Document ID: SEC-2013-2058-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: BATS Exchange, Inc.
Posted Date: 2013-12-04T05:00Z

[Federal Register Volume 78, Number 233 (Wednesday, December 4, 2013)]
[Notices]
[Pages 72949-72951]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-28969]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70952; File No. SR-BATS-2013-056]

Self-Regulatory Organizations; BATS Exchange, Inc.; Order 
Approving a Proposed Rule Change To Amend Rule 12.6 To Conform to FINRA 
Rule 5320 Relating to Trading Ahead of Customer Orders

November 27, 2013.

I. Introduction

    On October 3, 2013, BATS Exchange, Inc. (the ``Exchange'' or 
``BATS'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), 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 amend BATS Rule 12.6 (``Rule 
12.6'') to make it substantially similar to Financial Industry 
Regulatory Authority (``FINRA'') Rule 5320. The proposed rule change 
was published for comment in the Federal Register on October 22, 
2013.\3\ The Commission received no comments on the proposal. This 
order approves 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. 70662 (October 11, 
2013), 78 FR 62828 (SR-BATS-2013-056) (``Notice'').
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II. Description of the Proposed Rule Change

    The Exchange proposes to amend Rule 12.6, which limits trading 
ahead of customer orders by Members,\4\ to have the rule substantially 
conform to FINRA Rule 5320.\5\ As with FINRA Rule 5320, the proposed 
amendments to Rule 12.6 would prohibit Members from trading ahead of 
customer orders, subject to specified exceptions. Rule 12.6, as 
proposed to be amended, would include exceptions for large orders and 
institutional accounts, proprietary transactions effected by a trading 
unit of a Member with no knowledge of customer orders held by another 
trading unit of the Member, riskless principal transactions, 
intermarket sweep orders (``ISOs''), and odd lot and bona fide error 
transactions, described below. Rule 12.6 also would provide the same 
guidance as FINRA Rule 5320 with respect to minimum price improvement 
standards, order handling procedures, and trading outside normal market 
hours.
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    \4\ Members are registered brokers or dealers that have been 
admitted to membership at the Exchange. BATS Rule 1.5(n).
    \5\ See Securities Exchange Act Release No. 63895 (February 11, 
2011), 76 FR 9386 (February 17, 2011) (SR-FINRA-2009-90).
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Background

    Current Rule 12.6, the customer order protection rule, generally 
prohibits Members from trading on a proprietary basis ahead of, or 
along with, customer orders that are executable at the same price as 
the proprietary order. The current rule contains several exceptions 
that make it permissible for a Member to enter a proprietary order 
while representing a customer order that could be executed at the same 
price, including permitting transactions for the purpose of 
facilitating the execution, on a riskless principal basis, of one or 
more customer orders.

Proposal To Adopt Text of FINRA Rule 5320

    To harmonize its rules with FINRA, the Exchange proposes to delete 
the current text of Rule 12.6 and its supplementary material and adopt 
the text and supplementary material of FINRA Rule 5320, with certain 
changes, as Rule 12.6. FINRA Rule 5320 generally provides that a FINRA 
member that accepts and holds an order in an equity security for its 
own customer, or a customer of another broker-dealer, without 
immediately executing the order is prohibited from trading that 
security on the same side of the market for its own account at a price 
that would satisfy the customer order, unless it immediately thereafter 
executes the customer order up to the size and at the same or better 
price at which it traded for its own account.

Exceptions

    The proposed amendments to Rule 12.6 would include exceptions to 
the prohibition against trading ahead of customer orders. A Member that 
meets the conditions of an exception would be permitted to trade a 
security on the same side of the market for its own account at a price 
that would satisfy a customer order in certain circumstances. The 
exceptions are set forth below.

Large Orders and Institutional Accounts

    One exception would permit a Member to negotiate terms and

[[Page 72950]]

conditions with respect to the acceptance of certain large-sized orders 
(orders of 10,000 shares or more unless such orders are less than 
$100,000 in value) or orders from institutional accounts. The term 
``institutional account'' would be defined in accordance with FINRA 
Rule 4512(c). Accordingly, an institutional account would be defined as 
the account of: (1) A bank savings and loan association, insurance 
company or registered investment company; (2) an investment adviser 
registered either with the SEC under Section 203 of the Investment 
Advisers Act or with a state securities commission (or any agency or 
office performing like functions); or (3) any other person (whether a 
natural person, corporation, partnership, trust or otherwise) with 
total assets of at least $50 million. This exception to Rule 12.6, as 
amended, would require the Member to provide clear and comprehensive 
written disclosure to each customer at account opening and annually 
thereafter that: (a) States that the Member may trade proprietarily at 
prices that would satisfy the customer order; and (b) provides the 
customer with a meaningful opportunity to opt in to the Rule 12.6 
protections with respect to all or any portion of its order. In 
addition, if a customer does not opt in to the protections with respect 
to all or any portion of its order, the Member may reasonably conclude 
that such customer has consented to the Member trading a security on 
the same side of the market for its own account at a price that would 
satisfy the customer's order.\6\
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    \6\ A customer would retain the right to withdraw consent at any 
time. Therefore, a Member's reasonable conclusion that a customer 
has consented to the Member trading along with such customer's order 
would be subject to further instruction and modification from the 
customer.
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    In lieu of providing written disclosure to customers at account 
opening and annually thereafter, Rule 12.6 would permit Members to 
provide clear and comprehensive oral disclosure to, and obtain consent 
from, a customer on an order-by-order basis. Under Rule 12.6, the 
Member would be required to document who provided such consent and that 
such consent evidences the customer's understanding of the terms and 
conditions of the order. If a customer opted in to the protections of 
Rule 12.6, a Member could still obtain consent on an order-by-order 
basis to trade ahead of or along with an order from that customer, 
provided that the Member documented who provided such consent and that 
such consent evidenced the customer's understanding of the terms and 
conditions of the order.

No-Knowledge Exception

    The Exchange also proposes to include in Interpretation and Policy 
.02 a ``no-knowledge'' exception to Rule 12.6. The proposed exception 
would allow one trading unit of a Member to trade in a proprietary 
capacity and at prices that would satisfy customer orders held by 
another, separate trading unit of the Member (``the No-Knowledge 
Exception''). The No-Knowledge Exception would be applicable with 
respect to NMS stocks, as defined in Rule 600 of Regulation NMS under 
the Act.
    To avail itself of the No-Knowledge Exception, a Member would be 
required to meet certain conditions. First, it would have to implement 
and utilize an effective system of internal controls (such as 
appropriate information barriers) that operate to prevent the 
proprietary trading unit from obtaining knowledge of the customer 
orders held by a separate trading unit. As proposed, Interpretation and 
Policy .02 would make clear that appropriate information barriers must, 
at a minimum, comply with the Exchange's existing requirements 
regarding the prevention of the misuse of material, non-public 
information, which are set forth in Exchange Rule 5.5. Second, the 
Member would have to provide, at account opening and annually 
thereafter, a written description of how it handles customer orders and 
the circumstances under which it may trade proprietarily, including in 
a market-making capacity, at prices that would satisfy the customer 
order. A Member must maintain records indicating which orders rely on 
the No-Knowledge Exception and produce these records to the Exchange 
upon request. Under the proposed exception, the onus would be on the 
Member to produce sufficient documentation justifying reliance on the 
No-Knowledge Exception for any given trade. To ensure clarity and 
transparency regarding this exception and others, the Exchange will 
issue a regulatory notice informing Members of the proposed revisions 
to Rule 12.6. The Exchange will include in the regulatory notice the 
effective date for the rule as amended, which shall be at least 30 days 
after Commission approval of the proposed amendments to Rule 12.6 in 
order to allow Members to make any necessary changes to their internal 
policies or processes.

Riskless Principal Exception

    Another proposed amendment to Rule 12.6 would not apply to a 
proprietary trade made by the Member to facilitate the execution, on a 
riskless principal basis, of another order from a customer (whether its 
own customer or the customer of another broker-dealer). To take 
advantage of this exception, the Member would have to: (a) Submit a 
report, contemporaneously with the execution of the facilitated order, 
identifying the trade as riskless principal to the Exchange; and (b) 
have written policies and procedures to ensure that riskless principal 
transactions relied upon for this exception comply with applicable 
Exchange rules. At a minimum, these policies and procedures would have 
to require: (1) Receipt of the customer order before execution of the 
offsetting principal transaction; and (2) execution of the offsetting 
principal transaction at the same price as the customer order, 
exclusive of any markup or markdown, commission equivalent, or other 
fee and allocation to a riskless principal or customer account in a 
consistent manner and within 60 seconds of execution.
    Members would have to have supervisory systems in place that 
produce records that enable the Member and the Exchange to reconstruct 
accurately, readily, and in a time-sequenced manner all orders on which 
a Member relies in claiming this exception.

ISO Exception

    A further proposed amendment to Rule 12.6 would exempt a Member 
from the obligation to execute a customer order in a manner consistent 
with Rule 12.6 with regard to trading for its own account when the 
Member routed an ISO in compliance with Rule 600(b)(30)(ii) of 
Regulation NMS, if the customer order is received after the Member 
routed the ISO. If a Member routes an ISO to facilitate a customer 
order, and that customer has consented to not receiving the better 
prices obtained by the ISO, the Member would also be exempt with 
respect to any trading for its own account that is the result of the 
ISO with respect to the consenting customer's order.

Odd Lot and Bona Fide Error Exception

    The Exchange also proposes to except a Member's proprietary trade 
that: (1) Offsets a customer odd lot order (i.e., an order less than 
one round lot, which is typically 100 shares); or (2) corrects a bona 
fide error. With respect to bona fide errors, the Member would be 
required to demonstrate and document the basis upon which a transaction 
meets the bona fide error exception. For purposes of this proposed 
exception, the Exchange would adopt the definition of ``bona fide 
error'' found in Regulation NMS's exemption for error correction

[[Page 72951]]

transactions.\7\ Thus, a bona fide error would be:
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    \7\ Securities Exchange Act Release No. 55884 (June 8, 2007), 72 
FR 32926, 32927 (June 14, 2007) (Order Exempting Certain Error 
Correction Transactions from Rule 611 of Regulation NMS under the 
Securities Exchange Act of 1934).
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    (i) The inaccurate conveyance or execution of any term of an order 
including, but not limited to, price, number of shares or other unit of 
trading; identification of the security; identification of the account 
for which securities are purchased or sold; lost or otherwise misplaced 
order tickets; short sales that were instead sold long or vice versa; 
or the execution of an order on the wrong side of a market; (ii) the 
unauthorized or unintended purchase sale or allocation of securities or 
the failure to follow specific client instructions; (iii) the incorrect 
entry of data into relevant systems, including reliance on incorrect 
cash positions, withdrawals, or securities positions reflected in an 
account; or (iv) a delay, outage, or failure of a communication system 
used to transmit market data prices or to facilitate the delivery or 
execution of an order.\8\
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    \8\ Id.
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Minimum Price Improvement Standards

    The proposed rule change also would establish the minimum amount of 
price improvement necessary for a Member to execute an order on a 
proprietary basis when holding an unexecuted limit order in that same 
security without being required to execute the held limit order.
    In addition, if the minimum price improvement standards set forth 
in proposed Interpretation and Policy .06, paragraphs (a) through (g) 
would trigger the protection of a pending customer limit order, any 
better-priced customer limit order(s) must also be protected under the 
amended Rule, even if those better-priced limit orders would not be 
directly triggered under these minimum price improvement standards.

Order Handling Procedures

    The proposed rule change would provide that a Member must make 
every effort to execute a marketable customer order that it receives 
fully and promptly. A Member holding a marketable customer order that 
has not been immediately executed would have to make every effort to 
cross such order with any other order received by the Member on the 
other side of the market, up to the size of such order at a price that 
is no less than the best bid and no greater than the best offer at the 
time that the subsequent order is received by the Member and that is 
consistent with the terms of the orders. If a Member were holding 
multiple orders on both sides of the market that have not been 
executed, the Member would have to make every effort to cross or 
otherwise execute such orders in a manner reasonable and consistent 
with the objectives of Rule 12.6, as amended, and with the terms of the 
orders. A Member could satisfy the crossing requirement by 
contemporaneously buying from the seller and selling to the buyer at 
the same price.

Trading Outside Normal Market Hours

    Under the proposed amendments to Rule 12.6, a Member generally 
could limit the life of a customer order to the period of normal market 
hours of 9:30 a.m. to 4:00 p.m. Eastern Time. However, if the customer 
and Member agreed to the processing of the customer's order outside 
normal market hours, the protections of Rule 12.6, as amended, would 
apply to that customer's order at all times the customer order is 
executable by the Member.

III. Discussion and Commission Findings

    After careful review of the proposed rule change, the Commission 
finds that the Exchange's proposal is consistent with the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\9\ In particular, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(5) of the Act,\10\ which 
requires that the rules of a national securities exchange be designed, 
among other things, to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, 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.
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    \9\ In approving the BATS proposed rule change, the Commission 
has considered its impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change, which is 
designed to establish a single standard to protect customer orders from 
member firms trading ahead of those orders, will help assure the 
protection of customer orders without imposing undue regulatory costs 
on industry participants. Moreover, the Commission believes that the 
proposed rule change will define important parameters by which Members 
must abide when trading proprietarily while holding customer orders. In 
addition, because the Exchange is proposing to make its customer order 
protection rule substantially similar to the customer order protection 
rules of FINRA \11\ and other exchanges,\12\ the Commission believes 
that the proposed rule change will help reduce the complexity of the 
customer order protection rules for those firms subject to these rules. 
Taken together, the proposed rule change should provide Members with 
clarity and guidance and thereby promote the efficient functioning of 
the securities markets.

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    \11\ See FINRA Rule 5320, supra note 5.
    \12\ Several national securities exchanges submitted proposed 
rule changes to adopt customer order protection rules that are 
substantially similar to FINRA Rule 5320. See, e.g., Securities 
Exchange Act Release No. 64418 (May 6, 2011), 76 FR 27735 (May 12, 
2011) (SR-CHX-2011-08); Securities Exchange Act Release No. 65165 
(August 18, 2011), 76 FR 53009 (August 24, 2011) (SR-NYSEAmex-2011-
59); Securities Exchange Act Release No. 65166 (August 18, 2011), 76 
FR 53012 (August 24, 2011) (SR-NYSEArca-2011-57); Securities 
Exchange Act Release No. 69504 (May 2, 2013), 78 FR 26828 (May 8, 
2013) (SR-CBOE-2013-027); and Securities Exchange Act Release No. 
70011 (July 19, 2013), 78 FR 44994 (July 25, 2013) (SR-CBOE-2013-
074).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-BATS-2013-056) be, and it 
hereby is, approved.
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    \13\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Trading and Markets, pursuant 
to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-28969 Filed 12-3-13; 8:45 am]
BILLING CODE 8011-01-P