[Federal Register Volume 75, Number 124 (Tuesday, June 29, 2010)]
[Notices]
[Pages 37488-37494]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-15707]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62359; File No. SR-FINRA-2009-054]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by
Amendment No. 1, To Establish in the Market for OTC Equity Securities
Certain Regulatory Protections Derived From Certain Rules Adopted by
the Commission in the Market for Listed Securities
June 22, 2010.
I. Introduction
On August 7, 2009, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to establish certain regulatory protections for
the market for OTC Equity Securities \3\ that are similar to those
established for national market system securities by Regulation NMS.\4\
The proposed rule change was published for comment in the Federal
Register on August 26, 2009.\5\ The Commission received 12 comments on
the Initial Notice.\6\ On
[[Page 37489]]
March 1, 2010, FINRA filed Amendment No. 1 to the proposed rule change.
The proposed rule change, as amended, was published for comment in the
Federal Register on March 16, 2010.\7\ The Commission received two
comment letters in response to the Amended Notice.\8\ This order
approves the proposed rule change, as modified by Amendment No. 1
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See FINRA Rule 6420(d) (defining OTC Equity Security as
``any non-exchange-listed security and certain exchange-listed
securities that do not otherwise qualify for real-time trade
reporting''). Pursuant to Securities Exchange Act Release No. 61979
(April 23, 2010), 75 FR 23316 (May 3, 2010), effective June 28,
2010, the term OTC Equity Security will be defined in FINRA Rule
6420(c) as ``any equity security that is not an `NMS stock' as that
term is defined in Rule 600(b)(47) of Regulation NMS; provided,
however, that the term ``OTC Equity Security'' shall not include any
Restricted Equity Security.''
\4\ 17 CFR 242.600 et seq.
\5\ See Securities Exchange Act Release No. 60515 (August 17,
2009), 74 FR 43207 (``Initial Notice'').
\6\ See Submission via SEC WebForm from anonymous, dated
September 1, 2009; Letter to Nancy M. Morris, Commission, from Janet
M. Kissane, Senior Vice President--Legal and Corporate Secretary,
NYSE Euronext, dated September 23, 2009 (``ArcaEdge Letter'');
Letter to Elizabeth M. Murphy, Secretary, Commission, from Leonard
J. Amoruso, General Counsel, Knight Capital Group, Inc., and Michael
T. Corrao, Chief Compliance Officer, Knight Equity Markets, L.P.,
dated September 16, 2009 (``Knight Letter''); Letter to Elizabeth M.
Murphy, Secretary, Commission, from William Assatly, Senior Vice
President--Trading, Mercator Associates, dated September 16, 2009
(``Mercator Letter''); Letter from Daniel Kanter, President, and
Craig Carlino, Chief Compliance Officer, Monroe Securities, Inc.,
dated September 16, 2009 (``Monroe Letter''); Letter to Elizabeth M.
Murphy, Secretary, Commission, from R. Cromwell Coulson, Chief
Executive Officer, Pink OTC Markets, Inc., dated September 23, 2009
(``Pink OTC Letter''); Letter to Elizabeth M. Murphy, Secretary,
Commission, from R. Cromwell Coulson, Chief Executive Officer, Pink
OTC Markets, Inc., dated January 6, 2010 (``Pink OTC 2 Letter'');
Letter to Elizabeth M. Murphy, Secretary, Commission, from Ann L.
Vlcek, Managing Director and Associate General Counsel, Securities
Industry and Financial Markets Association, dated October 13, 2009
(``SIFMA Letter''); Letter to Elizabeth M. Murphy, Secretary,
Commission, from Kimberly Unger, Executive Director, The Securities
Traders Association of New York, Inc., dated September 14, 2009
(``STANY Letter''); Letter to Elizabeth M. Murphy, Secretary,
Commission, from Kimberly Unger, Executive Director, The Securities
Traders Association of New York, Inc., dated September 16, 2009
(``STANY 2 Letter''); Letter to Florence H. Harmon, Deputy
Secretary, Commission, from Elaine M. Kaven, Chief Compliance
Officer, StockCross Financial Services, Inc., dated September 16,
2009 (``StockCross Letter''); Letter to Elizabeth M. Murphy,
Secretary, Commission, from Christopher Nagy, Managing Director
Order Strategy, Co-Head of Government Relations, TD Ameritrade,
Inc., dated October 5, 2009 (``TD Ameritrade Letter'').
\7\ See Securities Exchange Act Release No. 61677 (March 9,
2010), 75 FR 12584 (``Amended Notice'').
\8\ See Letter from Daniel Kanter, President and Craig Carlino,
Chief Compliance Officer, Monroe Securities, dated April 6, 2010
(``Monroe 2 Letter''); Letter to Elizabeth M. Murphy, Commission,
from R. Cromwell Coulson, Chief Executive Officer, Pink OTC Markets
Inc., dated April 9, 2010 (``Pink OTC 3 Letter'').
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II. Description of the Proposed Rule Change
With this proposed rule change, FINRA proposes to establish certain
regulatory protections for the market for OTC Equity Securities that
are similar to those established for national market system securities
by Regulation NMS. First, FINRA proposes to adopt Rule 6434 (Minimum
Pricing Increment for OTC Equity Securities) to impose restrictions on
the display of quotes and orders for OTC Equity Securities in sub-penny
increments similar to those in Rule 612 of Regulation NMS.\9\ Rule 6434
would prohibit members from displaying, ranking, or accepting from any
person a bid or offer, order, or indication of interest in an OTC
Equity Security in an increment smaller than $0.01 if the bid or offer,
order, or indication of interest is priced $1.00 or greater per share.
As initially filed, FINRA proposed to prohibit members from displaying,
ranking, or accepting a bid or offer, order, or an indication of
interest in an OTC Equity Security in an increment smaller than: (1)
$0.0001, if the bid or offer, order, or indication of interest were
priced between $0.01 and $1.00 per share; and (2) $0.000001, if the bid
or offer, order, or indication of interest were priced less than $0.01
per share.\10\ As discussed below, FINRA subsequently amended the
proposal to prohibit members from displaying, ranking, or accepting
from any person a bid or offer, order, or indication of interest in an
OTC Equity Security in an increment smaller than $0.0001 for bids,
offers, orders, and indications of interest priced below $1.00 per
share. If an order or indication of interest is priced less than
$0.0001 per share, a member may rank or accept, but not display, that
order or indication of interest in an increment of $0.000001 or
greater.
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\9\ 17 CFR 242.612.
\10\ See Initial Notice, 74 FR at 43207.
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Second, FINRA proposes to adopt Rule 6437 (Prohibition from Locking
or Crossing Quotation in OTC Equity Securities) to require that members
implement policies and procedures that reasonably avoid the display of,
or engaging in a pattern or practice of displaying, locking, or
crossing quotations in any OTC Equity Security within the same inter-
dealer quotation system. This is similar to Rule 610(d) of Regulation
NMS.\11\
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\11\ 17 CFR 242.610(d).
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Third, FINRA is proposing a new regulatory approach to fees for
accessing quotations in OTC Equity Securities. FINRA is deleting its
Rule 6540(c), which provides that an alternative trading system
(``ATS'') or electronic communications network (``ECN'') must reflect
non-subscriber access or post-transaction fees in the ATS's or ECN's
posted quote in the OTC Bulletin Board montage. In addition, FINRA
proposes to allow market makers--as well as ATSs and ECNs--to charge
access fees. As a result, market makers, ATSs, and ECNs may charge
access fees that are not displayed in the quotation. Simultaneously,
however, FINRA proposes to adopt new Rule 6450 (Restrictions on Access
Fees) that would establish a cap on non-subscriber access and post-
transaction fees in all OTC Equity Securities, similar to Rule 610(c)
of Regulation NMS.\12\ Rule 6450 would provide that, if the price of
the published quotation were $1.00 or more, the fee or fees cannot
exceed or accumulate to more than $0.003 per share. As initially filed,
if the price of the published quotation were less than $1.00, the fee
could not exceed 0.3% of the published quotation price per share. As
discussed below, FINRA subsequently amended this portion of the
proposal to provide that, if the price of the published quotation were
less than $1.00 per share, fees cannot exceed or accumulate to more
than the lesser of 0.3% of the quotation price per share, or 30% of the
minimum pricing increment under Rule 6434.
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\12\ 17 CFR 242.610(c).
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Fourth, FINRA proposes to adopt Rule 6460 (Display of Customer
Limit Orders), similar to Rule 604 of Regulation NMS.\13\ Under Rule
6460, a market maker displaying a priced quotation in an inter-dealer
quotation system would be required to immediately display a customer
limit orders that it receives that (1) improves the price of the bid or
offer displayed by the market maker; or (2) improves the size of its
bid or offer by more than a de minimis amount, where it is priced equal
to the best bid or offer in the inter-dealer quotation system where the
market maker is quoting. Similar to Rule 604 of Regulation NMS, Rule
6460 excepts any customer limit order that (1) is executed upon receipt
of the order; (2) is placed by a customer who expressly requests that
the order not be displayed; (3) is an odd-lot order; (4) is a block
size order, unless a customer placing such order requests that the
order be displayed; (5) is delivered immediately upon receipt to a
national securities exchange or to an electronic communications network
that widely disseminates such order and complies with the Rule's
provisions relating to such electronic communications network; (6) is
delivered immediately upon receipt to another OTC market maker that
complies with the proposed limit order display requirements with
respect to that order; or (7) is an all-or-none order. In Amendment No.
1, FINRA proposed to add an exception for customer limit orders that
are priced less than $0.0001 per share, consistent with the revision to
proposed Rule 6434 that allows a member to rank or accept, but not
display, an order or indication of interest in an increment as small as
$0.000001, if the order or indication of interest is priced less than
$0.0001 per share.
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\13\ 17 CFR 242.604.
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[[Page 37490]]
FINRA also proposed to make conforming changes to certain of its
other rules to reflect the establishment of these new rules.
III. Summary of Comments
The Commission received 12 comments regarding the Initial Notice
\14\ and two comment letters regarding the Amended Notice. These
comment letters are summarized below. Contemporaneously with filing
Partial Amendment No. 1, FINRA submitted a response to the comments on
the Initial Notice.
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\14\ See supra note 6.
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Minimum Quoting Increments. One commenter supported this aspect of
the proposal, stating that it would improve depth and liquidity in the
marketplace by mitigating potential harms associated with sub-penny
quoting, including ``stepping ahead'' of publicly displayed orders.\15\
Other commenters stated that sub-penny quoting may produce flickering
quotes \16\ or result in increased quote traffic without providing any
discernable benefit to investors.\17\
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\15\ See TD Ameritrade Letter at 2.
\16\ See Pink OTC Letter at 8; STANY Letter at 2.
\17\ See STANY Letter at 2.
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Other commenters disagreed with the proposal as it relates to
minimum quoting increments. While one commenter supported restrictions
on sub-penny pricing in theory, it stated that the minimum quoting
increments for shares priced below $1.00 per share were not
``meaningful'' increments.\18\ Another commenter argued that certain
stocks priced above $1.00 per share have benefited from the ability to
trade in sub-penny increments, and that prohibiting sub-penny quoting
could thus negatively impact the integrity of the OTC equity
market.\19\ Two commenters stated that securities traded in sub-penny
increments ``have traded efficiently for decades,'' \20\ one of which
added that FINRA had offered no empirical data to support its
proposal.\21\
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\18\ See Pink OTC Letter at 8.
\19\ See SIFMA Letter at 2.
\20\ Mercator Letter at 1; see also Knight Letter at 2.
\21\ See Knight Letter at 2.
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One commenter stated that the proposed minimum increments were
still small, and would not prevent stepping ahead of customer orders or
flickering quotes.\22\ Another commenter noted that the initially
proposed price increment of $0.000001 for stocks priced below $0.01 per
share would create 10,000 price points below $0.01, which could lead to
``significant operational and market quality issues,'' especially since
most securities in the OTC equity markets trade at prices less than
$0.01.\23\ Another commenter proposed that the minimum price increment
for securities priced between $0.10 and $1.00 per share should be
$0.001, and that the minimum price increment for securities priced
below $0.01 per share should be $0.0001.\24\
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\22\ See ArcaEdge Letter at 2.
\23\ See Knight Letter at 2.
\24\ See ArcaEdge Letter at 2.
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Locked and Crossed Markets. Three commenters supported this aspect
of the proposal.\25\ One commenter stated that the proposal would lead
to a more fair and orderly market, as it would enhance the usefulness
of quotation information and decrease investor confusion.\26\ Three
commenters noted, however, that investors would be better served if the
proposal were extended across all inter-dealer quotation systems, and
not just within separate inter-dealer quotation systems.\27\ One of
these commenters stated that the duty to avoid locked and crossed
markets should be co-extensive with the duty of best execution.\28\
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\25\ See ArcaEdge Letter at 2; TD Ameritrade Letter at 2; STANY
Letter at 2.
\26\ See TD Ameritrade Letter at 2.
\27\ See Pink OTC Letter at 6; STANY Letter at 2; TD Ameritrade
Letter at 2.
\28\ See Pink OTC Letter at 7.
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Two commenters stated that FINRA's proposal was unlikely to
actually prevent locked or crossed markets,\29\ because market
participants already make reasonable efforts to avoid locked or crossed
markets,\30\ and market participants most likely lock or cross the
market to avoid paying access fees.\31\ One commenter supported FINRA's
efforts to reduce locked and crossed markets, but stated that this
proposal did not provide any data to support a conclusion that locked
and crossed markets are occurring with sufficient frequency to impact
market quality.\32\ Another commenter stated that the number of locked
and crossed markets would increase if Rule 6450 were adopted and if the
requirement to display access fees in the quote were eliminated.\33\
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\29\ See Mercator Letter at 1; StockCross Letter at 2.
\30\ See Mercator Letter at 1.
\31\ See Mercator Letter at 2; see also StockCross Letter at 2.
\32\ See Knight Letter at 3.
\33\ See SIFMA Letter at 3.
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Some commenters believed that the adoption of Rule 6450 would
increase the incidence of locked and crossed markets resulting from
``access-fee'' trading.\34\ One commenter noted that, since the
proposed rule does not prohibit locking/crossing across inter-dealer
quotation systems, market participants can lock or cross across
markets, while receiving ``an instant, virtually riskless profit'' of
the access fee.\35\
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\34\ See Knight Letter at 3; StockCross Letter at 2.
\35\ Knight Letter at 3.
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Limit Order Display. Three commenters endorsed proposed FINRA Rule
6460.\36\ One of these commenters stated that investors ``gain enormous
benefits of added transparency when market centers are required to
display limit orders that are better than that market center's current
best bid or offer.'' \37\ Another commenter stated that the proposal
would foster increased quote competition and ultimately narrow spreads,
promote greater depth and liquidity, and minimize investor transaction
costs.\38\
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\36\ See ArcaEdge Letter at 4; Knight Letter at 5; TD Ameritrade
Letter at 2.
\37\ TD Ameritrade Letter at 2.
\38\ See ArcaEdge Letter at 4.
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A few commenters believed that a limit order display rule, without
more, could harm investors.\39\ One of these commenters stated that the
proposed rule would likely be detrimental to retail and institutional
investors looking to take sizeable positions in thinly traded stocks,
as the displaying of a sizeable customer order will affect the way
competing markets will react to the market.\40\ One commenter noted
that a limit order display rule could weaken the pricing leverage of a
customer, as the displaying of an order ``may well scare away bids or
offers, since in thinly traded markets, many bids and offers are at
risk quotes by market makers which are risking their own capital.''
\41\ Another commenter stated that this proposal infringed upon the
``experience and judgment of markets participants'' and the ``nature of
any free market enterprise.'' \42\
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\39\ See Mercator Letter at 1; STANY Letter at 2.
\40\ See Mercator Letter at 1.
\41\ Monroe Securities Letter at 1.
\42\ StockCross Letter at 1.
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One commenter believed that the proposed rule would act as a
disincentive for broker-dealers to display quotations in an inter-
dealer quotation system, because broker-dealers are free to withdraw
from publishing a quotation in an OTC Equity Security at any time.\43\
This commenter thus asserted that proposed Rule 6460 should be amended
to require a broker-dealer that receives a customer limit order in an
OTC Equity Security to execute the order, display the order in an
inter-dealer quotation system or alternative trading system that makes
its quotes publicly available, or transmit
[[Page 37491]]
the order to another broker-dealer who will display the order.\44\
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\43\ See Pink OTC 2 Letter at 3-4.
\44\ See id. at 4. The commenter acknowledged that its suggested
change, however, would necessitate modifications to Rule 15c2-11
under the Act. See id.
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A few commenters suggested alternatives to the proposed limit order
display rule.\45\ One of these commenters suggested permitting a
broker-dealer to post part of a limit order, because small orders are
more likely to be executed than large orders.\46\ The other commenter
stated that, while market makers should be required to display only the
price of an order, they should have discretion over display of the size
of the order.\47\ Specifically, this commenter believed that a broker
should have discretion with at least 50% of the aggregate order size,
and should not be required to display size that is more than ten times
the tier size with respect to any order or aggregate of orders at that
price level.\48\
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\45\ See Pink OTC Letter at 11-12; STANY Letter at 2.
\46\ See STANY Letter at 2.
\47\ See Pink OTC Letter at 11.
\48\ See id.
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Some commenters took issue with the proposed exceptions.\49\ One
commenter noted that, at a minimum, the proposed definition of ``block-
size'' should be clarified, given the lack of liquidity of OTC Equity
Securities.\50\ Two commenters indicated that the current minimum quote
size is a better standard for the required display size,\51\ and one
commenter suggested that limit orders of less than the minimum
quotation size for OTC Equity Securities should not be required to be
displayed.\52\
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\49\ See Knight Letter at 5-6; Pink OTC Letter at 12; SIFMA
Letter at 4.
\50\ See SIFMA Letter at 4.
\51\ See Knight Letter at 5-6; SIFMA Letter at 4.
\52\ See Pink OTC Letter at 12.
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One commenter also proposed that Rule 6460 be amended to require
the display of customer limit orders in OTC debt securities.\53\
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\53\ See Pink OTC 2 Letter at 5.
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Access Fees. Some commenters voiced their opposition to access fees
in general.\54\ One commenter stated that such fees are especially
harmful to the OTC market, which is characterized by relatively
infrequent trading and less natural liquidity.\55\ That commenter also
noted that market makers have operated successfully without charging
access fees.\56\
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\54\ See Mercator Letter at 2; STANY Letter at 2.
\55\ See Mercator Letter at 2.
\56\ See id.
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Other commenters opposed the aspect of the proposal that would
result in undisplayed access fees.\57\ One commenter stated that FINRA
should be required to demonstrate that the benefits of introducing
``hidden'' access fees exceed the ``recognized harm hidden access fees
cause to investor confidence and market quality.'' \58\ Other
commenters stated that the current rule offers greater
transparency,\59\ and that the proposal is ``in effect a license for
all market participants to charge access fees and keep those fees
hidden from the public quote.'' \60\ Another commenter noted that
access fees in OTC equity markets constitute a significant component of
the price of a security, and that removing the requirement to display
access fees would ``distort considerably the true market value of the
security.'' \61\ One commenter stated that this proposal would force
market participants to pass fees on to the customer or pay the fees
themselves when interacting with a displayed quotation.\62\ Yet another
commenter stated that the proposal would result in an unlevel playing
field in the OTCBB market, if only electronic communications networks
or alternative trading systems could utilize undisplayed access
fees.\63\
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\57\ See Knight Letter at 4; Pink OTC Letter at 4.
\58\ Pink OTC Letter at 5.
\59\ See SIFMA Letter at 3.
\60\ STANY Letter at 2.
\61\ Knight Letter at 4.
\62\ See StockCross Letter at 2.
\63\ See SIFMA Letter at 3.
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Some commenters stated that the proposal would result in fee-driven
gaming or the increased incidence of locked and crossed markets.\64\
One such commenter noted that access fees in OTC equity markets
constitute a ``significant component'' of the transaction and market
price for a security, and that allowing the non-display of access fees
would create ``a new natural hunting ground for rebate trading'' and
large volumes that otherwise would not occur.\65\ Market participants
would take advantage of ``inter-venue access fee quote arbitrage,''
with the result being fee disputes and locked markets.\66\ Another
commenter stated that market participants have little incentive to lock
or cross markets where non-displayed access fees are not permitted, and
that markets without non-displayed access fees have lower compliance
costs.\67\ Another commenter stated that eliminating the requirement to
display non-subscriber access fees would also reduce displayed
liquidity and encourage ``undisplayed sub-penny price jumping.'' \68\
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\64\ See Knight Letter at 4; Pink OTC Letter at 5; STANY Letter
at 2.
\65\ Knight Letter at 4-5.
\66\ Id. at 5.
\67\ See Pink OTC Letter at 5.
\68\ SIFMA Letter at 3.
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Two commenters supported the proposed access fee cap.\69\ One
commenter stated that, by imposing a uniform limitation of fees, this
proposal would contribute to an ``accurate evaluation of the actual
quotations displayed in the public markets.'' \70\ The other commenter
stated that this requirement would foster a competitive market by
``leveling the playing field amongst all market participants,'' as the
current rule has ``artificially supported a dealer-driven market.''
\71\ That commenter also noted that uniform access fees would prevent
access fee gaming.\72\
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\69\ See ArcaEdge Letter at 3; TD Ameritrade Letter at 2.
\70\ TD Ameritrade Letter at 2.
\71\ ArcaEdge Letter at 3.
\72\ See id. at 4.
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Two commenters stated that the proposed fee cap should be revised
to 30% of the minimum quoting increment,\73\ as access fees greater
than the quote increment are not, by definition, de minimis.\74\ One
commenter also stated that FINRA should consider rules requiring
broker-dealers to charge equal access or post transaction fees to all
non-subscribers.\75\
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\73\ See ArcaEdge Letter at 4; Pink OTC Letter at 10.
\74\ See Pink OTC Letter 9.
\75\ See ArcaEdge Letter at 4.
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IV. Amendment No. 1
In response to comments, FINRA filed Amendment No. 1 that proposed
two substantive changes to its initial filing. First, FINRA proposed to
amend Rule 6434 (Minimum Pricing Increment for OTC Equity Securities)
to change the minimum quoting increment for orders and indications of
interest priced under $1.00 per share. Initially, FINRA proposed to
permit increments as small as $0.0001 for orders and indications of
interest that were priced below $1.00 and equal to or greater than
$0.01 per share, and quoting increments of $0.000001 for orders and
indications of interest priced below $0.01 per share. As amended, FINRA
proposed to permit quoting increments of $0.0001 for orders and
indications of interest priced under $1.00 and equal to or greater than
$0.0001 per share. FINRA also proposed a limited exception for orders
and indications of interest priced less than $0.0001 per share. Under
this exception, members would be permitted to rank or accept (but not
display) orders and indications of interest in an increment of
$0.000001 or greater for orders and indications of interest that are
priced
[[Page 37492]]
under $0.0001 per share. FINRA stated that this exception recognized
the fact that some OTC Equity Securities trade at prices less than
$0.0001, and that restricting quoting in those securities to increments
of $0.0001 would effectively eliminate trading in those securities.\76\
FINRA also noted that most systems could not display pricing increments
smaller than four decimal places, and that requiring securities priced
under $1.00 and equal to or greater than $0.0001 per share to be quoted
in increments of $0.0001 would promote uniformity in the OTC equity
market at this price level.\77\
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\76\ See Amended Notice, 75 FR at 12586.
\77\ See id.
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Second, FINRA proposed to amend Rule 6450 (Restrictions on Access
Fees) to revise the access fee cap on quotations priced below $1.00 per
share. As revised, the cap would be the lesser of 0.3% of the per-share
quotation price, or 30% of the minimum permissible quotation increment.
FINRA stated that this revised method of calculating access fees for
securities priced under $1.00 would ``ensure that the access fee is
always less than the relevant quotation increment.'' \78\
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\78\ Id. at 12585.
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Finally, FINRA proposed to amend Rule 6460 (Display of Customer
Limit Orders) to add an exception to the display requirement for
customer limit orders priced less than $0.0001 per share, to correspond
with the revision to proposed Rule 6434 permitting members to rank or
accept, but not display, orders and indications of interest priced
below $0.0001 per share in an increment as small as $0.000001.
V. Summary of Comments on Amendment No. 1
Two comments were submitted in response to the Amended Notice. One
commenter reiterated its opposition to the application of the proposed
limit order display rule, and requested that the definition of ``block
size'' for OTC securities be defined as an order that is ``of at least
10,000 shares or * * * has a market value of at least $100,000.'' \79\
This commenter stated that the current rule is designed for penny
stocks only, and that the proposed definition would give larger orders
in non-penny stocks the benefit of the block-size exemption.\80\
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\79\ Monroe 2 Letter at 1.
\80\ See id.
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The second commenter reiterated its concerns with both the proposed
limit order display requirement and the proposed rule against locked
and crossed markets.\81\ This commenter noted that the proposed limit
order display rule would not require the publication of a customer
limit order if the broker-dealer handling the order were not a market
maker, as defined under FINRA's rules.\82\ In addition, the commenter
stated that the proposed rule would not apply to market makers that do
not publish a quotation in an inter-dealer quotation system for the
security that is the subject of the customer limit order.\83\ The
commenter stated that the rule would discourage broker-dealers from
making publicly displayed markets in OTC Equity Securities.\84\
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\81\ See Pink OTC 3 Letter at 1.
\82\ See id. at 3.
\83\ See id. at 2.
\84\ See id. at 3.
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The commenter also criticized FINRA's amended proposal regarding
locked and crossed markets.\85\ According to the commenter, FINRA
stated in its amended proposal that it would be unreasonable to require
broker-dealers to avoid locked and crossed markets across inter-dealer
quotation systems because there is not a mandated quotation mechanism
for OTC Equity Securities.\86\ The commenter pointed out that it itself
``currently disseminates a widely accessible, consolidated national
best bid and offer for OTC Equity Securities'' quoted in inter-dealer
quotation systems.\87\ The commenter stated that these data should be
used by broker-dealers in avoiding locking and crossing markets across
multiple inter-dealer quotation systems, and that FINRA should have
purchased this market data from the commenter.
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\85\ See id. at 4.
\86\ See Pink OTC 3 Letter at 4.
\87\ Id. at 5.
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Finally, the commenter stated that, unlike in the market for NMS
securities, no business model in the market for OTC Equity Securities
depends on the receipt of access fees among broker-dealers.\88\ As an
alternative to the proposed rule, the commenter suggested that FINRA
allow ECNs to trade on a riskless principal basis with non-subscriber
broker-dealers.\89\
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\88\ See id. at 8.
\89\ See id.
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VI. FINRA's Response to Comments on Amendment No. 1
In response to comments on the proposed limit order display rule,
FINRA reiterated its view that the appropriate trigger for an
obligation to display a customer limit order is when an OTC market
maker already is displaying a priced quotation for the security in an
inter-dealer quotation system (unless an exception applies).\90\ FINRA
similarly reiterated its view that, once triggered, the limit order
display requirement should apply to the full size of a customer limit
order.\91\ FINRA noted that its approach was consistent with the
Commission's determination when it first proposed a limit order display
rule that the presumption should be to display ``unless such orders are
of block size, the customer requests that its order not be displayed,
or one of the exceptions to the rule applies.'' \92\
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\90\ See letter to Elizabeth M. Murphy, Secretary, Commission,
dated June 22, 2010 from Racquel L. Russell, Assistant General
Counsel, Regulatory Policy and Oversight (``FINRA Response
Letter'').
\91\ See id.
\92\ See id. at 3 (citing Securities Exchange Act Release No.
36310 (September 29, 1995) 60 FR 52792 (October 10, 1995)).
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FINRA also responded to the issue of whether the prohibition on
locked and crossed markets should apply across inter-dealer quotation
systems. FINRA stated that, at this time, the prohibition on locked and
crossed markets should apply only within (and thus not across) inter-
dealer quotation systems ``due to the lack of an SRO-sponsored widely
accessible, consolidated national best bid and offer for OTC equity
securities.'' \93\
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\93\ Id. at 3-4.
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FINRA also reiterated its position that the proposed cap on access
fees is the fairest and most appropriate resolution of the access fee
issue, and that proposed Rule 6450 ``permits a landscape where market
forces can drive the adoption of various business models in the OTC
market.'' \94\
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\94\ Id. at 4.
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VII. Discussion and Findings
After careful consideration of the amended proposal, the comments
received, and FINRA's responses thereto, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities association.\95\ In particular, the Commission finds that
the proposal is consistent with Section 15A(b)(6) of the Act,\96\ which
requires, among other things, that FINRA rules be designed to prevent
fraudulent and manipulative acts and practices; to promote just and
equitable principles of trade; to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions
[[Page 37493]]
in securities; to remove impediments to and perfect the mechanism of a
free and open market and a national market system; and, in general, to
protect investors and the public interest. The Commission does not
believe that any comments have been raised that should preclude
approval of the proposal.
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\95\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\96\ 15 U.S.C. 78o-3(b)(6).
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With this proposal, FINRA seeks to introduce into the market for
OTC Equity Securities--over which it has supervisory responsibilities
\97\--certain regulatory protections that were introduced by the
Commission into the market for exchange-listed securities by Regulation
NMS. The Commission adopted Regulation NMS in 2005 to ``modernize and
strengthen the national market system for equity securities.'' \98\
Among the elements of Regulation NMS were: (1) A rule establishing a
uniform quoting increment of no less than one penny for quotations in
NMS stocks equal to or greater than $1.00 per share, to promote greater
price transparency and consistency; (2) a cap on fees for accessing
protected quotations, to ensure the ``fairness and accuracy of
displayed quotations by establishing an outer limit on the cost of
accessing such quotations;'' \99\ and (3) a rule requiring the
exchanges and FINRA to require their members reasonably to avoid
locking or crossing protected quotations. Under the same authority used
to establish Regulation NMS, the Commission had previously established
a rule that generally requires display of customer limit orders.\100\
Many of the same concerns expressed by the Commission in adopting
Regulation NMS and the Limit Order Display Rule for exchange-listed
securities also apply to the market in OTC Equity Securities. The rules
proposed here by FINRA appear reasonably designed to address these
concerns, and follow closely the regulatory approach set forth in the
Commission's rules. Therefore, the Commission believes that FINRA's
proposal is consistent with the Act.
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\97\ See Section 15A(b)(11) of the Act, 15 U.S.C. 78o-3(b)(11)
(rules of a national securities association must ``include
provisions governing the form and content of quotations relating to
securities sold otherwise than on a national securities exchange'').
\98\ Securities Exchange Act Release 51808 70 FR 37496, 37496
(June 29, 2005) (``Reg NMS Adopting Release'').
\99\ Reg NMS Adopting Release, id., 70 FR at 37502.
\100\ See Securities Exchange Act Release No. 37619A (September
6, 1996), 61 FR 48290 (September 12, 1996) (adopting Rule 11Ac1-4
under the Act, which requires the display of customer limit orders
priced better than a specialist's or OTC market maker's quote)
(``Limit Order Display Release'').
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With respect to the proposal to restrict sub-penny quoting, the
Commission agrees with FINRA that the same concerns that were
articulated in the context of Regulation NMS also exist for OTC Equity
Securities. Such concerns include ``stepping ahead'' of standing limit
orders by an economically insignificant amount, which reduces
incentives to display limit orders and provide liquidity to the
markets, and the increased incidence of ``flickering quotes'' and the
resulting regulatory compliance and capacity burdens.\101\
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\101\ See Reg NMS Adopting Release, supra note 98, 70 FR at
37553.
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Like Rule 612 of Regulation NMS,\102\ proposed FINRA Rule 6434
requires that the minimum increment for bids, offers, orders, and
indications of interest priced $1.00 or more per share is one penny.
Furthermore, like Rule 612, proposed FINRA Rule 6434 requires that the
minimum increment for bids, offers, orders, and indications of interest
priced between $1.00 and $0.0001 per share is one hundredth of a penny.
Unlike Rule 612, however, proposed FINRA Rule 6434 contains an
additional provision for bids, offers, orders, and indications of
interest priced below $0.0001 per share. Under this provision, a member
may rank or accept (but not display) an order or indication of interest
in an increment as small as $0.000001.\103\ FINRA stated that this
exception recognizes the fact that some OTC Equity Securities trade at
prices less than $0.0001, and that restricting quoting in those
securities to increments of $0.0001 would effectively eliminate trading
in those securities.\104\
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\102\ 17 CFR 242.612.
\103\ In the FINRA Response Letter, FINRA noted that a member's
customer order protection obligations under IM-2110-2 (Trading Ahead
of Customer Limit Order) continue to apply. See FINRA Response
Letter, supra note 90 at 2.
\104\ See Amended Notice, 75 FR at 12586.
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The Commission believes that proposed Rule 6434 is consistent with
the Act because it adopts pricing increments similar to those set forth
in Rule 612. Although the proposed rule differs from Rule 612 in that
it permits acceptance of orders and indications of interest priced
below $0.0001 per share in finer increments, the Commission believes
that this is a reasonable accommodation given that certain OTC Equity
Securities currently trade at very low prices.
With respect to FINRA's proposal regarding locking or crossing
quotations, the Commission agrees with FINRA that many of the same
concerns that were articulated in the context of Regulation NMS--
namely, that locked and crossed markets may confuse investors and
create market inefficiencies \105\--also exist for OTC Equity
Securities. In response to commenters inquiring why FINRA did not
extend this rule across inter-dealer quotation systems, FINRA stated
that it is not practicable to extend locking and crossing restrictions
across inter-dealer markets due to the lack of a widely accessible,
consolidated national best bid and offer for OTC Equity Securities. The
Commission believes that FINRA's proposal is consistent with the Act
and is a reasonable first step to address problems caused by locked and
crossed markets, while recognizing the market data limitations for OTC
Equity Securities.
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\105\ See Reg NMS Adopting Release, supra note 98, 70 FR at
37547.
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The Commission also finds that FINRA's proposal regarding access
fees is consistent with the Act, for the same reasons that the
Commission adopted its own rules regarding access fees. In the Reg NMS
Adopting Release, the Commission noted that a flat access fee was the
``fairest and most appropriate solution to what has been a longstanding
and contentious issue.'' \106\ The Commission noted that this fee would
apply equally to ECNs, market makers, and other trading centers.\107\
The Commission also noted that, for quotations to be fair and useful,
``there must be some limit on the extent to which the true price can
vary from the displayed price,'' and concluded that the cap on access
fees ``harmoniz[ed] quotation practices and preclude[ed] the distortive
effects of exorbitant fees.'' \108\ The Commission agrees with FINRA
that the same considerations apply here. In capping the fees that may
be charged to access a quotation in an OTC Equity Security, and in
drafting the rule to apply to ATSs, ECNs, and market makers, the
proposed rule is reasonably designed to promote transparency and fair
competition in the market for OTC Equity Securities.
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\106\ Reg NMS Adopting Release, supra note 98, 70 FR at 37545.
\107\ See id.
\108\ Id.
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As noted above, a number of commenters argued that this access fee
provision applicable to sub-penny quotations, as originally proposed,
could lead to certain gaming activity. In response to these comments,
FINRA proposed in Amendment No. 1 to modify the cap on access fees for
sub-penny quotations. Specifically, the access fee cap would be the
lesser of 0.3% of the published quotation price on a per-share basis,
or 30% of the minimum allowable increment. The Commission believes that
the amended
[[Page 37494]]
proposal is reasonably designed to minimize access fee gaming, as it
prevents the access fee from exceeding the minimum quoting increment.
Finally, the Commission finds that FINRA's proposal to adopt a
limit order display rule is consistent with the Act. With certain
exceptions, the proposal requires a market maker displaying a priced
quote in an inter-dealer quotation system to immediately display a
customer limit order that it receives that (1) improves the price of
the bid or offer displayed by the market maker, or (2) improves the
size of its bid or offer by more than a de minimis amount where it is
priced equal to the best bid or offer in the inter-dealer quotation
system where the market maker is quoting. The Commission believes that
extending limit order display requirements to OTC Equity Securities is
reasonably designed to increase transparency in the market for OTC
Equity Securities. As it has previously stated, the Commission believes
that limit orders are a valuable component of price discovery, and that
uniformly requiring display of such orders will encourage tighter,
deeper, and more efficient markets.\109\ Commenters generally supported
the proposed limit order display requirement, although some commenters
requested certain clarifications and modifications. In response to
comments, FINRA noted in Amendment No. 1 that its proposed limit order
display rule would not require display of customer orders that would
result in a violation of the minimum quotation size tiers prescribed in
FINRA Rule 6450 (Minimum Quotation Size Requirements For OTC Equity
Securities).\110\ FINRA also proposed a new exception for limit orders
priced less than $0.0001 per share, consistent with the changes made to
proposed FINRA Rule 6434 prohibiting the display of a bid or offer,
order, or indication of interest in any OTC Equity Security priced less
than $0.0001 per share.\111\
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\109\ See Limit Order Display Release, supra note 100, 61 FR at
48294. Rule 11Ac1-4, which was adopted prior to the approval of The
Nasdaq Stock Market as a national securities exchange, applied
generally to exchange specialists and Nasdaq market makers. Rule
11Ac1-4 was subsequently redesignated as Rule 604 under Regulation
NMS. See NMS Adopting Release, supra note 98.
\110\ See Amended Notice, supra note 7.
\111\ See id.
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One commenter expressed concern that the proposed limit order
display rule would apply only to OTC market-makers, rather than to all
broker-dealers displaying a priced quotation in an inter-dealer
quotation system or ECN, which could lead to a reduction in quotation
activity in OTC Equity Securities. The Commission notes that FINRA's
limit order display proposal acknowledges the role that market makers
traditionally have played in providing price discovery and liquidity to
the OTC Equity Securities market.
Further, in response to commenters' concerns that market makers be
permitted greater discretion to display only a portion of a customer
limit order, FINRA noted that, where the member believes that a
customer would be best served by not displaying the full size of a
limit order, the member is free to obtain the customer's consent to
refrain from displaying such customer's order, as permitted by a
proposed exception to the limit order display requirement. As it has
previously stated, the Commission believes that the presumption of
limit order display is the proper approach.\112\ The Commission further
believes that FINRA's limit order display proposal marks a positive
step in efforts to improve the transparency of OTC Equity Securities
and the handling of customer limit orders in this market sector.
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\112\ See Limit Order Display Release, supra note 100, 61 FR at
48301 (stating ``[t]he Commission believes that the rule
appropriately establishes a presumption that limit orders should be
displayed, unless such orders are of block size, the customer
requests that its order not be displayed, or one of the exceptions
to the rule applies. The exception allowing a customer to request
that its limit order not be displayed gives the customer ultimate
control in determining whether to trust the display of the limit
order to the discretion of a market professional, or to display the
order either in full, or in part, to other potential market
interest.'').
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VIII. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-FINRA-2009-054), as modified by
Amendment No. 1 thereto, be, and hereby is, approved.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\113\
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\113\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-15707 Filed 6-28-10; 8:45 am]
BILLING CODE 8010-01-P