[Federal Register Volume 85, Number 17 (Monday, January 27, 2020)]
[Notices]
[Pages 4726-4752]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01253]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88008; File No. SR-BatsBZX-2017-34]
Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order
Setting Aside Action by Delegated Authority and Approving a Proposed
Rule Change, as Modified by Amendments No. 1 and 2, To Introduce Cboe
Market Close, a Closing Match Process for Non-BZX Listed Securities
Under New Exchange Rule 11.28
January 21, 2020.
I. Introduction
The official closing price for a listed security is generally
determined each day through a closing auction conducted by that
security's primary listing exchange. A closing auction is a point in
time event conducted at the end of each trading day pursuant to a
process set forth in the primary listing exchange's rules \1\ that
determines a security's official closing price by executing all orders
participating in the auction at a single price. Closing auctions are
designed to set closing prices that maximize the number of shares
executed and minimize the amount of the imbalance between orders to buy
a security and orders to sell a security. Market participants seeking
to execute orders at a security's official closing price may do so by
submitting a variety of order types to a closing auction, such as:
---------------------------------------------------------------------------
\1\ See, e.g., NYSE Rule 123C; and Nasdaq Rule 4754.
---------------------------------------------------------------------------
Market-on-close (``MOC'') orders, which are orders to
either buy or sell a security that are specifically designated to be
executed at a security's official closing price;
[[Page 4727]]
limit-on-close (``LOC'') orders, which are orders to
either buy or sell a security at a specific price or better that are
specifically designated to execute in that security's closing auction;
and
imbalance-only orders, which are limit orders (i.e.,
orders that specify a target execution price) designated to only
execute in a closing auction against an imbalance of closing auction
eligible trading interest, should there be any.
In addition, limit orders that are resting on the primary listing
exchange's order book at the time that a closing auction begins may
also participate in a closing auction.\2\ Furthermore, market
participants may seek to execute an order at the official closing price
on off-exchange venues, such as alternative trading systems (``ATSs'')
and with broker-dealers. While these orders that are executed off-
exchange would not be included in the closing auction on the primary
listing exchange, they would be executed at the official closing price
that is determined by the primary listing exchange.
---------------------------------------------------------------------------
\2\ Limit orders resting on an exchange's order book are orders
to buy or sell a security at specific price or better that are
eligible for execution at any point during regular intraday trading
or in a closing auction.
---------------------------------------------------------------------------
On May 5, 2017, Bats BZX Exchange, Inc. (now known as Cboe BZX
Exchange, Inc.) (``BZX'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \3\ and Rule 19b-4
thereunder,\4\ a proposed rule change to adopt a match process for MOC
orders in non-BZX listed securities referred to as ``Cboe Market
Close.'' \5\ Through Cboe Market Close, BZX would seek to match buy and
sell MOC orders for non-BZX listed securities and execute at BZX those
matched buy and sell MOC orders in such securities at the official
closing price published by the relevant primary listing exchange.
---------------------------------------------------------------------------
\3\ 15 U.S.C. 78s(b)(1).
\4\ 17 CFR 240.19b-4.
\5\ The Commission published notice of the proposed rule change
in the Federal Register on May 22, 2017. See Securities Exchange Act
Release No. 80683 (May 16, 2017), 82 FR 23320 (``Notice''). On July
3, 2017, the Commission designated a longer period within which to
approve the proposed rule change, disapprove the proposed rule
change, or institute proceedings to determine whether the proposed
rule change should be disapproved. See Securities Exchange Act
Release No. 81072, 82 FR 31792 (Jul. 10, 2017). On August 18, 2017,
the Commission instituted proceedings under Section 19(b)(2)(B) of
the Act, 15 U.S.C. 78s(b)(2)(B), to determine whether to approve or
disapprove the proposed rule change. See Securities Exchange Act
Release No. 81437, 82 FR 40202 (Aug. 24, 2017) (``OIP''). On
November 17, 2017, pursuant to Section 19(b)(2) of the Act, 15
U.S.C. 78s(b)(2), the Commission designated a longer period for
Commission action on proceedings to determine whether to disapprove
the proposed rule change. See Securities Exchange Act Release No.
82108, 82 FR 55894 (Nov. 24, 2017). On December 1, 2017, the
Exchange filed Amendment No. 1 to the proposed rule change, renaming
``Bats Market Close'' as ``Cboe Market Close.'' The only change in
Amendment No. 1 was to rename the proposed closing match process as
Cboe Market Close. Because Amendment No. 1 was a technical amendment
and did not materially alter the substance of the proposed rule
change or raise unique or novel regulatory issues, Amendment No. 1
was not subject to notice and comment. For purposes of consistency
and readability, all references to the proposed match process for
MOC orders discussed herein will be to ``Cboe Market Close.''
---------------------------------------------------------------------------
On January 17, 2018, the Commission, acting through authority
delegated to the Division of Trading and Markets,\6\ approved the
proposed rule change, as modified by Amendment No. 1 (``Approval
Order'').\7\ On January 31, 2018, NYSE Group, Inc. (``NYSE'') and The
Nasdaq Stock Market LLC (``Nasdaq'') filed petitions for review of the
Approval Order (``Petitions for Review''). Pursuant to Commission Rule
of Practice 431(e), the Approval Order was stayed by the filing with
the Commission of a notice of intention to petition for review.\8\ On
March 1, 2018, the Commission issued a scheduling order, pursuant to
Commission Rule of Practice 431, granting the Petitions for Review of
the Approval Order and providing until March 22, 2018, for any party or
other person to file a written statement in support of, or in
opposition to, the Approval Order.\9\ On April 12, 2018, NYSE and
Nasdaq submitted written statements in opposition to the Approval Order
and BZX submitted a written statement in support of the Approval
Order.\10\
---------------------------------------------------------------------------
\6\ 17 CFR 200.30-3(a)(12).
\7\ Securities Exchange Act Release No. 82522, 83 FR 3205 (Jan.
23, 2018).
\8\ 17 CFR 201.431(e). See Letter to Christopher Solgan,
Assistant General Counsel, Cboe Global Markets, Inc. (Jan. 24, 2018)
(providing notice of receipt of notices of intention to petition for
review of delegated action and stay of order), available at https://www.sec.gov/rules/sro/batsbzx/2018/sr-batsbzx-2017-34-letter-from-secretary-to-cboe.pdf.
\9\ See Securities Exchange Act Release No. 82794, 83 FR 9561
(Mar. 6, 2018). On March 16, 2018, the Office of the Secretary,
acting by delegated authority, issued an order on behalf of the
Commission granting a motion for an extension of time to file
statements on or before April 12, 2018. See Securities Exchange Act
Release No. 82896, 83 FR 12633 (Mar. 22, 2018).
\10\ See Statement of NYSE Group, Inc. in Opposition to the
Division's Order Approving a Rule to Introduce Cboe Market Close
(``NYSE Statement''); Statement of the Nasdaq Stock Market LLC in
Opposition to Order Granting Approval of a Proposed Rule Change, as
Modified by Amendment No. 1, to Introduce Cboe Market Close
(``Nasdaq Statement''); and Statement of Cboe BZX Exchange, Inc. in
Support of Commission Staff's Approval Order (``BZX Statement'').
The Nasdaq Statement included two reports, one by Harvey Pitt and
Chester Spatt (``Pitt/Spatt Report''), and one by Yakov Amihud and
Haim Mendelson (``Amihud/Mendelson Report'').
---------------------------------------------------------------------------
On October 4, 2018, BZX filed Amendment No. 2 to the proposed rule
change to address a comment made by NYSE and Nasdaq in their
statements. The Commission published Amendment No. 2 for comment in the
Federal Register on December 4, 2018.\11\ The Commission received one
comment letter on Amendment No. 2.\12\
---------------------------------------------------------------------------
\11\ See Securities Exchange Act Release No. 84670 (Nov. 28,
2018), 83 FR 62646 (``Amendment No. 2'').
\12\ See Letter from Jeffrey S. Davis, Deputy General Counsel,
Nasdaq (Dec. 18, 2018) (``Nasdaq Letter 4'').
---------------------------------------------------------------------------
In response to the NYSE and Nasdaq Petitions, the Commission has
conducted a de novo review of BZX's proposal, giving careful
consideration to the entire record--including BZX's amended proposal,
the Petitions for Review, and all comments and statements submitted--to
determine whether the proposal is consistent with the requirements of
the Act and the rules and regulations issued thereunder that are
applicable to a national securities exchange. Under Section 19(b)(2)(C)
of the Act, the Commission must approve the proposed rule change of a
self-regulatory organization (``SRO'') if the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
the applicable rules and regulations thereunder; if it does not make
such a finding, the Commission must disapprove the proposed rule
change.\13\ Additionally, under Rule 700(b)(3) of the Commission's
Rules of Practice, the ``burden to demonstrate that a proposed rule
change is consistent with the Exchange Act and the rules and
regulations issued thereunder . . . is on the self-regulatory
organization that proposed the rule change.'' \14\ The description of a
proposed rule change, its purpose and operation, its effect, and a
legal analysis of its consistency with applicable requirements must all
be sufficiently detailed and specific to support an affirmative
Commission finding.\15\ Any failure of a self-regulatory organization
to provide the information elicited by Form 19b-4 may result in the
Commission not having a sufficient basis to make an affirmative finding
that a proposed rule change is consistent with the Act and the rules
and regulations issued thereunder that are applicable to the self-
regulatory organization.\16\
---------------------------------------------------------------------------
\13\ 15 U.S.C. 78s(b)(2)(C).
\14\ 17 CFR 201.700(b)(3).
\15\ Id.
\16\ Id.
---------------------------------------------------------------------------
The Commission has considered whether the proposal is consistent
with the Act, including Section 6(b)(8) of the
[[Page 4728]]
Act, which requires that the rules of a national securities exchange
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act,\17\ as well as Section 6(b)(5)
of the Act, which requires, among other things, that the rules of a
national securities exchange be designed to prevent fraudulent and
manipulative acts and practices, remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, protect investors and the public interest.\18\
---------------------------------------------------------------------------
\17\ 15 U.S.C. 78f(b)(8).
\18\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------
For the reasons discussed further herein, BZX has met its burden to
show that the proposed rule change is consistent with the Act, and this
order sets aside the Approval Order and approves BZX's proposed rule
change, as amended. In particular, the Commission concludes that the
record before the Commission demonstrates that Cboe Market Close should
introduce and promote competitive forces among national securities
exchanges for the execution of MOC orders. In addition, the record
demonstrates that Cboe Market Close should not disrupt the closing
auction price discovery process nor should it materially increase the
risk of manipulation of official closing prices. Therefore, and as
explained further below, the Commission finds the proposal consistent
with Sections 6(b)(8) and 6(b)(5) of the Act.
The Commission recognizes that Cboe Market Close, once implemented,
would introduce a new match process for non-BZX listed securities, and
more generally, could potentially contribute to new dynamics in certain
aspects of the public equity markets. The Commission and Commission
staff regularly monitor changes in the equity markets, including
changes in market quality and investor outcomes (among other things),
and will be mindful of potential effects associated with Cboe Market
Close. To that end, no later than one year after the date that Cboe
Market Close becomes effective, the Commission staff will advise the
Commission of its assessment of any post-implementation effects or
changes on market quality or investor outcomes. The Commission and
Commission staff regularly receive input from the public, including
investors, other exchanges and markets, and other market participants
on matters related to market quality, investor outcomes and related
issues. For convenience, we are providing an email box as a method for
members of the public who wish to submit data, analyses or observations
concerning any such matters, including in respect of post-
implementation effects or changes associated with Cboe Market Close, to
communicate with the Commission's staff. That email box is:
[email protected].\19\
---------------------------------------------------------------------------
\19\ Submissions received may be made public; personal
identifying information in the submission will not be redacted or
edited, so you should submit only information that you wish to make
available publicly.
---------------------------------------------------------------------------
II. Summary of the Proposal
BZX proposes to introduce Cboe Market Close, a match process for
MOC orders \20\ in non-BZX listed securities. Through Cboe Market
Close, a BZX Member would be able to submit buy and sell MOC orders for
non-BZX listed securities to the BZX System.\21\ Cboe Market Close
would not accept LOC orders or any other order types. Once accepted,
the System would seek to match buy and sell MOC orders and execute
those matched buy and sell MOC orders at the official closing price for
the security that is published by its primary listing exchange.
---------------------------------------------------------------------------
\20\ BZX defines the term ``Market-On-Close'' or ``MOC'' to mean
a BZX market order that is designated for execution only in the
Closing Auction. See Exchange Rule 11.23(a)(15). The Exchange
proposed to amend the description of Market-On-Close orders to
include orders designated to execute in the proposed Cboe Market
Close. A BZX market order is defined in BZX Rule 11.9(a)(1) as
``[a]n order to buy or sell a stated amount of a security that is to
be executed at the NBBO when the order reaches the Exchange . . .
.''
\21\ The term ``System'' is defined as ``the electronic
communications and trading facility designated by the Board through
which securities orders of Users are consolidated for ranking,
execution and, when applicable, routing away.'' See BZX Rule
1.5(aa). The term ``Board'' is defined as ``the Board of Directors
of the Exchange.'' See BZX Rule 1.5(f).
---------------------------------------------------------------------------
BZX Members \22\ would be able to enter, cancel, or replace MOC
orders designated for participation in Cboe Market Close beginning at
6:00 a.m. Eastern Time until 3:35 p.m. Eastern Time (``MOC Cut-Off
Time'').\23\ Members would not be able to enter, cancel, or replace MOC
orders designated for participation in the proposed Cboe Market Close
after the MOC Cut-Off Time.
---------------------------------------------------------------------------
\22\ The term ``Member'' is defined as ``any registered broker
or dealer that has been admitted to membership in the Exchange.''
See BZX Rule 1.5(n).
\23\ Currently, the NYSE designates the cut-off time for the
entry of NYSE Market At-the-Close Orders as 3:50 p.m. Eastern Time.
See NYSE Rule 123C. Nasdaq, in turn, designates the cut-off time for
the entry of Nasdaq Market On Close Orders as 3:55 p.m. Eastern
Time. See Nasdaq Rule 4702.
---------------------------------------------------------------------------
Members would be required to mark as ``short'' or ``short exempt''
all short sale MOC orders. MOC orders marked short would be rejected,
while MOC orders marked short exempt would be accepted and processed by
the System.\24\
---------------------------------------------------------------------------
\24\ See Amendment No. 2. In Amendment No. 2, the Exchange added
Interpretation and Policies .04 to proposed BZX Rule 11.28 to
reflect the handling of MOC orders marked as ``short'' or ``short
exempt.'' The Exchange stated that all MOC orders marked short would
be rejected to ensure that the Exchange is able to comply with the
Exchange's obligations under Rule 201 of Regulation SHO in the event
a short sale circuit breaker is triggered and the official closing
price determined by the primary listing exchange is not above the
national best bid.
---------------------------------------------------------------------------
At the MOC Cut-Off Time, the System would match for execution all
buy and sell MOC orders entered into the System with execution priority
determined based on time-received.\25\ Any remaining balance of
unmatched shares would be cancelled and returned to the Member(s). The
System would disseminate, via the Cboe Auction Feed,\26\ the total size
of all buy and sell MOC orders matched per security via Cboe Market
Close. All matched buy and sell MOC orders would remain on the System
until the publication of the official closing price by the primary
listing exchange. Upon publication of the official closing price by the
primary listing exchange, the System would execute all previously
matched buy and sell MOC orders at that official closing price.\27\ If
there is no initial official closing price published by 8:00 p.m.
Eastern Time for any security, BZX
[[Page 4729]]
would cancel all matched MOC orders in such security.
---------------------------------------------------------------------------
\25\ As set forth in proposed Interpretation and Policy .02, the
Exchange would cancel all MOC orders designated to participate in
Cboe Market Close in the event the Exchange becomes impaired prior
to the MOC Cut-Off Time and is unable to recover within 5 minutes
from the MOC Cut-Off Time. The Exchange states that this would
provide Members time to route their orders to the primary listing
exchange's closing auction. Should the Exchange become impaired
after the MOC Cut-Off Time, proposed Interpretation and Policy .02
states that the Exchange would retain all matched MOC orders and
execute those orders at the official closing price once it is
operational.
\26\ The Cboe Auction Feed disseminates information regarding
the current status of price and size information related to auctions
conducted by the Exchange and the data is provided at no charge. See
BZX Rule 11.22(i). The Exchange also proposed to amend BZX Rule
11.22(i) to reflect that the Cboe Auction Feed would also include
the total size of all buy and sell orders matched via Cboe Market
Close.
\27\ The Exchange would report the execution of all previously
matched buy and sell orders to the applicable securities information
processor and will designate such trades as ``.P'', Prior Reference
Price. See Notice at 23321. In the case where the primary listing
exchange suffers an impairment and is unable to perform its closing
auction process, BZX would utilize the official closing price
published by the exchange designated by the primary listing
exchange. See proposed Interpretation and Policy .01. In addition,
proposed Interpretation and Policy .03 specifies that up until the
closing of the applicable securities information processor at 8:00
p.m. Eastern Time, BZX intends to monitor the initial publication of
the official closing price, and any subsequent changes to the
published official closing price, and adjust the price of such
trades accordingly.
---------------------------------------------------------------------------
BZX states that it is proposing to adopt Cboe Market Close in
response to requests from market participants, particularly buy-side
firms, for an alternative to the primary listing exchanges' closing
auctions that still provides an execution at a security's official
closing price.\28\ BZX intends to file a separate proposal related to
fees for MOC orders executed in the Cboe Market Close. BZX stated that,
under this separate proposal, the fees for Cboe Market Close would be
set and maintained over time at a rate less than the fee charged by the
applicable primary listing exchange for its own respective closing
mechanism.\29\
---------------------------------------------------------------------------
\28\ See Notice at 23321.
\29\ See id.
---------------------------------------------------------------------------
BZX contends that the proposal would not compromise the price
discovery function performed by the primary listing exchanges' closing
auctions because Cboe Market Close would only accept, match, and
execute MOC orders, which are designated to execute at the security's
official closing price.\30\ In order to avoid an impact on price
discovery, BZX states that Cboe Market Close would not accept limit
orders, which are orders to buy or sell a security at a specific price
or better and are the basis from which price formation occurs in a
closing auction.\31\
---------------------------------------------------------------------------
\30\ See BZX Rule 11.9(a)(2) which defines a ``limit order'' as
``[a]n order to buy or sell a stated amount of a security at a
specified price or better.''
\31\ See Notice at 23321.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange.\32\ The
Commission therefore approves the proposed rule change. In particular,
as discussed below, the Commission finds that the proposal is
consistent with: Section 6(b)(8) of the Act,\33\ which requires that
the rules of a national securities exchange not impose any burden on
competition not necessary or appropriate in furtherance of the purposes
of the Act; and Section 6(b)(5) of the Act,\34\ which requires that the
rules of a national securities exchange, among other things, be
designed to prevent fraudulent and manipulative acts and practices,
promote just and equitable principles of trade, remove impediments and
perfect the mechanism of a free and open market and a national market
system, and, in general, protect investors and the public interest.
Further, the Commission believes that the proposal is consistent with
the statutory objective of fair and orderly markets under Section 11A
of the Act.
---------------------------------------------------------------------------
\32\ In approving this proposed rule change, the Commission has
considered the proposed rule change's impact on efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f). The
Commission addresses comments about economic effects of the proposed
rule change on efficiency and competition below in Section III.A.
The Commission addresses the effects of the proposed rule change on
capital formation below in Sections III.B.1 and III.C.
\33\ 15 U.S.C. 78f(b)(8).
\34\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
The Commission received a number of comment letters addressing the
proposed rule change's consistency with these provisions, specifically
focusing on its potential effect on: (1) Competition; (2) price
discovery and fragmentation; (3) issuers and other market participants;
(4) market complexity and operational risk; and (5) manipulation. The
Commission addresses each of these issues below.
First, the Commission addresses arguments raised that the proposal
is inconsistent with Section 6(b)(8) of the Act because it would burden
competition by, among other things, free-riding on the investments of
the primary listing exchanges in their closing auctions. We find that,
on the contrary, the proposal will not impose any burden on competition
not necessary or appropriate in furtherance of the purposes of the Act,
and, in fact, it should promote competition among MOC order execution
venues and foster price competition for MOC order execution fees.
Second, the Commission addresses comments regarding the proposal's
consistency with Section 6(b)(5) of the Act. These commenters argue
that the proposal would fragment the execution of MOC orders and
thereby disrupt closing auction price discovery, increase market
complexity and operational risk, and increase the risk of manipulation
through, among things, information asymmetries. The Commission finds,
based on Cboe Market Close's design and the record before us, that the
proposal is consistent with Section 6(b)(5) of the Act. As explained
below, because Cboe Market Close will only execute MOC orders against
other MOC orders, it should not disrupt the closing auction price
discovery process. Furthermore, Cboe Market Close should not
significantly increase market complexity and operational risk because
it will simply constitute an additional optional MOC order execution
venue for market participants, and an optional data feed that market
participants may choose to monitor for information regarding the total
size of matched MOC orders via Cboe Market Close. Lastly, as discussed
below, Cboe Market Close should not materially increase the risk of
manipulation through information asymmetries because the information
that may be discerned by participants of Cboe Market Close is of
limited usefulness, and BZX has made detailed commitments regarding its
plans to surveil, detect, and prevent against any potential
manipulation through the use of Cboe Market Close.
A. Effect on Competition
1. Price Competition and ``Free Riding''
a. Comments on the Proposal
A number of commenters addressed the proposal's effect on
competition. Some commenters supporting the proposal stated that it
would increase competition among exchanges for executions of orders at
the close.\35\ These commenters asserted that increased competition
could result in reduced fees for market participants.\36\ Some of these
commenters characterized the primary listing exchanges as maintaining a
``monopoly'' on orders seeking a closing price with no market
competition, which they argued has, and would continue to, result in a
continual increase in fees for such orders if the proposal were not
approved.\37\ Commenters also asserted that the primary listing
exchanges have taken advantage of increasing volume at the close by
charging significantly higher fees for participation in the closing
auctions than for intraday
[[Page 4730]]
trading.\38\ One commenter added that the high costs of closing
transactions are exacerbated because primary listing exchanges assess a
fee on both sides of the closing auction executions, and imbalance
feeds for auctions are only available as part of the exchanges' premium
data products.\39\ Two commenters who opposed the proposal acknowledged
that increasing fees and lack of price competition with respect to
closing auctions are of concern, but suggested alternatively that
regulatory checks on closing auction pricing, such as fee caps, could
be put into place.\40\
---------------------------------------------------------------------------
\35\ See Letters from: Donald K. Ross, Jr., Executive Chairman,
PDQ Enterprise, LLC (June 6, 2017) (``PDQ Letter''); Ray Ross, Chief
Technology Officer, Clearpool Group (June 12, 2017) (``Clearpool
Letter'') at 2; Venu Palaparthi, SVP, Compliance, Regulatory and
Government Affairs, Virtu Financial (June 12, 2017) (``Virtu
Letter'') at 2; Theodore R. Lazo, Managing Director and Associate
General Counsel, SIFMA (June 13, 2017) (``SIFMA Letter 1'') at 2;
John Ramsay, Chief Market Policy Officer, Investors Exchange LLC
(June 23, 2017) (``IEX Letter'') at 1; David M. Weisberger, Head of
Equities, ViableMkts (Aug. 3, 2017) (``ViableMkts Letter'') at 1-2;
and Donald Bollerman (Aug. 18, 2017) (``Bollerman Letter'') at 2.
\36\ See PDQ Letter; Clearpool Letter at 2; Virtu Letter at 2;
SIFMA Letter 1 at 2; IEX Letter at 1; ViableMkts Letter at 1;
Bollerman Letter at 2; and Letter from Theodore R. Lazo, Managing
Director and Associate General Counsel, SIFMA (Aug. 18, 2017)
(``SIFMA Letter 2'').
\37\ See IEX Letter at 3; Clearpool Letter at 2; and ViableMkts
Letter at 1-2. However, one commenter also stated that it believes
the fees charged by NYSE and Nasdaq for participating in their
closing auctions are not excessive and there is no need for
additional fee competition for executing orders at the official
closing price. See Letter from Ari M. Rubenstein, Co-Founder and
Chief Executive Officer, GTS Securities LLC (June 22, 2017) (``GTS
Securities Letter 1'') at 5.
\38\ See, e.g., Clearpool Letter at 2; and ViableMkts Letter at
1-2 (estimating that the average ``capture'' for MOC orders executed
in the Nasdaq and NYSE closing auctions is likely over 20 mils per
share compared to the average capture that ranges from a negative
number to 10 mils on Nasdaq and from a negative number to 16 mils on
NYSE for intraday executions).
\39\ See Clearpool Letter at 2.
\40\ See Letters from: Ari M. Rubenstein, Co-Founder and Chief
Executive Officer, GTS Securities LLC (Aug. 17, 2017) (``GTS
Securities Letter 2'') at 6 (acknowledging that many market
participants were concerned that the primary listing exchanges
``have too much pricing power relative to the closing auction'');
and Mehmet Kinak, Head of Global Equity Market Structure &
Electronic Trading, et al., T. Rowe Price Associates, Inc. (July 7,
2017) (``T. Rowe Price Letter'') at 3 (stating that closing auction
fees ``have been steadily increasing in the absence of competitive
alternatives'').
---------------------------------------------------------------------------
One commenter argued that the proposal does not unduly burden
competition as exchanges often attempt to compete by adopting
functionality or fee schedules developed by competitors.\41\ Another
commenter also asserted that the proposal is not fully competitive with
closing auctions, as it does not accept priced orders or disseminate
imbalance information.\42\ Rather, the commenter believed that the
proposal competes with other un-priced orders in closing auctions
which, in its view, is not ``destructive to the mission of the closing
auction.'' \43\
---------------------------------------------------------------------------
\41\ See IEX Letter at 3.
\42\ See ViableMkts Letter at 5.
\43\ See id. ViableMkts also argued that the effect of this
competition will most likely be increased volumes at the closing
price because of lower marginal costs and the potential to attract
new types of investors to transact at the closing price. See id.
---------------------------------------------------------------------------
In contrast, other commenters argued that the proposal would impose
a burden on competition not necessary or appropriate in furtherance of
the purposes of the Act, including by ``free-riding'' on the
investments the primary listing exchanges have made in their closing
auctions.\44\ These commenters asserted that the proposal would
unfairly burden competition as it would allow BZX to use the closing
prices established through the auction of a primary listing exchange,
without bearing any of the attendant costs or risks.\45\ In particular,
NYSE and Nasdaq asserted that the existing exchange fees for closing
auctions reflect the investments that have been made in developing and
operating the closing auctions, including the rules and procedures
governing the auctions, the technology to determine the official
closing price of a security, and the surveillance tools necessary to
monitor the closing process.\46\ In addition, Nasdaq and NYSE
highlighted the regulatory costs related to operating a closing
auction.\47\ Specifically, Nasdaq and NYSE cited compliance costs
associated with Regulation Systems Compliance and Integrity
(``Regulation SCI'').\48\ Nasdaq and NYSE explained that Regulation SCI
was adopted by the Commission to enhance the robustness and resiliency
of the technological systems of ``SCI entities,'' including
exchanges.\49\ They stated that closing auctions are ``critical SCI
systems'' under Regulation SCI, and as such, are subject to heightened
requirements and increased compliance costs, as compared to other ``SCI
systems.'' \50\ Nasdaq and NYSE asserted that, because Cboe Market
Close is not a closing auction and thus not a ``critical SCI system''
under the regulation, BZX would be at a competitive advantage by not
having to incur such additional compliance costs when competing to
attract MOC orders.\51\ Because BZX would not have to bear any of the
aforementioned expenses of developing and conducting a closing auction,
NYSE and Nasdaq concluded that BZX would be able to charge fees to
execute MOC orders at the official closing price at a price with which
the primary listing exchanges could not realistically compete.\52\
Nasdaq further argued that because the closing fees of NYSE and Nasdaq
would always be undercut by BZX, it would diminish incentives for the
primary listing exchanges to invest in enhancements to their closing
auctions.\53\ In addition, Nasdaq argued that the proposal would
decrease incentives to serve as a listing exchange if it could not
offset the cost of its regulatory responsibilities as a listing
exchange with the revenue derived from executing MOC orders in Nasdaq-
listed securities.\54\
---------------------------------------------------------------------------
\44\ See, e.g., Letters from: Elizabeth K. King, General Counsel
and Corporate Secretary, NYSE (June 13, 2017) (``NYSE Letter 1'') at
9-10; Elizabeth K. King, General Counsel and Corporate Secretary,
NYSE (Nov. 3, 2017) (``NYSE Letter 3'') at 1; Edward S. Knight,
Executive Vice President and General Counsel, Nasdaq, Inc. (June 12,
2017) (``Nasdaq Letter 1'') at 5-6 & 9; Edward S. Knight, Executive
Vice President and General Counsel, Nasdaq, Inc. (Sept. 18, 2017)
(``Nasdaq Letter 2'') at 7-8; Jon Stonehouse, CEO, and Tom Staab,
CFO, BioCryst Pharmaceuticals, Inc. (July 31, 2017) (``BioCryst
Letter'') at 2; Charles Beck, Chief Financial Officer, Digimarc
Corporation (Aug. 3, 2017) (``Digimarc Letter'') at 1-2; Michael J.
Chewens, Senior Executive Vice President & Chief Financial Officer,
NBT Bancorp Inc. (Aug. 11, 2017) (``NBT Bancorp Letter'') at 2;
Patrick L. Donnelly, Executive Vice President & General Counsel,
Sirius XMHoldings Inc. (Aug. 17, 2017) (``Sirius Letter'') at 2; and
Gabrielle Rabinovitch, VP, Investor Relations, PayPal Holdings, Inc.
(Sept. 12, 2017) (``PayPal Letter'') at 1; NYSE Statement at 14-18;
Nasdaq Statement at 10-16; and Pitt/Spatt Report at 11-12, 19-20.
See also Letter from James J. Angel, Associate Professor, McDonough
School of Business, Georgetown University (July 30, 2017) (``Angel
Letter'') at 3 (calling for a rationalization of intellectual
property protection in order to foster productive innovation).
\45\ See, e.g., NYSE Letter 1 at 9; NYSE Letter 3 at 5; NYSE
Statement at 14-18; Nasdaq Statement at 10-16; Pitt/Spatt Report at
11-12, 19-20; and Letters from: Elizabeth K. King, General Counsel
and Corporate Secretary, NYSE (Aug. 9, 2017) (``NYSE Letter 2'') at
1-3; and Elizabeth K. King, General Counsel and Corporate Secretary,
NYSE (Jan. 12, 2018) (``NYSE Letter 4'') at 1. In contrast, one
commenter argued that BZX would not be ``free-riding'' on the
primary listing exchanges' price discovery process because it is ``a
regular and accepted practice'' to match orders at reference prices.
See SIFMA Letter 2 at 2.
\46\ See NYSE Letter 1 at 9; NYSE Letter 2 at 2; NYSE Letter 3
at 5; NYSE Statement at 14-16; and Nasdaq Statement at 11, 15.
Moreover, NYSE stated that it dedicates resources to providing
systems to designated market makers (``DMMs'') necessary to
facilitate the closing of trading as well as to floor brokers to
enter and manage their customers' closing interest. See NYSE Letter
2 at 2; and NYSE Statement at 15.
\47\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
\48\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
\49\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
\50\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
\51\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
Nasdaq and NYSE also argued that Cboe Market Close results in
regulatory disparities similar to those that the Commission found in
its Benchmark Disapproval Order to unnecessarily and inappropriately
burden competition. See discussion, infra Section III.A.2.
\52\ See Nasdaq Statement at 11-12; and NYSE Statement at 15-16.
NYSE stated that the majority of costs associated with operating a
closing auction are fixed costs. If NYSE were to reduce the fees
charged for participating in its closing auction, NYSE stated that
there likely would be other impacts on the exchange's overall fee
structure. See NYSE Statement at 15-16.
\53\ See Nasdaq Statement at 11. See also PayPal Letter at 1
(citing concerns about the ``incentive structure'' that the proposal
presents).
\54\ See Nasdaq Statement at 12-13.
---------------------------------------------------------------------------
Nasdaq and NYSE further stated that BZX is not proposing to develop
its own auction or improve the functionality of the closing auctions in
the primary listing exchanges, but rather merely using the price
generated by the listing exchanges through their proprietary
processes.\55\ Nasdaq added that in order
[[Page 4731]]
for BZX to meaningfully enhance competition, it would have to generate
its own closing price.\56\ NYSE also stated that the proposal differs
from the competing auctions currently run by Nasdaq and NYSE Arca in
securities not listed on their exchanges because those auctions are
independent price-discovery auction events that do not rely on prices
established by the primary listing exchange. Therefore, in NYSE's view,
those auctions compete on a ``level playing field'' and serve as an
alternative method of establishing an official closing price if a
primary listing exchange is unable to conduct a closing auction due to
a technology issue.\57\
---------------------------------------------------------------------------
\55\ See Nasdaq Statement at 15 (citing also the Pitt/Spatt
Report, which asserted that the Cboe Market Close `is not . . . a
strategically equivalent product to that previously developed by
Nasdaq'); and NYSE Statement at 14-15, 19-20. See also Pitt/Spatt
Report at 11-12 (noting the Cboe Market Close ``deliberately lacks
any mechanism for determining the price'' at which matched MOCs
would be executed and is dependent on the Nasdaq closing cross).
\56\ See Nasdaq Statement at 13. See also infra notes 240-242
(discussing comments on the proposal's effect on price discovery and
competing auctions and over-the-counter matching services).
\57\ See NYSE Letter 1 at 6; NYSE Letter 2 at 3-4; NYSE Letter 3
at 5; and NYSE Statement at 20 n.59. In response, one commenter
stated that these competing auctions were not originally proposed to
only serve as a back-up to a primary listing exchanges' closing
auction. See SIFMA Letter 2 at 2. In addition, one commenter stated
that such competing auctions are not expressly limited to operating
only when another primary listing exchange is experiencing a
failure. See Bollerman Letter at 3.
---------------------------------------------------------------------------
Nasdaq also argued that the proposal undermines intra-market
competition, by removing orders from Nasdaq's auction book.\58\
Specifically, Nasdaq asserted that, by diverting orders away from NYSE
and Nasdaq, the proposal would detract from robust price competition
and discovery, which Nasdaq argued is necessary for the exchange to
arrive at the most accurate closing price.\59\ NYSE also argued that
the proposal affects competition for listings, as issuers choose where
to list their securities based on how primary listing exchanges are
able to centralize liquidity and perform closing auctions.\60\ In
addition, Nasdaq argued that price competition between exchanges is not
as important a form of competition as innovation because price
competition elevates fragmentation, sacrifices quote and order
interaction, and, in the case of Cboe Market Close, undermines
innovation.\61\ Further, Nasdaq stated that BZX's comparisons to pegged
orders--where the price is based upon reference data that does not
originate on that exchange--were misplaced because all exchanges
contribute to the prices to which such orders are pegged, whereas BZX
does not contribute to the closing price on a primary listing
exchange.\62\
---------------------------------------------------------------------------
\58\ See Nasdaq Letter 1 at 9; and Nasdaq Statement at 12-14.
\59\ See Nasdaq Letter 1 at 10; Nasdaq Letter 2 at 7-8; and
Nasdaq Statement at 13. See also infra Section III.B (discussing
comments on the proposal's effect on price discovery).
\60\ See NYSE Letter 1 at 9.
\61\ See Nasdaq Letter 2 at 8.
\62\ See id. at 13.
---------------------------------------------------------------------------
Nasdaq and NYSE also disputed the purported benefits of the
proposal for market participants.\63\ First, Nasdaq and NYSE asserted
that the cost savings from Cboe Market Close is unlikely to be passed
along to investors because broker-dealers typically pay an exchange's
transaction fees.\64\ Further, Nasdaq and NYSE asserted that the
proposal would not enhance competition with respect to execution
quality, but rather may harm execution quality.\65\ In this regard,
Nasdaq argued that because orders would be irrevocable earlier than on
the listing exchange, it would impair the price discovery function on
the primary listing exchanges' closing auctions,\66\ while NYSE stated
that the proposal would reduce the amount of MOC orders in the closing
auctions, thereby reducing the quality of the closing price and
inhibiting competition.\67\
---------------------------------------------------------------------------
\63\ See Nasdaq Statement at 16; and NYSE Statement at 18-19.
\64\ See Nasdaq Statement at 16; and NYSE Statement at 18-19.
\65\ See Nasdaq Statement at 16; and NYSE Statement at 20.
\66\ See Nasdaq Statement at 16.
\67\ See NYSE Statement at 20.
---------------------------------------------------------------------------
b. BZX Response to Comments
BZX asserted that the proposal would enhance rather than burden
competition by promoting competition in the use of MOC orders.\68\
Specifically, BZX stated that the proposal would have a positive effect
on competition as it offers a price-competitive alternative that will
not affect the price discovery process.\69\ BZX stated that it believes
that this increased price competition will result in lower fees for
market participants seeking an execution of MOC orders at the official
closing price.\70\ In response to NYSE and Nasdaq assertions that fee
reductions would not be passed along to investors, BZX argued that,
even if broker-dealers do not directly pass through lower fees to their
customers, customers would still receive indirect benefits from lower
execution fees such as general fee reductions from broker-dealers or
other improvements that broker-dealers may make due to cost
savings.\71\
---------------------------------------------------------------------------
\68\ See Letters from: Joanne Moffic-Silver, Executive Vice
President, General Counsel, and Corporate Secretary, Bats Global
Markets, Inc. (Aug. 2, 2017) (``BZX Letter 1'') at 10-11; and Joanne
Moffic-Silver, Executive Vice President, General Counsel, and
Corporate Secretary, Bats Global Markets, Inc. (Oct. 11, 2017)
(``BZX Letter 2'') at 6-7. BZX further argued that Nasdaq's
assertion that the proposal would undermine competition amongst
orders is misplaced. BZX believes that paired-off MOC orders--which
are not price-setting orders but rather the beneficiaries of price
discovery--do not affect interactions that take place on another
exchange because orders compete with each other for executions
within each individual exchange based on the parameters a market
participant places on its orders. See BZX Letter 1 at 11.
\69\ See BZX Letter 2 at 7.
\70\ See BZX Statement at 22.
\71\ See BZX Letter 2 at 7.
---------------------------------------------------------------------------
BZX also challenged the assertion that it was ``free-riding'' on
the primary listing exchanges' closing auctions.\72\ BZX argued that
instead it was, on balance, providing a ``a materially better value to
the marketplace'' in two ways: by not diverting price-forming limit
orders away from the primary listing exchange; and by providing users
with the official closing price because any other price would be
undesirable to market participants and potentially harmful to price
formation.\73\ BZX further argued that there is precedent for an
exchange to execute orders solely at reference prices while not also
displaying priced orders for that security.\74\ In addition, BZX stated
that no rule or regulation provides the primary listing exchange with
control over how other market participants use the official closing
price in their matching engines or with regard to the pricing of their
own products, such as mutual funds, ETFs, and indices.\75\ BZX also
stated that improving and mimicking functionality enhances the
competitive dynamic among exchanges.\76\ Further, BZX stated that the
Commission has approved the operation of competing closing auctions,
noting in particular the closing auctions on Nasdaq, NYSE Arca, and the
American Stock Exchange.\77\
---------------------------------------------------------------------------
\72\ See BZX Letter 1 at 5; and BZX Letter 2 at 7.
\73\ See BZX Letter 1 at 5.
\74\ See BZX Letter 1 at 6; and BZX Letter 2 at 7 (describing
NYSE's after hours crossing sessions which execute orders at the
NYSE official closing price and the ISE Stock Exchange functionality
that only executed orders at the midpoint of the NBBO and did not
display orders).
\75\ See BZX Letter 2 at 8.
\76\ See id.
\77\ See BZX Letter 1 at 6. See also infra Section III.B.3
(discussing BZX's comments on competing closing auctions with regard
to price discovery). In addition, in response to Nasdaq's contention
that it is aware of no regulator in any jurisdiction that has
sanctioned a diversion of orders from the primary listing exchange
closing auction, BZX noted the Ontario Securities Commission's
approval of a similar proposal by Chi-X Canada ATS, which it said is
currently owned by Nasdaq, to match MOC orders at the closing price
established by the Toronto Stock Exchange. See Nasdaq Letter 1 at
10; BZX Letter 1 at 7; and BZX Letter 2 at 2 (stating that the
Ontario Securities Commission found that the proposal would not
threaten the integrity of the price formation process and would
pressure the Toronto Stock Exchange to competitively price
executions during their closing auction).
---------------------------------------------------------------------------
[[Page 4732]]
BZX also asserted that Cboe Market Close would create benefits for
market participants beyond price competition.\78\ In particular, BZX
argued that it would be unable to attract order flow based solely on
lower execution fees, so it would have to build a ``viable alternative
venue to which market participants will choose to send their orders,''
including continually improving Cboe Market Close technology.\79\ This,
in turn, BZX argued, would likely cause the primary listing exchanges
to seek to improve quality and performance of their auctions, thereby
enhancing competition and benefiting market participants generally.\80\
---------------------------------------------------------------------------
\78\ See BZX Statement at 23-24.
\79\ See BZX Statement at 23-24.
\80\ See BZX Statement at 23-24.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
BZX and other commenters have provided evidence that, over the past
several years, closing auction fees have steadily increased and are
significantly higher than fees for intraday trading.\81\ For example,
BZX stated that the per share proceeds (i.e., the per share fee charged
to the buyer plus the per share fee charged to the seller) for the
primary listing exchanges based on the top tier fees they assess for
closing auction trades is $0.0012 per share for NYSE and $0.0018 per
share for Nasdaq, while the primary listing exchanges' per share
proceeds from intraday trading based on the top tier fees and rebates
they assess for intraday trades are much lower, specifically $0.00055
for NYSE and -$0.00005 for Nasdaq.\82\ Another commenter estimated
that, under Nasdaq and NYSE's tiered fee structures, the average
proceeds from MOC orders executed in the Nasdaq and NYSE closing
auctions is likely over $0.0020 per share compared to the average per
share proceeds from intraday executions, which ranges from a negative
number to $0.0010 on Nasdaq and from a negative number to $0.0016 on
NYSE.\83\
---------------------------------------------------------------------------
\81\ See Notice at 23321 and n.9; and supra notes 38-39 and
accompanying text. Specifically, BZX states that NYSE's closing
auction fees have gone up by 16%, while Nasdaq's fees have increased
by 60%. See Notice at 23321; and BZX Statement at 3 and n.11.
\82\ See Notice at 23321; and BZX Statement at 3 and n.11. NYSE
and Nasdaq utilize fee structures whereby they pay per share rebates
to market participants who provide liquidity on their exchanges. As
a result, the per share proceeds figures for intraday trading
provided by BZX and other commenters may be reflected as negative
amounts because a rebate paid to a liquidity provider may, in some
instances, exceed the fee charged to a liquidity taker.
\83\ See ViableMkts Letter at 1-2. See also Clearpool Letter at
2. The Commission notes that a recent academic paper supports this
notion. See Eric Budish, Robin S. Lee, and John J. Shim, Will the
Market Fix the Market? A Theory of Stock Exchange Competition and
Innovation, (May 6, 2019), available at https://www.nber.org/papers/w25855.pdf.
---------------------------------------------------------------------------
While the development and ongoing costs associated with the primary
listing exchanges' closing auctions may play a role in the fees for
closing auctions, NYSE and Nasdaq have not provided any data or details
to support this assertion.\84\ And those costs are unlikely to account
for the entirety of the wide disparity between closing auction fees and
intraday trading fees demonstrated by BZX and other commenters. While
BZX would not be conducting the closing auction that would determine
the execution price for orders executed in Cboe Market Close, by
providing an additional exchange venue to execute MOC orders, the
availability of Cboe Market Close should foster price competition for
the execution of MOC orders. Further, as noted above, BZX stated that
it intends to file a separate proposal related to fees for MOC orders
executed in the Cboe Market Close that would set and maintain such fees
over time at a rate less than the fee charged by the applicable primary
listing exchange for its own respective closing mechanism.\85\ Although
some commenters argued that lower fees resulting from the proposal
would not generally benefit market participants because such fees are
typically not passed through from a broker-dealer to its customers, the
Commission believes that the costs of closing auctions can have a
negative effect on brokers and the investors that they serve,
particularly for smaller and mid-size brokers.\86\ The Commission
believes that fostering price competition for the execution of MOC
orders may facilitate the ability for smaller and mid-size brokers to
better compete for investors' MOC order flow, and greater choice among,
and participation by, broker-dealers in handling MOC orders should
inure to the benefit of end investors.
---------------------------------------------------------------------------
\84\ The Commission requested such information in the OIP,
asking specifically: What are the current costs associated with a
primary listing market developing and operating a closing auction,
and to what extent (and if so, how) are these costs passed on to
market participants today? How do the fixed costs associated with
developing closing auctions compare to the variable costs of
conducting closing auctions? How do the revenues collected from
closing auctions compare to these costs? See OIP at 40211.
\85\ See supra note 29 and accompanying text.
\86\ See, e.g., Clearpool Letter at 1.
---------------------------------------------------------------------------
While the primary listing exchanges and other commenters argue that
BZX is ``free riding'' on investments of the primary listing exchanges
in the development and maintenance of the closing auction process--and
thus impeding competition in a manner inconsistent with the Act--this
concern must be evaluated against the enhanced competition that the
proposal should provide. In particular, BZX has demonstrated that the
proposal will not impose a burden on competition that is not necessary
or appropriate in furtherance of the purposes of the Act because it
should promote competition among MOC order execution venues and foster
price competition for MOC order execution fees, areas which currently
appear to be lacking the same competitive forces as intraday trading.
In this regard, as discussed above, commenters assert that the primary
listing exchanges have taken advantage of the ``monopoly'' they have on
orders seeking a closing price to impose high per share fees for orders
executed in the closing auctions.\87\ Because Cboe Market Close will
provide an additional venue to execute MOC orders, the proposal should
introduce further competition, which may result in benefits to
investors generally. And while some commenters suggested capping
closing auction fees to address the lack of competition,\88\ Cboe
Market Close represents a market-based solution that is designed to
foster price competition for MOC orders without impairing the integrity
of the primary listing exchanges' closing auctions.
---------------------------------------------------------------------------
\87\ See supra notes 36-38 and accompanying text.
\88\ See supra note 40 and accompanying text.
---------------------------------------------------------------------------
Moreover, in the highly competitive environment of the current
national market system with numerous exchanges competing for order
flow, it is commonplace for exchanges to attempt to mimic or build upon
various functionalities of their competitors.\89\ This practice does
not, in and of itself, result in a competitive burden that is not
necessary or appropriate in furtherance of the purposes of the Act.
While BZX is not proposing to generate
[[Page 4733]]
its own auction price, it has developed a process that will benefit the
market because, based on BZX's representations, it should foster price
competition and thereby decrease costs for market participants.\90\
---------------------------------------------------------------------------
\89\ Exchanges regularly file proposed rule changes with the
Commission as required under Section 19(b) of the Act and Rule 19b-4
thereunder to adopt, for example, new products, order types, order
modifiers, price improvement mechanisms, risk mechanisms, and other
functionality that is based upon, and designed to compete with, that
of other competing exchanges. Reflecting this commonplace practice,
the requirements of Form 19b-4, with which exchanges must comply to
file such proposed rule changes, provide that exchanges must,
``[s]tate whether the proposed rule change is based on a rule either
of another self-regulatory organization or of the Commission, and if
so, identify the rule and explain any differences between the
proposed rule change and that rule . . .'' See Item 8, Form 19b-4,
available at: https://www.sec.gov/files/form19b-4.pdf.
\90\ See supra note 29 and accompanying text.
---------------------------------------------------------------------------
In addition to the proposal's intended effect on price competition,
the Commission also believes that the proposal may result in other
benefits to market participants generally, including execution quality
competition for MOC orders. The Commission believes that implementation
of Cboe Market Close could incent other venues, including the primary
listing exchanges, as well as ATSs and off-exchange matching venues, to
continue to innovate and compete to attract MOC orders to their venues.
As noted above, BZX stated that it would be unable to attract MOC order
flow solely on the basis of lower execution fees, and asserted that it
and the primary listing exchanges would continually need to improve
their technology and quality of their MOC order execution offerings in
order to compete for such order flow. The proposal would also provide
an opportunity for market participants to assess and compare their
experience in seeking to execute MOC orders on different national
securities exchanges and off-exchange venues, which would foster
further competition and may enhance the quality and efficiency of MOC
order executions.\91\
---------------------------------------------------------------------------
\91\ See, e.g., ViableMkts Letter at 2 (stating that Cboe Market
Close may attract MOC liquidity from market participants that
currently may not utilize the primary listing exchanges' closing
auctions and that participation by these market participants may
also benefit the market more broadly).
---------------------------------------------------------------------------
The primary listing exchanges argue that the proposal diminishes
incentives to invest in enhancements to closing auctions. But, in the
Commission's view, the proposal could actually incent these exchanges
to innovate and enhance their closing auctions in order to compete for
MOC orders despite the additional costs of obtaining a closing
execution on the primary listing exchange, to the extent the costs for
such executions will indeed be higher than those for Cboe Market
Close.\92\ Ultimately, the Commission believes that the success of the
Cboe Market Close in competing with the primary listing exchanges and
off-exchange matching venues for MOC orders will not depend solely on
lower fees. Rather, it will depend on a variety of factors, including
the quality of the MOC order execution services and the attendant risks
and costs associated with such executions.\93\
---------------------------------------------------------------------------
\92\ While Nasdaq also argued that the proposal decreases
incentives to serve as a listing exchange if it cannot offset the
cost of regulatory responsibilities of being a listing exchange with
fees from the closing auction, the Commission finds such argument to
be unpersuasive. The Commission believes that the primary listing
exchanges have other means to recoup those costs such as using
existing fees such as their ``Trading Rights Fee,'' which they have
asserted is used to help defray costs of regulating the market.
\93\ See infra note 195 and accompanying text.
---------------------------------------------------------------------------
Among such factors that market participants may consider in
determining the venue to which it will send MOC orders are regulatory
protections, including Regulation SCI. The requirements of Regulation
SCI were designed to strengthen the infrastructure of the U.S.
securities markets and improve its resilience when technological issues
arise.\94\ As NYSE and Nasdaq pointed out, systems used for closing
auctions on the primary listing exchanges are ``critical SCI systems''
under Regulation SCI and as such, are held to heightened requirements
under the regulation as compared to ``SCI systems.'' The Commission
determined that closing auction systems are critical to the continuous
and orderly functioning of the securities markets because they, among
other things, establish official closing prices, and therefore they
should be subject to an increased level of obligation as compared to
other SCI systems.\95\ Accordingly, systems that directly support
closing auctions on the primary listing exchanges are subject to a two-
hour resumption goal following a wide-scale disruption and increased
information dissemination provisions following a systems issue.\96\
---------------------------------------------------------------------------
\94\ See Securities Exchange Act Release No. 73639 (Nov. 19,
2014), 79 FR 72252 (Dec. 5, 2014) (``SCI Adopting Release'').
\95\ See SCI Adopting Release at 72277-78. ``Critical SCI
systems'' are defined in Rule 1000 of Regulation SCI to include,
among other things, any SCI systems of, or operated by, or on behalf
of, an SCI entity that directly support functionality relating to
openings, reopenings, and closings on the primary listing market. 17
CFR 242.1000.
\96\ See 17 CFR 242.1001(a)(2)(v) and 1002(c)(3). See also SCI
Adopting Release at 72277.
---------------------------------------------------------------------------
NYSE and Nasdaq stated that there are additional costs due to
compliance with the heightened Regulation SCI requirements for their
closing auction systems that would put them at a competitive
disadvantage. Although Cboe Market Close systems, as proposed, would
also be subject to Regulation SCI as ``SCI systems,'' based on the
Regulation SCI rule definitions, they would not be ``critical SCI
systems,'' and thus would not be subject to the heightened requirements
of the regulation. Similarly, off-exchange MOC matching systems of ATSs
and broker-dealers would not be ``critical SCI systems'' and further,
may not be subject to any of the requirements of Regulation SCI if such
entities do not meet the definition of ``SCI entity'' under the
regulation.\97\ Importantly, Cboe Market Close is not a closing
auction, but rather matches and executes MOC orders at a security's
official closing price. Accordingly, Cboe Market Close will not serve
the same function to the markets as the closing auctions on the primary
listing exchanges. Regulation SCI, by design, takes a risk-based
approach, and designates as critical SCI systems those systems that the
Commission believes should be subject to the highest level of
requirements based on their criticality.\98\ The fact that systems
would be subject to different requirements of Regulation SCI because of
differences in their design, utility, and function does not establish a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Act.
---------------------------------------------------------------------------
\97\ Regulation SCI is not applicable to non-ATS broker-dealers.
Further, an ATS is only subject to the requirements of Regulation
SCI if it meets certain volume thresholds under the definition of
``SCI ATS.'' See 17 CFR 242.1000.
\98\ In the SCI Adopting Release, the Commission acknowledged
that critical SCI systems may be subject to additional costs, but
stated that, ``by distinguishing critical systems, Regulation SCI is
consistent with a risk-based approach that targets areas that would
generate the most benefits.'' SCI Adopting Release at 72411.
---------------------------------------------------------------------------
Additionally, the Commission believes that some market participants
could potentially view the lack of these heightened protections for
Cboe Market Close as a potential risk that may factor into their
determination as to whether to send MOC orders to BZX or to the primary
listing exchanges. Commenters, including the listing exchanges,
emphasized the importance of the closing auctions to the operation of
the markets, and touted such closing auctions' reliability, integrity,
stability, and resiliency.\99\ As such, the Commission believes that
market participants may continue to favor the primary listing exchanges
for their MOC order executions, in part, because such critical SCI
systems are subject to the heightened protections of Regulation SCI,
such that their MOC orders are being handled on trading platforms that
are subject to the highest operational resumption standards and are
thus designed to be less susceptible to the potential risk of
operational outages, instability or other disruptions.
---------------------------------------------------------------------------
\99\ See, e.g., Nasdaq Letter 1 at 3 and Nasdaq Statement at 4-
5. Comment letters from listed issuers also referenced the
reliability, strength, and integrity of the closing auction
processes on the primary listing exchanges. See, e.g., NBT Bancorp
Letter, at 2.
---------------------------------------------------------------------------
[[Page 4734]]
In addition, the primary listing exchanges advanced several
theories as to how the proposal could undermine other types of
competition, such as intramarket competition, by diverting orders away
from the primary listing exchanges and thereby preventing such orders
from interacting and competing on a primary listing exchange. But this
result is not unique to Cboe Market Close. In particular, when one
exchange innovates, makes enhancements, or modifies exchange fees, it
may result in market participants sending more order flow to one
exchange and less volume to other exchanges, thereby potentially
decreasing intramarket competition among orders on a particular
exchange. Thus, enhancing competition between exchanges will, in many
cases, have an inverse effect on intramarket competition. The
Commission does not believe this to be an inappropriate burden on
competition in this case.
2. Differing Regulatory Standards
a. Comments on the Proposal
Several commenters referenced the Commission's order disapproving a
Nasdaq proposal to create a Benchmark Order (``Benchmark Disapproval
Order'') in arguing that BZX has not satisfied its obligation to
demonstrate that the proposal is consistent with the Act.\100\ Nasdaq
and NYSE characterized the Benchmark Disapproval Order as finding that
Nasdaq's proposal would give it an unfair advantage over competing
broker-dealers due to regulatory disparities, and the exchanges
asserted that similar regulatory disparities exist with BZX's proposal.
Specifically, NYSE and Nasdaq argued that the proposal creates a
disparate regulatory regime between the primary listing exchanges and
BZX because BZX would not be subject to the heightened standards
applicable to critical SCI systems under Regulation SCI, nor would BZX
be required to make or enforce rules for a closing auction.\101\ Nasdaq
further argued that the Benchmark Disapproval Order establishes that
``the Commission has been disinclined to approve proposed rule changes
in which the exchange cannot clearly articulate how a proposal to offer
a service is consistent with the policy goals of the Act with respect
to national securities exchanges,'' and BZX has not done so.\102\
---------------------------------------------------------------------------
\100\ See Securities Exchange Act Release No. 68629 (Jan. 11,
2013), 78 FR 3928 (Jan. 17, 2013) (NASDAQ-2012-059).
\101\ See NYSE Statement at 17-18; and Nasdaq Statement at 12.
See also supra notes 47-52 accompanying text (discussing the
regulatory costs of operating a closing auction, including those
related to Regulation SCI).
\102\ See Nasdaq Letter 1 at 5.
---------------------------------------------------------------------------
Similarly, SIFMA relied on the Benchmark Disapproval Order in
asserting that BZX is proposing to offer a function identical to that
currently offered by broker-dealers, yet would benefit from regulatory
immunity as well as the limits on liability contained in BZX Rule
11.16.\103\ SIFMA stated that, while it supports the proposal, it
believes that as a condition of approval, BZX and the Commission should
clarify in writing that Cboe Market Close would not be entitled to any
application of regulatory immunity and that the Exchange should amend
its Rule 11.16 to provide that Cboe Market Close would not be subject
to the monetary limits on the Exchange's liability.\104\
---------------------------------------------------------------------------
\103\ See Letter from Theodore R. Lazo, Managing Director and
Associate General Counsel, SIFMA (Dec. 8, 2017) (``SIFMA Letter 3'')
at 2-4.
\104\ See id. at 1.
---------------------------------------------------------------------------
With respect to regulatory immunity, SIFMA asserted that both
courts and the Commission have stated that regulatory immunity applies
only in situations where an exchange is exercising its regulatory
authority over its member, pursuant to the Act.\105\ SIFMA stated that
because Cboe Market Close would not be a self-regulatory function
whereby the exchange would be regulating its members, BZX should not be
entitled to apply regulatory immunity for any losses arising from the
functionality.\106\ In addition, SIFMA stated that BZX Rule 11.16
currently limits the liability exposure of the Exchange to its
members.\107\ SIFMA asserted that BZX's limits on liability set forth
in Rule 11.16 ``bear no relation to the actual amount of financial loss
that could result from an exchange malfunction.'' \108\ SIFMA argued
that the ``disparity is particularly acute'' with respect to the
proposal because broker-dealers currently perform services akin to Cboe
Market Close without a limitation on their liability.\109\ Accordingly,
SIFMA stated that, as a condition of operating Cboe Market Close, BZX
should carve it out from the liability limits of Rule 11.16.\110\
---------------------------------------------------------------------------
\105\ See id. at 2-3.
\106\ See id. at 3.
\107\ See BZX Rule 11.16.
\108\ See SIFMA Letter 3 at 4.
\109\ See id.
\110\ See id.
---------------------------------------------------------------------------
b. BZX Response to Comments
BZX argued that its proposal does not implicate the same issues as
the Benchmark Disapproval Order because the Commission's disapproval
rested primarily on its finding that it raised issues under the Market
Access Rule.\111\ BZX also stated that, unlike Nasdaq's proposal which
was designed to compete with the services offered by broker-dealers, it
is seeking to compete on price with the primary listing exchanges'
closing auctions.\112\
---------------------------------------------------------------------------
\111\ See id. at 11.
\112\ See BZX Letter 1 at 10.
---------------------------------------------------------------------------
BZX responded to SIFMA's comments on regulatory immunity and its
limitation on liability rule by stating that the concerns raised were
``not germane to whether the [p]roposal is consistent with the Act,''
and further stated that it believed it would be inappropriate in the
context of a filing on one proposed rule change to set a new standard
on an issue that has broad application to all exchange services as well
as National Market System Plans.\113\ BZX also asserted that SIFMA did
not provide any evidence to support its claim that its members have
been disadvantaged by the Exchange's limitation of liability rule as
compared to limitation on liability provisions in a broker-dealer's
contracts with its clients, which often disclaim all liability.\114\
---------------------------------------------------------------------------
\113\ See Letter from Joanne Moffic-Silver, Executive Vice
President, General Counsel, and Corporate Secretary, Cboe Global
Markets, Inc. (Jan. 3, 2018) (``BZX Letter 3'') at 5.
\114\ See id.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
The Commission does not believe that the differing regulatory
standards applicable to Cboe Market Close and the primary listing
exchanges' closing auctions create an unfair burden on competition.
This is because, as discussed above, the Commission believes that, Cboe
Market Close differs from the primary listing exchanges' closing
auctions in design, utility, and function. As also discussed above, the
fact that closing auction systems are subject to the heightened
requirements of Regulation SCI for critical SCI systems could encourage
market participants to send MOC orders to closing auctions on the
primary listing exchanges due to the additional regulatory protections
required of such systems.\115\
---------------------------------------------------------------------------
\115\ See supra notes 94-96 and accompanying text.
---------------------------------------------------------------------------
With regard to SIFMA's comments regarding competition with broker-
dealer services and the applicability of limitations on liability, the
Commission believes Cboe Market Close may compete with the off-exchange
matching services operated by broker-dealers.\116\ Broker-dealers and
national securities exchanges currently compete with respect to a
variety of functions and services that they offer to market
[[Page 4735]]
participants within the current national market system. The Commission
does not agree with commenters' characterizations that the Benchmark
Disapproval Order broadly prohibits such competition or that the
existence of different regulatory requirements applicable to exchanges
on the one hand, and broker-dealers on the other hand is per se
evidence of an unfair competitive advantage. The fact that a national
securities exchange proposes to offer functionality that is similar to
a service offered by a broker-dealer does not, in and of itself, render
such functionality an inappropriate burden on competition. Rather, the
proposal must be considered in the broader context of the existing
competitive landscape and different regulatory structures applicable to
exchanges and broker-dealers under the Act, respectively. In
particular, while it is true that BZX may benefit from the protections
of its limitations on liability provisions that may not be available to
broker-dealers, this must be considered along with the other regulatory
requirements imposed on BZX that are not applicable to broker-dealers,
such as obligations to enforce compliance by its members and persons
associated with its members with the Act, the rules and regulations
thereunder, and its own rules, as discussed below, among others.\117\
Therefore, with respect to BZX's proposal, the Commission believes
that, on balance and in light of the differing requirements under the
Act and the rules and regulations thereunder applicable to national
securities exchanges and broker-dealers, the limitations on liability
available to BZX do not impose an inappropriate burden on competition
and the proposal is consistent with Section 6(b)(8) of the Act.
---------------------------------------------------------------------------
\116\ See BZX Letter 2 at 11.
\117\ 15 U.S.C. 78s(g)(1). The Commission also notes that MOC
orders submitted to other exchanges' closing auctions would
similarly be subject to those exchanges' rules governing limitations
on liability.
---------------------------------------------------------------------------
With respect to the judicial doctrine of regulatory immunity, the
Commission has taken the position that immunity from suit ``is properly
afforded to the exchanges when engaged in their traditional self-
regulatory functions--where the exchanges act as regulators of their
members,'' including ``the core adjudicatory and prosecutorial
functions that have traditionally been accorded absolute immunity, as
well as other functions that materially relate to the exchanges'
regulation of their members,'' but should not ``extend to functions
performed by an exchange itself in the operation of its own market, or
to the sale of products and services arising out of those functions.''
\118\ The Court of Appeals for the Second Circuit recently reached a
similar conclusion.\119\ The Commission has also recognized that an
exchange's invocation of immunity from suit should be examined on a
```case-by-case basis,' with `the party asserting immunity bear[ing]
the burden of demonstrating [an] entitlement to it.' '' \120\ For
purposes of its consideration of BZX's proposal, the Commission notes,
as discussed in further detail below, that BZX represented that it
would continue to surveil for potentially manipulative activities and
BZX made commitments to enhance its surveillance procedures and work
with other SROs to detect and prevent manipulative activity through the
use of Cboe Market Close.\121\ However, whether and to what extent a
court would determine Cboe Market Close to fall within an exchange's
traditional regulatory functions depends on an assessment of the facts
and circumstances of the particular allegations before it and is beyond
the scope of the Commission's consideration of the proposed rule change
pursuant to the Act.
---------------------------------------------------------------------------
\118\ Brief of the Securities and Exchange Commission, Amicus
Curiae, No. 15-3057, City of Providence v. Bats Global Markets, Inc.
(2d Cir.) (``City of Providence Amicus Br.''), at 22.
\119\ City of Providence v. Bats Global Markets, Inc., 878 F.3d
36 (2d Cir. 2017) (``When an exchange engages in conduct to operate
its own market that is distinct from its oversight role, it is
acting as a regulated entity--not a regulator. Although the latter
warrants immunity, the former does not.'').
\120\ City of Providence Amicus Br. at 21 (quoting In re NYSE
Specialists Secs. Litig., 503 F.3d 89, 96 (2d Cir. 2007)).
\121\ See infra Section III.E.3.c.
---------------------------------------------------------------------------
B. Price Discovery and Fragmentation
Many commenters addressed the potential effects of the proposal on
price discovery in the closing auctions on the primary listing
exchanges, including the effect of additional fragmentation of MOC
interest among multiple execution venues.
1. Effect of MOC Orders on Price Discovery
a. Comments on the Proposal
Some commenters stated that the proposal would harm price discovery
in the closing auctions on the primary listing exchanges.\122\ For
example, Nasdaq argued that BZX's MOC orders would be incapable of
contributing to price discovery, and instead would draw orders and
quotations away from primary closing auctions and undermine the
mechanisms used to set closing prices.\123\ Nasdaq asserted that any
attempt to divert trading interest from its closing auction would be
detrimental to investors as it would inhibit Nasdaq's closing auction
from functioning as intended and would negatively affect the price
discovery process and, consequently, the quality of the official
closing price.\124\ Nasdaq argued that Cboe Market Close would deprive
it of critical information about the supply and demand of Nasdaq-listed
securities, and that both the information Nasdaq disseminated about its
closing auction and the price-discovery function of the auction would
be impaired.\125\ Nasdaq stated that even though BZX would disseminate
the amount of paired-off shares at 3:35 p.m., Nasdaq would have no way
to confirm that the information that BZX would disseminate regarding
the amount of matched volume in Cboe Market Close is accurate or ensure
that the information is timely disclosed.\126\
---------------------------------------------------------------------------
\122\ See, e.g., Letters from: John M. Bowers, Bowers Securities
(June 14, 2017) (``Bowers Letter''); Andrew Stevens, General
Counsel, IMC Financial Markets (June 30, 2017) (``IMC Letter'');
Cameron Bready, Senior Executive VP, Chief Financial Officer, Global
Payments Inc. (Aug. 17, 2017) (``Global Payments Letter''); Mike
Gregoire, CEO, CA Technologies (Aug. 17, 2017) (``CA Technologies
Letter''); Nasdaq Letter 2; NYSE Letter 3; Nasdaq Letter 1; NYSE
Letter 1; GTS Letter 2; T. Rowe Price Letter; NBT Bancorp Letter;
Sirius Letter; PayPal Letter; NYSE Letter 2; NYSE Statement; and
Nasdaq Statement. See also Letter from Representative Sean P. Duffy
and Representative Gregory W. Meeks (Aug. 9, 2017) (``Duffy/Meeks
Letter''), at 1 (stating that public companies are expressing
concern that the proposal will further fragment the market and cause
harm to the pricing of their companies' shares at the close and, as
such, they are concerned the proposal may disrupt the process for
determining the closing price on the primary listing exchange, which
is viewed as ``an incredibly well-functioning part of the capital
markets.''). In addition, one commenter urged the Commission to
conduct a close analysis of the proposal and stated that if the BZX
proposal would seriously degrade the quality of the closing price,
then it should be rejected. See Angel Letter.
\123\ See Nasdaq Letter 1 at 5 and 8 (stating that, for this
reason Nasdaq did not believe the proposal promotes fair and orderly
markets in accordance with Sections 6 and 11A of the Act); and
Nasdaq Letter 2 at 3-7.
\124\ See Nasdaq Letter 1 at 11; and Nasdaq Letter 2 at 5-6. See
also Nasdaq Statement at 22. Nasdaq also stated that while BZX does
not have a responsibility to contribute to price discovery in
Nasdaq's closing auction, it also is obligated to avoid
affirmatively undermining price discovery. See Nasdaq Letter 1 at 5.
In addition, Nasdaq stated that it considered, but chose not to,
disclose segmented information, such as matched MOC or limit-on-
close (``LOC'') shares, for its closing auction in a piecemeal
fashion, because Nasdaq believed it would lead to unintended
consequences and undermine price discovery in the closing auction.
See id. at 4; and Nasdaq Letter 2 at 6.
\125\ See Nasdaq Statement at 22.
\126\ See id. at 23.
---------------------------------------------------------------------------
Nasdaq also expressed concern that the availability of Cboe Market
Close could affect the behavior of limit orders,
[[Page 4736]]
which Nasdaq asserted would harm price discovery at the market
close.\127\ In Nasdaq's view, reducing MOC orders in the closing
auction could affect the behavior of limit orders by reducing the
ability of both continuous book limit orders \128\ and LOC orders to
compete with each other and to interact with MOC orders, which it
asserted is essential to its closing auction.\129\ Specifically, Nasdaq
contended that if BZX were to disseminate at 3:35 p.m. that a certain
amount of shares were paired-off for execution in Cboe Market Close,
but Nasdaq subsequently published little or no paired-off or imbalance
shares in its imbalance publications,\130\ further participation in the
intraday trading session leading up to the closing auction and in the
closing auction could be discouraged, and thus there would be little
ongoing price discovery, because market participants would know they
would not have the ability to interact with market orders.\131\ Nasdaq
contrasted the BZX proposal with its own closing auction process,
arguing that after Nasdaq disseminates an imbalance notification that
combines MOC and LOC orders, market participants can continue to submit
orders to interact with existing auction interest.\132\ In addition,
Nasdaq submitted the Pitt/Spatt Report, which asserted that the
proposal would detrimentally affect Nasdaq closing auctions by
preventing MOC orders from engaging with price-sensitive orders (LOC
orders or imbalance-only orders) and by altering the behavior of market
participants whose MOC orders went unfilled on BZX.\133\
---------------------------------------------------------------------------
\127\ See Nasdaq Letter 1 at 5 and 11; and Nasdaq Statement at
25-26 (citing Pitt/Spatt Report at 18).
\128\ A continuous book limit order is a limit order that is
eligible for execution during the regular intraday trading session
or in the closing auction. See supra note 2.
\129\ See Nasdaq Letter 2 at 5-6. Nasdaq did not submit any
specific data regarding the effect of the proposal on the use of LOC
orders.
\130\ Nasdaq publishes an ``Order Imbalance Indicator'' which
includes, among other things, the price at which the maximum number
of shares of orders eligible for participation in its closing
auction could execute as well as the size of any imbalance. See
Nasdaq Rule 4754(a)(7).
\131\ See Nasdaq Letter 2 at 6.
\132\ See id.
\133\ See Pitt/Spatt Report at 15-19.
---------------------------------------------------------------------------
Moreover, Nasdaq argued that even if the proposal only resulted in
fewer MOC orders submitted to Nasdaq closing auctions, investors would
be harmed because the official closing price could potentially
represent a stale or undermined price.\134\ Nasdaq asserted that its
closing auction is designed to maximize the number of shares that can
be executed at a single price and that the number of MOC orders affects
the number of shares able to execute in a closing auction.\135\ Nasdaq
added that because Cboe Market Close would undermine closing auction
price discovery, Cboe Market Close would also inhibit efficient capital
allocation and thereby impair capital formation.\136\
---------------------------------------------------------------------------
\134\ See Nasdaq Letter 1 at 12. See also Nasdaq Letter 2 at 6
(providing an example of how Nasdaq believes the proposal could
cause a stale closing price). Nasdaq also stated that a credible
independent study of the potential risk to price discovery is
essential in order to consider whether the proposal is consistent
with the Act. See Nasdaq Letter 1 at 12.
\135\ See id. at 11. Nasdaq submitted a memorandum providing,
among other things, data relating to the level of matched MOC volume
in Nasdaq closing auctions spanning the period of January 1, 2017
through September 30, 2017 (``Nasdaq Data Memo'').
\136\ See Nasdaq Statement at 37.
---------------------------------------------------------------------------
Nasdaq also argued that the proposal would harm price discovery
because fragmentation of MOC orders would directly affect closing
auctions for which Nasdaq only received MOC orders. Nasdaq contended
that, if all those MOC orders were removed from the Nasdaq closing
auction, the last sale price would become the official closing price,
as opposed to the price being determined through the price discovery
process of its closing auction.\137\ Nasdaq discussed several
hypothetical examples where removal of all MOC orders from certain of
its previously conducted closing auctions would have resulted in use of
the last sale price as the official closing price and provided
aggregated statistics denoting the differential between the last sale
price and the official closing price in such situations.\138\ The
examples provided assume that the BZX proposal would result in no
market participants choosing to send any MOC orders to the primary
listing exchanges' closing auctions. Nasdaq asserted this would be the
case because market participants would choose to submit their MOC
orders to the lower cost execution venue.\139\ Further, both Nasdaq and
NYSE explained that if the fees set by BZX for Cboe Market Close were
lower than the primary listing exchanges and there was no competitive
response by the primary listing exchanges, a likely outcome would be
that market participants would choose to submit their MOC orders to
BZX.\140\
---------------------------------------------------------------------------
\137\ See Nasdaq Letter 2 at 3; and Nasdaq Statement at 23-24.
\138\ See Nasdaq Letter 2 at 3-5; and Nasdaq Statement at 23.
Specifically, Nasdaq identified 1,653 closing crosses between
January 1, 2016, and August 31, 2017, where removal of all MOC
orders would have changed the closing prices. Nasdaq asserts that
this would have changed the closing valuation of Nasdaq issuers ``by
nearly $870,000,000 of aggregate impact.''
\139\ See Nasdaq Statement at 25. While NYSE asserted that one
``plausible outcome'' of the BZX proposal is that the majority of
MOC orders would migrate to Cboe Market Close, it acknowledged that
it was ``hard to predict what would happen if the [BZX] proposal
were to be approved.'' See Assessment of the DERA Analysis conducted
by D. Timothy McCormick, Ph.D. (Jan. 11, 2018) (``NYSE Report''), at
22.
\140\ Id. See also Nasdaq Statement at 24.
---------------------------------------------------------------------------
The Pitt/Spatt Report submitted by Nasdaq states that, according to
formal auction theory, the auction price and bidding behaviors of
auction participants are determined by the rules of the auction.\141\
The Pitt/Spatt Report asserts that the price and bidding behaviors in
the closing auction on the primary listing exchange (such as the Nasdaq
closing auction) will change if a competing earlier auction (such as
the Cboe Market Close) is introduced, even though the rules in the
closing auction on the primary listing exchange are unchanged.
According to the Pitt/Spatt Report, one way in which bidding behavior
is affected is that traders with MOC orders may reallocate those orders
to the Cboe Market Close to obtain an earlier matching resolution at
3:35 p.m. while still retaining the ability to participate in the
Nasdaq closing auction. According to the report, this change in bidding
behavior would then affect the closing price on the listing exchange
for two reasons. First, the ``proposed [Cboe] Market Close would
prevent the direct interaction of the siphoned-off orders with price
sensitive orders, which are at the heart of true `price discovery,' and
necessarily would influence the determination of the closing price.''
\142\ Second, participants in the Cboe Market Close, ``[a]rmed with
information about the extent to which the matching efforts were
successful (or unsuccessful), . . . would potentially alter the
aggressiveness with which they would engage in the Nasdaq Market Close
after the conclusion of the [Cboe] Market Close at 3:35 p.m.'' \143\
---------------------------------------------------------------------------
\141\ See Pitt/Spatt Report at 15.
\142\ See id. at 17-18.
\143\ See id. at 17.
---------------------------------------------------------------------------
NYSE argued that even though Cboe Market Close would only accept
MOC orders, it could materially affect official closing prices
determined through a NYSE closing auction.\144\ NYSE emphasized the
importance of the centralization of orders during the closing auction
on the primary listing exchange.\145\ NYSE, as well as Nasdaq, also
asserted that the proposal contradicts the Commission's approval of
amendments to the National Market
[[Page 4737]]
System Plan to Address Extraordinary Market Volatility (the ``LULD
Plan'') which, they argue, centralized re-opening auction liquidity at
the primary listing exchange by prohibiting other market centers from
re-opening following a trading pause until the primary listing exchange
conducts a re-opening auction.\146\ These commenters asserted that it
would be inconsistent for the Commission to find it in the public
interest to consolidate trading in a re-opening auction, while
sanctioning fragmentation of trading in a closing auction.\147\
---------------------------------------------------------------------------
\144\ See NYSE Letter 1 at 3; and NYSE Statement at 23.
\145\ See NYSE Statement at 21. See also NYSE Report at 12; and
NYSE Letter 1 at 4.
\146\ See Nasdaq Letter 1 at 6; NYSE Letter 1 at 3; and Nasdaq
Letter 2 at 12.
\147\ See Nasdaq Letter 1 at 6; NYSE Letter 1 at 3; and Nasdaq
Letter 2 at 12.
---------------------------------------------------------------------------
NYSE stated that producing a reliable and accurate closing price
for a security requires transparency into the ``full information''
about the volume of buy and sell orders and the extent of any
imbalances.\148\ NYSE also stated that the closing auction is ``an
iterative process'' that provides ``periodic information about order
imbalances, indicative price, matched volume, and other metrics'' to
help market participants anticipate the likely closing price, and that
allows for investors to find contra-side liquidity and assess whether
to offset imbalances, and for orders to be priced based on the true
supply and demand in the market.\149\ NYSE added that market
participants rely on information disseminated by the primary listing
exchanges to make trading decisions in the continuous market before the
closing auction as well as to determine the price, size, and type of
on-close orders they choose to enter, all of which ``ultimately
determine the closing price.'' \150\ NYSE stated that not disclosing to
market participants the balance of unmatched MOC volume submitted to
Cboe Market Close would deprive closing auction market participants of
``core data necessary'' to the auction's normal functioning.\151\
---------------------------------------------------------------------------
\148\ See NYSE Statement at 21.
\149\ See NYSE Report at 12. See also NYSE Letter 1 at 4.
\150\ See NYSE Statement at 21-22.
\151\ See id. at 22.
---------------------------------------------------------------------------
NYSE also asserted that information to be disseminated by BZX on
the amount of matched MOC volume could discourage liquidity providers
from participating in the closing process because they would surmise
that their orders would be less likely to interact with market orders
in the closing auction.\152\ NYSE also argued that its DMMs would lose
full visibility into the size and composition of MOC interest, and thus
would likely have to make more risk-adverse closing decisions,
resulting in inferior price formation.\153\ Other commenters asserted
that the proposal would make it more difficult for DMMs to facilitate
an orderly close of NYSE listed securities as they would lose the
ability to continually assess the composition of MOC interest.\154\
Many of these commenters, all of whom are issuers listed on NYSE,
asserted that one of the reasons they chose to list on NYSE was the
ability to have access to a DMM that is responsible for facilitating an
orderly closing auction.\155\
---------------------------------------------------------------------------
\152\ See NYSE Report at 13 and 23; and NYSE Statement at 23.
See also NYSE Report at 12 (arguing that ``[a]nticipation that there
will be MOC orders in the closing auction is a critical component
feeding into the decisions of liquidity providers and other market
participants'' trading in the closing auction).
\153\ See NYSE Letter 1 at 4. See also NYSE Statement at 22.
GTS, a DMM on NYSE, argued that MOC orders are a vital component of
closing prices and that the types of orders submitted to the closing
auction, such as limit or market, also affect its pricing
determinations. See GTS Securities Letter 1 at 2-3; and GTS
Securities Letter 2 at 3. In response to this assertion, ViableMkts
argues that use of Cboe Market Close is voluntary. Accordingly, if a
market participant wanted a DMM to be aware of their closing
activity they could still send their orders to the NYSE closing
auction. See ViableMkts Letter at 4.
\154\ See, e.g., GTS Securities Letter 1 at 2-3; Letter from Jay
S. Sidhu, Chairman, Chief Executive Officer, Customers Bancorp, Inc.
(June 27, 2017) (``Customers Bancorp Letter''); Letter from Joanne
Freiberger, Vice President, Treasurer, Masonite International
Corporation (June 27, 2017) (``Masonite International Letter''); IMC
Letter at 1-2; and Letter from Daniel S. Tucker, Senior Vice
President and Treasurer, Southern Company (July 5, 2017) (``Southern
Company Letter''). Several commenters also asserted that the
proposal would have potentially detrimental effects on NYSE floor
brokers. See Bowers Letter; Letter from Jonathan D. Corpina, Senior
Managing Partner, Meridian Equity Partners (June 16, 2017); Letter
from Fady Tanios, Chief Executive Officer, and Brian Fraioli, Chief
Compliance Officer, Americas Executions, LLC (June 16, 2017)
(``Americas Executions Letter''); and GTS Securities Letter 2 at 4.
\155\ See, e.g., Masonite International Letter; Letter from
Sherri Brillon, Executive Vice-President and Chief Financial
Officer, Encana Corporation (June 29, 2017); Letter from Steven C.
Lilly, Chief Financial Officer, Triangle Capital Corporation (June
29, 2017); and Letter from Robert F. McCadden, Executive Vice
President and Chief Financial Officer, Pennsylvania Real Estate
Investment Trust (June 29, 2017).
---------------------------------------------------------------------------
NYSE also argued that the proposal would detrimentally affect price
discovery on the NYSE Arca and NYSE American automated closing
auctions. NYSE stated that in the six months prior to June 2017 there
were 130 instances where the official closing price determined through
a NYSE Arca closing auction was based entirely on paired-off market
order volume.\156\ In those instances, pursuant to NYSE Arca rules,
``the Official Closing Price for that auction is the midpoint of the
Auction NBBO as of the time the auction is conducted.'' \157\ NYSE
stated that if all market orders for a NYSE Arca listed security were
sent to BZX, the official closing price would instead be the
consolidated last sale price, which can differ from the midpoint of the
Auction NBBO by as much as 3.2%.\158\
---------------------------------------------------------------------------
\156\ See NYSE Letter 1 at 5. See also NYSE Report at 11-12.
\157\ See NYSE Letter 1 at 5. NYSE Arca Rule 7.35-E(a)(5)
defines ``Auction NBBO'' to mean ``an NBBO [National Best Bid and
Offer] that is used for purposes of pricing an auction. An NBBO is
an Auction NBBO when (i) there is an NBB [National Best Bid] above
zero and NBO [National Best Offer] for the security and (ii) the
NBBO is not crossed.''
\158\ See NYSE Letter 1 at 5.
---------------------------------------------------------------------------
Multiple commenters stated that one of the benefits of a
centralized closing auction conducted by the primary listing exchange
is that it allows market participants to fairly assess supply and
demand such that the closing prices reflect both market sentiment and
total market participation.\159\ Because they believed that the
proposal may cause orders to be diverted away from the primary listing
exchanges, these commenters argued that it would negatively affect the
reliability and value of closing auction prices. Several commenters
further argued that centralized closing auctions provide better
opportunities to fill large orders with relatively little price
impact.\160\
---------------------------------------------------------------------------
\159\ See Bowers Letter; Americas Executions Letter; Letter from
Mickey Foster, Vice President, Investor Relations, FedEx Corporation
(July 14, 2017); and Nasdaq Statement at 21. See also, e.g., Letter
from Rob Bernshteyn, Chief Executive Officer, Chairman of the Board
of Directors, Coupa Software, Inc. (July 12, 2017) (``Coupa Software
Letter''); Letter from Jeff Green, Founder, Chief Executive Officer
and Chairman of the Board of Directors, The Trade Desk Inc. (July
26, 2017) (``Trade Desk Letter''); and Global Payments Letter.
\160\ See, e.g., Bowers Letter; Customers Bancorp Letter; and
Letter from David B. Griffith, Investor Relations Manager, Orion
Group Holdings, Inc. (June 27, 2017) (``Orion Group Letter'').
---------------------------------------------------------------------------
In contrast, several commenters stated that the proposal would not
negatively affect price discovery in the primary listing exchanges'
closing auctions because Cboe Market Close would only execute MOC
orders that can be paired-off against other MOC orders, and not orders
that directly affect price discovery, such as limit orders, including
LOC orders.\161\ Some of these commenters also argued that, because BZX
will publish the size of matched MOC orders in advance of the primary
listing exchange's cut-off time, market participants would have
available information needed to make further decisions regarding order
execution,
[[Page 4738]]
and thus price discovery would not be impaired.\162\
---------------------------------------------------------------------------
\161\ See PDQ Letter; Clearpool Letter at 3; Virtu Letter at 2;
SIFMA Letter 1 at 2; IEX Letter at 1-2; Angel Letter at 4;
ViableMkts Letter at 3-4; and Bollerman Letter at 1. See also SIFMA
Letter 2 at 1-2.
\162\ See Clearpool Letter at 3; SIFMA Letter 1 at 2; IEX Letter
at 2; Angel Letter at 4; ViableMkts Letter at 3; and SIFMA Letter 2
at 1.
---------------------------------------------------------------------------
b. BZX Response to Comments
In response to concerns regarding the effect of the proposal on the
price discovery process, BZX argued that it expects the Cboe Market
Close would have no effect on price discovery because the proposal
would only match MOC orders and would require the Exchange to publish
the number of matched shares in advance of the primary listing
exchanges' cut-off times on a data feed that is available free of
charge.\163\ BZX also stated that it does not believe the proposal
would affect the use of LOC orders on the primary listing exchanges as
LOC orders provide price protection, by restricting the price at which
the order can execute to a price that is the same or better than the
LOC order's limit price. BZX stated that it does not believe that the
lower fees charged to MOC orders that participate in Cboe Market Close
would outweigh the risk of receiving an execution at an unfavorable
price.\164\ BZX further challenged commenters' concerns that Cboe
Market Close could pull all MOC orders away from the primary listing
exchanges and alter the calculation of the closing price, stating that
such a scenario could occur today as a result of competing closing
auctions and broker-dealers that offer internal MOC order matching
solutions.\165\
---------------------------------------------------------------------------
\163\ See BZX Letter 1 at 3-4; BZX Letter 2 at 2 and 10; and BZX
Statement at 9-10. In addition, BZX offered to disseminate this
information via the applicable securities information processor, in
addition to the Cboe Auction Feed. See BZX Letter 1 at 4 and 12-13;
and BZX Letter 2 at 2.
\164\ See BZX Letter 2 at 3.
\165\ See BZX Letter 1 at 4-5 (stating that neither NYSE nor
Nasdaq prohibits their members from withholding MOC orders from
their closing auctions); and BZX Letter 2 at 2-3.
---------------------------------------------------------------------------
In response to NYSE and Nasdaq comments regarding the consistency
of the Cboe Market Close with Amendment 12 of the LULD Plan, BZX
asserted that while the amendment to the LULD Plan cited by NYSE and
Nasdaq granted the primary listing exchange the ability to set the re-
opening price, the amendment did not mandate the consolidation of
orders at the primary listing exchange following a trading halt.\166\
BZX believes the proposal is consistent with the LULD Plan as it seeks
to avoid producing a ``bad'' or ``outlier'' closing price and does not
affect the centralization of price-setting closing auction orders.\167\
---------------------------------------------------------------------------
\166\ See BZX Letter 1 at 8-9. See also Bollerman Letter at 3.
\167\ See BZX Letter 1 at 8-9.
---------------------------------------------------------------------------
In response to NYSE's arguments regarding the effect on a DMM's
ability to price the close, BZX argued that this point highlights what
it believes to be an additional benefit of allowing it to compete with
NYSE's closing auction.\168\ Specifically, BZX argued that NYSE's
assertion that DMMs consider the composition of closing interest in
making pricing decisions ``suggests that the NYSE closing auction is
not a true auction and can be an immediate detriment to users sending
MOC orders of meaningful size to the NYSE.'' \169\ Accordingly, BZX
stated that it believed Cboe Market Close would offer a beneficial
alternative pool of liquidity and execution mechanism for large MOC
order senders.\170\
---------------------------------------------------------------------------
\168\ See BZX Letter 1 at 10.
\169\ Id. See also supra note 153 and accompanying text.
\170\ BZX Letter 1 at 10. In response, NYSE argued that BZX's
claims regarding the role of the DMM were not germane to whether the
proposal is consistent with the Act and stated that it believed the
scale of its closing auction and the low levels of volatility
observed in the auction demonstrate its effectiveness. See NYSE
Letter 2 at 4.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
The Commission has carefully analyzed and considered the proposal's
potential effects, if any, on the primary listing exchanges' closing
auctions, including their price discovery functions, and the
reliability and integrity of closing prices. The Commission finds that
BZX has demonstrated that based on the design of the proposal, Cboe
Market Close should not disrupt the price discovery process in the
closing auctions of the primary listing exchanges.\171\
---------------------------------------------------------------------------
\171\ For these reasons, the Commission also believes the
proposal will not impair capital formation. See supra note 136.
---------------------------------------------------------------------------
Importantly, Cboe Market Close will only accept, match, and execute
unpriced MOC orders with other unpriced MOC orders (i.e., paired-off
MOC orders). Contrary to some commenters' assertions that MOC orders
contribute to the determination of the official closing price, the
Commission believes that paired-off MOC orders, which do not specify a
price but instead seek to be executed at whatever closing price is
established via the primary listing exchange's closing auction, do not
directly contribute to setting the official closing price of securities
on the primary listing exchanges but, rather, are inherently the
recipients of price formation information.\172\ As many commenters
stated, the price determined in a closing auction is designed to be a
reflection of market supply and demand, and closing auctions are
designed to set closing prices that maximize the number of shares
executed and minimize the amount of the imbalance between buy and sell
interest (i.e., demand and supply). The orders that actively
participate in, and contribute to, the price formation process in a
closing auction would be orders that specify a desired execution price
such as LOC orders, imbalance-only orders, and other limit (priced)
orders that may participate in the closing auction. In addition,
unpaired MOC orders may contribute to price formation because they
suggest an imbalance of supply or demand. Thus, none of the orders that
could influence the formation of the official closing price in a
closing auction would be executed in the Cboe Market Close and could
continue to be submitted to the primary listing exchange.
---------------------------------------------------------------------------
\172\ See supra notes 134-153 (discussing Nasdaq's and NYSE's
arguments of how MOCs can contribute to the closing price).
---------------------------------------------------------------------------
The orders identified above affect the determination of an official
closing price because they directly affect the total number of shares
that are executed in an auction. More specifically, a limit order or
LOC order would only execute in a closing auction if the official
closing price is at or better than that order's limit price. In
addition, in a closing auction, the imbalance amount of MOC orders
(i.e., unpaired MOC orders) would only execute if there was limit order
trading interest (e.g., LOC orders or imbalance-only orders) on the
opposite side of the unpaired MOC orders that was eligible to execute
in the closing auction.\173\ In contrast, as BZX and commenters
stated,\174\ executing paired-off MOC orders in the manner BZX proposes
would not affect the net imbalance of closing eligible trading interest
because only paired-off MOC orders, and not the orders identified above
that actively participate in, and contribute to, the closing auction
price formation process, would be executed in Cboe Market Close.
Accordingly, the proposal should not disrupt the price discovery
process and closing auction price formation.
---------------------------------------------------------------------------
\173\ In other words, if there was a buy MOC order that could
not be executed against a sell MOC order, the buy MOC order would
only execute in the closing auction if there was a sell limit order
that was able to execute in the closing auction. See, e.g.,
ViableMkts Letter at 3-4 (providing examples that illustrate how
executing paired-off MOC orders in the primary listing exchange's
closing auction or on a different venue does not ultimately impact
the price discovery process in the closing auction because only MOC
orders that cannot be paired-off with other MOC orders are eligible
to execute against limit orders in a closing auction).
\174\ See, e.g., Notice at 23321; ViableMkts Letter at 3-4; and
Virtu Letter at 2.
---------------------------------------------------------------------------
[[Page 4739]]
Several commenters made assertions that matched MOC order flow
provides informational content regarding the depth of the market that
indicates true supply and demand and contributes to market
participants' decisions regarding order submission and ultimately price
formation.\175\ But BZX proposes to publish and disseminate the size of
matched MOC orders at 3:35 p.m., which is well in advance of the order
entry cut-off times for the primary listing exchanges' closing
auctions.\176\ Market participants seeking to ascertain closing auction
liquidity supply and demand could incorporate that information with any
pertinent information disseminated by the primary listing exchanges.
Therefore, the Commission believes that the information disseminated by
BZX could be used by market participants in conjunction with the
information disseminated by the primary listing exchange to make order
submission decisions.
---------------------------------------------------------------------------
\175\ See supra notes 149-153 and 159 and accompanying text.
\176\ See supra note 23.
---------------------------------------------------------------------------
And the Commission disagrees with NYSE that, in order for the
Commission to approve the proposed rule change, BZX should also
disclose the balance of unpaired shares that were submitted to Cboe
Market Close.\177\ NYSE stated that market participants use the
imbalance information published by the primary listing exchanges--which
includes information on available, actionable liquidity--to make order
submission decisions. However, unpaired shares on Cboe Market Close
would represent only a subset of cancelled buying and selling interest
that is no longer actionable and therefore, in the absence of any data
or further justification to the contrary, the Commission does not
believe that publishing this information would have a meaningful effect
on the closing auction price formation process.
---------------------------------------------------------------------------
\177\ NYSE did not explain why it believed that MOC imbalances
in Cboe Market Close would be important information.
---------------------------------------------------------------------------
Furthermore, the Commission does not find Nasdaq's concern
regarding its inability to confirm the accuracy of information
disseminated by BZX compelling. A fundamental aspect of the national
market system is reliance by national securities exchanges on
information disseminated by another exchange, supplemented by
Commission oversight of such legally enforceable obligations. Indeed,
all national securities exchanges, including Nasdaq, regularly rely on
information disseminated by other national securities exchanges in
other contexts, such as for the handling, routing, and execution of
orders.\178\
---------------------------------------------------------------------------
\178\ See, e.g., Nasdaq Rule 4759 (which states that Nasdaq
consumes quotation data from proprietary exchange data feeds for the
handling, routing, and execution of orders, as well as for
regulatory compliance processes related to those functions).
---------------------------------------------------------------------------
The Pitt/Spatt Report argues that, according to formal auction
theory, bidding behaviors and closing price outcomes will be affected
by the introduction of the Cboe Market Close. But, even if some market
participants choose to send their MOC orders to the Cboe Market Close,
the Commission believes that closing price efficiency is unlikely to be
affected.\179\ The official closing price established through the
closing auction on the primary listing exchange is ultimately
determined by the intersection of supply and demand, and the price does
not change if an equal number of shares from MOC buy orders and MOC
sell orders are executed away from the auction. If an unequal number of
shares from MOC buy orders and MOC sell orders are sent to Cboe Market
Close, then the shares that were not paired-off in Cboe Market Close
are likely to be resubmitted back to the closing auction on the primary
listing exchange. This is because the traders who would send MOC orders
to Cboe Market Close instead of the closing auction on the primary
listing exchange have a revealed preference for obtaining the closing
price for such orders. If the trader fails to be paired-off on Cboe
Market Close, then resubmitting their order to the closing auction on
the primary listing exchange remains their primary option for obtaining
the closing price.
---------------------------------------------------------------------------
\179\ Price efficiency is a measure of the quality of the
closing price that is designed to assess whether the closing price
reflects all relevant information.
---------------------------------------------------------------------------
It is possible that the unpaired shares from Cboe Market Close
could be sent to a broker-dealer who offers off-exchange executions at
the closing price. However, as a general matter, data show that most
traders do not execute orders at the official closing price by trading
off-exchange with broker-dealers.\180\ That is, the data indicate that
most traders have a revealed preference for trading in the official
closing auction on the primary listing exchange over trading off-
exchange with a broker-dealer at the official closing price. Thus, the
Commission believes that the addition of the Cboe Market Close would
not change this preference for trading in the official closing auction
on the primary listing exchange over trading off-exchange with a
broker-dealer, even if the trader ultimately chooses to trade in Cboe
Market Close over both of these options. Finally, although it is
possible that the trader who fails to execute in the Cboe Market Close
could submit their order to the regular intraday trading session
between 3:35 p.m. and 4:00 p.m., the Commission views this possibility
as unlikely because, by virtue of sending a MOC order to Cboe Market
Close, the trader has a revealed preference in executing at the
official closing price, which is not guaranteed in the regular intraday
trading session. Thus, the unpaired shares from the Cboe Market Close
are likely to be resubmitted back to the official closing auction, and
the Commission therefore believes that the closing price on the primary
listing exchange is likely to remain unaffected by the Cboe Market
Close.
---------------------------------------------------------------------------
\180\ See infra note 194 and accompanying text.
---------------------------------------------------------------------------
Some commenters also argued that the proposal would affect the
submission of LOC orders to the primary listing exchanges. But as BZX
stated, LOC orders by their terms specify a price and therefore provide
price protection. Thus, utilization of a LOC order suggests that a
market participant is price sensitive and uniquely interested in
obtaining an execution at, or better than, its specified price. By
contrast, MOC orders do not specify a price and are submitted by market
participants who may be less price sensitive and who may prioritize
other aspects of a closing execution over price.\181\ In addition, the
cut-off times for submitting LOC orders to the primary listing
exchanges are later in the trading day than the Cboe Market Close cut-
off time. As such, the Commission does not believe that, solely on the
basis of lower fees, it is likely that market participants would be
more inclined to assume the risk of submitting MOC orders to the Cboe
Market Close at or before 3:35 p.m. in circumstances where they
otherwise would have submitted price-protected LOC orders into the
primary listing exchanges' closing auctions later in the day.
---------------------------------------------------------------------------
\181\ See also BZX Letter 2 at 3.
---------------------------------------------------------------------------
As discussed above, Nasdaq and NYSE also asserted that the Cboe
Market Close could discourage submission of orders in the intraday
trading session and closing auctions in certain circumstances, such as
if there were a large amount of paired-off MOC orders in Cboe Market
Close and a subsequent lack of imbalance information disseminated on
the primary listing exchanges.\182\ However, the Commission does not
believe the availability of the Cboe Market Close would increase this
[[Page 4740]]
risk beyond what currently exists. Again, Cboe Market Close would only
execute paired-off MOC orders and therefore would not affect the net
imbalance of MOC orders. And the Commission believes that the
submission of orders could similarly be discouraged today if a large
amount of MOC orders in a security had been paired-off on the primary
listing exchange and there was little or no resulting imbalance
disseminated by such exchange in their order imbalance indications.
Irrespective of the exchange upon which the MOC orders are paired-off,
the net imbalance published by the primary listing exchange would be
expected to be the same. Moreover, because Cboe Market Close would
publish the volume of paired-off MOC orders 15 minutes prior to the
current NYSE MOC order entry cut-off time and 20 minutes prior to the
current Nasdaq MOC order entry cut-off, market participants should have
sufficient time to incorporate information relating to the levels of
MOC interest paired-off in the Cboe Market Close in a given security
into their decisions about order submissions into the closing auctions.
---------------------------------------------------------------------------
\182\ See supra notes 129-131 and 152 and accompanying text.
---------------------------------------------------------------------------
The Commission also disagrees with commenters that asserted that
the proposal would inhibit DMMs' ability to establish closing prices
because they would no longer have full visibility into the size and
composition of MOC interest.\183\ First, DMMs currently do not have
full visibility into the composition of MOC interest, because they
currently have no visibility into MOC interest traded on off-exchange
venues. Thus, the proposal would not alter the information DMMs have
relating to MOC interest executed off-exchange. Second, as already
discussed above, the Commission believes that market participants,
including DMMs, will have access, via the Cboe Auction Feed, to the
amount of paired-off MOC volume on BZX well in advance of NYSE's order
entry cut-off time and the start of the NYSE closing auction. A NYSE
DMM could, for example, use the Cboe Market Close disseminated
information regarding paired-off MOC interest for a given security in
conjunction with information disseminated by the primary listing
exchange in establishing the relevant context for any imbalances in
NYSE closing auctions and calculating appropriate closing prices.\184\
Moreover, the Commission believes that, as BZX stated, the Cboe Market
Close could benefit market participants that do not wish to disclose
information regarding their orders to DMMs by providing another venue
to which they may send their orders for execution at the closing
price.\185\
---------------------------------------------------------------------------
\183\ See supra note 153 and accompanying text.
\184\ In addition, one commenter that is supportive of the
proposal is a DMM on NYSE who stated that the proposal ensures that
the price discovery process remains intact because BZX would only
match buy and sell MOC orders and not limit orders, which it stated,
ultimately lead to price formation. See Virtu Letter at 2.
\185\ See supra notes 168-170 and accompanying text.
---------------------------------------------------------------------------
Nor does the Commission agree with those commenters that argued
that the proposal contradicts the Commission's approval of Amendment 12
to the LULD Plan.\186\ As stated above, NYSE and Nasdaq asserted that
it would be contradictory for the Commission to find it in the public
interest in Amendment 12 of the LULD Plan to require the centralization
of re-opening auction liquidity at the primary listing exchange, but
sanction the execution of closing auction trading interest on a venue
other than the primary listing exchange.\187\ However, the LULD Plan
does not mandate that market participants consolidate their orders at
the primary listing exchanges, but rather requires that a trading pause
continue until the primary listing exchange has re-opened trading.\188\
While trading may not begin until the re-opening on the primary listing
exchange, market participants continue to have the choice as to where
to submit their orders. Likewise, with respect to Cboe Market Close,
official closing prices would continue to be determined through the
closing auctions conducted by the primary listing exchanges. However,
market participants would have the choice to submit their orders to
Cboe Market Close or a closing auction on a primary listing exchange to
obtain an execution at the official closing price.
---------------------------------------------------------------------------
\186\ See supra note 149 (discussing comments arguing that it
would be inconsistent for the Commission to find it in the public
interest to consolidate trading in a re-opening auction, while
sanctioning fragmentation of trading in a closing auction).
\187\ See supra notes 146-147 and accompanying text.
\188\ See Securities Exchange Act Release No. 79845 (Jan. 19,
2017), 82 FR 8551, 8552 (Jan. 26, 2017). See also BZX Letter 1 at 8-
9; and Bollerman Letter at 3.
---------------------------------------------------------------------------
As discussed above, NYSE and Nasdaq argued that if the proposed
rule change resulted in the removal of all MOC orders from the primary
listing exchanges' closing auctions, and circumstances arose such that
due to other factors no closing auction could be held, in accordance
with NYSE Arca's and Nasdaq's rules the official closing price would be
the consolidated last sale price.\189\ NYSE and Nasdaq provided data
and, in the case of Nasdaq, counterfactual examples,\190\ that sought
to quantify the extent to which last consolidated sale prices would
have differed from closing prices determined through closing auctions.
NYSE and Nasdaq argue that these examples show that price discovery
would be harmed if they were unable to conduct closing auctions because
they did not receive any MOC orders and there was no other closing
auction-eligible trading interest. However, the Commission believes
that differences in prices alone are not dispositive of effects with
respect to price discovery or efficiency, and it is not clear that the
data NYSE and Nasdaq submitted actually reflects an effect on price
discovery.
---------------------------------------------------------------------------
\189\ See Nasdaq Letter 2 at 3; NYSE Letter 1 at 5. See also,
e.g., NYSE Rule 123C(1)(e); NYSE Arca Rule 1.1(ll)1.
\190\ See supra note 138 and accompanying text (stating that
Nasdaq identified previously conducted closing auctions that
consisted entirely of MOC orders and described what it believed the
official closing price would have been had no MOC orders been
submitted to those closing auctions).
---------------------------------------------------------------------------
First, the data and analyses that commenters provided did not
analyze subsequent price changes on the next trading day following the
closing auction. Thus, it is unclear whether the price differentials
between the official closing price and the price of the last sale prior
to the closing auction indicate better or worse price discovery or
efficiency. A large difference between a reference price (e.g., the
last sale price) and the official closing price may reflect relevant
market information if the official closing price persists to the next
trading day, or it may reflect a temporary price pressure if the
official closing price subsequently reverses to the reference price on
the next trading day.\191\ Second, when comparing price differences
across securities, the analyses did not distinguish whether the
observed differences were due to the removal of MOC orders from the
primary listing exchange or due to liquidity differences. And because
Nasdaq's analysis involved only 1,653 closing crosses that occurred
between January 1, 2016, and August 31, 2017 (which the Commission
estimates accounts for approximately 0.44% of all Nasdaq closing
auctions over that time period) the Nasdaq analysis may not be a
representative sample.\192\ Finally, Nasdaq did not address the
liquidity of the securities analyzed. If the securities
[[Page 4741]]
analyzed were highly illiquid, price differences between the last sale
price and the closing auction price may have been large for reasons
unrelated to the specifics of the auction mechanism.\193\ Given these
limitations, the data and analysis provided in these comments do not
alter the Commission's conclusion that the proposal is consistent with
the Act.
---------------------------------------------------------------------------
\191\ See, e.g., Joel Hasbrouck, ``Measuring the Information
Content of Stock Trades,'' Journal of Finance 46, 179-207 (1991),
available at www.jstor.org/stable/2328693.
\192\ See supra note 138.
\193\ See id. See also NYSE Report at 12 (``The difference
between the last sale price in the continuous market and the closing
auction price, particularly for less active securities where the
last sale price may be stale, can be significant.'').
---------------------------------------------------------------------------
In addition, the Commission acknowledges that it may be possible
that following implementation of the Cboe Market Close there could be
instances in which no MOC orders participate in a primary listing
exchange's closing auction. But the fact that the majority of MOC
orders today continue to be executed in the closing auctions on the
primary listing exchanges \194\ despite the numerous destinations
currently available to which MOC orders may be sent (including primary
listing exchange auctions, competing closing auctions, ATSs, and other
off-exchange venues) suggests that at least some market participants
base decisions regarding where to send closing orders not solely on
fees, but rather on many other factors, including the reliability,
stability, technology and surveillance associated with such
auctions.\195\ Similarly, in assessing whether to utilize Cboe Market
Close, market participants may evaluate other consequences of using the
proposed mechanism, such as by monitoring the extent to which their
orders were matched or not matched on BZX (with the resulting need to
send their MOC orders to more than one venue if not matched), as well
as the opportunity cost incurred by committing to transact at the
closing price at an earlier time than they otherwise would have had
they chosen to send their MOC orders to the primary listing exchanges.
Moreover, should market participants choose to send a substantial
portion of MOC orders to the Cboe Market Close, the primary listing
exchanges have various other options available to them to try to
compete for such orders, for example, through improvements to their
auction processes or through modifications to their fee structures, and
it is unlikely that such exchanges would choose to accept the complete
loss of MOC order market share and make no attempt at a competitive
response.
---------------------------------------------------------------------------
\194\ See Memorandum to File from DERA, Bats Market Close: Off-
Exchange Closing Volume and Price Discovery, dated December 1, 2017
(``DERA Analysis''), available at https://www.sec.gov/files/bats_moc_analysis.pdf (finding that, on average, approximately 9.3%
of closing volume is matched off-exchange at the primary listing
exchange's closing price); NYSE Report at 22 (stating that closing
auctions on the listing exchanges currently process the vast
majority of the MOC and LOC orders in the market); and Nasdaq Data
Memo (providing data relating to the level of matched MOC volume in
Nasdaq closing auctions).
\195\ See generally, Nasdaq Letter 1 at 3-4 (asserting that the
Nasdaq closing cross has been successful due to its integrity,
stability, reliability, and regulation).
---------------------------------------------------------------------------
Further, the use of the consolidated last sale price as the
official closing price in situations when a primary listing exchange
does not conduct a closing auction is not mandated by the Act or rules
thereunder, but rather is established by the rules of that
exchange.\196\ Therefore, if a primary listing exchange believes that
such prices no longer reflect an appropriate closing price in those
scenarios, it is within the exchange's discretion to reevaluate whether
reliance on the last consolidated sale price is the appropriate means
for determining the official closing price in such scenarios. An
exchange may, at any time, file a proposed rule change to amend its
rules to establish alternative methods that it believes to be more
appropriate for determining the official closing price should no
auction be held.
---------------------------------------------------------------------------
\196\ See, e.g., NYSE Rule 123C(1)(e); and NYSE Arca Rule
1.1(ll)(1)(C).
---------------------------------------------------------------------------
2. Off-Exchange MOC Activity and Fragmentation
a. Comments on the Proposal
Commenters, including Nasdaq and NYSE, also argued that the
proposal is inconsistent with Section 6(b)(5) of the Act because it
would fragment the markets beyond what currently occurs through off-
exchange closing price matching by broker-dealers. Nasdaq and NYSE
stated that such off-exchange activity is structurally different from
Cboe Market Close and thus asserted that it would be inappropriate to
analogize to such off-exchange activity in evaluating the
proposal.\197\ Nasdaq stated that the proposal would introduce a new
category of price-matching venues, and that as a neutral trading
platform, an exchange such as BZX is capable of attracting and
aggregating more liquidity than a broker-dealer which would exacerbate
the harm caused by fragmentation.\198\ In the Pitt/Spatt Report, Nasdaq
added that the underlying structure of off-exchange markets is
different from the proposal in various respects.\199\ Moreover,
according to Nasdaq, trades resulting from broker-dealer off-exchange
activity are often also involved in the closing auction on the primary
listing exchange, thus also contributing to closing auction price
discovery.\200\ Both Nasdaq and NYSE argued that it should not be
assumed that the current level of MOC orders executed away from the
primary listing exchange is a reasonable proxy for the effect of the
proposal.\201\ Nasdaq and NYSE stated that broker-dealers that execute
MOC orders on behalf of clients at the closing price could be risking
their own capital on such transactions.\202\ Nasdaq and NYSE stated
that such capital commitment by broker-dealers would likely be a
constraining force on the magnitude of MOC orders executed away from
primary listing exchanges, while BZX would have no such obligation to
commit capital in Cboe Market Close.\203\ For this reason, NYSE also
argued that the BZX proposal, if successful, could result in a much
higher percentage of MOC orders diverted away from the primary listing
exchange than what occurs today.\204\
---------------------------------------------------------------------------
\197\ See, e.g., Nasdaq Letter 2 at 13; and NYSE Report at 10.
GTS further stated that it believes such broker-dealer services
deprive the DMM of content that is critical to pricing a closing
auction and the Commission should study the effect of this activity
on closing auctions. See GTS Securities Letter 2 at 4. See infra
note 232 and accompanying text discussing the DERA analysis of the
relationship between the proportion of MOC orders currently executed
off-exchange and closing price discovery and efficiency.
\198\ See Nasdaq Letter 2 at 13.
\199\ See Pitt/Spatt Report at 21.
\200\ See id. The Nasdaq Data Memo also provided data and
analysis arguing that a portion of the broker-dealer volume executed
off-exchange after the close at the primary listing exchange's
closing price reflects brokers submitting customers' interest to the
closing cross and subsequently reporting an over-the-counter trade
between the broker and its customers. See also Nasdaq Statement at
31.
\201\ See NYSE Report at 10; and Nasdaq Statement at 30.
\202\ See NYSE Report at 10; and Nasdaq Statement at 30.
\203\ See NYSE Report at 10; and Nasdaq Statement at 30.
\204\ See NYSE Report at 10.
---------------------------------------------------------------------------
In addition, NYSE provided data that focused on existing off-
exchange matching services.\205\ NYSE stated that data it analyzed from
certain closing auctions with large imbalances \206\ shows that, for
securities with 1,000 shares or less reported at the official closing
price (resulting from executions
[[Page 4742]]
that occurred both on and off-exchange), volatility in the last 10
minutes of trading leading into the closing auction is 52% higher when
more than 75% of the volume executed at that security's official
closing price (i.e., closing share volume) is executed off-exchange,
compared to when less than 25% of a security's closing share volume is
executed off-exchange. In addition, NYSE asserted that its data showed
that the official closing price generated in auctions for securities
with 1,000 shares or less reported at the official closing price
(resulting from executions that occurred both on and off-exchange) was
more than twice as far away from the last consolidated sale price and
nearly twice as far away from the market volume weighted average price
(``VWAP'') over the last two minutes of trading before the closing
auction when more than 75% of a security's closing share volume is
executed off-exchange.\207\ Accordingly, NYSE concluded that these
price differentials suggest that existing fragmentation degrades the
quality of the closing price and further asserted that this
demonstrates ``a substantial likelihood that any appreciable
redirection'' of MOC orders from the primary listing exchange to Cboe
Market Close would negatively affect price discovery and would be most
acute for ``less-liquid'' stocks.\208\
---------------------------------------------------------------------------
\205\ See NYSE Letter 3 at 3; and NYSE Statement at 22. See also
NYSE Letter 2 at 4. The Commission notes that NYSE also asserted, in
regards to the DERA Analysis, that drawing conclusions regarding
Cboe Market Close's potential impact on price discovery by comparing
Cboe Market Close to off-exchange MOC activity represented an
apples-to-oranges comparison due to the structural differences
between the proposal and the services of broker-dealers executing
MOC orders off-exchange. See NYSE Statement at 25.
\206\ See NYSE Letter 3 at 3. NYSE stated that it reviewed
closing auctions with imbalances of 50% of paired shares as of 3:50
p.m. See id. at 4.
\207\ See id. at 3-4. NYSE provided data that they asserted
illustrates that the same degradation in the quality of the official
closing price also occurs in closes for securities with 10,000
shares or more reported at the official closing price. See id. at 4.
\208\ See id. at 3-4; and NYSE Statement at 23-24.
---------------------------------------------------------------------------
b. BZX Response to Comments
BZX stated that several off-exchange venues currently offer
executions at the official closing price and therefore provide a forum
to which participants may choose to send MOC orders in lieu of sending
MOC or LOC orders to the primary listing exchange.\209\ Contrary to
assertions by Nasdaq and NYSE,\210\ BZX provided certain data regarding
trading volume at the close on venues other than primary listing
exchanges to show that the proposal would ``not introduce a new type of
fragmentation at the close.'' \211\ BZX asserted that because this
existing fragmentation has had no adverse effect on the price discovery
process, there is no basis to believe that the proposal ``would
negatively contribute to meaningful fragmentation to the detriment of
the price discovery process.'' \212\
---------------------------------------------------------------------------
\209\ BZX Letter 2 at 3.
\210\ See Nasdaq Statement at 28; and NYSE Statement at 21.
\211\ See BZX Letter 2 at 4-5. BZX stated that over the first
nine months of 2017, off-exchange volume at the official closing
price represented approximately 30% of Nasdaq closing volume for
Nasdaq-listed securities and 23% of NYSE closing volume for NYSE-
listed securities and that, over the course of 2017, the amount of
off-exchange closing volume has been increasing. See id. BZX
estimated, based on its internal data, that this off-exchange volume
represented approximately $270 billion and $426 billion in notional
volume in Nasdaq-listed and NYSE-listed securities, respectively.
See BZX Statement at 16.
\212\ See id.
---------------------------------------------------------------------------
Moreover, other commenters argued that the proposal could increase
transparency, reliability and price discovery at the close by incenting
brokers that would otherwise seek to match MOC orders off-exchange to
re-direct their MOC orders to a public exchange.\213\ In addition, BZX
argued that attracting order flow away from off-exchange venues would
have the additional benefit of increasing the amount of volume at the
close executed on systems subject to the resiliency requirements of
Regulation SCI.\214\
---------------------------------------------------------------------------
\213\ See Clearpool Letter at 3-4; ViableMkts Letter at 4-5; and
BZX Letter 2 at 5-6. See also Angel Letter at 4.
\214\ See BZX Letter 2 at 11.
---------------------------------------------------------------------------
BZX presented several critiques in response to NYSE's data
regarding the effect of off-exchange MOC activity on closing auction
price formation. First, BZX stated that NYSE did not provide the number
of closing auctions included in its data set.\215\ Based on its own
analysis, discussed below, BZX estimated that the number of auctions
included in NYSE's data set for auctions with 1,000 shares or less was
less than a 100th of 1% of all auctions.\216\ Therefore, BZX argued
that NYSE's findings are ``of no statistical significance'' and BZX
also asserted that NYSE selectively chose its data to support NYSE's
conclusions.\217\
---------------------------------------------------------------------------
\215\ See BZX Letter 3 at 2.
\216\ See id. at 2-3; and BZX Statement at 13-14
\217\ See BZX Letter 3 at 2-3.
---------------------------------------------------------------------------
BZX further argued that it is possible that low volume securities
with severe imbalances would be subject to price variations between the
last sale and the official closing price, regardless of the amount of
off-exchange closing activity.\218\ In addition, BZX stated that the
data that NYSE provided for auctions with more than 10,000 shares shows
that the ``impact on closing prices is dampened in more actively traded
securities,'' which BZX believes undercuts NYSE's conclusions and
``further highlights the selective and limited nature of NYSE's data
set.'' \219\
---------------------------------------------------------------------------
\218\ See id.
\219\ See id.
---------------------------------------------------------------------------
Furthermore, despite assertions from Nasdaq and NYSE that BZX did
not provide data on the effect of off-exchange MOC activity on closing
auction price formation,\220\ BZX conducted its own analysis of data
from all primary auctions in NYSE-listed securities for which there was
a closing auction and a last sale regular way trade, regardless of
size, from January 2, 2017 through September 29, 2017.\221\ BZX stated
that its analysis shows that ``the average price gap between the last
sale and the official closing price was 9.09 basis points across all
groups.'' \222\ BZX stated that it also found that ``price gaps are
greater amongst auctions with less than 25% of closing volume''
executed off-exchange.\223\ BZX concluded that its analysis contradicts
NYSE's conclusions, asserting that it shows that ``the amount of [off-
exchange] closing volume has little to no relationship to the primary
listing [exchange's] closing auction process.'' \224\
---------------------------------------------------------------------------
\220\ See Nasdaq Statement at 28; and NYSE Statement at 21.
\221\ See BZX Letter 3 at 3. BZX stated that it reviewed
auctions with imbalances of 50% or more of paired shares at 3:55p.m.
BZX also stated that it compared auctions where less than 25%, 25%
to 50%, 50% to 75%, and more than 75%, of the closing volume was
reported to the TRF. BZX also grouped its data amongst auctions with
1,000,000 shares or more, 100,000 shares to 1,000,000 shares, 10,000
to 100,000 shares, 1,000 to 10,000 shares, and less than 1,000
shares.
\222\ Id. See also BZX Statement at 12 n. 41 (noting that it,
like NYSE, utilized the difference between the last sale price and
official closing price to determine price impact but it believes
this to be a ``reasonable measure of the quality'' of closing
auction price discovery).
\223\ See BZX Letter 3 at 3.
\224\ Id. at 3-4. See also BZX Statement at 13.
---------------------------------------------------------------------------
In addition, BZX stated that it also found similar patterns ``when
it analyzed securities based on their [average daily volume] instead of
auction size.'' \225\ BZX acknowledged that, while securities with
average daily volume of less than 10,000 shares appear to have the most
volatility, these securities account for a small percentage of overall
auction volume, and argued that such volatility ``is more likely
indicative of the applicable security's trading characteristics.''
\226\
---------------------------------------------------------------------------
\225\ See BZX Letter 3 at 3.
\226\ See id. at 4. See also BZX Statement at 13.
---------------------------------------------------------------------------
BZX added that there is no support for a contention that the effect
of the proposal on price discovery may be greater because more market
participants might use an exchange offering as opposed to a non-
exchange offering.\227\ As such, BZX asserted that its data provides
compelling evidence for the proposal's potential lack of an effect on
price discovery.\228\
---------------------------------------------------------------------------
\227\ See BZX Statement at 13 n. 46.
\228\ See id. at 15.
---------------------------------------------------------------------------
[[Page 4743]]
c. Commission Discussion and Findings
As Nasdaq and NYSE noted,\229\ comparisons to off-exchange MOC
activity are not a perfect measure of the potential resulting effect of
the proposal because the structures of many off-exchange MOC trading
mechanisms differ from the structure of Cboe Market Close. Importantly,
unlike what occurs in some off-exchange MOC activity, Cboe Market Close
would only execute paired-off MOC interest, and therefore, even if it
attracts a larger percentage of MOC orders than are currently executed
off-exchange, Cboe Market Close would not affect the net MOC order
imbalance, which could contribute to price formation in a closing
auction. The Commission agrees with NYSE and Nasdaq that it should not
rely on inapposite analogies in approving the proposal. Therefore, and
as discussed in more detail below, in finding that Cboe Market Close is
consistent with Section 6(b)(5) the Act, the Commission is not
persuaded by (or otherwise relying upon) any analyses or comparisons
submitted to the record that focused on the purported effects of off-
exchange MOC activity.
---------------------------------------------------------------------------
\229\ See supra notes 198-203 and accompanying text.
---------------------------------------------------------------------------
However, if the Commission were to consider analyses regarding off-
exchange MOC activity, the Commission notes that the NYSE analysis,
when comparing price differences across securities, did not distinguish
whether the observed price differences were due to the removal of MOC
orders from the primary listing exchange or due to liquidity or other
differences not controlled for in the analysis. As described above,
NYSE provided an analysis comparing price differences between
securities in which 75% of the total closing volume was executed off-
exchange, and securities in which 25% of the total closing volume was
executed off-exchange. NYSE argued that securities with more off-
exchange MOC activity have more closing price volatility. However, the
Commission believes that closing price volatility and off-exchange
activity may be correlated with unobserved liquidity factors. For
example, small stocks tend to have high trading costs (e.g., wider
spreads, thinner order books) and more volatility on average.\230\
Therefore, it is possible that the price differences observed by the
commenter could be due to differences in liquidity or other factors not
controlled for in the analysis, rather than the levels of off-exchange
MOC activity.\231\ In contrast, the data provided by BZX covers a
broader set of auctions and provides more granular data. That data
observed greater volatility in less-liquid stocks and illustrates that
those securities account for a much smaller percentage of auction
volume, and the observed difference is likely indicative of liquidity
or other characteristics common to less-liquid stocks.
---------------------------------------------------------------------------
\230\ For example, one study examined fragmentation in the U.S.
equities markets and showed that small cap stocks are more
fragmented than large cap stocks for Nasdaq-listed issues. It also
found that fragmentation is correlated with higher short-term
volatility, but increased market efficiency. See Maureen O'Hara and
Mao Ye, ``Is Market Fragmentation Harming Market Quality?,'' Journal
of Financial Economics 100, 459-474 (2011), available at http://www.sciencedirect.com/science/article/pii/S0304405X11000390.
\231\ See also supra notes 215-228 and accompanying text
(discussing BZX's comments with respect to NYSE's analysis and BZX's
own analysis of such data).
---------------------------------------------------------------------------
d. DERA Analysis
In connection with the consideration of the proposal, the staff
from the Commission's Division of Economic and Risk Analysis (``DERA'')
sought to explore the correlation of closing price discovery and
efficiency with existing off-exchange MOC activity.\232\ DERA found
that, in a sample spanning the first quarter of 2017, variation in off-
exchange MOC share (i.e., the amount of MOC volume executed off-
exchange relative to the amount of volume executed in the primary
listing exchange closing auction) is not significantly correlated with
closing price discovery or efficiency, controlling for primary auction
activity, off-exchange trading activity during regular trading hours,
average market capitalization, average daily trading volume, average
daily stock return volatility, and closing price volatility.\233\ In
further sample splits (e.g., by listing venue, security type, and index
inclusion), DERA found some mixed evidence of statistically significant
correlations, but no consistent or conclusive evidence that contradicts
the full-sample analysis. This staff analysis was placed in the comment
file prior to the issuance of the Approval Order. And, while the
Approval Order recognized that a comparison to off-exchange MOC
activity represents an inapposite analogy for purposes of considering
the proposal's potential effect on closing auction price discovery, it
discussed the DERA Analysis, which suggested that existing levels of
fragmentation of closing auctions through the off-exchange MOC activity
DERA studied are not, on average, significantly correlated with closing
price discovery or efficiency.
---------------------------------------------------------------------------
\232\ See DERA Analysis supra note 194. The DERA Analysis states
that it does not attempt to establish a causal link between off-
exchange activity and closing price discovery and efficiency. See
DERA Analysis at 1-2.
\233\ Though the DERA Analysis' findings suggest ``that existing
levels of fragmentation do not, on average, correlate with price
discovery or price efficiency,'' the DERA Analysis makes clear that
``the data we have does not allow us to predict how [Cboe Market
Close] would affect price discovery in the closing auction process,
and market participants' use of limit-on-close orders in the closing
auction processes.''
---------------------------------------------------------------------------
NYSE and Nasdaq both stated that the Commission should not attempt
to estimate the effect of Cboe Market Close through a comparison to
off-exchange MOC trading because of the structural differences between
off-exchange MOC trading and Cboe Market Close.\234\ They also both
critiqued the methodology employed in the DERA Analysis.\235\ In
addition, the Amihud/Mendelson Report commissioned by Nasdaq purports
to provide evidence of a negative and statistically significant
relationship between closing price efficiency, measured by weighted
price contribution (WPC), and the off-exchange market share (OEMS) of
closing volume that occurs off-exchange between 4:00 p.m. and 4:10 p.m.
at the closing price. In particular, the Amihud/Mendelson Report
studies the largest 500 Nasdaq stocks by market capitalization during
the last two quarters of 2017 and states that a one standard deviation
increase in OEMS decreases WPC1 (their first measure of closing price
efficiency) by 9.4% of its mean and WPC2 (their second measure of
closing price efficiency) by 25.7% of its mean. The Amihud/Mendelson
Report further purports to show that their results are robust to the
inclusion of stock fixed effects, date fixed effects, and a variety of
intraday control variables.
---------------------------------------------------------------------------
\234\ See NYSE Statement at 25 (stating that comparing Cboe
Market Close to off-exchange MOC trading is an ``apples-to-oranges
comparison''). See also Nasdaq Statement at 31.
\235\ See, e.g., NYSE Report at 9-18; Nasdaq Statement at 29-31;
Pitt/Spatt Report at 21.
---------------------------------------------------------------------------
As previously stated, the Commission agrees with NYSE and Nasdaq
that the structure of existing mechanisms to conduct off-exchange MOC
trading may not, in all instances, be identical to Cboe Market
Close.\236\ Therefore, the Commission's belief that Cboe Market Close
should not disrupt the price discovery process and closing auction
price formation is not dependent on the DERA Analysis or other studies
focused on off-exchange MOC activity.\237\ While the Commission has
reviewed NYSE's and Nasdaq's critiques of the
[[Page 4744]]
methodology of the DERA Analysis, the DERA Analysis does not bear on
the Commission's decision to approve BZX's proposal.
---------------------------------------------------------------------------
\236\ See supra notes 198-203 and accompanying text.
\237\ See supra Section III.B.
---------------------------------------------------------------------------
Furthermore, even though NYSE's and Nasdaq's critiques of the
methodology of the DERA Analysis are not relevant to this order, the
Commission notes that it is not persuaded by the findings of the
Amihud/Mendelson Report because it believes there are two
methodological flaws in that study that lead to an overstatement of the
economic significance of the findings. First, the Amihud/Mendelson
Report expresses the changes in WPC1 and WPC2 as percentages of their
respective means. The means of WPC1 and WPC2 are very close to zero
because any individual WPC1 or WPC2 observation can be positive or
negative. The percentage decreases in WPC1 and WPC2 appear high (9.4%
and 25.7%) because the OEMS effects on WPC1 and WPC2 are expressed as
percentages of near-zero numbers. If the Amihud/Mendelson Report
expressed the OEMS effects on WPC1 and WPC2 as a percentage of their
respective standard deviations instead, then the Amihud/Mendelson
Report would obtain much lower percentage effects that are unlikely to
be economically significant. Second, the Amihud/Mendelson Report takes
the log transformation of the OEMS variable in their tests. By
construction, the OEMS variable is bound between zero and one, and
taking the log transformation of this variable will greatly skew its
distribution and increase its standard deviation. If the standard
deviation of the OEMS variable is inflated, then any economic effect on
closing price efficiency resulting from a one standard deviation
increase in the OEMS variable will also be inflated. These
methodological flaws cast doubt on the economic significance of the
findings in the Amihud/Mendelson Report.
3. Competing Closing Auctions
a. Comments on the Proposal
In support of its proposal, BZX stated that Nasdaq and NYSE Arca
operate closing auctions for securities listed on other exchanges and
that these closing auctions produce independent prices that may differ
from a security's official closing price determined in the closing
auction conducted by the security's primary listing exchange.\238\ BZX
stated that in contrast to Cboe Market Close, these competing closing
auctions not only fragment closing auction trading interest, but also
detrimentally impact price discovery.\239\
---------------------------------------------------------------------------
\238\ See Notice at 23322.
\239\ See BZX Letter 1 at 3-4.
---------------------------------------------------------------------------
In response, both Nasdaq and NYSE distinguished the Cboe Market
Close from competing closing auctions currently operated by Nasdaq and
NYSE Arca for securities listed on other exchanges. Nasdaq stated that
the BZX proposal is a price-matching order type and not a competitive
single-priced auction that offers price discovery.\240\ Nasdaq stated
that its single-priced auction for non-Nasdaq listed stocks was
designed to maximize order interaction and improve price discovery for
issuers, and was not designed to siphon orders away from the primary
listing exchange without seeking to improve price discovery.\241\
Accordingly, Nasdaq argued that the fact that it and NYSE Arca offer
competing closing auctions is irrelevant to evaluating BZX's proposal
because those auctions are fundamentally different from the BZX
proposal.\242\ Similarly, NYSE argued that it believed it was
misleading to compare the proposal to these competing closing auctions
operated by Nasdaq and NYSE Arca for securities listed on other
exchanges because BZX would be offering neither a competing closing
auction nor a facility to establish the official closing price should a
primary listing exchange invoke its closing auction contingency
plan.\243\
---------------------------------------------------------------------------
\240\ See Nasdaq Letter 2 at 8-9.
\241\ See id. at 9.
\242\ See id.
\243\ See NYSE Letter 2 at 3.
---------------------------------------------------------------------------
Nasdaq further argued that competing closing auctions cause minimal
fragmentation, as volumes in those auctions are ``miniscule.'' \244\
Nasdaq further asserted that less than half of Nasdaq-listed corporate
issues experience price dislocations in competing closing
auctions.\245\ Moreover, both Nasdaq and NYSE stated that there were
multiple instances when they had received orders in their competing
closing auctions for securities listed on another exchange, and they
both chose to contact the firms that submitted those orders and
encouraged them to instead route their orders directly to the primary
listing exchange.\246\
---------------------------------------------------------------------------
\244\ See Nasdaq Letter 2 at 9-11. See also NYSE Letter 3 at 5-
6. NYSE also stated that it does not have a business interest in
running closing auctions for securities listed on other markets. It
stated it operates the NYSE Arca closing auction for resiliency
purposes, which it believes outweighs any modest negative effect on
fragmentation. See id.
\245\ See Nasdaq Letter 2 at 11.
\246\ See id. at 13; and NYSE Letter 3 at 6. See also infra note
253 and accompanying text.
---------------------------------------------------------------------------
In contrast, other commenters stated that these competing closing
auctions may attract price-setting limit orders from the primary
listing exchange and impede price discovery, unlike the BZX proposal
which is limited to market orders.\247\
---------------------------------------------------------------------------
\247\ See Clearpool Letter at 3; IEX Letter at 2; Angel Letter
at 4; SIFMA Letter 2 at 2; and Bollerman Letter at 3.
---------------------------------------------------------------------------
b. BZX Response to Comments
As noted above, BZX stated that, unlike Cboe Market Close, the
competing closing auctions operated by Nasdaq and NYSE Arca accept
price-setting limit orders, in addition to MOC orders, and therefore
may harm price discovery.\248\ Therefore, BZX questioned whether
Nasdaq's and NYSE's concerns regarding the potential impact of Cboe
Market Close should not also apply to the competing closing auctions
operated by Nasdaq and NYSE Arca.\249\ BZX argued that Nasdaq and
NYSE's assertions that they currently attract low trading volumes in
their competing closing auctions are irrelevant to an analysis of their
potential effect on fragmentation.\250\ BZX argued that should these
auctions see an increase in order flow, they would increase existing
market fragmentation.\251\ BZX also asserted that such competing
closing auctions often may produce bad auction prices on the non-
primary listing exchange, as compared to the proposed Cboe Market Close
which would ensure that market participants receive the official
closing price.\252\ In addition, in response to NYSE's assertion that
it contacted firms that submitted orders to NYSE Arca's competing
closing auction and encouraged them to instead submit
[[Page 4745]]
orders to the primary listing exchange, BZX provided data that it
stated evidences that NYSE has not, in fact, discouraged order flow to
their competing auctions and that NYSE Arca's competing auction
``continues to maintain not insignificant monthly volume'' in at least
two securities.\253\
---------------------------------------------------------------------------
\248\ See BZX Letter 1 at 5; BZX Letter 2 at 2; and BZX Letter 3
at 4. BZX provided evidence of 14 instances in June 2017 where a
Nasdaq-listed security had no volume in Nasdaq's closing auction but
did have volume in NYSE Arca's closing auction. See BZX Letter 1 at
5.
\249\ See, e.g., BZX Letter 2 at 2.
\250\ See BZX Letter 1 at 6.
\251\ See id. BZX also stated that, despite their potential
utility as a back-up in case of a market impairment, Nasdaq and NYSE
Arca run these competing auctions on a daily basis, regardless of
whether there is an impairment at a primary listing exchange. See
id. BZX further questioned why these exchanges do not utilize test
symbols and test data in order to confirm the operational integrity
of the auction processes without potentially harming the price
discovery process by the primary's closing auction. See BZX Letter 3
at 5.
\252\ See BZX Letter 1 at 4; and BZX Letter 2 at 2. BZX asserted
that 86% of closing auctions conducted by Nasdaq for NYSE-listed
securities in June 2017 resulted in closing prices different from
the official closing price and 84% of competing closing auctions
conducted by NYSE Arca for Nasdaq-listed securities in June 2017
resulted in closing prices different from the official closing
price. BZX Letter 1 at 4.
\253\ BZX Letter 3 at 4.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
The Commission believes, as some commenters argued, that there are
certain fundamental differences between BZX's proposed Cboe Market
Close and existing competing closing auctions. First, BZX's proposed
Cboe Market Close is not a closing auction. Further, as NYSE and Nasdaq
stated, their existing competing, single-priced closing auctions accept
LOC orders (which specify target prices) and therefore, produce closing
prices independent from those determined through the primary listing
exchanges' closing auctions. As pointed out by BZX, this could affect
the closing price on the primary listing exchange by potentially
diverting LOC orders that contribute to price discovery away from the
primary listing exchange's closing auction.\254\ In contrast, BZX's
proposal would not accept LOC orders. Rather, Cboe Market Close only
matches MOC orders. Thus, based on its design, Cboe Market Close should
not affect the price formation process in the closing auctions on the
primary listing exchanges.
---------------------------------------------------------------------------
\254\ Competing auctions could also potentially reduce the
centralization of orders at the primary listing exchange's closing
auction, which NYSE and Nasdaq argued was a critical element of the
primary listing exchanges' closing auctions. See Nasdaq Letter 1 at
11; Nasdaq Letter 2 at 5-6; Nasdaq Statement at 22; NYSE Statement
at 21; NYSE Report at 12; and NYSE Letter 1 at 4.
---------------------------------------------------------------------------
C. Potential Effect on Issuers and Other Market Participants
1. Comments on the Proposal
Several commenters stated that the proposal could harm issuers,
particularly small and mid-cap companies.\255\ Many of these commenters
argued that because, in their view, the proposal undermines the
reliability of the closing process and/or the official closing price it
also poses a risk to listed companies and their shareholders.\256\ Many
of these commenters, some of which are issuers, stated that the current
centralized closing auctions on the primary listing exchanges
contribute meaningful liquidity to a company's stock, facilitate
investment in the company, and help to lower the cost of capital. These
commenters expressed concern that the potential additional
fragmentation they believed could be caused by the proposal could
negatively affect liquidity during the closing auction, causing
detrimental effects to listed issuers.\257\
---------------------------------------------------------------------------
\255\ See, e.g., Nasdaq Letter 1 at 6-7; Nasdaq Letter 2 at 1-2;
Nasdaq Statement at 27; NYSE Letter 1 at 3; GTS Securities Letter 1
at 2-5; Customers Bancorp Letter; Orion Group Letter; IMC Financial
Letter at 1-2; Southern Company Letter; Letter from Cole Stevens,
Investor Relations Associate, Nobilis Health, (July 6, 2017)
(``Nobilis Health Letter''); Letter from Christopher A. Iacovella,
Chief Executive Officer, Equity Dealers of America, (July 12, 2017)
(``EDA Letter'') at 1-2; Coupa Software Letter; Trade Desk Letter;
and Duffy/Meeks Letter at 1.
\256\ See, e.g., NYSE Letter 1 at 3; IMC Financial Letter at 1-
2; Nobilis Health Letter; EDA Letter at 1-2; Coupa Software Letter;
Letter from M. Farooq Kathwari, Chairman, President & CEO, Ethan
Allen Interiors, Inc. (July 24, 2017) (``Ethan Allen Letter'');
Trade Desk Letter; BioCryst Letter; Digimarc Letter; Duffy/Meeks
Letter at 1-2; NBT Bancorp Letter; Global Payments Letter; CA
Technologies Letter; Sirius Letter; and PayPal Letter. Several
issuers also asserted that decentralizing closing auctions will
increase volatility, reduce visibility, and negatively affect
liquidity for equity securities. See, e.g., Customers Bancorp
Letter; Orion Group Letter; and Nobilis Health Letter.
\257\ See, e.g., Customers Bancorp Letter; Orion Group Letter;
Southern Company Letter; and Duffy/Meeks Letter at 1-2. In contrast,
one commenter argued that the proposal would attract more liquidity
at the official closing price because the lower aggregate cost of
trading at the official closing price would likely result in
incremental increases in trading volumes at the official closing
price. In addition, this commenter stated that the ability to enter
MOC orders into Cboe Market Close with little risk of information
leakage may attract an additional source of liquidity from ``patient
investors'' that seek to trade large amounts of stock but may not
utilize the primary listing exchanges' closing auctions due to
concerns about information leakage. See ViableMkts Letter at 2.
---------------------------------------------------------------------------
In addition, commenters stated that closing prices play an
important role in the pricing of pooled investment vehicles, derivative
securities, and benchmark indices.\258\ One of these commenters
asserted that because the closing price is a critical data point for
investors, the Commission should take ``great caution'' in considering
any changes related to the primary listing exchanges' closing
auctions.\259\
---------------------------------------------------------------------------
\258\ See Pitt/Spatt Report at 6-7; and Letter from Alexander J.
Matturri, CEO, S&P Dow Jones Indices (July 18, 2017) (``SPDJI
Letter'') at 1-2. See also, e.g., Coupa Software Letter; and Trade
Desk Letter.
\259\ See SPDJI Letter at 2. See also NYSE Report at 23-24. In
contrast, one commenter acknowledged that while affecting the
quality of the closing price is an objection that deserves close
analysis, as the closing price is ``the most important price of the
day,'' and would warrant rejection of the proposal, the commenter
does not believe the proposal would harm the quality of the closing
price. See Angel Letter at 4.
---------------------------------------------------------------------------
Moreover, some commenters argued that the centralization of
liquidity at the open and close of trading, and how primary listing
exchanges perform during the opening and closing, are important factors
for issuers in determining where to list their securities.\260\
Commenters also stated that the additional risk posed to listed
companies from an unreliable or unrepresentative closing price and/or
process could affect an issuer's decision where to list and/or cause
companies to forgo going public.\261\ Nasdaq added that the proposal
would undermine confidence in the price discovery process and the mere
perception of these risks could discourage issuers from going
public.\262\
---------------------------------------------------------------------------
\260\ See, e.g., EDA Letter at 1; Duffy/Meeks Letter at 1; and
GTS Securities Letter 2 at 1-2.
\261\ See, e.g., NYSE Letter 1 at 3 and 9; GTS Securities Letter
1 at 3-5; and EDA Letter at 1. In addition, one commenter stated
that further fragmenting the market would limit the quality and
quantity of information on trading dynamics that the primary listing
exchanges provide to their listed issuers. See CA Technologies
Letter.
\262\ See Nasdaq Statement at 27-28.
---------------------------------------------------------------------------
2. BZX Response to Comments
BZX stated that because the proposal only matches paired-off MOC
orders, it ``would not adversely impact the trading environment for
issuers and their securities.'' \263\ BZX further stated that unlike
the competing closing auctions run by NYSE Arca and Nasdaq, the
proposal would not create a price that deviates from the official
closing price, and therefore, the proposal ``would not impact listed
issuers or the market for their securities.'' \264\
---------------------------------------------------------------------------
\263\ See BZX Letter 1 at 2 and 4; and BZX Letter 2 at 10.
\264\ See BZX Letter 2 at 10.
---------------------------------------------------------------------------
3. Commission Discussion and Findings
As discussed above, BZX has demonstrated that because Cboe Market
Close will only execute paired-off MOC orders, it should not disrupt
the price discovery process.\265\ Accordingly, the proposal should not
lead to the detrimental effects that commenters have raised regarding
the reliability of official closing prices, confidence in closing
prices and pricing of benchmark indices, increased volatility,
liquidity conditions for particular stocks, and the cost of raising
capital. Further, as described above, because BZX will disseminate the
amount of matched shares at 3:35 p.m.--well before the cut-off time for
the primary listing exchanges' closing auctions \266\--the Commission
does not believe that the proposal would negatively affect visibility
and transparency into the closing auction process on the primary
listing exchanges, nor would it limit the quality and quantity of
information on trading dynamics that the primary
[[Page 4746]]
listing exchanges could provide to their listed issuers.
---------------------------------------------------------------------------
\265\ See supra Section III.B.
\266\ See supra note 23.
---------------------------------------------------------------------------
D. Effect on Market Complexity and Operational Risk
1. Comments on the Proposal
Several commenters addressed the potential effect of the proposal
on market complexity and operational risk to the securities markets.
Some of these commenters believed that the proposal would not
introduce significant additional complexity or operational risk. For
example, two commenters argued that the proposal could enhance the
resiliency of the closing auction process by providing market
participants an additional mechanism through which to execute orders at
the official closing price in the event of a disruption at a primary
listing exchange.\267\ Another commenter argued that exchanges already
have many market data feeds that firms must purchase to ensure that
they have all of the information necessary to make informed execution
decisions and that adding another data feed will not add complexity
given the small amount of information that goes into the closing data
feed and the current capabilities of market participants to re-
aggregate multiple data feeds.\268\
---------------------------------------------------------------------------
\267\ See SIFMA Letter 1 at 2; and ViableMkts Letter at 3
(further stating that once BZX is able to process MOC orders, BZX
would be in a position to develop the capability to offer a full
backup closing auction process).
\268\ See Clearpool Letter at 4.
---------------------------------------------------------------------------
In contrast, other commenters argued that the proposal would add
unnecessary market complexity and operational risk to the securities
markets. Nasdaq asserted that the proposal would impair the statutory
objective of fair and orderly markets by ``fostering complexity and
fragmentation in the securities markets.'' \269\ In particular, Nasdaq
and other commenters stated that the proposal would exacerbate market
complexity by requiring market participants to monitor and analyze an
additional data feed, the Cboe Auction Feed.\270\ These commenters
argued that monitoring an additional data feed could create challenges
and increase operational risk by creating another point of failure at a
critical time of the trading day.\271\ Some commenters stated that
additional exchanges, broker-dealers, or ATSs are likely to adopt
similar functionality to Cboe Market Close, which would require
monitoring of even more data feeds and further increase fragmentation,
risk, and operational challenges in the market.\272\ While
acknowledging that sophisticated market participants are capable of
monitoring additional data feeds, Nasdaq and NYSE argued that many
closing auction participants are less-active traders than the
professional market participants who trade during the continuous
trading session.\273\ Such market participants, they argued, do not
have the technology and systems to analyze an additional data feed and
would thereby be placed at a disadvantage to sophisticated market
participants who already have such systems in place.\274\
---------------------------------------------------------------------------
\269\ See Nasdaq Statement at 32.
\270\ See Nasdaq Statement at 33; NYSE Letter 1 at 7; NYSE
Statement at 26-27; and IMC Letter at 1.
\271\ See IMC Letter at 1; NYSE Letter 1 at 7; and Nasdaq
Statement at 33. See also Ethan Allen Letter (arguing the proposal
would add a layer of complexity).
\272\ See NYSE Letter 3 at 3; NYSE Statement at 26; T. Rowe
Price Letter at 1-2; Nasdaq Letter 1 at 8; and Nasdaq Statement at
33-34.
\273\ See Nasdaq Statement at 33-34; and NYSE Statement at 27-
28.
\274\ See Nasdaq Statement at 33-34; and NYSE Statement at 27-
28.
---------------------------------------------------------------------------
One commenter also argued that the proposal increases operational
risk and complexity at a critical point of the trading day by forcing
market participants whose orders did not match in Cboe Market Close to
quickly send MOC orders from one exchange to another before the cut-off
time at the primary listing exchange closing auction.\275\ This added
complexity, the commenter argued, puts additional stress on the systems
of exchanges and increases the potential for disruptions.\276\
---------------------------------------------------------------------------
\275\ See GTS Securities Letter 1 at 6. Furthermore, NYSE argued
that in certain situations, investors may not be able to participate
in a closing auction on NYSE American or NYSE Arca if they wait
until after their order was cancelled by BZX to send in a market-on-
close order to closing auctions on NYSE Arca and NYSE American. NYSE
explained that in situations where there is an order imbalance
priced outside the Auction Collars, orders on the side of the
imbalance are not guaranteed to participate in the closing auctions
on those two exchanges. Earlier submitted MOC orders have priority.
See NYSE Letter 1 at 8.
\276\ See GTS Securities Letter 1 at 6.
---------------------------------------------------------------------------
2. BZX Response to Comments
In response, BZX argued that the proposal would not increase market
complexity or operational risks.\277\ BZX characterized the proposal as
a simple crossing process that provides one additional venue, among the
many that exist today, to which market participants may send MOC
orders.\278\ BZX asserted that Cboe Market Close would provide a way to
address the single point of failure risk that exists for closing
auctions conducted on the primary listing exchanges.\279\ Specifically,
BZX argued that in the event there is an impairment at a primary
listing exchange, Cboe Market Close could provide an alternative option
for market participants to route MOC orders and still receive the
official closing price.\280\
---------------------------------------------------------------------------
\277\ See BZX Letter 1 at 12; BZX Letter 2 at 10-11; and BZX
Statement at 17-20.
\278\ See BZX Statement at 17.
\279\ See BZX Letter 1 at 12; and BZX Letter 2 at 10-11.
\280\ See id. In contrast, Nasdaq argued that Cboe Market Close
could not serve as a back-up for a primary listing exchange
suffering an impairment because it is not a price-discovering
auction and would not operate in the absence of the auction it would
be backing-up. See Nasdaq Letter 2 at 12.
---------------------------------------------------------------------------
BZX also argued that modern software can easily and simply add
volume data disseminated by the primary listing exchanges regarding the
closing auction and data regarding matched MOC orders from the Cboe
Market Close.\281\ Moreover, BZX stated that it believed the 3:35 p.m.
cut-off time would provide market participants with adequate time to
receive any necessary information and to route any unmatched orders to
the primary listing exchange.\282\ BZX stated that market participants
would not be obligated to use Cboe Market Close or subscribe to its
data feed (or any other additional functionality or feeds that
competitors develop), and accordingly, may weigh the value of seeking
an execution in such a facility against any perceived risks.\283\ BZX
also stated that the proposal should not be evaluated based on
speculation about whether others might mimic the functionality in the
future.\284\
---------------------------------------------------------------------------
\281\ See BZX Letter 1 at 4; BZX Letter 2 at 3; and BZX
Statement at 19.
\282\ See BZX Letter 2 at 8; and BZX Statement at 18.
\283\ See BZX Letter 2 at 8-9; and BZX Statement at 19. In
contrast, NYSE argued that it is irrelevant whether it is optional
to send market orders to the Cboe Market Close, as the analysis
should turn on whether the mere existence of the Cboe Market Close
would increase complexity and operational risk in the market. See
NYSE Letter 3 at 2.
\284\ See BZX Statement at 19.
---------------------------------------------------------------------------
3. Commission Discussion and Findings
The Cboe Market Close will offer market participants an additional
venue to which they may send orders for execution at the official
closing price and an additional data feed that some market participants
may choose to monitor. However, as several commenters stated, many
market participants already monitor multiple data feeds, and the
Commission believes that the market participants that monitor
information disseminated by BZX relating to Cboe Market Close would
likely already maintain systems and software that are able to aggregate
such feeds. While NYSE and Nasdaq argue that many closing auction
[[Page 4747]]
participants are less active, less sophisticated participants that
would not have the systems or ability to aggregate an additional feed,
there are currently numerous destinations available to send MOC
orders--primary listing auctions, competing auctions, ATSs, and other
off-exchange venues. As a result, the Commission believes that even
less active traders seeking closing executions likely already monitor,
have the capability to monitor, or rely on their broker-dealers to
monitor, multiple data points for closing auction liquidity and
information.
Further, the Commission notes that exchanges currently offer a wide
array of proprietary market data products providing expansive trading
information, including auction information.\285\ Unlike some of these
other proprietary market data feeds offered by certain exchanges, the
Cboe Auction Feed is equally available to all market participants at no
charge,\286\ and, as part of this proposal, BZX has proposed to enhance
the Cboe Auction Feed to include only one point of additional data
(total matched shares in the Cboe Market Close), once a day.
Accordingly, the Commission does not believe that monitoring the Cboe
Auction feed or having one additional venue to which market
participants may submit MOC interest would significantly increase
complexity or fragmentation, or impose substantial burdens on market
participants, in such a manner as to render the proposal inconsistent
with the Act.\287\ Specifically, the Commission does not believe that
the proposal adds such a level of complexity so as to be inconsistent
with the Act, such as, among other things, by impeding fair and orderly
markets, imposing impediments to a free and open market and a national
market system, being unfairly discriminatory, or impeding fair
competition among market participants.
---------------------------------------------------------------------------
\285\ See, e.g., Clearpool Letter at 2 (stating that imbalance
feeds that are published for NYSE's and Nasdaq's closing auctions
are only available as part of the exchanges' premium data products).
Therefore, less active traders that wish to trade in the NYSE or
Nasdaq closing auction arguably already would have the technology
and systems necessary to integrate the additional proprietary data
products offered by the exchanges.
\286\ BZX does not charge a fee for the data provided by the
Cboe Auction Feed, which also includes market data not related to
Cboe Market Close; however, BZX does charge logical port and
connectivity fees for the receipt of the Cboe Auction Feed.
\287\ See also supra Section III.B. further discussing and
addressing concerns regarding the potential effects of the proposal
on fragmentation of the markets.
---------------------------------------------------------------------------
In addition, in response to comments regarding the potential for
other exchanges and venues to adopt similar functionality that would
require monitoring of even more data feeds, again the Commission
believes that those participants that would choose to monitor such data
feeds likely already have the capability to monitor and aggregate
information from multiple data feeds.
Finally, the Commission believes that because BZX will disseminate
the amount of paired-off shares well in advance of the order entry cut-
off times for the primary listing exchanges' closing auctions, the
proposal is reasonably designed to limit market complexity and risk by
giving market participants adequate time to review the necessary data,
make informed decisions about closing order submission, and route
orders to the primary listing exchange when desired.\288\
---------------------------------------------------------------------------
\288\ As noted above, NYSE pointed out one instance on NYSE Arca
and NYSE American where, pursuant to their rules, if there is an
order imbalance priced outside of the Auction Collars, orders are
not guaranteed to participate in the closing auction, and MOC orders
entered earlier in the day have priority over later-arriving MOC
orders. As such, NYSE argued that if a market participant waits to
enter an MOC order on NYSE Arca or NYSE American until after their
MOC order is cancelled by BZX, that MOC order could lose priority
over earlier-entered MOC orders. See supra note 275. However, as
noted above, market participants are not required to send MOC orders
to Cboe Market Close. Further, the Commission believes that the
operation of the NYSE Arca and NYSE American's auctions are clearly
delineated in their rules, and this limited scenario is the type of
potential risk that the Commission expects that market participants
will need to evaluate in any determination as to whether to send
their orders to Cboe Market Close.
---------------------------------------------------------------------------
E. Manipulation
1. Manipulation Due to Information Asymmetries
a. Comments on the Proposal
Several commenters asserted that the proposal would increase the
risk of manipulation. Commenters argued that the proposal increases
opportunities for manipulation due, in part, to the information
asymmetries that they argue Cboe Market Close would create. For
example, Nasdaq argued that information obtained by Cboe Market Close
participants regarding their paired-off MOC orders could be used to
gauge the depth of the market, the direction and magnitude of existing
imbalances, and the likely depth remaining at Nasdaq, creating
manipulation opportunities and undermining fair and orderly
markets.\289\ Similarly, NYSE offered several hypothetical examples to
illustrate how Cboe Market Close could potentially be used to
manipulate the official closing price, including by providing market
participants who participate in Cboe Market Close with useful
information that is unavailable to other market participants, such as
the direction of an imbalance.\290\ Although not citing concerns
regarding manipulation specifically, T. Rowe Price similarly argued
that the proposal would lead to information asymmetries that could
result in changes in continuous trading behavior leading into the
market close as some market participants could be trading on
information gathered from Cboe Market Close pairing results.\291\
Specifically, T. Rowe Price asserted that a market participant that is
aware of the composition of volume paired-off through Cboe Market Close
at 3:35 p.m. would be in a position to use that information to
influence its trading behavior over the next ten to fifteen minutes
leading in to the closing auction cut-off times on NYSE and Nasdaq,
respectively.\292\
---------------------------------------------------------------------------
\289\ See Nasdaq Letter 1 at 8; Nasdaq Letter 2 at 13-14; Nasdaq
Statement at 17-20; and Pitt/Spatt Report at 21-23. The Nasdaq
Statement and accompanying Pitt/Spatt Report provided several
examples to illustrate how such information could potentially be
utilized to ``mark the close,'' learn the direction of the order
imbalance, and/or determine the relative magnitude of the imbalance.
For example, Nasdaq argued that a market participant could enter
both buy and sell MOC orders in the Cboe Market Close to learn the
likely direction of the MOC imbalance in advance of other market
participants and use such information to its benefit in the closing
auction on the primary listing exchange. See Nasdaq Statement at 17-
20; and Pitt/Spatt Report at 21-23.
\290\ See NYSE Letter 1 at 6; and NYSE Statement at 28-30.
However, ViableMkts argued that because these market participants
would not know the full magnitude of the imbalance, it does not
believe the proposal creates an incremental risk of manipulation.
See ViableMkts Letter at 5.
\291\ See T. Rowe Price Letter at 2-3.
\292\ See id. T. Rowe Price argued that, as a result, the
proposal could not only affect price discovery in closing auctions
on the primary listing exchanges but it could also affect continuous
trading behavior. See id.
---------------------------------------------------------------------------
While Nasdaq acknowledged that information asymmetries exist today
as a result of broker-dealer MOC order matching services, it argued
that BZX, ``as a neutral platform, is more likely to gather orders from
multiple brokers and enable a small number of participants to gain
actionable asymmetric information,'' which could potentially change the
Nasdaq closing price.\293\
[[Page 4748]]
Nasdaq also distinguished its closing auction from the proposed Cboe
Market Close, stating that by having its data dissemination and cut-off
time occur simultaneously, all market participants learn the imbalance
at the same time, avoiding such risks.\294\
---------------------------------------------------------------------------
\293\ See Nasdaq Letter 2 at 14. Nasdaq argued that this would
weaken the price discovery process, create a cycle of closing price
deterioration, and increase volatility. See id. But see supra
Section III.B, discussing why the Commission believes the proposal,
based on its design, will not disrupt the price discovery process of
the primary listing exchanges' closing auctions.
\294\ See Nasdaq Letter 2 at 14; Nasdaq Statement at 18; and
Pitt/Spatt Report at 23.
---------------------------------------------------------------------------
Nasdaq further argued that information asymmetries can undermine
public confidence in the markets.\295\ In particular, Nasdaq asserted
that the proposal could disincent market participants from submitting
LOC orders for fear of competing with other market participants with
more market information.\296\ This decreased liquidity, Nasdaq argued,
could make stocks even more susceptible to manipulation, particularly
those with relatively lower levels of liquidity.\297\
---------------------------------------------------------------------------
\295\ See Nasdaq Statement at 19.
\296\ See Nasdaq Statement at 19.
\297\ See Nasdaq Statement at 19-20.
---------------------------------------------------------------------------
b. BZX Response to Comments
In contrast, BZX argued that information asymmetries are inherent
in trading, including the primary listing exchanges closing
auctions.\298\ For example, BZX argued that the current operation of d-
Quotes \299\ on NYSE provides an informational advantage to NYSE DMMs
and floor brokers, and allows d-Quotes to be entered, modified, or
cancelled up until 3:59:50 p.m. while other market participants are
prohibited from entering, modifying or cancelling on-close orders after
3:45 p.m.\300\ Lastly, BZX argued that the information disseminated
through the Cboe Auction Feed would not provide any indication of
whether the cancelling of a particular side of an order that has not
been matched back to a market participant ``is meaningful or just
happenstance,'' which limits this information's ability to create or
increase manipulative activity.\301\
---------------------------------------------------------------------------
\298\ See BZX Letter 1 at 11-12; BZX Letter 2 at 9; and BZX
Statement at 20.
\299\ Pursuant to NYSE Rules, a floor broker may enter
discretionary instructions as to size and/or price with respect to
his or her e-Quotes (``discretionary e-Quotes'' or ``d-Quotes'').
The discretionary instructions relate to the price at which the d-
Quote may trade and the number of shares to which the discretionary
price instructions apply. Discretionary instructions are active
during the trading day, unless the Protected Best Bid and Offer
(``PBBO'') (as defined in NYSE Rule 1.1(o)) is crossed, and at the
opening, reopening and closing transactions, and may include
instructions to participate in the opening or closing transaction
only. Exchange systems will reject any d-Quotes that are entered 10
seconds or less before the scheduled close of trading. Executions of
d-Quotes within the discretionary pricing instruction range are
considered non-displayable interest. See NYSE Rule 70.25(a).
\300\ See BZX Letter 1 at 12; and BZX Letter 2 at 9. The
Commission notes that NYSE's cut-off time for entering, modifying,
or cancelling on-close orders is now 3:50 p.m. See NYSE Rule
123C(2)(a)(i).
\301\ See id.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
While commenters argue that those who participate in Cboe Market
Close would be able to discern the direction of an imbalance and use
such information to manipulate the closing price, the Commission
believes the utility of such gleaned information is limited. In
particular, a market participant would only be able to determine the
direction of the imbalance, and would have difficulty determining the
magnitude of any imbalance, as it would only know the unexecuted size
of its own order.\302\ In addition, the information would only be with
regard to the pool of liquidity on BZX and would provide no insight
into imbalances on the primary listing exchange, competing auctions,
ATSs, or other off-exchange matching services which, as described
above, can represent a significant portion of trading volume at the
close.
---------------------------------------------------------------------------
\302\ While Nasdaq argued that the size of a market
participant's cancelled order and time of day would provide some
indication of the magnitude of the imbalance, as discussed herein,
the Commission believes the value of this information to be
extremely limited as it does not give accurate or comprehensive
insight into the overall MOC imbalance size in the Cboe Market Close
or of the MOC imbalances in the entire market inclusive of other
venues. See Nasdaq Statement at 18. The Commission acknowledges that
the greater the size of the cancelled order, the more useful the
information may be in determining the imbalance magnitude on Cboe
Market Close, but the Commission believes it is unlikely that a
market participant would risk placing and receiving an execution of
a large MOC order (for example, 10,000 shares as in Nasdaq's
example), purely to gain limited insight into MOC imbalance size.
The risk of receiving an execution of a large order that may be
inconsistent with a market participant's goals is likely to eclipse
any limited potential benefit that could be gained.
---------------------------------------------------------------------------
Likewise, while a market participant would be able to determine
whether its own order made up a large or small percentage of the
paired-off shares for a security in Cboe Market Close, it would not be
able to determine the composition of same-side or contra-side MOC
orders submitted to Cboe Market Close, nor would such information
enable it to determine the composition of orders submitted to the
primary listing exchange, competing auctions, ATSs, or other off-
exchange matching services.\303\ Therefore, the Commission believes the
utility of this information is also limited.
---------------------------------------------------------------------------
\303\ While one commenter expressed concern that market
participants that are aware of the composition of volume paired-off
through Cboe Market Close would be in a position to use that
information to influence their trading behavior leading up to the
close, under BZX's proposal, BZX would only publish the size, and
not the composition, of paired-off MOC shares, and such disseminated
information would be available to all market participants. See supra
notes 291-292 and accompanying text.
---------------------------------------------------------------------------
Further, the Commission believes information asymmetries as those
described by commenters exist today and are inherent in trading,
including with respect to closing auctions. For example, any party to a
trade gains valuable insight regarding the depth of the market when an
order is executed or partially executed. In addition, on NYSE, not only
DMMs,\304\ but also NYSE floor brokers have access to closing auction
imbalance information that is not simultaneously available to other
market participants, far in advance of the NYSE order entry cut-off
time. Specifically, pursuant to NYSE rules, floor brokers receive the
amount of, and any imbalance between, MOC and marketable LOC interest
every fifteen seconds beginning at 2:00 p.m. until 3:50 p.m.\305\ Floor
brokers are permitted to provide their customers with specific data
points from this imbalance feed. In arguing for the Commission to
approve its proposal to disseminate such information to floor brokers,
NYSE stated that the imbalance information does not represent overall
supply or demand for a security, but rather is a small subset of buying
and selling interest that is subject to change before the close, nor is
it actionable prior to 15 minutes before the close.\306\ NYSE further
asserted that it believed the information it disseminates to all
participants at 3:45 p.m. is more material to investors, as it is more
accurate, complete, and timely information.\307\
---------------------------------------------------------------------------
\304\ The Commission has acknowledged the information
asymmetries that benefit DMMs, explaining that, ``[i]n return for
their obligations and responsibilities, DMMs have significant
priority and informational advantages in trading on the Exchanges,
both during continuous trading and during the closing auction'' and
that ``DMMs have unique access to aggregated information about
closing auction interest at each price level, and during the auction
itself, DMMs are aware of interest represented by floor brokers,
which is not publicly disseminated''. See Securities Exchange
Release No. 81150 (July 20, 2017), 82 FR 33534, 33536-37 (July 20,
2017) (NYSE-2016-71 and NYSEMKT-2016-99) (``NYSE DMM Disapproval
Order'').
\305\ See NYSE Rule 123C(6)(b).
\306\ See Securities Exchange Act Release No. 62923 (Sept. 15,
2010), 75 FR 57541, 57542 (Sept. 21, 2010) (SR-NYSE-2010-20; SR-
NYSEAmex-2010-25).
\307\ See id.
---------------------------------------------------------------------------
The Commission believes that the same arguments apply with respect
to BZX's proposal. In particular, as discussed above, even if a market
participant becomes aware of the
[[Page 4749]]
direction of the imbalance for a security in Cboe Market Close as a
result of receiving a cancellation of part or all of that participant's
order, such information does not represent overall supply or demand for
the security, is subject to change before the close, and is only one
piece of relevant information. Therefore, given these limitations, the
Commission believes that such information is likely less useful than
other more comprehensive information regarding the close that would be
available to market participants, such as the total matched amount of
MOC shares that would be disseminated by BZX at 3:35 p.m. and available
to all market participants on equal terms, as well as any imbalance
information disseminated by the primary listing exchanges.
Given the limited usefulness of information that can be discerned
from participants of Cboe Market Close, the Commission also believes it
is unlikely that the proposal will have a negative effect on public
confidence in the markets or on market participants' use of LOC orders
in the close. This is not to say that merely because some information
asymmetries exist in the market today and are inherent in all trading
that those created by Cboe Market Close need not be carefully
considered. Rather, after careful consideration and analysis of the
proposal and the information that may be gleaned from Cboe Market
Close, its utility, and potential use, the Commission believes BZX has
demonstrated that the potential for increased manipulation due to
information asymmetries created by this proposal is negligible and that
it is in line with other proposals that have similarly introduced
certain limited information asymmetries into the market but been found
by the Commission to be consistent with the Act, as described
above.\308\
---------------------------------------------------------------------------
\308\ The Commission believes that Nasdaq's reliance on recent
Direct Edge and NYSE enforcement cases as support for the principle
that the Commission has found informational advantages to be
inconsistent with the Act is misplaced. See Nasdaq Statement at 19.
Both of the cases cited by Nasdaq are distinguishable from the
current proposal in that they involved instances where the
exchanges' rules were inaccurate or incomplete regarding the
description of the operation of certain order types. Informational
asymmetries arose as a result of such inaccuracies and/or omissions
in the exchanges' rules and because only certain members had access
to correct information regarding the operation of such order types.
See Securities Exchange Act Release No. 82808, In the Matter of NYSE
LLC, NYSE American LLC, and NYSE Arca, Inc. (Mar. 6, 2018),
available at: https://www.sec.gov/litigation/admin/2018/33-10463.pdf
and Securities Exchange Act Release No. 74032, In the Matter of EDGA
Exchange, Inc. (Jan. 12, 2015) (settled orders), available at:
https://www.sec.gov/litigation/admin/2015/34-74032.pdf (``It is
essential that an exchange operate in compliance with its own rules
regarding order types so that the exchange's members and all other
participants in trading that occurs on an exchange can understand on
what terms and conditions their trading will be conducted. When an
exchange fails to completely and accurately describe its order types
in its rules, it creates a significant risk that the manner in which
those order types operate will not be understood by all market
participants, thereby compromising the integrity and fairness of
trading on that exchange. This risk is compounded when the exchange
discloses information regarding the operation of those order types
to some but not all of its members.'').
---------------------------------------------------------------------------
2. Other Causes for Increased Potential for Manipulation
a. Comments on the Proposal
Commenters advanced several other theories as to how the proposal
could enhance the risk of manipulation.\309\ For example, NYSE and
Nasdaq asserted that the potential for manipulative activity at the
close would increase because primary listing exchange closing auctions
would decrease in size and thus be easier to manipulate.\310\ NYSE and
Nasdaq also argued that the proposal facilitates manipulative activity
by providing an incentive for market participants to influence the
closing price when they know they have been successfully matched on BZX
to the benefit of the price of its already matched order.\311\ Further,
NYSE argued that market participants could manipulate information
leading up to the close by entering orders into Cboe Market Close in an
attempt to send a false signal regarding demand and subsequently
reverse such positions after hours.\312\
---------------------------------------------------------------------------
\309\ See, e.g., NYSE Letter 1 at 6; NYSE Report at 19-22; and
Americas Executions Letter.
\310\ See NYSE Letter 1 at 6; and Nasdaq Statement at 19-20. See
also supra notes 295-297 (discussing Nasdaq's assertion that the
proposal would affect public confidence in the markets, resulting in
decreased liquidity and more susceptibility to manipulation).
\311\ See NYSE Letter 1 at 6; NYSE Report at 19; Nasdaq
Statement at 17; and Pitt/Spatt Report at 22-23.
\312\ See NYSE Report at 19-20.
---------------------------------------------------------------------------
Some commenters did not believe Cboe Market Close would increase
manipulation. For example, one commenter stated that incentives to
manipulate the closing price already exist and it is unlikely the
proposal would result in increased manipulation of the market
close.\313\
---------------------------------------------------------------------------
\313\ See Angel Letter at 5.
---------------------------------------------------------------------------
b. BZX Response to Comments
In response, BZX argued that the proposal does not introduce any
specific or new ways to manipulate the closing price.\314\ BZX further
asserted that commenters' arguments regarding increased chances for
manipulation ignore the supervisory responsibilities and capabilities
of exchanges and the existing cross-market surveillance conducted by
FINRA today.\315\ As discussed in more detail below, BZX stated that it
would continue to surveil for potentially manipulative activities and
made commitments to enhance surveillance procedures and work with other
SROs to detect and prevent manipulation through the use of Cboe Market
Close.\316\
---------------------------------------------------------------------------
\314\ See BZX Letter 1 at 11; BZX Letter 2 at 9; and BZX Letter
4 at 1-2.
\315\ See BZX Letter 1 at 11; and BZX Letter 2, at 9.
\316\ See BZX Letter 1 at 11; BZX Letter 2 at 9; and BZX Letter
4 at 1-2. See also infra Section III.E.3.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
The Commission recognizes that, with or without Cboe Market Close,
the potential exists that there may be market participants who may seek
to engage in manipulative or illegal trading activity, including with
respect to closing prices.\317\ While an exchange must show that their
proposal is designed to prevent fraudulent and manipulative acts and
practices, the Act does not require an exchange to ensure, with
certainty, that their proposal will not give rise to any attempted
manipulation or illegal acts. Scholarly articles have suggested that
closing auction manipulations are often characterized by large,
unrepresentatively priced orders submitted in the final seconds of the
auction.\318\ Accordingly, while it is possible that the potential for
manipulation could increase if the closing auctions on the primary
listing exchanges decreased significantly in size, existing
surveillance systems should be able to continue to detect such
activity.\319\ With respect to NYSE's
[[Page 4750]]
comment that the proposal would provide an incentive for market
participants to influence the closing price when they know they have
been successfully matched on BZX, market participants can attempt this
today with respect to existing off-exchange MOC matching services,
including ATSs (which are surveilled by FINRA), and any attempts to use
Cboe Market Close to do this would result in such activity occurring on
BZX, a national securities exchange with obligations under the Act to
regulate and surveil its market. Similarly, entering non-bona fide
orders in an attempt to give the appearance of high demand is not a new
form of potential manipulation unique to the proposal; rather, similar
forms of market manipulation exist today, and the Commission believes
that current surveillance systems are designed to detect such activity.
---------------------------------------------------------------------------
\317\ NYSE also asserted that arbitrageurs will look for
opportunities presented by Cboe Market Close to ``gam[e] the
system.'' However, NYSE also acknowledged that, ``[i]t is hard to
predict all of the ways in which, and the degree to which, this
might occur because it will depend on a wide range of variables,
including the degree of usage of the [Cboe Market Close], the
changes to order flow and liquidity provision in the primary listing
exchange's closing mechanism, the profits realized from
manipulation, and the vitality of market oversight.'' See NYSE
Report at 19-22. Further, the Pitt/Spatt Report acknowledged that,
``closing prices are inherently somewhat vulnerable to
manipulation.'' See Pitt/Spatt Report at 22.
\318\ See Carole Comerton-Forde and Talis J. Putnins,
``Measuring Closing Price Manipulation,'' Journal of Financial
Intermediation 20, 135-158 (2011), available at https://www.sciencedirect.com/science/article/pii/S104295731000015X; and
Talis J. Putnins, ``Market Manipulation: A Survey,'' Journal of
Economic Surveys, 26, 952-967 (2012), available at http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6419.2011.00692.x/full.
\319\ See infra Section III.E.3 for discussion of the
obligations under the Act of national securities exchanges, as self-
regulatory organizations, to surveil for manipulative activity on
their markets.
---------------------------------------------------------------------------
3. Surveillance
a. Comments on the Proposal
Lastly, some commenters argued that BZX and other exchanges would
need to develop new cross-market surveillance systems in order to
address these risks and expressed concerns regarding the costs and
complexities of doing so.\320\ For example, NYSE stated that there are
no safeguards built-in to the proposal to prevent manipulation, and
identifying manipulative activity would also become more difficult
under the proposal due to the time difference between the Cboe Market
Close and primary listing exchange closing auctions and the cross-
market nature of the manipulation.\321\ Further, NYSE argued that
market participants may have legitimate reasons to want to reverse
their trades that have been matched in Cboe Market Close by trading in
the primary listing exchange auction, and thus, it would be difficult
to distinguish between manipulative behavior and legitimate trading
activity.\322\ Both NYSE and Nasdaq stated that BZX's commitment to
enhance its surveillance mechanisms \323\ and its statutory obligation
to surveil for manipulative activity was insufficient to render the
proposal consistent with the Act.\324\ Nasdaq recommended that, at a
minimum, BZX should be required to memorialize its enhanced procedures
in its rules,\325\ and NYSE added that BZX must demonstrate
affirmatively that the proposal is designed to prevent fraudulent
activity, not merely mitigate the risks of such activity.\326\ In
contrast, IEX argued that participation in the Cboe Market Close,
followed by activity intended to affect the closing price on the
primary listing exchange, would make manipulation of closing crosses as
or more conspicuous than other trading patterns for which exchanges
already conduct surveillance.\327\ Two commenters also stated that the
Consolidated Audit Trail would provide a new tool for detecting any
such manipulation.\328\
---------------------------------------------------------------------------
\320\ See Nasdaq Letter 2 at 14; Nasdaq Statement at 20-21;
Pitt/Spatt Report at 23-24; NYSE Report at 20-21; NYSE Letter 1 at
6; NYSE Statement at 30; GTS Securities Letter 1 at 6; and GTS
Securities Letter 2 at 5.
\321\ See NYSE Report at 20-21; NYSE Letter 1 at 6; and NYSE
Statement at 30.
\322\ See NYSE Report at 19; and NYSE Statement at 30.
\323\ See infra notes 329-338 and accompanying text.
\324\ See Nasdaq Statement at 21; and NYSE Statement at 31. As
support for this argument, Nasdaq and NYSE referenced a Commission
disapproval of a proposal by NYSE to eliminate certain restrictions
on the trading activities of DMMs that were designed to address the
risk of manipulative activity. See Nasdaq Statement at 21; and NYSE
Statement at 31 (discussing the Commission's disapproval of NYSE-
2016-17). See also NYSE DMM Disapproval Order, supra note 304.
\325\ See Nasdaq Statement at 21 (citing the Commission's
Benchmark Disapproval Order as support for the assertion that an
exchange must include any enhanced procedures to mitigate risk in
its rules). See also Securities Exchange Act Release No. 68629 (Jan.
11, 2013), 78 FR 3928 (Jan. 17, 2013) (NASDAQ-2012-059).
\326\ See NYSE Statement at 31.
\327\ See IEX Letter at 2.
\328\ See id. at 2-3; and Bollerman Letter at 2.
---------------------------------------------------------------------------
b. BZX Response to Comments
In response, BZX made several arguments as to why it does not
believe that the proposal creates a potential for increased
manipulation.\329\ BZX stated that, should the Commission approve the
proposal, both it and FINRA, as well as other exchanges, would continue
to surveil for manipulative activity and seek to address such
behavior.\330\ BZX further stated that it is ``committed to enhancing
its current surveillance procedures and working with other [SROs],
including FINRA, the NYSE, and Nasdaq, to ensure that any potential
inappropriate trading activity is detected and prevented.'' \331\ In
addition, BZX stated that, consistent with its obligations as an SRO,
it currently surveils all trading activity on its system including
trading activity at the close, and intends to implement and enhance in-
house surveillance processes designed to detect potential manipulative
activity related to the Cboe Market Close.\332\ In particular, BZX
stated that the surveillance would include, among other things,
monitoring for possible non-bona fide order activity, such as the
submission of orders for the purpose of gaining an informational
advantage, the entry of large size orders on one side of the market, or
other trading activity that would indicate a pattern or practice aimed
at manipulating the closing auction.\333\ BZX committed to provide the
Commission staff its surveillance plan and stated that it would
implement that plan on the date that Cboe Market Close becomes
available to market participants.\334\
---------------------------------------------------------------------------
\329\ See BZX Letter 1 at 11-12; and BZX Letter 2 at 9.
\330\ See BZX Letter 1 at 11; and BZX Letter 2 at 9.
\331\ See Letter from Joanne Moffic-Silver, Executive Vice
President, General Counsel, and Corporate Secretary, Cboe Global
Markets, Inc. (Jan. 12, 2018) (``BZX Letter 4'') at 1. See also BZX
Statement at 21-22.
\332\ See BZX Letter 4 at 1.
\333\ See BZX Letter 4 at 1.
\334\ See id. at 2.
---------------------------------------------------------------------------
BZX also highlighted the cross-market surveillance that FINRA
conducts on its behalf.\335\ In particular, BZX stated that FINRA's
comprehensive cross-market surveillance program can monitor for
nefarious activity by a market participant across two or more markets
and includes surveillance designed to detect activity geared towards
manipulating a security's closing price.\336\ Stating that it currently
provides FINRA the necessary trade data to conduct such surveillance,
BZX represented that it is also committed to work with FINRA on
enhancements to the current cross market surveillance program to
account for any potential manipulative activity by participants in Cboe
Market Close and the primary listing exchanges' closing auctions.\337\
BZX also stated that, as a member of the Intermarket Surveillance Group
(``ISG''), it would share the necessary information concerning Cboe
Market Close with NYSE and Nasdaq, as part of their participation in
ISG, to allow them to properly surveil for potentially manipulative
activity within their closing auctions.\338\
---------------------------------------------------------------------------
\335\ See id. Under regulatory services agreements, national
securities exchanges, such as BZX, may enter into contracts with
other regulatory entities, such as FINRA, to provide regulatory
services on the exchange's behalf. Notwithstanding the existence of
a regulatory services agreement, the exchange retains legal
responsibility for the regulation of its members and its market and
the performance of its regulatory services provider.
\336\ Id.
\337\ See id. at 2; and BZX Statement at 21.
\338\ See BZX Letter 4 at 2; and BZX Statement at 21.
---------------------------------------------------------------------------
c. Commission Discussion and Findings
With respect to manipulative or illegal trading activity more
broadly, self-regulatory organizations such as
[[Page 4751]]
BZX and the primary listing exchanges have an obligation under the Act
to surveil for manipulative activity on their markets. The Commission
agrees with commenters who say that relying on this obligation alone
and/or a mere declaration that existing surveillances are adequate is
not necessarily sufficient to render a proposal consistent with the
Act. At the same time, contrary to commenters' assertions that enhanced
surveillance procedures must be included as part of the exchange's
proposed rules,\339\ exchanges generally do not delineate detailed
surveillance procedures in their rules as doing so could present a
security risk and potentially give those seeking to engage in
manipulative behavior advance notice as to how the exchange will be
monitoring and surveilling for such behavior and potentially a roadmap
for evading detection.\340\
---------------------------------------------------------------------------
\339\ As noted above, Nasdaq argued that the Commission made
clear in its Benchmark Disapproval Order that if an exchange
represents that it will enhance its oversight procedures to mitigate
the risks of a proposal, it must, at a minimum, memorialize such
procedures in its rules. See supra note 325. However, the Commission
does not agree that the Benchmark Disapproval Order imposed such a
requirement. The Benchmark Disapproval Order discussed the lack of
order handling requirements being set forth in the Nasdaq proposed
rule change. The Benchmark Order Disapproval did not express the
need for surveillance procedures to be set forth in a proposed rule
change. The Benchmark Disapproval Order discussion was specific to
concerns regarding risk controls of Rule 15c3-5 and the general
statements that were made by Nasdaq that although such Rule 15c3-5
risk controls were inapplicable, it would impose substantial risk
controls on the proposed Benchmark Orders. The Commission noted in
its disapproval order that Nasdaq had not amended the proposed rule
change to address this concern or detail its commitments, but that
if appropriately developed and reflected in the proposed rule
change, the Commission's concerns could have been potentially
addressed. See Benchmark Disapproval Order at 3929-30.
\340\ The staff reviews the adequacy and effectiveness of self-
regulatory organizations' surveillance procedures and programs as
part of its routine and for-cause examinations and inspections.
---------------------------------------------------------------------------
For the reasons discussed above, the Commission believes that the
proposal raises only a minimal risk of increased manipulation, and
this, coupled with the detailed commitments made by BZX to enhance
surveillance and share surveillance plans with the Commission
staff,\341\ support the Commission's finding that BZX has demonstrated
that its proposal is designed to prevent fraudulent and manipulative
acts and practices.\342\ In particular, the Commission believes that
existing self-regulatory organization surveillance and enforcement
activity, and the enhanced measures that the Exchange has represented
that it would take to surveil for and detect manipulative activity
related to the proposal, would help to deter market participants who
might otherwise seek to try and abuse Cboe Market Close or a closing
auction on a primary listing exchange. While the Commission agrees with
BZX that the proposal raises minimal risk of increased manipulation, it
also believes that it is prudent and consistent with an Exchange's
surveillance obligations to undertake efforts to tailor and enhance
surveillance measures in anticipation of any potentially manipulative
conduct that may arise in connection with Cboe Market Close. Such
actions to enhance surveillance procedures are not unique to the
current proposal; rather, exchanges commonly make changes to their
surveillance programs to better detect manipulative or improper
behavior in connection with proposed rule changes to implement new
functionality. Thus, the Commission expects that, once the proposal is
implemented, BZX will continue to closely monitor Cboe Market Close and
implement new or enhanced surveillance measures, as necessary, designed
to identify potential manipulative behavior that potentially could
result from Cboe Market Close. Further, the Commission expects that, as
required by Section 19(g)(1) of the Act,\343\ BZX, FINRA, and other
national securities exchanges will enforce compliance by their members
and persons associated with their members with the Act, the rules and
regulations thereunder, and their own rules, including with regard to
manipulative conduct.
---------------------------------------------------------------------------
\341\ Id.
\342\ As noted above, NYSE and Nasdaq referenced the NYSE DMM
Disapproval Order as support for the argument that an exchange must
affirmatively demonstrate that its proposal is designed to prevent
fraudulent activity and that a mere commitment to comply with market
surveillance obligations is insufficient. See NYSE DMM Disapproval
Order. As stated, the Commission generally agrees with these
principles; however, it believes that the factual differences
between the NYSE DMM Disapproval Order and the current BZX proposal
support a different outcome. In particular, in the case of the NYSE
DMM Disapproval Order, NYSE proposed to eliminate existing
restrictions on DMM trading activity that, when adopted and
subsequently retained through several market model changes, were
determined to be necessary to address the risk of DMM manipulative
activity. Although NYSE asserted that the rule was no longer needed
because of developments in the equity markets and that existing
rules and surveillances would address the manipulation risk, the
Commission found, among other things, that NYSE had not met its
burden of establishing how these other rules and surveillance
procedures were an adequate substitute for the rule that NYSE sought
to delete. See NYSE DMM Disapproval Order at 33537 (stating that,
``the Commission believes that NYSE and NYSE MKT have merely
asserted that, but not explained how, existing surveillances can act
as an adequate substitute for this bright-line rule''). In contrast,
as described above, the Commission believes that BZX has established
that there is minimal risk of increased manipulation from its
current proposal and has described its plans for enhanced
surveillance.
\343\ 15 U.S.C. 78s(g)(1).
---------------------------------------------------------------------------
With respect to NYSE's comment on the potential challenges that
time differences or cross-market activity may pose in identifying
manipulative activity,\344\ these issues also exist today with respect
to existing off-exchange MOC matching services as well as to trading
generally. Surveillance procedures already must account for time
differences and cross-market activity throughout the trading day. To
the extent that such attempted manipulative activity instead occurs on
BZX, it would simply shift surveillance from FINRA to BZX, a national
securities exchange with obligations under the Act to regulate and
surveil its market. Further, with regard to comments concerning the
challenge of differentiating between legitimate trading and
manipulative activity, this too exists today with regard to many
different trading scenarios and is not unique to this proposal. Despite
the challenges of detecting and accurately identifying manipulative
activity, SROs have been able to design their surveillance programs to
flag potentially manipulative behavior in a variety of contexts and
then subsequently further analyze and investigate such behavior to
determine whether, in fact, there is evidence of improper activity. The
Commission expects the same to be true with regard to Cboe Market
Close. Further, the Commission agrees with the commenters that noted
that the Consolidated Audit Trail is designed to provide an additional
cross-market surveillance mechanism that should help to identify and
prevent any potentially manipulative activity.
---------------------------------------------------------------------------
\344\ See supra note 321 and accompanying text.
---------------------------------------------------------------------------
F. Amendment No. 2
BZX filed Amendment No. 2 to the proposed rule change in response
to the statements submitted by Nasdaq and NYSE which stated, among
other arguments, that Cboe Market Close would potentially cause BZX to
violate Rule 201(b) of Regulation SHO.\345\
---------------------------------------------------------------------------
\345\ See supra note 10.
---------------------------------------------------------------------------
Rule 201(b) of Regulation SHO generally requires that trading
centers, such as the Exchange, establish, maintain, and enforce written
policies and procedures that are reasonably designed to (i) prevent the
execution or display of a short sale order of a covered security at a
price that is less than or equal to the current national best bid if
the price of that covered security decreases by 10% or more from that
[[Page 4752]]
covered security's closing price as determined by the listing market
for that covered security as of the end of regular trading hours on the
prior day, and (ii) impose such short sale circuit breaker restriction
for the remainder of the day and the following day. In addition, the
Exchange's policies and procedures, among other things, must be
reasonably designed to permit the execution or display of a short sale
order of a covered security marked ``short exempt'' without regard to
whether the order is at a price that is less than or equal to the
current national best bid.
In Amendment No. 2, the Exchange recognized that since the Cboe
Market Close will match buy and sell MOC orders at 3:35 p.m. without
knowing the later determined execution price (namely, the official
closing price as determined by the primary listing exchange), there is
a possibility that a short sale MOC order that is matched for execution
in the Cboe Market Close could result in an execution price that
violates Rule 201 of Regulation SHO. To prevent such a violation of
Rule 201 of Regulation SHO, the Exchange proposed to reject all short
sale MOC orders that are designated for participation in the Cboe
Market Close. The Exchange noted, however, that MOC orders marked
``short exempt'' are not subject to the short sale circuit breaker
restriction under Regulation SHO, and would therefore be accepted for
participation in the Cboe Market Close.
One commenter addressed the proposed Amendment No. 2.\346\ In
particular, Nasdaq acknowledged that the proposed amendment could help
BZX avoid violations of Rule 201 of Regulation SHO.\347\ The Commission
believes that the Exchange's proposed handling of short sale MOC orders
and ``short exempt'' MOC orders in the context of the Cboe Market
Close, as described in Amendment No. 2, will help to ensure that the
Exchange is in compliance with its responsibilities under Rule 201(b)
of Regulation SHO and is otherwise consistent with the protection of
investors and in the public interest.
---------------------------------------------------------------------------
\346\ See Nasdaq Letter 4.
\347\ See id. (noting also Nasdaq's belief that Amendment No. 2
did not address any of the other issues that had been raised in
prior comment letters).
---------------------------------------------------------------------------
IV. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with the Act and the rules and regulations
thereunder applicable to a national securities exchange.
It is therefore ordered, pursuant to Rule 431 of the Commission's
Rules of Practice, that the earlier action taken by delegated
authority, Exchange Act Release No. 82522 (January 17, 2018), 83 FR
3205 (January 23, 2018), is set aside and, pursuant to Section 19(b)(2)
of the Exchange Act, the proposed rule change (SR-BatsBZX-2017-34), as
modified by Amendment No. 1 and Amendment No. 2, hereby is approved.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01253 Filed 1-24-20; 8:45 am]
BILLING CODE 8011-01-P