# Amendments Regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2022-01975

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** March 18, 2022
- **Citation:** 87 FR 15496

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 232, 240, 242, and 249
[Release No. 34-94062; File No. S7-02-22]
RIN 3235-AM45
Amendments Regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is proposing to amend Rule 3b-16 under Securities Exchange Act of 1934 (“Exchange Act”), which defines certain terms used in the statutory definition of “exchange” under Section 3(a)(1) of the Exchange Act to include systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities. In addition, the Commission is re-proposing amendments to its regulations under the Exchange Act that were initially proposed in September 2020 for ATSs to take into consideration systems that may fall within the definition of exchange because of the proposed amendments and operate as an ATS. The Commission is re-proposing, with certain revisions, amendments to its regulations for ATSs that trade government securities as defined under Section 3(a)(42) of the Exchange Act (“government securities”) or repurchase and reverse repurchase agreements on government securities (“Government Securities ATSs”). The Commission is also proposing to amend Form ATS-N for NMS Stock ATSs, which would require existing NMS Stock ATSs to amend their existing disclosures. In addition, the Commission is proposing to amend the fair access rule for ATSs. The Commission is also proposing to require electronic filing of and to modernize Form ATS-R and Form ATS, which would require existing Form ATS filers to amend their existing disclosures. Further, the Commission is re-proposing amendments to its regulations regarding systems compliance and integrity to apply to ATSs that meet certain volume thresholds in U.S. Treasury Securities or in a debt security issued or guaranteed by a U.S. executive agency, or government-sponsored enterprise (“Agency Securities”).

DATES:

Comments should be received on or before April 18, 2022.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form (
https://www.sec.gov/regulatory-actions/how-to-submit-comments
); or

• Send an email to
rule-comments@sec.gov.
Please include File Number S7-02-22 on the subject line.

Paper Comments

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

All submissions should refer to File Number S7-02-22. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's internet website (
https://www.sec.gov/rules/proposed.shtml
). Comments are also available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Operating conditions may limit access to the Commission's public reference room. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly.

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

FOR FURTHER INFORMATION CONTACT:

Regulation ATS: Tyler Raimo, Assistant Director, at (202) 551-6227; Matthew Cursio, Special Counsel, at (202) 551-5748; David Garcia, Special Counsel, at (202) 551-5681; Megan Mitchell, Special Counsel, at (202) 551-4887; Amir Katz, Special Counsel, at (202) 551-7653; and Joanne Kim, Attorney Advisor, at (202) 551-4393, and for Regulation SCI: David Liu, Special Counsel, at (312) 353-6265 and Sara Hawkins, Special Counsel, at (202) 551-5523, Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is proposing amendments to the following rules under the Exchange Act: (1) 17 CFR 232.101 (Rule 101 of Regulation S-T); (2) 17 CFR 240.3b-16 (Rule 3b-16); (3) 17 CFR 242.300 (Rule 300 of Regulation ATS);
1

(4) 17 CFR 242.301 (Rule 301 of Regulation ATS); (5) 17 CFR 242.302 (Rule 302 of Regulation ATS); (6) 17 CFR 242.304 (Rule 304 of Regulation ATS);
2

and (7) 17 CFR 242.1000 (Rule 1000 of Regulation SCI).
3

1
“Regulation ATS” consists of 17 CFR 242.300 through 242.304 (Rules 300 through 304 under the Exchange Act).
See also
Regulation ATS Adopting Release,
infra
note 31.

2
The Commission adopted Rule 304 on July 18, 2018.
See
Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018) (“NMS Stock ATS Adopting Release”).

3
The Commission adopted 12 CFR 242.1000 through 242.1007 (Regulation SCI) on November 19, 2014.
See
Securities Exchange Act Release No. 73639 (November 19, 2014), 79 FR 72252 (December 5, 2014) (“Regulation SCI Adopting Release”).

I. Introduction

In September 2020, the Commission issued a proposal to amend Regulation ATS and Regulation SCI for Government Securities ATSs (“2020 Proposal”).
4

The Commission recognized the critical role of government securities in the U.S. and global economy, the significant volume in government securities transacted on systems currently operating as ATSs, and these ATSs' growing importance to investors and overall securities market structure. Notwithstanding their importance for government securities, the investor protection and fair and orderly market principles of Regulation ATS have limited application to Government Securities ATSs.
5

For

example, an ATS that limits its securities activities to government securities or reverse repurchase agreements on government securities (“repos”) and registers as a broker-dealer or is a bank (
i.e.,
a Currently Exempted Government Securities ATS) is exempt from exchange registration and is not required to comply with Regulation ATS. Further, ATSs that trade
both
government securities and non-government securities (
e.g.,
corporate bonds) are subject to Regulation ATS but are not required to comply with many of its investor protection and fair and orderly markets provisions, including public transparency rules and the obligation to provide fair access to investors if the ATS has significant trading volume. In addition, ATSs that trade government securities are not subject to the systems integrity provisions of Regulation SCI.

4

See
Securities Exchange Act Release No. 90019 (September 28, 2020), 85 FR 87106 (December 31, 2020).

5
For the purposes of this re-proposal, the term “Government Securities ATS” refers to an ATS that trades government securities or repos and includes ATSs that would be subject to Regulation ATS after the effective date of any final rule. This term includes three categories of ATSs. First, a “Currently Exempted Government Securities ATS” means an ATS that trades government securities or repos, is operating as of the effective date of any final rule, and was formerly not required to comply with Regulation ATS under 17 CFR 240.3a1-1(a)(3) (Exchange Act Rule 3a1-1(a)(3)) exemption prior to the effective date of any final rule. Second, a “Current Government Securities ATS” means an ATS that trades government securities or repos and is operating pursuant to an initial operation report on Form ATS on file with the Commission as of the effective date of any final rule. Finally, when referring to regulatory requirements after the effective date of any final rule, the term “Government Securities ATS” also includes a Communication Protocol System that trades U.S.

Government securities or repos on U.S. Government securities and that chooses to operate as an ATS after the effective date of any final rule. A “Communication Protocol System” would include a system that offers protocols and the use of non-firm trading interest to bring together buyers and sellers of securities. The re-proposal also uses the term “Legacy Government Securities ATS,” which includes all ATSs that trade government securities or repos and are operating as of the effective date of any final rule, regardless of whether the ATSs are operating pursuant to an initial operation report on Form ATS on file with the Commission (
i.e.,
all Current Government Securities ATSs and Currently Exempted Government Securities ATSs).

To promote operational transparency, investor protection, system integrity, fair and orderly markets, and regulatory oversight for Government Securities ATSs, the Commission proposed in the 2020 Proposal to: Eliminate the exemption from compliance with Regulation ATS for Currently Exempted Government Securities ATSs; require all Government Securities ATSs to publicly file Form ATS-G, on which they would disclose information about their operations and potential conflicts of interest; provide a process for the Commission to review Form ATS-G disclosures for clarity, completeness, and potential violations of law and, if necessary, declare ineffective Form ATS-G filings; and require an ATS that has significant volume for U.S. Treasury Securities or Agency Securities to: (1) Establish reasonable standards for access to the ATS and apply those standards to all prospective and current subscribers in a fair and non-discriminatory manner pursuant Rule 301(b)(5) of Regulation ATS (“Fair Access Rule”); and (2) comply with the operational capability, security, business continuity planning, incident reporting, and related requirements under Regulation SCI.
6

The Commission issued a concept release (“Concept Release”) in addition to the 2020 Proposal on the regulation of fixed income electronic trading platforms.
7

The Concept Release requested comments on a wide range of topics, including the different regulatory treatment among fixed income electronic trading platforms that use diverse trading protocols or business models and various aspects of government securities, corporate bonds, and municipal securities trading, including their operations, services, fees, market data, and participants.

6
The Commission also had proposed to amend Regulation ATS to: Require that Form ATS and Form ATS-R be filed with the Commission electronically through the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system and modernize both forms; eliminate confidential treatment of the types of securities that an ATS trades as disclosed on the ATS's Form ATS and Form ATS-R; update and correct Form ATS-N; change the reasons for which the Commission could extend the initial Form ATS-N review period; require NMS Stock ATSs to post on their websites the most recently disseminated Form ATS-N, except for any amendment that the Commission has declared ineffective or that has been withdrawn; and remove the exclusion from compliance with the Fair Access Rule and Rule 301(b)(6) under Regulation ATS for an ATS that matches non-displayed customer orders using prices disseminated by an effective transaction reporting plan.

7

See
2020 Proposal,
supra
note 4.

The Commission received comments in response to the 2020 Proposal and Concept Release.
8

Commenters expressed broad support for the 2020 Proposal. In general, commenters supported the proposed requirements to remove the exemption for Currently Exempted Government Securities ATSs and to require public disclosures on Form ATS-G.
9

However, some commenters expressed concern regarding aspects of the 2020 Proposal, including the proposed enhanced disclosure requirements and effectiveness regime
10

and the proposal to require Government Securities ATSs that meet certain volume thresholds to register as national securities exchanges.
11

In addition, commenters who opined on the Fair Access Rule and Regulation SCI had differing views about whether and how to apply them to Government Securities ATSs.
12

8
These comment letters are available at
https://www.sec.gov/comments/s7-12-20/s71220.htm
and discussed throughout this proposal.

9

See, e.g.,
letter from Marcia E. Asquith, Executive Vice President & Corporate Secretary, Financial Industry Regulatory Authority, Inc., dated March 1, 2021 (“FINRA Letter”) at 2; letter from Rob Toomey, Managing Director & Associate General Counsel, Securities Industry and Financial Markets Association, Chris Killian, Managing Director, Securitization and Credit, Securities Industry and Financial Markets Association, and Leslie Norwood, Managing Director, Associate General Counsel, Securities Industry and Financial Markets Association, dated March 1, 2021 (“SIFMA Letter”) at 2; letter from Elisabeth Kirby, Head of U.S. Market Structure, Tradeweb Markets Inc., dated March 1, 2021 (“Tradeweb Letter”) at 2; letter from Jennifer W. Han, Chief Counsel & Head of Regulatory Affairs, Managed Funds Association, dated March 1, 2021 (“MFA Letter”) at 2-3; and Tyler Gellasch, Executive Director, Healthy Markets Association, dated March 22, 2021 (“Healthy Markets Letter”) at 7.

10

See
letter from Robert Laorno, General Counsel, ICE Bonds Securities Corporation, dated March 8, 2021 (“ICE Bonds Letter I”) at 5.

11

See
letter from Kathleen M. Cronin, Senior Managing Director, General Counsel and Corporate Secretary, CME Group Inc., dated February 26, 2021 (“BrokerTec Letter”) at 3-4.

12

See, e.g.,
SIFMA Letter at 5 (supporting the proposed volume thresholds); Americans for Financial Reform Education Fund, dated March 1, 2021 (“AFREF Letter”) at 3 (supporting the proposed threshold with respect to Regulation SCI and stating that they believe the proposed threshold for the Fair Access Rule is too low); Healthy Markets Letter at 10-11 (recommending a lower threshold for Regulation SCI); letter from Gregory Babyak, Global Head of Regulatory Affairs, Bloomberg L.P., dated March 1, 2021 (“Bloomberg Letter”) at 5-6 (stating that the proposed thresholds are too high); ICE Bonds Letter I at 5 (suggesting a 20 percent threshold for application of Regulation SCI); Tradeweb Letter at 3, 11 (recommending a “more material” threshold for applying Regulation SCI).
See also infra
Sections III.B.4 and III.C.

In addition, the Commission received substantial comment on the Concept Release, in particular concerning the regulatory framework for fixed income electronic trading platforms. Many commenters recognized that certain electronic trading platforms for fixed income securities are not regulated as registered exchanges or ATSs despite performing the same market function as those regulated markets.
13

Several commenters expressed support for the Commission to expand the scope of its exchange regulation to encompass more fixed income platforms,
14

while several other commenters believed that such action is not necessary or appropriate.
15

13

See, e.g.,
letter from Stephen John Berger, Managing Director, Global Head of Government and Regulatory Policy, Citadel, dated March 1, 2021 (“Citadel Letter”); letter from Joanna Mallers, Secretary, FIA Principal Traders Group, dated March 1, 2021 (“FIA PTG Letter”) at 2; letter from Robert Laorno, General Counsel, ICE Bonds Securities Corporation, dated March 15, 2021 (“ICE Bonds Letter II”) at 2-4; FINRA Letter at 6; MFA Letter at 8; Tradeweb Letter at 4.

14

See, e.g.,
Citadel Letter; FIA PTG Letter; ICE Bonds Letter II.

15

See, e.g.,
letter from Sarah A. Bessin, Associate General Counsel, Investment Company Institute and Nhan Nguyen, Counsel, Investment Company Institute, dated March 1, 2021 (“ICI Letter”) at 2, 7; letter from Scott Pintoff, General Counsel, MarketAxess, dated March 1, 2021 (“MarketAxess Letter”) at 2-4; Bloomberg Letter at 17-20.

Advances in technology and innovation since Regulation ATS was adopted in 1998
16

have changed the methods by which securities markets bring together buyers and sellers of

securities. As discussed further below, innovations in trading protocols have increased efficiencies and access to discover liquidity and prices, search for a counterparty, and agree upon the terms of a trade. Instead of using exchange markets that offer only the use of firm orders and provide matching algorithms, market participants are able to connect to numerous Communication Protocol Systems, which offer the use of protocols and non-firm trading interest to bring together buyers and sellers of securities. Communication Protocol Systems today perform similar market place functions of bringing together buyers and sellers as registered exchanges and ATSs and have become an increasingly preferred choice of trading venue, particularly for fixed income securities. However, as a function of how Exchange Act Rule 3b-16 currently defines the terms in Section 3(a)(1) of the Exchange Act, Communication Protocol Systems do not fall within the definition of exchange. As a result, Communication Protocol Systems are not subject to the same regulatory requirements as registered exchanges and ATSs and the investors using them do not receive the investor protection, fair and orderly markets, transparency, and oversight benefits stemming from exchange regulation. Further, by Communication Protocol Systems falling outside the definition of exchange, a disparity has developed among similar markets that bring together buyers and sellers of securities, in which some are regulated as exchanges and others are not. This regulatory disparity can create a competitive imbalance and a lack of investor protections.
17

16

See
Regulation ATS Adopting Release,
infra
note 31.

17

See infra
Section VIII.C.3.a.

Given the changing conditions among markets to bring together buyers and sellers of securities, and taking into consideration comment letters submitted in response to the 2020 Proposal and the Concept Release, the Commission is proposing to amend Exchange Act Rule 3b-16 regarding what “shall be considered to constitute, maintain, or provide `a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange' as those terms are used” in the statutory definition of “exchange” under Exchange Act Section 3(a)(1).
18

The proposed amendments to Exchange Act Rule 3b-16(a) would include Communication Protocol Systems that make available for trading any type of security, including, among others, government securities, corporate bonds, municipal securities, NMS stocks, equity securities that are not NMS stocks, private restricted securities, repurchase agreements and reverse repurchase agreements, foreign sovereign debt, and options. Including Communication Protocol Systems within the definition of “exchange” would appropriately regulate a market place that brings together buyers and sellers of securities, extend the benefits of the exchange regulatory framework to investors that use such systems, and reduce regulatory disparities among like markets.

18
17 CFR 240.3b-16(a).

In addition, because the Commission is proposing to amend Exchange Act Rule 3b-16 to include Communication Protocol Systems within the definition of exchange and taking into consideration comments received in response to the 2020 Proposal and the Concept Release, the Commission is re-proposing and revising previously proposed amendments to Regulation ATS and Regulation SCI for Government Securities ATSs that include the following:
19

(1) Re-proposing to eliminate the exemption from compliance with Regulation ATS for an ATS that trades only government securities or repos and is operated by a broker-dealer or is a bank; (2) re-proposing, with certain revisions, to require a Government Securities ATS that has significant volume for U.S. Treasury Securities or Agency Securities to comply with the Fair Access Rule under Regulation ATS and Regulation SCI;
20

(3) re-proposing to apply the enhanced disclosure and filing requirements of Rule 304 of Regulation ATS, which are currently applicable to NMS Stock ATSs, to all Government Securities ATSs; (4) proposing to require Government Securities ATSs to file Form ATS-N, as revised, instead of previously proposed Form ATS-G;
21

(5) proposing several changes to Form ATS-N that would be applicable to both Government Securities ATSs and NMS Stock ATSs, including questions about the ATS's interaction with related markets, liquidity providers, and activities the ATS undertakes to surveil and monitor its market; (6) proposing amendments to Form ATS-N that would require existing NMS Stock ATSs to file an amendment to their existing disclosures on Form ATS-N; (7) proposing to add a new type of amendment to Form ATS-N to report changes to fee disclosures; (8) proposing to amend the Form ATS-N review and effectiveness process to permit the Commission to extend the review period for Form ATS-N amendments;
22

(9) proposing to make certain changes to the Fair Access Rule that would apply to all ATSs that are subject to the rule;
23

and (10) re-proposing electronic filing of Form ATS-R and Form ATS and proposing certain changes to the categories of securities reported on Form ATS-R.
24

19
U.S. Treasury Securities and Agency Securities are not classes of securities for purposes of Exchange Act Rule 3a1-1(b).

20
The Commission is re-proposing to amend Regulation ATS to require that Form ATS and Form ATS-R be filed with the Commission electronically through EDGAR and to modernize both forms; eliminate confidential treatment of the types of securities that an ATS trades as disclosed on the ATS's Form ATS and Form ATS-R; and remove the exclusion from compliance with the Fair Access Rule and Rule 301(b)(6) under Regulation ATS for an ATS that matches non-displayed customer orders using prices disseminated by an effective transaction reporting plan. Covered ATSs would not be required to post on their websites the most recently disseminated Form ATS-N, but would be required to provide pursuant to Rule 304(b)(3)(i) a direct URL hyperlink to the Commission's website that contains the documents made public by the Commission under Rule 304(b)(2).

21
In the 2020 Proposal, the Commission proposed that Government Securities ATSs file proposed Form ATS-G. Given the significant overlap between proposed Form ATS-G and existing Form ATS-N, the Commission is now proposing that Government Securities ATSs file Form ATS-N, which is currently filed by NMS Stock ATSs, and proposing to revise Form ATS-N to apply disclosures for Government Securities ATSs that would fall under the proposed definition of “exchange.”
See
Appendix A for the proposed revisions to Form ATS-N. The Commission believes that this would limit the number of unique forms and simplify filing requirements.

22
The Commission is also re-proposing to change the reasons for which the Commission could extend the initial Form ATS-N review period.
See infra
Section IV.A.

23

See infra
Section V.A.

24

See infra
Section V.B.

II. Proposed Amendments Regarding the Definition of Exchange

A. Exchange Regulatory Framework

Exchange Act Section 3(a)(1) states that the term “exchange” means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.
25

25

See
15 U.S.C. 78c(a)(1).

Section 5 of the Exchange Act
26

requires an organization, association, or

group of persons that meets the definition of “exchange” under Section 3(a)(1) of the Exchange Act,
27

unless otherwise exempt, to register with the Commission as a national securities exchange pursuant to Section 6 of the Exchange Act.
28

As discussed further below, registered national securities exchanges are self-regulatory organizations (“SROs”),
29

and must comply with regulatory requirements applicable to both national securities exchanges and SROs.
30

26
15 U.S.C. 78e.

27

See infra
note 31.

28
15 U.S.C. 78f. A “national securities exchange” is an exchange registered as such under Section 6 of the Exchange Act.

29
Section 3(a)(26) of the Exchange Act defines a self-regulatory organization as any national securities exchange, registered securities association, registered clearing agency, or (with limitations) the Municipal Securities Rulemaking Board (“MSRB”).
See
15 U.S.C. 78c(a)(26).
See also
Securities Exchange Act Release No. 76474 (November 18, 2015), 80 FR 80998, 81025 (December 28, 2015) (“NMS Stock ATS Proposing Release”) at 81000-01 nn.20-26 and accompanying text (discussing certain differences between certain obligations and benefits applicable to national securities exchanges and those applicable to ATSs).

30

See, e.g.,
15 U.S.C. 78f and 78s.

In the Exchange Act, Congress provided a broad definition of the term “exchange,” permitting the Commission to apply the definition flexibly as the securities markets evolve over time.
31

In 1998, the Commission adopted Regulation ATS.
32

At that time, the Commission recognized that advances in technology had increasingly blurred the line between exchange and broker-dealer activities
33

and that ATSs that existed then were used by market participants as functional equivalents of exchanges.
34

To more accurately describe the range of markets that performed exchange functions at that time, the Commission concurrently adopted Exchange Act Rule 3b-16 to define terms
35

used in the statutory definition of “exchange” under Exchange Act Section 3(a)(1).

31

See
Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844, 70850 and 70898 (December 22, 1998) (“Regulation ATS Adopting Release”).
See also
15 U.S.C. 78e and 78f. The Commission noted that it was recognized at the time the Exchange Act was enacted that a regulatory structure for securities exchanges would “be of little value tomorrow if it is not flexible enough to meet new conditions immediately as they arise and demand attention in the public interest.”
See
Regulation ATS Adopting Release at 70898, n.520 (citing Commission, Report of the Special Study of the Securities Markets of the Securities and Exchange Commission, H.R. Doc. No. 95, 88th Cong., 1st Sess. Pt. 1 (1963) at 6 and S. Rep. No. 792, 73rd Cong., 2d Sess. (1934) at 5 (noting that “exchanges cannot be regulated efficiently under a rigid statutory program,” and that “considerable latitude is allowed for the exercise of administrative discretion in the regulation of both”)).

32

See
Regulation ATS Adopting Release,
supra
note 31, at 70850.

33

See id.
at 70847.

34

See id.

35
The Commission adopted Exchange Act Rule 3b-16 under Section 3(b) of the Exchange Act (power to define terms). 15 U.S.C. 78c(b).

In Exchange Act Rule 3b-16(a), the Commission defined these terms, in light of the markets that existed at that time, to include any organization, association, or group of persons that: (1) Brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.
36

Rule 3b-16(b) explicitly excluded certain systems that the Commission believed were not exchanges.
37

Accordingly, a system is not included in the Commission's interpretation of “exchange” if: (1) The system fails to meet the two-part test in paragraph (a) of Rule 3b-16; (2) the system falls within one of the exclusions in paragraph (b) of Rule 3b-16; or (3) the Commission otherwise conditionally or unconditionally exempts
38

the system from the definition.

36

See
17 CFR 240.3b-16(a).

37

See
Regulation ATS Adopting Release,
supra
note 31, at 70852. Specifically, Rule 3b-16(b) excludes from the definition of exchange systems that perform only traditional broker-dealer activities, including: Systems that route orders to a national securities exchange, a market operated by a national securities association, a broker-dealer for execution, or systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met.

38

See
17 CFR 240.3b-16(e).

When the Commission adopted Exchange Act Rule 3b-16, the Commission also adopted Exchange Act Rule 3a1-1(a) to exempt ATSs from the definition of “exchange” under Section 3(a)(1) of the Exchange Act. Exchange Act Rule 3a1-1(a)(2)
39

exempts from the Exchange Act Section 3(a)(1) definition of “exchange” an organization, association, or group of persons that complies with Regulation ATS,
40

which requires, among other things, meeting the definition of an ATS and registering as a broker-dealer.
41

Rule 300(a) of Regulation ATS defines an ATS as any organization, association, person, group of persons, or system: (1) That constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16; and (2) that does not: (i) Set rules governing the conduct of subscribers other than the conduct of such subscribers' trading on such organization, association, person, group of persons, or system; or (ii) discipline subscribers other than by exclusion from trading.
42

Governing the conduct of or disciplining subscribers are functions performed by an SRO that the Commission believed should be regulated as such.
43

Accordingly, pursuant to Rule 300(a), a trading system that performs SRO functions or functions common to national securities exchanges, such as establishing listing standards, is precluded from the definition of ATS and would be required to register as a national securities exchange, be operated by a national securities association, or seek another exemption.
44

39

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

40

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

Rule 3a1-1(b) provides an exception to the Rule 3a1-1(a) exemptions pursuant to which the Commission may require a trading system that is a substantial market to register as a national securities exchange, if the Commission finds doing so is necessary or appropriate in the public interest or consistent with the protection of investors.
See
17 CFR 240.3a1-1(b).
See also
Regulation ATS Adopting Release,
supra
note 31, at 70857-58.

41

See
17 CFR 242.300(a); 17 CFR 242.301(a); and 17 CFR 242.301(b)(1). In addition to the other requirements of Regulation ATS, to qualify for the Rule 3a1-1(a) exemption, an organization, association, or group of persons must otherwise meet the definition of “exchange.”

42

See
17 CFR 242.300(a).

43

See
Regulation ATS Adopting Release,
supra
note 31, at 70859.

44

See id.

As a result of the exemption, an ATS that complies with Regulation ATS is not required by Section 5 of the Exchange Act to register as a national securities exchange, is not an SRO, and, therefore, is not required to comply with regulatory requirements applicable to national securities exchanges and SROs.
45

An ATS that fails to comply with the requirements of Regulation ATS would no longer qualify for the exemption provided under Rule 3a1-1(a)(2), and thus, risks operating as an unregistered exchange in violation of Section 5 of the Exchange Act.
46

45

See generally
Sections 5, 6, and 19 of the Exchange Act, 15 U.S.C. 78e, 78f, and 78s.

46

See
15 U.S.C. 78e.

B. Adopting the Definition of Exchange for Evolving Market Places

1. Orders-Focused Markets Under Current Rule 3b-16

When the Commission adopted Exchange Act Rule 3b-16(a), the Commission sought to more accurately describe the range of markets that performed exchange functions as those were understood at that time.
47

In the Regulation ATS Adopting Release, the Commission observed that ATSs at that time provided services more akin to exchange functions than broker-dealer functions, such as matching counterparties' orders, executing trades, operating limit order books, and facilitating active price discovery.
48

47

See
Regulation ATS Adopting Release,
supra
note 31, at 70900.

48

See id.
at 70848.

In the Regulation ATS Adopting Release, the Commission identified two elements of Exchange Act Rule 3b-16 that most accurately reflected the functions and uses of exchange markets at that time. These elements were the bringing together of orders of multiple buyers and sellers of securities and that trading takes place according to established, non-discretionary rules or procedures.
49

When considering what constituted an exchange at that time, the Commission focused on the expectations of the participants regarding how an execution would occur without the discretion of the operator. Because orders instruct a trading system to carry out the intention of participants in accordance with programmed trading procedures, orders, along with established, non-discretionary methods, contribute to how trading system participants could understand and expect to receive an execution.
50

In addition, the Commission stated that “an essential indication of the non-discretionary status of rules and procedures is that those rules and procedures are communicated to the systems users” and “[t]hus, participants have an expectation regarding the manner of execution—that is, if an order is entered, it will be executed in accordance with those procedures and not at the discretion of a counterparty or intermediary.”
51

49

See id.
at 70900.

50
For example, the Commission stated in the Regulation ATS Adopting Release that “an alternative trading system that posts firm orders to buy and sell a security does raise a certain expectation of execution at those quoted prices” and that “[t]he expectation is based on the life of the outstanding orders in the system, rather than continuous two sided quotations published by specialist and market makers.”
See id.
at 70899, n.532.

51

See id.
at 70900.

Further, at the time Exchange Act Rule 3b-16(a) was adopted, most ATSs operating met the criteria of the rule in that they offered the use of orders and algorithms that matched orders.
52

ATSs at that time allowed broker-dealers to place and execute orders on the system and the systems functioned as limit order books where orders are executed according to time, price, and size priority.
53

Accordingly, orders and established, non-discretionary methods undergirded Exchange Act Rule 3b-16 to reflect functions of exchange markets at that time. When discussing orders in the Regulation ATS Adopting Release, however, the Commission stated that systems that displayed bona fide, non-firm trading interest
54

or did not establish rules or operate a trading facility
55

would not fall within Rule 3b-16(a).

52

See id.
at 70899-900, n.536.

53

See id.
at 70899, n.525.

54

See id.
at 70850. In the Regulation ATS Adopting Release, the Commission stated, “[g]enerally, however, a system that displays
bona fide,
non-firm indications of interest—including, but not limited to indications of interest to buy or sell a particular security without either prices or quantities associated with those indications—will not be displaying “orders” and, therefore, not fall within Rule 3b-16.”
See id.

55

See id.
The Commission also stated that “[u]nless a system also establishes rules or operates a trading facility under which subscribers can agree to the terms of their trades, the system will not be included within Rule 3b-16, even if it brings together `orders.' ”
See id.

2. Prevalence of Systems Offering Non-Firm Trading Interest and Structured Protocols

Advances in technology have facilitated innovations and more efficient or diverse methods to bring together buyers and sellers of securities.
56

In the Commission's experience, Communication Protocol Systems, which can use various technologies and connectivity, generally offer the use of non-firm trading interest and establish protocols to prompt and guide buyers and sellers to communicate, negotiate, and agree to the terms of the trade without relying solely on the use of orders. Below is a non-exhaustive list of some Communication Protocol Systems.

56

See id.
at 70848.

One example of a Communication Protocol System is a “Request-for-Quote” (“RFQ”) system. RFQ systems are designed to allow market participants to obtain quotes for a particular security by sending messages to one or multiple potential respondents on the system simultaneously. RFQ systems may be “disclosed,” in which case the participants with established relationships interact only with each other, or anonymous, in which case the parties may not have established relationships. The system provider requires a participant to enter information in a message, which may include the name of the initiator, Committee on Uniform Securities ldentificalion Procedures (CUSIP) number, side, and size. The system provider also provides protocols for participants to communicate with each other and negotiate a price or size of a trade. For example, participants receiving an RFQ message can choose to interact with the initiator by responding within a time period designated by the system provider with a priced quote. These methods can serve the same function as auctions where the respondents compete to offer the best price. The initiator can then select among the quote responses that it wishes to interact with through the system by either accepting one of multiple responses or rejecting all responses within a period of time set by the system provider. The match of the request and response results in an agreement to the terms of the trade between a buyer and a seller, which then proceeds to post-trade processing.
57

An RFQ list protocol (“RFQ List”), which is a form of RFQ protocol used commonly to trade U.S. Treasury Securities, may include a collection of RFQ inquiries that are submitted as a group but priced as individual items.
58

The RFQ List (defined by each system provider but generally more than two listed items) may be executed in its entirety, in pieces, or not at all. A liquidity provider that is responding to the list request may apply a “good for” time that is associated with the executable prices provided.

57
Communication Protocol Systems also may offer a workup functionality or blotter scraping functionality to gather non-firm trading interest and facilitate the negotiation and execution of trades. In a workup, a system may have a private phase, where the two original contra-parties submitting orders can negotiate, and a public phase where all subscribers can submit orders at the workup price.

58
An RFQ List may be referred to as a Bid Wanted in Competition (“BWIC”) or Offer Wanted in Competition (“OWIC”) in the corporate bond market. Both serve a similar purpose to the RFQ List in allowing the submitter to solicit bids and offers on a number of securities at one time.

A Communication Protocol System could also include a system that electronically displays continuous firm or non-firm trading interest, or “stream axes,” in a security or type of security to participants on the system. Axes typically represent an indication of

interest to sell or buy a bond (but can include firm quotes), and can either serve as a starting point for negotiation between participants or be executed immediately. Systems that stream axes take many forms. Some system providers provide connectivity and protocols for participants to electronically communicate and negotiate the terms of a trade. Other system providers offer participants more automated processes, whereby participants auto-execute against a streamed quote and agree upon the terms of a trade without negotiation. Typically, the system is programmed with permission options to allow participants to decide who can or cannot receive their axes. In such a case, the trading interest exchanged between the parties is typically firm and functions as orders.

Conditional order systems may be Communication Protocol Systems that offer the use of trading interest that may not be executable until after a user takes subsequent action. For example, a system provider may require conditional orders to contain a symbol, side, and size and provide protocols for participants to send and receive invitation messages to trade. The system would be designed for conditional orders to match with other trading interest, which can either be a firm order or another non-firm conditional order.
59

Upon a match, the system may send a firm-up invitation messages to both participants. The system protocols may permit a participant using a conditional order to either decline the firm-up invite, accept the firm-up invite, or counter the response to firm up.
60

During the time that the parties' trading interest is matched until the invitation to firm-up expires, is canceled, is executed, or is declined, the system protocols may require that the non-firm trading interest be committed and the shares cannot trade elsewhere.
61

Using the system protocols, the matched parties can modify the attributes of the non-firm trading interest (
i.e.,
price, size) before accepting the firm-up invitation. To the extent either a seller or buyer changes the attributes, an execution will only occur if each contra-party's corresponding attributes will still be met. If both matching parties accept the firm-up invite, the parties would agree upon the terms of the trade and an execution would occur.

59
Based on Commission staff experience, some NMS Stock ATSs disclose protocols to allow conditional orders to interact with the ATS's limit order book, thereby increasing the interaction among potential buyers and sellers and access to liquidity.

60
An order resting on an ATS limit order book that can interact with a conditional order does not receive a firm-up invite and therefore does not send firm-up responses.

61
Many conditional order and RFQ systems monitor their participants' firm-up rates and may limit or deny the use of the system by a participant if the participant's firm-up rate falls below a certain percentage. While the system provider typically monitors these firm-up rates to help ensure that participants do not abuse the system, such monitoring and actions taken against participants for not firming-up may incentivize participants to not back away. Thus, conditional orders or RFQs can be firm in practice and in this way may meet the definition of order under current Regulation ATS.
See
17 CFR 242.300(e) (“any firm indication of a willingness to buy or sell a security”).

Other systems have developed to bring together buyers and sellers of securities through the use of bilateral negotiation protocols and non-firm trading interest. Negotiation systems focus on providing a forum for buyers and sellers to see displayed non-firm trading interest, access liquidity, find a counterparty, and negotiate a trade through the use of their communication technology. The system may allow participants to select certain pre-approved participants and then exchange messages for purposes of agreeing to the terms of a trade. Negotiation systems may have fewer parameters for communicating trading interest than RFQ protocols; for example, negotiation systems provide features that are designed to prompt participants to interact with each other and provide parameters around that interaction, such as time for responses or requirements on the content of the message. A system may “scrape” or obtain the symbol of trading interest that a participant is seeking from the participant's order management or execution management system and use that to alert other participants on its system about potential contra-side interest in seeking to initiate a negotiation. The market participants using negotiation systems may complete a transaction outside of the system.

As trading in securities has become more electronic, Communication Protocol Systems perform the function of a market place and have become a preferred method for market participants to discover prices, find a counterparty, and execute a trade, particularly for government securities and other fixed income markets. One commenter on the 2020 Proposal and Concept Release, for example, stated that multilateral trading venues using RFQ protocols are some of the most significant multilateral trading venues operating in fixed income markets regulated by the Commission, including the U.S. Treasury market.
62

This commenter stated that RFQ trading venues dominate the dealer-to-customer segment of the U.S. Treasury market and in the aggregate account for approximately 50 percent of total electronic trading volume on multilateral U.S. Treasury trading venues.
63

Another large electronic trading venue for fixed income products estimated that its average daily volume using an RFQ protocol increased from $223 million in the second quarter of 2017 to $1.17 billion in the second quarter of 2021.
64

Systems offering conditional order protocols have increased over the past several years, particularly for trading NMS stocks. Today, 26 NMS Stock ATSs have disclosed on their public Form ATS-N that they send or receive messages indicating trading interest, such as conditional orders.

62

See
Citadel Letter at 1-2.

63

See id.
This commenter noted that multilateral RFQ trading venues are formally registered in other asset classes and jurisdictions, and that there are “well-established precedents” to delineate the scope of multilateral trading venues subject to regulation.

64
Tradeweb Investor Presentation, July 2021,
available at: https://investors.tradeweb.com/static-files/e63caabf-d71d-46c0-9589-353fb8b93388.

Communication Protocol Systems, like registered exchanges and ATSs, offer their participants several benefits, including reducing counterparty search costs, bringing together diverse market participants, and making it efficient and simple to find a counterparty and agree upon the terms of a trade. These systems improve price discovery from the voice protocols that were used more widely in the fixed income market in the past by offering participants systems and protocols that are specifically designed to allow participants to contact, and receive responses from, multiple potential counterparties at one time, as opposed to the more time-consuming process of calling each potential counterparty individually. RFQ protocols, for example, allow an initiator to share and attempt to trade its entire trading interest all at once. In contrast, under a limit order book model, for example, the seeker of liquidity may find it can only execute its trading interest in a piecemeal fashion. RFQs also allow initiators to more easily demonstrate that they attempted to achieve best execution by showing that the initiator sent requests for quotes to multiple dealers for a security. In addition, participants may find conditional orders attractive when seeking to trade at size or to avoid information leakage.

While Communication Protocol Systems may bring together buyers and sellers for all types of securities and allow participants to negotiate a trade,

they are particularly useful to market participants to trade less liquid securities, find counterparties for large size trades, and minimize information leakage and adverse impact of large size trades. For example, market participants can use Communication Protocol Systems to post and see non-firm trading interest on several trading venues simultaneously, thereby increasing their ability to find a counterparty and reduce search costs. When resting non-firm trading interest on a trading venue, market participants can use non-firm trading interest as a tool to avoid the risk of double-execution.
65

Participants that use conditional orders, for example, may place the same trading interest at various trading centers in search of liquidity because it would allow them to accept or decline responses if they receive more than one. Participants may find locating a counterparty on a limit order book system for less liquid securities more difficult and choose instead to use a Communication Protocol System, such as an RFQ system, because such system allows the initiating participant to use non-firm trading interest to solicit quotes from multiple market participants for less liquid securities and negotiate a size or price for such securities.

65
For example, a market participant that rests the same non-firm trading interest on two trading venues has the ability to back away from one if both are lifted (
i.e.,
preliminarily matched). In such case, the market participant is able to complete one trade and cancel or back away from the other.

3. Lack of Investor Protections and Disparate Regulation Among Market Places

Given the changes in methods for bringing buyers and sellers together over the past couple of decades, the contrast between market place functions of exchanges that offer the use of orders and trading facilities and systems that offer the use of trading interest and protocols has become increasingly blurred. Both types of systems share the same business objectives and engage in similar market activities; however, one type of system is subject to the exchange regulatory framework while the other is not.
66

Today, Communication Protocol Systems perform similar market place functions as registered exchanges and ATSs and have become venues for investors to discover prices, find a counterparty, and agree upon the terms of a trade. Because Communication Protocol Systems do not fall within the definition of “exchange” and are thus not required to register as national securities exchanges, they are not required to comply with the same Federal securities laws and regulations applicable to registered exchanges
67

or ATSs.
68

Market participants use Communication Protocol Systems for certain advantages that these market places offer for trading securities; however, when doing so, market participants cannot avail themselves of the same investor protections, fair and orderly market principles, and Commission oversight that apply to today's registered exchanges or ATSs.
69

This regulatory gap also creates disparities that affect competitive balances among like market places for securities.
70

Consistent with the statutory definition of “exchange” in Exchange Act Section 3(a)(1), and as discussed above, today Communication Protocol Systems provide a “market place” for bringing together purchasers and sellers of securities.
71

The current proposal will use the flexibility granted to the Commission by Congress to update Exchange Act Rule 3b-16 to address these developments in the markets for securities, the corresponding lack of investor protections, and disparate regulation among these markets.
72

66

See
U.S. Securities and Exchange Commission Fixed Income Market Structure Advisory Committee (“FIMSAC”), Recommendation for the SEC to Review the Framework for the Oversight of Electronic Trading Platforms for Corporate and Municipal Bonds (July 16, 2018),
available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-electronic-trading-platforms-recommendation.pdf
(expressing concern about regulatory harmonization among fixed income trading platforms, recognizing that some firms were regulated as ATSs, while some were regulated as broker-dealers or not regulated at all).

67

See infra
Section II.D.1.

68

See infra
Section II.D.2.

69

See infra
Section II.D.

70

See infra
Section VIII.C.3.a.

71

See supra
Section II.A.

72
The Commission is not proposing to amend Exchange Act Rule 3b-16(b), which excludes from the definition of “exchange” systems that perform only traditional broker-dealer activities, including: Systems that route orders to a national securities exchange, a market operated by a national securities association, a broker-dealer for execution, or systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met. These systems would continue to not fall within the definition of “exchange.” As discussed below, and consistent with the Commission's views expressed in the Regulation ATS Adopting Release, a broker-dealer's exercise of discretion and judgment over its customers' orders or trading interest does not make the broker-dealer an exchange.
See
Regulation ATS Adopting Release,
supra
note 31, at 70851.
See also infra
Section II.C.3. The Commission is proposing to add an exclusion to Rule 3b-16(a) for systems that allow issuers to sell their own securities to investors.
See infra
Section II.C.2. Further, as explained below, the Commission is not proposing to include within the definition of “exchange” a system that unilaterally displays trading interest without offering a trading facility or communication protocols to bring together buyers and sellers. Also, systems that provide general connectivity for persons to communicate without protocols, such as utilities or electronic web chat providers, would not fall within the definition of exchange.
See id.

Including Communication Protocol Systems within the definition of “exchange” would provide market participants that use these market places with the investor protections, fair and orderly market principles, and Commission oversight provided by the exchange regulatory framework.
73

A Communication Protocol System that chooses to register as an exchange would be an SRO and be subject to the requirements of Section 6 of the Exchange Act, as discussed further below.
74

However, the Commission expects that many Communication Protocol Systems would choose instead to comply with the conditions of the Regulation ATS exemption, which includes registering as a broker-dealer.
75

As discussed further below, Communication Protocol Systems complying with Regulation ATS would also be subject to the Regulation ATS investor protection provisions, including the requirement to establish written safeguards and procedures to protect confidential subscriber trading information
76

and operational transparency requirements of Form ATS-N for ATSs that trade NMS stocks or government securities or repos.
77

They would also be subject to fair and orderly markets provisions under the Fair Access Rule.
78

Registering as a broker-dealer would subject a Communication Protocol System to Commission and Financial Industry Regulatory Authority (“FINRA”) oversight.
79

As a FINRA member, the Communication Protocol System would be subject to FINRA's investor protection and examination and market surveillance programs and would be required to comply with FINRA's trade reporting rules.

73

See infra
Section II.D.

74

See infra
Section II.D.1.

75

See infra
Section II.D.2.

76

See infra
note 170 and accompanying text.

77

See infra
notes 139-142 and accompanying text. A Communication Protocol System that operates as an ATS but trades securities other than NMS stocks or government securities would file Form ATS.

78

See infra
notes 154-155 and accompanying text.

79

See infra
notes 131-133 and accompanying text.

The proposal to include Communication Protocol Systems within the definition of exchange would promote competition by reducing cost disparities and creating a more level competitive landscape.
80

Several commenters in response to the Concept

Release expressed concerns regarding the disparity in regulatory treatment between exchanges, ATSs, and other fixed income platforms.
81

In addition, FIMSAC expressed concern about the lack of regulatory harmonization among fixed income electronic trading platforms, recognizing that some firms are regulated as ATSs, while others are regulated as broker-dealers or not at all, and stated that these distinctions in regulatory oversight complicate efforts to improve the efficiency and resiliency of the fixed income electronic trading markets.
82

In response to the Concept Release, one commenter stated that the current regulatory framework puts ATSs at a competitive disadvantage to non-ATS trading platforms, which are not subject to the same regulatory obligations designed to protect investors and the integrity of the fixed income markets.
83

Another commenter stated its belief that disparate regulatory treatment across trading platforms impacts market efficiency and competition and introduces potential resiliency risks.
84

Another commenter stated that electronic platforms for bringing together buyers and sellers of fixed income securities for the purpose of effecting transactions should generally be regulated the same regardless of how they are structured internally.
85

The Commission recognizes that the regulatory costs associated with registering and operating as a registered exchange are higher than the regulatory costs associated with registering as a broker-dealer and complying with Regulation ATS. However, Communication Protocol Systems operating outside the exchange regulatory framework are subject to neither national securities exchange nor ATS regulatory costs and therefore have an advantage when competing against other markets that also bring together buyers and sellers of securities.
86

As discussed further in Section VIII, a trading system that performs an exchange market function but is not subject to the exchange regulatory regime could receive a competitive advantage because such systems are not subject to the compliance costs to which regulated exchanges are subject.

80

See infra
Section VIII.C.3.a.

81

See, e.g.,
ICE Bonds Letter II at 2-4; Citadel Letter at 2; MFA Letter at 6 (suggesting that to ensure that similarly situated entities are treated similarly in the trading of government securities, the Commission should review the appropriateness of similar regulation on multiple-to-multiple trading venues with significant volume); MarketAxess Letter at 1 (stating that there should be a common regulatory framework for all multilateral fixed income electronic trading platforms that requires minimum standards of conduct and oversight in areas such as trade reporting, resiliency, cyber-security, operational reporting, financial standards, examination, surveillance, and confidentiality).

82

See supra
note 66. The FIMSAC concerns were highlighted by the Commission in the Concept Release.

83

See
ICE Bonds Letter II at 4 (stating that the benefits of subjecting non-ATS trading platforms to the same regulatory obligations as current ATSs will be substantial).

84

See
FIA PTG Letter at 2.
See also
Citadel Letter at 2 (stating that excluding multilateral RFQ platforms from the current regulatory framework creates an unlevel regulatory field).

85

See
letter from Michael Decker, Senior Vice President for Public Policy, Bond Dealers of America, dated March 1, 2021 (“BDA Letter”) at 2.
See also
FINRA Letter at 6-10 (noting inconsistent regulatory treatment among electronic and hybrid fixed income trading platforms, as well as potential regulatory gaps, flowing in part from the definitions and guidance adopted in 1998 in Regulation ATS). The commenter stated its belief that it would be beneficial for the Commission to provide guidance that specifically addresses the characteristics of RFQ trading systems and evaluate whether they meet the “exchange” definition for purposes of Regulation ATS.

86

See infra
Section VIII.C.3.a.i.

Amending Exchange Act Rule 3b-16(a) to include non-firm trading interest would eliminate the possibility that systems may offer the use of non-firm trading interest that, in practice, functions as firm orders, so as to avoid exchange registration or complying with Regulation ATS. In the Regulation ATS Adopting Release, the Commission expressed concern that system providers may label trading interest that is firm in practice as non-firm.
87

The providers of such systems may take the position that their systems arguably do not use “orders” and thus do not fall within the criteria of Rule 3b-16. For example, systems that offer the use of non-firm trading interest may monitor participants' firm-up rates in response to a quote they received and may penalize a participant with a low firm-up rate either economically or by limiting its ability to use features of its system. Such activities could cause participants on the systems to believe that trading interest that they submit or receive is effectively firm and affect their behavior on the system. The difference between what is a firm order and what is not requires careful scrutiny of the design of the system, the trading interest offered, and what actually takes place among buyers and sellers interacting on the systems. The Commission believes, however, that the use of firm or non-firm trading interest by a system should no longer be a factor in determining whether a system performs the function of a market place because both firm and non-firm trading interest can be used by a system with the same purpose and effect to bring together buyers and sellers of securities.
88

87

See
Regulation ATS Adopting Release,
supra
note 31, at 70850.

88

See supra
Section II.B.2.

Finally, for clarity, Exchange Act Rule 3b-16(a) would continue to encompass systems that make available for trading any type of security. The definition of “exchange” under Section 3(a)(1) of the Exchange Act and current Exchange Act Rule 3b-16(a) applies to all securities, including government securities, corporate bonds, municipal securities, NMS stocks, equity securities that are not NMS stocks, private restricted securities, repurchase agreements and reverse repurchase agreements, foreign sovereign debt, and options, and does not exempt or exclude any security or type of securities. The Commission believes that it is important for any system that falls within the criteria of Rule 3b-16(a) to be subject to the exchange regulatory framework, notwithstanding how thinly traded or novel a security may be, and participants on such systems should be able to avail themselves of the same benefits that participants on registered exchanges or ATSs receive. Accordingly, the proposed amendments to Rule 3b-16(a) do not change the Commission's interpretation of the statutory definition of “exchange”—that is, it applies to all securities.

The Commission received several comments in response to the Concept Release expressing reservations about revising Exchange Act Rule 3b-16 to include certain fixed income markets within the definition of exchange. One commenter stated that doing so would insert unnecessary intermediation between dealers and their customers and threaten to distort the market structure by creating a one-size-fits-all approach that is biased against the trading of less-liquid instruments, damaging liquidity formation.
89

Another commenter expressed concern about the Commission creating additional regulatory obligations in the fixed income space and believed the Commission should undertake a more in-depth review of fixed income trading, engage in discussion with the industry, and outline the problems that any proposed regulations are intended to solve before moving forward with any such regulatory proposal.
90

Likewise, another commenter stated its belief that the Commission should not impose

Regulation ATS and the current exchange framework on existing and emerging electronic trading protocols and functionalities that do not meet the existing definition of an ATS or an exchange
91

because such rules are better suited for regulating systems and trading practices in the equity markets.
92

In addition, one commenter stated that there are a variety of trading protocols that have developed within the fixed income market—such as those that are primarily order-driven (such as retail-focused order books) and others that are driven by price requests (such as RFQs)—and that the market continues to innovate.
93

This commenter stated its belief that the Commission should take into account these distinctions and apply a lighter regulatory approach in order to avoid stifling innovation.
94

89

See
Bloomberg Letter at 17-20. This commenter specifically cited RFQs as a new protocol that has helped in discovering less liquid instruments.

90

See
SIFMA Letter at 11. The commenter stated its belief that systems that merely act as informational conduits should remain outside the scope of Regulation ATS.

91

See
ICI Letter at 2, 7. This commenter stated that, for example, tools that facilitate trade-related communications between market participants should not be subject to rules that are better-suited for order book protocols.

92

See id.
at 8.

93

See
MarketAxess Letter at 2-4.

94

See id.

The Commission notes that these comments focused on the fixed income market exclusively. However, these comments have aided in the formulation of this proposal for revising the Commission interpretation of the definition of “exchange,” and the Commission looks forward to receiving more comments to aid in its deliberations. As a preliminary response to the comment letters summarized in this section, the Commission does not believe that the proposed amendments to Exchange Act Rule 3b-16 would create a one-size-fits-all model, imposing unnecessary intermediation between dealers and their customers,
95

or import concepts from the equity markets onto emerging electronic trading protocols that would damage the market structure in the fixed income markets.
96

Form ATS and Form ATS-N do not impose or favor any specific market structure or manner of trading, and the Commission is proposing to amend Form ATS-N to accommodate the operations of Communication Protocol Systems. Further, the Commission preliminarily does not believe that regulating fixed income systems, or systems for other asset classes of securities, under the exchange regulatory framework, particularly Regulation ATS, would stifle innovation or be biased against less-liquid instruments using an RFQ protocol. Regulation ATS is designed to be flexible enough to accommodate the evolving technology of ATSs and allow for systems to continue to innovate without the regulatory obligations of registered exchanges, which are SROs.
97

In the years since its adoption in 1998, many systems that chose to operate under the Regulation ATS exemption have had varied business models, including offering RFQ protocols as part of their overall ATS services, for trading different types of securities, including, among others, government securities, corporate bonds, municipal securities, NMS stocks, equity securities that are not NMS stocks, private restricted securities, repurchase agreements and reverse repurchase agreements, foreign sovereign debt, and options.

95

See
Bloomberg Letter at 17-20.

96

See
ICI Letter at 8.

97

See
Regulation ATS Adopting Release,
supra
note 31, at 70846.

The Commission seeks public comment on all aspects its proposal to amend Exchange Act Rule 3b-16(a), the Communication Protocol Systems that would fall within the definition of “exchange,” and the existing exchange regulatory requirements that would apply to a Communication Protocol System.

C. Proposed Amendments to Exchange Act Rule 3b-16

Today, Exchange Act Rule 3b-16 provides that an organization, association, or group of persons meets the definition of “exchange” if it doesn't meet one of the exceptions of the rule and it: (1) Brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade.

The Commission is proposing to amend Exchange Act Rule 3b-16 to, among other things, include non-firm indications of a willingness to buy or sell a security, in addition to orders, within the interpretation, define “trading interest,” add “communication protocols” as an established method that an organization, association, or group of persons can provide to bring together buyers and sellers of securities, simplify and align the rule text with the statutory definition of exchange under Section 3(a)(1) of the Exchange Act, and add an exclusion under Exchange Act Rule 3b-16(b). Accordingly, the Commission is proposing to amend Exchange Act Rule 3b-16 to provide that an organization, association, or group of persons would be considered to constitute, maintain, or provide an exchange if it is not subject to an exception under Rule 3b-16(b) and it: (1) Brings together buyers and sellers of securities using trading interest; and (2) makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade.

1. Trading Interest; Brings Together Buyers and Sellers

The Commission is proposing to add a definition of the term “trading interest” to Exchange Act Rule 3b-16 and amend the rule to replace “orders” with “trading interest.” The definition of trading interest would allow for clear and consistent application of the revised functional test for “exchange” under Rule 3b-16.

Under the proposal, Exchange Act Rule 3b-16(a) would continue to apply to systems that use orders, as that term is currently defined and applied in Rule 3b-16(c), to bring together buyers and sellers because the term “orders” would be included in the definition of “trading interest.” “Trading interest,” as proposed, would include “orders,” as the term is defined under Rule 3b-16(c), or any non-firm indication of a willingness to buy or sell a security that identifies at least the security and either quantity, direction (buy or sell), or price.
98

Based on Commission staff experience, generally, trading systems have offered non-firm trading interest that included the symbol and one of the following: Quantity, direction, or price. For example, a message that is sent to system participants for an NMS stock that only identifies the NMS stock symbol and quantity that the participant seeks to trade would be considered trading interest. A message sent by a participant of a corporate bond system to five potential counterparties that only identifies the CUSIP for a bond and an instruction to buy would be considered trading interest, as proposed, because it contains the symbol and direction. If the same initiating participant only provided the symbol and requested a two-sided quote in response, the response would constitute trading interest as it would identify the symbol

and a price. Indeed, Commission staff has observed that ATSs that offer a negotiation functionality to bring together buyers and sellers offer the use of non-firm trading interest that includes the symbol and one of the following: Quantity, direction, or price. In addition, there are instances where systems offer the use of non-firm trading interest, such as an indication of interest, that includes the symbol and direction but does not explicitly include a quantity or price, which can be inferred from the facts and circumstances accompanying the trading interest.
99

The Commission believes that a system that offers the use of a message that identifies the security and either the quantity, direction, or price would provide sufficient information to bring together buyers and sellers of securities because it allows a market participant to communicate its intent to trade and a reasonable person receiving the information to decide whether to trade or engage in further communications with the sender.
100

98
In conjunction with adding the defined term “trading interest” to Rule 3b-16, the Commission is proposing to add the definition of “trading interest” to Rule 300 of Regulation ATS.
See
proposed Rule 300(q). In addition, to encompass persons who transact in trading interest, and not only orders, the Commission is also proposing to change the definition of “Subscriber” in Rule 300(b) to include any person submitting, disseminating, or displaying “trading interest.”
See
Rule 300(b), as proposed to be revised.

99

See
Regulation ATS Adopting Release,
supra
note 31, at 70850.

100
A system that uses trading interest to bring together buyers and sellers would not meet the definition of “exchange,” however, unless it also met all the elements of Rule 3b-16(a), including the element “makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade.”

On the other hand, the Commission preliminarily believes that a message that only indicates the security to be traded without more information would not be trading interest and a system that only offers the use of such messages would be unlikely to bring together buyers and sellers and does not warrant the regulatory oversight accompanying classification as an exchange. Nevertheless, if a system is designed to permit an initiating participant to submit a message that only contains a symbol, yet a responding participant can submit a message that contains a symbol and either quantity, direction, or price that the initiator can accept, the message by the responding participant and acceptance by the initiator would be trading interest because each of these contain the symbol and at least direction, size, or price. As proposed, the revised criteria of Exchange Act Rule 3b-16(a) that include “trading interest,” as defined herein, would capture the vast majority of systems that bring together buyers and sellers to agree to the terms of a trade despite not including systems where solely the security is identified. If adopted, however, the Commission would continue to monitor market developments to ascertain whether such systems may warrant further regulation in the future.

The Commission is also proposing to amend Rule 3b-16(a)(1) to change the reference to a system that “brings together the orders” to “brings together buyers and sellers of securities using trading interest.” Systems that use non-firm trading interest allow participants to communicate their trading intentions, either on a bilateral or multilateral basis, to negotiate a trade. Unlike orders, non-firm trading interest typically does not interact with other non-firm trading interest without further action by the potential counterparties. Rather, the potential counterparties submitting non-firm trading interest interact with each other through the use of communication protocols. To provide for the use of both firm order interaction and participants' interaction through non-firm trading interest, the Commission is proposing to amend Rule 3b-16(a) to replace “brings together orders” with “brings together buyers and sellers of securities using trading interest.” The phrase “brings together buyers and sellers of securities using trading interest” still captures systems that use orders. The Commission is not proposing to change the meaning of “to bring together” as defined in the Regulation ATS Adopting Release
101

nor is the Commission proposing to exclude from Rule 3b-16(a) systems that use orders to bring together buyers and sellers of securities—such systems would still be subject to Rule 3b-16.

101

See id.
at 70849.

The Commission is proposing to amend Exchange Act Rule 3b-16(a)(2) to simplify the rule text and align the rule text with the proposed changes to Rule 3b-16(a)(1). Specifically, the Commission is proposing to replace “under which such orders interact with each other and the buyers and sellers entering such orders agree to the terms of a trade” with “under which buyers and sellers can interact and agree to the terms of a trade.” As explained above, because the Commission is proposing to amend Rule 3b-16(a) to include trading interest, and is no longer limiting the application of the rule to orders, the focus on “interaction” should be between buyers and sellers rather than orders. For similar reasons, the Commission is proposing to delete from the rule text the phrase “the buyers and sellers entering such orders.” This proposed change is designed to simplify the rule text and remove the reference to orders because the proposed amendments to Rule 3b-16(a) also include non-firm trading interest in addition to orders.

2. Multiple; Exclusion for Issuer Systems

The Commission is proposing to remove the reference to securities of “multiple” buyers and sellers from Exchange Act Rule 3b-16(a)(1) and is proposing to codify in Rule 3b-16(b)(3) an example the Commission provided in the Regulation ATS Adopting Release for systems that allow issuers to sell their own securities to investors. These proposed changes are not intended to change the existing scope of Rule 3b-16(a) but only to clarify its application.

The term “multiple” was added to Rule 3b-16(a) to help reinforce that single counterparty systems were not included in the definition of “exchange.”
102

These systems primarily included systems used by issuers to sell their own securities and systems used by market makers registered with an SRO, which are currently specifically excluded from Rule 3b-16(a) under Rule 3b-16(b)(2). The Commission believes that the term “multiple” could be misconstrued to mean that RFQ systems, for example, do not meet the criteria of Rule 3b-16(a) because a
transaction
request typically involves one buyer and multiple sellers or one seller and multiple buyers.
103

102

See id.

103
One commenter on the 2020 Proposal and Concept Release stated its belief that RFQ platforms do not meet the criteria of Rule 3b-16 because such platforms do not offer “multiple-to-multiple” order interaction among participants and that the RFQ platforms instead facilitate trading between an individual market participant (requester) and potential liquidity providers (responders).
See
ICI Letter at 2, 7.

Under current Rule 3b-16(a), whether a system meets the “multiple” prong depends on whether the system, when viewed in its entirety, includes more than one buyer and more than one seller and is not determined on a transaction-by-transaction basis. A system, such as an RFQ system, that is designed to provide the ability of more than one buyer to request quotes from more than one seller in securities at the same or different times would meet the “multiple” prong of Rule 3b-16(a) because such systems do not include a single counterparty.
104

Because RFQ systems have more than one buyer and more than one seller, such systems do not have a single counterparty and thus

would meet the standard of “multiple buyers and sellers” under Rule 3b-16(a)(1). Nevertheless, removing the term “multiple” would mitigate confusion and the potential to misconstrue the application of Rule 3b-16(a) to systems with non-firm trading interest, including RFQ systems, and aligns the rule with the statutory definition of “exchange.”
105

104
The mere interpositioning of a designated counterparty to provide for the anonymity of counterparties to a trade or for settlement purposes after the purchasing and selling counterparties to a trade have been matched would not, by itself, mean the system does not have multiple buyers and sellers.
See
Regulation ATS Adopting Release,
supra
note 31, at 70849.

105
The use of plural terms in “buyer
s
and seller
s
” in Rule 3b-16(a) and “purchaser
s
and seller
s
” (emphasis added) in the statutory definition of “exchange” makes sufficiently clear that an exchange need only have more than one buyer and more than one seller participating on the system to meet this prong.

The Commission is proposing to amend Rule 3b-16(b) to add an exclusion from Rule 3b-16(a) for systems that allow an issuer to sell its securities to investors. The Commission stated in the Regulation ATS Adopting Release that systems for issuers to sell their own securities would not fall within Rule 3b-16(a) because such systems have a single counterparty that is selling its securities.
106

The Commission continues to believe that such systems do not meet the criteria of Rule 3b-16(a) because the systems do not bring together multiple buyers and multiple sellers. Given the proposal to remove the term “multiple” from Rule 3b-16(a)(1), adding the exclusion for issuer systems would clarify that such systems do not fall within the criteria of Rule 3b-16(a).

106

See supra
note 102 and accompanying text.

3. Established Methods; Communication Protocols

The Commission is proposing to amend Rule 3b-16(a)(2) to replace “uses established, non-discretionary methods” with the phrase “makes available established, non-discretionary methods.” The proposed change to use the word “makes available” rather than “uses” is designed to capture established, non-discretionary methods that an organization, association, or group of persons may provide, whether directly or indirectly, for buyers and sellers to interact and agree upon terms of a trade. In contrast to the term “uses,” the Commission believes the term “makes available” would be applicable to Communication Protocol Systems because such systems take a more passive role in providing to their participants the means and protocols to interact, negotiate, and come to an agreement.

The term “makes available” is also intended to make clear that, in the event that a party other than the organization, association, or group of persons performs a function of the exchange, the function performed by that party would still be captured for purposes of determining the scope of the exchange under Exchange Act Rule 3b-16. In the Regulation ATS Adopting Release, the Commission stated that it will attribute the activities of a trading facility to a system if that facility is offered by the system directly or indirectly (such as where a system arranges for a third party or parties to offer the trading facility).
107

The Commission has further recognized how a system may consist of various functionalities, mechanisms, or protocols that operate collectively to bring together the orders for securities of multiple buyers and sellers using non-discretionary methods under the criteria of Rule 3b-16(a), and how, in some circumstances, these various functionalities, mechanisms, or protocols may be offered or performed by another business unit of the registered broker-dealer or government securities broker or government securities dealer that operates the ATS (“broker-dealer operator”) or by a separate entity.
108

These principles equally apply to an organization, association, or group of persons that arranges with another party to provide, for example, a trading facility or communication protocols, or parts thereof, to bring together buyers and sellers and perform a function of a system under Rule 3b-16. Using the term “makes available” will help ensure that the investor protection and fair and orderly markets provisions of the exchange regulatory framework apply to all the activities that consist of the system that meets the criteria of Rule 3b-16(a), notwithstanding whether those activities are performed by a party other than the organization that is providing the market place.
109

107

See
Regulation ATS Adopting Release,
supra
note 31, at 70852.

108

See
NMS Stock ATS Adopting Release,
supra
note 2, at 38844 (citing Regulation ATS Adopting Release, 63 FR 70852).

109
Depending on the activities of the persons involved with the market place, a group of persons, who may each perform a part of the 3b-16 system, can together provide, constitute, or maintain a market place or facilities for bringing together purchasers and sellers of securities and together meet the definition of exchange. In such a case, the group of persons would have the regulatory responsibility for the exchange.

The Commission is not proposing to delete the term “non-discretionary” from Rule 3b-16(a)(2). The term “non-discretionary” was added to Rule 3b-16(a)(2) to modify “methods” to distinguish the activities of an exchange from the activities of a broker-dealer.
110

As discussed in the Regulation ATS Adopting Release, broker-dealers exercise control, judgement, or discretion over their customers' orders or trading interests
111

while an exchange operates pursuant to programmed procedures or set rules and does not exercise discretion over orders or trading interest entered into the system.
112

The Commission continues to believe that the distinction between an exchange and a broker-dealer explained in the Regulation ATS Adopting Release is appropriate and the Commission is not proposing to amend Exchange Act Rule 3b-16(a) to include activities of broker-dealers within the definition of “exchange.”
113

110

See
Regulation ATS Adopting Release,
supra
note 31, at 70863.

111

See id.
at 70851.

112

See id.
at 70850.

113
If a system meets the criteria of Exchange Act Rule 3b-16(a) but includes in that system the ability of the system operator to apply its discretion for handling trading interest, these activities employing discretion by the system operator would be included in the system that meets the criteria of Rule 3b-16(a) and be subject to Federal securities laws and rules applicable to a registered exchange or ATS (including, for example, requirements to provide disclosures about the system operator's activities on Form ATS or ATS-N and, if the ATS is subject to the Fair Access Rule, include in its written standards why the activities of the system operator that result in the different treatment of subscribers are fair and not unreasonably discriminatory).

The term “non-discretionary” should not be misconstrued to mean that a system does not meet the definition of exchange if it permits buyers or sellers using the system to exercise discretion with regard to the use of the system. Under current Rule 3b-16(a)(2), the phrase “uses established, non-discretionary methods” applies to the organization, association, or group of persons that provides the means—the trading facility or rules—under which orders interact. Thus, an organization that meets the definition of “exchange” does not exercise any discretion in the matching of buyers and sellers or their orders and buyers and sellers participating on an exchange can use their own discretion in finding and selecting a counterparty.
114

The phrase

“established, non-discretionary methods” continues to convey that the system provider is providing the trading facility or communication protocols or setting rules and is not applying its discretion in matching counterparties on the system.
115

114
One commenter on the 2020 Proposal and Concept Release stated their belief that “unlike an ATS on which trading takes place on a non-discretionary basis, trading discretion is a defining feature of these protocols; a requesting participant can choose the number and identity of participants that will receive the RFQ, while participants who receive an RFQ can choose whether to respond.”
See
ICI Letter at 7.
See also
Bloomberg Letter at 23 (describing that an RFQ “consists of discretionary directed order communication network messaging” and stating its belief that such messaging is not an ATS function because RFQs lack a non-discretionary commitment to trade) and MarketAxess Letter at n.2 (stating its belief that an RFQ trading requestor's trading discretion puts the protocol outside the requirement that the platform use “established, non-discretionary methods under which such orders interact with each other”). The “established, non-discretionary methods” element

of Rule 3b-16(a)(2) pertains to the discretion applied by the system provider to bring together buyers and sellers and not discretion that participants may apply. For example, a system provider that matches buyers and sellers using its judgement or discretion would not be using established, non-discretionary methods. As the Commission stated in the Regulation ATS Adopting Release, where customers of a broker-dealer exercise control over their own orders in a trading system operated by the broker-dealer, that broker-dealer is unlikely to be viewed as using discretionary methods in handling the order.
See
Regulation ATS Adopting Release,
supra
note 31, at 70851.

115

See id.
(describing that, for example, the Commission does not believe that block trading desks, which generally retain some discretion in determining how to execute a customer's order, and frequently commit capital to satisfy their customers' needs, use established, non-discretionary methods).

The Commission is proposing to amend Rule 3b-16(a)(2) to add “communication protocols” as an established method that an organization, association, or group of persons can provide to bring together buyers and sellers of securities. Systems that bring together buyers and sellers of securities may function as exchange market places of securities without orders or a trading facility for orders to interact. In the Commission's experience, communication protocols, which can be applied to various technologies and connectivity, generally use non-firm trading interest as opposed to orders to prompt and guide buyers and sellers to communicate, negotiate, and agree to the terms of the trade. For example, if an entity makes available a chat feature, which requires certain information to be included in a chat message (
e.g.,
price, quantity) and sets parameters and structure designed for participants to communicate about buying or selling securities, the system would have established communication protocols.

While Communication Protocol Systems may not match counterparties' trading interest, buyers and sellers using these can be brought together to interact, either on a bilateral or multilateral basis, and agree upon the terms of the trade. Protocols that a system offers may take many forms and could include: Setting minimum criteria for what messages must contain; setting time periods under which buyers and sellers must respond to messages; restricting the number of persons a message can be sent to; limiting the types of securities about which buyers and sellers can communicate; setting minimums on the size of the trading interest to be negotiated; or organizing the presentation of trading interest, whether firm or non-firm, to participants. These examples are not exhaustive, and the determination of whether the system meets Rule 3b-16(a)(2) would depend on the particular facts and circumstances of each system. Nevertheless, as proposed, the Commission would take an expansive view of what would constitute “communication protocols” under this prong of Rule 3b-16(a).
116

116
One commenter suggested a litmus test to assist the Commission in determining whether a fixed-income trading platform for corporate bonds and municipal securities meets the criteria that warrant registration as an exchange or ATS. According to the commenter, the most relevant criteria were: Whether the system provides multilateral trading, whether the technology provider has any influence on picking the counterparties, whether the system enables any sharing of real-time information across multiple counterparties, whether the system provider has any access to real-time information, and whether the transactions happen on the technology platform.
See
letter from Vijay Kedia, President and CEO, FlexTrade Systems, dated March 1, 2021 (“FlexTrade Systems Letter”) at 2. As discussed above, the Commission believes that conditions have changed whereby systems that offer the use trading interest and protocols to bring together buyers and sellers of securities perform an exchange market place function similar to systems that offer the use of orders and trading facilities. As proposed, a Communication Protocol System can still meet the criteria of Exchange Act Rule 3b-16 even if it has no role in matching counterparties nor displays trading interest. In addition, neither the current rule nor the proposed amendments require that, for a system to be an exchange, an execution occur on the system; rather, that the buyers and sellers agree to the terms of the trade on the system is sufficient.
See
Regulation ATS Adopting Release,
supra
note 31, at 70852 (stating “whether or not the actual execution of the order takes place on the system is not a determining factor of whether the system falls under Rule 3b-16”). Also, applying some of the criteria that the commenter suggested (whether system provider have any access to real-time information; whether the transactions happen on the technology platform) could result in the exclusion of certain RFQ platforms from the definition of exchange.

The Commission preliminarily believes that certain systems would not fall within the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended, because the organization, association, or group of persons would not be considered to be providing a trading facility or communication protocol and therefore would not be considered to be making available established, non-discretionary methods under Rule 3b-16(a)(2).
117

The Commission continues to believe that systems that passively display trading interest, such as systems referred to in the industry as bulletin boards, but do not provide means for buyers and sellers to contact each other and agree to the terms of the trade on the system would not be encompassed by Rule 3b-16(a) as proposed to be amended.
118

For example, the Commission does not believe that a system that unilaterally displays trading interest without offering a trading facility or communication protocols to bring together buyers and sellers would be considered to be making available established, non-discretionary methods.
119

In the Regulation ATS Adopting Release, the Commission stated that “[u]nless a system also establishes rules and operates a trading facility under which subscribers can agree to the terms of their trades, the system will not be included within Rule 3b-16 even if it brings together `orders.' ”
120

These systems may display trading interest to potential buyers and sellers, but the system provider is not making available established methods for buyers and sellers to interact and agree upon terms of a trade. If adopted, however, the Commission would continue to monitor market developments to ascertain whether such systems may warrant further regulation in the future.

117
To the extent that a system is currently operating consistently with the circumstances described in a staff no-action letter, a system that falls within the scope of Rule 3b-16(a) and seeks to rely on the ATS exemption would need to register as a broker-dealer to comply with the broker-dealer registration requirement under Regulation ATS, regardless of any prior staff statement. Upon the adoption of any final rule, some letters and other staff statements, or portions thereof, may be moot, superseded, or otherwise inconsistent with the final rule and, therefore, would be withdrawn or modified.

118

See
Regulation ATS Adopting Release,
supra
note 31, at 70850.
See also
FINRA Letter at 9-10 (requesting the Commission provide additional guidance on the regulatory classification of bulletin boards).

119

See
SIFMA Letter at 11 (stating that systems that merely act as informational conduits should remain outside the scope of Regulation ATS); FlexTrade Systems Letter at 2-4 (stating that software vendors that provide functionality for displaying prices do not meet the definition of an exchange).

120

See
Regulation ATS Adopting Release,
supra
note 31, at 70850.

Similarly, a system that displays trading interest and provides only connectivity among participants without providing a trading facility to match orders or providing protocols for participants to communicate and interact would not meet the criteria of Rule 3b-16(a) because such system would not be considered to be making available established, non-discretionary methods. For example, systems that only provide general connectivity for persons to communicate without protocols, such as utilities or electronic web chat providers, would not fall within the communication protocols prong of the proposed rule because such providers are not specifically designed

to bring together buyers and seller of securities or provide procedures or parameters for buyers and sellers for securities to interact. To the extent that such systems are designed for securities and provide communication protocols for buyers and sellers to interact and agree to the terms of a trade, such systems would fall within the criteria of Exchange Act Rule 3b-16(a) as proposed to be revised.

D. Exchange Registration or ATS Exemption for Communication Protocol Systems Under the Proposed Rules

The proposed amendments to Exchange Act Rule 3b-16(a) would scope Communication Protocol Systems into the definition of “exchange,” in which case, the systems may decide between registering as a national securities exchange or registering as a broker-dealer and complying with Regulation ATS. The Commission believes that many Communication Protocol Systems would likely choose to be regulated as an ATS because of the lighter regulatory requirements imposed on them, as compared to the regulatory requirements of registered exchanges, which are SROs. Unlike a national securities exchange, an ATS can trade any type of security and its users are not limited to broker-dealers. In addition, an ATS is not an SRO, is not subject to Section 6 of the Exchange Act, and does not require Commission approval for its activities. Complying with Regulation ATS would therefore allow Communication Protocol Systems more flexibility in the operation of their business than registering as an exchange.
121

121
ATSs have more flexibility in the operation of their business than exchanges insofar as ATSs are not subject to Section 6 of the Exchange Act and are not required to comply with the statutory standards with respect to unfair discrimination, burdens on competition, and the equitable allocation of reasonable fees.

Further, many Communication Protocol Systems make available for trading fixed income securities that are only traded over-the-counter and are not typically registered and approved for listing on an exchange.
122

Unless a national securities exchange receives an exemption to trade unregistered debt securities,
123

it may only list and trade registered debt securities, whereas Communication Protocol Systems need not receive such an exemption to trade unregistered debt securities. Notwithstanding, the Commission discusses the regulatory requirements for both regulatory alternatives below. The Commission is not proposing to make changes to the regulatory structure for exchanges or the requirements for national securities exchanges. The proposed changes to the regulatory requirements under Regulation ATS are discussed in more detail below.
124

122
Section 12(a) of the Exchange Act makes it unlawful for any member, broker, or dealer to effect any transaction in any security (other than an exempted security) on a national securities exchange unless a registration statement has been filed with the Commission and is in effect as to such security for such exchange in accordance with the provisions of the Exchange Act and the rules and regulations thereunder. 15 U.S.C. 78l(a). Section 12(b) of the Exchange Act, 15 U.S.C. 78l(b), contains procedures for the registration of securities on a national securities exchange. Section 12(a) does not apply to an exchange that the Commission has exempted from registration as a national securities exchange.
See, e.g.,
Securities Exchange Act Release No. 28899 (February 20, 1991), 56 FR 8377 (February 29, 1991).
See also
Regulation ATS Adopting Release,
supra
note 31, at 70886.

123

See, e.g.,
Securities Exchange Act Release No. 54767 (November 16, 2006), 71 FR 67680 (November 22, 2006) (SR-NYSE-2004-69) (issuing exemption permitting NYSE to trade unregistered debt securities on its bonds platform, now known as NYSE Bonds).

124

See infra
Section III.B.2 (discussing proposed changes to Rule 301(b)(1) of Regulation ATS), Section IV (discussing proposed changes to Rule 304 and Form ATS-N), Section V.A (discussing proposed changes to Rule 301(b)(5) and 301(b)(6)), and Section V.C (discussing proposed changes to Rule 301(b)(2)(vii)).

1. National Securities Exchange Registration

A Communication Protocol System that chooses to register as a national securities exchange would be required to do so pursuant to Sections 5 and 6 of the Exchange Act. A national securities exchange is an SRO and must set standards of conduct for its members, administer examinations for compliance with these standards, coordinate with other SROs with respect to the dissemination of consolidated market data, and generally take responsibility for enforcing its own rules and the provisions of the Exchange Act and the rules and regulations thereunder. Before a national securities exchange may commence operations, the Commission must approve its application for registration filed on Form 1.
125

Section 6(b) of the Exchange Act requires, among other things, that the national securities exchange be so organized and have the capacity to carry out the purposes of the Exchange Act and to comply and enforce compliance by its members, and persons associated with its members, with the Federal securities laws and the rules of the exchange.
126

Pursuant to Section 6 of the Exchange Act, national securities exchanges must establish rules that generally: (1) Are designed to prevent fraud and manipulation, promote just and equitable principles of trade, and protect investors and the public interest; (2) provide for the equitable allocation of reasonable fees; (3) do not permit unfair discrimination; (4) do not impose any unnecessary or inappropriate burden on competition; and (5) with limited exceptions, allow any broker-dealer to become a member.
127

125

See
15 U.S.C. 78f.

126

See
Section 6(b)(1) of the Exchange Act, 15 U.S.C. 78f(b)(1). The Commission must also find that the national securities exchange has rules that meet certain criteria.
See generally
Exchange Act Section 6(b)(2) through (10), 15 U.S.C. 78f(b)(2) through (10).

127

See
Section 6(b) of the Exchange Act.

After approval of its application for registration, a national securities exchange must file with the Commission any proposed changes to its rules.
128

The initial application on Form 1, amendments thereto, and filings for proposed rule changes, in combination, publicly disclose important information about national securities exchanges, such as trading services and fees. The Commission's order approving the application is also public. The Commission oversees the exchanges under the Exchange Act through, among other things, its examination authority under Section 17, its enforcement authority under Sections 19(h)(1) and 21C, its authority to approve and disapprove rules under Section 19(b), and its rulemaking authority under various Exchange Act provisions. Under the Exchange Act, securities traded on a national securities exchange must be registered with the Commission and approved for listing on an exchange. National securities exchanges can only have broker-dealer members. As an SRO, a national securities exchange enjoys certain unique benefits, such as limited immunity from private liability with respect to its regulatory functions and the ability to receive consolidated revenue under the national market system plans for equity market data (
i.e.,
Consolidated Tape Association (CTA)/Consolidated Quotation (CQ) and Unlisted Trading Privilege (UTP)),
129

among others.

128

See generally
Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b).

129
Details and the history of each plan can be found at
https://www.ctaplan.com/plans;
and
https://www.utpplan.com.

2. Regulation ATS Exemption; Broker-Dealer Registration

A Communication Protocol System may choose to operate as an ATS pursuant to Regulation ATS, which exempts an ATS from the definition of “exchange” on the condition that the ATS is in compliance with the requirements of Regulation ATS. An ATS that fails to comply with the requirements of Regulation ATS would

no longer qualify for the ATS exemption and thus risks operating as an unregistered exchange in violation of Section 5 of the Exchange Act.

To operate under the exemption, an ATS must register as a broker-dealer under Exchange Act Section 15 or as a government securities broker or government securities dealer under Exchange Act Section 15C(a)(1)(A),
130

and comply with the filing and conduct obligations associated with being a registered broker-dealer, including membership in an SRO, such as FINRA,
131

and compliance with the SRO's rules.
132

Requiring Communication Protocol Systems to register as broker-dealers and be a member of an SRO would ensure that they are subject to SRO examination and market surveillance, trade reporting obligations, and certain investor protection rules. Broker-dealer registration provides important investor protections under the Federal securities laws and FINRA rules, such as: (1) Various disclosure and supervision obligations; (2) anti-money laundering obligations (including suspicious activity reporting); (3) FINRA over-the-counter (OTC) trade reporting requirements, including requirements to maintain membership in, or maintain an effective clearing arrangement with a participant of, a clearing agency registered under the Exchange Act; and (4) Commission examinations and FINRA examinations and surveillance of members and markets that its members operate.

130
The Commission is proposing to amend Rule 301(b)(1) to allow an ATS to register as a government securities broker or government securities dealer under Exchange Act Section 15C(a)(1)(A).
See infra
notes 272-278 and accompanying text.

131

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

132

See
Regulation ATS Adopting Release,
supra
note 31, at 70903.

In addition, ATSs are subject to certain reporting and disclosure requirements, as applicable. ATSs other than NMS Stock ATSs or, as proposed, Government Securities ATSs, would be required, pursuant to Rule 301(b)(2) of Regulation ATS, to file an initial operation report with the Commission on Form ATS
133

at least 20 days before commencing operations or, in the case of Newly Designated ATSs,
134

no later than 30 calendar days after the effective date of any final rule.
135

Form ATS provides the Commission with the opportunity to identify problems that might impact investors before the system begins to operate.
136

Unlike a Form 1 filed by a national securities exchange, a Form ATS is not approved by the Commission.
137

Also unlike a Form 1 application, a Form ATS is deemed confidential when filed.
138

Requiring Communication Protocol Systems to file Form ATS and amendments thereto will help the Commission monitor and oversee such ATSs' operations.

133
Form ATS and the Form ATS Instructions are
available at https://www.sec.gov/about/forms/formats.pdf.
Form ATS would require, among other things, that the ATS (other than a Government Securities ATS or NMS Stock ATS) provide information about: Classes of subscribers and differences in access to the services offered by the ATS to different groups or classes of subscribers; securities the ATS expects to trade; any entity other than the ATS involved in its operations; the manner in which the system operates; how subscribers access the trading system; procedures governing entry of trading interest and execution; and trade reporting, clearance and settlement of trades on the ATS.
See infra
Section V.B (describing proposed changes to Form ATS). Regulation ATS provides that a report on Form ATS or Form ATS-R shall be considered filed upon receipt by the Division of Trading and Markets, at the Commission's principal office in Washington, DC (
i.e.,
in paper form), and that information filed by an ATS on Form ATS is deemed confidential when filed.
See
17 CFR 242.301(b)(2)(vii).
See also infra
Section V.C.

134
“Newly Designated ATSs” would be defined as ATSs operating as of the effective date of any final rule that meet the criteria under Rule 3b-16(a) as of the effective date of any final rule but did not meet the criteria under Rule 3b-16(a) in effect prior to the effective date of any final rule.
See
Rule 300(r).

135

See infra
note 180 and accompanying text. The Commission is also proposing changes to Rule 301(b)(2)(i) to clarify that the requirement to file Form ATS does not apply to Covered ATSs or Covered Newly Designated ATSs.
See
proposed Rule 301(b)(2)(i).
See also
proposed Rule 300(s) (defining “Covered Newly Designated ATS”).

136

See
Regulation ATS Adopting Release,
supra
note 31, at 70864.

137
Form ATS provides the Commission with notice about an ATS's operations prior to commencing operations. An ATS is also required to notify the Commission of any changes in its operations by filing an amendment to its initial operation report. There are three types of amendments to an initial operation report. First, if any material change is made to its operations, the ATS must file an amendment on Form ATS at least 20 calendar days before implementing such change.
See
17 CFR 242.301(b)(2)(ii). A “material change,” includes, but is not limited to, any change to the operating platform, the types of securities traded, or the types of subscribers. In addition, the Commission has stated that ATSs implicitly make materiality decisions in determining when to notify their subscribers of changes.
See
Regulation ATS Adopting Release,
supra
note 31, at 70864. Second, if any information contained in the initial operation report becomes inaccurate for any reason and has not been previously reported to the Commission as an amendment on Form ATS, the ATS must file an amendment on Form ATS correcting the information within 30 calendar days after the end of the calendar quarter in which the system has operated.
See
17 CFR 242.301(b)(2)(iii). Third, an ATS must promptly file an amendment on Form ATS correcting information that it previously reported on Form ATS after discovery that any information was inaccurate when filed.
See
17 CFR 242.301(b)(2)(iv). An ATS is required to promptly file a cessation of operations on Form ATS.
See
17 CFR 242.301(b)(2)(v).

138

See
17 CFR 242.301(b)(2)(vii); Form ATS at 3, General Instructions A.7.

NMS Stock ATSs and, as proposed, Government Securities ATSs, would be subject to enhanced filing and disclosure requirements under Rule 304 of Regulation ATS. NMS Stock ATSs or Government Securities ATSs would, in lieu of Form ATS, be required to file public Form ATS-N in EDGAR, in which they must disclose detailed information about the manner in which their trading systems operate and the potential for conflicts of interest and information leakage.
139

Form ATS-N is subject to a Commission review and effectiveness process.
140

An NMS Stock ATS or Government Securities ATS would not be permitted to operate pursuant to the Rule 3a1-1(a)(2) exemption until its Form ATS-N has become effective.
141

In addition, the ATS would be required to file amendments on Form ATS-N to provide notice of changes to its operations and broker-dealer and affiliate relationships.
142

Form ATS-N and the Commission review and effectiveness process, which is described in detail below,
143

would provide operational transparency and regulatory oversight of Communication Protocol Systems that are NMS Stock ATSs or Government Securities ATSs.

139

See
proposed changes to 17 CFR 242.304.

140

See infra
Section IV.A.

141

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

142

See infra
Section IV.A.

143

See infra
Section IV.

In addition, all ATSs are required to periodically, by paper submission, report certain information about transactions in the ATS and information about certain activities on Form ATS-R within 30 calendar days after the end of each calendar quarter in which the market has operated, pursuant to Rule 301(b)(9).
144

Form ATS-R requires quarterly volume information for specified categories of securities, as well as a list of all securities traded in the ATS during the quarter and a list of all subscribers that were participants during the quarter,
145

and for ATSs subject to the Fair Access Rule to provide certain additional

information.
146

Like Form ATS, Rule 301(b)(2)(vii) and the instructions to Form ATS-R provide that Form ATS-R is deemed confidential when filed.
147

The information reported on Form ATS-R by Communication Protocol Systems would permit the Commission to monitor the trading on these ATSs for compliance with the Exchange Act and applicable rules thereunder and enforce the Fair Access Rule.
148

144

See
17 CFR 242.301(b)(9)(i). Form ATS-R and the Form ATS-R Instructions are
available at https://www.sec.gov/about/forms/formats-r.pdf. See also
Section V.B (describing proposed changes to Form ATS-R).

145

See
Form ATS-R at 4, Items 1 and 2 (describing the requirements for Exhibit A and Exhibit B of Form ATS-R). ATSs must also complete and file Form ATS-R within 10 calendar days after ceasing to operate.
See
17 CFR 242.301(b)(9)(ii); Form ATS-R at 2, General Instructions A.2 to Form ATS-R.

146
Form ATS-R also requires an ATS that is subject to the fair access obligations under Rule 301(b)(5) of Regulation ATS to provide a list of all persons granted, denied, or limited access to the ATS during the period covered by the ATS-R and designate for each person each of the following: Whether the person was granted, denied, or limited access; the date the ATS took such action; the effective date of such action; and the nature of any denial or limitation of access.
See
Form ATS-R at 6, Item 7 (explaining requirements for Exhibit C).

147

See
17 CFR 242.301(b)(2)(vii); Form ATS-R at 2, General Instruction A.7.

148

See
Regulation ATS Adopting Release,
supra
note 31, at 70874 and 70878.

NMS Stock ATSs must comply with certain order display and execution access obligations
149

under Rule 301(b)(3) if the ATS displays subscriber orders in an NMS stock to any person (other than an employee of the ATS) and meets certain volume requirements.
150

These order display and execution access obligations were adopted by the Commission with the expectation they would promote additional market integration and further discourage two-tier markets when trading in an NMS stock on an ATS reaches a certain level.
151

In addition, an NMS Stock ATS must not charge any fee to broker-dealers that access the ATS through a national securities exchange or national securities association that is inconsistent with the equivalent access to the NMS Stock ATS that is required under Rule 301(b)(3)(iii).
152

This requirement is designed to promote equal access to ATSs.

149
An ATS that displays orders and meets the volume requirements must provide to a national securities exchange or national securities association the prices and sizes of the orders at the highest buy price and the lowest sell price for such NMS stock, displayed to more than one person in the ATS, for inclusion in the quotation data made available by the national securities exchange or national securities association pursuant to Rule 602 under Regulation NMS.
See
17 CFR 242.301(b)(3)(ii). With respect to any such displayed order, the ATS must provide to any broker-dealer that has access to the national securities exchange or national securities association to which the ATS provides the prices and sizes of displayed orders pursuant to Rule 301(b)(3)(ii), the ability to effect a transaction with such orders that is equivalent to the ability of such broker-dealer to effect a transaction with other orders displayed on the exchange or by the association; and at the price of the highest priced buy order or lowest priced sell order displayed for the lesser of the cumulative size of such priced orders entered therein at such price, or the size of the execution sought by such broker-dealer.
See
17 CFR 242.301(b)(3)(iii).

150
An ATS that displays subscriber orders in an NMS stock must comply with Rule 301(b)(3) if, during at least four of the preceding six calendar months, it had an average daily trading volume of 5% or more of the aggregate average daily share volume for that NMS stock, as reported by an effective transaction reporting plan.
See
17 CFR 242.301(b)(3)(i).

151

See
Regulation ATS Adopting Release,
supra
note 31, at 70867.

152

See
17 CFR 242.301(b)(4). In addition, if the national securities exchange or national securities association to which an ATS provides the prices and sizes of orders under Rules 301(b)(3)(ii) and (iii) establishes rules designed to assure consistency with standards for access to quotations displayed on such national securities exchange, or the market operated by such national securities association, the ATS shall not charge any fee to members that is contrary to, that is not disclosed in the manner required by, or that is inconsistent with any standard of equivalent access established by such rules.
See id.

As discussed in more detail below,
153

ATSs are required to comply with the Fair Access Rule
154

under Rule 301(b)(5) if the ATS meets volume thresholds in NMS stocks, equity securities that are not NMS stocks and for which transactions are reported to an SRO, municipal securities, or corporate debt securities.
155

The Commission is proposing to apply the requirements of the Fair Access Rule to trading of U.S. Treasury Securities and Agency Securities on ATSs.
156

153

See infra
Section III.B.4 and Section V.A.

154
An ATS subject to the Fair Access Rule, as proposed to be revised, must: Establish and apply reasonable written standards for granting, limiting, and denying access to the services of the ATS; make and keep records of all grants of access including, for all participants, the reasons for granting such access, and all denials or limitations of access and reasons, for each applicant and participant, for denying or limiting access; and report on Form ATS-R a list of persons granted, denied, and limited access to the ATS.
See infra
Section V.A.

155

See
17 CFR 242.301(b)(5).

156

See infra
Section III.B.4.

Additionally, under Rule 301(b)(6) (“Capacity, Integrity, and Security Rule”), an ATS that trades only municipal securities or corporate fixed income debt with 20% or more of the average daily volume traded in the U.S. during at least four of the preceding six calendar months would be required to comply with capacity, integrity, and security standards
157

with respect to those systems that support order entry, order routing, order execution, transaction reporting, and trade compari

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2022-01975. Public record. Not legal advice.