[Federal Register Volume 84, Number 206 (Thursday, October 24, 2019)]
[Proposed Rules]
[Pages 56956-56958]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-22994]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-87327; File No. S7-18-19]


Commission Statement on Market Structure Innovation for Thinly 
Traded Securities

AGENCY: Securities and Exchange Commission.

ACTION: Commission statement.

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SUMMARY: This Securities and Exchange Commission (``Commission'') 
statement (``Statement'') is intended to facilitate the development of 
proposals that will improve secondary market trading for equity 
securities that trade in lower volume (``thinly traded securities''). 
The Commission's interest in considering proposals for improvement in 
this segment of the secondary market extends to proposals that could 
include the suspension or termination of unlisted trading privileges 
(``UTP'') and/or exemptive relief from Regulation NMS and other rules 
under the Securities Exchange Act of 1934 (``Exchange Act'').

DATES: The Commission's statement was effective October 17, 2019.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/policy.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-18-19 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 S7-18-19. This file number 
should be included on the subject line if email is used. To help us 
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/policy.shtml). Comments are 
also available for website viewing and printing in the Commission's 
Public Reference Room, 100 F Street NE, Washington, DC 20549-1090 on 
official business days between the hours of 10:00 a.m. and 3:00 p.m. 
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. Studies, 
memoranda, or other substantive items may be added by the Commission or 
staff to the comment file. A notification of the inclusion in the 
comment file of any materials will be made available on the 
Commission's website. To ensure direct electronic receipt of such 
notifications, sign up through the ``Stay Connected'' option at 
www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Cristie March, Senior Special Counsel; 
Deborah Flynn, Special Counsel; Christopher Chow, Special Counsel; or 
Liliana Burnett, Attorney-Adviser, at 202-551-5550, in the Division of 
Trading and Markets, Securities and Exchange Commission, 100 F Street 
NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: 

I. Introduction

    The Commission is issuing this Statement to facilitate the ability 
of market participants to develop innovative proposals for changes in 
equity market structure that are designed to improve trading in thinly 
traded securities. Although the Commission believes that the current 
equity market structure generally works well for securities that trade 
in higher volume, the Commission has concerns that the current ``one-
size-fits-all'' equity market structure, as largely governed under 
Regulation NMS,\1\ may not be optimal for thinly traded securities.
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    \1\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005) (adopting 17 CFR 242.600 through 
242.613 (Regulation NMS)) (``NMS Release''). ``NMS'' stands for the 
National Market System.
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    The secondary market for thinly traded securities faces liquidity 
challenges that can have a negative effect on both investors and 
issuers. In particular, thinly traded securities, which are often also 
smaller-capitalization securities, tend to have wider spreads and less 
displayed size relative to securities that trade in greater volume, 
often resulting in higher transaction costs for investors.\2\ Potential 
investors in such securities also may be concerned that they could 
encounter difficulties finding the necessary liquidity to establish or 
unwind positions in the stocks.\3\ A lack of readily available 
liquidity also may discourage potential market makers from electing to 
make markets in those

[[Page 56957]]

securities.\4\ For these reasons, a thinly traded security could affect 
a potential investor's willingness to invest in that issuer's 
securities, possibly resulting in even fewer trades.\5\ Having a less 
liquid security also could negatively affect an issuer's financing 
(e.g., the cost of capital).\6\ Staff in the Division of Trading and 
Markets has issued a paper providing additional background on the 
unique trading challenges and characteristics related to thinly traded 
securities.\7\
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    \2\ See Division of Trading and Markets Data Paper: Empirical 
Analysis of Liquidity Demographics and Market Quality, April 10, 
2018, available at https://www.sec.gov/files/thinly_traded_eqs_data_summary.pdf, at 1 (summarizing the quoting 
and trading characteristics of NMS stocks on the lower end of the 
liquidity spectrum).
    \3\ See, e.g., Transcript for Roundtable on Market Structure for 
Thinly-Traded Securities, April 23, 2018, available at https://www.sec.gov/spotlight/equity-market-structure-roundtables/thinly-traded-securities-rountable-042318-transcript.txt (``Transcript''), 
at 35; see also Thierry Foucault, Ohad Kadan & Eugene Kandel, 
Liquidity Cycles and Make/Take Fees in Electronic Markets, 68 J. 
Fin. 299 (2013) (discussing the externality of liquidity demand 
increases resulting in the increasing supply of liquidity, and an 
exogenous increase in the supply of liquidity resulting in an 
increase in the demand for liquidity).
    \4\ See, e.g., Transcript, supra note 3, at 24.
    \5\ In addition, one Roundtable participant suggested that it 
also could affect a company's attractiveness to current and 
prospective employees. See id. at 21, 85-86.
    \6\ See, e.g., Alexander W. Butler, Gustavo Grullon & James P. 
Weston, Stock Market Liquidity and the Cost of Issuing Equity, 40(2) 
J. Fin. & Quant. Anal. 331 (2005) (finding that stock liquidity is 
an important determinant of the cost of raising external capital and 
that investment bank fees are significantly lower for firms with 
more liquid stock); Jonathan Brogaard, Dan Li & Ying Xia, Stock 
Liquidity and Default Risk, 124(3) J. Fin. Econ. 486 (2007) (finding 
that stock liquidity reduces firm default risk by improving stock 
price informational efficiency and facilitating corporate governance 
by blockholders).
    \7\ See Securities and Exchange Commission, Division of Trading 
and Markets, Staff Background Paper on the Market Structure for 
Thinly Traded Securities (October 17, 2019), available at https://www.sec.gov/rules/policy/2019/thinly-traded-securities-tm-background-paper.pdf (``Staff Background Paper'').
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    The Commission recognizes there are various factors that affect the 
liquidity of a security and that market structure changes can address 
only part of the overall listing and trading environment for thinly 
traded securities. However, the Commission believes that there are a 
number of market structure changes \8\ that could improve secondary 
market trading for thinly traded securities and is therefore issuing 
this Statement to encourage innovative approaches in this regard.\9\
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    \8\ As discussed further below, market participants have 
suggested, for example, heightened market making obligations and 
market making incentives, periodic intraday auctions, non-automated 
auctions, and indicative quoting.
    \9\ Pursuant to the Congressional Review Act, the Office of 
Information and Regulatory Affairs has designated this policy 
statement as not a ``major rule,'' as defined by 5 U.S.C. 804(2). 
See 5 U.S.C. 801 et seq.
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II. Commission Position

A. Potential Market Structure Innovations for Thinly Traded Securities

    The Commission believes that certain market structure innovations 
that may provide benefits to thinly traded securities, when applied on 
one given exchange, may be less likely to succeed if the securities are 
subject to concurrent trading on multiple exchanges with different 
trading models. Accordingly, to be effective, these innovations may 
require the suspension or termination of UTP.\10\ UTP permits 
securities listed on any national securities exchange to be traded by 
other such exchanges.\11\ Currently, UTP is automatically extended to a 
security once it begins trading on the listing exchange.\12\ Similarly, 
some market structure innovations related to improving markets for 
thinly traded securities may require relief from certain Regulation NMS 
or other Exchange Act rules to be effective. Therefore, for thinly 
traded securities, the Commission is interested in considering 
proposals for market structure innovations in conjunction with the 
potential suspension or termination of UTP and/or the possibility of 
exemptive relief from Regulation NMS and other rules under the Exchange 
Act.\13\
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    \10\ The Commission understands that the suspension or 
termination of UTP may have effects on intermarket competition and, 
as noted below, welcomes comment on this matter and other matters 
raised in this Statement.
    \11\ 15 U.S.C. 78l(f).
    \12\ See Securities Exchange Act Release No. 43217, 65 FR 53560 
(September 5, 2000) (eliminating the one-day waiting period for 
exchanges to extend UTP to listed IPOs).
    \13\ Exchanges may submit market structure innovation proposals 
as rule filings in accordance with Section 19(b) of the Exchange Act 
and the rules thereunder. See 15 U.S.C. 78s(b). An application to 
suspend or terminate UTP for thinly traded securities under Section 
12(f) of the Exchange Act and the rules thereunder may be submitted 
to the Commission. See 15 U.S.C. 78l(f). Requests for exemptive 
relief from Regulation NMS or other rules under the Exchange Act for 
thinly traded securities may also be submitted to the Commission. 
See 15 U.S.C. 78mm(a). To the extent non-exchanges would like to 
recommend market structure innovations, those recommendations may be 
submitted to File Number S7-18-19 for this Statement.
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    A number of suggested market structure approaches to improve 
liquidity for thinly traded securities were raised at the Roundtable 
and elsewhere. One approach that has been suggested is that an exchange 
could provide market makers with incentives to assume heightened market 
making obligations for thinly traded securities.\14\ The concern 
expressed is that market makers may lack adequate incentives to quote, 
especially with significant order interest, at or inside the displayed 
best bid or offer in thinly traded securities, particularly during 
periods of increased volatility. Increased incentives to be in--and 
stay in--the markets for these securities could encourage market makers 
to quote more frequently and in greater size, which in turn could lead 
to narrower spreads and increased displayed order interest. An exchange 
might also explore ways to incentivize market makers to provide 
additional liquidity not only during normal market conditions, but also 
during times of market stress when liquidity in these securities can 
become even scarcer.
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    \14\ See, e.g., Transcript, supra note 3, at 49, 150-52, 192-93. 
For example, in the past, human market makers such as New York Stock 
Exchange specialists were the exclusive market makers in a range of 
allocated securities (including those that were thinly traded and 
actively traded) and, as a result, had more comprehensive 
information about the trading interest in those securities that 
facilitated their ability to meet heightened affirmative and 
negative obligations and incentivized their quoting activity.
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    Others have suggested that an exchange could implement periodic 
intraday auctions as a means of concentrating liquidity in thinly 
traded securities at times other than solely at the market open and 
market close.\15\ To the extent that liquidity in these securities does 
not efficiently coalesce when traded across multiple equity exchanges 
in intervals of microseconds, such an approach might facilitate more 
efficient order interaction and price formation by concentrating 
liquidity at one exchange and at distinct time intervals during the 
trading day.\16\ Doing so may help to resolve difficulties that market 
participants currently have in finding contra-side liquidity, 
particularly for larger-size orders.
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    \15\ See, e.g., Yakov Amihud, Haim Mendelson & Beni Lauterbach, 
Market Microstructure and Securities Values: Evidence from the Tel 
Aviv Stock Exchange, 45 J. Fin. Econ. 365 (1997) (noting that adding 
additional auctions to the trading day on the Tel Aviv stock 
exchange was associated with an increase in liquidity and that some 
European stock exchanges already include an intra-day call auction 
where continuous trading is paused for a period while a call auction 
is performed). See also Transcript, supra note 3, at 137; Nasdaq 
Application to Permit Issuer Choice to Consolidate Liquidity by 
Suspending Unlisted Trading Privileges (April 25, 2018), available 
at https://www.sec.gov/comments/265-31/26531-3515735-162293.pdf, at 
5.
    \16\ See, e.g., Robert Schwartz & Reto Francioni, Call Auction 
Trading, Encyclopedia of Finance 477 (2013) (stating that ``[t]he 
electronic call auction is appealing for small and mid-cap stocks 
because order batching augments the efficiency of liquidity 
provision by focusing liquidity at specific points in time'' and 
that ``[f]or securities with little liquidity and less frequent 
trading, one or two calls per day may suffice.'').
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    Another market structure change that has been suggested to help 
improve liquidity is the introduction of non-automated markets for 
thinly traded securities.\17\ Such an approach could enable an exchange 
to offer a negotiated market (i.e., a market that would permit buyers 
and sellers to communicate directly to determine an agreed upon price), 
whether for thinly traded securities orders generally, or for larger-
size orders more specifically. Such a negotiated market might address 
certain

[[Page 56958]]

liquidity challenges that fully continuous markets pose to thinly 
traded securities (e.g., the increased risk of ``missing the market'' 
when displaying an order).\18\ A related approach might be for an 
exchange to allow more informative indicative quoting \19\ in thinly 
traded securities as opposed to requiring firm quoting (again, whether 
as a general matter or for larger-size orders), to facilitate trade 
negotiation and incentivize market maker participation.
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    \17\ See, e.g., Transcript, supra note 3, at 79, 124, 149-52. 
See also id. at 26 (discussing the lack of negotiated trading on 
exchanges).
    \18\ This situation arises, for instance, when a displayed order 
is posted to a continuous market. The displayed order signals a buy 
or sell intention to the market, but instead of the displayed order 
being filled, a separate trade occurs either at or slightly better 
than the initially displayed price. Because the market consequently 
moves away from the initially displayed price, the initial posted 
order goes unexecuted. See also Staff Background Paper, supra note 
7, at 12 (describing the Roundtable discussions of the difficulties 
in filling orders).
    \19\ See, e.g., Transcript, supra note 3, at 80-81 (stating that 
indications of interest currently often are static or stale). An 
indicative quote is an expression of interest to transact designed 
to attract the contra side of the trade but that is not a firm 
quote.
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    The Commission notes that these potential market structure changes 
are merely a few examples of the types of innovations that exchanges 
and other market participants could consider developing that might 
facilitate improved trading in thinly traded securities. This list is 
not intended to be exhaustive or to limit the possibilities market 
participants could consider. The Commission encourages exchanges and 
other market participants, including issuers, to explore various types 
of market structure innovations to address the liquidity challenges in 
trading these securities.

B. Invitation for Proposals To Address the Market for Thinly Traded 
Securities

    To better facilitate secondary market trading in thinly traded 
securities, one possible approach is for a national securities exchange 
that lists thinly traded securities to consider submitting a proposal 
focused on enhancing the market structure for these securities. To the 
extent a listing exchange would like to submit a proposal for an 
innovation that incorporates or depends on the suspension or 
termination of UTP, such an exchange could apply for the suspension or 
termination of UTP pursuant to Section 12(f) of the Exchange Act so 
that these securities that an exchange lists would no longer trade on 
other national securities exchanges.\20\ As necessary to implement its 
proposed innovations, an exchange could submit requests for exemptive 
relief from Regulation NMS or other Exchange Act rules.\21\ The 
Commission recognizes that market structure changes may not address all 
of the challenges faced by issuers whose securities are thinly traded. 
But to the extent that the current secondary market requirements could 
be tailored to better serve thinly traded securities without negatively 
affecting trading as a whole, the Commission is interested in 
evaluating proposals that listing exchanges may submit. The Commission 
notes that market structure changes to improve trading in thinly traded 
securities could have implications for the broader market structure. 
The Commission encourages any proposal to address these potential 
broader market structure effects. In addition, the Commission expects 
any proposal to demonstrate how it would satisfy any relevant statutory 
requirements including, for example, Section 6, Section 11A, and 
Section 12 of the Exchange Act.\22\ The Commission would evaluate any 
proposals pursuant to such relevant statutory requirements.
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    \20\ See 15 U.S.C. 78l(f).
    \21\ At this time, the Commission's initiative is focused on 
encouraging on-exchange innovation for thinly traded securities and 
is not intended to address OTC trading of these securities.
    \22\ See 15 U.S.C. 78f, 15 U.S.C. 78k-1, and 15 U.S.C. 78l, 
respectively.
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    To facilitate the Commission's evaluation, it would be helpful for 
a proposal to address certain considerations. For example, a proposal 
should define what ``thinly traded security'' means, whether based on 
average daily trading volume, number of trades, share volume, or dollar 
volume, potentially combined with additional factors such as market 
capitalization, number of shareholders, or public float. Such proposals 
should also include an explanation of how the thresholds were set, 
including any relevant data and analysis.
    The proposal should address whether all securities that meet a 
chosen threshold test are included in the tier, or whether listed 
companies may opt in or out. If listed companies may opt in or out, the 
proposal should also address how the benefit of this mechanism 
justifies the potential additional operational complexity this may 
impose on NMS market participants.
    To the extent relevant, the Commission encourages exchange 
proposals that involve the suspension or termination of UTP to address: 
(1) Steps that might be taken to enhance the technological resilience 
of its new trading tier in light of the greater dependence of market 
participants on a single exchange; and (2) business continuity plan(s) 
in the event of the failure of an exchange's systems that would affect 
trading in, and required quote and trade information dissemination 
regarding, the thinly traded securities.
    The Commission encourages all proposals to address: (1) How and 
when a security would begin trading in the thinly traded security tier, 
and how it would transition out of the tier if that security no longer 
qualifies for trading in the tier; (2) how the exchange would address 
NMS Plan market data revenue allocation for any thinly traded 
securities not subject to UTP; and (3) the data the exchange would 
collect and make available and the data analysis it would conduct to 
enable an assessment of the success of the proposal.\23\ A proposal 
also could consider the collection and sharing of data to measure the 
market-wide effects of: (i) Limiting trading of the affected securities 
to a single exchange, including any market quality benefits or costs 
that may result from consolidating the liquidity pool; (ii) relief from 
Exchange Act rules that restrict the ability of exchanges to innovate 
beyond the fully continuous market models that exist today; and (iii) 
any other innovative market structure modifications. The Commission 
welcomes comments on matters addressed in this Statement, including any 
potential effects on intermarket competition for listing and trading 
thinly traded securities, as well as related potential effects on 
market transparency and the protection of investors.
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    \23\ In so doing, an exchange could consider describing how it 
could evaluate the success of a proposal, including: (i) The data 
that could be collected; (ii) the testing and comparative analysis 
based on specified metrics that could be conducted to determine the 
effectiveness of the program; (iii) an explanation of the 
statistical approach it could employ in its testing and comparisons; 
and (iv) the empirical analysis it could perform.
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    The Commission looks forward to engaging with exchanges that list 
and trade thinly traded securities, market participants involved in 
this segment of the equities market, including issuers, investors, and 
others to facilitate market structure innovations that can meaningfully 
improve secondary market trading for these securities.

    By the Commission.

    Dated: October 17, 2019.
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-22994 Filed 10-23-19; 8:45 am]
 BILLING CODE 8011-01-P