Notice2024-03539
Joint Industry Plan; Order Instituting Proceedings To Determine Whether To Approve or Disapprove the Twenty-Third Amendment to the National Market System Plan To Address Extraordinary Market Volatility by Cboe BYX Exchange, Inc., Cboe BZX Exchange, Inc., Cboe EDGA Exchange, Inc., Cboe EDGX Exchange, Inc., The Financial Industry Regulatory Authority, Inc., Investors Exchange LLC, Long-Term Stock Exchange, Inc., MEMX LLC, MIAX Pearl, LLC, NASDAQ BX, Inc., NASDAQ PHLX LLC, The NASDAQ Stock Market LLC, New York Stock Exchange LLC, NYSE American LLC, NYSE Arca, Inc., NYSE Chicago, Inc., and NYSE National, Inc.
Primary source
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Published
February 22, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 36 (Thursday, February 22, 2024)</title>
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[Federal Register Volume 89, Number 36 (Thursday, February 22, 2024)]
[Notices]
[Pages 13389-13395]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-03539]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99545; File No. 4-631]
Joint Industry Plan; Order Instituting Proceedings To Determine
Whether To Approve or Disapprove the Twenty-Third Amendment to the
National Market System Plan To Address Extraordinary Market Volatility
by Cboe BYX Exchange, Inc., Cboe BZX Exchange, Inc., Cboe EDGA
Exchange, Inc., Cboe EDGX Exchange, Inc., The Financial Industry
Regulatory Authority, Inc., Investors Exchange LLC, Long-Term Stock
Exchange, Inc., MEMX LLC, MIAX Pearl, LLC, NASDAQ BX, Inc., NASDAQ PHLX
LLC, The NASDAQ Stock Market LLC, New York Stock Exchange LLC, NYSE
American LLC, NYSE Arca, Inc., NYSE Chicago, Inc., and NYSE National,
Inc.
February 15, 2024.
I. Introduction
On October 24, 2023, NYSE Group, Inc., on behalf of the
Participants \1\ to the National Market System Plan to Address
Extraordinary Market Volatility (``Plan''),\2\ filed with the
Securities and Exchange Commission (``Commission''), pursuant to
section 11A(a)(3) of the Securities Exchange Act of 1934 (``Act'' or
``Exchange Act'') \3\ and Rule 608 thereunder,\4\ a proposal
(``Proposal'' or ``Proposed Amendment'') to amend Appendix A to the
Plan to provide that all exchange-traded products (``ETPs'') will be
assigned to Tier 1 of the Plan, except for single stock ETPs, which
will be assigned to the same tier as their underlying stock, and in
each case adjusted for any leverage factor. The Proposed Amendment was
published for comment in the Federal Register on November 21, 2023.\5\
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\1\ The Participants are: Cboe BYX Exchange, Inc., Cboe BZX
Exchange, Inc., Cboe EDGA Exchange, Inc., Cboe EDGX Exchange, Inc.,
The Financial Industry Regulatory Authority, Inc., Investors
Exchange LLC, Long-Term Stock Exchange, Inc., MEMX LLC, MIAX Pearl,
LLC, NASDAQ BX, Inc., NASDAQ PHLX LLC, The NASDAQ Stock Market LLC,
New York Stock Exchange LLC, NYSE American LLC, NYSE Arca, Inc.,
NYSE Chicago, Inc., and NYSE National, Inc. (collectively,
``Participants'').
\2\ On May 31, 2012, the Commission approved the Plan, as
modified by Amendment No. 1. See Securities Exchange Act Release No.
67091, 77 FR 33498 (June 6, 2012) (File No. 4-631) (``Approval
Order''). On February 20, 2013, the Commission noticed for immediate
effectiveness the Second Amendment to the Plan. See Securities
Exchange Act Release No. 68953, 78 FR 13113 (February 26, 2013). On
April 3, 2013, the Commission approved the Third Amendment to the
Plan. See Securities Exchange Act Release No. 69287, 78 FR 21483
(April 10, 2013). On August 27, 2013, the Commission noticed for
immediate effectiveness the Fourth Amendment to the Plan. See
Securities Exchange Act Release No. 70273, 78 FR 54321 (September 3,
2013). On September 26, 2013, the Commission approved the Fifth
Amendment to the Plan. See Securities Exchange Act Release No.
70530, 78 FR 60937 (October 2, 2013). On January 7, 2014, the
Commission noticed for immediate effectiveness the Sixth Amendment
to the Plan. See Securities Exchange Act Release No. 71247, 79 FR
2204 (January 13, 2014). On April 3, 2014, the Commission approved
the Seventh Amendment to the Plan. See Securities Exchange Act
Release No. 71851, 79 FR 19687 (April 9, 2014). On February 19,
2015, the Commission approved the Eight Amendment to the Plan. See
Securities Exchange Act Release No. 74323, 80 FR 10169 (February 25,
2015). On October 22, 2015, the Commission approved the Ninth
Amendment to the Plan. See Securities Exchange Act Release No.
76244, 80 FR 66099 (October 28, 2015). On April 21, 2016, the
Commission approved the Tenth Amendment to the Plan. See Securities
Exchange Act Release No. 77679, 81 FR 24908 (April 27, 2016). On
August 26, 2016, the Commission noticed for immediate effectiveness
the Eleventh Amendment to the Plan. See Securities Exchange Act
Release No. 78703, 81 FR 60397 (September 1, 2016). On January 19,
2017, the Commission approved the Twelfth Amendment to the Plan. See
Securities Exchange Act Release No. 79845, 82 FR 8551 (January 26,
2017). On April 13, 2017, the Commission approved the Thirteenth
Amendment to the Plan. See Securities Exchange Act Release No.
80455, 82 FR 18519 (April 19, 2017). On April 28, 2017, the
Commission noticed for immediate effectiveness the Fourteenth
Amendment to the Plan. See Securities Exchange Act Release No.
80549, 82 FR 20928 (May 4, 2017). On September 26, 2017, the
Commission noticed for immediate effectiveness the Fifteenth
Amendment to Plan. See Securities Exchange Act Release No. 81720, 82
FR 45922 (October 2, 2017). On March 15, 2018, the Commission
noticed for immediate effectiveness the Sixteenth Amendment to the
Plan. See Securities Exchange Act Release No. 82887, 83 FR 12414
(March 21, 2018) (File No. 4-631). On April 12, 2018, the Commission
approved the Seventeenth Amendment to the Plan. See Securities
Exchange Act Release No. 83044, 83 FR 17205 (April 18, 2018). On
April 11, 2019, the Commission approved the Eighteenth Amendment to
the Plan. See Securities Exchange Act Release No. 85623, 84 FR 16086
(April 17, 2019) (``Amendment 18''). On February 5, 2020, the
Commission noticed for immediate effectiveness the Nineteenth
Amendment to the Plan. See Securities Exchange Act Release No.
88122, 85 FR 7805 (February 11, 2020) (File No. 4-631). On April 21,
2020, the Commission approved the Twentieth Amendment to the Plan.
See Securities Exchange Act Release No. 88704, 85 FR 23383 (April
27, 2020). On July 29, 2020, the Commission noticed for immediate
effectiveness the Twenty-First Amendment to the Plan. See Securities
Exchange Act Release No. 89420, 85 FR 46762 (August 3, 2020) (File
No. 4-631). On October 1, 2020, the Commission noticed for immediate
effectiveness the Twenty-Second Amendment to the Plan. See
Securities Exchange Act Release No. 90068, 85 FR 63322 (October 7,
2020) (File No. 4-631).
\3\ 15 U.S.C. 78k-1(a)(3).
\4\ 17 CFR 242.608.
\5\ See Securities Exchange Act Release No. 98928 (November 14,
2023), 88 FR 81131 (``Notice''). Comments received in response to
the Notice can be found on the Commission's website at: <a href="https://www.sec.gov/comments/4-631/4-631.htm">https://www.sec.gov/comments/4-631/4-631.htm</a>.
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This order institutes proceedings under Rule 608(b)(2)(i) of
Regulation NMS \6\ to determine whether to approve or disapprove the
Proposed Amendment or to approve the Proposed Amendment with any
changes or subject to any conditions the Commission deems necessary or
appropriate after considering public comment.
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\6\ 17 CFR 242.608(b)(2)(i).
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II. Background
The Participants filed the Plan with the Commission on April 5,
2011 \7\ to create a market-wide limit up-limit down mechanism intended
to address extraordinary market volatility in NMS Stocks, as defined in
Rule 600(b)(47) of Regulation NMS under the Exchange Act.\8\ The Plan
sets forth procedures that provide for market-wide limit up-limit down
requirements to prevent trades in individual NMS Stocks from occurring
outside of the specified Price Bands.\9\ These limit up-limit down
requirements are coupled with Trading Pauses, as defined in Section
I(Y) of the Plan, to accommodate more fundamental price moves. In
particular, the Participants adopted the Plan to address extraordinary
volatility in the securities markets, i.e., significant fluctuations in
individual securities' prices over a short period of time, such as
those experienced during the ``Flash Crash'' on the afternoon of May 6,
2010.
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\7\ On May 31, 2012, the Commission approved the Plan, as
modified by Amendment No. 1. See Approval Order, supra note 2.
\8\ 17 CFR 242.600(b)(47).
\9\ See Notice, 88 FR at 81144-45 (setting forth the defined
terms as used under the Plan). For purposes of this order, all
capitalized terms referenced, but not otherwise defined, herein
shall have the meanings as defined under the Plan or as defined in
the Notice.
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As set forth in more detail in the Plan, the single plan processor
(``Processor'' or ``Processors''), which is responsible for
consolidation of information for an NMS Stock pursuant to Rule 603(b)
of Regulation NMS under the Exchange Act, calculates and disseminates a
lower Price Band and upper Price Band for each NMS Stock. As set forth
in Section V of the Plan, the Price Bands are based on a Reference
Price for each NMS Stock that equals the arithmetic mean price of
Eligible Reported Transactions for the NMS Stock over the immediately
preceding five-minute period. The Price Bands for an NMS Stock are
calculated by applying the Percentage Parameters, as set out in
Appendix A to the Plan,\10\ for such NMS Stock to the Reference
[[Page 13390]]
Price, with the lower Price Band being a Percentage Parameter below the
Reference Price, and the upper Price Band being a Percentage Parameter
above the Reference Price.
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\10\ See Notice, 88 FR at 81148 (Appendix A to the Plan).
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Appendix A to the Plan sets out the definitions of Tier 1 and Tier
2 NMS Stocks and the Percentage Parameters for each. Appendix A
currently provides that Tier 1 includes all NMS Stocks included in the
S&P 500 Index and the Russell 1000 Index, as well as ``eligible'' ETPs.
Appendix A specifies:
To determine eligibility for an ETP to be included as a Tier 1
NMS Stock, all ETPs across multiple asset classes and issuers,
including domestic equity, international equity, fixed income,
currency, and commodities and futures will be identified. Leveraged
ETPs will be excluded, and the list will be sorted by notional
consolidated average daily volume (``CADV''). The period used to
measure CADV will be from the first day of the previous fiscal half
year up until one week before the beginning of the next fiscal half
year. Daily volumes will be multiplied by closing prices and then
averaged over the period. ETPs, including inverse ETPs, that trade
over $2,000,000 CADV will be eligible to be included as a Tier 1 NMS
Stock.
The eligible ETPs are then listed in Schedule 1 to Appendix A, and
the list is reviewed and updated semi-annually. All ETPs that do not
meet the ``eligibility'' definition are currently assigned to Tier 2.
For Tier 1 NMS Stocks, Appendix A defines the Percentage Parameters
as:
<bullet> 5% for Tier 1 NMS Stocks with a Reference Price more than
$3.00;
<bullet> 20% for Tier 1 NMS Stocks with a Reference Price equal to
$0.75 and up to and including $3.00; and
<bullet> The lesser of $0.15 or 75% for Tier 1 NMS Stocks with a
Reference Prices less than $0.75.
For Tier 2 NMS Stocks, Appendix A defines the Percentage Parameters
as:
<bullet> 10% for Tier 2 NMS Stocks with a Reference Price of more
than $3.00;
<bullet> 20% for Tier 2 NMS Stocks with a Reference Price equal to
$0.75 and up to and including $3.00; and
<bullet> The lesser of $0.15 or 75% for Tier 2 NMS Stocks with a
Reference Price less than $0.75.
The Percentage Parameter for a Tier 2 NMS Stock that is a leveraged
ETP is the applicable Percentage Parameter set forth above, multiplied
by the leverage ratio of such product.
III. Summary of the Proposed Amendment <SUP>11</SUP>
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\11\ This section summarizes the proposed changes to the Plan
and the Participants' analysis supporting the proposed changes, as
described in the Notice. For a full discussion of the Proposed
Amendment, including the Participants' justifications for the
Proposed Amendment, see Notice, supra note 5.
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The Participants propose to amend Appendix A to delete the
definition of ETPs ``eligible'' for Tier 1, and to specify that all
ETPs except for single-stock ETPs would be assigned to Tier 1. The
Participants also propose to delete Schedule 1 to Appendix A as
obsolete. Under the Proposal, Appendix A, Section I, paragraph (1)
would read as follows:
Tier 1 NMS Stocks shall include all NMS Stocks included in the
S&P 500 Index and the Russell 1000 Index, and all exchange-traded
products (``ETP''), except for single stock ETPs, which will be
assigned to the same Tier as their underlying stock, adjusted for
any leverage factor.
Because all leveraged ETPs (except Tier 2 single stock ETPs) would
be assigned to Tier 1, the Participants also propose to add text into
Section I of Appendix A describing how the Percentage Parameters would
be set for leveraged ETPs. The Participants propose to insert the
following as paragraph (5) of Section I, and to renumber the paragraphs
of Section I accordingly:
Notwithstanding the foregoing, the Percentage Parameters for a
Tier 1 NMS Stock that is a leveraged ETP shall be the applicable
Percentage Parameter set forth in clauses (2), (3), or (4) above,
multiplied by the leverage ratio of such product.
A. Study Data
The Participants reviewed trading and quoting in all ETPs during
the period from Q4 of 2019 through Q2 of 2021. This time span afforded
the Participants the opportunity to study how the Plan performed during
certain stressful periods. The ETPs studied covered several asset
classes, including domestic equities, international equities, fixed
income, currency, commodity, and digital currency ETPs.
At the time the Participants conducted the study, there were not
yet any single stock ETPs listed in the U.S. markets. Because a single
stock ETP should closely track the price movement and volatility of its
underlying security, the Participants assert that it should be assigned
to the same tier, adjusted for any leverage factor, to maintain uniform
and congruous application of controls.
The Participants also excluded Tier 2 ETPs with a Reference Price
of $3.00 or less, since ETPs with a Reference Price of $3.00 or less
are subject to identical Percentage Parameters under Tier 1 and Tier 2.
The Participants also excluded the last 25 minutes of the trading day
from the study, since the Percentage Parameters for Tier 1 and Tier 2
NMS Stocks with Reference Prices more than $3.00 are identical during
that period.
B. Study Methodology
The Participants' study consists of three parts. First, the
Participants compared the realized volatility and incidence of Limit
States and Trading Halts in Tier 2 ETPs against both Tier 1 and Tier 2
non-ETPs, to review the reasonableness of assigning ETPs to Tier 2.
Second, the Participants calculated theoretical Tier 1 (i.e., 5%)
Price Bands for all Tier 2 ETPs in the study. For example, normally a
Tier 2 ETP with a Reference Price of $10.00 would have a lower Price
Band of $9.00 and an upper Price Band of $11.00 (i.e., 10% bands). For
purposes of the study, that same ETP would have a theoretical Tier 1
lower Price Band of $9.50 and an upper Price Band of $10.50 (i.e., 5%
bands). Once the theoretical narrower bands were calculated, the
Participants identified all trades that occurred at prices between the
theoretical narrower bands and the actual Tier 2 bands. The
Participants then calculated the total notional value if all trades
beyond the theoretical narrow bands had been prevented, as well as the
total notional value if all such trades had occurred at the price of
the new bands, to determine the range of potential notional value
impact of applying Tier 1 bands to Tier 2 ETPs. The Participants also
studied the price movement following these ``breaches'' of the
theoretical narrower bands and the likelihood of reversion to determine
the efficacy of tightening the bands.
Third, the Participants compared market quality changes and the
frequency of Limit States and Trading Halts for Tier 1 ETPs vs. Tier 2
ETPs by studying the ETPs that shift from one tier to the other as part
of the current semi-annual review process.
C. Study Results
1. Volatility of Tier 2 ETPs vs. Tier 1 and Tier 2 Non-ETPs
For the first part of the study, the Participants compared the
volatility of Tier 2 ETPs during the study period to the volatility of
non-ETP securities. If the purpose of Tier 2's wider bands is to
address higher expected volatility in Tier 2 NMS Stocks, but ETPs in
Tier 2 are already less volatile than non-ETPs in Tier 1, that would
suggest that ETPs do not actually need Tier 2's wider bands.
According to the Participants, except for single-stock, commodity,
and foreign exchange-based ETPs, ETPs are, by definition, diversified
instruments.
[[Page 13391]]
Notwithstanding the lower trading volumes associated with the less
liquid ETPs included in Tier 2, Tier 2 ETPs exhibit volatilities that
are lower than those observed for Tier 1 non-ETPs that already trade
with narrower Price Bands today.
The Participants calculated quote volatilities \12\ for all
securities that were part of the Plan during 2021. Non-leveraged Tier 2
ETPs had an average quote volatility of 0.241 basis points with a 90th
percentile of 0.275 basis points. Those figures are lower than for Tier
1 non-ETPs during the same period, which had an average quote
volatility of 0.258 basis points with a 90th percentile of 0.446 basis
points. Tier 2 non-ETPs had more than four times higher average quote
volatility and almost double the average quote volatility at the 90th
percentile compared to Tier 2 non-leveraged ETPs. Leveraged Tier 2 ETPs
were somewhat higher than non-leveraged Tier 2 ETPs, with an average
quote volatility of 0.736 basis points and a 90th percentile of 1.317
basis points. Most leveraged ETPs represent commodities or volatility
index products, which would be expected to exhibit higher volatility.
However, these products' Price Bands are also multiplied by their
leverage factor, which makes their higher volatility relative to other
ETPs acceptable.
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\12\ The Participants measured quote volatility as the average
basis point change of each second's mid-point during core hours
annualized.
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In comparing the incidence of Trading Pauses and Limit States
during 2021 by Tier 1 non-ETPs, Tier 2 ETPs, and Tier 2 non-ETPs priced
above $3.00, the data shows that during 2021, Tier 2 non-leveraged ETPs
had fewer Trading Pauses and Limit States than Tier 1 non-ETPs, even
though the Tier 2 non-leveraged ETPs comprised nearly 50% more
securities. In addition, Tier 2 non-ETPs had roughly four times the
number of symbols, but 63 times the number of Limit States per day
compared to Tier 2 non-leveraged ETPs. Tier 2 ETPs at the 90th
percentile did not have any Trading Pauses, while there were 30 Trading
Pauses for Tier 2 non-ETPs.
Overall, the comparison between Tier 1 non-ETPs and Tier 2 ETPs
shows that quote volatility of Tier 2 ETPs operating under wider Price
Bands is lower than Tier 1 non-ETPs, and that the incidence of Limit
States and Trading Pauses for Tier 1 non-ETPs is substantially higher
than that of Tier 2 ETPs. By contrast, Tier 2 non-ETPs are considerably
more volatile than Tier 1 non-ETPs, which substantiates the wider Price
Bands applied to these securities, as the higher number of Limit States
and Trading Pauses in Tier 2 non-ETPs are occurring under 10% Price
Bands. The Participants believe that these data indicate that the Price
Bands are not well-calibrated to the realized volatility for Tier 2
ETPs and should not be twice as wide as those for Tier 1 non-ETPs.
2. Analysis of ETP Trades Executing Past Theoretical Tier 1 Bands
For the second part of the study, the Participants sought to
identify the range of potential notional value that would have been
impacted during the study period if trades in Tier 2 ETPs had been
bounded by 5% Price Bands instead of 10% Price Bands. Specifically, the
Participants calculated theoretical Tier 1 (i.e., 5%, adjusted for
leverage factor) Price Bands for all Tier 2 ETPs in the study
(``Theoretical Tier 1 Bands''). Once the theoretical narrower bands
were calculated, the Participants identified 101,956 trades that
occurred at prices between the Theoretical Tier 1 Bands and the actual
Tier 2 bands. The Participants then calculated the upper and lower
ranges of the notional value of the trades that would have been
impacted during the study period if Tier 2 ETPs had been subject to the
narrower Theoretical Tier 1 Bands instead of the actual Tier 2 bands.
The Participants drilled down into the results to determine, on a
day-by-day basis, the amount of notional value prevented, and the
number of symbols impacted, by the narrower Theoretical Tier 1 Bands.
Most of the notional value that would have been prevented by using the
narrower Theoretical Tier 1 Bands for Tier 2 ETPs occurred across a
handful of trade dates when the markets were very volatile. Together,
the 10 days with the highest notional value for trades prevented
account for 59% of the trades prevented and 61% of the total notional
value overall. More than $45 million in trades could have been
prevented during the pandemic-driven volatility in 2020. In contrast,
over the entire study period, the number of Tier 2 ETPs that would have
been impacted by using narrower Theoretical Tier 1 Bands was a median
of nine ETPs per day.
The Participants conclude that on most days, tighter Price Bands
would have had little impact on the trading of Tier 2 ETPs. However,
during periods of extreme volatility overall, the narrower bands may
prevent unnecessary volatility in Tier 2 ETPs. Using narrower Tier 1
Bands for these ETPs could protect investors from executing trades at
inferior prices that may occur due to transitory gaps in liquidity.
The Participants recognize that the positive impacts of using
narrower Theoretical Tier 1 Bands would be blunted if the price trend
that triggers a Trading Pause continues in the same direction. To study
this issue, the Participants computed several statistics to measure the
impact of blocking these trades at the narrower Theoretical Tier 1
Bands. The Participants calculated these statistics as a fraction of
simple trade counts, as well as the percentage of shares that were
impacted by the theoretical narrower bands. The calculations are as
follows:
1. Last mid-quote 5 minutes after the blocked trade compared to
the trade execution price.
2. Last mid-quote 10 minutes after the blocked trade compared to
the trade execution price.
3. Same as #1, except cases where the stock paused in the next 5
minutes (because there may not be reliable 5-minute mid-quotes).
4. Same as #2, except cases where the stock paused in the next
10 minutes (because there may not be reliable 10-minute mid-quotes).
5. Same as #1-#4, except measured against the theoretical
narrower bands. This measures the worst-case situation, where none
of the trades would have occurred and the full impact of blocking
the trades is shown.
Prices 5 and 10 minutes after a theoretically prevented trade
usually reverted away from the offending trade price towards prior
prices, and less often moved back to levels inside the new bands. When
prices do not revert, the benefit of the tighter bands is less clear,
but the tendency toward reversion is further evidence in support of
narrowing the bands to Tier 1 levels. After 5 minutes, more than 70% of
the trades and nearly 75% of the shares impacted had their last quote
return to price levels prior to the move that caused the breach of the
Theoretical Tier 1 Band. After 10 minutes, reversion rates improved
further (i.e., more than 75% of trades and 78% of shares). When Trading
Pauses are excluded, the results appeared even more positive, although
the Participants believe that including Trading Pauses is the superior
measure, as these situations better reflect the general direction of
the market.
The Participants note that during the study period, only 7.1% of
the trades that executed beyond the narrower Theoretical Tier 1 Bands
(4.6% of shares executed across the entire study period) ultimately
resulted in a Trading Pause under the bands currently in place. Prices
did ultimately hit a Limit State within 10 minutes in 12.6% of the
trades that moved through the bands, accounting for 10.3% of shares
traded, but as noted above, less than half of these shares resulted in
a Trading Pause.
The Participants note that by narrowing the bands, in all
likelihood,
[[Page 13392]]
there may be an increase in Trading Pauses, even with market makers
moving liquidity in front of the revised tighter bands. Because prices
may likely revert inside the bands after 10 minutes, these Trading
Pauses may be beneficial for investors. Such Trading Pauses may also be
beneficial for investors because many Tier 2 ETPs do not trade
actively. Their initial Price Bands are often based on the prior day's
official closing price, which may not perfectly reflect current market
conditions, but their Reference Prices and Price Bands are not reset if
there are no trades. In such cases, it may be beneficial to trigger a
Trading Pause that will permit a reopening auction, which can more
efficiently aggregate liquidity, determine equilibrium prices, reset
the Price Bands, and further mitigate volatility.
3. Market Quality Changes When ETPs Change Tier Designation
For the third part of the study, the Participants examined ETPs
that have moved between tiers. As background, at launch, each ETP is
assigned to Tier 2. Per Appendix A, tiers are recalculated at the end
of each June and December and any non-leveraged ETPs that trade over
$2,000,000 CADV during the measurement period move from Tier 2 to Tier
1. It is common for an otherwise-illiquid ETP to have one or two very
high-volume days immediately after listing, causing it to be
recategorized into Tier 1, and then ultimately settle back into Tier 2
following its second measurement period.
These tier changes provide the Participants with an opportunity to
evaluate and compare the market quality of ETPs under different price
band regimes. The Participants understand that, in some cases, changes
in the volume of trades are what cause an ETP to change from one tier
to another, and the improvements in market quality may be attributable
to that increased volume, and not the tier change in and of itself. But
as noted above, the Plan initially assigns ETPs into Tier 2
irrespective of their volume of trades, and many are then subsequently
reassigned to Tier 1 due to high notional volume on a few days after
they are first funded, without experiencing any real change in notional
volume overall. As such, the Participants believe that market quality
changes after a tier shift are meaningful because they are often not
due to developments in the character of the market for the ETPs.
The Participants compared quoted spreads and notional liquidity at
the NBBO, comparing changes in these two values from half-year to half-
year for ETPs that: stayed in Tier 1; stayed in Tier 2; switched from
Tier 1 to Tier 2; and switched from Tier 2 to Tier 1.
ETPs that were in Tier 1 in the second half of 2019 and stayed in
Tier 1 during the first half of 2020 had their consolidated quoted
spread increase by 102.0%, while those that shifted to Tier 2 saw their
consolidated quoted spread widen by 152.3%. Tier 2 ETPs that moved to
Tier 1 in the first half of 2020 had their spreads rise 96.6%--less
than those that stayed in Tier 1 for both periods. ETPs that stayed in
Tier 2 performed the worst, with their spreads increasing by 175.7%.
The pattern is similar regarding ETPs that changed tier in the second
half of 2020. ETPs that stayed in Tier 1 had their spreads narrow by
34.2% while those that moved to Tier 2 performed worse, with their
spreads tightening by 26.7%. Tier 2 ETPs that remained in Tier 2
performed similarly to those that stayed in Tier 1, with their spreads
narrowing by 35.7%. The best performing category was ETPs that moved to
Tier 1 from Tier 2, as their spreads narrowed by 43.6%.
The Participants note that narrower spreads can lead to less
available liquidity, but the tier changes studied above do not appear
to have caused a negative impact on liquidity. For ETPs that changed
tiers between the second half of 2019 and the first half of 2020, the
amount of available liquidity dropped a similar amount for Tier 1 ETPs
that stayed in Tier 1 or moved to Tier 2. Tier 2 ETPs in general lost
fewer dollars at the inside, but those Tier 2 ETPs that transferred to
Tier 1 did lose slightly more--12.2% versus 10.1%. For ETPs that
changed tiers between the first half and second half of 2020, Tier 2
ETPs again saw the largest increase in liquidity, with those that moved
to Tier 1 gaining 51.0% versus just 38.0% for those that stayed in Tier
2. Tier 1 ETPs that moved to Tier 2 saw a drop in liquidity inside of
4.2%. Finally, for those ETPs that changed tiers between the second
half of 2020 and the first half of 2021, Tier 2 ETPs that moved to Tier
1 saw the smallest gains in liquidity at the inside, increasing just
32.1% compared to Tier 2 ETPs that remained in Tier 2, which gained
42.7%. Tier 1 ETPs, whether they stayed in Tier 1 or moved to Tier 2,
garnered larger gains of liquidity at the inside.
In sum, for two of the three half-year changes the Participants
studied, spreads improved and there was a neutral to positive effect on
inside liquidity for ETPs shifting from Tier 2 to Tier 1. The opposite
was true for Tier 2 ETPs that changed tier from the second half of 2020
to the first half of 2021. These results show that, on balance, market
quality statistics improved for Tier 2 ETPs that moved to Tier 1.
The Participants note that even if market quality statistics
improved for Tier 2 ETPs that moved to Tier 1, the efficacy of such a
move might be questioned if the move created notably more Limit States
or Trading Pauses. To study this issue, the Participants examined three
statistics for ETPs that had a tier change in either direction from one
period to the next:
<bullet> the average number of Trading Pauses per symbol during the
next half-year;
<bullet> the average number of Limit States per symbol during the
next half-year; and
<bullet> the average number of seconds in a Limit State per symbol
during the next half-year.
Narrowing the Price Bands for ETPs that moved from Tier 2 into Tier
1 did not increase the incidence of Trading Pauses, Limit States, or
the amount of time spent in Limit States. The Participants assert that
this is likely because market participants adjust their behavior and
provide more liquidity to ETPs once their bands are tightened. The
Participants acknowledge that the number of ETPs that move between
Tiers, especially into Tier 1 after being in Tier 2, is relatively
small and may not provide a significant enough population to offer
strong support for that statistic. The Participants note, however, that
Amendment 18 removed double-wide bands at the open for all stocks and
at the close for Tier 2 stocks, market participants adjusted to the
tighter bands without a large increase in Trading Pauses.
D. Study Conclusions
In sum, the Participants' study shows the following:
<bullet> Tier 1 non-ETPs are far more likely than Tier 2 ETPs to
enter into Limit States and Trading Pauses due to the underlying
volatility of these securities. This finding suggests that the Price
Band width for Tier 2 ETPs is poorly calibrated relative to their
actual trading behavior.
<bullet> During the study period, the notional value of trades that
would have been prevented if Tier 2 ETPs had used tighter Tier 1 bands
would have been substantial for such thinly traded products, bounded on
the lower end at $36.8 million and the upper end at $711.1 million.
<bullet> In the majority of cases where a trade would have been
prevented by the narrower Theoretical Tier 1 Bands, prices reverted by
the end of the following 5- and 10-minute periods,
[[Page 13393]]
suggesting that having these thinly-traded ETPs in Tier 1 would protect
investors from executing trades at inferior prices that may occur due
to transitory gaps in liquidity rather than fundamental valuation
changes.
<bullet> In most cases where ETPs have been reclassified from Tier
2 to Tier 1, market quality improved as evidenced by the lower quote
volatility, tighter spreads, and increased liquidity for ETPs that
moved from Tier 2 to Tier 1.
<bullet> Using tighter Tier 1 bands for all ETPs would provide
greater investor protection from temporary liquidity gaps, which are
facilitated by the wider price bands in Tier 2.
<bullet> The number of Limit States and Trading Pauses decreased
when Tier 2 ETPs moved to Tier 1 and increased when Tier 1 ETPs moved
to Tier 2.
From this evidence, the Participants conclude that moving Tier 2
ETPs to Tier 1 would improve market quality, more effectively dampen
volatility, provide greater investor protection, and decrease the
number of unnecessary Limit States and Trading Pauses.
The Participants also state that the Proposed Amendment does not
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Exchange Act. The Participants
assert that the Proposed Amendment to the Plan would apply to all
market participants equally and would not impose a competitive burden
on one category of market participants in favor of another category of
market participant. The Proposed Amendment would apply to trading on
all Trading Centers and all NMS Stocks would be subject to the amended
Plan's requirements. The Participants do not believe that the Proposed
Amendment introduces terms that are unreasonably discriminatory for the
purposes of Section 11A(c)(1)(D) of the Exchange Act because it would
apply to all market participants equally.
IV. Summary of Comments
In response to the Notice, the Commission received several comments
on the Proposed Amendment.\13\ A few commenters generally oppose the
Plan and Proposed Amendment,\14\ and one commenter representing a
consortium of market participants support the Proposal.\15\
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\13\ See supra note 5.
\14\ See Letters from Alexander Kuchta dated November 27, 2023
(``Kuchta Letter''); Anonymous dated November 27, 2023 (``Anonymous
Letter''); Subhra Mazumdar dated November 27, 2023 (``Mazundar
Letter''); Joe Edwards dated November 27, 2023 (``Edwards Letter'');
Rax Nahali dated November 27, 2023 (``Nahali Letter''); and Rene
Wright dated November 27, 2023 (``Wright Letter'').
\15\ See Letter to Vanessa Countryman, Secretary, Commission,
from Samara Cohen, Chief Investment Officer of ETF and Index
Investments, BlackRock, et al. dated December 18, 2023 (``BlackRock
Letter'').
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Several commenters believe that the Proposed Amendment poses a
significant threat to the foundational principles of a free and open
markets.\16\ Some commenters state that the proposed tighter price
bands would effectively limit the natural price discovery process,
which would infringe upon free market principles.\17\ One commenter
states that these tighter controls may lead to increased
volatility.\18\ The commenter further states that leveraged
derivatives, such as options and futures, allow significant positions
to be taken with relatively less capital. In the hands of large market
participants, according to this commenter, these instruments could
potentially be used in conjunction with the predictable price range
boundaries to manipulate market conditions, highlighting the need for a
thorough evaluation of the rule's implications on market dynamics and
fairness.\19\ The same commenter concludes that the Proposal caters to
the interests of larger, institutional investors who may benefit from
reduced volatility and more predictable price movements at the expense
of smaller, retail investors.\20\ Some commenters state that the
Proposal enables the Participants to control the price of a security
inappropriately.\21\
---------------------------------------------------------------------------
\16\ See, e.g., Kuchta Letter; Nahali Letter; Wright Letter.
\17\ See Kuchta Letter; Edwards Letter; Nahali Letter (noting
that volatility is a part of the market).
\18\ See Kuchta Letter (stating that ``as trades accumulate at
the band limits, the resumption of trading could trigger sudden and
sharp price movements, contrary to the proposal's intent to reduce
volatility'').
\19\ See id.
\20\ See id.
\21\ See Mazundar Letter; Nahali Letter.
---------------------------------------------------------------------------
Separately, one commenter in support of the Proposal concludes that
using Tier 1 Percentage Parameters for all ETPs would better protect
investors during temporary liquidity gaps, which may be exacerbated by
the wider price bands for Tier 2 NMS Stocks.\22\ The commenter asserts
that ETP liquidity gaps can occur for reasons that may not reflect the
ETP's fundamental value.\23\ The commenter states that in these
instances, the risk of an inefficient execution away from the fair
value of the ETP's holdings (as far as 10% away from a Tier 2 ETP's
reference price) rises, and the application of Tier 1 Percentage
Parameters would improve transparency and efficiency, particularly
during periods of extreme volatility.\24\ In addition, the commenter
states that, in instances of sustained order imbalances and/or gaps in
liquidity in the market for an ETP, a trading pause would help attract
liquidity from diverse market participants and promote price discovery
through the reopening mechanism, helping to keep ETP prices in line
with the value of underlying holdings.\25\ The commenter agrees that
ETPs were assigned to tiers based on an assumption that lower-volume
ETPs were more suited for wider price parameters, and states that the
data presented in the Proposed Amendment suggests that assumption was
wrong.\26\ The commenter states that the analysis demonstrated that on
average, Tier 2 ETPs across asset classes exhibit lower quote
volatility than Tier 1 non-ETP stocks.\27\ In light of the findings
derived from the study, the imposed semi-annual migration of ETPs from
one tier to the other appears to be overly complex, arbitrary, and
unnecessary.\28\
---------------------------------------------------------------------------
\22\ See BlackRock Letter at 1.
\23\ See id. at 2 (noting that outsized or aggressive orders,
temporary uncertainty about any inputs into the calculation of the
ETP's fair value, or lower levels of market participation, which is
more common in newly listed ETPs, can cause these ETP prices not to
reflect fundamental value).
\24\ See id.
\25\ See id.
\26\ See id.
\27\ See id.
\28\ See id.
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V. Proceedings To Determine Whether To Approve or Disapprove the
Proposed Amendment
The Commission is instituting proceedings pursuant to Rule
608(b)(2)(i) of Regulation NMS,\29\ and Rules 700 and 701 of the
Commission's Rules of Practice,\30\ to determine whether to approve or
disapprove the Proposed Amendment or to approve the Proposed Amendment
with any changes or subject to any conditions the Commission deems
necessary or appropriate. The Commission is instituting proceedings to
have sufficient time to consider the complex issues raised by Proposed
Amendment, including comments received. Institution of proceedings does
not indicate that the Commission has reached any conclusions with
respect to any of the issues involved. Rather, the Commission seeks and
encourages interested persons to provide additional comment on the
Proposed Amendment to inform the Commission's analysis.
---------------------------------------------------------------------------
\29\ 17 CFR 242.608.
\30\ 17 CFR 201.700; 17 CFR 201.701.
---------------------------------------------------------------------------
Rule 608(b)(2) of Regulation NMS provides that the Commission
``shall
[[Page 13394]]
approve a national market system plan or proposed amendment to an
effective national market system plan, with such changes or subject to
such conditions as the Commission may deem necessary or appropriate, if
it finds that such plan or amendment is necessary or appropriate in the
public interest, for the protection of investors and the maintenance of
fair and orderly markets, to remove impediments to, and perfect the
mechanisms of, a national market system, or otherwise in furtherance of
the purposes of the Exchange Act.'' \31\ Rule 608(b)(2) further
provides that the Commission shall disapprove a national market system
plan or proposed amendment if it does not make such a finding.\32\ In
the Notice, the Commission sought comment on the Proposed Amendment,
including whether the Proposed Amendment is consistent with the
Exchange Act.\33\ In this order, pursuant to Rule 608(b)(2)(i) of
Regulation NMS,\34\ the Commission is providing notice of the grounds
for disapproval under consideration:
---------------------------------------------------------------------------
\31\ 17 CFR 242.608(b)(2).
\32\ Id.
\33\ See Notice, supra note 5.
\34\ 17 CFR 242.608(b)(2)(i).
---------------------------------------------------------------------------
<bullet> Whether, consistent with Rule 608 of Regulation NMS, the
Participants have demonstrated how the Proposed Amendment is necessary
or appropriate in the public interest, for the protection of investors
and the maintenance of fair and orderly markets, to remove impediments
to, and perfect the mechanisms of, a national market system, or
otherwise in furtherance of the purposes of the Exchange Act.\35\
---------------------------------------------------------------------------
\35\ 17 CFR 242.608(b)(2).
---------------------------------------------------------------------------
Under the Commission's Rules of Practice, the ``burden to
demonstrate that a NMS plan filing is consistent with the Exchange Act
and the rules and regulations issued thereunder. . . is on the plan
participants that filed the NMS plan filing.'' \36\ The description of
the NMS plan filing, its purpose and operation, its effect, and a legal
analysis of its consistency with applicable requirements must all be
sufficiently detailed and specific to support an affirmative Commission
finding.\37\ Any failure of the plan participants that filed the NMS
plan filing to provide such detail and specificity may result in the
Commission not having a sufficient basis to make an affirmative finding
that the NMS plan filing is consistent with the Exchange Act and the
applicable rules and regulations thereunder.\38\
---------------------------------------------------------------------------
\36\ 17 CFR 201.701(b)(3)(ii).
\37\ Id.
\38\ Id.
---------------------------------------------------------------------------
VI. Commission's Solicitation of Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
issues identified above, as well as any other concerns they may have
with the Proposal. In particular, the Commission invites the written
views of interested persons concerning whether the Proposal is
consistent with Section 6(b)(5), Section 6(b)(8), or any other
provision of the Act, or the rules and regulations thereunder. Although
there do not appear to be any issues relevant to approval or
disapproval that would be facilitated by an oral presentation of views,
data, and arguments, the Commission will consider, pursuant to Rule
608(b)(2)(i) of Regulation NMS,\39\ any request for an opportunity to
make an oral presentation.\40\ The Commission asks that commenters
address the sufficiency and merit of the Participants' statements in
support of the Proposed Amendment,\41\ in addition to any other
comments they may wish to submit about the Proposed Amendment. In
particular, the Commission seeks comment on the following:
---------------------------------------------------------------------------
\39\ 17 CFR 242.608(b)(2)(i).
\40\ Rule 700(c)(ii) of the Commission's Rules of Practice
provides that ``[t]he Commission, in its sole discretion, may
determine whether any issues relevant to approval or disapproval
would be facilitated by the opportunity for an oral presentation of
views.'' 17 CFR 201.700(c)(ii).
\41\ See Notice, supra note 5.
1. The Participants propose to amend Appendix A of the Plan by
deleting the definition of ETPs ``eligible'' for Tier 1 and to
specify that all ETPs, except for single stock ETPs, would be
assigned to Tier 1. What are commenters' views on whether the
Proposal is consistent with the Exchange Act?
2. Because all leveraged ETPs (except Tier 2 single stock ETPs)
would be assigned to Tier 1, the Participants also propose to add
text into Section I of Appendix A describing how the Percentage
Parameters would be set for leveraged ETPs. What are commenters'
views on whether this Proposal regarding leveraged ETPs to the Plan
is consistent with the Exchange Act?
3. The Proposal acknowledges that the ETPs studied covered
several asset classes, including domestic equities, international
equities, fixed income, currency, commodity, and digital currency
ETPs. For example, the Participants' analysis provides aggregate
statistical information with respect to Tier 2 ETPs as a whole. In
addition, the Proposal states that, except for single-stock,
commodity, and foreign exchange-based ETPs, ETPs are by definition
diversified instruments and that the analysis in the Proposal
supports the modern portfolio theory that portfolios of securities
exhibit lower volatility than individual securities, unless those
products are perfectly correlated. The Proposed Amendment to the
Plan, which would assign all ETPs to Tier 1, only excludes single
stock ETPs, but does not propose to exclude other ETPs based on
other single reference assets, such as ETPs based on single
commodities or single digital currency-related assets. Do commenters
agree that the methodology and results of the analysis support the
conclusions drawn by the Participants? Please explain. Does this
aggregated approach to evaluating Tier 2 ETPs as a whole support the
conclusions drawn by the Participants with respect to different
segments of Tier 2 ETPs? For example, what are commenters' views on
whether the Proposal's study explains why such other ETPs, such as
those based on a single asset (other than stocks) or those that
might not otherwise reflect the volatility characteristics described
in the Proposal, should be assigned to Tier 1?
4. The Proposal provides analysis concerning the potential
impacts that the Proposal could have on the market. Among other
things, the analysis states that the proposed narrower bands may
have caused minimal disruption during periods of less volatility,
amounting usually to a few dozen trades per day. In contrast, the
analysis shows that the Proposal could have had a much larger impact
on trading during periods of greater volatility. Table 4, Panel A,
for example, shows that during the first half of 2020, the Proposal
could have impacted approximately $147 million of trading in Tier 2
ETPs on a single day; approximately $577 million of trading in Tier
2 ETPs could have been impacted over these six months. Chart 1 of
the Proposal \42\ also shows that over 500 Tier 2 ETPs would have
been affected daily during March 2020, a significant percentage of
the total number of Tier 2 ETPs. In the Proposal, the Participants
also provide analysis that supports the view that the potential
impact on trading likely would not be as significant as suggested in
Table 4, Panel A. For example, in Table 4, Panel B, the Proposal
provides analysis that assumes that all impacted trading would
execute at the proposed price bands; under this more conservative
assumption, notional volume in Tier 2 ETPs would only change by $8
million on any given day in the first half of 2020, while total
notional volume in Tier 2 ETPs over these six months would only
change by $30 million. The Proposal states that it is not likely
that the Proposal's impact would be as significant as suggested by
the analysis in Table 4, Panel A, because there could be significant
additional volume executed at or near the proposed price bands. What
are commenters' views on the Proposal's analysis of the potential
impact on trading? Are commenters concerned that the Proposal's
impact on trading during periods of significant volatility would
further contribute to that market stress?
---------------------------------------------------------------------------
\42\ According to the Participants, Chart 1 describes the amount
of notional value prevented, and the number of symbols impacted, by
the narrower Theoretical Tier 1 Bands on a day-to-day basis. See
Notice, 88 FR at 81136.
---------------------------------------------------------------------------
5. One of the Proposal's conclusions is that, in a majority of
cases where a trade
[[Page 13395]]
would have been prevented by the proposed narrower bands
(Theoretical Blocked Trades), prices reverted back to within the
proposed narrower bands. To support this conclusion, the Proposal
provides an analysis that trades in Tier 2 ETPs that executed
outside the proposed narrower bands are generally followed by mid-
point prices within the narrower bands. According to the Proposal,
this analysis suggests that the Proposal would protect investors
from trading at inferior prices that may occur because of transitory
gaps in liquidity instead of fundamental valuation changes. Do
commenters agree that the analysis appropriately measures price
reversion and that the Theoretical Blocked Trades often executed
during temporary liquidity gaps? If not, how do commenters suggest
the analysis could examine the extent to which Theoretical Blocked
Trades executed during temporary liquidity gaps? Please explain.
6. The Proposal compares the quote volatility of Tier 2 ETPs to
that of Tier 1 non-ETPs, where quote volatility is measured using
the mid-point at each second. With this measure of volatility, the
Proposal concludes that Tier 2 ETPs have lower quote volatility than
Tier 1 non-ETPs, suggesting that Tier 2 ETPs are not too volatile
for the Tier 1 price bands. In addition, the Proposal acknowledges
that Tier 2 ETPs are often thinly traded. What are commenters' views
on whether the comparative analysis has adequately captured Tier 2
ETP volatility in support of the conclusion that they are not too
volatile for the Tier 1 price bands? For example, would infrequent
trading interest bias the analysis due to infrequent updates of the
mid-point? Are there other measures of volatility that would be more
appropriate? Please explain.
7. The Participants state that the Plan does not impose any
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act. Do commenters
believe that the Plan, as proposed to be amended, imposes any burden
on competition that is not necessary or appropriate in furtherance
of the purposes of the Exchange Act?
8. Further, would the Proposal have a positive, negative, or
neutral impact on competition? Please explain. How would the
Proposal impact competition across ETP issuers or ETPs on similar
baskets of securities currently in different tiers? Please explain.
How would any impact on competition from the Proposal benefit or
harm the national market system or the various market participants?
Please describe and explain how, if at all, aspects of the national
market system or different market participants would be affected.
Please support any response with data, if possible.
9. More generally, to the extent possible please provide
specific data, analyses, or studies for support regarding any
impacts of the Proposal on competition.
The Commission requests that commenters provide analysis to support
their views, if possible.
Interested persons are invited to submit written data, views, and
arguments regarding whether the Proposed Amendment should be approved
or disapproved by March 14, 2024. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
March 28, 2024. Comments may be submitted by any of the following
methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#2153544d440c424e4c4c444f5552615244420f464e57"><span class="__cf_email__" data-cfemail="e290978e87cf818d8f8f878c9691a2918781cc858d94">[email protected]</span></a>. Please include
file number 4-631 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to: Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to file number 4-631. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (<a href="https://www.sec.gov/rules/sro.shtml">https://www.sec.gov/rules/sro.shtml</a>).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for 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. Copies of the filing also will be available for inspection and
copying at the Participants' principal offices. Do not include personal
identifiable 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 protection. All submissions should
refer to file number 4-631 and should be submitted on or before March
14, 2024.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\43\
---------------------------------------------------------------------------
\43\ 17 CFR 200.30-3(a)(85).
---------------------------------------------------------------------------
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-03539 Filed 2-21-24; 8:45 am]
BILLING CODE 8011-01-P
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