[Federal Register Volume 84, Number 249 (Monday, December 30, 2019)]
[Notices]
[Pages 71997-72007]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28024]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87814; File No. SR-IEX-2019-15]


Self-Regulatory Organizations: Investors Exchange LLC; Notice of 
Filing of Proposed Rule Change To Add a New Discretionary Limit Order 
Type

December 20, 2019.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 
1934 (the ``Act''),\2\ and Rule 19b-4 thereunder,\3\ notice is hereby 
given that on December 16, 2019, the Investors Exchange LLC (``IEX'' or 
the ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
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\ 15 U.S.C. 78a.
    \3\ 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

    (a) Pursuant to the provisions of Section 19(b)(1) under the 
Act,\4\ and Rule 19b-4 thereunder,\5\ IEX is filing with the Commission 
a proposed rule change to add a new Discretionary Limit order type (a 
``D-Limit'' order).
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    \4\ 15 U.S.C. 78s(b)(1).
    \5\ 17 CFR 240.19b-4.
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    The text of the proposed rule change is available at the Exchange's 
website at www.iextrading.com, at the principal office of the Exchange, 
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, the self-regulatory organization 
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. The self-regulatory organization 
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
    The Exchange proposes to introduce a new order type, a 
Discretionary Limit or ``D-Limit'' order, that is designed to protect 
liquidity providers from potential adverse selection by latency 
arbitrage trading strategies.\6\
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    \6\ As proposed, a D-Limit order is also eligible to take 
resting liquidity on entry. If not executed on entry, the order will 
post to the Order Book and be available to provide liquidity.
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Background
    IEX believes that in the current market environment, market 
participants that have access to the fastest and most complete view of 
market data from all the major exchanges are able to predict imminent 
changes to national best bid and offer quotations (``NBBO''),\7\ 
representing the best displayed bid and offer prices that are available 
in the market at any point in time. By sending orders to ``take 
liquidity'' against orders that are resting on exchanges or other 
trading venues in very small windows of time, generally no more than a 
few milliseconds before an anticipated change in the NBBO, trading 
firms seeking to exploit these speed and information asymmetry 
advantages can profit, to the corresponding disadvantage of 
institutional investors and other participants, whose resting orders 
are ``picked off'' by these faster firms at ``stale'' prices.
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    \7\ The term ``NBBO'' means the national best bid or offer, as 
set forth in Rule 600(b) of Regulation NMS under the Act, determined 
as set forth in IEX Rule 11.410(b). See IEX Rule 1.160(u).
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    IEX further believes that this trading activity creates a 
substantial disincentive to market participants to provide exchange 
quotes and other orders that rest on exchanges' order books. To 
compensate for the resulting adverse selection, among other reasons, 
many exchanges employ maker-taker style fee schedules which pay rebates 
to liquidity providers that trade on their markets (``Maker-Taker'').
    This phenomenon, commonly referred to as ``latency arbitrage,'' has 
led to proposals by equity and futures markets specifically designed to 
provide protection for resting orders in order to incentivize market 
makers and other liquidity providers to maintain tighter spreads with 
larger size. Most recently, Cboe EDGA Exchange, Inc. (``EDGA'') 
proposed a four-millisecond asymmetrical delay mechanism or ``speed 
bump'' that would apply only to incoming executable orders.\8\ As set 
forth in its rule change proposal seeking Commission approval of this 
asymmetrical speedbump, EDGA states that the purpose of the 
asymmetrical speed bump is to provide ``an opportunity for liquidity 
providers to process cross-asset signals, and update their published 
quotations accordingly, before trading at stale prices with orders 
submitted by opportunistic trading firms that benefit from a latency 
advantage.'' \9\ The EDGA proposal describes the challenges for 
liquidity providers as follows:
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    \8\ See Securities Exchange Act Release No. 86168 (June 20, 
2019), 84 FR 30282 (June 26, 2019) (SR-CboeEDGA-2019-012).
    \9\ See supra note 8, at 30283.

    Today, liquidity providers are frequently unable to adjust their 
displayed quotes based on changes in market information . . . before 
the fastest trading firms can trade against their quotes. Market 
makers and other liquidity providers use sophisticated pricing

[[Page 71998]]

algorithms to determine how to price securities in the often 
hundreds or thousands of equity securities that they quote. . . . 
The potential for trading at stale prices increases risk for firms 
that wish to provide liquidity to the market, and harms market 
quality by causing liquidity providers to enter quotes that are 
wider or for a smaller size than they may otherwise be willing to 
trade.\10\
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    \10\ See supra note 8, at 30283.

    As discussed more fully below, IEX's proposal to establish a D-
Limit order type is designed to protect liquidity providers, 
institutional investors as well as market makers, from potential 
adverse selection by latency arbitrage trading strategies in a fair and 
nondiscriminatory manner, without, as some commenters have mentioned, 
introducing concerns around unnecessary complexity, disparate 
treatment, and fair access by institutional investors to displayed 
quotations that have been voiced with regard to the EDGA asymmetrical 
speed bump proposal.\11\
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    \11\ See comments on Release No. 34-86168; File No. SR-CboeEDGA-
2019-012 available at: https://www.sec.gov/comments/sr-cboeedga-2019-012/srcboeedga2019012.htm.
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    Since before and after it became an exchange, IEX has sought to 
design its market in a way that creates a transparent and level playing 
field where both investors and market professionals can participate and 
have confidence in the fairness of the system. In general, these 
aspects of our market involve ways to counter or reduce speed 
advantages that can harm investors by exposing them to execution at 
stale prices when their orders are traded against by traders with more 
complete and timely information about market prices.
    These aspects include the use of a so-called ``speed bump,'' a 
symmetrical delay mechanism consisting of a length of coiled optical 
fiber, which, together with the physical distance from the location 
where members connect to the IEX systems where orders are matched, 
delays all incoming orders by 350 microseconds. The speed bump is 
designed to protect non-displayed orders, typically placed on behalf of 
institutional investors, that are ``pegged'' to a given price, often 
the midpoint of the NBBO, i.e., the Midpoint Price.\12\ The speed bump 
allows IEX's matching engine to update the prices of resting pegged 
orders in line with price changes on other markets to lessen the 
possibility of adverse selection when a new Midpoint Price is 
established. By repricing the order based on the current market, 
resting orders are less likely to be executed at stale prices when 
incoming orders by other exchange participants with the advantage of a 
more current view of market prices seek to execute against resting 
pegged orders on IEX.
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    \12\ See IEX Rule 1.160(t).
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    The speed bump works together with certain non-displayed order 
types that are designed to provide further protection to non-displayed 
orders and encourage brokers to place those orders on IEX. These 
include Discretionary Peg \13\ (``DPeg''), which, in its current 
iteration, is an order pegged to trade at one minimum price variation, 
or ``tick,'' below the national best bid (``NBB''),\14\ in the case of 
buy orders, or one tick above the national best offer (``NBO''),\15\ in 
the case of sell orders, unless the submitter of the order has 
specified a limit price that is less aggressive than this default 
resting price. For most stocks, the minimum tick under Commission rules 
is one cent. In most circumstances, DPeg orders can also trade at a 
more aggressive price (one more favorable to the counterparty), but 
only to the midpoint, when there are incoming orders that are willing 
to trade at that price.
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    \13\ See IEX Rule 11.190(b)(10). IEX has two other order types 
that are based on the DPeg order type: The Retail Liquidity Provider 
order and the Corporate Discretionary Peg order. See Rule 
11.190(b)(14) and (16).
    \14\ The term ``NBB'' shall mean the national best bid, as set 
forth in Rule 600(b) of Regulation NMS under the Act, determined as 
set forth in IEX Rule 11.410(b). See Rule 1.160(u).
    \15\ The term ``NBO'' shall mean the national best offer, as set 
forth in Rule 600(b) of Regulation NMS under the Act, determined as 
set forth in IEX Rule 11.410(b). See Rule 1.160(u).
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    Similarly, the primary peg \16\ (``PPeg'') order type is pegged to 
one tick below the NBB, for a buy order, and one tick above the NBO, 
for a sell order, but is also available to trade at a price up to the 
NBB or down to the NBO, unless further restricted by the order's limit 
price. When DPeg and PPeg orders are eligible to trade at prices more 
aggressive than their default prices, they are said to be ``exercising 
discretion'' to trade at these more aggressive prices.
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    \16\ See IEX Rule 11.190(b)(8).
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    In addition, IEX uses a proprietary mathematical calculation, the 
crumbling quote indicator (``CQI''), to determine when its pegged order 
types are eligible to exercise discretion. The CQI is a transparent 
formula, codified in IEX's rulebook, designed to predict whether a 
particular quote is unstable or ``crumbling,'' meaning that the NBB is 
likely about to decline or the NBO is likely about to increase. As set 
forth in IEX Rule 11.190(g), the Exchange utilizes real time relative 
quoting activity of certain Protected Quotations \17\ and a proprietary 
mathematical calculation (the ``quote instability calculation'') to 
assess the probability of an imminent change to the current Protected 
NBB to a lower price or Protected NBO to a higher price for a 
particular security (``quote instability factor''). When the quoting 
activity meets predefined criteria and the quote instability factor 
calculated is greater than the Exchange's defined quote instability 
threshold, the System \18\ treats the quote as unstable and the CQI is 
on at that price level for up to two milliseconds (hereafter referred 
to as the ``quote instability determination price level'' or the ``CQI 
Price''). During all other times, the quote is considered stable, and 
the CQI is off. The System independently assesses the stability of the 
Protected NBB and Protected NBO for each security.\19\
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    \17\ Pursuant to IEX Rule 11.190(g), references to ``Protected 
Quotations'' include quotations from the New York Stock Exchange LLC 
(``NYSE''); The Nasdaq Stock Market LLC (``Nasdaq''); NYSE Arca, 
Inc. (``NYSE Arca''); Nasdaq BX, Inc. (``Nasdaq BX''); Cboe BZX 
Exchange, Inc. (``Cboe BZX''); Cboe BYX Exchange, Inc. (``Cboe 
BYX''); Cboe EDGX Exchange, Inc. (``EDGX''); and EDGA.
    \18\ See IEX Rule 1.160(nn).
    \19\ IEX has revised the CQI formula twice since its exchange 
launch in order to enhance the accuracy of the CQI in predicting 
quote instability and increasing the protection provided to pegged 
orders.
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    When IEX determines, pursuant to the CQI methodology, that the 
current market for a security is unstable--meaning there is a 
heightened probability of an imminent quote change at the NBB or NBO--
IEX's System will prevent DPeg and PPeg orders on that side of the 
market from exercising discretion and trading at a price that is more 
aggressive than their default resting prices. In this way, IEX seeks to 
protect these orders from being executed at unfavorable prices during 
these very short periods of time when they face a high risk that the 
market price will immediately move against them, and IEX's System 
allows them to trade at more aggressive prices, with a higher 
probability of execution, in all other circumstances.
    DPeg and PPeg orders have been widely adopted by a diverse group of 
IEX Members. During September 2019, such orders constituted 38% of 
overall IEX traded volume (DPeg volume was 35% and PPeg volume was 3%) 
and 55% of liquidity adding volume (DPeg volume was 49% and PPeg volume 
was 6%). 70 of 145 IEX Members traded using DPeg or PPeg orders (these 
Members represent 90% of the total volume traded on IEX), with 84% of 
this volume originating from full-service firms, 9% from proprietary 
trading

[[Page 71999]]

firms, and 7% from agency firms.\20\ IEX believes that this usage 
evidences that a large range of market participants with diverse 
business models have a high degree of confidence in the utility of the 
CQI formula.
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    \20\ See infra note 58 and accompanying text for a discussion of 
IEX's classification of its Members' logical order entry ports.
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    All of these aspects of IEX's design--the speed bump, the pegged 
order types, and the CQI--are designed to work together to provide 
better execution opportunities for these orders, which are favored by 
institutional investors, by protecting them from being executed at 
inferior prices in narrow time windows when the NBBO is in transition. 
As described further below, these features have provided substantial 
benefits in terms of execution outcomes to investors and other 
participants using these IEX order types.
    In addition to these other features of IEX's market, since January 
1, 2018, IEX has imposed an additional fee on Members that send more 
than a certain threshold of their orders to take liquidity during 
periods when the CQI is on (the ``CQ Remove Fee''). The CQ Remove Fee 
is intended to incentivize participants to send orders to provide 
liquidity to IEX by reducing the volume of orders involving trading 
strategies that seek to exploit information advantages while the NBBO 
is in transition. The CQ Remove Fee has resulted in an incremental 
reduction in the use of such strategies on IEX. IEX believes the 
limited impact from the fee is a result of the fact that the potential 
profits from the use of such strategies substantially exceed the 
profits lost from the CQ Remove Fee.\21\
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    \21\ The Exchange is effectively limited in setting the CQ 
Remove Fee by Rule 610(c) of Regulation NMS. 17 CFR 242.610(c).
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    The innovations IEX has introduced have succeeded in providing new 
execution opportunities for investors, particularly through the use of 
the pegged order types described above, and they have provided IEX 
participants with opportunities for improved executions compared to 
other venues.\22\ At the same time, IEX believes that the willingness 
of market participants to provide liquidity through other order types, 
including displayed orders, is substantially negatively affected by the 
trading strategies described above. Without an order type that 
leverages the protective features of the CQI, 24% of displayed volume 
on IEX is executed when the CQI is on, compared to only 3% of 
nondisplayed volume during September 2019. As discussed in detail 
below, IEX trading data reveals that liquidity-providing orders that 
are executed while the CQI is on are subject to significant differences 
in short term markouts,\23\ compared to liquidity-providing orders 
executed when the CQI is off, and the significant volume of orders that 
are sent during these very small time intervals (on IEX as well as 
other exchanges) accentuates this impact.
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    \22\ See, e.g., Wah, Elaine, et al. ``A Comparison of Execution 
Quality across U.S. Stock Exchanges,'' (April 19, 2017), available 
at https://iextrading.com/docs/A%20Comparison%20of%20Execution%20Quality%20across%20U.S.%20Stock%20Exchanges.pdf.
    \23\ The term markouts refers to changes in the midpoint of the 
NBBO measured from the perspective of either the liquidity providing 
resting order or liquidity removing taking order over a specified 
period of time following the time of execution.
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    Maker-Taker exchanges use rebate payments to induce participants to 
post quotes and other resting orders on exchanges notwithstanding these 
negative impacts. A variety of significant concerns have been raised 
regarding the effect of paying rebates as compensation to a relatively 
small number of liquidity providers, which include conflicts of 
interest, increased market fragmentation, effectiveness, and adding 
unnecessary complexity to overall equity market structure by 
incentivizing market participants to attempt to continually readjust 
their order routing to navigate a multitude of constantly changing 
transaction fee schedules.\24\ The Commission has adopted a transaction 
fee pilot, to assess these concerns about existing exchange fee 
structures, which is designed to test potential improvements to market 
quality from reducing access fees and prohibiting rebates on all 
exchanges.\25\ Moreover, the substantial use of ``Taker-Maker'' 
exchange fee models, which charge fees to liquidity providing orders 
and pay rebates to liquidity taking orders, evidences that exchanges 
can compete for displayed order flow without paying rebates.
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    \24\ See generally, transcript of Commission ``Roundtable on 
Market Data Products, Market Access Services, and their Associated 
Fees'' (October 25, 2018) available at: https://www.sec.gov/spotlight/equity-market-structure-roundtables/roundtable-market-data-market-access-102518-transcript.pdf.
    \25\ See Securities Exchange Act Release 84875 (December 19, 
2018); 84 FR 5202 (February 20, 2019).
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    In view of these factors, the Exchange believes that it is 
appropriate to also leverage the CQI to expand the IEX protective 
design to displayed and non-pegged non-displayed limit orders.\26\ The 
Exchange further believes that providing such protection would 
incentivize the entry of liquidity providing orders on IEX by 
protecting such orders from adverse selection by market participants 
leveraging sophisticated latency arbitrage strategies to exploit 
informational advantages when IEX's probabilistic model determines that 
the market appears to be moving adversely to them.
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    \26\ IEX currently allows limit orders to be either ``displayed, 
non-displayed, or partially displayed.'' See IEX Rule 11.190(a)(1). 
Displayed orders must be limit orders, see IEX Rule 11.190(b)(1), 
but non-displayed orders can be either a market, limit, or pegged 
order. See IEX Rule 11.190(b)(3). Furthermore, pegged orders can be 
submitted with or without a limit price, with the exception of 
Market Maker Peg orders, which must be limit orders. See IEX Rule 
11.190(b)(8), (9), (10), (13), and (16).
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    Accordingly, IEX is proposing the D-Limit order type as an 
alternative means of encouraging market makers and other participants, 
including institutional investors, to provide liquidity, by adjusting 
the price of these orders in the narrow time windows when the CQI is 
on, to better protect them from being ``picked off'' during those 
intervals. IEX believes that D-Limit represents a logical extension of 
its efforts to date to create a trading platform that encourages 
participation by investors and market professionals and maximizes 
opportunities for investors to trade at a fair price. D-Limit orders 
would be available to all IEX Members in a fair and nondiscriminatory 
manner.
    As discussed further below, IEX believes that exchanges must be 
allowed to innovate in narrowly targeted ways to protect resting orders 
from being unfairly exploited by information asymmetries. IEX also 
believes such measures are important to enhance the value and integrity 
of protected quotes generally, and that D-Limit will benefit market 
quality by leading to deeper liquidity, displayed and non-displayed, 
and increased opportunities for participants interacting with this 
liquidity to receive favorable executions.
Proposal
    The Exchange proposes to amend IEX Rule 11.190(b)(7), which is 
currently reserved, to add a D-Limit order which may be a displayed or 
non-displayed limit order that upon entry and when posting to the Order 
Book,\27\ is priced to be equal to and ranked at the order's limit 
price,\28\ but will be adjusted to a less-aggressive price during 
periods of quote instability, as defined in IEX Rule 11.190(g), as 
described more fully

[[Page 72000]]

below. Otherwise, a D-Limit order will operate in the same manner as a 
displayed or non-displayed limit order, as applicable.
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    \27\ See IEX Rule 1.160(p).
    \28\ A non-displayed D-Limit order with a limit price more 
aggressive than the Midpoint Price will be subject to the Midpoint 
Price Constraint and be booked and ranked on the Order Book at a 
price equal to the Midpoint Price pursuant to IEX Rule 11.190(h)(2).
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    As proposed, if upon entry of a D-Limit buy (sell) order the CQI is 
on and the order has a limit price equal to or higher (lower) than the 
quote instability determination price level (i.e., the CQI Price), the 
price of the order will be automatically adjusted by the System to one 
(1) MPV \29\ lower (higher) than the CQI price. Similarly, when 
unexecuted shares of a D-Limit buy (sell) order are posted to the Order 
Book, if a quote instability determination is made and such shares are 
ranked and displayed (in the case of a displayed order) by the System 
at a price equal to or higher (lower) than the CQI Price, the price of 
the order will be automatically adjusted by the System to one (1) MPV 
lower (higher) than the CQI Price. A D-Limit order that is subject to 
an automatic adjustment will not revert to the price at which it was 
previously ranked and displayed (in the case of a displayed order). 
Once the price of a D-Limit order that has been posted to the Order 
Book is automatically adjusted by the System, the order will continue 
to be ranked and displayed (in the case of a displayed order) at the 
adjusted price, unless subject to another automatic adjustment, or if 
the order is subject to the price sliding provisions of IEX Rule 
11.190(h). When the price of a D-Limit order is adjusted the order will 
receive a new time priority. If multiple D-Limit orders are adjusted at 
the same time, their relative time priority will be maintained. 
Further, when the price of a D-Limit order is adjusted, the Member that 
entered the order will receive an order restatement message from the 
Exchange notifying the Member of the price adjustment.\30\
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    \29\ See IEX Rule 11.210.
    \30\ A restatement notice is an automated message from the 
Exchange System informing the Member that the price of its order has 
been adjusted.
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    D-Limit orders are subject to the price sliding provisions of IEX 
Rule 11.190(h), as noted above. This provision provides for price 
sliding in the event of a locked or crossed market, to enforce the 
Midpoint Price Constraint,\31\ to comply with the display or execution 
requirements for a short sale order not marked short exempt during a 
Short Sale Period,\32\ or to comply with the Limit Up-Limit Down Price 
Constraint.\33\ As set forth in IEX Rule 11.190(h), an order that has 
been subject to price sliding will be repriced back to its more 
aggressive limit price when the market condition changes such that the 
condition necessitating the price sliding is no longer applicable.\34\
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    \31\ See note 28 supra.
    \32\ See IEX Rule 11.290(d).
    \33\ See IEX Rule 11.190(h)(5).
    \34\ See IEX Rule 11.190(h) for a complete description of the 
price sliding provisions. See also note 28 supra regarding 
applicability of the Midpoint Price Constraint.
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    Pursuant to proposed IEX Rule 11.190(b)(7), a D-Limit order:

    (A) Must be submitted with a limit price.
    (B) May have a TIF of DAY, GTX, SYS or GTT.
    (C) Is not eligible for routing pursuant to IEX Rule 11.230(b) 
and (c)(2).
    (D) May not be an ISO.\35\
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    \35\ See IEX Rule 11.190(b)(12).
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    (E) Is eligible to trade only during the Regular Market 
Session.\36\ A D-Limit order marked with a TIF of DAY that is 
submitted to the System before the opening of the Regular Market 
Session will be queued by the System until the start of the Regular 
Market Session; a D-Limit order marked with a TIF other than DAY 
will be rejected when submitted to the System during the Pre-Market 
Session.\37\ A D-Limit order submitted into the System after the 
closing of the Regular Market Session will be rejected.
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    \36\ See IEX Rule 1.160(gg).
    \37\ See IEX Rule 1.160(z).
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    (F) May not be a minimum quantity order.\38\
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    \38\ See IEX Rule 11.190(b)(11).
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    (G) May be an odd lot, round lot, or mixed lot. However, a D-
Limit order marked for display will not be displayed unless it is at 
least one round lot. If a D-Limit order marked for display is 
submitted with, or decremented either by execution or the User order 
amendment to an order quantity of less than one round lot, it will 
be treated as an odd lot order which is, by definition, non-
displayed and will receive a new time stamp, pursuant to IEX Rule 
11.220(a)(3).
    (H) May not be a Reserve Order.\39\
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    \39\ See IEX Rule 11.190(b)(2).
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    (I) Displayed Discretionary Limit orders are not eligible to be 
invited by the System to Recheck as described in IEX Rule 
11.230(a)(4)(D).
    (J) Discretionary Limit orders are subject to the Price Sliding 
provisions of IEX Rule 11.190(h).

    The proposed rule change would thus extend the protective features 
of the CQI to displayed and non-displayed D-Limit orders to protect 
such orders from potential adverse selection by preventing them from 
trading at a price that IEX's CQI formula predicts is unstable and thus 
imminently stale.
    The following examples illustrate the operation of the price 
adjustment functionality of D-Limit orders: \40\
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    \40\ The following examples all describe D-Limit buy orders. 
Each of the examples also applies to a D-Limit sell order, except 
that any price adjustments to a D-Limit sell order would adjust the 
order price to one MPV above the CQI Price in effect.

    1. The PBBO \41\ in XYZ is 10.05-10.10 and a displayed D-Limit 
order to buy with a limit price of 10.05 is resting on the IEX Order 
Book at its limit price. A quote instability determination is made 
at the PBB \42\ of 10.05. Because the limit (and displayed) price of 
the D-Limit order is equal to the CQI Price, the price of the order 
is adjusted to 10.04.
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    \41\ The term ``PBBO'' refers to the national best bid or offer 
that is a protected quotation, determined as set forth in IEX Rule 
11.410(b). See IEX Rule 1.160(cc).
    \42\ The term ``PBB'' refers to the national best bid that is a 
protected quotation, determined as set forth in IEX Rule 11.410(b). 
See IEX Rule 1.160(cc).
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    2. The PBBO in XYZ is 10.05-10.10 and a displayed D-Limit order 
to buy with a limit price of 10.04 is resting on the IEX Order Book 
at its limit price. A quote instability determination is made at the 
PBB of 10.05. Because the limit and displayed price of the D-Limit 
order is less than the CQI Price, the price of the order is not 
adjusted.
    3. Following the order adjustment in Example 1, the PBB reverts 
to 10.05. The order remains displayed at its adjusted limit price of 
10.04 because a D-Limit order that has been adjusted continues to be 
ranked and displayed at its adjusted price, regardless of a change 
in the PBB, unless subject to another automatic adjustment.
    4. Following the order adjustment in Example 1, a new quote 
instability determination is made at the PBB of 10.04. Because the 
limit and displayed price of the D-Limit order is equal to the CQI 
Price, the price of the order is adjusted again to 10.03.
    5. Following the order adjustment in Example 1, the PBB reverts 
to 10.05 and a new quote instability determination is made at the 
PBB of 10.05. Because the limit and displayed price of the D-Limit 
order is lower than the CQI Price, the price of the order is not 
adjusted.
    6. The PBBO in XYZ is 10.05-10.10 and a non-displayed D-Limit 
order to buy with a limit price of 10.06 is resting on the IEX Order 
Book at its limit price. A quote instability determination is made 
at the PBB of 10.05. Because the limit price of the D-Limit order is 
higher than the CQI Price, the price of the order is adjusted to 
10.04.
    7. The PBBO in XYZ is 10.05-10.10 and a non-displayed D-Limit 
order to buy with a limit price of 10.05 is resting on the IEX Order 
Book at its limit price. A quote instability determination is made 
at the PBB of 10.05. Because the limit price of the D-Limit order is 
equal to the CQI Price, the price of the order is adjusted to 10.04. 
Subsequently, the PBB moves to 10.03 and a new quote instability 
determination is made at the PBB of 10.03. The price of the order is 
adjusted to a price of 10.02.
    8. The PBBO in XYZ is 10.05-10.10 and the quote instability 
determination is in effect for the PBB at 10.05. A D-Limit order to 
buy XYZ with a limit price of 10.05 enters the IEX Order Book. 
Because the limit price of the order is equal to the CQI Price in 
effect, the price of the order is adjusted to and booked at 
10.04.\43\
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    \43\ The order is not executable on entry at 10.04 because of 
the Midpoint Price Constraint. Pursuant to IEX Rule 11.190(h)(2), a 
non-displayed limit order posting to the Order Book which has a 
limit price more aggressive than the Midpoint Price will be booked 
and ranked on the Order Book non-displayed at a price equal to the 
Midpoint Price.
---------------------------------------------------------------------------

    9. The PBBO in XYZ is 10.05-10.10 and the quote instability 
determination is in

[[Page 72001]]

effect for the PBB at 10.05. A D-Limit order to buy XYZ with a limit 
price of 10.04 enters the IEX Order Book. Because the limit price of 
the order is lower than the CQI Price in effect, the price of the 
order is not adjusted.\44\
---------------------------------------------------------------------------

    \44\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------

    10. The PBBO in XYZ is 10.05-10.10 and the quote instability 
determination is in effect for the PBB at 10.05. A D-Limit order to 
buy XYZ with a limit price of 10.06 enters the IEX Order Book. 
Because the limit price of the order is higher than the CQI Price in 
effect, the price of the order is adjusted to and booked at 
10.04.\45\
---------------------------------------------------------------------------

    \45\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------

    11. The PBBO in XYZ is 10.05-10.10 and the quote instability 
determination is in effect for the PBB at 10.05. The PBB crumbles to 
10.04 but the quote instability determination is still in effect at 
10.05. A D-Limit order to buy XYZ with a limit price of 10.05 enters 
the IEX Order Book. Because the limit price of the order is equal to 
the CQI Price in effect, the price of the order is adjusted to and 
booked at 10.04.\46\
---------------------------------------------------------------------------

    \46\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------

    12. The PBBO in XYZ is 10.04-10.10 and the quote instability 
determination is in effect at 10.05 (the prior PBB). A D-Limit order 
to buy XYZ with a limit price of 10.05 enters the IEX Order Book. 
Because the limit price of the order is equal to the CQI Price in 
effect, the price of the order is adjusted to and booked at 
10.04.\47\
---------------------------------------------------------------------------

    \47\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------

    13. The PBBO in XYZ is 10.04-10.10 and the quote instability 
determination is in effect at 10.05 (the prior PBB). A D-Limit order 
to buy XYZ with a limit price of 10.06 enters the IEX Order Book. 
Because the limit price of the order is higher than the CQI Price in 
effect, the price of the order is adjusted to and booked at 
10.04.\48\
---------------------------------------------------------------------------

    \48\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------

    14. The PBBO in XYZ is 10.04-10.10 and the quote instability 
determination is in effect at 10.05 (the prior PBB). A D-Limit order 
to buy XYZ with a limit price of 10.04 enters the IEX Order Book. 
Because the limit price of the order is lower than the CQI Price in 
effect, the price of the order is booked at 10.04.\49\
---------------------------------------------------------------------------

    \49\ The order is not executable on entry. See supra note 43.

    D-Limit orders would be available to all Members on a fair and 
impartial basis and no particular technology or access to high speed 
connectivity or market data is necessary to obtain the protective 
benefits of a D-Limit order. The Exchange will adjust the price of a D-
Limit order based on the transparent, rule-based CQI formula. In 
contrast, the use of ``asymmetric'' speed bumps (those imposed only on 
the taker of liquidity) in order to provide a benefit to resting 
orders, requires access to sophisticated technology, connectivity and 
market data in order to cancel or adjust an order in the brief time 
period that an incoming order is delayed.
    IEX is not proposing any changes to IEX Rule 11.240(c) which 
specifies that the System operates as an ``automated market center'' 
and displays ``automated quotations'' within the meaning of Regulation 
NMS, except in the event that a systems malfunction renders the System 
incapable of displaying automated quotations. Automated quotations of 
an automated trading center are protected quotations pursuant to Rule 
600(b)(62) of Regulation NMS \50\ and entitled to trade-through 
protection pursuant to Rule 611 of Regulation NMS \51\ (the ``Order 
Protection Rule''). Consequently, displayed D-Limit orders will qualify 
as automated quotations within the meaning of Regulation NMS (except in 
the event that a systems malfunction renders the System incapable of 
displaying automated quotations).\52\
---------------------------------------------------------------------------

    \50\ 17 CFR 242.600(b)(62).
    \51\ 17 CFR 242.611.
    \52\ 17 CFR 242.602(a)(3)(i).
---------------------------------------------------------------------------

2. Statutory Basis
    IEX believes that the proposed rule change is consistent with the 
provisions of Section 6(b) \53\ of the Act in general, and furthers the 
objectives of Section 6(b)(5) of the Act \54\ in particular, in that it 
is 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. Specifically, the Exchange believes the proposed rule 
change is consistent with the protection of investors and the public 
interest because it is designed to protect resting D-Limit orders from 
adverse selection associated with latency arbitrage by limiting 
execution to one MPV lower than the CQI Price (for buy orders) or one 
MPV higher than the CQI Price (for sell orders) when the Exchange's 
probabilistic model identifies that the NBB or NBO appears to be moving 
adversely to them, thereby reducing the potential to execute at an 
imminently stale price.
---------------------------------------------------------------------------

    \53\ 15 U.S.C. 78f.
    \54\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    In addition, the Exchange believes that the proposed rule change is 
consistent with the protection of investors and the public interest 
because it is designed to incentivize the entry of additional resting 
orders, including displayed orders on the Exchange, thereby enhancing 
price discovery and the overall liquidity profile on the Exchange to 
the benefit of all market participants. Based on market data analysis 
during September 2019, the Exchange identified that there are 
significant differences in short term markouts (and pro forma profit 
and loss) \55\ for resting and taking orders between executions when 
the CQI is on and off, regardless of whether the NBB (NBO) moves lower 
(higher) within two milliseconds of the Exchange's determination of 
quote instability. Specifically, when the CQI is on, liquidity removing 
orders that execute on IEX (trading with a liquidity providing order 
resting on the Order Book, including but not limited to Discretionary 
Peg and primary peg orders) experience positive price markouts one 
second after the trade on a share basis 76% of the time, compared to 
23.5% of the time when the CQI is off. Correspondingly, resting 
liquidity providing orders that trade when the CQI is on experience 
negative price markouts one second after the trade 76% of the time, 
compared to 23.5% of the time when CQI is off. Similarly, 55.9% of all 
orders received when the CQI is on (whether or not executed on IEX) 
arrive immediately prior to a favorable price move (based on one second 
markouts), compared to 19.5% of orders received when the CQI is off.
---------------------------------------------------------------------------

    \55\ For purposes of this analysis, a pro forma profit or loss 
is calculated as the difference between the midpoint of the NBBO at 
the time of the execution compared to one second after.
---------------------------------------------------------------------------

    Moreover, the breakdown of orders entered and shares removed when 
the CQI is on or off evidences that certain trading strategies appear 
to involve entering liquidity taking orders targeting resting orders at 
prices that are likely to imminently move adversely from the 
perspective of the resting order. Across all approximately 8,000 
symbols available for trading on IEX, the CQI is on only 1.64 seconds 
per symbol per day on average (0.007% of the time during regular market 
hours),\56\ but 33.7% of marketable orders \57\ are received during 
those time periods, which indicates that certain types of trading 
strategies are seeking to

[[Page 72002]]

aggressively target liquidity providers during periods of quote 
instability.
---------------------------------------------------------------------------

    \56\ On a volume weighted basis, the CQI is on for 5.9 seconds 
per day per symbol, 0.025% of the time during regular market hours. 
IEX plans to file a proposed rule change with the Commission shortly 
to incrementally optimize and enhance the effectiveness of the quote 
instability calculation in determining whether the CQI is on. Based 
on a modeling analysis, IEX estimates that the updated calculation 
will result in the CQI being on 0.009% of the time during regular 
market hours, on average, and incrementally increase the expected 
number of CQI determinations by approximately 20%.
    \57\ An order is considered marketable for this analysis if it 
was a market order or its limit price is at or more aggressive than 
the contra-side quotation.
---------------------------------------------------------------------------

    Further, based upon IEX's classification of its Members' logical 
order entry ports (also known as ``sessions'') as originating from 
proprietary trading firms, full service broker-dealers, or agency 
broker-dealers,\58\ proprietary trading firms are more likely to seek 
to trade against IEX resting orders while the CQI is on, while sessions 
classified as full-service and agency are more likely to seek to trade 
against IEX resting orders during the remainder of the day. Within the 
two millisecond periods following CQI determinations, proprietary 
trading firms submit 6.8 times as many marketable-to-mid shares (i.e., 
shares priced at least as aggressively as the midpoint and eligible to 
trade) compared to full-service and agency firms; while outside of 
those two millisecond periods, the situation is reversed, with full-
service and agency firms submitting 3.4 times as many marketable-to-mid 
shares compared to proprietary trading firms (based on daily averages 
from September 2019).
---------------------------------------------------------------------------

    \58\ On a best efforts basis, IEX classifies proprietary trading 
firms as those that are trading for their own account rather than 
acting in an agency capacity for an independent beneficial owner. 
Agency broker-dealers are firms that trade on behalf of customers 
that are independent beneficial owner but do not commit capital to 
facilitate their customers' orders. Full-service broker-dealers are 
also trading on behalf of an independent beneficial owner but they 
also have the ability to commit capital to facilitate a customer 
order.
---------------------------------------------------------------------------

    When looking at the impact of trading when the CQI is on and off 
for non-pegged limit orders, the data strongly supports that such 
orders are systematically subjected to adverse impacts of latency 
arbitrage strategies. During September 2019, non-pegged limit orders 
accounted for 17% of volume traded on IEX (13% of traded volume was 
from displayed limit orders). In the aggregate, these orders 
experienced significant differences in short term markouts (and pro 
forma profit and loss) between executions when the CQI is on and off, 
regardless of whether the NBB (NBO) moves lower (higher) within two 
milliseconds of the Exchange's determination of quote instability. 
Resting limit orders that trade when the CQI is on experience negative 
price markouts one second after the trade 76% of the time, compared to 
34% of the time when CQI is off. In addition, for marketable incoming 
orders to take liquidity that arrive when IEX has a displayed quote, 
21% arrive during the 0.007% of the trading day when the CQI is on.
    Moreover, for displayed limit orders that added liquidity during 
September 2019, the disparity in markouts between such orders that 
traded when the CQI was on versus off was material and evident of 
latency arbitrage.\59\ For such orders that traded when the CQI was on, 
the average markouts were negative $.0036 per share ten milliseconds 
after trade time. In contrast, when the CQI was off, the average 
markouts were positive $.0045 at 10 milliseconds, a performance 
difference of $.0081 per share at 10 milliseconds post trade. From one 
second through five minutes the performance difference between CQI on 
vs CQI off trades was never smaller than $.0048 per share.
---------------------------------------------------------------------------

    \59\ See Stockland, Eric. ``Modern Day Latency Arbitrage: 
Predicting Price Changes,'' (April 10, 2017), available at https://medium.com/boxes-and-lines/modern-day-latency-arbitrage-predicting-price-changes-738edc25a28d.
---------------------------------------------------------------------------

    The Exchange believes that this data is particularly significant 
and evidences that Members entering liquidity taking orders when the 
CQI is on appear to be able to engage in a form of latency arbitrage by 
leveraging fast proprietary market data feeds and connectivity along 
with predictive strategies to chase short-term price momentum and 
successfully target resting orders at unstable prices. IEX believes 
that these types of trading strategies, with concentrated and 
aggressive tactics during moments of quote instability, are detrimental 
to the experience of other IEX participants. As further discussed 
below, IEX believes that such trading strategies create disparate 
burdens on resting orders, particularly limit orders that do not 
currently benefit from the CQI or the speedbump.
    The Exchange believes that IEX data thus demonstrates that 
displayed and non-displayed limit orders are subject to systematic 
adverse impacts from latency arbitrage strategies. The Exchange 
believes that these adverse impacts constitute an implicit tax on 
liquidity providers that operates to disincentivize market participants 
from entering limit orders that contribute to meaningful price 
discovery. Other exchanges use rebates and volume tiers to essentially 
compensate market makers and other liquidity providers for posting 
aggressive limit orders.\60\ As discussed above, IEX believes that 
these pricing schemes can contribute to a number of conflicts of 
interest and market distortions including, among others, conflicts of 
interests, excess intermediation and potential adverse selection, 
market fragmentation, complexity, the proliferation of new order types 
to enable avoidance of fees, and elevated fees to subsidize 
rebates.\61\ In contrast, IEX seeks to incentivize liquidity providing 
orders through superior execution quality, but this incentive can be 
undercut by trading strategies that target resting orders during 
periods of quote instability. Thus, IEX believes that additional 
approaches to incentivize displayed liquidity are warranted, and that 
the D-Limit order type is one reasonable approach to compete with other 
venues for liquidity providing order flow without relying on rebates 
and tiered pricing. As discussed above, the widespread adoption of DPeg 
and PPeg order types that utilize the CQI formula evidences that a 
diverse group of Members have confidence in the utility of the CQI and 
its protective features. IEX believes that, as a result, a similarly 
diverse group of Members are likely to use D-Limit orders.
---------------------------------------------------------------------------

    \60\ See, e.g., NYSE Price List 2019, available at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf; see 
also Nasdaq General Equity and Options Rule, Equity 7 Section 
118(a)(1) available at http://nasdaq.cchwallstreet.com/NASDAQTools/PlatformViewer.asp?selectednode=chp%5F1%5F1%5F2%5F2&manual=%2Fnasdaq%2Fmain%2Fnasdaq%2Dllcrules%2F; Cboe BZX U.S. Equities Exchange Fee 
Schedule, available at https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/.
    \61\ See Wah, Elaine, ``Gone in Sixty Seconds'' (September 21, 
2018) available at: https://medium.com/boxes-and-lines/gone-in-sixty-seconds-22094adeb0de.
---------------------------------------------------------------------------

    The Exchange further believes that the proposed rule change is 
consistent with the Act because it would be available to all Members on 
a fair, equal and nondiscriminatory basis. All Members, regardless of 
their technological sophistication, can enter D-Limit orders and 
benefit from their protection against latency arbitrage. More 
specifically, a Member using a D-Limit order would not need to be able 
to have the technological capability (e.g., through the use of high 
speed connectivity and market data purchased from other exchanges) to 
identify that the quote is unstable and send an order message to cancel 
or reprice its resting order faster than another Member with such 
technological capability can trade against the order. The Exchange will 
adjust the price of a D-Limit order based on the transparent, rule-
based CQI formula.
    IEX believes the fact that the D-Limit order is specifically 
designed to disincentivize trading strategies seeking to take liquidity 
while the CQI is on does not amount to ``unfair discrimination between 
customers, issuers, brokers, or dealers,'' within the meaning of the 
Act. The existing equity market structure is replete with

[[Page 72003]]

examples of exchange rules that seek to incentivize, disincentivize, or 
deter various types of trading activity. Maker-Taker price structures, 
which are used by all the largest exchanges, by their nature provide 
more favorable exchange economics to liquidity-providing compared to 
liquidity-taking activity. Nasdaq charges ``excess order fees'' on 
certain members that have a relatively high ratio of orders entered 
away from the NBBO to orders that are executed, subject to carve-outs 
for certain low-volume members and certain registered market 
makers.\62\ Nasdaq justified the fee based on its design to improve the 
quality of displayed liquidity to the benefit of all market 
participants.\63\
---------------------------------------------------------------------------

    \62\ See Nasdaq General Equity and Options Rule, Equity 7 
Section 118(m).
    \63\ See Securities Exchange Act Release No. 66951 (May 9, 
2012), 77 FR 28647 (May 15, 2012) (SR-NASDAQ-2012-055).
---------------------------------------------------------------------------

    Further, IEX's CQI Remove Fee is expressly designed to benefit and 
incentivize the placing of resting, non-displayed orders by limiting 
the profitability of the same trading strategies that motivate the 
current proposal. Moreover, IEX's existing speed bump is designed to 
limit executions of non-displayed, pegged orders before the Exchange 
has the ability to update and reprice those orders based on its own 
view of market prices. In approving the speed bump, the Commission 
found that:

    IEX's [speed bump] is thus narrowly designed to allow IEX to 
update the prices of non-displayed resting pegged orders so that 
they can achieve their intended purpose--pricing that is accurately 
benchmarked to the NBBO. . . . The Commission thus finds that IEX's 
ability to update the prices of resting pegged orders . . . is not 
designed to unfairly discriminate among members to the detriment of 
investors or the public interest and is intended to benefit 
investors that post pegged orders.'' \64\
---------------------------------------------------------------------------

    \64\ Securities Exchange Act Release No. 78101 (June 17, 2016), 
81 FR 41142, 41157 (June 23, 2016).

    The Exchange believes that it is similarly not unfairly 
discriminatory to use a narrowly tailored means to provide protection 
to and encourage the placing of displayed limit orders on IEX by 
investors and market makers by providing them a measure of protection 
from the trading strategies documented above. The Exchange further 
believes that the proposed rule change is consistent with the 
protection of investors and the public interest because the 
circumstances under which a D-Limit order will be adjusted are narrowly 
tailored, transparent and predictable. As discussed above, the CQI is 
only on for an extremely small percentage of the trading day and is 
designed to protect impacted order types during these very narrow 
windows of time. Even if IEX enhances the CQI formula (as noted above), 
the nature of the CQI will remain intact--it will continue to focus on 
protecting impacted orders against latency arbitrage trading strategies 
during very narrow windows of time. Even though D-Limit orders may not 
be accessible to other market participants during these narrow 
timeframes, the Exchange does not believe that this impact is unfairly 
discriminatory because during the vast majority of time D-Limit quotes 
will be accessible. Moreover, the purpose of limiting such 
accessibility is to incentivize liquidity providers to post displayed 
orders on IEX by protecting them as discussed above. To the extent that 
such incentive is successful, all market participants, including takers 
of liquidity, will benefit.
    The CQI formula used to determine whether and when to adjust an 
order's price is codified in IEX Rule 11.190(g) and is, on average, on 
for only 0.007% of the trading day for each security. During the 
remaining 99.993% of the trading day, D-Limit orders would be available 
to trade at their resting price in the same manner as any other limit 
order. In contrast, whether an order will be cancelled or adjusted in 
an exchange with an asymmetrical speed bump would not be transparent or 
predictable since such changes are determined exclusively by the market 
participant that entered the order. Further, the price of a D-Limit 
order would only be adjusted when the CQI formula predicts that the 
relevant quote is unstable while an asymmetrical speed bump enables a 
market participant to cancel or adjust the price of an order on an ad 
hoc basis for any reason and frequency.
    Notwithstanding that D-Limit orders will be subject to price 
adjustment when the CQI is on, IEX believes that this functionality is 
consistent with the ``firm quote'' requirements of Regulation NMS Rule 
602(b) \65\ in that it will not result in a meaningful amount of quote 
``fading'' compared to the quote fading, both explicit and implicit, 
that exists and is permitted today. This quote fading falls into three 
broad categories.
---------------------------------------------------------------------------

    \65\ 17 CFR 242.602(b).
---------------------------------------------------------------------------

    First, several other exchanges offer displayed order types that are 
pegged to the NBBO and thus are subject to price adjustments, including 
to a less aggressive price as the NBBO changes (i.e., explicit quote 
fading). EDGA, for example, offers a MidPoint Discretionary order that 
is pegged to the same-side NBB or NBO with discretion to execute at 
more aggressive prices up to and including the midpoint of the NBBO or 
the order's limit price.\66\ A MidPoint Discretionary order can be 
displayed or non-displayed. In the case of a displayed MidPoint 
Discretionary order, the order's display price is adjusted in response 
to changes in the NBB (for buy orders) or NBO (for sell orders) which 
can result in a displayed order being adjusted to a less aggressive 
price than it was previously displayed at if the NBB or NBO moves to a 
less aggressive price. Thus, displayed MidPoint Discretionary orders 
are subject to quote fading if the NBB or NBO, as applicable, moves to 
a less aggressive price. IEX believes that this price adjustment 
functionality is substantially similar to the proposed D-Limit price 
adjustment functionality in that both order types will adjust to a less 
aggressive price in response to certain objective criteria. The 
displayed price of a MidPoint Discretionary order will move to a less 
aggressive price if the NBB or NBO moves to a less aggressive price, 
while the displayed price of a D-Limit order will move to a less 
aggressive price if IEX's CQI formula predicts that the NBB or NBO is 
likely to move to a less aggressive price.
---------------------------------------------------------------------------

    \66\ See EDGA Equity Rule 11.8(e).
---------------------------------------------------------------------------

    EDGA adopted the MidPoint Discretionary order through an 
immediately effective rule filing.\67\ Four years later, EDGA's 
affiliate, EDGX filed an immediately effective rule filing to adopt a 
comparable MidPoint Discretionary order type, the displayed version of 
which is also pegged to the same-side NBB or NBO and thus subject to 
price adjustments to a less aggressive price when the NBBO moves to 
such a price.\68\ Neither the EDGA nor EDGX rule filings raised any 
issues or concerns regarding quote fading of displayed MidPoint 
Discretionary orders. In addition, Nasdaq offers a discretionary order 
type for which the display price can be pegged to a floating price 
range \69\ and NYSE Arca and NYSE each offers a primary pegged order 
type that has a

[[Page 72004]]

working price pegged to the same-side PBBO that must include a minimum 
of one round lot displayed.\70\ Thus, these displayed pegged orders 
will also be adjusted to a less aggressive price when the same-side 
NBBO or PBBO, as applicable, moves to a less aggressive price. 
Similarly, the Commission's approval of a Nasdaq rule filing that 
includes adoption of its displayed discretionary order type does not 
include any discussion of potential quote fading issues.\71\
---------------------------------------------------------------------------

    \67\ See Securities Exchange Act Release No. 67226 (June 20, 
2012), 77 FR 38113 (June 26, 2012) (SR-EDGA-2012-022) (Notice of 
Filing and Immediate Effectiveness to Amend EDGA Rules to Add the 
MidPoint Discretionary order). Two years later, in 2014, EDGA filed 
another rule change proposal to restructure its order type rules, 
including the MidPoint Discretionary order. See Securities Exchange 
Act Release No. 73592 (November 13, 2014), 79 FR 68937 (November 19, 
2014) (SR-EDGA-2014-020).
    \68\ See Securities Exchange Act Release No. 84327 (October 1, 
2018), 83 FR 50416 (October 5, 2018) (SR-CboeEDGX-2018-041).
    \69\ See Nasdaq Rule 4703(g) and Section 3.3.2 of Nasdaq's SUMO 
FIX Programming Specification for FIX 4.2 available at: https://nasdaqtrader.com/content/technicalsupport/specifications/TradingProducts/fix_orders_sb.pdf.
    \70\ See NYSE Arca Rule 7.31-E(h)(2) and NYSE Rule 7.31(h)(2).
    \71\ See Securities Exchange Act Release No. 75252 (June 22, 
2015), 80 FR 36865 (June 26, 2015) (SR-NASDAQ-2015-024).
---------------------------------------------------------------------------

    Data for September 2019 identified that there were approximately 
5,500 volume-weighted average NBBO quote changes per symbol each day to 
a less aggressive price, compared to 5,427 volume-weighted average CQI 
determinations per symbol each day. IEX believes that this data 
evidences that D-Limit orders would be subject to a comparable number 
of changes to a less aggressive price as order types of other exchanges 
that peg to the near side NBBO or PBBO. And as discussed earlier, the 
CQI is on for only 1.64 seconds per symbol per day on average (0.007% 
of the time during regular market hours). Thus, IEX believes that this 
data supports that D-Limit, like the other exchanges' order types 
discussed above, is a narrowly tailored approach to provide for price 
adjustments to a less aggressive price for displayed orders pursuant to 
transparent and objective criteria. IEX believes that order types that 
are subject to repricing in response to an exchange determining that 
the NBBO has changed provide relevant precedent to repricing based on 
an exchange determining--pursuant to a transparent formula--that the 
NBBO is likely in the process of changing. In both cases, the repricing 
trigger is based on the NBBO. Although D-Limit orders would be repriced 
based on a transparent formula predicting an imminent change to the 
NBBO, rather than an exchange's determination that the NBBO has 
changed, the formula is narrowly tailored, designed to provide 
protection to market participants at all levels of sophistication, and 
codified in an IEX rule. And in both cases, the automatic change to the 
quote's price is explicitly intended to prevent executions at the 
originally displayed price. While the D-Limit proposal is novel in that 
it would provide an exchange with flexibility to reprice a displayed 
order, that flexibility is limited by the narrowly tailored CQI formula 
which itself is based on publicly available market data inputs and 
designed to protect liquidity providers from adverse selection by 
latency arbitrage trading strategies. Although such protection is 
designed to benefit liquidity providers, IEX believes that it will also 
benefit liquidity takers to the extent that the protection results in 
more resting liquidity available to liquidity takers. Consequently, IEX 
believes that its D-Limit order type proposal is approvable in 
accordance with this precedent.
    Second, explicit quote fading exists on options exchanges, which 
offer several mechanisms to assist their members in managing risk and 
avoiding unintended executions. These mechanisms include risk 
management functionality that will automatically cancel resting orders 
and quotes based on member configured triggers such as total traded 
volume, percent traded volume, notional, net Delta or Vega 
exposure.\72\ Notably, the automatic triggers appear to occur inside 
the exchange matching engine as opposed to requiring an order or cancel 
message from the member. Other exchanges also offer order and quote 
purge functionality that is designed to help members manage risk by 
providing dedicated (and effectively faster) ports to enter mass 
cancellations of multiple resting orders.\73\ While IEX appreciates 
that market makers and other market participants posting displayed 
orders on options exchanges face materially greater risks than on 
equities markets, in view of the enormous number of individual option 
series available for quoting on options markets, IEX believes that they 
nonetheless provide relevant precedent for the risk management 
protections that D-Limit orders would provide. Market participants on 
both options and equities markets face significant challenges in 
cancelling or adjusting resting orders during times of market 
transition, in the face of other market participants engaged in 
sophisticated latency arbitrage efforts.
---------------------------------------------------------------------------

    \72\ See, e.g., NYSE Arca Rule 6.40-O; Nasdaq ISE, LLC Options 
3, Section 15(a)(3)(B); Nasdaq GEMX, LCC Options 3, Section 
15(a)(3)(B); Nasdaq MRX, LLC Options 3, Section 15(a)(3)(B); Miami 
International Securities Exchange LLC (``MIAX'') Rule 519A; Nasdaq 
Rule 6130; Market Maker Risk Management Information Sheet for Nasdaq 
PHLX LLC (``Nasdaq PHLX'')/Nasdaq Options Market (``NOM'')/Nasdaq BX 
available at https://www.nasdaq.com/docs/MarketMakerRiskManagement_PHLX_NOM_BX.pdf; and Order Risk Management 
Information Sheet for Nasdaq PHLX/NOM/Nasdaq BX available at https://www.nasdaq.com/docs/OrderRiskManagement_PHLX_NOM_BX.pdf.
    \73\ See ``CBOE Purge Ports Frequently Asked Questions'' 
available at https://cdn.cboe.com/resources/features/Cboe_USO_PurgePortsFAQs.pdf and MIAX Rule 519C.
---------------------------------------------------------------------------

    Third, an example of implicit quote fading is the manner in which 
other exchanges offer expensive, high-speed proprietary market data 
feeds and connectivity products that sophisticated market participants 
can leverage (along with predictive strategies) to not only target 
resting orders at unstable prices but to cancel or adjust resting 
orders more quickly than market participants not using such products 
and strategies can access their resting orders. As a result, when the 
market for a particular security is in transition, these sophisticated 
market participants are often able to cancel resting orders before less 
sophisticated market participants can access them.\74\
---------------------------------------------------------------------------

    \74\ See, e.g., Malinova, Katya and Park, Andreas, ``Does High 
Frequency Trading Add Noise to Prices?'' (April 17, 2017) at 5, 
available at https://www.rsm.nl/fileadmin/home/Department_of 
_Finance_VG5_/LQ2017/Malinova_Katya.pdf (``When someone trades 
against their quotes on one venue, market makers rush to cancel 
their quotes on the other venue; if the market maker is very fast, 
it may be able to cancel the other quote before portions of a 
presumed multi-market order reach the other venue.'').
---------------------------------------------------------------------------

    Thus, the Exchange believes that D-Limit orders will operate in a 
manner consistent with the ``firm quote'' requirements of Regulation 
NMS Rule 602(b) \75\ and with existing order types, practices and 
precedent for protected quotations under the Order Protection Rule, as 
discussed above. D-Limit orders will be subject to execution at their 
ranked and displayed price (if displayable) at the time an incoming 
order reaches the Exchange for execution against the D-Limit order. Any 
price adjustment that occurs must occur before that point in time. This 
is similar to the EDGA displayed MidPoint Discretionary order type, 
which is subject to price adjustment to a less aggressive displayed 
price in response to NBBO changes. As a result, a displayed MidPoint 
Discretionary order may not be available for execution at its 
previously displayed price by the time an incoming order reaches the 
exchange for execution. Although a D-Limit displayed order would be 
adjusted to a less aggressive price than the NBBO, while a MidPoint 
Discretionary order will be adjusted to a less aggressive price that 
has become the same-side NBBO, in both cases the order is no longer 
available for execution at its previously displayed price. Further, 
options exchanges cancel quotes and displayed orders as a result of 
automated risk management functionality or enable cancellation through 
faster purge ports. In those

[[Page 72005]]

situations, an order or quote that was previously displayed may not be 
available for execution by the time an incoming order reaches the 
exchange engine for execution. Moreover, all resting displayed orders 
may be unavailable in the event that another order or a cancel message 
is actionable prior to an incoming order reaching the engine, 
particularly when targeted by a sophisticated market participant 
engaged in latency arbitrage. And, as noted above, D-Limit orders will 
only be subject to price adjustment on average for 0.007% of the 
trading day, while the frequency of order cancellation or non-
availability attributable to the existing exchange mechanisms and 
practices is determined by each market participant and not subject to 
any transparent limitations.
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    \75\ See supra note 65.
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    Further, IEX believes that displayed D-Limit orders would clearly 
qualify as ``automated quotations'' and therefore ``protected 
quotations'' under Regulation NMS, as discussed in the Purpose section. 
This conclusion is supported by two key considerations. First, IEX will 
not impose any delay on orders seeking to access D-Limit quotations 
beyond that which the Commission has already approved as consistent 
with the requirements for ``automated quotations.'' Second, adjusting 
prices of D-Limit displayed orders when the CQI is on is consistent 
with well-established precedent allowing other exchanges to 
automatically adjust the prices of protected quotations based on 
changes in overall market prices.
    Under Rule 611 of Regulation NMS,\76\ ``trade-through'' protections 
are extended to each protected bid or offer, which is defined in 
relevant part as ``an automated quotation that is the best bid or best 
offer of a national securities exchange.'' \77\ The term ``automated 
quotation'' is defined as one that permits an incoming order to be 
marked as immediate-or-cancel (``IOC'') and that ``immediately and 
automatically'' executes an IOC order against the displayed quotation 
up to its full size, cancels any unexecuted portion, transmits to the 
sender a message indicating the action taken, and updates the quotation 
to reflect a change to its material terms.\78\
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    \76\ 17 CFR 242.611.
    \77\ 17 CFR 242.600(b)(61)(iii).
    \78\ 17 CFR 242.600(b)(4).
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    In approving IEX's exchange application, in response to arguments 
that federal securities regulations did not permit exchanges to impose 
any intentional delay, however small, on access to protected 
quotations, the Commission determined that IEX's 350 microsecond 
``speed bump,'' which is applied to incoming and outbound messages, is 
``well within the range of geographic and technological latencies that 
market participants experience today'' and therefore is ``comparable 
to--and even less than--delays attributable to other markets that 
currently are included in the NBBO.'' \79\ The Commission thus 
concluded that, because IEX's speed bump is de minimis, its displayed 
quotes were immediately accessible and entitled to protected quotation 
status.\80\
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    \79\ See note 64 supra at 41161.
    \80\ See note 64 supra at 41162.
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    Access to D-Limit quotes will not be subject to any delay beyond 
that to which all IEX's orders, displayed and non-displayed, are now 
subject. Accordingly, all D-Limit quotes will be immediately accessible 
under Regulation NMS.
    Moreover, based on precedent, the fact that D-Limit displayed 
orders are subject to automatic repricing based on changes in market 
prices does not affect their status as protected quotations. For 
example, as discussed above, EDGA has an approved Midpoint 
Discretionary Order, which allows members to post displayed or non-
displayed liquidity at the NBBO with discretion to execute at prices 
extending to and including the NBBO midpoint.\81\ This EDGA order type 
automatically reprices the order based on changes in the NBBO 
(including to a less aggressive price), which benefits market 
participants that use the order type by helping to assure they are not 
executed at ``stale'' prices as well as to provide an opportunity for 
those orders to execute at a more aggressive NBBO when prices move in 
that direction. Similarly, various exchanges, including IEX, have 
received approval for ``market maker peg'' order types, which 
automatically reprice orders to allow market makers to meet their 
quoting obligations on those exchanges by automatically repricing those 
orders to within a designated percentage away from the NBBO.\82\
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    \81\ See note 66 supra.
    \82\ See, e.g., IEX Rule 11.190(b)(13); Cboe BZX Rule 
11.9(c)(15); Nasdaq Rule 4702(b)(7).
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    All these order types allow an exchange to automatically reprice 
resting orders based on determinations by the individual exchanges, in 
reading price updates from all exchanges, that the NBBO has changed. 
With respect to the automated quotation definition, a participant 
seeking to access a Midpoint Discretionary Order or market maker peg 
order displayed at any one time may fail to execute at that price if 
the order has been repriced by the exchange in the time between the 
transmission of the order and its receipt and processing by the 
exchange's systems. The potential that this will occur depends on 
various factors, including, among others, the distance between the 
point where the sender transmits the order to the exchange's systems 
and how quickly those systems update their understanding of the NBBO 
relative to the speed at which they process orders to take liquidity.
    Because the use of a de minimis delay does not affect the ability 
of a displayed order to qualify as a protected quotation, there is no 
reason it should lose that status because its price is adjusted 
automatically by the exchange in response to changes in the NBBO, as is 
the case with the EDGA Midpoint Discretionary Order or the Nasdaq 
displayed discretionary order. IEX does not believe that there are any 
material differences in this regard between repricing that occurs in 
response to an exchange determining the NBBO has changed, and repricing 
based on an exchange determining--pursuant to a transparent formula--
that the NBBO is likely in the process of changing. In either case, the 
automatic change to the quote's price is explicitly intended to prevent 
executions at the originally displayed price.
    D-Limit orders are differentiated because they are explicitly 
designed to prevent executions in small time increments when the CQI is 
on. While this functionality discriminates against the use of trading 
strategies with more complete and timely information about market 
prices that intentionally seek to trade against resting orders during 
these time periods at stale prices, IEX believes that the D-Limit 
functionality is not unfairly discriminatory within the meaning of the 
Act because it is a narrowly tailored means of protecting, and thereby 
encouraging the use of, displayed quotations by both investors and 
market makers. Moreover, for the reasons discussed in the Purpose 
section, the Exchange believes that the proposed D-Limit order type may 
result in market participants entering more displayed and other resting 
limit orders on IEX, and at more aggressive prices, sizes and duration, 
which would benefit all market participants and thereby further the 
purposes of the Act.
    Further, IEX believes that the specified order attributes for D-
Limit orders are consistent with the Act because they are structured to 
facilitate efficient execution of D-Limit orders in a manner consistent 
with existing functionality and order types.

[[Page 72006]]

    Additionally, IEX believes that the proposal is consistent with 
protection of investors and the public interest in that the D-Limit 
order type is designed to assist Members in obtaining best execution 
for their customers by providing an opportunity to execute at the NBBO, 
but limiting executions at the NBBO when the NBBO appears to be 
unstable, thereby reducing the potential to execute at an imminently 
stale price.
    In conclusion, IEX believes that the proposed new D-Limit order 
type is consistent with the protection of investors and the public 
interest purposes of the Act in that it is designed to protect 
liquidity providers from certain adverse impacts of latency arbitrage 
strategies, and thereby incentivize the entry of additional resting 
orders, including displayed orders on the Exchange, thus enhancing 
price discovery and the overall liquidity profile on the Exchange to 
the benefit of all market participants.

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

    IEX 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. To the contrary, the proposal 
is designed to enhance IEX's competitiveness by incentivizing the entry 
of increased liquidity. With regards to inter-market competition, other 
exchanges are free to adopt similar order types to the extent that the 
proposed changes pose a competitive threat to their business. In this 
regard, the Exchange notes that NYSE American LLC (``NYSE Amex'') 
previously adopted a rule copying an earlier iteration of the 
Exchange's Discretionary Peg order type and quote stability 
calculation.\83\
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    \83\ See NYSE Amex Rule 7.31E(h)(3)(D).
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    In addition, the Exchange believes that the proposed rule change 
will enhance its ability to compete with alternative trading systems 
(``ATSs''). In this regard, IEX believes that a meaningful segment of 
market participants choose to rest orders on non-displayed ATSs in 
order to obtain protection from latency arbitrage strategies. As 
opposed to exchanges, ATSs can be structured to enable counter-party 
selection so that participants can choose to avoid interacting with 
certain counterparties deemed to be undesirable.\84\ The Exchange 
believes that counter-party selection is important to some of these 
market participants, in part to avoid being subject to adverse latency 
arbitrage. While the proposed rule change will not enable counter-party 
selection, IEX believes that to the degree it is successful in reducing 
the impact of latency arbitrage strategies targeting resting orders at 
stale prices, it may reduce the need for counter-party selection and 
thereby incentivize such market participants to post displayed and 
other limit orders on IEX. Accordingly, the Exchange also believes that 
the proposed rule change will not result in any burden on inter-market 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Act.
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    \84\ See Securities Exchange Act Release No. 83663 (July 18, 
2018), 83 FR 38768, 38853 (August 7, 2018).
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    With regards to intra-market competition, D-Limit orders will be 
available to all Members on a fair, impartial and nondiscriminatory 
basis. While the proposed rule change is designed to provide certain 
protections to limit orders, all Members are eligible to enter D-Limit 
orders on the same terms and the protections will be available to all 
Members on the same terms. Moreover, the Exchange does not believe that 
the proposed change will result in any burden on Members seeking to 
cross the spread and execute at the far side quote (the NBO (NBB) for 
buy (sell) orders) or to Members seeking to conduct a market wide sweep 
with intermarket sweep orders. D-Limit orders will only be subject to 
potential adjustment for an extremely small percentage of the trading 
day and the rest of the time will be available for execution, if 
consistent with the order's limit price, at the far side quote. To the 
extent that a D-Limit order is adjusted to a less aggressive price 
while a Member is seeking to access the full displayed size of the 
order at the prior more aggressive price with an intermarket sweep 
order, the Member would be permitted to trade-through the D-Limit order 
at the more aggressive price pursuant to Rule 611(b)(6) of Regulation 
NMS.\85\ Moreover, the proposed change would provide potential benefits 
to such Members to the extent there is more liquidity available on IEX 
as a result of the protections provided to users of D-Limit orders. As 
discussed above, the protections offered by the D-Limit order type, as 
proposed, are intended in part to incentivize additional resting limit 
orders to be entered on the Exchange, which would provide additional 
available liquidity to all Members.
---------------------------------------------------------------------------

    \85\ Regulation NMS Rule 611(b)(6) provides an exception to its 
trade-through requirements if the transaction that constituted the 
trade-through was effected by a trading center that simultaneously 
routed an intermarket sweep order to execute against the full 
displayed size of any protected quotation in the NMS stock that was 
traded through. See 17 CFR 242.611(b); see also Question 4.06 in 
``Responses to Frequently Asked Questions Concerning Rule 611 and 
610 of Regulation NMS'' (April 4, 2008), available at https://www.sec.gov/divisions/marketreg/nmsfaq610-11.htm.
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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 up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall:
    (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-IEX-2019-15 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-IEX-2019-15. 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

[[Page 72007]]

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 also will be available for inspection and copying at the 
principal offices of the Exchange. 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-IEX-
2019-15, and should be submitted on or before January 21, 2020.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\86\
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    \86\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2019-28024 Filed 12-27-19; 8:45 am]
BILLING CODE 8011-01-P