[Federal Register Volume 69, Number 247 (Monday, December 27, 2004)]
[Proposed Rules]
[Pages 77424-77519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-27934]



[[Page 77423]]

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Part III





Securities and Exchange Commission





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17 CFR Parts 200, 201, 230, et al.



Regulation NMS; Proposed Rule

  Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / 
Proposed Rules  

[[Page 77424]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR PARTS 200, 201, 230, 240, 242, 249, and 270

[Release No. 34-50870; File No. S7-10-04]
RIN 3235-AJ18


Regulation NMS

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rules and amendments to joint industry plans.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
reproposing rules under Regulation NMS and two amendments to the joint 
industry plans for disseminating market information. In addition to 
redesignating the national market system rules previously adopted under 
Section 11A of the Securities Exchange Act of 1934 (``Exchange Act''), 
Regulation NMS would include new substantive rules that are designed to 
modernize and strengthen the regulatory structure of the U.S. equity 
markets. First, the ``Trade-Through Rule'' would require trading 
centers to establish, maintain, and enforce written policies and 
procedures reasonably designed to prevent the execution of trades at 
prices inferior to protected quotations displayed by other trading 
centers, subject to an applicable exception. To be protected, a 
quotation must be immediately and automatically accessible. Second, the 
``Access Rule'' would require fair and non-discriminatory access to 
quotations, establish a limit on access fees to harmonize the pricing 
of quotations across different trading centers, and require each 
national securities exchange and national securities association to 
adopt and enforce rules that prohibit their members from engaging in a 
pattern or practice of displaying quotations that lock or cross 
automated quotations. Third, the ``Sub-Penny Rule'' would prohibit 
market participants from accepting, ranking, or displaying orders, 
quotations, or indications of interest in a pricing increment smaller 
than a penny, except for orders, quotations, or indications of interest 
that are priced at less than $1.00 per share. Finally, the Commission 
is reproposing amendments to the ``Market Data Rules'' that would 
update the requirements for consolidating, distributing, and displaying 
market information, as well as amendments to the joint industry plans 
for disseminating market information that would modify the formulas for 
allocating plan revenues (``Allocation Amendment'') and broaden 
participation in plan governance (``Governance Amendment'').

DATES: Comments must be received on or before January 26, 2005. Given 
the advanced stage of this rulemaking initiative, the Commission 
anticipates taking further action as expeditiously as possible after 
the end of the comment period. It therefore strongly encourages the 
public to submit their comments within the prescribed comment period. 
Comments received after that point cannot be assured of full 
consideration by the Commission.

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: Trade-Through Rule: Heather Seidel, 
Attorney Fellow, at (202) 942-0788, Jennifer Colihan, Special Counsel, 
at (202) 942-0735, David Hsu, Special Counsel, at (202) 942-0731, or 
Raymond Lombardo, Attorney, at (202) 942-8080; Access Rule: Heather 
Seidel, Attorney Fellow, at (202) 942-0788, or David Liu, Attorney, at 
(202) 942-8085; Sub-Penny Rule: Michael Gaw, Senior Special Counsel, at 
(202) 942-0158, or Ronesha Butler, Special Counsel, at (202) 942-0791; 
Market Data Rules, Allocation Amendment, and Governance Amendment: 
Sapna C. Patel, Special Counsel, at (202) 942-0166, or David Hsu, 
Special Counsel, at (202) 942-0731; Regulation NMS: Yvonne Fraticelli, 
Special Counsel, at (202) 942-0197; all of whom are in the Division of 
Market Regulation, Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
    A. Need for Modernization of the NMS
    B. Objectives for Future NMS
    C. Overview of Reproposed Rules
    1. Trade-Through Rule
    2. Access Rule
    3. Sub-Penny Rule
    4. Market Data Rules and Plans
II. Trade-Through Rule
    A. Response to Comments and Basis for Reproposed Rule
    1. Need for Intermarket Trade-Through Rule
    2. Limiting Protection to Automated and Accessible Quotations
    3. Workable Implementation of Intermarket Trade-Through 
Protection
    4. Elimination of Proposed Opt-Out Exception
    5. Scope of Protected Quotations--Market BBO Alternative and 
Voluntary Depth Alternative
    6. Benefits and Implementation Costs of Trade-Through Rule
    B. Description of Reproposed Rule
    1. Scope of Rule
    2. Requirement of Reasonable Policies and Procedures
    3. Exceptions
    4. Duty of Best Execution
III. Access Rule
    A. Response to Comments and Basis for Reproposed Rule
    1. Access to Quotations
    2. Limitation on Access Fees
    3. Locking or Crossing Quotations
    B. Description of Reproposed Rule
    1. Access to Quotations
    2. Limitation on Access Fees
    3. Locking or Crossing Quotations
    4. Regulation ATS Fair Access
IV. Sub-Penny Rule
    A. Background
    B. Commission Proposal on Sub-Penny Quoting
    C. Comments Received
    1. Comments Addressing Overall Proposal
    2. Response to Other Comments
    D. Exemptive Authority
V. Market Data Rules and Plan Amendments
    A. Response to Comments and Basis for Reproposed Rules
    1. Alternative Data Dissemination Models
    2. Level of Fees and Plan Governance
    3. Revenue Allocation Formula
    4. Distribution and Display of Data
    B. Description of Reproposed Rules and Amendments
    1. Allocation Amendment

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    2. Governance Amendment
    3. Consolidation, Distribution, and Display of Data
VI. Regulation NMS
VII. General Request for Comment
VIII. Paperwork Reduction Act
IX. Consideration of Costs and Benefits
X. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition and Capital Formation
XI. Consideration of Impact on the Economy
XII. Regulatory Flexibility Act
XIII. Statutory Authority
XIV. Text of Reproposed Amendments to the CTA Plan, the CQ Plan, and 
the Nasdaq UTP Plan
XV. Text of Reproposed Rules

I. Introduction

    The Commission is reproposing Regulation NMS, a series of 
initiatives designed to modernize and strengthen the national market 
system (``NMS'') for equity securities.\1\ These initiatives include:
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    \1\ The Commission originally proposed Regulation NMS in 
February 2004. Securities Exchange Act Release No. 49325 (Feb. 26, 
2004), 69 FR 11126 (Mar. 9, 2004) (``Proposing Release''). It issued 
a supplemental request for comment in May 2004. Securities Exchange 
Act Release No. 49749 (May 20, 2004), 69 FR 30142 (May 26, 2004) 
(``Supplemental Release'').
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    (1) A new Trade-Through Rule, which would establish for all NMS 
stocks the fundamental principle of price priority for automated 
quotations that are immediately accessible;
    (2) A new Access Rule, which would promote fair and non-
discriminatory access to quotations displayed by NMS trading centers 
through a private linkage approach;
    (3) A new Sub-Penny Rule, which would establish 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;
    (4) Amendments to the Market Data Rules and joint industry plans 
that would allocate plan revenues to self-regulatory organizations 
(``SROs'') for their contributions to public price discovery and 
promote wider and more efficient distribution of market data; and
    (5) A reorganization of existing Exchange Act rules governing the 
NMS to promote greater clarity and understanding of the rules.
    The NMS encompasses the stocks of more than 5000 listed companies, 
which collectively represent more than $14 trillion in U.S. market 
capitalization. NMS stocks are traded simultaneously at a variety of 
different venues, including national securities exchanges, alternative 
trading systems (``ATSs''), and market-making securities dealers. Fair 
and efficient trading of NMS stocks is essential if the equity markets 
are to meet the long-term investment needs of the public and to reduce 
the cost of capital for listed companies. Section 11A of the Exchange 
Act charges the Commission with facilitating the establishment of an 
NMS that links multiple trading centers into a unified system that 
promotes the fairest and most efficient equity markets possible. The 
reproposed rules are intended to assure that the NMS remains up to date 
and continues to serve the interests of investors, listed companies, 
and the public.

A. Need for Modernization of the NMS

    The reproposed rules would implement a major overhaul of the 
existing structure of the NMS, much of which was originally designed in 
the 1970s and 1980s. This overhaul is necessary to respond to sweeping 
changes that have reshaped the equity markets in recent years. First, 
communications and trading technologies have greatly expanded the 
available options for routing and executing orders in NMS stocks. 
Establishing connectivity among all types of securities industry 
participants has become both less costly and more flexible. Order-
routing systems can be programmed to monitor prices at multiple trading 
centers, assess the most effective trading strategy to meet the needs 
of a particular customer, and instantaneously route orders to one or 
more trading centers to implement that strategy. Trading centers, in 
turn, are able to offer a near instantaneous response to incoming 
orders seeking to access automated quotations.
    Another significant change has been the intensified competition 
among different types of markets that simultaneously trade many of the 
same NMS stocks, regardless of the particular market where the stocks 
are listed. These include (1) Traditional exchanges with active trading 
floors, which even now are evolving to expand the range of choices that 
they offer investors for both automated and manual trading; (2) purely 
electronic markets, which offer both standard limit orders and 
conditional orders that are designed to facilitate complex trading 
strategies; (3) market-making securities dealers, which offer both 
automated execution of smaller orders and the commitment of capital to 
facilitate the execution of larger, institutional orders; (4) regional 
exchanges, many of which have adopted automated systems for executing 
smaller orders; and (5) automated matching systems that permit 
investors, particularly large institutions, to seek counter-parties to 
their trades with minimal publicity and price impact.
    Finally, the initiation of trading in penny increments in 2001 
transformed the equity markets. The number of quotation updates 
increased, and the quoted size at any particular price level dropped. 
The change clearly has benefited many investors, particularly retail 
investors that typically use smaller orders. Reducing the standard 
trading increment from \1/16\ths to pennies allowed effective spreads 
to narrow for small orders.\2\ As a result, the trading costs of small 
orders have dropped dramatically.\3\
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    \2\ For small orders, the effective spread between bid and offer 
prices represents the most significant implicit trading cost. In 
addition to the implicit trading costs associated with the prices at 
which their orders are executed, investors must pay explicit costs 
of trading, such as broker commissions.
    \3\ Effective spreads declined substantially almost immediately 
after decimalization, and had declined an additional 40% by November 
2003. Proposing Release, 69 FR at 11128, 11165.
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    For institutional investors that generally need to trade in large 
sizes, however, the results of decimal trading have been less clear 
cut. The primary component of trading costs for large orders is price 
impact--the change in stock price caused by the difficulty of executing 
large orders to buy (with rising prices) or to sell (with declining 
prices).\4\ The price impact for large orders, which generally will be 
many times the effective spread for small orders in the same stock, is 
largely determined by market depth and liquidity. The greater the depth 
and liquidity, the less the price impact of large orders. Given that 
millions of individuals invest in NMS stocks indirectly through these 
institutions, it is vitally important for the NMS to promote depth and 
liquidity for the trading of large orders.
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    \4\ See Securities and Exchange Commission, Release Nos. 33-8349 
(Dec. 18, 2003), 68 FR 74820, 74822 (Dec. 24, 2003) (concept release 
on measures to improve disclosure of mutual fund transaction costs; 
notes that estimates of price impact costs range from 0.18% to 1.0% 
of the principal amount of transactions).
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    To respond to all of these changes, the Commission has undertaken a 
deliberate and systematic review of market structure. We actively have 
sought out the views of the public and securities industry 
participants. Even prior to formulating proposals, our review included 
multiple public hearings and roundtables, an advisory committee, three 
concept releases, the issuance of temporary exemptions intended in part 
to generate useful data on policy alternatives, and a constant dialogue 
with industry participants and investors. This process continued after

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the proposals were published for public comment.\5\ We held a public 
hearing on the proposals in April 2004 (``NMS Hearing'').\6\ To give 
the public an opportunity to respond to important developments at the 
hearing, we published a supplemental request for comment and extended 
the comment period on the proposals.\7\ The public submitted more than 
700 comment letters that encompassed a wide range of views. On one 
point, however, commenters agreed--the time has come to modernize the 
NMS.
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    \5\ Proposing Release, 69 FR at 11126.
    \6\ 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).
    \7\ Supplemental Release, 69 FR at 30142.
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    The Commission believes that the insights of the commenters, as 
well as those of the NMS Hearing panelists, have contributed to 
significant improvements in the original proposals. Responding 
appropriately to these comments has caused the reproposed rules to 
differ in some respects from the rule text as originally proposed. As 
discussed extensively below, all of the changes address issues that 
were raised in the Proposing Release and Supplemental Release and that 
prompted substantial public comment. Rather than adopt rules at this 
point, however, the Commission is implementing a reproposal process to 
afford the public an additional opportunity to review and comment on 
the details of the rules. Given the advanced stage of rulemaking, it 
anticipates taking further action as expeditiously as possible after 
the end of the comment period. The Commission therefore strongly 
encourages the public to submit their comments within the comment 
period. Comments received after that point cannot be assured of full 
consideration by the Commission. In its evaluation of further 
rulemaking action, the Commission will consider, in addition to the 
comments received in response to this release, all comments received on 
the Proposing Release and Supplemental Release.

B. Objectives for Future NMS

    The reproposed rules are designed to strengthen the NMS in three 
primary ways. First, they would update antiquated rules that no longer 
adequately serve the purposes for which they were adopted. Second, they 
would help level the competitive playing field by promoting equal 
regulation of different types of stocks and markets. Third, they would 
promote greater order interaction and displayed depth, of particular 
value for the large orders of institutional investors.
    Taken together, the Commission believes the reproposed rules would 
significantly improve the fairness and efficiency of the NMS in the 
future. The NMS is premised on promoting fair competition among 
markets, while at the same time assuring that all of these markets are 
linked together, through facilities and rules, in a unified system that 
promotes interaction among the orders of buyers and sellers in a 
particular NMS stock. The NMS thereby incorporates two distinct types 
of competition--competition among individual markets and competition 
among individual orders--that together contribute to efficient markets. 
Vigorous competition among markets promotes more efficient and 
innovative trading services, while integrated competition among orders 
promotes more efficient pricing of individual stocks. Together, they 
produce markets that offer signal benefits for investors and listed 
companies.
    The Commission has sought to avoid the extremes of (1) isolated 
markets that trade an NMS stock without regard to trading in other 
markets and thereby fragment the competition among buyers and sellers 
in that stock, and (2) a totally centralized system that loses the 
benefits of vigorous competition and innovation among individual 
markets. To achieve the appropriate degree of integration, the 
Commission primarily has relied on two tools. First, consolidated 
display of market data promotes transparency of the best prices for an 
NMS stock. Second, intermarket ``rules of the road'' establish a 
framework within which competition among individual markets can 
flourish on terms that ultimately benefit investors. The reproposed 
rules would continue this strategy. They are designed to strengthen and 
enhance the efficiency of linkages among the various competing markets, 
but without mandating any particular type of trading model. Investor 
choice and competition will determine the relative success or failure 
of the various competing markets.
    Some have suggested that the Commission should move away from the 
fundamental NMS concept of promoting both competition among markets and 
competition among the buyers and sellers in a stock. They believe that, 
instead, markets should be allowed to trade in isolation from one 
another. This approach, of course, was in effect until 1975 when 
Congress directed the Commission to facilitate the establishment of an 
NMS. After fully considering the matter, Congress specifically found 
that linking the individual markets would ``foster efficiency, enhance 
competition, increase the information available to brokers, dealers, 
and investors, facilitate the offsetting of investors' orders, and 
contribute to the best execution of such orders.'' \8\ The wisdom of 
this congressional finding has been proven by thirty years of practical 
experience. The NMS needs to be enhanced and modernized, not because it 
has failed investors, but because it has been so successful in 
promoting growth, efficiency, innovation, and competition that many of 
its old rules now are outdated. Since the NMS was created nearly thirty 
years ago, trading volume has exploded, competition among market 
centers has intensified, and investor trading costs have shrunk 
dramatically. The Commission preliminarily believes that the reproposed 
rules would contribute to further growth and efficiency in the NMS and 
thereby serve the interests of investors, listed companies, and the 
public in the future.
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    \8\ Section 11A(a)(1)(D) of the Exchange Act.
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C. Overview of Reproposed Rules

1. Trade-Through Rule
    The Trade-Through Rule (reproposed Rule 611 under Regulation NMS) 
\9\ would establish intermarket protection against trade-throughs for 
all NMS stocks. A trade-through occurs when one trading center executes 
an order at a price that is inferior to the price of a protected 
quotation, often representing an investor limit order, displayed by 
another trading center.\10\ Many commenters on the proposals, 
particularly large institutional investors, strongly supported the need 
for enhanced protection of limit orders against trade-throughs.\11\ 
They

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emphasized that limit orders are the building blocks of public price 
discovery and efficient markets. They stated that a uniform rule for 
all NMS stocks, by enhancing protection of displayed prices, would 
encourage greater use of limit orders and contribute to increased 
market liquidity and depth. The Commission preliminarily agrees that 
strengthened protection of displayed limit orders would help reward 
market participants for displaying their trading interest and thereby 
promote fairer and more vigorous competition among orders seeking to 
supply liquidity. It therefore has decided to repropose Rule 611 to 
strengthen the protection of displayed and automatically accessible 
quotations in NMS stocks. As discussed below, today we are proposing 
two alternatives that would each further this goal, and we are seeking 
public comment on which alternative is likely best to advance the 
principle of limit order protection while preserving intermarket 
competition and avoiding practical implementation problems.
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    \9\ Although this release refers to reproposed Rule 611 as the 
``Trade-Through Rule,'' the text of the Rule would be named ``Order 
Protection Rule'' if adopted. The term ``Trade-Through Rule'' is 
used in this release to avoid confusion, given that the term has 
been widely used in public debate. The term ``Order Protection 
Rule,'' however, better captures the Commission's purpose for the 
Rule. Specifically, it is designed to protect both (1) limit orders 
represented by displayed and automated quotations, by prohibiting 
trading centers from executing trades at inferior prices; and (2) 
market orders and marketable limit orders (which have limit prices 
that render them subject to immediate execution at market prices 
without display), by requiring trading centers either to execute the 
orders at the best, immediately accessible prices or to route the 
orders to trading centers displaying such prices.
    \10\ The nature and scope of quotations that would be protected 
under the Trade-Through Rule are discussed in detail in sections 
II.A.2 and II.B.1 below.
    \11\ See infra, note 38 (overview of commenters supporting 
trade-through proposal).
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    As with the original proposal, the reproposed Trade-Through Rule 
would take a substantially different approach than the trade-through 
provisions currently set forth in the Intermarket Trading System 
(``ITS'') Plan,\12\ which apply only to exchange-listed stocks. The ITS 
provisions are not promulgated by the Commission, but rather are rules 
of the markets participating in the ITS Plan. These rules were drafted 
decades ago and do not distinguish between manual and automated 
quotations. Moreover, they state that markets ``should avoid'' trade-
throughs and require an after-the-fact complaint procedure pursuant to 
which, if a trade-through occurs, the aggrieved market may seek 
satisfaction from the market that traded through. Finally, the ITS 
provisions have significant gaps in their coverage, particularly for 
large, block transactions (10,000 shares or greater), that have 
seriously weakened their protection of limit orders.
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    \12\ The full title of the ITS Plan is ``Plan for the Purpose of 
Creating and Operating an Intermarket Communications Linkage 
Pursuant to Section 11A(c)(3)(B) of the Securities Exchange Act of 
1934.'' The ITS Plan was initially approved by the Commission in 
1978. Securities Exchange Act Release No. 14661 (Apr. 14, 1978), 43 
FR 17419 (Apr. 24, 1978). All national securities exchanges that 
trade exchange-listed stocks and the NASD are participants in the 
ITS Plan. It requires each participant to provide electronic access 
to its displayed best bid or offer to other participants and 
provides an automated mechanism for routing orders, called 
commitments to trade, to access those displayed prices. The 
participants also agreed to avoid trade-throughs and locked markets 
and to adopt rules addressing such practices.
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    In contrast, the reproposed Trade-Through Rule would only protect 
quotations that are immediately accessible through automatic execution. 
It thereby would address a serious weakness in the ITS provisions, 
which were drafted for a world of floor-based markets and fail to 
reflect the disparate speed of response between manual and automated 
quotations. By requiring order routers to wait for a response from a 
manual market, the ITS trade-through provisions can cause an order to 
miss both the best price of a manual quotation and slightly inferior 
prices at automated markets that would have been immediately 
accessible. The Trade-Through Rule would eliminate this potential 
inefficiency by protecting only automated quotations. It also would 
promote equal regulation and fair competition among markets by 
eliminating any potential advantage that the ITS trade-through 
provisions may have given manual markets over automated markets.
    In addition, the reproposed Trade-Through Rule incorporates an 
approach to trade-throughs that is stricter and more comprehensive than 
the ITS provisions. First, it would require trading centers to 
establish, maintain, and enforce written policies and procedures that 
are reasonably designed to prevent trade-throughs, or, if relying on 
one of the rule's exceptions, that are reasonably designed to assure 
compliance with the exception. To assure effective compliance, such 
policies and procedures would need to incorporate objective standards 
that were coded into a trading center's automated systems. Moreover, a 
trading center would be required to regularly surveil to ascertain the 
effectiveness of its policies and procedures and to take prompt action 
to remedy deficiencies. Second, the Trade-Through Rule would eliminate 
very significant gaps in the coverage of the ITS provisions that have 
undermined the extent to which they protect limit orders and promote 
fair and orderly trading. In particular, the ITS provisions do not 
cover the large transactions of broker-dealers acting as block 
positioners in exchange-listed stocks. They also exclude trade-throughs 
of 100-share quotations, thereby allowing the limit orders of small 
investors to be bypassed. The Trade-Through Rule would close both of 
these gaps in coverage.
    With respect to the scope of quotations to be protected, the 
Commission is proposing two alternatives, one of which would represent 
a more fundamental departure from the existing ITS provisions by 
potentially extending limit-order protection beyond the best limit 
orders on a market's book. The definition of ``protected bid'' or 
``protected offer'' in paragraph (b)(57) of reproposed Rule 600 
controls the scope of quotations that would be protected by the Trade-
Through Rule. The first alternative (``Market BBO Alternative'') would 
protect only the best bids and offers (``BBOs'') of the nine self-
regulatory organizations (``SROs'') and The Nasdaq Stock Market, Inc. 
(``Nasdaq'') whose members currently trade NMS stocks. The scope of 
quotations covered by this alternative is comparable to the ITS 
provisions. The second alternative (``Voluntary Depth Alternative'') 
also would protect the BBOs of the various SROs and Nasdaq, but would 
establish a mechanism for a market voluntarily to secure protection for 
its depth-of-book quotations at prices below its best bid or above its 
best offer. These alternatives are discussed in more detail in section 
II.A.5 below.
    The rule text of the original proposal included a general ``opt-
out'' exception that would have allowed market participants to 
disregard displayed quotations. Such an exception would have left a 
significant gap in protection of the best displayed prices and thereby 
severely reduced the proposal's potential benefits. The elimination of 
any protection for manual quotations is the principal reason that this 
broad exception is no longer necessary in the Trade-Through Rule as 
reproposed. In addition, the Rule adds a number of tailored exceptions 
that carve out those situations in which many investors may otherwise 
have felt they legitimately needed to opt-out of a displayed quotation. 
These exceptions are more consistent with the principle of protecting 
the best price than a general opt-out exception. The additional 
exceptions also would help assure that the Trade-Through Rule is 
workable for high-volume stocks. Examples of these exceptions include 
intermarket sweep orders, quotations displayed by markets that fail to 
meet the response requirements for automated quotations, and flickering 
quotations with multiple prices displayed in a single second.\13\
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    \13\ Flickering quotations are discussed further in section 
II.A.3 below.
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    Some commenters questioned the need to extend a trade-through rule 
to Nasdaq stocks.\14\ These commenters generally emphasized the much 
improved efficiency of trading in Nasdaq stocks in recent years. They 
particularly were concerned that extension of intermarket price 
protection to Nasdaq stocks, at least in

[[Page 77428]]

the absence of a general opt-out exception, would interfere with 
current trading methods.
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    \14\ See infra, notes 40-42 and accompanying text.
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    The Commission preliminarily believes, however, that intermarket 
price protection would benefit investors and strengthen the NMS in all 
NMS stocks. It would contribute to the maintenance of fair and orderly 
markets and, thereby, promote investor confidence in the markets. As 
discussed below,\15\ trade-through rates currently are significant in 
both Nasdaq and exchange-listed stocks. For example, approximately 1 of 
every 40 trades in both Nasdaq and NYSE stocks represents a significant 
trade-through of a displayed quotation. For hundreds of active Nasdaq 
stocks, approximately 1 of every 11 shares traded is a significant 
trade-through. The routine execution of trades at prices inferior to 
those offered by displayed and accessible limit orders is inconsistent 
with basic notions of fairness and orderliness, particularly for 
investors, both large and small, who post limit orders and see those 
orders routinely traded through. These trade-throughs can undermine 
incentives to display limit orders. Moreover, many of the investors 
whose market orders are executed at inferior prices may not, in fact, 
be aware they received an inferior price from their broker and 
executing market. In sum, the Commission preliminarily believes that a 
uniform rule establishing price protection on an order-by-order basis 
is needed to protect the interests of investors, promote the display of 
limit orders, and thereby improve the efficiency of the NMS as a whole.
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    \15\ See infra, notes 59-61 and accompanying text.
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2. Access Rule
    The Access Rule (reproposed Rule 610 under Regulation NMS) would 
set forth new standards governing access to quotations in NMS stocks. 
As emphasized by many commenters on the proposals,\16\ protecting the 
best displayed prices against trade-throughs would be futile if broker-
dealers and trading centers were unable to access those prices fairly 
and efficiently. Accordingly, Rule 610 is designed to promote access to 
quotations in three ways. First, it would enable the use of private 
linkages offered by a variety of connectivity providers,\17\ rather 
than mandating a collective linkage facility such as ITS, to facilitate 
the necessary access to quotations. The lower cost and increased 
flexibility of connectivity in recent years has made private linkages a 
feasible alternative to hard linkages, absent barriers to access. Using 
private linkages, market participants may obtain indirect access to 
quotations displayed by a particular trading center through the 
members, subscribers, or customers of that trading center. To promote 
this type of indirect access, Rule 610 would prohibit a trading center 
from imposing unfairly discriminatory terms that would prevent or 
inhibit the access of any person through members, subscribers, or 
customers of such trading center.
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    \16\ See infra, section III.A.1.
    \17\ Private linkages are discussed further in section III.A.1 
below.
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    Second, reproposed Rule 610 would limit the fees that any trading 
center can charge (or allow to be charged) for accessing its protected 
quotations to no more than $0.003 per share. The purpose of the fee 
limitation is to ensure the fairness and accuracy of displayed 
quotations by establishing an outer limit on the cost of accessing such 
quotations. For example, if the price of a protected offer to sell an 
NMS stock is displayed at $10.00, the total cost to access the offer 
and buy the stock will be $10.00, plus a fee of no more than $0.003. 
The reproposed rule thereby would assure order routers that displayed 
prices are, within a limited range, true prices.
    The reproposed fee limitation substantially simplifies the proposed 
limitation on fees, which, in general, would have limited the fees of 
individual market participants to $0.001 per share, with an accumulated 
cap of $0.002 per share. Perhaps more than any other single issue, the 
proposed limitation on access fees splintered the commenters.\18\ Some 
supported the proposal as a worthwhile compromise on an extremely 
difficult issue. They believed that it would level the playing field in 
terms of who could charge fees, as well as give greater certainty to 
market participants that quoted prices will, essentially, be true 
prices. Others were strongly opposed to any limitation on fees, 
believing that competition alone would be sufficient to address high 
fees that distort quoted prices. Still others were equally adamant that 
all access fees of electronic communications networks (``ECNs'') 
charged to non-subscribers should be prohibited entirely, although they 
did not see a problem with fees charged to a market's members or 
subscribers. Although consensus could not be achieved on any particular 
approach, commenters expressed a strong desire for resolution of a 
difficult issue that has caused discord within the securities industry 
for many years.
---------------------------------------------------------------------------

    \18\ The comments on access fees are addressed in section 
III.A.2 below.
---------------------------------------------------------------------------

    The Commission preliminarily believes that a single, uniform fee 
limitation of $0.003 per share would be the fairest and most 
appropriate resolution of the access fee issue. First, it would not 
seriously interfere with current business practices, as trading centers 
have very few fees on their books of more than $0.003 per share or earn 
substantial revenues from such fees.\19\ Second, the uniform fee 
limitation would promote equal regulation of different types of trading 
centers, where previously some had been permitted to charge fees and 
some had not. Finally and most importantly, the fee limitation of Rule 
610 would be necessary to support the integrity of the price protection 
requirement established by the reproposed Trade-Through Rule. In the 
absence of a fee limitation, some ``outlier'' trading centers might 
take advantage of the requirement to protect displayed quotations by 
charging exorbitant fees to those required to access the outlier's 
quotations. Rule 610's fee limitation would preclude the initiation of 
this business practice, which would compromise the fairness and 
efficiency of the NMS.
---------------------------------------------------------------------------

    \19\ See infra, section III.A.2.
---------------------------------------------------------------------------

    Finally, reproposed Rule 610 would require SROs to establish and 
enforce rules that, among other things, prohibit their members from 
engaging in a pattern or practice of displaying quotations that lock or 
cross the automated quotations of other trading centers. Trading 
centers would be allowed, however, to display automated quotations that 
lock or cross the manual quotations of other trading centers. The 
reproposed rule thereby would reflect the disparity in speed of 
response between automated and manual quotations, while also promoting 
fair and orderly markets by establishing that the first automated 
quotation at a price, whether it be a bid or an offer, is entitled to 
an execution at that price instead of being locked or crossed by a 
quotation on the other side of the market.
3. Sub-Penny Rule
    The Sub-Penny Rule (reproposed Rule 612 under Regulation NMS) would 
prohibit market participants from displaying, ranking, or accepting 
quotations in NMS stocks that are priced in an increment of less than 
$0.01, unless the price of the quotation is less than $1.00. If the 
price of the quotation is less than $1.00, the minimum increment would 
be $0.0001. A strong consensus of commenters supported the sub-penny 
proposal as a means to promote greater price

[[Page 77429]]

transparency and consistency, as well as to protect displayed limit 
orders.\20\ In particular, Rule 612 would address the practice of 
``stepping ahead'' of displayed limit orders by trivial amounts. It 
therefore should further encourage the display of limit orders and 
improve the depth and liquidity of trading in NMS stocks.
---------------------------------------------------------------------------

    \20\ The comments on the sub-penny proposal are discussed in 
section IV.C below.
---------------------------------------------------------------------------

4. Market Data Rules and Plans
    The reproposed amendments to the Market Data Rules (reproposed 
Rules 601 and 603 under Regulation NMS) and joint industry plans 
(``Plans'') \21\ are designed to promote the wide availability of 
market data and to allocate revenues to SROs that produce the most 
useful data for investors. They would strengthen the existing market 
data system, which provides investors in the U.S. equity markets with 
real-time access to the best quotations and most recent trades in the 
thousands of NMS stocks throughout the trading day. For each stock, 
quotations and trades are continuously collected from many different 
trading centers and then disseminated to the public in a consolidated 
stream of data. As a result, investors of all types have access to a 
reliable source of information for the best prices in NMS stocks. When 
Congress mandated the creation of the NMS in 1975, it noted that the 
systems for disseminating consolidated market data would ``form the 
heart of the national market system.'' \22\ Accordingly, one of the 
Commission's most important responsibilities is to preserve the 
integrity and affordability of the consolidated data stream.
---------------------------------------------------------------------------

    \21\ The three joint-industry plans are (1) the CTA Plan, which 
is operated by the Consolidated Tape Association and disseminates 
transaction information for exchange-listed securities, (2) the CQ 
Plan, which disseminates consolidated quotation information for 
exchange-listed securities, and (3) the Nasdaq UTP Plan, which 
disseminates consolidated transaction and quotation information for 
Nasdaq-listed securities. The last restatements of the CTA Plan and 
the CQ Plan were approved in 1996. Securities Exchange Act Release 
No. 37191 (May 9, 1996), 61 FR 24842 (File No. SR-CTA/CQ-96-1). The 
amended versions of the CTA Plan and the CQ Plan were filed as 
attachments to File No. SR-CTA/CQ-96-1, which are available in the 
Commission's Public Reference Room. There have been several 
subsequent amendments to the CTA and CQ Plans; the Plans have not 
been republished in this connection. The Nasdaq UTP Plan was last 
published in its entirety in 2004. Securities Exchange Act Release 
No. 49137 (Jan. 28, 2004), 69 FR 5217 (Feb. 3, 2004).
    \22\ H.R. Rep. No. 94-229, 94th Cong., 1st Sess. 93 (1975).
---------------------------------------------------------------------------

    The reproposed amendments would promote this objective in several 
different respects. First, they would update the formulas for 
allocating revenues generated by market data fees to the various SRO 
participants in the Plans. The current Plan formulas are seriously 
flawed by an excessive focus on the number of trades, no matter how 
small the size, reported by an SRO. They thereby create an incentive 
for distortive behavior, such as wash sales and trade shredding,\23\ 
and fail to reflect an SRO's contribution to the best displayed 
quotations in NMS stocks. The reproposed formula would correct these 
flaws. It also is much less complex than the proposal, primarily 
because, consistent with the approach of the Trade-Through Rule and 
Access Rule, the new formula would eliminate any reward for manual 
quotations. It therefore should promote an allocation of revenues to 
the various SROs that more closely reflects the usefulness to investors 
of each SRO's market information.
---------------------------------------------------------------------------

    \23\ Trade shredding, or the splitting of large trades into a 
series of 100-share trades, is discussed further in section V.A 
below.
---------------------------------------------------------------------------

    The reproposed amendments also are intended to improve the 
transparency and effective operation of the Plans by broadening 
participation in Plan governance. They would require the creation of 
advisory committees composed of non-SRO representatives. Such 
committees would give interested parties an opportunity to be heard on 
Plan business, prior to any decision by the Plan operating committees. 
Finally, the amendments would promote the wide availability of market 
data by authorizing markets to distribute their own data independently 
(while still providing their best quotations and trades for 
consolidated dissemination through the Plans) and streamlining outdated 
requirements for the display of market data to investors.
    Many commenters on the market data proposals expressed frustration 
with the current operation of the Plans.\24\ These commenters generally 
fell into two groups. One group, primarily made up of individual 
markets that receive market data fees, believed that the current model 
of consolidation should be discarded in favor of a new model, such as a 
``multiple consolidator'' model under which each SRO would sell its own 
data separately. The other group, primarily made up of securities 
industry participants that pay market data fees, believed that the 
current level of fees is too high. This group asserted that, prior to 
modifying the allocation of market data revenues, the Commission should 
address the level of fees that generated those revenues.\25\
---------------------------------------------------------------------------

    \24\ Comments on the market data proposals are discussed in 
section V.A.2 below.
    \25\ Some commenters mistakenly believed that the level of 
market data fees had been left unreviewed for many years. In fact, 
the Commission comprehensively reviewed market data fees in 1999, 
which led to a 75% reduction in fees paid by retail investors for 
market data. See infra, note 295.
---------------------------------------------------------------------------

    The Commission has considered these concerns at length in the 
recent past. As was noted in the Proposing Release,\26\ a drawback of 
the current market data model, which requires all SROs to participate 
jointly in disseminating data through a single consolidator, is that it 
affords little opportunity for market forces to determine the overall 
level of fees or the allocation of those fees to the individual SROs. 
Prior to publishing the proposals, therefore, the Commission undertook 
an extended review of the various alternatives for disseminating market 
data to the public in an effort to identify a better model. These 
alternatives were discussed at length in the Proposing Release, but 
each has serious weaknesses. The Commission particularly is concerned 
that the integrity and reliability of the consolidated data stream must 
not be compromised by any changes to the market data structure.
---------------------------------------------------------------------------

    \26\ Proposing Release, 69 FR at 11177.
---------------------------------------------------------------------------

    For example, although allowing each SRO to sell its data separately 
to multiple consolidators may appear at first glance to subject the 
level of fees to competitive forces, this conclusion does not withstand 
closer scrutiny. If the benefits of a fully consolidated data stream 
are to be preserved, each consolidator would need to purchase the data 
of each SRO to assure that the consolidator's data stream in fact 
included the best quotations and most recent trade report in an NMS 
stock. Payment of every SRO's fees would effectively be mandatory, 
thereby affording little room for competitive forces to influence the 
level of fees.
    The Commission also has considered the suggestion of many in the 
second group of commenters that market data fees should be cut back to 
encompass only the costs of the Plans to collect and disseminate market 
data. Under this approach, the individual SROs would no longer be 
allowed to fund any portion of their operational and regulatory 
functions through market data fees.\27\ Yet, as discussed in the 
Commission's 1999 concept release on

[[Page 77430]]

market data,\28\ nearly the entire burden of collecting and producing 
market data is borne by the individual markets, not by the Plans. If, 
for example, an SRO's systems fail on a high-volume trading day and it 
can no longer provide its data to the Plans, investors will suffer the 
consequences of a flawed data stream, regardless of whether the Plan is 
able to continue operating.
---------------------------------------------------------------------------

    \27\ The U.S. equity markets are not alone in their reliance on 
market information revenues as a significant source of funding. All 
of the other major world equity markets currently derive large 
amounts of revenues from selling market information. See infra, note 
308 and accompanying text.
    \28\ Securities Exchange Act Release No. 42208 (Dec. 9, 1999), 
64 FR 70613 (Dec. 17, 1999) (``Market Information Release'').
---------------------------------------------------------------------------

    If the Commission were to limit market data fees to cover only Plan 
costs, SRO funding would have been cut by $386 million in 2003.\29\ 
Given the potential harm if vital SRO functions are not adequately 
funded, the Commission believes that the level of market data fees is 
most appropriately addressed in a context that looks at SRO funding as 
a whole. It therefore has requested comment on this issue in its recent 
concept release on SRO structure.\30\ In addition, the recently 
proposed rules to improve SRO transparency would, if adopted, assist 
the public in assessing the level and use of market data fees by the 
various SROs.\31\
---------------------------------------------------------------------------

    \29\ See Proposing Release, 69 FR at 11179 (table setting forth 
revenue allocations for 2003).
    \30\ Securities Exchange Act Release No. 50700 (Nov. 18, 2004), 
69 FR 71256 (Dec. 8, 2004) (``SRO Structure Release'').
    \31\ Securities Exchange Act Release No. 50699 (Nov. 18, 2004), 
69 FR 71126 (Dec. 8, 2004) (``SRO Transparency Release'').
---------------------------------------------------------------------------

    In sum, there is inherent tension between assuring price 
transparency for investors, which is a fundamental objective of the 
Exchange Act,\32\ and expanding the extent to which market forces 
determine market data fees and SRO revenues. Each alternative model for 
data dissemination has its particular strengths and weaknesses. The 
great strength of the current model, however, is that it benefits 
investors, particularly retail investors, by helping them to assess 
quoted prices at the time they place an order and to evaluate the best 
execution of their orders against such prices by obtaining data from a 
single source that is highly reliable and comprehensive. In the absence 
of full confidence that this benefit would be retained if a different 
model were adopted, the Commission has decided to repropose such 
immediate steps as are necessary to improve the operation of the 
current model.
---------------------------------------------------------------------------

    \32\ Section 11A(a)(1)(C)(iii) of the Exchange Act.
---------------------------------------------------------------------------

II. Trade-Through Rule

    The Commission is reproposing Rule 611 under Regulation NMS to 
establish protection against trade-throughs for all NMS stocks. Rule 
611(a)(1) would require a trading center (which includes national 
securities exchanges, exchange specialists, ATSs, OTC market makers, 
and block positioners)\33\ to establish, maintain, and enforce written 
policies and procedures that are reasonably designed to prevent trade-
throughs of protected quotations and, if relying on an exception, that 
are reasonably designed to assure compliance with the terms of the 
exception. Rule 611(a)(2) would require a trading center to regularly 
surveil to ascertain the effectiveness of its policies and procedures 
and to take prompt action to remedy deficiencies in such policies and 
procedures. To qualify for protection, a quotation must be automated. 
Rule 600(b)(3) would define an automated quotation as one that, among 
other things, is displayed and immediately accessible through automatic 
execution. Rule 611 would not require market participants to route 
orders to access any manual quotations, which generally entail a much 
slower speed of response than automated quotations.
---------------------------------------------------------------------------

    \33\ An ``OTC market maker'' in a stock is defined in reproposed 
Rule 600(b)(52) of Regulation NMS as, in general, a dealer that 
holds itself out as willing to buy and sell the stock, otherwise 
than on a national securities exchange, in amounts of less than 
block size (less than 10,000 shares). A block positioner in a stock, 
in contrast, limits its activity in the stock to transactions of 
10,000 shares or greater.
---------------------------------------------------------------------------

    Reproposed Rule 611(b) would set forth a variety of exceptions to 
make intermarket price protection as efficient and workable as 
possible. These would include an intermarket sweep exception, which 
would allow market participants simultaneously to access multiple price 
levels at different trading centers--a particularly important function 
now that trading in penny increments has dispersed liquidity across 
multiple price levels. The intermarket sweep exception would enable 
trading centers that receive sweep orders to execute those orders 
immediately, without waiting for better-priced quotations in other 
markets to be updated. In addition, Rule 611 would provide exceptions 
for the quotations of trading centers experiencing, among other things, 
a material delay in providing a response to incoming orders and for 
flickering quotations with prices that have been displayed for less 
than one second. Both exceptions are designed to limit the application 
of Rule 611 to quotations that are truly automated and accessible.
    By strengthening price protection in the NMS for quotations that 
can be accessed fairly and efficiently, reproposed Rule 611 is designed 
to further the interests of both investors who submit displayed limit 
orders and investors who submit marketable orders.\34\ Price protection 
encourages the display of limit orders by increasing the likelihood 
that they will receive an execution in a timely manner. Limit orders 
typically establish the best prices for an NMS stock. Greater use of 
limit orders would increase market depth and liquidity, thereby 
improving the quality of execution for the large market orders of 
institutional investors. Moreover, strong intermarket price protection 
would offer greater assurance, on an order-by-order basis, to investors 
who submit market orders that their orders in fact will be executed at 
the best prices, which can be difficult for investors, particularly 
retail investors, to monitor.\35\ Finally, market orders would need to 
be routed only to quotations that are truly accessible.
---------------------------------------------------------------------------

    \34\ For ease of reference in this release, the term ``limit 
order'' generally will refer to a non-marketable order and the term 
``marketable order'' will refer to both market orders and marketable 
limit orders. A non-marketable limit order has a limit price that 
prevents its immediate execution at current market prices. Because 
these orders cannot be executed immediately, they generally are 
publicly displayed to attract contra side interest at the price. In 
contrast, a ``marketable limit order'' has a limit price that 
potentially allows its immediate execution at current market prices. 
As discussed further below, marketable limit orders often cannot be 
filled at current market prices because of insufficient liquidity 
and depth at the market price. See infra, text accompanying note 49.
    \35\ Investors generally will know the best quoted prices at the 
time they place an order by referring to the consolidated quotation 
stream for a stock. In the interval between order submission and 
order execution, however, quoted prices can change. If the order 
execution price provided by a market differs from the best quoted 
price at order submission, it can be particularly difficult for 
retail investors to assess whether the difference was attributable 
to changing quoted prices or to an inferior execution by the market. 
The Trade-Through Rule would help assure, on an order-by-order 
basis, that markets effect trades at the best available prices.
---------------------------------------------------------------------------

A. Response to Comments and Basis for Reproposed Rule

    Rule 611 as reproposed reflects a number of changes to the rule as 
proposed. As discussed below, the Commission made these changes in 
response to substantial public comment on the proposed rule and on the 
issues arising out of the NMS Hearing that were addressed in the 
Supplemental Release. The public submitted more than 700 comments 
addressing the trade-through proposal.\36\ Although the comments 
covered a very wide range of matters, they particularly focused on the 
following issues:
---------------------------------------------------------------------------

    \36\ The Commission has considered the views of all commenters 
in formulating Rule 611 as reproposed, as well as the other rules 
and amendments reproposed today.
---------------------------------------------------------------------------

    (1) Whether an intermarket trade-through rule is needed to promote 
fair

[[Page 77431]]

and efficient equity markets, particularly for Nasdaq stocks which have 
not been subject to the current ITS trade-through provisions;
    (2) Whether only automated and immediately accessible quotations 
should be given trade-through protection and, if so, what is the best 
approach for defining such quotations;
    (3) Whether intermarket protection against trade-throughs can be 
implemented in a workable manner, particularly for high-volume stocks;
    (4) Whether the proposed exception allowing a general opt-out of 
protected quotations is necessary or appropriate, particularly if 
manual quotations are excluded from trade-through protection;
    (5) Whether the scope of quotations entitled to trade-through 
protection should extend beyond the best bids and offers of the various 
markets; and
    (6) Whether the benefits of an intermarket trade-through rule would 
justify its cost of implementation.
    In the following sections, the Commission responds to comments on 
the trade-through proposal and discusses the basis for its reproposal 
of Rule 611.
1. Need for Intermarket Trade-Through Rule
    Commenters were divided on the central issue of whether intermarket 
protection of displayed quotations is needed to promote the fairest and 
most efficient markets for investors.\37\ Many commenters strongly 
supported the adoption of a uniform rule for all NMS stocks as 
necessary to protect the best displayed prices and encourage the public 
display of limit orders.\38\ They stressed that limit orders are the 
cornerstone of efficient, liquid markets and should be afforded as much 
protection as possible. They noted, for example, that limit orders 
typically establish the ``market'' for a stock. In the absence of limit 
orders setting the current market price, there would be no benchmark 
for the submission and execution of marketable orders. Focusing solely 
on best execution of marketable orders (and the interests of orders 
that take displayed liquidity), therefore, would miss a critical part 
of the equation for promoting the most efficient markets (i.e., the 
best execution of orders that supply displayed liquidity and thereby 
provide public price discovery). Commenters supporting the need for an 
intermarket trade-through rule also believed that a trade-through rule 
would increase investor confidence by helping to eliminate the 
impression of unfairness when an investor's order executes at a price 
that is worse than the best displayed quotation, or when a trade occurs 
at a price that is inferior to the investor's displayed order.\39\
---------------------------------------------------------------------------

    \37\ Nearly all commenters, both those supporting and opposing 
the need for an intermarket trade-through rule, agreed that the 
current ITS trade-through provisions are seriously outdated and in 
need of reform. They particularly focused on the problems created by 
affording equal protection against trade-throughs to both automated 
and manual quotations. Reproposed Rule 611 responds to these 
problems by protecting only automated quotations.
    \38\ Approximately 138 commenters favored a trade-through rule 
that did not include an exception allowing market participants to 
opt-out of the rule. Commenters in this group included (1) many 
mutual fund companies and the Investment Company Institute; (2) 
approximately 24 individual investors and the Consumer Federation of 
America and the National Association of Individual Investors 
Corporation, (3) floor-based exchanges and their members, (4) 
approximately 29 listed companies, (5) a variety of securities 
industry participants, and (6) 12 members of Congress. In addition, 
many commenters supported an opt-out exception to a trade-through 
rule, but varied in the extent to which they made clear whether they 
supported a trade-through rule in general. These commenters are 
included in footnote 99 below addressing supporters of an opt-out 
exception.
    \39\ See, e.g., Letter from Barbara Roper, Director of Investor 
Protection, Consumer Federation of America, to Jonathan G. Katz, 
Secretary, Commission, dated June 17, 2004 (``Consumer Federation 
Letter'') at 2; Letter from Ari Burstein, Associate Counsel, 
Investment Company Institute, to Jonathan G. Katz, Secretary, 
Commission, dated June 30, 2004 (``ICI Letter'') at 7.
---------------------------------------------------------------------------

    Other commenters, in contrast, opposed any intermarket trade-
through rule.\40\ These commenters did not believe that such a rule is 
necessary to promote the protection of limit orders, the best execution 
of market orders, or efficient markets in general. They asserted that, 
given public availability of each market's quotations and ready access 
by all market participants to such quotations, competition among 
markets, a broker's existing duty of best execution, and economic self-
interest would be sufficient to protect limit orders and produce the 
most fair and efficient markets. They therefore believed that any 
trade-through rule would be unnecessary and costly. These commenters 
also were concerned that any trade-through rule could interfere with 
the ability of competitive forces to produce efficient markets, 
particularly for Nasdaq stocks.
---------------------------------------------------------------------------

    \40\ Approximately 242 commenters opposed any trade-through 
rule. Approximately 179 of these commenters utilized ``Letter Type 
C,'' which primarily supported an opt-out exception to the proposed 
rule, but also suggested that no trade-through rule would be 
simpler. Letter Type C is posted on the Commission's Internet Web 
site (http://www.sec.gov/rules/proposed.shtml). The remaining 
commenters included securities industry participants, particularly 
electronic markets and their participants, a variety of local 
political and community groups and individuals, and 17 members of 
Congress.
---------------------------------------------------------------------------

    Commenters opposed to any trade-through rule also generally cited a 
lack of empirical evidence justifying the need for intermarket 
protection against trade-throughs. They noted, for example, that 
trading in Nasdaq stocks has never been subject to an intermarket 
trade-through rule, while trading in exchange-listed stocks, 
particularly NYSE stocks, has been subject to the ITS trade-through 
provisions. Given the difference in regulatory requirements between 
Nasdaq and NYSE stocks, many commenters relied on two factual 
contentions to show that a trade-through rule is not needed: (1) 
Trading in Nasdaq stocks currently is more efficient than trading in 
NYSE stocks; \41\ and (2) fewer trade-throughs occur in Nasdaq stocks 
than NYSE stocks.\42\ Based on these factual contentions, opposing 
commenters concluded that a trade-through rule is not necessary to 
promote efficiency or to protect the best displayed prices.
---------------------------------------------------------------------------

    \41\ See, e.g., Letter from Ellen L.S. Koplow, Executive Vice 
President and General Counsel, Ameritrade Holding Corporation, to 
Jonathan G. Katz, Secretary, Commission, dated June 30, 2004 
(``Ameritrade Letter I''), Appendix at 10; Letter from William 
O'Brien, Chief Operating Officer, Brut LLC, to Jonathan G. Katz, 
Secretary, Commission, dated July 29, 2004 (``Brut Letter'') at 10; 
Letter from Eric D. Roiter, Senior Vice President & General Counsel, 
Fidelity Management and Research Company, to Jonathan G. Katz, 
Secretary, Commission, dated June 22, 2004 (``Fidelity Letter I'') 
at 11; Letter from Edward J. Nicoll, Chief Executive Officer, 
Instinet Group Incorporated, to Jonathan G. Katz, Secretary, 
Commission, dated June 30, 2004 (``Instinet Letter'') at 3, 9 & 
Exhibit A; Letter from Edward S. Knight, The Nasdaq Stock Market, 
Inc., to Jonathan G. Katz, Secretary, Commission, dated July 2, 2004 
(``Nasdaq Letter II'') at 6 and Attachment II; Letter from Bruce N. 
Lehmann & Joel Hasbrouck, Organizers, Reg NMS Study Group, to 
Jonathan G. Katz, Secretary, Commission (no date) (``NMS Study Group 
Letter'') at 4; Letter from David Colker, Chief Executive Officer & 
President, National Stock Exchange, to Jonathan G. Katz, Secretary, 
Commission, dated June 29, 2004 (``NSX Letter'') at 3; Letter from 
Huw Jenkins, Managing Director, Head of Equities for the Americas, 
UBS Securities LLC, to Jonathan G. Katz, Secretary, Commission, 
dated June 30, 2004 (``UBS Letter'') at 4.
    \42\ See, e.g., Letter from Kim Bang, President & Chief 
Executive Officer, Bloomberg Tradebook LLC, to Jonathan G. Katz, 
Secretary, Commission, dated June 30, 2004 (``Bloomberg Tradebook 
Letter'') at 10; Fidelity Letter I at 11; Letter from Suhas Daftuar, 
Managing Director, Hudson River Trading, to Jonathan G. Katz, 
Secretary, Commission, dated August 13, 2004 (``Hudson River Trading 
Letter'') at 1; Instinet Letter at 14; Nasdaq Letter II at 6 and 
Attachment III.
---------------------------------------------------------------------------

    A few commenters submitted empirical data to support the claim that 
trading in Nasdaq stocks is more efficient than trading in NYSE 
stocks.\43\

[[Page 77432]]

Specifically, they submitted tables asserting that effective spreads in 
Nasdaq stocks in the S&P 500 are significantly narrower than effective 
spreads in NYSE stocks in the S&P 500.\44\ To help assess and respond 
to the views of commenters on market efficiency, the Commission staff 
analyzed Rule 11Ac1-5 reports and other trading data to evaluate the 
markets for Nasdaq and NYSE stocks.\45\ The staff studies indicate that 
the execution quality statistics submitted by commenters are flawed. 
The claimed large and systematic disparities between Nasdaq and NYSE 
effective spreads disappear when an analysis of execution quality more 
appropriately controls for differences in stocks, order types, and 
order sizes.\46\ The staff studies reveal that both the market for 
Nasdaq stocks and the market for NYSE stocks have significant 
strengths. But, as discussed below, both markets also have weaknesses 
that could be reduced by strengthened protection against trade-
throughs.
---------------------------------------------------------------------------

    \43\ Instinet Letter, Exhibit A; Nasdaq Letter II, Attachment 
II. The Mercatus Center referenced several statistical studies in 
its comment letter and concluded that the findings of such studies 
are mixed. Letter from Susan E. Dudley, Director, Regulatory Studies 
Program, Mercatus Center, George Mason University, to Jonathan G. 
Katz, Secretary, Commission, dated May 24, 2004 (``Mercatus Center 
Letter'') at 3.
    \44\ Nasdaq and Instinet based their tables on statistics 
derived from the reports (``Dash 5 Reports'') on order execution 
quality made public by markets pursuant to Exchange Act Rule 11Ac1-5 
(proposed to be redesignated as Rule 605 under Regulation NMS). 
Their source for these reports is Market Systems, Inc. (``MSI''), a 
private vendor that collects the reports of all markets each month 
and includes them in a searchable database. MSI also is the source 
of the Dash 5 Reports used in the staff analyses.
    \45\ Memorandum to File, from Office of Economic Analysis, dated 
December 15, 2004 (comparative analysis of execution quality for 
NYSE and NASDAQ stocks based on a matched sample of stocks) 
(``Matched Pairs Study''); Memorandum to File, from Division of 
Market Regulation, dated December 15, 2004 (comparative analysis of 
Rule 11Ac1-5 statistics by S&P Index) (``S&P Index Study''). The 
Matched Pair Study and S&P Index Study have been placed in Public 
File No. S7-10-04 and are available for inspection on the 
Commission's Internet Web site (http://www.sec.gov).
    \46\ Matched Pairs Study, Tables 4-10; S&P Index Study, Tables 
2-9.
---------------------------------------------------------------------------

    First, the effective spread analyses submitted by commenters do 
not, in a number of respects, reflect appropriately the comparative 
trading costs in Nasdaq and NYSE stocks.\47\ They were presented in 
terms of ``cents-per-share'' and therefore failed to control for the 
varying level of stock prices between Nasdaq stocks and NYSE stocks in 
the S&P 500. Lower priced stocks naturally will tend to have lower 
spreads in terms of cents-per-share than higher priced stocks, even 
when such cents-per-share spreads constitute a larger percentage of 
stock price and therefore represent trading costs for investors that 
consume a larger percentage of their investment. By using cents-per-
share statistics, commenters did not adjust for the fact that the 
average prices of Nasdaq stocks are significantly lower than the 
average prices of NYSE stocks. For example, the average price of Nasdaq 
stocks in the S&P 500 in January 2004 was $34.14, while the average 
price of NYSE stocks was $41.32.\48\
---------------------------------------------------------------------------

    \47\ The effective spread is a useful measure of trading costs, 
particularly for small order sizes, because it reflects the prices 
actually received by investors when compared to the best quotes at 
the time a market received an order. Consequently, unlike the quoted 
spread, the effective spread reflects any cost to investors caused 
by movement in prices during a delay between receipt of an order and 
execution of an order. In other words, the effective spread 
penalizes slow markets for failing to execute trades at their quoted 
prices at the time they received an order. It therefore provides an 
appropriate criterion with which to compare execution quality 
between automated and manual markets for comparable stocks, order 
types, and order sizes. As discussed below, however, effective 
spread statistics do not capture trading costs that are attributable 
to low fill rates--the failure to obtain an execution--for 
marketable limit orders.
    \48\ S&P Index Study, Table 1.
---------------------------------------------------------------------------

    The effective spread analyses submitted by commenters also were 
weakened by their failure to address the much lower fill rates of 
orders in Nasdaq stocks than orders in NYSE stocks. The commenters 
submitted ``blended'' statistics that encompassed both market orders 
and marketable limit orders. The effective spread statistics for these 
order types are not comparable, however, because market orders do not 
have a limit price that precludes their execution at prices inferior to 
the prevailing market price at time of order receipt. In contrast, the 
limit price of marketable limit orders often precludes an execution, 
particularly when there is a lack of liquidity and depth at the 
prevailing market price. For example, the fill rates for marketable 
limit orders in Nasdaq stocks generally are less than 75%, and often 
fall below 50% for larger order sizes.\49\
---------------------------------------------------------------------------

    \49\ Matched Pairs Study, Table 10; S&P Index Study, Tables 7, 
9.
---------------------------------------------------------------------------

    Accordingly, investors must accept trade-offs when deciding whether 
to submit market orders or marketable limit orders (particularly when 
the limit price equals or is very close to the current market price). 
Use of a limit price generally assures a narrower spread by precluding 
an execution an inferior price. By precluding an execution, however, 
the limit price may cause the investor to ``miss the market'' if prices 
move away (for example, if prices rise when an investor is attempting 
to buy). Effective spreads for marketable limit orders therefore 
represent trading costs that are conditional on execution, while 
effective spreads for market orders much more completely reflect the 
entire trading cost for a particular order. Market orders represent 
only approximately 14% of the blended flow of market and marketable 
limit orders in Nasdaq stocks (reflecting the fact that ECNs now 
dominate Nasdaq order flow and limit orders represent the vast majority 
of ECN order flow).\50\ In contrast, market orders represent 
approximately 36% of the blended order flow in NYSE stocks.\51\ 
Accordingly, the effective spread statistics for marketable limit 
orders, and particularly for orders in Nasdaq stocks, must be 
considered in conjunction with the fill rate for such orders--a narrow 
spread is good, but the benefits are greatly limited if investors are 
unable to obtain an execution at that spread. The analyses presented by 
the commenters, however, did not address the respective fill rates for 
Nasdaq stocks and NYSE stocks or reflect the inherent differences in 
measuring the trading costs of market orders and marketable limit 
orders.
---------------------------------------------------------------------------

    \50\ An overwhelming majority of market orders in Nasdaq stocks 
are executed by market-making dealers pursuant to agreement with 
their correspondent or affiliated brokers.
    \51\ Matched Pairs Study at 1.
---------------------------------------------------------------------------

    The analyses prepared by Commission staff are designed to provide 
appropriate evaluations of comments on the efficiency of trading in 
Nasdaq and NYSE stocks. In particular, they are more finely tuned to 
evaluate trading for different types of stocks with varying trading 
volume, different types of orders, and different sizes of orders. These 
analyses indicate that the markets for Nasdaq and NYSE stocks each have 
weaknesses that an intermarket price protection rule could help 
address. For example, the effective spread statistics for large, 
electronically-received market orders in NYSE stocks show significant 
``slippage''--the amount by which orders are executed at prices 
inferior to the national best bid or offer (``NBBO'') at the time of 
order receipt.\52\ Slippage often results in effective spreads for 
large orders that are many times wider than the effective spreads for 
small orders in the same NYSE stocks. By protecting automated 
quotations, the reproposed Trade-Through Rule should enhance the depth 
and liquidity available for large, electronic orders in NYSE stocks.
---------------------------------------------------------------------------

    \52\ Matched Pairs Study, Tables 4, 7; S&P Index Study, Tables 
2, 4, 6, 8.
---------------------------------------------------------------------------

    For Nasdaq stocks, the Rule 11Ac1-5 statistics reveal very low fill 
rates for larger sizes of marketable limit orders (e.g., 2000 shares or 
more), which generally fall below 50% for most Nasdaq stocks. Contrary 
to the assertion of some commenters,\53\ certainty of

[[Page 77433]]

execution clearly is not a strength of the current market for Nasdaq 
stocks. Certainty of a fast response is a strength, but much of the 
time the response to large orders will be a ``no fill'' at any given 
trading center. The reproposed Trade-Through Rule is designed to 
enhance depth and liquidity and thereby improve the execution quality 
of large orders in Nasdaq stocks.\54\
---------------------------------------------------------------------------

    \53\ See, e.g., Instinet Letter at 9; Nasdaq Letter II at 6. In 
addition to effective spread statistics, Instinet submitted 
statistics indicating that combined market and marketable limit 
orders in Nasdaq stocks were more likely to be executed at or inside 
the NBBO than such orders in NYSE stocks. Instinet Letter, Table I-
C. These statistics, however, only reflect orders that in fact 
receive an execution--not the large volume of orders in Nasdaq 
stocks that fail to receive any execution at all.
    \54\ Some commenters asserted that the large number of limit 
orders in Nasdaq stocks indicates that sufficient incentives exist 
for the placement of limit orders in such stocks. See, e.g., 
Instinet Letter at 11; Letter from Thomas N. McManus, Managing 
Director & Counsel, Morgan Stanley & Co. Incorporated, to Jonathan 
G. Katz, Secretary, Commission, dated August 19, 2004 (``Morgan 
Stanley Letter'') at 14. Strengthened intermarket trade-through 
protection, however, is designed to improve the quality of limit 
orders in a stock, particularly their displayed size, and thereby 
promote greater depth and liquidity. This goal is not achieved, for 
example, by a large number of limit orders with small sizes and high 
cancellation rates.
---------------------------------------------------------------------------

    Effective spread statistics do not, of course, reflect all types of 
trading costs. They focus on the execution price of individual orders 
in comparison with the best quoted prices at the time orders are 
received. As a result, they do not capture trading costs that are 
associated with the short-term movement of quoted prices, or 
volatility. To further assist the Commission in evaluating the views of 
commenters, Commission staff also has analyzed short-term volatility 
for trading in Nasdaq and NYSE stocks.\55\ This analysis particularly 
focuses on transitory volatility--short-term fluctuations away from the 
fundamental or ``true'' value of a stock. Transitory volatility should 
be distinguished from fundamental volatility--price fluctuations 
associated with factors independent of market structure, such as 
earnings changes and other economic determinants of stock prices. The 
staff analysis found that transitory volatility is significantly higher 
for Nasdaq stocks than for NYSE stocks.\56\ Excessive transitory 
volatility indicates a shortage of liquidity. Such volatility may 
provide benefits in the form of profitable trading opportunities for 
short-term traders or market makers, but these benefits come at the 
expense of other investors, who would be buying at artificially high or 
selling at artificially low prices. Retail investors, in particular, 
tend to be relatively uninformed concerning short-term price movements 
and are apt to bear the brunt of the trading costs associated with 
excessive transitory volatility. The reproposed Trade-Through Rule, by 
promoting greater depth and liquidity, is designed to help reduce 
excessive transitory volatility in Nasdaq stocks.
---------------------------------------------------------------------------

    \55\ Memorandum to File, from Office of Economic Analysis, dated 
December 15, 2004 (analysis of volatility for stocks switching from 
NASDAQ to NYSE) (``Volatility Study''). The Volatility Study has 
been placed in Public File No. S7-10-04 and is available for 
inspection on the Commission's Internet Web site (http://www.sec.gov).
    \56\ Volatility Study at 1.
---------------------------------------------------------------------------

    The second principal factual contention of commenters opposed to a 
trade-through rule is premised on the claim that there are fewer trade-
throughs in Nasdaq stocks, which are not covered by any trade-through 
rule, than in NYSE stocks, which are covered by the ITS trade-through 
provisions.\57\ One commenter asserted that, outside the exchange-
listed markets, competition alone had been sufficient to create a ``no-
trade through zone.''\58\ To respond to these claims, the Commissions 
staff examined public quotation and trade data to analyze the incidence 
of trade-throughs for Nasdaq and NYSE stocks.\59\ It found that the 
overall trade-through rates for Nasdaq stocks and NYSE stocks were, 
respectively, 7.9% and 7.2% of the total volume of traded shares.\60\ 
When considered as a percentage of number of trades, the overall trade-
throughs rate for both Nasdaq and NYSE stocks was 2.5%. In addition, 
the staff analysis found that the amount of the trade-throughs was 
significant--2.3 cents per share on average for Nasdaq stocks and 2.2 
cents per share for NYSE stocks.\61\
---------------------------------------------------------------------------

    \57\ See, e.g., Bloomberg Tradebook Letter at 10; Fidelity 
Letter I at 11; Hudson River Trading Letter at 1; Instinet Letter at 
14; Nasdaq Letter II at 6 and Attachment III.
    \58\ Letter from Kevin J. P. O'Hara, Chief Administrative 
Officer & General Counsel, Archipelago Holdings, Inc., to Jonathan 
G. Katz, Secretary, Commission, dated September 24, 2004 (``ArcaEx 
Letter'') at 3.
    \59\ Memorandum to File, from Office of Economic Analysis, dated 
December 15, 2004 (analysis of trade-throughs in Nasdaq and NYSE 
issues) (``Trade-Through Study''). The Trade-Through Study has been 
placed in Public File No. S7-10-04 and is available for inspection 
on the Commission's Internet Web site (http://www.sec.gov). To 
eliminate false trade-throughs, the staff calculated trade-through 
rates using a 3-second window--a reference price must have been 
displayed one second before a trade and still have been displayed 
one second after a trade. In addition, the staff eliminated 
quotations displayed by the American Stock Exchange LLC (``Amex'') 
from the analysis of Nasdaq stocks because they were manual 
quotations. Finally, the staff used the time of execution of a 
trade, if one was given, rather than time of the trade report 
itself. This methodology was designed to eliminate manual trades, 
such as block trades, that might not be reported for several seconds 
after the trade was effected manually.
    \60\ Trade-Through Study, Tables 4, 11.
    \61\ Id., Tables 3, 10.
---------------------------------------------------------------------------

    The staff analysis also revealed that a large volume of block 
transactions (10,000 shares or greater) trade through displayed 
quotations. Block transactions represent approximately 50% of total 
trade-through volume for both Nasdaq and NYSE stocks.\62\ Importantly, 
many block transactions currently are not subject to the ITS trade-
through provisions that apply to exchange-listed stocks. Broker-dealers 
that act solely as block positioners are not covered by the ITS trade-
through provisions if they print their trades in the over-the-counter 
(``OTC'') market. In addition to not covering the trades of block 
positioners, the ITS trade-through provisions include an exception for 
100-share quotations. They therefore often may fail to protect the 
small orders of retail investors. When block trade-throughs and trade-
throughs of 100-share quotations are eliminated, the overall trade-
through rate for NYSE stocks is reduced from 7.2% to approximately 2.3% 
of total share volume.\63\ The two gaps in ITS coverage therefore 
account for most of the trade-through volume in NYSE stocks. The 
reproposed Trade-Through Rule, by closing these gaps in protection 
against trade-throughs, would establish much stronger price protection 
than the ITS provisions.
---------------------------------------------------------------------------

    \62\ Id., Tables 4, 11.
    \63\ Id., Table 11.
---------------------------------------------------------------------------

    In sum, relevant data supports the need for an intermarket rule to 
strengthen price protection and improve the quality of trading in both 
Nasdaq and exchange-listed stocks. The arguments of some commenters 
that competitive forces alone are sufficient to achieve these 
objectives fail to take into account two structural problems--
principal/agent conflicts of interest and ``free-riding'' on displayed 
prices.
    Agency conflicts occur when brokers may have incentives to act 
otherwise than in the best interest of their customers. Customers, 
particularly retail investors, may have difficulty monitoring whether 
their individual orders miss the best displayed prices at the time they 
are executed.\64\ Given the large number of trades that fail to obtain 
the best displayed prices (e.g., approximately 1 in 40 trades for both 
Nasdaq and NYSE stocks, or approximately 98,000 trades per day in 
Nasdaq stocks),\65\ the Commission is

[[Page 77434]]

concerned that many of the investors that ultimately received the 
inferior price on these trades may not be aware that their orders did 
not, in fact, obtain the best price. The reproposed Trade-Through Rule 
would backstop a broker's duty of best execution by prohibiting the 
practice of executing orders at inferior prices, absent an applicable 
exception.
---------------------------------------------------------------------------

    \64\ See supra, note 35 (discussion of difficulty for investors 
to monitor whether their order execution prices equal the best 
quoted prices at the time of order execution).
    \65\ In October 2004, there were 3.9 million average daily 
trades reported in Nasdaq stocks. Source: http://www.nasdaqtrader.com. The average trade-through rate of 2.5% for 
Nasdaq stocks yields average daily trade-throughs of approximately 
98,000.
---------------------------------------------------------------------------

    Just as importantly, even when market participants act in their own 
economic self-interest, or brokers act in the best interests of their 
customers, they may deliberately choose, for various reasons, to bypass 
(i.e., not protect) limit orders with the best displayed prices. For 
example, an institution may be willing to accept a dealer's execution 
of a particular block order at a price outside the NBBO, thereby 
transferring the risk of any further price impact to the dealer. Market 
participants that execute orders at inferior prices without protecting 
displayed limit orders are effectively ``free-riding'' on the price 
discovery provided by those limit orders. Displayed limit orders 
benefit all market participants by establishing the best prices, but, 
when bypassed, do not themselves receive a benefit, in the form of an 
execution, for providing this public good. This economic externality, 
in turn, creates a disincentive for investors to display limit orders, 
particularly limit orders of any substantial size.
    As demonstrated by the current rate of trade-throughs of the best 
quotations in Nasdaq and NYSE stocks, these structural problems often 
can lead to executions at prices that are inferior to displayed 
quotations, meaning that limit orders are being bypassed. The frequent 
bypassing of limit orders can cause fewer limit orders to be placed. 
The Commission therefore preliminarily believes that the reproposed 
Trade-Through Rule is needed to encourage greater use of limit orders. 
The more limit orders available at better prices and greater size, the 
more liquidity available to fill incoming marketable orders. Increased 
liquidity, in turn, could lead market participants to interact more 
often with displayed orders, which would lead to greater use of limit 
orders, and thus begin the cycle again. The end result should be an NMS 
that more fully meets the needs of a broad spectrum of investors, 
particularly the long-term investors, as opposed to short-term traders, 
that benefit most from improved market depth and liquidity.
2. Limiting Protection to Automated and Accessible Quotations
    The trade-through proposal sought to strengthen protection against 
trade-throughs, while also addressing problems posed by the inherent 
differences in quotations displayed by automated markets, which are 
immediately accessible, and quotations displayed by manual markets, 
which are not. The proposal included an exception that would have 
allowed automated markets to trade through manual markets, but only up 
to certain amounts that varied depending upon the price of the 
security. Under the proposal, a market would be classified as 
``manual'' if it did not provide for an immediate automated response to 
all incoming orders attempting to access its displayed quotations.\66\
---------------------------------------------------------------------------

    \66\ Proposing Release, 69 FR at 11140.
---------------------------------------------------------------------------

    At the NMS Hearing, a significant portion of the discussion of the 
trade-through proposal addressed issues relating to quotations of 
automated and manual markets. Representatives of two floor-based 
exchanges announced their intent to establish ``hybrid'' trading 
facilities that would offer automatic execution of orders seeking to 
interact with their displayed quotations, while at the same time 
maintaining a traditional floor.\67\ These representatives acknowledged 
the difficulties posed in developing an efficient hybrid market, but 
emphasized that they were committed to developing such facilities and 
that such facilities were likely to become operational prior to any 
implementation of Regulation NMS.
---------------------------------------------------------------------------

    \67\ Hearing Tr. at 90-92, 94-97, 120.
---------------------------------------------------------------------------

    Other panelists at the NMS Hearing strongly believed that manual 
quotations should not receive any protection against trade-throughs and 
that the proposed trade-through amounts should be eliminated.\68\ They 
noted, however, that existing order routing technologies are capable of 
identifying, on a quote-by-quote basis, indications from a market that 
a particular quotation is not immediately and automatically accessible 
(i.e., is a manual quotation). Using this functionality, a trade-
through rule could classify individual quotations as automated or 
manual, rather than classifying an entire market as manual solely 
because it displayed manual quotations on occasion.
---------------------------------------------------------------------------

    \68\ Hearing Tr. at 57-58, 67, 142-144, 157-158.
---------------------------------------------------------------------------

    To give the public a full opportunity to comment on these issues, 
the Supplemental Release described the developments at the NMS Hearing 
and requested comment on whether a trade-through rule should protect 
only automated quotations and whether the rule should adopt a ``quote-
by-quote'' approach to identifying protected quotations.\69\ The 
Supplemental Release also requested comment on the requirements for an 
automated quotation, including whether the rule should impose a maximum 
response time, such as one second, on the total time for a market to 
respond to an order in an automated manner. Comment also was requested 
on mechanisms for enforcing compliance with the automated quotation 
requirements.
---------------------------------------------------------------------------

    \69\ Supplemental Release, 69 FR at 30142-30144.
---------------------------------------------------------------------------

    Nearly all commenters believed that only automated quotations 
should receive protection against trade-throughs and that therefore the 
proposed limitation on trade-through amounts for manual markets should 
be eliminated.\70\ The Commission agrees. The reproposed Trade-Through 
Rule would protect only those quotations that are immediately and 
automatically accessible. Providing protection to manual quotations, 
even limited to trade-throughs beyond a certain amount, potentially 
would lead to undue delays in the routing of investor orders, thereby 
outweighing the benefits of price protection. If the Trade-Through Rule 
were adopted, investors would have the choice of whether to access a 
manual quotation and wait for a response or to access an automated 
quotation with an inferior price and obtain an immediate response. 
Moreover, those who route limit orders would be able to control whether 
their orders are protected by evaluating the extent to which various 
trading centers display automated versus manual quotations.
---------------------------------------------------------------------------

    \70\ See, e.g., Ameritrade Letter I at 8; Letter from Lou 
Klobuchar Jr., President and Chief Brokerage Officer, E*TRADE 
Financial Corporation, to Jonathan G. Katz, Secretary, Commission, 
dated June 30, 2004 (``E*Trade Letter'') at 6; ICI Letter at 12; 
Nasdaq Letter II at 9, 14; Letter from Marc Lackritz, President, 
Securities Industry Association, to Jonathan G. Katz, Secretary, 
Commission, dated June 30, 2004 (``SIA Letter'') at 15.
---------------------------------------------------------------------------

    Commenters expressed differing views, however, on the appropriate 
standards for automated quotations and on the standards that should 
govern ``hybrid'' markets--those that display both automated and manual 
quotations. These issues are discussed below.
    a. Standards for Automated Quotations. Nearly all commenters 
addressing the issue believed that only quotations that are truly firm 
and fully accessible should qualify as ``automated.'' \71\ To achieve 
this goal,

[[Page 77435]]

they suggested that, at a minimum, the market displaying an automated 
quotation should be required to provide a functionality for an incoming 
order to receive an immediate and automated (i.e., without human 
intervention) execution up to the full displayed size of the quotation. 
In addition, they believed the market should provide an immediate and 
automated response to the sender of the order indicating whether the 
order had been executed (in full or in part) and an immediate and 
automated updating of the quotation. A number of commenters advocated a 
specific time standard for distinguishing between manual and automated 
quotations, ranging from one second down to 250 milliseconds.\72\ Other 
commenters did not believe the definition of automated quotation should 
include a specific time standard, generally because setting a specific 
standard might discourage innovation and become a ``ceiling'' on market 
performance.\73\
---------------------------------------------------------------------------

    \71\ See, e.g., Letter from John J. Wheeler, Vice President, 
Director of U.S. Equity Trading, American Century Investment 
Management Inc., to Jonathan G. Katz, Secretary, Commission, dated 
June 30, 2004 (``American Century Letter'') at 3; Letter from C. 
Thomas Richardson, Citigroup Global Markets, Inc., to Jonathan G. 
Katz, Secretary, Commission, dated July 20, 2004 (``Citigroup 
Letter'') at 6-7; Letter from Gary Cohn, Managing Director, Goldman, 
Sachs & Co., to Jonathan G. Katz, Secretary, Commission, dated July 
19, 2004 (``Goldman Sachs Letter'') at 4-5; ICI Letter at 13; Morgan 
Stanley Letter at 7; SIA Letter at 6.
    \72\ See, e.g., Ameritrade Letter I at 6; Bloomberg Tradebook 
Letter at 13; Letter from Kenneth R. Leibler, Chairman, Boston Stock 
Exchange, Inc., to Jonathan G. Katz, Secretary, Commission, dated 
June 30, 2004 (``BSE Letter'') at 7; Consumer Federation Letter at 
3; Letter from David A. Herron, Chief Executive Officer, Chicago 
Stock Exchange, to Jonathan G. Katz, Secretary, Commission, dated 
June 30, 2004 (``CHX Letter'') at 7-8; Citigroup Letter at 7; 
Goldman Sachs Letter at 2; ICI Letter at 3, 10; Nasdaq Letter II at 
3, 13; Letter from John Martello, Managing Director, Tower Research 
Capital LLC, to Jonathan G. Katz, Secretary, Commission, dated June 
30, 2004 (``Tower Research Letter'') at 5.
    \73\ See, e.g., American Century Letter at 3, Letter from 
Salvatore F. Sodano, Chairman & Chief Executive Officer, American 
Stock Exchange LLC, to Jonathan G. Katz, Secretary, Commission, 
dated June 30, 2004 (``Amex Letter''), Exhibit A at 6; Brut Letter 
at 7; Letter from Matt D. Lyons, Capital Research and Management 
Company, to Jonathan G. Katz, Secretary, Commission, dated June 28, 
2004 (``Capital Research Letter'') at 2; Fidelity Letter I at 8; 
Instinet Letter at 4; Letter from John H. Bluher, Executive Vice 
President & General Counsel, Knight Trading Group, to William H. 
Donaldson, Chairman, Commission, dated April 15, 2004 (``Knight 
Letter'') at 5; Letter from James T. Brett, J.P. Morgan Securities 
Inc., to Jonathan G. Katz, Secretary, Commission, dated July 8, 2004 
(``JP Morgan Letter'') at 3; Morgan Stanley Letter at 7; Letter from 
Darla C. Stuckey, Corporate Secretary, New York Stock Exchange, 
Inc., to Jonathan G. Katz, Secretary, Commission, dated July 2, 2004 
(``NYSE Letter''), Attachment at 3; Letter from David Humphreville, 
President, The Specialist Association, to Jonathan G. Katz, 
Secretary, Commission, dated June 30, 2004 (``Specialist Assoc. 
Letter'') at 8; Letter from Lisa M. Utasi, President, et al., The 
Security Traders Association of New York, Inc., to Jonathan G. Katz, 
Secretary, Commission, dated June 30, 2004 (``STANY Letter'') at 4; 
Letter from George U. Sauter, Managing Director, The Vanguard Group, 
Inc., to Jonathan G. Katz, Secretary, Commission, dated July 14, 
2004 (``Vanguard Letter'') at 4.
---------------------------------------------------------------------------

    The Commission has included in the reproposal a definition of 
automated quotation that incorporates the three elements suggested by 
commenters: (1) Acting on an incoming order, (2) responding to the 
sender of the order, and (3) updating the quotation. In particular, 
reproposed Rule 600(b)(3) would require that the trading center 
displaying an automated quotation must provide an ``immediate-or-
cancel'' (``IOC'') functionality for an incoming order to execute 
immediately and automatically against the quotation up to its full 
size, and for any unexecuted portion of such incoming order to be 
cancelled immediately and automatically without being routed elsewhere. 
The trading center also must immediately and automatically respond to 
the sender of an IOC order. To qualify as ``automatic,'' no human 
discretion exercised after the time an order is received would be 
permissible in determining any action taken with respect to an order. 
Trading centers would be required to offer this IOC functionality only 
to customers that request immediate action and response by submitting 
an IOC order. Customers therefore would have the choice of whether to 
require an immediate response from the trading center, or to allow the 
market to take further action on the order (such as by routing the 
order elsewhere, seeking additional liquidity for the order, or 
displaying the order). Finally, trading centers would be required to 
immediately and automatically update their automated quotations to 
reflect any change to their material terms (such as a change in price, 
size, or ``automated'' status).
    The definition of automated quotation does not set forth a specific 
time standard for responding to an incoming order. The Commission 
agrees with commenters that the standard should simply be 
``immediate''--i.e., a trading center's systems should provide the 
fastest response possible without any programmed delay. Nevertheless, 
the Commission also is concerned that trading centers with well-
functioning systems should not be unnecessarily slowed down waiting for 
responses from a trading center that is experiencing a systems problem. 
Consequently, rather than fixing a specific time standard that may 
become obsolete as systems improve over time, Rule 611(b)(1) would 
address the problem of slow trading centers by providing an exception 
for quotations displayed by trading centers that are experiencing, 
among other things, a material delay in responding to incoming orders. 
Given current industry conditions, the Commission believes that 
repeatedly failing to respond within one second after receipt of an 
order would constitute a material delay.\74\ Accordingly, a trading 
center would act reasonably in the current trading environment if it 
bypassed the quotations of another trading center that had repeatedly 
failed to respond to orders within a one-second time frame (after 
adjusting for any potential delays in transmission not attributable to 
the other trading center).\75\ This ``self-help'' remedy, discussed 
further in sections II.A.3 and II.B.3 below, would give trading centers 
needed flexibility to deal with a trading center that is experiencing 
systems problems, rather than forcing smoothly-functioning trading 
centers to slow down for a problem market.
---------------------------------------------------------------------------

    \74\ Cf. Ameritrade Letter I at 6 (one second response time is 
appropriate); CHX Letter at 8 (receive, execute, and report back 
within one second); Citigroup Letter at 7 (turnaround time of no 
more than one second); Goldman Sachs Letter at 4 (orders executed or 
cancelled within not more than one second).
    \75\ As discussed further in section II.B.3 below, a trading 
center utilizing the material delay exception would be required to 
establish specific and objective parameters for its use of the 
exception in its policies and procedures.
---------------------------------------------------------------------------

    b. Standards for Automated Trading Centers. The trade-through 
proposal would have classified a market as manual if it did not provide 
automated access to all orders seeking access to its displayed 
quotations. Many commenters responded positively to the concept of 
allowing hybrid markets to display both automated and manual quotations 
that was raised at the NMS Hearing and discussed in the Supplemental 
Release. Most national securities exchanges believed that focusing on 
whether individual quotations are automated or manual would permit 
hybrid markets to function, thereby expanding the range of trading 
choices for investors.\76\ For example, Amex stated that hybrid markets 
would offer investors the choice to utilize auction markets when 
advantageous for them to do so, while at the same time offering 
automatic execution to those investors desiring speed and certainty of 
a fast response.\77\ A majority of other commenters also believed that 
the application of any trade-through rule should depend on whether a 
particular quotation is

[[Page 77436]]

automated.\78\ They believed that such a rule would achieve the 
benefits of encouraging limit orders and improving market depth and 
liquidity, while avoiding indirectly mandating a particular market 
structure.
---------------------------------------------------------------------------

    \76\ See, e.g., Amex Letter at 5; Letter from William J. 
Brodsky, Chairman & Chief Executive Officer, Chicago Board Options 
Exchange, Inc., to Jonathan G. Katz, Secretary, Commission, dated 
July 1, 2004 (``CBOE Letter'') at 3; CHX Letter at 7; NYSE Letter at 
4.
    \77\ Amex Letter, Appendix A at 4.
    \78\ See, e.g., Letter from Joseph M. Velli, Senior Executive 
Vice President, The Bank of New York, to Jonathan G. Katz, 
Secretary, Commission, dated June 30, 2004 (``BNY Letter'') at 2; 
E*Trade Letter at 6; ICI Letter at 7, 13; Morgan Stanley Letter at 
6.
---------------------------------------------------------------------------

    Although generally supportive of the concept of hybrid markets, 
several commenters expressed concern about how the ``quote-by-quote'' 
approach to protected quotations would operate in practice.\79\ The ICI 
noted that ``[w]e are concerned that if it is left completely up to an 
individual market's discretion when a quote is `automated' or manual, 
that market could base its decision on what is in the best interests of 
that market and its members, as opposed to the best interests of 
investors and other market participants.'' \80\ These commenters 
suggested that the Commission should provide clear guidelines as to 
when and how a market could switch its quotations from automated to 
manual, and vice versa, so as to prevent abuse by the market.
---------------------------------------------------------------------------

    \79\ See, e.g., Citigroup Letter at 6; ICI Letter at 13; Morgan 
Stanley Letter at 7; Nasdaq Letter II at 13-14;Vanguard Letter at 5.
    \80\ ICI Letter at 13.
---------------------------------------------------------------------------

    After considering the views of commenters, the Commission has 
decided to include in the reproposal an approach that would offer 
flexibility for a hybrid market to display both automated and manual 
quotations, but only when such a market meets basic standards that 
promote fair and efficient access by the public to the market's 
automated quotations. This approach is designed to allow markets to 
offer a variety of trading choices to investors, but without requiring 
other markets and market participants to route orders to a hybrid 
market with quotations that are not truly accessible. Reproposed Rule 
600(b)(4) therefore sets forth requirements for a trading center to 
qualify as an ``automated trading center.'' Unless a trading center met 
these requirements, none of its quotations could qualify as automated, 
and therefore protected, quotations.
    To qualify as an automated trading center, the trading center must 
have implemented such systems and rules as are necessary to render it 
capable of displaying quotations that meet the action, response, and 
updating requirements set forth in the definition of an automated 
quotation. Further, the trading center must identify all quotations 
other than automated quotations as manual quotations, and must 
immediately identify its quotations as manual quotations whenever it 
has reason to believe that it is not capable of displaying automated 
quotations. These requirements are designed to enable other trading 
centers readily to determine whether a particular quotation displayed 
by a hybrid trading center is protected by the reproposed Trade-Through 
Rule. Finally, an automated trading center must adopt reasonable 
standards limiting when its quotations change from automated quotations 
to manual quotations, and vice versa, to specifically defined 
circumstances that promote fair and efficient access to its automated 
quotations and are consistent with the maintenance of fair and orderly 
markets.
    These requirements are designed to promote efficient interaction 
between a hybrid market and other trading centers. The requirement that 
automated quotations cannot be switched on and off except in 
specifically defined circumstances is particularly intended to assure 
that hybrid markets do not give their members, or anyone else, 
overbroad discretion to control the automated or manual status of the 
trading center's quotations, which potentially could disadvantage less 
favorably situated market participants. Changes from automated to 
manual quotations, and vice versa, must to subject to specific, 
enforceable limitations as to the timing of switches. For a trading 
center to qualify as entitled to display any protected quotations, the 
public in general must have fair and efficient access to a trading 
center's quotations.
3. Workable Implementation of Intermarket Trade-Through Protection
    Several commenters expressed concern that the proposed trade-
through rule could not be implemented in a workable manner, 
particularly for high-volume stocks.\81\ Morgan Stanley, for example, 
asserted that an inefficient trading center might have inferior systems 
that would delay routed orders and potentially diminish their quality 
of execution.\82\ Instinet emphasized that protecting a market's 
quotations ``confers enormous power on a market * * * Such power can 
and will be abused either directly (e.g., by quoting slower than 
executing orders) or indirectly (e.g., not investing in more than 
minimum system capacity or redundancy).'' \83\ Hudson River Trading 
noted that markets sometimes experience temporary systems problems and 
questioned how a trade-through rule would handle these scenarios.\84\ 
Nasdaq observed that quotations in many Nasdaq stocks are updated more 
than two times per second. It said that these frequent changes could 
lead to many false indications of trade-throughs and that eliminating 
these ``false positives'' would greatly reduce the percentage of 
transactions subject to a trade-through rule.\85\ Finally, many 
commenters noted that market participants need the ability to sweep 
multiple price levels simultaneously at different trading centers. They 
emphasized that a trade-through rule should accommodate this trading 
strategy by freeing each trading center to execute orders immediately 
without waiting for other trading centers to update their better priced 
quotations.\86\
---------------------------------------------------------------------------

    \81\ See, e.g., Hudson River Trading Letter at 3; Instinet 
Letter at 18-19; Morgan Stanley Letter at 11-12; Letter from Edward 
S. Knight, The Nasdaq Stock Market, Inc., to Jonathan G. Katz, 
Secretary, Commission, dated September 29, 2004 (``Nasdaq Letter 
III'') at 3.
    \82\ Morgan Stanley Letter at 12.
    \83\ Instinet Letter at 17.
    \84\ Hudson River Trading Letter at 3. This commenter also 
raised a number of quite specific questions concerning the operation 
of an intermarket trade-through rule. To address these detailed 
order sequencing and response scenarios, trading centers would be 
entitled to adopt policies and procedures that reasonably resolve 
the practical difficulties of handling fast-arriving orders in a 
fair and orderly fashion. For example, if a trading center routed 
orders to other markets to access the full size of protected 
quotations under the reproposed Trade-Through Rule, it would be 
allowed to continue trading without regard to a particular market's 
quotations until it has received a response from such market. With 
respect to concern that traders would not be able to control the 
routing of their own orders if markets are required to route out to 
other markets, a trader's use of the IOC functionality specified in 
Rule 600(b)(3) would preclude the first market from routing to other 
markets.
    \85\ Nasdaq Letter III at 3-4.
    \86\ See, e.g., Brut Letter at 10; Citigroup Letter at 10; 
E*Trade Letter at 8; Goldman Sachs Letter at 7.
---------------------------------------------------------------------------

    The Commission fully agrees with these commenters that intermarket 
protection against trade-throughs must be workable and implemented in a 
way that promotes fair and orderly markets. It therefore has formulated 
the reproposed Trade-Through Rule to achieve this objective in a 
variety of ways. First and most importantly, only automated trading 
centers, as defined in Rule 600(b)(4), that are capable of providing 
immediate responses to incoming orders would be eligible to have their 
quotations protected. Moreover, an automated trading center is required 
to identify its quotations as manual (and therefore not protected) 
whenever it has reason to believe that it is not capable of providing 
immediate responses to orders. Thus, a trading center that experiences 
a systems

[[Page 77437]]

problem, whether because of a flood of orders or otherwise, must 
immediately identify its quotations as manual.
    If the reproposed Trade-Through Rule were adopted, the Commission 
would monitor and enforce the foregoing requirements for automated 
trading centers and automated quotations. Nevertheless, it concurs with 
commenters' concerns that well-functioning trading centers should not 
be dependent on the willingness and capacity of other markets to meet, 
and the Commission's ability to enforce, these automation requirements. 
The Trade-Through Rule therefore provides a ``self-help'' remedy that 
would allow trading centers to bypass the quotations of a trading 
center that fails to meet the immediate response requirement. Rule 
611(b)(1) sets forth an exception that applies to quotations displayed 
by trading centers that are experiencing a failure, material delay, or 
malfunction of its systems or equipment. To implement this exception 
consistent with the requirements of Rule 611(a), trading centers would 
have to adopt policies and procedures reasonably designed to avoid 
dealing with problem trading centers. Such policies and procedures 
would need to set forth specific and objective parameters for 
initiating and monitoring compliance with the self-help remedy. Given 
current industry capabilities, the Commission believes that trading 
centers should be entitled to bypass another trading center's 
quotations if it repeatedly fails to respond within one second to 
incoming orders attempting to access its protected quotations. 
Accordingly, trading centers would have the necessary flexibility to 
respond to problems at another trading center as they occur during the 
trading day. The Commission, of course, also would monitor a trading 
center's compliance with the policies and procedures required by Rule 
611(a) to affirm that the trading center bypasses quotations only when, 
in fact, another trading center is experiencing a material delay.
    In many active NMS stocks, the price of a trading center's best 
displayed quotations often can change multiple times in a single second 
(``flickering quotations''). These rapid changes can create the 
impression that a quotation was traded-through, when in fact the trade 
was effected nearly simultaneously with display of the quotation.\87\ 
To address the problem of flickering quotations, reproposed Rule 
611(b)(8) sets forth an exception that allows trading centers a one-
second ``window'' prior to a transaction for trading centers to 
evaluate the quotations at another trading center. Trading centers 
would be entitled to trade at any price equal to or better than the 
least aggressive best bid or best offer, as applicable, displayed by 
the other trading center during that one-second window.\88\ For 
example, if the best bid price displayed by another trading center has 
flickered between $10.00 and $10.01 during the one-second window, the 
trading center that received the order could execute a trade at $10.00 
without violating Rule 611. By addressing the flickering quotation 
problem in this way, reproposed Rule 611(b)(8) would give trading 
centers added flexibility to deal with the practical difficulties of 
protecting quotations displayed by other trading centers.
---------------------------------------------------------------------------

    \87\ A number of commenters were concerned about flickering 
quotations and recommended an exemption to address the problem. CHX 
Letter at 5; E*Trade Letter at 9; JP Morgan Letter at 3; Letter from 
Richard A. Korhammer, Chairman & Chief Executive Officer, Lava 
Trading Inc., to Jonathan G. Katz, Secretary, Commission (no date) 
(``Lava Trading Letter'') at 5; SIA Letter at 10; Letter from Mary 
McDermott-Holland, Chairman & John C. Giesea, President, Security 
Traders Association, to Jonathan G. Katz, Secretary, Commission, 
dated June 30, 2004 (``STA Letter'') at 5.
    \88\ The Commission emphasizes that reproposed Rule 611 is 
designed to facilitate intermarket trade-through protection only. 
Compliance with the Rule would not be a substitute for meeting the 
best execution responsibilities of brokers-dealers. As a result, the 
best execution responsibilities of broker-dealers that engage in 
``price-matching'' business practices that depend on the NBBO would 
not be affected by Rule 611's exception for flickering quotations. 
In making a best execution determination, for example, a broker-
dealer could not rely on the Rule's exception to justify ignoring a 
recently displayed, better-priced quotation when experience shows 
that the quotation is likely to be accessible.
---------------------------------------------------------------------------

    The Commission believes that excepting flickering prices from 
trade-through protection would ease the implementation of the 
reproposed Trade-Through Rule without significantly reducing its 
benefits.\89\ In this regard, it appears that many of the potential 
implementation difficulties with respect to high-volume stocks are 
related to the general problem of dealing with sub-second time 
increments. The Commission generally does not believe that the benefits 
would justify the costs imposed on trading centers of attempting to 
implement an intermarket price priority rule at the level of sub-second 
time increments. Accordingly, Rule 611 has been formulated to relieve 
trading centers of this burden.\90\
---------------------------------------------------------------------------

    \89\ Even with the one-second exception for flickering 
quotations, reproposed Rule 611 would address a large number of 
trade-throughs that currently occur in the equity markets. The 
substantial trade-through rates discussed in section II.A.1 above 
were calculated using a 3-second window. Rule 611 would address all 
of these trade-throughs, assuming no other exception was applicable.
    \90\ Several commenters raised questions concerning ``clock 
drift'' and time lags between different data sources. See, e.g., 
Hudson River Trading Letter at 2; Nasdaq Letter III at 4. These 
implementation issues would most appropriately be addressed in the 
context of a trading center's reasonable policies and procedures. 
Clearly, one essential procedure would be for trading centers to 
implement clock synchronization practices that meet or exceed 
industry standards. In addition, a trading center's compliance with 
the Trade-Through Rule would be assessed based on the times that 
orders and quotations are received, and trades are executed, at that 
trading center. In contrast, to comply with the locking/crossing 
provisions of the reproposed Access Rule (Rule 610(d)), a trading 
center would be required reasonably to avoid displaying a quotation 
that would lock or cross a quotation at the time it is displayed by 
a Plan processor in the consolidated quotation stream.
---------------------------------------------------------------------------

    Paragraphs (b)(5) and (b)(6) of reproposed Rule 611 set forth 
exceptions for intermarket sweep orders. The exceptions respond to the 
need of market participants to access multiple price levels 
simultaneously at different trading centers. An intermarket sweep order 
is defined in Rule 600(b)(30) as a limit order that meets the following 
requirements: (1) The limit order is identified as an intermarket sweep 
order when routed to a trading center, and (2) simultaneously with the 
routing of the limit order, one or more additional limit orders are 
routed to execute against all better-priced protected quotations 
displayed by other trading centers up to their displayed size. These 
additional orders also must be marked as intermarket sweep orders to 
inform the receiving trading center that they can be immediately 
executed without regard to protected quotations in other markets. 
Paragraph (b)(5) would allow a trading center to execute immediately 
any order identified as an intermarket sweep order, without regard for 
better-priced protected quotations displayed at one or more other 
trading centers. The exception is fully consistent with the principle 
of protecting the best displayed prices because it is premised on the 
condition that the trading center or broker-dealer responsible for 
routing the order will have attempted to access all better-priced 
protected quotations up to their displayed size.\91\ Consequently, 
there is no reason why the trading center that receives an intermarket 
sweep order while displaying an inferior-priced quotation should be 
required to delay an execution of the order.
---------------------------------------------------------------------------

    \91\ Reserve size, in contrast, is not displayed. Trading 
centers and broker-dealers therefore would not be required to route 
orders to access reserve size.
---------------------------------------------------------------------------

    Paragraph (b)(6) would authorize a trading center itself to route 
intermarket sweep orders and thereby enable

[[Page 77438]]

immediate execution of a transaction at a price inferior to a protected 
quotation at another trading center. For example, paragraph (b)(6) 
could be used by a dealer that wished immediately to execute a block 
transaction at a price three cents down from the NBBO, as long as the 
dealer simultaneously routed orders to access all better-priced 
protected quotations. By facilitating intermarket sweep orders of all 
kinds, Rule 611 as reproposed would allow a much wider range of 
beneficial trading strategies than the rule as proposed. In addition, 
the intermarket sweep exception would help prevent an ``indefinite 
loop'' scenario in which waves of orders otherwise might be required to 
chase the same quotations from trading center to trading center, one 
price level at a time.\92\
---------------------------------------------------------------------------

    \92\ The indefinite loop scenario also is addressed by (1) the 
self-help remedy in reproposed Rule 611(b)(1) for trading centers to 
deal with slow response times and (2) the requirement that trading 
centers immediately stop displaying automated (and therefore 
protected) quotations when they can no longer meet the immediate 
response requirement for automated quotations.
---------------------------------------------------------------------------

4. Elimination of Proposed Opt-Out Exception
    The rule text of the trade-through proposal included a broad 
exception for persons to opt-out of the best displayed prices if they 
provided informed consent. The Proposing Release indicated that the 
exception was particularly intended to allow investors to bypass manual 
markets, to execute block transactions without moving the market price, 
and to help discipline markets that provided slow executions or 
inadequate access to their quotations.\93\ The Commission also noted, 
however, that an opt-out exception would be inconsistent with the 
principle of price protection and, if used frequently, could undermine 
investor confidence that their orders will receive the best available 
price. It therefore requested comment on an automated execution 
alternative to the opt-out exception, under which all markets would be 
required to provide an automated response to electronic orders. At the 
subsequent NMS Hearing, some panelists questioned whether, assuming 
only truly accessible and automated quotations were protected, there 
was a valid reason for opting-out of such a quotation.\94\ To address 
this issue, the Commission requested comment in the Supplemental 
Release on whether the proposed opt-out exception would be necessary if 
manual quotations were excluded from trade-through protection.
---------------------------------------------------------------------------

    \93\ Proposing Release, 69 FR at 11138.
    \94\ Hearing Tr. at 32, 58, 65, 74, 80, 84-85, 154.
---------------------------------------------------------------------------

    Many commenters opposed a general opt-out exception.\95\ They 
believed that it would be inconsistent with the principle of price 
protection and undermine the very benefits the trade-through rule is 
designed to provide. American Century, for example, asserted that the 
Commission should focus on the limit order investors who have ``opted-
in'' to the NMS, rather than on those that wish to opt-out.\96\ 
Vanguard noted that an opt-out exception might serve a short-term 
desire to obtain an immediate execution, but ``without recognizing the 
second order effect of potentially significantly reducing liquidity in 
the long term.'' \97\ Similarly, the ICI stated that ``while our 
members may be best served on a particular trade by `opting-out' from 
executing against the best price placed in another market, we believe 
that in the long term, all investors will benefit by having a market 
structure where all limit orders are protected and investors are 
provided with an incentive to place those orders in the markets.'' \98\ 
All of the foregoing views were conditioned on an assumption that only 
accessible, automated quotations would be protected by a trade-through 
rule.
---------------------------------------------------------------------------

    \95\ See supra, note 38 (overview of commenters supporting a 
strong trade-through rule without an opt-out exception).
    \96\ American Century Letter at 4.
    \97\ Vanguard Letter at 5.
    \98\ ICI Letter at 14 (emphasis in original).
---------------------------------------------------------------------------

    Many other commenters, in contrast, supported the proposed opt-out 
exception.\99\ Aside from concerns that a trade-through rule would be 
unworkable without an opt-out exception, which were discussed in the 
preceding section, the primary concerns of these commenters were that, 
without an opt-out exception, a trade-through rule would (1) dampen 
competition among markets, particularly with respect to factors other 
than price; and (2) restrict the freedom of choice for market 
participants to route marketable orders to trading centers that are 
most appropriate for their particular trading objectives and to achieve 
best execution. As discussed next, the Commission has formulated the 
reproposed Trade-Through Rule to respond to these concerns, while still 
preserving the benefits of intermarket price protection.
---------------------------------------------------------------------------

    \99\ Approximately 367 commenters supported an opt-out 
exception. Approximately 211 of these commenters opposed a trade-
through rule and endorsed an opt-out to remediate what they viewed 
as its adverse effects. Of these 211 commenters, 179 commenters 
utilized Form Letter C. The remaining commenters supporting an opt-
out exception included a variety of securities industry participants 
and 15 members of Congress.
---------------------------------------------------------------------------

    a. Preserving Competition Among Markets. Many commenters believed 
that an opt-out exception was necessary to promote competition among 
trading centers, particularly competition based on factors other than 
price, such as speed of response. For example, 179 commenters submitted 
letters stating that, in the absence of an opt-out exception, ``Reg. 
NMS will freeze market development and, over the long term, could hurt 
investors.'' \100\ Morgan Stanley asserted that allowing market 
participants to opt-out ``would reward markets that provide faster and 
surer executions, and conversely, would penalize those markets that are 
materially slower or are displaying smaller quote sizes by ignoring 
those quotes.'' \101\ Instinet believed that, without an opt-out 
exception, a trade-through rule ``would virtually eliminate intermarket 
competition by forcing operational and technological uniformity on each 
marketplace, negating price competition, system performance, or any 
other differentiating feature that a market may develop.'' \102\
---------------------------------------------------------------------------

    \100\ Letter Type C.
    \101\ Morgan Stanley Letter at 11-12.
    \102\ Instinet Letter at 19.
---------------------------------------------------------------------------

    The Commission recognizes the vital importance of preserving 
vigorous competition among markets, but believes that commenters have 
overstated the risk that such competition would be dampened by adoption 
of a trade-through rule without a general opt-out exception. Even if 
reproposed Rule 611 were adopted, markets likely would have strong 
incentives to continue to compete and innovate to attract both 
marketable orders and limit orders. Market participants and 
intermediaries responsible for routing marketable orders, consistent 
with their desire to achieve the best price and their duty of best 
execution, would continue to rank trading centers according to the 
total range of services provided by those markets. Such services 
include cost, speed of response, sweep functionality, and a wide 
variety of complex order types. The most competitive trading center 
would be the first choice for routing marketable orders, thereby 
enhancing the likelihood of execution for limit orders routed to that 
trading center. Because likelihood of execution is of such great 
importance to limit orders, routers of limit orders would be attracted 
to this preferred trading center. More limit orders would enhance the 
depth and liquidity offered by the

[[Page 77439]]

preferred trading center, thereby increasing its attractiveness for 
marketable orders, and beginning the cycle all over again.\103\
---------------------------------------------------------------------------

    \103\ Importantly, reproposed Rule 611 would not require that 
limit orders be routed to any particular market, as it does, at 
least indirectly, marketable orders. Consequently, competitive 
forces would be fully operative to discipline markets that offer 
poor services to limit orders, such as limiting the extent to which 
limit orders can be cancelled in changing market conditions or 
providing slow speed of cancellation.
---------------------------------------------------------------------------

    Conversely, trading centers that offer poor services, such as a 
slower speed of response, likely would rank near the bottom in order-
routing preference of most market participants and intermediaries. 
Whenever the least-preferred trading center was merely posting the same 
price as other trading centers, orders would be routed to other trading 
centers. As a result, limit orders displayed on the least preferred 
trading center would be least likely to be executed in general. 
Moreover, such limit orders would be the least likely to be executed 
when prices move in favor of the limit orders, and the most likely to 
be executed only when prices are moving against the limit order, adding 
the cost of ``adverse selection'' to the cost of a low likelihood of 
execution. In sum, the lowest ranked trading center in order-routing 
preference, with or without intermarket price protection, would suffer 
the consequences of offering a poor range of services to the routers of 
marketable orders.\104\ The Commission therefore preliminarily does not 
believe that the absence of an opt-out exception would freeze market 
development or eliminate competition among markets.
---------------------------------------------------------------------------

    \104\ As discussed below in section III.A.2, a competitive 
problem could arise if a least preferred market was allowed to 
charge exorbitant fees to access its protected quotations, and then 
pass most of the fee on as rebates to liquidity providers to offset 
adverse selection costs. To address the problem of such an 
``outlier'' market, reproposed Rule 610(c) would set forth a uniform 
fee limitation for accessing protected quotations.
---------------------------------------------------------------------------

    b. Promoting the Interests of Both Marketable Orders and Limit 
Orders. Many commenters that supported an opt-out exception believed 
that an ability to opt-out of the best displayed prices was necessary 
to promote full freedom of choice in the routing of marketable orders, 
and particularly to allow factors other than quoted prices to be 
considered. For example, 179 commenters submitted a letter stating that 
``[i]nvestors are driven by price, but prices that are inaccessible 
either because of lagging execution time within a market or 
insufficient liquidity at the best price point impact the overall costs 
associated with trading securities in today's markets. The Trade 
Through rule may harm investors by restricting their ability to achieve 
best execution, and investors deserve the opportunity to make 
choices.'' \105\ Similarly, Fidelity asserted that ``as a fiduciary to 
the mutual funds under our management, we should be free to reach our 
own informed judgment regarding the market center where our funds' 
trades are to be executed, particularly when a delay may open the way 
for exchange floor members and others to exploit an informational 
advantage that arises not from their greater investment or trading 
acumen but merely from their privileged presence on the physical 
trading floor.'' \106\
---------------------------------------------------------------------------

    \105\ Letter Type C.
    \106\ Fidelity Letter I at 6-7.
---------------------------------------------------------------------------

    The Commission agrees that the interests of investors in choosing 
the trading center to which to route marketable orders are vitally 
important, but believes that advocates of the opt-out exception have 
failed to consider the interests of all investors--both those who 
submit marketable orders and those who submit limit orders. A fair and 
efficient NMS must serve the interests of both types of investors. 
Moreover, their interests are inextricably linked together. Displayed 
limit orders are the primary source of public price discovery. They 
typically set quoted spreads, supply liquidity, and in general 
establish the public ``market'' for a stock. The quality of execution 
for marketable orders, which, in turn, trade with displayed liquidity, 
depends to a great extent on the quality of market established by limit 
orders (i.e., the narrowness of quoted spreads and the available 
liquidity at various price levels).
    Limit orders, however, make the first move--when submitted, they 
must be displayed rather than executed, and therefore offer a ``free 
option'' for other market participants to trade a stock by submitting 
marketable orders and taking the liquidity supplied by limit orders. 
Consequently, the fate of limit orders is dependent on the choices made 
by those who route marketable orders. Much of the time, the interests 
of marketable orders in obtaining the best available price are aligned 
with those of limit orders that are displaying the best available 
price. But, as shown by the significant trade-through rates discussed 
in section II.A.1 above (even for automated quotations in Nasdaq 
stocks), the interests of marketable orders and limit orders are not 
always aligned.
    One important example where the interests of limit orders and 
marketable orders often diverge are large, block trades. Several 
commenters noted that they often are willing to bypass the best quoted 
prices if they can obtain an immediate execution of large orders at a 
fixed price that is several cents away from the best prices.\107\ Yet 
these block trades often will be priced based on the displayed 
quotations in a stock. They thereby demonstrate the ``free-riding'' 
economic externality that, as discussed in section II.A.1 above, is at 
the heart of the need for intermarket price protection. To achieve the 
full benefits of intermarket price protection, all investors must be 
governed by a uniform rule that encompasses their individual trades. 
For any particular trade, an investor may believe that the best course 
of action is to bypass displayed quotations in favor of executing 
larger size immediately. The Commission believes, however, that the 
long-term strength of the NMS as a whole is best promoted by fostering 
greater depth and liquidity, and it follows from this that the 
Commission should examine the extent to which it can encourage the 
limit orders that provide this depth and liquidity to the market at the 
best prices. Allowing individual market participants to pick and choose 
when to respect displayed quotations could undercut the fundamental 
reason for displaying the liquidity in the first place.
---------------------------------------------------------------------------

    \107\ See, e.g., Fidelity Letter I at 9; Morgan Stanley Letter 
at 12.
---------------------------------------------------------------------------

    Consequently, the Commission has decided to eliminate the proposed 
opt-out exception from the reproposal because it could severely detract 
from the benefits of intermarket order protection. Instead, reproposed 
Rule 611 has been modified to address the concerns of those who 
otherwise may have felt they needed to opt-out of protected quotations. 
In particular, it would incorporate an approach that seeks to serve the 
interests of both marketable orders and limit orders by appropriately 
balancing these interests in the contexts where they may diverge. In 
this way, the reproposed Trade-Through Rule is intended to promote the 
overall efficiency of the NMS for all investors.
    First and most importantly, reproposed Rule 611 would protect only 
immediately accessible quotations that are available through automatic 
execution. It would never require investors submitting marketable 
orders to access ``maybe'' quotations that, after arrival of the order, 
are subject to human intervention and thereby create the potential for 
other market participants to determine whether to honor the quotation. 
Moreover, as discussed in section II.A.2 above,

[[Page 77440]]

reproposed Rule 611 includes a variety of provisions designed to assure 
that marketable orders must be routed only to well-functioning trading 
centers displaying executable quotations.
    Second, reproposed Rule 611 has been formulated to promote the 
interests of investors seeking immediate execution of specific order 
types that reduce their total trading costs, particularly for larger 
orders, by, among other things, minimizing price impact costs. 
Paragraph (b)(7), for example, sets forth an exception that would allow 
the execution of volume-weighted average price (``VWAP'') orders, as 
well as other types of orders that are not priced with reference to the 
quoted price of a stock at the time of execution and for which the 
material terms were not reasonably available at the time the commitment 
to execute the order was made. This exception would serve the interests 
of marketable orders and is consistent with the principle of protecting 
the best displayed quotations.
    Although reproposed Rule 611 does not provide a general exception 
for block orders, it seeks to address the legitimate interest of 
investors in obtaining an immediate execution in large size (and 
thereby minimizing price impact). The intermarket sweep order exception 
would allow broker-dealers to continue to facilitate the execution of 
block orders. The entire size of a large order can be executed 
immediately at any price, so long as the broker-dealer routes orders 
seeking to execute against the full displayed size of better-priced 
protected quotations. The size of the order therefore need not be 
parceled out over time in smaller orders that might tip the market 
about pending orders. By both allowing immediate execution of the large 
order and protecting better-priced quotations, reproposed Rule 611 is 
designed to appropriately balance the interests for investors on both 
sides of the market.
    The Commission recognizes, however, that the existence of a 
intermarket price protection, without an opt-out exception, may 
interfere to some extent with the extremely short-term trading 
strategies of some market participants. Some of these strategies can be 
affected by a delay in order-routing or execution of as little as 3/
10ths of one second. Given the current NMS structure with multiple 
competing markets, any protection of displayed quotations in one market 
could affect the implementation of short-term trading strategies in 
another market. This conflict between protecting the best displayed 
prices and facilitating short-term trading strategies raises a 
fundamental policy question--should the overall efficiency of the NMS 
defer to the needs of professional traders, many of whom rarely intend 
to hold a position overnight? Or should the NMS serve the needs of 
longer-term investors, both large and small, that will benefit 
substantially from intermarket price protection?
    The Commission believes that two of the most important public 
policy functions of the secondary equity markets are to minimize 
trading costs for long-term investors and to reduce the cost of capital 
for listed companies. These functions are inherently connected, because 
the cost of capital of listed companies depends on the trading costs of 
those who are willing to accept the investment risk of holding 
corporate stock for an extended period. To the extent that the 
interests of professional traders and market intermediaries in a broad 
opt-out exception conflict with those of investors, the interests of 
investors are entitled to take precedence. In this way, the NMS will 
fulfill its Exchange Act objectives to promote fair and efficient 
equity markets for investors and to serve the public interest.
5. Scope of Protected Quotations: Market BBO Alternative and Voluntary 
Depth Alternative
    The trade-through proposal would have protected all quotations 
disseminated by a Plan processor in the consolidated quote stream. 
Currently, the scope of these quotations depends on the regulatory 
status of an SRO. Under Exchange Act Rule 11Ac1-1 (``Quote Rule'') 
(proposed to be redesignated as Rule 602), exchange SROs are required 
to provide only their best bids and offers (``BBOs'') in a stock. In 
contrast, a national securities association, which currently 
encompasses Nasdaq's trading facilities and the NASD's ADF, must 
provide BBOs of its individual members. Consequently, the proposal 
would have protected only a single BBO of an exchange and not any 
additional quotations in its depth of book (``DOB''). For Nasdaq 
facilities and the ADF, however, the proposal would have protected 
member BBOs at multiple price levels. The Proposing Release requested 
comment on whether only a single BBO for Nasdaq and the ADF should be 
protected.\108\
---------------------------------------------------------------------------

    \108\ Proposing Release, 69 FR at 11136.
---------------------------------------------------------------------------

    Commenters expressed concern that the proposed rule text would 
protect the BBOs of individual market makers and ATSs in Nasdaq's 
facilities and the ADF, but only a single BBO of exchange SROs.\109\ 
The Specialist Association, for example, believed that it would be 
unfair to offer greater protection to the quotations of members of an 
association SRO than to those of an exchange SRO.\110\ Morgan Stanley 
stated that to ``equalize the protections available to all market 
participants, we believe the Commission should treat SuperMontage as a 
single market for purposes of the trade-through rule, instead of 
treating each individual Nasdaq market maker as a separate quoting 
market participant.'' \111\
---------------------------------------------------------------------------

    \109\ See, e.g., Goldman Sachs Letter at 6; Morgan Stanley 
Letter at 8; NYSE Letter, Attachment at 4; Specialist Assoc. Letter 
at 3.
    \110\ Specialist Assoc. Letter at 3.
    \111\ Morgan Stanley Letter at 8.
---------------------------------------------------------------------------

    The Commission agrees that reproposed Rule 611 should not mandate a 
regulatory disparity between the quotations displayed through exchange 
SROs and those displayed through Nasdaq facilities and the ADF. 
Potentially, Nasdaq and the ADF could attract a significant number of 
limit orders if they were able to offer order protection that was not 
available at exchange SROs. This result would not be consistent with 
the Exchange Act goals of fair competition among markets and the equal 
regulation of markets.\112\ Each of the proposed alternatives for the 
definition of ``protected bid'' and ``protected offer'' in reproposed 
Rule 600(b)(57) (the Market BBO Alternative and the Voluntary Depth 
Alternative) therefore encompasses the BBOs of an exchange, Nasdaq, and 
the ADF. In this way, exchange markets would be treated comparably with 
Nasdaq and the ADF under either alternative.
---------------------------------------------------------------------------

    \112\ Exchange Act Section 11A(a)(1)(C)(ii) and 11A(c)(1)(F).
---------------------------------------------------------------------------

    The Proposing Release also addressed the issue of extending trade-
through protection to DOB quotations, but questioned whether protecting 
all DOB quotations would be feasible at this time.\113\ Comment 
specifically was requested, however, on whether protection should be 
extended beyond the BBOs of SROs if individual markets voluntarily 
provided DOB quotations through the facilities of an effective national 
market system plan.\114\ At the subsequent NMS Hearing, a panelist 
specifically endorsed the policy and feasibility of extending trade-
through protection to DOB quotations, as long as

[[Page 77441]]

such quotations were automated and accessible: ``Automatically 
executable quotes, whether they are on the top of the book or up and 
down the book, should be protected by the trade-through rule, and 
manual quotes should not be. This is a simple and technically easy idea 
to implement.'' \115\
---------------------------------------------------------------------------

    \113\ Proposing Release, 69 FR at 11136.
    \114\ Id. The Commission does not believe that markets should be 
required to disseminate their DOB quotations in the consolidated 
data stream and thereby obtain trade-through protection for such 
quotations. Rather, the Voluntary Depth Alternative would allow each 
market the freedom to choose the course of action most appropriate 
for its particular competitive strategy.
    \115\ Hearing Tr. at 57 (testimony of Thomas Peterffy, Chairman, 
Interactive Brokers Group).
---------------------------------------------------------------------------

    Most of the subset of comment letters that specifically addressed 
the DOB issue supported the approach of extending trade-through 
protection to all limit orders displayed in the NMS, not merely the 
BBOs of the various markets.\116\ The Consumer Federation of America, 
for example, stated that ``such an approach would result in better 
price transparency and help to address complaints that decimal pricing 
has reduced price transparency because of the relatively thin volume of 
trading interest displayed in the best bid and offer.'' \117\ The ICI 
recognized that protecting all displayed limit orders might not be 
feasible at this time, but urged the Commission to examine the issue 
further.\118\
---------------------------------------------------------------------------

    \116\ American Century Letter at 2; Ameritrade Letter I at 4; 
BNY Letter at 2; Capital Research Letter at 2; Consumer Federation 
Letter at 2; Goldman Sachs Letter at 6; ICI Letter at 8. See also 
ArcaEx Letter at 7 (supports trade-through protection for exchange-
listed stocks only, but for entire depth-of-book). But see Letter 
from Samuel F. Lek, Chief Executive Officer, Lek Securities 
Corporation, to Jonathan G. Katz, Secretary, Commission, dated May 
24, 2004 (``Lek Securities Letter'') at 7; Specialist Assoc. Letter 
at 3.
    \117\ Consumer Federation Letter at 2.
    \118\ ICI Letter at 8.
---------------------------------------------------------------------------

    The Commission recognizes, however, that other commenters may have 
chosen not to address the alternative of protecting voluntary DOB 
quotations because it was not included in the proposed rule text. In 
this reproposal, therefore, the Commission has decided to propose rule 
text for two alternatives: (1) The Market BBO Alternative that would 
protect only the BBOs of the exchange SROs, Nasdaq, and the ADF, or (2) 
the Voluntary Depth Alternative that, in addition to protecting BBOs, 
would protect the DOB quotations that markets voluntarily disseminate 
in the consolidated quotations stream. The alternatives are 
incorporated in two alternative definitions of ``protected bid'' and 
``protected offer'' in Rule 600(b)(57). Comment is requested on which 
of the two alternatives would most further the Exchange Act objectives 
for the NMS in a practical and workable manner. The following 
discussion is intended to highlight issues that commenters may wish to 
address when evaluating the two alternatives.
    Comment is requested on whether extending trade-through protection 
to DOB quotations would significantly increase the benefits of the 
reproposed Trade-Through Rule. Would protecting quotations at multiple 
price levels further encourage the display of limit orders and thereby 
significantly enhance depth and liquidity in the NMS? Since 
decimalization, quoted spreads have narrowed substantially. Market 
participants often may not be willing to quote in significant size at 
the inside prices, but might be willing to do so at a price that is a 
penny or more away from the inside prices. Granting trade-through 
protection to such quotations potentially would reward this beneficial 
quoting activity.
    In assessing the potential benefits of DOB protection, commenters 
should consider the effect of the reserve (or undisplayed) size 
function that many trading centers offer investors. For example, Market 
A may be displaying a best offer of 1000 shares at $10.00, and DOB 
offers of 2000 shares at $10.01 and 2000 shares at $10.02. With a 
reserve size function, however, Market A may have an additional 1000 
shares offered at $10.00 and an additional 2000 shares offered at 
$10.01, neither of which is displayed. Assuming the displayed offers of 
$10.00, $10.01, and $10.02 were protected quotations under the 
Voluntary Depth Alternative, Market B could execute a trade at $10.03 
only by simultaneously routing an order to execute against the 
accumulated displayed size of the protected quotations at Market A. 
Market B therefore would be required to route a buy order, identified 
as an intermarket sweep order, to Market A with a limit price of $10.02 
for a total of 5000 shares (the accumulated amount of the displayed 
size of protected quotations with a price of $10.02 or better at Market 
A). Under the priority rules currently in effect at electronic markets, 
undisplayed size has priority over displayed size at a inferior price. 
Accordingly, Market A would execute the 5000 share buy order as 
follows: 2000 shares at $10.00 (1000 displayed plus 1000 reserve) and 
3000 shares at $10.01 (2000 displayed plus 1000 reserve). While Market 
B would have complied with the Rule, the displayed $10.02 offer at 
Market A would still go unfilled when Market B traded at $10.03. 
Comment is requested on the extent to which this outcome would detract 
from the benefits of the Voluntary Depth Alternative.
    The Commission also requests comment on whether the Voluntary Depth 
Alternative could be implemented in a practical and cost-effective 
manner. To comply, trading centers would need to monitor a 
significantly larger number of protected quotations displayed by other 
markets and route orders to execute against such quotations.\119\ The 
Voluntary Depth Alternative, however, would not increase the number of 
orders that a trading center would be required to route to other 
trading centers if only BBOs were protected. Instead, the size of the 
routed orders would need to be increased to reflect the accumulated 
depth displayed by other trading centers in their protected DOB 
quotations.
---------------------------------------------------------------------------

    \119\ As a means to address capacity issues, the SRO 
participants in the applicable market data Plans potentially could 
determine to disseminate only those DOB quotations that were within 
a certain number of price levels away from the NBBO.
---------------------------------------------------------------------------

    In addition, protection of DOB quotations would not be feasible 
unless (1) market participants have a source of information that 
clearly identifies the quotations to be protected, (2) such quotation 
information is made available on fair and reasonable terms, and (3) 
market participants have fair and efficient access to the protected 
quotations at reasonable cost (i.e., without paying exorbitant access 
fees). Moreover, the applicable regulatory authorities must be able to 
monitor and enforce compliance with a rule that protected DOB 
quotations. At a minimum, this would require an objective and uniform 
source to identify the quotations that are protected at any particular 
time. Comment is requested on whether the Voluntary Depth Alternative 
would meet these vitally important requirements.
    The Voluntary Depth Alternative would set up a process through 
which individual markets could choose to secure protection for their 
DOB quotations by disseminating them in the consolidated quotation 
stream. To implement this approach, the SRO participants in the market 
data Plans would need to establish a mechanism for individual markets 
to disseminate their quotations through the Plan processor and have 
them designated as protected quotations. The participants in the Nasdaq 
UTP Plan already have agreed on such a mechanism.\120\ It provides that 
the future processor for the Plan should have the ability to collect, 
consolidate, and disseminate quotations at multiple price levels beyond 
the BBO from any participant that voluntarily chooses to submit such 
quotations. The participant would be expected to bear the costs of 
processing

[[Page 77442]]

its additional information. If the Voluntary Depth Alternative were 
adopted and any individual market were willing to disseminate its DOB 
quotations through the Plan processors, the participants in each of the 
Plans would be expected to agree on a fair and equitable means to 
disseminate such quotations.
---------------------------------------------------------------------------

    \120\ Nasdaq UTP Plan, section XXI, Depth of Book Display 
(published in Securities Exchange Act Release No. 49137 (Jan. 28, 
2004), 69 FR 5217, 5225 (Feb. 3, 2004).
---------------------------------------------------------------------------

    As noted in section II.A.3 above, any intermarket protection 
against trade-throughs must be workable and implemented in a way that 
promotes fair and orderly markets. To the extent commenters are 
concerned about practical problems with implementing the Trade-Through 
Rule, would the basis for these concerns be magnified by the Voluntary 
Depth Proposal? Specifically, comment is requested on all issues 
relating to the feasibility and desirability of disseminating DOB 
quotations through Plan processors.\121\ For example, would the 
voluntary dissemination of protected DOB quotations through the Plan 
processors create a single point of failure that could threaten the 
stability of trading in NMS stocks?
---------------------------------------------------------------------------

    \121\ In its discussion of the market data proposal, the 
Proposing Release requested comment on whether and, if so, on what 
terms Plan processors should be required to disseminate data on 
behalf of individual markets. Proposing Release, 69 FR at 11184 n. 
300. In response, one commenter was concerned that, at a minimum, 
the Plans should offer all participants the same opportunity on the 
same terms to disseminate additional data. Instinet Letter at 48. 
The Commission agrees that the Plans must act fairly and reasonably 
toward all participants. To assure that the Plans were responsive to 
individual markets that were willing to display DOB quotations and 
that they treated such participants fairly and reasonably, the 
Commission would monitor the deliberations of the Plan operating 
committees and, if necessary, take action to strengthen the NMS and 
promote the interests of investors.
---------------------------------------------------------------------------

    In addition, it would be inappropriate to extend trade-through 
protection to any quotation unless it was publicly available and 
accessible on fair and reasonable terms. For example, the limitation on 
access fees set forth in reproposed Rule 610(c) would apply to any 
protected quotation, whether a BBO or DOB quotation. Moreover, any fee 
charged for DOB information disseminated pursuant to a market data Plan 
would have to be filed with the Commission for approval. The fee could 
be approved only if it was fair and reasonable and appropriately 
justified by Plan participants. The Commission requests comment on how 
best to evaluate the fairness and reasonableness of fees for DOB 
quotations if the Voluntary Depth Alternative were adopted.
    Finally, the Commission requests comment on the effect that 
adoption of the Voluntary Depth Alternative would have on competition 
among markets. One commenter, for example, suggested that protection of 
DOB quotations might cause increased fragmentation of liquidity across 
different markets because limit orders, no matter where displayed, 
would have price protection.\122\ Another commenter, in contrast, 
asserted that protecting only BBOs would lead to greater fragmentation 
because limit orders would be routed to any market where they would set 
or equal the BBO and thereby obtain trade-through protection.\123\ 
Comment is requested on the fragmentation issue, as well as in general 
on whether protecting DOB quotations would inappropriately limit the 
terms of market competition so as to harm investors and the efficiency 
of the NMS. For example, would adoption of the Voluntary Depth 
Alternative inappropriately reduce the scope of competition among 
markets to the payment of liquidity rebates for executed limit orders? 
Comment also is requested on whether adoption of the Voluntary Depth 
Alternative would generate forces that would lead to a monopolization 
of trading in a single trading facility.
---------------------------------------------------------------------------

    \122\ Letter from Bruce Lisman, Bear, Stearns & Co., Inc., to 
Jonathan G. Katz, Secretary, Commission, dated November 26, 2004 
(``Bear Stearns Letter''), at 2.
    \123\ Goldman Sachs Letter at 6.
---------------------------------------------------------------------------

6. Benefits and Implementation Costs of Trade-Through Rule
    Commenters were concerned about the cost of implementing the 
original trade-through proposal. Some argued that, in general, 
implementing the proposed rule would be too expensive and would 
outweigh any perceived benefits of the rule.\124\ Commenters also were 
concerned about the cost of specific requirements in the proposed rule, 
particularly the procedural requirements associated with the proposed 
opt-out exception (e.g., obtaining informed consent from customers and 
disclosing the NBBO to customers).\125\
---------------------------------------------------------------------------

    \124\ See, e.g., Bloomberg Tradebook Letter at 14; Fidelity 
Letter I at 12; Instinet Letter at 14, 15; Nasdaq Letter II at 2; 
Letter from Junius W. Peake, Monfort Distinguished Professor of 
Finance, Kenneth W. Monfort College of Business, University of 
Northern Colorado, dated April 23, 2004 (``Peake Letter I'') at 2; 
Reg NMS Study Group Letter at 4; Letter from Richard A. Rosenblatt, 
Chief Executive Officer, & Joseph C. Gawronski, Chief Operating 
Officer, Rosenblatt Securities Inc., to William H. Donaldson, 
Chairman, Commission, dated June 23, 2004 (``Rosenblatt Securities 
Letter II'') at 4; STANY Letter at 3; UBS Letter at 8.
    \125\ See, e.g., Ameritrade Letter I at 8, 9; Brut Letter at 12; 
Citigroup Letter at 8-9; E*TRADE Letter at 7; Letter from W. Leo 
McBlain, Chairman, & Thomas J. Jordan, Executive Director, Financial 
Information Forum, to Jonathan G. Katz, Secretary, Commission, dated 
July 9, 2004 (``Financial Information Forum Letter'') at 2; JP 
Morgan Letter at 4; SIA Letter at 12-14.
---------------------------------------------------------------------------

    In assessing the implementation costs of the reproposed Trade-
Through Rule, it is important to recognize that much, if not all, of 
the connectivity among trading centers necessary to implement 
intermarket price protection has already been put in place. Trading 
centers for exchange-listed securities already are connected through 
the ITS. The Commission understands that, at least as an interim 
solution, ITS facilities and rules could be modified relatively easily 
and at low cost to enable an automatic execution functionality. With 
respect to Nasdaq stocks, connectivity among trading centers already is 
established through private linkages. Routing out to other trading 
centers when necessary to obtain the best prices for Nasdaq stocks is 
an integral part of the business plan of many trading centers, even 
when not affirmatively required by best execution responsibilities. 
Moreover, a variety of private vendors currently offer connectivity to 
NMS trading centers for both exchange-listed and Nasdaq stocks.
    Some of the commenters based their concerns about implementation 
costs on the estimated costs included in the Proposing Release for 
purposes of the Paperwork Reduction Act of 1995 (``PRA'').\126\ The 
Commission has revised its estimate of the PRA costs associated with 
the proposed rule to reflect the streamlined requirements of Rule 611 
as reproposed, and to reflect a further refinement of the estimated 
number of trading centers subject to the rule.\127\ In particular, Rule 
611 as reproposed does not contain the proposed opt-out exception. 
Costs associated with this proposed exception represented a large 
portion of the overall estimated costs described in the Proposing 
Release, and are no longer applicable.\128\ In total, eliminating the 
opt-out procedural requirements alone reduces the estimate of the 
Proposing Release by $294 million in start-up costs and $207 million in 
annual costs.
---------------------------------------------------------------------------

    \126\ 44 U.S.C. 3501 et seq.
    \127\ The revised PRA analysis is forth in section VIII.A below.
    \128\ Specifically, the estimated costs of providing investors 
with disclosure necessary to obtain informed consent to opt-outs and 
retaining records relating to such disclosures were $100 million in 
start-up costs and $59 million annually. Further, the estimated 
costs of the proposed requirement for broker-dealers to provide 
every customer that opted out with the NBBO at the time of execution 
were $194 million in start-up costs and almost $148 million 
annually.
---------------------------------------------------------------------------

    The Commission also has refined its estimate of the number of 
broker-dealers that would be required to establish, maintain, and 
enforce policies and

[[Page 77443]]

procedures designed to prevent trade-throughs pursuant to the rule as 
reproposed. In the Proposing Release, the Commission estimated that 
potentially all of the 6,768 registered broker-dealers would be subject 
to this requirement, but acknowledged that it believed the figure was 
likely overly-inclusive because it might include registered broker-
dealers that do not effect transactions in NMS stocks.\129\ After 
further consideration, the Commission believes that this number indeed 
greatly overestimated the number of registered broker-dealers that 
would be subject to the rule, given that most of those broker-dealers 
do not engage in the business of executing orders internally. The 
estimated number therefore has been reduced to approximately 600 
broker-dealers.\130\
---------------------------------------------------------------------------

    \129\ Proposing Release 69 FR at 11145 n.95.
    \130\ The estimate is described further in section VIII.A below.
---------------------------------------------------------------------------

    Taken together, these changes substantially reduce the estimated 
costs associated with implementation of and ongoing compliance with 
Rule 611 as reproposed. As discussed further in section VIII.A below, 
the estimated PRA costs associated with reproposed Rule 611 are $17.8 
million in start-up costs and $3.5 million in annual costs. In 
addition, as discussed further in section IX.A.2 below, the estimated 
implementation costs for necessary systems modifications are $126 
million in start-up costs and $18.4 million in annual costs. 
Accordingly, the total estimated costs are $143.8 million in start-up 
costs and $21.9 million in annual costs.
    The Commission preliminarily believes that the benefits of 
strengthening price protection for exchange-listed stocks (e.g., by 
eliminating the gaps in ITS coverage of block positioners and 100-share 
quotes) and introducing price protection for Nasdaq stocks would be 
substantial, although the total amount is difficult to quantify. One 
objective, though quite conservative, estimate of benefits is the 
dollar amount of quotations that currently are traded through. The 
Commission staff's analysis of current trade-through rates indicates 
that over 12 billion shares of displayed quotations in Nasdaq and NYSE 
stocks were traded through in 2003, by an average amount of 2.3 cents 
for Nasdaq stocks and 2.2 cents for NYSE stocks.\131\ These traded-
through quotations represent approximately $209 million in Nasdaq 
stocks and $112 million in NYSE stocks, for a total of $321 million in 
bypassed limit orders and inferior prices for investors in 2003 that 
could have been addressed by strong trade-through protection.\132\ The 
Commission preliminarily believes that this $321 million estimated 
annual benefit, particularly when combined with the benefits of 
enhanced investor confidence in the fairness and orderliness of the 
equity markets, would justify the one-time costs of implementation and 
ongoing annual costs of the reproposed Trade-Through Rule.
---------------------------------------------------------------------------

    \131\ Trade-Through Study at 3, 5.
    \132\ Id. at 3.
---------------------------------------------------------------------------

    The foregoing estimate of benefits is very conservative because it 
is based solely on the size of displayed quotations in the absence of 
strong price protection. In essence, it measures the problem--a 
shortage of quoted depth--that the reproposed Trade-Through Rule is 
designed to address, rather than the benefits that it could achieve. 
Every trade-through transaction potentially sends a message to market 
participants that their displayed quotations can be and are ignored by 
other market participants. When the total share volume of trade-through 
transactions that do not interact with displayed quotations reaches 8% 
and above for hundreds of the most actively traded NMS stocks,\133\ 
this message is unlikely to be missed by those who watched their 
quotations being traded through. Certainly, the common practice of 
trading through displayed size is most unlikely to prompt market 
participants to display even greater size.
---------------------------------------------------------------------------

    \133\ See Trade-Through Study, Tables 4 and 11.
---------------------------------------------------------------------------

    A primary objective of the reproposed Trade-Through Rule is to 
increase displayed depth and liquidity in the NMS and thereby reduce 
trading costs for a wide spectrum of investors, particularly 
institutional investors that must trade in large sizes. Precisely 
estimating the extent to which strengthened price protection would 
improve market depth and liquidity, and thereby lower the trading costs 
of investors, is very difficult. The difficulty of estimation should 
not hide from view, however, the enormous potential benefits for 
investors of improving the depth and efficiency of the NMS. Because of 
the huge dollar amount of trading volume in NMS stocks--more than $17 
trillion in 2003 \134\--even the most incremental improvement in market 
depth and liquidity could generate a dollar amount of benefits that 
annually would dwarf the one-time start-up costs of implementing trade-
through protection.
---------------------------------------------------------------------------

    \134\ World Federation of Exchanges, Annual Report (2003), at 
86.
---------------------------------------------------------------------------

    One approach to evaluating the potential benefits of the reproposed 
Trade-Through Rule is to examine a category of investors that stand to 
benefit a great deal from improved depth and liquidity for NMS stocks--
the shareholders in U.S. equity mutual funds. In 2003, the total assets 
of such funds were $3.68 trillion.\135\ The average portfolio turnover 
rate for equity funds was 55%, meaning that their total purchases and 
sales of securities amounted to approximately $4.048 trillion.\136\ A 
leading authority on the trading costs of institutional investors has 
estimated that in the second quarter of 2003 the average price impact 
experienced by investment managers ranged from 17.4 basis points for 
giant-capitalization stocks, 21.4 basis points for large-capitalization 
stocks, and up to 35.4 basis points for micro-capitalization 
stocks.\137\ In addition, it estimated the cost attributable to adverse 
price movements while searching for liquidity for institutional orders, 
which often are too large simply to be presented to the market. Its 
estimate of liquidity search costs ranged from 13 basis points for 
giant capitalization stocks, 23 basis points for large capitalization 
stocks, and up to 119 basis points for micro-capitalization stocks. 
Assuming that the average price impact costs and liquidity search costs 
incurred across all stocks were a conservative 37.4 basis points,\138\ 
the shareholders in U.S. equity mutual funds incurred implicit trading 
costs of $15.1 billion in 2003. Based on a hypothetical assumption 
that, in light of the current share volume of trade-through 
transactions that does not interact with displayed liquidity, 
intermarket trade-through protection could improve depth and liquidity 
for NMS stocks by at least 5% (or an average reduction of 1.87 basis 
points in price impact and liquidity search costs for large investors), 
the savings in trading costs for U.S equity funds alone,

[[Page 77444]]

and the improved returns for their millions of individual shareholders, 
would have amounted to approximately $755 million in 2003.
---------------------------------------------------------------------------

    \135\ Investment Company Institute, Mutual Fund Fact Book 
(2004), at 55.
    \136\ Id. at 64. Portfolio turnover is reported as the lesser of 
portfolio sales or purchases divided by average net assets. Because 
price impact occurs for both purchases and sales, the turnover rate 
must be doubled, then multiplied by total fund assets, to estimate 
the total value of trading that would be affected by an improvement 
in depth and liquidity.
    \137\ Plexus Group, Inc., Commentary 80, ``Trading Truths: How 
Mis-Measurement of Trading Costs Is Leading Investors Astray,'' 
(April 2004), at 2-3.
    \138\ The estimate of 37.4 basis points is the average of the 
total market impact and liquidity search costs for giant 
capitalization stocks (30.4 basis points) and the total market 
impact and liquidity search costs for large capitalization stocks 
(44.4 basis points). The much higher market impact and liquidity 
search costs of midcap, smallcap, and microcap stocks are not 
included.
---------------------------------------------------------------------------

    Of course, the benefits of improved depth and liquidity for the 
equity holdings of other types of investors, including pension funds, 
insurance companies, and individuals, are not incorporated in the 
foregoing calculations. In 2003, these other types of investors held 
78% of the value of publicly traded U.S. equity outstanding, with 
equity mutual funds holding the remaining 22%.\139\ Assuming that these 
other types of investors experienced a reduction in trading costs that 
merely equaled the reduction of trading costs for equity mutual funds, 
the assumed 5% improvement in market depth and liquidity could yield 
total trading cost savings for all investors of over $1.5 billion 
annually. Such savings would improve the investment returns of equity 
ownership, thereby promoting the retirement and other long-term 
financial interests of individual investors and reducing the cost of 
capital for listed companies.
---------------------------------------------------------------------------

    \139\ Mutual Fund Factbook, supra note 135, at 59.
---------------------------------------------------------------------------

B. Description of Reproposed Rule

    Reproposed Rule 611 can be divided into three elements: (1) The 
provisions that establish the scope of the Rule's coverage, most of 
which are set forth in the definitions of Rule 600(b); (2) the 
operative requirements of paragraphs (a) of Rule 611, which, among 
other things, mandate the adoption and enforcement of written policies 
and procedures that are reasonably designed to prevent trade throughs 
of protected quotations and, if relying on an exception, that are 
reasonably designed to assure compliance with the terms of the 
exception, and (3) the exceptions set forth in paragraph (b) of Rule 
611. These elements are discussed below, followed by a section 
emphasizing that a broker's duty of best execution would in not be 
lessened if reproposed Rule 611 were adopted.
1. Scope of Rule
    The scope of reproposed Rule 611 would largely be determined by a 
series of definitions set forth in Rule 600(b). In general, the Rule 
would address trade-throughs of protected quotations in NMS stocks by 
trading centers. A ``trading center'' is defined in Rule 600(b)(78) as 
a national securities exchange or national securities association that 
operates an SRO trading facility,\140\ an ATS,\141\ an exchange market 
maker,\142\ an OTC market maker,\143\ or any other broker or dealer 
that executes orders internally by trading as principal or crossing 
orders as agent. This last phrase is intended particularly to cover 
block positioners. An ``NMS stock'' is defined in paragraphs (b)(47) 
and (b)(46) of Rule 600 as a security, other than an option, for which 
transaction reports are collected, processed and made available 
pursuant to an effective national market system plan. This definition 
effectively covers stocks listed on a national securities exchange and 
stocks included in either the National Market or SmallCap tiers of 
Nasdaq. It does not include stocks quoted on the OTC Bulletin Board or 
elsewhere in the OTC market.
---------------------------------------------------------------------------

    \140\ An ``SRO trading facility'' is defined in reproposed Rule 
600(b)(72) as a facility operated by an SRO that executes orders in 
a security or presents orders to members for execution.
    \141\ An ``alternative trading system'' is defined in reproposed 
Rule 600(b)(2) with a cross reference to Regulation ATS.
    \142\ An ``exchange market maker'' is defined in reproposed Rule 
600(b)(24).
    \143\ An ``OTC market maker'' is defined in reproposed Rule 
600(b)(52).
---------------------------------------------------------------------------

    The term ``trade-through'' is defined in Rule 600(b)(77) as the 
purchase or sale of an NMS stock during regular trading hours,\144\ 
either as principal or agent, at a price that is lower than a protected 
bid or higher than a protected offer. Rule 600(b)(57), which defines a 
``protected bid'' or ``protected offer,'' \145\ includes three main 
elements: (1) An automated quotation, (2) displayed by an automated 
trading center, and (3) alternative proposals for the scope of 
quotations that are to be protected--the Market BBO Alternative and the 
Voluntary Depth Alternative. These three elements are described in more 
detail below.
---------------------------------------------------------------------------

    \144\ The term ``regular trading hours'' is defined in 
reproposed Rule 600(b)(64) as the time between 9:30 a.m. and 4 p.m., 
unless otherwise specified.
    \145\ Protected bid and protected offer are collectively defined 
as a ``protected quotation'' in reproposed Rule 600(b)(58).
---------------------------------------------------------------------------

    As discussed above, an ``automated quotation'' is defined in 
reproposed Rule 600(b)(3) as a quotation displayed by a trading center 
that: (1) Permits an incoming order to be marked as immediate-or-
cancel; (2) immediately and automatically executes an order marked as 
immediate-or-cancel against the displayed quotation up to its full 
size; (3) immediately and automatically cancels any unexecuted portion 
of an order marked as immediate-or-cancel without routing the order 
elsewhere; (4) immediately and automatically transmits a response to 
the sender of an order marked as immediate-or-cancel indicating the 
action taken with respect to such order; and (5) immediately and 
automatically displays information that updates the displayed quotation 
to reflect any change to its material terms.
    Consequently, a quotation would not qualify as ``automated'' if any 
human intervention after the time an order is received is allowed to 
determine the action taken with respect to the quotation. The term 
``immediate'' precludes any coding of automated systems or other type 
of intentional device that would delay the action taken with respect to 
a quotation. Although a trading center must provide an IOC/no-routing 
functionality for incoming orders, it also can offer additional 
functionalities. Among the changes to material terms that require an 
immediate update to a quotation are price, size, and automated/manual 
indicator. Any quotation that does not meet the requirements for an 
automated quotation is defined in Rule 600(b)(37) as a ``manual 
quotation.''
    As discussed above, an ``automated trading center'' is defined in 
reproposed Rule 600(b)(4) as a trading center that: (1) Has implemented 
such systems and rules as are necessary to render it capable of 
displaying quotations that meet the requirements for an automated 
quotation set forth in paragraph (b)(3) of this section; (2) identifies 
all quotations other than automated quotations as manual quotations; 
(3) immediately identifies its quotations as manual quotations whenever 
it has reason to believe that it is not capable of displaying automated 
quotations; and (4) has adopted reasonable standards limiting when its 
quotations change from automated quotations to manual quotations, and 
vice versa, to specifically defined circumstances that promote fair and 
efficient access to its automated quotations and are consistent with 
the maintenance of fair and orderly markets. The requirement of 
reasonable standards for switching the automated/manual status of 
quotations is designed to preclude any practices that would cause 
confusion among market participants concerning the status of a trading 
center's quotations or that would inappropriately advantage the members 
or customers of a trading center at the expense of the public.
    The third element of the definition of protected quotations in Rule 
600(b)(57) addresses the scope of quotations displayed by a trading 
center that are entitled to protected status. As discussed above, the 
Commission is requesting comment on two alternatives. Under the Market 
BBO Alternative, only an automated quotation that is the BBO

[[Page 77445]]

of an exchange SRO, the BBO of Nasdaq, and the BBO of the NASD (i.e., 
the ADF) would qualify as a protected quotation. The Voluntary Depth 
Alternative would protect, in addition to all of the quotations 
protected under the Market BBO Alternative, such additional bids or 
offers that are designated as protected bids or protected offers 
pursuant to an effective national market system plan. Thus, the minimum 
quotations that would be protected at present under either alternative 
are the BBOs of each exchange SRO, The NASDAQ Market Center, and the 
NASD's ADF. In addition, the Voluntary Depth Alternative would 
establish a mechanism pursuant to which a market, on a voluntary basis, 
would be allowed to obtain trade-through protection for its DOB 
quotations. In particular, the market would need to arrange to have its 
DOB quotations designated as protected pursuant to one of the market 
data Plans. Section II.A.5 above discusses the two alternatives and 
requests comment on specific issues.
2. Requirement of Reasonable Policies and Procedures
    Paragraph (a)(1) of reproposed Rule 611 would require a trading 
center to establish, maintain, and enforce written policies and 
procedures that are reasonably designed to prevent trade-throughs of 
protected quotations in NMS stocks that do not fall within an exception 
set forth in paragraph (b) of Rule 611 and, if relying on such an 
exception, that are reasonably designed to assure compliance with the 
terms of the exception. In addition, paragraph (a)(2) of Rule 611 would 
require a trading center to regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph 
(a)(1) and to take prompt action to remedy deficiencies in such 
policies and procedures. As discussed in the Proposing Release, the 
Commission continues to believe that it would be inappropriate to 
implement a complete prohibition against any trade-throughs, 
particularly given the realities of intermarket trading and order-
routing in many high-volume NMS stocks.\146\ The requirement of written 
policies and procedures, as well as the responsibility assigned to 
trading centers to regularly surveil to ascertain the effectiveness of 
their procedures and take prompt remedial steps, is intended to achieve 
the objective of eliminating all trade-throughs that reasonably can be 
prevented, while also recognizing the inherent difficulties of 
eliminating trade-through transactions that, despite a trading center's 
reasonable efforts, may occur due to random and accidental causes. The 
Commission requests comment, however, on whether this approach is 
sufficient to address enforceability concerns. In this regard, should 
the Commission, instead or in addition, explicitly prohibit trade-
throughs absent an applicable exception? Could a prohibition against 
trade-throughs be fashioned that would establish a fair, effective, and 
workable standard to govern trading center conduct?
---------------------------------------------------------------------------

    \146\ Proposing Release, 69 FR at 11137 (noting the problem of 
``false positive'' trade-throughs caused by rapidly changing 
quotations, even when a trading center took reasonable precautions 
to prevent trade-throughs).
---------------------------------------------------------------------------

    At a minimum, a trading center's policies and procedures must 
enable the trading center (and persons responsible for transacting on 
its market, such as specialists) to monitor, on a real-time basis, the 
protected quotations displayed by other trading centers so as to 
determine the prices at which the trading center can and cannot execute 
trades. In addition, a trading center's policies and procedures must 
establish objective standards and parameters governing its use of the 
exceptions set forth in Rule 611(b). A trading center's automated 
order-handling and trading systems must be programmed in accordance 
with these policies and procedures. Finally, the trading center must 
take such steps as are necessary to enable it to enforce its policies 
and procedures effectively. For example, trading centers will need to 
establish procedures such as regular exception reports to evaluate 
their trading and order-routing practices. Such reports would need to 
be examined to affirm that a trading center's policies and procedures 
have been followed by its personnel and properly coded into its 
automated systems and, if not, to promptly identify the reasons and 
take remedial action.
    Of course, surveillance is an important component of a trading 
center's satisfaction of its legal obligations. In the context of this 
rulemaking, paragraph (a)(2) of Rule 611 would reinforce the ongoing 
enforcement requirement by explicitly assigning an affirmative 
responsibility to trading centers to surveil to ascertain the 
effectiveness of their policies and procedures. Trading centers cannot 
merely establish policies and procedures that may be reasonable when 
created and assume that such policies and procedures continue to 
satisfy the requirements of Rule 611. Rather, trading centers must 
regularly assess the continuing effectiveness of their procedures and 
take prompt action when needed to remedy deficiencies.
3. Exceptions
    Rule 611(b) sets forth a variety of exceptions addressing 
transactions that may fall within the definition of a trade-through, 
but which would not be subject to the operative requirements of the 
Rule. The exceptions primarily are designed to achieve workable 
intermarket price protection and to facilitate certain trading 
strategies and order types that are useful to investors, but also are 
consistent with the principle of price protection.
    Paragraph (b)(1) excepts a transaction if the trading center 
displaying the protected quotation that was traded through was 
experiencing a failure, material delay, or malfunction of its systems 
or equipment when the trade-through occurred. As discussed in section 
II.A.3 above, the exception for a ``material delay'' would give trading 
centers a self-help remedy if another trading center repeatedly fails 
to provide an immediate (within one second under current trading 
conditions) response to incoming orders attempting to access its 
quotes. The trading center receiving an order could only be held 
responsible for its own turnaround time (i.e., from the time it first 
received an order to the time it transmits a response to the order). 
Accordingly, the routing trading center would be required to develop 
policies and procedures that allow for any potential delays in 
transmission not attributable to the receiving trading center. Trading 
centers would need to establish reasonable and objective parameters 
governing their use of the material delay exemption. For example, a 
single failure to respond within one second generally would not justify 
future bypassing of another trading center's quotations. Many failures 
to respond within one second in a short time period, in contrast, 
clearly would warrant use of the exception. Moreover, prior to 
disregarding quotations, a trading center should attempt to resolve the 
problem by contacting the other trading center that has failed to 
respond immediately.
    Paragraph (b)(8) of Rule 611 sets forth an exception for flickering 
quotations. It excepts a transaction if the trading center displaying 
the protected quotation that was traded through had displayed, within 
one second prior to execution of the trade-through, a best bid or best 
offer, as applicable, for the NMS stock with a price that was equal or 
inferior to the price of the trade-through transaction. This exception 
thereby provides a ``window'' to address false indications of trade-
throughs that in actuality are attributable to rapidly

[[Page 77446]]

moving quotations. It also potentially would reduce the number of 
instances in which a trading center must alter its normal trading 
procedures and route orders to other trading centers to comply with 
reproposed Rule 611. The exception is thereby intended to promote more 
workable intermarket price protection.
    Paragraphs (b)(5) and (b)(6) of Rule 611 set forth exceptions for 
intermarket sweep orders. An intermarket sweep order is defined in Rule 
600(b)(30) as a limit order \147\ that meets the following 
requirements: (1) when routed to a trading center, the limit order is 
identified as an intermarket sweep order, and (2) simultaneously with 
the routing of the limit order identified as an intermarket sweep 
order, one or more additional limit orders, as necessary, are routed to 
execute against the full displayed size of all protected quotations 
with a superior price. These additional limit orders must be marked as 
intermarket sweep orders to allow the receiving market center to 
execute the order immediately without regard to better-priced 
quotations displayed at other trading centers (by definition, each of 
the additional limit orders would meet the requirements for an 
intermarket sweep order). Paragraph (c) of Rule 611 would require that 
the trading center or broker-dealer responsible for the routing of an 
intermarket sweep order take reasonable steps to establish that orders 
are properly routed in an attempt to execute against all applicable 
protected quotations. A trading center or broker-dealer would be 
required to satisfy this requirement regardless whether it routes the 
order through its own systems or sponsors a customer's access through a 
third-party vendor's systems. Paragraph (b)(5) would allow a trading 
center immediately to execute any order identified as an intermarket 
sweep order. It therefore need not delay its execution for the updating 
of the better-priced quotations at other trading centers to which 
orders were routed simultaneously with the intermarket sweep order. 
Paragraph (b)(6) would allow a trading center itself to route 
intermarket sweep orders and thereby clear the way for immediate 
internal executions at the trading center. This exception particularly 
would facilitate the immediate execution of block orders by dealers on 
behalf of their institutional clients.
---------------------------------------------------------------------------

    \147\ Such a limit order would be ``marketable'' because it 
would be immediately subject to execution at current displayed 
prices. Consequently, ``limit order'' is used differently in this 
context than elsewhere in this release, where it is used to refer to 
non-marketable orders that generally will be displayed, in contrast 
to marketable orders that generally will not be displayed. See 
supra, note 34 (description of marketable limit orders and non-
marketable limit orders).
---------------------------------------------------------------------------

    To illustrate the operation of the intermarket sweep order 
exception, assume that the Market BBO Alternative were adopted and a 
broker-dealer's customer wished to sell a large amount of an NMS stock. 
Trading Center A is displaying the national best bid of 500 shares at 
$10.00, along with quotations in its proprietary depth-of-book data 
feed of 1500 shares at $9.99, and 5000 shares at $9.97. The customer 
decides to sweep all liquidity on Trading Center A down to $9.97. 
Assume also that Trading Center B is displaying a protected bid of 2000 
shares at $9.99, Trading Center C is displaying a protected bid of 400 
shares at $9.98, and Trading Center D is displaying a protected bid of 
200 shares at $9.97. The broker-dealer could execute this trade for its 
customer, subject to its best execution responsibilities, by 
simultaneously routing the following orders: (1) An intermarket sweep 
order to Trading Center A with a limit price of $9.97 and a size of 
7000 shares; (2) an intermarket sweep order to Trading Center B with a 
limit price of $9.99 and a size of 2000 shares; and (3) an intermarket 
sweep order to Trading Center C with a limit price of $9.98 and a size 
of 400 shares. All of these orders would meet the requirements of Rule 
600(b)(30) because the necessary orders simultaneously were routed to 
execute against the displayed size of all better-priced protected 
quotations. Trading Centers A, B, and C all could execute their orders 
immediately without regard to the protected quotations displayed at 
other trading centers. No order would need to be routed to Trading 
Center D because the price of its bid was not superior to the most 
inferior limit price of the order routed to Trading Center A. Assuming 
the customer obtained a fill for each of its orders at the displayed 
prices and sizes,\148\ it would have been able to obtain an immediate 
execution of a 9400-share trade by sweeping through four price levels 
at Trading Center A, while also honoring the protected quotations at 
two other trading centers. The trade therefore would have both upheld 
the principle of price protection and served the customer's legitimate 
interest in obtaining an immediate execution of large size.
---------------------------------------------------------------------------

    \148\ An intermarket sweep order could go unfilled because the 
protected quotation at a trading center was accessed or withdrawn 
prior to the trading center's receipt of the intermarket sweep 
order. In addition, the existence of undisplayed orders or reserve 
size at some trading centers could result in an execution at better 
prices than may have been indicated by the displayed prices and 
sizes. The router of an intermarket sweep order would only be 
responsible, however, for routing orders in accordance with the 
displayed price and size of protected quotations. Whether the orders 
actually execute against the protected quotations, or go unfilled 
because the quotations have been previously executed or withdrawn, 
is not within the responsibility or control of the router of the 
intermarket sweep order.
---------------------------------------------------------------------------

    The exception in paragraph (b)(7) of Rule 611 would facilitate 
other types of orders that often are useful to investors--benchmark 
orders. It would except the execution of an order at a price that was 
not based, directly or indirectly, on the quoted price of an NMS stock 
at the time of execution and for which the material terms were not 
reasonably determinable at the time the commitment to execute the order 
was made. A common example of a benchmark order is a VWAP order. Assume 
a broker-dealer's customer decides to buy a stock at 9 a.m. before the 
markets open for normal trading. The customer submits, and the broker-
dealer accepts, an order to buy 100,000 shares at the volume-weighted 
average price of the stock from opening until 1 p.m. At 1 p.m., the 
national best offer in the stock is $20.00, but the relevant volume-
weighted average price (in a rising market) is $19.90. The broker-
dealer would be able to rely on the benchmark order exception to 
execute the order at $19.90 at 1 p.m., without regard to better-priced 
protected quotations at other trading centers. Of course, any 
transactions effected by the broker-dealer during the course of the day 
to obtain sufficient stock to fill the benchmark order would remain 
subject to Rule 611. The benchmark exception also would encompass the 
execution of an order that is benchmarked to a market's single-priced 
opening, as the Commission would not interpret such an opening price to 
be the ``quoted price'' of the NMS stock at the time of execution.\149\
---------------------------------------------------------------------------

    \149\ The Commission preliminarily does not believe that 
``stopped'' orders should be excepted from reproposed Rule 611 
because their execution is based, at least indirectly, on the quoted 
price of a stock at the time of execution and their material terms 
are known when the commitment to execute the order was made. Comment 
is requested on the extent to which the proposed rule language 
appropriately designates those transactions that should be excepted 
because they are consistent with the price protection objectives of 
reproposed Rule 611.
---------------------------------------------------------------------------

    Finally, paragraph (b) of Rule 611 includes a variety of other 
exceptions: (1) transactions other than ``regular way'' contracts; 
\150\ (2) single-price

[[Page 77447]]

opening, reopening, or closing transactions; and (3) transactions 
executed at a time when protected quotations were crossed. The crossed 
quotation exception would not apply when a protected quotation crosses 
a non-protected (e.g., manual) quotation.\151\
---------------------------------------------------------------------------

    \150\ ``Regular way'' refers to bids, offers, and transactions 
that embody the standard terms and conditions of a market. Thus, 
this exception would apply to a transaction that was executed other 
than pursuant to standardized terms and conditions, for instance a 
transaction that has extended settlement terms.
    \151\ Rule 611 as reproposed does not include two exceptions 
that were included in the proposed rule. One was for trade-throughs 
of ``non-firm'' quotations. This exception is unnecessary because a 
quotation that is not firm would not qualify as an automated, and 
therefore protected, quotation. The other proposed exception was for 
a transaction by a trading center experiencing systems problems. To 
the extent such a transaction is isolated and could not have been 
reasonably avoided, it would not be addressed by reasonable policies 
and procedures. If such transactions occurred repeatedly, however, 
they would call into question whether the trading center in fact had 
implemented reasonable policies and procedures to prevent trade-
throughs.
---------------------------------------------------------------------------

4. Duty of Best Execution
    The Commission emphasizes that adoption of reproposed Rule 611 
would in no way lessen a broker-dealer's duty of best execution. 
Broker-dealers still must seek the most advantageous terms reasonably 
available under the circumstances for their customer orders. They must 
carry out a regular and rigorous review of the quality of markets to 
evaluate their order execution policies, including their decisions 
concerning the markets to which to route customer order flow.\152\ The 
protection against trade-throughs that would be provided by Rule 611 
would not diminish the broker-dealer's responsibility for evaluating 
the execution quality of markets, regardless of the exceptions set 
forth in the Rule. Moreover, Rule 611 could not be used to justify the 
internal execution of retail orders by a market maker at prices 
inferior to the best available quotations.
---------------------------------------------------------------------------

    \152\ See generally Securities Exchange Act Release No. 37619A 
(Sept. 6, 1996), 61 FR 48290, 48322-48333 (Sept. 12, 1996) 
(discussion of best execution responsibilities).
---------------------------------------------------------------------------

    Several commenters who supported excluding manual quotations from 
trade-through protection also suggested that manual quotations should 
be excluded from the NBBO that is calculated and disseminated by Plan 
processors.\153\ Under this approach, market participants could 
disregard manual quotations for purposes of assessing the best 
execution of customer orders and calculating execution quality 
statistics under Rule 11Ac1-5 (proposed to be redesignated as Rule 
605). The Commission has decided not to propose the elimination of 
manual quotations from the NBBO at this time. Under the Quote Rule, 
broker-dealers must honor their firm quotations, although the speed of 
their response may vary according to whether such a quotation is 
automated or manual. A common business practice of many market makers 
is to use the NBBO to price investor orders, particularly those of 
retail investors. Currently, manual quotations establish the NBBO in 
many NMS stocks. The Commission is concerned that eliminating manual 
quotations from the NBBO potentially would widen the spreads in many 
stocks, even though the quotations often may in fact represent the best 
indication of the current market price of the stock. Of course, broker-
dealers would continue to be able to assess the availability of manual 
quotations in making their best execution analyses.
---------------------------------------------------------------------------

    \153\ See, e.g., Citigroup Letter at 3, 6; Goldman Sachs Letter 
at 5-6; Morgan Stanley Letter at 7; SIA Letter at 7.
---------------------------------------------------------------------------

III. Access Rule

    For the NMS to fulfill its statutory objectives, fair and efficient 
access to each of the individual markets that participate in the NMS is 
essential. One of the NMS objectives, for example, is to assure the 
practicability of brokers executing investors' orders in the best 
market.\154\ Another is to assure the efficient execution of securities 
transactions.\155\ Clearly, neither of these objectives can be achieved 
if brokers cannot fairly and efficiently route orders to execute 
against the best quotations for a stock, wherever such quotations are 
displayed in the NMS. In 1975, Congress determined that the ``linking 
of all markets'' for NMS stocks through communications and data 
processing facilities would ``foster efficiency; enhance competition; 
increase the information available to brokers, dealers, and investors; 
facilitate the offsetting of investors' orders; and contribute to the 
best execution of investors' orders.'' \156\ Since 1975, there have 
been dramatic improvements in communications and processing 
technologies. Reproposed Rule 610 is intended to capitalize on these 
improvements and thereby enhance the ``linking of all markets'' for the 
future NMS.
---------------------------------------------------------------------------

    \154\ Section 11A(a)(1)(C)(iv) of the Exchange Act.
    \155\ Section 11A(a)(1)(C)(i) of the Exchange Act.
    \156\ Section 11A(a)(1)(D) of the Exchange Act.
---------------------------------------------------------------------------

    All SROs that trade exchange-listed stocks currently are linked 
through ITS, a collective intermarket linkage facility. ITS provides a 
means of access to exchanges and Nasdaq by permitting each market to 
send a ``commitment to trade'' through the system, with receiving 
markets generally having up to 30 seconds to respond.\157\ ITS also 
provides access to quotations of participants without fees and 
establishes uniform rules to govern quoting practices.\158\ Thus, while 
ITS promotes access that is uniform and free, it also is often slow and 
limited. Moreover, it is governed by a unanimous vote requirement that 
impedes innovation.
---------------------------------------------------------------------------

    \157\ ITS Plan, Section 6(b)(i).
    \158\ ITS Plan, Sections 6(b), 8(d), and 11(b).
---------------------------------------------------------------------------

    In contrast, there is no collective intermarket linkage system for 
SROs that trade Nasdaq stocks. Instead, access is achieved primarily by 
private linkages among individual trading centers. This approach has 
demonstrated its advantages among electronic markets. It is flexible 
and can readily incorporate technological advances as they occur. There 
is no intermarket system, however, that offers free access to 
quotations in Nasdaq stocks. Nor are the trading centers for Nasdaq 
stocks subject to uniform intermarket standards governing their quoting 
and trading practices. The fees for access to quotations in Nasdaq 
stocks, as well as the absence of standards for quotations that lock 
and cross markets, have been the source of severe disputes among 
participants in the market for Nasdaq stocks for many years. Moreover, 
private linkages have not worked effectively with respect to the Amex 
manual trading of Nasdaq stocks, nor have they been successful in 
preventing intentional barriers to access, especially involving fees.
    Reproposed Rule 610 is based on the Commission's determination that 
fair and efficient access to markets could be achieved without a 
collective intermarket linkage facility such as ITS.\159\ It reproposes 
a private linkage approach for all NMS stocks, but with modifications 
to address the most serious problems that have arisen with this 
approach in the trading of Nasdaq stocks. Rule 610 would address three 
subject areas: (1) access to quotations, (2) fees for access to 
protected quotations, and (3) locking and crossing quotations. In 
addition, the Commission is reproposing a modification to the fair 
access requirements of Regulation ATS that would extend their 
application to ATSs with 5% of trading volume in a security.\160\
---------------------------------------------------------------------------

    \159\ Were reproposed Rule 610 to be adopted, the Commission 
anticipates that SRO participants would be permitted to withdraw 
from the ITS Plan, assuming they had otherwise arranged to meet 
their access responsibilities.
    \160\ The modification of Regulation ATS is discussed in section 
III.B.4 below.

---------------------------------------------------------------------------

[[Page 77448]]

A. Response to Comments and Basis for Reproposed Rule

1. Access to Quotations
    Paragraphs (a) and (b) of reproposed Rule 610 would address access 
to quotations. Among the variety of services offered by equity markets, 
access to displayed quotations, particularly the best quotations of a 
trading center, is most vital for the smooth functioning of intermarket 
trading. Brokers responsible for routing their customers' orders, as 
well as investors that make their own order-routing decisions, clearly 
must have fair and efficient access to the best quotations of all 
trading centers to achieve best execution of those orders. In addition, 
trading centers themselves must have the ability to execute orders 
against the displayed quotations of other market centers. Indeed, the 
very existence of intermarket protection against trade-throughs is 
premised on the ability of trading centers to trade with, rather than 
trade through, the protected quotations displayed by other trading 
centers.
    Access to quotations, sometimes referred to as ``order execution 
access,'' \161\ should be distinguished from a broader type of access 
that encompasses all of the different types of services offered by 
markets, such as the right to display limit orders or to submit complex 
order types. To obtain the full range of their services, markets 
generally require that an individual or firm become members or 
subscribers of the market. This type of access, or ``membership 
access,'' subsumes access to quotations and is governed by particular 
regulatory requirements. Sections 6(b)(2) and 15A(b)(3) of the Exchange 
Act, for example, provide for fair access to membership in SROs. 
Similarly, Rule 301(b)(5) of Regulation ATS prohibits certain high 
volume ATSs from denying fair access to their services.\162\ Reproposed 
Rule 610(a) and (b), in contrast, would only address the 
responsibilities of trading centers to provide order execution access 
to their quotations.
---------------------------------------------------------------------------

    \161\ See Rule 301(b)(3) of Regulation ATS (order display and 
execution access requirements).
    \162\ As discussed in section III.B.4 below, the Commission is 
reproposing an amendment to the fair access requirements of 
Regulation ATS that would extend their application to ATSs with 5% 
of trading volume in a security.
---------------------------------------------------------------------------

    The access proposal sought to achieve the goal of fair and 
efficient access to quotations primarily by prohibiting trading centers 
from unfairly discriminating against non-members or non-subscribers 
that attempt to access quotations through a member or subscriber of the 
trading center. Market participants could either become members or 
subscribers of a trading center to obtain direct access to its 
quotations, or they could obtain indirect access by ``piggybacking'' on 
the direct access of members or subscribers. These forms of access are 
widely used today in the market for Nasdaq stocks (as well as to a 
lesser extent in the market for exchange-listed stocks). Instead of 
every market participant establishing separate linkages with every 
trading facility, many different private firms have entered the 
business of linking with a wide range of trading centers and then 
offering their customers access to those trading centers through the 
private firms' linkages. Competitive forces determine the types and 
costs of these private linkages.
    Most commenters supported this private linkage approach for access 
to quotations.\163\ They frequently noted the success of private 
linkages among electronic markets for Nasdaq stocks and contrasted the 
speed and usefulness of those linkages with the ITS linkage for 
exchange-listed stocks. Morgan Stanley noted that ``[p]rivate linkages 
are much easier to establish and operate and can be constructed 
directly between [order execution facilities] or through market 
intermediaries. The smooth operation of the market for Nasdaq stocks 
today clearly demonstrates the power of private linkages.'' \164\ The 
SIA stated that ``for competitive reasons, market participants will be 
interested in the most up-to-date technology and routing methods 
available at any given time, and the proposed standards would permit 
such technology to evolve on an ongoing basis.\165\ The NYSE concluded 
that ``[i]n the market for listed stocks, we believe that proposed 
Regulation NMS will provide the framework for alternatives to ITS for 
intermarket access.'' \166\
---------------------------------------------------------------------------

    \163\ See, e.g., Citigroup Letter at 12; Consumer Federation 
Letter at 4; Goldman Sachs Letter at 4; ICI Letter at 16-17; Morgan 
Stanley Letter at 17; Nasdaq Letter II at 20; NYSE Letter, 
Attachment at 6; Letter from Carrie E. Dwyer, General Counsel & 
Executive Vice President, Charles Schwab & Co., Inc., to Jonathan G. 
Katz, Secretary, Commission, dated June 30, 2004 (``Schwab Letter'') 
at 17; SIA Letter at 16; UBS Letter at 8.
    \164\ Morgan Stanley Letter at 17.
    \165\ SIA Letter at 16.
    \166\ NYSE Letter, Attachment at 7.
---------------------------------------------------------------------------

    A few commenters opposed the proposed private linkages 
approach.\167\ Some questioned whether multiple private linkages could 
match the efficiency of a single, uniform intermarket linkage, although 
they generally emphasized that the current ITS linkage needed to be 
enhanced. The BSE, for example, stated that ``[m]ultiple individual 
links to every market is not an economical or practical solution and it 
would enable gaming opportunities within the markets via technology.'' 
\168\ The Alliance of Floor Brokers suggested that problems with the 
ITS linkage, such as its slow speed and lack of structural flexibility, 
``should be addressed before it is determined to replace it with some, 
as yet unspecified, routing methodology or mechanism.'' \169\ The 
Commission has considered these views, but preliminarily believes that 
the benefits of private linkages, including their flexibility to meet 
the needs of different market participants and the scope they allow for 
competitive forces to determine linkages, justifies reliance on this 
model rather than a single intermarket linkage.
---------------------------------------------------------------------------

    \167\ See, e.g., Letter from Brendan R. Dowd, Daniel W. Tandy & 
Ronald Zdrojeski, Alliance of Floor Brokers, to Jonathan G. Katz, 
Secretary, Commission, dated June 24, 2004 (``Alliance of Floor 
Brokers Letter'') at 2; Ameritrade Letter I, Appendix at 11; BSE 
Letter at 7; CHX Letter at 13; E*Trade Letter at 9.
    \168\ BSE Letter at 7.
    \169\ Alliance of Floor Brokers Letter at 2.
---------------------------------------------------------------------------

    Several commenters, including some that otherwise supported the 
proposal, expressed concern about particular problems that might arise 
under a private linkage approach.\170\ Some were concerned that 
requiring non-discriminatory access to markets might undermine the 
value of SRO membership. CHX stated that ``[b]y requiring the Exchange 
to grant non-members access to the full capabilities of its order 
execution systems, the Commission's fair access proposal would 
inappropriately require the Exchange's members to help fund the costs 
of operating a market that could be routinely used by non-members. It 
would severely undercut the value of membership and enable non-members 
to free-ride on the fees paid by members.'' \171\ Amex stated that ``to 
the extent that the proposed rule undermines our right to differentiate 
between members (who pay fees and have duties and responsibilities to 
the Exchange) and non-members in our charges, it could effectively 
remove any incentive for Amex membership.''\172\
---------------------------------------------------------------------------

    \170\ Alliance of Floor Brokers Letter at 10; Amex Letter, 
Exhibit A at 25-26; BSE Letter at 12; CHX Letter at 14; Citigroup 
Letter at 12; Letter from Edith H. Hallahan, First Vice President, 
Deputy General Counsel, Philadelphia Stock Exchange, to Jonathan G. 
Katz, Secretary, Commission, dated August 10, 2004 (``Phlx Letter'') 
at 2; STANY Letter at 9.
    \171\ CHX Letter at 14.
    \172\ Amex Letter, Exhibit A at 26.
---------------------------------------------------------------------------

    The Commission does not believe that adoption of a private linkage 
approach would seriously undermine the value of membership in SROs that 
offer valuable

[[Page 77449]]

services to their members. First, the fact that markets would not be 
allowed to impose unfairly discriminatory terms on non-members who 
obtain indirect access to quotations through members does not mean that 
non-members would obtain free access to quotations. Members who provide 
piggyback access would be providing a useful service and presumably 
would charge a fee for such service. The fee would be subject to 
competitive forces and likely would reflect the costs of SRO 
membership, plus some element of profit to the SRO's members. As a 
result, non-members that frequently make use of indirect access are 
likely to contribute indirectly to the costs of the SRO market. 
Moreover, the unfair discrimination standard of Rule 610(a) would apply 
only to access to quotations, not to the full panoply of services that 
markets generally provide only to their members.
    On the other hand, any attempt by an SRO to charge differential 
fees based on the non-member status of the person obtaining indirect 
access to quotations, such as whether it is a competing market maker, 
would violate the anti-discrimination standard of reproposed Rule 610. 
As noted above, fair and efficient access to quotes is essential to the 
functioning of the NMS. To comply with the Trade-Through Rule and their 
duty of best execution, trading centers often may be required to access 
the quotations of other trading centers. If a trading center charged 
discriminatory fees to competitors accessing its quotations, it would 
interfere in the functioning of the private linkage approach and 
detract from its usefulness to trading centers in meeting their 
regulatory responsibilities.
    Other types of differential fees, however, would not violate the 
anti-discrimination standard of reproposed Rule 610. Fees with volume-
based discounts or fees that are reasonably based on the cost of 
providing a particular service would be permitted, so long as they do 
not vary based on the non-member status of a person obtaining indirect 
access to quotations. For example, a member providing indirect access 
would be entitled to obtain a volume discount on the full amount of its 
volume, including the volume accounted for by persons obtaining 
indirect access to quotations.
    Another specific concern expressed by commenters about the private 
linkage approach was assuring efficient linkage to trading centers with 
a small amount of trading volume that do not make their quotations 
accessible through an SRO trading facility.\173\ Such quotations 
currently are displayed only through the ADF, a display-only quotation 
facility operated by the NASD, and must be accessed directly at the 
trading center. The proposal would have only required such trading 
centers to provide access to SROs and other ADF participants. At the 
NMS Hearing, several panelists expressed concern that this requirement 
would be inadequate to assure sufficient access, which prompted the 
Commission to request comment on the matter in its Supplemental 
Release.\174\ It noted that panelists at the NMS Hearing had suggested 
that relatively inactive ATSs and market makers should be required to 
publish their quotations in an SRO trading facility, at least until 
their share of trading reached a point where the cost of direct 
connections to those markets would not be out of proportion to their 
volume of trading. Alternatively, the Supplemental Release requested 
comment on whether an SRO without a trading facility, of which the NASD 
is currently the only one, should be required to ensure that any ATS or 
market maker is directly connected to most market participants before 
publishing its quotations in a display-only facility.
---------------------------------------------------------------------------

    \173\ Amex Letter at 8; Brut Letter at 19; Citigroup Letter at 
13; E*Trade Letter at 9; Nasdaq Letter II at 22; SIA Letter at 16; 
Specialist Assoc. Letter at 12; STA Letter at 4; STANY Letter at 10; 
UBS Letter at 9.
    \174\ Hearing Tr. at 135, 138-140; Supplemental Release, 69 FR 
at 30146.
---------------------------------------------------------------------------

    Several commenters supported the approach of requiring low-volume 
trading centers to make their quotations available through an SRO 
trading center.\175\ Brut, for example, stated that the presence of 
such low-volume trading centers ``requires vast industry investments to 
establish private connectivity (or utilize vendors) to access these 
markets--no matter how small or potentially how fleeting--to satisfy 
best execution obligations and avoid market disruption. The effort and 
investment to establish such connectivity is disproportionate to the 
liquidity on such market.'' \176\ Brut further noted that it had sought 
to avoid such ADF trading centers in the past, but that the extension 
of trade-through protection to Nasdaq stocks would eliminate this 
option.
---------------------------------------------------------------------------

    \175\ See, e.g., Brut Letter at 13; Citigroup Letter at 13; SIA 
Letter at 17 (some firms).
    \176\ Brut Letter at 13.
---------------------------------------------------------------------------

    The SIA also believed that ``reliance solely on the SEC's proposed 
market access rules would fail to address access issues related to 
smaller markets * * *. If the SEC obligates market participants to 
trade with [a smaller ADF market maker or ATS] by promulgating a trade-
through rule, we are concerned about the firms' burden of creating many 
private linkages to many small ATSs that may charge exorbitant fees for 
the necessary access.'' \177\ SIA members were divided, however, on the 
best means to resolve the issue. Some favored requiring smaller trading 
centers to make their quotes accessible through an SRO trading center. 
Other SIA members, as well as other commenters, recommended requiring 
all trading centers to make their best quotations available through a 
public intermarket linkage facility.\178\
---------------------------------------------------------------------------

    \177\ SIA Letter at 16.
    \178\ See, e.g., Ameritrade Letter I, Appendix at 11; E*Trade 
Letter at 9; SIA Letter at 17.
---------------------------------------------------------------------------

    One commenter, in contrast, believed that access to trading centers 
quoting on the ADF should be addressed by requiring the NASD to add an 
order execution functionality to ADF. NexTrade stated that the ADF was 
created to make participation in Nasdaq's SuperMontage facility 
voluntary. It believed that ``the Commission should re-evaluate whether 
or not 'private sector' solutions for SROs without an execution 
mechanism are sufficient for the investment community to satisfy its 
various obligations under the Act.'' \179\
---------------------------------------------------------------------------

    \179\ Letter from John M. Schaible, President, NexTrade 
Holdings, Inc., to Jonathan G. Katz, Secretary, Commission, dated 
July 29, 2004 (``NexTrade Letter'') at 14.
---------------------------------------------------------------------------

    After considering the various views of commenters, the Commission 
preliminarily has determined not to require small market centers to 
make their quotations accessible through an SRO trading facility. As 
discussed below, it believes that broker-dealers should continue to 
have the option of trading in the OTC market. Nor is the NASD 
statutorily required to provide an order execution functionality in the 
ADF. Instead, the Commission has reproposed Rule 610(b)(1), which 
requires all trading centers that choose to display quotations in an 
SRO display-only quotation facility to provide a level and cost of 
access to such quotations that is substantially equivalent to the level 
and cost of access to quotations displayed by SRO trading facilities.
    The NASD, as a national securities association, is subject to 
different regulatory requirements than a national securities exchange. 
It is responsible for regulating the OTC market (i.e., trading by 
broker-dealers otherwise than on a national securities exchange). 
Section 15A(b)(11) of the Exchange Act requires an association to have 
rules governing the form and content of quotations relating to 
securities sold otherwise than

[[Page 77450]]

on a national securities exchange that are published by a member of the 
association. Such rules must be designed to produce fair and 
informative quotations and to promote orderly procedures for 
collecting, distributing, and publishing quotations. The Exchange Act 
does not, however, require an association to establish a facility for 
executing orders against the quotations of its members.
    ATSs and market makers that wish to trade NMS stocks can choose 
from a number of options for quoting and trading. They can become a 
member of a national securities exchange and quote and trade through 
the exchange's trading facilities. They can participate in the NASDAQ 
Market Center and quote and trade through that facility. Finally, they 
can quote and trade in the OTC market. The existence of the NASD's ADF 
makes this third choice possible by providing a facility for displaying 
quotations and reporting transactions in the consolidated data 
stream.\180\
---------------------------------------------------------------------------

    \180\ Under Rule 301(b)(3) of Regulation ATS, an ATS is required 
to display its quotations in the consolidated data stream only in 
those securities for which its trading volume reaches 5% of total 
trading volume.
---------------------------------------------------------------------------

    The Commission preliminarily believes that those ATSs and market 
makers that choose to display quotations in the ADF should bear the 
responsibility of providing a level and cost of access to their 
quotations that is substantially equivalent to the level and cost of 
access to quotations displayed by SRO trading facilities. Although the 
Exhange Act allows an individual broker-dealer to have the option of 
trading in the OTC market, it does not mandate that the securities 
industry in general subsidize the costs of accessing a broker-dealer's 
quotations in the OTC market. Under reproposed Rule 610(b)(1), 
therefore, ADF participants would be required to establish the 
necessary connectivity that would facilitate efficient access to their 
quotations. As noted in the Commission's order approving the pilot 
program for the ADF, the reduction in communications line costs in 
recent years and the advent of competing access providers offer the 
potential for multiple competitive means of access to the various 
trading centers that trade NMS stocks.\181\ To meet their regulatory 
requirements, ADF participants would have the option of establishing 
connections to these industry access providers, which in turn have 
extensive connections to a wide array of market participants. As the 
self-regulatory authority responsible for the OTC market, the NASD 
would need to assess the extent to which ADF participants have met the 
access standards of reproposed Rule 610.
---------------------------------------------------------------------------

    \181\ Securities Exchange Act Release No. 46249 (July 24, 2002), 
67 FR 49821 (July 31, 2002).
---------------------------------------------------------------------------

2. Limitation on Access Fees
    Many trading centers charge fees that are triggered when incoming 
orders execute against their displayed quotations.\182\ Such access 
fees particularly have characterized the business models of ECNs, which 
typically pass a substantial portion of the access fee on to customers 
as rebates for supplying the accessed liquidity (i.e., by submitting 
non-marketable limit orders). For Nasdaq stocks, ECNs have charged 
access fees directly to their subscribers, but also have charged access 
fees to non-subscribers when their quotations have been displayed and 
executed through Nasdaq facilities. Other types of trading centers, 
including exchange SROs, also charge fees that are triggered when 
incoming orders access their displayed quotations. These fees have only 
been charged to their members, because only members have the right to 
route orders to an exchange other than through ITS. For exchange-listed 
stocks, moreover, the ITS has provided free intermarket access to 
quotations for its participants. Finally, market makers have not been 
permitted to charge any fee for counterparties accessing their 
quotations under the Quote Rule.
---------------------------------------------------------------------------

    \182\ A full description of the current framework for access 
fees is provided in the Proposing Release. 69 FR at 11156.
---------------------------------------------------------------------------

    The reproposed trade-through protection and linkage requirements 
would significantly alter the regulatory landscape that has shaped 
access fee practices in the past. For exchange-listed stocks, Rule 610 
reproposes a private linkage approach that relies on access through 
members and subscribers rather than through a public intermarket 
linkage system. For access outside of ITS, markets would pay, directly 
or indirectly, the fees charged by other markets to their members and 
subscribers. For Nasdaq stocks, the reproposed Trade-Through Rule 
would, for the first time, establish price protection, so market 
participants would no longer have the option of bypassing the 
quotations of trading centers with access fees that they view as too 
high.
    The benefits of strengthened price protection and more efficient 
linkages could be compromised if trading centers were able to charge 
substantial fees for accessing their quotations. Moreover, the wider 
the disparity in the level of access fees, the less useful and accurate 
are the prices of quotations displayed for NMS stocks. For example, if 
two trading centers displayed offers to buy an NMS stock for $10.00 per 
share, one offer might be accessible for a total price of $10.00 plus a 
$0.003 fee and the other offer might be accessible for a total price of 
$10.00 plus a $0.009 fee. If each trading center rebated all except 
$0.001 of their fees to liquidity providers (as is often the case), one 
customer submitting a limit order to sell at $10.00 would receive 
$10.002, while another customer submitting a limit order to sell at 
$10.00 would receive $10.008. What appeared in the consolidated data 
stream to be identical quotations would in fact be far from identical, 
and market participants potentially would have powerful incentives to 
display their limit orders in high fee markets to obtain an economic 
reward beyond the quoted price of their limit order.
    To address the potential distortions caused by substantial, 
disparate fees, the access proposal included a limitation on fees. 
Trading centers would have been limited to a fee of no more than $0.001 
per share. Liquidity providers also would have been limited to a fee of 
no more than $0.001 per share for attributable quotations, but could 
not have charged any fee for non-attributable quotations. In addition, 
the proposal established an accumulated fee limitation of no more than 
$0.002 per share for any transaction. At the NMS Hearing, panelists 
displayed a sharp divergence of opinion on access fees, with some 
panelists arguing that agency markets must be allowed to charge for 
services, and other panelists arguing that access fees distort 
quotation prices.\183\ In the Supplemental Release, therefore, the 
Commission requested comment on all aspects of the proposed fee 
limitations, including whether it should adopt a single accumulated fee 
limitation that would apply to all types of market centers, and, if so, 
whether the proposed $0.002 per share was an appropriate amount, or 
whether the amount should be higher or lower.\184\
---------------------------------------------------------------------------

    \183\ See, e.g., Hearing Tr. at 166, 168.
    \184\ Supplemental Release, 69 FR at 30147.
---------------------------------------------------------------------------

    Commenters were splintered on the issue of access fees. A number 
were supportive of the Commission's proposal as a worthwhile compromise 
on an extremely difficult issue.\185\ They believed that the proposal 
would level

[[Page 77451]]

the playing field in terms of who could charge fees, and provide some 
measure of certainty to market participants that the quoted price will 
be, essentially, the price they will pay. Other commenters were 
strongly opposed to any limitation on fees, believing that competition 
alone would sufficiently address the high fees that distort quoted 
prices.\186\ One asserted that ``[c]ompetitive forces have 
satisfactorily dealt with the issue of outlier ECNs. . . [M]arket 
participants have put them at the bottom of their order routing tables, 
which means that orders placed on these ECNs would be the last to be 
executed at any price level, a position that no market participant 
wants to be in.'' \187\ In contrast, some commenters argued that all 
access fees charged to non-members and non-subscribers should be 
prohibited, but believed that the proposed fee limitations should not 
apply to SRO transaction fees, particularly those that are filed with 
the Commission for approval.\188\ Finally, a few commenters questioned 
the Commission's authority to set limitations on access fees.\189\
---------------------------------------------------------------------------

    \185\ See, e.g., BNY Letter at 4; Letter from Kenneth Griffin, 
President & Chief Executive Officer, Citadel Investment Group, 
L.L.C., to Jonathan G. Katz, Secretary, Commission, dated July 9, 
2004 (``Citadel Letter'') at 9; Citigroup Letter at 14; E*Trade 
Letter at 10; Nasdaq Letter II at 3; SIA Letter (some members) at 
18.
    \186\ See, e.g., Brut Letter at 12; Instinet Letter at 24; SIA 
Letter (some firms) at 18.
    \187\ Instinet Letter at 27.
    \188\ See, e.g., Amex Letter at 7-8; Goldman Sachs Letter at 5; 
Knight Letter at 2; NYSE Letter at 5; STA Letter at 6.
    \189\ See, e.g., Instinet Letter at 24; Letter from Roderick 
Covlin, Executive Vice President, TrackECN, to William H. Donaldson, 
Chairman, Commission, dated May 10, 2004 (``TrackECN Letter'') at 1.
---------------------------------------------------------------------------

    The Commission acknowledges the many difficult issues associated 
with access fees, but is concerned that these issues must be resolved 
to promote a fair and efficient NMS, particularly under the reproposed 
regulatory structure. As the SIA noted while discussing the divergent 
views of its members both opposing and supporting access fees, 
``[p]erhaps the only point of agreement in this debate is a desire for 
the resolution of the issue.'' \190\
---------------------------------------------------------------------------

    \190\ SIA Letter at 17.
---------------------------------------------------------------------------

    After considering the many divergent views of commenters, the 
Commission preliminarily believes that a flat limitation on access fees 
to $0.003 per share would be the fairest and most appropriate solution 
to what has been a longstanding and contentious issue.\191\ The 
limitation is intended to achieve several objectives. First, it would 
greatly simplify the proposal by eliminating the separate limitations 
for trading centers and liquidity providers, as well as the associated 
attribution requirement. A single accumulated fee cap would apply 
equally to all types of trading centers and all types of market 
participants, thereby promoting the NMS objective of equal regulation 
of markets and broker-dealers.\192\
---------------------------------------------------------------------------

    \191\ For the relatively small number of NMS stocks priced under 
$1.00, fees would be limited to 0.3% of the quotation price per 
share to prevent fees from constituting an excessive percentage of 
share price.
    \192\ Section 11A(c)(1)(F) of the Exchange Act.
---------------------------------------------------------------------------

    Second, the $0.003 fee limitation would be consistent with current 
business practices, as very few trading centers charge fees that exceed 
this amount.\193\ Based on recent inquiries, it appears that only two 
ECNs currently charge fees that exceed $0.003. One charges $0.004 for 
access through ADF, and the other charges $0.009 for access through the 
ADF. Neither of these ECNs currently accounts for a large percentage of 
trading volume. In addition, a few SROs have large fees on their books 
for transactions in ETFs that exceed a certain size (e.g., 2100 
shares). It is unlikely that these fees generate a large amount of 
revenues.
---------------------------------------------------------------------------

    \193\ Cf. Instinet Letter at 38 (``there is no basis for 
adopting any limitation other than at the prevailing $0.003 per 
share level, which was arrived at through open competition among 
ATSs, ECNs, and SRO markets in the Nasdaq market'').
---------------------------------------------------------------------------

    Accordingly, the reproposed fee limitation would not reduce, much 
less eliminate, the fees that currently are charged by agency markets. 
The Commission recognizes that agency trading centers perform valuable 
agency services in bringing buyers and sellers together, and that their 
business model historically has relied, at least in part, on charging 
fees for execution of orders against their displayed quotations. 
Prohibiting access fees entirely would unduly harm this business model.
    Although not intended to reduce access fees, the reproposed fee 
limitation would be designed to preclude individual trading centers 
from raising their fees substantially in an attempt to take improper 
advantage of strengthened protection against trade-throughs and the 
adoption of a private linkage regime. In particular, the reproposed fee 
limitation would be necessary to address ``outlier'' trading centers 
that otherwise might charge high fees and pass most of the fees through 
as rebates to attract liquidity providers. It also would preclude a 
trading center from charging high fees selectively to competitors, 
practices that have arisen in the market for Nasdaq stocks, with 
limited success. In the absence of a fee limitation, however, the 
adoption of the Trade-Through Rule and private linkages could 
significantly boost the viability of the outlier business model. 
Outlier markets might well try to take advantage of intermarket price 
protection by acting essentially as a toll booth between price levels. 
The high fee market likely would be the last market to which orders 
would be routed, but prices could not move to the next level until 
someone routed an order to take out the displayed price at the outlier 
market. Because an outlier market could be no worse than last in order-
routing preference, no matter how high its fees, it might see little 
downside to charging exceptionally high fees, such as $0.009, and 
passing most of the fee on to liquidity providers as rebates. In sum, 
while markets would have significant incentives to compete to be near 
the top in order-routing priority,\194\ there might be little incentive 
to avoid being the least-preferred market if fees were not limited.
---------------------------------------------------------------------------

    \194\ See supra, section II.A.4.a (discussion of competitive 
implications of trade-through protection).
---------------------------------------------------------------------------

    The $0.003 cap would preclude the outlier business model. It would 
place all markets on a level playing field in terms of the fees they 
can charge and the rebates they can pass on to liquidity providers. 
Some markets might choose to charge lower fees, thereby increasing 
their ranking in the preferences of order routers. Others might charge 
the full $0.003 and rebate a substantial proportion to liquidity 
providers. Competition would determine which strategy was most 
successful.
    Moreover, the fee limitation would be necessary to achieve the 
purposes of the Exchange Act. Access fees tend to be highest when 
markets use them to fund substantial rebates to liquidity providers, 
rather than merely to compensate for agency services. If outlier 
markets were allowed to charge exorbitant fees and pass most of them 
through as rebates, the published quotations of such markets would not 
reliably indicate the true price that is actually available to 
investors or that would be realized by liquidity providers. Section 
11A(c)(1)(B) of the Exchange Act authorizes the Commission to adopt 
rules assuring the fairness and usefulness of quotation in information. 
For quotations to be fair and useful, there must be some limit on the 
extent to which the true price for those who access quotations, and the 
true price realized by those who supply liquidity for quotations, can 
vary from the displayed price. Consequently, the $0.003 fee limitation 
would further the statutory purposes of the NMS by harmonizing 
quotation practices and precluding the distortive effects of exorbitant 
fees and liquidity rebates. Moreover, the fee limitation would be 
needed to further the statutory purpose of enabling broker-dealers to 
route orders in a manner consistent with the

[[Page 77452]]

operation of the NMS.\195\ To protect limit orders, orders must be 
routed to those markets displaying the best-priced quotations. This 
purpose would be thwarted if market participants were allowed to charge 
exorbitant fees that distort quoted prices.
---------------------------------------------------------------------------

    \195\ Section 11A(c)(1)(E) of the Exchange Act authorizes the 
Commission to adopt rules assuring that broker-dealers transmit 
orders for NMS stocks in a manner consistent with the establishment 
and operation of a national market system.
---------------------------------------------------------------------------

    Finally, the access fee limitation is narrowly drafted to cover 
only quotations that market participants would be required to access 
because of the Trade-Through Rule. The limitation would not apply to 
depth-of-book quotations (unless such quotations were designated as 
protected quotations under the Voluntary Depth Alternative) or to any 
other services offered by markets. It thereby would provide the 
necessary support for proper functioning of the Trade-Through Rule and 
private linkages, while leaving trading centers otherwise free to set 
fees subject only to other applicable standards (e.g., prohibiting 
unfair discrimination).
3. Locking or Crossing Quotations
    The access proposal provided that the SROs must establish and 
enforce rules (1) requiring their members reasonably to avoid posting 
quotations that lock or cross the quotations of other markets, (2) 
enabling the reconciliation of locked or crossed markets, and (3) 
prohibiting their members from engaging in a pattern or practice of 
locking or crossing quotations. In light of the discussion at the NMS 
Hearing concerning automated quotations and automated markets,\196\ the 
Supplemental Release requested comment on whether market participants 
should be allowed to submit automated quotations that lock or cross 
manual quotations.\197\
---------------------------------------------------------------------------

    \196\ See supra, section II.A.2.
    \197\ Supplemental Release, 69 FR at 30147.
---------------------------------------------------------------------------

    Most of the commenters who addressed the issue supported the 
proposed restrictions on locking and crossing quotations.\198\ They 
generally agreed that the practice of displaying quotations that lock 
or cross previously displayed quotations is inconsistent with fair and 
orderly markets and detracts from market efficiency. One noted, for 
example, that locked and crossed markets ``can be a sign of an 
inefficient market structure'' and ``may create confusion for 
investors, as it is unclear under such circumstances what is the true 
trading interest in a stock.''\199\ Some commenters asserted that 
locked markets often occur when a market participant deliberately posts 
a locking quotation to avoid paying a fee to access the quotation of 
another market and to receive a liquidity rebate for an execution 
against its own displayed quotation.\200\ Nasdaq submitted data 
regarding the frequency of locked and crossed markets. During a one-
week period in March 2004, it found that markets for Nasdaq stocks were 
locked or crossed an average of 509,018 times each day, with an average 
of 194,638 of the locks and crosses lasting more than 1 second and an 
average duration of all locks and crosses of 3.1 seconds.\201\ Nasdaq 
stocks currently are not subject to provisions discouraging intermarket 
locking or crossing quotations such as those contained in the ITS Plan.
---------------------------------------------------------------------------

    \198\ Amex Letter, Exhibit A at 27-28; Letter from Steve 
Swanson, Chief Executive Officer & President, Automated Trading 
Desk, LLC, to Jonathan G. Katz, Secretary, Commission, dated June 
30, 2004 (``ATD Letter'') at 3; Brut Letter at 17; BSE Letter at 13; 
Citigroup Letter at 14; E*Trade Letter at 10; ICI Letter at 18; JP 
Morgan Letter at 6; Nasdaq Letter II at 23-24; NYSE Letter, 
Attachment at 9; SIA Letter at 19-20; STA Letter at 6; STANY Letter 
at 8; UBS Letter at 9-10.
    \199\ ICI Letter at 18.
    \200\ Amex Letter, Exhibit A at 27-28; ATD Letter at 3; ICI 
Letter at 18; Nasdaq Letter II at 23.
    \201\ Nasdaq Letter II at 23.
---------------------------------------------------------------------------

    A few commenters opposed restricting the practice of locking or 
crossing quotations.\202\ They generally believed that the proposal 
would impair market transparency and efficiency, such as by prohibiting 
the display of information as to the true level of trading interest or 
information that a particular market's quotations may be inaccessible. 
One commenter identified a number of causes, apart from access fees and 
liquidity rebates, that could lead to locked and crossed markets.\203\ 
These included determinations by market participants that quotations 
displayed by a locked or crossed market are not truly accessible, 
decisions by market participants that the potential disadvantages of 
routing away outweigh the potential advantages (e.g., loss of execution 
priority on the market place currently displaying the order), and 
decisions by market participants to exclusively use a particular market 
to run a trading strategy, even at the risk of missing some trading 
opportunities.
---------------------------------------------------------------------------

    \202\ Letter from Linda Lerner, General Counsel, Domestic 
Securities, Inc., to Jonathan G. Katz, Secretary, Commission, dated 
September 9, 2004 (``Domestic Securities Letter'') at 2-3; Hudson 
River Trading Letter at 5-6; Instinet Letter at 39-41; Letter from 
Michael J. Simon, Senior Vice President & Secretary, International 
Securities Exchange, Inc., to Jonathan G. Katz, Secretary, 
Commission, dated June 30, 2004 (``ISE Letter'') at 7-8; Tower 
Research Letter at 6-8.
    \203\ Instinet Letter at 39.
---------------------------------------------------------------------------

    The Commission has decided to repropose restrictions on the 
practice of displaying locking or crossing quotations, but, consistent 
with its approach in the reproposed Trade-Through Rule, has modified 
the proposal to allow automated quotations to lock or cross manual 
quotations. Rule 610(d) as reproposed thereby would address the concern 
that manual quotations may not be fully accessible and would recognize 
that allowing automated quotations to lock or cross manual quotations 
may provide useful market information. The Commission preliminarily 
believes, however, that an automated quotation is entitled to 
protection from locking or crossing quotations. When two market 
participants are willing to trade at the same quoted price, giving 
priority to the first-displayed automated quotation would contribute to 
fair and orderly markets. Moreover, the basic principle underlying the 
NMS is to promote fair competition among markets, but within a unified 
system that also promotes interaction between all of the buyers and 
sellers in a particular NMS stock. Allowing market participants simply 
to ignore accessible quotations in other markets and routinely display 
locking and crossing quotations would be inconsistent with this 
principle.

B. Description of Reproposed Rule

    Paragraphs (a) and (b) of reproposed Rule 610 address access to all 
quotations displayed by an SRO trading facility or by an SRO display-
only facility. Paragraph (c) addresses the fees charged for access to 
protected quotations, and paragraph (d) addresses locking and crossing 
quotations. The Commission also is reproposing an extension of the 
scope of the fair access requirements of Regulation ATS.
1. Access to Quotations
    a. Quotations of SRO Trading Facilities. Paragraph (a) of 
reproposed Rule 610 applies to quotations of an SRO trading facility. 
In reproposed Rule 600(b)(72), an SRO trading facility is defined as a 
facility operated by a national securities exchange or a national 
securities association that executes orders in securities or presents 
orders to members for execution.\204\ This definition therefore would 
encompass the trading facilities of each of the exchanges, as well as 
the NASDAQ Market Center. The term ``quotations'' is defined in 
reproposed Rule 600(b)(63) as bids and offers, and ``bid'' or ``offer'' 
is defined in reproposed Rule 600(b)(8) as the bid

[[Page 77453]]

price or the offer price communicated by a member of a national 
securities exchange or national securities association to any broker or 
dealer or to any customer. Reproposed Rule 610(a) therefore would apply 
to the entire depth of book of displayed orders of an SRO trading 
facility.
---------------------------------------------------------------------------

    \204\ For clarity, the definition of ``SRO trading facility'' 
replaces the definition of ``quoting market center'' in the 
proposal. It is consistent with the old definition.
---------------------------------------------------------------------------

    Reproposed Rule 610(a) would prohibit an SRO from imposing unfairly 
discriminatory terms that prevent or inhibit any person from obtaining 
efficient access through a member of the SRO to the quotations in an 
NMS stock displayed by the SRO trading facility. This anti-
discrimination standard is designed to give non-members indirect access 
to quotations through members, but is premised on the fact that the 
SRO's members themselves have fair and efficient access to the 
quotations of the SRO's trading facility. Such access currently is 
addressed by a series of provisions of the Exchange Act. Sections 
6(b)(1) and 15A(b)(2) require that an exchange or association must have 
the capacity to be able to carry out the purposes of the Exchange Act. 
Sections 6(b)(5) and 15A(b)(6) require an exchange or association to 
have rules designed to remove impediments to and perfect the mechanism 
of a free and open market and a national market system. Section 
11A(a)(1)(C) provides that two of the objectives of a national market 
system are to assure the economically efficient execution of securities 
transactions and the practicability of brokers executing investors' 
orders in the best market. Neither of these objectives is possible if 
an SRO's members--those entities that have the right to trade directly 
on an SRO facility--do not themselves have fair and efficient access to 
the quotations displayed on such facility.
    Reproposed Rule 610(a) would build on this existing regulatory 
structure by prohibiting unfair discrimination that prevents or 
inhibits non-members from piggybacking on the access of members. In the 
absence of mandatory public linkages directly between markets, the 
ability to obtain indirect access is necessary to assure that competing 
markets can meet the requirements of the Trade-Through Rule and that 
all brokers can fulfill their duty of best execution. In general, any 
SRO rule or practice that treats orders less favorably based on the 
identity of the ultimate party submitting the order through an SRO 
member would violate reproposed Rule 610(a). Thus, for example, 
charging differential fees or reducing an order's priority based on the 
identity of a member's customer would violate reproposed Rule 610(a).
    Given the critical importance of indirect access to the private 
linkage approach incorporated in reproposed Rule 610(a), the Commission 
intends to review the current extent to which SRO members have fair and 
efficient access to quotations in NMS stocks that are displayed on an 
SRO trading facility, which term does not include the NASD's ADF, as 
discussed below. In this regard, it emphasizes that the SROs cannot 
meet the access requirements of the Exchange Act by relying on access 
provided by trading centers that are not a facility operated by the 
SRO. Thus, if a trading center displays quotes on an SRO trading 
facility, but also provides direct access to such quotes, that SRO 
could not rely on the level of direct access to the non-SRO trading 
center to meet its Exchange Act responsibilities. An SRO trading 
facility must itself provide fair and efficient access to the 
quotations that are displayed as quotations of such SRO. Stated another 
way, an SRO trading facility cannot be used simply as a conduit for the 
display of quotations that cannot be accessed fairly and efficiently 
through the SRO trading facility itself. Accordingly, each SRO's 
facilities would be reviewed to determine whether they were able to 
meet the enhanced need for access under the reproposed regulatory 
structure.
    b. Quotations of SRO Display-Only Facility. Paragraph (b) of 
reproposed Rule 610 would apply to all quotations displayed by an SRO 
display-only facility. The term ``SRO display-only facility'' is 
defined in reproposed Rule 600(b)(71) as a facility operated by a 
national securities exchange or national securities association that 
displays quotations in securities, but does not execute orders against 
such quotations. For quotations in NMS stocks, this definition 
currently would encompass only the NASD's ADF.\205\
---------------------------------------------------------------------------

    \205\ As proposed, the indirect access requirement for ADF 
participants would have applied only to trading centers whose 
quotations were solely accessible in the ADF and not through an SRO 
trading facility. As reproposed, Rule 610(b)(1) applies to all 
quotations displayed on an SRO display-only facility, even if the 
trading center also displays quotations in an SRO trading facility. 
This modification is needed to preclude the consolidated data stream 
from giving a misleading indication of available liquidity. Separate 
quotations displayed on an SRO trading facility and an SRO display-
only facility must each be fully accessible.
---------------------------------------------------------------------------

    Paragraph (b)(1) of reproposed Rule 610 would require any trading 
center that displays quotations in NMS stocks through an SRO display-
only facility to provide a level and cost of access to such quotations 
that is substantially equivalent to the level and cost of access to 
quotations displayed by SRO trading facilities. The phrase ``level and 
cost of access'' would encompass both (1) the policies, procedures, and 
standards that govern access to quotations of the trading center, and 
(2) the connectivity through which market participants can obtain 
access and the cost of such connectivity. As discussed in section 
III.A.1 above, trading centers that choose to display quotations in an 
SRO display-only facility would be required to bear the responsibility 
of establishing the necessary connections to afford fair and efficient 
access to their quotations. The nature and cost of these connections 
for market participants seeking to access the trading center's 
quotations would need to be substantially equivalent to the nature and 
cost of connections to SRO trading facilities. In recent years, a 
variety of different types of entities have entered the business of 
providing connections for brokers and market participants to different 
trading centers. The Commission anticipates that ADF participants would 
take advantage of these service providers to establish the necessary 
connectivity. The NASD, as the self-regulatory authority responsible 
for enforcing compliance by ADF participants with the requirements of 
the Exchange Act, would need to evaluate the connectivity of ADF 
participants to determine whether it meets the requirements of Rule 
610(b)(1).
    Paragraph (b)(2) of reproposed Rule 610 would prohibit any trading 
center that displays quotations through an SRO display-only facility 
from imposing unfairly discriminatory terms that prevent or inhibit any 
person from obtaining efficient access to such quotations through a 
member, subscriber, or customer of the trading center. This prohibition 
parallels the prohibition in reproposed Rule 610(a) that applies to the 
quotations of SRO trading facilities. Thus, a trading center's 
differential treatment of orders based on the identity of the party 
ultimately submitting an order through a member, subscriber, or 
customer of such trading center generally would be prohibited.
2. Limitation on Access Fees
    Reproposed Rule 610(c) would limit the fees that could be charged 
for access to protected quotations. It provides that a trading center 
shall not impose, nor permit to be imposed, any fee or fees for the 
execution of orders against its protected quotations in an NMS stock 
that exceed or accumulate to more than $0.003 per share or, for its 
protected quotations with a price of less than $1.00, that exceed or 
accumulate to

[[Page 77454]]

more than 0.3% of the quotation price per share.
    Thus, the scope of reproposed Rule 610(c) would be limited to 
quotations protected by the Trade-Through Rule. Under the alternative 
definitions of ``protected bid'' and ``protected offer'' reproposed for 
Rule 600(b)(57), the fee limitation would apply, at a minimum, to an 
automated quotation that is the BBO of an exchange, the NASDAQ Market 
Center, or the ADF. If the Voluntary Depth Alternative were adopted and 
markets voluntarily obtained protection for their depth-of-book 
quotations, the fee limitation also would apply to orders accessing 
these quotations.\206\ When triggered, the fee limitation of Rule 
610(c) would apply to any order execution at the displayed price of the 
protected quotation. It therefore would encompass executions against 
both the displayed size and any reserve size at the price of a 
protected quotation.
---------------------------------------------------------------------------

    \206\ See supra, section II.A.5 (scope of quotations protected 
by reproposed Trade-Through Rule).
---------------------------------------------------------------------------

    Reproposed Rule 610(c) would encompass a wide variety of fees 
currently charged by trading centers, including both the fees commonly 
known as access fees charged by ECNs and the transaction fees charged 
by SROs. So long as the fees are based on the execution of an order 
against a protected quotation, the restriction of reproposed Rule 
610(c) would apply. Conversely, fees not triggered by the execution of 
orders against protected quotations (e.g., certain periodic fees such 
as monthly or annual fees) generally would not be included.
    In addition, reproposed Rule 610(c) would encompass any fee charged 
directly by a trading center, as well as any fee charged by market 
participants that display quotations through the trading center's 
facilities. Trading centers would have flexibility in establishing 
their fee schedules to comply with reproposed Rule 610(c). In 
particular, trading centers could impose a limit on the fees that 
market participants are permitted to charge for quotations that are 
accessed through a trading center's facilities. For example, Nasdaq has 
adopted such a limit for quotations displayed by the NASDAQ Market 
Center.\207\
---------------------------------------------------------------------------

    \207\ NASD Rule 4623(b)(6).
---------------------------------------------------------------------------

    If reproposed Rule 610(c) were adopted, market makers would be 
permitted to charge fees for accessing their quotations, so long as 
such fees met the Rule's requirements. Market makers currently are not 
permitted to charge access fees under the Quote Rule. To promote the 
equal regulation of markets, the Commission preliminarily believes 
that, if reproposed Rule 610(c) were adopted, it would be consistent 
with the Quote Rule for market makers to charge access fees. In 
particular, market makers would be permitted to charge fees for 
executions of orders against their protected quotations irrespective of 
whether the order executions are effected on an SRO trading facility or 
directly by the market maker.
3. Locking or Crossing Quotations
    Reproposed Rule 610(d) would restrict locking or crossing 
quotations, but would recognize that locked and crossed markets can 
occur accidentally, especially given the differing speeds with which 
trading centers update their quotations. It would require that each 
national securities exchange and national securities association 
establish and enforce rules that: (1) Require its members to reasonably 
avoid displaying quotations that lock or cross any protected quotation 
in an NMS stock, or of displaying manual quotations that lock or cross 
any quotation in an NMS stock disseminated pursuant to an effective 
national market system plan; (2) are reasonably designed to assure the 
reconciliation of locked or crossed quotations in an NMS stock; and (3) 
prohibit its members from engaging in a pattern or practice of 
displaying quotations that lock or cross any protected quotation in an 
NMS stock, or of displaying manual quotations that lock or cross any 
quotation in an NMS stock disseminated pursuant to an effective 
national market system plan.
    Thus, reproposed Rule 610(d) would distinguish between protected 
(and therefore automated) \208\ quotations and manual quotations. 
Protected quotations could not be crossed or locked by any other 
quotations. Manual quotations, in contrast, could be locked or crossed 
by automated quotations, but could not themselves lock or cross any 
other quotations included in the consolidated data stream, whether 
automated or manual. Recognizing that quotations may on occasion 
accidentally lock or cross other quotations, reproposed Rule 610(d) 
would require members to ``reasonably avoid'' locking and crossing and 
prohibits a ``pattern or practice'' of locking or crossing. SRO rules 
could include so-called ``ship and post'' procedures that require a 
market participant to attempt to execute against a relevant displayed 
quotation while posting a quotation that could lock or cross such a 
quotation. Finally, reproposed Rule 610(d)(2) would require that each 
SRO's rules be reasonably designed to enable the reconciliation of 
locked or crossed quotations in an NMS stock. Such rules would require 
the market participant responsible for displaying the locking or 
crossing quotation to take reasonable action to resolve the locked or 
crossed market.
---------------------------------------------------------------------------

    \208\ Under Rule 600(b)(57), only automated quotations can 
qualify as protected quotations.
---------------------------------------------------------------------------

4. Regulation ATS Fair Access
    The ``fair access'' standards of Rule 301(b)(5) of Regulation ATS 
\209\ require a covered ATS, among other things, to (1) establish 
written standards for granting access on its system, and (2) not 
unreasonably prohibit or limit any person in respect to services 
offered by the ATS by applying its access standards in an unfair or 
discriminatory manner. The Commission is reproposing an amendment to 
this section of Regulation ATS to lower the threshold that triggers the 
Regulation ATS fair access requirements from 20% of the average daily 
volume in a security to 5%.\210\ Under the access approach reproposed 
today, the fairness and efficiency of private linkages would assume 
heightened importance. A critical component of private linkages is the 
ability of interested market participants to become members or 
subscribers of a trading center, particularly those trading centers 
with significant trading volume. As discussed in section III.A1 above, 
market participants then may use their membership or subscribership 
access as a means for others to obtain indirect access by piggybacking 
on the direct access of members or subscribers. The Commission 
therefore believes that it would be appropriate to lower the fair 
access threshold of Regulation ATS.\211\ Lowering the threshold for 
paragraph (b)(5) of Rule 301 also would make its coverage consistent 
with the 5% threshold triggering the order display and execution access 
requirements of Rule 301(b)(3). As a result, each ATS required to 
disseminate its quotations in the consolidated data stream also would 
be prohibited from unreasonably

[[Page 77455]]

limiting market participants from becoming a subscriber or customer. 
Aside from lowering the threshold, the substantive requirements of Rule 
301(b)(5) would be left unchanged.
---------------------------------------------------------------------------

    \209\ 17 CFR 242.301(b)(5).
    \210\ The Regulation ATS fair access requirements are triggered 
on a security-by-security basis for equity securities. See 
Securities Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 
70844, 70873 (Dec. 22, 1998).
    \211\ One commenter opposed the proposal to lower the threshold 
for Regulation ATS fair access, primarily because it largely acts as 
an agency broker that routes orders to other venues. Bloomberg 
Tradebook Letter at 7. The Commission preliminarily believes that 
ATSs, which by definition has chosen to offer market functions 
beyond mere agency routing, would appropriately be subject to 
regulatory requirements that reflect such functions.
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IV. Sub-Penny Rule

    The Commission today is reproposing Rule 612 under the Exchange Act 
which would govern sub-penny quoting of NMS stocks. Rule 612 would 
impose new requirements on any bid, offer, order, or indication of 
interest that is displayed, ranked, or accepted by a national 
securities exchange, national securities association, ATS, vendor, or 
broker-dealer. The reproposed rule incorporates the substance of the 
initially proposed rule with a few minor revisions, as discussed below.

A. Background

    In June 2000, the Commission issued an order directing NASD and the 
national securities exchanges to act jointly in developing a plan to 
convert their quotations in equity securities and options from 
fractions to decimals.\212\ The June 2000 Order stated that the plan 
could fix the minimum price variation (``MPV'') during the phase-in 
period, provided that the MPV was no greater than $0.05 and no less 
than $0.01 for any equity security.\213\ The June 2000 Order also 
required NASD and the exchanges to provide the Commission with studies 
analyzing how decimal conversion had affected systems capacity, 
liquidity, and trading behavior, including an analysis of whether there 
should be a uniform MPV.\214\ The Commission stated that, if NASD or an 
exchange wished to move to quoting stocks in an increment less than 
$0.01, its study should include a full analysis of the potential impact 
on the market requesting the change and on the markets as a whole.\215\ 
Furthermore, the Commission required each SRO to propose a rule change 
under Section 19(b) of the Exchange Act \216\ to establish its 
individual choice of MPV for securities traded on its market.\217\ NASD 
and the exchanges complied with these requirements, and in August 2002 
the Commission approved rule changes from all of these SROs to 
establish MPVs in NMS stocks of $0.01.\218\
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    \212\ See Securities Exchange Act Release No. 42194 (June 8, 
2000), 65 FR 38010 (June 19, 2000) (``June 2000 Order''). On January 
28, 2000, the Commission ordered NASD and the exchanges to 
facilitate an orderly transition to decimal pricing in the 
securities markets. See Securities Exchange Act Release No. 42360 
(Jan. 28, 2000), 65 FR 5003 (Feb. 2, 2000). In that order, the 
Commission set a timetable for NASD and the exchanges to begin 
trading some equity securities, and options on those securities, in 
decimals by July 3, 2000, and to begin trading all equities and 
options by January 3, 2001. See January 2000 Order, 65 FR at 5005. 
In April 2000, the Commission issued another order staying the 
original deadlines for decimalization. See Securities Exchange Act 
Release No. 42685 (Apr. 13, 2000), 65 FR 21046 (Apr. 19, 2000).
    \213\ See June 2000 Order, 65 FR at 38013. The June 2000 Order 
also required that at least some equity securities be quoted in 
minimum increments of $0.01. See id.
    \214\ See id.
    \215\ See id.
    \216\ 15 U.S.C. 78s(b).
    \217\ See June 2000 Order, 65 FR at 38013.
    \218\ See Securities Exchange Act Release No. 46280 (July 29, 
2002), 67 FR 50739 (Aug. 5, 2002) (``August 2002 Order'') (approving 
SR-Amex-2002-02, SR-BSE-2002-02, SR-CBOE-2002-02, SR-CHX-2002-06, 
SR-CSE-2002-02, SR-ISE-2002-06, SR-NASD-2002-08, SR-NYSE-2002-12, 
SR-PCX-2002-04, and SR-Phlx-2002-05).
---------------------------------------------------------------------------

    Between the June 2000 Order and the August 2002 Order, the 
Commission issued a Concept Release seeking public comment on the 
potential impact of sub-penny pricing,\219\ including its effect on: 
(1) Price clarity (e.g., the potential to cause ephemeral or 
``flickering'' quotations); (2) market depth (i.e., the number of 
shares available at a given price); (3) compliance with the Order 
Handling Rules and other price-dependent rules; and (4) the operations 
and capacity of automated systems.\220\ The Commission received 33 
comments on the Concept Release.\221\ The majority of commenters 
opposed sub-penny pricing. Some stated that the negative effects of 
decimal trading would be exacerbated by reducing the MPV even further, 
without meaningfully reducing spreads or securing other benefits for 
the markets or investors.\222\ These commenters recommended that all 
securities have an MPV of at least a penny.\223\ A smaller number of 
commenters believed that the forces of competition, rather than 
regulation by the Commission or Congress, should determine the 
MPV.\224\ These commenters suggested that a smaller MPV could improve 
market efficiency and provide investors with greater opportunity for 
price improvement. They argued in general that the problems 
accompanying decimals could be resolved through technology 
enhancements, rather than through regulation.
---------------------------------------------------------------------------

    \219\ Securities Exchange Act Release No. 44568 (July 18, 2001), 
66 FR 38390 (July 24, 2001) (``Concept Release'').
    \220\ See 66 FR at 38391-95.
    \221\ For a list of the commenters, see Proposing Release, 69 FR 
at 11165.
    \222\ See id.
    \223\ However, some commenters that opposed sub-penny quoting 
thought that trading in sub-pennies should be permitted. See id.
    \224\ See id. at 11165-66.
---------------------------------------------------------------------------

    In August 2003, Nasdaq submitted a proposed rule change to the 
Commission to adopt an MPV of $0.001 for Nasdaq-listed securities.\225\ 
Nasdaq stated that, unless and until a uniform MPV is established, it 
believed it must implement an MPV of $0.001 to remain competitive with 
ECNs that permit their subscribers to quote in sub-pennies. 
Simultaneous with the proposed rule change, Nasdaq filed a petition for 
Commission action urging the Commission ``to adopt a uniform rule 
requiring market participants to quote and trade Nasdaq securities in a 
consistent monetary increment * * * with the exception of average price 
trades.'' \226\
---------------------------------------------------------------------------

    \225\ See SR-NASD-2003-121. Nasdaq has since withdrawn this 
proposal.
    \226\ Letter to Jonathan G. Katz, Secretary, Commission, from 
Edward S. Knight, Executive Vice President, Nasdaq, dated August 4, 
2003 (``Nasdaq Petition'').
---------------------------------------------------------------------------

B. Commission Proposal on Sub-Penny Quoting

    In February 2004, the Commission proposed new Rule 612 that would 
govern quoting in sub-pennies as part of the overall Regulation NMS 
proposal. In the Proposing Release, the Commission summarized the 
conversion of the U.S. securities markets from fractional to 
decimalized trading and stated its view that, on balance, the benefits 
of decimalization have justified the costs. The Commission cautioned, 
however, that if the MPV decreases beyond a certain level the potential 
costs to investors and the markets might increase and could at some 
point surpass any potential benefits.\227\ To address this concern, 
proposed Rule 612 would prohibit any national securities exchange, 
national securities association, ATS, vendor, or broker-dealer from 
displaying, ranking, or accepting from any person bid, offer, order, or 
indication of interest in any NMS stock priced in an increment less 
than $0.01. Proposed Rule 612 would not impose this restriction on any 
NMS stock the share price of which is below $1.00.
---------------------------------------------------------------------------

    \227\ See Proposing Release, 69 FR at 11165.
---------------------------------------------------------------------------

    The proposed rule was designed to limit the ability of a market 
participant to gain execution priority by bettering the price of 
another limit order by an economically insignificant amount. In issuing 
the sub-penny proposal, the Commission cited research performed by OEA 
strongly suggesting that much sub-penny quoting currently taking place 
results from market participants attempting to step ahead of limit 
orders for the smallest economic increment possible.\228\ This 
conclusion was based on the high incidence of sub-penny

[[Page 77456]]

trades that cluster around the $0.001 and $0.009 price points.
---------------------------------------------------------------------------

    \228\ See 69 FR at 11169-70.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission pointed to a variety of 
potential problems caused by sub-penny quoting, including the 
following:
     If investors' limit orders lose execution priority for a 
nominal amount, investors may over time decline to use them, thus 
depriving the markets of liquidity.
     When market participants can gain execution priority for 
an infinitesimally small amount, important customer protection rules 
such as exchange priority rules and NASD's Manning rule \229\ could be 
rendered meaningless. Without these protections, professional traders 
would have more opportunity to take advantage of non-professionals, 
which could result in the latter either losing executions or receiving 
executions at inferior prices.
---------------------------------------------------------------------------

    \229\ See NASD IM-2110-2 (generally requiring that a member firm 
that accepts and holds an unexecuted limit order from its customer 
in a Nasdaq security and that continues to trade the subject 
security for its own market-making account at prices that would 
satisfy the customer's limit order, without executing that limit 
order, shall be deemed to have acted in a manner inconsistent with 
just and equitable principles of trade). The impetus for this rule 
was a case brought by a customer of an NASD member firm, William 
Manning, who alleged that the firm had accepted his limit order, 
failed to execute it, and violated its fiduciary duty to him by 
trading ahead of the order. In the Manning decision, In re E.F. 
Hutton & Co., Exchange Act Release No. 25887 (July 6, 1988), the 
Commission affirmed NASD's finding that a member firm, upon 
acceptance of a customer's limit order, undertakes a fiduciary duty 
to its customer and cannot trade for its own account at prices more 
favorable than the customer's order.
---------------------------------------------------------------------------

     Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to 
satisfy their best execution obligations and other regulatory 
responsibilities. The best execution obligation requires a broker-
dealer to seek for its customer's transaction the most favorable terms 
reasonably available under the circumstances.\230\ This standard is 
premised on the practical ability of the broker-dealer to determine 
whether a displayed price is reasonably obtainable under the 
circumstances.
---------------------------------------------------------------------------

    \230\ See Securities Exchange Act Release No. 37619A (Sept. 6, 
1996), 61 FR 48290, 48322 (Sept. 12, 1996) (adopting the 
Commission's Order Handling Rules). A broker-dealer's duty of best 
execution derives from common law agency principles and fiduciary 
obligations and is incorporated in both SRO rules and, through 
judicial and Commission decisions, in the antifraud provisions of 
the federal securities laws. See id.
---------------------------------------------------------------------------

     Widespread sub-penny quoting could decrease market depth 
(i.e., the number of shares available at the NBBO). This could lead to 
higher transaction costs, particularly for institutional investors 
(such as pension funds and mutual funds), which are more likely to 
place large orders. These higher transaction costs would likely be 
passed on to retail investors whose assets are managed by the 
institutions.
     Decreasing depth at the inside also could cause such 
institutions to rely more on execution alternatives away from the 
exchanges and Nasdaq that are designed to help larger investors find 
matches for large blocks of securities. Such a trend could increase 
fragmentation of the securities markets.

C. Comments Received

    The Commission sought comment on all aspects of proposed Rule 612, 
including the potential problems with sub-penny quoting noted above. Of 
the comments that the Commission received in response to the Regulation 
NMS Proposing Release, approximately 60 separate commenters addressed 
the sub-penny proposal.
1. Comments Addressing Overall Proposal
    A majority of commenters supported the proposed sub-penny 
rule.\231\ Several commenters concurred with the Commission's view that 
sub-penny quoting is widely used to step-ahead of competing limit 
orders.\232\ One commenter, an ECN, stated that it carried out an 
informal survey of its buy-side clients, and of the 158 responses 
received 145 said that they opposed sub-penny quoting.\233\ The ECN 
concluded that ``[its] clients believe that quoting in sub pennies is 
used, not for bona fide price improvement, but to jump ahead of their 
limit orders.'' \234\ Another commenter, a large discount brokerage 
firm, stated that it ceased allowing its clients to submit sub-penny 
orders in April 2003 ``because it had determined that clients were 
using sub-pennies to step ahead of resting limit orders and undermining 
the Manning provision.'' \235\ A third commenter stated that the 
reduction of the MPV has allowed ``speculators'' to post quotations at 
small increments ahead of institutional trading interest, resulting in 
decreased liquidity as such institutional interest began seeking 
methods of execution other than the posting of limit orders. \236\
---------------------------------------------------------------------------

    \231\ See, e.g., AFB Letter at 12; American Century Letter at 2; 
Ameritrade Letter at 10; Archipelago Letter at 14; ATD Letter at 3-
4; Bloomberg Tradebook Letter at 2; BoNY Letter at 4; BSE Letter at 
13-14; CBOE Letter at 7; Citadel Letter at 9; Citigroup Letter at 
14-15; CSE Letter at 23; Denizkurt E-mail; E*Trade Letter at 11; 
Financial Information Forum Letter at 2-3; Financial Services 
Roundtable Letter at 5-6; Florida State Board Letter at 2; Goldman 
Sachs Letter at 10; ICI Letter at 19-20; ISE Letter at 8; JP Morgan 
Letter at 6-7; Knight Letter at 7-8; Lava Trading Letter at 5; 
Lehman Brothers Letter at 5; Liquidnet Letter at 8; LSC Letter at 
11; Morgan Stanley Letter at 3; Nasdaq Letter at 1-2; NYSE Letter at 
9-10; NSX Letter at 9; Peake I Letter at 13; Reuters Letter at 4; 
Schwab Letter at 17; SIA Letter at 20-21; Specialist Assoc. Letter 
at 13-15; STA Letter at 7; STANY Letter at 13-14; UBS Letter at 10; 
Vanguard Letter at 6.
    \232\ See, e.g., Ameritrade Letter at 10; Archipelago Letter at 
14; ATD Letter at 3; Bloomberg Tradebook Letter at 2; Citadel Letter 
at 9; Citigroup Letter at 14; ICI Letter at 7-8; Tullo Letter at 8.
    \233\ See Bloomberg Tradebook Letter at 2.
    \234\ Id.
    \235\ Ameritrade Letter at 10.
    \236\ See Tullo Letter at 8.
---------------------------------------------------------------------------

    Furthermore, the commenters supporting the Commission's sub-penny 
proposal were generally of the view that the marginal benefits of a 
further reduction in the MPV were not justified by the associated 
costs.\237\ Several commenters argued, in essence, that ``[a]n 
industry-wide shift to quoting in sub-pennies would * * * require 
costly additional investments in systems capacity while producing 
little in the way of more efficient markets.'' \238\ Several commenters 
also believed that sub-penny quotations increase the incidence of quote 
flickering, which in turn may have adverse effects such as creating 
investor confusion or impeding a broker-dealer's duty of best 
execution.\239\
---------------------------------------------------------------------------

    \237\ See, e.g., Citigroup Letter at 14; LSC Letter at 11; STA 
Letter at 7; STANY Letter at 10-11.
    \238\ Reuters Letter at 4. See also Financial Information Forum 
Letter at 2-3; Financial Services Roundtable Letter at 6; Knight 
Letter at 7; Lehman Brothers Letter at 5.
    \239\ See, e.g., Citadel Letter at 9; ICI Letter at 7; Knight 
Letter at 7; Reuters Letter at 4; SIA Letter at 20-21.
---------------------------------------------------------------------------

    However, a minority of commenters opposed the Commission's proposal 
to prohibit sub-penny quoting.\240\ These commenters generally argued 
that the MPV should be determined by market forces. Two commenters 
believed that regulating quoting conventions would ``prevent 
marketplaces from making subsequent innovative changes to their 
quotation increments to respond to the needs of investors'' \241\ and 
``legislate[] a maximum efficiency for the market instead of allowing 
further improvement.'' \242\ Other commenters stated that quoting in 
sub-pennies can increase liquidity, lower trading costs,

[[Page 77457]]

and promote efficient pricing in the equity markets.\243\
---------------------------------------------------------------------------

    \240\ See Brut Letter at 24; Domestic Securities Summary of 
Intended Testimony (no page numbers); GETCO Letter (no page 
numbers); Hudson River Trading Meeting Memo (no page numbers); 
Instinet Letter at 50; King Letter at 1; Mercatus Center Letter at 
7; NexTrade Letter at 9-10; Reg NMS Study Group Letter at 9; Tower 
Research Letter at 8; Vie Securities Letter at 3.
    \241\ Instinet Letter at 50.
    \242\ E-mail from John Martello, Managing Director, Tower 
Research Capital LLC, to [email protected], dated March 26, 
2004.
    \243\ See Hudson River Trading Testimony (no page numbers); 
GETCO Letter (no page numbers).
---------------------------------------------------------------------------

    These commenters generally argued that regulation was not necessary 
to remedy any perceived abuses caused by sub-penny quoting. Two 
commenters noted that some trading markets already have abandoned sub-
penny quoting.\244\ Another commenter added that ``[t]he problems 
attributed to subpenny quoting have been largely cleared up by the 
market, and are likely to further improve if the Commission removes 
some uncertainty from the marketplace by withdrawing its proposal.'' 
\245\ This commenter also criticized the Nasdaq and OEA studies on 
which the Commission relied in issuing the sub-penny proposal.\246\
---------------------------------------------------------------------------

    \244\ See Brut Letter at 24; Regulatory Studies Letter at 9.
    \245\ Tower Research Letter at 8.
    \246\ See id. Tower Research argued, for example, that the 
studies do not differentiate between sub-penny trades and sub-penny 
quotations and that clustering of sub-penny trades around the $0.001 
and $0.009 price points could be the result of other activity, such 
as market makers offering sub-penny price improvement. In response 
to this comment, OEA reviewed the sources of data used in the 
original study and found that sub-penny trades cluster at these two 
price points in both markets where trades necessarily result from 
quotations, such as ECNs, and where that is not necessarily the 
case. Accordingly, OEA continues to believe that market participants 
frequently used their ability to quote in sub-pennies to step ahead 
of competing limit orders by the smallest possible amount.
---------------------------------------------------------------------------

    Under reproposed Rule 612, the minimum spread for most NMS stocks 
would be $0.01. Two commenters stated that, as a result, investors 
would suffer harm from artificially widened spreads.\247\ Another 
commenter stated that ``the primary result of eliminating subpenny 
trading would be to preserve a minimum profit for market makers, and 
would result in significantly worse realized prices for the vast 
majority of market participants not in the business of making 
markets.'' \248\ This commenter analyzed trading in six high-volume 
securities and concluded that proposed Rule 612 would have costs of 
over $400 million in these securities alone due to wider spreads.\249\ 
Another commenter stated that, if all markets traded QQQQ solely in 
sub-pennies, the savings would be approximately $150 million per 
year.\250\
---------------------------------------------------------------------------

    \247\ See Instinet Letter at 51; Mercatus Center Letter at 9.
    \248\ Tower Group Letter at 8.
    \249\ See id. at 9.
    \250\ See Instinet Letter at 50.
---------------------------------------------------------------------------

    In summary, the comments received have reinforced the Commission's 
preliminary view that there are substantial drawbacks to allowing sub-
penny quoting, and the Commission believes that a uniform rule 
prohibiting sub-penny quoting (except for quotations less than $1.00) 
is appropriate in this case. Sub-penny quoting generally impedes 
transparency by reducing market depth at the NBBO and increasing quote 
flickering. In an environment where the NBBO can change very quickly, 
broker-dealers will have more difficulty in carrying out their duties 
of best execution and complying with other regulatory requirements that 
require them to identify the best bid or offer available at a 
particular moment (such as the Manning rule and the short sale rule).
    The Commission preliminarily believes that the $400 million and 
$150 million estimates of the cost to the markets caused by wider 
spreads provided by commenters are inaccurate and excessive. These 
estimates appear to assume that all trading activity would occur at 
narrower quoted spreads. The Commission does not believe that the 
commenters provided any evidence to justify that assumption. Currently, 
no national securities exchange or national securities association 
permits quoting in sub-pennies; sub-penny quoting occurs on only a 
small number of ATSs. Because spreads on most markets already cannot be 
smaller than $0.01, the Commission preliminarily does not believe that 
reproposed Rule 612 would require these markets to take any action that 
would cause their spreads to widen. Therefore, the Commission believes 
that the cost to these markets of not having sub-penny spreads should 
not be considered costs of the reproposed rule.\251\
---------------------------------------------------------------------------

    \251\ With respect to the ATSs that currently do permit some NMS 
stocks to be quoted in sub-pennies, the Commission staff has 
estimated that the costs of widened spreads in these securities 
would be approximately $48 million annually (or approximately $33 
million if the Commission were to exempt QQQQ from reproposed Rule 
612). See Memorandum to File from Office of Economic Analysis, dated 
December 15, 2004. A copy of this study has been placed in Public 
File No. S7-10-04 and is available for inspection on the 
Commission's Internet Web site (http://www.sec.gov/rules/proposed/s71004.shtml).
---------------------------------------------------------------------------

    Finally, the Commission agrees with the many commenters that 
believed that prohibiting sub-penny quoting will deter the practice of 
stepping ahead of exposed trading interest by an economically 
insignificant amount. Limit orders provide liquidity to the market and 
perform an important price-setting function. The Commission is 
concerned that, if a quotation or order can lose execution priority 
because of economically insignificant price improvement from a later-
arriving quotation or order, liquidity could diminish and some market 
participants could incur greater execution costs. As one commenter, the 
Investment Company Institute, stated, ``[t]his potential for the 
increased stepping-ahead of limit orders would create a significant 
disincentive for market participants to enter any sizeable volume into 
the markets and would reduce further the value of displaying limit 
orders.'' \252\ Improved liquidity should decrease the costs of 
trading, especially for large orders, since larger size should be 
available at fewer price points than would exist in a sub-penny quoting 
environment.
---------------------------------------------------------------------------

    \252\ ICI Letter at 20.
---------------------------------------------------------------------------

    The reproposed rule would make only minor changes to the initially 
proposed rule. Reproposed Rule 612(a) would prohibit sub-penny 
quotations in NMS stocks over $1.00. Rule 612(b) would allow sub-penny 
quotations below $1.00, but only to four decimal places. Rule 612(c) 
would establish procedures for the Commission to grant exemptions from 
paragraphs (a) and (b).
2. Response to Other Comments
    Beyond addressing the general thrust of the proposed sub-penny 
rule, some commenters discussed more specific matters. The Commission 
has revised the proposed sub-penny rule in response to certain of these 
comments, as discussed below.
    a. Restriction Based on Price of the Quotation not Price of the 
Stock. As initially proposed, the restriction on sub-penny quoting 
would be triggered if the price of the NMS stock itself were above 
$1.00. One commenter sought clarification of when an NMS stock became 
sub-penny eligible, suggesting a threshold of trading below $1.00 for 
30 consecutive business days.\253\ A second commenter suggested instead 
that the prohibition should derive from the price of the order, rather 
than the price of the stock; in other words, the rule should permit any 
sub-penny quotation below $1.00 and prohibit any sub-penny quotation 
above $1.00, regardless of the price level where the stock was in fact 
trading.\254\ The second commenter argued that this approach ``does not 
require countless re-classifications of stocks as 'sub-penny eligible' 
based on fluctuations in their valuation, stock splits, or other price 
movements.'' \255\
---------------------------------------------------------------------------

    \253\ See Citigroup Letter at 15.
    \254\ See Brut Letter at 25.
    \255\ Id.
---------------------------------------------------------------------------

    The Commission agrees with the second commenter. Basing the 
restrictions on the price of the quotation or order rather than the 
price of the NMS stock itself would spare market participants the need 
to track the

[[Page 77458]]

eligibility of stocks priced near the $1.00 threshold. Accordingly, 
paragraph (a) of reproposed Rule 612 would prohibit bids, offers, 
orders, and indications of interest equal to or greater than $1.00 in 
an increment smaller than $0.01. Therefore, a market participant could 
not, for example, accept a sell order in an NMS stock priced at 
$1.0025, even if the stock were trading below $1.00. The Commission 
requests comment on the new approach taken in reproposed Rule 612(a).
    b. Quotations Below $1.00. The Commission initially proposed a 
threshold of $1.00 below which the prohibition on sub-penny quoting 
would not apply and requested comment on whether that threshold was 
appropriate. The majority of commenters addressing this issue believed 
that it would be useful for low-priced securities to trade in 
increments finer than a penny, because a penny would constitute a 
significant percentage of the overall price. These commenters viewed 
$1.00 as an appropriate threshold.\256\ One commenter stated that there 
is ``real demand for sub-penny trading (and therefore subpenny quoting) 
in securities trading below $1.00, due to the low trading value of the 
security.'' \257\ The Commission agrees that sub-penny quotations for 
very low-priced securities largely represent genuine trading interest 
rather than an effort to step ahead of competing limit orders by an 
economically insignificant amount. In such cases, a sub-penny increment 
is more likely to represent a significant amount of the price of the 
quotation or order. Accordingly, the prohibition on sub-penny quoting 
in paragraph (a) of reproposed Rule 612 would apply only to bids, 
offers, orders, and indications of interest priced $1.00 or greater.
---------------------------------------------------------------------------

    \256\ See Archipelago Letter at 14; BSE Letter at 14; Citigroup 
Letter at 15; LSC Letter at 11; SIA Letter at 21; STANY Letter at 
14.
    \257\ Archipelago Letter at 14.
---------------------------------------------------------------------------

    Two commenters suggested that the Commission establish an MPV for 
quotations below $1.00; both recommended allowing such quotations to 
extend to four decimal places.\258\ The Commission agrees with these 
commenters and believes that it is reasonable to restrict quotations 
below $1.00 to four decimal places. Accordingly, paragraph (b) of 
reproposed Rule 612 would prohibit bids, offers, orders, and 
indications of interest priced less than $1.00 in an increment smaller 
than $0.0001. Without the ability to quote very low-priced securities 
in sub-pennies, market participants would be forced to express their 
trading interest in increments that represented a substantial portion 
of the overall quotation. However, if the number of decimal places for 
quotations in low-priced securities were not limited, the problems 
caused by sub-penny quoting of higher-priced securities, discussed 
above, could arise. Restricting quotations below $1.00 to four decimal 
places would avoid these problems. Under reproposed Rule 612, a 
quotation of $0.9987 x $1.00 would be permissible but a quotation of 
$0.9987 x $1.0001 would not. The Commission requests comment on whether 
limiting quotations priced below $1.00 to four decimal places is 
appropriate.
---------------------------------------------------------------------------

    \258\ See Citigroup Letter at 15; SIA Letter at 21.
---------------------------------------------------------------------------

    c. Revisiting the Penny Increment. Some commenters, while generally 
acknowledging problems caused by sub-penny quoting, recommended that 
the Commission consider increasing the MPV above $0.01.\259\ One 
commenter believed that ``[t]he Commission should seriously consider 
experimenting with different tick sizes to help determine the optimal 
tick policy.'' \260\ A second commenter recommended that the Commission 
establish an MPV of a $0.01 for high-volume stocks, $0.05 middle-volume 
stocks, and $0.10 for the low-volume stocks.\261\ A third commenter 
stated that ``sub-penny quoting does little, if anything, to degrade 
the market from its current state'' because, in the commenter's view, 
``the true damage was done to the market in the shift from a 
fractionalized environment to a penny spread environment.'' \262\
---------------------------------------------------------------------------

    \259\ See Amex Letter at 30; Angel Letter at 10; Anil Abraham 
Memo at 2; BoNY Letter at 4; Citadel Letter at 10; McGuire Summary 
of Intended Testimony (no page numbers); Tullo Letter at 9.
    \260\ Angel Letter at 10.
    \261\ See Tullo Letter at 9.
    \262\ NexTrade Letter at 9.
---------------------------------------------------------------------------

    Under reproposed Rule 612, the Commission would set a floor for the 
MPV, not determine the optimal MPV. Penny pricing was established by 
rules that were proposed by NASD and each of the national securities 
exchanges that trade NMS stocks and approved by the Commission pursuant 
to Section 19(b) of the Exchange Act.\263\ While some commenters have 
raised liquidity concerns regarding the $0.01 MPV, the move to decimals 
(and specifically the move to a penny MPV for equity securities) also 
has reduced spreads, thus resulting in reduced trading costs for 
investors entering orders--particularly smaller orders--that are 
executed at or within the quotations. Therefore, the Commission did not 
propose a higher MPV as part of the initial Regulation NMS proposal. 
However, if the SROs in the future believe that an increase in the MPV 
is necessary or desirable, they may propose rule changes to institute 
the higher MPV. The Commission would evaluate those proposals under the 
requirements of the Exchange Act at that time.
---------------------------------------------------------------------------

    \263\ 15 U.S.C. 78s(b). See supra note .
---------------------------------------------------------------------------

    d. Exemptions for Specific NMS Stocks. As initially proposed, Rule 
612 included a provision that would establish procedures for the 
Commission to grant exemptions to the rule, and the Commission 
requested comment on whether certain securities should be exempted from 
Rule 612.\264\ In particular, the Commission asked whether exchange-
traded fund shares (``ETFs''), which are derivatively priced, raise the 
same concerns that have been expressed with respect to sub-penny 
pricing generally.\265\
---------------------------------------------------------------------------

    \264\ See Proposing Release, 69 FR at 11172.
    \265\ See id.
---------------------------------------------------------------------------

    Of the commenters who addressed this issue, the majority argued 
that the sub-penny prohibition should apply to all NMS stocks, 
including ETFs.\266\ These commenters generally believed that sub-penny 
quoting raises the same type of concerns for ETFs as for other types of 
securities.\267\ On the other hand, other commenters provided arguments 
that exemptions for at least certain securities would be appropriate. 
One commenter that opposed Rule 612 argued that, if the Commission 
nevertheless did approve the rule, it should provide an exemption for 
QQQQ and other ETFs.\268\ This commenter argued that these securities 
``uniquely lend[] themselves to subpenny quoting and trading'' because 
``the[ir] derivative nature * * * enables investors to determine their 
true value at any point in time by calculating the aggregate price of 
the securities constituting a particular ETF.'' \269\ Other commenters, 
while not explicitly recommending that the Commission grant particular 
exemptions, argued that sub-penny quoting was reasonable for certain 
securities.\270\ One of these commenters noted, for example, that 
quotations in QQQQ are not clustered around the $0.001 and $0.009 price 
points, which suggests that sub-penny quotations are

[[Page 77459]]

not being entered for the purpose of stepping ahead.\271\
---------------------------------------------------------------------------

    \266\ See Amex Letter, Exhibit A, at 29; ICI Letter at 20; 
Knight Letter at 8; Morgan Stanley Letter at 21; NYSE Letter at 10; 
SIA Letter at 21; Specialist Association Letter at 14.
    \267\ See, e.g., Amex Letter, Exhibit A, at 29; ICI Letter at 
20.
    \268\ See Instinet Letter at 51.
    \269\ Id.
    \270\ See Brut Letter at 25; Mercatus Center Letter at 9-10; 
Tower Research Letter at 9, 14-15.
    \271\ See Mercatus Center Letter at 9.
---------------------------------------------------------------------------

    At this time, the Commission believes that a basis likely may exist 
to grant an exemption from the sub-penny quoting prohibition for QQQQ 
and perhaps other actively traded ETFs. This exemption would permit a 
national securities exchange, national securities association, ATS, 
vendor, or broker or dealer to display, rank, or accept from any person 
a bid or offer, an order, or an indication of interest--in QQQQ or 
perhaps other actively traded ETFs--in increments smaller than $0.01. 
The Commission intends to consider this matter further during the 
phase-in period for Regulation NMS, if Regulation NMS is adopted. The 
Commission also notes that, while the proposed effective date for 
Regulation NMS as a whole would be [November 5, 2005], the effective 
date for reproposed Rule 612(c), if adopted, would be 60 days from date 
of publication of final Regulation NMS in the Federal Register. 
Therefore, the Commission could exercise its exemptive authority such 
that any exemptions that it may grant pursuant to reproposed Rule 
612(c) could take effect simultaneously with the main prohibitions of 
Rule 612.
    e. Sub-Penny Trading. The Commission stated in the Proposing 
Release that it did not at that time believe that trading in sub-penny 
increments raised the same concerns as sub-penny quoting. Therefore, 
the proposed rule would not prohibit an exchange or association from 
printing a trade in sub-penny increments that was, for example, the 
result of a mid-point or volume-weighted pricing algorithm, as long as 
the exchange or association or its members did not otherwise violate 
the proposed rule with respect to the trading interest that resulted in 
the execution. For example, a system that accepted unpriced orders that 
were then matched at the midpoint of the NBBO would not violate the 
proposed rule even though resulting executions could occur in share 
prices of less than one cent. In addition, a broker-dealer could, 
consistent with the proposed rule, provide price improvement to a 
customer order in an amount that resulted in an execution in an 
increment less than a penny so long as the broker-dealer did not accept 
orders that were priced in increments less than a penny. The Commission 
sought specific comment on this aspect of the proposal.
    Every commenter that addressed this issue agreed that any sub-penny 
rule should permit sub-penny trades that result from midpoint and 
average-price algorithms.\272\ While most of these commenters believed 
that the rule should permit broker-dealers to offer sub-penny price 
improvement to their customers' orders,\273\ a few commenters urged the 
Commission to bar this practice.\274\ After considering these views, 
the Commission has determined not to revise the sub-penny rule in a 
manner that would prohibit sub-penny trading, whether that trading 
results from midpoint or VWAP algorithms or from broker-dealers 
offering sub-penny price improvement. The Commission continues to 
believe that trading in sub-penny increments does not at this time 
raise the same concerns as sub-penny quoting.
---------------------------------------------------------------------------

    \272\ See STANY Letter at 14; STA Letter at 7; SIA Letter at 21; 
UBS Letter at 10; ACIM Letter at 2; E*Trade Letter at 11; Amex 
Letter at 12; Liquidnet Letter at.8.
    \273\ See ACIM Letter at 2; Amex Letter, Exhibit A, at 31-32; 
E*Trade Letter at 11; Liquidnet Letter at 8; BSE Letter at 14; 
Morgan Stanley Letter at 21; SIA Letter at 21; STA Letter at 7; 
STANY Letter at 14; UBS Letter at 10.
    \274\ See CHX Letter at 23; Goldman Sachs Letter at 10; SIA 
Letter at 21.
---------------------------------------------------------------------------

    f. Acceptance of Sub-Penny Quotations. The Commission initially 
proposed to prohibit national securities exchanges, national securities 
associations, ATSs, vendors, and broker-dealers from displaying, 
ranking, or accepting quotations in NMS stocks that are priced in sub-
pennies. One commenter argued that the rule should allow a market 
participant to accept sub-penny quotations if it consistently re-prices 
such quotations to an acceptable increment and does not give the sub-
penny quotations any special priority for ranking or execution 
purposes.\275\ A second commenter disagreed, arguing that rounding a 
sub-penny quotation to the nearest penny may be confusing for 
investors.\276\ The Commission agrees with the second commenter and has 
determined to revise the proposed rule. The Commission believes that 
little purpose would be served by permitting market participants to 
accept sub-penny quotations when such quotations could not be displayed 
or considered for purposes of ranking. Furthermore, the Commission 
agrees that permitting market participants to accept sub-penny 
quotations that must be rounded to comply with the requirements of 
reproposed Rule 612 could cause confusion among investors.
---------------------------------------------------------------------------

    \275\ See Brut Letter at 26.
    \276\ See CHX Letter at 23.
---------------------------------------------------------------------------

    g. Application to Options Markets. The initially proposed rule, by 
its terms, would apply only to NMS stocks, but the Commission requested 
comment on whether the rule should apply to options.\277\ Currently, 
SRO rules require options to be quoted on the U.S. markets in 
increments of $0.05 and $0.10. Therefore, the problems that could be 
created by sub-penny quoting currently do not exist in the options 
markets.
---------------------------------------------------------------------------

    \277\ See Proposing Release, 69 FR at 11172.
---------------------------------------------------------------------------

    Two commenters believed that the rule should not apply to quoting 
in options.\278\ One of these commenters, assuming that the rule as 
proposed would allow options with a premium of less than $1.00 to be 
quoted in sub-pennies and options with a premium over $1.00 to be 
quoted in pennies, argued that this approach ``would overwhelm the 
already taxed capacity of existing options quote processing systems.'' 
\279\ The Commission believes that it is not necessary or appropriate 
at this time to apply reproposed Rule 612 to options. If a national 
securities exchange seeks to quote options in pennies or sub-pennies in 
the future, it would first need to propose a rule change to that effect 
under Section 19(b) of the Exchange Act.\280\ The Commission would have 
an opportunity to consider such a proposal at that time, after 
providing notice and obtaining public comment.\281\
---------------------------------------------------------------------------

    \278\ See Amex Letter, Exhibit A, at 32; SIA Letter at 21.
    \279\ Id.
    \280\ 15 U.S.C. 78s(b).
    \281\ The Commission has previously stated that, ``[g]iven the 
implications of penny quoting for OPRA, penny quoting would require 
very careful review by the Commission.'' Securities Exchange Act 
Release No. 49068 (Jan. 13, 2004), 69 FR 2775, 2789 (Jan. 20, 2004) 
(``BOX Approval Order'').
---------------------------------------------------------------------------

    A third commenter, while agreeing strongly with the proposed sub-
penny rule, argued that the Commission also should prohibit the Boston 
Options Exchange (``BOX''), a facility of the Boston Stock Exchange, 
from using ``sub-increment'' pricing (i.e., penny prices below the 
standard $0.05 and $0.10 increments used for options) in its ``PIP'' 
auction.\282\ By initiating a PIP auction, a BOX market participant may 
execute a portion of its agency order as principal in pennies, and BOX 
market makers can match that price or offer price improvement to those 
orders in penny increments during the three-second auction. The 
Commission previously has approved the BOX trading rules, including the 
rules governing the PIP, pursuant to Section 19(b) of the Exchange 
Act.\283\ The PIP uses pennies in an auction, not in public quotations. 
Therefore, the Commission does not believe that the PIP raises the same 
problems caused sub-penny quotations of non-option securities and, 
therefore, that it is not

[[Page 77460]]

necessary to prohibit the use of pennies in BOX's PIP.
---------------------------------------------------------------------------

    \282\ See CBOE Letter at 8.
    \283\ BOX Approval Order, 69 FR at 2789.
---------------------------------------------------------------------------

D. Exemptive Authority

    Reproposed Rule 612(c) would establish procedures for the 
Commission to exempt from the provisions of Rule 612 any person, 
security, or quotation, or any class or classes or persons, securities, 
or quotations, if it determines that such exemption is necessary or 
appropriate in the public interest, and is consistent with the 
protection of investors. The Commission could grant such exemption 
either unconditionally or on specified terms and conditions. Reproposed 
Rule 612(c) also would provide that the Commission may grant an 
exemption from the sub-penny prohibition by order.

V. Market Data Rules and Plan Amendments

    The Exchange Act rules and joint-SRO Plans for disseminating market 
information to the public are the heart of the NMS. Pursuant to these 
rules and Plans, investors are able to obtain real-time access to the 
best current quotes and most recent trades for all NMS stocks. As a 
result, investors of all types--large and small--have access to a 
comprehensive, accurate, and reliable source of information for the 
prices of any NMS stock at any time during the trading day.
    The SROs generate consolidated market data by participating in the 
Plans.\284\ Pursuant to the Plans, three separate networks disseminate 
consolidated market information for NMS stocks: (1) Network A for 
securities listed on the NYSE, (2) Network B for securities listed on 
the Amex and other national securities exchanges, and (3) Network C for 
securities traded on Nasdaq. For each security, the data includes (1) 
an NBBO with prices, sizes, and market center identifications, (2) a 
montage of the best bids and offers from each SRO that includes prices, 
sizes, and market center identifications, and (3) a consolidated set of 
trade reports in the security. The Networks establish fees for this 
data, which must be filed for Commission approval.\285\ In 2003, the 
Networks collected $424 million in revenues derived from market data 
fees and, after deduction of Network expenses, distributed $386 million 
to their individual SRO participants.\286\
---------------------------------------------------------------------------

    \284\ See infra, note 21.
    \285\ See Exchange Act Rule 11Aa3-2(c)(1).
    \286\ See Proposing Release, 69 FR at 11179 (table setting forth 
revenues, expenses, and allocations of net income for Networks A, B, 
and C).
---------------------------------------------------------------------------

    The overriding objective of the rules and Plan amendments 
reproposed today would be to preserve the vital benefits that investors 
currently enjoy, while addressing those particular problems with the 
current rules and Plans that are most in need of reform. The changes 
fall into three categories: (1) Modifying the current formulas for 
allocating market data revenues to the SROs to more appropriately 
reflect their contributions to public price discovery, (2) establishing 
non-voting advisory committees to broaden participation in Plan 
governance, and (3) updating and streamlining the various Exchange Act 
rules that govern the distribution and display of market information.

A. Response to Comments and Basis for Reproposed Rules

1. Alternative Data Dissemination Models
    In addition to proposing specific rules and amendments, the 
Proposing Release discussed and requested comment on the Commission's 
decision not to propose an alternative model of data dissemination to 
the replace the current consolidation model.\287\ The great strength of 
the current model is that it benefits investors, particularly retail 
investors, by enabling them to assess prices and evaluate the best 
execution of their orders by obtaining data from a single source that 
is highly reliable and comprehensive. But, by requiring vendors and 
broker-dealers to display data to investors that is consolidated from 
all markets, the current model effectively also requires the purchase 
of data from all markets. As a result, the most significant drawback of 
the current model is that it offers little opportunity for market 
forces to determine a Network's fees, or the allocation of those fees 
to a Network's SRO participants. Network fees must be closely 
scrutinized for fairness and reasonableness, and the revenues resulting 
from those fees must be allocated to the SROs pursuant to a Plan 
formula. In addition, individual markets have less freedom to innovate 
in individually providing their quotation and trade data.
---------------------------------------------------------------------------

    \287\ Proposing Release, 69 FR at 11176-11179.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission specifically considered 
three alternative models that potentially could introduce greater 
competition and flexibility into the dissemination of market data: (1) 
A deconsolidation model, (2) a competing consolidators model, and (3) a 
hybrid model. It decided not to propose any of these alternative models 
after consideration of the benefits and drawbacks of each model. The 
Commission did, however, request comment on whether it should develop 
an alternative model for disseminating market data to the public, and, 
in particular, on its evaluation of the strengths and weaknesses of the 
current model and of the various alternative models for the 
dissemination of market data.
    In response to the Commission's request for comment, a minority of 
commenters expressed their views regarding the appropriate structure 
for the dissemination of market information to the public. One group 
believed that the current model requiring the display of consolidated 
data in a stock through a Plan processor has produced significant 
benefits for investors and the markets, although they also strongly 
recommended that its operation needed to be improved in significant 
respects.\288\ Another group of commenters, in contrast, asserted that 
the current system has inhibited competition among markets and that the 
Plans should be eliminated.\289\ These commenters further suggested 
deregulation of market data by allowing markets to sell their own data, 
and by allowing market forces and competition to control the pricing of 
such data. They advocated a competing consolidators model or a hybrid 
model.
---------------------------------------------------------------------------

    \288\ See, e.g., Amex Letter, Exhibit A at 11; Angel Letter I at 
1; CBOE Letter at 2, 9; CHX Letter at 18-20; Financial Information 
Forum Letter at 4; Schwab Letter at 11-13; SIA Letter at 26-28; 
STANY Letter at 14.
    \289\ See, e.g., Alliance of Floor Brokers Letter at 11; Letter 
from Daniel M. Clifton, Executive Director, American Shareholders 
Association, to Jonathan G. Katz, Secretary, Commission, dated June 
10, 2004 (``ASA Letter'') at 2; ArcaEx Letter at 4, 12, 14; Brut 
Letter at 22; Financial Services Roundtable Letter at 7; ISE Letter 
at 8-10; Nasdaq Letter II at 24-26; NYSE Letter, Attachment at 10-
11; Letter from Phil Lynch, Chief Executive Officer, Reuters America 
LLC, to Jonathan G. Katz, Secretary, Commission, dated June 30, 2004 
(``Reuters Letter'') at 2; Specialist Assoc. Letter at 17.
---------------------------------------------------------------------------

    a. Competing Consolidators Model. Under a competing consolidators 
model, the consolidated display requirement would be retained, but the 
Plans and Networks would no longer be necessary. Each of the nine SROs 
that participate in the NMS, as well as Nasdaq, would be allowed to 
establish its own fees, to enter into and administer its own market 
data contracts, and to provide its own data distribution facility. Any 
number of data vendors or broker-dealers (i.e., ``competing 
consolidators'') could purchase data from the individual SROs, 
consolidate the data, and distribute it to investors and other data 
users. Of the commenters that urged the Commission to adopt a competing

[[Page 77461]]

consolidators model,\290\ the NYSE, for example, believed that allowing 
the markets to withdraw from the Plans would ``reestablish the link 
between the value of a market's data * * * and the fair allocation of 
costs among * * * users,'' thereby ending inter-market subsidies and 
market-distortive initiatives created by the current system.'' \291\ 
Similarly, ArcaEx stated that ``the best way to reform the [P]lans is 
to abolish them altogether and to adopt a competing consolidators 
model.'' \292\
---------------------------------------------------------------------------

    \290\ See, e.g., ArcaEx Letter at 12, 14; ISE Letter at 8-9; 
NYSE Letter, Attachment at 10-11.
    \291\ NYSE Letter at 7 and Attachment at 10. The NYSE provided 
several reasons for the elimination of the Plans.
    \292\ AcraEx Letter at 14.
---------------------------------------------------------------------------

    The Commission has considered the comments advocating a competing 
consolidators model, but continues to question the extent to which the 
model would in fact subject the level of market data fees to 
competitive forces. If the benefits of a fully consolidated data stream 
are to be preserved for investors, every consolidator would need to 
purchase the data of each SRO to assure that the consolidator's data 
stream in fact included the best quotations and most recent trade 
report in all NMS stocks. Moreover, to comply with the reproposed 
Trade-Through Rule, each market center would need the quotation data 
from every other market center in a security. As a practical matter, 
payment of every SRO's fees would be mandatory, thereby affording 
little room for competitive forces to influence the level of fees. 
Consequently, far from freeing the Commission from involvement in 
market data fee disputes, the multiple consolidator model would require 
review of at least ten separate fees for individual SROs and Nasdaq. 
The overall level of fees would not be reduced unless one or more of 
the SROs or Nasdaq was willing to accept a significantly lower amount 
of revenues than they currently are allocated by the Plans. It seems 
unlikely that any SRO or Nasdaq would voluntarily propose lower fees to 
reduce their current revenues, and some might well propose higher fees 
to increase their revenues, particularly those with dominant market 
shares whose information is most vital to investors. No commenter 
offered useful, objective standards for the Commission to use in 
evaluating the separate fees of SROs and Nasdaq. For this and for data 
quality concerns,\293\ the Commission remains unconvinced that 
discarding the current model in favor of a multiple consolidator model 
would benefit investors and the NMS in general.
---------------------------------------------------------------------------

    \293\ See Proposing Release, 69 FR at 11178.
---------------------------------------------------------------------------

    b. Hybrid Model. Nasdaq advocated a hybrid model of data 
dissemination as a compromise if the Commission believes that it is 
necessary to retain the Plans.\294\ Under a hybrid approach, basic 
elements of the current model (including the consolidated display 
requirement and the Plans) would be retained for quotations 
representing the NBBO, but all trade reports and all quotations other 
than the NBBO would be deconsolidated. Because much less consolidated 
data would be disseminated under this model, the fees for consolidated 
data would be reduced commensurately. The individual SROs would 
distribute their own trade and quotation information separately and 
establish fees for such information. To obtain the data eliminated from 
the consolidated system, investors would need to pay the separate SRO 
fees.
---------------------------------------------------------------------------

    \294\ Nasdaq Letter II at 26-28.
---------------------------------------------------------------------------

    In sum, Nasdaq suggested that consolidated data fees should be 
reduced,\295\ but only in the context of advocating a hybrid model that 
would drastically reduce the quantity of data that would be 
disseminated to investors (i.e., by eliminating all trade reports and 
all quotations other than the NBBO). Nasdaq stated that the Commission 
should allow competitive forces to determine the individual SRO fees 
for deconsolidated data because trade reports and non-NBBO quotations 
are not ``essential to investors.'' \296\
---------------------------------------------------------------------------

    \295\ At the NMS Hearing, a representative of Nasdaq stated that 
the current $20 fee for professionals to obtain market data in 
Nasdaq stocks is too high; that the fee, based on a recent analysis 
of Nasdaq's cost structure, should be around $5 to $7; and that the 
$20 fee is a monopoly price ``set almost twenty years ago without 
any active review of how that relates.'' Hearing Tr. at 223-224, 
253. These remarks subsequently engendered some confusion among the 
public, which was reflected in many comments on the market data 
proposals addressing the level of fees. To put these comments in 
perspective and dispel any potential misconceptions, the following 
points should be kept in mind: (1) In 1999, the Commission undertook 
a comprehensive review of market data fees and revenues, which led 
to a 75% reduction in the fees paid by retail investors for market 
data; (2) Nasdaq's suggested $5 to $7 monthly fee for professional 
investors would entitle them to only the NBBO in Nasdaq stocks, 
which is a fraction of the data that currently is disseminated for 
the $20 monthly fee for professional investors for consolidated 
trades and quotations in Nasdaq stocks; and (3) Nasdaq's $5 to $7 
cost estimate encompassed only its own costs and therefore excluded 
the costs of other SROs that now represent a large percentage of 
trading in Nasdaq-listed stocks.
    \296\ Nasdaq Letter II at 27.
---------------------------------------------------------------------------

    The Commission believes, however, that comprehensive trade and 
quotation information, even beyond the NBBO, is vital to investors. It 
remains concerned that an SRO with a significant share of trading in 
NMS stocks could exercise market power in setting fees for its data. 
Few investors could afford to do without the best quotations and trades 
of such an SRO that is dominant in a significant number of stocks. In 
the absence of a solid basis to believe that full trade and quotation 
information would continue to be widely available and affordable to all 
types of investors under a hybrid model, the Commission has determined 
that the most responsible course of action is to take such immediate 
steps are necessary to improve the operation of the current 
consolidation model.\297\
---------------------------------------------------------------------------

    \297\ The Commission also is concerned about the risk of 
compromising the quality of market information if the hybrid model 
were adopted. Proposing Release, 69 FR at 11178.
---------------------------------------------------------------------------

2. Level of Fees and Plan Governance
    a. Level of Fees. In the Proposing Release, the Commission 
emphasized that one of its primary goals with respect to market data is 
to assure reasonable fees that promote its wide public availability. 
Comment was requested on the extent to which investors and other data 
users were relatively satisfied with the products and fees offered by 
the Networks.\298\ At the NMS Hearing, several panelists addressed the 
current level of fees and questioned whether such fees remained 
reasonably related to the cost of market data.\299\ The Supplemental 
Release therefore noted the panelists' views and welcomed comments on 
the reasonableness of market data fees and whether the Commission 
should modify its approach to reviewing such fees.\300\
---------------------------------------------------------------------------

    \298\ Proposing Release, 69 FR at 11179.
    \299\ Hearing Tr. at 223-224, 228-229, 230-231, 233.
    \300\ Supplemental Release, 69 FR at 30148.
---------------------------------------------------------------------------

    Many commenters recommended that the level of market data fees 
should be reviewed and that, in particular, greater transparency 
concerning the costs of market data and the fee-setting process is 
needed.\301\ The Commission agrees. To respond to commenters' concerns, 
it has initiated a review of market data fees in its concept release 
relating to SRO structure.\302\ The release discusses and requests 
comment on a number of issues raised by commenters in the context of 
SRO revenues and the funding of self-regulation--in particular, whether 
market data fees are reasonable, whether the Commission should

[[Page 77462]]

reconsider a flexible cost-based approach as described in the 1999 
Market Information Release, and whether market data fees should be used 
to fund SRO operational or regulatory costs. The Commission also has 
taken steps to promote more transparency with respect to market data 
fees and the use of market data revenues through its proposal on SRO 
transparency.\303\ The proposal would greatly increase SRO transparency 
by requiring, among other things, that SROs file public reports with 
the Commission detailing their sources of revenues and their uses of 
these revenues. Such reports would enhance the public's ability to 
evaluate the role of market data revenues in funding SROs. For example, 
proposed amendments to Form 1, Exhibit I would require exchange SROs to 
disclose their revenues earned from market information fees, itemized 
by product, and proposed new Rule 17a-26 would require SROs to file 
electronic quarterly and annual reports on particular aspects of their 
regulatory activities.
---------------------------------------------------------------------------

    \301\ See, e.g., Ameritrade Letter I at 3, 10; ASA Letter at 2; 
Bloomberg Tradebook Letter at 8-9; Brut Letter at 21-23; Citigroup 
Letter at 15; Financial Information Forum Letter at 3; Financial 
Services Roundtable Letter at 6-7; Goldman Sachs Letter at 2, 10; 
ICI Letter at 21-22; Morgan Stanley Letter at 21-22; Schwab Letter 
at 2; SIA Letter at 22; STANY Letter at 14; UBS Letter at 10.
    \302\ SRO Structure Release, supra note 30.
    \303\ SRO Transparency Release, supra note 31.
---------------------------------------------------------------------------

    Some commenters suggested that, instead of modifying the Plan 
formulas for allocating market data revenues, the Commission should 
impose a cost-based limitation on fees.\304\ Most, however, adopted a 
very restricted view of market data costs--solely the costs of the 
Networks to collect data from the individual SROs and disseminate it to 
the public.\305\ Yet nearly the entire financial burden of collecting 
and producing market data is borne by the individual markets, not by 
the Networks. If, for example, an SRO's systems break down on a high-
volume trading day and it can no longer provide its data to the 
Networks, investors would suffer the consequences of a defective data 
stream, regardless of whether the Networks are able to continue 
operating.
---------------------------------------------------------------------------

    \304\ See, e.g., Ameritrade Letter I at 10; Goldman Sachs Letter 
at 10; SIA Letter at 22.
    \305\ See, e.g., ASA Letter at 2; Citigroup Letter at 16; Schwab 
Letter at 6; SIA Letter at 25.
---------------------------------------------------------------------------

    The commenters' suggested approach to market data fees would 
eliminate any funding for the SROs that supply data to the Networks, 
which would have reduced SRO funding by $386 million in 2003.\306\ The 
Commission is reluctant to impose such a significant and sudden 
reduction in SRO funding without taking due care for the consequences 
it might have on the integrity of the U.S. equity markets. When the 
Commission last reviewed market data fees and revenues in 1999, it 
noted the direct connection between an SRO's operational and regulatory 
functions and the value of its market information:
---------------------------------------------------------------------------

    \306\ See supra, note 29.

    [T]he value of a market's information is dependent on the 
quality of the market's operation and regulation. Information is 
worthless if it is cut off during a systems outage (particularly 
during a volatile, high-volume trading day when reliable access to 
market information is most critical), tainted by fraud or 
manipulation, or simply fails to reflect accurately the buying and 
---------------------------------------------------------------------------
selling interest in a security.\307\

    Moreover, the U.S. equity markets are not alone in their reliance 
on market data revenues as a substantial source of funding. All of the 
other major world equity markets currently derive large amounts of 
revenues from selling market information, despite having significantly 
less trading volume and less market capitalization than the NYSE and 
Nasdaq. To illustrate, the following table sets forth the respective 
market information revenues, dollar value of trading, and market 
capitalization for the largest world equity markets in 2003: \308\
---------------------------------------------------------------------------

    \307\ Market Information Release, 64 FR at 70614-70615.
    \308\ Data for this table is derived from the 2003 annual 
reports of the various markets and from statistics compiled by the 
World Federation of Exchanges. The exchange rates are as of August 
15, 2004.

------------------------------------------------------------------------
                                    Data       Trading        Market
                                  revenues      volume    capitalization
                                 (millions)  (trillions)    (trillions)
------------------------------------------------------------------------
London........................         $180         $3.6           $2.5
NYSE..........................          172          9.7           11.3
Nasdaq........................          147          7.1            2.8
Deutsche Bourse...............          146          1.3            1.1
Euronext......................          109          1.9            2.1
Tokyo.........................           60          2.1            3.0
------------------------------------------------------------------------

    In sum, the Commission is committed to assuring that investors are 
not required to pay unreasonable or unfair fees for the consolidated 
market information that they must have to participate in the U.S. 
equity markets. On the other hand, we must maintain high standards of 
SRO performance, without which the data they produce would be worth 
little. Some commenters suggested that SRO funding should be provided 
through more specifically targeted fees, such as an additional 
regulatory fee to fund market regulation costs. Given the potential 
harm if vital SRO functions are not adequately funded, we believe that 
the level of market data fees is most appropriately addressed in a 
context that looks at SRO funding as a whole. The Commission's review 
of SRO structure, governance, and transparency provides a useful 
context in which these competing policy concerns can be evaluated and 
balanced appropriately.
    The Commission does not believe, however, that reform of the 
current revenue allocation formulas should be delayed until its review 
of fees is completed. The distortions caused by these formulas are 
substantial and ongoing. In particular, it appears that market 
participants increasingly are engaging in the practice of trade 
shredding (i.e., splitting large trades into multiple 100-share trades) 
as a means to increase their share of market data revenues under the 
current Plan formulas. As discussed below, the reproposed formula would 
represent a substantial improvement because it is designed to eliminate 
trade shredding and other gaming of the current formulas and because it 
would more directly allocate revenues to those markets that contribute 
data to the consolidated data stream that is most useful to investors.
    b. Plan Governance. The Commission is reproposing, substantially as 
proposed, an amendment to the Plans that would require the creation of 
non-voting advisory committees (``Governance Amendment''). It provides 
that the members of an advisory committee have the right to submit 
their views to the Plan operating committees on Plan matters, including 
any new or modified product, fee, contract, or pilot program. Most 
commenters supported the Governance

[[Page 77463]]

Amendment.\309\ They generally believed that expanding the 
participation of non-SROs parties in Plan governance would be a 
constructive step. Only a few commenters disagreed, stating that 
interested parties currently have the ability to communicate their 
views on Plan matters or questioning the efficacy of the 
committees.\310\
---------------------------------------------------------------------------

    \309\ See, e.g., Amex Letter at 10; Citigroup Letter at 17; 
Financial Information Forum Letter at 4; Financial Services 
Roundtable Letter at 6-7; ICI Letter at 4 and 21 n. 35; Instinet 
Letter at 7, 46; Nasdaq Letter II at 33; Reuters Letter at 3; STANY 
Letter at 15.
    \310\ CBOE Letter at 2, 17; ISE Letter at 2; Specialist Assoc. 
Letter at 16.
---------------------------------------------------------------------------

    A number of commenters, however, believed that the proposal did not 
go far enough to reform the Plans and that even greater participation 
by interested non-SRO parties in the Plans is needed.\311\ Brut 
suggested that the Commission ``consider applying SRO governance 
standards to [Network processors] going forward, subjecting their 
operations to the same standards of transparency and accountability'' 
in order to limit their monopoly power.\312\ These commenters also 
raised concerns regarding several other aspects of Plan governance, 
including current administrative costs and burden, the unanimous vote 
requirement for Plan action, and the current process for reviewing SRO 
fee filings and Plan amendments. For instance, the SIA believed that 
inconsistencies among the Networks regarding administrative 
requirements and burdens (i.e., agreements and contracts, billing 
policies, data use policies, and annual audit requirements) contribute 
to high market data fees and should be reduced, streamlined, and made 
uniform.\313\
---------------------------------------------------------------------------

    \311\ See, e.g., Letter from W. Hardy Callcott, to Jonathan G. 
Katz, Secretary, Commission, dated May 6, 2004 (``Callcott Letter'') 
at 4-5 n.10; Citigroup Letter at 17; Financial Services Roundtable 
Letter at 6-7; Goldman Sachs Letter at 12-13; Instinet Letter at 46; 
Morgan Stanley Letter at 22; Schwab Letter at 8; SIA Letter at 26; 
STANY Letter at 15.
    \312\ Brut Letter at 24.
    \313\ SIA Letter at 27-28.
---------------------------------------------------------------------------

    In many respects, the Commission agrees with the concerns expressed 
by commenters on the administration of the Plans. It believes, however, 
the Governance Amendment would represent a useful first step toward 
improving the responsiveness of Plan participants and the efficiency of 
Plan operations. Expanding the participation of interested parties 
other than SROs in Plan governance should improve transparency, as well 
as provide an established mechanism for alternative views to be heard. 
Earlier and more broadly based participation could contribute to the 
ability of the Plans to achieve consensus on disputed issues. Going 
forward, the Commission is receptive to additional steps that would 
improve Plan operations in general, particularly those that would 
streamline fee administration procedures and burdens. Enhanced 
participation of advisory committee members in Plan affairs potentially 
should help further this process.
3. Revenue Allocation Formula
    The proposal included an amendment to the Plans that would modify 
their formulas for allocating market data revenues to SRO Participants. 
The current Plan formulas are based solely on the trading activity of 
an SRO. The proposed formula was intended to address three serious 
weaknesses in the old formulas: (1) The absence of any allocation of 
revenues for the quotations contributed by an SRO to the consolidated 
data stream, (2) an excessive emphasis on the number of trades reported 
by an SRO that has led to distortive trading practices, such as wash 
sales, trade shredding, and print facilities, and (3) a disproportional 
allocation of revenues for a relatively small number of stocks with 
extremely high trading volume, to the detriment of the thousands of 
other stocks included in a Network, typically issued by smaller 
companies, with less trading volume.
    To address these problems, the proposed formula included a number 
of elements, including a Quoting Share, an NBBO Improvement Share, a 
Trading Share, and a Security Income Allocation. The Quoting Share and 
NBBO Improvement Share would have provided an allocation of revenues 
for an SRO's quotations. In particular, the Quoting Share would have 
allocated revenues for all quotes, both automated and manual, according 
to the dollar size and length of time that such quotes equaled the 
price of the NBBO. It included an automatic cutoff of credit for manual 
quotations, however, when they were left alone at the NBBO. This cut-
off was intended to preclude SROs from being allocated revenues merely 
for slowness in updating their manual quotations. The NBBO Improvement 
Share would have allocated revenues to SROs for the extent to which 
they displayed quotations that improved the price of the NBBO.
    At the NMS Hearing, representatives of floor-based exchanges stated 
their intention to adopt hybrid trading models that would primarily 
display automated quotations.\314\ In response, the Commission, in its 
Supplemental Release, stated that the prospect of hybrid trading models 
presented an opportunity for simplifying the proposed allocation 
formula.\315\ It noted that the purpose of the automatic cutoff for 
manual quotations was to minimize the allocation of revenues for 
potentially stale quotations and requested comment on whether only 
automated quotes should be entitled to earn an allocation of revenues. 
The Supplemental Release also noted that the NBBO Improvement Share was 
significantly more complex than the other aspects of the proposed 
formula and that it had been proposed largely to counter the potential 
for an excessive allocation of revenues for manual quotations. Comment 
was requested on whether there was any need for the NBBO Improvement 
Share if manual quotations were excluded from the formula.
---------------------------------------------------------------------------

    \314\ Hearing Tr. at 85, 90-92, 94-97, 120-121.
    \315\ Supplemental Release, 69 FR at 30148.
---------------------------------------------------------------------------

    The comments generally addressed four broad categories of issues: 
(1) Whether the current Plan formulas need to be updated, (2) whether 
quotations should be considered in allocating revenues, (3) whether the 
size of trades should be considered in allocating revenues, and (4) 
whether the allocation of revenues should be allocated more evenly 
across all of a Network's stocks. These comments are discussed below.
    a. Need for New Formula. Many commenters agreed with the Commission 
that, if the Networks were to continue allocating revenues to the SROs, 
the current allocation formulas needed to be updated.\316\ Many of 
these commenters also believed that the proposed formula should be 
modified in several respects, and their specific suggestions to improve 
the proposed formula are discussed below. In general, however, they 
agreed with the objectives of the proposal to eliminate much of the 
incentive for distortive trade reporting practices and to begin 
providing some allocation of revenues for the quotations that SROs 
contribute to the consolidated data stream.
---------------------------------------------------------------------------

    \316\ See, e.g., Amex Letter at 11; ATD Letter at 4; Bloomberg 
Tradebook Letter at 7; BSE Letter at 15; ICI Letter at 21; Morgan 
Stanley Letter at 22; Nasdaq Letter II at 31; NYSE Letter, 
Attachment at 11-12; STA Letter at 7; UBS Letter 10; Vanguard Letter 
at 6.
---------------------------------------------------------------------------

    Other commenters, in contrast, opposed changing the current 
allocation formulas.\317\ Their specific objections to the proposed 
formula are discussed below, but they also opposed changing the current 
formulas for more general reasons. First, some believed that, rather

[[Page 77464]]

than changing the formulas, the Commission simply should prohibit the 
particular distortive practices caused by the old formulas and enforce 
the existing prohibitions against such practices. Commenters also 
opposed the proposed formula because they believed it incorporated 
arbitrary judgments about the value of quotations and trades. Finally, 
those opposed to changing the Plan formulas also believed that the 
proposed formula was simply too complex to be implemented effectively 
and that its costs exceeded any benefits that were likely to be gained.
---------------------------------------------------------------------------

    \317\ See, e.g., ArcaEx Letter at 12; Brut Letter at 22; 
Instinet Letter at 41; NSX Letter at 6; Phlx Letter at 4; Letter 
from Ronald A. Oguss, President, Xanadu Investment Co., to Jonathan 
G. Katz, Secretary, Commission, dated June 29, 2004 (``Xanadu 
Letter'') at 2.
---------------------------------------------------------------------------

    The Commission has considered the views of these commenters, but 
does not believe that they warrant leaving the current Plan formulas in 
place. First, the Commission intends to continue to enforce the 
existing prohibitions against distortive trade reporting practices. 
Rather than attempting to formulate new prohibitions that address every 
conceivable harmful practice, however, it has determined to address 
directly the ultimate source of the problem by reproposing revisions to 
the current formulas. As long as the allocation of market data revenues 
is based primarily on reporting a large number of very small trades, 
the incentive for distortive trading reporting will continue. Moreover, 
as discussed below, the current formulas are flawed in several 
important respects beyond the incentives they create for distortive 
trading reporting practices.
    The Commission preliminarily does not believe that the reproposed 
formula would incorporate arbitrary judgments about the value of trades 
and quotes. In this regard, it is important to recognize that any 
formula for allocating market data revenues would reflect some judgment 
regarding the contribution of the various SROs to the consolidated data 
stream; otherwise, the revenues could simply be allocated equally among 
all Plan participants. The Commission's goal in reproposing a new 
formula is to improve the judgments incorporated in the old Plan 
formulas to more fully achieve NMS objectives.
    For example, the current formula for Network A and Network B treats 
a 100-share trade the same as a 20,000 share trade in the same stock, 
even though their importance for price discovery purposes clearly is 
not equal. All of the current Plan formulas treat a quotation as having 
no value if it did not result in a trade, even if the quotation was 
fully accessible and established the NBBO for a substantial period of 
time, thereby providing price discovery for trades occurring at other 
markets that internalize orders with reference to the NBBO price. Such 
formulas based solely on an SRO's trading activity may have been 
adequate many years ago when a single market dominated each group of 
securities, but are seriously outdated now that trading is split among 
many different markets whose contributions to the public data stream 
can vary considerably.
    The reproposed formula would reflect fairly straightforward 
determinations about the kinds of data that, in general, are likely to 
be useful to investors. For example, a $50,000 quote at the NBBO in a 
stock is likely more useful to investors than a $2000 quote in the same 
stock. Similarly, a $50,000 trade in a stock is likely more useful to 
investors in assessing the trading trend of that stock than a $2000 
trade; again, not necessarily in every case, but in general and on 
average. The reproposed formula would represent a substantial 
improvement on the old formulas.\318\
---------------------------------------------------------------------------

    \318\ Some commenters were concerned that the proposed formula's 
use of dollar volume calculations did not sufficiently allocate 
revenues to markets that trade low-priced stocks. See, e.g., BSE 
Letter at 18; CHX Letter at 16. The Commission preliminarily 
believes that dollar volume would be the most appropriate measure, 
in general, of the importance to investors of trading and quoting 
information. Per share stock prices, in contrast, are a more 
arbitrary measure because they are dependent, to a large extent, on 
the number of shares a company chooses to issue, both originally and 
through stock splits and reverse stock splits. To the extent the 
commenters were concerned about the less active stocks of smaller 
companies, the Security Income Allocation of the reproposed formula 
would incorporate the square root function precisely to more 
appropriately allocate revenues to SROs that provide a venue for 
price discovery in these stocks. See section V.A.3.d below.
---------------------------------------------------------------------------

    The Commission agrees with commenters that the proposed formula was 
very complex and may have been difficult to implement efficiently. They 
particularly noted that the proposed NBBO Improvement Share was very 
difficult to understand and had the potential to be abused through 
gaming behavior. Given that only automated quotations would be entitled 
to earn an allocation under the reproposed formula, the proposed NBBO 
Improvement Share can be deleted, as well as the proposed cutoff of 
credits for manual quotations left alone at the NBBO. The elimination 
of these two elements greatly reduces the complexity of the reproposed 
formula and should promote more efficient implementation of the 
formula. In addition, the 15% of the Security Income Allocation that 
was allocated to the NBBO Improvement Share in the proposed formula 
would now be shifted to the Quoting Share to establish a generally even 
allocation of revenues between trading and quoting.
    The Commission does not agree, however, with those commenters who 
argued that it would be overly costly and complex to calculate the 
other elements of the proposed formula. An SRO's Trading Share, for 
example, would not be materially more difficult to calculate than the 
current Network C formula, which is based on an average of the SRO's 
proportion of trades and share volume. The Security Income Allocation 
merely would use the square root function, which is a simple arithmetic 
calculation. Finally, some commenters believed that the Quoting Share, 
which would incorporate the total dollar size of the NBBO in a stock 
throughout the trading year, would result in astronomically high 
numbers that would be extremely difficult to calculate.\319\ In fact, 
the largest number of Quote Credits in a year for even the highest 
price stock with the greatest displayed depth at the NBBO would be very 
unlikely to reach beyond the trillions, a number well within the 
capabilities of even the most basic spreadsheet program.\320\ Moreover, 
it is the proportion of an SRO's Quote Credits in relation to other 
SROs that would determine an allocation, not the absolute amount of 
Quote Credits.
---------------------------------------------------------------------------

    \319\ See, e.g., CBOE Letter at 14 (calculation of Quote Credits 
will ``yield astronomical numbers'' that ``can be expressed only in 
exponential terms''); NSX Letter at 7 (calculation of large number 
of Quote Credits is ``particularly ludicrous'').
    \320\ For example, assume a stock with an average price of $100 
per share has an unusually large average quoted size of 200,000 
shares at both the national best bid and the national best offer 
throughout every second of the trading year. Over an average 252 
trading days during a year, the total Quote Credits in this stock 
would be 235.9 trillion ($100*400,000*252*23,400 seconds per trading 
day). Quote Credits would only be calculated for individual Network 
stocks and would not be totaled across all Network stocks.
---------------------------------------------------------------------------

    Finally, a few commenters were concerned about the effect of 
modifying the current allocation formulas on the existing business 
models and terms of competition for the various markets.\321\ The 
Commission recognizes that reforming formulas that have remained 
unchanged for many years could affect the competitive position of 
various markets. Given the severe deficiencies of these formulas, 
however, it does not believe that the interests of any particular 
business model should preclude updating the formulas to reflect current 
market conditions. The reproposed formula is intended to reflect more 
appropriately the contributions of the various SROs to the consolidated 
data stream and thereby better align the interests of individual 
markets with the interests of investors.
---------------------------------------------------------------------------

    \321\ See, e.g., Brut Letter at 22; CHX Letter at 21-22; NSX 
Letter at 6.
---------------------------------------------------------------------------

    b. Quotations that Equal the NBBO. Many commenters supported the 
proposal to allocate a portion of market

[[Page 77465]]

data revenues based on an SRO's quotations, particularly if only 
automated and accessible quotations would qualify for an 
allocation.\322\ Some commenters, however, were concerned about the 
risk of harmful gaming behavior by market participants.\323\ For 
example, Instinet stated that the ``fundamental problem with the 
Commission's proposed formula stems from the inherently low cost for 
market participants to generate quotation information and the 
consequent high potential for gaming behavior in any formula that 
attempts to reward such behavior.'' \324\ A specific type of gaming 
that concerned commenters was ``flickering quotes''--quotes that are 
flashed for a short period of time solely to earn market data revenues, 
but are not truly accessible and therefore do not add any value to the 
consolidated quote stream.
---------------------------------------------------------------------------

    \322\ See, e.g., Amex Letter at 11; ATD Letter at 4; Bloomberg 
Tradebook Letter at 7-8; Morgan Stanley Letter at 22-23; STA Letter 
at 7; Vanguard Letter at 6.
    \323\ See, e.g., ArcaEx Letter at 13; Brut Letter at 22; CHX 
Letter at 19; Instinet Letter at 41.
    \324\ Instinet Letter at 41.
---------------------------------------------------------------------------

    The Commission recognizes that abusive quoting behavior is a 
legitimate concern. It preliminarily does not believe, however, that 
the reproposed formula would be unacceptably vulnerable to gaming, 
particularly because only automated and fully accessible quotations 
would be entitled to earn a share of market data revenues. The 
potential cost of displaying such quotations, in the form of 
unprofitable trades, should not be underestimated. Quotations would 
earn significant revenues only if they represent a significant 
proportion of the total size of quotations displayed at the NBBO for a 
stock throughout the trading year. The risk of losses that could result 
from the execution of orders against large quotations would be likely 
to dwarf any potential allocation of market data revenues. With the 
advent of highly sophisticated order-routing algorithms, automated 
quotations throughout the NMS can be accessed with lightning speed. 
Some of these algorithms are specifically designed to search the market 
for displayed liquidity and sweep such liquidity immediately when it is 
displayed. The market discipline imposed by these order-routing 
practices should greatly reduce the potential for ``low cost'' 
quotations at the NBBO if the reproposed formula were adopted. A market 
participant would need to think carefully about whether it is truly 
willing to trade at a price, particularly a price as attractive as the 
NBBO, before displaying accessible and automated quotations to earn 
market data revenues.
    A few commenters also opposed the proposed Quoting Share because 
they believed it represented an attempt by the Commission to control 
the quoting behavior of market participants.\325\ ArcaEx stated for 
example, that the ``most important question is how paying for top-of-
book quotes--on a time- and size-weighted basis or on any other basis--
encourages beneficial behavior,'' and questioned whether the Quoting 
Share would achieve this result. Brut asserted that ``[n]ot only would 
[the proposed formula] increase the potential unnatural trading and 
quoting behavior, it signifies a desire to use market structure 
regulation to micro-manage market participant behavior * * *'' \326\
---------------------------------------------------------------------------

    \325\ ArcaEx Letter at 13; Brut Letter at 22, Phlx Letter at 4.
    \326\ Brut Letter at 22.
---------------------------------------------------------------------------

    These commenters appear to have misunderstood the Commission's 
objective in proposing to update the current Plan formulas. As noted 
above, it is unlikely that a marginal increase in market data revenues 
would significantly alter the quoting behavior of market participants, 
at least for those not already interested in trading a stock for 
separate reasons. The potential cost of unprofitable trades would be 
too high. Rather, the Commission's primary objective would be to 
correct an existing flaw in the current formulas by allocating revenues 
to those SROs that, even now, benefit investors by contributing useful 
quotations to the consolidated data stream. Currently, such SROs do not 
receive any allocation for providing a venue for this beneficial 
quoting activity. Basing an allocation on the extent to which an SRO's 
quotes equal the NBBO would be an appropriate means to correct this 
flaw, even if it does not always reflect the precise value of 
quotations.\327\
---------------------------------------------------------------------------

    \327\ ArcaEx noted that top-of-book quotes make only a partial 
contribution to price discovery and that depth-of-book quotes are 
particularly important since decimalization. ArcaEx Letter at 13. 
The Commission agrees that depth-of-book quotes are important to 
investors, and for that reason has reproposed amendments to the 
market data rules to facilitate the independent dissemination of a 
market's depth of book. The rules would not prevent such a market 
from charging fees for depth-of-book quotations that are fair and 
reasonable and not unreasonably discriminatory.
---------------------------------------------------------------------------

    c. Number and Dollar Volume of Trades. The current Plan formulas 
allocate revenues based on the number of trades (Networks A and B) or 
on the average of number of trades and share volume of trades (Network 
C) reported by SROs. By focusing solely on trading activity (and 
particularly by rewarding the reporting of many trades no matter how 
small their size), these formulas have contributed to a variety of 
distortive trade reporting practices, including wash sales, shredded 
trades, and SRO print facilities. To address these practices and to 
establish a more broad-based measure of an SRO's contribution to the 
consolidated trade stream, the proposed formula provided that an SRO's 
Trading Share in a particular stock would be calculated by taking the 
average of the SRO's percentage of total dollar volume in the stock and 
the SRO's percentage of qualified trades in the stock. A ``qualified 
trade'' was defined as having a dollar volume of $5000 or more. The 
Proposing Release requested comment on whether this amount should be 
higher or lower, or whether trades with a size of less than $5000 
should receive credit that was proportional to their size.\328\
---------------------------------------------------------------------------

    \328\ Proposing Release, 69 FR at 11181.
---------------------------------------------------------------------------

    Several commenters believed that small trades contribute to price 
discovery and should be entitled to earn at least some credit in the 
calculation of the number of qualified trades.\329\ The Commission 
agrees and has included in the reproposed formula a provision that 
awards a fractional proportion of a qualified report for trades of less 
than $5000. Thus, a $2500 trade would constitute \1/2\ of a qualified 
report. This approach would greatly reduce the potential for large 
allocations attributable to shredded trades, while recognizing the 
contribution of small trades to price discovery.
---------------------------------------------------------------------------

    \329\ See, e.g., BSE Letter at 16; CHX Letter at 19-20; E*Trade 
Letter at 11.
---------------------------------------------------------------------------

    Two commenters asserted that the $5000 threshold was 
arbitrary.\330\ As noted in the Proposing Release, an analysis of 
Network A data indicates that approximately 90% of dollar volume and 
50% of trades exceed this threshold. The Commission preliminarily 
believes that the $5000 figure represents a reasonable attempt to 
address the problem of shredding large trades into 100-share trades. By 
providing only a proportional allocation for trades with dollar amounts 
below this threshold, the ability of market participants to generate 
large revenue allocations by shredding trades would be greatly reduced. 
For example, a 2000-share trade in a $25 stock could be shredded into 
twenty trades in the absence of a dollar threshold for qualified 
trades, but could be shredded into only ten qualified trades under the 
reproposed formula--a reduction of 50%. Moreover, when combined with 
the allocation of 50% of revenues to the

[[Page 77466]]

Quoting Share and the allocation of another 25% of revenues based on 
the dollar volume of trades, the $5000 threshold for qualified trades 
would eliminate much of the potential reward for trade shredding under 
reproposed formula.
---------------------------------------------------------------------------

    \330\ E*Trade Letter at 11; Instinet Letter at 42.
---------------------------------------------------------------------------

    d. Allocation of Revenues Among Network Stocks. The proposed 
formula included a Security Income Allocation, pursuant to which a 
Network's total distributable revenues would be allocated among each of 
the Network's stocks based on the square root of dollar volume. The 
square root function was intended to adjust for the highly 
disproportionate level of trading in the very top tier of Network 
stocks. A few hundred stocks (e.g., the top 5%) are much more heavily 
traded than the other thousands of Network stocks. The Proposing 
Release noted that an allocation that simply was directly proportional 
to trading volume would fail to reflect adequately the importance of 
price discovery for the vast majority of stocks.\331\
---------------------------------------------------------------------------

    \331\ Proposing Release, 69 FR at 11180.
---------------------------------------------------------------------------

    Of the commenters that addressed this issue, four supported the use 
of a square root function to allocate revenues among stocks.\332\ 
Nasdaq, for example, noted that the ``methodology will reduce the 
disparity between the value of data of the most active and least active 
securities.'' \333\ Other commenters, in contrast, opposed the use of 
the square root function to allocate revenues among Network 
stocks.\334\ ArcaEx believed that the proposed allocation method 
``introduces a steeply progressive tax on liquid stocks to subsidize 
illiquid stocks'' and that the allocation of revenues should remain 
directly proportional to trading volume.\335\
---------------------------------------------------------------------------

    \332\ Amex Letter, Exhibit A at 15; Nasdaq Letter II at 32; NYSE 
Letter, Attachment at 12; Specialist Assoc. Letter at 16 n.21.
    \333\ Nasdaq Letter II at 32.
    \334\ ArcaEx Letter at 12; CBOE Letter at 11; Xanadu Letter at 
2-3.
    \335\ ArcaEx Letter at 12.
---------------------------------------------------------------------------

    The Commission has retained the square root function in the 
reproposed formula to allocate distributable Network revenues more 
appropriately among all of the stocks included in a Network. Although 
the extent to which Network stocks are tiered according to trading 
volume varies among the three Networks, it is quite pronounced in each 
of them. The use of the square root function reflects the Commission's 
judgment that, on average and not necessarily in every particular case, 
a $50,000 trade in a stock with an average daily trading volume of 
$500,000 is marginally more useful to investors than a $50,000 trade in 
a stock with an average daily trading volume of $500 million. Markets 
that provide price discovery in less active stocks serve an extremely 
important function for investors in those stocks. Price discovery not 
only benefits those investors who choose to trade on any particular 
day, but also benefits those who simply need to monitor the status of 
their investment. Efficient secondary markets support buy-and-hold 
investors by offering them a ready opportunity to trade at any time at 
a fair price if they need to buy or sell a stock. Indeed, this enhanced 
assurance is one of the most important contributions of secondary 
markets to efficient capital-formation and to reducing the cost of 
capital for listed companies. The square root function would allocate 
revenues to markets that perform this function for less-active stocks 
by marginally increasing their percentage of market data revenues, 
while still allocating a much greater dollar amount to more actively 
traded stocks.
4. Distribution and Display of Data
    Most commenters supported the proposal authorizing the independent 
distribution of market data outside of what is required by the 
Plans.\336\ They generally agreed that the proposal would allow 
investors and vendors greater freedom to make their own decisions 
regarding the data they need. They also believed that the Commission's 
``fair and reasonable'' and ``not unreasonably discriminatory'' 
standards are appropriate to ensure that the independently distributed 
market data would be made available to all investors and data users. A 
few commenters, in contrast, objected to the proposed standards, 
asserting that the standards would not effectively protect investors 
and ``weaker and newer markets from predatory actions by stronger 
markets or the potential loss of data integrity.'' \337\
---------------------------------------------------------------------------

    \336\ See, e.g., Brut Letter at 21, 23; CBOE Letter at 2, 17; 
Citigroup Letter at 16; Financial Information Forum Letter at 4; 
Letter from Coleman Stipanovich, Executive Director, State Board of 
Administration of Florida, to Jonathan G. Katz, Secretary, 
Commission, dated June 29, 2004 (``Florida State Board Letter'') at 
2; Financial Services Roundtable Letter at 6; Goldman Sachs Letter 
at 12; ICI Letter at 4, 21 n.35; Instinet Letter at 45; Nasdaq 
Letter II at 33; NYSE Letter, Attachment at 12; Reuters Letter at 3; 
Schwab Letter at 13.
    \337\ See, e.g., Amex Letter at 10, Exhibit A at 13.
---------------------------------------------------------------------------

    The Commission is reproposing Rule 603(a) as proposed. The ``fair 
and reasonable'' and ``not unreasonably discriminatory'' requirements 
in reproposed Rule 603(a) are derived from the language of Section 
11A(c) of the Exchange Act. Under Section 11A(c)(1)(C), the more 
stringent ``fair and reasonable'' requirement is applicable to an 
``exclusive processor,'' which is defined in Section 3(a)(22)(B) of the 
Exchange Act as an SRO or other entity that distributes the market 
information of an SRO on an exclusive basis. Reproposed Rule 603(a)(1) 
would extend this requirement to non-SRO markets when they act in 
functionally the same manner as exclusive processors and are the 
exclusive source of their own data. Applying this requirement to non-
SROs would be consistent with Section 11A(c)(1)(F) of the Exchange Act, 
which grants the Commission rulemaking authority to ``assure equal 
regulation of all markets'' for NMS Securities.
    Commenters were concerned about the statement in the Proposing 
Release that the distribution standards would prohibit a market from 
distributing its data independently on a more timely basis than it 
makes available the ``core data'' that is required to be disseminated 
through a Network processor.\338\ Instinet, for example, requested that 
the Commission clarify that the proposal would not require a market 
center to artificially slow the independent delivery of its data in 
order to synchronize its delivery with the data disseminated by the 
Network.\339\ Reproposed Rule 603(a) would not require a market center 
to synchronize the delivery of its data to end-users with delivery of 
data by a Network processor to end-users. Rather, independently 
distributed data could not be made available on a more timely basis 
than core data is made available to a Network processor. Stated another 
way, reproposed Rule 603(a) would require that an SRO or broker-dealer 
must not transmit data to a vendor or user any sooner than it transmits 
the data to a Network processor.
---------------------------------------------------------------------------

    \338\ Amex Letter, Exhibit A at 12.; Instinet Letter at 47; 
Reuters Letter at 2.
    \339\ Instinet Letter at 47.
---------------------------------------------------------------------------

    A majority of the commenters supported the Commission's proposed 
reduction of the consolidated display requirements, stating that it 
should lead to lower costs for investors.\340\ A few commenters, 
however, opposed eliminating the requirement to display a full montage 
of market BBOs.\341\ Amex, for example, believed that elimination of 
the montage would confuse investors

[[Page 77467]]

and make it more complicated for vendors and broker-dealers to manage 
market data.
---------------------------------------------------------------------------

    \340\ See, e.g., Brut Letter at 21, 23; Financial Information 
Forum Letter at 3-4; Instinet Letter at 7, 45; Nasdaq Letter II at 
27, 32; Reuters Letter at 2-3.
    \341\ See, e.g., Amex Letter at 9 & Exhibit A at 12; Bloomberg 
Tradebook Letter at 9; Callcott Letter at 1, 2, 5.
---------------------------------------------------------------------------

    The Commission does not believe that streamlining the consolidated 
display requirement would detract from the quality of information made 
available to investors. Reproposed Rule 603(c) would continue to 
require the disclosure of basic information (i.e., prices, sizes and 
market center identifications of the NBBO, along with the most recent 
last sale information). It would allow market forces, rather than 
regulatory requirements, to determine what, if any, additional 
quotations outside the NBBO are displayed to investors. Investors who 
need the BBOs of each SRO, as well as more comprehensive depth-of-book 
information, would be able to obtain such data from markets or third 
party vendors.

B. Description of Reproposed Rules and Amendments

1. Allocation Amendment
    The Commission is reproposing with modifications an amendment to 
each of the Plans (``Allocation Amendment'') that incorporates a broad 
based measure of the contribution of an SRO's quotes and trades to the 
consolidated data stream.\342\ The reproposed formula reflects a two-
step process. First, a Network's distributable revenues (e.g., $150 
million) would be allocated among the many individual securities (e.g., 
3000) included in the Network's data stream. Second, the revenues that 
are allocated to an individual security (e.g., $200,000) then would be 
allocated among the SROs based on measures of the usefulness to 
investors of their trades and quotes in the security. The Allocation 
Amendment provides that, notwithstanding any other provision of a Plan, 
its SRO participants would receive an annual payment for each calendar 
year that is equal to the sum of the SRO's Trading Shares and Quoting 
Shares in each Network security for the year.\343\ These two types of 
Shares would be dollar amounts that would be calculated based on SRO 
trading and quoting activity in each Network security.
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    \342\ In 2002, the Commission abrogated several SRO proposals 
for rebating data revenues to market participants. Securities 
Exchange Act Release No. 46159 (July 2, 2002), 67 FR 45775 (July 10, 
2002). The purpose of the abrogation was to allow more time for the 
Commission to consider market data issues. Given that the current 
Plan allocation formulas would be updated to allocate revenues for 
more beneficial quoting and trading behavior, the Commission 
anticipates that rebates would be permitted in the future if the 
reproposed formula were adopted, assuming their terms meet 
applicable Exchange Act standards and SROs are able to meet their 
regulatory responsibilities. Such SRO rebates would, of course, have 
to be filed with the Commission for approval.
    \343\ Two commenters were concerned that the new formula might 
prohibit the Network's current practice of making estimated 
quarterly payments of Network revenues, with a final reconciliation 
at the end of the year. BSE Letter at 18, 19; CHX Letter at 22. The 
reproposed formula, however, merely tracks existing Plan language 
for the calculation of ``Annual Shares'' or ``annual payments.'' 
Nothing in the reproposed formula would prohibit Networks from 
making estimated quarterly payments.
---------------------------------------------------------------------------

    a. Security Income Allocation. The first step of the reproposed 
formula would be to allocate a Network's total distributable revenues 
among the many different securities that are included in a Network (the 
``Security Income Allocation''). Paragraph (b) of the reproposed 
Allocation Amendment would base this allocation on the square root of 
dollar volume of trading in each security. Use of the square root 
function would more appropriately allocate revenues among stocks with 
widely differing trading volume. A small number of Network stocks are 
much more heavily traded than the great majority of Network stocks. By 
proportionally shifting revenues away from the very top tier of active 
stocks and increasing the allocation across other stocks, the Security 
Income Allocation is intended to reflect more adequately the importance 
of price discovery for all Network stocks.
    b. Trading Share. Under paragraph (c) of the reproposed Allocation 
Amendment, an SRO's Trading Share in a particular Network security 
would be a dollar amount that is determined by multiplying (i) an 
amount equal to the lesser of (A) 50% of the Security Income Allocation 
for the Eligible Security or (B) an amount equal to $2.00 multiplied by 
the total number of qualified transaction reports disseminated by the 
Processor in the Eligible Security during the calendar year, by (2) the 
SRO's Trade Rating in the security. A Trade Rating would be a number 
that represents the SRO's proportion of dollar volume and qualified 
trades in the security, as compared to the dollar volume and qualified 
trades of all SROs. The Trade Ratings of all SROs would add up to a 
total of one. Thus, for example, multiplying 50% of the Security Income 
Allocation for a Network security (e.g., $200,000) by an SRO's Trade 
Rating in that security (e.g., 0.2555) would produce a dollar amount 
(e.g., 50% x $200,000 x 0.2555 = $25,550) that is the SRO's Trading 
Share for the security for the year.
    Applying 50% of the Security Income Allocation to the Trading Share 
reflects a judgment that generally trades and quotes are of 
approximately equal importance for price discovery purposes. For 
securities with lower trading volume, however, this percentage can 
disproportionately allocate revenues for a small number of trades 
during the year, at the expense of those markets that aggressively 
quote a security throughout the year. For example, 50% of the Security 
Income Allocation for a security with 10 qualified trades during the 
year might be $300. Rather than allocate the full $300 to those SROs 
that reported a small number of trades (for an average per trade 
allocation of $30), the reproposed formula would include a cap of $2 
per qualified transaction report, so that a total of only $20 would be 
allocated pursuant to the Trading Share. The difference of $280 ($300 
minus $20) would be shifted to the Quoting Share to allocate revenues 
to those markets that consistently displayed valuable quotes in the 
security throughout the more than 250 trading days during the year. The 
amount of the cap of $2 per qualified transaction report exceeds the 
highest amount per transaction report currently allocated for any of 
the three Networks.
    An SRO's Trade Rating would be calculated by taking the average of 
(1) the SRO's percentage of total dollar volume reported in the Network 
security during the year, and (2) the SRO's percentage of total 
qualified trades reported in the Network security for the year. A 
transaction report with a dollar volume of $5000 or more would 
constitute one qualified report. A transaction report with a dollar 
volume of less than $5000 would constitute a proportional fraction of a 
qualified transaction report. As a result, all sizes of transaction 
reports would contribute toward an SRO's Trade Rating.
    c. Quoting Share. Under paragraph (d) of the reproposed Allocation 
Amendment, an SRO's Quoting Share in a particular Network Security 
would be a dollar amount that is determined by multiplying (i) an 
amount equal to 50% of the Security Income Allocation for the security, 
plus the difference, if greater than zero, between 50% of the Security 
Income Allocation for the Eligible Security and an amount equal to 
$2.00 multiplied by the total number of qualified transaction reports 
disseminated by the Processor in the Eligible Security during the 
calendar year, by (ii) the SRO's Quote Rating in the security. A Quote 
Rating would be a number that represents the SRO's proportion of 
quotations that equaled the price of the NBBO during the year (``Quote 
Credits''), as compared to the Quote Credits of all SRO's during the 
year. The Quote Ratings of all SROs

[[Page 77468]]

would add up to a total of one. Multiplying 50% of the Security Income 
Allocation for a Network security (plus any shifted allocation from the 
Trading Share) by an SRO's Quote Rating in that security would produce 
a dollar amount that is the SRO's Quoting Share for the security for 
the year.
    An SRO would earn one Quote Credit for each second of time and 
dollar value of size that the SRO's automated quotation during regular 
trading hours equals the price of the NBBO.\344\ Thus, for example, a 
bid with a dollar value of $4000 (e.g., a bid of $20 with a size of 200 
shares) that equals the national best bid for three seconds would be 
entitled to 12,000 Quote Credits. If an SRO quotes simultaneously at 
both the national best bid and the national best offer, it would earn 
Quote Credits for each quote. An automated quotation is defined by 
reference to reproposed Rule 600(b)(3) under Regulation NMS. Thus, an 
SRO's manual quotations would not be entitled to earn any Quote 
Credits.
---------------------------------------------------------------------------

    \344\ Regular trading hours are defined in reproposed Rule 
600(b)(64) of Regulation NMS as between 9:30 a.m. and 4 p.m. eastern 
time, unless otherwise specified pursuant to the procedures 
established in reproposed Rule 605(a)(2).
---------------------------------------------------------------------------

2. Governance Amendment
    The Governance Amendment is reproposed substantially as proposed. 
Paragraph (a) would mandate the formation of a Plan advisory committee. 
Paragraph (b) of the Governance Amendment would set forth the 
composition and selection process for such an advisory committee. 
Members of the advisory committee would be selected by the Plan 
operating committee, by majority vote, for two-year terms. At least one 
representative would be selected from each of the following five 
categories: (1) A broker-dealer with a substantial retail investor 
customer base, (2) a broker-dealer with a substantial institutional 
investor customer base, (3) an ATS, (4) a data vendor, and (5) an 
investor. Each Plan participant also would have the right to select one 
additional member to the advisory committee that is not employed by or 
affiliated with any Plan participant or its affiliates or facilities.
    Paragraphs (c) and (d) of the Governance Amendment would set forth 
the function of the advisory committee and the requirements for its 
participation in Plan affairs. Pursuant to paragraph (c), members of an 
advisory committee would have the right to submit their views to the 
operating committee on Plan matters, including, but not limited to, any 
new or modified product, fee, contract, or pilot program that is 
offered or used pursuant to the Plan. Paragraph (d) provides that 
members would have the right to attend all operating committee meetings 
and to receive any information distributed to the operating committee 
relating to Plan matters, except when the operating committee, by 
majority vote, decides to meet in executive session after determining 
that an item of Plan business requires confidential treatment.
3. Consolidation, Distribution, and Display of Data
    a. Independent Distribution of Information. The Commission is 
reproposing, substantially as proposed, the amendment to current Rule 
11Aa3-1 (reproposed to be designated as Rule 601), which would rescind 
the prohibition on SROs and their members from disseminating their 
trade reports independently.\345\ Under reproposed Rule 601, members of 
an SRO would continue to be required to transmit their trades to the 
SRO (and SROs would continue to transmit trades to the Networks 
pursuant to the Plans), but such members also would be free to 
distribute their own data independently, with or without fees.
---------------------------------------------------------------------------

    \345\ Reproposed Regulation NMS would remove the definitions in 
former paragraph (a) of current Rule 11Aa3-1 and place them in 
reproposed Rule 600(b). Current subparagraphs (c)(2) and (c)(3) of 
Rule 11Aa3-1 would be rescinded. As a result, current subparagraph 
(c)(4) of current Rule 11Aa3-1 would be redesignated as subparagraph 
(b)(2) of reproposed Rule 601.
---------------------------------------------------------------------------

    Reproposed Rule 603(a) would establish uniform standards for 
distribution of both quotations and trades that would create an 
equivalent regulatory regime for all types of markets. First, Rule 
603(a)(1) would require that any market information \346\ distributed 
by an exclusive processor, or by a broker or dealer (including ATSs and 
market makers) that is the exclusive source of the information, be made 
available to securities information processors on terms that are fair 
and reasonable. Rule 603(a)(2) would require that any SRO, broker, or 
dealer that distributes market information must do so on terms that are 
not unreasonably discriminatory. These requirements would prohibit, for 
example, a market from making its ``core data'' (i.e., data that it is 
required to provide to a Network processor) available to vendors on a 
more timely basis than it makes available the core data to a Network 
processor. With respect to non-core data, however, Network processors 
occupy a unique competitive position. As Network processor, it acts on 
behalf of all markets in disseminating consolidated information, yet it 
also may be closely associated with the competitor of a market. The 
Commission believes that markets should have considerable leeway in 
determining whether, or on what terms, they provide additional, non-
core data to a Network processor.
---------------------------------------------------------------------------

    \346\ The information covered by the amendment tracks the 
language of Section 11A(c) of the Exchange Act, which applies to 
``information with respect to quotations for or transactions in'' 
securities. This statutory language encompasses a broad range of 
information, including information relating to limit orders held by 
a market center. See, e.g., S. Report No. 94-75, 94th Cong., 1st 
Sess. 9 (1975) (``In the securities markets, as in most other active 
markets, it is critical for those who trade to have access to 
accurate, up-to-the-second information as to the prices at which 
transactions in particular securities are taking place (i.e., last 
sale reports) and the prices at which other traders have expressed 
their willingness to buy or sell (i.e., quotations).'').
---------------------------------------------------------------------------

    b. Consolidation of Information. All of the SROs currently 
participate in Plans that provide for the dissemination of consolidated 
information for the NMS Stocks that they trade. The Plans were adopted 
in order to enable the SROs to comply with Exchange Act rules regarding 
the reporting of trades and distribution of quotations. With respect to 
trades, paragraph (b) of Exchange Act Rule 11Aa3-1 (proposed to be 
redesignated as Rule 601(a)) requires each SRO to file transaction 
reporting plans that specify, among other things, how its transactions 
are to be consolidated with the transactions of other SROs. With 
respect to quotations, paragraph (b)(1) of Exchange Act Rule 11Ac1-1 
(proposed to be redesignated as Rule 602(a)(1)) requires an SRO to 
establish and maintain procedures for making its best quotes available 
to vendors.
    To confirm by Exchange Act rule that both existing and any new SROs 
would be required to continue to participate in such joint-SRO plans, 
reproposed Rule 603(b) would require SROs to act jointly pursuant to 
one or more NMS plans to disseminate consolidated information for NMS 
Stocks. Such consolidated information would be required to include an 
NBBO that is calculated in accordance with the definition set forth in 
reproposed Rule 600(b)(42).\347\ In addition, the NMS plans would be 
required to provide for the dissemination of all consolidated 
information for an individual NMS stock through a single processor. 
Thus, different processors would be permitted to disseminate 
information for different NMS stocks (e.g., SIAC for Network A stocks, 
and Nasdaq for Network C stocks), but all quotations and trades in

[[Page 77469]]

a stock would be disseminated through a single processor. As a result, 
information users, particularly retail investors, could obtain data 
from a single source that reflects the best quotations and most recent 
trade price for a security, no matter where such quotations and trade 
are displayed in the NMS.
---------------------------------------------------------------------------

    \347\ Reproposed Rule 600(b)(42) of Regulation NMS defines 
``national best bid and national best offer.''
---------------------------------------------------------------------------

    c. Display of Consolidated Information. Reproposed Rule 603(c) 
(currently Exchange Act Rule 11Ac1-2) substantially revises the 
consolidated display requirement. It would incorporate a new definition 
of ``consolidated display'' (set forth in reproposed Rule 600(b)(13)) 
that would be limited to the prices, sizes, and market center 
identifications of the NBBO, along with the ``consolidated last sale 
information'' (which is defined in Rule 600(b)(12)). Beyond disclosure 
of this basic information, market forces, rather than regulatory 
requirements, would be allowed to determine what, if any, additional 
data from other market centers is displayed. In particular, investors 
and other information users ultimately would be able to decide whether 
they need additional information in their displays.
    In addition, reproposed Rule 603(c) would narrow the contexts in 
which a consolidated display is required to those when it is most 
needed--a context in which a trading or order-routing decision could be 
implemented. For example, the consolidated display requirement would 
continue to cover broker-dealers who provide on-line data to their 
customers in software programs from which trading decisions can be 
implemented. Similarly, the requirement would continue to apply to 
vendors who provide displays that facilitate order routing by broker-
dealers. It would not apply, however, when market data is provided on a 
purely informational website that does not offer any trading or order-
routing capability.\348\
---------------------------------------------------------------------------

    \348\ The amendment would retain the exemptions currently set 
forth in Rule 11Ac1-2(f) (proposed to be redesignated as Rule 
603(c)(2)) for exchange and market linkage displays. The current 
exemption for displays used by SROs for monitoring or surveillance 
purposes would no longer be necessary because of the limitation of 
the amendment to trading and order-routing contexts.
---------------------------------------------------------------------------

VI. Regulation NMS

    To simplify the structure of the rules adopted under Section 11A of 
the Exchange Act (``NMS rules''), the rules reproposed today would 
designate the NMS rules as Regulation NMS, renumber the NMS rules, and 
would establish a new definitional rule, reproposed Rule 600 (``NMS 
Security Designation and Definitions''). Rule 600(a) would replace 
Exchange Act Rule 11Aa2-1, which designates ``reported securities'' as 
NMS securities. In addition, Rule 600(b) would include, in alphabetical 
order, all of the defined terms used in Regulation NMS. Regulation NMS 
would include reproposed Rules 610, 611, and 612 in addition to the 
existing NMS rules. The new rule series would be Rule 600 through Rule 
612 (17 CFR 242.600-612).
    Reproposed Rule 600 would provide a single set of definitions that 
would be used throughout Regulation NMS. To create a single set of 
definitions, Rule 600 would update or delete from the existing NMS 
rules some terms that have become obsolete and eliminate the use of 
multiple inconsistent definitions for identical terms. In addition, 
Rule 600 reproposes new terms, ``NMS security'' and ``NMS stock,'' to 
replace some terms that have been eliminated. These terms would be 
necessary to maintain distinctions between NMS rules that apply only to 
equity securities and ETFs (e.g., Exchange Act Rules 11Ac1-4 and 11Ac1-
5, proposed to be redesignated as Rules 604 and 605) and those that 
apply to equity securities, ETFs, and options (e.g., Exchange Act Rules 
11Ac1-1 and 11Ac1-6, proposed to be redesignated as Rules 602 and 606). 
Rule 600 would retain, unchanged, most definitions used in the existing 
NMS rules and would include definitions used in the new NMS rules 
reproposed today. The definitional changes would not affect the 
substantive requirements of the existing NMS rules. In addition, the 
reproposal would amend a number of other Commission rules that cross-
reference current NMS rules or that use terms that Regulation NMS would 
amend or eliminate.
    The Commission received no comments regarding proposed Rule 600, 
the proposed redesignation of the NMS rules as Regulation NMS, or the 
proposed changes to other Commission rules. Accordingly, the Commission 
is reproposing Rule 600 and redesignating the NMS rules as Regulation 
NMS, and reproposing technical amendments to certain other Commission 
rules that cross-reference current NMS rules or that use terms that 
Regulation NMS would amend or eliminate, substantially as 
proposed.\349\
---------------------------------------------------------------------------

    \349\ See infra note 394 for a list of rules to which technical 
amendments are proposed that are in addition to those originally 
proposed.
---------------------------------------------------------------------------

A. Description of Regulation NMS

    Reproposed Regulation NMS would renumber and, in some cases, rename 
the existing NMS rules, and would incorporate Rule 600 and the other 
NMS rules reproposed today. Where applicable, existing NMS rules would 
be amended to remove the definitions that have been consolidated in 
Rule 600. The titles and numbering of the rules in Regulation NMS, 
including the NMS rules reproposed today, would be as follows:
     Rule 600: NMS Security Designation and Definitions (would 
replace Exchange Act Rule 11Aa2-1, which the Commission is proposing to 
rescind, and incorporate definitions from the existing NMS rules and 
the reproposed new rules);
     Rule 601: Dissemination of Transaction Reports and Last 
Sale Data with Respect to Transactions in NMS Stocks (would renumber 
and rename current Exchange Act Rule 11Aa3-1, the substance of which 
would be modified); \350\
---------------------------------------------------------------------------

    \350\ In the market data rules, discussed in Section V., the 
Commission is reproposing substantive amendments to Exchange Act 
Rule 11Aa3-1 (proposed to be redesignated as Rule 601).
---------------------------------------------------------------------------

     Rule 602: Dissemination of Quotations in NMS Securities 
(would renumber and rename current Exchange Act Rule 11Ac1-1 (``Quote 
Rule''), the substance of which would remain largely intact);
     Rule 603: Distribution, Consolidation, and Display of 
Information with Respect to Quotations for and Transactions in NMS 
Stocks (would renumber and rename current Exchange Act Rule 11Ac1-2 
(``Vendor Display Rule''), the substance of which would be modified 
substantially); \351\
---------------------------------------------------------------------------

    \351\ In the market data rules, discussed in Section V., the 
Commission reproposes substantive amendments to the Vendor Display 
Rule.
---------------------------------------------------------------------------

     Rule 604: Display of Customer Limit Orders (would renumber 
current Exchange Act Rule 11Ac1-4 (``Limit Order Display Rule''), the 
substance of which would remain largely intact);
     Rule 605: Disclosure of Order Execution Information (would 
renumber current Exchange Act Rule 11Ac1-5, the substance of which 
would remain largely intact);
     Rule 606: Disclosure of Order Routing Information (would 
renumber current Exchange Act Rule 11Ac1-6, the substance of which 
would remain largely intact);
     Rule 607: Customer Account Statements (would renumber 
current Exchange Act Rule 11Ac1-3, the substance of which would remain 
largely intact);
     Rule 608: Filing and Amendment of National Market System 
Plans (would renumber current Exchange Act Rule 11Aa3-2, the substance 
of which would remain largely intact);

[[Page 77470]]

     Rule 609: Registration of Securities Information 
Processors: Form of Application and Amendments (would renumber current 
Exchange Act Rule 11Ab2-1, the substance of which would remain largely 
intact);
     Rule 610: Access to Quotations (reproposed in this 
release);
     Rule 611: Order Protection Rule (reproposed in this 
release); and
     Rule 612: Minimum Pricing Increment (reproposed in this 
release).

B. Rule 600--NMS Security Designation and Definitions

1. NMS Security Designation--Transaction Reporting Requirements for 
Equities and Listed Options

    Section 11A(a)(2) of the Exchange Act directs the Commission to 
``designate the securities or classes of securities qualified for 
trading in the national market system.'' \352\ The 1975 Amendments and 
the legislative history to the 1975 Amendments were silent as to the 
particular standards the Commission should employ in designating NMS 
securities.\353\ Instead, Congress provided the Commission with the 
flexibility and discretion to base NMS designation standards on the 
Commission's experience in facilitating the development of an NMS.\354\
---------------------------------------------------------------------------

    \352\ 15 U.S.C. 78k-1(a)(2).
    \353\ See Securities Exchange Act Release No. 23817 (Nov. 17, 
1986), 51 FR 42856 (Nov. 26, 1986) (proposing amendments to Exchange 
Act Rules 11Aa2-1 and 11Aa3-1).
    \354\ See id.
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    To satisfy the requirement that it designate the securities 
qualified for trading in the NMS, the Commission adopted Exchange Act 
Rule 11Aa2-1 in 1981.\355\ Exchange Act Rule 11Aa2-1 defines the term 
``national market system security'' to mean ``any reported security as 
defined in Rule 11Aa3-1.'' A ``reported security'' is ``any security or 
class of securities for which transaction reports are collected, 
processed and made available pursuant to an effective transaction 
reporting plan.'' \356\ An ``effective transaction reporting plan'' is 
``any transaction reporting plan approved by the Commission pursuant to 
this section.'' \357\ A ``transaction reporting plan'' is ``any plan 
for collecting, processing, making available or disseminating 
transaction reports with respect to transactions in reported securities 
filed with the Commission pursuant to, and meeting the requirements of, 
this section.'' \358\ The effective transaction reporting plans are the 
CTA Plan and the Nasdaq UTP Plan.
---------------------------------------------------------------------------

    \355\ See Securities Exchange Act Release No. 17549 (Feb. 17, 
1981), 46 FR 13992 (Feb. 25, 1981) (adopting Exchange Act Rule 
11Aa2-1).
    \356\ See Exchange Act Rule 11Aa3-1(a)(4).
    \357\ See Exchange Act Rule 11Aa3-1(a)(3).
    \358\ See Exchange Act Rule 11Aa3-1(a)(2).
---------------------------------------------------------------------------

    In addition to identifying those securities deemed to be NMS 
securities, when adopted, the Exchange Act Rule 11Aa2-1 designation 
also tacitly identified those securities that did not meet that 
designation (i.e., securities other than those that were so designated 
as NMS securities). Historically, securities excluded from this 
designation included standardized options and small capitalization 
equity securities (a subset of which has been identified as Nasdaq 
SmallCap securities). Trading in options and Nasdaq SmallCap securities 
has increased over the past three decades and gradually many of the 
rules that govern NMS securities have been applied to these securities. 
As a result, much of the terminology that has been used to distinguish 
NMS securities from options and Nasdaq SmallCap securities has become 
obsolete.
    For example, the Nasdaq UTP Plan provides for the collection from 
Plan participants, and the consolidation and dissemination to vendors, 
subscribers and others, of quotation and transaction information in 
``eligible securities.'' Prior to 2001, the Nasdaq UTP Plan defined an 
``eligible security'' as any Nasdaq National Market security as to 
which unlisted trading privileges have been granted to a national 
securities exchange pursuant to Section 12(f) of the Exchange Act or 
that is listed on a national securities exchange. In 2001, the Nasdaq 
UTP Plan was amended to include Nasdaq SmallCap securities.\359\ As a 
result, Nasdaq SmallCap securities became ``eligible securities'' 
because they are now reported through an effective transaction 
reporting plan (i.e., the Nasdaq UTP Plan), bringing them within the 
purview of the NMS security designation. Several definitions in the 
existing NMS rules, however, do not reflect the inclusion of Nasdaq 
SmallCap securities in the Nasdaq UTP Plan and therefore must be 
updated. Regulation NMS would do so.
---------------------------------------------------------------------------

    \359\ See NASD Rule 4200 for the definition of a Nasdaq SmallCap 
security. The Nasdaq UTP Plan provides for the collection from Plan 
participants, and the consolidation and dissemination to vendors, 
subscribers and others, of quotation and transaction information in 
``eligible securities.'' ``Eligible securities'' initially included 
Nasdaq NMS securities listed on an exchange or traded on an exchange 
pursuant to a grant of unlisted trading privileges. See Securities 
Exchange Act Release No. 28146 (June 26, 1990), 55 FR 27917 (July 6, 
1990) (order approving the Nasdaq UTP Plan on a pilot basis). In 
2001, the Nasdaq UTP Plan was amended to, among other things, revise 
the definition of ``eligible securities'' to include Nasdaq SmallCap 
securities. See Securities Exchange Act Release No. 45081 (Nov. 19, 
2001), 66 FR 59273 (Nov. 27, 2001) (order approving Amendment No. 12 
to the Nasdaq UTP Plan).
---------------------------------------------------------------------------

    In addition, transactions in exchange-listed options are reported 
through the Plan for Reporting of Consolidated Options Last Sale 
Reports and Quotation Information (``OPRA Plan'').\360\ Unlike the CTA 
Plan and the Nasdaq UTP Plan--transaction reporting plans that the 
Commission approved pursuant to Exchange Act Rules 11Aa3-1 and 11Aa3-2 
(proposed to be redesignated as Rules 601 and 608)--the Commission 
approved the OPRA Plan pursuant to Exchange Act Rule 11Aa3-2 (proposed 
to be redesignated as Rule 608).\361\ As such, the OPRA Plan is an 
``effective national market system plan'' but not an ``effective 
transaction reporting plan.'' While at their core the CTA Plan, the 
Nasdaq UTP Plan, and the OPRA Plan perform essentially the same 
function (i.e., they govern the consolidated reporting of securities 
transactions by Plan participants), because the OPRA Plan is not an 
effective transaction reporting plan, listed options covered by the 
OPRA Plan are technically not ``securities for which transaction 
reports are collected, processed, and made available pursuant to an 
effective transaction reporting plan.'' Therefore, listed options were 
not considered NMS securities as defined by Exchange Act Rule 11Aa2-1. 
While the impact of this distinction may not be readily apparent, the 
differences in the way the Plans are designated dictates the securities 
laws and regulations that apply to securities reported pursuant to 
those Plans.
---------------------------------------------------------------------------

    \360\ The exchanges that are participants to the OPRA Plan are 
Amex, BSE, CBOE, ISE, PCX, and Phlx.
    \361\ See Securities Exchange Act Release No. 17638 (Mar. 18, 
1981), 22 S.E.C. Docket 484 (Mar. 31, 1981). Exchange Act Rule 
11Aa3-2 (proposed to be redesignated as Rule 608) codifies the 
procedures that SROs must follow to seek approval for or amendment 
of a national market system plan.
---------------------------------------------------------------------------

    Further, as discussed below, some terms in the existing NMS rules 
have become superfluous or outdated, and some NMS rules define 
identical terms differently. To provide a consolidated set of 
definitions applicable to all of the NMS rules, Regulation NMS would 
eliminate these inconsistencies. The definitional changes reproposed 
today, however, are not intended to change materially the scope of the 
existing NMS rules.
2. NMS Security and NMS Stock
    Some NMS rules, including the Quote Rule (proposed to be 
redesignated as Rule 602) and Exchange Act Rule 11Ac1-6 (proposed to be 
redesignated as Rule 606), currently apply to both (1)

[[Page 77471]]

equities, ETFs and related securities for which transaction reports are 
made available pursuant to an effective transaction reporting plan, and 
(2) listed options for which market information is made available 
pursuant to an effective national market system plan. To provide a 
single term that will be used in any provision of Regulation NMS that 
applies to both categories of securities, Regulation NMS reproposes a 
new term, ``NMS security.'' \362\
    Because many rules in Regulation NMS, including the Limit Order 
Display Rule (proposed to be redesignated as Rule 604) and Exchange Act 
Rule 11Ac1-5 (proposed to be redesignated as Rule 605), continue to be 
inapplicable to listed options, Regulation NMS reproposes a new term, 
``NMS stock'' that would be used in those provisions. Regulation NMS 
would define the term ``NMS stock'' as ``any NMS security other than an 
option.'' \363\
---------------------------------------------------------------------------

    \362\ Specifically, reproposed Regulation NMS would define an 
``NMS security'' as ``any security or class of securities for which 
transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan, or an effective 
national market system plan for reporting transactions in listed 
options.'' This definition is used to define a ``reported security'' 
in the Quote Rule. See Exchange Act Rule 11Ac1-1(a)(20). For the 
reasons described below, the Commission would eliminate the term 
``reported security'' from the Quote Rule and would not include it 
in Regulation NMS.
    \363\ Reproposed Rule 600(b)(47).
---------------------------------------------------------------------------

3. Changes to Existing Definitions in the NMS Rules
    Reproposed Rule 600(b) would provide a single set of definitions 
that would be used throughout Regulation NMS. To create a single set of 
definitions, Regulation NMS would eliminate multiple, inconsistent 
definitions of identical terms. In addition, Regulation NMS would amend 
some definitions in the NMS rules to reflect changed conditions in the 
marketplace or to modernize references. For example, as discussed 
above, several definitions in the existing NMS rules have been rendered 
obsolete by the extension of the Nasdaq UTP Plan to Nasdaq SmallCap 
securities.\364\ Because the Nasdaq UTP Plan includes Nasdaq SmallCap 
securities, those securities now are ``securities for which transaction 
reports are collected, processed and made available pursuant to an 
effective transaction reporting plan'' (i.e., they are ``reported'' 
securities).\365\ For this reason, it is no longer necessary to 
distinguish, as several existing NMS rules do, between ``reported'' 
securities and equity securities for which market information is made 
available through Nasdaq.\366\ Accordingly, Regulation NMS would 
eliminate or revise the defined terms in the existing NMS rules that 
make this distinction.
---------------------------------------------------------------------------

    \364\ See supra Section VI.B.1.
    \365\ The Vendor Display Rule and Exchange Act Rule 11Aa3-1 
define the term ``reported security'' to mean ``any security or 
class of securities for which transaction reports are collected, 
processed and made available pursuant to an effective transaction 
reporting plan.'' See Exchange Act Rules 11Ac1-2(a)(20) and 11Aa3-
1(a)(4). As discussed more fully below, the Quote Rule provides a 
different definition of ``reported security.''
    \366\ See e.g., paragraph (a)(4) of the Vendor Display Rule 
(defining ``subject security'' to mean ``(i) any reported security; 
and (ii) any other equity security as to which transaction reports, 
last sale data or quotation information is disseminated through 
NASDAQ''); and paragraph (a)(6) of the Quote Rule (defining 
``covered security'' to mean ``any reported security and any other 
security for which a transaction report, last sale data or quotation 
information is disseminated through an automated quotation system as 
described in Section 3(a)(51)(A)(ii) of the Act (15 U.S.C. 
78c(a)(51)(A)(ii))'').
---------------------------------------------------------------------------

    a. Covered Security. Different definitions of the term ``covered 
security'' appeared in the Quote Rule, the Limit Order Display Rule, 
and Exchange Act Rule 11Ac1-6.\367\ In addition, as discussed below, 
the term has become obsolete. Therefore, Regulation NMS would eliminate 
the term ``covered security'' from the NMS rules and replaces it with 
the term ``NMS security'' or ``NMS stock,'' as applicable, depending 
upon the scope of the particular rule.
---------------------------------------------------------------------------

    \367\ Although the Quote Rule and the Limit Order Display Rule 
each define the term ``covered security'' as ``any reported security 
and any other security for which a transaction report, last sale 
data or quotation information is disseminated through an automated 
quotation system as described in Section 3(a)(51)(A)(ii) of the Act 
(15 U.S.C. 78c(a)(51)(A)(ii)),'' the scope of the definitions is not 
identical because each rule defines the term ``reported security'' 
differently. The Quote Rule defines a ``reported security'' to mean 
``any security or class of securities for which transaction reports 
are collected, processed and made available pursuant to an effective 
transaction reporting plan, or an effective national market system 
plan for reporting transactions in listed options.'' See Exchange 
Act Rule 11Ac1-1(a)(20). The Limit Order Display Rule defines a 
``reported security'' to mean ``any security or class of securities 
for which transaction reports are collected, processed, and made 
available pursuant to an effective transaction reporting plan.'' See 
Exchange Act Rule 11Ac1-4(a)(10).
    Exchange Act Rule 11Ac1-6 defines the term ``covered security'' 
to mean: ``(i) any national market system security and any other 
security for which a transaction report, last sale data or quotation 
information is disseminated through an automated quotation system as 
defined in Section 3(a)(51)(A)(ii) of the Act (15 U.S.C. 
78c(a)(51)(A)(ii)); and (ii) any option contract traded on a 
national securities exchange for which last sale reports and 
quotation information are made available pursuant to an effective 
national market system plan.'' See Exchange Act Rule 11Ac1-6(a)(1).
---------------------------------------------------------------------------

    b. Reported Security. Several NMS rules used the term ``reported 
security.'' Although the Limit Order Display Rule, the Vendor Display 
Rule, and Exchange Act Rule 11Aa3-1 contain identical definitions of 
``reported security,'' the Quote Rule provides a different 
definition.\368\ Because the term ``reported security'' is defined 
inconsistently in the NMS rules and in light of the reproposed changes 
to related terms, Regulation NMS would eliminate the term ``reported 
security'' from the NMS rules and replace it with the term ``NMS 
security'' or ``NMS stock,'' depending on the scope of the particular 
rule.
---------------------------------------------------------------------------

    \368\ The Limit Order Display Rule, the Vendor Display Rule, and 
Exchange Act Rule 11Aa3-1 define a ``reported security'' to mean 
``any security or class of securities for which transaction reports 
are collected, processed and made available pursuant to an effective 
transaction reporting plan.'' See Exchange Act Rules 11Ac1-4(a)(10), 
11Ac1-2(a)(20), and 11Aa3-1(a)(4). The Quote Rule defines the term 
``reported security'' to mean ``any security or class of securities 
for which transaction reports are collected, processed, and made 
available pursuant to an effective transaction reporting plan, or an 
effective national market system plan for reporting transactions in 
listed options.'' See Exchange Act Rule 11Ac1-1(a)(20). As discussed 
above, this release reproposes substantial modifications to the 
Vendor Display Rule.
---------------------------------------------------------------------------

    The Limit Order Display Rule uses the term ``reported security'' 
solely for the purpose of defining the term ``covered security.'' \369\ 
Because Regulation NMS would eliminate the term ``covered security,'' 
the term ``reported security'' also would not be needed in the Limit 
Order Display Rule (proposed to be redesignated as Rule 604). 
Therefore, the term ``NMS stock'' would replace the term ``covered 
security'' in the Limit Order Display Rule.
---------------------------------------------------------------------------

    \369\ The Limit Order Display Rule defines a ``covered 
security'' to include both reported securities and other securities 
for which market information is disseminated through Nasdaq. See 
Exchange Act Rule 11Ac1-4(a)(5).
---------------------------------------------------------------------------

    Similarly, the Quote Rule uses the term ``reported security'' 
primarily to define the term ``covered security.'' \370\ Because 
Regulation NMS would eliminate the term ``covered security,'' the Quote 
Rule (proposed to be redesignated as Rule 602) \371\ also would not use 
the term ``reported security.''
---------------------------------------------------------------------------

    \370\ The Quote Rule defines a ``covered security'' to include 
both reported securities and other securities for which market 
information is disseminated through Nasdaq. See Exchange Act Rule 
11Aa1-1(a)(6).
    \371\ In paragraph (b)(1)(ii) of the Quote Rule (proposed to be 
redesignated as Rule 602), which requires a registered national 
securities association to disseminate quotations at all times when 
last sale information is available with respect to ``reported 
securities,'' the reference to ``reported security'' would be 
replaced by a reference to ``NMS security.''
---------------------------------------------------------------------------

    c. Subject Security. The Quote Rule and the Vendor Display Rule 
both use the term ``subject security,'' although they define the term 
differently. To

[[Page 77472]]

eliminate this inconsistency, the reproposed Vendor Display Rule 
(proposed to be redesignated as Rule 603) would not use the term 
``subject security'' and Regulation NMS would retain a slightly 
modified version of the definition of ``subject security'' currently 
found in the Quote Rule.
    The Vendor Display Rule defines the term ``subject security'' to 
mean ``(i) any reported security; and (ii) any other equity security as 
to which transaction reports, last sale data or quotation information 
is disseminated through NASDAQ.'' \372\ As discussed above, the 
extension of the Nasdaq UTP Plan to include Nasdaq SmallCap securities 
renders obsolete the distinction between a ``reported security'' and a 
security for which market information is disseminated through Nasdaq. 
Accordingly, the reproposed Vendor Display Rule (proposed to be 
redesignated as Rule 603) would use the term ``NMS stock'' rather than 
``subject security.''
---------------------------------------------------------------------------

    \372\ See Exchange Act Rule 11Ac1-2(a)(4).
---------------------------------------------------------------------------

    The Quote Rule defines the term ``subject security'' to mean:
    (i) With respect to an exchange: (A) Any exchange-traded security 
other than a security for which the executed volume of such exchange, 
during the most recent calendar quarter, comprised one percent or less 
of the aggregate trading volume for such security as reported in the 
consolidated system; and (B) Any other covered security for which such 
exchange has in effect an election, pursuant to paragraph (b)(5)(i) of 
this section, to collect, process, and make available to quotation 
vendors bids, offers, quotation sizes, and aggregate quotation sizes 
communicated on such exchange; and
    (ii) With respect to a member of an association: (A) Any exchange-
traded security for which such member acts in the capacity of an OTC 
market maker unless the executed volume of such member, during the most 
recent calendar quarter, comprised one percent or less of the aggregate 
trading volume for such security as reported in the consolidated 
system; and (B) Any other covered security for which such member acts 
in the capacity of an OTC market maker and has in effect an election, 
pursuant to paragraph (b)(5)(ii) of this section, to communicate to its 
association bids, offers and quotation sizes for the purpose of making 
such bids, offers and quotation sizes available to quotation 
vendors.\373\
---------------------------------------------------------------------------

    \373\ See Exchange Act Rule 11Ac1-1(a)(25) (emphasis added).
---------------------------------------------------------------------------

    Because the Quote Rule (proposed to be redesignated as Rule 602) 
would continue to apply to both listed options and equities covered by 
an effective transaction reporting plan, Regulation NMS's definition of 
``subject security'' would revise the Quote Rule's definition of 
``subject security'' by replacing references to a ``covered security'' 
with references to an ``NMS security.'' In addition, for the reasons 
discussed below, Regulation NMS would replace the phrase ``reported in 
the consolidated system'' with the phrase ``reported pursuant to an 
effective transaction reporting plan or effective national market 
system plan.''
    d. Consolidated System. As noted above, the definition of the term 
``subject security'' in the Quote Rule uses the phrase ``reported in 
the consolidated system.'' \374\ Paragraph (a)(5) of the Quote Rule 
defines the term ``consolidated system'' to mean ``the consolidated 
transaction reporting system, including a transaction reporting system 
operating pursuant to an effective national market system plan.'' \375\
---------------------------------------------------------------------------

    \374\ Id.
    \375\ See Exchange Act Rule 11Ac1-1(a)(5).
---------------------------------------------------------------------------

    Regulation NMS would clarify the definition of ``subject security'' 
by eliminating the phrase ``reported in the consolidated system'' and 
replacing it with the phrase ``reported pursuant to an effective 
transaction reporting plan or an effective national market system 
plan.'' Thus, Regulation NMS would define a ``subject security'' to 
include, among other things: (1) With respect to a national securities 
exchange, any exchange-traded security other than a security for which 
the executed volume of such exchange, during the most recent calendar 
quarter, comprised one percent or less of the aggregate trading volume 
for such security as reported pursuant to an effective transaction 
reporting plan or effective national market system plan; and (2) with 
respect to a member of a national securities association, any exchange-
traded security for which such member acts in the capacity of an OTC 
market maker unless the executed volume of such member, during the most 
recent calendar quarter, comprised one percent or less of the aggregate 
trading volume for such security as reported pursuant to an effective 
transaction reporting plan or effective national market system 
plan.\376\
---------------------------------------------------------------------------

    \376\ Reproposed Rule 600(b)(73).
---------------------------------------------------------------------------

    This change would provide a clearer definition of ``subject 
security'' by indicating that the trading volume referred to in the 
definition is the trading volume in a security that is reported 
pursuant to an effective transaction reporting plan or an effective 
national market system plan. Although replacing the phrase ``reported 
in the consolidated system'' with the phrase ``reported pursuant to an 
effective transaction reporting plan or an effective national market 
system plan'' produces a clearer definition of ``subject security,'' it 
would not alter the scope or the substance of the definition.\377\
---------------------------------------------------------------------------

    \377\ This change also would impact certain non-NMS rules that 
define the term ``consolidated system.'' See, e.g., Exchange Act 
Rule 10b-18(a)(7) (``consolidated system means the consolidated 
transaction reporting system contemplated by Rule 11Aa3-1''). As 
discussed below, the Commission is also reproposing to amend certain 
non-NMS rules that are affected by the definitional changes 
reproposed today.
---------------------------------------------------------------------------

    e. National Securities Exchange. Section 3(a)(1) of the Exchange 
Act defines the term ``exchange'' to mean ``any organization, 
association, or group of persons * * * which constitutes, maintains, or 
provides a market place or facilities for bringing together purchasers 
and sellers of securities or for otherwise performing with respect to 
securities the functions commonly performed by a stock exchange as that 
term is generally understood.* * *'' \378\ Exchange Act Rule 3b-
16,\379\ adopted in 1998, interprets the statutory definition of 
``exchange'' broadly to include any organization, association, or group 
of persons that: (1) brings together the orders for securities of 
multiple buyers and sellers; and (2) uses established, non-
discretionary methods (whether by providing a trading facility or by 
setting rules) under which such orders interact with each other, and 
the buyers and sellers entering such orders agree to the terms of a 
trade. Exchange Act Rule 3b-16 was designed to provide ``a more 
comprehensive and meaningful interpretation of what an exchange is in 
light of today's markets.'' \380\
---------------------------------------------------------------------------

    \378\ 15 U.S.C. 78c(a)(1).
    \379\ 17 CFR 240.3b-16.
    \380\ See Securities Exchange Act Release No. 40760 (Dec. 8, 
1998), 63 FR 70844 (Dec. 22, 1998) (adopting Regulation ATS).
---------------------------------------------------------------------------

    The Quote Rule's definition of an ``exchange market maker'' defines 
the term ``national securities exchange'' as an ``exchange.'' \381\ To 
avoid confusion between a ``national securities exchange'' and the 
broader interpretation of ``exchange'' set forth in Exchange Act Rule 
3b-16, Regulation NMS would use the term ``national

[[Page 77473]]

securities exchange'' rather than ``exchange'' throughout the 
Regulation. The national securities exchange definition is intended to 
capture only those entities that operate as national securities 
exchanges and that are registered as such with the Commission. It is 
not intended to capture those entities that meet the ``exchange'' 
definition under Regulation ATS but that operate as something other 
than a national securities exchange. The use of this term would be 
consistent with the use of the term ``exchange'' in the existing NMS 
rules.
---------------------------------------------------------------------------

    \381\ Specifically, the Quote Rule states that the term 
``exchange market maker'' shall mean ``any member of a national 
securities exchange (`exchange') who is registered as a specialist 
or market maker pursuant to the rules of such exchange.'' See 
Exchange Act Rule 11Ac1-1(a)(9). The statutory requirements 
applicable to a national securities exchange are set forth in 
Section 6 of the Exchange Act, 15 U.S.C. 78f.
---------------------------------------------------------------------------

    f. OTC Market Maker. The Quote Rule and Exchange Act Rule 11Ac1-5 
define the term ``OTC market maker'' differently.\382\ Unlike the Quote 
Rule, Exchange Act Rule 11Ac1-5 defines the term ``OTC market maker'' 
to include an explicit reference to a securities dealer that holds 
itself out as being willing to buy from and sell to customers or others 
in the United States. Regulation NMS would retain the reference to 
transactions with ``customers or others in the United States'' to 
indicate clearly that a foreign dealer could be an ``OTC market maker'' 
if it acts as a securities dealer with respect to customers or others 
in the United States.
---------------------------------------------------------------------------

    \382\ Compare Exchange Act Rules 11Ac1-1(a)(13) and 11Ac1-
5(a)(18).
---------------------------------------------------------------------------

    Accordingly, Regulation NMS would define ``OTC market maker'' as 
``any dealer that holds itself out as being willing to buy from and 
sell to its customers, or others, in the United States, an NMS stock 
for its own account on a regular or continuous basis otherwise than on 
a national securities exchange.'' \383\
---------------------------------------------------------------------------

    \383\ The reproposed definition of ``OTC market maker'' uses the 
term ``NMS stock'' because there is no OTC market in standardized 
options.
---------------------------------------------------------------------------

    g. Vendor. The term ``vendor'' or ``quotation vendor'' is defined 
differently in three NMS rules: the Quote Rule, the Vendor Display 
Rule, and Exchange Act Rules 11Aa3-1.\384\ Although the definitions are 
similar, the definition of ``vendor'' in the Vendor Display Rule is the 
most comprehensive because it encompasses any SIP that disseminates 
transaction reports, last sale data, or quotation information, whereas 
the other definitions are less complete in identifying the types of 
information that vendors typically make available. To provide a uniform 
and comprehensive definition of the term ``vendor,'' Regulation NMS 
reproposes to include the definition of ``vendor'' as it was defined in 
the Vendor Display Rule.\385\
---------------------------------------------------------------------------

    \384\ The Quote Rule define the term ``quotation vendor'' to 
mean ``any securities information processor engaged in the business 
of disseminating to brokers, dealers or investors on a real-time 
basis, bids and offers made available pursuant to this section, 
whether distributed through an electronic communications network or 
displayed on a terminal or other display device.'' See Exchange Act 
Rule 11Ac1-1(a)(19). Exchange Act Rule 11Aa3-1(a)(11) defines the 
term ``vendor'' to mean ``any securities information processor 
engaged in the business of disseminating transaction reports or last 
sale data with respect to transactions in reported securities to 
brokers, dealers or investors on a real-time or other current and 
continuing basis, whether through an electronic communications 
network, moving ticker or interrogation device.'' The Vendor Display 
Rule defines the term ``vendor'' to mean ``any securities 
information processor engaged in the business of disseminating 
transaction reports, last sale data or quotation information with 
respect to subject securities to brokers, dealers or investors on a 
real-time or other current and continuing basis, whether through an 
electronic communications network, moving ticker or interrogation 
device.'' See Exchange Act Rule 11Ac1-2(a)(2).
    \385\ See Exchange Act Rule 11Ac1-2(a)(2).
---------------------------------------------------------------------------

    h. Best Bid, Best Offer, and National Best Bid and National Best 
Offer. The Quote Rule and the Vendor Display Rule define the terms 
``best bid'' and ``best offer'' differently.\386\ In addition, Exchange 
Act Rule 11Ac1-5(a)(7) defines the term ``consolidated best bid and 
offer'' to mean ``the highest firm bid and the lowest firm offer for a 
security that is calculated and disseminated on a current and 
continuous basis pursuant to an effective national market system 
plan.'' Regulation NMS would retain the definitions of ``best bid'' and 
``best offer'' used in the Quote Rule. A new term called ``national 
best bid and national best offer'': (1) Would replace the term ``best 
bid and best offer'' as that term is used in the Vendor Display Rule; 
and (2) would replace the term ``consolidated best bid and offer'' as 
that term is used in Exchange Act Rule 11Ac1-5. This new term refers to 
the best quotations that are calculated and disseminated by a plan 
processor pursuant to an effective national market system plan.\387\ 
The definition of ``national best bid and national best offer'' also 
would address instances where multiple market centers transmit 
identical bids and offers to the plan processor pursuant to an NMS plan 
by establishing the way in which these bids and offers are to be 
prioritized.\388\
---------------------------------------------------------------------------

    \386\ The Quote Rule states that ``[t]he terms best bid and best 
offer shall mean the highest priced bid and the lowest priced 
offer.'' See Exchange Act Rule 11Ac1-1(a)(3). The Vendor Display 
Rule (Exchange Act Rule 11Ac1-2(a)(15)) defines the terms ``best 
bid'' and ``best offer'' as follows:
    (i) With respect to quotations for a reported security, the 
highest bid or lowest offer for that security made available by any 
reporting market center pursuant to Sec.  240.11Ac1-1 (Rule 11Ac1-1 
under the Act) (excluding any bid or offer made available by an 
exchange during any period such exchange is relieved of its 
obligations under paragraphs (b) (1) and (2) of Sec.  240.11Ac1-1 by 
virtue of paragraph (b)(3)(i) thereof)); Provided, however, That in 
the event two or more reporting market centers make available 
identical bids or offers for a reported security, the best bid or 
best offer (as the case may be) shall be computed by ranking all 
such identical bids or offers (as the case may be) first by size 
(giving the highest ranking to the bid or offer associated with the 
largest size), then by time (giving the highest ranking to the bid 
or offer received first in time); and
    (ii) With respect to quotations for a subject security other 
than a reported security, the highest bid or lowest offer (as the 
case may be) for such security disseminated by an over-the-counter 
market maker in Level 2 or 3 of NASDAQ.
    \387\ The definition of ``reporting market center'' currently in 
paragraph (a)(14) of the Vendor Display Rule and incorporated into 
that Rule's definitions of ``best bid'' and ``best offer'' would no 
longer be necessary and therefore would be deleted.
    \388\ See reproposed Rule 600(b)(42).
---------------------------------------------------------------------------

    i. Bid or Offer, Customer, Nasdaq Security, and Responsible Broker 
or Dealer. Regulation NMS also would update or clarify the following 
terms in the NMS rules: ``bid'' or ``offer;'' ``customer;'' ``Nasdaq 
security;'' and ``responsible broker or dealer.''
    The Quote Rule defines the terms ``bid and offer'' to mean ``the 
bid price and the offer price communicated by an exchange member or OTC 
market maker to any broker or dealer, or to any customer, at which it 
is willing to buy or sell one or more round lots of a covered security, 
as either principal or agent, but shall not include indications of 
interest.'' \389\ Regulation NMS would update this definition by 
replacing the term ``OTC market maker'' with the phrase ``member of a 
national securities association'' and call the term ``bid or offer'' 
rather than ``bid and offer'' to reflect the fact that the terms are 
not always used in the conjunctive. Modifying the definition to apply 
to any member of a national securities association would clarify that 
bids and offers include quotations communicated not only by OTC market 
makers but also by ATSs, ECNs, and order entry firms that are members 
of the NASD but that are not market makers.
---------------------------------------------------------------------------

    \389\ See Exchange Act Rule 11Ac1-1(a)(4). Paragraph (a)(6) of 
the Vendor Display Rule uses the Quote Rule's definition of ``bid'' 
and ``offer'' for reported securities, but it defines ``bid'' and 
``offer'' for Nasdaq SmallCap securities as ``the most recent bid or 
offer price of an over-the-counter market maker disseminated through 
Level 2 or 3 of NASDAQ.'' Because Nasdaq SmallCap securities now are 
reported securities, it is unnecessary to maintain the distinction 
between reported securities and Nasdaq SmallCap securities. 
Accordingly, to update and provide a single definition of the terms 
``bid'' and ``offer,'' Regulation NMS would eliminate the 
definitions of ``bid'' and ``offer'' used in the Vendor Display Rule 
and retain modified versions of the terms as they are defined in the 
Quote Rule.
---------------------------------------------------------------------------

    Expanding the definition of ``bid or offer'' could have the 
unintended consequence of also expanding the scope of the Quote Rule 
(proposed to be redesignated as Rule 602) where those terms are used to 
apply to members of a national securities association that are not OTC 
market makers (e.g., ECNs and

[[Page 77474]]

ATSs). To avoid this unintended expansion of the scope of the Quote 
Rule (proposed to be redesignated as Rule 602), Regulation NMS 
reproposes a revised version of the Quote Rule's definition of 
``responsible broker or dealer.'' \390\ In particular, Regulation NMS 
would amend the portion of the definition of ``responsible broker or 
dealer'' found in paragraph (a)(21)(ii) of the Quote Rule \391\ to 
limit its scope to bids and offers communicated by an OTC market maker.
---------------------------------------------------------------------------

    \390\ See Exchange Act Rule 11Ac1-1(a)(21).
    \391\ See Exchange Act Rule 11Ac1-1(a)(21)(ii).
---------------------------------------------------------------------------

    Regulation NMS also would amend the definition of the term 
``customer.'' The Quote Rule defines that term to mean ``any person 
that is not a registered broker-dealer.'' \392\ To indicate that the 
scope of the definition includes broker-dealers that are exempt from 
registration as well as registered broker-dealers, Regulation NMS would 
revise the definition by deleting the term ``registered.'' Thus, 
Regulation NMS would define the term ``customer'' to mean ``any person 
that is not a broker-dealer.''
---------------------------------------------------------------------------

    \392\ See Exchange Act Rule 11Ac1-1(a)(26).
---------------------------------------------------------------------------

    Exchange Act Rule 11Aa3-1 defines the term ``NASDAQ security'' to 
mean ``any registered equity security for which quotation information 
is disseminated in the National Association of Securities Dealers 
Automated Quotation system (``NASDAQ'').'' \393\ This acronym is now 
outdated. Therefore, to modernize this definition and to ensure that 
any type of registered security that Nasdaq lists is covered by the 
definition, Regulation NMS would define the term ``Nasdaq security'' to 
mean ``any registered security listed on The Nasdaq Stock Market, 
Inc.''
---------------------------------------------------------------------------

    \393\ See Exchange Act Rule 11Aa3-1(a)(6).
---------------------------------------------------------------------------

4. Definitions in the Regulation NMS Rules Reproposed Today
    Reproposed Rule 600(b) includes a number of new definitions used in 
reproposed Rules 610 through 612 of Regulation NMS. These new terms are 
discussed in detail in Sections II through V above. Specifically, for 
the reasons discussed above, Regulation NMS reproposes the following 
terms: automated quotation, automated trading center, consolidated 
display, consolidated last sale information, intermarket sweep order, 
manual quotation, protected bid or protected offer, SRO display-only 
facility, SRO trading facility, trade-through, and trading center.

C. Changes to Other Rules

    In addition to the changes described above, the rules reproposed 
today would amend a number of rules that cross-reference current NMS 
rules or that use terms that Regulation NMS would amend or eliminate. 
These amendments are intended to be non-substantive. Specifically, the 
rules reproposed today would make conforming changes to the following 
rules: \394\ Sec.  200.30-3; \395\ Sec.  200.800, Subpart N; \396\ 
Sec.  201.101; \397\ Rule 144 \398\ under the Securities Act of 1933; 
\399\ Exchange Act Rule 0-10; \400\ Exchange Act Rule 3a51-1 \401\; 
Exchange Act Rule 3a55-1; \402\ Exchange Act Rule 3b-16; \403\ Exchange 
Act Rules 10a-1; \404\ Exchange Act Rule 10b-10; \405\ Exchange Act 
Rule 10b-18; \406\ Exchange Act Rule 15b9-1; \407\ Exchange Act Rule 
12a-7; \408\ Exchange Act Rule 12f-1; \409\ Exchange Act Rule 12f-2; 
\410\ Exchange Act Rule 15c2-11; \411\ Exchange Act Rule 19c-3; \412\ 
Exchange Act Rule 19c-4; \413\ Exchange Act Rule 31; \414\ Rule 100 of 
Regulation M under the Exchange Act; \415\ Rule 300 of Regulation ATS 
under the Exchange Act; \416\ Rule 301 of Regulation ATS under the 
Exchange Act; \417\ Sec.  249.1001; \418\ and Rule 17a-7 under the 
Investment Company Act of 1940.\419\
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    \394\ Sec.  200.800, Subpart N, Sec.  201.101, Exchange Act 
Rules 0-10, 3a51-1(e), 3a55-1, 10a-1, and 31, and Rule 17a-7 under 
the Investment Company Act of 1940 are in addition to those included 
in the Proposing Release.
    \395\ 17 CFR 200.30-3. In addition to conforming changes, the 
Commission is reproposing to amend this rule to grant the Director 
of the Division of Market Regulation the authority to grant 
exemptions to Rules 610 through 612.
    \396\ 17 CFR 200.800, Subpart N.
    \397\ 17 CFR 201.101.
    \398\ 17 CFR 230.144.
    \399\ 15 U.S.C. 77a et seq.
    \400\ 17 CFR 240.0-10.
    \401\ 17 CFR 240.3a51-1.
    \402\ 17 CFR 240.3a55-1. Section 3(a)(55)(C)(vi) under the 
Exchange Act and Section 1a(25)(B)(vi) of the Commodity Exchange Act 
(``CEA'') provide that an index is not a narrow-based security index 
if a future on the index is traded on or subject to the rules of a 
board of trade and meets such requirements as are established by 
rule, regulation, or order jointly by the two Commissions. Pursuant 
to this authority, the Commission and the Commodity Futures Trading 
Commission (``CFTC'') jointly adopted Exchange Act Rule 3a55-1 and 
CEA Rule 41.11. The Commission today is proposing to substitute 
``NMS securities, as defined in Sec.  242.600,'' for ``reported 
securities, as defined in Sec.  240.11Ac1-1'' in Exchange Act Rule 
3a55-1. The new term ``NMS security'' is proposed to be defined in 
Sec.  242.600 the same as the term ``reported security'' is defined 
in current Exchange Act Rule 11Ac1-1. Accordingly, the proposed 
changes to Rule 3a55-1 are technical. If the Commission adopts 
Regulation NMS, the changes to Rule 3a55-1, and identical changes to 
CEA Rule 41.11, would need to be adopted jointly by the Commission 
and the CFTC.
    \403\ 17 CFR 240.3b-16.
    \404\ 17 CFR 240.10a-1.
    \405\ 17 CFR 240.10b-10.
    \406\ 17 CFR 240.10b-18.
    \407\ 17 CFR 240.15b9-1.
    \408\ 17 CFR 240.12a-7.
    \409\ 17 CFR 240.12f-1.
    \410\ 17 CFR 240.12f-2.
    \411\ 17 CFR 240.15c2-11.
    \412\ 17 CFR 240.19c-3.
    \413\ 17 CFR 240.19c-4.
    \414\ 17 CFR 240.31.
    \415\ 17 CFR 242.100.
    \416\ 17 CFR 242.300.
    \417\ 17 CFR 242.301. The Commission also is proposing a 
technical change to Rule 301(b)(3)(iii) of Regulation ATS to correct 
a cross-reference to Rule 301(b)(3)(ii)(A) by deleting the reference 
to subparagraph (A). This change would not have any substantive 
effect.
    \418\ 17 CFR 249.1001.
    \419\ 17 CFR 270.17a-7.
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VII. General Request for Comment

    In addition to any specific requests for comment included above, 
the Commission generally requests comment on all aspects of the 
reproposals described above. Interested persons are invited to submit 
written presentations of views, data, and arguments concerning the 
reproposals, including the feasibility and practicality of implementing 
the reproposals and the costs and benefits associated with the 
reproposals. In addition, the Commission will continue to accept 
comment on all issues that were previously raised in the Proposing 
Release and Supplemental Release. Finally, the Commission requests 
comment, assuming it were to adopt the reproposals, on the nature and 
length of implementation and phase-in periods that would be appropriate 
to allow market participants time to adapt to the new regulatory 
structure and implement the reproposals in an efficient and orderly 
manner. The Commission will consider all comments previously submitted 
in response to the Proposing Release, the Hearing, and the Supplemental 
Release, in addition to all comments received in response to this 
release, in evaluating any further action taken on Regulation NMS.

VIII.Paperwork Reduction Act

A. Trade-Through Rule

    The reproposed Trade-Through Rule contains collection of 
information requirements within the meaning of the Paperwork Reduction 
Act of 1995.\420\ The Commission published a notice requesting comment 
on the collection of information requirements in the Proposing Release, 
and submitted these requirements to the Office of Management and Budget 
(``OMB'') for

[[Page 77475]]

review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The 
Commission is resubmitting these requirements to the OMB for review in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not 
conduct or sponsor, and a person is not required to respond to, an 
information collection unless it displays a currently valid OMB control 
number. The title of the affected collection is ``Order Protection 
Rule'' under OMB control number 3235-0600.\421\
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    \420\ 44 U.S.C. 3501 et seq. (``Paperwork Reduction Act'').
    \421\ See supra note 9.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission proposed to create three 
new information collections. The first collection of information arose 
from the proposed requirement that trading centers \422\ adopt policies 
and procedures reasonably designed to prevent the execution of a 
transaction at prices inferior to prices displayed by other trading 
centers. The other two collections of information related to 
requirements in a proposed exception to the Trade-Through Rule included 
in the Proposing Release--the opt-out exception.\423\ The revised 
Trade-Through proposal does not contain an opt-out exception, and 
therefore, the collections of information associated with the proposed 
opt-out exception are no longer applicable.\424\
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    \422\ In the Proposing Release, the Commission used the term 
``order execution facility'' to describe the entities that would be 
subject to the proposed rule. In the revised proposal, these 
entities are referred to as ``trading centers.'' Specifically, a 
``trading center'' would be defined to mean a national securities 
exchange or national securities association that operates an SRO 
trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker or dealer that 
executes orders internally by trading as principal or crossing 
orders as agent. See reproposed Rule 600(b)(78).
    \423\ See Section III.G.1. of the Proposing Release.
    \424\ See supra Section II.A.4.
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    The Commission has revised the discussion below to reflect the 
requirements of the reproposed Trade-Through Rule.
1. Summary of Collection of Information
    The reproposed Trade-Through Rule would require a trading center to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to prevent the execution of trades at prices 
inferior to protected quotations displayed by other trading centers, 
unless a valid exception applies, and, if relying on such an exception, 
that are reasonably designed to assure compliance with the terms of the 
exception. The nature and extent of the policies and procedures that a 
trading center would be required to establish to comply with this 
requirement would depend upon the type, size, and nature of the trading 
center.
2. Proposed Use of Information
    The requirement that each trading center establish, maintain, and 
enforce written policies and procedures reasonably designed to prevent 
the execution of trades at prices inferior to protected quotations 
displayed by other trading centers or to assure compliance with the 
terms of an exception would help ensure that the trading center and its 
customers, subscribers, members, and employees, as applicable, 
generally avoid engaging in trade-throughs, unless a valid exception is 
applicable.
3. Respondents
    The requirement for each trading center to establish written 
policies and procedures reasonably designed to prevent the execution of 
trade-throughs potentially would apply to eight registered national 
securities exchanges that trade NMS stocks and the NASD,\425\ and 
approximately 600 broker-dealers registered with the Commission.\426\ 
The Commission requests comment on the accuracy of these figures.
---------------------------------------------------------------------------

    \425\ There are eight national securities exchanges (Amex, BSE, 
CBOE, CHX, NSX, NYSE, Phlx and PCX) and one national securities 
association (NASD) that trade NMS stocks and thus would be subject 
to the reproposed Rule. The ISE does not trade NMS stocks and thus 
would not be subject to the reproposed Rule.
    \426\ After further analysis, the Commission has revised the 
estimated number of broker-dealers that would be subject to the 
reproposed Trade-Through Rule. The revised number includes the 
approximately 585 firms that were registered equity market makers or 
specialists at year-end 2003 (this number was derived from annual 
FOCUS reports and discussion with SRO staff), as well as ATSs that 
operate trading systems that trade NMS stocks. The Commission 
preliminarily believes it is reasonable to assume that in general, 
firms that are block positioners--i.e., firms that are in the 
business of executing orders internally--are the same firms that are 
registered market makers (for instance, they may be registered as a 
market maker in one or more Nasdaq stocks and carry on a block 
positioner business in exchange-listed stocks), especially given the 
amount of capital necessary to carry on such a business.
---------------------------------------------------------------------------

    The Commission has considered each of these respondents for the 
purposes of calculating the reporting burden under the reproposed 
Trade-Through Rule.
4. Total Annual Reporting and Recordkeeping Burden
    The Commission has modified the estimated total annual reporting 
and recordkeeping burden for this collection of information to take 
into account changes made to the reproposed Trade-Through Rule. The 
revisions relate to the burden necessary to establish written policies 
and procedures reasonably designed to assure compliance with the 
exceptions contained in the reproposed Rule. Thus, trading centers 
would need to develop written policies and procedures for preventing 
and monitoring for trade-throughs that do not fall within an enumerated 
exception, and, if relying on such an exception, that are reasonably 
designed to assure compliance with the terms of the exception, to 
assure that they are in compliance with the Rule.
    Although the exact nature and extent of the required policies and 
procedures that a trading center would be required to establish likely 
would vary depending upon the nature of the trading center (e.g., SRO 
vs. non-SRO, full service broker-dealer vs. market maker), the 
Commission broadly estimates that it would take an SRO trading center 
approximately 270 hours of legal,\427\ compliance,\428\ information 
technology \429\ and business operations personnel \430\ time,\431\ and 
a non-SRO

[[Page 77476]]

trading center approximately 210 hours of legal, compliance, 
information technology and business operations personnel time,\432\ to 
develop the required policies and procedures.
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    \427\ Based on industry sources, the Commission estimates that 
the average hourly rate for outsourced legal service in the 
securities industry is between $150 per hour and $300 per hour. For 
purposes of this Release, the Commission will use the highest rate 
of $300 per hour to determine potential outsourced legal costs 
associated with the proposed rule. For in-house legal services, the 
Commission estimates that the average hourly rate for an attorney in 
the securities industry is approximately $82 per hour. The $82 per 
hour figure for an attorney is from the Securities Industry 
Association, Report on Management & Professional Earnings in the 
Securities Industry 2003 (Sept. 2003), adjusted by the SEC staff for 
an 1800-hour work-year with a 35% upward adjustment for overhead, 
reflecting the cost of supervision, space, and administrative 
support.
    \428\ The Commission estimates that the average hourly rate for 
an assistant compliance director in the securities industry is 
approximately $103 per hour. The $103 per hour figure for an 
assistant compliance director is from the Securities Industry 
Association, Report on Management & Professional Earnings in the 
Securities Industry 2003 (Sept. 2003), adjusted by the SEC staff for 
an 1800-hour work-year with a 35% upward adjustment for overhead, 
reflecting the cost of supervision, space, and administrative 
support.
    \429\ The Commission estimates that the average hourly rate for 
a senior computer programmer in the securities industry is 
approximately $67 per hour. The $67 per hour figure for a senior 
computer programmer is from the Securities Industry Association, 
Report on Management & Professional Earnings in the Securities 
Industry 2003 (Sept. 2003), adjusted by the SEC staff for an 1800-
hour work-year with a 35% upward adjustment for overhead, reflecting 
the cost of supervision, space, and administrative support.
    \430\ The Commission estimates that the average hourly rate for 
an operations manager in the securities industry is approximately 
$70 per hour. The $70 per hour figure for an operations manager is 
from the Securities Industry Association, Report on Management & 
Professional Earnings in the Securities Industry 2002 (Sept. 2002), 
adjusted by the SEC staff for an 1800-hour work-year with a 35% 
upward adjustment for overhead, reflecting the cost of supervision, 
space, and administrative support.
    \431\ The Commission anticipates that of the 270 hours it 
estimates would be spent to establish the required policies and 
procedures, 120 hours would be spent by legal personnel, 105 hours 
would be spent by compliance personnel, 20 hours would be spent by 
information technology personnel and 25 hours would be spent by 
business operations personnel of the SRO trading center.
    \432\ The Commission anticipates that of 210 hours it estimates 
would be spent to establish policies and procedures, 87 hours would 
be spent by legal personnel, 77 hours would be spent by compliance 
personnel, 23 hours would be spent by information technology 
personnel and 23 hours would be spent by business operations 
personnel of the non-SRO trading center.
---------------------------------------------------------------------------

    Included within this estimate, the Commission expects that SRO and 
non-SRO respondents may incur one-time external costs for out-sourced 
legal services. While the Commission recognizes that the amount of 
legal outsourcing utilized to help establish written policies and 
procedures may vary widely from entity to entity, it estimates that on 
average, each trading center would outsource 50 hours of legal time in 
order to establish policies and procedures in accordance with the 
reproposed Rule.
    The Commission estimates that there would be an initial one-time 
burden of 220 burden hours per SRO trading center or 1,980 hours,\433\ 
and 160 burden hours per non-SRO trading center \434\ or 96,000 hours, 
for a total of 97,980 burden hours to establish policies and procedures 
reasonably designed to prevent the execution of a trade-through, for an 
estimated one-time initial cost of $8,646,405.\435\ The Commission 
estimates a capital cost of approximately $9,135,000 for both SRO and 
non-SRO trading centers resulting from outsourced legal work \436\ for 
a total one-time initial cost of $17,781,405.\437\
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    \433\ The estimated 1,980 burden hours necessary for SRO trading 
centers to establish policies and procedures are calculated by 
multiplying nine times 220 hours (9 x 220 hours = 1,980 hours).
    \434\ The estiamted 96,000 burden hours necessary for non-SRO 
trading centers to establish policies and procedures are calculated 
by multiplying 600 times 160 hours (600 x 160 hours = 96,000 hours).
    \435\ This figure was calculated as follows: (70 legal hours x 
$82) + (105 compliance hours x $103) + (20 information technology 
hours x $67) + (25 business operation hours x $70) = $19,645 pier 
SRO x 9 SROs = $176,805 total cost for SROs; (37 legal hours x $82) 
+ (77 compliance hours x $103) + (23 information technology hours x 
$67) + (23 business operation hours x $70) = $14,116 per broker-
dealer x 600 broker-dealers = $8,469,600 total cost for broker-
dealers, $176,805 + $8,469,000 = $8,646,405.
    \436\ This figure was calculated as follows: (50 legal hours x 
$300 x 9 SROs) + (50 legal hours x $300 x 600 broker-dealers) = 
$9,135,000.
    \437\ This figure was calculated by adding $8,646,405 and 
$9,135,000.
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    Once a trading center has established written policies and 
procedures reasonably designed to prevent trade-throughs in its market, 
the Commission estimates that it would take the average SRO and non-SRO 
trading center approximately two hours per month of internal legal time 
and three hours of internal compliance time to ensure that its written 
policies and procedures are up-to-date and remain in compliance with 
reproposed Rule 611. The Commission staff estimates that these ongoing 
costs would be 60 hours annually per respondent, for a total estimated 
annual cost of $3,456,684.\438\
---------------------------------------------------------------------------

    \438\ This figure was calculated as follows: (2 legal hours x 12 
months x $82) x (9 + 600) + (3 compliance hours x 12 months x $103) 
x (9 + 600)) = $3,456,684.
---------------------------------------------------------------------------

5. General Information About Collection of Information
    This collection of information would be mandatory. The Commission 
expects that the written policies and procedures that would be 
generated pursuant to reproposed Rule 611 would be communicated to the 
members, subscribers, and employees (as applicable) of all entities 
covered by the reproposed Rule. To the extent that this information is 
made available to the Commission, it would not be kept confidential. 
Any records generated in connection with the reproposed Rule's 
requirement to establish written policies and procedures would be 
required to be preserved in accordance with, and for the periods 
specified in, Exchange Act Rules 17a-1 \439\ and 17a-4(e)(7).\440\
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    \439\ 17 CFR 240.17a-1.
    \440\ 17 CFR 240.17a-4(e)(7).
---------------------------------------------------------------------------

6. General Request for Comment
    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to: (i) Evaluate whether the proposed collection of 
information is necessary for the proper performance of the functions of 
the agency, including whether the information shall have practical 
utility; (ii) evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collection of information; (iii) determine 
whether there are ways to enhance the quality, utility, and clarity of 
the information to be collected; and (iv) evaluate whether there are 
ways to minimize the burden of the collection of information on those 
who are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-10-04. 
Requests for materials submitted to OMB by the Commission with regard 
to this collection of information should be in writing, refer to File 
No. S7-10-04, and be submitted to the Securities and Exchange 
Commission, Records Management, Office of Filings and Information 
Services, 450 Fifth Street, NW., Washington, DC 20549-0609. As OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

B. Access Rule

    In the Proposing Release, the Commission requested comment on its 
preliminary view that proposed Rule 610 and the proposed amendment to 
Rule 301(b)(5) under Regulation ATS do not contain a collection of 
information requirement as defined by the Paperwork Reduction Act.\441\ 
No comments were submitted that addressed the issue. The Commission 
continues to believe that reproposed Rule 610 and the reproposed 
amendment to Rule 301(b)(5) do not contain a collection of information 
requirement.
---------------------------------------------------------------------------

    \441\ Proposing Release, 69 FR at 11160.
---------------------------------------------------------------------------

C. Sub-Penny Rule

    In the Proposing Release, the Commission stated its preliminary 
view that proposed Rule 612 does not contain a collection of 
information requirement as defined by the Paperwork Reduction Act.\442\ 
Although the Commission solicited comment on the PRA implications of 
the proposed Sub-Penny Rule, no commenters addressed this issue. The 
Commission continues to believe that reproposed Rule 612 does not 
contain a collection of information requirement.
---------------------------------------------------------------------------

    \442\ Proposing Release, 69 FR at 11172.
---------------------------------------------------------------------------

D. Market Data Rules and Plan Amendments

    In the Proposing Release, the Commission stated its preliminary 
view that the proposed amendments to the joint-industry plans and to 
Exchange Act Rules 11Aa3-1 and 11Ac1-2 (proposed to be redesignated as 
Rules 601 and 603) do not impose a collection of information 
requirement as defined

[[Page 77477]]

by the Paperwork Reduction Act.\443\ No comments were received that 
addressed this issue. The Commission continues to believe that these 
reproposed amendments do not contain a collection of information 
requirement.
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    \443\ Proposing Release, 69 FR at 11186.
---------------------------------------------------------------------------

E. Regulation NMS

    In the Proposing Release, the Commission stated its preliminary 
view that proposed Rule 600, the redesignation of the NMS rules, and 
the conforming amendments to various rules do not impose a collection 
of information requirement as defined by the Paperwork Reduction 
Act.\444\ No comments were received that addressed this issue. The 
Commission continues to believe that these proposed amendments do not 
contain a collection of information requirement.
---------------------------------------------------------------------------

    \444\ Proposing Release, 69 FR at 11197.
---------------------------------------------------------------------------

IX. Consideration of Costs and Benefits

    In the Proposing Release, the Commission identified certain costs 
and benefits of the Regulation NMS proposals, and, to help evaluate the 
costs and benefits, requested comment on all aspects of the costs and 
benefits and encouraged commenters to identify or supply any relevant 
data concerning the costs or benefits of the proposal.\445\ To the 
extent commenters discussed costs and benefits, the Commission has 
considered those comments. The Commission renews its request for 
comments on the costs and benefits of the Regulation NMS proposals. The 
Commission encourages commenters to identify, discuss, analyze, and 
supply relevant data concerning the costs or benefits of the reproposed 
rules.
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    \445\ Proposing Release, 69 FR at 11148-11150, 11161, 11172-73, 
11186-89, 11197-98.
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A. Trade-Through Rule

    Reproposed Rule 611 would require a trading center (which includes 
national securities exchanges and national securities associations that 
operate SRO trading facilities, ATSs, market makers, and block 
positioners) to establish, maintain, and enforce written policies and 
procedures that are reasonably designed to prevent trade-throughs of 
protected quotations, and, if relying on an exception, that are 
reasonably designed to assure compliance with the terms of the 
exception. To qualify for protection, a quotation would be required to 
be displayed and immediately accessible through automatic execution. 
The reproposed Rule also would require a trading center to regularly 
surveil to ascertain the effectiveness of the policies and procedures 
and to take prompt remedial action to remedy deficiencies in such 
policies and procedures.
    Reproposed Rule 611 would include a variety of exceptions to make 
intermarket price protection as efficient and workable as possible. 
These would include an intermarket sweep exception, which would allow 
market participants simultaneously to access multiple price levels at 
different trading centers--a particularly important function now that 
trading in penny increments has dispersed liquidity across multiple 
price levels. The intermarket sweep exception would enable trading 
centers that receive sweep orders to execute those orders immediately, 
without waiting for better-priced quotations in other markets to be 
updated. In addition, reproposed Rule 611 would, among other things, 
provide exceptions for the quotations of trading centers experiencing a 
material delay (generally of more than one second) in providing a 
response to incoming orders, as well as for flickering quotations with 
prices that have been displayed for less than one second.
1. Benefits
    Many commenters supported the adoption of a uniform rule against 
trade-throughs for all NMS stocks and discussed the benefits that such 
a rule would bring to the markets.\446\ These commenters noted that 
such a uniform rule would encourage the use of displayed limit orders, 
thus increasing depth and liquidity in the market.\447\ Some of these 
commenters also stated that the trade-through proposal would increase 
investor confidence by helping to eliminate the impression of 
unfairness when an investor's order executes at a price that is worse 
than another displayed order, or when a trade occurs at a price that is 
inferior to the investor's displayed order.\448\ As discussed above in 
Section II.A.1, the Commission preliminarily agrees with these 
commenters.
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    \446\ See supra Section II.A.1.
    \447\ See, e.g., BNY Letter at 2; Consumer Federation Letter at 
2; ICI Letter at 7.
    \448\ See, e.g., Consumer Federation Letter at 2; ICI Letter at 
7.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the reproposed Trade-
Through Rule would enhance the overall fairness and efficiency of the 
NMS and produce significant benefits for investors. By providing 
greater protection for displayed prices, the reproposed Rule would 
serve to enhance the depth and liquidity of the NMS, and thus 
contribute to the maintenance of fair and orderly markets. By better 
protecting the interests of investors, both those that post limit 
orders and those that execute against posted limit orders, the 
reproposed Rule would promote investor confidence in the NMS. The 
reproposed Rule would be a significant improvement over the existing 
ITS trade-through rule, and would level the competitive playing field 
among markets by eliminating the potential advantage that the ITS rule 
afforded to manual markets.
    The Commission preliminarily believes that the proposed Trade-
Through Rule is necessary to, and would serve to, enhance protection of 
displayed prices. Investors who post limit orders, and trading centers 
that quote aggressively, should not see trades occurring on another 
market at a price inferior to their orders, except in circumstances 
where an exception applies. By requiring trading centers to establish 
written policies and procedures reasonably designed to prevent trade-
throughs and to comply with exceptions, and by requiring them to 
regularly surveil to ascertain the effectiveness of the policies and 
procedures and to take prompt remedial action to remedy deficiencies in 
such policies and procedures, the reproposed Rule should help ensure 
that displayed limit orders are not routinely bypassed by transactions 
occurring in other markets at inferior prices. By providing this 
protection for displayed prices, the Rule would serve to promote 
greater display of limit orders and more aggressive quoting. An 
increase in the use of limit orders and aggressive quoting should 
enhance price discovery and depth and liquidity in the markets; greater 
depth and liquidity would lead to improved execution quality for 
marketable orders, particularly for the execution of large 
institutional orders where statistics show there is room for 
improvement in both the markets for the trading of Nasdaq and exchange-
listed stocks.\449\
---------------------------------------------------------------------------

    \449\ See supra Section II.A.1.
---------------------------------------------------------------------------

    Comment is requested on whether extending trade-through protection 
to DOB quotations \450\ would significantly increase the benefits of 
the reproposed Trade-Through Rule. Would protecting quotations at 
multiple price levels further encourage the display of limit orders and 
thereby significantly enhance depth and liquidity in the NMS? Since 
decimalization, quoted spreads have narrowed substantially. Market 
participants often may not be willing to quote in significant size at 
the inside prices, but might be willing to do so at a price that is a 
penny or more

[[Page 77478]]

away from the inside prices. Granting trade-through protection to such 
quotations potentially would reward this beneficial quoting activity. 
In assessing the potential benefits of DOB protection, commenters 
should consider the effect of the reserve (or undisplayed) size 
function that many trading centers offer investors.\451\
---------------------------------------------------------------------------

    \450\ See supra Section II.A.5.
    \451\ For example, Market A may be displaying a best offer of 
1000 shares at $10.00, and DOB offers of 2000 shares at $10.01 and 
2000 shares at $10.02. With a reserve size function, however, Market 
A may have an additional 1000 shares offered at $10.00 and an 
additional 2000 shares offered at $10.01, neither of which is 
displayed. Assuming the displayed offers of $10.00, $10.01, and 
$10.02 were protected quotations under the Voluntary Depth 
Alternative, Market B could execute a trade at $10.03 only by 
simultaneously routing an order to execute against the accumulated 
displayed size of the protected quotations at Market A. Market B 
therefore would be required to route a buy order, identified as an 
intermarket sweep order, to Market A with a limit price of $10.02 
for a total of 5000 shares (the accumulated amount of the displayed 
size of protected quotations with a price of $10.02 or better at 
Market A). Under the priority rules currently in effect at 
electronic markets, undisplayed size has priority over displayed 
size at an inferior price. Accordingly, Market A would execute the 
5000 share buy order as follows: 2000 shares at $10.00 (1000 
displayed plus 1000 reserve) and 3000 shares at $10.01 (2000 
displayed plus 1000 reserve). While Market B would have complied 
with the Rule, the displayed $10.02 offer at Market A would still go 
unfilled when Market B traded at $10.03. Comment is requested on the 
extent to which this outcome would detract from the benefits of the 
Voluntary Depth Alternative.
---------------------------------------------------------------------------

    By requiring trading centers to establish written policies and 
procedures reasonably designed to prevent trade-throughs and to comply 
with exceptions, and by requiring them to regularly surveil to 
ascertain the effectiveness of the policies and procedures and to take 
prompt remedial action to remedy deficiencies in such policies and 
procedures, the reproposed Rule also should help ensure that investors 
that submit marketable orders consistently receive executions at the 
best displayed bid or offer (or better). The Rule should facilitate the 
ability of a broker-dealer to achieve best execution for its customer 
orders because the market to which a broker-dealer routes an order 
would not execute the order at a price that is inferior to a protected 
bid or offer displayed on the other market (unless an exception 
applies).\452\ By better protecting the interests of all investors--
both those that post limit orders and those that execute against posted 
limit orders--the reproposed Rule should bolster investor confidence in 
the integrity of the NMS, which should encourage investors to be more 
willing to invest in the market, thus adding depth and liquidity to the 
markets and promoting the ability of listed companies to raise capital.
---------------------------------------------------------------------------

    \452\ The Commission emphasizes that adoption of reproposed Rule 
611 would in no way lessen a broker-dealer's duty of best execution. 
See supra section II.B.4.
---------------------------------------------------------------------------

    Almost all commenters agreed that the current ITS trade-through 
rule must be fixed to accommodate the realities of today's NMS, in 
particular the differences in operation among automated and non-
automated markets. Reproposed Rule 611, by providing protection only 
for automated quotations displayed by automated trading centers, would 
significantly update the ITS trade-through rule. Intermarket efficiency 
and certainty of execution in the NMS would be improved as automated 
markets would no longer need to wait for responses from non-automated 
markets and thus would be able to execute trades more quickly without 
regard for potentially unavailable quotations displayed on non-
automated markets. The reproposed Rule also would level the playing 
field by eliminating the potential competitive advantage the existing 
ITS rule provides to manual markets. In addition, by providing an 
incentive for non-automated markets to automate--because market 
participants may be less likely to send their order flow to a market 
center whose orders can be ignored by other markets--the proposed Rule 
generally should improve the accessibility of bids and offers for all 
investors and increase the efficiency of the NMS.
    When an investor receives an execution in one market at a price 
that is inferior to a price displayed in another market, that ``trade-
through'' has a cost to the investor receiving the inferior execution. 
The Commission preliminarily believes that the benefits of 
strengthening price protection for exchange-listed stocks (by 
eliminating the gaps in ITS coverage of block positioners and 100-share 
quotes) and introducing price protection for Nasdaq stocks would be 
substantial, although the total amount is difficult to quantify. One 
objective, though quite conservative, estimate of benefits is the 
dollar amount of quotations that currently are traded through. 
Commission staff's analysis of current trade-through rates indicates 
that over 12 billion shares of displayed quotations in Nasdaq and NYSE 
stocks were traded through in 2003, by an average amount of 2.3 cents 
for Nasdaq stocks and 2.2 cents for NYSE stocks.\453\ These traded-
through quotations represent approximately $209 million in Nasdaq 
stocks and $112 million in NYSE stocks, for a total of $321 million in 
bypassed limit orders and inferior prices for investors in 2003 that 
could have been addressed by strong trade-through protection. The 
Commission preliminarily believes that this $321 million estimated 
annual benefit, particularly when combined with the benefits of 
enhanced investor confidence in the fairness and orderliness of the 
equity markets, would justify the one-time costs of implementation and 
ongoing annual costs of the reproposed Trade-Through Rule.
---------------------------------------------------------------------------

    \453\ See supra Section II.A.1.
---------------------------------------------------------------------------

    The foregoing estimate of annual benefits is very conservative 
because it is based solely on depth of quotations that are displayed in 
the absence of strong price protection. In essence, it measures the 
problem--a shortage of quoted depth--that reproposed Rule 611 is 
designed to address, rather than the benefits that it would achieve. 
Every trade-through transaction potentially sends a message to market 
participants that their displayed quotations can be and are ignored by 
other market participants. When the total share volume of trade-through 
transactions that do not interact with displayed quotations reaches 8% 
and above for hundreds of the most actively traded NMS stocks, this 
message is unlikely to be missed by those who watched their quotations 
being traded through. Certainly, the practice of trading through 
displayed size is most unlikely to prompt market participants to 
display even greater size.
    As discussed above,\454\ a primary objective of reproposed Rule 611 
is to increase displayed depth and liquidity in the NMS and thereby 
reduce trading costs for a wide spectrum of investors, particularly 
institutional investors that trade in large sizes. It is difficult, 
however, to precisely measure the extent to which strengthened price 
protection would improve market depth and liquidity, and thereby lower 
trading costs of investors. The difficulty of estimation, however, 
should not hide from view the enormous potential benefit for investors 
of improving depth and efficiency of the NMS. Because of the huge 
dollar amount of trading volume in NMS stocks--more than $17 trillion 
in 2003\455\--even the most incremental improvement in market depth and 
liquidity could generate a dollar amount of benefits that annually 
would dwarf the one-time start-up costs of implementing trade-through 
protection.
---------------------------------------------------------------------------

    \454\ Id.
    \455\ World Federation of Exchanges, Annual Report (2003), at 
86.

---------------------------------------------------------------------------

[[Page 77479]]

    One approach to evaluating the potential benefits of the reproposed 
Rule is to examine a category of investors that stand to benefit a 
great deal from improved depth and liquidity for NMS stocks--the 
shareholders of U.S. equity mutual funds. In 2003, the total assets of 
such funds were $3.68 trillion.\456\ The average portfolio turnover 
rate for equity funds was 55%, meaning that the total purchases and 
sales of the securities they held total approximately $4.048 
trillion.\457\ A leading authority on the trading costs of 
institutional investors has estimated that in 2003 the average price 
impact experienced by investment managers in U.S. stocks ranged from 
17.4 basis points for giant-capitalization stocks, 21.4 basis points 
for large-capitalization stocks, and up to 35.4 basis points for micro-
capitalization stocks.\458\ In addition, it estimated the cost 
attributable to adverse price movements while searching for liquidity 
for institutional orders, which often are too large simply to be 
presented to the market. Its estimate of search costs ranged from 13 
basis points for giant capitalization stocks, 23 basis points for large 
capitalization stocks, and up to 119 basis points for micro-
capitalization stocks. Assuming that the average price impact and 
search costs incurred across all stocks is a conservative 37.4 basis 
points,\459\ the shareholders in U.S. equity mutual funds incurred 
implicit trading costs of $15.1 billion in 2003. Based on a 
hypothetical assumption that, in light of the current share volume of 
trade-through transactions that does not interact with displayed 
liquidity,\460\ intermarket trade-through protection could improve 
depth and liquidity for NMS stocks by at least 5% (or an average 
reduction of 1.87 basis points in price impact and liquidity search 
costs for large investors), the savings in trading costs for U.S. 
equity mutual funds alone, and the improved returns for their millions 
of individual shareholders, would have amounted to approximately $755 
million in 2003.
---------------------------------------------------------------------------

    \456\ Mutual Fund Fact Book, supra note 135 at 55.
    \457\ Id. at 64. Portfolio turnover is measured by adding total 
fund purchases and sales, dividing by 2, and then dividing by total 
fund assets. Because price impact occurs for both purchases and 
sales, the turnover rate must be doubled, then multiplied by total 
fund assets, to measure the total value of trading that is affected 
by price impact costs.
    \458\ Plexus Group, Inc., Commentary 80, ``Trading Truths: How 
Mis-Measurement of Trading Costs Is Leading Investors Astray,'' 
(April 2004), at 2.
    \459\ The estimate of 37.4 basis points is the average of the 
total market impact and liquidity search costs for giant 
capitalization stocks (30.4 basis points) and the total market 
impact and liquidity search costs for large capitalization stocks 
(44.4 basis points). The much higher market impact and liquidity 
search costs of midcap, smallcap, and microcap stocks are not 
included.
    \460\ See supra Section II.A.1.
---------------------------------------------------------------------------

    Of course, the benefits of improved depth and liquidity for the 
direct equity holdings of other types of investors, such as pension 
funds, insurance companies, and individuals, are not incorporated in 
the foregoing calculations. In 2003, these other types of investors 
held 78% of the value of publicly traded U.S. equity outstanding, with 
equity mutual funds holding the remaining 22%.\461\ Assuming that these 
other types of investors experienced a reduction in trading costs that 
merely equaled the estimated reduction of trading costs for equity 
mutual funds, the assumed 5% improvement in market depth and liquidity 
could yield total trading cost savings of over $1.5 billion annually. 
Such savings would improve the investment returns of equity ownership, 
thereby promoting the retirement and other long-term financial 
interests of individual investors and reducing the cost of capital for 
listed companies.
---------------------------------------------------------------------------

    \461\ Mutual Fund Fact Book, supra note 135 at 59.
---------------------------------------------------------------------------

2. Costs
    Some commenters expressed concern over the anticipated cost of 
implementing the trade-through proposal.\462\ These commenters argued 
that proposed Rule 611 would be too expensive and that the costs 
associated with implementing it would outweigh the perceived benefits 
of the rule. Some commenters were concerned about the cost of specific 
requirements in the proposed rule, particularly the procedural 
requirements associated with the proposed opt-out exception (e.g., 
obtaining informed consent from customers and disclosing the NBBO to 
customers).\463\ As discussed above, however, the reproposed Trade-
Through Rule does not contain an opt-out exception, as was originally 
proposed.\464\ Therefore, the concerns expressed by commenters relating 
to the costs of implementing an opt-out exception are not applicable. 
Commenters also expressed concern that applying the trade-through 
proposal to the Nasdaq market would harm market efficiency and 
execution quality.\465\ As discussed above, the Commission 
preliminarily believes that a uniform rule that serves to limit the 
incidence of trade-throughs would improve market efficiency and benefit 
execution quality.\466\
---------------------------------------------------------------------------

    \462\ See, e.g., Bloomberg Tradebook Letter at 14; Fidelity 
Letter I at 12; Instinet Letter at 14, 15; Nasdaq Letter II at 2; 
Peake Letter I at 2; Reg NMS Study Group Letter at 4; Rosenblatt 
Securities Letter II at 4; STANY Letter at 3; UBS Letter at 8.
    \463\ See, e.g., Ameritrade Letter I at 8; Brut Letter at 10-12; 
Citigroup Letter at 8-9; E*TRADE Letter at 7; Financial Information 
Forum Letter at 2; JP Morgan Letter at 4; SIA Letter at 12-15.
    \464\ See supra Section II.A.4.
    \465\ See, e.g., Citadel Letter at 6; Hudson River Trading 
Letter at 1-2; Instinet Letter at 12, 14; Nasdaq Letter II at 1-2, 
5.
    \466\ See supra Section II.A.1.
---------------------------------------------------------------------------

    The Commission recognizes that there would be significant one-time 
costs to implement the reproposed Trade-Through Rule. Trading centers 
would necessarily incur costs associated with establishing, 
maintaining, and enforcing written policies and procedures reasonably 
designed to prevent trade-throughs--in other words, with determining a 
course of action for how the trading center would comply with the 
requirements of the Rule, including compliance with the exceptions 
contained in the reproposed Rule. Although the extent of these costs 
would vary because the exact nature and extent of each trading center's 
written policies and procedures would depend on the type, size and 
nature of each entity's business, as discussed above in Section 
VIII.A., for purposes of the PRA the Commission broadly estimates that 
each SRO trading center would incur an average one-time initial cost 
for establishing such policies and procedures of approximately $34,645, 
and each non-SRO trading center would incur an average one-time initial 
cost for establishing policies and procedures of approximately $29,116, 
for a total of $17,781,405.\467\
---------------------------------------------------------------------------

    \467\ See supra notes 431 to 437 and accompanying text. As with 
any new Commission rule, trading centers also would have to take 
steps to educate and train their employees as to the scope and 
impact of, and how to comply with, the reproposed Rule and the 
policies and procedures implemented by the trading center.
---------------------------------------------------------------------------

    Each trading center also would incur initial up-front costs 
associated with taking action necessary to implement the written 
policies and procedures it has developed, which would include necessary 
modifications to order routing and execution systems to ``hard-code'' 
compliance with the Rule and the exceptions. For instance, 
modifications to order routing and execution systems would need to be 
made to route and execute orders in compliance with the requirements of 
the proposed Rule to prevent trade-throughs of protected quotations 
(which would include, for instance, the ability to recognize quotations 
identified in the consolidated quotation system as manual quotations on 
a quotation-by-quotation basis). Trading centers would need to make 
sure they have connectivity to other trading centers in

[[Page 77480]]

the NMS that could post protected quotations, whether through 
proprietary linkages or through use of third-party services. As noted 
below, however, the Commission preliminarily believes that most of this 
private linkage functionality already exists, particularly in the 
market for Nasdaq securities. Surveillance systems would need to be 
modified to assure an effective mechanism for monitoring transactions 
after-the-fact for ongoing compliance purposes. Also, trading systems 
would need to be programmed to recognize when exceptions to the 
operative provisions of reproposed Rule 611 were applicable. For 
example, trading centers would need to be able to identify outgoing and 
recognize incoming orders as intermarket sweep orders. Data feeds and 
market vendor systems would need to be modified to accommodate order 
identifiers for manual quotations and intermarket sweep orders, which 
costs (to the extent incurred) would likely be passed along to the end 
users of these systems, the trading centers. These costs are included 
within the estimates below.
    For non-SRO trading centers that rely upon their own internal order 
routing and execution management systems, of which the Commission 
preliminarily estimates that there are approximately 20, the Commission 
preliminarily estimates the average cost of necessary systems changes 
to implement the Rule would be approximately $3 million per trading 
center, for a total one-time start-up cost of approximately $60 
million.\468\ The Commission preliminarily estimates that the remaining 
non-SRO trading centers that would be subject to the reproposed Rule 
would utilize outside vendors to provide these services, consistent 
with their current use of such services for order routing and execution 
management. For these non-SRO trading centers, the Commission 
preliminarily estimates the cost of necessary systems modifications 
that would be passed along to the trading centers to be approximately 
$50,000 per trading center, for a total initial cost of $21 
million.\469\ The Commission also preliminarily estimates that the 
average cost to the nine SROs to make necessary system modifications to 
implement the reproposed Rule would be $5 million per SRO, for a total 
of $45 million. Therefore, preliminary estimated overall total one-time 
implementation costs, added to PRA costs, would be approximately $144 
million.
---------------------------------------------------------------------------

    \468\ This number is an average estimated cost; thus, it would 
overestimate the costs for some trading centers and underestimate it 
for others. For instance, it likely overestimates the cost for ATS 
trading centers, particularly smaller ones, as opposed to full-
service broker-dealer trading centers, in part because of the 
narrower business focus of some ATSs.
    \469\ Given that floor-based market-makers and specialists 
utilize exchange execution systems, the Commission preliminarily 
believes it is reasonable to assume that such market-makers and 
specialists would not incur substantial systems-related costs to 
implement the reproposed Rule independent of the costs that would be 
incurred by the exchange on whose floor they operate to make changes 
to the exchange's execution systems. Thus, these entities 
(approximately 160 of the 585) are not directly included within the 
cost estimates.
---------------------------------------------------------------------------

    In addition, broker-dealers that would not fall within the proposed 
definition of a trading center but that employ their own smart-order 
routing technology to route orders to multiple trading centers could 
choose to route orders in compliance with the proposed intermarket 
sweep exception. These broker-dealers would need to make necessary 
modifications to their order routing practices and proprietary order 
routing systems to monitor the protected quotations of trading centers 
and to properly identify such intermarket sweep orders. The Commission 
preliminarily does not believe that this category of broker-dealers is 
very large. The Commission also preliminarily believes it likely that 
most if not all of these non-trading center broker-dealers that employ 
their own order-routing technology already have systems in place that 
monitor best-priced quotations across markets, and thus does not 
believe that the changes necessary to implement the intermarket sweep 
order would be substantial.
    With respect to maintaining and updating its required written 
policies and procedures to ensure they continue to be in compliance 
with the reproposed Rule, for purposes of the PRA the Commission 
preliminarily estimates that the average annual cost for each trading 
center would be approximately $5,676 per trading center per year, for a 
total annual cost for all trading centers of $3,456,684.\470\ With 
regard to ongoing monitoring for and enforcement of trading in 
compliance with the Rule, the Commission preliminarily believes that, 
once the tools necessary to carry out on-going monitoring have been put 
in place (which are included in the above cost estimates), a trading 
center would be able to incorporate ongoing monitoring and enforcement 
within the scope of its existing surveillance and enforcement policies 
and procedures without a substantial additional burden.
---------------------------------------------------------------------------

    \470\ See supra note 438 and accompanying text.
---------------------------------------------------------------------------

    The Commission recognizes, however, that this ongoing compliance 
would not be cost-free, and that trading centers would incur some 
additional annual costs associated with ongoing compliance, including 
compliance costs of reviewing transactions. For instance, the 
Commission recognizes that access to a database of BBO information for 
each trading center whose quotations would be protected by the 
reproposed Trade-Through Rule would be necessary to monitor 
transactions for compliance with the Rule on an after-the-fact basis. 
The Commission believes that this information currently is available, 
at least with respect to the BBO of each trading center, and 
understands that such information currently is maintained by at least 
one industry vendor. The Commission preliminarily believes that the 
cost to each trading center to access this database would be 
incremental in relation to the cost of other services provided by the 
vendor.\471\ The Commission preliminarily estimates that each trading 
center would incur an average annual ongoing compliance cost of $30,144 
for a total annual cost of $18,357,696 for all trading centers.\472\
---------------------------------------------------------------------------

    \471\ The Commission acknowledges that, under the Voluntary 
Depth Alternative for protected quotations (see supra Section 
II.A.5) if a trading center were to choose to include its depth-of-
book quotations in the consolidated quotation system and provide 
trade-through protection for those orders (to the extent they are 
automated quotations), it would be necessary for the industry to 
have access to that depth-of-book information on a real-time and 
historical basis, and that trading centers may incur additional 
costs associated with accessing and storing this data. The 
Commission requests comments on these costs.
    \472\ This figure was calculated as follows: (16 compliance 
hours x $103) + (8 information technology hours x $67) + (4 legal 
hours x $82) x 12 months = $30,144 per trading center x 609 trading 
centers = $18,357,696. See supra notes 427 to 429 for notation as to 
hourly rates.
---------------------------------------------------------------------------

    The Commission also requests comment on whether the Voluntary Depth 
Alternative could be implemented in a practical and cost-effective 
manner.\473\ To comply, trading centers would need to monitor a 
significantly larger number of protected quotations displayed by other 
markets and route orders to execute against such quotations.\474\ The 
Voluntary Depth Alternative, however, would not increase the number of 
orders that a trading center would be required to route to other 
trading centers if only BBOs were protected. Instead, the size of the 
routed orders would need to be increased to reflect the accumulated 
depth displayed by other trading centers

[[Page 77481]]

in their protected DOB quotations. In addition, the applicable 
regulatory authorities must be able to monitor and enforce compliance 
with a rule that protected DOB quotations. At a minimum, this would 
require an objective and uniform source to identify the quotations that 
are protected at any particular time.
---------------------------------------------------------------------------

    \473\ See supra Section II.A.5. for a discussion of the 
Voluntary Depth Alternative.
    \474\ See supra note 471. As a means to address capacity issues, 
the SRO participants in the applicable market data Plans potentially 
could determine to disseminate only those DOB quotations that were 
within a certain number of price levels away from the NBBO.
---------------------------------------------------------------------------

    As noted in section II.A.3 above, any intermarket protection 
against trade-throughs must be workable and implemented in a way that 
promotes fair and orderly markets. To the extent commenters are 
concerned about practical problems with implementing the Trade-Through 
Rule, would the basis for these concerns be magnified by the Voluntary 
Depth Proposal? Specifically, comment is requested on all issues 
relating to the feasibility and desirability of disseminating DOB 
quotations through Plan processors.\475\ For example, would the 
voluntary dissemination of protected DOB quotations through the Plan 
processors create a single point of failure that could threaten the 
stability of trading in NMS stocks?
---------------------------------------------------------------------------

    \475\ The Voluntary Depth Alternative would set up a process 
through which individual markets could choose to secure protection 
for their DOB quotations by disseminating them in the consolidated 
quotation stream. To implement this approach, the SRO participants 
in the market data Plans would need to establish a mechanism for 
individual markets to disseminate their quotations through the Plan 
processor and have them designated as protected quotations. See 
supra Section II.A.5.
---------------------------------------------------------------------------

    The Commission also requests comment on the effect that adoption of 
the Voluntary Depth Alternative would have on competition among 
markets. One commenter, for example, suggested that protection of DOB 
quotations might cause increased fragmentation of liquidity across 
different markets because limit orders, no matter where displayed, 
would have price protection.\476\ Another commenter, in contrast, 
asserted that protecting only BBOs would lead to greater fragmentation 
because limit orders would be routed to any market where they would set 
or equal the BBO and thereby obtain trade-through protection.\477\ 
Comment is requested on the fragmentation issue, as well as in general 
on whether protecting DOB quotations would inappropriately limit the 
terms of market competition so as to harm investors and the efficiency 
of the NMS. For example, would adoption of the Voluntary Depth 
Alternative inappropriately reduce the scope of competition among 
markets to the payment of liquidity rebates for executed limit orders? 
Comment also is requested on whether adoption of the Voluntary Depth 
Alternative would generate forces that would lead to a monopolization 
of trading in a single trading facility.
---------------------------------------------------------------------------

    \476\ Bear Stearns Letter at 2.
    \477\ Goldman Sachs Letter at 6.
---------------------------------------------------------------------------

    In assessing the costs of systems changes that may be required by 
the reproposed Rule, it is important to recognize that much, if not 
all, of the connectivity among trading centers necessary to implement 
intermarket price protection has already been put in place. For 
example, trading centers for exchange-listed securities already are 
connected through the ITS. The Commission understands that ITS 
facilities and rules can be modified relatively easily and at low cost 
to enable an automatic execution functionality. With respect to Nasdaq 
stocks, connectivity among trading centers already is established 
through private linkages. Routing out to other trading centers when 
necessary to obtain the best prices for Nasdaq stocks is an integral 
part of the business plan of many trading centers, even when not 
affirmatively required by best execution responsibilities. Moreover, a 
variety of private vendors currently offer connectivity to NMS trading 
centers for both exchange-listed and Nasdaq stocks. Many of the broker-
dealers that are non-SRO trading centers that would be subject to the 
Rule already employ smart order routing technology, either their own 
systems or those of outside vendors, which should limit the cost of 
implementing systems changes. The Commission also understands that the 
cost to the Plan processors to incorporate the reproposed Trade-Through 
Rule and its exceptions would be minimal.
    In determining these estimates the Commission also has considered 
that many market participants are already making changes to their 
systems to become more competitive. Many of the changes being made 
would assist the market participants in preparing for implementation of 
the reproposed Trade-Through Rule. For example, Nasdaq, which 
previously did not have an order routing system, recently purchased 
Brut, LLC in order to acquire access to such a system. The Commission 
preliminarily believes that this acquisition should reduce the costs 
that would be incurred by Nasdaq to implement the reproposed Trade-
Through Rule. The Commission also notes that the NYSE is in the process 
of modifying its Direct+ System to make more quotations available on an 
automated basis.\478\ These changes that the NYSE has undertaken should 
reduce the cost of additional systems changes needed to implement the 
Trade-Through Rule.
---------------------------------------------------------------------------

    \478\ See Securities Exchange Act Release Nos. 50173 (Aug. 10, 
2004), 69 FR 50407 (Aug. 16, 2004) and 50667 (Nov. 15, 2004), 69 FR 
67980 (Nov. 22, 2004) (SR-NYSE-2004-05).
---------------------------------------------------------------------------

    Overall, the Commission preliminarily believes that the reproposed 
Trade-Through Rule would produce significant benefits that justify the 
costs of implementation of the Rule.

B. Access Rule

    Reproposed Rule 610 of Regulation NMS would set forth new standards 
governing access to quotations in NMS stocks. These standards would 
prohibit trading centers from imposing unfairly discriminatory terms 
that would prevent or inhibit the efficient access of any person 
through members, subscribers, or customers of such trading center, and 
enable access to NMS quotations through private linkages, rather than 
mandating a collective intermarket linkage facility. In addition, in 
order to ensure the fairness and accuracy of displayed quotations, the 
reproposed Rule would establish an outer limit on the cost of accessing 
protected quotations of no more than $0.003 per share (or 0.3% of the 
quotation price per share for quotations priced less than $1). 
Reproposed Rule 610 also would require SROs to establish and enforce 
rules that would, among other things, prohibit their members from 
engaging in a pattern or practice of displaying quotations that lock or 
cross the automated quotations of other trading centers. Finally, the 
reproposed amendment to Rule 301 of Regulation ATS would lower the 
threshold that triggers the Regulation ATS fair access requirements 
from 20% to 5% of average daily volume in a security.
1. Benefits
    The Commission preliminarily believes that the reproposed Access 
Rule would help achieve the statutory objectives for the NMS by 
promoting fair and efficient access to each individual market. By 
relying on private linkages, rather than mandating a collective 
intermarket linkage facility, the access provisions of reproposed Rule 
610(a) and (b) would allow market centers to connect through flexible 
and cost effective technologies widely used in the markets today, 
particularly in the market for Nasdaq stocks. This would allow firms to 
capitalize on the dramatic improvements in communications and 
processing technologies in recent years, and thereby enhance the 
linking of all

[[Page 77482]]

markets for the future NMS. Private linkages also would provide 
flexibility to meet the needs of different market participants and 
allow competitive forces to determine the specific nature and cost of 
connectivity. The reproposed access provisions of Rule 610(a) and (b) 
thus would allow market participants to fairly and efficiently route 
orders to execute against the best quotations for a stock, wherever 
such quotations are displayed in the NMS. The Commission believes that 
fair and efficient access to the best quotations of all trading centers 
is critical to achieving best execution of those orders.
    The reproposed access provisions of Rule 610(a) and (b) also would 
promote fair and efficient access to quotations by prohibiting a 
trading center from unfairly discriminating against non-members or non-
subscribers that attempt to access its quotations through a member or 
subscriber of such trading center. Such fair access to the quotations 
of other trading centers is critical for compliance with the reproposed 
Trade-Through Rule and broker-dealers' duty of best execution.
    The reproposed fee limitation of Rule 610(c) would address the 
potential distortions caused by substantial, disparate fees. As a 
result of the reproposed fee limitation, displayed prices would more 
closely reflect actual costs to trade, thereby enhancing the usefulness 
of market information. The proposed fee limitation also would establish 
a level playing field across all market participants and trading 
centers. A single accumulated fee limitation would apply equally to all 
types of trading centers and all types of market participants, thereby 
promoting the NMS objective of equal regulation of markets and broker-
dealers.
    The reproposed fee limitation also should help address the 
``outlier'' business model under which a trading center charges high 
fees for access to its quotations and passes most of the fees through 
as rebates to attract liquidity providers. These outliers might attempt 
to take advantage of intermarket price protection by acting essentially 
as a toll booth between price levels. Particularly with a trade-through 
rule, even though high fee markets likely would be the last market to 
which orders would be routed, prices could not move to the next level 
until someone routed an order to take out the displayed price at the 
outlier market. Such a business model would detract from the usefulness 
of quotation information and impede market efficiency and competition. 
The reproposed fee cap would preclude the outlier business model. It 
would place all markets on a level playing field in terms of the fees 
they can charge and ultimately the rebates they can pass on to 
liquidity providers. Some markets might choose to charge lower fees, 
thereby increasing their ranking in the preferences of order routers. 
Others might charge the full $0.003 and rebate a substantial proportion 
to liquidity providers. Competition would determine which strategy was 
most successful.\479\
---------------------------------------------------------------------------

    \479\ The Commission preliminarily believes that the reproposed 
fee limitation on protected quotations priced less than $1.00 would 
provide the same benefits.
---------------------------------------------------------------------------

    The restrictions on locking or crossing quotations in reproposed 
Rule 610(d) should promote fair and orderly markets. Locked and crossed 
markets can cause confusion among investors concerning trading interest 
in a stock. Restricting the practice of submitting locking or crossing 
quotations therefore would enhance the usefulness of quotation 
information. Consistent with the approach to trade-through protection, 
however, reproposed Rule 610(d) would allow automated quotations to 
lock or cross manual quotations. Reproposed Rule 610(d) thereby would 
address the concern that manual quotations may not be fully accessible 
and recognize that allowing automated quotations to lock or cross 
manual quotations may provide useful market information regarding the 
accessibility of quotations. The Commission preliminarily believes, 
however, that an automated quotation is entitled to protection from 
locking or crossing quotations. When two market participants are 
willing to trade at the same quoted price, giving priority to the 
first-displayed automated quotation should contribute to fair and 
orderly markets. Moreover, the basic principle underlying the NMS is to 
promote fair competition among markets, but within a unified system 
that also promotes interaction between all of the buyers and sellers in 
a particular NMS stock. Allowing market participants simply to ignore 
accessible quotations in other markets and routinely display locking 
and crossing quotations would be inconsistent with this principle. The 
reproposed restrictions on locking or crossing quotations, in 
conjunction with the reproposed Trade-Through Rule, should encourage 
trading against displayed quotations and enhance the depth and 
liquidity of the markets.
    Finally, lowering of the fair access threshold of Rule 301(b)(5) 
under Regulation ATS \480\ from 20% to 5% of average daily trading 
volume in a security would further strengthen access to the full range 
of services of ATSs with significant trading volume in NMS stocks. Such 
access is particularly important for success of the private linkage 
approach proposed for access to quotations. The lowering of the fair 
access threshold also would make its coverage consistent with the 
existing 5% threshold triggering the order display and execution access 
requirements of Rule 301(b)(3) of Regulation ATS.\481\ As a result, 
each ATS that is required to disseminate its quotations in the 
consolidated data stream also would be prohibited from unfairly 
prohibiting or limiting market participants from becoming a subscriber 
or customer.
---------------------------------------------------------------------------

    \480\ 17 CFR 242.301(b)(5).
    \481\ 17 CFR 242.301(b)(3).
---------------------------------------------------------------------------

    In reproposing Rule 610 and the amendment to Rule 301 of Regulation 
ATS, the Commission seeks to help ensure that securities transactions 
can be executed efficiently, at prices established by vigorous and fair 
competition among market centers. By enabling fair access and 
transparent pricing among diverse marketplaces within a unified 
national market, the Commission preliminarily believes that the access 
proposal would foster efficiency, enhance competition, and contribute 
to the best execution of orders for NMS securities.
2. Costs
    The Commission preliminarily believes that reproposed Rule 610 and 
the reproposed amendments to Rule 301 of Regulation ATS would not 
impose significant costs on most trading centers and market 
participants. The system changes necessary to meet the new access 
standards should be minor. Currently, private linkages are widely used 
in the equity markets, particularly for trading in Nasdaq stocks.\482\ 
Moreover, the Commission understands that the ITS facilities that 
currently provide intermarket access for exchange-listed stocks could 
be modified at minimal cost to provide an auto-execution functionality, 
at least as an interim measure until private linkages were fully 
established for exchange-listed stocks.
---------------------------------------------------------------------------

    \482\ One commenter, however, felt that the bilateral links 
required for private linkages would be particularly burdensome to 
smaller market centers compared to an ITS-type structure. Letter 
from Donald E. Weeden to Jonathan G. Katz, Secretary, Commission, 
dated June 30, 2004, at 9-10.
---------------------------------------------------------------------------

    While commenters were generally supportive of the Commission's 
proposal to employ private linkages to provide access between markets, 
some commenters expressed concern that the effort and investment to 
establish such

[[Page 77483]]

connectivity to smaller markets would likely be disproportionate to the 
liquidity on such a market.\483\ Reproposed Rule 610(b)(1), however, 
would require trading centers that display quotations in the ADF to 
provide a level and cost of access to their quotations that is 
substantially equivalent to the level and cost of access to quotations 
displayed by SRO trading facilities.
---------------------------------------------------------------------------

    \483\ See, e.g., Brut Letter at 13; Citigroup Letter at 13; SIA 
Letter at 16-17; UBS Letter at 9.
---------------------------------------------------------------------------

    Currently, three ATSs display quotations in the ADF, two of which 
also display quotations through the NASDAQ Market Center. Reproposed 
Rule 610(b) may require these trading centers to incur additional costs 
to enhance the level of access to their quotations and to lower the 
cost of connectivity for market participants seeking to access their 
quotations. The extent to which these trading centers in fact incur 
additional costs to comply with the proposed access standard would be 
largely within the control of the trading center itself. ATSs and 
market makers that wish to trade NMS stocks can choose from a number of 
options for quoting and trading. They can become a member of a national 
securities exchange and quote and trade through the exchange's trading 
facilities. They can participate in the NASDAQ Market Center and quote 
and trade through that facility. Finally, they can quote and trade in 
the OTC market. The existence of the NASD's ADF makes this third choice 
possible by providing a facility for displaying quotations and 
reporting transactions in the consolidated data stream.\484\ As a 
result, the additional connectivity requirements of reproposed Rule 
610(b) would be triggered only by a trading center that displays its 
quotations in the consolidated data stream and chooses not to provide 
access to those quotations through an SRO trading facility.
---------------------------------------------------------------------------

    \484\ Under Rule 301(b)(3) of Regulation ATS, an ATS is required 
to display its quotations in the consolidated data stream only in 
those securities for which its trading volume reaches 5% of total 
trading volume.
---------------------------------------------------------------------------

    Currently, nine SROs operate trading facilities in NMS stocks. 
Market participants throughout the securities industry generally have 
established connectivity to these nine points of access to quotations 
in NMS stocks. By choosing to display quotations in the ADF, a trading 
center effectively could require the entire industry to establish 
connectivity to an additional point of access. Potentially, many 
trading centers could choose to display quotations in the ADF, thereby 
significantly increasing the overall costs of connectivity in the NMS. 
Such an inefficient outcome would become much more likely if an ADF 
trading center were not required to assume responsibility for the 
additional costs associated with its decision to display quotations 
outside of an established SRO trading facility. Consequently, the 
reproposed access standard in Rule 610(b)(2) would help reduce overall 
industry costs by more closely aligning the burden of additional 
connectivity with those entities whose choices have created the need 
for additional connectivity.
    To meet the standard contained in reproposed Rule 610(b)(1), a 
trading center would be allowed to take advantage of the greatly 
expanded connectivity options that have been offered by competing 
access service providers in recent years.\485\ These industry access 
providers have extensive connections to a wide array of market 
participants through a variety of direct access options and private 
networks. A trading center potentially could meet the requirement of 
reproposed Rule 610(b)(1) by establishing connections to and offering 
access through such vendors. The option of participation in existing 
market infrastructure and systems should greatly reduce a trading 
center's cost of compliance.\486\
---------------------------------------------------------------------------

    \485\ As noted in the Commission's order approving the pilot 
program for the ADF, the reduction in communications line costs in 
recent years and the advent of competing access providers offer the 
potential for multiple competitive means of access to the various 
trading centers that trade NMS stocks. Securities Exchange Act 
Release No. 46249, supra note 181.
    \486\ As the self-regulatory authority responsible for the OTC 
market, the NASD would need to assess the extent to which ADF 
participants have met the access standards of reproposed Rule 610.
---------------------------------------------------------------------------

    Several commenters, including some that otherwise supported the 
proposal, expressed concern that requiring non-discriminatory access to 
markets might undermine the value of SRO membership.\487\ The 
Commission preliminarily does not believe that adoption of a private 
linkage approach would seriously undermine the value of membership in 
SROs that offer valuable services to their members. First, the fact 
that markets would not be allowed to impose unfairly discriminatory 
terms on non-members who obtain indirect access to quotations through 
members does not mean that non-members would obtain free access to 
quotations. Members who provide piggyback access would be providing a 
useful service and presumably would charge a fee for such service. The 
fee would be subject to competitive forces and likely would reflect the 
costs of SRO membership, plus some element of profit to the SRO's 
members. As a result, non-members that frequently make use of indirect 
access are likely to contribute indirectly to the costs of the SRO 
market. Moreover, the unfair discrimination standard of Rule 610(a) 
would apply only to access to quotations, not to the full panoply of 
services that markets generally provide only to their members.
---------------------------------------------------------------------------

    \487\ Alliance of Floor Brokers Letter at 10; Amex Letter, 
Exhibit A at 25-26; BSE Letter at 12; CHX Letter at 14; Citigroup 
Letter at 12; Phlx Letter at 2; STANY Letter at 9.
---------------------------------------------------------------------------

    The Commission preliminarily does not believe that the proposed fee 
limitation of reproposed Rule 610(c) would impose significant new costs 
on most trading centers. A few commenters were concerned about the 
costs to market participants of administering a fee program under the 
original proposal, which would have limited trading centers to a fee of 
$0.001 and broker-dealers to a fee of $0.001.\488\ The revised 
proposal, by imposing a single accumulated fee limitation of $0.003 
(when the price of the protected quotation is $1 or more), would 
greatly simplify the proposed fee limitation and likely would leave 
existing fee practices largely intact. Entities that currently charge 
and collect fees would continue to do so. Market makers likely would 
collect fees through an SRO trading facility or ECN through which it 
displayed limit orders or quotations, and the administration of such 
fee program likely would be handled by the SRO or ECN. Therefore, the 
revised fee limitation should not impose significant new administrative 
costs.
---------------------------------------------------------------------------

    \488\ Brokerage America Letter at 1; Oppenheimer Letter at 2; 
STANY Letter at 11.
---------------------------------------------------------------------------

    The reproposed fee limitation of Rule 610(c) would, however, affect 
the few markets that currently impose access fees of greater than 
$0.003 per share that apply to a wide range of NMS stocks.\489\ These 
markets could be required to re-evaluate their business models in light 
of the adopted fee limitation. In particular, they likely would need to 
reduce the rebates they currently pay to liquidity providers. The 
reproposed limitation also would affect a few trading centers that 
charge significant access fees for large transactions in specific types 
of NMS stocks, such as ETFs. It is unlikely, however, that such fees 
currently generate a large amount of revenues.\490\
---------------------------------------------------------------------------

    \489\ See supra note 193 and accompanying text.
    \490\ The Commission preliminarily believes that the same 
analysis would apply to the reproposed fee limitation on protected 
quotations priced less than $1.00.
---------------------------------------------------------------------------

    The locked and crossed provisions of reproposed Rule 610(d) should 
not impose significant additional costs for

[[Page 77484]]

the SROs. All SROs currently have rules restricting locking and 
crossing quotations in exchange-listed stocks to comply with the 
provisions of the ITS Plan. Such SROs also collect the data and related 
information required to monitor locked and crossed markets, and the 
Commission preliminarily believes that the additional surveillance and 
enforcement costs related to the provisions would be minor. The 
Commission recognizes, however, that reproposed Rule 610(d), by 
restricting locked markets with respect to automated quotations, could 
impose certain trading costs associated with widened spreads if an 
order that would otherwise have been displayed was not displayed. 
Although locked markets do occur a certain percentage of the time, they 
do not occur all the time, and thus, the average spread is between zero 
and a penny (a penny being the MPV for all but a very few stocks). 
Thus, the Commission preliminarily believes that any widening of 
average spreads caused solely by the reproposed rule would be limited 
to the difference between a sub-penny and penny spread. In addition, a 
locked market often does not actually represent two market participants 
willing to buy and sell at the same price because it is likely that the 
locking market participant is not truly willing to trade at the 
displayed locking price, but instead chooses to lock rather than 
execute against the already-displayed quotation to receive a liquidity 
rebate.
    Finally, reducing the fair access thresholds of Regulation ATS 
would require ATSs that exceed the 5% threshold level to comply with 
Rule 301(b)(5) under Regulation ATS. Rule 301(b)(5) requires ATSs, 
among other things, to establish written standards for granting access 
to trading on its system, to not unreasonably prohibit or limit access 
to its services, to keep records of all grants or denials of access, 
and to report such information on Form ATS-R. The Commission 
preliminarily believes that the costs to meet these requirements are 
justified by the need to promote fair and efficient access to trading 
centers with significant volume.

C. Sub-Penny Rule

    Reproposed Rule 612 would prohibit market participants from 
displaying, ranking, or accepting quotations in NMS stocks that are 
priced in an increment less than $0.01, unless the per share price of 
the quotation is less than $1.00. It would permit sub-penny quotations 
below $1.00, but only to four decimal places.
1. Benefits
    The Commission believes that the markets' conversion to decimal 
pricing has benefited investors by, among other things, clarifying and 
simplifying pricing for investors, making the U.S. securities markets 
more competitive internationally, and reducing trading costs by 
narrowing spreads. The Commission is concerned, however, that if the 
MPV decreases beyond a certain point, some of the benefits of decimals 
could be lost while some of the negative effects are exacerbated. The 
Commission preliminarily believes that reproposed Rule 612, which would 
prohibit an MPV of less than $0.01 for most NMS stocks, would have 
several benefits. The majority of the commenters supported the proposal 
and noted various potential benefits of the proposed rule.\491\
---------------------------------------------------------------------------

    \491\ See supra section IV.C.1.
---------------------------------------------------------------------------

    The Commission preliminarily believes that sub-penny quoting 
impedes transparency by reducing market depth at the NBBO and 
increasing quote flickering. In an environment where the NBBO can 
change very quickly, broker-dealers have more difficulty in carrying 
out their duties of best execution and complying with other regulatory 
requirements that require them to identify the best bid or offer 
available at a particular moment (such as the Commission's short sale 
rule and the NASD's Manning rule).\492\
    In addition, the Commission agrees with the many commenters that 
believed that prohibiting sub-penny quoting would deter the practice of 
stepping ahead of exposed trading interest by an economically 
insignificant amount. Limit orders provide liquidity to the market and 
perform an important price-setting function. The Commission is 
concerned that, if a quotation or order can lose execution priority 
because of economically insignificant price improvement from a later-
arriving quotation or order, liquidity could diminish and some market 
participants could incur greater execution costs. As one commenter, the 
Investment Company Institute, stated, ``[t]his potential for the 
increased stepping-ahead of limit orders would create a significant 
disincentive for market participants to enter any sizeable volume into 
the markets and would reduce further the value of displaying limit 
orders.'' \493\ Improved liquidity should decrease the costs of 
trading, especially for large orders.\494\ Market participants may be 
more likely to place limit orders if they know that other market 
participants cannot quote ahead of them by a sub-penny amount.
---------------------------------------------------------------------------

    \492\ Rule 10a-1 under the Exchange Act, 17 CFR 240.10a-1, and 
NASD IM-2110-2.
    \493\ ICI Letter at 20.
    \494\ One commenter argued that a prohibition on sub-penny 
quoting should not affect institutional investors' trading costs 
because improvements in trading technology (such as auto-execution 
and VWAP trading algorithms) allow them to fill large orders at 
minimal cost. See Tower Research Letter at 9-10. While the 
Commission agrees that such improvements have been useful, it 
believes that this commenter does not consider the costs involved in 
having to develop these technologies in response, at least in part, 
to insufficient liquidity. Moreover, the Commission believes that 
this commenter also does not consider the positive externalities 
that limit orders have on price discovery and price competition; 
orders that execute without being quoted do not contribute to price 
discovery and price competition.
---------------------------------------------------------------------------

2. Costs
    The Commission recognizes that reproposed Rule 612 would impose 
certain costs on the U.S. securities markets. Currently, certain NMS 
stocks are quoted--and in the absence of the rule, others in the future 
could be quoted--in sub-pennies. For these NMS stocks, quoted spreads 
would be wider than they otherwise would be, because reproposed Rule 
612 would not allow market participants to narrow the spread by a sub-
penny amount.
    Two commenters stated that investors would suffer harm from 
artificially widened spreads.\495\ Another commenter stated that ``the 
primary result of eliminating subpenny trading would be to preserve a 
minimum profit for market makers, and would result in significantly 
worse realized prices for the vast majority of market participants not 
in the business of making markets.'' \496\ This commenter analyzed 
trading in six high-volume securities and concluded that proposed Rule 
612 would have costs of over $400 million in these securities alone due 
to wider spreads.\497\ Another commenter stated that, if all markets 
traded QQQQ solely in sub-pennies, the savings would be approximately 
$150 million per year.\498\ This commenter, however, did not provide 
data or analysis showing how it reached this conclusion. No other 
commenters provided any quantitative analysis of the costs that a sub-
penny quoting rule would impose by widening spreads to at least a full 
penny.
---------------------------------------------------------------------------

    \495\ See Instinet Letter at 51; Mercatus Letter at 9.
    \496\ Tower Research Letter at 8.
    \497\ Id. at 9.
    \498\ See Instinet Letter at 50.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the $400 million and 
$150 million estimates of the cost to the markets caused by wider 
spreads provided by these two commenters are

[[Page 77485]]

inaccurate and excessive. This estimate appears to assume that all 
trading activity would occur at these narrower quoted spreads. The 
Commission does not believe that these commenters provided any evidence 
to substantiate that assumption. Currently, no national securities 
exchange or national securities association permits quoting in sub-
pennies; sub-penny quoting occurs on only a small number of ATSs. 
Therefore, because spreads on most markets already cannot be smaller 
than $0.01, these markets would not be required to take any action in 
response to reproposed Rule 612 that would cause their spreads to 
widen. Therefore, the cost to these markets of not having sub-penny 
spreads should not be considered costs of the reproposed rule. With 
respect to the ATSs that currently do permit some NMS stocks to be 
quoted in sub-pennies, the Commission staff performed a study of trade 
data in Nasdaq, NYSE, and Amex stocks to better consider commenters' 
claims. Based on that study, the Commission staff estimates that the 
costs of widened spreads in these securities would be approximately $48 
million annually (or approximately $33 million if the Commission were 
to exempt QQQQ from reproposed Rule 612).\499\
---------------------------------------------------------------------------

    \499\ See Memorandum from the Office of Economic Analysis, 
Commission, to File, dated December 15, 2004. This study is 
available on the Commission's Internet Web site (http://www.sec.gov/rules/proposed/s71005.shtml) and from the Commission's Public 
Reference Room.
---------------------------------------------------------------------------

    In this study, the Commission staff obtained public data from 
NYSE's ``Trade and Quote'' files for all NYSE-listed and Amex-listed 
stocks and public data from the Nastraq trade file for Nasdaq-listed 
stocks, for the period June 7-10, 2004. Based on trading activity from 
the Nasdaq-listed securities, Commission staff estimated that 1.5% of 
all trades over $1.00 were reported in a sub-penny increment.\500\ 
These trades accounted for 4.7% of share volume. However, not all 
trades that were reported as having a sub-penny price resulted from 
sub-penny quotations. Commission staff excluded VWAP trades which are 
marked as such in the Nastraq file.\501\ Based on this screened 
dataset, Commissions staff estimated that 1.4% of trades were reported 
in sub-penny increments accounting for 2.4% of share volume. Commission 
staff then calculated the dollar cost if all such trades executed at 
the near-side penny rather than at a sub-penny amount. This price 
difference, multiplied by the executed volume, produces a dollar cost 
per trade.\502\ Summed across all sub-penny trades, the average daily 
cost for this sample was $80,973. At 252 trading days per year, this 
results in $20,400,235 on an annual basis.
---------------------------------------------------------------------------

    \500\ Trades below $1.00 were excluded from the sample as Rule 
612 would not prohibit sub-penny quotations priced less than $1.00.
    \501\ Executions occurring at a sub-penny price resulting from a 
mid-point, VWAP, or similar volume-weighted pricing algorithm would 
not be prohibited by reproposed Rule 612. For purposes of this 
study, Commission staff excluded all other trades that have a 
condition code other than ``regular way'' (e.g., trades reported 
after normal trading hours, bunched trades, next-day trades, 
previous reference price trades, and late trade reports).
    \502\ For example, the cost to a sub-penny trade at price 
$25.248 for 300 shares is as follows. The assumption is that, 
without sub-penny quotations, this trade would have occurred at 
$25.25--a difference of $0.002 per share. At 300 shares, this trades 
incurs a cost of $0.60 ($0.002 x 300). A sub-penny trade at $25.242 
would incur a cost of $0.002 per share under the assumption that, 
under Rule 612, it would execute at $25.24.
---------------------------------------------------------------------------

    Commission staff performed a similar analysis on the trade data for 
Amex-listed stocks, except that the data set did not permit VWAP trades 
to be excluded.\503\ On an annualized basis, Commission staff estimated 
that the gross cost resulting from slightly wider spreads would be $16 
million (or only $1.2 million if QQQQ is excluded). Similarly, the 
Commission staff estimated that the gross costs from wider spreads 
would be approximately $12 million annually for NYSE-listed stocks.
---------------------------------------------------------------------------

    \503\ See supra note 499.
---------------------------------------------------------------------------

    Another potential cost of reproposed Rule 612 is that market 
participants that have developed systems that allow their users to 
quote in sub-pennies would, for most NMS stocks, lose the ability to 
gain any market advantage from such enhancements. In addition, any 
market participant that currently allows its users to display, rank, or 
accept orders or quotations in sub-pennies would incur costs in 
reprogramming its systems to prevent the entry of sub-penny orders or 
quotations. The Commission preliminarily believes, however, that these 
costs would be negligible. Currently, the exchanges and Nasdaq do not 
permit sub-penny quoting; only two major ECNs permit sub-penny quoting, 
but only in a limited number of securities.\504\ These ECNs would have 
to take only minor steps to readjust their systems to comply with 
reproposed Rule 612. Finally, the Commission preliminarily believes 
that paragraph (b) of reproposed Rule 612, which would prohibit 
quotations below $1.00 from extending beyond four decimal places, would 
have negligible systems costs. The Commission currently is not aware of 
any market that quotes and trades NMS stocks in increments beyond four 
decimal places and preliminarily believes, therefore, that no market 
would incur systems costs to limit quotations below $1.00 to a maximum 
of four decimal places.
---------------------------------------------------------------------------

    \504\ As of December 6, 2004, one of these ECNs (Brut) permitted 
sub-penny quoting only in securities priced below $5.00; the other 
ECN (Inet) permitted sub-penny quoting for securities priced below 
$1.00 and also for four other securities (QQQQ, SMH, JDSU, and 
SIRI).
---------------------------------------------------------------------------

    After carefully considering all the comments received, the 
Commission preliminarily believes that, on balance, the benefits of 
reproposed Rule 612 would justify the costs.

D. Market Data Rules and Plan Amendments

    The Commission is reproposing amendments to the rules relating to 
the dissemination of market information to the public. In particular, 
the Commission is reproposing amendments to the Plans \505\ to modify 
the current formulas for allocating market data revenues to the SROs, 
and to require the establishment of non-voting advisory committees 
comprised of interested parties other than SROs. In addition, the 
Commission is reproposing to rescind the current prohibition in 
Exchange Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601) on 
SROs and their members from independently distributing their own trade 
reports, and is reproposing an amendment to Exchange Act Rule 11Ac1-2 
(proposed to be redesignated as Rule 603) to incorporate uniform 
standards pursuant to which they may independently distribute their own 
trade reports and quotations (outside of providing the requisite 
information to Plan processors). The Commission is further reproposing 
to amend Exchange Act Rule 11Ac1-2 (proposed to be redesignated as Rule 
603) to make explicit that all SROs must act jointly through the Plans 
and through a single processor per security to disseminate consolidated 
market information in NMS stocks to the public. Finally, the Commission 
is reproposing amendments to Exchange Act Rule 11Ac1-2 (proposed to be 
redesignated as Rule 603) to streamline and simplify the consolidated 
display requirements by reducing the data required to be displayed 
under the rule, and by limiting the range of the rule to the display of 
such data in trading and order-routing contexts.
---------------------------------------------------------------------------

    \505\ See supra note 21 and accompanying text.
---------------------------------------------------------------------------

1. Revenue Allocation Formula
    a. Benefits. The Commission preliminarily believes that the 
reproposed amendment to the Plans

[[Page 77486]]

modifying the current formulas for allocating market data revenues 
would be beneficial to the marketplace because the new allocation 
formula would allocate revenues to markets based on the value of their 
quotations in addition to their trades. The current formulas allocate 
Plan revenues based solely on the number or share volume of an SRO's 
reported trades, and do not allocate revenues to those market centers 
that generate quotations with the best prices and the largest sizes 
that are an important source of public price discovery. The new 
allocation formula also should help to reduce the economic and 
regulatory distortions caused by the current formulas, including wash 
sales, trade shredding, and SRO print facilities.\506\ Because the 
reproposed formula would address these distortive practices and would 
allocate revenues to those market centers that provide the most useful 
market information, the Commission preliminarily believes that the NMS 
would be benefited as a whole.
---------------------------------------------------------------------------

    \506\ See Proposing Release, 69 FR at 11179-11180.
---------------------------------------------------------------------------

    The reproposed new revenue allocation formula would encompass a 
two-step process. Under the proposed initial step, the ``Security 
Income Allocation,'' a Network's distributable revenues would be 
allocated among the individual securities included in the Network's 
data stream based on the square root of the dollar volume of trading in 
each security. Use of the square root function is appropriate to take 
into account the level of trading activity in each security, while 
adjusting for the disproportionate level of trading in the most active 
NMS stocks when distributing revenues among the various securities.
    Following this initial distribution of revenues, the next step in 
the process would be to allocate the revenues distributed to an 
individual security among the various SROs that trade the security 
based on each SRO's trading and quoting activity. Specifically, under 
the reproposed ``Trading Share'' criterion, fifty percent of the 
revenues allocated to a particular security (subject to a $2 cap per 
qualified transaction report) would be allocated to SROs based on their 
proportion of the total dollar volume and number of qualified trades 
(transactions that have a dollar volume of $5,000 or greater) in that 
security. A few commenters stated that small trades (transactions that 
have a dollar value of less than $5000) should be entitled to partial 
credit under this criterion because these trades also contribute to 
public price discovery.\507\ The Commission acknowledges the benefits 
of small trades and has amended the original proposed new formula to 
provide for a proportional allocation of revenues for such trades. The 
reproposed Trading Share measure is intended to allocate revenue to 
those SROs that actively trade in the security, thereby providing 
liquidity and price discovery, while reducing the potential for the 
shredding of trade volume.
---------------------------------------------------------------------------

    \507\ See, e.g., BSE Letter at 16; CHX Letter at 19-20; E*TRADE 
Letter at 11.
---------------------------------------------------------------------------

    Under the reproposed ``Quoting Share'' criterion, fifty percent of 
the revenues allocated to a particular security under the Security 
Income Allocation measure would be allocated to SROs based on their 
proportion of credits earned for the time and size of their quotations 
at the NBBO in that security during regular trading hours. Many 
commenters agreed with the Commission that, if the Networks were to 
continue allocating revenues to the SROs, the current allocation 
formulas needed to be updated.\508\ In particular, some of these 
commenters noted the benefits of adding a quoting component to the new 
formula,\509\ especially if revenues are allocated only for automated 
and accessible quotations. Some commenters, however, were concerned 
that the inclusion of quotations in the proposed new allocation formula 
could lead new types of ``gaming'' of the formula, such as flashing 
quotations with no real intention to trade at those prices simply to 
earn more quote credits--and thereby more revenues--under the Quoting 
Share measure.\510\ The Commission preliminarily believes that the 
proposed requirement that quotations last at least one second to earn 
credits coupled with overall market discipline imposed by current 
order-routing practices discouraging ``low-cost'' quotations at the 
NBBO should minimize the potential for such gaming behavior. The 
Quoting Share criterion of the reproposed formula is intended to do 
what the current formulas do not--allocate revenue to those markets 
whose quotations frequently equal the best prices and for the largest 
sizes.
---------------------------------------------------------------------------

    \508\ See, e.g., Amex Letter at 11; ATD Letter at 4; Bloomberg 
Tradebook Letter at 7; BSE Letter at 15; ICI Letter at 21; Morgan 
Stanley Letter at 22; Nasdaq Letter II at 31; NYSE Letter, 
Attachment at 11-12; STA Letter at 7; UBS Letter 10; Vanguard Letter 
at 6.
    \509\ See, e.g., Amex Letter at 11; ATD Letter at 4; Bloomberg 
Tradebook Letter at 7-8; Morgan Stanley Letter at 22-23; NYSE 
Letter, Attachment at 11; STA Letter at 7; Vanguard Letter at 6.
    \510\ See, e.g., ArcaEx Letter at 13; Brut Letter at 22; CHX 
Letter at 19; Instinet Letter at 41.
---------------------------------------------------------------------------

    The Commission received a number of comments regarding the 
potential cost and complexity of the proposed revenue allocation 
formula.\511\ The Commission notes that, consistent with the approach 
of the reproposed Trade-Through Rule and the reproposed Access Rule, it 
has determined to eliminate from the reproposed formula the most 
complex elements of the proposed allocation formula that were intended 
primarily to address the problem of manual quotation--the ``NBBO 
Improvement Share'' criterion and the automatic cut-off for manual 
quotations left at the NBBO under the Quoting Share criterion. Because 
the revised formula would only allocate revenues for automated 
quotations, and manual quotations would be excluded from the any 
revenue allocation, the Commission believes that it is no longer 
necessary to include an NBBO Improvement Share criterion and automatic 
cut-off for manual quotations in the proposed new formula. As a result, 
the reproposed formula is substantially less complex than originally 
proposed.
---------------------------------------------------------------------------

    \511\ See, e.g., Angel Letter I at 11; BSE Letter at 15, 18; 
Brut Letter at 22-23; Callcott Letter at 4; CBOE Letter at 2, 9; 
Instinet Letter at 42; ISE Letter at 9; Nasdaq Letter II at 31; NSX 
Letter at 7; NYSE Letter, Attachment at 11; Phlx Letter at 3-4.
---------------------------------------------------------------------------

    In sum, the Commission preliminarily believes that the greatest 
benefit of allocating Plan revenues to the SROs based equally on the 
proposed Trading Share and Quoting Share measures is that such measures 
would allocate revenues to an SRO for its overall contribution of both 
quotations and trades, while reducing the incentive for distortive 
trade reporting practices caused by the current formulas. Investors 
would benefit from the proposed new formula because these broad-based 
measures would allocate revenues to those SROs that provide investors 
with the most useful market information, and thus that contribute to 
public price discovery, by allocating them a larger portion of Plan 
revenues.
    b. Costs. The Commission recognizes that the current allocation 
formulas have been used since the creation of the Plans and Networks in 
the 1970s, and that the SROs and the Network processors have become 
familiar with those formulas for purposes of allocating revenues and 
structuring their businesses. Because the reproposed new allocation 
formula is more detailed than the current formulas, the Network 
processors would have to learn the particular features of the new 
formula and would have to consider SRO quotations in addition to 
reported trades as a measure for allocating Plan revenues. Accordingly, 
the Network processors, or some other entity retained by the Networks, 
would be required to

[[Page 77487]]

develop a program to calculate the Trading Shares and Quoting Shares of 
the SRO participants. All of the data necessary for implementation of 
the formula would be disseminated through the consolidated data stream 
on a real-time basis. If a single entity were retained to handle the 
task for all three Networks, the Commission estimates that it would 
cost approximately $1 million annually to make the requisite 
calculations under the proposed new formula and to disseminate the 
results to the SRO participants on a daily basis. This estimated cost 
of implementation and compliance represents only \1/4\ of one percent 
of the total revenues collected and distributed through the Plans for 
2003.
    In addition, some SROs are likely to be allocated a smaller portion 
of Plan revenues under the reproposed new allocation formula than they 
would have received under the existing formulas, while other SROs would 
receive a larger portion of revenues. This would result if certain SROs 
are currently reporting a large number of trades or share volume of 
trades, but are not necessarily providing the best quotations or trades 
with larger sizes. A few commenters expressed concern that certain 
business models would be adversely impacted by the proposed new 
allocation formula,\512\ particularly for those markets that primarily 
handle small retail order flow.\513\ The Commission recognizes that 
reforming formulas that have remained unchanged for many years may 
affect the competitive position of various markets. Given the severe 
deficiencies of these formulas, however, it does not believe that the 
interests of any particular business model should preclude updating the 
formulas to reflect current market conditions. The reproposed formula 
is designed to reflect more appropriately the contributions of the 
various SROs to the consolidated data stream and thereby better align 
the interests of individual markets with the interests of investors. 
The Commission therefore preliminarily believes that the benefits of 
the proposed new allocation formula justify the costs of 
implementation.
---------------------------------------------------------------------------

    \512\ See, e.g., Brut Letter at 22; BSE Letter at 16; CHX Letter 
at 19, 21-22; E*TRADE Letter at 11; NSX Letter at 6-7.
    \513\ See, e.g., BSE Letter at 16; CHX Letter at 19, 21-22; 
E*TRADE Letter at 11. The Commission is proposing a provision in the 
new formula that would provide a partial allocation of revenues for 
smaller trades that have a dollar value of less than $5,000. This 
provision should lessen impact of the modified formula on exchanges 
that handle small retail orders.
---------------------------------------------------------------------------

2. Plan Governance
    a. Benefits. The Commission preliminarily believes that the 
reproposed amendment to the Plans requiring the creation of advisory 
committees would improve Plan governance. Under the Plans, a 
representative of each SRO participating in the Plan is a member of the 
operating committee that governs that Plan. The reproposed amendment to 
the Plans would require the establishment of non-voting advisory 
committees comprised solely of persons not employed by or affiliated 
with an SRO participant. This reproposal is intended to broaden 
participation in the governance of the Plans.
    The proposed amendment would require the SRO participants to select 
the members of the advisory committee comprised, at a minimum, of one 
or more representatives associated with (1) A broker-dealer with a 
substantial retail investor base, (2) a broker-dealer with a 
substantial institutional investor customer base, (3) an ATS, (4) a 
data vendor, and (5) an investor. In addition, each SRO participant 
would be entitled to select an additional committee member. The 
Commission believes that the composition of the advisory committee 
would give interested parties other than the SROs a voice in matters 
that affect them.
    The members of the advisory committee would have the right to 
submit their views to the operating committee on Plan business (other 
than matters determined to be confidential by a majority of Plan 
participants), prior to any decision made by the operating committee, 
and would have the right to attend operating committee meetings. 
Broader participation in the Plans through the creation of Plan 
advisory committees would be beneficial to the administration of the 
Plans because it would provide transparency to the Plan governance 
process and could promote the formation of industry consensus on 
disputed issues.
    b. Costs. The reproposed amendment to the Plans requiring the 
formation of advisory committees could potentially result in costs to 
the SRO participants who would be required to engage in a selection 
process for purposes of establishing such committees. A Plan's 
operating committee as a whole would be required to select a minimum of 
five committee members, while each SRO participant also would have the 
right to select an additional committee member. This selection process 
could potentially result in added costs and administrative burden and 
expense to the SRO participants.
    The reproposed Plan amendment also could potentially disrupt the 
current governance of the Plans by their participants. Since the 
creation of the Plans, representatives from the SROs have been the sole 
participants in the Plans and have been responsible for their 
administration. A few commenters believed that the additional 
participation of non-SRO parties could potentially increase the 
difficulty of reaching a consensus on Plan business, stating that too 
many members on an advisory committee could complicate and disrupt, 
rather than assist, Plan operations due to differing agendas.\514\ 
Although such a result may occur at times, the Commission preliminarily 
believes that this cost would be justified by the benefits that could 
be gained by increasing the transparency of Plan operations and giving 
parties other than SROs an opportunity to submit their views. In the 
past, the Plans may not have adequately considered the viewpoints of 
non-SRO parties on important issues such as fees and administrative 
burdens. Establishing advisory committees would address this problem 
and thereby potentially make the Plans more responsive to the needs of 
market participants and investors.
---------------------------------------------------------------------------

    \514\ See, e.g., Amex Letter, Exhibit A at 21-22; ISE Letter at 
10; Reuters Letter at 3.
---------------------------------------------------------------------------

3. Proposed Amendments to Rules 11Aa3-1 and 11Ac1-2 (Proposed to Be 
Redesignated as Rules 601 and 603)
    a. Independent Distribution of Information.
    i. Benefits. The Commission is reproposing an amendment to Exchange 
Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601) that would 
rescind the prohibition on SROs and their members from disseminating 
their trade reports independently.\515\ Under the reproposed amendment 
to Exchange Act Rule 11Aa3-1 (proposed to be redesignated as Rule 601), 
members of an SRO would continue to be required to transmit their 
trades to the SRO (and SROs would continue to transmit trades to the 
Networks pursuant to the Plans), but such members also would be free to 
distribute their own data independently, with or without fees. The 
Commission preliminarily believes that independently distributed 
information could be beneficial to investors and other information 
users because depth-

[[Page 77488]]

of-book quotations have become increasingly important as decimal 
trading has spread displayed depth across a greater number of price 
points.
---------------------------------------------------------------------------

    \515\ Proposed Regulation NMS would remove the definitions in 
paragraph (a) of Exchange Act Rule 11Aa3-1 (proposed to be 
redesignated as Rule 601) and place them in proposed Rule 600. 
Subparagraphs (c)(2) and (c)(3) of Exchange Act Rule 11Aa3-1 
(proposed to be redesignated as Rule 601) would be rescinded. As a 
result, subparagraph (c)(4) of Exchange Act Rule 11Aa3-1 would be 
redesignated as subparagraph (b)(2) of Rule 601.
---------------------------------------------------------------------------

    Reproposed Rule 603(a) would establish uniform standards for 
distribution of both quotations and trades. The reproposed standards 
would require an exclusive processor, or a broker or dealer with 
respect to information for which it is the exclusive source, that 
distributes quotation and transaction information in an NMS stock to a 
securities information processor (``SIP'') to do so on terms that are 
fair and reasonable. In addition, those SROs, brokers, or dealers that 
distribute such information to a SIP, broker, dealer, or other persons 
would be required to do so on terms that are not unreasonably 
discriminatory. Furthermore, these uniform standards would be based, in 
part, on similar requirements found in Sections 3 and 11A of the 
Exchange Act \516\ for SROs and entities that distribute SRO 
information on an exclusive basis. The Commission preliminarily 
believes that extending these requirements to non-SRO market centers, 
including ATSs and market makers, would help assure equal regulation of 
all markets that trade NMS stocks.
---------------------------------------------------------------------------

    \516\ 15 U.S.C. 78c and 15 U.S.C. 78k-1.
---------------------------------------------------------------------------

    ii. Costs. The Commission recognizes that the rescission of the 
prohibition on independent distribution of trade reports under Rule 
11Aa3-1 (proposed to be redesignated as Rule 601) could potentially 
lead to market centers incurring costs associated with the independent 
distribution of their market data if they choose to distribute such 
data without charging a fee. In addition, investors may have to pay for 
additional data if market centers choose to charge a fee for the 
additional data. Furthermore, a corollary to one commenter's assertion 
that market centers could benefit from additional revenues if market 
centers choose to distribute their own quotation information \517\ is 
that the data from one or more other market centers could potentially 
become more or less valuable than another market center's data, and 
thereby increase or reduce that market center's overall income. The 
Commission preliminarily does not believe that there will be any costs 
associated with the requirement to establish uniform standards for the 
distribution of trades and quotations pursuant to reproposed Rule 
603(a), but requests comment on this issue.
---------------------------------------------------------------------------

    \517\ Specialist Assoc. Letter at 16-17.
---------------------------------------------------------------------------

    b. Consolidation of Information.
    i. Benefits. All SROs currently participate in Plans that provide 
for the dissemination of consolidated information for the NMS stocks 
that they trade. Reproposed Rule 603(b) would confirm by Exchange Act 
rule that both existing and any new SROs would be required to continue 
to participate in joint-industry plans to disseminate consolidated 
information in NMS stocks to the public. This reproposed amendment 
would provide the benefit of clarifying that all SROs--whether existing 
or new--would be required to participate jointly in one or more Plans 
to disseminate consolidated information in NMS stocks. The reproposed 
amendment also would require that all quotation and trade information 
for an individual NMS stock be disseminated through a single processor 
(currently, SIAC or Nasdaq). The Commission preliminarily believes that 
requiring a single processor for a particular security would help to 
ensure that investors continue to receive the benefits of obtaining 
consolidated information from a single source.
    ii. Costs. Given that consolidated market information currently is 
disseminated through a single processor per stock, the Commission does 
not foresee any new costs associated with reproposed Rule 603(b).
    c. Display of Consolidated Information.
    i. Benefits. Reproposed Rule 603(c) (currently Exchange Act Rule 
11Ac1-2) would substantially revise the consolidated display 
requirement by limiting its scope. It would incorporate a new 
definition of ``consolidated display'' (set forth in reproposed Rule 
600(b)(13)) that is limited to the prices, sizes, and market center 
identifications of the NBBO, along with the ``consolidated last sale 
information'' (which is defined in proposed Rule 600(b)(14)). Beyond 
disclosure of this basic information, market forces, rather than 
regulatory requirements, would be allowed to determine what, if any, 
additional data from other market centers is displayed. In particular, 
investors and other information users ultimately would be able to 
decide whether they need additional information in their displays.
    Reproposed Rule 603(c) also would eliminate the burden on vendors 
and broker-dealers to display a complete montage of quotations from all 
market centers trading a particular security, which would include the 
price of quotations that may be far away from the current NBBO. 
Furthermore, vendors and broker-dealers would have the ability to 
decide what, if any, additional data from other market centers beyond 
this basic disclosure to display. Vendors, broker-dealers, and 
investors would benefit from this reduced consolidated display 
requirement through a more efficient use of system capacity and because 
the costs of obtaining necessary data could be lowered. The Commission 
believes that giving investors the ability to choose (and pay for) only 
the data they need and use would be beneficial.
    Reproposed Rule 603(c) would narrow the contexts in which a 
consolidated display is required to those when it is most needed--a 
context in which a trading or order-routing decision could be 
implemented. For example, the consolidated display requirement would 
continue to cover broker-dealers who provide on-line data to their 
customers in software programs from which trading decisions can be 
implemented. Similarly, the requirement would continue to apply to 
vendors who provide displays that facilitate order routing by broker-
dealers. It would not apply, however, when market data is provided on a 
purely informational website that does not offer any trading or order-
routing capability. Reproposed Rule 603(c) also would simplify the rule 
language to require that consolidated data be made available in an 
equivalent manner as other data and would rescind unnecessary 
provisions in order to update the Rule.\518\ Reproposed Rule 603(c) 
should benefit broker-dealers and vendors by making compliance with the 
reproposed Rule's more tailored requirements easier and more efficient.
---------------------------------------------------------------------------

    \518\ The provisions proposed to be rescinded include 
requirements relating to moving tickers, categories of market 
information, and representative bids and offers.
---------------------------------------------------------------------------

    ii. Costs. A potential cost attributable to reproposed Rule 603(c) 
could be that there currently may be individuals who use the displayed 
montage of quotations from all market centers trading a particular 
security. If vendors and broker-dealers determined not to display this 
additional information, these investors would be required to obtain the 
additional data at additional cost. Reproposed Rule 603(c) also could 
potentially result in an administrative cost or burden for vendors and 
broker-dealers that would be required to assess in what circumstances 
they are displaying market data information for trading and order-
routing purposes and in what circumstances they are displaying such 
information for other purposes. The Commission preliminarily believes 
that such a cost would be minimal.

[[Page 77489]]

E. Regulation NMS

    The Commission is reproposing to redesignate the current NMS rules 
adopted under Section 11A of the Exchange Act \519\ as Regulation NMS, 
make non-substantive conforming changes to various rules, and create a 
separate definitional rule, Rule 600, which would contain all of the 
defined terms used in Regulation NMS. Currently, each NMS rule includes 
its own set of definitions, and some identical terms, such as ``covered 
security,'' ``reported security,'' and ``subject security,'' are 
defined inconsistently. Although reproposed Rule 600 would retain, 
unchanged, most of the definitions used in the existing NMS rules, it 
would delete or revise obsolete definitions and eliminate the use of 
inconsistent definitions for identical terms. Reproposed Rule 600 would 
not alter the requirements or operation of the existing NMS rules.
---------------------------------------------------------------------------

    \519\ 15 U.S.C. 78k-1.
---------------------------------------------------------------------------

1. Benefits
    The Commission believes that reproposed Rule 600 and the related 
proposed amendments to various rules would benefit all entities that 
are and would be subject to the requirements of the rules contained in 
Regulation NMS, including broker-dealers, national securities 
exchanges, the NASD, ECNs, SIPS, and vendors. By eliminating or 
revising obsolete and inconsistent definitions and adopting a single 
set of definitions that would be used throughout Regulation NMS, 
reproposed Rule 600 should make Regulation NMS clearer and easier to 
understand, thereby facilitating compliance with its requirements and 
potentially easing the compliance burden on entities subject to 
Regulation NMS. Increased compliance with Regulation NMS would, in 
turn, benefit investors and the public interest. Similarly, the related 
non-substantive amendments to various rules would ensure that those 
rules use the definitions provided in reproposed Rule 600 and refer 
accurately to the redesignated NMS rules.
2. Costs
    Reproposed Rule 600 would update and clarify the definitions used 
in existing NMS rules. Neither reproposed Rule 600 nor the related 
conforming proposed amendments to various rules would alter the 
existing requirements of the NMS rules or other Commission rules. 
Accordingly, the Commission believes that reproposed Rule 600 and the 
related amendments would impose few additional costs on entities 
subject to Regulation NMS. Although some additional personnel costs may 
be incurred in reviewing the changes, the Commission believes that 
these costs would be minimal.

X. Consideration of Burden on Competition, and Promotion of Efficiency, 
Competition, and Capital Formation

    Section 3(f) of the Exchange Act \520\ requires the Commission, 
when engaging in rulemaking that requires the Commission to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition and capital formation. Section 23(a) of the Exchange Act 
\521\ requires the Commission to consider whether the action will 
promote efficiency, competition and capital formation. Section 23(a)(2) 
prohibits the Commission from adopting any rule that would impose a 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act.\522\ To assist the Commission in 
evaluating the costs and benefits of Regulation NMS, the Commission 
solicited comment in the Proposing Release on whether any of the 
proposals discussed therein would have an adverse effect on competition 
that is neither necessary nor appropriate in furtherance of the 
purposes of the Exchange Act, and whether they would, if adopted, 
promote efficiency, competition and capital formation. The Commission 
also requested commenters to provide empirical data and other factual 
support for their views on these subjects. The Commission has 
considered comments received and has reproposed these rules, taking 
into account these comments. The Commission requests comment on these 
issues in the context of the reproposed rules.
---------------------------------------------------------------------------

    \520\ 15 U.S.C. 78c(f).
    \521\ 15 U.S.C. 78w(a).
    \522\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

A. Trade-Through Rule

    The Commission preliminarily believes that the price protection 
that would be provided by the reproposed Trade-Through Rule would 
encourage the use of limit orders and aggressive quoting, which should 
help improve the price discovery process, and contribute to increased 
liquidity and depth in the markets. The greater the number of limit 
orders available at better prices and greater size, the more liquidity 
available to fill incoming marketable orders. Thus, greater depth and 
liquidity should lead to improved execution quality, particularly for 
larger-sized institutional orders. The Commission also preliminarily 
believes that the reproposed Trade-Through Rule, by providing 
intermarket price protection for accessible, automated orders and not 
requiring automated markets to wait for responses from non-automated 
markets, would help promote efficiency in the markets by more 
effectively linking markets together and integrating trading centers 
with different market structures into the NMS, and by providing an 
incentive for non-automated markets to automate. Reproposed Rule 611 
also should promote investor confidence in the markets by helping to 
ensure that customer orders are executed at the best price available 
and providing protection against limit orders being bypassed by 
inferior priced executions. Comment is requested on whether extending 
trade-through protection to DOB quotations would significantly increase 
the benefits of the reproposed Trade-Through Rule. Would protecting 
quotations at multiple price levels further encourage the display of 
limit orders and thereby significantly enhance depth and liquidity in 
the NMS?
    The Commission recognizes the vital importance of preserving 
competition among market centers,\523\ and preliminarily believes that 
reproposed Rule 611 would promote intermarket competition by leveling 
the playing field between automated and non-automated markets and, to 
the extent that the existing trade-through rule serves to constrain 
competition, by removing this barrier to competition. In addition, the 
Commission preliminarily believes that market participants and 
intermediaries, consistent with their desire to achieve the best price 
and their duty of best execution, would continue to rank trading 
centers according to the total range of services provided by such 
markets. The most competitive--i.e. attractive--trading center would be 
the first choice for routing marketable orders, thereby enhancing the 
likelihood of execution for limit orders routed to that trading center. 
Because likelihood of execution is very important to limit orders, 
routers of limit orders likely would be attracted to this preferred 
trading center. More limit orders would enhance the depth and liquidity 
at the preferred trading center, thereby increasing its attractiveness 
for marketable orders, and beginning the cycle over again.
---------------------------------------------------------------------------

    \523\ Many commenters believed that an opt-out exception was 
necessary to promote competition among trading centers, particularly 
competition based on factors other than price, such as speed of 
response. See supra Section II.A.4.a.

---------------------------------------------------------------------------

[[Page 77490]]

    Trading centers that offer poor services, such as slow response 
times, would likely rank near the bottom in order-routing preferences 
of market participants and intermediaries. Whenever a least-preferred 
trading center is merely posting the same price as other trading 
centers, orders would be routed to the other, more preferred, trading 
centers. Competitive forces would continue to dictate that the lowest 
ranked trading center in order-routing preference would suffer from 
offering a poor range of services to the routers of marketable orders. 
The Commission therefore preliminarily does not believe that reproposed 
Rule 611 would eliminate competition among markets.
    The Commission requests comment on the effect that adoption of the 
Voluntary Depth Alternative would have on competition among markets. 
One commenter, for example, suggested that protection of DOB quotations 
might cause increased fragmentation of liquidity across different 
markets because limit orders, no matter where displayed, would have 
price protection.\524\ Another commenter, in contrast, asserted that 
protecting only BBOs would lead to greater fragmentation because limit 
orders would be routed to any market where they would set or equal the 
BBO and thereby obtain trade-through protection.\525\ Comment is 
requested on the fragmentation issue, as well as in general on whether 
protecting DOB quotations would inappropriately limit the terms of 
market competition so as to harm investors and the efficiency of the 
NMS. For example, would adoption of the Voluntary Depth Alternative 
inappropriately reduce the scope of competition among markets to the 
payment of liquidity rebates for executed limit orders? Comment also is 
requested on whether adoption of the Voluntary Depth Alternative would 
generate forces that would lead to a monopolization of trading in a 
single trading facility.
---------------------------------------------------------------------------

    \524\ Bear Stearns Letter at 2.
    \525\ Goldman Sachs Letter at 6.
---------------------------------------------------------------------------

    The end result should be an NMS that more fully meets the needs of 
a wide spectrum of investors, particularly long-term investors and 
publicly traded companies, by providing increased efficiency and 
improved depth and liquidity to our capital markets. By providing 
increased efficiency and promoting investor confidence in quality 
executions, investors may be more willing to invest in our capital 
markets, thus promoting the ability of listed companies to raise 
capital at lower cost.

B. Access Rule

    Reproposed Rule 610 would establish standards governing access to 
quotations in NMS stocks that (1) prohibit trading centers from 
unfairly discriminating against non-members members or non-subscribers 
that attempt to access quotations through a member or subscriber of the 
trading center, and enable access to NMS quotations through private 
linkages, (2) establish an outer limit on the cost of accessing such 
quotations of no more than $0.003 per share, and (3) require SROs to 
establish and enforce rules that, among other things, prohibit their 
members from engaging in a pattern or practice of displaying quotations 
that lock or cross the automated quotations of other trading centers. 
The reproposed amendment to Rule 301(b)(5) under Regulation ATS would 
lower the threshold that triggers the Regulation ATS fair access 
requirements from 20% to 5% of average daily volume in a security.
    The reproposed access provisions are intended to bolster investor 
confidence in the markets by helping to ensure investors that their 
orders will be executed at the best prices and will not subject to 
hidden fees, regardless of the market on which the execution takes 
place. By generally imposing a uniform fee limitation of $0.003 per 
share, the proposed rules would promote equal regulation of different 
types of trading centers, where currently some are permitted to charge 
fees and some are not, thereby leveling the playing field among diverse 
market centers. Moreover, the Commission preliminarily believes that, 
by prohibiting a trading center from imposing unfairly discriminatory 
terms that would prevent or inhibit the efficient access of any person 
through members, subscribers, or customers of such trading center, the 
reproposed rule would promote competition among trading centers.
    The Commission preliminarily believes that reproposed Rule 610 also 
would increase transparency and efficiency in the market, thereby 
enhancing investor confidence, and thus capital formation. 
Specifically, the reproposed Rule would permit private linkages between 
markets, rather than mandating a collective intermarket linkage 
facility. Private linkages would permit market centers to connect 
through cost effective and technologically advanced communications 
networks. Such systems are widely utilized in the market for Nasdaq 
stocks today and should provide speed and flexibility to trading 
centers and their market participants. The use of private linkages 
should encourage interaction between the markets and reduce 
fragmentation by removing impediments to the execution of orders 
between and among marketplaces, thereby increasing efficiency and 
competition.
    Several commenters expressed concerns regarding the impact that the 
access fee proposal could have on competition.\526\ As discussed in 
detail in Section III, the Commission preliminarily believes that the 
flat limitation on access fees of $0.003 per share would be the fairest 
and most appropriate solution to what has been a longstanding and 
contentious issue. A single accumulated fee cap would apply equally to 
all types of trading centers and all types of market participants, 
thereby promoting the NMS objective of equal regulation of markets and 
broker-dealers.\527\ The $0.003 fee limitation would be consistent with 
current business practices, as very few trading centers charge fees 
that exceed this amount.\528\ In addition, a fee limitation is 
necessary to preclude individual trading centers from raising their 
fees substantially in an attempt to take improper advantage of 
strengthened protection against trade-throughs and the adoption of a 
private linkage regime.
---------------------------------------------------------------------------

    \526\ See, e.g., Amex Letter, Exhibit A at 23-24; Bloomberg 
Summary of Intended Testimony at 3; BrokerageAmerica Letter at 1; 
Brut Letter at 14; CHX Letter at 15; Domestic Securities Summary of 
Intended Testimony; Instinet Letter at 28, 33-34; TrackECN Letter at 
3.
    \527\ Section 11A(c)(1)(F) of the Exchange Act.
    \528\ Cf. Instinet Letter at 35 (``there is no basis for 
adopting any limitation other than at the prevailing $0.003 per 
share level, which was arrived at through open competition among 
ATSs, ECNs, and SRO markets in the Nasdaq market'').
---------------------------------------------------------------------------

    In addition, the reproposed rule is designed to reduce the 
instances of locked and crossed quotations, which should promote 
capital formation by providing market participants a clear picture of 
the true trading interest in a stock. Moreover, the Commission 
preliminarily believes that the reproposed access provisions would 
encourage interaction between the markets and reduce fragmentation by 
removing impediments to the execution of orders between and among 
marketplaces, thereby increasing efficiency and competition. Finally, 
the Commission preliminarily believes that the reproposed access rule 
would assist broker-dealers in evaluating and complying with their best 
execution obligations.

[[Page 77491]]

C. Sub-Penny Rule

    The Commission has considered reproposed Rule 612 in light of 
Sections 3(f) and 23(a)(2) of the Exchange Act and preliminarily 
believes that the rule would not impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act. To the contrary, by preserving the benefits of decimalization and 
guarding against the less desirable effects of further reducing the 
MPV, reproposed Rule 612 should promote fair and vigorous competition. 
The Commission acknowledges that the Rule would, in some circumstances, 
prevent market participants from offering marginally better prices. 
Some commenters argued that a prohibition on quoting in sub-pennies, at 
least in some NMS stocks, would inhibit price competition and 
artificially widen spreads.\529\ Nevertheless, the Commission is 
concerned that sub-penny quoting may be used by market participants 
more as a means of stepping ahead of competing limit orders for an 
economically insignificant amount than of promoting genuine price 
competition.
---------------------------------------------------------------------------

    \529\ See, e.g., Instinet Letter at 47; Mercatus Center Letter 
at 9-10; Tower Research Letter at 8-11.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the reproposed Rule 
would assist broker-dealers in evaluating and complying with their best 
execution obligations, as well as other rules premised on identifying 
the price of a security at a particular moment in time. The Commission 
also preliminarily believes that the reproposed Rule would enhance 
depth and transparency by preventing trading interest from being spread 
across an increasing number of price points. It also would prevent 
market participants from gaining priority over a standing limit order 
without making an economically significant contribution to the price of 
a security. In these respects, the reproposed Rule would encourage 
market participants to use limit orders, an important source of 
liquidity. Accordingly, the reproposed Rule may promote market 
efficiency, competition, and capital formation. In addition, the 
reproposed Rule also would bolster investor confidence by ensuring that 
their orders, especially large orders, can be executed without 
incurring large transaction costs. This increase in investor confidence 
should also promote market efficiency, competition, and capital 
formation.
    The Commission believes that the reproposed Rule would establish 
common quoting conventions that would increase transparency in the 
markets. Moreover, the Commission preliminarily believes that the 
reproposed Rule would encourage interaction between the markets and 
reduce fragmentation by removing impediments to the execution of orders 
between and among markets. The increased transparency in the markets 
and reduction of fragmentation between the markets may bolster investor 
confidence, thereby promoting capital formation.

D. Market Data Rules and Plan Amendments

    The Commission preliminarily believes that the reproposed Plan 
amendment modifying the current revenue allocation formulas would 
promote efficiency and competition in the marketplace by eliminating 
incentives for market participants to engage in distortive trading 
practices such as wash trades, trade shredding, and SRO print 
facilities to obtain market data revenues. Similarly, the Commission 
preliminarily believes that the reproposed Plan amendment requiring the 
creation of non-voting advisory committees would promote efficiency in 
the administration of the Plans by allowing interested parties other 
than SROs to have a voice in Plan matters, which could, in turn, 
contribute to the resolution of potential disputes that SRO 
participants would otherwise bring before the Commission or to the 
courts. Furthermore, reproposed amendments to Rule 11Ac1-2 (proposed to 
be redesignated as Rule 603) should promote efficiency and competition 
among market centers by helping to assure that independently reported 
trade and quotation information is distributed on terms that are fair 
and reasonable and not unreasonably discriminatory. Reproposed Rule 
603(a) would allow investors and vendors greater freedom to make their 
own decisions regarding the data they need and thus the proposal should 
lead to lower costs to investors. Broker-dealers who do not need the 
data beyond the prices, sizes, market center identifications of the 
NBBO and consolidated last sale information would not required to 
receive (and pay for) such data, thereby promoting efficiency. 
Reproposed Rule 603(b) also should promote efficiency in the 
dissemination of consolidated market information by requiring that all 
SROs act jointly through the Plans to disseminate such information to 
the public.
    The Commission preliminarily believes that the proposed Plan 
amendments would assist in capital formation through a more appropriate 
allocation of the Networks' revenues to those SROs that contribute most 
to public price discovery, and by potentially minimizing costs that may 
arise from having to resolve disputes relating to the administration of 
the Plans through broader representation. Reproposed Rule 603(c) also 
would eliminate the requirement to display a complete montage of 
quotations from all market centers and should therefore promote capital 
formation by reducing the costs to vendors and broker-dealers that are 
currently required to display quotations that may be far away from the 
NBBO.
    The Commission further preliminarily believes that the reproposed 
amendments to the Plans and to Rules 11Aa3-1 and 11Ac1-2 (proposed to 
be redesignated as Rules 601 and 603) would not impose any competitive 
burden that is not necessary and appropriate in furtherance of the 
purposes of the Exchange Act. Although modifying the allocation formula 
could shift revenues among the SRO participants in the Plans, the 
formula would allocate revenue to those SROs that contribute useful 
information to the consolidated data stream and thereby would promote 
competition on terms that will benefit investors. The Commission also 
preliminarily believes that the reproposed Plan amendment requiring the 
Plans to form non-voting advisory committees should enhance and promote 
competition by broadening Plan governance to include non-SRO parties, 
and thereby provide greater transparency in the administration of such 
Plans. Furthermore, the reproposed amendments to Rules 11Aa3-1 and 
11Ac1-2 (proposed to be redesignated as Rules 601 and 603) should 
lessen the burden on vendors and broker-dealers from having to comply 
with certain consolidated display requirements. Competition among 
markets also would be enhanced by enabling markets to independently 
distribute their own market data. In sum, the Commission preliminarily 
believes that the proposed amendments would enhance rather than burden 
competition.

E. Regulation NMS

    Reproposed Rule 600, the redesignation of the existing NMS rules as 
Regulation NMS, and the related proposed conforming changes to other 
Commission rules should help to promote efficiency and capital 
formation by making the NMS rules easier to understand, thereby helping 
to reduce compliance costs for entities subject to the rules. Enhanced 
clarity in the definitions used in Regulation NMS

[[Page 77492]]

also should benefit investors and the public interest by facilitating 
compliance with the requirements of reproposed Regulation NMS. Because 
Rule 600 would clarify the existing definitions used in Regulation NMS 
without imposing new requirements, and because the redesignation of the 
NMS rules as Regulation NMS and the conforming changes to other 
Commission rules would create no new substantive requirements, Rule 600 
and the related changes should not impose a burden on competition or 
alter the competitive standing of entities subject to Regulation NMS.

XI. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \530\ the Commission must advise the Office 
of Management and Budget as to whether the proposed regulation 
constitutes a ``major'' rule. Under SBREFA, a rule is considered 
``major'' where, if adopted, it results or is likely to result in:
---------------------------------------------------------------------------

    \530\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     A significant adverse effect on competition, investment, 
or innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. The Commission requested 
comment in the Proposing Release on the potential impact of the 
proposed regulation on the economy on an annual basis, including a 
request for commenters to provide empirical data and other factual 
support for their view to the extent possible.\531\ The Commission did 
not receive any comments specific to the potential impact of the 
proposed rules on the economy on an annual basis. The Commission renews 
its request for comment contained in the Proposing Release.
---------------------------------------------------------------------------

    \531\ Proposing Release, 69 FR at 11151, 11162, 11174, 11189-90, 
11198.
---------------------------------------------------------------------------

XII. Regulatory Flexibility Act

    Section 3(a) of the Regulatory Flexibility Act \532\ requires the 
Commission to undertake an Initial Regulatory Flexibility Analysis 
(``IRFA'') of the proposed rules and amendments on small entities 
unless the Commission certifies that the proposed rules and amendments, 
if adopted, would not have a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \532\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Trade-Through Rule

    The Commission hereby certifies, pursuant to Section 603(b) of the 
Regulatory Flexibility Act,\533\ that reproposed Rule 611 would not 
have a significant economic impact on a substantial number of small 
entities.\534\ Reproposed Rule 611 would require any trading center 
\535\ to establish, maintain, and enforce written policies and 
procedures reasonably designed to prevent trade-throughs of protected 
quotations in NMS stocks that do not fall within an exception to the 
reproposed Rule, and, if relying on such an exception, that are 
reasonably designed to assure compliance with the terms of the 
exception. Further, trading centers would be required to regularly 
surveil to ascertain the effectiveness of such policies and procedures 
and to take prompt remedial action to remedy deficiencies in such 
policies and procedures. Thus, only those entities that fall within the 
definition of trading center would be subject to the reproposed Rule. 
In addition, brokers-dealers that would not be included within the 
definition of trading center but that employ their own order smart-
routing systems to route orders to multiple trading centers may choose 
to (but would not be required to) use the intermarket sweep order 
functionality of the proposed intermarket sweep exception.\536\ In 
addition, vendors that would not be subject to reproposed Rule 611 may 
need to make system modifications to support the operation of the 
reproposed Rule.
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    \533\ 5 U.S.C. 603(b).
    \534\ The Commission included an IRFA in the Proposing Release 
for proposed Rule 611. Proposing Release, 69 FR at 11151-53. The 
certificate contained herein is based on a further refinement of the 
number of entities that would be subject to reproposed Rule 611 and 
the impact of the reproposed Rule.
    \535\ A trading center would be defined as a national securities 
exchange or national securities association that operates an SRO 
trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker or dealer that 
executes orders internally by trading as principal or crossing 
orders as agent.
    \536\ An intermarket sweep order would be defined in Rule 
600(b)(30) as a limit order that meets the following requirements: 
(1) The limit order is identified as an intermarket sweep order when 
routed to a trading center, and (2) simultaneously with the routing 
of the limit order, one or more additional orders are routed to 
execute against all better-priced protected quotations displayed by 
other trading centers up to their displayed size. These additional 
orders must be marked to inform the receiving trading center that 
they are associated with an intermarket sweep order. Paragraph 
(c)(5) of reproposed Rule 611 would allow a trading center to 
execute immediately any order identified as an intermarket sweep 
order, without regard for better-priced protected quotations 
displayed at one or more other trading centers. Similarly, paragraph 
(c)(6) of reproposed Rule 611 would authorize a trading center 
itself to route intermarket sweep orders and thereby enable 
immediate execution of a transaction at a price inferior to a 
protected quotation at another trading center.
---------------------------------------------------------------------------

    The current national securities exchanges and one national 
securities association that would be subject to the proposed Rule are 
not considered ``small entities'' for purposes of the Regulatory 
Flexibility Act.\537\ The remaining trading centers that would be 
subject to reproposed Rule 611 are registered broker-dealers. The 
Commission has preliminarily determined that approximately 600 broker-
dealers registered with the Commission,\538\ which includes broker-
dealers operating as equity ATSs, broker-dealers registered as market 
makers or specialists in NMS stocks, and any broker-dealer that is in 
the business of executing orders internally in NMS stocks, would be 
subject to reproposed Rule 611. Of these 600 broker-dealers, only two 
are considered small for purposes of the Regulatory Flexibility Act 
pursuant to the standards of Rule 0-10(c) under the Exchange Act.\539\
---------------------------------------------------------------------------

    \537\ See 17 CFR 240.0-10(e) and 13 CFR 121.201.
    \538\ See supra note 426.
    \539\ Pursuant to Rule 0-10(c) under the Exchange Act, 17 CFR 
240.0-10(c), a broker-dealer is defined as a small entity for 
purposes of the Exchange Act and the Regulatory Flexibility Act if 
the broker-dealer had a total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the date in the prior fiscal 
year as of which its audited financial statements were prepared, and 
it is not affiliated with any person (other than a natural person) 
that is not a small entity.
---------------------------------------------------------------------------

    With respect to non-trading center broker-dealers that employ their 
own smart-order routing technology and that would choose to route 
orders in compliance with the proposed intermarket sweep exception (and 
thus would need to make necessary modifications to their order routing 
practices and proprietary order routing systems), the Commission 
preliminarily does not believe that this category of broker-dealers 
would be very large, and also preliminarily does not believe that any 
such broker-dealer that would employ its own order routing systems 
would be considered small, given the cost of operating such proprietary 
systems.\540\ The Commission also believes it likely that, given the 
nature of their business, most if not all of these non-trading center 
broker-dealers that employ their own order-routing technology already 
have systems in place that monitor best-priced quotations across 
markets, and thus

[[Page 77493]]

preliminarily does not believe that the changes necessary to implement 
the intermarket sweep order would be significant. With respect to any 
vendor that may determine to make systems modifications to support the 
operation of reproposed Rule 611, only 16 of the approximately 80 
existing vendors are considered small.\541\ Accordingly, the Commission 
does not believe that reproposed Rule 611 would have a significant 
economic impact on a substantial number of small entities.
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    \540\ Id.
    \541\ A vendor is defined as any securities information 
processor engaged in the business of disseminating transaction 
reports or last sale data with respect to transactions in reported 
securities to brokers, dealers or investors on a real-time or other 
current and continuing basis, whether through an ECN, moving ticker 
or interrogation device. See 17 CFR 11Aa3-1(a)(11). Rule 0-10(g) 
states that the term ``small business'' or ``small organization,'' 
when referring to a securities information processor, means any 
securities information processor that: (1) Had gross revenues of 
less than $10 million during the preceding fiscal year (or in the 
time it has been in business, if shorter); (2) provided service to 
fewer than 100 interrogation devices or moving tickers at all times 
during the preceding fiscal year (or in the time that it has been in 
business, if shorter); and (3) is not affiliated with any person 
(other than a natural person) that is not a small business or small 
organization under this section. 17 CFR 240.0-10(g). The Commission 
estimates that there are approximately 80 vendors, only 16 of which 
are considered small entities.
---------------------------------------------------------------------------

    The Commission encourages written comments regarding this 
certification. The Commission requests that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact. In particular, the Commission 
requests comment on (a) the number of small entities that would be 
affected by reproposed Rule 611; (b) the nature of any impact 
reproposed Rule 611 would have on small entities and empirical data 
supporting the extent of the impact; and (c) how to quantify the number 
of small entities that would be affected by or how to quantify the 
impact of reproposed Rule 611.

B. Access Rule

    The Commission hereby certifies, pursuant to Section 603(b) of the 
Regulatory Flexibility Act,\542\ that reproposed Rule 610 and the 
reproposed amendments to Rule 301 of Regulation ATS would not have a 
significant economic impact on a substantial number of small 
entities.\543\ Reproposed Rule 610 would prohibit any trading center 
\544\ from imposing unfairly discriminatory terms that would prevent or 
inhibit the access of any person through members, subscribers, or 
customers of such trading center. Further, the reproposed Rule would 
restrict access fees imposed by trading centers to a maximum of $0.003 
per share. Finally, reproposed Rule 610 would require national 
securities exchanges and national securities associations to establish 
and enforce rules that, among other things, prohibit their members from 
engaging in a pattern or practice of displaying quotations that lock or 
cross the automated quotations of other trading centers. Thus, 
reproposed Rule 610 would impact only those entities that fall within 
the definition of trading center. The reproposed access provisions also 
would lower the threshold that triggers the fair access requirements in 
Rule 301 of Regulation ATS from 20% to 5% of average daily volume in a 
security. This amendment would potentially impact the existing 
operating ATSs.
---------------------------------------------------------------------------

    \542\ 5 U.S.C. 603(b).
    \543\ The Commission included an IRFA for the access proposal in 
the Proposing Release. Proposing Release, 69 FR at 11162-63. The 
certification contained herein is based on a further refinement of 
the entities that would be subject to reproposed access requirements 
and the impact of the proposed rules.
    \544\ A trading center would be defined as a national securities 
exchange or national securities association that operates an SRO 
trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker or dealer that 
executes orders internally by trading as principal or crossing 
orders as agent.
---------------------------------------------------------------------------

    The current national securities exchanges and national securities 
association that would be subject to the reproposed Rule are not 
considered ``small entities'' for purposes of the Regulatory 
Flexibility Act.\545\ The remaining entities that would be subject to 
reproposed Rule 610 and the reproposed amendments to Rule 301 of 
Regulation ATS are registered broker-dealers. The Commission has 
preliminarily determined that approximately 600 broker-dealers 
registered with the Commission,\546\ which includes broker-dealers 
operating as equity ATSs, broker-dealers registered as market makers or 
specialists in NMS stocks, and any other broker-dealer that is in the 
business of executing orders internally, would be subject to Rule 610. 
In addition, the existing operating ATSs (which are or are operated by 
registered broker-dealers) potentially could be subject to the 
reproposed amendment to Rule 301 of Regulation ATS. Of these broker-
dealers, only two are considered small for purposes of the Regulatory 
Flexibility Act pursuant to the standards of Rule 0-10(c) under the 
Exchange Act.\547\ Accordingly, the Commission preliminarily does not 
believe that reproposed Rule 610 and the reproposed amendments to Rule 
301 of Regulation ATS would have a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \545\ See 17 CFR 240.0-10(e) and 13 CFR 121.201.
    \546\ See supra note 426.
    \547\ See supra note 539.
---------------------------------------------------------------------------

    The Commission encourages written comments regarding this 
certification. The Commission requests that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact. In particular, the Commission 
requests comment on (a) the number of small entities that would be 
affected by reproposed Rule 610 and the reproposed amendment to Rule 
301 of Regulation ATS; (b) the nature of any impact reproposed Rule 610 
and the reproposed amendment to Rule 301 of Regulation ATS would have 
on small entities and empirical data supporting the extent of the 
impact; and (c) how to quantify the number of small entities that would 
be affected by or how to quantify the impact of reproposed Rule 610 and 
the reproposed amendment to Rule 301 of Regulation ATS.

C. Sub-Penny Rule

    This IRFA relating to reproposed Rule 612 has been prepared in 
accordance with 5 U.S.C. 603. This IRFA is substantially the same as 
the one contained in the Proposing Release.\548\ The Commission did not 
receive any comment on the IRFA contained in the Proposing Release.
---------------------------------------------------------------------------

    \548\ Proposing Release, 69 FR at 11174-75.
---------------------------------------------------------------------------

1. Reasons for the Proposed Action
    The Commission is concerned that, while the conversion from 
fractions to decimals benefited investors by clarifying and simplifying 
pricing for investors, making our markets more competitive 
internationally, and reducing trading costs by narrowing spreads, these 
benefits could be sacrificed by decreasing the MPV from a penny to 
pricing increments finer than a penny. The Commission is particularly 
concerned that sub-penny orders can be used to step ahead of competing 
limit orders for an economically insignificant amount.
    The Commission believes that this would be an opportune time to 
address these issues by proposing a uniform standard of quoting in NMS 
stocks. The Commission is thus proposing to prohibit any vendor, 
exchange, association, broker-dealer, or ATS (including ECNs) from 
accepting, ranking, or displaying quotations, orders, or indications of 
interest in NMS stocks in sub-penny increments (except for quotations, 
orders, or indications of

[[Page 77494]]

interest priced less than $1.00 per share, in which case the price may 
not extend beyond four decimal places).
2. Objectives
    The reproposed rule is designed to fulfill several objectives. 
Reproposed Rule 612 is designed to prevent widespread quoting in sub-
pennies, which could harm the markets and investors, by undermining a 
number of the benefits of decimalization. In particular, sub-penny 
quotation could impair broker-dealers' efforts to meet their best 
execution obligations, and interfere with investors' understanding of 
securities prices. In addition, the reproposed rule is designed to 
enhance depth by preventing quotations from being spread across an 
increasing number of price points, while also encouraging the use of 
limit orders--an important source of liquidity--by preventing competing 
market participants from stepping ahead of limit orders for an 
economically insignificant amount.
3. Legal Basis
    Pursuant to the Exchange Act and, particularly, Sections 3(b), 5, 
6, 11A, 15, 15A, 17(a) and (b), 19, 23(a), and 36 thereof, 15 U.S.C. 
78c(b), 78e, 78f, 78k-1, 78o, 78mm, 78q(a) and (b), and 78w(a), the 
Commission reproposes Rule 612.
4. Small Entities Subject to the Rule
    The reproposed rule would apply to any national securities 
exchange, national securities association, ATS, vender, or broker or 
dealer. ATSs that are not registered as exchanges are required to 
register as broker-dealers. Accordingly, ATSs would be considered small 
entities if they fall within the standard for small entities that would 
apply to broker-dealers. Each type of market participant that would be 
affected by the reproposed rule is discussed below.
a. National Securities Exchanges and National Securities Association
    Rule 0-10(e) under the Exchange Act \549\ provides that the term 
``small business'' or ``small organization,'' when referring to an 
exchange, means any exchange that: (1) Has been exempted from the 
reporting requirements of Rule 11Aa3-1 under the Exchange Act; and (2) 
is not affiliated with any person (other than a natural person) that is 
not a small business or small organization, as defined by Rule 0-10. No 
national securities exchanges are small entities because none meets 
these criteria. There is one national securities association (NASD) 
that would be subject to reproposed Rule 612. NASD is not a small 
entity as defined by 13 CFR 121.201.
---------------------------------------------------------------------------

    \549\ 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

b. Broker-Dealers
    Commission rules generally define a broker-dealer as a small entity 
for purposes of the Exchange Act and the Regulatory Flexibility Act if 
the broker-dealer had a total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the date in the prior fiscal year 
as of which its audited financial statements were prepared, and the 
broker-dealer is not affiliated with any person (other than a natural 
person) that is not a small entity.\550\ The Commission estimates that 
as of the end of 2003, there were approximately 6,565 Commission-
registered broker-dealers,\551\ of which approximately 905 would be 
considered small entities pursuant to the standard of Rule 0-10(c) 
under the Exchange Act.\552\
---------------------------------------------------------------------------

    \550\ 17 CFR 240.0-10(c).
    \551\ This number reflects the number of FOCUS filings.
    \552\ 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

c. Vendors
    A vendor is defined as any securities information processor engaged 
in the business of disseminating transaction reports or last sale data 
with respect to transactions in reported securities to brokers, dealers 
or investors on a real-time or other current and continuing basis, 
whether through an ECN, moving ticker or interrogation device.\553\ 
Rule 0-10(g) \554\ states that the term ``small business'' or ``small 
organization,'' when referring to a securities information processor, 
means any securities information processor that: (1) Had gross revenues 
of less than $10 million during the preceding fiscal year (or in the 
time it has been in business, if shorter); (2) provided service to 
fewer than 100 interrogation devices or moving tickers at all times 
during the preceding fiscal year (or in the time that it has been in 
business, if shorter); and (3) is not affiliated with any person (other 
than a natural person) that is not a small business or small 
organization under this section. The Commission estimates that there 
are approximately 80 vendors, 16 of which are considered small 
entities. The Commission seeks comment on whether these estimates are 
accurate.
---------------------------------------------------------------------------

    \553\ See 17 CFR 11Aa3-1(a)(11).
    \554\ 17 CFR 240.0-10(g).
---------------------------------------------------------------------------

5. Reporting, Recordkeeping, and Other Compliance Requirements
    Reproposed Rule 612 would not impose any new reporting, 
recordkeeping or other compliance requirements on market participants 
that are small entities.
6. Duplicative, Overlapping or Conflicting Federal Rules
    The Commission believes that there are no federal rules that 
duplicate, overlap or conflict with the proposed rule.
7. Significant Alternatives
    Pursuant to Section 3(a) of the RFA,\555\ the Commission must 
consider the following types of alternatives: (1) The establishment of 
differing compliance or reporting requirements or timetables that take 
into account the resources available to small entities; (2) the 
clarification, consolidation, or simplification of compliance and 
reporting requirements under the proposed rule for small entities; (3) 
the use of performance rather than design standards; and (4) an 
exemption from coverage of the proposed rule, or any part thereof, for 
small entities.
---------------------------------------------------------------------------

    \555\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The primary goal of the reproposed rule is to provide a uniform 
pricing increment for NMS stocks. As such, imposing different 
compliance or reporting requirements, and possibly a different 
timetable for implementing compliance or reporting requirements, for 
small entities could undermine the goal of uniformity. In addition, the 
Commission preliminarily believes that it would not be consistent with 
the primary goal of the proposal to further clarify, consolidate, or 
simplify the reproposed rule for small entities. The Commission also 
does not believe that it is necessary to consider whether small 
entities should be permitted to use performance rather than design 
standards to comply with the proposed rule because the rule already 
reproposes performance standards and does not dictate for entities of 
any size any particular design standards (e.g., technology) that must 
be employed to achieve the objectives of the proposed rule. The 
Commission also preliminarily believes that it would be inconsistent 
with the purposes of the Exchange Act to specify different requirements 
for small entities or to exempt broker-dealers from the proposed rule.
8. Request for Comments
    The Commission encourages written comments on matters discussed in 
the IRFA. In particular, the Commission

[[Page 77495]]

requests comments on (i) the number of small entities that would be 
affected by the reproposed rule; (ii) the nature of any impact the 
reproposed rule would have on small entities and empirical data 
supporting the extent of the impact; and (iii) how to quantify the 
number of small entities that would be affected by and how to quantify 
the impact of the reproposed rule. Such comments will be considered in 
the preparation of the Final Regulatory Flexibility Analysis, if the 
reproposed rule is adopted, and will be placed in the same public file 
as comments on the reproposed rule itself.

D. Market Data Rules and Plan Amendments

1. Regulatory Flexibility Act Certification for the Plan Amendments
    Pursuant to 5 U.S.C. 605(b) of the Regulatory Flexibility Act,\556\ 
the Commission certified in the Proposing Release that amending the 
Plans to (1) modify the current formulas for allocating market data 
revenues, and (2) require the establishment of non-voting advisory 
committees would not have a significant economic impact on a 
substantial number of small entities.\557\ The Commission did not 
receive any comments on the certification. The Commission renews its 
request for comment on the certification, which is set forth below.
---------------------------------------------------------------------------

    \556\ 5 U.S.C. 605(b).
    \557\ Proposing Release, 69 FR at 11190-91.
---------------------------------------------------------------------------

    The Commission hereby certifies, pursuant to 5 U.S.C. 603(b), that 
the reproposed amendments to the Plans, if adopted, would not have a 
significant economic impact on a substantial number of small entities. 
The reproposed amendments to the Plans imposing a new net income 
allocation formula would only impact the SROs,\558\ SIAC ( the 
processor for the CTA Plans and the CQ Plan), and Nasdaq (the processor 
for the Nasdaq UTP Plan). The reproposed amendments to the Plans 
requiring the establishment of an advisory committee would apply only 
to Plan participants. SIAC and Nasdaq would not be considered ``small 
entities'' for purposes of the Regulatory Flexibility Act.\559\ The 
Plan participants are either national securities exchanges or a 
national securities association and, as such, are not small 
entities.\560\ Accordingly, the Commission does not believe that the 
reproposed amendments to the Plans would have a significant economic 
impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \558\ Paragraph (e) of Exchange Act Rule 0-10 provides that the 
term ``small entity,'' when referring to an exchange, means any 
exchange that has been exempted from the reporting requirements of 
17 CFR 240.11Aa3-1 and is not affiliated with any person that is not 
a small entity. Under this standard, none of the exchanges affected 
by the proposed rule is a small entity. Similarly, the national 
securities association affected by the proposed rule is not small 
entity as defined by 13 CFR 121.201.
    \559\ See 17 CFR 240.0-10(g).
    \560\ See 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

2. Initial Regulatory Flexibility Analysis for Proposed Amendments to 
Rules 11Aa3-1 and 11Ac1-2 (Proposed To Be Redesignated as Rules 601 and 
603)
    This IRFA has been prepared in accordance with 5 U.S.C. 603. It 
relates to the proposed amendments to Rules 11Aa3-1 and 11Ac1-2 under 
the Exchange Act (proposed to be redesignated as Rules 601 and 603 of 
Regulation NMS).\561\ This IRFA is substantially the same as the one 
contained in the Proposing Release.\562\ The Commission did not receive 
any comment on the IRFA contained in the Proposing Release.
---------------------------------------------------------------------------

    \561\ 17 CFR 240.11Aa3-1 and 17 CFR 240.11Ac1-2.
    \562\ Proposing Release, 69 FR 11190-91.
---------------------------------------------------------------------------

a. Reasons for the Proposed Action
    The Commission believes that an overall modernization of the rules 
for disseminating market data to the public is necessary to address 
problems posed by the current market data rules. The Commission 
proposes to retain the core elements of the current rules--price 
discovery and mandatory consolidation--which provide important benefits 
to investors and to others who use market information, while amending 
other parts of the current rules that have resulted in serious economic 
and regulatory distortions. More specifically, the Commission 
reproposes to amend Rules 11Aa3-1 and 11Ac1-2 (proposed to be 
redesignated as Rules 601 and 603) to lift certain restrictions in 
order to reduce the burden on and to provide simplification and 
uniformity for those market centers, broker-dealers, and data vendors 
that have to comply with requirements under the Rules.
b. Objectives
    The reproposed amendments to Rules 11Aa3-1 and 11Ac1-2 (proposed to 
be redesignated as Rules 601 and 603) are designed to fulfill several 
objectives. First, the reproposed amendment to Rule 11Aa3-1 (proposed 
to be redesignated as Rule 601) is intended to provide market centers, 
including ATSs and market makers, with flexibility to independently 
distribute their own trade reports, aside from their obligation to 
provide their trade reports to an SRO or to the Networks (depending on 
the type of market center). Second, a prime objective of the reproposed 
amendments to Rule 11Ac1-2 (proposed to be redesignated as Rule 603) is 
to provide uniform standards for all market centers, including non-SRO 
market centers and entities that are exclusive processors of SRO market 
data, for the independent distribution of market data. Third, the 
objective of the reproposed amendment to Rule 11Ac1-2 (proposed to be 
redesignated as Rule 603) providing that all SROs act jointly through 
the Plans and disseminate their consolidated information through a 
single processor is to clarify the current practice among the SROs and 
to require continued participation in the Plans and dissemination 
through one processor per security. Fourth, an additional objective of 
the reproposed amendments to Rule 11Ac1-2 (proposed to be redesignated 
as Rule 603) is to reduce consolidated display requirements on broker-
dealers and vendors and to limit their consolidated display obligations 
to the disclosure of the NBBO and consolidated last sale information, 
and to the display of market information in a trading or order-routing 
context. Finally, the reproposed amendments to Rule 11Ac1-2 (proposed 
to be redesignated as Rule 603) are intended to ease the burden of 
compliance by simplifying the current consolidated display requirements 
under the Rule and by rescinding old provisions in the Rule that are 
outdated and no longer necessary.
c. Legal Basis
    The Commission reproposes amendments to Rules 11Aa3-1 and 11Ac1-2 
(proposed to be redesignated as Rules 601 and 603) pursuant to its 
authority set forth in Sections 2, 3(b), 5, 6, 11A, 15, 15A, 17(a), 19, 
23(a), and 36 of the Exchange Act, and Rules 11Aa3-2(b)(2) and 11Aa3-
2(c)(1) thereunder.\563\
---------------------------------------------------------------------------

    \563\ 15 U.S.C. 78b, 78c(b), 78e, 78f, 78k-1, 78o, 78o-3, 
78q(a), 78s; 78w(a), and 78mm; 17 CFR 240.11Aa3-2(b)(2) and 17 CFR 
240.11Aa3-2(c)(1).
---------------------------------------------------------------------------

d. Small Entities Subject to the Rule
    The reproposed amendments to Rules 11Aa3-1 and 11Ac1-2 (proposed to 
be redesignated as Rules 601 and 603) would affect ATSs, market makers, 
broker-dealers, and SIPs that could potentially be small entities. 
Paragraph (c) of Rule 0-10 under the Exchange Act \564\ defines the 
term ``small business'' or ``small organization,'' when referring to a 
broker-dealer, to mean a broker or dealer that had total capital of 
less than $500,000 on the date in the prior fiscal year as of which its

[[Page 77496]]

audited financial statements were prepared, or if not required to file 
such statements, it had total capital of less than $500,000 on the last 
business day of the preceding fiscal year; and is not affiliated with 
any person (other than a natural person) that is not a small business 
or small organization. ATSs and market makers would be considered 
broker-dealers for purposes of this definition. Paragraph (g) of Rule 
0-10\565\ defines the term ``small business'' or ``small 
organization,'' when referring to a SIP, to mean a SIP that had gross 
revenues of less than $10 million during the preceding fiscal year and 
provided service to fewer than 100 interrogation devices or moving 
tickers at all times during the preceding fiscal year; and is not 
affiliated with any person (other than a natural person) that is not a 
small business or small organization.
---------------------------------------------------------------------------

    \564\ 17 CFR 240.0-10(c).
    \565\ 17 CFR 240.0-10(g).
---------------------------------------------------------------------------

    As of December 31, 2003, the Commission estimates that there are 
approximately 905 registered broker-dealers, including ATSs and market 
makers, that would be considered small entities. In addition, 
approximately 16 SIPs would be considered small entities. The 
Commission's reproposed amendment to Rule 11Aa3-1 (proposed to be 
redesignated as Rule 601) would enable small market centers, including 
ATSs and market makers, that contribute to consolidated information, if 
they so choose, to also independently distribute their own trade 
reports. The Commission's reproposed amendments to Rule 11Ac1-2 
(proposed to be redesignated as Rule 603) would reduce the compliance 
burden on small broker-dealers and SIPs by limiting the data required 
to be consolidated and displayed under the rule.\566\
---------------------------------------------------------------------------

    \566\ The reproposed amendment to Rule 11Ac1-2 (proposed to be 
redesignated as Rule 603), providing that all SROs act jointly 
through the Plans and disseminate their consolidated information 
through a single processor would only apply to the SROs, which are 
not ``small entities'' for purposes of the Regulatory Flexibility 
Act.
---------------------------------------------------------------------------

    The Commission requests comment on the number of small entities 
that would be impacted by the reproposed amendments, including any 
available empirical data.
e. Reporting, Recordkeeping and Other Compliance Requirements
    The reproposed amendments to Rules 11Aa3-1 and 11Ac1-2 (proposed to 
be redesignated as Rules 601 and 603) would not impose any new 
reporting, recordkeeping or other compliance requirements on ATSs, 
market makers, broker-dealers, and SIPs that are small entities. SROs 
that would be subject to these reproposed amendments would not be 
considered small entities.
f. Duplicative, Overlapping or Conflicting Federal Rules
    The Commission believes that there are no rules that duplicate, 
overlap or conflict with the reproposed amendments to Rules 11Aa3-1 and 
11Ac1-2 (proposed to be redesignated as Rules 601 and 603).
g. Significant Alternatives
    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant adverse impact on small entities. In 
connection with the reproposed amendments, the Commission has 
considered the following alternative models for disseminating market 
data to the public: (1) A competing consolidators model under which 
each SRO would be allowed to sell its market data separately to any 
number of consolidators; (2) a rescission of the consolidated display 
requirement and allowing all SROs and other market centers to 
distribute their market data individually; and (3) a hybrid model that 
would retain the consolidated display requirement and existing Networks 
solely for the dissemination of the NBBO, but allow the SROs to 
distribute their own quotations and trades independently and without a 
consolidated display requirement. These alternative models were all 
intended to introduce more competition in the marketplace and greater 
flexibility in market data dissemination.
    The primary goal of the reproposed amendments to Rules 11Aa3-1 and 
11Ac1-2 (proposed to be redesignated as Rules 601 and 603) is to retain 
the benefits of the consolidated display requirement, which provides a 
uniform, consolidated stream of data and is the single most important 
tool for unifying all of the market centers trading NMS Stocks, while 
providing market centers that contribute to consolidated information 
with the ability to independently distribute their own market data and 
reducing the consolidated display requirements on broker-dealers and 
SIPs. The Commission preliminarily believes that these potential 
alternative models pose an unacceptable risk of losing important 
benefits that investors and other information users receive under the 
current system--an affordable and highly reliable stream of quotations 
and trades that is consolidated from all significant market centers 
trading an NMS Stock. The Commission also does not believe that it is 
necessary to consider whether small entities should be permitted to use 
performance rather than design standards to comply with the proposed 
amendments as the amendments already propose performance standards and 
do not dictate for entities of any size any particular design standards 
(e.g., technology) that must be employed to achieve the objectives of 
the proposed amendments.
h. Solicitation of Comments
    The Commission encourages comments with respect to any aspect of 
this IRFA. In particular, the Commission requests comments regarding: 
(1) The number of small entities that may be affected by the reproposed 
amendments; (2) the existence or nature of the potential impact of the 
reproposed amendments on small entities discussed in the analysis; and 
(3) how to quantify the impact of the reproposed amendments. Commenters 
are asked to describe the nature of any impact and provide empirical 
data supporting the extent of the impact. Such comments will be 
considered in the preparation of the Final Regulatory Flexibility 
Analysis, if the proposals are adopted, and will be placed in the same 
public file as comments on the reproposed amendments themselves.

E. Regulation NMS

    Pursuant to 5 U.S.C. 605(b), the Commission certified in the 
Proposing Release that proposed Rule 600 and the redesignation of the 
NMS rules as Regulation NMS would not have a significant economic 
impact on a substantial number of small entities.\567\ The Commission 
received no comments regarding this certification. The Commission 
renews its request for comment on the certification, which is set forth 
below.
---------------------------------------------------------------------------

    \567\ Proposing Release, 69 FR at 11198.
---------------------------------------------------------------------------

    The Commission hereby certifies, pursuant to 5 U.S.C. 605(b), that 
reproposed Rule 600 and the related reproposed amendments, if adopted, 
would not have a significant economic impact on a substantial number of 
small entities. Reproposed Rule 600 would revise and clarify the 
definitions used in proposed Regulation NMS, thereby facilitating 
compliance with proposed Regulation NMS and potentially easing the 
compliance burden on entities seeking to comply with the regulation. 
Neither reproposed Rule 600 nor the related reproposed amendments of 
the NMS rules would alter the existing requirements of the NMS rules. 
Accordingly, the Commission does not

[[Page 77497]]

believe that reproposed Rule 600 and the re-designation of the NMS 
rules as proposed Regulation NMS would have a significant impact on a 
substantial number of small entities.

XIII. Statutory Authority

    Pursuant to the Exchange Act and particularly, Sections 2, 3(b), 5, 
6, 11A, 15, 15A, 17(a) and (b), 19, 23(a), and 36 thereof, 15 U.S.C. 
78b, 78c(b), 78e, 78f, 78k-1, 78o, 78o-3, 78q(a) and (b), 78s; 78w(a), 
and 78mm, and Rules 11Aa3-2(b)(2) and 11Aa3-2(c)(1) thereunder, 17 CFR 
240.11Aa3-2(b)(2) and 17 CFR 240.11Aa3-2(c)(1), the Commission proposes 
to: (1) Redesignate the NMS rules under Section 11A of the Exchange Act 
as Regulation NMS rules; (2) adopt Rules 600, 610, 611, and 612 of 
Regulation NMS; (3) amend current Rules 11Aa3-1 and 11Ac1-2 under the 
Exchange Act and redesignate them as Rules 601 and 603 of Regulation 
NMS; (4) amend the CTA Plan, the CQ Plan, and the Nasdaq UTP Plan; and 
(5) amend various other rules to reflect the adoption of Regulation 
NMS, as set forth below.

XIV. Text of Proposed Amendments to the CTA Plan, the CQ Plan, and the 
Nasdaq UTP Plan

    The Commission hereby proposes to amend the CTA Plan, the CQ Plan, 
and the Nasdaq UTP Plan to incorporate the new net income allocation 
formula into each Plan, which would supersede the existing allocation 
formulas in those Plans, and to incorporate the new Plan governance 
language into each Plan.
    Set forth below is the text of (1) the proposed new allocation 
formula to be incorporated into each of the Plans, and (2) the proposed 
new Plan governance language to be incorporated into each of the Plans.

Formula Amendment

    () Allocation of Net Income.
    (a) Annual Payment. Notwithstanding any other provision of this 
Plan, each Participant eligible to receive distributable net income 
under the Plan shall receive an annual payment for each calendar year 
that is equal to the sum of the Participant's Trading Shares and 
Quoting Shares, as defined below, in each Eligible Security for the 
calendar year.
    (b) Security Income Allocation. The Security Income Allocation for 
an Eligible Security shall be determined by multiplying (i) the 
distributable net income of the Plan for the calendar year by (ii) the 
Volume Percentage for such Eligible Security. The Volume Percentage for 
an Eligible Security shall be determined by dividing (i) the square 
root of the dollar volume of transaction reports disseminated by the 
Processor in such Eligible Security during the calendar year divided by 
(ii) the sum of the square roots of the dollar volume of transaction 
reports disseminated by the Processor in each Eligible Security during 
the calendar year.
    (c) Trading Share. The Trading Share of a Participant in an 
Eligible Security shall be determined by multiplying (i) an amount 
equal to the lesser of (A) fifty percent of the Security Income 
Allocation for the Eligible Security or (B) an amount equal to $2.00 
multiplied by the total number of qualified transaction reports 
disseminated by the Processor in the Eligible Security during the 
calendar year, by (ii) the Participant's Trade Rating in the Eligible 
Security. A Participant's Trade Rating in an Eligible Security shall be 
determined by taking the average of (i) the Participant's percentage of 
the total dollar volume of transaction reports disseminated by the 
Processor in the Eligible Security during the calendar year, and (ii) 
the Participant's percentage of the total number of qualified 
transaction reports disseminated by the Processor in the Eligible 
Security during the calendar year. A transaction report with a dollar 
volume of $5000 or more shall constitute one qualified transaction 
report. A transaction report with a dollar volume of less than $5000 
shall constitute a fraction of a qualified transaction report that 
equals the dollar volume of the transaction report divided by $5000.
    (d) Quoting Share. The Quoting Share of a Participant in an 
Eligible Security shall be determined by multiplying (i) an amount 
equal to fifty percent of the Security Income Allocation for the 
Eligible Security, plus the difference, if greater than zero, between 
fifty percent of the Security Income Allocation for the Eligible 
Security and an amount equal to $2.00 multiplied by the total number of 
qualified transaction reports disseminated by the Processor in the 
Eligible Security during the calendar year, by (ii) the Participant's 
Quote Rating in the Eligible Security. A Participant's Quote Rating in 
an Eligible Security shall be determined by dividing (i) the sum of the 
Quote Credits earned by the Participant in such Eligible Security 
during the calendar year by (ii) the sum of the Quote Credits earned by 
all Participants in such Eligible Security during the calendar year. A 
Participant shall earn one Quote Credit for each second of time 
multiplied by dollar value of size that a firm automated bid (offer) 
transmitted by the Participant to the Processor during regular trading 
hours is equal to the price of the national best bid (offer) in the 
Eligible Security. An automated bid (offer) shall have the meaning 
specified in Rule 600 of Regulation NMS of the Exchange Act for an 
``automated quotation.'' The dollar value of size of a quote shall be 
determined by multiplying the price of a quote by its size.

Governance Amendment

    () Advisory Committee.
    (a) Formation. Notwithstanding any other provision of this Plan, an 
Advisory Committee to the Plan shall be formed and shall function in 
accordance with the provisions set forth in this section.
    (a) Composition. Members of the Advisory Committee shall be 
selected for two-year terms as follows:
    (1) Operating Committee Selections. By affirmative vote of a 
majority of the Participants entitled to vote, the Operating Committee 
shall select at least one representative from each of the following 
categories to be members of the Advisory Committee: (i) A broker-dealer 
with a substantial retail investor customer base, (ii) a broker-dealer 
with a substantial institutional investor customer base, (iii) an 
alternative trading system, (iv) a data vendor, and (v) an investor.
    (2) Participant Selections. Each Participant shall have the right 
to select one member of the Advisory Committee. A Participant shall not 
select any person employed by or affiliated with any Participant or its 
affiliates or facilities.
    (c) Function. Members of the Advisory Committee shall have the 
right to submit their views to the Operating Committee on Plan matters, 
prior to a decision by the Operating Committee on such matters. Such 
matters shall include, but not be limited to, any new or modified 
product, fee, contract, or pilot program that is offered or used 
pursuant to the Plan.
    (d) Meetings and Information. Members of the Advisory Committee 
shall have the right to attend all meetings of the Operating Committee 
and to receive any information concerning Plan matters that is 
distributed to the Operating Committee; provided, however, that the 
Operating Committee may meet in executive session if, by affirmative 
vote of a majority of the Participants entitled to vote, the Operating 
Committee determines that an item of Plan business requires 
confidential treatment.

[[Page 77498]]

XV. Text of Reproposed Rules

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations 
(Government agencies), Organization and functions (Government 
agencies).

17 CFR Part 201

    Administrative practice and procedure, Securities.

17 CFR Parts 230 and 270

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 240, 242, and 249

    Brokers, Reporting and recordkeeping requirements, Securities.

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of the Federal Regulations is proposed to be amended as 
follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND 
REQUESTS

    1. The general authority citation for part 200 is revised to read 
as follows:

    Authority: 15 U.S.C. 77s, 78d, 78d-1, 78d-2, 78w, 78ll(d), 78mm, 
79t, 77sss, 80a-37, 80b-11 and 7202 unless otherwise noted.
* * * * *
    2. Section 200.30-3 is amended by:
    a. Removing paragraphs (a)(62) and (a)(71);
    b. Redesignating paragraphs (a)(63) through (a)(82) as paragraphs 
(a)(62) through (a)(80);
    c. Revising paragraphs (a)(27), (a)(28), (a)(36), (a)(37), (a)(42), 
(a)(49), (a)(61), and newly redesignated paragraphs (a)(68), and 
(a)(69); and
    d. Adding new paragraphs (a)(81), (a)(82), and (a)(83).
    The revisions and additions read as follows:


Sec.  200.30-3  Delegation of authority to Director of Division of 
Market Regulation.

* * * * *
    (a) * * *
    (27) To approve amendments to the joint industry plan governing 
consolidated transaction reporting declared effective by the Commission 
pursuant to Rule 601 (17 CFR 242.601) or its predecessors, Rule 11Aa3-1 
and Rule 17a-15, and to grant exemptions from Rule 601 pursuant to Rule 
601(f) (17 CFR 242.601(f)) to exchanges trading listed securities that 
are designated as national market system securities until such times as 
a Joint Reporting Plan for such securities is filed and approved by the 
Commission.
    (28) To grant exemptions from Rule 602 (17 CFR 242.602), pursuant 
to Rule 602(d) (17 CFR 242.602(d)).
* * * * *
    (36) To grant exemptions from Rule 603 (17 CFR 242.603), pursuant 
to Rule 603(d) (17 CFR 242.603(d)).
    (37) Pursuant to Rule 600 (17 CFR 242.600), to publish notice of 
the filing of a designation plan with respect to national market system 
securities, or any proposed amendment thereto, and to approve such plan 
or amendment.
* * * * *
    (42) Under 17 CFR 242.608(e), to grant or deny exemptions from 17 
CFR 242.608.
* * * * *
    (49) Pursuant to section 11A(b) of the Act (15 U.S.C. 78k-1(b)) and 
Rule 609 thereunder (17 CFR 242.609), to publish notice of and, by 
order, grant under section 11A(b) of the Act and Rule 609 thereunder: 
Applications for registration as a securities information processor; 
and exemptions from that section and any rules or regulations 
promulgated thereunder, either conditionally or unconditionally.
* * * * *
    (61) To grant exemptions from Rule 604 (17 CFR 242.604), pursuant 
to Rule 604(c) (17 CFR 242.604(c)).
* * * * *
    (68) Pursuant to Rule 605(b) (17 CFR 242.605(b)), to grant or deny 
exemptions, conditionally or unconditionally, from any provision or 
provisions of Rule 605 (17 CFR 242.605).
    (69) Pursuant to Rule 606(c) (17 CFR 242.606(c)), to grant or deny 
exemptions, conditionally or unconditionally, from any provision or 
provisions of Rule 606 (17 CFR 242.606).
* * * * *
    (81) To grant or deny exemptions from Rule 610 (17 CFR 242.610), 
pursuant to Rule 610(e) (17 CFR 242.610(e)).
    (82) To grant or deny exemptions from Rule 611 (17 CFR 242.611), 
pursuant to Rule 611(d) (17 CFR 242.611(d)).
    (83) To grant or deny exemptions from Rule 612 (17 CFR 242.612), 
pursuant to Rule 612(c) (17 CFR 242.612(c)).

Subpart N--Commission Information Collection Requirements Under the 
Paperwork Reduction Act: OMB Control Numbers

    3. The authority citation for Subpart N continues to read as 
follows:

    Authority: 44 U.S.C. 3506; 44 U.S.C. 3507.

    4. Section 200.800 is amended by revising paragraph (b) to read as 
follows:


Sec.  200.800  OMB control numbers assigned pursuant to the Paperwork 
Reduction Act.

    (a) * * *
    (b) Display.

------------------------------------------------------------------------
                                       17 CFR part or
                                        section where       Current OMB
Information collection requirement     identified and       Control No.
                                          described
------------------------------------------------------------------------
Regulation S-X....................  Part 210............       3235-0009
Regulation S-B....................  Part 228............       3235-0417
Regulation S-K....................  Part 229............       3235-0071
Rule 154..........................  230.154.............       3235-0495
Rule 155..........................  230.155.............       3235-0549
Rule 236..........................  230.236.............       3235-0095
Rule 237..........................  230.237.............       3235-0528
Regulation A......................  230.251 thru 230.263       3235-0286
Regulation C......................  230.400 thru 230.494       3235-0074
Rule 425..........................  230.425.............       3235-0521
Rule 477..........................  230.477.............       3235-0550
Rule 489..........................  230.489.............       3235-0411
Rule 498..........................  230.498.............       3235-0488
Regulation D......................  230.501 thru 230.506       3235-0076
Regulation E......................  230.601 thru               3235-0232
                                     230.610a.
Rule 604..........................  230.604.............       3235-0232
Rule 605..........................  230.605.............       3235-0232
Rule 609..........................  230.609.............       3235-0233
Rule 701..........................  230.701.............       3235-0522

[[Page 77499]]

 
Regulation S......................  230.901 thru 230.905       3235-0357
Regulation S-T....................  Part 232............       3235-0424
Form SB-1.........................  239.9...............       3235-0423
Form SB-2.........................  239.10..............       3235-0418
Form S-1..........................  239.11..............       3235-0065
Form S-2..........................  239.12..............       3235-0072
Form S-3..........................  239.13..............       3235-0073
Form N-2..........................  239.14..............       3235-0026
Form N-1A.........................  239.15A.............       3235-0307
Form S-6..........................  239.16..............       3235-0184
Form S-8..........................  239.16b.............       3235-0066
Form N-3..........................  239.17a.............       3235-0316
Form N-4..........................  239.17b.............       3235-0318
Form S-11.........................  239.18..............       3235-0067
Form N-14.........................  239.23..............       3235-0336
Form N-5..........................  239.24..............       3235-0169
Form S-4..........................  239.25..............       3235-0324
Form F-1..........................  239.31..............       3235-0258
Form F-2..........................  239.32..............       3235-0257
Form F-3..........................  239.33..............       3235-0256
Form F-4..........................  239.34..............       3235-0325
Form F-6..........................  239.36..............       3235-0292
Form F-7..........................  239.37..............       3235-0383
Form F-8..........................  239.38..............       3235-0378
Form F-9..........................  239.39..............       3235-0377
Form F-10.........................  239.40..............       3235-0380
Form F-80.........................  239.41..............       3235-0404
Form F-X..........................  239.42..............       3235-0379
Form F-N..........................  239.43..............       3235-0411
Form ET...........................  239.62..............       3235-0329
Form ID...........................  239.63..............       3235-0328
Form SE...........................  239.64..............       3235-0327
Form TH...........................  239.65..............       3235-0425
Form 1-A..........................  239.90..............       3235-0286
Form 2-A..........................  239.91..............       3235-0286
Form 144..........................  239.144.............       3235-0101
Form 1-E..........................  239.200.............       3235-0232
Form CB...........................  239.800.............       3235-0518
Rule 6a-1.........................  240.6a-1............       3235-0017
Rule 6a-3.........................  240.6a-3............       3235-0021
Rule 6a-4.........................  240.6a-4............       3235-0554
Rule 6h-1.........................  240.6h-1............       3235-0555
Rule 8c-1.........................  240.8c-1............       3235-0514
Rule 9b-1.........................  240.9b-1............       3235-0480
Rule 10a-1........................  240.10a-1...........       3235-0475
Rule 10b-10.......................  240.10b-10..........       3235-0444
Rule 10b-17.......................  240.10b-17..........       3235-0476
Rule 10b-18.......................  240.10b-18..........       3235-0474
Rule 10A-1........................  240.10A-1...........       3235-0468
Rule 11a1-1(T)....................  240.11a1-1(T).......       3235-0478
Rule 12a-5........................  240.12a-5...........       3235-0079
Regulation 12B....................  240.12b-1 thru             3235-0062
                                     240.12b-36.
Rule 12d1-3.......................  240.12d1-3..........       3235-0109
Rule 12d2-1.......................  240.12d2-1..........       3235-0081
Rule 12d2-2.......................  240.12d2-2..........       3235-0080
Rule 12f-1........................  240.12f-1...........       3235-0128
Rule 13a-16.......................  240.13a-16..........       3235-0116
Regulation 13D/G..................  240.13d-1 thru             3235-0145
                                     240.13d-7.
Schedule 13D......................  240.13d-101.........       3235-0145
Schedule 13G......................  240.13d-102.........       3235-0145
Rule 13e-1........................  240.13e-1...........       3235-0305
Rule 13e-3........................  240.13e-3...........       3235-0007
Schedule 13E-3....................  240.13e-100.........       3235-0007
Schedule 13e-4F...................  240.13e-101.........       3235-0375
Regulation 14A....................  240.14a-1 thru             3235-0059
                                     240.14a-12.
Schedule 14A......................  240.14a-101.........       3235-0059
Regulation 14C....................  240.14c-1...........       3235-0057
Schedule 14C......................  240.14c-101.........       3235-0057
Regulation 14D....................  240.14d-1 thru             3235-0102
                                     240.14d-9.
Schedule TO.......................  240.14d-100.........       3235-0515
Schedule 14D-1....................  240.14d-101.........       3235-0102
Schedule 14D-9....................  240.14d-101.........       3235-0102
Schedule 14D-1F...................  240.14d-102.........       3235-0376

[[Page 77500]]

 
Schedule 14D-9F...................  240.14d-103.........       3235-0382
Regulation 14E....................  240.14e-1 thru             3235-0102
                                     240.14e-2.
Rule 14f-1........................  240.14f-1...........       3235-0108
Rule 15a-4........................  240.15a-4...........       3235-0010
Rule 15a-6........................  240.15a-6...........       3235-0371
Rule 15b1-1.......................  240.15b1-1..........       3235-0012
Rule 15b6-1(a)....................  240.15b6-1(a).......       3235-0018
Rule 15c1-5.......................  240.15c1-5..........       3235-0471
Rule 15c1-6.......................  240.15c1-6..........       3235-0472
Rule 15c1-7.......................  240.15c1-7..........       3235-0134
Rule 15c2-1.......................  240.15c2-1..........       3235-0485
Rule 15c2-5.......................  240.15c2-5..........       3235-0198
Rule 15c2-7.......................  240.15c2-7..........       3235-0479
Rule 15c2-8.......................  240.15c2-8..........       3235-0481
Rule 15c2-11......................  240.15c2-11.........       3235-0202
Rule 15c2-12......................  240.15c2-12.........       3235-0372
Rule 15c3-1.......................  240.15c3-1..........       3235-0200
Rule 15c3-1(c)(13)................  240.15c3-1(c)(13)...       3235-0499
Appendix F to Rule 15c3-1.........  240.15c3-1f.........       3235-0496
Rule 15c3-3.......................  240.15c3-3..........       3235-0078
Rule 15c3-4.......................  240.15c3-4..........       3235-0497
Rule 15d-16.......................  240.15d-16..........       3235-0116
Rule 15g-2........................  240.15g-2...........       3235-0434
Rule 15g-3........................  240.15g-3...........       3235-0392
Rule 15g-4........................  240.15g-4...........       3235-0393
Rule 15g-5........................  240.15g-5...........       3235-0394
Rule 15g-6........................  240.15g-6...........       3235-0395
Rule 15g-9........................  240.15g-9...........       3235-0385
Rule 15Aj-1.......................  240.15Aj-1..........       3235-0044
Rule 15Ba2-1......................  240.15Ba2-1.........       3235-0083
Rule 15Ba2-5......................  240.15Ba2-5.........       3235-0088
Rule 15Bc3-1......................  240.15Bc3-1.........       3235-0087
Rule 17a-1........................  240.17a-1...........       3235-0208
Rule 17a-2........................  240.17a-2...........       3235-0201
Rule 17a-3........................  240.17a-3...........       3235-0033
Rule 17a-3(a)(16).................  240.17a-3(a)(16)....       3235-0508
Rule 17a-4........................  240.17a-4...........       3235-0279
Rule 17a-4(b)(10).................  240.17a-4(b)(10)....       3235-0506
Rule 17a-5........................  240.17a-5...........       3235-0123
Rule 17a-5(c).....................  240.17a-5(c)........       3235-0199
Rule 17a-6........................  240.17a-6...........       3235-0489
Rule 17a-7........................  240.17a-7...........       3235-0131
Rule 17a-8........................  240.17a-8...........       3235-0092
Rule 17a-9T.......................  240.17a-9T..........       3235-0524
Rule 17a-10.......................  240.17a-10..........       3235-0122
Rule 17a-11.......................  240.17a-11..........       3235-0085
Rule 17a-12.......................  240.17a-12..........       3235-0498
Rule 17a-13.......................  240.17a-13..........       3235-0035
Rule 17a-19.......................  240.17a-19..........       3235-0133
Rule 17a-22.......................  240.17a-22..........       3235-0196
Rule 17a-25.......................  240.17a-25..........       3235-0540
Rule 17f-1(b).....................  240.17f-1(b)........       3235-0032
Rule 17f-1(c).....................  240.17f-1(c)........       3235-0037
Rule 17f-1(g).....................  240.17f-1(g)........       3235-0290
Rule 17f-2(a).....................  240.17f-2(a)........       3235-0034
Rule 17f-2(c).....................  240.17f-2(c)........       3235-0029
Rule 17f-2(d).....................  240.17f-2(d)........       3235-0028
Rule 17f-2(e).....................  240.17f-2(e)........       3235-0031
Rule 17f-5........................  240.17f-5...........       3235-0269
Rule 17h-1T.......................  240.17h-1T..........       3235-0410
Rule 17h-2T.......................  240.17h-2T..........       3235-0410
Rule 17Ab2-1......................  240.17Ab2-1(a)......       3235-0195
Rule 17Ac2-1......................  240.17Ac2-1.........       3235-0084
Rule 17Ad-2(c), (d), and (h)......  240.17Ad-2(c), (d)         3235-0130
                                     and (h).
Rule 17Ad-3(b)....................  240.17Ad-3(b).......       3235-0473
Rule 17Ad-4(b) and (c)............  240.17Ad-4(b) and          3235-0341
                                     (c).
Rule 17Ad-6.......................  240.17Ad-6..........       3235-0291
Rule 17Ad-7.......................  240.17Ad-7..........       3235-0291
Rule 17Ad-10......................  240.17Ad-10.........       3235-0273
Rule 17Ad-11......................  240.17Ad-11.........       3235-0274
Rule 17Ad-13......................  240.17Ad-13.........       3235-0275
Rule 17Ad-15......................  240.17Ad-15.........       3235-0409
Rule 17Ad-16......................  240.17Ad-16.........       3235-0413

[[Page 77501]]

 
Rule 17Ad-17......................  240.17Ad-17.........       3235-0469
Rule 19b-1........................  240.19b-1...........       3235-0354
Rule 19b-4........................  240.19b-4...........       3235-0045
Rule 19b-4(e).....................  240.19b-4(e)........       3235-0504
Rule 19b-5........................  240.19b-5...........       3235-0507
Rule 19b-7........................  240.19b-7...........       3235-0553
Rule 19d-1........................  240.19d-1(b) thru          3235-0206
                                     240.19d-1(i).
Rule 19d-2........................  240.19d-2...........       3235-0205
Rule 19d-3........................  240.19d-3...........       3235-0204
Rule 19h-1........................  240.19h-1(a), (c)          3235-0259
                                     thru (e), and (g).
Rule 24b-1........................  240.24b-1...........       3235-0194
Rule 101..........................  242.101.............       3235-0464
Rule 102..........................  242.102.............       3235-0467
Rule 103..........................  242.103.............       3235-0466
Rule 104..........................  242.104.............       3235-0465
Rule 301..........................  242.301.............       3235-0509
Rule 302..........................  242.302.............       3235-0510
Rule 303..........................  242.303.............       3235-0505
Rule 604..........................  242.604.............       3235-0462
Rule 605..........................  242.605.............       3235-0542
Rule 606..........................  242.606.............       3235-0541
Rule 607..........................  242.607.............       3235-0435
Rule 608..........................  242.608.............       3235-0500
Rule 609..........................  242.609.............       3235-0043
Rule 611..........................  242.611.............       3235-0600
Regulation S-P....................  Part 248............       3235-0537
Form 1............................  249.1...............       3235-0017
Form 1-N..........................  249.10..............       3235-0554
Form 25...........................  249.25..............       3235-0080
Form 26...........................  249.26..............       3235-0079
Form 3............................  249.103.............       3235-0104
Form 4............................  249.104.............       3235-0287
Form 5............................  249.105.............       3235-0362
Form 8-A..........................  249.208a............       3235-0056
Form 10...........................  249.210.............       3235-0064
Form 10-SB........................  249.210b............       3235-0419
Form 18...........................  249.218.............       3235-0121
Form 20-F.........................  249.220f............       3235-0288
Form 40-F.........................  249.240f............       3235-0381
Form 6-K..........................  249.306.............       3235-0116
Form 8-K..........................  249.308.............       3235-0060
Form 10-Q.........................  249.308a............       3235-0070
Form 10-QSB.......................  249.308b............       3235-0416
Form 10-K.........................  249.310.............       3235-0063
Form 10-KSB.......................  249.310b............       3235-0420
Form 11-K.........................  249.311.............       3235-0082
Form 18-K.........................  249.318.............       3235-0120
Form 12B-25.......................  249.322.............       3235-0058
Form 15...........................  249.323.............       3235-0167
Form 13F..........................  249.325.............       3235-0006
Form SE...........................  249.444.............       3235-0327
Form ET...........................  249.445.............       3235-0329
Form ID...........................  249.446.............       3235-0328
Form DF...........................  249.448.............       3235-0482
Form BD...........................  249.501.............       3235-0012
Form BDW..........................  249.501a............       3235-0018
Form BD-N.........................  249.501b............       3235-0556
Form X-17A-5......................  249.617.............       3235-0123
Form X-17A-19.....................  249.635.............       3235-0133
Form ATS..........................  249.637.............       3235-0509
Form ATS-R........................  249.638.............       3235-0509
Form X-15AJ-1.....................  249.802.............       3235-0044
Form X-15AJ-2.....................  249.803.............       3235-0044
Form 19b-4........................  249.819.............       3235-0045
Form 19b-4(e).....................  249.820.............       3235-0504
Form Pilot........................  249.821.............       3235-0507
Form SIP..........................  249.1001............       3235-0043
Form MSD..........................  249.1100............       3235-0083
Form MSDW.........................  249.1110............       3235-0087
Form X-17F-1A.....................  249.1200............       3235-0037
Form TA-1.........................  249b.100............       3235-0084
Form TA-W.........................  249b.101............       3235-0151
Form TA-2.........................  249b.102............       3235-0337

[[Page 77502]]

 
Form CA-1.........................  249b.200............       3235-0195
Rule 1(a).........................  250.1(a)............       3235-0170
Rule 1(b).........................  250.1(b)............       3235-0170
Rule 1(c).........................  250.1(c)............       3235-0164
Rule 2............................  250.2...............       3235-0161
Rule 3............................  250.3...............       3235-0160
Rule 7............................  250.7...............       3235-0165
Rule 7(d).........................  250.7(d)............       3235-0165
Rule 20(b)........................  250.20(b)...........       3235-0125
Rule 20(c)........................  250.20(c)...........       3235-0125
Rule 20(d)........................  250.20(d)...........       3235-0163
Rule 23...........................  250.23..............       3235-0125
Rule 24...........................  250.24..............       3235-0126
Rule 26...........................  250.26..............       3235-0183
Rule 29...........................  250.29..............       3235-0149
Rule 44...........................  250.44..............       3235-0147
Rule 45...........................  250.45..............       3235-0154
Rule 47(b)........................  250.47(b)...........       3235-0163
Rule 52...........................  250.52..............       3235-0369
Form 53...........................  250.53..............       3235-0426
Rule 54...........................  250.54..............       3235-0427
Rule 57(a)........................  250.57(a)...........       3235-0428
Rule 57(b)........................  250.57(b)...........       3235-0429
Rule 58...........................  250.58..............       3235-0457
Rule 62...........................  250.62..............       3235-0152
Rule 71(a)........................  250.71(a)...........       3235-0173
Rule 72...........................  250.72..............       3235-0149
Rule 83...........................  250.83..............       3235-0181
Rule 87...........................  250.87..............       3235-0552
Rule 88...........................  250.88..............       3235-0182
Rule 93...........................  250.93..............       3235-0153
Rule 94...........................  250.94..............       3235-0153
Rule 95...........................  250.95..............       3235-0162
Rule 100(a).......................  250.100(a)..........       3235-0125
Uniform System of Accounts for      Part 256............       3235-0153
 Mutual Service Companies and
 Subsidiary Service Companies,
 Public Utility Holding Company
 Act of 1935.
Preservation and Destruction of     Part 257............       3235-0306
 Records of Registered Public
 Utility Holding Companies and of
 Mutual and Subsidiary Service
 Companies.
Form U5A..........................  259.5a..............       3235-0170
Form U5B..........................  259.5b..............       3235-0170
Form U5S..........................  259.5s..............       3235-0164
Form U-1..........................  259.101.............       3235-0125
Form U-13-1.......................  259.113.............       3235-0182
Form U-6B-2.......................  259.206.............       3235-0163
Form U-57.........................  259.207.............       3235-0428
Form U-9C-3.......................  259.208.............       3235-0457
Form U-12(I)-A....................  259.212a............       3235-0173
Form U-12(I)-B....................  259.212b............       3235-0173
Form U-13E-1......................  259.213.............       3235-0162
Form U-R-1........................  259.221.............       3235-0152
Form U-13-60......................  259.313.............       3235-0153
Form U-3A-2.......................  259.402.............       3235-0161
Form U-3A3-1......................  259.403.............       3235-0160
Form U-7D.........................  259.404.............       3235-0165
Form U-33-S.......................  259.405.............       3235-0429
Form ET...........................  259.601.............       3235-0329
Form ID...........................  259.602.............       3235-0328
Form SE...........................  259.603.............       3235-0327
Rule 7a-15 thru 7a-37.............  260.7a-15 thru             3235-0132
                                     260.7a-37.
Form T-1..........................  269.1...............       3235-0110
Form T-2..........................  269.2...............       3235-0111
Form T-3..........................  269.3...............       3235-0105
Form T-4..........................  269.4...............       3235-0107
Form ET...........................  269.6...............       3235-0329
Form ID...........................  269.7...............       3235-0328
Form SE...........................  269.8...............       3235-0327
Form T-6..........................  269.9...............       3235-0391
Rule 0-1..........................  270.0-1.............       3235-0531
Rule 2a-7.........................  270.2a-7............       3235-0268
Rule 2a19-1.......................  270.2a19-1..........       3235-0332
Rule 3a-4.........................  270.3a-4............       3235-0459
Rule 6c-7.........................  270.6c-7............       3235-0276
Rule 6e-2.........................  270.6e-2............       3235-0177

[[Page 77503]]

 
Rule 7d-1.........................  270.7d-1............       3235-0311
Rule 7d-2.........................  270.7d-2............       3235-0527
Section 8(b) of the Investment      270.8b-1 thru 270.8b-      3235-0176
 Company Act of 1940.                32.
Rule 10f-3........................  270.10f-3...........       3235-0226
Rule 11a-2........................  270.11a-2...........       3235-0272
Rule 11a-3........................  270.11a-3...........       3235-0358
Rule 12b-1........................  270-12b-1...........       3235-0212
Rule 17a-7........................  270.17a-7...........       3235-0214
Rule 17a-8........................  270.17a-8...........       3235-0235
Rule 17e-1........................  270.17e-1...........       3235-0217
Rule 17f-1........................  270.17f-1...........       3235-0222
Rule 17f-2........................  270.17f-2...........       3235-0223
Rule 17f-4........................  270.17f-4...........       3235-0225
Rule 17f-6........................  270.17f-6...........       3235-0447
Rule 17f-7........................  270-17f-7...........       3235-0529
Rule 17g-1(g).....................  270.17g-1(g)........       3235-0213
Rule 17j-1........................  270.17j-1...........       3235-0224
Rule 18f-1........................  270.18f-1...........       3235-0211
Rule 18f-3........................  270.18f-3...........       3235-0441
Rule 19a-1........................  270.19a-1...........       3235-0216
Rule 20a-1........................  270-20a-1...........       3235-0158
Rule 22d-1........................  270-22d-1...........       3235-0310
Rule 23c-1........................  270.23c-1...........       3235-0260
Rule 23c-3........................  270.23c-3...........       3235-0422
Rule 27e-1........................  270.27e-1...........       3235-0545
Rule 30b2-1.......................  270.30b2-1..........       3235-0220
Rule 30d-2........................  270.30d-2...........       3235-0494
Rule 30e-1........................  270.30e-1...........       3235-0025
Rule 31a-1........................  270.31a-1...........       3235-0178
Rule 31a-2........................  270.31a-2...........       3235-0179
Rule 32a-4........................  270.32a-4...........       3235-0530
Rule 34b-1........................  270.34b-1...........       3235-0346
Rule 35d-1........................  270-35d-1...........       3235-0548
Form N-5..........................  274.5...............       3235-0169
Form N-8A.........................  274.10..............       3235-0175
Form N-2..........................  274.11a-1...........       3235-0026
Form N-3..........................  274.11b.............       3235-0316
Form N-4..........................  274.11c.............       3235-0318
Form N-8B-2.......................  274.12..............       3235-0186
Form N-6F.........................  274.15..............       3235-0238
Form 24F-2........................  274.24..............       3235-0456
Form N-18F-1......................  274.51..............       3235-0211
Form N-54A........................  274.53..............       3235-0237
Form N-54C........................  274.54..............       3235-0236
Form N-SAR........................  274.101.............       3235-0330
Form N-27E-1......................  274.127e-1..........       3235-0545
Form N-27F-1......................  274.127f-1..........       3235-0546
Form N-17D-1......................  274.200.............       3235-0229
Form N-23C-1......................  274.201.............       3235-0230
Form N-8F.........................  274.218.............       3235-0157
Form N-17F-1......................  274.219.............       3235-0359
Form N-17F-2......................  274.220.............       3235-0360
Form N-23c-3......................  274.221.............       3235-0422
Form ET...........................  274.401.............       3235-0329
Form ID...........................  274.402.............       3235-0328
Form SE...........................  274.403.............       3235-0327
Rule 0-2..........................  275.0-2.............       3235-0240
Rule 203-3........................  275.203-3...........       3235-0538
Rule 204-2........................  275.204-2...........       3235-0278
Rule 204-3........................  275.204-3...........       3235-0047
Rule 206(3)-2.....................  275.206(3)-2........       3235-0243
Rule 206(4)-2.....................  275.206(4)-2........       3235-0241
Rule 206(4)-3.....................  275.206(4)-3........       3235-0242
Rule 206(4)-4.....................  275.206(4)-4........       3235-0345
Form ADV..........................  279.1...............       3235-0049
Schedule I to Form ADV............  279.1...............       3235-0490
Form ADV-W........................  279.2...............       3235-0313
Form ADV-H........................  379.3...............       3235-0538
Form 4-R..........................  279.4...............       3235-0240
Form 5-R..........................  279.5...............       3235-0240
Form 6-R..........................  279.6...............       3235-0240
Form 7-R..........................  279.7...............       3235-0240
Form ADV-E........................  279.8...............       3235-0361
------------------------------------------------------------------------


[[Page 77504]]

PART 201--RULES OF PRACTICE

    5. The authority citation for part 201 continues to read as 
follows:

    Authority: 15 U.S.C. 77s, 78w, 78x, 79t, 77sss, 80a-37 and 80b-
11; 5 U.S.C. 504(c)(1).

    6. Section 201.101 is amended by revising paragraphs (a)(9)(vi) and 
(a)(9)(vii) to read as follows:


Sec.  201.101  Definitions.

    (a) * * *
    (9) * * *
    (vi) By the filing, pursuant to Sec.  242.601 of this chapter, of 
an application for review of an action or failure to act in connection 
with the implementation or operation of any effective transaction 
reporting plan; or
    (vii) By the filing, pursuant to Sec.  242.608 of this chapter, of 
an application for review of an action taken or failure to act in 
connection with the implementation or operation of any effective 
national market system plan; or
* * * * *

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    7. The general authority citation for part 230 is revised to read 
as follows:

    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77s, 77z-3, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 
78mm, 79t, 77sss, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-37, 
unless otherwise noted.
* * * * *
    8. Section 230.144 is amended by:
    a. Removing the authority citation following Sec.  230.144; and
    b. Revising paragraph (e)(1)(iii).
    The revision reads as follows:


Sec.  230.144  Persons deemed not to be engaged in a distribution and 
therefore not underwriters.

* * * * *
    (e) * * *
    (1) * * *
    (iii) The average weekly volume of trading in such securities 
reported pursuant to an effective transaction reporting plan or an 
effective national market system plan as those terms are defined in 
Sec.  242.600 of this chapter during the four-week period specified in 
paragraph (e)(1)(ii) of this section.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    9. The general authority citation for part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 78c, 
78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 
78p, 78q, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 79q, 79t, 77eee, 77ggg, 
77nnn, 77sss, 77ttt, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *
    10. Section 240.0-10 is amended by revising paragraph (e)(1) to 
read as follows:


Sec.  240.0-10  Small entities under the Securities Exchange Act for 
purposes of the Regulatory Flexibility Act.

* * * * *
    (e) * * *
    (1) Has been exempted from the reporting requirements of Sec.  
242.601 of this chapter; and
* * * * *
    11. Section 240.3a51-1 is amended by revising the introductory text 
of paragraphs (a) and (e) to read as follows:


Sec.  240.3a51-1  Definition of ``penny stock''.

* * * * *
    (a) That is an NMS stock, as defined in Sec.  242.600 of this 
chapter:
* * * * *
    (e) That is registered, or approved for registration upon notice of 
issuance, on a national securities exchange that makes transaction 
reports available pursuant to Sec.  242.601 of this chapter, provided 
that:
* * * * *
    12. Section 240.3a55-1 is amended by revising paragraphs (a)(2)(ii) 
and (b)(2)(ii)(B) to read as follows:


Sec.  240.3a55-1  Method for determining market capitalization and 
dollar value of average daily trading volume; application of the 
definition of narrow-based security index.

    (a) * * *
    (2) * * *
    (ii) The 750 securities with the largest market capitalization 
shall be identified from the universe of all NMS securities, as defined 
in Sec.  242.600 of this chapter, that are common stock or depositary 
shares.
    (b) * * *
    (2) * * *
    (ii) * * *
    (B) The 675 securities with the largest dollar value of ADTV shall 
be identified from the universe of all NMS securities as defined in 
Sec.  242.600 of this chapter that are common stock or depositary 
shares.
* * * * *
    13. Section 240.3b-16 is amended by revising paragraph (d) to read 
as follows:


Sec.  240.3b-16  Definitions of terms used in Section 3(a)(1) of the 
Act.

* * * * *
    (d) For the purposes of this section, the terms bid and offer shall 
have the same meaning as under Sec.  242.600 of this chapter.
* * * * *
    14. Section 240.10a-1 is amended by revising paragraphs (a)(1), 
(e)(5)(ii) and (e)(11) to read as follows:


Sec.  240.10a-1  Short sales.

    (a)(1)(i) No person shall, for his own account or for the account 
of any other person, effect a short sale of any security registered on, 
or admitted to unlisted trading privileges on, a national securities 
exchange, if trades in such securities are reported pursuant to an 
``effective transaction reporting plan'' as defined in Sec.  242.600 of 
this chapter and information as to such trades is made available in 
accordance with such plan on a real-time basis to vendors of market 
transaction information:
    (A) Below the price at which the last sale thereof, regular way, 
was reported pursuant to an effective transaction reporting plan; or
    (B) At such price unless such price is above the next proceeding 
different price at which a sale of such security, regular way, was 
reported pursuant to an effective transaction reporting plan.
    (ii) The provisions of paragraph (a)(1)(i) of this section hereof 
shall not apply to transactions by any person in Nasdaq securities as 
defined in Sec.  242.600 of this chapter, except for those Nasdaq 
securities for which transaction reports are collected, processed, and 
made available pursuant to the plan originally submitted to the 
Commission pursuant to Sec.  240.17a-15 (subsequently amended and 
redesignated as Sec.  240.11Aa3-1 and subsequently redesignated as 
Sec.  242.601 of this chapter), which plan was declared effective as of 
May 17, 1974.
* * * * *
    (e) * * *
    (5) * * *
    (ii) Effected at a price equal to the most recent offer 
communicated for the security by such registered specialist, registered 
exchange market maker or third market maker to an exchange or a 
national securities association (``association'') pursuant to Sec.  
242.602 of this chapter, if such offer, when communicated, was equal to 
or above the last sale, regular way, reported for such security 
pursuant to an effective transaction reporting plan:
    Provided, however, That any exchange, by rule, may prohibit its 
registered specialist and registered exchange market makers from 
availing themselves of the exemption afforded by this paragraph (e)(5) 
if that exchange

[[Page 77505]]

determines that such action is necessary or appropriate in its market 
in the public interest or for the protection of investors;
* * * * *
    (11) Any sale of a security covered by paragraph (a) of this 
section (except a sale to a stabilizing bid complying with Sec.  
242.104 of this chapter) by any broker or dealer, for his own account 
or for the account of any other person, effected at a price equal to 
the most recent offer communicated by such broker or dealer to an 
exchange or association pursuant to Sec.  242.602 of this chapter in an 
amount less than or equal to the quotation size associated with such 
offer, if such offer, when communicated, was:
    (i) Above the price at which the last sale, regular way, for such 
security was reported pursuant to an effective transaction reporting 
plan; or
    (ii) At such last sale price, if such last sale price is above the 
next preceding different price at which a sale of such security, 
regular way, was reported pursuant to an effective transaction 
reporting plan.
* * * * *
    15. Section 240.10b-10 is amended by:
    a. Revising paragraphs (a)(2)(i)(C), (a)(2)(ii)(B) and (d)(7);
    b. Removing paragraph (d)(8); and
    c. Redesignating paragraphs (d)(9) and (d)(10) as paragraphs (d)(8) 
and (d)(9).
    The revisions read as follows:


Sec.  240.10b-10  Confirmation of transactions.

* * * * *
    (a) * * *
    (1) * * *
    (i) * * *
    (C) For a transaction in any NMS stock as defined in Sec.  242.600 
of this chapter or a security authorized for quotation on an automated 
interdealer quotation system that has the characteristics set forth in 
section 17B of the Act (15 U.S.C. 78q-2), a statement whether payment 
for order flow is received by the broker or dealer for transactions in 
such securities and the fact that the source and nature of the 
compensation received in connection with the particular transaction 
will be furnished upon written request of the customer; provided, 
however, that brokers or dealers that do not receive payment for order 
flow in connection with any transaction have no disclosure obligations 
under this paragraph; and
* * * * *
    (ii) * * *
    (B) In the case of any other transaction in an NMS stock as defined 
by Sec.  242.600 of this chapter, or an equity security that is traded 
on a national securities exchange and that is subject to last sale 
reporting, the reported trade price, the price to the customer in the 
transaction, and the difference, if any, between the reported trade 
price and the price to the customer.
* * * * *
    (d) * * *
    (7) NMS stock shall have the meaning provided in Sec.  242.600 of 
this chapter.
* * * * *
    16. Section 240.10b-18 is amended by revising paragraph (a)(6) to 
read as follows:


Sec.  240.10b-18  Purchases of certain equity securities by the issuer 
and others.

* * * * *
    (a) * * *
    (6) Consolidated system means a consolidated transaction or 
quotation reporting system that collects and publicly disseminates on a 
current and continuous basis transaction or quotation information in 
common equity securities pursuant to an effective transaction reporting 
plan or an effective national market system plan (as those terms are 
defined in Sec.  242.600 of this chapter).
* * * * *


Sec.  240.11Aa2-1 through 240.11Ac1-6  [Removed]

    17. The undesignated center heading preceding Sec.  240.11Aa2-1 and 
Sec. Sec.  240.11Aa2-1 through 240.11Ac1-6 are removed.
    18. Section 240.12a-7 is amended by revising the introductory text 
of paragraph (a)(2) to read as follows:


Sec.  240.12a-7  Exemption of stock contained in standardized market 
baskets from section 12(a) of the Act.

    (a) * * *
    (2) The stock is an NMS stock as defined in Sec.  242.600 of this 
chapter and is either:
* * * * *
    19. Section 240.12f-1 is amended by:
    a. Removing the authority citation following the section;
    b. Removing ``and'' at the end of paragraph (a)(3); and
    c. Revising paragraph (a)(4).
    The revision reads as follows:


Sec.  240.12f-1  Applications for permission to reinstate unlisted 
trading privileges.

    (a) * * *
    (4) Whether transaction information concerning such security is 
reported pursuant to an effective transaction reporting plan 
contemplated by Sec.  242.601 of this chapter;
* * * * *
    20. Section 240.12f-2 is amended by revising paragraph (a) to read 
as follows:


Sec.  240.12f-2  Extending unlisted trading privileges to a security 
that is the subject of an initial public offering.

    (a) General provision. A national securities exchange may extend 
unlisted trading privileges to a subject security when at least one 
transaction in the subject security has been effected on the national 
securities exchange upon which the security is listed and the 
transaction has been reported pursuant to an effective transaction 
reporting plan, as defined in Sec.  242.600 of this chapter.
* * * * *
    21. Section 240.15b9-1 is amended by:
    a. Removing the authority citation following the section; and
    b. Revising paragraph (c).
    The revision reads as follows:


Sec.  240.15b9-1  Exemption for certain exchange members.

* * * * *
    (c) For purposes of this section, the term Intermarket Trading 
System shall mean the intermarket communications linkage operated 
jointly by certain self-regulatory organizations pursuant to a plan 
filed with, and approved by, the Commission pursuant to Sec.  242.608 
of this chapter.
    22. Section 240.15c2-11 is amended by revising paragraph (f)(5) to 
read as follows:


Sec.  240.15c2-11  Initiation or resumption of quotations without 
specified information.

* * * * *
    (a) * * *
    (5) The publication or submission of a quotation respecting a 
Nasdaq security (as defined in Sec.  242.600 of this chapter), and such 
security's listing is not suspended, terminated, or prohibited.
* * * * *
    23. Section 240.19c-3 is amended by revising paragraph (b)(6) to 
read as follows:


Sec.  240.19c-3  Governing off-board trading by members of national 
securities exchanges.

* * * * *
    (b) * * *
    (6) The term effective transaction reporting plan shall mean any 
plan approved by the Commission pursuant to Sec.  242.601 of this 
chapter for collecting, processing, and making available transaction 
reports with respect to transactions in an equity security or class of 
equity securities.
    24. Section 240.19c-4 is amended by revising paragraph (e)(6) to 
read as follows:

[[Page 77506]]

Sec.  240.19c-4  Governing certain listing or authorization 
determinations by national securities exchanges and associations.

* * * * *
    (e) * * *
    (6) The term exchange shall mean a national securities exchange, 
registered as such with the Securities and Exchange Commission pursuant 
to section 6 of the Act (15 U.S.C. 78f), which makes transaction 
reports available pursuant to Sec.  242.601 of this chapter; and
* * * * *
    25. Section 240.31 is amended by revising paragraph (a)(11)(v) to 
read as follows:


Sec.  240.31  Section 31 transaction fees.

    (a) Definitions. For the purpose of this section, the following 
definitions shall apply:
* * * * *
    (11) * * *
    (v) Any sale of a security that is executed outside the United 
States and is not reported, or required to be reported, to a 
transaction reporting association as defined in Sec.  242.600 and any 
approved plan filed thereunder;
* * * * *

PART 242--REGULATIONS M, SHO, ATS, AC, AND NMS AND CUSTOMER MARGIN 
REQUIREMENTS FOR SECURITY FUTURES

    26. The authority citation for part 242 is revised to read as 
follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

    27. The part heading for part 242 is revised as set forth above.

    28. Section 242.100 is amended by revising the definition for 
``electronic communications network'' and ``Nasdaq'' found in paragraph 
(b) to read as follows:


Sec.  242.100  Preliminary note; definitions.

* * * * *
    (b) * * *
    Electronic communications network has the meaning provided in Sec.  
242.600.
* * * * *
    Nasdaq means the electronic dealer quotation system owned and 
operated by The Nasdaq Stock Market, Inc.
* * * * *
    29. Section 242.300 is amended by:
    a. Revising paragraphs (g) and (h);
    b. Removing paragraphs (i) and (j); and
    c. Redesignating paragraphs (k), (l), and (m) as paragraphs (i), 
(j), and (k).
    The revisions read as follows:


Sec.  242.300  Definitions.

* * * * *
    (g) NMS stock shall have the meaning provided in Sec.  242.600; 
provided, however, that a debt or convertible security shall not be 
deemed an NMS stock for purposes of this Regulation ATS.
    (h) Effective transaction reporting plan shall have the meaning 
provided in Sec.  242.600.
* * * * *
    30. Section 242.301 is amended by revising paragraphs (b)(3), 
(b)(5), and (b)(6) to read as follows:


Sec.  242.301  Requirements for alternative trading systems.

* * * * *
    (b) * * *
    (3) Order display and execution access.
    (i) An alternative trading system shall comply with the 
requirements set forth in paragraph (b)(3)(ii) of this section, with 
respect to any NMS stock in which the alternative trading system:
    (A) Displays subscriber orders to any person (other than 
alternative trading system employees); and
    (B) During at least 4 of the preceding 6 calendar months, had an 
average daily trading volume of 5 percent or more of the aggregate 
average daily share volume for such NMS stock as reported by an 
effective transaction reporting plan.
    (ii) Such alternative trading system shall provide to a national 
securities exchange or national securities association the prices and 
sizes of the orders at the highest buy price and the lowest sell price 
for such NMS stock, displayed to more than one person in the 
alternative trading system, for inclusion in the quotation data made 
available by the national securities exchange or national securities 
association to vendors pursuant to Sec.  242.602.
    (i) With respect to any order displayed pursuant to paragraph 
(b)(3)(ii) of this section, an alternative trading system shall provide 
to any broker-dealer that has access to the national securities 
exchange or national securities association to which the alternative 
trading system provides the prices and sizes of displayed orders 
pursuant to paragraph (b)(3)(ii) of this section, the ability to effect 
a transaction with such orders that is:
    (A) Equivalent to the ability of such broker-dealer to effect a 
transaction with other orders displayed on the exchange or by the 
association; and
    (B) At the price of the highest priced buy order or lowest priced 
sell order displayed for the lesser of the cumulative size of such 
priced orders entered therein at such price, or the size of the 
execution sought by such broker-dealer.
* * * * *
    (5) Fair access.
    (i) An alternative trading system shall comply with the 
requirements in paragraph (b)(5)(ii) of this section, if during at 
least 4 of the preceding 6 calendar months, such alternative trading 
system had:
    (A) With respect to any NMS stock, 5 percent or more of the average 
daily volume in that security reported by an effective transaction 
reporting plan;
    (B) With respect to an equity security that is not an NMS stock and 
for which transactions are reported to a self-regulatory organization, 
5 percent or more of the average daily trading volume in that security 
as calculated by the self-regulatory organization to which such 
transactions are reported;
    (C) With respect to municipal securities, 5 percent or more of the 
average daily volume traded in the United States;
    (D) With respect to investment grade corporate debt, 5 percent or 
more of the average daily volume traded in the United States; or
    (E) With respect to non-investment grade corporate debt, 5 percent 
or more of the average daily volume traded in the United States.
    (ii) An alternative trading system shall:
    (A) Establish written standards for granting access to trading on 
its system;
    (B) Not unreasonably prohibit or limit any person in respect to 
access to services offered by such alternative trading system by 
applying the standards established under paragraph (b)(5)(ii)(A) of 
this section in an unfair or discriminatory manner;
    (C) Make and keep records of:
    (1) All grants of access including, for all subscribers, the 
reasons for granting such access; and
    (2) All denials or limitations of access and reasons, for each 
applicant, for denying or limiting access; and
    (D) Report the information required on Form ATS-R (Sec.  249.638 of 
this chapter) regarding grants, denials, and limitations of access.
    (iii) Notwithstanding paragraph (b)(5)(i) of this section, an 
alternative trading system shall not be required to comply with the 
requirements in paragraph (b)(5)(ii) of this section, if such 
alternative trading system:
    (A) Matches customer orders for a security with other customer 
orders;
    (B) Such customers' orders are not displayed to any person, other 
than

[[Page 77507]]

employees of the alternative trading system; and
    (C) Such orders are executed at a price for such security 
disseminated by an effective transaction reporting plan, or derived 
from such prices.
    (6) Capacity, integrity, and security of automated systems.
    (i) The alternative trading system shall comply with the 
requirements in paragraph (b)(6)(ii) of this section, if during at 
least 4 of the preceding 6 calendar months, such alternative trading 
system had:
    (A) With respect to any NMS stock, 20 percent or more of the 
average daily volume reported by an effective transaction reporting 
plan;
    (B) With respect to equity securities that are not NMS stocks and 
for which transactions are reported to a self-regulatory organization, 
20 percent or more of the average daily volume as calculated by the 
self-regulatory organization to which such transactions are reported;
    (C) With respect to municipal securities, 20 percent or more of the 
average daily volume traded in the United States;
    (D) With respect to investment grade corporate debt, 20 percent or 
more of the average daily volume traded in the United States; or
    (E) With respect to non-investment grade corporate debt, 20 percent 
or more of the average daily volume traded in the United States.
    (i) With respect to those systems that support order entry, order 
routing, order execution, transaction reporting, and trade comparison, 
the alternative trading system shall:
    (A) Establish reasonable current and future capacity estimates;
    (B) Conduct periodic capacity stress tests of critical systems to 
determine such system's ability to process transactions in an accurate, 
timely, and efficient manner;
    (C) Develop and implement reasonable procedures to review and keep 
current its system development and testing methodology;
    (D) Review the vulnerability of its systems and data center 
computer operations to internal and external threats, physical hazards, 
and natural disasters;
    (E) Establish adequate contingency and disaster recovery plans;
    (F) On an annual basis, perform an independent review, in 
accordance with established audit procedures and standards, of such 
alternative trading system's controls for ensuring that paragraphs 
(b)(6)(ii)(A) through (E) of this section are met, and conduct a review 
by senior management of a report containing the recommendations and 
conclusions of the independent review; and
    (G) Promptly notify the Commission staff of material systems 
outages and significant systems changes.
    (iii) Notwithstanding paragraph (b)(6)(i) of this section, an 
alternative trading system shall not be required to comply with the 
requirements in paragraph (b)(6)(ii) of this section, if such 
alternative trading system:
    (A) Matches customer orders for a security with other customer 
orders;
    (B) Such customers' orders are not displayed to any person, other 
than employees of the alternative trading system; and
    (C) Such orders are executed at a price for such security 
disseminated by an effective transaction reporting plan, or derived 
from such prices.
* * * * *
    31. Part 242 is amended by adding Regulation NMS, Sec. Sec.  
242.600 through 242.612 to read as follows:
Sec.

Regulation NMS--Regulation of the National Market System

242.600 NMS security designation and definitions.
242.601 Dissemination of transaction reports and last sale data with 
respect to transactions in NMS stocks.
242.602 Dissemination of quotations in NMS securities.
242.603 Distribution, consolidation, and display of information with 
respect to quotations for and transactions in NMS stocks.
242.604 Display of customer limit orders.
242.605 Disclosure of order execution information.
242.606 Disclosure of order routing information.
242.607 Customer account statements.
242.608 Filing and amendment of national market system plans.
242.609 Registration of securities information processors: form of 
application and amendments.
242.610 Access to quotations.
242.611 Order protection rule.
242.612 Minimum pricing increment.

Regulation NMS--Regulation of the National Market System


Sec.  242.600  NMS security designation and definitions.

    (a) The term national market system security as used in section 
11A(a)(2) of the Act (15 U.S.C. 78k-1(a)(2)) shall mean any NMS 
security as defined in paragraph (b) of this section.
    (b) For purposes of Regulation NMS (Sec. Sec.  242.600 through 
242.612), the following definitions shall apply:
    (1) Aggregate quotation size means the sum of the quotation sizes 
of all responsible brokers or dealers who have communicated on any 
national securities exchange bids or offers for an NMS security at the 
same price.
    (2) Alternative trading system has the meaning provided in Sec.  
242.300(a).
    (3) Automated quotation means a quotation displayed by a trading 
center that:
    (i) Permits an incoming order to be marked as immediate-or-cancel;
    (ii) Immediately and automatically executes an order marked as 
immediate-or-cancel against the displayed quotation up to its full 
size;
    (iii) Immediately and automatically cancels any unexecuted portion 
of an order marked as immediate-or-cancel without routing the order 
elsewhere;
    (iv) Immediately and automatically transmits a response to the 
sender of an order marked as immediate-or-cancel indicating the action 
taken with respect to such order; and
    (v) Immediately and automatically displays information that updates 
the displayed quotation to reflect any change to its material terms.
    (4) Automated trading center means a trading center that:
    (i) Has implemented such systems and rules as are necessary to 
render it capable of displaying quotations that meet the requirements 
for an automated quotation set forth in paragraph (b)(3) of this 
section;
    (ii) Identifies all quotations other than automated quotations as 
manual quotations;
    (iii) Immediately identifies its quotations as manual quotations 
whenever it has reason to believe that it is not capable of displaying 
automated quotations; and
    (iv) Has adopted reasonable standards limiting when its quotations 
change from automated quotations to manual quotations, and vice versa, 
to specifically defined circumstances that promote fair and efficient 
access to its automated quotations and are consistent with the 
maintenance of fair and orderly markets.
    (5) Average effective spread means the share-weighted average of 
effective spreads for order executions calculated, for buy orders, as 
double the amount of difference between the execution price and the 
midpoint of the national best bid and national best offer at the time 
of order receipt and, for sell orders, as double the amount of 
difference between the midpoint of the national best bid and national 
best offer at the time of order receipt and the execution price.
    (6) Average realized spread means the share-weighted average of 
realized spreads for order executions calculated, for buy orders, as 
double the amount of

[[Page 77508]]

difference between the execution price and the midpoint of the national 
best bid and national best offer five minutes after the time of order 
execution and, for sell orders, as double the amount of difference 
between the midpoint of the national best bid and national best offer 
five minutes after the time of order execution and the execution price; 
provided, however, that the midpoint of the final national best bid and 
national best offer disseminated for regular trading hours shall be 
used to calculate a realized spread if it is disseminated less than 
five minutes after the time of order execution.
    (7) Best bid and best offer mean the highest priced bid and the 
lowest priced offer.
    (8) Bid or offer means the bid price or the offer price 
communicated by a member of a national securities exchange or member of 
a national securities association to any broker or dealer, or to any 
customer, at which it is willing to buy or sell one or more round lots 
of an NMS security, as either principal or agent, but shall not include 
indications of interest.
    (9) Block size with respect to an order means it is:
    (i) Of at least 10,000 shares; or
    (ii) For a quantity of stock having a market value of at least 
$200,000.
    (10) Categorized by order size means dividing orders into separate 
categories for sizes from 100 to 499 shares, from 500 to 1999 shares, 
from 2000 to 4999 shares, and 5000 or greater shares.
    (11) Categorized by order type means dividing orders into separate 
categories for market orders, marketable limit orders, inside-the-quote 
limit orders, at-the-quote limit orders, and near-the-quote limit 
orders.
    (12) Categorized by security means dividing orders into separate 
categories for each NMS stock that is included in a report.
    (13) Consolidated display means:
    (i) The prices, sizes, and market identifications of the national 
best bid and national best offer for a security; and
    (ii) Consolidated last sale information for a security.
    (14) Consolidated last sale information means the price, volume, 
and market identification of the most recent transaction report for a 
security that is disseminated pursuant to an effective national market 
system plan.
    (15) Covered order means any market order or any limit order 
(including immediate-or-cancel orders) received by a market center 
during regular trading hours at a time when a national best bid and 
national best offer is being disseminated, and, if executed, is 
executed during regular trading hours, but shall exclude any order for 
which the customer requests special handling for execution, including, 
but not limited to, orders to be executed at a market opening price or 
a market closing price, orders submitted with stop prices, orders to be 
executed only at their full size, orders to be executed on a particular 
type of tick or bid, orders submitted on a ``not held'' basis, orders 
for other than regular settlement, and orders to be executed at prices 
unrelated to the market price of the security at the time of execution.
    (16) Customer means any person that is not a broker or dealer.
    (17) Customer limit order means an order to buy or sell an NMS 
stock at a specified price that is not for the account of either a 
broker or dealer; provided, however, that the term customer limit order 
shall include an order transmitted by a broker or dealer on behalf of a 
customer.
    (18) Customer order means an order to buy or sell an NMS security 
that is not for the account of a broker or dealer, but shall not 
include any order for a quantity of a security having a market value of 
at least $50,000 for an NMS security that is an option contract and a 
market value of at least $200,000 for any other NMS security.
    (19) Directed order means a customer order that the customer 
specifically instructed the broker or dealer to route to a particular 
venue for execution.
    (20) Dynamic market monitoring device means any service provided by 
a vendor on an interrogation device or other display that:
    (i) Permits real-time monitoring, on a dynamic basis, of 
transaction reports, last sale data, or quotation information with 
respect to a particular security; and
    (ii) Displays the most recent transaction report, last sale data, 
or quotation information with respect to that security until such 
report, data, or information has been superseded or supplemented by the 
display of a new transaction report, last sale data, or quotation 
information reflecting the next reported transaction or quotation in 
that security.
    (21) Effective national market system plan means any national 
market system plan approved by the Commission (either temporarily or on 
a permanent basis) pursuant to Sec.  242.608.
    (22) Effective transaction reporting plan means any transaction 
reporting plan approved by the Commission pursuant to Sec.  242.601.
    (23) Electronic communications network means any electronic system 
that widely disseminates to third parties orders entered therein by an 
exchange market maker or OTC market maker, and permits such orders to 
be executed against in whole or in part; except that the term 
electronic communications network shall not include:
    (i) Any system that crosses multiple orders at one or more 
specified times at a single price set by the system (by algorithm or by 
any derivative pricing mechanism) and does not allow orders to be 
crossed or executed against directly by participants outside of such 
times; or
    (ii) Any system operated by, or on behalf of, an OTC market maker 
or exchange market maker that executes customer orders primarily 
against the account of such market maker as principal, other than 
riskless principal.
    (24) Exchange market maker means any member of a national 
securities exchange that is registered as a specialist or market maker 
pursuant to the rules of such exchange.
    (25) Exchange-traded security means any NMS security or class of 
NMS securities listed and registered, or admitted to unlisted trading 
privileges, on a national securities exchange; provided, however, that 
securities not listed on any national securities exchange that are 
traded pursuant to unlisted trading privileges are excluded.
    (26) Executed at the quote means, for buy orders, execution at a 
price equal to the national best offer at the time of order receipt 
and, for sell orders, execution at a price equal to the national best 
bid at the time of order receipt.
    (27) Executed outside the quote means, for buy orders, execution at 
a price higher than the national best offer at the time of order 
receipt and, for sell orders, execution at a price lower than the 
national best bid at the time of order receipt.
    (28) Executed with price improvement means, for buy orders, 
execution at a price lower than the national best offer at the time of 
order receipt and, for sell orders, execution at a price higher than 
the national best bid at the time of order receipt.
    (29) Inside-the-quote limit order, at-the-quote limit order, and 
near-the-quote limit order mean non-marketable buy orders with limit 
prices that are, respectively, higher than, equal to, and lower by 
$0.10 or less than the national best bid at the time of order receipt, 
and non-marketable sell orders with limit prices that are, 
respectively, lower than, equal to, and higher by $0.10 or less than 
the national best offer at the time of order receipt.
    (30) Intermarket sweep order means a limit order for an NMS stock 
that meets the following requirements:

[[Page 77509]]

    (i) When routed to a trading center, the limit order is identified 
as an intermarket sweep order; and
    (ii) Simultaneously with the routing of the limit order identified 
as an intermarket sweep order, one or more additional limit orders, as 
necessary, are routed to execute against the full displayed size of any 
protected bid, in the case of a limit order to sell, or the full 
displayed size of any protected offer, in the case of a limit order to 
buy, for the NMS stock with a price that is superior to the limit price 
of the limit order identified as an intermarket sweep order. These 
additional routed orders also must be marked as intermarket sweep 
orders.
    (31) Interrogation device means any securities information 
retrieval system capable of displaying transaction reports, last sale 
data, or quotation information upon inquiry, on a current basis on a 
terminal or other device.
    (32) Joint self-regulatory organization plan means a plan as to 
which two or more self-regulatory organizations, acting jointly, are 
sponsors.
    (33) Last sale data means any price or volume data associated with 
a transaction.
    (34) Listed equity security means any equity security listed and 
registered, or admitted to unlisted trading privileges, on a national 
securities exchange.
    (35) Listed option means any option traded on a registered national 
securities exchange or automated facility of a national securities 
association.
    (36) Make publicly available means posting on an Internet Web site 
that is free and readily accessible to the public, furnishing a written 
copy to customers on request without charge, and notifying customers at 
least annually in writing that a written copy will be furnished on 
request.
    (37) Manual quotation means any quotation other than an automated 
quotation.
    (38) Market center means any exchange market maker, OTC market 
maker, alternative trading system, national securities exchange, or 
national securities association.
    (39) Marketable limit order means any buy order with a limit price 
equal to or greater than the national best offer at the time of order 
receipt, or any sell order with a limit price equal to or less than the 
national best bid at the time of order receipt.
    (40) Moving ticker means any continuous real-time moving display of 
transaction reports or last sale data (other than a dynamic market 
monitoring device) provided on an interrogation or other display 
device.
    (41) Nasdaq security means any registered security listed on The 
Nasdaq Stock Market, Inc.
    (42) National best bid and national best offer means, with respect 
to quotations for an NMS security, the best bid and best offer for such 
security that are calculated and disseminated on a current and 
continuing basis by a plan processor pursuant to an effective national 
market system plan; provided, that in the event two or more market 
centers transmit to the plan processor pursuant to such plan identical 
bids or offers for an NMS security, the best bid or best offer (as the 
case may be) shall be determined by ranking all such identical bids or 
offers (as the case may be) first by size (giving the highest ranking 
to the bid or offer associated with the largest size), and then by time 
(giving the highest ranking to the bid or offer received first in 
time).
    (43) National market system plan means any joint self-regulatory 
organization plan in connection with:
    (i) The planning, development, operation or regulation of a 
national market system (or a subsystem thereof) or one or more 
facilities thereof; or
    (ii) The development and implementation of procedures and/or 
facilities designed to achieve compliance by self-regulatory 
organizations and their members with any section of this Regulation NMS 
and part 240, subpart A of this chapter promulgated pursuant to section 
11A of the Act (15 U.S.C. 78k-1).
    (44) National securities association means any association of 
brokers and dealers registered pursuant to section 15A of the Act (15 
U.S.C. 78o-3).
    (45) National securities exchange means any exchange registered 
pursuant to section 6 of the Act (15 U.S.C. 78f).
    (46) NMS security means any security or class of securities for 
which transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan, or an effective 
national market system plan for reporting transactions in listed 
options.
    (47) NMS stock means any NMS security other than an option.
    (48) Non-directed order means any customer order other than a 
directed order.
    (49) Odd-lot means an order for the purchase or sale of an NMS 
stock in an amount less than a round lot.
    (50) Options class means all of the put option or call option 
series overlying a security, as defined in section 3(a)(10) of the Act 
(15 U.S.C. 78c(a)(10)).
    (51) Options series means the contracts in an options class that 
have the same unit of trade, expiration date, and exercise price, and 
other terms or conditions.
    (52) OTC market maker means any dealer that holds itself out as 
being willing to buy from and sell to its customers, or others, in the 
United States, an NMS stock for its own account on a regular or 
continuous basis otherwise than on a national securities exchange in 
amounts of less than block size.
    (53) Participants, when used in connection with a national market 
system plan, means any self-regulatory organization which has agreed to 
act in accordance with the terms of the plan but which is not a 
signatory of such plan.
    (54) Payment for order flow has the meaning provided in Sec.  
240.10b-10 of this chapter.
    (55) Plan processor means any self-regulatory organization or 
securities information processor acting as an exclusive processor in 
connection with the development, implementation and/or operation of any 
facility contemplated by an effective national market system plan.
    (56) Profit-sharing relationship means any ownership or other type 
of affiliation under which the broker or dealer, directly or 
indirectly, may share in any profits that may be derived from the 
execution of non-directed orders.
Alternative A

Proposed Market BBO Alternative for Paragraph (b)(57) of This Section

    (57) Protected bid or protected offer means a quotation in an NMS 
stock that:
    (i) Is displayed by an automated trading center;
    (ii) Is disseminated pursuant to an effective national market 
system plan; and
    (iii) Is an automated quotation that is the best bid or best offer 
of a national securities exchange, the best bid or best offer of The 
Nasdaq Stock Market, Inc., or the best bid or best offer of a national 
securities association other than the best bid or best offer of The 
Nasdaq Stock Market, Inc.
Alternative B

Proposed Voluntary Depth Alternative for Paragraph (b)(57) of This 
Section

    (57) Protected bid or protected offer means a quotation in an NMS 
stock that:
    (i) Is displayed by an automated trading center;
    (ii) Is disseminated pursuant to an effective national market 
system plan; and
    (iii) Is an automated quotation that is the best bid or best offer 
of a national securities exchange, the best bid or best

[[Page 77510]]

offer of The Nasdaq Stock Market, Inc., or the best bid or best offer 
of a national securities association other than the best bid or best 
offer of The Nasdaq Stock Market, Inc., or such additional bids or 
offers that are designated as protected bids or protected offers 
pursuant to an effective national market system plan.
    (58) Protected quotation means a protected bid or a protected 
offer.
    (59) Published aggregate quotation size means the aggregate 
quotation size calculated by a national securities exchange and 
displayed by a vendor on a terminal or other display device at the time 
an order is presented for execution to a responsible broker or dealer.
    (60) Published bid and published offer means the bid or offer of a 
responsible broker or dealer for an NMS security communicated by it to 
its national securities exchange or association pursuant to Sec.  
242.602 and displayed by a vendor on a terminal or other display device 
at the time an order is presented for execution to such responsible 
broker or dealer.
    (61) Published quotation size means the quotation size of a 
responsible broker or dealer communicated by it to its national 
securities exchange or association pursuant to Sec.  242.602 and 
displayed by a vendor on a terminal or other display device at the time 
an order is presented for execution to such responsible broker or 
dealer.
    (62) Quotation size, when used with respect to a responsible 
broker's or dealer's bid or offer for an NMS security, means:
    (i) The number of shares (or units of trading) of that security 
which such responsible broker or dealer has specified, for purposes of 
dissemination to vendors, that it is willing to buy at the bid price or 
sell at the offer price comprising its bid or offer, as either 
principal or agent; or
    (ii) In the event such responsible broker or dealer has not so 
specified, a normal unit of trading for that NMS security.
    (63) Quotations and quotation information mean bids, offers and, 
where applicable, quotation sizes and aggregate quotation sizes.
    (64) Regular trading hours means the time between 9:30 a.m. and 
4:00 p.m. Eastern Time, or such other time as is set forth in the 
procedures established pursuant to Sec.  242.605(a)(2).
    (65) Responsible broker or dealer means:
    (i) When used with respect to bids or offers communicated on a 
national securities exchange, any member of such national securities 
exchange who communicates to another member on such national securities 
exchange, at the location (or locations) or through the facility or 
facilities designated by such national securities exchange for trading 
in an NMS security a bid or offer for such NMS security, as either 
principal or agent; provided, however, that, in the event two or more 
members of a national securities exchange have communicated on or 
through such national securities exchange bids or offers for an NMS 
security at the same price, each such member shall be considered a 
responsible broker or dealer for that bid or offer, subject to the 
rules of priority and precedence then in effect on that national 
securities exchange; and further provided, that for a bid or offer 
which is transmitted from one member of a national securities exchange 
to another member who undertakes to represent such bid or offer on such 
national securities exchange as agent, only the last member who 
undertakes to represent such bid or offer as agent shall be considered 
the responsible broker or dealer for that bid or offer; and
    (ii) When used with respect to bids and offers communicated by an 
OTC market maker to a broker or dealer or a customer, the OTC market 
maker communicating the bid or offer (regardless of whether such bid or 
offer is for its own account or on behalf of another person).
    (66) Revised bid or offer means a market maker's bid or offer which 
supersedes its published bid or published offer.
    (67) Revised quotation size means a market maker's quotation size 
which supersedes its published quotation size.
    (68) Self-regulatory organization means any national securities 
exchange or national securities association.
    (69) Specified persons, when used in connection with any 
notification required to be provided pursuant to Sec.  242.602(a)(3) 
and any election (or withdrawal thereof) permitted under Sec.  
242.602(a)(5), means:
    (i) Each vendor;
    (ii) Each plan processor; and
    (iii) The processor for the Options Price Reporting Authority (in 
the case of a notification for a subject security which is a class of 
securities underlying options admitted to trading on any national 
securities exchange).
    (70) Sponsor, when used in connection with a national market system 
plan, means any self-regulatory organization which is a signatory to 
such plan and has agreed to act in accordance with the terms of the 
plan.
    (71) SRO display-only facility means a facility operated by a 
national securities exchange or national securities association that 
displays quotations in a security, but does not execute orders against 
such quotations or present orders for execution.
    (72) SRO trading facility means a facility operated by a national 
securities exchange or a national securities association that executes 
orders in a security or presents orders to members for execution.
    (73) Subject security means:
    (i) With respect to a national securities exchange:
    (A) Any exchange-traded security other than a security for which 
the executed volume of such exchange, during the most recent calendar 
quarter, comprised one percent or less of the aggregate trading volume 
for such security as reported pursuant to an effective transaction 
reporting plan or effective national market system plan; and
    (B) Any other NMS security for which such exchange has in effect an 
election, pursuant to Sec.  242.602(a)(5)(i), to collect, process, and 
make available to a vendor bids, offers, quotation sizes, and aggregate 
quotation sizes communicated on such exchange; and
    (ii) With respect to a member of a national securities association:
    (A) Any exchange-traded security for which such member acts in the 
capacity of an OTC market maker unless the executed volume of such 
member, during the most recent calendar quarter, comprised one percent 
or less of the aggregate trading volume for such security as reported 
pursuant to an effective transaction reporting plan or effective 
national market system plan; and
    (B) Any other NMS security for which such member acts in the 
capacity of an OTC market maker and has in effect an election, pursuant 
to Sec.  242.602(a)(5)(ii), to communicate to its association bids, 
offers, and quotation sizes for the purpose of making such bids, 
offers, and quotation sizes available to a vendor.
    (74) Time of order execution means the time (to the second) that an 
order was executed at any venue.
    (75) Time of order receipt means the time (to the second) that an 
order was received by a market center for execution.
    (76) Time of the transaction has the meaning provided in Sec.  
240.10b-10 of this chapter.
    (77) Trade-through means the purchase or sale of an NMS stock 
during regular trading hours, either as principal or agent, at a price 
that is lower than a protected bid or higher than a protected offer.
    (78) Trading center means a national securities exchange or 
national securities association that operates an

[[Page 77511]]

SRO trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker or dealer that executes 
orders internally by trading as principal or crossing orders as agent.
    (79) Trading rotation means, with respect to an options class, the 
time period on a national securities exchange during which:
    (i) Opening, re-opening, or closing transactions in options series 
in such options class are not yet completed; and
    (ii) Continuous trading has not yet commenced or has not yet ended 
for the day in options series in such options class.
    (80) Transaction report means a report containing the price and 
volume associated with a transaction involving the purchase or sale of 
one or more round lots of a security.
    (81) Transaction reporting association means any person authorized 
to implement or administer any transaction reporting plan on behalf of 
persons acting jointly under Sec.  242.601(a).
    (82) Transaction reporting plan means any plan for collecting, 
processing, making available or disseminating transaction reports with 
respect to transactions in NMS stocks filed with the Commission 
pursuant to, and meeting the requirements of, Sec.  242.601.
    (83) Vendor means any securities information processor engaged in 
the business of disseminating transaction reports, last sale data, or 
quotation information with respect to NMS securities to brokers, 
dealers, or investors on a real-time or other current and continuing 
basis, whether through an electronic communications network, moving 
ticker, or interrogation device.


Sec.  242.601  Dissemination of transaction reports and last sale data 
with respect to transactions in NMS stocks.

    (a)(1) Every national securities exchange shall file a transaction 
reporting plan regarding transactions in listed equity and Nasdaq 
securities executed through its facilities, and every national 
securities association shall file a transaction reporting plan 
regarding transactions in listed equity and Nasdaq securities executed 
by its members otherwise than on a national securities exchange.
    (2) Any transaction reporting plan, or any amendment thereto, filed 
pursuant to this section shall be filed with the Commission, and 
considered for approval, in accordance with the procedures set forth in 
Sec.  242.608(a) and (b). Any such plan, or amendment thereto, shall 
specify, at a minimum:
    (i) The listed equity and Nasdaq securities or classes of such 
securities for which transaction reports shall be required by the plan;
    (ii) Reporting requirements with respect to transactions in listed 
equity securities and Nasdaq securities, for any broker or dealer 
subject to the plan;
    (iii) The manner of collecting, processing, sequencing, making 
available and disseminating transaction reports and last sale data 
reported pursuant to such plan;
    (iv) The manner in which such transaction reports reported pursuant 
to such plan are to be consolidated with transaction reports from 
national securities exchanges and national securities associations 
reported pursuant to any other effective transaction reporting plan;
    (v) The applicable standards and methods which will be utilized to 
ensure promptness of reporting, and accuracy and completeness of 
transaction reports;
    (vi) Any rules or procedures which may be adopted to ensure that 
transaction reports or last sale data will not be disseminated in a 
fraudulent or manipulative manner;
    (vii) Specific terms of access to transaction reports made 
available or disseminated pursuant to the plan; and
    (viii) That transaction reports or last sale data made available to 
any vendor for display on an interrogation device identify the 
marketplace where each transaction was executed.
    (3) No transaction reporting plan filed pursuant to this section, 
or any amendment to an effective transaction reporting plan, shall 
become effective unless approved by the Commission or otherwise 
permitted in accordance with the procedures set forth in Sec.  242.608.
    (b) Prohibitions and reporting requirements.
    (1) No broker or dealer may execute any transaction in, or induce 
or attempt to induce the purchase or sale of, any NMS stock:
    (i) On or through the facilities of a national securities exchange 
unless there is an effective transaction reporting plan with respect to 
transactions in such security executed on or through such exchange 
facilities; or
    (ii) Otherwise than on a national securities exchange unless there 
is an effective transaction reporting plan with respect to transactions 
in such security executed otherwise than on a national securities 
exchange by such broker or dealer.
    (2) Every broker or dealer who is a member of a national securities 
exchange or national securities association shall promptly transmit to 
the exchange or association of which it is a member all information 
required by any effective transaction reporting plan filed by such 
exchange or association (either individually or jointly with other 
exchanges and/or associations).
    (c) Retransmission of transaction reports or last sale data. 
Notwithstanding any provision of any effective transaction reporting 
plan, no national securities exchange or national securities 
association may, either individually or jointly, by rule, stated policy 
or practice, transaction reporting plan or otherwise, prohibit, 
condition or otherwise limit, directly or indirectly, the ability of 
any vendor to retransmit, for display in moving tickers, transaction 
reports or last sale data made available pursuant to any effective 
transaction reporting plan; provided, however, that a national 
securities exchange or national securities association may, by means of 
an effective transaction reporting plan, condition such retransmission 
upon appropriate undertakings to ensure that any charges for the 
distribution of transaction reports or last sale data in moving tickers 
permitted by paragraph (d) of this section are collected.
    (d) Charges. Nothing in this section shall preclude any national 
securities exchange or national securities association, separately or 
jointly, pursuant to the terms of an effective transaction reporting 
plan, from imposing reasonable, uniform charges (irrespective of 
geographic location) for distribution of transaction reports or last 
sale data.
    (e) Appeals. The Commission may, in its discretion, entertain 
appeals in connection with the implementation or operation of any 
effective transaction reporting plan in accordance with the provisions 
of Sec.  242.608(d).
    (f) Exemptions. The Commission may exempt from the provisions of 
this section, either unconditionally or on specified terms and 
conditions, any national securities exchange, national securities 
association, broker, dealer, or specified security if the Commission 
determines that such exemption is consistent with the public interest, 
the protection of investors and the removal of impediments to, and 
perfection of the mechanisms of, a national market system.


Sec.  242.602  Dissemination of quotations in NMS securities.

    (a) Dissemination requirements for national securities exchanges 
and national securities associations.
    (1) Every national securities exchange and national securities 
association shall

[[Page 77512]]

establish and maintain procedures and mechanisms for collecting bids, 
offers, quotation sizes, and aggregate quotation sizes from responsible 
brokers or dealers who are members of such exchange or association, 
processing such bids, offers, and sizes, and making such bids, offers, 
and sizes available to vendors, as follows:
    (i) Each national securities exchange shall at all times such 
exchange is open for trading, collect, process, and make available to 
vendors the best bid, the best offer, and aggregate quotation sizes for 
each subject security listed or admitted to unlisted trading privileges 
which is communicated on any national securities exchange by any 
responsible broker or dealer, but shall not include:
    (A) Any bid or offer executed immediately after communication and 
any bid or offer communicated by a responsible broker or dealer other 
than an exchange market maker which is cancelled or withdrawn if not 
executed immediately after communication; and
    (B) Any bid or offer communicated during a period when trading in 
that security has been suspended or halted, or prior to the 
commencement of trading in that security on any trading day, on that 
exchange.
    (ii) Each national securities association shall, at all times that 
last sale information with respect to NMS securities is reported 
pursuant to an effective transaction reporting plan, collect, process, 
and make available to vendors the best bid, best offer, and quotation 
sizes communicated otherwise than on an exchange by each member of such 
association acting in the capacity of an OTC market maker for each 
subject security and the identity of that member (excluding any bid or 
offer executed immediately after communication), except during any 
period when over-the-counter trading in that security has been 
suspended.
    (2) Each national securities exchange shall, with respect to each 
published bid and published offer representing a bid or offer of a 
member for a subject security, establish and maintain procedures for 
ascertaining and disclosing to other members of that exchange, upon 
presentation of orders sought to be executed by them in reliance upon 
paragraph (b)(2) of this section, the identity of the responsible 
broker or dealer who made such bid or offer and the quotation size 
associated with it.
    (3)(i) If, at any time a national securities exchange is open for 
trading, such exchange determines, pursuant to rules approved by the 
Commission pursuant to section 19(b)(2) of the Act (15 U.S.C. 
78s(b)(2)), that the level of trading activities or the existence of 
unusual market conditions is such that the exchange is incapable of 
collecting, processing, and making available to vendors the data for a 
subject security required to be made available pursuant to paragraph 
(a)(1) of this section in a manner that accurately reflects the current 
state of the market on such exchange, such exchange shall immediately 
notify all specified persons of that determination. Upon such 
notification, responsible brokers or dealers that are members of that 
exchange shall be relieved of their obligation under paragraphs (b)(2) 
and (c)(3) of this section and such exchange shall be relieved of its 
obligations under paragraphs (a)(1) and (2) of this section for that 
security; provided, however, that such exchange will continue, to the 
maximum extent practicable under the circumstances, to collect, 
process, and make available to vendors data for that security in 
accordance with paragraph (a)(1) of this section.
    (ii) During any period a national securities exchange, or any 
responsible broker or dealer that is a member of that exchange, is 
relieved of any obligation imposed by this section for any subject 
security by virtue of a notification made pursuant to paragraph 
(a)(3)(i) of this section, such exchange shall monitor the activity or 
conditions which formed the basis for such notification and shall 
immediately renotify all specified persons when that exchange is once 
again capable of collecting, processing, and making available to 
vendors the data for that security required to be made available 
pursuant to paragraph (a)(1) of this section in a manner that 
accurately reflects the current state of the market on such exchange. 
Upon such renotification, any exchange or responsible broker or dealer 
which had been relieved of any obligation imposed by this section as a 
consequence of the prior notification shall again be subject to such 
obligation.
    (4) Nothing in this section shall preclude any national securities 
exchange or national securities association from making available to 
vendors indications of interest or bids and offers for a subject 
security at any time such exchange or association is not required to do 
so pursuant to paragraph (a)(1) of this section.
    (5)(i) Any national securities exchange may make an election for 
purposes of the definition of subject security in Sec.  242.600(b)(73) 
for any NMS security, by collecting, processing, and making available 
bids, offers, quotation sizes, and aggregate quotation sizes in that 
security; except that for any NMS security previously listed or 
admitted to unlisted trading privileges on only one exchange and not 
traded by any OTC market maker, such election shall be made by 
notifying all specified persons, and shall be effective at the opening 
of trading on the business day following notification.
    (ii) Any member of a national securities association acting in the 
capacity of an OTC market maker may make an election for purposes of 
the definition of subject security in Sec.  242.600(b)(73) for any NMS 
security, by communicating to its association bids, offers, and 
quotation sizes in that security; except that for any other NMS 
security listed or admitted to unlisted trading privileges on only one 
exchange and not traded by any other OTC market maker, such election 
shall be made by notifying its association and all specified persons, 
and shall be effective at the opening of trading on the business day 
following notification.
    (iii) The election of a national securities exchange or member of a 
national securities association for any NMS security pursuant to this 
paragraph (a)(5) shall cease to be in effect if such exchange or member 
ceases to make available or communicate bids, offers, and quotation 
sizes in such security.
    (b) Obligations of responsible brokers and dealers.
    (1) Each responsible broker or dealer shall promptly communicate to 
its national securities exchange or national securities association, 
pursuant to the procedures established by that exchange or association, 
its best bids, best offers, and quotation sizes for any subject 
security.
    (2) Subject to the provisions of paragraph (b)(3) of this section, 
each responsible broker or dealer shall be obligated to execute any 
order to buy or sell a subject security, other than an odd-lot order, 
presented to it by another broker or dealer, or any other person 
belonging to a category of persons with whom such responsible broker or 
dealer customarily deals, at a price at least as favorable to such 
buyer or seller as the responsible broker's or dealer's published bid 
or published offer (exclusive of any commission, commission equivalent 
or differential customarily charged by such responsible broker or 
dealer in connection with execution of any such order) in any amount up 
to its published quotation size.
    (3)(i) No responsible broker or dealer shall be obligated to 
execute a transaction for any subject security as provided in paragraph 
(b)(2) of this section to purchase or sell that subject

[[Page 77513]]

security in an amount greater than such revised quotation if:
    (A) Prior to the presentation of an order for the purchase or sale 
of a subject security, a responsible broker or dealer has communicated 
to its exchange or association, pursuant to paragraph (b)(1) of this 
section, a revised quotation size; or
    (B) At the time an order for the purchase or sale of a subject 
security is presented, a responsible broker or dealer is in the process 
of effecting a transaction in such subject security, and immediately 
after the completion of such transaction, it communicates to its 
exchange or association a revised quotation size, such responsible 
broker or dealer shall not be obligated by paragraph (b)(2) of this 
section to purchase or sell that subject security in an amount greater 
than such revised quotation size.
    (ii) No responsible broker or dealer shall be obligated to execute 
a transaction for any subject security as provided in paragraph (b)(2) 
of this section if:
    (A) Before the order sought to be executed is presented, such 
responsible broker or dealer has communicated to its exchange or 
association pursuant to paragraph (b)(1) of this section, a revised bid 
or offer; or
    (B) At the time the order sought to be executed is presented, such 
responsible broker or dealer is in the process of effecting a 
transaction in such subject security, and, immediately after the 
completion of such transaction, such responsible broker or dealer 
communicates to its exchange or association pursuant to paragraph 
(b)(1) of this section, a revised bid or offer; provided, however, that 
such responsible broker or dealer shall nonetheless be obligated to 
execute any such order in such subject security as provided in 
paragraph (b)(2) of this section at its revised bid or offer in any 
amount up to its published quotation size or revised quotation size.
    (4) Subject to the provisions of paragraph (a)(4) of this section:
    (i) No national securities exchange or OTC market maker may make 
available, disseminate or otherwise communicate to any vendor, directly 
or indirectly, for display on a terminal or other display device any 
bid, offer, quotation size, or aggregate quotation size for any NMS 
security which is not a subject security with respect to such exchange 
or OTC market maker; and
    (ii) No vendor may disseminate or display on a terminal or other 
display device any bid, offer, quotation size, or aggregate quotation 
size from any national securities exchange or OTC market maker for any 
NMS security which is not a subject security with respect to such 
exchange or OTC market maker.
    (5)(i) Entry of any priced order for an NMS security by an exchange 
market maker or OTC market maker in that security into an electronic 
communications network that widely disseminates such order shall be 
deemed to be:
    (A) A bid or offer under this section, to be communicated to the 
market maker's exchange or association pursuant to this paragraph (b) 
for at least the minimum quotation size that is required by the rules 
of the market maker's exchange or association if the priced order is 
for the account of a market maker, or the actual size of the order up 
to the minimum quotation size required if the priced order is for the 
account of a customer; and
    (B) A communication of a bid or offer to a vendor for display on a 
display device for purposes of paragraph (b)(4) of this section.
    (ii) An exchange market maker or OTC market maker that has entered 
a priced order for an NMS security into an electronic communications 
network that widely disseminates such order shall be deemed to be in 
compliance with paragraph (b)(5)(i)(A) of this section if the 
electronic communications network:
    (A)(1) Provides to a national securities exchange or national 
securities association (or an exclusive processor acting on behalf of 
one or more exchanges or associations) the prices and sizes of the 
orders at the highest buy price and the lowest sell price for such 
security entered in, and widely disseminated by, the electronic 
communications network by exchange market makers and OTC market makers 
for the NMS security, and such prices and sizes are included in the 
quotation data made available by such exchange, association, or 
exclusive processor to vendors pursuant to this section; and
    (2) Provides, to any broker or dealer, the ability to effect a 
transaction with a priced order widely disseminated by the electronic 
communications network entered therein by an exchange market maker or 
OTC market maker that is:
    (i) Equivalent to the ability of any broker or dealer to effect a 
transaction with an exchange market maker or OTC market maker pursuant 
to the rules of the national securities exchange or national securities 
association to which the electronic communications network supplies 
such bids and offers; and
    (ii) At the price of the highest priced buy order or lowest priced 
sell order, or better, for the lesser of the cumulative size of such 
priced orders entered therein by exchange market makers or OTC market 
makers at such price, or the size of the execution sought by the broker 
or dealer, for such security; or
    (B) Is an alternative trading system that:
    (1) Displays orders and provides the ability to effect transactions 
with such orders under Sec.  242.301(b)(3); and
    (2) Otherwise is in compliance with Regulation ATS (Sec.  242.300 
through Sec.  242.303).
    (c) Transactions in listed options.
    (1) A national securities exchange or national securities 
association:
    (i) Shall not be required, under paragraph (a) of this section, to 
collect from responsible brokers or dealers who are members of such 
exchange or association, or to make available to vendors, the quotation 
sizes and aggregate quotation sizes for listed options, if such 
exchange or association establishes by rule and periodically publishes 
the quotation size for which such responsible brokers or dealers are 
obligated to execute an order to buy or sell an options series that is 
a subject security at its published bid or offer under paragraph (b)(2) 
of this section;
    (ii) May establish by rule and periodically publish a quotation 
size, which shall not be for less than one contract, for which 
responsible brokers or dealers who are members of such exchange or 
association are obligated under paragraph (b)(2) of this section to 
execute an order to buy or sell a listed option for the account of a 
broker or dealer that is in an amount different from the quotation size 
for which it is obligated to execute an order for the account of a 
customer; and
    (iii) May establish and maintain procedures and mechanisms for 
collecting from responsible brokers and dealers who are members of such 
exchange or association, and making available to vendors, the quotation 
sizes and aggregate quotation sizes in listed options for which such 
responsible broker or dealer will be obligated under paragraph (b)(2) 
of this section to execute an order from a customer to buy or sell a 
listed option and establish by rule and periodically publish the size, 
which shall not be less than one contract, for which such responsible 
brokers or dealers are obligated to execute an order for the account of 
a broker or dealer.
    (2) If, pursuant to paragraph (c)(1) of this section, the rules of 
a national securities exchange or national securities association do 
not require its members to communicate to it their quotation sizes for 
listed options, a responsible broker or dealer that is a

[[Page 77514]]

member of such exchange or association shall:
    (i) Be relieved of its obligations under paragraph (b)(1) of this 
section to communicate to such exchange or association its quotation 
sizes for any listed option; and
    (ii) Comply with its obligations under paragraph (b)(2) of this 
section by executing any order to buy or sell a listed option, in an 
amount up to the size established by such exchange's or association's 
rules under paragraph (c)(1) of this section.
    (3) Thirty second response. Each responsible broker or dealer, 
within thirty seconds of receiving an order to buy or sell a listed 
option in an amount greater than the quotation size established by a 
national securities exchange's or national securities association's 
rules pursuant to paragraph (c)(1) of this section, or its published 
quotation size must:
    (i) Execute the entire order; or
    (ii)(A) Execute that portion of the order equal to at least:
    (1) The quotation size established by a national securities 
exchange's or national securities association's rules, pursuant to 
paragraph (c)(1) of this section, to the extent that such exchange or 
association does not collect and make available to vendors quotation 
size and aggregate quotation size under paragraph (a) of this section; 
or
    (2) Its published quotation size; and
    (B) Revise its bid or offer.
    (4) Notwithstanding paragraph (c)(3) of this section, no 
responsible broker or dealer shall be obligated to execute a 
transaction for any listed option as provided in paragraph (b)(2) of 
this section if:
    (i) Any of the circumstances in paragraph (b)(3) of this section 
exist; or
    (ii) The order for the purchase or sale of a listed option is 
presented during a trading rotation in that listed option.
    (d) Exemptions. The Commission may exempt from the provisions of 
this section, either unconditionally or on specified terms and 
conditions, any responsible broker or dealer, electronic communications 
network, national securities exchange, or national securities 
association if the Commission determines that such exemption is 
consistent with the public interest, the protection of investors and 
the removal of impediments to and perfection of the mechanism of a 
national market system.


Sec.  242.603  Distribution, consolidation, and display of information 
with respect to quotations for and transactions in NMS stocks.

    (a) Distribution of information.
    (1) Any exclusive processor, or any broker or dealer with respect 
to information for which it is the exclusive source, that distributes 
information with respect to quotations for or transactions in an NMS 
stock to a securities information processor shall do so on terms that 
are fair and reasonable.
    (2) Any national securities exchange, national securities 
association, broker, or dealer that distributes information with 
respect to quotations for or transactions in an NMS stock to a 
securities information processor, broker, dealer, or other persons 
shall do so on terms that are not unreasonably discriminatory.
    (b) Consolidation of information. Every national securities 
exchange on which an NMS stock is traded and national securities 
association shall act jointly pursuant to one or more effective 
national market system plans to disseminate consolidated information, 
including a national best bid and national best offer, on quotations 
for and transactions in NMS stocks. Such plan or plans shall provide 
for the dissemination of all consolidated information for an individual 
NMS stock through a single plan processor.
    (c) Display of information.
    (1) No securities information processor, broker, or dealer shall 
provide, in a context in which a trading or order-routing decision can 
be implemented, a display of any information with respect to quotations 
for or transactions in an NMS stock without also providing, in an 
equivalent manner, a consolidated display for such stock.
    (2) The provisions of paragraph (c)(1) of this section shall not 
apply to a display of information on the trading floor or through the 
facilities of a national securities exchange or to a display in 
connection with the operation of a market linkage system implemented in 
accordance with an effective national market system plan.
    (d) Exemptions. The Commission, by order, may exempt from the 
provisions of this section, either unconditionally or on specified 
terms and conditions, any person, security, or item of information, or 
any class or classes of persons, securities, or items of information, 
if the Commission determines that such exemption is necessary or 
appropriate in the public interest, and is consistent with the 
protection of investors.


Sec.  242.604  Display of customer limit orders.

    (a) Specialists and OTC market makers. For all NMS stocks:
    (1) Each member of a national securities exchange that is 
registered by that exchange as a specialist, or is authorized by that 
exchange to perform functions substantially similar to that of a 
specialist, shall publish immediately a bid or offer that reflects:
    (i) The price and the full size of each customer limit order held 
by the specialist that is at a price that would improve the bid or 
offer of such specialist in such security; and
    (ii) The full size of each customer limit order held by the 
specialist that:
    (A) Is priced equal to the bid or offer of such specialist for such 
security;
    (B) Is priced equal to the national best bid or national best 
offer; and
    (C) Represents more than a de minimis change in relation to the 
size associated with the specialist's bid or offer.
    (2) Each registered broker or dealer that acts as an OTC market 
maker shall publish immediately a bid or offer that reflects:
    (i) The price and the full size of each customer limit order held 
by the OTC market maker that is at a price that would improve the bid 
or offer of such OTC market maker in such security; and
    (ii) The full size of each customer limit order held by the OTC 
market maker that:
    (A) Is priced equal to the bid or offer of such OTC market maker 
for such security;
    (B) Is priced equal to the national best bid or national best 
offer; and
    (C) Represents more than a de minimis change in relation to the 
size associated with the OTC market maker's bid or offer.
    (b) Exceptions. The requirements in paragraph (a) of this section 
shall not apply to any customer limit order:
    (1) That is executed upon receipt of the order.
    (2) That is placed by a customer who expressly requests, either at 
the time that the order is placed or prior thereto pursuant to an 
individually negotiated agreement with respect to such customer's 
orders, that the order not be displayed.
    (3) That is an odd-lot order.
    (4) That is a block size order, unless a customer placing such 
order requests that the order be displayed.
    (5) That is delivered immediately upon receipt to a national 
securities exchange or national securities association-sponsored 
system, or an electronic communications network that complies with the 
requirements of Sec.  242.602(b)(5)(ii) with respect to that order.
    (6) That is delivered immediately upon receipt to another exchange 
member or OTC market maker that complies with the requirements of this 
section with respect to that order.
    (7) That is an ``all or none'' order.
    (c) Exemptions. The Commission may exempt from the provisions of 
this

[[Page 77515]]

section, either unconditionally or on specified terms and conditions, 
any responsible broker or dealer, electronic communications network, 
national securities exchange, or national securities association if the 
Commission determines that such exemption is consistent with the public 
interest, the protection of investors and the removal of impediments to 
and perfection of the mechanism of a national market system.


Sec.  242.605  Disclosure of order execution information.

    Preliminary Note: Section 242.605 requires market centers to make 
available standardized, monthly reports of statistical information 
concerning their order executions. This information is presented in 
accordance with uniform standards that are based on broad assumptions 
about order execution and routing practices. The information will 
provide a starting point to promote visibility and competition on the 
part of market centers and broker-dealers, particularly on the factors 
of execution price and speed. The disclosures required by this section 
do not encompass all of the factors that may be important to investors 
in evaluating the order routing services of a broker-dealer. In 
addition, any particular market center's statistics will encompass 
varying types of orders routed by different broker-dealers on behalf of 
customers with a wide range of objectives. Accordingly, the statistical 
information required by this section alone does not create a reliable 
basis to address whether any particular broker-dealer failed to obtain 
the most favorable terms reasonably available under the circumstances 
for customer orders.
    (a) Monthly electronic reports by market centers.
    (1) Every market center shall make available for each calendar 
month, in accordance with the procedures established pursuant to 
paragraph (a)(2) of this section, a report on the covered orders in NMS 
stocks that it received for execution from any person. Such report 
shall be in electronic form; shall be categorized by security, order 
type, and order size; and shall include the following columns of 
information:
    (i) For market orders, marketable limit orders, inside-the-quote 
limit orders, at-the-quote limit orders, and near-the-quote limit 
orders:
    (A) The number of covered orders;
    (B) The cumulative number of shares of covered orders;
    (C) The cumulative number of shares of covered orders cancelled 
prior to execution;
    (D) The cumulative number of shares of covered orders executed at 
the receiving market center;
    (E) The cumulative number of shares of covered orders executed at 
any other venue;
    (F) The cumulative number of shares of covered orders executed from 
0 to 9 seconds after the time of order receipt;
    (G) The cumulative number of shares of covered orders executed from 
10 to 29 seconds after the time of order receipt;
    (H) The cumulative number of shares of covered orders executed from 
30 seconds to 59 seconds after the time of order receipt;
    (I) The cumulative number of shares of covered orders executed from 
60 seconds to 299 seconds after the time of order receipt;
    (J) The cumulative number of shares of covered orders executed from 
5 minutes to 30 minutes after the time of order receipt; and
    (K) The average realized spread for executions of covered orders; 
and
    (ii) For market orders and marketable limit orders:
    (A) The average effective spread for executions of covered orders;
    (B) The cumulative number of shares of covered orders executed with 
price improvement;
    (C) For shares executed with price improvement, the share-weighted 
average amount per share that prices were improved;
    (D) For shares executed with price improvement, the share-weighted 
average period from the time of order receipt to the time of order 
execution;
    (E) The cumulative number of shares of covered orders executed at 
the quote;
    (F) For shares executed at the quote, the share-weighted average 
period from the time of order receipt to the time of order execution;
    (G) The cumulative number of shares of covered orders executed 
outside the quote;
    (H) For shares executed outside the quote, the share-weighted 
average amount per share that prices were outside the quote; and
    (I) For shares executed outside the quote, the share-weighted 
average period from the time of order receipt to the time of order 
execution.
    (2) Every national securities exchange on which NMS stocks are 
traded and each national securities association shall act jointly in 
establishing procedures for market centers to follow in making 
available to the public the reports required by paragraph (a)(1) of 
this section in a uniform, readily accessible, and usable electronic 
form. In the event there is no effective national market system plan 
establishing such procedures, market centers shall prepare their 
reports in a consistent, usable, and machine-readable electronic 
format, and make such reports available for downloading from an 
Internet website that is free and readily accessible to the public.
    (3) A market center shall make available the report required by 
paragraph (a)(1) of this section within one month after the end of the 
month addressed in the report.
    (b) Exemptions. The Commission may, by order upon application, 
conditionally or unconditionally exempt any person, security, or 
transaction, or any class or classes of persons, securities, or 
transactions, from any provision or provisions of this section, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest, and is consistent with the protection of 
investors.


Sec.  242.606  Disclosure of order routing information.

    (a) Quarterly report on order routing.
    (1) Every broker or dealer shall make publicly available for each 
calendar quarter a report on its routing of non-directed orders in NMS 
securities during that quarter. For NMS stocks, such report shall be 
divided into three separate sections for securities that are listed on 
the New York Stock Exchange, Inc., securities that are qualified for 
inclusion in The Nasdaq Stock Market, Inc., and securities that are 
listed on the American Stock Exchange LLC or any other national 
securities exchange. Such report also shall include a separate section 
for NMS securities that are option contracts. Each of the four sections 
in a report shall include the following information:
    (i) The percentage of total customer orders for the section that 
were non-directed orders, and the percentages of total non-directed 
orders for the section that were market orders, limit orders, and other 
orders;
    (ii) The identity of the ten venues to which the largest number of 
total non-directed orders for the section were routed for execution and 
of any venue to which five percent or more of non-directed orders were 
routed for execution, the percentage of total non-directed orders for 
the section routed to the venue, and the percentages of total non-
directed market orders, total non-directed limit orders, and total non-
directed other orders for the section that were routed to the venue; 
and
    (iii) A discussion of the material aspects of the broker's or 
dealer's relationship with each venue identified

[[Page 77516]]

pursuant to paragraph (a)(1)(ii) of this section, including a 
description of any arrangement for payment for order flow and any 
profit-sharing relationship.
    (2) A broker or dealer shall make the report required by paragraph 
(a)(1) of this section publicly available within one month after the 
end of the quarter addressed in the report.
    (b) Customer requests for information on order routing.
    (1) Every broker or dealer shall, on request of a customer, 
disclose to its customer the identity of the venue to which the 
customer's orders were routed for execution in the six months prior to 
the request, whether the orders were directed orders or non-directed 
orders, and the time of the transactions, if any, that resulted from 
such orders.
    (2) A broker or dealer shall notify customers in writing at least 
annually of the availability on request of the information specified in 
paragraph (b)(1) of this section.
    (c) Exemptions. The Commission may, by order upon application, 
conditionally or unconditionally exempt any person, security, or 
transaction, or any class or classes of persons, securities, or 
transactions, from any provision or provisions of this section, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest, and is consistent with the protection of 
investors.


Sec.  242.607  Customer account statements.

    (a) No broker or dealer acting as agent for a customer may effect 
any transaction in, induce or attempt to induce the purchase or sale 
of, or direct orders for purchase or sale of, any NMS stock or a 
security authorized for quotation on an automated inter-dealer 
quotation system that has the characteristics set forth in section 17B 
of the Act (15 U.S.C. 78q-2), unless such broker or dealer informs such 
customer, in writing, upon opening a new account and on an annual basis 
thereafter, of the following:
    (1) The broker's or dealer's policies regarding receipt of payment 
for order flow from any broker or dealer, national securities exchange, 
national securities association, or exchange member to which it routes 
customers' orders for execution, including a statement as to whether 
any payment for order flow is received for routing customer orders and 
a detailed description of the nature of the compensation received; and
    (2) The broker's or dealer's policies for determining where to 
route customer orders that are the subject of payment for order flow 
absent specific instructions from customers, including a description of 
the extent to which orders can be executed at prices superior to the 
national best bid and national best offer.
    (b) Exemptions. The Commission, upon request or upon its own 
motion, may exempt by rule or by order, any broker or dealer or any 
class of brokers or dealers, security or class of securities from the 
requirements of paragraph (a) of this section with respect to any 
transaction or class of transactions, either unconditionally or on 
specified terms and conditions, if the Commission determines that such 
exemption is consistent with the pubic interest and the protection of 
investors.


Sec.  242.608  Filing and amendment of national market system plans.

    (a) Filing of national market system plans and amendments thereto.
    (1) Any two or more self-regulatory organizations, acting jointly, 
may file a national market system plan or may propose an amendment to 
an effective national market system plan (``proposed amendment'') by 
submitting the text of the plan or amendment to the Secretary of the 
Commission, together with a statement of the purpose of such plan or 
amendment and, to the extent applicable, the documents and information 
required by paragraphs (a)(4) and (5) of this section.
    (2) The Commission may propose amendments to any effective national 
market system plan by publishing the text thereof, together with a 
statement of the purpose of such amendment, in accordance with the 
provisions of paragraph (b) of this section.
    (3) Self-regulatory organizations are authorized to act jointly in:
    (i) Planning, developing, and operating any national market 
subsystem or facility contemplated by a national market system plan;
    (ii) Preparing and filing a national market system plan or any 
amendment thereto; or
    (iii) Implementing or administering an effective national market 
system plan.
    (4) Every national market system plan filed pursuant to this 
section, or any amendment thereto, shall be accompanied by:
    (i) Copies of all governing or constituent documents relating to 
any person (other than a self-regulatory organization) authorized to 
implement or administer such plan on behalf of its sponsors; and
    (ii) To the extent applicable:
    (A) A detailed description of the manner in which the plan or 
amendment, and any facility or procedure contemplated by the plan or 
amendment, will be implemented;
    (B) A listing of all significant phases of development and 
implementation (including any pilot phase) contemplated by the plan or 
amendment, together with the projected date of completion of each 
phase;
    (C) An analysis of the impact on competition of implementation of 
the plan or amendment or of any facility contemplated by the plan or 
amendment;
    (D) A description of any written understandings or agreements 
between or among plan sponsors or participants relating to 
interpretations of the plan or conditions for becoming a sponsor or 
participant in the plan; and
    (E) In the case of a proposed amendment, a statement that such 
amendment has been approved by the sponsors in accordance with the 
terms of the plan.
    (5) Every national market system plan, or any amendment thereto, 
filed pursuant to this section shall include a description of the 
manner in which any facility contemplated by the plan or amendment will 
be operated. Such description shall include, to the extent applicable:
    (i) The terms and conditions under which brokers, dealers, and/or 
self-regulatory organizations will be granted or denied access 
(including specific procedures and standards governing the granting or 
denial of access);
    (ii) The method by which any fees or charges collected on behalf of 
all of the sponsors and/or participants in connection with access to, 
or use of, any facility contemplated by the plan or amendment will be 
determined and imposed (including any provision for distribution of any 
net proceeds from such fees or charges to the sponsors and/or 
participants) and the amount of such fees or charges;
    (iii) The method by which, and the frequency with which, the 
performance of any person acting as plan processor with respect to the 
implementation and/or operation of the plan will be evaluated; and
    (iv) The method by which disputes arising in connection with the 
operation of the plan will be resolved.
    (6) In connection with the selection of any person to act as plan 
processor with respect to any facility contemplated by a national 
market system plan (including renewal of any contract for any person to 
so act), the sponsors shall file with the Commission a statement 
identifying the person selected, describing the material terms under 
which such person is to serve as plan processor, and indicating the 
solicitation efforts, if any, for alternative plan processors, the 
alternatives

[[Page 77517]]

considered and the reasons for selection of such person.
    (7) Any national market system plan (or any amendment thereto) 
which is intended by the sponsors to satisfy a plan filing requirement 
contained in any other section of this Regulation NMS and part 240, 
subpart A of this chapter shall, in addition to compliance with this 
section, also comply with the requirements of such other section.
    (b) Effectiveness of national market system plans.
    (1) The Commission shall publish notice of the filing of any 
national market system plan, or any proposed amendment to any effective 
national market system plan (including any amendment initiated by the 
Commission), together with the terms of substance of the filing or a 
description of the subjects and issues involved, and shall provide 
interested persons an opportunity to submit written comments. No 
national market system plan, or any amendment thereto, shall become 
effective unless approved by the Commission or otherwise permitted in 
accordance with paragraph (b)(3) of this section.
    (2) Within 120 days of the date of publication of notice of filing 
of a national market system plan or an amendment to an effective 
national market system plan, or within such longer period as the 
Commission may designate up to 180 days of such date if it finds such 
longer period to be appropriate and publishes its reasons for so 
finding or as to which the sponsors consent, the Commission shall 
approve such plan or amendment, with such changes or subject to such 
conditions as the Commission may deem necessary or appropriate, if it 
finds that such plan or amendment is necessary or appropriate in the 
public interest, for the protection of investors and the maintenance of 
fair and orderly markets, to remove impediments to, and perfect the 
mechanisms of, a national market system, or otherwise in furtherance of 
the purposes of the Act. Approval of a national market system plan, or 
an amendment to an effective national market system plan (other than an 
amendment initiated by the Commission), shall be by order. Promulgation 
of an amendment to an effective national market system plan initiated 
by the Commission shall be by rule.
    (3) A proposed amendment may be put into effect upon filing with 
the Commission if designated by the sponsors as:
    (i) Establishing or changing a fee or other charge collected on 
behalf of all of the sponsors and/or participants in connection with 
access to, or use of, any facility contemplated by the plan or 
amendment (including changes in any provision with respect to 
distribution of any net proceeds from such fees or other charges to the 
sponsors and/or participants);
    (ii) Concerned solely with the administration of the plan, or 
involving the governing or constituent documents relating to any person 
(other than a self-regulatory organization) authorized to implement or 
administer such plan on behalf of its sponsors; or
    (iii) Involving solely technical or ministerial matters. At any 
time within 60 days of the filing of any such amendment, the Commission 
may summarily abrogate the amendment and require that such amendment be 
refiled in accordance with paragraph (a)(1) of this section and 
reviewed in accordance with paragraph (b)(2) of this section, if it 
appears to the Commission that such action is necessary or appropriate 
in the public interest, for the protection of investors, or the 
maintenance of fair and orderly markets, to remove impediments to, and 
perfect the mechanisms of, a national market system or otherwise in 
furtherance of the purposes of the Act.
    (4) Notwithstanding the provisions of paragraph (b)(1) of this 
section, a proposed amendment may be put into effect summarily upon 
publication of notice of such amendment, on a temporary basis not to 
exceed 120 days, if the Commission finds that such action is necessary 
or appropriate in the public interest, for the protection of investors 
or the maintenance of fair and orderly markets, to remove impediments 
to, and perfect the mechanisms of, a national market system or 
otherwise in furtherance of the purposes of the Act.
    (5) Any plan (or amendment thereto) in connection with:
    (i) The planning, development, operation, or regulation of a 
national market system (or a subsystem thereof) or one or more 
facilities thereof; or
    (ii) The development and implementation of procedures and/or 
facilities designed to achieve compliance by self-regulatory 
organizations and/or their members of any section of this Regulation 
NMS and part 240, subpart A of this chapter promulgated pursuant to 
section 11A of the Act (15 U.S.C. 78k-1), approved by the Commission 
pursuant to section 11A of the Act (or pursuant to any rule or 
regulation thereunder) prior to the effective date of this section 
(either temporarily or permanently) shall be deemed to have been filed 
and approved pursuant to this section and no additional filing need be 
made by the sponsors with respect to such plan or amendment; provided, 
however, that all terms and conditions associated with any such 
approval (including time limitations) shall continue to be applicable; 
provided, further, that any amendment to such plan filed with or 
approved by the Commission on or after the effective date of this 
section shall be subject to the provisions of, and considered in 
accordance with the procedures specified in, this section.
    (c) Compliance with terms of national market system plans. Each 
self-regulatory organization shall comply with the terms of any 
effective national market system plan of which it is a sponsor or a 
participant. Each self-regulatory organization also shall, absent 
reasonable justification or excuse, enforce compliance with any such 
plan by its members and persons associated with its members.
    (d) Appeals. The Commission may, in its discretion, entertain 
appeals in connection with the implementation or operation of any 
effective national market system plan as follows:
    (1) Any action taken or failure to act by any person in connection 
with an effective national market system plan (other than a prohibition 
or limitation of access reviewable by the Commission pursuant to 
section 11A(b)(5) or section 19(d) of the Act (15 U.S.C. 78k-1(b)(5) or 
78s(d))) shall be subject to review by the Commission, on its own 
motion or upon application by any person aggrieved thereby (including, 
but not limited to, self-regulatory organizations, brokers, dealers, 
issuers, and vendors), filed not later than 30 days after notice of 
such action or failure to act or within such longer period as the 
Commission may determine.
    (2) Application to the Commission for review, or the institution of 
review by the Commission on its own motion, shall not operate as a stay 
of any such action unless the Commission determines otherwise, after 
notice and opportunity for hearing on the question of a stay (which 
hearing may consist only of affidavits or oral arguments).
    (3) In any proceedings for review, if the Commission, after 
appropriate notice and opportunity for hearing (which hearing may 
consist solely of consideration of the record of any proceedings 
conducted in connection with such action or failure to act and an 
opportunity for the presentation of reasons supporting or opposing such 
action or failure to act) and upon consideration of such other data, 
views, and arguments as it deems relevant, finds that the action or 
failure to act is in accordance with the applicable provisions of such 
plan and that the applicable provisions are, and were,

[[Page 77518]]

applied in a manner consistent with the public interest, the protection 
of investors, the maintenance of fair and orderly markets, and the 
removal of impediments to, and the perfection of the mechanisms of a 
national market system, the Commission, by order, shall dismiss the 
proceeding. If the Commission does not make any such finding, or if it 
finds that such action or failure to act imposes any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Act, the Commission, by order, shall set aside such action and/
or require such action with respect to the matter reviewed as the 
Commission deems necessary or appropriate in the public interest, for 
the protection of investors, and the maintenance of fair and orderly 
markets, or to remove impediments to, and perfect the mechanisms of, a 
national market system.
    (e) Exemptions. The Commission may exempt from the provisions of 
this section, either unconditionally or on specified terms and 
conditions, any self-regulatory organization, member thereof, or 
specified security, if the Commission determines that such exemption is 
consistent with the public interest, the protection of investors, the 
maintenance of fair and orderly markets and the removal of impediments 
to, and perfection of the mechanisms of, a national market system.


Sec.  242.609  Registration of securities information processors: form 
of application and amendments.

    (a) An application for the registration of a securities information 
processor shall be filed on Form SIP (Sec.  249.1001) in accordance 
with the instructions contained therein.
    (b) If any information reported in items 1-13 or item 21 of Form 
SIP or in any amendment thereto is or becomes inaccurate for any 
reason, whether before or after the registration has been granted, the 
securities information processor shall promptly file an amendment on 
Form SIP correcting such information.
    (c) The Commission, upon its own motion or upon application by any 
securities information processor, may conditionally or unconditionally 
exempt any securities information processor from any provision of the 
rules or regulations adopted under section 11A(b) of the Act (15 U.S.C. 
78k-1(b)).
    (d) Every amendment filed pursuant to this section shall constitute 
a ``report'' within the meaning of sections 17(a), 18(a) and 32(a) of 
the Act (15 U.S.C. 78q(a), 78r(a), and 78ff(a)).


Sec.  242.610  Access to quotations.

    (a) Quotations of SRO trading facility. A national securities 
exchange or national securities association shall not impose unfairly 
discriminatory terms that prevent or inhibit any person from obtaining 
efficient access through a member of the national securities exchange 
or national securities association to the quotations in an NMS stock 
displayed through its SRO trading facility.
    (b) Quotations of SRO display-only facility.
    (1) Any trading center that displays quotations in an NMS stock 
through an SRO display-only facility shall provide a level and cost of 
access to such quotations that is substantially equivalent to the level 
and cost of access to quotations displayed by SRO trading facilities in 
that stock.
    (2) Any trading center that displays quotations in an NMS stock 
through an SRO display-only facility shall not impose unfairly 
discriminatory terms that prevent or inhibit any person from obtaining 
efficient access to such quotations through a member, subscriber, or 
customer of the trading center.
    (c) Fees for access to protected quotations. A trading center shall 
not impose, nor permit to be imposed, any fee or fees for the execution 
of orders against its protected quotations in an NMS stock that exceed 
or accumulate to more than the following limits:
    (1) If the price of a protected quotation is $1.00 or more, the fee 
or fees cannot exceed or accumulate to more than $0.003 per share; or
    (2) If the price of a protected quotation is less than $1.00, the 
fee or fees cannot exceed or accumulate to more than 0.3% of the 
quotation price per share.
    (d) Locking or crossing quotations. Each national securities 
exchange and national securities association shall establish and 
enforce rules that:
    (1) Require its members reasonably to avoid displaying quotations 
that lock or cross any protected quotation in an NMS stock, and to 
avoid displaying manual quotations that lock or cross any quotation in 
an NMS stock disseminated pursuant to an effective national market 
system plan;
    (2) Are reasonably designed to assure the reconciliation of locked 
or crossed quotations in an NMS stock; and
    (3) Prohibit its members from engaging in a pattern or practice of 
displaying quotations that lock or cross any protected quotation in an 
NMS stock, or of displaying manual quotations that lock or cross any 
quotation in an NMS stock disseminated pursuant to an effective 
national market system plan.
    (e) Exemptions. The Commission, by order, may exempt from the 
provisions of this section, either unconditionally or on specified 
terms and conditions, any person, security, quotations, orders, or 
fees, or any class or classes of persons, securities, quotations, 
orders, or fees, if the Commission determines that such exemption is 
necessary or appropriate in the public interest, and is consistent with 
the protection of investors.


Sec.  242.611  Order protection rule.

    (a) Reasonable policies and procedures.
    (1) A trading center shall establish, maintain, and enforce written 
policies and procedures that are reasonably designed to prevent trade-
throughs of protected quotations in NMS stocks that do not fall within 
an exception set forth in paragraph (b) of this section and, if relying 
on such an exception, that are reasonably designed to assure compliance 
with the terms of the exception.
    (2) A trading center shall regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph 
(a)(1) of this section and shall take prompt action to remedy 
deficiencies in such policies and procedures.
    (b) Exceptions.
    (1) The transaction that constituted the trade-through was effected 
when the trading center displaying the protected quotation that was 
traded through was experiencing a failure, material delay, or 
malfunction of its systems or equipment when the trade-through 
occurred.
    (2) The transaction that constituted the trade-through was not a 
``regular way'' contract.
    (3) The transaction that constituted the trade-through was a 
single-priced opening, reopening, or closing transaction by the trading 
center.
    (4) The transaction that constituted the trade-through was executed 
at a time when a protected bid was priced higher than a protected offer 
in the NMS stock.
    (5) The transaction that constituted the trade-through was the 
execution of an order identified as an intermarket sweep order.
    (6) The transaction that constituted the trade-through was effected 
by a trading center that simultaneously routed an intermarket sweep 
order to execute against the full displayed size of any protected 
quotation in the NMS stock that was traded through.
    (7) The transaction that constituted the trade-through was the 
execution of an order at a price that was not based, directly or 
indirectly, on the quoted

[[Page 77519]]

price of the NMS stock at the time of execution and for which the 
material terms were not reasonably determinable at the time the 
commitment to execute the order was made.
    (8) The trading center displaying the protected quotation that was 
traded through had displayed, within one second prior to execution of 
the transaction that constituted the trade-through, a best bid or best 
offer, as applicable, for the NMS stock with a price that was equal or 
inferior to the price of the trade-through transaction.
    (c) Intermarket sweep orders. The trading center, broker, or dealer 
responsible for the routing of an intermarket sweep order shall take 
reasonable steps to establish that such order meets the requirements 
set forth in Sec.  242.600(b)(30).
    (d) Exemptions. The Commission, by order, may exempt from the 
provisions of this section, either unconditionally or on specified 
terms and conditions, any person, security, transaction, quotation, or 
order, or any class or classes of persons, securities, quotations, or 
orders, if the Commission determines that such exemption is necessary 
or appropriate in the public interest, and is consistent with the 
protection of investors.


Sec.  242.612  Minimum pricing increment.

    (a) No national securities exchange, national securities 
association, alternative trading system, vendor, or broker or dealer 
shall display, rank, or accept from any person a bid or offer, an 
order, or an indication of interest in any NMS stock equal to or 
greater than $1.00 in an increment smaller than $0.01.
    (b) No national securities exchange, national securities 
association, alternative trading system, vendor, or broker or dealer 
shall display, rank, or accept from any person a bid or offer, an 
order, or an indication of interest in any NMS stock less than $1.00 in 
an increment smaller than $0.0001.
    (c) Exemptions. The Commission, by order, may exempt from the 
provisions of this section, either unconditionally or on specified 
terms and conditions, any person, security, quotation, or order, or any 
class or classes or persons, securities, quotations, or orders, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest, and is consistent with the protection of 
investors.

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    32. The authority citation for part 249 continues to read in part 
as follows:

    Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; and 18 U.S.C. 
1350, unless otherwise noted.
* * * * *
    33. Section 249.1001 is revised to read as follows:


Sec.  249.1001  Form SIP, for application for registration as a 
securities information processor or to amend such an application or 
registration.

    This form shall be used for application for registration as a 
securities information processor, pursuant to section 11A(b) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78k-1(b)) and Sec.  242.609 
of this chapter, or to amend such an application or registration.
    34. Form SIP (referenced in Sec.  249.1001) is amended by revising 
Instruction 6 of General Instructions for Preparing and Filing Form SIP 
to read as follows:

    Note: The text of Form SIP does not and this amendment will not 
appear in the Code of Federal Regulations.

FORM SIP

* * * * *

GENERAL INSTRUCTIONS FOR PREPARING AND FILING FORM SIP

* * * * *
    6. Rule 609(b) of Regulation NMS requires that if any information 
contained in items 1 through 13 or item 21 of this application, or any 
supplement or amendment thereto, is or becomes inaccurate for any 
reason, an amendment must be filed promptly on Form SIP correcting such 
information.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    35. The authority citation for part 270 continues to read in part 
as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *
    36. Section 270.17a-7 is amended by revising paragraph (b)(1) to 
read as follows:


Sec.  270.17a-7  Exemption of certain purchase or sale transactions 
between an investment company and certain affiliated persons thereof.

* * * * *
    (b) * * *
    (1) If the security is an ``NMS stock'' as that term is defined in 
17 CFR 242.600, the last sale price with respect to such security 
reported in the consolidated transaction reporting system 
(``consolidated system'') or the average of the highest current 
independent bid and lowest current independent offer for such security 
(reported pursuant to 17 CFR 242.602) if there are no reported 
transactions in the consolidated system that day; or
* * * * *

    By the Commission.

    Dated: December 16, 2004.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-27934 Filed 12-26-04; 8:45 am]
BILLING CODE 8010-01-P