Proposed Rule2022-27616
Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders
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Published
December 29, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission" or "SEC") is proposing to amend certain rules of Regulation National Market System ("Regulation NMS") under the Securities Exchange Act of 1934, as amended ("Exchange Act") to adopt variable minimum pricing increments for the quoting and trading of NMS stocks, reduce the access fee caps, and enhance the transparency of better priced orders.
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[Federal Register Volume 87, Number 249 (Thursday, December 29, 2022)]
[Proposed Rules]
[Pages 80266-80359]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-27616]
[[Page 80265]]
Vol. 87
Thursday,
No. 249
December 29, 2022
Part II
Securities and Exchange Commission
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17 CFR Part 242
Regulation NMS: Minimum Pricing Increments, Access Fees, and
Transparency of Better Priced Orders; Proposed Rule
Federal Register / Vol. 87 , No. 249 / Thursday, December 29, 2022 /
Proposed Rules
[[Page 80266]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-96494; File No. S7-30-22]
RIN 3235-AN23
Regulation NMS: Minimum Pricing Increments, Access Fees, and
Transparency of Better Priced Orders
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing to amend certain rules of Regulation National
Market System (``Regulation NMS'') under the Securities Exchange Act of
1934, as amended (``Exchange Act'') to adopt variable minimum pricing
increments for the quoting and trading of NMS stocks, reduce the access
fee caps, and enhance the transparency of better priced orders.
DATES: Comments should be received on or before March 31, 2023.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form <a href="https://www.sec.gov/rules/submitcomments.html">https://www.sec.gov/rules/submitcomments.html</a>; or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#ec9e998089c18f8381818982989facd08dcc849e898ad1" http: sec.gov">sec.gov</a>">rule-comments@<a href="http://sec.gov">sec.gov</a></a>. Please include
File Number S7-30-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-30-22. 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 of submission. The Commission will post all
comments on the Commission's website (<a href="https://www.sec.gov/rules/proposed.shtml">https://www.sec.gov/rules/proposed.shtml</a>). Comments are also available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549 on official business days between the hours of 10
a.m. and 3 p.m. Operating conditions may limit access to the
Commission's Public Reference Room. 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 our website. To ensure direct electronic receipt
of such notifications, sign up through the ``Stay Connected'' option at
<a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Kelly Riley, Senior Special Counsel,
Johnna Dumler, Special Counsel, Steve Kuan, Special Counsel, Marc
McKayle, Special Counsel, and Ted Uliassi, Special Counsel, at (202)
551-5500, Office of Market Supervision, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to
the following rules under Regulation NMS:
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CFR citation (17
Commission reference CFR)
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Rule 600(b)(59)................................... Sec.
242.600(b)(59)
Rule 600(b)(78)................................... Sec.
242.600(b)(78)
Rule 603.......................................... Sec. 242.603
Rule 610.......................................... Sec. 242.610
Rule 612.......................................... Sec. 242.612
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I. Introduction
A. Rule 612--Minimum Pricing Increments
B. Rule 610--Access to Quotations
C. Transparency of Better Priced Orders
II. Amendment to Rule 612 of Regulation NMS--Minimum Pricing
Increment
A. Background
B. Rule 612
1. Exchange Retail Liquidity Programs (``RLPs'')
C. Tick Size Considerations Since Regulation NMS
D. Issues Raised in the Current Market Structure
E. Proposals by Market Participants
1. Reduce the Tick Size to $0.005 for Tick-Constrained Stocks
2. Variable Tick Sizes
F. Proposal to Amend Rule 612
1. Minimum Pricing Increments
2. Quotations and Orders in NMS Stocks Priced at $1.00 or More
3. Quotations and Orders in NMS Stocks Priced Less Than $1.00
4. Minimum Pricing Increment for Trading
G. Proposed Implementation Period
H. Request for Comment
III. Amendments to Rule 610 of Regulation NMS--Fees for Access to
Quotations
A. Background
1. Regulation NMS
2. Exchange Fee Models
B. Current Rule 610(c)
C. Proposal To Reduce Fees for Access to Protected Quotations
and Increase Fee Transparency
1. Reduce Fees for Access to Protected Quotations
2. Require That All Exchange Fees and Rebates Be Determinable at
the Time of an Execution
D. Request for Comment
IV. Transparency of Better Priced Orders
A. Background
1. Infrastructure Implementation: Phased Transition Plan and
Current Status
B. Accelerate Implementation of Round Lots and Odd-Lot
Information
1. Odd-Lot Information
2. Round Lots
3. Display of Round Lots and Odd-Lot Information
4. Proposed Compliance Date
C. Request for Comment
D. Proposed Definition of Best Odd-Lot Orders
E. Request for Comment
V. Economic Analysis
A. Introduction
B. Market Failure
C. Baseline
1. Tick Sizes
2. Access Fees
3. Round Lots and Market Data Infrastructure
4. Affected Entities and Markets
D. Economic Effects
1. Modification of Rule 612 To Create a Tiered Tick Structure
2. Minimum Pricing Increment for Trading
3. Lower Access Fee Cap
4. Exchange Fees and Rebates Determinable at the Time of
Execution
5. Acceleration of the MDI Rules and Addition of Information
About Best Odd-Lot Orders
6. Compliance Costs
E. Effect on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
F. Reasonable Alternatives
1. Alternative Trading Increment
2. Alternative Tick Sizes
3. Alternative Access Fee
4. Do Not Accelerate Odd-Lot Information or Create BOLO
G. Request for Comment
VI. Paperwork Reduction Act
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden
1. Initial Burden Hours and Costs
2. Ongoing Burden Hours and Costs
E. Collection of Information is Mandatory
F. Confidentiality
G. Revisions to Current MDI Rules Burden Estimates
H. Request for Comments
VII. Consideration of Impact on the Economy
VIII. Regulatory Flexibility Act Certification and Initial
Regulatory Flexibility Act Analysis
A. Proposed Amendments to Rule 612--Initial Regulatory
Flexibility Analysis
1. Reasons for the Proposed Action
2. Legal Basis
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other Compliance Requirements
[[Page 80267]]
5. Duplicative, Overlapping, or Conflicting Federal Rules
6. Significant Alternatives
7. Request for Comments
B. Proposed Amendments to Rule 610
C. Proposed Amendments to Rule 603 and Definitions Odd-Lot
Information and Regulatory Data Under Rule 600
Statutory Authority and Text of the Proposed Rule Amendments
I. Introduction
Section 11A of the Exchange Act \1\ directs the Commission to
facilitate the establishment of a national market system in accordance
with specified Congressional findings. In furtherance of this
direction, the Commission adopted Regulation NMS in 2005, which
includes several provisions that updated and modernized the national
market system to take advantage of the data processing and
communications technology that were available at that time and to
address the then recent changes that had occurred in the markets.
Regulation NMS was designed to achieve the objectives of section 11A of
efficient, competitive, fair and orderly markets.\2\
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\1\ 15 U.S.C. 78k-1.
\2\ 15 U.S.C. 78k-1(a).
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In Section 11A of the Exchange Act, Congress recognized that new
technology could ``create the opportunity for more efficient and
effective market operations.'' \3\ The market structure and technology
available today is vastly different from what was available when
Regulation NMS was adopted. Today, electronic trading has all but
supplanted manual trading and electronic trading systems can handle and
process data at speeds that would have been unheard of when Regulation
NMS was adopted. As the national market system has evolved, the
Commission has amended several aspects of Regulation NMS to address and
reflect changes in the markets.\4\ Most recently, in 2020, the
Commission adopted rules to update and modernize the equity market
infrastructure responsible for the collection, consolidation, and
dissemination of equity market data in the national market system by
expanding the content of NMS market data and establishing a
decentralized consolidation model for NMS market data (``MDI
Rules'').\5\
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\3\ 15 U.S.C. 78k-1(a)(1)(B).
\4\ See Securities Exchange Act Release No. 84528 (Nov. 2,
2018), 83 FR 58338 (Nov. 19, 2018) (``Disclosure of Order Handling
Information'' in which the Commission adopted new order handling
disclosure requirements). The Commission has continually reviewed
the national market system and issues related to equity market
structure since Regulation NMS was adopted. In 2010, the Commission
issued a Concept Release on Equity Market Structure seeking public
comments on high frequency trading, order routing, market data
linkages, and undisplayed liquidity. See Securities Exchange Act
Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010)
(``Concept Release on Equity Market Structure''). In 2015, the SEC
formed the Equity Market Structure Advisory Committee (``EMSAC''),
which considered issues related to Regulation NMS and equity market
structure. The archives of these meetings are available at <a href="https://www.sec.gov/spotlight/emsac/emsac-archives.htm">https://www.sec.gov/spotlight/emsac/emsac-archives.htm</a>.
\5\ Securities Exchange Act Release No. 90610 (Dec. 9, 2020), 86
FR 18596 (Apr. 9, 2021) (``MDI Adopting Release'').
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While the MDI Rules, in part, updated the NMS market data to enable
investors to see, and more readily access, better-priced quotations,\6\
the Commission believes that other aspects of Regulation NMS need to be
updated in light of the current trading environment. Investors should
have access to the best priced quotations available in the national
market system and such prices generally should be determined by
competitive market forces. Among the rules adopted under Regulation
NMS, rule 610 sets forth standards governing access to quotations in
NMS stocks and rule 612 establishes minimum pricing increments for NMS
stocks.\7\ In the current trading environment, rule 612 should be
updated by reducing the minimum pricing increment for certain NMS
stocks to allow market participants, including investors, to better
determine the prices at which they would bid or offer. Further, rule
610 contains maximum access fee caps that were based on the trading
environment in 2005. These access fee caps should be reduced in
conjunction with the reduction of the minimum pricing increments under
rule 612 to help to ensure that the access fee caps do not become too
large in relation to the minimum pricing increments.\8\ The Commission
has not revised rule 610 or rule 612 since they were adopted and the
Commission believes that these rules should be revised to reflect the
current trading environment and so that they can continue to fulfill
the goals of section 11A of the Exchange Act. The amendments proposed
herein--varying and lowering the minimum pricing increments for the
quoting and trading of certain NMS stocks, reducing the access fee
caps, and accelerating the dissemination of information about
quotations in smaller sizes--would enhance trading opportunities for
all investors. They would also serve to help ensure that orders placed
in the national market system reflect the best prices available for all
investors.
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\6\ Id. at 18601.
\7\ See 17 CFR 242.610 and 17 CFR 242.612.
\8\ See infra section III for further discussion of the
relationship between access fees and minimum pricing increments.
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Congress' findings promulgated in 1975 as set forth in section 11A
of the Exchange Act continue to guide the Commission as it considers
the issues that exist within the national market system in 2022. Among
the findings that guide the Commission in overseeing the national
market system, the Commission must consider the availability of ``[n]ew
data processing and communications techniques [that] create the
opportunity for more efficient and effective market operations'' \9\
and that it is in the public interest, appropriate for investor
protection and the maintenance of fair and orderly markets to assure
``economically efficient execution of securities transactions,'' ``fair
competition among brokers and dealers, among exchange markets, and
between exchange markets and markets other than exchange markets,'' and
``the practicality of brokers executing investors' orders in the best
market.'' \10\ These findings support our decision to propose
amendments to rules 610 and 612 of Regulation NMS in light of the
tremendous changes that have occurred in the markets since 2005.
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\9\ 15 U.S.C. 78k-1(a)(1)(B).
\10\ 15 U.S.C. 78k-1(a)(1)(c)(i), (ii), and (iv).
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Further, the MDI Rules are in the process of being implemented.\11\
While the content of market data that will be made available within the
national market system will provide many benefits to investors,\12\ the
Commission scheduled the implementation of the MDI Rules over a period
of time to minimize disruption to the markets and to facilitate an
orderly transition.\13\ As discussed in section IV.B below, in part due
to implementation delays after the adoption of the MDI Rules, the
Commission believes that the transition period set forth in the MDI
Adopting Release should be partially modified so that investors and
market participants would be provided with some of the benefits of the
MDI Rules, including greater transparency regarding the best priced
orders available in the market, sooner than the originally adopted
implementation schedule.\14\ Section 11A of the Exchange Act provides
that ``[i]t is in the public interest and appropriate for the
protection of investors and the maintenance of fair and orderly markets
to assure . . . the availability to brokers, dealers, and investors of
information with respect to
[[Page 80268]]
quotations for and transactions in securities.'' \15\ Acceleration of
some of the MDI Rules would help to fulfill this statutory goal.
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\11\ See MDI Adopting Release, supra note 5.
\12\ Id.
\13\ See id. at 18699. As discussed below, the transition to the
new MDI Rules has been delayed. See infra note 357 and accompanying
text.
\14\ See infra sections IV, V.D.5, and V.D.6 (discussing the
costs and benefits of accelerating the round lot and odd-lot
information definitions).
\15\ 15 U.S.C. 78k-1(a)(1)(C)(iii).
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A. Rule 612--Minimum Pricing Increments
The Commission adopted rule 612 of Regulation NMS to implement
minimum pricing increments (also known as minimum price variations or
tick sizes) for NMS stocks. Currently, quotations for NMS stocks priced
at, or greater than, $1.00 per share the minimum pricing increment is
$0.01, while quotations for NMS stocks priced less than $1.00 per share
the minimum pricing increment is $0.0001. Specifically, rule 612(a)
states that ``[n]o national securities exchange, national securities
association, alternative trading system, vendor, or broker or dealer
shall display, rank, or accept from any person a bid or offer, an
order, or an indication of interest in any NMS stock priced in an
increment smaller than $0.01 if that bid or offer, order, or indication
of interest is priced equal to, or greater than, $1.00 per share.''
Rule 612(b) applies to bids, offers, orders, and indications of
interest in any NMS stock priced less than $1.00 per share and
specifies that the increment cannot be smaller than $0.0001. The
Commission adopted rule 612 to address concerns about sub-penny quoting
by protecting displayed limit orders and promoting transparent and
consistent pricing. The Commission stated that the rule ``was designed
to limit the ability of a market participant to gain execution priority
over competing limit orders by stepping ahead by an economically
insignificant amount.'' \16\
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\16\ See Exchange Act Release No. 51808 (June 9, 2005), 70 FR
37496 (June 29, 2005) (``Regulation NMS Adopting Release''). See
also Exchange Act Release No. 49325 (Feb. 26, 2004), 69 FR 11126
(Mar. 9, 2004) (``Regulation NMS Proposing Release''). The
Commission issued a supplemental request for comment on proposed
Regulation NMS in May 2004. See Securities Exchange Act Release No.
49749 (May 20, 2004), 69 FR 30142 (May 26, 2004) (``Supplemental
Release''). On Dec. 16, 2004, the Commission re-proposed Regulation
NMS in its entirety for public comment. See Securities Exchange Act
Release No. 50870 (Dec. 16, 2004), 69 FR 77424 (Dec. 27, 2004)
(``Re-proposing Release'').
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There are various issues related to market developments which
suggest that the Commission should update the minimum pricing
increments for the U.S. equity markets. Specifically, many NMS stocks
today are constrained by the minimum pricing increment of $0.01 that is
required under rule 612 and thus are not able to be priced by market
forces. That is, based on liquidity and price competition, these stocks
could be priced more aggressively within the spread than is possible
with the current minimum pricing increment of $0.01. ``Tick-
constrained'' stocks, i.e., stocks that have a time weighted average
quoted spread of 1.1 cents or less make up the majority of the current
trading volume, and their presence suggests that the rule 612 minimum
pricing increment of $0.01 may now be too large for certain stocks,
which, in turn, results in the pricing of such stocks being
artificially constrained.\17\ Trading in tick-constrained stocks would
be improved if competitive market forces could establish prices in sub-
penny increments, which could reduce quoted spreads.
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\17\ In this release, tick-constrained stocks are defined as
those that have a time weighted quoted spread of $0.011 or less
calculated during regular trading hours. See infra note 102 and
accompanying text, infra note 448 and accompanying text and Table 4.
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In addition, the competitive dynamic between trading in the certain
parts of the over-the-counter (``OTC'') market and trading on national
securities exchanges and alternative trading systems (``ATSs'') caused
by, among other things, rule 612 has continued to shift over time.\18\
Specifically, while rule 612 prohibits exchanges, ATSs and broker-
dealers from displaying, ranking or accepting quotes and orders in NMS
stocks that are priced at, or greater than, $1.00 per share in sub-
penny increments, the rule does not prohibit trading in sub-penny
increments. In application, however, certain OTC market participants
are able to trade more freely in sub-penny increments than others.
Specifically, while rule 612 requires an OTC market maker to only
accept priced orders in a penny increment, it does not prevent OTC
market makers from executing an order in a sub-penny amount. Trading on
national securities exchanges and ATSs, however, largely occurs in
penny increments because national securities exchanges and ATSs
generally execute trades at the prices that orders and quotes must be
displayed, accepted or ranked under rule 612.\19\ Among other things,
the ability of OTC market makers to trade more readily in finer
increments (i.e., offering sub-penny price improvement over the
displayed quote) compared to the trading on exchanges and ATS has
contributed to the increased percentage of executions that occur off-
exchange.\20\ Finally, since the adoption of rule 612, there have been
technological advancements that enable trading and order routing
systems of market participants to handle the increased message traffic
that could occur if smaller or varied minimum pricing increments were
implemented for NMS stocks.
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\18\ See infra section II.D.
\19\ Exchanges and ATSs execute orders in sub-penny increments
if the price of the execution is the midpoint of the national best
bid and national best offer (``NBBO''), if the orders are benchmark
trades such as volume-weighted average price (``VWAP'') and time-
weighted average price (``TWAP''), or if an exchange has a retail
liquidity program (``RLP'') that operates pursuant to exemptions
granted by the Commission that allow such programs to provide
executions in tenths of a cent. See Regulation NMS Adopting Release,
supra note 16, at 37556. See also infra section II.
\20\ See, e.g., Staff Report on Equity and Options Market
Structure Conditions in Early 2021 (``Staff Report on Equity and
Options Market Structure'') at section 2.4 for a discussion of Order
Execution and Segmentation of Individual Investor Flow. Staff
reports, Investor Bulletins, and other staff documents (including
those cited herein) represent the views of Commission staff and are
not a rule, regulation, or statement of the Commission. The
Commission has neither approved nor disapproved the content of these
staff documents and, like all staff statements, they have no legal
force or effect, do not alter or amend applicable law, and create no
new or additional obligations for any person. See also Edwin Hu and
Dermot Murphy, ``Competition for Retail Order Flow and Market
Quality'' (June 8, 2022), available at <a href="https://ssrn.com/abstract=4070056">https://ssrn.com/abstract=4070056</a> (retrieved from SSRN Elsevier database) (noting
that approximately 27% of trading volume is routed from retail
brokerages to seven internalizing broker-dealers and estimating that
two of those firms handle 70% of the volume from 2017 to 2021; and
concluding that promoting more competitive markets for retail order
flow could save investors billions of dollars in transaction costs).
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Under section 11A(a)(1) of the Exchange Act, Congress found that
``[i]t is in the public interest and appropriate for the protection of
investors and the maintenance of fair and orderly markets to assure--
(i) economically efficient execution of securities transactions; [and]
(ii) fair competition among brokers and dealers, among exchange
markets, and between exchange markets and markets other than exchange
markets. . . .'' \21\ The Commission, consistent with the Congressional
mandate and direction of section 11A(a)(2) of the Exchange Act to carry
out these objectives, proposes to amend rule 612 to establish variable
minimum pricing increments for quotations and orders in NMS stocks that
are priced at, or greater than, $1.00 per share based on objective and
measurable criteria and make such minimum pricing increments applicable
to the trading of all NMS stocks regardless of price, subject to
certain specified exceptions.\22\
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\21\ 15 U.S.C. 78k-1(a)(1)(C).
\22\ The proposed rule would not change the minimum pricing
increment of rule 612(b), which permits sub-penny increments for
quotations and orders in NMS stocks that are priced less than $1.00
per share. See infra section II.F.3.
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As discussed in section II.F \23\ the Commission is proposing to
amend rule 612 in a manner that would extend
[[Page 80269]]
beyond tick-constrained stocks. The Commission believes that it is
timely, and consistent with section 11A of Exchange Act, to replace and
modernize the current ``one-size-fits-all'' tick approach with an
objectively calculated and varied approach that would determine the
minimum pricing increments for particular NMS stocks in a manner that
would reflect differences in their trading characteristics. The
Commission believes that the proposed variable minimum pricing
increments would address the issues related to tick-constrained stocks,
help to prevent other stocks from becoming tick-constrained, and reduce
transaction costs for many stocks without harming the displayed
liquidity in, and execution quality of, NMS stocks that may be higher
priced and/or trade with wider spreads. In addition, the Commission is
proposing to apply the amended rule 612 minimum pricing increments to
the quoting and trading of NMS stocks in order to promote fair
competition and equal regulation between trading in the OTC market and
trading on exchanges and ATSs, particularly as it relates to retail
order flow.
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\23\ See infra section II.F.
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The Commission believes that requiring orders to be executed in the
minimum pricing increment would enhance competition among trading
centers by ensuring that all trading centers would be able to compete
in the same price increment. The Commission believes applying the
proposed minimum pricing increments to the trading of NMS stocks
regardless of trading venue would also preserve most meaningful price
improvement opportunities and potentially benefit the market as
increased competition for orders, and between market participants,
could promote innovation.\24\
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\24\ See infra sections V.D.2 and V.E.2.a.
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As further discussed in section II.F, the Commission is proposing
to amend rule 612 such that the minimum pricing increment for
quotations and orders in NMS stocks that are priced at $1.00 or more
per share would be variable and no smaller than (1) $0.001, if the Time
Weighted Average Quoted Spread for the NMS stock during the Evaluation
Period was equal to, or less than, $0.008; \25\ (2) $0.002, if the Time
Weighted Average Quoted Spread for the NMS stock during the Evaluation
Period was greater than $0.008 but less than, or equal to, $0.016; (3)
$0.005, if the Time Weighted Average Quoted Spread for the NMS stock
during the Evaluation Period was greater than $0.016 but less than, or
equal to, $0.04; and (4) $0.01, if the Time Weighted Average Quoted
Spread for the NMS stock during the Evaluation Period was greater than
$0.04. Under this proposal, the primary listing exchanges would measure
and calculate the Time Weighted Average Quoted Spread of each NMS stock
in order to determine the applicable minimum pricing increment for such
NMS stock during the months of March, June, September, and December of
a particular calendar year (i.e., ``Evaluation Period'') for the three
months to follow. Finally, the Commission is proposing that the minimum
pricing increments set forth by rule 612, subject to specified
exceptions, be applicable to the trading of all NMS stocks.
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\25\ Currently, no NMS stock would qualify for this minimum
pricing increment. See infra note 211.
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B. Rule 610--Access to Quotations
The Commission adopted rule 610 to help to fulfill the statutory
objectives of fair and efficient access to the individual markets that
participate in the national market system.\26\ The Commission described
rule 610 as supporting the national market system objectives of
assuring ``the practicability of brokers executing investors' orders in
the best market'' \27\ and ``the efficient execution of securities
transactions.'' \28\ Rule 610 addresses three issues related to access
to quotations: (1) the means of access to quotations; (2) the fees for
access to protected quotations and any other quotations that are the
best bid or best offer of an exchange; and (3) locking and crossing
quotations.
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\26\ See Regulation NMS Adopting Release, supra note 16, at
37497, 37538.
\27\ Id. at 37538. See also 15 U.S.C. 78k-1(a)(1)(C)(iv).
\28\ See Regulation NMS Adopting Release, supra note 16, at
37538. See also 15 U.S.C. 78k-1(a)(1)(C)(i).
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Rule 610 imposes a limit on the fees that can be charged for access
to protected quotations.\29\ For NMS stocks priced at, or greater than,
$1.00 per share, a trading center \30\ shall not impose, nor permit to
be imposed, any fee for the execution of an order against a protected
quotation that exceeds $0.0030 per share, and for NMS stocks that are
priced at less than $1.00 per share, a trading center shall not impose,
nor permit to be imposed, any fee for the execution of an order against
a protected quotation that exceeds 0.3% of the quotation price per
share. The Commission adopted the access fee caps to preserve the
benefits of strengthened price protection and more efficient linkages
among trading centers that could be disrupted if substantial fees for
accessing quotations were charged.\31\ The access fee caps were
calculated based upon the then current fees that were charged by
certain trading venues and reflect the minimum pricing increment of
$0.01 per share.\32\ The access fee caps have not changed since their
adoption in 2005.
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\29\ A protected quotation is defined in rule 600(b)(71) as ``a
protected bid or protected offer.'' 17 CFR 242.600(b)(71). A
protected bid or protected offer is defined as ``a quotation in an
NMS stock that: (i) Is displayed by an automated trading center;
(ii) Is disseminated pursuant to an effective national market system
plan; and (iii) Is an automated quotation that is the best bid or
best offer of a national securities exchange, the best bid or best
offer of the Nasdaq Stock Market, Inc., or the best bid or best
offer of a national securities association.'' 17 CFR 242.600(b)(70).
\30\ A trading center is defined in rule 600(b)(95) 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.'' 17 CFR 242.600(b)(95).
\31\ See Regulation NMS Adopting Release, supra note 16, at
37544.
\32\ See id. at 37545.
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In the time since the adoption of rule 610, the national securities
exchanges have adopted complex fee schedules, with fees charged and
rebates paid, in part, to encourage the submission of liquidity.\33\
The fee schedules of the national securities exchanges also include
various volume-based tiers that seek to reward market participants for
submitting a minimum level of liquidity.\34\ The fees included in these
schedules are largely calculated based on volume in a given month and
are therefore calculated at month's end. This timing impedes the
ability of market participants, including investors, to evaluate the
total price of a trade at the time of execution and impedes a market
participant's ability to evaluate best execution and order routing.
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\33\ See infra section III.A.2.
\34\ See infra section III.A.2.
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The Commission proposes to amend rule 610 in two ways. First, to
reflect the lower variable minimum pricing increments proposed under
rule 612, the Commission proposes to reduce the access fee caps for
protected quotations in NMS stocks priced $1.00 or more to $0.0005 per
share for NMS stocks that have a minimum pricing increment of $0.001;
and $0.001 per share for NMS stocks that have a minimum pricing
increment greater than $0.001 per share; and for protected quotations
in NMS stocks priced less than $1.00 per share to 0.05% of the
quotation price. The proposed level of the access fee caps seeks to
balance the need to reduce the access fee caps to accommodate the
reduction in the minimum pricing increments and preserve the ability of
[[Page 80270]]
the agency market business models to charge fees for access.\35\
Consistent with the Commission's proposal to adopt lower variable
minimum pricing increments, the Commission is proposing reduced
variable access fee caps based on the minimum pricing increment and the
price of the protected quotation.\36\ The Commission believes the
proposed fee caps are consistent with current market practices and
would lead to pricing that is better aligned with today's transaction
costs.\37\
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\35\ Agency market trading centers are those that bring together
buyers and sellers and typically charge a fee for their execution
services. The Commission has previously recognized that ``agency
trading centers perform valuable agency services in bringing buyers
and sellers together, and that their business model historically has
relied, at least in part, on charging fees for execution of orders
against their displayed quotations.'' See Regulation NMS Adopting
Release, supra note 16, at 37545.
\36\ See infra section III.C.1.
\37\ See infra note 297 and accompanying text.
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Second, to facilitate the ability of market participants to
understand and calculate the total price of transactions at the time of
execution, the Commission proposes to amend rule 610 to require
exchanges to make the amounts of all fees and rebates determinable at
the time of execution.
C. Transparency of Better Priced Orders
The Commission adopted the MDI Rules, which expanded the content of
data that will be made available for dissemination within the national
market system and adopted a decentralized consolidation model for the
collection, consolidation, and dissemination of consolidated market
data.\38\ One goal in expanding the data made available within the
national market system was to increase transparency about better prices
available in the market.\39\ To accomplish this, the Commission, in the
MDI Rules, adopted a new definition of round lot, which will increase
transparency about smaller sized orders in higher priced stocks by
assigning NMS stocks priced over $250 to round lot sizes that are less
than the 100 share round lot size that is predominant today.
---------------------------------------------------------------------------
\38\ MDI Adopting Release, supra note 5. Several exchanges filed
petitions for review in the U.S. Court of Appeals for the District
of Columbia Circuit, which were denied on May 24, 2022. The Nasdaq
Stock Market LLC, et al v. SEC, No. 21-1100 (D.C. Cir. May 24,
2022).
\39\ See Securities Exchange Act Release No. 88216 (Feb. 14,
2020), 85 FR 16726, 16730-31 (Mar. 24, 2020) (``MDI Proposing
Release''). See infra note 327 for a description of the data
currently provided within the national market system.
---------------------------------------------------------------------------
In addition, the MDI Rules included odd-lot information in the data
that will be made available within the national market system. ``Odd-
lot information'' is defined as (1) odd-lot transactions, and (2) odd-
lots at a price greater than or equal to the national best bid and less
than or equal to the national best offer, aggregated at each price
level at each national securities exchange and national securities
association.\40\ Therefore, once implemented, information regarding the
prices and sizes of odd-lot orders priced better than the national best
bid and national best offer (``NBBO'') will be made available within
the national market system and is expected to be made widely available
to investors.\41\ These new definitions will significantly enhance
transparency about better priced orders available in the market. For
the reasons explained in the MDI Adopting Release, the Commission
adopted a phased transition plan for the MDI Rules that sequenced the
implementation of these data elements in the later stages of the
transition.\42\
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\40\ For example, if the national best bid for XYZ, Inc. is 100
shares at $25.00, and there are three orders of five shares and two
orders of ten shares at $25.01 on Exchange A, this would be
represented as ``35 shares at $25.01 on Exchange A'' pursuant to the
definition of odd-lot information adopted under the MDI Rules. MDI
Adopting Release, supra note 5, at 18613.
\41\ MDI Adopting Release, supra note 5, at 18612-13.
\42\ See id. at 18698.
---------------------------------------------------------------------------
The Commission proposes to accelerate implementation of the round
lot and odd-lot information definitions adopted under the MDI Rules so
that this information is made available to investors within the
national market system sooner. Information about better priced orders
available in the market is important for investors to be able to
understand the current prices and liquidity in the market when entering
their orders.\43\ This information is also important for market
participants who have best execution obligations.\44\
---------------------------------------------------------------------------
\43\ See id. at 18612.
\44\ Id. See also infra note 359.
---------------------------------------------------------------------------
Furthermore, while the odd-lot information definition includes all
prices better than the NBBO for which there is liquidity available in
an odd-lot size, it does not identify a consolidated best odd-lot
order. Establishing a defined best odd-lot order would provide further
relevant information to investors and market participants. A
consolidated best odd-lot order would be useful to investors in
deciding the terms of an order by providing information about the
price, size, and market of the best priced buy and sell orders
available in the market against which their own orders could execute.
Further, a best odd-lot order would be useful to investors to measure
the amount of price improvement they receive for the execution of their
orders. The Commission believes that amending the definition of odd-lot
information to include a best odd-lot order would be consistent with
section 11A of the Exchange Act, which provides, among other things,
that it is in the public interest and appropriate for the protection of
investors and the maintenance of fair and orderly markets to assure the
availability of information with respect to quotations in
securities.\45\ Further, a best odd-lot order would be consistent with
section 11A(c)(1)(B) of the Exchange Act as it would assure the
usefulness of quotation information.\46\ Together with accelerating the
implementation of the definitions of round lot and odd-lot information,
these proposed amendments would provide investors with enhanced
transparency about better priced orders available in the market.
---------------------------------------------------------------------------
\45\ 15 U.S.C. 78k-1(a)(1)(C)(iii).
\46\ 15 U.S.C. 78k-1(c)(1)(B).
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II. Amendment to Rule 612 of Regulation NMS--Minimum Pricing Increment
A. Background
Prior to implementing decimal pricing in April 2001, fractions of a
dollar were utilized to represent the minimum pricing increments for
the United States equity markets (e.g., \1/8\, \1/16\, and \1/32\ of a
dollar).\47\ The conversion to decimal pricing reduced the allowable
minimum pricing increment to $0.01 and the exchanges adopted rules that
established minimum pricing increments of $0.01 for equities
trading.\48\ However, after the conversion to decimal pricing, the
display and execution of sub-penny quotes increased off-exchange.\49\
The increase
[[Page 80271]]
of sub-penny quoting and trading in the OTC market raised concerns
because these quotes were not readily transparent, or accessible, to
many average investors.\50\
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\47\ A tick is the minimum pricing increment that can be used to
trade securities. Decimalization set the tick size to penny
increments from fractional increments, such as \1/8\ or \1/16\ of a
dollar. For a discussion of the implementation of decimal pricing,
see Order Directing the Exchanges and the Financial Industry
Regulatory Authority to Submit a Tick Size Pilot Plan, Exchange Act
Release No. 72460 (June 24, 2014), 79 FR 36840 (June 30, 2014).
\48\ See Exchange Act Release No. 46280 (July 29, 2002), 67 FR
50739 (Aug. 5, 2002) (order approving proposed rule changes and
amendments related to decimal pricing). In this order, the
Commission approved the proposals of the then-existing exchanges and
the National Association of Securities Dealers, Inc. (the
predecessor to the Financial Industry Regulatory Authority, Inc.
(``FINRA'')) to establish a minimum pricing increment of $0.01 for
equity issues, $0.05 for option issues quoted under $3.00 a
contract, and $0.10 for option issues quoted at $3.00 a contract or
greater.
\49\ See Regulation NMS Proposing Release, supra note 16, at
11163. See also Report to Congress on Decimalization, Commission
(July 2012) (``Decimalization Report'') available at <a href="https://www.sec.gov/files/decimalization-072012.pdf">https://www.sec.gov/files/decimalization-072012.pdf</a>.
\50\ See Regulation NMS Proposing Release, supra note 16 at
11164.
---------------------------------------------------------------------------
In 2004, as part of Regulation NMS, the Commission proposed rule
612 to implement minimum pricing increments for quoting in NMS stocks.
The Commission stated that while the benefits of decimalization
justified the costs, there was a potential for costs to investors and
the markets to surpass the benefits if the minimum pricing increment
decreased beyond a certain level.\51\ Rule 612 was designed to ``deter
the practice of stepping ahead of exposed trading interest by an
economically insignificant amount,'' \52\ which could discourage
investors from submitting limit orders. The Commission reasoned that
``if orders lose execution priority because competing orders step ahead
for an economically insignificant amount, liquidity could diminish.''
\53\ Further, the Commission was concerned that sub-penny quotes could
decrease market depth (i.e., the number of shares of a security that is
available at any given price), which in turn could increase transaction
costs and cause institutions ``to rely more on execution alternatives
away from the exchanges'' and ``[s]uch a trend could increase
fragmentation of the securities markets.'' \54\ In addition, the
Commission stated that sub-penny quoting could inhibit the ability of
broker-dealers to meet certain regulatory obligations by increasing the
incidences of so-called ``flickering'' quotes.\55\ At the time, the
Commission did not believe that the potential benefits of marginally
better prices offered by sub-penny increments for quotes and orders in
securities priced at, or greater than, $1.00 per share were likely to
justify the costs of permitting sub-penny quotes to be displayed,
accepted and ranked.\56\ However, the Commission acknowledged the
possibility that the markets could evolve over time and cause the
balance of the costs and benefits to shift.\57\
---------------------------------------------------------------------------
\51\ See id. at 11165.
\52\ Id. at 37553.
\53\ Id. at 37551. Further, the Commission stated that ``[w]hen
market participants can gain execution priority for an
infinitesimally small amount, important customer protection rules
such as exchange priority rules and [FINRA's] Manning rule could be
rendered meaningless'' and that without such protections,
``professional traders would have more opportunity to take advantage
of non-professionals,'' which could lead to lost executions or
executions occurring at inferior prices. Id.
\54\ Id. at 37552. The Commission stated that a decrease in
market depth could ``lead to higher transaction costs, particularly
for institutional investors (such as pension funds and mutual funds)
that are more likely to place large orders,'' which ``would likely
be passed on to retail investors whose assets are managed by the
institutions.'' Id.
\55\ Id. at 37552. The Commission described ``flickering
quotations'' as occurring when the price of a trading center's best
displayed quotations changes multiple times in a single second and
stated that flickering quotations ``could make it more difficult for
broker-dealers to satisfy their best execution obligations and other
regulatory responsibilities.'' Id.
\56\ Id. at 37553 (``Even assuming that quoting in sub-penny
increments would reduce spreads, the Commission continues to
believe, on balance, that the costs of sub-penny quoting are not
justified by the benefits.'')
\57\ Id. (``Nevertheless, the Commission acknowledges the
possibility that the balance of costs and benefits could shift in a
limited number of cases or as the markets continue to evolve.'')
---------------------------------------------------------------------------
When rule 612 was adopted, the Commission considered the impact of
sub-penny trading but did not believe that such trading raised the same
concerns as sub-penny quoting. Specifically, the Commission stated
that, unlike sub-penny quoting, sub-penny executions do not cause quote
flickering, decrease depth at the inside of the market or raise systems
capacity issues.\58\ In addition, the Commission stated that sub-penny
executions were generally beneficial to retail investors.\59\
---------------------------------------------------------------------------
\58\ See Regulation NMS Adopting Release, supra note 16, at
37556.
\59\ See id.
---------------------------------------------------------------------------
B. Rule 612
In 2005, the Commission adopted rule 612 of Regulation NMS to
establish uniform minimum pricing increments for NMS stocks. Rule 612
prohibits national securities exchanges, national securities
associations, ATSs, vendors and broker-dealers from displaying,
ranking, or accepting quotations, orders, or indications of interest in
any NMS stock priced in an increment smaller than $0.01 if the
quotation, order, or indication of interest is priced equal to, or
greater than, $1.00 per share. Rule 612 also prohibits national
securities exchanges, national securities associations, ATSs, vendors,
and broker-dealers from displaying, ranking or accepting quotations,
orders and indications of interest in an NMS stock in an increment
smaller than $0.0001 if the quotation, order or indication of interest
in an NMS stock is priced less than $1.00 per share. Under rule 612, an
exchange, association, ATS, vendor or broker-dealer must reject a quote
or order for an NMS stock that is explicitly priced in an impermissible
increment.\60\
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\60\ See id. See also, e.g., NYSE Rule 7.6 (Trading
Differentials) (``The minimum price variation (MPV) for quoting and
entry of orders in securities traded on the Exchange is $0.01, with
the exception of securities that are priced less than $1.00 for
which the MPV for quoting and entry of orders is $0.0001.''); see
also Nasdaq Rule Equity 1 Equity Definitions (a)(13) (``The term
minimum price increment means $0.01 in the case of a System Security
priced at $1 or more per share, and $0.0001 in the case of a System
Security priced at less than $1 per share.'').
---------------------------------------------------------------------------
Rule 612 does not prohibit quotes and orders from being executed in
sub-penny increments. In the Regulation NMS Adopting Release, the
Commission stated that the rule does not prohibit a sub-penny execution
resulting from a midpoint, volume-weighted algorithm, or from price
improvement so long as the execution does not result from an
impermissibly priced sub-penny order or quote.\61\
---------------------------------------------------------------------------
\61\ See Regulation NMS Adopting Release, supra note 12, at
37556.
---------------------------------------------------------------------------
1. Exchange Retail Liquidity Programs (``RLPs'')
After its adoption, the Commission granted exemptions from rule 612
to various national securities exchanges to establish ``retail
liquidity programs'' that allow them to accept and rank certain quotes
and orders from certain participants in sub-penny increments as small
as $0.001.\62\ RLPs were designed to attract retail orders to exchanges
by providing such orders potential price improvement at sub-penny
levels because ``most marketable retail order flow is executed in the
OTC markets, pursuant to bilateral agreements, without ever reaching a
public exchange'' and that OTC market makers typically paid retail
brokers for their order flow.\63\
---------------------------------------------------------------------------
\62\ NYSE Rule 107C; Securities Exchange Act Release No. 67347
(July 3, 2012), 77 FR 40673 (July 10, 2012) (approving retail
liquidity programs on a pilot basis for NYSE and NYSE Amex and
granting rule 612 exemption) (NYSE Retail Liquidity Program Approval
Order); CBOE BYX Rule 11.24; Securities Exchange Act Release No.
68303 (Nov. 27, 2012), 77 FR 71652 (Dec. 3, 2012) (CBOE BYX Retail
Pilot Program Approval Order); Nasdaq BX Rule 4780; Securities
Exchange Act Release No. 73702 (Nov. 28, 2014), 79 FR 72049 (Dec. 4,
2014) (NASDAQ BX Retail Pilot Program Approval Order).
\63\ See NYSE Retail Liquidity Program Approval Order, supra
note 62 at 40679.
---------------------------------------------------------------------------
The Commission stated that ``[i]nternalizing broker-dealer[s] can
offer sub-penny executions, provided that such executions do not result
from impermissible sub-penny orders or quotations'' by ``typically
select[ing] a sub-penny price for a trade without quoting at that exact
amount or accepting orders from retail customers seeking that exact
price.'' \64\ The Commission stated that, in contrast, exchange
members, when submitting orders and quotations to exchanges, ``cannot
compete for marketable retail order flow on the same basis because it
would be impractical for exchange electronic systems to generate sub-
[[Page 80272]]
penny executions'' without firms ``having first submitted sub-penny
orders or quotations, which the Sub-Penny Rule expressly prohibits.''
\65\ The Commission found that the first RLP, which was approved on a
pilot basis, was reasonably designed to benefit retail investors by
providing price improvement to retail order flow and ``could promote
competition for retail order flow among execution venues.'' \66\
---------------------------------------------------------------------------
\64\ Id. at 40862.
\65\ Id.
\66\ Id. at 40679.
---------------------------------------------------------------------------
The Commission also found that the proposed RLPs were reasonably
designed to minimize the concerns raised by sub-penny quoting.\67\
Specifically, using the same analytical framework as the Regulation NMS
Adopting Release, the Commission reasoned that the proposed RLPs did
not raise concerns related to quote flickering or reduced depth at the
inside quotation because the sub-penny prices would not be disseminated
through the Equity Data Plans.\68\ In addition, the Commission did not
believe the proposed RLPs would reduce incentives to post limit orders
because market participants that display limit orders were unable to
interact with marketable retail order flow that was almost entirely
executed in the OTC market.\69\ Exchanges proposed RLPs, in part, to
address the differences in market structure that divert retail
liquidity off-exchange. However, to date, the RLPs have not attracted a
significant volume of retail order flow.\70\
---------------------------------------------------------------------------
\67\ Id. at 40682. See also CBOE BYX Retail Pilot Program
Approval Order, supra note 62 at 71658; and NASDAQ BX Retail Pilot
Program Approval Order, supra note 62 at 72053.
\68\ NYSE Retail Liquidity Program Approval Order at 40682.
There are three effective national market system plans that govern
the collection, consolidation, processing, and dissemination of
certain NMS information. They are: (1) the Consolidated Tape
Association Plan (``CTA Plan''); (2) the Consolidated Quotation Plan
(``CQ Plan''); and (3) the Joint Self-Regulatory Organization Plan
Governing the Collection, Consolidation, and Dissemination of
Quotation and Transaction Information for Nasdaq-Listed Securities
Traded on Exchanges on an Unlisted Trading Privileges Basis (``UTP
Plan'') (together, the ``Equity Data Plans''). See also MDI Adopting
Release, supra note 5.
\69\ Id. at 40680.
\70\ See, e.g., How Can The Buy Side Interact With Retail Flow,
Rosenblatt Securities, Feb. 14, 2022, available at <a href="https://www.rblt.com/market-reports/how-can-the-buy-side-interact-with-retail-flow">https://www.rblt.com/market-reports/how-can-the-buy-side-interact-with-retail-flow</a> (``The various exchange retail programs consistently
account for less than 0.2% of consolidated volume.''). According to
NYSE, most order handling processes ignore retail interest that is
available in the RLPs because resting interest in RLPs does not
display price or size. See NYSE, Price improvement, tick
harmonization & investor benefit (Aug. 22, 2022) (``NYSE Tick
Harmonization Paper''), available at <a href="https://www.nyse.com/publicdocs/nyse/NYSE_Price_Improvement_202208.pdf">https://www.nyse.com/publicdocs/nyse/NYSE_Price_Improvement_202208.pdf</a>. See also <a href="https://www.nyse.com/data-insights/what-exchanges-can-and-cannot-offer-retail-traders">https://www.nyse.com/data-insights/what-exchanges-can-and-cannot-offer-retail-traders</a>. See also NYSE Retail Liquidity Program Approval
Order at 40682.
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C. Tick Size Considerations Since Regulation NMS
Minimum pricing increments have been considered several times since
the Commission adopted rule 612. In 2010, the Commission issued the
Concept Release on Equity Market Structure, which examined the then
current equity market structure and invited public comment on various
market structure issues, including high frequency trading, order
routing, market data linkages, and undisplayed liquidity.\71\ Among
other things, the Commission discussed internalization by broker-
dealers and stated that ``[t]here may be greater incentives for broker-
dealer internalization in low-priced stocks than in higher priced
stocks.'' \72\ The Commission stated that in low-priced stocks, the one
cent per share minimum pricing increment is much larger on a percentage
basis than it is in higher-priced stocks.\73\ In the discussion on
undisplayed liquidity, the Commission sought comment on whether public
price discovery and execution quality may have suffered and
specifically questioned whether the minimum pricing increment should be
reduced for lower priced stocks.\74\ In response, the Commission
received several letters opposing \75\ and supporting \76\ a pilot
program to test sub-penny tick increments. The Commission also received
letters recommending a pilot program to test a wider variety of tick
sizes.\77\
---------------------------------------------------------------------------
\71\ See Concept Release on Equity Market Structure, supra note
4.
\72\ Id.
\73\ Id.
\74\ Id.
\75\ See, e.g., Letters from Karrie McMillan, General Counsel,
Investment Company Institute, dated Apr. 21, 2010; Ann Vlcek,
Managing Director and Associate General Counsel, Securities Industry
and Financial Markets Association (``SIFMA''), dated Apr. 29, 2010;
James J. Angel, Associate Professor, McDonough School of Business,
Georgetown University; Lawrence E. Harris, Fred V. Keenan Chair in
Finance, Professor of Finance and Business Economics, Marshall
School of Business, University of Southern California; Chester S.
Spatt, Pamela R. and Kenneth B. Dunn Professor of Finance, Director,
Center for Financial Markets, Tepper School of Business, Carnegie
Mellon University, dated Feb. 23, 2010.
\76\ See, e.g., Letters from Eric Swanson, General Counsel, BATS
Exchange, Inc., dated Apr. 21, 2010 and Eric W. Hess, General
Counsel, Direct Edge, dated Apr. 28, 2010.
\77\ See, e.g., Letters from Janet M. Kissane, SVP--Legal and
Corporate Secretary, Office of the General Counsel, NYSE Euronext,
dated Apr. 23, 2010; and John A. McCarthy, General Counsel, GETCO
LLC, Christopher R. Concannon, Partner, Virtu Financial LLC, and
Leonard J. Amoruso, General Counsel, Knight Capital Group, Inc.,
dated July 9, 2010.
---------------------------------------------------------------------------
In 2010, three exchange operators jointly petitioned the Commission
to use its exemptive authority under rule 612(c) to allow the exchanges
to implement a 6-month pilot program that would reduce the minimum
pricing increment to $0.005 for a limited set of 30 NMS stocks priced
from $1.00 to $20.00 (including one exchange-traded fund (``ETF'') that
was trading at greater than $20.00).\78\ The Joint Petition stated that
at that time a significant percentage of the volume in these securities
(4%) was transacting at a $0.005 increment and that a large percentage
of share volume in securities priced below $20 occurred in securities
that were routinely quoted at the minimum pricing increment, indicating
a likelihood that price discovery was being constrained.\79\ The Joint
Petition also stated that ``a disproportionately high percentage of
transactions in securities priced between $1 and $20 dollars are
occurring away from lit markets, which [they] believe indicates a lack
of quote competition.'' \80\ The petitioners stated that the $0.01
minimum pricing increment resulted in artificially wide publicly-
displayed quotes for certain lower-priced, liquid securities, which, in
turn, negatively impacted the public price discovery process and
resulted in inferior execution prices for investors.\81\
---------------------------------------------------------------------------
\78\ See Letter from Chris Isaacson, Chief Operating Officer,
BATS Exchange, Inc., Eric Noll, Executive Vice President, NASDAQ OMX
Group, Inc., and Larry Leibowitz, Chief Operating Officer, NYSE
Euronext, Inc. to Elizabeth M. Murphy, Secretary, Commission, dated
on Apr. 30, 2010 (``Joint Petition'') available at <a href="https://www.sec.gov/spotlight/regnms/jointnmsexemptionrequest043010.pdf">https://www.sec.gov/spotlight/regnms/jointnmsexemptionrequest043010.pdf</a>. The
petitioners stated that the pilot would allow the Commission to
collect data to study the impact of the reduction of the minimum
increment without making a long term policy commitment. The
petitioners did not propose to reduce the access fee caps under rule
610 because the $0.005 increment would have continued to be higher
than the access fee cap, which would prevent the public display of a
protected quote that is not accurate when the access fee is factored
in. Id. at 7.
\79\ Id. at 6.
\80\ Id. at 2.
\81\ Id. at 1.
---------------------------------------------------------------------------
In 2012, Congress passed the Jumpstart Our Business Startups Act
(``JOBS Act''), which contained provisions relating to the impact of
decimalization on small and middle capitalization companies. Section
106(b) of the JOBS Act directed Commission to conduct a study on how
decimalization affected the number of initial public offerings
(``IPOs'') and the liquidity and trading of smaller capitalization
company securities. The Commission submitted a staff study to Congress
in July 2012.\82\ While the Decimalization Report did not reach any
firm conclusions about the impact of
[[Page 80273]]
decimalization on the number of IPOs or the liquidity and trading of
small capitalization companies, it did recommend that the Commission
conduct a roundtable where recommendations could be presented on a
pilot program that would generate data to allow the Commission to
further assess decimalization's impact. Commission staff held a
roundtable on February 5, 2013, during which there was broad support
among panelists for the Commission to conduct a pilot program to gather
information, particularly with respect to the impact of wider minimum
pricing increments on liquidity in smaller capitalization
companies.\83\ In 2016, the Commission initiated a Tick Size Pilot for
small- and mid-size capitalized stocks to test larger quoting and
trading increments (``TSP'').\84\ After the expiration of the 2-year
pilot program, the Commission staff observed that, on average,
increasing the tick size resulted in deteriorating market quality for
stocks that became tick-constrained under the pilot.\85\
---------------------------------------------------------------------------
\82\ See Decimalization Report, supra note 49.
\83\ For a complete discussion about the Feb. 6, 2013 roundtable
and the discussions that led to the implementation of the tick size
pilot, see Securities Exchange Act Release No. 72460 (June 24,
2014), 79 FR 36840 (June 30, 2014) (Order Directing the Exchange and
FINRA to submit a Tick Size Pilot Plan).
\84\ See Securities Exchange Act Release No. 74892 (May 6,
2015), 80 FR 27513 (May 13, 2015) (Order Approving the National
Market System Plan to Implement a Tick Size Pilot Program, available
at <a href="https://www.govinfo.gov/content/pkg/FR-2015-05-13/pdf/2015-11425.pdf">https://www.govinfo.gov/content/pkg/FR-2015-05-13/pdf/2015-11425.pdf</a>).
\85\ DERA Tick Size Pilot and Market Quality (Jan. 31, 2018),
available at <a href="https://www.sec.gov/dera/staff-papers/white-papers/dera_wp_tick_size-market_quality">https://www.sec.gov/dera/staff-papers/white-papers/dera_wp_tick_size-market_quality</a>. See also Who Provides Liquidity,
And When?, Sida Li, Xin Wang, and Mao Ye, Journal of Financial
Economics 141, no. 3 (2021) (finding that wider tick sizes reduce
liquidity, encourage the speed race among high-frequency traders,
and allocate resources to latency reduction) and Yashar Barardehi,
Peter Dixon, Qiyu Liu, and Ariel Lohr, Tick Sizes and Market
Quality: Revisiting the Tick Size Pilot (working paper, Dec. 14,
2022) available at <a href="https://www.sec.gov/files/dera_wp_ticksize-pilot-revisit.pdf">https://www.sec.gov/files/dera_wp_ticksize-pilot-revisit.pdf</a> (observing that market quality improved at the end of
the pilot for stocks that were tick constrained under the TSP).
Dixon, Liu, and Lohr are financial economists in the Division of
Economic and Risk Analysis at the SEC. Barardehi is at the Argyros
School of Business & Economics, Chapman University, and is a part-
time consultant with the SEC.
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D. Issues Raised in the Current Market Structure
In 2005, when rule 612 was adopted, the markets were still largely
typified by manual trading on exchange floors.\86\ Since then, the
markets have overwhelmingly transitioned to electronic trading with
orders being accepted, routed, displayed, and executed via low latency
trading systems.\87\ Equity market structure and competitive dynamics
have also changed,\88\ and trading and order routing systems can handle
and process an amount of data that would have been unprecedented and
unfathomable in 2005.\89\ NMS stocks are traded on-exchange (i.e., on
one or more of the 16 currently registered national securities
exchanges) or off-exchange (e.g., on one or more of the 33 currently
registered NMS Stock ATSs \90\ or by OTC market makers).\91\ As of
September 2022, on-exchange volume is approximately 58% while off-
exchange/OTC volume is approximately 42%,\92\ while in 2007, on-
exchange share volume was 71% and off-exchange/OTC volume was
approximately 29%.\93\ The market structure of the OTC market that
permits the execution of orders more readily in sub-penny amounts has
been a factor that contributes to this result.
---------------------------------------------------------------------------
\86\ See Concept Release on Equity Market Structure, supra note
4.
\87\ See MDI Adopting Release, supra note 5.
\88\ The Concept Release on Equity Market Structure describes
the transition of the modern equity trading markets away from the
largely centralized, manual structure to the dispersed automated
structure that exists today. See Concept Release on Equity market
Structure, supra note 4. See also Staff Report on Algorithmic
Trading in the U.S. Capital Markets (Aug. 5, 2020) (``Staff Report
on Algorithmic Trading'') (this staff report updated some of the
Concept Release's details and described certain developments that
have occurred since 2010).
\89\ See Staff Report on Algorithmic Trading (describing the
broad use of algorithms in contemporary securities markets).
\90\ See <a href="https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm">https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm</a>.
\91\ See Staff Report on Equity and Options Market Structure,
supra note 20.
\92\ Source: Equity consolidated data feeds (CTS and UTDF), as
collected by MIDAS; NYSE Daily TAQ.
\93\ Source: Equity consolidated data feeds (CTS and UTDF), as
collected by MIDAS; NYSE Daily TAQ.
---------------------------------------------------------------------------
While rule 612 does not prohibit executions from occurring in sub-
penny increments, there are various factors that lead to sub-penny
trading occurring more frequently off-exchange compared to on-exchanges
or ATSs. Specifically, exchanges and ATSs typically match quotes and
orders in the penny increment in which explicitly priced quotes and
orders must be submitted under rule 612. Sub-penny trading occurs on
exchanges and ATSs pursuant to either: (1) exchange rules and order
types that permit executions at midpoint of the NBBO or volume-weighted
executions or (2) exemptions that have been granted by the Commission
under rule 612(c) (i.e., RLPs).\94\ Accordingly exchange rules, and the
requirement that such rules comply with rule 612, limit sub-penny
trading on exchanges.
---------------------------------------------------------------------------
\94\ See supra section II.B.1.
---------------------------------------------------------------------------
OTC market makers execute in sub-penny increments with more
regularity as a result of their ability to offer price improvement in
between the NBBO after such orders have been accepted by the OTC market
maker in the permissible penny increment.\95\ OTC market makers, unlike
market participants on an exchange or ATS, are not limited by their
market structure to generally execute orders in the minimum pricing
increment that the order was accepted. Instead, OTC market makers are
able to trade as principal with orders that they receive and in the
increment that they determine. As a result, OTC market makers may trade
more readily in sub-penny increments which helps to provide an
advantage over their exchange and ATS counterparts in attracting order
flow.
---------------------------------------------------------------------------
\95\ OTC market makers internalize orders by trading principally
on the other side of the orders that they accept. See Staff Report
on Equity and Options Market Structure, supra note 20.
---------------------------------------------------------------------------
Today, most marketable retail order flow is executed off-exchange
by OTC market makers who, in addition to not being limited by exchange
rules, offer, in many cases, payment for order flow (``PFOF'') for
retail orders.\96\ Further, 37% of executions off-exchange are reported
in sub-penny amounts that are not associated with midpoint trades.\97\
As further discussed in the Economic Analysis, data suggests that of
the total dollar value of sub-penny trades that are not midpoint
trades, 11% occurred on-exchange while 89% occurred off-exchange.\98\
While this dynamic provides retail orders that execute OTC with a
measure of price improvement, the Commission is concerned that these
retail orders are not exposed to competitive forces on the public
market (since these retail orders are typically directed from one
broker-dealer to another wholesale broker-dealer by contractual
arrangement). As a result, these retail orders are not publicly
displayed and do not contribute to the
[[Page 80274]]
price competition and discovery mechanism of the lit markets. The
Commission is seeking to address concerns about the competitive dynamic
between exchanges/ATSs and OTC market makers because the ability of OTC
market makers to more readily trade in finer sub-penny increments than
exchanges and ATSs factors into the increasing percentage of equity
volume that is executed off-exchange.\99\
---------------------------------------------------------------------------
\96\ ``Payment for order flow'' is defined in Rule 10b-10 under
the Exchange Act. 17 CFR 240.10b-10(d)(8). Rule 10b-10 further
prescribes information that a broker or dealer must disclose to its
customer on the customer's confirmation. The rule requires that the
broker-dealer disclose to the customer, among other things, ``[t]he
amount of any remuneration received or to be received by the broker
from such customer in connection with the transaction . . .'' and
``the source and amount of any other remuneration received or to be
received by the broker in connection with the transaction. . . .''
17 CFR 240.10b-10(a)(2)(B) and (D).
\97\ See infra section V.C.1.b and accompanying text.
\98\ See infra section V.C.1.b and Table 8.
\99\ See Staff Report on Equity and Options Market Structure at
11. See also Kwan, Amy, Ronald Masulis, and Thomas H. McInish,
``Trading rules, competition for order flow and market
fragmentation,'' Journal of Financial Economics 115, no. 2 (2015):
330-348.
---------------------------------------------------------------------------
The fact that rule 612 does not prohibit sub-penny trading and the
underlying regulatory framework that results in greater opportunities
to trade OTC in sub-penny increments makes it more difficult for
exchanges and ATSs to compete with OTC market makers for retail order
flow. The Commission believes that the contrast between on and off-
exchange sub-penny trading and the competitive responses by market
participants results in market complexity and inefficiencies (e.g.,
inverted taker-maker fee structures, tiered fee structures,
segmentation via RLPs, excessive fragmentation and
intermediation).\100\ The proposed amendments to rule 612 would level
the competitive playing field in this regard by requiring market
participants, regardless of trading venue, to offer price improvement
to investor orders in the same minimum pricing increments, unlike today
where OTC market makers are able to offer investor orders price
improvement in smaller pricing increments compared to their exchange
and ATS counterparts.
---------------------------------------------------------------------------
\100\ See, e.g., Enhancing Competition, Transparency and
Resiliency in U.S. Financial Markets, Citadel Securities (May 2021)
available at <a href="https://fe7a500fc6adae9c30fb.b-cdn.net/wp-content/uploads/2021/05/EnhancingCompetitionTransparencyandResiliencyinUSFinancialMarkets.pdf">https://fe7a500fc6adae9c30fb.b-cdn.net/wp-content/uploads/2021/05/EnhancingCompetitionTransparencyandResiliencyinUSFinancialMarkets.pdf</a>
(``Citadel Report'') (``This regulatorily mandated tick size
impedes the ability of exchanges to compete for order flow in
symbols that are highly liquid and commonly trade inside a bid-offer
spread of a penny. We believe this `constrained' tick size directly
leads to complexities and inefficiencies--such as driving order flow
into alternative venues, complex exchange pricing structures, and
increased overall market fragmentation.''). See also Enhancing U.S.
Equity Market Structure for Retail Investors, Committee on Capital
Markets Regulation (Sept. 2021) (``CCMR Report'') available at
<a href="https://www.capmktsreg.org/wp-content/uploads/2021/09/CCMR-Enhancing-Retail-Equity-Market-Structure-09.01.2021-2.pdf">https://www.capmktsreg.org/wp-content/uploads/2021/09/CCMR-Enhancing-Retail-Equity-Market-Structure-09.01.2021-2.pdf</a>.
---------------------------------------------------------------------------
In addition, some NMS stocks are considered to be tick-constrained,
meaning that they regularly experience a time-weighted average quoted
spread of 1.1 cents or less, which indicates that these stocks are
frequently quoted in the smallest increment permitted under the
rule.\101\ The Commission identified 1,337 NMS stocks that would be
considered tick-constrained under this metric.\102\ These tick-
constrained NMS stocks account for 56.1% of estimated share volume and
23.2% of estimated dollar volume.\103\ NMS stocks become tick-
constrained because rule 612's minimum pricing increment prohibits
quoting these stocks in increments smaller than provided under the
rule. These stocks would experience smaller quoted spreads but for the
requirement under rule 612.
---------------------------------------------------------------------------
\101\ See infra note 448.
\102\ See infra note 448 and accompanying text and infra Table
4.
\103\ Id.
---------------------------------------------------------------------------
Certain market participants have conducted data analysis on the
effects of rule 612 and concluded that a $0.01 increment may not be
appropriate for all stocks.\104\ For instance, MEMX LLC (``MEMX'')
issued a report in August 2021, which provided data that suggests that
``[a] significant portion of the U.S. equity market trades with a
consistent penny spread throughout most of the trading day.'' \105\
MEMX provided data from the first half of 2021 indicating that many
tick-constrained stocks, based on MEMX's definition, are actively
traded securities that ``as a group [account] for 47% of volume, 28% of
trades, and 25% of notional value executed.'' \106\ According to MEMX,
the ``[q]uoted spreads in these securities are limited not by supply
and demand, but rather by outdated regulatory constraints that apply
the same tick regime to securities with different trading
characteristics.'' \107\
---------------------------------------------------------------------------
\104\ See, e.g., The Tick-Constrained Stock Problem by Phil
Mackintosh (Jan. 20, 2022), available at <a href="https://www.nasdaq.com/articles/the-tick-constrained-stock-problem">https://www.nasdaq.com/articles/the-tick-constrained-stock-problem</a>) (``Nasdaq Paper''). See
also Petition for Rulemaking to Amend Rule 612 of Regulation NMS to
Adopt Intelligent Tick-Size Regime, dated Dec. 16, 2019, submitted
by John A. Zecca, Executive Vice President, Chief Legal Officer &
Chief Regulatory Officer, Nasdaq Inc. available at <a href="https://www.sec.gov/rules/petitions/2019/petn4-756.pdf">https://www.sec.gov/rules/petitions/2019/petn4-756.pdf</a> (``Nasdaq Intelligent
Tick Proposal''); The Impact of Tick Constrained Securities on the
U.S. Equity Market (available at <a href="https://www.nyse.com/publicdocs/Tick_Constrained_Stocks.pdf">https://www.nyse.com/publicdocs/Tick_Constrained_Stocks.pdf</a>) (``NYSE White Paper'') (no date
available); and Cboe Proposes Tick-Reduction Framework to Ensure
Market Structure Benefits All Investors (available at <a href="https://www.cboe.com/insights/posts/cboe-proposes-tick-reduction-framework-to-ensure-market-structure-benefits-all-investors/">https://www.cboe.com/insights/posts/cboe-proposes-tick-reduction-framework-to-ensure-market-structure-benefits-all-investors/</a>) (``Cboe
Proposal'').
\105\ See MEMX Tick Constrained Securities (Aug. 2021) (``MEMX
Report'') available at <a href="https://memx.com/wp-content/uploads/MEMX-Market-Structure-Report-Tick-Constrained-Securities.pdf">https://memx.com/wp-content/uploads/MEMX-Market-Structure-Report-Tick-Constrained-Securities.pdf</a>. MEMX
reviewed data from the first and second quarter of 2021. MEMX data
suggested that on average 998 stocks during the period were tick-
constrained, which MEMX defined as those NMS stocks that had an
average quoted spread of 1.1 cents or less. In addition, on Aug. 30,
2021, MEMX filed a Request for Exemptive Relief Pursuant to Rule
612(c) of Regulation NMS to Permit a Minimum Increment of $0.005 in
``Tick Constrained'' NMS Stocks. See Letter from Adrian Griffiths,
Head of Market Structure, MEMX to Vanessa Countryman, Secretary,
Commission dated Aug. 30, 2021 (``MEMX Exemption Request'').
\106\ MEMX Report, supra note 105, at 9.
\107\ Id. at 9.
---------------------------------------------------------------------------
MEMX analyzed tick-constrained stocks across different price
buckets and found that tick-constraint occurs more frequently in lower-
priced securities, ``where the one cent minimum increment is more
``economically significant'' relative to the price of a share of
stock.'' \108\ According to MEMX's analysis, ``two-thirds (66%) of all
tick-constrained securities trade in the two lowest price buckets,''
which included stocks priced between $1.00 and $20.00 per share.\109\
MEMX's analysis concluded that low-priced stocks are ``more likely to
be tick constrained, and the impact of that tick constraint in terms of
basis point spread, which is relevant when measuring the cost of
entering into a transaction, is also largest in these securities.''
\110\ However, MEMX stated that tick-constraint issues can occur across
different price buckets, including in high-priced, actively-traded
stocks.\111\ MEMX's analysis also found that tick-constrained stocks
typically have more liquidity at the NBBO than stocks that are not
tick-constrained. The findings were similar for stocks and exchange
traded products (``ETPs'') with varying notional values traded.\112\
---------------------------------------------------------------------------
\108\ Id. at 10.
\109\ Id.
\110\ Id.
\111\ Id. at 11.
\112\ Id. at 15-17.
---------------------------------------------------------------------------
MEMX analyzed securities that trade at least $100 million notional
value each day and concluded that more than one half of equity ETPs are
tick-constrained.\113\ MEMX stated that tick-constrained actively-
traded ETPs have spreads that are artificially wide ``despite the fact
that ETPs can be priced more efficiently due to the ability to
accurately derive ETP prices and an effective arbitrage mechanism that
keeps ETP prices in line with those of its underlying securities.''
\114\
---------------------------------------------------------------------------
\113\ Id. at 13.
\114\ Id.
---------------------------------------------------------------------------
The New York Stock Exchange (``NYSE'') published a white paper that
stated the current $0.01 minimum pricing increment is a wider tick than
market forces would otherwise produce for tick-constrained stocks.\115\
NYSE stated that tick-constrained stocks tend to trade with high
volume, relatively low prices, and quoted spreads near $0.01, and
exhibit higher levels of inaccessible liquidity (i.e., order flow
[[Page 80275]]
that is only available to select market participants) \116\ which
hampers transparency and price discovery.\117\ NYSE stated that the
uniform rule 612 minimum pricing increment of $0.01 for all NMS stocks
that are priced at, or above, $1.00 per share increases inaccessible
liquidity, which results in ``different market experiences for
different participants.'' \118\
---------------------------------------------------------------------------
\115\ See NYSE White Paper, supra note 104.
\116\ NYSE stated that retail order flow is an example of
inaccessible liquidity because it is largely sent to OTC market
making firms that can execute such orders on a principal basis at
prices inside the best displayed prices. Id. at 1. NYSE stated that
retail order flow has increased as a percentage of the market. Id.
\117\ Id. at 1.
\118\ Id. at 2.
---------------------------------------------------------------------------
NYSE explained that some high-volume, lower-priced securities
``trade consistently with a spread of exactly $0.01 and maintain very
deep order books at the national best price.'' \119\ NYSE said that
this dynamic makes ``it difficult for liquidity providers to receive a
fill, except at undesirable times such as when the price is about to
change'' and that ``queue competition contributes to high-cost
infrastructure deployments'' as market participants need to develop low
latency technology to be the fastest to a new price and has also led to
the development of inverted fee venues, ``which allow, for a cost,
liquidity providers to pay for better queue position.'' \120\ According
to NYSE, these dynamics show that rule 612 has influenced an ``arms
race'' in market technology and venue fragmentation. NYSE also stated
that ``artificially wide tick sizes raise transaction costs and harm
execution quality.'' \121\ NYSE estimated that ``trading in tick
constrained securities typically increase[s] transaction costs by about
one billion dollars per year . . .'' \122\
---------------------------------------------------------------------------
\119\ Id.
\120\ Id.
\121\ Id.
\122\ Id. at 12.
---------------------------------------------------------------------------
NYSE developed a ``Tick Constrained Index'' based on consolidated
quoted spread and NBBO coverage to identify stocks that it considered
tick-constrained using data from 2019. NYSE's tick-constrained stocks
represented 538 symbols in the second half of 2020, which had an
average intraday volume of 4,254,664 shares per symbol, and 25.9% of
intraday volume. NYSE estimated that the minimum $0.01 spread ``cost
investors over $1.7 billion in the first half of 2020 . . . [and] $499
million'' in the second half of 2020.\123\ NYSE also analyzed the
impact of volatility in 2020 on tick-constrained stocks and concluded
that tick-constrained stocks responded differently than non-tick-
constrained stocks to extreme volatility. Specifically, tick-
constrained stocks spreads did not widen (52.72%) as much as non-tick-
constrained (163.33%), but the depth at the inside decreased
significantly more in tick-constrained stocks (-73.24%) compared to
non-tick-constrained stocks (-39.75%).\124\ According to NYSE, market
makers managed their risk in tick-constrained stocks by reducing
liquidity because they could not reduce prices. NYSE also noted that
exchange market makers are unable to compete with off-exchange
providers in providing price improvement.\125\
---------------------------------------------------------------------------
\123\ Id. at 4.
\124\ Id. at 6-7.
\125\ Id. at 8.
---------------------------------------------------------------------------
More recently, NYSE published a study on price improvement and
minimum pricing increments.\126\ NYSE analyzed consolidated exclusive
securities information processor (``SIP'') data from January 1, 2022,
to June 30, 2022.\127\ NYSE estimates that in the first half of 2022
approximately $72 million per day aggregated price improvement was
provided and that of this amount 48% was delivered on exchange and 52%
was delivered off-exchange.\128\ Further, NYSE estimates that 12.4% of
the total price improvement came from non-midpoint trades in either
tenths or hundredths of a cent, which are increments that exchanges
have limited ability to trade.\129\ According to NYSE's analysis,
harmonizing the trading increment across exchange and non-exchange
trading ``could yield $6.3MM per day ($1.8B per year) in investor cost
savings based on projected incremental savings if exchanges could offer
sub-penny price improvement in a competitive manner.'' \130\
---------------------------------------------------------------------------
\126\ See NYSE Tick Harmonization Paper, supra note 70 at 2.
\127\ Id. at 3.
\128\ Id. at 4.
\129\ Id.
\130\ Id. at 2. NYSE described ``trade increment harmonization''
as ``equal trade pricing rules for all on and off exchange trading,
with exchanges able to display quotes at twice the trade pricing
increment.'' NYSE analyzed the possible impact of a half cent
quoting increment coupled with a harmonized quarter cent trading
increment. Id. at 5.
---------------------------------------------------------------------------
NYSE stated that exchanges currently provide: (1) 1.17x the amount
of off-exchange price improvement when combining the midpoint and round
penny trade prices; and (2) 77% as much price improvement as off-
exchange trades when spreads are wider than $0.01.\131\ NYSE applied
these ratios to current off-exchange sub-penny price improvement
estimates to calculate an additional $7.3 million in daily price
improvement.\132\
---------------------------------------------------------------------------
\131\ Id. at 2.
\132\ Id.
---------------------------------------------------------------------------
NYSE also examined data related to stocks that frequently trade
with a $0.01 spread and found that trades did not frequently execute in
increments as small as $0.0001, which is the increment that off-
exchange market makers can use in executing trades.\133\ In addition,
according to NYSE, most price improvement is delivered to trades where
the bid-offer spread is larger than $0.10. NYSE also examined price
improvement trends during ``calm'' \134\ and volatile markets.\135\
According to NYSE, exchanges tend to provide a larger share of the
total price improvement during volatile markets, while off-exchange
venues increase their share of total price improvement when volatility
drops.\136\
---------------------------------------------------------------------------
\133\ Id. at 8.
\134\ NYSE defined a ``calm'' market for purposes of its
analysis as ``when there is a stable quoted market price for a
restrictive 100 milliseconds before and after the trade.'' Id. at 9.
\135\ Id.
\136\ Id.
---------------------------------------------------------------------------
Finally, NYSE considered the impact of allowing sub-penny quoting
on market infrastructure.\137\ NYSE stated that the industry is capable
of accommodating an increase in message traffic that may accompany
lower minimum pricing increments.\138\ NYSE calculated several
estimates of potential increased message traffic that resulted in
increases in messages of the exchanges' best quotations between 25% and
152% and stated that these increases would ``lead to small changes in
messaging levels relative to historical fluctuations and overall
messaging rates that remain quite modest compared to data volumes
prevalent in current-day options trading.'' \139\
---------------------------------------------------------------------------
\137\ Id. at 10-11.
\138\ Id. at 10.
\139\ Id. at 11.
---------------------------------------------------------------------------
The Nasdaq Stock Market (``Nasdaq'') has also conducted studies on
minimum pricing increments. According to Nasdaq, trading in tick-
constrained stocks is more complicated and more expensive, with
artificially wider spreads and longer order queues, which slows order
fulfillment and leads to the increased routing to exchanges that have
inverted taker/maker fee structures.\140\ Nasdaq stated that as the
price of the securities falls, the one penny minimum pricing increment
becomes large as a percentage of value. For example, Nasdaq stated that
for a stock priced above $1,000 per share, one penny is less than 0.10
basis point (one basis point is equal to 0.01% or 0.0001), while for a
stock priced $1.00, one penny represents 100 basis points.
[[Page 80276]]
Nasdaq stated that this is harmful for smaller less liquid stocks
because the minimum pricing increment represents a higher percentage of
value which ends up costing investors money. Nasdaq stated that when
faced with a spread constraint, market participants trade more on
inverted venues to narrow the spread due to the inverted pricing
structures. According to Nasdaq, substantial queue lengths result in
inverted usage and stocks priced lower than $5 tend to have longer
queues.
---------------------------------------------------------------------------
\140\ See Nasdaq Paper and Nasdaq Intelligent Tick at 4, supra
note 104.
---------------------------------------------------------------------------
For higher priced stocks, Nasdaq stated that a tick size that is
too small can result in increased volatility and less price competition
which impairs price discovery. According to Nasdaq, higher stock prices
from less frequent stock splits can eventually lead to wider spreads
and more odd-lot trading. Nasdaq found that fill rates are generally
higher for low-priced stocks, and fill rates begin to decline once a
stock is priced greater than $100. Further, Nasdaq stated that a tick
size that is too small can reduce the significance of time priority
because traders can outbid resting orders by an economically
insignificant amount. Nasdaq stated that this discourages traders from
improving displayed prices and reduces incentives to post displayed
liquidity. Nasdaq stated that certain high priced stocks with spreads
closer to $1.00 have odd-lots inside the NBBO much more frequently than
high priced stocks with spreads below $0.02. Nasdaq further stated that
if high priced stocks traded at a wider tick, there would be more
displayed depth at each tick increment.
Nasdaq concluded that if the minimum pricing increment is too wide
(tick-constrained) or too small (stocks trading in multiple
increments), the mismatch creates inefficiency that increases the
issuer's cost of capital, hurting issuers and investor returns,
potentially harming economic growth and retirement stability.
Recently, the Cboe Exchange, Inc. (``Cboe'') examined the NBBO of
all NMS securities above $1.00 from January 3, 2022, to August 23,
2022, during regular trading hours, excluding opening and closing
auctions and locked and crossed markets.\141\ Cboe stated that most
securities are not tick-constrained and that a one-size-fits-all finer
minimum pricing increment ``risks creating a structure that attempts to
solve a problem that does not exist for most securities and introduces
roadblocks to the liquidity aggregation and price discovery process.''
\142\
---------------------------------------------------------------------------
\141\ See Cboe Proposal at 1, supra note 104.
\142\ Id.
---------------------------------------------------------------------------
Cboe stated that out of 10,125 securities, only 9% (877) should be
considered preliminarily tick-constrained, which Cboe defined as stocks
with an average quoted spread of 1.1 cents or less.\143\ Cboe found
that these 877 securities represent 49% of average daily volume and 22%
of average daily notional value traded.\144\ Cboe found that 88% of NMS
stocks are quoted at spreads above $0.015 and 37% of securities
representing 25% average daily notional value are being quoted at
spreads above $0.10.\145\
---------------------------------------------------------------------------
\143\ Id.
\144\ Id.
\145\ Id.
---------------------------------------------------------------------------
E. Proposals by Market Participants
Various market participants have suggested that rule 612 be
amended. Throughout the years, market participants have advocated that
the minimum pricing increment: (1) only be reduced for NMS stocks that
are tick-constrained; \146\ (2) be varied based on certain objective
and measurable trading characteristics of a particular NMS stock; \147\
or (3) be increased for higher-priced stocks.\148\ The Commission has
studied and considered the alternative approaches that are described in
this section, and at this time has determined to propose rule 612
amendments that would implement variable minimum pricing increments for
the quoting and trading of NMS stocks priced at, or above, $1.00 per
share based on the Time-Weighted Average Quoted Spread during an
Evaluation Period.
---------------------------------------------------------------------------
\146\ See Joint Petition, supra note 78. See also MEMX Exemption
Request, supra note 105.
\147\ See Nasdaq Intelligent Tick Proposal, supra note 104.
\148\ See TSP, supra note 85.
---------------------------------------------------------------------------
As discussed more fully in section II.F., the Commission believes
that the proposed amendments to rule 612 addresses the concerns that
have arisen since its adoption in a manner that is consistent with the
Congressional directives, set forth by section 11A of the Exchange Act,
to facilitate the establishment of the national market system.
Specifically, the Commission has designed the proposed rule 612
amendments to achieve the section 11A objectives of fair competition,
economically efficient executions, and equal regulation by addressing
concerns related to: (1) tick-constrained stocks; and (2) fair
competition for retail order flow across trading venues.
1. Reduce the Tick Size to $0.005 for Tick-Constrained Stocks
Some market participants have recommended that rule 612 be amended
to lower the minimum pricing increment to $0.005 only for NMS stocks
that are tick-constrained.\149\ Specifically, MEMX submitted a request
that the Commission exercise its exemptive authority under rule 612(c)
of Regulation NMS to permit market participants, including exchanges,
associations, ATSs, vendors and broker-dealers, to display, rank, and
accept bids or offers, orders, and indications of interest in $0.005
\150\ increments for those NMS stocks that are ``tick-constrained,''
which MEMX would define as those stocks that trade with an average
quoted spread of 1.1 cents or less.\151\ MEMX requested that average
daily spreads be calculated on a monthly basis and that a stock would
have its minimum pricing increment reduced based upon a prior calendar
month.\152\ MEMX stated that the current increment ``is demonstrably
too wide'' for certain stocks and ``imposes unnecessary costs on
investors.'' \153\ MEMX also stated that quoting in tick-constrained
stocks is based on ``outdated regulatory constraints'' as opposed to
``supply and demand'' which in turn ``harm[s] public price discovery
and increas[es] transaction costs.'' \154\ Further, MEMX stated that
reducing the minimum pricing increment for tick-constrained stocks
would minimize implicit trading costs for investors, e.g., spread
costs.\155\
---------------------------------------------------------------------------
\149\ See Citadel Report, supra note 91 at 4 and CCMR Report,
supra note 91 at 10. See MEMX Exemption Request, supra note 105.
\150\ MEMX did not explain how MEMX arrived at the $0.005
increment. However, MEMX also requested that orders be permitted to
execute at the midpoint of the NBBO.
\151\ MEMX, in conjunction with its request for relief pursuant
to rule 612(c) to reduce the minimum increment for tick-constrained
stocks to $0.005, also requested relief pursuant rule 610(c) to
limit access fees for tick-constrained stocks for any national
securities exchange, national securities association, or other
trading center. MEMX stated that the rule 610 access fee and the
rule 612 minimum increment are ``intimately tied'' to each other.
See MEMX Exemption Request, supra note 105 at 8.
\152\ MEMX suggested using a calendar month calculation to be
similar to the round lot calculation adopted under the MDI Rules.
MEMX stated that using a similar schedule could reduce complexity.
See id. at 3.
\153\ Id. at 2.
\154\ Id. at 1.
\155\ Id. at 6.
---------------------------------------------------------------------------
MEMX stated that reducing the minimum increment ``would reduce
transaction costs and facilitate more robust price discovery by
enabling liquidity providers to post more aggressive quotations within
the current penny spread. . .'' \156\ In addition, MEMX stated that
reducing the minimum pricing increment for tick-constrained stocks
would be in the
[[Page 80277]]
public interest and consistent with the protection of investors because
``the potential savings are likely to be substantial'' due to the
amount of trading that occurs in tick-constrained stocks.\157\
---------------------------------------------------------------------------
\156\ Id.
\157\ Id.
---------------------------------------------------------------------------
MEMX addressed the factors that the Commission identified in the
Regulation NMS Adopting Release for consideration of exemptions under
rule 612(c). In the Regulation NMS Adopting Release,\158\ the
Commission stated that the factors it would consider and evaluate in
the context of an exemption request under rule 612(c), amongst other
things, would include: (1) if the security always trades with a penny
spread and there is tremendous liquidity available on both sides of the
market; \159\ (2) whether the NMS stock was an ETF or other derivative
that could be readily converted into its underlying securities or vice
versa, in which case the true value of the security is derived from its
underlying components and might be a sub-penny increment; (3) if there
is a large volume of sub-penny executions in that security due to price
improvement; and (4) if the security was low priced. Specifically, MEMX
stated that ``(1) almost one thousand NMS stocks accounting for nearly
half of all volume and about a quarter of all trades and notional value
traded on a daily basis are tick constrained, meaning that they
consistently trade with a penny increment; (2) such tick constrained
NMS stocks trade with `tremendous' liquidity at the NBBO as quoting
activity is forced to cluster at the minimum increment instead of more
aggressive prices that would offer improved economics to investors; (3)
tick constraints occur frequently and are most impactful in (A) low-
priced NMS stocks where a one cent spread is more economically
significant in relation [to] the price of the security; and (B) ETPs
whose prices can be appropriately derived from their underlying
constituents.'' \160\
---------------------------------------------------------------------------
\158\ See Regulation NMS Adopting Release, supra note 16, at
37554. MEMX did not analyze whether there is large volume of sub-
penny executions due to price improvement. MEMX stated that
executions in sub-penny increments ``are likely to be indicative of
retail internalization as opposed to market participants seeking to
trade within a tick-constrained spread.'' See MEMX Exemption
Request, supra note 105, at 4.
\159\ See Regulation NMS Adopting Release, supra note 16, at
37554 (quoting a commenter).
\160\ MEMX Exemption Request, supra note 105, at 6 (footnotes
omitted).
---------------------------------------------------------------------------
Further, MEMX stated that the objectives underlying rule 612 would
not be jeopardized if the exemption was granted and the minimum pricing
increment was reduced. Specifically, MEMX stated that because market
participants are unable to improve displayed prices for tick-
constrained stocks, the previously articulated policy concern of
stepping ahead of displayed orders by ``economically insignificant
amounts'' was not relevant. MEMX stated that reducing the tick size
would promote price competition for those stocks that are currently
hindered by regulation.\161\
---------------------------------------------------------------------------
\161\ See id. at 7.
---------------------------------------------------------------------------
Citadel also recommended that ``[t]he Commission should reduce the
minimum tick size to a half-penny for symbols trading above $1.00 per
share that are tick constrained (i.e., have a penny spread the
overwhelming majority of the time).'' \162\ Citadel stated that the
rule 612 minimum pricing increment ``impedes the ability of exchanges
to compete for order flow in symbols that are highly liquid and
commonly trade inside the bid-offer spread of a penny.'' \163\ Citadel
continued that tick constraints lead to ``complexities and
inefficiencies,'' including ``driving order flow into alternative
venues, complex exchange pricing structures, and increased overall
market fragmentation.'' \164\ Citadel stated that a reduced tick size
for tick-constrained stocks would allow exchanges to display more
aggressive prices and improve on-exchange execution quality and
exchange competitiveness.\165\ Citadel also suggested, without
elaborating, that allowing sub-penny quoting more broadly ``could raise
other concerns.'' \166\
---------------------------------------------------------------------------
\162\ Citadel Report, supra note 100 at 4.
\163\ Id.
\164\ Id.
\165\ See id.
\166\ Id.
---------------------------------------------------------------------------
Finally, the CCMR recommended that the Commission revise rule 612
to allow $0.005 increments in stocks that always trade with a penny
spread.\167\ CCMR cited the analysis conducted by MEMX to support its
recommendation. CCMR, however, stated that it did not recommend a
$0.001 tick size. CCMR stated that a tick size that is too narrow can
harm market quality. CCMR stated that a smaller tick size that is too
narrow ``can cause ``flickering quotations,'' in which a stock quote
rapidly switches back and forth between prices complicating broker-
dealer routing decisions and hindering their ability to get the best
prices for investors.'' \168\ In addition, CCMR stated that smaller
tick sizes could ``enable ``stepping ahead'' whereby a trader uses an
economically insignificant quote to ``step ahead'' of an existing
order, reducing the likelihood that orders posted by fundamental
investors will be executed,'' which would create a disincentive for the
public display of orders.\169\
---------------------------------------------------------------------------
\167\ See CCMR Report, supra note 100 at 10.
\168\ Id.
\169\ Id.
---------------------------------------------------------------------------
More recently, Cboe proposed a framework to reduce the minimum tick
size to $0.005 for tick-constrained stocks that demonstrate other
objective criteria.\170\ Specifically, Cboe would designate a security
as tick-constrained and thus eligible for a $0.005 minimum pricing
increment if a stock exhibits: (1) a high quote-size-to-trade-size
ratio; and (2) a high average daily notional turnover.\171\ According
to Cboe, a high quote-size-to-trade-size ratio demonstrates that ``even
though there is an abundance of liquidity, the current $0.01 tick
constraint disincentivizes investors to cross the spread due to high
costs, resulting in a lack of trade executions.'' \172\ Further, a high
average daily notional turnover would be an objective criterion
``because it focuses the tick-reduction effort on high turnover
securities that would benefit from the ability to trade in finer
increments.'' \173\ For each criterion, Cboe would include stocks that
fall within the top 75 percentile in the lower minimum pricing
increment.\174\ Using its criteria and parameters, Cboe identified 67
stocks that would be eligible for a reduction in the minimum pricing
increment.\175\
---------------------------------------------------------------------------
\170\ See Cboe Proposal, supra note 104, at 9.
\171\ See id.
\172\ Id. at 4.
\173\ Id. Cboe further stated that thinly-traded securities,
which would have a low notional turnover, should not be the focus of
reducing minimum pricing increments.
\174\ See id. at 6.
\175\ See id. at 7.
---------------------------------------------------------------------------
Cboe's proposal would include a reevaluation every quarter or bi-
annually for the criteria and parameters.\176\ Cboe would also decouple
the quoting increments from trading increments.\177\ Cboe stated that
decoupling the quoting and trading increments would allow retail
auctions to increase trading competition in finer increments without
impacting the broader market.\178\ Finally, Cboe proposed a
consideration of wider ticks to facilitate enhanced liquidity
[[Page 80278]]
aggregation of securities that trade with wider spreads.\179\
---------------------------------------------------------------------------
\176\ See id.
\177\ See id.
\178\ See id. (Cboe also proposed to accelerate the addition of
odd-lot orders to the exclusive SIPs and to modernize rule 604 to
increase the threshold to display block orders from 10,000 shares
and $200,000 to 50,000 shares and $500,000).
\179\ Id. at 9.
---------------------------------------------------------------------------
2. Variable Tick Sizes
In December 2019, Nasdaq submitted a petition for rulemaking to
request that the Commission amend rule 612 to replace the current
``one-size-fits all'' tick regime with an ``intelligent tick regime''
that would utilize multiple tick sizes based on certain measurable
criteria of NMS stocks.\180\ Under the Nasdaq proposal: (1) stocks
would trade in one of six increments ($0.005; $0.01; $0.02; $0.05;
$0.10; and $0.25); (2) stocks would be categorized based upon their
duration weighted average quoted spread over the measurement period;
(3) stocks would be assigned the next smallest increment by quoted
spread (e.g., a stock with average spread of $0.12 would be in the
$0.10 increment category); and (4) listing exchanges would calculate
and calibrate quoted spreads, determine applicable increments, and
publish stock lists. Nasdaq stated that an intelligent tick regime
``would improve markets and benefit all key stakeholders--investors,
public companies, and exchange members alike.'' \181\ Nasdaq stated
that it is sub-optimal to apply the $0.01 increment equally
``regardless of market capitalization, volume, or share price.'' \182\
Nasdaq stated that currently, under rule 612, ``a $2 stock'' quotes
with the same minimum pricing increment ``as a $2,000 stock.'' \183\
---------------------------------------------------------------------------
\180\ See Nasdaq Intelligent Ticks, A Blueprint for a Better
Tomorrow (``Nasdaq Intelligent Tick''), available at <a href="https://www.nasdaq.com/docs/2019/12/16/Intelligent-Ticks.pdf">https://www.nasdaq.com/docs/2019/12/16/Intelligent-Ticks.pdf</a>.
\181\ Id. at 4.
\182\ Id. at 4.
\183\ Id. at 4.
---------------------------------------------------------------------------
According to Nasdaq, its proposal would address tick-related issues
for: (1) low-priced tick-constrained securities; and (2) high-priced
securities that trade with significantly wider spreads. Nasdaq stated
that ``if the tick is too wide (tick constrained) or too small (stocks
trading in multiple tick increments), the mismatch creates inefficiency
that increases the companies' cost of capital . . . and hurts listed
companies and investor returns. . . .'' \184\ Specifically, Nasdaq
stated that tick-constrained stocks tend to have lower prices and that
``tick-constraints create long quotation queues, [slow] fulfillment . .
. [create inefficiencies] and . . . [diminish] price discovery. . .
.'',\185\ which drives trading ``to inverted taker-maker markets . . .
where larger, lower priced, more liquid stocks tend to trade heavily.''
\186\ Nasdaq stated that reducing the minimum pricing increment for
tick-constrained stocks ``would reduce bid-ask spreads, [save]
investors money, and make trading more efficient.'' \187\
---------------------------------------------------------------------------
\184\ Id. at 15.
\185\ Id. at 6.
\186\ Id. at 6-7.
\187\ Id. at 4.
---------------------------------------------------------------------------
Conversely, Nasdaq stated that high-priced stocks that trade with
wider spreads ``increase[ ] investor costs, usage of odd-lots,
flickering quotations, non-displayed trading that doesn't support price
discovery, and price instability.'' \188\ For such high-priced stocks,
Nasdaq also states that ``outbidding becomes so inexpensive that time
priority becomes essentially non-existent'' and ``[destroys] the reward
and incentive to post passive liquidity and diminishing price
discovery.'' \189\
---------------------------------------------------------------------------
\188\ Id. at 4.
\189\ Id. at 4. See also Cboe Proposal, supra note 104.
---------------------------------------------------------------------------
F. Proposal To Amend Rule 612
The Commission believes that based on current market conditions it
is appropriate to update and modernize the rule 612 minimum pricing
increment for quotes and orders in NMS stocks priced equal to, or
greater than, $1.00 per share. The proposed amendments to rule 612
would also help to ensure, among other things, the ``equal regulation
of all markets for qualified securities and all exchange members,
brokers, and dealers effecting transactions in such securities.'' \190\
Moreover, the proposed amendments to rule 612 also would facilitate
fair competition and equal regulation that would help market forces to
determine the prices of NMS stocks.\191\
---------------------------------------------------------------------------
\190\ 15 U.S.C. 78k-1(c)(1)(F).
\191\ See Regulation NMS Proposing Release, supra note 49.
---------------------------------------------------------------------------
In the Regulation NMS Adopting Release, the Commission acknowledged
the possibility that the balance of costs and benefits of sub-penny
quoting and trading could shift as the markets evolved. The Commission
believes such a shift has occurred and the benefits of quoting and
trading in sub-pennies more broadly and consistently across the
national market system would be consistent with the goals of section
11A of the Exchange Act and appropriate in today's market structure.
Specifically, when rule 612 was adopted the Commission expressed
concerns related to ``stepping ahead'' and quote flickering. The
Commission believes that in today's market the concerns related to
these issues have diminished or have been mitigated. For instance, in
2005 there was concern that quoting in sub-penny increments would allow
orders to step ahead of displayed orders by economically insignificant
amounts. However, data demonstrates that in today's market a
significant percentage of executions occur in sub-penny increments as a
result of midpoint executions and sub-penny price improvement provided
by OTC market makers who internalize retail orders or RLPs on
exchanges.\192\ For many stocks, including those that are tick-
constrained, a sub-penny execution is no longer economically
insignificant. A majority of the trading volume for NMS stocks is tick-
constrained, which indicates that the one cent minimum pricing
increment is too large for such stocks, that a smaller sub-penny
increment would be an economically meaningful increment for such stocks
to be able to quote and trade, and that the current minimum pricing
increment is constraining the ability of market participants to trade
consistent with the principles of supply and demand. Further, the
increased speed of quoting and trading has alleviated many of the
concerns from 2005, as many market participants are now able to react
to quote changes in microseconds.
---------------------------------------------------------------------------
\192\ See infra section V.C.1.
---------------------------------------------------------------------------
As discussed in section V.D.1, the Commission estimates that the
proposal to amend rule 612 would reduce the minimum pricing increment
to $0.005 or less for 81.9% of the share volume, which represents
approximately 60.2% of dollar volume that trades with a spread of
approximately $0.04 or less.\193\ These stocks generally have lower
prices and consistent liquidity at the top of the book for both bids
and offers. As a result of these characteristics, sub-penny increments,
particularly in relation to the stock price, will generally be
economically significant.\194\ The Commission believes that because
liquidity is consistently on both sides of the market for most tick and
near tick-constrained securities, a smaller minimum pricing increment
should be economically significant and allow market forces to better
determine the appropriate price increment and depth for such stocks.
---------------------------------------------------------------------------
\193\ See infra section V.D.1, Table 8.
\194\ See also MEMX Exemption Request, supra note 105 at 7.
---------------------------------------------------------------------------
When rule 612 was adopted, the Commission was concerned about the
potential for quotes to flicker if the quoting increment was too small.
The Commission believes that for tick-constrained and near tick-
constrained stocks, the proposed minimum pricing increments are not
``too small,'' rather,
[[Page 80279]]
the current quoting and trading of these stocks suggest that the
current minimum pricing increment is too large. Advancements in
technology since 2005 should reduce flickering quotes concerns.\195\
Specifically, the systems currently used in the market by exchanges and
other market participants can accommodate many levels of data with
extreme low latency \196\ and should be able to readily adjust to any
potential increase of system traffic that could result from price
movements at a smaller minimum pricing increment.\197\
---------------------------------------------------------------------------
\195\ In the Regulation NMS Re-Proposing Release, the Commission
described ``flickering'' quotes as quotes that flashed for a short
period of time solely to earn market data revenues, but were not
truly accessible and therefore did not add any value to the
consolidated quote stream. See Regulation NMS Re-Proposing Release,
supra, note 16. Since 2004, market quotation and trading systems
have improved along with technological advances. Today, low latency
systems and ultrafast communication protocols allow market
participants to access quotes and execute trades in microseconds.
Therefore, the ``flickering'' issue discussed in 2004 is largely no
longer relevant today.
\196\ For example, in the second quarter of 2011, the average
peak message per second for Tapes A and B as reported by the CTA/CQ
Plan was 339,855 and for Tape C as reported by the UTP Plan was
97,370. In the second quarter of 2022, the average peak message per
second for Tapes A and B was 1,015,000 and for Tape C was 408,300.
In the second quarter of 2011, the average latency reported was less
than one millisecond for Tapes A and B and 5.1 milliseconds for Tape
C. In the second quarter of 2022, the average latency reported for
Tape A and B was 18 microseconds and for Tape C it was 13.6
microseconds. See <a href="https://www.ctaplan.com/publicdocs/CTA_Operating_Metrics_Q22011.pdf">https://www.ctaplan.com/publicdocs/CTA_Operating_Metrics_Q22011.pdf</a>; <a href="https://www.ctaplan.com/publicdocs/ctaplan/CTAPLAN_Processor_Metrics_2Q2022.pdf">https://www.ctaplan.com/publicdocs/ctaplan/CTAPLAN_Processor_Metrics_2Q2022.pdf</a> and <a href="https://www.utpplan.com/DOC/UTP_website_Statistics_Q2-2022-June.pdf">https://www.utpplan.com/DOC/UTP_website_Statistics_Q2-2022-June.pdf</a>. See
also MDI Adopting Release, supra note 5, at 18638.
\197\ For example, market participants that collect options
market data from the Options Price Reporting Authority (``OPRA'')
can readily handle message traffic that exceeds the messages
disseminated in the national market system for NMS stocks. In the
second quarter of 2022, OPRA reported 36.4 million messages per
second. See OPRA Key Operating Metrics of U.S. Options Securities
Information Processor, available at <a href="https://www.opraplan.com/document-library">https://www.opraplan.com/document-library</a>. See also NYSE Tick Harmonization Paper, supra note
126 at 11 (stating that OPRA handles many times more messages than
the equities market).
---------------------------------------------------------------------------
In the Regulation NMS Adopting Release, the Commission identified
several factors that it would consider in the context of a request for
an exemption from the minimum pricing increments required under the
rule.\198\ Specifically, the Commission said it would evaluate the
following factors: (i) if an NMS stock was consistently trading with a
penny spread with significant liquidity available on both sides of the
market; \199\ (ii) if the NMS stock is an ETF or other derivative that
can be readily converted into its underlying securities or vice versa,
in which case the true value of the security as derived from its
underlying components might be at a sub-penny increment; \200\ (iii) if
a large volume of sub-penny executions in an NMS stock occurs due to
price improvement; and (iv) if the NMS stocks are low-priced.
Currently, there is evidence that: (1) a significant percentage of the
total volume of NMS stocks is consistently tick-constrained with
liquidity on both sides of the market,\201\ (2) the majority of tick-
constrained stocks trade at $30 or less,\202\ and (3) a large volume of
sub-penny executions occur in the market.\203\ The Commission believes
that rule 612 should be updated based on current market conditions.
---------------------------------------------------------------------------
\198\ See Regulation NMS Adopting Release, supra note 16, at
37554.
\199\ See id.
\200\ Rule 612 applies to NMS stocks, including ETFs. In the
Regulation NMS Adopting Release, the Commission considered whether
sub-penny quoting of ETFs, which are derivatively priced, raised the
same concerns as other NMS stocks. The Commission stated that a
basis may exist to exempt actively traded ETFs from the rule. See
Regulation NMS Adopting Release, supra note 16, at 37554. MEMX
stated that its data shows that ``more than half of equity ETPs and
the vast majority of fixed income, commodity, and other ETPs trading
at least 100 million notional each day are tick- constrained.'' MEMX
Exemption Request, supra note 105 at 6. Further, in the Joint
Petition, the petitioners requested an exemption from rule 612 to
allow sub-penny quoting for one ETF, the QQQQ. See Joint Petition,
supra note 78 at 1.
\201\ See MEMX stated that, according to its research, liquidity
at the quote for tick-constrained stocks is five to eight times
higher for corporate securities and nine to 59 times higher for ETPs
than securities trading with a spread between $0.02 and $0.03. See
MEMX Report, supra note 105, at 3. See also MEMX Exemption Request,
supra note 105 at 4. See also NYSE White Paper, supra note 119 at
10.
\202\ MEMX provided data that approximately 80% of tick-
constrained stocks traded at $30 per share or less. See MEMX Report,
supra note 105 at 10.
\203\ See supra note 192 and accompanying text.
---------------------------------------------------------------------------
The Commission proposes amendments to rule 612 to: (1) introduce a
variable minimum pricing increment structure for quotes and orders in
NMS stocks priced at, or greater than, $1.00 per share; and (2) require
executions to occur in the minimum pricing increment, both on-exchange
and OTC, subject to certain exceptions. The Commission preliminarily
believes the proposed amendments to rule 612 would promote: (1) fair
and orderly markets and economically efficient executions, particularly
for tick-constrained NMS stocks and retail order flow; and (2) fair
competition and equal regulation between OTC market makers, exchanges,
and ATSs that compete for retail liquidity by requiring that NMS stocks
trade with the same minimum pricing increment regardless of venue
(i.e., on or off-exchange). The Commission also believes that amended
rule 612 would promote price discovery and price competition,
particularly for tick-constrained stocks and retail order flow, by
permitting the quoting and trading of certain NMS stocks in finer
increments that would vary based on objective criteria but must be
uniform across trading venues. The Commission believes this proposal
would result in pricing that is more in accordance with the principles
of supply and demand.\204\
---------------------------------------------------------------------------
\204\ See infra sections V.C.1 and V.D.1.
---------------------------------------------------------------------------
1. Minimum Pricing Increments
Currently, rules 612(a) and (b) are structured in a parallel manner
in that they both contain requirements for national securities
exchanges, national securities associations, ATSs, vendors, brokers and
dealers when displaying, ranking and accepting quotations, orders and
indications of interest. Each paragraph establishes the minimum pricing
increment based on the price of the quote, order, or indication of
interest. Proposed rule 612(b), similar to current rules 612(a) and
(b), would set forth when and how the minimum pricing increment
requirements would be applicable to specific market participants.
However, unlike current rules 612(a) and (b), proposed rule 612(b)
would make the minimum pricing increment applicable to the quoting and
trading of all NMS stocks. Specifically, proposed rule 612(b) would
state that ``[n]o national securities exchange, national securities
association, alternative trading system, vendor, or broker or dealer
shall display, rank, accept from any person, or execute a bid or offer,
an order, or an indication of interest in any NMS stock priced in an
increment smaller than the applicable increment required by paragraph
(c) or (d).'' As discussed further below, proposed rule 612(c) would
add the proposed variable minimum pricing increments for quotations,
orders and indications of interest in NMS stocks priced equal to, or
greater than, $1.00 per share and proposed rule 612(d) would contain
the minimum pricing increment for quotations, orders and indications of
interest in NMS stocks priced less than $1.00 per share.
2. Quotations and Orders in NMS Stocks Priced at $1.00 or More
The Commission proposes to amend rule 612 to introduce a variable
minimum pricing increment model for quotations and orders in NMS stocks
that are priced equal to, or greater than, $1.00 per share. The
Commission preliminarily believes that a variable
[[Page 80280]]
minimum pricing increment model would allow minimum pricing increments
to be better suited to the trading characteristics of the particular
stocks. Since rule 612 was adopted, several commenters have suggested
that the single minimum pricing increment may not be appropriate for
all stocks.\205\
---------------------------------------------------------------------------
\205\ See supra section II.D.
---------------------------------------------------------------------------
The Commission proposes to vary the minimum pricing increment for
quotations, orders and indications of interest in NMS stocks priced
equal to, or greater than, $1.00 per share based on a Time Weighted
Average Quoted Spread,\206\ which would be calculated by the primary
listing exchange for the particular NMS stock on a quarterly basis
during a month long Evaluation Period.\207\ Under this proposal, the
four potential minimum pricing increments for a particular NMS stock
would be:
---------------------------------------------------------------------------
\206\ Proposed rule 612(a)(i) would define ``Time Weighted
Average Quoted Spread'' as ``the average dollar value difference
between the NBB and NBO during regular trading hours where each
instance of a unique NBB and NBO is weighted by the length of time
that the quote prevailed as the NBB or NBO.'' See infra section
II.F.2.a.i.
\207\ Proposed rule 612(a)(ii) would define ``Evaluation
Period'' as the last month of a calendar quarter (Mar. in the first
quarter, June in the second quarter, Sept. in the third quarter and
Dec. in the fourth quarter) of a calendar year during which the
primary listing exchange shall measure the Time Weighted Average
Quoted Spread of an NMS stock that is priced equal to or greater
than $1.00 per share to determine the minimum pricing increment to
be in effect for an NMS stock for the next calendar quarter, as set
forth by paragraph (c).'' See infra section II.F.2.a.ii.
---------------------------------------------------------------------------
(1) $0.001, if the Time Weighted Average Quoted Spread for the NMS
stock during the Evaluation Period was equal to, or less than, $0.008;
(2) $0.002, if the Time Weighted Average Quoted Spread for the NMS
stock during the Evaluation Period was greater than $0.008 but less
than, or equal to, $0.016;
(3) $0.005, if the Time Weighted Average Quoted Spread for the NMS
stock during the Evaluation Period was greater than $0.016 but less
than, or equal to, $0.04; and
(4) $0.01, if the Time Weighted Average Quoted Spread for the NMS
stock during the Evaluation Period was greater than $0.04.
Under this proposal, because the applicable minimum pricing
increment for an NMS stock for a calendar quarter would be established
based on the stock's Time Weighted Average Quoted Spread during the
Evaluation Period, an NMS stock could have a different minimum pricing
increment every quarter of the calendar year. The Commission believes
that the proposal that the applicable minimum pricing increment for a
particular NMS stock be effective for a three month period is
appropriate in order to balance the need to update the minimum pricing
increment at regular intervals such that the increment can reflect
market conditions without updating too frequently as to introduce undue
complexity to the market system.\208\
---------------------------------------------------------------------------
\208\ MEMX suggested in its proposal that NMS stocks be
evaluated on a monthly basis to determine a stock's average quoted
spread. MEMX stated that a monthly evaluation would minimize
complexity as it would be similar to the schedule to determine an
NMS stock's round lot. See MEMX Exemption Request, supra note 105,
at 3. The Commission believes that a quarterly evaluation and
assignment is appropriate to reflect the current trading
characteristics of an NMS stock. Further, the Commission believes
that a monthly shift in the pricing of an NMS stock would be more
complex and disruptive to the markets than a monthly shift in the
size of a round lot. The Commission requests comment on whether a
quarterly basis is the appropriate timeframe. See infra section
II.G.
---------------------------------------------------------------------------
Preliminarily, the Commission believes that the proposed variable
minimum pricing increments would address the issues related to tick-
constrained stocks and help to prevent other stocks that trade with
relatively small spreads from becoming tick-constrained. The Commission
also believes that the proposal would reduce transaction costs for many
NMS stocks without harming the execution quality or dispersing the
liquidity of stocks that are not tick-constrained and trade with wider
spreads. As discussed below, assigning a small minimum pricing
increment to a stock that has a wider spread can be harmful to
displayed liquidity as liquidity would be spread across more price
increments.\209\ Minimum pricing increments that are too small can also
add to complexity in trading and increase the risk of stepping ahead.
The Commission believes that proposing to vary the minimum pricing
increments based on the Time Weighted Average Quoted Spread represents
a balancing of pricing, liquidity, complexity, and price improvement
opportunities.\210\
---------------------------------------------------------------------------
\209\ See infra section V.C.1.
\210\ See infra sections V.C.1 and V.D.1.
---------------------------------------------------------------------------
This proposal to amend rule 612 to implement variable minimum
pricing increments would reduce the minimum pricing increment to $0.001
for all NMS stocks that are priced equal to, or greater than, $1.00 per
share if the Time Weighted Average Quoted Spread for the NMS stock
during the Evaluation Period was equal to, or less than, $0.008.\211\
Further, proposed rule 612 would reduce the minimum pricing increment
to $0.002 for all NMS stocks that are priced equal to, or greater than,
$1.00 per share if the Time Weighted Average Quoted Spread for the NMS
stock during the Evaluation Period was equal to, or less than, $0.016.
Proposed rule 612 is designed to directly address the concerns that the
current minimum pricing increment of $0.01 creates an artificial price
constraint on certain NMS stocks and prevents such stocks from reaching
a natural price that would be within a penny spread. The Commission
estimates that tick-constrained stocks make up over half (approximately
56.1%) of the market's share volume, which is estimated to be the
equivalent of 23.2% of dollar volume.\212\ While the Commission cannot
estimate the number of these stocks that would have a Time Weighted
Average Quoted Spread of $0.008 or less due to the $0.01 minimum
pricing increment, the Commission estimates that 1,707 stocks, which
make up an estimated 64% of share volume, and represent 37.9% of
estimated dollar volume, have average spreads that are less than
$0.016.\213\ The Commission believes that reducing the minimum pricing
increment to $0.001 or $0.002 for such stocks would allow a more
natural price discovery process to occur and preserve meaningful price
discovery opportunities between the spread. In addition, the Commission
believes that investor trading costs due to spreads would be reduced as
a result of the smaller increments and spreads that would be permitted
for stocks that are currently tick-constrained.
---------------------------------------------------------------------------
\211\ Initially, no NMS stock would qualify for the $0.001
minimum pricing increment due to the current rule 612 one cent
minimum pricing increment restricting the minimum possible tick
size. Further, as discussed below, the Commission proposes a
staggered implementation of the new minimum pricing increments. See
infra section II.G.
\212\ See infra section V.C.1.
\213\ See Table 8 infra section V.D.1.
---------------------------------------------------------------------------
Currently, approximately 2,648 stocks, which is an estimated 17.9%
of share volume, and an estimated 22.3% of dollar volume, trade with a
spread that is greater than $0.016 and less than or equal to
$0.04.\214\ This proposal would also reduce the minimum pricing
increment to $.005 for NMS stocks that trade with a Time Weighted
Average Quoted Spread that is greater than $0.016 and less than or
equal to $0.04.\215\ The Commission believes that the proposal would
provide pricing flexibility for these stocks that trade with smaller
spreads and prevent such stocks from becoming tick-constrained in the
future. The Commission also believes that, by reducing the minimum
pricing increments for these stocks that trade with smaller spreads,
investor trading costs would be reduced as a result of smaller spreads
while price
[[Page 80281]]
improvement opportunities would be preserved.
---------------------------------------------------------------------------
\214\ See id.
\215\ See infra section V.D.1.
---------------------------------------------------------------------------
The Commission believes that the execution quality for stocks with
a Time Weighted Average Quoted Spread of equal to, or less than, $0.04
would not be harmed under the proposal (i.e., NMS stocks that would
quote and trade with a minimum pricing increment of $0.001, $0.002 or
$0.005).\216\ Further, the Commission believes that the liquidity at or
near the NBBO for such stocks would not disperse or thin out across
price levels because, as discussed below, the proposal is designed such
that stocks priced equal to, or greater than, $1.00 per share with a
Time Weighted Average Quoted Spread of less than $0.04 would generally
have at least 3 to 4 price points but not have more than eight price
points inside the quoted spread.\217\
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\216\ See infra section V.D.1
\217\ For example, if the bid for a stock is $10.00, and the
stock has an average quoted spread of $0.010, it would be assigned a
$0.002 minimum pricing increment and would have four price levels
within the average quoted spread (i.e., 10.002, 10.004, 10.006, and
10.008). See also infra section V.D.1. However, if that same stock
trades with a spread that is wider than the average quoted spread
used to determine the minimum pricing increment there would be more
than four price levels. For instance, if the bid for the stock was
$10.00 and the ask was $10.02 then there would be nine price levels
with the quoted spread (i.e., 10.002, 10.004, 10.006, 10.008, 10.01,
10.012, 10.014, 10.016. 10.018).
---------------------------------------------------------------------------
As further discussed in section V.D.1 below, the Commission
believes that a certain minimum number of ticks intra-spread would be
beneficial to market quality in the trading of NMS stocks. The proposal
would increase the number of increments between the spread for those
NMS stocks that are tick-constrained. Initially, these stocks would
transition from having, on average, one increment between the spread to
either having 1 to 8 increments or 4 to 5 increments between the
spread, depending on whether the stock would be assigned to a $0.001 or
$0.002 minimum pricing increment. Thereafter, if, for instance, the
Time Weighted Average Quoted Spread for one of these NMS stocks widens
during an Evaluation Period, such stock would be assigned to a larger
minimum pricing increment for the next quarter. Conversely, if the Time
Weighted Average Quoted Spread for one of these NMS stock narrows
during an Evaluation Period, such stock would be assigned to a smaller
minimum pricing increment for the next quarter, if available. The
proposal is designed to maintain a certain number of increments between
the spread for efficient trading, without creating too many increments
between the spread which could impact execution priority for an
infinitesimally amount or reduce market depth. Accordingly, NMS stocks
would be moved between the proposed minimum pricing increments based on
their quoting characteristics. In sum, the Commission believes that the
proposal will allow NMS stocks that have relatively small average
quoted spreads to be priced with minimum pricing increments that are
more reflective of the principles of supply and demand and mitigate the
dispersion of liquidity across price points.
Under the proposal, NMS stocks that are priced equal to, or greater
than, $1.00 per share that have a Time Weighted Average Quoted Spread
greater than $0.04 would continue to have a minimum pricing increment
of $0.01. Based on current market conditions, the Commission estimates
that approximately 7,792 stocks, which is estimated to be 18.1% of
share volume, and estimated to be 39.8% of dollar volume, trade with a
spread that is greater than $0.04.\218\ The Commission believes that
the proposal would have little or no impact on these NMS stocks that
would continue to quote at the $0.01 minimum pricing increment.\219\
The Commission proposes to retain the current minimum pricing increment
for stocks that fall into this category because these stocks are
neither tick-constrained nor near constrained stocks. Stated another
way, stocks that have a Time Weighted Average Quoted Spread of greater
than $0.04 are able to be competitively priced based on market forces
and the principles of supply and demand so would continue to have a
$0.01 minimum pricing increment. Further, as described above, if these
stocks were to become tick-constrained, or experience a reduction in
its average quoted spread, the minimum pricing increment would be
adjusted downward following the next Evaluation Period.
---------------------------------------------------------------------------
\218\ See infra section V.D.1, Table 8.
\219\ See infra section V.D.1.
---------------------------------------------------------------------------
Although certain market participants recommend that the minimum
pricing increment be reduced to $0.005 only for tick-constrained
stocks,\220\ the Commission believes that many stocks that currently
trade with an average quoted spread of $0.011 could continue to be
tick-constrained if the minimum pricing increment for such stocks were
only reduced to $0.005. Accordingly, the Commission is proposing to
reduce the minimum pricing increment for tick-constrained stocks as
well as stocks that are near tick-constrained or otherwise have average
quoted spreads less than $0.04 to either $0.001, $0.002 or $0.005,
which would likely reduce the minimum quoting increment for more than
81.9% of the trading volume for NMS stocks. Overall, the Commission
expects that the impact on liquidity and trade execution would be
positive because tick constraints prevent market participants from
quoting the prices that reflect supply and demand, and the reduction in
the minimum pricing increments would lead to narrower spreads and
better market quality. The Commission determined to propose the reduced
minimum pricing increments of $0.001, $0.002, and $0.005, in part,
because many investors will have familiarity with, or an awareness of,
trades that occur in these specific increments because of how trading
is conducted today. The Commission believes this because today, two of
the most common increments for the price improvement of stocks that
trade OTC are $0.001 and $0.002, and price improvement on exchanges and
ATSs often occurs through midpoint executions in an increment of
$0.005. The Commission also selected these particular pricing
increments because, as described above, the proposed amendments to rule
612 are designed to: (1) correlate the Time Weighted Average Quoted
Spread to the minimum pricing increments, which limits the number of
potential price points within the spread, which, in turn, should
mitigate the loss of liquidity that can occur when the minimum tick
size is reduced and the number of pricing increments increases; \221\
and (2) preserve meaningful price improvement for the majority of NMS
stocks that would trade at minimum pricing increments that are $0.005
or less.
---------------------------------------------------------------------------
\220\ See supra section II.E.1.
\221\ Id.
---------------------------------------------------------------------------
For stocks priced equal to, or greater than, $1.00 per share with
Time Weighted Average Quoted Spreads equal to or less than $0.04, the
Commission believes the reduction in the minimum pricing increment
would be largely beneficial to the trading environment. Specifically,
the Commission believes that reducing the minimum pricing increment
would remove tick-constraints for a large percentage of the total
trading volume, and allow market participants to quote at the prices
that equate supply and demand, which in turn would lead to narrower
spreads and better market quality.
The Commission also believes the proposal would increase price
discovery for stocks that are tick-constrained, or near-tick-
constrained, and reduce transaction costs for investors without
[[Page 80282]]
negatively impacting execution quality for stocks that are not tick-
constrained. The Commission's proposal differs from the tiered approach
for minimum pricing increments suggested by market participants as
described in section II.E.2. The Commission's proposed variable minimum
pricing increments are designed to offset the potential dilution of
liquidity and depth at the top of the book while providing market
participants with a range of price points (generally four to eight)
between the quoted spread to provide price improvement opportunities to
investor orders.
With regard to changing the minimum pricing increment, the
Commission proposes to target tick-constrained stocks, and those stocks
that trade with relatively smaller spreads that could become tick-
constrained by reducing and varying the minimum tick size. While some
market participants have suggested that the Commission impose larger
minimum pricing increments for certain NMS stocks,\222\ the proposed
rule would not change or increase the minimum pricing increment for any
NMS Stocks that trade with a Time Weighted Average Quoted Spread
greater than $0.04, or separately for higher-priced stocks. The
Commission believes that the current $0.01 increment for NMS stocks
that trade with a Time Weighted Average Quoted Spread greater than
$0.04, regardless of price, remains sufficient based on their trading
characteristics.\223\ Commission review of academic literature suggests
that there are not consistent results as to how a larger tick size
would affect market quality for stocks with wider spreads.\224\
Further, the Commission believes that increasing the tick size, for
example for higher priced securities, which tend to trade with wider
spreads, could result in the inadvertent and unintended constraining of
the pricing of such stocks.\225\ The Commission does not expect the
trading environment for stocks with prices lower than $1.00 per share,
or Time Weighted Average Quoted Spreads greater than $0.04, to be
significantly impacted because under the proposal the minimum pricing
increment would not change for such stocks.
---------------------------------------------------------------------------
\222\ See Nasdaq Intelligent Tick Proposal, supra note 180 at 8.
\223\ See also infra note 548 and accompanying text. Further,
minimum pricing increments that are too large or static could
frustrate the natural pricing mechanism of quotes and orders. See
also supra note 85. The Commission requests comment on whether
larger tick sizes should be imposed on certain NMS stocks. See infra
section II.H.
\224\ Id.
\225\ See supra note 223. See also supra note 85 and
accompanying text.
---------------------------------------------------------------------------
a. Proposed Definitions
Proposed rule 612(a) would define the terms ``Time Weighted Average
Quoted Spread'' and ``Evaluation Period.''
i. Time Weighted Average Quoted Spread
Proposed rule 612(a)(i) would define the term ``Time Weighted
Average Quoted Spread'' as ``the average dollar value difference
between the NBB and NBO during regular trading hours \226\ where each
instance of a unique NBB and NBO is weighted by the length of time that
the quote prevailed as the NBB or NBO.'' The Commission proposes to use
Time Weighted Average Quoted Spread as the measure for determining the
minimum pricing increment because it would directly address the issue
of tick-constrained stocks.\227\ The Commission believes that this
metric represents what the quoted spread typically would be at any
point in time during the trading day for an NMS Stock. It also
represents the expected costs of trading that market participants would
have experienced throughout the day. In addition, the Commission
believes that the primary listing exchanges should have experience
using time weighted average quoted spread as a metric, and that
calculating the minimum pricing increments for NMS stocks on a
quarterly basis balances the need for regular updates of the tick size
for NMS Stock based on the Time Weighted Average Quoted Spread with the
need to avoid undue complexity related to more frequent updates.
---------------------------------------------------------------------------
\226\ The Commission proposes to use quotations only during
regular trading hours because after hours trading is generally less
liquid and more volatile.
\227\ Market participants have suggested similar measurements
for determining minimum pricing increments. For example, MEMX
suggested looking at the average quoted spread of an NMS stock to
determine if such stock should be permitted to have a smaller
minimum pricing increment. See MEMX Exemption Request, supra note
105 at 3. Nasdaq suggested categorizing stocks to a minimum pricing
increment based a duration weighted average quoted spread over a
measurement period. See Nasdaq Intelligent Tick, supra note 180 at
8. The Commission preliminarily believes that the proposed Time
Weighted Average Quoted Spread would be more precise than the
suggestions from MEMX and Nasdaq, and the proposed definition would
be sufficiently specific to determine a stock's average quoted
spread.
---------------------------------------------------------------------------
ii. Evaluation Period
Proposed rule 612(a)(ii) would define the term Evaluation Period as
``the last month of a calendar quarter (March in the first quarter,
June in the second quarter, September in the third quarter and December
in the fourth quarter) of a calendar year during which the primary
listing exchange shall measure the Time Weighted Average Quoted Spread
of an NMS stock that is priced equal to, or greater than, $1.00 per
share to determine the minimum pricing increment to be in effect for an
NMS stock for the next calendar quarter, as set forth by paragraph
(c).'' The Commission proposes that the Evaluation Period be one month
in order to balance the need to select a period that is: (1) long
enough such that a few extreme or aberrant days of trading activity
during the Evaluation Period would not unduly effect the Time Weighted
Average Quoted Spread calculation; and (2) short enough such that the
calculation of the Time Weighted Average Quoted Spread would likely be
representative of current market conditions.
As proposed, the applicable minimum pricing increment for the
quoting and trading of the particular NMS stock, based on the Time
Weighted Average Quoted Spread as prescribed by amended rule 612(c),
would then be established for the following quarter on the first
business day following the completion of the Evaluation Period.\228\
Further, the Commission proposes that the calculation to determine the
particular tick for an NMS stock be done on a quarterly basis in order
to balance the need for regular updates of the tick size while not
introducing undue complexity to the market system by updating the tick
size too frequently. MEMX suggested that the minimum pricing increment
be evaluated on a monthly basis.\229\ The MEMX Exemption Request,
however, would only develop one additional pricing increment for NMS
stocks that would become tick-constrained. The Commission's proposal
would be more complex and would require the potential reclassification
to four minimum pricing increments.
---------------------------------------------------------------------------
\228\ As proposed, minimum pricing increments would be
implemented on the first business day after an Evaluation Period.
The Commission requests comment on whether this would be a
sufficient amount of time for the market and market participants to
implement new minimum pricing increments for any NMS stock that may
experience a change in its Time Weighted Average Quoted Spread. See
section II.H.
\229\ See MEMX Exemption Request, supra note 105. See also supra
section II.E.1.
---------------------------------------------------------------------------
iii. Regulatory Data
The Commission proposes to amend the definition of regulatory data
in Rule 600(b)(78) of Regulation NMS to require the primary listing
exchange for each NMS stock to calculate and provide to competing
consolidators, self-aggregators, and the exclusive SIPs an
[[Page 80283]]
indicator of the applicable minimum pricing increment required under
the proposed amendments to rule 612. The Commission believes that it is
appropriate and important that the primary listing exchanges play a
central role in the administration of the proposed amendments to rule
612 by calculating the Time Weighted Average Quoted Spread for each NMS
stock and to provide this information to the exclusive SIPs and
competing consolidators for dissemination. The primary listing
exchanges are well-situated to perform these functions as they have
direct and immediate access to pricing information about their own
listed securities, and already perform similar calculations--and
provide the results to the exclusive SIPs--today.\230\ In addition,
under the MDI rules, the primary listing exchanges would be required to
calculate and provide several regulatory data elements to competing
consolidators and self-aggregators.\231\ For example, the primary
listing exchange will calculate the average monthly closing price of
each of its NMS stocks, assign each stock to a round lot size
corresponding to that average monthly closing price, and include an
indicator of the applicable round lot size in the data it makes
available to competing consolidators and self-aggregators.\232\
---------------------------------------------------------------------------
\230\ See MDI Proposing Release, supra note 39, at 16762; MDI
Adopting Release, supra note 5, at 18634-35.
\231\ 17 CFR 242.600(b)(78); see MDI Proposing Release, supra
note 39, at 16759-63; MDI Adopting Release, supra note 5, at 18633-
35.
\232\ See MDI Adopting Release, supra note 5, at 18633-35 See
also infra section IV.B (discussing proposed amendments to the
definition of ``regulatory data'' that would require the primary
listing exchange to provide an indicator of the applicable round lot
size to the exclusive SIPs).
---------------------------------------------------------------------------
The proposed indicator would thus be included in NMS data \233\
disseminated by the exclusive SIPs and competing consolidators, which
should help to ensure the wide availability of information about the
applicable minimum pricing increment for each NMS stock, which in turn
will enable market participants to trade in a more informed manner.
Further, the Commission believes that information about the relevant
minimum pricing increment should be provided to the exclusive SIPs,
competing consolidators, and self-aggregators because the minimum
pricing increment might change from quarter to quarter.
---------------------------------------------------------------------------
\233\ See infra note 324.
---------------------------------------------------------------------------
3. Quotations and Orders in NMS Stocks Priced Less Than $1.00
Currently, the minimum pricing increment for quotations and orders
in NMS stocks that are priced less than $1.00 per share is $0.0001.
When it adopted this increment, the Commission stated that the sub-
penny increment would largely represent genuine trading interest for
low-price stocks rather than attempts to unfairly step ahead of
displayed orders and that the sub-penny increment represents a
significant amount of the price of the quotation or order.\234\ The
Commission believes that this increment remains appropriate for these
NMS stocks.
---------------------------------------------------------------------------
\234\ See Regulation NMS Adopting Release, supra note 16, at
37555.
---------------------------------------------------------------------------
Due to the other proposed amendments to rule 612, the minimum
pricing increment for quotations and orders in NMS stocks that are
priced less than $1.00 per share would be set forth in proposed rule
612(d). Rule 612(d) as proposed to be amended would state that
``[e]xcept as provided in paragraph (e), the minimum increment for any
bid or offer, order, or indication of interest for an NMS stock priced
less than $1.00 per share shall be no smaller than $0.0001.'' Proposed
rule 612(b) would make the minimum pricing increment set forth in
proposed rule 612(d) applicable to the quoting and trading of NMS
stocks priced less than $1.00 per share. The Commission believes, for
the reasons discussed below, that the minimum pricing increment should
be applied to trading as well as quoting.\235\
---------------------------------------------------------------------------
\235\ See infra section V.C.1.b.
---------------------------------------------------------------------------
4. Minimum Pricing Increment for Trading
The Commission proposes that the variable minimum pricing
increments of rule 612 as proposed to be amended would apply to all
trading--on exchanges, ATSs, and OTC. This means that all quotes and
orders, regardless of price, would be required to execute in the
applicable minimum pricing increments set forth by proposed rule 612(c)
or (d), subject to the specified exceptions set forth in proposed rule
612(e). Proposed amendments to rule 612(e) would provide exceptions
for: (1) orders that execute, but are not explicitly priced at, the
midpoint of the NBBO or the protected bid and protected offer
(``PBBO''); \236\ and (2) orders that execute at a price that was not
based, directly or indirectly, on the quoted price of an NMS stock at
the time of execution and for which the material terms were not
reasonably determinable at the time the commitment to execute the order
was made (e.g., VWAP or TWAP trades).\237\
---------------------------------------------------------------------------
\236\ See 17 CFR 242.600(b)(70) for a definition of PBBO.
\237\ See supra note 19.
---------------------------------------------------------------------------
The Commission is concerned about the increase of orders that are
executed OTC in price increments that exchanges and ATSs cannot
practically provide,\238\ and believes that harmonization of the
minimum pricing increment for the quoting and trading across venues
would promote competition and innovation, while preserving most
meaningful price improvement opportunities.\239\ The Commission
believes that amending rule 612 to require executions to occur at the
relevant minimum pricing increment, subject to the specified
exceptions, would help to address the competitive disparity that
occurs, in part, because certain OTC executions may occur more freely
in sub-penny increments, while the opportunity for sub-penny executions
on exchanges and ATSs are much more limited.\240\
---------------------------------------------------------------------------
\238\ See supra section II.D. See also infra section V.C.1.b and
Table 3.
\239\ See infra section V.D.2.
\240\ In the European Union, minimum pricing increments are
applied to quoting and trading. See Art. 49 of the Directive 2014/
65/EU of the European Parliament and of the Council Directive 2014/
65/EU of the European Parliament and of the Council of 15 May 2014
on markets in financial instruments and amending Directive 2002/92/
EC and Directive 2011/61/EU and Art. 17a of the Regulation (EU)
2019/2033 of the European Parliament and of the Council of 27
November 2019 on the prudential requirements of investment firms and
amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No
600/2014 and (EU) No 806/2014.
---------------------------------------------------------------------------
Currently, much of the sub-penny trading that occurs OTC is a
result of price improvement (i.e., executions that occur between the
spread). The most commonly offered sub-penny increments for price
improvement are $0.0001, $0.001 and $0.002.\241\ Under this proposal,
price improvement of $0.0001 would no longer be available for NMS
stocks that are priced equal to, or greater than, $1.00 per share, but
trades would be able to occur in $0.001 and $0.002 for those stocks
that are assigned to such increments.\242\ Further, executions at even
finer increments would still be permitted to occur at the midpoint.
---------------------------------------------------------------------------
\241\ See infra section V.D.2.
\242\ See infra section V.D.2.
---------------------------------------------------------------------------
The variable minimum pricing increments have also been designed to
facilitate trading between the spread to accommodate price improvement
opportunities.\243\ The Commission believes that applying the minimum
pricing increment to trading across all venues should promote equal
regulation and fair competition among market participants such as
exchanges, OTC
[[Page 80284]]
market makers, and ATSs for retail order flow.\244\
---------------------------------------------------------------------------
\243\ See supra note 217. See also section V.D.2.
\244\ See 15 U.S.C. 78k-1 (a)(1)(C)(ii) and (c)(1)(F).
---------------------------------------------------------------------------
Finally, the Commission believes that the proposed exceptions to
the requirement that orders in NMS stocks be executed in the applicable
minimum pricing increment would promote fair and orderly markets and
economically efficient executions.\245\ These proposed exceptions would
codify current trading activity that is common and widespread under
rule 612. Today, orders that are not explicitly priced in an
impermissible sub-penny increment may execute at the midpoint of the
NBBO/PBBO, even if the midpoint price would be an otherwise
impermissible sub-penny quoting increment.\246\ Similarly, orders that
are not explicitly priced in an impermissible sub-penny increment, such
as benchmark trades (e.g., VWAP or TWAP trades) may execute in an
otherwise impermissible quoting increment under amended rule 612.\247\
Mid-point and benchmark orders are widely used and viewed by liquidity
providers as important options for handling orders and implementing
trading strategies that can reduce the market impact of their trades.
In addition, mid-point liquidity provides price improvement
opportunities for market participants on the other side of these
trades.
---------------------------------------------------------------------------
\245\ See 15 U.S.C. 78k-1 (a)(1)(C)(i).
\246\ See supra note 61.
\247\ Id.
---------------------------------------------------------------------------
G. Proposed Implementation Period
The Commission proposes to stagger the implementation of the
variable minimum pricing increments for NMS Stocks that are priced
equal to, or greater than $1.00 in order to facilitate an orderly
transition for NMS stocks that would have minimum pricing increments
that are less than $0.01. The implementation period would also provide
for longer periods than the proposed quarterly time period between
Evaluation Periods to allow the market and investors to become
accustomed to the smaller increments.
------------------------------------------------------------------------
Time period Minimum pricing increment
------------------------------------------------------------------------
First Implementation Period (1) NMS stocks with a Time Weighted
\a\. Average Quoted Spread that is $0.04 or
less:
The first and second quarters $0.005 increment, and
of effectiveness. (2) NMS stocks with a Time Weighted
Average Quoted Spread greater than
$0.04: $0.01.
Minimum pricing increments would not
apply to trading.
Second Implementation Period (1) NMS stocks with a Time Weighted
\b\. Average Quoted Spread that is $0.016 or
less:
The third and fourth quarters $0.002 minimum pricing increment,
of effectiveness. (2) NMS stocks with a Time Weighted
Average Quoted Spread that is greater
than $0.016 but less than, or equal to,
$0.04: $0.005 minimum pricing increment,
and
(3) NMS stocks with a Time Weighted
Average Quoted Spread that is greater
than $0.04: $0.01 minimum pricing
increment.
Minimum pricing increments would not
apply to trading.
Third Implementation Period Full implementation. All of the minimum
\c\. pricing increments would be effective.
The fifth quarter of Minimum pricing increments would apply to
effectiveness. trading.
------------------------------------------------------------------------
\a\ The primary listing exchanges would calculate the Time Weighted
Average Quoted Spreads for NMS stocks during the first Evaluation
Period that occurs after the proposed rule's effectiveness. For
example, if the proposed rule was effective in July, the primary
listing exchanges would calculate the Time Weighted Average Quoted
Spreads in Sept. and assign the minimum pricing increments for the
fourth quarter of that year and the first quarter of the following
year.
\b\ For the second implementation period, the primary listing exchanges
would calculate the Time Weighted Average Quoted Spreads during the
month in the Evaluation Period that would fall during the second
quarter of effectiveness. In the example above, the primary listing
exchange would calculate the Time Weighted Average Quoted Spreads
during Mar. and assign minimum pricing increments during the second
and third quarters of that year.
\c\ For the final implementation period, the primary listing exchanges
would calculate the Time Weighted Average Quoted Spreads during the
month in the Evaluation Period that would fall during the fourth
quarter of effectiveness. In the example above, the primary listing
exchange would calculate the Time Weighted Average Quoted Spread in
Sept. and assign the minimum pricing increments for the fourth quarter
of that year.
Specifically, for the first implementation period, upon
effectiveness of any amendments to rule 612, the primary listing
exchanges would calculate the Time Weighted Average Quoted Spreads for
all NMS stocks for the first proposed Evaluation Period \248\ and
assign the relevant minimum pricing increments as required under
proposed rule 600(b)(78). The minimum pricing increments calculated
during the first Evaluation Period would be in effect for the following
two quarters (i.e., for six months). During the first two quarters of
proposed rule 612's effectiveness, proposed rule 612 would be
implemented as follows: (1) NMS stocks with a Time Weighted Average
Quoted Spread of $0.04 or less would be assigned to the $0.005
increment for the first quarter of effectiveness, and (2) NMS stocks
with a Time Weighted Average Quoted Spread greater than $0.04 would be
assigned to remain in the $0.01 minimum pricing increment.\249\ The
minimum pricing increments that are less than $0.005 (i.e., $0.002 and
$0.001) would not be implemented during the first quarter of
effectiveness.
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\248\ The initial proposed Evaluation Period (Mar., June, Sept.,
or Dec., as applicable) would be the first full calendar month after
the effectiveness of rule 612. For example, if the effectiveness
would be on Feb. 14, then the initial proposed Evaluation Period
would be Mar. If the effectiveness would be on Mar. 15, then the
initial proposed Evaluation Period would be June.
\249\ The proposed changes to rule 610 would become effective
during the first stage of implementing proposed rule 612. However,
the $0.0005 access fee cap would not be become relevant until the
final stage of implementing proposed rule 612 when the $0.001
minimum pricing increment becomes effective. While proposed rule 610
has proposed variable access fee caps, the proposed access fee caps
are based on the relevant minimum pricing increment.
---------------------------------------------------------------------------
For the second implementation period, at the end of the second
quarter of effectiveness of any proposed amendments to rule 612, the
primary listing exchanges would calculate the Time Weighted Average
Quoted Spreads during the next Evaluation Period (i.e., the month at
the end of the second quarter of effectiveness) and assign the relevant
proposed minimum pricing increment as required under proposed rule
600(b)(78). The minimum pricing increments calculated during the
Evaluation Period would be in effect for the following two quarters
(i.e., for six months). During the third and fourth quarters of
proposed rule 612's effectiveness: (1) NMS stocks with a Time Weighted
Average Quoted Spread that is $0.016 or less would be assigned
[[Page 80285]]
to the proposed $0.002 minimum pricing increment, (2) NMS stocks with a
Time Weighted Average Quoted Spread that is greater than $0.016 but
less than, or equal to, $0.04 would be assigned to the proposed $0.005
minimum pricing increment, and (3) NMS stocks with a Time Weighted
Average Quoted Spread of greater than $0.04 would be assigned to the
proposed $0.01 minimum pricing increment. The $0.001 minimum pricing
increment would not be implemented during the third and fourth quarters
of effectiveness.
Finally, for the third implementation period, at the end of the
fourth quarter of effectiveness of any proposed amendments to rule 612,
the primary listing exchanges would calculate the Time Weighted Average
Quoted Spreads during the next Evaluation Period (i.e., the month at
the end of the fourth quarter) and assign the relevant proposed minimum
pricing increment as required under proposed rule 600(b)(78). During
the fifth quarter of effectiveness of proposed rule 612, all of the
variable minimum pricing increments would be effective. Accordingly,
(1) NMS stocks with a Time Weighted Average Quoted Spread that is
$0.008 or less would be assigned to the proposed $0.001 minimum pricing
increment, (2) NMS stocks with a Time Weighted Average Quoted Spread
that is greater than $0.008 but less than, or equal to, $0.016 would be
assigned the proposed $0.002 minimum pricing increment, (3) NMS stocks
with a Time Weighted Average Quoted Spread that is greater than $0.016
but less than, or equal to $0.04, would be assigned to the proposed
$0.005 minimum pricing increment, and (4) NMS stocks with a Time
Weighted Average Quoted Spread that is greater than $0.04 would be
assigned to the proposed $0.01 minimum pricing increment.
The Commission proposes to implement the requirement to trade in
the applicable minimum pricing increment during the fifth quarter of
effectiveness of any proposed amendments to rule 612. Accordingly,
during the first two implementation periods of effectiveness (i.e., the
first four quarters), as today, market participants would be permitted
to trade in increments that differ from those that are required under
rule 612 for accepting, ranking and displaying of quotes and
orders.\250\ The Commission believes that delaying the requirement that
orders in NMS stock be executed in the minimum pricing increments until
the fifth quarter of effectiveness would help to facilitate an orderly
transition by allowing market participants additional time to adjust
and comply with the requirement to quote and trade with the proposed
minimum pricing increments set forth by the rule for a particular
category of NMS stocks. As discussed in section II.F.1 above, the
proposed variable minimum pricing increments have been developed so
that there are increments at which market participants can trade
between the spread and they are assigned based on the quoting
characteristics of each NMS stock. Therefore, the Commission proposes
to implement the trading requirement once all of the proposed minimum
pricing increments have become effective.
---------------------------------------------------------------------------
\250\ See supra section II.D.
---------------------------------------------------------------------------
Thereafter, at the end of the fifth quarter of effectiveness of
proposed rule 612, the primary listing exchanges would calculate the
Time Weighted Average Quoted Spreads during the next Evaluation Period
and assign the relevant proposed minimum pricing increment as required
under proposed rule 600(b)(78). All of the variable minimum pricing
increments for quoting and trading would be effective on a going
forward basis.
H. Request for Comment
The Commission requests comment on the proposed amendments to rule
612 and on other potential alternatives to the proposed minimum pricing
increments.
1. Would the proposed variable minimum pricing increments for
quotes and orders in NMS stocks priced equal to, or greater than, $1.00
per share address the concerns that have been raised in the market
about tick-constrained stocks? If not, why not?
2. Are the proposed minimum pricing increments appropriate for NMS
stocks? If not, why not, and what minimum pricing increments would be
appropriate?
3. Should all NMS stocks have the same minimum pricing increment
instead of the proposed variable minimum pricing increments determined
by the proposed Time Weighted Average Quoted Spreads? If so, why? What
should be the minimum pricing increment?
4. Are the proposed average quoted spread thresholds for each
proposed minimum pricing increment appropriate? Why or why not?
5. Are the proposed minimum pricing increments economically
significant for the NMS stocks that have the relevant Time Weighted
Average Quoted Spread? Please explain.
6. Would the proposed minimum pricing increments cause flickering
quotes? Please explain.
7. Would the proposed minimum pricing increments reduce displayed
liquidity? Please explain.
8. Is the Time Weighted Average Quoted Spread the appropriate
measure for assigning a minimum pricing increment for orders in NMS
stocks that are priced $1.00 or more per share? If not, what would be
the appropriate measure and why?
9. Is the Evaluation Period an appropriate time period to calculate
the Time Weighted Average Quoted Spread? If not, what would be an
appropriate time period and why?
10. Should the minimum pricing increment be modified on a quarterly
basis? If not, how often should the minimum pricing increments be
potentially modified, e.g., on a monthly basis, on a bi-annual basis,
on an annual basis?
11. Should the minimum pricing increment be uniform for all NMS
stocks based on the per share price of a quote or order similar to
today? Should there be more than two minimum pricing increments
structures based on the price of an order or quotation of an NMS stock
in rule 612? For example, should there be other price cutoffs in
addition to the $1.00 price cutoff for specifying the relevant minimum
pricing increment structure? If so, what should the price cutoffs be
and what should be the minimum increment? If so, what should the
uniform minimum pricing increment be? What should the price threshold
be?
12. Is the $0.01 minimum pricing increment for quotes and orders
priced equal to, or greater than, $1.00 per share or more, appropriate
for some NMS stocks? If so, which NMS stocks and why?
13. Is each of the proposed Time Weighted Average Quoted Spreads
that would determine the relevant minimum pricing increments
appropriate for establishing the proposed minimum pricing increments?
Is each of the Time Weighted Average Quoted Spread thresholds
appropriate? Is each of the proposed minimum pricing increments related
to the relevant Time Weighted Average Quoted Spreads appropriate? If
not, why not, and what would be more appropriate measures and
increments? Please explain.
14. The proposed minimum pricing increments are determined based
upon proposed Time Weighted Average Quoted Spreads and have been
designed to facilitate trading within the spread to accommodate price
improvement opportunities. Are the proposed
[[Page 80286]]
minimum pricing increments and the proposed spread requirements
appropriate to allow price improvement opportunities within the spread?
If not, why not? Are there too many or not enough minimum pricing
increments?
15. Should a minimum pricing increment larger than $0.01 be imposed
for some NMS stocks, such as high priced stocks with wider spreads? Why
or why not? If so, what should the increased minimum pricing increment
be? What objective criteria should be used to identify such NMS stocks
and why?
16. Should NMS stocks that have a Time Weighted Average Quoted
Spread greater than $0.04 retain the $0.01 minimum quoting increment?
Is the proposed $0.04 Time Weighted Average Quoted Spread appropriate
for retaining the $0.01 minimum pricing increment for such stocks? If
not, why not and what would be more appropriate?
17. Is the $0.0001 minimum pricing increment for quotes and orders
priced less than $1.00 per share still appropriate? Should it be
reduced or increased? If so, why?
18. Should the minimum pricing increment be reduced only for those
NMS stocks that are tick-constrained? Why or why not? If yes, what
should the minimum pricing increment for tick-constrained stocks be? If
yes, what should be the criteria to determine whether an NMS stock is
tick-constrained?
19. Should certain types of NMS stocks, such as ETFs or NMS stocks
with smaller market capitalization, have a different minimum pricing
increment? \251\ If so, which types of NMS stocks should have a
different minimum pricing increment and why? If so, what should the
minimum pricing increment for such stocks be and why?
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\251\ Currently, all types of NMS stocks are subject to the
existing rule 612 minimum pricing increments and rule 612 does not
differentiate between different types of NMS stocks. See also note
200, supra.
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20. Are there other means to categorize NMS stocks for determining
a minimum pricing increment? For example, should categories be based on
share price, market value, trading volume, any other criterion, or a
combination of criteria? As proposed, NMS stocks would be assigned a
minimum pricing increment based on the Time Weighted Average Quoted
Spread. How should average quoted spread be computed, over what time
horizon, and how often should this criterion be updated? Should the
formula for calculating Time Weighted Average Quoted Spread accommodate
other elements, such as, for example, certain corporate actions like
stock splits and reverse stock splits that changes the price of the
shares? If so, how?
21. New minimum pricing increments would be established for the
following quarter on the first business day following the completion of
the Evaluation Period. Is the Evaluation Period the appropriate number
of days to calculate the new minimum pricing increments? Is the
proposed time to implement, i.e., on the first business day following
the completion of the Evaluation Period, sufficient for the markets and
market participants to implement? If not, what would be a more
appropriate time period to implement the new minimum pricing increment
and why?
22. Should the proposed minimum pricing increments apply to
trading? Should the proposed trading increments be the same as the
proposed quoting increments? Please explain why or why not.
23. Do the proposed minimum pricing increments provide sufficient
price levels for trading within the quoted spread? Are there sufficient
levels to provide price improvement opportunities given that the
trading increments would be governed by the proposed rule? Should there
be different minimum pricing increments for quoting and trading? Please
explain.
24. Are the proposed exceptions for trading in the minimum pricing
increment appropriate? Why or why not? Should there be other exceptions
from the proposed requirement to trade in the minimum pricing
increment, such as for retail or segmented orders? How should other
exceptions, such as retail or segmented orders, be defined? Please
explain.
25. Would the proposed variable minimum pricing increments be
overly burdensome or complex for the markets to implement? Please
explain.
26. Would the proposed variable minimum pricing increment be
confusing for investors? Would the variable minimum pricing increments
add unnecessary complexity to the market? If so, please explain.
27. Should the primary listing exchange be required to provide an
indicator of the applicable minimum pricing increments to competing
consolidators, self-aggregators, and the appropriate exclusive SIP? Why
or why not?
28. In section V.F., the Commission discusses different reasonable
alternatives--uniform $0.005 tick, a two-tier alternative ($0.005 and
$0.01 depending on the Time Weighted Average Quoted Spread), $0.001 for
retail or segmented trades, and variable tick size based on share
price. Would any of these alternatives address the concerns identified
in a more appropriate manner? If so, which alternative and why?
29. Should the Commission stagger the implementation of rule 612 as
proposed? If yes, are the time periods for the staggered implementation
appropriate? Should the implementation phases be structured
differently, and if so, how? If not, should there be an additional time
period to implement rule 612 so the market and market participants can
have sufficient time? Should the proposed minimum pricing increments
for trading be implemented at the end of the implementation period? If
not, when should the proposed minimum pricing increment be applied to
trading?
III. Amendments to Rule 610 of Regulation NMS--Fees for Access to
Quotations
A. Background
1. Regulation NMS
Regulation NMS, among other things, established intermarket
protection against trade-throughs for all NMS stocks.\252\ The
Commission supplemented those requirements with rules addressing fair
and efficient access to quotations and limits on fees charged to access
newly protected quotations.\253\ The Commission stated that access to
displayed quotations, particularly the best quotations of a trading
center, is ``vital for the smooth functioning of intermarket trading.''
\254\ Specifically, the Commission adopted rule 610, which addresses
three areas related to access to quotations: (1) the means of access to
quotations; (2) the fees for access to protected quotations and any
other quotations that are the best bid or best offer of an exchange or
national securities association; and (3) locking and crossing
quotations.
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\252\ See Rule 611 of Regulation NMS; 17 CFR 242.611.
\253\ See Regulation NMS Adopting Release, supra note 16, at
37538-50.
\254\ See id. at 37539.
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In the context of fees for access to quotations, rule 610(c)
imposes an access fee cap which prohibits a trading center from
imposing, or permitting to be imposed, any fees for the execution of an
order against a protected quotation \255\ of the trading center or any
other quotation of the trading center that is the best bid or best
offer of an exchange or association that exceed or accumulate to more
than $0.0030 per
[[Page 80287]]
share for quotations of $1.00 or more per share.\256\ Rule 610(c) also
imposes an access fee cap of 0.3% of the quotation price if the price
of the protected quotation or other quotation is less than $1.00 per
share.\257\ The access fee caps apply to executions against protected
quotations \258\ and therefore the fees of trading centers that do not
display protected quotations, such as ATSs or OTC markets makers, are
not subject to rule 610(c)'s access fee caps.\259\ Further, the rule
610(c) access fee caps do not apply to non-displayed interest or depth-
of-book quotes.\260\ The Commission adopted the rule 610(c) access fee
caps in order to prevent high fees from undermining Regulation NMS's
price protection and linkage requirements, while leaving trading
centers otherwise free to set fees subject only to other applicable
standards (e.g., prohibition on unfair discrimination).\261\ The access
fee caps were designed to ensure that all investors would have fair and
non-discriminatory access to protected quotations.\262\
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\255\ See supra note 29 (defining ``protected quotation'').
\256\ See 17 CFR 242.610(c). See also Regulation NMS Adopting
Release, supra note 16, 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
$0.001 per share, with a total accumulated access fee limit of
$0.0020 per share in any transaction. See Regulation NMS Proposing
Release, supra note 16, at 11158-59. 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. at 11157-58. The Commission ultimately adopted
an access fee cap of $0.0030 in order to simplify the initial
proposal and align the amount of the cap with the amount charged by
most trading centers at the time, among other reasons. See
Regulation NMS Adopting Release, supra note 16, at 37502 and 37545.
\257\ See Regulation NMS Adopting Release, supra note 16, at
37545 n.419 (noting that ``[f]or the relatively small number of NMS
stocks priced under $1.00, fees will be limited to 0.3% of the
quotation price per share to prevent fees from constituting an
excessive percentage of share price.'').
\258\ See supra note 29. As stated above, rule 610(c) also
applies to any other quotation of a trading center that is the best
bid or offer of an exchange or association. The Commission stated
that the access fee caps should apply to manual quotations that are
the best bid or offer to the same extent that it applies to
protected quotations to preclude any incentive for trading centers
to display manual quotations as a means to charge higher access
fees. See Regulation NMS Adopting Release, supra note 16, at 37546.
For purposes of this discussion, references to protected quotations
also include manual quotations that are the best bid or best offer
of an exchange or association.
\259\ If an ATS or OTC market maker displayed a protected
quotation, its fees would be subject to the access fee caps under
rule 610(c). However, exchange fees and the fees of non-exchange
trading centers are treated very differently under the Federal
securities laws. For example, one of the distinguishing features of
registered national securities exchanges is that--unlike non-
exchange trading centers--their fees are subject to the principles-
based standards set forth in the Exchange Act, as well as the rule
filing requirements thereunder. In particular, the Federal
securities laws require the entirety of each and every fee, due, and
charge assessed by an exchange to be transparent and publicly
posted, and must be an equitable allocation of reasonable dues, fees
and other charges and not be unfairly discriminatory. See 15 U.S.C.
78f(b)(4) and (5). Similar requirements do not apply to the fees of
non-exchange trading centers that do not provide public transparency
into their respective fee schedules and typically are negotiated on
a customer-by-customer basis. The fees assessed by non-exchange
trading centers are bespoke, and the fees paid (or not paid) by
market participants to ATSs and other off-exchange venues are
negotiated between each market participant and the trading venue,
the result being that the number of fee permutations and differences
across brokers for any single ATS could be substantial.
\260\ See Regulation NMS Adopting Release, supra note 16, at
37546.
\261\ See id. at 37543-46 (The Commission expressed concern that
without a fee limitation, the adoption of the Order Protection Rule
and private linkages could ``significantly boost the viability of
the outlier business model.'' Such outlier markets ``might well try
to take advantage of intermarket price protection by acting
essentially as a toll booth between price levels'' with the high fee
market likely to 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 such 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.''). Id. at 37546.
\262\ See id. at 37497.
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At the time of adoption, the $0.0030 fee limitation was consistent
with the then-prevailing market level and general business practices,
as very few trading centers charged fees in excess of that amount.\263\
The Commission adopted the 0.3% fee limitation on quotations priced
less than $1.00 to prevent fees from constituting an excessive
percentage of share price.\264\ The purpose of the access fee
limitation was to help ensure the fairness and accuracy of displayed
quotations by establishing an outer limit on the cost of accessing such
quotations.\265\ In adopting the rule, the Commission sought to
``assure order routers that displayed prices are, within a limited
range, true prices.'' \266\ Since the adoption of rule 610 in 2005, the
Commission has continued to consider the impact of access fees on
market structure and market quality, but has not previously proposed to
modify the amount of the access fee caps despite significant changes in
the equity markets.\267\
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\263\ The $0.0030 per share cap largely codified the then-
prevailing fee level set through competition among the various
trading centers. See id. 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.'').
\264\ See id. at 37544 n.406.
\265\ See id. at 37502, 37583, and 37595.
\266\ Id. at 37502. (The Commission stated that the fee
limitation was necessary to achieve the purposes of the Exchange Act
because ``[a]ccess fees tend to be highest when markets use them to
fund substantial rebates to liquidity providers, rather than merely
to compensate for agency services.'' Consequently, [i]f outlier
markets are allowed to charge high fees and pass most of them
through as rebates, the published quotations of such markets would
not reliably indicate the true price that is actually available to
investors or that would be realized by liquidity providers.''
Section 11A(c)(1)(B) of the Exchange Act authorizes the Commission
to adopt rules assuring the fairness and usefulness of quotation
information. In adopting the current fee caps, the Commission stated
that, for quotations to be fair and useful, ``there must be some
limit on the extent to which the true price for those who access
quotations can vary from the displayed price.'' The Commission
concluded that ``the $0.0030 fee limitation will further the
statutory purposes of the NMS by harmonizing quotation practices and
precluding the distortive effects of exorbitant fees.''). Id. at
37584.
\267\ See Securities Exchange Act Release No. 84875 (Dec. 19,
2018), 84 FR 5202 (Feb. 20, 2019) (``Transaction Fee Pilot Adopting
Release''). Further, the Equity Market Structure Advisory Commission
also considered, among other things, whether the access fee cap
should be modified. See Equity Market Structure Advisory Committee,
Oct. 27, 2015, information available at <a href="https://www.sec.gov/spotlight/emsac/emsac-archives.htm">https://www.sec.gov/spotlight/emsac/emsac-archives.htm</a>.
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2. Exchange Fee Models
The predominant pricing structure for transactions that has
developed among the equities exchanges to attract order flow is the
``maker-taker'' pricing model, in which the exchange pays a rebate to a
``maker'' or provider of liquidity and charges a fee to a ``taker'' of
liquidity.\268\ The exchange 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.\269\ For maker-taker exchanges, the
amount of the taker fee is typically limited by the access fee caps
imposed by rule 610(c) on the fees the exchange can charge to access
its protected
[[Page 80288]]
quotation or best bid/offer for NMS stocks. The rule 610(c) access fee
caps apply to the fees assessed on an incoming order that executes
against a resting protected quote, but does not address the rebates
that may be paid. However, the rule 610(c) access fee caps typically
indirectly limit the average amount of the rebates that an exchange
offers to less than $0.0030 per share in order to maintain net positive
transaction revenues. Thus, an exchange may have higher access fees to
fund higher liquidity rebates \270\ to attract more trading volume.
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\268\ See SRO fee schedules, which are available on each SRO's
website. See also infra section V.C.2, Table 5. This discussion
focuses on exchange fees because, currently, only exchanges display
protected quotations. If an ATS or OTC market maker displayed a
protected quotation, its fees would be subject to the access fee
caps under rule 610(c). However, exchange fees and the fees of non-
exchange trading centers are treated very differently under the
Federal securities laws. See supra note 259.
\269\ A few exchanges have adopted a ``taker-maker'' pricing
model (also called an inverted model), in which they charge a fee
the provider of liquidity and pay a rebate to the taker of
liquidity. See, e.g., Nasdaq BX fee schedule available at <a href="https://www.nasdaqtrader.com/trader.aspx?id=bx_pricing">https://www.nasdaqtrader.com/trader.aspx?id=bx_pricing</a> (as of July 5, 2022);
NYSE National fee schedule available at <a href="https://www.nyse.com/publicdocs/nyse/regulation/nyse/NYSE_National_Schedule_of_Fees.pdf">https://www.nyse.com/publicdocs/nyse/regulation/nyse/NYSE_National_Schedule_of_Fees.pdf</a>
(as of Jan. 1, 2022); and Cboe EDGA fee schedule available at
<a href="https://www.cboe.com/us/equities/membership/fee_schedule/edga/">https://www.cboe.com/us/equities/membership/fee_schedule/edga/</a> (as
of Apr. 1, 2022). See also infra section V.C.2, Table 5. For taker-
maker exchanges, the amount of the maker fee charged to the provider
of liquidity is not bounded by the rule 610(c) access fee cap
because such fee is not a charge to access the market's best bid/
offer for NMS stocks, but such fees typically are no more than
$0.0030.
\270\ This was one of the concerns the Commission identified
when it approved the access fee caps. See Regulation NMS Adopting
Release, supra note 16, at 37545 (``[T]he fee limitation is
necessary to achieve the purposes of the Exchange Act. Access fees
tend to be highest when markets use them to fund substantial rebates
to liquidity providers, rather than merely to compensate for agency
services.'').
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In recent years, a variety of concerns have been expressed about
the prevailing maker-taker fee model, in particular the rebates
exchanges pay to attract orders. For example, many have argued that the
prevailing access fee structure creates a conflict of interest for
broker-dealers, who must provide the best execution to their customers'
orders while facing potentially conflicting economic incentives to
avoid fees or earn rebates from the trading centers to which they
direct those orders for execution.\271\ Others have expressed concern
that maker-taker access fees may: (1) 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;
\272\ (2) 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; \273\ (3) introduce unnecessary market
complexity through the proliferation of new exchange order types (and
new exchanges) designed solely to take advant
[…truncated; see source link]Indexed from Federal Register on December 29, 2022.
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