[Federal Register Volume 78, Number 174 (Monday, September 9, 2013)]
[Notices]
[Pages 55126-55128]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-21816]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70303]


Order Exempting Broker-Dealers Participating in NYSE Arca, Inc.'s 
Lead Market Maker Incentive Program From Section 11(d)(1) of the 
Securities Exchange Act of 1934 and Rule 11d1-2 Thereunder

September 3, 2013.
    On June 6, 2013, the Securities and Exchange Commission 
(``Commission'') approved a proposed rule change of NYSE Arca, Inc. 
(``Exchange'' or ``NYSE Arca'') to adopt new NYSE Arca Equities Rule 
8.800 (``Rule 8.800''). Rule 8.800 establishes an incentive program on 
a pilot basis (``Incentive Program'') for Lead Market Makers (``LMMs'') 
in certain exchange-traded products (``ETPs'').\1\ The Incentive 
Program is designed to encourage market makers to take LMM assignments 
in certain lower volume ETPs by offering an alternative fee structure 
for those LMMs and ``LMM Payments'' that would be funded from the 
Exchange's general revenues if the LMM meets or exceeds certain 
performance standards set forth in Rule 8.800(c) that relate to the 
LMM's quoting activity in the ETP. The costs of the Incentive Program 
would be funded by charging participating issuers non-refundable 
``Optional Incentive Fees'' which may be paid by sponsors on behalf of 
the issuer.
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    \1\ Securities Exchange Act Release No. 69706 (June 6, 2013), 78 
FR 35340 (June 12, 2013) (SR-NYSEArca-2013-34) (the ``Approval 
Order''). The Approval Order contains a detailed description of the 
Incentive Program. On March 21, 2013, the Exchange filed with the 
Commission, pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934, as amended (``Act'' or ``Exchange Act'') and Rule 19b-4 
thereunder, a proposed rule change to establish the Program. The 
proposed rule change, as modified by Amendment No. 1 thereto, was 
published for comment in the Federal Register on April 11, 2013. 
Securities Exchange Act Release No. 69335 (Apr. 5, 2013), 78 FR 
21681 (Apr. 11, 2013). The Approval Order grants approval of the 
proposed rule change, as modified by Amendments No. 1 and 2.
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    Section 11(d)(1) of the Exchange Act \2\ generally prohibits a 
broker-dealer from extending or maintaining credit, or arranging for 
the extension or maintenance of credit, on shares of new issue 
securities, if the broker-dealer participated in the distribution of 
the new issue securities within the preceding 30 days. Shares of open-
end investment companies and unit investment trusts registered under 
the Investment Company Act of 1940, such as exchange traded fund 
(``ETF'') shares, are distributed in a continuous manner. Broker-
dealers that sell such securities are therefore participating in the 
``distribution'' of a new issue for purposes of Section 11(d)(1).\3\
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    \2\ 15 U.S.C. 78k(d)(1).
    \3\ See, e.g., Exchange Act Release Nos. 6726 (Feb. 8, 1962), 27 
FR 1415 (Feb. 15, 1962) and 21577 (Dec. 18, 1984), 49 FR 50174 (Dec. 
27, 1984).
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    The Division of Trading and Markets, acting under delegated 
authority, granted an exemption from Section 11(d)(1) and Rule 11d1-2 
thereunder to broker-dealers that have entered into an agreement with 
an ETF's distributor to place orders with the distributor to purchase 
or redeem the ETF's shares (``Broker-Dealer APs'').\4\ The SIA 
Exemption allows a Broker-Dealer AP to extend or maintain credit, or 
arrange for the extension or maintenance of credit, to or for customers 
on the shares of qualifying ETFs subject to the condition that neither 
the Broker-Dealer AP, nor any natural person associated with the 
Broker-Dealer AP, directly or indirectly (including through any 
affiliate of the Broker-Dealer AP), receives from the fund complex any 
payment, compensation, or other economic incentive to promote or sell 
the shares of the ETF to persons outside the fund complex, other than 
non-cash compensation permitted under NASD Rule 2830(l)(5)(A), (B), or 
(C). This condition is intended to eliminate special incentives that 
Broker-Dealer APs and their associated persons might otherwise have to 
``push'' ETF shares.
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    \4\ See Letter from Catherine McGuire, Chief Counsel, Division 
of Trading and Markets, Securities and Exchange Commission to 
Securities Industry Association (Nov. 21, 2005) (``SIA Exemption'').
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    The Incentive Program will permit certain ETPs, including ETFs and 
commodity-based exchange traded trusts, to voluntarily incur increased 
listing fees payable to the Exchange. In turn, the Exchange will use a 
portion of the fees to make LMM Payments to market makers that improve 
the market quality of participating issuers'

[[Page 55127]]

securities.\5\ LMM Payments will be accrued solely for quoting activity 
on the Exchange. Broker-dealers receiving the incentive payments would 
not be in compliance with the compensation condition of the SIA 
Exemption discussed above.\6\ Therefore, an LMM that is also a Broker-
Dealer AP for an ETF (or an associated person or an affiliate of a 
Broker-Dealer AP) that receives the incentives will not be able to rely 
on the SIA Exemption from Section 11(d)(1).\7\
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    \5\ Among other things, the Incentive Program requires LMMs to: 
(1) Maintain continuous, two-sided trading interest where the price 
of the bid (offer) interest is not more than a designated percentage 
away from the then current NBBO; (2) maintain quotes or orders at 
the NBBO or better (the ``Inside'') during the month during Core 
Trading Hours in accordance with certain maximum width and minimum 
depth thresholds based on daily share volume and share price, unless 
the thresholds are otherwise met by quotes or orders of all market 
participants across all markets trading the security; (3) maintain 
quotes or orders on NYSE Arca at the NBBO that meet either a time-
at-the-Inside requirement or a size-setting NBBO requirement; and 
(4) for at least 90% of the time when quotes may be entered during 
Core Trading Hours each trading day, as averaged over the course of 
a month, maintain (A) at least 2,500 shares of attributable, 
displayed posted buy liquidity on the Exchange that is priced no 
more than 2% away from the NBB for the particular ETP; and (B) at 
least 2,500 shares of attributable, displayed posted offer liquidity 
on the Exchange that is priced no more than 2% away from the NBO for 
the particular ETP. If an LMM does not meet these quoting 
requirements, it will not receive an LMM Payment, and an LMM that 
does not meet or exceed these performance standards for any two of 
the three months of a quarter or for five months during the pilot 
period may lose its LMM status. Request Letter at 5.
    \6\ The incentive payments market makers may receive under Rule 
8.800 are indirect payments from the fund complex to the market 
maker and that those payments are compensation to promote or sell 
the shares of the ETF.
    \7\ See Approval Order, supra note 1, at 31-33.
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    Thus, NYSE Arca has requested, on behalf of itself and those 
broker-dealers that receive payments under the Incentive Program as 
discussed in its letter, an exemption from the requirements of Section 
11(d)(1) of the Exchange Act and Rule 11d1-2 thereunder.\8\
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    \8\ Letter from Janet McGinness, Senior Vice President and 
Secretary, NYSE Euronext to David Blass, Chief Counsel, Division of 
Trading and Markets, Securities and Exchange Commission (September 
3, 2013) (``Request Letter''). The relief requested is similar to 
the relief the Commission previously granted to NASDAQ Stock Market 
LLC in connection with its pilot Market Quality Program. See 
Exchange Act Release No. 69892 (June 28, 2013).
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    NYSE Arca maintains that a Broker-Dealer AP and a broker-dealer 
that is not a Broker-Dealer AP in a particular ETF, but effects 
transactions in shares of the ETF exclusively in the secondary market 
(``Non-AP Broker-Dealer'') should be able to rely on the SIA Exemption, 
notwithstanding the receipt of payments under the Incentive Program. 
Among other things, the Exchange notes that the LMM Payment is provided 
only to LMMs that meet or exceed market quality standards and that the 
Incentive Program will not provide an incentive for LMMs to ``push'' 
the securities of participating issuers.\9\ Rather, the Exchange states 
that the Incentive Program is intended to foster enhanced liquidity, 
robust quoting activity, narrowed spreads, and reduced transaction 
costs for investors in participating ETPs. NYSE Arca notes that the LMM 
Payments are not attributable to LMMs executing transactions in 
securities, but only for LMMs' two-sided quoting activity. The Exchange 
also states that the disclosure provisions of the Incentive Program 
will alert and educate investors about the program and the LMM 
Payments.\10\
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    \9\ Congress adopted Section 11(d)(1) in response to concerns 
about potential conflicts of interest faced by persons acting as 
both brokers and dealers in the distribution of new issue 
securities. In a House report accompanying the Exchange Act, 
Congress noted:
    It is difficult to serve two masters. And it is particularly 
difficult to give impartial advice to a client if the dealer-broker 
has his own securities to sell, particularly when they are new 
securities for which there is no ready market.
    H.R. Rep. No. 1383, 73d Cong., 2d Sess. 15 (1934). Congress 
concluded that forcing the separation of brokers and dealers would 
have led brokers to abandon their dealer business, impairing the 
mechanism to distribute new securities. In lieu of this measure, 
Congress required broker-dealers to disclose to customers the 
capacity in which they were acting and adopted section 11(d)(1) 
prohibiting broker-dealers from extending margin on new issue 
securities in the distribution of which the broker-dealer had 
participated. Id.
    \10\ Request Letter at 7. The Exchange notes that its new rules 
are designed to provide comprehensive and accessible disclosure to 
investors about the MQP Program through the Exchange's Web site or 
the Web sites of the participating issuers. New Rules 8.800(b)(6) 
and (7) require the Exchange to disclose on its Web site the 
following information with respect to the operation of the Incentive 
Program: (i) The ETPs participating in the Incentive Program and the 
LMM assigned to each participating ETP; (ii) the date a particular 
ETP begins participating or ceases participating in the Incentive 
Program; (iii) the date the Exchange receives written notice of an 
issuer's intent to withdraw its ETP from the Incentive Program, or 
an LMM's intent to withdraw from its ETP assignment(s) in the 
Incentive Program, and, in each case, the intended withdrawal date, 
if provided; and (iv) the amount of the Optional Incentive Fee for 
each ETP. The Exchange also will include on its Web site a fair and 
balanced description of the Incentive Program, including a 
description of the potential benefits and risks that may be 
attendant with an ETP's participation in the program. An issuer of 
an ETP that is approved to participate in the Incentive Program will 
also be required to (i) issue a press release to the public when an 
ETP commences or ceases participation in the Incentive Program, (ii) 
post such press release on its Web site, and (iii) provide on its 
Web site a hyperlink to the Exchange's Web page describing the 
Incentive Program.
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    NYSE Arca also asserts that the Incentive Program's goal of 
enhancing market quality is most likely to be accomplished if the 
program attracts as many participating market makers as possible. In 
the Exchange's view, eligible market makers may decline to participate 
in the program if no exemption from Section 11(d)(1) and Rule 11d1-2 is 
available, either because the market makers may already extend credit 
to customers on the securities of participating issuers or because the 
value to market makers of offering credit services to customers on such 
securities may outweigh the value of participating in the Incentive 
Program.\11\ The Commission recognizes that broker-dealers that have to 
choose between participating in the Incentive Program and having the 
ability to offer credit services to customers in reliance on the SIA 
Exemption for business reasons may determine to continue to offer the 
credit services and decline to participate in the Incentive Program. In 
other words, the lack of an available exemption from Section 11(d)(1) 
and Rule 11d1-2 thereunder could serve to reduce the number of market 
makers in the Incentive Program.
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    \11\ Request Letter at 6.
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    The Commission finds that it is appropriate in the public interest, 
and is consistent with the protection of investors, to grant a limited 
exemption from Section 11(d)(1) of the Exchange Act and Rule 11d1-2 
thereunder to Broker-Dealer APs and Non-AP Broker-Dealers that 
participate in the Incentive Program. The Incentive Program is intended 
to improve market quality by promoting enhanced liquidity, reduced 
spreads, and reduced cost of investing in the securities of 
participating issuers. The Commission believes that granting the 
exemption will encourage a larger number of market makers to 
participate in the Incentive Program and that a larger number of 
participating market makers should create greater potential for the 
market quality improvements the Incentive Program aims to achieve. The 
Commission notes in particular that the Exchange will determine to pay 
an LMM Payment only if an LMM maintains certain minimum quoting 
standards.\12\ No portion of the LMM Payment is attributable to sales 
of ETP securities and thus the LMM Payment should provide no direct 
incentive for LMMs to promote the sale of ETP securities. Thus, the 
Commission does not believe that the LMM Payment will provide the kind 
of incentive for ``share-pushing'' with which Congress was concerned 
when it enacted Section 11(d).\13\ Moreover, the required Web site

[[Page 55128]]

disclosures, discussed above,\14\ should also help LMMs' customers 
understand the Program's effect on LMMs' incentives and thus will help 
investors to make informed decisions in light of the additional 
incentives LMMs may have in providing quotes for these securities.
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    \12\ See note 5, supra.
    \13\ See note 9, supra.
    \14\ See note 10, supra.
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Conclusion

    It is therefore ordered, that Broker-Dealer APs and Non-AP Broker-
Dealers that participate in the Incentive Program, may rely on the SIA 
Exemption pertaining to Section 11(d)(1) and Rule 11d1-2 
thereunder,\15\ subject to the conditions provided in that exemption, 
notwithstanding that Broker-Dealer APs and Non-AP Broker-Dealers may 
receive LMM Payments for participating in the Incentive Program as 
described in your request.
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    \15\ See note 4, supra.
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    This exemption will expire when the Incentive Program terminates, 
and is subject to modification or revocation at any time the Commission 
determines that such action is necessary or appropriate in furtherance 
of the purposes of the Exchange Act.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(62).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-21816 Filed 9-6-13; 8:45 am]
BILLING CODE 8011-01-P