[Federal Register Volume 69, Number 102 (Wednesday, May 26, 2004)]
[Proposed Rules]
[Pages 30142-30149]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-11879]



[[Page 30141]]

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Part IX





Securities and Exchange Commission





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17 CFR Parts 200, 230, 240, 242, and 249



Regulation NMS; Proposed Rule

  Federal Register / Vol. 69, No. 102 / Wednesday, May 26, 2004 / 
Proposed Rules  

[[Page 30142]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200, 230, 240, 242, and 249

[Release No. 34-49749; File No. S7-10-04]
RIN 3235-AJ18


Regulation NMS

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule; extension of comment period and supplemental 
request for comment.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
extending the comment period on rules proposed under Regulation NMS, 
which were published in Securities Exchange Act Release No. 49325 
(February 26, 2004), 69 FR 11126 (March 9, 2004) (``Proposing 
Release''). The original comment period would have expired on May 24, 
2004. The new comment period will expire on June 30, 2004. In addition, 
the Commission is supplementing its request for comment on the proposed 
rules to reflect the hearing on Regulation NMS that was held on April 
21, 2004 (``NMS Hearing''). During the NMS Hearing, panelists discussed 
developments that bear on many significant issues raised by the 
proposed rules. The Commission is publishing this supplemental request 
for comment and extending the comment period to assure that the public 
has a full opportunity to address such issues in their comments.

DATES: Comments should be received on or before June 30, 2004.

ADDRESSES: Comments may be submitted by any of the following methods:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-10-04 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number S7-10-04. This file 
number should be included on the subject line if e-mail is used. To 
help us process and review your comments more efficiently, please use 
only one method. The Commission will post all comments on the 
Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments also are available for public inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549. All comments received will be posted without 
change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.

FOR FURTHER INFORMATION CONTACT: Daniel M. Gray, Attorney Fellow, at 
(202) 942-0159, or Heather Seidel, Attorney Fellow, at (202) 942-0788, 
Division of Market Regulation, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Proposing Release published Regulation NMS for public comment. 
In addition to redesignating the existing national market system 
(``NMS'') rules adopted under Section 11A of the Securities Exchange 
Act of 1934 (``Exchange Act''), Regulation NMS incorporated four 
substantive proposals that are designed to enhance and modernize the 
regulatory structure of the U.S. equity markets. First, the Commission 
proposed a uniform rule for all NMS market centers that, subject to two 
significant exceptions, would require a market center to establish, 
maintain, and enforce policies and procedures reasonably designed to 
prevent ``trade-throughs''--the execution of an order in its market at 
a price that is inferior to a price displayed in another market 
(``Trade-Through Proposal''). Second, the Commission proposed a rule 
that would modernize the terms of access to quotations and execution of 
orders in the NMS (``Access Proposal''). The third proposal would 
prohibit market participants from accepting, ranking, or displaying 
orders, quotes, or indications of interest in a pricing increment finer 
than a penny, except for securities with a share price of below $1.00 
(``Sub-Penny Quoting Proposal''). Finally, the Commission proposed 
amendments to the rules and joint industry plans for disseminating 
market information to the public that, among other things, would modify 
the formulas for allocating plan revenues to reward markets for more 
broadly based contributions to public price discovery (``Market Data 
Proposal'').
    On April 21, 2004, the Commission held the NMS Hearing in New York 
City.\1\ The NMS Hearing was composed of a series of seven panels that 
collectively addressed each of the four proposals. The panelists 
included a wide range of market participants who discussed the 
proposals themselves, as well as their own initiatives intended, at 
least in part, to respond to the proposals. The Commission is extending 
the comment period and publishing this supplemental request for comment 
to give the public a fuller opportunity to reflect the NMS Hearing in 
their comments on the proposals.\2\
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    \1\ A full transcript of the NMS Hearing (``Hearing Tr.''), as 
well as an archived video and audio webcast, is available on the 
Commission's Internet Web site (http://www.sec.gov).
    \2\ The discussion in this supplemental request for comment 
assumes familiarity with the Proposing Release and therefore does 
not restate all of the specific terms of the proposals. In addition, 
the Commission continues to request comment on all of the matters 
set forth in the Proposing Release.
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    A significant element of the NMS Hearing was the intention 
expressed by various representatives of exchanges with traditional 
trading floors to establish facilities in the coming months that will 
offer automatic execution of orders seeking to interact with their 
displayed quotations (``Auto-Ex Facilities'').\3\ Panelists also 
emphasized that the essential element of an effective Auto-Ex Facility 
is an immediate automated response (i.e., one without any manual 
intervention) to the router of the incoming order.\4\ They stated that 
the response must be either that the order was executed (in full or in 
part) or that it could not be executed (because, for example, a prior 
incoming order already had executed against the displayed quotation). 
The exchange representatives acknowledged the challenges posed by 
developing an efficient hybrid market--one that integrates an active 
trading floor with an Auto-Ex Facility. They emphasized, however, that 
they were well advanced in their efforts and indicated that such 
facilities are likely to become operational within a time frame that 
could precede any potential implementation date for Regulation NMS, 
should the Commission decide to adopt the proposals.\5\
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    \3\ Hearing Tr. at 85, 90-92, 94-97, 120.
    \4\ Hearing Tr. at 32, 55-56, 65-66, 158.
    \5\ For each of the four substantive proposals under Regulation 
NMS, the Proposing Release requested comment on the appropriate 
phase-in period that would be needed to allow participants time to 
adapt to the proposed new regulatory environment.
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    In addition, panelists at the NMS Hearing noted that existing order 
routing technologies were capable of identifying, on a quote-by-quote 
basis, indications from a market center that a particular quotation was 
not accessible

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through an Auto-Ex Facility.\6\ The ability to display such a quotation 
potentially would give exchanges with trading floors the flexibility to 
integrate effectively the trading floor with an Auto-Ex Facility. 
Rather than being classified as ``fast'' or ``slow,'' markets would be 
allowed to offer choices to investors. In those particular contexts 
when a market's quotation was not accessible through an Auto-Ex 
Facility (for example, to provide an opportunity for the floor to 
generate additional price discovery or price improvement), the 
quotation would be identified as such and order-routers could respond 
accordingly. As discussed further below, the Regulation NMS proposals 
also could be drafted to reflect whether a quotation was, or was not, 
accessible through an Auto-Ex Facility. Competitive forces and the 
needs of investors, rather than regulatory classifications, would 
determine the relative success of various types of manual and automated 
trading facilities.
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    \6\ Hearing Tr. at 57, 142-144, 157-158.
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    The near-term prospect that quotations displayed in the NMS may be 
predominantly accessible through Auto-Ex Facilities, but with some 
flexibility for markets to offer investors the choice of manual 
trading, potentially has very significant consequences for the rules 
proposed under Regulation NMS. Some of the most difficult issues raised 
by the proposals, particularly those relating to trade-throughs, 
access, and market data, derive from the problem of accommodating both 
auto-executable and manual quotations within the NMS. These problems 
could largely disappear in the near future if NMS quotes become 
predominately accessible through Auto-Ex Facilities. One of the primary 
purposes of the supplemental request for comment that follows is to 
encourage the public to address the opportunities that such a 
development would offer for making substantial progress toward a more 
efficient NMS for investors.

II. Trade-Through Proposal

A. Exception for Manual Quotes

    The Proposing Release recognized that there are differences between 
the speed and certainty of response in electronic (i.e. automated) 
versus manual (i.e. non-automated) markets. To provide flexibility to 
market centers with different market structures, the Commission 
proposed an exception to the trade-through rule to allow an automated 
market to trade-through a non-automated market up to a certain 
amount.\7\ Many panelists at the NMS Hearing agreed that the 
distinction between an automated and non-automated market--a market 
that provides immediate access to its quotes through automatic 
execution and one that does not--is important, and that market 
participants should be able to trade-through a manual market.\8\ 
Panelists at the NMS Hearing, however, expressed the view that the 
distinction could, and perhaps should, be made between manual and 
automated quotes, rather than manual and automated markets.\9\
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    \7\ The Commission requested comment on all aspects of this 
proposed exception, including in particular how to define an 
automated market, and by what amount a market should be allowed to 
trade-through a manual market. See Section III.D.2 of the Proposing 
Release.
    \8\ See, e.g., Hearing Tr. at 56-57, 63-67, 72, 75-76, 86, 132, 
136, 142, 158. One panelist characterized the distinction as between 
``maybe'' and executable firm quotes. See Hearing Tr. at 52-53, 55-
57.
    \9\ Hearing Tr. at 57-58, 142-144, 157-158.
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    The Commission therefore requests further comment on the operation 
of the proposed exception for manual markets. Specifically, the 
Commission requests comment as to whether the exception from the 
proposed trade-through rule should apply to quotes that are not 
immediately accessible through an Auto-Ex Facility (a manual or non-
automated quote), rather than providing an overall exception for a 
manual market.\10\ Would narrowing the scope of the proposed exception 
to manual quotes allow market centers and broker-dealers to more 
efficiently execute orders across markets, while at the same time 
preserving the protections of a trade-through rule? By not forcing a 
market center into a rigid classification--automated or manual, would 
providing an exception for manual quotes, on a quote-by-quote basis, 
provide more flexibility for market centers with different market 
structures to compete more fairly with each other? For instance, would 
narrowing the exception to manual quotes, which would allow a market 
center with an Auto-Ex Facility to display a manual quote in particular 
limited circumstances, provide more flexibility for a market center 
with a floor-based structure to effectively integrate its trading floor 
with an Auto-Ex Facility, if it so desired? \11\ Would a quote-by-quote 
exception allow markets more flexibility to provide investors a choice 
as to a manual or automatic execution? Comment also is requested on 
whether a quote-by-quote exception would create difficulties for 
routing systems that could not be easily managed.
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    \10\ In Section III.B of this Release, the Commission requests 
further comment on whether or not there should be trade-through 
protection for ``high-fee'' quotes. See also Section III.F of the 
Proposing Release that requested comment on this issue as well.
    \11\ See Hearing Tr. at 57 (panelist expressing the view that 
focusing on automated quotes would provide market centers with 
flexibility to evolve towards a more automated system in any way 
they see fit).
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    The Commission requests comment as to the best way to effectuate a 
quote-by-quote exception to the proposed trade-through rule for manual 
quotes. Panelists at the NMS Hearing stated that it would be possible 
to attach an identifier to manual quotes in the consolidated quote 
stream so that all market participants would know the quote was a 
manual quote.\12\ The Commission requests comment on the feasibility of 
this approach, and how it would work in practice. Should the Commission 
explicitly require each market center, as part of its required policies 
and procedures,\13\ to implement a process to identify any non-
automated bid or offer that it posts in the consolidated quote stream 
as manual? Should the Commission require that the NMS plans that govern 
the collection, consolidation and dissemination of quotes in NYSE, Amex 
and Nasdaq-listed stocks be amended to provide for this functionality 
with regard to the quotes sent to the processors for those plans? \14\ 
Should each self-regulatory organization (``SRO'') be required, as part 
of its policies and procedures for complying with the proposed trade-
through rule, to impose a requirement on its members that they identify 
their bids and offers as manual when submitting them to the SRO?
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    \12\ Hearing Tr. at 57, 142, 157-158.
    \13\ See Section III.C.5 of the Proposing Release for a 
discussion of the required policies and procedures that each order 
execution facility would be required to establish, maintain and 
enforce pursuant to the proposed trade-through rule, proposed Rule 
611 of Regulation NMS.
    \14\ The NMS plans are described in Sections III.B.1 and VI.A of 
the Proposing Release.
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    Comment also is requested on whether a market center should be able 
to decide on a security-by-security basis whether its quotes will be 
automated or manual. The Commission recognizes that an exception for 
manual quotes, as outlined above, would necessarily provide market 
centers with this (and more) flexibility, by allowing them to identify 
all quotes in a particular security as manual quotes. If the Commission 
adopted an exception to the trade-through rule for manual markets 
rather than manual quotes, however, should the exception explicitly 
allow a market to choose to be

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automated or manual on a security-by-security basis?
1. Definition of an ``Automated'' Quote
    Several panelists at the NMS Hearing expressed the view that the 
concept of an ``automated'' market or quote must encompass an immediate 
automated response to the order router as to what action was taken with 
respect to the order.\15\ In other words, certainty as to whether an 
order seeking to interact with a displayed quote can immediately 
interact with such quote--knowing instantaneously whether an order was 
executed (in full or in part) or cancelled--is key.
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    \15\ See, e.g., Hearing Tr. at 54-57, 65-66, 133, 158.
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    In the Proposing Release, the Commission proposed to define an 
``automated order execution facility'' as a order execution facility 
that provides for an immediate automated response to all incoming 
orders for up to the full size of its best bid and offer disseminated 
pursuant to an effective national market system plan, without any 
restrictions on executions.\16\ The Commission requests comment on 
whether it should make explicit in the proposed definition of an 
automated market or automated quote that providing an immediate 
automated response would include immediately sending a report back to 
the market center that submitted the order, either reporting an 
execution or cancellation. In addition, should the Commission make 
explicit that the automated market or quote must provide an automatic 
execution functionality for the whole order or provide an automatic 
cancellation for the remaining portion of an order not executed against 
the quote?
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    \16\ See Section III.D.2.a of the Proposing Release and 
paragraph (b)(3) of proposed Rule 600 of Regulation NMS. The 
Commission requested detailed comment on this proposed definition. 
See Section III.D.2 of the Proposing Release.
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    The Commission also requested comment in the Proposing Release as 
to whether it should provide specific guidance with regard to what 
``immediate'' would mean in terms of providing an automated 
response.\17\ Panelists believed that, at a minimum, for a quote to be 
considered automated there must be no manual or human intervention 
involved in responding to an order seeking to interact with that 
quote.\18\ In the Proposing Release, the Commission requested comment 
as to whether it would be appropriate to impose a performance standard 
with respect to response times.\19\ The Commission notes that panelists 
at the NMS Hearing advocated imposing a maximum response time, such as 
one second or a quarter of a second.\20\
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    \17\ See Section III.D.2.a of the Proposing Release.
    \18\ See Hearing Tr. at 29, 32, 55-56, 59.
    \19\ See Section III.D.2.a of the Proposing Release.
    \20\ See Hearing Tr. 59 and 86 (advocating a \1/4\ of a second, 
at least 98% of the time), 62 (advocating that a fast market is 
under one second).
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    The Commission requests further comment on whether it should impose 
performance standards, such as no less than one second, or a quarter of 
a second, or some other time frame, on the total time for a market 
center to respond to an order in an automated manner, i.e., the time 
from when the order is received by the executing market center to the 
time that the executing market center sends a report back to the order 
router indicating the action taken with respect to the order. Would 
imposing a performance standard alleviate concern that, because each 
market otherwise would be able to determine what ``immediate'' means 
with respect to its own bids and offers, a market participant might be 
required to access a better price on a market center that it did not 
believe provided an immediate response? Would market centers continue 
to have an incentive to compete on the basis of execution speed if a 
performance standard were imposed? \21\ The Commission also requests 
comment on whether there is a need to impose a response time of less 
than one second. Specifically, would investors benefit significantly, 
or at all, from sub-second response times? If so, how would they 
benefit? Additionally, would it be necessary or advisable to impose 
sub-second response times in order to promote a smoothly operating 
marketplace?
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    \21\ See Hearing Tr. at 25-28.
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    The Commission requests comment with regard to surveiling for and 
enforcing compliance with a performance standard. In particular, the 
Commission requests comment on whether, if it were to adopt a 
performance standard, it should require that each market center 
publicly disclose the percentage of time, or each actual instance, that 
it did not provide a response in compliance with the standards required 
by the rule. Would requiring public disclosure provide an added 
incentive for market centers to continue to improve their technology 
and the services they provide? Would it allow market participants and 
the Commission to better determine if the quotes of a market center 
that the market center determine to be automated are indeed automated 
in compliance with the proposed standards? Is there any other mechanism 
by which market participants could determine whether market centers 
were providing an immediate automated response in compliance with any 
performance standards imposed?
    One panelist at the NMS Hearing expressed the view that a market 
center posting a bid or offer should be required to automatically 
update that quote, in order to be deemed an automated market.\22\ The 
Commission agrees that providing an automatic update to the best bid or 
offer is important because market participants other than the 
participant whose order executed against the quote need to know whether 
a particular quote is still available or not. Not updating a quote to 
immediately reflect the true status of the quote inhibits full 
transparency and could lead to uncertainty as to whether the market 
center's quotes are indeed immediately accessible through an Auto-Ex 
Facility. The Commission therefore requests comment on whether, in 
order for a market center or quote to be considered automated, the 
market center posting the quote should be required to provide for an 
automated update to the quote it is executed against. The Commission 
also requests comment on whether it should impose a performance 
standard, such as one second, on the time within which the order 
execution facility would be required to update its automated quote. 
Finally, comment is requested on whether the Commission should require 
market centers to provide an automatic cancellation functionality that 
would allow a market participant that has put a limit order on the 
market center's limit order book to automatically cancel the limit 
order. If so, should the Commission require that cancellations be 
honored within a certain time frame, such as less than one second?
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    \22\ Hearing Tr. at 14.
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2. Allowable Trade-Through Amount
    In the Proposing Release, the Commission requested comment on the 
amount by which a market should be allowed to trade through a manual 
market.\23\ Panelists at the NMS Hearing expressed the view that a 
market center should be allowed to trade-through a manual market by an 
unlimited amount.\24\ One panelist stated that the ability to trade-
through a manual market has to be ``unfettered'' because of a concern 
with the practicality of complying with the proposed tiered approach 
(which would look to the NBBO of the security at the time of execution 
for purposes of determining the allowable trade-through amount)

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given the incidence of flickering prices in today's market.\25\ The 
Commission requests further comment as to the amount by which a market 
should be allowed to trade through a manual quote. Specifically, the 
Commission requests comment as to whether there should be no limit. As 
emphasized in the Proposing Release, however, such an exception to the 
trade-through rule would in no way alter or lessen a broker-dealer's 
duty to achieve best execution.\26\
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    \23\ See Section III.D.2.c of the Proposing Release.
    \24\ Hearing Tr. at 57-58, 67.
    \25\ Hearing Tr. at 67. See Section III.D.2.c of the Proposing 
Release for a detailed description of the proposed allowable trade-
through amounts.
    \26\ Section III.C.7 of the Proposing Release.
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B. Opt-Out Exception

    Panelists were split about the need for an opt-out exception. Some 
panelists at the NMS Hearing expressed the view that there would be no 
need, or valid policy reason, to allow a market to trade through an 
automated market or automated quote of another market.\27\ In addition, 
representatives of two floor-based exchanges have publicly expressed 
the intent to take the necessary steps to become automated for purposes 
of the proposed exception to the trade-through rule.\28\ Thus, the 
Commission requests comment as to whether, if it were to adopt an 
exception to the trade-through rule for manual quotes, the proposed 
opt-out exception would still be necessary or desirable.
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    \27\ Hearing Tr. at 32, 58, 65, 74, 80, 84, 85, 154.
    \28\ Hearing Tr. at 85, 88, 90-92, 94-95, 97, 116.
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    Other panelists supported an opt-out exception.\29\ Several 
panelists at the NMS Hearing stated that one benefit of the proposed 
opt-out exception is that it could create market pressure that would 
discipline markets that provided slow executions or inadequate access 
to their markets.\30\ The Commission requests comment on this issue. 
Would there be less of a need for the opt-out as a mechanism for market 
discipline if the Commission were to adopt explicit performance 
standards with regard to defining what an ``immediate'' automated 
response means under an exception for manual quotes?
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    \29\ Hearing Tr. at 14-15, 18, 19, 36.
    \30\ Hearing Tr. at 28, 35-36, 43.
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    If commenters believe that an additional mechanism is needed to 
exert market pressure on market centers, what type of mechanism would 
be effective but still support the underlying goals of price protection 
and best execution? For instance, as discussed above in Section II.A.1, 
whether or not the Commission adopted a performance standard with 
regard to an exception for a manual market or quote, should the 
Commission require each market center to publicly disclose how often it 
provided an immediate automated response within certain time frames or 
within the performance standards?
    Another potential use of the opt-out exception could be to by-pass 
quotations likely to be unavailable due to prior execution. Such a use 
could arise, for example, when a quotation suddenly becomes attractive 
to many traders at the same time (e.g., because of a price change in a 
related security). One can conceive of circumstances in which a large, 
and perhaps rapidly growing, number of orders pursues a small and 
rapidly changing number of quotations. The Commission would be 
concerned if such scenarios could severely impact individual market 
centers or even interfere with the smooth functioning of the 
marketplace. The Commission requests comment on whether such scenarios 
are likely, what their potential impact might be, and whether a 
specific exception to the trade-through rule is needed to provide 
market participants with acceptable means to execute their orders under 
such conditions. If commenters believe an exception is needed, the 
Commission requests information on the nature of the requirement and 
the form that such an exception might take. The Commission requests 
comment on whether an opt-out exception would be needed for customers 
of order execution facilities that do not currently interact with other 
exchanges or order execution facilities.

C. Other Exceptions

    The Commission also is requesting further comment as to whether 
there are particular types of transactions the execution of which 
should be excepted from the proposed trade-through rule that are not 
covered by the proposed exceptions, consistent with the fundamental 
policies of price priority.\31\ For example, should there be an 
exception provided for basket or program trades that are executed at a 
single price distinct from current prices for each of the securities 
contained in the basket? In addition, should an exception be provided 
for an ``intermarket sweep order'' by which a market participant can 
simultaneously route orders to interact with all best bids and offers 
displayed in the consolidated quote system? \32\ As proposed, paragraph 
(b)(7) of Rule 611 of Regulation NMS would provide an exception for 
those instances where an order execution facility sends an order to 
execute against a better-priced order displayed on another market at 
the same time or prior to executing an order in its own market at an 
inferior price.\33\ The Commission recognizes, however, that a market 
center that receives one part of an ``intermarket sweep order'' would 
not know that other ``sweep'' order(s) have been sent to other market 
centers to attempt to execute against any better-priced bids or offers 
displayed on those markets, unless the order(s) were identified in some 
manner. Thus, the receiving market could, pursuant to the proposed 
trade-through rule, route the order it received to another market 
displaying a better price, even though the order router already has 
attempted to take out those better prices. Therefore, the Commission is 
requesting comment as to how each order sent by a market participant in 
compliance with a ``sweep order'' exception should be identified so 
that the receiving market center would be able to execute the order 
without regard to whether a better price were displayed on another 
market center.
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    \31\ See Section III.D of the Proposing Release for a discussion 
of the proposed exceptions to the trade-through rule.
    \32\ An ``intermarket sweep order'' could arise where a market 
center wants to be able to route an order(s) to execute against any 
better-priced bid(s) or offer(s) on other market center(s) at the 
same time as or prior to executing the remaining balance in its own 
market at an inferior price, or a market participant could wish to 
execute the entirety of an order it holds by sending orders to 
interact with the best bids and offers displayed on other market 
centers. See Hearing Tr. at 53-54, 145-146.
    \33\ See Section III.D.3 and note 82 of the Proposing Release.
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D. Type of Securities Subject to the Proposed Rule

    Some panelists at the NMS Hearing questioned the need for a trade-
through rule and argued against extending the trade-through rule to the 
Nasdaq market. Given the prospect of greater automation of execution 
facilities discussed at the NMS Hearing, the Commission requests 
comment on how such a development would affect the need for a trade-
through rule in the market for listed securities. In this connection, 
the Commission also reiterates its request for comment on the need to 
expand the trade-through rule to the Nasdaq market.

III. Access Proposal

    The Access Proposal includes three primary parts: standards for 
market access, limitations on access fees, and standards to address 
locked or crossed quotations. An overview of the Access Proposal is set 
forth below to promote greater understanding of its details and to 
assist commenters in formulating their views. Next, additional comment 
is requested on the potential alternatives

[[Page 30146]]

for other aspects of Regulation NMS if access fees are not limited to a 
de minimis amount.

A. Overview of Access Proposal

1. Market Access Standards
    Paragraph (a) of proposed Rule 610 under Regulation NMS would 
establish access standards for two types of market centers, which 
between the two would encompass all quotations that are disseminated to 
the public through the consolidated data stream. First, an SRO order 
execution facility (defined in proposed Rule 600(b)(61) as a ``quoting 
market center'') would be prohibited from imposing unfairly 
discriminatory terms that inhibit a non-member, non-customer, or non-
subscriber from obtaining access to quotations and the execution of 
orders through a member, customer, or subscriber.\34\ Second, any 
broker-dealer whose quotations are not available for execution through 
any SRO order execution facility (such a broker-dealer would be defined 
in proposed Rule 600(b)(62) as a ``quoting market participant'' 
(``QMP'')) \35\ also would be prohibited from imposing unfairly 
discriminatory terms that inhibited a non-member, non-customer, or non-
subscriber from obtaining access to quotations or the execution of 
orders through a member, customer, or subscriber. This standard is 
intended to assure that all parties have effective indirect access 
through members and subscribers to quotations displayed by SRO order 
execution facilities and QMPs, thereby obviating the necessity for 
direct, intermarket linkages between market centers such as the 
Intermarket Trading System (``ITS'').
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    \34\ The phrase ``access to quotations and execution of orders'' 
would encompass access both to a market's best bid and offer and to 
quotations included in a market's ``depth of book.''
    \35\ Currently, the only broker-dealers that would fall within 
the proposed definition of a QMP are ATSs or market makers whose 
quotations are displayed in the consolidated data stream solely 
through the Alternative Display Facility (``ADF'') operated by the 
NASD. If a broker-dealer makes its quotations available for 
execution through any SRO order execution facility, it would not 
fall within the proposed definition of a QMP.
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    In addition, the Access Proposal would address direct access to 
markets in two contexts. First, paragraph (a)(2)(i) of proposed Rule 
610 would require a QMP to provide access to its quotations to allow 
SRO order execution facilities and other QMPs to route orders for 
execution to the QMP on terms as favorable as those that the QMP grants 
to its most preferred member, customer, or subscriber. This additional 
requirement is necessary because a QMP's quotes would not, by 
definition, be otherwise available for execution through any SRO order 
execution facility. Second, the trading threshold that triggers the 
fair access standards of Rule 301(b)(5) of Regulation ATS would be 
lowered from 20% to 5% of the average daily volume in a security.\36\ 
When subject to such fair access standards, an ATS is prohibited from 
unreasonably limiting any person from obtaining access to the ATS's 
services, such as by becoming a direct subscriber of the ATS.\37\
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    \36\ 17 CFR 242.301(b)(5).
    \37\ The fair access standards of paragraph (b)(5) of Rule 301 
of Regulation ATS do not require ATSs to provide indirect access to 
non-subscribers to such services as displaying limit orders, use of 
special handling orders, or proprietary market data. Paragraph 
(b)(3) of Rule 301 addresses the ``execution access'' required to an 
ATS's best bid and offer that is provided to an SRO for inclusion in 
the consolidated data stream. It requires an ATS to provide 
execution access that is equivalent to the access provided to other 
quotations displayed through such SRO.
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    The Commission continues to request comment on all of the issues 
relating to standards of direct and indirect access that were raised in 
the Proposing Release. In addition, panelists at the NMS Hearing 
indicated that access could remain a problem at relatively inactive 
ATSs or market makers with little trading volume whose quotations were 
displayed only in the ADF (and therefore fell within the proposed 
definition of a QMP).\38\ Market participants could obtain access to 
such quotations only through direct connections with the particular ATS 
or market maker. Panelists suggested that such an entity should be 
required to publish its quotations in an SRO order execution facility, 
at least until its share of trading reached a point where the cost of 
direct connections with multiple market participants would not be out 
of proportion to the entity's level of trading. Comment is requested on 
this issue. Alternatively, SROs without an order execution facility 
could be required to ensure that any potential QMP is directly 
connected to most market participants, before publishing that QMP's 
quotations. Finally, comment is requested in general on whether market 
participants currently have effective and efficient access to SRO order 
execution facilities and QMPs and whether this access provides a sound 
basis for the proposed regulatory approach.
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    \38\ Hearing Tr. at 135, 138-139.
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2. Limitations on Access Fees
    Paragraph (b) of proposed Rule 610 would establish a de minimis 
standard for access fees. The fee limitation with the broadest scope is 
set forth in proposed paragraph (b)(4), which would limit to no more 
than $0.002 per share in any transaction the accumulated access fees 
that could be charged by any SRO order execution facility, QMP, or 
other broker-dealer to any person, including subscribers, members, or 
other market centers.\39\ This de minimis standard is designed to 
promote a common quoting convention and to facilitate the ready 
comparison of quotations across the NMS.
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    \39\ The term ``access fee'' as used in proposed Rule 610 would 
include any fee charged by an SRO order execution facility, QMP, or 
broker-dealer that is based on the execution of orders against its 
displayed quotations. It therefore encompasses both the specific 
fees charged by ATSs to non-subscribers for access to their 
quotations, as well as any other fees charged by SROs and ATSs to 
their members and subscribers that are based on the execution of 
orders against their displayed quotations. Comment is requested on 
the definition of access fees. Should it be broadened to include 
order cancellation fees, fees for capacity usage, or any fee charged 
by the market center specific to a transaction?
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    Application of the proposed fee limitations to different types of 
entities would vary depending on how a quotation were accessed by an 
order router. Such access could be divided into three categories.
    First, quotations could be accessed through an SRO order execution 
facility. Under paragraph (b)(1) of proposed Rule 610, the SRO order 
execution facility would be authorized to charge a fee of no more than 
$0.001 per share. In addition, if the quote were attributable to a 
particular broker-dealer, the broker-dealer also would be authorized to 
charge a fee of no more than $0.001 per share under paragraph (b)(3) of 
proposed Rule 610. The purpose of the ``attributable'' requirement is 
to enable an order router to know in advance whether an additional 
broker-dealer fee would be charged when a quotation is accessed through 
an SRO order execution facility.\40\ The quotation therefore would not 
need to be explicitly attributed to a broker-dealer individually in the 
consolidated data stream. Instead, the ``attributable'' requirement 
would be satisfied if an SRO effectively and publicly identified the 
broker-dealer responsible for a quotation. For example, a quotation 
would be attributable if the SRO identified a single specialist 
responsible for all quotations in a given security, or

[[Page 30147]]

if the SRO disseminated a proprietary public data stream identifying 
the broker-dealer responsible for a particular quotation.
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    \40\ Comment is requested on whether this policy objective to 
give advance notice could be achieved with respect to non-
attributable quotes (for example, if the SRO specified the fee that 
could be charged by broker-dealers who displayed non-attributable 
quotes through the SRO's order execution facility). Comment also is 
requested on alternatives other than an attribution requirement for 
achieving the objective of notifying order-routers that an 
additional broker-dealer fee would be charged for accessing a 
quotation through an SRO order execution facility.
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    Second, quotations could be accessed through a QMP (i.e., an ATS or 
market maker whose quotes were displayed in the ADF and were not 
accessible through any SRO order execution facility). This type of 
entity would be authorized to charge a fee of no more than $0.001 per 
share.
    Third, quotes could be accessed directly through a broker-dealer 
who was not a QMP because its quotes also were accessible through an 
SRO order execution facility. Except for the accumulated fee limitation 
of $0.002 per share set forth in paragraph (b)(4) of proposed Rule 610, 
this type of direct access to a non-QMP broker-dealer's quotes is not 
specifically covered by the proposal. Consequently, the fees for this 
type of access to quotations would continue to be governed by existing 
rules, which vary depending on whether the broker-dealer is an ATS or a 
market maker.
    Under this third type of access, ATSs, which are subject to the 
access standards of Regulation ATS, would continue to be allowed to 
charge a fee for access to their quotations, subject to the accumulated 
fee limitation of $0.002 per share. Although ATSs would not be 
explicitly limited to a fee of $0.001, as are SRO order execution 
facilities, competitive factors likely would preclude ATSs from being 
able to retain more than $0.001 of the maximum $0.002 fee. Broker-
dealers with displayable orders would know that they could submit such 
orders directly to an SRO order execution facility and charge a fee of 
$0.001.\41\ Consequently, they would be unlikely to submit their orders 
to an ATS if the ATS does not agree to pay a rebate of at least $0.001 
to match what the broker-dealer could obtain through an SRO order 
execution facility. If the ATS charged the maximum $0.002 fee, this 
would leave the ATS with only $0.001 after the rebate to the broker-
dealer--the same fee that an SRO order execution facility would be 
authorized to charge under paragraph (b)(1) of proposed Rule 610.
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    \41\ If, however, the broker-dealer with a displayable order 
wished to retain anonymity, it could not charge a fee for an 
execution through an SRO order execution facility because the quote 
would not be attributable. In contrast, the broker-dealer could 
retain its anonymity by placing the order with an ATS. Comment is 
requested in note 42 above on possible alternatives to the 
attribution requirement, which could eliminate the difference in 
treatment between access to quotations through SRO order execution 
facilities and direct access through ATSs.
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    In contrast to ATSs, market makers currently are not permitted to 
charge a fee for access to their quotes under Exchange Act Rule 11Ac1-
1(c)(2) (the ``Quote Rule'') (proposed to be redesignated as Rule 602 
under Regulation NMS). If adopted, Rule 610(b)(3) would affirmatively 
authorize a market maker to charge a fee of no more than $0.001 per 
share only in the specific context of when an attributable quote were 
accessed through an SRO order execution facility. Outside of this 
context, however, existing rules would continue to apply and market 
makers would not be authorized to charge a fee for direct access to 
their quotes. Unlike ATSs, market makers are not subject to the 
additional access requirements imposed by Regulation ATS.
    For each of the fee limitations in proposed Rule 610(b), the scope 
of quotations covered by the limitation should be interpreted in 
conjunction with the definitions in proposed Rule 600(b)(61) and (62) 
of a ``quoting market center'' and a ``quoting market participant.'' 
The definitions would encompass, respectively, an SRO order execution 
facility that made its best bid and offer available pursuant to the 
Quote Rule, and a broker-dealer that provided its best bid and offer to 
an SRO pursuant the Quote Rule or Regulation ATS. The scope of the fee 
limitations in proposed Rule 610(b) would be limited to these best bids 
and offers, all of which are disseminated to the public through the 
consolidated data stream. Such bids and offers would be eligible for 
trade-through protection under the proposed trade-through rule. These 
bids and offers also are eligible to be designated as national best 
bids and offers (``NBBOs) and therefore could have significant 
implications for purposes of a broker-dealer's duty of best execution. 
The proposed fee limitations would help assure that all order routers 
had efficient access to the quotations necessary to fulfill their 
regulatory responsibilities. The fee limitations would not, however, 
cover quotations included in a market's depth of book. Accessing depth 
of book is more subject to the choice of order routers than accessing 
best bids and offers. Also, order routers can avoid interacting with a 
market's depth of book by submitting an order with a limit price at the 
best bid or offer.\42\
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    \42\ The fee limitations would apply to any order execution at 
the displayed price of the best bid or offer. They therefore would 
encompass executions against both the displayed size and the reserve 
size of a quotation.
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    Comment is requested on the structure of the various fee 
limitations set forth in proposed Rule 610(b). Comment also is 
requested on whether the Commission should simply adopt a single 
accumulated fee limitation, such as the one set forth in paragraph 
(b)(4) that would apply to all types of market centers. If a single 
accumulated fee limitation were adopted, would $0.002 per share be an 
appropriate amount, or should it be higher or lower? Comment also is 
requested on whether fee limitations should apply to undisplayed orders 
at prices better than the best displayed quote, reserve size at the 
displayed quote, or quotes displayed or available at prices inferior to 
the displayed quote. Are these limitations needed to avoid discouraging 
the display of quotes? Further, would limiting access fees discourage 
the display of quotes?
3. Locked or Crossed Quotations
    Paragraph (c) of proposed Rule 610 sets forth standards addressing 
locked or crossed quotations. It would require every SRO to establish 
and enforce rules that require its members to avoid locking or crossing 
quotations, that are reasonably designed to enable market participants 
to reconcile locked or crossed quotations, and that prohibit its 
members from engaging in a pattern or practice of locking or crossing 
quotations.
    As discussed above, panelists at the NMS Hearing suggested that 
quotations not accessible through an Auto-Ex Facility should be 
identified as such in the consolidated data stream. Comment is 
requested on whether market participants submitting quotations that are 
automatically executable should be allowed to lock or cross quotations 
that are identified as not being automatically executable.\43\
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    \43\ As discussed below, the Commission also is requesting 
comment on the issue of whether, if the proposed fee limitations are 
not adopted, markets with de minimis fees should be allowed to 
display quotations that lock quotations with high fees.
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B. Alternatives to Access Fee Limitations

    The Proposing Release requested comment on how other aspects of 
proposed Regulation NMS would be affected if the Commission ultimately 
determined not to limit access fees to a de minimis amount. In the 
discussion of the Trade-Through Proposal, for example, comment was 
requested on whether, if fees were not limited, quotations with fees of 
greater than a de minimis amount should be excluded from protection 
under the proposed trade-through rule.\44\ In addition, the discussion 
of the Market Data Proposal noted the close connection between the

[[Page 30148]]

issue of limiting access fees and allocating market data revenues based 
on a market's quotations. Comment was requested on whether, if fees 
were not limited, quotations with greater than de minimis fees should 
be excluded from an allocation of market data revenues.\45\
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    \44\ Section III.F of the Proposing Release.
    \45\ Section VI.C.2 and note 289 of the Proposing Release. The 
Proposing Release also noted that quotations displayed in the 
consolidated data stream often may be locked because one or both 
quotes may have a fee attached. Comment was requested on whether 
limiting fees to a de minimis amount would help address this 
problem. Section IV.B.4 of the Proposing Release.
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    The Commission renews its request for comment on whether it should 
or should not adopt any access fee limitation and, if it does not adopt 
a fee limitation, on alternative measures that potentially could be 
adopted. In particular, should quotations with high fees be treated 
differently than quotations with de minimis fees for purposes of the 
other proposals? The differing treatment could reflect the fact that, 
for example, a $10.00 quotation with a high fee is not equal to $10.00 
quotation with a de minimis fee. Quotations with fees of more than a de 
minimis amount could be identified as such in the consolidated data 
stream, analogous to the identification of quotations not accessible 
through an Auto-Ex Facility that was discussed above. Such high-fee 
quotations could be excluded from protection under the trade-through 
rule, eliminated from the allocation of market data revenues, and 
subject to locking quotations from market centers with de minimis 
fees.\46\ Comment is requested on the advisability of these 
alternatives, as compared with adopting a limitation on access fees.
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    \46\ In Section IV.B.4 of the Proposing Release, the Commission 
requested comment on whether there should be an exception from the 
locked quotation provisions of proposed Rule 610(c) for quotations 
of automated markets that lock quotations that are only manually 
accessible. A similar exception could be made for quotations of de 
minimis fee markets that lock quotations with high fees.
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IV. Market Data Proposal

    At the NMS Hearing, the market data panelists focused primarily on 
two issues--the level of market data fees and the complexity of the 
proposed formula for allocating market data revenues to the SROs. The 
Commission wishes to request additional comment on these issues.

A. Market Data Fees

    Several panelists at the NMS Hearing addressed the current level of 
fees charged by the market data Networks and questioned whether such 
fees remain reasonably related to the cost of market data.\47\ For 
example, a representative of Nasdaq stated that it recently had 
examined its costs and concluded that, instead of the current $20 
monthly fee for professional investors to obtain basic data--NBBO and 
trades--in Nasdaq-listed stocks, the number should be approximately $5 
to $7 per month.\48\ He did not discuss, however, the costs incurred by 
Nasdaq to produce the full quotation data (``Level II data'') that is 
disseminated by Network C. Another panelist stated that the Networks 
should be required to disclose publicly the actual cost of providing 
market data to the public.\49\ The Commission would welcome public 
comment addressing the reasonableness of market data fees and whether 
the Commission should modify its approach to reviewing such fees. As 
noted in the Proposing Release, one of the Commission's primary goals 
with respect to market data is to assure reasonable fees that promote 
the wide public availability of market information.\50\ Indeed, an 
extensive public record has been developed on this issue over the last 
five years. This record includes the Commission's 1999 concept release 
on market information fees and revenues (``Concept Release''),\51\ the 
public comments received in response to the Concept Release, and the 
2001 report of the Commission's Advisory Committee on Market 
Information (``Advisory Committee'').\52\ In formulating their comments 
on these matters, commenters are encouraged to consider and respond to 
the views reflected in the public record.
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    \47\ See, e.g., Hearing Tr. at 223-224, 228-229, 230-231.
    \48\ Hearing Tr. at 223-224.
    \49\ Hearing Tr. at 230.
    \50\ Section VI.B of the Proposing Release.
    \51\ Securities Exchange Act Release No. 42208 (December 9, 
1999), 64 FR 70613 (December. 17, 1999).
    \52\ Report of the Advisory Committee on Market Information: A 
Blueprint for Responsible Change (September 14, 2001) (available at 
http://www.sec.gov).
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B. Revenue Allocation Formula

    At the NMS Hearing, some panelists questioned the complexity and 
cost of the proposed formula for allocating market data revenues to the 
SROs. The Commission wishes to request supplemental comment on this 
issue.
    First, the prospect that, in the future, displayed quotes for NMS 
stocks may be predominantly accessible through Auto-Ex Facilities 
presents an opportunity for simplifying the proposed formula. As 
proposed, the calculation of an SRO's Quoting Share, which would reward 
markets for the time and size of their quotes at the NBBO, would 
include an automatic cut-off when quotes that are not fully accessible 
through automatic execution are left alone at the NBBO. The purpose of 
the automatic cutoff for manual quotes was to minimize the reward for 
quotes that could be stale if in the process of being manually updated. 
The Commission requests comment on whether only quotes that are 
accessible through an Auto-Ex Facility should be considered in the 
allocation of market data revenues, thereby eliminating any need for 
the formula to include an automatic cutoff applicable to manual 
quotes.\53\
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    \53\ Comment was requested in section III.B above on whether, if 
access fees are not limited, quotes with fees of greater than a de 
minimis amount should be excluded from the allocation of market data 
revenue.
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    Second, comment is requested on whether, if manual quotes were 
excluded from the calculation of Quoting Shares, the proposed 
additional measure of quoting activity--the proposed NBBO Improvement 
Share--should be eliminated from the formula. The NBBO Improvement 
Share is significantly more complex than the other aspects of the 
formula, which essentially are calculated already by those who track 
the trading and quoting activity of market centers. The NBBO 
Improvement Share was designed primarily to single out and reward price 
leaders--those market centers that quote most aggressively by 
frequently displaying better prices and thereby helping to narrow 
quoted spreads. An additional measure of quoting activity was 
particularly important to offset the advantage that manual quotes could 
have in the calculation of Quoting Shares. Such manual quotes might 
merely match the prices set by other markets, yet not be accessed 
quickly because not automatically executable. As a result, manual 
quotes would tend to equal the NBBO for long periods of time merely 
because they were the least accessible quotes available at the price. 
If manual quotes were excluded from the calculation of Quoting Shares, 
the need for an additional quoting measure would be somewhat 
diminished. Comment is requested on whether the benefit of rewarding 
aggressive quote improvement justifies the increased complexity of 
calculating the NBBO Improvement Share.
    Finally, although the Proposing Release itself recognized that the 
proposed formula is relatively complex, the difficulty and cost of 
implementing the formula may have been overstated at the NMS Hearing. 
No additional data is necessary to calculate the formula beyond the 
quote and trade data that

[[Page 30149]]

already is disseminated by the Network processors and stored by data 
vendors. The formula would not need to be calculated in real-time, nor 
would anyone other than the Network processors and other industry 
participants need to deal with the formula directly. Consequently, it 
does not appear that adoption of the formula would impose any 
additional ``downstream'' systems costs on vendors or broker-dealers. 
Indeed, if necessary, a single vendor could be retained by all three 
Networks to program and process the calculations required by the 
proposed formula, thereby potentially reducing the implementation costs 
by a significant amount. Comment is requested on the potential 
implementation costs of the proposed formula and on possible ways to 
minimize such costs.

V. General Request For Comment

    In addition to the supplemental requests for comment set forth 
above, the Commission renews its requests for comment on the Regulation 
NMS proposals that were published in the Proposing Release. It 
particularly encourages the public to consider the significant matters 
discussed during the NMS Hearing when formulating their comments.

    Dated: May 20, 2004.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-11879 Filed 5-25-04; 8:45 am]
BILLING CODE 8010-01-P