SEC Division of Trading and Markets no-action letter: EDGX Exchange

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

DIVISION OF

TRADING AND MARKETS

May 26, 2010
Mr. Eric W. Hess
General Counsel and Secretary
EDGX Exchange, Inc.
545 Washington Boulevard, 6th Floor
Jersey City, NJ 07310
Dear Mr. Hess:
Based on the facts and representations set forth in your letter dated March 18,2010, we find that it is appropriate in the public interest, and consistent with the protection ofinvestors to grant, and hereby grant, to Members1 that execute trades for their customers on the EDGX Exchange using the Exchange's Trading System, a limited exemption pursuant to Rule 10b-lO(t) under the Act from the requirement in Rule 10b-1O(a)(2)(i)(A) to disclose to their customers the name ofthe person from whom a security was purchased, or to whom it was sold, or the fact that such information will be provided upon the customer's written request. This exemption is limited to trades that Members execute on the EDGX Exchange using the post trade anonymity feature described in your letter? In granting this exemption, we note in particular, your representation that all orders submitted to the Exchange's Trading System will automatically match against each other in strict price-time priority. You represented in your letter that the only exception to price/time priority matching will occur when a Member marks an incoming order with an anti-internalization qualifier ("AIQ Modifier"). In your letter you stated that if an order contains an AIQ Modifier, the EDGX Exchange system will not execute the order against the submitting Member's trading interest submitted under the same market participant identification number. Ifthe order with the AIQ Modifier is not filled in its entirety, or the submitting Member has the only displayed order on the opposite side ofthe market at the best price, the order or the unfilled portion ofthe order with the AIQ Modifier will be returned to the submitting Member. 1 Unless otherwise noted, each defined term in this letter has the same meaning as defined, directly or by reference, in your letter. 2 This exemption does not apply to orders routed to an away trading center for execution.

Mr. Eric W. Hess
May 26,2010
Yo:u also request assurance that the Staffwill not recommend enforcement action to the Commission under paragraph (a) of Rule 1Ob-l 0 under the Act if a Member confirms its capacity as "agent" when the Member submits a customer's order to the Exchange, in its role as the customer's agent, and the order is executed on the Exchange in a trade with an anonymous contra-party that turns out to be the Member trading in a principal (including proprietary) capacity. Your request is limited to those situations in which both: (1) the No Knowledge Requirement; and (2) the Parity Requirement are satisfied. Based on the facts and representations setforth in your letter, the Staffwill not recommend enforcement action to the Commission under paragraph (a) of Rule 1Ob-l 0 if a Member indicates on confirmations to its customers that the Member acted as agent on a customer's behalf when a representative ofthe Member submits a customer order to the Exchange on an agency basis and that order is executed on the Exchange in a trade with an anonymous contra-party that turns out to be the Member trading in a principal (including proprietary) capacity, provided that the Member complies with all other requirements ofRule 10b-lO in confirming the customer's order, including paragraph (a)(2)(i) thereof, and provided that the handling and execution ofthe customer order complies with the No Knowledge and Parity Requirements.3 In taking this position, we note in particular your representation regarding your expectation that same firm volume, as a percentage oftotal volume, will not be material for either high or low trading volume securities.4 We also note that Members continue to have a duty of best execution.5 The Office of Financial Responsibility has instructed us to inform you that the Staff will not recommend enforcement action to the Commission if, in lieu ofmaking and preserving a separate record, Members rely on the Exchange's retention ofthe identities ofthe Members that execute anonymous trades on the Exchange, for the period specified Rule l7a-4(a), to satisfy the requirements ofRules l7a-3(a)(l) and l7a-4(a) under the Act. The Staff notes, however, that a Member has the responsibility to make, keep current, and preserve records of all purchases and sales of securities in accordance with Rules l7a-3 and l7a-4 ofthe Act for trades on the EDGX Exchange ifthe Member knows the identity ofthe contra-party. 3 This Staffposition applies only to trades that Members execute on the Exchange's Trading System. This Staff position does not apply to orders routed to an away trading center for execution. 4 In this regard, we note your representation that, one year after the Trading System becomes fully operational, you will review trade data to determine the actual percentage ofsame fIrm volume versus total volume in high and low volume securities to confIrm that this number is not material, and that you will create and maintain a record ofyour determination. S See, e.g.,
Regulation NMS, Exchange Act ReI. NO. 49325 (February 26, 2004), 69 Fed. Reg. 11126, 11137 (March 9,2004) ("A broker-dealer still must seek the most advantageous terms reasonably available under the circumstances for all customer orders. A broker-dealer must carry out a regular and rigorous review ofthe quality ofmarket centers to evaluate its best execution policies, including the determination as to which markets it routes customer order flow.").

Mr. Eric W. Hess
May 26,2010
These exemptive and no-action positions are subject to modification or revocation if at any time the Commission or Staff determines that such action is necessary or appropriate in furtherance ofthe purposes ofthe Act. In addition, these positions are based solely upon the representations you have made and are limited strictly to the facts and conditions described in your incoming letter. Any different facts or circumstances, including any change to the operation ofthe Exchange, may require a different response.6 Finally, we express no view with respect to other questions the proposed activities ofthe Exchange or any Members relying on this relief may raise, including the applicability of any other federal or state laws or the applicability of self-regulatory organization rules concerning customer account statements or confirmations. For the Commission,

by the Division ofTrading and Markets,

pursuant to delegated authority,7

Paula Jenson
Deputy Chief Counsel
6 For example, the continued availability ofthese positions is dependent on same firm volume as a perceritage of total volume in fact not being material for either high or low trading volume securities one year following the launch ofthe Exchange and thereafter. 7 17 CFR § 200.30-3(a)(32).

EDGX EXCHANGE, INC.
DirectEdge
545 Washington Boulevard, 6'h Floor

Jersey City, New Jersey 07310

March 18,2010
Mr. James L. Eastman

Associate Director and Chief Counsel

Division of Trading and Markets

Securities and Exchange Commission

100 F Street, N.E. Washington, DC 20549-000 I

Re: Request for a Limited Exemption from Paragraph (a)(2)(i)(A) of Rule IOb-IO Under the Securities Exchange Act of 1934 (the "Act") and Request for No￾Action Relief from Rules IOb-IO(a)(2), 17a-3(a)(l) and 17a-4(a) Under the Act Dear Mr. Eastman:
EDGX Exchange, Inc. (the "EDGX Exchange" or "Exchange" or "Applicant") respectfully requests a limited exemption from paragraph (a)(2)(i)(A) of Rule IOb-10 1 under the Securities Exchange Act of 1934 ("Act") on behalf of members of the Exchange that execute trades on the Exchange for their customers ("Members"). The Exchange will operate a fully automated electronic book ("order book") for orders to buy or sell securities ("orders") with a continuous, automated matching function which will provide for strict price-time priority execution ("Trading System"). The order book and rules also provide for post trade anonymity through settlement for trades executed through the Exchange.2 The Applicant also requests, on behalf of its Members, your assurance that the staff of the Division ofTrading and Markets ("Staff") will not recommend that the Commission take any enforcement action under paragraph (a) of Rule IOb-IO under the Act in connection with the activities of Members executing orders for their customers in the circumstances described below. Specifically, the Applicant requests this relief to permit a Member to indicate on a customer confirmation that the Member acted as agent (where the Member submits a customer's order on the Exchange in the Member's role as the customer's agent (hereinafter "Customer Order")) and the order is executed in a trade Paragraph (I) of Rule lOb-I 0 under the Act provides the Securities and Exchange Commission ("SEC" or "Commission") authority to issue exemptions from the requirements contained in paragraphs (a) and (b) of the rules promulgated under the Act. , As explained herein the Exchange does not request an exemption for when it reveals the identity of a Member or a Member's clearing firm: (i) for regulatory purposes or to comply with an order of a court or arbitrator; or (ii) when a Qualified Clearing Agency (as defined in Exchange Rule 1.5(t)) such as the National Securities Clearing Corporation ceases to act for a Member or the Member's clearing firm, and determines not 10 guaranlee the settlement of the Member's trades. See Exchange Rule 11.11(e). Direct Edge, 545 Washington Boulevard, 6th Fl., Jersey City, NJ 07310 Tel 201,942.8220 Fax 201.557.8019 www.dlrectedgecom

with an anonymous contra-party that turns out to be the Member or one of its affiliates trading in a principal (including proprietary) capacity (hereinafter "Principal Order"), so long as the conditions set out below are met and the Member otherwise complies with all other requirements of Rule lOb-lO in confirming the customer's order, including paragraph (a)(2)(i) thereof. This request for no-action relief is limited, however, to those situations in which the following requirements are met: (I) the representatives ofthe Member or its affiliates submitting Principal Orders do not have knowledge about Customer Orders submitted by the Member and the Member representatives submitting Customer Orders do not have knowledge about Principal Orders submitted by the Member or its affiliates (the "No Knowledge Requirement"); and (2) the Member does not determine or influence the selection of the contra-party(ies) against which such Customer Orders will be executed (the "Parity Requirement"). Finally, Applicant requests certain no-action relief from the requirements of Rules 17a-3(a)(I) and 17a-4(a) under the Act, as described below. A. Background - EDGX Exchange Direct Edge Holdings, Inc. is the sole owner of EDGA Exchange ("EDGA Exchange") and EDGX Exchanges, Inc., ("EDGX Exchange") which will each operate a fully automated electronic order book for orders to buy and sell securities with a continuous, automated matching function. This request, however, for interpretive guidance is strictly limited to EDGX ExchangeJ EDGX Exchange is a registered national securities exchange under Section 6 of the Exchange Act. 4 The Members of the Exchange consist of those broker-dealers admitted to membership and entitled to enter orders in, and receive executions through, the Exchange's order book or otherwise. The Exchange will operate an order book for orders with a continuous, automated matching function, in compliance with the Exchange's rules and Regulation NMS under the Act ("Reg NMS"). Liquidity will be derived from orders to buy and orders to sell submitted to the Exchange electronically by its Members from remote locations. The order book and the Exchange's rules will provide for strict price-time priority execution. Under Rule 11.8, orders will be prioritized on a strict-time basis, first by price and then by time. Incoming orders are first matched for execution against orders on the Exchange order book. Orders that cannot be executed are eligible for routing to away EDGA Exchange, Inc. will file an analogous request for interpretive guidance regarding Rule 10b￾10. See Securities Exchange Act Release No. 61698 (March 12,20 1O)(File os. J0-194 and 10-196) (Federal Register Notice pending).

trading centers5 All trades will be executed through the Exchange's Trading System on an anonymous basis. The transaction reports produced by the Trading System will indicate the details of the transactions executed in the Trading System but shall not reveal contra party identities. Transactions executed in the Trading System will also be cleared and settled anonymously6 EDGX Exchange does permit a member to prevent its incoming orders from being executed against its own trading interest. Specifically, members have the ability to use an anti-internalization qualifier ("AlQ modifier"). Once set, the system will not execute the order against the member's trading interest submitted under the same MPID (market participant ID). For example, if Member I, a member ofthe Exchange, submits an order to sell with the AIQ modifier, the system will determine whether Member I has a bid that is at the best bid price for the security under the same MPID as the order to sell. If Member I's bid is first in time among several member bids at the best price, the system will, in accordance with Member I 's instructions, cancel either the latest order or the smallest order when the matching contra party order has the same MPID7 B. Rule 10b-IO

1. Contra-Party Identity Requirement
   Rule IOb-1 0, among other things, requires a broker-dealer to disclose to its customers the identity of the party the broker-dealer sold to or bought from to fill the customer's order. Specifically, under paragraph (i)(A) of Rule IOb-lO(a)(2), when a broker-dealer is acting as agent for a customer, some other person, or for both the customer and some other person, the broker-dealer must disclose "[t]he name ofthe person from whom the security was purchased, or to whom it was sold, for such customer or the fact that the information will be furnished upon written request of such customer" (the "Contra-Party Identity Requirement"). A broker-dealer can provide this information on the confirmation, or it has the option to provide the information to a customer at a later time after receiving a written request from the customer. A broker-dealer has this option as long as it discloses on the confirmation that the contra-party information is available upon written request. 5 See Exchange Rule 11.9. The Exchange understands that the exemptive and no-action relief would not apply to any situation in which the Trading System routes an order to an away trading center for execution, as such executions would be governed by the rules of the away trading cenler. 6 Except for the conditions set forth in Exchange Rule 11.11. See supra n. 2. 7 Members use the AIQ modifier for compliance and business reasons. For example, using the modifier prevents order flow from appearing as a wash sale on an Exchange or broker/dealers' compliance reports. Additionally, using the modifier allows firms to internalize order flow rather than sending it to an exchange for execution.

Trades are executed with total anonymity at the Exchange, where the identity of the actual contra-party is not revealed when the trade is executed. 8 Therefore, Members will not know the identity ofthe party to whom they sold securities or from whom they purchased securities. Without this information, Members cannot comply with the Contra￾Party Identity Requirement. To permit Exchange Members to utilize the EDGX Exchange without violating Rule IOb-1 a, the Exchange is seeking an exemption, on behalfofsuch Members, from the Contra-Party Identity Requirement when Members execute transactions on the Exchange. The Contra-Party Identity Requirement, in conjunction with the other requirements of paragraph (a)(2) of Rule lOb-la, is designed to provide customers with information that could alert them to potential conflicts of interest their broker-dealer may have had when handling their orders9 The Exchange believes an exemption from the Contra-Party Identity Requirement when Member trades on the Exchange would not diminish the public policy and investor protection objectives of the Contra- Party Identity Requirement of Rule IOb-1 a. The Exchange believes the potential for a conflict ofinterest is less likely in those circumstances when a Member trades on the Exchange because the trades are executed at the best price available on the Exchange and the contra-party is determined based upon multiple factors not controlled by the Member. In such situations, Members are not permitted the discretion in executing the order that would normally give rise to the opportunity for a conflict of interest.
2. Identification as Agent on Confirmation
Applicant requests no-action relief, on behalf of its Members, to permit Members to indicate on a customer confirmation that the Member has acted as agent where the Member submits a customer's order through the electronic trading facilities of EDGX Exchange, in the Member's role as the customer's agent, and the order is executed in a trade with an anonymous contra-party that turns out to be the Member or one of its affiliates trading in a principal (including proprietary) capacity. a. No Knowledge Requirement This request is limited to those circumstances in which the representatives of a Member and its affiliates submitting Principal Orders do not have knowledge about Customer Orders submitted by the Member, and the Member representatives submitting Customer Orders have no knowledge about Principal Orders submitted by the Member or its affiliates. A Member will be able to satisfY the No Knowledge Requirement if it Paragraph(a)(2) ofRuJe lOb-I 0 requires a broker-dealer to disclose on a confirmation to a customer the capacity in which the broker-dealer handled the customer's order (i.e, as agent or principal), and whether the broker-dealer acted as agent for some other person, or as agent for both the customer and some other person. Paragraph (i)(D) of Rule lOb· J0(a)(2) requires a broker-dealer to disclose to its customer the source and amount of remuneration received, or to be received, by the broker-dealer in connection with the trade. 9

implements and utilizes an effective system of internal controls such as appropriate information barriers, that operate to prevent the representatives of the Member or its affiliates submitting Principal Orders from obtaining knowledge about the Customer Orders submitted by the Member, and the representative ofthe Members submitting Customer Orders from obtaining knowledge about the Principal Orders submitted by the Member or its affiliates. To be effective, such a system of internal controls must include specific policies and procedures that prevent each Principal Order submitter separated by the information barriers from obtaining knowledge regarding Customer Orders submitted by the Member, and each Customer Order submitter separated by the information barriers from obtaining knowledge regarding Principal Orders submitted by the Member or its affiliates. b. Parity Requirement In addition to this No Knowledge Requirement, this request is limited to those situations in which the Member does not in any way determine or influence the selection ofthe trading interest against which a customer order will be executed. I 0 As stated, the EDGX Exchange's order book will not support functionality that would allow a broker￾dealer to select or influence against whom its orders will be executed. II Where the Customer Order and the Principal Order are executed against each other by the order book, a Member indicating in the confirmation that the firm has acted as agent does not increase the risk of fraud against the customer, where the No Knowledge Requirement and the Parity Requirement are met. To the contrary, the matching of the agency and the proprietary trading interests occurs at the best price available and the contra-side is determined based upon priority factors established by the rules of the Exchange. 12 Moreover, the proposed action does not diminish investor protection because it does not relieve a Member's duty of best execution. 13 \0 The SEC has issued no-action relief for Rule 10b-10 under these circumstances. See Leller from Brian A. Bussey, Assistant Chief Counsel, Division of Market Regulation, to James C. Yong, Chief Regulatory Officer, National Stock Exchange (October 13,2006); Leller from Brian A. Bussey, Assistant Chief Counsel, Division of Market Regulation, to Edward S. Knigh~ Executive Vice President and General Counsel, Nasdaq (January 26, 2005); and Letter from Brian A. Bussey, Assistant Chief Counsel, Division of Market Regulation. to Aleksandra Radakovic, Vice President, J.P Morgan Securities Inc. (August 4, 2005). " If such functionality were to be offered in the future, the Exchange understands that the relief requested by this letter would not apply to this functionality. \2 The Exchange expects that same firm volume, i.e.. an execution in which a firm's agency order is matched against the same firm's principal (including proprietary) trading interest, as a percentage of total volume in a security through the Trading System
will not be material for either high or low trading volume securities. The Exchange represents that one year after the Trading System becomes fully operational, the Exchange will review trade data to determine the actual percentage of same firm volume versus total volume in high and low volume securities to conf1JTI1 that this number is not material. The Exchange will create and maintain a record of the determination. J3 See Regulation NMS, Exchange Act ReI. No. 49325 (Feb. 26, 2004), 69 Fed. Reg. 11126, 11137 (March 9, 2004) (UA broker-dealer still must seek the most advantageous terms reasonably available under

C. Books and Record Retention
Rule 17a-3(a)(l) under the Act requires that broker-dealers make and keep current records of all purchases and sales of securities, including "the name or other designation of the person from whom purchased or received or to whom sold or delivered." Rule 17a￾4(a) under the Act requires that the records be preserved for six (6) years, the first two (2) years "in an easily accessible place." Applicant asks that the Commission staff not recommend enforcement action to the Commission if, in lieu of making and preserving a separate record, a broker-dealer relies on the Exchange's retention of the identities of Members that execute anonymous trades through EDGX Exchange to satisfY requirements of Rules 17a-3(a)(l) and 17a-4(a) under the Act. A broker-dealer would retain the responsibility to make, keep current and preserve records of all purchase and sales of securities in accordance with Exchange Act Rules 17a-3 and 17a-4 for trades on EDGX Exchange if the broker-dealer knows of the contra-party, including those instances where EDGX Exchange discloses the contra-party to a trade. Based on the above, the Applicant believes that the requested exemption is appropriate and consistent with the protection of investors. Should you have any questions regarding the Applicant's exemption request, you can reach me at (201) 942 8239. Very truly yours, , j? Eric W. Hess

General Counsel and Secretary,

EDGX Exchange, Inc.

cc; Mr. David Hsu (SEC) - via electronic mail
Ms. Heidi Pilpel (SEC) - via electronic mail
Mr. Joshua Kans (SEC) - via electronic mail
Ms. Donna Chambers (SEC) - via electronic mail Mr. Ignacio Sandoval (SEC) - via electronic mail Mr. William O'Brien (Direct Edge) Mr. Jeffrey Rosenstrock (Direct Edge) the circumstances for all customer orders. A broker-dealer must carry out a regular and rigorous review of the quality of the market centers to evaluate its best execution policies, including the determination as to which markets it routes customer order flow.")