Proposed Rule2023-23398
Volume-Based Exchange Transaction Pricing for NMS Stocks
Primary source
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Published
November 6, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing a new rule under the Securities Exchange Act of 1934 ("Exchange Act") to prohibit national securities exchanges from offering volume-based transaction pricing in connection with the execution of agency-related orders in certain stocks. If exchanges offer such pricing for their members' proprietary orders, the proposal would require the exchanges to adopt rules and written policies and procedures related to compliance with the prohibition, as well as disclose, on a monthly basis, certain information including the total number of members that qualified for each volume tier during the month.
Full Text
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[Federal Register Volume 88, Number 213 (Monday, November 6, 2023)]
[Proposed Rules]
[Pages 76282-76341]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-23398]
[[Page 76281]]
Vol. 88
Monday,
No. 213
November 6, 2023
Part II
Securities and Exchange Commission
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17 CFR Parts 232 and 240
Volume-Based Exchange Transaction Pricing for NMS Stocks; Proposed Rule
Federal Register / Vol. 88 , No. 213 / Monday, November 6, 2023 /
Proposed Rules
[[Page 76282]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 232 and 240
[Release No. 34-98766; File No. S7-18-23]
RIN 3235-AN29
Volume-Based Exchange Transaction Pricing for NMS Stocks
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing a new rule under the Securities Exchange Act of 1934
(``Exchange Act'') to prohibit national securities exchanges from
offering volume-based transaction pricing in connection with the
execution of agency-related orders in certain stocks. If exchanges
offer such pricing for their members' proprietary orders, the proposal
would require the exchanges to adopt rules and written policies and
procedures related to compliance with the prohibition, as well as
disclose, on a monthly basis, certain information including the total
number of members that qualified for each volume tier during the month.
DATES: Comments should be received on or before January 5, 2024.
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/2023/10/feetiers">https://www.sec.gov/rules/2023/10/feetiers</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#bbc9ced7de96d8d4d6d6ded5cfc8fbc8ded895dcd4cd"><span class="__cf_email__" data-cfemail="740601181159171b1919111a0007340711175a131b02">[email protected]</span></a>. Please include
file number S7-18-23 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 S7-18-23. 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. Do not include personal information
in submissions; you should submit only information that you wish to
make available publicly. We may redact in part or withhold entirely
from publication submitted material that is obscene or subject to
copyright.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
A summary of the proposal of not more than 100 words is posted on
the Commission's website (<a href="https://www.sec.gov/rules/2023/10/feetiers">https://www.sec.gov/rules/2023/10/feetiers</a>).
FOR FURTHER INFORMATION CONTACT: Richard Holley III, Assistant
Director, Yvonne Fraticelli, Special Counsel, Terri Evans, Special
Counsel, or Julia Zhang, 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 to add new 17
CFR 240.6b-1 (Rule 6b-1 under the Exchange Act) and amend 17 CFR
232.101 (Rule 101 of Regulation S-T) and 17 CFR 232.405 (Rule 405 of
Regulation S-T).
Table of Contents
I. Introduction
A. Background
B. Volume-Based Exchange Transaction Pricing
C. Commission Concerns
1. Competition Among Members
2. Conflicts of Interest
3. Exchange Competition
II. Description of Proposed Rule
A. Overview of Proposed Rule
B. Prohibition on Volume-Based Exchange Transaction Pricing for
Agency-Related Volume
C. Anti-Evasion
D. Transparency for Volume-Based Pricing on Member Proprietary
Orders
III. Paperwork Reduction Act
A. Summary of Collections of Information
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-
Related Volume
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
B. Proposed Use of Information
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-
Related Volume
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
C. Respondents
D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-
Related Volume
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
E. Collection of Information Is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
H. Request for Comments
IV. Economic Analysis
A. Introduction
B. Baseline
1. Exchange Pricing
2. Volume-Based Tiers and Order Routing Incentives
3. Routing Incentives and Potential Conflicts of Interest
4. The Market To Provide Exchange Access
5. Lack of Tier Transparency
C. Economic Effects
1. Effect of the Proposed Ban on Volume-Based Tiers for Non-
Principal Orders
2. Effects of Proposed Requirement of Rules and Policies and
Procedures To Prevent Evasion
3. Effects of the Transparency Provisions
D. Effect on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Reasonable Alternatives
1. Ban Volume-Based Pricing for All Orders
2. Ban Volume-Based Pricing for All Orders Except Registered
Market Makers
3. Proceed With Transparency Provisions for All Orders Without
Tiers Prohibition
4. Banning the Linking of Volume-Based Tiers for Closing
Auctions To Consolidated Volume
5. Require Disclosures of Volume-Based Pricing in Proprietary
Volume in NMS Stocks To Be Posted on Exchange Websites or Submitted
Through a Different System
6. Require a Different Structured Data Language for the
Disclosures of Volume-Based Pricing in Proprietary Volume in NMS
Stocks
7. Remove Structured Data Language Requirement for Disclosures
of Volume-Based Pricing in Proprietary Volume in NMS Stocks
F. Request for Comment
V. Regulatory Flexibility Act Certification
[[Page 76283]]
VI. Consideration of Impact on the Economy
Statutory Authority
I. Introduction
A. Background
National securities exchanges (``exchanges'') that trade NMS stocks
\1\ maintain pricing schedules that set forth the transaction pricing
they apply to their broker-dealer members \2\ that execute orders on
their trading platforms.\3\ As self-regulatory organizations under the
Exchange Act, exchanges are subject to unique principles and processes
that do not apply to other businesses.\4\ For example, all proposed
rules of an exchange,\5\ including exchange transaction pricing
proposals, must be filed with the Commission.\6\ In addition, pricing
schedules must be publicly posted on the exchange's website.\7\
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\1\ See 17 CFR 242.600(b)(55) (defining ``NMS stock'').
\2\ Exchange rules limit their membership to registered brokers
or dealers. See, e.g., Cboe BZX Exchange, Inc. (``Cboe BZX'') Rule
2.3.
\3\ This release uses the term ``price'' or ``pricing'' to refer
to the fees (charges incurred for an execution), rebates (refundable
credits in connection with an execution), and other incentives
(e.g., discounts or caps that are not refundable credits but are
credited to the member's billing account) that exchanges assess to
their members for transactions on the exchange. Rebates are
refundable because they can exceed the fees (transaction fees and
other fees) that members incur. See, e.g., Remarks of Chris
Concannon, Cboe Global Markets, before the SEC Roundtable on Market
Data Products, Market Access Services, and Their Associated Fees,
Oct. 25, 2018, Transcript at 74-75, available at <a href="https://www.sec.gov/spotlight/equity-market-structure-roundtables/roundtable-market-data-market-access-102518-transcript.pdf">https://www.sec.gov/spotlight/equity-market-structure-roundtables/roundtable-market-data-market-access-102518-transcript.pdf</a> (``Five
out of the top 10 get a check from us after the costs of their
connectivity and market data. So we are cutting them a check monthly
after their costs.'') (``Remarks of Chris Concannon'').
\4\ See, e.g., 15 U.S.C. 78f and 78s.
\5\ See 15 U.S.C. 78c(a)(27) (defining ``rules'') and 17 CFR
240.19b-4(c) (providing further information on the phrase ``stated
policies, practices, and interpretations'').
\6\ See 15 U.S.C. 78s(b). Exchange pricing proposals are
effective immediately upon filing with the Commission because the
Exchange Act does not require advance notice or Commission approval
before an exchange may implement a pricing change. 15 U.S.C.
78s(b)(3)(A)(ii). Within 60 days after the date of filing of an
immediately effective proposal, the Commission may summarily
temporarily suspend the proposal if it appears to the Commission
that a suspension is necessary or appropriate in the public
interest, for the protection of investors, or otherwise in
furtherance of the purposes of the Exchange Act. See 15 U.S.C.
78s(b)(3)(C). If the Commission suspends the proposal, the
Commission will institute proceedings under section 19(b)(2)(B) (15
U.S.C. 78s(b)(2)(B)) of the Exchange Act to determine whether the
proposal should be approved or disapproved. See 15 U.S.C.
78s(b)(3)(C). At the conclusion of the proceedings, the Commission
shall approve a proposal if it finds that it is consistent with the
requirements of the Exchange Act, or it shall disapprove the
proposal if it does not make such a finding. See 15 U.S.C.
78s(b)(2)(C). If the Commission does not suspend an immediately
effective filing on or before the sixtieth day after the filing
date, the Exchange Act does not deem the proposal to have been
approved by the Commission. See 15 U.S.C. 78s(b)(2)(D) (providing
when a proposed rule change shall be deemed to have been approved by
the Commission).
\7\ See 17 CFR 240.19b-4(m).
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The Exchange Act further requires that exchange pricing proposals,
among other things, provide for the ``equitable allocation of
reasonable dues, fees, and other charges among its members and issuers
and other persons using its facilities'' \8\ that ``are not designed to
permit unfair discrimination between customers, issuers, brokers, or
dealers'' \9\ and ``do not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of'' the
Exchange Act.\10\ With respect to the requirement that the rules of an
exchange not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act, the
Senate Banking, Housing and Urban Affairs Committee report that
accompanied the 1975 amendments to the Exchange Act stated that ``this
paragraph is designed to make clear that a balance must be struck
between regulatory objectives and competition, and that unless an
interference with competition is justified in terms of the achievement
of a statutory objective, it cannot stand.'' \11\
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\8\ 15 U.S.C. 78f(b)(4).
\9\ 15 U.S.C. 78f(b)(5).
\10\ 15 U.S.C. 78f(b)(8).
\11\ Securities Acts Amendments of 1975, Report of the Senate
Comm. on Banking, Housing and Urban Affairs to Accompany S.249, S.
Rep. No. 94-75, 94th Cong., 1st Sess. 11 (1975), at 96 (``Senate
Report'').
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Section 11A of the Exchange Act \12\ directs the Commission to
facilitate the establishment of a national market system in accordance
with specified Congressional findings. Among the Congressional findings
are assuring (i) fair competition among brokers and dealers and among
exchange markets, and (ii) the practicability of brokers executing
investors' orders in the best market.\13\ Rather than setting forth
minimum components of the national market system, the Exchange Act
grants the Commission broad authority to oversee the implementation,
operation, and regulation of the national market system consistent with
Congressionally determined goals and objectives.\14\
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\12\ 15 U.S.C. 78k-1.
\13\ 15 U.S.C. 78k-1(a)(1)(C)(ii) and (iv).
\14\ See Senate Report, supra note 11, at 8-9.
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B. Volume-Based Exchange Transaction Pricing
As part of its ongoing efforts to assess whether aspects of the
national market system continue to meet the statutory goals and
objectives as markets and market participants evolve, the Commission is
considering the impact of volume-based exchange transaction pricing in
NMS stocks. Many exchanges use increasingly complex transaction pricing
schedules that feature differentiated incentives (e.g., lower fees or
higher rebates) that depend on member volume.\15\ These exchanges
[[Page 76284]]
offer members lower fees or higher rebates as the number of shares the
member executes on the exchange reaches successively higher predefined
volume-based levels (``tiers''). The transaction volume that qualifies
a member for a better fee or rebate tier typically is measured as a
fraction of total consolidated market volume, rather than a fixed
value. Such tiers are commonly based on a member achieving a designated
average daily volume on the exchange that equals or exceeds a certain
percentage of total market volume in a given month (e.g., an average
daily volume on the exchange that equals or exceeds 0.10% of the total
consolidated market volume).\16\ Each member's tier is calculated by
the exchange as of the end of a month and reset thereafter on a monthly
basis.\17\ The large number of available tiers, and possible
combinations of some tiers,\18\ greatly complicate exchange pricing
schedules and that complexity can make it more difficult for the public
to understand and meaningfully comment on exchange pricing
proposals.\19\
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\15\ Exchange transaction pricing for NMS stocks is
characterized by three different pricing models: (1) maker-taker
(where the liquidity providing ``maker'' receives a rebate from the
exchange and the ``taker'' that executes against that resting order
pays a fee to the exchange); (2) taker-maker or inverted (where
liquidity takers are offered a rebate and liquidity providers are
assessed a fee); and (3) flat (where an exchange does not offer
rebates and instead charges a fee to neither side of a trade, one
side of a trade, or both sides of a trade). In rebate pricing
models, the exchange's transaction revenue (``net capture'') is the
difference between the fee it collects on one side of the trade and
the rebate it pays out on the other side of the trade. As of Mar.
2023, nine exchanges had a maker-taker pricing model. See Cboe BZX
pricing schedule, available at <a href="https://www.cboe.com/us/equities/membership/fee_schedule/bzx/">https://www.cboe.com/us/equities/membership/fee_schedule/bzx/</a>; Cboe EDGX Exchange, Inc. (``Cboe
EDGX'') pricing schedule, available at <a href="https://www.cboe.com/us/equities/membership/fee_schedule/edgx/">https://www.cboe.com/us/equities/membership/fee_schedule/edgx/</a>; Nasdaq PHLX, LLC (``Phlx
(PSX)'') pricing schedule, available at <a href="https://listingcenter.nasdaq.com/rulebook/phlx/rules/phlx-equity-7">https://listingcenter.nasdaq.com/rulebook/phlx/rules/phlx-equity-7</a>; The
Nasdaq Stock Market LLC (``Nasdaq'') pricing schedule, available at
<a href="http://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2#rebates">http://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2#rebates</a>;
NYSE Arca, Inc. (``NYSE Arca'') pricing schedule, available at
<a href="https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf">https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf</a>; NYSE American LLC (``NYSE
American'') pricing schedule, available at <a href="https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf">https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf</a>; New York Stock Exchange, LLC
(``NYSE'') pricing schedule, available at <a href="https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf">https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf</a>; MEMX, LLC pricing
schedule, available at <a href="https://info.memxtrading.com/fee-schedule/">https://info.memxtrading.com/fee-schedule/</a>;
and MIAX PEARL, LLC (``MIAX Pearl'') equities pricing schedule,
available at <a href="https://www.miaxoptions.com/sites/default/files/fee_schedule-files/MIAX_Pearl_Equities_Fee_Schedule_01012023_1.pdf">https://www.miaxoptions.com/sites/default/files/fee_schedule-files/MIAX_Pearl_Equities_Fee_Schedule_01012023_1.pdf</a>.
As of Mar. 2023, four exchanges had a taker-maker pricing model. See
Cboe BYX Exchange, Inc. (``Cboe BYX'') pricing schedule, available
at <a href="https://www.cboe.com/us/equities/membership/fee_schedule/byx/">https://www.cboe.com/us/equities/membership/fee_schedule/byx/</a>;
Cboe EDGA Exchange, Inc. (``Cboe EDGA'') pricing 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>;
and NYSE National, Inc. (``NYSE National'') pricing 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>. Nasdaq BX, Inc. (``BX'') also
uses the taker-maker pricing model but charges a $0.0007 fee if a
member fails to reach any liquidity removing rebate tier. See BX
pricing schedule, available at <a href="http://www.nasdaqtrader.com/trader.aspx?id=bx_pricing">http://www.nasdaqtrader.com/trader.aspx?id=bx_pricing</a>. As of Mar. 2023, Investors Exchange LLC
(``IEX'') and NYSE Chicago, Inc. (``NYSE Chicago'') offer a flat
pricing model. See IEX pricing schedule, available at <a href="https://www.iexexchange.io/resources/trading/fee-schedule#transaction-fees">https://www.iexexchange.io/resources/trading/fee-schedule#transaction-fees</a>
and NYSE Chicago pricing schedule, available at <a href="https://www.nyse.com/publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf">https://www.nyse.com/publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf</a>. As of
Sept. 1, 2023, IEX began offering a rebate of $0.0004 per share on
displayed orders that add liquidity for executions at or above $1.
Another exchange, Long-Term Stock Exchange, Inc., (``LTSE'') does
not charge fees to transact. See <a href="https://ltse.com/trading/market-overview">https://ltse.com/trading/market-overview</a>.
\16\ Tier criteria typically reference a member's average total
daily traded share volume on the exchange during the month as a
percentage of the average total daily market volume in stocks
reported by one or more of the consolidated tapes (``Tapes'') during
the month pursuant to effective national market system plans that
govern the collection, consolidation, processing, and dissemination
of certain national market system information. See, e.g., Nasdaq
pricing schedule, supra note 15. There currently are three such
effective national market system plans. 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
``Equities Data Plans''). The Equities Data Plans disseminate SIP
data over three separate networks: (1) Tape A for securities listed
on NYSE; (2) Tape B for securities listed on exchanges other than
NYSE and Nasdaq; and (3) Tape C for securities listed on Nasdaq. The
CTA Plan governs the collection, consolidation, processing, and
dissemination of last sale information for Tape A and Tape B
securities. The CQ Plan governs the collection, consolidation,
processing, and dissemination of quotation information for Tape A
and Tape B securities. Finally, the UTP Plan governs the collection,
consolidation, processing, and dissemination of last sale and
quotation information for Tape C securities. See also Securities
Exchange Act Release No. 98271 (Sept. 1, 2023), 88 FR 61630 (Sept.
7, 2023) (File No. 4-757) (Order directing the exchanges and the
Financial Industry Regulatory Authority (``FINRA'') to file a
national market system plan regarding consolidated equity market
data).
\17\ Currently, as exchanges assess transaction pricing to their
members on a monthly basis in arrears, exchanges apply the highest
tier a member achieves during a month to all of the member's
executions during that month (e.g., if a member qualifies for Tier 2
in June (out of 4 tiers), all of its June volume will be assessed at
the Tier 2 rate, including volume transacted at the lower Tiers 4
and 3 earlier in the month). Separately, the Commission has proposed
to require exchanges to make the amounts of all fees and rebates
determinable at the time of execution, which would require volume-
based exchange transaction pricing to be applied prospectively
rather than retroactively to the start of a month. See Securities
Exchange Act Release No. 96494 (Dec. 14, 2022), 87 FR 80266, 80270
(Dec. 29, 2022) (File No. S7-30-22) (``Access Fee Proposal''). The
Commission encourages commenters to review the Access Fee Proposal
to determine whether it might affect their comments on this release.
As exchanges compete to attract liquidity, frequent pricing changes
(typically effective and/or operative on the first business day of a
month) are common. See, e.g., id. at 87 FR at 80311 (stating that
between Jan. 2018 and June 2022, market participants interacting
with all exchanges had to adjust to an average of 155 fee changes
per year across all exchanges).
\18\ See infra Table 2 (showing the number of available tiers at
each exchange in March 2023, ranging from 0 to 93). Some exchanges
offer additive incentives, including ``step-up'' rebates, that can
be earned in addition to a standard tiered incentive. See, e.g.,
Cboe BZX Fee Schedule's Step-Up Tiers, available at <a href="https://www.cboe.com/us/equities/membership/fee_schedule/bzx/">https://www.cboe.com/us/equities/membership/fee_schedule/bzx/</a>. See also
infra Tables 1 and 2.
\19\ See Letter to Brent Fields, Secretary, Commission, from
Rich Steiner, RBC Capital Markets (Oct. 16, 2018) (``RBC Letter'')
at 8 (comment letter on File No. S7-05-18) (``Our analysis
identifies at least 1,023 pricing paths across the exchanges. Over
one-third, or 381, of these paths consist of rebates. These 1,023
pricing paths are themselves determined by at least 3,762 pricing
variables.'').
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Volume-based exchange transaction pricing raises competitive
concerns among exchange members as well as among exchanges. With
respect to members competing for customers,\20\ members with lower
exchange volume do not qualify for the more favorable volume-based
exchange transaction pricing tiers available to high-volume members.
Accordingly, lower-volume members may find it difficult to compete for
customer order flow because they are unable to pass through to
customers the favorable exchange transaction pricing or lower
commissions that are available to higher-volume members.\21\ Similar
competitive concerns also may be present for members as a result of
volume-based exchange transaction pricing when they trade proprietarily
using principal orders where no customers are involved.
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\20\ A ``customer'' of a member is anyone using the services of
the member to access the exchange, including another exchange
member, a non-member broker-dealer, an institution, or any other
person.
\21\ See Letter from Tyler Gellasch, President and CEO, Healthy
Markets Association, to Gary Gensler, Chair, Commission, dated Nov.
16, 2022 at 4 (``Healthy Markets Letter''), available at <a href="https://healthymarkets.org/wp-content/uploads/2022/12/HMA-Ltr-re-Volume-Based-Pricing-11-16-22-1.pdf">https://healthymarkets.org/wp-content/uploads/2022/12/HMA-Ltr-re-Volume-Based-Pricing-11-16-22-1.pdf</a> (stating that to ``the extent that
different competitors fall into different pricing tiers, it will
directly impact the competitive balance between those firms''). The
letter also includes suggestions for potential reforms to exchange
routing incentives and transaction pricing fees. See id. at 4.
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As a result of volume-based exchange transaction pricing, lower-
volume members may seek to route some or all of their orders through
high-volume members to qualify for better exchange pricing.\22\ As that
happens, the lower-volume members that are otherwise competing with the
high-volume members become customers of their high-volume competitors.
This dynamic can lead to order flow becoming increasingly concentrated
among a small number of high-volume members, who then qualify for even
higher tiers (i.e., tiers that feature lower fees or higher rebates) as
a result of that flow, which further impacts the ability of lower-
volume members to compete with them in a self-reinforcing cycle.\23\
This concentration impacts customers by reducing the number of exchange
members capable of offering them competitive exchange transaction
pricing. Further, lower-volume exchange members provide a subsidy for
the high-volume members when exchanges use the higher fees and lower
rebates of the lower-volume members to fund the lower fees and higher
rebates the exchange offers to high-volume members.\24\ Accordingly,
the Commission is concerned that volume-based exchange transaction
pricing may have the effect of ensuring that high-volume members retain
a persistent competitive advantage over lower-volume exchange
members.\25\
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\22\ See, e.g., Securities Exchange Act Release No. 63241 (Nov.
3, 2010), 75 FR 69792 at 69793 (Nov. 15, 2010) (``Rule 15c3-5
Adopting Release'') (discussing that certain market participants may
find the wide range of access arrangements, including sponsored and/
or direct market access, beneficial and that such arrangements may
``reduce trading costs by lowering operational costs, commissions,
and exchange fees'').
\23\ See infra section IV.B.4 (The Market to Provide Exchange
Access).
\24\ See id.
\25\ See 15 U.S.C. 78f(b)(4) (requiring that the rules of an
exchange provide for the equitable allocation of reasonable dues,
fees, and other charges among its members); (b)(5) (requiring that
the rules of an exchange, among other things, not be designed to
permit unfair discrimination); (b)(8) (requiring that the rules of
an exchange not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act); and
15 U.S.C. 78k-1(a)(1)(C) (finding it in the public interest and
appropriate for the protection of investors and the maintenance of
fair and orderly markets to assure fair competition among brokers
and dealers, and among exchange markets).
---------------------------------------------------------------------------
In addition, volume-based transaction pricing tiers may provide
incentives to members of more than one exchange to route orders to one
particular exchange in order to qualify for that exchange's tiers and
achieve lower fees and higher
[[Page 76285]]
rebates as a result.\26\ With respect to customer orders, an economic
incentive to route customer orders to a particular exchange to achieve
volume tiers on that specific exchange can present a conflict of
interest between members and customers when members do not fully pass-
through exchange transaction fees and rebates to their customers and
instead retain for themselves the benefits of tiered exchange
transaction pricing.\27\
---------------------------------------------------------------------------
\26\ Membership can overlap across the exchanges. For example,
as of Feb. 21, 2023, MIAX Pearl Equities Exchange had 49 members and
NYSE had 143 members. See <a href="https://www.miaxoptions.com/exchange-members/pearl-equities">https://www.miaxoptions.com/exchange-members/pearl-equities</a> and <a href="https://www.nyse.com/markets/nyse/membership">https://www.nyse.com/markets/nyse/membership</a>. Forty-two of those MIAX Pearl Equities Exchange's
members were also members of NYSE.
\27\ The Commission understands that full pass-through of
exchange transaction pricing by members to their customers is less
common.
---------------------------------------------------------------------------
Volume-based exchange transaction pricing also can impact
competition among exchanges. For example, when a primary listing
exchange bases pricing in its closing auction on the volume that a
member executes on the exchange during regular trading hours, members
that prefer (or whose customers prefer) the primary listing exchange's
closing auction are incentivized to route orders to the exchange during
the regular hours trading session in order to obtain more favorable
pricing in the closing auction, which could negatively affect the
ability of other exchanges to compete for that volume during regular
trading hours.\28\
---------------------------------------------------------------------------
\28\ See, e.g., NYSE pricing schedule, supra note 15 (offering
incremental per share discounts on market-at-the-close orders
depending on a member's average daily trading volume that added
liquidity to NYSE during the billing month as a percentage of CADV).
According to NYSE, the proposed discounts were designed ``to align
incentives among both trading on the close and intraday trading on
the Exchange.'' See Securities Exchange Act Release No. 94543 (Mar.
19, 2022), 87 FR 19544 at 19543 (Apr. 4, 2022). The NYSE further
stated ``that other marketplaces provide discounts based on intraday
adding volume, and that aligning incentives for lower pricing at the
close with additional intraday volume is thus neither novel nor an
unreasonable stance in a competitive marketplace.'' Id. at 19546.
---------------------------------------------------------------------------
As discussed below, the proposed rule would prohibit exchanges from
offering volume-based transaction fees, rebates, or other incentives in
connection with the execution of agency or riskless principal orders in
NMS stocks.\29\ This prohibition is designed to remove a competitive
impediment between higher-volume and lower-volume members when they
compete for customer business, and also to mitigate the conflict of
interest between members and customers presented by volume-based
exchange transaction pricing tiers when members are routing customer
orders to an exchange for execution. Because the prohibition in
proposed Rule 6b-1 would be limited to agency and riskless principal
orders, exchanges would continue to have the ability to provide tiered
transaction pricing for member proprietary volume, and therefore this
proposed prohibition does not seek to address any potential concerns
associated with the routing of proprietary orders.
---------------------------------------------------------------------------
\29\ While the proposed rule addresses only NMS stocks, the
Commission is requesting comment below on whether the proposal
should be applied to options.
---------------------------------------------------------------------------
With respect to proprietary volume, the proposed rule would enhance
transparency of tiered exchange transaction pricing for such volume by
requiring exchanges to disclose the number of members that qualify for
each of their pricing tiers. This information is intended to facilitate
the Commission's review of proposed pricing changes and provide the
public with additional relevant information for assessing and providing
informed comment on exchange pricing proposals, including assessing
exchange statements about the number of members that may qualify for a
proposed tier, assessing the actual effect of a pricing change, and
assessing whether a tier meets the applicable statutory standards.\30\
---------------------------------------------------------------------------
\30\ See supra notes 8-10 and accompanying text (discussing the
Exchange Act principles applicable to exchange pricing proposals).
---------------------------------------------------------------------------
C. Commission Concerns
As introduced above and further discussed below, the Commission has
several concerns about volume-based exchange transaction pricing.
First, the Commission is concerned about the impact of volume-based
exchange transaction pricing, as tiered pricing has expanded and
evolved, on competition among exchange members, such as when broker-
dealers are competing for customers. Second, the Commission is
concerned that the desire to qualify for volume-based transaction
pricing tiers exacerbates a conflict of interest between members and
their customers when members route customers' orders for execution
because the member can economically benefit from its routing decision.
Specifically, tiered transaction pricing exacerbates that conflict
because the benefit to the member increases as the number of orders it
executes on the exchange increases, and for the highest tier it meets
during a month, the member receives that higher rebate or lower fee on
all of its orders that it executed on that exchange during the month.
Finally, the Commission is concerned that tiered pricing may impose a
burden on exchange competition, especially when exchanges base pricing
for an auction, trading session, or special program on volume submitted
during regular trading hours outside that auction, trading session, or
program.
As discussed above, the Commission is able to summarily temporarily
suspend individual exchange proposed rule changes related to
transaction pricing shortly after they are filed.\31\ This post hoc
filing-by-filing approach, however, does not address similar pricing
across other exchanges. The Commission is proposing this rule as a
cross-exchange approach intended to facilitate investor protection and
the public interest while enhancing competition among members and among
exchanges.
---------------------------------------------------------------------------
\31\ See supra note 6. See also 15 U.S.C. 78s(b)(3)(C).
---------------------------------------------------------------------------
1. Competition Among Members
Some exchange pricing schedules have evolved to the point of
offering exceptionally specific pricing tiers, where some observers
have questioned whether certain tiers may be available to only a
limited number of members.\32\ The Commission is concerned that
exchanges' tiered transaction pricing may confer an inappropriate
benefit on a small group of members to the detriment of other members
by offering the best prices (i.e., the lowest fees and highest rebates)
only to the exchange's highest volume members.\33\ In turn, this
advantage may significantly limit the ability of lower-volume members
to compete with higher-volume members for the order flow volume
necessary to reach higher tiers.
---------------------------------------------------------------------------
\32\ See John Ramsay, Chief Market Policy Officer, IEX, Why
Exchange Rebate Tiers are Anti-Competitive (June 5, 2023), available
at <a href="https://www.iex.io/article/why-exchange-rebate-tiers-are-anti-competitive">https://www.iex.io/article/why-exchange-rebate-tiers-are-anti-competitive</a> (``Ramsay Article'') (stating that some ``exchanges
offer specialized `bespoke' volume tiers with formulas that are so
specific, they can appear to be specifically designed to benefit one
or a few firms, and it is widely assumed that some are'' (citation
omitted) and that ``tailored-tier rates seems to have the effect, if
not the purpose, of allowing the highest-volume firms that already
have a competitive edge to keep it''). See id. See also infra Table
2.
\33\ See supra note 26 and accompanying text. See also infra
section IV.B.1.b, Volume-Based Pricing Tiers.
---------------------------------------------------------------------------
By design, volume-based exchange transaction pricing involves an
exchange assessing different fees and offering different rebates and
other incentives to different members for executions of orders with
identical terms (symbol, price, size, side, order type, etc.). The
range in fees and rebates can vary considerably, as shown below in
Table 1. While the transaction price for each execution is small in
absolute dollar terms, the percentage difference between what different
members are
[[Page 76286]]
assessed can be large, and the cumulative effect may quickly add up
across the billions of shares executed each trading day. To show the
range of individual tiered transaction fees that apply to different
members engaged in the same activity, Table 1 shows the primary pricing
model for each equities exchange and presents a general summary of the
number and dollar range of each exchange's basic volume-based
transaction tiers applicable during regular trading hours.\34\
---------------------------------------------------------------------------
\34\ The fees and rebates shown in Table 1 are derived from the
exchanges' Mar. 2023 pricing schedules. See supra note 15. Table 1
shows only the generally available core pricing tiers, meaning it
excludes fees and rebates applicable to special activities that may
not apply to every member: orders not executed on the exchange
(i.e., routed to an away exchange); executions resulting from an
auction or specific order types (e.g., closing auctions or retail
liquidity program order types or non-displayed order types);
incentives for specific purposes (e.g., setting the best bid or
offer price); registered market-maker incentives; non-rebate
incentives; and cross-asset tiers (options versus equities). Table 1
also excludes fees and rebates tied to increased volume compared to
a specific date because those additive rebates are not generally
available pricing tiers. Moreover, the dollar ranges in Table 1 do
not net together additive fees or rebates and count them as a
separate tier (e.g., where a base rebate could be combined with a
step-up additive rebate) because those are in addition to other
tiers and the exchanges do not identify them as separate named
tiers. Further, the number of categories is a count of those
separately listed fees or rebates used in determining the range of
an exchange's basic fees or rebates for purposes of Table 1.
Table 1--Summary of Transaction-Based Pricing Schedules for Displayed/Regular Orders on Equities Exchanges
During Regular Trading Hours as of Mar. 2023
----------------------------------------------------------------------------------------------------------------
Fees and rebates for transactions at or above $1.00 on Tapes A, B & C *
-----------------------------------------------------------------------------------------------------------------
Exchange Pricing model Fees (# of categories) Rebates (# of categories)
----------------------------------------------------------------------------------------------------------------
Cboe BZX.......................... Maker-Taker.......... $0.0030 (Tapes A, B & C--1 ($0.0016)-($0.0031)
each). (Tapes A, B & C--7
each).
Cboe BYX.......................... Taker-Maker.......... $0.0012-$0.0020 (Tapes A, ($0.0002)-($0.0015)
B & C--6 each). (Tapes A, B & C--2
each).
Cboe EDGA......................... Taker-Maker.......... $0.0015-$0.0030 (Tapes A, ($0.0016)-($0.0022)
B & C--4 each). (Tapes A, B & C--3
each).
Cboe EDGX......................... Maker-Taker.......... $0.00275-$0.0030 (Tapes A, ($0.0016)-($0.0029)
B & C--2 each). (Tapes A, B & C--4
each).
BX................................ Taker-Maker/Flat..... $0.0012-$0.0030 (Tapes A, ($0.0004)-($0.0018) **
B & C--5 each). (Tapes A, B & C--5
each).
Phlx (PSX)........................ Maker-Taker.......... $0.0030 (Tapes A, B & C--1 ($0.0020)-($0.0032)
each). (Tapes A, B & C--2
each).
Nasdaq............................ Maker-Taker.......... $0.0030 (Tapes A, B & C--1 ($0.0013)-($0.00305)
each). (Tapes A, B & C--11
each).
NYSE Arca......................... Maker-Taker.......... $0.0029-$0.0030 (Tape A-- ($0.0016)-($0.0034) (Tape
1, Tapes B & C--2 each). A--7, Tapes B & C--10
each).
NYSE American..................... Maker-Taker.......... $0.0026-$0.0030 (Tapes A, ($0.0020)-($0.0026)
B & C--3 each). (Tapes A, B & C--3
each).
NYSE.............................. Maker-Taker.......... $0.0026-$0.0030 (Tapes A & ($0.0012)-($0.0031) (Tape
B--1 each, Tape C--3). A--2, Tape B--4 & Tape
C--5).
NYSE National..................... Taker-Maker.......... $0.0020-$0.0029 (Tapes A, $0.000-($0.0030) (Tapes
B & C--5 each). A, B & C--5 each).
NYSE Chicago...................... Flat................. $0.0010 (Tapes A, B & C--1 $0.00 (0).
each).
IEX............................... Flat................. $0.0009 (Tapes A, B & C--1 $0.000 (0).
each).
MEMX.............................. Maker-Taker.......... $0.0029-$0.0030 (Tapes A, ($0.0018)--($0.00335)
B & C--3 each). (Tapes A, B & C--5
each).
MIAX Pearl........................ Maker-Taker.......... $0.00275-$0.00295 (Tapes ($0.0029)-($0.0036)
A, B & C--3 each). (Tapes A, B & C--4
each).
LTSE.............................. Free................. $0.0000 (0)............... $0.0000 (0).
----------------------------------------------------------------------------------------------------------------
* Table 1 reflects that, as of Mar. 2023, some exchanges apply fees and rebates according to the market data
Tape on which a security is disseminated, which is based on the security's primary listing exchange. Tape A is
for securities listed on NYSE, Tape B is for securities listed on exchanges other than NYSE and Nasdaq, and
Tape C is for securities listed on Nasdaq.
** BX charges a $0.0007 fee for Tapes A, B and C if a member fails to reach any liquidity removing rebate tier.
Volume-based exchange transaction pricing is more complicated and
varied than what is presented in Table 1. For example, many exchanges
also offer additional step-up tiers that increase the amount of rebates
offered, as well as specific tiering programs for registered market-
maker activity, selected order types that an exchange seeks to
incentivize, or special programs like retail liquidity programs. Fees
also may vary depending on whether an order is displayable or non-
displayed or is executed in the opening or closing auction. To show the
complexity of volume-based exchange transaction pricing, Table 2
identifies the number of volume-based pricing levels each exchange
offers.\35\
---------------------------------------------------------------------------
\35\ Table 2 counts separately listed fee or rebate levels that
are based on the achievement of a specified volume level and
assessed on a per share basis. Additive rebates or other incentives
were only counted once and not added together and counted separately
with each applicable base price. Different Tapes with differing fees
or rebates were counted separately, but Tapes with the same fee or
rebate were not counted separately. Different fees for separate
order types that reference the same volume level were counted
separately. Base fees and rebates that are not based on volume were
not counted.
Table 2--Count of Transaction Pricing Levels That Are Based on Volume
for Executions at or Above $1 as of Mar. 2023
------------------------------------------------------------------------
Volume-based
Exchange pricing levels
------------------------------------------------------------------------
NYSE.................................................... 93
Nasdaq.................................................. 74
NYSE Arca............................................... 72
Cboe BZX................................................ 26
[[Page 76287]]
BX...................................................... 20
Cboe EDGX............................................... 19
MEMX.................................................... 13
Cboe BYX................................................ 11
NYSE National........................................... 11
NYSE American........................................... 10
Cboe EDGA............................................... 8
MIAX Pearl.............................................. 8
Phlx (PSX).............................................. 4
IEX..................................................... 0
LTSE.................................................... 0
NYSE Chicago............................................ 0
------------------------------------------------------------------------
Unless the terms of the pricing tier provide otherwise, a member's
customer volume and its proprietary orders typically are combined for
purposes of determining whether the member qualifies for a volume tier.
Once a member attains a volume tier, the pricing advantage it receives
from reaching that volume tier may turn into a competitive advantage in
two ways.\36\ First, the member can use the advantaged pricing it
receives to benefit its proprietary trading business (i.e., it may pay
lower fees or receive higher rebates on that business compared to other
members that do not qualify for the favorable pricing tier). Second,
the member may be able to attract additional order flow from customers
because it can offer customers the same lower fees and higher rebates
either directly through pass-through exchange transaction pricing or
indirectly through lower commissions. This would allow the member to
further increase and consolidate customer order flow, which in turn
would help the member reach and maintain higher tiers. The gap in
transaction pricing between base fees and rebates and top-tier fees and
rebates can make it more difficult for new and lower-volume members to
compete, putting both their proprietary and customer business at a
competitive disadvantage.
---------------------------------------------------------------------------
\36\ See Healthy Markets Letter, supra note 21, at 5-6 (stating
that pricing tiers ``offer cheaper trading for larger firms with
greater order volumes [which] puts smaller firms at a competitive
disadvantage on order and execution prices'' and further stating
that as a consequence, ``several larger trading firms will then use
their lower rates to attract greater order flow--consolidating order
flow at the largest trading firms'' and as ``order flow has
aggregated to the largest firms, this has increased their ability to
garner for themselves even better rates; further expanding the gap
between themselves and smaller firms'').
---------------------------------------------------------------------------
Members at the best exchange pricing tiers can further widen the
competitive gap by using their tiered pricing advantage to sell
sponsored access \37\ and direct market access \38\ services to
customers (including other member and non-member broker-dealers with
whom they compete as well as any other customer that wants direct
access to an exchange), through which the customer (including other
broker-dealers) uses the sponsoring member's systems and connectivity
to access an exchange. The sponsoring member benefits by being able to
count the volume from its sponsored customers toward its own volume
tiers, which can benefit the sponsored customers if they receive better
pass-through pricing or lower commissions as a result, as well as the
sponsoring member's proprietary trading business that also receives
that better transaction pricing.\39\ In turn, if the sponsored customer
receives pass-through pricing from the sponsoring member, the sponsored
customer may be able to share in part of the sponsoring member's
advantaged pricing (subject to the fees or mark-up it pays to the
sponsoring member for the services), which can result in the sponsored
customer paying lower exchange fees or earning higher exchange rebates
than if it executed transactions on the exchange directly.\40\ These
private arrangements between a sponsoring member and its sponsored
customer, however, work to further entrench the competitive advantage
that exchange pricing tiers provide to high-volume members because, as
the Commission understands, sponsoring members typically do not pass
along the entirety of their transaction pricing advantage to their
sponsored broker-dealer customers (thereby maintaining the sponsoring
members' exchange transaction pricing advantage). As a result, the
sponsoring members' broker-dealer customers depend on using the
services of their competitors--the sponsoring members--to access any
advantaged exchange transaction pricing their competitors are able to
obtain through these access arrangements, which the sponsored broker-
dealer customers could not obtain on their own. The extent to which any
such pass-through transaction pricing is provided to sponsored
customers is uncertain because these arrangements are not
disclosed.\41\
---------------------------------------------------------------------------
\37\ Sponsored access generally refers to an arrangement whereby
a member permits a customer to route orders directly to an exchange
using technology supplied by the customer that bypasses the member's
trading system but not its market access checks. See Rule 15c3-5
Adopting Release, supra note 22, at 69793 (describing sponsored
access as ``referring to an arrangement whereby a broker-dealer
permits customers to enter orders into a trading center that bypass
the broker-dealer's trading system and are routed directly to a
trading center . . .'').
\38\ Generally, direct market access refers to an arrangement
whereby a member permits a customer to use its trading systems to
send orders directly to a trading center. See id. at 69793
(describing direct market access as an ``arrangement whereby a
broker-dealer permits customers to enter orders into a trading
center but such orders flow through the broker-dealer's trading
systems prior to reaching the trading center'').
\39\ See, e.g., id. at 69793 n. 11 (stating that ``[e]xchange
members may use access arrangements as a means to aggregate order
flow from multiple market participants under one MPID to achieve
higher transaction volume and thereby qualify for more favorable
pricing tiers'').
\40\ See id. at 69793 (discussing, in part, how direct market
access or sponsored access arrangements may help to reduce certain
costs such as exchange fees). See also infra section IV.B.4.
\41\ See infra section IV.B.4.b.
---------------------------------------------------------------------------
2. Conflicts of Interest
With respect to agency brokerage activity, where the member
transacts on an exchange for purposes of filling an order for another
person, the Commission is concerned that volume-based exchange
transaction pricing exacerbates a conflict of interest between the
member and its customer.\42\ Specifically, when the member executes an
agency order, it faces an economic incentive to route the order to one
particular exchange over others to achieve volume tier requirements on
that exchange that could result in reduced fees or increased rebates
(and, in both cases, the member would retain some or all of the benefit
for itself if it does not pass through that better exchange transaction
pricing to its customer).\43\
---------------------------------------------------------------------------
\42\ While some rules may seek to address conflicts of interest
in the context of agency brokerage activity, this proposal seeks to
mitigate the conflict specific to volume-based exchange transaction
pricing at its source through the proposed prohibition. See, e.g.,
Securities Exchange Act Release No. 96496 (Dec. 14, 2022), 88 FR
5440 (Jan. 27, 2023) (``Regulation Best Execution Proposing
Release''). The Commission encourages commenters to review the
Regulation Best Execution Proposing Release to determine whether it
might affect their comments on this release.
\43\ Customers could benefit from exchange tiered pricing if
members pass some or all of the savings through to the customers
either directly or in the form of lower commissions or other
subsidies. See also Access Fee Proposal, supra note 17 (proposing,
among other things, revisions to the access fee cap in 17 CFR
242.610 (Rule 610 of Regulation NMS)). The Commission encourages
commenters to review the Access Fee Proposal to determine whether it
might affect their comments on this release.
---------------------------------------------------------------------------
While exchange fees and rebates in general may contribute to a
conflict of interest between a member and its customer when routing
orders, volume-based fees and rebates can exacerbate that conflict
because they present an additional economic incentive to
[[Page 76288]]
members when selecting an exchange for routing: the member's desire to
reach volume tiers on an exchange to achieve preferential pricing.
Specifically, volume-based pricing may incentivize members to route
customer order flow to certain exchanges for the purpose of meeting
tier qualification, which has the potential to be costly to customers
if it comes at the expense of execution quality. Moreover, this
incentive may be particularly enticing for members because customer
volume can accrue towards the member's total volume level, giving it
the ability to achieve more favorable tiered pricing for all of its
order flow, including proprietary orders that the member sends to the
exchange for its own account. The fact that volume-based exchange
transaction pricing applies to both agency-related and proprietary
order flow even further exacerbates the conflict of interest between a
member and its customer because the routing decisions a member makes
with respect to its agency-related order flow can also benefit its
unrelated proprietary business. Finally, it may be challenging for
customers to understand and assess the impact that tiered exchange
pricing may have on broker-dealer routing decisions due to the
complexity of the exchanges' tiered pricing schedules, which makes it
difficult for customers to provide a check against any conflicts of
interest.\44\ Accordingly, the economic incentive presented by tiered
exchange transaction pricing may affect members' order routing
decisions, exacerbating a conflict of interest that can potentially
harm investors with inferior executions when members route customer
orders to exchanges.\45\
---------------------------------------------------------------------------
\44\ See Healthy Markets Letter, supra note 21, at 4 (``The
inherent conflict of interest created by different pricing tiers may
also impact how brokers treat their own customers in a way that
isn't quite as transparent as simply chasing the higher rebate or
lower fee venue. For example, a broker with a less-sophisticated
customer may send orders to a venue so that the firm would reach a
certain tier threshold, despite the broker's awareness that
executions on that venue may result in inferior execution outcomes
to investors. However, the same broker, if faced with the same order
from a more-sophisticated customer, may not.''). See also
Recommendation of the SEC Investor Advisory Committee Regarding
Exchange Rebate Tier Disclosure (Jan. 24, 2020), available at
<a href="https://www.sec.gov/spotlight/investor-advisory-committee-2012/exchange-rebate-tier-disclosure.pdf">https://www.sec.gov/spotlight/investor-advisory-committee-2012/exchange-rebate-tier-disclosure.pdf</a>. In the recommendation, the
Investor Advisory Committee stated that ``[t]he lack of public
disclosure concerning the structure of rebates for executing
brokers'' exacerbates ``a principle-agency conflict in the receipt
of rebates for orders executed on behalf of clients but not shared
with clients.''
\45\ See infra section IV.B.3.
---------------------------------------------------------------------------
3. Exchange Competition
An exchange's volume-based transaction pricing schedule is designed
to entice members to route orders to that exchange over other exchanges
by lowering fees or increasing rebates as volume-based transaction
tiers are met. Pricing tiers that are based on total consolidated
volume may create additional incentives for members to route to certain
exchanges, particularly towards the end of each month as members seek
to achieve tier targets to qualify for a better pricing tier on that
exchange. This dynamic may harm the ability of other exchanges to
compete for order flow during that time.
Further, certain forms of exchange transaction pricing tiers can
raise unique issues and concerns. For example, if a primary listing
exchange for a stock were to base its closing auction pricing on the
volume a member executes during regular trading hours outside of the
auction, members that send customer orders in that stock to the primary
listing exchange's closing auction may be incentivized to also route to
the exchange during regular hours to qualify for tiered pricing in the
closing auction.\46\ In this scenario, the exchange is leveraging its
role as the primary listing exchange for a stock, in addition to the
closing auction it provides for that stock, to use members' desire to
achieve tiered pricing in the closing auction as an incentive for those
members to also route to the exchange during the regular trading
session.
---------------------------------------------------------------------------
\46\ See also infra section IV.B.1.c.
---------------------------------------------------------------------------
Accordingly, the Commission is concerned about the potential for
exchanges to use some forms of volume-based exchange transaction
pricing to insulate certain portions of member volume from competition
while at the same time over-emphasizing competition based on fee
tiering, which can constrain innovation among exchanges in other areas
and impose a burden on competition among exchanges that may be
inconsistent with the goals of a national market system.
II. Description of Proposed Rule
A. Overview of Proposed Rule
The Commission is proposing a rule designed to address its specific
concerns with volume-based exchange transaction pricing schedules.\47\
Proposed Rule 6b-1 has three components. First, the proposed rule would
prohibit equities exchanges from offering volume-based exchange
transaction pricing in connection with the execution of agency or
riskless principal orders in NMS stocks (``agency-related
volume'').\48\ The proposed rule would not prohibit exchanges from
offering volume-based exchange transaction pricing for member
proprietary volume where the member is trading solely for its own
account and not in connection with filling an order for a customer.\49\
---------------------------------------------------------------------------
\47\ The proposed rule would provide a consistent approach to
these issues, which the Commission could not achieve through
piecemeal suspensions of individual exchange pricing filings.
\48\ See proposed Rule 6b-1(a).
\49\ See infra section IV.E.1 and 2 (proposing alternatives that
would prohibit exchanges from offering volume-based exchange
transaction pricing for member proprietary volume).
---------------------------------------------------------------------------
Second, the proposed rule contains an anti-evasion clause that
would require equities exchanges that have volume-based transaction
pricing for member proprietary volume to adopt rules to require members
to engage in practices that facilitate the exchange's ability to comply
with the prohibition on volume-based exchange transaction pricing in
connection with the execution of agency-related volume.\50\ The
proposed rule also would require exchanges to establish, maintain, and
enforce written policies and procedures that are reasonably designed to
detect and deter members from receiving volume-based exchange
transaction pricing in connection with the execution of agency or
riskless principal orders in NMS stocks.\51\ This requirement would
help to promote an exchange's compliance with the proposed rule by
ensuring that an exchange develops mechanisms that would prevent its
members from inappropriately receiving volume-based
[[Page 76289]]
exchange transaction pricing for agency-related orders.\52\
---------------------------------------------------------------------------
\50\ See proposed Rule 6b-1(b)(1). Exchanges would have
flexibility under the proposed rule as to what rules to adopt. For
example, an exchange may allow members to designate that certain of
their ports or sessions handle exclusively agency-related orders or
exclusively proprietary orders as a means to facilitate the
exchange's ability to comply with the prohibition. If the member
does not use separate ports in that manner, the exchange could
require members to indicate for billing purposes which orders are
agency-related and ineligible for tiered pricing if the exchange
does not already have a mechanism to distinguish those orders. Or,
if a member does not conduct an agency business and only trades
proprietarily or does not trade proprietarily and only trades on an
agency basis, an exchange may not need to require anything
additional from that member for purposes of this proposed rule.
\51\ See proposed Rule 6b-1(b)(2). For example, if an exchange
allows members to designate that certain of their ports or sessions
handle exclusively agency-related orders or exclusively proprietary
orders as a means to facilitate the exchange's ability to comply
with the prohibition, an exchange might adopt a policy and procedure
to review the ports and sessions designated by members to make sure
that members are not, for example, submitting agency-related orders
though a port or session the member has designated as solely for
proprietary orders.
\52\ See, e.g., section 6(b)(1) of the Exchange Act, 15 U.S.C.
78f(b)(1) (requiring an exchange to be so organized and have the
capacity ``to be able to carry out the purposes of [the Exchange
Act] and to comply, and . . . to enforce compliance by its members
and persons associated with its members with the provisions of [the
Exchange Act], the rules and regulations thereunder, and the rules
of the exchange'').
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Third, the proposed rule would require equities exchanges that have
volume-based transaction pricing for member proprietary volume to
submit electronically to the Commission disclosures of the number of
members that qualify for their volume-based transaction pricing.\53\
Specifically, such exchanges would be required to submit electronic,
machine-readable structured data tables of their volume-based
transaction pricing tiers and the number of members that qualify for
each tier in an Interactive Data File in accordance with 17 CFR 232.405
(Rule 405 of Regulation S-T),\54\ and the public would be able to
access those disclosures through the Commission's EDGAR system.\55\
Additional public transparency regarding the number of members that
qualify for each pricing tier for their proprietary volume would help
the Commission, members, and the public understand how the benefits of
volume-based pricing are distributed and the potential impact on
members, which should facilitate and inform members', the public's, and
other exchanges' efforts to submit comment letters on volume-based
exchange transaction pricing proposals to further inform the Commission
as it considers those proposals. For example, information on the number
of members that have qualified for a newly adopted pricing tier would
allow the Commission and interested parties to assess exchange
statements regarding the number of members that the exchange estimated
should qualify for a proposed new tier or amended tier. In addition,
such information would provide a data point for the Commission to
consider in determining whether a proposed tier meets the applicable
statutory standards and whether the Commission should temporarily
suspend the newly adopted pricing tier.
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\53\ See proposed Rule 6b-1(c). Consistent with the proposed
disclosure requirement, the Commission also is proposing to amend 17
CFR 232.101 (Rule 101 of Regulation S-T) to add the disclosure
required under proposed Rule 6b-1(c) as a filing that must be
submitted electronically.
\54\ See proposed 17 CFR 232.405(b)(6). Rule 405 of Regulation
S-T applies to the submission of Interactive Data Files. The
Commission is proposing conforming changes in Rule 405 of Regulation
S-T to reflect the inclusion of proposed Rule 6b-1(c). Such files
must be submitted using Inline XBRL. See proposed 17 CFR
232.405(a)(3). The Commission also is proposing conforming changes
to Rule 101 of Regulation S-T to reflect the inclusion of proposed
Rule 6b-1. See proposed 17 CFR 232.101.
\55\ As discussed below in section II.D, Request for Comments,
the Commission is soliciting comment on other potential metrics for
the disclosures, including the volume of shares at each tier and the
dollar amount of fees, rebates, or other incentives at each tier.
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B. Prohibition on Volume-Based Exchange Transaction Pricing for Agency-
Related Volume
The Commission is concerned about the impact of exchange tiered
transaction pricing on competition among an exchange's members. As
discussed above, volume-based exchange transaction pricing can
frustrate and impede the ability of new and lower-volume members to
compete with high-volume members, including for customer order flow,
which can reduce the number of members that are able to offer customers
the highest-tiers of exchange transaction pricing.\56\ For example, if
a member that qualifies for the best pricing tier can offer a customer
pass-through of its $0.0015 take fee for executing on Exchange A, but a
member that does not qualify for a tier can only offer a customer pass-
through of its $0.0030 take fee on that same exchange for execution of
the same customer order, the lower-volume member faces a distinct and
measurable disadvantage even though both are members of Exchange A. The
Commission also is concerned that volume-based exchange transaction
pricing that applies to agency-related volume exacerbates a conflict of
interest between members and their customers when members face an
economic incentive to earn increasingly lower fees or higher rebates or
other incentives from an exchange in connection with the execution of
more customer orders on that exchange.\57\
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\56\ See supra sections I.B (Volume-Based Exchange Transaction
Pricing), and I.C.1 (Competition Among Members).
\57\ See supra section I.C.2 (Conflicts of Interest).
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Accordingly, to address the Commission's concerns with member
competition, as well as the conflict of interest between members and
their customers, the prohibition on volume-based exchange transaction
pricing in proposed Rule 6b-1(a) would apply to agency-related volume.
Specifically, the proposed rule would prohibit exchanges from offering
volume-based transaction fees, rebates, or other incentives in
connection with the execution of agency or riskless principal orders in
NMS stocks.\58\
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\58\ To comply with the prohibition, an exchange that offers
volume-based transaction fees, rebates, or other incentives in
connection with the execution of agency or riskless principal orders
in NMS stocks would need to file a proposed rule change on Form 19b-
4 to remove any such pricing from its pricing schedule.
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The proposed prohibition would apply broadly to all executions
where a member is executing an agency or riskless principal order in an
NMS stock for the purpose of filling a customer order and is not
trading for its own account. For purposes of the proposed rule,
customers could include, for example, other members, non-member broker-
dealers, institutions, an affiliate of the member, natural persons, or
any person that uses the member to access an exchange, including
through direct market access or sponsored access services.
The proposed rule would define riskless principal to mean ``a
transaction in which, after having received an order to buy from a
customer, the broker or dealer purchased the security from another
person to offset a contemporaneous sale to such customer or, after
having received an order to sell from a customer, the broker or dealer
sold the security to another person to offset a contemporaneous
purchase from such customer.'' That definition is consistent with other
Commission definitions of the term.\59\
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\59\ See, e.g., 17 CFR 240.3a5-1(b) (exempting banks from the
definition of ``dealer'' under the Exchange Act when acting in a
riskless principal capacity when certain conditions are met, which
states that ``[f]or purposes of this section, the term riskless
principal transaction means a transaction in which, after having
received an order to buy from a customer, the bank purchased the
security from another person to offset a contemporaneous sale to
such customer or, after having received an order to sell from a
customer, the bank sold the security to another person to offset a
contemporaneous purchase from such customer.''); 17 CFR 240.3a5-2
(exemption from the definition of ``dealer'' for banks effecting
transactions in securities issued pursuant to Regulation S); 17 CFR
255.6(c)(2) (other permitted proprietary trading activities); 17 CFR
240.31(a)(14) (Section 31 transaction fees); 17 CFR 230.144A(a)(5)
(private resales of securities to institutions); and 17 CFR 230.144
(persons deemed not to be engaged in a distribution and therefore
not underwriters) (defining the term ``riskless principal
transaction'' generally without reference to price, but further
providing in 17 CFR 230.144(f)(1)(iii) the possible manners of sale,
one of which is a riskless principal transaction where the
offsetting trades are executed at the same price). Generally, the
exchanges use the terms ``agency'' and ``riskless principal'' in
their rules without defining them because the terms are widely and
commonly understood. For example, Cboe BZX refers to the terms
``agency'' and ``riskless principal'' 12 times each in its rulebook
(covering equities and options rules), but does not separately
define either term, except with respect to retail orders under its
Retail Order Attribution Program. See Cboe BZX Rule 11.25(a)(2)
(retail order attribution program, referring to a ``riskless
principal order that meets the criteria of FINRA Rule 5320.03'').
Moreover, each of the exchange rules that implement the Consolidated
Audit Trail, which requires the capture of the capacity of the
member executing the order, whether principal, agency, or riskless
principal, uses those terms in an identical manner without defining
them. See, e.g., Nasdaq General 7, Section 3(a)(1)(E)(iv); BZX Rule
4.7(a)(1)(E)(iv). See also Limited Liability Company Agreement of
Consolidated Audit Trail, LLC, Article VI, Section 6.3(d)(v)(D).
Those terms also are not defined within the CAT NMS Plan.
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[[Page 76290]]
Like agency orders, riskless principal orders are one way for a
member to fill a customer's order. Riskless principal orders involve
contemporaneous buys and sells that are ``riskless'' to the member, in
that the member does not take on the market risk of price moves in the
stock because it buys or sells to promptly transfer the position to a
customer rather than retain the position for any significant length of
time in its own account.
Some rules, in contexts other than exchange transaction pricing,
include definitions of the term ``riskless principal'' that require the
price of both legs of the riskless principal trade be at the same
price.\60\ In addition, FINRA has a definition of riskless principal
that specifies that the member's principal trade and the customer fill
occur at the ``same price.'' \61\
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\60\ See, e.g., 17 CFR 242.201(a)(8) (concerning ``short
exempt'' order marking for certain riskless principal orders) and 17
CFR 240.10b-18 (purchases of certain equity securities by the issuer
and others).
\61\ See, e.g., FINRA Rule 5320.03 (excluding riskless principal
transactions from FINRA's Prohibition Against Trading Ahead of
Customer Orders) and FINRA Rule 6380B(d)(3)(B) (concerning reporting
to the FINRA/NYSE Trade Reporting Facility). The FINRA rule
prohibiting trading ahead of customer orders generally prohibits
members from trading for their own account at a price that would
satisfy the customer order, subject to an exception for riskless
principal orders. Exchanges have incorporated FINRA's rule by
reference or have adopted similar rules. See, e.g., FINRA Rule
5320.03 and BZX Rule 12.6.03.
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The definition of riskless principal in proposed Rule 6b-1 does not
require the principal leg and customer leg to occur at the same price.
Proposed Rule 6b-1 uses a broader definition of riskless principal to
achieve the purposes of the proposed rule and to limit the ability of
members to easily circumvent the proposed rule's prohibition by an
economically insignificant amount. For example, if the proposed rule
contained a ``same price'' requirement in the definition of riskless
principal, a member might attempt to circumvent the prohibition by
providing an economically insignificant different price on the customer
leg--one that varied by the smallest fraction of a penny possible--to
avoid classifying the transaction as ``riskless principal.'' If
proposed Rule 6b-1 excluded such a transaction from its definition of
riskless principal, the member would qualify for volume-based exchange
transaction pricing on the principal leg of the transaction even though
the transaction had the defining characteristics of a riskless
principal trade because the member did not take on the market risk of
price moves in the stock and promptly transferred the position to the
customer. A definition that includes the concept of ``same price''
therefore would not achieve the Commission's goals of prohibiting
volume-based exchange transaction pricing for agency-related volume.
Because orders executed in the capacity of agent and riskless
principal both are done to fill a customer order, the conflict of
interest exacerbated by exchange tiered transaction pricing is equally
present for both: the member faces conflicting economic incentives when
choosing the exchange execution venue, and the customer bears any costs
associated with an execution that results from that decision. The
Commission therefore proposes to treat riskless principal orders the
same as agency orders for purposes of proposed Rule 6b-1(a).
Finally, because proposed Rule 6b-1(a) would prohibit exchanges
from offering volume-based transaction pricing in connection with the
execution of agency or riskless principal orders in NMS stocks, which
represent a member's agency-related volume, it would prohibit exchanges
from counting that agency-related volume towards any volume-based
transaction tiers applicable to the member's proprietary volume. For
example, if a member is engaged in proprietary trading (e.g., as a
registered market maker on the exchange) and also has a separate
division or affiliate that is engaged in a customer brokerage business
(e.g., as an executing broker for non-member brokers), an exchange
could not count the member's agency-related volume towards any volume-
based transaction tiers the member qualifies for on its proprietary
volume. Similarly, because the proposal would prohibit volume-based
exchange transaction pricing in connection with the execution of agency
or riskless principal orders in NMS stocks, it would prohibit exchanges
from basing transaction pricing in an auction on agency-related volume
executed within or outside the auction. In either case, an exchange
could count only the member's proprietary volume to determine the
pricing tier for the member's proprietary trades.
Prohibiting volume-based exchange transaction pricing for agency-
related orders is intended to promote competition among members for
customer business. It also is intended to mitigate the conflict of
interest between members and customers that is exacerbated by exchange
tiered pricing where the member economically benefits from its choice
of exchange execution venue for customer orders. The proposed rule
would eliminate one incentive--reaching a volume tier--for a member to
route a customer order to a particular exchange when doing so might not
be in the customer's interest.
Request for Comments
The Commission generally requests comment from the public on all
aspects of proposed Rule 6b-1(a), including its objectives and its
terms to achieve those objectives. More specific requests for comment
are set forth below. As much as possible, commenters are requested to
provide empirical data in support of any arguments or analyses and to
offer explanations for their views.
1. Do commenters believe that volume-based exchange transaction
pricing impacts competition among members when competing for customers
on an agency basis? Do sponsored access and direct market access
arrangements contribute to these competitive effects when exchange
members compete for customers? Why or why not? Does volume-based
exchange transaction pricing impact competition among members when
trading proprietarily? If there is an impact, is the impact greater for
members when they are competing for customers or when they are trading
proprietarily, or is the impact equivalent?
2. Do commenters believe that volume-based exchange transaction
pricing exacerbates the conflict of interest between members and
customers when members are routing customer orders, because of the
member's desire to qualify for volume-based transaction tiers? Would
complete pass through of exchange pricing to the member's customer
eliminate that conflict? Why or why not? To what extent do members
completely or partially pass through all exchange pricing to their
customer? Do customers prefer pass through exchange transaction pricing
or broker commissions, and for what reasons? Is the Commission's
understanding correct that full and partial pass-through of exchange
transaction pricing by members to their customers is less common? For
sponsored access and direct market access arrangements, how common is
pass-through of exchange transaction fees? What types of pass-through
arrangements are most common and how much does the sponsoring member
typically retain as compensation?
[[Page 76291]]
3. To what extent does volume-based exchange transaction pricing
impact competition among exchanges, and/or between exchanges and off-
exchange venues, such as alternative trading systems (``ATSs'') and
wholesaler broker-dealers?
4. To what extent is volume-based exchange transaction pricing used
by exchanges to attract specific types of members or customers of
members, such as proprietary traders, registered market makers, or
agency customers? Among agency customers, are any particular types of
customers particularly attracted by volume-based exchange transaction
pricing, such as long-term investors, short-term traders, investment
advisers, and institutional investors?
5. To what extent is the ability of an exchange to attract order
flow from specific types of members or customers through volume-based
exchange transaction pricing or other forms of targeted pricing
necessary to support competition between exchanges and off-exchange
venues? For example, if exchanges lack the ability to offer such
pricing on agency-related order flow, could that potentially make off-
exchange venues relatively more attractive as a destination for that
flow? If so, should the Commission address such a competitive
disparity? For example, should the Commission expand the scope of the
prohibition on volume-based transaction pricing for agency-related
volume in certain stocks to off-exchange venues such as ATSs?
6. How consistently do individual exchange members hit specific
tiers over time? How do members respond to volume-based exchange
transaction pricing changes and how do those member responses differ
across different exchanges?
7. How does using volume-based exchange transaction pricing as a
means of compensating liquidity providers compare to other fee and non-
fee methods of attracting those liquidity providers? Do exchange-
registered market makers react differently from other members that
provide liquidity to exchange transaction pricing? Does volume-based
exchange transaction pricing affect liquidity taking orders differently
from liquidity providing orders?
8. Would the proposed prohibition on volume-based exchange
transaction pricing in connection with the execution of agency or
riskless principal orders in NMS stocks address the concerns the
Commission identified about member competition and conflicts of
interests between members and customers? Why or why not?
9. Is the proposed definition of riskless principal in proposed
Rule 6b-1(a) appropriate? Why or why not? If the definition included a
``same price'' requirement, do commenters agree that the Commission
would not be able to achieve its objectives for the proposed rule? Why
or why not?
10. Do exchanges have rules and policies and procedures in place
that require members to mark their orders for transaction billing
purposes in a manner that would readily allow exchanges to comply with
the proposed prohibition, or would those rules and policies and
procedures need to be revised to accommodate the proposed prohibition?
11. Should the Commission also prohibit volume-based exchange
transaction pricing for member proprietary volume (i.e., should the
Commission prohibit exchanges from offering volume-based transaction
pricing for all volume in NMS stocks)? \62\ Why or why not? Would doing
so obviate the need for the anti-evasion provisions in proposed Rule
6b-1(b) and the proposed disclosures in proposed Rule 6b-1(c) since
tiered pricing would no longer be permitted? Would a broader
prohibition that includes both agency-related and proprietary orders
address the Commission's concerns, discussed above in section I.C,
about competition among members and competition among exchanges, as
well as the conflict of interest between members and customers with
respect to agency-related order flow? How would a broader prohibition
affect exchange fees and rebates compared to what they offer today?
Would exchanges be able to extend their best fee and rebate pricing to
all members? Why or why not? If not, and if the purpose of tiered
transaction pricing is to attract more order flow from members, why
would exchanges not be able to offer the best pricing to all members to
attract the greatest possible volume?
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\62\ See infra section IV.E.1.
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12. If the Commission extends the prohibition on volume-based
exchange transaction pricing to member proprietary volume, should
displayed liquidity-adding orders from an exchange's registered market
makers in their registered or appointed symbols not be subject to the
prohibition in order to provide exchanges with a means to incentivize
displayed quotes from their registered market makers? In other words,
should the Commission prohibit exchanges from offering volume-based
transaction pricing for all volume in NMS stocks, but subject to a
carve-out only for displayed liquidity providing orders from exchange
registered market makers in their registered or appointed symbols? \63\
Should such an exception be limited to registered exchange market
makers that are subject to minimum quantitative and qualitative
quotation requirements that meet or exceed the highest such standards
in place among national securities exchanges to avoid conferring a
benefit without meaningful corresponding obligations that protect
investors? Would continuing to allow volume-based exchange transaction
pricing for displayed liquidity-adding orders from such exchange
registered market-makers in their registered or appointed symbols be an
appropriate benefit to encourage members to become and remain
registered market makers and to provide publicly displayed quotes,
consistent with their quoting obligations? Would tiered pricing
encourage greater quoted depth or narrower quoted spreads, or both, for
displayed quotes? If the Commission adopted a broader prohibition on
volume-based transaction pricing with a carve-out for registered market
makers, would the anti-evasion provisions in proposed Rule 6b-1(b) and
the transparency disclosures in proposed Rule 6b-1(c) be less relevant
in circumstances where the only reportable activity would be the
activity of registered market makers who are subject to exchange market
making rules?
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\63\ See infra section IV.E.2.
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13. Instead of prohibiting volume-based exchange transaction
pricing, should the Commission instead allow exchanges to offer volume-
based pricing to attract order flow, but require the volume tiers to be
based on total aggregate volume submitted to the exchange, with the
associated tiered pricing applied to all members uniformly? For
example, an exchange could establish a volume-based pricing tier that
considers cumulative exchange-level liquidity-adding activity, where
all liquidity-adding volume executions from all members is combined to
count towards the tier, and, after a tier threshold is reached, the
enhanced rebate would be available to all members equally. Would this
alternative address the Commission's concerns regarding competition
among members? Would it impose a burden on competition among exchanges
and a conflict of interest between members and customers when routing
customer orders because of the incentives to reach tiers? Would that
burden and conflict be greater than, or less than, under the current
tiering structure? Would this alternative obviate the need for the
anti-
[[Page 76292]]
evasion provisions in proposed Rule 6b-1(b) and the transparency
disclosures in proposed Rule 6b-1(c)?
14. If exchanges continue to offer volume-based transaction pricing
for member proprietary orders, should the Commission prohibit an
exchange from basing tiers on total consolidated volume (``TCV''), or
another metric that is based on volume transacted on other exchanges
and off-exchange, and instead limit volume-based transaction tiers to
volume that occurs solely on the exchange as a means of promoting
competition among exchanges? Do tiers based on TCV constrain
competition among exchanges by seeking primarily to preserve relative
exchange market share? Why or why not? Even if tiers were not permitted
to be based on TCV, could exchanges effectively circumvent such a
prohibition by replicating a similar approach using absolute numbers
and updating them on a monthly basis based on future estimates of total
consolidated market volume? Why or why not?
15. If exchanges continue to offer volume-based transaction pricing
for member proprietary orders, should the Commission prohibit exchanges
from basing tiers in an auction, trading session, or special program or
order types (e.g., retail liquidity program) on volume done outside
that auction, trading session, or program or order type? For example,
should the Commission prohibit exchanges from basing tiers in the
closing auction on volume transacted during regular trading hours in
order to prevent an exchange from leveraging its closing auction in a
manner that harms the ability of other exchanges to compete with it in
the regular hours trading session? Do these types of arrangements
impact competition among exchanges and among members? Why or why not?
16. Should the Commission prohibit volume-based exchange
transaction pricing for agency-related orders also for listed options?
Why or why not? Would extending the prohibition to listed options
implicate the same costs and benefits that would apply to a prohibition
on volume-based exchange transaction pricing for NMS stocks, or are
there unique aspects of the listed options markets that would apply
different costs or result in different benefits? What would those
differences be?
17. If the Commission also prohibits volume-based exchange
transaction pricing for member proprietary volume in NMS stocks, should
listed options also be included within the broader prohibition? If the
Commission were to adopt a broader prohibition on all volume-based
exchange transaction pricing and apply it to all NMS securities
(including NMS stocks and listed options), should it carve-out
displayed liquidity-adding orders from an exchange's registered market
makers in their assigned options classes and series from such a
prohibition? Should there be any particular minimum quantitative and
qualitative quoting requirements to qualify for the carve-out? Would
such a carve-out for listed options be an appropriate benefit to
encourage members to become and remain registered market makers and
undertake registered market making obligations in the same way that it
would for NMS stocks? Does tiered pricing encourage greater quoted
depth or narrower quoted spreads, or both, for listed options in a
similar manner to NMS stocks? If the Commission were to allow exchanges
to offer volume-based transaction pricing but require that tiers be
aggregated across all members and the associated pricing be applicable
to all members uniformly, should that condition apply to listed options
as well as NMS stocks?
18. Instead of prohibiting volume-based exchange transaction
pricing for agency and riskless principal orders, should the Commission
instead prohibit exchanges from offering tiers that are reasonably
achievable by only one or a few members based on those members' order
flow? Why or why not? If such a prohibition were adopted, would it be
appropriate, for example, to prohibit tiers for which fewer than 50% of
an exchange's members could have met the tier criteria during the prior
month? Would assuring that exchanges set tier criteria at levels for
which at least 50% of the exchange's members are capable of meeting
based on order flow they route help assure that such tiered pricing
meets the applicable statutory standards because at least a majority of
members would be eligible to receive it? Would such a prohibition
increase competition among members for customers while providing
exchanges with the ability to offer tiered pricing at levels that
incentivize members to contribute additional liquidity to the exchange?
Alternatively, would it be appropriate, for example, to prohibit tiers
for which only one, two, three, or four members are capable of
qualifying to prevent tiers that are only achievable by only a few
members and help assure that tiers meet the applicable statutory
standards? Should any of the above prohibitions also be applied to
proprietary orders for the account of a member? Why or why not? Should
such a prohibition also apply to listed options? Why or why not?
C. Anti-Evasion
The prohibition in proposed Rule 6b-1(a) is intended in part to
address the conflict of interest between members and customers that is
exacerbated by volume-based exchange transaction pricing schedules when
members route customer orders to an exchange, as well as address
burdens on competition that volume-based exchange transaction pricing
can impose on members competing for customer business. In light of the
combination of these conflicts and potential competitive advantages,
the Commission is concerned that members may have a financial incentive
to mischaracterize their agency-related orders to continue to qualify
for volume-based pricing.
To mitigate this incentive to mischaracterize order capacities,
proposed Rule 6b-1(b)(1) would require an equities exchange that offers
volume-based transaction pricing for member proprietary orders to have
a rule to require its members to engage in practices that facilitate
the exchange's ability to comply with the prohibition on volume-based
exchange transaction pricing in connection with the execution of
agency-related volume.\64\ The proposed rule would provide exchanges
with flexibility to adopt a rule that is tailored to its needs,
systems, and members. For example, an exchange rule could require
members to identify, for transaction pricing and billing purposes,
their proprietary orders for their own account and submit or mark them
in a distinct manner from all other orders. Similarly, an exchange
could adopt or enhance any existing rule that requires members to
properly label orders or identify which types of orders are submitted
through specific ports or sessions to ensure the accuracy of order
marking and ensure that members do not mislabel or misdirect orders
specifically for transaction billing purposes.\65\ Proposed Rule 6b-
1(b)(1) would support proposed Rule 6b-1(a)'s prohibition on volume-
based transaction fees, rebates, or other incentives in connection with
the execution of agency or riskless principal orders in NMS stocks.
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\64\ If an exchange does not offer volume-based transaction
pricing, then it would not be required to adopt such a rule.
\65\ Many exchanges already have rules requiring members to
accurately mark their orders. See, e.g., Nasdaq General 3, Rule
1032(a)(6) (requiring members to ``input [ ] accurate information
into the System. . . .'').
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Second, proposed Rule 6b-1(b)(2) would require the exchange to
establish,
[[Page 76293]]
maintain, and enforce written policies and procedures reasonably
designed to detect and deter members from receiving volume-based
pricing in connection with the execution of agency-related volume.
While exchanges generally already establish, maintain, and enforce
written policies to detect and deter non-compliance with their rules
and the Federal securities laws and rules to ensure compliance with
their obligations under the Exchange Act,\66\ the Commission is adding
a specific and complementary requirement in proposed Rule 6b-1 to help
ensure exchange compliance with the proposed rule. Proposed Rule 6b-
1(a) would apply specifically to exchange pricing schedules and how
exchanges assess and collect fees and offer rebates and other
incentives to members. For example, exchanges could develop written
policies and procedures to audit member activity to ensure the proper
marking of orders and review trading records to ensure that the
exchange is not unintentionally offering tiered transaction pricing on
agency-related volume. Proposed Rule 6b-1(b)(2) would complement
existing exchange rules requiring the accurate marking of orders and
thereby facilitate the ability of exchanges to comply with proposed
Rule 6b-1(a).
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\66\ See, e.g., 15 U.S.C. 78s(g)(1).
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Request for Comments
The Commission generally requests comment from the public on all
aspects of proposed Rule 6b-1(b), including its objectives and its
terms to achieve those objectives. More specific requests for comment
are set forth below. As much as possible, commenters are requested to
provide empirical data in support of any arguments or analyses and to
offer explanations for their views.
19. Is the anti-evasion clause in proposed Rule 6b-1(b)
appropriately designed to ensure exchange compliance with the proposed
prohibition on volume-based exchange transaction pricing in connection
with the execution of agency or riskless principal orders? Why or why
not? To what extent are practices or systems already in place that
could facilitate members accurately marking orders so that exchanges
can distinguish proprietary and agency orders for transaction billing
purposes?
D. Transparency for Volume-Based Pricing on Member Proprietary Orders
Proposed Rule 6b-1(c) would add a new public disclosure requirement
for exchanges that offer volume-based transaction pricing in connection
with the execution of proprietary orders in NMS stocks for the account
of a member.\67\ For purposes of proposed Rule 6b-1(c), proprietary
orders are those where the member is trading solely for its own account
and not in connection with filling an order for a customer. Proprietary
orders are principal capacity orders and are not agency or riskless
principal capacity orders.
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\67\ Exchanges that do not offer any volume-based transaction
pricing would not be required to submit the disclosures required
under proposed Rule 6b-1(c).
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Disclosing information about the manner in which an exchange's
tiered transaction pricing applies across its membership would enhance
public transparency regarding the application of an exchange's tiered
pricing structure for member proprietary volume. In turn, the increased
transparency would enhance the ability of members, other exchanges, and
the public in considering and commenting on whether proposed volume-
based pricing changes applicable to member proprietary volume provide
for the ``equitable allocation of reasonable dues, fees, and other
charges'' \68\ that are ``not designed to permit unfair
discrimination'' between broker-dealers \69\ and that do not ``impose
any burden on competition not necessary or appropriate in furtherance
of the purposes'' \70\ of the Exchange Act. For example, monthly
disclosures would provide timely information during the 60 day
suspension period of an exchange's proposed pricing change that would
allow the public to see the impact of a new or revised pricing tier
during the first month it was in effect. The Commission and the public
could use that information to assess exchange statements about the
number of members that the exchange expected to qualify for a proposed
tier, and commenters could use that information to provide comment as
to whether a tier change meets the applicable statutory standards.
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\68\ 15 U.S.C. 78f(b)(4).
\69\ 15 U.S.C. 78f(b)(5).
\70\ 15 U.S.C. 78f(b)(8).
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The Commission also believes that the public disclosure of such
information would be consistent with section 11A of the Exchange Act in
that it could assist in assuring ``fair competition among brokers and
dealers, [and] among exchange markets'' and ``the practicability of
brokers executing investors' orders in the best market.'' \71\ For
example, the proposed disclosures would allow interested parties to see
how many members have qualified for an exchange's pricing tiers, and
how members have responded to tiered pricing changes (e.g., by looking
at month-to-month disclosures to see how many members moved up to a new
or revised tier to qualify for a more generous pricing incentive). That
information could be useful in helping the Commission and public
commenters assess whether pricing tier changes are reasonable,
equitably allocated, not unfairly discriminatory, and do not impose a
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act.\72\
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\71\ 15 U.S.C. 78k-1(a)(1)(C)(ii) and (iv).
\72\ Under the proposed rule, an exchange would not have to
identify its members by name in the proposed transparency
disclosures.
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Specifically, proposed Rule 6b-1(c) would require equities
exchanges to submit electronically to the Commission, within five
calendar days after the end of each calendar month, the information
described below. Given that exchanges assess transaction prices to
their members on a monthly basis according to their respective pricing
tiers, the Commission believes that such information should be readily
available to exchanges, since they are already familiar with the
pricing tier for which each member qualifies. Further, submitting the
disclosures within five calendar days after the end of each calendar
month would help ensure that the information is available in a timely
manner for the Commission and the public's consideration after an
exchange implements a new pricing change to show the impact of the
pricing change during the first month that it was billed to members.
This timing would allow time for the Commission and the public to
review this data before the expiration of the period within which the
Commission is able to summarily temporarily suspend a proposed rule
change.\73\
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\73\ See supra note 6 and accompanying text (discussing
suspensions).
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The content of the disclosures is intended to show a high-level and
anonymized summary of the volume-based transaction tiers applicable to
the execution of proprietary orders in NMS stocks for the account of a
member and how many members qualify for each tier. Monthly tables would
show, for example, the potential impact of any recent tiered
transaction pricing change for member proprietary orders during the
month that it was first in effect following the exchange's proposed
rule change as well as how members qualify over time for pricing tiers
that do not change. While the Commission reviews each proposed rule
change, the actual
[[Page 76294]]
effect of a pricing change cannot be known in advance or guaranteed.
The information in the proposed disclosures is intended to provide the
Commission and the public with insight into the application of an
exchange's volume-based transaction pricing schedule, which would allow
interested persons to better assess an exchange's volume tiers,
particularly where the highest rebate or lowest tiers on an exchange
are occupied by only one or a few members. Therefore, having more
timely and readily available information with respect to the actual
effect of an exchange transaction pricing change would be useful to the
Commission in determining whether to summarily temporarily suspend a
proposed rule change before the deadline to summarily temporarily
suspend expires. Further, the Commission also believes such information
would be useful to the public in assessing the impact of the proposed
rule change and further informing their comments on a proposed pricing
change.
First, proposed Rule 6b-1(c)(1) would require every exchange that
offers volume-based transaction fees, rebates, or other incentives in
connection with the execution of proprietary orders in NMS stocks to
submit electronically to the Commission each calendar month, within
five calendar days after the end of the month, the number of members
that executed proprietary orders in NMS stocks on the exchange for the
member's account. The proposed rule would require monthly submissions
because exchange fees are typically effective at the beginning of a
calendar month and revised as frequently as monthly.\74\ The Commission
believes that this information could be used to better understand the
impact of an exchange's volume-based transaction pricing structure
across its members. Specifically, this number would provide the
baseline denominator against which one could calculate percentages of
members that met a specific tier.\75\ Seeing the total number of
members with proprietary orders during a month would thus provide the
baseline against which the number of members qualifying for any one
tier in that month could be understood.
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\74\ See supra note 17 and accompanying text. Further, as
discussed above, monthly disclosure would also provide the
Commission with timely information to consider whether to
temporarily suspend a proposed rule change within the statutory
deadline of 60 days beginning on the date of filing of such proposed
rule change. See 15 U.S.C. 78s(b)(3)(C).
\75\ See infra section II.D., Request for Comments (requesting
comment on other benchmarks).
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Second, proposed Rule 6b-1(c)(2) would require every exchange that
offers volume-based transaction fees, rebates, or other incentives in
connection with the execution of proprietary orders in NMS stocks to
disclose a structured data table for each volume-based transaction fee,
rebate, and other incentive that includes information to promote
transparency regarding how that tier applies among the exchange's
membership. Exchanges would be required to submit electronically to the
Commission each calendar month, within five calendar days after the end
of the month, the following information for each month:
1. A label to identify the ``base'' fee and rebate. Showing the
base fee or rebate allows the reader of the table to compare and
evaluate each tiered pricing level against what the exchange otherwise
would assess to its members in the absence of volume-based pricing.\76\
The inclusion of the base fee and rebate information in structured data
format also would allow data analysis and computations to be performed,
which would facilitate comparisons over time and across exchanges.
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\76\ The base fee would be the highest fee that the exchange
assesses to members by default if no incentives apply. Similarly,
the base rebate would be the lowest rebate that the exchange
provides to members if no incentives apply.
---------------------------------------------------------------------------
2. A label to identify each pricing tier. For example, ``Liquidity
Providing Rebate Tier 1,'' ``Step-up Rebate Tier 1,'' or ``Removing
Tier 2.'' The label used in the disclosure would be required to
correspond to the label the exchange uses in its pricing schedule so
that the public can easily locate the tier on the exchange's pricing
schedule. Providing a label in structured data format also would allow
for data analysis using those labels to identify each pricing tier.
Results from such analysis would then be easily referenced against the
exchange's pricing schedule.
3. The amount of the fee, rebate, or other incentive. This
information would allow the reader of the table to understand what
pricing applies to each pricing tier without having to consult the
exchange's pricing schedule. In addition, the inclusion of the pricing
amount in a structured data format would allow data analysis and
computations to be performed, which would facilitate comparisons over
time and across exchanges.
4. An explanation of the tier requirements. Including this
explanation would allow the reader of the table to understand the
requirements for achieving each tier without having to consult the
exchange's pricing schedule. In addition, having this information in
structured data format would allow data analysis and computations to be
performed, which would facilitate comparisons over time and across
exchanges.
5. The total number of members that qualified for the base fee,
base rebate, or each tier during the month. This disclosure would
provide important transparency into the application of volume-based
exchange transaction pricing and how the prices apply among an
exchange's membership. Among other things, it could provide members
with insight as to the tiers that other members with whom they compete
qualify, which could be useful in considering whether an exchange's
pricing is imposing a burden on the member's ability to compete with
those other members. It also may provide insight into how an exchange's
fees and rebates are distributed among members and whether those fees
that fund the rebates the exchange offers, as well as fund part of the
exchange's operations, constitute an equitable allocation among
members. It also would provide data against which exchange
representations made as part of or in connection with proposed pricing
changes could be verified.
Proposed Rule 6b-1(c) would require that the information be
provided in an easily understandable table format, using structured
data specified by the Commission.\77\ Exchanges would be required to
retain those records and information pursuant to 17 CFR 240.17a-1 (Rule
17a-1).\78\
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\77\ See proposed Rule 6b-1(c)(3). Under proposed Rule 6b-
1(c)(3), exchanges would be required to provide information using
Interactive Data File in accordance with Rule 405 of Regulation S-T.
\78\ 17 CFR 240.17a-1. Generally, Rule 17a-1(b) requires
national securities exchanges to retain specified documents for a
period of not less than five years, the first two years in an easily
accessible place.
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Request for Comments
The Commission generally requests comment from the public on all
aspects of proposed Rule 6b-(c), including its objectives and its terms
to achieve those objectives. More specific requests for comment are set
forth below. As much as possible, commenters are requested to provide
empirical data in support of any arguments or analyses and to offer
explanations for their views.
20. Is the definition of proprietary order described in section
II.D. appropriate? If the definition described in section II.D. is not
appropriate, what definition should the Commission use for purposes of
Rule 6b-1? Should the Commission include the definition
[[Page 76295]]
described in section II.D (or another definition) in Rule 6b-1, or is
the term commonly understood without needing to be defined in the rule?
21. Does the proposed 5 calendar day deadline for exchanges to
submit the transparency disclosures after the end of each calendar
month under proposed Rule 6b-1(c) provide exchanges with sufficient
time to prepare and submit the disclosures? If an exchange files a
proposed rule change related to transaction pricing that becomes
effective on the first day of a month, does the proposed 5 calendar day
deadline after the end of that month provide sufficient time for the
Commission and commenters to consider the disclosures before the
expiration of the 60-day statutory deadline to summarily temporarily
suspend the proposed rule change at issue? If 5 calendar days is not
sufficient for exchanges to submit the transparency disclosures, would
a 7 or 10 calendar day deadline provide sufficient time? If an exchange
files a proposed rule change related to transaction pricing that
becomes effective on the first day of a month, would a 7 or 10 calendar
day deadline after the end of that month provide sufficient time for
the Commission and commenters to consider the disclosures before the
expiration of the 60-day statutory deadline to summarily temporarily
suspend the proposed rule change at issue?
22. Should the transparency disclosures under proposed Rule 6b-1(c)
also require exchanges to report the number of their registered market
makers on the exchange during a month if an exchange offers volume-
based transaction pricing tiers solely applicable to its market makers,
in order to allow the public to see how many registered market makers
qualify for exchange tiered pricing that is applicable only to such
members? Would that information be useful to calculate percentages for
the volume-based transaction tiers that apply specifically to market
makers (e.g., to be able to calculate that 10% of registered market
makers qualified for the market-maker liquidity providing rebate Tier
2)? Would that information be helpful to better understand the impact
of exchange tiered transaction pricing on competition between
registered market maker members and members that trade proprietarily
but not as registered market makers?
23. Should the transparency disclosure under proposed Rule 6b-1(c)
also require exchanges to separately report the number of members that
participated during the month in any program that has its own volume-
based transaction pricing in order to be able to compute percentages
specific to the program? For example, tiers specific to Tape A, B, and
C, to stocks under $1, to a retail liquidity program, or to the closing
auction. Would that more granular level of information be useful to
commenters in commenting on specific individual pricing proposals that
affect such programs? For example, if an exchange has tiers for Tape B
and reports only ten members that qualified for them in a month, would
it be useful to know that only 12 out of forty members transacted in
Tape B stocks on the exchange that month so that percentages can be
calculated out of eligible entities rather than all members? Why or why
not?
24. Should the transparency disclosure under proposed Rule 6b-1(c)
also require exchanges to report the following:
a. the applicable trading session (e.g., pre-market, opening
auction, regular hours, closing auction, post-market) to allow readers
of the tables to more quickly identify with certainty which tiers apply
to which trading session and allow researchers to be able to use
electronic means to parse that data;
b. the applicable securities (e.g., Tape A, B, or C; sub-$1,
exchange traded funds, etc.) to allow readers of the tables to more
quickly identify with certainty which tiers apply to which securities
and allow researchers to be able to use electronic means to parse that
data;
c. whether the fee, rebate, or other incentive is applicable to
adding or removing liquidity to allow readers of the tables to more
quickly identify with certainty which tiers apply to which types of
activity and allow researchers to be able to use electronic means to
parse that data;
d. the number of MPIDs qualifying for the price level during the
month to provide a different metric to assess how many members qualify
for each pricing tier;
e. the cumulative volume of shares qualifying for the tier during
the month to provide more context to understand the amount of volume
that qualifies at each pricing tier, which the number of members alone
would not capture, and to allow comparison with the exchange's overall
volume;
f. the cumulative dollar amount of fees, rebates, or other
incentives (as applicable) at the tier during the month to better
understand the financial impact of each pricing tier, both on members
and on the exchange, and allow comparison of that impact between tiers;
and
g. the average transaction fee paid and rebate received by members
during the month.
25. Would additional columns allow easier sorting and analysis of
the tables by machine or otherwise? If so, please explain.
26. Should the transparency disclosures under proposed Rule 6b-1(c)
require exchanges to report every net price combination for any volume-
based fee, rebate, or other incentive, including all additive or
creditable pricing (e.g., a liquidity providing rebate of $0.0028 plus
a step-up tier of $0.0003 would be reported as its own pricing tier of
$0.0031)? Would doing so be helpful to show whether volume-based
transaction tiers are customized to a specific member?
27. Should the transparency disclosures under proposed Rule 6b-1(c)
be posted on an exchange's website in addition to, or instead of, being
submitted electronically to the Commission? Why or why not?
28. Are there uses beyond those identified in this release for the
transparency disclosures? For example, would having volume-based
exchange transaction fees in a structured data format help members as
well as other market participants and academics parse the pricing
schedules across exchanges and track changes over time? Would the
transparency disclosures affect routing preferences among members
trading proprietarily? Would members use the disclosures to comment on
exchange proposed rule change filings or advocate for exchanges to
change their transaction pricing if they have more transparency of the
tiers for which their competitors qualify? Would that transparency
provide a useful datapoint to assess whether volume-based exchange
transaction pricing proposals meet the applicable statutory standards?
Why or why not?
29. Would the proposed disclosure provision raise any issues
related to disclosures of proprietary trading information or other
confidentiality concerns, especially if the disclosures were read in
conjunction with broker-dealer Rule 605/606 reports?
30. Do exchanges enter into arrangements with members about
transaction pricing for proprietary and/or agency-related orders that
result in or are connected to an exchange proposal to adopt or amend a
specific volume-based transaction pricing tier? If so, what types of
terms and conditions might such an arrangement include? To what extent
are these arrangements memorialized in writing? How many such
arrangements, if any, do exchanges enter into each year? If such
[[Page 76296]]
arrangements exist but are not commonly memorialized in writing, should
the Commission add a provision to proposed Rule 6b-1 to require
exchanges to ``document any arrangement, whether written or oral,
concerning volume-based transaction pricing, including the parties to
the arrangement, all qualitative and quantitative terms concerning the
arrangement, and the date and terms of any changes to the
arrangement''?
III. Paperwork Reduction Act
Certain provisions of proposed Rule 6b-1 contain ``collection of
information requirements'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\79\ The Commission is submitting these
collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11.\80\ An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless the agency
displays a currently valid control number.\81\ The title of the new
collection of information is ``Volume-Based Exchange Transaction
Pricing for NMS Stocks.''
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\79\ 44 U.S.C. 3501 et seq.
\80\ 44 U.S.C. 3507; 5 CFR 1320.11.
\81\ 5 CFR 1320.11(l).
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A. Summary of Collections of Information
The proposed rule includes collection of information requirements
within the meaning of the PRA.
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-Related
Volume
As discussed above, proposed Rule 6b-1(a) provides that equities
exchanges shall not offer volume-based transaction fees, rebates, or
other incentives in connection with the execution of agency or riskless
principal orders in NMS stocks. This prohibition would require equities
exchanges that currently offer volume-based transaction pricing for
agency-related orders to file a proposed rule change with the
Commission to update their price lists.
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
Proposed Rule 6b-1(b)(1) would require an equities exchange that
offers volume-based transaction pricing in connection with the
execution of proprietary orders in NMS stocks for the account of a
member to adopt a rule to require its members to engage in practices
that facilitate the exchange's ability to comply with the prohibition
in proposed Rule 6b-1(a).
3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
Proposed Rule 6b-1(b)(2) would require an equities exchange that
offers volume-based transaction pricing in connection with the
execution of proprietary orders in NMS stocks for the account of a
member to establish, maintain, and enforce written policies and
procedures reasonably designed to detect and deter members from
receiving volume-based pricing in connection with the execution of
agency or riskless principal orders in NMS stocks.
4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
Proposed Rule 6b-1(c) would require an equities exchange that
offers volume-based transaction fees, rebates, or other incentives in
connection with the execution of proprietary orders in NMS stocks for
the account of a member to submit electronically to the Commission
information regarding those fees, rebates, or other incentives,
including how many members qualify for such fees, rebates, or other
incentives on a monthly basis.
B. Proposed Use of Information
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-Related
Volume
The collection of information associated with Rule 6b-1(a) would be
exchange rule filings with the Commission to eliminate volume-based
pricing for agency-related orders from their pricing schedules. The
collection of information would bring the exchanges into compliance
with Rule 6b-1(a), which would foster competition among broker-dealers
and mitigate conflicts of interest for agency-related volume.
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
Proposed Rule 6b-1(b)(1) would assist exchanges in complying with
proposed Rule 6b-1(a) by requiring exchanges to impose rules that
require members to engage in practices, such as accurate order marking,
to better enable the exchange to assess its pricing in compliance with
the proposed rule.
3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
Proposed Rule 6b-1(b)(2) would assist national securities exchanges
in complying with proposed Rule 6b-1(a) by requiring them to adopt
policies and procedures reasonably designed to detect and deter members
from receiving volume-based exchange transaction pricing in connection
with the execution of agency or riskless principal orders in NMS
stocks.
4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
The disclosure of information about how an exchange's volume-based
transaction pricing for member proprietary orders applies across its
membership would enhance the transparency of an exchange's tiered
pricing structure. In turn, the increased transparency would enhance
the ability of members, other exchanges, and the public in considering
and commenting on proposed volume-based pricing changes applicable to
member proprietary volume.
C. Respondents
The respondents to these collections of information would be
national securities exchanges that offer volume-based transaction fees,
rebates, or other incentives in connection with the execution of orders
in NMS stocks. Currently, while there are 16 national securities
exchanges that trade NMS stocks, only 13 offer volume-based transaction
pricing. Therefore, there are 13 estimated respondents.
D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Rule 6b-1(a)--Prohibition on Volume-Based Pricing for Agency-Related
Volume
As discussed above, proposed Rule 6b-1(a) would require equities
exchanges that currently offer volume-based transaction pricing to file
a rule change with the Commission to update their price list, if
necessary, to eliminate any existing volume-based pricing that would
not comply with the proposed rule. This would be a one-time initial
burden, and exchanges should not incur an ongoing burden once they have
updated their rules. However, the PRA burden associated with the
collection of information resulting from exchange rule filings that
would be required pursuant to proposed Rule 6b-1(a) would be covered by
the existing PRA burden estimates for Rule 19b-4 because those changes
would be filed on Form 19b-4.\82\
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\82\ See SEC File No. 270-38, OMB Control No. 3235-0045 (June
21, 2023), available at <a href="https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202304-3235-017">https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202304-3235-017</a>.
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[[Page 76297]]
2. Rule 6b-1(b)(1)--Rules To Prevent Evasion
Proposed Rule 6b-1(b)(1) would require an equities exchange that
offers volume-based transaction pricing to have rules to require its
members to engage in practices that facilitate the exchange's ability
to comply with the prohibition in proposed Rule 6b-1(a). Similar to the
burden for Rule 6b-1(a), this would be a one-time initial burden,
although an exchange may decide to amend the rule it adopts pursuant to
proposed Rule 6b-1(b)(1) from time to time. However, the PRA burden
associated with the collection of information resulting from exchange
rule filings that would be required pursuant to proposed Rule 6b-
1(b)(1) would also be covered by the existing PRA burden estimates for
Rule 19b-4 because those changes would be filed on Form 19b-4.\83\ The
Commission encourages comments on this point.
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\83\ See id.
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3. Rule 6b-1(b)(2)--Policies and Procedures To Prevent Evasion
Proposed Rule 6b-1(b)(2) would require exchanges to establish,
maintain, and enforce written policies and procedures to detect and
deter members from receiving volume-based exchange transaction pricing
in connection with the execution of agency or riskless principal orders
in NMS stocks. Exchanges would incur an initial burden and an annual
ongoing burden associated with proposed Rule 6b-1(b)(2). The Commission
believes that many exchanges generally already have rules and policies
and procedures in place to ensure that members are correctly marking
their orders, though those policies and procedures may need to be
updated to ensure compliance with the proposed rule in the context of
exchange transaction pricing.
Exchanges, at a minimum, would be required to review their existing
policies and procedures. Certain exchanges may need to supplement or
revise their policies and procedures to ensure that they are reasonably
designed to deter and detect members from receiving tiered pricing on
orders for which tiered pricing is prohibited. Although the exact
nature and extent of compliance with proposed Rule 6b-1(b)(2) would
likely differ based on the existing policies and procedures of each
respondent, the Commission estimates that the one-time, initial burden
to update or adopt any additional written policies and procedures
required under proposed Rule 6b-1(b)(2) would be approximately 50 hours
per exchange or 650 burden hours across 13 exchanges that have volume-
based transaction pricing.\84\
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\84\ The Commission derived the total estimated burdens from the
following estimates: (Attorney at 30 hours) + (Compliance Counsel at
10 hours) + (Chief Compliance Officer at 5 hours) + (General Counsel
at 5 hours) = 50 burden hours. 50 burden hours per exchange x 13
respondents = 650 total burden hours. The Commission's estimate is
informed by the estimated filing burden for Form 19b-4 (34 hours).
See Supporting Statement for the Paperwork Reduction Act Information
Collection Submission for Form 19b-4 (Apr. 18, 2023), available at
<a href="https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202304-3235-017">https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202304-3235-017</a>. The Commission believes that the policies and procedures
required under proposed Rule 6b-1(b)(2) may require more effort to
prepare than the proposed rule change required under proposed Rule
6b-1(b)(1).
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The 13 equities exchanges that have volume-based transaction
pricing would incur annual ongoing burden hours to maintain and review
their policies and procedures adopted under proposed Rule 6b-1(b)(2) to
ensure their effectiveness. Those exchanges also would need to review
for compliance pursuant to their policies and procedures. The
Commission estimates that each exchange would likely spend an average
of 25 hours per year on an ongoing basis, for a total of 325 hours
across all 13 exchanges.\85\
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\85\ The Commission derived the total estimated burdens from the
following estimates: (Compliance Attorney at 12 hours) + (Compliance
Manager at 8 hours) + (Business analyst at 5 hours) = 25 burden
hours. 25 burden hours per exchange x 13 respondents = 325 total
burden hours. The ongoing burden hours associated with proposed Rule
6b-1(b)(2) is estimated to be lower than the initial burdens because
the Commission expects it to be less burdensome to maintain and
review existing policies and procedures than to establish new ones.
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4. Rule 6b-1(c)--Transparency for Volume-Based Pricing on Member
Proprietary Orders
Proposed Rule 6b-1(c) would require exchanges that offer volume-
based transaction pricing for the execution of proprietary orders in
NMS stocks for the account of a member to submit electronically to the
Commission aggregated information regarding how many members qualify
for those pricing tiers. These submissions would be accessible to the
public via the EDGAR system and would reflect each exchange's
particular pricing structure. The exchanges would likely incur an
initial burden and an annual ongoing burden associated with Rule 6b-
1(c). Exchanges have ready access to all of the underlying information
and data necessary to comply with proposed Rule 6b-1(c) because the
disclosures are summaries of the pricing schedules that exchanges
maintain and the exchanges know the number of members that qualify for
a particular pricing tier because they calculate the fees, rebates, and
other incentives applicable to their members on a monthly basis.
Consequently, the proposed rule would not require exchanges to acquire
or record an entirely new and unfamiliar set of information. The
exchanges, however, would be required to present the required
information and data in a new structured data format and submit such
information electronically to the Commission on a monthly basis.
Exchange pricing schedules are publicly available and identify all
of the exchange's volume-based transaction fees, rebates, and other
incentives. To comply with proposed Rule 6b-1(c)(2), the exchange would
have to identify each volume-based transaction fee, rebate, and other
incentive, and: (i) use a label to identify the base fee or rebate,
(ii) use a label to identify each pricing tier that corresponds to the
label used in the exchange's pricing schedule, (iii) identify the
amount of the fee, rebate, or other incentive, (iv) provide an
explanation of the tier requirement, and (v) provide the total number
of members that qualified for the base fee, base rebate, or each tier
during the month. Parts (i) through (iv) would require the exchange to
take information from its publicly accessible pricing schedule and put
it into the required structured data format. The information required
for part (v) would be readily available to the exchange since it
assesses transaction prices to its members on a monthly basis in
accordance with its pricing schedule and thus knows which members
qualify for which tiers though exchanges currently are not required to
publicly disclose a tally of that information by tier.
Furthermore, proposed Rule 6b-1(c)(1) requires the exchange to
identify the number of members that executed proprietary orders in NMS
stocks for the member's account on the exchange during the month.
Exchanges do not currently publicly disclose a tally of this
information. However, exchanges generally have ready access to trading
information of their members that would reveal this information and
exchanges generally know which of their members are engaged in an
agency business, which are engaged in proprietary trading, and which
are engaged in both because exchanges broadly know about what lines of
business their members are engaged in as part of their membership
registration. Accordingly, the burden on exchanges to calculate the
number of members engaged in proprietary trading would be low.
The Commission estimates that each exchange would incur 58 initial
burden
[[Page 76298]]
hours for the creation of new tables to ensure that data responsive to
the proposed disclosure requirements is correctly collected and
formatted, and to set up automated programs where appropriate, or 754
total initial burden hours across 13 exchanges.\86\ The Commission does
not believe the information required to be aggregated and included in
disclosures made pursuant to proposed Rule 6b-1(c) would require
respondents to acquire new hardware or systems to process the
information required in the reports. Rather, the exchanges' initial
burden would consist of creating and formatting a table that would be
responsive to the requirements of proposed Rule 6b-1(c). As described
above, this would require the exchanges to convert a portion of the
information available on their publicly accessible pricing schedules
into a structured data format. Once created, these tables should not
change unless the exchanges create new pricing tiers or change the
requirements or dollar amounts of existing tiers. The Commission
solicits comment on the accuracy of these estimates.
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\86\ The Commission derived the total estimated burdens from the
following estimates: (Sr. Programmer at 25 hours) + (Sr. Systems
Analyst at 10 hours) + (Compliance Manager at 10 hours) +
(Compliance Attorney at 8 hours) + (Director of Compliance at 5
hour) = 58 burden hours. 58 burden hours per exchange x 13
respondents = 754 total burden hours.
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Furthermore, because exchanges are not currently subject to EDGAR
filing requirements, equities exchanges would incur a one-time
compliance burden of submitting Form ID in order to be able to submit
the disclosures electronically to the Commission through EDGAR.
Respondents would apply for access to EDGAR using Form ID and receive
access codes to submit documents through the EDGAR system. The
Commission estimates that each filer that currently does not have
access to EDGAR would incur an initial, one-time burden of 0.30 hours
to complete and submit a Form ID.\87\ However, the PRA burden
associated with completing and submitting a Form ID would be covered by
the existing PRA burden estimates for Form ID.\88\
---------------------------------------------------------------------------
\87\ Form ID (OMB control number 3235-0328) must be completed
and filed with the Commission by all individuals, companies, and
other organizations who seek access to file electronically on EDGAR.
Accordingly, a filer that does not already have access to EDGAR must
submit a Form ID, along with the notarized signature of an
authorized individual, to obtain an EDGAR identification number and
access codes to file on EDGAR. See Supporting Statement for the
Paperwork Reduction Act Information Collection Submission for Form
ID (Dec. 20, 2021), available at <a href="https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202112-3235-003">https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202112-3235-003</a> (stating that it takes 0.3
hours to prepare Form ID).
\88\ See id.
---------------------------------------------------------------------------
The 13 equities exchanges that have volume-based transaction
pricing also would incur annual ongoing burden hours to aggregate and
disseminate the information required under proposed Rule 6b-1(c).
Proposed Rule 6b-1(c) would require exchanges to submit electronically
updated information each month. An exchange generally would not need to
update the disclosure information required under proposed Rule 6b-
1(c)(2)(i)-(iv) unless the exchange amends its pricing schedule, in
which case the exchange would need to make targeted changes to these
disclosures in accordance with the changes it makes to its pricing
schedule. The Commission expects that the disclosures required by
proposed Rule 6b-1(c)(1) and Rule 6b-1(c)(2)(v) would possibly change
and could need to be updated as frequently as each month. The
Commission believes the exchanges would use automated programs to meet
the ongoing monthly reporting obligation under proposed Rule 6b-1(c)
but each report may require staff to verify the accuracy of the
information. The Commission estimates that each exchange would incur 8
burden hours per monthly report for a total of 96 ongoing burden hours
on an annual basis.\89\ Therefore, the Commission estimates 1,248 total
ongoing annual burden hours across 13 exchanges.\90\
---------------------------------------------------------------------------
\89\ The Commission derived the total estimated burdens from the
following estimates: (Compliance Attorney at 6 hours) + (Compliance
Manager at 2 hours) = 8 burden hours per monthly filing. 8 burden
hours x 12 months = 96 annual burden hours per respondent.
\90\ 96 annual burden hours per exchange x 13 respondents =
1,248 total burden hours per year.
Table 3--PRA Summary Table
----------------------------------------------------------------------------------------------------------------
Ongoing
Initial burden burden hours Total ongoing
Rule Number of hours per Total initial per burden hours
respondents respondent burden hours respondent on on annual
annual basis basis
----------------------------------------------------------------------------------------------------------------
Rule 6b-1(b)(2)................. 13 50 650 25 325
Rule 6b-1(c).................... 13 58 754 96 1,248
-------------------------------------------------------------------------------
Total....................... .............. 108 1,404 121 1,573
----------------------------------------------------------------------------------------------------------------
E. Collection of Information Is Mandatory
The collection of information discussed above would be a mandatory
collection of information.
F. Confidentiality of Responses to Collection of Information
The collection of information under proposed Rule 6b-1(a) and 6b-
1(b)(1) would not be confidential because exchange proposed rule
changes filed with the Commission are public information. Similarly,
the collection of information under proposed Rule 6b-1(c) also would
not be confidential. Rather, each exchange would be required to submit
electronically to the Commission the information required under
proposed Rule 6b-1(c) and this information would be made publicly
available. The collection of information under proposed Rule 6b-1(b)(2)
concerning the written policies and procedures would contain
information about an exchange's regulatory program because those
materials would provide details on how the exchange enforces compliance
with its rules, specifically how the exchange detects and deters
members from receiving volume-based transaction pricing in connection
with the execution of agency and riskless principal orders in NMS
stocks. Accordingly, where the Commission requests that an exchange
produce those documents, an exchange can request confidential treatment
of the information. If such confidential treatment request is made, the
Commission anticipates that it will keep the information confidential
subject to applicable law.
[[Page 76299]]
G. Retention Period for Recordkeeping Requirements
National securities exchanges would be required to retain records
and information pursuant to Rule 17a-1 under the Exchange Act \91\ for
a period of five years.
---------------------------------------------------------------------------
\91\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------
H. Request for Comments
The Commission requests comment on whether the estimates for burden
hours and costs are reasonable. Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission solicits comments to: (1) evaluate whether the proposed
collections of information are necessary for the proper performance of
the functions of the Commission, including whether the information
would have practical utility; (2) evaluate the accuracy of the
Commission's estimate of the burden of the proposed collections of
information; (3) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(4) determine whether there are ways to minimize the burden of the
collections of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Secretary, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090, with
reference to File Number S7-18-23. Requests for materials submitted to
OMB by the Commission with regard to this collection of information
should be in writing, with reference to File Number S7-18-23 and be
submitted to the Securities and Exchange Commission, Office of FOIA/PA
Services, 100 F Street NE, Washington, DC 20549-2736. As OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication, a comment to OMB is best
assured of having its full effect if OMB receives it within 30 days of
publication.
IV. Economic Analysis
A. Introduction
The Commission is mindful of the economic effects, including the
benefits and costs, of the proposed rule. Section 3(f) of the Exchange
Act provides that when engaging in rulemaking that requires the
Commission to consider or determine whether an action is necessary or
appropriate in the public interest, to also consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\92\ Section 23(a)(2) of
the Exchange Act also requires the Commission to consider the effect
that the proposed rule would have on competition, and it prohibits the
Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the Exchange
Act.\93\ The analysis below addresses the likely economic effects of
the proposed rule, including the anticipated benefits and costs of the
amendments and their likely effects on efficiency, competition, and
capital formation. The Commission also discusses the potential economic
effects of certain alternatives to the approaches taken in this
proposal.
---------------------------------------------------------------------------
\92\ See 15 U.S.C. 78c(f).
\93\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The Commission is proposing to prohibit volume-based transaction
fees, rebates, or other incentives in connection with the execution of
agency or riskless principal orders in NMS stocks, as well as the
disclosure of, among other things, the number of exchange members that
qualify for different transaction pricing tiers.
The proliferation of tiered transaction pricing schedules across
many exchanges has resulted in a complex system of transaction-based
fees, which, along with a lack of transparency regarding how many
members qualify for the various pricing tiers, makes it difficult for
market participants to assess the tiered transaction pricing schedules'
impact on the fees and rebates ultimately realized across exchange
members. Further, it may be the case that some tiers only have a single
market participant that ultimately qualifies for that tier in a given
month. This lack of transparency presents a challenge to other exchange
members, exchanges, and interested parties to assess for themselves
whether an exchange's proposed transaction price schedule meets the
applicable statutory standards, so that they can comment on such a
proposed fee rule. It is also possible that the general complexity of
the tiers inhibits the ability of all market participants to understand
the price of exchange services and understand the impact of the
particular price schedules implemented. By prohibiting the application
of volume-based pricing for agency-related orders the proposed rule
would help simplify pricing for agency-related order flow whilst the
proposed disclosure provisions will help promote transparency for
principal order flow, for which volume-based transaction pricing will
continue to be permitted.
While exchanges compete, in part, on the basis of their price
schedules, volume-based transaction pricing may reduce competition
among executing brokers, which could increase costs for investors. With
volume-based transaction pricing, rebates go up and fees go down as a
broker-dealer's volume increases, meaning that such pricing gives
higher-volume broker-dealers lower trading costs. As a result, smaller
firms, such as new entrants, face higher trading costs relative to
high-volume incumbent broker-dealers, potentially reducing competition
and raising costs for investors.
The implementation of volume-based transaction fee and rebate
pricing introduce additional incentives to concentrate order flow on a
given exchange. Volume-based tiers may encourage the concentration of a
member's order flow on the exchange by offering more favorable pricing
to a member who executes greater trading volume on their platform. Not
only does volume-based transaction price tiering incentivize the
concentration of order flow, it also indirectly increases the
opportunity cost of routing orders to a competing venue, because by
doing so the exchange member lowers the likelihood that it will qualify
for a better pricing tier. This concentration also directly reduces the
ability of an exchange not offering rebates to compete with those that
do. Rebates themselves are a less transparent means of incentivizing
liquidity as compared with bid-ask spreads. Thus, the proliferation of
volume-based tiers may reduce efficiency by making a non-rebate-focused
model difficult to sustain.
The application of volume-based pricing to non-principal order flow
adds to the conflict of interest between a broker and its customer as
broker-dealers may be incentivized to execute customer orders in a
manner that would not be consistent with the broker-dealer's duty of
best execution (to execute customer trades at the most favorable terms
reasonably available under the circumstances).\94\ Tier qualification
is based on the exchange member's total monthly trading volume
[[Page 76300]]
and upon qualification the pricing of that tier applies to the entirety
of the member's trading volume on the exchange. Diverting order flow to
other trading venues may risk the member losing out on higher rebates
or lower fees for a whole swath of their order flow. Volume-based
pricing tiers thereby generate the potential for exchange members to
concentrate customer order flow onto particular exchanges in order to
increase the likelihood of tier qualification possibly contrary to the
interests of individual customers.
---------------------------------------------------------------------------
\94\ The Commission has previously described a non-exhaustive
list of factors that may be relevant to a broker-dealers' best
execution analysis. See Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496 at 37538 (June 29, 2005).
---------------------------------------------------------------------------
Exchanges, particularly those with the largest market share, are
unlikely to unilaterally reduce the use of transaction pricing tiers or
address the advantages that the application of these pricing tiers to
agency-related volume creates for high-volume broker-dealers.\95\ An
exchange may perceive that unilaterally excluding agency trading volume
from volume-based transaction pricing tiers would reduce one incentive
for members to concentrate agency orders on their exchange, risking
that their members instead direct that order flow to competing
exchanges with volume-based pricing tiers. Because of this incentive to
concentrate order flow, an exchange that unilaterally eliminated
volume-based transaction pricing tiers for agency-related order flow
could experience a loss of trading volume, especially if competing
venues continue to reward agency-related order flow concentration. If
all existing exchanges moved to exclude agency-related volume from
volume-based transaction pricing tiers, the potential gains from a
single exchange (or new entrant) deviating and charging volume-based
prices could be very high, reducing the likelihood that such an effort
would be successful without the aid of a regulatory prohibition. In
this case the exchanges, particularly those with members with high-
volume agency order flow, may also lose activity as the reduced
incentive to concentrate order flow may result in broker-dealers
routing order-flow to other venues.
---------------------------------------------------------------------------
\95\ Agency-related order flow represents a substantial share of
trading volume, comprising 56% of trading volume across the equities
exchanges in Jan. 2023. See infra Table 4.
---------------------------------------------------------------------------
Exchanges are required to file changes to their price schedules
with the Commission and publish their pricing schedules online.
However, when filing such proposed rule changes and publishing such
pricing schedules, they typically refrain from disclosing the number of
members that qualify for their different tiers, information which would
be useful to market participants. Knowledge of this would aid exchange
members, other exchanges, and the public in considering and commenting
on whether proposed volume-based pricing changes are equitable and not
unfairly discriminatory. The Commission does not believe that the
exchanges themselves can be expected to rectify the lack of tier
transparency because doing so may reveal valuable information to their
competitors as well as risk potential reputational costs.\96\ Along
with the proposed prohibition of volume-based pricing for agency-
related order flow the Commission is proposing to require exchanges to
disclose the number of members which qualify for each pricing tier.
Given the proposed prohibition of volume-based tiers for agency order
flow the proposed disclosures would relate to tiers that would only
apply to principal order flow. The Commission expects that the proposed
disclosures would provide important information to interested parties
to provide comment on future proposed changes to an exchange's pricing
schedule. Observing the distribution of principal volume tier
qualification and its variation over time would allow interested
parties to better assess if pricing tiers had been narrowly tailored
for the benefit of some members and could be judged to be unfair. The
disclosure of more information on how many members qualify for each
principal pricing tier would add costs and could lead to reputational
damage to an exchange if the exchange's pricing structure is publicly
perceived to be unfair.
---------------------------------------------------------------------------
\96\ See section IV.C.3.b.ii for a discussion of the potential
reputational costs that the disclosure of tier qualification numbers
may have.
---------------------------------------------------------------------------
B. Baseline
1. Exchange Pricing
As discussed above in section I.B, many stock exchanges utilize a
transaction pricing model that involves charging one party to a trade a
per-share fee while offering the other party a per-share rebate. While
exchange transaction pricing structures vary, with some exchanges
charging both sides a fee or no fee at all, most of the on-exchange
volume goes to exchanges which provide a rebate to the resting limit
order and charge the fee to the marketable order. This type of fee
structure is referred to as ``maker-taker'' pricing. Exchanges may
employ maker-taker fees as a means of attracting competitively priced
liquidity to post on an exchange, which, in turn, helps attract trading
to the exchange.
Many exchanges incorporate volume-based transaction tiers into
their pricing schedules, meaning that they offer improved pricing terms
to members that execute more trading volume on the exchange, typically
as a percent of total consolidated volume. These pricing tiers provide
an incentive for exchange members to concentrate their order flow on a
subset of exchanges, rather than route their orders more broadly across
all competing exchanges, so as to increase their chances of qualifying
for a higher tier on a specific exchange. In turn, this also helps to
secure an exchange's share of the market, and in some cases may affect
competition among exchanges.
a. Transaction Fees and Rebates
Exchanges generally seek to increase the amount of trading that
occurs on their respective venue. Exchanges generate revenue, in part,
from trade executions \97\ by charging transaction fees net of any
rebate they pay out, subject to a fee cap.\98\ Because some market
participants are sensitive to the level of fees and rebates, exchange
fee schedules would affect an exchange's market share. Given that most
exchanges set their access fees at or near the access fee cap it is
particularly the variation in the rebates they offer which is more
likely to influence an exchange's market share.\99\
---------------------------------------------------------------------------
\97\ Exchanges also generate significant revenue from selling
access to the data generated by the exchange as well by charging
fees for connectivity.
\98\ See 17 CFR 242.610 (Rule 610(c)), which prohibits trading
centers from imposing a fee exceeding $0.0030 to access a quote in
stock priced at or greater than $1.00. This level is commonly
referred to as 30 mils with 1 mil defined as $0.0001. For quotes
priced less than $1.00 the fee cap is at 0.3% of the quotation
price.
\99\ For instance, an exchange stated in a proposed rule change
that ``[t]he Exchange first notes that it operates in a highly
competitive market in which market participants can readily direct
order flow to competing venues if they deem fee levels at a
particular venue to be excessive or incentives to be insufficient.''
See Securities Exchange Act Release No. 94252 (Feb. 15, 2022) 87 FR
9780 at 9781 (Feb. 22, 2022) (SR-CboeBZX-2022-008).
---------------------------------------------------------------------------
A major component of the market to provide trade executions is the
competition among exchanges in attracting competitively priced
liquidity as a means of capturing more order flow.\100\ Competitive
quotes increase the likelihood that marketable orders will flow to an
exchange which result in trades.\101\ Exchanges aim to attract
[[Page 76301]]
competitively priced quotes because, holding other considerations
constant, it is generally in market participants' interest to route
their order to the venue with the best prices insofar as doing so would
be consistent with the duty of best execution that broker-dealers have
with regard to customer orders. In addition to these incentives, the
Order Protection Rule also contributes to the competition for order
flow by requiring that, with specified exceptions,\102\ orders must
execute at prices that are equal to or superior to the prevailing
national best bid and offer (NBBO).
---------------------------------------------------------------------------
\100\ Exchanges also compete with off-exchange trading venues
such as ATSs and wholesaler broker-dealers to attract transactions.
\101\ Exchanges can try to attract such quotes by paying rebates
on limit orders. By offering to pay the market participant who sends
a limit order to an exchange a rebate should the limit be hit, the
exchange may be able to increase to total number limit orders sent
to it. This may increase likelihood that the exchange ends up with
the best-priced limit order in a given symbol.
\102\ See 17 CFR 242.611 (Rule 611). The rule requires trading
centers to ``establish, maintain, and enforce written policies and
procedures that are reasonably designed to prevent trade-throughs on
that trading center of protected quotations in NMS stocks'' (a
trade-through occurs when one trading center executes an order at a
price that is inferior to the price of a protected quotation). The
prevention of trade-throughs means that marketable orders are more
likely to be executed on trading venues with competitively priced
quotations at the NBBO.
---------------------------------------------------------------------------
The competitive environment that has emerged from the desire to
attract competitively priced liquidity contributes to the predominance
of maker-taker pricing across exchanges.\103\ In January 2023, 9 of the
16 exchanges employed maker-taker pricing and the trading volume on
those 9 exchanges make up 89% of trading volume which occurred on the
exchanges.\104\ As discussed above in section I.B., exchanges typically
adopt one of three different forms of transaction pricing models,
including maker-taker, inverted, or flat.\105\ The ``maker-taker''
pricing model encourages liquidity provision by paying rebates to limit
orders (i.e., the ``makers'') that the exchange funds by charging fees
on marketable orders.
---------------------------------------------------------------------------
\103\ See supra note 15.
\104\ See Table 4.
\105\ See supra section I.B (describing the different exchange
pricing models).
---------------------------------------------------------------------------
Outside of the maker-taker pricing model, other exchanges have
adopted inverted or flat pricing models. These exchanges collectively
represent a smaller portion of the overall market share. As reported in
Table 4, inverted pricing venues, which charge a fee to passive limit
orders and pay a rebate to marketable orders, accounted for only 6% of
traded share volume in January 2023. Flat venues accounted for roughly
5% of traded share volume in January 2023.
It is likely that the lack of an incentive to post limit orders in
the form of a transaction rebate contributes to the limited share of
these non-maker-taker venues. Conditional on the quoted price on
different exchanges being the same, a trader would be expected to
prefer routing its marketable order to either an inverted or free venue
over a maker-taker venue to avoid the access fee and potentially earn a
rebate instead. However, a market observer has stated that the
occurrence of equivalently priced quotes at the NBBO between maker-
taker exchanges and non-maker-taker exchanges is an infrequent
occurrence.\106\ The infrequency of this occurrence may be due, in
part, to the lack of rebates for limit orders on these non-maker-taker
exchanges.
---------------------------------------------------------------------------
\106\ For a discussion of how long different exchanges spend
quoting at the NBBO, see Phil Mackintosh, Three Charts That Show the
Importance of a Competitive Bid/Offer NBBO (Dec. 4, 2018), available
at <a href="https://www.nasdaq.com/articles/three-charts-that-show-the-importance-of-a-competitive-bid-offer-nbbo-2018-12-04">https://www.nasdaq.com/articles/three-charts-that-show-the-importance-of-a-competitive-bid-offer-nbbo-2018-12-04</a>.
---------------------------------------------------------------------------
Three exchange groups together make up a large majority of the
market share in the exchange landscape with the Nasdaq group (Nasdaq,
BX, Phlx (PSX)) making up 30% of the market by trading volume, the
Intercontinental Exchange group (NYSE, NYSE American, NYSE Arca, NYSE
Chicago, NYSE National) making up 34% and Cboe Global Markets (Cboe
BZX, Cboe BYX, Cboe EDGA, Cboe EDGX) making up 24%.
Table 4--Exchange Trading Volume and Share by Liquidity Type, Jan. 2023
[The following table breaks apart the total buy and sell executed order flow from all exchange members using a
sample of CAT data for the month of Jan 2023. Exchange members are identified as the set of unique CRD IDs in
CAT which have directly routed orders to any of the national equities exchanges in the month. Exchange member
CRDs are also verified in the CAT Industry Member Identifier List daily reference data. For each exchange the
number of shares executed under the CAT allowable trade capacities of Agency, Principal, and Riskless Principal
are reported. Trade capacity in CAT is defined by the exchange member for its side of a trade and represents the
capacity in which the exchange member acted at trade time. Trades with the sale condition codes-M--Market Center
Official Close, -Q--Market Center Official Open, -V--Contingent Trade, -7--Qualified Contingent Trade (QCT), -8--
Placeholder for 611 Exempt, and -9--Corrected Consolidated Close (per listing market) were excluded. The share
of total trading volume across all exchanges for orders of a specific capacity are reported under the trading
volume. The fourth column, ``Total'' reports the total trading volume for each exchange with the exchange's
volume-based exchange market share reported below.]
----------------------------------------------------------------------------------------------------------------
Riskless
Exchange Agency Principal principal Total
----------------------------------------------------------------------------------------------------------------
Nasdaq \b\ (Maker-Taker)................ 42,381,231,425 26,084,186,949 256,443,292 68,721,861,666
32.04% 24.37% 13.90% 28.50%
NYSE \a\ (Maker-Taker).................. 23,578,087,344 15,663,850,087 145,114,774 39,387,052,205
17.82% 14.64% 7.86% 16.33%
NYSE Arca \a\ (Maker-Taker)............. 19,581,312,954 19,600,669,528 129,269,046 39,311,251,528
14.80% 18.31% 7.00% 16.30%
Cboe EDGX \c\ (Maker-Taker)............. 13,478,973,097 12,512,933,159 677,345,568 26,669,251,824
10.19% 11.69% 36.70% 11.06%
Cboe BZX \c\ (Maker-Taker).............. 9,612,667,056 10,242,339,878 367,462 19,855,374,396
7.27% 9.57% 0.02% 8.23%
MEMX (Maker-Taker)...................... 6,308,673,864 6,746,470,107 186,541,931 13,241,685,902
4.77% 6.30% 10.11% 5.49%
IEX..................................... 6,860,652,435 3,905,276,620 7,011,129 10,772,940,184
(Flat).................................. 5.19% 3.65% 0.38% 4.47%
Cboe EDGA \c\........................... 3,401,951,122 2,289,187,280 109,407,328 5,800,545,730
(Inverted).............................. 2.57% 2.14% 5.93% 2.41%
Cboe BYX \c\............................ 1,950,854,778 2,582,413,642 131,506,520 4,664,774,940
(Inverted).............................. 1.47% 2.41% 7.13% 1.93%
[[Page 76302]]
MIAX Pearl (Maker-Taker)................ 1,803,716,409 2,527,733,474 153,910,919 4,485,360,802
1.36% 2.36% 8.34% 1.86%
NYSE National \a\....................... 827,209,968 1,489,403,927 1,340,645 2,317,954,540
(Inverted).............................. 0.63% 1.39% 0.07% 0.96%
Phlx (PSX) \b\ (Maker-Taker)............ 877,534,988 1,342,954,596 53,580 2,220,543,164
0.66% 1.25% 0.00% 0.92%
BX \b\.................................. 713,708,890 965,538,116 32,818,578 1,712,065,584
(Inverted).............................. 0.54% 0.90% 1.78% 0.71%
NYSE American \a\ (Maker-Taker)......... 712,130,625 818,767,495 14,185,250 1,545,083,370
0.54% 0.77% 0.77% 0.64%
NYSE Chicago \a\........................ 177,946,002 254,499,006 120,789 432,565,797
(Flat).................................. 0.13% 0.24% 0.01% 0.18%
LTSE.................................... 10,749,491 1,411,063 0 12,160,554
(Free).................................. 0.01% 0.00% 0.00% 0.01%
-----------------------------------------------------------------------
Total............................... 132,277,400,448 107,027,634,927 1,845,436,811 241,150,472,186
100.00% 100.00% 100.00% ................
54.85% 44.38% 0.77%
----------------------------------------------------------------------------------------------------------------
\a\ Part of NYSE/ICE Exchange group of exchanges.
\b\ Part of the Nasdaq group of exchanges.
\c\ Part of the Cboe group of exchanges.
The Commission estimates revenues generated from net transaction
fees for the different exchange groups using volume-weighted average
net capture rates which were made publicly available either through 10-
Q filings or published online; the reported net capture rates are
averages for all the different transactions occurring across the
various equities exchanges in each exchange group.\107\ The Commission
estimates that one exchange group had revenue generated from net
transaction fees in its US equities exchanges of approximately
$37,347,258 in January 2023,\108\ another exchange group had revenue of
$46,498,861,\109\ and a third exchange group had revenue of
$10,828,089.\110\
---------------------------------------------------------------------------
\107\ The Commission is making the assumption that the reported
average net capture rates collected from public disclosure hold for
the trading volume reported in Table 4. The publicly sourced data
regarding average net capture rates for the exchanges which are
publicly-traded issuers include the period of analysis, January
2023, as the disclosures pertain to Q1 2023. See infra notes 126,
127, 128.
\108\ The revenue numbers are calculated as the sum of the total
trading volume for the venues in an exchange group reported in Table
4 by their average net capture rate. Intercontinental Exchange, the
parent firm of NYSE, reports on page 38 of its Form 10-Q filing for
the three months ending Mar. 31, 2023 that its net capture for U.S.
equities transactions was approximately 4.5 mils in Q1 2023.
\109\ Nasdaq did not report its net capture in its Form 10-K
filing, however, Nasdaq provides information on its investor
relations web page which indicates that the average net capture
across all Nasdaq platforms for U.S. equities transactions in Q1
2023 was 6.4 mils. See Nasdaq 2023/2022 Monthly Volumes, NASDAQ,
available at <a href="https://ir.nasdaq.com/static-files/465d2157-c476-4546-a9f7-8d7ad0c9be77">https://ir.nasdaq.com/static-files/465d2157-c476-4546-a9f7-8d7ad0c9be77</a>.
\110\ Cboe reports in its Form 10-Q filing for the three months
ending Mar 31, 2023, that its net capture for U.S. equities
transactions was approximately 1.9 mils for Q1 2023.
---------------------------------------------------------------------------
The four exchanges outside of those three exchange groups made up
the remaining 11.81% of the market in January 2023. One exchange is a
free exchange, meaning that it does not charge access fees (nor does it
pay out transaction rebates) and hence does not generate revenue from
transaction net capture fees.\111\ Another exchange charges a flat fee
of $0.0009 per share to both liquidity providers and liquidity takers
leading to net capture of $0.0018 and an estimated transactions revenue
of $19,391,292 for January 2023.\112\ The remaining two exchanges are
not publicly-traded issuers and do not publicly disclose their net
capture rates. The Commission understands based on Staff conversations
with industry members that the net capture for non-auction trading in
stocks is likely close to $0.0002 per share and uses this assumed net
capture rate when estimating the transaction revenues for these
exchanges.\113\ Using the assumed net capture of $0.0002, or 2 mils,
the Commission estimates the January 2023 transaction revenues for
these two exchanges to be $2,648,337 and $897,072 respectively.\114\
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\111\ The exchange, LTSE does not charge fees to transact. See
supra note 15.
\112\ See IEX pricing schedule, supra note 15.
\113\ The assumption that the remaining two exchanges (MEMX &
MIAX Pearl) earn an estimated 2 mils net capture per transaction is
in line with prior Commission discussions and would put them in line
with the net capture rate reported by the Cboe group. See supra note
110.
\114\ See supra note 98 defining the term ``mil''.
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The maker-taker transaction pricing model and higher rebates play
an important role in attracting competitively priced quotes and
capturing market share, as suggested by the market share statistics of
Table 4.
[[Page 76303]]
There are important factors which serve to limit the liquidity of lower
volume exchanges; these exchanges are not the primary listing market
for any securities as they are newer, and they also tend to be more
specialized or structured to facilitate specific trading strategies.
The idea that the maker-taker transaction pricing model and rebates
offered play an important role in exchange market share is also
supported by the results of an experiment run by one maker-taker
exchange, Nasdaq, in which it reduced both its fees and rebates. The
experiment resulted in less competitive liquidity being supplied to the
exchange along with a decrease in the exchange's market share in the
treated stocks. That market share fell despite the reduction in
transaction fees being greater than the reduction in rebates suggests
that changes in the transaction pricing applicable to liquidity-
providing order flow may have a greater effect on exchange market share
than similar changes in the transaction pricing applicable to
liquidity-demanding order flow. In this experiment, the exchange
unilaterally reduced both access fees and rebates for a set of 14
stocks. Over the course of the experiment Nasdaq reported a significant
drop in a number of liquidity provision measures.\115\ Per the Nasdaq
reports, the average number of shares displayed by Nasdaq at the NBBO
in the experiment declined by 45%, average time at the NBBO declined by
4.7 percentage points from 92.7% to 88.0%, liquidity share \116\ fell
from 29% to 19%, and the share of liquidity provided by the exchange's
top five liquidity providers prior to the experiment decreased from
44.5% to 28.7%. These changes align with the findings of one academic
study (the ``Swan Study'') which also analyzed the Nasdaq
experiment.\117\
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\115\ Nasdaq produced two reports concerning their access fee
experiment. See Frank Hatheway, Nasdaq Access Fee Experiment (Mar.
2015), available at https://pages.stern.nyu.edu/~jhasbrou/
SternMicroMtg/Old/SternMicroMtg2015/Supplemental/
Access%20Fee%20Experiment%20-%20Month%20One%20Report%20Final.pdf.
See also Frank Hatheway, Nasdaq Access Fee Experiment Report II
(Mar. 2015), available at https://pages.stern.nyu.edu/~jhasbrou/
SternMicroMtg/Old/SternMicroMtg2015/Supplemental/
Access%20Fee%20Experiment%20-%20Second%20Report%20Final.pdf
(``Nasdaq Access Fee Experiment Report II'').
\116\ ``Liquidity Share'' is a measure of an exchange's
displayed liquidity, factoring in both the frequency it is at the
NBBO and the size of its quote. The calculation involves weighing
the average size quoted by an exchange that is concurrently quoting
at the NBBO by the duration of time spent quoting at the NBBO to
yield a quantity which is referred to as ``Average Liquidity.'' This
value is then divided by the total average liquidity of all
exchanges quoting the stock to compute the liquidity share. See
Nasdaq Access Fee Experiment Report II, supra note 115.
\117\ See Yiping Lin, Peter Lawrence Swan, and Frederick H. deB.
Harris, ``Why Maker-Taker Fees Improve Exchange Quality: Theory and
Natural Experimental Evidence'' (Mar. 14, 2019), available at
<a href="https://ssrn.com/abstract=3034901">https://ssrn.com/abstract=3034901</a> (retrieved from SSRN Elsevier
database).
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Both the Nasdaq reports and the Swan Study found that Nasdaq's
market share fell in traded stocks, with Nasdaq reporting an average
decline of 1.8 percentage points. The Swan Study found that the Nasdaq
share loss was captured by the two highest rebate-paying stock
exchanges. As the experiment also reduced fees in addition to rebates,
the reported reduction in market share was a net effect of both
reductions, it is likely that the reduction in market share would be
greater had access fees not also been reduced.\118\ Other factors which
may have contributed to the decrease in market share include the
improved fill rates and fill times, as well as narrower effective and
realized spreads net of transaction rebates and fees on competing
exchanges which were reported in the Swan Study.
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\118\ Conditional on compliance with Rule 611 and keeping all
else equal, including other considerations of execution quality,
traders typically would prefer to route their marketable order to a
trading venue with a lower access fee. Thus, a reduction in access
fees would help attract marketable orders and increase trading
volume.
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b. Volume-Based Pricing Tiers
Stock exchange transaction pricing schedules often operate with a
tiered system that relies on the volume an exchange member brings to
the exchange to determine its transaction pricing tier for a given
month. Qualification to different rebate and fee tiers is determined at
the end of each month and typically is based on a member's average
daily share volume for the month as a percentage of the total
consolidated volume that month.\119\ This kind of pricing method where
exchanges offer different fee and rebate levels to members based on the
amount of trading volume each member executes on the exchange is
referred to as volume-based exchange transaction pricing.\120\ The tier
threshold is often expressed as a percentage of the total consolidated
volume reported by one or all consolidated tapes for the month.\121\ It
is common that tier thresholds are defined relative to the trading
volume of the market as a whole; it is seldom the case that tier
thresholds are set as an absolute number of shares.
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\119\ See supra note 17 (discussing the Commission's Access Fee
Proposal that would require exchanges to make the amounts of all
fees and rebates determinable at the time of execution, which would
require volume-based transaction pricing tiers to be applied
prospectively rather than retroactively to the start of a month).
\120\ Volume-based tiers in trading often have different
qualifications. For instance, some tiers require adding Average
Daily Volume (``ADV''), while others consider total ADV (both add
and remove volume), and some tiers are tape dependent. There are
also specific tiers for mid-point liquidity (``MPL'') orders, non-
displayed limit orders, and opening/closing auction trading, to name
a few.
\121\ For example, an exchange may require a member to
accumulate, on a specific tape, an amount of adding trading volume
(trade volume from trades which executed against a member's
liquidity providing order) greater than X% of the total consolidated
trading volume for that specific tape.
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The Commission understands that exchanges make use of volume-based
tiers as a means of encouraging their members to execute orders on
their venue. Volume-based tiers encourage exchange members to
concentrate, or execute a larger share of their order flow, on the
exchange in order to qualify for the higher rebates or lower fees
offered by higher volume pricing tiers.\122\
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\122\ See infra section IV.B.2 for a discussion of the
incentives introduced by volume-based pricing tiers.
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The pricing terms of the tiers reserved for high volume exchange
members may be subsidized through higher net capture rates of lower-
volume members or via other lines of business such as those earned from
providing connectivity and market data.\123\ The fact that many
exchanges offer high-tier rebates that exceed the Rule 610 access fee
cap in magnitude implies a need for cross-subsidization to support
these rebate tiers. In a 2018 roundtable on market data and market
access, one exchange that participated in the roundtable stated that
five out of their ten largest members by trading volume receive payment
from the exchange even after factoring in the costs of connectivity and
market data.\124\ This suggests that the rebates an exchange pays to
those members may be subsidized by the net transaction fees paid by
other exchange members or the fees paid for other services such as data
and connectivity.
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\123\ A flat pricing schedule does not allow an exchange to
offer some traders a higher rebate (lower fee) by offering others a
lower rebate (higher fee). In principle the cross-subsidization of
rebates from other business lines could occur in the absence of
pricing tiers though this is likely to be more costly since the flat
nature of the pricing schedule would mean that the trading of all
members would have to subsidized rather than, potentially, just the
trades of the members which qualify for the preferential pricing
tiers.
\124\ See Remarks of Chris Concannon, supra note 3, Transcript
at 74-75.
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Newer or smaller exchanges may find it difficult to attract order-
flow away from the larger legacy exchanges given that a sizable portion
of order flow is provided by the high-volume exchange
[[Page 76304]]
members which qualify for the top tiers and similar terms would have to
be offered to those members to pull them away. As previously discussed,
exchanges are able to use volume-based pricing as a means of increasing
the rebates earned by a few high-volume exchange members often at the
expense of members with less trading volume; the lack of a large
trading base could make it difficult to profitably subsidize the top
tiers from the trades of other exchange members. Smaller or newer
exchanges looking to compete with larger exchanges would find it
difficult to compete with larger exchanges by cutting transaction fees.
In the case of a maker-taker exchange, cutting take fees may require
lower rebates for liquidity provision by lowering the degree to which
those rebates can be funded via take fees. Cutting make rebates
relative to those offered on other exchanges would likely hamper an
exchange's tendency to attract competitively priced limit orders
putting the exchange in a competitively disadvantageous position. In
the case of an inverted or flat venue, cutting make fees could help an
exchange attract more liquidity however because these exchanges by
their very nature, charge fees rather than pay rebates to liquidity
providers, makes them less attractive as a venue to post a competitive
quote, all else being equal. Alternatively, smaller or newer exchanges
could try to compete with the larger maker-taker exchanges on the basis
of offering larger make rebates, lacking substantial trading volume
could make cross-subsidization of rebates difficult possibly meaning
that the exchange may need to operate their trading business at a loss
in order to match or beat the top rebates of other exchanges.\125\ The
lack of a similar membership base, trading volume, and data and
connectivity subscribers make it difficult for smaller exchanges to
sustainably provide volume-based tiers competitive with the top tiers
offered by the largest exchanges.
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\125\ For example, a new exchange in 2020 implemented a pricing
schedule with high rebate tiers which would generate losses while
the venue tried to establish market share. See Shanny Basar, New
Exchange MEMX Details `Smart' Pricing Structure (Sept. 15, 2020)
available at <a href="https://www.tradersmagazine.com/am/memx-unveils-smart-pricing-structure/">https://www.tradersmagazine.com/am/memx-unveils-smart-pricing-structure/</a>.
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An alternative view on the complexity of pricing schemes offered by
the dominant exchange families \126\ is to regard the range of volume-
based discounts as a form of product proliferation, a preemptive
strategy for limiting the range of profitable choices available for
newer and smaller exchanges. Reminiscent of behavior by established
firms when attempting to corner the market across other industry
settings,\127\ the range of pricing bundles offered by the dominant
exchanges may likewise have partial exclusionary effects.
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\126\ Most of the public exchanges are organized based on
families of affiliated exchanges, where the exchanges within a
family are owned by the same holding company but may employ distinct
business models (e.g., charging a ``make'' fee on taker-maker
exchanges or a ``take'' fee on maker-taker exchanges).
\127\ See Jean Tirole, The Theory of Industrial Organization,
346-52 (1988) for a discussion of leading firms' incentive to pack
the product space so as constrain the market niche for new or minor
firms. A motivating example is ``the Swedish Tobacco Company, upon
losing its legal monopoly position in 1961, reacted by offering
twice as many brands.'' Id. at 346. Dominant firm's preemptive
decision to introduce a menu of latent choices is also analyzed in
Yong Chao, Guofu Tan, and Adam Chi Leung Wong, ``Optimal Nonlinear
Pricing by a Dominant Firm under Competition'', 14 Am. Econ. J.:
Microeconomics 240 (May 2022).
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c. Tying Closing Auction Fees to Consolidated Volume
The daily closing price of NMS equities is typically established by
means of the closing auction, which is run at the end of each trading
day by the primary listing exchange for the respective equity. Because
of the significance of the closing price to a variety of financial
market functions, including the measuring of tracking error in index
funds, many market participants are highly desirous of executing trades
at precisely the daily closing price, an outcome that can be
facilitated by participating in the closing auction on the listing
exchange. Listing exchanges may be able to exploit this demand for
participation in the closing auction by offering discounts on auction
orders to members who send volume into the intraday trading sessions.
This practice may help listing exchanges preserve or extend their
market power, potentially at the expense of reducing the welfare of the
exchange members.
A number of factors contribute to high and growing \128\ demand for
participation in closing auctions. One significant reason for this is
that an important performance metric for passive funds, the tracking
error, is tied to the daily closing price set by these closing
auctions. For this reason, index funds and exchange-traded funds are
motivated to concentrate flow in the closing auctions so as to minimize
tracking errors.\129\
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\128\ For S&P 500 stocks, the daily average fraction of a
stock's closing auction trades over total shares traded increased
from 3.5% in 2010 to 10% in 2018. See Yanbin Wu, ``Closing Auction,
Passive Investing, and Stock Prices,'' 9 (Aug. 2019), available at
<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3440239">https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3440239</a>. Another
source reports that the shares that the NYSE closing auctions
commanded doubled over a five-year period to nearly 7% of NYSE-
listed volume in recent years. See ``Behind the Scenes--An Insider's
Guide to the NYSE Closing Auction,'' available at <a href="https://www.nyse.com/article/nyse-closing-auction-insiders-guide">https://www.nyse.com/article/nyse-closing-auction-insiders-guide</a>.
\129\ Yanbin Wu, ``Closing Auction, Passive Investing, and Stock
Prices,'' supra note 128.
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Listing exchanges operate closing auctions that set an official
closing price for their listed securities.\130\ This makes them an
obvious means by which a market participant can get its trades executed
at the official closing price. Some alternatives do exist, for example,
some broker-dealers may offer to internalize customer orders at the
closing auction price,\131\ once it is determined on the listing
exchange. Another example of an alternative is the pre-match close
offered by one exchange for market-on-close orders.\132\ However, if a
market participant wishes to execute an on-exchange trade at the
official closing price determined by the primary listing exchange, and
use a limit-on-close order for that trade, the only option is to send
that order to the listing exchange's closing auction.
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\130\ The exchanges that currently have listings are Nasdaq,
NYSE, NYSE Arca, and Cboe's BZX. See Cboe's ``The Impact Closing
Auctions Have on Volumes'' (Nov. 18, 2020), available at <a href="https://www.cboe.com/insights/posts/the-impact-closing-auctions-have-on-volumes/">https://www.cboe.com/insights/posts/the-impact-closing-auctions-have-on-volumes/</a>.
\131\ Staff experience suggests that some broker-dealers aim to
enhance their volumes and attract flow by guaranteeing the listing
market's official closing price at no additional cost.
\132\ See <a href="https://www.cboe.com/us/equities/trading/offerings/cboe_market_close/">https://www.cboe.com/us/equities/trading/offerings/cboe_market_close/</a>.
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Some primary listing exchanges implement closing auction pricing
tiers that involve discounts which are based on the member's overall
trading volume on the same exchange.\133\ Specifically, the exchange
pricing schedule is such that higher consolidated volume (overall
volume from both auctions and regular trading hours) helps broker-
dealers qualify for more favorable fees and rebates on auction orders.
Industry practitioners refer to ``auction linked pricing'' as a
discount on auction orders based on the continuous trading volume.\134\
This practice is a form of tying or conditional pricing. The related
literature, referenced in the following paragraph, has shown that tying
can reduce competition and has potential
[[Page 76305]]
exclusionary effects. There is a lack of consensus within the economic
literature on the anti-competitive potential of offering price
discounts for allocating a target purchasing level in a bundled goods
context. However, the theoretical literature has provided examples
arguing that tying the sales of a monopolized or dominant product to
other product(s) can be a profitable way for a firm to protect its
market power, oftentimes through partially foreclosing the more
competitive portion of the market to competitors.\135\ In other
imperfectly competitive market settings, offering more generous terms
for purchasing a bundle of different goods can also result in greater
producer surplus.\136\ Bundling arrangements may have partial
exclusionary effects when a dominant firm takes advantage of its
captive (non-contestable) portion of demand and ties its captive demand
with part of its contestable demand.\137\ Mor
[…truncated; see source link]Indexed from Federal Register on November 6, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.