[Federal Register Volume 77, Number 132 (Tuesday, July 10, 2012)]
[Notices]
[Pages 40673-40682]
[FR Doc No: 2012-16769]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67347; File Nos. SR-NYSE-2011-55; SR-NYSEAmex-2011-84]

Self-Regulatory Organizations; New York Stock Exchange LLC; NYSE
Amex LLC; Order Granting Approval to Proposed Rule Changes, as Modified
by Amendments Nos. 1 and 2, Adopting NYSE Rule 107C To Establish a
Retail Liquidity Program for NYSE-Listed Securities on a Pilot Basis
Until 12 Months From Implementation Date, and Adopting NYSE Amex Rule
107C To Establish a Retail Liquidity Program for NYSE Amex Equities
Traded Securities on a Pilot Basis Until 12 Months From Implementation
Date, and Granting Exemptions Pursuant to Rule 612(c) of Regulation NMS

July 3, 2012.

I. Introduction

    On October 19, 2011, the New York Stock Exchange LLC (``NYSE'') and
NYSE Amex LLC (``NYSE Amex'' and together with NYSE, the ``Exchanges'')
each filed with the Securities and Exchange Commission (``Commission'')
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
establish a Retail Liquidity Program (``Program'') on a pilot basis for
a period of one year from the date of implementation, if approved. The
proposed rule changes were published for comment in the Federal
Register on November 9, 2011.\3\ The Commission received 28 comments on
the NYSE proposal \4\ and 4 comments on the NYSE Amex proposal.\5\ On
December 19, 2011, the Commission extended the time for Commission
action on the proposed rule changes until February 7, 2012.\6\ In
connection

with the proposals, the Exchanges requested exemptive relief from Rule
612 of Regulation NMS,\7\ which among other things prohibits a national
securities exchange from accepting or ranking orders priced greater
than $1.00 per share in an increment smaller than $0.01.\8\ The
Exchanges submitted a consolidated response letter on January 3,
2012.\9\ On January 17, 2012, the Exchanges each filed Amendment No. 1
to their proposals.\10\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release Nos. 65671 (November 2,
2011), 76 FR 69774 (SR-NYSE Amex-2011-84); and 65672 (November 2,
2011), 76 FR 69788 (SR-NYSE-2011-55).
     On May 14, 2012, NYSE Amex filed a proposed rule change,
immediately effective upon filing, to change its name to NYSE MKT
LLC. See SR-NYSEAmex-2012-32. To remain consistent with the previous
documents that were submitted in connection with these proposals,
the Commission will refer to NYSE MKT LLC as NYSE Amex throughout
this order.
    \4\ See Letters to the Commission from Sal Arnuk, Joe Saluzzi
and Paul Zajac, Themis Trading LLC, dated October 17, 2011 (``Themis
Letter''); Garret Cook, dated November 4, 2011 (``Cook Letter'');
James Johannes, dated November 27, 2011 (``Johannes Letter''); Ken
Voorhies, dated November 28, 2011 (``Voorhies Letter''); William
Wuepper, dated November 28, 2011 (``Wuepper Letter''); A. Joseph,
dated November 28, 2011 (``Joseph Letter''); Leonard Amoruso,
General Counsel, Knight Capital, Inc., dated November 28, 2011
(``Knight Letter I''); Kevin Basic, dated November 28, 2011 (``Basic
Letter''); J. Fournier, dated November 28, 2011 (``Fournier
Letter''); Ullrich Fischer, CTO, PairCo, dated November 28, 2011
(``PairCo Letter''); James Angel, Associate Professor of Finance,
McDonough School of Business, Georgetown University, dated November
28, 2011 (``Angel Letter''); Jordan Wollin, dated November 29, 2011
(``Wollin Letter''); Aaron Schafter, President, Great Mountain
Capital Management LLC, dated November 29, 2011 (``Great Mountain
Capital Letter''); Wayne Koch, Trader, Bright Trading, dated
November 29, 2011 (``Koch Letter''); Kurt Schact, CFA, Managing
Director, and James Allen, CFA, Head, Capital Markets Policy, CFA
Institute, dated November 30, 2011 (``CFA Letter I''); David Green,
Bright Trading, dated November 30, 2011 (``Green Letter''); Robert
Bright, Chief Executive Officer, and Dennis Dick, CFA, Market
Structure Consultant, Bright Trading LLC, dated November 30, 2011
(``Bright Trading Letter''); Bodil Jelsness, dated November 30, 2011
(``Jelsness Letter''); Christopher Nagy, Managing Director, Order
Routing and Market Data Strategy, TD Ameritrade, dated November 30,
2011 (``TD Ameritrade Letter''); Laura Kenney, dated November 30,
2011 (``Kenney Letter''); Suhas Daftuar, Hudson River Trading LLC,
dated November 30, 2011 (``Hudson River Trading Letter''); Bosier
Parsons, Bright Trading LLC, dated November 30, 2011 (``Parsons
Letter''); Mike Stewart, Head of Global Equities, UBS, dated
November 30, 2011 (``UBS Letter''); Dr. Larry Paden, Bright Trading,
dated December 1, 2011 (``Paden Letter''); Thomas Dercks, dated
December 1, 2011 (``Dercks Letter''); Eric Swanson, Secretary, BATS
Global Markets, Inc., dated December 6, 2011 (``BATS Letter''); Ann
Vlcek, Director and Associate General Counsel, Securities Industry
and Financial Markets Association, dated December 7, 2011 (``SIFMA
Letter I''); and Al Patten, dated December 29, 2011 (``Patten
Letter'').
    \5\ See Knight Letter I; CFA Letter I; TD Ameritrade Letter; and
letter to the Commission from Shannon Jennewein, dated November 30,
2011 (``Jennewein Letter'').
    \6\ See Securities Exchange Act Release No. 66003, 76 FR 80445
(December 23, 2011).
    \7\ 17 CFR 242.612 (``Sub-Penny Rule'').
    \8\ See Letter from Janet M. McGinness, Senior Vice President-
Legal and Corporate Secretary, Office of the General Counsel, NYSE
Euronext, to Elizabeth M. Murphy, Secretary, Commission, dated
October 19, 2011. The Exchanges amended the exemptive relief request
on January 13, 2012. See Letter from Janet M. McGinness, Senior Vice
President-Legal and Corporate Secretary, Office of the General
Counsel, NYSE Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated January 13, 2012 (``Amended Request for Sub-Penny
Rule Exemption'').
    \9\ See Letter to the Commission from Janet McGinnis, Senior
Vice President, Legal & Corporate Secretary, Legal & Government
Affairs, NYSE Euronext, dated January 3, 2012 (``Exchanges' Response
Letter I'').
    \10\ In Amendment No. 1, the Exchanges propose to modify the
proposals as follows: (1) To state that Retail Member Organizations
may receive free executions for their retail orders and the fees and
credits for liquidity providers and Retail Member Organizations
would be determined based on experience with the Retail Liquidity
Program in the first several months; (2) to correct a typographical
error referring to the amount of minimum price improvement on a 500
share order; (3) to indicate the Retail Liquidity Identifier would
be initially available on each Exchange's proprietary data feeds,
and would be later available on the public market data stream; and
(4) to limit the Retail Liquidity Program to securities that trade
at prices equal to or greater than $1.00 per share.
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    On February 7, 2012, the Commission instituted proceedings to
determine whether to disapprove the proposed rule changes, as modified
by Amendments No. 1.\11\ On February 16, 2012, the Exchanges each filed
Amendment No. 2 to their proposals, which the Commission published for
comment in the Federal Register on March 1, 2012.\12\ In response to
the Order Instituting Proceedings and the Notice of Amendments No. 2,
the Commission received four additional comment letters on the
proposals.\13\ On March 20, 2012, the Exchanges submitted a
consolidated response letter to the Commission's Order Instituting
Proceedings.\14\ Additionally, on April 10, 2012, the Exchanges
submitted a consolidated response to the comments concerning Amendments
No. 2.\15\ Finally, on April 11, 2012, the Exchanges submitted a letter
requesting that the staff of the Division of Trading and Markets not
recommend any enforcement action under Rule 602 of Regulation NMS
(``Quote Rule'') based on the Exchanges' and liquidity providers'
participation in the Program (``No-Action Request Letter'').\16\
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    \11\ See Securities Exchange Act Release No. 66346, 77 FR 7628
(February 13, 2012) (``Order Instituting Proceedings'').
    \12\ See Securities Exchange Act Release No. 66464 (February 24,
2012), 77 FR 12629. In Amendment No. 2, the Exchanges propose to
modify the proposals as follows: (1) Limit the definition of
``Retail Order''; (2) modify the definition of the Retail Liquidity
Identifier; and (3) clarify the treatment of odd lots, round lots,
and part of a round lot order.
    \13\ See Letters to the Commission from Leonard Amoruso, General
Counsel, Knight Capital, Inc., dated March 7, 2012 (``Knight Letter
II''); Kurt Schact, CFA, Managing Director, Rhodri Preece, CFA,
Director, Capital Markets Policy, and James Allen, CFA, Head,
Capital Markets Policy, CFA Institute, dated March 21, 2012 (``CFA
Letter II''); Ann Vlcek, Director and Associate General Counsel,
Securities Industry and Financial Markets Association, dated March
23, 2012 (``SIFMA Letter II''); and Jim Toes, President and CEO, and
Jennifer Green Setzenfand, Chairman, Security Traders Association,
dated April 26, 2012 (``STA Letter'').
    \14\ See Letter to the Commission from Janet McGinnis, Senior
Vice President, Legal & Corporate Secretary, Legal & Government
Affairs, NYSE Euronext, dated March 20, 2012 (``Exchanges' Response
Letter II'').
    \15\ See Letter to the Commission from Janet McGinnis, Senior
Vice President, Legal & Corporate Secretary, Legal & Government
Affairs, NYSE Euronext, dated April 10, 2012 (``Exchanges' Response
Letter III'').
    \16\ See Letter from Janet M. McGinness, Senior Vice President-
Legal and Corporate Secretary, Office of the General Counsel, NYSE
Euronext to Robert Cook, Director, Division of Trading and Markets,
dated April 11, 2012.
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    This order approves the proposed rule change, as modified by
Amendments Nos. 1 and 2, and grants exemptions from the Sub-Penny Rule
sought by the Exchanges in relation to the proposed rule changes.

II. Description of the Proposals

    The Exchanges are proposing to establish a Program on a pilot basis
to attract retail order flow to the NYSE for NYSE-listed securities,
and to NYSE Amex for NYSE Amex-listed securities as well as securities
listed on The NASDAQ Stock Market LLC (``Nasdaq'') and traded pursuant
to unlisted trading privileges (``UTP''). The proposed Program would
allow such order flow to receive potential price improvement, and would
be limited to trades occurring at prices equal to or greater than $1.00
per share.
    Under the proposed Program, a new class of market participants
called Retail Liquidity Providers would be able to provide potential
price improvement, in the form of a non-displayed order that is priced
better than the Exchange's best protected bid or offer (``PBBO''),\17\
called a Retail Price Improvement Order. Other Exchange member
organizations would be allowed, but not required, to submit Retail
Price Improvement Orders. When there is a Retail Price Improvement
Order in a particular security, the Exchange will disseminate an
indicator, known as the Retail Liquidity Identifier, indicating that
such interest exists. In response, a new class of market participants
known as Retail Member Organizations could submit a new type of order,
called a Retail Order, to the Exchange. A Retail Order would interact,
to the extent possible, with available contra-side Retail Price
Improvement Orders.\18\ The Exchanges would approve member
organizations to be Retail Liquidity Providers and/or Retail Member
Organizations.
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    \17\ The terms protected bid and protected offer would have the
same meaning as defined in Rule 600(b)(57) of Regulation NMS. Rule
600(b)(57) of Regulation NMS defines ``protected bid'' and
``protected offer'' as ``a quotation in an NMS stock that: (i) [i]s
displayed by an automated trading center; (ii) [i]s disseminated
pursuant to an effective national market system plan; and (iii) [i]s
an automated quotation that is the best bid or best offer of a
national securities exchange, the best bid or best offer of the
Nasdaq Stock Market, Inc., or the best bid or best offer of a
national securities association other than the best bid or best
offer of the Nasdaq Stock Market, Inc.'' 17 CFR 242.600(b)(57).
    \18\ As explained further below, the Exchanges have proposed
three kinds of Retail Orders, two of which could execute against
other interest if they were not completely filled by contra-side
Retail Price Improvement Order interest. All Retail Orders would
first execute against available contra-side Retail Price Improvement
Orders. Any remaining portion of the Retail Order would then either
cancel, be executed as an immediate-or-cancel order, or be routed to
another market for execution, depending on the type of Retail Order.
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Types of Orders and Identifier

    A Retail Order would be an agency order that originated from a
natural person and not a trading algorithm or any other computerized
methodology. A Retail Order would be an immediate or cancel order. The
Retail Member Organization submitting the order would not be able to
alter the terms of such order with respect to price or side of the
market. A Retail Order could be submitted in a round lot, odd lot, or
partial round lot amounts.
    A Retail Liquidity Provider would be required to submit Retail
Price Improvement Orders for securities that are assigned to the Retail
Liquidity Provider, as further discussed below. A Retail Price
Improvement Order would be required to be priced better than the PBBO
by at least $0.001 per share.
    When a Retail Price Improvement Order is available that is priced
at least $0.001 more than the PBBO for a particular security, the
Exchange would disseminate an identifier, called a Retail Liquidity
Identifier. The Exchanges initially proposed to disseminate the
identifier through their proprietary data feeds; they then amended
their

proposals to state that they would implement the Program in a manner
that allowed the dissemination of the identifier through the
consolidated public market data stream as soon as practicable, and they
now represent that they will in fact be able to disseminate the
identifier through the consolidated public market data stream as soon
as the Program is implemented, if it is approved.\19\ The identifier
would reflect the symbol for a particular security and the side (buy or
sell) of the Retail Price Improvement Order, but it would not include
the price or size of such interest.
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    \19\ See Exchanges' Response Letter III. For UTP eligible
securities traded on NYSE Amex, however, the Exchanges represented
that the identifier will only be available through the Exchanges'
proprietary data feeds until on or about October 1, 2012, at which
time NASDAQ will make the identifier for UTP eligible securities
available through the consolidated public market data stream. See
email from Brendon Weiss, NYSE Euronext, to Steve Kuan, Division of
Trading and Markets, Commission, dated June 26, 2012.
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Retail Member Organizations

    In order to become a Retail Member Organization, an Exchange member
organization must conduct a retail business or handle retail orders on
behalf of another broker-dealer. The member organization must submit an
application with supporting documentation and an attestation to the
Exchange that the order flow would qualify as Retail Orders.
    The Exchange would review the application and notify the member
organization of the Exchange's decision in writing. If a member
organization did not receive approval to become a Retail Member
Organization, then the member organization could appeal as provided
below or reapply 90 days after the Exchange issued the disapproval.
    The Exchange would require a Retail Member Organization to have
written policies and procedures in place to assure that only bona fide
retail orders are designated as such. The written policies and
procedures would require that the Retail Member Organization exercise
due diligence to assure that entry of a Retail Order is in compliance
with the proposed rule, prior to entry of that Retail Order. In
addition, the Retail Member Organization must monitor whether the
Retail Order meets the requirements of the proposed rule.
    If the Retail Member Organization represented the Retail Order from
another broker-dealer, then the Retail Member Organization must have
adequate supervisory procedures to assure that the Retail Order meets
the proposed definition. Every year, the Retail Member Organization
must obtain from each broker-dealer a written representation that the
Retail Orders the broker-dealer sends comply with the proposed rule and
must monitor the broker-dealer's order flow to meet the requirements of
the proposed rule.

Retail Order Interactions

    Under the proposal, a Retail Member Organization submitting a
Retail Order could choose one of three ways for the Retail Order to
interact with available contra-side interest. First, a Retail Order
could interact only with available contra-side Retail Price Improvement
Orders. The Exchange would label this a Type 1 Retail Order and such
orders would not interact with other available contra-side interest in
Exchange systems or route to other markets. Portions of a Type 1 Retail
Order that are not executed would be cancelled.
    Second, a Retail Order could interact first with available contra-
side Retail Price Improvement Orders and any remaining portion would be
executed as a non-routable Regulation NMS-compliant Immediate or Cancel
Order.\20\ The Exchange would label this a Type 2 Retail Order.
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    \20\ Such order would sweep the Exchange's book without being
routed to other markets, and any remaining portion would be
cancelled.
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    Finally, a Retail Order could interact first with available contra-
side Retail Price Improvement Orders and any remaining portion would be
executed as a routable NYSE Immediate or Cancel Order.\21\ The Exchange
would label this a Type 3 Retail Order.
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    \21\ Such order would sweep the Exchange's book and be routed to
other markets and any remaining portion would be cancelled.
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Priority and Allocation

    The Exchange would follow price-time priority, ranking Retail Price
Improvement Orders according to price and then time of entry, without
regard to the size of the order. Executions would occur at the best
price that completes the incoming Retail Order, unless there was not
sufficient Retail Price Improvement interest to fill such order, in
which case the Retail Order would be executed at the price that results
in the greatest fill for that order, consistent with its terms. If
there are remaining Retail Price Improvement Orders, they would be
available for further incoming Retail Orders. As noted above, Retail
Orders not executed would be cancelled.

Retail Liquidity Provider Qualifications and Admission

    To qualify, a member organization must be approved as a Designated
Market Maker \22\ or Supplemental Liquidity Provider \23\ on the
Exchange and demonstrate an ability to meet the requirements of a
Retail Liquidity Provider. Moreover, the member organization must have
mnemonics or the ability to accommodate other Exchange-supplied
designations that identify to the Exchange Retail Liquidity Provider
trading activity in assigned securities.\24\
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    \22\ See NYSE Rule 103 and NYSE Amex Rule 103.
    \23\ See NYSE Rule 107B and NYSE Amex Rule 107B.
    \24\ The member organization would not be allowed to use the
mnemonic or designation for non-Retail Liquidity Provider trading
activities. Further, the member organization would not receive
credit for trading activity as a Retail Liquidity Provider if the
member organization did not use such mnemonic or designation.
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    A member organization must submit an application with supporting
documentation to the Exchange. Thereafter, the Exchange would notify
the member organization as to whether it is approved as a Retail
Liquidity Provider. More than one member organization could act as a
Retail Liquidity Provider for a security, and a member organization
could act as a Retail Liquidity Provider for more than one security. A
member organization could request the Exchange to be assigned certain
securities. Once approved, the member organization must establish
connectivity with relevant Exchange systems prior to trading.
    The Exchange would notify a member organization in writing if the
Exchange does not approve the member organization's application to be a
Retail Liquidity Provider. Such member organization could request an
appeal as provided below. The member organization could also reapply 90
days after the Exchange issues the disapproval notice.
    Once approved as a Retail Liquidity Provider, a member organization
could withdraw by providing notice to the Exchange. The withdrawal
would become effective when the Exchange reassigns the securities to
another Retail Liquidity Provider, but no later than 30 days after the
Exchange receives the withdrawal notice. In the event that the Exchange
takes longer than 30 days to reassign the securities, the withdrawing
Retail Liquidity Provider would have no further obligations under the
proposed rule.

Retail Liquidity Provider Requirements

    The proposed rule changes would impose several requirements on
Retail Liquidity Providers. First, a Retail Liquidity Provider could
enter a Retail

Price Improvement Order electronically into Exchange systems only in
its assigned securities. A Retail Liquidity Provider must maintain
Retail Price Improvement Orders that are better than the PBBO at least
5% of the trading day for each assigned security.
    To calculate the 5% quoting requirement, the Exchange would
determine the average percentage of time a Retail Liquidity Provider
maintains a Retail Price Improvement Order in each assigned security
during the regular trading day on a daily and monthly basis. The
Exchange would use the following definitions. The ``Daily Bid
Percentage'' would be calculated by determining the percentage of time
a Retail Liquidity Provider maintains a Retail Price Improvement Order
priced higher than the best protected bid during each trading day for a
calendar month. The ``Daily Offer Percentage'' would be calculated by
determining the percentage of time a Retail Liquidity Provider
maintains a Retail Price Improvement Order priced lower than the best
protected offer during each trading day for a calendar month. The
``Monthly Average Bid Percentage'' would be calculated for each
security by summing the security's ``Daily Bid Percentages'' for each
trading day in a calendar month, then dividing the resulting sum by the
total number of trading days in such month. The ``Monthly Average Offer
Percentage'' would be calculated for each security by summing the
security's ``Daily Offer Percentages'' for each trading day in a
calendar month, then dividing the resulting sum by the total number of
trading days in such month.
    The proposed rule changes specify that only Retail Price
Improvement Orders entered through the trading day would be used when
calculating the 5% quoting requirements. Further, a Retail Liquidity
Provider would have an initial two-month grace period from the 5%
quoting requirement, so that the Exchange would impose the 5% quoting
requirements on the first day of the third consecutive calendar month
after the member organization began operation as a Retail Liquidity
Provider.

Penalties for Failure to Meet Requirements

    The proposed rule changes provide for penalties when a Retail
Liquidity Provider or a Retail Member Organization fails to meet the
requirements of the rule.
    If a Retail Liquidity Provider fails to meet the 5% quoting
requirements in any assigned security for three consecutive months, the
Exchange, in its sole discretion, may: (1) Revoke the assignment of any
or all of the affected securities; (2) revoke the assignment of
unaffected securities; or (3) disqualify the member organization to
serve as a Retail Liquidity Provider. If the Exchange moves to
disqualify a Retail Liquidity Provider's status, then the Exchange
would notify, in writing, the Retail Liquidity Provider one calendar
month prior to the determination. Likewise, the Exchange would notify
the Retail Liquidity Provider in writing if the Exchange ultimately
determined to disqualify the status of that Retail Liquidity Provider.
As noted earlier, a Retail Liquidity Provider that is disqualified may
appeal as provided below or reapply.
    With respect to Retail Member Organizations, the Exchange could
disqualify a Retail Member Organization if the Retail Orders submitted
by the Retail Member Organization did not comply with the requirements
of the proposed rule. The Exchange would have sole discretion to make
such a determination. The Exchange would provide written notice to the
Retail Member Organization when disqualification determinations are
made. Similar to a disqualified Retail Liquidity Provider, a
disqualified Retail Member Organization could appeal as provided below
or reapply.

Appeal Process

    Under the proposals, the Exchange would establish a Retail
Liquidity Program Panel to review disapproval or disqualification
decisions. An affected member organization would have five business
days after notice to request review. If a member organization is
disqualified as a Retail Liquidity Provider and has appealed, the
Exchange would stay the reassignment of securities pending completion
of the appeal process.
    The Panel would consist of the Exchange's Chief Regulatory Officer
or his or her designee, and two officers of the Exchange as designated
by the co-head of U.S. Listings and Cash Execution. The Panel would
review the appeal and issue a decision within the time frame prescribed
by the Exchange. The Panel's decision would constitute final action by
the Exchange, and the Panel could modify or overturn any Exchange
action taken under the proposed rule.

III. Comment Letters and the Exchanges' Responses

    As noted above, the Commission received a total of 32 comment
letters concerning the NYSE proposal and 7 comment letters concerning
the NYSE Amex proposal, including letters submitted after the
Commission published the Order Instituting Proceedings and Notice of
Amendments No. 2. Several commenters expressed support for some or all
elements of the Exchanges' proposed Program.\25\ For instance, one
commenter expressed general support for the proposals \26\ and another
commenter offered support for the Exchanges' efforts to enhance price
competition for retail customer order flow.\27\ Another commenter was
supportive of the proposals to the extent they promoted transparency,
competition, efficiency, and greater investor choice in the capital
markets.\28\ Two other commenters expressed broad support for the
proposals' potential to benefit individual retail investors.\29\
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    \25\ See Johannes Letter; Knight Letter I; Angel Letter; TD
Ameritrade Letter; UBS Letter; Dercks Letter; and BATS Letter.
    \26\ See TD Ameritrade Letter (stating that the proposals are
``quite appealing'' to the interests of ``fair and transparent
markets that benefit retail investors'' although there were still
specific issues to be addressed).
    \27\ See BATS Letter.
    \28\ See UBS Letter.
    \29\ See Johannes Letter and Dercks Letter.
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    However, a number of commenters raised concerns about the proposed
rule changes. The main areas of concern were: (1) The time and manner
of the Commission's action on the proposed rule changes, given the
potential impact on overall market structure; (2) the proposals' impact
on the Sub-Penny Rule; (3) whether the proposals impede fair access;
and (4) whether the proposals implicate rules and standards relating to
best execution and order protection.

1. Time and Manner of Commission Action

    Several commenters requested that the Commission delay taking
action on the proposals until the Commission has had additional time to
examine the proposals' potential impact on market structure.\30\ For
example, several commenters stated that the issues raised by the
proposals should be considered through Commission rulemaking, rather
than through a self-regulatory organization's proposed rule change,
because of the proposals' impact on the Sub-Penny Rule \31\ as well as
the

competitive landscape of the markets.\32\ Commenters questioned whether
the standard action period applicable to self-regulatory organizations'
proposed rule changes was enough time for the Commission to analyze
relevant data and sufficiently consider the effects the proposals might
have on the equities markets.\33\ Another commenter did not expressly
oppose Commission approval of the proposals on a pilot basis, but
cautioned that to the extent the Commission approves an effective
reduction in the minimum price variation, or ``tick size,'' below
$0.01, the Commission should do so on the basis of industry-wide pilot
studies that test various tick sizes and publish the studies' data for
public review and comment.\34\ Lastly, a commenter requested that the
Commission consider disapproving the proposals while it carefully
studies the potential market impact of the Program; this commenter felt
such delay was warranted in this case because it felt the Program is
not designed to cure a market deficiency, but rather to help the
Exchanges acquire market share.\35\
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    \30\ In contrast, one commenter requested the Commission to
expedite approval of the proposals. See Johannes Letter. Other
commenters did not address issues that specifically related to the
proposals but rather offered general comments about market
structure, particularly computer or high frequency trading. See
Wuepper Letter; Fischer Letter; Cook Letter; Voorhies Letter; Joseph
Letter; Basic Letter; and Jelsness Letter.
    \31\ See Knight Letter I; SIFMA Letter I; SIFMA Letter II; and
STA Letter.
    \32\ See Knight Letter I; Hudson River Trading Letter; Knight
Letter II; and STA Letter.
    \33\ See Knight Letter I and SIFMA Letter I.
    \34\ See Angel Letter. Expressing similar general concerns but
not offering specific comment on the proposal, one commenter urged
the Commission to exercise caution when considering expert testimony
offered by for-profit industry participants as it relates to market
structure regulation. See Themis Letter.
    \35\ See Knight Letter II.
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    The Exchanges responded that the proposed Program is designed to
attract retail order flow to the Exchanges by competing with the
current practices of broker-dealers that internalize much of the
market's retail order flow. Additionally, the Exchanges responded that
the fees and credits they would implement as part of the Program would
be similar to those used by investors in the over-the-counter (``OTC'')
market with retail order flow providers.\36\
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    \36\ See also UBS Letter (stating that the proposed programs
would not necessarily lead to more sub-penny activity, but would
rather shift some of that activity from the over-the-counter markets
to the Exchanges).
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2. Impact on the Sub-Penny Rule

    A number of commenters raised concerns about the proposed Program's
use of sub-penny orders, and its implications with respect to the Sub-
Penny Rule.\37\ One commenter noted that, by accepting and ranking non-
displayed orders in sub-penny increments, the proposals could
discourage liquidity by allowing ``dark'' liquidity to step ahead of
posted limit orders for only a trivial amount.\38\ The same commenter
observed that allowing non-displayed liquidity to gain an execution
advantage over displayed limit orders for trivial per share amounts
could result in wider bid-ask spreads.\39\
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    \37\ The Sub-Penny Rule is codified at 17 CFR 242.612. See supra
note 7.
    \38\ See Angel Letter.
    \39\ See id.
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    Other commenters articulated similar concerns about protecting
public limit orders and public price discovery,\40\ particularly with
respect to institutional and retail investors,\41\ and one commenter
stated that the proposals might lead to a potential increase in sub-
penny trading.\42\ In addition, one commenter pointed out the potential
technical systems and capacity issues that could result from
effectively reducing the minimum price increment from $0.01 to $0.001,
thereby substantially increasing the number of price points between
each dollar level.\43\ Lastly, a commenter stated that any study of the
data generated while the Program was operating on a limited pilot basis
would not be sufficiently meaningful in assessing the broader market
structure impact of these types of proposals.\44\
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    \40\ See Voorhies Letter; Joseph Letter; Fournier Letter; PairCo
Letter; Wollin Letter; Great Mountain Capital Letter; Koch Letter;
CFA Letter I; Green Letter; Bright Trading Letter; TD Ameritrade
Letter; Kenney Letter; Parsons Letter; and BATS Letter.
    \41\ See TD Ameritrade Letter; Knight Letter II; CFA Letter II;
and SIFMA Letter II.
    \42\ See TD Ameritrade Letter.
    \43\ See Knight Letter I. In a second comment letter, Knight
asked whether eliminating the proposed Retail Liquidity Identifier
might remedy the Regulation NMS issues it felt could be implicated
by the dissemination of a message that would signal the presence of
sub-penny quotes on the Exchanges' books. See Knight Letter II.
    \44\ See Knight Letter II.
---------------------------------------------------------------------------

    In response, the Exchanges stated that currently, OTC market makers
internalize retail order flow at negotiated sub-penny prices and not at
their publicly displayed quotes. The Exchanges agree that the market
structure impact of sub-penny executions may warrant further Commission
consideration. However, the Exchanges also believe that the Program
does not raise any new issues with respect to sub-penny executions;
rather it simply seeks to compete for retail order flow within the
current market landscape, while offering potentially greater price
improvement to retail investors and transparency to the marketplace.
    The Exchanges also rejected commenters' concerns about non-
displayed liquidity stepping ahead of displayed limit orders for
insignificant amounts. According to the Exchanges, the Commission's
guidance with respect to the Sub-Penny Rule concerns market
professionals using displayed sub-penny orders to gain execution
priority over customer limit orders. The Exchanges distinguished the
proposed Program by noting that the Retail Liquidity Identifier would
not be priced and Retail Price Improvement Orders would not be
displayed. Accordingly, the Exchanges stated that the Program would
limit its sub-penny activity to sub-penny executions. Similarly, in
response to comments about the consequences of moving the ``tick size''
to $0.001, the Exchanges stated that the ``tick size'' would not in
fact be altered because the sub-penny components of the Program would
not be displayed.
    Finally, in response to the concern that the proposals might lead
to more sub-penny trading, the Exchanges stated that they do not
anticipate such a result because they believe instead that the
proposals would likely reallocate existing retail order flow from
internalizing broker-dealers to the Exchanges. Moreover, the Exchanges
stated that, if the proposals led to additional sub-penny executions
for retail order flow, it would benefit retail investors by creating
additional price competition, and, therefore, greater opportunity for
price improvement, for such retail order flow.

3. Fair Access

    Commenters also highlighted several elements of the Program that
potentially implicate the Commission's rules governing fair access.
First, several commenters raised questions about whether the proposals
would, in essence, create a private market. Some commenters wrote that
the proposed segmentation of retail order flow could amount to unfair
discrimination,\45\ for example, by creating trading interest that
would not be accessible by institutional investors.\46\ One commenter
suggested that the proposed Program would be akin to operating a
limited access dark pool that could have the effect of creating a two-
tiered market.\47\
---------------------------------------------------------------------------

    \45\ See CFA Letter I and Hudson River Trading Letter. At least
one commenter took the opposite view and supported market
participant segmentation programs so long as such segmentation is
done in an objective and transparent manner. See UBS Letter.
    \46\ See SIFMA Letters I and II; see also STA Letter (expressing
concern over the program's differentiation between retail and
institutional order flow, particularly since some individual
investors may utilize managed funds--which may not be classified as
``Retail Member Organizations''--as an investment vehicle).
    \47\ See Knight Letter I.
---------------------------------------------------------------------------

    Some commenters also took issue with the proposals to the extent
that the

Retail Liquidity Identifier would be disseminated only through a
proprietary data feed rather than the public market data stream.\48\
These commenters felt that limiting dissemination of the Retail
Liquidity Identifier to a proprietary data feed could unfairly harm
small firms who do not pay for the proprietary feed \49\ or create a
private, two-tiered market where those who can afford the proprietary
feed can view and potentially obtain the best prices.\50\ Another
commenter suggested that the Program could undermine the Commission's
policies underlying the Quote Rule because the Exchanges would not be
displaying the ``best'' orders they receive, i.e., the sub-penny Retail
Price Improvement Orders that the Exchanges would accept and rank under
the Program.\51\
---------------------------------------------------------------------------

    \48\ See SIFMA Letters I and II and BATS Letter.
    \49\ See SIFMA Letter I.
    \50\ See BATS Letter.
    \51\ See Knight Letter II; see also SIFMA Letter II (stating
that the Identifier would constitute a ``de facto'' quote, and
contending that the Commission should address the Identifier, along
with actionable indications of interest, through Commission
rulemaking).
---------------------------------------------------------------------------

    The Exchanges responded that the proposals do not create a fair
access issue because, in their view, the Retail Liquidity Identifier
does not meet the definition of ``quotation'' under Regulation NMS. In
essence, the Exchanges believe that the Retail Liquidity Identifier
cannot be considered a ``bid'' or ``offer'' because the identifier
would not contain a price. According to the Exchanges, there would be
no fairness issue in signifying the presence of liquidity by
distributing the Retail Liquidity Identifier through a proprietary data
feed, especially because participation in the proposed program would be
discretionary. However, in response to concerns about the dissemination
of the Retail Liquidity Identifier, the Exchanges represented in their
third consolidated response letter that the Retail Liquidity Identifier
would be available through the consolidated public market data stream
immediately upon implementation of the Program, if approved.
    Another issue raised by the commenters relates to the clarity and
transparency of certain defined terms in the proposals. Specifically,
some commenters expressed concern that, under the proposals, the
Exchanges would have too much discretion to certify or approve Retail
Member Organizations and Retail Liquidity Providers, creating the
potential for discriminatory treatment.\52\ Two commenters also stated
that the definition of ``Retail Order,'' which relies on the
representation of the broker sending the order, may not be sufficiently
clear.\53\ One commenter noted that the definition may impose too great
of an administrative burden on participants in the Program, as
participants would be required to surveil their Retail Orders to ensure
that they comply with the proposed requirements.\54\ In response to the
Exchanges' Amendments No. 2, which narrowed the definition of ``Retail
Order,'' one commenter posited that the re-proposed definition was
vague because the phrase providing that orders ``cannot originate from
a trading algorithm or any computerized methodology'' is unclear in
scope.\55\
---------------------------------------------------------------------------

    \52\ See Hudson River Trading Letter; BATS Letter; and SIFMA
Letter II.
    \53\ See Hudson River Trading Letter and Knight Letter I.
    \54\ See Knight Letter I.
    \55\ See SIFMA Letter II.
---------------------------------------------------------------------------

    The Exchanges responded that they would continually monitor and
evaluate all aspects of the Retail Member Organization certification
process during the pilot period. The Exchanges disagreed that the
definition of ``Retail Order'' and the Retail Member Organization
certification process are unclear or not subject to enforcement.
According to the Exchanges, the authentication and certification
procedures, together with the requirement that Retail Member
Organizations have written policies and procedures to assure that they
only submit qualifying retail orders, would result in reliable
identification and segmentation of retail order flow. The Exchanges
also did not believe there were ambiguities in defining a Retail Order
to exclude orders originating from a trading algorithm or computerized
methodology; however, the Exchanges committed to providing interpretive
guidance to any firms that have questions about the definition.
Finally, the Exchanges stated that the Program would be subject to
regulatory review by FINRA pursuant to a regulatory services agreement
with the Exchanges.
    Commenters also raised issues related to access fees. One commenter
suggested that the appropriate amount of access fees would need to be
revisited if the ``tick size'' is reduced from $0.01 to $0.001 because
the maximum allowable fee of $0.003 per share would significantly
increase in relation to the minimum pricing increment.\56\ Another
commenter noted that the proposals could open the door to revisiting
whether access fees may be included in quotes, assuming the Program
leads to sub-penny quotations.\57\ Finally, one commenter questioned
whether the proposals would result in true price competition because
non-Retail Liquidity Providers would likely be charged higher access
fees for executions with Retail Orders than Retail Liquidity Providers,
and would most likely not be able to quote as aggressively as Retail
Liquidity Providers as a result.\58\
---------------------------------------------------------------------------

    \56\ See Knight Letter I.
    \57\ See SIFMA Letter I.
    \58\ See BATS Letter.
---------------------------------------------------------------------------

    The Exchanges responded that approval of the proposals does not
require reexamination of any access fee issue. The Exchanges noted that
there would be no visible prices disseminated as part of the program
and expressed the view that the proposals did not contemplate
``quotes'' subject to the Commission's fair access rules. Given that
the proposals did not contemplate ``quotes,'' the Exchanges also
contended that a broker's obligations under Regulation NMS would not
require it to route a retail order to the Exchanges to interact with a
Retail Price Improvement Order. Finally, the Exchanges believe that the
proposals comport with the principles behind the Commission's access
rules because they intend to welcome broad participation in the
Program.

4. Best Execution

    Several commenters took the position that the Program would
complicate broker-dealers' best execution duties. According to one
commenter, the Exchanges' dissemination of the Retail Liquidity
Identifier would raise a number of issues, including whether broker-
dealers would be required to route to the Exchanges when they see a
Retail Liquidity Identifier; whether, if other exchanges were to adopt
similar proposals and disseminate flags similar to the Retail Liquidity
Identifier, a broker-dealer would be required to sweep all liquidity
inside the spread before executing at the NBBO; whether the Exchanges
would be required to route Retail Orders they receive to other market
centers if those away markets offered the possibility of further price
improvement; and whether broker-dealers would be required to subscribe
to the Exchanges' proprietary feeds to be able to receive the Retail
Liquidity Identifier.\59\
---------------------------------------------------------------------------

    \59\ See Knight Letter I; see also SIFMA Letter II (raising
similar questions about broker-dealers' best execution obligations).
---------------------------------------------------------------------------

    Another commenter questioned whether, if other exchanges were to
adopt competing programs and disseminate flags similar to the Retail

Liquidity Identifier over their proprietary feeds, a broker-dealer
would be required to subscribe to each proprietary feed in order to
fill its best execution obligations.\60\ Relatedly, another commenter
stated that the proposals would result in confusion among broker-
dealers unsure of how the dissemination of the Retail Liquidity
Identifier would affect their smart order routing.\61\ Finally, one
commenter suggested that FINRA's best execution and interpositioning
rules would need to be updated to reflect the fact that Retail
Liquidity Identifiers would be widely disseminated yet not accessible
by non-retail clients.\62\
---------------------------------------------------------------------------

    \60\ See BATS Letter.
    \61\ See SIFMA Letters I and II.
    \62\ See UBS Letter.
---------------------------------------------------------------------------

    The Exchanges responded that they believe the proposals do not
raise any best execution challenges that are not already confronted by
broker-dealers in the current market environment. The Exchanges stated
that best execution is a facts and circumstances determination and
requires many factors to be considered.\63\
---------------------------------------------------------------------------

    \63\ See Exchanges' Response Letter I (citing Securities
Exchange Act Release No. 43590 (November 17, 2000), 65 FR 75414
(December 1, 2000) (Disclosure of Order Execution and Routing
Practices Adopting Release)).
---------------------------------------------------------------------------

    One commenter also raised related concerns about the proposals'
potential impact on broker-dealer obligations under FINRA Rule 5320,
also known as the ``Manning'' rule.\64\ FINRA Rule 5320 generally
prohibits broker-dealers from trading ahead of their customer orders.
The commenter noted that firms that both offer Retail Price Improvement
Orders and accept customer orders will likely find themselves in a
position where they must fill the customer order at a loss, assuming
their Retail Price Improvement Orders get executed before the customer
order.\65\
---------------------------------------------------------------------------

    \64\ See Knight Letter I.
    \65\ See id. In an example offered by the commenter, assume the
NYSE best bid and offer is 10.01 x 10.02. A non-Retail Liquidity
Provider, that also handles retail customer orders, posts a Retail
Price Improvement bid at $10.015 for 500 shares. The Retail Price
Improvement order executes against an eligible Retail Order, and
buys 500 shares at $10.015. If that non-Retail Liquidity Provider
also holds a customer limit order to buy 500 shares at $10.01, the
commenter states that the non-RLP would be obligated, under the
current Manning rule, to sell the 500 shares to its client at
$10.01--losing $0.005 per share in the process.
---------------------------------------------------------------------------

    In response to this comment, the Exchanges stated that the Manning
obligations of a Retail Liquidity Provider would be no different from
the obligations on an OTC market maker that internalizes orders. The
Exchanges stated that OTC market makers commonly rely on the ``no-
knowledge'' exception contained in Supplementary Material .02 of FINRA
Rule 5320 to separate their proprietary trading from their handling of
customer orders. The Exchanges expressed their view that this exception
should be equally applicable to Retail Liquidity Providers
participating in the Program.

IV. Discussion and Commission Findings

    After careful review of the proposals, the comment letters
received, and the Exchanges' responses, the Commission finds that the
proposed rule changes are consistent with the requirements of the Act
and the rules and regulations thereunder that are applicable to a
national securities exchange. In particular, the Commission finds that
the proposed rule changes, subject to their terms as pilots, are
consistent with Section 6(b)(5) of the Act,\66\ which requires, among
other things, that the rules of a national securities exchange be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in securities, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest; and not be
designed to permit unfair discrimination between customers, issuers,
brokers or dealers.
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission finds that the Program, as it is proposed on a pilot
basis, is consistent with the Act because it is reasonably designed to
benefit retail investors by providing price improvement to retail order
flow. The Commission also believes that the Program could promote
competition for retail order flow among execution venues, and that this
could benefit retail investors by creating additional price improvement
opportunities for their order flow. Currently, most marketable retail
order flow is executed in the OTC markets, pursuant to bilateral
agreements, without ever reaching a public exchange. The Commission
recently noted that ``a very large percentage of marketable
(immediately executable) order flow of individual investors'' is
executed, or ``internalized,'' by broker-dealers in the OTC
markets.\67\ A recent review of the order flow of eight retail brokers
revealed that nearly 100% of their customer market orders were routed
to OTC market makers.\68\ The same review found that such routing is
often done pursuant to arrangements under which retail brokers route
their order flow to certain OTC market makers in exchange for payment
for such order flow.\69\ To the extent that the Program may provide
price improvement to retail orders that equals what would be provided
under such OTC internalization arrangements, the Program could benefit
retail investors. To better understand the Program's potential impact,
data concerning such potential investor benefit, including the level of
price improvement provided by the Program, will be submitted by the
Exchanges and would be reviewed by the Commission prior to any
extension of the Program beyond the proposed one-year pilot term, or
permanent approval of the Program.
---------------------------------------------------------------------------

    \67\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity
Market Structure'').
    \68\ See id.
    \69\ See id.
---------------------------------------------------------------------------

    The Program proposes to create additional price improvement
opportunities for retail investors by segmenting retail order flow on
the Exchanges and requiring liquidity providers that want to interact
with such retail order flow to do so at a price at least $0.001 per
share better than the Protected Best Bid or Offer. As noted above, some
commenters questioned the fairness of treating retail order flow
differently from other order flow on an exchange by offering price
improvement opportunities only to retail orders. Commenters also raised
several concerns relating to the way the Program proposes to define and
identify retail order flow.
    In this case, the Commission finds that while the Program would
treat retail order flow differently from order flow submitted by other
market participants, such segmentation would not be inconsistent with
Section 6(b)(5) of the Act, which requires that the rules of an
exchange are not designed to permit unfair discrimination.\70\ The
Commission has previously recognized that the markets generally
distinguish between individual retail investors, whose orders are
considered desirable

by liquidity providers because such retail investors are presumed on
average to be less informed about short-term price movements, and
professional traders, whose orders are presumed on average to be more
informed.\71\ The Commission has further recognized that, because of
this distinction, liquidity providers are generally more inclined to
offer price improvement to less informed retail orders than to more
informed professional orders.\72\ Absent opportunities for price
improvement, retail investors may encounter wider spreads that are a
consequence of liquidity providers interacting with informed order
flow. By creating additional competition for retail order flow, the
Program is reasonably designed to attract retail order flow to the
exchange environment, while helping to ensure that retail investors
benefit from the better price that liquidity providers are willing to
give their orders. Certain commenters also expressed concern that the
Program could create a private market or otherwise impede fair
access.\73\ In this regard, the Commission notes that the Retail
Liquidity Identifier will be disseminated through the consolidated
public market data stream, and thus be widely viewable by market
participants, and that members of the Exchanges that would not
otherwise participate as Retail Liquidity Providers would be able to
participate in the Program by submitting Retail Price Improvement
Orders.
---------------------------------------------------------------------------

    \70\ The comment letters and the Exchanges' responses contained
extensive discussion of whether the Program's proposed Retail
Liquidity Identifier constitutes a ``quote'' which would be subject
to Rule 610 of Regulation NMS. That rule, known as the ``Fair Access
Rule,'' contains a similar prohibition on unfair discrimination. The
Commission finds that the Program is not unfairly discriminatory
under both Section 6(b)(5) of the Act and Rule 610 of Regulation
NMS. Because the Commission has determined that the Program is not
unfairly discriminatory pursuant to Rule 610, it need not determine
whether the Retail Liquidity Identifier is a ``quote'' for purposes
of Rule 610.
    \71\ See Concept Release on Equity Market Structure, supra note
67; see also Securities Exchange Act Release No. 64781 (June 30,
2011), 76 FR 39953 (July 7, 2011) (approving a program proposed by
an options exchange that would provide price improvement
opportunities to retail orders based, in part, on questions about
execution quality of retail orders under payment for order flow
arrangements in the options markets).
     While certain commenters expressed concern that institutional
investors, including those that invest money on behalf of individual
retail clients, would not be eligible to qualify as Retail Member
Organizations and submit Retail Orders, the Commission notes that
institutional investors tend to be more informed than retail
investors. See supra note 46.
    \72\ See Securities Exchange Act Release No. 64781 (June 30,
2011), 76 FR 39953 (July 7, 2011) (noting that ``it is well known in
academic literature and industry practice that prices tend to move
against market makers after trades with informed traders, often
resulting in losses for market makers,'' and that such losses are
often borne by uninformed retail investors through wider spreads
(citing H.R. Stoll, ``The supply of dealer services in securities
markets,'' Journal of Finance 33 (1978), at 1133-51; L. Glosten & P.
Milgrom, ``Bid ask and transaction prices in a specialist market
with heterogeneously informed agents,'' Journal of Financial
Economics 14 (1985), at 71-100; and T. Copeland & D. Galai,
``Information effects on the bid-ask spread,'' Journal of Finance 38
(1983), at 1457-69)).
    \73\ See supra notes 45 through 51 and accompanying text.
---------------------------------------------------------------------------

    As noted above, certain commenters questioned the fairness of
preventing institutional investors from submitting Retail Orders, and
thus receiving price improvement on their orders.\74\ In this regard,
the Commission notes that the Program might create a desirable
opportunity for institutional investors to interact with retail order
flow that they are not able to reach currently. Member organizations
that are not Retail Liquidity Providers can seek to interact with
Retail Orders by submitting Retail Price Improvement Orders. Today,
institutional investors often do not have the chance to interact with
marketable retail orders that are executed pursuant to internalization
arrangements. Thus, institutional investors, if they participate in the
Program by submitting Retail Price Improvement Orders, may be able to
reduce their possible adverse selection costs by interacting with
retail order flow previously unavailable to them.
---------------------------------------------------------------------------

    \74\ See supra notes 45 through 47 and accompanying text.
---------------------------------------------------------------------------

    The Commission does not share the concern expressed by several
commenters that the Program will cause a major shift in market
structure. Instead, the Commission believes the Program should closely
replicate the trading dynamics that exist in the OTC markets and will
simply present another competitive venue for retail order flow
execution. While some commenters stated that the Program would
potentially increase sub-penny trading, the Commission believes that
the Program will likely reallocate existing retail order flow from the
OTC markets to the Exchanges, and is not likely to alter the incentives
for market participants to post limit orders in a material way, given
that liquidity providers already interact with most retail order flow
in non-displayed markets.\75\ In this regard, however, the Commission
notes that it is approving the Program on a pilot basis, and will
monitor the Program throughout the pilot period for its potential
effects on public price discovery, and on the broader market structure.
---------------------------------------------------------------------------

    \75\ For the same reasons, the Commission does not believe that
the Program will create any best execution challenges that are not
already present in today's markets. A broker's best execution
obligations are determined by a number of facts and circumstances,
including (1) The character of the market for the security (e.g.,
price, volatility, relative liquidity, and pressure on available
communications); (2) the size and type of transaction; (3) the
number of markets checked; (4) accessibility of the quotation; and
(5) the terms and conditions of the order which result in the
transaction. See FINRA Rule 5310; see also Disclosure of Order
Execution and Routing Practices Adopting Release, supra note 633. A
broker would consider the Program when conducting this analysis.
    Furthermore, with respect to the scope of FINRA Rule 5320 (the
``Manning'' rule), the Commission notes that the Manning obligations
of a Retail Liquidity Provider likely would not be appreciably
different from the current obligations of an OTC market maker that
internalizes orders.
---------------------------------------------------------------------------

    When the Commission is engaged in rulemaking or the review of a
rule filed by a self-regulatory organization, and is required to
consider or determine whether an action is necessary or appropriate in
the public interest, the Commission shall also consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\76\ As discussed above,
the Commission believes that this Program will promote competition for
retail order flow, by allowing Exchange members, either as Retail
Liquidity Providers, or on an ad hoc basis, to submit Retail Price
Improvement Orders to interact with Retail Orders. Such competition may
promote efficiency by facilitating the price discovery process.
Moreover, the Commission does not believe that the Program will have a
significant effect on market structure, or will create any new
inefficiencies in current market structure. Finally, to the extent the
Program is successful in attracting retail order flow, it may generate
additional investor interest in trading securities, thereby promoting
capital formation.
---------------------------------------------------------------------------

    \76\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission also believes that the Program is sufficiently
tailored to provide the benefits of potential price improvement only to
bona fide retail order flow originating from natural persons.\77\ The
Commission finds that the Program provides an objective process by
which a member organization could become a Retail Member Organization
or a Retail Liquidity Provider, and for appropriate oversight by the
Exchanges to monitor for continued compliance with the terms of these
provisions. The Exchanges have limited the definition of Retail Order
to an agency order that originates from a natural person and not a
trading algorithm or any other computerized methodology.

Furthermore, a Retail Order must be submitted by a Retail Member
Organization that is approved by the Exchanges. In addition, Retail
Member Organizations would be required to maintain written policies and
procedures to help ensure that they designate as Retail Orders only
those orders which qualify under the Program. If a member's application
to become a Retail Member Organization or a Retail Liquidity Provider
is denied by the Exchange, that member may appeal that determination or
re-apply. Similarly, a Retail Liquidity Provider that is disqualified
for failing to meet its quoting requirements may appeal or re-apply to
the Program. The Commission believes that these standards should help
ensure that only retail order flow is submitted into the Program and
thereby promote just and equitable principles of trade and protect
investors and the public interest, while also providing an objective
process through which members may become Retail Member Organizations or
Retail Liquidity Providers. The Commission also notes that the
Exchanges have represented that they would continually monitor all
aspects of the Retail Member Organization certification process during
the pilot period, and that the Program would be subject to regulatory
review by FINRA pursuant to a regulatory services agreements with the
Exchanges.
---------------------------------------------------------------------------

    \77\ In addition, the Commission believes that the Program's
provisions concerning the certification, approval, and potential
disqualification of Retail Member Organizations and Retail Liquidity
Providers are not inconsistent with the Act. These provisions, which
contain appeal procedures for adverse decisions against those who
seek to become Retail Member Organizations or who are disqualified
from their status as such, are substantially similar to provisions
in the Exchanges' rules establishing the Supplemental Liquidity
Provider Program. See NYSE Rule 107B(j)-(k) and NYSE Amex Rule
107B(i)-(j).
---------------------------------------------------------------------------

    In addition, the Commission finds that the Program's proposed
dissemination of a Retail Liquidity Identifier would increase the
amount of pricing information available to the marketplace and is
consistent with the Act. The identifier would be disseminated through
the consolidated public market data stream \78\ to advertise the
presence of a Retail Price Improvement Order with which Retail Orders
could interact. The identifier would reflect the symbol for a
particular security and the side of the Retail Price Improvement Order
interest, but it would not include the price or size of such interest.
The identifier would alert market participants to the existence of a
Retail Price Improvement Order and should provide market participants
with more information about the availability of price improvement
opportunities for retail orders than is currently available.\79\ Given
the benefits of adding this information to the marketplace, the
Commission believes that the Identifier is an appropriate part of the
Program.\80\
---------------------------------------------------------------------------

    \78\ Certain commenters expressed concerns that the original
proposals' plan to limit dissemination of the Retail Liquidity
Identifier to the Exchanges' proprietary data feeds was unfair. See
supra notes 48 through 50 and accompanying text. In this regard, the
Commission notes that the Exchanges have committed to making the
Retail Liquidity Identifier immediately available through the
consolidated public market data stream for securities listed on NYSE
and NYSE Amex, and have represented that the Retail Liquidity
Identifier for UTP eligible securities should be available through
the consolidated public market data stream in on or about October 1,
2012. See supra note 19.
    \79\ As noted above, certain commenters questioned whether
dissemination of the Retail Liquidity Identifier would be compatible
with the Quote Rule. See supra note 51. In connection with the
proposals, the Exchanges have requested that the staff of the
Commission not recommend enforcement action to the Commission,
either against the Exchanges or Retail Liquidity Providers, under
the Quote Rule relating to the kind of information disseminated
through Retail Liquidity Identifier. See Letter from Janet M.
McGinness, Senior Vice President--Legal and Corporate Secretary,
Office of the General Counsel, NYSE Euronext to Robert Cook,
Director, Division of Trading and Markets, dated April 11, 2012. The
staff has determined to grant the Exchanges' No Action request
pursuant to a letter which is also being issued today. See Letter
from David Shillman, Associate Director, Division of Trading and
Markets, to Janet McGinness, Senior Vice President--Legal and
Corporate Secretary, Office of the General Counsel, NYSE Euronext,
dated July 3, 2012.
    \80\ Although one commenter stated that the Retail Liquidity
Identifier should be eliminated from the Program, as it was
``tantamount to displaying sub-penny quotations in the lit
markets,'' see Knight Letter II, for the reasons discussed below,
the Commission believes that the benefits of the Program justify
granting exemptive relief from Rule 612(c) of Regulation NMS. See
also SIFMA Letter II (urging the Commission to address sub-penny
quoting through the rulemaking process rather than an exemptive
request specific to a market participant).
---------------------------------------------------------------------------

    Lastly, some commenters questioned whether the exchange rule filing
process was an appropriate means to introduce the Program, given the
Program's impact on broader market structure, and the limited timeframe
in which the Commission would be able to consider the Program and
comments thereto. Given that the Program involves modifying the
Exchanges' trading rules to create new order types and categories of
members, however, the Commission believes that the Program was
appropriately proposed through the rule filing process pursuant to
Section 19(b)(1) of the Act. In addition, the Commission does not
believe that the Program is likely to significantly impact market
structure because the Program is designed to replicate the trading
dynamics that exist in the OTC markets and will simply present another
competitive venue for retail order flow execution.
    Furthermore, the Commission notes that it is approving the Program
on a pilot basis. Approving the Program on a pilot basis will allow the
Exchanges and market participants to gain valuable practical experience
with the Program during the pilot period. This experience should allow
the Exchanges and the Commission to determine whether modifications to
the Program are necessary or appropriate prior to any Commission
decision to approve the Program on a permanent basis. The Exchanges
also have agreed to provide the Commission with a significant amount of
data that should assist the Commission in its evaluation of the
Program. Specifically, the Exchanges have represented that they ``will
produce data throughout the pilot, which will include statistics about
participation, the frequency and level of price improvement provided by
the Program, and any effects on the broader market structure.'' The
Commission expects that the Exchanges will monitor the scope and
operation of the Program and study the data produced during that time
with respect to such issues, and will propose any modifications to the
Program that may be necessary or appropriate.
    The Commission also welcomes additional comments, and empirical
evidence, on the Program during the pilot period to further assist the
Commission in its evaluation of the Program.\81\ The Commission notes
that any permanent approval of the Program would require a proposed
rule change by the Exchanges, and such rule change will provide an
opportunity for public comment prior to further Commission action.\82\
---------------------------------------------------------------------------

    \81\ For instance, one commenter noted the need for market
participants to consider the impact that the Program will have on a
number of factors, including trading technologies and capacity,
operational costs, execution quality, liquidity, and gaming. See
Knight Letter I. The Commission would welcome data from market
participants on these topics, as well as any others, during the
pilot period.
    \82\ One comment suggested that the Program should only be
considered in tandem with industry-wide pilot studies on tick size.
See Angel Letter. As discussed above, the Commission believes that
the proposals are properly considered through the rule filing
process, and expects to monitor and study data produced during the
Program's pilot term.
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V. Exemption From the Sub-Penny Rule

    Pursuant to its authority under Rule 612(c) of Regulation NMS,\83\
the Commission hereby grants each Exchange a limited exemption from the
Sub-Penny Rule to operate the Program. For the reasons discussed below,
the Commission determines that such action is necessary or appropriate
in the public interest, and is consistent with the protection of
investors. The exemptions shall operate for a period of 12 months,
coterminous with the effectiveness of the proposed rule changes
approved today.
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    \83\ 17 CFR 242.612(c).
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    When the Commission adopted the Sub-Penny Rule in 2005, it
identified a

variety of problems caused by sub-pennies that the Sub-Penny Rule was
designed to address:
     If investors' limit orders lose execution priority for a
nominal amount, investors may over time decline to use them, thus
depriving the markets of liquidity.
     When market participants can gain execution priority for a
nominal amount, important customer protection rules such as exchange
priority rules and the Manning Rule could be undermined.
     Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to
satisfy their best execution obligations and other regulatory
responsibilities.
     Widespread sub-penny quoting could decrease market depth
and lead to higher transaction costs.
     Decreasing depth at the inside could cause institutions to
rely more on execution alternatives away from the exchanges,
potentially increasing fragmentation in the securities markets.\84\
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    \84\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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    At the same time, the Commission ``acknowledge[d] the possibility
that the balance of costs and benefits could shift in a limited number
of cases or as the markets continue to evolve.'' \85\ Therefore, the
Commission also adopted Rule 612(c), which provides that the Commission
may grant exemptions from the Sub-Penny Rule, either unconditionally or
on specified terms and conditions, if it determined that such exemption
is necessary or appropriate in the public interest, and is consistent
with the protection of investors.
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    \85\ Id. at 37553.
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    The Commission believes that the Exchanges' proposal raises such a
case. As described above, under the current market structure, few
marketable retail orders in equity securities are routed to exchanges.
The vast majority of marketable retail orders are internalized by OTC
market makers, who typically pay retail brokers for their order flow.
Retail investors can benefit from such arrangements to the extent that
OTC market makers offer them price improvement over the NBBO. Price
improvement is typically offered in sub-penny amounts.\86\ An
internalizing broker-dealer can offer sub-penny executions, provided
that such executions do not result from impermissible sub-penny orders
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or
accepting orders from retail customers seeking that exact price.
Exchanges--and exchange member firms that submit orders and quotations
to exchanges--cannot compete for marketable retail order flow on the
same basis, because it would be impractical for exchange electronic
systems to generate sub-penny executions without exchange liquidity
providers or retail brokerage firms having first submitted sub-penny
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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    \86\ When adopting the Sub-Penny Rule, the Commission considered
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their
customers, but declined to do so. The Commission stated that
``trading in sub-penny increments does not raise the same concerns
as sub-penny quoting'' and that ``sub-penny executions due to price
improvement are generally beneficial to retail investors.'' Id. at
37556.
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    The limited exemptions granted today should promote competition
between exchanges and OTC market makers in a manner that is reasonably
designed to minimize the problems that the Commission identified when
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will
not be disseminated through the consolidated quotation data stream,
which should avoid quote flickering and its reduced depth at the inside
quotation. Furthermore, while the Commission remains concerned about
providing enough incentives for market participants to display limit
orders, the Commission does not believe that granting this exemption
(and approving the accompanying proposed rule changes) will reduce such
incentives. Market participants that display limit orders currently are
not able to interact with marketable retail order flow because it is
almost entirely routed to internalizing OTC market makers that offer
sub-penny executions. Consequently, enabling the Exchanges to compete
for this retail order flow through the Program should not materially
detract from the current incentives to display limit orders, while
potentially resulting in greater order interaction and price
improvement for marketable retail orders. To the extent that the
Program may raise Manning and best execution issues for broker-dealers,
these issues are already presented by the existing practices of OTC
market makers.
    The exemptions being granted today are limited to a one-year pilot.
The Exchanges have stated that ``sub-penny trading and pricing could
potentially result in undesirable market behavior,'' and therefore they
will ``monitor the Program in an effort to identify and address any
such behavior.'' \87\ Furthermore, the Exchanges have represented that
they ``will produce data throughout the pilot, which will include
statistics about participation, the frequency and level of price
improvement provided by the Program, and any effects on the broader
market structure.'' \88\ The Commission expects to review the data and
observations of the Exchanges before determining whether and, if so,
how to extend these exemptions from the Sub-Penny Rule.\89\
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    \87\ Amended Request for Sub-Penny Rule Exemption, supra note 8,
at 4, n. 6.
    \88\ Id.
    \89\ In particular, the Commission expects the Exchanges to
observe how maker/taker transaction charges, whether imposed by the
Exchanges or by other markets, might impact the use of the Program.
Market distortions could arise where the size of a transaction
rebate, whether for providing or taking liquidity, is greater than
the size of the minimum increment permitted by the Program ($0.001
per share).
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VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\90\ that the proposed rules changes (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84), as modified by Amendments Nos. 1 and 2, be and hereby are,
approved on a one-year pilot basis.
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    \90\ 15 U.S.C. 78s(b)(2).
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    It is also hereby ordered that, pursuant to Rule 612(c) of
Regulation NMS, each Exchange is given a limited exemption from Rule
612 of Regulation NMS allowing it to accept and rank orders priced
equal to or greater than $1.00 per share in increments of $0.001, in
the manner described in the proposed rule changes above, on a one-year
pilot basis coterminous with the effectiveness of the proposed rule
changes.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\91\
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    \91\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-16769 Filed 7-9-12; 8:45 am]
BILLING CODE 8011-01-P