Self-Regulatory Organizations; BATS Exchange, Inc.; Order Approving a Proposed Rule Change To Amend Rule 12.6 To Conform to FINRA Rule 5320 Relating…

Self-Regulatory Organizations; BATS Exchange, Inc.; Order Approving a Proposed Rule Change To Amend Rule 12.6 To Conform to FINRA Rule 5320 Relating to Trading Ahead of Customer Orders

November 27, 2013.

I. Introduction

On October 3, 2013, BATS Exchange, Inc. (the "Exchange" or "BATS") filed with the Securities and Exchange Commission ("Commission" or "SEC"), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 ("Act") /1/ and Rule 19b-4 thereunder, /2/ a proposed rule change to amend BATS Rule 12.6 ("Rule 12.6") to make it substantially similar to Financial Industry Regulatory Authority ("FINRA") Rule 5320. The proposed rule change was published for comment in the Federal Register on October 22, 2013. /3/ The Commission received no comments on the proposal. This order approves the proposed rule change.

FOOTNOTE 1 15 U.S.C. 78s(b)(1). END FOOTNOTE

FOOTNOTE 2 17 CFR 240.19b-4. END FOOTNOTE

FOOTNOTE 3 See Securities Exchange Act Release No. 70662 (October 11, 2013), 78 FR 62828 (SR-BATS-2013-056) ("Notice"). END FOOTNOTE

II. Description of the Proposed Rule Change

The Exchange proposes to amend Rule 12.6, which limits trading ahead of customer orders by Members, /4/ to have the rule substantially conform to FINRA Rule 5320. /5/ As with FINRA Rule 5320, the proposed amendments to Rule 12.6 would prohibit Members from trading ahead of customer orders, subject to specified exceptions. Rule 12.6, as proposed to be amended, would include exceptions for large orders and institutional accounts, proprietary transactions effected by a trading unit of a Member with no knowledge of customer orders held by another trading unit of the Member, riskless principal transactions, intermarket sweep orders ("ISOs"), and odd lot and bona fide error transactions, described below. Rule 12.6 also would provide the same guidance as FINRA Rule 5320 with respect to minimum price improvement standards, order handling procedures, and trading outside normal market hours.

FOOTNOTE 4 Members are registered brokers or dealers that have been admitted to membership at the Exchange. BATS Rule 1.5(n). END FOOTNOTE

FOOTNOTE 5 See Securities Exchange Act Release No. 63895 (February 11, 2011), 76 FR 9386 (February 17, 2011) (SR-FINRA-2009-90). END FOOTNOTE

Background

Current Rule 12.6, the customer order protection rule, generally prohibits Members from trading on a proprietary basis ahead of, or along with, customer orders that are executable at the same price as the proprietary order. The current rule contains several exceptions that make it permissible for a Member to enter a proprietary order while representing a customer order that could be executed at the same price, including permitting transactions for the purpose of facilitating the execution, on a riskless principal basis, of one or more customer orders.

Proposal To Adopt Text of FINRA Rule 5320

To harmonize its rules with FINRA, the Exchange proposes to delete the current text of Rule 12.6 and its supplementary material and adopt the text and supplementary material of FINRA Rule 5320, with certain changes, as Rule 12.6. FINRA Rule 5320 generally provides that a FINRA member that accepts and holds an order in an equity security for its own customer, or a customer of another broker-dealer, without immediately executing the order is prohibited from trading that security on the same side of the market for its own account at a price that would satisfy the customer order, unless it immediately thereafter executes the customer order up to the size and at the same or better price at which it traded for its own account.

Exceptions

The proposed amendments to Rule 12.6 would include exceptions to the prohibition against trading ahead of customer orders. A Member that meets the conditions of an exception would be permitted to trade a security on the same side of the market for its own account at a price that would satisfy a customer order in certain circumstances. The exceptions are set forth below.

Large Orders and Institutional Accounts

One exception would permit a Member to negotiate terms and conditions with respect to the acceptance of certain large-sized orders (orders of 10,000 shares or more unless such orders are less than $100,000 in value) or orders from institutional accounts. The term "institutional account" would be defined in accordance with FINRA Rule 4512(c). Accordingly, an institutional account would be defined as the account of: (1) A bank savings and loan association, insurance company or registered investment company; (2) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or (3) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million. This exception to Rule 12.6, as amended, would require the Member to provide clear and comprehensive written disclosure to each customer at account opening and annually thereafter that: (a) States that the Member may trade proprietarily at prices that would satisfy the customer order; and (b) provides the customer with a meaningful opportunity to opt in to the Rule 12.6 protections with respect to all or any portion of its order. In addition, if a customer does not opt in to the protections with respect to all or any portion of its order, the Member may reasonably conclude that such customer has consented to the Member trading a security on the same side of the market for its own account at a price that would satisfy the customer's order. /6/

FOOTNOTE 6 A customer would retain the right to withdraw consent at any time. Therefore, a Member's reasonable conclusion that a customer has consented to the Member trading along with such customer's order would be subject to further instruction and modification from the customer. END FOOTNOTE

In lieu of providing written disclosure to customers at account opening and annually thereafter, Rule 12.6 would permit Members to provide clear and comprehensive oral disclosure to, and obtain consent from, a customer on an order-by-order basis. Under Rule 12.6, the Member would be required to document who provided such consent and that such consent evidences the customer's understanding of the terms and conditions of the order. If a customer opted in to the protections of Rule 12.6, a Member could still obtain consent on an order-by-order basis to trade ahead of or along with an order from that customer, provided that the Member documented who provided such consent and that such consent evidenced the customer's understanding of the terms and conditions of the order.

No-Knowledge Exception

The Exchange also proposes to include in Interpretation and Policy .02 a "no-knowledge" exception to Rule 12.6. The proposed exception would allow one trading unit of a Member to trade in a proprietary capacity and at prices that would satisfy customer orders held by another, separate trading unit of the Member ("the No-Knowledge Exception"). The No-Knowledge Exception would be applicable with respect to NMS stocks, as defined in Rule 600 of Regulation NMS under the Act.

To avail itself of the No-Knowledge Exception, a Member would be required to meet certain conditions. First, it would have to implement and utilize an effective system of internal controls (such as appropriate information barriers) that operate to prevent the proprietary trading unit from obtaining knowledge of the customer orders held by a separate trading unit. As proposed, Interpretation and Policy .02 would make clear that appropriate information barriers must, at a minimum, comply with the Exchange's existing requirements regarding the prevention of the misuse of material, non-public information, which are set forth in Exchange Rule 5.5. Second, the Member would have to provide, at account opening and annually thereafter, a written description of how it handles customer orders and the circumstances under which it may trade proprietarily, including in a market-making capacity, at prices that would satisfy the customer order. A Member must maintain records indicating which orders rely on the No-Knowledge Exception and produce these records to the Exchange upon request. Under the proposed exception, the onus would be on the Member to produce sufficient documentation justifying reliance on the No-Knowledge Exception for any given trade. To ensure clarity and transparency regarding this exception and others, the Exchange will issue a regulatory notice informing Members of the proposed revisions to Rule 12.6. The Exchange will include in the regulatory notice the effective date for the rule as amended, which shall be at least 30 days after Commission approval of the proposed amendments to Rule 12.6 in order to allow Members to make any necessary changes to their internal policies or processes.

Riskless Principal Exception

Another proposed amendment to Rule 12.6 would not apply to a proprietary trade made by the Member to facilitate the execution, on a riskless principal basis, of another order from a customer (whether its own customer or the customer of another broker-dealer). To take advantage of this exception, the Member would have to: (a) Submit a report, contemporaneously with the execution of the facilitated order, identifying the trade as riskless principal to the Exchange; and (b) have written policies and procedures to ensure that riskless principal transactions relied upon for this exception comply with applicable Exchange rules. At a minimum, these policies and procedures would have to require: (1) Receipt of the customer order before execution of the offsetting principal transaction; and (2) execution of the offsetting principal transaction at the same price as the customer order, exclusive of any markup or markdown, commission equivalent, or other fee and allocation to a riskless principal or customer account in a consistent manner and within 60 seconds of execution.

--This is a summary of a Federal Register article originally published on the page number listed below--

Citation: "78 FR 72949"

Document Number: "Release No. 34-70952; File No. SR-BATS-2013-056"

Federal Register Page Number: "72949"

"Notices"