[Federal Register Volume 84, Number 195 (Tuesday, October 8, 2019)]
[Notices]
[Pages 53788-53791]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-21881]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87200; File No. SR-CboeEDGX-2019-012]
Self-Regulatory Organizations; Cboe EDGX Exchange, Inc.; Order
Granting Approval of a Proposed Rule Change, as Modified by Amendment
No. 1, To Introduce Retail Priority
October 2, 2019
I. Introduction
On March 18, 2019, Cboe EDGX Exchange, Inc. (``Exchange'' or
``EDGX'') 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 introduce order book priority for equity orders
submitted on behalf of retail investors. The proposed rule change was
published for comment in the Federal Register on April 5, 2019.\3\ The
Commission received five comment letters from four commenters on the
proposed rule change.\4\ On May 16,
[[Page 53789]]
2019, the Commission extended the time period within which to approve,
disapprove the proposed rule change, or institute proceedings to
determine whether to approve or disapprove the proposed rule change to
July 4, 2019.\5\ On June 18, 2019, the Exchange filed Amendment No. 1
to the proposed rule change, which replaced and superseded the proposed
rule change as originally filed.\6\ On July 2, 2019, the Commission
published Amendment No. 1 for notice and comment and instituted
proceedings to under Section 19(b)(2)(B) of the Act \7\ to determine
whether to approve or disapprove the proposed rule change, as modified
by Amendment No. 1.\8\ On August 19, 2019 the Exchange submitted a
response to comments.\9\ This order approves the proposed rule change,
as modified by Amendment No. 1.
II. Description of 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. 85482 (April 2,
2019), 84 FR 13729 (``Notice'').
\4\ See letters to Vanessa Countryman, Acting Secretary,
Commission, from Sean Paylor, Trader, AJO, L.P., dated April 25,
2019 and September 16, 2019 (``AJO Letter 1'' and ``AJO Letter 2'',
respectively); Joseph Saluzzi and Sal Arnuk, Partners, Themis
Trading LLC, dated May 8, 2019 (``Themis Letter''); T. Sean Bennett,
Principal Associate General Counsel, Nasdaq, dated May 9, 2019
(``Nasdaq Letter''); letter to Eduardo A. Aleman, Deputy Secretary,
Commission from Stephen John Berger, Global Heady of Government &
Regulatory Policy, Citadel Securities, dated April 26, 2019
(``Citadel Letter''). All comments received by the Commission on the
proposed rule change are available at: https://www.sec.gov/comments/sr-cboeedgx-2019-012/srcboeedgx2019012.htm.
\5\ See Securities Exchange Act Release No. 85879, 84 FR 23591
(May 16, 2019).
\6\ Amendment No. 1 modified the proposed rule change by: (1)
Adding a proposed definition of ``Retail Priority Order''; (2)
applying the proposed enhanced priority to ``Retail Priority
Orders'' instead of ``Retail Orders''; (3) imposing certain
requirements on Retail Member Organizations that enter ``Retail
Priority Orders''; (4) removing the proposed requirement that
``Retail Orders'' must be identified as such on the EDGX Book Feed;
and (5) requiring that all ``Retail Priority Orders'' be identified
as such on the EDGX Book Feed. To promote transparency of its
proposed amendment, when EDGX filed Amendment No. 1 with the
Commission, it also submitted Amendment No. 1 as a comment letter to
the file, which the Commission posted on its website and placed in
the public comment file for SR-CboeEDGX-2019-012 (available at
https://www.sec.gov/comments/sr-cboeedgx-2019-012/srcboeedgx2019012.htm).
\7\ 15 U.S.C. 78s(b)(s)(B).
\8\ See Securities Exchange Act Release No. 86280 (July 2,
2019), 84 FR 32808 (July 9, 2019) (``Notice of Amendment No. 1'').
Specifically, the Commission instituted proceedings to allow for
additional analysis of the proposed rule change's consistency with
Section 6(b)(5) of the Act, 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,'' and ``to protect investors and the
public interest.'' See id. at 32815 (citing 15 U.S.C. 78f(b)(5)).
\9\ See Letter to Vanessa Countryman, Secretary, Commission,
from Adrian Griffiths, Assistant General Counsel, EDGX, dated August
19, 2019 (``EDGX Response Letter'').
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EDGX proposes to introduce order book priority for Retail Priority
Orders. In addition, EDGX proposes to require that Retail Priority
Orders always be designated as such on the EDGX Book Feed.\10\
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\10\ See EDGX Rule 13.8.
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A. Background
EDGX operates based on price/display/time priority, similar to many
other equities and options exchanges.\11\ Under this framework, a
better priced order maintains priority over an order at a worse price.
At a particular price, the first Displayed \12\ order resting on the
EDGX Book \13\ at a particular price has priority over the next order
and so on based on the time of order entry. Non-Displayed \14\ orders
at that price are further categorized into a number of priority bands,
with orders within each priority band prioritized again based on the
time of order entry.
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\11\ See EDGX Rule 11.9.
\12\ ``Displayed'' is an instruction the User may attach to an
order stating that the order is to be displayed by the System on the
EDGX Book. See EDGX Rule 11.6(e)(1).
\13\ ``EDGX Book'' means the System's electronic file of orders.
See EDGX Rule 1.5(d).
\14\ ``Non-Displayed'' is an instruction the User may attach to
an order stating that the order is not to be displayed by the System
on the EDGX Book. See EDGX Rule 11.6(e)(2).
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Under EDGX rules, a ``Retail Order'' is defined as an agency or
riskless principal order that meets the criteria of FINRA Rule 5320.03
\15\ that originates from a natural person and is submitted to the
Exchange by a Retail Member Organization, 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.\16\ A ``Retail Member Organization''
(``RMO'') is a Member (or a division thereof) that has been approved by
the Exchange under EDGX Rule 11.21 to submit Retail Orders. EDGX Rule
11.21(b) describes the qualification and application process for
becoming a Retail Member Organization; generally, any member may
qualify as a Retail Member Organization if it conducts a retail
business or routes retail orders on behalf of another broker-dealer.
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\15\ FINRA Rule 5320.03 clarifies that an Retail Member
Organization may enter Retail Orders on a riskless principal basis,
provided that (i) the entry of such riskless principal orders meet
the requirements of FINRA Rule 5320.03, including that the Retail
Member Organization maintains supervisory systems to reconstruct, in
a time sequenced manner, all Retail Orders that are entered on a
riskless principal basis; and (ii) the Retail Member Organization
submits a report, contemporaneously with the execution of the
facilitated order, that identifies the trade as riskless principal.
\16\ Retail Member Organizations will only be able to designate
their orders as Retail Orders on either an order-by-order basis
using FIX ports or by designating certain of their FIX ports at the
Exchange as ``Retail Order Ports.'' Unless otherwise instructed by
the Retail Member Organization, a Retail Order will be identified as
Retail when routed to an away Trading Center. See EDGX Rule
11.21(d).
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B. Retail Order Priority
The Exchange proposes to amend EDGX Rule 11.9 to introduce order
book priority benefits exclusively to Retail Orders that are entered on
behalf of retail investors that enter a limited number of equity orders
each trading day. Such orders are being defined by the Exchange as a
``Retail Priority Order.'' \17\ To qualify as a Retail Priority Order,
the order must be a Retail Order, as defined in EDGX Rule 11.21(a)(2),
that is entered on behalf of a person that does not place more than 390
equity orders per day on average during a calendar month for its own
beneficial account(s).\18\ All orders entered on behalf of a retail
customer would be counted to determine whether a customer's Retail
Orders could be identified as Retail Priority Orders. This would
therefore include both orders routed to other exchanges and orders that
are not entered as Retail Orders (e.g., because the price of such
orders is modified by a broker-dealer algorithm).\19\
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\17\ See proposed EDGX Rule 11.9, Interpretations and Policies
.01.
\18\ Id. The Exchange states that 390 orders per day represents
one order entered each minute during regular trading hours--i.e.,
from 9:30 a.m. ET to 4:00 p.m. ET. See supra note 8, Notice of
Amendment No. 1 at 32809.
\19\ The Exchange also addresses how to count parent/child
orders and cancel/replace orders when determining whether the 390
order per day threshold has been exceeded. As proposed, parent/child
orders would be counted as a single order--i.e., a ``parent'' order
that is broken into multiple ``child'' orders by a broker or dealer,
or by an algorithm housed at a broker or dealer or by an algorithm
licensed from a broker or dealer, but which is housed with the
customer, would count as one order even if the ``child'' orders are
routed across multiple exchanges. In addition, with one exception
for parent/child orders, any order that cancels and replaces an
existing order would count as a separate order. An order that
cancels and replaces any ``child'' order resulting from a ``parent''
order that is broken into multiple ``child'' orders, would not count
as a new order. See supra note 8 at 32809-10.
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Pursuant to the proposal, RMOs that enter Retail Priority Orders
would be required to have reasonable policies and procedures in place
to ensure that such orders are appropriately represented on
[[Page 53790]]
the Exchange.\20\ Such policies and procedures should provide for a
review of retail customers' activity on at least a quarterly basis.\21\
Retail Orders for any retail customer that had an average of more than
390 orders per day during any month of a calendar quarter would not be
eligible to be entered as Retail Priority Orders for the next calendar
quarter.\22\ RMOs would be required to conduct a quarterly review and
make any appropriate changes to the way in which they are representing
orders within five business days after the end of each calendar
quarter.\23\ While RMOs would only be required to review their accounts
on a quarterly basis, if during a quarter the Exchange identifies a
retail customer for which orders are being represented as Retail
Priority Orders but that has averaged more than 390 orders per day
during a month, the Exchange would notify the RMO, and the RMO would be
required to change the manner in which it is representing the retail
customer's orders within five business days.\24\ The Exchange notes
that the proposed provisions relating to the obligations of RMOs are
similar to the obligations applicable to the Priority Customer
designation in the options industry.\25\
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\20\ See proposed EDGX Rule 11.9, Interpretations and Policies
.02.
\21\ Id.
\22\ See proposed EDGX Rule 11.9, Interpretations and Policies
.02(a).
\23\ Id.
\24\ See proposed EDGX Rule 11.9, Interpretations and Policies
.02(b).
\25\ See Notice of Amendment No. 1, supra note 8, at 32810.
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As described more fully in Amendment No. 1, that portion of a
Retail Order with a Displayed instruction would be given allocation
priority ahead of all other available interest on the EDGX Book.\26\
This would be true of both orders executed pursuant to the regular
priority bands described in EDGX Rule 11.9(a)(2)(A), and orders priced
at the midpoint of the NBBO pursuant to EDGX Rule 11.9(a)(2)(B) where
Retail Priority Orders subject to Display-Price Sliding would have
priority ahead of limit orders entered with such an instruction as well
as any other orders resting at the midpoint of the NBBO. In addition,
since Reserve Orders contain a Displayed instruction but include both
Displayed and Non-Displayed shares, the Reserve Quantity of Retail
Priority Orders would be given priority ahead of the Reserve Quantity
of other limit orders on the EDGX Book. Retail Priority Orders that are
not willing to be displayed, or are only willing to be displayed at a
less aggressive price than the execution price, would not receive any
special priority. This priority for Retail Orders would be in place
during all trading sessions and would be available to orders entered
for participation in the Exchange's opening process and the re-opening
process following a halt.\27\
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\26\ Id.
\27\ Id.
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C. Retail Order Attribution
Currently, RMOs that submit Retail Orders to the Exchange have the
option of identifying Retail Orders as such on the EDGX Book Feed.\28\
In the instant proposal, EDGX is requiring that Retail Priority Orders
always be designated as such on the EDGX Book Feed.\29\ Retail Orders
that are not designated as Retail Priority Orders could continue to be
attributed or not, at the discretion of the RMO.
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\28\ See EDGX Rule 11.21(f).
\29\ See proposed EDGX Rule 11.21(f).
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III. Comment Summary
The Commission received five comment letters from four commenters
on the proposed rule change.\30\ All four commenters express concerns
about the proposed rule change, as initially proposed. Following the
publication of Amendment No. 1, the one of the four commenters
submitted another comment letter that expresses continuing concerns
about the proposed rule change, as amended.
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\30\ See supra note 4.
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Two commenters expressed concerns about the Exchange's initial
definition of ``Retail Order,'' both noting that the definition does
not adequately distinguish retail investors' orders from active
professional traders' orders, potentially resulting in the granting of
queue priority to professional traders.\31\ One commenter stated that
this would impair market quality, undermine the intended benefits for
bona fide retail investors, adversely affect institutional investor
fill rates, and impair the provision of displayed liquidity.\32\ This
commenter also suggested that active professional orders could more
easily implement spread capture models by simply trading back-and-forth
at the top of the queue.\33\ This commenter further suggested that the
Exchange should amend the definition of ``Retail Order'' and noted that
the options markets use a definition of ``professional customer'' to
distinguish them from retail customers.\34\ The other commenter
expressed concern that the Exchange has not addressed issues with
enforcing the Retail Order definition, by, among other things, failing
to adequately consider investor protection issues raised by the
proposed rule change.\35\ This commenter stated that the Exchange does
not provide any detail on how it would protect investors from the
misuse of retail priority and believes that the Exchange must provide
more detail on how it will protect investors.\36\
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\31\ See Citadel Letter, supra note 4, at 1-2; Nasdaq Letter,
supra note 4, at 1.
\32\ See Citadel Letter, supra note 4, at 1-2.
\33\ See Citadel Letter, supra note 4, at 2.
\34\ See Citadel Letter, supra note 4, at 2.
\35\ See Nasdaq Letter, supra note 4, at 1.
\36\ See Nasdaq Letter, supra note 4, at 2.
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One commenter stated that the initial rule proposal is ``the
quintessential example of customer discrimination.'' \37\ This
commenter noted that the initial rule proposal is purportedly designed
with ordinary investors in mind, but the Retail Order designation can
only be utilized by a minority of ordinary investors, noting that
pension funds and institutional managers trading on behalf of
``ordinary investors'' would not receive the benefit of order
priority.\38\ This commenter maintained that the proposed order type
discriminates against a significant portion of ordinary investors as
initially proposed and even as amended.\39\
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\37\ See AJO Letter 1, supra note 4, at 2-3.
\38\ See AJO Letter 1, supra note 4, at 1; see also AJO Letter
2, supra note 4, at 2.
\39\ See AJO Letter 1, supra note 4, at 4; see also AJO Letter
2, supra note 4, at 2, 4.
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Three commenters expressed concerns relating to the requirement, as
set forth in the initial proposal, that Retail Orders will be
designated as such on the EDGX Book Feed.\40\ Two of these commenters
stated that only those market participants who purchase the appropriate
EDGX proprietary data feeds will have access to this information, and
identifying Retail Orders will allow these market participants to
identify institutional orders.\41\ One commenter suggested that this
places these market participants at an ``informational advantage over
others.'' \42\ Another commenter stated that such order information
leakage will result in increased adverse selection for institutional
investors and also believes that the unique data will make the relevant
EDGX data feed more valuable and likely encourages consumers of those
data feeds to continue purchasing these data feeds.\43\ One commenter
noted that institutional investors have no ability to opt out, unlike
Retail Member Organizations that could
[[Page 53791]]
choose to submit orders that would qualify as Retail Orders if so
designated, but are submitted without applying such designation.\44\
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\40\ See Nasdaq Letter, supra note 4, at 2-3; AJO Letter 1,
supra note 4 at 2; Themis Letter, supra note 4 at 2.
\41\ See AJO Letter 1, supra note 4, at 2; Themis Letter, supra
note 4, at 1-2.
\42\ See AJO Letter 1, supra note 4, at 2.
\43\ See Themis Letter, supra note 4, at 2.
\44\ See AJO Letter 1, supra note 4, at 3.
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In its response letter, EDGX states that the proposal, as modified
by Amendment No. 1, limits retail priority to only a subset of Retail
Orders (i.e., Retail Priority Orders) and therefore renders the
information leakage question ``moot'' because the RMO would retain the
choice of whether or not to attribute the order.\45\ EDGX also notes
that because only a subset of Retail Orders would be required to be
attributed on the EDGX Book Feed, market participants would not be able
to infer that any non-attributable order is an institutional order.\46\
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\45\ See EDGX Response Letter, supra note 9 at 2. One commenter
maintained that there is still ``information leakage'' which will
permit institutional orders to be identified after the Exchange
amended the original proposal to remove the requirement that all
retail orders be attributed. See AJO Letter 2, supra note 4, at 2.
\46\ Id.
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EDGX responds to the concern raised by a commenter regarding the
possible abuse of retail order priority by noting that the Exchange has
limited retail priority to orders entered on behalf of investors that
enter only a limited number of equity order each trading day, and
asserting that the Exchange has an effective regulatory program to
address member compliance with the retail priority order
requirements.\47\ EDGX also states that its Regulatory Division intends
to implement enhancements to its current regulatory program designed to
oversee RMO compliance with the retail priority rules to ensure that
orders entered with a priority attribute are appropriately marked.\48\
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\47\ See EDGX Response Letter, supra note 9 at 3.
\48\ Id.
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IV. 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.\49\ In particular, the
Commission finds that the proposed rule change, as modified by
Amendment No. 1, is consistent with Section 6(b)(5) of the Act,\50\
which requires, among other things, that the Exchange's rules be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, 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.
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\49\ In approving this proposed rule change the Commission notes
that it has considered the proposed rule's impact on efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f).
\50\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the Exchange's proposal represents a
reasonable effort to enhance the ability of bona fide retail trading
interest to compete for executions with orders entered by other market
participants that may be better equipped to optimize their place in the
intermarket queue.\51\ Under the proposal, bona fide retail orders will
be in a position to compete for executions as long as they are
qualified as such and attributed as such, which should lead to
increased or more immediate execution opportunities on the Exchange for
resting Retail Priority Orders. Furthermore, in order to qualify as a
Retail Priority Order, the Exchange is requiring RMOs that enter Retail
Priority Orders to have reasonable policies and procedures in place to
ensure that such order are appropriately represented on the
Exchange.\52\ RMOs also must conduct a quarterly review of retail
customers' activity and make any appropriate changes to the way in
which the RMO is representing orders within five business days after
the end of each calendar quarter. In addition, if the Exchange
identifies a retail customer whose orders are being represented by an
RMO that exceed 390 order per day during a month, the Exchange will
notify the RMO and the RMO will be required to change the manner in
which it is representing the retail customer's orders within five
business days. The Commission also notes that the Exchange's Regulatory
Division intends to implement enhancements to its current regulatory
program designed to oversee RMO compliance with the retail priority
rules to ensure that orders entered with a priority attribute are
appropriate marked.\53\
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\51\ Under existing EDGX Rules, to qualify as a RMO, Members
must submit to the Exchange, among other things, an attestation that
substantially all orders submitted as Retail Orders will qualify as
such, and must have written policies and procedures that are
reasonably designed to ensure that the Member will only designate
orders as Retail Order if all the requirements of a Retail Order are
met. In addition, if the Member represents Retail Orders from
another broker-dealer customer, that Member's supervisory procedures
must be reasonably designed to assure that the orders it receives
from such broker dealer customer that it designates as Retail Orders
meet the definition of a Retail Order. Such Members also must (i)
obtain an annual written representation from each broker-dealer
customer that sends it orders to be designated as Retail Orders that
entry of such orders as Retail Orders will be in compliance with the
requirements specified by the Exchange, and (ii) monitor whether its
broker-dealer customer's Retail Order flow continues to meet the
applicable requirements. See generally EDGX Rule 11.21(b).
\52\ See proposed EDGX Rule 11.9, Interpretations and Policies
.02.
\53\ Id.
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For the foregoing reasons, the Commission finds that the proposed
rule change, as modified by Amendment No. 1, is consistent with Section
6(b)(5) of the Act \54\ and the rules and regulations thereunder
applicable to a national securities exchange.
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\54\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\55\ that the proposed rule change, as modified by Amendment No. 1
(SR-CboeEDGX-2019-012) be, and hereby is, approved.
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\55\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\56\
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\56\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-21881 Filed 10-7-19; 8:45 am]
BILLING CODE 8011-01-P