[Federal Register Volume 76, Number 63 (Friday, April 1, 2011)]
[Notices]
[Pages 18280-18283]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-7688]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64132; File No. SR-BATS-2011-009]


Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of 
Proposed Rule Change, as Modified by Amendment No. 1, To Create a 
Directed Order Program on a 6-Month Pilot Basis

March 28, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on March 16, 2011, BATS Exchange, Inc. (``Exchange'' or ``BATS'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by the Exchange. On March 24, 2011, the Exchange 
filed Amendment No. 1 to the proposed rule filing.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as modified by Amendment No. 1, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange listed additional data that 
the Exchange will include in monthly reports to be provided to the 
Commission during the pilot program.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is filing with the Commission a proposal for the BATS 
Exchange Options Market (``BATS Options'') to create, on a pilot basis, 
new BATS Rule 21.1(d)(13), entitled ``Market Maker Price Improving 
Orders'' and new BATS Rule 21.1(d)(14), entitled ``Directed Orders.'' 
The Exchange also proposes to amend existing BATS Rule 21.1(d)(2), 
entitled ``Price Improving Orders.''
    The text of the proposed rule change is available at the Exchange's 
Web site at http://www.batstrading.com, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant parts of such 
statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange is proposing certain modifications and additions to 
its rules related to the trading of options. First, the Exchange is 
proposing the establishment of new Rule 21.1(d)(13), entitled Market 
Maker Price Improving Orders. Second the Exchange is proposing the 
establishment of new Rule 21.1(d)(14), entitled Directed Orders. Third, 
the Exchange is proposing to modify the text of Rule 21.1(d)(6), 
entitled Price Improving Orders, to make a clarifying change.\4\
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    \4\ The Exchange previously filed a proposal to establish a 
directed order program for BATS Options. See Securities Exchange Act 
Release No. 63403 (December 1, 2010), 75 FR 76059 (December 7, 2010) 
(SR-BATS-2010-034) (notice of filing of directed order program 
proposal). The Exchange withdrew its original filing in its entirety 
and has re-filed this proposal to address comments received on the 
proposal by eliminating the originally proposed midpoint order 
functionality, to provide additional clarity in a few areas, and to 
propose operation of the directed order program on a pilot basis. In 
a manner consistent with this filing, the Exchange also responded to 
comments received on the original proposal. See Letter from Eric J. 
Swanson, Secretary, BATS Exchange, Inc. to Elizabeth M. Murphy, 
Secretary, U.S. Securities and Exchange Commission dated February 
24, 2011.
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    The Exchange is proposing the rule changes described below to 
establish a directed order program through which members of BATS 
Options (``Options Members'') can direct an order to a particular BATS 
Options Market Maker for potential execution at a price improved over 
the existing National Best Bid (``NBB'') or National Best Offer 
(``NBO''). As part of this program, BATS is proposing to define two new 
order types. The first would be new Rule 21.1(d)(13), entitled Market 
Maker Price Improving Orders, which are orders from a BATS Options 
Market Maker to buy or sell an option that has a displayed price and 
size and a non-displayed price at which the BATS Options Market Maker 
is willing to trade with a Directed Order. As proposed, a Market Maker 
Price Improving Order would be ranked on the BATS Options Book at its 
displayed price. The non-displayed price of the Market Maker Price 
Improving Order would not be entered into the BATS Options Book, but 
would be, along with its displayed size, converted to a buy or sell 
order at its non-displayed price in

[[Page 18281]]

response to a Directed Order directed to the BATS Options Market Maker. 
For the avoidance of doubt, the Exchange reiterates that, as proposed, 
the full displayed size of a Market Maker Price Improving Order, and 
only the full displayed size of a Market Maker Price Improving Order, 
is available to trade with a Directed Order directed to a BATS Options 
Market Maker. Key to the structure of the proposal is that it creates 
incentives for displayed price and size discovery available to all 
market participants.
    The second new order type proposed would be new Rule 21.1(d)(14), 
entitled Directed Orders, which are orders from a BATS Options Member 
that are directed for execution to a particular BATS Options Market 
Maker. For a BATS Options Market Maker to participate in an execution 
against a Directed Order, (1) the Directed Order must be from a BATS 
Options Member that is on a list of eligible Options Members provided 
to the Exchange by the BATS Options Market Maker, in a manner 
prescribed by the Exchange, (2) the BATS Options Market Maker must be 
publicly quoting on BATS at the NBB (for sell Directed Orders) or NBO 
(for buy Directed Orders) with a Market Maker Price Improving Order 
that contains a non-displayed amount of price improvement over the NBB 
or NBO at the time the Directed Order arrives to the Exchange, and (3) 
the Directed Order must be marketable against the non-displayed price 
of the Market Maker Price Improving Order.
    If the above conditions are met, and if there are no other non-
displayed orders at prices equal to or better than the non-displayed 
price of the Market Maker Price Improving Order, the Directed Order 
will trade with the Market Maker Price Improving Order up to the full 
displayed size of the Market Maker Price Improving Order. Any remaining 
contracts from the Directed Order will be handled, consistent with the 
instructions on the Directed Order, in accordance with the order 
display and book processing requirements of Rule 21.8 and, if 
applicable, processed in accordance with the order routing requirements 
of Rule 21.9.
    If there are non-displayed orders on the BATS Options Book at 
prices equal to or better than the non-displayed price of the Market 
Maker Price Improving Order, those other non-displayed orders will in 
all cases have priority over the non-displayed price of the Market 
Maker Price Improving Order. In such circumstances, the Market Maker 
Price Improving Order may still execute at its non-displayed price 
against the Directed Order consistent with the price/time priority 
provisions of Rule 21.8 to the extent of any remaining contracts of the 
Directed Order. Any contracts remaining of the Directed Order will 
continue to be processed in a manner consistent with the order display 
and book processing provisions of Rule 21.8, and if applicable, the 
order routing provisions of Rule 21.9.
    As proposed, an Options Market Maker Price Improving Order would be 
required to have a non-displayed price better than the displayed limit 
price that could be entered in an increment as small as (1) one cent. 
The non-displayed price of a Market Maker Price Improving Order is not 
entered into the BATS Options Book, and is only eligible to trade with 
a Directed Order to the extent that certain conditions precedent are 
satisfied, including (1) that the displayed price of the Market Maker 
Price Improving Order is equal to the NBB (for sell directed orders) or 
the NBO (for buy directed orders) at the time the Directed Order 
arrives to the Exchange, and (2) that there are no other orders on the 
BATS Options Book at prices equal to or better than the non-displayed 
prices of the Market Maker Price Improving Order.\5\
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    \5\ As described in proposed Rule 11.9(c)(13)(B), all other 
interest on the BATS Book at prices equal to or better than the non-
displayed price of the Market Maker Price Improving Order has 
priority over the Market Maker Price Improving Order and, hence, 
will execute first against the Directed Order.
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    As noted elsewhere in this proposal, in all cases a Market Maker 
Price Improving Order must include a displayed price that is equal to 
the NBB or NBO for such order to be eligible to execute at its non-
displayed price against a Directed Order. As such, the proposal 
enhances the public price discovery process--if the market maker is not 
publicly quoting at the NBB or NBO at the time the Directed Order 
arrives to BATS Options, the market maker will only trade with that 
Directed Order to the extent that any other interest on the BATS 
Options Book at or better than the NBB or NBO and any other interest 
with price/time priority over the market maker's order is first 
satisfied. Accordingly, in order to enjoy the benefits of trading 
against Directed Orders, a market maker is required to publicly display 
a competitively priced order which is available, and hence at risk, to 
all Options Members.
    The Exchange is also proposing to delete certain language from its 
existing Price Improving Order rule text. In particular, as currently 
written, Rule 21.1(d)(6) states that ``Price Improving Orders that are 
available for display * * *.'' \6\ The Exchange is proposing to delete 
the clause ``that are available to display,'' which although intended 
to simply distinguish an order executed upon arrival to the Exchange 
from an order posting to the BATS Options Book, has the potential to 
cause confusion to the extent it may suggest that Price Improving 
Orders can be posted on the BATS Options Book without a displayed 
price. That is not the case today, would not be the case under the 
proposed changes to the rules, and BATS is proposing to delete this 
clause to eliminate any confusion on this point.
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    \6\ Emphasis added.
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    The elements of the Exchange's proposal to create a directed order 
program are specifically designed to enhance opportunities available in 
the market for Options Members to obtain price improvement for customer 
orders in the context of BATS' price/time priority, continuous auction 
market. By requiring BATS Options Market Makers to be quoting at the 
NBB or NBO to participate in an execution against a Directed Order 
directed to it, BATS' proposal incentivizes market makers to 
competitively quote and thereby furthers the public price discovery 
process. By further requiring BATS Options Market Makers to include a 
non-displayed price better than the displayed limit price at an 
increment as small as (1) one cent, the proposal increases the 
opportunities for customer orders to receive price improvement over the 
NBBO. Moreover, by permitting all Options Members to enter orders in 
the same increments as Market Maker Price Improving Orders, and 
according those orders in all cases priority at their non-displayed 
prices over Market Maker Price Improving Orders, the proposal avoids 
creating participation guarantees in place at other markets and instead 
promotes market-wide competition for executions at prices between the 
NBBO.
    Further, the proposal provides all market participants, including 
other market makers that do not have orders directed to them, with the 
ability to compete with market makers for executions against Directed 
Orders. BATS notes that all members, including market makers, have the 
ability to enter Price Improving Orders and any other orders that can 
compete in the same price increments with a particular market maker's 
Market Maker Price Improving Order. In options classes not subject to 
the penny pilot, market makers and non-market makers have the ability 
under the proposal to post orders with non-displayed prices at penny 
increments between the NBBO. Importantly, in all cases, market makers 
cede priority to all other orders priced equal to or better than the 
non-

[[Page 18282]]

displayed price of their Market Maker Price Improving Orders. In 
options classes subject to the penny pilot, all market participants can 
effectively compete against non-displayed Market Maker Price Improving 
Orders simply by improving the NBBO. In BATS' price/time priority 
market, the non-displayed portion of a Market Maker Price Improving 
Order will only execute at the non-displayed price when that price is 
the best available price. In addition, through its fee structure and 
``maker/taker'' pricing, BATS currently incents and intends to continue 
to provide certain incentives to BATS Options Members to display 
aggressively priced liquidity on BATS Options.
    BATS also wishes to make clear that its proposal has no impact on 
its existing rules regarding customer order facilitation. Today, BATS 
members seeking to facilitate customer order on BATS Options must 
comply with facilitation rules requiring the member to expose either 
the customer order or the principal order on the exchange for one 
second prior to a facilitation execution. These rules are similar to 
rules in effect on other exchanges, and the Exchange's proposal does 
not amend these requirements.\7\
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    \7\ Specifically, BATS Rule 22.12 prohibits Options Members from 
executing ``as principal orders they represent as agent unless (a) 
agency orders are first exposed on BATS Options for at least one (1) 
second or (b) the Options Member has been bidding or offering on 
BATS Options for at least one (1) second prior to receiving an 
agency order that is executable against such bid or offer 
(exposure).'' Rule 22.12 prevents Options Members from executing 
agency orders to increase economic gain from trading against the 
order without first giving other trading interest on BATS Options an 
opportunity to either trade with the agency order or to trade at the 
execution price when the Options Member was already bidding or 
offering on the book.
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    Pursuant to the proposed directed order program, a BATS Options 
Member who notifies a BATS Options Market Maker of its intention to 
submit a Directed Order to BATS Options so that the BATS Options Market 
Maker could change its quotation to match the NBB or NBO immediately 
prior to submission of the Directed Order would be engaging in conduct 
inconsistent with just and equitable principles of trade in violation 
of Rule 3.1 and Rule 18.4(f). In addition, a BATS Options Market Maker 
who becomes aware of a customer order from an affiliated broker-dealer 
or desk within the same broker-dealer and acts on such information to 
change its quotations to match the NBB or NBO immediately prior to 
submission of a Directed Order would be in violation of the Exchange's 
Rule 22.10, ``Limitations on Dealings''. BATS will proactively conduct 
surveillance for such conduct and enforce against such violations.
    The Exchange is proposing to adopt Rules 21.1(d)(13) and 
21.1(d)(14) as a six month pilot. During this pilot period, the 
Exchange will study the impact of the rules and will provide the 
Commission with monthly reports detailing its ongoing review of the 
pilot. These reports will include: data and analysis regarding price 
improvement trends following implementation of the directed order 
program, an assessment of the quotation spreads on BATS Options, data 
reflecting the size and depth of markets, and descriptions of any 
patterns that emerge during the pilot period. Specific data included in 
such reports will include, but not be limited to: (1) The number of 
Directed Orders submitted to BATS Options; (2) the number of Market 
Maker Price Improving Orders submitted to BATS Options; (3) information 
regarding the types of market participants that sent Directed Orders; 
(4) the number of Market Makers that participated in the directed order 
program; (5) the percentage of time that Market Makers participating in 
the directed order program were at the NBBO when a Directed Order 
arrived at BATS Options; (6) the number of orders, excluding Market 
Maker Price Improving Orders, against which an incoming Directed Order 
executed; (7) the proportion of each Directed Order that was executed 
against a Market Maker Price Improving Order; (8) the percentage of 
Directed Orders that received price improvement over the NBBO; (9) the 
average amount of price improvement for Directed Orders; and (10) data 
related to the quality of the best bid and offer on BATS Options.
2. Statutory Basis
    Approval of the rule changes proposed in this submission on a pilot 
basis is consistent with the requirements of the Act and the rules and 
regulations thereunder that are applicable to a national securities 
exchange, and, in particular, with the requirements of Section 6(b) of 
the Act.\8\ In particular, the proposed change is consistent with 
Section 6(b)(5) of the Act,\9\ because it would promote just and 
equitable principles of trade, remove impediments to, and perfect the 
mechanism of, a free and open market and a national market system, and, 
in general, protect investors and the public interest.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that the proposed rule meets these 
requirements in that it promotes competition for customer orders and 
furthers the public price discovery process by both incentivizing BATS 
Options Market Makers to publicly display aggressive quotes at the 
NBBO, as well as incentivizing BATS Options Market Makers and all other 
BATS Options Members to post non-displayed prices better than the NBBO. 
BATS notes that the Commission has previously found consistent with the 
Act non-displayed order types designed to provide price improvement at 
prices smaller than the minimum price variation in listed options.\10\
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    \10\ See, e.g., BATS Options Rule 21.1(d)(6) ``Price Improving 
Orders''; Nasdaq Options Market Rule Chapter VI, Section 1(e)(6) 
``Price Improving Orders''.
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    Moreover, the Commission has previously approved rules that provide 
specialist or market maker guarantees up to a certain percentage so 
long as the specialist or market maker is quoting at the NBBO and such 
guarantees do not rise to a level that could have a material adverse 
impact on quote competition with a particular exchange.\11\ While BATS' 
directed order program requires BATS Options Market Makers to be 
quoting at the NBB or NBO to be eligible to trade with an incoming 
Directed Order directed to it, in contrast to prior rules approved by 
the Commission, BATS' proposed directed order program provides no 
participation guarantees that could negatively impact quote 
competition. By not providing such guarantees, BATS's proposed directed 
order program provides incentives to BATS Options Market Makers as well 
as all other BATS Options Members to aggressively quote, both at the 
NBBO and at non-displayed prices better than the NBBO.
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    \11\ See, e.g., Securities Exchange Act Release No. 51759 (May 
27, 2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91) (order 
approving the establishment of a directed order process with certain 
specialist participation guarantees).
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    In addition, the Commission has previously approved rules that 
permit a specialist or market maker to determine the firms from which 
it will accept directed or preferenced orders. The Commission has 
explicitly approved a process similar to that proposed by BATS in the 
equity markets in which only those members who have been permissioned 
by a market maker are eligible to submit directed orders to the market 
maker.\12\ And, the Commission

[[Page 18283]]

has implicitly approved such processes in the options markets by 
allowing certain price improvement auctions to exist pursuant to pilot 
programs, which auctions provide the ability of an options member to 
submit a customer order along with a contra-side principal order from 
the options member into a brief price improvement auction in which all 
members have the ability to compete for the execution.\13\ BATS' 
proposed rule changes are similar in nature to these price improvement 
auctions, except that under BATS' proposal, competition for the 
execution with a Directed Order occurs in the context of BATS' 
continuous, price/time priority auction, rather than during a separate, 
one-second price improvement auction. As such, concerns about customer 
orders potentially ``missing the market'' during that exposure period 
are not present. That said, however, BATS has proposed to the 
Commission price improvement data and other data deemed necessary to 
evaluate the impact of the proposal. Also, as previously mentioned, 
BATS' proposal differs from existing price improvement auctions due to 
the fact that BATS Options Market Makers would have no participation 
guarantees.
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    \12\ See Securities Exchange Act Release No. 52827 (November 23, 
2005), 70 FR 72193 (December 1, 2005) (SR-PCX-2005-56) (order 
approving certain modifications to the PCX Equities, Inc.'s Directed 
Order Process on the Archipelago Exchange).
    \13\ See, e.g., BOX Rule Section 18 ``The Price Improvement 
Period'' and ISE Rule 723 ``Price Improvement Mechanism for Crossing 
Transactions'' (both of which providing a mechanism for options 
members that want to internalize customer orders the ability to do 
so on the exchanges subject to a requirement that such orders first 
be exposed to all other options members through a brief price 
improvement auction).
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    The Exchange notes market makers already retain the discretion to 
pay certain firms non-transparent payment for order flow amounts. The 
proposal similarly retains that existing discretion for market makers, 
but provides a mechanism for such payments, or at least a portion of 
such payments, to be provided in a transparent fashion to the Directed 
Order in the form of price improvement over the NBBO.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change imposes 
any burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No.1, is consistent with the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-BATS-2011-009 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

    All submissions should refer to File Number SR-BATS-2011-009. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for Web site 
viewing and printing in the Commission's Public Reference Room, 100 F 
Street, NE., Washington, DC 20549, on official business days between 
the hours of 10 a.m. and 3 p.m. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
Exchange. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
BATS-2011-009 and should be submitted on or before April 22, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-7688 Filed 3-31-11; 8:45 am]
BILLING CODE 8011-01-P