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IX. Consideration of Costs and Benefits
In the Proposing Release, the Commission identified certain costs and benefits of the Regulation NMS proposals, and, to help evaluate the costs and benefits, requested comment on all aspects of the costs and benefits and encouraged commenters to identify or supply any relevant data concerning the costs or benefits of the proposal.445 To the extent commenters discussed costs and benefits, the Commission has considered those comments. The Commission renews its request for comments on the costs and benefits of the Regulation NMS proposals. The Commission encourages commenters to identify, discuss, analyze, and supply relevant data concerning the costs or benefits of the reproposed rules.
A. Trade-Through Rule
Reproposed Rule 611 would require a trading center (which includes national securities exchanges and national securities associations that operate SRO trading facilities, ATSs, market makers, and block positioners) to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs of protected quotations, and, if relying on an exception, that are reasonably designed to assure compliance with the terms of the exception. To qualify for protection, a quotation would be required to be displayed and immediately accessible through automatic execution. The reproposed Rule also would require a trading center to regularly surveil to ascertain the effectiveness of the policies and procedures and to take prompt remedial action to remedy deficiencies in such policies and procedures.
Reproposed Rule 611 would include a variety of exceptions to make intermarket price protection as efficient and workable as possible. These would include an intermarket sweep exception, which would allow market participants simultaneously to access multiple price levels at different trading centers — a particularly important function now that trading in penny increments has dispersed liquidity across multiple price levels. The intermarket sweep exception would enable trading centers that receive sweep orders to execute those orders immediately, without waiting for better-priced quotations in other markets to be updated. In addition, reproposed Rule 611 would, among other things, provide exceptions for the quotations of trading centers experiencing a material delay (generally of more than one second) in providing a response to incoming orders, as well as for flickering quotations with prices that have been displayed for less than one second.
1. Benefits
Many commenters supported the adoption of a uniform rule against trade-throughs for all NMS stocks and discussed the benefits that such a rule would bring to the markets.446 These commenters noted that such a uniform rule would encourage the use of displayed limit orders, thus increasing depth and liquidity in the market.447 Some of these commenters also stated that the trade-through proposal would increase investor confidence by helping to eliminate the impression of unfairness when an investor's order executes at a price that is worse than another displayed order, or when a trade occurs at a price that is inferior to the investor's displayed order.448 As discussed above in Section II.A.1, the Commission preliminarily agrees with these commenters.
The Commission preliminarily believes that the reproposed Trade-Through Rule would enhance the overall fairness and efficiency of the NMS and produce significant benefits for investors. By providing greater protection for displayed prices, the reproposed Rule would serve to enhance the depth and liquidity of the NMS, and thus contribute to the maintenance of fair and orderly markets. By better protecting the interests of investors, both those that post limit orders and those that execute against posted limit orders, the reproposed Rule would promote investor confidence in the NMS. The reproposed Rule would be a significant improvement over the existing ITS trade-through rule, and would level the competitive playing field among markets by eliminating the potential advantage that the ITS rule afforded to manual markets.
The Commission preliminarily believes that the proposed Trade-Through Rule is necessary to, and would serve to, enhance protection of displayed prices. Investors who post limit orders, and trading centers that quote aggressively, should not see trades occurring on another market at a price inferior to their orders, except in circumstances where an exception applies. By requiring trading centers to establish written policies and procedures reasonably designed to prevent trade-throughs and to comply with exceptions, and by requiring them to regularly surveil to ascertain the effectiveness of the policies and procedures and to take prompt remedial action to remedy deficiencies in such policies and procedures, the reproposed Rule should help ensure that displayed limit orders are not routinely bypassed by transactions occurring in other markets at inferior prices. By providing this protection for displayed prices, the Rule would serve to promote greater display of limit orders and more aggressive quoting. An increase in the use of limit orders and aggressive quoting should enhance price discovery and depth and liquidity in the markets; greater depth and liquidity would lead to improved execution quality for marketable orders, particularly for the execution of large institutional orders where statistics show there is room for improvement in both the markets for the trading of Nasdaq and exchange-listed stocks.449
Comment is requested on whether extending trade-through protection to DOB quotations450 would significantly increase the benefits of the reproposed Trade-Through Rule. Would protecting quotations at multiple price levels further encourage the display of limit orders and thereby significantly enhance depth and liquidity in the NMS? Since decimalization, quoted spreads have narrowed substantially. Market participants often may not be willing to quote in significant size at the inside prices, but might be willing to do so at a price that is a penny or more away from the inside prices. Granting trade-through protection to such quotations potentially would reward this beneficial quoting activity. In assessing the potential benefits of DOB protection, commenters should consider the effect of the reserve (or undisplayed) size function that many trading centers offer investors.451
By requiring trading centers to establish written policies and procedures reasonably designed to prevent trade-throughs and to comply with exceptions, and by requiring them to regularly surveil to ascertain the effectiveness of the policies and procedures and to take prompt remedial action to remedy deficiencies in such policies and procedures, the reproposed Rule also should help ensure that investors that submit marketable orders consistently receive executions at the best displayed bid or offer (or better). The Rule should facilitate the ability of a broker-dealer to achieve best execution for its customer orders because the market to which a broker-dealer routes an order would not execute the order at a price that is inferior to a protected bid or offer displayed on the other market (unless an exception applies).452 By better protecting the interests of all investors - both those that post limit orders and those that execute against posted limit orders - the reproposed Rule should bolster investor confidence in the integrity of the NMS, which should encourage investors to be more willing to invest in the market, thus adding depth and liquidity to the markets and promoting the ability of listed companies to raise capital.
Almost all commenters agreed that the current ITS trade-through rule must be fixed to accommodate the realities of today's NMS, in particular the differences in operation among automated and non-automated markets. Reproposed Rule 611, by providing protection only for automated quotations displayed by automated trading centers, would significantly update the ITS trade-through rule. Intermarket efficiency and certainty of execution in the NMS would be improved as automated markets would no longer need to wait for responses from non-automated markets and thus would be able to execute trades more quickly without regard for potentially unavailable quotations displayed on non-automated markets. The reproposed Rule also would level the playing field by eliminating the potential competitive advantage the existing ITS rule provides to manual markets. In addition, by providing an incentive for non-automated markets to automate - because market participants may be less likely to send their order flow to a market center whose orders can be ignored by other markets - the proposed Rule generally should improve the accessibility of bids and offers for all investors and increase the efficiency of the NMS.
When an investor receives an execution in one market at a price that is inferior to a price displayed in another market, that "trade-through" has a cost to the investor receiving the inferior execution. The Commission preliminarily believes that the benefits of strengthening price protection for exchange-listed stocks (by eliminating the gaps in ITS coverage of block positioners and 100-share quotes) and introducing price protection for Nasdaq stocks would be substantial, although the total amount is difficult to quantify. One objective, though quite conservative, estimate of benefits is the dollar amount of quotations that currently are traded through. Commission staff's analysis of current trade-through rates indicates that over 12 billion shares of displayed quotations in Nasdaq and NYSE stocks were traded through in 2003, by an average amount of 2.3 cents for Nasdaq stocks and 2.2 cents for NYSE stocks.453 These traded-through quotations represent approximately $209 million in Nasdaq stocks and $112 million in NYSE stocks, for a total of $321 million in bypassed limit orders and inferior prices for investors in 2003 that could have been addressed by strong trade-through protection. The Commission preliminarily believes that this $321 million estimated annual benefit, particularly when combined with the benefits of enhanced investor confidence in the fairness and orderliness of the equity markets, would justify the one-time costs of implementation and ongoing annual costs of the reproposed Trade-Through Rule.
The foregoing estimate of annual benefits is very conservative because it is based solely on depth of quotations that are displayed in the absence of strong price protection. In essence, it measures the problem — a shortage of quoted depth — that reproposed Rule 611 is designed to address, rather than the benefits that it would achieve. Every trade-through transaction potentially sends a message to market participants that their displayed quotations can be and are ignored by other market participants. When the total share volume of trade-through transactions that do not interact with displayed quotations reaches 8% and above for hundreds of the most actively traded NMS stocks, this message is unlikely to be missed by those who watched their quotations being traded through. Certainly, the practice of trading through displayed size is most unlikely to prompt market participants to display even greater size.
As discussed above,454 a primary objective of reproposed Rule 611 is to increase displayed depth and liquidity in the NMS and thereby reduce trading costs for a wide spectrum of investors, particularly institutional investors that trade in large sizes. It is difficult, however, to precisely measure the extent to which strengthened price protection would improve market depth and liquidity, and thereby lower trading costs of investors. The difficulty of estimation, however, should not hide from view the enormous potential benefit for investors of improving depth and efficiency of the NMS. Because of the huge dollar amount of trading volume in NMS stocks - more than $17 trillion in 2003455 – even the most incremental improvement in market depth and liquidity could generate a dollar amount of benefits that annually would dwarf the one-time start-up costs of implementing trade-through protection.
One approach to evaluating the potential benefits of the reproposed Rule is to examine a category of investors that stand to benefit a great deal from improved depth and liquidity for NMS stocks – the shareholders of U.S. equity mutual funds. In 2003, the total assets of such funds were $3.68 trillion.456 The average portfolio turnover rate for equity funds was 55%, meaning that the total purchases and sales of the securities they held total approximately $4.048 trillion.457 A leading authority on the trading costs of institutional investors has estimated that in 2003 the average price impact experienced by investment managers in U.S. stocks ranged from 17.4 basis points for giant-capitalization stocks, 21.4 basis points for large-capitalization stocks, and up to 35.4 basis points for micro-capitalization stocks.458 In addition, it estimated the cost attributable to adverse price movements while searching for liquidity for institutional orders, which often are too large simply to be presented to the market. Its estimate of search costs ranged from 13 basis points for giant capitalization stocks, 23 basis points for large capitalization stocks, and up to 119 basis points for micro-capitalization stocks. Assuming that the average price impact and search costs incurred across all stocks is a conservative 37.4 basis points,459 the shareholders in U.S. equity mutual funds incurred implicit trading costs of $15.1 billion in 2003. Based on a hypothetical assumption that, in light of the current share volume of trade-through transactions that does not interact with displayed liquidity,460 intermarket trade-through protection could improve depth and liquidity for NMS stocks by at least 5% (or an average reduction of 1.87 basis points in price impact and liquidity search costs for large investors), the savings in trading costs for U.S. equity mutual funds alone, and the improved returns for their millions of individual shareholders, would have amounted to approximately $755 million in 2003.
Of course, the benefits of improved depth and liquidity for the direct equity holdings of other types of investors, such as pension funds, insurance companies, and individuals, are not incorporated in the foregoing calculations. In 2003, these other types of investors held 78% of the value of publicly traded U.S. equity outstanding, with equity mutual funds holding the remaining 22%.461 Assuming that these other types of investors experienced a reduction in trading costs that merely equaled the estimated reduction of trading costs for equity mutual funds, the assumed 5% improvement in market depth and liquidity could yield total trading cost savings of over $1.5 billion annually. Such savings would improve the investment returns of equity ownership, thereby promoting the retirement and other long-term financial interests of individual investors and reducing the cost of capital for listed companies.
2. Costs
Some commenters expressed concern over the anticipated cost of implementing the trade-through proposal.462 These commenters argued that proposed Rule 611 would be too expensive and that the costs associated with implementing it would outweigh the perceived benefits of the rule. Some commenters were concerned about the cost of specific requirements in the proposed rule, particularly the procedural requirements associated with the proposed opt-out exception (e.g., obtaining informed consent from customers and disclosing the NBBO to customers).463 As discussed above, however, the reproposed Trade-Through Rule does not contain an opt-out exception, as was originally proposed.464 Therefore, the concerns expressed by commenters relating to the costs of implementing an opt-out exception are not applicable. Commenters also expressed concern that applying the trade-through proposal to the Nasdaq market would harm market efficiency and execution quality.465 As discussed above, the Commission preliminarily believes that a uniform rule that serves to limit the incidence of trade-throughs would improve market efficiency and benefit execution quality.466
The Commission recognizes that there would be significant one-time costs to implement the reproposed Trade-Through Rule. Trading centers would necessarily incur costs associated with establishing, maintaining, and enforcing written policies and procedures reasonably designed to prevent trade-throughs — in other words, with determining a course of action for how the trading center would comply with the requirements of the Rule, including compliance with the exceptions contained in the reproposed Rule. Although the extent of these costs would vary because the exact nature and extent of each trading center's written policies and procedures would depend on the type, size and nature of each entity’s business, as discussed above in Section VIII.A., for purposes of the PRA the Commission broadly estimates that each SRO trading center would incur an average one-time initial cost for establishing such policies and procedures of approximately $34,645, and each non-SRO trading center would incur an average one-time initial cost for establishing policies and procedures of approximately $29,116, for a total of $17,781,405.467
Each trading center also would incur initial up-front costs associated with taking action necessary to implement the written policies and procedures it has developed, which would include necessary modifications to order routing and execution systems to "hard-code" compliance with the Rule and the exceptions. For instance, modifications to order routing and execution systems would need to be made to route and execute orders in compliance with the requirements of the proposed Rule to prevent trade-throughs of protected quotations (which would include, for instance, the ability to recognize quotations identified in the consolidated quotation system as manual quotations on a quotation-by-quotation basis). Trading centers would need to make sure they have connectivity to other trading centers in the NMS that could post protected quotations, whether through proprietary linkages or through use of third-party services. As noted below, however, the Commission preliminarily believes that most of this private linkage functionality already exists, particularly in the market for Nasdaq securities. Surveillance systems would need to be modified to assure an effective mechanism for monitoring transactions after-the-fact for ongoing compliance purposes. Also, trading systems would need to be programmed to recognize when exceptions to the operative provisions of reproposed Rule 611 were applicable. For example, trading centers would need to be able to identify outgoing and recognize incoming orders as intermarket sweep orders. Data feeds and market vendor systems would need to be modified to accommodate order identifiers for manual quotations and intermarket sweep orders, which costs (to the extent incurred) would likely be passed along to the end users of these systems, the trading centers. These costs are included within the estimates below.
For non-SRO trading centers that rely upon their own internal order routing and execution management systems, of which the Commission preliminarily estimates that there are approximately 20, the Commission preliminarily estimates the average cost of necessary systems changes to implement the Rule would be approximately $3 million per trading center, for a total one-time start-up cost of approximately $60 million.468 The Commission preliminarily estimates that the remaining non-SRO trading centers that would be subject to the reproposed Rule would utilize outside vendors to provide these services, consistent with their current use of such services for order routing and execution management. For these non-SRO trading centers, the Commission preliminarily estimates the cost of necessary systems modifications that would be passed along to the trading centers to be approximately $50,000 per trading center, for a total initial cost of $21 million.469 The Commission also preliminarily estimates that the average cost to the nine SROs to make necessary system modifications to implement the reproposed Rule would be $5 million per SRO, for a total of $45 million. Therefore, preliminary estimated overall total one-time implementation costs, added to PRA costs, would be approximately $144 million.
In addition, broker-dealers that would not fall within the proposed definition of a trading center but that employ their own smart-order routing technology to route orders to multiple trading centers could choose to route orders in compliance with the proposed intermarket sweep exception. These broker-dealers would need to make necessary modifications to their order routing practices and proprietary order routing systems to monitor the protected quotations of trading centers and to properly identify such intermarket sweep orders. The Commission preliminarily does not believe that this category of broker-dealers is very large. The Commission also preliminarily believes it likely that most if not all of these non-trading center broker-dealers that employ their own order-routing technology already have systems in place that monitor best-priced quotations across markets, and thus does not believe that the changes necessary to implement the intermarket sweep order would be substantial.
With respect to maintaining and updating its required written policies and procedures to ensure they continue to be in compliance with the reproposed Rule, for purposes of the PRA the Commission preliminarily estimates that the average annual cost for each trading center would be approximately $5,676 per trading center per year, for a total annual cost for all trading centers of $3,456,684.470 With regard to ongoing monitoring for and enforcement of trading in compliance with the Rule, the Commission preliminarily believes that, once the tools necessary to carry out on-going monitoring have been put in place (which are included in the above cost estimates), a trading center would be able to incorporate ongoing monitoring and enforcement within the scope of its existing surveillance and enforcement policies and procedures without a substantial additional burden.
The Commission recognizes, however, that this ongoing compliance would not be cost-free, and that trading centers would incur some additional annual costs associated with ongoing compliance, including compliance costs of reviewing transactions. For instance, the Commission recognizes that access to a database of BBO information for each trading center whose quotations would be protected by the reproposed Trade-Through Rule would be necessary to monitor transactions for compliance with the Rule on an after-the-fact basis. The Commission believes that this information currently is available, at least with respect to the BBO of each trading center, and understands that such information currently is maintained by at least one industry vendor. The Commission preliminarily believes that the cost to each trading center to access this database would be incremental in relation to the cost of other services provided by the vendor.471 The Commission preliminarily estimates that each trading center would incur an average annual ongoing compliance cost of $30,144 for a total annual cost of $18,357,696 for all trading centers.472
The Commission also requests comment on whether the Voluntary Depth Alternative could be implemented in a practical and cost-effective manner.473 To comply, trading centers would need to monitor a significantly larger number of protected quotations displayed by other markets and route orders to execute against such quotations.474 The Voluntary Depth Alternative, however, would not increase the number of orders that a trading center would be required to route to other trading centers if only BBOs were protected. Instead, the size of the routed orders would need to be increased to reflect the accumulated depth displayed by other trading centers in their protected DOB quotations. In addition, the applicable regulatory authorities must be able to monitor and enforce compliance with a rule that protected DOB quotations. At a minimum, this would require an objective and uniform source to identify the quotations that are protected at any particular time.
As noted in section II.A.3 above, any intermarket protection against trade-throughs must be workable and implemented in a way that promotes fair and orderly markets. To the extent commenters are concerned about practical problems with implementing the Trade-Through Rule, would the basis for these concerns be magnified by the Voluntary Depth Proposal? Specifically, comment is requested on all issues relating to the feasibility and desirability of disseminating DOB quotations through Plan processors.475 For example, would the voluntary dissemination of protected DOB quotations through the Plan processors create a single point of failure that could threaten the stability of trading in NMS stocks?
The Commission also requests comment on the effect that adoption of the Voluntary Depth Alternative would have on competition among markets. One commenter, for example, suggested that protection of DOB quotations might cause increased fragmentation of liquidity across different markets because limit orders, no matter where displayed, would have price protection.476 Another commenter, in contrast, asserted that protecting only BBOs would lead to greater fragmentation because limit orders would be routed to any market where they would set or equal the BBO and thereby obtain trade-through protection.477 Comment is requested on the fragmentation issue, as well as in general on whether protecting DOB quotations would inappropriately limit the terms of market competition so as to harm investors and the efficiency of the NMS. For example, would adoption of the Voluntary Depth Alternative inappropriately reduce the scope of competition among markets to the payment of liquidity rebates for executed limit orders? Comment also is requested on whether adoption of the Voluntary Depth Alternative would generate forces that would lead to a monopolization of trading in a single trading facility.
In assessing the costs of systems changes that may be required by the reproposed Rule, it is important to recognize that much, if not all, of the connectivity among trading centers necessary to implement intermarket price protection has already been put in place. For example, trading centers for exchange-listed securities already are connected through the ITS. The Commission understands that ITS facilities and rules can be modified relatively easily and at low cost to enable an automatic execution functionality. With respect to Nasdaq stocks, connectivity among trading centers already is established through private linkages. Routing out to other trading centers when necessary to obtain the best prices for Nasdaq stocks is an integral part of the business plan of many trading centers, even when not affirmatively required by best execution responsibilities. Moreover, a variety of private vendors currently offer connectivity to NMS trading centers for both exchange-listed and Nasdaq stocks. Many of the broker-dealers that are non-SRO trading centers that would be subject to the Rule already employ smart order routing technology, either their own systems or those of outside vendors, which should limit the cost of implementing systems changes. The Commission also understands that the cost to the Plan processors to incorporate the reproposed Trade-Through Rule and its exceptions would be minimal.
In determining these estimates the Commission also has considered that many market participants are already making changes to their systems to become more competitive. Many of the changes being made would assist the market participants in preparing for implementation of the reproposed Trade-Through Rule. For example, Nasdaq, which previously did not have an order routing system, recently purchased Brut, LLC in order to acquire access to such a system. The Commission preliminarily believes that this acquisition should reduce the costs that would be incurred by Nasdaq to implement the reproposed Trade-Through Rule. The Commission also notes that the NYSE is in the process of modifying its Direct+ System to make more quotations available on an automated basis.478 These changes that the NYSE has undertaken should reduce the cost of additional systems changes needed to implement the Trade-Through Rule.
Overall, the Commission preliminarily believes that the reproposed Trade-Through Rule would produce significant benefits that justify the costs of implementation of the Rule.
B. Access Rule
Reproposed Rule 610 of Regulation NMS would set forth new standards governing access to quotations in NMS stocks. These standards would prohibit trading centers from imposing unfairly discriminatory terms that would prevent or inhibit the efficient access of any person through members, subscribers, or customers of such trading center, and enable access to NMS quotations through private linkages, rather than mandating a collective intermarket linkage facility. In addition, in order to ensure the fairness and accuracy of displayed quotations, the reproposed Rule would establish an outer limit on the cost of accessing protected quotations of no more than $0.003 per share (or 0.3% of the quotation price per share for quotations priced less than $1). Reproposed Rule 610 also would require SROs to establish and enforce rules that would, among other things, prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross the automated quotations of other trading centers. Finally, the reproposed amendment to Rule 301 of Regulation ATS would lower the threshold that triggers the Regulation ATS fair access requirements from 20% to 5% of average daily volume in a security.
1. Benefits
The Commission preliminarily believes that the reproposed Access Rule would help achieve the statutory objectives for the NMS by promoting fair and efficient access to each individual market. By relying on private linkages, rather than mandating a collective intermarket linkage facility, the access provisions of reproposed Rule 610(a) and (b) would allow market centers to connect through flexible and cost effective technologies widely used in the markets today, particularly in the market for Nasdaq stocks. This would allow firms to capitalize on the dramatic improvements in communications and processing technologies in recent years, and thereby enhance the linking of all markets for the future NMS. Private linkages also would provide flexibility to meet the needs of different market participants and allow competitive forces to determine the specific nature and cost of connectivity. The reproposed access provisions of Rule 610(a) and (b) thus would allow market participants to fairly and efficiently route orders to execute against the best quotations for a stock, wherever such quotations are displayed in the NMS. The Commission believes that fair and efficient access to the best quotations of all trading centers is critical to achieving best execution of those orders.
The reproposed access provisions of Rule 610(a) and (b) also would promote fair and efficient access to quotations by prohibiting a trading center from unfairly discriminating against non-members or non-subscribers that attempt to access its quotations through a member or subscriber of such trading center. Such fair access to the quotations of other trading centers is critical for compliance with the reproposed Trade-Through Rule and broker-dealers' duty of best execution.
The reproposed fee limitation of Rule 610(c) would address the potential distortions caused by substantial, disparate fees. As a result of the reproposed fee limitation, displayed prices would more closely reflect actual costs to trade, thereby enhancing the usefulness of market information. The proposed fee limitation also would establish a level playing field across all market participants and trading centers. A single accumulated fee limitation would apply equally to all types of trading centers and all types of market participants, thereby promoting the NMS objective of equal regulation of markets and broker-dealers.
The reproposed fee limitation also should help address the "outlier" business model under which a trading center charges high fees for access to its quotations and passes most of the fees through as rebates to attract liquidity providers. These outliers might attempt to take advantage of intermarket price protection by acting essentially as a toll booth between price levels. Particularly with a trade-through rule, even though high fee markets likely would be the last market to which orders would be routed, prices could not move to the next level until someone routed an order to take out the displayed price at the outlier market. Such a business model would detract from the usefulness of quotation information and impede market efficiency and competition. The reproposed fee cap would preclude the outlier business model. It would place all markets on a level playing field in terms of the fees they can charge and ultimately the rebates they can pass on to liquidity providers. Some markets might choose to charge lower fees, thereby increasing their ranking in the preferences of order routers. Others might charge the full $0.003 and rebate a substantial proportion to liquidity providers. Competition would determine which strategy was most successful.479
The restrictions on locking or crossing quotations in reproposed Rule 610(d) should promote fair and orderly markets. Locked and crossed markets can cause confusion among investors concerning trading interest in a stock. Restricting the practice of submitting locking or crossing quotations therefore would enhance the usefulness of quotation information. Consistent with the approach to trade-through protection, however, reproposed Rule 610(d) would allow automated quotations to lock or cross manual quotations. Reproposed Rule 610(d) thereby would address the concern that manual quotations may not be fully accessible and recognize that allowing automated quotations to lock or cross manual quotations may provide useful market information regarding the accessibility of quotations. The Commission preliminarily believes, however, that an automated quotation is entitled to protection from locking or crossing quotations. When two market participants are willing to trade at the same quoted price, giving priority to the first-displayed automated quotation should contribute to fair and orderly markets. Moreover, the basic principle underlying the NMS is to promote fair competition among markets, but within a unified system that also promotes interaction between all of the buyers and sellers in a particular NMS stock. Allowing market participants simply to ignore accessible quotations in other markets and routinely display locking and crossing quotations would be inconsistent with this principle. The reproposed restrictions on locking or crossing quotations, in conjunction with the reproposed Trade-Through Rule, should encourage trading against displayed quotations and enhance the depth and liquidity of the markets.
Finally, lowering of the fair access threshold of Rule 301(b)(5) under Regulation ATS480 from 20% to 5% of average daily trading volume in a security would further strengthen access to the full range of services of ATSs with significant trading volume in NMS stocks. Such access is particularly important for success of the private linkage approach proposed for access to quotations. The lowering of the fair access threshold also would make its coverage consistent with the existing 5% threshold triggering the order display and execution access requirements of Rule 301(b)(3) of Regulation ATS.481 As a result, each ATS that is required to disseminate its quotations in the consolidated data stream also would be prohibited from unfairly prohibiting or limiting market participants from becoming a subscriber or customer.
In reproposing Rule 610 and the amendment to Rule 301 of Regulation ATS, the Commission seeks to help ensure that securities transactions can be executed efficiently, at prices established by vigorous and fair competition among market centers. By enabling fair access and transparent pricing among diverse marketplaces within a unified national market, the Commission preliminarily believes that the access proposal would foster efficiency, enhance competition, and contribute to the best execution of orders for NMS securities.
2. Costs
The Commission preliminarily believes that reproposed Rule 610 and the reproposed amendments to Rule 301 of Regulation ATS would not impose significant costs on most trading centers and market participants. The system changes necessary to meet the new access standards should be minor. Currently, private linkages are widely used in the equity markets, particularly for trading in Nasdaq stocks.482 Moreover, the Commission understands that the ITS facilities that currently provide intermarket access for exchange-listed stocks could be modified at minimal cost to provide an auto-execution functionality, at least as an interim measure until private linkages were fully established for exchange-listed stocks.
While commenters were generally supportive of the Commission's proposal to employ private linkages to provide access between markets, some commenters expressed concern that the effort and investment to establish such connectivity to smaller markets would likely be disproportionate to the liquidity on such a market.483 Reproposed Rule 610(b)(1), however, would require trading centers that display quotations in the ADF to provide a level and cost of access to their quotations that is substantially equivalent to the level and cost of access to quotations displayed by SRO trading facilities.
Currently, three ATSs display quotations in the ADF, two of which also display quotations through the NASDAQ Market Center. Reproposed Rule 610(b) may require these trading centers to incur additional costs to enhance the level of access to their quotations and to lower the cost of connectivity for market participants seeking to access their quotations. The extent to which these trading centers in fact incur additional costs to comply with the proposed access standard would be largely within the control of the trading center itself. ATSs and market makers that wish to trade NMS stocks can choose from a number of options for quoting and trading. They can become a member of a national securities exchange and quote and trade through the exchange's trading facilities. They can participate in the NASDAQ Market Center and quote and trade through that facility. Finally, they can quote and trade in the OTC market. The existence of the NASD's ADF makes this third choice possible by providing a facility for displaying quotations and reporting transactions in the consolidated data stream.484 As a result, the additional connectivity requirements of reproposed Rule 610(b) would be triggered only by a trading center that displays its quotations in the consolidated data stream and chooses not to provide access to those quotations through an SRO trading facility.
Currently, nine SROs operate trading facilities in NMS stocks. Market participants throughout the securities industry generally have established connectivity to these nine points of access to quotations in NMS stocks. By choosing to display quotations in the ADF, a trading center effectively could require the entire industry to establish connectivity to an additional point of access. Potentially, many trading centers could choose to display quotations in the ADF, thereby significantly increasing the overall costs of connectivity in the NMS. Such an inefficient outcome would become much more likely if an ADF trading center were not required to assume responsibility for the additional costs associated with its decision to display quotations outside of an established SRO trading facility. Consequently, the reproposed access standard in Rule 610(b)(2) would help reduce overall industry costs by more closely aligning the burden of additional connectivity with those entities whose choices have created the need for additional connectivity.
To meet the standard contained in reproposed Rule 610(b)(1), a trading center would be allowed to take advantage of the greatly expanded connectivity options that have been offered by competing access service providers in recent years.485 These industry access providers have extensive connections to a wide array of market participants through a variety of direct access options and private networks. A trading center potentially could meet the requirement of reproposed Rule 610(b)(1) by establishing connections to and offering access through such vendors. The option of participation in existing market infrastructure and systems should greatly reduce a trading center's cost of compliance.486
Several commenters, including some that otherwise supported the proposal, expressed concern that requiring non-discriminatory access to markets might undermine the value of SRO membership.487 The Commission preliminarily does not believe that adoption of a private linkage approach would seriously undermine the value of membership in SROs that offer valuable services to their members. First, the fact that markets would not be allowed to impose unfairly discriminatory terms on non-members who obtain indirect access to quotations through members does not mean that non-members would obtain free access to quotations. Members who provide piggyback access would be providing a useful service and presumably would charge a fee for such service. The fee would be subject to competitive forces and likely would reflect the costs of SRO membership, plus some element of profit to the SRO's members. As a result, non-members that frequently make use of indirect access are likely to contribute indirectly to the costs of the SRO market. Moreover, the unfair discrimination standard of Rule 610(a) would apply only to access to quotations, not to the full panoply of services that markets generally provide only to their members.
The Commission preliminarily does not believe that the proposed fee limitation of reproposed Rule 610(c) would impose significant new costs on most trading centers. A few commenters were concerned about the costs to market participants of administering a fee program under the original proposal, which would have limited trading centers to a fee of $0.001 and broker-dealers to a fee of $0.001.488 The revised proposal, by imposing a single accumulated fee limitation of $0.003 (when the price of the protected quotation is $1 or more), would greatly simplify the proposed fee limitation and likely would leave existing fee practices largely intact. Entities that currently charge and collect fees would continue to do so. Market makers likely would collect fees through an SRO trading facility or ECN through which it displayed limit orders or quotations, and the administration of such fee program likely would be handled by the SRO or ECN. Therefore, the revised fee limitation should not impose significant new administrative costs.
The reproposed fee limitation of Rule 610(c) would, however, affect the few markets that currently impose access fees of greater than $0.003 per share that apply to a wide range of NMS stocks.489 These markets could be required to re-evaluate their business models in light of the adopted fee limitation. In particular, they likely would need to reduce the rebates they currently pay to liquidity providers. The reproposed limitation also would affect a few trading centers that charge significant access fees for large transactions in specific types of NMS stocks, such as ETFs. It is unlikely, however, that such fees currently generate a large amount of revenues.490
The locked and crossed provisions of reproposed Rule 610(d) should not impose significant additional costs for the SROs. All SROs currently have rules restricting locking and crossing quotations in exchange-listed stocks to comply with the provisions of the ITS Plan. Such SROs also collect the data and related information required to monitor locked and crossed markets, and the Commission preliminarily believes that the additional surveillance and enforcement costs related to the provisions would be minor. The Commission recognizes, however, that reproposed Rule 610(d), by restricting locked markets with respect to automated quotations, could impose certain trading costs associated with widened spreads if an order that would otherwise have been displayed was not displayed. Although locked markets do occur a certain percentage of the time, they do not occur all the time, and thus, the average spread is between zero and a penny (a penny being the MPV for all but a very few stocks). Thus, the Commission preliminarily believes that any widening of average spreads caused solely by the reproposed rule would be limited to the difference between a sub-penny and penny spread. In addition, a locked market often does not actually represent two market participants willing to buy and sell at the same price because it is likely that the locking market participant is not truly willing to trade at the displayed locking price, but instead chooses to lock rather than execute against the already-displayed quotation to receive a liquidity rebate.
Finally, reducing the fair access thresholds of Regulation ATS would require ATSs that exceed the 5% threshold level to comply with Rule 301(b)(5) under Regulation ATS. Rule 301(b)(5) requires ATSs, among other things, to establish written standards for granting access to trading on its system, to not unreasonably prohibit or limit access to its services, to keep records of all grants or denials of access, and to report such information on Form ATS-R. The Commission preliminarily believes that the costs to meet these requirements are justified by the need to promote fair and efficient access to trading centers with significant volume.
C. Sub-Penny Rule
Reproposed Rule 612 would prohibit market participants from displaying, ranking, or accepting quotations in NMS stocks that are priced in an increment less than $0.01, unless the per share price of the quotation is less than $1.00. It would permit sub-penny quotations below $1.00, but only to four decimal places.
1. Benefits
The Commission believes that the markets' conversion to decimal pricing has benefited investors by, among other things, clarifying and simplifying pricing for investors, making the U.S. securities markets more competitive internationally, and reducing trading costs by narrowing spreads. The Commission is concerned, however, that if the MPV decreases beyond a certain point, some of the benefits of decimals could be lost while some of the negative effects are exacerbated. The Commission preliminarily believes that reproposed Rule 612, which would prohibit an MPV of less than $0.01 for most NMS stocks, would have several benefits. The majority of the commenters supported the proposal and noted various potential benefits of the proposed rule.491
The Commission preliminarily believes that sub-penny quoting 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 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 Commission's short sale rule and the NASD's Manning rule).492
In addition, the Commission agrees with the many commenters that believed that prohibiting sub-penny quoting would 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."493 Improved liquidity should decrease the costs of trading, especially for large orders.494 Market participants may be more likely to place limit orders if they know that other market participants cannot quote ahead of them by a sub-penny amount.
2. Costs
The Commission recognizes that reproposed Rule 612 would impose certain costs on the U.S. securities markets. Currently, certain NMS stocks are quoted – and in the absence of the rule, others in the future could be quoted – in sub-pennies. For these NMS stocks, quoted spreads would be wider than they otherwise would be, because reproposed Rule 612 would not allow market participants to narrow the spread by a sub-penny amount.
Two commenters stated that investors would suffer harm from artificially widened spreads.495 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."496 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.497 Another commenter stated that, if all markets traded QQQQ solely in sub-pennies, the savings would be approximately $150 million per year.498 This commenter, however, did not provide data or analysis showing how it reached this conclusion. No other commenters provided any quantitative analysis of the costs that a sub-penny quoting rule would impose by widening spreads to at least a full penny.
The Commission preliminarily believes that the $400 million and $150 million estimates of the cost to the markets caused by wider spreads provided by these two commenters are inaccurate and excessive. This estimate appears to assume that all trading activity would occur at these narrower quoted spreads. The Commission does not believe that these commenters provided any evidence to substantiate 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. Therefore, because spreads on most markets already cannot be smaller than $0.01, these markets would not be required to take any action in response to reproposed Rule 612 that would cause their spreads to widen. Therefore, the cost to these markets of not having sub-penny spreads should not be considered costs of the reproposed rule. With respect to the ATSs that currently do permit some NMS stocks to be quoted in sub-pennies, the Commission staff performed a study of trade data in Nasdaq, NYSE, and Amex stocks to better consider commenters' claims. Based on that study, the Commission staff estimates that the costs of widened spreads in these securities would be approximately $48 million annually (or approximately $33 million if the Commission were to exempt QQQQ from reproposed Rule 612).499
In this study, the Commission staff obtained public data from NYSE's "Trade and Quote" files for all NYSE-listed and Amex-listed stocks and public data from the Nastraq trade file for Nasdaq-listed stocks, for the period June 7-10, 2004. Based on trading activity from the Nasdaq-listed securities, Commission staff estimated that 1.5% of all trades over $1.00 were reported in a sub-penny increment.500 These trades accounted for 4.7% of share volume. However, not all trades that were reported as having a sub-penny price resulted from a sub-penny quotations. Commission staff excluded VWAP trades which are marked as such in the Nastraq file.501 Based on this screened dataset, Commissions staff estimated that 1.4% of trades were reported in sub-penny increments accounting for 2.4% of share volume. Commission staff then calculated the dollar cost if all such trades executed at the near-side penny rather than at a sub-penny amount. This price difference, multiplied by the executed volume, produces a dollar cost per trade.502 Summed across all sub-penny trades, the average daily cost for in this sample was $80,973. At 252 trading days per year, this results in $20,400,235 on an annual basis.
Commission staff performed a similar analysis on the trade data for Amex-listed stocks, except that the data set did not permit VWAP trades to be excluded.503 On an annualized basis, Commission staff estimated that the gross cost resulting from slightly wider spreads would be $16 million (or only $1.2 million if QQQQ is excluded). Similarly, the Commission staff estimated that the gross costs from wider spreads would be approximately $12 million annually for NYSE-listed stocks.
Another potential cost of reproposed Rule 612 is that market participants that have developed systems that allow their users to quote in sub-pennies would, for most NMS stocks, lose the ability to gain any market advantage from such enhancements. In addition, any market participant that currently allows its users to display, rank, or accept orders or quotations in sub-pennies would incur costs in reprogramming its systems to prevent the entry of sub-penny orders or quotations. The Commission preliminarily believes, however, that these costs would be negligible. Currently, the exchanges and Nasdaq do not permit sub-penny quoting; only two major ECNs permit sub-penny quoting, but only in a limited number of securities.504 These ECNs would have to take only minor steps to readjust their systems to comply with reproposed Rule 612. Finally, the Commission preliminarily believes that paragraph (b) of reproposed Rule 612, which would prohibit quotations below $1.00 from extending beyond four decimal places, would have negligible systems costs. The Commission currently is not aware of any market that quotes and trades NMS stocks in increments beyond four decimal places and preliminarily believes, therefore, that no market would incur systems costs to limit quotations below $1.00 to a maximum of four decimal places.
After carefully considering all the comments received, the Commission preliminarily believes that, on balance, the benefits of reproposed Rule 612 would justify the costs.
D. Market Data Rules and Plan Amendments
The Commission is reproposing amendments to the rules relating to the dissemination of market information to the public. In particular, the Commission is reproposing amendments to the Plans505 to modify the current formulas for allocating market data revenues to the SROs, and to require the establishment of non-voting advisory committees comprised of interested parties other than SROs. In addition, the Commission is reproposing to rescind the current prohibition in Exchange Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601) on SROs and their members from independently distributing their own trade reports, and is reproposing an amendment to Exchange Act Rule 11Ac1-2 (proposed to be resdesignated as Rule 603) to incorporate uniform standards pursuant to which they may independently distribute their own trade reports and quotations (outside of providing the requisite information to Plan processors). The Commission is further reproposing to amend Exchange Act Rule 11Ac1-2 (proposed to be resdesignated as Rule 603) to make explicit that all SROs must act jointly through the Plans and through a single processor per security to disseminate consolidated market information in NMS stocks to the public. Finally, the Commission is reproposing amendments to Exchange Act Rule 11Ac1-2 (proposed to be resdesignated as Rule 603) to streamline and simplify the consolidated display requirements by reducing the data required to be displayed under the rule, and by limiting the range of the rule to the display of such data in trading and order-routing contexts.
1. Revenue Allocation Formula
a. Benefits
The Commission preliminarily believes that the reproposed amendment to the Plans modifying the current formulas for allocating market data revenues would be beneficial to the marketplace because the new allocation formula would allocate revenues to markets based on the value of their quotations in addition to their trades. The current formulas allocate Plan revenues based solely on the number or share volume of an SRO's reported trades, and do not allocate revenues to those market centers that generate quotations with the best prices and the largest sizes that are an important source of public price discovery. The new allocation formula also should help to reduce the economic and regulatory distortions caused by the current formulas, including wash sales, trade shredding, and SRO print facilities.506 Because the reproposed formula would address these distortive practices and would allocate revenues to those market centers that provide the most useful market information, the Commission preliminarily believes that the NMS would be benefited as a whole.
The reproposed new revenue allocation formula would encompass a two-step process. Under the proposed initial step, the "Security Income Allocation," a Network's distributable revenues would be allocated among the individual securities included in the Network's data stream based on the square root of the dollar volume of trading in each security. Use of the square root function is appropriate to take into account the level of trading activity in each security, while adjusting for the disproportionate level of trading in the most active NMS stocks when distributing revenues among the various securities.
Following this initial distribution of revenues, the next step in the process would be to allocate the revenues distributed to an individual security among the various SROs that trade the security based on each SRO's trading and quoting activity. Specifically, under the reproposed "Trading Share" criterion, fifty percent of the revenues allocated to a particular security (subject to a $2 cap per qualified transaction report) would be allocated to SROs based on their proportion of the total dollar volume and number of qualified trades (transactions that have a dollar volume of $5,000 or greater) in that security. A few commenters stated that small trades (transactions that have a dollar value of less than $5000) should be entitled to partial credit under this criterion because these trades also contribute to public price discovery.507 The Commission acknowledges the benefits of small trades and has amended the original proposed new formula to provide for a proportional allocation of revenues for such trades. The reproposed Trading Share measure is intended to allocate revenue to those SROs that actively trade in the security, thereby providing liquidity and price discovery, while reducing the potential for the shredding of trade volume.
Under the reproposed "Quoting Share" criterion, fifty percent of the revenues allocated to a particular security under the Security Income Allocation measure would be allocated to SROs based on their proportion of credits earned for the time and size of their quotations at the NBBO in that security during regular trading hours. 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.508 In particular, some of these commenters noted the benefits of adding a quoting component to the new formula,509 especially if revenues are allocated only for automated and accessible quotations. Some commenters, however, were concerned that the inclusion of quotations in the proposed new allocation formula could lead new types of "gaming" of the formula, such as flashing quotations with no real intention to trade at those prices simply to earn more quote credits — and thereby more revenues — under the Quoting Share measure.510 The Commission preliminarily believes that the proposed requirement that quotations last at least one second to earn credits coupled with overall market discipline imposed by current order-routing practices discouraging "low-cost" quotations at the NBBO should minimize the potential for such gaming behavior. The Quoting Share criterion of the reproposed formula is intended to do what the current formulas do not — allocate revenue to those markets whose quotations frequently equal the best prices and for the largest sizes.
The Commission received a number of comments regarding the potential cost and complexity of the proposed revenue allocation formula.511 The Commission notes that, consistent with the approach of the reproposed Trade-Through Rule and the reproposed Access Rule, it has determined to eliminate from the reproposed formula the most complex elements of the proposed allocation formula that were intended primarily to address the problem of manual quotation — the "NBBO Improvement Share" criterion and the automatic cut-off for manual quotations left at the NBBO under the Quoting Share criterion. Because the revised formula would only allocate revenues for automated quotations, and manual quotations would be excluded from the any revenue allocation, the Commission believes that it is no longer necessary to include an NBBO Improvement Share criterion and automatic cut-off for manual quotations in the proposed new formula. As a result, the reproposed formula is substantially less complex than originally proposed.
In sum, the Commission preliminarily believes that the greatest benefit of allocating Plan revenues to the SROs based equally on the proposed Trading Share and Quoting Share measures is that such measures would allocate revenues to an SRO for its overall contribution of both quotations and trades, while reducing the incentive for distortive trade reporting practices caused by the current formulas. Investors would benefit from the proposed new formula because these broad-based measures would allocate revenues to those SROs that provide investors with the most useful market information, and thus that contribute to public price discovery, by allocating them a larger portion of Plan revenues.
b. Costs
The Commission recognizes that the current allocation formulas have been used since the creation of the Plans and Networks in the 1970s, and that the SROs and the Network processors have become familiar with those formulas for purposes of allocating revenues and structuring their businesses. Because the reproposed new allocation formula is more detailed than the current formulas, the Network processors would have to learn the particular features of the new formula and would have to consider SRO quotations in addition to reported trades as a measure for allocating Plan revenues. Accordingly, the Network processors, or some other entity retained by the Networks, would be required to develop a program to calculate the Trading Shares and Quoting Shares of the SRO participants. All of the data necessary for implementation of the formula would be disseminated through the consolidated data stream on a real-time basis. If a single entity were retained to handle the task for all three Networks, the Commission estimates that it would cost approximately $1 million annually to make the requisite calculations under the proposed new formula and to disseminate the results to the SRO participants on a daily basis. This estimated cost of implementation and compliance represents only 1/4 of one percent of the total revenues collected and distributed through the Plans for 2003.
In addition, some SROs are likely to be allocated a smaller portion of Plan revenues under the reproposed new allocation formula than they would have received under the existing formulas, while other SROs would receive a larger portion of revenues. This would result if certain SROs are currently reporting a large number of trades or share volume of trades, but are not necessarily providing the best quotations or trades with larger sizes. A few commenters expressed concern that certain business models would be adversely impacted by the proposed new allocation formula,512 particularly for those markets that primarily handle small retail order flow.513 The Commission recognizes that reforming formulas that have remained unchanged for many years may 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 designed 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. The Commission therefore preliminarily believes that the benefits of the proposed new allocation formula justify the costs of implementation.
2. Plan Governance
a. Benefits
The Commission preliminarily believes that the reproposed amendment to the Plans requiring the creation of advisory committees would improve Plan governance. Under the Plans, a representative of each SRO participating in the Plan is a member of the operating committee that governs that Plan. The reproposed amendment to the Plans would require the establishment of non-voting advisory committees comprised solely of persons not employed by or affiliated with an SRO participant. This reproposal is intended to broaden participation in the governance of the Plans.
The proposed amendment would require the SRO participants to select the members of the advisory committee comprised, at a minimum, of one or more representatives associated with (1) a broker-dealer with a substantial retail investor base, (2) a broker-dealer with a substantial institutional investor customer base, (3) an ATS, (4) a data vendor, and (5) an investor. In addition, each SRO participant would be entitled to select an additional committee member. The Commission believes that the composition of the advisory committee would give interested parties other than the SROs a voice in matters that affect them.
The members of the advisory committee would have the right to submit their views to the operating committee on Plan business (other than matters determined to be confidential by a majority of Plan participants), prior to any decision made by the operating committee, and would have the right to attend operating committee meetings. Broader participation in the Plans through the creation of Plan advisory committees would be beneficial to the administration of the Plans because it would provide transparency to the Plan governance process and could promote the formation of industry consensus on disputed issues.
b. Costs
The reproposed amendment to the Plans requiring the formation of advisory committees could potentially result in costs to the SRO participants who would be required to engage in a selection process for purposes of establishing such committees. A Plan's operating committee as a whole would be required to select a minimum of five committee members, while each SRO participant also would have the right to select an additional committee member. This selection process could potentially result in added costs and administrative burden and expense to the SRO participants.
The reproposed Plan amendment also could potentially disrupt of the current governance of the Plans by their participants. Since the creation of the Plans, representatives from the SROs have been the sole participants in the Plans and have been responsible for their administration. A few commenters believed that the additional participation of non-SRO parties could potentially increase the difficulty of reaching a consensus on Plan business, stating that too many members on an advisory committee could complicate and disrupt, rather than assist, Plan operations due to differing agendas.514 Although such a result may occur at times, the Commission preliminarily believes that this cost would be justified by the benefits that could be gained by increasing the transparency of Plan operations and giving parties other than SROs an opportunity to submit their views. In the past, the Plans may not have adequately considered the viewpoints of non-SRO parties on important issues such as fees and administrative burdens. Establishing advisory committees would address this problem and thereby potentially make the Plans more responsive to the needs of market participants and investors.
3. Proposed Amendments to Rules 11Aa3-1 and 11Ac1-2 (Proposed to Be Redesignated as Rules 601 and 603)
a. Independent Distribution of Information
i. Benefits
The Commission is reproposing an amendment to Exchange Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601) that would rescind the prohibition on SROs and their members from disseminating their trade reports independently.515 Under the reproposed amendment to Exchange Act Rule 11Aa3-1 (proposed to be redesignated as 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. The Commission preliminarily believes that independently distributed information could be beneficial to investors and other information users because depth-of-book quotations have become increasingly important as decimal trading has spread displayed depth across a greater number of price points.
Reproposed Rule 603(a) would establish uniform standards for distribution of both quotations and trades. The reproposed standards would require an exclusive processor, or a broker or dealer with respect to information for which it is the exclusive source, that distributes quotation and transaction information in an NMS stock to a securities information processor ("SIP") to do so on terms that are fair and reasonable. In addition, those SROs, brokers, or dealers that distribute such information to a SIP, broker, dealer, or other persons would be required to do so on terms that are not unreasonably discriminatory. Furthermore, these uniform standards would be based, in part, on similar requirements found in Sections 3 and 11A of the Exchange Act516 for SROs and entities that distribute SRO information on an exclusive basis. The Commission preliminarily believes that extending these requirements to non-SRO market centers, including ATSs and market makers, would help assure equal regulation of all markets that trade NMS stocks.
ii. Costs
The Commission recognizes that the rescission of the prohibition on independent distribution of trade reports under Rule 11Aa3-1 (proposed to be redesignated as Rule 601) could potentially lead to market centers incurring costs associated with the independent distribution of their market data if they choose to distribute such data without charging a fee. In addition, investors may have to pay for additional data if market centers choose to charge a fee for the additional data. Furthermore, a corollary to one commenter's assertion that market centers could benefit from additional revenues if market centers choose to distribute their own quotation information517 is that the data from one or more other market centers could potentially become more or less valuable than another market center's data, and thereby increase or reduce that market center's overall income. The Commission preliminarily does not believe that there will be any costs associated with the requirement to establish uniform standards for the distribution of trades and quotations pursuant to reproposed Rule 603(a), but requests comment on this issue.
b. Consolidation of Information
i. Benefits
All SROs currently participate in Plans that provide for the dissemination of consolidated information for the NMS stocks that they trade. Reproposed Rule 603(b) would confirm by Exchange Act rule that both existing and any new SROs would be required to continue to participate in joint-industry plans to disseminate consolidated information in NMS stocks to the public. This reproposed amendment would provide the benefit of clarifying that all SROs — whether existing or new — would be required to participate jointly in one or more Plans to disseminate consolidated information in NMS stocks. The reproposed amendment also would require that all quotation and trade information for an individual NMS stock be disseminated through a single processor (currently, SIAC or Nasdaq). The Commission preliminarily believes that requiring a single processor for a particular security would help to ensure that investors continue to receive the benefits of obtaining consolidated information from a single source.
ii. Costs
Given that consolidated market information currently is disseminated through a single processor per stock, the Commission does not foresee any new costs associated with reproposed Rule 603(b).
c. Display of Consolidated Information
i. Benefits
Reproposed Rule 603(c) (currently Exchange Act Rule 11Ac1-2) would substantially revise the consolidated display requirement by limiting its scope. It would incorporate a new definition of "consolidated display" (set forth in reproposed Rule 600(b)(13)) that is limited to the prices, sizes, and market center identifications of the NBBO, along with the "consolidated last sale information" (which is defined in proposed Rule 600(b)(14)). 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.
Reproposed Rule 603(c) also would eliminate the burden on vendors and broker-dealers to display a complete montage of quotations from all market centers trading a particular security, which would include the price of quotations that may be far away from the current NBBO. Furthermore, vendors and broker-dealers would have the ability to decide what, if any, additional data from other market centers beyond this basic disclosure to display. Vendors, broker-dealers, and investors would benefit from this reduced consolidated display requirement through a more efficient use of system capacity and because the costs of obtaining necessary data could be lowered. The Commission believes that giving investors the ability to choose (and pay for) only the data they need and use would be beneficial.
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. Reproposed Rule 603(c) also would simplify the rule language to require that consolidated data be made available in an equivalent manner as other data and would rescind unnecessary provisions in order to update the Rule.518 Reproposed Rule 603(c) should benefit broker-dealers and vendors by making compliance with the reproposed Rule's more tailored requirements easier and more efficient.
ii. Costs
A potential cost attributable to reproposed Rule 603(c) could be that there currently may be individuals who use the displayed montage of quotations from all market centers trading a particular security. If vendors and broker-dealers determined not to display this additional information, these investors would be required to obtain the additional data at additional cost. Reproposed Rule 603(c) also could potentially result in an administrative cost or burden for vendors and broker-dealers that would be required to assess in what circumstances they are displaying market data information for trading and order-routing purposes and in what circumstances they are displaying such information for other purposes. The Commission preliminarily believes that such a cost would be minimal.
E. Regulation NMS
The Commission is reproposing to redesignate the current NMS rules adopted under Section 11A of the Exchange Act519 as Regulation NMS, make non-substantive conforming changes to various rules, and create a separate definitional rule, Rule 600, which would contain all of the defined terms used in Regulation NMS. Currently, each NMS rule includes its own set of definitions, and some identical terms, such as "covered security," "reported security," and "subject security," are defined inconsistently. Although reproposed Rule 600 would retain, unchanged, most of the definitions used in the existing NMS rules, it would delete or revise obsolete definitions and eliminate the use of inconsistent definitions for identical terms. Reproposed Rule 600 would not alter the requirements or operation of the existing NMS rules.
1. Benefits
The Commission believes that reproposed Rule 600 and the related proposed amendments to various rules would benefit all entities that are and would be subject to the requirements of the rules contained in Regulation NMS, including broker-dealers, national securities exchanges, the NASD, ECNs, SIPS, and vendors. By eliminating or revising obsolete and inconsistent definitions and adopting a single set of definitions that would be used throughout Regulation NMS, reproposed Rule 600 should make Regulation NMS clearer and easier to understand, thereby facilitating compliance with its requirements and potentially easing the compliance burden on entities subject to Regulation NMS. Increased compliance with Regulation NMS would, in turn, benefit investors and the public interest. Similarly, the related non-substantive amendments to various rules would ensure that those rules use the definitions provided in reproposed Rule 600 and refer accurately to the redesignated NMS rules.
2. Costs
Reproposed Rule 600 would update and clarify the definitions used in existing NMS rules. Neither reproposed Rule 600 nor the related conforming proposed amendments to various rules would alter the existing requirements of the NMS rules or other Commission rules. Accordingly, the Commission believes that reproposed Rule 600 and the related amendments would impose few additional costs on entities subject to Regulation NMS. Although some additional personnel costs may be incurred in reviewing the changes, the Commission believes that these costs would be minimal.
X. Consideration of Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation
Section 3(f) of the Exchange Act520 requires the Commission, when engaging in rulemaking that requires the Commission to consider or determine whether an action is necessary or appropriate in the public interest, to consider whether the action will promote efficiency, competition and capital formation. Section 23(a) of the Exchange Act521 requires the Commission to consider whether the action will promote efficiency, competition and capital formation. Section 23(a)(2) prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.522 To assist the Commission in evaluating the costs and benefits of Regulation NMS, the Commission solicited comment in the Proposing Release on whether any of the proposals discussed therein would have an adverse effect on competition that is neither necessary nor appropriate in furtherance of the purposes of the Exchange Act, and whether they would, if adopted, promote efficiency, competition and capital formation. The Commission also requested commenters to provide empirical data and other factual support for their views on these subjects. The Commission has considered comments received and has reproposed these rules, taking into account these comments. The Commission requests comment on these issues in the context of the reproposed rules.
A. Trade-Through Rule
The Commission preliminarily believes that the price protection that would be provided by the reproposed Trade-Through Rule would encourage the use of limit orders and aggressive quoting, which should help improve the price discovery process, and contribute to increased liquidity and depth in the markets. The greater the number of limit orders available at better prices and greater size, the more liquidity available to fill incoming marketable orders. Thus, greater depth and liquidity should lead to improved execution quality, particularly for larger-sized institutional orders. The Commission also preliminarily believes that the reproposed Trade-Through Rule, by providing intermarket price protection for accessible, automated orders and not requiring automated markets to wait for responses from non-automated markets, would help promote efficiency in the markets by more effectively linking markets together and integrating trading centers with different market structures into the NMS, and by providing an incentive for non-automated markets to automate. Reproposed Rule 611 also should promote investor confidence in the markets by helping to ensure that customer orders are executed at the best price available and providing protection against limit orders being bypassed by inferior priced executions. Comment is requested on whether extending trade-through protection to DOB quotations would significantly increase the benefits of the reproposed Trade-Through Rule. Would protecting quotations at multiple price levels further encourage the display of limit orders and thereby significantly enhance depth and liquidity in the NMS?
The Commission recognizes the vital importance of preserving competition among market centers,523 and preliminarily believes that reproposed Rule 611 would promote intermarket competition by leveling the playing field between automated and non-automated markets and, to the extent that the existing trade-through rule serves to constrain competition, by removing this barrier to competition. In addition, the Commission preliminarily believes that market participants and intermediaries, consistent with their desire to achieve the best price and their duty of best execution, would continue to rank trading centers according to the total range of services provided by such markets. The most competitive - i.e. attractive - trading center would be the first choice for routing marketable orders, thereby enhancing the likelihood of execution for limit orders routed to that trading center. Because likelihood of execution is very important to limit orders, routers of limit orders likely would be attracted to this preferred trading center. More limit orders would enhance the depth and liquidity at the preferred trading center, thereby increasing its attractiveness for marketable orders, and beginning the cycle over again.
Trading centers that offer poor services, such as slow response times, would likely rank near the bottom in order-routing preferences of market participants and intermediaries. Whenever a least-preferred trading center is merely posting the same price as other trading centers, orders would be routed to the other, more preferred, trading centers. Competitive forces would continue to dictate that the lowest ranked trading center in order-routing preference would suffer from offering a poor range of services to the routers of marketable orders. The Commission therefore preliminarily does not believe that reproposed Rule 611 would eliminate competition among markets.
The Commission requests comment on the effect that adoption of the Voluntary Depth Alternative would have on competition among markets. One commenter, for example, suggested that protection of DOB quotations might cause increased fragmentation of liquidity across different markets because limit orders, no matter where displayed, would have price protection.524 Another commenter, in contrast, asserted that protecting only BBOs would lead to greater fragmentation because limit orders would be routed to any market where they would set or equal the BBO and thereby obtain trade-through protection.525 Comment is requested on the fragmentation issue, as well as in general on whether protecting DOB quotations would inappropriately limit the terms of market competition so as to harm investors and the efficiency of the NMS. For example, would adoption of the Voluntary Depth Alternative inappropriately reduce the scope of competition among markets to the payment of liquidity rebates for executed limit orders? Comment also is requested on whether adoption of the Voluntary Depth Alternative would generate forces that would lead to a monopolization of trading in a single trading facility.
The end result should be an NMS that more fully meets the needs of a wide spectrum of investors, particularly long-term investors and publicly traded companies, by providing increased efficiency and improved depth and liquidity to our capital markets. By providing increased efficiency and promoting investor confidence in quality executions, investors may be more willing to invest in our capital markets, thus promoting the ability of listed companies to raise capital at lower cost.
B. Access Rule
Reproposed Rule 610 would establish standards governing access to quotations in NMS stocks that (1) prohibit trading centers from unfairly discriminating against non-members members or non-subscribers that attempt to access quotations through a member or subscriber of the trading center, and enable access to NMS quotations through private linkages, (2) establish an outer limit on the cost of accessing such quotations of no more than $0.003 per share, and (3) require SROs to establish and enforce rules that, among other things, prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross the automated quotations of other trading centers. The reproposed amendment to Rule 301(b)(5) under Regulation ATS would lower the threshold that triggers the Regulation ATS fair access requirements from 20% to 5% of average daily volume in a security.
The reproposed access provisions are intended to bolster investor confidence in the markets by helping to ensure investors that their orders will be executed at the best prices and will not subject to hidden fees, regardless of the market on which the execution takes place. By generally imposing a uniform fee limitation of $0.003 per share, the proposed rules would promote equal regulation of different types of trading centers, where currently some are permitted to charge fees and some are not, thereby leveling the playing field among diverse market centers. Moreover, the Commission preliminarily believes that, by prohibiting a trading center from imposing unfairly discriminatory terms that would prevent or inhibit the efficient access of any person through members, subscribers, or customers of such trading center, the reproposed rule would promote competition among trading centers.
The Commission preliminarily believes that reproposed Rule 610 also would increase transparency and efficiency in the market, thereby enhancing investor confidence, and thus capital formation. Specifically, the reproposed Rule would permit private linkages between markets, rather than mandating a collective intermarket linkage facility. Private linkages would permit market centers to connect through cost effective and technologically advanced communications networks. Such systems are widely utilized in the market for Nasdaq stocks today and should provide speed and flexibility to trading centers and their market participants. The use of private linkages should encourage interaction between the markets and reduce fragmentation by removing impediments to the execution of orders between and among marketplaces, thereby increasing efficiency and competition.
Several commenters expressed concerns regarding the impact that the access fee proposal could have on competition.526 As discussed in detail in Section III, the Commission preliminarily believes that the flat limitation on access fees of $0.003 per share would be the fairest and most appropriate solution to what has been a longstanding and contentious issue. A single accumulated fee cap would apply equally to all types of trading centers and all types of market participants, thereby promoting the NMS objective of equal regulation of markets and broker-dealers.527 The $0.003 fee limitation would be consistent with current business practices, as very few trading centers charge fees that exceed this amount.528 In addition, a fee limitation is necessary to preclude individual trading centers from raising their fees substantially in an attempt to take improper advantage of strengthened protection against trade-throughs and the adoption of a private linkage regime.
In addition, the reproposed rule is designed to reduce the instances of locked and crossed quotations, which should promote capital formation by providing market participants a clear picture of the true trading interest in a stock. Moreover, the Commission preliminarily believes that the reproposed access provisions would encourage interaction between the markets and reduce fragmentation by removing impediments to the execution of orders between and among marketplaces, thereby increasing efficiency and competition. Finally, the Commission preliminarily believes that the reproposed access rule would assist broker-dealers in evaluating and complying with their best execution obligations.
C. Sub-Penny Rule
The Commission has considered reproposed Rule 612 in light of Sections 3(f) and 23(a)(2) of the Exchange Act and preliminarily believes that the rule would not impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. To the contrary, by preserving the benefits of decimalization and guarding against the less desirable effects of further reducing the MPV, reproposed Rule 612 should promote fair and vigorous competition. The Commission acknowledges that the Rule would, in some circumstances, prevent market participants from offering marginally better prices. Some commenters argued that a prohibition on quoting in sub-pennies, at least in some NMS stocks, would inhibit price competition and artificially widen spreads.529 Nevertheless, the Commission is concerned that sub-penny quoting may be used by market participants more as a means of stepping ahead of competing limit orders for an economically insignificant amount than of promoting genuine price competition.
The Commission preliminarily believes that the reproposed Rule would assist broker-dealers in evaluating and complying with their best execution obligations, as well as other rules premised on identifying the price of a security at a particular moment in time. The Commission also preliminarily believes that the reproposed Rule would enhance depth and transparency by preventing trading interest from being spread across an increasing number of price points. It also would prevent market participants from gaining priority over a standing limit order without making an economically significant contribution to the price of a security. In these respects, the reproposed Rule would encourage market participants to use limit orders, an important source of liquidity. Accordingly, the reproposed Rule may promote market efficiency, competition, and capital formation. In addition, the reproposed Rule also would bolster investor confidence by ensuring that their orders, especially large orders, can be executed without incurring large transaction costs. This increase in investor confidence should also promote market efficiency, competition, and capital formation.
The Commission believes that the reproposed Rule would establish common quoting conventions that would increase transparency in the markets. Moreover, the Commission preliminarily believes that the reproposed Rule would encourage interaction between the markets and reduce fragmentation by removing impediments to the execution of orders between and among markets. The increased transparency in the markets and reduction of fragmentation between the markets may bolster investor confidence, thereby promoting capital formation.
D. Market Data Rules and Plan Amendments
The Commission preliminarily believes that the reproposed Plan amendment modifying the current revenue allocation formulas would promote efficiency and competition in the marketplace by eliminating incentives for market participants to engage in distortive trading practices such as wash trades, trade shredding, and SRO print facilities to obtain market data revenues. Similarly, the Commission preliminarily believes that the reproposed Plan amendment requiring the creation of non-voting advisory committees would promote efficiency in the administration of the Plans by allowing interested parties other than SROs to have a voice in Plan matters, which could, in turn, contribute to the resolution of potential disputes that SRO participants would otherwise bring before the Commission or to the courts. Furthermore, reproposed amendments to Rule 11Ac1-2 (proposed to be redesignated as Rule 603) should promote efficiency and competition among market centers by helping to assure that independently reported trade and quotation information is distributed on terms that are fair and reasonable and not unreasonably discriminatory. Reproposed Rule 603(a) would allow investors and vendors greater freedom to make their own decisions regarding the data they need and thus the proposal should lead to lower costs to investors. Broker-dealers who do not need the data beyond the prices, sizes, market center identifications of the NBBO and consolidated last sale information would not required to receive (and pay for) such data, thereby promoting efficiency. Reproposed Rule 603(b) also should promote efficiency in the dissemination of consolidated market information by requiring that all SROs act jointly through the Plans to disseminate such information to the public.
The Commission preliminarily believes that the proposed Plan amendments would assist in capital formation through a more appropriate allocation of the Networks' revenues to those SROs that contribute most to public price discovery, and by potentially minimizing costs that may arise from having to resolve disputes relating to the administration of the Plans through broader representation. Reproposed Rule 603(c) also would eliminate the requirement to display a complete montage of quotations from all market centers and should therefore promote capital formation by reducing the costs to vendors and broker-dealers that are currently required to display quotations that may be far away from the NBBO.
The Commission further preliminarilybelieves that the reproposed amendments to the Plans and to Rules 11Aa3-1 and 11Ac1-2 (proposed to be redesignated as Rules 601 and 603) would not impose any competitive burden that is not necessary and appropriate in furtherance of the purposes of the Exchange Act. Although modifying the allocation formula could shift revenues among the SRO participants in the Plans, the formula would allocate revenue to those SROs that contribute useful information to the consolidated data stream and thereby would promote competition on terms that will benefit investors. The Commission also preliminarilybelieves that the reproposed Plan amendment requiring the Plans to form non-voting advisory committees should enhance and promote competition by broadening Plan governance to include non-SRO parties, and thereby provide greater transparency in the administration of such Plans. Furthermore, the reproposed amendments to Rules 11Aa3-1 and 11Ac1-2 (proposed to be redesignated as Rules 601 and 603) should lessen the burden on vendors and broker-dealers from having to comply with certain consolidated display requirements. Competition among markets also would be enhanced by enabling markets to independently distribute their own market data. In sum, the Commission preliminarilybelieves that the proposed amendments would enhance rather than burden competition.
E. Regulation NMS
Reproposed Rule 600, the redesignation of the existing NMS rules as Regulation NMS, and the related proposed conforming changes to other Commission rules should help to promote efficiency and capital formation by making the NMS rules easier to understand, thereby helping to reduce compliance costs for entities subject to the rules. Enhanced clarity in the definitions used in Regulation NMS also should benefit investors and the public interest by facilitating compliance with the requirements of reproposed Regulation NMS. Because Rule 600 would clarify the existing definitions used in Regulation NMS without imposing new requirements, and because the redesignation of the NMS rules as Regulation NMS and the conforming changes to other Commission rules would create no new substantive requirements, Rule 600 and the related changes should not impose a burden on competition or alter the competitive standing of entities subject to Regulation NMS.
XI. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, or "SBREFA,"530 the Commission must advise the Office of Management and Budget as to whether the proposed regulation constitutes a "major" rule. Under SBREFA, a rule is considered "major" where, if adopted, it results or is likely to result in:
An annual effect on the economy of $100 million or more (either in the form of an increase or a decrease);
A major increase in costs or prices for consumers or individual industries; or
A significant adverse effect on competition, investment, or innovation.
If a rule is "major," its effectiveness will generally be delayed for 60 days pending Congressional review. The Commission requested comment in the Proposing Release on the potential impact of the proposed regulation on the economy on an annual basis, including a request for commenters to provide empirical data and other factual support for their view to the extent possible.531 The Commission did not receive any comments specific to the potential impact of the proposed rules on the economy on an annual basis. The Commission renews its request for comment contained in the Proposing Release.
XII. Regulatory Flexibility Act
Section 3(a) of the Regulatory Flexibility Act532 requires the Commission to undertake an Initial Regulatory Flexibility Analysis ("IRFA") of the proposed rules and amendments on small entities unless the Commission certifies that the proposed rules and amendments, if adopted, would not have a significant economic impact on a substantial number of small entities.
A. Trade-Through Rule
The Commission hereby certifies, pursuant to Section 603(b) of the Regulatory Flexibility Act,533 that reproposed Rule 611 would not have a significant economic impact on a
substantial number of small entities.534 Reproposed Rule 611 would require any trading center535 to establish, maintain, and enforce written policies and procedures reasonably designed to prevent trade-throughs of protected quotations in NMS stocks that do not fall within an exception to the reproposed Rule, and, if relying on such an exception, that are reasonably designed to assure compliance with the terms of the exception. Further, trading centers would be required to regularly surveil to ascertain the effectiveness of such policies and procedures and to take prompt remedial action to remedy deficiencies in such policies and procedures. Thus, only those entities that fall within the definition of trading center would be subject to the reproposed Rule. In addition, brokers-dealers that would not be included within the definition of trading center but that employ their own order smart-routing systems to route orders to multiple trading centers may choose to (but would not be required to) use the intermarket sweep order functionality of the proposed intermarket sweep exception.536 In addition, vendors that would not be subject to reproposed Rule 611 may need to make system modifications to support the operation of the reproposed Rule.
The current national securities exchanges and one national securities association that would be subject to the proposed Rule are not considered "small entities" for purposes of the Regulatory Flexibility Act.537 The remaining trading centers that would be subject to reproposed Rule 611 are registered broker-dealers. The Commission has preliminarily determined that approximately 600 broker-dealers registered with the Commission,538 which includes broker-dealers operating as equity ATSs, broker-dealers registered as market makers or specialists in NMS stocks, and any broker-dealer that is in the business of executing orders internally in NMS stocks, would be subject to reproposed Rule 611. Of these 600 broker-dealers, only two are considered small for purposes of the Regulatory Flexibility Act pursuant to the standards of Rule 0-10(c) under the Exchange Act.539
With respect to non-trading center broker-dealers that employ their own smart-order routing technology and that would choose to route orders in compliance with the proposed intermarket sweep exception (and thus would need to make necessary modifications to their order routing practices and proprietary order routing systems), the Commission preliminarily does not believe that this category of broker-dealers would be very large, and also preliminarily does not believe that any such broker-dealer that would employ its own order routing systems would be considered small, given the cost of operating such proprietary systems.540 The Commission also believes it likely that, given the nature of their business, most if not all of these non-trading center broker-dealers that employ their own order-routing technology already have systems in place that monitor best-priced quotations across markets, and thus preliminarily does not believe that the changes necessary to implement the intermarket sweep order would be significant. With respect to any vendor that may determine to make systems modifications to support the operation of reproposed Rule 611, only 16 of the approximately 80 existing vendors are considered small.541 Accordingly, the Commission does not believe that reproposed Rule 611 would have a significant economic impact on a substantial number of small entities.
The Commission encourages written comments regarding this certification. The Commission requests that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of the impact. In particular, the Commission requests comment on (a) the number of small entities that would be affected by reproposed Rule 611; (b) the nature of any impact reproposed Rule 611 would have on small entities and empirical data supporting the extent of the impact; and (c) how to quantify the number of small entities that would be affected by or how to quantify the impact of reproposed Rule 611.
B. Access Rule
The Commission hereby certifies, pursuant to Section 603(b) of the Regulatory Flexibility Act,542 that reproposed Rule 610 and the reproposed amendments to Rule 301 of Regulation ATS would not have a significant economic impact on a substantial number of small entities.543 Reproposed Rule 610 would prohibit any trading center544 from imposing unfairly discriminatory terms that would prevent or inhibit the access of any person through members, subscribers, or customers of such trading center. Further, the reproposed Rule would restrict access fees imposed by trading centers to a maximum of $0.003 per share. Finally, reproposed Rule 610 would require national securities exchanges and national securities associations to establish and enforce rules that, among other things, prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross the automated quotations of other trading centers. Thus, reproposed Rule 610 would impact only those entities that fall within the definition of trading center. The reproposed access provisions also would lower the threshold that triggers the fair access requirements in Rule 301 of Regulation ATS from 20% to 5% of average daily volume in a security. This amendment would potentially impact the existing operating ATSs.
The current national securities exchanges and national securities association that would be subject to the reproposed Rule are not considered "small entities" for purposes of the Regulatory Flexibility Act.545 The remaining entities that would be subject to reproposed Rule 610 and the reproposed amendments to Rule 301 of Regulation ATS are registered broker-dealers. The Commission has preliminarily determined that approximately 600 broker-dealers registered with the Commission,546 which includes broker-dealers operating as equity ATSs, broker-dealers registered as market makers or specialists in NMS stocks, and any other broker-dealer that is in the business of executing orders internally, would be subject to Rule 610. In addition, the existing operating ATSs (which are or are operated by registered broker-dealers) potentially could be subject to the reproposed amendment to Rule 301 of Regulation ATS. Of these broker-dealers, only two are considered small for purposes of the Regulatory Flexibility Act pursuant to the standards of Rule 0-10(c) under the Exchange Act.547 Accordingly, the Commission preliminarily does not believe that reproposed Rule 610 and the reproposed amendments to Rule 301 of Regulation ATS would have a significant economic impact on a substantial number of small entities.
The Commission encourages written comments regarding this certification. The Commission requests that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of the impact. In particular, the Commission requests comment on (a) the number of small entities that would be affected by reproposed Rule 610 and the reproposed amendment to Rule 301 of Regulation ATS; (b) the nature of any impact reproposed Rule 610 and the reproposed amendment to Rule 301 of Regulation ATS would have on small entities and empirical data supporting the extent of the impact; and (c) how to quantify the number of small entities that would be affected by or how to quantify the impact of reproposed Rule 610 and the reproposed amendment to Rule 301 of Regulation ATS.
C. Sub-Penny Rule
This IRFA relating to reproposed Rule 612 has been prepared in accordance with 5 U.S.C. 603. This IRFA is substantially the same as the one contained in the Proposing Release.548 The Commission did not receive any comment on the IRFA contained in the Proposing Release.
1. Reasons for the Proposed Action
The Commission is concerned that, while the conversion from fractions to decimals benefited investors by clarifying and simplifying pricing for investo