[Federal Register: August 21, 2008 (Volume 73, Number 163)]
[Notices]
[Page 49498-49507]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21au08-93]
[[Page 49498]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-58375; File No. 10-182]
In the Matter of the Application of BATS Exchange, Inc. for
Registration as a National Securities Exchange; Findings, Opinion, and
Order of the Commission
August 18, 2008.
I. Introduction
On November 8, 2007, BATS Exchange, Inc. (``BATS Exchange'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission'') a Form 1 application (``Form 1'') under the Securities
Exchange Act of 1934 (``Act''), seeking registration as a national
securities exchange pursuant to Section 6 of the Act.\1\ On February
13, 2008, BATS Exchange submitted Amendment No. 1 to its Form 1. Notice
of the application, as amended, was published for comment in the
Federal Register on February 20, 2008.\2\ The Commission received one
comment letter regarding the BATS Exchange Form 1.\3\ On June 18, 2008,
BATS Exchange filed Amendment No. 2 to its Form 1.\4\
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\1\ 15 U.S.C. 78f.
\2\ See Securities Exchange Act Release No. 57322 (February 13,
2008), 73 FR 9370 (``Notice'').
\3\ The commenter expressed support for the BATS Exchange Form
1. See letter from Brian McPartlin dated February 14, 2008.
\4\ In Amendment No. 2, BATS Exchange modified its application
by: (1) Updating its response to the Form 1 Exhibits to reflect,
among other things, certain personnel changes, the existence of a
new affiliate, BATS Trading Limited, audited financials for BATS
Trading, Inc. (``BATS Trading''), and how BATS Exchange intends to
fulfill its regulatory obligations; (2) adding a provision to the
BATS Exchange Amended and Restated By-Laws that allows the
stockholder of BATS Exchange to appoint the initial Member
Representative Directors to the BATS Exchange Board, and amending
the definition of ``Executive Representative'' of a member of BATS
Exchange; (3) updating certain provisions of the Investors Rights
Agreement; and (4) amending the BATS Holdings Amended and Restated
Certificate of Incorporation to reduce the number of authorized
shares of stock of BATS Holdings, Inc. (``BATS Holdings''). BATS
Exchange also made certain modifications to its proposed rules to:
(1) Change the start of its pre-opening session from 9:00 a.m. to
8:00 a.m.; (2) remove the ability of a person to submit one
membership application with the Financial Industry Regulatory
Authority, Inc. (``FINRA''), when applying for membership in both
FINRA and BATS Exchange; (3) clarify that the requirement for
eligibility for BATS Exchange membership of membership in another
SRO applies for continued membership; (4) clarify that the 90-day
waive-in period will begin on the date that BATS Exchange's
application for registration as a national securities exchange is
approved by the Commission; (5) amend the BATS Only Order type to
provide that a non-displayed order would get a new timestamp when it
becomes displayed; (6) add continuing education requirements for
Authorized Traders that are substantially similar to those of FINRA;
(7) specify certain BATS Exchange rules and recommended fine amounts
for minor rule violations; (8) delete a provision requiring non-
clearing members to implement certain procedures of FINRA's Code of
Practice; (9) amend its rule relating to failures to deliver/receive
to conform to Regulation SHO; and (10) adding a rule to codify the
ability of BATS Exchange to enter into an agreement with another
self-regulatory organization (``SRO'') to provide regulatory
services to BATS Exchange. The changes proposed in Amendment No. 2
either are not material or are otherwise responsive to the concerns
of the Commission.
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II. Statutory Standards
Under Sections 6(b) and 19(a) of the Act,\5\ the Commission shall
by order grant a registration as a national securities exchange if it
finds that the exchange is so organized and has the capacity to carry
out the purposes of the Act and can comply, and can enforce compliance
by its members and persons associated with its members, with the
provisions of the Act, the rules and regulations thereunder, and the
rules of the exchange.
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\5\ 15 U.S.C. 78f(b) and 78s(a).
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As discussed in greater detail below, the Commission finds that
BATS Exchange's application for exchange registration meets the
requirements of the Act and the rules and regulations thereunder.
Further, the Commission finds that the proposed rules of BATS Exchange
are consistent with Section 6 of the Act in that, among other things,
they are designed to: (1) Assure fair representation of an exchange's
members in the selection of its directors and administration of its
affairs and provide that, among other things, one or more directors
shall be representative of investors and not be associated with the
exchange, or with a broker or dealer; (2) prevent fraudulent and
manipulative acts and practices, promote just and equitable principles
of trade, foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect to,
and facilitating transactions in securities, remove impediments to and
perfect the mechanisms of a free and open market and a national market
system; and (3) protect investors and the public interest. The
Commission also believes that the rules of BATS Exchange are consistent
with Section 11A of the Act.\6\ Finally, the Commission finds that the
proposed rules of BATS Exchange do not impose any burden on competition
not necessary or appropriate in furtherance of the purposes of the
Act.\7\
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\6\ 15 U.S.C. 78k-1.
\7\ 15 U.S.C. 78f(b)(8).
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III. Discussion
A. Corporate Structure
BATS Exchange has applied to the Commission to register as a
national securities exchange. BATS Holdings, a Delaware corporation,
will wholly own BATS Exchange and BATS Trading. Currently, BATS
Trading, a registered broker-dealer, operates the BATS ECN. Before
operation of BATS Exchange as a national securities exchange, BATS
Trading will transfer most of its assets to BATS Exchange. BATS Trading
will continue as a broker-dealer with the sole function of providing
outbound order routing services to BATS Exchange.\8\
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\8\ See BATS Exchange Rule 2.11. See also infra note 151 and
accompanying text.
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1. Self-Regulatory Function of BATS Exchange; Relationship Between BATS
Holdings, Inc. and BATS Exchange; Jurisdiction Over BATS Holdings, Inc.
Although BATS Holdings will not itself carry out regulatory
functions, its activities with respect to the operation of BATS
Exchange must be consistent with, and not interfere with, the
Exchange's self-regulatory obligations. The proposed BATS Holdings
corporate documents include certain provisions that are designed to
maintain the independence of the Exchange's self-regulatory function
from BATS Holdings, enable the Exchange to operate in a manner that
complies with the federal securities laws, including the objectives of
Sections 6(b) and 19(g) of the Act, and facilitate the ability of the
Exchange and the Commission to fulfill their regulatory and oversight
obligations under the Act.\9\
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\9\ See BATS Holdings Amended and Restated By-Laws Article XII
and Article XIV, Sections 14.01, 14.02, 14.03, 14.04, 14.05, and
14.06.
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For example, BATS Holdings submits to the Commission's jurisdiction
with respect to activities relating to BATS Exchange,\10\ and agrees to
provide the Commission and BATS Exchange with access to its books and
records that are related to the operation or administration of BATS
Exchange.\11\ In addition, to the extent they are related to the
operation or administration of BATS Exchange, the books, records,
premises, officers, directors, agents, and employees of BATS Holdings
shall be deemed the books, records, premises, officers, directors,
agents, and employees of BATS Exchange for purposes of, and subject to
oversight pursuant to, the Act.\12\ BATS Holdings
[[Page 49499]]
also agrees to keep confidential non-public information relating to the
self-regulatory function \13\ of BATS Exchange and not to use such
information for any non-regulatory purpose.\14\ In addition, the board
of directors of BATS Holdings, as well as its officers, employees, and
agents, are required to give due regard to the preservation of the
independence of the Exchange's self-regulatory function.\15\ Further,
BATS Holdings By-Laws require that any changes to the BATS Holdings
Certificate of Incorporation and By-Laws be submitted to the Board of
Directors of the Exchange (``Exchange Board''), and, if such amendment
is required to be filed with the Commission pursuant to Section 19(b)
of the Act, such change shall not be effective until filed with, or
filed with and approved by, the Commission.\16\ The Commission finds
that these provisions are consistent with the Act, and that they will
assist the Exchange in fulfilling its self-regulatory obligations and
in administering and complying with the requirements of the Act.
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\10\ See BATS Holdings Amended and Restated By-Laws Article XIV,
Section 14.05.
\11\ See BATS Holdings Amended and Restated By-Laws Article XIV,
Section 14.03.
\12\ Id.
\13\ This requirement to keep confidential non-public
information relating to the self-regulatory function shall not limit
the Commission's ability to access and examine such information or
limit the ability of directors, officers, or employees of BATS
Holdings to disclose such information to the Commission. See BATS
Holdings Amended and Restated By-Laws Article XIV, Section 14.02.
\14\ See BATS Holdings Amended and Restated By-Laws Article XIV,
Section 14.02.
\15\ See BATS Holdings Amended and Restated By-Laws Article XIV,
Section 14.01.
\16\ See BATS Holdings Amended and Restated Certificate of
Incorporation TWELFTH and BATS Holdings Amended and Restated By-Laws
Article XII.
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The Commission also believes that under Section 20(a) of the Act
\17\ any person with a controlling interest in BATS Exchange would be
jointly and severally liable with and to the same extent that BATS
Exchange is liable under any provision of the Act, unless the
controlling person acted in good faith and did not directly or
indirectly induce the act or acts constituting the violation or cause
of action. In addition, Section 20(e) of the Act \18\ creates aiding
and abetting liability for any person who knowingly provides
substantial assistance to another person in violation of any provision
of the Act or rule thereunder. Further, Section 21C of the Act \19\
authorizes the Commission to enter a cease-and-desist order against any
person who has been ``a cause of'' a violation of any provision of the
Act through an act or omission that the person knew or should have
known would contribute to the violation. These provisions are
applicable to BATS Holdings' dealings with BATS Exchange.
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\17\ 15 U.S.C. 78t(a).
\18\ 15 U.S.C. 78t(e).
\19\ 15 U.S.C. 78u-3.
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2. Ownership and Voting Limitations; Changes in Control of BATS
Exchange
The BATS Holdings proposed Amended and Restated Certificate of
Incorporation includes restrictions on the ability to own and vote
shares of capital stock of BATS Holdings.\20\ These limitations are
designed to prevent any shareholder from exercising undue control over
the operation of BATS Exchange and to assure that the Exchange and the
Commission are able to carry out their regulatory obligations under the
Act.
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\20\ These provisions are generally consistent with ownership
and voting limits approved by the Commission for other SROs. See
e.g., Securities Exchange Act Release Nos. 53963 (June 8, 2006), 71
FR 34660 (June 15, 2006) (SR-NSX-2006-03) (``NSX Demutualization
Order''); 51149 (February 8, 2005), 70 FR 7531 (February 14, 2005)
(SR-CHX-2004-26) (``CHX Demutualization Order''); and 49098 (January
16, 2004), 69 FR 3974 (January 27, 2004) (SR-Phlx-2003-73) (``Phlx
Demutualization Order'').
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Generally, no person, either alone or together with its related
persons,\21\ may beneficially own more than forty percent of any class
of capital stock of BATS Holdings.\22\ The BATS Holdings proposed
Amended and Restated Certificate of Incorporation prohibits BATS
Exchange members, either alone or together with their related persons,
from beneficially owning more than twenty percent of shares of any
class of capital stock of BATS Holdings.\23\ If any stockholder
violates these ownership limits, BATS Holdings will redeem the shares
in excess of the applicable ownership limit for their fair market
value.\24\ In addition, no person, alone or together with its related
persons, may vote or cause the voting of more than twenty percent of
the voting power of the then issued and outstanding capital stock of
BATS Holdings.\25\ If any stockholder purports to vote, or cause the
voting of, shares that would violate this voting limit, BATS Holdings
will not honor such vote in excess of the voting limit.\26\
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\21\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (a)(ii).
\22\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (b)(i)(A).
\23\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (b)(i)(B).
\24\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (e).
\25\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (b)(i)(C).
\26\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (d).
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The BATS Holdings Board may waive the forty percent ownership
limitation applicable to non-BATS Exchange member stockholders and the
twenty percent voting limitation, pursuant to a resolution duly adopted
by the Board of Directors, if it makes certain findings. Any such
waiver would not be effective until approved by the Commission pursuant
to Section 19 of the Act.\27\ However, as long as BATS Holdings
directly or indirectly controls BATS Exchange, the BATS Holdings Board
cannot waive the voting and ownership limits above twenty percent for
BATS Exchange members and their related persons.\28\
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\27\ See BATS Holdings Amended and Restated Certificate of
Incorporation FIFTH (b)(ii)(B).
\28\ These provisions are generally consistent with waiver of
ownership and voting limits approved by the Commission for other
SROs. See e.g., NSX Demutualization Order, supra note 20; CHX
Demutualization Order, supra note 20; and Securities Exchange Act
Release No. 49718 (May 17, 2004), 69 FR 29611 (May 24, 2004) (SR-
PCX-2004-08).
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Members that trade on an exchange traditionally have ownership
interests in such exchange. As the Commission has noted in the past,
however, a member's interest in an exchange could become so large as to
cast doubt on whether the exchange can fairly and objectively exercise
its self-regulatory responsibilities with respect to that member.\29\ A
member that is a controlling shareholder of an exchange might be
tempted to exercise that controlling influence by directing the
exchange to refrain from, or the exchange may hesitate to, diligently
monitor and surveil the member's conduct or diligently enforce its
rules and the federal securities laws with respect to conduct by the
member that violates such provisions.
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\29\ See, e.g., Securities Exchange Act Release Nos. 53128
(January 13, 2006), 71 FR 3550 (January 23, 2006) (File No. 10-131)
(``Nasdaq Exchange Registration Order'') and 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (``NYSE/
Archipelago Merger Approval Order'').
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In addition, as proposed, BATS Exchange will be a wholly-owned
subsidiary of BATS Holdings. The BATS Exchange Amended and Restated By-
Laws identifies this ownership structure.\30\ Any changes to the BATS
Exchange Amended and Restated By-Laws, including any change in the
provision that identifies BATS Holdings as the sole owner, must be
filed with and approved by the Commission pursuant to Section 19 of the
Act.\31\ Further, pursuant to the BATS Exchange Amended and Restated
By-Laws, BATS Holdings may not transfer or assign, in whole or in part,
its ownership interest in BATS Exchange.\32\
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\30\ See BATS Exchange Amended and Restated By-Laws Article
I(cc).
\31\ See 15 U.S.C. 78s.
\32\ See BATS Exchange Amended and Restated By-Laws Article IV,
Section 7.
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[[Page 49500]]
The Commission believes that these provisions are consistent with
the Act. These requirements should minimize the potential that a person
could improperly interfere with or restrict the ability of the
Commission or the Exchange to effectively carry out their regulatory
oversight responsibilities under the Act.
3. BATS Exchange
BATS Exchange has applied to the Commission to register as a
national securities exchange. As part of its exchange application, the
Exchange has filed the BATS Exchange Certificate of Incorporation and
the proposed Amended and Restated By-Laws of BATS Exchange. In these
documents, among other things, BATS Exchange establishes the
composition of the Exchange Board and the BATS Exchange committees.
a. The BATS Exchange Board of Directors
The Exchange Board will be the governing body of BATS Exchange and
possess all of the powers necessary for the management of the business
and affairs of the Exchange and the execution of its responsibilities
as an SRO. Under the BATS Exchange Amended and Restated By-Laws:
The Exchange Board will be composed of ten directors; \33\
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\33\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 2(a).
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One director will be the Chief Executive Officer of BATS
Exchange; \34\
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\34\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 2(b).
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The number of Non-Industry Directors,\35\ including at
least one Independent Director,\36\ will equal or exceed the sum of the
number of Industry Directors \37\ and Member Representative Directors;
\38\ and
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\35\ ``Non-Industry Director'' means a Director who is an
Independent Director or any other individual who would not be an
Industry Director. See BATS Exchange Amended and Restated By-Laws
Article I(v).
\36\ ``Independent Director'' means a ``Director who has no
material relationship with the [Exchange], or any Exchange Member or
any affiliate of any such Exchange Member; provided, however, that
an individual who otherwise qualifies as an Independent Director
shall not be disqualified from serving in such capacity solely
because such Director is a Director of the [Exchange] or its
stockholder.'' See BATS Exchange Amended and Restated By-Laws
Article I(m).
\37\ Generally, an ``Industry Director'' is, among other things,
a Director that is or has been within the past three years an
officer, director, employee, or owner of a broker-dealer. In
addition, persons who have a consulting or employment relationship
with the Exchange and its affiliates, are considered ``Industry.''
See BATS Exchange Amended and Restated By-Laws Article I(o).
\38\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 2(b)(i).
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At least twenty percent of the directors on the Exchange
Board will be Member Representative Directors.\39\
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\39\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 2(b)(ii). ``Member Representative Director'' means a
``Director who has been elected by stockholders after having been
nominated by the Member Nominating Committee or by an Exchange
Member pursuant to these By-Laws and confirmed as the nominee of
Exchange Members after majority vote of Exchange Members, if
applicable. A Member Representative Director must be an officer,
director, employee, or agent of an Exchange member that is not a
Stockholder Exchange Member.'' See BATS Exchange Amended and
Restated By-Laws Article I(s). See also BATS Exchange Amended and
Restated By-Laws Article III, Section 4(b).
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BATS Holdings will appoint the initial Exchange Board, including
the Member Representative Directors, which shall serve until the first
annual meeting of stockholders.\40\ The first annual meeting of the
stockholders will be held prior to BATS Exchange commencing operations
as a national securities exchange.\41\ At the first annual meeting of
stockholders, a new Exchange Board will be elected pursuant to the BATS
Exchange Amended and Restated By-Laws. Therefore, prior to commencing
operations as a national securities exchange, BATS Exchange Members
will have the opportunity to participate in the selection of Member
Representative Directors, and the Exchange Board will be in compliance
with the compositional requirements contained in the BATS Exchange
Amended and Restated By-Laws.\42\
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\40\ See BATS Exchange Amended and Restated By-Laws Article I(s)
and Article III, Section 4(g); see also Amendment No. 2.
\41\ See BATS Exchange Amended and Restated By-Laws Article IV,
Section 1(b).
\42\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 2.
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BATS Holdings will appoint the initial Nominating Committee \43\
and Member Nominating Committee,\44\ consistent with each committee's
compositional requirements,\45\ to nominate candidates for election to
the Exchange Board. Each of the Nominating Committee and Member
Nominating Committee, after completion of its respective duties for
nominating directors for election to the Board for that year, shall
nominate candidates to serve on the succeeding year's Nominating
Committee or Member Nominating Committee, as applicable. Additional
candidates for the Member Nominating Committee may be nominated and
elected by BATS Exchange Members pursuant to a petition process.\46\
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\43\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 2. The Nominating Committee will be comprised of at least
three directors, and the number of Non-Industry members on the
Nominating Committee must equal or exceed the number of Industry
members.
\44\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 3. The Member Nominating Committee will be comprised of at
least three directors, and each member of the Member Nominating
Committee shall be a Member Representative member.
\45\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 1.
\46\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 1.
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The Nominating Committee will nominate candidates for each director
position other than the Member Representative Directors, and BATS
Holdings, as the sole shareholder, will elect those directors. The
Member Nominating Committee will nominate candidates for each Member
Representative Director position on the Exchange Board.\47\ Additional
candidates may be nominated for the Member Representative Director
positions by BATS Exchange Members pursuant to a petition process.\48\
If no candidates are nominated pursuant to a petition process, then the
initial nominees of the Member Nominating Committee will be nominated
as Member Representative Directors by the Nominating Committee. If a
petition process produces additional candidates, then the candidates
nominated pursuant to a petition process, together with those nominated
by the Member Nominating Committee, will be presented to BATS Exchange
Members for election to determine the final nomination of Member
Representative Directors.\49\ The candidates who receive the most votes
will be nominated as Member Representative Directors by the Nominating
Committee.\50\ BATS Holdings, as the sole shareholder, will elect those
candidates nominated by the Nominating Committee as Member
Representative Directors.\51\
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\47\ The Member Nominating Committee will solicit comments from
BATS Exchange Members for the purpose of approving and submitting
names of candidates for election to the position of Member
Representative Director. See BATS Exchange Amended and Restated By-
Laws Article III, Section 4(b).
\48\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 4(c). The petition must be signed by Executive
Representatives of ten percent or more of the Exchange members. No
Exchange member, together with its affiliates, may account for more
than fifty percent of the signatures endorsing a particular
candidate. Id.
\49\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 4(e) and (f). Each BATS Exchange Member shall have the right
to cast one vote for each available Member Representative Director
nomination, provided that any such vote must be cast for a person on
the List of Candidates and that no BATS Exchange Member, together
with its affiliates, may account for more than twenty percent of the
votes cast for a candidate. Id.
\50\ See BATS Exchange Amended and Restated By-Laws Article III,
Section 4(f).
\51\ Id.
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[[Page 49501]]
The Commission believes that the requirement in the BATS Exchange
Amended and Restated By-Laws that twenty percent of the directors be
Member Representative Directors and the means by which they are chosen
by members provides for the fair representation of members in the
selection of directors and the administration of BATS Exchange
consistent with the requirement in Section 6(b)(3) of the Act.\52\ As
the Commission has previously noted, this requirement helps to ensure
that members have a voice in the use of self-regulatory authority, and
that an exchange is administered in a way that is equitable to all
those who trade on its market or through its facilities.\53\
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\52\ 15 U.S.C. 78f(b)(3).
\53\ See Nasdaq Exchange Registration Order and NYSE/Archipelago
Merger Approval Order, supra note 29.
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The Commission has previously stated its belief that the inclusion
of public, non-industry representatives on exchange oversight bodies is
critical to an exchange's ability to protect the public interest.\54\
Further, public, non-industry representatives help to ensure that no
single group of market participants has the ability to systematically
disadvantage other market participants through the exchange governance
process. The Commission believes that public directors can provide
unique, unbiased perspectives, which should enhance the ability of the
Exchange Board to address issues in a non-discriminatory fashion and
foster the integrity of BATS Exchange.\55\ The Commission believes that
the Exchange Board satisfies the requirements in Section 6(b)(3) of the
Act,\56\ which requires that one or more directors be representative of
issuers and investors and not be associated with a member of the
exchange, or with a broker or dealer.\57\
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\54\ See, e.g., Regulation of Exchanges and Alternative Trading
Systems, Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998) (``Regulation ATS Release'').
\55\ See Nasdaq Exchange Registration Order and NYSE/Archipelago
Merger Approval Order, supra note 29.
\56\ 15 U.S.C. 78f(b)(3).
\57\ The number of Non-Industry Directors on the Exchange Board
must equal or exceed the sum of the Industry and Member
Representative Directors, and the Exchange Board must include at
least one Independent Director. See BATS Exchange Amended and
Restated By-Laws Article III, Section 2(b)(i).
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b. BATS Exchange Committees
In the BATS Exchange Amended and Restated By-Laws, BATS Exchange
has proposed to establish several committees. Specifically, BATS
Exchange has proposed to establish the following committees that would
be appointed by the Chairman of the Exchange Board, with the approval
of the Exchange Board: A Compensation Committee; \58\ Audit Committee;
\59\ Regulatory Oversight Committee; \60\ Appeals Committee; \61\
Executive Committee; \62\ and Finance Committee.\63\ In addition, BATS
Exchange has proposed to establish a Nominating Committee \64\ and a
Member Nominating Committee, which would be elected on an annual basis
by vote of stockholders.\65\ For the reasons discussed above, the
Commission believes that BATS Exchange's proposed committees should
enable BATS Exchange to carry out its responsibilities under the Act
and are consistent with the Act.
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\58\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(a). The Compensation Committee will be comprised of at
least three people, and each voting member of the Compensation
Committee shall be a Non-Industry Director. Id.
\59\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(b). The Audit Committee will be comprised of at least
three people, and a majority of the Audit Committee members shall be
Non-Industry Directors and a Non-Industry Director shall serve as
Chairman of the Audit Committee. Id.
\60\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(c). The Regulatory Oversight Committee will be comprised
of at least three people, and each member of the Regulatory
Oversight Committee shall be a Non-Industry Director. Id.
\61\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(d). The Appeals Committee shall consist of one Independent
Director, one Industry Director, and one Member Representative
Director. Id.
\62\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(e). The number of Non-Industry Directors on the Executive
Committee shall equal or exceed the number of Industry Directors.
The percentage of Independent Directors on the Executive Committee
shall be at least as great as the percentage of Independent
Directors on the whole Exchange Board, and the percentage of Member
Representative Directors on the Executive Committee shall be at
least as great as the percentage of Member Representative Directors
on the whole Exchange Board. Id.
\63\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(f).
\64\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 2, and supra note 43.
\65\ See BATS Exchange Amended and Restated By-Laws Article VI,
Section 1, and supra note 44. Additional candidates for the Member
Nominating Committee may be nominated and elected by BATS Exchange
members pursuant to a petition process. See supra note 48 and
accompanying text.
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B. Regulation of BATS Exchange
As a prerequisite for the Commission's approval of an exchange's
application for registration, an exchange must be organized and have
the capacity to carry out the purposes of the Act.\66\ Specifically, an
exchange must be able to enforce compliance by its members, and persons
associated with its members, with the federal securities laws and the
rules of the exchange.\67\
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\66\ See Section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1).
\67\ Id. See also Section 19(g) of the Act, 15 U.S.C. 78s(g).
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1. Membership
Membership on BATS Exchange will be open to any registered broker
or dealer that is a member of another registered national securities
exchange or association, or any natural person associated with such a
registered broker or dealer.\68\ To remain eligible for membership in
BATS Exchange, a BATS Exchange member must be a member of another SRO
at all times.\69\
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\68\ See BATS Exchange Rules 2.3 and 2.5(a)(4) and Amendment No.
2.
\69\ Id.
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For a temporary 90-day period after approval of BATS Exchange's
application, an applicant that is an active member of another SRO and
is a current or former subscriber to the BATS ECN will be able to apply
through an expedited process to become a BATS Exchange member, and to
register with BATS Exchange all of its associated persons whose
registrations are active at the time BATS Exchange is approved as a
national securities exchange, by submitting a waive-in application
form, including membership agreements.\70\ BATS Exchange may request
additional documentation in addition to the waive-in application form
in order to determine that a waive-in applicant meets BATS Exchange's
qualification standards.\71\ All of the firm's associated persons who
are registered in categories recognized by BATS Exchange rules would
become registered persons of a BATS Exchange member firm.\72\
All other applicants (and after the 90-day period has ended, those
that could have waived in through the expedited process) may apply for
membership in BATS Exchange by submitting a full membership application
to BATS Exchange.\73\ Applications for association with an Exchange
Member shall be submitted to the Exchange on Form U-4 and such other
forms as BATS Exchange may prescribe.
---------------------------------------------------------------------------
\70\ See BATS Exchange Rule 2.4.
\71\ Id.
\72\ Id.
\73\ See BATS Exchange Rule 2.6 and Amendment No. 2.
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BATS Exchange will receive and review all applications for
membership in the Exchange. If the Exchange is satisfied that the
applicant is qualified for membership, the Exchange will promptly
notify the applicant, in writing, of such determination, and the
applicant shall be a member of the
[[Page 49502]]
Exchange.\74\ If the Exchange is not satisfied that the applicant is
qualified for membership, the Exchange shall promptly notify the
applicant of the grounds for denial.\75\ Once an applicant is a member
of the Exchange, it must continue to possess all the qualifications set
forth in the BATS Exchange rules. When the Exchange has reason to
believe that an Exchange member or associated person of a member fails
to meet such qualifications, the Exchange may suspend or revoke such
person's membership or association.\76\
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\74\ See BATS Exchange Rule 2.6(c).
\75\ See BATS Exchange Rule 2.6(d).
\76\ See BATS Exchange Rule 2.7; see also BATS Exchange Rules
Chapters VII and VIII.
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Appeal of a staff denial, suspension, or termination of membership
will be heard by the Appeals Committee.\77\ Decisions of the Appeals
Committee will be made in writing and will be sent to the parties to
the proceeding. The decisions of the Appeals Committee will be subject
to review by the Exchange Board, on its own motion, or upon written
request by the aggrieved party or by the Chief Regulatory Officer
(``CRO''). The Exchange Board will have sole discretion to grant or
deny the request. The Exchange Board will conduct the review of the
Appeals Committee's decision. The Exchange Board may affirm, reverse,
or modify the Appeals Committee's decision. The Exchange Board's
decision is final.\78\
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\77\ See BATS Exchange Rule 10.3; see also BATS Exchange Amended
and Restated By-Laws Article V, Section 6(d).
\78\ See BATS Exchange Rule 10.5(b). Membership decisions are
subject to review by the Commission. See BATS Exchange Rule 10.7.
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The Commission finds that the BATS Exchange's membership rules are
consistent with Section 6 of the Act,\79\ specifically Section 6(b)(2)
of the Act,\80\ which requires that a national securities exchange have
rules that provide that any registered broker or dealer or natural
person associated with such broker or dealer may become a member and
any person may become associated with an exchange member. The
Commission notes that pursuant to Section 6(c) of the Act, an exchange
must deny membership to any person, other than a natural person, that
is not a registered broker or dealer, any natural person that is not,
or is not associated with, a registered broker or dealer, and
registered broker-dealers that do not satisfy certain standards, such
as financial responsibility or operational capacity. As a registered
exchange, BATS Exchange must independently determine if an applicant
satisfies the standards set forth in the Act, regardless of whether an
applicant is a member of another SRO.\81\
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\79\ 15 U.S.C. 78f.
\80\ 5 U.S.C. 78f(b)(2).
\81\ See Nasdaq Exchange Registration Order, supra note 29.
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2. Regulatory Independence
BATS Exchange has proposed several measures to help ensure the
independence of its regulatory function from its market operations and
other commercial interests. The regulatory operations of BATS Exchange
will be supervised by the CRO and monitored by the Regulatory Oversight
Committee. The Regulatory Oversight Committee will consist of three
members, each of whom must be a Non-Industry Director.\82\ The
Regulatory Oversight Committee will be responsible for monitoring the
adequacy and effectiveness of the Exchange's regulatory program,
assessing the Exchange's regulatory performance, and assisting the
Exchange Board in reviewing the Exchange's regulatory plan and the
overall effectiveness of the Exchange's regulatory functions.\83\ The
Regulatory Oversight Committee also will meet with the CRO in executive
session at regularly scheduled meetings and at any time upon request of
the CRO or any member of the Regulatory Oversight Committee.\84\
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\82\ See BATS Exchange Amended and Restated By-Laws Articles
I(v) and V, Section 6(c).
\83\ See BATS Exchange Amended and Restated By-Laws Article V,
Section 6(c).
\84\ See BATS Exchange Amended and Restated By-Laws Article VII,
Section 9.
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BATS Exchange proposes that its CRO have general supervision of the
regulatory operations of the Exchange, including overseeing
surveillance, examination, and enforcement functions.\85\ The CRO also
will administer any regulatory services agreement with another SRO to
which BATS Exchange is a party.\86\ The CRO will be an Executive Vice
President or Senior Vice President that reports directly to the Chief
Executive Officer.\87\ The CRO also may serve as BATS Exchange's
General Counsel.\88\ In addition, any revenues received by BATS
Exchange from fees derived from its regulatory function or regulatory
penalties will not be used for non-regulatory purposes.\89\
---------------------------------------------------------------------------
\85\ Id.
\86\ Id.
\87\ Id.
\88\ Id. See Nasdaq Exchange Registration Order, supra note 29.
\89\ See BATS Exchange Amended and Restated By-Laws Article X,
Section 4.
---------------------------------------------------------------------------
The Commission is concerned about the potential for unfair
competition and conflicts of interest between an exchange's self-
regulatory obligations and its commercial interests that could exist if
an exchange were to otherwise become affiliated with one of its
members, as well as the potential for unfair competitive advantage that
the affiliated member could have by virtue of informational or
operational advantages, or the ability to receive preferential
treatment.\90\ BATS Exchange Rule 2.10 provides that without the prior
approval of the Commission, BATS Exchange or any entity with which it
is affiliated shall not, directly or indirectly, acquire or maintain an
ownership interest in a BATS Exchange member, and a BATS Exchange
member shall not be or become an affiliate of BATS Exchange, or an
affiliate of any affiliate of the Exchange.\91\ BATS Exchange also has
proposed for Commission approval BATS Exchange Rule 2.11, which
provides that BATS Trading, a registered broker-dealer, will provide an
Outbound Router function as a facility of the Exchange pursuant to
certain conditions and limitations.\92\ BATS Trading is an affiliate of
BATS Exchange and will become a member of BATS Exchange. This
affiliation would not be consistent with proposed Rule 2.10 absent
prior Commission approval. As part of the approval today of BATS
Exchange's application for registration as a national securities
exchange, the Commission is approving BATS Exchange Rule 2.11.
---------------------------------------------------------------------------
\90\ See, e.g., Securities Exchange Act Release No. 53382
(February 27, 2006), 71 FR 11251 (March 6, 2006).
\91\ See BATS Exchange Rule 2.10.
\92\ See infra Section III.E.
---------------------------------------------------------------------------
The Commission believes that the Exchange's proposal is consistent
with the Act, particularly with Section 6(b)(1), which requires an
exchange to be so organized and have the capacity to carry out the
purposes of the Act.\93\ Although the Commission continues to be
concerned about potential unfair competition and conflict of interest
between an exchange's self-regulatory obligations and its commercial
interests when an exchange is affiliated with one of its members, the
Commission believes that it is consistent with the Act to permit BATS
Trading to become an affiliate of BATS Exchange for the limited
Outbound Router function, in light of the protections afforded by the
conditions and limitations imposed in BATS Exchange's rules.\94\
---------------------------------------------------------------------------
\93\ See 15 U.S.C. 78f(b)(1).
\94\ See infra Section III.E. The Commission has approved
similar arrangements for other SROs. See, e.g., Securities Exchange
Act Release Nos. 57478 (March 12, 2008), 73 FR 14521 (March 18,
2008) (SR-NASDAQ-2007-004) (``NOM Approval Order'') and 54391
(August 31, 2006), 71 FR 52836 (September 7, 2006) (SR-NSX-2006-08)
(``NSX Blade Approval Order'').
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[[Page 49503]]
3. Regulatory Contract
Although BATS Exchange will be an SRO with all of the attendant
regulatory obligations under the Act, it has entered into a regulatory
contract with FINRA (``Regulatory Contract''), under which FINRA will
perform certain regulatory functions on BATS Exchange's behalf.\95\
Specifically, BATS Exchange represents that FINRA will assist Exchange
staff on registration issues on an as-needed basis, investigate
potential violations of BATS Exchange's rules or federal securities
laws related to activity on the Exchange, conduct examinations related
to market conduct on the Exchange by Members, assist the Exchange with
disciplinary proceedings pursuant to BATS Exchange's Rules, including
issuing charges and conducting hearings, and provide dispute resolution
services to BATS Exchange Members on behalf of the Exchange, including
operation of the Exchange's arbitration program. BATS Exchange
represents that FINRA also will provide the Exchange with access to
FINRA's WebCRD system, and will assist with programming BATS-specific
functionality relating to such system.\96\ Notwithstanding the
Regulatory Contract, BATS Exchange will retain ultimate legal
responsibility for the regulation of its members and its market.
---------------------------------------------------------------------------
\95\ See BATS Exchange Rule 13.7; see also Amendment No. 2.
Pursuant to the applicable provisions of the Freedom of Information
Act, 5 U.S.C. 552, and Commission regulations thereunder, 17 CFR
200.83, BATS Exchange has requested confidential treatment for the
Regulatory Contract.
\96\ See Amendment No. 2.
---------------------------------------------------------------------------
The Commission believes that it is consistent with the Act to allow
BATS Exchange to contract with FINRA to perform examination,
enforcement, and disciplinary functions.\97\ These functions are
fundamental elements to a regulatory program, and constitute core self-
regulatory functions. It is essential to the public interest and the
protection of investors that these functions are carried out in an
exemplary manner, and the Commission believes that FINRA has the
expertise and experience to perform these functions on behalf of BATS
Exchange.\98\
---------------------------------------------------------------------------
\97\ See, e.g., Regulation ATS Release, supra note 54. See also
Securities Exchange Act Release 50122 (July 29, 2004), 69 FR 47962
(August 6, 2004) (SR-Amex-2004-32) (order approving rule that
allowed Amex to contract with another SRO for regulatory services)
(``Amex Regulatory Services Approval Order''); NOM Approval Order,
supra note 94; and Nasdaq Exchange Registration Order, supra note
29.
\98\ See Amex Regulatory Services Approval Order, supra note 97;
NOM Approval Order, supra note 94; and Nasdaq Exchange Registration
Order, supra note 29. The Commission notes that the Regulatory
Contract is not before the Commission and, therefore, the Commission
is not acting on it.
---------------------------------------------------------------------------
At the same time, BATS Exchange, unless relieved by the Commission
of its responsibility,\99\ bears the responsibility for self-regulatory
conduct and primary liability for self-regulatory failures, not the SRO
retained to perform regulatory functions on the Exchange's behalf. In
performing these regulatory functions, however, FINRA may nonetheless
bear liability for causing or aiding and abetting the failure of BATS
Exchange to perform its regulatory functions.\100\ Accordingly,
although FINRA will not act on its own behalf under its SRO
responsibilities in carrying out these regulatory services for BATS
Exchange, FINRA may have secondary liability if, for example, the
Commission finds that the contracted functions are being performed so
inadequately as to cause a violation of the federal securities laws by
BATS Exchange.\101\
---------------------------------------------------------------------------
\99\ See Section 17(d)(1) of the Act and Rule 17d-2 thereunder,
15 U.S.C. 78q(d)(1) and 17 CFR 240.17d-2. See also infra notes 103-
110 and accompanying text.
\100\ For example, if failings by FINRA have the effect of
leaving BATS Exchange in violation of any aspect of BATS Exchange's
self-regulatory obligations, BATS Exchange would bear direct
liability for the violation, while FINRA may bear liability for
causing or aiding and abetting the violation. See Nasdaq Exchange
Registration Order, supra note 29 and Securities Exchange Act
Release No. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000)
(File No. 10-127) (order approving the International Securities
Exchange LLC's application for registration as a national securities
exchange).
\101\ Id.
---------------------------------------------------------------------------
Although BATS Exchange has entered into the Regulatory Contact, the
provisions in the Regulatory Contract that will specify the particular
BATS Exchange and Commission rules for which FINRA will provide certain
regulatory functions have not been finalized. Accordingly, the
Commission is conditioning the operation of BATS Exchange on the
execution of the Regulatory Contract and finalization of the provisions
in the Regulatory Contract that will specify the BATS Exchange and
Commission rules for which FINRA will provide regulatory
functions.\102\
---------------------------------------------------------------------------
\102\ Alternatively, BATS Exchange could demonstrate that it has
the ability to fulfill its regulatory obligations.
---------------------------------------------------------------------------
4. 17d-2 Agreement
Section 19(g)(1) of the Act \103\ requires every SRO to examine its
members and persons associated with its members and to enforce
compliance with the federal securities laws and the SRO's own rules,
unless the SRO is relieved of this responsibility pursuant to Section
17(d) of the Act.\104\ Section 17(d) was intended, in part, to
eliminate unnecessary multiple examinations and regulatory duplication
with respect to members of more than one SRO (``common members'').\105\
Rule 17d-2 of the Act permits SROs to propose joint plans allocating
regulatory responsibilities concerning common members.\106\ These
agreements, which must be filed with and approved by the Commission,
generally cover such regulatory functions as personnel registration,
branch office examinations, and sales practices. Commission approval of
a 17d-2 plan relieves the specified SRO of those regulatory
responsibilities allocated by the plan to another SRO.\107\ Many
existing SROs have entered in to such agreements.\108\
---------------------------------------------------------------------------
\103\ 15 U.S.C. 78s(g)(1).
\104\ 15 U.S.C. 78q(d).
\105\ See Securities Exchange Act Release No. 12935 (October 28,
1976), 41 FR 49091 (November 8, 1976) (``Rule 17d-2 Adopting
Release'').
\106\ 17 CFR 240.17d-2.
\107\ See Rule 17d-2 Adopting Release, supra note 105.
\108\ See, e.g., Securities Exchange Act Release Nos. 13326
(March 3, 1977), 42 FR 13878 (March 14, 1977) (NYSE/Amex); 13536
(May 12, 1977), 42 FR 26264 (May 23, 1977) (NYSE/BSE); 14152
(November 9, 1977), 42 FR 59339 (November 16, 1977) (NYSE/CSE);
13535 (May 12, 1977), 42 FR 26269 (May 23, 1977) (NYSE/CHX); 13531
(May 12, 1977), 42 FR 26273 (May 23, 1977) (NYSE/PSE); 14093
(October 25, 1977), 42 FR 57199 (November 1, 1977) (NYSE/Phlx);
15191 (September 26, 1978), 43 FR 46093 (October 5, 1978) (NASD/BSE,
CSE, CHX and PSE); 16858 (May 30, 1980), 45 FR 37927 (June 5, 1980)
(NASD/BSE, CSE, CHX and PSE); 42815 (May 23, 2000), 65 FR 34762 (May
31, 2000) (NASD/ISE); and 54136 (July 12, 2006), 71 FR 40759 (July
18, 2006) (NASD/Nasdaq).
---------------------------------------------------------------------------
BATS Exchange has represented to the Commission that BATS Exchange
and FINRA intend to file a 17d-2 agreement with the Commission covering
common members of BATS Exchange and FINRA. This agreement would
allocate to FINRA regulatory responsibility, with respect to common
members, for the following:
FINRA will examine common members of BATS Exchange and
FINRA for compliance with federal securities laws, rules and
regulations, and rules of BATS Exchange that have been certified by
BATS Exchange as identical or substantially similar to FINRA rules.
FINRA will investigate common members of BATS Exchange and
FINRA for violations of federal securities laws, rules or regulations,
or BATS Exchange rules that has been certified by BATS Exchange as
identical or substantially identical to a FINRA rule.
FINRA will enforce compliance by common members with
federal securities laws, rules and regulations, and rules of BATS
Exchange that have been certified by BATS Exchange as
[[Page 49504]]
identical or substantially similar to FINRA rules.
Because BATS Exchange anticipates entering into this 17d-2
agreement, it has not made provision to fulfill the regulatory
obligations that would be undertaken by FINRA under this agreement with
respect to common members of BATS Exchange and FINRA.\109\ Accordingly,
the Commission is conditioning the operation of BATS Exchange on
approval by the Commission of a 17d-2 agreement between BATS Exchange
and FINRA that allocates the above specified matters to FINRA.\110\
---------------------------------------------------------------------------
\109\ The Commission notes that regulation that is to be covered
by the 17d-2 agreement for common members will be carried out by
FINRA under the Regulatory Contract for BATS Exchange members that
are not also members of FINRA.
\110\ Alternatively, BATS Exchange could demonstrate that it has
the ability to fulfill its regulatory obligations.
---------------------------------------------------------------------------
5. Discipline and Oversight of Members
As noted above, a prerequisite for the Commission approval of an
exchange's application for registration, an exchange must be organized
and have the capacity to carry out the purposes of the Act.
Specifically, an exchange must be able to enforce compliance by its
members and persons associated with its members with federal securities
laws and the rules of the exchange.\111\ As noted above, pursuant to
the Regulatory Contract, FINRA will perform many of the initial
disciplinary processes on behalf of BATS Exchange.\112\ For example,
FINRA will investigate potential securities laws violations, issue
complaints, and conduct hearings pursuant to BATS Exchange rules.
Appeals from disciplinary decisions will be heard by the Appeals
Committee \113\ and the Appeals Committee's decision shall be final. In
addition, the Exchange Board may on its own initiative order review of
a disciplinary decision.\114\
---------------------------------------------------------------------------
\111\ See 15 U.S.C. 78f(b)(1).
\112\ See supra note 97 and accompanying text.
\113\ See BATS Exchange Rule 8.10(b).
\114\ See BATS Exchange Rule 8.10(c).
---------------------------------------------------------------------------
The BATS Amended and Restated By-Laws and BATS Exchange rules
provide that the Exchange has disciplinary jurisdiction over its
members so that it can enforce its members' compliance with its rules
and the federal securities laws.\115\ The Exchange's rules also permit
it to sanction members for violations of its rules and violations of
the federal securities laws by, among other things, expelling or
suspending members, limiting members' activities, functions, or
operations, fining or censuring members, or suspending or barring a
person from being associated with a member, or any other fitting
sanction.\116\ BATS Exchange's rules also provide for the imposition of
fines for certain minor rule violations in lieu of commencing
disciplinary proceedings.\117\ Accordingly, as a condition to the
operation of BATS Exchange, a Minor Rule Violation Plan (``MRVP'')
filed by BATS Exchange under Act Rule 19d-1(c)(2) must be declared
effective by the Commission.\118\
---------------------------------------------------------------------------
\115\ See generally BATS Exchange Amended and Restated By-Laws
Article X and BATS Exchange Rules Chapters II and VIII.
\116\ See BATS Exchange Rules 2.2 and 8.1(a).
\117\ See BATS Exchange Rule 8.15 and Amendment No. 2.
\118\ 17 CFR 240.19d-1(c)(2).
---------------------------------------------------------------------------
The Commission finds that the BATS Exchange's Amended and Restated
By-Laws and rules concerning its disciplinary and oversight programs
are consistent with the requirements of Sections 6(b)(6) and 6(b)(7)
\119\ of the Act in that they provide fair procedures for the
disciplining of members and persons associated with members. The
Commission further finds that the rules of BATS Exchange provide it
with the ability to comply, and with the authority to enforce
compliance by its members and persons associated with its members, with
the provisions of the Act, the rules and regulations thereunder, and
the rules of BATS Exchange.\120\
---------------------------------------------------------------------------
\119\ 15 U.S.C. 78f(b)(6) and (b)(7).
\120\ See Section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1).
---------------------------------------------------------------------------
C. BATS Exchange Trading System
1. Trading Rules
BATS Exchange will operate a fully automated electronic order book.
Exchange members and entities that enter into sponsorship arrangements
with Exchange members will have access to the BATS Exchange system
(collectively, ``Users'').\121\ Users will be able to electronically
submit market and various types of limit orders to the Exchange from
remote locations. All orders submitted to BATS Exchange will be
displayed unless designated otherwise by the BATS Exchange member
submitting the order. Displayed orders will be displayed on an
anonymous basis at a specified price. Non-displayed orders will not be
displayed but will be ranked in the BATS Exchange system at a specified
price.\122\ The BATS Exchange system will continuously and
automatically match orders pursuant to price/time priority, except that
displayed orders will have priority over non-displayed orders at the
same price.\123\
---------------------------------------------------------------------------
\121\ To obtain authorized access to the BATS Exchange System,
each User must enter in to a User Agreement with the Exchange. See
BATS Exchange Rule 11.3(a).
\122\ BATS Exchange rules do not provide for specialists or
market makers.
\123\ See BATS Exchange Rule 11.8.
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The BATS Exchange system is designed to comply with Rule 611 of
Regulation NMS \124\ by requiring that, for any execution to occur on
the Exchange during regular trading hours, the price must be equal to,
or better than, any ``protected quotation'' within the meaning of
Regulation NMS (``Protected Quotation''), unless an exception to Rule
611 of Regulation NMS applies.\125\ BATS Exchange will direct any
orders or portion of orders that cannot be executed in their entirety
to away markets for execution through BATS Trading, unless the terms of
the orders direct the Exchange not to route such orders away.\126\
---------------------------------------------------------------------------
\124\ 17 CFR 242.611.
\125\ See BATS Exchange Rule 11.9.
\126\ See BATS Exchange Rule 11.9(a)(2).
---------------------------------------------------------------------------
BATS Exchange intends to operate as an automated trading center in
compliance with Rule 600(b)(4) of Regulation NMS.\127\ BATS Exchange
will display automated quotations at all times except in the event that
a systems malfunction renders the system incapable of displaying
automated quotations.\128\ The Exchange has designed its rules relating
to orders, modifiers, and order execution to comply with the
requirements of Regulation NMS, including an immediate-or-cancel
functionality.\129\ These proposed rules include accepting orders
marked as intermarket sweep orders, which will allow orders so
designated to be automatically matched and executed without reference
to Protected Quotations at other trading centers,\130\ and routing
orders marked as intermarket sweep orders by a User to a specific
trading center for execution.\131\ In addition, BATS Exchange rules
address locked and crossed markets,\132\ as required by Rule 610(d) of
Regulation NMS.\133\ The Commission believes that BATS Exchange's rules
are consistent with the Act, in particular with the requirements of
Rule 610(d) and Rule 611 of Regulation NMS.
---------------------------------------------------------------------------
\127\ 17 CFR 242.600(b)(4).
\128\ See BATS Exchange Rule 11.9(c); see also 17 CFR
242.600(b)(3).
\129\ See BATS Exchange Rules 11.5 and 11.9; see also 17 CFR
242.600(b)(3).
\130\ See BATS Exchange Rule 11.5(d)(1).
\131\ See BATS Exchange Rule 11.5(d)(2).
\132\ See BATS Exchange Rule 11.16.
\133\ 17 CFR 242.610(d).
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As stated above, BATS Exchange intends to operate as an automated
[[Page 49505]]
trading center and have its best bid and best offer be a Protected
Quotation.\134\ To meet their regulatory responsibilities under Rule
611(a) of Regulation NMS, market participants must have sufficient
notice of new Protected Quotations, as well as all necessary
information (such as final technical specifications).\135\ Therefore,
the Commission believes that it would be a reasonable policy and
procedure under Rule 611(a) for industry participants to begin treating
BATS Exchange's best bid and best offer as a Protected Quotation within
90 days after the date of this order, or such later date as BATS
Exchange begins operation as a national securities exchange.
---------------------------------------------------------------------------
\134\ 17 CFR 242.600(b)(58).
\135\ See Securities Exchange Act Release No. 53829 (May 18,
2006), 71 FR 30038, 30041 (May 24, 2006).
---------------------------------------------------------------------------
2. Section 11 of the Act
Section 11(a)(1) of the Act \136\ prohibits a member of a national
securities exchange from effecting transactions on that exchange for
its own account, the account of an associated person, or an account
over which it or its associated person exercises discretion
(collectively, ``covered accounts'') unless an exception applies. Rule
11a2-2(T) \137\ under the Act, known as the ``effect versus execute''
rule, provides exchange members with an exemption from the Section
11(a)(1) prohibition. Rule 11a2-2(T) permits an exchange member,
subject to certain conditions, to effect transactions for covered
accounts by arranging for an unaffiliated member to execute the
transactions on the exchange. To comply with Rule 11a2-2(T)'s
conditions, a member: (i) Must transmit the order from off the exchange
floor; (ii) may not participate in the execution of the transaction
once it has been transmitted to the member performing the execution;
\138\ (iii) may not be affiliated with the executing member; and (iv)
with respect to an account over which the member has investment
discretion, neither the member nor its associated person may retain any
compensation in connection with effecting the transaction except as
provided in the Rule.
---------------------------------------------------------------------------
\136\ 15 U.S.C. 78k(a)(1).
\137\ 17 CFR 240.11a2-2(T).
\138\ The member may, however, participate in clearing and
settling the transaction.
---------------------------------------------------------------------------
In a letter to the Commission,\139\ BATS Exchange requested that
the Commission concur with BATS Exchange's conclusion that BATS
Exchange members that enter orders into the BATS Exchange system
satisfy the requirements of Rule 11a2-2(T). For reasons set forth
below, the Commission believes that BATS Exchange members entering
orders into the BATS Exchange system would satisfy the conditions of
the Rule.
---------------------------------------------------------------------------
\139\ See letter to David Shillman, Associate Director, Division
of Trading and Markets, Commission, from J. Craig Long, Foley &
Lardner LLP, dated June 24, 2008 (``BATS Exchange 11(a) Letter'').
---------------------------------------------------------------------------
The Rule's first condition is that orders for covered accounts be
transmitted from off the exchange floor. The BATS Exchange system
receives orders electronically through remote terminals or computer-to-
computer interfaces. In the context of other automated trading systems,
the Commission has found that the off-floor transmission requirement is
met if a covered account order is transmitted from a remote location
directly to an exchange's floor by electronic means.\140\ Since the
BATS Exchange system receives orders electronically through remote
terminals or computer-to-computer interfaces, the Commission believes
that the BATS Exchange system satisfies the off-floor transmission
requirement.
---------------------------------------------------------------------------
\140\ See, e.g., Nasdaq Exchange Registration Order, supra note
29; and Securities Exchange Act Release Nos. 49068 (January 13,
2004), 69 FR 2775 (January 20, 2004) (order approving the Boston
Options Exchange as an options trading facility of the Boston Stock
Exchange); 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001)
(order approving Archipelago Exchange (``ArcaEx'') as electronic
trading facility of the Pacific Exchange (``PCX'') (``ArcaEx
Order'')); 29237 (May 24, 1991), 56 FR 24853 (May 31, 1991)
(regarding NYSE's Off-Hours Trading Facility); 15533 (January 29,
1979), 44 FR 6084 (January 31, 1979) (regarding the American Stock
Exchange (``Amex'') Post Execution Reporting System, the Amex
Switching System, the Intermarket Trading System, the Multiple
Dealer Trading Facility of the Cincinnati Stock Exchange, the PCX
Communications and Execution System, and the Philadelphia Stock
Exchange's (``Phlx'') Automated Communications and Execution System
(``1979 Release'')); and 14563 (March 14, 1978), 43 FR 11542 (March
17, 1978) (regarding the NYSE's Designated Order Turnaround System
(``1978 Release'')).
---------------------------------------------------------------------------
Second, the rule requires that the member not participate in the
execution of its order. BATS Exchange represented that at no time
following the submission of an order is a member able to acquire
control or influence over the result or timing of an order's
execution.\141\ According to BATS Exchange, the execution of a member's
order is determined solely by what orders, bids, or offers are present
in the system at the time the member submits the order. Accordingly,
the Commission believes that a BATS Exchange member would not
participate in the execution of an order submitted into the BATS
Exchange system.
---------------------------------------------------------------------------
\141\ See BATS Exchange 11(a) Letter, supra note 139. The member
may cancel or modify the order, or modify the instructions for
executing the order, but only from off the Exchange floor. Id. The
Commission has stated that the non-participation requirement is
satisfied under such circumstances so long as such modifications or
cancellations are also transmitted from off the floor. See
Securities Exchange Act Release No. 14563 (March 14, 1978), 43 FR
11542 (March 17, 1978) (stating that the ``non-participation
requirement does not prevent initiating members from canceling or
modifying orders (or the instructions pursuant to which the
initiating member wishes orders to be executed) after the orders
have been transmitted to the executing member, provided that any
such instructions are also transmitted from off the floor'').
---------------------------------------------------------------------------
Third, Rule 11a2-2(T) requires that the order be executed by an
exchange member who is unaffiliated with the member initiating the
order. The Commission has stated that this requirement is satisfied
when automated exchange facilities, such as the BATS Exchange system,
are used, as long as the design of these systems ensures that members
do not possess any special or unique trading advantages in handling
their orders after transmitting them to the exchange.\142\ BATS
Exchange has represented that the design of the BATS Exchange system
ensures that no member has any special or unique trading advantage in
the handling of its orders after transmitting its orders to BATS
Exchange.\143\ Based on BATS Exchange's representation, the Commission
believes that the BATS Exchange system satisfies this requirement.
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\142\ In considering the operation of automated execution
systems operated by an exchange, the Commission noted that while
there is no independent executing exchange member, the execution of
an order is automatic once it has been transmitted into the systems.
Because the design of these systems ensures that members do not
possess any special or unique trading advantages in handling their
orders after transmitting them to the exchange, the Commission has
stated that executions obtained through these systems satisfy the
independent execution requirement of Rule 11a2-2(T). See 1979
Release, supra note 140.
\143\ See BATS Exchange 11(a) Letter, supra note 139.
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Fourth, in the case of a transaction effected for an account with
respect to which the initiating member or an associated person thereof
exercises investment discretion, neither the initiating member nor any
associated person thereof may retain any compensation in connection
with effecting the transaction, unless the person authorized to
transact business for the account has expressly provided otherwise by
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T).\144\ BATS Exchange
[[Page 49506]]
represented that BATS Exchange members trading for covered accounts
over which they exercise investment discretion must comply with this
condition in order to rely on the rule's exemption.\145\
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\144\ 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written
contract to retain compensation, in connection with effecting
transactions for covered accounts over which such member or
associated person thereof exercises investment discretion, to
furnish at least annually to the person authorized to transact
business for the account a statement setting forth the total amount
of compensation retained by the member in connection with effecting
transactions for the account during the period covered by the
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra
note 140 (stating ``[t]he contractual and disclosure requirements
are designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\145\ See BATS Exchange 11(a) Letter, supra note 139.
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D. Section 11A of the Act
Section 11A of the Act and the rules thereunder form the basis of
our national market system and impose requirements on exchanges to
implement its objectives. Specifically, national securities exchanges
are required, under Rule 601 of Regulation NMS,\146\ to file
transaction reporting plans regarding transactions in listed equity and
Nasdaq securities that are executed on their facilities. Currently
registered exchanges satisfy this requirement by participating in the
Consolidated Transaction Association Plan (``CTA Plan'') for listed
equities and the Joint Self-Regulatory Organization Plan Governing the
Collection, Consolidation and Dissemination of Quotation and
Transaction Information for Nasdaq-Listed Securities Traded on
Exchanges on an Unlisted Trading Privileges Basis (``Nasdaq UTP Plan'')
for Nasdaq securities.\147\ Before BATS Exchange can begin operating as
an exchange, it must join these plans as a participant.
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\146\ 17 CFR 242.601.
\147\ These plans also satisfy the requirement in Rule 603 that
national securities exchanges and national securities associations
act jointly pursuant to an effective national market system plan to
disseminate consolidated information, including a national best bid
and offer, and quotations for and transactions in NMS stocks. See 17
CFR 242.603. See also Nasdaq Exchange Registration Order, supra note
29.
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National securities exchanges are required, under Rule 602 of
Regulation NMS,\148\ to collect bids, offers, quotation sizes and
aggregate quotation sizes from those members who are responsible broker
or dealers. National securities exchanges must then make this
information available to vendors at all times when the exchange is open
for trading. The current exchanges satisfy this requirement by
participating in the Consolidated Quotation System Plan (``CQ Plan'')
for listed equity securities and the Nasdaq UTP Plan for Nasdaq
securities. Before BATS Exchange can begin operating as an exchange it
also must join the CQ Plan as a participant, in addition to the CTA
Plan and the Nasdaq UTP Plan.
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\148\ 17 CFR 242.602.
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Finally, national securities exchanges must make available certain
order execution information pursuant to Rule 605 of Regulation
NMS.\149\ Current exchanges have standardized the required disclosure
mechanisms by participating in the Order Execution Quality Disclosure
Plan.\150\ BATS Exchange must join this plan before it begins
operations as an exchange.
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\149\ 17 CFR 242.605.
\150\ See Securities Exchange Act Release No. 44177 (April 12,
2001), 66 FR 19814 (April 17, 2001).
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E. Order Routing
As noted above in Section III.A., BATS Exchange proposes to offer
routing services to its Users through its affiliated broker-dealer,
BATS Trading. BATS Trading will provide ``outbound'' routing of orders
from the Exchange to other trading centers (such function of BATS
Trading is referred to as the ``Outbound Router''), and BATS Trading
will engage in no other activities unless approved by the
Commission.\151\ The Outbound Router function of BATS Trading will
operate as a facility (as defined in Section 3(a)(2) of the Act) of the
Exchange. As such, the Outbound Router function of BATS Trading is
subject to the Exchange's and the Commission's continuing oversight. In
particular, and without limitation, under the Act, the Exchange is
responsible for filing with the Commission proposed rule changes and
fees relating to the BATS Trading Outbound Router function and BATS
Trading Outbound Router function will be subject to exchange non-
discrimination requirements.\152\
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\151\ See BATS Exchange Rule 2.11(a)(4).
\152\ See BATS Exchange Rule 2.11(a)(1).
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BATS Trading will be a member of FINRA, an SRO unaffiliated with
BATS Exchange or any of its affiliates, that is its designated
examining authority.\153\ Also, BATS Exchange will establish and
maintain procedures and internal controls reasonably designed to
restrict the flow of confidential and proprietary information between
BATS Exchange and its facilities, and any other entity, including any
affiliate of BATS Trading, and, if BATS Trading or any of its
affiliates engages in any other business activities other than the
Outbound Router function, between the segment of BATS Trading or its
affiliate that provides the other business activities and the Outbound
Router function.\154\ In addition, the books, records, premises,
officers, directors, agents, and employees of BATS Trading, as a
facility of the Exchange, will be deemed to be those of the Exchange
for purposes of and subject to oversight pursuant to the Act.\155\
Further, Users are not required to use the Outbound Router function of
BATS Trading to route orders,\156\ and a User is free to route its
orders to other market centers through alternative means.\157\
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\153\ See BATS Exchange Rule 2.11(a)(2).
\154\ See BATS Exchange Rule 2.11(a)(5).
\155\ See BATS Exchange Rule 2.11(b).
\156\ A User that does not wish to use the Outbound Router
function of BATS Trading could submit an Immediate-or-Cancel Order
or another order type that is not eligible for order routing
pursuant to BATS Exchange rules, such as a BATS Only Order. See BATS
Exchange Rule 11.5.
\157\ See BATS Exchange Rule 2.11(a)(3).
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In light of the protections discussed above, the Commission
believes that BATS Exchange rules and procedures regarding use of BATS
Trading to route orders to away markets are consistent with the
Act.\158\
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\158\ The Commission has approved similar arrangements for other
SROs. See, e.g., NOM Approval Order and NSX Blade Approval Order,
supra note 94.
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F. Listing Requirements/Unlisted Trading Privileges
BATS Exchange initially does not intend to list any securities.
Accordingly, BATS Exchange has not proposed rules that would allow it
to list any securities at this time.\159\ Instead, BATS Exchange has
proposed to trade securities pursuant to unlisted trading privileges,
consistent with Section 12(f) of the Act and Rule 12f-5 thereunder.
Rule 12f-5 requires an exchange that extends unlisted trading
privileges to securities to have in effect a rule or rules providing
for transactions in the class or type of security to which the exchange
extends unlisted trading privileges.\160\ BATS Exchange's proposed
rules require that any security traded on the BATS Exchange be
registered under the Act and listed on the New York Stock Exchange LLC,
NYSE Arca, the American Stock Exchange LLC, or The NASDAQ Stock Market
LLC. BATS Exchange's proposed
[[Page 49507]]
rules provide for transactions in the class or type of security to
which the exchange intends to extend unlisted trading privileges.\161\
In addition, pursuant to its rules, BATS Exchange will cease trading
any equity security admitted to unlisted trading privileges that is no
longer listed on one of these exchanges. The Commission finds that
these rules are consistent with the Act.\162\
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\159\ BATS Exchange has incorporated listing standards for
certain derivative securities products in its rules. However, BATS
Exchange's rules will prohibit BATS Exchange from listing any
derivative security product pursuant to these listing standards
until BATS Exchange submits a proposed rule change to the Commission
to amend its listing standards to comply with Rule 10A-3 under the
Act and incorporate qualitative listing criteria. See BATS Exchange
Rule 14.1(a).
\160\ 17 CFR 240.12f-5. See also Securities Exchange Act Release
No. 35737 (April 21, 1995), 60 FR 20891 (April 28, 1995) (adopting
Rule 12f-5).
\161\ Id. BATS Exchange's rules currently do not provide for the
trading of options, security futures, or other similar instruments.
\162\ BATS Exchange has represented to the Commission that it
intends to phase-in the trading of securities currently trading on
the BATS ECN to BATS Exchange, and that it will provide appropriate
advance notice to its members of the phase-in schedule. The
Commission believes that this approach is appropriate and should
help maintain an orderly transition to the BATS Exchange.
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IV. Exemption from Section 19(b) of the Act With Regard to FINRA Rules
Incorporated by Reference
BATS Exchange proposes to incorporate by reference certain FINRA
rules as Exchange rules. Thus, for certain Exchange rules, Exchange
members will comply with an Exchange rule by complying with the FINRA
rule referenced.\163\ In connection with its proposal to incorporate
FINRA rules by reference, BATS Exchange requested, pursuant to Rule
240.0-12,\164\ an exemption under Section 36 of the Act from the rule
filing requirements of Section 19(b) of the Act for changes to those
BATS Exchange rules that are effected solely by virtue of a change to a
cross-referenced FINRA rule.\165\ BATS Exchange proposes to incorporate
by reference categories of rules (rather than individual rules within a
category) that are not trading rules. BATS Exchange agrees to provide
written notice to its members whenever a proposed rule change to a
FINRA rule that is incorporated by reference is proposed.\166\
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\163\ BATS Exchange proposed to incorporate by reference the
12000 and 13000 Series of FINRA's NASD Manual, the NASD Code of
Arbitration Procedure for Customer and Industry Disputes. See BATS
Exchange Rule 9.1.
\164\ See 17 CFR 240.0-12.
\165\ See letter to Nancy Morris, Secretary, Commission, from J.
Craig Long, Foley & Lardner, dated June 24, 2008.
\166\ BATS Exchange will provide such notice via a posting on
the same Web site location where BATS Exchange will post its own
rule filings pursuant to Commission Rule 19b-4(l). The posting will
include a link to the location on the FINRA Web site where the
proposed rule change is posted. See id.
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Using its authority under Section 36 of the Act,\167\ the
Commission previously exempted certain SROs from the requirement to
file proposed rule changes under Section 19(b) of the Act.\168\ Each
such exempt SRO agreed to be governed by the incorporated rules, as
amended from time to time, but is not required to file a separate
proposed rule change with the Commission each time the SRO whose rules
are incorporated by reference seeks to modify its rules.
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\167\ 15 U.S.C. 78mm.
\168\ See, e.g., Securities Exchange Act Release No. 49260
(February 17, 2004), 69 FR 8500 (February 24, 2004) and Nasdaq
Exchange Registration Order, supra note 29.
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In addition, each such exempt SRO incorporated by reference only
regulatory rules (i.e., margin, suitability, arbitration), not trading
rules, and incorporated by reference whole categories of rules (i.e.,
did not ``cherry-pick'' certain individual rules within a category).
Each such exempt SRO had reasonable procedures in place to provide
written notice to its members each time a change is proposed to the
incorporated rules of another SRO in order to provide its members with
notice of a proposed rule change that affects their interests, so that
they would have an opportunity to comment on it.
The Commission is granting BATS Exchange's request for exemption,
pursuant to Section 36 of the Act, from the rule filing requirements of
Section 19(b) of the Act with respect to the rules that BATS Exchange
proposes to incorporate by reference. This exemption is conditioned
upon BATS Exchange providing written notice to its members whenever
FINRA proposes to change a rule that BATS Exchange has incorporated by
reference. The Commission believes that this exemption is appropriate
in the public interest and consistent with the protection of investors
because it will promote more efficient use of Commission and SRO
resources by avoiding duplicative rule filings based on simultaneous
changes to identical rules sought by more than one SRO. Consequently,
the Commission grants BATS Exchange's exemption request.
V. Conclusion
It is ordered that the application of BATS Exchange for
registration as a national securities exchange be, and hereby is,
granted.
It is further ordered that operation of BATS Exchange is
conditioned on the satisfaction of the requirements below:
A. Participation in National Market System Plans. BATS Exchange
must join the CTA Plan, the CQ Plan, the Nasdaq UTP Plan, and the Order
Execution Quality Disclosure Plan.
B. Intermarket Surveillance Group. BATS Exchange must join the
Intermarket Surveillance Group.
C. Minor Rule Violation Plan. A MRVP filed by BATS Exchange under
Rule 19d-1(c)(2) must be declared effective by the Commission.\169\
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\169\ 17 CFR 240.19d-1(c)(2).
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D. 17d-2 Agreement. An agreement pursuant to Rule 17d-2 \170\
between FINRA and BATS Exchange that allocates to FINRA regulatory
responsibility for those matters specified above \171\ must be approved
by the Commission, or BATS Exchange must demonstrate that it
independently has the ability to fulfill all of its regulatory
obligations.
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\170\ 17 CFR 240.17d-2.
\171\ See supra notes 103 to 110 and accompanying text.
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E. Regulatory Contract. The Regulatory Contract between BATS
Exchange and FINRA containing those matters specified above \172\ must
be executed and the provisions in the Regulatory Contract that will
specify the BATS Exchange and Commission rules for which FINRA will
provide certain of the regulatory functions under the Regulatory
Contract must be finalized, or BATS Exchange must demonstrate that it
independently has the ability to fulfill all of its regulatory
obligations.
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\172\ See supra notes 95 to 102 and accompanying text.
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F. Examination by the Commission. BATS Exchange must have, and
represent in a letter to the staff in the Commission's Office of
Compliance Inspections and Examinations that it has, adequate
procedures and programs in place to effectively regulate BATS Exchange.
It is further ordered, pursuant to Section 36 of the Act,\173\ that
BATS Exchange shall be exempt from the rule filing requirements of
Section 19(b) of the Act \174\ with respect to the FINRA rules BATS
Exchange proposes to incorporate by reference into BATS Exchange's
rules, subject to the conditions specified in this Order.
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\173\ 15 U.S.C. 78mm.
\174\ 15 U.S.C. 78s(b).
By the Commission (Chairman Cox and Commissioners Casey,
Aguilar, and Paredes); Commissioner Walter not participating.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-19388 Filed 8-20-08; 8:45 am]
BILLING CODE 8010-01-P