48632 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

1 17 CFR 242.602. 

2 17 CFR 242.301(b). 

3Consolidated quotation data captures the bestpriced quotations from exchanges, ATSs, and other 

trading centers for listed equities and options. This 

core data for a security is consolidated and 

distributed to the public by a single central 

processor pursuant to Commission rules. 

4 17 CFR 242.610(d). 

5See infra note 19. 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 242 

[Release No. 34–60684; File No. S7–21–09] 

RIN 3235–AK40 

Elimination of Flash Order Exception 

From Rule 602 of Regulation NMS 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’) is 

concerned that the exception for flash 

orders from quoting requirements under 

the Securities Exchange Act of 1934 

(‘‘Exchange Act’’), which originated in 

the context of manual trading floors for 

quotations that were considered 

‘‘ephemeral,’’ is no longer necessary or 

appropriate in today’s highly automated 

trading environment. Accordingly, the 

Commission is proposing to amend Rule 

602 of Regulation NMS under the 

Exchange Act to eliminate an exception 

for the use of flash orders by equity and 

options exchanges. In general, flash 

orders are communicated to certain 

market participants and either executed 

immediately or withdrawn immediately 

after communication. If the proposed 

amendment were adopted, the 

Commission would apply Rule 301(b) of 

Regulation ATS under the Exchange Act 

in a consistent manner with regard to 

the use of flash orders by alternative 

trading systems. The Commission also 

would apply the restrictions on locking 

or crossing quotations in Rule 610(d) of 

Regulation NMS in a consistent manner 

to prohibit the practice of displaying 

marketable flash orders. 

DATES: Comments should be received on 

or before November 23, 2009. 

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 

No. S7–21–09 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 Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File No. 

S7–21–09. 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 are also available for public 

inspection and copying in the 

Commission’s Public Reference Room, 

100 F Street, NE., Washington, DC 

20549 on official business days between 

the hours of 10 a.m. and 3 p.m. 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: 

Theodore S. Venuti, Special Counsel, at 

(202) 551–5658, Arisa Tinaves, Special 

Counsel, at (202) 551–5676, Gary M. 

Rubin, Attorney, at (202) 551–5669, 

Division of Trading and Markets, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–7010. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Introduction 

II. Description of Flash Orders 

III. Flash Order Exception From Quoting 

Requirements 

IV. Proposed Elimination of Flash Order 

Exception 

V. Request for Comments 

VI. Paperwork Reduction Act 

VII. Consideration of Costs and Benefits 

VIII. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition and Capital 

Formation 

IX. Consideration of Impact on the Economy 

X. Regulatory Flexibility Act 

XI. Statutory Authority 

XII. Text of Proposed Rule Amendment 

I. Introduction 

Rule 602 of Regulation NMS 1 and 

Rule 301(b) of Regulation ATS 2 require 

exchanges and alternative trading 

systems (‘‘ATSs’’), respectively, to 

provide their best-priced quotations to 

the consolidated quotation data that is 

widely disseminated to the public.3 The 

Commission is proposing to amend Rule 

602 to eliminate the exception for the 

use of flash orders by equity and options 

exchanges. If the proposed amendment 

were adopted, the Commission would 

apply Rule 301(b) in a consistent 

manner regarding the use of flash orders 

by ATSs. Finally, the Commission 

would also apply the restrictions on 

locking or crossing quotations in Rule 

610(d) of Regulation NMS 4 in a 

consistent manner to prohibit the 

practice of displaying flash orders with 

marketable prices. The practical result 

of the proposal, if adopted, would be 

that any flash orders with nonmarketable prices would need to be 

included in the consolidated quotation 

data and that the more frequently used 

practice of flashing orders with 

marketable prices to certain market 

participants would be prohibited. 

Exchanges and ATSs would be required 

to handle marketable orders that they 

are unable to execute at the best 

displayed prices in another manner, 

such as by routing marketable orders 

away to execute against the best 

displayed quotations at another 

exchange or ATS. 

As discussed in section III below, 

Rule 602 generally requires exchanges 

to make their best bids and offers in 

U.S.-listed securities available in the 

consolidated quotation data that is 

widely disseminated to the public. 

Paragraph (a)(1)(i)(A) of Rule 602, 

however, excludes bids and offers 

communicated on an exchange that 

either are executed immediately after 

communication or cancelled or 

withdrawn if not executed immediately 

after communication. Rule 602 has 

included this language since the original 

adoption of its predecessor rule in 1978. 

The exception was intended to facilitate 

manual trading in the crowd on 

exchange floors by excluding quotations 

that then were considered ‘‘ephemeral’’ 

and impractical to include in the 

consolidated quotation data.5 As 

securities trading became much more 

automated in recent years, automated 

markets began to disseminate 

information electronically concerning 

orders that either were to be executed 

immediately or withdrawn if not 

executed immediately. These 

electronically disseminated orders had a 

duration that was even shorter than the 

ephemeral manual quotations that were 

contemplated in 1978. The orders 

qualifying for the ‘‘immediate execution 

or withdrawal’’ exception from Rule 602 

now are widely referred to as ‘‘flash 

orders.’’ 

The Commission is concerned that the 

exception for flash orders, whether 

manual or automated, from Exchange 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48633 

6See infra notes 54–56 and accompanying text. 

7The basic type of order that accesses a market’s 

liquidity without the possibility of a flash is the 

‘‘immediate-or-cancel’’ (‘‘IOC’’) order. An IOC order 

only seeks to take any liquidity that is currently 

available at a market when the order arrives with 

no possibility of further action by the market with 

the order. In contrast, a flash order is transmitted 

to other market participants in an effort to attract 

additional liquidity to the market. See, e.g., Rule 

600(b)(3) of Regulation NMS (for a quotation to 

qualify as an ‘‘automated quotation’’ that can be 

protected against trade-throughs, the trading center 

displaying the quotation must provide an 

immediate-or-cancel functionality); Chicago Board 

Stock Exchange (‘‘CBSX’’) Rule 52.6(a) (immediateor-cancel orders will not be flashed). 

8See, e.g., Letter dated June 3, 2009 from William 

O’Brien, Chief Executive Officer, Direct Edge ECN 

LLC (‘‘Direct Edge’’) to Elizabeth M. Murphy, 

Secretary, Commission (‘‘Direct Edge Letter’’) at 1 

(Direct Edge’s Enhanced Liquidity Provider 

program provides optional display period for 

marketable orders); International Securities 

Exchange (‘‘ISE’’) Rule 803, Supplementary 

Material .02 (prior to sending a Linkage Order to 

another exchange, a Public Customer Order shall be 

exposed at the national best bid for a sell order or 

national best offer price for a buy order). 

9The term ‘‘national best bid and national best 

offer’’ is defined in Rule 600(b)(42) of Regulation 

NMS as the highest priced bid and the lowest 

priced offer disseminated in the consolidated 

quotation data. The characteristics of marketable 

and non-marketable orders are discussed at length 

in the Commission’s Concept Release on Market 

Fragmentation. Securities Exchange Act Release No. 

42450 (February 23, 2000) 65 FR 10577 (February 

28, 2000) (SR–NYSE–99–48) (‘‘Concept Release on 

Market Fragmentation’’). 

10See, e.g., Securities Exchange Act Release No. 

51808 (June 9, 2005) 70 FR 37496, 37502 (June 29, 

2005) (‘‘NMS Release’’) (‘‘[T]he Commission 

believes that a rule establishing price protection on 

an order-by-order basis for all NMS stocks 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.’’); Concept 

Release on Market Fragmentation, supra note 9, at 

10577 (‘‘The Commission is concerned, however, 

that customer limit orders and dealer quotes may 

be isolated from full interaction with other buying 

and selling interest in today’s markets. * * * To the 

extent that the price-setting customer’s limit order 

remains unexecuted and subsequent buying interest 

is filled at the customer’s price, the customer’s 

order has been isolated, and the incentive of 

customers to improve prices potentially 

compromised.’’); Securities Exchange Act Release 

No. 37619A (September 6, 1996), 61 FR 48290, 

48297 (September 12, 1996) (‘‘Order Handling Rules 

Release’’) (‘‘In 1975, Congress envisioned an NMS 

in which public limit orders in qualified securities 

would have a central role. Congress anticipated that 

the NMS would make all specialists and market 

makers aware of public customer limit orders held 

anywhere in the system, and provide enhanced 

protection and priority for limit orders in stocks 

qualified for trading in the national market 

system.’’); see also S. Report No. 90–75, 94th Cong., 

1st Sess. 18 (1975) (‘‘The Committee is satisfied that 

S. 249 grants the Commission complete and 

effective authority to implement a system for the 

satisfaction of public limit orders.’’). 

11See, e.g., CBSX Rule 52.6(a) (under CBSX flash 

order rule, the CBSX system will automatically 

attempt to match market orders against orders at the 

best price in the CBSX book unless filling the order 

would result in an execution of a trade-through of 

another exchange’s protected quotation); Boston 

Options Exchange Rules, ch. 5, sec. 16(b)(iii)(2) 

(under BOX flash order rule, if there is a quote on 

BOX that is equal to the NBBO, then the order will 

be executed against the relevant quote). 

12See, e.g., CBSX Rule 52.6(a) (orders ‘‘flashed to 

CBSX Traders at the NBBO price for a period of 

time not to exceed 500 milliseconds as determined 

by CBSX’’); ISE Rule 803, Supplementary Material 

.02 (before a Linkage Order is sent to another 

exchange, ‘‘a Public Customer Order shall be 

exposed at the current NBBO price to all Exchange 

Members for a time period established by the 

Exchange not to exceed one (1) second’’). 

13See, e.g., Direct Edge Letter, supra note 8, at 4 

(Direct Edge provides its data feed with flash order 

information at no charge to any recipient who 

wishes to receive the data). 

Act quoting requirements is no longer 

necessary or appropriate in today’s 

highly automated trading environment. 

The consolidated quotation data is 

designed to provide investors with a 

single source of information for the best 

prices in a listed security, rather than 

forcing investors to obtain such 

information by subscribing to all of the 

data feeds of the many exchanges and 

ATSs that trade listed securities. The 

flashing of order information could lead 

to a two-tiered market in which the 

public does not have access, through the 

consolidated quotation data streams, to 

information about the best available 

prices for U.S.-listed securities that is 

available to some market participants 

through proprietary data feeds. In 

addition, flash orders may significantly 

detract from incentives for market 

participants to display their trading 

interest publicly, though flash orders do 

offer potential benefits to certain types 

of market participants.6 The 

Commission therefore is proposing to 

eliminate the exception for flash orders 

from Exchange Act quoting 

requirements. 

II. Description of Flash Orders 

As noted in section IV.B.1 below, the 

phrases ‘‘executed immediately’’ or 

‘‘withdrawn if not executed 

immediately’’ in Rule 602(a)(1)(i)(A) can 

cover a variety of different trading 

mechanisms on both a manual trading 

floor and an automated trading system. 

In general, however, the particular type 

of electronic flash order that equity and 

options markets now use the most has 

the following basic features: 

First, the use of a flash order type is 

voluntary. Markets that offer flash order 

types also offer order types that provide 

order routers with the ability to access 

liquidity at the market without using a 

flash order type.7

Second, flash orders almost always 

are ‘‘marketable’’ 8—they are buy orders 

that are immediately executable at the 

price of the national best offer and sell 

orders that are immediately executable 

at the price of the national best bid.9 For 

example, if the national best bid and 

national best offer (‘‘NBBO’’) in a listed 

security are $20.10 and $20.15, 

respectively, marketable buy orders are 

executable at $20.15 and marketable sell 

orders are executable at $20.10. 

Marketable orders can be said to ‘‘take’’ 

liquidity. The submitter wants to trade 

immediately and is willing to pay the 

‘‘spread’’ between the NBBO (in the 

example, the five cent difference 

between $20.10 and $20.15) for the 

opportunity to trade immediately. In 

contrast, non-marketable orders—for 

example, those orders that establish the 

national best bid and offer—are 

‘‘resting’’ orders that seek to trade at 

better prices than those that are 

immediately available and to earn the 

NBBO spread rather than pay it. These 

resting orders provide quotation 

information for investors and add 

liquidity and depth to the market. Nonmarketable orders run the risk, however, 

of missing an execution if they are 

unable to interact with contra side 

marketable order flow. That is why the 

Commission long has been concerned 

with promoting the opportunity for 

publicly displayed orders to interact 

with contra side marketable order 

flow.10

Third, on arrival at a market and prior 

to being flashed, flash orders first will 

interact immediately with any available 

contra side trading interest at the 

exchange that receives the order.11 For 

example, a marketable flash order to buy 

can execute immediately against a 

displayed order at the receiving 

exchange that is priced at the national 

best offer. As a result, the public is able 

to interact with such orders at that 

market—prior to the order being 

flashed—by submitting a nonmarketable resting order that is priced at 

the national best bid for buy orders and 

the national best offer for sell orders. 

Fourth, if a market does not have 

available trading interest at the national 

best offer when a marketable flash order 

to buy arrives, or at the national best bid 

when a marketable flash order to sell 

arrives, the market will flash the order 

to its market participants at the national 

best offer for flash orders to buy and the 

national best bid for flash orders to 

sell.12 The markets disseminate the 

order information as part of their data 

feeds. Some distribute the data only to 

members, and some provide the data to 

anyone who wants to receive it.13

Fifth, market participants that receive 

the flashed order information have a 

very brief period in which to respond 

with their own order to execute against 

the flashed order at a price that matches 

the NBBO price (that is, the national 

best offer for flash orders to buy and the 

national best bid for flash orders to sell). 

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48634 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

14See, e.g., BOX Rules, ch. 5, sec. 16(b)(iii)(2(a) 

(one second); CBSX Rule 52.6(a) (no more than 500 

milliseconds); ISE Rule 803, Supplementary 

Material .02 (not to exceed one second). 

15See, e.g., CBSX Rule 52.6(a) (‘‘CBSX System 

shall route [intermarket sweep orders] on behalf of 

the market order to all Protected Quotations priced 

better than the CBSX disseminated price’’); ISE Rule 

803, Supplementary Material .02(d) (if an order 

cannot be executed in full after exposure, ‘‘the 

Primary Market Maker will proceed to send a 

Linkage Order on the customer’s behalf for the 

balance of the order’’ if it is marketable against the 

then-current NBBO). 

16The term ‘‘responsible broker or dealer’’ is 

defined in Rule 600(b)(65) of Regulation NMS. 

17FINRA collects quotation data from over-thecounter market participants, including ATSs. 

18The consolidated quotation data streams and 

their policy objectives are fully described in the 

Commission’s Concept Release on Regulation of 

Market Information Fees and Revenues. Securities 

Exchange Act Release No. 42208 (December 9, 

1999) 64 FR 70613 (December 17, 1999). 

19See Securities Exchange Act Release No. 14415 

(January 26, 1978), 43 FR 4342 (February 1, 1978) 

(‘‘This determination is consistent with the 

Commission’s intent in providing this exception for 

‘ephemeral’ quotations in the 1977 Proposal; that is, 

that the Rule as adopted reflects the fact that certain 

non-specialist participants in exchange ‘crowds’ 

have bids and offers which, while narrowing the 

exchange quotation for an instant in time, never in 

fact become part of the quoted market on the 

exchange because they are withdrawn immediately 

if not accepted.’’). Rule 602 originally was 

designated as Rule 11Ac1–1 under the Exchange 

Act. It was redesignated as Rule 602 as part of the 

adoption of Regulation NMS in 2005, but its 

substance was unchanged. 

20 In general, ATSs that meet a 5% volume 

threshold in NMS stocks are required to include 

their best-priced displayed orders in the 

consolidated quotation data. See infra note 64. 

21A ‘‘locking’’ quotation has a price that equals 

the price of the previously displayed contra side 

NBBO. For example, if the national best offer to sell 

were $20, a subsequent bid to buy with a price of 

$20 would be a locking quotation. A ‘‘crossing’’ 

quotation has a price that is higher or lower than 

the price of the previously displayed contra side 

NBBO. For example, if the national best offer to sell 

were $20, a subsequent bid to buy with any price 

higher than $20 would be a crossing quotation. 

Conversely, if the national best bid to buy were $19, 

a subsequent offer to sell with any price lower than 

$19 would be a crossing quotation. 

22All equities exchanges and the NASD were 

participants in the ITS Plan. The ITS Plan is 

described in the NMS Release, supra note 10, at 

37501. 

23Restrictions on locking and crossing quotations 

for exchange-listed options currently are imposed 

in the Options Linkage Plan. The Options Linkage 

Plan is a Commission-approved national market 

system plan. Securities Exchange Act Release No. 

60405 (July 30, 2009), 74 FR 39362 (August 6, 2009) 

(Order Approving the National Market System Plan 

Relating to Options Order Protection and Locked/ 

Crossed Markets Submitted by the Chicago Board 

Options Exchange, Incorporated, International 

Securities Exchange, LLC, The NASDAQ Stock 

Market LLC, NASDAQ OMX BX, Inc., NASDAQ 

OMX PHLX, Inc., NYSE Amex LLC, and NYSE 

Arca, Inc.) (‘‘Options Linkage Plan’’). Similar to 

Rule 610(d), Section 6 of the Options Linkage Plan 

requires the options exchanges to adopt rules that 

prohibit their members from engaging in a pattern 

or practice of displaying locking or crossing 

quotations. 

24The first exchange to use the flash order 

exception for electronically communicated orders 

was the Boston Options Exchange (‘‘BOX’’) facility 

of the Boston Stock Exchange (‘‘BSE’’). Securities 

Exchange Act Release No. 49068 (January 13, 2004), 

69 FR 2775 (January 20, 2004) (SR–BSE–2002–15). 

BOX flashed orders as part of a process called an 

‘‘NBBO filter.’’ 

25See id. at 2776–2777 (‘‘Overall, the 

Commission believes that approving the BSE’s 

proposal to establish trading rules for the BOX 

facility should confer important benefits to the 

public and provide U.S. market participants with a 

new market in which to trade standardized options. 

As a fully electronic options market with relatively 

lower barriers to access, BOX’s entry into the 

options marketplace may potentially reduce the 

costs of trading to investors and market 

professionals, enhance innovation, and increase 

competition between and among the options 

exchanges, resulting in better prices and executions 

for investors.’’) (citations omitted). 

The time periods vary in length, but 

generally are one second or less.14 As a 

result, although all those who take a 

market’s data feed will receive the 

flashed order information, only market 

participants with pre-programmed 

systems capable of responding very 

rapidly will have a realistic opportunity, 

as a practical matter, to respond to a 

flashed order. In other words, only those 

who have invested in sophisticated 

trading systems are able to effectively 

access flash orders. 

Sixth, if there is an order responding 

to the flashed order, the flash order will 

execute against the response. If there is 

no response to the flashed order, 

markets generally will route orders 

away to execute against the best-priced 

quotations on other markets.15

III. Flash Order Exception From 

Quoting Requirements 

Rule 602 generally requires exchanges 

to make available to vendors, including 

the central processors for the 

consolidated quotation data that is 

widely disseminated to the public, the 

best bids and best offers for listed 

securities that are communicated on an 

exchange by any responsible broker or 

dealer.16 The consolidated quotation 

data streams are the primary vehicles for 

public price transparency in the U.S. 

equity and options markets. The central 

processors for these data streams collect 

the best bids and best offers from the 

exchanges and Financial Industry 

Regulatory Authority (‘‘FINRA’’) 17 and 

distribute them in consolidated data 

streams that are widely available to the 

public. The consolidated data streams 

are designed to assure that the public 

has affordable, accurate, and reliable 

real-time information on the best prices 

available for listed securities.18

Paragraph (a)(1)(i)(A) of Rule 602, 

however, excepts ‘‘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.’’ This language was 

included in the predecessor to Rule 602 

when it originally was adopted in 1978 

and was intended to accommodate the 

‘‘ephemeral’’ quotations of nonspecialist participants in exchange 

crowds.19 As a result, bids and offers 

that either are immediately executed or, 

if not executed, immediately cancelled 

or withdrawn are not required to be 

included in the consolidated quotation 

data. 

By its terms, Rule 602(a)(1)(i)(A) 

applies only to exchanges. The relevant 

parts of Rule 602 in the over-the-counter 

context apply to national securities 

associations and OTC market makers. 

As a result, ATSs generally are not 

directly subject to Rule 602 

requirements. Rule 301(b)(3)(ii) of 

Regulation ATS, however, requires 

certain ATSs to include their best priced 

orders displayed to more than one 

person in the consolidated quotation 

data made available to the public 

pursuant to Rule 602.20 Consistent with 

the language in Rule 602 excepting 

exchanges from including flash orders 

in the consolidated quotation data, the 

Commission has not applied Rule 301 to 

require ATSs to include flash orders in 

the consolidated quotation data. 

Similarly, the Commission has not 

applied the Rule 610(d) restrictions on 

displaying quotations that ‘‘lock’’ or 

‘‘cross’’ another market’s displayed 

quotation, to flash orders with 

marketable prices.21 For many years, the 

restrictions on locking and crossing 

quotations for exchange-listed equities 

were imposed in the Intermarket 

Trading System (‘‘ITS’’) Plan.22 In 2005, 

the Commission adopted Rule 610(d) of 

Regulation NMS to address locking and 

crossing quotations for NMS stocks. 

Among other things, Rule 610(d) 

requires the self-regulatory 

organizations (‘‘SROs’’) to adopt rules 

that prohibit their members from 

engaging in a pattern or practice of 

displaying quotations that lock or cross 

protected quotations in NMS stocks.23

In January 2004, the Commission 

approved an exchange rule filing for 

orders in listed options that were 

flashed electronically to market 

participants for a three-second period, 

rather than manually on the floor of an 

exchange.24 The Commission generally 

has sought to interpret its rules in such 

a way that they promote fair 

competition between manual and 

automated markets.25 The Commission 

noted that the electronic flash process 

was designed to protect against trading 

through better displayed prices at other 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48635 

26 Id. at 2783. 

27See, e.g., Securities Exchange Act Release Nos. 

51544 (April 14, 2005) 70 FR 20613 (April 20, 2005) 

(SR–Phlx-2005–03); 53167 (January 23, 2006) 71 FR 

5094 (January 31, 2006) (SR–CBOE–2005–89); 

57812 (May 12, 2008) 73 FR 28846 (May 19, 2008) 

(SR–ISE–2008–28). 

28Securities Exchange Act Release No. 54422 

(September 11, 2006) 71 FR 54537 (September 15, 

2006) (SR–CBOE–2004–21). 

29Securities Exchange Act Release Nos. 60040 

(June 3, 2009) 74 FR 27577 (June 10, 2009) (SR– 

BATS–2009–014); 59875 (May 6, 2009) 74 FR 22794 

(May 14, 2009) (SR–NASDAQ–2009–043); 60039 

(June 3, 2009) 74 FR 27635 (June 9, 2009 (SR– 

NASDAQ–2009–050); and 60037 (June 3, 2009) 74 

FR 27367 (June 9, 2009) (SR–NASDAQ–2009–048). 

30Rule 19b–4(f)(6) permits a proposed rule 

change to become immediately effective so long as 

each policy issue raised by the proposed trading 

rule: (1) has been considered previously by the 

Commission when the Commission approved 

another exchange’s trading rule; and (2) the rule 

change resolves such policy issue in a manner 

consistent with such prior approval. Securities 

Exchange Act Release No. 58092 (July 3, 2008) 73 

FR 40144, 40147 (July 11, 2008). 

31See id. at 40147 (‘‘[T]he Commission recognizes 

that national securities exchanges registered under 

section 6(a) of the Exchange Act face increased 

competitive pressures from entities that trade the 

same or similar financial instruments—such as 

foreign exchanges, futures exchanges, ECNs, and 

ATSs. These competitors can change their trading 

rules or trade new products without filing them 

with the Commission.’’). 

32Letter dated May 28, 2009 from Janet M. 

Kissane, Senior Vice President—Legal & Corporate 

Secretary, Office of the General Counsel, NYSE 

Euronext to Elizabeth M. Murphy, Secretary, 

Commission (‘‘NYSE Euronext Letter’’); Letter dated 

June 4, 2009 from Stephen Schuler and Daniel 

Tierney, Managing Members, Global Electronic 

Trading Company to Elizabeth M. Murphy, 

Secretary, Commission (‘‘GETCO Letter’’); Letter 

dated June 4, 2009 from Ann Vlcek, Managing 

Director and Associate General Counsel, Securities 

Industry and Financial Markets Association to 

Elizabeth M. Murphy, Secretary, Commission 

(‘‘SIFMA Letter’’); and Letter dated June 17, 2009 

from William P. Neuberger and Andrew F. 

Silverman, Managing Directors, Global Co-Heads of 

Morgan Stanley Electronic Trading to Elizabeth M. 

Murphy, Secretary, Commission (‘‘Morgan Stanley 

Letter’’). 33NYSE Euronext Letter at 3; see also GETCO 

Letter at 3; Morgan Stanley Letter at 5–6. 34 GETCO Letter at 4; see also NYSE Euronext 

Letter at 6 (‘‘reducing publicly available liquidity in 

this way may impact bid-offer spreads and the 

execution costs to customers’’). 

35Morgan Stanley Letter at 4. 

36SIFMA Letter at 2. 

37See Direct Edge Letter, supra note 8. 

38 Direct Edge Letter at 4. 

39 Direct Edge Letter at 2. 

40Letter dated June 30, 2009 from Woodbine 

Associates (‘‘Woodbine Letter’’) at 1, 2. 

41The Commission’s estimate of flash order 

trading volume in July 2009 reflects discussions 

with the markets that offered flash orders during 

that time—CBSX, Direct Edge, BATS, Nasdaq, and 

Nasdaq OMX BX for equity trading, and BOX, 

CBOE, and ISE for options trading. These volume 

estimates reflect executions by market participants 

in response to flashed order information. 

42See Securities Exchange Act Release Nos. 

60569 (August 26, 2009), 74 FR 45268 (September 

1, 2009) (SR–BATS–2009–028); 60570 (August 26, 

2009), 74 FR 45504 (September 2, 2009) (SR– 

NASDAQ–2009–079); 60571 (August 26, 2009), 74 

FR 45502 (September 2, 2009) (SR–BX–2009–051). 

The Commission notes that, if the proposal is 

adopted, exchanges with flash order rules would 

need to file proposed rule changes to eliminate 

flash orders from their rule books. 

43See also supra note 32. 

markets, and that the process would 

allow exchange participants to provide 

efficient and competitive executions for 

flashed orders.26 Subsequently, other 

options exchanges adopted similar 

rules.27

In September 2006, the Commission 

approved an exchange rule filing for the 

use of flash orders on the equity trading 

platform of the Chicago Board Options 

Exchange (‘‘CBOE’’).28 The Commission 

received no comments on the CBOE 

proposal. In May 2009, two more 

exchanges—Nasdaq and BATS—filed 

proposed rule changes to begin offering 

flash orders for equity trading.29 The 

proposed rule changes of Nasdaq and 

BATS cited the Commission’s previous 

approval of the CBSX filing and were 

filed as immediately effective pursuant 

to Exchange Act Rule 19b–4(f)(6).30 In 

this regard, the Nasdaq and BATS 

filings fell within the interpretive 

guidance issued by the Commission last 

year that was designed to streamline the 

handling of SRO proposed rule changes, 

particularly for exchange trading 

rules.31

Commenters opposed to the Nasdaq 

and BATS filings raised serious 

concerns about the effect of flash orders 

on investors and on the integrity of the 

markets.32 NYSE Euronext noted that in 

today’s trading environment, ‘‘where 

trading and reaction time are discussed 

in micro seconds, an order that is held 

for even 500 milliseconds cannot be 

deemed an ‘‘immediate’’ execution.’’ 33

GETCO was concerned that flash orders 

reduce the incentive to display 

aggressively priced liquidity, noting that 

‘‘[m]arket participants interested in 

finding the best priced orders to execute 

against would be encouraged to join the 

disparate system of ‘step-up’ order 

display systems on the various 

exchanges so that they could execute 

against better priced ‘step-up’ orders 

without displaying limit orders on the 

public markets.’’ 34 Similarly, Morgan 

Stanley stated that ‘‘[w]e believe that the 

[proposed rule changes] will provide a 

material disincentive to publicly display 

limit orders on exchanges, thereby 

impairing price discovery.’’ 35 Further, 

SIFMA sought a fuller public discussion 

of issues raised by the proposed rule 

changes, including ‘‘the creation of 

essentially a two tiered market (with 

some able to pay for a non-public direct 

data feed to trade with better-priced 

quotes versus those quotes that are 

accessible to the general public), thus 

raising fair access issues and issues re: 

investor confidence, transparency and 

our market structure in general.’’ 36

In contrast, Direct Edge—an 

alternative trading system—submitted a 

comment letter supporting the proposed 

rule changes.37 The letter noted that 

Direct Edge offers a pre-routing display 

product to its participants—the 

Enhanced Liquidity Provider (‘‘ELP’’) 

program—pursuant to which marketable 

orders are displayed to any of its 

participants who wish to receive the 

information in a data feed for which 

there is no charge.38 It stated that 

‘‘[l]iquidity-aggregation products like 

Direct Edge’s ELP program seek to bring 

together traditional and non-traditional 

liquidity in a consolidated, easy-toaccess manner designed to maximize 

the potential for execution, reduce 

implicit and explicit transaction costs, 

and otherwise improve execution 

quality for our customers.’’ 39 Another 

commenter, Woodbine Associates, was 

concerned that flash orders could have 

an ‘‘undesirable impact’’ if offered by 

market centers with a majority of order 

flow, but recommended that the 

Commission ‘‘allow flash orders, 

monitor their use, and study the effect 

on the market.’’40

For listed equities and listed options 

in July 2009, the Commission estimates 

that the total volume of flash orders that 

received an execution during the flash 

process was approximately 3.1% and 

1.9%, respectively, of total trading 

volume.41 BATS, Nasdaq, and Nasdaq 

OMX BX decided to discontinue 

offering a flash order type as of 

September 1, 2009.42 Accordingly, the 

total volume of executed flash orders 

may have declined as of that date. 

IV. Proposed Elimination of Flash 

Order Exception 

A. Concerns About Flash Orders 

The Commission is proposing to 

eliminate the flash order exception from 

Exchange Act quoting requirements. 

The Commission is concerned that the 

use of flash orders by exchanges and 

other markets, particularly if it were to 

expand in trading volume, could detract 

from the fairness and efficiency of the 

national market system.43 In its analysis 

of flash order types, the Commission 

will consider the interests of long-term 

investors and the extent to which they 

are helped or harmed by these orders, 

rather than on the interests of 

professional short-term traders that may 

have invested in sophisticated trading 

systems capable of responding to flash 

orders. The interests of long-term 

investors and professional short-term 

traders in fair and efficient markets 

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48636 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

44NMS Release, supra note 10, at 37500 (noting 

that ‘‘it makes little sense to refer to someone as 

‘investing’ in a company for a few seconds, 

minutes, or hours’’). The Commission further noted 

that giving priority to the interests of long-term 

investors is consistent with both the legislative 

history of the Exchange Act and the strong policy 

goal to reduce the cost of capital for U.S.-listed 

companies. Id. at 37499–37500. 

45See NYSE Euronext Letter at 4. 

46See Rule 603(b) of Regulation NMS (providing 

for the dissemination of all consolidated 

information for an individual NMS stock through a 

single plan processor). 

47See, e.g., NMS Release, supra note 10, at 37527 

(‘‘The Commission believes, however, that the longterm 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.’’); Order Handling 

Rules Release, supra note 10, at 48293 (‘‘[T]he 

display of customer limit orders advances the 

national market system goal of the public 

availability of quotation information, as well as fair 

competition, market efficiency, best execution, and 

disintermediation.’’). 

48See NMS Release, supra note 10, at 37505. 

49For example, some of these undisplayed venues 

are called ‘‘dark pools,’’ which are reported to 

execute approximately 8% of total trading volume 

in listed equities. See, e.g., Nina Mehta, Inching 

Toward Dark Pool Reporting Standards, Traders 

Magazine Online News, June 26, 2009, http:// 

tradersmagazine.com/news/dark-pool-reporting103943-1.html. In addition, some exchanges, when 

they do not have available trading interest to 

execute marketable orders at the best displayed 

prices, give participants a choice of routing their 

orders in response to ‘‘indications of interest’’ from 

undisplayed venues that are not included in the 

consolidated quotation data. See, e.g., NYSE Arca, 

‘‘Client Notice: NYSE Arca to Provide Indication of 

Interest (IOI) Routing’’ (March 12, 2008) (routing 

service for ‘‘non-displayed liquidity pools’’). 

50See supra note 10. 

51As noted in note 23 supra, the Options Linkage 

Plan includes a prohibition on a pattern or practice 

of displaying locking or crossing quotations in 

listed options that is analogous to Rule 610(d). 

often will coincide. Indeed, vigorous 

competition among professional shortterm traders can itself lead to very 

important benefits for long-term 

investors, including narrower spreads 

and greater depth. If, however, the 

interests of long-term investors and 

professional short-term traders conflict, 

the Commission previously has 

emphasized that ‘‘its clear responsibility 

is to uphold the interests of long-term 

investors.’’ 44 The Commission 

preliminarily believes that, in today’s 

highly automated trading environment, 

the exception for flash orders from 

Exchange Act quoting requirements may 

no longer serve the interests of longterm investors and could detract from 

the efficiency of the national market 

system. 

Today, the overwhelming majority of 

trading volume in listed equities and 

listed options is routed and executed 

through highly automated systems. 

Among other things, these sophisticated 

systems have dramatically reduced the 

time period for collecting and 

disseminating quotations.45 In contrast 

to the primarily manual trading when 

the Commission originally adopted the 

exception for flash orders in 1978, flash 

orders no longer are clearly 

distinguishable from quotations that are 

disseminated in the consolidated 

quotation data. As a result, the rationale 

for requiring markets to include their 

best-priced quotations in the 

consolidated quotation data and for 

prohibiting the practice of displaying 

quotations with prices that lock 

previously displayed quotations would 

appear to apply equally to flash orders 

in today’s trading environment. 

The Commission also is concerned 

that flash orders may create a two-tiered 

market in which the public does not 

have access, through the consolidated 

quotation data streams, to information 

about the best available prices for listed 

securities. A flash order generally is 

displayed at a marketable price that will 

be better than the best displayed price 

for the security in the consolidated 

quotation data. For example, a flash 

order to buy would be displayed at a 

higher price than the national best bid, 

and a flash order to sell would be 

displayed at a lower price than the 

national best offer. Yet the public does 

not receive this flashed order 

information in the consolidated 

quotation data. Instead, only those 

market participants that receive a 

market’s individual data feed have 

access to the improved price 

information. The consolidated quotation 

data streams are intended to provide a 

single source of information on the best 

prices for a listed security across all 

markets, rather than force the public to 

obtain data from many different 

exchanges and other markets to learn 

the best prices.46 This objective would 

not be met if exchanges and ATSs 

disseminate pricing information that, 

due to the technological evolution of the 

markets, is functionally quite similar to 

quotations, yet is not required to be 

included in the consolidated quotation 

data. 

In addition, the Commission is 

concerned about the extent to which 

flash orders may discourage the public 

display of trading interest and harm 

quote competition among markets. The 

Commission long has emphasized the 

need to encourage displayed liquidity in 

the form of publicly displayed limit 

orders.47 Such orders establish the 

current ‘‘market’’ for a stock and thereby 

provide a critical reference point for 

investors. Flash orders, however, 

generally are executed by a market at 

prices that match the best displayed 

prices for a stock at another market. In 

this respect, flash orders potentially 

deprive those who publicly display 

their interest at the best price from 

receiving a speedy execution at that 

price. The opportunity to obtain the 

fastest possible execution at a price is 

the primary incentive for the display of 

trading interest.48 Particularly if flash 

orders were offered by all major markets 

for a security and greatly expanded in 

trading volume, they could significantly 

undermine the incentives to display 

limit orders and to quote competitively, 

and thereby detract from the efficiency 

of the national market system. 

For example, the flash process 

provides a vehicle for certain market 

participants to match displayed prices 

on an order-by-order basis by 

responding to flashes. It therefore gives 

these participants a ‘‘last-mover’’ 

advantage over displayed orders in 

other markets. Rather than displaying 

their orders or quotations in advance of 

incoming marketable order flow to 

attract an execution, these market 

participants can wait to receive the 

flashed order and program their systems 

to pick and choose when to execute. 

The availability of this ‘‘flash’’ 

alternative to quoting as a means to 

supply liquidity may reduce their 

incentives to display liquidity. 

Moreover, the flash process diverts a 

certain amount of order flow that 

otherwise might be routed directly to 

execute against displayed quotations in 

other markets. The Commission 

recognizes that orders in listed equities 

may be routed to venues that do not 

display their trading interest in the 

consolidated quotation data.49 Certain 

benefits, including adding liquidity, 

may result from routing orders to 

undisplayed venues. Given the 

importance of displayed quotations for 

market efficiency,50 however, the 

Commission is particularly concerned 

about additional marketable order 

flow—orders that are immediately 

executable at the national best bid or 

offer—that may be diverted from the 

public quoting markets and that could 

further reduce the incentives for the 

public display of quotations. 

The Commission also is concerned 

that the flashing of orders at marketable 

prices may undermine the purposes of 

Rule 610(d) of Regulation NMS, which 

is designed to protect displayed 

quotations from being locked by equalpriced contra side quotations.51

Marketable prices are, by definition, 

prices that at least equal the best contra 

side quotation for a stock. For example, 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48637 

52NMS Release, supra note 10, at 37547. 53As noted in section V below, the Commission’s 

staff is reviewing other forms of dark trading 

interest that are not included in the consolidated 

public quotation data, and the Commission expects 

to consider initiatives in this area in the near future. 54See Direct Edge Letter at 2. 

a marketable flash order to buy will be 

displayed at the price of the national 

best offer and a marketable flash order 

to sell will be displayed at the price of 

the national best bid. In adopting Rule 

610(d), the Commission emphasized 

that ‘‘giving priority to the firstdisplayed quotation will encourage the 

posting of quotations and contribute to 

fair and orderly markets.’’ 52 The 

Commission preliminarily believes that 

flash orders may be inconsistent with 

this policy. The flashing of orders is no 

longer distinguishable in today’s highly 

automating trading from the 

dissemination of automated quotations. 

If marketable flash orders were included 

in the consolidated quotation data, for 

example, such orders clearly would be 

locking quotations in violation of Rule 

610(d). The practical result of the 

Commission’s proposal, therefore, 

would be that flash orders could no 

longer be displayed to anyone at prices 

that equal the best priced contra side 

quotation in a stock. A market that was 

unable to execute incoming marketable 

orders at the best prices would need to 

handle them in another fashion. 

Depending on the order router’s wishes, 

a market could route the order away to 

access the best displayed prices on other 

exchanges, reprice and display the order 

at a permissible price, or cancel the 

order back to the order router. It also is 

possible, however, that the order may be 

routed to a dark venue.53

The proposed elimination of the 

exception for flash orders from 

Exchange Act quoting requirements also 

likely would affect the competition 

among exchanges and ATSs for trading 

volume. Much of a market’s revenue is 

generated, directly or indirectly, 

through the execution of trades. 

Accordingly, markets have strong 

incentives to maximize their executed 

volume, both by attracting the largest 

possible volume of order flow and by 

executing as much of that order flow as 

possible. Flash orders give markets an 

additional opportunity to execute 

marketable orders even if they do not 

have available contra trading interest at 

the best displayed prices when the flash 

order arrives. In this respect, flash 

orders can be viewed as one competitive 

strategy to maximize a market’s trading 

volume and revenues, which would be 

curtailed by adoption of the proposal. 

The Commission preliminarily 

believes, however, that any limitation 

on a market’s competitive choices 

would be justified by other effects of the 

proposal that would promote 

competition, protect investors, and 

enhance efficiency. As an initial matter, 

it is important to recognize that, both 

currently and if the proposal were 

adopted, all exchanges and ATSs would 

operate under the same rules for flash 

orders. Currently, the availability of the 

flash order type benefits markets that do 

not have available contra side trading 

interest at the best displayed prices 

when an order arrives by giving them a 

second chance to execute the order. In 

this respect, the current rule tends to 

benefit those markets that have the least 

available trading interest at the best 

prices, including displayed limit orders. 

If adopted, the proposal would give 

markets even greater incentives to 

attract trading interest at the best 

displayed prices, including displayed 

limit orders, in advance of the arrival of 

marketable orders, as well as better 

opportunities to attract marketable order 

flow by displaying the best prices. It 

thereby would promote competition for 

the displayed liquidity that is vital to 

the fairness and efficiency of the listed 

securities markets. In addition, the 

proposal would help protect the 

interests of investors who are willing to 

display their trading interest publicly. 

Finally, the flashing of orders to many 

market participants creates a risk that 

recipients of the information could act 

in ways that disadvantage the flashed 

order. With today’s sophisticated order 

handling and execution systems, those 

market participants with the fastest 

systems are able to react to information 

in a shorter time frame than the length 

of the flash order exposures. As a result, 

such a participant would be capable of 

receiving a flashed order and reacting to 

it before the flashed order, if it did not 

receive a fill in the flash process, could 

be executed elsewhere. For example, a 

recipient of a flash order that was 

quoting on another exchange would be 

capable of adjusting its quotes to avoid 

being hit by the flash order if it 

subsequently were routed to that 

exchange. Alternatively, a recipient 

would be capable of rapidly 

transmitting orders that would take out 

trading interest at other exchanges 

before an unfilled flash order could be 

routed to those exchanges. In both cases, 

a flashed order that did not receive an 

execution in the flash process would 

also be less likely to receive a quality 

execution elsewhere. 

Of course, flash orders are voluntary 

on the part of order routers. They 

involve a willing decision on the part of 

order routers to disseminate the order 

information to a group that generally 

will include highly sophisticated 

professional traders. Those who choose 

to use the flash order type (which often 

will be a broker that owes a duty of best 

execution to its customer for the routing 

decision) probably already consider the 

extent to which flashed orders may 

contain significant information content 

that could lead the recipients of flash 

order information to act contrary to the 

interests of the orders. Stated another 

way, those who are highly concerned 

about information leakage generally 

would be unlikely to flash their order 

information to a large number of 

professional traders. As a result, there is 

an inverse relationship between the 

extent to which flash orders are used 

beneficially by order submitters and the 

extent to which the recipients of flash 

orders could gain an information 

advantage. If used beneficially by order 

submitters, the information leakage and 

information advantage would be 

minimized for the user of the flash 

order. If not used beneficially, however, 

the flash order type appears to raise 

particular risks for customers whose 

order information is flashed. 

The Commission recognizes that flash 

orders offer potential benefits to certain 

types of market participants. For those 

seeking liquidity, the flash mechanism 

may attract additional liquidity from 

market participants who are not willing 

to display their trading interest publicly. 

Flash orders thereby may provide an 

opportunity for a better execution than 

if they were routed elsewhere.54 There 

is no guarantee, for example, that an 

order routed to execute against a 

displayed quotation will, in fact, obtain 

an execution. The displayed quotation 

may already be executed against or 

cancelled before the routed order 

arrives. Of course, the delay in routing 

during a flash period may further 

decrease the likelihood of an execution 

in the displayed market for the flash 

order because prices at the displayed 

market may move away from the flash 

order during the flash process. Those 

who route flash orders, however, may 

use them selectively in those contexts 

where they believe an order is less 

likely to receive a full execution if 

routed elsewhere. 

In addition, many markets that 

display quotations charge fees (often 

known as ‘‘take’’ fees) for accessing 

those quotations. Flash orders may be 

executed through the flash process for 

lower fees than the fees charged by 

many markets for accessing displayed 

quotations. Indeed, some markets have 

offered rebates on orders that are 

executed during a flash, so that the 

order, rather than paying a fee, will earn 

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48638 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

55NASDAQ OMX, Flash Functionality, http:// 

www.nasdaqtrader.com/content/ProductsServices/ 

Trading/Flash_factsheet.pdf and BATS Global 

Markets, BATS Exchange Releases BOLT, http:// 

www.batstrading.com/resources/press_releases/ 

BATS_Exchange_Announces_BOLT_FINAL.pdf. As 

noted supra note 42, Nasdaq and BATS have 

announced that they will no longer offer a flash 

order functionality as of September 1, 2009. 

56When it adopted Rule 610(d), the Commission 

specifically considered and disapproved the 

practice of deliberately locking a displayed 

quotation to obtain a liquidity rebate. NMS Release, 

supra note 10, at 37547 (restriction on locking 

quotations was intended to address a market 

participant that ‘‘chooses to lock rather than 

execute the already-displayed quotation to receive 

a liquidity rebate’’). 

57See, e.g., Section 2(a) of the Exchange Act 

(securities transactions are affected with a national 

public interest which makes it necessary to ‘‘insure 

the maintenance of fair and honest markets in such 

transactions’’). 

58NMS Release, supra note 10, at 37516. 

59 Id. 

60See, e.g., Concept Release on Market 

Fragmentation, supra note 9, at 10584 n. 53 (citing 

academic studies finding that the required display 

of customer limit orders, by providing greater price 

transparency and enhancing public price discovery, 

led to substantial reductions in transaction costs for 

both retail and institutional investors). 

61See, e.g., BOX Rules, ch. V, sec. 18 (Price 

Improvement Mechanism); CBOE Rule 6.13A 

(Simple Auction Liaison); and ISE Rule 716(d) 

(Facilitation Mechanism). 

a rebate.55 The combined difference 

between receiving a rebate for an 

executed flash order versus paying a fee 

for accessing a displayed quotation may 

be a significant incentive for traders to 

submit flash orders.56

Finally, some market participants that 

choose to receive and respond to flash 

orders may represent large institutional 

investors that are reluctant to display 

quotations publicly to avoid revealing 

their full trading interest to the market, 

but are willing to step up on an orderby-order basis and provide liquidity to 

flash orders. Such investors may have 

the sophisticated systems themselves to 

respond to flash orders or may rely on 

the systems of their brokers. Executions 

against flash orders could help lower 

the transaction costs of these 

institutional investors. 

The Commission expects that any 

negative effect of the elimination of the 

exception for flash orders from 

Exchange Act quoting requirements 

would be mitigated by the ability of 

market participants to adapt their 

trading strategies to the new rules. In 

addition, higher incentives to display 

liquidity and alternative forms of 

competition for order flow could 

mitigate any negative effect of the 

proposal. 

To summarize, the Commission 

recognizes that flash orders may have 

some benefits, but preliminarily 

believes that, in the context of today’s 

highly automated trading environment, 

those benefits do not justify the negative 

aspects of flash orders. In reaching this 

preliminary view, the Commission also 

has considered the potential damage to 

public confidence in the securities 

markets caused by practices that may 

give professional short-term traders an 

unfair advantage over long-term 

investors. Professional short-term 

traders inevitably have advantages in 

the active trading of securities—that is, 

buying and selling securities repeatedly 

throughout the trading day. Active 

trading is a highly competitive 

endeavor, and many professional shortterm traders devote substantial 

resources to develop the systems and 

expertise to trade successfully. 

Ultimately, this competition among 

professional short-term traders can 

greatly benefit long-term investors if it 

leads to better execution quality (such 

as narrower spreads and greater 

liquidity) when investors enter the 

market to establish or liquidate their 

positions in a security. 

Practices that may give professional 

short-term traders undue advantages 

without creating sufficient corollary 

benefits to long-term investors, or that 

can undermine the goals of Commission 

rules, for example promoting displayed 

liquidity, may cause damage to public 

confidence in the fairness of the 

markets, and this must be considered by 

the Commission in fulfilling its 

regulatory responsibility under the 

Exchange Act. Indeed, the 

Congressional concern to maintain and 

promote public confidence in the 

fairness of the securities markets has 

been a hallmark of the federal securities 

laws for the last 75 years.57

The Commission also has considered 

the potential costs and benefits of flash 

orders at the level of individual 

transactions. When an order is flashed 

and receives an execution, three 

different market participants are most 

directly affected: (1) The submitter of 

the flash order that received an 

execution; (2) the receiver of the flashed 

information that supplied dark liquidity 

to the order; (3) and the market 

participant that was willing to supply 

liquidity through a publicly displayed 

quotation establishing the best price for 

a security, yet did not receive an 

execution at that price. Although the 

first two parties received the benefits of 

a desired trade, potentially with lower 

fees than they otherwise might have 

paid, the third party that established the 

best displayed price did not receive an 

execution and thereby suffered a cost. 

Moreover, displayed liquidity is a 

public good that benefits investors and 

traders generally.58 When the market 

participants that generate this public 

good are harmed by a missed trading 

opportunity, it creates an externality 

that can detract from the efficiency of 

the securities markets.59 Though the 

costs of failing to reward the public 

display of liquidity are difficult to 

quantify, the Commission’s practical 

experience over the years with 

initiatives to promote the public display 

of liquidity have demonstrated their 

value for investors.60

Given all of these factors, the 

Commission preliminarily believes that 

the benefits of flash orders for some 

market participants do not justify their 

costs to other market participants, the 

national market system, and the public 

interest. It therefore is proposing to 

eliminate the exception for flash orders 

from Exchange Act quoting 

requirements. 

B. Description of Proposal 

1. Proposed Amendment of Rule 602 

Under the proposal, paragraph 

(a)(1)(i)(A) of Rule 602 would be 

eliminated in its entirety. The 

Commission recognizes that a number of 

exchanges currently offer a variety of 

trading services other than flash orders 

that conceivably could be affected by 

the elimination of the paragraph. These 

may include price improvement 

auctions and various types of 

facilitation and exposure mechanisms 

for large orders.61 The Commission 

preliminarily believes that the status of 

these trading mechanisms under Rule 

602 would not be altered by the 

proposed amendment. For example, the 

Commission preliminarily believes that 

orders exposed as part of a competitive 

auction that provides an opportunity to 

obtain better prices than displayed 

quotations generally would not 

constitute bids and offers that must be 

provided to the consolidated quotation 

stream, nor would the responses to 

those orders if they were actionable only 

with respect to the exposed order. 

Comment is requested on the potential 

impact of the proposal on exchange 

trading services other than flash orders. 

As noted in section III above, the 

language in Rule 602(a)(1)(i)(A) 

originally was adopted to accommodate 

ephemeral quotations on manual trading 

floors. Historically, exchange members 

located on trading floors have 

conducted on the spot discussions of 

price which could not practically be 

reflected in the published quotation and 

were generally understood to fall within 

the exemption of Rule 602(a)(1)(i)(A). 

Although trading floors have changed 

dramatically in recent years, some of the 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48639 

62See section V below for a more detailed 

discussion of alternative regulatory approaches. 

63Rule 602(d) provides that such exemptions may 

be granted either unconditionally or on specified 

terms and conditions, if the Commission 

determined that such exemptions were 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. See, 

e.g., Letter from Robert L.D. Colby, Deputy Director, 

Division of Market Regulation, Commission, to 

Michael J. Simon, Senior Vice President and 

General Counsel, ISE, dated December 8, 2004 

(Commission staff acting by delegated authority to 

grant ISE a limited exemption from its obligations 

under Rule 602(a) in connection with ISE’s Price 

Improvement Mechanism). 

64An ATS becomes subject to the Regulation ATS 

display requirement if, during at least four of the 

preceding six calendar months, it had an average 

daily trading volume of 5% or more of the aggregate 

average daily share volume for such NMS stock as 

reported by an effective transaction reporting plan. 

17 CFR 242.301(b)(3)(i)(B). 

65See, e.g., Section 11A(a)(1)(c)(ii) of the 

Exchange Act (one of the objectives of the national 

market system is to assure fair competition 

‘‘between exchange markets and markets other than 

exchange markets’’). 

66See Securities Exchange Act Release No. 40760 

(December 8, 1998), 63 FR 70844, 70850 (December 

22, 1998) (‘‘Regulation ATS Adopting Release’’) 

(‘‘The label put on an order—‘firm’ or ‘not firm’— 

is not dispositive. For example a system claiming 

it displays only ‘‘indications of interest’’ that are 

not orders, may be covered by the new 

interpretation of ‘exchange’ if those indications are, 

in fact, firm in practice.) 

67As noted in note 23 supra, the Options Linkage 

Plan includes a prohibition of a pattern or practice 

of displaying locking or crossing quotations in 

listed options that is analogous to Rule 610(d). If 

flash orders for listed options were no longer 

excepted from Rule 602 and therefore required to 

be included in the OPRA quotations data, the 

Commission also would consider the Option 

Linkage Plan’s restrictions on locking or crossing 

quotations to apply to the display of marketable 

flash orders. 

historical practices may still be 

necessary for the effective functioning of 

a trading floor. For example, when floor 

brokers represent large discretionary 

orders they must be able to discuss 

terms of a prospective trade. If it were 

necessary to make such terms public, it 

would interfere with, and might make 

impossible, the effective representation 

of such large orders on a trading floor. 

Similarly, floor brokers can ‘‘request a 

market’’ in a security either 

hypothetically (or conditionally) or with 

a view to executing a particular order in 

hand. In either case, the response of the 

‘‘trading crowd’’ can be different than 

the published quotation. It may be 

impractical to require such responses to 

be published. Even if publication were 

technically feasible, it could 

significantly impair floor brokers’ ability 

to represent large orders effectively. 

There may be other examples as well of 

floor practices that are necessary for 

floors to function effectively, but that 

could be viewed as conflicting with 

Rule 602 as proposed to be amended. 

The Commission preliminarily 

believes that the concerns about flash 

orders discussed above apply both with 

respect to the electronic flashing of 

orders and the manual flashing of orders 

to exchange crowds. These concerns 

include particularly the danger of a twotiered market in which the public does 

not have access, through the 

consolidated quotation data streams, to 

information about the best available 

prices, and the effect on incentives to 

display trading interest publicly. In 

addition, the Commission has sought to 

establish a regulatory framework that 

maintains fair competition between 

automated markets and manual markets. 

The Commission requests comment on 

whether the elimination of the flash 

order exception for both automated 

trading systems and manual trading 

floors would seriously detract from the 

viability of trading floors in the modern, 

mostly electronic, trading environment. 

It also requests comment on whether 

Rule 602 should permit trading floors to 

continue manual ‘‘flashing’’ of orders if 

electronic ‘‘flashing’’ is prohibited and 

what, if any, conditions should apply. 

In sum, the proposed amendment of 

Rule 602 conceivably could affect a 

number of practices of both electronic 

exchanges and manual trading floors. To 

the extent that particular practices do 

not raise the policy concerns of flash 

orders under specific circumstances, but 

would be constrained or eliminated by 

the proposed amendment, the 

Commission requests comment on 

whether it should adopt a narrower 

regulatory approach than the full 

elimination of the flash order 

exception.62 In addition, the 

Commission could grant exemptions 

from the requirements of Rule 602, as 

necessary and appropriate, pursuant to 

Rule 602(d).63

2. Application of Rule 301(b) 

If the Commission adopts the 

proposed elimination of the flash order 

exception from Rule 602, the 

Commission would apply Rule 301(b) of 

Regulation ATS in a consistent manner 

to ATSs that use flash orders. Rule 

301(b) sets forth requirements for ATSs, 

one of which is order display and 

execution access. Paragraph (b)(3)(ii) of 

Rule 301 requires an ATS that meets a 

5% volume threshold in an NMS 

stock 64 to 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 ATS, for inclusion in the 

quotation data made available by such 

exchange or association pursuant to 

Rule 602 of Regulation NMS. The 

Commission has sought to promote fair 

competition between exchanges and 

ATSs, consistent with their varying 

regulatory responsibilities.65 The 

Commission has not applied Rule 301(b) 

in a manner inconsistent with Rule 602, 

with respect to flash orders or 

otherwise. 

Accordingly, if the proposed 

amendment to Rule 602 is adopted, the 

Commission would consider orders that 

a threshold ATS displays to more than 

one person in the ATS that either are 

immediately executed or withdrawn if 

not immediately executed to be orders 

covered by Rule 301(b)(3)(ii) that must 

be provided to a national securities 

exchange or national securities 

association for inclusion in the 

consolidated quotation data. Such 

orders would be covered regardless of 

the particular term that an ATS might 

use to characterize the order, such as 

‘‘indication of interest.’’ 66

3. Application of Rule 610(d) 

Finally, if the Commission adopts the 

proposed amendment to Rule 602, the 

Commission would apply the 

restrictions on locking or crossing 

quotations in Rule 610(d) in a consistent 

manner to prohibit the practice of 

displaying marketable flash orders. Rule 

610(d) requires each national securities 

exchange and national securities 

association to establish, maintain, and 

enforce rules that, among other things, 

prohibit members from engaging in a 

pattern or practice of displaying 

quotations that lock or cross any 

‘‘protected quotation,’’ as defined in 

Rule 600(b)(57), in an NMS stock.67

Under the proposed amendment of Rule 

602, flash orders would no longer be 

excepted from the requirement to 

include best-priced quotations and 

orders in the consolidated quotation 

data. If that amendment is adopted, the 

Commission would consider the display 

by SRO members of quotations that 

either are immediately executed or 

withdrawn if not immediately executed 

to be the display of quotations that are 

subject to the locking and crossing 

restrictions of Rule 610(d), like any 

other quotation required by Rule 602(a) 

to be included in the consolidated 

quotation data. As a result, flash orders 

with non-marketable prices would not 

be locking or crossing quotations and 

would need to be included in the 

consolidated quotation data. Orders 

with marketable prices, however, could 

no longer be flashed, because if 

displayed they would be subject to the 

locking and crossing restrictions in Rule 

610(d). 

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48640 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

68See, e.g., Oversight Hearing on Current State 

and Agenda, Hearing Before the Subcomm. on 

Capital Markets, Insurance and GovernmentSponsored Enterprises of the House of 

Representatives Comm. on Financial Services, 

111th Cong. (July 14, 2009) (testimony of Mary L. 

Schapiro, Chairman, Commission); Mary L. 

Schapiro, Chairman, Commission, Address before 

the New York Financial Writers’ Association 

Annual Awards Dinner (June 18, 2009) (transcript 

available at http://www.sec.gov). 

V. Request for Comments 

The Commission seeks comment and 

data on all aspects of the proposed 

amendment of Rule 602, including its 

implications for the application of Rule 

301(b) and Rule 610(d). In particular, 

comment and data are requested on the 

effect of flash orders on the fairness and 

efficiency of the markets for listed 

securities and on the interests of longterm investors in these securities. If 

adopted, would the proposal promote 

investor confidence by addressing the 

potential for a two-tiered market with 

respect to access to information about 

the best prices for listed securities? 

Would the proposal help to promote the 

display of quotations in public markets 

by eliminating one type of trading in 

which ‘‘dark’’ liquidity is provided that 

matches the prices of previously 

displayed public quotations? Would the 

proposal reduce the potential for 

information leakage that could detract 

from the execution quality of marketable 

orders? Conversely, would the proposal 

deprive investors of a trading tool that, 

if used beneficially, can lead to 

improved quality of execution for 

marketable orders? 

Comment and data also are requested 

on the following questions. What are 

some of the trading strategies that 

employ flash orders? Is the use of flash 

orders in the best interests of these 

traders and how would the inability to 

use flash orders affect these traders? Are 

there alternatives to using flash orders 

in such trading strategies? How are 

market participants likely to change 

their behavior if unable to use flash 

orders? What are the likely effects of 

these changes? Which market centers 

are likely to benefit from any changes in 

order routing practices? How would the 

proposal affect transaction costs 

incurred by various market participants? 

How would overall transaction costs 

change? In the absence of flash orders, 

would the limit orders setting the best 

displayed price benefit with faster or 

more probable executions? 

Comment and data also are requested 

on the use of flash orders by exchanges 

for listed options and whether concerns 

about flash orders should be assessed 

differently in that context. For example, 

trades in listed options are required to 

be executed on an exchange that has 

public quoting responsibilities rather 

than at over-the-counter venues that are 

not required to publish quotations. In 

addition, the incentives for the display 

of liquidity for derivative instruments 

such as listed options may be different 

from such incentives for cash equities. 

Finally, listed options are priced largely 

on the value of the underlying 

securities; market participants typically 

update quotations prices as the 

underlying prices change. Given these 

differences and others between equity 

and options trading, should the 

Commission adopt a different approach 

for flash orders in listed options than for 

flash orders in listed equities? 

The Commission also requests 

comment and data on narrower 

regulatory approaches than a complete 

elimination of the exception for flash 

orders from Exchange Act quoting 

requirements. Section IV.B.1 above, for 

example, requests comment on issues 

relating to manual trading floors and the 

extent to which such floors, as they 

currently operate, continue to need the 

exception for flash orders. In addition, 

are there additional features or 

limitations that could be added to the 

use of flash orders that would 

significantly alter the respective costs 

and benefits discussed in this release? 

For example, would requiring broader 

dissemination of flashed order 

information—such as in the 

consolidated quotation data—address 

concerns about two-tiered access to 

information about the best prices for 

listed securities? Could these concerns 

about two-tiered access be addressed by 

conditioning a market’s provision of a 

flash order type on its making available 

flash order information to anyone 

without charge, even though the data 

would not be in a single consolidated 

feed? If flash order information were 

more broadly disseminated, how should 

the Commission assess the policy 

objectives behind existing restrictions 

on the display of locking quotations? 

Also, could exchanges address concerns 

about the misuse of flash order 

information through tailored 

surveillance or other regulatory 

procedures? Could concerns about 

information leakage be addressed by 

requiring brokers to provide detailed 

disclosure to a customer about the risks, 

or requiring the customer’s affirmative 

consent, before allowing the customer’s 

order to be flashed? Would requiring the 

recipient of a flash order to offer price 

improvement ameliorate any of the 

concerns discussed above? 

The Commission further seeks 

comment on the application of Rule 

301(b) of Regulation ATS and Rule 

610(d) of Regulation NMS consistent 

with the proposed amendment to Rule 

602, if adopted. Are there any special 

considerations applicable to ATSs that 

would justify applying a different 

standard from exchanges with respect to 

the inclusion of ATS orders in the 

consolidated quotation data? Are there 

any special considerations applicable to 

flash quotes that would justify applying 

a different standard from other types of 

displayed quotations for purposes of the 

locking and crossing restrictions? 

The Commission strongly encourages 

commenters to respond within the 

designated comment period. It intends 

to act quickly in reviewing the 

comments and assessing further action. 

In this regard, the Commission also is 

actively reviewing other forms of ‘‘dark’’ 

trading interest (that is, trading interest 

that is not included in the consolidated 

public quotation data) that may be 

detrimental to the fairness and 

efficiency of the national market system. 

Dark trading interest, as well as the 

information that some undisplayed 

venues currently disseminate to market 

participants concerning such trading 

interest, is not generally available to the 

public.68 Comment and data are 

requested on the use of flash orders as 

a mechanism to interact with dark 

liquidity and whether other 

mechanisms for accessing dark liquidity 

either do or do not raise policy concerns 

that are analogous to flash orders. The 

Commission is developing initiatives in 

this area, as well as reviewing other 

market structure issues, including those 

concerning Regulation ATS thresholds, 

direct market access, high frequency 

trading, and co-location. 

VI. Paperwork Reduction Act 

The Commission believes that 

eliminating the flash order exception, if 

adopted, would not substantively or 

materially change collection burdens 

under the requirements of Rule 602 of 

Regulation NMS. If adopted, the 

proposal would prohibit the practice of 

displaying marketable flash orders. 

Exchanges would be required to handle 

marketable orders that they are unable 

to execute at the best displayed prices 

in another manner, such as by routing 

marketable orders away to execute 

against the best displayed quotations at 

another exchange or ATS. Because 

exchanges would not be permitted to 

display these orders in the consolidated 

quotation data, no new collection of 

information would be required under 

Rule 602 with regard to marketable flash 

orders. In contrast, non-marketable flash 

orders would be required to be 

displayed in the consolidated quotation 

data. The Commission preliminarily 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48641 

69The information collection contained in Rule 

602, entitled ‘‘Dissemination of Quotations—Rule 

11Ac1–1,’’ the precursor to Rule 602, has been 

assigned control number 3235–0461. The 

Commission, however, will be updating the overall 

burden estimate for this collection of information to 

account for an increase in the number of exchanges 

subject to the Rule. 

70 44 U.S.C. 3501, et seq. 

71See supra notes 18 and 57. 

72See supra note 18 and accompanying text. 

73See supra note 47. 74See supra note 10. 

believes, however, that the additional 

burden of including non-marketable 

flash orders with the large volume of 

quotations that exchanges already 

include in the consolidated quotation 

data under Rule 602 would not be 

material.69

In addition, the Commission does not 

believe that the application of Rule 

301(b) of Regulation ATS and Rule 

610(d) of Regulation NMS consistent 

with the proposed amendment to Rule 

602 contain ‘‘collection of information 

requirements’’ within the meaning of 

the Paperwork Reduction Act of 1995.70

Rule 301(b) of Regulation ATS would 

apply to the use of flash orders by 

alternative trading systems. The 

Commission believes that this would 

affect fewer than ten entities. Rule 

610(d) of Regulation NMS would 

prohibit the practice of displaying flash 

orders with prices that lock or cross 

previously displayed quotations. The 

Commission believes that Rule 610(d) 

does not contain a collection of 

information requirement as defined by 

the Paperwork Reduction Act. 

Accordingly, the Commission believes 

that the application of Rule 301(b) of 

Regulation ATS and Rule 610(d) of 

Regulation NMS consistent with the 

proposed amendment to Rule 602 

imposes no new collection of 

information requirements. The 

Commission encourages comments on 

this point. 

VII. Consideration of Costs and Benefits 

We are sensitive to the costs and 

benefits of our proposal to eliminate the 

exception for flash orders from 

Exchange Act quoting requirements. We 

request comment on the costs and 

benefits associated with the proposed 

amendment. The Commission has 

identified certain costs and benefits of 

the proposal and requests comment on 

all aspects of its preliminary cost-benefit 

analysis, including identification and 

assessments of any costs and benefits 

not discussed in this analysis. The 

Commission also seeks comments on 

the value of any of the benefits 

identified and welcomes comments on 

the accuracy of any of the costs 

described in each section of this costbenefit analysis, as well as elsewhere in 

this release. Finally, the Commission 

requests that commenters provide data 

and any other information or statistics 

that the commenters relied on to reach 

any conclusions on such estimates. 

A. Benefits 

As discussed above, the proposal is 

intended to prevent a two-tiered market 

in which the public does not have 

access, through the consolidated 

quotation data streams, to information 

about the best available prices for listed 

securities, to promote the goals of the 

consolidated quotation system, and to 

help promote public confidence in the 

fairness of the listed securities 

markets.71 A flash order generally is 

displayed at a marketable price that will 

be better than the best displayed price 

for the security in the consolidated 

quotation data. For example, a flash 

order to buy would be displayed at a 

higher price than the national best bid, 

and a flash order to sell would be 

displayed at a lower price than the 

national best offer. Yet the public does 

not receive this flash order information 

in the consolidated quotation data. 

Instead, only the participants of a 

particular market that receive the 

market’s data feed have access to the 

improved price information. The 

consolidated quotation data streams are 

intended to provide a single source of 

information on the best prices from all 

markets, rather than force the public to 

obtain data from many different 

exchanges and other markets to learn 

the best prices. A single source of data 

facilitates investor access to the best 

prices in the national market system, 

and helps promote best execution.72

This objective would be undermined if 

exchanges and ATSs disseminate 

pricing information that is functionally 

quite similar to quotations, yet is not 

required to be included in the 

consolidated quotation data. 

The proposal is intended to promote 

the public display of trading interest 

and quote competition among markets. 

The Commission long has emphasized 

the need to encourage displayed 

liquidity in the form of publicly 

displayed limit orders.73 Such orders 

establish the current ‘‘market’’ for a 

stock and thereby provide a critical 

reference point for investors. Flash 

orders, however, generally are executed 

by a market at prices that match the best 

displayed prices for a stock at another 

market. In this respect, flash orders 

potentially deprive those who publicly 

display their interest at the best prices 

from receiving a speedy execution, or 

any execution, at that price. The 

opportunity to obtain the fastest 

possible execution at a price is the 

primary incentive for the display of 

trading interest. Particularly if flash 

orders were offered by all major markets 

for a security and greatly expanded in 

trading volume, they could significantly 

undermine the incentives to display 

limit orders and to quote competitively, 

and thereby detract from the efficiency 

of the national market system. 

For example, the flash process 

provides a vehicle for certain market 

participants to match displayed prices 

on an order-by-order basis by 

responding to flashes. It therefore gives 

these participants a ‘‘last-mover’’ 

advantage over displayed orders in 

other markets. Rather than displaying 

their orders or quotations in advance of 

incoming marketable order flow to 

attract an execution, these market 

participants can wait to receive the 

flashed order and program their systems 

to pick and choose when to execute. 

The availability of this ‘‘flash’’ 

alternative to quoting as a means to 

supply liquidity may reduce their 

incentives to display liquidity. 

Moreover, the flash process diverts a 

certain amount of order flow that 

otherwise might be routed directly to 

execute against displayed orders and 

quotations in other markets. The 

Commission recognizes that some 

markets route orders to dark venues 

rather than to displayed trading venues. 

Certain benefits, including adding 

liquidity, may result from routing orders 

to undisplayed venues. Given the 

importance of displayed quotations for 

market efficiency, 74 however, the 

Commission is particularly concerned 

about additional marketable order 

flow—orders that are immediately 

executable at the national best bid or 

offer—that may be diverted from the 

public quoting markets and that could 

further reduce the incentives for the 

public display of quotations. 

The Commission also is concerned 

that the flashing of orders at marketable 

prices may undermine the purposes of 

Rule 610(d) of Regulation NMS, which 

is designed to protect displayed 

quotations from being locked by equalpriced contra side quotations. 

Marketable prices are, by definition, 

prices that at least equal the best contra 

side quotation for a stock. For example, 

a marketable flash order to buy will be 

displayed at the price of the national 

best offer and a marketable flash order 

to sell will be displayed at the price of 

the national best bid. In adopting Rule 

610(d), the Commission emphasized 

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75See supra note 52. 76As noted in section V above, the Commission’s 

staff is reviewing other forms of dark trading 

interest that are not included in the consolidated 

public quotation data, and the Commission expects 

to consider initiatives in this area in the near future. 

77Source: www.arcavision.com (consolidated 

volume in July 2009). 

78The estimate of the volume of flash order 

trading is based on discussions with markets that 

continue to offer flash orders as of September 2009. 

79See Direct Edge Fee Schedule, http:// 

www.directedge.com/fee_schedule.aspx; CBSX Fee 

Schedule, http://www.cboe.com/publish/ 

cbsxfeeschedule/cbsxfeeschedule.pdf. 

80 Id. 

displayed quotation will encourage the 

posting of quotations and contribute to 

fair and orderly markets.’’ 75 The 

Commission preliminarily believes that 

flash orders may be inconsistent with 

this goal because the flashing of orders 

is no longer distinguishable, in certain 

key respects, from the dissemination of 

automated quotations. If marketable 

flash orders were included in the 

consolidated quotation data, for 

example, such orders clearly would be 

locking quotations in violation of Rule 

610(d). The practical result of the 

proposal, therefore, would be that flash 

orders could no longer be displayed to 

anyone at prices that equal the best 

priced contra side quotation in a stock. 

A market that was unable to execute 

incoming marketable orders at the best 

prices would need to handle them in 

another fashion, such as by routing the 

order away to access the best displayed 

prices on other exchanges, or cancelling 

the order back to the submitter. It is also 

possible that the order may be routed to 

a dark venue.76

The elimination of flash orders would 

also change markets’ competitive 

strategies to maximize trading volume 

and revenues. Currently, the availability 

of the flash order type benefits markets 

that do not have available contra side 

trading interest at the best displayed 

prices when an order arrives by giving 

them a second chance to execute the 

order. In this respect, the current rule 

tends to benefit those markets that have 

the least available trading interest at the 

best prices, including displayed limit 

orders. If adopted, the proposal would 

give markets even greater incentives to 

attract trading interest at the best 

displayed prices, including displayed 

limit orders, in advance of the arrival of 

marketable orders. It thereby would 

promote competition for the displayed 

liquidity that is so vital to the fairness 

and efficiency of the listed securities 

markets. 

Finally, the flashing of orders to many 

market participants creates a risk that 

recipients of the information could act 

in ways that disadvantage the flashed 

order. With today’s sophisticated order 

handling and execution systems, those 

market participants with the fastest 

systems are able to react to information 

in a shorter time frame than the length 

of the flash order exposures. As a result, 

such a participant would be capable of 

receiving a flashed order and reacting to 

it before the flashed order, if it did not 

receive a fill in the flash process, could 

be executed elsewhere. For example, a 

recipient of a flash order that was 

quoting on another exchange could 

adjust its quotes to avoid being hit by 

the flash order if it subsequently were 

routed to that exchange. Alternatively, a 

recipient rapidly could transmit orders 

that would take out trading interest at 

other exchanges before an unfilled flash 

order could be routed to those 

exchanges. In both cases, a flashed order 

that did not receive an execution in the 

flash process would also be less likely 

to receive a quality execution elsewhere. 

At the same time, because flash orders 

are voluntary on the part of order 

routers, they involve a willing decision 

on the part of order routers to 

disseminate the order information to a 

group that generally will include highly 

sophisticated professional traders. 

Those who choose to use the flash order 

type (which often will be a broker that 

owes a duty of best execution to its 

customer for the routing decision) 

probably already consider the extent to 

which flashed orders may contain 

significant information content that 

could lead the recipients of flash order 

information to act contrary to the 

interests of the orders. Stated another 

way, those who are highly concerned 

about information leakage generally 

would be unlikely to flash their order 

information to a large number of 

professional traders. As a result, there is 

an inverse relationship between the 

extent to which flash orders are used 

beneficially by order submitters and the 

extent to which the recipients of flash 

orders could gain an information 

advantage. If used beneficially, the 

information leakage and information 

advantage would be minimized. If not 

used beneficially, however, the flash 

order type appears to raise particular 

risks for customers whose order 

information is flashed. 

The Commission seeks comment on 

the anticipated benefits of the proposal, 

including whether the proposal will: (1) 

Help prevent a two-tiered market in 

terms of access to information about the 

best available prices for listed securities; 

(2) promote the public display of trading 

interest; (3) help prevent displayed 

quotations from being locked by equalpriced contra-side quotations; (4) 

promote competition among markets for 

displayed liquidity; (5) reduce the risk 

of detrimental information leakage 

about customer orders. The Commission 

further seeks comment on whether the 

anticipated benefits differ between the 

equity markets and the options markets. 

B. Costs 

The proposed elimination of the 

exception for flash orders from 

Exchange Act quoting requirements 

could preclude potential benefits that 

flash orders offer to certain market 

participants. For those seeking liquidity, 

the flash mechanism may attract 

additional liquidity from market 

participants who are not willing to 

display their interest publicly. Flash 

orders thereby may provide an 

opportunity for a better execution than 

if they were routed elsewhere. There is 

no guarantee, for example, that an order 

routed to execute against a displayed 

quotation will, in fact, obtain an 

execution. The displayed quotation may 

already be executed against or cancelled 

before the routed order arrives. Of 

course, the delay in routing during a 

flash period may further decrease the 

likelihood of an execution for the flash 

order elsewhere because prices may 

move away from the flash order during 

the flash process. Those who route flash 

orders, however, may use them 

selectively in those contexts where they 

believe an order is less likely to receive 

a full execution if routed elsewhere. 

Another potential cost to market 

participants is that many markets that 

display quotations charge fees (often 

known as ‘‘take’’ fees) for accessing 

those quotations. Flash orders may be 

executed through the flash process for 

lower fees than the fees charged by 

many markets for accessing displayed 

quotations. Professional short-term 

traders with large trading volume may 

be particularly sensitive to the level of 

these fees. 

For example, the Commission 

estimates an average daily volume in 

listed equities of 8.8 billion shares per 

day 77 and that flash volume accounts 

for 0.8% of this volume.78 The 

Commission believes that access fees for 

executed flash orders in the equities 

markets range from $0.0010 per share to 

$0.0029 per share.79 It estimates that the 

average access fee is $0.0015 per share. 

In contrast, it estimates that the average 

access fee for accessing a displayed 

quotation is $0.0029 per share.80 The 

total cost from increased fees for all 

flash order users on a yearly basis in 

listed equities, therefore, would be 

approximately $24,837,120 (8.8 billion 

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81The Options Clearing Corporation, Volume 

Statistics, http://www.optionsclearing.com/market/ 

vol_data/2009/daily/jul_09.jsp. 82The Commission estimates average daily 

volume of executed flash orders in July at 265,052 

contracts. This figure reflects discussions with the 

relevant markets. 83See BOX, CBOE, and ISE fee schedules. 84See BOX, CBOE, and ISE fee schedules. 85This figure represents the approximate charge 

for a Linkage Order derived from discussions with 

the relevant markets. 

86This figure reflects discussions with the 

relevant markets. 

87 $ 193 per hour figure for a Programmer Analyst 

is from SIFMA’s Management & Professional 

Earnings in the Securities Industry 2008, modified 

by Commission staff to account for an 1800-hour 

work-year and multiplied by 5.35 to account for 

bonuses, firm size, employee benefits and overhead. 

88See Securities Exchange Act Release No. 50486 

(October 4, 2004), 69 FR 60287, 60294 (October 8, 

2004) (File No. S7–18–04) (adopting release 

requiring SROs to file proposed rule changes 

electronically with the Commission). 

89 $ 305 per hour figure for an Attorney is from 

SIFMA’s Management & Professional Earnings in 

the Securities Industry 2008, modified by 

Commission staff to account for an 1800-hour workyear and multiplied by 5.35 to account for bonuses, 

firm size, employee benefits and overhead. 

90 15 U.S.C. 78c(f). 

91 15 U.S.C. 78w(a)(2). 

shares × .8% × $0.0014 per share 

increase in access fee × 252 trading 

days). The Commission believes this 

estimate is an upper bound since market 

participants would adapt their strategies 

to minimize transaction costs under the 

new conditions. 

In addition, some options exchanges 

offer lower access fees for market 

participants using flash orders. The 

Commission estimates an average daily 

volume in listed options of 13,898,735 

contracts per day 81 and that flash 

volume accounts for 1.9% of this 

volume.82 The Commission believes 

that access fees for executed flash orders 

in the options markets range from $0.00 

per contract to $0.15 per contract.83 It 

estimates that an average access fee is 

$.01 per contract.84 In contrast, the 

average access fee for accessing a 

displayed quotation costs the market 

participant $0.21 per contract.85 The 

total cost from increased fees for all 

flash order users on a yearly basis in 

listed options, therefore, would be 

approximately $13,309,429 (13,898,735 

contracts × 1.9% × $0.20 per contract 

increase in access fee × 252 trading 

days) . As noted above, the Commission 

expects the actual cost may be lower as 

market participants would minimize the 

impact by refining their trading 

strategies. 

The Commission recognizes that some 

market participants that choose to 

receive and respond to flash orders may 

represent large institutional investors 

that are not willing to display their 

interest to avoid revealing their trading 

interest to the market, but are willing to 

step up on an order-by-order basis and 

provide liquidity to flash orders. Such 

investors may have the sophisticated 

systems themselves to respond to flash 

orders or may rely on the systems of 

their brokers. Executions against flash 

orders could help lower the transaction 

costs of these institutional investors. In 

addition, as discussed below in Section 

VIII, flash orders give markets an 

additional opportunity to execute 

marketable orders even if they do not 

have available contra trading interest at 

the best displayed prices when the flash 

order arrives. In this respect, flash 

orders can be viewed as a market’s 

competitive strategy to maximize 

trading volume and revenues that would 

be eliminated by adoption of the 

proposed amendments. 

The Commission expects that any 

negative effect of the elimination of the 

exception for flash orders from 

Exchange Act quoting requirements 

would be mitigated by the ability of 

market participants to adapt their 

trading strategies to the new rules. Also, 

higher incentives to display liquidity 

and alternative forms of competition for 

order flow additionally could mitigate 

any negative effect of the proposal. 

The markets with five trading systems 

that offer an electronic flash order 

functionality would need to make 

systems changes to comply with the 

proposed elimination of the exception 

for flash orders from Exchange Act 

quoting requirements. The Commission 

estimates that a programming change for 

a market requires approximately 20–30 

hours per market of coding 86 at an 

average hourly cost of $193 to eliminate 

the flash order functionality.87 The 

Commission estimates that the aggregate 

cost of programming changes for these 

markets to be approximately $19,300– 

$28,950. 

In addition, the Commission believes 

that three exchanges currently have 

rules in place that provide for flash 

orders on five trading systems. The 

Commission estimates that these 

markets will each need to file proposed 

rule changes to remove the flash order 

functionality from their respective rule 

books for each system, for a total of five 

rule changes. The Commission estimates 

that a routine rule change requires 

approximately 34 hours for an exchange 

to complete 88 at an average hourly cost 

of $305.89 The Commission estimates 

that the aggregate cost of one proposed 

rule change for each trading system 

would total approximately $51,850. 

Finally, the five exchanges that 

operate trading floors for equities or 

options may need to reflect manual 

trading interest at non-marketable prices 

in the consolidated quotation data if 

they currently rely on the flash order 

exception for any such floor activity. 

The Commission preliminarily believes 

that the five exchanges currently have 

systems and procedures for floor 

members to include trading interest in 

the exchanges’ automated systems. 

Accordingly, the elimination of the flash 

order exception should not impose a 

material new systems burden on these 

exchanges. 

The Commission requests comment 

on any direct or indirect costs of the 

proposed amendment and asks 

commenters to quantify those costs, 

where possible. Specifically, the 

Commission requests comments on the 

following questions: 

• What are some of the trading 

strategies that employ flash orders? Is 

the use of flash orders in the best 

interest of these traders and how would 

the inability to use flash orders impact 

these traders? 

• How are market participants likely 

to change their behavior in the absence 

of flash orders? What are the likely costs 

of these changes? 

• How will the proposal impact 

transaction costs incurred by various 

market participants? On net, how will 

overall transaction costs change? 

• How would the proposal affect 

competition between trading venues? 

What costs will be imposed as a result? 

• In the absence of flash orders, will 

the limit orders setting the best price 

benefit with faster or more probable 

executions? 

VIII. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition and Capital 

Formation 

Section 3(f) of the Exchange Act 90

requires the Commission, whenever it 

engages in rulemaking and is required to 

consider or determine whether an action 

is necessary or appropriate in the public 

interest, to consider whether the action 

would promote efficiency, competition, 

and capital formation. In addition, 

Section 23(a)(2) of the Exchange Act 

requires the Commission, when making 

rules under the Exchange Act, to 

consider the impact such rules would 

have on competition. Exchange Act 

Section 23(a)(2) also 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.91 As discussed below, 

the Commission’s preliminary view is 

that the proposed amendment should 

promote efficiency and competition and 

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48644 Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 

92See NMS Release, supra note 10, at 37516 

(‘‘Displayed limit orders benefit all market 

participants by establishing the best prices * * * ’’). 

93See supra note 47. 

94See Order Handling Rules Release, supra note 

10, at 48293 (‘‘[T]he display of customer limit 

orders advances the national market system goal of 

the public availability of quotation information, as 

well as fair competition, market efficiency, best 

execution, and disintermediation.’’). 

95See supra note 58. 

96See supra note 49. 

97See NMS Release, supra note 10, at 37505 

(‘‘[M]arket orders need only be routed to markets 

displaying quotations that are truly accessible’’). 

98Public Law 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). 

99See 17 CFR 240.0–10(e). 

will have minimal impact, if any, on 

promotion of capital formation. 

The proposed elimination of the 

exception for flash orders from 

Exchange Act quoting requirements 

would affect the competition among 

exchanges and ATSs for trading volume. 

Much of a market’s revenue is 

generated, directly or indirectly, 

through the execution of trading 

volume. Accordingly, markets have 

strong incentives to maximize their 

volume, both by attracting the largest 

possible volume of order flow and by 

executing as much of that order flow as 

possible after it arrives at the exchange. 

Flash orders give markets an additional 

opportunity to execute marketable 

orders even if they do not have available 

contra trading interest at the best 

displayed prices when the flash order 

arrives. In this respect, flash orders can 

be viewed as a market’s competitive 

strategy to maximize trading volume 

and revenues that would be eliminated 

by adoption of the proposed 

amendments. 

The Commission preliminarily 

believes, however, that any limitation 

on a market’s competitive choices 

would be justified by other effects of the 

proposal that would promote 

competition and enhance efficiency. As 

an initial matter, it is important to 

recognize that, both currently and if the 

proposal were adopted, all markets 

(including exchanges and ATSs) would 

operate under the same rules for flash 

orders. Currently, the availability of the 

flash order type benefits markets that do 

not have available contra side trading 

interest at the best displayed prices 

when an order arrives by giving them a 

second chance to execute the order. In 

this respect, the current rule tends to 

benefit those markets that have the least 

available trading interest at the best 

prices, including displayed limit orders. 

If adopted, the proposal would give 

markets even greater incentives to 

attract trading interest at the best 

displayed prices, including displayed 

limit orders, in advance of the arrival of 

marketable orders.92 It thereby would 

promote competition for the displayed 

liquidity that is vital to the fairness and 

efficiency of the listed securities 

markets. Encouraging the use of 

displayed limit orders should help 

improve the price discovery process, 

and in turn, contribute to increased 

liquidity and depth in the markets.93

The deeper and more liquid the markets 

are, the more willing the public may be 

to invest its capital, thus promoting 

capital formation. 

The proposal also is designed to 

promote efficiency by giving a further 

incentive for markets to compete to 

attract displayed limit orders and 

generally to encourage the public 

display of trading interest.94 Given that 

the overwhelming majority of trading 

volume in listed securities is routed and 

executed through highly automated 

systems, flash orders are no longer 

clearly distinguishable from the best 

bids and offers for listed securities that 

are required to be collected and 

disseminated in the consolidated 

quotation stream. There is little 

practical reason to treat flash orders 

differently from other bids and offers 

with respect to Exchange Act quoting 

requirements. 

Yet those who display bids and offers 

appear to be harmed by the disparity in 

regulatory treatment between flash 

orders and displayed bids and offers. 

For example, the flash order process 

permits market participants to wait to 

receive the flashed orders and program 

their systems to pick and choose when 

to execute. The exception for flash 

orders may thereby undermine the 

incentives for market participants to 

display their trading interest. If adopted, 

the proposal could lead market 

participants to display more of their 

trading interest. Such a result would be 

consistent with the Commission’s 

emphasis on the need to encourage 

displayed liquidity—a critical reference 

point for investors.95 Additionally, 

because the flash order process diverts 

a certain amount of order flow that 

might otherwise be routed directly to 

execute against displayed quotations in 

other markets, the exception for flash 

orders may further reduce the incentives 

for the public display of quotations.96

While some flash orders may be 

cancelled or routed to trading venues 

that do not display their trading interest 

in the consolidation quotation stream, 

the Commission preliminarily believes 

that eliminating the exception for flash 

orders would result in more order flow 

being routed to execute against 

displayed trading interest and would 

promote the fairness and efficiency of 

the listed securities markets.97

Based on the analysis above, the 

Commission preliminarily believes that 

the proposed elimination of the 

exception for flash orders from 

Exchange Act quoting requirements 

would not impose any burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. The 

Commission requests comment on all 

aspects of this analysis and, in 

particular, on whether the proposed 

elimination of the exception for flash 

orders would place a burden on 

competition, as well as the effect of the 

proposal on efficiency, competition, and 

capital formation. Commenters are 

requested to provide empirical data and 

other factual support for their views if 

possible. 

IX. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 98 the Commission 

must advise the OMB 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: (1) An 

annual effect on the economy of $100 

million or more (either in the form of an 

increase or a decrease); (2) a major 

increase in costs or prices for consumers 

or individual industries; or (3) 

significant adverse effect on 

competition, investment or innovation. 

The Commission requests comment 

on the potential impact of the proposed 

rule amendment on the economy on an 

annual basis. Commenters are requested 

to provide empirical data and other 

factual support for their view to the 

extent possible. 

X. Regulatory Flexibility Act 

The Commission hereby certifies, 

pursuant to 5 U.S.C. 603(b), that the 

proposed amendment to the Exchange 

Act quoting requirements and consistent 

application of Rule 610(d), if adopted, 

would not have a significant economic 

impact on a substantial number of small 

entities to which it applies. The 

proposed amendment to Rule 602 and 

consistent application of Rule 610(d) 

would apply to national securities 

exchanges, none of which is a small 

entity as defined by Commission 

rules.99 The consistent application of 

Rule 610(d) also would affect one 

national securities association, which is 

not a small entity as defined by 13 CFR 

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Federal Register / Vol. 74, No. 183 / Wednesday, September 23, 2009 / Proposed Rules 48645 

100See 17 CFR 240.0–10(c). 

121.201. In addition, the consistent 

application of Rule 301(b) would only 

affect ATSs, none of which are small 

entities as defined by Commission 

Rules.100

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. 

XI. Statutory Authority 

Pursuant to the Exchange Act and 

particularly, Sections 2, 3(b), 5, 6, 11, 

11A, 15, 15A, 17(a) and (b), 19, 23(a), 

and 36 thereof, 15 U.S.C. 78b, 78c(b), 

78e, 78f, 78k, 78k–1, 78o, 78o–3, 78q(a) 

and (b), 78s, 78w(a), and 78mm, the 

Commission proposes to amend Rule 

602 of Regulation NMS. 

XII. Text of Proposed Rule Amendment 

List of Subjects in 17 CFR Part 242 

Brokers, Reporting and recordkeeping 

requirements, Securities. 

For the reasons set out in the 

preamble, Title 17, Chapter II, of the 

Code of Federal Regulations is proposed 

to be amended as follows. 

PART 242—REGULATIONS M, SHO, 

ATS, AC, AND NMS AND CUSTOMER 

MARGIN REQUIREMENTS FOR 

SECURITY FUTURES 

1. The authority citation for Part 242 

continues 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. 

§ 242.602 [Amended] 

2. Section 242.602 is amended by 

removing and reserving paragraph 

(a)(1)(i)(A). 

By the Commission. 

Dated: September 18, 2009. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. E9–22911 Filed 9–22–09; 8:45 am] 

BILLING CODE 8010–01–P 

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