Document ID: SEC-2013-1052-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NYSE Arca, Inc.
Posted Date: 2013-06-12T04:00Z

[Federal Register Volume 78, Number 113 (Wednesday, June 12, 2013)]
[Notices]
[Pages 35340-35349]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-13886]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69706; File No. SR-NYSEArca-2013-34]

Self-Regulatory Organizations; NYSE Arca, Inc.; Order Granting 
Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 
2 Thereto, To Implement a One-Year Pilot Program for Issuers of Certain 
Exchange-Traded Products Listed on the Exchange

June 6, 2013.
    On March 21, 2013, NYSE Arca, Inc. (``Exchange'' or ``NYSE Arca'') 
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 
implement the NYSE Arca ETP Incentive Program (``Incentive Program''), 
a one-year pilot program for issuers of certain exchange-traded 
products (``ETPs'') listed on the Exchange. On April 5, 2013, the 
Exchange submitted Amendment No. 1 to the proposed rule change, which 
replaced and superseded the proposed rule change in its entirety.\3\ 
The proposed rule change, as modified by Amendment No. 1, was published 
for comment in the Federal Register on April 11, 2013.\4\ The 
Commission received two comment letters on the proposal.\5\ On May 29, 
2013, the Exchange submitted Amendment No. 2 to the proposed rule 
change.\6\ This order grants approval of the proposed rule change, as 
modified by Amendment Nos. 1 and 2 thereto.\7\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ SR-NYSEArca-2013-34 replaced and superseded SR-NYSEArca-
2012-37, which was withdrawn by the Exchange. See Securities 
Exchange Act Release Nos. 66966 (May 11, 2012), 77 FR 29419 (May 17, 
2012) and 68616 (Jan. 10, 2013), 78 FR 3482 (Jan. 16, 2013) (SR-
NYSEArca-2012-37).
    \4\ See Securities Exchange Act Release No. 69335 (Apr. 5, 
2013), 78 FR 21681 (``Notice'').
    \5\ See Letter from John T. Hyland, Chief Investment Officer, 
United States Commodity Funds LLC, dated Apr. 10, 2013 (``USCF 
Letter''), and Letter from Stanislav Dolgopolov, Assistant Adjunct 
Professor, UCLA School of Law, dated Apr. 26, 2013 (``Dolgopolov 
Letter'').
    \6\ In Amendment No. 2, the Exchange proposed to: (i) amend the 
rule text to provide that an LMM in the Incentive Program will 
remain obligated to satisfy the general requirements of NYSE Arca 
Equities Rule 7.23, rather than the general requirements of NYSE 
Arca Rule 7.23; (ii) amend the rule text to provide that the 
Exchange will disclose on its Web site the date it receives written 
notice of an issuer's intent to withdraw its ETP from the Incentive 
Program, or an LMM's (as defined herein) intent to withdraw from its 
ETP assignment(s) in the Incentive Program, and, in each case, the 
intended withdrawal date, if provided; and (iii) clarify that the 
Exchange's monthly public report to the Commission relating to the 
Incentive Program will (a) compare, to the extent practicable, ETPs 
before and after they are in the Incentive Program, and will further 
provide data and analysis about the market quality of ETPs that 
exceed the one million CADV (as defined herein) threshold and 
``graduate,'' or are otherwise withdrawn or terminated from, the 
Incentive Program, and (b) include market quality data for 
comparable ETPs that are listed on the Exchange but not 
participating in the Incentive Program. Amendment No. 2 provides 
clarification to the proposed rule change, and because it does not 
materially affect the substance of the proposed rule change, 
Amendment No. 2 does not require notice and comment.
    \7\ Today the Commission also is granting exemptive relief from 
Rule 102 under Regulation M concerning the Incentive Program. See 
Securities Exchange Act Release No. 69707 (June 6, 2013) (Order 
Granting a Limited Exemption from Rule 102 of Regulation M 
Concerning the NYSE Arca, Inc.'s Exchange-Traded Product Incentive 
Program Pilot Pursuant to Regulation M Rule 102(e)).
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I. Description of the Proposal

    As set forth in more detail in the Notice,\8\ the Exchange is 
proposing to adopt new NYSE Arca Equities Rule 8.800 and to amend its 
fee schedules to set forth the requirements for the Incentive Program, 
which will be a one-year pilot program for issuers of certain ETPs 
listed on the Exchange.\9\ The Exchange states that the Incentive 
Program is designed to enhance the market quality for ETPs by 
incentivizing Market Makers \10\ to take Lead Market Maker (``LMM'') 
assignments in certain lower volume ETPs by offering an alternative fee 
structure for such LMMs that would be funded from the Exchange's 
general revenues.\11\ The Exchange states that participation in the 
Incentive Program would be entirely voluntary on the part of both LMMs 
and issuers, and that the costs of the Incentive Program would be 
offset by charging participating issuers non-refundable ``Optional 
Incentive Fees,'' which would be credited to the Exchange's general 
revenues.\12\
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    \8\ See Notice, supra note 4.
    \9\ The Exchange currently has two Schedules of Fees and Charges 
for Exchange Services; one that is for listings (``Listing Fee 
Schedule'') and another that is for trade-related charges (``Trading 
Fee Schedule''). To differentiate them, the Exchange also proposes 
to change the name of the Listing Fee Schedule to ``Schedule of Fees 
and Charges for Exchange Listing Services.''
    \10\ A Market Maker is an Equity Trading Permit Holder (``ETP 
Holder'') that acts as a Market Maker pursuant to NYSE Arca Equities 
Rule 7. See NYSE Arca Equities Rule 1.1(v). An ETP Holder is a sole 
proprietorship, partnership, corporation, limited liability company, 
or other organization in good standing that has been issued an 
Equity Trading Permit. See NYSE Arca Equities Rule 1.1(n).
    \11\ See Notice, supra note 4, at 21682.
    \12\ Id.
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A. Eligible Products, Issuer Application, and LMM Assignment

    An ETP will be eligible to participate in the Incentive Program if 
(i) it is listed

[[Page 35341]]

on the Exchange as of the commencement of the pilot period or becomes 
listed during the pilot period; (ii) the listing is under NYSE Arca 
Equities Rules 5.2(j)(3) (Investment Company Units), 5.2(j)(5) (Equity 
Gold Shares), 8.100 (Portfolio Depositary Receipts), 8.200 (Trust 
Issued Receipts), 8.201 (Commodity-Based Trust Shares), 8.202 (Currency 
Trust Shares), 8.203 (Commodity Index Trust Shares), 8.204 (Commodity 
Futures Trust Shares), 8.300 (Partnership Units), 8.600 (Managed Fund 
Shares), or 8.700 (Managed Trust Securities); (iii) with respect to an 
ETP that listed on the Exchange before the commencement of the 
Incentive Program, the ETP has a consolidated average daily volume 
(``CADV'') of one million shares or less for at least the preceding 
three months and the issuer of such ETP has not suspended the issuance 
or redemption of new shares; \13\ and (iv) it is compliant with 
continuing listing standards, if the ETP was added to the Incentive 
Program after listing on the Exchange.\14\
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    \13\ The Exchange maintains a list of ETPs that have suspended 
the issuance of new shares, which is available at https://etp.nyx.com/en/trading-information/us/funds-closed-creation.
    \14\ See proposed NYSE Arca Equities Rule 8.800(a).
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    An issuer that wishes to have an ETP participate in the Incentive 
Program and pay the Exchange an Optional Incentive Fee will be required 
to submit a written application in a form prescribed by the Exchange 
for each ETP.\15\ An issuer may apply to have its ETP participate at 
the time of listing or thereafter at the beginning of each quarter 
during the pilot period.\16\ An issuer may not have more than five ETPs 
that were listed on the Exchange prior to the pilot period participate 
in the Incentive Program.\17\ However, there will be no limitation on 
the number of ETPs per issuer listed during the pilot period that can 
participate in the program.\18\ In order for its ETP to be eligible to 
participate in the Incentive Program, an issuer must be current in all 
payments due to the Exchange.\19\
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    \15\ See proposed NYSE Arca Equities Rule 8.800(b)(1).
    \16\ Id.
    \17\ Id.
    \18\ See Notice, supra note 4, at 21685.
    \19\ See proposed NYSE Arca Equities Rule 8.800(b)(2).
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    Proposed NYSE Arca Equities Rule 8.800(b)(3) provides that the 
Exchange will communicate the ETP(s) proposed for inclusion in the 
Incentive Program on a written solicitation that will be sent to all 
qualified LMMs \20\ along with the Optional Incentive Fee the issuer 
will pay the Exchange for each ETP. The issuer will determine the 
amount of the Optional Incentive Fee for each ETP within a permitted 
range that will be set forth in the Exchange's Listing Fee 
Schedule.\21\ Proposed NYSE Arca Equities Rule 8.800(b)(4) provides 
that after the Exchange provides the written solicitation to LMMs, no 
individual associated with an LMM may contact such issuer or the 
Exchange staff about that ETP until the assignment of the LMM is made, 
except as otherwise permitted in the proposed rules. If more than one 
qualified LMM proposes to serve as such for a particular ETP, Exchange 
staff will select the LMM pursuant to the provisions set forth in the 
proposed rules.\22\ The issuer of the ETP may choose to submit a letter 
to the Exchange staff indicating its preference and supporting 
justification for a particular LMM, and the Exchange staff may consider 
such letter in performing its duty to select an LMM, but such letter 
will not be determinative of the particular LMM selected by the 
Exchange.\23\ Within two business days after the final LMM interview, 
the Exchange staff, in its sole discretion, will select an LMM and 
notify the LMM and the issuer.\24\
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    \20\ The written solicitation will be included in the ``Green 
Sheet,'' which is the common term for an email communication sent by 
Exchange staff members to all qualified LMMs prior to an LMM 
selection. The Green Sheet includes, among other things, the name, 
symbol and description of the ETP(s) as well as the name of the 
issuer and a link to the ETP prospectus. A qualified LMM must 
complete the application for a specific ETP or group of ETPs. See 
Notice, supra note 4, at 21685-6, n.15.
    \21\ See proposed NYSE Arca Equities Rule 8.800(b)(3). See also 
Section I(C) infra for further discussion of the Optional Incentive 
Fee.
    \22\ See proposed NYSE Arca Equities Rule 8.800(b)(5). An LMM 
may provide material to the Exchange staff, which may include a 
corporate overview of the LMM and the trading experience of its 
personnel. Exchange staff will meet with representatives of each LMM 
if requested by the LMM, and no more than three representatives of 
each LMM may participate in the meeting, each of whom must be 
employees of the LMM, and one of whom must be the individual trader 
of the LMM who is proposed to trade the ETP. If the LMM is 
unavailable to appear in person, a telephone interview with that LMM 
would be acceptable. Meetings will normally be held at the Exchange, 
unless the Exchange agrees that they may be held elsewhere. Id.
    \23\ Id.
    \24\ Id. Proposed NYSE Arca Equities Rule 8.800(b)(5) is modeled 
in part on New York Stock Exchange Rule 103B(III)(B)(1), which 
governs Designated Market Maker unit assignments for equities listed 
on the NYSE. See Notice, supra note 4, at 21686, n.20.
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B. Disclosure Relating to the Incentive Program

    Pursuant to proposed NYSE Arca Equities Rule 8.800(b)(6), the 
Exchange will provide notification on a dedicated page on its Web site 
regarding: (i) The ETPs participating in the Incentive Program; (ii) 
the date a particular ETP begins participating and ceases participating 
in the Incentive Program; (iii) the LMM assigned to each ETP 
participating in the Incentive Program; (iv) the date the Exchange 
receives written notice of an issuer's intent to withdraw its ETP from 
the Incentive Program, or an LMM's intent to withdraw from its ETP 
assignment(s) in the Incentive Program, and, in each case, the intended 
withdrawal date, if provided; and (v) the amount of the Optional 
Incentive Fee for each ETP.\25\ This page will also include a fair and 
balanced description of the Incentive Program, including: (i) a 
description of the Incentive Program's operation as a pilot, including 
the effective date thereof; (ii) the potential benefits that may be 
realized by an ETP's participation in the Incentive Program; (iii) the 
potential risks that may be attendant with an ETP's participation in 
the Incentive Program; (iv) the potential impact resulting from an 
ETP's entry into and exit from the Incentive Program; and (v) how 
interested parties can request additional information regarding the 
Incentive Program and/or the ETPs participating therein.\26\
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    \25\ See proposed NYSE Arca Equities Rule 8.800(b)(6). See also 
Amendment No. 2, supra note 6.
    \26\ See proposed NYSE Arca Equities Rule 8.800(b)(6).
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    Under proposed NYSE Arca Equities Rule 8.800(b)(7), an issuer of an 
ETP that is approved to participate in the Incentive Program will be 
required to issue a press release to the public when an ETP commences 
or ceases participation in the Incentive Program. The press release 
will be in a form and manner prescribed by the Exchange, and if 
practicable, will be issued at least two days before the ETP commences 
or ceases participation in the Incentive Program.\27\ The issuer also 
will be required to dedicate space on its Web site, or, if it does not 
have a Web site, on the Web site of the adviser or sponsor of the ETP, 
to (i) include any such press releases and (ii) provide a hyperlink to 
the dedicated page on the

[[Page 35342]]

Exchange's Web site that describes the Incentive Program.\28\
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    \27\ See proposed NYSE Arca Equities Rule 8.800(b)(7). The 
issuer's press release will be required to include language 
describing, for example, that while the impact of participation in 
or exit from the Incentive Program, which is optional, cannot be 
fully understood until objective observations can be made in the 
context of the Incentive Program, potential impacts on the market 
quality of the issuer's ETP may result, including with respect to 
the average spread and average quoted size for the ETP. See Notice, 
supra note 4, at 21686, n.21.
    \28\ See proposed NYSE Arca Equities Rule 8.800(b)(7). The 
disclosure requirements set forth in the proposal would be in 
addition to, and would not supersede, the prospectus disclosure 
requirements under the Securities Act of 1933 or the Investment 
Company Act of 1940. See Notice, supra note 4, at 21686, n.22.
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C. Optional Incentive Fee

    The Exchange proposes to amend its Listing Fee Schedule to provide 
that the Optional Incentive Fee under NYSE Arca Rule 8.800 may 
initially range from $10,000 to $40,000, as determined by the issuer of 
an ETP.\29\ The Optional Incentive Fee for each ETP will be paid by the 
issuer to the Exchange in quarterly installments at the beginning of 
each quarter and prorated if the issuer commences participation for an 
ETP in the Incentive Program after the beginning of a quarter.\30\ If 
an LMM does not meet its performance standards (as described below) for 
an ETP in any given month in such quarter, the issuer would not receive 
any refund or credit from the Exchange following the end of the 
quarter.\31\ If the ETP has a sponsor, the sponsor may pay the Optional 
Incentive Fee to the Exchange.\32\
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    \29\ See proposed Listing Fee Schedule. Optional Incentive Fees 
paid by an issuer will be credited to the Exchange's general 
revenues. An issuer participating in the Incentive Program will 
still be required to pay applicable listing and annual fees. See 
Notice, supra note 4, at 21686, n.16.
    \30\ See proposed Listing Fee Schedule.
    \31\ Id.
    \32\ Id. The term ``sponsor'' means the registered investment 
adviser that provides investment management services to an ETP or 
any of such investment adviser's parents or subsidiaries. Id.
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D. Incentive Program LMM Performance Standards

    Proposed NYSE Arca Equities Rule 8.800(c) describes the proposed 
Incentive Program LMM performance standards (``Incentive Program LMM 
Performance Standards'') that will apply to an LMM for each ETP 
participating in the Incentive Program to which it is assigned. An LMM 
in the Incentive Program also will remain obligated to satisfy the 
general requirements of NYSE Arca Equities Rule 7.23.\33\
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    \33\ See proposed NYSE Arca Equities Rule 8.800(c)(1). See also 
Amendment No. 2, supra note 6.
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    Pursuant to proposed NYSE Arca Equities Rule 8.800(c)(2), an LMM 
will be subject to a ``Market-Wide Requirement.'' Specifically, an LMM 
will be required to maintain quotes or orders at the National Best Bid 
or Offer (``NBBO'') or better (``Inside'') during the month during Core 
Trading Hours in accordance with the following maximum width and 
minimum depth thresholds, which are provided in proposed Commentary .01 
to Rule 8.800.\34\
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    \34\ See proposed NYSE Arca Equities Rule 8.800(c)(2). Proposed 
Commentary .01 to NYSE Arca Equities Rule 8.800 provides that (i) 
the spread thresholds will be calculated as the time-weighted 
average throughout the trading day and then averaged, by day, across 
the month and (ii) the depth thresholds will be calculated as the 
average of (a) the average time-weighted bid depth and (b) the 
average time-weighted ask depth.

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                                                                                                                    Prices ($)
          Daily share volume                  Quote type               Requirement       ---------------------------------------------------------------
                                                                                              0-4.99          5-14.99        15-49.99       50 or more
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0-4,999..............................  Inside..................  Width (%)..............           15.00            6.00            5.00            4.00
                                                                 Depth (sh).............          700             400             300             200
5,000-24,999.........................  Inside..................  Width (%)..............            7.00            3.00            2.00            1.50
                                                                 Depth (sh).............          700             400             300             200
25,000-74,999........................  Inside..................  Width (%)..............            5.00            1.50            1.00            0.70
                                                                 Depth (sh).............          700             400             300             200
75,000-199,999.......................  Inside..................  Width (%)..............            3.00            1.00            0.50            0.30
                                                                 Depth (sh).............          700             400             300             200
200,000-499,999......................  Inside..................  Width (%)..............            2.00            0.60            0.30            0.20
                                                                 Depth (sh).............          700             400             300             200
500,000 or more......................  Inside..................  Width (%)..............            1.00            0.30            0.20            0.10
                                                                 Depth (sh).............         2000            1000             500             300
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However, the Market-Wide Requirement will not apply to an LMM if these 
thresholds are otherwise met by quotes or orders of all market 
participants across all markets trading the ETP.\35\
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    \35\ Id.
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    Pursuant to proposed NYSE Arca Equities Rule 8.800(c)(3), an LMM 
also will be subject to a NYSE Arca-specific requirement, which can be 
satisfied in one of two ways. First, an LMM may satisfy the ``Time-at-
the-Inside Requirement'' under proposed NYSE Arca Equities Rule 
8.800(c)(3)(A), pursuant to which an LMM will be required to maintain 
quotes or orders on the Exchange at the NBBO or better at least 15% of 
the time when quotes may be entered during Core Trading Hours each 
trading day, as averaged over the course of a month.\36\ Alternatively, 
an LMM may choose to satisfy the ``Size-Setting NBBO Requirement'' 
under proposed NYSE Arca Equities Rule 8.800(c)(3)(B), pursuant to 
which an LMM will be required to maintain ``size-setting'' quotes or 
orders on the Exchange, as compared to trading interest on other 
markets, at the NBBO or better at least 25% of the time when quotes may 
be entered during Core Trading Hours each trading day, as averaged over 
the course of a month; provided, however, that the Size-Setting NBBO 
Requirement will not apply to an LMM if this threshold is otherwise met 
by quotes or orders of other market participants on NYSE Arca.\37\
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    \36\ Proposed Commentary .01 to NYSE Arca Equities Rule 8.800 
provides that the Time-at-the-Inside Requirement will be calculated 
as the average of (a) the percentage of time the LMM has a bid on 
the Exchange at the National Best Bid (``NBB'') and (b) the 
percentage of time the LMM has an offer on the Exchange at the 
National Best Offer (``NBO'').
    \37\ Proposed Commentary .01 to NYSE Arca Equities Rule 8.800 
provides that: (i) The Size-Setting NBBO Requirement will be 
calculated throughout the trading day and then averaged, by day, 
across the month; (ii) quotes and orders of all market participants 
across all markets trading the security will be considered when 
calculating the Size-Setting NBBO Requirement; (iii) a quote or 
order will be considered ``size-setting'' if it is at the NBB or 
NBO; (iv) if multiple quotes or orders exist at the same price, the 
quote or order with the largest size will be considered ``size-
setting;'' and (v) if multiple quotes or orders exist at the same 
price and the same size, the quote or order with the earliest entry 
time will be considered ``size-setting.''
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    Finally, under proposed NYSE Arca Equities Rule 8.800(c)(4), for at 
least 90% of the time when quotes may be entered during Core Trading 
Hours each trading day, as averaged over the course of a month, an LMM 
will be required to maintain (A) at least 2,500 shares of attributable, 
displayed posted buy liquidity on the Exchange that is priced no more 
than 2% away from the NBB for the particular ETP, and (B) at least

[[Page 35343]]

2,500 shares of attributable, displayed posted offer liquidity on the 
Exchange that is priced no more than 2% away from the NBO for the 
particular ETP.
    Proposed Commentary .01 to NYSE Arca Equities Rule 8.800 provides 
that only displayed quotes and orders will be considered for purposes 
of the Incentive Program LMM Performance Standards.

E. LMM Payment

    Proposed NYSE Arca Equities Rule 8.800(d) provides that the 
Exchange will credit an LMM for an ``LMM Payment,'' which will be 
determined by the Exchange and set forth in the Trading Fee Schedule. 
An LMM participating in the Incentive Program would not be entitled to 
an LMM Payment unless and until it meets or exceeds the Incentive 
Program LMM Performance Standards for an assigned ETP, as determined by 
the Exchange.\38\ LMM Payments will be paid by the Exchange from its 
general revenues.\39\
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    \38\ See Notice, supra note 4, at 21687.
    \39\ Id.
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    The Exchange proposes to amend its Trading Fee Schedule to provide 
that at the end of each quarter, the Exchange will credit an LMM an LMM 
Payment for each month during such quarter that the LMM meets or 
exceeds its Incentive Program LMM Performance Standards for an assigned 
ETP. If an LMM does not meet or exceed the Incentive Program LMM 
Performance Standards for an assigned ETP for a particular month, or 
the ETP is withdrawn from the Incentive Program, then the LMM Payment 
will be zero for such month.\40\ The amount of the LMM Payment for a 
particular month will not exceed \1/3\ of the quarterly Optional 
Incentive Fee, as determined by the issuer, less an Exchange 
administration fee of 5%.\41\ LMMs participating in the Fixed Incentive 
Program will be subject to the transaction fees and credits applicable 
to ETP Holders and Market Makers for transactions in their assigned 
ETPs during the quarter instead of the LMM transaction fees and 
credits.\42\ If an issuer does not pay its quarterly installments to 
the Exchange on time and the ETP continues to be listed, the Exchange 
will continue to credit the LMM if the LMM meets its Incentive Program 
LMM Performance Standards.\43\
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    \40\ See proposed Trading Fee Schedule.
    \41\ Id.
    \42\ Id. The Exchange currently provides LMMs with an 
opportunity to receive incrementally higher transaction credits and 
incur incrementally lower transaction fees (``LMM Rates'') compared 
to standard liquidity maker-taker rates (``Standard Rates''). See 
Notice, supra note 4, at 21682. LMMs in the Incentive Program would 
be subject to the Standard Rates instead of the LMM Rates. Id. at 
21687.
    \43\ See proposed Trading Fee Schedule.
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F. Withdrawal and Reallocation

    Proposed NYSE Arca Equities Rule 8.800(e) describes the 
circumstances for withdrawal from the Incentive Program. First, if an 
ETP no longer meets continuing listing standards, suspends the creation 
and/or redemption of shares, or liquidates, it will be automatically 
withdrawn from the Incentive Program as of the ETP suspension date.\44\
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    \44\ See proposed NYSE Arca Equities Rule 8.800(e)(1).
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    Second, the Exchange, in its discretion, may allow an issuer to 
withdraw an ETP from the Incentive Program before the end of the pilot 
period if the assigned LMM is unable to meet its Incentive Program LMM 
Performance Standards for any two of the three months of a quarter or 
for five months during the pilot period and no other qualified ETP 
Holder was able to take over the assignment.\45\
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    \45\ See proposed NYSE Arca Equities Rule 8.800(e)(2).
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    Third, an LMM may withdraw from all of its ETP assignments in the 
Incentive Program, or the Exchange, in its discretion, may allow an LMM 
to withdraw from a particular ETP before the end of the pilot period if 
the Exchange determines that there are extraneous circumstances that 
prevent the LMM from meeting its Incentive Program LMM Performance 
Standards for such ETP that do not affect its other ETP assignments in 
the Incentive Program.\46\ In either case, the LMM's ETP(s) will be 
reallocated in accordance with proposed NYSE Arca Equities Rule 
8.800(f) (described below).
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    \46\ See proposed NYSE Arca Equities Rule 8.800(e)(3).
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    Fourth, if an ETP maintains a CADV of one million shares or more 
for three consecutive months, it will be automatically withdrawn from 
the Incentive Program within one month thereafter.\47\ If after such 
automatic withdrawal the ETP fails to maintain a CADV of one million 
shares or more for three consecutive months, the issuer of the ETP may 
reapply for the Incentive Program one month thereafter.\48\
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    \47\ See proposed NYSE Arca Equities Rule 8.800(e)(4).
    \48\ Id.
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    Finally, if the issuer is not current in all payments due to the 
Exchange for two consecutive quarters, its ETP will be automatically 
terminated from the Incentive Program.\49\
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    \49\ See proposed NYSE Arca Equities Rule 8.800(e)(5).
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    Proposed NYSE Arca Equities Rule 8.800(f) describes the LMM 
reallocation process. If the LMM for a particular ETP does not meet or 
exceed its Incentive Program LMM Performance Standards for any two of 
the three months of a quarter or for five months during the pilot 
period, or chooses to withdraw from the Incentive Program, and at least 
one other qualified Market Maker has agreed to become the assigned LMM 
under the Incentive Program, then the ETP will be reallocated and 
another LMM will be solicited and assigned in accordance with proposed 
NYSE Arca Equities Rule 8.800(b).\50\ The reallocation process will be 
completed no sooner than the end of the current quarter and no later 
than the end of the following quarter.\51\
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    \50\ See proposed NYSE Arca Equities Rule 8.800(f).
    \51\ Id.
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G. Implementation of Pilot

    The Incentive Program will be offered to issuers from the date of 
implementation, which will occur no later than 90 days after Commission 
approval of the filing, until one calendar year after 
implementation.\52\ During the pilot period, the Exchange will assess 
the Incentive Program and may expand the criteria for ETPs that are 
eligible to participate, for example, to permit issuers to include more 
than five ETPs that were listed on the Exchange before the pilot period 
commenced.\53\ At the end of the pilot period, the Exchange will 
determine whether to continue or discontinue the Incentive Program or 
make it permanent.\54\
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    \52\ See Notice, supra note 4, at 21688.
    \53\ Id. The Commission notes that any modifications to the 
terms of the proposal would require a rule filing with the 
Commission pursuant to Section 19(b) of the Exchange Act and Rule 
19b-4 thereunder.
    \54\ The Commission notes that any proposed continuance of the 
Program or proposal to make the Program permanent would require a 
rule filing with the Commission pursuant to Section 19(b) of the 
Exchange Act and Rule 19b-4 thereunder.
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    During the Incentive Program, the Exchange will provide the 
Commission with certain market quality reports each month, which will 
also be posted on the Exchange's Web site.\55\ Such reports will 
include the Exchange's analysis regarding the Incentive Program and 
whether it is achieving its goals, as well as market quality data such 
as (for all ETPs listed as of the date of implementation of the 
Incentive Program and listed during the pilot period for comparative 
purposes, including comparable ETPs that are listed on the Exchange but 
not participating in the Incentive Program):

[[Page 35344]]

volume (CADV and NYSE Arca average daily volume); NBBO bid/ask spread 
differentials; LMM participation rates; NYSE Arca market share; LMM 
time spent at the inside; LMM time spent within $0.03 of the inside; 
percent of time NYSE Arca had the best price with the best size; LMM 
quoted spread; LMM quoted depth; and Rule 605 statistics (one-month 
delay).\56\ These reports will also compare, to the extent practicable, 
ETPs before and after they are in the Incentive Program, and will 
further provide data and analysis about the market quality of ETPs that 
exceed the one million CADV threshold and ``graduate,'' or are 
otherwise withdrawn or terminated from, the Incentive Program.\57\ In 
connection with the proposal, the Exchange will provide other data and 
information related to the Incentive Program as may be periodically 
requested by the Commission.\58\ In addition, the Exchange states that 
issuers may utilize ArcaVision to analyze and replicate data on their 
own.\59\
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    \55\ See Notice, supra note 4, at 21688.
    \56\ Id. See also Amendment No. 2, supra note 6.
    \57\ See Amendment No. 2, supra note 6.
    \58\ See Notice, supra note 4, at 21688.
    \59\ Id. NYSE Arca provides ArcaVision free of charge to the 
public via the Web site www.ArcaVision.com. According to the 
Exchange, ArcaVision offers a significant amount of trading data and 
market quality statistics for every Regulation NMS equity security 
traded in the United States, including all ETPs. Publicly available 
reports within ArcaVision, which include relevant comparative data, 
are the Symbol Summary, Symbol Analytics, Volume Comparison and 
Quotation Comparison reports, among others. In addition, users can 
create the reports on a per[hyphen]symbol basis over a flexible time 
frame and can also take advantage of predefined symbol sets based on 
type of ETP or issuer. Users can also create their own symbol lists. 
The Exchange states that ArcaVision allows an ETP issuer to see 
additional information specific to its LMM and other Market Makers 
in each ETP via the ``ArcaVision Market Maker Summary'' reporting 
mechanism. Id.
---------------------------------------------------------------------------

H. Surveillance

    The Exchange represents that its surveillance procedures will be 
adequate to properly monitor the trading of ETPs participating in the 
Incentive Program on the Exchange during all trading sessions and to 
detect and deter violations of Exchange rules and applicable federal 
securities laws.\60\ The Exchange states that trading of the ETPs 
through the Exchange will be subject to FINRA's surveillance procedures 
for derivative products,\61\ and that the Exchange may obtain 
information via the Intermarket Surveillance Group (``ISG'') from other 
exchanges that are members or affiliates of the ISG; and from issuers 
and public and non-public data sources such as, for example, 
Bloomberg.\62\
---------------------------------------------------------------------------

    \60\ See Notice, supra note 4, at 21690.
    \61\ FINRA surveils trading on the Exchange, including ETP 
trading, pursuant to a Regulatory Services Agreement (``RSA''). The 
Exchange is responsible for FINRA's performance under this RSA. Id. 
at 21689, n.29
    \62\ Id. at 21690.
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II. Summary of Comment Letters

    The Commission received two comment letters in support of the 
proposed rule change.\63\ One commenter states that it supports 
regulatory changes that result in more efficient markets for issuers of 
ETPs and thus supports the Incentive Program.\64\ This commenter 
encourages programs that make it possible for all firms to attempt to 
list new and innovative securities in the marketplace and have an 
opportunity to receive adequate support from the market making 
community, as the commenter believes such developments directly benefit 
new entrants, existing small competitors, and investors.\65\ This 
commenter emphasizes that the program is being implemented as a pilot 
and thus will be fairly easy for either the Exchange or the Commission 
to alter or terminate with little or no negative consequences to the 
marketplace.\66\ Further, the commenter states its observation that the 
current market model does not encourage broker/dealers to assume the 
additional responsibilities of being an LMM and that this proposal 
should encourage more market makers to become LMMs.\67\ The commenter 
suggests that the success of the program should be measured by the 
increase in the number of firms willing to act as an LMM under the 
proposal, rather than how tight spreads are in ETPs subject to the 
pilot.\68\
---------------------------------------------------------------------------

    \63\ See USCF Letter and Dolgopolov Letter, supra note 5.
    \64\ See USCF Letter, supra note 5, at 1.
    \65\ Id. at 2.
    \66\ Id. at 1.
    \67\ Id. at 1-2.
    \68\ Id. at 2.
---------------------------------------------------------------------------

    Another commenter points out that several academic studies have 
found that the imposition of market making obligations in exchange for 
certain privileges tends to enhance market quality, resulting in 
improved economic efficiency rather than mere wealth transfers.\69\ 
This commenter states that, to the extent the Incentive Program 
promotes the adoption of trading obligations that enhance liquidity, it 
is likely to promote economic efficiency.\70\ The commenter states that 
while there may be some concerns that payments to market makers 
represent subsidies, this should not necessarily be viewed negatively, 
as studies have shown that the subsidization of liquidity can improve 
economic welfare and increase ``the size of the pie.'' \71\ The 
commenter further argues that a direct subsidy in the form of regular 
payments from issuers/sponsors to market makers, such as the one 
proposed pursuant to the Incentive Program, may have an advantage over 
traditional indirect subsidies provided to market makers (e.g., time or 
information advantages, order flow allocation, etc.), which have 
historically been subject to abuse, insofar as the fees and payments 
under the Incentive Program are transparent and flow through and are 
monitored by the Exchange.\72\ The commenter further states that the 
specificity of the eligibility criteria for LMMs in the proposal should 
mitigate the concern that having just one market maker participant in 
the Incentive Program would be detrimental to competition.\73\ 
Similarly, this commenter recognizes that manipulation is a concern 
with respect to this proposal, but states that the administration and 
monitoring of the Incentive Program by the Exchange is a mitigating 
factor.\74\
---------------------------------------------------------------------------

    \69\ See Dolgopolov Letter, supra note 5, at 3, citing to the 
following studies: Amber Anand & Daniel G. Weaver, The Value of the 
Specialist: Empirical Evidence from the CBOE, 9 J. FIN. MKTS. 100, 
102-04 (2006); Rafi Eldor et al., The Contribution of Market Makers 
to Liquidity and Efficiency of Options Trading in Electronic 
Markets, 30 J. BANKING & FIN. 2025, 2025, 2029-31 (2006); M. 
Nimalendran & Giovanni Petrella, Do Thinly-Traded Stocks Benefit 
from Specialist Intervention?, 27 J. BANKING & FIN. 1823, 1829-30, 
1851-52 (2003); Marios A. Panayides, Affirmative Obligations and 
Market Making with Inventory, 86 J. FIN. ECON. 513, 513 (2007); and 
Narayan Y. Naik & Pradeep K. Yadav, Trading Costs of Public 
Investors with Obligatory and Voluntary Market-Making: Evidence from 
Market Reforms 1, 17, 35 (Eur. Fin. Ass'n, Annual Conference Paper 
No. 408, 2003), available at http://ssrn.com/abstract=424982.
    \70\ See Dolgopolov Letter, supra note 5, at 5.
    \71\ See Dolgopolov Letter, supra note 5, at 2, citing the 
following studies: Kumar Venkataraman & Andrew C. Waisburd, The 
Value of the Designated Market Maker, 42 J. FIN. & QUANT. ANALYSIS 
735 (2007); Kalman J. Cohen et al., The Impact of Designated Market 
Makers on Security Prices, 1 J. BANKING & FIN. 219, 245 (1977); 
Jennifer Huang & Jiang Wang, Market Liquidity, Asset Prices, and 
Welfare, 95 J. FIN. ECON. 107, 109 (2010); Wen Mao & Michael S. 
Pagano, Specialists as Risk Managers: The Competition Between 
Intermediated and Non-Intermediated Markets, 35 J. BANKING & FIN. 
51, 64 (2011); and Johannes A. Skjeltorp & Bernt Arne 
[Oslash]degaard, Why Do Listed Firms Pay for Market Making in Their 
Own Stock? 16, 30 (May 2012) (unpublished manuscript) (on file with 
author), available at http://ssrn.com/abstract=1944057).
    \72\ Id. at 2-3.
    \73\ Id. at 4.
    \74\ Id. at 4-5.
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III. Discussion and Commission Findings

    The Commission has carefully considered the proposed rule change, 
as modified by Amendment Nos. 1 and 2 thereto, and finds that the 
proposed rule change, as modified by Amendment

[[Page 35345]]

Nos. 1 and 2 thereto, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to national 
securities exchanges. In particular, as discussed below, the Commission 
finds that the proposed rule change is consistent with Section 6(b)(4) 
of the Act,\75\ which requires that the rules of a national securities 
exchange provide for the equitable allocation of reasonable dues, fees, 
and other charges among its members and issuers and other persons using 
its facilities, and with Section 6(b)(5) of the Act,\76\ which 
requires, among other things, that the rules of a national securities 
exchange be designed 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, and that the rules not be designed 
to permit unfair discrimination between customers, issuers, brokers, or 
dealers. Further, as required by Section 3(f) of the Act, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation.\77\
---------------------------------------------------------------------------

    \75\ 15 U.S.C. 78f(b)(4).
    \76\ 15 U.S.C. 78f(b)(5).
    \77\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Incentive Program, as proposed to be implemented on a pilot 
basis, is designed to enhance the market quality for certain lower 
volume ETPs participating in the program by incentivizing Market Makers 
to take LMM assignments in such ETPs by offering an alternative fee 
structure for such LMMs. As proposed by the Exchange, to be eligible to 
receive quarterly LMM Payments, an LMM participating in the program 
will be required to comply with the Incentive Program LMM Performance 
Standards, which are higher than the standard quoting requirements 
applicable to Market Makers on the Exchange. Specifically, in addition 
to satisfying the requirements of NYSE Arca Equities Rule 7.23, and 
subject to certain exceptions as further described above, an LMM 
participating in the program will be required to comply with the 
Market-Wide Requirement, and also with either the Time-at-the-Inside 
Requirement or the Size-Setting NBBO Requirement. In addition, an LMM 
participating in the Incentive Program must quote at least 2,500 shares 
of attributable, displayed liquidity within 2% of the NBB or NBO 90% of 
the time during Core Trading Hours. An LMM will receive an LMM Payment 
in an amount not to exceed \1/3\ of the quarterly Optional Incentive 
Fee, less an Exchange administration fee of 5%, for each month the LMM 
meets or exceeds these heightened performance standards. Thus, the 
proposal is designed to incentivize LMMs participating in the Incentive 
Program to quote more often, and in greater quoted size, at the NBBO by 
conditioning the LMM Payment on whether an LMM meets or exceeds the 
Incentive Program LMM Performance Standards, including the Market-Wide 
Requirement, the Time-at-the Inside Requirement or, alternatively, the 
Size-Setting NBBO Requirement, and the additional requirement that an 
LMM must quote at least 2,500 shares of attributable, displayed 
liquidity within 2% of the NBB or NBO 90% of the time during Core 
Trading Hours. As a result, the proposal has the potential to improve 
the market quality of the ETPs that participate in the Incentive 
Program by encouraging LMMs to provide liquidity in such ETPs 
consistent with the Incentive Program LMM Performance Standards.\78\ 
This potential improved market quality, were it to occur, could benefit 
investors in the form of enhanced liquidity, narrowed spreads, and 
reduced transaction costs.
---------------------------------------------------------------------------

    \78\ The Exchange states that when there is an LMM assigned to a 
security listed on NYSE Arca, long-term investors trading on the 
Exchange in the secondary market likely experience enhanced market 
quality compared to similar securities for which there are no LMMs 
assigned. See Notice, supra note 4, at 21683. The Exchange further 
states that in the fourth quarter of 2012, there were 609 ETPs 
listed on NYSE Arca that traded less than 10,000 shares CADV, and of 
those ETPs, 567 had LMMs while 42 did not, and the average spread 
for the ETPs with LMMs was 0.79% and the average quote size was 
3,014 shares, while the average spread for the ETPs without LMMs was 
11.52% and the average quote size was 1,655 shares. Id. In addition, 
the Exchange states that during the same time period, there were 410 
ETPs listed on NYSE Arca that traded between 10,000 shares and 
100,000 shares CADV, and of those ETPs, 396 had LMMs while 14 did 
not, and the average spread for the ETPs with LMMs was 0.23% and the 
average quote size was 6,643 shares, while the average spread for 
ETPs without LMMs was 0.36% and the average quote size was 2,613 
shares. Id. The Exchange maintains that these observations are 
consistent over longer time periods and that there has been a 
greater variance in market quality for ETPs without LMMs. Id. at 
21683-4.
---------------------------------------------------------------------------

    In addition, because the quoted bid-ask spread in a security 
represents one of the main drivers of transaction costs for investors, 
and because high price volatility should generally deter investors from 
trading low-liquidity ETPs, the Incentive Program, were the potential 
benefits of the program to occur, should facilitate a more-efficient 
and less-uncertain trading environment for investors.\79\ Furthermore, 
were the potential benefits of the Incentive Program to occur, 
improving the liquidity of certain low-volume ETPs may lead to both an 
overall increase in ETP trading volume and a redistribution of trading 
volume toward lower-volume ETPs that would not otherwise attract 
sufficient liquidity to successfully participate in the market.
---------------------------------------------------------------------------

    \79\ Transaction costs are generally defined as the penalty that 
an investor pays for transacting. Transaction costs have four 
components: commissions; bid/ask spread; market impact; and 
opportunity cost. See Grinold, Kahn. Active Portfolio Management, 
Second Edition, Chapter 16. An increase in bid-ask spreads will 
inevitably increase the transaction costs of an investor. In 
addition, transactions in low-liquidity securities have a higher 
market impact when compared to other more liquid securities. See 
Albert Kyle's (1985) measure of market impact (Kyle's Lambda), 
defining an inverse relationship between volume and price impact. 
Therefore, the lower the volume of the ETP or stock, the higher the 
market impact of any transaction in that stock. This last effect 
acts as a disincentive to trading that security. Therefore, an 
environment where an ETP trades more often and with a larger number 
of shares will reduce transaction costs both through the narrowing 
of spreads and lower market impact.
---------------------------------------------------------------------------

    While the Commission believes that the Incentive Program has the 
potential to improve market quality of the ETPs participating in the 
program, the Commission is concerned about unintended consequences of 
the Incentive Program. For example, the Incentive Program could have 
the potential to distort market forces because the Incentive Program 
may act to artificially influence trading in ETPs that otherwise would 
not be traded. Similarly, the Commission recognizes concerns about the 
potential negative impact on an ETP participating in the program, such 
as reduced liquidity and wider spreads, when an ETP is withdrawn or 
terminated from the Incentive Program. While the Commission is mindful 
of these concerns, the Commission believes, for the reasons described 
below, that certain aspects of the Incentive Program could help 
mitigate these concerns.
    First, the proposal contains disclosure provisions that will help 
to alert and educate potential and existing investors in the ETPs 
participating in the Program about the program. Specifically, the 
Exchange will disclose on its Web site the following information: (i) 
the ETPs participating in the Incentive Program and the LMM assigned to 
each participating ETP; (ii) the date a particular ETP begins 
participating or ceases participating in the Incentive Program; (iii) 
the date the Exchange receives written notice of an issuer's intent to 
withdraw its ETP from the Incentive Program, or an LMM's intent to 
withdraw from its ETP assignment(s) in the Incentive Program, and, in 
each case, the intended withdrawal date, if

[[Page 35346]]

provided; and (iii) the amount of the Optional Incentive Fee for each 
ETP. The Exchange also will include on its Web site a fair and balanced 
description of the Incentive Program, including a description of the 
potential benefits and risks that may be attendant with an ETP's 
participation in the program. Furthermore, an issuer of an ETP that is 
approved to participate in the Incentive Program will be required to 
issue a press release to the public when an ETP commences or ceases 
participation in the Incentive Program, to post such press release on 
its Web site, and to provide on its Web site a hyperlink to the 
Exchange's Web page describing the Incentive Program. This disclosure 
will help to inform investors and other market participants which ETPs 
are participating in the Incentive Program, which LMMs are assigned to 
each ETP, the amount of Optional Incentive Fee an issuer will incur as 
a result of participating in the Incentive Program, the maximum amount 
of LMM Payments an LMM could potentially receive from the Exchange 
under the Incentive Program, and the potential benefits and risks of 
the program. A wide variety of ETPs are currently listed and trading 
today, and the Commission believes that such disclosure could be 
helpful for investors and other market participants to discern which 
ETPs listed on the Exchange are and are not subject to the Incentive 
Program and to make informed investment decisions with respect to 
ETPs.\80\
---------------------------------------------------------------------------

    \80\ The concurrent exemptive relief the Commission is issuing 
today from Rule 102 under Regulation M concerning the Incentive 
Program also contains additional disclosure requirements. See 
Securities Exchange Act Release No. 69707 (June 6, 2013), supra note 
7.
---------------------------------------------------------------------------

    Second, the Incentive Program is targeted at a subset of ETPs, 
namely those ETPs that are generally less liquid and which the Exchange 
believes might benefit most from the Incentive Program. Specifically, 
as proposed, ETPs that are otherwise eligible for the Incentive Program 
will not be eligible if they have a CADV of more than 1,000,000 shares 
for three consecutive months. Likewise, the Incentive Program will 
terminate with respect to a particular ETP if the ETP sustains a CADV 
of 1,000,000 shares or more for three consecutive months.
    Finally, as proposed by the Exchange, the Incentive Program will be 
limited to a one-year pilot. The Commission believes that it is 
important to implement the Incentive Program as a pilot. Operating the 
Incentive Program as a pilot will allow assessment of whether the 
Incentive Program is in fact achieving its goal of improving the market 
quality of ETPs by incentivizing Market Makers to take LMM assignments, 
prior to any proposal or determination to make the program 
permanent.\81\ In addition, approval on a pilot basis will allow the 
assessment, prior to any proposal or determination to make the program 
permanent, of whether the Incentive Program has any unintended impact 
on the participating ETPs, securities not participating in the program, 
or the market or market participants generally.
---------------------------------------------------------------------------

    \81\ The Exchange would be required to file with the Commission 
any proposal to extend the Incentive Program beyond the pilot period 
or to make the program permanent pursuant to Section 19(b) of the 
Exchange Act and the rules and regulations thereunder. Such a filing 
would be published for comment in the Federal Register pursuant to 
Section 19(b) and Rule 19b-4.
---------------------------------------------------------------------------

    The Exchange has represented that during the pilot it will submit 
monthly reports to the Commission about market quality in respect of 
the Incentive Program and that these reports will be posted on the 
Exchange's public Web site. The Exchange has represented that such 
reports will include the Exchange's analysis regarding the Incentive 
Program and whether it is achieving its goals, as well as market 
quality data for all ETPs listed as of the date of implementation of 
the Incentive Program and listed during the pilot period (for 
comparative purposes, including comparable ETPs that are listed on the 
Exchange but not participating in the Incentive Program) such as volume 
(CADV and NYSE Arca average daily volume), NBBO bid/ask spread 
differentials, LMM participation rates, NYSE Arca market share, LMM 
time spent at the inside, LMM time spent within $0.03 of the inside, 
percent of time NYSE Arca had the best price with the best size, LMM 
quoted spread, LMM quoted depth, and Rule 605 statistics (one-month 
delay). In addition, the Exchange has represented that it will provide 
in the monthly public report to the Commission data and analysis on the 
market quality of ETPs after they exceed the one million CADV threshold 
and ``graduate'' from the program or are otherwise withdrawn or 
terminated from the program. The Exchange also has represented that it 
will provide to the Commission and any other data and information 
related to the Incentive Program as may be periodically requested by 
the Commission in connection with the proposal. In addition, the 
Exchange has represented that issuers may utilize ArcaVision to analyze 
and replicate data on their own.\82\ This information will help the 
Commission, the Exchange, and other interested persons to evaluate 
whether the Incentive Program has resulted in the intended benefits it 
is designed to achieve, any unintended consequences resulting from the 
Incentive Program, and the extent to which the Incentive Program 
alleviates or aggravates the concerns the Commission has noted, 
including previously-stated Commission concerns relating to issuer 
payments to market makers.\83\
---------------------------------------------------------------------------

    \82\ See supra note 59 and accompanying text.
    \83\ See infra notes 86-89 and accompanying text.
---------------------------------------------------------------------------

    For example, the Exchange and the Commission will look to assess 
what impact, if any, there is on the market quality of ETPs that 
withdraw or are otherwise terminated from the Incentive Program. One 
way for an ETP to be terminated from the Incentive Program is if it 
exceeds the 1,000,000 CADV threshold included within the rules.\84\ The 
Commission recognizes that the Incentive Program may not, in the one-
year pilot period, produce sufficient data (i.e., a large number of 
ETPs that enter and exit the Incentive Program) to allow a full 
assessment of whether termination (or withdrawal) of an ETP from the 
program has resulted in any unintended consequences on the market 
quality of the ETP or otherwise. However, the Commission believes that 
the proposal strikes a reasonable balance between (i) setting the 
threshold for ``graduation'' from the Incentive Program high enough to 
encourage participation in the program and (ii) setting the threshold 
low enough to have a sufficient number of ETPs graduate from the 
Incentive Program within the pilot period so that the Exchange, the 
Commission, and other interested persons can assess the impact, if any, 
of the Incentive Program, including ``graduation'' of ETPs from the 
program.
---------------------------------------------------------------------------

    \84\ See proposed NYSE Arca Equities Rule 8.800(e)(4).
---------------------------------------------------------------------------

    Furthermore, the pilot structure of the Incentive Program will 
provide information to help determine whether any provisions of the 
Incentive Program should be modified. For example, based on data from 
the pilot, the Exchange may determine that the 1,000,000 CADV 
termination threshold is not an appropriate threshold on which to base 
eligibility for the program or that the program should be time-limited.
    The Commission believes that the design of the Incentive Program 
and the public disclosure requirements, coupled with implementation of 
the proposal on a pilot basis, should help mitigate potential concerns 
the Commission has noted above relating to any unintended or negative 
effects of the Incentive

[[Page 35347]]

Program on the ETP market and investors.
    The Commission has previously expressed concerns relating to 
payments by issuers to market makers. Financial Industry Regulatory 
Authority (``FINRA'') Rule 5250 (formerly NASD Rule 2460) prohibits 
FINRA members and their associated persons from directly or indirectly 
accepting any payment from an issuer for acting as a market maker.\85\ 
FINRA Rule 5250 was implemented, in part, to address concerns about 
issuers paying market makers, directly or indirectly, to improperly 
influence the price of an issuer's stock and because of conflict of 
interest concerns between issuers and market makers.\86\ FINRA Rule 
5250 was designed to preserve ``the integrity of the marketplace by 
ensuring that quotations accurately reflect a broker-dealer's interest 
in buying or selling a security.'' \87\ Specifically, in the NASD Rule 
2460 Approval Order, the Commission found that the

    ``decision by a firm to make a market in a given security and 
the question of price generally are dependent on a number of 
factors, including, among others, supply and demand, the firm's 
expectations toward the market, its current inventory position, and 
exposure to risk and competition. This decision should not be 
influenced by payments to the member from issuers or promoters. 
Public investors expect broker-dealers' quotations to be based on 
the factors described above. If payments to broker-dealers by 
promoters and issuers were permitted, investors would not be able to 
ascertain which quotations in the marketplace are based on actual 
interest and which quotations are supported by issuers or promoters. 
This structure would harm investor confidence in the overall 
integrity of the marketplace.''\88\
---------------------------------------------------------------------------

    \85\ FINRA has amended Rule 5250 to create an exception for 
payments to members that are expressly provided for under the rules 
of a national securities exchange that are effective after being 
filed with, or filed with and approved by, the Commission pursuant 
to the requirements of the Act. See Securities Exchange Act Release 
No. 69398 (Apr. 18, 2013), 78 FR 24261 (Apr. 24, 2013). This 
amendment to FINRA Rule 5250 became effective May 15, 2013.
    \86\ See Securities Exchange Act Release No. 38812 (July 3, 
1997), 62 FR 37105 (July 10, 1997) (SR-NASD-97-29) (``NASD Rule 2460 
Approval Order''), at 37107.
    \87\ See id. at 37107.
    \88\ See id.

    The Commission also added that ``such payments may be viewed as a 
conflict of interest since they may influence the member's decision as 
to whether to quote or make a market in a security and, thereafter, the 
prices that the member would quote.''\89\
---------------------------------------------------------------------------

    \89\ See id. at 37106.
---------------------------------------------------------------------------

    The Commission believes that a number of aspects of the Incentive 
Program mitigate the concerns that FINRA Rule 5250 was designed to 
address. First, the Commission believes that the terms of the Incentive 
Program are generally objective, clear, and transparent. The standards 
for the Incentive Program are set forth in proposed NYSE Arca Equities 
Rule 8.800 and the Exchange's Listing Fee Schedule and Trading Fee 
Schedule (further described above) \90\ and describe the ETP 
eligibility criteria, application and assignment process, fee and 
payment structure, performance standards that an LMM must meet and 
maintain to secure an LMM Payment, withdrawal and termination 
standards, and LMM reallocation process. These requirements apply to 
all ETPs, issuers, and LMMs participating in the Incentive Program.
---------------------------------------------------------------------------

    \90\ See supra Section I.
---------------------------------------------------------------------------

    Second, the Exchange also will provide notification on its public 
Web site regarding the various aspects of the Incentive Program. As 
discussed above, this disclosure will include: (i) the ETPs 
participating in the Incentive Program and the LMM assigned to each 
participating ETP; (ii) the date a particular ETP begins participating 
or ceases participating in the Incentive Program; (iii) the date the 
Exchange receives written notice of an issuer's intent to withdraw its 
ETP from the Incentive Program, or an LMM's intent to withdraw from its 
ETP assignment(s) in the Incentive Program, and, in each case, the 
intended withdrawal date, if provided; (iv) the amount of the Optional 
Incentive Fee for each ETP; and (v) a fair and balanced description of 
the Incentive Program, including the potential benefits and risks that 
may be attendant with an ETP's participation in the program. In 
addition, an issuer of an ETP participating in the Incentive Program 
will be required to issue a press release when an ETP commences or 
ceases participation in the Incentive Program, to post such press 
release on its Web site, and to provide on its Web site a hyperlink to 
the Exchange's Web page describing the Incentive Program.
    And third, ETPs participating in the Incentive Program will be 
traded on the Exchange, which is a regulated market, pursuant to the 
current trading and reporting rules of the Exchange, and pursuant to 
the Exchange's established market surveillance and trade monitoring 
procedures. The Exchange will administer the application and acceptance 
of the ETPs and LMMs into the Incentive Program and will manage the 
payment of the LMM Payment to LMMs from the Exchange's general 
revenues. An LMM would not be entitled to an LMM Payment unless and 
until it meets or exceed the Incentive Program LMM Performance 
standards for an assigned ETP, as determined by the Exchange. The 
Exchange has represented that the Exchange will be responsible for 
assigning LMMs to particular ETPs, and an issuer's preference will not 
be determinative. Furthermore, the Optional Incentive Fees will be paid 
into the Exchange's general revenues, and the LMM Payments will be paid 
out of the Exchange's general revenues. If an LMM does not meet is 
Incentive Program LMM Performance Standards for an ETP for a given 
month, the issuer will not receive any refund or credit from the 
Exchange. If an issuer does not pay its quarterly installment of the 
Optional Incentive Fee for a particular ETP to the Exchange on time, 
the Exchange will continue to credit the LMM for LMM Payments as long 
as the LMM meets is Incentive Program LMM Performance Standards. The 
Commission believes that these factors, taken together, should help to 
mitigate the conflict of interest and other concerns that the 
Commission has previously identified \91\ relating to issuers paying 
for market making.\92\
---------------------------------------------------------------------------

    \91\ See NASD Rule 2460 Approval Order, supra note 86, and supra 
notes 86-89. See also Securities Act Release No. 6334 (Aug. 6, 
1981), 46 FR 42001 (Aug. 18, 1981), at Section IV.B (Treatment as 
Statutory Underwriter). The Exchange notes that the derivative and 
open-ended nature of many of the ETPs eligible to participate in the 
Incentive Program would allow for transparent intrinsic intraday 
pricing and, as such, the Exchange does not believe such products 
would lend themselves to the type of market manipulation that FINRA 
Rule 5250 was designed to prevent. See Notice, supra note 4, at 
21688-9.
    \92\ Until the amendment to FINRA Rule 5250 to exempt payments 
made pursuant to the rules of a national securities exchange from 
the prohibition on payments by issuers to market makers under FINRA 
Rule 5250 becomes effective, receipt of payments pursuant to the 
Incentive Program by an LMM that is a FINRA member would be in 
violation of FINRA Rule 5250. See supra note 85.
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    The Commission believes that it is reasonable and consistent with 
the Act for the Exchange to limit the Incentive Program to certain 
types of securities to allow the Exchange, through a pilot, to assess 
whether the program will have the desired effect of improving the 
market quality of these securities before implementing the program on a 
permanent basis. The Commission believes that it is reasonable and 
consistent with the Act for the Exchange to limit the Incentive Program 
to products under the 1,000,000 CADV threshold, to support the 
Exchange's stated purpose to ``support the provision

[[Page 35348]]

of consistent liquidity in lower-volume ETPs listed on the 
Exchange.''\93\
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    \93\ See Notice, supra note 4, at 21688. In addition, under the 
proposal an issuer would not be permitted to have more than five 
existing ETPs (i.e., ETPs that are listed on the Exchange prior to 
the pilot) participate in the Incentive Program. The Commission 
believes that it is reasonable and consistent with the Act for the 
Exchange to limit the number of existing ETPs per issuer that may 
participate in the Incentive Program during the pilot period, as all 
issuers participating in the program will be subject to this limit. 
Furthermore, such limit should allow for the analysis of the impact 
of the Fixed Incentive Program during the pilot on eligible ETPs 
participating and not participating in the program, as the number of 
those existing eligible ETPs that may participate in the program 
will be limited.
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    The Commission believes that the Optional Incentive Fees are an 
equitable allocation of reasonable fees. First, participation in the 
Incentive Program is voluntary. An entity is free to determine whether 
it would be economically desirable to pay the Optional Incentive Fee, 
given the permitted range of the fee, the trading characteristics of 
the ETP, and the anticipated benefit. If an issuer chooses to 
participate in the Incentive Program with respect to an ETP, it will 
have the discretion to designate the amount of the Optional Incentive 
Fee it will pay, between $10,000 and $40,000. The Optional Incentive 
Fees will be paid for by either the issuer that has an ETP 
participating in the Incentive Program or the sponsor associated with 
such issuer. Thus, the Optional Incentive Fee will be incurred and paid 
for by an entity that has chosen to participate in, and that may 
potentially benefit from, the Incentive Program.\94\ An entity that 
chooses not to participate will not be required to pay any additional 
fee beyond the standard listing and annual fees. Further, the permitted 
range of Optional Incentive Fees will be the same for any issuer 
wishing to participate in the program.
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    \94\ Issuers of exchange-traded funds registered under the 1940 
Act are prohibited from paying directly or indirectly for 
distribution of their shares (i.e., directly or indirectly financing 
any activity that is primarily intended to result in the sale of 
shares), unless such payments are made pursuant to a plan that meets 
the requirements of Rule 12b-1 under the 1940 Act. Although the 
services at issue could be primarily intended to result in the sale 
of fund shares, the Commission has stated that such a determination 
will depend on the surrounding circumstances. See Payment of Asset-
Based Sales Loads by Registered Open-End Management Investment 
Companies, Investment Company Act Release No. 16431 (June 13, 1988) 
(``1988 12b-1 Release''). As the Commission has noted previously, if 
a fund makes payments that are ostensibly for a non-distribution 
purpose, and the recipient of those payments finances distribution, 
the question arises whether the fund's assets are being used 
indirectly for distribution. The Commission has stated that there 
can be no precise definition of what types of expenditures 
constitute indirect use of fund assets, and this determination is 
based on the facts and circumstances of each individual case. In 
addition, fund directors, particularly independent directors bear 
substantial responsibility for making that judgment. See Bearing of 
Distribution Expenses by Mutual Funds, Investment Company Act 
Release No. 11414 (October 28, 1980).
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    The Commission also believes that allowing the issuer some 
discretion when determining the amount of the Optional Incentive Fee 
amount is consistent with the Act. Not all ETPs are alike, and trading 
in certain products may be riskier or more costly than trading in 
others. The Commission believes that it is reasonable to allow each 
issuer to choose to participate in the program and to determine the 
amount, subject to a permitted range, at which it is desirable to 
incentivize LMMs through the Optional Incentive Fee to improve the 
market quality of ETPs participating in the program. Further, as 
discussed above, the payment of the Optional Incentive Fee will be 
transparent to the marketplace, as this information will be disclosed 
on the Exchange's Web site.

IV. Section 11(d)(1) of the Exchange Act

    Section 11(d)(1) of the Exchange Act \95\ generally prohibits a 
broker-dealer from extending or maintaining credit, or arranging for 
the extension or maintenance of credit, on shares of new issue 
securities, if the broker-dealer participated in the distribution of 
the new issue securities within the preceding 30 days. The Commission's 
view is that shares of open-end investment companies and unit 
investment trusts registered under the 1940 Act, such as ETP shares, 
are distributed in a continuous manner, and broker-dealers that sell 
such securities are therefore participating in the ``distribution'' of 
a new issue for purposes of Section 11(d)(1).\96\
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    \95\ 15 U.S.C. 78k(d)(1).
    \96\ See, e.g., Exchange Act Release Nos. 6726 (Feb. 8, 1962), 
27 FR 1415 (Feb. 15, 1962) and 21577 (Dec. 18, 1984), 49 FR 50174 
(Dec. 27, 1984).
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    The Division of Trading and Markets, acting under delegated 
authority, granted an exemption from Section 11(d)(1) and Rule 11d1-2 
thereunder for broker-dealers that have entered into an agreement with 
an exchange-traded fund's distributor to place orders with the 
distributor to purchase or redeem the exchange-traded fund's shares 
(``Broker-Dealer APs).\97\ The SIA Exemption allows a Broker-Dealer AP 
to extend or maintain credit, or arrange for the extension or 
maintenance of credit, to or for customers on the shares of qualifying 
exchange-traded funds subject to the condition that neither the Broker-
Dealer AP, nor any natural person associated with the Broker-Dealer AP, 
directly or indirectly (including through any affiliate of the Broker-
Dealer AP), receives from the fund complex any payment, compensation, 
or other economic incentive to promote or sell the shares of the 
exchange-traded fund to persons outside the fund complex, other than 
non-cash compensation permitted under NASD Rule 2830(l)(5)(A), (B), or 
(C). This condition is intended to eliminate special incentives that 
Broker-Dealer APs and their associated persons might otherwise have to 
``push'' exchange-traded fund shares.\98\
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    \97\ See Letter from Catherine McGuire, Chief Counsel, Division 
of Trading and Markets, Securities and Exchange Commission to 
Securities Industry Association (Nov. 21, 2005) (``SIA Exemption'').
    \98\ Trading and markets staff provided no-action relief from 
Section 11(d)(1) for broker-dealers engaging in secondary market 
proprietary or customer transactions in securities of Commodity-
based Exchange-Traded Trusts (``CBETTs'') similar to the 
Commission's SIA Exemption. This relief is conditioned on the 
broker-dealer and any natural person associated with the broker-
dealer not receiving from the Fund complex, directly or indirectly, 
any payment, compensation or other economic incentive to promote or 
sell Shares to persons outside of the Fund complex, other than non-
cash compensation permitted under NASD Rule 2830(1)(5)(A), (B), or 
(C). See No-Action Letter re: DB Commodity Index Tracking Fund and 
DB Commodity Services LLC (Jan. 19, 2006); No-Action Letter re: 
Rydex Specialized Products LLC (Dec. 5, 2005); No-Action Letter re: 
streetTRACKS Gold Trust (Dec. 12, 2005); and No-Action Letter re: 
iShares COMEX Gold Trust (Dec. 12, 2005).
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    The Incentive Program will permit certain ETPs to voluntarily incur 
increased listing fees payable to the Exchange. In turn, the Exchange 
will use the fees to make incentive payments to market makers that 
improve the liquidity of participating issuers' securities, and thus 
enhance the market quality for the participating issuers. Incentives 
payments will be accrued for, among other things, executing purchases 
and sales on the Exchange. Receipt of the incentive payments by certain 
broker-dealers will implicate the conditions of the SIA Exemption \99\ 
from the new issue lending restriction in Section 11(d)(1) of the 
Exchange Act discussed above. The Commission's view is that the 
incentive payments market makers will receive under the proposal are 
indirect payments from the fund complex to the market maker and that 
those payments are compensation to promote or sell the shares of the 
ETP. Therefore, a market maker that is also a broker-dealer receiving 
the incentives will not be able to rely on the SIA Exemption from 
Section 11(d)(1).\100\ This does not mean that broker-dealers cannot 
participate in the Incentive Program; it merely means they cannot rely 
on the SIA Exemption \101\ while

[[Page 35349]]

doing so. Thus, broker-dealers that participate in the Incentive 
Program will need to comply with Section 11(d)(1) unless there is 
another applicable exemption.
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    \99\ See also note 98, supra.
    \100\ Id.
    \101\ Id.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\102\ that the proposed rule change (SR-NYSEArca-2013-34), as 
modified by Amendment Nos. 1 and 2 thereto, be, and it hereby is, 
approved.
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    \102\ 15 U.S.C. 78s(b)(2).
    \103\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\103\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-13886 Filed 6-11-13; 8:45 am]
BILLING CODE 8011-01-P