS 

security previously listed or admitted to 

unlisted trading privileges on only one 

exchange and not traded by any OTC 

market maker, such election shall be 

made by notifying all specified persons, 

and shall be effective at the opening of 

trading on the business day following 

notification. 

(ii) Any member of a national 

securities association acting in the 

capacity of an OTC market maker may 

make an election for purposes of the 

definition of subject security in 

§ 242.600(b)(73) for any NMS security, 

by communicating to its association 

bids, offers, and quotation sizes in that 

security; except that for any other NMS 

security listed or admitted to unlisted 

trading privileges on only one exchange 

and not traded by any other OTC market 

maker, such election shall be made by 

notifying its association and all 

specified persons, and shall be effective 

at the opening of trading on the business 

day following notification. 

(iii) The election of a national 

securities exchange or member of a 

national securities association for any 

NMS security pursuant to this 

paragraph (a)(5) shall cease to be in 

effect if such exchange or member 

ceases to make available or 

communicate bids, offers, and quotation 

sizes in such security. 

(b) Obligations of responsible brokers 

and dealers.

(1) Each responsible broker or dealer 

shall promptly communicate to its 

national securities exchange or national 

securities association, pursuant to the 

procedures established by that exchange 

or association, its best bids, best offers, 

and quotation sizes for any subject 

security. 

(2) Subject to the provisions of 

paragraph (b)(3) of this section, each 

responsible broker or dealer shall be 

obligated to execute any order to buy or 

sell a subject security, other than an 

odd-lot order, presented to it by another 

broker or dealer, or any other person 

belonging to a category of persons with 

whom such responsible broker or dealer 

customarily deals, at a price at least as 

favorable to such buyer or seller as the 

responsible broker’s or dealer’s 

published bid or published offer 

(exclusive of any commission, 

commission equivalent or differential 

customarily charged by such 

responsible broker or dealer in 

connection with execution of any such 

order) in any amount up to its published 

quotation size. 

(3)(i) No responsible broker or dealer 

shall be obligated to execute a 

transaction for any subject security as 

provided in paragraph (b)(2) of this 

section to purchase or sell that subject 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77513

security in an amount greater than such 

revised quotation if: 

(A) Prior to the presentation of an 

order for the purchase or sale of a 

subject security, a responsible broker or 

dealer has communicated to its 

exchange or association, pursuant to 

paragraph (b)(1) of this section, a 

revised quotation size; or 

(B) At the time an order for the 

purchase or sale of a subject security is 

presented, a responsible broker or dealer 

is in the process of effecting a 

transaction in such subject security, and 

immediately after the completion of 

such transaction, it communicates to its 

exchange or association a revised 

quotation size, such responsible broker 

or dealer shall not be obligated by 

paragraph (b)(2) of this section to 

purchase or sell that subject security in 

an amount greater than such revised 

quotation size.

(ii) No responsible broker or dealer 

shall be obligated to execute a 

transaction for any subject security as 

provided in paragraph (b)(2) of this 

section if: 

(A) Before the order sought to be 

executed is presented, such responsible 

broker or dealer has communicated to 

its exchange or association pursuant to 

paragraph (b)(1) of this section, a 

revised bid or offer; or 

(B) At the time the order sought to be 

executed is presented, such responsible 

broker or dealer is in the process of 

effecting a transaction in such subject 

security, and, immediately after the 

completion of such transaction, such 

responsible broker or dealer 

communicates to its exchange or 

association pursuant to paragraph (b)(1) 

of this section, a revised bid or offer; 

provided, however, that such 

responsible broker or dealer shall 

nonetheless be obligated to execute any 

such order in such subject security as 

provided in paragraph (b)(2) of this 

section at its revised bid or offer in any 

amount up to its published quotation 

size or revised quotation size. 

(4) Subject to the provisions of 

paragraph (a)(4) of this section: 

(i) No national securities exchange or 

OTC market maker may make available, 

disseminate or otherwise communicate 

to any vendor, directly or indirectly, for 

display on a terminal or other display 

device any bid, offer, quotation size, or 

aggregate quotation size for any NMS 

security which is not a subject security 

with respect to such exchange or OTC 

market maker; and 

(ii) No vendor may disseminate or 

display on a terminal or other display 

device any bid, offer, quotation size, or 

aggregate quotation size from any 

national securities exchange or OTC 

market maker for any NMS security 

which is not a subject security with 

respect to such exchange or OTC market 

maker. 

(5)(i) Entry of any priced order for an 

NMS security by an exchange market 

maker or OTC market maker in that 

security into an electronic 

communications network that widely 

disseminates such order shall be 

deemed to be: 

(A) A bid or offer under this section, 

to be communicated to the market 

maker’s exchange or association 

pursuant to this paragraph (b) for at 

least the minimum quotation size that is 

required by the rules of the market 

maker’s exchange or association if the 

priced order is for the account of a 

market maker, or the actual size of the 

order up to the minimum quotation size 

required if the priced order is for the 

account of a customer; and 

(B) A communication of a bid or offer 

to a vendor for display on a display 

device for purposes of paragraph (b)(4) 

of this section. 

(ii) An exchange market maker or 

OTC market maker that has entered a 

priced order for an NMS security into an 

electronic communications network that 

widely disseminates such order shall be 

deemed to be in compliance with 

paragraph (b)(5)(i)(A) of this section if 

the electronic communications network: 

(A)(1) Provides to a national securities 

exchange or national securities 

association (or an exclusive processor 

acting on behalf of one or more 

exchanges or associations) the prices 

and sizes of the orders at the highest 

buy price and the lowest sell price for 

such security entered in, and widely 

disseminated by, the electronic 

communications network by exchange 

market makers and OTC market makers 

for the NMS security, and such prices 

and sizes are included in the quotation 

data made available by such exchange, 

association, or exclusive processor to 

vendors pursuant to this section; and 

(2) Provides, to any broker or dealer, 

the ability to effect a transaction with a 

priced order widely disseminated by the 

electronic communications network 

entered therein by an exchange market 

maker or OTC market maker that is: 

(i) Equivalent to the ability of any 

broker or dealer to effect a transaction 

with an exchange market maker or OTC 

market maker pursuant to the rules of 

the national securities exchange or 

national securities association to which 

the electronic communications network 

supplies such bids and offers; and 

(ii) At the price of the highest priced 

buy order or lowest priced sell order, or 

better, for the lesser of the cumulative 

size of such priced orders entered 

therein by exchange market makers or 

OTC market makers at such price, or the 

size of the execution sought by the 

broker or dealer, for such security; or 

(B) Is an alternative trading system 

that: 

(1) Displays orders and provides the 

ability to effect transactions with such 

orders under § 242.301(b)(3); and 

(2) Otherwise is in compliance with 

Regulation ATS (§ 242.300 through 

§ 242.303). 

(c) Transactions in listed options.

(1) A national securities exchange or 

national securities association: 

(i) Shall not be required, under 

paragraph (a) of this section, to collect 

from responsible brokers or dealers who 

are members of such exchange or 

association, or to make available to 

vendors, the quotation sizes and 

aggregate quotation sizes for listed 

options, if such exchange or association 

establishes by rule and periodically 

publishes the quotation size for which 

such responsible brokers or dealers are 

obligated to execute an order to buy or 

sell an options series that is a subject 

security at its published bid or offer 

under paragraph (b)(2) of this section; 

(ii) May establish by rule and 

periodically publish a quotation size, 

which shall not be for less than one 

contract, for which responsible brokers 

or dealers who are members of such 

exchange or association are obligated 

under paragraph (b)(2) of this section to 

execute an order to buy or sell a listed 

option for the account of a broker or 

dealer that is in an amount different 

from the quotation size for which it is 

obligated to execute an order for the 

account of a customer; and 

(iii) May establish and maintain 

procedures and mechanisms for 

collecting from responsible brokers and 

dealers who are members of such 

exchange or association, and making 

available to vendors, the quotation sizes 

and aggregate quotation sizes in listed 

options for which such responsible 

broker or dealer will be obligated under 

paragraph (b)(2) of this section to 

execute an order from a customer to buy 

or sell a listed option and establish by 

rule and periodically publish the size, 

which shall not be less than one 

contract, for which such responsible 

brokers or dealers are obligated to 

execute an order for the account of a 

broker or dealer. 

(2) If, pursuant to paragraph (c)(1) of 

this section, the rules of a national 

securities exchange or national 

securities association do not require its 

members to communicate to it their 

quotation sizes for listed options, a 

responsible broker or dealer that is a 

77514 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

member of such exchange or association 

shall: 

(i) Be relieved of its obligations under 

paragraph (b)(1) of this section to 

communicate to such exchange or 

association its quotation sizes for any 

listed option; and 

(ii) Comply with its obligations under 

paragraph (b)(2) of this section by 

executing any order to buy or sell a 

listed option, in an amount up to the 

size established by such exchange’s or 

association’s rules under paragraph 

(c)(1) of this section. 

(3) Thirty second response. Each 

responsible broker or dealer, within 

thirty seconds of receiving an order to 

buy or sell a listed option in an amount 

greater than the quotation size 

established by a national securities 

exchange’s or national securities 

association’s rules pursuant to 

paragraph (c)(1) of this section, or its 

published quotation size must: 

(i) Execute the entire order; or 

(ii)(A) Execute that portion of the 

order equal to at least: 

(1) The quotation size established by 

a national securities exchange’s or 

national securities association’s rules, 

pursuant to paragraph (c)(1) of this 

section, to the extent that such exchange 

or association does not collect and make 

available to vendors quotation size and 

aggregate quotation size under 

paragraph (a) of this section; or 

(2) Its published quotation size; and 

(B) Revise its bid or offer. 

(4) Notwithstanding paragraph (c)(3) 

of this section, no responsible broker or 

dealer shall be obligated to execute a 

transaction for any listed option as 

provided in paragraph (b)(2) of this 

section if: 

(i) Any of the circumstances in 

paragraph (b)(3) of this section exist; or 

(ii) The order for the purchase or sale 

of a listed option is presented during a 

trading rotation in that listed option. 

(d) Exemptions. The Commission may 

exempt from the provisions of this 

section, either unconditionally or on 

specified terms and conditions, any 

responsible broker or dealer, electronic 

communications network, national 

securities exchange, or national 

securities association if the Commission 

determines that such exemption is 

consistent with the public interest, the 

protection of investors and the removal 

of impediments to and perfection of the 

mechanism of a national market system.

§ 242.603 Distribution, consolidation, and 

display of information with respect to 

quotations for and transactions in NMS 

stocks. 

(a) Distribution of information.

(1) Any exclusive processor, or any 

broker or dealer with respect to 

information for which it is the exclusive 

source, that distributes information with 

respect to quotations for or transactions 

in an NMS stock to a securities 

information processor shall do so on 

terms that are fair and reasonable. 

(2) Any national securities exchange, 

national securities association, broker, 

or dealer that distributes information 

with respect to quotations for or 

transactions in an NMS stock to a 

securities information processor, broker, 

dealer, or other persons shall do so on 

terms that are not unreasonably 

discriminatory. 

(b) Consolidation of information.

Every national securities exchange on 

which an NMS stock is traded and 

national securities association shall act 

jointly pursuant to one or more effective 

national market system plans to 

disseminate consolidated information, 

including a national best bid and 

national best offer, on quotations for and 

transactions in NMS stocks. Such plan 

or plans shall provide for the 

dissemination of all consolidated 

information for an individual NMS 

stock through a single plan processor. 

(c) Display of information.

(1) No securities information 

processor, broker, or dealer shall 

provide, in a context in which a trading 

or order-routing decision can be 

implemented, a display of any 

information with respect to quotations 

for or transactions in an NMS stock 

without also providing, in an equivalent 

manner, a consolidated display for such 

stock. 

(2) The provisions of paragraph (c)(1) 

of this section shall not apply to a 

display of information on the trading 

floor or through the facilities of a 

national securities exchange or to a 

display in connection with the 

operation of a market linkage system 

implemented in accordance with an 

effective national market system plan. 

(d) Exemptions. The Commission, by 

order, may exempt from the provisions 

of this section, either unconditionally or 

on specified terms and conditions, any 

person, security, or item of information, 

or any class or classes of persons, 

securities, or items of information, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest, and is consistent 

with the protection of investors.

§ 242.604 Display of customer limit orders. 

(a) Specialists and OTC market 

makers. For all NMS stocks: 

(1) Each member of a national 

securities exchange that is registered by 

that exchange as a specialist, or is 

authorized by that exchange to perform 

functions substantially similar to that of 

a specialist, shall publish immediately a 

bid or offer that reflects: 

(i) The price and the full size of each 

customer limit order held by the 

specialist that is at a price that would 

improve the bid or offer of such 

specialist in such security; and 

(ii) The full size of each customer 

limit order held by the specialist that: 

(A) Is priced equal to the bid or offer 

of such specialist for such security; 

(B) Is priced equal to the national best 

bid or national best offer; and 

(C) Represents more than a de 

minimis change in relation to the size 

associated with the specialist’s bid or 

offer. 

(2) Each registered broker or dealer 

that acts as an OTC market maker shall 

publish immediately a bid or offer that 

reflects: 

(i) The price and the full size of each 

customer limit order held by the OTC 

market maker that is at a price that 

would improve the bid or offer of such 

OTC market maker in such security; and 

(ii) The full size of each customer 

limit order held by the OTC market 

maker that: 

(A) Is priced equal to the bid or offer 

of such OTC market maker for such 

security; 

(B) Is priced equal to the national best 

bid or national best offer; and 

(C) Represents more than a de 

minimis change in relation to the size 

associated with the OTC market maker’s 

bid or offer. 

(b) Exceptions. The requirements in 

paragraph (a) of this section shall not 

apply to any customer limit order: 

(1) That is executed upon receipt of 

the order. 

(2) That is placed by a customer who 

expressly requests, either at the time 

that the order is placed or prior thereto 

pursuant to an individually negotiated 

agreement with respect to such 

customer’s orders, that the order not be 

displayed. 

(3) That is an odd-lot order. 

(4) That is a block size order, unless 

a customer placing such order requests 

that the order be displayed. 

(5) That is delivered immediately 

upon receipt to a national securities 

exchange or national securities 

association-sponsored system, or an 

electronic communications network that 

complies with the requirements of 

§ 242.602(b)(5)(ii) with respect to that 

order. 

(6) That is delivered immediately 

upon receipt to another exchange 

member or OTC market maker that 

complies with the requirements of this 

section with respect to that order. 

(7) That is an ‘‘all or none’’ order. 

(c) Exemptions. The Commission may 

exempt from the provisions of this 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77515

section, either unconditionally or on 

specified terms and conditions, any 

responsible broker or dealer, electronic 

communications network, national 

securities exchange, or national 

securities association if the Commission 

determines that such exemption is 

consistent with the public interest, the 

protection of investors and the removal 

of impediments to and perfection of the 

mechanism of a national market system.

§ 242.605 Disclosure of order execution 

information. 

Preliminary Note: Section 242.605 

requires market centers to make 

available standardized, monthly reports 

of statistical information concerning 

their order executions. This information 

is presented in accordance with uniform 

standards that are based on broad 

assumptions about order execution and 

routing practices. The information will 

provide a starting point to promote 

visibility and competition on the part of 

market centers and broker-dealers, 

particularly on the factors of execution 

price and speed. The disclosures 

required by this section do not 

encompass all of the factors that may be 

important to investors in evaluating the 

order routing services of a broker-dealer. 

In addition, any particular market 

center’s statistics will encompass 

varying types of orders routed by 

different broker-dealers on behalf of 

customers with a wide range of 

objectives. Accordingly, the statistical 

information required by this section 

alone does not create a reliable basis to 

address whether any particular brokerdealer failed to obtain the most 

favorable terms reasonably available 

under the circumstances for customer 

orders. 

(a) Monthly electronic reports by 

market centers.

(1) Every market center shall make 

available for each calendar month, in 

accordance with the procedures 

established pursuant to paragraph (a)(2) 

of this section, a report on the covered 

orders in NMS stocks that it received for 

execution from any person. Such report 

shall be in electronic form; shall be 

categorized by security, order type, and 

order size; and shall include the 

following columns of information: 

(i) For market orders, marketable limit 

orders, inside-the-quote limit orders, atthe-quote limit orders, and near-thequote limit orders: 

(A) The number of covered orders; 

(B) The cumulative number of shares 

of covered orders; 

(C) The cumulative number of shares 

of covered orders cancelled prior to 

execution; 

(D) The cumulative number of shares 

of covered orders executed at the 

receiving market center; 

(E) The cumulative number of shares 

of covered orders executed at any other 

venue; 

(F) The cumulative number of shares 

of covered orders executed from 0 to 9 

seconds after the time of order receipt; 

(G) The cumulative number of shares 

of covered orders executed from 10 to 

29 seconds after the time of order 

receipt; 

(H) The cumulative number of shares 

of covered orders executed from 30 

seconds to 59 seconds after the time of 

order receipt;

(I) The cumulative number of shares 

of covered orders executed from 60 

seconds to 299 seconds after the time of 

order receipt; 

(J) The cumulative number of shares 

of covered orders executed from 5 

minutes to 30 minutes after the time of 

order receipt; and 

(K) The average realized spread for 

executions of covered orders; and 

(ii) For market orders and marketable 

limit orders: 

(A) The average effective spread for 

executions of covered orders; 

(B) The cumulative number of shares 

of covered orders executed with price 

improvement; 

(C) For shares executed with price 

improvement, the share-weighted 

average amount per share that prices 

were improved; 

(D) For shares executed with price 

improvement, the share-weighted 

average period from the time of order 

receipt to the time of order execution; 

(E) The cumulative number of shares 

of covered orders executed at the quote; 

(F) For shares executed at the quote, 

the share-weighted average period from 

the time of order receipt to the time of 

order execution; 

(G) The cumulative number of shares 

of covered orders executed outside the 

quote; 

(H) For shares executed outside the 

quote, the share-weighted average 

amount per share that prices were 

outside the quote; and 

(I) For shares executed outside the 

quote, the share-weighted average 

period from the time of order receipt to 

the time of order execution. 

(2) Every national securities exchange 

on which NMS stocks are traded and 

each national securities association 

shall act jointly in establishing 

procedures for market centers to follow 

in making available to the public the 

reports required by paragraph (a)(1) of 

this section in a uniform, readily 

accessible, and usable electronic form. 

In the event there is no effective 

national market system plan 

establishing such procedures, market 

centers shall prepare their reports in a 

consistent, usable, and machinereadable electronic format, and make 

such reports available for downloading 

from an Internet website that is free and 

readily accessible to the public. 

(3) A market center shall make 

available the report required by 

paragraph (a)(1) of this section within 

one month after the end of the month 

addressed in the report. 

(b) Exemptions. The Commission 

may, by order upon application, 

conditionally or unconditionally 

exempt any person, security, or 

transaction, or any class or classes of 

persons, securities, or transactions, from 

any provision or provisions of this 

section, if the Commission determines 

that such exemption is necessary or 

appropriate in the public interest, and is 

consistent with the protection of 

investors.

§ 242.606 Disclosure of order routing 

information. 

(a) Quarterly report on order routing.

(1) Every broker or dealer shall make 

publicly available for each calendar 

quarter a report on its routing of nondirected orders in NMS securities 

during that quarter. For NMS stocks, 

such report shall be divided into three 

separate sections for securities that are 

listed on the New York Stock Exchange, 

Inc., securities that are qualified for 

inclusion in The Nasdaq Stock Market, 

Inc., and securities that are listed on the 

American Stock Exchange LLC or any 

other national securities exchange. Such 

report also shall include a separate 

section for NMS securities that are 

option contracts. Each of the four 

sections in a report shall include the 

following information: 

(i) The percentage of total customer 

orders for the section that were nondirected orders, and the percentages of 

total non-directed orders for the section 

that were market orders, limit orders, 

and other orders; 

(ii) The identity of the ten venues to 

which the largest number of total nondirected orders for the section were 

routed for execution and of any venue 

to which five percent or more of nondirected orders were routed for 

execution, the percentage of total nondirected orders for the section routed to 

the venue, and the percentages of total 

non-directed market orders, total nondirected limit orders, and total nondirected other orders for the section that 

were routed to the venue; and 

(iii) A discussion of the material 

aspects of the broker’s or dealer’s 

relationship with each venue identified 

77516 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

pursuant to paragraph (a)(1)(ii) of this 

section, including a description of any 

arrangement for payment for order flow 

and any profit-sharing relationship. 

(2) A broker or dealer shall make the 

report required by paragraph (a)(1) of 

this section publicly available within 

one month after the end of the quarter 

addressed in the report. 

(b) Customer requests for information 

on order routing.

(1) Every broker or dealer shall, on 

request of a customer, disclose to its 

customer the identity of the venue to 

which the customer’s orders were 

routed for execution in the six months 

prior to the request, whether the orders 

were directed orders or non-directed 

orders, and the time of the transactions, 

if any, that resulted from such orders. 

(2) A broker or dealer shall notify 

customers in writing at least annually of 

the availability on request of the 

information specified in paragraph 

(b)(1) of this section. 

(c) Exemptions. The Commission 

may, by order upon application, 

conditionally or unconditionally 

exempt any person, security, or 

transaction, or any class or classes of 

persons, securities, or transactions, from 

any provision or provisions of this 

section, if the Commission determines 

that such exemption is necessary or 

appropriate in the public interest, and is 

consistent with the protection of 

investors.

§ 242.607 Customer account statements. 

(a) No broker or dealer acting as agent 

for a customer may effect any 

transaction in, induce or attempt to 

induce the purchase or sale of, or direct 

orders for purchase or sale of, any NMS 

stock or a security authorized for 

quotation on an automated inter-dealer 

quotation system that has the 

characteristics set forth in section 17B of 

the Act (15 U.S.C. 78q-2), unless such 

broker or dealer informs such customer, 

in writing, upon opening a new account 

and on an annual basis thereafter, of the 

following: 

(1) The broker’s or dealer’s policies 

regarding receipt of payment for order 

flow from any broker or dealer, national 

securities exchange, national securities 

association, or exchange member to 

which it routes customers’ orders for 

execution, including a statement as to 

whether any payment for order flow is 

received for routing customer orders 

and a detailed description of the nature 

of the compensation received; and 

(2) The broker’s or dealer’s policies 

for determining where to route customer 

orders that are the subject of payment 

for order flow absent specific 

instructions from customers, including a 

description of the extent to which 

orders can be executed at prices 

superior to the national best bid and 

national best offer. 

(b) Exemptions. The Commission, 

upon request or upon its own motion, 

may exempt by rule or by order, any 

broker or dealer or any class of brokers 

or dealers, security or class of securities 

from the requirements of paragraph (a) 

of this section with respect to any 

transaction or class of transactions, 

either unconditionally or on specified 

terms and conditions, if the Commission 

determines that such exemption is 

consistent with the pubic interest and 

the protection of investors.

§ 242.608 Filing and amendment of 

national market system plans. 

(a) Filing of national market system 

plans and amendments thereto.

(1) Any two or more self-regulatory 

organizations, acting jointly, may file a 

national market system plan or may 

propose an amendment to an effective 

national market system plan (‘‘proposed 

amendment’’) by submitting the text of 

the plan or amendment to the Secretary 

of the Commission, together with a 

statement of the purpose of such plan or 

amendment and, to the extent 

applicable, the documents and 

information required by paragraphs 

(a)(4) and (5) of this section. 

(2) The Commission may propose 

amendments to any effective national 

market system plan by publishing the 

text thereof, together with a statement of 

the purpose of such amendment, in 

accordance with the provisions of 

paragraph (b) of this section. 

(3) Self-regulatory organizations are 

authorized to act jointly in: 

(i) Planning, developing, and 

operating any national market 

subsystem or facility contemplated by a 

national market system plan; 

(ii) Preparing and filing a national 

market system plan or any amendment 

thereto; or 

(iii) Implementing or administering an 

effective national market system plan. 

(4) Every national market system plan 

filed pursuant to this section, or any 

amendment thereto, shall be 

accompanied by: 

(i) Copies of all governing or 

constituent documents relating to any 

person (other than a self-regulatory 

organization) authorized to implement 

or administer such plan on behalf of its 

sponsors; and

(ii) To the extent applicable: 

(A) A detailed description of the 

manner in which the plan or 

amendment, and any facility or 

procedure contemplated by the plan or 

amendment, will be implemented; 

(B) A listing of all significant phases 

of development and implementation 

(including any pilot phase) 

contemplated by the plan or 

amendment, together with the projected 

date of completion of each phase; 

(C) An analysis of the impact on 

competition of implementation of the 

plan or amendment or of any facility 

contemplated by the plan or 

amendment; 

(D) A description of any written 

understandings or agreements between 

or among plan sponsors or participants 

relating to interpretations of the plan or 

conditions for becoming a sponsor or 

participant in the plan; and 

(E) In the case of a proposed 

amendment, a statement that such 

amendment has been approved by the 

sponsors in accordance with the terms 

of the plan. 

(5) Every national market system plan, 

or any amendment thereto, filed 

pursuant to this section shall include a 

description of the manner in which any 

facility contemplated by the plan or 

amendment will be operated. Such 

description shall include, to the extent 

applicable: 

(i) The terms and conditions under 

which brokers, dealers, and/or selfregulatory organizations will be granted 

or denied access (including specific 

procedures and standards governing the 

granting or denial of access); 

(ii) The method by which any fees or 

charges collected on behalf of all of the 

sponsors and/or participants in 

connection with access to, or use of, any 

facility contemplated by the plan or 

amendment will be determined and 

imposed (including any provision for 

distribution of any net proceeds from 

such fees or charges to the sponsors 

and/or participants) and the amount of 

such fees or charges; 

(iii) The method by which, and the 

frequency with which, the performance 

of any person acting as plan processor 

with respect to the implementation and/

or operation of the plan will be 

evaluated; and 

(iv) The method by which disputes 

arising in connection with the operation 

of the plan will be resolved. 

(6) In connection with the selection of 

any person to act as plan processor with 

respect to any facility contemplated by 

a national market system plan 

(including renewal of any contract for 

any person to so act), the sponsors shall 

file with the Commission a statement 

identifying the person selected, 

describing the material terms under 

which such person is to serve as plan 

processor, and indicating the 

solicitation efforts, if any, for alternative 

plan processors, the alternatives 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77517

considered and the reasons for selection 

of such person. 

(7) Any national market system plan 

(or any amendment thereto) which is 

intended by the sponsors to satisfy a 

plan filing requirement contained in any 

other section of this Regulation NMS 

and part 240, subpart A of this chapter 

shall, in addition to compliance with 

this section, also comply with the 

requirements of such other section. 

(b) Effectiveness of national market 

system plans.

(1) The Commission shall publish 

notice of the filing of any national 

market system plan, or any proposed 

amendment to any effective national 

market system plan (including any 

amendment initiated by the 

Commission), together with the terms of 

substance of the filing or a description 

of the subjects and issues involved, and 

shall provide interested persons an 

opportunity to submit written 

comments. No national market system 

plan, or any amendment thereto, shall 

become effective unless approved by the 

Commission or otherwise permitted in 

accordance with paragraph (b)(3) of this 

section. 

(2) Within 120 days of the date of 

publication of notice of filing of a 

national market system plan or an 

amendment to an effective national 

market system plan, or within such 

longer period as the Commission may 

designate up to 180 days of such date if 

it finds such longer period to be 

appropriate and publishes its reasons 

for so finding or as to which the 

sponsors consent, the Commission shall 

approve such plan or amendment, with 

such changes or subject to such 

conditions as the Commission may 

deem necessary or appropriate, if it 

finds that such plan or amendment is 

necessary or appropriate in the public 

interest, for the protection of investors 

and the maintenance of fair and orderly 

markets, to remove impediments to, and 

perfect the mechanisms of, a national 

market system, or otherwise in 

furtherance of the purposes of the Act. 

Approval of a national market system 

plan, or an amendment to an effective 

national market system plan (other than 

an amendment initiated by the 

Commission), shall be by order. 

Promulgation of an amendment to an 

effective national market system plan 

initiated by the Commission shall be by 

rule. 

(3) A proposed amendment may be 

put into effect upon filing with the 

Commission if designated by the 

sponsors as: 

(i) Establishing or changing a fee or 

other charge collected on behalf of all of 

the sponsors and/or participants in 

connection with access to, or use of, any 

facility contemplated by the plan or 

amendment (including changes in any 

provision with respect to distribution of 

any net proceeds from such fees or other 

charges to the sponsors and/or 

participants); 

(ii) Concerned solely with the 

administration of the plan, or involving 

the governing or constituent documents 

relating to any person (other than a selfregulatory organization) authorized to 

implement or administer such plan on 

behalf of its sponsors; or 

(iii) Involving solely technical or 

ministerial matters. At any time within 

60 days of the filing of any such 

amendment, the Commission may 

summarily abrogate the amendment and 

require that such amendment be refiled 

in accordance with paragraph (a)(1) of 

this section and reviewed in accordance 

with paragraph (b)(2) of this section, if 

it appears to the Commission that such 

action is necessary or appropriate in the 

public interest, for the protection of 

investors, or the maintenance of fair and 

orderly markets, to remove impediments 

to, and perfect the mechanisms of, a 

national market system or otherwise in 

furtherance of the purposes of the Act. 

(4) Notwithstanding the provisions of 

paragraph (b)(1) of this section, a 

proposed amendment may be put into 

effect summarily upon publication of 

notice of such amendment, on a 

temporary basis not to exceed 120 days, 

if the Commission finds that such action 

is necessary or appropriate in the public 

interest, for the protection of investors 

or the maintenance of fair and orderly 

markets, to remove impediments to, and 

perfect the mechanisms of, a national 

market system or otherwise in 

furtherance of the purposes of the Act. 

(5) Any plan (or amendment thereto) 

in connection with: 

(i) The planning, development, 

operation, or regulation of a national 

market system (or a subsystem thereof) 

or one or more facilities thereof; or 

(ii) The development and 

implementation of procedures and/or 

facilities designed to achieve 

compliance by self-regulatory 

organizations and/or their members of 

any section of this Regulation NMS and 

part 240, subpart A of this chapter 

promulgated pursuant to section 11A of 

the Act (15 U.S.C. 78k–1), approved by 

the Commission pursuant to section 

11A of the Act (or pursuant to any rule 

or regulation thereunder) prior to the 

effective date of this section (either 

temporarily or permanently) shall be 

deemed to have been filed and approved 

pursuant to this section and no 

additional filing need be made by the 

sponsors with respect to such plan or 

amendment; provided, however, that all 

terms and conditions associated with 

any such approval (including time 

limitations) shall continue to be 

applicable; provided, further, that any 

amendment to such plan filed with or 

approved by the Commission on or after 

the effective date of this section shall be 

subject to the provisions of, and 

considered in accordance with the 

procedures specified in, this section. 

(c) Compliance with terms of national 

market system plans. Each selfregulatory organization shall comply 

with the terms of any effective national 

market system plan of which it is a 

sponsor or a participant. Each selfregulatory organization also shall, 

absent reasonable justification or 

excuse, enforce compliance with any 

such plan by its members and persons 

associated with its members. 

(d) Appeals. The Commission may, in 

its discretion, entertain appeals in 

connection with the implementation or 

operation of any effective national 

market system plan as follows: 

(1) Any action taken or failure to act 

by any person in connection with an 

effective national market system plan 

(other than a prohibition or limitation of 

access reviewable by the Commission 

pursuant to section 11A(b)(5) or section 

19(d) of the Act (15 U.S.C. 78k–1(b)(5) 

or 78s(d))) shall be subject to review by 

the Commission, on its own motion or 

upon application by any person 

aggrieved thereby (including, but not 

limited to, self-regulatory organizations, 

brokers, dealers, issuers, and vendors), 

filed not later than 30 days after notice 

of such action or failure to act or within 

such longer period as the Commission 

may determine.

(2) Application to the Commission for 

review, or the institution of review by 

the Commission on its own motion, 

shall not operate as a stay of any such 

action unless the Commission 

determines otherwise, after notice and 

opportunity for hearing on the question 

of a stay (which hearing may consist 

only of affidavits or oral arguments). 

(3) In any proceedings for review, if 

the Commission, after appropriate 

notice and opportunity for hearing 

(which hearing may consist solely of 

consideration of the record of any 

proceedings conducted in connection 

with such action or failure to act and an 

opportunity for the presentation of 

reasons supporting or opposing such 

action or failure to act) and upon 

consideration of such other data, views, 

and arguments as it deems relevant, 

finds that the action or failure to act is 

in accordance with the applicable 

provisions of such plan and that the 

applicable provisions are, and were, 

77518 Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 

applied in a manner consistent with the 

public interest, the protection of 

investors, the maintenance of fair and 

orderly markets, and the removal of 

impediments to, and the perfection of 

the mechanisms of a national market 

system, the Commission, by order, shall 

dismiss the proceeding. If the 

Commission does not make any such 

finding, or if it finds that such action or 

failure to act imposes any burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Act, the Commission, by 

order, shall set aside such action and/

or require such action with respect to 

the matter reviewed as the Commission 

deems necessary or appropriate in the 

public interest, for the protection of 

investors, and the maintenance of fair 

and orderly markets, or to remove 

impediments to, and perfect the 

mechanisms of, a national market 

system. 

(e) Exemptions. The Commission may 

exempt from the provisions of this 

section, either unconditionally or on 

specified terms and conditions, any selfregulatory organization, member 

thereof, or specified security, if the 

Commission determines that such 

exemption is consistent with the public 

interest, the protection of investors, the 

maintenance of fair and orderly markets 

and the removal of impediments to, and 

perfection of the mechanisms of, a 

national market system.

§ 242.609 Registration of securities 

information processors: form of application 

and amendments. 

(a) An application for the registration 

of a securities information processor 

shall be filed on Form SIP (§ 249.1001) 

in accordance with the instructions 

contained therein. 

(b) If any information reported in 

items 1–13 or item 21 of Form SIP or in 

any amendment thereto is or becomes 

inaccurate for any reason, whether 

before or after the registration has been 

granted, the securities information 

processor shall promptly file an 

amendment on Form SIP correcting 

such information. 

(c) The Commission, upon its own 

motion or upon application by any 

securities information processor, may 

conditionally or unconditionally 

exempt any securities information 

processor from any provision of the 

rules or regulations adopted under 

section 11A(b) of the Act (15 U.S.C. 

78k–1(b)). 

(d) Every amendment filed pursuant 

to this section shall constitute a 

‘‘report’’ within the meaning of sections 

17(a), 18(a) and 32(a) of the Act (15 

U.S.C. 78q(a), 78r(a), and 78ff(a)).

§ 242.610 Access to quotations. 

(a) Quotations of SRO trading facility.

A national securities exchange or 

national securities association shall not 

impose unfairly discriminatory terms 

that prevent or inhibit any person from 

obtaining efficient access through a 

member of the national securities 

exchange or national securities 

association to the quotations in an NMS 

stock displayed through its SRO trading 

facility. 

(b) Quotations of SRO display-only 

facility.

(1) Any trading center that displays 

quotations in an NMS stock through an 

SRO display-only facility shall provide 

a level and cost of access to such 

quotations that is substantially 

equivalent to the level and cost of access 

to quotations displayed by SRO trading 

facilities in that stock. 

(2) Any trading center that displays 

quotations in an NMS stock through an 

SRO display-only facility shall not 

impose unfairly discriminatory terms 

that prevent or inhibit any person from 

obtaining efficient access to such 

quotations through a member, 

subscriber, or customer of the trading 

center. 

(c) Fees for access to protected 

quotations. A trading center shall not 

impose, nor permit to be imposed, any 

fee or fees for the execution of orders 

against its protected quotations in an 

NMS stock that exceed or accumulate to 

more than the following limits: 

(1) If the price of a protected 

quotation is $1.00 or more, the fee or 

fees cannot exceed or accumulate to 

more than $0.003 per share; or 

(2) If the price of a protected 

quotation is less than $1.00, the fee or 

fees cannot exceed or accumulate to 

more than 0.3% of the quotation price 

per share. 

(d) Locking or crossing quotations.

Each national securities exchange and 

national securities association shall 

establish and enforce rules that: 

(1) Require its members reasonably to 

avoid displaying quotations that lock or 

cross any protected quotation in an 

NMS stock, and to avoid displaying 

manual quotations that lock or cross any 

quotation in an NMS stock disseminated 

pursuant to an effective national market 

system plan; 

(2) Are reasonably designed to assure 

the reconciliation of locked or crossed 

quotations in an NMS stock; and 

(3) Prohibit its members from 

engaging in a pattern or practice of 

displaying quotations that lock or cross 

any protected quotation in an NMS 

stock, or of displaying manual 

quotations that lock or cross any 

quotation in an NMS stock disseminated 

pursuant to an effective national market 

system plan. 

(e) Exemptions. The Commission, by 

order, may exempt from the provisions 

of this section, either unconditionally or 

on specified terms and conditions, any 

person, security, quotations, orders, or 

fees, or any class or classes of persons, 

securities, quotations, orders, or fees, if 

the Commission determines that such 

exemption is necessary or appropriate 

in the public interest, and is consistent 

with the protection of investors.

§ 242.611 Order protection rule. 

(a) Reasonable policies and 

procedures.

(1) A trading center shall establish, 

maintain, and enforce written policies 

and procedures that are reasonably 

designed to prevent trade-throughs of 

protected quotations in NMS stocks that 

do not fall within an exception set forth 

in paragraph (b) of this section and, if 

relying on such an exception, that are 

reasonably designed to assure 

compliance with the terms of the 

exception. 

(2) A trading center shall regularly 

surveil to ascertain the effectiveness of 

the policies and procedures required by 

paragraph (a)(1) of this section and shall 

take prompt action to remedy 

deficiencies in such policies and 

procedures. 

(b) Exceptions.

(1) The transaction that constituted 

the trade-through was effected when the 

trading center displaying the protected 

quotation that was traded through was 

experiencing a failure, material delay, or 

malfunction of its systems or equipment 

when the trade-through occurred. 

(2) The transaction that constituted 

the trade-through was not a ‘‘regular 

way’’ contract. 

(3) The transaction that constituted 

the trade-through was a single-priced 

opening, reopening, or closing 

transaction by the trading center. 

(4) The transaction that constituted 

the trade-through was executed at a time 

when a protected bid was priced higher 

than a protected offer in the NMS stock. 

(5) The transaction that constituted 

the trade-through was the execution of 

an order identified as an intermarket 

sweep order. 

(6) The transaction that constituted 

the trade-through was effected by a 

trading center that simultaneously 

routed an intermarket sweep order to 

execute against the full displayed size of 

any protected quotation in the NMS 

stock that was traded through. 

(7) The transaction that constituted 

the trade-through was the execution of 

an order at a price that was not based, 

directly or indirectly, on the quoted 

Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Proposed Rules 77519

price of the NMS stock at the time of 

execution and for which the material 

terms were not reasonably determinable 

at the time the commitment to execute 

the order was made. 

(8) The trading center displaying the 

protected quotation that was traded 

through had displayed, within one 

second prior to execution of the 

transaction that constituted the tradethrough, a best bid or best offer, as 

applicable, for the NMS stock with a 

price that was equal or inferior to the 

price of the trade-through transaction. 

(c) Intermarket sweep orders. The 

trading center, broker, or dealer 

responsible for the routing of an 

intermarket sweep order shall take 

reasonable steps to establish that such 

order meets the requirements set forth 

in § 242.600(b)(30). 

(d) Exemptions. The Commission, by 

order, may exempt from the provisions 

of this section, either unconditionally or 

on specified terms and conditions, any 

person, security, transaction, quotation, 

or order, or any class or classes of 

persons, securities, quotations, or 

orders, if the Commission determines 

that such exemption is necessary or 

appropriate in the public interest, and is 

consistent with the protection of 

investors.

§ 242.612 Minimum pricing increment. 

(a) No national securities exchange, 

national securities association, 

alternative trading system, vendor, or 

broker or dealer shall display, rank, or 

accept from any person a bid or offer, 

an order, or an indication of interest in 

any NMS stock equal to or greater than 

$1.00 in an increment smaller than 

$0.01. 

(b) No national securities exchange, 

national securities association, 

alternative trading system, vendor, or 

broker or dealer shall display, rank, or 

accept from any person a bid or offer, 

an order, or an indication of interest in 

any NMS stock less than $1.00 in an 

increment smaller than $0.0001. 

(c) Exemptions. The Commission, by 

order, may exempt from the provisions 

of this section, either unconditionally or 

on specified terms and conditions, any 

person, security, quotation, or order, or 

any class or classes or persons, 

securities, quotations, or orders, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest, and is consistent 

with the protection of investors.

PART 249—FORMS, SECURITIES 

EXCHANGE ACT OF 1934 

32. The authority citation for part 249 

continues to read in part as follows:

Authority: 15 U.S.C. 78a et seq. and 7201 

et seq.; and 18 U.S.C. 1350, unless otherwise 

noted.

* * * * *

33. Section 249.1001 is revised to read 

as follows:

§ 249.1001 Form SIP, for application for 

registration as a securities information 

processor or to amend such an application 

or registration. 

This form shall be used for 

application for registration as a 

securities information processor, 

pursuant to section 11A(b) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78k–1(b)) and § 242.609 of this 

chapter, or to amend such an 

application or registration. 

34. Form SIP (referenced in 

§ 249.1001) is amended by revising 

Instruction 6 of General Instructions for 

Preparing and Filing Form SIP to read 

as follows:

Note: The text of Form SIP does not and 

this amendment will not appear in the Code 

of Federal Regulations.

FORM SIP

* * * * *

GENERAL INSTRUCTIONS FOR 

PREPARING AND FILING FORM SIP

* * * * *

6. Rule 609(b) of Regulation NMS 

requires that if any information 

contained in items 1 through 13 or item 

21 of this application, or any 

supplement or amendment thereto, is or 

becomes inaccurate for any reason, an 

amendment must be filed promptly on 

Form SIP correcting such information.

* * * * *

PART 270—RULES AND 

REGULATIONS, INVESTMENT 

COMPANY ACT OF 1940 

35. The authority citation for part 270 

continues to read in part as follows:

Authority: 15 U.S.C. 80a–1 et seq., 80a–

34(d), 80a–37, and 80a–39, unless otherwise 

noted.

* * * * *

36. Section 270.17a–7 is amended by 

revising paragraph (b)(1) to read as 

follows:

§ 270.17a–7 Exemption of certain 

purchase or sale transactions between an 

investment company and certain affiliated 

persons thereof.

* * * * *

(b) * * *

(1) If the security is an ‘‘NMS stock’’

as that term is defined in 17 CFR 

242.600, the last sale price with respect 

to such security reported in the 

consolidated transaction reporting 

system (‘‘consolidated system’’) or the 

average of the highest current 

independent bid and lowest current 

independent offer for such security 

(reported pursuant to 17 CFR 242.602) 

if there are no reported transactions in 

the consolidated system that day; or

* * * * *

By the Commission.

Dated: December 16, 2004. 

J. Lynn Taylor, 

Assistant Secretary.

[FR Doc. 04–27934 Filed 12–26–04; 8:45 am] 

BILLING CODE 8010–01–P