[Federal Register Volume 83, Number 58 (Monday, March 26, 2018)]
[Proposed Rules]
[Pages 13008-13078]
[FR Doc No: 2018-05545]

Vol. 83

Monday,

No. 58

March 26, 2018

Part II

 Securities and Exchange Commission

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17 CFR Parts 200 and 242

 Transaction Fee Pilot for NMS Stocks; Proposed Rule

Federal Register / Vol. 83 , No. 58 / Monday, March 26, 2018 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200 and 242

[Release No. 34-82873; File No. S7-05-18]
RIN 3235-AM04

Transaction Fee Pilot for NMS Stocks

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing to conduct a Transaction Fee Pilot for National
Market System (``NMS'') stocks to study the effects that transaction-
based fees and rebates may have on, and the effects that changes to
those fees and rebates may have on, order routing behavior, execution
quality, and market quality more generally. The data generated by the
proposed pilot should help inform the Commission, as well as market
participants and the public, about any such effects and thereby
facilitate a data-driven evaluation of the need for regulatory action
in this area.

DATES: Comments should be received on or before May 25, 2018.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include
File Number S7-05-18 on the subject line.

Paper Comments

     Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.

All submissions should refer to File Number S7-05-18. 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 website (http://www.sec.gov/rules/proposed.shtml).
Comments are also available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549-1090 on official business days between the hours of 10:00 a.m.
and 3:00 p.m. All comments received will be posted without change.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Richard Holley III, Assistant
Director; Johnna Dumler, Special Counsel; Erika Berg, Special Counsel;
or Benjamin Bernstein, Attorney-Advisor, each with the Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549, or at<PHONE_NUMBER>.

SUPPLEMENTARY INFORMATION: The Commission is proposing to adopt Rule
610T to establish a Transaction Fee Pilot.

Table of Contents

I. Overview
II. Transaction Fees
    A. Background
    B. Calls for a Pilot
    C. Comments on the EMSAC Recommendation
III. Discussion of the Proposed Pilot
    A. Applicable Trading Centers
    B. Securities
    C. Proposed Pilot Design
    1. Test Group 1
    2. Test Group 2
    3. Test Group 3
    4. Control Group
    D. Duration
    E. Data
    1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
    2. Exchange Transaction Fee Summary
    3. Order Routing Data
    F. Implementation Period
IV. Paperwork Reduction Act
    A. Summary of Collection of Information
    1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
    2. Exchange Transaction Fee Summary
    3. Order Routing Data
    B. Proposed Use of Information
    C. Respondents
    D. Total Initial and Annual Reporting and Recordkeeping Burdens
    1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
    2. Exchange Transaction Fee Summary
    3. Order Routing Data
    E. Collection of Information is Mandatory
    F. Confidentiality of Responses to Collection of Information
    G. Retention Period for Recordkeeping Requirements
    H. Request for Comments
V. Economic Analysis
    A. Background on Transaction-Based Fees and Potential Conflicts
of Interest
    1. Overview of Transaction-Based Fees
    2. Potential Conflicts of Interest
    B. Baseline
    1. Current Information Baseline
    2. Current Market Environment
    C. Analysis of Benefits and Costs of Proposed Transaction Fee
Pilot
    1. Benefits of Proposed Transaction Fee Pilot
    2. Costs of Proposed Transaction Fee Pilot
    D. Impact on Efficiency, Competition, and Capital Formation
    1. Efficiency
    2. Competition
    3. Capital Formation
    E. Alternatives
    1. Expand Proposed Transaction Fee Pilot To Include ATSs
    2. Trade-At Test Group
    3. No Overlap With Tick Size Pilot
    4. Adjustments to the Proposed Transaction Fee Pilot Structure
    F. Request for Comment
VI. Consideration of Impact on the Economy
VII. Regulatory Flexibility Analysis
VIII. Statutory Authority and Text of the Proposed Rule

I. Overview

    As an integral part of its oversight of the U.S. equities markets,
where liquidity is dispersed across a large number of trading centers
that are linked through technology and regulation into a national
market system, the Commission assesses market developments, including
changes in technology and business practices, as it seeks to ensure
that the current regulatory framework continues to effectively and
efficiently promote fair and orderly markets, investor protection, and
capital formation. From a regulatory perspective, today's equity market
structure has been shaped by, among other things, Regulation NMS,
adopted in 2005, which established the regulatory framework within
which the markets transitioned from a primarily manual to a primarily
automated trading environment.\1\ Among other things, Regulation NMS
put in place order protection requirements to govern intermarket
trading in an electronically linked world of dispersed markets, and
supplemented those requirements with rules addressing fair and
efficient access to quotations and limits on fees charged to access
newly protected quotations.\2\ Subsequent to the adoption of Regulation
NMS, market practices, aided by technological innovation, including
advancements in data

management and analysis, and competition, have continued to evolve.
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    \1\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37543-46 (June 29, 2005) (``NMS Adopting
Release'').
    \2\ See id.
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    Since the adoption of Regulation NMS, the Commission and its staff
have undertaken a number of reviews of market structure and market
events.\3\ In addition, the Commission has focused on initiatives to
preserve the operational integrity of markets and market participants
\4\ and pursued a number of initiatives to enhance regulatory oversight
of the markets, improve the information available to market
participants about execution activity and the operation of Alternative
Trading Systems (``ATSs''), and explored options to improve how equity
market structure works for small companies.\5\
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    \3\ See, e.g., Securities Exchange Act Release No. 61358
(January 14, 2010), 75 FR 3594, 3600 and 3603 (January 21, 2010)
(``Concept Release'') (evaluating broadly the performance of market
structure since Regulation NMS, particularly for long-term investors
and for businesses seeking to raise capital, and soliciting comment
on whether regulatory initiatives to improve market structure are
needed). See also Findings Regarding the Market Events of May 6,
2010 (September 30, 2012), available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf (a report of the staffs of the
Commission and the Commodity Futures Trading Commission to the Joint
Advisory Committee on Emerging Regulatory Issues on the events of
May 6, 2010 (the ``Flash Crash''), which analyzed the extraordinary
volatility experienced on that day and market participant behavior
in response thereto). In response to lessons learned during the
Flash Crash, the Commission and the self-regulatory organizations
(``SROs'') focused on a number of critical market structure
initiatives, including single stock circuit breakers for select NMS
stocks and the Limit Up-Limit Down Plan successor thereto, which now
serves as the primary volatility moderator in the U.S. equity
markets. See, e.g., Securities Exchange Act Release Nos. 62252 (June
10, 2010), 75 FR 34186 (June 16, 2010) (File Nos. SR-BATS-2010-014;
SR-EDGA-2010-01; SR-EDGX-2010-01; SR-BX-2010-037; SR-ISE-2010-48;
SR-NYSE-2010-39; SR-NYSEAmex-2010-46; SR-NYSEArca-2010-41; SR-
NASDAQ-2010-061; SR-CHX-2010-10; SR-NSX-2010-05; SR-CBOE-2010-047)
(order approving rule changes to provide for trading pauses in
individual stocks when the price moves ten percent or more in the
preceding five minute period); 62251 (June 10, 2010), 75 FR 34183
(June 16, 2010) (File No. SR-FINRA-2010-025) (order approving a rule
to permit a halt trading otherwise than on an exchange where a
primary listing market has issued a trading pause due to
extraordinary market conditions); and 67091 (May 31, 2012), 77 FR
33498 (June 6, 2012) (File No. 4-631) (order approving, on a pilot
basis, the national market system plan to address extraordinary
market volatility).
    \4\ See Securities Exchange Act Release Nos. 63241 (November 3,
2010), 75 FR 69792 (November 15, 2010) (File No. S7-03-10) (Market
Access Rule) and 73639 (November 19, 2014), 79 FR 72252 (December 5,
2014) (File No. S7-01-13) (Regulation Systems Compliance and
Integrity).
    \5\ See Securities Exchange Act Release Nos. 79318 (November 15,
2016), 81 FR 84696 (November 23, 2016) (File No. 4-698) (order
approving the National Market System Plan Governing the Consolidated
Audit Trail); 78309 (July 13, 2016), 81 FR 49431 (July 27, 2016)
(File No. S7-14-16) (proposed amendments to Rule 606 of Regulation
NMS that would require broker-dealers to disclose additional data to
their customers on their routing and execution of institutional
orders); 76474 (November 18, 2015), 80 FR 80997 (December 28, 2015)
(File No. S7-23-15) (proposed rule concerning operational
transparency and regulatory oversight of ATSs); and 74892 (May 6,
2015), 80 FR 27514, 27517-18 (May 13, 2015) (File No. 4-657) (order
approving the NMS Plan to Implement a Tick Size Pilot Program)
(``Tick Size Pilot Approval Order'').
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    In addition, the Equity Market Structure Advisory Committee
(``EMSAC'') provided the Commission with diverse perspectives on the
structure and operations of the U.S. equities markets, as well as
advice and recommendations on matters related to equity market
structure.\6\ In particular, the EMSAC's recommendations helped to
shape the proposal contained herein--namely, a pilot program to produce
data on the effect of equity exchange transaction fees and rebates, and
changes to those fees and rebates, on order routing behavior, execution
quality, and market quality. Informed by EMSAC's recommendation, the
Commission believes that an appropriately constructed pilot should
provide a valuable source of data to facilitate an informed data-driven
discussion about potential alternative approaches to prevailing fee
structures.
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    \6\ The EMSAC was a Federal Advisory Committee established as a
broad-based group of experts charged with providing the Commission
recommendations on a range of complex market structure issues. See
Securities Exchange Act Release No. 74092 (January 20, 2015), 80 FR
3673 (January 23, 2015) (File No. 265-29). See also Equity Market
Structure Advisory Committee--Subcommittees, available at https://www.sec.gov/spotlight/equity-market-structure/equity-market-structure-advisory-committee-subcommittees.htm. The EMSAC and its
four subcommittees discussed a variety of equity market structure
issues, including Regulation NMS, trading venue regulation, market
quality, and customer issues. One of the EMSAC's subcommittees
focused exclusively on Regulation NMS, especially Rule 610(c)
(access fees) and Rule 611 (order protection), and considered
whether parts of Regulation NMS should be updated in light of the
evolution of technology, markets, and market participants. As part
of its ongoing review of market structure, the Commission is
considering the EMSAC's recommendations as it assesses potential
changes to Regulation NMS.
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    The discussion below references various types of ``trading
centers,'' which is a collective term that refers broadly to the venues
that trade NMS stocks.\7\ For purposes of this release, the term
``trading center'' includes national securities exchanges that are
registered with the Commission and that trade NMS stocks (referred to
herein as ``equities exchanges'' or ``exchanges''), as well as other
types of ``non-exchange venues'' that trade NMS stocks, including ATSs
and broker-dealers that internalize orders by matching them off-
exchange with reference to the national best bid and offer.\8\ As
discussed below, the proposed Pilot would apply only to equities
exchanges.
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    \7\ See 17 CFR 242.600(b)(78) (defining ``trading center'' as
``a national securities exchange or national securities association
that operates an SRO trading facility, an alternative trading
system, an exchange market maker, an OTC market maker, or any other
broker or dealer that executes orders internally by trading as
principal or crossing orders as agent.'').
    \8\ See 17 CFR 242.600(b)(42) (defining ``national best bid and
national best offer'').
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II. Transaction Fees

A. Background

    Exchanges and other trading centers aggregate orders to buy and
sell securities from market participants and have historically charged
their members and users fees when they match an order to buy against an
order to sell, at which point an execution occurs. As competition among
trading centers intensified in the late 1990s, ATSs, and then
exchanges, began to offer rebates to attract order flow.\9\ The
predominant model that has emerged in the U.S. equities markets is the
``maker-taker'' fee model, in which, on the one hand, a trading center
pays its broker-dealer participants a per share rebate to provide
(i.e., ``make'') liquidity in securities and, on the other hand, the
trading center assesses them a fee to remove (i.e., ``take'')
liquidity.\10\ The trading center earns as revenue the difference
between the fee paid by the ``taker'' of liquidity and the rebate paid
to the provider or ``maker'' of liquidity. In a variation on this
theme, some other trading centers have adopted a ``taker-maker''
pricing model (also called an inverted model), in which they charge

the provider of liquidity and pay a rebate to the taker of
liquidity.\11\
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    \9\ See, e.g., Memorandum on Maker-Taker Fees on Equities
Exchanges from the Commission's Division of Trading and Markets to
the Market Structure Advisory Committee (October 20, 2015),
available at https://www.sec.gov/spotlight/emsac/memo-maker-taker-fees-on-equities-exchanges.pdf (outlining the development of the
maker-taker fee model in the U.S. and summarizing the current public
debate about its impact on equity market structure) (``Staff Maker-
Taker Memo''). The memo traces the development of transaction fees
and summarizes the potential benefits and limitations of maker-taker
pricing by presenting market participants' divergent views.
    \10\ See id. New fees that an exchange seeks to impose on its
members or persons using its facilities are effective on the day
that the exchange files them with the Commission, and neither
advance notice nor Commission action is required before an exchange
may implement a fee change. See 15 U.S.C. 78s(b)(3)(A)(ii). Though
Form 19b-4 fee filings are not subject to Commission approval, the
Commission may, within 60 days after an exchange filed its fee
change with the Commission, summarily suspend the new fee and
institute proceedings to determine whether to disapprove it. See 15
U.S.C. 78s(b)(3)(C). Exchange fees are subject to the statutory
standards set forth in Section 6 of the Securities Exchange Act of
1934 (``Exchange Act''), which require, among other things, that an
exchange's fees be an ``equitable allocation'' of ``reasonable''
fees and that they not be ``designed to permit unfair
discrimination.'' See 15 U.S.C. 78f(b)(4)-(5).
    \11\ See, e.g., Cboe BYX U.S. Equities Exchange Fee Schedule (as
of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/byx/.
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    The Commission periodically has addressed the ``access fees''
charged by trading centers to access their quotes.\12\ In 2005, the
Commission again spoke to this issue by adopting Rule 610(c) under
Regulation NMS, which prohibits trading centers from imposing, or
permitting to be imposed, any fees for the execution of an order
against a ``protected quotation'' \13\ that exceed or accumulate to
more than $0.0030 per share.\14\ The $0.0030 per share cap largely
codified the prevailing fee level set through competition among the
various trading centers.\15\ The cap on access fees established by Rule
610(c) sought in part to prevent high access fees in excess of the cap
from undermining Regulation NMS's price protection and linkage
requirements, while preserving the business model used by trading
centers dependent upon revenue from fees.\16\
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    \12\ For example, in the mid-1990s, the Commission allowed an
electronic communication network (``ECN'') to facilitate specialist
and market maker quotation obligations by communicating to the
public quotation system the best price and size of orders entered
into the ECN by specialists or market makers as long as the ECN met
certain conditions and noted that ECNs may impose fees for access to
its system that are ``similar to the communications and systems
charges imposed by various markets, if not structured to discourage
access by non-subscriber broker-dealers.'' Securities Exchange Act
Release No. 37619A (September 6, 1996), 61 FR 48290, 48314 n.272
(September 12, 1996) (File No. S7-30-95). See also Securities
Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844,
70871 (December 22, 1998) (File No. S7-12-98). Commission staff
subsequently issued a series of no-action letters with respect to
access fees charged by ECNs to non-subscribers. These letters
permitted fees in amounts equal to those that they charge a
``substantial proportion'' of their active broker-dealer
subscribers, but no more than $0.009 per share. See Securities
Exchange Act Release No. 49325 (February 26, 2004), 69 FR 11126,
11156 (March 9, 2004) (File No. S7-10-04) (``NMS Proposing
Release'') (discussing the no-action relief and the inability of
ECNs to charge fees that have the effect of creating barriers to
access for non-subscribers).
    \13\ Rule 600(b)(58) of Regulation NMS defines a ``protected
quotation'' as a ``protected bid or a protected offer.'' 17 CFR
242.600(b)(58). Rule 600(b)(57) of Regulation NMS, in turn, defines
a ``protected bid or protected offer'' as a quotation in an NMS
stock that is: (i) Displayed by an ``automated trading center,''
(ii) disseminated pursuant to an effective national market system
plan, and (iii) an ``automated quotation'' that is the best bid or
best offer of a national securities exchange or national securities
association. 17 CFR 242.600(b)(57). See also 17 CFR 242.600(b)(3)
(defining ``automated quotation'').
    \14\ See 17 CFR 242.610(c). See also NMS Adopting Release, supra
note 1, at 37543-46. In the Regulation NMS Proposing Release, the
Commission initially proposed to cap the access fees that any
individual market participant could charge for equities at $0.0010
per share, with a total accumulated access fee limit of $0.0020 per
share in any transaction. See NMS Proposing Release, supra note 12,
at 11157-59. In its proposal, the Commission expressed concern that
access fees added significant non-transparent costs to transactions,
potentially encouraged locked markets, and created an unequal
playing field as non-ECN broker-dealers were not permitted to charge
access fees in addition to their posted quotations. See id. However,
the Commission ultimately adopted an access fee cap of $0.0030, in
order to simplify the initial proposal (see NMS Adopting Release,
supra note 1, at 37502) and for the reasons outlined infra at notes
15-16 and accompanying text. See 17 CFR 242.610(c). See also NMS
Adopting Release, supra note 1, at 37545.
    \15\ See NMS Adopting Release, supra note 1, at 37545 (stating
that ``the $0.003 fee limitation is consistent with current business
practices, as very few trading centers currently charge fees that
exceed this amount'').
    \16\ See id. at 37596 (``In the absence of a fee limitation, the
adoption of the Order Protection Rule and private linkages could
significantly boost the viability of the outlier business model.
Outlier markets might well try to take advantage of intermarket
price protection by acting essentially as a toll booth between price
levels. The high fee market likely will be the last market to which
orders would be routed, but prices could not move to the next level
until someone routed an order to take out the displayed price at the
outlier market. Therefore, the outlier market might see little
downside to charging exceptionally high fees, such as $0.009, even
if it is last in priority.''). See also 17 CFR 242.610(c). Maker-
taker fees also are subject to the proposed rule change process for
fees under the Exchange Act. See 15 U.S.C. 78s(b)(3)(A) and 17 CFR
240.19b-4(f)(2).
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    For maker-taker exchanges, the amount of the taker fee is bounded
by the cap imposed by Rule 610(c) on the fees the exchange can charge
to access its best bid/offer for NMS stocks.\17\ This cap applies to
the fees assessed on an incoming order that executes against a resting
order or quote, but does not directly limit rebates paid. The Rule
610(c) cap on fees also typically indirectly limits the amount of the
rebates that an exchange offers to less than $0.0030 per share in order
to maintain net positive transaction revenues.\18\ For taker-maker
exchanges, the amount of the maker fee charged to the provider of
liquidity is not bounded by the Rule 610(c) cap, but such fees
typically are no more than $0.0030, and the taker of liquidity earns a
rebate.\19\
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    \17\ See 17 CFR 242.610(c).
    \18\ See, e.g., Staff Maker-Taker Memo, supra note 9, at 3. For
example, a maker-taker equities exchange may charge a member $0.0030
to remove liquidity and pay a rebate of $0.0025 to the member that
adds liquidity. See, e.g., Cboe BZX U.S. Equities Exchange Fee
Schedule (as of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/. The revenue earned by a
maker-taker exchange on transactions equals the difference between
the fee charged and the rebate paid.
    \19\ See, e.g., Cboe BYX U.S. Equities Exchange Fee Schedule (as
of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/byx/ (where, for securities above $1.00, the
fee for adding liquidity is $0.0019 and the rebate for removing
liquidity is $0.0005). The make fee on a taker-maker exchange is not
bounded by Rule 610(c) because such fee is not a charge to access
the market's best bid/offer for NMS stocks.
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    As discussed below, the maker-taker and taker-maker fee models
adopted by exchanges have attracted considerable attention.\20\ In
recent years, a variety of concerns have been expressed about the
maker-taker fee model, in particular the rebates they pay to attract
orders. For example, some have questioned whether the prevailing fee
structure has created a conflict of interest for broker-dealers, who
must pursue the best execution of their customers' orders while facing
potentially conflicting economic incentives to avoid fees or earn
rebates--both of which typically are not passed through the broker-
dealer to its customers--from the trading centers to which they direct
those orders for execution.\21\ One academic study of selected market
data suggested that some broker-dealers route non-marketable orders to
the trading center offering the highest rebate, and do so in a manner
that the authors contended might not be consistent with the broker-
dealers' duty of best execution.\22\ Others have expressed concern that
maker-taker access fees may (a) undermine market transparency since
displayed prices do not account for exchange transaction fees or
rebates and therefore do not reflect the net economic costs of a trade;
(b) serve as a way to effectively quote in sub-penny increments on a
net basis when the effect of a maker-taker exchange's sub-penny rebate
is taken into account even though the minimum quoting increment is
expressed in full pennies; (c) introduce unnecessary market complexity
through the proliferation of new exchange order types (and new
exchanges) designed solely to take advantage of pricing models; and (d)
drive orders to non-exchange trading centers as market participants
seek to avoid the higher

fees that exchanges charge to subsidize the rebates they offer.\23\
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    \20\ See infra notes 21-28 and accompanying text. See also U.S.
Dep't of the Treasury, A Financial System that Creates Economic
Opportunity: Capital Markets 62-63 (2017).
    \21\ See, e.g., Stanislav Dolgopolov, ``The Maker-Taker Pricing
Model and its Impact on the Securities Market Structure: A Can of
Worms for Securities Fraud?,'' 8 Va. L. & Bus. Rev. 231, 270 (2014),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2399821.
    \22\ Robert H. Battalio, Shane A. Corwin, and Robert H.
Jennings, ``Can Brokers Have It All? On the Relation Between Make-
Take Fees and Limit Order Execution Quality,'' Journal of Finance
71, 2193-2237 (2016), available at http://onlinelibrary.wiley.com/doi/10.1111/jofi.12422/full (``Battalio Equity Market Study''). A
non-marketable order is an order with a limit price that prevents
its immediate execution at current market prices. See also infra
note 229 (discussing non-marketable orders).
    \23\ See, e.g., Curt Bradbury, Market Structure Task Force
Chair, Board of Directors, SIFMA, and Kenneth E. Bentsen Jr.,
President and Chief Executive Officer, SIFMA, Opinion, ``How to
Improve Market Structure,'' N.Y. Times (July 14, 2014), available at
http://dealbook.nytimes.com/2014/07/14/how-to-improve-market-structure/?_r=0; Larry Harris, ``Maker-Taker Pricing Effects on
Market Quotations,'' at 24-25 (November 14, 2013), available at
http://bschool.huji.ac.il/.upload/hujibusiness/Maker-taker.pdf
(``Harris''); Dolgopolov, supra note 21; Letter from Richard
Steiner, Global Equities Liaison to Regulatory & Government Affairs,
RBC Capital Markets, to Elizabeth Murphy, Secretary, Commission, at
4 (November 22, 2013) (``RBC Capital Markets Letter I''), available
at https://www.sec.gov/;comments/s7-02-10/s70210-411.pdf.
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    By contrast, others have indicated that the maker-taker model may
have positive effects by enabling exchanges to compete with non-
exchange trading centers and narrowing quoted spreads by subsidizing
posted prices.\24\ In particular, maker-taker fees may narrow displayed
spreads in some securities insofar as the liquidity rebate effectively
subsidizes the prices of displayed liquidity.\25\ In turn, that
displayed liquidity may establish the national best bid and offer,
which is often used as the benchmark for marketable order flow,
including retail order flow, that is executed off-exchange by either
matching or improving upon those prices.\26\ Accordingly, retail orders
may benefit indirectly from the subsidy provided by maker-taker
exchanges.
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    \24\ See, e.g., Michael Brolley & Katya Malinova, ``Informed
Trading and Maker-Taker Fees in a Low Latency Limit Order Market,''
at 2 (October 24, 2013), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2178102 (``If a maker rebate is introduced in
competitive markets, the bid-ask spread will decline by (twice) the
maker rebate.'') (``Brolley and Malinova''); Shawn O'Donoghue, ``The
Effect of Maker-Taker Fees on Investor Order Choice and Execution
Quality in U.S. Stock Markets'' (January 23, 2015), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2607302
(``O'Donoghue''); and Jean-Edouard Colliard & Thierry Foucault,
``Trading Fees and Efficiency in Limit Order Markets,'' Oxford
University Press, at n.13 (September 1, 2012), available at http://thierryfoucault.com/publications/research-papers/ (arguing that
maker-taker rebates may help equities exchanges compete with off-
exchange payment for order flow arrangements, in which wholesale
broker-dealers purchase retail order flow for trading off-exchange).
    \25\ See, e.g., Letter from Richie Prager, Managing Director,
Head of Trading and Liquidity Strategies, BlackRock, Inc., to Mary
Jo White, Chair, SEC, at 2 (September 12, 2014), available at:
http://www.sec.gov/comments/s7-02-10/s70210-419.pdf (``Some
participants have called for elimination of rebates and maker-taker
pricing in its entirety in conjunction with access fees, but
BlackRock believes that incentives for providing liquidity
positively impact market structure. Incentives promote price
discovery in public markets, increase available liquidity and
tighten spreads. Rebates compensate liquidity providers for exposing
orders to adverse selection and information leakage.''). See also
Harris, supra note 23, at 1-2 (noting that while economic theory
suggests that maker-taker pricing should have narrowed average bid-
ask spreads, intervening factors, such as the growth in electronic
trading, make it difficult to ``entirely attribute[ ]'' the observed
reduction in bid-ask spreads to maker-taker pricing; in addition,
spreads cannot decrease for stocks that already trade at penny-wide
spreads).
    \26\ See Concept Release, supra note 3, at 3600.
---------------------------------------------------------------------------

    Some have urged the Commission to gather data to assess the
potential impact of transaction fees and rebates in the U.S.
markets.\27\ Most recently, as discussed below, the EMSAC recommended
that the Commission conduct a pilot to study the impact of transaction
fees on market quality and order routing behavior.\28\ Informed by that
recommendation, the views of those submitting comment letters on the
EMSAC's proposal, and the information and research described herein,
the Commission is proposing that a pilot program be conducted that
would produce data on the effects of equity exchange transaction fees
and rebates, and possible effects of changes in those fees and rebates,
on order routing behavior, execution quality, and market quality.
---------------------------------------------------------------------------

    \27\ See infra note 29 and accompanying text. Limited
experiments on a single market with a limited subset of securities,
like the test performed by The Nasdaq Stock Market LLC (``Nasdaq'')
discussed below, where order flow can quickly move to other
exchanges that are not taking part in the experiment, do not offer
the same insights as a comprehensive market-wide study on
transaction fees. See infra notes 30-34 and accompanying text.
    \28\ See Recommendation for an Access Fee Pilot (July 8, 2016),
available at https://www.sec.gov/spotlight/emsac/recommendation-access-fee-pilot.pdf (``EMSAC Pilot Recommendation''); see also
supra note 38 and accompanying text.
---------------------------------------------------------------------------

B. Calls for a Pilot

    The concept of a pilot program to gather data to study the effects
of the maker-taker model on market quality and order routing behavior
has attracted increasing attention in recent years.\29\ Nasdaq
experimented with changes to its transaction fees when it lowered
access fees and rebates in 14 stocks over a four-month period in
2015.\30\ Through its experiment, Nasdaq observed that ``[l]iquidity
providers [were] the primary responders to the fee changes during the
experiment,'' whereas there were ``no significant changes in the nature
of liquidity taking during the pilot.'' \31\ While liquidity providers
could readily route orders to other trading centers offering higher
maker rebates, Nasdaq offered a number of possible explanations for why
liquidity takers did not appear to respond to its experiment, including
the fact that order routing decisions were primarily driven by best
execution parameters not by exchange fees.\32\ For these reasons,
Nasdaq itself observed that ``the results for Nasdaq would not
necessarily be duplicated industry-wide if access fees and rebates were
reduced across the board.'' \33\ In other words, Nasdaq's experiment
involved a small sample of stocks on a single market for a short
duration, all of which make it difficult to draw inferences about what
would happen if all exchanges participated in the same experiment
simultaneously. The Commission preliminarily believes, therefore, that
a pilot is necessary to gather data to facilitate analysis of the

impact of fees and rebates on the equities exchanges broadly.\34\
---------------------------------------------------------------------------

    \29\ See, e.g., Letter from Micah Hauptman, Financial Services
Counsel, Consumer Federation of America, to Brent J. Fields,
Secretary, Commission, at 2 (December 22, 2014), available at
https://www.sec.gov/comments/4-657/4657-64.pdf (recommending an
access fee pilot as an alternative to a tick size pilot); and RBC
Capital Markets Letter I, supra note 23, at 3.
    \30\ See Securities Exchange Act Release No. 73967 (December 30,
2014), 80 FR 594 (January 6, 2015) (SR-NASDAQ-2014-128) (``Nasdaq
Pilot'') (lowering the access fee to remove liquidity from $0.0030
to $0.0005 and reducing the credit paid to display liquidity to
$0.0004 (such credits otherwise ranged from $0.0015 to $0.00305)).
    \31\ See Nasdaq Access Fee Experiment May 2015 Report, at 1,
available at http://www.nasdaqomx.com/digitalAssets/98/98718_accessfeereporttwo.pdf (``Nasdaq May Report''). Nasdaq noted
that one of the aims of its experiment was to ``examine the
importance of liquidity provider rebates to participant firms'
posting behavior on Nasdaq.'' Id. Nasdaq's experiment showed what it
characterized as statistically significant effects on the Nasdaq
Stock Market. For example, Nasdaq observed the following initial
impact on its market share: ``In aggregate, Nasdaq's equally-
weighted market share in the experiment stocks declined by 2.9
percentage points from January to February. This compares to a
decline of 0.9 percentage points in Nasdaq market share in the
control stocks. The change observed in the experiment stocks is
statistically significant using the diff-in-diff measure.'' See
Nasdaq Access Fee Experiment March 2015 Report, at 1, available at
http://images.qnasdaqomx.com/Web/NASDAQOMX/%7Be737af7a-07e8-4119-859c-096b306fc6f2%7D_Fee_Cap_Report_3-6-15v3.pdf (``Nasdaq March
Report''). It also observed the following impact on its displayed
liquidity: ``Nasdaq's time at the NBBO in the experiment stocks
declined 4.9 percentage points from 93.0% in January to 88.1%
February (Figure 2). This compares to a decline of 0.3 percentage
points in the control stocks. The difference between the experiment
and control stocks is statistically significant.'' See id. at 2.
    \32\ See, e.g., Nasdaq May Report, supra note 31, at 3. Other
possible explanations offered by Nasdaq include, for example, the
fact that the number of stocks in its experiment was too low to
justify broker-dealers recoding their liquidity taking algorithms in
response to the experiment, the possibility that liquidity taking
activity for some firms may not consider access fees, or that some
liquidity taking algorithms may be based on displayed size. See id.
(``. . . a fifth conjecture is that the economic incentives for
taking liquidity from sources other than Nasdaq are not materially
affected by the reduction in Nasdaq's access fees'').
    \33\ Nasdaq May Report, supra note 31, at 1. See also EMSAC
Pilot Recommendation, supra note 28, at 3 (``Limited experiments,
such as the recent Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about the potential
impact of market-wide policy reform on access fees.'').
    \34\ See, e.g., Nasdaq May Report, supra note 31, at 1 (noting
that ``. . . the results for Nasdaq would not necessarily be
duplicated industry-wide if access fees and rebates were reduced
across the board.''). See also EMSAC Pilot Recommendation, supra
note 28, at 3 (``Limited experiments, such as the recent Nasdaq
pilot, have shown that individual market experiments do not yield
conclusive results about the potential impact of market-wide policy
reform on access fees.''); Nasdaq March Report, supra note 31, at 3
(``Some commentators on the access fee experiment have indicated
that a voluntary change in the access fee by one exchange in
fourteen stocks does not tell you what would happen if there were a
mandatory change in the regulatory maximum access fee across all
exchanges in a considerable number of stocks of NMS stocks. We do
not disagree with that point. Nasdaq believed in launching the
experiment that fourteen stocks were enough to induce behavioral
changes with statistically and economically measurable changes. The
results from February have proven that belief was correct.''); and
Letter from Theodore R. Lazo, Managing Director and Associate
General Counsel, SIFMA, to Brent J. Fields, Secretary, Commission
(January 30, 2015), at 2, available at http://www.sec.gov/comments/sr-nasdaq-2014-128/nasdaq2014128-1.pdf (``In particular, the
proposal's limited scope and application cannot act as a substitute
for a market-wide access fee reduction that would change the
dynamics of access fees and rebates across the entire market. For
the proposal to accurately measure the structural impact of reduced
access fees, the proposal should be carried out across all exchanges
and with a larger sampling of symbols.''). See also Section
V.B.1.b.i infra for additional discussion of the Nasdaq study.
---------------------------------------------------------------------------

    More recently, the EMSAC's Regulation NMS Subcommittee
(``Subcommittee'') \35\ prepared an outline for a potential access fee
pilot, and the EMSAC discussed that outline, and the topic of access
fees in general, at its April 2016 meeting.\36\ Following that meeting,
the Subcommittee revised its recommendation and prepared a formal
recommendation for consideration by the EMSAC.\37\ The EMSAC considered
that revised proposal and recommended that the Commission pursue an
access fee pilot.\38\ The EMSAC's recommendation stated:
---------------------------------------------------------------------------

    \35\ The Subcommittee first convened in November 2015, and began
by focusing on maker-taker access fees. In a series of meetings over
the following months, the Subcommittee assembled an outline of
proposed terms for an access fee pilot. It identified general goals
and prepared a recommendation for the consideration of the full
EMSAC for the scope of a potential pilot, including stock selection,
pricing buckets, and duration, and it also considered the potential
inclusion of non-exchange markets, taker-maker exchanges, and a
trade-at component. Minutes of those meetings and other information
are available at https://www.sec.gov/spotlight/equity-market-structure/equity-market-structure-advisory-committee-subcommittees.htm.
    \36\ See Framework for a Potential Access Fee Pilot (April 19,
2016), available at https://www.sec.gov/spotlight/emsac/emsac-regulation-nms-subcommittee-recommendation-041916.pdf. At its April
2016 meeting, EMSAC discussed the topic of maker-taker fees and
heard from a number of outside experts. See EMSAC Transcript, April
26, 2016, available at https://www.sec.gov/spotlight/emsac/emsac-042616-transcript.txt.
    \37\ See Regulation NMS Subcommittee Recommendation for an
Access Fee Pilot (June 10, 2016), available at https://www.sec.gov/spotlight/emsac/emsac-regulation-nms-recommendation-61016.pdf
(``June Recommendation'').
    \38\ The EMSAC considered the Subcommittee's June Recommendation
and adopted it, by a vote of 15-1, with slight modifications that
preserved the basic structure of the June Recommendation but
incorporated additional detail, for example, settling on a two-year
term and recommending 100 securities in each test bucket. See EMSAC
Pilot Recommendation, supra note 28. See also EMSAC Transcript, July
8, 2016, available at https://www.sec.gov/spotlight/emsac/emsac-070816-transcript.txt. The EMSAC member who voted against the EMSAC
Pilot Recommendation noted his concern that ``capping access fees is
going to discourage liquidity provision and increase spreads''
before voting against the EMSAC Pilot Recommendation. See id. at
22:24-23:6.

    The intent of the proposed pilot is to better understand, within
the context of our current market structure, the effect of access
fees on liquidity provision, liquidity taking and order routing with
the ultimate goal of improving market quality. The Committee does
not believe that there are any certain or predetermined outcomes
from the pilot, and the net effect of many counterbalancing factors
are not believed to be significantly beneficial or detrimental to
any single group. Ultimately, the findings from the pilot are purely
intended to inform the broader debate on how to improve market
quality for issuers, investors and market participants.\39\
---------------------------------------------------------------------------

    \39\ EMSAC Pilot Recommendation, supra note 28, at 1.

    The EMSAC's pilot recommendation featured four buckets of common
stocks and Exchange-Traded Funds (``ETFs'') \40\ with a market
capitalization of at least $3 billion: A control bucket and three test
buckets with successively lower access fee caps of $0.0020, $0.0010,
and $0.0002.\41\ Consistent with the scope of Rule 610(c) of Regulation
NMS, the EMSAC recommendation did not include an outright prohibition
on rebates or include taker-maker exchanges in the pilot.\42\ The EMSAC
recommended a two-year term for a pilot and outlined a number of
metrics that could be assessed in connection with the pilot.\43\
---------------------------------------------------------------------------

    \40\ See infra note 96 (discussing ETFs).
    \41\ See EMSAC Pilot Recommendation, supra note 28, at 2. The
EMSAC noted that it ``intentionally selected $.0002 as the rate in
Bucket 4 in order to create a bucket where any rebate should result
in a de minimis economic incentive.'' Id. at 4.
    \42\ In addition, consistent with the framework of Rule 610(c),
the EMSAC's proposed fee caps would apply to protected quotations
and not depth of book quotations, and would have no direct
application to ATSs. See id. at 2.
    \43\ See id. at 2. The recommendation did not include a ``trade-
at'' provision that would restrict price matching of protected
quotations, but mentioned an option to include ATSs in the pilot.
See id. at 5 (noting that if trade-at were included, ``the likely
shift of flows as a result of trade-at would both make the pilot
more complex and impact the effective measurement of the access fee
change''). The EMSAC also noted that ``[t]he tick pilot will yield
some trade-at results that can be further studied; thus duplication
is not warranted.'' See id. See also Tick Size Pilot Approval Order,
supra note 5, at 27517-18 (discussing a trade-at prohibition that,
subject to certain exceptions, prevents a trading center that was
not quoting from price matching protected quotations and permits a
trading center that was quoting at a protected quotation to execute
orders at that level, but only up to the amount of its displayed
size).
---------------------------------------------------------------------------

C. Comments on the EMSAC Recommendation

    Following the establishment of the EMSAC, the Commission received a
number of comment letters regarding the impact of access fees and
rebates in the equities markets.\44\ Several

commenters voiced support for a pilot in general or for the various
proposals considered by the Subcommittee and the EMSAC that culminated
in the EMSAC Pilot Recommendation. One commenter, for example,
expressed support for an access fee pilot and characterized the
Subcommittee's recommendation as ``an excellent roadmap'' for such a
pilot.\45\ Other commenters that support an access fee pilot remarked
that the maker-taker pricing model contributes to opaque, non-
transparent markets, increases market complexity and fragmentation, and
generates conflicts of interest that may impede best execution of
orders, and they urged the Commission to act promptly on a pilot that
could produce useful data on these issues.\46\
---------------------------------------------------------------------------

    \44\ Letter from Haim Bodek, Managing Principal, and Stanislav
Dolgopolov, Regulatory Consultant, Decimus Capital Markets, LLC, to
Brent J. Fields, Secretary, Commission (April 25, 2016), available
at https://www.sec.gov/comments/265-29/26529-63.pdf (``Decimus
Capital Markets Letter''); Letter from Elizabeth King, NYSE, to
Brent J. Fields, Secretary, Commission (May 13, 2016), available at
https://www.sec.gov/comments/265-29/26529-66.pdf (``NYSE Letter'');
Letter from Joan C. Conley, Senior Vice President and Corporate
Secretary, Nasdaq, to Brent J. Fields, Secretary, Commission (May
24, 2016), available at https://www.sec.gov/comments/265-29/26529-71.pdf (``Nasdaq Letter''); Letter from Richard Steiner, RBC Capital
Markets, to The Honorable Mary Jo White, Chair, Commission (May 24,
2016), available at https://www.sec.gov/comments/265-29/26529-70.pdf
(``RBC Capital Markets Letter II''); Letter from Security Traders
Association to SEC EMSAC (June 15, 2016), available at https://www.sec.gov/comments/265-29/26529-74.pdf (``Security Traders
Association Letter''); Letter from Kermit Kubitz to SEC EMSAC (July
5, 2016), available at https://www.sec.gov/comments/265-29/26529-73.htm (``Kubitz Letter''); Letters from J A to Chair White,
Commissioners, and SEC EMSAC (May 23, 2016, & September 13, 2016),
available at https://www.sec.gov/comments/265-29/26529-68.htm &
https://www.sec.gov/comments/265-29/26529-85.htm (``J A Letters'');
Letter from Richard Steiner, Electronic Trading Strategist, RBC
Capital Markets, to Mary Jo White, Chair, Commission (September 23,
2016), available at https://www.sec.gov/comments/265-29/26529-86.pdf
(``RBC Capital Markets Letter III''); Letter from Tyler Gellasch,
Executive Director, Healthy Markets Association, to Brent J. Fields,
Secretary, Commission (December 23, 2016), available at https://www.sec.gov/comments/265-29/26529-1441899-130023.pdf (``Healthy
Markets Letter I''); Letter from Theodore R. Lazo, Managing Director
& Associate General Counsel, SIFMA, to Brent J. Fields, Secretary,
Commission (March 29, 2017), available at https://www.sec.gov/comments/265-29/26529-1674696-149276.pdf (``SIFMA Letter''); Letter
from Tyler Gellasch, Executive Director, Healthy Markets
Association, to Brent J. Fields, Secretary, Commission (April 3,
2017), available at https://www.sec.gov/comments/265-29/26529-1681516-149500.pdf (``Healthy Markets Letter II''); Letter from
Tyler Gellasch, Executive Director, Healthy Markets Association, to
Hon. W. Jay Clayton, Chairman, Commission (June 13, 2017), available
at https://www.sec.gov/comments/265-29/26529-1801830-153704.pdf
(``Healthy Markets Letter III''); Letter from Chris Concannon,
President and Chief Operating Officer, Cboe, Thomas Wittman, CEO,
The Nasdaq Stock Market LLC, and Thomas W. Farley, President, NYSE,
to Hon. Jay Clayton, Chairman, Commission (October 13, 2017),
available at https://www.sec.gov/comments/265-29/26529-2641078-161300.pdf (``Joint Exchange Letter''); Letter from Brad Katsuyama,
Chief Executive Officer, and John Ramsay, Chief Market Policy
Officer, Investors Exchange LLC, to Hon. Jay Clayton, Chairman,
Commission (November 15, 2017), available at https://www.sec.gov/comments/265-29/26529-2691444-161491.pdf (``IEX Letter''); Email
from Tim Quast, President, ModernNetworks IR LLC, to Hon. Jay
Clayton, Chairman, Commission (December 5, 2017), available at
https://www.sec.gov/comments/265-29/26529-2777697-161622.pdf.
    \45\ See Decimus Capital Markets Letter, supra note 44, at 2.
    \46\ See, e.g., Letter from Ari Burstein, Associate General
Counsel, Investment Company Institute, to Brent Fields, Secretary,
Commission (May 11, 2015), available at https://www.sec.gov/comments/265-29/26529-10.pdf (recommending that the Commission
establish a pilot program that would prohibit rebates and reduce
access fees) (``Investment Company Institute Letter I''); Letter
from Managed Funds Association to SEC EMSAC (September 29, 2015),
available at https://www.sec.gov/comments/265-29/26529-28.pdf
(urging ``a disciplined, data-driven study'' and calling for
analysis of access fees' effects on market liquidity, order routing,
execution transparency, transaction costs, and competition); Letter
from David W. Blass, General Counsel, Investment Company Institute,
to SEC EMSAC (January 20, 2016), available at https://www.sec.gov/comments/265-29/26529-48.pdf (urging the Commission to establish a
phased pilot program for highly liquid stocks that would reduce
access fees and prohibit rebates) (``Investment Company Letter
II''); Letter from the Trading Issues Committee, Canadian Security
Traders Association, Inc., to Brent Fields, Secretary, Commission
(April 6, 2016), available at https://www.sec.gov/comments/265-29/26529-61.pdf (proposing a cross-border study on the effect of
rebates on market quality in conjunction with the Canadian
Securities Administrators); J A Letters, supra note 44 (retail
investor supporting proposed pilot but suggesting test of payment
for order flow and inclusion of ``trade-at'' provision); Security
Traders Association Letter, supra note 44 (supporting a pilot of
limited number of securities with varying access fee caps and ``no
other variables''); RBC Capital Markets Letter III, supra note 44
(concluding that an access fee pilot based on the EMSAC
recommendation would be ``a positive step'' and further suggesting a
no-rebate bucket and the inclusion of taker-maker exchanges and
ATSs); Healthy Markets Letter I, supra note 44 (applauding many
aspects of the EMSAC recommendation, but suggesting that it include
all trading venues and a ``trade-at'' provision); SIFMA Letter,
supra note 44 (proposing, as one alternative, that the Commission
adopt the EMSAC recommendation); IEX Letter, supra note 44
(supporting the concept of a fee pilot conducted by the SEC, but
recommending that the pilot include a no-rebate bucket and apply to
inverted exchanges).
---------------------------------------------------------------------------

    Some of these same commenters suggested modifications to the ideas
ultimately embodied in the EMSAC Pilot Recommendation. For example, one
commenter suggested including a wider range of securities with lower
market capitalizations, instead of focusing only on the highly liquid
securities proposed by the EMSAC.\47\ Several other commenters argued
that any pilot should either ban rebates altogether or include a ``no-
rebate'' test bucket--an approach that the EMSAC considered, but did
not ultimately recommend.\48\ Finally, a number of commenters advocated
for applying a pilot to taker-maker exchanges as well as ATSs.\49\
---------------------------------------------------------------------------

    \47\ See Decimus Capital Markets Letter, supra note 44, at 11.
But cf. Investment Company Institute Letter II, supra note 46, at 6-
7 (asserting that pilot securities should be highly liquid stocks,
as measured by average daily trading volume); Joint Exchange Letter,
supra note 44, at 5 (expressing concern that liquidity in less
active stocks could be negatively impacted by a pilot, but
acknowledging that, ``if less active stocks are omitted, it is
difficult to envision the securities that should be selected . .
.''). See also infra Section III.B (discussing the securities to be
included in the proposed pilot, which incorporates a broader range
of securities than the EMSAC recommendation, including NMS stocks
with market capitalizations below $3 billion).
    \48\ See Investment Company Institute Letter II, supra note 46,
at 7 (recommending that the Commission establish a phased pilot
program for highly liquid stocks that would reduce access fees and
prohibit rebates); RBC Capital Markets Letter III, supra note 44, at
3 (advocating for the inclusion of a ``no-rebate'' bucket in the
pilot); Healthy Markets Letter II, supra note 44, at 6 n.15
(suggesting that the Commission establish a pilot that eliminates
rebates); SIFMA Letter, supra note 44, at 9-10 (suggesting, as an
alternative to an access fee pilot, that the Commission eliminate
rebates); IEX Letter, supra note 44, at 3-4 (stating that
restrictions on access fees may not help the Commission to evaluate
alternatives to the current exchange pricing system, which is driven
primarily by rebates, and advocating for the inclusion of a ``no-
rebate'' bucket in the pilot). See also Nasdaq Letter, supra note
44, at 3 (asserting that any pilot should apply to both fees and
rebates). But cf. NYSE Letter, supra note 44, at 3-4 (arguing that
elimination of rebates, without any other offsetting incentives, may
reduce market-maker incentives to provide liquidity). See also infra
Section III.C (discussing the design of the proposed pilot, which
includes a ``no-rebate'' bucket).
    \49\ See RBC Capital Markets Letter III, supra note 44, at 4
(suggesting that the pilot should be applied to taker-maker
exchanges and ATSs); Healthy Markets Letter I, supra note 44, at 3-4
(taking the view that ``all relevant exchanges'' and ATSs should be
included in the pilot). See also Nasdaq Letter, supra note 44, at 3
(recommending that the Commission establish a pilot that applies to
all trading centers, including ATSs); Joint Exchange Letter, supra
note 44, at 5 (recommending that the pilot apply to trading in all
off-exchange venues); IEX Letter, supra note 44, at 4 (suggesting
that the access fee pilot should include taker-maker exchanges). See
also infra Section III.A (discussing the Commission's decision to
include taker-maker exchanges, but not ATSs, in the proposed pilot).
---------------------------------------------------------------------------

    In a joint letter, three exchanges recommended several other
changes \50\ if the Commission proceeds with a pilot based on the
EMSAC's recommendation.\51\ These commenters suggested that such a
pilot should, among other things: (1) Study ``all forms of
remuneration,'' in part by adding measures specifically to study ATS
and broker-dealer remuneration and to show how the savings realized by
broker-dealers from lowered exchange transaction fees are ``returned to
customers,'' \52\ (2) measure costs to issuers and shareholders and
allow issuers to have a voice in whether they are included in a
pilot,\53\ (3) pre-announce the measures for benchmarking and tracking
the impact of a pilot,\54\ and (4) ``measure gross shifts in trading
from exchange to off-exchange venues and among off-exchange venues.''
\55\
---------------------------------------------------------------------------

    \50\ See notes 47 and 49 supra, and note 62 infra, for a
discussion of other changes recommended by these three exchanges.
    \51\ See Joint Exchange Letter, supra note 44, at 4-5.
    \52\ But cf. IEX Letter, supra note 44, at 2 (``The idea that a
substantial conflict of interest cannot be addressed unless all
other conflicts are addressed simultaneously is not viable.'').
    \53\ See Section III.B infra (discussing the Commission's
decision to include a broader range of securities than the EMSAC
recommendation, including NMS stocks with market capitalizations
below $3 billion). See also Sections V.C.2.b and V.D.3 infra
(discussing the potential costs to small and mid-capitalization
issuers).
    \54\ See Section III.E infra (discussing the measures that the
Commission intends to use to benchmark and track the impact of the
proposed Pilot).
    \55\ See Joint Exchange Letter, supra note 44, at 4-5. See also
Section III.E.3 infra (discussing the order routing data that the
Commission intends to use to measure shifts in trading); Section
V.E.1 infra (noting that the Commission can use existing data
sources to track shifts in trading between equities exchanges and
ATSs).
---------------------------------------------------------------------------

    Other commenters expressed concern regarding the impact of a
pilot.\56\ For example, the New York Stock Exchange LLC (``NYSE'')
believed that, while the pilot's lowered fee caps in the three test
groups would reduce the direct costs paid by broker-dealers to access
displayed exchange quotations, it also would effectively limit the
rebates paid

by exchanges to attract liquidity, which could ``reduce the
competitiveness of exchanges relative to dark pools. . . .'' \57\ NYSE
further argued that the Subcommittee's concept for a pilot was
``designed to test investors' and listed companies' tolerance for
worsening market quality'' since market making and market quality ``are
largely driven by incentives and corresponding obligations.'' \58\ NYSE
recommended an alternative initiative that would lower access fee caps,
prohibit maker-taker pricing models, and institute a ``trade-at''
rule.\59\
---------------------------------------------------------------------------

    \56\ See, e.g., Letter from David M. Weisberger, Managing
Director and Global Head, RegOne Solutions, a Markit company, to
Brent Fields, Secretary, Commission (October 9, 2015), available at
https://www.sec.gov/comments/265-29/26529-30.pdf (raising various
questions about proposals to modify access fees, including risks
that such proposals could hurt retail investors and lower available
liquidity); Letter from John I. Sanders & Benjamin Leighton, Wake
Forest School of Law Community Law and Business Clinic (October 20,
2015), at 6-7, available at https://www.sec.gov/comments/265-29/26529-33.pdf (opining that a shift away from maker-taker pricing
could affect liquidity and suggesting that the Commission instead
focus on utilizing market manipulation rules, limiting order types,
and regulating colocation).
    \57\ NYSE Letter, supra note 44, at 3. NYSE was critical of the
potential application of access fee caps to non-displayed liquidity,
an idea considered but not recommended by the EMSAC, because it
believed that such caps on exchanges would advantage ATSs. Id. at 5-
6.; but cf. RBC Capital Markets Letter III, supra note 44, at 4
(asserting that the pilot program should cover non-displayed orders
on exchanges to ensure complete and accurate data). See also infra
Section III.C (discussing the design of the proposed pilot).
    \58\ See NYSE Letter, supra note 44, at 3.
    \59\ See id. at 6. Some commenters seemed to agree with NYSE
that a ``trade-at'' rule should be included in the pilot. See Nasdaq
Letter, supra note 44, at 2. Others opposed inclusion of a ``trade-
at'' rule. See RBC Capital Markets Letter III, supra note 44
(stating that a ``trade-at'' rule would be duplicative, given the
inclusion of such a component in the Tick Size Pilot, and opining
that a ``trade-at'' rule could obscure data showing the impact of
pricing); Healthy Markets Letter I, supra note 44, at 4 (noting that
inclusion of a ``trade-at'' rule would increase the pilot's
complexity and decrease its utility, but opining that all trading
venues should be included in the pilot if a ``trade-at'' rule is
excluded). See also infra Section III.C (discussing the design of
the proposed pilot).
---------------------------------------------------------------------------

    Nasdaq suggested the Commission pursue an alternative pilot that
caps both fees and rebates, as it believed that more meaningful data
would result by removing price from market participants' routing
decisions.\60\ Nasdaq also argued that the pilot should apply to all
trading centers.\61\ Finally, Nasdaq thought that a two-year term for a
pilot would be too long, observing that its own transaction fee
experiment suggested that the impact on liquidity provision was evident
quickly.\62\
---------------------------------------------------------------------------

    \60\ See Nasdaq Letter, supra note 44, at 3. See also infra
Section III.C.3 (discussing the Pilot's inclusion of a ``no-rebate''
bucket).
    \61\ See Nasdaq Letter, supra note 44, at 3. See also infra
Section III.A (discussing the Commission's decision to expand on the
EMSAC Pilot Recommendation to apply the Pilot to all equities
exchanges, but not to ATSs).
    \62\ See Nasdaq Letter, supra note 44, at 3; Joint Exchange
Letter, supra note 44, at 5 (recommending that the proposed pilot
last no more than one year and that the Commission develop criteria
for evaluating the possibility of the pilot's early termination).
See also, e.g., Nasdaq May Report, supra note 31, at 1 (summarizing
some of Nasdaq's explanations regarding the results of its
transaction fee experiment); and infra Section III.D (discussing the
Commission's decision to limit the two-year term recommended by
EMSAC with an automatic sunset at the end of the first year).
---------------------------------------------------------------------------

    One commenter, the Chicago Board Options Exchange, Incorporated,
now known as Cboe Exchange, Inc. (``Cboe''), recommended against doing
a pilot, and instead suggested abolishing the equity fee cap and
requiring ATSs to file fee changes with the Commission.\63\ Similarly,
Nasdaq, NYSE, and Cboe jointly suggested that the Commission should
forgo conducting a pilot that only touches on one aspect of Regulation
NMS and instead recommended a broader review of the impact of
remuneration on routing and trading.\64\ Alternatively, Nasdaq, NYSE,
and Cboe recommended that, if the Commission seeks to conduct an access
fee pilot, it should first (1) articulate a strong and clear duty of
best execution to ameliorate the conflict of interest between a broker
and its customer, (2) require improved disclosures regarding execution
quality and routing practices to deter potential conflicts, and (3)
adopt its proposed amendments to Regulation ATS \65\ to enhance the
operational transparency of ATSs.\66\
---------------------------------------------------------------------------

    \63\ See Letter from Edward T. Tilly, CEO, Cboe, to SEC EMSAC
(January 28, 2016), available at https://www.sec.gov/comments/265-29/26529-51.pdf. Cboe opined that ``broad and arbitrary price
controls'' are a ``drastic measure'' that conflicts with ``the very
concept of a market-based system.'' Id. at 9-10. As another
alternative, one commenter proposed that the Commission require
venues to include ``all-in'' costs in their visible quotes. See
Letter from Michael J. Friedman, General Counsel, Trillium, to Brent
J. Fields, Secretary, Commission (May 14, 2015), available at
https://www.sec.gov/comments/265-29/26529-18.pdf.
    \64\ See Joint Exchange Letter, supra note 44, at 2 and 6.
Investors Exchange LLC (``IEX''), disagreed with this suggestion and
pointed out that the Commission ``has been engaged in a holistic
review of market structure at least since the issuance of its Equity
Market Structure Concept Release in 2010,'' which ``has led to
consideration of the Fee Pilot.'' See IEX Letter, supra note 44, at
3. IEX further opined that maker-taker pricing need not be addressed
simultaneously with all other market structure issues, given ``the
amount of fees and rebates involved (over $2.5 billion in 2016), the
inefficiencies that result from hundreds of pricing tiers, and the
proven negative consequences to investors that result from routing
orders to high rebate exchanges.'' Id. at 2-3.
    \65\ Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998).
    \66\ See Joint Exchange Letter, supra note 44, at 2-4. But cf.
IEX Letter, supra note 44, at 3 (characterizing this recommendation
as one with ``no logic other than commercial protectionism in
delaying action on fees and rebates'').
---------------------------------------------------------------------------

    Investors' Exchange LLC (``IEX'') responded to the comments jointly
submitted by Nasdaq, NYSE, and Cboe by characterizing those exchanges'
arguments as ``part of a familiar playbook to stave off market
reform.'' \67\ While IEX agreed that Nasdaq, NYSE, and Cboe had
identified important areas for consideration, IEX did not support
delaying action on a transaction fee pilot \68\ and disputed whether
the broad review suggested by Nasdaq, NYSE, and Cboe was necessary.\69\
Rather, IEX strongly supported the idea of a transaction fee pilot, but
recommended that any such pilot include a ``no-rebate'' bucket and
apply to inverted exchanges.\70\
---------------------------------------------------------------------------

    \67\ See IEX Letter, supra note 44, at 2.
    \68\ See id. at 3.
    \69\ See id. at 2-3; see also notes 52 and 64 supra.
    \70\ See id. at 1-4; see also notes 48-49 supra.
---------------------------------------------------------------------------

III. Discussion of the Proposed Pilot

    The Commission is proposing to conduct a Transaction Fee Pilot (the
``Pilot'' or ``Transaction Fee Pilot'') for NMS stocks, as described
below. In formulating this proposal, the Commission has taken into
consideration the recommendation of the EMSAC for an access fee pilot,
the views of those submitting comment letters on the EMSAC's proposal,
and the information and research described throughout this release. The
Commission's proposal, in an effort to more broadly test the impact of
transaction fees and rebates, differs from the EMSAC's recommendation
in several respects, as discussed further below.\71\ The Commission
notes that the proposed Pilot is not designed to test the impact of
transaction fees and rebates on all aspects of equities market
structure, including market fragmentation and the proliferation of
complex order types, but rather focuses on order routing behavior,
execution quality, and market quality.
---------------------------------------------------------------------------

    \71\ Because the proposed Pilot would apply more broadly to more
types of transaction fees beyond only fees to access a protected
quotation, the Commission therefore is not characterizing the
proposal as an ``Access Fee Pilot.''
---------------------------------------------------------------------------

    The following chart summarizes the proposed terms of the Pilot,
which are discussed in more detail below:

[GRAPHIC] [TIFF OMITTED] TP26MR18.000

A. Applicable Trading Centers

    The proposed Pilot, consistent with the EMSAC's recommendation,
would apply solely to the equities exchanges. The fee cap under Rule
610(c), on which the proposed Pilot is largely based, does not apply to
options exchanges.\72\ Specifically, the fee cap under Rule 610(c)
applies to NMS stocks on a per share basis whereas options contracts
are derivatives that represent a number of shares, typically 100 shares
of stock per options contract for a single-stock option, and the
current fee cap under Rule 610(c) is not calibrated to account for that
difference.\73\ Because options and equities are materially different
types of securities, the current fee cap applicable to equities
exchanges does not apply, and cannot readily be applied, to options
exchanges. If options exchanges were to be included in a pilot, the
Commission would first need to create a new type of fee cap to apply to
options exchanges and then consider how that cap would impact current
options exchange fee models, which would introduce considerable
additional complexity.\74\ For these reasons, the Commission is not
proposing to include options exchanges in the proposed Pilot.
---------------------------------------------------------------------------

    \72\ See 17 CFR 242.610(c) (addressing ``fees for the execution
of an order . . . in an NMS stock,'' where ``NMS stock'' is defined
as ``any NMS security other than an option'' under 17 CFR
242.600(b)(47)).
    \73\ As a result, options exchange fees for the execution of one
options contract typically far exceed the Rule 610(c) cap of
$0.0030. See, e.g., NYSE Arca Options Fee Schedule, available at
https://www.nyse.com/publicdocs/nyse/markets/arca-options/NYSE_Arca_Options_Fee_Schedule.pdf (including fees, as of September
2017, of $0.50 for electronic executions that take liquidity in
Penny Pilot Issues for Broker-Dealer orders).
    \74\ See also EMSAC Pilot Recommendation, supra note 28, at 5.
None of the comment letters submitted to the EMSAC advocated for
including options exchanges in an access fee pilot.
---------------------------------------------------------------------------

    However, the scope of the proposed Pilot would be broader than both
the EMSAC's recommendation and Rule 610(c), in that it would include
all equities exchanges--including taker-maker exchanges. For example,
the proposed Pilot's fee cap in Test Groups 1 and 2 (detailed below)
would apply the cap to the take fee on a maker-taker exchange and also
would apply the cap to the maker fee on a taker-maker exchange.\75\ The
EMSAC did not recommend including taker-maker exchanges or ATSs in an
access fee pilot because it endeavored to remain consistent with the
current market structure, including the Rule 610(c) access fee cap,
which only caps fees for removing a protected quotation and does not
apply to ATSs.\76\ A number of commenters disagreed with the approach
recommended by the EMSAC.\77\ These commenters asserted that a pilot
would provide more meaningful data if applied more broadly; \78\ one
commenter explained that a broader approach would reduce the
possibility of ``gaming,'' as well as provide more accurate testing of
order flows.\79\ Another commenter believed that liquidity and market
quality on traditional, maker-taker exchanges would suffer unless
taker-maker exchanges and ATSs were included in the proposed Pilot.\80\
Another

commenter believed that a pilot should include all equities exchanges
and ATSs, but acknowledged that a pilot based on the current parameters
of Rule 610(c) would be difficult to apply to taker-maker exchanges and
ATSs.\81\
---------------------------------------------------------------------------

    \75\ See supra note 19 (discussing Rule 610(c) and the taker-
maker model). The proposed fee caps in Test Groups 1 and 2 (detailed
below) would not apply to rebates. For example, the proposed Pilot's
fee cap in Test Group 2 would not apply the cap to the maker rebate
on a maker-taker exchange, nor would it apply the cap to the taker
rebate on a taker-maker exchange.
    \76\ See EMSAC Pilot Recommendation, supra note 28, at 5.
    \77\ See supra note 49.
    \78\ See, e.g., Nasdaq Letter, supra note 44, at 3; IEX Letter,
supra note 44, at 4 (arguing that inverted exchanges should be
included in a pilot because the pilot otherwise would test ``only
how much distortive pricing can be transferred to these venues'').
    \79\ See RBC Capital Markets Letter III, supra note 44, at 4.
But cf. infra notes 86-93 and accompanying text (acknowledging the
potential for ``gaming,'' but discussing the Commission's decision
to exclude ATSs from the Pilot).
    \80\ See Nasdaq Letter, supra note 44, at 2. But cf. infra notes
89-93 and accompanying text (noting that Nasdaq's fee experiment
results would not necessarily be duplicated in an industry-wide
pilot and explaining that the Pilot could potentially improve the
competitive position of exchanges vis-[agrave]-vis ATSs).
    \81\ See Healthy Markets Letter I, supra note 44, at 4; see also
Section III.A infra (discussing the difficulties of applying the
Pilot to ATSs).
---------------------------------------------------------------------------

    The Commission believes that the proposed Pilot should be designed
to broadly study the impact of transaction fees and rebates on order
routing behavior, execution quality, and market quality. To achieve a
broader study, the Commission preliminarily believes that including all
equities exchanges, including taker-maker exchanges, in the proposed
Pilot is appropriate. Including all equities exchanges in the proposed
Pilot will ensure that the Pilot will collect data on all equities
markets that are registered national securities exchanges, whose fees
are all subject to the requirements of the Exchange Act and the rule
filing requirements thereunder, thus treating equally all similarly
situated entities.
    However, expanding the proposed Pilot to non-exchange trading
centers, such as ATSs, whose fees currently are not subject to Rule
610(c) would have the effect of imposing, in the terms of a pilot, an
entirely new regulatory regime on entities whose fees are not currently
subject to the substantive and process requirements applicable to
exchanges, and that are currently not subject to access fee caps in any
respect. The Commission, therefore, believes that doing so would
introduce a number of complexities that it preliminarily does not
believe are warranted for purposes of this proposed Pilot. In
particular, while equities exchanges charge transaction-based fees,
ATSs, especially ``dark pool'' ATSs that are part of a large broker-
dealer order handling business, may not charge separate transaction-
based fees for executions in their ATSs, and instead might use bundled
pricing that does not associate particular orders with particular
fees.\82\ Consequently, incorporating ATSs into the proposed Pilot
would be substantially more complex if the proposed Pilot required ATSs
to radically change their fee models and renegotiate their pricing
arrangements with their customers in order to assess fees differently
than they do today solely to accommodate the proposed Pilot.\83\
---------------------------------------------------------------------------

    \82\ See, e.g., Letter from William P. Neuberger and Andrew F.
Silverman, Managing Directors and Global Co-Heads of Morgan Stanley
Electronic Trading, to Brent J. Fields, Secretary, Commission (May
19, 2016), available at https://www.sec.gov/comments/s7-23-15/s72315-37.pdf (commenting on File No. S7-23-15 concerning regulation
of NMS Stock Alternative Trading Systems and noting that ATS fees
may be bundled with brokerage services).
    \83\ See infra Section V.E.1. (noting that the inclusion of ATSs
in the proposed Pilot may not be practical and is likely to
substantially increase the costs of the proposed Pilot).
---------------------------------------------------------------------------

    Because the proposed Pilot is designed to study, among other
things, the potential conflicts of interest faced by broker-dealers
when routing orders as a result of transaction fees and rebates, it is
necessary to be able to directly observe the effects of changes in
transaction fees and rebates on their trading. As discussed above, some
have questioned whether a broker-dealer's economic incentive to avoid
transaction-based fees and earn transaction-based rebates impacts its
order routing decisions in a manner that creates a misalignment between
the broker-dealer's economic interests and its obligation to seek the
best execution for its customer's order.\84\ To the extent ATSs do not
charge transaction-based fees, it is not practicable to include them in
a pilot that is structured to test the impact of changes in transaction
fees. Accordingly, the Commission preliminarily believes that excluding
ATSs from the proposed Pilot is appropriate, and that broadly applying
the Pilot to all equities exchanges, regardless of their pricing model,
will allow the proposed Pilot to collect data on the effects of changes
in transaction fees and rebates, which will permit the study of, among
other things, potential conflicts of interest faced by broker-dealers
when routing orders.\85\
---------------------------------------------------------------------------

    \84\ See supra notes 21-22 and accompanying text.
    \85\ While ATSs would not be subject to the proposed Pilot, data
on ATS market share are available from FINRA, available at https://otctransparency.finra.org, which could provide an indication of
whether routing to ATSs increase or decrease during the proposed
Pilot. See infra Section V.C.1.b. (discussing possible changes in
routing to ATSs during the proposed Pilot).
---------------------------------------------------------------------------

    The Commission acknowledges the concerns raised by Nasdaq about
excluding ATSs from the proposed Pilot.\86\ Specifically, Nasdaq noted
that during its fee experiment, when Nasdaq lowered its rebates,
liquidity providers ``immediately moved their quotes to other
exchanges.'' \87\ As a result, Nasdaq stated that unless ATSs are
included in the pilot ``we are likely to find that liquidity and market
quality on exchanges will be fundamentally harmed, ultimately to the
detriment of public investors'' and ``[i]ssuers included in the pilot
would see a diminishment of transparent quotes, widening of quoted
spreads, and an inferior overall trading experience.'' \88\ However, as
discussed above, unlike for liquidity adding orders, Nasdaq found ``no
significant changes in the nature of liquidity taking'' during its fee
experiment.\89\ The Commission believes, as discussed above and as
Nasdaq itself observes, that ``the results for Nasdaq would not
necessarily be duplicated industry-wide if access fees and rebates were
reduced across the board.'' \90\ For example, the fact that some market
participants ``immediately moved their quotes to other exchanges'' may
be because other equities exchanges did not participate in Nasdaq's fee
experiment and those market participants who specifically sought to
quote on an equities exchange, and not an ATS, responded accordingly by
moving some of their activity to equities exchanges that continued to
offer rebates. The Commission notes that the proposed Pilot would not
impact the ability of an equities exchange to maintain a ``protected
quote,'' an advantage that an ATS does not enjoy, and to the extent
that the demand associated with liquidity taking on exchanges remains
stable, it could continue to attract liquidity providers desiring that
protection despite changes to rebates. Further, the Commission notes
that some have argued that high equities exchange maker rebates
necessitate high offsetting taker fees, which may cause some liquidity
taking order flow to migrate to non-exchange trading centers in search
of lower transaction costs.\91\ The proposed Pilot's lower fee caps in
Test Groups 1 and 2, discussed below, could possibly improve the
competitive position of exchanges vis-[agrave]-vis ATSs.\92\
---------------------------------------------------------------------------

    \86\ See Nasdaq Letter, supra note 44, at 2.
    \87\ Id.
    \88\ Id.
    \89\ See Nasdaq May Report, supra note 31, at 1.
    \90\ Nasdaq May Report, supra note 31, at 1. See also EMSAC
Pilot Recommendation, supra note 28, at 3 (``Limited experiments,
such as the recent Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about the potential
impact of market-wide policy reform on access fees.'').
    \91\ See, e.g., BlackRock Inc. Viewpoint, U.S. Equity Market
Structure: An Investor Perspective, at 7 (April 2014), available at
https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-us-equity-market-structure-april-2014.pdf (``Reducing the
access fee caps is one solution that would narrow the price
disparity and lessen the impact of cost in routing decisions. This
may also curb the usage of off-exchange venues, such as dark pools
and internalizers, as a major benefit of these trading platforms is
their cost efficiency relative to exchanges.'') (``BlackRock
Viewpoint'').
    \92\ See id.
---------------------------------------------------------------------------

    Accordingly, the Commission preliminarily believes that it is
appropriate to exclude ATSs from the proposed Pilot, which also is
consistent

with the EMSAC's recommendation.\93\ The Commission further notes that
the inclusion of ATSs is discussed as an alternative in the economic
analysis below.
---------------------------------------------------------------------------

    \93\ See EMSAC Pilot Recommendation, supra note 28, at 5 (``. .
. the Committee does not believe that extending the application of
Rule 610(c) to ATSs would be a beneficial part of the pilot given
that (i) such limitation does not apply today, (ii) ATSs are not
afforded a protected quote, and (iii) ATS transaction fees generally
take the form of an institutional commission.'').
---------------------------------------------------------------------------

    The Commission requests comment on the trading centers to be
included in the proposed Pilot. In particular, the Commission solicits
comment on the following. To the extent possible, please provide
specific data, analyses, or studies for support.
    1. The proposed Pilot would apply to all equities exchanges. Should
the scope be expanded or reduced? If so, what should the scope be? What
would be the anticipated impacts of the revised scope?
    2. Should the Commission include taker-maker equities exchanges in
the proposed Pilot? Why or why not? What would be the anticipated
impact of excluding taker-maker equities exchanges from the proposed
Pilot?
    3. Should the proposed Pilot be expanded to include ATSs? Why or
why not? What would be the anticipated impact of including ATSs in the
proposed Pilot? If the proposed Pilot were expanded to include ATSs,
should all ATSs be included or only certain ATSs? What, if any, are the
potential competitive impacts of excluding ATSs from the proposed
Pilot? Would including ATSs in the proposed Pilot have any likely
effect on ATS business models? To what extent do ATSs charge fees that
are not transaction-based? If the proposed Pilot includes ATSs, how
should it apply to ATS fees that are not transaction-based? Also, to
apply the proposed Pilot to ATSs, would the Commission need to impose
other new requirements on ATSs, such as fee disclosure requirements? If
ATSs were to be included in the proposed Pilot, would they be able to
collect and report the proposed data \94\ or would changes be necessary
to accommodate ATSs?
---------------------------------------------------------------------------

    \94\ See Section III.E infra for a description of the proposed
data.
---------------------------------------------------------------------------

    4. Should the proposed Pilot include options exchanges? Why or why
not? What would be the anticipated impact of including options
exchanges in the proposed Pilot? How would the quality and extent of
the data be impacted by including or excluding options exchanges? What,
if any, are the potential impacts, including competitive impacts, of
excluding options exchanges from the proposed Pilot? What, if any, are
the potential competitive impacts of subjecting options exchanges to
fee caps?

B. Securities

    The Commission proposes to include in the Pilot all NMS stocks,
which includes common stocks and Exchange-Traded Products (``ETPs''),
among other securities,\95\ with an initial share price at the time the
pre-Pilot Period commences of at least $2, an unlimited duration or a
duration beyond the end of the post-Pilot Period, and no restrictions
on market capitalization (collectively, ``Pilot Securities'').\96\ As
discussed below, throughout the duration of the proposed Pilot,
including the pre- and post-Pilot Periods, if a Pilot Security in one
of the Test Groups closes below $1, the security would be removed from
the Test Group and would no longer be subject to the Pilot pricing
restrictions.\97\
---------------------------------------------------------------------------

    \95\ See 17 CFR 242.600(b)(47) (defining ``NMS stock''). The
Commission notes that although the EMSAC recommended limiting the
access fee pilot to common stocks and ETFs, because Rule 610(c)
applies to all NMS stocks, and not just common stocks and ETPs
(including ETFs), the Commission preliminarily believes it is
appropriate to extend the Pilot to all NMS stocks.
    \96\ The EMSAC recommended including ETFs, which are open-end
fund vehicles or unit investment trusts that are registered as
investment companies under the Investment Company Act of 1940. The
Commission's proposal uses the broader term of ETPs, which, in
addition to ETFs, also includes trust or partnership vehicles that
are not registered under the 1940 Act because they do not invest
primarily in securities, as well as Exchange-Traded Notes
(``ETNs''). ETNs are senior debt instruments that pay a return based
on the performance of a reference asset. Unlike the two other
categories of ETPs, ETNs are not pooled vehicles, and they do not
hold an underlying portfolio of securities or other assets. See
generally Securities Exchange Act Release No. 75165 (June 12, 2015),
80 FR 34729, 34731 (June 17, 2015) (Request for Comment on Exchange-
Traded Products). The EMSAC record, including transcripts of EMSAC
meetings, does not contain any substantive discussion of the
distinction between ETFs and ETPs. However, all such securities are
``NMS stocks'' subject to Rule 610(c), and the Commission
preliminarily does not believe there is a meaningful basis to
justify excluding any of them from the proposed Pilot. See 17 CFR
242.600(b)(47) (defining ``NMS stock''). See also proposed Rule
610T(b)(1)(ii) (defining ``Pilot Securities'').
    \97\ See also proposed Rule 610T(b)(3)(ii)(D) (concerning the
Pilot Securities Change List and the capture of the date on which
any Pilot Security closes below $1).
---------------------------------------------------------------------------

    While the EMSAC did not specify a minimum price threshold, the
Commission is proposing an initial $2 threshold that would apply at the
time of the initial Pilot Securities selection, as was done for the
Tick Size Pilot. On a continuing basis, the price threshold would be
$1, also as was done for the Tick Size Pilot. If a Test Group
security's share price closes below $1 at the end of a trading day
during the proposed Pilot, it would be dropped from the Test Group and
removed from the proposed Pilot.\98\ Under Rule 610(c), stocks with
quotations of less than $1 are subject to a structurally different fee
cap (based on a percentage of the quoted price) than stocks with
quotations of $1 or greater (based on a fixed dollar amount),\99\ and
equities exchanges typically also assess fees differently for stocks
priced less than $1 (i.e., based on a percentage of the price rather
than a fixed fee amount).\100\ Accordingly, the $1 minimum continuing
price threshold recognizes those distinctions and avoids applying the
proposed Pilot's Test Group fixed dollar fee caps to securities below
$1 for which a fixed dollar cap would be incompatible with the current
existing percentage-based standards applicable to those
securities.\101\
---------------------------------------------------------------------------

    \98\ See Section III.E.1 infra (discussing the obligations for
primary listing exchanges to maintain Lists of Pilot Securities that
will be updated as necessary prior to the beginning of trading on
each day the U.S. equities markets are open for trading to
communicate changes to Pilot Securities). Stocks in the Control
Group that close below $1 would be removed from the Pilot. As
discussed below, exchanges would be required to record on the Pilot
Securities Change Lists the date that a stock closes below $1.
    \99\ While Rule 610(c) imposes a cap of $0.0030 for a protected
quotation of $1.00 or more, the cap is 0.3% when the protected
quotation is less than $1.00. See 17 CFR 242.610(c).
    \100\ See, e.g., New York Stock Exchange Price List, available
at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf.
    \101\ For example, applying Test Group 2's $0.0015 cap to a
security priced at $0.25, which currently would be subject to a fee
cap of $0.00075 under Rule 610(c) (i.e., 0.3% of $0.25) would be
inapposite.
---------------------------------------------------------------------------

    The Commission preliminarily believes that an initial minimum $2
per share price threshold at the time of the initial stock selection
captures substantially all NMS stocks while also providing a cushion so
that substantially all of the securities selected for each Test Group
will remain part of their respective Test Groups for the duration of
the proposed Pilot and not be dropped on account of their share price
closing below $1 during the Pilot, as it is uncommon for securities
priced at $2 or more to fall below $1.\102\ This

initial threshold also will increase the likelihood that the securities
in each Test Group remain the same throughout the entire proposed
Pilot, which will provide consistency in the Test Groups and avoid any
adverse impact caused by changes to the composition of the Test
Groups.\103\
---------------------------------------------------------------------------

    \102\ Based on data computed from Center for Research on
Securities Prices (CRSP), during the last five years (2012-2016),
94.4% of publicly traded common stocks and ETPs had a share price
above $2. Of those stocks, only 4.3% dropped below $1 at any point
in that period. In addition, NYSE and Nasdaq can initiate delisting
proceedings if a security trades below $1 for a certain period of
time. See, e.g., NYSE Listed Company Manual Section 802.01C; Nasdaq
Equity Rule 5450(a)(1). See also Cboe BYX Rule 14.7(e)(1) (continued
listing requirement of a minimum bid price of $1 per share); NYSE
Arca Rule 5.2(c) (maintenance requirement of a $5 closing bid price
or $3 closing bid price under the alternate listing requirement).
    \103\ Similarly, the requirement that Pilot Securities have an
unlimited duration or a duration beyond the end of the post-Pilot
Period is intended to avoid selecting stocks that would expire and
drop out during the Pilot, which also should provide consistency in
the Test Groups and avoid adverse impacts caused by changes to the
composition of the Test Groups.
---------------------------------------------------------------------------

    With respect to market capitalization, the EMSAC recommended
limiting the pilot to large capitalization stocks with a minimum market
capitalization of $3 billion in part to avoid overlap with the Tick
Size Pilot, which commenced on October 3, 2016, and is scheduled to
last for a two-year period until October 3, 2018.\104\ The Commission
notes that the Tick Size Pilot may conclude before the proposed Pilot
commences, but if not, the Commission believes that the strong support
for a pilot in the near term, reflected in the comments summarized
above, as well as the proposed Pilot's design, which, as discussed
below, would protect the integrity of the data in both pilots, weighs
in favor of proceeding expeditiously and not waiting for the Tick Size
Pilot to first expire.\105\
---------------------------------------------------------------------------

    \104\ See EMSAC Pilot Recommendation, supra note 28, at 2. See
also EMSAC Transcript, April 26, 2016, supra note 36, at 27:7-15
(reflecting the Subcommittee's desire to run the Tick Size Pilot
simultaneously with the Pilot without either program impacting the
other). See also Investor Alert: Tick Size Pilot Program--What
Investors Need to Know, available at https://www.sec.gov/oiea/investor-alerts-bulletins/ia_ticksize.html (summarizing the Tick
Size Pilot).
    \105\ See, e.g., Healthy Markets Letter I, supra note 44, at 5
(noting that ``market participants, experts, and policymakers have
been clamoring for the Commission to adopt a study to address order
routing incentives for years''); RBC Capital Markets Letter III,
supra note 44, at 1 (``[T]he sooner that a pilot can be approved and
commenced, the sooner the Commission will have the benefit of the
pilot's data, and the sooner it can implement needed reforms.'');
IEX Letter, supra note 44, at 4 (``The EMSAC recommendation was
issued more than one year ago, and no one believes that concerns
over maker-taker pricing have become less relevant since then. We
believe that the time to proceed with the pilot is long past
due.'').
---------------------------------------------------------------------------

    The Commission preliminarily believes that a more comprehensive
pilot covering all NMS stocks, including those with market
capitalizations below $3 billion, would produce a more meaningful
dataset to facilitate broader analysis of the impact of transaction
fees and rebates across the full spectrum of NMS stocks, including both
large market capitalization companies with potentially substantial
liquidity and trading activity as well as mid- and small capitalization
companies with potentially less trading activity. A broader dataset
will, in turn, permit the Commission and researchers to perform more
in-depth analyses among different segments of the securities market,
which may be more informative than a narrower pilot for evaluations of
the various theories for how transaction fees and rebates may impact
routing behavior, execution quality, and market quality.
    For example, some have suggested that transaction rebates are
distortive and unnecessary for liquid large capitalization companies
because, to the extent that those securities already trade at spreads
no wider than the minimum trading increment, the rebate cannot serve to
narrow the quoted spread further and the high fee that offsets the
rebate undermines price transparency because a quote at the same
displayed price on different equities exchanges (with different levels
of fees) less closely reflects the actual net price to trade at any one
exchange.\106\ The limitation or removal of rebates for liquid large
capitalization stocks therefore may be less likely to lead to
deterioration in market quality in those securities.\107\ On the other
hand, some have argued that the beneficial aspects of rebates,
including their potential to contribute to narrowing quoted spreads,
may outweigh their potential for these distortions in mid- and small
capitalization securities, which can face persistent challenges in
attracting liquidity.\108\ Accordingly, transaction rebates may
facilitate the provision of beneficial liquidity for mid- and small
capitalization securities, and may outweigh any negative distortive
impact on broker-dealer incentives, market complexity, or price
transparency.\109\
---------------------------------------------------------------------------

    \106\ See, e.g., James Angel, Lawrence Harris & Chester Spatt,
``Equity Trading in the 21st Century,'' Quarterly Journal of Finance
1, (2011), available at https://doi.org/10.1142/S2010139211000067
(noting that ``[t]he obfuscation makes it more difficult for traders
to recognize the true costs of their trading.'') (``Angel, Harris,
and Spatt''); Joe Ratterman, Chief Executive Officer, & Chris
Concannon, President, BATS, ``Open Letter to U.S. Securities
Industry Participants Re: Market Structure Reform Discussion,'' at 1
(January 6, 2015), available at http://cdn.batstrading.com/resources/newsletters/OpenLetter010615.pdf (``BATS Open Letter'')
(arguing that ``[a] substantial reduction in access fees, and their
corresponding rebates, would help remove conflicts or a perception
of conflicts with respect to those highly liquid securities that no
longer require liquidity incentives.'').
    \107\ See, e.g., BlackRock Viewpoint, supra note 91, at 7 (``The
value of liquidity and therefore the need for incentives and rebates
is not the same across all stocks. Regulators should review whether
highly liquid stocks require any rebates at all.'').
    \108\ See, e.g., BATS Open Letter, supra note 106, at 3 (``. . .
BATS does not believe that highly liquid securities require as great
a rebate as less liquid securities. . . . '').
    \109\ See id.
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    To study these possible effects, the Commission believes it is
important to gather data on the impact of fees and rebates on stocks of
all market capitalizations. While it is possible that some observations
from a pilot focused on large capitalization stocks also could be
relevant to mid- and small capitalization stocks, it is likely that
other observations could be inapposite, and without including smaller
stocks in a pilot, the Commission and researchers would lack data to
study the impact on them.
    Implementing without undue delay a broad pilot that includes stocks
of all market capitalizations could potentially cause the Pilot to
overlap with the Tick Size Pilot. Although such an overlap may be
unlikely, the proposed Pilot has been designed so that, if necessary,
it could proceed simultaneously with the Tick Size Pilot without
distorting the effects of either pilot.\110\ Specifically, as discussed
further below, in the event of an overlap each Test Group would be
comprised of two subgroups, one of which contains securities included
in the Tick Size Pilot, and one of which does not, enabling the
Commission and researchers to identify and control for any possible
effects of an overlap.\111\ The Commission therefore believes that this
proposed Pilot design would protect the integrity of the data in both
the proposed Pilot and the Tick Size Pilot, to the extent that the
pilots overlap.\112\ Staging one transaction fee pilot for large
capitalization stocks in

the near term (i.e., that does not overlap with the Tick Size Pilot's
$3 billion market capitalization threshold) and conducting a separate,
subsequent transaction fee pilot for mid- and small capitalization
stocks following the conclusion of the Tick Size Pilot also would
achieve that objective. However, the Commission preliminarily believes
that it is preferable to proceed expeditiously with a broad transaction
fee pilot because the data to be collected from the proposed Pilot, and
the analyses that will follow, will help inform the Commission and the
public on the potential impact of transaction fees and rebates across
all segments of NMS stocks.
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    \110\ See Section III.C infra for additional explanation
regarding how the Pilot would control for the potential overlap with
the Tick Size Pilot. Notably, if the two pilots overlap and the Tick
Size Pilot ends before the proposed Pilot (if adopted) ends, the
Transaction Fee Pilot's proposed Test Groups would not change.
Alternatively, if the two pilots would not overlap at all because
the Tick Size Pilot ends before the proposed Pilot (if adopted)
commences, then the overlap design discussed below would not be
necessary. See Section III.C (noting that each Test Group would
remain constant for the duration of the proposed Pilot with only
limited exceptions).
    \111\ The proposed overlap structure, which can be seen in Test
Groups 1(a), 2(a), and 3(a) reflected in the table below titled
``Proposed Pilot Design of the Transaction Fee Pilot for NMS
Stocks,'' is specifically designed to enable comparison between
subgroups within a particular Test Group, as well as across Test
Groups, to identify any differences between those securities that
overlap with the Tick Size Pilot and those that do not.
    \112\ In addition, conducting both pilots simultaneously would
increase the amount of data collected while both pilots are active,
which may increase the statistical power of tests of the marginal
impact of transaction fees or rebates or of different tick sizes.
Statistical power refers to the ability for statistical tests to
identify differences across samples when those differences are
indeed significant.
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    Further, the Commission preliminarily does not believe that
including smaller capitalization stocks in the proposed Pilot should
disproportionately harm those issuers, even though it may result in the
reduction or elimination of transaction-based rebate incentives \113\
that would otherwise be used to attract posted liquidity in those
stocks on maker-taker exchanges, as discussed above.\114\ While the
proposed Pilot would reduce or eliminate rebate incentives to transact
in those securities on an exchange for certain Test Groups, the
proposed Pilot would not impact the ability of an exchange to maintain
a ``protected quote,'' which may offset the reduced rebate incentive
and continue to serve as an incentive to attract liquidity
providers.\115\ In addition, the proposed Pilot would reduce exchange
transaction fees for certain Test Groups, as discussed below, thereby
making it less expensive--and consequently more attractive--to transact
in those securities on an exchange, which also may offset the reduced
rebate incentive and attract liquidity providers. Accordingly,
including in the proposed Pilot smaller capitalization companies that
are part of the Tick Size Pilot will allow the Commission to collect
data in the near term on the impact of transaction fees and rebates on
NMS stocks, including smaller capitalization stocks, which may trade
differently than large capitalization stocks and thus may be affected
differently by changes to transaction fees and rebates.
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    \113\ See supra notes 108-109 and accompanying text for an
explanation of the beneficial aspects of rebates for mid- and small
capitalization securities. See also Section V.C.2.f infra for a
discussion of the potential impact of subjecting small-
capitalization securities to both the Tick Size Pilot and the
proposed Pilot.
    \114\ See, e.g., EMSAC Pilot Recommendation, supra note 28, at 1
(noting that there may not be ``any certain or predetermined
outcomes from the pilot, and the net effect of many counterbalancing
factors are not believed to be significantly beneficial or
detrimental to any single group.'').
    \115\ The Commission has a variety of mechanisms to address
issues that may arise under the Pilot. See 15 U.S.C. 78mm.
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    The Commission requests comment on the securities to be included in
the proposed Pilot. In particular, the Commission solicits comment on
the following. To the extent possible, please provide specific data,
analyses, or studies for support.
    5. Is the proposed sample size of securities for the proposed Pilot
reasonable? If not, what other selection criteria should be used? What
changes should the Commission consider to inclusion or exclusion from
the sample set? Should the Commission include a narrower or broader
universe of securities? In particular, should only common stocks and
ETPs be included in the proposed Pilot and should other types of NMS
stocks, like rights and warrants, be excluded from the Pilot? Why or
why not? Is the proposed selection method for the Pilot reasonable?
    6. Is the inclusion of ETPs appropriate? Does the proposed Pilot
design account for relevant distinctions between ETPs and other stocks?
Should the proposed Pilot exclude ETPs that are not ETFs?
    7. If the Commission excludes ETPs from the proposed Pilot, what
would be the effects on the quality and extent of data? How would this
impact the study?
    8. Should other types of securities be included, such as options?
Should certain securities be excluded? Why or why not?
    9. If the timing of the proposed Pilot appears likely to coincide
with the Tick Size Pilot, would it be reasonable to proceed
simultaneously with the proposed Pilot? Why or why not? To the extent
that there is no overlap between the proposed Pilot and the Tick Size
Pilot, the Commission would not retain the overlap design. Do
commenters agree with this approach?
    10. Is the initial $2 per share threshold reasonable? Why or why
not? Is there another level at which this threshold should be set?
    11. Is the $1 per share minimum continuing price threshold
reasonable? Why or why not? Is there another level at which this
threshold should be set?
    12. Should the Commission require a minimum market capitalization?
If so, what should be the threshold? What would be the impacts of this
revised market capitalization threshold?
    13. Should the Commission require a minimum trading volume for NMS
stocks in the proposed Pilot?
    14. What are the likely effects of the proposed Pilot on issuers
and capital formation? In particular, are different types of issuers
likely to be affected in different ways by the proposed Pilot, and, if
so, how?
    15. Should issuers be allowed to opt out of the proposed Pilot or
would allowing issuers to opt out adversely affect the proposed Pilot?
If so, how? What would be the impact on the extent and quality of the
data? For example, could it reduce the representativeness of the
results obtained from the Pilot, particularly if those issuers that opt
out are predominantly one type of issuer (e.g., small or mid-
capitalization issuers)? If issuers were allowed to opt out, should
only certain types of issuers be allowed to opt out, e.g., small-
capitalization stocks or stocks with low levels of liquidity? How
should the Commission consider the benefits and costs on the overall
Pilot? How should the costs to issuers and shareholders be measured?

C. Proposed Pilot Design

    Pursuant to proposed Rule 610T(b)(1), the Commission would
designate by notice the initial List of Pilot Securities. That list
would place each NMS stock that meets the initial criteria to be a
Pilot Security into one of the three proposed Test Groups or into the
Control Group. Each of the three Test Groups would be selected through
stratified sampling by market capitalization, share price, and
liquidity.\116\ The composition of each Test Group would remain
constant for the duration of the proposed Pilot, except that the
exchanges would update this information, as described below, to reflect
changes to the composition of the groups caused by mergers, delistings,
or removal from a Test Group due to the share price of a stock closing
below $1.
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    \116\ Stratified sampling refers to selecting stocks for each
Test Group and the Control Group according to predefined criteria.
As proposed, the predefined criteria would result in each Test Group
and the Control Group containing a group of stocks that, as a group,
reflect a similar distribution of market capitalization, share
price, and liquidity. For example, when stratifying stocks on the
basis of liquidity, each Test Group and the Control Group would have
a similar distribution of high, moderate, and low liquidity
securities.
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    Each Test Group would contain 1,000 NMS stocks, with the remainder
of eligible NMS stocks to be included in the Control Group. If the
proposed Transaction Fee Pilot is adopted and commences before the end
of the Tick Size Pilot, the selection of the common stocks for the
Transaction Fee Pilot Test Groups would take into consideration the
common stocks in the Tick Size Pilot.\117\ If the two pilots would not

overlap at all because the Tick Size Pilot ends before the proposed
Pilot (if adopted) commences, then the overlap design of dividing each
group into two subgroups would not be necessary and each Test Group
would simply contain 1,000 NMS stocks without subgroups.
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    \117\ Specifically, if the two pilots would overlap, then each
of the proposed Transaction Fee Pilot's three Test Groups would be
divided into two subgroups--one that overlaps with the Tick Size
Pilot and one that does not overlap. The subgroups that overlap with
the Tick Size Pilot would each contain 270 NMS stocks (45 stocks
would be selected from each of the three Tick Size Pilot test groups
(45 stocks x 3 Tick Size Pilot groups = 135 total), with the
remaining 135 stocks coming from the Tick Size Pilot's control
group, for a total of 270 common stocks). The subgroups that do not
overlap with the Tick Size Pilot would each contain 730 NMS stocks:
150 large-capitalization common stocks, 100 small- and mid-
capitalization stocks that do not overlap with the Tick Size Pilot,
260 ETPs, and 220 other NMS stocks. For purposes of the proposed
Pilot, large-capitalization common stocks would be common stocks
with market capitalizations above $3 billion and conversely, small-
and mid-capitalization common stocks would be those with market
capitalizations of $3 billion or less. See Section III.B supra for
discussion regarding including securities with market
capitalizations above, as well as below, $3 billion in the proposed
Pilot. See also proposed Rule 610T(b)(2)(ii)(D) (containing fields
for certain types of NMS stocks that would be included in the
proposed Pilot). The Commission would select stocks from the pool of
securities eligible for the Tick Size Pilot in the same manner as it
selects the stocks that would not overlap with the Tick Size Pilot.
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    The Commission preliminarily believes that this design would be
representative of the size of the overall population of NMS stocks and
would provide sufficient statistical power to identify differences
among the Test Groups with respect to common stocks and ETPs.\118\ This
selection methodology for the Pilot Securities is intended to help
ensure that the proposed Transaction Fee Pilot Test Groups would be
similar in composition to each other and to the Control Group, as well
as to the composition of the Tick Size Pilot test groups. This proposed
design would reduce the likelihood that the proposed Transaction Fee
Pilot would cause data issues for the study of the Tick Size Pilot and
vice versa.\119\
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    \118\ See supra note 112 (defining ``statistical power''). The
Commission preliminarily believes that any reduction in the number
of NMS stocks in any particular group could provide less statistical
power and thereby affect the conclusions of the Pilot.
    \119\ See Section V.C.1.a.i.A infra. The proposed design ensures
that similar proportions of stocks impacted by the Tick Size Pilot
would be included in each Test Group of the Transaction Fee Pilot,
such that any Tick Size Pilot effects would be uniform across the
proposed Pilot. Researchers would therefore be able to control for
those effects and minimize any data distortion.
---------------------------------------------------------------------------

    While the EMSAC limited its recommendation by proposing test groups
modeled on the current regulatory structure reflected in Rule 610(c),
the Commission instead has preliminarily determined to more broadly
study the impact of all transaction fees on order routing behavior,
execution quality, and market quality.\120\ Including all equities
exchanges in the proposed Pilot, even those with taker-maker fee
models, would ensure that the Pilot will collect data on all equities
markets that are registered national securities exchanges, whose fees
are all subject to the requirements of the Exchange Act and the rule
filing requirements thereunder, thus treating equally all similarly
situated entities.
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    \120\ The Commission notes that one of the goals of Rule 610(c)
was to support the integrity of the price protection requirement
established by Rule 611 of Regulation NMS. See NMS Adopting Release,
supra note 1, at 37503 (``Finally and most importantly, the fee
limitation of Rule 610 is necessary to support the integrity of the
price protection requirement established by the adopted Order
Protection Rule. In the absence of a fee limitation, some `outlier'
trading centers might take advantage of the requirement to protect
displayed quotations by charging exorbitant fees to those required
to access the outlier's quotations. Rule 610's fee limitation
precludes the initiation of this business practice, which would
compromise the fairness and efficiency of the NMS.'').
---------------------------------------------------------------------------

    In addition, as is the case currently under Rule 610(c), the
proposed Pilot would permit equities exchanges to charge varied
transaction fees for Pilot Securities within each Test Group, so long
as such fees comply with the conditions (including the applicable cap)
set for that group. The Commission believes that this would allow
equities exchanges to continue to compete for order flow by adjusting
their access fees within the bounds of the proposed Pilot.
    The Commission is proposing to apply the following pricing
restrictions to Test Groups 1, 2, and 3, and the Control Group would
remain subject to the current access fee cap in Rule 610(c):

[GRAPHIC] [TIFF OMITTED] TP26MR18.001

1. Test Group 1
    For Pilot Securities in Test Group 1, equities exchanges could
neither impose, nor permit to be imposed, any fee or fees for the
display of, or execution against, the displayed best bid or offer of
such market in NMS stocks that exceeds or accumulates to more than
$0.0015 per share. The cap in Test Group 1 would apply to transaction
fees assessed on the remover (taker) of liquidity as well as
transaction fees assessed on the provider (maker) of liquidity.\121\
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    \121\ In other words, the fee cap in Test Group 1 would apply
the cap to the take fee charged to the taker on a maker-taker
exchange and also would apply the cap to the make fee charged to the
maker on a taker-maker exchange.
---------------------------------------------------------------------------

    The EMSAC recommended three test groups, with fee caps of $0.0020,
$0.0010, and $0.0002, respectively. The Commission also is proposing
three test groups, two with fee caps of $0.0015 and $0.0005, and one
that prohibits rebates and Linked Pricing. The Commission preliminarily
believes that it is appropriate to test an intermediate reduction in
the fee cap. However, because the proposed Pilot includes a no-rebate
bucket, the Commission preliminary believes it is preferable to test a
cap, set at half of the current $0.0030 cap, rather than two
intermediate caps as EMSAC recommended. This approach will allow the
proposed Pilot to test more pronounced changes to the status quo
without increasing the total number of Test Groups. Accordingly, as
discussed below, in addition to the $0.0015 test group, the proposed
Pilot also includes a test group of $0.0005 (as proposed Test Group 2)
as well as a no-rebate bucket (which EMSAC did not recommend).\122\ The
Commission preliminarily believes that having a total of three Test
Groups would allow the proposed Pilot to test several different
scenarios while avoiding overcomplicating the Pilot and would represent
a pilot design with which the exchanges are familiar because it aligns

with the Tick Size Pilot's three test groups.\123\
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    \122\ See infra Section III.C.2 (discussing proposed Test Group
2) and Section III.C.3 (discussing proposed Test Group 3).
    \123\ Maintaining three test groups for the proposed Pilot would
allow it to align closely with the Tick Size Pilot's three test
groups, with which the exchanges are familiar. In addition, the
proposed Test Groups have been designed to account for overlap
between the two pilots and control for the potential that such
overlap could possibly affect the results of the Pilot. See supra
Section III.B.
---------------------------------------------------------------------------

    Finally, the EMSAC's proposed first group would have applied its
cap only to fees assessed for removing liquidity, which is consistent
with the application of Rule 610(c)'s fee cap.\124\ As discussed above,
the Commission instead is proposing to apply Test Group 1's cap to fees
assessed for removing or posting liquidity. In other words, as
discussed above, the proposed cap in Test Group 1 would apply to maker-
taker pricing as well as taker-maker pricing, which some comments
submitted in response to the EMSAC's recommendation supported. The
Commission preliminarily believes that applying the cap in Test Group 1
to any fees assessed--including to fees for providing liquidity in a
taker-maker pricing model--would help achieve the purpose of the
proposed Pilot by applying the test conditions broadly to all equities
exchange transaction fees and not just fees for accessing a protected
quotation.
---------------------------------------------------------------------------

    \124\ See supra note 76 and accompanying text (noting that the
Rule 610(c) access fee cap only caps fees for removing a protected
quotation).
---------------------------------------------------------------------------

2. Test Group 2
    For Pilot Securities in Test Group 2, equities exchanges could
neither impose, nor permit to be imposed, any fee or fees for the
display of, or execution against, the displayed best bid or offer of
such market that exceed or accumulate to more than $0.0005 per share.
The cap in Test Group 2 would apply to transaction fees assessed on the
remover (taker) of liquidity as well as transaction fees assessed on
the provider (maker) of liquidity.\125\
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    \125\ In other words, the fee cap in Test Group 2 would apply
the cap to the take fee charged to the taker on a maker-taker
equities exchange and also would apply the cap to the make fee
charged to the maker on a taker-maker equities exchange.
---------------------------------------------------------------------------

    The level of the Commission's proposed cap for Test Group 2 is
intended to introduce a materially lower cap than Test Group 1 to
further reduce the potential distortion created by current levels of
rebates, while continuing to permit, for the preponderance of exchange
transaction volume, the ability of an exchange to maintain its net
profit on a transaction.\126\ Specifically, Test Group 2 would prohibit
exchanges from charging more than $0.0005 on one side of a transaction,
which means an exchange would only have that amount (or less) to fund
the rebate it pays to the other side of the transaction, unless it uses
other sources of revenue to subsidize the rebate. Therefore, the
Commission expects that Test Group 2's $0.0005 cap would significantly
reduce, if not eliminate, the likelihood that an exchange would choose
to offer rebates at their current levels for Pilot Securities in this
group, while nevertheless retaining the ability of exchanges to compete
by offering rebates if they so choose.\127\ Accordingly, Test Group 2
is designed to test the impact of materially lower rebates and fees,
where the potentially distortive effects of rebates, and the fees used
to fund those rebates, is greatly reduced and thereby gather data on
the impact of that reduction on order routing decisions, execution
quality, and market quality.
---------------------------------------------------------------------------

    \126\ For example, if an exchange's base fee to take liquidity
is $0.0030 and its base rebate to provide liquidity is $0.0020, the
exchange would earn $0.0010 (net capture rate). The proposed cap for
Test Group 2 would allow such an exchange to maintain its current
net capture rate on such transaction if it charged both sides
$0.0005, though charging both sides of a transaction for Test Group
2 securities would result in a change to the exchange's fee model to
a ``traditional'' pricing structure for those securities. As of
December 2017, Nasdaq's base take fee was $0.0030 and its base
rebate was $0.0020; NYSE's base take fee was $0.0030 and its base
rebate was $0.0014; NYSE Arca's base take fee was $0.0030 and its
base rebate was $0.0020; and CboeBZX's base take fee was $0.0030 and
its base rebate was $0.0020. See, respectively, http://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2 (Nasdaq), https://www.nyse.com/markets/nyse/trading-info/fees (NYSE), https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf (NYSE Arca), and https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/ (CboeBZX).
    \127\ For example, a maker-taker equities exchange might choose
to offer a $0.0004 rebate and charge a fee of $0.0005 for stocks in
Test Group 2. In this way, exchanges could continue to compete with
one another by offering rebates. Compared to current levels of
rebates, which may approach the level of the current $0.0030 cap, a
rebate of $0.0004, by comparison, would be materially lower.
---------------------------------------------------------------------------

3. Test Group 3
    For Pilot Securities in Test Group 3, equities exchanges generally
would be prohibited from offering rebates, either for removing or
posting liquidity, and, as discussed further below, from offering a
discount or incentive on transaction fee pricing applicable to removing
(providing) liquidity that is linked to providing (removing) liquidity.
In addition, for the reason discussed below, Test Group 3 would be
unique in that the prohibition on rebates would apply not only to
displayed top-of-book \128\ liquidity, but also would apply to depth-
of-book \129\ and undisplayed liquidity.\130\ In contrast, Test Groups
1 and 2, like the Rule 610(c) fee cap, only cap fees for the execution
of an order against a ``protected quotation,'' which is defined as an
exchange's displayed top-of-book quote.\131\ While rebates would be
prohibited in Test Group 3, transaction fees for securities in Test
Group 3 would remain subject to the current $0.0030 access fee cap in
Rule 610(c) for accessing a protected quotation.\132\
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    \128\ ``Top-of-book'' means the aggregated best bid and best
offer resting on an exchange; in other words, aggregate interest
that represents the highest bid (to buy) and the lowest offer (to
sell). See 17 CFR 242.600(b)(7) (defining ``best bid'' and ``best
offer'').
    \129\ ``Depth-of-book'' refers to all resting bids and offers
other than the best bid and best offer; in other words, all orders
to buy at all price levels less aggressive than the highest priced
bid (to buy) or all offers to sell at all price levels less
aggressive than the lowest priced offer (to sell). See 17 CFR
242.600(b)(8) (defining ``bid'' and ``offer'').
    \130\ ``Undisplayed'' refers to resting orders that are
``hidden'' and not displayed publicly in the consolidated market
data. See 17 CFR 242.600(b)(13) (defining ``consolidated display''
and (b)(60) (defining ``published bid and published offer''). See
also infra notes 136-139 and accompanying text.
    \131\ See 17 CFR 242.600(b)(58) (defining ``protected
quotation'').
    \132\ In other words, Test Group 3 would prohibit rebates for
both posting and taking liquidity, but would remain subject to Rule
610(c), which caps fees for taking liquidity. Test Group 3 would not
cap fees for posting liquidity.
---------------------------------------------------------------------------