Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders

Federal RegisterDec 29, 2022

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-96494; File No. S7-30-22]

RIN 3235-AN23

Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is proposing to amend certain rules of Regulation National Market System (“Regulation NMS”) under the Securities Exchange Act of 1934, as amended (“Exchange Act”) to adopt variable minimum pricing increments for the quoting and trading of NMS stocks, reduce the access fee caps, and enhance the transparency of better priced orders.

DATES:

Comments should be received on or before March 31, 2023.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form

https://www.sec.gov/rules/submitcomments.html;

• Send an email to

rule-comments@sec.gov

. Please include File Number S7-30-22 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 S7-30-22. 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 of submission. The Commission will post all comments on the Commission's 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. All comments received will be posted without change. 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 our 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:

Kelly Riley, Senior Special Counsel, Johnna Dumler, Special Counsel, Steve Kuan, Special Counsel, Marc McKayle, Special Counsel, and Ted Uliassi, Special Counsel, at (202) 551-5500, 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 Regulation NMS:

Commission reference

CFR citation (17 CFR)

Rule 600(b)(59)

§ 242.600(b)(59)

Rule 600(b)(78)

§ 242.600(b)(78)

Rule 603

§ 242.603

Rule 610

§ 242.610

Rule 612

§ 242.612

I. Introduction

A. Rule 612—Minimum Pricing Increments

B. Rule 610—Access to Quotations

C. Transparency of Better Priced Orders

II. Amendment to Rule 612 of Regulation NMS—Minimum Pricing Increment

A. Background

B. Rule 612

1. Exchange Retail Liquidity Programs (“RLPs”)

C. Tick Size Considerations Since Regulation NMS

D. Issues Raised in the Current Market Structure

E. Proposals by Market Participants

1. Reduce the Tick Size to $0.005 for Tick-Constrained Stocks

2. Variable Tick Sizes

F. Proposal to Amend Rule 612

1. Minimum Pricing Increments

2. Quotations and Orders in NMS Stocks Priced at $1.00 or More

3. Quotations and Orders in NMS Stocks Priced Less Than $1.00

4. Minimum Pricing Increment for Trading

G. Proposed Implementation Period

H. Request for Comment

III. Amendments to Rule 610 of Regulation NMS—Fees for Access to Quotations

A. Background

1. Regulation NMS

2. Exchange Fee Models

B. Current Rule 610(c)

C. Proposal To Reduce Fees for Access to Protected Quotations and Increase Fee Transparency

1. Reduce Fees for Access to Protected Quotations

2. Require That All Exchange Fees and Rebates Be Determinable at the Time of an Execution

D. Request for Comment

IV. Transparency of Better Priced Orders

A. Background

1. Infrastructure Implementation: Phased Transition Plan and Current Status

B. Accelerate Implementation of Round Lots and Odd-Lot Information

1. Odd-Lot Information

2. Round Lots

3. Display of Round Lots and Odd-Lot Information

4. Proposed Compliance Date

C. Request for Comment

D. Proposed Definition of Best Odd-Lot Orders

E. Request for Comment

V. Economic Analysis

A. Introduction

B. Market Failure

C. Baseline

1. Tick Sizes

2. Access Fees

3. Round Lots and Market Data Infrastructure

4. Affected Entities and Markets

D. Economic Effects

1. Modification of Rule 612 To Create a Tiered Tick Structure

2. Minimum Pricing Increment for Trading

3. Lower Access Fee Cap

4. Exchange Fees and Rebates Determinable at the Time of Execution

5. Acceleration of the MDI Rules and Addition of Information About Best Odd-Lot Orders

6. Compliance Costs

E. Effect on Efficiency, Competition, and Capital Formation

1. Efficiency

2. Competition

3. Capital Formation

F. Reasonable Alternatives

1. Alternative Trading Increment

2. Alternative Tick Sizes

3. Alternative Access Fee

4. Do Not Accelerate Odd-Lot Information or Create BOLO

G. Request for Comment

VI. Paperwork Reduction Act

A. Summary of Collection of Information

B. Proposed Use of Information

C. Respondents

D. Total Annual Reporting and Recordkeeping Burden

1. Initial Burden Hours and Costs

2. Ongoing Burden Hours and Costs

E. Collection of Information is Mandatory

F. Confidentiality

G. Revisions to Current MDI Rules Burden Estimates

H. Request for Comments

VII. Consideration of Impact on the Economy

VIII. Regulatory Flexibility Act Certification and Initial Regulatory Flexibility Act Analysis

A. Proposed Amendments to Rule 612—Initial Regulatory Flexibility Analysis

1. Reasons for the Proposed Action

2. Legal Basis

3. Small Entities Subject to the Rule

4. Reporting, Recordkeeping, and Other Compliance Requirements

5. Duplicative, Overlapping, or Conflicting Federal Rules

6. Significant Alternatives

7. Request for Comments

B. Proposed Amendments to Rule 610

C. Proposed Amendments to Rule 603 and Definitions Odd-Lot Information and Regulatory Data Under Rule 600

Statutory Authority and Text of the Proposed Rule Amendments

I. Introduction

Section 11A of the Exchange Act

directs the Commission to facilitate the establishment of a national market system in accordance with specified Congressional findings. In furtherance of this direction, the Commission adopted Regulation NMS in 2005, which includes several provisions that updated and modernized the national market system to take advantage of the data processing and communications technology that were available at that time and to address the then recent changes that had occurred in the markets. Regulation NMS was designed to achieve the objectives of section 11A of efficient, competitive, fair and orderly markets.

15 U.S.C. 78k-1.

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

In Section 11A of the Exchange Act, Congress recognized that new technology could “create the opportunity for more efficient and effective market operations.”

The market structure and technology available today is vastly different from what was available when Regulation NMS was adopted. Today, electronic trading has all but supplanted manual trading and electronic trading systems can handle and process data at speeds that would have been unheard of when Regulation NMS was adopted. As the national market system has evolved, the Commission has amended several aspects of Regulation NMS to address and reflect changes in the markets.

Most recently, in 2020, the Commission adopted rules to update and modernize the equity market infrastructure responsible for the collection, consolidation, and dissemination of equity market data in the national market system by expanding the content of NMS market data and establishing a decentralized consolidation model for NMS market data (“MDI Rules”).

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

See

Securities Exchange Act Release No. 84528 (Nov. 2, 2018), 83 FR 58338 (Nov. 19, 2018) (“Disclosure of Order Handling Information” in which the Commission adopted new order handling disclosure requirements). The Commission has continually reviewed the national market system and issues related to equity market structure since Regulation NMS was adopted. In 2010, the Commission issued a Concept Release on Equity Market Structure seeking public comments on high frequency trading, order routing, market data linkages, and undisplayed liquidity.

See

Securities Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010) (“Concept Release on Equity Market Structure”). In 2015, the SEC formed the Equity Market Structure Advisory Committee (“EMSAC”), which considered issues related to Regulation NMS and equity market structure. The archives of these meetings are available at

https://www.sec.gov/spotlight/emsac/emsac-archives.htm

Securities Exchange Act Release No. 90610 (Dec. 9, 2020), 86 FR 18596 (Apr. 9, 2021) (“MDI Adopting Release”).

While the MDI Rules, in part, updated the NMS market data to enable investors to see, and more readily access, better-priced quotations,

the Commission believes that other aspects of Regulation NMS need to be updated in light of the current trading environment. Investors should have access to the best priced quotations available in the national market system and such prices generally should be determined by competitive market forces. Among the rules adopted under Regulation NMS, rule 610 sets forth standards governing access to quotations in NMS stocks and rule 612 establishes minimum pricing increments for NMS stocks.

In the current trading environment, rule 612 should be updated by reducing the minimum pricing increment for certain NMS stocks to allow market participants, including investors, to better determine the prices at which they would bid or offer. Further, rule 610 contains maximum access fee caps that were based on the trading environment in 2005. These access fee caps should be reduced in conjunction with the reduction of the minimum pricing increments under rule 612 to help to ensure that the access fee caps do not become too large in relation to the minimum pricing increments.

The Commission has not revised rule 610 or rule 612 since they were adopted and the Commission believes that these rules should be revised to reflect the current trading environment and so that they can continue to fulfill the goals of section 11A of the Exchange Act. The amendments proposed herein—varying and lowering the minimum pricing increments for the quoting and trading of certain NMS stocks, reducing the access fee caps, and accelerating the dissemination of information about quotations in smaller sizes—would enhance trading opportunities for all investors. They would also serve to help ensure that orders placed in the national market system reflect the best prices available for all investors.

Id.

at 18601.

See

17 CFR 242.610 and 17 CFR 242.612.

See infra

section III for further discussion of the relationship between access fees and minimum pricing increments.

Congress' findings promulgated in 1975 as set forth in section 11A of the Exchange Act continue to guide the Commission as it considers the issues that exist within the national market system in 2022. Among the findings that guide the Commission in overseeing the national market system, the Commission must consider the availability of “[n]ew data processing and communications techniques [that] create the opportunity for more efficient and effective market operations”

and that it is in the public interest, appropriate for investor protection and the maintenance of fair and orderly markets to assure “economically efficient execution of securities transactions,” “fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets,” and “the practicality of brokers executing investors' orders in the best market.”

These findings support our decision to propose amendments to rules 610 and 612 of Regulation NMS in light of the tremendous changes that have occurred in the markets since 2005.

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

15 U.S.C. 78k-1(a)(1)(c)(i), (ii), and (iv).

Further, the MDI Rules are in the process of being implemented.

While the content of market data that will be made available within the national market system will provide many benefits to investors,

the Commission scheduled the implementation of the MDI Rules over a period of time to minimize disruption to the markets and to facilitate an orderly transition.

As discussed in section IV.B below, in part due to implementation delays after the adoption of the MDI Rules, the Commission believes that the transition period set forth in the MDI Adopting Release should be partially modified so that investors and market participants would be provided with some of the benefits of the MDI Rules, including greater transparency regarding the best priced orders available in the market, sooner than the originally adopted implementation schedule.

Section 11A of the Exchange Act provides that “[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure . . . the availability to brokers, dealers, and investors of information with respect to

quotations for and transactions in securities.”

Acceleration of some of the MDI Rules would help to fulfill this statutory goal.

See

MDI Adopting Release,

supra

note 5.

Id.

See id.

at 18699. As discussed below, the transition to the new MDI Rules has been delayed.

See infra

note 357 and accompanying text.

See infra

sections IV, V.D.5, and V.D.6 (discussing the costs and benefits of accelerating the round lot and odd-lot information definitions).

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

A. Rule 612—Minimum Pricing Increments

The Commission adopted rule 612 of Regulation NMS to implement minimum pricing increments (also known as minimum price variations or tick sizes) for NMS stocks. Currently, quotations for NMS stocks priced at, or greater than, $1.00 per share the minimum pricing increment is $0.01, while quotations for NMS stocks priced less than $1.00 per share the minimum pricing increment is $0.0001. Specifically, rule 612(a) states that “[n]o national securities exchange, national securities association, alternative trading system, vendor, or broker or dealer shall display, rank, or accept from any person a bid or offer, an order, or an indication of interest in any NMS stock priced in an increment smaller than $0.01 if that bid or offer, order, or indication of interest is priced equal to, or greater than, $1.00 per share.” Rule 612(b) applies to bids, offers, orders, and indications of interest in any NMS stock priced less than $1.00 per share and specifies that the increment cannot be smaller than $0.0001. The Commission adopted rule 612 to address concerns about sub-penny quoting by protecting displayed limit orders and promoting transparent and consistent pricing. The Commission stated that the rule “was designed to limit the ability of a market participant to gain execution priority over competing limit orders by stepping ahead by an economically insignificant amount.”

See

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

See also

Exchange Act Release No. 49325 (Feb. 26, 2004), 69 FR 11126 (Mar. 9, 2004) (“Regulation NMS Proposing Release”). The Commission issued a supplemental request for comment on proposed Regulation NMS in May 2004.

See

Securities Exchange Act Release No. 49749 (May 20, 2004), 69 FR 30142 (May 26, 2004) (“Supplemental Release”). On Dec. 16, 2004, the Commission re-proposed Regulation NMS in its entirety for public comment.

See

Securities Exchange Act Release No. 50870 (Dec. 16, 2004), 69 FR 77424 (Dec. 27, 2004) (“Re-proposing Release”).

There are various issues related to market developments which suggest that the Commission should update the minimum pricing increments for the U.S. equity markets. Specifically, many NMS stocks today are constrained by the minimum pricing increment of $0.01 that is required under rule 612 and thus are not able to be priced by market forces. That is, based on liquidity and price competition, these stocks could be priced more aggressively within the spread than is possible with the current minimum pricing increment of $0.01. “Tick-constrained” stocks,

i.e.,

stocks that have a time weighted average quoted spread of 1.1 cents or less make up the majority of the current trading volume, and their presence suggests that the rule 612 minimum pricing increment of $0.01 may now be too large for certain stocks, which, in turn, results in the pricing of such stocks being artificially constrained.

Trading in tick-constrained stocks would be improved if competitive market forces could establish prices in sub-penny increments, which could reduce quoted spreads.

In this release, tick-constrained stocks are defined as those that have a time weighted quoted spread of $0.011 or less calculated during regular trading hours.

See infra

note 102 and accompanying text,

infra

note 448 and accompanying text and Table 4.

In addition, the competitive dynamic between trading in the certain parts of the over-the-counter (“OTC”) market and trading on national securities exchanges and alternative trading systems (“ATSs”) caused by, among other things, rule 612 has continued to shift over time.

Specifically, while rule 612 prohibits exchanges, ATSs and broker-dealers from displaying, ranking or accepting quotes and orders in NMS stocks that are priced at, or greater than, $1.00 per share in sub-penny increments, the rule does not prohibit trading in sub-penny increments. In application, however, certain OTC market participants are able to trade more freely in sub-penny increments than others. Specifically, while rule 612 requires an OTC market maker to only accept priced orders in a penny increment, it does not prevent OTC market makers from executing an order in a sub-penny amount. Trading on national securities exchanges and ATSs, however, largely occurs in penny increments because national securities exchanges and ATSs generally execute trades at the prices that orders and quotes must be displayed, accepted or ranked under rule 612.

Among other things, the ability of OTC market makers to trade more readily in finer increments (

i.e.,

offering sub-penny price improvement over the displayed quote) compared to the trading on exchanges and ATS has contributed to the increased percentage of executions that occur off-exchange.

Finally, since the adoption of rule 612, there have been technological advancements that enable trading and order routing systems of market participants to handle the increased message traffic that could occur if smaller or varied minimum pricing increments were implemented for NMS stocks.

See infra

section II.D.

Exchanges and ATSs execute orders in sub-penny increments if the price of the execution is the midpoint of the national best bid and national best offer (“NBBO”), if the orders are benchmark trades such as volume-weighted average price (“VWAP”) and time-weighted average price (“TWAP”), or if an exchange has a retail liquidity program (“RLP”) that operates pursuant to exemptions granted by the Commission that allow such programs to provide executions in tenths of a cent.

See

Regulation NMS Adopting Release,

supra

note 16, at 37556.

See also infra

section II.

See, e.g.,

Staff Report on Equity and Options Market Structure Conditions in Early 2021 (“Staff Report on Equity and Options Market Structure”) at section 2.4 for a discussion of Order Execution and Segmentation of Individual Investor Flow. Staff reports, Investor Bulletins, and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these staff documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person.

See also

Edwin Hu and Dermot Murphy, “Competition for Retail Order Flow and Market Quality” (June 8, 2022),

available at https://ssrn.com/abstract=4070056

(retrieved from SSRN Elsevier database) (noting that approximately 27% of trading volume is routed from retail brokerages to seven internalizing broker-dealers and estimating that two of those firms handle 70% of the volume from 2017 to 2021; and concluding that promoting more competitive markets for retail order flow could save investors billions of dollars in transaction costs).

Under section 11A(a)(1) of the Exchange Act, Congress found that “[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure—(i) economically efficient execution of securities transactions; [and] (ii) fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets. . . .”

The Commission, consistent with the Congressional mandate and direction of section 11A(a)(2) of the Exchange Act to carry out these objectives, proposes to amend rule 612 to establish variable minimum pricing increments for quotations and orders in NMS stocks that are priced at, or greater than, $1.00 per share based on objective and measurable criteria and make such minimum pricing increments applicable to the trading of all NMS stocks regardless of price, subject to certain specified exceptions.

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

The proposed rule would not change the minimum pricing increment of rule 612(b), which permits sub-penny increments for quotations and orders in NMS stocks that are priced less than $1.00 per share.

See infra

section II.F.3.

As discussed in section II.F

the Commission is proposing to amend rule 612 in a manner that would extend

beyond tick-constrained stocks. The Commission believes that it is timely, and consistent with section 11A of Exchange Act, to replace and modernize the current “one-size-fits-all” tick approach with an objectively calculated and varied approach that would determine the minimum pricing increments for particular NMS stocks in a manner that would reflect differences in their trading characteristics. The Commission believes that the proposed variable minimum pricing increments would address the issues related to tick-constrained stocks, help to prevent other stocks from becoming tick-constrained, and reduce transaction costs for many stocks without harming the displayed liquidity in, and execution quality of, NMS stocks that may be higher priced and/or trade with wider spreads. In addition, the Commission is proposing to apply the amended rule 612 minimum pricing increments to the quoting and trading of NMS stocks in order to promote fair competition and equal regulation between trading in the OTC market and trading on exchanges and ATSs, particularly as it relates to retail order flow.

See infra

section II.F.

The Commission believes that requiring orders to be executed in the minimum pricing increment would enhance competition among trading centers by ensuring that all trading centers would be able to compete in the same price increment. The Commission believes applying the proposed minimum pricing increments to the trading of NMS stocks regardless of trading venue would also preserve most meaningful price improvement opportunities and potentially benefit the market as increased competition for orders, and between market participants, could promote innovation.

See infra

sections V.D.2 and V.E.2.a.

As further discussed in section II.F, the Commission is proposing to amend rule 612 such that the minimum pricing increment for quotations and orders in NMS stocks that are priced at $1.00 or more per share would be variable and no smaller than (1) $0.001, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was equal to, or less than, $0.008;

(2) $0.002, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.008 but less than, or equal to, $0.016; (3) $0.005, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.016 but less than, or equal to, $0.04; and (4) $0.01, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.04. Under this proposal, the primary listing exchanges would measure and calculate the Time Weighted Average Quoted Spread of each NMS stock in order to determine the applicable minimum pricing increment for such NMS stock during the months of March, June, September, and December of a particular calendar year (

i.e.,

“Evaluation Period”) for the three months to follow. Finally, the Commission is proposing that the minimum pricing increments set forth by rule 612, subject to specified exceptions, be applicable to the trading of all NMS stocks.

Currently, no NMS stock would qualify for this minimum pricing increment.

See infra

note 211.

B. Rule 610—Access to Quotations

The Commission adopted rule 610 to help to fulfill the statutory objectives of fair and efficient access to the individual markets that participate in the national market system.

The Commission described rule 610 as supporting the national market system objectives of assuring “the practicability of brokers executing investors' orders in the best market”

and “the efficient execution of securities transactions.”

Rule 610 addresses three issues related to access to quotations: (1) the means of access to quotations; (2) the fees for access to protected quotations and any other quotations that are the best bid or best offer of an exchange; and (3) locking and crossing quotations.

See

Regulation NMS Adopting Release,

supra

note 16, at 37497, 37538.

Id.

at 37538.

See also

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

See

Regulation NMS Adopting Release,

supra

note 16, at 37538.

See also

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

Rule 610 imposes a limit on the fees that can be charged for access to protected quotations.

For NMS stocks priced at, or greater than, $1.00 per share, a trading center

shall not impose, nor permit to be imposed, any fee for the execution of an order against a protected quotation that exceeds $0.0030 per share, and for NMS stocks that are priced at less than $1.00 per share, a trading center shall not impose, nor permit to be imposed, any fee for the execution of an order against a protected quotation that exceeds 0.3% of the quotation price per share. The Commission adopted the access fee caps to preserve the benefits of strengthened price protection and more efficient linkages among trading centers that could be disrupted if substantial fees for accessing quotations were charged.

The access fee caps were calculated based upon the then current fees that were charged by certain trading venues and reflect the minimum pricing increment of $0.01 per share.

The access fee caps have not changed since their adoption in 2005.

A protected quotation is defined in rule 600(b)(71) as “a protected bid or protected offer.” 17 CFR 242.600(b)(71). A protected bid or protected offer is defined as “a quotation in an NMS stock that: (i) Is displayed by an automated trading center; (ii) Is disseminated pursuant to an effective national market system plan; and (iii) Is an automated quotation that is the best bid or best offer of a national securities exchange, the best bid or best offer of the Nasdaq Stock Market, Inc., or the best bid or best offer of a national securities association.” 17 CFR 242.600(b)(70).

A trading center is defined in rule 600(b)(95) as “a national securities exchange or national securities association that operates an SRO trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent.” 17 CFR 242.600(b)(95).

See

Regulation NMS Adopting Release,

supra

note 16, at 37544.

See id.

at 37545.

In the time since the adoption of rule 610, the national securities exchanges have adopted complex fee schedules, with fees charged and rebates paid, in part, to encourage the submission of liquidity.

The fee schedules of the national securities exchanges also include various volume-based tiers that seek to reward market participants for submitting a minimum level of liquidity.

The fees included in these schedules are largely calculated based on volume in a given month and are therefore calculated at month's end. This timing impedes the ability of market participants, including investors, to evaluate the total price of a trade at the time of execution and impedes a market participant's ability to evaluate best execution and order routing.

See infra

section III.A.2.

See infra

section III.A.2.

The Commission proposes to amend rule 610 in two ways. First, to reflect the lower variable minimum pricing increments proposed under rule 612, the Commission proposes to reduce the access fee caps for protected quotations in NMS stocks priced $1.00 or more to $0.0005 per share for NMS stocks that have a minimum pricing increment of $0.001; and $0.001 per share for NMS stocks that have a minimum pricing increment greater than $0.001 per share; and for protected quotations in NMS stocks priced less than $1.00 per share to 0.05% of the quotation price. The proposed level of the access fee caps seeks to balance the need to reduce the access fee caps to accommodate the reduction in the minimum pricing increments and preserve the ability of

the agency market business models to charge fees for access.

Consistent with the Commission's proposal to adopt lower variable minimum pricing increments, the Commission is proposing reduced variable access fee caps based on the minimum pricing increment and the price of the protected quotation.

The Commission believes the proposed fee caps are consistent with current market practices and would lead to pricing that is better aligned with today's transaction costs.

Agency market trading centers are those that bring together buyers and sellers and typically charge a fee for their execution services. The Commission has previously recognized that “agency trading centers perform valuable agency services in bringing buyers and sellers together, and that their business model historically has relied, at least in part, on charging fees for execution of orders against their displayed quotations.”

See

Regulation NMS Adopting Release,

supra

note 16, at 37545.

See infra

section III.C.1.

See infra

note 297 and accompanying text.

Second, to facilitate the ability of market participants to understand and calculate the total price of transactions at the time of execution, the Commission proposes to amend rule 610 to require exchanges to make the amounts of all fees and rebates determinable at the time of execution.

C. Transparency of Better Priced Orders

The Commission adopted the MDI Rules, which expanded the content of data that will be made available for dissemination within the national market system and adopted a decentralized consolidation model for the collection, consolidation, and dissemination of consolidated market data.

One goal in expanding the data made available within the national market system was to increase transparency about better prices available in the market.

To accomplish this, the Commission, in the MDI Rules, adopted a new definition of round lot, which will increase transparency about smaller sized orders in higher priced stocks by assigning NMS stocks priced over $250 to round lot sizes that are less than the 100 share round lot size that is predominant today.

MDI Adopting Release,

supra

note 5. Several exchanges filed petitions for review in the U.S. Court of Appeals for the District of Columbia Circuit, which were denied on May 24, 2022.

The Nasdaq Stock Market LLC, et al

SEC,

No. 21-1100 (D.C. Cir. May 24, 2022).

See

Securities Exchange Act Release No. 88216 (Feb. 14, 2020), 85 FR 16726, 16730-31 (Mar. 24, 2020) (“MDI Proposing Release”).

See infra

note 327 for a description of the data currently provided within the national market system.

In addition, the MDI Rules included odd-lot information in the data that will be made available within the national market system. “Odd-lot information” is defined as (1) odd-lot transactions, and (2) odd-lots at a price greater than or equal to the national best bid and less than or equal to the national best offer, aggregated at each price level at each national securities exchange and national securities association.

Therefore, once implemented, information regarding the prices and sizes of odd-lot orders priced better than the national best bid and national best offer (“NBBO”) will be made available within the national market system and is expected to be made widely available to investors.

These new definitions will significantly enhance transparency about better priced orders available in the market. For the reasons explained in the MDI Adopting Release, the Commission adopted a phased transition plan for the MDI Rules that sequenced the implementation of these data elements in the later stages of the transition.

For example, if the national best bid for XYZ, Inc. is 100 shares at $25.00, and there are three orders of five shares and two orders of ten shares at $25.01 on Exchange A, this would be represented as “35 shares at $25.01 on Exchange A” pursuant to the definition of odd-lot information adopted under the MDI Rules. MDI Adopting Release,

supra

note 5, at 18613.

MDI Adopting Release,

supra

note 5, at 18612-13.

See id.

at 18698.

The Commission proposes to accelerate implementation of the round lot and odd-lot information definitions adopted under the MDI Rules so that this information is made available to investors within the national market system sooner. Information about better priced orders available in the market is important for investors to be able to understand the current prices and liquidity in the market when entering their orders.

This information is also important for market participants who have best execution obligations.

See id.

at 18612.

Id. See also infra

note 359.

Furthermore, while the odd-lot information definition includes all prices better than the NBBO for which there is liquidity available in an odd-lot size, it does not identify a consolidated best odd-lot order. Establishing a defined best odd-lot order would provide further relevant information to investors and market participants. A consolidated best odd-lot order would be useful to investors in deciding the terms of an order by providing information about the price, size, and market of the best priced buy and sell orders available in the market against which their own orders could execute. Further, a best odd-lot order would be useful to investors to measure the amount of price improvement they receive for the execution of their orders. The Commission believes that amending the definition of odd-lot information to include a best odd-lot order would be consistent with section 11A of the Exchange Act, which provides, among other things, that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure the availability of information with respect to quotations in securities.

Further, a best odd-lot order would be consistent with section 11A(c)(1)(B) of the Exchange Act as it would assure the usefulness of quotation information.

Together with accelerating the implementation of the definitions of round lot and odd-lot information, these proposed amendments would provide investors with enhanced transparency about better priced orders available in the market.

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

15 U.S.C. 78k-1(c)(1)(B).

II. Amendment to Rule 612 of Regulation NMS—Minimum Pricing Increment

A. Background

Prior to implementing decimal pricing in April 2001, fractions of a dollar were utilized to represent the minimum pricing increments for the United States equity markets (

e.g.,

1/8

1/16

, and

1/32

of a dollar).

The conversion to decimal pricing reduced the allowable minimum pricing increment to $0.01 and the exchanges adopted rules that established minimum pricing increments of $0.01 for equities trading.

However, after the conversion to decimal pricing, the display and execution of sub-penny quotes increased off-exchange.

The increase

of sub-penny quoting and trading in the OTC market raised concerns because these quotes were not readily transparent, or accessible, to many average investors.

A tick is the minimum pricing increment that can be used to trade securities. Decimalization set the tick size to penny increments from fractional increments, such as

1/8

1/16

of a dollar. For a discussion of the implementation of decimal pricing,

see

Order Directing the Exchanges and the Financial Industry Regulatory Authority to Submit a Tick Size Pilot Plan, Exchange Act Release No. 72460 (June 24, 2014), 79 FR 36840 (June 30, 2014).

See

Exchange Act Release No. 46280 (July 29, 2002), 67 FR 50739 (Aug. 5, 2002) (order approving proposed rule changes and amendments related to decimal pricing). In this order, the Commission approved the proposals of the then-existing exchanges and the National Association of Securities Dealers, Inc. (the predecessor to the Financial Industry Regulatory Authority, Inc. (“FINRA”)) to establish a minimum pricing increment of $0.01 for equity issues, $0.05 for option issues quoted under $3.00 a contract, and $0.10 for option issues quoted at $3.00 a contract or greater.

See

Regulation NMS Proposing Release,

supra

note 16, at 11163.

See also

Report to Congress on Decimalization, Commission (July 2012) (“Decimalization Report”)

available at https://www.sec.gov/files/decimalization-072012.pdf.

See

Regulation NMS Proposing Release,

supra

note 16 at 11164.

In 2004, as part of Regulation NMS, the Commission proposed rule 612 to implement minimum pricing increments for quoting in NMS stocks. The Commission stated that while the benefits of decimalization justified the costs, there was a potential for costs to investors and the markets to surpass the benefits if the minimum pricing increment decreased beyond a certain level.

Rule 612 was designed to “deter the practice of stepping ahead of exposed trading interest by an economically insignificant amount,”

which could discourage investors from submitting limit orders. The Commission reasoned that “if orders lose execution priority because competing orders step ahead for an economically insignificant amount, liquidity could diminish.”

Further, the Commission was concerned that sub-penny quotes could decrease market depth (

i.e.,

the number of shares of a security that is available at any given price), which in turn could increase transaction costs and cause institutions “to rely more on execution alternatives away from the exchanges” and “[s]uch a trend could increase fragmentation of the securities markets.”

In addition, the Commission stated that sub-penny quoting could inhibit the ability of broker-dealers to meet certain regulatory obligations by increasing the incidences of so-called “flickering” quotes.

At the time, the Commission did not believe that the potential benefits of marginally better prices offered by sub-penny increments for quotes and orders in securities priced at, or greater than, $1.00 per share were likely to justify the costs of permitting sub-penny quotes to be displayed, accepted and ranked.

However, the Commission acknowledged the possibility that the markets could evolve over time and cause the balance of the costs and benefits to shift.

See id.

at 11165.

Id.

at 37553.

Id.

at 37551. Further, the Commission stated that “[w]hen market participants can gain execution priority for an infinitesimally small amount, important customer protection rules such as exchange priority rules and [FINRA's] Manning rule could be rendered meaningless” and that without such protections, “professional traders would have more opportunity to take advantage of non-professionals,” which could lead to lost executions or executions occurring at inferior prices.

Id.

at 37552. The Commission stated that a decrease in market depth could “lead to higher transaction costs, particularly for institutional investors (such as pension funds and mutual funds) that are more likely to place large orders,” which “would likely be passed on to retail investors whose assets are managed by the institutions.”

Id.

at 37552. The Commission described “flickering quotations” as occurring when the price of a trading center's best displayed quotations changes multiple times in a single second and stated that flickering quotations “could make it more difficult for broker-dealers to satisfy their best execution obligations and other regulatory responsibilities.”

Id.

at 37553 (“Even assuming that quoting in sub-penny increments would reduce spreads, the Commission continues to believe, on balance, that the costs of sub-penny quoting are not justified by the benefits.”)

Id.

(“Nevertheless, the Commission acknowledges the possibility that the balance of costs and benefits could shift in a limited number of cases or as the markets continue to evolve.”)

When rule 612 was adopted, the Commission considered the impact of sub-penny trading but did not believe that such trading raised the same concerns as sub-penny quoting. Specifically, the Commission stated that, unlike sub-penny quoting, sub-penny executions do not cause quote flickering, decrease depth at the inside of the market or raise systems capacity issues.

In addition, the Commission stated that sub-penny executions were generally beneficial to retail investors.

See

Regulation NMS Adopting Release,

supra

note 16, at 37556.

See id.

B. Rule 612

In 2005, the Commission adopted rule 612 of Regulation NMS to establish uniform minimum pricing increments for NMS stocks. Rule 612 prohibits national securities exchanges, national securities associations, ATSs, vendors and broker-dealers from displaying, ranking, or accepting quotations, orders, or indications of interest in any NMS stock priced in an increment smaller than $0.01 if the quotation, order, or indication of interest is priced equal to, or greater than, $1.00 per share. Rule 612 also prohibits national securities exchanges, national securities associations, ATSs, vendors, and broker-dealers from displaying, ranking or accepting quotations, orders and indications of interest in an NMS stock in an increment smaller than $0.0001 if the quotation, order or indication of interest in an NMS stock is priced less than $1.00 per share. Under rule 612, an exchange, association, ATS, vendor or broker-dealer must reject a quote or order for an NMS stock that is explicitly priced in an impermissible increment.

See id. See also, e.g.,

NYSE Rule 7.6 (Trading Differentials) (“The minimum price variation (MPV) for quoting and entry of orders in securities traded on the Exchange is $0.01, with the exception of securities that are priced less than $1.00 for which the MPV for quoting and entry of orders is $0.0001.”);

See also

CBOE BYX Retail Pilot Program Approval Order,

supra

note 62 at 71658; and NASDAQ BX Retail Pilot Program Approval Order,

supra

note 62 at 72053.

NYSE Retail Liquidity Program Approval Order at 40682. There are three effective national market system plans that govern the collection, consolidation, processing, and dissemination of certain NMS information. They are: (1) the Consolidated Tape Association Plan (“CTA Plan”); (2) the Consolidated Quotation Plan (“CQ Plan”); and (3) the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation, and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchanges on an Unlisted Trading Privileges Basis (“UTP Plan”) (together, the “Equity Data Plans”).

See also

MDI Adopting Release,

supra

note 5.

Id.

at 40680.

See, e.g.,

How Can The Buy Side Interact With Retail Flow, Rosenblatt Securities, Feb. 14, 2022,

available at https://www.rblt.com/market-reports/how-can-the-buy-side-interact-with-retail-flow

(“The various exchange retail programs consistently account for less than 0.2% of consolidated volume.”). According to NYSE, most order handling processes ignore retail interest that is available in the RLPs because resting interest in RLPs does not display price or size.

See

NYSE, Price improvement, tick harmonization & investor benefit (Aug. 22, 2022) (“NYSE Tick Harmonization Paper”),

available at https://www.nyse.com/publicdocs/nyse/NYSE_Price_Improvement_202208.pdf.

See also https://www.nyse.com/data-insights/what-exchanges-can-and-cannot-offer-retail-traders. See also

NYSE Retail Liquidity Program Approval Order at 40682.

C. Tick Size Considerations Since Regulation NMS

Minimum pricing increments have been considered several times since the Commission adopted rule 612. In 2010, the Commission issued the Concept Release on Equity Market Structure, which examined the then current equity market structure and invited public comment on various market structure issues, including high frequency trading, order routing, market data linkages, and undisplayed liquidity.

Among other things, the Commission discussed internalization by broker-dealers and stated that “[t]here may be greater incentives for broker-dealer internalization in low-priced stocks than in higher priced stocks.”

The Commission stated that in low-priced stocks, the one cent per share minimum pricing increment is much larger on a percentage basis than it is in higher-priced stocks.

In the discussion on undisplayed liquidity, the Commission sought comment on whether public price discovery and execution quality may have suffered and specifically questioned whether the minimum pricing increment should be reduced for lower priced stocks.

In response, the Commission received several letters opposing

and supporting

a pilot program to test sub-penny tick increments. The Commission also received letters recommending a pilot program to test a wider variety of tick sizes.

See

Concept Release on Equity Market Structure,

supra

note 4.

Id.

See, e.g.,

Letters from Karrie McMillan, General Counsel, Investment Company Institute, dated Apr. 21, 2010; Ann Vlcek, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association (“SIFMA”), dated Apr. 29, 2010; James J. Angel, Associate Professor, McDonough School of Business, Georgetown University; Lawrence E. Harris, Fred V. Keenan Chair in Finance, Professor of Finance and Business Economics, Marshall School of Business, University of Southern California; Chester S. Spatt, Pamela R. and Kenneth B. Dunn Professor of Finance, Director, Center for Financial Markets, Tepper School of Business, Carnegie Mellon University, dated Feb. 23, 2010.

See, e.g.,

Letters from Eric Swanson, General Counsel, BATS Exchange, Inc., dated Apr. 21, 2010 and Eric W. Hess, General Counsel, Direct Edge, dated Apr. 28, 2010.

See, e.g.,

Letters from Janet M. Kissane, SVP—Legal and Corporate Secretary, Office of the General Counsel, NYSE Euronext, dated Apr. 23, 2010; and John A. McCarthy, General Counsel, GETCO LLC, Christopher R. Concannon, Partner, Virtu Financial LLC, and Leonard J. Amoruso, General Counsel, Knight Capital Group, Inc., dated July 9, 2010.

In 2010, three exchange operators jointly petitioned the Commission to use its exemptive authority under rule 612(c) to allow the exchanges to implement a 6-month pilot program that would reduce the minimum pricing increment to $0.005 for a limited set of 30 NMS stocks priced from $1.00 to $20.00 (including one exchange-traded fund (“ETF”) that was trading at greater than $20.00).

The Joint Petition stated that at that time a significant percentage of the volume in these securities (4%) was transacting at a $0.005 increment and that a large percentage of share volume in securities priced below $20 occurred in securities that were routinely quoted at the minimum pricing increment, indicating a likelihood that price discovery was being constrained.

The Joint Petition also stated that “a disproportionately high percentage of transactions in securities priced between $1 and $20 dollars are occurring away from lit markets, which [they] believe indicates a lack of quote competition.”

The petitioners stated that the $0.01 minimum pricing increment resulted in artificially wide publicly-displayed quotes for certain lower-priced, liquid securities, which, in turn, negatively impacted the public price discovery process and resulted in inferior execution prices for investors.

See

Letter from Chris Isaacson, Chief Operating Officer, BATS Exchange, Inc., Eric Noll, Executive Vice President, NASDAQ OMX Group, Inc., and Larry Leibowitz, Chief Operating Officer, NYSE Euronext, Inc. to Elizabeth M. Murphy, Secretary, Commission, dated on Apr. 30, 2010 (“Joint Petition”)

available at https://www.sec.gov/spotlight/regnms/jointnmsexemptionrequest043010.pdf.

The petitioners stated that the pilot would allow the Commission to collect data to study the impact of the reduction of the minimum increment without making a long term policy commitment. The petitioners did not propose to reduce the access fee caps under rule 610 because the $0.005 increment would have continued to be higher than the access fee cap, which would prevent the public display of a protected quote that is not accurate when the access fee is factored in.

Id.

at 7.

Id.

at 6.

Id.

at 2.

Id.

at 1.

In 2012, Congress passed the Jumpstart Our Business Startups Act (“JOBS Act”), which contained provisions relating to the impact of decimalization on small and middle capitalization companies. Section 106(b) of the JOBS Act directed Commission to conduct a study on how decimalization affected the number of initial public offerings (“IPOs”) and the liquidity and trading of smaller capitalization company securities. The Commission submitted a staff study to Congress in July 2012.

While the Decimalization Report did not reach any firm conclusions about the impact of

decimalization on the number of IPOs or the liquidity and trading of small capitalization companies, it did recommend that the Commission conduct a roundtable where recommendations could be presented on a pilot program that would generate data to allow the Commission to further assess decimalization's impact. Commission staff held a roundtable on February 5, 2013, during which there was broad support among panelists for the Commission to conduct a pilot program to gather information, particularly with respect to the impact of wider minimum pricing increments on liquidity in smaller capitalization companies.

In 2016, the Commission initiated a Tick Size Pilot for small- and mid-size capitalized stocks to test larger quoting and trading increments (“TSP”).

After the expiration of the 2-year pilot program, the Commission staff observed that, on average, increasing the tick size resulted in deteriorating market quality for stocks that became tick-constrained under the pilot.

See

Decimalization Report,

supra

note 49.

For a complete discussion about the Feb. 6, 2013 roundtable and the discussions that led to the implementation of the tick size pilot,

see

Securities Exchange Act Release No. 72460 (June 24, 2014), 79 FR 36840 (June 30, 2014) (Order Directing the Exchange and FINRA to submit a Tick Size Pilot Plan).

See

Securities Exchange Act Release No. 74892 (May 6, 2015), 80 FR 27513 (May 13, 2015) (Order Approving the National Market System Plan to Implement a Tick Size Pilot Program,

available at https://www.govinfo.gov/content/pkg/FR-2015-05-13/pdf/2015-11425.pdf).

DERA Tick Size Pilot and Market Quality (Jan. 31, 2018),

available at https://www.sec.gov/dera/staff-papers/white-papers/dera_wp_tick_size-market_quality. See also

Who Provides Liquidity, And When?, Sida Li, Xin Wang, and Mao Ye, Journal of Financial Economics 141, no. 3 (2021) (finding that wider tick sizes reduce liquidity, encourage the speed race among high-frequency traders, and allocate resources to latency reduction) and Yashar Barardehi, Peter Dixon, Qiyu Liu, and Ariel Lohr,

Tick Sizes and Market Quality: Revisiting the Tick Size Pilot

(working paper, Dec. 14, 2022)

available at https://www.sec.gov/files/dera_wp_ticksize-pilot-revisit.pdf

(observing that market quality improved at the end of the pilot for stocks that were tick constrained under the TSP). Dixon, Liu, and Lohr are financial economists in the Division of Economic and Risk Analysis at the SEC. Barardehi is at the Argyros School of Business & Economics, Chapman University, and is a part-time consultant with the SEC.

D. Issues Raised in the Current Market Structure

In 2005, when rule 612 was adopted, the markets were still largely typified by manual trading on exchange floors.

Since then, the markets have overwhelmingly transitioned to electronic trading with orders being accepted, routed, displayed, and executed via low latency trading systems.

Equity market structure and competitive dynamics have also changed,

and trading and order routing systems can handle and process an amount of data that would have been unprecedented and unfathomable in 2005.

NMS stocks are traded on-exchange (

i.e.,

on one or more of the 16 currently registered national securities exchanges) or off-exchange (

e.g.,

on one or more of the 33 currently registered NMS Stock ATSs

or by OTC market makers).

As of September 2022, on-exchange volume is approximately 58% while off-exchange/OTC volume is approximately 42%,

while in 2007, on-exchange share volume was 71% and off-exchange/OTC volume was approximately 29%.

The market structure of the OTC market that permits the execution of orders more readily in sub-penny amounts has been a factor that contributes to this result.

See

Concept Release on Equity Market Structure,

supra

note 4.

See

MDI Adopting Release,

supra

note 5.

The Concept Release on Equity Market Structure describes the transition of the modern equity trading markets away from the largely centralized, manual structure to the dispersed automated structure that exists today.

See

Concept Release on Equity market Structure,

supra

note 4.

See also

Staff Report on Algorithmic Trading in the U.S. Capital Markets (Aug. 5, 2020) (“Staff Report on Algorithmic Trading”) (this staff report updated some of the Concept Release's details and described certain developments that have occurred since 2010).

See

Staff Report on Algorithmic Trading (describing the broad use of algorithms in contemporary securities markets).

See https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm.

See

Staff Report on Equity and Options Market Structure,

supra

note 20.

Source: Equity consolidated data feeds (CTS and UTDF), as collected by MIDAS; NYSE Daily TAQ.

While rule 612 does not prohibit executions from occurring in sub-penny increments, there are various factors that lead to sub-penny trading occurring more frequently off-exchange compared to on-exchanges or ATSs. Specifically, exchanges and ATSs typically match quotes and orders in the penny increment in which explicitly priced quotes and orders must be submitted under rule 612. Sub-penny trading occurs on exchanges and ATSs pursuant to either: (1) exchange rules and order types that permit executions at midpoint of the NBBO or volume-weighted executions or (2) exemptions that have been granted by the Commission under rule 612(c) (

i.e.,

RLPs).

Accordingly exchange rules, and the requirement that such rules comply with rule 612, limit sub-penny trading on exchanges.

See supra

section II.B.1.

OTC market makers execute in sub-penny increments with more regularity as a result of their ability to offer price improvement in between the NBBO after such orders have been accepted by the OTC market maker in the permissible penny increment.

OTC market makers, unlike market participants on an exchange or ATS, are not limited by their market structure to generally execute orders in the minimum pricing increment that the order was accepted. Instead, OTC market makers are able to trade as principal with orders that they receive and in the increment that they determine. As a result, OTC market makers may trade more readily in sub-penny increments which helps to provide an advantage over their exchange and ATS counterparts in attracting order flow.

OTC market makers internalize orders by trading principally on the other side of the orders that they accept.

See

Staff Report on Equity and Options Market Structure,

supra

note 20.

Today, most marketable retail order flow is executed off-exchange by OTC market makers who, in addition to not being limited by exchange rules, offer, in many cases, payment for order flow (“PFOF”) for retail orders.

Further, 37% of executions off-exchange are reported in sub-penny amounts that are not associated with midpoint trades.

As further discussed in the Economic Analysis, data suggests that of the total dollar value of sub-penny trades that are not midpoint trades, 11% occurred on-exchange while 89% occurred off-exchange.

While this dynamic provides retail orders that execute OTC with a measure of price improvement, the Commission is concerned that these retail orders are not exposed to competitive forces on the public market (since these retail orders are typically directed from one broker-dealer to another wholesale broker-dealer by contractual arrangement). As a result, these retail orders are not publicly displayed and do not contribute to the

price competition and discovery mechanism of the lit markets. The Commission is seeking to address concerns about the competitive dynamic between exchanges/ATSs and OTC market makers because the ability of OTC market makers to more readily trade in finer sub-penny increments than exchanges and ATSs factors into the increasing percentage of equity volume that is executed off-exchange.

“Payment for order flow” is defined in Rule 10b-10 under the Exchange Act. 17 CFR 240.10b-10(d)(8). Rule 10b-10 further prescribes information that a broker or dealer must disclose to its customer on the customer's confirmation. The rule requires that the broker-dealer disclose to the customer, among other things, “[t]he amount of any remuneration received or to be received by the broker from such customer in connection with the transaction . . .” and “the source and amount of any other remuneration received or to be received by the broker in connection with the transaction. . . .” 17 CFR 240.10b-10(a)(2)(B) and (D).

See infra

section V.C.1.b and accompanying text.

See infra

section V.C.1.b and Table 8.

See

Staff Report on Equity and Options Market Structure at 11.

See also

Kwan, Amy, Ronald Masulis, and Thomas H. McInish, “Trading rules, competition for order flow and market fragmentation,” Journal of Financial Economics 115, no. 2 (2015): 330-348.

The fact that rule 612 does not prohibit sub-penny trading and the underlying regulatory framework that results in greater opportunities to trade OTC in sub-penny increments makes it more difficult for exchanges and ATSs to compete with OTC market makers for retail order flow. The Commission believes that the contrast between on and off-exchange sub-penny trading and the competitive responses by market participants results in market complexity and inefficiencies (

e.g.,

inverted taker-maker fee structures, tiered fee structures, segmentation via RLPs, excessive fragmentation and intermediation).

100

The proposed amendments to rule 612 would level the competitive playing field in this regard by requiring market participants, regardless of trading venue, to offer price improvement to investor orders in the same minimum pricing increments, unlike today where OTC market makers are able to offer investor orders price improvement in smaller pricing increments compared to their exchange and ATS counterparts.

100

See, e.g.,

Enhancing Competition, Transparency and Resiliency in U.S. Financial Markets, Citadel Securities (May 2021)

available at https://fe7a500fc6adae9c30fb.b-cdn.net/wp-content/uploads/2021/05/EnhancingCompetitionTransparencyandResiliencyinUSFinancialMarkets.pdf

(“Citadel Report”) (“This regulatorily mandated tick size impedes the ability of exchanges to compete for order flow in symbols that are highly liquid and commonly trade inside a bid-offer spread of a penny. We believe this `constrained' tick size directly leads to complexities and inefficiencies—such as driving order flow into alternative venues, complex exchange pricing structures, and increased overall market fragmentation.”).

See also

Enhancing U.S. Equity Market Structure for Retail Investors, Committee on Capital Markets Regulation (Sept. 2021) (“CCMR Report”)

available at https://www.capmktsreg.org/wp-content/uploads/2021/09/CCMR-Enhancing-Retail-Equity-Market-Structure-09.01.2021-2.pdf.

In addition, some NMS stocks are considered to be tick-constrained, meaning that they regularly experience a time-weighted average quoted spread of 1.1 cents or less, which indicates that these stocks are frequently quoted in the smallest increment permitted under the rule.

101

The Commission identified 1,337 NMS stocks that would be considered tick-constrained under this metric.

102

These tick-constrained NMS stocks account for 56.1% of estimated share volume and 23.2% of estimated dollar volume.

103

NMS stocks become tick-constrained because rule 612's minimum pricing increment prohibits quoting these stocks in increments smaller than provided under the rule. These stocks would experience smaller quoted spreads but for the requirement under rule 612.

101

See infra

note 448.

102

See infra

note 448 and accompanying text and

infra

Table 4.

103

Id.

Certain market participants have conducted data analysis on the effects of rule 612 and concluded that a $0.01 increment may not be appropriate for all stocks.

104

For instance, MEMX LLC (“MEMX”) issued a report in August 2021, which provided data that suggests that “[a] significant portion of the U.S. equity market trades with a consistent penny spread throughout most of the trading day.”

105

MEMX provided data from the first half of 2021 indicating that many tick-constrained stocks, based on MEMX's definition, are actively traded securities that “as a group [account] for 47% of volume, 28% of trades, and 25% of notional value executed.”

106

According to MEMX, the “[q]uoted spreads in these securities are limited not by supply and demand, but rather by outdated regulatory constraints that apply the same tick regime to securities with different trading characteristics.”

107

104

See, e.g.,

The Tick-Constrained Stock Problem by Phil Mackintosh (Jan. 20, 2022),

available at https://www.nasdaq.com/articles/the-tick-constrained-stock-problem)

(“Nasdaq Paper”).

See also

Petition for Rulemaking to Amend Rule 612 of Regulation NMS to Adopt Intelligent Tick-Size Regime, dated Dec. 16, 2019, submitted by John A. Zecca, Executive Vice President, Chief Legal Officer & Chief Regulatory Officer, Nasdaq Inc.

available at https://www.sec.gov/rules/petitions/2019/petn4-756.pdf

(“Nasdaq Intelligent Tick Proposal”); The Impact of Tick Constrained Securities on the U.S. Equity Market (

available at https://www.nyse.com/publicdocs/Tick_Constrained_Stocks.pdf)

(“NYSE White Paper”) (no date available); and Cboe Proposes Tick-Reduction Framework to Ensure Market Structure Benefits All Investors (

available at https://www.cboe.com/insights/posts/cboe-proposes-tick-reduction-framework-to-ensure-market-structure-benefits-all-investors/)

(“Cboe Proposal”).

105

See

MEMX Tick Constrained Securities (Aug. 2021) (“MEMX Report”)

available at https://memx.com/wp-content/uploads/MEMX-Market-Structure-Report-Tick-Constrained-Securities.pdf.

MEMX reviewed data from the first and second quarter of 2021. MEMX data suggested that on average 998 stocks during the period were tick-constrained, which MEMX defined as those NMS stocks that had an average quoted spread of 1.1 cents or less. In addition, on Aug. 30, 2021, MEMX filed a Request for Exemptive Relief Pursuant to Rule 612(c) of Regulation NMS to Permit a Minimum Increment of $0.005 in “Tick Constrained” NMS Stocks.

See

Letter from Adrian Griffiths, Head of Market Structure, MEMX to Vanessa Countryman, Secretary, Commission dated Aug. 30, 2021 (“MEMX Exemption Request”).

106

MEMX Report,

supra

note 105, at 9.

107

Id.

at 9.

MEMX analyzed tick-constrained stocks across different price buckets and found that tick-constraint occurs more frequently in lower-priced securities, “where the one cent minimum increment is more “economically significant” relative to the price of a share of stock.”

108

According to MEMX's analysis, “two-thirds (66%) of all tick-constrained securities trade in the two lowest price buckets,” which included stocks priced between $1.00 and $20.00 per share.

109

MEMX's analysis concluded that low-priced stocks are “more likely to be tick constrained, and the impact of that tick constraint in terms of basis point spread, which is relevant when measuring the cost of entering into a transaction, is also largest in these securities.”

110

However, MEMX stated that tick-constraint issues can occur across different price buckets, including in high-priced, actively-traded stocks.

111

MEMX's analysis also found that tick-constrained stocks typically have more liquidity at the NBBO than stocks that are not tick-constrained. The findings were similar for stocks and exchange traded products (“ETPs”) with varying notional values traded.

112

108

Id.

at 10.

109

Id.

110

Id.

111

Id.

at 11.

112

Id.

at 15-17.

MEMX analyzed securities that trade at least $100 million notional value each day and concluded that more than one half of equity ETPs are tick-constrained.

113

MEMX stated that tick-constrained actively-traded ETPs have spreads that are artificially wide “despite the fact that ETPs can be priced more efficiently due to the ability to accurately derive ETP prices and an effective arbitrage mechanism that keeps ETP prices in line with those of its underlying securities.”

114

113

Id.

at 13.

114

Id.

The New York Stock Exchange (“NYSE”) published a white paper that stated the current $0.01 minimum pricing increment is a wider tick than market forces would otherwise produce for tick-constrained stocks.

115

NYSE stated that tick-constrained stocks tend to trade with high volume, relatively low prices, and quoted spreads near $0.01, and exhibit higher levels of inaccessible liquidity (

i.e.,

order flow

that is only available to select market participants)

116

which hampers transparency and price discovery.

117

NYSE stated that the uniform rule 612 minimum pricing increment of $0.01 for all NMS stocks that are priced at, or above, $1.00 per share increases inaccessible liquidity, which results in “different market experiences for different participants.”

118

115

See

NYSE White Paper,

supra

note 104.

116

NYSE stated that retail order flow is an example of inaccessible liquidity because it is largely sent to OTC market making firms that can execute such orders on a principal basis at prices inside the best displayed prices.

Id.

at 1. NYSE stated that retail order flow has increased as a percentage of the market.

Id.

117

Id.

at 1.

118

Id.

at 2.

NYSE explained that some high-volume, lower-priced securities “trade consistently with a spread of exactly $0.01 and maintain very deep order books at the national best price.”

119

NYSE said that this dynamic makes “it difficult for liquidity providers to receive a fill, except at undesirable times such as when the price is about to change” and that “queue competition contributes to high-cost infrastructure deployments” as market participants need to develop low latency technology to be the fastest to a new price and has also led to the development of inverted fee venues, “which allow, for a cost, liquidity providers to pay for better queue position.”

120

According to NYSE, these dynamics show that rule 612 has influenced an “arms race” in market technology and venue fragmentation. NYSE also stated that “artificially wide tick sizes raise transaction costs and harm execution quality.”

121

NYSE estimated that “trading in tick constrained securities typically increase[s] transaction costs by about one billion dollars per year . . .”

122

119

Id.

120

Id.

121

Id.

122

Id.

at 12.

NYSE developed a “Tick Constrained Index” based on consolidated quoted spread and NBBO coverage to identify stocks that it considered tick-constrained using data from 2019. NYSE's tick-constrained stocks represented 538 symbols in the second half of 2020, which had an average intraday volume of 4,254,664 shares per symbol, and 25.9% of intraday volume. NYSE estimated that the minimum $0.01 spread “cost investors over $1.7 billion in the first half of 2020 . . . [and] $499 million” in the second half of 2020.

123

NYSE also analyzed the impact of volatility in 2020 on tick-constrained stocks and concluded that tick-constrained stocks responded differently than non-tick-constrained stocks to extreme volatility. Specifically, tick-constrained stocks spreads did not widen (52.72%) as much as non-tick-constrained (163.33%), but the depth at the inside decreased significantly more in tick-constrained stocks (−73.24%) compared to non-tick-constrained stocks (−39.75%).

124

According to NYSE, market makers managed their risk in tick-constrained stocks by reducing liquidity because they could not reduce prices. NYSE also noted that exchange market makers are unable to compete with off-exchange providers in providing price improvement.

125

123

Id.

at 4.

124

Id.

at 6-7.

125

Id.

at 8.

More recently, NYSE published a study on price improvement and minimum pricing increments.

126

NYSE analyzed consolidated exclusive securities information processor (“SIP”) data from January 1, 2022, to June 30, 2022.

127

NYSE estimates that in the first half of 2022 approximately $72 million per day aggregated price improvement was provided and that of this amount 48% was delivered on exchange and 52% was delivered off-exchange.

128

Further, NYSE estimates that 12.4% of the total price improvement came from non-midpoint trades in either tenths or hundredths of a cent, which are increments that exchanges have limited ability to trade.

129

According to NYSE's analysis, harmonizing the trading increment across exchange and non-exchange trading “could yield $6.3MM per day ($1.8B per year) in investor cost savings based on projected incremental savings if exchanges could offer sub-penny price improvement in a competitive manner.”

130

126

See

NYSE Tick Harmonization Paper,

supra

note 70 at 2.

127

Id.

at 3.

128

Id.

at 4.

129

Id.

130

Id.

at 2. NYSE described “trade increment harmonization” as “equal trade pricing rules for all on and off exchange trading, with exchanges able to display quotes at twice the trade pricing increment.” NYSE analyzed the possible impact of a half cent quoting increment coupled with a harmonized quarter cent trading increment.

Id.

at 5.

NYSE stated that exchanges currently provide:

(1) 1.17× the amount of off-exchange price improvement when combining the midpoint and round penny trade prices; and (2) 77% as much price improvement as off-exchange trades when spreads are wider than $0.01.

131

NYSE applied these ratios to current off-exchange sub-penny price improvement estimates to calculate an additional $7.3 million in daily price improvement.

132

131

Id.

at 2.

132

Id.

NYSE also examined data related to stocks that frequently trade with a $0.01 spread and found that trades did not frequently execute in increments as small as $0.0001, which is the increment that off-exchange market makers can use in executing trades.

133

In addition, according to NYSE, most price improvement is delivered to trades where the bid-offer spread is larger than $0.10. NYSE also examined price improvement trends during “calm”

134

and volatile markets.

135

According to NYSE, exchanges tend to provide a larger share of the total price improvement during volatile markets, while off-exchange venues increase their share of total price improvement when volatility drops.

136

133

Id.

at 8.

134

NYSE defined a “calm” market for purposes of its analysis as “when there is a stable quoted market price for a restrictive 100 milliseconds before and after the trade.”

Id.

at 9.

135

Id.

136

Id.

Finally, NYSE considered the impact of allowing sub-penny quoting on market infrastructure.

137

NYSE stated that the industry is capable of accommodating an increase in message traffic that may accompany lower minimum pricing increments.

138

NYSE calculated several estimates of potential increased message traffic that resulted in increases in messages of the exchanges' best quotations between 25% and 152% and stated that these increases would “lead to small changes in messaging levels relative to historical fluctuations and overall messaging rates that remain quite modest compared to data volumes prevalent in current-day options trading.”

139

137

Id.

at 10-11.

138

Id.

at 10.

139

Id.

at 11.

The Nasdaq Stock Market (“Nasdaq”) has also conducted studies on minimum pricing increments. According to Nasdaq, trading in tick-constrained stocks is more complicated and more expensive, with artificially wider spreads and longer order queues, which slows order fulfillment and leads to the increased routing to exchanges that have inverted taker/maker fee structures.

140

Nasdaq stated that as the price of the securities falls, the one penny minimum pricing increment becomes large as a percentage of value. For example, Nasdaq stated that for a stock priced above $1,000 per share, one penny is less than 0.10 basis point (one basis point is equal to 0.01% or 0.0001), while for a stock priced $1.00, one penny represents 100 basis points.

Nasdaq stated that this is harmful for smaller less liquid stocks because the minimum pricing increment represents a higher percentage of value which ends up costing investors money. Nasdaq stated that when faced with a spread constraint, market participants trade more on inverted venues to narrow the spread due to the inverted pricing structures. According to Nasdaq, substantial queue lengths result in inverted usage and stocks priced lower than $5 tend to have longer queues.

140

See

Nasdaq Paper and Nasdaq Intelligent Tick at 4,

supra

note 104.

For higher priced stocks, Nasdaq stated that a tick size that is too small can result in increased volatility and less price competition which impairs price discovery. According to Nasdaq, higher stock prices from less frequent stock splits can eventually lead to wider spreads and more odd-lot trading. Nasdaq found that fill rates are generally higher for low-priced stocks, and fill rates begin to decline once a stock is priced greater than $100. Further, Nasdaq stated that a tick size that is too small can reduce the significance of time priority because traders can outbid resting orders by an economically insignificant amount. Nasdaq stated that this discourages traders from improving displayed prices and reduces incentives to post displayed liquidity. Nasdaq stated that certain high priced stocks with spreads closer to $1.00 have odd-lots inside the NBBO much more frequently than high priced stocks with spreads below $0.02. Nasdaq further stated that if high priced stocks traded at a wider tick, there would be more displayed depth at each tick increment.

Nasdaq concluded that if the minimum pricing increment is too wide (tick-constrained) or too small (stocks trading in multiple increments), the mismatch creates inefficiency that increases the issuer's cost of capital, hurting issuers and investor returns, potentially harming economic growth and retirement stability.

Recently, the Cboe Exchange, Inc. (“Cboe”) examined the NBBO of all NMS securities above $1.00 from January 3, 2022, to August 23, 2022, during regular trading hours, excluding opening and closing auctions and locked and crossed markets.

141

Cboe stated that most securities are not tick-constrained and that a one-size-fits-all finer minimum pricing increment “risks creating a structure that attempts to solve a problem that does not exist for most securities and introduces roadblocks to the liquidity aggregation and price discovery process.”

142

141

See

Cboe Proposal at 1,

supra

note 104.

142

Id.

Cboe stated that out of 10,125 securities, only 9% (877) should be considered preliminarily tick-constrained, which Cboe defined as stocks with an average quoted spread of 1.1 cents or less.

143

Cboe found that these 877 securities represent 49% of average daily volume and 22% of average daily notional value traded.

144

Cboe found that 88% of NMS stocks are quoted at spreads above $0.015 and 37% of securities representing 25% average daily notional value are being quoted at spreads above $0.10.

145

143

Id.

144

Id.

145

Id.

E. Proposals by Market Participants

Various market participants have suggested that rule 612 be amended. Throughout the years, market participants have advocated that the minimum pricing increment: (1) only be reduced for NMS stocks that are tick-constrained;

146

(2) be varied based on certain objective and measurable trading characteristics of a particular NMS stock;

147

or (3) be increased for higher-priced stocks.

148

The Commission has studied and considered the alternative approaches that are described in this section, and at this time has determined to propose rule 612 amendments that would implement variable minimum pricing increments for the quoting and trading of NMS stocks priced at, or above, $1.00 per share based on the Time-Weighted Average Quoted Spread during an Evaluation Period.

146

See

Joint Petition,

supra

note 78.

See also

MEMX Exemption Request,

supra

note 105.

147

See

Nasdaq Intelligent Tick Proposal,

supra

note 104.

148

See

TSP,

supra

note 85.

As discussed more fully in section II.F., the Commission believes that the proposed amendments to rule 612 addresses the concerns that have arisen since its adoption in a manner that is consistent with the Congressional directives, set forth by section 11A of the Exchange Act, to facilitate the establishment of the national market system. Specifically, the Commission has designed the proposed rule 612 amendments to achieve the section 11A objectives of fair competition, economically efficient executions, and equal regulation by addressing concerns related to: (1) tick-constrained stocks; and (2) fair competition for retail order flow across trading venues.

1. Reduce the Tick Size to $0.005 for Tick-Constrained Stocks

Some market participants have recommended that rule 612 be amended to lower the minimum pricing increment to $0.005 only for NMS stocks that are tick-constrained.

149

Specifically, MEMX submitted a request that the Commission exercise its exemptive authority under rule 612(c) of Regulation NMS to permit market participants, including exchanges, associations, ATSs, vendors and broker-dealers, to display, rank, and accept bids or offers, orders, and indications of interest in $0.005

150

increments for those NMS stocks that are “tick-constrained,” which MEMX would define as those stocks that trade with an average quoted spread of 1.1 cents or less.

151

MEMX requested that average daily spreads be calculated on a monthly basis and that a stock would have its minimum pricing increment reduced based upon a prior calendar month.

152

MEMX stated that the current increment “is demonstrably too wide” for certain stocks and “imposes unnecessary costs on investors.”

153

MEMX also stated that quoting in tick-constrained stocks is based on “outdated regulatory constraints” as opposed to “supply and demand” which in turn “harm[s] public price discovery and increas[es] transaction costs.”

154

Further, MEMX stated that reducing the minimum pricing increment for tick-constrained stocks would minimize implicit trading costs for investors,

e.g.,

spread costs.

155

149

See

Citadel Report,

supra

note 91 at 4 and CCMR Report,

supra

note 91 at 10.

See

MEMX Exemption Request,

supra

note 105.

150

MEMX did not explain how MEMX arrived at the $0.005 increment. However, MEMX also requested that orders be permitted to execute at the midpoint of the NBBO.

151

MEMX, in conjunction with its request for relief pursuant to rule 612(c) to reduce the minimum increment for tick-constrained stocks to $0.005, also requested relief pursuant rule 610(c) to limit access fees for tick-constrained stocks for any national securities exchange, national securities association, or other trading center. MEMX stated that the rule 610 access fee and the rule 612 minimum increment are “intimately tied” to each other.

See

MEMX Exemption Request,

supra

note 105 at 8.

152

MEMX suggested using a calendar month calculation to be similar to the round lot calculation adopted under the MDI Rules. MEMX stated that using a similar schedule could reduce complexity.

See id.

at 3.

153

Id.

at 2.

154

Id.

at 1.

155

Id.

at 6.

MEMX stated that reducing the minimum increment “would reduce transaction costs and facilitate more robust price discovery by enabling liquidity providers to post more aggressive quotations within the current penny spread. . .”

156

In addition, MEMX stated that reducing the minimum pricing increment for tick-constrained stocks would be in the

public interest and consistent with the protection of investors because “the potential savings are likely to be substantial” due to the amount of trading that occurs in tick-constrained stocks.

157

156

Id.

157

Id.

MEMX addressed the factors that the Commission identified in the Regulation NMS Adopting Release for consideration of exemptions under rule 612(c). In the Regulation NMS Adopting Release,

158

the Commission stated that the factors it would consider and evaluate in the context of an exemption request under rule 612(c), amongst other things, would include: (1) if the security always trades with a penny spread and there is tremendous liquidity available on both sides of the market;

159

(2) whether the NMS stock was an ETF or other derivative that could be readily converted into its underlying securities or vice versa, in which case the true value of the security is derived from its underlying components and might be a sub-penny increment; (3) if there is a large volume of sub-penny executions in that security due to price improvement; and (4) if the security was low priced. Specifically, MEMX stated that “(1) almost one thousand NMS stocks accounting for nearly half of all volume and about a quarter of all trades and notional value traded on a daily basis are tick constrained, meaning that they consistently trade with a penny increment; (2) such tick constrained NMS stocks trade with `tremendous' liquidity at the NBBO as quoting activity is forced to cluster at the minimum increment instead of more aggressive prices that would offer improved economics to investors; (3) tick constraints occur frequently and are most impactful in (A) low-priced NMS stocks where a one cent spread is more economically significant in relation [to] the price of the security; and (B) ETPs whose prices can be appropriately derived from their underlying constituents.”

160

158

See

Regulation NMS Adopting Release,

supra

note 16, at 37554. MEMX did not analyze whether there is large volume of sub-penny executions due to price improvement. MEMX stated that executions in sub-penny increments “are likely to be indicative of retail internalization as opposed to market participants seeking to trade within a tick-constrained spread.”

See

MEMX Exemption Request,

supra

note 105, at 4.

159

See

Regulation NMS Adopting Release,

supra

note 16, at 37554 (quoting a commenter).

160

MEMX Exemption Request,

supra

note 105, at 6 (footnotes omitted).

Further, MEMX stated that the objectives underlying rule 612 would not be jeopardized if the exemption was granted and the minimum pricing increment was reduced. Specifically, MEMX stated that because market participants are unable to improve displayed prices for tick-constrained stocks, the previously articulated policy concern of stepping ahead of displayed orders by “economically insignificant amounts” was not relevant. MEMX stated that reducing the tick size would promote price competition for those stocks that are currently hindered by regulation.

161

See id.

at 7.

Citadel also recommended that “[t]he Commission should reduce the minimum tick size to a half-penny for symbols trading above $1.00 per share that are tick constrained (

i.e.,

have a penny spread the overwhelming majority of the time).”

162

Citadel stated that the rule 612 minimum pricing increment “impedes the ability of exchanges to compete for order flow in symbols that are highly liquid and commonly trade inside the bid-offer spread of a penny.”

163

Citadel continued that tick constraints lead to “complexities and inefficiencies,” including “driving order flow into alternative venues, complex exchange pricing structures, and increased overall market fragmentation.”

164

Citadel stated that a reduced tick size for tick-constrained stocks would allow exchanges to display more aggressive prices and improve on-exchange execution quality and exchange competitiveness.

165

Citadel also suggested, without elaborating, that allowing sub-penny quoting more broadly “could raise other concerns.”

166

162

Citadel Report,

supra

note 100 at 4.

163

Id.

164

Id.

165

See id.

166

Id.

Finally, the CCMR recommended that the Commission revise rule 612 to allow $0.005 increments in stocks that always trade with a penny spread.

167

CCMR cited the analysis conducted by MEMX to support its recommendation. CCMR, however, stated that it did not recommend a $0.001 tick size. CCMR stated that a tick size that is too narrow can harm market quality. CCMR stated that a smaller tick size that is too narrow “can cause “flickering quotations,” in which a stock quote rapidly switches back and forth between prices complicating broker-dealer routing decisions and hindering their ability to get the best prices for investors.”

168

In addition, CCMR stated that smaller tick sizes could “enable “stepping ahead” whereby a trader uses an economically insignificant quote to “step ahead” of an existing order, reducing the likelihood that orders posted by fundamental investors will be executed,” which would create a disincentive for the public display of orders.

169

167

See

CCMR Report,

supra

note 100 at 10.

168

Id.

169

Id.

More recently, Cboe proposed a framework to reduce the minimum tick size to $0.005 for tick-constrained stocks that demonstrate other objective criteria.

170

Specifically, Cboe would designate a security as tick-constrained and thus eligible for a $0.005 minimum pricing increment if a stock exhibits: (1) a high quote-size-to-trade-size ratio; and (2) a high average daily notional turnover.

171

According to Cboe, a high quote-size-to-trade-size ratio demonstrates that “even though there is an abundance of liquidity, the current $0.01 tick constraint disincentivizes investors to cross the spread due to high costs, resulting in a lack of trade executions.”

172

Further, a high average daily notional turnover would be an objective criterion “because it focuses the tick-reduction effort on high turnover securities that would benefit from the ability to trade in finer increments.”

173

For each criterion, Cboe would include stocks that fall within the top 75 percentile in the lower minimum pricing increment.

174

Using its criteria and parameters, Cboe identified 67 stocks that would be eligible for a reduction in the minimum pricing increment.

175

170

See

Cboe Proposal,

supra

note 104, at 9.

171

See id.

172

Id.

at 4.

173

Id.

Cboe further stated that thinly-traded securities, which would have a low notional turnover, should not be the focus of reducing minimum pricing increments.

174

See id.

at 6.

175

See id.

at 7.

Cboe's proposal would include a reevaluation every quarter or bi-annually for the criteria and parameters.

176

Cboe would also decouple the quoting increments from trading increments.

177

Cboe stated that decoupling the quoting and trading increments would allow retail auctions to increase trading competition in finer increments without impacting the broader market.

178

Finally, Cboe proposed a consideration of wider ticks to facilitate enhanced liquidity

aggregation of securities that trade with wider spreads.

179

176

See id.

177

See id.

178

See id.

(Cboe also proposed to accelerate the addition of odd-lot orders to the exclusive SIPs and to modernize rule 604 to increase the threshold to display block orders from 10,000 shares and $200,000 to 50,000 shares and $500,000).

179

Id.

at 9.

2. Variable Tick Sizes

In December 2019, Nasdaq submitted a petition for rulemaking to request that the Commission amend rule 612 to replace the current “one-size-fits all” tick regime with an “intelligent tick regime” that would utilize multiple tick sizes based on certain measurable criteria of NMS stocks.

180

Under the Nasdaq proposal: (1) stocks would trade in one of six increments ($0.005; $0.01; $0.02; $0.05; $0.10; and $0.25); (2) stocks would be categorized based upon their duration weighted average quoted spread over the measurement period; (3) stocks would be assigned the next smallest increment by quoted spread (

e.g.,

a stock with average spread of $0.12 would be in the $0.10 increment category); and (4) listing exchanges would calculate and calibrate quoted spreads, determine applicable increments, and publish stock lists. Nasdaq stated that an intelligent tick regime “would improve markets and benefit all key stakeholders—investors, public companies, and exchange members alike.”

181

Nasdaq stated that it is sub-optimal to apply the $0.01 increment equally “regardless of market capitalization, volume, or share price.”

182

Nasdaq stated that currently, under rule 612, “a $2 stock” quotes with the same minimum pricing increment “as a $2,000 stock.”

183

180

See

Nasdaq Intelligent Ticks, A Blueprint for a Better Tomorrow (“Nasdaq Intelligent Tick”),

available at https://www.nasdaq.com/docs/2019/12/16/Intelligent-Ticks.pdf.

181

Id.

at 4.

182

Id.

at 4.

183

Id.

at 4.

According to Nasdaq, its proposal would address tick-related issues for: (1) low-priced tick-constrained securities; and (2) high-priced securities that trade with significantly wider spreads. Nasdaq stated that “if the tick is too wide (tick constrained) or too small (stocks trading in multiple tick increments), the mismatch creates inefficiency that increases the companies' cost of capital . . . and hurts listed companies and investor returns. . . .”

184

Specifically, Nasdaq stated that tick-constrained stocks tend to have lower prices and that “tick-constraints create long quotation queues, [slow] fulfillment . . . [create inefficiencies] and . . . [diminish] price discovery. . . .”,

185

which drives trading “to inverted taker-maker markets . . . where larger, lower priced, more liquid stocks tend to trade heavily.”

186

Nasdaq stated that reducing the minimum pricing increment for tick-constrained stocks “would reduce bid-ask spreads, [save] investors money, and make trading more efficient.”

187

184

Id.

at 15.

185

Id.

at 6.

186

Id.

at 6-7.

187

Id.

at 4.

Conversely, Nasdaq stated that high-priced stocks that trade with wider spreads “increase[ ] investor costs, usage of odd-lots, flickering quotations, non-displayed trading that doesn't support price discovery, and price instability.”

188

For such high-priced stocks, Nasdaq also states that “outbidding becomes so inexpensive that time priority becomes essentially non-existent” and “[destroys] the reward and incentive to post passive liquidity and diminishing price discovery.”

189

188

Id.

at 4.

189

Id.

at 4.

See also

Cboe Proposal,

supra

note 104.

F. Proposal To Amend Rule 612

The Commission believes that based on current market conditions it is appropriate to update and modernize the rule 612 minimum pricing increment for quotes and orders in NMS stocks priced equal to, or greater than, $1.00 per share. The proposed amendments to rule 612 would also help to ensure, among other things, the “equal regulation of all markets for qualified securities and all exchange members, brokers, and dealers effecting transactions in such securities.”

190

Moreover, the proposed amendments to rule 612 also would facilitate fair competition and equal regulation that would help market forces to determine the prices of NMS stocks.

191

190

15 U.S.C. 78k-1(c)(1)(F).

191

See

Regulation NMS Proposing Release,

supra

note 49.

In the Regulation NMS Adopting Release, the Commission acknowledged the possibility that the balance of costs and benefits of sub-penny quoting and trading could shift as the markets evolved. The Commission believes such a shift has occurred and the benefits of quoting and trading in sub-pennies more broadly and consistently across the national market system would be consistent with the goals of section 11A of the Exchange Act and appropriate in today's market structure. Specifically, when rule 612 was adopted the Commission expressed concerns related to “stepping ahead” and quote flickering. The Commission believes that in today's market the concerns related to these issues have diminished or have been mitigated. For instance, in 2005 there was concern that quoting in sub-penny increments would allow orders to step ahead of displayed orders by economically insignificant amounts. However, data demonstrates that in today's market a significant percentage of executions occur in sub-penny increments as a result of midpoint executions and sub-penny price improvement provided by OTC market makers who internalize retail orders or RLPs on exchanges.

192

For many stocks, including those that are tick-constrained, a sub-penny execution is no longer economically insignificant. A majority of the trading volume for NMS stocks is tick-constrained, which indicates that the one cent minimum pricing increment is too large for such stocks, that a smaller sub-penny increment would be an economically meaningful increment for such stocks to be able to quote and trade, and that the current minimum pricing increment is constraining the ability of market participants to trade consistent with the principles of supply and demand. Further, the increased speed of quoting and trading has alleviated many of the concerns from 2005, as many market participants are now able to react to quote changes in microseconds.

192

See infra

section V.C.1.

As discussed in section V.D.1, the Commission estimates that the proposal to amend rule 612 would reduce the minimum pricing increment to $0.005 or less for 81.9% of the share volume, which represents approximately 60.2% of dollar volume that trades with a spread of approximately $0.04 or less.

193

These stocks generally have lower prices and consistent liquidity at the top of the book for both bids and offers. As a result of these characteristics, sub-penny increments, particularly in relation to the stock price, will generally be economically significant.

194

The Commission believes that because liquidity is consistently on both sides of the market for most tick and near tick-constrained securities, a smaller minimum pricing increment should be economically significant and allow market forces to better determine the appropriate price increment and depth for such stocks.

193

See infra

section V.D.1, Table 8.

194

See also

MEMX Exemption Request,

supra

note 105 at 7.

When rule 612 was adopted, the Commission was concerned about the potential for quotes to flicker if the quoting increment was too small. The Commission believes that for tick-constrained and near tick-constrained stocks, the proposed minimum pricing increments are not “too small,” rather,

the current quoting and trading of these stocks suggest that the current minimum pricing increment is too large. Advancements in technology since 2005 should reduce flickering quotes concerns.

195

Specifically, the systems currently used in the market by exchanges and other market participants can accommodate many levels of data with extreme low latency

196

and should be able to readily adjust to any potential increase of system traffic that could result from price movements at a smaller minimum pricing increment.

197

195

In the Regulation NMS Re-Proposing Release, the Commission described “flickering” quotes as quotes that flashed for a short period of time solely to earn market data revenues, but were not truly accessible and therefore did not add any value to the consolidated quote stream.

See

Regulation NMS Re-Proposing Release,

supra,

note 16. Since 2004, market quotation and trading systems have improved along with technological advances. Today, low latency systems and ultrafast communication protocols allow market participants to access quotes and execute trades in microseconds. Therefore, the “flickering” issue discussed in 2004 is largely no longer relevant today.

196

For example, in the second quarter of 2011, the average peak message per second for Tapes A and B as reported by the CTA/CQ Plan was 339,855 and for Tape C as reported by the UTP Plan was 97,370. In the second quarter of 2022, the average peak message per second for Tapes A and B was 1,015,000 and for Tape C was 408,300. In the second quarter of 2011, the average latency reported was less than one millisecond for Tapes A and B and 5.1 milliseconds for Tape C. In the second quarter of 2022, the average latency reported for Tape A and B was 18 microseconds and for Tape C it was 13.6 microseconds.

See https://www.ctaplan.com/publicdocs/CTA_Operating_Metrics_Q22011.pdf

;

https://www.ctaplan.com/publicdocs/ctaplan/CTAPLAN_Processor_Metrics_2Q2022.pdf

and

https://www.utpplan.com/DOC/UTP_website_Statistics_Q2-2022-June.pdf

See also

MDI Adopting Release,

supra

note 5, at 18638.

197

For example, market participants that collect options market data from the Options Price Reporting Authority (“OPRA”) can readily handle message traffic that exceeds the messages disseminated in the national market system for NMS stocks. In the second quarter of 2022, OPRA reported 36.4 million messages per second.

See

OPRA Key Operating Metrics of U.S. Options Securities Information Processor,

available at https://www.opraplan.com/document-library

See also

NYSE Tick Harmonization Paper,

supra

note 126 at 11 (stating that OPRA handles many times more messages than the equities market).

In the Regulation NMS Adopting Release, the Commission identified several factors that it would consider in the context of a request for an exemption from the minimum pricing increments required under the rule.

198

Specifically, the Commission said it would evaluate the following factors: (i) if an NMS stock was consistently trading with a penny spread with significant liquidity available on both sides of the market;

199

(ii) if the NMS stock is an ETF or other derivative that can be readily converted into its underlying securities or vice versa, in which case the true value of the security as derived from its underlying components might be at a sub-penny increment;

200

(iii) if a large volume of sub-penny executions in an NMS stock occurs due to price improvement; and (iv) if the NMS stocks are low-priced. Currently, there is evidence that: (1) a significant percentage of the total volume of NMS stocks is consistently tick-constrained with liquidity on both sides of the market,

201

(2) the majority of tick-constrained stocks trade at $30 or less,

202

and (3) a large volume of sub-penny executions occur in the market.

203

The Commission believes that rule 612 should be updated based on current market conditions.

198

See

Regulation NMS Adopting Release,

supra

note 16, at 37554.

199

See id.

200

Rule 612 applies to NMS stocks, including ETFs. In the Regulation NMS Adopting Release, the Commission considered whether sub-penny quoting of ETFs, which are derivatively priced, raised the same concerns as other NMS stocks. The Commission stated that a basis may exist to exempt actively traded ETFs from the rule.

See

Regulation NMS Adopting Release,

supra

note 16, at 37554. MEMX stated that its data shows that “more than half of equity ETPs and the vast majority of fixed income, commodity, and other ETPs trading at least 100 million notional each day are tick- constrained.” MEMX Exemption Request,

supra

note 105 at 6. Further, in the Joint Petition, the petitioners requested an exemption from rule 612 to allow sub-penny quoting for one ETF, the QQQQ.

See

Joint Petition,

supra

note 78 at 1.

201

See

MEMX stated that, according to its research, liquidity at the quote for tick-constrained stocks is five to eight times higher for corporate securities and nine to 59 times higher for ETPs than securities trading with a spread between $0.02 and $0.03.

See

MEMX Report,

supra

note 105, at 3.

See also

MEMX Exemption Request,

supra

note 105 at 4.

See also

NYSE White Paper,

supra

note 119 at 10.

202

MEMX provided data that approximately 80% of tick-constrained stocks traded at $30 per share or less.

See

MEMX Report,

supra

note 105 at 10.

203

See supra

note 192 and accompanying text.

The Commission proposes amendments to rule 612 to: (1) introduce a variable minimum pricing increment structure for quotes and orders in NMS stocks priced at, or greater than, $1.00 per share; and (2) require executions to occur in the minimum pricing increment, both on-exchange and OTC, subject to certain exceptions. The Commission preliminarily believes the proposed amendments to rule 612 would promote: (1) fair and orderly markets and economically efficient executions, particularly for tick-constrained NMS stocks and retail order flow; and (2) fair competition and equal regulation between OTC market makers, exchanges, and ATSs that compete for retail liquidity by requiring that NMS stocks trade with the same minimum pricing increment regardless of venue (

i.e.,

on or off-exchange). The Commission also believes that amended rule 612 would promote price discovery and price competition, particularly for tick-constrained stocks and retail order flow, by permitting the quoting and trading of certain NMS stocks in finer increments that would vary based on objective criteria but must be uniform across trading venues. The Commission believes this proposal would result in pricing that is more in accordance with the principles of supply and demand.

204

See infra

sections V.C.1 and V.D.1.

1. Minimum Pricing Increments

Currently, rules 612(a) and (b) are structured in a parallel manner in that they both contain requirements for national securities exchanges, national securities associations, ATSs, vendors, brokers and dealers when displaying, ranking and accepting quotations, orders and indications of interest. Each paragraph establishes the minimum pricing increment based on the price of the quote, order, or indication of interest. Proposed rule 612(b), similar to current rules 612(a) and (b), would set forth when and how the minimum pricing increment requirements would be applicable to specific market participants. However, unlike current rules 612(a) and (b), proposed rule 612(b) would make the minimum pricing increment applicable to the quoting and trading of all NMS stocks. Specifically, proposed rule 612(b) would state that “[n]o national securities exchange, national securities association, alternative trading system, vendor, or broker or dealer shall display, rank, accept from any person, or execute a bid or offer, an order, or an indication of interest in any NMS stock priced in an increment smaller than the applicable increment required by paragraph (c) or (d).” As discussed further below, proposed rule 612(c) would add the proposed variable minimum pricing increments for quotations, orders and indications of interest in NMS stocks priced equal to, or greater than, $1.00 per share and proposed rule 612(d) would contain the minimum pricing increment for quotations, orders and indications of interest in NMS stocks priced less than $1.00 per share.

2. Quotations and Orders in NMS Stocks Priced at $1.00 or More

The Commission proposes to amend rule 612 to introduce a variable minimum pricing increment model for quotations and orders in NMS stocks that are priced equal to, or greater than, $1.00 per share. The Commission preliminarily believes that a variable

minimum pricing increment model would allow minimum pricing increments to be better suited to the trading characteristics of the particular stocks. Since rule 612 was adopted, several commenters have suggested that the single minimum pricing increment may not be appropriate for all stocks.

205

See supra

section II.D.

The Commission proposes to vary the minimum pricing increment for quotations, orders and indications of interest in NMS stocks priced equal to, or greater than, $1.00 per share based on a Time Weighted Average Quoted Spread,

206

which would be calculated by the primary listing exchange for the particular NMS stock on a quarterly basis during a month long Evaluation Period.

207

Under this proposal, the four potential minimum pricing increments for a particular NMS stock would be:

206

Proposed rule 612(a)(i) would define “Time Weighted Average Quoted Spread” as “the average dollar value difference between the NBB and NBO during regular trading hours where each instance of a unique NBB and NBO is weighted by the length of time that the quote prevailed as the NBB or NBO.”

See infra

section II.F.2.a.i.

207

Proposed rule 612(a)(ii) would define “Evaluation Period” as the last month of a calendar quarter (Mar. in the first quarter, June in the second quarter, Sept. in the third quarter and Dec. in the fourth quarter) of a calendar year during which the primary listing exchange shall measure the Time Weighted Average Quoted Spread of an NMS stock that is priced equal to or greater than $1.00 per share to determine the minimum pricing increment to be in effect for an NMS stock for the next calendar quarter, as set forth by paragraph (c).”

See infra

section II.F.2.a.ii.

(1) $0.001, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was equal to, or less than, $0.008;

(2) $0.002, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.008 but less than, or equal to, $0.016;

(3) $0.005, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.016 but less than, or equal to, $0.04; and

(4) $0.01, if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was greater than $0.04.

Under this proposal, because the applicable minimum pricing increment for an NMS stock for a calendar quarter would be established based on the stock's Time Weighted Average Quoted Spread during the Evaluation Period, an NMS stock could have a different minimum pricing increment every quarter of the calendar year. The Commission believes that the proposal that the applicable minimum pricing increment for a particular NMS stock be effective for a three month period is appropriate in order to balance the need to update the minimum pricing increment at regular intervals such that the increment can reflect market conditions without updating too frequently as to introduce undue complexity to the market system.

208

MEMX suggested in its proposal that NMS stocks be evaluated on a monthly basis to determine a stock's average quoted spread. MEMX stated that a monthly evaluation would minimize complexity as it would be similar to the schedule to determine an NMS stock's round lot.

See

MEMX Exemption Request,

supra

note 105, at 3. The Commission believes that a quarterly evaluation and assignment is appropriate to reflect the current trading characteristics of an NMS stock. Further, the Commission believes that a monthly shift in the pricing of an NMS stock would be more complex and disruptive to the markets than a monthly shift in the size of a round lot. The Commission requests comment on whether a quarterly basis is the appropriate timeframe.

See infra

section II.G.

Preliminarily, the Commission believes that the proposed variable minimum pricing increments would address the issues related to tick-constrained stocks and help to prevent other stocks that trade with relatively small spreads from becoming tick-constrained. The Commission also believes that the proposal would reduce transaction costs for many NMS stocks without harming the execution quality or dispersing the liquidity of stocks that are not tick-constrained and trade with wider spreads. As discussed below, assigning a small minimum pricing increment to a stock that has a wider spread can be harmful to displayed liquidity as liquidity would be spread across more price increments.

209

Minimum pricing increments that are too small can also add to complexity in trading and increase the risk of stepping ahead. The Commission believes that proposing to vary the minimum pricing increments based on the Time Weighted Average Quoted Spread represents a balancing of pricing, liquidity, complexity, and price improvement opportunities.

210

209

See infra

section V.C.1.

210

See infra

sections V.C.1 and V.D.1.

This proposal to amend rule 612 to implement variable minimum pricing increments would reduce the minimum pricing increment to $0.001 for all NMS stocks that are priced equal to, or greater than, $1.00 per share if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was equal to, or less than, $0.008.

211

Further, proposed rule 612 would reduce the minimum pricing increment to $0.002 for all NMS stocks that are priced equal to, or greater than, $1.00 per share if the Time Weighted Average Quoted Spread for the NMS stock during the Evaluation Period was equal to, or less than, $0.016. Proposed rule 612 is designed to directly address the concerns that the current minimum pricing increment of $0.01 creates an artificial price constraint on certain NMS stocks and prevents such stocks from reaching a natural price that would be within a penny spread. The Commission estimates that tick-constrained stocks make up over half (approximately 56.1%) of the market's share volume, which is estimated to be the equivalent of 23.2% of dollar volume.

212

While the Commission cannot estimate the number of these stocks that would have a Time Weighted Average Quoted Spread of $0.008 or less due to the $0.01 minimum pricing increment, the Commission estimates that 1,707 stocks, which make up an estimated 64% of share volume, and represent 37.9% of estimated dollar volume, have average spreads that are less than $0.016.

213

The Commission believes that reducing the minimum pricing increment to $0.001 or $0.002 for such stocks would allow a more natural price discovery process to occur and preserve meaningful price discovery opportunities between the spread. In addition, the Commission believes that investor trading costs due to spreads would be reduced as a result of the smaller increments and spreads that would be permitted for stocks that are currently tick-constrained.

211

Initially, no NMS stock would qualify for the $0.001 minimum pricing increment due to the current rule 612 one cent minimum pricing increment restricting the minimum possible tick size. Further, as discussed below, the Commission proposes a staggered implementation of the new minimum pricing increments.

See infra

section II.G.

212

See infra

section V.C.1.

213

See

Table 8

infra

section V.D.1.

Currently, approximately 2,648 stocks, which is an estimated 17.9% of share volume, and an estimated 22.3% of dollar volume, trade with a spread that is greater than $0.016 and less than or equal to $0.04.

214

This proposal would also reduce the minimum pricing increment to $.005 for NMS stocks that trade with a Time Weighted Average Quoted Spread that is greater than $0.016 and less than or equal to $0.04.

215

The Commission believes that the proposal would provide pricing flexibility for these stocks that trade with smaller spreads and prevent such stocks from becoming tick-constrained in the future. The Commission also believes that, by reducing the minimum pricing increments for these stocks that trade with smaller spreads, investor trading costs would be reduced as a result of smaller spreads while price

improvement opportunities would be preserved.

214

See id.

215

See infra

section V.D.1.

The Commission believes that the execution quality for stocks with a Time Weighted Average Quoted Spread of equal to, or less than, $0.04 would not be harmed under the proposal (

i.e.,

NMS stocks that would quote and trade with a minimum pricing increment of $0.001, $0.002 or $0.005).

216

Further, the Commission believes that the liquidity at or near the NBBO for such stocks would not disperse or thin out across price levels because, as discussed below, the proposal is designed such that stocks priced equal to, or greater than, $1.00 per share with a Time Weighted Average Quoted Spread of less than $0.04 would generally have at least 3 to 4 price points but not have more than eight price points inside the quoted spread.

217

216

See infra

section V.D.1

217

For example, if the bid for a stock is $10.00, and the stock has an average quoted spread of $0.010, it would be assigned a $0.002 minimum pricing increment and would have four price levels within the average quoted spread (

i.e.,

10.002, 10.004, 10.006, and 10.008).

See also infra

section V.D.1. However, if that same stock trades with a spread that is wider than the average quoted spread used to determine the minimum pricing increment there would be more than four price levels. For instance, if the bid for the stock was $10.00 and the ask was $10.02 then there would be nine price levels with the quoted spread (

i.e.,

10.002, 10.004, 10.006, 10.008, 10.01, 10.012, 10.014, 10.016. 10.018).

As further discussed in section V.D.1 below, the Commission believes that a certain minimum number of ticks intra-spread would be beneficial to market quality in the trading of NMS stocks. The proposal would increase the number of increments between the spread for those NMS stocks that are tick-constrained. Initially, these stocks would transition from having, on average, one increment between the spread to either having 1 to 8 increments or 4 to 5 increments between the spread, depending on whether the stock would be assigned to a $0.001 or $0.002 minimum pricing increment. Thereafter, if, for instance, the Time Weighted Average Quoted Spread for one of these NMS stocks widens during an Evaluation Period, such stock would be assigned to a larger minimum pricing increment for the next quarter. Conversely, if the Time Weighted Average Quoted Spread for one of these NMS stock narrows during an Evaluation Period, such stock would be assigned to a smaller minimum pricing increment for the next quarter, if available. The proposal is designed to maintain a certain number of increments between the spread for efficient trading, without creating too many increments between the spread which could impact execution priority for an infinitesimally amount or reduce market depth. Accordingly, NMS stocks would be moved between the proposed minimum pricing increments based on their quoting characteristics. In sum, the Commission believes that the proposal will allow NMS stocks that have relatively small average quoted spreads to be priced with minimum pricing increments that are more reflective of the principles of supply and demand and mitigate the dispersion of liquidity across price points.

Under the proposal, NMS stocks that are priced equal to, or greater than, $1.00 per share that have a Time Weighted Average Quoted Spread greater than $0.04 would continue to have a minimum pricing increment of $0.01. Based on current market conditions, the Commission estimates that approximately 7,792 stocks, which is estimated to be 18.1% of share volume, and estimated to be 39.8% of dollar volume, trade with a spread that is greater than $0.04.

218

The Commission believes that the proposal would have little or no impact on these NMS stocks that would continue to quote at the $0.01 minimum pricing increment.

219

The Commission proposes to retain the current minimum pricing increment for stocks that fall into this category because these stocks are neither tick-constrained nor near constrained stocks. Stated another way, stocks that have a Time Weighted Average Quoted Spread of greater than $0.04 are able to be competitively priced based on market forces and the principles of supply and demand so would continue to have a $0.01 minimum pricing increment. Further, as described above, if these stocks were to become tick-constrained, or experience a reduction in its average quoted spread, the minimum pricing increment would be adjusted downward following the next Evaluation Period.

218

See infra

section V.D.1, Table 8.

219

See infra

section V.D.1.

Although certain market participants recommend that the minimum pricing increment be reduced to $0.005 only for tick-constrained stocks,

220

the Commission believes that many stocks that currently trade with an average quoted spread of $0.011 could continue to be tick-constrained if the minimum pricing increment for such stocks were only reduced to $0.005. Accordingly, the Commission is proposing to reduce the minimum pricing increment for tick-constrained stocks as well as stocks that are near tick-constrained or otherwise have average quoted spreads less than $0.04 to either $0.001, $0.002 or $0.005, which would likely reduce the minimum quoting increment for more than 81.9% of the trading volume for NMS stocks. Overall, the Commission expects that the impact on liquidity and trade execution would be positive because tick constraints prevent market participants from quoting the prices that reflect supply and demand, and the reduction in the minimum pricing increments would lead to narrower spreads and better market quality. The Commission determined to propose the reduced minimum pricing increments of $0.001, $0.002, and $0.005, in part, because many investors will have familiarity with, or an awareness of, trades that occur in these specific increments because of how trading is conducted today. The Commission believes this because today, two of the most common increments for the price improvement of stocks that trade OTC are $0.001 and $0.002, and price improvement on exchanges and ATSs often occurs through midpoint executions in an increment of $0.005. The Commission also selected these particular pricing increments because, as described above, the proposed amendments to rule 612 are designed to: (1) correlate the Time Weighted Average Quoted Spread to the minimum pricing increments, which limits the number of potential price points within the spread, which, in turn, should mitigate the loss of liquidity that can occur when the minimum tick size is reduced and the number of pricing increments increases;

221

and (2) preserve meaningful price improvement for the majority of NMS stocks that would trade at minimum pricing increments that are $0.005 or less.

220

See supra

section II.E.1.

221

Id.

For stocks priced equal to, or greater than, $1.00 per share with Time Weighted Average Quoted Spreads equal to or less than $0.04, the Commission believes the reduction in the minimum pricing increment would be largely beneficial to the trading environment. Specifically, the Commission believes that reducing the minimum pricing increment would remove tick-constraints for a large percentage of the total trading volume, and allow market participants to quote at the prices that equate supply and demand, which in turn would lead to narrower spreads and better market quality.

The Commission also believes the proposal would increase price discovery for stocks that are tick-constrained, or near-tick-constrained, and reduce transaction costs for investors without

negatively impacting execution quality for stocks that are not tick-constrained. The Commission's proposal differs from the tiered approach for minimum pricing increments suggested by market participants as described in section II.E.2. The Commission's proposed variable minimum pricing increments are designed to offset the potential dilution of liquidity and depth at the top of the book while providing market participants with a range of price points (generally four to eight) between the quoted spread to provide price improvement opportunities to investor orders.

With regard to changing the minimum pricing increment, the Commission proposes to target tick-constrained stocks, and those stocks that trade with relatively smaller spreads that could become tick-constrained by reducing and varying the minimum tick size. While some market participants have suggested that the Commission impose larger minimum pricing increments for certain NMS stocks,

222

the proposed rule would not change or increase the minimum pricing increment for any NMS Stocks that trade with a Time Weighted Average Quoted Spread greater than $0.04, or separately for higher-priced stocks. The Commission believes that the current $0.01 increment for NMS stocks that trade with a Time Weighted Average Quoted Spread greater than $0.04, regardless of price, remains sufficient based on their trading characteristics.

223

Commission review of academic literature suggests that there are not consistent results as to how a larger tick size would affect market quality for stocks with wider spreads.

224

Further, the Commission believes that increasing the tick size, for example for higher priced securities, which tend to trade with wider spreads, could result in the inadvertent and unintended constraining of the pricing of such stocks.

225

The Commission does not expect the trading environment for stocks with prices lower than $1.00 per share, or Time Weighted Average Quoted Spreads greater than $0.04, to be significantly impacted because under the proposal the minimum pricing increment would not change for such stocks.

222

See

Nasdaq Intelligent Tick Proposal,

supra

note 180 at 8.

223

See also infra

note 548 and accompanying text. Further, minimum pricing increments that are too large or static could frustrate the natural pricing mechanism of quotes and orders.

See also infra

section IV.B (discussing proposed amendments to the definition of “regulatory data” that would require the primary listing exchange to provide an indicator of the applicable round lot size to the exclusive SIPs).

The proposed indicator would thus be included in NMS data

233

disseminated by the exclusive SIPs and competing consolidators, which should help to ensure the wide availability of information about the applicable minimum pricing increment for each NMS stock, which in turn will enable market participants to trade in a more informed manner. Further, the Commission believes that information about the relevant minimum pricing increment should be provided to the exclusive SIPs, competing consolidators, and self-aggregators because the minimum pricing increment might change from quarter to quarter.

233

See infra

note 324.

3. Quotations and Orders in NMS Stocks Priced Less Than $1.00

Currently, the minimum pricing increment for quotations and orders in NMS stocks that are priced less than $1.00 per share is $0.0001. When it adopted this increment, the Commission stated that the sub-penny increment would largely represent genuine trading interest for low-price stocks rather than attempts to unfairly step ahead of displayed orders and that the sub-penny increment represents a significant amount of the price of the quotation or order.

234

The Commission believes that this increment remains appropriate for these NMS stocks.

234

See

Regulation NMS Adopting Release,

supra

note 16, at 37555.

Due to the other proposed amendments to rule 612, the minimum pricing increment for quotations and orders in NMS stocks that are priced less than $1.00 per share would be set forth in proposed rule 612(d). Rule 612(d) as proposed to be amended would state that “[e]xcept as provided in paragraph (e), the minimum increment for any bid or offer, order, or indication of interest for an NMS stock priced less than $1.00 per share shall be no smaller than $0.0001.” Proposed rule 612(b) would make the minimum pricing increment set forth in proposed rule 612(d) applicable to the quoting and trading of NMS stocks priced less than $1.00 per share. The Commission believes, for the reasons discussed below, that the minimum pricing increment should be applied to trading as well as quoting.

235

See infra

section V.C.1.b.

4. Minimum Pricing Increment for Trading

The Commission proposes that the variable minimum pricing increments of rule 612 as proposed to be amended would apply to all trading—on exchanges, ATSs, and OTC. This means that all quotes and orders, regardless of price, would be required to execute in the applicable minimum pricing increments set forth by proposed rule 612(c) or (d), subject to the specified exceptions set forth in proposed rule 612(e). Proposed amendments to rule 612(e) would provide exceptions for: (1) orders that execute, but are not explicitly priced at, the midpoint of the NBBO or the protected bid and protected offer (“PBBO”);

236

and (2) orders that execute at a price that was not based, directly or indirectly, on the quoted price of an NMS stock at the time of execution and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made (

e.g.,

VWAP or TWAP trades).

237

236

See

17 CFR 242.600(b)(70) for a definition of PBBO.

237

See supra

note 19.

The Commission is concerned about the increase of orders that are executed OTC in price increments that exchanges and ATSs cannot practically provide,

238

and believes that harmonization of the minimum pricing increment for the quoting and trading across venues would promote competition and innovation, while preserving most meaningful price improvement opportunities.

239

The Commission believes that amending rule 612 to require executions to occur at the relevant minimum pricing increment, subject to the specified exceptions, would help to address the competitive disparity that occurs, in part, because certain OTC executions may occur more freely in sub-penny increments, while the opportunity for sub-penny executions on exchanges and ATSs are much more limited.

240

238

See supra

section II.D.

See also infra

section V.C.1.b and Table 3.

239

See infra

section V.D.2.

240

In the European Union, minimum pricing increments are applied to quoting and trading.

See

Art. 49 of the Directive 2014/65/EU of the European Parliament and of the Council Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU and Art. 17a of the Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014.

Currently, much of the sub-penny trading that occurs OTC is a result of price improvement (

i.e.,

executions that occur between the spread). The most commonly offered sub-penny increments for price improvement are $0.0001, $0.001 and $0.002.

241

Under this proposal, price improvement of $0.0001 would no longer be available for NMS stocks that are priced equal to, or greater than, $1.00 per share, but trades would be able to occur in $0.001 and $0.002 for those stocks that are assigned to such increments.

242

Further, executions at even finer increments would still be permitted to occur at the midpoint.

241

See infra

section V.D.2.

242

See infra

section V.D.2.

The variable minimum pricing increments have also been designed to facilitate trading between the spread to accommodate price improvement opportunities.

243

The Commission believes that applying the minimum pricing increment to trading across all venues should promote equal regulation and fair competition among market participants such as exchanges, OTC

market makers, and ATSs for retail order flow.

244

243

See supra

note 217.

See also

section V.D.2.

244

See

15 U.S.C. 78k-1 (a)(1)(C)(ii) and (c)(1)(F).

Finally, the Commission believes that the proposed exceptions to the requirement that orders in NMS stocks be executed in the applicable minimum pricing increment would promote fair and orderly markets and economically efficient executions.

245

These proposed exceptions would codify current trading activity that is common and widespread under rule 612. Today, orders that are not explicitly priced in an impermissible sub-penny increment may execute at the midpoint of the NBBO/PBBO, even if the midpoint price would be an otherwise impermissible sub-penny quoting increment.

246

Similarly, orders that are not explicitly priced in an impermissible sub-penny increment, such as benchmark trades (

e.g.,

VWAP or TWAP trades) may execute in an otherwise impermissible quoting increment under amended rule 612.

247

Mid-point and benchmark orders are widely used and viewed by liquidity providers as important options for handling orders and implementing trading strategies that can reduce the market impact of their trades. In addition, mid-point liquidity provides price improvement opportunities for market participants on the other side of these trades.

245

See

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

246

See supra

note 61.

247

Id.

G. Proposed Implementation Period

The Commission proposes to stagger the implementation of the variable minimum pricing increments for NMS Stocks that are priced equal to, or greater than $1.00 in order to facilitate an orderly transition for NMS stocks that would have minimum pricing increments that are less than $0.01. The implementation period would also provide for longer periods than the proposed quarterly time period between Evaluation Periods to allow the market and investors to become accustomed to the smaller increments.

Time period

Minimum pricing increment

First Implementation Period

(1) NMS stocks with a Time Weighted Average Quoted Spread that is $0.04 or less:

The first and second quarters of effectiveness

$0.005 increment, and

(2) NMS stocks with a Time Weighted Average Quoted Spread greater than $0.04: $0.01.

Minimum pricing increments would not apply to trading.

Second Implementation Period

(1) NMS stocks with a Time Weighted Average Quoted Spread that is $0.016 or less:

The third and fourth quarters of effectiveness

$0.002 minimum pricing increment,

(2) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.016 but less than, or equal to, $0.04: $0.005 minimum pricing increment, and

(3) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.04: $0.01 minimum pricing increment.

Minimum pricing increments would not apply to trading.

Third Implementation Period

Full implementation. All of the minimum pricing increments would be effective.

The fifth quarter of effectiveness

Minimum pricing increments would apply to trading.

The primary listing exchanges would calculate the Time Weighted Average Quoted Spreads for NMS stocks during the first Evaluation Period that occurs after the proposed rule's effectiveness. For example, if the proposed rule was effective in July, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads in Sept. and assign the minimum pricing increments for the fourth quarter of that year and the first quarter of the following year.

For the second implementation period, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads during the month in the Evaluation Period that would fall during the second quarter of effectiveness. In the example above, the primary listing exchange would calculate the Time Weighted Average Quoted Spreads during Mar. and assign minimum pricing increments during the second and third quarters of that year.

For the final implementation period, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads during the month in the Evaluation Period that would fall during the fourth quarter of effectiveness. In the example above, the primary listing exchange would calculate the Time Weighted Average Quoted Spread in Sept. and assign the minimum pricing increments for the fourth quarter of that year.

Specifically, for the first implementation period, upon effectiveness of any amendments to rule 612, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads for all NMS stocks for the first proposed Evaluation Period

248

and assign the relevant minimum pricing increments as required under proposed rule 600(b)(78). The minimum pricing increments calculated during the first Evaluation Period would be in effect for the following two quarters (

i.e.,

for six months). During the first two quarters of proposed rule 612's effectiveness, proposed rule 612 would be implemented as follows: (1) NMS stocks with a Time Weighted Average Quoted Spread of $0.04 or less would be assigned to the $0.005 increment for the first quarter of effectiveness, and (2) NMS stocks with a Time Weighted Average Quoted Spread greater than $0.04 would be assigned to remain in the $0.01 minimum pricing increment.

249

The minimum pricing increments that are less than $0.005 (

i.e.,

$0.002 and $0.001) would not be implemented during the first quarter of effectiveness.

248

The initial proposed Evaluation Period (Mar., June, Sept., or Dec., as applicable) would be the first full calendar month after the effectiveness of rule 612. For example, if the effectiveness would be on Feb. 14, then the initial proposed Evaluation Period would be Mar. If the effectiveness would be on Mar. 15, then the initial proposed Evaluation Period would be June.

249

The proposed changes to rule 610 would become effective during the first stage of implementing proposed rule 612. However, the $0.0005 access fee cap would not be become relevant until the final stage of implementing proposed rule 612 when the $0.001 minimum pricing increment becomes effective. While proposed rule 610 has proposed variable access fee caps, the proposed access fee caps are based on the relevant minimum pricing increment.

For the second implementation period, at the end of the second quarter of effectiveness of any proposed amendments to rule 612, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads during the next Evaluation Period (

i.e.,

the month at the end of the second quarter of effectiveness) and assign the relevant proposed minimum pricing increment as required under proposed rule 600(b)(78). The minimum pricing increments calculated during the Evaluation Period would be in effect for the following two quarters (

i.e.,

for six months). During the third and fourth quarters of proposed rule 612's effectiveness: (1) NMS stocks with a Time Weighted Average Quoted Spread that is $0.016 or less would be assigned

to the proposed $0.002 minimum pricing increment, (2) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.016 but less than, or equal to, $0.04 would be assigned to the proposed $0.005 minimum pricing increment, and (3) NMS stocks with a Time Weighted Average Quoted Spread of greater than $0.04 would be assigned to the proposed $0.01 minimum pricing increment. The $0.001 minimum pricing increment would not be implemented during the third and fourth quarters of effectiveness.

Finally, for the third implementation period, at the end of the fourth quarter of effectiveness of any proposed amendments to rule 612, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads during the next Evaluation Period (

i.e.,

the month at the end of the fourth quarter) and assign the relevant proposed minimum pricing increment as required under proposed rule 600(b)(78). During the fifth quarter of effectiveness of proposed rule 612, all of the variable minimum pricing increments would be effective. Accordingly, (1) NMS stocks with a Time Weighted Average Quoted Spread that is $0.008 or less would be assigned to the proposed $0.001 minimum pricing increment, (2) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.008 but less than, or equal to, $0.016 would be assigned the proposed $0.002 minimum pricing increment, (3) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.016 but less than, or equal to $0.04, would be assigned to the proposed $0.005 minimum pricing increment, and (4) NMS stocks with a Time Weighted Average Quoted Spread that is greater than $0.04 would be assigned to the proposed $0.01 minimum pricing increment.

The Commission proposes to implement the requirement to trade in the applicable minimum pricing increment during the fifth quarter of effectiveness of any proposed amendments to rule 612. Accordingly, during the first two implementation periods of effectiveness (

i.e.,

the first four quarters), as today, market participants would be permitted to trade in increments that differ from those that are required under rule 612 for accepting, ranking and displaying of quotes and orders.

250

The Commission believes that delaying the requirement that orders in NMS stock be executed in the minimum pricing increments until the fifth quarter of effectiveness would help to facilitate an orderly transition by allowing market participants additional time to adjust and comply with the requirement to quote and trade with the proposed minimum pricing increments set forth by the rule for a particular category of NMS stocks. As discussed in section II.F.1 above, the proposed variable minimum pricing increments have been developed so that there are increments at which market participants can trade between the spread and they are assigned based on the quoting characteristics of each NMS stock. Therefore, the Commission proposes to implement the trading requirement once all of the proposed minimum pricing increments have become effective.

250

See supra

section II.D.

Thereafter, at the end of the fifth quarter of effectiveness of proposed rule 612, the primary listing exchanges would calculate the Time Weighted Average Quoted Spreads during the next Evaluation Period and assign the relevant proposed minimum pricing increment as required under proposed rule 600(b)(78). All of the variable minimum pricing increments for quoting and trading would be effective on a going forward basis.

H. Request for Comment

The Commission requests comment on the proposed amendments to rule 612 and on other potential alternatives to the proposed minimum pricing increments.

1. Would the proposed variable minimum pricing increments for quotes and orders in NMS stocks priced equal to, or greater than, $1.00 per share address the concerns that have been raised in the market about tick-constrained stocks? If not, why not?

2. Are the proposed minimum pricing increments appropriate for NMS stocks? If not, why not, and what minimum pricing increments would be appropriate?

3. Should all NMS stocks have the same minimum pricing increment instead of the proposed variable minimum pricing increments determined by the proposed Time Weighted Average Quoted Spreads? If so, why? What should be the minimum pricing increment?

4. Are the proposed average quoted spread thresholds for each proposed minimum pricing increment appropriate? Why or why not?

5. Are the proposed minimum pricing increments economically significant for the NMS stocks that have the relevant Time Weighted Average Quoted Spread? Please explain.

6. Would the proposed minimum pricing increments cause flickering quotes? Please explain.

7. Would the proposed minimum pricing increments reduce displayed liquidity? Please explain.

8. Is the Time Weighted Average Quoted Spread the appropriate measure for assigning a minimum pricing increment for orders in NMS stocks that are priced $1.00 or more per share? If not, what would be the appropriate measure and why?

9. Is the Evaluation Period an appropriate time period to calculate the Time Weighted Average Quoted Spread? If not, what would be an appropriate time period and why?

10. Should the minimum pricing increment be modified on a quarterly basis? If not, how often should the minimum pricing increments be potentially modified,

e.g.,

on a monthly basis, on a bi-annual basis, on an annual basis?

11. Should the minimum pricing increment be uniform for all NMS stocks based on the per share price of a quote or order similar to today? Should there be more than two minimum pricing increments structures based on the price of an order or quotation of an NMS stock in rule 612? For example, should there be other price cutoffs in addition to the $1.00 price cutoff for specifying the relevant minimum pricing increment structure? If so, what should the price cutoffs be and what should be the minimum increment? If so, what should the uniform minimum pricing increment be? What should the price threshold be?

12. Is

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