Securities and Exchange Commission.
The Securities and Exchange Commission is issuing a final interpretation with respect to the definition of automated quotation under Rule 600(b)(3) of Regulation NMS.
Effective June 23, 2016.
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FOR FURTHER INFORMATION CONTACT:
Richard Holley III, Assistant Director, Michael Bradley, Special Counsel, or Michael Ogershok, Attorney-Adviser, Office of Market Supervision, at 202-551-5777, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.
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Rule 611 of Regulation NMS provides intermarket protection against trade-throughs for “automated” (as opposed to “manual”) quotations of NMS stocks. Under Regulation NMS, an “automated” quotation is one that, among other things, can be executed “immediately and automatically” against an incoming immediate-or-cancel order. The Regulation NMS Adopting Release issued in 2005 makes clear that this formulation was intended to distinguish and exclude from protection quotations on manual markets that produced delays measured in seconds in responding to an incoming order, because delays of that magnitude would impair fair and efficient access to an Start Printed Page 40786exchange's quotations.
In the Regulation NMS Adopting Release, the Commission interpreted the term “immediate” to “preclude[ ] any coding of automated systems or other type of intentional device that would delay the action taken with respect to a quotation.” 
In light of the application of Investors' Exchange LLC (“IEX”) 
to register as an exchange and technological and market developments since the adoption of Regulation NMS, the Commission decided to revisit this interpretation. The Commission believes its prior interpretation should be updated given technological and market developments since the adoption of Regulation NMS, in particular the emergence of low latency trading strategies and related technology that permit trading decisions to be made in microseconds, neither of which were contemplated by the Commission or commenters in 2005.
As further addressed below, the Commission now interprets “immediate” in the context of Regulation NMS as not precluding a de minimis intentional delay—i.e., a delay so short as to not frustrate the purposes of Rule 611 by impairing fair and efficient access to an exchange's quotations.
A. Regulation NMS: Automated Quotation and Protected Quotation
In general, Rule 611 under Regulation NMS (the “Order Protection Rule,” or “Trade-Through Rule”) protects the best “automated” quotations of exchanges by obligating other trading centers to honor those “protected” quotations by not executing trades at inferior prices, or “trading through” such best automated quotations.
Only an exchange that is an “automated trading center” 
displaying an “automated quotation” 
is entitled to this protection.
Trading centers must establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs of protected quotations, unless an exception or exemption applies.
There are several provisions in Regulation NMS that impact whether the Order Protection Rule applies. First, Rule 600(b)(58) defines a “protected quotation” as a “protected bid or a protected offer.” 
Rule 600(b)(57), in turn, defines a “protected bid or protected offer” as a quotation in an NMS stock that is: (i) Displayed by an “automated trading center,” (ii) disseminated pursuant to an effective national market system plan, and (iii) an “automated quotation” that is the best bid or best offer of a national securities exchange or national securities association.
In order for an exchange to operate as an “automated trading center,” it must, among other things, have “implemented such systems, procedures, and rules as are necessary to render it capable of displaying quotations that meet the requirements for an `automated quotation' set forth in [Rule 600(b)(3) of Regulation NMS].” 
Rule 600(b)(3) defines an “automated quotation” as one that:
i. Permits an incoming order to be marked as immediate-or-cancel;
ii. Immediately and automatically executes an order marked as immediate-or-cancel against the displayed quotation up to its full size;
iii. Immediately and automatically cancels any unexecuted portion of an order marked as immediate-or-cancel without routing the order elsewhere;
iv. Immediately and automatically transmits a response to the sender of an order marked as immediate-or-cancel indicating the action taken with respect to such order; and
v. Immediately and automatically displays information that updates the displayed quotation to reflect any change to its material terms.
Any quotation that does not meet the requirements for an automated quotation is defined in Rule 600(b)(37) as a “manual” quotation.
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In adopting Regulation NMS, the Commission recognized that there would be unintentional time delays by automated trading centers in responding to orders, albeit very short ones.
Although a number of commenters on Regulation NMS advocated for a specific time standard, ranging from one second down to 250 milliseconds,
to distinguish between manual and automated quotations,
the Commission declined to set such a standard.
Instead, in interpreting the term “immediate[ ]” when adopting Rules 600 and 611, the Commission stated that “[t]he term `immediate' precludes any coding of automated systems or other type of intentional device that would delay the action taken with respect to a quotation.” 
The only precise time standards approved by the Commission in Rule 611 and the Regulation NMS Adopting Release arise in the context of two exceptions to Rule 611 covering circumstances in which trade-through protection would not apply. These exceptions illustrate the time dimensions the Commission had in mind in distinguishing quotations that should receive trade-through protection from those that should not, and notably, both use a one-second standard.
Specifically, Rule 611(b)(1) provides that trading centers may trade through quotations of automated trading centers that experience a “failure, material delay, or malfunction.” 
The Commission accepted that the “immediate” standard necessarily would accommodate unintentional delays below the threshold of a “material delay,” which it interpreted in light of “current industry conditions” as one where a market was “repeatedly failing to respond within one second after receipt of an order.” 
The Commission similarly established a one-second standard for the exception in Rule 611(b)(8), which excepts trade-through protection where the trading center that was traded-through had displayed, within the prior one second, a price equal or inferior to the price of the trade-through transaction.
In discussing the 611(b)(8) exception, the Commission stated that it “generally does not believe that the benefits would justify the costs imposed on trading centers of attempting to implement an intermarket price priority rule at the level of sub-second time increments. Accordingly, Rule 611 has been formulated to relieve trading centers of this burden.” 
In adopting these exceptions to Rule 611, the Commission contemplated the existence of very short unintentional delays of a magnitude up to one second that would not affect the protected status of an “immediate” automated quotation. Since then, the market and the technology have evolved.
B. The Commission's Updated Interpretation of Automated Quotation
The Commission proposed to interpret “immediate” when determining whether a trading center maintains an “automated quotation” for purposes of Rule 611 “to include response time delays at trading centers that are de minimis, whether intentional or not.” 
The Commission further stated its preliminary belief “that, in the current market, delays of less than a millisecond in quotation response times may be at a de minimis level that would not impair a market participant's ability to access a quote, consistent with the goals of Rule 611 and because such delays are within the geographic and technological latencies experienced by market participants today.” 
As discussed below, the Commission received a number of comments on its proposed interpretation and, after considering those comments, has determined to issue a revised interpretation from that which it originally proposed, as detailed further below.
II. Comments Received and Commission Discussion
The Commission received 24 comments 
on its proposed Start Printed Page 40788interpretation.
Commenters raised a number of issues, including whether intentional sub-millisecond delays are in fact de minimis or would materially complicate market structure, as well as requests to clarify the scope and details of the interpretation.
A. De minimis for Purposes of Rule 611
Several commenters questioned whether de minimis intentional delays were permissible and whether delays of less than a millisecond could be considered de minimis in the current market. One commenter asserted that any intentional delay, even a de minimis one, “is flatly inconsistent with the plain meaning of `immediate[ ],' ” 
referring to the dictionary definition of that term as “ `[o]ccurring without delay' or `instant'.” 
Another commenter asserted that “[o]ne millisecond is not de minimis in any context except from the perspective of a human trader” and noted that a millisecond “is over 10 times longer than the response time of most exchanges today.” 
The commenter believed that sub-millisecond delays would “impair a market participant's ability to access a quote.” 
Another commenter argued that a millisecond is “excessively long when compared to computer response times.” 
One commenter believed that a sub-millisecond standard “will become obsolete at faster and faster rates” as communications technology evolves.
Other commenters expressed concern that intentional access delays, even de minimis ones, could add unnecessary complexity to the markets. In particular, the commenters stressed that such delays could cause orders to be routed to protected quotes that are no longer available. For example, one commenter expressed concern that the proposed interpretation could turn the national market system “into a hall of mirrors where it's impossible to know which prices are real and which are latent reflections.” 
The commenter opined that intentional access delays would “harm market transparency and degrade the value of the NBBO” and “lead directly to lower fill rates” when orders cannot be filled because the exchange with an access delay displays a stale better-priced quote that no longer exists but has yet to communicate that information.
Another commenter argued that the interpretation could make market structure “considerably more complex” and lead to “ghost quotes” that could “cloud price discovery and corrode execution quality.” 
The commenter further noted that “an artificial delay in an exchange quote anywhere affects the markets everywhere” and expressed concern that the proposed interpretation could negatively impact otherwise efficient and accessible markets.
One commenter expressed concern that intentional delays might “open the floodgates to a new wave of complex order types” with delays ranging from 1 to 1,000 microseconds.
Other commenters, however, opined that intentional access delays would not add complexity to the markets and would fit within current latencies experienced by trading centers. For example, one commenter asserted that a 350 microsecond delay is “not much more than the normal latency that all trading platforms impose,” and that an exchange could achieve the same delay by “locat[ing] its primary data center 65 or more miles away from the other exchange data centers.” 
In response to a comment that the dictionary definition of the term “immediate[ ]” precludes any delay in accessing quotations, the Commission notes that quotations cannot be accessed Start Printed Page 40789instantaneously.
As the Commission repeatedly acknowledged when adopting Regulation NMS, even “immediately” accessible protected quotations in the context of Rules 600 and 611 are necessarily subject to some delay.
Specifically, as noted above, the Regulation NMS Adopting Release discussed these delays and, although the Commission declined to set a specific time standard, it contemplated the existence of very short unintentional delays of a magnitude up to one second in the exceptions to Rule 611.
The Commission notes that, when it adopted Regulation NMS in 2005, processing times were longer than they are now.
Today, low latency technology permits trading decisions to be made in microseconds, and certain market participants use the fastest gateways and purchase co-location to compete to access quotations at those speeds.
As discussed further below, however, even the fastest market participants today must access protected quotations on trading centers where there are delays of several milliseconds as a result of geography alone. In addition, trading centers today are attempting to address concerns with the fastest trading strategies by creating very small delays in accessing their quotations.
The Commission does not agree that such efforts are incompatible with the Order Protection Rule. In the context of Regulation NMS, the term “immediate” does not preclude all intentional delays regardless of their duration, and such preclusion is not necessary to achieve the objectives of Rule 611. As long as any intentional delay is de minimis—i.e., does not impair fair and efficient access to an exchange's protected quotations—it is consistent with both the text and purpose of Rule 611.
In response to commenters that argued that an intentional de minimis delay would harm market transparency, degrade the NBBO, or cloud price discovery, the Commission notes, as discussed further below, that Rule 600(b)(3)(v) requires trading centers to immediately update their displayed quotations to reflect material changes. Market participants today already necessarily experience very short delays in receiving updates to displayed quotations, as a result of geographic and technological latencies, similar to those experienced when accessing protected quotations. The Commission does not believe the introduction of intentional delays of even smaller magnitude will impair fair and efficient access to protected quotations.
In response to commenters' concern that an intentional delay is not de minimis or could add complexity to the market, the Commission notes that its interpretation does not address whether delays are de minimis in all trading contexts, but rather only whether they impair fair and efficient access to an exchange's quotations when a market participant routes an order to comply with Rule 611.
Systems processing and transit times, whether at the exchange, the market participant sending the order, or its agent, all create latencies in accessing protected quotations.
Even the most technologically advanced market participants today encounter delays in accessing protected quotations of other “away” automated trading centers that either are transitory (e.g., as a result of message queuing) or permanent (e.g., as a result of physical distance). Furthermore, as noted above, any market participant co-located with the major exchanges' data centers in northern New Jersey necessarily encounters delays of 3-4 milliseconds—due to geography alone—in accessing the protected quotations of securities traded on the Chicago Stock Exchange's matching engine in Chicago.
No commenter asserted that the periodic message queuing or minor systems-processing delays encountered at exchanges with protected quotations, or the time it takes to access the protected quotes of the Chicago Stock Exchange's Chicago facility, would, for example, materially undermine market quality or price transparency, or the efficiency of order routing or trading strategies.
The Commission acknowledges that interpreting “immediate” to include an intentional de minimis access delay, because it would be additive, may increase the overall latency in accessing a particular protected quotation, albeit by a very small amount. Such delays may be a detectable difference for the most latency-sensitive market participants and could marginally impact the efficiency of some of their quoting and trading strategies, even if such intervals likely are immaterial to investors with less advanced trading technology or a longer-term investing horizon. But the Commission believes that just as the geographic and technological delays experienced today do not impair fair and efficient access to an exchange's quotations or otherwise frustrate the objectives of Rule 611, the addition of a de minimis intentional access delay is consistent with Rule 600(b)(3)'s “immedia[cy]” requirement.
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Further, the Commission notes that its interpretation uses a de minimis standard specifically so that it may evolve with technological and market developments. As it did when it established the “immediate” standard, the Commission believes it remains appropriate to avoid “specifying a specific time standard that may become obsolete as systems improve over time.” 
As explained further below, the Commission's revised interpretation provides that the term “immediate” precludes any coding of automated systems or other type of intentional device that would delay the action taken with respect to a quotation unless such delay is de minimis in that it would not impair a market participant's ability to fairly and efficiently access a quote, consistent with the goals of Rule 611.
B. Operation of Access Delays
Several commenters that expressed general concerns with an intentional access delay, even a de minimis one, expressed a particular concern with those that would be “selectively” applied (e.g., intentional delays that are applied to members but not to the exchange itself).
In addition, several commenters asserted that the Commission's proposed interpretation was overbroad based on their belief that it would “permit all sub-millisecond delays, regardless of how those delays operate, the reasoning and incentives behind the delays, or the impacts on the markets and investors.” 
These commenters instead urged the Commission to “evaluate each proposed delay, regardless of its duration, and specifically determine that it is designed and applied in a manner that is consistent with the purposes of the Exchange Act.” 
Another commenter urged the Commission to “take into account not just the length of the delay, but also its purpose.” 
The Commission notes that this interpretation does not address whether any particular access delay is unfairly discriminatory, an inappropriate or unnecessary burden on competition, or otherwise inconsistent with the Act. Rather, it clarifies that if an intentional access delay is de minimis, then it is “immediate” for purposes of Rules 600(b)(3) and 611. While the Commission's interpretation is narrowly focused on the meaning and application of the word “immediate[ ]” in Rule 600(b)(3) in light of technological and market developments since the adoption of Regulation NMS in 2005, the evaluation of any proposed access delay would involve additional considerations.
Specifically, this interpretation does not obviate the requirement of individualized review of proposed access delays, including de minimis delays, for consistency with the Exchange Act and Regulation NMS. Any exchange seeking to impose an access delay must reflect that in its rules, which are required to be filed with the Commission as part of the exchange application or as an individual proposed rule change. This interpretation does not alter the requirement that any exchange access delay must be fully described in a written rule of the exchange, which in turn must be filed with the Commission and published for notice and comment, nor does it obviate the need for a proposed rule change that would impose an access delay otherwise to comply with the Act and the regulations thereunder applicable to the exchange.
Accordingly, the commenters' concerns and recommended conditions are addressed by the existing requirements and process through which exchanges publicly propose their rule changes under the Act, and each proposed access delay would be scrutinized on an individual basis through that process.
Any proposed application of an access delay would therefore be subject to notice, comment, and the Commission's separate evaluation of the proposed rule change.
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C. Other Comments
A few commenters asked the Commission to provide more detail on the application of the proposed interpretation.
For example, one commenter asked whether it applies to both inbound and outbound delays and whether it should be based on the exchange's fastest or slowest means of connecting.
Other commenters asked how much variance will be permitted and whether unintentional delays also should be covered by the interpretation.
The interpretation of “immediate” applies to the term as used in Rule 600(b)(3), so that it applies to any intentional delay imposed by an exchange through any means provided by the exchange to access its quotations. Further, as modified here from the proposed interpretation, the interpretation applies only to intentional delays, as unintentional delays are addressed by the existing exception contained in Rule 611(b)(1).
Finally, in response to the commenters asking if both inbound and outbound delays should be taken into account when measuring the length of an intentional delay, the Commission notes that the intentional delay, as it pertains to the Order Protection Rule, is measured as a cumulative delay experienced by a non-routable order—in other words, the intentional delay applied on an order message sent into an exchange system through each of the events specified in the definition of “automated quotation” in Rule 600(b)(3). Specifically, any intentional delay imposed by the exchange in (1) executing an immediate-or-cancel order against its displayed quotation up to its full size, (2) cancelling any unexecuted portion of such order, or (3) transmitting a response to the sender of such order, should be added together in assessing compliance with Rule 611.
One commenter recommended that the Commission engage in notice and comment rulemaking to effect “a change of this magnitude,” which it argued contradicts the “plain meaning of the term `immediate.' ” 
The commenter argued that an interpretation is only appropriate to “provide guidance on how a new service or product not contemplated at the time a rule was adopted should be treated under existing rules.” 
As discussed above, however, the Commission does not believe the dictionary definition of the term “immediate[ ]” forecloses de minimis intentional delays (i.e., intentional delays so short that they do not impair fair and efficient access to an exchange's quotations). The Commission is updating its prior interpretation in light of technological and market developments since the adoption of Regulation NMS in 2005 to accommodate very short intentional delays that do not impair fair and efficient access to protected quotations. Although the Commission did afford an opportunity for notice and comment by publishing a draft interpretation for comment, and did take the comments it received into consideration, the Commission was not required to undertake notice and comment rulemaking when updating its interpretation of its own regulation.
Other commenters focused on what they viewed as a potential opportunity for manipulative activity that could result from an access delay to a market displaying a protected quotation. One commenter opined that an access delay would make it easier to manipulate markets “by taking advantage of stale and inaccessible quotations displayed during the duration of any access delays,” and that such manipulative behavior “could be particularly powerful in relatively illiquid stocks.” 
As an example, the commenter posited that a market participant could “safely manipulate a closing auction by sending displayed orders to an exchange with an intentional 999 microsecond delay and timing the submission of those orders for display 998 microseconds or less before the close” because “no other market participant could reach them in time.” 
Another commenter argued that access delays could lead to “stale prices [that] are guaranteed to be displayed for a specific period of time up to 1 millisecond,” which would cause pegged orders on other exchanges to “be traded against at known stale prices” when such pegged order is pegged to the stale price on the exchange with the access delay.
The commenter argued that this could lead to “a potentially new mechanism for spoofing . . . with the objective of affecting pegged orders on other exchanges.” 
The Commission notes that the scenarios discussed by commenters are not related to the issue addressed by this interpretation—whether an intentional delay that is so short as not Start Printed Page 40792to frustrate the goals of Rule 611 by interfering with fair and efficient access to an exchange's quotations is consistent with Rule 600(b)(3)'s “immedia[cy]” requirement.
If a delay is de minimis, then whether it is unintentional or intentional in nature is not expected to alter the potential for manipulative activity or make it harder to detect and prosecute. One commenter noted that it is important “to contemplate and address the potential for abuse” 
when an access delay is proposed and approved. The Commission agrees that such scrutiny—both by the exchange proposing an access delay, and by the Commission when considering whether to approve a proposed access delay rule—would be important. The Commission notes that, pursuant to Section 19(b) and Rule 19b-4, the proposing exchange would be required to consider and address in its rule change filing the potential for abuse of any proposed access delay, which would then be subject to notice, comment, and Commission review. Further, even after the rule change became effective, the Commission believes it would be incumbent on the exchange to remain vigilant in surveilling for abuses and violative conduct of its access delay rule, and consider amending its access delay if necessary, among other considerations, for the protection of investors and the public interest.
III. Commission's Interpretation
In response to technological and market developments since the adoption of Regulation NMS,
the Commission believes that it is appropriate to provide an updated interpretation of the meaning of the term “immediate” in Rule 600(b)(3).
Solely in the context of determining whether a trading center maintains an “automated quotation” for purposes of Rule 611 of Regulation NMS, the Commission does not interpret the term “immediate” used in Rule 600(b)(3) by itself to prohibit a trading center from implementing an intentional access delay that is de minimis—i.e., a delay so short as to not frustrate the purposes of Rule 611 by impairing fair and efficient access to an exchange's quotations. Accordingly, the Commission's revised interpretation provides that the term “immediate” precludes any coding of automated systems or other type of intentional device that would delay the action taken with respect to a quotation unless such delay is de minimis.
The Commission's updated interpretation recognizes that a de minimis access delay, even if it involves an “intentional device” that delays access to an exchange's quotation, is compatible with the exchange having an “automated quotation” under Rule 600(b)(3) and thus a “protected quotation” under Rule 611.
Under this interpretation, Rule 600(b)(3)'s “immedia[cy]” requirement does not necessarily foreclose an automated trading center's use of very small intentional delays to address concerns arising from low latency trading strategies and other market structure issues. For example, intentional access delays that are well within the geographic and technological latencies experienced by market participants when routing orders are de minimis to the extent they would not impair a market participant's ability to access a displayed quotation consistent with the goals of Rule 611.
The interpretation does not change the existing requirement that, prior to being implemented, an intentional delay of any duration must be fully disclosed and codified in a written rule of the exchange that has become effective pursuant to Section 19 of the Act, where the exchange met its burden of articulating how the purpose, operation, and application of the delay is consistent with the Act and the rules and regulations thereunder applicable to the exchange.
In the Notice of Proposed Interpretation, the Commission stated its preliminary belief “that, in the current market, delays of less than a millisecond in quotation response times may be at a de minimis level that would not impair a market participant's ability to access a quote, consistent with the goals of Rule 611 and because such delays are within the geographic and technological latencies experienced by market participants today.” 
As discussed above, the Commission received a number of comments on that specific guidance.
At this time, the Commission is not adopting the proposed guidance under this interpretation that delays of less than one millisecond are de minimis. The Commission believes that, in light of the evolving nature of technology and the markets, and the need to assess the impact of intentional access delays on the markets, establishing a bright line de minimis threshold is not appropriate at this time. Rather, the Commission Start Printed Page 40793believes that the interpretation is best focused on whether an intentional delay is so short as to not frustrate the purposes of Rule 611 by impairing fair and efficient access to an exchange's quotations. As it makes findings as to whether particular access delays are de minimis in the context of individual exchange proposals,
the Commission recognizes that such findings create common standards that must be applied fairly and consistently to all market participants.
The Staff will also conduct a study within two years regarding the effects of intentional access delays on market quality, including price discovery and report back to the Commission with the results of any recommendations. Based on the results of that study or earlier as it determines, the Commission will reassess whether further action is appropriate.
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Text of Amendments
For the reasons set out in the preamble, the Commission is amending Title 17, chapter II, of the Code of Federal Regulations as follows:
PART 241—INTERPRETATIVE RELEASES RELATING TO THE SECURITIES EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER
Part 241 is amended by adding Release No. 34-78102 to the list of interpretative releases as follows:
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|Interpretation Regarding Automated Quotations Under Regulation NMS||34-78102||June 17, 2016||121 FR [Insert FR Page Number].|
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By the Commission.
Dated: June 17, 2016.
Robert W. Errett,
[FR Doc. 2016-14876 Filed 6-22-16; 8:45 am]
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