[Federal Register Volume 83, Number 88 (Monday, May 7, 2018)]
[Notices]
[Pages 20131-20137]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-09612]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83129; File No. SR-FINRA-2018-015]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend 
FINRA Rule 6433 To Adopt the OTC Quotation Tier Pilot as Permanent

April 30, 2018.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 20, 2018, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend FINRA Rule 6433 (Minimum Quotation Size 
Requirements for OTC Equity Securities) to adopt as permanent the 
minimum quotation sizes for OTC equity securities currently operating 
on a pilot basis, scheduled to expire on June 7, 2018.
    The text of the proposed rule change is available on FINRA's 
website at http://www.finra.org, at the principal office of FINRA 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, FINRA 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. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    FINRA proposes to amend Rule 6433 (Minimum Quotation Size 
Requirements for OTC Equity Securities) (the ``Rule'') to adopt as 
permanent the minimum quotation sizes applicable to quotations in OTC 
equity securities \3\ that were proposed pursuant to File No. SR-FINRA-
2011-058 and implemented on a pilot basis on November 12, 2012 (``Tier 
Size Pilot'' or ``Pilot'').\4\ The Pilot was initially approved for a 
one-year term, has been extended ten times, and currently is scheduled 
to expire on June 7, 2018.\5\
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    \3\ An OTC equity security is an equity security that is not an 
``NMS Stock'' as defined in Rule 600(b)(47) of SEC Regulation NMS; 
provided, however, that the term ``OTC equity security'' shall not 
include any Restricted Equity Security. See FINRA Rule 6420(f).
    \4\ See Securities Exchange Act Release No. 65568 (October 14, 
2011), 76 FR 65307 (October 20, 2011) (Notice of Filing of File No. 
SR-FINRA-2011-058) (``Original Proposal'').
    \5\ See Securities Exchange Act Release No. 67208 (June 15, 
2012), 77 FR 37458 (June 21, 2012) (Notice of Filing of Amendment 
No. 2 and Order Granting Accelerated Approval of a Proposed Rule 
Change, as Modified by Amendment Nos. 1 and 2, To Amend FINRA Rule 
6433 (Minimum Quotation Size Requirements for OTC Equity 
Securities)) (Order Approving File No. SR-FINRA-2011-058, as 
amended); see also Securities Exchange Act Release No. 70839 
(November 8, 2013), 78 FR 68893 (November 15, 2013) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to November 14, 2014; File No. SR-FINRA-
2013-049); Securities Exchange Act Release No. 73299 (October 3, 
2014), 79 FR 61120 (October 9, 2014) (Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change to Extend the Tier Size 
Pilot to February 13, 2015; File No. SR-FINRA-2014-041); Securities 
Exchange Act Release No. 74251 (February 11, 2015), 80 FR 8741 
(February 18, 2015) (Notice of Filing and Immediate Effectiveness of 
a Proposed Rule Change to Extend the Tier Size Pilot to May 15, 
2015; File No. SR-FINRA-2015-002); Securities Exchange Act Release 
No. 74927 (May 12, 2015), 80 FR 28327 (May 18, 2015) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to August 14, 2015; File No. SR-FINRA-
2015-010); Securities Exchange Act Release No. 75639 (August 7, 
2015), 80 FR 48615 (August 13, 2015) (Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change to Extend the Tier Size 
Pilot to December 11, 2015; File No. SR-FINRA-2015-028); Securities 
Exchange Act Release No. 76519 (November 24, 2015), 80 FR 75155 
(December 1, 2015) (Notice of Filing and Immediate Effectiveness of 
a Proposed Rule Change to Extend the Tier Size Pilot to June 10, 
2016; File No. SR-FINRA-2015-051); Securities Exchange Act Release 
No. 77923 (May 26, 2016), 81 FR 35432 (June 2, 2016) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to December 9, 2016; File No. SR-FINRA-
2016-016); Securities Exchange Act Release No. 79401 (November 25, 
2016), 81 FR 86762 (December 1, 2016) (Notice of Filing and 
Immediate Effectiveness of a Proposed Rule Change to Extend the Tier 
Size Pilot to June 9, 2017; File No. SR-FINRA-2016-044); Securities 
Exchange Act Release No. 80727 (May 18, 2017), 82 FR 23953 (May 24, 
2017) (Notice of Filing and Immediate Effectiveness of a Proposed 
Rule Change to Extend the Tier Size Pilot to December 8, 2017; File 
No. SR-FINRA-2017-014); Securities Exchange Act Release No. 82153 
(November 22, 2017), 82 FR 56300 (November 28, 2017) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to June 7, 2018; File No. SR-FINRA-2017-
035).
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    The Pilot tiers were designed to: (1) Simplify the structure of the 
minimum quotation sizes; (2) facilitate the display of customer limit 
orders under Rule 6460 (Display of Customer Limit Orders) (``limit 
order display rule''); and (3) expand the scope of the Rule to provide 
for uniform treatment of the types and sources of quotations that would 
be subject to the Rule.\6\ FINRA believes the Pilot has resulted in its 
intended objectives, and particularly notes that the Pilot has yielded 
a significant positive result with regard to increased display of 
customer limit orders. At the same time, market quality measures have 
been neutral (i.e., unchanged) or slightly positive (i.e., slightly 
improved) overall during the Pilot, as compared to the pre-Pilot 
period, as discussed more fully below. Accordingly, FINRA believes it 
is appropriate and consistent with the Act to adopt the Pilot tier 
sizes on a permanent basis.
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    \6\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37458.
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Objectives of the Pilot
    FINRA Rule 6433 sets forth the minimum quotation sizes applicable 
to the display of quotations in OTC equity securities on any inter-
dealer quotation system that permits quotation updates on a real-time 
basis. The Rule provides different minimum quotation sizes that apply 
depending upon the price level of the bid or offer in the security.
    Prior to the Pilot, which has been in effect since November 12, 
2012,\7\ Rule

[[Page 20132]]

6433 provided for nine tier sizes that applied only to market makers' 
proprietary quotes. The pre-Pilot tiers ranged in price points from 
$0.00 through $2,500.01, and are shown below in Table 1.
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    \7\ Regulatory Notice 12-51 (November 2012); see also Regulatory 
Notice 12-37 (August 2012).

                                 Table 1
------------------------------------------------------------------------
                                                           Minimum quote
                  Price (bid or offer)                      size (# of
                                                              shares)
------------------------------------------------------------------------
$0 to $0.50.............................................           5,000
$0.51 to $1.00..........................................           2,500
$1.01 to $10.00.........................................             500
$10.01 to $100.00.......................................             200
$100.01 to $200.00......................................             100
$200.01 to $500.00......................................              25
$500.01 to $1,000.00....................................              10
$1,000.01 to $2,500.00..................................               5
$2,500.01 +.............................................               1
------------------------------------------------------------------------

    Under the Pilot, the number of tiers was reduced from nine to six, 
and the tiers apply to all quotations displayed by market makers, 
whether representing proprietary or customer interest, as well as 
quotations displayed by non-market makers (i.e., alternative trading 
systems or any other member firm).\8\ The Pilot tiers ultimately 
adopted are shown below in Table 2.
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    \8\ FINRA initially proposed six tiers, some of which were 
different from those ultimately adopted. However, in response to 
comments received, FINRA amended the filing to increase the minimum 
quotation size for most price points between $0.02 and $1.00. FINRA 
stated that the amended tiers were intended to facilitate the 
display of additional liquidity by market makers. See Securities 
Exchange Act Release No. 66819 (April 17, 2012), 77 FR 23770 (April 
20, 2012) (Amendment No. 1 to File No. SR-FINRA-2011-058); see also 
Original Proposal.

                                 Table 2
------------------------------------------------------------------------
                                                           Minimum quote
                  Price (bid or offer)                      size (# of
                                                              shares)
------------------------------------------------------------------------
$0.0001 to $0.0999......................................          10,000
$0.10 to $0.1999........................................           5,000
$0.20 to $0.5099........................................           2,500
$0.51 to $0.9999........................................           1,000
$1.00 to $174.99........................................             100
$175.00 +...............................................               1
------------------------------------------------------------------------

    The Pilot tiers simplified the tier structure by reducing the 
number of tiers from nine to six. In addition, for price points between 
$1.00 and $174.99, the Pilot established a minimum quotation size of 
100 shares, which is comparable to the minimums generally applicable to 
quotations in securities on equity exchanges. The Pilot also revised 
the smallest price point from $0.00 to $0.0001 to conform to the 
minimum quotation increments under Rule 6434 (Minimum Pricing Increment 
for OTC Equity Securities).\9\
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    \9\ Rule 6434, among other things, prohibits members from 
displaying a bid or offer in an OTC equity security in an increment 
smaller than $0.01 if the bid or offer is priced $1.00 or greater 
per share, or in an increment smaller than $0.0001 if the bid or 
offer is priced below $1.00.
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    Importantly, the Pilot was designed to facilitate the display of 
customer limit orders under FINRA's limit order display rule, which 
generally requires that OTC market makers fully display better-priced 
customer limit orders (or same-priced customer limit orders that are at 
the best bid or offer and that increase the OTC market maker's size by 
more than a de minimis amount). Pursuant to the limit order display 
rule, OTC market makers are not required to display a customer limit 
order on an inter-dealer quotation system unless doing so would comply 
with the minimum quotation size applicable to the price of the 
quotation under the Rule. Therefore, although a customer limit order 
may otherwise have been required to be displayed under the limit order 
display rule--for example, because it improved price or the size (more 
than a de minimis amount)--if the order is less than the minimum 
quotation size prescribed by Rule 6433, the member is not required to 
display the order. Thus, FINRA believed that the revisions implemented 
by the Pilot would improve overall display of customer limit orders.
    For example, because the Pilot would reduce the minimum quotation 
size from 2,500 to 100 shares for securities priced at or above $1.00, 
FINRA believed that competitively priced customer limit orders, which 
tend to be smaller-sized orders, would more likely be displayed and 
potentially yield a variety of benefits, including improved price 
transparency, enhanced execution of customer limit orders, and narrower 
spreads. In addition, in a memorandum on potential effects of the 
Pilot, SEC staff economists noted that enhanced visibility of customer 
limit orders could reduce customers' execution costs.\10\
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    \10\ See Memorandum to File No. SR-FINRA-2011-058 re: FINRA 
Proposal to Reduce Minimum Quotation Size in OTC Market Tiers from 
Division of Risk, Strategy, and Financial Innovation, dated June 1, 
2012, available at: http://www.sec.gov/comments/sr-finra-2011-058/finra2011058-13.pdf.
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    An additional objective of the Pilot was to expand the Rule's scope 
to apply to all member quotations on an inter-dealer quotation system. 
Prior to the Pilot, the Rule applied only to market makers' proprietary 
quotes in OTC equity securities on an inter-dealer quotation system. 
Under the Pilot, the minimum tier sizes apply to any member quotations 
entered on an inter-dealer quotation system (including quotes 
representing customer interest and quotations entered by non-market 
makers).
Concerns Raised During the Proposal Process and Data Commitment
    The Commission received several comments in response to FINRA's 
Tier Size Pilot proposal. Commenters generally were supportive of the 
goal of increased customer limit order display; \11\ however, 
commenters also raised concerns regarding the impact of revised tiers. 
Specifically, certain commenters questioned whether the Pilot might 
harm market quality by permitting market makers to post quotes 
representing minimum dollar value commitments that are not financially 
meaningful, or otherwise eroding market maker liquidity in OTC equity 
securities.\12\ In addition, some commenters believed that there was 
not sufficient data analysis to support the proposed changes to the 
tier sizes.\13\
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    \11\ See Order Approving File No. SR-FINRA-2011-058.
    \12\ See id.
    \13\ See id. at 37461-62.
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    In response to commenters' concerns, FINRA filed Amendment No. 1 to 
the Original Proposal to increase the minimum quotation sizes for most 
price points between $0.02 and $1.00, and proposed that the revised 
tiers operate as a one-year pilot instead of as a permanent amendment. 
FINRA also submitted Amendment No. 2 to the Original Proposal to, among 
other things, specify the items of data that FINRA would collect and 
provide to the Commission during the duration of the Pilot; 
specifically:
    1. The price of the first trade of each trading day executed at or 
after 9:30:00 a.m., based on execution time.
    2. The price of the last trade of each trading day executed at or 
before 4:00:00 p.m., based on execution time.
    3. Daily share volume.
    4. Daily dollar volume.
    5. Number of limit orders from customers and in total.
    6. Percentage of the day that the size of the BBO equals the 
minimum quote size.
    7. Number of market makers actively quoting.
    8. Number of executions from a limit order and number of limit 
orders at the BBO or better by tier size from a customer and in total.
    9. Liquidity/BBO metrics
    a. Time-weighted quoted spread.
    b. Effective spread.
    c. Time-weighted quoted depth (number of shares) at the inside.

[[Page 20133]]

    d. Time-weighted quoted depth (dollar value of shares) at the 
inside.
    FINRA also committed to submitting an assessment, at least 60 days 
before the end of the Pilot, that addressed the impact of the Pilot, 
the concerns raised by commenters during the rule filing process, and 
whether the Pilot resulted in the desired effects.\14\
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    \14\ See Amendment No. 2 to File No. SR-FINRA-2011-058, 
available at http://www.finra.org/file/amendment-no-2-propose-rule-change.
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Pilot Assessment
    FINRA submitted its assessment on the operation of the Tier Size 
Pilot on September 13, 2013, which utilized pilot data covering the 
period from November 12, 2012 through June 30, 2013.\15\ The 2013 
Assessment, discussed in greater detail below, included a 
recommendation, based on the extensive analysis conducted, that the 
Pilot tiers be adopted as permanent. Nonetheless, FINRA extended the 
Pilot duration to allow the effects of the Pilot to be more thoroughly 
reviewed.\16\ During this extension, the Staff of the Division of 
Economic and Risk Analysis (``DERA'') of the SEC conducted a study, 
which assessed the impact of the Pilot on liquidity. The study was 
published as a memorandum to file (``DERA Memo to File'').\17\ And 
while the two studies covered different time periods and employed 
different methods, the DERA Memo to File reported findings consistent 
with those of the FINRA 2013 Assessment. In light of the 2013 
Assessment, FINRA's further observations, and the DERA Memo to File, 
FINRA continues to believe that it is appropriate to permanently adopt 
the tier sizes that have been in operation since November 12, 2012, and 
is proposing to do so at this time.
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    \15\ FINRA engaged a third-party, Cornerstone Research, to 
conduct an analysis of the impact of the Pilot on OTC market 
quality. The 2013 assessment is part of the SEC's comment file for 
SR-FINRA-2011-058 and also is available on FINRA's website at: 
http://www.finra.org/industry/rule-filings/sr-finra-2011-058 (``2013 
Assessment'').
    \16\ See supra note 5.
    \17\ See Memorandum to File No. SR-FINRA-2011-058 re: FINRA's 
Pilot Program Amending Minimum Quotation Size Requirements for OTC 
Equity Securities from DERA, dated July 28, 2017, available at: 
https://www.sec.gov/files/otc_tiersizepilot_memo.pdf.
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    FINRA believes the 2013 Assessment demonstrated that the Pilot 
accomplished its objectives, including increased customer limit order 
display, and that key market quality indicators have been unchanged or 
have slightly improved overall. FINRA continued to collect and provide 
Pilot data to the SEC since the 2013 Assessment. In addition, FINRA has 
continued to monitor the impact of the operation of the Pilot on market 
quality metrics for the over-the-counter marketplace, which FINRA 
generally believes indicate positive trends overall, providing 
continued support for permanent adoption of the Pilot tiers.\18\ 
Moreover, the DERA Memo to File provided further evidence, in a 
regression framework, that supports the conclusion that the Pilot had a 
neutral to positive impact on market quality.
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    \18\ FINRA engaged in outreach with member firms that are active 
in the market for OTC Equity Securities regarding the operation of 
the Tier Size Pilot, and the majority of those firms did not oppose 
the permanent adoption of the Pilot.
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    Specifically, FINRA believes that the 2013 Assessment demonstrated 
that the Pilot has resulted in a meaningful increase in the display of 
customer limit orders. Moreover, FINRA believes the data collected 
during the Pilot also supports that market quality has not been harmed, 
as suggested by the analysis of market quality measures such as spreads 
and market depth.
(A) Enhanced Customer Limit Order Display
    When the Commission approved the Pilot, it recognized the potential 
benefits of enhancing customer limit order display. Notably, the 
Commission found that ``[i]n the Commission's view, FINRA's proposed 
revisions are designed to protect investors by revising the Rule's tier 
thresholds such that a larger percentage of customer limit orders are 
reflected in quotations for OTC equity securities, thereby potentially 
improving the prices at which customer limit orders will be executed, 
consistent with the protection of investors and the public interest.'' 
\19\ FINRA believes the Pilot clearly has achieved the objective of 
increased customer limit order display.
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    \19\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37466. See also Memorandum to file from Division of Risk, Strategy, 
and Financial Innovation, dated June 1, 2012, supra note 10.
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    As noted in FINRA's September 2013 Assessment, between November 1, 
2012 and June 30, 2013, for all tier sizes combined, there was a 13% 
increase in the number of customer limit orders that met the minimum 
quotation sizes to be eligible for display under the Pilot tiers. FINRA 
also observed a significant increase in the number of customer limit 
orders in securities priced between $0.20 and $100.00 that became 
eligible for display. This trend continued through July 31, 2014. 
Specifically, between July 1, 2013 and July 31, 2014, FINRA observed, 
for all tier sizes combined, an 18.45% increase in the number of 
customer limit orders that met the minimum quotation sizes and, 
therefore, eligible for display--also with the most significant 
increase observed for securities priced between $0.20 and $100.00.
    Tables 3 and 4 below show the percentage of customer limit orders 
that were equal to or greater than the minimum quotation size under 
both the Pilot and pre-Pilot tier sizes for the specified price ranges 
for the periods of November 1, 2012 through June 30, 2013, and from 
July 1, 2013 through July 31, 2014, respectively.

                                                     Table 3
                                    [November 1, 2012 through June 30, 2013]
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                                                                  Customer limit                  Customer limit
                   Price range                      Pilot tier    orders >= tier  Pre-pilot tier  orders >= tier
                                                       size          size (%)          size          size (%)
----------------------------------------------------------------------------------------------------------------
0.0001-0.0999...................................          10,000           78.29           5,000           86.30
0.10-0.1999.....................................           5,000           56.89           5,000           56.89
0.20-0.5099.....................................           2,500           57.35           5,000           43.30
0.51-0.9999.....................................           1,000           72.81           2,500           46.05
1.00-10.00......................................             100           97.86             500           74.73
10.01-100.00....................................             100           98.24             200           87.93
100.01-174.99...................................             100           90.49             100           90.49
175.00-200.00...................................               1             100             100           96.71
200.01-500.00...................................               1             100              25           90.74
500.01-1,000.00.................................               1             100              10           64.62
1,000.00-2,500.00...............................               1             100               5           61.38

[[Page 20134]]

 
2,500.00+.......................................               1             100               1          100.00
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                                                     Table 4
                                      [July 1, 2013 through July 31, 2014]
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                                                                  Customer limit                  Customer limit
                   Price range                      Pilot tier    orders >= tier  Pre-pilot tier  orders >= tier
                                                       size          size (%)          size          size (%)
----------------------------------------------------------------------------------------------------------------
0.0001-0.0999...................................          10,000           78.29           5,000           88.70
0.10-0.1999.....................................           5,000           56.89           5,000           57.78
0.20-0.5099.....................................           2,500           57.35           5,000           42.31
0.51-0.9999.....................................           1,000           72.81           2,500           42.10
1.00-10.00......................................             100           97.86             500           68.36
10.01-100.00....................................             100           98.24             200           78.03
100.01-174.99...................................             100           90.49             100           90.60
175.00-200.00...................................               1             100             100           91.94
200.01-500.00...................................               1             100              25           89.41
500.01-1,000.00.................................               1             100              10           66.65
1,000.00-2,500.00...............................               1             100               5           65.58
2,500.00+.......................................               1             100               1          100.00
----------------------------------------------------------------------------------------------------------------

    As was noted in the 2013 Assessment, of the 301,628,686 customer 
limit orders in OTC equity securities reported to FINRA's Order Audit 
Trail System (``OATS'') between November 1, 2012 and June 30, 2013, 
over 86.6% were priced between $0.20 and $100.00. Of particular note, 
58.7 million customer limit orders, or almost 20% of all customer limit 
orders, were priced between $1.00 and $10.00. This price range 
experienced an increase of almost 24% in the number of customer limit 
orders that met the minimum quotation size to be eligible for display 
under the Pilot. Further, 181.6 million customer limit orders, or over 
60% of all customer limit orders, were priced between $10.01 and 
$100.00. This price range experienced an increase of over 10% in the 
number of customer limit orders that met the tier sizes and were 
eligible for display under the Pilot tier sizes. Consequently, the 2013 
Assessment found that an additional 32 million customer limit orders 
priced between $1.00 and $100.00 became eligible for display during the 
Pilot that otherwise would not have been eligible for display.
    The trends during the period since the 2013 Assessment are similar. 
Specifically, of the 573,973,197 customer limit orders in OTC equity 
securities reported to OATS between July 1, 2013 and July 31, 2014, 
81.4% were priced between $0.20 and $100.00. Of particular note, 114.5 
million customer limit orders, or almost 20% of all customer limit 
orders, were priced between $1.00 and $10.00. From July 1, 2013 through 
July 31, 2014, this price range experienced an increase of over 29% in 
the number of customer limit orders that met the minimum quotation size 
to be eligible for display under the Pilot than would have been 
eligible in the absence of the Pilot. Further, 312.1 million customer 
limit orders, or over 54% of all customer limit orders, were priced 
between $10.01 and $100.00. This price range experienced an increase of 
over 19% in the number of customer limit orders that met the tier sizes 
and were eligible for display under the Pilot tier sizes. Consequently, 
an additional 94.9 million customer limit orders priced between $1.00 
and $100.00 became eligible for display during the Pilot between June 
30, 2013 and July 31, 2014 than otherwise would have been eligible for 
display.
    Thus, with an aggregate overall increase in displayed customer 
limit orders in OTC equity securities over the period from November 12, 
2012 through July 31, 2014 of 16.24%, representing approximately 142 
million additional orders than otherwise would have been eligible for 
display, FINRA believes that the impact of the Pilot on limit order 
display has clearly been positive, with stronger than average results 
concentrated in the price points ranging from $10.01 and $100.00 (the 
range in which the majority of all customer limit orders fell 
(approximately 57%)).
(B) Impact on Market Quality
    When the Commission approved the Pilot, it acknowledged that the 
Pilot may raise issues of ``potentially competing forces''--enhanced 
customer limit order display on the one hand, and potential harm to OTC 
equity market quality (liquidity, efficiency, and volatility) on the 
other.\20\ On balance, however, the Commission expressed the view that 
``as well as increasing the number of customer limit orders eligible 
for display and the potential for better executions, arguments can be 
made that FINRA's proposal will benefit the OTC market by facilitating 
market making activity, narrowing spreads and increasing liquidity.'' 
\21\
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    \20\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37467.
    \21\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37467.
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    FINRA believes that analysis of the Pilot and pre-Pilot data 
generally shows that the market quality measures the Commission 
identified--i.e., market maker activity, spreads and liquidity \22\--
were unchanged to slightly improved, and that, therefore, there has 
been an overall neutral to positive impact on OTC market quality for 
the

[[Page 20135]]

majority of tiers as compared to the pre-Pilot data.\23\
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    \22\ To the extent the Commission expressed concern about 
volatility when it approved the Pilot, its concern was premised on 
the Pilot's impact on liquidity. See, e.g., Order Approving File No. 
SR-FINRA-2011-058, 77 FR at 37470 (``[I]f the revised tier sizes 
result in less activity by market makers, overall liquidity in the 
marketplace could decline. Such a decline could result in increased 
volatility and less efficient pricing for OTC equity securities.'') 
(internal citation omitted).
    \23\ FINRA notes that, from an analytical perspective, changes 
in market quality measures may not be attributable solely due to the 
Pilot, since they may also be impacted by other contemporaneous 
market factors.
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    As noted in the 2013 Assessment, where minimum quotation size 
decreased under the Pilot, effective spreads generally remained the 
same or narrowed, quoted spreads narrowed, and price impact generally 
decreased. The 2013 Assessment also stated that some of the market 
quality metrics provided inconclusive results, specifically for Tier 1 
securities, where the minimum quote size requirement increased. The 
2013 Assessment documented that effective spreads had widened, but with 
no significant reduction in quoted depth.\24\
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    \24\ For Tier 1 securities, the DERA Memo to File finds that 
both quoted and effective spreads increase between the pre-Pilot 
period (November 14, 2011 through October 31, 2012) and the Pilot 
period (November 12, 2012 through November 28, 2014) covered by the 
analysis. However, the DERA Memo to File does not find sufficient 
evidence that these increases in spreads were caused by the Pilot, 
as spreads started to widen at least six months prior to the 
implementation of the Pilot.
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    In the post-2013 Assessment period of July 1, 2013 through July 31, 
2014, FINRA has observed that the number of stocks quoted in the OTC 
market has remained relatively constant \25\ and market makers 
continued to provide liquidity.\26\ The number of BBO quotes also 
significantly increased throughout 2014, the second year of the Pilot; 
as it generally hovered around 2 million per day during the Pre-Pilot 
period, but steadily increased, reaching a high of approximately 6 
million per day in early 2014 and leveling off to an average of 5 
million per day during the month of July 2014. The average number of 
trades per day was higher during the first two years of the Pilot 
compared to the pre-Pilot level, and more than tripled by March 
2014.\27\ However, trading activity appears to have leveled-off in mid-
2014, albeit still at levels above the pre-Pilot trading.\28\ Liquidity 
continued to be provided at levels greater than the minimum required 
depth, evidenced by executions at sizes greater than the required 
minimums, which enabled the execution of large trades in the OTC 
market. For example, for Tier 1 securities where the minimum quotation 
size increased, the number of trades executed above the minimum size 
increased by approximately 75%. While there was virtually no change in 
the frequency of trades above the minimum size for Tiers 2 and 3, all 
the other tiers experienced a positive change. Trading in sizes greater 
than the minimum quotation occurred infrequently in these tiers both 
prior to and during the pilot.
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    \25\ The number of stocks quoted on the OTC market remained 
stable at around 10,000 throughout the pre-Pilot period, and during 
the period covered in the 2013 Assessment and FINRA's subsequent 
observations (November 1, 2012 through July 31, 2014).
    \26\ There was an average of nine market-makers for each symbol 
with no significant change in the number between the pre-Pilot 
period, and during the period covered in the 2013 Assessment and 
FINRA's subsequent observations (November 1, 2012 through July 31, 
2014).
    \27\ The daily number of trades executed during the year prior 
to the Pilot is estimated at approximately 75,000, and reached 
around 250,000 trades by the end of the first quarter in 2014.
    \28\ The daily average number of trades was approximately 
100,000 by July 2014.
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    The analysis of data from the second year of the Pilot also 
confirms FINRA's position that the impact of the change in the minimum 
quotation size on the market quality metrics is generally positive. 
FINRA staff analyzed the change in five measures to evaluate the impact 
of the Pilot on market quality--time-weighted quoted spreads, volume-
weighted spreads, time-weighted quoted depth at the BBO, time-weighted 
quoted depth around the BBO, and price impact. Time-weighted quoted 
spreads continued to narrow during the first two years of the Pilot and 
these positive changes in time-weighted quoted spreads between the pre-
Pilot and the first two years of the Pilot were statistically 
significant for all tiers.\29\ Similarly, volume-weighted spreads were 
unchanged (or slightly narrowed) for all tiers between the pre-Pilot 
period and the first two years of the Pilot when accounting for the 
longer Pilot period.
---------------------------------------------------------------------------

    \29\ For stocks in price tiers where the minimum quotation size 
requirement decreased, the DERA Memo to File also finds that both 
quoted and effective spreads decrease between the pre-Pilot period 
(from November 14, 2011 to October 31, 2012) and the Pilot period 
(November 12, 2012 to November 28, 2014) covered by the analysis. 
Furthermore, the DERA Memo to File's analysis suggests that these 
decreases in spreads may reflect causal effects of the Pilot. In 
contrast, for stocks in price tiers where the minimum quotation size 
requirement increased or remained the same, the DERA Memo to File 
does not find sufficient evidence that the Pilot had a causal impact 
on spreads.
---------------------------------------------------------------------------

    The displayed depth decreased slightly for most tiers, but a 
consideration of depth beyond the BBO demonstrated that any declines 
were mostly statistically insignificant across tiers in the first two 
years of the Pilot. FINRA believes that consideration of depth beyond 
the BBO is a useful additional measure for assessing market depth.
    In addition, based on a data review using the same methodology as 
was employed for the 2013 Assessment, subsequent to the completion of 
the 2013 Assessment, FINRA observed that the price impact of 
hypothetical market orders continued to remain lower during the second 
year of the Pilot period than during the pre-Pilot period.\30\ For 
example, the following two tables present the price impact for 
hypothetical market buy and sell orders with sizes five times larger 
than the minimum size requirement for each tier. The price impact 
associated with the hypothetical orders is estimated to have declined 
for all tiers, which is an indication of improved market quality. The 
decline is significant for all levels except for Tiers 5b and 5c (for 
buy trades) and Tier 1 (for sell trades).\31\
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    \30\ As discussed in the 2013 Assessment, the price impact of 
hypothetical market orders is the effective half spread for a 
hypothetical market ``sweep'' order of a particular size. In other 
words, it is an estimate of what the volume-weighted average 
effective half spread would have been had a market order been broken 
up and routed to the market makers based on price priority.
    \31\ [Content of footnote 31 moved to the body of the text due 
to Federal Register requirements.]
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    [Content of footnote 31: The t-statistic is designed to measure 
whether the price impact associated with a trade of a given (relative) 
size is different between the pre-Pilot and Pilot sample periods. The 
difference is tested for significance by calculating the two-sample un-
pooled Student's t-statistic,
[GRAPHIC] [TIFF OMITTED] TN07MY18.025

    The null hypothesis (i.e., that price impact is unchanged between 
the two sample periods) is rejected at the 90% and 95% confidence 
levels, if the t-statistics are greater than 1.65 and 1.96, 
respectively.]

[[Page 20136]]



                                                     Table 5
                             [Price Impact for Hypothetical Large Market Buy Orders]
----------------------------------------------------------------------------------------------------------------
               Minimum quotation     Number of    Pre-pilot (10/  Pilot (11/2012-
     Tier         size change         stocks      2011- 10/2012)      7/2014)       Difference      t-statistic
----------------------------------------------------------------------------------------------------------------
1............  Increased........           3,586          0.0055          0.0050         -0.0005          (2.60)
2............  Maintained.......           1,254          0.0235          0.0197         -0.0038          (5.03)
3............  Decreased........           1,752          0.0506          0.0420         -0.0086          (6.41)
4............  Decreased........           1,537          0.0969          0.0810         -0.0159          (5.00)
5a...........  Decreased........           3,038          0.3295          0.2530         -0.0765          (7.79)
5b...........  Decreased........           2,026          1.1630          1.0661         -0.0969          (1.55)
5c...........  Maintained.......             177          4.8322          4.7906         -0.0416          (0.06)
----------------------------------------------------------------------------------------------------------------


                                                     Table 6
                            [Price Impact for Hypothetical Large Market Sell Orders]
----------------------------------------------------------------------------------------------------------------
               Minimum quotation     Number of    Pre-pilot (10/  Pilot (11/2012-
     Tier         size change         stocks      2011- 10/2012)      7/2014)       Difference      t-statistic
----------------------------------------------------------------------------------------------------------------
1............  Increased........           3,931          0.0062          0.0059         -0.0003          (1.60)
2............  Maintained.......           1,483          0.0233          0.0169         -0.0064          (3.41)
3............  Decreased........           1,787          0.0540          0.0311         -0.0229          (4.87)
4............  Decreased........           1,676          0.1214          0.0656         -0.0558          (4.95)
5a...........  Decreased........           3,059          0.4170          0.1500         -0.2670          (6.01)
5b...........  Decreased........           2,145          2.3563          0.4214         -1.9349          (6.79)
5c...........  Maintained.......             288         14.8135          4.2683        -10.5452          (3.13)
----------------------------------------------------------------------------------------------------------------

    As noted above, the 2013 Assessment was not conclusive as to the 
impact of the Pilot on market quality for Tier 1 securities, the only 
tier where the minimum quotation size increased. For example, the 2013 
Assessment indicated that the time-weighted quoted spread was unchanged 
for Tier 1 securities in the Pilot period. However, from June 30, 2013 
to July 2014, there was a statistically significant narrowing of time-
weighted quoted spreads in this tier. Evidence from the second year of 
the Pilot suggests that volume-weighted effective spreads and depth 
beyond the BBO were unchanged from pre-Pilot levels, but there was a 
statistically significant increase in depth at the BBO. Therefore, the 
updated analysis provides reliable evidence that market quality for 
Tier 1 securities has also improved during the Pilot.\32\ The data for 
other tiers, however, continue to provide reliable evidence that market 
quality has been unchanged or slightly improved under the Pilot. Thus, 
because the Pilot had a demonstrable positive impact on customer limit 
order display, and appears to have had an overall neutral to positive 
impact on market quality, FINRA believes it is appropriate and in the 
best interest of investors to adopt the Pilot tiers as permanent.
---------------------------------------------------------------------------

    \32\ As noted in note 24, supra, the DERA Memo to File finds 
that quoted and effective spreads for Tier 1 securities increase 
between the pre-Pilot period of November 14, 2011 to October 31, 
2012 and the Pilot period of November 12, 2012 to November 28, 2014 
covered by the analysis, but it does not find sufficient evidence 
that these increases in spreads were caused by the Pilot.
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    As noted in Item 2 of this filing, because the filing would allow 
Rule 6433 to continue to operate without interruption, if the 
Commission approves the proposed rule change, the implementation date 
of the proposed rule change shall be the date of approval by the 
Commission.
(C) Alternatives Considered
    In developing the proposed rule change, FINRA considered several 
alternatives to the proposed rule change, to ensure that it (1) 
simplifies the structure of the minimum quotation sizes; and (2) 
facilitates the display of customer limit orders under Rule 6460 
(Display of Customer Limit Orders) (``limit order display rule'') 
without having a negative impact on market quality and the number of 
customer limit orders that are eligible for display. Accordingly, FINRA 
considered alternative price points and minimum quotation sizes in 
forming the tiers and evaluated the number of customer limit orders 
that would be eligible for display. FINRA also assessed the potential 
impact associated with alternative price bands across multiple sample 
periods, and concluded that the tier structure that was adopted under 
the Pilot resulted in the maximum number of customer limit orders that 
would be eligible for display without harming competition in the OTC 
equity securities market. In addition, FINRA staff revised the smallest 
price point to conform to the minimum quotation increments under FINRA 
Rule 6434 and increased the minimum quotation sizes for most price 
points between $0.02 and $1.00. FINRA believes that the pilot tiers 
continue to be appropriate and should be adopted on a permanent basis.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\33\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA also believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(11) of the Act.\34\ 
Section 15A(b)(11) requires that FINRA rules include provisions 
governing the form and content of quotations relating to securities 
sold otherwise than on a national securities exchange which may be 
distributed or published by any member or person associated with a 
member, and the persons to whom such quotations may be supplied.
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78o-3(b)(6).
    \34\ 15 U.S.C. 78o-3(b)(11).
---------------------------------------------------------------------------

    FINRA believes that adopting the Pilot tiers as permanent would 
promote just and equitable principles of trade

[[Page 20137]]

and protect investors and the public interest. The 2013 Assessment and 
subsequent observations clearly demonstrate that the Pilot has resulted 
in increased display of customer limit orders. The 2013 Assessment 
found a 13% increase in the number of customer limit orders that met 
the minimum quotation sizes to be eligible for display across all Pilot 
tiers, and the updated data through July 2014 shows an even greater 
increase of 18.45% than otherwise would have been eligible for display. 
Notably, the increase in customer limit orders eligible for display was 
significant in tiers that make up substantial percentages of the 
overall volume transacted in OTC equity securities.
    FINRA further believes that any concerns about market quality 
raised by public commenters prior to the Commission's approval of Pilot 
have not materialized. In fact, FINRA believes that the Pilot has had a 
positive impact on OTC market quality for the majority of OTC equity 
securities and tiers. As more fully detailed above, FINRA believes the 
Pilot data shows overall a slight reduction in spreads for most OTC 
equity securities with no negative (and perhaps a positive) impact on 
liquidity.
    As noted previously, when the Commission approved the Pilot, it 
emphasized the potential benefits of increasing customer limit order 
display. For instance, the Commission noted that increased limit order 
display could potentially improve the prices at which customer limit 
orders will be executed, consistent with the protection of investors 
and the public interest.\35\ The Commission also has stated its belief 
that greater customer limit order display could increase quote 
competition, narrow spreads, and increase the likelihood of price 
improvement for OTC equity securities.\36\ The Commission had 
maintained a longstanding view that there are benefits to promoting 
customer limit order display.\37\
---------------------------------------------------------------------------

    \35\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37466.
    \36\ See id. at 37469.
    \37\ See id. at 37469 n.168 (citing, among other things, the 
Commission's 1996 Order Handling Rules Release).
---------------------------------------------------------------------------

    Accordingly, FINRA believes that the Pilot accomplished its 
intended objectives and realized benefits anticipated in its adoption, 
including greater customer limit order display. At the same time, 
market quality indicators during the Pilot suggest that the revised 
tiers and greater customer limit order display did not result in a 
harmful reduction in liquidity for OTC equity securities. As a result, 
FINRA believes it is consistent with the Act to adopt the Pilot tiers 
as permanent.

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. Despite some initial concerns 
from commenters that the Pilot may have negative effects on market 
makers who quote OTC equity securities, as the Pilot has progressed, 
FINRA observed an overall increase in the number of market makers 
quoting OTC equity securities across the duration of the Pilot. 
Accordingly, given the increase in the number of market makers quoting 
OTC equity securities, as demonstrated by the analysis using the first 
two years of data from the Pilot, and the increased display of customer 
limit orders, FINRA believes the Pilot has generated evidence that 
support the Commission's preliminary view ``that the [Pilot] could 
enhance competition.'' \38\
---------------------------------------------------------------------------

    \38\ See Order Approving File No. SR-FINRA-2011-058, 77 FR at 
37469.
---------------------------------------------------------------------------

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

    Written comments were neither solicited nor received.

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 (i) as the Commission may 
designate up to 90 days of such date 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 such 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 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 email to [email protected]. Please include 
File Number SR-FINRA-2018-015 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2018-015. This 
file number should be included on the subject line if email 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 website (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 website 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 10:00 a.m. and 
3:00 p.m. Copies of the filing will also be available for inspection 
and copying at the principal office of FINRA. All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-FINRA-2018-015 and should be submitted 
on or before May 29, 2018.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\39\
---------------------------------------------------------------------------

    \39\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-09612 Filed 5-4-18; 8:45 am]
 BILLING CODE 8011-01-P