[Federal Register Volume 82, Number 133 (Thursday, July 13, 2017)]
[Notices]
[Pages 32386-32392]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-14666]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81097; File No. SR-NASDAQ-2016-161]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Approving a Proposed Rule Change, as Modified by Amendment No. 1, To 
Adopt a New Extended Life Priority Order Attribute Under Rule 4703, and 
To Make Related Changes to Rules 4702, 4752, 4753, 4754, and 4757

July 7, 2017.

I. Introduction

    On November 17, 2016, the NASDAQ Stock Market LLC (``Exchange'' or 
``Nasdaq'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to adopt a new extended life priority order 
(``ELO'') attribute for designated retail orders under Nasdaq Rule 
(``Rule(s)'') 4703, and to make related changes to Rules 4702, 4752, 
4753, 4754, and 4757. The proposed rule change was published for 
comment in the Federal Register on December 5, 2016.\3\ On January 17, 
2017, pursuant to Section 19(b)(2) of the Act,\4\ the Commission 
designated a longer period within which to approve the proposed rule 
change, disapprove the proposed rule change, or institute proceedings 
to determine whether to approve or disapprove the proposed rule 
change.\5\ The Commission initially received seven comment letters on 
the proposed rule change.\6\ On February 17, 2017, the Exchange filed 
Amendment No. 1 to the proposed rule change \7\ and submitted a comment 
response letter.\8\ The Commission subsequently received two additional 
comment letters on the proposed rule change.\9\ On March 3, 2017, the 
Commission instituted proceedings under Section 19(b)(2)(B) of the Act 
\10\ to determine whether to approve or disapprove the proposed rule 
change, as modified by Amendment No. 1.\11\ The Commission received two 
additional comment letters on the proposed rule change in response to 
the Order Instituting Proceedings.\12\ On April 24, 2017, the Exchange 
submitted a second comment response letter.\13\ On May 31, 2017, the 
Exchange extended the time period for Commission action to August 2, 
2017. This order approves the proposed rule change, as modified by 
Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 79428 (November 30, 
2016), 81 FR 87628 (``Notice'').
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 79810, 82 FR 8244 
(January 24, 2017). The Commission designated March 5, 2017 as the 
date by which the Commission shall approve or disapprove, or 
institute proceedings to determine whether to approve or disapprove, 
the proposed rule change.
    \6\ See Letters to Brent J. Fields, Secretary, Commission, from: 
Joseph Saluzzi and Sal Arnuk, Partners, Themis Trading LLC, dated 
December 19, 2016 (``Themis Letter I''); Eric Swanson, EVP, General 
Counsel, and Secretary, Bats Global Markets, Inc., dated December 
22, 2016 (``BATS Letter''); Adam Nunes, Head of Business 
Development, Hudson River Trading LLC, dated December 22, 2016 
(``Hudson River Trading Letter''); Joanna Mallers, Secretary, FIA 
Principal Traders Group, dated December 23, 2016 (``FIA PTG Letter 
I''); Adam C. Cooper, Senior Managing Director and Chief Legal 
Officer, Citadel Securities, dated December 27, 2016 (``Citadel 
Letter I''); Andrew Stevens, General Counsel, IMC Financial Markets, 
dated December 28, 2016 (``IMC Letter''); and Venu Palaparthi, SVP, 
Compliance, Regulatory & Government Affairs, Virtu Financial LLC, 
dated February 9, 2017 (``Virtu Letter'').
    \7\ In Amendment No. 1, the Exchange: (i) Specified that the ELO 
attribute would be available during ``System Hours'' as defined in 
Rule 4701(g); (ii) clarified that any subsequent proposal to broaden 
the availability of the ELO attribute would be set forth in a 
distinct rule filing; (iii) provided additional details regarding 
the calculation of the 99% ELO eligibility requirement; (iv) 
proposed to assess members' compliance with ELO eligibility 
requirements on a monthly basis instead of a quarterly basis as 
initially proposed; (v) stated that, concurrently with the initial 
launch of the ELO attribute, it will implement new surveillances to 
identify any potential misuse of the ELO attribute; (vi) provided 
additional discussions regarding the availability of the ELO 
identifier on the Exchange's TotalView ITCH market data feed; (vii) 
provided additional details as to how the ELO attribute would 
operate with other order attributes and cross-specific order types; 
(viii) provided information regarding the Exchange's implementation 
of the ELO attribute; and (ix) provided additional justifications 
for proposing the ELO attribute. Amendment No. 1 has been placed in 
the public comment file for SR-NASDAQ-2016-161 at https://www.sec.gov/comments/sr-nasdaq-2016-161/nasdaq2016161-1589828-132168.pdf.
    \8\ See Letter to Brent J. Fields, Secretary, Commission, from 
T. Sean Bennett, Associate Vice President and Principal Associate 
General Counsel, Nasdaq, dated February 17, 2017 (``Nasdaq Response 
Letter I'').
    \9\ See Letters to Brent J. Fields, Secretary, Commission, from: 
John Ramsay, Chief Market Policy Officer, Investors Exchange LLC, 
dated March 2, 2017 (``IEX Letter''); and Joseph Saluzzi and Sal 
Arnuk, Partners, Themis Trading LLC, dated March 3, 2017 (``Themis 
Letter II'').
    \10\ 15 U.S.C. 78s(b)(2)(B).
    \11\ See Securities Exchange Act Release No. 80149, 82 FR 13168 
(March 9, 2017) (``Order Instituting Proceedings'').
    \12\ See Letter to Brent J. Fields, Secretary, Commission, from 
Joanna Mallers, Secretary, FIA Principal Traders Group, dated March 
30, 2017 (``FIA PTG Letter II''); Letter to Eduardo A. Aleman, 
Assistant Secretary, Commission, from Stephen John Berger, Managing 
Director, Government & Regulatory Policy, Citadel Securities, dated 
March 30, 2017 (``Citadel Letter II'').
    \13\ See Letter to Brent J. Fields, Secretary, Commission, from 
T. Sean Bennett, Associate Vice President and Principal Associate 
General Counsel, Nasdaq, dated April 24, 2017 (``Nasdaq Response 
Letter II'').
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II. Description of the Proposal, as Modified by Amendment No. 1

    The Exchange has proposed to offer a new ELO attribute, which would 
allow certain displayed retail orders to receive higher priority on the 
Nasdaq book than other orders at the same price (``Extended Life 
Priority''), and to make conforming changes to its rules. As discussed 
in more detail below, the Exchange has proposed to amend Rule 4703 to 
set forth the ELO attribute in new subparagraph (m), add an attachment 
B to its designated retail order attestation form that sets forth an 
attestation that would be required of members in connection with 
utilizing the ELO attribute, and make related changes to Rules 4702(b), 
4752, 4753, 4754, and 4757.

A. Proposed Rule 4703(m) and Attestation

    Proposed Rule 4703(m) states that ELO is an order attribute that 
allows an order to receive priority in the Nasdaq book above other 
orders resting on the Nasdaq book at the same price that are

[[Page 32387]]

not designated with the ELO attribute.\14\ As proposed, the ELO 
attribute would be available only for displayed orders that qualify as 
Designated Retail Orders,\15\ and would be available during System 
Hours.\16\ A Designated Retail Order with the ELO attribute that is not 
marketable upon entry would be ranked on the Nasdaq book ahead of other 
displayed orders at the same price level that do not have the ELO 
attribute, but behind any other ELO orders at the same price level that 
the Exchange received previously.\17\
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    \14\ See also proposed changes to Rule 4757(a)(1)(B).
    \15\ See proposed Rule 4703(m). A ``Designated Retail Order'' is 
an agency or riskless principal order that meets the criteria of 
FINRA Rule 5320.03 and that originates from a natural person and is 
submitted to Nasdaq by a member that designates it pursuant to Rule 
7018, provided that no change is made to the terms of the order with 
respect to price or side of market and the order does not originate 
from a trading algorithm or any other computerized methodology. See 
Rule 7018. If a Designated Retail Order with a non-display attribute 
is also entered with the ELO attribute, the ELO attribute would be 
ignored and the order would be ranked on the Nasdaq book as a non-
displayed order without Extended Life Priority. See proposed Rule 
4703(m). The Exchange has stated that it may propose to extend the 
availability of the ELO functionality to all orders that meet the 
requirements of the ELO attribute at a later time. See Notice, 81 FR 
at 87630; see also Amendment No. 1. According to the Exchange, any 
such proposal would be made through a separate filing of a proposed 
rule change with the Commission, and would likely require 
significant changes to the operation of the ELO attribute to account 
for the different participants eligible to use the attribute. See 
Amendment No. 1.
    \16\ See Amendment No. 1. See also Rule 4701(g) (defining 
``System Hours'' to mean the period of time beginning at 4:00 a.m. 
ET and ending at 8:00 p.m. ET (or such earlier time as may be 
designated by Nasdaq on a day when Nasdaq closes early)).
    \17\ See proposed Rule 4703(m); see also Notice, 81 FR at 87631.
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    As proposed, at least 99% of the Designated Retail Orders with the 
ELO attribute entered by the member must exist unaltered on the Nasdaq 
book for a minimum of one second for an Exchange member to be eligible 
to use the ELO attribute.\18\ Exchange members would be required to 
submit a signed written attestation that they will comply with these 
eligibility requirements.\19\
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    \18\ See proposed Rule 4703(m). The Exchange has stated that it 
will monitor the effectiveness of the one-second minimum resting 
time and the 99% threshold, and will propose to adjust these 
requirements, as needed, in a separate proposed rule change with the 
Commission. See Amendment No. 1.
    \19\ See proposed Rule 4703(m). The Exchange has proposed to 
amend its designated retail order attestation form to add an 
attachment B in order to require members to attest to compliance 
with the eligibility requirements for the ELO attribute, and to 
attest to their understanding of the penalties in cases of non-
compliance. See proposed changes to the designated retail order 
attestation form, included as Exhibit 3 to Amendment No. 1. As 
proposed, the designated retail order attestation form also would 
inform members that they can designate certain order entry ports as 
``Retail Extended Life Order Ports'' or tag each order as a ``Retail 
Extended Life Order.'' See id.
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    For purposes of determining compliance with the 99% threshold, the 
Exchange would measure the number of orders with the ELO attribute that 
rested for one second or longer and divide that value by the number of 
orders that the member marked with the ELO attribute.\20\ Moreover, the 
one second time frame would begin at the time the ELO order is entered 
into the Nasdaq book and would conclude once the order is removed from 
the Nasdaq book or modified by the participant or the Nasdaq 
system.\21\ As proposed, any change to an order that would currently 
result in the order losing priority (i.e., a change in the order's time 
stamp) would, if applied to an ELO order, be considered an alteration 
of the ELO order and stop the clock in terms of determining whether the 
order rested on the book unaltered for at least one second.\22\ In this 
vein, the Exchange stated that any type of update to an order that 
creates a new time stamp for priority purposes would count as a 
modification of the order and noted, by way of example, that each time 
an ELO order is updated due to pegging,\23\ re-pricing, or reserve 
replenishment, the one-second timer would restart.\24\ The Exchange 
also stated that full cancellations would stop the timer.\25\ In 
addition, a sub-second full or partial execution of an ELO order 
resting on the Nasdaq book would not count as an order modification for 
purposes of determining compliance with the ELO eligibility 
requirements.\26\ Accordingly, a sub-second partial execution of an ELO 
order would not reset the time from which the one second time frame is 
measured for the remainder of the order.\27\ Likewise, a member's 
reduction of the size of a resting ELO order prior to one second 
elapsing also would not count as an alteration for purposes of 
determining compliance with the ELO eligibility requirements.\28\
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    \20\ See Amendment No. 1.
    \21\ See id. For an ELO order that Nasdaq routes upon receipt, 
the one second time frame would begin if and when the order returns 
to Nasdaq and is posted on the Nasdaq book. See id.
    \22\ See id.
    \23\ The Exchange illustrated through an example that each time 
an ELO order with a primary or market pegging attribute has its 
price updated, it would be considered a new order for purposes of 
determining its resting time. See id. According to the Exchange, 
each price update would be considered a separate order for 
determining compliance with the ELO eligibility requirements. See 
id.
    \24\ See id.
    \25\ See id.
    \26\ See proposed Rule 4703(m); see also Amendment No. 1.
    \27\ See Amendment No. 1.
    \28\ See id.
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    As noted above, only displayed Designated Retail Orders would be 
eligible for the ELO attribute, and if a Designated Retail Order with a 
non-display attribute also is entered with the ELO attribute, the order 
would be added to the Nasdaq book as a non-displayed order without 
Extended Life Priority.\29\ By way of example, the Exchange noted that 
an order with minimum quantity or midpoint pegging attributes would not 
be able to receive Extended Life Priority because an order with either 
of those attributes must be non-displayed.\30\ The Exchange also noted 
that a reserve order has a displayed portion and non-displayed portion, 
and the displayed portion of a reserve order with the ELO attribute 
would be eligible to receive Extended Life Priority while the non-
displayed portion of the order would not.\31\ If the displayed portion 
of such an order receives a full execution, the displayed quantity 
would be replenished from the non-displayed reserve quantity, the 
newly-replenished displayed size would receive a new time stamp and 
Extended Life Priority based on that time stamp, and a new timer would 
start for purposes of determining compliance with the one second 
requirement.\32\
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    \29\ See proposed Rule 4703(m); see also supra note 15.
    \30\ See Amendment No. 1.
    \31\ See id.
    \32\ See id.
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    As proposed, an order designated with the ELO attribute would only 
have Extended Life Priority if it is ranked at its displayed price. 
Specifically, proposed Rule 4703(m) would provide that an ELO order 
that is adjusted by the Exchange system upon entry to be displayed on 
the Nasdaq book at one price but ranked on the book at a different, 
non-displayed price would be ranked without the ELO attribute at the 
non-displayed price. If the Nasdaq system subsequently adjusts such an 
order to be displayed and ranked on the Nasdaq book at the same price, 
the order would be assigned Extended Life Priority and ranked on the 
book in time priority among other orders with Extended Life Priority at 
that price.\33\
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    \33\ See proposed Rule 4703(m).
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    Additionally, proposed Rule 4703(m) would provide that, for 
purposes of the Nasdaq opening, closing, and halt crosses, all ELO 
orders on the Nasdaq book upon initiation of a cross may participate in 
such a cross and retain priority among orders posted on the Nasdaq book 
that also participate in the

[[Page 32388]]

cross. Upon initiation of a cross, all ELO orders on the Nasdaq book 
that are eligible to participate in a cross would be processed in 
accordance with Rule 4752 (Opening Process), Rule 4753 (Nasdaq Halt 
Cross), or Rule 4754 (Nasdaq Closing Cross), as applicable.\34\ ELO 
orders that are held by the Nasdaq system for participation in the 
opening or closing cross would not have Extended Life Priority in the 
cross,\35\ but would be assigned Extended Life Priority if the order 
joins the Nasdaq book upon completion of the cross.\36\ Any orders with 
Extended Life Priority that are not executed in a cross would be ranked 
on the Nasdaq book with Extended Life Priority.\37\
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    \34\ See id.
    \35\ According to the Exchange, cross-specific orders marked 
with the ELO attribute would be eligible to participate in the 
Nasdaq opening, halt, and closing crosses, but they would be ranked 
for purposes of a cross execution without the ELO attribute. See 
Notice, 81 FR at 87631. By contrast, orders with the ELO attribute 
that are ranked on the Nasdaq book (i.e., orders that are in the 
continuous market) would retain Extended Life Priority for purposes 
of a cross execution. See id. See also Amendment No. 1.
    \36\ See proposed Rule 4703(m).
    \37\ See id.
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    The Exchange stated that it would carefully monitor members' use of 
the ELO attribute on a monthly basis and would not rely solely on a 
member's attestation with regard to ELO usage.\38\ The Exchange also 
stated that it would determine whether a member was in compliance with 
the ELO eligibility requirements for a given month within five business 
days of the end of that month.\39\ A member that does not meet the ELO 
eligibility requirements for any given month would be ineligible to 
receive Extended Life Priority for its orders in the month immediately 
following the month in which it did not comply.\40\ Following the end 
of the ineligible month, a member would once again be able to enter ELO 
orders if it completes a new attestation.\41\ If a member fails to meet 
the ELO eligibility requirements for a second time, its orders would 
not be eligible for Extended Life Priority for the two months 
immediately following the month in which it did not meet the 
eligibility requirements for the second time.\42\ If a member fails to 
meet the ELO eligibility requirements for a third time, it would no 
longer be eligible to receive Extended Life Priority for its 
orders.\43\ In addition, concurrently with the launch of the ELO 
attribute, the Exchange would implement new surveillances to identify 
any potential misuse of the ELO attribute.\44\ Moreover, any attempted 
manipulation or misrepresentation of the nature of an ELO order (e.g., 
representing a non-retail order to be a Designated Retail Order) would 
be a violation of Nasdaq's rules.\45\
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    \38\ See Amendment No. 1.
    \39\ See id.
    \40\ See id.; see also proposed new attachment B to the 
Exchange's designated retail order attestation form at Exhibit 3 to 
Amendment No. 1. The Exchange has stated that its system would 
prevent a member that is not eligible to participate in the program 
from entering orders that are flagged with Extended Life Priority 
(including such designation on the port level). See Notice, 81 FR at 
87630 n.17.
    \41\ See Amendment No. 1; see also proposed new attachment B to 
the Exchange's designated retail order attestation form at Exhibit 3 
to Amendment No. 1.
    \42\ Following the end of the ineligible months, a member would 
once again be able to enter ELO orders if it completes a new 
attestation. See Amendment No. 1; see also proposed new attachment B 
to the Exchange's designated retail order attestation Form at 
Exhibit 3 to Amendment No. 1.
    \43\ See Amendment No. 1; see also proposed new attachment B to 
the Exchange's designated retail order attestation form at Exhibit 3 
to Amendment No. 1.
    \44\ See Amendment No. 1.
    \45\ See id. According to Nasdaq, like the current surveillances 
it conducts, the new surveillances would identify potential 
violative conduct that would be investigated by Nasdaq and FINRA, 
and if the conduct is found to be violative, the offending member 
would be subject to disciplinary action. See id. (citing the Nasdaq 
Rule 9000 Series). See also infra notes 96-98 and accompanying text.
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    The Exchange has proposed to designate orders with the ELO 
attribute with a new, unique identifier.\46\ Specifically, orders with 
the ELO attribute may be individually designated with the new 
identifier, or may be entered through an order port that has been set 
to designate, by default, all orders with the new identifier.\47\ 
Orders marked with the new identifier--whether on an order-by-order 
basis or via a designated port--would be disseminated via Nasdaq's 
TotalView ITCH data feed.\48\
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    \46\ See Notice, 81 FR at 87630-31; see also proposed new 
attachment B to the Exchange's designated retail order attestation 
form at Exhibit 3 to Amendment No. 1.
    \47\ See Notice, 81 FR at 87630-31; see also proposed new 
attachment B to the Exchange's designated retail order attestation 
form at Exhibit 3 to Amendment No. 1.
    \48\ See Notice, 81 FR at 87630-31. The Exchange is not 
proposing to disseminate the ELO identifier via the SIP data feeds. 
See Amendment No. 1.
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B. Additional Conforming Rule Changes

    In connection with the proposed addition of Rule 4703(m), the 
Exchange has proposed to make conforming changes to Rules 
4702(b)(1)(C), (b)(2)(C), and (b)(4)(C) to indicate that the ELO 
attribute may be assigned to price to comply, price to display, and 
post-only orders, respectively. In addition, the Exchange has proposed 
to amend Rules 4752 (Opening Process), 4753 (Nasdaq Halt Cross), and 
4754 (Nasdaq Closing Cross) to incorporate ELO orders into the cross 
execution priority hierarchies set forth in each of those rules.

C. Implementation

    The Exchange has stated that it plans to implement the ELO 
functionality for Designated Retail Orders in a measured manner.\49\ 
Specifically, the Exchange anticipates a rollout of the ELO 
functionality, beginning with a small set of symbols and gradually 
expanding further, and that it will publish the symbols that are 
eligible for the ELO attribute on its Web site.\50\ According to the 
Exchange, the exact implementation date would be reliant on several 
factors, such as the results of extensive testing and industry events 
and initiatives.\51\ The Exchange currently plans to implement the 
initial set of symbols for ELO in the third quarter of 2017.\52\
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    \49\ See Amendment No. 1.
    \50\ See id. The Exchange noted that, in symbols that are not 
eligible for the ELO functionality, it would accept orders submitted 
with the ELO attribute as non-ELO orders. See id.
    \51\ See id.
    \52\ See id. The Exchange stated that it would notify market 
participants via an Equity Trader Alert once a specific date for the 
initial rollout is determined. See id.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\53\ In particular, the 
Commission finds that the proposed rule change is consistent with 
Section 6(b)(5) of the Act,\54\ which requires, among other things, 
that the rules of a national securities exchange be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in facilitating transactions in securities, to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system and, in general, to protect 
investors and the public interest, and that the rules are not designed 
to permit unfair discrimination between customers, issuers, brokers, or 
dealers; and Section 6(b)(8) of the Act,\55\ which requires that the 
rules of a national securities

[[Page 32389]]

exchange not impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.
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    \53\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \54\ 15 U.S.C. 78f(b)(5).
    \55\ 15 U.S.C. 78f(b)(8).
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    The Commission believes that the Exchange's proposed ELO 
functionality should benefit retail investors by providing enhanced 
order book priority to retail order flow that is not marketable upon 
entry. Such enhanced order book priority could result in additional or 
more immediate execution opportunities on the Exchange for resting 
retail orders that otherwise would be farther down in the order book 
queue, and thereby enhance execution opportunities for retail 
investors.
    As noted above, the Commission received eleven comment letters on 
the proposed rule change,\56\ and two response letters from the 
Exchange.\57\ One of the commenters expressed support for the proposal, 
but encouraged additional safeguards to minimize the opportunity for 
potential gaming of the ELO eligibility requirements.\58\ Other 
commenters expressed concerns that focused on the availability of the 
ELO attribute only to retail orders; the eligibility requirements for 
the ELO attribute, including the attestation requirement and the 
Exchange's methods for monitoring compliance and imposing discipline 
for non-compliance; the identification of ELO orders in Nasdaq's market 
data feed; and the potential conflict between the proposed ELO 
eligibility requirements and other activities of the member.
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    \56\ See supra notes 6, 9, and 12. The IMC Letter broadly 
supported the comments articulated in FIA PTG Letter I.
    \57\ See supra notes 8 and 13.
    \58\ See Virtu Letter. Another commenter also stated its strong 
support for exchange innovation and providing additional choices for 
retail orders, but expressed concern that the Exchange did not 
propose strong enough penalties or controls to deter abuse on a 
real-time basis. See BATS Letter at 1.
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    Four commenters expressed concern that the Exchange's proposal 
would be unfairly discriminatory by providing the ELO functionality 
only to retail orders.\59\ One commenter argued that the proposal would 
unfairly burden competition because it would allow the Exchange to 
compete for order flow by creating an order attribute that 
inappropriately favors certain market participants at the expense of 
others.\60\ Two commenters argued that the proposal is unnecessary, 
stating that there is insufficient evidence that retail investors are 
experiencing difficulty in obtaining fills for resting orders and 
therefore would benefit from the proposed functionality.\61\
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    \59\ See FIA PTG Letter I at 3-4; Hudson River Trading Letter at 
2; Citadel Letter I at 4; Citadel Letter II at 1 and 4; IMC Letter. 
Three commenters also expressed general concerns with respect to the 
potential expansion of the ELO functionality beyond retail orders, 
or noted that their concerns regarding the enhanced priority 
provided to retail orders under the proposal could be exacerbated in 
connection with any such expansion. See BATS Letter at 1; Citadel 
Letter I at 6; FIA PTG Letter I at 6. In response to these concerns, 
the Exchange noted that any future expansion of the ELO 
functionality beyond retail orders would be subject to a separate 
rule filing with the Commission. See Nasdaq Response Letter I at 7. 
See also Amendment No. 1.
    \60\ See Citadel Letter I at 4.
    \61\ See FIA PTG Letter I at 2-3; Citadel Letter I at 1-2; 
Citadel Letter II at 4-5.
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    Four commenters also expressed concern that the proposal would 
increase equity market structure complexity, create uncertainty 
regarding the priority of resting orders, and negatively impact market 
liquidity and price discovery.\62\ According to these commenters, the 
increased uncertainty among liquidity providers would result in wider 
spreads, which would adversely impact long-term investors, including 
institutional and retail investors.\63\ One of these commenters 
suggested that the proposal would negatively impact market makers' 
hedging strategies in ETFs and their underlying securities, and the 
associated risk and cost would be borne by institutional and retail 
investors.\64\ Another commenter argued that ELO orders should not 
receive priority over other orders that have already been resting for 
at least one second, and that doing so would discourage other market 
participants from displaying liquidity.\65\
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    \62\ See Citadel Letter I at 3-7; Citadel Letter II at 4-5; FIA 
PTG Letter I at 1-3 and 5-6; FIA PTG Letter II at 1-2; Hudson River 
Letter at 2-3; IMC Letter.
    \63\ See Citadel Letter I at 3-4; Citadel Letter II at 4; FIA 
PTG Letter I at 5.
    \64\ See Citadel Letter I at 3.
    \65\ See Hudson River Trading Letter at 2-3.
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    In response, the Exchange stated its belief that the growth in 
internalization and the speed of execution has required differentiation 
of retail orders, which are typically entered by long-term investors, 
from those of other market participants.\66\ The Exchange noted that 
the proposal is an effort to promote displayed orders with longer time 
horizons to enhance the market so that it works better for a wider 
array of market participants.\67\ According to the Exchange, unlike 
professional market makers and automated liquidity providers, who 
commonly invest in low-latency technology to facilitate efficient order 
book placement, retail investors generally have a longer investment 
horizon, do not necessarily monitor market changes over very short time 
periods, and generally have not focused on efficient order queue 
placement of displayed orders.\68\ As a result, the Exchange believes 
that its current price/display/time priority structure may limit retail 
investors from effectively participating on the Exchange, particularly 
in highly-liquid securities where the sequence of order arrival is 
important to participation in ensuing transactions on the Nasdaq order 
book.\69\ The Exchange also noted that providing the proposed ELO 
functionality to retail investors would help improve execution quality 
and retail participation in on-exchange transactions, which should 
improve overall market quality on the Exchange.\70\ According to the 
Exchange, an increase in participation from the retail segment of the 
market would increase the diversity of the marketplace and thereby 
improve general market function and price discovery.\71\ Further, the 
Exchange stated that providing a mechanism by which retail orders may 
have an increased chance of execution on the Exchange would promote 
competition among the Exchange, its exchange peers, and off-exchange 
trading venues.\72\
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    \66\ See Amendment No. 1.
    \67\ The Exchange also noted that the proposal would provide 
firms handling retail order flow with additional options to consider 
when determining the best way to represent and execute retail non-
marketable limit orders. See Nasdaq Response Letter I at 3. In 
addition, the Exchange argued that the proposal would benefit 
publicly traded companies by promoting long-term investment in 
corporate securities. See id. at 2.
    \68\ See Amendment No. 1.
    \69\ See Notice, 81 FR at 87630; see also Amendment No. 1.
    \70\ See Nasdaq Response Letter I at 3 and 7; Nasdaq Response 
Letter II at 6-7.
    \71\ See Amendment No. 1. In particular, the Exchange stated its 
belief that markets and price discovery best function through the 
interactions of a diverse set of market participants. See id. The 
Exchange also stated its belief that robust price discovery is best 
served when there are many different perspectives on what the price 
and timing of a transaction should be. See id.
    \72\ See Nasdaq Response Letter I at 7.
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    The Commission recognizes that market participants generally 
distinguish individual retail investors from professional traders, and 
that retail investors are presumed to be less informed than 
professional traders. Recognizing this distinction, the Commission 
believes that the Exchange's proposal to provide the ELO functionality 
only to Designated Retail Orders is consistent with the Act. In 
particular, the Commission believes that the Exchange's proposal 
represents a reasonable effort to enhance the ability of retail trading 
interest to participate effectively on an exchange without 
discriminating unfairly against other

[[Page 32390]]

market participants or inappropriately or unnecessarily burdening 
competition.
    The Commission also does not share the concern expressed by some 
commenters that the proposed ELO functionality would have a detrimental 
market impact, such as by causing wider spreads. The Commission 
believes that the proposal could lead to increased or more immediate 
execution opportunities on the Exchange for resting retail orders. 
Moreover, given that the ELO attribute would only be available for 
Designated Retail Orders that are displayed, to the extent that 
Exchange members send more retail interest to the Exchange due to the 
availability of the ELO functionality, this could translate into more 
displayed retail interest on the Exchange. If the ELO functionality 
contributes to greater displayed liquidity on the Exchange, this may 
benefit all market participants by improving the price discovery 
process. In addition, due to the greater likelihood that retail orders 
would have priority at the prevailing inside market as a result of the 
ELO functionality, the proposal may in fact encourage tighter spreads 
and price formation because non-retail liquidity providers may need to 
quote more aggressively than the prevailing market in order to gain 
priority.
    With regard to the Exchange's proposed eligibility requirements for 
the ELO attribute, four commenters expressed concern that the 
Exchange's initial proposal to monitor for compliance with the ELO 
eligibility requirements on a quarterly basis would be insufficient to 
appropriately surveil for misuse of the functionality.\73\ Two of these 
commenters advocated for stronger or more immediate penalties for 
failure to comply with the ELO eligibility requirements.\74\ 
Specifically, one commenter noted that the Exchange should monitor for 
and penalize abuse on an intra-quarter basis, and that the proposal 
should impose stronger penalties to deter abuse.\75\ The other 
commenter opined that the Exchange should conduct weekly reviews and 
that a participant should be prohibited from utilizing the ELO 
functionality after two weeks of non-compliance.\76\ Moreover, two 
commenters suggested that the Exchange should automate the one second 
resting time for ELO orders.\77\
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    \73\ See BATS Letter at 1-2; Citadel Letter I at 4; Themis 
Letter I at 2-3; Virtu Letter at 2.
    \74\ See BATS Letter at 2; Virtu Letter at 2.
    \75\ See BATS Letter at 1-2.
    \76\ See Virtu Letter at 2.
    \77\ See FIA PTG Letter I at 5; Themis Letter I at 3.
---------------------------------------------------------------------------

    In addition, three commenters argued that, under the proposed 
attestation requirement, a participant could game the 99% threshold by 
improperly inflating its number of compliant ELO orders, such as by 
submitting a large number of non-marketable ELO Orders, while 
impermissibly benefiting from its non-compliant 1% of ELO Orders.\78\ 
One of these commenters also stated that the Exchange has not provided 
sufficient clarity regarding how it would calculate whether at least 
99% of a member's ELO orders have rested unaltered on the Nasdaq book 
for a minimum of one second.\79\ Further, two commenters expressed 
concern that the Exchange has not sufficiently limited the definition 
of ``Designated Retail Order'' for purposes of the proposed 
functionality to truly capture retail investors and to prevent misuse 
of the definition.\80\
---------------------------------------------------------------------------

    \78\ See FIA PTG Letter I at 4; Citadel Letter I at 6; IEX 
Letter at 2.
    \79\ See FIA PTG Letter I at 4. See also IMC Letter.
    \80\ See FIA PTG Letter I at 4; Citadel Letter I at 4-5.
---------------------------------------------------------------------------

    In response, the Exchange amended its proposal to add additional 
detail regarding the ELO functionality, including how the proposed one-
second timer would operate and how the 99% threshold would be 
calculated, as well as to shorten the review period for determining 
compliance with the eligibility requirements from a quarterly review to 
a monthly review period.\81\ The Exchange also stated that it believes 
its proposed 99% threshold is appropriate, noting that the standard 
would require ``near perfect performance'' while allowing some 
flexibility in the event any unforeseen issues may result in de minimis 
non-compliance.\82\ Further, the Exchange stated that it would 
establish new surveillances to detect potential misuse of the proposed 
functionality and noted that any attempt to game or otherwise abuse the 
ELO functionality would be a violation of the Exchange's rules and 
would subject the member to potential disciplinary action.\83\
---------------------------------------------------------------------------

    \81\ See Nasdaq Response Letter I at 4 and Amendment No. 1. See 
also supra notes 20-28 and 38-43 and accompanying text.
    \82\ See Nasdaq Response Letter I at 4.
    \83\ See id. See also supra notes 44-45 and accompanying text.
---------------------------------------------------------------------------

    In addition, the Exchange stated that the definition of Designated 
Retail Order is clear that the member entering such an order must have 
policies and procedures designed to ensure that the order complies with 
the requirements of the definition, including that the order originate 
from a natural person.\84\ The Exchange also stated that the definition 
of Designated Retail Order allows for orders to originate from 
organizations in very limited circumstances.\85\ The Exchange noted 
that, accordingly, it does not believe that there is latitude for a 
member to legally represent itself as eligible to enter an order with 
ELO priority when the order does not fit within the definition of 
Designated Retail Order.\86\
---------------------------------------------------------------------------

    \84\ See Nasdaq Response Letter I at 6. See also Rule 7018 
(defining ``Designated Retail Order'').
    \85\ See Nasdaq Response Letter I at 6.
    \86\ See id.
---------------------------------------------------------------------------

    One commenter asserted that the increased frequency of monitoring 
proposed in Amendment No. 1 did not address its concerns with the 
Exchange's proposed monitoring and enforcement mechanisms.\87\ This 
commenter stated that the Exchange has not offered any specifics about 
its proposed new surveillance mechanisms, and that the proposed 
penalties for misuse of the ELO attribute would not address the problem 
that other market participants that traded with non-compliant ELO 
orders were doing so under false assumptions.\88\ Another commenter was 
supportive of the changes proposed in Amendment No. 1 (i.e., shortening 
of the review period from quarterly to monthly; addition of details 
regarding how the ELO eligibility requirements operate; and development 
of new surveillances to detect potential misuse of the ELO attribute), 
but noted that the amendment and the Exchange's response did not fully 
alleviate its specific concerns regarding the definition of 
``Designated Retail Order'' and the potential for gaming.\89\ 
Similarly, one commenter noted that the Exchange has not explained how 
highly sophisticated day traders or other professional traders who are 
natural persons would be prevented from utilizing the ELO 
attribute.\90\
---------------------------------------------------------------------------

    \87\ See IEX Letter at 3.
    \88\ See id. at 2-3.
    \89\ See FIA PTG Letter II at 2.
    \90\ See Citadel Letter I at 4-5; Citadel Letter II at 3.
---------------------------------------------------------------------------

    In reply, the Exchange noted that its proposed rules are properly 
designed to maintain compliance and that it would actively enforce the 
proposed rules to achieve compliance.\91\ The Exchange also asserted 
that, because a market participant's broker-dealer would make the 
determination to enter an order as ELO, if a professional trader were 
to make consistent sub-second cancellations of its orders, presumably 
the broker-dealer would determine that orders entered by this customer 
are not best suited for ELO usage.\92\ Finally, the Exchange reiterated 
that it would monitor behavior to ensure that market participants are 
not taking steps to

[[Page 32391]]

circumvent the letter, intent, or spirit of the rule.\93\
---------------------------------------------------------------------------

    \91\ See Nasdaq Response Letter II at 5-6.
    \92\ See id. at 6.
    \93\ See id.
---------------------------------------------------------------------------

    The Commission believes that the proposal is reasonably designed to 
ensure that the eligibility criteria for ELO usage are followed 
appropriately and to prevent fraudulent and manipulative acts and 
practices. In this regard, the Commission believes that the measures 
the Exchange has represented that it would take in order to address 
member non-compliance with the ELO eligibility criteria, and to surveil 
for, investigate, and punish misuse or gaming of the ELO functionality, 
are sufficient to encourage members to take all reasonable steps 
necessary to comply with the ELO eligibility criteria and provide 
sufficient deterrence to members who otherwise would abuse the 
functionality. In particular, the Commission notes that the Exchange 
has represented that it will carefully monitor its members' use of the 
ELO attribute on a monthly basis and not rely solely on a member's 
attestation with regard to ELO usage.\94\ If a member does not comply 
with the ELO eligibility requirements, it will face suspension, and 
ultimately prohibition, from ELO usage.\95\ The Exchange also has 
proposed to implement new surveillances that are designed to identify 
any potential misuse of the ELO attribute.\96\ Any potentially 
violative conduct identified by the new surveillances would be 
investigated.\97\ If the conduct is found to be violative, the 
offending member(s) would be subject to disciplinary action.\98\ The 
Commission notes that disciplinary actions could result in penalties 
that are in addition to the suspension or prohibition of ELO usage.
---------------------------------------------------------------------------

    \94\ See Amendment No. 1. The attestation form for ELO usage 
would require the member to attest, among other things, that it has 
implemented policies and procedures that are reasonably designed to 
ensure that substantially all orders designated by the member as 
Designated Retail Orders comply with the requirements for such 
orders. See Notice, 81 FR at 87630 n.15; see also Amendment No. 1 
and the designated retail order attestation form at Exhibit 3 to 
Amendment No. 1.
    \95\ See Amendment No. 1; see also proposed new attachment B to 
the Exchange's designated retail order attestation form at Exhibit 3 
to Amendment No. 1.
    \96\ See Amendment No. 1.
    \97\ See id.
    \98\ See id. and supra note 45 and accompanying text; see also 
Nasdaq Rule 9000 Series.
---------------------------------------------------------------------------

    With regard to the identification of ELO orders in Nasdaq's 
TotalView ITCH market data feed, four commenters expressed concern that 
the proposed ELO order identifier would reveal to market participants 
that certain orders are retail orders and must remain unaltered for at 
least one second.\99\ Two of these commenters noted that, through the 
process of elimination, market participants also would be able to 
identify the preponderance of other quotes as coming from institutions 
or professional market makers.\100\ One of these commenters also 
contended, however, that not tagging ELO orders would prevent liquidity 
providers from being able to identify their place in the queue, and 
that this uncertainty would lead to wider spreads and smaller order 
size.\101\
---------------------------------------------------------------------------

    \99\ See Citadel Letter I at 5; FIA PTG Letter I at 5; Themis 
Letter I at 1-2; IEX Letter at 1-2.
    \100\ See FIA PTG Letter I at 5; IEX Letter at 1-2.
    \101\ See FIA PTG Letter I at 5.
---------------------------------------------------------------------------

    The Exchange stated that it does not believe that information 
leakage is a concern with respect to the current proposal because the 
ELO functionality would be available only to retail orders, and retail 
investor interest is most often represented by one order at a single 
price.\102\ In addition, according to the Exchange, the identification 
of ELO orders in the Exchange's TotalView ITCH market data feed would 
provide transparency that would be valuable for the industry in 
evaluating the efficacy of the proposal.\103\
---------------------------------------------------------------------------

    \102\ See Nasdaq Response Letter I at 6-7. The Exchange 
acknowledged that information leakage could be a concern for some 
non-retail market participants who may build or unwind significant 
trading positions or engage in proprietary and confidential trading 
strategies, and that it may be an issue if the ELO attribute were to 
be applied as currently proposed to non-retail market participant 
orders. See id. at 6.
    \103\ See id. at 7.
---------------------------------------------------------------------------

    One commenter disagreed with the Exchange's argument that 
information leakage would not be a concern with respect to retail 
orders.\104\ This commenter suggested that with knowledge that an order 
has selected the ELO attribute, a market participant may choose to 
route to that order last, knowing it would have to remain unaltered for 
at least one second, which could provide lower fill rates for ELO 
orders if the market participant is able to complete its order on other 
venues before routing to Nasdaq to interact with the ELO order.\105\ 
This commenter also suggested that it is not clear how a retail 
investor could opt out of the ELO functionality in light of the fact 
that Nasdaq would permit Exchange members to designate all orders 
submitted through a particular entry port as ELO orders.\106\ Two other 
commenters asserted that the Exchange's response does not address the 
concern that the ELO identifier could help market participants identify 
institutional investor orders.\107\
---------------------------------------------------------------------------

    \104\ See Citadel Letter II at 2.
    \105\ See id.
    \106\ See id. See also FIA PTG Letter I at 3 (stating that the 
decision whether to classify order flow as ELO would be made by 
brokers, not their retail customers).
    \107\ See IEX Letter at 1-2; Themis Letter II at 2.
---------------------------------------------------------------------------

    In reply, the Exchange asserted that the proposal would create 
transparency, not information leakage.\108\ According to the Exchange, 
transparency differs from information leakage because it is purposeful, 
equally visible to all, and fully disclosed in public rule proposals, 
whereas information leakage is generally understood to be inadvertent, 
selective, and secretive.\109\ The Exchange also reiterated that ELO is 
a voluntary feature, and its use can be quickly discontinued (and must 
be quickly discontinued if necessary to comply with the duty of best 
execution) if ELO orders produce negative results.\110\
---------------------------------------------------------------------------

    \108\ See Nasdaq Response Letter II at 3-4.
    \109\ See id. at 4.
    \110\ See id.
---------------------------------------------------------------------------

    In addition, the Exchange did not share the concern that the 
identification of ELO orders on the Exchange's data feed could affect 
routing strategies and lead to lower fill rates for ELO orders. 
According to the Exchange, most members utilize transaction cost 
analytic tools to evaluate and measure the related impact of an 
execution by weighing opportunity cost and market impact.\111\ The 
Exchange stated that it expects that, as a result of ELO, Nasdaq 
execution quality metrics will improve over time and members will 
adjust routing behavior to ensure a higher degree of interaction with 
the Nasdaq book.\112\
---------------------------------------------------------------------------

    \111\ See id.
    \112\ See id.
---------------------------------------------------------------------------

    The Exchange also stated that the identification of ELO orders 
would not allow market participants to say with any assurance that all 
other orders are of a particular participant type because not all 
retail orders will be designated as ELO.\113\ The Exchange also noted 
that retail market participants tend to invest in certain heavily-
traded securities, which do not lend themselves to easy identification 
of the nature of the market participant behind the order.\114\
---------------------------------------------------------------------------

    \113\ See id.
    \114\ See id. at 4-5. The Exchange also addressed the statement 
made by a commenter that consumers of the Exchange's proprietary 
data feeds already have information that can be used to identify 
which orders are submitted by electronic trading firms. The Exchange 
sought to correct this statement because its TotalView ITCH market 
data feed supports voluntary market marker identification or 
``attribution,'' which is used to allow identification of market 
maker quotes and orders to meet their quoting obligations. According 
to the Exchange, this specification is not limited to any type of 
market participant, and is wholly voluntary. See id. at 7.

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

[[Page 32392]]

    The Commission believes that market participants (retail and non-
retail) are not likely to be detrimentally affected by other market 
participants' knowledge, via the ELO identifier, that certain orders 
originated from retail investors and must remain unchanged for at least 
one second. In particular, information leakage would likely not be a 
concern for retail interest because retail interest is most often 
represented by one order at a single price.\115\ Also, the lack of an 
ELO attribute on any particular order would likely not allow market 
participants to say with any assurance that the order is of a 
particular participant type.\116\ Moreover, the Commission does not 
believe that identification of ELO orders would necessarily result in 
market participants choosing to route to ELO orders last and therefore 
result in lower fill rates for these orders.\117\ In addition, the 
Commission notes that the use of the ELO attribute is voluntary.
---------------------------------------------------------------------------

    \115\ See supra note 102 and accompanying text.
    \116\ See supra notes 113-114 and accompanying text.
    \117\ See supra note 105 and accompanying text.
---------------------------------------------------------------------------

    Finally, one commenter suggested that the proposal could create a 
conflict with FINRA Rule 5320, commonly known as the Manning rule.\118\ 
According to the commenter, if a broker-dealer has routed a customer 
ELO order to Nasdaq but is required to pull that ELO order within one 
second and fill it to comply with its obligations under FINRA Rule 
5320, that broker-dealer could become out of compliance with the ELO 
requirements and, as a result, its retail customer limit orders could 
be disadvantaged vis-[aacute]-vis other broker-dealers' retail customer 
limit orders.\119\ This commenter also asserted that an Exchange member 
may receive a sub-second cancellation request from a customer, which 
could cause the member to fall under the 99% threshold and become 
ineligible to submit ELO orders on behalf of other customers.\120\
---------------------------------------------------------------------------

    \118\ See Citadel Letter I at 2. FINRA Rule 5320(a) states that 
``[e]xcept as provided herein, a member that accepts and holds an 
order in an equity security from its own customer or a customer of 
another broker-dealer without immediately executing the order is 
prohibited from trading that security on the same side of the market 
for its own account at a price that would satisfy the customer 
order, unless it immediately thereafter executes the customer order 
up to the size and at the same or better price at which it traded 
for its own account.''
    \119\ See Citadel Letter I at 2.
    \120\ See id. at 5.
---------------------------------------------------------------------------

    In response, the Exchange stated that the Manning obligations of a 
member using the ELO functionality would be no different from the 
obligations on an OTC market maker that internalizes orders and relies 
on the ``no-knowledge'' exception to separate its proprietary trading 
from its handling of customer orders.\121\ The Exchange stated that 
this exception should be equally applicable to a member using the ELO 
functionality.\122\ The Exchange also noted that it believes that 
retail investor limit orders that are posted on the Exchange will 
generally not be cancelled in a short period of time such as one 
second, because retail investors tend to have long-term investment 
goals and increasing the chance of receiving an execution is worth the 
risk of their order resting for one second or longer.\123\
---------------------------------------------------------------------------

    \121\ See Nasdaq Response Letter I at 5. See also Supplementary 
Material .02 to FINRA Rule 5320.
    \122\ See Nasdaq Response Letter I at 5.
    \123\ See id. at 4. See also FIA PTG Letter I at 3 (stating that 
most retail participants do not cancel orders within one second).
---------------------------------------------------------------------------

    In response to the Exchange, the commenter disputed the Exchange's 
assertion that the ``no knowledge'' exception to the Manning rule 
should address its concern, noting that it would persist where a firm 
may choose not to use the ``no-knowledge'' exception in order to 
provide higher fill rates or price improvement opportunities to its 
customers.\124\ In reply, the Exchange noted that this scenario posited 
by the commenter is representative of a voluntary strategy used by the 
broker-dealer, and that the broker-dealer is not compelled to use 
ELO.\125\
---------------------------------------------------------------------------

    \124\ See Citadel Letter II at 3-4.
    \125\ See Nasdaq Response Letter II at 7.
---------------------------------------------------------------------------

    The Commission does not believe that the commenter's assertion that 
broker-dealers could be conflicted in their ability to utilize the ELO 
functionality and also comply with their obligations under FINRA Rule 
5320 is a basis for finding that the Exchange's proposal is 
inconsistent with the Act. As the Exchange noted, the ``no-knowledge'' 
exception to FINRA Rule 5320 could be applicable to an Exchange member 
using the ELO functionality.\126\ To the extent firms choose not to 
rely on the ``no-knowledge'' exception, any limitation on such firms' 
ability to utilize the ELO functionality and resulting effect on their 
ability to compete with other broker-dealers that handle retail order 
flow would stem from the firms' business judgment, not the eligibility 
criteria for ELO attribute usage, which apply uniformly to any Exchange 
member seeking to utilize the ELO functionality.
---------------------------------------------------------------------------

    \126\ See Nasdaq Response Letter I at 5. See also Supplementary 
Material .02 to FINRA Rule 5320.
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\127\ that the proposed rule change (SR-NASDAQ-2016-161), as 
modified by Amendment No. 1, be, and hereby is, approved.
---------------------------------------------------------------------------

    \127\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\128\
Eduardo A. Aleman,
Assistant Secretary.
---------------------------------------------------------------------------

    \128\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2017-14666 Filed 7-12-17; 8:45 am]
 BILLING CODE 8011-01-P