[Federal Register Volume 89, Number 183 (Friday, September 20, 2024)]
[Notices]
[Pages 77203-77208]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-21508]



[[Page 77203]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-101036; File No. 4-631]


Joint Industry Plan; Order Disapproving the Twenty-Third 
Amendment to the National Market System Plan To Address Extraordinary 
Market Volatility

September 16, 2024.

I. Introduction

    On October 24, 2023, NYSE Group, Inc., on behalf of the 
Participants \1\ to the National Market System Plan to Address 
Extraordinary Market Volatility (``Plan''), filed with the Securities 
and Exchange Commission (``Commission''), pursuant to section 11A(a)(3) 
of the Securities Exchange Act of 1934 (``Act'' or ``Exchange Act'') 
\2\ and Rule 608 thereunder,\3\ a proposal (``Proposal'' or ``Proposed 
Amendment'') to amend the Plan. The Proposed Amendment was published 
for comment in the Federal Register on November 21, 2023.\4\ On 
February 15, 2024, the Commission instituted proceedings pursuant to 
Rule 608(b)(2)(i) of Regulation NMS \5\ to determine whether to approve 
or disapprove the Proposed Amendment or to approve the Proposed 
Amendment with any changes or subject to any conditions the Commission 
deems necessary or appropriate.\6\ On May 14, 2024, the Commission 
designated a longer period within which to conclude proceedings 
regarding the Proposed Amendment.\7\ On July 18, 2024, the Commission 
designated a longer period for Commission action on the Proposed 
Amendment.\8\
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    \1\ The Participants are: Cboe BYX Exchange, Inc., Cboe BZX 
Exchange, Inc., Cboe EDGA Exchange, Inc., Cboe EDGX Exchange, Inc., 
the Financial Industry Regulatory Authority, Inc., Investors 
Exchange LLC, Long-Term Stock Exchange, Inc., MEMX LLC, MIAX Pearl, 
LLC, NASDAQ BX, Inc., NASDAQ PHLX LLC, The NASDAQ Stock Market LLC, 
New York Stock Exchange LLC, NYSE American LLC, NYSE Arca, Inc., 
NYSE Chicago, Inc., and NYSE National, Inc. (collectively, 
``Participants'').
    \2\ 15 U.S.C. 78k-1(a)(3).
    \3\ 17 CFR 242.608.
    \4\ See Securities Exchange Act Release No. 98928 (Nov. 14, 
2023), 88 FR 81131 (``Notice''). Comments received in response to 
the Notice can be found on the Commission's website at: https://www.sec.gov/comments/4-631/4-631.htm.
    \5\ 17 CFR 242.608(b)(2)(i).
    \6\ See Securities Exchange Act Release No. 99545 (Feb. 15, 
2024), 89 FR 13389 (Feb. 22, 2024) (``OIP''). Comments received in 
response to the OIP can be found on the Commission's website at: 
https://www.sec.gov/comments/4-631/4-631.htm.
    \7\ See Securities Exchange Act Release No. 100127 (May 14, 
2024), 89 FR 43969 (May 20, 2024).
    \8\ See Securities Exchange Act Release No. 100556 (July 18, 
2024), 89 FR 59779 (July 23, 2024).
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    This order disapproves the Proposed Amendment.

II. Overview

    The Participants adopted the Plan to address extraordinary 
volatility in the securities markets, i.e., significant fluctuations in 
individual securities' prices over a short period of time, such as 
those experienced during the ``Flash Crash'' on the afternoon of May 6, 
2010. The Plan sets forth procedures that provide for market-wide limit 
up-limit down requirements to prevent trades in individual NMS Stocks 
from occurring outside of the specified Price Bands to address 
instances of extraordinary volatility in NMS Stocks.\9\ These limit up-
limit down requirements are coupled with Trading Pauses to accommodate 
more fundamental price moves.
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    \9\ See Notice, 88 FR at 81144-45 (setting forth the defined 
terms as used under the Plan). For purposes of this order, all 
capitalized terms referenced, but not otherwise defined, herein 
shall have the meanings as defined under the Plan or as defined in 
the Notice.
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    As set forth in more detail in the Plan, the single plan processor, 
which is responsible for consolidation of information for an NMS Stock 
pursuant to Rule 603(b) of Regulation NMS under the Exchange Act, 
calculates and disseminates a lower Price Band and upper Price Band for 
each NMS Stock. As set forth in Section V of the Plan, the Price Bands 
are based on a Reference Price for each NMS Stock that equals the 
arithmetic mean price of Eligible Reported Transactions for the NMS 
Stock over the immediately preceding five-minute period. The Price 
Bands for an NMS Stock are calculated by applying the Percentage 
Parameters, as set out in Appendix A to the Plan,\10\ for such NMS 
Stock to the Reference Price, with the lower Price Band being a 
Percentage Parameter below the Reference Price, and the upper Price 
Band being a Percentage Parameter above the Reference Price.
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    \10\ See Notice, 88 FR at 81148 (Appendix A to the Plan).
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    Appendix A to the Plan sets out the definitions of Tier 1 and Tier 
2 NMS Stocks and the Percentage Parameters for each. Appendix A 
currently provides that Tier 1 includes all NMS Stocks included in the 
S&P 500 Index and the Russell 1000 Index, as well as ``eligible'' ETPs, 
which are ETPs that trade over $2,000,000 notional consolidated average 
daily volume (``CADV'') over a period from the first day of the 
previous fiscal half year up until one week before the beginning of the 
next fiscal half year. Eligible ETPs are listed in Schedule 1 to 
Appendix A, and the list is reviewed and updated semi-annually. All 
ETPs that do not meet the ``eligibility'' definition are currently 
assigned to Tier 2.
    For Tier 1 NMS Stocks, Appendix A defines the Percentage Parameters 
as:
    <bullet> 5% for Tier 1 NMS Stocks with a Reference Price more than 
$3.00;
    <bullet> 20% for Tier 1 NMS Stocks with a Reference Price equal to 
$0.75 and up to and including $3.00; and
    <bullet> The lesser of $0.15 or 75% for Tier 1 NMS Stocks with a 
Reference Price less than $0.75.
    For Tier 2 NMS Stocks, Appendix A defines the Percentage Parameters 
as:
    <bullet> 10% for Tier 2 NMS Stocks with a Reference Price of more 
than $3.00;
    <bullet> 20% for Tier 2 NMS Stocks with a Reference Price equal to 
$0.75 and up to and including $3.00; and
    <bullet> The lesser of $0.15 or 75% for Tier 2 NMS Stocks with a 
Reference Price less than $0.75.
    Appendix A further provides that the Percentage Parameter for a 
Tier 2 NMS Stock that is a leveraged ETP is the applicable Percentage 
Parameter set forth above, multiplied by the leverage ratio of such 
product.

III. Summary of the Proposed Amendment \11\
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    \11\ This section summarizes the proposed changes to the Plan 
and the Participants' analysis supporting the proposed changes, as 
described in the Notice. The Notice contains the Participants' full 
discussion of the Proposed Amendment, including the Participants' 
justifications for the Proposed Amendment. See Notice, supra note 4.
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    The Participants propose to amend Appendix A to delete the 
definition of ETPs ``eligible'' for Tier 1, and to specify that all 
ETPs except for single-stock ETPs would be assigned to Tier 1. The 
Proposed Amendment would generally result in tighter Price Bands being 
applied on Tier 2 ETPs than currently apply. The Participants also 
propose to delete Schedule 1 to Appendix A as obsolete. Under the 
Proposal, Appendix A, Section I, paragraph (1) would read as follows:

    Tier 1 NMS Stocks shall include all NMS Stocks included in the 
S&P 500 Index and the Russell 1000 Index, and all exchange-traded 
products (``ETP''), except for single stock ETPs, which will be 
assigned to the same Tier as their underlying stock, adjusted for 
any leverage factor.

    Because all leveraged ETPs (except Tier 2 single-stock ETPs) would 
be assigned to Tier 1, the Participants also propose to add text into 
Section I of Appendix A describing how the Percentage Parameters would 
be set for leveraged ETPs. The Participants propose to insert the 
following as paragraph (5) of Section I, and to renumber the paragraphs 
of Section I accordingly:

    Notwithstanding the foregoing, the Percentage Parameters for a 
Tier 1 NMS

[[Page 77204]]

Stock that is a leveraged ETP shall be the applicable Percentage 
Parameter set forth in clauses (2), (3), or (4) above, multiplied by 
the leverage ratio of such product.

    At the request of ETP issuers, the Participants conducted a study 
concerning the calibration of the Percentage Parameters set forth in 
the Plan with respect to ETPs in Tier 2.\12\ The Participants 
subsequently conducted additional analysis (``Supplemental Analysis'') 
on the narrowing of the Percentage Parameters.\13\ The Participants 
reached the following conclusions based on the analysis in the study 
and the Supplemental Analysis (collectively ``Analyses''):
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    \12\ See Notice, 88 FR at 81133.
    \13\ The Participants submitted a letter with the Supplemental 
Analysis in support of the Proposed Amendment. See Letter from 
Robert Books, Chair, Operating Committee of the Plan, dated June 17, 
2024 (``Participants' Letter'').
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    <bullet> Tier 1 non-ETPs are far more likely than Tier 2 ETPs to 
enter into Limit States and Trading Pauses due to the underlying 
volatility of these securities. This finding suggests that the Price 
Band width for Tier 2 ETPs is poorly calibrated relative to their 
actual trading behavior.\14\ The Supplemental Analysis performed by the 
Participants reached the same conclusion using two different 
methodologies.\15\
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    \14\ See Notice, 88 FR at 81142.
    \15\ See Participants' Letter at 3 (``When combined with the 
data in the Proposal's Table 2 concerning the incidence of Limit 
States and Trading Pauses among Tier 1 non-ETPs and Tier 2 ETPs and 
non-ETPs, these additional volatility statistics provide further 
support for the Participant's conclusion in the Proposal . . . that 
the current Price Bands are not well-calibrated to the realized 
volatility for Tier 2 ETPs and should not be twice as wide as those 
for Tier 1 non-ETPs.'').
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    <bullet> During the period looked at in the study presented in the 
Proposed Amendment, the notional value of trades that would have been 
prevented if Tier 2 ETPs had used tighter Tier 1 Price Bands would have 
been substantial for such thinly traded products, bounded on the lower 
end at $36.8 million and the upper end at $711.1 million.\16\
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    \16\ See Notice, 88 FR at 81142. See also id. at 81135-36 
(explaining how the Participants calculated the upper and lower 
ranges of the notional value of trades).
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    <bullet> The Participants calculated theoretical Tier 1 (i.e., 5%, 
adjusted for the leverage factor) Price Bands for all Tier 2 ETPs in 
the study presented in the Proposed Amendment (``Theoretical Tier 1 
Bands'').\17\ In this analysis from the study, the Participants 
compared the execution price to the midpoint price of the National Best 
Bid or Offer (``NBBO'') at five and ten minutes after such execution. 
Using this methodology, in the majority of cases where a trade would 
have been prevented by the narrower Theoretical Tier 1 Bands, prices 
reverted by the end of the following five- and ten-minute periods, 
suggesting that having these thinly traded ETPs in Tier 1 would protect 
investors from executing trades at inferior prices that may occur due 
to transitory gaps in liquidity rather than fundamental valuation 
changes.\18\ In the Supplemental Analysis, the Participants used a 
different methodology, specifically comparing the midpoint of the NBBO 
at five and ten minutes after the trade to the midpoint of the NBBO 
\19\ at the time of execution, to demonstrate price movement after 
theorical block trades and again reached conclusions they state support 
the Proposed Amendment.\20\
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    \17\ Id. at 81135.
    \18\ Id. at 81142.
    \19\ While the Supplemental Analysis stated that it compared the 
midpoint of the NBBO at five and ten minutes after the trade to the 
midpoint of the quote at the time of execution, in the context of 
the analysis performed, the Commission understands that ``quote'' 
meant the NBBO at the time of execution, given the use of the 
midpoint at five and ten minutes in the Supplemental Analysis and 
the use of the NBBO midpoint in the Participant's study that was 
part of the Proposal.
    \20\ See Participants' Letter at 4 (stating that the results of 
the Supplemental Analysis show that ``more than 60% of the time, 
prices 5 and 10 minutes after a theoretically prevented trade 
reverted away from the offending trade price towards prior prices. 
Share volume reversion remained above 50% after five minutes and 
above 60% after 10 minutes. This tendency toward reversion is 
further evidence in support of narrowing the bands to Tier 1-
levels.''). The Participants state they conducted this additional 
price reversion analysis to account for concerns with the prior 
analysis, which compared the execution prices of Tier 2 ETPs to the 
midpoint of the NBBO five and ten minutes after such execution. See 
Participants' Letter at 4.
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    <bullet> In most cases where ETPs have been reclassified from Tier 
2 to Tier 1, market quality improved as evidenced by the lower quote 
volatility, tighter spreads, and increased liquidity for ETPs that 
moved from Tier 2 to Tier 1.\21\
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    \21\ See Notice, 88 FR at 81142.
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    <bullet> Using tighter Tier 1 bands for all ETPs would provide 
greater investor protection from temporary liquidity gaps, which are 
facilitated by the wider Price Bands in Tier 2.\22\
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    \22\ Id.
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    <bullet> The number of Limit States and Trading Pauses decreased 
when Tier 2 ETPs moved to Tier 1, and increased when Tier 1 ETPs moved 
to Tier 2.\23\
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    \23\ Id.
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    Based on these conclusions, the Participants state that they 
believe that moving Tier 2 ETPs to Tier 1 would improve market quality, 
more effectively dampen volatility, decrease the number of unnecessary 
Limit States and Trading Pauses, and thereby provide greater investor 
protection.\24\
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    \24\ See Notice, 88 FR at 81142. See also Participants' Letter 
at 6.
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IV. Discussion

A. The Applicable Standard of Review

    Under Rule 608(b)(2) of Regulation NMS, the Commission shall 
approve a national market system plan or proposed amendment to an 
effective national market system plan, with such changes or subject to 
such conditions as the Commission may deem necessary or appropriate, if 
it finds that such plan or amendment is necessary or appropriate in the 
public interest, for the protection of investors and the maintenance of 
fair and orderly markets, to remove impediments to, and perfect the 
mechanisms of, a national market system, or otherwise in furtherance of 
the purposes of the Exchange Act.\25\ Under Rule 700(b)(3)(ii) of the 
Commission's Rules of Practice, the ``burden to demonstrate that a NMS 
plan filing is consistent with the Exchange Act and the rules and 
regulations issued thereunder that are applicable to NMS plans is on 
the plan participants that filed the NMS plan filing.'' \26\ The 
Commission shall disapprove a national market system plan or proposed 
amendment if it does not make such a finding.\27\
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    \25\ 17 CFR 242.608(b)(2).
    \26\ 17 CFR 201.700(b)(3)(ii). In addition, Rule 700(b)(3)(ii) 
of the Commission's Rules of Practice states that ``[a]ny failure of 
the plan participants that filed the NMS plan filing to provide such 
detail and specificity may result in the Commission not having a 
sufficient basis to make an affirmative finding that a NMS plan 
filing is consistent with the Exchange Act and the rules and 
regulations issued thereunder that are applicable to NMS plans.'' 
Id.
    \27\ 17 CFR 242.608(b)(2). Approval or disapproval of a national 
market system plan, or an amendment to an effective national market 
system plan (other than an amendment initiated by the Commission), 
shall be by order. Id.
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    For the reasons described below, the Participants have not 
demonstrated that the Proposal meets the standard under Rule 608(b)(2) 
of Regulation NMS. As such, the Commission is disapproving the Proposed 
Amendment because it cannot make the finding that the Proposed 
Amendment is necessary or appropriate in the public interest, for the 
protection of investors and the maintenance of fair and orderly 
markets, to remove impediments to, and perfect the mechanisms of, a 
national market system, or otherwise in furtherance of the purposes of 
the Exchange Act.\28\
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    \28\ 17 CFR 242.608(b)(2).

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[[Page 77205]]

B. Comments Received

    Certain commenters express support for the Proposed Amendment.\29\ 
One commenter states that it is important to maintain the leverage 
factor adjustment when moving leveraged ETPs into Tier 1.\30\ Another 
commenter, writing on behalf of a ``diverse cross-section of market 
participants,'' states that using Tier 1 Percentage Parameters for all 
ETPs would better protect investors during temporary liquidity 
gaps.\31\ The commenter states that the risk of an inefficient 
execution away from the fair value of the ETP's holdings (as far as 10% 
away from a Tier 2 ETP's Reference Price) rises in the case of a 
liquidity gap resulting from an outsized or aggressive order, temporary 
uncertainty about any inputs into the calculation of the ETP's fair 
value, or lower levels of market participation.\32\ This commenter also 
states that the application of Tier 1 Percentage Parameters may enhance 
investor protection, provide a better ETP execution experience for 
market participants, and would improve transparency and efficiency, 
particularly during periods of extreme volatility.\33\ Another 
commenter states that the Participants' data presented in the Proposed 
Amendment showed that while narrow Price Bands resulted in more trading 
halts in the time period studied, had narrower Price Bands been in 
place for ETPs during periods of extreme volatility, retail investor 
executions at inferior prices would likely have been prevented.\34\ 
Some commenters that support the proposal state that ETPs are assigned 
to tiers based on an assumption that lower-volume ETPs are more suited 
for wider Price Parameters, and state that the data presented in the 
Proposed Amendment suggest that this assumption was wrong.\35\ Some 
commenters that support the Proposal state that the analysis from the 
study in the Proposed Amendment demonstrated that on average, Tier 2 
ETPs across asset classes exhibit lower quote volatility than Tier 1 
non-ETP stocks.\36\ In light of the findings derived from the study, 
some commenters state that the imposed semi-annual migration of ETPs 
from one tier to the other appears to be overly complex, arbitrary, and 
unnecessary.\37\ One commenter states that there is no reason to expect 
the Tier 1 Price Band is inappropriate for Tier 2 ETPs that are based 
on a single reference asset, stating that approximately 33% of single 
asset commodity based ETPs representing a wide range of commodity types 
are Tier 1 securities.\38\
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    \29\ See Letters from Samara Cohen, Chief Investment Officer of 
ETF and Index Investments, BlackRock, et al., dated Dec. 18, 2023 
(``BlackRock Letter''); Kenneth Fang, Associate General Counsel, and 
Kevin Ercoline, Assistant General Counsel, Investment Company 
Institute, dated Mar. 14, 2024 (``ICI Letter'') (expressing support 
for the comments made in the BlackRock Letter); Ellen Greene, 
Managing Director, Equities & Options Market Structure, Securities 
Industry and Financial Markets Association (``SIFMA'') and Kevin 
Ehrlich, Managing Director, SIFMA Asset Management Group, dated Apr. 
22, 2024 (``SIFMA Letter'').
    \30\ See ICI Letter at 4. See also SIFMA Letter at 3 (stating 
that multiplying the Tier 1 Percentage Parameters by an ETP's 
leverage ratio, as proposed, would address potential volatility in 
these products).
    \31\ See BlackRock Letter at 1.
    \32\ Id. at 2.
    \33\ See id. at 1-2. Some commenters state that, in instances of 
sustained order imbalances and/or gaps in liquidity in the market 
for an ETP, a trading pause would help attract liquidity from 
diverse market participants and promote price discovery through the 
reopening mechanism, helping to keep ETP prices in line with the 
value of underlying holdings. See BlackRock Letter at 2. See also 
ICI Letter at 3 (stating that during periods of extreme volatility 
and transitory gaps in liquidity, it may be beneficial for a trading 
pause to be triggered); SIFMA Letter at 2.
    \34\ See ICI Letter at 3.
    \35\ See BlackRock Letter at 2. See also ICI Letter at 4 
(stating that the Participants' data demonstrate that an assumption 
that lower-volume ETPs were more suited for wider Price Bands was 
not accurate).
    \36\ See BlackRock Letter at 2. See also ICI Letter at 4 
(stating Tier 2 ETPs on average exhibit lower quote volatility than 
Tier 1 non-ETP stocks); SIFMA Letter at 2-3 (stating that the 
Participants' study showed that ETPs assigned to Tier 2 had quote 
volatilities lower than both Tier 1 ETPs and Tier 2 non-ETPs).
    \37\ See BlackRock Letter at 2. See also SIFMA Letter at 4 
(stating that approval of the Proposed Amendment ``would benefit 
investors by reducing complexity and enhancing fair and orderly 
markets for trading ETPs'').
    \38\ See SIFMA Letter at 3 (stating additionally that several 
ETPs consisting of currency products are also assigned to Tier 1).
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    Some commenters oppose the Proposed Amendment,\39\ with some 
commenters stating that the proposed tighter Price Bands would 
effectively limit the natural price discovery process, which would 
infringe upon free market principles \40\ and may lead to increased 
volatility.\41\ One commenter further states that leveraged 
derivatives, such as options and futures, allow significant positions 
to be taken with relatively less capital.\42\ The same commenter states 
that the Proposal caters to the interests of larger, institutional 
investors who may benefit from reduced volatility and more predictable 
price movements at the expense of smaller, retail investors.\43\ Some 
commenters state that the Proposal enables the Participants to control 
the price of a security inappropriately.\44\
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    \39\ See, e.g., Letters from Alexander Kuchta dated Nov. 27, 
2023 (``Kuchta Letter''); Rax Nahali dated Nov. 27, 2023 (``Nahali 
Letter''); and Rene Wright dated Nov. 27, 2023 (``Wright Letter'').
    \40\ See Kuchta Letter. See also Joe Edwards dated Nov. 27, 2023 
(``Edwards Letter'') (stating that ``[t]his rule goes against the 
ideals of a free and fair market''); Nahali Letter (stating that 
``[i]f the markets are as free and fair as the SEC suggests they 
are, there is no need for this rule to be in place'').
    \41\ See Kuchta Letter (stating that ``as trades accumulate at 
the band limits, the resumption of trading could trigger sudden and 
sharp price movements, contrary to the proposal's intent to reduce 
volatility'').
    \42\ See id.
    \43\ See id.
    \44\ See Mazundar Letter. See also Nahali Letter (stating the 
rule ``would allow the exchanges to collude and set prices where 
they want them.'').
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C. Participants' Findings and Commission Response

    The Commission approved the Plan in 2012 on a pilot basis, 
recognizing that after the Participants and the public gain experience 
with the operations of the Plan, modifications may be necessary or 
appropriate.\45\ At the time the Commission permanently approved the 
Plan in 2019, the Commission recognized that robust, data-driven 
assessments of the Plan's effectiveness are important to ensure that 
the Plan remains designed to achieve its objective,\46\ and the 
Commission supports continuing efforts to improve the operation of the 
Plan consistent with Rule 608 of Regulation NMS under the Exchange 
Act.\47\
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    \45\ See Securities Exchange Act Release No. 67091 (May 31, 
2012), 77 FR 33498, 33510 (June 6, 2012) (``LULD Plan Approval 
Order'').
    \46\ See Securities Exchange Act Release No. 85623 (Apr. 11, 
2019), 84 FR 16086, 16090 (Apr. 17, 2019).
    \47\ 17 CFR 242.608.
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    The Participants state that assigning all ETPs, except for single 
stock ETPs, to Tier 1 would improve market quality, more effectively 
dampen volatility, provide greater investor protection, and decrease 
the number of unnecessary Limit States and Trading Pauses for Tier 2 
ETPs.\48\ For these reasons, the Participants state that the Proposed 
Amendment is consistent with Rule

[[Page 77206]]

608(b)(2). As discussed in detail below, the Participants have not 
carried their burden of demonstrating why the Proposed Amendment is 
consistent with Rule 608 of Regulation NMS.
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    \48\ See Notice, 88 FR at 81141. The Participants state that 
when ETPs moved from Tier 2 to Tier 1 there was an improvement in 
market quality and a decrease in the number of Trading Pauses, Limit 
States, or the amount of time spent in Limit States, as compared 
with ETPs that remained in Tier 2 during the period studied by the 
Participants. The Participants state that this is likely because 
market participants will change their behavior and provide more 
liquidity to ETPs if the bands are tightened. The Participants also 
state that market participants adjusted to tighter Price Bands after 
Amendment 18 to the Plan narrowed the Price Bands near the open and 
close of trading. However, the Participants state that this analysis 
concerning Trading Pauses and Limit States may not offer strong 
support for its conclusions given the relatively small number of 
ETPs that move between Tier 1 and Tier 2 designations; further, the 
Participants state that, ``in some cases, changes in the volume of 
trades are what cause an ETP to change from one tier to another, and 
the improvements in market quality may be attributable to that 
increased volume, and not the tier change in and of itself.'' Id.
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    In the Proposal, the Participants state that, except for single-
stock, commodity, and foreign exchange-based ETPs, ETPs are diversified 
instruments and that the analysis in the Proposal supports the modern 
portfolio theory that portfolios of securities exhibit lower volatility 
than individual securities, unless those products are perfectly 
correlated. At the same time, the Participants acknowledge that the 
ETPs studied cover several asset classes, including domestic equities, 
international equities, fixed income, currency, commodity, and digital 
currency ETPs.\49\ The Participants' Analyses, however, provide 
aggregate statistical information with respect to all Tier 2 ETPs 
despite securities within this group having different trading 
characteristics. These Analyses and the resulting aggregate statistical 
information concern the volatility characteristics of Tier 2 ETPs and 
the potential costs (i.e., trading activity disruption) and benefits 
(i.e., protecting investors from trading at inferior prices that may 
occur because of transitory gaps in liquidity rather than fundamental 
value changes; market quality improvement) of designating all Tier 2 
ETPs as Tier 1 securities. The Commission is concerned that these 
aggregate statistical analyses for Tier 2 ETPs do not reflect the 
trading characteristics and potential effects of the Proposed Amendment 
for many Tier 2 ETPs.
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    \49\ Id. at 81134.
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    According to the Annual Report for 2023 by the Operating Committee 
of the Plan, in 2023 there were over two thousand ETPs designated as 
Tier 2 securities.\50\ While the Proposed Amendment would exclude 
single stock ETPs from automatically being designated as Tier 1 
securities,\51\ the Proposal would not exclude other Tier 2 ETPs, 
including those based on other single reference assets,\52\ that may 
exhibit substantially different trading characteristics than those 
reflected in the Proposal's aggregate statistical analysis concerning 
the over two thousand Tier 2 ETPs or otherwise provide data 
demonstrating why these Tier 2 ETPs would be appropriately designated 
as Tier 1 securities regardless of their different trading 
characteristics. The above-mentioned issues were raised by the 
Commission in the Notice and OIP.\53\
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    \50\ See Annual Report for 2023 of the Operating Committee of 
the Plan to Address Extraordinary Market Volatility, May 3, 2024 
(available at https://www.luldplan.com/studies).
    \51\ The Participants state that the purpose of having different 
LULD tiers is to assign Price Bands that are commensurate with a 
security's underlying volatility and that single stock ETPs should 
be assigned to the same LULD tier as the underlying security because 
the ETP should closely track the price movement and volatility of 
its underlying security. See Notice, 88 FR at 81133.
    \52\ With respect to the comment that there are many single 
reference asset ETPs that currently are Tier 1 securities, those 
securities are designated as Tier 1 securities because their CADV 
meets the standard set forth in the Plan for ETPs that are 
designated as Tier 1 securities. See supra note 3838 38and 
accompanying text. The fact that some single reference asset ETPs 
may be appropriately characterized as Tier 1 securities under the 
Plan does not demonstrate that all single reference asset ETPs would 
be appropriately designated as Tier 1 securities because different 
single reference asset ETPs may have different trading 
characteristics that result in them being appropriately categorized 
as Tier 2 securities. The Participants' Analyses do not provide 
sufficient detail and specificity concerning these securities for 
the Commission to make an affirmative finding that the Proposed 
Amendment meets the standard for approval. See 17 CFR 
201.700(b)(3)(ii). See also infra note 56.
    \53\ See Notice, 88 FR at 81143 and OIP, 89 FR at 13394.
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    For example, key elements of the Analyses aggregate all trades of 
Tier 2 ETPs together.\54\ Such a method will effectively ignore Tier 2 
ETPs that trade infrequently--this is because any analysis that uses 
aggregate trading statistics will be driven by the ETPs with a high 
level of trading activity, while ETPs with a low level of trading will 
have a low weight in the statistical analysis. This result is 
compounded by combining leveraged and non-leveraged Tier 2 ETPs in the 
same group because trading activity among Tier 2 ETPs is highly skewed 
by leveraged ETPs. All leveraged ETPs are in Tier 2 regardless of their 
trading volume, and some have a high level of volume.\55\ In contrast, 
a non-leveraged ETP is only in Tier 2 if it has less than $2 million 
CADV per day over the past six months. This implies that an aggregate 
analysis of all Tier 2 ETP trades will be driven by a relatively small 
number of high-volume leveraged ETPs, and such analysis will 
effectively ignore the vast majority of Tier 2 ETPs.\56\ Because 
elements of the Analyses are driven by a small number of high-volume 
leveraged ETPs, it is not appropriate to extend the conclusions from 
the Analyses to the nearly 2,000 non-leveraged Tier 2 ETPs with 
substantially less volume; therefore, key analyses--such as the 
analysis of price dynamics around the Price Bands--do not support 
moving all 2,000 Tier 2 ETPs into Tier 1. A more granular statistical 
analysis could show that, for certain ETPs that are currently in Tier 
2, the move to Tier 1 and resultant narrower Price Bands would result 
in excessive Straddle States, Limit States and Trading Pauses that are 
not due to extraordinary volatility caused by transitory gaps in 
liquidity, which these measures are designed to mitigate, but instead 
would unduly interrupt trading activity driven by fundamental value 
changes. For this reason, the Participants' Analyses do not provide 
sufficient detail and specificity concerning these securities for the 
Commission to make an affirmative finding that the Proposed Amendment 
meets the standard for approval.\57\
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    \54\ In the analysis in the Proposed Amendment, Table 3, 4, 5, 
and Chart 1 aggregate all Tier 2 ETP trades into a single group; 
Table B of the Supplemental Analysis does likewise. These tables 
quantify the amount of volume that would be affected by tighter 
bands, and the price dynamics around the tighter bands.
    \55\ For example, in the second half of 2023, TQQQ, SQQQ, and 
SOXL averaged daily volume in excess of $1 billion; these are all 
ETPs with a leverage ratio of three. The 20 Tier 2 ETPs with the 
highest dollar volume each averaged over $100 million per day during 
this period. For this analysis, a stock's tier is assigned based on 
FINRA's OTC Transparency Data, http://www.finra.org/industry/OTC-Transparency, which classifies stocks by tier on a weekly basis. A 
stock is considered an ETP if its security description in the TAQ 
database is `ETF,' `ETN,' or `ETV.' The TAQ database also contains 
information on the ETPs' Price Bands, which the Commission uses to 
infer the ETPs' leveraged ratios (e.g., a Price Band of 30% during 
the day implies that the ETP has a leverage ratio of three). 
Finally, trading volume for each stock comes from WRDS intra-day 
indicators.
    \56\ The OIP raised the issue that an aggregated approach to 
evaluating Tier 2 ETPs may not support moving all Tier 2 ETPs into 
Tier 1. See OIP, 89 FR at 13394. In response, the Participants 
provided a disaggregated analysis of commodity ETPs in the 
Supplemental Analysis that they believe shows that commodity ETPs 
should not be excluded from Tier 1 designation under the Proposed 
Amendment because they have similar characteristics to ETPs already 
in Tier 1; however, this disaggregated analysis contained only 65 
Tier 2 ETPs. See Participants' Letter at 4-6. This disaggregated 
analysis does not sufficiently address the Commission's concerns 
because it does not provide insight as to whether it is appropriate 
to move other Tier 2 ETPs to Tier 1. Commission analysis indicates 
that, in the second half of 2023, the 20 Tier 2 ETPs with the 
highest share volume comprised 80% of all share volume among Tier 2 
ETPs. Those same ETPs account for 74% of all Tier 2 ETP dollar 
volume, and 76% of all Tier 2 ETP trade volume. This implies that 
the trade-weighted aggregated analysis in the Proposed Amendment 
(see supra note 54) was likely driven by approximately 20 out of the 
2,000 Tier 2 ETPs; separately analyzing 65 Tier 2 ETPs still 
overlooks the vast majority of Tier 2 ETPs.
    \57\ See 17 CFR 242.608(b)(2). See also 17 CFR 
201.700(b)(3)(ii).
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    In addition to the issues discussed above, in the Notice and OIP 
the Commission addressed potential issues with respect to the 
Participants' statements regarding the Proposed Amendment's benefits 
and analysis concerning the volatility characteristics of Tier 2 ETPs 
as compared to Tier 1

[[Page 77207]]

securities that are not ETPs.\58\ The Participants state that the 
Proposed Amendment would protect investors from executing trades at 
inferior prices that may occur due to transitory gaps in liquidity 
rather than fundamental valuation,\59\ and some commenters state their 
support for this element of the Proposal's analysis.\60\ However, as 
discussed further below, the study presented in the Proposed Amendment 
and the Supplemental Analysis supporting this investor protection 
benefit are not robust or compelling. The Participants rely on the 
Analyses, which documented price reversion after Theoretical Tier 1 
Bands had been breached in Tier 2 ETPs, as evidence that investors 
transacted at inferior prices and would have benefited from tighter 
Price Bands.\61\
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    \58\ See Notice, 88 FR at 81143 and OIP, 89 FR at 13395.
    \59\ See Notice, 88 FR at 81137-38.
    \60\ See supra notes 31-33 and accompanying text.
    \61\ See Notice, 88 FR at 81137; Participants' Letter at 4.
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    There are three concerns with the price reversion analysis provided 
in the study presented in the Proposed Amendment and the Supplemental 
Analysis. First, as stated above, the price reversion analyses in the 
study in the Proposed Amendment and Supplemental Analysis are done on 
an aggregate basis for all Tier 2 ETPs. Many Tier 2 ETPs may show 
different price reversion results than reflected in the Analyses. 
Second, the conclusions from the study's price reversion analysis are 
not robust because that price reversion analysis compared trade prices 
that occurred outside of the Theoretical Tier 1 Bands to subsequent 
midpoint prices. This methodology is flawed because by comparing the 
execution price to a subsequent midpoint price, the methodology could 
incorrectly identify a price reversion--which is cited as evidence of 
inferior trades--even if nothing else changes with respect to the 
security (e.g., fundamental value, bid and ask prices stay constant) or 
even if the midpoint price continues to move in the same direction.\62\ 
The Commission requested comment concerning the analysis included with 
the Proposal in the Notice and OIP,\63\ and the Participants performed 
a Supplemental Analysis to address concerns that the Proposal's 
analysis could overestimate the degree of price reversion.\64\ In 
particular, the Participants performed a price reversion analysis that 
compared the midpoint of the NBBO at five and ten minutes after the 
trade to the midpoint of the NBBO at the time of execution.\65\ While 
this methodology in the Supplemental Analysis \66\ is more robust than 
the methodology of the study included in the Proposed Amendment, it 
also showed a decrease in the amount of price reversion experienced by 
Tier 2 ETPs. This raises a third concern. In particular, the additional 
price reversion analysis reflects some reversion metrics dropping from 
74% in the Proposal to 52% in the Supplemental Analysis. Given that 
prices fluctuate unpredictably over such short horizons, prices should 
revert 50% of the time and continue in the same direction 50% of the 
time; therefore, this estimated reversion probability of 52% in the 
Supplemental Analysis is little better than chance and does not support 
the Participants' statement that investors would have been protected by 
the tighter band.\67\ The reduction in the estimated amount of price 
reversion also increases the likelihood that some individual Tier 2 
ETPs experience price continuation--rather than reversion--near the 
Theoretical Tier 1 Bands, but this possibility cannot be detected when 
all two thousand Tier 2 ETPs are included in the aggregate statistical 
analysis.
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    \62\ For example, consider a trade that crosses below the lower 
Theoretical Tier 1 Band. It is likely that this trade executed at 
the bid (because the bid price is lower than the ask). Assume the 
bid is at $9 and the ask is at $11. If there is no price reversion--
that is, the bid ($9) and ask ($11) stay the same after this trade--
then the subsequent midpoint price ($10) would be higher than the 
trade price ($9), resulting in the methodology incorrectly 
identifying this as a price reversion. It is also possible that 
prices exhibited continuation--that is, prices continued to fall--
but the subsequent midpoint did not fall below the original bid. 
Both of these cases would incorrectly be coded as a ``price 
reversion'' in the Proposal's analysis; the Proposal's analysis 
therefore appears to overestimate the degree of price reversion.
    \63\ See Notice, 88 FR at 81143 and OIP, 89 FR at 13394-95.
    \64\ See Participants' Letter at 4.
    \65\ Id.
    \66\ Id.
    \67\ The Supplemental Analysis shows higher reversion when 
measured as a fraction of trades, which implies that trades with a 
low number of shares are more likely to revert. This analysis does 
not calculate reversion on a dollar-weighted basis, so it is unclear 
what fraction of dollars may have been executed during a transitory 
gap in liquidity.
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    The Participants also state that Tier 2 ETPs are less volatile than 
Tier 1 non-ETP securities, and that this lesser volatility is evidence 
that the current Price Bands for Tier 2 ETPs are poorly calibrated.\68\ 
Some commenters supported this element of the Proposal's analysis.\69\ 
However, that volatility analysis is also flawed.\70\ First, as 
discussed above, the Participants' Analyses are insufficiently granular 
as they combine nearly two thousand non-leveraged Tier 2 ETPs into a 
single group and compare them to all Tier 1 non-ETPs. Yet there may be 
many non-leveraged Tier 2 ETPs that reflect substantially different 
trading characteristics, and the Participants' Analyses do not provide 
sufficient detail and specificity concerning these securities for the 
Commission to make an affirmative finding that the Proposed Amendment 
meets the standard for approval.\71\
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    \68\ See Notice, 88 FR at 81134-37.
    \69\ See supra notes 34-36 and accompanying text.
    \70\ See Notice, 88 FR at 81143 and OIP, 89 FR at 13395.
    \71\ See 17 CFR 242.608(b)(2). See also 17 CFR 
201.700(b)(3)(ii).
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    Some non-leveraged Tier 2 ETPs--due to their relatively low trading 
volume--may experience trades that are spread out over time. When the 
time between trades is longer, the amount of new information in the 
market since the last trade will generally be higher, resulting in 
greater price changes--i.e., greater volatility--from trade-to-
trade.\72\ A tighter Price Band for these securities will be likely to 
inhibit this new information from being incorporated into trade prices 
and the Participants' Analyses do not address this possibility and its 
potential impact.\73\ Second, volatility is an imprecise metric for 
determining Price Bands. This is because volatility is averaged over 
many days and many stocks, while the Price Bands are meant to curb 
extraordinary volatility (e.g., the velocity of significant price 
moves).\74\ Average levels of volatility, therefore, are a coarse 
metric in determining whether a stock can sustain tighter Price 
Bands.\75\ Third, the

[[Page 77208]]

Proposal's analysis measured volatility using changes in the midpoint 
price of Tier 2 ETPs from second-to-second. This method of analysis is 
not robust for studying the volatility of securities that trade 
infrequently or have low quoting activity because the estimated 
volatility will be biased toward zero for these securities.\76\ As part 
of the Supplemental Analysis the Participants provided a new analysis 
of the volatility Tier 2 ETPs.\77\ While this analysis uses a more 
robust method for evaluating the volatility of Tier 2 ETPs as compared 
to Tier 1 non-ETPs, it presents the same concerns discussed above. In 
particular, it is an insufficiently granular statistical analysis of 
all Tier 2 ETP volatility, and there may be many Tier 2 ETPs that 
exhibit different trading characteristics, which the Analyses do not 
take into consideration. This possibility is evident in the 
distributional statistics in the Supplemental Analysis: the average 
quote volatilities for Tier 2 ETPs (both leveraged and non-leveraged) 
are multiples of the median quote volatilities, implying that the 
distribution is skewed by observations with volatility far higher than 
the average. Tier 1 ETPs exhibit less evidence of skewness. Therefore, 
the supplemental volatility analysis does not support moving all Tier 2 
ETPs into Tier 1.
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    \72\ Changes in stock valuations are often modelled as a 
``random walk.'' In such a model, the stock's value moves randomly 
at successive steps; as the number of steps increases, the 
dispersion in the stock's value also increases (i.e., the change in 
stock value is more volatile when it is measured over a longer 
horizon (because there are more steps as the horizon increases)). 
When a stock trades relatively infrequently, there are more such 
steps between trades, which generates greater volatility from one 
trade to the next.
    \73\ As discussed in the previous paragraph, many Tier 2 ETPs 
may show different price reversion results than reflected in the 
aggregate statistical analysis. For example, when a stock's trades 
are spread out over time, it will experience greater price changes 
trade-to-trade due to the greater amount of information between 
trades; such price changes will be less likely to revert after 
crossing the Theoretical Tier 1 Bands because the price change is 
driven by new information rather than a temporary liquidity gap.
    \74\ See LULD Plan Approval Order, 77 FR at 33508-33510. As the 
participants' analysis shows in Table 2 of the Proposed Amendment, 
limit states and trading pauses are rare events.
    \75\ The methodology studying theoretical blocked trades more 
precisely captures the relevant periods of extraordinary volatility 
because this method includes only relatively rare events in which 
prices move several percentage points within a short time period. 
But, as discussed previously, this analysis was aggregated in a way 
that makes its results impossible to generalize to the typical Tier 
2 ETP.
    \76\ For example, consider two ETPs with the same fundamental 
volatility but different levels of trading activity. Suppose the 
first ETP is traded frequently with quote updates every second; it 
therefore has 23,400 second-to-second returns during the trading day 
(sixty updates per minute for 6.5 hours). Suppose that the second 
ETP only receives a quote update once per minute; it will have 390 
second-to-second returns, and 23,010 seconds with an unchanged 
midpoint (i.e., a return of 0). The Proposal's methodology is likely 
to estimate a substantially lower volatility for the second ETP due 
to the fact that the vast majority of observations are coded as a 0. 
Using the NBBO files in the TAQ database for the second half of 
2023, the Commission estimates that the median non-leveraged Tier 2 
ETP receives approximately 2,900 NBBO updates per day; this implies 
that the second-to-second volatility calculation for the median Tier 
2 ETP will use at least 20,500 seconds with a return of 0 due to a 
lack of data (23,400 seconds per day, less the 2,900 NBBO updates). 
In contrast, the median Tier 1 security receives over 23,400 NBBO 
updates per day. It is likely therefore that the Proposal's 
methodology underestimates the volatility of non-leveraged Tier 2 
ETPs due to the prevalence of missing returns. The Participants 
disagreed with this assessment of their methodology, stating that 
``quotes for even thinly-traded ETPs change frequently as market 
makers update their valuations of ETPs' underlying portfolios, so it 
is not the case that the computation of quote volatility is biased 
by many zeroes.'' See Participants' Letter at 2. The Participants 
did not provide any evidence to support this statement.
    \77\ See Participants' Letter at 2-4.
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    Accordingly, based on the study in the Proposal and the 
Supplemental Analysis and for the reasons discussed throughout this 
order, the Commission cannot find that designating over two thousand 
ETPs as Tier 1 securities and subjecting them to tighter Price Bands is 
necessary or appropriate in the public interest, for the protection of 
investors and the maintenance of fair and orderly markets, to remove 
impediments to, and perfect the mechanisms of, a national market 
system, or otherwise in furtherance of the purposes of the Act, as 
required for approval of a plan amendment pursuant to Rule 608(b)(2). 
Designating Tier 2 ETPs as Tier 1 securities based on an aggregate 
statistical analysis could result in excessive Straddle States, Limit 
States and Trading Pauses in certain affected ETPs due to tighter Price 
Bands, and thus unduly impede trading in many securities for market 
participants that trade in these securities.

V. Conclusion

    For the reasons set forth above, the Commission does not find, 
pursuant to Section 11A of the Act,\78\ and Rule 608(b)(2) 
thereunder,\79\ that the Proposed Amendment is necessary or appropriate 
in the public interest, for the protection of investors and the 
maintenance of fair and orderly markets, to remove impediments to, and 
perfect the mechanisms of, a national market system, or otherwise in 
furtherance of the purposes of the Act.
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    \78\ 15 U.S.C. 78k-1.
    \79\ 17 CFR 242.608(b)(2).
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    It is therefore ordered, pursuant to Section 11A of the Act, and 
Rule 608(b)(2) thereunder, that the Proposed Amendment (File No. 4-631) 
be, and it hereby is, disapproved.

    By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-21508 Filed 9-19-24; 8:45 am]
BILLING CODE 8011-01-P