3594 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

1Securities Exchange Act Release No. 51808 

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

(‘‘Regulation NMS Release’’). 

2Securities Exchange Act Release No. 37619A 

(September 6, 1996), 61 FR 48290 (September 12, 

1996) (‘‘Order Handling Rules Release’’). 

3See, e.g., In the Matter of National Association 

of Securities Dealers, Inc., Administrative 

Proceeding File No. 3–9056, Securities Exchange 

Act Release No. 37538 (August 8, 1996). 

4 In November 2009, for example, NYSE-listed 

stocks represented approximately 78% of the 

market capitalization of the Wilshire 5000 Total 

Market Index. Wilshire Associates, http:// 

wilshire.com/Indexes/Broad/Wilshire5000/ 

Characteristics.html (November 17, 2009). 

5NASDAQ itself offered limited automated 

execution functionality until the introduction of 

SuperMontage in 2002. See Securities Exchange Act 

Release No. 46429 (August 29, 2002), 67 FR 56862 

(September 5, 2002) (Order with Respect to the 

Implementation of NASDAQ’s SuperMontage 

Facility). Prior to 2002, however, many electronic 

communication networks (‘‘ECNs’’) and market 

makers trading NASDAQ stocks provided 

predominantly automated executions. 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 242 

[Release No. 34–61358; File No. S7–02–10] 

RIN 3235–AK47 

Concept Release on Equity Market 

Structure 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Concept release; request for 

comments. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’) is 

conducting a broad review of the 

current equity market structure. The 

review includes an evaluation of equity 

market structure performance in recent 

years and an assessment of whether 

market structure rules have kept pace 

with, among other things, changes in 

trading technology and practices. To 

help further its review, the Commission 

is publishing this concept release to 

invite public comment on a wide range 

of market structure issues, including 

high frequency trading, order routing, 

market data linkages, and undisplayed, 

or ‘‘dark,’’ liquidity. The Commission 

intends to use the public’s comments to 

help determine whether regulatory 

initiatives to improve the current equity 

market structure are needed and, if so, 

the specific nature of such initiatives. 

DATES: Comments should be received on 

or before April 21, 2010. 

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. S7–02–10 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. 

S7–02–10. 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: 

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. Exchange Act Requirements for a National 

Market System 

III. Overview of Current Market Structure 

A. Trading Centers 

1. Registered Exchanges 

2. ECNs 

3. Dark Pools 

4. Broker-Dealer Internalization 

B. Linkages 

1. Consolidated Market Data 

2. Trade-Through Protection 

3. Broker Routing Services 

IV. Request for Comments 

A. Market Structure Performance 

1. Long-Term Investors 

a. Market Quality Metrics 

b. Fairness of Market Structure 

2. Other Measures 

B. High Frequency Trading 

1. Strategies 

a. Passive Market Making 

b. Arbitrage 

c. Structural 

d. Directional 

2. Tools 

a. Co-Location 

b. Trading Center Data Feeds 

3. Systemic Risks 

C. Undisplayed Liquidity 

1. Order Execution Quality 

2. Public Price Discovery 

3. Fair Access and Regulation of ATSs 

D. General Request for Comments 

I. Introduction 

The secondary market for U.S.-listed 

equities has changed dramatically in 

recent years. In large part, the change 

reflects the culmination of a decadeslong trend from a market structure with 

primarily manual trading to a market 

structure with primarily automated 

trading. When Congress mandated the 

establishment of a national market 

system for securities in 1975, trading in 

U.S.-listed equities was dominated by 

exchanges with manual trading floors. 

Trading equities today is no longer as 

straightforward as sending an order to 

the floor of a single exchange on which 

a stock is listed. As discussed in section 

III below, the current market structure 

can be described as dispersed and 

complex: (1) Trading volume is 

dispersed among many highly 

automated trading centers that compete 

for order flow in the same stocks; and 

(2) trading centers offer a wide range of 

services that are designed to attract 

different types of market participants 

with varying trading needs. 

A primary driver and enabler of this 

transformation of equity trading has 

been the continual evolution of 

technologies for generating, routing, and 

executing orders. These technologies 

have dramatically improved the speed, 

capacity, and sophistication of the 

trading functions that are available to 

market participants. Changes in market 

structure also reflect the markets’ 

response to regulatory actions such as 

Regulation NMS, adopted in 2005,1 the 

Order Handling Rules, adopted in 

1996,2 as well as enforcement actions, 

such as those addressing anticompetitive behavior by market makers 

in NASDAQ stocks.3

The transformation of equity trading 

has encompassed all types of U.S.-listed 

stocks. In recent years, however, it is 

perhaps most apparent in stocks listed 

on the New York Stock Exchange 

(‘‘NYSE’’), which constitute nearly 80% 

of the capitalization of the U.S. equity 

markets.4 In contrast to stocks listed on 

the NASDAQ Stock Market LLC 

(‘‘NASDAQ’’), which for more than a 

decade have been traded in a highly 

automated fashion at many different 

trading centers,5 NYSE-listed stocks 

were traded primarily on the floor of the 

NYSE in a manual fashion until October 

2006. At that time, NYSE began to offer 

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Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 3595 

6See Securities Exchange Act Release No. 53539 

(March 22, 2006), 71 FR 16353 (March 31, 2006) 

(File No. SR–NYSE–2004–05) (approving proposal 

to create a ‘‘Hybrid Market’’ by, among other things, 

increasing the availability of automated executions); 

Pierre Paulden, Keep the Change, Institutional 

Investor (December 19, 2006) (‘‘Friday, October 6, 

was a momentous day for the New York Stock 

Exchange. That morning the Big Board broke with 

214 years of tradition when it began phasing in a 

new hybrid market structure that can execute trades 

electronically, bypassing face-to-face auctions on its 

famed floor.’’). Prior to the Hybrid Market, NYSE 

offered limited automated executions. 

7Regulation NMS Release, 70 FR at 37505 n. 55 

(‘‘Nearly all commenters, both those supporting and 

opposing the need for an intermarket trade-through 

rule, agreed that the current ITS trade-through 

provisions are seriously outdated and in need of 

reform. They particularly focused on the problems 

created by affording equal protection against tradethroughs to both automated and manual 

quotations.’’). 

8NYSE Euronext, ‘‘NYSE Euronext Announces 

Trading Volumes for October 2009 (November 6, 

2009) (‘‘Tape A matched market share for NYSE was 

25.1% in October 2009, above the 24.5% market 

share reported in October 2008’’) (available at http:// 

www.nyse.com/press/125741917814.html); 

Securities Exchange Act Release No. 59039 

(December 2, 2008), 73 FR 74770, 74782 (December 

9, 2008) (File No. SR–NYSEArca–2006–21) (‘‘Given 

the competitive pressures that currently 

characterize the U.S. equity markets, no exchange 

can afford to take its market share percentages for 

granted—they can change significantly over time, 

either up or down. * * * For example, the NYSE’s 

reported market share of trading in NYSE-listed 

stocks declined from 79.1% in January 2005 to 

30.6% in June 2008.’’) (citations omitted). 

fully automated access to its displayed 

quotations.6 An important impetus for 

this change was the Commission’s 

adoption of Regulation NMS in 2005, 

which eliminated the trade-through 

protection for manual quotations that 

nearly all commenters believed was 

seriously outdated.7

The changes in the nature of trading 

for NYSE-listed stocks have been 

extraordinary, as indicated by the 

comparisons of trading in 2005 and 

2009 in Figures 1 through 5 below: 

BILLING CODE 8011–01–P 

BILLING CODE 8011–01–C 

Figure 1—NYSE executed 

approximately 79.1% of the 

consolidated share volume in its listed 

stocks in January 2005, compared to 

25.1% in October 2009.8

Figure 2—NYSE’s average speed of 

execution for small, immediately 

executable (marketable) orders was 10.1 


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3596 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

9NYSE Euronext, Rule 605 Reports for January 

2005 and October 2009 (available at http:// 

www.nyse.com/equities/nyseequities/ 

1201780422054.html) (NYSE average speed of 

execution for small (100–499 shares) market orders 

and marketable limit orders was 10.1 seconds in 

January 2005 and 0.7 seconds in October 2009). 

10NYSE Euronext, Consolidated Volume in NYSE 

Listed Issues 2000–2009 (available at http:// 

www.nyxdata.com/nysedata/NYSE/FactsFigures/ 

tabid/115/Default.aspx). 

11NYSE Euronext, Consolidated Volume in NYSE 

Listed Issues 2000–2009 (available at http:// 

www.nyxdata.com/nysedata/NYSE/FactsFigures/ 

tabid/115/Default.aspx). 

12NYSE Euronext, Consolidated Volume in NYSE 

Listed Issues 2000–2009 (available at http:// 

www.nyxdata.com/nysedata/NYSE/FactsFigures/ 

tabid/115/Default.aspx). 

13Securities Exchange Act Release No. 60684 

(September 18, 2009), 74 FR 48632 (September 23, 

2009) (‘‘Flash Order Release’’). 

14Securities Exchange Act Release No. 60997 

(November 13, 2009), 74 FR 61208 (November 23, 

2009) (‘‘Non-Public Trading Interest Release’’). 

15Securities Exchange Act Release No. [citation 

unavailable] (‘‘Market Access Release’’). 16 15 U.S.C. 78k–1. 

seconds in January 2005, compared to 

0.7 seconds in October 2009.9

Figure 3—Consolidated average daily 

share volume in NYSE-listed stocks was 

2.1 billion shares in 2005, compared to 

5.9 billion shares (an increase of 181%) 

in January through October 2009.10

Figure 4—Consolidated average daily 

trades in NYSE-listed stocks was 2.9 

million trades in 2005, compared to 22.1 

million trades (an increase of 662%) in 

January through October 2009.11

Figure 5—Consolidated average trade 

size in NYSE-listed stocks was 724 

shares in 2005, compared to 268 shares 

in January through October 2009.12

The foregoing statistics for NYSElisted stocks are intended solely to 

illustrate the sweeping changes that are 

characteristic of trading in all U.S.-listed 

equities, including NASDAQ-listed 

stocks and other equities such as 

exchange-traded funds (‘‘ETFs’’). They 

are not intended to indicate whether 

these changes have led to a market 

structure that is better or worse for longterm investors—an important issue on 

which comment is requested in section 

IV.A.1 below. Rather, the statistics for 

NYSE-listed stocks provide a useful 

illustration simply because the changes 

occurred both more rapidly and more 

recently for NYSE-listed stocks than 

other types of U.S.-listed equities. 

To more fully understand the effects 

of these and other changes in equity 

trading, the Commission is conducting a 

comprehensive review of equity market 

structure. It is assessing whether market 

structure rules have kept pace with, 

among other things, changes in trading 

technology and practices. The review 

already has led to several rulemaking 

proposals that address particular issues 

and that are intended primarily to 

preserve the integrity of longstanding 

market structure principles. One 

proposal would eliminate the exception 

for flash orders from the Securities 

Exchange Act of 1934 (‘‘Exchange Act’’) 

quoting requirements.13 Another would 

address certain practices associated 

with non-public trading interest, 

including dark pools of liquidity.14 In 

addition, the Commission today is 

proposing for public comment an 

additional market structure initiative to 

address the risk management controls of 

broker-dealers with market access.15

The Commission is continuing its 

review. It recognizes that market 

structure issues are complex and require 

a broad understanding of statutory 

requirements, economic principles, and 

practical trading considerations. Given 

this complexity, the Commission 

believes that its review would be greatly 

assisted by receiving the benefit of 

public comment on a broad range of 

market structure issues. It particularly is 

interested in hearing the views of all 

types of investors and other market 

participants and in receiving as much 

data and analysis as possible in support 

of commenters’ views. 

Commenters’ views on both the 

strengths and weaknesses of the current 

market structure are sought. Views on 

both strengths and weaknesses can help 

identify new initiatives that would 

enhance the strengths or improve on the 

weaknesses, avoid changes that would 

unintentionally cause more harm than 

good, and suggest whether any current 

rules are no longer necessary or are 

counterproductive to the objectives of 

the Exchange Act. As discussed in 

section II below, Congress mandated 

that the national market system should 

achieve a range of objectives—efficient 

execution of transactions, fair 

competition among markets, price 

transparency, best execution of investor 

orders, and the interaction of investor 

orders when consistent with efficiency 

and best execution. Additionally, the 

Commission’s mission includes the 

protection of investors and the 

facilitation of capital formation. 

Appropriately achieving each of these 

objectives requires a balanced market 

structure that can accommodate a wide 

range of participants and trading 

strategies. 

This release is intended to facilitate 

public comment by first giving a basic 

overview of the legal and factual 

elements of the current equity market 

structure and then presenting a wide 

range of issues for comment. The 

Commission cautions that it has not 

reached any final conclusions on the 

issues presented for comment. The 

discussion and questions in this release 

should not be interpreted as slanted in 

any particular way on any particular 

issue. The Commission intends to 

consider carefully all comments and to 

complete its review in a timely fashion. 

At that point, it will determine whether 

there are any problems that require a 

regulatory initiative and, if so, the 

nature of that initiative. Moreover, a 

new regulatory requirement would first 

be published in the form of a proposal 

that would give the public an 

opportunity to comment on the specifics 

of the proposal prior to adoption. 

II. Exchange Act Requirements for a 

National Market System 

In Section 11A of the Exchange Act,16

Congress directed the Commission to 

facilitate the establishment of a national 

market system in accordance with 

specified findings and objectives. The 

initial Congressional findings were that 

the securities markets are an important 

national asset that must be preserved 

and strengthened, and that new data 

processing and communications 

techniques create the opportunity for 

more efficient and effective market 

operations. Congress then proceeded to 

mandate a national market system 

composed of multiple competing 

markets that are linked through 

technology. In particular, Congress 

found that it is in the public interest and 

appropriate for the protection of 

investors and the maintenance of fair 

and orderly markets to assure five 

objectives: 

(1) Economically efficient execution 

of securities transactions; 

(2) Fair competition among brokers 

and dealers, among exchange markets, 

and between exchange markets and 

markets other than exchange markets; 

(3) The availability to brokers, dealers, 

and investors of information with 

respect to quotations and transactions in 

securities; 

(4) The practicability of brokers 

executing investors’ orders in the best 

market; and 

(5) An opportunity, consistent with 

efficiency and best execution, for 

investors’ orders to be executed without 

the participation of a dealer. 

The final Congressional finding was 

that these five objectives would be 

fostered by the linking of all markets for 

qualified securities through 

communication and data processing 

facilities. Specifically, Congress found 

that such linkages would foster 

efficiency; enhance competition; 

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Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 3597 

17See, e.g., Securities Exchange Act Release No. 

42450 (February 3, 2000), 65 FR 10577, 10580 

(February 28, 2000) (‘‘Fragmentation Concept 

Release’’) (‘‘[A]lthough the objectives of vigorous 

competition on price and fair market center 

competition may not always be entirely congruous, 

they both serve to further the interests of investors 

and therefore must be reconciled in the structure of 

the national market system.’’). 

18H.R. Rep. 94–123, 94th Cong., 1st Sess. 50 

(1975). 

19See S. Rep. 94–75, 94th Cong., 1st Sess. 2 

(1975) (‘‘S. 249 would lay the foundation for a new 

and more competitive market system, vesting in the 

SEC power to eliminate all unnecessary or 

inappropriate burdens on competition while at the 

same time granting to that agency complete and 

effective powers to pursue the goal of centralized 

trading of securities in the interest of both 

efficiency and investor protection.’’); Regulation 

NMS Release, 70 FR at 37499 (‘‘Since Congress 

mandated the establishment of an NMS in 1975, the 

Commission frequently has resisted suggestions that 

it adopt an approach focusing on a single form of 

competition that, while perhaps easier to 

administer, would forfeit the distinct, but equally 

vital, benefits associated with both competition 

among markets and competition among orders.’’). 

20Rule 600(b)(47) of Regulation NMS defines 

‘‘NMS stock’’ to mean any NMS security other than 

an option. Rule 600(b)(46) defines ‘‘NMS security’’ 

to mean any security for which trade reports are 

made available pursuant to an effective transaction 

reporting plan. In general, NMS stocks are those 

that are listed on a national securities exchange. 

21Sources of estimated trading volume 

percentages: NASDAQ; NYSE Group; BATS; Direct 

Edge; data compiled from Forms ATS for 3d quarter 

2009. 

increase the information available to 

brokers, dealers, and investors; facilitate 

the offsetting (matching) of investors’ 

orders; and contribute to the best 

execution of investors’ orders. 

Over the years, these findings and 

objectives have guided the Commission 

as it has sought to keep market structure 

rules up-to-date with continually 

changing economic conditions and 

technology advances. This task has 

presented certain challenges because, as 

noted previously by the Commission, 

the five objectives set forth in Section 

11A can, at times, be difficult to 

reconcile.17 In particular, the objective 

of matching investor orders, or ‘‘order 

interaction,’’ can be difficult to reconcile 

with the objective of promoting 

competition among markets. Order 

interaction promotes a system that 

‘‘maximizes the opportunities for the 

most willing seller to meet the most 

willing buyer.’’ 18 When many trading 

centers compete for order flow in the 

same stock, however, such competition 

can lead to the fragmentation of order 

flow in that stock. Fragmentation can 

inhibit the interaction of investor orders 

and thereby impair certain efficiencies 

and the best execution of investors’ 

orders. Competition among trading 

centers to provide specialized services 

for investors also can lead to practices 

that may detract from public price 

transparency. On the other hand, 

mandating the consolidation of order 

flow in a single venue would create a 

monopoly and thereby lose the 

important benefits of competition 

among markets. The benefits of such 

competition include incentives for 

trading centers to create new products, 

provide high quality trading services 

that meet the needs of investors, and 

keep trading fees low. 

The Commission’s task has been to 

facilitate an appropriately balanced 

market structure that promotes 

competition among markets, while 

minimizing the potentially adverse 

effects of fragmentation on efficiency, 

price transparency, best execution of 

investor orders, and order interaction.19

An appropriately balanced market 

structure also must provide for strong 

investor protection and enable 

businesses to raise the capital they need 

to grow and to benefit the overall 

economy. Given the complexity of this 

task, there clearly is room for reasonable 

disagreement as to whether the market 

structure at any particular time is, in 

fact, achieving an appropriate balance of 

these multiple objectives. Accordingly, 

the Commission believes it is important 

to monitor these issues and, 

periodically, give the public, including 

the full range of investors and other 

market participants, an opportunity to 

submit their views on the matter. This 

concept release is intended to provide 

such an opportunity. 

III. Overview of Current Market 

Structure 

This section provides a brief overview 

of the current equity market structure. It 

first describes the various types of 

trading centers that compete for order 

flow in NMS stocks 20 and among which 

liquidity is dispersed. It then describes 

the primary types of linkages between or 

involving these trading centers that are 

designed to enable market participants 

to trade effectively. This section 

attempts to highlight the features of the 

current equity market structure that may 

be most salient in presenting issues for 

public comment and is not intended to 

serve as a full description of the U.S. 

equity markets. 

A. Trading Centers 

A good place to start in describing the 

current market structure is by 

identifying the major types of trading 

centers and giving a sense of their 

current share of trading volume in NMS 

stocks. Figure 6 below provides this 

information with estimates of trading 

volume in September 2009: 21

Figure 6 

Trading Centers and Estimated % of 

Share Volume in NMS Stocks 

September 2009 

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3598 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

22 Data compiled from Forms ATS submitted to 

Commission for 3d quarter 2009. 

23More than 200 broker-dealers (excluding ATSs) 

have identified themselves to FINRA as market 

centers that must provide monthly reports on order 

execution quality under Rule 605 of Regulation 

NMS (list available at http://apps.finra.org/ 

datadirectory/1/marketmaker.aspx). 

24Consolidated quotation data is described in 

section III.B.1. below. 

25See, e.g., BATS Exchange, Inc., http:// 

batstrading.com/resources/features/ 

bats_exchange_Latency.pdf (June 2009) (average 

latency (time to accept, process, and acknowledge 

or fill order) of 320 microseconds; NASDAQ, 

http://www.nasdaqtrader.com/trader.aspx?id=inet 

(December 12, 2009) (average latency (time to 

accept, process, and acknowledge or fill order) of 

294 microseconds). 

26See, e.g., BATS Exchange, Inc., Rule 11.12 

(equally priced trading interest executed in time 

priority in the following order: (1) Displayed size 

of limit orders; (2) non-displayed limit orders; (3) 

pegged orders; (4) mid-point peg orders; (5) reserve 

size of orders; and (6) discretionary portion of 

discretionary orders); NASDAQ Rule 4757(a)(1) 

(book processing algorithm executes trading interest 

in the following order: (1) Displayed orders; (2) 

non-displayed orders and the reserve portion of 

quotes and reserve orders (in price/time priority 

among such interest); and (3) the discretionary 

portion of discretionary orders. 

Percent 

Registered Exchanges 

NASDAQ ....................................... 19.4 

NYSE ............................................ 14.7 

NYSE Arca ................................... 13.2 

BATS ............................................ 9.5 

NASDAQ OMX BX ....................... 3.3 

Other ............................................. 3.7 

Total Exchange ..................... 63.8 

ECNs 

2 Direct Edge ................................ 9.8 

3 Others ........................................ 1.0 

Total ECN .............................. 10.8 

Total Displayed Trading Center ....................................... 74.6 

Dark Pools 

Approximately 32 22 ...................... 7.9 

Broker-Dealer Internalization 

More than 200 23 .......................... 17.5 

Total Undisplayed Trading 

Center ................................ 25.4 

Figure 6 identifies two types of 

trading centers that display quotations 

in the consolidated quotation data that 

is widely distributed to the public— 

registered exchanges and ECNs.24 These 

displayed trading centers execute 

approximately 74.6% of share volume. 

Figure 6 also identifies two types of 

undisplayed trading centers—dark pools 

and broker-dealers that execute trades 

internally—that execute approximately 

25.4% of share volume. These four 

types of trading centers are described 

below. 

1. Registered Exchanges 

Registered exchanges collectively 

execute approximately 63.8% of share 

volume in NMS stocks, with no single 

exchange executing more than 19.4%. 

Registered exchanges must undertake 

self-regulatory responsibility for their 

members and file their proposed rule 

changes for approval with the 

Commission. These proposed rule 

changes publicly disclose, among other 

things, the trading services and fees of 

exchanges. 

The registered exchanges all have 

adopted highly automated trading 

systems that can offer extremely highspeed, or ‘‘low-latency,’’ order responses 

and executions. Published average 

response times at some exchanges, for 

example, have been reduced to less than 

1 millisecond.25 Many exchanges offer 

individual data feeds that deliver 

information concerning their orders and 

trades directly to customers. To further 

reduce latency in transmitting market 

data and order messages, many 

exchanges also offer co-location services 

that enable exchange customers to place 

their servers in close proximity to the 

exchange’s matching engine. Exchange 

data feeds and co-location services are 

discussed further in section IV.B.2. 

below. 

Registered exchanges typically offer a 

wide range of order types for trading on 

their automated systems. Some of their 

order types are displayable in full if 

they are not executed immediately. 

Others are undisplayed, in full or in 

part. For example, a reserve order type 

will display part of the size of an order 

at a particular price, while holding the 

balance of the order in reserve and 

refreshing the displayed size as needed. 

In general, displayed orders are given 

execution priority at any given price 

over fully undisplayed orders and the 

undisplayed size of reserve orders.26

In addition, many exchanges have 

adopted a ‘‘maker-taker’’ pricing model 

in an effort to attract liquidity providers. 

Under this model, non-marketable, 


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Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 3599 

27Securities Exchange Act Release No. 60651 

(September 11, 2009), 74 FR 47827 (September 17, 

2009) (Notice of filing of applications for 

registration as national securities exchanges by 

EDGX Exchange, Inc. and EDGA Exchange, Inc.). 

28See Non-Public Trading Interest Release, 74 FR 

at 61208–61209. 29 Data compiled from Forms ATS submitted to 

Commission for 3d quarter 2009. Some OTC market 

makers offer dark liquidity primarily in a principal 

capacity and do not operate as ATSs. For purposes 

of this release, these trading centers are not defined 

as dark pools because they are not ATSs. These 

trading centers may, however, offer electronic dark 

liquidity services that are analogous to those offered 

by dark pools. 30See, e.g., http://www.liquidnet.com/about/ 

liquidStats.html (average U.S. execution size in July 

2009 was 49,638 shares for manually negotiated 

trades via Liquidnet’s negotiation product); http:// 

www.pipelinetrading.com/AboutPipeline/ 

CompanyInfo.aspx (average trade size of 50,000 

shares in Pipeline). 

31See, e.g., http://www.nasdaqtrader.com/trader/ 

aspx?id=marketshare (average size of NASDAQ 

matched trades in July 2009 was 228 shares); 

http://nyxdata.com/nysedata/asp/factbook (NYSE 

Group average trade size in all stocks traded in July 

2009 was 267 shares). 

32 Data compiled from Forms ATS submitted to 

Commission for 3d quarter 2009. 

33See supra note 23. 

resting orders that offer (make) liquidity 

at a particular price receive a liquidity 

rebate if they are executed, while 

incoming orders that execute against 

(take) the liquidity of resting orders are 

charged an access fee. Rule 610(c) of 

Regulation NMS caps the amount of the 

access fee for executions against the best 

displayed prices of an exchange at 0.3 

cents per share. Exchanges typically 

charge a somewhat higher access fee 

than the amount of their liquidity 

rebates, and retain the difference as 

compensation. Sometimes, however, 

exchanges have offered ‘‘inverted’’ 

pricing and pay a liquidity rebate that 

exceeds the access fee. 

Highly automated exchange systems 

and liquidity rebates have helped 

establish a business model for a new 

type of professional liquidity provider 

that is distinct from the more traditional 

exchange specialist and over-thecounter (‘‘OTC’’) market maker. In 

particular, proprietary trading firms and 

the proprietary trading desks of multiservice broker-dealers now take 

advantage of low-latency systems and 

liquidity rebates by submitting large 

numbers of non-marketable orders 

(often cancelling a very high percentage 

of them), which provide liquidity to the 

market electronically. As discussed in 

section IV.B. below, these proprietary 

traders often are labeled high-frequency 

traders, though the term does not have 

a settled definition and may encompass 

a variety of strategies in addition to 

passive market making. 

2. ECNs 

The five ECNs that actively trade 

NMS stocks collectively execute 

approximately 10.8% of share volume. 

Almost all ECN volume is executed by 

two ECNs operated by Direct Edge, 

which has submitted applications for 

registration of its two trading platforms 

as exchanges.27 ECNs are regulated as 

alternative trading systems (‘‘ATSs’’). 

Regulation of ATSs is discussed in the 

next section below in connection with 

dark pools, which also are ATSs. The 

key characteristic of an ECN is that it 

provides its best-priced orders for 

inclusion in the consolidated quotation 

data, whether voluntarily or as required 

by Rule 301(b)(3) of Regulation ATS. In 

general, ECNs offer trading services 

(such as displayed and undisplayed 

order types, maker-taker pricing, and 

data feeds) that are analogous to those 

of registered exchanges. 

3. Dark Pools 

Dark pools are ATSs that, in contrast 

to ECNs, do not provide their bestpriced orders for inclusion in the 

consolidated quotation data. In general, 

dark pools offer trading services to 

institutional investors and others that 

seek to execute large trading interest in 

a manner that will minimize the 

movement of prices against the trading 

interest and thereby reduce trading 

costs.28 There are approximately 32 

dark pools that actively trade NMS 

stocks, and they executed 

approximately 7.9% of share volume in 

NMS stocks in the third quarter of 

2009.29 ATSs, both dark pools and 

ECNs, fall within the statutory 

definition of an exchange, but are 

exempted if they comply with 

Regulation ATS. Regulation ATS 

requires ATSs to be registered as brokerdealers with the Commission, which 

entails becoming a member of the 

Financial Industry Regulatory Authority 

(‘‘FINRA’’) and fully complying with the 

broker-dealer regulatory regime. Unlike 

a registered exchange, an ATS is not 

required to file proposed rule changes 

with the Commission or otherwise 

publicly disclose its trading services 

and fees. ATSs also do not have any 

self-regulatory responsibilities, such as 

market surveillance. The regulatory 

differences between registered 

exchanges and ATSs are addressed 

further in section IV.C.3. below. 

Dark pools can vary quite widely in 

the services they offer their customers. 

For example, some dark pools, such as 

block crossing networks, offer 

specialized size discovery mechanisms 

that attempt to bring large buyers and 

sellers in the same NMS stock together 

anonymously and to facilitate a trade 

between them. The average trade size of 

these block crossing networks can be as 

high as 50,000 shares.30 Most dark 

pools, though they may handle large 

orders, primarily execute trades with 

small sizes that are more comparable to 

the average size of trades in the public 

markets, which was less than 300 shares 

in July 2009.31 These dark pools that 

primarily match smaller orders (though 

the matched orders may be ‘‘child’’ 

orders of much larger ‘‘parent’’ orders) 

execute more than 90% of dark pool 

trading volume.32 The majority of this 

volume is executed by dark pools that 

are sponsored by multi-service brokerdealers. These broker-dealers also offer 

order routing services, trade as principal 

in the sponsored ATS, or both. 

4. Broker-Dealer Internalization 

The other type of undisplayed trading 

center is a non-ATS broker-dealer that 

internally executes trades, whether as 

agent or principal. Notably, many 

broker-dealers may submit orders to 

exchanges or ECNs, which then are 

included in the consolidated quotation 

data. The internalized executions of 

broker-dealers, however, primarily 

reflect liquidity that is not included in 

the consolidated quotation data. Brokerdealer internalization accordingly 

should be classified as undisplayed 

liquidity. There are a large number of 

broker-dealers that execute trades 

internally in NMS stocks—more than 

200 publish execution quality statistics 

under Rule 605 of Regulation NMS.33

Broker-dealer internalization accounts 

for approximately 17.5% of share 

volume in NMS stocks. 

Broker-dealers that internalize 

executions generally fall into two 

categories—OTC market makers and 

block positioners. An OTC market 

maker is defined in Rule 600(b)(52) of 

Regulation NMS as ‘‘any dealer that 

holds itself out as being willing to buy 

and sell to its customers, or others, in 

the United States, an NMS stock for its 

own account on a regular or continuous 

basis otherwise than on a national 

securities exchange in amounts of less 

than block size.’’ ‘‘Block size’’ is defined 

in Rule 600(b)(9) as an order of at least 

10,000 shares or for a quantity of stock 

having a market value of at least 

$200,000. A block positioner generally 

means any broker-dealer in the business 

of executing, as principal or agent, block 

size trades for its customers. To 

facilitate trades, block positioners often 

commit their own capital to trade as 

principal with at least some part of the 

customer’s block order. 

Broker-dealers that act as OTC market 

makers and block positioners conduct 

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34Review of Rule 606 Reports for 2d quarter 2009 

of eight broker-dealers with substantial number of 

retail customer accounts. 

35 Id. 

36H.R. Rep. No. 94–229, 94th Cong., 1st Sess. 93 

(1975). 

37The Commission has proposed lowering the 

trading volume threshold for order display 

obligations from 5% to 0.25%. Non-Public Trading 

Interest Release, 74 FR at 61213. 

38Rule 604 of Regulation NMS, for example, 

explicitly recognizes the ability of customers to 

control whether their limit orders are displayed to 

the public. Rule 604(b)(2) provides an exception 

from the limit order display requirement for orders 

that are placed by customers who expressly request 

that the order not be displayed. Rule 604(b)(4) 

provides an exception for all block size orders 

unless the customer requests that the order be 

displayed. 

39See, e.g., Rule 301(b)(3) of Regulation ATS; 

Rule 602(a)(1) of Regulation NMS; Order Handling 

Rules Release, 61 FR at 48307 (‘‘Although offering 

benefits to some market participants, widespread 

participation in these hidden markets has reduced 

the completeness and value of publicly available 

quotations contrary to the purposes of the NMS.’’). 

40Securities Exchange Act Release No. 60960 

(November 6, 2009), 74 FR 59272, 59273 (November 

17, 2009) (File No. SR–FINRA–2009–061) (in its 

description of the proposed rule change, FINRA 

stated that ‘‘[a]lthough members would have 30 

seconds to report, FINRA reiterates that—as is the 

case today—members must report trades as soon as 

practical and cannot withhold trade reports, e.g., by 

programming their systems to delay reporting until 

the last permissible second’’). 

41 Id. (from February 23, 2009 through February 

27, 2009, 99.90% of trades submitted to a FINRA 

Facility for public reporting were reported in 30 

seconds or less). 

42The three joint-industry plans are: (1) The CTA 

Plan, which is operated by the Consolidated Tape 

Association and disseminates transaction 

information for securities with their primary listing 

on exchanges other than NASDAQ; (2) the CQ Plan, 

which disseminates consolidated quotation 

information for securities with their primary listing 

on exchanges other than NASDAQ; and (3) the 

NASDAQ UTP Plan, which disseminates 

consolidated transaction and quotation information 

for securities with their primary listing on 

NASDAQ. The CTA Plan and CQ Plan are available 

at http://www.nyxdata.com/nysedata/ 

their business primarily by directly 

negotiating with customers or with 

other broker-dealers representing 

customer orders. OTC market makers, 

for example, appear to handle a very 

large percentage of marketable 

(immediately executable) order flow of 

individual investors that is routed by 

retail brokerage firms. A review of the 

order routing disclosures required by 

Rule 606 of Regulation NMS of eight 

broker-dealers with significant retail 

customer accounts reveals that nearly 

100% of their customer market orders 

are routed to OTC market makers.34 The 

review also indicates that most of these 

retail brokers either receive payment for 

order flow in connection with the 

routing of orders or are affiliated with 

an OTC market maker that executes the 

orders. The Rule 606 Reports disclose 

that the amount of payment for order 

flow generally is 0.1 cent per share or 

less.35

B. Linkages 

Given the dispersal of liquidity across 

a large number of trading centers of 

different types, an important question is 

whether trading centers are sufficiently 

linked together in a unified national 

market system. Thus far in this release, 

the term ‘‘dispersed’’ has been used to 

describe the current market structure 

rather than ‘‘fragmented.’’ The term 

‘‘fragmentation’’ connotes a negative 

judgment that the linkages among 

competing trading centers are 

insufficient to achieve the Exchange Act 

objectives of efficiency, price 

transparency, best execution, and order 

interaction. Whether fragmentation is in 

fact a problem in the current market 

structure is a critically important issue 

on which comment is requested in 

section IV below in a variety of contexts. 

This section will give an overview of the 

primary types of linkages that operate in 

the current market structure— 

consolidated market data, trade-through 

protection, and broker routing services. 

1. Consolidated Market Data 

When Congress mandated a national 

market system in 1975, it emphasized 

that the systems for collecting and 

distributing consolidated market data 

would ‘‘form the heart of the national 

market system.’’ 36 As described further 

below, consolidated market data 

includes both: (1) Pre-trade 

transparency—real-time information on 

the best-priced quotations at which 

trades may be executed in the future 

(‘‘consolidated quotation data’’); and (2) 

post-trade transparency—real-time 

reports of trades as they are executed 

(‘‘consolidated trade data’’). As a result, 

the public has ready access to a 

comprehensive, accurate, and reliable 

source of information for the prices and 

volume of any NMS stock at any time 

during the trading day. This information 

serves an essential linkage function by 

helping assure that the public is aware 

of the best displayed prices for a stock, 

no matter where they may arise in the 

national market system. It also enables 

investors to monitor the prices at which 

their orders are executed and assess 

whether their orders received best 

execution. 

Consolidated market data is collected 

and distributed pursuant to a variety of 

Exchange Act rules and joint-industry 

plans. With respect to pre-trade 

transparency, Rule 602 of Regulation 

NMS requires exchange members and 

certain OTC market makers that exceed 

a 1% trading volume threshold to 

provide their best-priced quotations to 

their respective exchanges or FINRA, 

and these self-regulatory organizations 

(‘‘SROs’’), in turn, are required to make 

this information available to vendors. 

Rule 604 of Regulation NMS requires 

exchange specialists and OTC market 

makers to display certain customer limit 

orders in their best-priced quotations 

provided under Rule 602. In addition, 

Rule 301(b)(3) of Regulation ATS 

requires an ATS that displays orders to 

more than one person in the ATS and 

exceeds a 5% trading volume threshold 

to provide its best-priced orders for 

inclusion in the quotation data made 

available under Rule 602.37

Importantly, the Commission’s rules 

do not require the display of a customer 

limit order if the customer does not 

wish the order to be displayed.38

Customers have the freedom to display 

or not display depending on their 

trading objectives. On the other hand, 

the selective display of orders generally 

is prohibited in order to prevent the 

creation of significant private markets 

and two-tiered access to pricing 

information.39 Accordingly, the display 

of orders to some market participants 

generally will require that the order be 

included in the consolidated quotation 

data that is widely available to the 

public. 

With respect to post-trade 

transparency, Rule 601 of Regulation 

NMS requires the equity exchanges and 

FINRA to file a transaction reporting 

plan regarding transactions in listed 

equity securities. The members of these 

SROs are required to comply with the 

relevant SRO rules for trade reporting. 

FINRA’s trade reporting requirements 

apply to all ATSs that trade NMS stocks, 

both ECNs and dark pools, as well as to 

broker-dealers that internalize. FINRA 

currently requires members to report 

their trades as soon as practicable, but 

no later than 90 seconds.40 FINRA has 

proposed to reduce the reporting time 

period to 30 seconds, noting that more 

than 99.9% of transactions are reported 

to FINRA in 30 seconds or less.41

Finally, Rule 603(b) of Regulation 

NMS requires the equity exchanges and 

FINRA to act jointly pursuant to one or 

more effective national market system 

plans to disseminate consolidated 

information, including an NBBO, on 

quotations for and transactions in NMS 

stocks. It also requires that consolidated 

information for each NMS stock be 

disseminated through a single plan 

processor. 

To comply with these requirements, 

the equity exchanges and FINRA 

participate in three joint-industry plans 

(‘‘Plans’’).42 Pursuant to the Plans, three 

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default.aspx?tabid=227. The NASDAQ UTP Plan is 

available at http://www.utpplan.com. 

43The Network financial information for 2008 is 

preliminary and unaudited. 

44Regulation NMS Release, 70 FR at 37567 

(‘‘Adopted Rule 603(a) will not require a market 

center to synchronize the delivery of its data to endusers with delivery of data by a Network processor 

to end-users. Rather independently distributed data 

could not be made available on a more timely basis 

than core data is made available to a Network 

processor. Stated another way, adopted Rule 603(a) 

prohibits an SRO or broker-dealer from transmitting 

data to a vendor or user any sooner than it transmits 

the data to a Network processor.’’). The plan 

processor for the CTA Plan and CQ Plan is the 

Securities Industry Automation Corporation 

(‘‘SIAC’’). The plan processor for the NASDAQ UTP 

Plan is NASDAQ. 

45Sources: SIAC for Network A and Network B; 

NASDAQ for Network C. 

separate networks distribute 

consolidated market data for NMS 

stocks: (1) Network A for securities with 

their primary listing on the NYSE; (2) 

Network B for securities with their 

primary listing on exchanges other than 

the NYSE or NASDAQ; and (3) Network 

C for securities with their primary 

listing on NASDAQ. The three Networks 

establish fees for the data, which must 

be filed for Commission approval. The 

three Networks collect the applicable 

fees and, after deduction of Network 

expenses (which do not include the 

costs incurred by SROs to generate 

market data and provide such data to 

the Networks), allocate the remaining 

revenues to the SROs. The revenues, 

expenses, and allocations for each of the 

three Networks are set forth in Table 1 

below:43

TABLE 1—2008 FINANCIAL INFORMATION FOR NETWORKS A, B, AND C 

Network A Network B Network C Total 

Revenues ................................................................................. $209,218,000 $119,876,000 $134,861,000 $463,955,000 

Expenses ................................................................................. 6,078,000 3,066,000 5,729,000 14,873,000 

Net Income .............................................................................. 203,140,000 116,810,000 129,132,000 449,082,000 

Allocations: 

NASDAQ ........................................................................... 47,845,000 34,885,000 60,614,000 143,343,000 

NYSE Arca ....................................................................... 37,080,000 38,235,000 26,307,000 101,622,000 

NYSE ................................................................................ 68,391,000 0 0 68,391,000 

FINRA ............................................................................... 24,325,000 16,458,000 20,772,000 61,555,000

NSX .................................................................................. 7,100,000 11,575,000 17,123,000 35,798,000

ISE .................................................................................... 15,260,000 1,477,000 1,883,000 18,620,000 

NYSE Amex ...................................................................... 1,000 9,760,000 14,000 9,775,000 

BATS ................................................................................ 2,356,000 2,770,000 1,538,000 6,664,000 

CBOE ................................................................................ 80,000 1,046,000 433,000 1,559,000 

CHX .................................................................................. 565,000 574,000 298,000 1,437,000 

Phlx ................................................................................... 134,000 30,000 146,000 310,000 

BSE ................................................................................... 3,000 .............................. 4,000 7,000 

In addition to providing quotation 

and trade information to the three 

Networks for distribution in 

consolidated data, many exchanges and 

ECNs offer individual data feeds 

directly to customers that include 

information that is provided in 

consolidated data. The individual data 

feeds of exchanges and ECNs also can 

include a variety of other types of 

information, such as ‘‘depth-of-book’’ 

quotations at prices inferior to their 

best-priced quotations. Rule 603(a) of 

Regulation NMS requires all exchanges, 

ATSs, and other broker-dealers that 

offer individual data feeds to make the 

data available on terms that are fair and 

reasonable and not unreasonably 

discriminatory. Exchanges, ATSs, and 

other broker-dealers are prohibited from 

providing their data directly to 

customers any sooner than they provide 

their data to the plan processors for the 

Networks.44 The fact that trading center 

data feeds do not need to go through the 

extra step of consolidation at a plan 

processor, however, means that such 

data feeds can reach end-users faster 

than the consolidated data feeds. The 

average latencies of the consolidation 

function at plan processors (from the 

time the processor receives information 

from the SROs to the time it distributes 

consolidated information to the public) 

are as follows: (1) Network A and 

Network B—less than 5 milliseconds for 

quotation data and less than 10 

milliseconds for trade data; and (2) 

Network C—5.892 milliseconds for 

quotation data and 6.680 milliseconds 

for trade data.45 The individual trading 

center data feeds are discussed below in 

section IV.B.2.b. 

2. Trade-Through Protection 

Another important type of linkage in 

the current market structure is the 

protection against trade-throughs 

provided by Rule 611 of Regulation 

NMS. A trade-through is the execution 

of a trade at a price inferior to a 

protected quotation for an NMS stock. A 

protected quotation must be displayed 

by an automated trading center, must be 

disseminated in the consolidated 

quotation data, and must be an 

automated quotation that is the best bid 

or best offer of an exchange or FINRA. 

Importantly, Rule 611 applies to all 

trading centers, not just those that 

display protected quotations. Trading 

center is defined broadly in Rule 

600(b)(78) to include, among others, all 

exchanges, all ATSs (including ECNs 

and dark pools), all OTC market makers, 

and any other broker-dealer that 

executes orders internally, whether as 

agent or principal. 

Rule 611(a)(1) requires all trading 

centers to establish, maintain, and 

enforce written policies and procedures 

that are reasonably designed to prevent 

trade-throughs of protected quotations, 

subject to the exceptions set forth in 

Rule 611(b). Protection against tradethroughs is an important linkage among 

trading centers because it provides a 

baseline assurance that: (1) Marketable 

orders will receive at least the best 

displayed price, regardless of the 

particular trading center that executes 

the order or where the best price is 

displayed in the national market system; 

and (2) quotations that are displayed at 

one trading center will not be bypassed 

by trades with inferior prices at any 

trading center in the national market 

system. 

Rule 611 also helps promote linkages 

among trading centers by encouraging 

them, when they do not have available 

trading interest at the best price, to route 

marketable orders to a trading center 

that is displaying the best price. 

Although Rule 611 does not directly 

require such routing services (a trading 

center can, for example, cancel and 

return an order when it does not have 

the best price), competitive factors have 

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46See Regulation NMS Release, 70 FR at 37538– 

37539 (‘‘Although ITS promotes access among 

participants that is uniform and free, it also is often 

slow and limited.’’). 

47See Regulation NMS Release, 70 FR at 37540 

(‘‘[M]any different private firms have entered the 

business of linking with a wide range of trading 

centers and then offering their customers access to 

those trading centers through the private firms’ 

linkages. Competitive forces determine the types 

and costs of these private linkages.’’). 

48The Commission has proposed reducing the 

threshold for order display and execution access to 

0.25%. Non-Public Trading Interest Release, 74 FR 

at 61213. It has not proposed to change the 

threshold for fair access in general. 

49See, e.g., Regulation NMS Release, 70 FR at 

37537–37538 (discussion of duty of best execution). 

50Securities Exchange Act Release No. 43590 

(November 17, 2000), 65 FR 75414, 75415 

(December 1, 2000) (Disclosure of Order Execution 

and Routing Practices). 

led many trading centers to offer routing 

services to their customers. Prior to Rule 

611, exchanges routed orders through an 

inflexible, partially manual system 

called the Intermarket Trading System 

(‘‘ITS’’).46 With Regulation NMS, 

however, the Commission adopted a 

‘‘private linkages’’ approach that relies 

exclusively on brokers to provide 

routing services, both among exchanges 

and between customers and exchanges. 

These broker routing services are 

discussed next. 

3. Broker Routing Services 

In a dispersed and complex market 

structure with many different trading 

centers offering a wide spectrum of 

services, brokers play a significant role 

in linking trading centers together into 

a unified national market system. 

Brokers compete to offer the 

sophisticated technology tools that are 

needed to monitor liquidity at many 

different venues and to implement order 

routing strategies. To perform this 

function, brokers may monitor the 

execution of orders at both displayed 

and undisplayed trading centers to 

assess the availability of undisplayed 

trading interest. Brokers may, for 

example, construct real-time ‘‘heat 

maps’’ in an effort to discern and access 

both displayed and undisplayed 

liquidity at trading centers throughout 

the national market system. 

Using their knowledge of available 

liquidity, many brokers offer smart 

order routing technology to access such 

liquidity. Many brokers also offer 

sophisticated algorithms that will take 

the large orders of institutional investors 

and others, divide a large ‘‘parent’’ order 

into many smaller ‘‘child’’ orders, and 

route the child orders over time to 

different trading centers in accordance 

with the particular trading strategy 

chosen by the customer. Such 

algorithms may be ‘‘aggressive,’’ for 

example, and seek to take liquidity 

quickly at many different trading 

centers, or they may be ‘‘passive,’’ and 

submit resting orders at one or more 

trading centers and await executions at 

favorable prices. 

To the extent they help customers 

cope with the dispersal of liquidity 

among a large number of trading centers 

of different types and achieve the best 

execution of their customers’ orders, the 

routing services of brokers can 

contribute to the broader policy goal of 

promoting efficient markets. 

Under the private linkages approach 

adopted by Regulation NMS, market 

participants obtain access to the various 

trading centers through broker-dealers 

that are members or subscribers of the 

particular trading center.47 Rule 610(a) 

of Regulation NMS, for example, 

prohibits an SRO trading facility from 

imposing unfairly discriminatory terms 

that would prevent or inhibit any 

person from obtaining efficient access 

through an SRO member to the 

displayed quotations of the SRO trading 

facility. Rule 610(c) limits the fees that 

a trading center can charge for access to 

its displayed quotations at the best 

prices. Rule 611(d) requires SROs to 

establish, maintain, and enforce rules 

that restrict their members from 

displaying quotations that lock or cross 

previously displayed quotations. 

Section 6(a)(2) of the Exchange Act 

requires registered exchanges to allow 

any qualified and registered brokerdealer to become a member of the 

exchange—a key element in assuring 

fair access to exchange services. In 

contrast, the access requirements that 

apply to ATSs are much more limited. 

Regulation ATS includes two distinct 

types of access requirements: (1) order 

display and execution access in Rule 

301(b)(3); and (2) fair access to ATS 

services in general in Rule 301(b)(5). An 

ATS must meet order display and 

execution access requirements if it 

displays orders to more than one person 

in the ATS and exceeds a 5% trading 

volume threshold.48 An ATS must meet 

the general fair access requirement if it 

exceeds a 5% trading volume threshold. 

If an ATS neither displays orders to 

more than one person in the ATS nor 

exceeds a 5% trading volume threshold, 

Regulation ATS does not impose access 

requirements on the ATS. 

An essential type of access that 

should not be overlooked is the fair 

access to clearance and settlement 

systems required by Section 17A of the 

Exchange Act. If brokers cannot 

efficiently clear and settle transactions 

at the full range of trading centers, they 

will not be able to perform their linkage 

function properly. 

The linkage function of brokers also is 

supported by a broker’s legal duty of 

best execution. This duty requires a 

broker to obtain the most favorable 

terms reasonably available when 

executing a customer order.49 Of course, 

this legal duty is not the only pressure 

on brokers to obtain best execution. The 

existence of strong competitive pressure 

to attract and retain customers 

encourages brokers to provide high 

quality routing services to their 

customers. In this regard, Rules 605 and 

606 of Regulation NMS are designed to 

support competition by enhancing the 

transparency of order execution and 

routing practices. Rule 605 requires 

market centers to publish monthly 

reports of statistics on their order 

execution quality. Rule 606 requires 

brokers to publish quarterly reports on 

their routing practices, including the 

venues to which they route orders for 

execution. As the Commission 

emphasized when it adopted the rules 

in 2000, ‘‘[b]y increasing the visibility of 

order execution and routing practices, 

the rules adopted today are intended to 

empower market forces with the means 

to achieve a more competitive and 

efficient national market system for 

public investors.’’ 50 In section IV.A.1.b. 

below, comment is requested on 

whether Rules 605 and 606 should be 

updated for the current market 

structure. 

IV. Request for Comments 

This section will focus on three 

categories of issues that the Commission 

particularly wishes to present for 

comment—the performance of the 

current market structure, high frequency 

trading, and undisplayed liquidity. The 

Commission emphasizes, however, that 

it is interested in receiving comments 

on all aspects of the equity market 

structure that the public believes are 

important. The discussion in this 

release should not be construed as in 

any way limiting the scope of comments 

that will be considered. 

This concept release focuses on the 

structure of the equity markets and does 

not discuss the markets for other types 

of instruments that are related to 

equities, such as options and OTC 

derivatives. The limited scope of this 

release is designed to focus on a discrete 

set of issues that have gained increased 

prominence in the equity markets. 

Comment is requested, however, on the 

extent to which the issues identified in 

this release are intertwined with other 

markets. For example, market 

participants may look to alternative 

instruments if they believe the equity 

markets are not optimal for their trading 

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51See, e.g., S. Report 94–75 at 3 (‘‘The rapid 

attainment of a national market system as envisaged 

by this bill is important, therefore, not simply to 

provide greater investor protection and bolster 

sagging investor confidence but also to assure that 

the country maintains a strong, effective and 

efficient capital raising and capital allocating 

system in the years ahead. The basic goals of the 

Exchange Act remain salutary and unchallenged: to 

provide fair and honest mechanisms for the pricing 

of securities, to assure that dealing in securities is 

fair and without undue preferences or advantages 

among investors, to ensure that securities can be 

purchased and sold at economically efficient 

transaction costs, and to provide, to the maximum 

degree practicable, markets that are open and 

orderly.’’). 

52See Regulation NMS Release, 70 FR at 37500 

(‘‘The Commission recognizes that it is important to 

avoid false dichotomies between the interests of 

short-term traders and long-term investors, and that 

many difficult line-drawing exercises can arise in 

precisely defining the difference between the two 

terms. For present purposes, however, these issues 

can be handled by simply noting that it makes little 

sense to refer to someone as ‘investing’ in a 

company for a few seconds, minutes, or hours.’’) 

(citation omitted). 

53See, e.g., Flash Order Release, 74 FR at 48635– 

48636; Regulation NMS Release, 70 FR at 37499– 

37501; Fragmentation Concept Release, 65 FR at 

10581 n. 26; see also S. Rep. No. 73–1455, 73rd 

Cong., 2d Sess. 5 (1934) (‘‘Transactions in securities 

on organized exchanges and over-the-counter are 

affected with the national public interest. * * * In 

former years transactions in securities were carried 

on by a relatively small portion of the American 

people. During the last decade, however, due 

largely to the development of means of 

communication * * * the entire Nation has become 

acutely sensitive to the activities on the securities 

exchanges. While only a fraction of the multitude 

who now own securities can be regarded as actively 

trading on the exchanges, the operations of these 

few profoundly affect the holdings of all.’’). 

objectives. Should the Commission 

consider the extent to which 

instruments substitute for one another 

in evaluating equity market structure? 

In addition, comment is requested on 

the impact of globalization on market 

structure. How does global competition 

for trading activity impact the U.S. 

market structure? Should global 

competition affect the approach to 

regulation in the U.S.? Will trading 

activity and capital tend to move either 

to the U.S. or overseas in response to 

different regulation in the U.S.? How 

should the Commission consider these 

globalization issues in its review of 

market structure? 

A. Market Structure Performance 

The secondary markets for NMS 

stocks are essential to the economic 

success of the country and to the 

financial well-being of individual 

Americans. High quality trading markets 

promote capital raising and capital 

allocation by establishing prices for 

securities and by enabling investors to 

enter and exit their positions in 

securities when they wish to do so.51

The Commission wishes to request 

comment broadly on how well or poorly 

the current market structure is 

performing its vital economic functions. 

In recent months, the Commission has 

heard a variety of concerns about 

particular aspects of the current market 

structure, as well as the view that recent 

improvements to the equity markets 

have benefitted both individual and 

institutional investors. The concerns 

about market structure often have 

related to high frequency trading and 

various types of undisplayed liquidity. 

Prior to discussing these particular areas 

of concern in this release, the 

Commission believes it is important to 

assess more broadly the performance of 

the market structure, particularly for 

long-term investors and for businesses 

seeking to raise capital. Assessing 

overall market structure performance 

should help provide context for 

particular concerns, as well as the 

nature of any regulatory response that 

may be appropriate to address concerns. 

1. Long-Term Investors 

In assessing the performance of the 

current equity market structure and 

whether it is meeting the relevant 

Exchange Act objectives, the 

Commission is particularly focused on 

the interests of long-term investors. 

These are the market participants who 

provide capital investment and are 

willing to accept the risk of ownership 

in listed companies for an extended 

period of time. Unlike long-term 

investors, professional traders generally 

seek to establish and liquidate positions 

in a shorter time frame. Professional 

traders with these short time frames 

often have different interests than 

investors concerned about the long-term 

prospects of a company.52 For example, 

short-term professional traders may like 

short-term volatility to the extent it 

offers more trading opportunities, while 

long-term investors do not. The net 

effect of trading strategies pursued by 

various short-term professional traders, 

however, may not increase volatility 

and may work to dampen volatility. 

Nevertheless, the interests of investors 

and professional traders may at times be 

aligned. Indeed, the collective effect of 

professional traders competing to profit 

from short-term trading strategies can 

work to the advantage of long-term 

investors. For example, as just noted, 

short-term trading strategies may work 

to dampen short-term volatility. 

Professional traders with an informed 

view of prices can promote efficient 

pricing. Professional traders competing 

to provide liquidity may narrow spreads 

and give investors the benefit of better 

prices when they simply want to trade 

immediately at the best available price. 

Given the difference in time horizons, 

however, the trading needs of long-term 

investors and short-term professional 

traders often may diverge. Professional 

trading is a highly competitive endeavor 

in which success or failure may depend 

on employing the fastest systems and 

the most sophisticated trading strategies 

that require major expenditures to 

develop and operate. Such systems and 

strategies may not be particularly useful, 

in contrast, for investors seeking to 

establish a long-term position rather 

than profit from fleeting price 

movements. Where the interests of longterm investors and short-term 

professional traders diverge, the 

Commission repeatedly has emphasized 

that its duty is to uphold the interests 

of long-term investors.53

Comment is requested on the 

practicality of distinguishing the 

interests of long-term investors from 

those of short-term professional traders 

when assessing market structure issues. 

In what circumstances should an 

investor be considered a ‘‘long-term 

investor’’? If a time component is 

needed to define this class of investor, 

how should the Commission determine 

the length of expected ownership that 

renders an investor ‘‘long-term’’? Under 

what circumstances would a distinction 

between a long-term investor and a 

short-term professional trader become 

unclear, and how prevalent are these 

circumstances? To the extent that 

improved market liquidity and depth 

promote the interests of long-term 

investors by leading to reduced 

transaction costs, what steps should the 

Commission consider taking to promote 

market liquidity and depth? 

Long-term investors include 

individuals that invest directly in 

equities and institutions that invest on 

behalf of many individuals. The 

Commission is interested in hearing 

how all types of individual investors 

and all sizes of institutional investors— 

small, medium, and large—are faring in 

the current market structure. For 

example, has the current market 

structure become so dispersed and 

complex that only the largest 

institutions can afford to deploy their 

own highly sophisticated trading tools? 

If so, are smaller institutions able to 

trade effectively? Some broker-dealers 

offer sophisticated trading tools, such as 

smart routing and algorithmic trading. 

How accessible are these trading tools to 

smaller institutions? Are the costs of 

paying for these tools so high that they 

are effectively inaccessible? Moreover, 

to the extent that a competitive 

advantage flows from these trading 

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54See, e.g., Memorandum to File from Office of 

Economic Analysis dated December 15, 2004 

regarding comparative analysis of execution quality 

on NYSE and NASDAQ based on a matched sample 

of stocks (‘‘Comparative Analysis of Execution 

Quality’’) (available at http://www.sec.gov/spotlight/ 

regnms.htm); Memorandum to File from Office of 

Economic Analysis dated December 15, 2004 

regarding Analysis of Volatility for Stocks 

Switching from Nasdaq to NYSE (available at http:// 

www.sec.gov/spotlight/regnms.htm); Office of 

Economic Analysis, Report on Comparison of Order 

Executions Across Equity Market Structures 

(January 8, 2001) (‘‘Report on Comparison of Order 

Executions’’) (available at http://www.sec.gov/news/ 

studies/ordrxmkt.htm); Commission, Report on the 

Practice of Preferencing (April 15, 1997) (available 

at http://www.sec.gov/news/studies/studiesarchive/ 

1997archive.shtml). 

55When assessing market structure during the 

development of Regulation NMS, for example, 

Commission staff used Rule 605 data to measure 

quoted spreads, effective spreads, realized spreads, 

price impact, net price improvement, execution 

speed, and fill rates. All of the cost values were 

calculated both in terms of absolute value (cents) 

and in terms of proportional costs as a percentage 

of stock prices. Comparative Analysis of Execution 

Quality at 8–9. 

56Fragmentation Concept Release, 65 FR at 10581 

n. 26 (‘‘In theory, short-term price swings that hurt 

investors on one side of the market can benefit 

investors on the other side of the market. In 

practice, professional traders, who have the time 

and resources to monitor market dynamics closely, 

are far more likely than investors to be on the 

profitable side of short-term price swings (for 

example, by buying early in a short-term price rise 

and selling early before the price decline).’’). 

57 Variance ratios are calculated by comparing 

return variances for a short time period with return 

variances for a longer time period. One of the 

advantages of this measure of volatility is that 

‘‘there is a built-in control for the underlying 

uncertainty as to the ‘true’ value of the stock. For 

example, the high variance of returns on technology 

stocks is to be expected given the high uncertainty 

as to their future cash flows. The point is that this 

uncertainty will manifest itself in both the daily 

and weekly return variances. When [Commission 

staff] divide the weekly return by the daily return, 

the natural uncertainty associated with the stock 

‘washes out’ and [Commission staff] are left with a 

measure associated with transaction costs or some 

other form of inefficiency.’’ Report on Comparison 

of Order Executions, supra note 54, at 18. 

58See generally Investment Company Act Release 

No. 26313 (December 18, 2003), 68 FR 74820, 74821 

(December 24, 2003) (Request for Comments on 

Measures to Improve Disclosure of Mutual Fund 

Transaction Costs) (‘‘The Commission is aware of 

the need for transparency of mutual fund fees and 

expenses and committed to improving disclosure of 

tools, does that competitive advantage 

help to promote and enable 

competition, beneficial innovation, and, 

ultimately, enhanced market quality? Is 

there a risk that certain competitive 

advantages may reduce competition or 

lead to detrimental innovations? To 

what extent is it important for market 

participants to be allowed to gain 

competitive advantages, such as by 

using more sophisticated trading tools? 

In addition, the Commission 

recognizes that there is wide variation 

in types of equity securities and that 

there may be important differences in 

market performance among the different 

types. With respect to corporate 

equities, for example, the Commission is 

interested in how market structure 

impacts stocks of varying levels of 

market capitalization (for example, top 

tier, large, middle, and small). A vital 

function of the equity markets is to 

support the capital raising function, 

including capital raising by small 

companies. The Commission recognizes 

that small company stocks may trade 

differently than large company stocks 

and requests comment specifically on 

how the market structure performs for 

smaller companies and whether it 

supports the capital raising function for 

them. 

a. Market Quality Metrics 

Given these broad concerns for all 

types of long-term investors and the full 

range of equities, what are useful 

metrics for assessing the performance of 

the current market structure? In the 

past, the Commission and its staff have 

considered a wide variety of metrics, 

most of which have applied to smaller 

orders (such as 10,000 shares or less).54

These metrics have included measures 

of spreads—the difference between the 

prices that buyers pay and sellers 

receive when they are seeking to trade 

immediately at the best prices. Spread 

measures include quoted spreads, 

effective spreads (which reflects 

whether investors receive prices that are 

better than, equal to, or worse than 

quoted spreads), and realized spreads 

(which reflects how investors are 

affected by subsequent price movements 

in a stock). Another often used metric 

has been speed of execution.55

Short-Term Volatility. Spreads and 

speed of execution may not, however, 

give a full picture of execution quality, 

even for the small orders of individual 

investors that generally will be fully 

executed in one transaction (unlike the 

large orders of institutional investors 

that may require many smaller 

executions). For example, short-term 

price volatility may harm individual 

investors if they are persistently unable 

to react to changing prices as fast as 

high frequency traders. As the 

Commission previously has noted, longterm investors may not be in a position 

to assess and take advantage of shortterm price movements.56 Excessive 

short-term volatility may indicate that 

long-term investors, even when they 

initially pay a narrow spread, are being 

harmed by short-term price movements 

that could be many times the amount of 

the spread. 

The Commission has used a variety of 

measures of short-term volatility, 

including variance ratios (for example, 5 

minute return variance to 60 minute 

return variance, 1 day return variance to 

1 week return variance, and 1 day return 

variance to 4 week return variance).57

Variance ratios are useful because they 

focus on short-term volatility that may 

be directly related to market structure 

quality, as opposed to long-term 

volatility that may be much more 

affected by fundamental economic 

forces that are independent of market 

structure quality. Another possible 

metric for assessing whether investors 

are harmed by short-term volatility is 

realized spread, which indicates 

whether prices moved for or against the 

submitter of the order after the order 

was executed. Rule 605, for example, 

measures realized spreads based on 

quotations 5 minutes after the time of 

order execution. 

Finally, the Commission has 

evaluated various measures of the depth 

that is immediately available to fill 

orders. These metrics include fill rates 

for limit orders, quoted size at the inside 

prices, the effect of reserve size and 

undisplayed size at the inside prices or 

better, and quoted depth at prices away 

from the inside. 

Metrics for Smaller Orders. Comment 

is requested on whether these metrics 

that focus on the execution of smaller 

orders continue to be useful. Which 

metrics are most useful in today’s 

market structure? Are there other useful 

metrics not listed above? Are there other 

relevant metrics that reflect how 

individual investors are likely to trade? 

For example, a significant number of 

individual investor orders are submitted 

after regular trading hours when such 

investors have an opportunity to 

evaluate their portfolios. These orders 

typically are executed at opening prices. 

What are the best metrics for assessing 

whether individual investor orders are 

executed fairly and efficiently at the 

opening? Are there other particular 

times or contexts in which retail 

investors often trade and, if so, what are 

the best metrics for determining 

whether they are treated fairly and 

efficiently in those contexts as well? 

Measuring Institutional Investor 

Transaction Costs. Most of the 

Commission’s past analyses of market 

performance have focused on the 

execution of smaller orders (for 

example, less than 10,000 shares), rather 

than attempting to measure the overall 

transaction costs of institutional 

investors to execute large orders (for 

example, greater than 100,000 shares). 

Measuring the transaction costs of 

institutional investors that need to trade 

in large size can be extremely 

complex.58 These large orders often are 

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the costs that are borne by mutual fund investors; 

but it is mindful of the complexities associated with 

identifying, measuring, and accounting for 

transaction costs.’’). 59See, e.g., U.S. Government Accountability 

Office, ‘‘Securities Markets: Decimal Pricing Has 

Contributed to Lower Trading Costs and a More 

Challenging Trading Environment,’’ at 96 (May 

2005) (‘‘We obtained data from three leading firms 

that collect and analyze information about 

institutional investors’ trading costs. These trade 

analytics firms * * * obtain trade data directly 

from institutional investors and brokerage firms and 

calculate trading costs, including market impact 

costs (the extent to which the security changes in 

price after the investor begins trading), typically for 

the purpose of helping investors and traders limit 

costs of trading. These firms also aggregate client 

data so as to approximate total average trading costs 

for all institutional investors. Generally, the client 

base represented in aggregate cost data can be used 

to make generalizations about the institutional 

investor industry.’’); see also Pam Abramowitz, 

Technology Drives Trading Costs, Institutional 

Investor (November 4, 2009) (13th annual survey of 

transaction costs conducted for Institutional 

Investor Magazine by Elkins/McSherry); Elkins 

McSherry LLC, ‘‘Trading Cost Averages and 

Volatility Continued to Decline in 3Q09’’ 

(November 2009) (available at https:// 

www.elkinsmcsherry.com/em/pdfs/Newsletters/ 

Nov_2009_newsletter.pdf); Investment Technology 

Group, Inc., ‘‘ITG Global Trading Cost Review: 2009 

Q2’’ (September 15, 2009) (available at http:// 

www.itg.com/news_events/papers/ 

ITGGlobalTradingCostReview_2009Q2.pdf). 

60A very recent study, for example, examined 

trading activity trends through the end of 2008. 

Chordia, Tarun, Richard Roll, & Avanidar 

Subrahmanyam, Why Has Trading Volume 

Increased? (January 6, 2010). It focused on 

comparisons of pre- and post-decimal trading in 

NYSE-listed stocks (subperiods from 1993–2000 

and 2001–2008). Among the study’s findings are 

that average effective spreads decreased 

significantly (from 10.2 cents to 2.2 cents for small 

trades (<$10,000) and from 10.7 cents to 2.7 cents 

for large trades (>$10,000)), while average depth 

available at the inside bid and offer declined 

significantly (from 11,130 shares to 2797 shares). 

61See infra note 81 and accompanying text. 

62See Chicago Board Options Exchange, ‘‘The 

CBOE Volatility Index—VIX,’’ at 1, 4 (‘‘VIX 

measures 30-day expected volatility of the S&P 500 

Index. The components of VIX are near- and nextterm put and call options, usually in the first and 

second SPX contract months.’’) (available at 

http://www.cboe.com/micro/vix/vixwhite.pdf). 

broken up into smaller child orders and 

executed in a series of transactions. 

Metrics that apply to small order 

executions may miss how well or poorly 

the large order traded overall. Direct 

measures of large order transaction costs 

typically require access to institutional 

order data that is not publicly available. 

In this regard, a few trading analytics 

firms with access to institutional order 

data publish periodic analyses of 

institutional investor transaction 

costs.59 These analyses allow such costs 

to be tracked over time to determine 

whether they are improving or 

worsening. Comment is requested on 

these published analyses generally and 

whether they accurately reflect the 

transaction costs experienced by 

institutional investors. Are there other 

studies or analyses of institutional 

trading costs that the Commission 

should consider? Comment is requested 

in general on other means for assessing 

the transaction costs of institutional 

investors in the current market 

structure. For example, are any of the 

measures of short-term volatility 

discussed above useful for assessing the 

transactions costs of larger orders and, 

if so, how? 

Trend of Market Quality Metrics. With 

respect to all of the metrics that are 

useful for assessing market structure 

performance for long-term investors, the 

Commission is interested in whether 

commenters believe they show 

improvement or worsening in recent 

years. For example, do the relevant 

metrics indicate that market quality has 

improved or worsened over the last ten 

years and the last five years? Have 

markets improved or worsened more 

recently, since January 2009? Which of 

the recent developments in market 

structure do you consider to have the 

greatest effect on market quality? The 

Commission wishes to hear about any 

current regulations that may be 

harming, rather than improving, market 

quality. Specifically, how could any 

current regulations be modified to fit 

more properly with the current market? 

Recognizing that there is no such 

thing as a perfect market structure that 

entirely eliminates transaction costs, the 

Commission believes that an 

understanding of trends is important 

because they provide a useful, 

pragmatic touchstone for assessing the 

goals with respect to market structure 

performance.60

Effect of Broad Economic Forces. The 

Commission notes that many metrics of 

market performance may be affected by 

broad economic forces, such as the 

global financial crisis during the 

Autumn of 2008, that operate 

independently of market structure. 

Periods of high volatility may be 

associated with high intermediation 

costs. This may reflect both 

compensation for risk assumed by 

liquidity providers and the higher 

demand for immediacy by long-term 

investors. How should the effect of these 

economic forces be adjusted for in 

assessing the performance of market 

structure over the last ten years, five 

years, and the last year? For example, 

the CBOE Volatility Index (‘‘VIX’’) 

reached record levels during 2008.61

The VIX is sometimes referred to as the 

‘‘fear index’’ because it measures 

expected volatility of the S&P 500 Index 

over the next 30 calendar days.62 To 

what extent are metrics of market 

structure performance correlated with 

the VIX or other analogous measures of 

volatility? Is the level of the VIX largely 

independent of market structure quality 

or are the level of the VIX and market 

structure quality interdependent? Given 

that the VIX measures expected 

volatility over the next 30 days, how 

important is the VIX to long-term 

investors? 

b. Fairness of Market Structure 

The Commission requests comment 

on whether the current market structure 

is fair for long-term investors. For 

example, the speed of trading has 

increased to the point that the fastest 

traders now measure their latencies in 

microseconds. Is it necessary or 

economically feasible for long-term 

investors to expend resources on the 

very fastest and most highly 

sophisticated systems or otherwise 

obtain access to these systems? If not, 

does the fact that professional traders 

likely always will be able to trade faster 

than long-term investors render the 

equity markets unfair for these 

investors? Or do the different trading 

needs and objectives of long-term 

investors mean that the disparities in 

speed in today’s market structure are 

not significant to the interests of such 

investors? In addition, what standards 

should the Commission apply in 

assessing the fairness of the equity 

markets? For example, is it unfair for 

market participants to obtain a 

competitive advantage by investing in 

technology and human resources that 

enable them to trade more effectively 

and profitably than others? 

Rules 605 and 606 and Other Tools to 

Protect Investor Interests. In assessing 

the fairness of the current market 

structure, the Commission is interested 

in whether long-term investors and their 

brokers have the tools they need to 

protect their own interests in a 

dispersed and complex market 

structure. Do, for example, brokerdealers provide routing tools to their 

agency customers that are as powerful 

and effective as the routing tools they 

may use for their proprietary trading? If 

not, is this difference in access to 

technology unfair to long-term 

investors? Or is a broker-dealer’s ability 

to develop and use more powerful and 

effective trading tools a competitive 

advantage that spurs competition and 

beneficial innovation? 

In addition, comment is requested on 

Rules 605 and 606, which were adopted 

in 2000. Do these rules need to be 

updated and, if so, in what respects? Do 

Rule 605 and Rule 606 reports continue 

to provide useful information for 

investors and their brokers in assessing 

the quality of order execution and 

routing practices? The Commission 

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63See supra note 34 and accompanying text. 

64Orders with a size of 10,000 shares or greater 

are exempt from Rule 605 reporting. See generally 

Staff Legal Bulletin 12R: Frequently Asked 

Questions About Rule 11Ac1–5 (Revised), now 

Regulation NMS Rule 605, Question 26: Exemption 

of Block Orders (available at http://www.sec.gov/ 

divisions/marketreg/disclosure.htm). Rule 606 

requires broker-dealers to report on their routing of 

‘‘non-directed orders,’’ which is defined in Rule 

600(b)(48) as limited to customer orders. ‘‘Customer 

order’’ is defined in Rule 600(b)(18) of Regulation 

NMS to exclude an order in NMS stocks with a 

market value of at least $200,000. See generally 

Staff Legal Bulletin 13A: Frequently Asked 

Questions About Rule 11Ac1–6, now Regulation 

NMS Rule 606, Question 6: Definition of Customer 

Orders—Large Order Exclusion (available at http:// 

www.sec.gov/divisions/marketreg/disclosure.htm). 

65 Intermarket sweep orders are exceptions 

provided in Rule 611(b)(5) and (6) that enable an 

order router to sweep one or more price levels 

simultaneously at multiple trading centers without 

violating trade-through restrictions. As defined in 

Rule 600(b)(30) of Regulation NMS, intermarket 

sweep orders must be routed to execute against the 

full displayed size of any protected quotation that 

otherwise would be traded through by the orders. 

In addition, a single ISO can be routed to the best 

displayed price at the time of routing to help assure 

an execution even if quotations change after the 

order is routed. See Responses to Frequently Asked 

Questions Concerning Rule 611 and Rule 610 of 

Regulation NMS, Question 4.04 (April 4, 2008 

Update) (available at http://www.sec.gov/divisions/ 

marketreg/nmsfaq610-11.htm). 

66An ISO is excluded from a Rule 605 report as 

requiring special handling if it has a limit price that 

is inferior to the NBBO at the time of order receipt. 

All other ISOs should be included in a Rule 605 

report, absent another applicable exclusion. Id. at 

Question 7.06. 

67See, e.g., Jonathan Spicer and Herbert Lash, 

Who’s Afraid of High-Frequency Trading?, 

Reuters.com, December 2, 2009 (available at 

http://www.reuters.com/article/ 

idUSN173583920091202) (‘‘High-frequency trading 

now accounts for 60 percent of total U.S. equity 

volume, and is spreading overseas and into other 

markets.’’); Scott Patterson and Geoffrey Rogow, 

What’s Behind High-Frequency Trading, Wall Street 

Journal, August 1, 2009 (‘‘High frequency trading 

now accounts for more than half of all stock-trading 

volume in the U.S.’’); 

68Market Access Release, supra note 15. 

notes that Rule 606 statistics reveal that 

brokers with significant retail customer 

accounts send the great majority of nondirected marketable orders to OTC 

market makers that internalize 

executions, often pursuant to payment 

for order flow arrangements.63 Do 

individual investors understand and 

pay attention to Rule 605 and 606 

statistics? If not, what market 

participants, if any, make decisions 

based on this data? Are those decisions 

beneficial to individual investors? 

Rule 605 currently requires that the 

speed of execution for immediately 

executable orders (market orders and 

marketable limit orders) be disclosed to 

the tenth of a second. Do investors and 

brokers need more finely tuned 

statistics, such as hundredths or 

thousandths of a second? For nonmarketable limit orders with prices that 

render them not immediately executable 

at the best displayed prices, the shortest 

time category is 0–9 seconds. Would a 

shorter time period be useful for 

investors that use non-marketable limit 

orders? In addition, Rule 605 does not 

include any statistics measuring the 

execution quality of orders submitted 

for execution at opening or closing 

prices. Would such statistics be helpful 

to investors? Rule 605 also does not 

include any statistics measuring 

commission costs of orders, access fees, 

or liquidity rebates. Would such 

statistics be helpful to investors? 

Rule 605 does not require disclosure 

of the amount of time that canceled nonmarketable orders are displayed in the 

order book of trading center before 

cancellation. Considering the high 

cancellation percentage of nonmarketable orders, should Rule 605 

require the disclosure of the average 

time that canceled orders were 

displayed in the order book? 

Conversely, should Rule 605 exclude or 

otherwise distinguish canceled orders 

with a very limited duration (such as 

less than one second)? 

Moreover, Rules 605 and 606 were 

drafted primarily with the interests of 

individual investors in mind and are 

focused on the execution of smaller 

orders. Orders with large sizes, for 

example, are excluded from both 

rules.64 Should the rules be updated to 

address the interests of institutional 

investors in efficiently executing large 

orders (whether in one large trade or 

many smaller trades)? If so, what 

metrics would be useful for institutional 

investors? 

Intermarket sweep orders (‘‘ISOs’’) are 

mostly used by institutional traders.65

Rule 605 disclosures do not report 

regular orders and ISOs separately.66

Would a distinction between ISO and 

non-ISO marketable orders benefit 

individual and/or institutional 

investors? Should any other order types 

be treated differently in Rule 605 

reports? 

More broadly, are there any 

approaches to improving the 

transparency of the order routing and 

order execution practices for 

institutional investors that the 

Commission should consider? For 

example, do institutional investors 

currently have sufficient information 

about the smart order routing services 

and order algorithms offered by their 

brokers? Would a regulatory initiative to 

improve disclosure of these broker 

services be useful and, if so, what type 

of initiative should the Commission 

pursue? 

2. Other Measures 

The Commission requests comment 

on any other measures of market 

structure performance that the public 

believes the Commission should 

consider. For example, are there useful 

metrics for assessing the quality of price 

discovery in equity markets, such as 

how efficiently prices respond to new 

information? In addition, what is the 

best approach for assessing whether the 

secondary markets are appropriately 

supporting the capital-raising function 

for companies of all sizes? 

B. High Frequency Trading 

One of the most significant market 

structure developments in recent years 

is high frequency trading (‘‘HFT’’). The 

term is relatively new and is not yet 

clearly defined. It typically is used to 

refer to professional traders acting in a 

proprietary capacity that engage in 

strategies that generate a large number 

of trades on a daily basis. These traders 

could be organized in a variety of ways, 

including as a proprietary trading firm 

(which may or may not be a registered 

broker-dealer and member of FINRA), as 

the proprietary trading desk of a multiservice broker-dealer, or as a hedge fund 

(all of which are referred to hereinafter 

collectively as a ‘‘proprietary firm’’). 

Other characteristics often attributed to 

proprietary firms engaged in HFT are: 

(1) The use of extraordinarily highspeed and sophisticated computer 

programs for generating, routing, and 

executing orders; (2) use of co-location 

services and individual data feeds 

offered by exchanges and others to 

minimize network and other types of 

latencies; (3) very short time-frames for 

establishing and liquidating positions; 

(4) the submission of numerous orders 

that are cancelled shortly after 

submission; and (5) ending the trading 

day in as close to a flat position as 

possible (that is, not carrying 

significant, unhedged positions overnight). Estimates of HFT volume in the 

equity markets vary widely, though they 

typically are 50% of total volume or 

higher.67 By any measure, HFT is a 

dominant component of the current 

market structure and is likely to affect 

nearly all aspects of its performance. 

The Commission today is proposing 

an initiative to address a discrete HFT 

concern that the Commission already 

has identified. It would address the use 

of various types of arrangements to 

obtain the fastest possible market 

access.68 This concept release is 

intended to request comment on the full 

range of concerns with respect to HFT, 

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69A ‘‘pinging’’ order is an immediate-or-cancel 

order that can be used to search for and access all 

types of undisplayed liquidity, including dark pools 

and undisplayed order types at exchanges and 

ECNs. The trading center that receives an 

immediate-or-cancel order will execute the order 

immediately if it has available liquidity at or better 

than the limit price of the order and otherwise will 

immediately respond to the order with a 

cancellation. As noted in section IV.B.1.d. below, 

there is an important distinction between using 

tools such as pinging orders as part of a normal 

search for liquidity with which to trade and using 

such tools to detect and trade in front of large 

trading interest as part of an ‘‘order anticipation’’ 

trading strategy. 

70Affirmative and negative obligations generally 

are intended to promote market quality. Affirmative 

obligations might include a requirement to 

consistently display high quality, two-sided 

quotations that help dampen price moves, while 

negative obligations might include a restriction on 

‘‘reaching across the market’’ to execute against 

displayed quotations and thereby cause price 

moves. 

71 It is possible for a single firm to provide 

liquidity in a variety of different forms. Some firms, 

for example, may blur the distinction between 

proprietary firms and OTC market makers by both 

trading actively in external trading centers and 

operating trading centers themselves that offer 

customers direct electronic access to their liquidity. 

in contrast to the discrete concerns the 

Commission already has identified. 

The lack of a clear definition of HFT, 

however, complicates the Commission’s 

broader review of market structure 

issues. The lack of clarity may, for 

example, contribute to the widely 

varying estimates of HFT volume in 

today’s equity markets. Although the 

term itself clearly implies a large 

volume of trades, some concerns that 

have been raised about particular 

strategies used by proprietary firms may 

not necessarily involve a large number 

of trades. Indeed, any particular 

proprietary firm may simultaneously be 

employing many different strategies, 

some of which generate a large number 

of trades and some that do not. 

Conceivably, some of these strategies 

may benefit market quality and longterm investors and others could be 

harmful. 

In sum, the types of firms engaged in 

professional trading and the types of 

strategies they employ can vary 

considerably. Rather than attempt any 

single, precise definition of HFT, this 

release will focus on particular 

strategies and tools that may be used by 

proprietary firms and inquire whether 

these strategies and tools raise concerns 

that the Commission should address. 

1. Strategies 

Comment generally is requested on 

the strategies employed by proprietary 

firms in the current market structure. 

What are the most frequently used 

strategies? What are the key features of 

each strategy? What technology tools 

and other market structure components 

(such as exchange fee structures) are 

necessary to implement each strategy? 

Have any of these strategies been a 

competitive response to particular 

market structure components or to 

particular problems or challenges in the 

current market structure? Does 

implementation of a specific strategy 

benefit or harm market structure 

performance and the interests of longterm investors? Is it possible to reliably 

identify harmful strategies through, for 

example, such metrics as adding or 

taking liquidity, or trading with 

(momentum) or against (contrarian) 

prevailing price movements? Are there 

regulatory tools that would address 

harmful strategies while at the same 

time have a minimal impact on 

beneficial strategies? 

Do commenters believe that the 

overall use of harmful strategies by 

proprietary firms is sufficiently 

widespread that the Commission should 

consider a regulatory initiative to 

address the problem? What type of 

regulatory initiative would be most 

effective? For example, should there be 

a minimum requirement on the duration 

of orders (such as one second) before 

they can be cancelled, whether across 

the board, in particular contexts, or 

when used by particular types of 

traders? If so, what would be an 

appropriate time period? Should the use 

of ‘‘pinging’’ orders by all or some 

traders to assess undisplayed liquidity 

be prohibited or restricted in all or some 

contexts? 69

The use of certain strategies by some 

proprietary firms has, in many trading 

centers, largely replaced the role of 

specialists and market makers with 

affirmative and negative obligations.70

Has market quality improved or suffered 

from this development? How important 

are affirmative and negative obligations 

to market quality in today’s market 

structure? Are they more important for 

any particular equity type or during 

certain periods, such as times of stress? 

Should some or all proprietary firms be 

subject to affirmative or negative trading 

obligations that are designed to promote 

market quality and prevent harmful 

conduct? Is there any evidence that 

proprietary firms increase or reduce the 

amount of liquidity they provide to the 

market during times of stress? 

As noted above, the Commission 

wishes to request comment broadly on 

all strategies used by proprietary firms. 

To help present issues for comment, but 

without limiting the broad request, this 

release next will briefly discuss four 

broad types of trading strategies that 

often are associated with proprietary 

firms—passive market making, 

arbitrage, structural, and directional. 

The discussion of directional strategies 

will focus on two directional strategies 

that may pose particular problems for 

long-term investors—order anticipation 

and momentum ignition. The 

Commission notes that many of the 

trading strategies discussed below are 

not new. What is new is the technology 

that allows proprietary firms to better 

identify and execute trading strategies. 

a. Passive Market Making 

Passive market making primarily 

involves the submission of nonmarketable resting orders (bids and 

offers) that provide liquidity to the 

marketplace at specified prices. While 

the proprietary firm engaging in passive 

market making may sometimes take 

liquidity if necessary to liquidate a 

position rapidly, the primary sources of 

profits are from earning the spread by 

buying at the bid and selling at the offer 

and capturing any liquidity rebates 

offered by trading centers to liquiditysupplying orders. If the proprietary firm 

is layering the book with multiple bids 

and offers at different prices and sizes, 

this strategy can generate an enormous 

volume of orders and high cancellation 

rates of 90% of more. The orders also 

may have an extremely short duration 

before they are cancelled if not 

executed, often of a second or less. 

Although proprietary firms that 

employ passive market making 

strategies are a new type of market 

participant, the liquidity providing 

function they perform is not new. 

Professional traders with a permanent 

presence in the marketplace, standing 

ready to buy and sell on an ongoing 

basis, are a perennial type of participant 

in financial markets. Proprietary firms 

largely have replaced more traditional 

types of liquidity providers in the equity 

markets, such as exchange specialists on 

manual trading floors and OTC market 

makers that trade directly with 

customers. In contrast, proprietary firms 

generally are not given special time and 

place privileges in exchange trading 

(nor are they subject to the affirmative 

and negative trading obligations that 

have accompanied such privileges). In 

addition, proprietary firms typically do 

not trade directly with customer order 

flow, but rather trade by submitting 

orders to external trading venues such 

as exchanges and ATSs.71

Proprietary firms participate in the 

marketplace in some ways that are 

similar to both exchange specialists and 

OTC market makers. Indeed, a single 

firm or its affiliates may operate 

simultaneously in all three capacities. 

For example, proprietary traders are like 

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3608 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

72The Commission has found that similar 

conduct is manipulative, in violation of Section 

10(b) of the Exchange Act and Rule 10b–5 

thereunder. See Terrance Yoshikawa, Securities 

Exchange Act Release No. 53731 (April 26, 2006) 

(Commission opinion affirming NASD disciplinary 

action). 73See, e.g., Sanford Grossman & Joseph Stiglitz, 

On the Impossibility of Informationally Efficient 

exchange specialists in the sense that 

they transact most of their volume in 

public markets where their orders will 

trade with all comers. Unlike the 

traditional floor specialists, however, 

they do not have time and place 

advantages, except insofar as their 

sophistication and size enables them to 

employ the fastest, most powerful 

systems for generating, routing, and 

cancelling orders and thereby most take 

advantage of the current highly 

automated market structure (including 

such tools as individual trading center 

data feeds and co-location discussed 

below in section IV.B.2.). Proprietary 

traders are analogous to OTC market 

makers in that they have considerable 

flexibility in trading without significant 

negative or affirmative obligations for 

overall market quality. But unlike an 

OTC market maker, a proprietary firm 

typically does not trade directly with 

customers. The proprietary firm 

therefore may not have ongoing 

relationships with customers that can 

pressure the proprietary trader to 

provide liquidity in tough trading 

conditions or less actively traded stocks. 

Quality of Liquidity. The Commission 

requests comment on the passive market 

making strategies of proprietary firms. 

To what extent do proprietary firms 

engage in the types of strategies 

described above? Do they provide 

valuable liquidity to the market for toptier, large, medium, and small 

capitalization stocks? Has market 

quality improved or worsened as 

traditional types of liquidity providers 

have been replaced by proprietary 

firms? Does the very brief duration of 

many of their orders significantly 

detract from the quality of liquidity in 

the current market structure? For 

example, are their orders accurately 

characterized as phantom liquidity that 

disappears when most needed by longterm investors and other market 

participants? Or, is the collective result 

of many different proprietary firms 

engaging in passive market making a 

relatively stable quoted market in which 

there are many quotation updates 

(primarily updates to size of the NBBO), 

but relatively few changes in the price 

of the NBBO? What types of data are 

most useful in assessing the quality of 

liquidity provided by proprietary firms? 

Liquidity Rebates. One important 

aspect of passive market making is the 

liquidity rebates offered by many 

exchanges and ECNs when resting 

orders that add liquidity are accessed by 

those seeking to trade immediately by 

taking liquidity. The Commission 

requests comment on the volume of 

high frequency trading geared toward 

earning liquidity rebates and on the 

benefits or drawbacks of such trading. 

Are liquidity rebates unfair to long-term 

investors because they necessarily will 

be paid primarily to proprietary firms 

engaging in passive market making 

strategies? Or do they generally benefit 

long-term investors by promoting 

narrower spreads and more immediately 

accessible liquidity? Do liquidity rebates 

reward proprietary firms for any 

particular types of trading that do not 

benefit long-term investors or market 

quality? For example, are there risk-free 

trading strategies driven solely by the 

ability to recoup a rebate that offer little 

or no utility to the marketplace? Are 

these strategies most likely when a 

trading center offers inverted pricing 

and pays a liquidity rebate that is higher 

than its access fee for taking liquidity? 

Does the distribution of consolidated 

market data revenues pursuant to the 

Plans lead to the current trading center 

pricing schedules? If so, would there be 

any benefits to restructuring the Plans 

and, if so, how? 

b. Arbitrage 

An arbitrage strategy seeks to capture 

pricing inefficiencies between related 

products or markets. For example, the 

strategy may seek to identify 

discrepancies between the price of an 

ETF and the underlying basket of stocks 

and buy (sell) the ETF and 

simultaneously sell (buy) the underlying 

basket to capture the price difference. 

Many of the trades necessary to execute 

an arbitrage strategy are likely to involve 

taking liquidity, in contrast to the 

passive market making strategy that 

primarily involves providing liquidity. 

In this respect, it is quite possible for a 

proprietary firm using an arbitrage 

strategy to trade with a proprietary firm 

using a passive market making strategy, 

and for both firms to end up profiting 

from the trade. Arbitrage strategies also 

generally will involve positions that are 

substantially hedged across different 

products or markets, though the hedged 

positions may last for several days or 

more. 

The Commission requests comment 

on arbitrage strategies and whether they 

benefit or harm the interests of longterm investors and market quality in 

general. To what extent do proprietary 

firms engage in the types of strategies 

described above? For example, what is 

the volume of trading attributable to 

arbitrage involving ETFs (both in the 

ETF itself and in any underlying 

securities) and has the increasing 

popularity of ETFs in recent years 

significantly affected volume and 

trading patterns in the equity markets? 

If so, has the impact of ETF trading been 

positive or negative for long-term 

investors and overall market quality? 

In addition, to what extent are 

arbitrage strategies focused on capturing 

pricing differences among the many 

different trading centers in NMS stocks? 

For example, do these arbitrage 

strategies significantly depend on 

latencies among trading center data 

feeds and the consolidated market data 

feeds? Are these strategies beneficial for 

long-term investors and market 

structure quality? If not, how should 

such strategies be addressed? 

c. Structural 

Some proprietary firm strategies may 

exploit structural vulnerabilities in the 

market or in certain market participants. 

For example, by obtaining the fastest 

delivery of market data through colocation arrangements and individual 

trading center data feeds (discussed 

below in section IV.B.2.), proprietary 

firms theoretically could profit by 

identifying market participants who are 

offering executions at stale prices. In 

addition, some market participants offer 

guarantee match features to guarantee 

the NBBO up to a certain limit. A 

proprietary firm could enter a small 

limit order in one part of the market to 

set up a new NBBO, after which the 

same proprietary firm triggers 

guaranteed match trades in the opposite 

direction.72 Are proprietary firms able 

to profitably exploit these structural 

vulnerabilities? To what extent do 

proprietary firms engage in the types of 

strategies described above? What is the 

effect of this trading on market quality? 

d. Directional 

Neither passive market making nor 

arbitrage strategies generally involve a 

proprietary firm taking a significant, 

unhedged position based on an 

anticipation of an intra-day price 

movement of a particular direction. 

There may, however, be a wide variety 

of short-term strategies that anticipate 

such a movement in prices. Some 

‘‘directional’’ strategies may be as 

straightforward as concluding that a 

stock price temporarily has moved away 

from its ‘‘fundamental value’’ and 

establishing a position in anticipation 

that the price will return to such value. 

These speculative strategies often may 

contribute to the quality of price 

discovery in a stock.73

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Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 3609 

Markets, American Economic Review (June 1980) 

(‘‘We propose here a model in which there is an 

equilibrium degree of disequilibrium: prices reflect 

the information of informed individuals 

(arbitrageurs) but only partially, so that those who 

expend resources do receive compensation. How 

informed the price system is depends on the 

number of individuals who are informed, but the 

number of individuals who are informed is itself an 

endogenous variable in the model.’’). 

74See Larry Harris, Trading and Exchanges: 

Market Microstructure for Practitioners (2003) at 

222, 245 (‘‘Harris Treatise’’) (‘‘Order anticipators are 

speculators who try to profit by trading before 

others trade. They make money when they correctly 

anticipate how other traders will affect prices or 

when they can extract option values from the orders 

that other traders offer to the market.’’) (emphasis 

in original). 75Harris Treatise at 251 (emphasis in original). 

The Commission requests comment 

on two types of directional strategies 

that may present serious problems in 

today’s market structure—order 

anticipation and momentum ignition. 

Order Anticipation Strategies. One 

example of an order anticipation 

strategy is when a proprietary firm seeks 

to ascertain the existence of one or more 

large buyers (sellers) in the market and 

to buy (sell) ahead of the large orders 

with the goal of capturing a price 

movement in the direction of the large 

trading interest (a price rise for buyers 

and a price decline for sellers).74 After 

a profitable price movement, the 

proprietary firm then may attempt to 

sell to (buy from) the large buyer (seller) 

or be the counterparty to the large 

buyer’s (seller’s) trading. In addition, 

the proprietary firm may view the 

trading interest of the large buyer 

(seller) as a free option to trade against 

if the price moves contrary to the 

proprietary firm’s position. 

Of course, any proprietary firm or 

other person that violates a duty to a 

large buyer or seller or misappropriates 

their order information and then uses 

the information for its own trading to 

the detriment of the large buyer and 

seller has engaged in misconduct that 

already is prohibited, such as forms of 

front running. Regulatory authorities 

currently examine for, investigate, and 

prosecute this type of misconduct and 

will continue to do so. The Commission 

requests comment on any regulatory 

change that would limit the potential for 

proprietary firms to profit from 

misconduct with respect to the trading 

activities of large buyers and sellers. 

The type of order anticipation strategy 

referred to in this release involves any 

means to ascertain the existence of a 

large buyer (seller) that does not involve 

violation of a duty, misappropriation of 

information, or other misconduct. 

Examples include the employment of 

sophisticated pattern recognition 

software to ascertain from publicly 

available information the existence of a 

large buyer (seller), or the sophisticated 

use of orders to ‘‘ping’’ different market 

centers in an attempt to locate and trade 

in front of large buyers and sellers. 

It is important to recognize the 

distinction between order anticipation 

and a normal search for liquidity to 

implement a trading strategy. When a 

proprietary firm employs an order 

anticipation strategy and detects a large 

buyer (seller), it will first attempt to buy 

(sell), and the proprietary firm largely 

will be indifferent to whether the party 

is a buyer or a seller. In contrast, longterm investors searching for liquidity to 

trade against will be seeking specifically 

either to establish a position or to 

liquidate a position. If buying, the longterm investor will attempt to find large 

selling interest and buy from it or, if 

selling, will attempt to find large buying 

interest and sell to it. Both the long-term 

investor and the large buyer (seller) 

benefit from the liquidity seeking 

strategy, in contrast to the order 

anticipation strategy where the large 

buyer (seller) is harmed when the 

proprietary firm initially trades in front 

of the large buyer (seller). 

Order anticipation is a not a new 

strategy. Indeed, a 2003 treatise on 

market structure described order 

anticipation as follows: ‘‘Order 

anticipators are parasitic traders. They 

profit only when they can prey on other 

traders. They do not make prices more 

informative, and they do not make 

markets more liquid. * * * Large 

traders are especially vulnerable to 

order anticipators.’’75 An important 

issue for purposes of this release is 

whether the current market structure 

and the availability of sophisticated, 

high-speed trading tools enable 

proprietary firms to engage in order 

anticipation strategies on a greater scale 

than in the past. Alternatively, is it 

possible that the widespread use of 

high-speed trading tools by a variety of 

proprietary firms and institutions limits 

the ability of market participants to 

engage in profitable order anticipation 

strategies? Does your answer depend on 

whether top tier, large, medium, or 

small market capitalization stocks are 

considered? 

The Commission requests comment 

on all aspects of order anticipation 

strategies. Do commenters believe that 

order anticipation significantly detracts 

from market quality and harms 

institutional investors (for example, 

does it represent a substantial transfer of 

wealth from the individuals represented 

by institutional investors to proprietary 

firms)? Do commenters believe that 

order anticipation has become more or 

less prevalent in recent years? If more 

prevalent, is the use of proprietary firm 

strategies an important factor in this 

development? If commenters believe 

order anticipation has become more 

prevalent, are there ways to distinguish 

order anticipation from other beneficial 

trading strategies? Are there regulatory 

tools that would effectively address 

concerns about order anticipation, 

without unintentionally interfering with 

other strategies that may be beneficial 

for long-term investors and market 

quality? 

Momentum Ignition Strategies. 

Another type of directional strategy that 

may raise concerns in the current 

market structure is momentum ignition. 

With this strategy, the proprietary firm 

may initiate a series of orders and trades 

(along with perhaps spreading false 

rumors in the marketplace) in an 

attempt to ignite a rapid price move 

either up or down. For example, the 

trader may intend that the rapid 

submission and cancellation of many 

orders, along with the execution of some 

trades, will ‘‘spoof’’ the algorithms of 

other traders into action and cause them 

to buy (sell) more aggressively. Or the 

trader may intend to trigger standing 

stop loss orders that would help cause 

a price decline. By establishing a 

position early, the proprietary firm will 

attempt to profit by subsequently 

liquidating the position if successful in 

igniting a price movement. This type of 

strategy may be most harmful in less 

actively traded stocks, which may 

receive little analyst or other public 

attention and be vulnerable to price 

movements sparked by a relatively 

small amount of volume. 

Of course, any market participant that 

manipulates the market has engaged in 

misconduct that already is prohibited. 

The Commission and other regulatory 

authorities already employ their 

examination and enforcement resources 

to detect violations and bring 

appropriate proceedings against the 

perpetrators. This concept release is 

focused on the issue of whether 

additional regulatory tools are needed to 

address illegal practices, as well as any 

other practices associated with 

momentum ignition strategies. For 

example, while spreading false rumors 

to cause price moves is illegal, such 

rumors can be hard to find (if not spread 

in writing), and it can be difficult to 

ascertain the identity of those who 

spread rumors to cause price moves. 

The Commission requests comment 

on whether momentum ignition 

strategies are a significant problem in 

the current market structure. To what 

extent do proprietary firms engage in 

the types of strategies described above? 

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3610 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

76Section 3(a)(27) of the Exchange Act defines 

‘‘rules of an exchange’’ as, among other things, a 

stated policy, practice, or interpretation of the 

exchange that the Commission has by rule 

determined to be rules of the exchange. Rule 19b4(b) under the Exchange Act defines ‘‘stated policy, 

practice, or interpretation’’ to mean, in part, [a]ny 

material aspect of the operation of the facilities of 

the self-regulatory organization.’’ The Commission 

views co-location services as being a material aspect 

of the operation of the facilities of an exchange. 

77Section 6(b)(4) and (5) of the Exchange Act. 

Does, for example, the speed of trading 

and ability to generate a large amount of 

orders across multiple trading centers 

render this type of strategy more of a 

problem today? If momentum ignition 

strategies have caused harm, are there 

objective indicia that would reliably 

identify problematic strategies? Are 

there regulatory tools (beyond the 

currently applicable anti-fraud and antimanipulation provisions) that would 

effectively reduce or eliminate the use 

of momentum ignition strategies while 

at the same time have a minimal impact 

on other strategies that are beneficial to 

long-term investors and market quality? 

2. Tools 

This section will focus on two 

important tools that often are used by 

proprietary firms to implement their 

short-term trading strategies—colocation and trading center data feeds. 

a. Co-Location 

Many proprietary firm strategies are 

highly dependent upon speed—speed of 

market data delivery from trading center 

servers to servers of the proprietary 

firm; speed of decision processing of 

trading engines of the proprietary firm; 

speed of access to trading center servers 

by servers of the proprietary firm; and 

speed of order execution and response 

by trading centers. Speed matters both 

in the absolute sense of achieving very 

small latencies and in the relative sense 

of being faster than competitors, even if 

only by a microsecond. Co-location is 

one means to save micro-seconds of 

latency. 

Co-location is a service offered by 

trading centers that operate their own 

data centers and by third parties that 

host the matching engines of trading 

centers. The trading center or third 

party rents rack space to market 

participants that enables them to place 

their servers in close physical proximity 

to a trading center’s matching engine. 

Co-location helps minimize network 

and other types of latencies between the 

matching engine of trading centers and 

the servers of market participants. 

The Commission believes that the colocation services offered by registered 

exchanges are subject to the Exchange 

Act. Exchanges that intend to offer colocation services must file proposed rule 

changes and receive approval of such 

rule changes in advance of offering the 

services to customers.76 The terms of colocation services must not be unfairly 

discriminatory, and the fees must be 

equitably allocated and reasonable.77

Fairness of Co-Location Services. 

Beyond these basic statutory 

requirements, the Commission broadly 

requests comment on co-location and 

whether it benefits or harms long-term 

investors and market quality. For 

example, does co-location provide 

proprietary firms an unfair advantage 

because they generally will have greater 

resources and sophistication to take 

advantage of co-location services than 

other market participants, including 

long-term investors? If so, specify how 

this disparity harms long-term investors. 

Conversely, does co-location offer 

benefits to long-term investors? For 

example, do co-location services enable 

liquidity providers to operate more 

efficiently and thereby increase the 

quality of liquidity they provide to the 

markets? Please quantify any harm or 

benefits, if possible. Is it fair for some 

market participants to pay to obtain 

better access to the markets than is 

available to those not in a position to 

pay for or otherwise obtain co-location 

services? Aside from physical 

proximity, are there other aspects of 

services offered by exchanges to colocation participants that may lead to 

unfair access concerns? 

In addition, are brokers generally able 

to obtain and use co-location services on 

behalf of their customers? If so, are longterm investors harmed by not being able 

to use co-location directly? Are colocation fees so high that they 

effectively create a barrier for smaller 

firms? Do commenters believe that colocation services fundamentally differ 

from other respects in which market 

participants can obtain latency 

advantages, particularly if co-location 

services are not in short supply and are 

available to anyone on terms that are 

fair and reasonable and not 

unreasonably discriminatory? 

If commenters believe that co-location 

services create unfair access to trading, 

should the Commission prohibit or 

restrict exchanges, and other trading 

centers, such as ATSs, from offering colocation services? If exchanges and 

other trading centers were no longer 

permitted to provide the services, would 

third parties, who may be outside the 

Commission’s regulatory authority, be 

encouraged to obtain space close to an 

exchange’s data center and rent such 

space to market participants? 

Alternatively, could exchanges and 

other trading centers batch process all 

orders each second and, if so, what 

would be the effect of such a policy on 

market quality? 

The Commission also requests 

comment on exchanges and other 

trading centers that place their trading 

engines in data facilities operated by 

third parties. Such parties are not 

regulated entities subject to the access 

and other requirements of the Exchange 

Act and Commission rules. Could this 

disparity create competitive 

disadvantages among trading centers? 

Should the third party data centers be 

considered facilities of the exchange or 

trading center? Alternatively, should the 

Commission require trading centers to 

obtain contractual commitments from 

third parties to provide any co-location 

services on terms consistent with the 

Exchange Act and Commission rules? 

With respect to those market 

participants that purchase co-location 

services, should exchanges and other 

trading centers be subject to specific 

requirements to help assure that all 

participants are treated in a manner that 

is not unfairly discriminatory? Latency 

can arise from a variety of sources, such 

as cable length and capacity, processing 

capabilities, and queuing. Is it possible 

for trading centers to guarantee equal 

latency across all market participants 

that use comparable co-location 

services? Should the Commission 

require latency transparency—the 

disclosure of information that would 

enable market participants to make 

informed decisions about their speed of 

access to an exchange or other trading 

center? Such disclosures could include, 

for example, periodic public reports on 

the latencies of the fastest market 

participants (on an anonymous basis), as 

well as private reports directly to 

individual market participants of their 

specific latencies. If latency disclosure 

should be required, what information 

should be disclosed and in what 

manner? 

Affirmative or Negative Trading 

Obligations. Finally, the Commission 

requests comment on whether all or 

some market participants (such as 

proprietary firms) that obtain colocation services should be subject to 

any affirmative or negative obligations 

with respect to their trading behavior. 

Such obligations historically were 

applied to exchange specialists that 

enjoyed a unique time and place 

advantage on the floor of an exchange. 

Are co-location services analogous to 

the specialist advantages? Or does the 

wider availability of co-location services 

to many market participants distinguish 

co-located market participants from 

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Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 3611 

78Regulation NMS Release, 70 FR at 37567. 

79See supra note 45 and accompanying text. 

80A broker-dealer conducting a general securities 

business that is required to register with the 

Commission under Section 15(b) of the Exchange 

Act must comply with the Commission’s net capital 

rule, Exchange Act Rule 15c3–1. Under Rule 15c3– 

1, broker-dealers are required to maintain, at all 

times, a minimum amount of net capital. This 

means that firms must be able to demonstrate that 

they have sufficient net capital for intra-day 

positions. In addition, if a broker-dealer is engaged 

in proprietary trading on margin, it may be subject 

to certain provisions of Regulation T, 12 CFR 220.1, 

et seq., as well as SRO margin rules applicable to 

broker-dealers. See, e.g., NYSE Rule 431(e)(5) 

(specialists’ and market makers’ accounts), (e)(6)(A) 

(broker/dealer accounts), (e)(6)(B) (Joint Back Office 

Arrangements) and NASD Rule 2520(e)(5), (e)(6)(A) 

and (e)(6)(B). Moreover, high frequency traders who 

are not broker-dealers must comply with the SRO 

day trading rules if they meet the definition of 

‘‘pattern day trader.’’ NYSE Rule 431(f)(8)(B) and 

NASD Rule 2520(f)(8)(B). 

81See, e.g., NYSE Euronext, Consolidated Volume 

in NYSE Listed Issues 2000–2009 (available at 

http://www.nyxdata.com/nysedata/NYSE/ 

FactsFigures/tabid/115/Default.aspx) (consolidated 

average daily volume in NYSE-listed stocks reached 

a then-record high of 7.1 billion shares in October 

2008, compared to an average of 3.4 billion shares 

for the year 2007); Pam Abramowitz, Technology 

Drives Trading Costs, Institutional Investor 

(November 4, 2009) (‘‘[V]olatility has fallen 

substantially over the past six to nine months as 

equity markets have rallied. * * * [The] VIX, 

which hit an all-time high of 89.53 in October 2008, 

averaged 25.49 in the third quarter of 2009, close 

to its precrisis historical average of 20.3’’); Tom 

Lauricella, Volatility Requires New Strategies, Wall 

Street Journal (October 20, 2008) (‘‘The stock 

market’s collapse and unprecedented daily price 

swings are forcing investors of all stripes to rethink 

their strategies, all the while looking for any hints 

that the financial markets will stabilize. * * * So 

far this month, there have been 10 days where the 

Dow Jones Industrial Average ricocheted in a range 

of more than 5% * * *’’). 

exchange specialists? If all or some colocation participants should be subject 

to trading obligations, what should be 

the nature of such obligations? For 

example, should some or all co-location 

participants be prohibited from 

aggressively taking liquidity and moving 

prices always or only under specified 

circumstances? If only under specified 

circumstances, what should those 

include or exclude? Should some or all 

co-location participants ever be required 

to provide liquidity on an ongoing basis 

or in certain contexts? 

b. Trading Center Data Feeds 

Another important tool widely used 

by proprietary firms is the individual 

data feeds offered by many exchanges 

and ECNs. As discussed in section 

III.B.1. above, the consolidated data 

feeds include the best-priced quotations 

of all exchanges and certain ATSs and 

all reported trades. The individual data 

feeds of exchanges and ECNs generally 

will include their own best-priced 

quotations and trades, as well as other 

information, such as inferior-priced 

orders included in their depth-of-book. 

When it adopted Regulation NMS in 

2005, the Commission did not require 

exchanges, ATSs, and other brokerdealers to delay their individual data 

feeds to synchronize with the 

distribution of consolidated data, but 

prohibited them from independently 

transmitting their own data any sooner 

than they transmitted the data to the 

plan processors.78

Given the extra step required for SROs 

to transmit market data to plan 

processors, and for plan processors to 

consolidate the information and 

distribute it the public, the information 

in the individual data feeds of 

exchanges and ECNs generally reaches 

market participants faster than the same 

information in the consolidated data 

feeds. The extent of the latency 

depends, among other things, on the 

speed of the systems used by the plan 

processors to transmit and process 

consolidated data and on the distances 

between the trading centers, the plan 

processors, and the recipients. As noted 

above,79 the Commission understands 

that the average latency of plan 

processors for the consolidated data 

feeds generally is less than 10 

milliseconds. This latency captures the 

difference in time between receipt of 

data by the plan processors from the 

SROs and distribution of the data by the 

plan processors to the public. 

Latency of Consolidated Data. The 

Commission requests comment on all 

aspects of the latency between 

consolidated data feeds and individual 

trading center data feeds. What have 

market participants experienced in 

terms of the degree of latency between 

trading center and consolidated data? Is 

the latency as small as possible given 

the necessity of the consolidation 

function, or could plan processor 

systems be improved to significantly 

reduce the latency from current levels, 

while still retaining the high level of 

reliability required of plan processors? 

More broadly, is the existence of any 

latency, or the disparity in information 

transmitted, fair to investors or other 

market participants that rely on the 

consolidated market data feeds and do 

not use individual trading center data 

feeds? If so, should the unfairness be 

addressed by a requirement that trading 

center data be delayed for a sufficient 

period of time to assure that 

consolidated data reaches users first? 

Would such a mandated delay 

adequately address unfairness? Would a 

mandatory delay seriously detract from 

the efficiency of trading and harm longterm investors and market quality? 

Should the Commission require that 

additional information be included in 

the consolidated market data feeds? 

Odd-Lot Transactions. Finally, the 

consolidated trade data currently does 

not include reports of odd lot orders or 

odd lot transactions (transactions with 

sizes of less than 1 round lot, which 

generally is 100 shares). It appears that 

a substantial volume of trading 

(approximately 4%) may be attributable 

to odd lot transactions. Why is the 

volume of odd lots so high? Should the 

Commission be concerned about this 

level of activity not appearing in the 

consolidated trade data? Has there been 

an increase in the volume of odd lots 

recently? If so, why? Do market 

participants have incentives to 

strategically trade in odd lots to 

circumvent the trade disclosure or other 

regulatory requirements? Would these 

trades be important for price discovery 

if they were included in the 

consolidated trade data? Should these 

transactions be required to be reported 

in the consolidated trade data? Why? 

3. Systemic Risks 

Stepping back from the particular 

strategies and tools used by proprietary 

traders, comment is requested more 

broadly on whether HFT poses 

significant risks to the integrity of the 

current equity market structure. For 

example, do the high speed and 

enormous message traffic of automated 

trading systems threaten the integrity of 

trading center operations? Also, many 

proprietary firms potentially could 

engage in similar or connected trading 

strategies that, if such strategies 

generated significant losses at the same 

time, could cause many proprietary 

firms to become financially distressed 

and lead to large fluctuations in market 

prices. To the extent that proprietary 

firms obtain financing for their trading 

activity from broker-dealers or other 

types of financial institutions, the 

significant losses of many proprietary 

firms at the same time also could lead 

to more widespread financial distress.80

Comment also is requested on 

whether proprietary traders help 

promote market integrity by providing 

an important source of liquidity in 

difficult trading conditions. The 

Commission notes that, from an 

operational standpoint, the equity 

markets performed well during the 

world-wide financial crisis in the 

Autumn of 2008 when volume and 

volatility spiked to record highs.81

Unlike some financial crises in the past, 

the equity markets continued to operate 

smoothly and participants generally 

were able to trade at currently displayed 

prices (though most investors likely 

suffered significant losses from the 

general decline of market prices). Does 

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82See Non-Public Trading Interest Release, 74 FR 

at 61209–61210. 

83As noted in section III.A.2. above, many brokerdealers may submit orders to exchanges or ECNs, 

which then are included in the consolidated 

quotation data. The internalized executions of 

broker-dealers, however, primarily reflect liquidity 

that is not included in the consolidated quotation 

data and are appropriately classified as undisplayed 

liquidity. 

the 2008 experience indicate that 

systemic risk is appropriately 

minimized in the current market 

structure? If not, what further steps 

should the Commission take to address 

systemic risk? Should, for example, all 

proprietary firms be required to register 

as broker-dealers and become members 

of FINRA to help assure that their 

operations are subject to full regulatory 

oversight? Moreover, does the current 

regulatory regime adequately address 

the particular concerns raised by 

proprietary firms and their trading 

strategies and tools? 

C. Undisplayed Liquidity 

As noted in section III.A. above, 

undisplayed liquidity is trading interest 

that is available for execution at a 

trading center, but is not included in the 

consolidated quotation data that is 

widely disseminated to the public. 

Undisplayed liquidity also is commonly 

known as ‘‘dark’’ liquidity. The 

Commission recently published 

proposals to address certain practices 

with respect to undisplayed liquidity. 

These include the use of actionable 

indications of interest, or ‘‘IOIs,’’ to 

attract order flow, the lowering of the 

trading volume threshold that would 

trigger ATS order display obligations, 

and the real-time disclosure of the 

identity of ATSs on the public reports 

of their executed trades.82 This release 

is intended to request comment on a 

wide range of issues with respect to 

undisplayed liquidity in all of its forms. 

Undisplayed liquidity in general is 

not a new phenomenon. Market 

participants that need to trade in large 

size, such as institutional investors, 

always have faced a difficult trading 

dilemma. On the one hand, if they 

prematurely reveal the full extent of 

their large trading interest to the market, 

then market prices are likely to run 

away from them (a price rise for those 

seeking to buy and a price decline for 

those seeking to sell), which would 

greatly increase their transaction costs 

and reduce their overall investment 

returns. On the other hand, if an 

institutional investor that wants to trade 

in large size does nothing, then it will 

not trade at all. Finding effective and 

innovative ways to trade in large size 

with minimized transaction costs is a 

perennial challenge for institutional 

investors, the brokers that represent 

their orders in the marketplace, and the 

trading centers that seek to execute their 

orders. 

A primary source of dark liquidity for 

many years was found on the manual 

trading floors of exchanges. The floor 

brokers ‘‘worked’’ the large orders of 

their customers by executing such 

orders in a number of smaller 

transactions without revealing to 

potential counterparties the total size of 

the order. One consequence of the 

decline in market share of the NYSE 

floor in recent years is that this 

historically large undisplayed liquidity 

pool in NYSE-listed stocks appears to 

have largely migrated to other types of 

venues. As discussed in section III.A.3. 

above, a recent form of undisplayed 

liquidity is the dark pool—an ATS that 

does not display quotations in the 

consolidated quotation data. Other 

sources of undisplayed liquidity are 

broker-dealers that internalize orders 83

and undisplayed order types of 

exchanges and ECNs. 

Although they offer liquidity that is 

not included in the consolidated 

quotation data, dark pools and OTC 

market makers generally trade with 

reference to the best displayed 

quotations and execute orders at prices 

that are equal to or better than the 

NBBO. Indeed, all dark pools and OTC 

market makers are covered by the tradethrough restrictions of Rule 611 and, 

subject to limited exceptions, cannot 

execute transactions at prices that are 

inferior to the best displayed prices. 

The Commission requests comment 

on all forms of undisplayed liquidity in 

the current market structure. It 

particularly wants to present three 

issues for comment—the effect of 

undisplayed liquidity on order 

execution quality, the effect of 

undisplayed liquidity on public price 

discovery, and fair access to sources of 

undisplayed liquidity. 

1. Order Execution Quality 

It appears that a significant percentage 

of the orders of individual investors are 

executed at OTC market makers, and 

that a significant percentage of the 

orders of institutional investors are 

executed in dark pools. Comment is 

requested on the order execution quality 

provided to these long-term investors. 

Given the strong Exchange Act policy 

preference in favor of price transparency 

and displayed markets, do dark pools 

and OTC market makers offer 

substantial advantages in order 

execution quality to long-term 

investors? If so, do these advantages 

justify the diversion of a large 

percentage of investor order flow away 

from the displayed markets that play a 

more prominent role in providing 

public price discovery? If investors were 

limited in their ability to use 

undisplayed liquidity, how would 

trading behavior change, if at all? What 

types of activity might evolve to replace 

undisplayed liquidity if its use were 

constrained? 

Individual Investors. Liquidity 

providers generally consider the orders 

of individual investors very attractive to 

trade with because such investors are 

presumed on average to not be as 

informed about short-term price 

movements as are professional traders. 

Do individual investor orders receive 

high quality executions when routed to 

OTC market makers? For example, does 

competition among OTC market makers 

to attract order flow lead to significantly 

better prices for individual investor 

orders than they could obtain in the 

public markets? Do OTC market makers 

charge access fees comparable to those 

charged by public markets? Does the 

existence of payment for order flow 

arrangements between routing brokers 

and OTC market makers (and 

internalization arrangements when the 

routing broker and OTC market maker 

are affiliated) detract from the quality of 

executions for investor orders? If more 

individual investor orders were routed 

to public markets, would it promote 

quote competition in the public 

markets, lead to narrower spreads, and 

ultimately improve order execution 

quality for individual investors beyond 

current levels? Finally, are a significant 

number of individual investor orders 

executed in dark pools and, if so, what 

is the execution quality for these orders? 

Institutional Investors. An important 

objective of many dark pools is to offer 

institutional investors an efficient venue 

in which to trade in large size (often by 

splitting a large parent order into many 

child orders) with minimized market 

impact. To what extent do dark pools 

meet this objective of improving 

execution quality for the large orders of 

institutional investors? Does execution 

quality vary across different types of 

dark pools and, if so, which types? If so, 

does this difference depend on the 

characteristics of particular securities 

(such as market capitalization and 

security price)? 

As noted above in section IV.C., many 

dark pools execute orders with reference 

to the displayed prices in public 

markets. Does this reference pricing 

create opportunities for institutional 

investors to be treated unfairly by 

improper behavior (such as placing a 

small order to change the NBBO for a 

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84The Commission has found that similar 

conduct is manipulative. See supra note 72. 

85See supra note 21 and accompanying text 

(estimated 25.4% of share volume in NMS stocks 

executed in undisplayed trading centers in 

September 2009). 86See supra notes 8 and 10 and accompanying 

text. 

87See Regulation NMS Release, 70 FR at 37529– 

37530 (discussion of decision not to adopt a 

‘‘Voluntary Depth Alternative’’ that would have 

provided trade-through protection to depth-of-book 

quotations that a market voluntarily included in the 

consolidated quotation data). 

very short period and quickly 

submitting orders to dark pools for 

execution at prices affected by the new 

NBBO)? 84 If so, to what extent does 

gaming occur? Do all types of dark pools 

employ anti-gaming tools? How 

effective are such tools? 

Finally, are institutional investors 

able to trade more efficiently using 

undisplayed liquidity at dark pools and 

broker-dealers than they are using the 

undisplayed liquidity at exchanges and 

ECNs? What are the advantages and 

disadvantages of each form of 

undisplayed liquidity? If the use of 

undisplayed liquidity at dark pools and 

broker-dealers were curtailed in any 

way, could institutional investors adjust 

by using undisplayed liquidity on 

exchanges and ECNs without incurring 

higher transaction costs? 

2. Public Price Discovery 

Comment is requested on whether the 

trading volume of undisplayed liquidity 

has reached a sufficiently significant 

level that it has detracted from the 

quality of public price discovery and 

execution quality. For example, has the 

level of undisplayed liquidity led to 

increased spreads, reduced depth, or 

increased short-term volatility in the 

displayed trading centers? If so, has 

such harm to public price discovery led 

to a general worsening of execution 

quality for investors in undisplayed 

markets that execute trades with 

reference to prices in the displayed 

markets? 

It appears that a significant percentage 

of the orders of long-term investors are 

executed either in dark pools or at OTC 

market makers, while a large percentage 

of the trading volume in displayed 

trading centers is attributable to 

proprietary firms executing short-term 

trading strategies. Has there in fact been 

an increase in the proportion of longterm investor orders executed in 

undisplayed trading centers? If so, what 

is the reason for this tendency and is the 

practice beneficial or harmful to longterm investors and to market quality? 

With respect to undisplayed order types 

on exchanges and ECNs, do commenters 

believe that these order types raise 

similar concerns about public price 

discovery as undisplayed liquidity at 

dark pools and broker-dealers? 

If commenters do not believe the 

current level of undisplayed liquidity 

has detracted from the quality of public 

price discovery, is there any level at 

which they believe the Commission 

should be concerned? In this regard, it 

appears that the overall percentage of 

trading volume between undisplayed 

trading centers and displayed trading 

centers has remained fairly steady for 

many years between 70% and 80%.85

Does this overall percentage accurately 

reflect the effect of undisplayed 

liquidity on public price discovery or 

does it mask potentially important 

changes in the routing of underlying 

types of order flow? For example, the 

NYSE captures a smaller percentage of 

trading in NYSE-listed stocks, while the 

overall volume in NYSE stocks has 

increased dramatically.86 Should this 

change in market share be interpreted to 

mean that a greater percentage of longterm individual investor and long-term 

institutional investor order flow in 

NYSE-listed stocks has shifted to dark 

pools and OTC market makers, while 

the public markets are executing an 

expanding volume of trading that is 

primarily attributable to HFT strategies? 

If so, does this underlying shift in order 

flow affect the quality of public price 

discovery in NYSE-listed stocks and 

what are the reasons for this 

development? Do similar order flow 

patterns affect the quality of public 

price discovery in stocks listed on other 

exchanges as well? 

Trade-At Rule. If commenters believe 

that the quality of public price 

discovery has been harmed by 

undisplayed liquidity, are there 

regulatory tools that the Commission 

should consider to address the problem? 

Should the Commission consider a 

‘‘trade-at’’ rule that would prohibit any 

trading center from executing a trade at 

the price of the NBBO unless the trading 

center was displaying that price at the 

time it received the incoming contraside order? Under this type of rule, for 

example, a trading center that was not 

displaying the NBBO at the time it 

received an incoming marketable order 

could either: (1) Execute the order with 

significant price improvement (such as 

the minimum allowable quoting 

increment (generally one cent)); or (2) 

route ISOs to full displayed size of 

NBBO quotations and then execute the 

balance of the order at the NBBO price. 

The Commission requests comment 

on all aspects of a trade-at rule. Would 

it help promote pre-trade public price 

discovery by preventing the diversion of 

a significant volume of highly valuable 

marketable order flow away from the 

displayed trading centers and to 

undisplayed trading centers? If so, to 

what extent would the increased routing 

of this marketable order flow to 

displayed trading centers create 

significantly greater incentives for 

market participants to display 

quotations in greater size or with more 

aggressive prices? 

Given the order-routing and trading 

system technologies currently in place 

to prevent trade-throughs, would it be 

feasible for market participants to 

comply with a trade-at rule at 

reasonable cost? Should a trade-at rule 

apply to all types of trading centers (e.g., 

exchanges, ECNs, OTC market makers, 

and dark pools) or only to some of 

them? If so, which ones and why? In 

addition, if the Commission were to 

consider such a rule, how should it treat 

the issue of displayed markets that 

charge access fees? Should it, for 

example, condition the ‘‘trade-at’’ 

protection of a displayed quotation on 

there being no access fee or an access 

fee that is much smaller than the current 

0.3 cent per share cap in Rule 610(c) of 

Regulation NMS? 

Depth-of-Book Protection. Rule 611 

currently provides trade-through 

protection only to quotations that reflect 

the best, ‘‘top-of-book,’’ prices of a 

trading center.87 Should Rule 611 be 

expanded to provide trade-through 

protection to the displayed ‘‘depth-ofbook’’ quotations of a trading center? 

Would depth-of-book protection 

significantly promote the greater display 

of trading interest? Is depth-of-book 

protection feasible under current trading 

conditions and could the securities 

industry implement depth-of-book 

protection at reasonable cost? 

Low-Priced Stocks. There may be 

greater incentives for broker-dealer 

internalization in low-priced stocks 

than in higher priced stocks. In lowpriced stocks, the minimum one cent 

per share pricing increment of Rule 612 

of Regulation NMS is much larger on a 

percentage basis than it is in higherpriced stocks. For example, a one cent 

spread in a $20 stock is 5 basis points, 

while a one cent spread in a $2 stock is 

50 basis points—10 times as wide on a 

percentage basis. Does the larger 

percentage spread in low-price stocks 

lead to greater internalization by OTC 

market makers or more trading volume 

in dark pools? If so, why? Should the 

Commission consider reducing the 

minimum pricing increment in Rule 612 

for lower priced stocks? 

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3614 Federal Register / Vol. 75, No. 13 / Thursday, January 21, 2010 / Proposed Rules 

88The Commission understands that ECNs, 

unlike most dark pools, generally offer wide access 

to their services, including undisplayed liquidity, 

even if not subject to the fair access requirement of 

Rule 301(b)(5) of Regulation ATS. 

89See, e.g., section IV.B.1.d. supra (discussion of 

order anticipation strategies that seek to ascertain 

the existence of large buyers and sellers). 90 Data compiled from Forms ATS submitted to 

Commission for 3d quarter 2009. 

3. Fair Access and Regulation of ATSs 

A significant difference between the 

undisplayed liquidity offered by 

exchanges and the undisplayed 

liquidity offered by dark pools and 

broker-dealers is the extent of access 

they allow to such liquidity. As noted 

in section III.B.3. above, registered 

exchanges are required to offer broad 

access to broker-dealers. As ATSs that 

are exempt from exchange registration, 

dark pools are not required to provide 

fair access unless they reach a 5% 

trading volume threshold in a stock, 

which none currently do.88 Brokerdealers that internalize also are not 

subject to fair access requirements. As a 

result, access to the undisplayed 

liquidity of dark pools and brokerdealers is determined primarily by 

private negotiation. 

The Commission requests comment 

on whether trading centers offering 

undisplayed liquidity are subject to 

appropriate regulatory requirements for 

the type of business they conduct. For 

example, should the trading volume 

threshold in Regulation ATS that 

triggers the fair access requirement be 

lowered from its current 5%? If so, what 

is the appropriate threshold? 

If an ATS exceeds the trading volume 

threshold, Regulation ATS requires that 

the ATS have access standards that do 

not unreasonably prohibit or limit any 

person in respect to access services, and 

prohibits the ATS from applying such 

standards in an unfair or discriminatory 

manner. Do commenters believe that all 

types of dark pools can comply with 

this fair access requirement, yet still 

achieve the objective of enabling 

institutional investors to trade in large 

size with minimized price impact? Can 

dark pool restrictions designed to 

prevent predatory trading behavior 89 be 

drafted in an objective fashion that 

would comply with the Regulation ATS 

fair access requirement? 

The majority of dark pool volume is 

executed in ATSs that are sponsored by 

multi-service broker-dealers.90 Can a 

broker-dealer sponsored dark pool apply 

objective fair access standards 

reasonably to prevent predatory trading, 

but without using such standards as a 

pretext to discriminate based on the 

competitive self interest of the 

sponsoring broker? 

Finally, do investors have sufficient 

information about dark pools to make 

informed decisions about whether in 

fact they should seek access to dark 

pools? Should dark pools be required to 

provide improved transparency on their 

trading services and the nature of their 

participants? If so, what disclosure 

should be required and in what manner 

should ATSs provide such disclosures? 

More broadly, are there any other 

aspects of ATS regulation that should be 

enhanced for dark pools or for all ATSs, 

including ECNs? For example, do ATSs 

contribute appropriately to the costs of 

consolidated market surveillance? 

Currently, FINRA is the SRO for ATSs, 

and ATSs must pay the applicable 

FINRA regulatory fees. Do these FINRA 

fees adequately reflect the significant 

volume currently executed by ATSs? 

Should ATSs be required to contribute 

more directly to the cost of market 

surveillance? Finally, are there any 

ways in which Regulation ATS should 

be modified or supplemented to 

appropriately reflect the significant role 

of ATSs in the current market structure? 

D. General Request for Comments 

The Commission requests and 

encourages all interested persons to 

submit their views on any aspect of the 

current equity market structure. While 

this release was intended to present 

particular issues for comment, it was 

not intended in any way to limit the 

scope of comments or issues to be 

considered. In addition, the views of 

commenters are of greater assistance 

when they are accompanied by 

supporting data and analysis. 

Dated: January 14, 2010. 

By the Commission. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. 2010–1045 Filed 1–20–10; 8:45 am] 

BILLING CODE 8011–01–P 

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