# Transaction Fee Pilot for NMS Stocks

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2018-27982

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** February 20, 2019
- **Citation:** 84 FR 5202

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 200 and 242
[Release No. 34-84875; File No. S7-05-18]
RIN 3235-0761
Transaction Fee Pilot for NMS Stocks

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting a new rule of Regulation National Market System (“Regulation NMS”) under the Securities and Exchange Act of 1934 (“Exchange Act”) to conduct a Transaction Fee Pilot (“Pilot”) for National Market System (“NMS”) stocks to study the effects that exchange transaction fee-and-rebate pricing models may have on order routing behavior, execution quality, and market quality. We expect the data generated by the pilot, combined with data from existing sources, will facilitate an empirical evaluation of whether the existing exchange transaction-based fee and rebate structure is operating effectively to further statutory goals.

DATES:

Effective date:
April 22, 2019 through December 29, 2023.

Compliance date:
As designated by Notice pursuant to 17 CFR 242.610T(c)(2).

FOR FURTHER INFORMATION CONTACT:

Richard Holley III, Assistant Director; Johnna Dumler, Special Counsel; Erika Berg, Special Counsel; or Benjamin Bernstein, Special Counsel, each with the Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549, or at (202) 551-5777.

SUPPLEMENTARY INFORMATION:

The Commission is adopting new 17 CFR 242.610T (Rule 610T) to conduct a Transaction Fee Pilot for NMS stocks.

Table of Contents

I. Executive Summary of Rule 610T

II. Discussion of Rule 610T

A. Focus on Exchange Pricing Models and the Distortions They Can Cause

1. Exchange Fee Models and Regulatory Framework

2. Impact of Exchange Fee Models

3. Focus on Exchange Fee Models

4. Non-Exchange Trading Centers

5. Options Exchanges

B. Securities

1. The Share Price Threshold of Pilot Securities

2. The Duration of Pilot Securities

3. Selecting Pilot Securities From All NMS Stocks

4. The Ability of Issuers to Opt Out of the Pilot

C. Pilot Design

1. Need for a Pilot

2. Pilot Design

3. No Overlap With Tick Size Pilot

4. Stratified Selection of Pilot Securities

5. Number of NMS Stocks Included in Each Test Group

6. Reduction to the Pilot Size

7. Fee Cap Test Groups

8. Control Group

9. Alternative Designs

10. Metrics To Assess the Pilot

D. Timing and Duration

1. Disclosure Initiatives and the Pilot

2. Automatic Sunset at Year One

3. Pre- and Post-Pilot Periods

4. Early Termination

5. Inclusion of a Phase-In Period

E. Data

1. Pilot Securities Exchange Lists and Pilot Securities Change Lists

2. Exchange Transaction Fee Summary

3. Order Routing Data

F. Implementation

G. The Commission's Authority To Conduct the Pilot

III. Paperwork Reduction Act

A. Summary of Collection of Information

B. Proposed Use of Information

C. Respondents

D. Total Initial and Annual Reporting and Recordkeeping Burdens

1. Pilot Securities Exchange Lists and Pilot Securities Change Lists

2. Exchange Transaction Fee Summaries

3. Order Routing Datasets

E. Collection of Information Is Mandatory

F. Confidentiality of Responses to Collection of Information

G. Retention Period for Recordkeeping Requirements

IV. Economic Analysis

A. Background and Market Failures

1. Market Failure at the Broker-Dealer Level

2. Market Failure at the Exchange Level

B. Baseline

1. Current Information Baseline

2. Current Market Environment

C. Analysis of Benefits and Costs of Transaction Fee Pilot

1. Benefits of Transaction Fee Pilot

2. Costs of the Pilot

D. Impact on Efficiency, Competition, and Capital Formation

1. Efficiency

2. Competition

3. Capital Formation

E. Alternatives

1. Propose Rulemaking Without Conducting a Pilot

2. Expand Transaction Fee Pilot To Include Non-Exchange Trading Centers

3. Trade-At Test Group

4. Alternative Pilot

5. Adjustments to the Transaction Fee Pilot Structure

V. Regulatory Flexibility Analysis

VI. Statutory Authority and Text of the Rule Amendments

I. Executive Summary of Rule 610T

Congress directed the Commission, through Section 11A of the Exchange Act, to facilitate the establishment of a national market system and use its broad authority to carry out the objectives of Section 11A, including, among others, to assure the economically efficient execution of securities transactions.
1

In furtherance of these goals, and as part of its oversight of registered national securities exchanges, the Commission periodically undertakes reviews of various aspects of market structure and current regulations to evaluate whether, in light of changes in technology and business practices, the current regulatory framework continues to fairly, effectively, and efficiently promote fair and orderly markets, serve the public interest and the protection of investors, and promote capital formation.

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

supra
Section II.G (discussing the Commission's authority to conduct the Pilot).

As discussed below, one aspect of the current regulatory framework focuses on the current pricing and fee structure for transactions in securities. As the Commission discussed in its Pilot proposal, the predominant transaction pricing structure that developed among equities exchanges to attract order flow is the “maker-taker” fee model.
2

Specifically, out of thirteen equities exchanges, seven utilize the “maker-taker” fee model, in which they pay a rebate to a provider of liquidity and charge a fee to a taker of liquidity. Among the remaining exchanges, four utilize a “taker-maker” pricing model (also called an inverted model) where they charge a fee to a provider of liquidity and pay a rebate to a taker of liquidity,
3

and two have a “flat fee” model.
4

In recent years this area has

attracted considerable attention and generated significant debate, focusing on the effects, both positive and negative, that exchange transaction-based pricing models may have on market quality and execution quality, with some commenters advocating action by the Commission.

2

See
Securities Exchange Act Release No. 82873 (March 14, 2018), 83 FR 13008 (March 26, 2018) (“Proposing Release” or “Proposal”).

3

See
Cboe BYX U.S. Equities Exchange Fee Schedule (as of December 2018),
available at

https://markets.cboe.com/us/equities/membership/fee_schedule/byx/;
Cboe EDGA U.S. Equities Exchange Fee Schedule (as of December 2018),
available at https://markets.cboe.com/us/equities/membership/fee_schedule/edga/;
Nasdaq BX Fee Schedule (as of December 2018),
available at

https://www.nasdaqtrader.com/Trader.aspx?id=bx_pricing;
NYSE National Schedule of Fees and Rebates (as of December 2018),
available at

https://www.nyse.com/publicdocs/nyse/regulation/nyse/NYSE_National_Schedule_of_Fees.pdf.
EDGA adopted a taker-maker fee schedule in July 2018.
See
Securities Exchange Act Release No. 83643 (July 16, 2018), 83 FR 34643 (July 20, 2018) (SR-CboeEDGA-2018-012).

4

See
Investors Exchange Fee Schedule (as of December 2018),
available at

https://iextrading.com/trading/fees/;
NYSE American Equities Trading Fees and Price List (as of December 2018),
available at

https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf.
NYSE American offers rebates to eDMMs in their assigned NYSE American-listed securities.

The Commission is uniquely situated and vested with the responsibility under Section 11A of the Exchange Act to examine the impact that this aspect of our market structure has on our national market system. And, in light of the questions raised about the impact of these fee models and the amount of attention garnered, we believe this is an area ripe for Commission review. But, the Commission currently lacks the data necessary to meaningfully analyze the impact that exchange transaction fee-and-rebate pricing models have on order routing behavior, market and execution quality, and our market structure generally. To address this information gap, the Commission has designed the Pilot to produce data that will facilitate a more thorough understanding of the potential issues associated with exchange transaction-based pricing models. In particular, the Commission has designed the Pilot to gather data on the effect both current regulatory fee caps and rebates have on market quality and execution quality. The data gathered will assist the Commission in determining whether any changes in the current regulatory framework are appropriate and enable the Commission to make more informed and effective policy decisions. This, in turn, enables the Commission to carry out the objectives of the national market system and oversee the national securities exchanges.

As discussed fully in the proposing release, the Commission proposed a pilot to test the effect of exchange transaction fees and rebates.
5

The following chart summarizes the terms of the Pilot as adopted, which are discussed in more detail below:

5

See
Proposing Release,
supra
note 2.

Transaction Fee Pilot for NMS Stocks

Duration
2 years with an automatic sunset at 1 year unless, no later than 30 days prior to that time, the Commission publishes a notice that the pilot shall continue for up to 1 additional year; plus a 6-month pre-Pilot Period and 6-month post-Pilot Period.

Applicable trading centers
Equities exchanges (including maker-taker & taker-maker) but not ATSs or other non-exchange trading centers.

Pilot securities
NMS stocks with average daily trading volumes ≥30,000 shares with a share price ≥$2 per share that do not close below $1 per share during the Pilot and that have an unlimited duration or a duration beyond the end of the post-Pilot Period.

Group
Number of NMS stocks
Fee cap
Rebates permitted?

Pilot design
Test Group 1
730

$0.0010 fee cap
for removing and providing displayed liquidity (no cap on rebates)

Yes.

Test Group 2
730 (plus appended Canadian interlisted stocks)
The 17 CFR 242.610(c) (Rule 610(c)) $0.0030 cap continues to apply to fees for removing displayed liquidity

No.
Rebates and Linked Pricing Prohibited
for removing and providing displayed and undisplayed liquidity (except for specified market maker activity).

Control Group
Pilot Securities not in Test Groups 1 or 2
The Rule 610(c) cap continues to apply to fees for removing displayed liquidity (no cap on rebates)
Yes.

Pilot data
1. Pilot Securities Exchange Lists and Pilot Securities Change Lists.

2. Exchange Transaction Fee Summary.

3. Order Routing Datasets.

II. Discussion of Rule 610T

In response to its proposal to conduct a Transaction Fee Pilot in NMS stocks (the “Pilot”), the Commission received a number of comment letters from a diverse group of commenters, including exchanges, investment managers, broker-dealers, and other market participants, as well as academics, listed issuers, analytics firms, market observers, and industry associations.
6

As discussed below, after review and consideration of the comments received, the Commission is adopting Rule 610T with certain modifications from that in the proposal.

6
The Proposal was developed, in part, by reference to a recommendation for an access fee pilot submitted to the Commission by the Equity Market Structure Advisory Committee (the “EMSAC”).
See
Proposing Release,
supra
note 2, at 13009, 13012-14.

A. Focus on Exchange Pricing Models and the Effects They Can Cause

1. Exchange Fee Models and Regulatory Framework

Regardless of the fee model, all fees of a registered national securities exchange “exchange”) are subject to the standards and process requirements set forth in the federal securities laws.
7

In particular, Section 6 of the Exchange Act requires, among other things, that the rules of an exchange provide for the “equitable allocation” of “reasonable” fees and that they not be “designed to permit unfair discrimination.”
8

Section 11A of the Exchange Act directs the Commission to use its authority to facilitate the establishment of a national market system for securities that assures economically efficient execution of securities transactions, fair competition, availability of information with respect

to quotations for and transactions in securities, and the practicability of brokers executing investors' orders in the best market.
9

In addition, Rule 610(c) of Regulation NMS imposes upon exchanges a fee cap of $0.0030 per share for the execution of an order against its “protected quotation.”
10

7
Under the Exchange Act, exchange fee changes are effective on the day that the exchange files them with the Commission, and neither advance notice nor Commission action is required before an exchange may implement a fee change.
See
15 U.S.C. 78s(b)(3)(A)(ii). The Commission may, within 60 days after an exchange filed its fee change with the Commission, summarily suspend the new fee and institute proceedings to determine whether to disapprove it.
See
15 U.S.C. 78s(b)(3)(C).

8

See
15 U.S.C. 78f(b)(4)-(5).

9

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

10
17 CFR 242.610(c); Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37543-46 (June 29, 2005) (“NMS Adopting Release”).
See also
17 CFR 242.600(b)(58) (defining “protected quotation”); 17 CFR 242.600(b)(57) (defining “protected bid or protected offer”); 17 CFR 242.600(b)(3) (defining “automated quotation”).

In 2005, when it adopted the fee limitation in Rule 610(c), the Commission noted, in part:

The adopted fee limitation set forth in Rule 610(c) of Regulation NMS is designed to preclude individual trading centers from raising their fees substantially in an attempt to take improper advantage of strengthened protection against trade-throughs and the adoption of a private linkage regime. In particular, the fee limitation is necessary to address `outlier' trading centers that otherwise might charge high fees to other market participants required to access their quotations by the Order Protection Rule. It also precludes a trading center from charging high fees selectively to competitors, practices that have occurred in the market for Nasdaq stocks. In the absence of a fee limitation, the adoption of the Order Protection Rule and private linkages could significantly boost the viability of the outlier business model. Outlier markets might well try to take advantage of intermarket price protection by acting essentially as a toll booth between price levels. The high fee market likely will be the last market to which orders would be routed, but prices could not move to the next level until someone routed an order to take out the displayed price at the outlier market.
11

11
NMS Adopting Release,
supra
note 10, at 37545.

In light of the considerable debate surrounding exchange fee models that pay rebates, which is well documented in the comment letters submitted on the proposed Pilot, and the passage of time since the Commission first adopted the Rule 610(c) fee cap as part of Regulation NMS in 2005, the Commission now seeks to gather data to facilitate an empirical assessment of the effect of exchange transaction fees and rebates broadly—including the impact and continued appropriateness of the Rule 610(c) fee cap
12

—by testing the effects of changes to exchange fees and rebates on the markets and market participant behavior.

12
At the time of its adoption in 2005, the fee cap codified the then-prevailing fee level set through competition among the various trading centers.
See
NMS Adopting Release,
supra
note 10, at 37545 (stating that “the $0.003 fee limitation is consistent with current business practices, as very few trading centers currently charge fees that exceed this amount”).

2. Impact of Exchange Fee Models

In response to the Proposing Release, the Commission received a number of comment letters criticizing existing fee-and-rebate pricing models, but also a number of comment letters expressing support for those same pricing regimes.
13

13
The potential distortions mentioned by the commenters (and discussed in this section) include, among others: (1) Conflicts of interest faced by routing broker-dealers; (2) excess intermediation and potential adverse selection; (3) market fragmentation; (4) exchange fee avoidance; (5) complexity; (6) transparency; and (7) elevated fees to subsidize rebates.

Many commenters focused on one potential distortion—whether current pricing models “present broker-dealers with a potential conflict of interest,” because their “duty to pursue best execution could be compromised when their trading venue decision is driven by the economic incentive to minimize access fees paid and maximize rebates received.”
14

As another commenter explained, “a broker is incentivized to route an order to the venue that pays it the most (or costs the least), instead of the venue that has the highest likelihood of offering the best execution for its customers, such as the one that offers a higher probability of execution or meaningful price improvement.”
15

As evidence of the potential harm that can result from the conflicts presented by exchange rebates, one commenter noted that institutional investors “that specifically instruct brokers to remove rebate-driven trading behaviors from their algorithms achieve significantly lower trading costs that result in higher returns to their investors.”
16

One commenter attributed this harm to the tendency of rebates to “affect the length of the order queue of passive limit orders on the major maker-taker exchanges, while high take fees on these markets make them less attractive for marketable orders that cross the spread.” The commenter argued that the “net result of this perverse pricing dynamic is a lower likelihood of execution and a higher likelihood of adverse selection for orders in the maker-taker queues,” because orders at the “middle or back of the queue . . . are less likely to trade at their desired price, and when they do trade, the overall market price as reflected by the [National Best Bid and Offer (“NBBO”)] is more likely to move against them, than when trading on venues that do not pay rebates.”
17

14
Capital Group Letter, at 2.
See also,

e.g.,
ICI Letter I, at 2; Vanguard Letter, at 2; Invesco Letter, at 2; CFA Letter, at 2; Oppenheimer Letter, at 2; Spatt Letter, at 4; AJO Letter, at 1; Larry Harris Letter, at 3.

15
Healthy Markets Letter I, at 5.
See also,

e.g.,
Copeland Letter, at 1; Wellington Letter, at 1; Norges Letter, at 2.

16
Babelfish Letter, at 1-3 (also referencing a Clearpool Group study that found that a “fee sensitive VWAP algorithm executed during volatile times incurred seven times as much cost as a fee agnostic algorithm”).
See also
T. Rowe Price Letter, at 2 (stating that “[r]etail orders . . . are generally placed on the exchange that offers the highest rebate to the broker, but show[s] lower execution quality in terms of reduced probability of execution”); Capital Group Letter, at 2 (“Our internal trade analysis suggests that execution quality may be negatively impacted when broker-dealers' routing decisions are made to minimize access fees.”).

17
IEX Letter I, at 6, A-1-A-2; IEX Letter II, at 7; IEX Letter IV (appending research to support these views).
See also, e.g.,
Babelfish Letter, at 2 (stating that a “frequently realized scenario is that flow sent solely to a high rebate destination waits in queue, often winds up canceled because price moves away, and then receives an inferior price upon the eventual execution”); Larry Harris Letter, at 1, 3; Brandes Letter, at 1-2.
But see
Grasso Letter, at 3 (“waiting for a rebate[ ] may be fine” if “you have low confidence about future prices for a large order and don't mind if the order trades slowly while you accumulate shares”).

A number of commenters discussed other potential effects of exchange pricing models. Some commenters believed that transaction fees and rebates contribute to market fragmentation
18

because they encourage investors to “turn to inverted markets to improve queue priority”
19

or to “route orders to non-exchange trading centers to avoid the higher access fees that exchanges charge to subsidize the rebates they offer.”
20

Likewise, one commenter thought that “transaction fees and rebates contribute to market complexity through the proliferation of new order types . . . designed to exploit different transaction pricing models.”
21

Other commenters believed that “[t]ransaction fees and rebates . . . undermine market transparency because the prices displayed by exchanges—and provided on trade reports—do not include fee or rebate information and therefore do not fully reflect net trade prices.”
22

Finally, some commenters

asserted that current pricing models unfairly subsidize rebates
23

or benefit sophisticated market participants like market-makers and proprietary traders at the expense of other market participants.
24

18

See, e.g.,
ICI Letter I, at 2.

19
Credit Suisse Commentary, at 2.
See also, e.g.,
Larry Harris Letter, at 3 (noting that “orders standing at inverted exchanges usually execute before orders standing at the same price at maker-taker exchanges”).

20
Capital Group Letter, at 2.
See also, e.g.,
IEX Letter I, at 3 (“Excessive take fees . . . have been criticized as leading to the migration of some order flow to less-regulated non-exchange venues in search of reduced transaction costs, resulting in increased market fragmentation and market complexity.”).

21
ICI Letter I, at 2.
See also, e.g.,
Vanguard Letter, at 2 (indicating that the “desire to maximize rebate revenue and avoid fees created order complexity within the equity markets as traders sought profitable trading strategies”).

22
ICI Letter I, at 2.
See also, e.g.,
Goldman Sachs Letter, at 3; Invesco Letter, at 2; State Street Letter,

at 2; Wellington Letter, at 1; Oppenheimer Letter, at 2; Capital Group Letter, at 3.

23

See, e.g.,
Clearpool Letter, at 3 (stating that “exchanges chase order flow and provide rebates and other pricing incentives to the largest trading firms at the expense of smaller market participants who cannot take advantage of such rebates and, in effect, end up subsidizing the trading of larger firms”); IEX Letter I, at 3 (stating that transaction fees are “used in effect to subsidize the payment of rebates,” which “results in a substantial penalty on investors and other participants who . . . have a need for immediate liquidity”).

24

See, e.g.,
T. Rowe Price Letter, at 2 (stating that rebates lead to “excessive intermediation . . . benefiting short-term intermediaries at the expense of long-term investors”); ModernIR Letter, at 3 (stating that rebates “promote[ ] arbitrage, and price-setting as its own end,” leading to a “paucity of real orders”); Larry Harris Letter, at 1, 5-6 (stating that current pricing models facilitate “the execution of various parasitic trading strategies by proprietary traders to the detriment of public investors”); Capital Group Letter, at 3.

Other commenters expressed support for current exchange pricing models. For example, one commenter believed that maker-taker pricing “provides important benefits to issuers and investors,” because exchanges “use rebates as a tool to promote displayed liquidity and price discovery, which results in competitive bid-ask spreads, saving transaction costs that investors may otherwise incur.”
25

Another commenter argued that rebates can promote displayed liquidity by providing “a payment in exchange for posters of liquidity giving up several valuable options,” including “the power to decide the time of the trade” and the ability to conceal trading intentions until the point of execution.
26

Building on this idea, one commenter characterized “[a]ccess fee caps and related rebates” as features that “enable exchanges to compete with non-exchange trading venues by essentially subsidizing the posted prices . . . and narrow[ing] the NBBO, making it slightly more expensive to either match or improve upon those prices off-exchange.”
27

25
State Street Letter, at 2.
See also, e.g.,
Virtu Letter, at 3; Fidelity Letter, at 3; Nasdaq Letter I, at 9; Cboe Letter I, at 15-16.
See also
Nasdaq Letter III, at Exhibit A (providing graphs using data from September 2018 on average quoted spread across exchanges in S&P 500 stocks and time at the best quote across those stocks).
But cf.
Larry Harris Letter, at 6-9 (acknowledging that “quoted spreads are narrower under maker-taker pricing,” but opining that “the narrower quoted spreads do not benefit the public”).

26
Magma Letter, at 3.
See also, e.g.,
NYSE Letter IV, at 2 (arguing that “pricing incentives enhance the quality and reliability of display markets”); FIA Letter, at 4.

27
FIA Letter, at 3-4.
See also
NYSE Letter I, at 6 (stating that rebates “allow liquidity providers to quote narrower spreads by providing another source of revenue”); Grasso Letter, at 4 (“the main outcome of exchange pricing seems to be that it forces exchanges to compete for customers,” because it “keeps their margins tight and gives them incentives to improve the quality of their offerings”).

As commenters fundamentally disagreed about the effect of exchange transaction fee models and whether they have a positive or a negative impact on the U.S. equities markets, commenters also held conflicting views regarding whether and how the Commission should conduct the Pilot.

3. Focus on Exchange Fee Models

Recognizing the unique regulatory framework applicable to exchange fees, and the disagreement over the impact of exchange fees and rebates on the markets and market participants, the Commission focused its proposed Pilot on studying the effect of exchange transaction fees and rebates on order routing behavior, execution quality, and market quality. Accordingly, the Commission proposed to include within the Pilot all equities exchanges regardless of fee model.

A large number of commenters supported applying the Pilot to all equities exchanges.
28

For example, one commenter believed that the Pilot “should include all equities exchanges . . . because rebates of any kind provide inducements to trade and distort markets.”
29

A different commenter thought that including taker-maker exchanges was “both logical and feasible, given that all equities exchanges assess fees that are subject to the Exchange Act and its rule filing requirements.”
30

Other commenters “agree[d] with the Commission's assessment that the Pilot should apply to all equity exchanges . . . thus treating all similarly situated exchanges equally,” because this would be “critically important in determining what impact the reduction of access fees or the elimination of rebates will have on order routing practices.”
31

Some other commenters, however, opposed including taker-maker exchanges in the Pilot, noting that Rule 610(c) does not apply to taker-maker exchanges.
32

28

See, e.g.,
Joint Asset Managers Letter, at 2; Brandes Letter, at 2; Themis Trading Letter I, at 3; AJO Letter, at 1-2; OMERS Letter, at 2; Copeland Letter, at 2; Virtu Letter, at 6; Nuveen Letter, at 2; BlackRock Letter, at 1; RBC Letter I, at 3; Vanguard Letter, at 2; CFA Letter, at 4; Wellington Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2; Clearpool Letter, at 5 n.8; TD Ameritrade Letter, at 4; Capital Group Letter, at 3; Healthy Markets Letter I, at 10; Morgan Stanley Letter, at 3 n.5; AGF Letter, at 1.

29
AJO Letter, at 1-2.

30

See
RBC Letter I, at 3-4.

31
Capital Group Letter, at 3.
See also, e.g.,
Clearpool Letter, at 5 n.8; Oppenheimer Letter, at 2; Brandes Letter, at 2; Copeland Letter, at 2.

32

See, e.g.,
Cboe Letter I, at 28.

After considering the comments on this issue, the Commission continues to believe that focusing the Pilot on equities exchanges regardless of fee model is appropriate because it treats alike similarly situated entities that all are subject to the same regulatory framework and thereby will allow the Commission to evaluate the effect of exchange fee-and-rebate pricing models and the continued appropriateness of the Rule 610(c) fee cap. Further, it would be incongruous to study rebates and fees offered by one type of equities exchange (maker-taker), but not another type of equities exchange (taker-maker) where the fees of both types of entities are subject to the same legal requirements and can introduce the same types of distortions that the Pilot seeks to study.

4. Non-Exchange Trading Centers

As proposed, the Pilot would exclude non-exchange trading centers such as alternative trading systems (“ATSs”).
33

Several commenters opined on this aspect of the proposal. A number of commenters agreed with the Commission's proposal to exclude non-exchange trading centers from the Pilot.
34

Some of those commenters noted that exchanges are subject to various fee-related regulatory provisions that are entirely inapplicable to non-exchange trading centers. For example, one commenter noted that non-exchange trading centers are not currently subject to any access fee caps, and including such trading venues in the Pilot “would have the unintended and harmful effect of unnecessarily changing ATS business models . . . .”
35

33

See
Proposing Release,
supra
note 2, at 13014. As discussed in the Proposing Release, the term “trading center” as used there and throughout this release is a collective term that refers broadly to the venues that trade NMS stocks.
See id.
at 13009 n.7. For purposes of this release, the term “trading center” includes national securities exchanges that are registered with the Commission and that trade NMS stocks (referred to herein as “equities exchanges” or “exchanges”), as well as other types of “non-exchange venues” that trade NMS stocks, including ATSs and broker dealers that internalize orders by matching them off-exchange with reference to the national best bid and offer.

34

See, e.g.,
Brandes Letter, at 2; AJO Letter, at 2; MFA Letter, at 2; BIDS Letter, at 1-2; BlackRock Letter, at 1; SIFMA Letter, at 5; Virtu Letter, at 6; Fidelity Letter, at 10; Citi Letter, at 2; Clearpool Letter, at 4-5; Luminex Letter, at 1; Morgan Stanley Letter, at 3 n.5.

35
Virtu Letter, at 6.
See also, e.g.,
SIFMA Letter, at 5; Clearpool Letter, at 5.

In addition, several commenters emphasized the fundamental ways in which the fee structures employed by

non-exchange trading centers are different from the fee models utilized by the equities exchanges and, as a result, concluded that excluding non-exchange trading centers was appropriate.
36

For example, one such commenter explained that “inducements (low fees, no fees, rebates) offered by ATSs and other off-exchange venues are not universal across all broker-dealers or market participants. Instead, the fees paid (or not paid) by market participants to ATSs and other off-exchange venues are negotiated between each market participant and the trading venue,” such that “the number of fee permutations and inconsistencies across brokers for any single ATS could be substantial.”
37

Still other commenters believed that excluding non-exchange trading centers from the Pilot was appropriate because “ATSs are not protected venues, and thus free market competition among them constrains their pricing power.”
38

One commenter supported excluding ATSs because “there is nothing to be gained by including venues that don't have the same underlying issues that exchanges present with their rebate and `maker-taker' pricing models.”
39

36

See, e.g.,
Morgan Stanley Letter, at 3 n.5 (stating that “many broker-dealer[ ] operators of ATSs generally charge clients an overall commission rate (rather than an access fee) for a bundle of services, including access to their ATSs”); BIDS Letter, at 1-2, AJO Letter, at 2; Healthy Markets Letter I, at 10.

37
AJO Letter, at 2.

38
Citi Letter, at 2.
See also, e.g.,
Fidelity Letter, at 10 (stating that “ATS' fee structures are already subject to competitive market forces and have more complex pricing models than exchanges[,] making their participation in the Proposed Pilot less useful”); SIFMA Letter, at 5 (opining that “competitive forces already push access fees [at ATSs] to an appropriate level . . . lower than the access fees charged by exchanges,” because ATS access fees “are included in the total cost consideration of trading”).

39
Luminex Letter, at 1.

On the other hand, other commenters expressed concerns with omitting non-exchange venues from the Pilot.
40

One concern was that by excluding non-exchange venues, the Pilot data would be incomplete. For example, one commenter believed that excluding non-exchange venues “could create an imperfect picture of the overall impact of the transaction fees put in place under the Pilot program” and could compromise the value and utility of the data collected during the Pilot.
41

Another commenter argued that by excluding non-exchange venues, the Pilot will not return “meaningful data upon which to make informed analysis and conclusions” because it would “ignore off-exchange trading representing approximately 39 percent of total U.S. equities market trading.”
42

This commenter further believed that the Pilot would be unable to properly assess the potential conflicts of interest because it will not know “the baseline for remuneration occurring off-exchange, or know what impact the Proposal has on that baseline[.]”
43

One commenter objected to excluding ATSs “based on the fact that the proposed Pilot is a `new regulatory regime' for ATSs . . . .”
44

While one commenter recognized the complexity involved with subjecting non-exchange trading centers to the access fee cap under Rule 610(c), it argued that such complexity did not provide a sufficient basis to treat exchanges and non-exchange trading centers disparately.
45

A few commenters recommended excluding ATSs, but requiring them to submit the required order routing data.
46

40

See, e.g.,
Nasdaq Letter I, at 2, 5-7; Cboe Letter I, at 12-13; MFS Letter, at 2; RBC Letter I, at 4; ASA Letter, at 3; ViableMkts Letter, at 2; Angel Letter II, at 2.

41

See
Wellington Letter, at 2 (acknowledging, however, that it is “impractical for the Commission to include off-exchange venues”).
See also, e.g.,
RBC Letter I, at 4; ProAssurance Letter, at 2.

42
Nasdaq Letter I, at 2, 5-7.
See also, e.g.,
NYSE Letter I, at 2.

43

See
Nasdaq Letter I, at 7.

44

See, e.g.,
Cboe Letter I, at 13.

45

See
NYSE Letter I, at 7-8.

46

See, e.g.,
Better Markets Letter, at 8.

The Commission believes that excluding non-exchange venues from the Pilot should not negatively impact the Pilot's data or impact its results. As noted above, the Pilot is designed, among other things, to assess the effects of exchange fee models. Because exchange fee models are materially different both in their structure and regulatory treatment, the potential effects that may be associated with exchange fee models are not applicable in the same manner to ATSs. Similarly, the question of whether rebates narrow the quoted spread is inapplicable to ATSs, which do not publicly display an automated quotation. Further, ATS activity is not being overlooked as increases or decreases in ATS volume during the Pilot will be reflected in other existing data sources. Accordingly, Commission researchers (hereinafter “researchers”) will be able to assess market-wide changes in order flow during the Pilot.

Further, even if non-exchange venues provided order routing data pursuant to the Pilot, researchers would be unable to meaningfully correlate changes in an ATS's order flow with the fees of that ATS because those fees are bespoke, typically bundled, and are not as transparent as exchange fees.
47

Exchange fees are not only fully transparent in published fee schedules, but exchange fee changes must be filed with the Commission and thus they have a precise effective date attached to each filing. This level of transparency for exchange fees and rebates, which is not present for ATSs,
48

is an important component facilitating researchers' ability to draw causal connections with the Pilot's results. While obtaining order routing data from ATSs might provide interesting insight into their business, it could not be meaningfully correlated with ATS fees and fee changes and is not necessary to study the Pilot's results. Rather, existing sources of data on ATS activity, including data published by the Financial Industry Regulatory Authority (“FINRA”), will permit researchers to observe changes in ATS activity during the Pilot.

47
As noted by several commenters, equities exchanges and non-exchange trading centers currently employ different fee models. While equities exchanges charge transaction-based fees, non-exchange trading centers may not charge separate transaction-based fees, but instead may use bundled pricing such that a particular order is not necessarily associated with a particular fee.
See, e.g.,
Morgan Stanley Letter, at 3 n.5 (stating that “many broker-dealer[ ] operators of ATSs generally charge clients an overall commission rate (rather than an access fee) for a bundle of services, including access to their ATSs”); BIDS Letter, at 1-2, AJO Letter, at 2.
See also
Proposing Release,
supra
note 2, at 13016. The Commission is not aware of any ATSs that currently pay transaction-based rebates.

48

See supra
notes 310-312 and accompanying text (discussing recent amendments to Regulation ATS and their relevance to the proposed Pilot).

Among commenters critical of excluding non-exchange venues, some believed it could raise competitive issues to apply the Pilot's pricing limitations to the equities exchanges, but not impose the same pricing limitations on non-exchange trading centers that trade the same equities securities.
49

One exchange commenter found it “inexplicabl[e]” that the Pilot “focuses only on exchanges and entirely ignores off-exchange venues, which are the venues that are most likely to benefit from a pilot that pointedly decreases the incentive (
i.e.,
rebates) to post protected quotes on-exchange.”
50

49

See, e.g.,
ASA Letter, at 3; Cboe Letter I, at 12, 26-27; Nasdaq Letter I, at 5-7; NYSE Letter I, at 3-8.

50

See
Cboe Letter I, at 12.
See also
Nasdaq Letter I, at 6; NYSE Letter I, at 3-5; NYSE Letter II, at 12.

Several commenters suggested that the exclusion of non-exchange trading centers from the Pilot could “create incentives for market participants to move more order flow to off-exchange platforms,” thereby putting the national securities exchanges at a competitive disadvantage as compared to off-exchange trading centers.
51

However, a

commenter suggested the opposite could happen and that the Pilot might actually “encourage more order flow to gravitate to the exchanges” because the Pilot would reduce the access fee cap on the equities exchanges thereby making it less expensive to transact on an exchange.
52

51

See, e.g.,
Wellington Letter, at 2; Oppenheimer Letter, at 3; Angel Letter II, at 2; Nasdaq Letter I, at 6-7; Cboe Letter I, at 12; NYSE Letter I, at 3-5; Curtiss-Wright Letter, at 1; ASA Letter, at 3.

52

See, e.g.,
Citi Letter, at 2; Decimus Letter, at 5-6.

The Commission does not believe that the Pilot necessarily will put the equities exchanges at a competitive disadvantage or disproportionally harm them when competing with non-exchange trading centers for investors' orders. Currently, only exchanges are subject to the Rule 610(c) fee cap, and Test Group 1 is designed to test a lower cap. The Commission does not believe that exchanges charging lower fees will necessarily make them less competitive with other venues for natural order flow, for example order flow that removes liquidity. Rather, it is possible that lower fees in Test Group 1 across all exchanges may actually improve their competitive position in attracting that order flow,
53

particularly with respect to fee sensitive routing algorithms because, all else being equal, fee sensitive algorithms generally seek to minimize trading costs and would likely rank exchanges more favorably in their routing tables when exchanges reduce their fees to remove liquidity.

53

See, e.g.,
Citi Letter, at 2; Decimus Letter, at 5-6.
See
also,
infra
Section IV.D “Impact on Efficiency, Competition and Capital Formation” and note 782
infra
and accompanying text.

In addition to testing a lower fee cap level, the Pilot also will test a prohibition on rebates and “Linked Pricing,” which, as discussed further below, is defined as a discount or incentive on transaction fee pricing applicable to removing (or providing) liquidity that is linked to providing (or removing) liquidity.
54

The intent of this is to gather data to assess, among other things, the effect of exchange rebates. Potential distortions, which may be caused or exacerbated by exchange rebates, may themselves be placing exchanges at a competitive disadvantage, in which case the elimination of rebates could improve the competitive position of exchanges, for example if taker fees are set at levels independent of the need to subsidize maker rebates. Once again, data is needed to empirically assess this issue, and the Commission believes that the Pilot is the best way to obtain that data.
55

54

See
Rule 610T(a)(2).

55

See infra
Section IV.A.2. and C.1.a.i.

Further, while exchanges may compete with non-exchange trading centers for order flow, exchange fees and the fees of non-exchange trading centers are treated very differently under the federal securities laws. Indeed, one of the distinguishing features of registered national securities exchanges is that—unlike non-exchange trading centers—their fees are subject to the principles-based standards set forth in the Exchange Act, as well as the rule filing requirements thereunder. In particular, the federal securities laws require the entirety of each and every fee, due, and charge assessed by an exchange to be transparent and publicly posted for all to see, and must be an equitable allocation of reasonable dues, fees and other charges and not be unfairly discriminatory.
56

On the other hand, similar requirements do not apply to the fees of non-exchange trading centers that do not provide public transparency into their full itemized fee schedules and typically are individually negotiated on a customer-by-customer basis.
57

By including all equities exchanges regardless of fee model, and excluding other types of trading centers, the Pilot is designed to include all trading centers whose fees are subject to the principles-based standards set forth in the Exchange Act as well as the rule filing requirements thereunder.
58

Thus, the Pilot will produce data to empirically evaluate the effects that transaction-based fees and rebates may have on, and the effects that changes to those fees and rebates may have on, order routing behavior, execution quality, and market quality more generally.

56

See
15 U.S.C. 78f(b)(4)-(5).

57
All exchange fee changes are published for public comment and required to be publicly posted on the internet, whereas fees of non-exchange trading centers are typically bespoke. Fee changes of non-exchange trading centers are not subject to the provisions of the federal securities laws requiring that fees be an “equitable allocation” of “reasonable” fees and not “unfairly discriminatory.”

58

See
15 U.S.C. 78f(b)(4)-(5) (requiring, among other things, that an exchange's fees be an “equitable allocation” of “reasonable” fees and that they not be “designed to permit unfair discrimination.”). In addition, only exchange fees are subject to the rule filing requirements under Section 19(b) of the Exchange Act and 17 CFR 240.19b-4 (Rule 19b-4) thereunder.
See also
Proposing Release,
supra
note 2, at 13016.

The Commission believes that subjecting non-exchange trading centers to the Pilot would go beyond the scope of the current regulatory framework that applies only to exchanges and would not further the Commission's evaluation of the impact of the existing regulatory regime, including, but not limited to, the Regulation NMS fee cap, which applies exclusively to exchange fees and rebates. In effect, the Pilot will help the Commission carry out its statutory responsibility to assess the effect of exchange fees and rebates, which do not apply to non-exchange trading centers.
59

59
While exchange fees are filed with the Commission on Form 19b-4 and the Commission publishes notice of them for public comment and has an opportunity to summarily suspend them within 60 days, the Commission's non-action on a fee filing within that period does not constitute an endorsement or approval of an exchange fee. Issues with fees and how they impact market participants and market structure may or may not be obvious at first and adverse effects may take time to manifest as the market adjusts to a new fee. The Commission, and the exchanges as self-regulatory organizations, must enforce their rules and the federal securities laws with the goal of protecting investors and the public interest.

5. Options Exchanges

Finally, the Commission proposed to exclude options exchanges from the Pilot, because options and equities are materially different types of securities. In addition, the access fee cap under Rule 610(c) does not currently apply to the options exchanges.
60

60

See
Proposing Release,
supra
note 2, at 13015.

Several commenters agreed with the Commission's exclusion of the options exchanges.
61

No commenters suggested that the Commission include options markets in the Pilot. For the reasons noted above and discussed in the Proposing Release, the Commission is not including options markets within the scope of the Pilot.
62

61

See, e.g.,
MFA Letter, at 2; SIFMA Letter, at 5; Fidelity Letter, at 10.

62

See
Proposing Release,
supra
note 2, at 13015.

B. Securities

As proposed, all NMS stocks
63

that meet specified initial and continuing minimum standards would be eligible for inclusion in the Pilot (collectively, “Pilot Securities”).
64

The Commission received a number of comments regarding the scope of Pilot Securities to be included in the Pilot.

63

See
17 CFR 242.600(b)(47) (defining “NMS stock”).

64

See
Proposing Release,
supra
note 2, at 13017.
See also
Proposed Rule 610T(b)(1)(ii).

1. The Share Price Threshold of Pilot Securities

The Commission proposed that an NMS stock must have a minimum initial share price of $2 at the time the pre-Pilot Period commences to be included in the Pilot and that any Pilot Securities that close below $1 at the end of a trading day during the proposed Pilot would be removed from the Pilot.
65

65

See
Proposing Release,
supra
note 2, at 13017; Proposed Rule 610T(b)(1)(ii). The Commission notes that the proposed language in Rule 610T(b)(1)(ii) has been modified slightly. As proposed, Rule 610T(b)(1)(ii) contained the phrase

“minimum initial share price of at least $2 . . . .” As adopted, the clause “minimum initial share price of $2” is being substituted for the phrase “minimum initial share price of at least $2” to delete redundant text. In addition, as proposed, Rule 610T(b)(1)(ii) explained that a Pilot Security that closes below $1 would be “removed from the Test Group or the Control Group and will no longer be subject to the pricing restrictions set forth in (a)(1)-(3). . . .” As adopted, this language is being modified slightly to make it more concise. Accordingly, as adopted, this language provides that if the share price of a Pilot Security closes below $1 at the end of a trading day “it will be removed from the Pilot.”

One commenter opposed the $2 initial minimum share price threshold as overly restrictive.
66

Other commenters, however, agreed that the securities in the Pilot should have an initial minimum $2 per share price threshold at the time of the initial stock selection, because this threshold “will capture virtually all NMS stocks while minimizing the risk that securities will drop out of the Pilot . . . .”
67

One of these commenters believed the proposed thresholds would “help ensure consistency among the Test Groups and limit the risk of data anomalies due to changes in the composition of those groups.”
68

Another commenter noted that the choice of “$2 and $1 thresholds . . . follows the reasonable parameters established during [the] . . . Tick Size Pilot” and asserted that the “determination to pull out securities that close at under $1 during the pilot seems appropriate, especially given the fundamentally different fee structures applicable to stocks with prices less than $1.00.”
69

66

See
Angel Letter I, at 2.

67
RBC Letter I, at 5.
See also,

e.g.,
Better Markets Letter, at 6; Healthy Markets Letter I, at 11-12.

68
RBC Letter I, at 5.

69
Healthy Markets Letter I, at 12.

The Commission continues to believe that the proposed share price thresholds for Pilot Securities are appropriate. The Commission notes that no commenters opposed the proposed $1 minimum continuing price threshold, which will exclude such stocks from the Pilot because stocks with quotations of less than $1 are subject to different regulatory and fee treatment.
70

The Commission continues to believe that an initial $2 share price threshold will best balance the need to include a broad set of NMS stocks in the Pilot with the desire to ensure that substantially all of the securities selected at the outset of the Pilot remain part of their respective Test Groups throughout the duration of the Pilot, including during the pre- and post-Pilot periods. The Commission does not believe that the $2 threshold is overly restrictive because, as discussed in the Proposal, it is uncommon for securities priced at $2 or more to fall below $1.
71

Lowering the initial stock selection threshold below $2 could increase the likelihood that securities selected for the Pilot get dropped from the Pilot if their share price closed below $1 during the Pilot. Such a result would change the composition of the Test Groups during the Pilot, which might adversely impact the quality of the data produced by the Pilot. For these reasons and the reasons discussed in the Proposing Release, the Commission adopts as proposed the share price thresholds set forth in Rule 610T(b)(1)(ii).

70

See
Proposing Release,
supra
note 2, at 13017.

71

See id.
at 13017 n.102 (noting that only 4.3% of publicly traded common stocks and ETPs with a share price above $2 during 2012-2016 dropped below $1 in that period).

2. The Duration of Pilot Securities

The Commission proposed that, in order to be included in the Pilot, an NMS stock must have an unlimited duration or a duration beyond the end of the post-Pilot period in order to be included in the Pilot.
72

No comments were received regarding this condition. For the reasons outlined in the Proposing Release, the Commission adopts this aspect of the Pilot as proposed.
73

72

See
Proposing Release,
supra
note 2, at 13017; Proposed Rule 610T(b)(1)(ii).

73

See
Proposing Release,
supra
note 2, at 13018 n.103.

3. Selecting Pilot Securities From All NMS Stocks

The Commission proposed to select Pilot Securities from among the entire universe of NMS stocks, subject to the minimum share price threshold and duration requirements. As proposed, the Pilot would include a broad and diverse cross-section of securities, including, for example, stocks of all market capitalizations as well as ETPs.

The Commission received comments on the universe of Pilot Securities that generally fell into four categories: (1) The inclusion of stocks with market capitalizations below $3 billion, (2) the inclusion of ETPs, (3) the inclusion of Canadian interlisted stocks, and (4) the inclusion of NMS stocks other than stocks of operating companies and ETPs. Each of these points is discussed below.

a. Market Capitalization and Liquidity

The Commission proposed to select Pilot Securities from among NMS stocks of all market capitalizations.
74

A few commenters recommended that the Pilot exclude securities with smaller market capitalizations and/or thinly-traded securities. One commenter suggested that the “majority of securities within the Test Groups should be more liquid” and that thinly-traded securities, if included, “should be a minority of all securities in the Test Groups.”
75

Similarly, one exchange commenter stated that the Pilot “should exclude less active stocks as the liquidity in such stocks will likely be severely and negatively impacted by this Pilot.”
76

This commenter asserted that “[l]ess active stocks are highly dependent on professional liquidity providers to post liquidity” and speculated that “[d]ecreasing incentives for liquidity providers to post liquidity in less active stocks will have a pronounced impact on liquidity . . . manifest[ing] in significantly wider spreads and significantly less depth in these securities.”
77

Noting that “many industry participants appear to advocate for increased incentives for liquidity provision in thinly-traded stocks,” the commenter did not believe that the Pilot's goals were “worth the risk to liquidity and capital formation that the Commission itself identifie[d.]”
78

74

See id.
at 13018. The EMSAC's recommendation was to limit a pilot to stocks above $3 billion in market capitalization in order to avoid overlap with the Tick Size Pilot.
See id.
The Commission notes, however, that the Tick Size Pilot ended on September 28, 2018 and the Pilot Period for the Transaction Fee Pilot will not start before the post-pilot period for the Tick Size Pilot ends on April 2, 2019.
See
Section II.C.3.
infra.

75
RBC Letter I, at 6.
See also, e.g.,
Harris Letter, at 1; T. Rowe Price Letter, at 4.

76
Cboe Letter I, at 28.

77

Id. See also, e.g.,
Morgan Stanley Letter, at 4; Leaf Letter, at 1.

78
Cboe Letter I, at 19.
See also, e.g.,
Proposing Release,
supra
note 2, at 13069.

Another commenter was similarly concerned that the Pilot would “have a significant impact on small to medium issuers since exchanges will not be able to provide incentives to market makers to support trading in those companies' securities.”
79

This commenter stated that “[l]iquidity rebates can be critical for such securities to motivate market makers to support the stock with aggressive and actionable quotations.”
80

Further, the commenter opined that the Pilot would “risk damaging companies' ability to efficiently raise capital,” which it believed would “particularly harm small and medium sized companies, for which the current market structure is already not

optimized.”
81

The commenter further argued that “incentives (rebates) are important to creating two-sided markets across all stocks, especially thinly traded stocks.”
82

79
Nasdaq Letter I, at 8-9.

80

Id.
at 3, 9 (alleging that the Pilot was “arbitrary and capricious and not in accordance with law,” because it gave “short shrift” to these concerns).
See also
Virtu Letter, at 7 (expressing concern that the Pilot would “harm investors in . . . less liquid ETPs, which will be faced with less liquidity and wider spreads when they seek to sell their holdings”).

81
Nasdaq Letter I, at 2.
See also
ASA Letter, at 5.

82
Nasdaq Letter III, at 1. The commenter provided a chart showing how the exchanges compare to each other with respect to maintaining a two-sided quote at least 50% of the day. In the chart, some of the exchanges with a higher percent of two-sided markets more than 50% of the day have taker-maker pricing, in which they incentivize the removal of liquidity and charge fees to the provider of liquidity.
Id.
at Exhibit A.
But cf.
NYSE Letter II, at 9-10 (arguing that rebates are necessary to promote display of liquidity).

Many other commenters supported including a broad scope of Pilot Securities. For example, a group of twenty-one asset managers submitting a joint letter stated that “[a]s many NMS stocks as possible should be in scope, including those with market capitalizations below $3bln,” in order to create a “meaningful” dataset.
83

Another commenter agreed that the Pilot “should encompass the broadest universe of securities, as is feasible, in order to maximize the sample size and provide the most robust dataset possible,” further arguing that “[o]mitting securities of a specific market cap seems arbitrary, would provide an incomplete view of the overall market, and runs the risk of excluding meaningful data and biasing the study.”
84

83
Joint Asset Managers Letter, at 2.
See also, e.g.,
Spatt Letter, at 1-2 (stating that the Pilot was a “very significant improvement over the EMSAC proposal” and that one of the “major improvements” was “the inclusion of lower market value stocks”); Healthy Markets Letter I, at 11-12; Wellington Letter, at 2; MFA Letter, at 2; Nuveen Letter, at 2; Lipson Letter, at 1; BlackRock Letter, at 1; Vanguard Letter, at 2; CFA Letter, at 4; CIEBA Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2.

84
AJO Letter, at 2.

Building on these arguments, other commenters believed it was important to specifically “test the argument that rebates are required to promote liquidity provision in illiquid stocks.”
85

One commenter noted that this debate “has raged for years,” which is “the point of the pilot: To provide market participants and the Commission with the data needed to make those analyses.”
86

Another commenter similarly asserted that the Pilot should include a broad set of NMS stocks to “help settle academic debates on the relative impact of rebates on liquid vs. less-liquid stocks and other supposedly beneficial aspects of rebates.”
87

85
Babelfish Letter, at 3.

86
Healthy Markets Letter I, at 13.

87
Better Markets Letter, at 6.
See also, e.g.,
Vanguard Letter, at 2 (“By including all NMS stocks, the SEC will receive data to analyze the impacts of transaction fees on market quality across various types of securities.”); TD Ameritrade Letter, at 6-7 n.11 (“including securities of small, mid and large cap companies . . . will include some data on the impact that varying transaction fees will have [on] thinly traded securities”).

Notably, some of these commenters directly challenged the argument, set forth by a number of other commenters, that thinly-traded or smaller-capitalization NMS stocks would be harmed by the Pilot's pricing restrictions. One commenter explained that, “for less liquid stocks, spreads tend to be wider, and as a result rebates become less relevant as a matter of simple mathematics.”
88

To illustrate the point, the commenter referred to a “stock that typically trades at a five-cent quoted spread,” noting that a “typical .0025 per share rebate would equal
one-twentieth
of the quoted spread, so in these instances a market maker's revenue from capturing the spread would far outweigh the contribution of the rebate”
89

(emphasis in original). Another commenter also questioned the “significance of liquidity rebates for making markets in less liquid/smaller-cap stocks,” because it believed this “marginal incentive to provide liquidity . . . is likely to be weak in the smaller-cap space typically characterized by wide bid-ask spreads . . . .”
90

To support this argument, the commenter referred to “an empirical study of changes in maker-taker arrangements on two European trading venues owned by BATS,” now owned by Cboe Global Markets, which suggested that “ `an elimination of the make fee and a reduced take fee cap would result in worse market quality for large capitalization stocks but
better market quality for small capitalization stocks' ”
(emphasis in original).
91

For this reason, the commenter asserted that the “link articulated by the opponents of the proposed pilot is at best uncertain and that the pilot
may
in fact result in improved liquidity for smaller-cap stocks” (emphasis in original).
92

The commenter therefore contended that it was “imperative to include a set of smaller-cap stocks in the pilot, as the opponents' claims on the existence of unambiguous harm to liquidity appear to be exaggerated and driven by preconceived notions.”
93

88
IEX Letter II, at 7.
See also
Credit Suisse Commentary, at 1, 3 (stating that the Pilot “is likely to affect stocks differently depending on their liquidity profile,” but expecting stocks “with wider spreads” in Test Groups 2 and 3 “to continue to behave similarly given that their liquidity may be less driven by rebate-incentivized trading strategies to begin with”).
But cf.
NYSE Letter II, at 11 (asserting that it was “untrue” that “spreads for less-liquid securities are not sensitive to rebate levels” and referring to chart showing that NYSE American-listed securities, “which are generally less-liquid securities” spent less average time at the NBBO compared to maker-taker venues).

89
IEX Letter II, at 7.

90
Decimus Letter, at 4-5 (citing Marios Panayides et al.,
Trading Fees and Intermarket Competition
26 (Charles A. Dice Ctr. for Research in Fin. Econ., Ohio State Univ., Working Paper No. 2017-3, 2017, available at,
https://ssrn.com/abstract=2910438
).

91

Id.
at 5.

92

Id.

93

Id.

The Commission believes that the many commenters have, through their analysis and ultimate disagreement on this issue, emphasized the need for the Pilot to test the effect of transaction fees and rebates on NMS stocks of all market capitalizations. It is unclear whether or not changes to fees and rebates would harm smaller capitalization or thinly-traded NMS stocks.
94

As some commenters have noted, it also is possible that the Pilot may have little effect on smaller-capitalization or thinly-traded NMS stocks or that the Pilot may even improve the liquidity of such stocks.
95

The Commission also notes that a pilot focused solely on large capitalization stocks may not produce sufficient data to investigate how changes to transaction fees and rebates will affect liquidity or capital formation across the market. Because including smaller-capitalization NMS stocks in the Pilot will produce a more meaningful dataset to support a broad investigation into the effect of transaction fees and rebates on the full spectrum of NMS stocks and among different segments of the securities market, the Commission adopts this aspect of the rule as proposed.

94

See, e.g.,
Proposing Release,
supra
note 2, at 13065-66, and 13069.

95

See, e.g.,
notes 88-92
supra
and accompanying text.

As discussed further below, notwithstanding the decision to include all NMS stocks regardless of market capitalization, the Commission believes it is appropriate to exclude certain thinly-traded securities (
e.g.,
securities that trade fewer than 30,000 shares per day), in part because rebates at that level of trading would be low enough to be unlikely to impact order routing behavior and researchers would be unlikely to get sufficient statistical power to analyze them in isolation at those volume levels.
96

96

See supra
Section II.C.6 (discussing the exclusion of securities that trade fewer than 30,000 shares per day on average from Test Groups 1 and 2).
See also supra
notes 88-92 and accompanying text. Accordingly, the Commission notes that many thinly-traded securities will be excluded from the Pilot, which should assuage commenters' concerns regarding the impact of the Pilot on less liquid or thinly-traded securities.

b. The Inclusion of ETPs

The Commission proposed to select Pilot Securities from among all NMS stocks, including ETPs. A number of commenters supported including ETPs in the Pilot. Several commenters noted, for example, that including ETPs “would produce a more inclusive analysis of rebates and fees across all segments of NMS stocks.”
97

One such commenter believed that “the benefits from collecting data that informs long-term market structure improvements will outweigh any potential temporary disadvantage.”
98

97
BlackRock Letter, at 1.
See also, e.g.,
Fidelity Letter, at 9.

98
Vanguard Letter, at 2.

On the other hand, a number of commenters expressed concern with including ETPs in the Pilot. For example, one commenter stated that “[m]any ETP issuers are . . . strongly opposed to the inclusion of ETPs in the Pilot” and suggested that the Commission had not “sufficiently explained why it is appropriate to include ETPs in any Pilot.”
99

This commenter noted that “exchanges have implemented numerous incentive structures designed to promote liquidity and narrow spreads in ETPs” that could be disrupted by the Pilot, “negatively impact[ing] liquidity and spreads in ETPs to the detriment of both new and existing investors.”
100

Similarly, another commenter expected the Pilot to “result in spreads widening for ETPs holding pilot stocks, even if ETPs are not included in the pilot, given that fair value calculations rely on underlying constituent pricing,” and therefore cautioned that “any negative effects of the pilot on transaction costs could be intensified for ETP investors.”
101

A few commenters “believe[d] that the goals of the pilot can be achieved without having to include ETPs in the pilot,” because “[t]he effects of the pilot on stocks will be sufficient to draw conclusions about potential changes to access fee rules.”
102

99
Cboe Letter I, at 17-18.

100

Id.

101
State Street Letter, at 3.

102

See, e.g., id.

The Commission continues to believe that it is important to include ETPs in the Pilot, because excluding them would hamper the Commission's ability to gather key data that could be used to inform future regulatory action in this area. The Commission does not believe it will be able to draw meaningful conclusions about the impact of changes to transaction fees and rebates on ETPs by observing the effects of the Pilot on other securities, in part because ETPs have a unique create-and-redeem process that does not apply to other NMS stocks.
103

Nevertheless, ETPs are subject to the same rules and fees that apply to all NMS stocks. To the extent that the Pilot results may inform future policymaking, Pilot data that includes all types of NMS stocks that would be impacted, including ETPs, will be more useful.

103

See, e.g.,
Securities Exchange Act Release No. 75165 (June 12, 2015), 80 FR 34729, 34732 (June 17, 2015) (Request for Comment on Exchange-Traded Products) (discussing the create-and-redeem process for ETPs); Transcript of the Division of Trading and Markets' Roundtable on Market Structure for Thinly-Traded Securities (April 23, 2018),
available at https://www.sec.gov/spotlight/equity-market-structure-roundtables/thinly-traded-securities-rountable-042318-transcript.txt
(Panel Three discussing ETPs). In particular, large volumes in ETPs can be transacted directly with the ETP issuer in creation units, making the trading center volume in ETPs less relevant to institutional traders that transact in large size orders.

Further, some commenters expressed concern regarding the potential for competitive effects among certain ETP issuers. As one commenter noted, “if two ETPs with similar underliers or that track the same index are placed in the two different [T]est [G]roups, the Pilot would inevitably determine winners and losers.”
104

Another commenter explained that “ETPs with similar investment strategies are more substitutable than stocks of operating companies,” such that “market quality metrics likely play a greater role in driving flows to ETPs.”
105

For that reason, “[i]f competing ETPs are in different test groups—and market quality varies among the test groups,” the commenter believed that “investors might migrate toward products in the test groups with better market quality,” thereby “tilt[ing] the playing field in favor of ETPs that happen to be assigned—at random—to test groups that perform better at the expense of other products.”
106

104
Morgan Stanley Letter, at 3-4.
See also
Nasdaq Letter I, at 8-9 (stating that the Pilot was “arbitrary and capricious and not in accordance with law,” in part because the Commission had “fail[ed] to consider” the competitive effects of placing “ETPs tracking similar indexes . . . in different test groups”); Cboe Letter I, at 17.

105
ICI Letter I, at 4 n.8.

106

Id.
at 4.
See also, e.g.,
NYSE Letter I, at 7; Nasdaq Letter I, at 8.

While a few commenters discussed which treatment group would be most problematic,
107

many of the commenters took no position on the direction of the presumed competitive impact and did not speculate about how (or whether) inclusion in specific Pilot Groups would help or harm ETPs.
108

107

See, e.g.,
Credit Suisse Commentary, at 6 (stating that the Pilot could “unintentionally advantage ETFs in the lower fee group”).
But cf.
Nasdaq Letter I, at 8 (stating that ETPs “in the lower rebate groups would find themselves at a competitive disadvantage to their competitors and may lose market share during the pilot as a result”).

108

See, e.g.,
SIFMA Letter, at 4-5; Invesco Letter, at 2-3; Morgan Stanley Letter, at 3-4.

To address the potential competitive harm, a few of these commenters recommended that the Commission exclude ETPs from the Pilot altogether,
109

while most recommended that the Commission select ETPs in a manner that may avoid any potential competitive effects among similar ETPs, by: (1) Rotating all of the Pilot Securities through the various treatment groups,
110

(2) rotating only ETPs through the various treatment groups,
111

or (3) placing in the same Test Group ETPs tracking similar indexes or holding similar investments.
112

109

See, e.g.,
Cboe Letter I, at 28; Invesco Letter, at 2-3; State Street Letter, at 3; STA Letter, at 4.

110

See, e.g.,
ICI Letter I, at 4-5, 5 n.10 (suggesting that the Commission rotate securities every three to six months); Oppenheimer Letter, at 3; Angel Letter II, at 3 (suggesting a quarterly rotation). These commenters did not believe that rotation would “adversely affect the validity of pilot data” or “impose more than a
de minimis
implementation burden or other costs on market participants.” ICI Letter I, at 4.
See also
Angel Letter II, at 3. These commenters suggested that “[a]nalysis of individual security characteristics before and after a rotation to a new group[ ] could yield relevant and important results.” Oppenheimer Letter, at 3.
See also
Angel Letter II, at 3.

111

See, e.g.,
SIFMA Letter, at 5; State Street Letter, at 4; Healthy Markets Letter II, at 8.

112
SIFMA Letter, at 4.
See also, e.g.,
Nuveen Letter, at 2; BlackRock Letter, at 2; FIA Letter, at 4; Fidelity Letter, at 9; State Street Letter, at 4; STANY Letter, at 4; Healthy Markets Letter II, at 8.
But cf.
Angel Letter II, at 3 (stating that “similar ETFs are probably the best natural controls for each other, as their underlying portfolios are virtually identical,” such that “similar ETFs should definitely be in different treatment groups to increase the power of the pilot”).

Other commenters criticized these proposed alternatives for selecting ETPs. One commenter, for example, questioned “whether any of the proposed remedies would address these concerns effectively or fairly.”
113

Another commenter expressed concern that the suggestions to place “similar” ETPs in the same Test Group might be too complex to implement, as determining whether ETPs are “similar” to one another for purposes of Pilot rotation can be extremely nuanced.
114

This commenter explained that an “effective classification should take into account an ETP's underlying index, portfolio constituents and asset class to provide an appropriate `apples to apples' analysis,” in addition to “factors such as assets under management, spread size and daily trading volume,” which the commenter believed “would

introduce unnecessary complexity into the Proposal.”
115

113
Schwab Letter, at 3.

114
Invesco Letter I, at 2-3.
See also, e.g.,
Healthy Markets Letter II, at 8 (noting that it may be “difficult to clearly and consistently define `similar' ETPs”).

115
Invesco Letter, at 2-3.

The Commission recognizes the concern that securities placed in one treatment group could be impacted differently than similar securities placed in a different treatment group. While that effect could occur for any security (
e.g.,
stocks of different operating companies in the same industry), it could potentially be more prominent for ETPs that may be substantially similar. Nevertheless, the Commission notes that similar ETPs are not necessarily identical and many other factors influence investor demand and trading, including expense ratios, trading commissions, and existing holdings.

The Commission has carefully considered the three alternatives suggested by the commenters
116

and declines to adopt them. Rotating either (1) all Pilot Securities or (2) only ETPs would increase complexity and could increase the costs of the Pilot as the Commission, exchanges, and market participants would need to manage a pilot whose securities change treatment groups every several months. In particular, a rotation design would be considerably more complex than the proposed design by, for example, adding more treatment subgroups and requiring frequent rotation of those subgroups. Given the choice between a simple Pilot design with a short duration, on one hand, and a considerably more complex design with a longer duration, on the other hand, the Commission prefers to adopt this aspect of the rule as proposed. Compared to the alternative designs suggested by some commenters, the proposal results in a short narrowly drawn pilot with fewer complexities and burdens, which is an outcome supported by many commenters.
117

116
The Commission also considered comments providing suggestions relevant to the implementation of these three alternatives. As discussed above, the Commission is not adopting the alternatives.

117

See
Section II.D.2 (discussing the duration of the Pilot) and Section II.C.5. through 6. (discussing the number of stocks to be included in the Pilot)
infra.

The Commission also considered the suggestion to group ETPs with similar underlying holdings into the same treatment group. While this suggestion involves slightly less ongoing complexity than rotating securities during the Pilot, the Commission declines to adopt this suggestion because it introduces its own complexity in that categorizing ETPs according to their underlying holdings (and potentially other characteristics) involves the exercise of subjective judgment. In addition, grouping similar ETPs can negatively impact the representativeness of the different treatment groups, particularly if all of the similar ETPs are similar in volume, price, and market capitalization. The Commission believes it may learn more from a study that compares how different pricing regimes affect similarly-situated ETPs, whereas keeping similar ETPs in the same treatment groups could reduce the quality and usefulness of Pilot's results by inhibiting the ability of researchers to compare treatment groups. While the potential exists that similar ETPs in different Pilot treatment groups might trade differently during the Pilot, it is not certain—and commenters held divergent views concerning—whether and to what extent the Pilot would be a contributing factor. Whether the absence of rebates or lower fees help or hurt trading in similar ETPs is far from certain, and whether investors would base trading decisions on those distinctions is unclear. Excluding ETPs to avoid speculative harm would, however, decidedly reduce the utility of the Pilot's results to inform future policy making. Therefore, the Commission has determined not to adopt a requirement to rotate securities or to group like ETPs. For these reasons, the Commission adopts the rule as proposed to include ETPs in the Pilot.

c. The Inclusion of Canadian Interlisted Stocks

In the Proposal, the Commission requested comment on the selection criteria and whether the Commission should consider inclusion or exclusion of certain stocks from the Pilot sample set.
118

In response, several commenters discussed the inclusion of Canadian interlisted stocks in the Pilot and recommended that the Commission coordinate with Canadian securities regulators to avoid altering the trading dynamics between Canada and the U.S. in those securities.
119

For example, one commenter was “concerned that the inclusion of Canadian interlisted stocks in either one of the reduced access fee or no rebate test groups may materially impact order flow by encouraging transactions to move away from U.S. exchanges and on to Canadian exchanges.”
120

Other commenters suggested that the Commission coordinate with the Canadian Securities Administrators to avoid “dramatic differences in the trading economics on inter-listed stocks between Canadian and U.S. markets.”
121

118

See
Proposing Release,
supra
note 2, at 13019 (Questions #5 and 8).
See also id.
at 13013 n.46 (noting the receipt of a letter from the Canadian Security Traders Association proposing a cross-border study on the effect of rebates on market quality in conjunction with the Canadian Securities Administrators).

119

See, e.g.,
Fidelity Letter, at 8; OMERS Letter, at 1; FIA Letter, at 4; Healthy Markets Letter I, at 35; STA Letter, at 5. Canadian interlisted stocks are stocks of Canada-based companies that are primarily listed on a Canadian exchange (generally the Toronto Stock Exchange), but that choose to also dually-list on a U.S. exchange.
See https://www.tsx.com/trading/toronto-stock-exchange/fee-schedule/ni-23-101
(for a quarterly list of approximately 187 interlisted securities published by the Toronto Stock Exchange featuring stocks that are listed on the Toronto Stock Exchange or the TSX Venture Exchange).

120
FIA Letter, at 4.
See also
Fidelity Letter, at 8.

121

See, e.g.,
STA Letter, at 5.

The Commission also received a comment letter from the academics retained by the Canadian Securities Administrators (“CSA”) to assist with planning, conducting, and analyzing a Canadian transaction fee pilot (“Canadian Pilot”).
122

According to the CSA researchers, the Canadian Pilot likely will propose that, for approximately 180 interlisted stocks, 90 of them would be included in a no-rebate test group with the remaining 90 placed in a control group.
123

In their letter, the CSA researchers requested that the Commission's Pilot treat interlisted stocks similarly to their Canadian Pilot proposal—
i.e.,
that both pilots place the same 90 interlisted stocks into their respective no-rebate group and place the other 90 stocks into their respective control group.
124

By doing so, the CSA researchers believe that both pilots will avoid confounding the analysis for each respective pilot with respect to interlisted stocks because differences in fees and rebates otherwise could incentivize shifts in cross-border routing.
125

122

See
CSA Letter. The preliminary details of the pilot contemplated by the CSA, as reflected in the CSA Letter, were not publicly available prior to the Proposing Release.

123

Id.
at 1.

124

Id.
at 2.

125

Id.
at 1-2.

The Commission agrees with the CSA researchers and believes that it is appropriate to coordinate with the CSA on a transaction fee pilot in order to avoid the potential for distortionary effects between U.S. and Canadian markets if rebates in the “no-rebate” interlisted stocks continue to be allowed on one country's exchanges but not the other.

Accordingly, in the event that the CSA proceeds with the Canadian Pilot concurrently with the Commission's Pilot, the Commission will append to the no-rebate Test Group the same Canadian interlisted stocks that the CSA selects for its no-rebate treatment group, and the remaining interlisted stocks will

be placed into the Control Group.
126

Placing the same interlisted stocks into the Pilot's no-rebate test group that the Canadian Pilot places into its no-rebate test group will avoid the potential to alter the trading dynamics between Canadian exchanges and U.S. exchanges in those stocks that otherwise could result if not all exchanges were subject to the same conditions, which should support the integrity of the no-rebate test groups in both pilots.
127

Coordination also will avoid the potential for the Commission's Pilot to interfere with the ability of Canadian securities regulators to conduct a pilot of their own on Canadian-listed stocks which could be adversely impacted in the absence of coordination.
128

The Commission appreciates the interest expressed by the CSA researchers in coordinating on a pilot with respect to interlisted stocks, and looks forward to cooperating with the CSA on this important data-gathering initiative in a manner that benefits both nations' securities markets.

126
In the event that the Canadian pilot does not go forward or does not commence simultaneously with the Commission's Pilot, interlisted stocks will be placed at the Pilot's outset into the Control Group. Placing interlisted stocks in the Control Group will preserve the status quo for interlisted stocks and avoid altering the trading dynamics in them between U.S. and Canadian exchanges, which will avoid adversely impacting Test Groups 1 and 2 with respect to those stocks. If the Canadian pilot does go forward, but the interlisted stocks that will be included in its no-rebate test group are not known by the Commission at the time the Commission issues the initial List of Pilot Securities, the Commission may separately issue a subsequent list identifying the interlisted stocks that will be appended to Test Group 2 or the Control Group for the remainder of the Pilot.

127

See, e.g.,
Proposing Release,
supra
note 2, at 13024 (discussing the design of proposed Test Group 3 and the prohibition in Linked Pricing to support the integrity of a no-rebate test group).
See also
CSA Letter, at 1 (expressing concern that “the results of the Canadian Pilot may be statistically and economically inconclusive” without coordination with the Pilot).

128

See
CSA Letter, at 1.

d. The Inclusion of Other Types of NMS Stocks

A few commenters addressed the inclusion of other types of NMS stocks, such as American Depositary Receipts (“ADRs”), rights, and warrants. One commenter supported the proposed broad scope of Pilot Securities and believed that “analysis of . . . ADRs could provide additional insight into the effect rebates and fees have on liquidity, spreads and the overall trade experience.”
129

Another commenter objected to the Commission's proposal to include rights and warrants in the Pilot, but did not explain the basis for its objection.
130

As noted above, however, most commenters expressed general support for a Pilot that includes all NMS stocks.
131

129
Oppenheimer Letter, at 3.

130
TD Ameritrade Letter, at 4.

131

See, e.g.,
Vanguard Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2.

The Commission continues to believe that it is appropriate to select Pilot Securities from among the overall universe of NMS stocks. Accordingly, the Commission will include all types of NMS stocks in the Pilot, subject to the selection criteria described below. The Commission believes this is appropriate because exchange fees and rebates apply to all NMS stocks, as does the fee cap under Rule 610(c). Aligning the scope of the Pilot with the scope of equities fees and the equities fee cap will best facilitate analysis of the impact of changes to transaction fees and rebates on different segments of the securities market. Excluding from its scope any categories of NMS stocks would deprive the Commission of data to inform future regulatory action regarding this segment of the market. For those reasons, the Commission adopts this aspect of the Pilot as proposed, subject to the selection methodology described below in Section II.C.

4. The Ability of Issuers To Opt Out of the Pilot

The Commission solicited comment as to whether issuers should be allowed to request that their securities not be included in one of the Pilot's Test Groups (
i.e.,
“opt out”) and the potential impact that such an approach might have on the extent and quality of the data collected by the Pilot.
132

132

See
Proposing Release,
supra
note 2, at 13019.

Several commenters argued that issuers should be permitted to opt out of participation in the Pilot based on process concerns. For example, one commenter's “largest concern [was] that the genesis of the proposal . . . deliberately excluded issuer representation” by “excluding the NYSE and Nasdaq from participation on the [EMSAC].”
133

This commenter asserted that the “exclusion . . . from participation in the pre-proposal discussions renders the `Opt Out' option absolutely essential.”
134

Another commenter suggested that the Commission could address such concerns by “conven[ing] a summit for issuers and perhaps [creating] a series of webcasts . . . to explain the purpose of the test,” as well as by “form[ing] an Issuer Advisory Committee that can weigh data and let companies opt into or out of a test.”
135

133
Issuer Network Letter I, at 2 (emphasis omitted) and Issuer Network Letter II.
See also
Cboe Letter I, at 14-15 (criticizing the Pilot as “based on recommendations made by a committee that, however well-meaning, was flawed in its construction” because it lacked “exchange or issuer representation”); Home Depot Letter, at 2 (stating that the EMSAC “did not include any input from issuers or issuer advocates . . . like NYSE and Nasdaq” and that it was “difficult” for “issuers . . . to understand how this Pilot could be implemented without input from the issuers . . . it will directly impact”); ModernIR Email, at 1 (stating that a “study . . . crafted without input or choice for issuers . . . would be an inexcusable travesty”).

134
Issuer Network Letter I, at 2, 7 (emphasis omitted).

135
ModernIR Email, at 1.
See also
Issuer Network Letter I, at 7 (suggesting that the Commission “[p]lace the Access Fee Pilot on hold for 90 days while [it] gathers a Blue Ribbon Panel . . . of a dozen or so NYSE and Nasdaq listed company financial executives so that we might conduct a comprehensive review” of the Pilot (emphasis omitted)).

The Commission's proposal was subject to a full notice-and-comment rulemaking process during which the Commission received a large number of comments from the public, including issuers and their listing exchanges. While the EMSAC recommendation was one of many inputs that informed the Commission's development of the Pilot, the Commission's Pilot differs substantially from EMSAC's recommendation as numerous commenters have recognized.
136

Accordingly, the Commission believes that issuers, as well as other market participants, have had ample opportunity to participate in the consideration of the Commission's proposal for the Pilot.

136
The EMSAC held meetings open to the public, which were publicly webcast, as it was developing its recommendations. To promote awareness of those meetings, the Commission issued press releases to announce those meetings, which included the agenda for those meetings.
See, e.g.,
SEC Press Release 2015-216 (announcing the agenda for an October 27, 2015 EMSAC meeting, highlighting the discussion of fees and rebates, and soliciting comments from the public thereon),
available at https://www.sec.gov/news/pressrelease/2015-216.html.
The Commission also published meeting minutes and transcripts of the full EMSAC meetings. Finally, the Commission provided a mechanism for the public to submit comments to the EMSAC for its consideration, and a number of people did submit comments.
See https://www.sec.gov/comments/265-29/265-29.shtml
(comment file for File No. 265-29).

Other commenters supported opt out based on specific concerns surrounding the potential impact of the Pilot. A number of these commenters were listed company issuers that expressed concern about how the Pilot would affect trading in their securities.
137

Commenters

supporting opt out emphasized the importance of giving issuers the ability to avoid potential costs and uncertainty resulting from the Pilot.
138

For example, one commenter believed that the Pilot could “caus[e] spreads to widen in securities selected for the test groups,” such that “companies conducting a repurchase program or secondary offering would incur higher costs,” and the Commission received a number of comment letters from listed issuers specifically referencing that point and echoing the same concerns.
139

This commenter further argued that “the Proposal would also harm the ability of issuers whose securities are subject to access fee caps to compete” with issuers not subject to the Pilot's exchange fee restrictions.
140

137

See, e.g.,
P&G Letter, at 1; McDermott Letter, at 1; Level Brands Letter, at 1; ACCO Letter, at 1; NorthWestern Letter, at 1-2; Ethan Allen Letter, at 1; Unitil Letter, at 1; Johnson Letter, at 2; Sensient Letter, at 2; Hawaii Letter, at 1; Cott Letter, at 1; Leaf Letter, at 1-2; First Majestic Letter, at 1; SIFCO Letter, at 2; Weingarten Letter, at 1; Ennis Letter, at 2; Trex Letter, at 1; Genesis Letter, at 1; Tredegar Letter, at 1; Energizer Letter, at 1; ProAssurance

Letter, at 1; Home Depot Letter, at 1; SMP Letter, at 2; Halliburton Letter, at 1; Era Letter, at 2; Natural Grocers Letter, at 2; Newpark Letter, at 2; Knight-Swift Letter, at 2; Farmer Mac Letter, at 1; BancorpSouth Letter, at 1-2; Haverty Letter, at 1; Ampco-Pittsburgh Letter, at 2; Anixter Letter, at 2; Avangrid Letter, at 2; NHC Letter, at 1; HP Letter, at 2; Curtiss-Wright Letter, at 2; Murphy Letter, at 1.

138

See, e.g.,
Cboe Letter I, at 29; ASA Letter, at 4-5.

139

See
Addendum to Healthy Markets Letter II, at 11 (attaching an email from NYSE to its listed companies).
See also
note 137
supra.

140

See
NYSE Letter I, at 4. In its letter, the commenter mentioned analysis it performed on NYSE-listed issuer secondary offerings in 2017 that suggested that issuers “with average spreads under 20 basis points paid an average discount to market price of 2.6%” and that “companies with spreads above 20 basis points had to discount their offerings nearly twice as much, to 4.9%.” NYSE Letter I, at 14 n.51. It is unclear, however, whether wider spreads
cause
larger offering discounts or whether they are simply
correlated
with them. For example, smaller companies that are less well capitalized may have a wider spread compared to a larger, better capitalized company, which could result in spreads being correlated with a company's cost of capital (
i.e.,
wider spreads could be a reflection of a company's relative credit risk and cost of capital, not a driver of it).

Many other commenters opposed opt out.
141

Some of these commenters dismissed the concerns described above regarding the potential costs on issuers whose stock is included in the Pilot.
142

For example, one commenter disagreed with the notion that “rebates are needed to incentivize market makers to quote tight spreads” in the stocks of certain issuers who had submitted comment letters.
143

This commenter explained that the “fifth of a cent rebate is not incentivizing a tight bid-ask spread in these issuers' stocks,” because that rebate represents an insignificant portion of their average spread.
144

Another commenter disagreed with the suggestion that the Pilot would have a negative impact on issuers, arguing that such position “directly contradicts the public support by investors for the Pilot.”
145

This commenter opined that the “fundamental forces of supply and demand that affect . . . the relative attractiveness of individual public company stocks will be in no way impaired if . . . exchanges are precluded from paying a rebate, or required to accept a lower access fee.”
146

141

See, e.g.,
Joint Asset Managers Letter, at 2; Citi Letter, at 5; AJO Letter, at 2; Lipson Letter, at 1.

142

See supra
notes 138-140 and accompanying text.

143
Themis Trading Letter II, at 3.

144

Id.
at 2-3.

145
IEX Letter II, at 3.
See also,

e.g.,
Joint Pension Plan Letter, at 2 (stating that the “asset manager/asset owner community is heavily supportive of such a pilot,” which should “provide the necessary confidence to all public companies to be included”); ICI Letter II, at 2 (“market structure is not a primary consideration guiding the investment decisions of long-term investors”); Joint Asset Managers Letter, at 2; Healthy Markets Letter II, at 2.
But cf.
NYSE Letter II, at 4 (stating that “many buy-side institutions” supporting the Pilot “are willing to experiment with real-world public companies and end investors to `get the data,' even if the expected impact of limiting or eliminating rebates will be a deterioration of the public quote”).

146
IEX Letter II, at 3-4.

Other commenters asserted that opt out would “adversely affect the quality of the data and the credibility of the Pilot,” which could weaken the findings that could be drawn from it.
147

One commenter explained that opt out “would undercut the ability of economists to draw sharp inferences based upon performance differences between the treated and control stocks” and that the “non-random character of `opt outs' ” could “disproportionately reflect firms that were especially responsive to feedback from the listing exchange or could disproportionately reflect less liquid stocks, which would be especially important for the access fee pilot.”
148

147
RBC Letter I, at 6.
See also,

e.g.,
LATEC Letter, at 2; Joint Pension Plan Letter, at 2; MFS Letter, at 3; Clearpool Letter, at 8.

148
Spatt Letter, at 3.
See also,

e.g.,
Healthy Markets Letter I, at 12; CII Letter, at 4.

One listed issuer, which is a large investment manager, “welcome[d] the opportunity for [its] stock to be included in the Pilot, with the ultimate goal of improving the overall market to be one where prices can be set by long-term investors without distortion from speculative market participants.”
149

This issuer did not “expect that a reduction or outright removal of rebates will have any significant or harmful effects on the quality of prices displayed in the public lit market, interfere with genuine liquidity and price formation, or negatively impact [its] stock's trading volume, spread or displayed size.”
150

149
T. Rowe Price Letter, at 4. The issuer explained that its stock, “on average, trades about 1.5 million shares daily, with an average displayed size of 200 shares and a spread of nearly $0.07,” with “40% of [its] average daily volume occur[ring] as displayed on exchange volume.”
Id.
at 4-5.

150

Id.
at 5.

Finally, two commenters further argued that opt out would be inconsistent with the existing market structure. One of these commenters observed that “[i]ssuers currently have no say over exchanges' policies” and that “exchanges that modify their access fees dozens of times a year do not survey issuers or permit them to opt-out of these fee changes or creation of order types.”
151

The other commenter opined that opt out “may set an unfortunate precedent that would allow an issuer to pick and choose among those aspects of the National Market System that it likes while rejecting other aspects that it may find less attractive to it, but [which] are necessary to the smooth functioning of [the] United States public equity markets.”
152

151
Better Markets Letter, at 7.

152
MFS Letter, at 3.

After careful consideration, the Commission does not believe that issuers should be permitted to opt out of participation in the Pilot. While the Commission understands issuers' concerns, allowing issuers to opt out could undermine the representativeness of the Pilot's treatment groups and potentially bias the Pilot's results, depending on the number and characteristics of issuers that opt out. In turn, researchers would be less able to rely on the data to perform analyses and draw specific conclusions about the impact of the Pilot, thereby limiting the usefulness of the Pilot's data to the Commission and future regulatory initiatives.
153

Although some commenters believe that issuers may incur potential costs or endure competitive harms depending on which of the Pilot's treatment groups their stock is in, other commenters have argued that such effects are unlikely to manifest. The Commission does not believe it is appropriate to implement an opt out provision that could frustrate the collection of useful and representative data based solely on concerns expressed by some commenters regarding uncertain harms. It is precisely because of this uncertainty that the Commission believes it is necessary to conduct the Pilot to study these contested issues through an objective empirical review of exchange transaction fees and rebates. For those reasons, the Commission

adopts this aspect of the Pilot as proposed.

153

See, e.g.,
Short Sale Position and Transaction Reporting, Study by the Staff of the Division of Economic and Risk Analysis, June 5, 2014, at 66-67 (discussing selection bias in the context of an “opt in” voluntary pilot design).

C. Pilot Design

1. Need for a Pilot

As a threshold issue, commenters disagreed about whether the Commission should conduct any kind of pilot study of transaction fees and rebates. One commenter, for example, characterized the proposed Pilot as “a solution in search of problem” and claimed that the Commission “has provided no evidence that existing fee practices are harming investors or interfering with fair competition.”
154

Another commenter believed that the Pilot was unnecessary, but for the opposite reason—namely, that there is ample evidence of the negative effects of exchange rebate pricing models, such that the Commission should instead take immediate action to ban them.
155

154
Cboe Letter I, at 5.
See also, e.g.,
Virtu Letter, at 1-2; Nasdaq Letter I, at 12-13.
But cf.
MFA Letter, at 2 (stating that “regulators should periodically assess market practices and regulations to ensure that U.S. equity markets continue to remain efficient, liquid, fair, resilient and transparent for all market participants”).

155

See
Larry Harris Letter, at 9-10.

Most commenters, however, thought a Commission-led pilot was necessary and supported the Commission's proposal to conduct one.
156

These supportive commenters observed that “market participants have heavily debated the effects that transaction-based fees, particularly access fees, and rebates may have on the equity markets” and “commend[ed] the SEC for advancing this discussion through a time-limited, empirical study.”
157

Some of those commenters thought a Commission-led pilot was necessary because competitive pressures among exchanges may serve as a barrier to market-led reforms in this area.
158

The Commission agrees with the commenters that stated that the Pilot is necessary because, as reflected in the comments discussed above,
159

there is strong disagreement about the impact of exchange fee-and-rebate pricing models but a lack of data to study the issue. The Commission believes it is important to further investigate these impacts.
160

156

See, e.g.,
Decimus Letter, at 4 (stating that the Pilot “would be valuable in generating concrete information and more preferable to back-of-the-envelope calculations based on questionable assumptions”); Wellington Letter, at 1 (stating that the Commission could only “draw[ ] definitive conclusions on the impact of existing pricing models . . . through an actual implementation” of the Pilot); Verret Letter I, at 4 (stating that the Commission “appears to have considered adoption of a mandatory rule to reshape market structure, and determined instead to take the more deliberative and less costly approach of an initial pilot program to generate more data from which it can determine a path forward on market structure reform”); IAC Recommendation, at 2; MFA Letter, at 2; ICI Letter I, at 1-2; RBC Letter I, at 2; Joint Asset Managers Letter, at 2; Clark-Joseph Letter, at 1; Babelfish Letter, at 3; State Street Letter, at 2; Themis Trading Letter II, at 3; IEX Letter I, at 2-3.

157
Fidelity Letter, at 2.
See also, e.g.,
Brandes Letter, at 1 (expressing support for the Pilot and the “Commission's effort to shed light into a subject of heated debate among market participants”); Barnard Letter, at 1 (stating that the Pilot was “important, as historically there are many views on this topic, but a paucity of credible data from which to draw conclusions”); Angel Letter II, at 1 (stating that “various commenters have wildly differing perspectives on what will happen under the pilot,” which is “strong evidence as to why the pilot is necessary”).

158

See, e.g.,
T. Rowe Price Letter, at 3; Clearpool Letter, at 2. The Commission notes that Nasdaq conducted an independent access fee experiment in 2015, but the limited nature of that experiment makes it difficult to draw conclusions from the data gathered by Nasdaq.
See
Proposing Release,
supra
note 2, at 13011-12.
See also, e.g.,
IEX Letter III, at 6 (“Nasdaq's experiment and its outcomes aren't a perfect proxy for what is likely to happen in the Transaction Fee Pilot. That experiment was done unilaterally and only in highly-liquid securities.”); Larry Harris Letter, at 9 (noting that Nasdaq's “experimental fee reduction did not occur at all trading venues that traded the subject securities,” demonstrating that “regulatory action is necessary to establish a common pricing standard because market forces alone will not do it”).

159

See
Section II.A.2 for a discussion of these comments.

160

See also
Section II.A.2 for a discussion of these impacts.

2. Pilot Design

For each NMS stock that meets the initial criteria to be a Pilot Security, discussed above, the Commission proposed to assign it to one of three Test Groups, with 1,000 NMS stocks each, or the Control Group.
161

The composition of each Test Group would remain constant for the duration of the Pilot, except, as described below, to reflect changes to the composition of the groups caused by mergers, delistings, or removal from a Test Group due to the share price of a stock closing below $1.
162

161

See
Proposing Release,
supra
note 2, at 13019. The Commission notes that the proposed language in Rule 610T(b)(2)(ii)(E) has been modified slightly. As proposed, Rule 610T(b)(2)(ii)(E) was labeled as “Test Group.” As adopted, the label “Pilot Group” is being substituted for the phrase “Test Group” to provide additional clarity.

162

See id.

The Commission received a number of comments on the proposed Pilot design, discussed below, focusing mainly on the number of securities included in each Test Group. After consideration of all the comments received and for the reasons discussed below, the Commission is adopting two Test Groups that each contain 730 NMS stocks, functionally combining proposed Test Groups 1 and 2 into a new Test Group 1 with a blended fee cap of $0.0010. Accordingly, for the duration of the Pilot, the following pricing restrictions will apply to Test Groups 1 and 2, while the Control Group will remain subject to the current access fee cap in Rule 610(c):

Proposed
Adopted

Fee Cap Test Group 1
1,000 NMS stocks
730 NMS stocks.

$0.0015 fee cap
for removing & providing displayed liquidity

$0.0010 fee cap
for removing & providing displayed liquidity.

Fee Cap Test Group 2
1,000 NMS stocks
Not adopted.

$0.0005 fee cap
for removing & providing displayed liquidity

No Rebate Test Group
1,000 NMS stocks
730 NMS stocks (plus appended Canadian interlisted stocks).

Rebates and Linked Pricing Prohibited
for removing & providing displayed & undisplayed liquidity (except for specified market maker activity)

No change.

Rule 610(c) cap applies
No change.

Control Group
Pilot Securities not in a Test Group
No change.

3. No Overlap With Tick Size Pilot

163

See
Proposing Release,
supra
note 2, at 13019-13020 n.117, 13020 (describing the proposed composition of the Tick Size Pilot overlap subgroups). In the Proposal, the Commission specifically solicited comment on whether the Pilot should overlap with the Tick Size Pilot.
See id.
at 13025.

While the Commission's proposed Pilot design took into consideration the possibility that the Pilot could have been adopted before the end of the Tick Size Pilot Program, the Commission also noted that the overlap design would not be necessary if that were not the case.
163

A few commenters opined on the potential overlap between the proposed Pilot and the Tick Size Pilot, disagreeing on whether overlap would be appropriate.
164

However, because the Tick Size Pilot ended on September 28, 2018, there no longer is any need for the Transaction Fee Pilot to control for potential data distortions that could have otherwise resulted from the simultaneous operation of the two pilot programs. Accordingly, the Commission is not adopting the proposed Tick Size Pilot overlap design.

164

Cf., e.g.,
Clark-Joseph Letter, at 2 (noting that overlap “certainly would not be a serious impediment”); SIFMA Letter, at 3 (arguing against an overlap).

Relatedly, some commenters discussed whether there should be a delay between the end of the Tick Size Pilot and the start of the proposed Transaction Fee Pilot, with commenters disagreeing on that point. For example, one commenter thought a delay would be appropriate to allow markets to normalize before conducting a subsequent pilot
165

while another commenter thought markets would revert to their baseline state extremely quickly after the Tick Size Pilot ends.
166

165

See
Cboe Letter I, at 30.

166

See
Healthy Markets Letter I, at 14.

The Tick Size Pilot concluded, but post-pilot data continues to be collected until April 2, 2019. However, the Transaction Fee Pilot is subject to a one-month implementation period followed by a six-month pre-Pilot Period. Accordingly, the core of the Transaction Fee Pilot will not commence until
after
the post-pilot period for the Tick Size Pilot ends. By then, the Commission believes that the markets will have had sufficient time to normalize and any overlap between the Transaction Fee Pilot's pre-Pilot Period and the Tick Size Pilot's post-pilot period will be minimal. In both cases, the respective pre- and post-pilot periods are collecting benchmark data on the status quo. As such, the overlap between them should not compromise either dataset.

Finally, two commenters recommended that the Commission analyze the Tick Size Pilot data prior to proceeding with the Transaction Fee Pilot.
167

While preliminary results from the Tick Size Pilot have been made public, the two pilots are sufficiently dissimilar that the Commission sees no reason for delay. The Tick Size Pilot tested a wider minimum increment (from one cent to five cents) for smaller-capitalization stocks, whereas the Transaction Fee Pilot will test a lower rate for the Rule 610(c) fee cap and a prohibition on exchange rebates (which typically are less than one-third of a penny) for stocks of all market capitalizations. Accordingly, findings from the Tick Size Pilot are not relevant to the design of the Transaction Fee Pilot.

167

See
Cboe Letter I, at 29; Nasdaq Letter I, at 4.

4. Stratified Selection of Pilot Securities

The Commission proposed to select the stocks to be included in each of the Test Groups and the Control Group through stratified sampling in a manner that permits comparisons between each Test Group and the Control Group.
168

168

See
Proposing Release,
supra
note 2, at 13019.

One commenter expressed support for the proposed approach to stratification and noted that it was “fundamental to the ability to undertake causal inference in this setting . . . .”
169

In contrast, a number of public company commenters expressed concern that stratified sampling could result in their stocks being placed in a different Test Group from other similar stocks in their “peer group,” which could complicate comparisons of their stock's performance against peer-group metrics.
170

As discussed above, those commenters supported allowing companies to “opt out” of the Pilot, which could impact the stratification.
171

Further, as discussed above, some commenters recommended that the Commission select ETPs for the Pilot in a manner that may avoid any potential competitive effects among similar ETPs, either by: (1) Rotating all of the Pilot Securities through the various treatment groups, (2) rotating only ETPs through the various treatment groups, or (3) grouping ETPs with similar underlying holdings into the same treatment group.
172

169

See
Spatt Letter, at 3.

170

See, e.g.,
Mastercard Letter, at 2; Avangrid Letter, at 2; Energizer Letter, at 1.

171

See supra
Section III.C.4.

172

See supra
Section III.C.3.b.

While the Commission understands the concerns of these commenters, as discussed above in Section II.B, allowing issuers to opt out of the Pilot could undermine the representativeness of the Pilot's treatment groups and bias the Pilot's results. Further, also as discussed above in Section II.B, rotating ETPs would require the Commission to implement a more complex and lengthy design in order to maintain sufficient statistical power, both of which would increase the costs and complexity of the Pilot—a result viewed unfavorably by most commenters. Finally, grouping similar ETPs also could negatively impact the stratification of the different treatment groups, particularly if all of the similar ETPs are similar in volume, price, and market capitalization. In turn, this could reduce the quality and usefulness of Pilot's results by inhibiting the ability of researchers to compare treatment groups. In order to ensure that the Pilot Securities are selected in a way that permits researchers to investigate causal connections, it is imperative to stratify the Test Groups so that researchers can study the effects of changes in fees and rebates within each Test Group, between Test Groups, and between a Test Group and the Control Group. In permitting this type of analysis, the Pilot should be better able to inform future policy considerations to improve the operation of the national market system to the benefit of investors and issuers alike. Accordingly, the Commission is adopting the stratified sampling construct as proposed.

5. Number of NMS Stocks Included in Each Test Group

The Commission proposed to include 1,000 Pilot Securities in each Test Group (
i.e.,
3,000 total across three Test Groups) with the remainder to be included in the Control Group in order to be representative of the overall population of NMS stocks and provide sufficient statistical power to identify differences between the Test Groups with respect to common stocks and ETPs.
173

173

See
Proposing Release,
supra
note 2, at 13019-20.

Several commenters supported including 1,000 stocks in each Test Group, believing that including 1,000 stocks in each Test Group would facilitate analysis of transaction fees and rebates on a broad cross section of different types of NMS stocks and generate statistically significant conclusions.
174

174

See
Brandes Letter, at 2; Themis Trading Letter I, at 3; Oppenheimer Letter, at 2; Spatt Letter, at 2; IEX Letter I, at 5; Verret Letter I, at 4; AGF Letter, at 2; MFA Letter, at 3.

Many commenters, however, thought that the Pilot should include fewer

securities in each Test Group.
175

Several of these commenters believed the Pilot could obtain statistically significant data even with fewer stocks in each Test Group.
176

Other commenters urged the Commission to reduce the number of securities included in the Test Groups in order to reduce costs associated with the Pilot.
177

Several commenters argued that the Pilot was effectively a large scale change to the current equity market structure and that it would be more appropriate for a pilot program to apply to a smaller percentage of the universe of NMS stocks.
178

Further to this point, several commenters believed that a large Pilot may be difficult to unwind, with one commenter stating that an immediate return to current transaction fee and rebate dynamics for stocks included in the Test Groups “could prove to be more disruptive to market participants and overall market quality than the actual implementation of the Pilot.”
179

Some commenters also believed the Pilot would negatively impact trading in the stocks placed in certain Test Groups, such as by adversely impacting spreads, and accordingly recommended including fewer stocks so as to limit potential negative consequences.
180

Of the commenters that advocated for reducing the number of Pilot Securities in each Test Group, some suggested alternative amounts to be included. Several commenters recommended including 100 stocks in each Test Group.
181

A few others suggested that each Test Group include 500 stocks.
182

One commenter recommended “a more tailored Pilot that includes the 225 most heavily traded names, 225 mid-cap stocks, 225 small caps and 225 ETFs would provide statistically significant data without burdening a material portion of the market.”
183

The Commission has carefully considered the concerns expressed by commenters regarding the size of the Pilot's Test Groups.
184

As previously discussed, the Commission cannot know in advance the full effects of the Pilot, whether they be positive or negative. Indeed, commenters expressed a variety of contradicting viewpoints and estimations about the potential impacts of the Pilot on the execution quality and market quality of NMS stocks that would be included in the Test Groups.
185

175

See
Magma Letter, at 3; FIA Letter, at 4; SIFMA Letter, at 4; Schwab Letter, at 2; Fidelity Letter, at 8-9; Citadel Letter, at 2; State Street Letter, at 3; Citi Letter, at 5; Clearpool Letter, at 7; TD Ameritrade Letter, at 1; STA Letter, at 3-4; STANY Letter, at 3; Nasdaq Letter I, at 10; Cboe Letter I, at 27; T. Rowe Price Letter, at 4; Mastercard Letter, at 2; NorthWestern Letter, at 1; Energizer Letter, at 1; Era Letter, at 1; Knight-Swift Letter, at 2; ASA Letter, at 4-5.

176

See
Magma Letter, at 3; Schwab Letter, at 2; Fidelity Letter, at 8-9; Clearpool Letter, at 7; STA Letter, at 3-4; Cboe Letter I, at 27.

177

See
SIFMA Letter, at 4; Schwab Letter, at 2; Citadel Letter, at 6; Citi Letter, at 5.

178

See
Magma Letter, at 3; FIA Letter, at 4; Citi Letter, at 5; Clearpool Letter, at 7; Nasdaq Letter I, at 10.

179

See
Citadel Letter, at 6.
See also
SIFMA Letter, at 4; Citi Letter, at 5.

180

See
STA Letter, at 3; STANY Letter, at 3; State Street Letter, at 3; TD Ameritrade Letter, at 1, 3; Mastercard Letter, at 2.

181

See
FIA Letter, at 4; Schwab Letter, at 2; State Street Letter, at 3; STANY Letter, at 3; Era Letter, at 1; Cboe Letter I, at 27.

182

See
SIFMA Letter, at 4; Citi Letter, at 5; STA Letter, at 3.

183

See
T. Rowe Price Letter, at 4.

184

See supra
notes 175-183 and accompanying text.

185

See, e.g.,

supra
notes 75-93 and accompanying text.

Given this uncertainty, it is crucial that the Pilot be able to produce results that are capable of facilitating an empirical review of the effect of the prevailing fee structures on the equities markets. To achieve this purpose, the Pilot needs to generate a sufficient number of observations over its one-year duration to obtain sufficient statistical power to identify differences among the Test Groups with respect to common stocks and ETPs, thereby permitting researchers to investigate causal connections using economic analysis capable of finding statistical significance. Statistical power refers to the ability for statistical tests to identify differences across samples when those differences are indeed significant and broadly is derived from the number of observations during a study. In other words, statistical power can be present when observing a limited number of subjects over a long period of time or a large number of subjects over a shorter period of time. Because the Commission desires a shorter duration for the Pilot, it therefore needs to have sufficient observable data points over the shorter pilot duration. Accordingly, if the Pilot does not contain enough securities, it may be incapable of producing statistically sound results and will not allow researchers to analyze differences in securities.

With statistical power and a sufficiently large sample size, researchers can conduct analysis of what impact (1) reductions in fees and (2) reductions in or prohibitions on rebates might have, if any, on stocks depending on their trading volume or market capitalization. A pilot design that would not provide this meaningful data about the impact that billions of dollars of exchange fees and rebates may have on the markets and market structure, would not achieve the Commission's goal of conducting a pilot capable of facilitating an objective empirical view to advance that debate.

To achieve these aims, using econometric methods designed to allow researchers to detect a 10% change with a standard confidence level of 95%, the Commission has determined that 730 securities in each Test Group are needed to enable the Pilot to produce statistically meaningful results capable of informing the Commission's future policymaking efforts. The Commission believes that a 10% change in behavior represents an economically meaningful change that will facilitate analysis of the Pilot's results, and therefore is an appropriate standard for the Pilot.
186

The determination to include 730 securities in each Test Group accounted for the need to obtain statistically significant results among stocks of various liquidity profiles as well as ETPs. While the number of NMS stocks that will be included in each Test Group will be larger than what was recommended by some commenters, the Commission believes that a smaller number of stocks may not have sufficient statistical power given the Pilot's proposed duration.
187

186
A confidence level of 95% is a standard accepted confidence level in statistical analyses.
See, e.g.,
William H. Greene, Econometric Analysis 1033 (Appendix C.6) (6th ed. 2007) (discussing standard confidence levels in academic research).

187

See also
note 695
infra.

Furthermore, in response to comments questioning why the Pilot included more securities than did the Tick Size Pilot, the Commission notes that the Tick Size Pilot featured 400 corporate stocks for each of its Test Groups.
188

Importantly, the Tick Size Pilot did not contain ETPs or large-cap stocks. In comparison, the Transaction Fee Pilot will contain ETPs and large-cap stocks. Accordingly, in light of the significantly higher number of securities eligible for inclusion, the Transaction Fee Pilot needs to include considerably more Pilot Securities than did the Tick Size Pilot, while continuing to achieve the same statistical power for each of those groups of securities.

188

See, e.g.,
Citadel Letter, at 6; TD Ameritrade Letter, at 2; Cboe Letter I, at 27.
See also
Securities Exchange Act Release No. 74892 (May 6, 2015), 80 FR 27514, 27517 (May 13, 2015) (File No. 4-657) (order approving the National Market System Plan to Implement a Tick Size Pilot Program).

Moreover, while several commenters either implicitly or explicitly referenced the EMSAC recommendation to include 100 stocks in each Test Group, EMSAC's recommendation differs substantially from the Commission's proposal. Notably, the EMSAC recommendation was limited to common stocks with a

market capitalization above $3 billion and did not include ETPs, mid- and small-cap stocks, or other types of NMS stocks. In order for the Pilot to permit a broader empirical review of the impact of transaction fees and rebates on order routing, execution quality, and market quality, it is critical that the sample size be representative of the population of NMS stocks for which exchange transaction fees and rebates are economically meaningful. The Pilot must

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2018-27982. Public record. Not legal advice.