Regulation of NMS Stock Alternative Trading Systems

Federal RegisterDec 28, 2015

Ask Donna

What actually matters in this document.

Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, 249

[Release No. 34-76474; File No. S7-23-15]

RIN 3235-AL66

Regulation of NMS Stock Alternative Trading Systems

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission is proposing to amend the regulatory requirements in Regulation ATS under the Securities Exchange Act of 1934 (“Exchange Act”) applicable to alternative trading systems (“ATSs”) that transact in National Market System (“NMS”) stocks (hereinafter referred to as (“NMS Stock ATSs”), including so called “dark pools.” First, the Commission is proposing to amend Regulation ATS to adopt Form ATS-N to provide information about the broker-dealer that operates the NMS Stock ATS (“broker-dealer operator”) and the activities of the broker-dealer operator and its affiliates in connection with the NMS Stock ATS, and to provide detailed information about the manner of operations of the ATS. Second, the Commission is proposing to make filings on Form ATS-N public by posting certain Form ATS-N filings on the Commission's internet Web site and requiring each NMS Stock ATS that has a Web site to post on the NMS Stock ATS's Web site a direct URL hyperlink to the Commission's Web site that contains the required documents. Third, the Commission is proposing to amend Regulation ATS to provide a process for the Commission to determine whether an entity qualifies for the exemption from the definition of “exchange” under Exchange Act Rule 3a1-1(a)(2) with regard to NMS stocks and declare an NMS Stock ATS's Form ATS-N either effective or, after notice and opportunity for hearing, ineffective. Fourth, under the proposal, the Commission could suspend, limit, or revoke the exemption from the definition of “exchange” after providing notice and opportunity for hearing. Fifth, the Commission is proposing to require that an ATS's safeguards and procedures to protect subscribers' confidential trading information be written. The Commission is also proposing to make conforming changes to Regulation ATS and Exchange Act Rule 3a1-1(a). Additionally, the Commission is requesting comment about, among other things, changing the requirements of the exemption from the definition of “exchange” pursuant to Exchange Act Rule 3a1-1(a) for ATSs that facilitate transactions in securities other than NMS stocks. Lastly, the Commission is also requesting comment regarding its consideration to amend Exchange Act Rules 600 and 606 to improve transparency around the handling and routing of institutional customer orders by broker-dealers.

DATES:

Comments should be received on or before February 26, 2016.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed

); or

• Send an email to

rule-comments@sec.gov

. Please include File Number S7-23-15 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-23-15. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/proposed.shtml

). Comments will also be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's Web site. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Tyler Raimo, Senior Special Counsel, at (202) 551-6227; Matthew Cursio, Special Counsel, at (202) 551-5748; Marsha Dixon, Special Counsel, at (202) 551-5782; Jennifer Dodd, Special Counsel, at (202) 551-5653; David Garcia, Special Counsel, at (202) 551-5681; or Derek James, Special Counsel, at (202) 551-5792; Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission is proposing: (1) New Form ATS-N under the Exchange Act provided by Rule 3a1-1(a) of the Exchange Act [17 CFR 240.3a1-1(a)], which NMS Stock ATSs would rely on to qualify for the exemption from the definition of “exchange”; (2) to amend Regulation ATS under the Exchange Act [17 CFR 242.300 through 242.303] to add new Rule 304 to provide new conditions for NMS Stock ATSs seeking to rely on the exemption from the definition of “exchange”; and (3) related amendments to Rule 300, 301, and 303 of Regulation ATS and Rule 3a1-1(a) under the Exchange Act [17 CFR 242.300; 17 CFR 242.301, 17 CFR 242.303; and 17 CFR 240.3a1-1]. The Commission is also proposing amendments to Rules 301(b)(10) and 303 of Regulation ATS under the Exchange Act [17 CFR 242.301(b)(10) and 17 CFR 242.303] to require all ATSs to make and keep written safeguards and written procedures to protect subscribers' confidential trading information.

Table of Contents

I. Introduction

II. Current ATS Regulatory Framework

A. Exemption From National Securities Exchange Registration

B. Conditions to the ATS Exemption; Confidential Notice Regime

III. Role of ATSs in the Current Equity Market Structure

A. Significant Source of Liquidity for NMS Stocks

B. Heightened Operational Complexity and Sophistication of NMS Stock ATSs

C. Lack of Operational Transparency for NMS Stock ATSs

D. Prior Comments on Operational Transparency and Regulatory Framework for NMS Stock ATSs

IV. Proposed Amendments to Regulation ATS and Rule 3a1-1 To Heighten Regulatory Requirements for ATSs That Transact in NMS Stocks

A. Proposed Definition of NMS Stock ATS

B. Rule 3a1-1(a)(2): Proposed Amendments to the Exemption From the Definition of “Exchange” for NMS Stock ATSs

C. Proposed Rule 304: Enhanced Filing Requirements for NMS Stock ATSs

1. Application of Existing Requirements to NMS Stock ATSs

2. Rule 301(b)(2) and Form ATS; ATSs That Trade in Non-NMS Stocks

3. Proposed Rule 304(a)(1)(i) and (ii): Filing and Review of Form ATS-N

4. Proposed Rule 304(a)(1)(iii): Declarations of Effectiveness or Ineffectiveness of Form ATS-N

5. Proposed Rule 304(a)(1)(iv): Orders Regarding Form ATS-N Effectiveness

6. Proposed Rule 304(a)(2): Form ATS-N Amendments

7. Proposed Rule 304(a)(3): Notice of Cessation

8. Proposed Rule 304(a)(4): Suspension, Limitation, or Revocation of the Exemption From the Definition of Exchange

D. Rule 304(b): Public Disclosure of Form ATS-N and Related Commission Orders

E. Rule 304(c)(1) and (2): Proposed Form ATS-N Requirements

V. Proposed Form ATS-N: Submission Type and Part I of Form ATS-N

VI. Part II of Proposed Form ATS-N: Broker-Dealer Operator Registration Information

VII. Part III of Proposed Form ATS-N: Activities of the Broker-Dealer Operator and Its Affiliates

A. The Relationship Between the Broker-Dealer Operator's Operation of the NMS Stock ATS and Its Other Operations

1. Background

2. Potential Conflicts of Interest for the Broker-Dealer Operator or Its Affiliates

B. Disclosures Required Under Part III of Proposed Form ATS-N

1. Proposed Definitions of “Affiliate” and “Control”

2. Non-ATS Trading Centers of the Broker-Dealer Operator

3. Multiple NMS Stock ATS Operations of the Broker-Dealer Operator

4. Products or Services Offered to Subscribers by the Broker-Dealer Operator

5. Broker-Dealer Operator Arrangements With Unaffiliated Trading Centers

6. Trading on the NMS Stock ATS by the Broker-Dealer Operator and Its Affiliates

7. Broker-Dealer Operator Smart Order Routers (or Similar Functionalities) and Algorithms

8. Shared Employees of NMS Stock ATS

9. Service Providers to the NMS Stock ATS

10. Differences in Availability of Services, Functionality, or Procedures

11. Confidential Treatment of Trading Information

VIII. Part IV of Proposed Form ATS-N: The Manner of Operations of the NMS Stock ATS

A. Subscribers

B. Hours of Operations

C. Types of Orders

D. Connectivity, Order Entry, and Co-Location

E. Segmentation of Order Flow and Notice About Segmentation

F. Display of Order and Trading Interest

G. Trading Services

H. Suspension of Trading, System Disruption or Malfunction

I. Opening, Reopening, and Closing Processes, and After Hours Procedures

J. Outbound Routing

K. Market Data

L. Fees

M. Trade Reporting, Clearance and Settlement

N. Order Display and Execution Access

O. Fair Access

P. Market Quality Statistics Published or Provided by the NMS Stock ATS to Subscribers

IX. Proposed Amendment to Rule 301(b)(10): Written Safeguards and Written Procedures To Protect Confidential Trading Information

X. Recordkeeping Requirements

XI. General Request for Comment

XII. Paperwork Reduction Act

A. Summary of Collection of Information

1. Requirements Relating to Rule 301(b)(10) of Regulation ATS

2. Requirements Relating to Proposed Rules 301(b)(2)(viii) and 304 of Regulation ATS, Including Proposed Form ATS-N

B. Proposed Use of Information

1. Proposed Amendments to Rules 301(b)(10) of Regulation ATS

2. Proposed Rules 301(b)(2)(viii), 304 of Regulation ATS, Including Proposed Form ATS-N, and 301(b)(9)

C. Respondents

D. Total Initial and Annual Reporting and Recordkeeping Burdens

1. Proposed Rules 301(b)(10) and 303(a)(1)(v) of Regulation ATS

2. Proposed Rules 301(b)(2)(viii) and 304 of Regulation ATS, Including Proposed Form ATS-N

E. Collection of Information Is Mandatory

F. Confidentiality of Responses to Collection of Information

G. Retention Period for Recordkeeping Requirements

H. Request for Comments

XIII. Economic Analysis

A. Background

B. Baseline

1. Current NMS Stock ATSs

2. Current Reporting Requirements for NMS Stock ATSs

3. Lack of Public Disclosure of NMS Stock ATS Operations and the Activities of the Broker-Dealer Operator and the Broker-Dealer Operator's Affiliates

4. NMS Stock ATS Treatment of Subscriber Confidential Trading Information

5. Current State of Competition Between NMS Stock ATSs and Registered National Securities Exchanges

6. Competition Among NMS Stock ATSs

7. Competition Between Broker-Dealers That Operate NMS Stock ATSs and Broker-Dealers That Do Not Operate NMS Stock ATSs

8. Effect of NMS Stock ATSs on the Current Market for NMS Stock Execution Services

C. Economic Effects and Effects on Efficiency, Competition, and Capital Formation

1. Costs and Benefits of Proposed Enhanced Filing Requirements

2. Costs and Benefits of Public Disclosures of Proposed Form ATS-N

3. Written Safeguards and Written Procedures To Protect Subscribers' Confidential Trading Information, and Proposed Recordkeeping Requirements

D. Alternatives

1. Require NMS Stock ATSs To Publicly Disclose Current Form ATS

2. Require Proposed Form ATS-N But Deem Information Confidential

3. Require NMS Stock ATSs To Publicly Disclose Proposed Form ATS-N But Not Declare Proposed Form ATS-N Effective or Ineffective

4. Initiate Differing Levels of Public Disclosure Depending on NMS Stock ATS Characteristics

5. Require NMS Stock ATSs To Register as National Securities Exchanges and Become SROs

6. Discontinue Quarterly Volume Reports on Form ATS-R

7. Require NMS Stock ATSs To Operate as Limited Purpose Entities

8. Lower the Fair Access Threshold for NMS Stock ATSs

9. Apply Proposed Rule 304 to ATSs That Trade Fixed Income Securities and ATSs that Solely Trade Government Securities

XIV. Consideration of Impact on the Economy

XV. Regulatory Flexibility Act Certification

XVI. Statutory Authority and Text of Proposed Amendments

I. Introduction

Section 11A(a)(2) of the Exchange Act,

enacted as part of the Securities Acts Amendments of 1975 (“1975 Amendments”),

directs the Commission, having due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets, to use its authority under the Exchange Act to facilitate the establishment of a national market system for securities in accordance with the Congressional findings and objectives set forth in Section 11A(a)(1) of the Exchange Act.

Among the findings and objectives in Section 11A(a)(1) are that “[n]ew data processing and communications techniques create the opportunity for more efficient and effective market operations”

and “[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure . . . the economically efficient execution of securities transactions”

and the “practicability of brokers executing investors' orders in the best markets.”

Congress also found, as noted by the Commission when it adopted Regulation ATS, that it was in the public interest to assure “fair

competition . . . between exchange markets and markets other than exchange markets.”

Congress recognized that the securities markets dynamically change and, accordingly, granted the Commission broad authority to oversee the implementation, operation, and regulation of the national market system in accordance with Congressional goals and objectives.

15 U.S.C. 78k-1(a)(2).

Public Law 94-29, 89 Stat. 97 (1975).

15 U.S.C. 78k-1(a)(1).

Section 11A(a)(1)(B) of the Exchange Act, 15 U.S.C. 78k-1(a)(1)(B).

Section 11A(a)(1)(C)(i) of the Exchange Act, 15 U.S.C. 78k-1(a)(1)(C)(i).

Section 11A(a)(1)(C)(iv) of the Exchange Act, 15 U.S.C. 78k-1(a)(1)(C)(iv).

See

Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844 (December 22, 1998) (Regulation of Exchanges and Alternative Trading Systems, hereinafter “Regulation ATS Adopting Release”) at 70858 n.113 and accompanying text (citing Section 11A(a)(1)(C)(ii) of the Exchange Act, 15 U.S.C. 78k-1(a)(1)(C)(ii)). The Commission also noted that a fundamental goal of a national market system was to “achieve a market characterized by economically efficient executions, fair competition, [and the] broad dissemination of basic market information.”

See id.

at 70858 n.113 (quoting S. Rep. No. 75, 94th Cong., 1st Sess. 8 (1975) at 101).

See id.

at 70858 n.110 and accompanying text (citing S. Rep. No. 75, 94th Cong., 1st Sess. 8 (1975) at 8-9). The Commission also noted that Congress explicitly rejected mandating specific components of a national market system because of uncertainty as to how technological and economic changes would affect the securities market.

See id.

at 70858 n.109 and accompanying text (citing S. Rep. No. 75, 94th Cong., 1st Sess. 8 (1975) at 8-9.

In December 1998, the Commission adopted Regulation ATS to advance the goals of the national market system and establish a regulatory framework for ATSs.

At that time, there had been a surge in a variety of alternative trading systems that traded NMS stocks and furnished services traditionally provided by national securities exchanges,

such as matching counterparties' orders, executing trades, operating limit order books, and facilitating active price discovery.

The Commission observed at the time that, among other things, activity on ATSs was not fully disclosed, or accessible, to investors, and that these systems had no obligation to provide investors a fair opportunity to participate on the systems or to treat their participants fairly.

The Commission noted in the Regulation ATS Adopting Release that while ATSs at that time operated in a manner similar to registered national securities exchanges, each type of trading center was subject to different regulatory regimes, and that these differences created disparities that affected investor protection and the operation of the markets as a whole, calling into question the fairness of the then-current regulatory requirements.

See generally

Regulation ATS Adopting Release,

supra

note 7.

See id.

at 70845.

See id.

at 70848.

See id.

at 70845.

See id.

at 70845-46 (noting that alternative trading systems prior to the adoption of Regulation ATS were private markets, which were open to only chosen subscribers, and were regulated as broker-dealers and not like registered national securities exchanges).

In response to the substantial changes in the way securities were traded at the time, and the regulatory disparity between registered national securities exchanges and non-exchange markets, the Commission adopted a new regulatory framework that the Commission believed would encourage market innovation, while ensuring basic investor protections,

by giving securities markets a choice to register as national securities exchanges, or to register as broker-dealers and comply with Regulation ATS. Regulation ATS was designed to permit market centers meeting the Commission's updated interpretation of the definition of “exchange,” as set forth in Exchange Act Rule 3b-16,

to select the regulatory framework more applicable to their business models. Among other things, Regulation ATS was intended to better integrate ATSs into the national market system, and ensure that market participants have fair access to ATSs with significant volume.

See id.

at 70847.

17 CFR 240.3b-16.

See

Regulation ATS Adopting Release,

supra

note 7, at 70846, 70874. The Commission also notes that when it adopted Regulation ATS, it stated its belief that the Commission's regulation of markets should both accommodate traditional market structures and provide sufficient flexibility to ensure that new markets promote fairness, efficiency, and transparency.

See

Regulation ATS Adopting Release,

supra

note 7, at 70846.

In the seventeen years since the Commission adopted Regulation ATS, the equity markets have evolved significantly, resulting in an increased number of trading centers and a reduced concentration of trading activity in NMS stocks.

The growth in trading centers and trading activity has been fueled primarily by advances in technology for generating, routing, and executing orders. These technologies have markedly improved the speed, capacity, and sophistication of the trading mechanisms and processes that are available to market participants. Today, ATSs that trade NMS stocks have become an integral part of the national market system, as the number of these ATSs, and the volume of NMS stocks transacted on them, has increased significantly since the adoption of Regulation ATS.

Despite the emergence of ATSs as a significant source of liquidity in NMS stocks among today's markets, and the fact that ATSs compete with, and operate with almost the same complexity and sophistication as, registered national securities exchanges, the regulatory requirements applicable to ATSs have remained, for the most part, the same since Regulation ATS was adopted.

See

Securities Exchange Act Release No. 73639 (November 19, 2014), 79 FR 72251 (December 5, 2014), 72262 (adopting final rules for systems compliance and integrity) (“SCI Adopting Release”) at 72262 n.105 and n.106 and accompanying text (discussing the increased significance of NMS Stock ATSs).

See infra

notes 116-122 and accompanying text.

The Commission notes that when the Commission adopted Regulation NMS, it also amended Regulation ATS to lower the threshold that triggers the Regulation ATS fair access requirements from 20% of the average daily volume in a security to 5%.

See

Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37550 (June 29, 2005) (“Regulation NMS Adopting Release”).

See also

Instruction G to proposed Form ATS-N.

Throughout this release, broker-dealer operators of NMS Stock ATSs that also provide brokerage or dealing services in addition to operating an NMS Stock ATS are referred to as “multi-service broker-dealers”.

See infra

Section VII.A (discussing the relationship between NMS Stock ATSs and the other business functions of their broker-dealer operators). The Commission notes that, although it was concerned at the time of adoption of Regulation ATS about conflicts of interest that may be present when the broker-dealer operator of an ATS also performs other trading functions (

see infra

notes 530-532 and accompanying text discussing the Commission's concerns regarding the potential for misuse of confidential trading information that led to the adoption of Rule 301(b)(10)), the business structure of broker-dealers that operate NMS Stock ATSs has changed since 1998.

See infra

note 375 and accompanying text.

Transparency is a hallmark of the U.S. securities markets and a primary tool by which investors protect their own interests, and the Commission is concerned that the current lack of transparency around potential conflicts of interest of the broker-dealer operator may impede market participants from adequately protecting their interests when doing business on the NMS Stock ATS. The Commission preliminarily believes that if market participants have more information about the operations of NMS Stock ATSs and the activities of the broker-dealer operators and the broker-dealer operators' affiliates, they could better evaluate whether to do business with an ATS and make more informed decisions about where to route their orders.

See, e.g.,

infra

notes 187 and 189 and accompanying text (discussing a comment by the Consumer Federation of America about how more detailed information about ATS operations would

allow participants to assess whether it makes sense to trade on that venue, and a comment by Bloomberg Tradebook LLC that because buy-side representatives might not be customers of all ATSs, they could not assess order interaction that occurs across the market structure); and

infra

note 374 (citing recent enforcement actions settled by the Commission, many of which, such as the Liquidnet Settlement, the Pipeline Settlement, the UBS Settlement, and the ITG Settlement, included allegations that subscribers were fraudulently misled about the operations of certain ATSs).

The Commission has long recognized that effective competition requires transparency and access across the national market system.

The Commission preliminarily believes that the proposals discussed below could promote more efficient and effective market operations by providing more transparency to market participants about the operations of ATSs and the potential conflicts of interest of the controlling broker-dealer operator and its affiliates.

The Commission preliminarily believes that the operational transparency rules being proposed today could increase competition among trading centers in regard to order routing and execution quality. For example, the proposed rules could reveal order interaction procedures that may result in the differential treatment of some order types handled by an NMS Stock ATS. This improved visibility, in turn, could cause market participants to shift order flow to NMS Stock ATSs that provide better opportunities for executions. The Commission preliminarily believes that the proposal could facilitate comparisons among trading centers in NMS stocks and increase competition by informing market participants about the operations of NMS Stock ATSs.

See generally

Regulation ATS Adopting Release,

supra

note 7.

See infra

Sections XIII.B and C (analyzing the possible impact from the current lack of public disclosure of NMS Stock ATSs' operations, as well as disparate levels of information available to market participants about NMS Stock ATS operations and the activities of their broker-dealer operators and their affiliates; the competitive environment between national securities exchanges and NMS Stock ATSs, between NMS Stock ATSs, and between broker-dealers that operate NMS Stock ATSs and broker-dealers that do not operate NMS Stock ATSs; and the anticipated costs and benefits of improving transparency).

The Commission preliminarily believes that a wide range of market participants would benefit from the operational transparency that would result from the proposal. For example, many brokers subscribe to NMS Stock ATSs and route their orders, and those of their customers, to NMS Stock ATSs for execution. The Commission preliminarily believes that improved transparency about the operations of NMS Stock ATSs could aid brokers with meeting their best execution obligations to their customers, as they can better assess the trading venues to which they route orders.

The duty of best execution requires broker-dealers to execute customers' trades at the most favorable terms reasonably available under the circumstances (

i.e.,

at the best reasonably available price).

The Commission has not viewed the duty of best execution as inconsistent with the automated routing of orders or requiring automated routing on an order-by-order basis to the market with the best quoted price at the time.

Rather, the duty of best execution requires broker-dealers to periodically assess the quality of competing markets to assure that order flow is directed to the markets providing the most beneficial terms for their customer orders.

See, e.g., infra

note 187 and accompanying text (noting that The Consumer Federation of America previously commented that Form ATS should require ATSs to provide “critical details about an ATS's participants, segmentation, and fee structure” because the “information will allow market participants, regulators, and third party analysts to assess whether an ATS's terms of access and service are such that it makes sense to trade on that venue”).

A broker-dealer's duty of best execution derives from common law agency principles and fiduciary obligations, and is incorporated in SRO rules and, through judicial and Commission decisions, in the antifraud provisions of the federal securities laws.

See

Order Execution Obligations, Securities Exchange Act Release No. 37619A (Sept. 6, 1996), 61 FR 48290, 48322 (Sept. 12, 1996).

See also

Newton

Merrill, Lynch, Pierce, Fenner & Smith, Inc.,

135 F.3d 266, 270, 273 (3d Cir. 1998) (en banc),

cert. denied,

525 U.S. 811 (1998) (finding that failure to satisfy the duty of best execution can constitute fraud because a broker-dealer, in agreeing to execute a customer's order, makes an implied representation that it will execute it in a manner that maximizes the customer's economic gain in the transaction, and stating that“[T]he basis for the duty of best execution is the mutual understanding that the client is engaging in the trade—and retaining the services of the broker as his agent—solely for the purpose of maximizing his own economic benefit, and that the broker receives her compensation because she assists the client in reaching that goal.”);

Matter of Marc N. Geman,

Securities Exchange Act Release No. 43963 (Feb. 14, 2001),

aff'd, Geman

SEC,

334 F.3d 1183 (10th Cir. 2003) (citing Newton, but deciding against finding a violation of the duty of best execution based on the record).

See also

Payment for Order Flow, Securities Exchange Act Release No. 34902 (Oct. 27, 1994), 59 FR 55006, 55009 (Nov. 2, 1994). If the broker-dealer intends not to act in a manner that maximizes the customer's economic gain when he accepts the order and does not disclose this to the customer, a trier of fact could find that the broker-dealer's implied representation was false.

See Newton,

135 F.3d at 273-274.

See

Regulation NMS Adopting Release,

supra

note 19, at 37538.

Id.

In addition, the Commission preliminarily believes that the proposal could also help customers of broker-dealers, whose orders are routed to an NMS Stock ATS for possible execution in the ATS, evaluate whether their broker-dealer fulfilled its duty of best-execution. The Commission preliminarily believes that institutional investors, who may subscribe to an NMS Stock ATS or whose orders may be routed to an NMS Stock ATS by their brokers, should have more information about how NMS Stock ATSs operate, including how the ATS may match and execute customer orders.

The Commission preliminarily believes that additional information about how NMS Stock ATSs operate could aid these investors in evaluating the routing decisions of their brokers and understanding whether their broker routed their orders to a trading venue that best fits their needs. To illustrate this point, institutional investors would likely find it useful to know whether an NMS Stock ATS provides execution priority to customer order flow, uses strict price-time priority rules to rank and execute orders, or applies certain execution allocation methodologies for institutional orders. Such information could permit an institutional investor to compare NMS Stock ATSs against each other, as well as against national securities exchanges, to determine which trading centers would best fit its needs. Additionally, there may be market participants, who may not currently subscribe to an NMS Stock ATS, that may wish to obtain information about how a particular NMS Stock ATS operates before sending orders to that trading venue.

See, e.g.,

Consumer Federation of America letter,

infra

note 175, at 22, 37-38 (expressing support for requiring all ATSs to publicly disclose Form ATS “so that the public can see how these venues operate,” and opining that the Commission should “undertake an exhaustive investigation of the current order types, requiring exchanges and all ATSs . . . to disclose in easily understandable terms what their purpose is, how they are used in practice, who is using them, and why they are not discriminatory or resulting in undue benefit or harm to any traders”); Citadel letter,

infra

note 214, at 4 (expressing the view that “dark pools should be subject to increased transparency,” and that “ATS operational information and filings should be publicly available”); KOR Group letter,

infra

note 175, at 12 (opining that the fact that “ATS filings are hidden from the public while the burden is on SROs to file publicly . . . does not serve the public interest in any way” and that there “should not be any reasoned argument against” making Form ATS publicly available); Liquidnet letter #1,

infra

note 166, at D-5-6, -11 (stating that the Commission should require institutional brokers, including institutional ATSs, to disclose to their customers specific order handling practices, including identification of external venues to which the broker routes orders, the process for crossing orders with other orders, execution of orders as agent and principal, a detailed description of the operation and function of each ATS or trading desk operated by the broker, and a clear and detailed description of each algorithm and order type offered by the broker and expressing the view that Form ATS should be made publicly available).

This proposal is primarily designed to provide market participants with greater transparency around the operations of

NMS Stock ATSs and potential conflicts of interest that may arise involving the broker-dealer operator and its affiliates. The proposed rules would require public, detailed information to be disclosed about the activities of the broker-dealer operator and its affiliates in connection with the NMS Stock ATS, including: Their operation of non-ATS trading centers and other NMS Stock ATSs; the products and services offered to subscribers; any arrangements with unaffiliated trading centers; trading activities on the NMS Stock ATS of the broker-dealer operator or its affiliates; the use of smart order routers (“SORs”) (or similar functionality) and algorithms used to send or receive orders or other trading interest to or from the NMS Stock ATS; shared employees of the NMS Stock ATS and third parties used to operate the NMS Stock ATS; any differences in the availability of services, functionalities, or procedures to subscribers and the availability of those services, functionalities, or procedures to the broker-dealer operator or its affiliates; and the NMS Stock ATS's safeguards and procedures to protect subscribers' confidential trading information. Form ATS-N would also require detailed information about the operations of the NMS Stock ATS, including: Any eligibility requirements and any terms and conditions imposed for subscribers; the NMS Stock ATS's hours of operation; the types of orders or other trading interest that can be entered on the NMS Stock ATS; any connectivity, order entry, and co-location procedures or services; the segmentation of order flow (and notice given about segmentation); the display of order and other trading interest; trading services, including matching methodologies, order interaction rules, and order handling and execution procedures; procedures governing the suspension of trading and trading during a system disruption or malfunction; opening, re-opening, closing, and after hours processes or trading procedures; any outbound routing services; the NMS Stock ATS's use of market data; fees, rebates, or other charges of the NMS Stock ATS; any trade reporting, clearance or settlement arrangements or procedures; order display and execution access and fair access information (if applicable); and market quality statistics published or provided to one or more subscribers. The Commission preliminarily believes that greater transparency in this regard would provide important information to market participants so they can evaluate whether submitting order flow to a particular NMS Stock ATS aligns with their trading or investment objectives. Among other things, these enhanced, public disclosures also are designed to limit the potential that a broker-dealer operator of an NMS Stock ATS could provide certain subscribers with greater disclosure about the operations and system functionalities of the ATS than it provides to other market participants.

The Commission also preliminarily believes that proposing a process for the Commission to determine whether an NMS Stock ATS qualifies for the exemption from the Exchange Act definition of “exchange” would facilitate better Commission oversight of NMS Stock ATSs and thus, better protection of investors.

The proposed process would provide the Commission with an opportunity to review disclosures on Form ATS-N for compliance with the Form ATS-N requirements, Regulation ATS, and other applicable requirements of the federal securities laws and regulations. To qualify for the exemption from the Exchange Act definition of “exchange,” an NMS Stock ATS would be required to file with the Commission a Form ATS-N, in accordance with the instructions therein, and the Form ATS-N would need to be declared effective by the Commission. The Commission would declare ineffective a Form ATS-N if it finds, after notice and opportunity for hearing, that such action is necessary or appropriate in the public interest and is consistent with the protection of investors.

If the Commission declares a Form ATS-N ineffective, the NMS Stock ATS would be prohibited from operating as an NMS Stock ATS,

but would not be prohibited from subsequently filing a new Form ATS-N. The Commission also preliminarily believes that proposing a process for the Commission to review and declare ineffective Form ATS-N Amendments, if it finds that such action is necessary or appropriate in the public interest and is consistent with the protection of investors, would aid the Commission's ongoing oversight of NMS Stock ATSs.

See

proposed Rule 304(a)(1)(i).

See also

proposed Rule 304(a)(2)(ii).

In this light, the Commission is proposing to amend Regulation ATS, including as follows: (1) Define in proposed Rule 300(k) of Regulation ATS the term NMS Stock ATS, amend the definition of “control” under current Rule 300(f) of Regulation ATS to specify that control means to direct the management or policies of the broker-dealer of an ATS, and amend the exemption from the definition of “exchange” in Rule 3a1-1(a) to require NMS Stock ATSs to comply with proposed Rule 304 (in addition to the other requirements of Regulation ATS) as a condition of the exemption; (2) amend Rule 301(b)(2) to require NMS Stock ATSs to file the reports and amendments mandated by proposed Rule 304, which would include filing proposed Form ATS-N, in lieu of current Form ATS, to provide detailed disclosures about an NMS Stock ATS's operations and the activities of its broker-dealer operator and its affiliates and amend Rule 301(b)(2) to require an ATS that effects transactions in both NMS stocks and non-NMS stocks to file the reports and amendments mandated by proposed Rule 304 for its NMS stock trading activity and the reports and amendments required under current Rule 301(b)(2) of Regulation ATS for its non-NMS stock trading activity; (3) amend Rule 301(b)(9) to require an ATS that trades both NMS stocks and non-NMS stocks to separately report its transactions in NMS stocks on one Form ATS-R, and its transactions in securities other than NMS stocks on another Form ATS-R; (4) provide a process for the Commission, pursuant to proposed Rule 304(a)(1), to declare a Form ATS-N effective or, after notice and opportunity for hearing, ineffective; (5) establish the requirements for amending Form ATS-N pursuant to proposed Rule 304(a)(2); (6) provide, pursuant to proposed Rule 304(a)(3), that a notice of cessation shall cause the Form ATS-N to be ineffective on the date designated by the NMS Stock ATS; (7) provide a process for the Commission, pursuant to proposed Rule 304(a)(4), to suspend, limit, or revoke the exemption of an NMS Stock ATS's Form ATS-N upon notice and after opportunity for hearing; (8) provide that the Commission, pursuant to proposed Rule 304(b), will publicly post on its Web site: each effective Form ATS-N, each properly filed Form ATS-N Amendment, and each properly filed Form ATS-N notice of cessation, as well as each order of effectiveness or ineffectiveness of a Form ATS-N, order of ineffectiveness of a Form ATS-N Amendment, and order suspending, limiting, or revoking an NMS Stock ATS's exemption, issued by the Commission; and also require each NMS Stock ATS that has a Web site to post on the NMS Stock ATS's Web site a

direct URL hyperlink to the Commission's Web site that contains the documents enumerated in proposed Rule 304(b)(2); (9) amend existing Rule 301(b)(10) of Regulation ATS to require all ATSs to adopt written safeguards and written procedures to protect subscribers' confidential trading information, as well as written oversight procedures to ensure those safeguards and procedures are followed; and (10) amend Rule 303(a) to require that the written safeguards and written procedures required by proposed Rule 301(b)(10) and reports pursuant to proposed Rule 304 be preserved.

II. Current ATS Regulatory Framework

A. Exemption From National Securities Exchange Registration

A fundamental component of the current ATS regulatory framework adopted by the Commission in 1998 is Exchange Act Rule 3b-16.

Rule 3b-16 was designed to address the blurring of traditional classifications between exchanges and broker-dealers as a result of advances in technology by providing a more comprehensive and meaningful interpretation of what constitutes an exchange under Section 3(a) of the Exchange Act.

Rule 3b-16(a) provides a functional test to assess whether a trading platform meets the definition of exchange under Section 3(a)(1) of the Exchange Act, and thus is required to register as a national securities exchange pursuant to Sections 5 and 6 of the Exchange Act.

Under Rule 3b-16, an organization, association, or group of persons shall be considered to constitute, maintain, or provide “a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange,” if such organization, association, or group of persons: (1) Brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.

See

17 CFR 240.3b-16.

See

Regulation ATS Adopting Release,

supra

note 7, at 70847. Pursuant to Section 3(a)(1) of the Exchange Act, the statutory definition of “exchange” means “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange . . . .” 15 U.S.C. 78c(a)(1).

See

15 U.S.C. 78e and 78f. A “national securities exchange” is an exchange registered as such under Section 6 of the Exchange Act.

See

17 CFR 240.3b-16(a).

The Commission adopted Exchange Act Rule 3b-16(b) to explicitly exclude certain systems that the Commission believed did not meet the exchange definition.

Specifically, Rule 3b-16(b) excludes systems that perform only traditional broker-dealer activities, including: (1) Systems that route orders to a national securities exchange, a market operated by a national securities association, or a broker-dealer for execution, or (2) systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met.

Accordingly, a system is not included in the Commission's interpretation of “exchange” if: (1) The system fails to meet the two-part test in paragraph (a) of Rule 3b-16; (2) the system falls within one of the exclusions in paragraph (b) of Rule 3b-16; or (3) the Commission otherwise conditionally or unconditionally exempts

the system from the definition.

See

Regulation ATS Adopting Release,

supra

note 7, at 70852.

See

17 CFR 240.3b-16(b). Rule 3b-16(b)(2) excludes systems that allow persons to enter orders for execution against the bids and offers of a single dealer if, as an incidental part of such activities, the system matches orders that are not displayed to any person other than the dealer and its employees; or in the course of acting as a registered market maker with an SRO, the system displays the limit orders of the market maker's, or other broker-dealer's, customers, and in addition, matches customer orders with those displayed limit orders and, as an incidental part of its market making activities, the system crosses or matches orders that are not displayed to any person other than the market maker and its employees.

See

17 CFR 240.3b-16(b)(2). The purpose of the exclusions in 17 CFR 240.3b-16(b)(2) was to encompass systems operated by third market makers, as well as those systems operated by dealers, primarily in debt securities, who display their own quotations to customers and other broker-dealers on a proprietary basis. Rule 3b-16(b)(2)(ii) was adopted to exclude registered market makers that display their own quotes and, in order to comply with a Commission or SRO rule, customer limit orders, and allow their customers and other broker-dealers to enter orders of execution against the displayed orders. Additionally, it was designed to allow registered market makers, as an incidental activity resulting from their market maker status, to match or cross orders for securities in which they make a market, even if those orders are not displayed.

See

Regulation ATS Adopting Release,

supra

note 7, at 70854.

See

17 CFR 240.3b-16(e).

For those systems that meet the criteria of Rule 3b-16(a) and are not excluded under Rule 3b-16(b) of the Exchange Act,

Rule 3a1-1(a)(2)

provides an exemption from the definition of “exchange.” Specifically, Exchange Act Rule 3a1-1(a)(2) exempts from the Exchange Act Section 3(a)(1) definition of “exchange” an organization, association, or group of persons that complies with Regulation ATS,

which includes, among other things, the requirement to register as a broker-dealer.

Therefore, an organization, association, or group of persons that complies with Regulation ATS is not subject to Section 5 of the Exchange Act,

which requires that an “exchange” register with the Commission as a national securities exchange pursuant to Section 6 of the Exchange Act

or otherwise be exempt. Additionally, an ATS that is not required to register as a national securities exchange pursuant to Section 5 is not an SRO

and is not required to comply with applicable requirements.

See

17 CFR 240.3b-16(b).

See

17 CFR 240.3a1-1(a)(2).

See

17 CFR 240.3a1-1(a)(2). Rule 3a1-1 also provides two other exemptions from the definition of “exchange” for any ATS operated by a national securities association, and any ATS not required to comply with Regulation ATS pursuant to Rule 301(a) of Regulation ATS.

See

17 CFR 240.3a1-1(a)(1) and (3).

See

17 CFR 242.301(b)(1).

15 U.S.C. 78e.

15 U.S.C. 78f.

See supra

note 21 (setting forth the statutory definition of SRO).

See, e.g.,

Section 19 of the Exchange Act, 15 U.S.C. 78s.

To satisfy the requirements of the Rule 3a1-1(a)(2) exemption, a system that otherwise meets the definition of an “exchange” must comply with Regulation ATS. An ATS that fails to comply with the requirements of Regulation ATS would no longer qualify for the exemption from the definition of an “exchange” provided under Exchange Act Rule 3a1-1(a)(2), and thus, risks operating as an unregistered exchange in violation of Section 5 of the Exchange Act.

See

15 U.S.C. 78e.

B. Conditions to the ATS Exemption; Confidential Notice Regime

Rule 300(a) of Regulation ATS defines an ATS as: “any organization, association, person, group of persons, or system: (1) [t]hat constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of [Rule 3b-16]; and (2) [t]hat does not: (i) [s]et rules governing the conduct of subscribers other than the conduct of such subscribers' trading on such organization, association, person, group of persons, or system; or (ii) [d]iscipline subscribers other than by exclusion

from trading.”

Governing the conduct of or disciplining subscribers are functions performed by an SRO that the Commission believes should be regulated as such.

Accordingly, pursuant to the definition in Rule 300(a), a trading system that performs SRO functions, or performs functions common to national securities exchanges, such as establishing listing standards, is precluded from the definition of ATS and would be required to register as a national securities exchange or be operated by a national securities association (or seek another exemption).

See

17 CFR 242.300(a).

See

Regulation ATS Adopting Release,

supra

note 7, at 70859. As the Commission noted when it adopted Regulation ATS, the Commission believes that any system that uses its market power to regulate its participants should be regulated as an SRO. The Commission noted that it would consider a trading system to be “governing the conduct of subscribers” outside the trading system if it imposed on subscribers, as conditions of participation in trading, any requirements for which the trading system had to examine subscribers for compliance. In addition, the Commission stated its belief that if a trading system imposed as conditions of participation, directly or indirectly, restrictions on subscribers' activities outside of the trading system, such a trading system should be a registered exchange or operated by a national securities association, but that the limitation would not preclude an alternative trading system from imposing credit conditions on subscribers or requiring subscribers to submit financial information to the alternative trading system.

See id.

Rule 301(b)(1) of Regulation ATS requires that every ATS that is subject to Regulation ATS, pursuant to paragraph (a) of Rule 301,

be registered as a broker-dealer under Section 15 of the Exchange Act,

and thus become a member of an SRO, such as FINRA.

In the Regulation ATS Adopting Release, the Commission stated that an ATS that registers as a broker-dealer must, in addition to complying with Regulation ATS, comply with the filing and conduct obligations associated with being a registered broker-dealer, including membership in an SRO and compliance with SRO rules.

Pursuant to Rule 301(a), certain ATSs that are subject to other appropriate regulations are not required to comply with Regulation ATS. These ATSs include those that are: Registered as an exchange under Section 6 of the Exchange Act; exempt from exchange registration based on the limited volume of transactions effected; operated by a national securities association; registered as a broker-dealer under Sections 15(b) or 15C of the Exchange Act, or is a bank, that limits its activities to certain instruments; or exempted, conditionally or unconditionally, by Commission order, after application by such alternative trading system. See 17 CFR 242.301(a). For example, an ATS that is registered as a broker-dealer, or is a bank, and limits its securities activities solely to government securities is not required to comply with Regulation ATS.

See

17 CFR 242.301(a)(4).

See

17 CFR 242.301(b)(1).

See

Section 15(b)(8) of the Exchange Act; 15 U.S.C. 78

(b)(8).

See also

supra

24 note and

infra

note 295 and accompanying text (setting forth the requirements of Section 15(b)(8) of the Exchange Act).

See

Regulation ATS Adopting Release,

supra

note 7, at 70903.

In addition, Rule 301(b)(2) of Regulation ATS requires an ATS to file an initial operation report with the Commission on Form ATS

at least 20 days before commencing operations.

The Commission stated in the Regulation ATS Adopting Release that Form ATS would provide the Commission the opportunity to identify problems that might impact investors before the system begins to operate.

Unlike a Form 1 filed by a national securities exchange, Form ATS is not approved by the Commission. Instead, Form ATS provides the Commission with notice about its operations prior to commencing operations.

Form ATS and the Form ATS Instructions are available at

http://www.sec.gov/about/forms/formats.pdf.

See

17 CFR 242.301(b)(2)(i).

See

Regulation ATS Adopting Release,

supra

note 7, at 70864.

See id.

As discussed more fully below, the current notice process applicable to ATSs is very different than the process by which exchanges register with the Commission and how amendments to exchange rules are regulated.

See infra

notes 158-162 and accompanying text.

Form ATS requires, among other things, that an ATS provide information about: Classes of subscribers and differences in access to the services offered by the ATS to different groups or classes of subscribers; securities the ATS expects to trade; any entity other than the ATS involved in its operations; the manner in which the system operates; how subscribers access the trading system; procedures governing order entry and execution; and trade reporting, clearance and settlement of trades on the ATS. Regulation ATS states that information filed by an ATS on Form ATS is “deemed confidential when filed.”

Thus, under the current regulatory requirements, market participants generally do not have information about, for example, how orders are entered, prioritized, handled, and executed on an NMS Stock ATS, ATSs are not otherwise required to publicly disclose such information.

See

17 CFR 242.301(b)(2)(vii).

The Commission does note, however, that some ATSs may currently make voluntary public disclosures.

See, e.g.,

infra

note 156.

In addition to providing notice of its initial operation, an ATS must notify the Commission of any changes in its operations by filing an amendment to its initial operation report. There are three types of amendments to an initial operation report.

First, if any material change is made to its operations, the ATS must file an amendment on Form ATS at least 20 calendar days before implementing such change.

Second, if any information contained in the initial operation report becomes inaccurate for any reason and has not been previously reported to the Commission as an amendment on Form ATS, the ATS must file an amendment on Form ATS correcting the information within 30 calendar days after the end of the calendar quarter in which the system has operated.

Third, an ATS must promptly file an amendment on Form ATS correcting information that it previously reported on Form ATS after discovery that any information was inaccurate when filed.

Also, upon ceasing to operate as an ATS, an ATS is required to promptly file a cessation of operations report on Form ATS.

As is the case with respect to initial operation reports, Form ATS amendments and cessation of operations reports serve as notice to the Commission of changes to the ATS's operations,

and Rule 301(b)(2)(vii) and the instructions to the form state that Form ATS is “deemed confidential.”

Form ATS is used for three types of submissions: Initial operation reports; amendments to initial operation reports; and cessation of operations reports. An ATS designates the type of submission on the form.

See

Form ATS.

See

17 CFR 242.301(b)(2)(ii). A “material change,” includes, but is not limited to, any change to the operating platform, the types of securities traded, or the types of subscribers. In addition, the Commission has stated that ATSs implicitly make materiality decisions in determining when to notify their subscribers of changes.

See

Regulation ATS Adopting Release,

supra

note 7, at 70864.

See also

infra

Section XIII.B.1.

Competitors for listed-equity (NMS) trading services also include several hundred OTC market makers and broker-dealers.

122

The NMS Stock ATS with the greatest volume executed approximately 12.7% of NMS Stock ATS share volume and 1.9% of the total consolidated NMS stock share trading volume.

The market share percentages were calculated by Commission staff using market volume statistics reported by BATS and FINRA ATS data collected from ATSs pursuant to FINRA Rule 4552.

See infra

Table 1—“NMS Stock ATSs Ranked by Dollar Trading Volume—March 30, 2015 to June 26, 2015.”

FINRA recently adopted a rule that requires NMS Stock ATSs to report aggregate weekly volume information and number of trades to FINRA in certain equity securities, including NMS stocks, some of which FINRA makes publicly available. Reporting is on a security-by-security basis for transactions occurring within the ATS. Each ATS is also required to use a unique MPID in its reporting to FINRA, such that its volume reporting is distinguishable from other transaction volume reported by the broker-dealer operator of the ATS, including volume reported for other ATSs operated by the same broker-dealer.

See

FINRA Rules 4552, 6160, 6170, 6480 and 6720.

See also

Securities Exchange Act Release No. 71341 (January 17, 2014), 79 FR 4213 (January 24, 2014) (SR-FINRA-2013-042) (order granting approval of a proposed rule change to require alternative trading systems to report volume information to FINRA and use a unique market participant identifier) (“FINRA ATS Reporting Approval”).

FINRA publishes on its Web site the trading information (volume and number of trades) reported for each equity security, with appropriate disclosures that the information is based on ATS-submitted reports and not on reports produced or validated by FINRA.

See id.

at 4214.

See also

Alternative Trading System (ATS) Transparency on FINRA's Web site,

http://www.finra.org/Industry/Compliance/MarketTransparency/ATS/

Another significant aspect of the increased role of NMS Stock ATSs in equity market structure is the proliferation of ATSs that trade NMS stocks but do not publicly display quotations in the consolidated quotation data, commonly referred to as “dark pools.”

123

Dark pools originally were designed to offer certain market participants, particularly institutional investors, the ability to minimize transaction costs when executing trades in large size by completing their trades without prematurely revealing the full extent of their trading interest to the broader market. The disclosure of large size trades could have an impact on the market, and reduce the likelihood of the orders being filled.

124

As the Commission has previously noted, some dark pools, such as block crossing networks, offer specialized size discovery mechanisms that attempt to bring large buyers and sellers in the same stock together anonymously and to facilitate a trade between them.

125

The traditional definition of block orders are orders for more than 10,000 shares,

126

however average trade sizes can far exceed this and be as high as 500,000 shares per trade.

127

123

The term “dark pool” is not used or defined in the Exchange Act or Commission rules. For purposes of this release, the term refers to NMS Stock ATSs that do not publicly display quotations in the consolidated quotation data.

See

Regulation of Non-Public Trading Interest, Securities Exchange Act Release No. 60997 (November 13, 2009), 74 FR 61208, 61209 (November 23, 2009) (“Regulation of Non-Public Trading Interest”) (proposing rules and amendment to joint-industry plans describing the term dark pool).

Some trading centers, such as OTC market makers, also offer dark liquidity, primarily in a principal capacity, and do not operate as ATSs. For purposes of this release, these trading centers are not defined as dark pools because they are not ATSs. These trading centers may, however, offer electronic dark liquidity services that are analogous to those offered by dark pools.

See id.

at 61209 n.8.

124

See, e.g.,

Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594, 3599 n.28 (January 21, 2010) (“2010 Equity Market Structure Release”).

125

See id.

at 3599.

126

See

Rule 600(b)(9) of Regulation NMS (defining block size with respect to an order), 17 CFR 242.600(b)(9).

See also

Laura Tuttle,

Alternative Trading Systems: Description of ATS Trading in National Market System Stocks,

at 9-10 (October 2013),

http://www.sec.gov/marketstructure/research/alternative-trading-systems-march-2014.pdf

(“Tuttle: ATS Trading in NMS Stocks”).

127

See infra,

Table 2—“NMS Stock ATSs Ranked by Average Trade Size—March 30, 2015 to June 26, 2015.”

Most dark pools today, however, primarily execute trades with small sizes that are more comparable to the average size of trades on registered national securities exchanges, which is 181 shares.

128

These dark pools that primarily match smaller orders (though the matched orders may be “child” orders of much larger “parent” orders) execute more than 90% of dark pool volume.

129

The majority of this volume is executed by dark pools that are operated by multi-service broker-dealers.

130

These broker-dealers typically also offer order routing services, trade as principal in the ATS that they are operating, or both.

131

128

See infra

note 725 and accompanying text.

129

See

2010 Equity Market Structure Release,

supra

note 124, 75 FR at 3599; see also

infra,

Table 2—“NMS Stock ATSs Ranked by Average Trade Size—March 30, 2015 to June 26, 2015.”

130

See infra

note 364 and accompanying text and Table 1—“NMS Stock ATSs Ranked by Dollar Trading Volume—March 30, 2015 to June 26, 2015.”

131

See

2010 Equity Market Structure Release,

supra

note 124, at 3599.

In recent years, as the number of NMS Stock ATSs has increased, so has the number of dark pools. The number of active dark pools trading NMS stocks has increased from approximately 10 in 2002,

132

to 32 in 2009,

133

to over 40 today.

134

Furthermore, in 2009, dark pools accounted for 7.9% of NMS share volume.

135

It is now estimated that of the approximately 397 billion shares traded in NMS stocks ($16.3 trillion), 14.9% of total NMS stock share volume is attributable to dark pools, with no

single individual dark pool executing more than 1.9% of total NMS stock share volume.

136

The Commission also notes that some NMS Stock ATSs, which do not provide their best priced-orders for inclusion in the consolidated quotation data, make available to subscribers real-time information about quotes, orders, or other trading interest on the NMS Stock ATS.

132

See

Regulation of Non-Public Trading Interest,

supra

note 123, at 61209 n.9 and accompanying text.

133

See

2010 Equity Market Structure Release,

supra

note 124, at 3598 n.22 and accompanying text.

134

Data compiled from Forms ATS and Forms ATS-R filed to the Commission as of the end of, and for the third quarter of, 2015.

135

See

2010 Equity Market Structure Release,

supra

note 124, at 3598.

136

See infra

Section XIII.B.1.

In contrast to dark pools, an ATS could be an Electronic Communication Network (“ECN”). ECNs are ATSs that provide their best-priced orders for inclusion in the consolidated quotation data, whether voluntarily or as required by Rule 301(b)(3) of Regulation ATS.

137

In general, ECNs offer trading services (such as displayed or non-displayed order types, maker-taker pricing, and data feeds) that are analogous to registered national securities exchanges.

138

137

See

Rule 600(b)(23) of Regulation NMS, 17 CFR 242.600(b)(23) (definition of “electronic communications network”);

See also

supra

notes 20-23 and accompanying text;

http://www.sec.gov/rules/sro.shtml

159

Among other things, Form 1 requires an exchange applying for registration as a national securities exchange to disclose its procedures governing entry and display of quotations and orders in its system, procedures governing the execution, reporting, clearance and settlement of transactions in connection with the system, and fees.

See

Form 1, Exhibits E.2-E.4. The disclosures required in Form 1 must include sufficient detail for the Commission to determine the exchange's rules are consistent with the Act.

See generally

15 U.S.C. 78f(b)(1). Once registered, a national securities exchange must file any proposed rule or any proposed change in, addition to, or deletion from its rules.

See

15 U.S.C. 78s(b)(2).

160

See

15 U.S.C. 78s(b)(1).

161

See

17 CFR 240.19b-4(f).

162

See supra

notes 20-25 and accompanying text and

infra

notes 342-343 and accompanying text (discussing, in more detail, the differences in the regulatory regimes for registered national securities exchanges and ATSs, including with respect to requirements related to transparency of operations).

See also

17 CFR 242.301(b)(2) (requiring ATSs to file amendments on Form ATS at least 20 days prior to implementing a material change to the operation of the ATS, and within 30 calendar days after the end of each calendar quarter to update any other information that has become inaccurate and not previously reported).

The Commission preliminarily believes that the increased complexity of NMS Stock ATS operations and the business structures of their broker-dealer operators, combined with a lack of transparency around the operation of NMS Stock ATSs and the activities of their broker-dealer operators, could inhibit a market participant's ability to assess an NMS Stock ATS as a potential trading venue. Further, the Commission recognizes that Form ATS was designed before NMS Stock ATSs operated at the level of complexity that they do today, and the equity market structure has substantially changed since Regulation ATS was adopted.

163

As such, the Commission preliminarily believes that transparency of NMS Stock ATSs' operations will promote competition and benefit investors by informing market participants about differences between trading venues that could impact the quality of the execution of their orders.

164

The Commission preliminarily believes that requiring ATSs to respond to proposed Form ATS-N, which would require more detailed information about the ATSs' operations and be made available to the public on the Commission's Web site, would facilitate the public's understanding of NMS Stock ATSs by improving the information available to market participants, enabling them to make better decisions about where to route their orders to achieve their investing or trading objectives.

163

The Commission preliminarily believes that information solicited on Form ATS-N would be similar to portions of what registered national securities exchange are required to publicly disclose, and thus, that disclosure of the information would not place NMS Stock ATSs at a competitive disadvantage with respect to competing trading venues.

See infra

Section IV.D. The Commission notes that, while some of the questions on Form ATS-N are designed to provide information about potential conflicts of interest arising from the activities of the broker-dealer operator or its affiliates and are dissimilar to information required to be disclosed by a national securities exchange, national securities exchanges must have rules that are consistent with the Exchange Act, and in particular Section 6. To date, national securities exchanges have implemented rules to address the potential for conflicts of interest when the national securities exchange is affiliated with a broker-dealer that is a member of the national securities exchange.

See, infra,

notes 369-373 and accompanying text (discussing the Commission's concerns regarding conflicts of interest in the context of national securities exchanges).

164

See infra

Section XIII.C (discussing the Commission's preliminary belief that the proposal would help market participants make better decisions about where to route their orders, improve the efficiency of capital allocation, and execution quality, and also addressing the effect of the disclosure of proprietary information on competition).

D. Prior Comments on Operational Transparency and Regulatory Framework for NMS Stock ATSs

The Commission is proposing to amend Regulation ATS to adopt Form ATS-N, which would require an NMS Stock ATS to publicly disclose detailed information about its operations and the activities of the broker-dealer operator and its affiliates. The Commission is also proposing to modify the regulatory requirements that apply to NMS Stock ATSs and qualify NMS Stock ATSs for the exemption from the definition of “exchange” under Exchange Act Rule 3a1-1(a)(2) by declaring the Form ATS-N effective or ineffective.

In 2009, the Commission proposed to amend the regulatory requirements of the Exchange Act that apply to non-public trading interest in NMS stocks, including dark pools.

165

Among other

things, the Commission proposed to substantially lower the trading volume threshold in Regulation ATS that triggers public display obligations for ATSs and to amend joint-industry plans for publicly disseminating consolidated trade data to require real-time disclosure of the identity of an ATS in the consolidated last-sale report. The Commission received four comments on its Regulation of Non-Public Interest proposal that directly relate to the amendments to Regulation ATS that the Commission is proposing today.

166

165

See

Regulation of Non-Public Trading Interest,

supra

note 123, at 62108 (proposing rules and amendment to joint-industry plans).

166

See

letter to Mary L. Schapiro, Chairman, Commission, from Sen. Edward E. Kaufman, United States Senate, dated August 5, 2010 (“Kaufman letter”); letters to Elizabeth M. Murphy, Secretary, Commission, from Janet M. Kissane, Senior Vice President, Legal & Corporate Secretary Office of the General Counsel, NYSE Euronext, dated February 22, 2010 (“NYSE Euronext letter #1”); from Jeffrey D. Morgan, CAE, President and CEO, National Investor Relations Institute, dated February 16, 2010 (“National Investor Relations Institute letter”); letter to the Commission, from Seth Merrin, Chief Executive Officer; Anthony Barchetto, Head of Trading Strategy; Jay Biancamo, Global Head of Marketplace; Vlad Khandros, Market Structure Analyst; Howard Meyerson, General Counsel, Liquidnet, Inc., dated December 21, 2009 (“Liquidnet letter #1”).

Three commenters expressed the view that the Commission should address the regulatory disparity between national securities exchanges and ATSs. Senator Edward E. Kaufman expressed the view that “as trading continues to become faster and more dispersed, it is that much more difficult for regulators to perform their vital oversight and surveillance functions,” and that “the Commission should consider strengthening the regulatory requirements for becoming an Alternative Trading System or starting a new trading platform for existing market centers.”

167

Senator Kaufman further urged the Commission to “harmonize rules across all market centers to ensure exchanges and ATSs are competing on a level playing field that serves the interests of all investors.” NYSE Euronext stated that because “ATSs now represent a significant share of trading volume in NMS stocks . . . the time is ripe to move to a framework that has consistent regulatory requirements when the trading activity at issue is essentially the same.”

168

The National Investor Relations Institute opined that “the same regulatory oversight, market surveillance, reporting, and other investor safeguards that exist for exchanges should be in place for all trading venues to ensure maximum investor protection.”

169

167

Kaufman letter,

supra

note 166, attachment at 4-5.

168

NYSE Euronext letter #1,

supra

note 166, at 3.

169

National Investor Relations Institute letter,

supra

note 166, at 2.

Liquidnet expressed the view that the Commission should require institutional brokers, including institutional ATSs, to disclose to their customers specific order handling practices and that Regulation ATS should be amended to enhance the review process of new ATSs and material changes to ATSs' business operations.

170

Liquidnet stated that disclosures by institutional brokers, including institutional ATSs, to their customers should include, among other things, identification of external venues to which the broker routes orders, the process for crossing orders with other orders received by the broker, execution of orders as agent and principal, a detailed description of the operation and function of each ATS or trading desk operated by the broker, a clear and detailed description of each algorithm and order type offered by the broker, categories of participant and admission criteria for each ATS or trading desk with which the customer's order can interact, and internal processes and policies to control dissemination of the institution's order and trade information and other confidential information.

171

Liquidnet also suggested that the Commission amend “Regulation ATS to permit the Commission to delay the effective date of a new ATS commencing operation or of an existing ATS implementing a material business change if the Commission believes that information in the ATS filing is unclear or incomplete or raises an issue of potential non-compliance with applicable law or regulation,” and expressed support for making publicly available ATS filings with the Commission.

172

170

See

Liquidnet letter #1,

supra

note 166, at D-5-6, 11.

171

See

Liquidnet letter #1,

supra

note 166, at D-5-6.

172

Id.

at D-11.

In 2010, the Commission issued a Concept Release that, among other things, solicited comment on whether trading centers offering undisplayed liquidity are subject to appropriate regulatory requirements for the type of business they conduct.

173

Specifically, the Commission asked, among other things, for comment on the following:

174

173

See

2010 Equity Market Structure Release,

supra

note 124, at 3614.

174

See id.

• Do investors have sufficient information about dark pools to make informed decisions about whether in fact they should seek access to dark pools? Should dark pools be required to provide improved transparency on their trading services and the nature of their participants? If so, what disclosures should be required and in what manner should ATSs provide such disclosures?

• Are there any other aspects of ATS regulation that should be enhanced for dark pools or for all ATSs, including ECNs?

• Are there any ways in which Regulation ATS should be modified or supplemented to appropriately reflect the significant role of ATSs in the current market structure?

The Commission received 20 comment letters that addressed these questions as they relate to the proposal.

175

The 20 comment letters offered contrasting views.

175

See

letters from Theodore R. Lazo, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated October 24, 2014 (“SIFMA letter #2); Richie Prager, Hubert De Jesus, Supurna Vedbrat, and Joanne Medero, BlackRock, Inc., dated September 12, 2014 (“Blackrock letter”); Micah Hauptman, Consumer Federation of America, dated September 9, 2014 (“Consumer Federation of America letter”); Christopher Nagy and Dave Lauer, KOR Group LLC, dated April 4, 2014 (“KOR Group letter”); Bill Neuberger, Andrew Silverman, Paul Fitzgerald, and Sapna Patel, Morgan Stanley, dated March 7, 2011 (“Morgan Stanley letter”); Raymond M. Tierney III and Gary Stone, Bloomberg Tradebook LLC, dated June 28, 2013 (“Bloomberg Tradebook letter”); Greg Tusar, Goldman Sachs Execution & Clearing, L.P., and Matthew Lavicka, Goldman Sachs & Co., dated June 25, 2010 (“Goldman Sachs letter”); Jeffrey S. Wecker, Lime Brokerage LLC, dated May 21, 2010 (“Lime Brokerage letter”); Andrew C. Small, Scottrade, dated May 19, 2010 (“Scottrade letter”); Kimberly Unger, The Security Traders Association of New York, Inc., dated May 10, 2010 (“Security Traders Association of New York letter”); Stuart J. Kaswell, Managed Funds Association, dated May 7, 2010 (“Managed Funds Association letter”); Raymond M. Tierney III, Bloomberg L.P., dated May 7, 2010 (“Bloomberg L.P. letter”); James J. Angel, Georgetown University, McDonough School of Business, dated January 16, 2011 (“Angel letter”); Joan C. Conley, Nasdaq OMX Group, Inc., dated April 30, 2010 (“Nasdaq OMX letter”); Ann Vlcek, Securities Industry and Financial Markets Association, dated April 29, 2010 (“SIFMA letter #1”); Joseph M. Velli, BNY ConvergEx Group, LLC, dated April 29, 2010 (“BNY CovergEx Group letter”); O. Mason Hawkins, Richard W. Hussey, Deborah L. Craddock, Jeffrey D. Engelberg, and W. Douglas Schrank, Southeastern Asset Management, Inc., dated April 28, 2010 (“Southeastern Asset Management letter”); Janet M. Kissane, NYSE Euronext, dated April 23, 2010 (“NYSE Euronext letter #2”); David C. Cushing, Wellington Management Company, LLP, dated April 21, 2010 (“Wellington Management Company letter”); Seth Merrin, Howard Meyerson, and Vlad Khandros, Liquidnet, Inc., dated March 26, 2010 (“Liquidnet letter #2”).

Five commenters expressed support for Commission action to address the regulatory disparity between national securities exchanges and ATSs, particularly where such trading venues perform similar functions. Security Traders Association of New York noted that it has “called for the harmonization of regulatory oversight and the need for similar rules across venues, including exchanges, ATSs and other liquidity sources that are connected through the

Reg. NMS regulatory framework.”

176

Nasdaq OMX expressed the view that the “Commission has flexibility to adopt a more principles-based regulatory structure” which it could use to “level the competitive playing field between ATSs and exchanges,” and that “[i]n areas where ATS and exchange activities overlap, differences in [regulatory] approach should persist only if there is a clear policy basis for those differences.”

177

NYSE Euronext opined that the “lighter regulatory oversight for ATSs puts transparent, regulated markets at a competitive disadvantage, to the potential detriment of investors” and that “now that ATSs represent a significant share of trading volume in NMS stocks, . . . the Commission should address the regulatory disparity between registered exchanges and ATSs that engage in trading activities analogous to traditional exchange trading.”

178

Wellington Management Company expressed the view that “regulatory requirements for types of venues should differ only to the extent the differentiated requirements are specifically designed to address clearly identifiable and compelling needs” and that “material disparities in regulatory requirements could make it difficult for exchanges to compete with ATSs and broker-dealers and could threaten their long-term survival.”

179

Liquidnet stated that “[t]o the extent that an exchange conducts the equivalent business function as a broker or an ATS, regulators should ensure that levels of regulation are consistent.”

180

176

Security Traders Association of New York letter,

supra

note 175, at 2.

177

Nasdaq OMX letter,

supra

note 175, at 13, 16.

178

NYSE Euronext letter #2,

supra

note 175, at 7.

179

Wellington Management Company letter,

supra

note 175, at 3.

180

Liquidnet letter #2,

supra

note 175, at F-7.

However, three commenters expressed the view that in order to rectify the regulatory disparity, the Commission should lessen regulatory burdens on exchanges, rather than enhance its regulation of ATSs. Goldman Sachs urged the Commission to “consider expanding the types of rule changes that exchanges . . . can propose on an immediately effective basis,” which “would help to level the playing field between exchanges and ATSs.”

181

Wellington Management Company opined that “the burden of regulation should be shared fairly by execution venues” and that “exchanges should be granted the ability to make certain rule changes in a manner similar to ATSs (

i.e.,

as a notification with SEC veto authority, and not as part of a lengthy notice, comment, and approval process).”

182

Liquidnet stated that “regulators should not impose unnecessary burdens on ATSs and brokers, but rather should remove unnecessary regulatory burdens from exchanges, to the extent that they exist.”

183

181

Goldman Sachs letter,

supra

note 175, at 10.

182

Wellington Management Company letter,

supra

note 175, at 3.

183

Liquidnet letter #2,

supra

note 175, at F-7.

Ten commenters expressed the view that ATSs and broker-dealers should be required to provide more enhanced disclosures regarding their operations, and described specific disclosures that the Commission should require of ATSs. SIFMA stated that the Commission “should require broker-dealers to publish on their Web sites, on a monthly basis, a standardized disclosure report that provides an overview of key macro issues that are of interest to clients,” including, among other things, “order types supported on the broker-dealer's ATS (if applicable).”

184

Blackrock, Inc. expressed the view that although some ATSs voluntarily publish their Form ATS filings and supplemental materials, the “particular operational features specified and degree of detail lack consistency from one [Form ATS] submission to another” and that “[a]dditional standardization and information are required in disclosures about ATS practices.”

185

Blackrock further stated that “[m]andatory ATS disclosures should include greater detail on how the platform calculates reference prices, determines order priority, matches orders between client segments, monitors execution quality, advertises orders, interacts with affiliates and is compensated by subscribers.”

186

The Consumer Federation of America stated that Form ATS should require ATSs to provide “critical details about an ATS's participants, segmentation, and fee structure” because the “information will allow market participants, regulators, and third party analysts to assess whether an ATS's terms of access and service are such that it makes sense to trade on that venue.”

187

The Consumer Federation of America further opined that “the Commission should undertake an exhaustive investigation of the current order types, requiring exchanges and all ATSs, including dark pools, to disclose in easily understandable terms what their purpose is, how they are used in practice, who is using them, and why they are not discriminatory or resulting in undue benefit or harm to any traders.”

188

184

SIFMA letter #2,

supra

note 175, at 13.

185

Blackrock letter,

supra

note 175, at 4.

186

Id.

187

Consumer Federation of America letter,

supra

note 175, at 22.

188

Id.

at 37-38.

Bloomberg Tradebook LLC noted that buy-side representatives with whom it met at a workshop for members of equity trading desks of asset managers stated that although they periodically send questionnaires to their brokers regarding order handling and internalization (dark pool) matching protocols, because the buy-side representatives might not be customers of all ATSs, they could not assess order interaction that occurs across the market structure.

189

Bloomberg Tradebook also recommended that the Commission ask exchanges and ATSs to complete a questionnaire with “Yes” and “No” checkboxes that would provide an overview of each exchange's or ATS's operations, and which Bloomberg Tradebook suggested could be posted on the Commission's Web site. Bloomberg Tradebook provided a sample questionnaire that included questions relating to, among other things, affiliations, riskless principal trades, trades effected in a proprietary capacity, sharing of orders or order information with affiliates or other trading venues and compensation for such sharing, operation of a smart order router and whether it gives preference to the exchange or ATS or an affiliate, priority rules, order types that enable customers to gain preference, and special fees or rebates which lead to a preference of one order over another.

190

189

Bloomberg Tradebook letter,

supra

note 175, at 1.

190

Id.

at 2-3.

Goldman Sachs recommended an enhanced disclosure regime for exchanges and ATSs consisting of four components. First, exchanges and ATSs would be required to “provide descriptions of the types of functionalities that they provide, such as types of orders (

e.g.,

flash/pinging orders, conditional orders), services (

e.g.,

co-location, special priority), and data (

e.g.,

depth-of-book quotations, per order information).” Second, they would “disclose the basis upon which members/subscribers access the type of order, service or data,” and “whether only a certain class of market participants has access.” Third, they would be required to disclose how commonly the functionality is used. Fourth, the exchanges and ATSs would disclose more market quality statistics “so that investors and other market

participants could better gauge execution quality.”

191

Goldman Sachs letter,

supra

note 175, at 9-10.

Lime Brokerage, LLC recommended that the Commission should require “transparency around pricing, access criteria and membership of dark pools.”

192

Managed Funds Association stated that “as long as co-location is available to investors, traders and larger brokers on an equal basis, the secondary market for such services to smaller customers from their brokers should be competitive and thus, fairly priced,” and therefore, “we believe market centers should disclose if they or third parties offer co-location services on a priority basis other than first available.”

193

SIFMA stated its belief that “added disclosure about co-location and other market access arrangements would be beneficial to market participants,” and that “[s]uch disclosure might describe standard, high speed, co-location, or other means by which members may access an exchange or ATS, and provide market participants with details regarding the categories of market participants that use each means of access, the data capacity associated with each arrangement, and the quotation and transaction volume attributable to each arrangement.”

194

192

Lime Brokerage letter,

supra

note 175, at 7.

193

Managed Funds Association letter,

supra

note 175, at 27.

194

SIFMA letter #1,

supra

note 175, at 7.

Southeastern Asset Management, Inc. commented that brokers and trading venues should disclose to investors information such as payments, rebates, and fees related to execution venues, venue rankings by routing brokers and routing venues, and the inputs that create the routing rankings, and the transparency of customer specific order routing and execution available to the specific customer.

195

Liquidnet recommended that institutional ATSs make similar disclosures to those it recommended when commenting on the Regulation of Non-Public Interest proposing rules and amendment to joint-industry plans.

196

195

See

Southeastern Asset Management letter,

supra

note 175, at 7.

196

See

Liquidnet letter #2, supra note 175, at F-1-F-2;

See also

Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchange on an Unlisted Trading Privilege Basis,

http://web.archive.org/web/20070114023844/http://www.utpdata.com/docs/UTP_PlanAmendment.pdf

at 2, 10-13 (“OTC/UTP Plan”) (describing the securities for which transaction information is collected and disseminated as any Nasdaq Global Market or Nasdaq Capital Market security, as defined in then-operative NASDAQ Rule 4200). Nasdaq Rule 5005(a)(26) defines Nasdaq Global Market security as: Any security listed on Nasdaq that (1) satisfies all applicable requirements of the Rule 5100 and 5200 Series and meets the criteria set forth in the Rule 5400 Series; (2) is a right to purchase such security; (3) is a warrant to subscribe to such security; or (4) is an Index Warrant which meets the criteria set forth in Rule 5725(a). Nasdaq Rule 5005(a)(28) defines Nasdaq Capital Market security as: Any security listed on The Nasdaq Capital Market that (1) satisfies all applicable requirements of the Rule 5100, 5200 and 5500 Series but that is not a Nasdaq Global Market security; (2) is a right to purchase such security; or (3) is a warrant to subscribe to such security.

These plans are filed with, and approved by, the Commission in accordance with the requirements of Rule 608 of Regulation NMS, and pursuant to Rule 601 of Regulation NMS, which requires every national securities exchange to “file a transaction reporting plan regarding transactions in listed equity and Nasdaq securities executed through its facilities” and every national securities association to “file a transaction reporting plan regarding transactions in listed equity and Nasdaq securities executed by its members otherwise than on a national securities exchange.”

221

17 CFR 242.300(a).

As it did in the Regulation ATS Adopting Release, the Commission notes that whether the actual execution of the order takes place on the system is not a determining factor of whether a system falls under Rule 3b-6. A trading system that falls within the Commission's functional definition of “exchange” pursuant to Rule 3b-6 will still be an “exchange,” even if it matches two trades and routes them to another system or exchange for execution.

See

Regulation ATS Adopting Release,

supra

note 7, at 70851-70852.

The Commission requests comment on the proposed definition of NMS Stock ATS. In particular, the Commission solicits comment on the following:

1. Do you believe the Commission should adopt a more limited or expansive definition of NMS Stock ATS? Why or why not? Please support your arguments.

2. Should the Commission create the NMS Stock ATS category? Why or why not? Please support your arguments.

3. Should the Commission modify its proposed definition in any way? If so, in what way and why? If not, why not? Please support your arguments.

B. Rule 3a1-1(a)(2): Proposed Amendments to the Exemption From the Definition of “Exchange” for NMS Stock ATSs

Exchange Act Rule 3a1-1(a) exempts from the definition of “exchange”: (1) Any alternative trading system operated by a national securities association,

222

(2) any alternative trading system that complies with Regulation ATS,

223

and (3) any alternative trading system that under Rule 301(a) of Regulation ATS is not required to comply with Regulation ATS.

224

Most ATSs fall within the second prong of Exchange Act Rule 3a1-1 and thus, must comply with Regulation ATS to qualify for an exemption from the statutory definition of an “exchange.”

222

17 CFR 240.3a1-1(a)(1).

223

17 CFR 240.3a1-1(a)(2).

224

17 CFR 240.3a1-1(a)(3).

As discussed in more detail below, the Commission is now proposing to expand the conditions with which NMS Stock ATSs would be required to comply in order to use the exemption from the definition of “exchange.” To provide for these new conditions, the Commission is proposing to amend Rules 3a1-1(a)(2) and (3) to include proposed Rule 304 within the scope of Regulation ATS.

225

Amended Rule 3a1-1(a)(2) would condition the exemption for any ATS that meets the definition of “NMS Stock ATS” on compliance with Rules 300 through 303 of Regulation ATS (except Rule 301(b)(2)) and proposed Rule 304.

226

The Commission is proposing to amend Rule 3a1-1(a)(3) by changing the reference to Rule 303 to proposed Rule 304. This is merely a conforming change to make clear that an NMS Stock ATS that meets the requirements of Rule 301(a) is not required to comply with Regulation ATS, which would be amended to include proposed Rule 304. Rule 3a1-1(a)(1), which exempts any ATS that is operated by a national securities association, is not impacted by the amendments the Commission is proposing today.

225

In Exchange Act Rules 3a1-1(a)(2) and (3), Regulation ATS is currently defined as “17 CFR 242.300 through 242.303.” The Commission is proposing to amend these references to Regulation ATS to define Regulation ATS as “17 CFR 242.300 through 242.304.”

226

See infra

Section IV.C. Specifically, the Commission is proposing to amend Rule 3a1-1(a)(2) by changing the reference to Rule 303 to proposed Rule 304. Under the proposal, an NMS Stock ATS would not be required to file the reports and amendments that it is currently required to file on Form ATS pursuant to Rule 302(b)(2), unless the ATS also effects transactions in securities other than NMS stock and is not otherwise exempt.

See

proposed Rule 301(b)(2)(viii).

The Commission preliminarily believes that amending the conditions to the Rule 3a1-1(a) exemption would more appropriately calibrate the level of operational transparency between registered national securities exchanges and NMS Stock ATSs, which in many regards, are functionally similar trading centers, while maintaining the regulatory framework that permits NMS Stock ATSs to decide whether to register and be regulated as broker-dealers or as national securities exchanges.

227

The Commission notes, as it has in other contexts,

228

that SRO and non-SRO markets, such as NMS Stock ATSs, are subject to different regulatory regimes, with a different mix of benefits and obligations. Pursuant to this proposal, NMS Stock ATSs would continue to be able to choose to register as national securities exchanges or as broker-dealers. The Commission is proposing, however, to increase the scope of the conditions to the exemption for the purpose of providing more transparency around the operations of NMS Stock ATSs and potential conflicts of interest resulting from the unique relationship between the broker-dealer operator and the NMS Stock ATS, as discussed further below. While questions have been raised in other contexts as to whether the broader regulatory framework for national securities exchanges and ATSs should be harmonized,

229

the Commission preliminarily believes that the proposals are an appropriate response to concerns about the need for transparency about the operations of NMS Stock ATSs and potential conflicts of interest resulting from the activities of their broker-dealer operators and the broker-dealer operators' affiliates. The Commission preliminarily believes that the proposals would help market participants make better informed decisions about where to route their orders for execution; the proposed disclosures would also provide the Commission with improved tools to carry out its oversight of NMS Stock ATSs. Moreover, as explained above, the Commission is concerned that market participants have limited information about the increasingly complex operations of NMS Stock ATSs,

230

and need more transparency on NMS Stock ATSs to fully evaluate how their orders are handled and executed on NMS Stock ATSs. The Commission preliminarily believes that the enhanced disclosures about the operations of NMS Stock ATSs elicited by proposed Form ATS-N would provide better information about how NMS Stock ATSs operate and, thereby, enable the Commission to determine whether additional regulatory changes for either or both national securities exchanges and ATSs are necessary.

227

See

Regulation ATS Adopting Release,

supra

note 7, at 70856-70857.

228

See, e.g.,

SCI Adopting Release,

supra

note 17, at 72264.

229

See id.

230

See supra

Sections III.B and C.

The Commission has considered the alternative of requiring different levels of disclosure among NMS Stock ATSs based on volume.

231

However, the Commission preliminarily believes that it is necessary and appropriate for the protection of market participants to apply the proposed heightened conditions for the Rule 3a1-1(a)(2) exemption to all NMS Stock ATSs. The Commission notes that market participants may subscribe to multiple ATSs and route orders in NMS stocks among various ATSs prior to receiving an execution. The Commission preliminarily believes that because orders in NMS stocks may be routed to any NMS Stock ATS, regardless of the volume traded on the NMS Stock ATS, all market participants would benefit from the disclosures provided pursuant to proposed Rule 304. Accordingly, the

Commission believes that the proposed rules addressing greater operational transparency should apply equally to all NMS Stock ATSs.

231

See infra

Section XIII.D.4.

The Commission requests comment on the scope of the proposed amendments to Rules 3a1-1(a)(2) and (3), which would apply the proposed new conditions of Rule 304 to all NMS Stock ATSs. In particular, the Commission solicits comment on the following:

4. Do you b

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.