Document ID: SEC-2012-1148-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: BATS Exchange, Inc.
Posted Date: 2012-07-16T04:00Z

[Federal Register Volume 77, Number 136 (Monday, July 16, 2012)]
[Notices]
[Pages 41829-41832]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17199]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67381; File No. SR-BATS-2012-026]

Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of 
Filing of Proposed Rule Change, as Modified by Amendment No. 1, To 
Adopt a New Market Maker Peg Order Available to Exchange Market Makers

July 10, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on June 26, 2012, BATS Exchange, Inc. (``Exchange'' or ``BATS'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items II and III below, which 
Items have been prepared by the Exchange. On July 6, 2012, the Exchange 
submitted Amendment No. 1 to the proposed rule change. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to adopt a new Market Maker Peg Order to 
provide similar functionality as the automated functionality provided 
to market makers under Rule 11.8(e).
    The text of the proposed rule change is available at the Exchange's 
Web site at http://www.batstrading.com, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant parts of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange is proposing to adopt a new Market Maker Peg Order to 
provide similar functionality presently available to Exchange market 
makers under Rule 11.8(e). The Exchange will continue to offer the 
present automated functionality provided to market makers under Rule 
11.8(e) for a period of three months after the adoption of the proposed 
Market Maker Peg Order. The purpose of this transition period, during 
which both the present automated system functionality under Rule 
11.8(e) and the Market Maker Peg Order will operate concurrently, is to 
afford market makers with the opportunity to gradually migrate away 
from the present automated system functionality under Rule11.8(e). 
Prior to the end of this three month period, the Exchange will submit a 
rule filing to retire the automated system functionality under Rule 
11.8(e).
    BATS adopted Rule 11.8(e) as part of an effort to address issues 
uncovered by the aberrant trading that occurred on May 6, 2010.\3\ The 
market maker quoter functionality offered by this rule is designed to 
help Exchange market makers meet the enhanced market maker obligations 
adopted post May 6, 2010,\4\ and avoid execution of market maker ``stub 
quotes'' in instances of aberrant trading.\5\ As part of these

[[Page 41830]]

enhanced obligations, the Exchange requires market makers for each 
stock in which they are registered to continuously maintain a two-sided 
quotation within a designated percentage of the National Best Bid and 
National Best Offer,\6\ as appropriate. Although the market maker 
quoter has been successful in allowing Exchange market makers to meet 
their enhanced obligations and in avoiding the deleterious effect on 
the markets caused by ``stub quote'' executions, the market maker 
quoter presents difficulties to market makers in meeting their 
obligations under Rule 15c3-5 under the Act (the ``Market Access 
Rule'') \7\ and Regulation SHO.\8\
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    \3\ Securities Exchange Act Release No. 63255 (November 5, 
2010), 75 FR 69484 (November 12, 2010) (SR-BATS-2010-025).
    \4\ Id.
    \5\ For each issue in which a market maker is registered, the 
market maker quoter functionality optionally creates a quotation for 
display to comply with market making obligations. Compliant 
displayed quotations are thereafter allowed to rest and are not 
adjusted unless the relationship between the quotation and its 
related national best bid or national best offer, as appropriate, 
either: (a) Shrinks to a specified number of percentage points away 
from the Designated Percentage towards the then current national 
best bid or national best offer, which number of percentage points 
will be determined and published in a circular distributed to 
Members from time to time, or (b) expands to within 0.5% of the 
applicable percentage necessary to trigger an individual stock 
trading pause, whereupon such bid or offer will be cancelled and re-
entered at the Designated Percentage away from the then current 
national best bid and national best offer, or if no national best 
bid or national best offer, at the Designated Percentage away from 
the last reported sale from the responsible single plan processor. 
Quotations independently entered by market makers are allowed to 
move freely towards the national best bid or national best offer, as 
appropriate, for potential execution. In the event of an execution 
against a quote generated pursuant to the market maker quoter 
functionality, the market maker's quote is refreshed on the executed 
side of the market at the applicable Designated Percentage away from 
the then national best bid (offer), or if no national best bid 
(offer), the last reported sale. See Rule 11.8(e).
    \6\ As defined by Regulation NMS Rule 600(b)(42). 17 CFR 
242.600.
    \7\ 17 CFR 240.15c3-5.
    \8\ 17 CFR 242.200 through 204.
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    The Market Access Rule requires a broker-dealer with market access, 
or that provides a customer or any other person with access to an 
exchange or alternative trading system through use of its market 
participant identifier or otherwise, to establish, document, and 
maintain a system of risk management controls and supervisory 
procedures reasonably designed to manage the financial, regulatory, and 
other risks of this business activity. These controls must be 
reasonably designed to ensure compliance with all regulatory 
requirements, which are defined as ``all federal securities laws, rules 
and regulations, and rules of self-regulatory organizations, that are 
applicable in connection with market access.'' \9\
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    \9\ 17 CFR 240.15c3-5.
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    In addition to the obligations of the Market Access Rule, broker-
dealers have independent obligations that arise under Regulation SHO. 
Regulation SHO obligations generally include properly marking sell 
orders, obtaining a ``locate'' for short sale orders, closing out fail 
to deliver positions, and, where applicable, complying with the short 
sale price test.\10\ While there are certain exceptions to some of the 
requirements of Regulation SHO where a market maker is engaged in bona-
fide market making activities,\11\ the availability of those exceptions 
is distinct and independent from whether a market maker submits an 
order that is a Market Maker Peg Order.
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    \10\ Supra note 8.
    \11\ See 17 CFR 242.203(b)(1). The Commission adopted a narrow 
exception to Regulation SHO's ``locate'' requirement for market 
makers that may need to facilitate customer orders in a fast moving 
market without possible delays associated with complying with such 
requirement. Only market makers engaged in bona fide market making 
in the security at the time they effect the short sale are excepted 
from the ``locate'' requirement. See Exchange Act Release No. 50103 
(July 28, 2004), 69 FR 48008, 48015 (August 6, 2004) (providing 
guidance as to what does not constitute bona-fide market making for 
purposes of claiming the exception to Regulation SHO's ``locate'' 
requirement). See also Exchange Act Release No. 58775 (October 14, 
2008), 73 FR 61690, 61698-9 (October 17, 2008) (providing guidance 
regarding what is bona-fide market making for purposes of complying 
with the market maker exception to Regulation SHO's ``locate'' 
requirement including without limitation whether the market maker 
incurs any economic or market risk with respect to the securities, 
continuous quotations that are at or near the market on both sides 
and that are communicated and represented in a way that makes them 
widely accessible to investors and other broker-dealers and a 
pattern of trading that includes both purchases and sales in roughly 
comparable amounts to provide liquidity to customers or other 
broker-dealers). Thus, market makers would not be able to rely 
solely on quotations priced in accordance with the Designated 
Percentages under proposed Rule 11.9(c)(14) [sic] or the market 
maker quoter functionality under Rule 11.8(e) for eligibility for 
the bona-fide market making exception to the ``locate'' requirement 
based on the criteria set forth by the Commission. It should also be 
noted that a determination of bona-fide market making is relevant 
for the purposes of a broker-dealer's close-out obligations under 
Rule 204 of Regulation SHO. See 17 CFR 242.204(a)(3).
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    The current market maker quoter functionality offered to market 
makers reprices and ``refreshes'' a market maker's quote when it is 
executed against, without any action required by the market maker. When 
a market maker's quote is refreshed by the Exchange, however, the 
market maker has an obligation to ensure that the requirements of the 
Market Access Rule and Regulation SHO are met. To meet these 
obligations, a market maker must actively monitor the status of its 
quotes and ensure that the requirements of the Market Access Rule and 
Regulation SHO are being satisfied.
Market Maker Peg Order
    In an effort to simplify market maker compliance with the 
requirements of the Market Access Rule and Regulation SHO, the Exchange 
is proposing to adopt a new order type available only to Exchange 
market makers, which offers functionality similar to the market maker 
quoter functionality, but also allows a market maker to comply with the 
regulatory requirements of the Market Access Rule and Regulation SHO. 
Specifically, the Exchange is proposing to replace the market maker 
quoter functionality with the Market Maker Peg Order. The Market Maker 
Peg Order would be a one-sided limit order and similar to other peg 
orders available to market participants in that the order is tied or 
``pegged'' to a certain price,\12\ but it would not be eligible for 
routing pursuant to Rule 11.13(a)(2) and would always be displayed. The 
Market Maker Peg Order would be limited to market makers and would have 
its price automatically set and adjusted, both upon entry and any time 
thereafter, in order to comply with the Exchange's rules regarding 
market maker quotation requirements and obligations.\13\ It is expected 
that market makers will perform the necessary checks to comply with 
Regulation SHO, as discussed above, prior to entry of a Market Maker 
Peg Order. Upon entry and at any time the order exceeds either the 
Defined Limit, as described in Rule 11.8(d)(2)(E), or moves a specified 
number of percentage points away from the Designated Percentage toward 
the then current National Best Bid or National Best Offer, the Market 
Maker Peg Order would be priced by the Exchange at the Designated 
Percentage \14\ away from the then current National Best Bid and 
National Best Offer. Where there is no National Best Bid or National 
Best Offer, the Market Maker Peg Order would, by default, be priced at 
the Designated Percentage away from the last reported sale from the 
responsible single plan processor, unless instructed by the market 
maker upon entry to cancel or reject where there is no NBB or NBO. In 
the absence of a National Best Bid or National Best Offer and last 
reported

[[Page 41831]]

sale, the order will be cancelled or rejected. Adjustment to the 
Designated Percentage is designed to avoid an execution against a 
Market Maker Peg Order that would initiate an individual stock trading 
pause. In the event of an execution against a Market Maker Peg Order 
that reduces the size of the Market Maker Peg Order below one round 
lot, the market maker would need to enter a new order, after performing 
the regulatory checks discussed above, to satisfy their obligations 
under Rule 11.8.\15\ In the event that pricing the Market Maker Peg 
Order at the Designated Percentage away from the then current National 
Best Bid and National Best Offer, or, if no National Best Bid or 
National Best Offer, to the Designated Percentage away from the last 
reported sale from the responsible single plan processor would result 
in the order exceeding its limit price, the order will be cancelled or 
rejected.
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    \12\ Rule 11.9(c)(8).
    \13\ The Market Maker Peg Order is one-sided so that a market 
maker seeking to use Market Maker Peg Orders to comply with the 
Exchange's rules regarding market maker quotation requirements would 
need to submit both a bid and an offer using the order type.
    \14\ The Designated Percentage is the individual stock pause 
trigger percentage listed in Interpretations and Policies .01 to 
Rule 11.8, less either: (i) two percentage points for securities 
that are included in the S&P 500[supreg] Index, Russell 1000[supreg] 
Index, and a pilot list of Exchange Traded Products and for all 
other NMS stocks with a price equal to or greater than $1 per share; 
or (ii) twenty percentage points for all NMS stocks with a price 
less than $1 per share that are not included in the S&P 500[supreg] 
Index, Russell 1000[supreg] Index, and a pilot list of Exchange 
Traded Products. See Rule 11.8(d)(2)(D).
    \15\ Rule 11.8 generally sets forth the Exchange's market maker 
requirements, which include quotation and pricing obligations.
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    The Exchange is also proposing to allow a market maker to designate 
an offset more aggressive (i.e. smaller) than the Designated Percentage 
for any given Market Maker Peg Order. This functionality will allow a 
market maker to quote at price levels that are closer to the National 
Best Bid and National Best Offer if it elects to do so. To use this 
functionality, upon entry, a market maker must designate the desired 
offset and a percentage away from the NBB or NBO at which the price of 
such bid or offer will be adjusted back to the desired offset (the 
``Reprice Percentage'').\16\ Thereafter,\17\ a Market Maker Peg Order 
with a market maker-designated offset will have its price automatically 
adjusted to the market maker-designated offset from the National Best 
Bid or National Best Offer or last reported sale upon reaching the 
Reprice Percentage.\18\ Identical to the behavior of Market Maker Peg 
Orders using the Defined Percentage and Defined Limit, in the absence 
of a National Best Bid or National Best Offer, Market Maker Peg Orders 
with a market maker-designated offset will, by default, have their 
price adjusted to the Market Maker-designated offset from the price of 
the last reported sale from the responsible single plan processor, or, 
if otherwise instructed by the Market Maker, will be cancelled or 
rejected. In the absence of a National Best Bid or National Best Offer 
and a last reported sale, a Market Maker Peg Order will be cancelled or 
rejected. In the event that pricing the Market Maker Peg Order at the 
market maker-designated offset away from the then current National Best 
Bid or National Best Offer or last reported sale would result in the 
order exceeding its limit price, the order will be cancelled or 
rejected.
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    \16\ If a market maker wishes, it can designate a more 
aggressive bid while using the Defined Percentage and Defined Limit 
for its offer, or vice versa.
    \17\ In the absence of an offset designation and/or Reprice 
Percentage, a Market Maker Peg Order will default to using the 
Defined Percentage and Defined Limit, and the repricing process 
whereby, upon reaching the Defined Limit, the price of a Market 
Maker Peg Order bid or offer will be adjusted by the System to the 
Designated Percentage away from the then current National Best Bid 
or National Best Offer, or, if no National Best Bid or National Best 
Offer, to the Designated Percentage away from the last reported sale 
from the responsible single plan processor.
    \18\ Market Maker Peg Orders with a market maker-designated 
offset may be able to qualify as bona-fide [sic] market making for 
purposes of Regulation SHO, depending on the facts and 
circumstances. A market maker entering such an order must consider 
the factors set forth by the Commission in determining whether 
reliance on the exceptions form the ``locate'' requirement of Rule 
203 for bona-fide market making is appropriate with respect to the 
particular Market Maker Peg Order and its designated offset. See 
supra note 11.
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    The Market Maker Peg Order will be accepted during Regular Trading 
Hours and the Pre-Opening and After Hours Trading Sessions. By default, 
the Market Maker Peg Order will be priced at 9:30 a.m. and will only be 
executable during Regular Trading Hours, however, upon entry, a User 
may direct the Exchange to automatically price and execute a Market 
Maker Peg Order during the Pre-Opening Session \19\ and After Hours 
Trading Session (``Extended Hours Market Maker Peg Orders'').\20\ 
During the Pre-Opening Session and After Hours Trading Session, the 
wider Designated Percentage and Defined Limit associated with the 9:30 
a.m.-9:45 a.m. and 3:35 p.m.-4 p.m. periods under Rule 11.8(e) will be 
applied to Extended Hours Market Maker Peg Orders for which the market 
maker has not designated an offset more aggressive than the Designated 
Percentage.
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    \19\ The Pre-Opening Session means the time between 8 a.m. and 
9:30 a.m. Eastern Time.
    \20\ The After Hours Trading Session means the time between 4 
p.m. and 5 p.m. Eastern Time.
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    BATS believes that this order-based approach is superior in terms 
of the ease in complying with the requirements of the Market Access 
Rule and Regulation SHO while also providing similar quote adjusting 
functionality to its market makers. Market makers would have control of 
order origination, as required by the Market Access Rule, while also 
allowing market makers to make marking and locate determinations prior 
to order entry, as required by Regulation SHO. As such, market makers 
are fully able to comply with the requirements of the Market Access 
Rule and Regulation SHO, as they would when placing any order, while 
also meeting their Exchange market making obligations. In this regard, 
the Market Maker Peg Order, like the current market maker quoter 
functionality, does not ensure that the market maker is satisfying the 
requirements of Regulation SHO, including the satisfaction of the 
locate requirement of Rule 203(b)(1) or an exception thereto.
2. Statutory Basis
    The statutory basis for the proposed rule change is Section 6(b)(5) 
of the Act,\21\ which requires the rules of an exchange 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. The 
proposed rule change also is designed to support the principles of 
Section 11A(a)(1) \22\ of the Act in that it seeks to assure fair 
competition among brokers and dealers and among exchange markets. The 
Exchange believes that the proposed rule meets these requirements in 
that it promotes transparency and uniformity across markets concerning 
minimum market maker quotation requirements and member obligations to 
comply with the regulatory requirements of the Market Access Rule and 
Regulation SHO. The Exchange also believes that providing Exchange 
market makers with a transition period, during which they may 
adequately test the new functionality, will serve to minimize the 
potential market impact caused by the implementation of the order type.
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    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78k-1(a)(1).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change imposes 
any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to

[[Page 41832]]

90 days of such date if it finds such longer period to be appropriate 
and publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will:
    A. By order approve or disapprove such proposed rule change; or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please 
include File Number SR-BATS-2012-026 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-BATS-2012-026. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-BATS-2012-026 and should be 
submitted on or before August 6, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-17199 Filed 7-13-12; 8:45 am]
BILLING CODE 8011-01-P