[Federal Register Volume 79, Number 233 (Thursday, December 4, 2014)]
[Notices]
[Pages 72049-72054]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-28474]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73702; File No. SR-BX-2014-048]


Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Order 
Granting Approval to Proposed Rule Change To Establish the Retail Price 
Improvement Program on a Pilot Basis Expiring Twelve Months From the 
Date of Implementation

November 28, 2014.

I. Introduction

    On October 17, 2014, The NASDAQ OMX BX Stock Market LLC (the 
``Exchange'' or ``BX'') filed with the Securities and Exchange 
Commission (``Commission'') pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to establish a Retail Price 
Improvement (``RPI'') Program (the ``Program'') on a pilot basis for a 
period of 12 months from the date of implementation, if approved. The 
proposed rule change was published for comment in the Federal Register 
on October 29, 2014.\3\ The Commission did not receive any comments on 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 73410 (October, 23, 
2014), 79 FR 64447 (SR-BX-2014-048) (``Notice'').
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    In connection with the proposal, the Exchange requested exemptive 
relief from Rule 612 of Regulation NMS,\4\ which, among other things, 
prohibits a national securities exchange from accepting or ranking 
orders priced greater than $1.00 per share in an increment smaller than 
$0.01.\5\ On October 10, 2014, the Exchange submitted a letter 
requesting that the staff of the Division of Trading and Markets not 
recommend any enforcement action under Rule 602 of Regulation NMS based 
on the Exchange's and its Members' participation in the Program.\6\
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    \4\ 17 CFR 242.612 (``Sub-Penny Rule'').
    \5\ See Letter from Jeffrey Davis, Deputy General Counsel, 
NASDAQ OMX BX, Inc., to Brent J. Fields, Secretary, Commission, 
dated October 10, 2014 (``Request for Sub-Penny Rule Exemption''). 
The Request for Sub-Penny Rule Exemption was submitted 
contemporaneously with the Exchange's original filing for this 
proposed rule change, which was filed on October 10, 2014. Because 
that filing did not comply with the rules of the Commission relating 
to the required form of a filing on Form 19b-4, it was rejected.
    \6\ See Letter from Jeffrey Davis, Deputy General Counsel, 
NASDAQ OMX BX, Inc., to Stephen Luparello, Director, Division of 
Trading and Markets, Commission, dated October 10, 2014. This letter 
was submitted contemporaneously with the Exchange's original filing 
for this proposed rule change, which was filed on October 10, 2014. 
As noted above, that filing was rejected because it did not comply 
with the rules of the Commission relating to the required form of a 
filing on Form 19b-4.
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    This order approves the proposed rule change and grants the 
exemption from the Sub-Penny Rule sought by the Exchange in relation to 
the proposed rule change.

II. Description of the Proposal

    The Exchange is proposing a 12-month pilot program to attract 
additional retail order flow to the Exchange, while also providing the 
potential for price improvement to retail order flow. The Program would 
be limited to trades occurring at prices equal to or greater than $1.00 
per share.\7\ All Regulation NMS securities traded on the Exchange 
would be eligible for inclusion in the Program.
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    \7\ The Exchange notes that certain orders submitted to the 
Program designated as eligible to interact with liquidity outside of 
the Program--Type 2 Retail Orders, discussed below--could execute at 
prices below $1.00 if they do in fact execute against liquidity 
outside of the Program.
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    Under the Program, a new class of market participants called Retail 
Member Organizations (``RMOs'') \8\ would be eligible to submit certain 
retail order flow (``Retail Orders'') to the Exchange. All Exchange 
Members would be permitted to provide potential price improvement for 
Retail Orders in the form of designated non-displayed interest, called 
a Retail Price Improvement Order (``RPI Order'' or ``RPI interest''), 
that is priced more aggressively than the Protected National Best Bid 
or Offer (``Protected NBBO'') \9\ by at least $0.001 per share. When 
RPI interest priced at least $0.001 per share better than the Protected 
Bid or Protected Offer for a particular security is available in the 
Exchange's system (the ``System''), the Exchange would disseminate an 
identifier, known as the Retail Liquidity Identifier, indicating that 
such interest exists. A Retail Order would interact, to the extent 
possible, with available contra-side RPI Orders and other price 
improving liquidity.\10\
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    \8\ An RMO would be a Member (or a division thereof) that has 
been approved by the Exchange to submit Retail Orders. See Proposed 
BX Rule 4780. A ``Member'' is any registered broker or dealer that 
has been admitted to membership in the Exchange. See BX Rule 
0120(i).
    \9\ The terms Protected Bid and Protected Offer are defined in 
Rule 600(b)(57) of Regulation NMS. 17 CFR 242.600(b)(57). The 
Exchange represents that, generally, the Protected Bid and Protected 
Offer, and the national best bid (``NBB'') and national best offer 
(``NBO,'' together with the NBB, the ``NBBO''), will be the same. 
However, it further represents that a market center is not required 
to route to the NBB or NBO if that market center is subject to an 
exception under Regulation NMS Rule 611(b)(1) or if such NBB or NBO 
is otherwise not available for an automatic execution. In such case, 
the Exchange states that the Protected NBBO would be the best-priced 
protected bid or offer to which a market center must route interest 
pursuant to Rule 611 of Regulation NMS.
    \10\ As explained further below, the Exchange has proposed two 
types of Retail Orders, one of which could execute against other 
contra-side interest if it was not completely filled by contra-side 
RPI Interest or other price-improving liquidity. All Retail Orders 
would first execute against available contra-side RPI Orders or 
other price-improving liquidity. Any remaining portion of the Retail 
Order would then either cancel, be executed as an immediate-or-
cancel order, or be routed to another market for execution, 
depending on the type of Retail Order. The Exchange notes that other 
price improving liquidity may include, but is not limited to: Booked 
non-displayed orders with a limit price that is more aggressive than 
the then-current NBBO; midpoint-pegged orders (which are by 
definition non-displayed and priced more aggressively than the 
NBBO); non-displayed orders pegged to the NBBO with an aggressive 
offset, as defined in Proposed BX Rule 4780(a)(4) as Other Price 
Improving Contra-Side Interest. Orders that do not constitute other 
price improving liquidity include, but are not limited to: Orders 
with a time-in-force instruction of IOC; displayed orders; limit 
orders priced less aggressively than the NBBO.
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Types of Orders and Identifier

    A Retail Order would be an agency or riskless principal \11\ order 
that originates from a natural person and is submitted to the Exchange 
by an RMO, provided that no change is made to the terms of the order 
with respect to price (except in the case of a market order being 
changed to a marketable limit order) or side of market and provided 
that the order does not originate from a trading algorithm or any other 
computerized methodology. A Retail Order is an Immediate or Cancel 
Order. As discussed in greater detail below, Retail Orders may be 
designated as Type 1 or Type 2. Retail Orders, regardless of Type, may 
be entered in sizes that are odd lots, rounds lots, or mixed lots.
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    \11\ In order to qualify as a ``Retail Order,'' a ``riskless 
principal'' order must satisfy the criteria set forth in FINRA Rule 
5320.03. RMOs that submit riskless principal orders as Retail Orders 
must maintain supervisory systems to reconstruct such orders in a 
time-sequenced manner, and the RMOs must submit reports 
contemporaneous with the execution of the facilitated orders that 
identify such trades as riskless principal.
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    An RPI Order would be non-displayed liquidity on the Exchange that 
is priced better than the Protected NBBO by at

[[Page 72050]]

least $0.001 per share and that is identified as such. RPI interest can 
be priced either as an explicitly priced limit order or implicitly 
priced as relative to the NBBO with an offset of at least $0.001. The 
price of an RPI Order with an offset would be determined by a Member's 
entry of the following into the Exchange: (1) RPI buy or sell interest; 
(2) an offset from the Protected NBBO, if any; and (3) a ceiling or 
floor price. RPI Orders submitted with an offset would be similar to 
other peg orders available to Members in that the order is tied or 
``pegged'' to a certain price, and would have its price automatically 
set and adjusted upon changes in the Protected NBBO, both upon entry 
and any time thereafter.
    RPI Orders in their entirety (the buy or sell interest, the offset, 
and the ceiling or floor) will remain non-displayed. The Exchange will 
also allow Members to enter RPI Orders that establish the exact limit 
price, which is similar to a non-displayed limit order currently 
accepted by the Exchange today, except that the Exchange will accept 
sub-penny limit prices on RPI Orders in increments of $0.001.\12\ The 
Exchange will monitor whether RPI buy or sell interest, adjusted by any 
offset and subject to the ceiling or floor price, is eligible to 
interact with incoming Retail Orders.
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    \12\ As noted above, supra note 5 and accompanying text, in 
connection with the Program, the Exchange requested exemptive relief 
from the Sub-Penny Rule of Regulation NMS, which, among other 
things, prohibits a national securities exchange from accepting or 
ranking orders priced greater than $1.00 per share in an increment 
smaller than $0.01.
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    When RPI interest priced at least $0.001 better than the Exchange's 
Protected Bid or Protected Offer for a particular security is available 
in the System, the Exchange would disseminate an identifier, known as 
the Retail Liquidity Identifier, indicating that such interest exists. 
The Exchange would implement the Program in a manner that allowed the 
dissemination of the identifier through consolidated data streams 
(i.e., pursuant to the Consolidated Tape Association Plan/Consolidated 
Quotation Plan (``CTA/CQ Plan'') for Tape A and Tape B securities, and 
the Nasdaq UTP Plan for Tape C securities as well as through 
proprietary Exchange data feeds). The Retail Liquidity Identifier would 
reflect the symbol and the side (buy or sell) of the RPI Order, but it 
would not include the price or size. In particular, the consolidated 
quoting outputs would include a field for codes related to the Retail 
Liquidity Identifier. The codes will indicate RPI interest that is 
priced better than the Exchange's Protected Bid or Protected Offer by 
at least the minimum level of price improvement as required by the 
Program.

Retail Member Organizations

    In order to become an RMO, a Member must conduct a retail business 
or handle retail orders on behalf of another broker-dealer. Any Member 
that wishes to obtain RMO status would be required to submit: (1) An 
application form; (2) supporting documentation sufficient to 
demonstrate the retail nature and characteristics of the applicant's 
order flow; \13\ and (3) an attestation, in a form prescribed by the 
Exchange, that substantially all orders submitted by the Member as a 
Retail Order would meet the qualifications for such orders under 
Proposed BX Rule 4780(b). If the Exchange disapproves the application, 
it would provide a written notice to the Member. The disapproved 
applicant could appeal the disapproval as provided below or re-apply 90 
days after the disapproval notice is issued by the Exchange. An RMO 
also could voluntarily withdraw from RMO status at any time by giving 
written notice to the Exchange.
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    \13\ For example, a prospective RMO could be required to provide 
sample marketing literature, Web site screenshots, other publicly 
disclosed materials describing the retail nature of their order 
flow, and such other documentation and information as the Exchange 
may require to obtain reasonable assurance that the applicant's 
order flow would meet the requirements of the Retail Order 
definition.
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    The Exchange would require an RMO to have written policies and 
procedures reasonably designed to assure that it will only designate 
orders as Retail Orders if all the requirements of a Retail Order are 
met. Such written policies and procedures would have to require the 
Member to exercise due diligence before entering a Retail Order to 
assure that entry as a Retail Order is in compliance with the proposed 
rule and to monitor whether orders entered as Retail Orders meet the 
applicable requirements. If the RMO represents Retail Orders from 
another broker-dealer customer, the RMO's supervisory procedures must 
be reasonably designed to assure that the orders received from the 
broker-dealer customer that are designated as Retail Orders meet the 
definition of a Retail Order. The RMO must obtain, from each broker-
dealer customer that sends it orders to be designated as Retail Orders, 
an annual written representation, in a form acceptable to the Exchange, 
that entry of orders as Retail Orders will be in compliance with the 
requirements of this proposed rule, and the RMO must monitor whether 
its broker-dealer customer's Retail Order flow continues to meet the 
applicable requirements.\14\
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    \14\ The Exchange represents that it or another self-regulatory 
organization on behalf of the Exchange will review an RMO's 
compliance with these requirements through an exam-based review of 
the RMO's internal controls. See Notice, supra note 3, 79 FR at 6449 
n.8.
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Retail Order Designations

    Under Proposed BX Rule 4780(f), an RMO submitting a Retail Order 
could choose one of two designations dictating how the Retail Order 
would interact with available contra-side interest. First, a Retail 
Order could interact only with available contra-side RPI interest and 
other price-improving liquidity. The RMO would label this a Type 1 
Retail Order, and such orders would not interact with available non-
price-improving, contra-side interest in the System or route to other 
markets. Portions of a Type 1 Retail Order that were not executed would 
be cancelled immediately and automatically.
    Second, an RMO could label a Retail Order as a Type 2-designated 
Retail Order. A Type 2-designated Retail Order would interact first 
with available contra-side RPI Orders and other price-improving 
liquidity, and any remaining portion would be eligible to interact with 
other interest in the System and, if designated as eligible for 
routing, would route to other markets in compliance with Regulation NMS 
and pursuant to BX Rule 4758. Any portion of the Retail Order that 
remained unexecuted would then be cancelled.

Priority and Allocation

    Under Proposed BX Rule 4780(g), the Exchange would follow price-
time priority, ranking RPI interest in the same security according to 
price and then time of entry into the System.\15\ Any remaining 
unexecuted RPI Orders would remain available to interact with other 
incoming Retail Orders if such interest is at an eligible price. Any 
remaining unexecuted portion of a Retail Order would cancel or execute 
in accordance with Proposed BX Rule 4780(f).\16\
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    \15\ See also BX Rule 4757 (setting forth the Exchange's price-
time priority methodology).
    \16\ The Exchange has provided three examples of how the 
priority and ranking of RPI Orders would operate. See Notice, supra 
note 3, 79 FR at 64449-50.
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Failure of RMO To Abide by Retail Order Requirements

    Proposed BX Rule 4780(c) addresses an RMO's failure to abide by 
Retail Order requirements. If an RMO were to designate orders submitted 
to the Exchange as Retail Orders and the

[[Page 72051]]

Exchange determined, in its sole discretion, that those orders failed 
to meet any of the requirements of Retail Orders, the Exchange could 
disqualify a Member from its status as an RMO. When disqualification 
determinations are made, the Exchange would provide a written 
disqualification notice to the Member. A disqualified RMO could appeal 
the disqualification as provided below or re-apply 90 days after the 
disqualification notice is issued by the Exchange.

Appeal of Disapproval or Disqualification

    Under Proposed BX Rule 4780(d), the Exchange would establish a 
Retail Price Improvement Program Panel (``RPI Panel'') to review 
disapproval or disqualification decisions. If a Member disputes the 
Exchange's decision to disapprove or disqualify it as an RMO, such 
Member could request, within five business days after notice of the 
decision is issued by the Exchange, that the RPI Panel review the 
decision to determine if it was correct. The RPI Panel would consist of 
the Exchange's Chief Regulatory Officer (or his or her designee) and 
two officers of the Exchange designated by the Exchange's Chief 
Executive Officer, and it would review the facts and render a decision 
within the timeframe prescribed by the Exchange. The RPI Panel could 
overturn or modify an action taken by the Exchange under Proposed Rule 
4780, and all determinations by the RPI Panel would constitute final 
action by the Exchange on the matter at issue.

III. Discussion and Commission Findings

    After careful review of the proposal, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder that are applicable to a national 
securities exchange. In particular, the Commission finds that the 
proposed rule change, subject to its term as a pilot, is consistent 
with Section 6(b)(5) of the Act,\17\ which requires, among other 
things, that the rules of a national securities exchange be designed to 
prevent fraudulent and manipulative acts and practices; to promote just 
and equitable principles of trade; to foster cooperation and 
coordination with persons engaged in regulating, clearing, settling, 
processing information with respect to, and facilitating transactions 
in securities; to remove impediments to and perfect the mechanism of a 
free and open market and a national market system; and, in general, to 
protect investors and the public interest and that the rules of a 
national securities exchange not be designed to permit unfair 
discrimination between customers, issuers, brokers or dealers.
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    \17\ 15 U.S.C. 78f(b)(5).
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    The Commission finds that the Program, as it is proposed on a pilot 
basis, is consistent with the requirements of the Act because the 
Program is reasonably designed to benefit retail investors by providing 
price improvement to retail order flow.\18\ The Commission also 
believes that the Program could promote competition for retail order 
flow among execution venues and that this could benefit retail 
investors by creating additional price improvement opportunities for 
their order flow. Currently, most marketable retail order flow is 
executed in the over-the-counter (``OTC'') markets, pursuant to 
bilateral agreements, without ever reaching a public exchange. The 
Commission has noted that ``a very large percentage of marketable 
(immediately executable) order flow of individual investors'' is 
executed, or ``internalized,'' by broker-dealers in the OTC 
markets.\19\ A previous review of the order flow of eight retail 
broker-dealers revealed that nearly 100% of their customer market 
orders were routed to OTC market makers.\20\ The same review found that 
such routing is often done pursuant to arrangements under which retail 
brokers route their order flow to certain OTC market makers in exchange 
for payment for such order flow.\21\ To the extent that the Program may 
provide price improvement to retail orders that equals what would be 
provided under such OTC internalization arrangements, the Program could 
benefit retail investors. So that the Exchange and the Commission can 
better understand the Program's potential impact, the Exchange 
represents that it ``will produce data throughout the pilot, which will 
include statistics about participation, the frequency and level of 
price improvement provided by the Program, and any effects on the 
broader market structure.'' \22\
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    \18\ The Commission has approved similar programs for New York 
Stock Exchange LLC and NYSE MKT LLC, Securities Exchange Act Release 
No. 67347 (July 3, 2012), 77 FR 40673 (July 10, 2012) (SR-NYSE-2011-
55; SR-NYSEAmex-2011-84) (``NYSE RLP Approval Order''), BATS Y-
Exchange, Inc., Securities Exchange Act Release No. 68303 (November 
27, 2012), 77 FR 71652 (December 3, 2012) (SR-BYX-2012-019) (``BATS 
Y RPI Approval Order''), and The NASDAQ Stock Market LLC, Securities 
Exchange Act Release No. 68937 (February 15, 2013), 78 FR 12397 
(February 22, 2013) (SR-NASDAQ-2012-129) (``NASDAQ RPI Approval 
Order'').
    \19\ See Securities Exchange Act Release No. 61358 (Jan. 14, 
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity 
Market Structure'').
    \20\ See id.
    \21\ See id.
    \22\ See Notice, supra note 3, 79 FR at 64450.
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    The Program proposes to create additional price improvement 
opportunities for retail investors by segmenting retail order flow on 
the Exchange and requiring liquidity providers that want to interact 
with such retail order flow to do so at a price at least $0.001 per 
share better than the Protected NBBO. The Commission finds that, while 
the Program would treat retail order flow differently from order flow 
submitted by other market participants, such segmentation would not be 
inconsistent with Section 6(b)(5) of the Act, which requires that the 
rules of an exchange are not designed to permit unfair discrimination. 
The Commission previously has recognized that the markets generally 
distinguish between individual retail investors, whose orders are 
considered desirable by liquidity providers because such retail 
investors are presumed on average to be less informed about short-term 
price movements, and professional traders, whose orders are presumed on 
average to be more informed.\23\ The Commission has further recognized 
that, because of this distinction, liquidity providers are generally 
more inclined to offer price improvement to less informed retail orders 
than to more informed professional orders.\24\ Absent opportunities for 
price improvement, retail investors may encounter wider spreads that 
are a consequence of liquidity providers interacting with informed 
order flow. By creating

[[Page 72052]]

additional competition for retail order flow, the Program is reasonably 
designed to attract retail order flow to the exchange environment, 
while helping to ensure that retail investors benefit from the better 
price that liquidity providers are willing to give their orders.
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    \23\ See NASDAQ RPI Approval Order, supra note 18, BATS Y RPI 
Approval Order, supra note 18 and NYSE RLP Approval Order, supra 
note 18. See also Concept Release on Equity Market Structure, supra 
note 19; Securities Exchange Act Release No. 64781 (June 30, 2011), 
76 FR 39953 (July 7, 2011) (SR-BATS-2011-009) (approving a program 
proposed by an options exchange that would provide price improvement 
opportunities to retail orders based, in part, on questions about 
execution quality of retail orders under payment for order flow 
arrangements in the options markets).
    \24\ See NASDAQ RPI Approval Order, supra note 18, BATS Y RPI 
Approval Order, supra note 18 and NYSE RLP Approval Order, supra 
note 18. See also Securities Exchange Act Release No. 64781 (June 
30, 2011), 76 FR 39953, 39957 n.50 (July 7, 2011) (SR-BATS-2011-009) 
(noting that ``it is well known in academic literature and industry 
practice that prices tend to move against market makers after trades 
with informed traders, often resulting in losses for market 
makers,'' and that such losses are often borne by uninformed retail 
investors through wider spreads (citing H.R. Stoll, ``The supply of 
dealer services in securities markets,'' Journal of Finance 33 
(1978), at 1133-51; L. Glosten & P. Milgrom, ``Bid ask and 
transaction prices in a specialist market with heterogeneously 
informed agents,'' Journal of Financial Economics 14 (1985), at 71-
100; and T. Copeland & D. Galai, ``Information effects on the bid-
ask spread,'' Journal of Finance 38 (1983), at 1457-69)).
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    The Commission notes that the Program might also create a desirable 
opportunity for institutional investors to interact with retail order 
flow that they are not able to reach currently. Today, institutional 
investors often do not have the chance to interact with marketable 
retail orders that are executed pursuant to internalization 
arrangements. Thus, by submitting RPI Orders, institutional investors 
may be able to reduce their possible adverse selection costs by 
interacting with retail order flow.
    When the Commission is engaged in rulemaking or the review of a 
rule filed by a self-regulatory organization, and is required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, the Commission shall also consider, in addition to 
the protection of investors, whether the action will promote 
efficiency, competition, and capital formation.\25\ As discussed above, 
the Commission believes this Program will promote competition for 
retail order flow by allowing Exchange Members to submit RPI Orders to 
interact with Retail Orders. Such competition may promote efficiency by 
facilitating the price discovery process. Moreover, the Commission does 
not believe that the Program will have a significant effect on market 
structure, or will create any new inefficiencies in current market 
structure. Finally, to the extent the Program is successful in 
attracting retail order flow, it may generate additional investor 
interest in trading securities, thereby promoting capital formation.
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    \25\ See 15 U.S.C. 78c(f).
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    The Commission also believes that the Program is sufficiently 
tailored to provide the benefits of potential price improvement only to 
bona fide retail order flow originating from natural persons.\26\ The 
Commission finds that the Program provides an objective process by 
which a Member organization could become an RMO and that the Program 
provides for appropriate oversight by the Exchange to monitor for 
continued compliance with the terms of these provisions. The Exchange 
has limited the definition of Retail Order to an agency or riskless 
principal order that originates from a natural person and not from a 
trading algorithm or any other computerized methodology. Furthermore, a 
Retail Order must be submitted by an RMO that is approved by the 
Exchange. In addition, RMOs would be required to maintain written 
policies and procedures to help ensure that they designate as Retail 
Orders only those orders that qualify under the Program. If a Member's 
application to become an RMO is denied by the Exchange, that Member may 
appeal the determination or re-apply. The Commission believes that 
these standards should help ensure that only retail order flow is 
submitted into the Program and that these standards thereby promote 
just and equitable principles of trade and protect investors and the 
public interest, while also providing an objective process through 
which Members may become RMOs.
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    \26\ In addition, the Commission believes that the Program's 
provisions concerning the approval and potential disqualification of 
RMOs are not inconsistent with the Act. See, e.g., NASDAQ RPI 
Approval Order, supra note 18, 78 FR at 12400 n.32, BATS Y RPI 
Approval Order, supra note 18, 77 FR at 71656 n.41 and NYSE RLP 
Approval Order, supra note 18, 77 FR at 40680 n.77.
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    In addition, the Commission finds that the Program's proposed 
dissemination of a Retail Liquidity Identifier would increase the 
amount of pricing information available to the marketplace and that is 
consistent with the requirement of the Act. The identifier would be 
disseminated through the consolidated public market data stream and 
proprietary Exchange data feeds to advertise the presence of a RPI 
Order with which Retail Orders could interact. The identifier would 
reflect the symbol for a particular security and the side of the RPI 
Order interest, but it would not include the price or size of such 
interest. The identifier would alert market participants to the 
existence of a RPI Order and should provide market participants with 
more information about the availability of price improvement 
opportunities for retail orders than is currently available.\27\
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    \27\ As the Commission noted when approving the comparable 
NASDAQ, BATS Y-Exchange, and NYSE programs, the Commission believes 
that the Program will not create any best execution challenges for 
brokers that are not already present in today's markets. A broker's 
best execution obligations are determined by a number of facts and 
circumstances, including: (1) The character of the market for the 
security (e.g., price, volatility, relative liquidity, and pressure 
on available communications); (2) the size and type of transaction; 
(3) the number of markets checked; (4) accessibility of the 
quotation; and (5) the terms and conditions of the order that 
results in the transaction. See NASDAQ RPI Approval Order, supra 
note 18, 78 FR at 12400 n.33, BATS Y RPI Approval Order, supra note 
18, 77 FR at 71657, and NYSE RLP Approval Order, supra note 18, 77 
FR at 40680 n.75 (all citing FINRA Rule 5310).
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    The Exchange asserts that the Program will operate in substantially 
the same manner as NASDAQ Rule 4780 \28\ and BATS Y-Exchange Rule 
11.24,\29\ which set forth the NASDAQ and BATS Y-Exchanges' Retail 
Price Improvement Programs, respectively, and that it would be similar 
to, but with distinctions from, New York Stock Exchange LLC's 
(``NYSE'') Rule 107C, which governs NYSE's Retail Liquidity 
Program.\30\ Accordingly, the Exchange believes that the Program should 
both enhance competition among market participants and encourage 
competition among exchange venues.\31\ Specifically, the Exchange 
asserts that allowing all Members to enter RPI Orders on equal terms, 
as opposed to adopting a special category of retail liquidity 
providers, as NYSE did with its Retail Liquidity Program, could result 
in a higher level of competition and maximize price improvement to 
incoming Retail Orders; \32\ that the Program should provide the 
maximum price improvement available to incoming Retail Orders because 
they will always interact with resting RPI Orders and other resting 
non-displayed liquidity; \33\ and that the Program will provide all of 
the price improvement available to incoming Retail Orders by allowing 
executions at multiple price levels, as opposed to a single clearing 
price level.\34\ The Commission finds that the Program is reasonably 
designed to enhance competition among market participants and encourage 
competition among exchange venues. The Commission also finds that the 
distinctions between the Exchange's Program and the approved programs 
on

[[Page 72053]]

other exchanges are reasonably designed to enhance the Program's price-
improvement benefits to retail investors and are, therefore, consistent 
with the Act.
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    \28\ See NASDAQ RPI Approval Order, supra note 18.
    \29\ See BATS Y RPI Approval Order, supra note 18.
    \30\ See NYSE RLP Approval Order, supra note 18.
    \31\ See Notice, supra note 3, 79 FR at 64451.
    \32\ See id. at 64450. The NYSE's Retail Liquidity Program 
creates a category of members, Retail Liquidity Providers, who are 
required to maintain a NYSE Retail Price Improvement Order that 
betters the protected best bid or offer at least 5% of the trading 
day in each assigned security and who receive lower execution fees 
as a result.
    \33\ See Notice, supra note 3, 79 FR at 64450. In contrast, 
pursuant to NYSE Rule 107C(k)(1), a NYSE Type 1-designated Retail 
Order will interact only with available contra-side NYSE Retail 
Price Improvement Orders and NYSE Mid-Point Passive Liquidity 
Orders. Pursuant to NYSE Rule 13, a Mid-Point Passive Liquidity 
Order ``is an undisplayed limit order that automatically executes at 
the mid-point of the protected best bid or offer.''
    \34\ See Notice, supra note 3, 79 FR at 64450-51. Under the 
NYSE'S Retail Liquidity Program, Retail Orders execute at the single 
price at which the order will be fully executed, unless there are 
separate MPL Orders with better pricing on the other side of the 
Retail Order. See NYSE Rule 107C(l) (providing examples of how 
orders execute under the NYSE's Retail Liquidity Program).
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    The Commission notes that it is approving the Program on a pilot 
basis. Approving the Program on a pilot basis will allow the Exchange 
and market participants to gain valuable practical experience with the 
Program during the pilot period. This experience should allow the 
Exchange and the Commission to determine whether modifications to the 
Program are necessary or appropriate prior to any Commission decision 
to approve the Program on a permanent basis. The Exchange also has 
agreed to provide the Commission with a significant amount of data that 
should assist the Commission in its evaluation of the Program. 
Specifically, the Exchange has represented that it ``will produce data 
throughout the pilot, which will include statistics about 
participation, the frequency and level of price improvement provided by 
the Program, and any effects on the broader market structure.'' \35\ 
The Commission expects that the Exchange will monitor the scope and 
operation of the Program and study the data produced during that time 
with respect to such issues and that the Exchange will propose any 
modifications to the Program that may be necessary or appropriate.
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    \35\ See supra note 22 and accompanying text.
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    The Commission also welcomes comments, and empirical evidence, on 
the Program during the pilot period to further assist the Commission in 
its evaluation of the Program. The Commission notes that any permanent 
approval of the Program would require a proposed rule change by the 
Exchange, and any such proposed rule change would provide an 
opportunity for public comment prior to further Commission action.

IV. Exemption From the Sub-Penny Rule

    Pursuant to its authority under Rule 612(c) of Regulation NMS,\36\ 
the Commission hereby grants the Exchange a limited exemption from the 
Sub-Penny Rule to operate the Program. For the reasons discussed below, 
the Commission determines that such an exemption is necessary or 
appropriate in the public interest and is consistent with the 
protection of investors. The exemption shall operate for a period of 12 
months, ending on the same date as the 12-month pilot period of the 
Program.
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    \36\ 17 CFR 242.612(c).
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    When the Commission adopted the Sub-Penny Rule in 2005, it 
identified a variety of problems caused by sub-pennies that the Sub-
Penny Rule was designed to address:
    <bullet> If investors' limit orders lose execution priority for a 
nominal amount, investors may over time decline to use them, thus 
depriving the markets of liquidity.
    <bullet> When market participants can gain execution priority for a 
nominal amount, important customer protection rules such as exchange 
priority rules and the Manning Rule could be undermined.
    <bullet> Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to 
satisfy their best execution obligations and other regulatory 
responsibilities.
    <bullet> Widespread sub-penny quoting could decrease market depth 
and lead to higher transaction costs.
    <bullet> Decreasing depth at the inside could cause institutions to 
rely more on execution alternatives away from the exchanges, 
potentially increasing fragmentation in the securities markets.\37\
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    \37\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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    At the same time, the Commission ``acknowledge[d] the possibility 
that the balance of costs and benefits could shift in a limited number 
of cases or as the markets continue to evolve.'' \38\ Therefore, the 
Commission also adopted Rule 612(c), which provides that the Commission 
may grant exemptions from the Sub-Penny Rule, either unconditionally or 
on specified terms and conditions, if it determined that such an 
exemption is necessary or appropriate in the public interest, and is 
consistent with the protection of investors.
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    \38\ Id. at 37553.
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    The Commission believes that the Exchange's proposal raises such a 
case. As described above, under the current market structure, few 
marketable retail orders in equity securities are routed to exchanges. 
The vast majority of marketable retail orders are internalized by OTC 
market makers, who typically pay retail brokers for their order flow. 
Retail investors can benefit from such arrangements to the extent that 
OTC market makers offer them price improvement over the NBBO. Price 
improvement is typically offered in sub-penny amounts.\39\ An 
internalizing broker-dealer can offer sub-penny executions, provided 
that such executions do not result from impermissible sub-penny orders 
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or 
accepting orders from retail customers seeking that exact price. 
Exchanges--and exchange member firms that submit orders and quotations 
to exchanges--cannot compete for marketable retail order flow on the 
same basis, because it would be impractical for exchange electronic 
systems to generate sub-penny executions without exchange liquidity 
providers or retail brokerage firms having first submitted sub-penny 
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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    \39\ When adopting the Sub-Penny Rule, the Commission considered 
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their 
customers, but declined to do so. The Commission stated that 
``trading in sub-penny increments does not raise the same concerns 
as sub-penny quoting'' and that ``sub-penny executions due to price 
improvement are generally beneficial to retail investors.'' Id. at 
37556.
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    The limited exemption granted today should promote competition 
between exchanges and OTC market makers in a manner that is reasonably 
designed to minimize the problems that the Commission identified when 
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will 
not be disseminated through the consolidated quotation data stream, 
which should avoid quote flickering and reduced depth at the inside 
quotation. Furthermore, while the Commission remains concerned about 
providing enough incentives for market participants to display limit 
orders, the Commission does not believe that granting this exemption 
(and approving the accompanying proposed rule change) will reduce such 
incentives. Market participants that display limit orders currently are 
not able to interact with marketable retail order flow because it is 
almost entirely routed to internalizing OTC market makers that offer 
sub-penny executions. Consequently, enabling the Exchanges to compete 
for this retail order flow through the Program should not materially 
detract from the current incentives to display limit orders, while 
potentially resulting in greater order interaction and price 
improvement for marketable retail orders. To the extent that the 
Program may raise Manning and best-execution issues for broker-dealers, 
these issues are already presented by the existing practices of OTC 
market makers.
    The exemption being granted today is limited to a one-year pilot. 
The Exchange has stated that ``sub-penny trading and pricing could 
potentially

[[Page 72054]]

result in undesirable market behavior'' and that, therefore, it will 
``monitor the Program in an effort to identify and address any such 
behavior.'' \40\ Furthermore, the Exchange has represented that it 
``will produce data throughout the pilot, which will include statistics 
about participation, the frequency and level of price improvement 
provided by the Program, and any effects on the broader market 
structure.'' \41\ The Commission expects to review the data and 
observations of the Exchange before determining whether and, if so, how 
to extend the exemption from the Sub-Penny Rule.\42\
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    \40\ See Request for Sub-Penny Rule Exemption, supra note 5, at 
3, n.6.
    \41\ See supra note 22 and accompanying text.
    \42\ In particular, the Commission expects the Exchange to 
observe how maker/taker transaction charges, whether imposed by the 
Exchange or by other markets, might impact the use of the Program. 
Market distortions could arise where the size of a transaction 
rebate, whether for providing or taking liquidity, is greater than 
the size of the minimum increment permitted by the Program ($0.001 
per share).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\43\ that the proposed rule change (SR-BX-2014-048) be, and hereby 
is, approved on a one-year pilot basis.
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    \43\ 15 U.S.C. 78s(b)(2).
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    It is also hereby ordered that, pursuant to Rule 612(c) of 
Regulation NMS, the Exchange is given a limited exemption from Rule 612 
of Regulation NMS allowing it to accept and rank orders priced equal to 
or greater than $1.00 per share in increments of $0.001, in the manner 
described in the proposed rule change above, for a period of 12 months, 
ending on the same date as the 12-month pilot period of the Program.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\44\
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    \44\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Brent J. Fields,
Secretary.
[FR Doc. 2014-28474 Filed 12-3-14; 8:45 am]
BILLING CODE 8011-01-P