SEC Division of Trading and Markets no-action letter: BATS Exchange, Inc.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

DIVISION OF

TRADING AND MARKETS

February 25, 2010
Mr. Eric Swanson
SVP, General Counsel
BATS Exchange, Inc,
8050 Marshall Drive, Suite 120
Lenexa, KS 66214-1585
Dear Mr. Swanson:
Based on the facts and representations set forth in your letter dated February 25, 2010, we find that it is appropriate in the public interest, and consistent with the protection ofinvestors to grant, and hereby grant, to Members] that execute options trades for their customers on the BATS Exchange using the Exchange's Trading System, a limited exemption pursuant to Rule lOb-10(f) under the Act from the requirement in Rule lOb-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 options trades that Members execute on the BATS Exchange using the post trade anonymity feature described in your letter. 2 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. 3 You also request assurance that the Staff will not recommend enforcement action to the Commission underparagraph (a) ofRule 1Ob-1 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 I 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. 3As noted in your letter, on October 23, 2008, the Commission, acting through delegated authority, granted BATS an exemption under a fact pattern similar to that set forth in your current request. See letter re: BATS Exchange (October 23,2008) ("2008 Exemption"). The 2008 Exemption applies to transactions effected under BATS's equity rules. Your current request applies to BATS's new options rules.

Mr. Eric Swanson
February 25,2010
.Requirement; and (2) the Parity Requirement are satisfied.
Based on the facts and representations set forth in your letter, the Staff will not

recommend enforcement action to the Commission under paragraph (a) of Rule 1Ob-1 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-1O 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;4

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.s We also note that Members continue to have a

duty of best execution.6

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 17a-4(a), to satisfy the requirements ofRules 17a-3(a)(1) and 17a-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 ofsecurities in accordance with Rules 17a-3 arid 17a-4 ofthe Act for trades on the BATS Exchange ifthe Member knows the identity ofthe contra-party. 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 4 This Staff position 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.

5 In this regard, we note your representation that, as part of your regulatory program, you will review trade data to determine the percentage of same 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 of such determinations. 6 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 of market centers to evaluate its best execution policies, including the determination as to which markets it routes customer order flow.").

Mr. Eric Swanson
February 25,2010 operation ofthe Exchange, may require a different response. 7 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 Commiss' ,n,

by the Division Trading and Markets,

p uant to dele ted authori~ty.-:-,8__

7 In this regard, we note your representation that the Exchange's rules do not provide for any special order type that would be an exception to the strict price-time priority handling oforders as set forth in Rule 2I.8(a) of the Exchange. s 17 CFR § 200.30-3(a)(32).

February 25, 2010
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 IDb-I 0 Under the Securities Exchange Act of 1934 (the "Act") and Request for No￾Action Relief from Rules IOb-l 0(a)(2), 17a-3(a)(l) and 17a-4(a) Under the Act Dear Mr. Eastman:
BATS Exchange, Inc. (the "BATS Exchange" or the "Exchange") respectfully requests a limited exemption from paragraph (a)(2)(i)(A) of Rule] Ob-] 0' under the Securities Exchange Act of 1934 ("Act") on behalf of members of the Exchange that execute options 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 options ("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 options trades executed through BATS Exchange.' BATS Exchange also requests, on behalf of its Members, your assmance that the staff of the Division of Trading and Markets ("Staff') will not recommend that the Commission take any enforcement action under paragraph (a) of Rule IDb-I 0 under the Act in connection with the activities of Members executing orders for their customers in the circumstances described below. Specifically, BATS Exchange 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 BATS Exchange in the Member's role as the customer's agent (hereinafter "Customer Order")) Pamgmph (I) of Rule lOb-I 0 uuder the Act provides the Securities and Exchange Commission ("SEC" or "Comlllission") authority to issue exemptions frolll the requirements contained in paragraphs (n) and (b) of the rules promulgated under the Act. Sce BATS Exehauge Rule 21.8(a). The Exchange rules do uot providc for any special order type that would be an exception to the strict price time priority ',"udHug ofOl'ders set forth iu Rule 21.8(a). As explained herein the Exchange does not request an exemption for when it reveals the identity of a Member or a Member's clearing finn: (i) when a registered clearing agency, such as the Options Clearing Corporatioll, ceases to act for a participant, or the Member's clearing firm, and the registered clearing agency determines 110t to guarantee the settlement of the Member's trades; (ii) for regulatOl)' purposes 01' to comply with all order of an arbitrator or co1ll1; (iii) when both parties to the transaction consent; or (iv) whell a Member's Order has been decremented by another Order submitted by that same Member. See BATS Exchange Rule 21.10. TEL. 913.8t5.7000 I FAX. 913.815.7119 I 8050 MARSHALL DRIVE. SUITE 120 I LENEXA, KS 66214·1585 I BATSTRAOINU.COM

February 25, 20 I0 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 (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-lOin 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 of the 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, BATS Exchange 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. Back ground - BATS Exchange BATS Exchange is a registered national securities exchange under Section 6 of thc Exchange Act.' The Members of the Exchange ("Members") 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 options rules will provide for strict price-time priority execution. Under Rule 21.8(a), options orders will be prioritized on a strict price-time basis, first by price and then by time. Incoming orders are first matched for execution against orders in the BATS order book. Orders that cannot be executed are eligible for routing to away trading centers.· All trades will be executed through the Exchange's Trading System on an anonymous basis. The transaction reports prodnced by thc Trading System will indicate the Although the Commissiou, aetiug through delegated mlthorit)', previousI)' gmuted BATS au exemptiou under a similar fact pattern, that exemption made specific reference 10 BATS's equity rules while our CllI'l'cnt request is in reference to BATS's Ilew options rules. See infra l10tc 5. BATS Exchange received approval of its application for registration as a national securities exchange on August 18,2008. Sec Exchange Act Release No. 58375 (August 18,2008). BATS Exehauge's rules applieahle to lmding equit)' optious were approved on Janumy 26, 2010. Sec Exchange Act Release No. 61419
(Jauuar)' 26, 20 I0),75 FR 5157 (Fehnlm)· 1,2010) (SR-BATS-2009-031).

• Sec BATS Exchange Rule 21.9. 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 ofthe away trading center. TEL. 913.815.7000 I FAX. 913.815.7119 I 8050 MARSHALL IlRIVE. SUITE 120 I LENEX,. KS 66214-1585 I RATSTRAIlING.COM

February 25, 2010 details of 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 anonymously.' The order book's matching system algorithm permits orders originated by a BATS Exchange member to execute against other orders from the same participant on the same basis as orders from other Members. In the order book's handling of displayed orders, which is based on strict price-time priority, a Member could receive an execution against itself, and under the Exchange's Rules, the Member would not know that it was the contra-side of the trade at the time of execution. B. Rule 10b-lO

1. Contra-Party Identity Requirement
   Rule lOb-I 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-I 0(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 of the 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. Trades are executed with total anonymity at BATS Exchange, where the identity of the actual contra-party is not revealed when the trade is executed.' Therefore, Members will not know the identity of the 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 BATS Exchange Members to utilize the BATS Exchange for options trading without violating Rule IOb-I 0, the Exchange is seeking an exemption, on behalf of snch Members, from the Contra-Party Identity Requirement when Members execnte options transactions at the BATS Exchange. The Contra-Party Identity Requirement, in conjunction with the other requirements of paragraph (a)(2) of Rule 10b-lO, 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 orders.' The Exchange believes an exemption from the Contra-Party Identity Requirement when Except for the conditions set forth in BATS Exchange Rnle 21.10. See suWa n. 3. !d. Paragraph (a)(2) of Rule 1Ob-l 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 persoll, or as agent for both the clistomer and some other person. Paragraph (i)(D) of Rule lOb-I 0(a)(2) requires a broker-dealer to disclose to its customer the TEL. 913.815.7000 I FAX. 913.815.7119 I 8050 MARSHAl.l. DRIVE. SUITE 120 I LENEXA. KS 66214-1585 I BATSTRADING.Cml 9

MI'. James L. Eastman
February 25, 2010
Member trades through the BATS Exchange would not diminish the public policy and investor protection objectives ofthe Contra- Party Identity Requirement of Rule IOb-l O. The Exchange believes the potential for a conflict of interest is less likely in those circumstances when a Member trades through BATS 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. Identi(ication as Agent 011 COI?(irmation
The Exchange 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 BATS 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 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 of the 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 of the trading interest against which a customer order will be executed. lO As stated, the BATS Exchange's source and amount ofrcl1lllllcration received, or to be received, by the broker-dealer in connection with the trade. lO The SEC has issued no-action relief for Rule lOb-I 0 under these circumstances. See Letter from Brian A. Bussey, Assistant ChicfCoullsel, Division of Market Regulation, to James C. Yong, Chief Regulatory Officer, National Stock Exchange (October 13,2006); Leiter fi'oml3rian A. Bussey, Assistant Chief Coullsel, Division of Market Regulatioll, to Edward S. Knight, Executive Vice President and General Counsel, Nasdaq (January 26, 2005); and Letter from Brian A. Bussey, Assistant Chief Counsel, Division TEL. 913.815.7000 I FAX. 913.815.7119 I 8050 MARSHALL DRIVE. SUITE 120 I LENEXA. KS 66214-[585 I UATSTRAD[NU.COM

February 25, 2010 order book will not support functionality that would allow a broker-dealer to select 01' influence against whom its orders will be execnted." 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. I)
C. Books and Record Retention
Rule 17a-3(a)(I) 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." The Exchange 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 BATS Exchange to satisfy requirements of Rules 17a-3(a)(I) 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 l7a-3 and 17a-4 for trades tluough BATS Exchange if the broker-dealer knows of the contra-party, including those instances where BATS Exchange discloses the contra-party to a trade.

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of Market Regulation, to Aleksandra Radakovic, Vice President, l.P Morgan Securities Inc. (August 4, 2005). II IfslIch fUllctionality were to be offered in the future, BATS Exchange understands that the rcliefl'cqucstcd by this Icltcr would not apply to this functionality. 12 The Exchange expects that same firm volume, Le., all execution in which a firm's agency order is matched against the same firm's principal (including proprietmy) trading interest, as a percentage oftolal volume in a seclII'ity through the Trading System will not be material for either high or low trading volume securities. The Exchange represents that as part of its regulatory program, the Exchange will review trade data to determine the percentage of same finn volumc vcrsus total volume in high and low volume securities to confirm that this number is not material. Thc Exchange will create and maintain arceoI'd of such determinations. 13 See Regulalion NMS, Exchange Act Release No. 49325 (Feb. 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 Ollt 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.") TEL. 9[3.8[5.7000 I FAX. 913.8[5.7 I [9 I 8050 MARSHALL DR[VE, SUITE 120 I LENEX,I. KS 66214-[ 585 I BATSTRAtl[NG.COM

February 25, 2010
Page G
In view of the foregoing, the Exchange respectfully requests that the Commission issue an exemption and such other relief as reflected in this letter. If you have any questions, please contact me at (2 I2) 378-8520. Very truly yours, Eric Swanson SVP, General Counsel cc: Mr. Daniel Fishel' (SEC) Mr. Ignacio Sandoval (SEC) Mr. Joe Ratterman (BATS) TEL. 913.815.7000 I FAX. 913.815.7119 I 8050 MARSHM.1. DRIVE. SUITE 120 I LENEXA. KS 66214·1585 I IlATSTRilDING.COM