Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Instituting Proceedings To Determine Whether To Approve or Disapprove a Proposed Rule Change Relating to Alternative Display Facility New Entrant

I. Introduction

On December 16, 2022, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 19b–4 thereunder, a proposed rule change to add IntelligentCross ATS (“IntelligentCross”) as a new entrant to the Alternative Display Facility (“ADF”) (“Proposal”). The proposed rule change was published for comment in the Federal Register on December 27, 2022. On February 9, 2023, the Commission extended the time period within which to approve, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to March 27, 2023. The Commission has received eight comment letters on the proposed rule change, two of which were received after the Extension. On February 16, 2023, IntelligentCross submitted a letter responding to the commenters. On March 13, 2023, FINRA submitted a letter responding to certain commenters. Under Section 19(b)(3)(C) of the Exchange Act, the Commission is hereby instituting proceedings to determine whether to approve or disapprove File Number SR–FINRA–2022–032.

II. Description of the Proposed Rule Change

The ADF is a quotation collection and trade reporting facility that provides ADF market participants ( i.e., ADF-registered market makers or electronic communications networks) the ability to post quotations, display orders and report transactions in NMS stocks for submission to the securities information processors (“SIP”) for consolidation and dissemination to vendors and other market participants. The ADF is also designed to deliver real-time data to FINRA for regulatory purposes, including enforcement of requirements imposed by Regulation NMS.

In particular, Regulation NMS includes an order protection rule that provides that a trading center “shall establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs on that trading center of protected quotations in NMS stocks” that do not fall within one of the exceptions set forth in the rule (“Order Protection Rule”). For quotations to be protected under the rule, they must be, among other things, executable “immediately and automatically” against an incoming immediate-or-cancel (“IOC”) order. In 2016, the Commission interpreted Regulation NMS's immediacy requirement to allow for “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.” The Commission stated that “[i]n 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.” Commission staff guidance has further stated that “consistent with the Commission's interpretation regarding automated quotation under Rule 600(b)(3) of Regulation NMS, delays of less than a millisecond are at a de minimis level that would not impair fair and efficient access to a quotation, consistent with the goals of Rule 611.”

In addition, Rule 610 of Regulation NMS requires that a trading center displaying quotations in an NMS stock through a self-regulatory organization (“SRO”) display-only facility (such as the ADF) “provide a level and cost of access to such quotations that is substantially equivalent to the level and cost of access to quotations displayed by SRO trading facilities in that stock.” Rule 610 also requires that a trading center displaying quotations in an NMS stock through an SRO display-only facility not impose unfairly discriminatory terms that prevent or inhibit any person from obtaining efficient access to such quotations through a member, subscriber, or customer of the trading center. In articulating this standard, the Commission noted that the level and cost of access would “encompass both (1) the policies, procedures, and standards that govern access to quotations of the trading center, and (2) the connectivity through which market participants can obtain access and the cost of such connectivity.” The nature and cost of connections for market participants seeking to access an ADF participant's quotations would need to be substantially equivalent to the nature and cost of connections to SRO trading facilities.

In evaluating whether ADF participants are meeting the access standards under Rule 610, Regulation NMS also requires FINRA to submit a proposed rule change under Section 19(b) of the Exchange Act in order to add a new ADF participant. Accordingly, FINRA is proposing to add IntelligentCross as a new ADF Market Participant. IntelligentCross is an NMS stock alternative trading system (“ATS”) operating pursuant to an effective Form ATS–N. IntelligentCross currently operates three separate limit order books with optional display capability distinguished by different fee structures—the ASPEN fee/fee limit order book (“ASPEN Fee/Fee”), ASPEN maker/taker limit order book, and ASPEN taker/maker limit order book (collectively, “IntelligentCross ASPEN”). FINRA states that the ASPEN Fee/Fee book would be the only order book displaying orders on the ADF.

IntelligentCross provided FINRA with a summary of its policies and procedures regarding access to its quotations in an NMS stock displayed on the ADF, and a summary of its proposed fees for such access. Based on IntelligentCross' representations, FINRA believes that IntelligentCross' proposed level and cost of access to quotations on the ASPEN Fee/Fee book is substantially equivalent to the level and cost of access to quotations displayed by an SRO trading facility, both in absolute and relative terms. FINRA also believes that the quotations displayed on ASPEN Fee/Fee book would meet the definition of an “automated quotation” under Regulation NMS.

In particular, FINRA states that IntelligentCross only permits registered broker-dealers to be subscribers to IntelligentCross, and subscribers can interact with ASPEN Fee/Fee book using conventional order types. The ASPEN Fee/Fee book will accept incoming intermarket sweep orders (“ISOs”) once it displays orders on the ADF.

FINRA states that the ASPEN Fee/Fee book establishes a matching schedule using an overnight optimization process based on historical performance measurements from prior days' matches across all three IntelligentCross ASPEN books. The match event time is randomized within the time band throughout the course of the trading day and any order that arrives prior to a match event (and that has not been cancelled, become unmarketable, or repriced) is eligible to participate in the next match event for that security.

IntelligentCross has represented to FINRA that, in the following cases, an incoming order on ASPEN Fee/Fee may not execute against a resting order at match event time when: (i) an existing resting order cancels prior to the next match event; (ii) an incoming order is canceled prior to the next match event; (iii) the NBBO moves between the time an order is received and the next match event takes place, making either the incoming order or the resting order non-marketable; or (iv) the NBBO changed before the next match event and pegged orders were repriced to the new NBBO, making the incoming order or the resting pegged order non-marketable.

FINRA states that ASPEN Fee/Fee's matching engine operates near-continuously and that, when a new order arrives in the ASPEN Fee/Fee book, it would participate in the next scheduled match event by interacting with existing orders in the order book within a maximum time capped at 900 microseconds.

FINRA states that for each match event time, ASPEN Fee/Fee retrieves the NBBO and processes all the orders that have arrived and have not been cancelled in price-time priority. No subscriber to IntelligentCross (or non-subscriber accessing IntelligentCross through a subscriber) is given any priority through the matching process and the matching process is blind to the identity of the subscriber. All matches are reported immediately to subscribers and the SIPs via a FINRA trade reporting facility and disseminated on IntelligentCross' market data feed.

FINRA further states that IntelligentCross utilizes a fee/fee pricing model for activity on ASPEN Fee/Fee book where both sides are charged the same fee for transactions. Eligible displayed orders are published via a free market data feed (“IQX market data feed”). IntelligentCross does not charge connectivity fees to its subscribers. FINRA states that firms wishing to access liquidity on ASPEN Fee/Fee may connect in a variety of ways. Firms that are IntelligentCross subscribers can connect to ASPEN Fee/Fee via a Financial Information Exchange (“FIX”) connection. Such access is available to subscribers through an internet protocol address via communications that are compliant with the FIX application programming interface (“API”) provided by IntelligentCross. IntelligentCross does not accept orders via any other forms of communication ( e.g., telephone, email, instant message). IntelligentCross allows a subscriber to determine its level of connectivity and does not tier or discriminate among subscribers.

Additionally, FINRA states that IntelligentCross has established and maintains policies and procedures related to periodic system capacity reviews and tests to ensure future capacity, as well as policies and procedures to identify potential weaknesses and reduce the risks of system failures and threats to system integrity. FINRA also states that, for purposes of displaying orders through the ADF, IntelligentCross' policies and procedures require continuous monitoring of ASPEN Fee/Fee's connections with an SRO display-only facility and, in the event that ASPEN Fee/Fee loses connection with the ADF, IntelligentCross has contingency plans in place, including removing ( i.e., “zeroing out”) all quotes previously published by the system to the ADF and notifying its subscribers of such interruption.

Finally, FINRA states that all members in good standing of an SRO would be eligible to become a subscriber to ASPEN Fee/Fee, and would be subject to eligibility requirements set by IntelligentCross.

III. Summary of Comments and Responses by IntelligentCross and FINRA

The Commission received seven comment letters opposing the Proposal, and one comment letter supporting the Proposal. Commenters opposing the Proposal generally state the Proposal lacks sufficient detail necessary for the Commission to approve the Proposal and point to several areas of concern. In particular, commenters raise concerns about whether the Proposal: (1) complies with the requirements of Regulation NMS; (2) should condition Commission's approval on additional representations by IntelligentCross; (3) provides a sufficient implementation period for the industry to adopt changes from the addition of IntelligentCross to the ADF; and (4) raises concerns about the ADF's technological infrastructure.

1. Compliance With Regulation NMS

Some commenters raise concern that IntelligentCross' displayed quotations do not meet the Commission's definition of “automated quotations” due to the intentional delay built into IntelligentCross' delayed matching process. In particular, some commenters state that the Proposal does not demonstrate how the intentionally delayed matching process is de minimis. Two commenters states that the Proposal wrongly assumes that any delay under a millisecond is de minimis. One commenter states that the “novel features” of the Proposal have not been adequately assessed to provide the Commission with sufficient basis to make an affirmative finding that the Proposal is consistent with the Exchange Act. One commenter states that the randomized nature of the matching process “creates significant challenges for best execution for brokers” and prevents “predictable staging of order sending activity by brokers across multiple venues,” resulting in “significant risk of material information leakage and quote fading—leading to materially worse execution quality for investors.”

Some commenters state that the ability for liquidity providers to cancel displayed ADF orders through IntelligentCross' functionality at any time raises questions about whether its functionality is consistent with Regulation NMS and prior Commission guidance. For example, some commenters state that they are concerned that a resting limit order could be canceled at any time (even after the incoming order is received) prior to the match, including when such incoming orders are routed to IntelligentCross consistent with regulatory obligations under the Order Protection Rule. One commenter states that the non-match event data stated in the Proposal is a “material” figure that “likely understates expected cancellation rates” if market participants are required to route order flow to IntelligentCross. Another commenter emphasizes that order posters in ASPEN Fee/Fee book have the ability to immediately cancel their orders, whereas order transmitters seeking to interact with that interest at the NBBO do not have the same ability to cancel their orders due to their regulatory obligation to attempt to access the protected quote.

In its response letter, IntelligentCross states that it disagrees with the characterizations made by commenters of the IntelligentCross matching process. Specifically, IntelligentCross states that its matching process is “completely symmetric in nature and does not favor a particular side of the trade; there is no differential treatment of certain market participants.” IntelligentCross states that both sides of the trade “can cancel or update their orders at any time prior to a match” and “must equally wait for the next scheduled match event to occur.” IntelligentCross also emphasizes that the regulatory obligations attendant to “protected quotations” under Regulation NMS do not provide a guarantee of an execution. Accordingly, IntelligentCross states that a market participant that routes an order to any market with the intention of matching against a displayed order may not ultimately receive an execution. Moreover, IntelligentCross disagrees with a commenter's statement that non-match events on IntelligentCross are “material” and states that there is no evidence to the effect that non-match rates would increase if market participants are required to route order flow to IntelligentCross.

IntelligentCross also disagrees with commenters that express concern regarding the ability for liquidity providers to cancel their order in IntelligentCross prior to a match event and believe it to be detrimental to the markets and investors. IntelligentCross points to its own user experience on the platform, and data specifying that “in January 2023, ASPEN Fee/Fee improved the NBBO over 5.3 million times per day (for orders of round-lot size or larger on arrival).” Additionally, IntelligentCross states that any “trade-offs” due to the manner of IntelligentCross' matching process “certainly do not frustrate the purpose of Regulation NMS by impairing fair and efficient access to IntelligentCross' displayed quotations.” Moreover, IntelligentCross states that there is no basis for the assumption that there is a significant risk of information leakage and quote fading due to an IntelligentCross protected quote.

In addressing commenter concerns regarding any difficulties for market participants to adapt to an IntelligentCross protected quote, IntelligentCross states it is already widely used by most major broker-dealer and electronic trading firms, and that any market participants should be able to account for the IntelligentCross protected quote without significant or material changes to its technology. Additionally, IntelligentCross points to the “technological capabilities of order routers today” and believes that a market participant “should not have difficulties in configuring their routers to adopt to the IntelligentCross matching process.”

Finally, IntelligentCross states that its matching process is consistent with the Commission Interpretation of Automated Quotations. IntelligentCross states that, while the Commission did not establish a “bright line de minimis threshold,” the ASPEN Fee/Fee matching engine “operates near-continuously and when a new order arrives in the ASPEN Fee/Fee book, it will participate in the next scheduled match event by interacting with existing orders in the order book within a maximum time capped at 900 microseconds.”

2. Additional Conditions to Approval of the Proposal

Two commenters raise questions regarding the regulatory process in connection with proposed changes to IntelligentCross' operations and fees associated with displaying protected quotations on the ADF. One commenter states that there is currently no process for ongoing operational changes at non-exchange venues with protected quotes and intentional access delays. This commenter states that without the exchange notice and comment process in connection with changes to operations, it seeks additional information on the process for managing such changes at IntelligentCross and the ADF.

One commenter states that if the Commission chooses to permit any trading center to disseminate quotations using the ADF, it must condition approval with limitations that are consistent with limitations imposed upon other trading venues ( i.e., exchanges) whose quotations have protected quotation status. In particular, this commenter states that approval of the Proposal should be conditioned upon IntelligentCross: (1) continuing to not charge for market data or connectivity; (2) having fees and rebates (if adopted) that are at or below those charged by exchanges; (3) notifying the Commission and FINRA of all changes related to the ASPEN Fee/Fee book; and (4) describing how any such changes are consistent with the ASPEN Fee/Fee book quotations continuing to be included as protected quotations is consistent with the Exchange Act and protection of investors. This commenter also states that both the Commission and FINRA should detail how they would “gather, review, analyze, and publish for public consideration” any changes to IntelligentCross' policies and procedures related to the Proposal, as well as describe how they would intervene to block or disallow any concerning changes in IntelligentCross' policies and procedures related to the ADF. Overarching this commenter's concerns with the Proposal are that any changes to the ASPEN Fee/Fee rules and operations should be treated the same for regulatory purposes as if they were changes made by an exchange, including that they are put out for notice and public comment, and subject to Commission disapproval.

In its response letter, IntelligentCross points to its current regulatory responsibilities associated with being a registered broker-dealer and an ATS, as well as the Regulation NMS obligations attached to being an ADF Participant. IntelligentCross also states that, while an ATS is not subject to the same requirements as exchanges, it also does not share the same benefits as exchanges. However, IntelligentCross states that it does not object to notifying the Commission and FINRA in advance if changes are made to the level and cost of access to the ASPEN Fee/Fee book impacting the display of IntelligentCross' protected quotations on the ADF, or the operation of the ASPEN Fee/Fee book impacting the provision of the protected quote. IntelligentCross also states that it does not object to an “appropriately structured process” to engage the Commission in evaluating and commenting on such changes. But IntelligentCross disagrees with the commenter's recommendation to condition IntelligentCross' approval on “continuing to not charge for market data or connectivity” given that it believes such a requirement would not be consistent with the limitations imposed on exchanges.

3. Implementation Period

Two commenters suggest that the proposed implementation period for the Proposal is too short given the connectivity arrangements that the industry would need time to establish. One commenter suggests an implementation period of no less than 120 days following the date of Commission approval. Another commenter suggest a period of no less than 90 days following the date of Commission approval.

In its response letter, IntelligentCross states that it has been working with industry participants to ensure that they have all the information necessary to prepare for the IntelligentCross protected quote. IntelligentCross also notes that most major broker-dealers and electronic trading firms are already connected to, and trading with, the IntelligentCross ATS. Moreover, IntelligentCross believes that a reasonable implementation timeframe would be to require that industry participants begin treating IntelligentCross' quotes as a protected quotation no later than 90 days after the date of the Commission's approval order.

4. ADF Technological Infrastructure

One commenter states that the Commission and FINRA should consider whether to “wind down” the ADF due to concerns regarding the latency and technological infrastructure of the ADF. Specifically, this commenter states that the Proposal does not provide any details of the ADF's systems capabilities and questions whether the “intake, processing, and dissemination systems [are] up to 2023 speed and capacity standards.” This commenter also expresses concern regarding the speed at which the ADF disseminates quotation data compared to the speed at which IntelligentCross' proprietary quotation feed is disseminated to market participants. This commenter states that it is unclear the extent to which “FINRA has attempted to upgrade the system” to address the latency gap.

In its response letter, FINRA states that it has made technological updates to the ADF infrastructure that make it “well-equipped to support use of the ADF by multiple market participants for quoting and trading purposes.” FINRA also asserts that its recent technological updates to the ADF have significantly reduced the ADF's processing latency times as compared to when the ADF was last operational in 2015. FINRA also represents that it continues to conduct capacity requirement testing with IntelligentCross and “aim[s] to address any potential areas identified for further improvement prior to IntelligentCross becoming an ADF Participant and sending quotes to the ADF (subject to SEC approval).” Accordingly, FINRA believes that any processing latency for the ADF would generally be in line with exchange processing latencies once IntelligentCross begins quoting on the ADF.

IV. Proceedings To Determine Whether To Approve or Disapprove SR–FINRA–2022–032 and Grounds for Disapproval Under Consideration

The Commission hereby institutes proceedings pursuant to Section 19(b)(2)(B) of the Exchange Act to determine whether the proposed rule change should be approved or disapproved. Institution of proceedings is appropriate at this time in view of the legal and policy issues raised by the proposal. Institution of proceedings does not indicate that the Commission has reached any conclusions with respect to any of the issues involved. Rather, the Commission seeks and encourages interested persons to provide additional comment on the proposed rule change to inform the Commission's analysis of whether to approve or disapprove the proposed rule change.

Pursuant to Section 19(b)(2)(B) of the Exchange Act, the Commission is providing notice of the grounds for possible disapproval under consideration. As described above, FINRA has proposed to add IntelligentCross to the ADF. The Commission is instituting proceedings to allow for additional analysis of, and input from commenters with respect to, the consistency of the proposal with the Section 15A(b)(6) of the Exchange Act, which requires, among other things, that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. The Commission believes that there are questions as to whether FINRA has provided sufficient information to demonstrate that the proposal to add IntelligentCross to the ADF is consistent with the Exchange Act and the rules thereunder.

Under 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 [SRO] that proposed the rule change.” 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, and any failure of an SRO to provide this information may result in the Commission not having a sufficient basis to make an affirmative finding that a proposed rule change is consistent with the Exchange Act and the applicable rules and regulations. The Commission is instituting proceedings to allow for additional consideration and comment on the issues raised herein.

V. Procedure: Request for Written Comments

The Commission requests that interested persons provide written submissions of their views, data, and arguments with respect to the issues identified above, as well as any other concerns they may have with the proposal. In particular, the Commission invites the written view of interested persons concerning whether the proposal is consistent with Section 15A(b)(6) of the Exchange Act, or any other provision of the Exchange Act, or the rules and regulations thereunder. Although there do not appear to be any issues relevant to approval or disapproval that would be facilitated by an oral presentation of views, data, and arguments, the Commission will consider, pursuant to Rule 19b–4, any request for an opportunity to make an oral presentation.

Interested persons are invited to submit written data, views, and arguments regarding whether the proposal should be approved or disapproved by April 20, 2023. Any person who wishes to file a rebuttal to any other person's submission must file that rebuttal by May 4, 2023.

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form ( http://www.sec.gov/rules/sro.shtml ); or

• Send an email to rule-comments@sec.gov. Please include File Number SR–FINRA–2022–032 on the subject line.

Paper Comments

• Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090.

All submissions should refer to File Number SR–FINRA–2022–032. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's internet website ( http://www.sec.gov/rules/sro.shtml ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of FINRA. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–FINRA–2022–032 should be submitted on or before April 20, 2023. Rebuttal comments should be submitted by May 4, 2023.