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IV. Sub-Penny Rule
The Commission today is reproposing Rule 612 under the Exchange Act which would govern sub-penny quoting of NMS stocks. Rule 612 would impose new requirements on any bid, offer, order, or indication of interest that is displayed, ranked, or accepted by a national securities exchange, national securities association, ATS, vendor, or broker-dealer. The reproposed rule incorporates the substance of the initially proposed rule with a few minor revisions, as discussed below.
A. Background
In June 2000, the Commission issued an order directing NASD and the national securities exchanges to act jointly in developing a plan to convert their quotations in equity securities and options from fractions to decimals.212 The June 2000 Order stated that the plan could fix the minimum price variation ("MPV") during the phase-in period, provided that the MPV was no greater than $0.05 and no less than $0.01 for any equity security.213 The June 2000 Order also required NASD and the exchanges to provide the Commission with studies analyzing how decimal conversion had affected systems capacity, liquidity, and trading behavior, including an analysis of whether there should be a uniform MPV.214 The Commission stated that, if NASD or an exchange wished to move to quoting stocks in an increment less than $0.01, its study should include a full analysis of the potential impact on the market requesting the change and on the markets as a whole.215 Furthermore, the Commission required each SRO to propose a rule change under Section 19(b) of the Exchange Act216 to establish its individual choice of MPV for securities traded on its market.217 NASD and the exchanges complied with these requirements, and in August 2002 the Commission approved rule changes from all of these SROs to establish MPVs in NMS stocks of $0.01.218
Between the June 2000 Order and the August 2002 Order, the Commission issued a Concept Release seeking public comment on the potential impact of sub-penny pricing,219 including its effect on: (1) price clarity (e.g., the potential to cause ephemeral or "flickering" quotations); (2) market depth (i.e., the number of shares available at a given price); (3) compliance with the Order Handling Rules and other price-dependent rules; and (4) the operations and capacity of automated systems.220 The Commission received 33 comments on the Concept Release.221 The majority of commenters opposed sub-penny pricing. Some stated that the negative effects of decimal trading would be exacerbated by reducing the MPV even further, without meaningfully reducing spreads or securing other benefits for the markets or investors.222 These commenters recommended that all securities have an MPV of at least a penny.223 A smaller number of commenters believed that the forces of competition, rather than regulation by the Commission or Congress, should determine the MPV.224 These commenters suggested that a smaller MPV could improve market efficiency and provide investors with greater opportunity for price improvement. They argued in general that the problems accompanying decimals could be resolved through technology enhancements, rather than through regulation.
In August 2003, Nasdaq submitted a proposed rule change to the Commission to adopt an MPV of $0.001 for Nasdaq-listed securities.225 Nasdaq stated that, unless and until a uniform MPV is established, it believed it must implement an MPV of $0.001 to remain competitive with ECNs that permit their subscribers to quote in sub-pennies. Simultaneous with the proposed rule change, Nasdaq filed a petition for Commission action urging the Commission "to adopt a uniform rule requiring market participants to quote and trade Nasdaq securities in a consistent monetary increment . . . with the exception of average price trades."226
B. Commission Proposal on Sub-Penny Quoting
In February 2004, the Commission proposed new Rule 612 that would govern quoting in sub-pennies as part of the overall Regulation NMS proposal. In the Proposing Release, the Commission summarized the conversion of the U.S. securities markets from fractional to decimalized trading and stated its view that, on balance, the benefits of decimalization have justified the costs. The Commission cautioned, however, that if the MPV decreases beyond a certain level the potential costs to investors and the markets might increase and could at some point surpass any potential benefits.227 To address this concern, proposed Rule 612 would prohibit any national securities exchange, national securities association, ATS, vendor, or broker-dealer from displaying, ranking, or accepting from any person bid, offer, order, or indication of interest in any NMS stock priced in an increment less than $0.01. Proposed Rule 612 would not impose this restriction on any NMS stock the share price of which is below $1.00.
The proposed rule was designed to limit the ability of a market participant to gain execution priority by bettering the price of another limit order by an economically insignificant amount. In issuing the sub-penny proposal, the Commission cited research performed by OEA strongly suggesting that much sub-penny quoting currently taking place results from market participants attempting to step ahead of limit orders for the smallest economic increment possible.228 This conclusion was based on the high incidence of sub-penny trades that cluster around the $0.001 and $0.009 price points.
In the Proposing Release, the Commission pointed to a variety of potential problems caused by sub-penny quoting, including the following:
If investors' limit orders lose execution priority for a nominal amount, investors may over time decline to use them, thus depriving the markets of liquidity.
When market participants can gain execution priority for an infinitesimally small amount, important customer protection rules such as exchange priority rules and NASD's Manning rule229 could be rendered meaningless. Without these protections, professional traders would have more opportunity to take advantage of non-professionals, which could result in the latter either losing executions or receiving executions at inferior prices.
Flickering quotations that can result from widespread sub-penny pricing could make it more difficult for broker-dealers to satisfy their best execution obligations and other regulatory responsibilities. The best execution obligation requires a broker-dealer to seek for its customer's transaction the most favorable terms reasonably available under the circumstances.230 This standard is premised on the practical ability of the broker-dealer to determine whether a displayed price is reasonably obtainable under the circumstances.
Widespread sub-penny quoting could decrease market depth (i.e., the number of shares available at the NBBO). This could lead to higher transaction costs, particularly for institutional investors (such as pension funds and mutual funds), which are more likely to place large orders. These higher transaction costs would likely be passed on to retail investors whose assets are managed by the institutions.
Decreasing depth at the inside also could cause such institutions to rely more on execution alternatives away from the exchanges and Nasdaq that are designed to help larger investors find matches for large blocks of securities. Such a trend could increase fragmentation of the securities markets.
C. Comments Received
The Commission sought comment on all aspects of proposed Rule 612, including the potential problems with sub-penny quoting noted above. Of the comments that the Commission received in response to the Regulation NMS Proposing Release, approximately 60 separate commenters addressed the sub-penny proposal.
1. Comments Addressing Overall Proposal
A majority of commenters supported the proposed sub-penny rule.231 Several commenters concurred with the Commission's view that sub-penny quoting is widely used to step-ahead of competing limit orders.232 One commenter, an ECN, stated that it carried out an informal survey of its buy-side clients, and of the 158 responses received 145 said that they opposed sub-penny quoting.233 The ECN concluded that "[its] clients believe that quoting in sub pennies is used, not for bona fide price improvement, but to jump ahead of their limit orders."234 Another commenter, a large discount brokerage firm, stated that it ceased allowing its clients to submit sub-penny orders in April 2003 "because it had determined that clients were using sub-pennies to step ahead of resting limit orders and undermining the Manning provision."235 A third commenter stated that the reduction of the MPV has allowed "speculators" to post quotations at small increments ahead of institutional trading interest, resulting in decreased liquidity as such institutional interest began seeking methods of execution other than the posting of limit orders.236
Furthermore, the commenters supporting the Commission's sub-penny proposal were generally of the view that the marginal benefits of a further reduction in the MPV were not justified by the associated costs.237 Several commenters argued, in essence, that "[a]n industry-wide shift to quoting in sub-pennies would . . . require costly additional investments in systems capacity while producing little in the way of more efficient markets."238 Several commenters also believed that sub-penny quotations increase the incidence of quote flickering, which in turn may have adverse effects such as creating investor confusion or impeding a broker-dealer's duty of best execution.239
However, a minority of commenters opposed the Commission's proposal to prohibit sub-penny quoting.240 These commenters generally argued that the MPV should be determined by market forces. Two commenters believed that regulating quoting conventions would "prevent marketplaces from making subsequent innovative changes to their quotation increments to respond to the needs of investors"241 and "legislate[] a maximum efficiency for the market instead of allowing further improvement."242 Other commenters stated that quoting in sub-pennies can increase liquidity, lower trading costs, and promote efficient pricing in the equity markets.243
These commenters generally argued that regulation was not necessary to remedy any perceived abuses caused by sub-penny quoting. Two commenters noted that some trading markets already have abandoned sub-penny quoting.244 Another commenter added that "[t]he problems attributed to subpenny quoting have been largely cleared up by the market, and are likely to further improve if the Commission removes some uncertainty from the marketplace by withdrawing its proposal."245 This commenter also criticized the Nasdaq and OEA studies on which the Commission relied in issuing the sub-penny proposal.246
Under reproposed Rule 612, the minimum spread for most NMS stocks would be $0.01. Two commenters stated that, as a result, investors would suffer harm from artificially widened spreads.247 Another commenter stated that "the primary result of eliminating subpenny trading would be to preserve a minimum profit for market makers, and would result in significantly worse realized prices for the vast majority of market participants not in the business of making markets."248 This commenter analyzed trading in six high-volume securities and concluded that proposed Rule 612 would have costs of over $400 million in these securities alone due to wider spreads.249 Another commenter stated that, if all markets traded QQQQ solely in sub-pennies, the savings would be approximately $150 million per year.250
In summary, the comments received have reinforced the Commission's preliminary view that there are substantial drawbacks to allowing sub-penny quoting, and the Commission believes that a uniform rule prohibiting sub-penny quoting (except for quotations less than $1.00) is appropriate in this case. Sub-penny quoting generally impedes transparency by reducing market depth at the NBBO and increasing quote flickering. In an environment where the NBBO can change very quickly, broker-dealers will have more difficulty in carrying out their duties of best execution and complying with other regulatory requirements that require them to identify the best bid or offer available at a particular moment (such as the Manning rule and the short sale rule).
The Commission preliminarily believes that the $400 million and $150 million estimates of the cost to the markets caused by wider spreads provided by commenters are inaccurate and excessive. These estimates appears to assume that all trading activity would occur at narrower quoted spreads. The Commission does not believe that the commenters provided any evidence to justify that assumption. Currently, no national securities exchange or national securities association permits quoting in sub-pennies; sub-penny quoting occurs on only a small number of ATSs. Because spreads on most markets already cannot be smaller than $0.01, the Commission preliminarily does not believe that reproposed Rule 612 would require these markets to take any action that would cause their spreads to widen. Therefore, the Commission believes that the cost to these markets of not having sub-penny spreads should not be considered costs of the reproposed rule.251
Finally, the Commission agrees with the many commenters that believed that prohibiting sub-penny quoting will deter the practice of stepping ahead of exposed trading interest by an economically insignificant amount. Limit orders provide liquidity to the market and perform an important price-setting function. The Commission is concerned that, if a quotation or order can lose execution priority because of economically insignificant price improvement from a later-arriving quotation or order, liquidity could diminish and some market participants could incur greater execution costs. As one commenter, the Investment Company Institute, stated, "[t]his potential for the increased stepping-ahead of limit orders would create a significant disincentive for market participants to enter any sizeable volume into the markets and would reduce further the value of displaying limit orders."252 Improved liquidity should decrease the costs of trading, especially for large orders, since larger size should be available at fewer price points than would exist in a sub-penny quoting environment.
The reproposed rule would make only minor changes to the initially proposed rule. Reproposed Rule 612(a) would prohibit sub-penny quotations in NMS stocks over $1.00. Rule 612(b) would allow sub-penny quotations below $1.00, but only to four decimal places. Rule 612(c) would establish procedures for the Commission to grant exemptions from paragraphs (a) and (b).
2. Response to Other Comments
Beyond addressing the general thrust of the proposed sub-penny rule, some commenters discussed more specific matters. The Commission has revised the proposed sub-penny rule in response to certain of these comments, as discussed below.
a. Restriction Based on Price of the Quotation not Price of the Stock
As initially proposed, the restriction on sub-penny quoting would be triggered if the price of the NMS stock itself were above $1.00. One commenter sought clarification of when an NMS stock became sub-penny eligible, suggesting a threshold of trading below $1.00 for 30 consecutive business days.253 A second commenter suggested instead that the prohibition should derive from the price of the order, rather than the price of the stock; in other words, the rule should permit any sub-penny quotation below $1.00 and prohibit any sub-penny quotation above $1.00, regardless of the price level where the stock was in fact trading.254 The second commenter argued that this approach "does not require countless re-classifications of stocks as 'sub-penny eligible' based on fluctuations in their valuation, stock splits, or other price movements."255
The Commission agrees with the second commenter. Basing the restrictions on the price of the quotation or order rather than the price of the NMS stock itself would spare market participants the need to track the eligibility of stocks priced near the $1.00 threshold. Accordingly, paragraph (a) of reproposed Rule 612 would prohibit bids, offers, orders, and indications of interest equal to or greater than $1.00 in an increment smaller than $0.01. Therefore, a market participant could not, for example, accept a sell order in an NMS stock priced at $1.0025, even if the stock were trading below $1.00. The Commission requests comment on the new approach taken in reproposed Rule 612(a).
b. Quotations Below $1.00
The Commission initially proposed a threshold of $1.00 below which the prohibition on sub-penny quoting would not apply and requested comment on whether that threshold was appropriate. The majority of commenters addressing this issue believed that it would be useful for low-priced securities to trade in increments finer than a penny, because a penny would constitute a significant percentage of the overall price. These commenters viewed $1.00 as an appropriate threshold.256 One commenter stated that there is "real demand for sub-penny trading (and therefore subpenny quoting) in securities trading below $1.00, due to the low trading value of the security."257 The Commission agrees that sub-penny quotations for very low-priced securities largely represent genuine trading interest rather than an effort to step ahead of competing limit orders by an economically insignificant amount. In such cases, a sub-penny increment is more likely to represent a significant amount of the price of the quotation or order. Accordingly, the prohibition on sub-penny quoting in paragraph (a) of reproposed Rule 612 would apply only to bids, offers, orders, and indications of interest priced $1.00 or greater.
Two commenters suggested that the Commission establish an MPV for quotations below $1.00; both recommended allowing such quotations to extend to four decimal places.258 The Commission agrees with these commenters and believes that it is reasonable to restrict quotations below $1.00 to four decimal places. Accordingly, paragraph (b) of reproposed Rule 612 would prohibit bids, offers, orders, and indications of interest priced less than $1.00 in an increment smaller than $0.0001. Without the ability to quote very low-priced securities in sub-pennies, market participants would be forced to express their trading interest in increments that represented a substantial portion of the overall quotation. However, if the number of decimal places for quotations in low-priced securities were not limited, the problems caused by sub-penny quoting of higher-priced securities, discussed above, could arise. Restricting quotations below $1.00 to four decimal places would avoid these problems. Under reproposed Rule 612, a quotation of $0.9987 x $1.00 would be permissible but a quotation of $0.9987 x $1.0001 would not. The Commission requests comment on whether limiting quotations priced below $1.00 to four decimal places is appropriate.
c. Revisiting the Penny Increment
Some commenters, while generally acknowledging problems caused by sub-penny quoting, recommended that the Commission consider increasing the MPV above $0.01.259 One commenter believed that "[t]he Commission should seriously consider experimenting with different tick sizes to help determine the optimal tick policy."260 A second commenter recommended that the Commission establish an MPV of a $0.01 for high-volume stocks, $0.05 middle-volume stocks, and $0.10 for the low-volume stocks.261 A third commenter stated that "sub-penny quoting does little, if anything, to degrade the market from its current state" because, in the commenter's view, "the true damage was done to the market in the shift from a fractionalized environment to a penny spread environment."262
Under reproposed Rule 612, the Commission would set a floor for the MPV, not determine the optimal MPV. Penny pricing was established by rules that were proposed by NASD and each of the national securities exchanges that trade NMS stocks and approved by the Commission pursuant to Section 19(b) of the Exchange Act.263 While some commenters have raised liquidity concerns regarding the $0.01 MPV, the move to decimals (and specifically the move to a penny MPV for equity securities) also has reduced spreads, thus resulting in reduced trading costs for investors entering orders – particularly smaller orders – that are executed at or within the quotations. Therefore, the Commission did not propose a higher MPV as part of the initial Regulation NMS proposal. However, if the SROs in the future believe that an increase in the MPV is necessary or desirable, they may propose rule changes to institute the higher MPV. The Commission would evaluate those proposals under the requirements of the Exchange Act at that time.
d. Exemptions for Specific NMS Stocks
As initially proposed, Rule 612 included a provision that would establish procedures for the Commission to grant exemptions to the rule, and the Commission requested comment on whether certain securities should be exempted from Rule 612.264 In particular, the Commission asked whether exchange-traded fund shares ("ETFs"), which are derivatively priced, raise the same concerns that have been expressed with respect to sub-penny pricing generally.265
Of the commenters who addressed this issue, the majority argued that the sub-penny prohibition should apply to all NMS stocks, including ETFs.266 These commenters generally believed that sub-penny quoting raises the same type of concerns for ETFs as for other types of securities.267 On the other hand, other commenters provided arguments that exemptions for at least certain securities would be appropriate. One commenter that opposed Rule 612 argued that, if the Commission nevertheless did approve the rule, it should provide an exemption for QQQQ and other ETFs.268 This commenter argued that these securities "uniquely lend[] themselves to subpenny quoting and trading" because "the[ir] derivative nature . . . enables investors to determine their true value at any point in time by calculating the aggregate price of the securities constituting a particular ETF."269 Other commenters, while not explicitly recommending that the Commission grant particular exemptions, argued that sub-penny quoting was reasonable for certain securities.270 One of these commenters noted, for example, that quotations in QQQQ are not clustered around the $0.001 and $0.009 price points, which suggests that sub-penny quotations are not being entered for the purpose of stepping ahead.271
At this time, the Commission believes that a basis likely may exist to grant an exemption from the sub-penny quoting prohibition for QQQQ and perhaps other actively traded ETFs. This exemption would permit a national securities exchange, national securities association, ATS, vendor, or broker or dealer to display, rank, or accept from any person a bid or offer, an order, or an indication of interest – in QQQQ or perhaps other actively traded ETFs – in increments smaller than $0.01. The Commission intends to consider this matter further during the phase-in period for Regulation NMS, if Regulation NMS is adopted. The Commission also notes that, while the proposed effective date for Regulation NMS as a whole would be [November 5, 2005], the effective date for reproposed Rule 612(c), if adopted, would be 60 days from date of publication of final Regulation NMS in the Federal Register. Therefore, the Commission could exercise its exemptive authority such that any exemptions that it may grant pursuant to reproposed Rule 612(c) could take effect simultaneously with the main prohibitions of Rule 612.
e. Sub-Penny Trading
The Commission stated in the Proposing Release that it did not at that time believe that trading in sub-penny increments raised the same concerns as sub-penny quoting. Therefore, the proposed rule would not prohibit an exchange or association from printing a trade in sub-penny increments that was, for example, the result of a mid-point or volume-weighted pricing algorithm, as long as the exchange or association or its members did not otherwise violate the proposed rule with respect to the trading interest that resulted in the execution. For example, a system that accepted unpriced orders that were then matched at the midpoint of the NBBO would not violate the proposed rule even though resulting executions could occur in share prices of less than one cent. In addition, a broker-dealer could, consistent with the proposed rule, provide price improvement to a customer order in an amount that resulted in an execution in an increment less than a penny so long as the broker-dealer did not accept orders that were priced in increments less than a penny. The Commission sought specific comment on this aspect of the proposal.
Every commenter that addressed this issue agreed that any sub-penny rule should permit sub-penny trades that result from midpoint and average-price algorithms.272 While most of these commenters believed that the rule should permit broker-dealers to offer sub-penny price improvement to their customers' orders,273 a few commenters urged the Commission to bar this practice.274 After considering these views, the Commission has determined not to revise the sub-penny rule in a manner that would prohibit sub-penny trading, whether that trading results from midpoint or VWAP algorithms or from broker-dealers offering sub-penny price improvement. The Commission continues to believe that trading in sub-penny increments does not at this time raise the same concerns as sub-penny quoting.
f. Acceptance of Sub-Penny Quotations
The Commission initially proposed to prohibit national securities exchanges, national securities associations, ATSs, vendors, and broker-dealers from displaying, ranking, or accepting quotations in NMS stocks that are priced in sub-pennies. One commenter argued that the rule should allow a market participant to accept sub-penny quotations if it consistently re-prices such quotations to an acceptable increment and does not give the sub-penny quotations any special priority for ranking or execution purposes.275 A second commenter disagreed, arguing that rounding a sub-penny quotation to the nearest penny may be confusing for investors.276 The Commission agrees with the second commenter and has determined to revise the proposed rule. The Commission believes that little purpose would be served by permitting market participants to accept sub-penny quotations when such quotations could not be displayed or considered for purposes of ranking. Furthermore, the Commission agrees that permitting market participants to accept sub-penny quotations that must be rounded to comply with the requirements of reproposed Rule 612 could cause confusion among investors.
g. Application to Options Markets
The initially proposed rule, by its terms, would apply only to NMS stocks, but the Commission requested comment on whether the rule should apply to options.277 Currently, SRO rules require options to be quoted on the U.S. markets in increments of $0.05 and $0.10. Therefore, the problems that could be created by sub-penny quoting currently do not exist in the options markets.
Two commenters believed that the rule should not apply to quoting in options.278 One of these commenters, assuming that the rule as proposed would allow options with a premium of less than $1.00 to be quoted in sub-pennies and options with a premium over $1.00 to be quoted in pennies, argued that this approach "would overwhelm the already taxed capacity of existing options quote processing systems."279 The Commission believes that it is not necessary or appropriate at this time to apply reproposed Rule 612 to options. If a national securities exchange seeks to quote options in pennies or sub-pennies in the future, it would first need to propose a rule change to that effect under Section 19(b) of the Exchange Act.280 The Commission would have an opportunity to consider such a proposal at that time, after providing notice and obtaining public comment.281
A third commenter, while agreeing strongly with the proposed sub-penny rule, argued that the Commission also should prohibit the Boston Options Exchange ("BOX"), a facility of the Boston Stock Exchange, from using "sub-increment" pricing (i.e., penny prices below the standard $0.05 and $0.10 increments used for options) in its "PIP" auction.282 By initiating a PIP auction, a BOX market participant may execute a portion of its agency order as principal in pennies, and BOX market makers can match that price or offer price improvement to those orders in penny increments during the three-second auction. The Commission previously has approved the BOX trading rules, including the rules governing the PIP, pursuant to Section 19(b) of the Exchange Act.283 The PIP uses pennies in an auction, not in public quotations. Therefore, the Commission does not believe that the PIP raises the same problems caused sub-penny quotations of non-option securities and, therefore, that it is not necessary to prohibit the use of pennies in BOX's PIP.
D. Exemptive Authority
Reproposed Rule 612(c) would establish procedures for the Commission to exempt from the provisions of Rule 612 any person, security, or quotation, or any class or classes or persons, securities, or quotations, if it determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. The Commission could grant such exemption either unconditionally or on specified terms and conditions. Reproposed Rule 612(c) also would provide that the Commission may grant an exemption from the sub-penny prohibition by order.
V. Market Data Rules and Plan Amendments
The Exchange Act rules and joint-SRO Plans for disseminating market information to the public are the heart of the NMS. Pursuant to these rules and Plans, investors are able to obtain real-time access to the best current quotes and most recent trades for all NMS stocks. As a result, investors of all types – large and small – have access to a comprehensive, accurate, and reliable source of information for the prices of any NMS stock at any time during the trading day.
The SROs generate consolidated market data by participating in the Plans.284 Pursuant to the Plans, three separate networks disseminate consolidated market information for NMS stocks: (1) Network A for securities listed on the NYSE, (2) Network B for securities listed on the Amex and other national securities exchanges, and (3) Network C for securities traded on Nasdaq. For each security, the data includes (1) an NBBO with prices, sizes, and market center identifications, (2) a montage of the best bids and offers from each SRO that includes prices, sizes, and market center identifications, and (3) a consolidated set of trade reports in the security. The Networks establish fees for this data, which must be filed for Commission approval.285 In 2003, the Networks collected $424 million in revenues derived from market data fees and, after deduction of Network expenses, distributed $386 million to their individual SRO participants.286
The overriding objective of the rules and Plan amendments reproposed today would be to preserve the vital benefits that investors currently enjoy, while addressing those particular problems with the current rules and Plans that are most in need of reform. The changes fall into three categories: (1) modifying the current formulas for allocating market data revenues to the SROs to more appropriately reflect their contributions to public price discovery, (2) establishing non-voting advisory committees to broaden participation in Plan governance, and (3) updating and streamlining the various Exchange Act rules that govern the distribution and display of market information.
A. Response to Comments and Basis for Reproposed Rules
1. Alternative Data Dissemination Models
In addition to proposing specific rules and amendments, the Proposing Release discussed and requested comment on the Commission's decision not to propose an alternative model of data dissemination to the replace the current consolidation model.287 The great strength of the current model is that it benefits investors, particularly retail investors, by enabling them to assess prices and evaluate the best execution of their orders by obtaining data from a single source that is highly reliable and comprehensive. But, by requiring vendors and broker-dealers to display data to investors that is consolidated from all markets, the current model effectively also requires the purchase of data from all markets. As a result, the most significant drawback of the current model is that it offers little opportunity for market forces to determine a Network's fees, or the allocation of those fees to a Network's SRO participants. Network fees must be closely scrutinized for fairness and reasonableness, and the revenues resulting from those fees must be allocated to the SROs pursuant to a Plan formula. In addition, individual markets have less freedom to innovate in individually providing their quotation and trade data.
In the Proposing Release, the Commission specifically considered three alternative models that potentially could introduce greater competition and flexibility into the dissemination of market data: (1) a deconsolidation model, (2) a competing consolidators model, and (3) a hybrid model. It decided not to propose any of these alternative models after consideration of the benefits and drawbacks of each model. The Commission did, however, request comment on whether it should develop an alternative model for disseminating market data to the public, and, in particular, on its evaluation of the strengths and weaknesses of the current model and of the various alternative models for the dissemination of market data.
In response to the Commission's request for comment, a minority of commenters expressed their views regarding the appropriate structure for the dissemination of market information to the public. One group believed that the current model requiring the display of consolidated data in a stock through a Plan processor has produced significant benefits for investors and the markets, although they also strongly recommended that its operation needed to be improved in significant respects.288 Another group of commenters, in contrast, asserted that the current system has inhibited competition among markets and that the Plans should be eliminated.289 These commenters further suggested deregulation of market data by allowing markets to sell their own data, and by allowing market forces and competition to control the pricing of such data. They advocated a competing consolidators model or a hybrid model.
a. Competing Consolidators Model
Under a competing consolidators model, the consolidated display requirement would be retained, but the Plans and Networks would no longer be necessary. Each of the nine SROs that participate in the NMS, as well as Nasdaq, would be allowed to establish its own fees, to enter into and administer its own market data contracts, and to provide its own data distribution facility. Any number of data vendors or broker-dealers (i.e., "competing consolidators") could purchase data from the individual SROs, consolidate the data, and distribute it to investors and other data users. Of the commenters that urged the Commission to adopt a competing consolidators model,290 the NYSE, for example, believed that allowing the markets to withdraw from the Plans would "reestablish the link between the value of a market's data…and the fair allocation of costs among…users," thereby ending inter-market subsidies and market-distortive initiatives created by the current system."291 Similarly, ArcaEx stated that "the best way to reform the [P]lans is to abolish them altogether and to adopt a competing consolidators model."292
The Commission has considered the comments advocating a competing consolidators model, but continues to question the extent to which the model would in fact subject the level of market data fees to competitive forces. If the benefits of a fully consolidated data stream are to be preserved for investors, every consolidator would need to purchase the data of each SRO to assure that the consolidator's data stream in fact included the best quotations and most recent trade report in all NMS stocks. Moreover, to comply with the reproposed Trade-Through Rule, each market center would need the quotation data from every other market center in a security. As a practical matter, payment of every SRO's fees would be mandatory, thereby affording little room for competitive forces to influence the level of fees. Consequently, far from freeing the Commission from involvement in market data fee disputes, the multiple consolidator model would require review of at least ten separate fees for individual SROs and Nasdaq. The overall level of fees would not be reduced unless one or more of the SROs or Nasdaq was willing to accept a significantly lower amount of revenues than they currently are allocated by the Plans. It seems unlikely that any SRO or Nasdaq would voluntarily propose lower fees to reduce their current revenues, and some might well propose higher fees to increase their revenues, particularly those with dominant market shares whose information is most vital to investors. No commenter offered useful, objective standards for the Commission to use in evaluating the separate fees of SROs and Nasdaq. For this and for data quality concerns,293 the Commission remains unconvinced that discarding the current model in favor of a multiple consolidator model would benefit investors and the NMS in general.
b. Hybrid Model
Nasdaq advocated a hybrid model of data dissemination as a compromise if the Commission believes that it is necessary to retain the Plans.294 Under a hybrid approach, basic elements of the current model (including the consolidated display requirement and the Plans) would be retained for quotations representing the NBBO, but all trade reports and all quotations other than the NBBO would be deconsolidated. Because much less consolidated data would be disseminated under this model, the fees for consolidated data would be reduced commensurately. The individual SROs would distribute their own trade and quotation information separately and establish fees for such information. To obtain the data eliminated from the consolidated system, investors would need to pay the separate SRO fees.
In sum, Nasdaq suggested that consolidated data fees should be reduced,295 but only in the context of advocating a hybrid model that would drastically reduce the quantity of data that would be disseminated to investors (i.e., by eliminating all trade reports and all quotations other than the NBBO). Nasdaq stated that the Commission should allow competitive forces to determine the individual SRO fees for deconsolidated data because trade reports and non-NBBO quotations are not "essential to investors."296
The Commission believes, however, that comprehensive trade and quotation information, even beyond the NBBO, is vital to investors. It remains concerned that an SRO with a significant share of trading in NMS stocks could exercise market power in setting fees for its data. Few investors could afford to do without the best quotations and trades of such an SRO that is dominant in a significant number of stocks. In the absence of a solid basis to believe that full trade and quotation information would continue to be widely available and affordable to all types of investors under a hybrid model, the Commission has determined that the most responsible course of action is to take such immediate steps are necessary to improve the operation of the current consolidation model.297
2. Level of Fees and Plan Governance
a. Level of Fees
In the Proposing Release, the Commission emphasized that one of its primary goals with respect to market data is to assure reasonable fees that promote its wide public availability. Comment was requested on the extent to which investors and other data users were relatively satisfied with the products and fees offered by the Networks.298 At the NMS Hearing, several panelists addressed the current level of fees and questioned whether such fees remained reasonably related to the cost of market data.299 The Supplemental Release therefore noted the panelists' views and welcomed comments on the reasonableness of market data fees and whether the Commission should modify its approach to reviewing such fees.300
Many commenters recommended that the level of market data fees should be reviewed and that, in particular, greater transparency concerning the costs of market data and the fee-setting process is needed.301 The Commission agrees. To respond to commenters' concerns, it has initiated a review of market data fees in its concept release relating to SRO structure.302 The release discusses and requests comment on a number of issues raised by commenters in the context of SRO revenues and the funding of self-regulation – in particular, whether market data fees are reasonable, whether the Commission should reconsider a flexible cost-based approach as described in the 1999 Market Information Release, and whether market data fees should be used to fund SRO operational or regulatory costs. The Commission also has taken steps to promote more transparency with respect to market data fees and the use of market data revenues through its proposal on SRO transparency.303 The proposal would greatly increase SRO transparency by requiring, among other things, that SROs file public reports with the Commission detailing their sources of revenues and their uses of these revenues. Such reports would enhance the public's ability to evaluate the role of market data revenues in funding SROs. For example, proposed amendments to Form 1, Exhibit I would require exchange SROs to disclose their revenues earned from market information fees, itemized by product, and proposed new Rule 17a-26 would require SROs to file electronic quarterly and annual reports on particular aspects of their regulatory activities.
Some commenters suggested that, instead of modifying the Plan formulas for allocating market data revenues, the Commission should impose a cost-based limitation on fees.304 Most, however, adopted a very restricted view of market data costs – solely the costs of the Networks to collect data from the individual SROs and disseminate it to the public.305 Yet nearly the entire financial burden of collecting and producing market data is borne by the individual markets, not by the Networks. If, for example, an SRO's systems break down on a high-volume trading day and it can no longer provide its data to the Networks, investors would suffer the consequences of a defective data stream, regardless of whether the Networks are able to continue operating.
The commenters' suggested approach to market data fees would eliminate any funding for the SROs that supply data to the Networks, which would have reduced SRO funding by $386 million in 2003.306 The Commission is reluctant to impose such a significant and sudden reduction in SRO funding without taking due care for the consequences it might have on the integrity of the U.S. equity markets. When the Commission last reviewed market data fees and revenues in 1999, it noted the direct connection between an SRO's operational and regulatory functions and the value of its market information:
[T]he value of a market's information is dependent on the quality of the market's operation and regulation. Information is worthless if it is cut off during a systems outage (particularly during a volatile, high-volume trading day when reliable access to market information is most critical), tainted by fraud or manipulation, or simply fails to reflect accurately the buying and selling interest in a security.307
Moreover, the U.S. equity markets are not alone in their reliance on market data revenues as a substantial source of funding. All of the other major world equity markets currently derive large amounts of revenues from selling market information, despite having significantly less trading volume and less market capitalization than the NYSE and Nasdaq. To illustrate, the following table sets forth the respective market information revenues, dollar value of trading, and market capitalization for the largest world equity markets in 2003:308
Data Revenues (millions) |
Trading Volume (trillions) |
Market Capitalization (trillions) | |
London |
$180 |
$3.6 |
$2.5 |
NYSE |
$172 |
$9.7 |
$11.3 |
Nasdaq |
$147 |
$7.1 |
$2.8 |
Deutsche Bourse |
$146 |
$1.3 |
$1.1 |
Euronext |
$109 |
$1.9 |
$2.1 |
Tokyo |
$60 |
$2.1 |
$3.0 |
In sum, the Commission is committed to assuring that investors are not required to pay unreasonable or unfair fees for the consolidated market information that they must have to participate in the U.S. equity markets. On the other hand, we must maintain high standards of SRO performance, without which the data they produce would be worth little. Some commenters suggested that SRO funding should be provided through more specifically targeted fees, such as an additional regulatory fee to fund market regulation costs. Given the potential harm if vital SRO functions are not adequately funded, we believe that the level of market data fees is most appropriately addressed in a context that looks at SRO funding as a whole. The Commission's review of SRO structure, governance, and transparency provides a useful context in which these competing policy concerns can be evaluated and balanced appropriately.
The Commission does not believe, however, that reform of the current revenue allocation formulas should be delayed until its review of fees is completed. The distortions caused by these formulas are substantial and ongoing. In particular, it appears that market participants increasingly are engaging in the practice of trade shredding (i.e., splitting large trades into multiple 100-share trades) as a means to increase their share of market data revenues under the current Plan formulas. As discussed below, the reproposed formula would represent a substantial improvement because it is designed to eliminate trade shredding and other gaming of the current formulas and because it would more directly allocate revenues to those markets that contribute data to the consolidated data stream that is most useful to investors.
b. Plan Governance
The Commission is reproposing, substantially as proposed, an amendment to the Plans that would require the creation of non-voting advisory committees ("Governance Amendment"). It provides that the members of an advisory committee have the right to submit their views to the Plan operating committees on Plan matters, including any new or modified product, fee, contract, or pilot program. Most commenters supported the Governance Amendment.309 They generally believed that expanding the participation of non-SROs parties in Plan governance would be a constructive step. Only a few commenters disagreed, stating that interested parties currently have the ability to communicate their views on Plan matters or questioning the efficacy of the committees.310
A number of commenters, however, believed that the proposal did not go far enough to reform the Plans and that even greater participation by interested non-SRO parties in the Plans is needed.311 Brut suggested that the Commission "consider applying SRO governance standards to [Network processors] going forward, subjecting their operations to the same standards of transparency and accountability" in order to limit their monopoly power.312 These commenters also raised concerns regarding several other aspects of Plan governance, including current administrative costs and burden, the unanimous vote requirement for Plan action, and the current process for reviewing SRO fee filings and Plan amendments. For instance, the SIA believed that inconsistencies among the Networks regarding administrative requirements and burdens (i.e., agreements and contracts, billing policies, data use policies, and annual audit requirements) contribute to high market data fees and should be reduced, streamlined, and made uniform.313
In many respects, the Commission agrees with the concerns expressed by commenters on the administration of the Plans. It believes, however, the Governance Amendment would represent a useful first step toward improving the responsiveness of Plan participants and the efficiency of Plan operations. Expanding the participation of interested parties other than SROs in Plan governance should improve transparency, as well as provide an established mechanism for alternative views to be heard. Earlier and more broadly based participation could contribute to the ability of the Plans to achieve consensus on disputed issues. Going forward, the Commission is receptive to additional steps that would improve Plan operations in general, particularly those that would streamline fee administration procedures and burdens. Enhanced participation of advisory committee members in Plan affairs potentially should help further this process.
3. Revenue Allocation Formula
The proposal included an amendment to the Plans that would modify their formulas for allocating market data revenues to SRO Participants. The current Plan formulas are based solely on the trading activity of an SRO. The proposed formula was intended to address three serious weaknesses in the old formulas: (1) the absence of any allocation of revenues for the quotations contributed by an SRO to the consolidated data stream, (2) an excessive emphasis on the number of trades reported by an SRO that has led to distortive trading practices, such as wash sales, trade shredding, and print facilities, and (3) a disproportional allocation of revenues for a relatively small number of stocks with extremely high trading volume, to the detriment of the thousands of other stocks included in a Network, typically issued by smaller companies, with less trading volume.
To address these problems, the proposed formula included a number of elements, including a Quoting Share, an NBBO Improvement Share, a Trading Share, and a Security Income Allocation. The Quoting Share and NBBO Improvement Share would have provided an allocation of revenues for an SRO's quotations. In particular, the Quoting Share would have allocated revenues for all quotes, both automated and manual, according to the dollar size and length of time that such quotes equaled the price of the NBBO. It included an automatic cutoff of credit for manual quotations, however, when they were left alone at the NBBO. This cut-off was intended to preclude SROs from being allocated revenues merely for slowness in updating their manual quotations. The NBBO Improvement Share would have allocated revenues to SROs for the extent to which they displayed quotations that improved the price of the NBBO.
At the NMS Hearing, representatives of floor-based exchanges stated their intention to adopt hybrid trading models that would primarily display automated quotations.314 In response, the Commission, in its Supplemental Release, stated that the prospect of hybrid trading models presented an opportunity for simplifying the proposed allocation formula.315 It noted that the purpose of the automatic cutoff for manual quotations was to minimize the allocation of revenues for potentially stale quotations and requested comment on whether only automated quotes should be entitled to earn an allocation of revenues. The Supplemental Release also noted that the NBBO Improvement Share was significantly more complex than the other aspects of the proposed formula and that it had been proposed largely to counter the potential for an excessive allocation of revenues for manual quotations. Comment was requested on whether there was any need for the NBBO Improvement Share if manual quotations were excluded from the formula.
The comments generally addressed four broad categories of issues: (1) whether the current Plan formulas need to be updated, (2) whether quotations should be considered in allocating revenues, (3) whether the size of trades should be considered in allocating revenues, and (4) whether the allocation of revenues should be allocated more evenly across all of a Network's stocks. These comments are discussed below.
a. Need for New Formula
Many commenters agreed with the Commission that, if the Networks were to continue allocating revenues to the SROs, the current allocation formulas needed to be updated.316 Many of these commenters also believed that the proposed formula should be modified in several respects, and their specific suggestions to improve the proposed formula are discussed below. In general, however, they agreed with the objectives of the proposal to eliminate much of the incentive for distortive trade reporting practices and to begin providing some allocation of revenues for the quotations that SROs contribute to the consolidated data stream.
Other commenters, in contrast, opposed changing the current allocation formulas.317 Their specific objections to the proposed formula are discussed below, but they also opposed changing the current formulas for more general reasons. First, some believed that, rather than changing the formulas, the Commission simply should prohibit the particular distortive practices caused by the old formulas and enforce the existing prohibitions against such practices. Commenters also opposed the proposed formula because they believed it incorporated arbitrary judgments about the value of quotations and trades. Finally, those opposed to changing the Plan formulas also believed that the proposed formula was simply too complex to be implemented effectively and that its costs exceeded any benefits that were likely to be gained.
The Commission has considered the views of these commenters, but does not believe that they warrant leaving the current Plan formulas in place. First, the Commission intends to continue to enforce the existing prohibitions against distortive trade reporting practices. Rather than attempting to formulate new prohibitions that address every conceivable harmful practice, however, it has determined to address directly the ultimate source of the problem by reproposing revisions to the current formulas. As long as the allocation of market data revenues is based primarily on reporting a large number of very small trades, the incentive for distortive trading reporting will continue. Moreover, as discussed below, the current formulas are flawed in several important respects beyond the incentives they create for distortive trading reporting practices.
The Commission preliminarily does not believe that the reproposed formula would incorporate arbitrary judgments about the value of trades and quotes. In this regard, it is important to recognize that any formula for allocating market data revenues would reflect some judgment regarding the contribution of the various SROs to the consolidated data stream; otherwise, the revenues could simply be allocated equally among all Plan participants. The Commission's goal in reproposing a new formula is to improve the judgments incorporated in the old Plan formulas to more fully achieve NMS objectives.
For example, the current formula for Network A and Network B treats a 100-share trade the same as a 20,000 share trade in the same stock, even though their importance for price discovery purposes clearly is not equal. All of the current Plan formulas treat a quotation as having no value if it did not result in a trade, even if the quotation was fully accessible and established the NBBO for a substantial period of time, thereby providing price discovery for trades occurring at other markets that internalize orders with reference to the NBBO price. Such formulas based solely on an SRO's trading activity may have been adequate many years ago when a single market dominated each group of securities, but are seriously outdated now that trading is split among many different markets whose contributions to the public data stream can vary considerably.
The reproposed formula would reflect fairly straightforward determinations about the kinds of data that, in general, are likely to be useful to investors. For example, a $50,000 quote at the NBBO in a stock is likely more useful to investors than a $2000 quote in the same stock. Similarly, a $50,000 trade in a stock is likely more useful to investors in assessing the trading trend of that stock than a $2000 trade; again, not necessarily in every case, but in general and on average. The reproposed formula would represent a substantial improvement on the old formulas.318
The Commission agrees with commenters that the proposed formula was very complex and may have been difficult to implement efficiently. They particularly noted that the proposed NBBO Improvement Share was very difficult to understand and had the potential to be abused through gaming behavior. Given that only automated quotations would be entitled to earn an allocation under the reproposed formula, the proposed NBBO Improvement Share can be deleted, as well as the proposed cutoff of credits for manual quotations left alone at the NBBO. The elimination of these two elements greatly reduces the complexity of the reproposed formula and should promote more efficient implementation of the formula. In addition, the 15% of the Security Income Allocation that was allocated to the NBBO Improvement Share in the proposed formula would now be shifted to the Quoting Share to establish a generally even allocation of revenues between trading and quoting.
The Commission does not agree, however, with those commenters who argued that it would overly costly and complex to calculate the other elements of the proposed formula. An SRO's Trading Share, for example, would not be materially more difficult to calculate than the current Network C formula, which is based on an average of the SRO's proportion of trades and share volume. The Security Income Allocation merely would use the square root function, which is a simple arithmetic calculation. Finally, some commenters believed that the Quoting Share, which would incorporate the total dollar size of the NBBO in a stock throughout the trading year, would result in astronomically high numbers that would be extremely difficult to calculate.319 In fact, the largest number of Quote Credits in a year for even the highest price stock with the greatest displayed depth at the NBBO would be very unlikely to reach beyond the trillions, a number well within the capabilities of even the most basic spreadsheet program.320 Moreover, it is the proportion of an SRO's Quote Credits in relation to other SROs that would determine an allocation, not the absolute amount of Quote Credits.
Finally, a few commenters were concerned about the effect of modifying the current allocation formulas on the existing business models and terms of competition for the various markets.321 The Commission recognizes that reforming formulas that have remained unchanged for many years could affect the competitive position of various markets. Given the severe deficiencies of these formulas, however, it does not believe that the interests of any particular business model should preclude updating the formulas to reflect current market conditions. The reproposed formula is intended to reflect more appropriately the contributions of the various SROs to the consolidated data stream and thereby better align the interests of individual markets with the interests of investors.
b. Quotations that Equal the NBBO
Many commenters supported the proposal to allocate a portion of market data revenues based on an SRO's quotations, particularly if only automated and accessible quotations would qualify for an allocation.322 Some commenters, however, were concerned about the risk of harmful gaming behavior by market participants.323 For example, Instinet stated that the "fundamental problem with the Commission's proposed formula stems from the inherently low cost for market participants to generate quotation information and the consequent high potential for gaming behavior in any formula that attempts to reward such behavior."324 A specific type of gaming that concerned commenters was "flickering quotes" – quotes that are flashed for a short period of time solely to earn market data revenues, but are not truly accessible and therefore do not add any value to the consolidated quote stream.
The Commission recognizes that abusive quoting behavior is a legitimate concern. It preliminarily does not believe, however, that the reproposed formula would be unacceptably vulnerable to gaming, particularly because only automated and fully accessible quotations would be entitled to earn a share of market data revenues. The potential cost of displaying such quotations, in the form of unprofitable trades, should not be underestimated. Quotations would earn significant revenues only if they represent a significant proportion of the total size of quotations displayed at the NBBO for a stock throughout the trading year. The risk of losses that could result from the execution of orders against large quotations would be likely to dwarf any potential allocation of market data revenues. With the advent of highly sophisticated order-routing algorithms, automated quotations throughout the NMS can be accessed with lightning speed. Some of these algorithms are specifically designed to search the market for displayed liquidity and sweep such liquidity immediately when it is displayed. The market discipline imposed by these order-routing practices should greatly reduce the potential for "low cost" quotations at the NBBO if the reproposed formula were adopted. A market participant would need to think carefully about whether it is truly willing to trade at a price, particularly a price as attractive as the NBBO, before displaying accessible and automated quotations to earn market data revenues.
A few commenters also opposed the proposed Quoting Share because they believed it represented an attempt by the Commission to control the quoting behavior of market participants.325 ArcaEx stated for example, that the "most important question is how paying for top-of-book quotes – on a time- and size-weighted basis or on any other basis – encourages beneficial behavior," and questioned whether the Quoting Share would achieve this result. Brut asserted that "[n]ot only would [the proposed formula] increase the potential unnatural trading and quoting behavior, it signifies a desire to use market structure regulation to micro-manage market participant behavior . . ."326
These commenters appear to have misunderstood the Commission's objective in proposing to update the current Plan formulas. As noted above, it is unlikely that a marginal increase in market data revenues would significantly alter the quoting behavior of market participants, at least for those not already interested in trading a stock for separate reasons. The potential cost of unprofitable trades would be too high. Rather, the Commission's primary objective would be to correct an existing flaw in the current formulas by allocating revenues to those SROs that, even now, benefit investors by contributing useful quotations to the consolidated data stream. Currently, such SROs do not receive any allocation for providing a venue for this beneficial quoting activity. Basing an allocation on the extent to which an SRO's quotes equal the NBBO would be an appropriate means to correct this flaw, even if it does not always reflect the precise value of quotations.327
c. Number and Dollar Volume of Trades
The current Plan formulas allocate revenues based on the number of trades (Networks A and B) or on the average of number of trades and share volume of trades (Network C) reported by SROs. By focusing solely on trading activity (and particularly by rewarding the reporting of many trades no matter how small their size), these formulas have contributed to a variety of distortive trade reporting practices, including wash sales, shredded trades, and SRO print facilities. To address these practices and to establish a more broad-based measure of an SRO's contribution to the consolidated trade stream, the proposed formula provided that an SRO's Trading Share in a particular stock would be calculated by taking the average of the SRO's percentage of total dollar volume in the stock and the SRO's percentage of qualified trades in the stock. A "qualified trade" was defined as having a dollar volume of $5000 or more. The Proposing Release requested comment on whether this amount should be higher or lower, or whether trades with a size of less than $5000 should receive credit that was proportional to their size.328
Several commenters believed that small trades contribute to price discovery and should be entitled to earn at least some credit in the calculation of the number of qualified trades.329 The Commission agrees and has included in the reproposed formula a provision that awards a fractional proportion of a qualified report for trades of less than $5000. Thus, a $2500 trade would constitute 1/2 of a qualified report. This approach would greatly reduce the potential for large allocations attributable to shredded trades, while recognizing the contribution of small trades to price discovery.
Two commenters asserted that the $5000 threshold was arbitrary.330 As noted in the Proposing Release, an analysis of Network A data indicates that approximately 90% of dollar volume and 50% of trades exceed this threshold. The Commission preliminarily believes that the $5000 figure represents a reasonable attempt to address the problem of shredding large trades into 100-share trades. By providing only a proportional allocation for trades with dollar amounts below this threshold, the ability of market participants to generate large revenue allocations by shredding trades would be greatly reduced. For example, a 2000-share trade in a $25 stock could be shredded into twenty trades in the absence of a dollar threshold for qualified trades, but could be shredded into only ten qualified trades under the reproposed formula – a reduction of 50%. Moreover, when combined with the allocation of 50% of revenues to the Quoting Share and the allocation of another 25% of revenues based on the dollar volume of trades, the $5000 threshold for qualified trades would eliminate much of the potential reward for trade shredding under reproposed formula.
d. Allocation of Revenues Among Network Stocks
The proposed formula included a Security Income Allocation, pursuant to which a Network's total distributable revenues would be allocated among each of the Network's stocks based on the square root of dollar volume. The square root function was intended to adjust for the highly disproportionate level of trading in the very top tier of Network stocks. A few hundred stocks (e.g., the top 5%) are much more heavily traded than the other thousands of Network stocks. The Proposing Release noted that an allocation that simply was directly proportional to trading volume would fail to reflect adequately the importance of price discovery for the vast majority of stocks.331
Of the commenters that addressed this issue, four supported the use of a square root function to allocate revenues among stocks.332 Nasdaq, for example, noted that the "methodology will reduce the disparity between the value of data of the most active and least active securities."333 Other commenters, in contrast, opposed the use of the square root function to allocate revenues among Network stocks.334 ArcaEx believed that the proposed allocation method "introduces a steeply progressive tax on liquid stocks to subsidize illiquid stocks" and that the allocation of revenues should remain directly proportional to trading volume.335
The Commission has retained the square root function in the reproposed formula to allocate distributable Network revenues more appropriately among all of the stocks included in a Network. Although the extent to which Network stocks are tiered according to trading volume varies among the three Networks, it is quite pronounced in each of them. The use of the square root function reflects the Commission's judgment that, on average and not necessarily in every particular case, a $50,000 trade in a stock with an average daily trading volume of $500,000 is marginally more useful to investors than a $50,000 trade in a stock with an average daily trading volume of $500 million. Markets that provide price discovery in less active stocks serve an extremely important function for investors in those stocks. Price discovery not only benefits those investors who choose to trade on any particular day, but also benefits those who simply need to monitor the status of their investment. Efficient secondary markets support buy-and-hold investors by offering them a ready opportunity to trade at any time at a fair price if they need to buy or sell a stock. Indeed, this enhanced assurance is one of the most important contributions of secondary markets to efficient capital-formation and to reducing the cost of capital for listed companies. The square root function would allocate revenues to markets that perform this function for less-active stocks by marginally increasing their percentage of market data revenues, while still allocating a much greater dollar amount to more actively traded stocks.
4. Distribution and Display of Data
Most commenters supported the proposal authorizing the independent distribution of market data outside of what is required by the Plans.336 They generally agreed that the proposal would allow investors and vendors greater freedom to make their own decisions regarding the data they need. They also believed that the Commission’s "fair and reasonable" and "not unreasonably discriminatory" standards are appropriate to ensure that the independently distributed market data would be made available to all investors and data users. A few commenters, in contrast, objected to the proposed standards, asserting that the standards would not effectively protect investors and "weaker and newer markets from predatory actions by stronger markets or the potential loss of data integrity."337
The Commission is reproposing Rule 603(a) as proposed. The "fair and reasonable" and "not unreasonably discriminatory" requirements in reproposed Rule 603(a) are derived from the language of Section 11A(c) of the Exchange Act. Under Section 11A(c)(1)(C), the more stringent "fair and reasonable" requirement is applicable to an "exclusive processor," which is defined in Section 3(a)(22)(B) of the Exchange Act as an SRO or other entity that distributes the market information of an SRO on an exclusive basis. Reproposed Rule 603(a)(1) would extend this requirement to non-SRO markets when they act in functionally the same manner as exclusive processors and are the exclusive source of their own data. Applying this requirement to non-SROs would be consistent with Section 11A(c)(1)(F) of the Exchange Act, which grants the Commission rulemaking authority to "assure equal regulation of all markets" for NMS Securities.
Commenters were concerned about the statement in the Proposing Release that the distribution standards would prohibit a market from distributing its data independently on a more timely basis than it makes available the "core data" that is required to be disseminated through a Network processor.338 Instinet, for example, requested that the Commission clarify that the proposal would not require a market center to artificially slow the independent delivery of its data in order to synchronize its delivery with the data disseminated by the Network.339 Reproposed Rule 603(a) would not require a market center to synchronize the delivery of its data to end-users with delivery of data by a Network processor to end-users. Rather, independently distributed data could not be made available on a more timely basis than core data is made available to a Network processor. Stated another way, reproposed Rule 603(a) would require that an SRO or broker-dealer must not transmit data to a vendor or user any sooner than it transmits the data to a Network processor.
A majority of the commenters supported the Commission’s proposed reduction of the consolidated display requirements, stating that it should lead to lower costs for investors.340 A few commenters, however, opposed eliminating the requirement to display a full montage of market BBOs.341 Amex, for example, believed that elimination of the montage would confuse investors and make it more complicated for vendors and broker-dealers to manage market data.
The Commission does not believe that streamlining the consolidated display requirement would detract from the quality of information made available to investors. Reproposed Rule 603(c) would continue to require the disclosure of basic information (i.e., prices, sizes and market center identifications of the NBBO, along with the most recent last sale information). It would allow market forces, rather than regulatory requirements, to determine what, if any, additional quotations outside the NBBO are displayed to investors. Investors who need the BBOs of each SRO, as well as more comprehensive depth-of-book information, would be able to obtain such data from markets or third party vendors.
B. Description of Reproposed Rules and Amendments
1. Allocation Amendment
The Commission is reproposing with modifications an amendment to each of the Plans ("Allocation Amendment") that incorporates a broad based measure of the contribution of an SRO’s quotes and trades to the consolidated data stream.342 The reproposed formula reflects a two-step process. First, a Network’s distributable revenues (e.g., $150 million) would be allocated among the many individual securities (e.g., 3000) included in the Network’s data stream. Second, the revenues that are allocated to an individual security (e.g., $200,000) then would be allocated among the SROs based on measures of the usefulness to investors of their trades and quotes in the security. The Allocation Amendment provides that, notwithstanding any other provision of a Plan, its SRO participants would receive an annual payment for each calendar year that is equal to the sum of the SRO’s Trading Shares and Quoting Shares in each Network security for the year.343 These two types of Shares would be dollar amounts that would be calculated based on SRO trading and quoting activity in each Network security.
a. Security Income Allocation
The first step of the reproposed formula would be to allocate a Network’s total distributable revenues among the many different securities that are included in a Network (the "Security Income Allocation"). Paragraph (b) of the reproposed Allocation Amendment would base this allocation on the square root of dollar volume of trading in each security. Use of the square root function would more appropriately allocate revenues among stocks with widely differing trading volume. A small number of Network stocks are much more heavily traded than the great majority of Network stocks. By proportionally shifting revenues away from the very top tier of active stocks and increasing the allocation across other stocks, the Security Income Allocation is intended to reflect more adequately the importance of price discovery for all Network stocks.
b. Trading Share
Under paragraph (c) of the reproposed Allocation Amendment, an SRO’s Trading Share in a particular Network security would be a dollar amount that is determined by multiplying (i) an amount equal to the lesser of (A) 50% of the Security Income Allocation for the Eligible Security or (B) an amount equal to $2.00 multiplied by the total number of qualified transaction reports disseminated by the Processor in the Eligible Security during the calendar year, by (2) the SRO’s Trade Rating in the security. A Trade Rating would be a number that represents the SRO’s proportion of dollar volume and qualified trades in the security, as compared to the dollar volume and qualified trades of all SROs. The Trade Ratings of all SROs would add up to a total of one. Thus, for example, multiplying 50% of the Security Income Allocation for a Network security (e.g., $200,000) by an SRO’s Trade Rating in that security (e.g., 0.2555) would produce a dollar amount (e.g., 50% x $200,000 x 0.2555 = $25,550) that is the SRO’s Trading Share for the security for the year.
Applying 50% of the Security Income Allocation to the Trading Share reflects a judgment that generally trades and quotes are of approximately equal importance for price discovery purposes. For securities with lower trading volume, however, this percentage can disproportionately allocate revenues for a small number of trades during the year, at the expense of those markets that aggressively quote a security throughout the year. For example, 50% of the Security Income Allocation for a security with 10 qualified trades during the year might be $300. Rather than allocate the full $300 to those SROs that reported a small number of trades (for an average per trade allocation of $30), the reproposed formula would include a cap of $2 per qualified transaction report, so that a total of only $20 would be allocated pursuant to the Trading Share. The difference of $280 ($300 minus $20) would be shifted to the Quoting Share to allocate revenues to those markets that consistently displayed valuable quotes in the security throughout the more than 250 trading days during the year. The amount of the cap of $2 per qualified transaction report exceeds the highest amount per transaction report currently allocated for any of the three Networks.
An SRO’s Trade Rating would be calculated by taking the average of (1) the SRO’s percentage of total dollar volume reported in the Network security during the year, and (2) the SRO’s percentage of total qualified trades reported in the Network security for the year. A transaction report with a dollar volume of $5000 or more would constitute one qualified report. A transaction report with a dollar volume of less than $5000 would constitute a proportional fraction of a qualified transaction report. As a result, all sizes of transaction reports would contribute toward an SRO's Trade Rating.
c. Quoting Share
Under paragraph (d) of the reproposed Allocation Amendment, an SRO’s Quoting Share in a particular Network Security would be a dollar amount that is determined by multiplying (i) an amount equal to 50% of the Security Income Allocation for the security, plus the difference, if greater than zero, between 50% of the Security Income Allocation for the Eligible Security and an amount equal to $2.00 multiplied by the total number of qualified transaction reports disseminated by the Processor in the Eligible Security during the calendar year, by (ii) the SRO’s Quote Rating in the security. A Quote Rating would be a number that represents the SRO’s proportion of quotations that equaled the price of the NBBO during the year ("Quote Credits"), as compared to the Quote Credits of all SRO’s during the year. The Quote Ratings of all SROs would add up to a total of one. Multiplying 50% of the Security Income Allocation for a Network security (plus any shifted allocation from the Trading Share) by an SRO’s Quote Rating in that security would produce a dollar amount that is the SRO’s Quoting Share for the security for the year.
An SRO would earn one Quote Credit for each second of time and dollar value of size that the SRO’s automated quotation during regular trading hours equals the price of the NBBO.344 Thus, for example, a bid with a dollar value of $4000 (e.g., a bid of $20 with a size of 200 shares) that equals the national best bid for three seconds would be entitled to 12,000 Quote Credits. If an SRO quotes simultaneously at both the national best bid and the national best offer, it would earn Quote Credits for each quote. An automated quotation is defined by reference to reproposed Rule 600(b)(3) under Regulation NMS. Thus, an SRO's manual quotations would not be entitled to earn any Quote Credits.
2. Governance Amendment
The Governance Amendment is reproposed substantially as proposed. Paragraph (a) would mandate the formation of a Plan advisory committee. Paragraph (b) of the Governance Amendment would set forth the composition and selection process for such an advisory committee. Members of the advisory committee would be selected by the Plan operating committee, by majority vote, for two-year terms. At least one representative would be selected from each of the following five categories: (1) a broker-dealer with a substantial retail investor customer base, (2) a broker-dealer with a substantial institutional investor customer base, (3) an ATS, (4) a data vendor, and (5) an investor. Each Plan participant also would have the right to select one additional member to the advisory committee that is not employed by or affiliated with any Plan participant or its affiliates or facilities.
Paragraphs (c) and (d) of the Governance Amendment would set forth the function of the advisory committee and the requirements for its participation in Plan affairs. Pursuant to paragraph (c), members of an advisory committee would have the right to submit their views to the operating committee on Plan matters, including, but not limited to, any new or modified product, fee, contract, or pilot program that is offered or used pursuant to the Plan. Paragraph (d) provides that members would have the right to attend all operating committee meetings and to receive any information distributed to the operating committee relating to Plan matters, except when the operating committee, by majority vote, decides to meet in executive session after determining that an item of Plan business requires confidential treatment.
3. Consolidation, Distribution, and Display of Data
a. Independent Distribution of Information
The Commission is reproposing, substantially as proposed, the amendment to current Rule 11Aa3-1 (reproposed to be designated as Rule 601), which would rescind the prohibition on SROs and their members from disseminating their trade reports independently.345 Under reproposed Rule 601, members of an SRO would continue to be required to transmit their trades to the SRO (and SROs would continue to transmit trades to the Networks pursuant to the Plans), but such members also would be free to distribute their own data independently, with or without fees.
Reproposed Rule 603(a) would establish uniform standards for distribution of both quotations and trades that would create an equivalent regulatory regime for all types of markets. First, Rule 603(a)(1) would require that any market information346 distributed by an exclusive processor, or by a broker or dealer (including ATSs and market makers) that is the exclusive source of the information, be made available to securities information processors on terms that are fair and reasonable. Rule 603(a)(2) would require that any SRO, broker, or dealer that distributes market information must do so on terms that are not unreasonably discriminatory. These requirements would prohibit, for example, a market from making its "core data" (i.e., data that it is required to provide to a Network processor) available to vendors on a more timely basis than it makes available the core data to a Network processor. With respect to non-core data, however, Network processors occupy a unique competitive position. As Network processor, it acts on behalf of all markets in disseminating consolidated information, yet it also may be closely associated with the competitor of a market. The Commission believes that markets should have considerable leeway in determining whether, or on what terms, they provide additional, non-core data to a Network processor.
b. Consolidation of Information
All of the SROs currently participate in Plans that provide for the dissemination of consolidated information for the NMS Stocks that they trade. The Plans were adopted in order to enable the SROs to comply with Exchange Act rules regarding the reporting of trades and distribution of quotations. With respect to trades, paragraph (b) of Exchange Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601(a)) requires each SRO to file transaction reporting plans that specify, among other things, how its transactions are to be consolidated with the transactions of other SROs. With respect to quotations, paragraph (b)(1) of Exchange Act Rule 11Ac1-1 (proposed to be redesignated as Rule 602(a)(1)) requires an SRO to establish and maintain procedures for making its best quotes available to vendors.
To confirm by Exchange Act rule that both existing and any new SROs would be required to continue to participate in such joint-SRO plans, reproposed Rule 603(b) would require SROs to act jointly pursuant to one or more NMS plans to disseminate consolidated information for NMS Stocks. Such consolidated information would be required to include an NBBO that is calculated in accordance with the definition set forth in reproposed Rule 600(b)(42).347 In addition, the NMS plans would be required to provide for the dissemination of all consolidated information for an individual NMS stock through a single processor. Thus, different processors would be permitted to disseminate information for different NMS stocks (e.g., SIAC for Network A stocks, and Nasdaq for Network C stocks), but all quotations and trades in a stock would be disseminated through a single processor. As a result, information users, particularly retail investors, could obtain data from a single source that reflects the best quotations and most recent trade price for a security, no matter where such quotations and trade are displayed in the NMS.
c. Display of Consolidated Information
Reproposed Rule 603(c) (currently Exchange Act Rule 11Ac1-2) substantially revises the consolidated display requirement. It would incorporate a new definition of "consolidated display" (set forth in reproposed Rule 600(b)(13)) that would be limited to the prices, sizes, and market center identifications of the NBBO, along with the "consolidated last sale information" (which is defined in Rule 600(b)(12)). Beyond disclosure of this basic information, market forces, rather than regulatory requirements, would be allowed to determine what, if any, additional data from other market centers is displayed. In particular, investors and other information users ultimately would be able to decide whether they need additional information in their displays.
In addition, reproposed Rule 603(c) would narrow the contexts in which a consolidated display is required to those when it is most needed – a context in which a trading or order-routing decision could be implemented. For example, the consolidated display requirement would continue to cover broker-dealers who provide on-line data to their customers in software programs from which trading decisions can be implemented. Similarly, the requirement would continue to apply to vendors who provide displays that facilitate order routing by broker-dealers. It would not apply, however, when market data is provided on a purely informational website that does not offer any trading or order-routing capability.348
VI. Regulation NMS
To simplify the structure of the rules adopted under Section 11A of the Exchange Act ("NMS rules"), the rules reproposed today would designate the NMS rules as Regulation NMS, renumber the NMS rules, and would establish a new definitional rule, reproposed Rule 600 ("NMS Security Designation and Definitions"). Rule 600(a) would replace Exchange Act Rule 11Aa2-1, which designates "reported securities" as NMS securities. In addition, Rule 600(b) would include, in alphabetical order, all of the defined terms used in Regulation NMS. Regulation NMS would include reproposed Rules 610, 611, and 612 in addition to the existing NMS rules. The new rule series would be Rule 600 through Rule 612 (17 CFR 242.600 - 612).
Reproposed Rule 600 would provide a single set of definitions that would be used throughout Regulation NMS. To create a single set of definitions, Rule 600 would update or delete from the existing NMS rules some terms that have become obsolete and eliminate the use of multiple inconsistent definitions for identical terms. In addition, Rule 600 reproposes new terms, "NMS security" and "NMS stock," to replace some terms that have been eliminated. These terms would be necessary to maintain distinctions between NMS rules that apply only to equity securities and ETFs (e.g., Exchange Act Rules 11Ac1-4 and 11Ac1-5, proposed to be redesignated as Rules 604 and 605) and those that apply to equity securities, ETFs, and options (e.g., Exchange Act Rules 11Ac1-1 and 11Ac1-6, proposed to be redesignated as Rules 602 and 606). Rule 600 would retain, unchanged, most definitions used in the existing NMS rules and would include definitions used in the new NMS rules reproposed today. The definitional changes would not affect the substantive requirements of the existing NMS rules. In addition, the reproposal would amend a number of other Commission rules that cross-reference current NMS rules or that use terms that Regulation NMS would amend or eliminate.
The Commission received no comments regarding proposed Rule 600, the proposed redesignation of the NMS rules as Regulation NMS, or the proposed changes to other Commission rules. Accordingly, the Commission is reproposing Rule 600 and redesignating the NMS rules as Regulation NMS, and reproposing technical amendments to certain other Commission rules thatcross-reference current NMS rules or that use terms that Regulation NMS would amend or eliminate, substantially as proposed.349
A. Description of Regulation NMS
Reproposed Regulation NMS would renumber and, in some cases, rename the existing NMS rules, and would incorporate Rule 600 and the other NMS rules reproposed today. Where applicable, existing NMS rules would be amended to remove the definitions that have been consolidated in Rule 600. The titles and numbering of the rules in Regulation NMS, including the NMS rules reproposed today, would be as follows:
Rule 600: NMS Security Designation and Definitions (would replace Exchange Act Rule 11Aa2-1, which the Commission is proposing to rescind, and incorporate definitions from the existing NMS rules and the reproposed new rules);
Rule 601: Dissemination of Transaction Reports and Last Sale Data with Respect to Transactions in NMS Stocks (would renumber and rename current Exchange Act Rule 11Aa3-1, the substance of which would be modified);350
Rule 602: Dissemination of Quotations in NMS Securities (would renumber and rename current Exchange Act Rule 11Ac1-1 ("Quote Rule"), the substance of which would remain largely intact);
Rule 603: Distribution, Consolidation, and Display of Information with Respect to Quotations for and Transactions in NMS Stocks (would renumber and rename current Exchange Act Rule 11Ac1-2 ("Vendor Display Rule"), the substance of which would be modified substantially);351
Rule 604: Display of Customer Limit Orders (would renumber current Exchange Act Rule 11Ac1-4 ("Limit Order Display Rule"), the substance of which would remain largely intact);
Rule 605: Disclosure of Order Execution Information (would renumber current Exchange Act Rule 11Ac1-5, the substance of which would remain largely intact);
Rule 606: Disclosure of Order Routing Information (would renumber current Exchange Act Rule 11Ac1-6, the substance of which would remain largely intact);
Rule 607: Customer Account Statements (would renumber current Exchange Act Rule 11Ac1-3, the substance of which would remain largely intact);
Rule 608: Filing and Amendment of National Market System Plans (would renumber current Exchange Act Rule 11Aa3-2, the substance of which would remain largely intact);
Rule 609: Registration of Securities Information Processors: Form of Application and Amendments (would renumber current Exchange Act Rule 11Ab2-1, the substance of which would remain largely intact);
Rule 610: Access to Quotations (reproposed in this release);
Rule 611: Order Protection Rule (reproposed in this release); and
Rule 612: Minimum Pricing Increment (reproposed in this release)
B. Rule 600 — NMS Security Designation and Definitions
1. NMS Security Designation — Transaction Reporting Requirements for Equities and Listed Options
Section 11A(a)(2) of the Exchange Act directs the Commission to "designate the securities or classes of securities qualified for trading in the national market system."352 The 1975 Amendments and the legislative history to the 1975 Amendments were silent as to the particular standards the Commission should employ in designating NMS securities.353 Instead, Congress provided the Commission with the flexibility and discretion to base NMS designation standards on the Commission’s experience in facilitating the development of an NMS.354
To satisfy the requirement that it designate the securities qualified for trading in the NMS, the Commission adopted Exchange Act Rule 11Aa2-1 in 1981.355 Exchange Act Rule 11Aa2-1 defines the term "national market system security" to mean "any reported security as defined in Rule 11Aa3-1." A "reported security" is "any security or class of securities for which transaction reports are collected, processed and made available pursuant to an effective transaction reporting plan."356 An "effective transaction reporting plan" is "any transaction reporting plan approved by the Commission pursuant to this section."357 A "transaction reporting plan" is "any plan for collecting, processing, making available or disseminating transaction reports with respect to transactions in reported securities filed with the Commission pursuant to, and meeting the requirements of, this section."358 The effective transaction reporting plans are the CTA Plan and the Nasdaq UTP Plan.
In addition to identifying those securities deemed to be NMS securities, when adopted, the Exchange Act Rule 11Aa2-1 designation also tacitly identified those securities that did not meet that designation (i.e., securities other than those that were so designated as NMS securities). Historically, securities excluded from this designation included standardized options and small capitalization equity securities (a subset of which has been identified as Nasdaq SmallCap securities). Trading in options and Nasdaq SmallCap securities has increased over the past three decades and gradually many of the rules that govern NMS securities have been applied to these securities. As a result, much of the terminology that has been used to distinguish NMS securities from options and Nasdaq SmallCap securities has become obsolete.
For example, the Nasdaq UTP Plan provides for the collection from Plan participants, and the consolidation and dissemination to vendors, subscribers and others, of quotation and transaction information in "eligible securities." Prior to 2001, the Nasdaq UTP Plan defined an "eligible security" as any Nasdaq National Market security as to which unlisted trading privileges have been granted to a national securities exchange pursuant to Section 12(f) of the Exchange Act or that is listed on a national securities exchange. In 2001, the Nasdaq UTP Plan was amended to include Nasdaq SmallCap securities.359 As a result, Nasdaq SmallCap securities became "eligible securities" because they are now reported through an effective transaction reporting plan (i.e., the Nasdaq UTP Plan), bringing them within the purview of the NMS security designation. Several definitions in the existing NMS rules, however, do not reflect the inclusion of Nasdaq SmallCap securities in the Nasdaq UTP Plan and therefore must be updated. Regulation NMS would do so.
In addition, transactions in exchange-listed options are reported through the Plan for Reporting of Consolidated Options Last Sale Reports and Quotation Information ("OPRA Plan").360 Unlike the CTA Plan and the Nasdaq UTP Plan — transaction reporting plans that the Commission approved pursuant to Exchange Act Rules 11Aa3-1 and 11Aa3-2 (proposed to be redesignated as Rules 601 and 608) — the Commission approved the OPRA Plan pursuant to Exchange Act Rule 11Aa3-2 (proposed to be redesignated as Rule 608).361 As such, the OPRA Plan is an "effective national market system plan" but not an "effective transaction reporting plan." While at their core the CTA Plan, the Nasdaq UTP Plan, and the OPRA Plan perform essentially the same function (i.e., they govern the consolidated reporting of securities transactions by Plan participants), because the OPRA Plan is not an effective transaction reporting plan, listed options covered by the OPRA Plan are technically not "securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan." Therefore, listed options were not considered NMS securities as defined by Exchange Act Rule 11Aa2-1. While the impact of this distinction may not be readily apparent, the differences in the way the Plans are designated dictates the securities laws and regulations that apply to securities reported pursuant to those Plans.
Further, as discussed below, some terms in the existing NMS rules have become superfluous or outdated, and some NMS rules define identical terms differently. To provide a consolidated set of definitions applicable to all of the NMS rules, Regulation NMS would eliminate these inconsistencies. The definitional changes reproposed today, however, are not intended to change materially the scope of the existing NMS rules.
2. NMS Security and NMS Stock
Some NMS rules, including the Quote Rule (proposed to be redesignated as Rule 602) and Exchange Act Rule 11Ac1-6 (proposed to be redesignated as Rule 606), currently apply to both (1) equities, ETFs and related securities for which transaction reports are made available pursuant to an effective transaction reporting plan, and (2) listed options for which market information is made available pursuant to an effective national market system plan. To provide a single term that will be used in any provision of Regulation NMS that applies to both categories of securities, Regulation NMS reproposes a new term, "NMS security."362
Because many rules in Regulation NMS, including the Limit Order Display Rule (proposed to be redesignated as Rule 604) and Exchange Act Rule 11Ac1-5 (proposed to be redesignated as Rule 605), continue to be inapplicable to listed options, Regulation NMS reproposes a new term, "NMS stock" that would be used in those provisions. Regulation NMS would define the term "NMS stock" as "any NMS security other than an option."363
3. Changes to Existing Definitions in the NMS Rules
Reproposed Rule 600(b) would provide a single set of definitions that would be used throughout Regulation NMS. To create a single set of definitions, Regulation NMS would eliminate multiple, inconsistent definitions of identical terms. In addition, Regulation NMS would amend some definitions in the NMS rules to reflect changed conditions in the marketplace or to modernize references. For example, as discussed above, several definitions in the existing NMS rules have been rendered obsolete by the extension of the Nasdaq UTP Plan to Nasdaq SmallCap securities.364 Because the Nasdaq UTP Plan includes Nasdaq SmallCap securities, those securities now are "securities for which transaction reports are collected, processed and made available pursuant to an effective transaction reporting plan" (i.e., they are "reported" securities).365 For this reason, it is no longer necessary to distinguish, as several existing NMS rules do, between "reported" securities and equity securities for which market information is made available through Nasdaq.366 Accordingly, Regulation NMS would eliminate or revise the defined terms in the existing NMS rules that make this distinction.
a. Covered Security
Different definitions of the term "covered security" appeared in the Quote Rule, the Limit Order Display Rule, and Exchange Act Rule 11Ac1-6.367 In addition, as discussed below, the term has become obsolete. Therefore, Regulation NMS would eliminate the term "covered security" from the NMS rules and replaces it with the term "NMS security" or "NMS stock," as applicable, depending upon the scope of the particular rule.
b. Reported Security
Several NMS rules used the term "reported security." Although the Limit Order Display Rule, the Vendor Display Rule, and Exchange Act Rule 11A