On July 18, the U.S. Securities and Exchange Commission (SEC) voted unanimously to adopt amendments to Regulation ATS1 that would require alternative trading systems (ATS) that trade NMS stocks2 (i.e., stocks listed on a national securities exchange) (NMS Stock ATSs), including “dark pools,” to publicly disclose detailed information about the operations of the NMS Stock ATS and the activities of the broker-dealer operator and its affiliates. The adopted amendments are intended to enhance transparency and oversight of NMS Stock ATSs and facilitate comparisons of different NMS Stock ATSs by market participants. The new disclosures also address the issues raised by disciplinary actions brought against ATSs and their broker-dealer operators. While the new rules are primarily focused on NMS Stock ATSs, several commissioners noted their support for extending some form of enhanced disclosures to non-NMS Stock ATSs, such as those trading fixed-income securities, in future rulemakings.3
The SEC proposed these rules to address a number of significant concerns. First, ATSs now account for a significant amount of trading in the market. When the SEC adopted Regulation ATS in 1998, there were eight registered national securities exchanges and 43 systems that would be eligible to operate as an ATS.4 As of March 31, 2018 there are 21 registered national securities exchanges and 87 ATSs with a Form ATS on file with the SEC. Of these, 12 exchanges and 41 ATSs trade or expect to trade NMS stocks. In the first quarter of 2018, ATSs that reported transactions in NMS stocks accounted for 11.4 percent of combined total share volume and 11.5 percent of total dollar volume of the market.5
Second, the relationship between broker-dealer operators of ATSs and the ATSs they operate has become much more complex and intertwined than when the SEC adopted Regulation ATS. In the SEC’s view, that operational and structural complexity gives rise to actual and perceived conflicts of interest that need to be addressed. Over the last number of years, such conflicts when unaddressed or not addressed properly have resulted in disciplinary actions brought against ATSs and their broker-dealer operators by the SEC, Financial Industry Regulatory Authority and other federal and state regulators. Virtually all of the 12 disciplinary actions brought by the SEC involved allegations that the ATS provided disparate information or functionality to its subscribers or impermissibly shared or used the confidential trading information of subscribers. The adopted rules are intended, among other things, to ensure that all market participants have access to the same information regarding the operations of an NMS Stock ATS. The SEC believes that the additional transparency disclosed on Form ATS-N should provide market participants with sufficient information to evaluate potential conflicts of interest. There are also widespread concerns of a perceived lack of transparency given that disclosures on the current Form ATS are confidential unless made public by the broker-dealer operator. According to the SEC, the lack of ATS transparency and the less stringent disclosure requirements of ATSs relative exchanges The SEC also indicated that the differences between ATSs and national securities exchanges with regard to disclosure obligations may have created a competitive imbalance between two functionally similar trading centers that trade the same security.
Finally, the enhanced disclosures will benefit investors, asset managers and broker-dealers in allowing better informed order routing and order execution decisions. Asset managers and broker-dealers would be expected to incorporate this new information into their regular and rigorous analysis for best execution and in otherwise making order routing decisions.
Compliance with the new rules will add significant additional costs to NMS Stock ATSs, and the SEC estimates that initial Form ATS-N filings will take more than five times the current hourly burden to complete an initial Form ATS (127.4 hours versus 20 hours).6 These heightened compliance costs may cause some NMS Stock ATSs to cease operations, which may drive liquidity to exchanges or dealer execution venues. NMS Stock ATSs that brave the new regulatory regime will need to carefully craft their disclosures to avoid disclosure of proprietary and commercially sensitive information while ensuring that their Form ATS-N submissions are effective. An overview of the new requirements is provided below with a more detailed appendix for compliance and legal professionals.
As adopted, NMS Stock ATSs would be required to disclose information about their operations on Form ATS-N pursuant to newly adopted Rule 304 of Regulation ATS. Form ATS-N submissions would be made electronically through the SEC’s EDGAR system and would be made public upon becoming effective.
Written Policies and Procedures to Protect Subscribers’ Confidential Trading Information
The adopted rules amend Regulation ATS to require that the safeguards and procedures to protect the confidential trading information of subscribers and to ensure adequate oversight and enforcement of such safeguards and procedures now be written.8 This requirement applies to all ATSs, including those that do not trade NMS stock, and is required within 60 days of publication of the adopted amendments in the Federal Register. Form ATS-N
Form ATS-N consists of three parts: (Part I) 10 items requiring basic information about the broker-dealer operator (e.g., name, address), (Part II) seven items requiring information regarding the broker-dealer operator and affiliates in connection with the NMS Stock ATS and (Part III) 26 items requiring information regarding the manner of operation and functionalities of the NMS Stock ATS.
Part I contains standard, expected information but newly requires NMS Stock ATSs to provide a redline or other document marked to reflect changes made to an effective Form ATS-N whenever a Form ATS-N amendment is submitted. Part II of Form ATS-N is intended to highlight potential conflicts of interest that may arise from the trading of the broker-dealer operator and/or its affiliates and requires disclosure as to whether a subscriber can opt out of trading against them. Part II also requires disclosure of information regarding other products and services offered by the broker-dealer operator and/or its affiliates to guard against selective disclosure of certain features to favored subscribers.
Part III covers a broad range of information regarding the NMS Stock ATS including a number of new requirements that were not fairly contemplated under current Form ATS disclosure regime such as (i) co-location services or other means of increasing or decreasing the speed of communication with the NMS Stock ATS; (ii) opening, reopening and closing procedures; (iii) the presence of liquidity providers on the NMS Stock ATS; (iv) routing orders out of the NMS Stock ATS; and (v) fees. More specific and standardized detail is also demanded by Form ATS-N with respect to order types, order book priority and order flow segmentation. Of particular note is item of 11 of Part III, which requires an NMS Stock ATS to provide a summary of its structure, facilities, functionalities, and mechanisms used to match orders and trading interest. This item serves as a narrative overview of the NMS Stock ATS and may prove challenging for broker-dealer operators to carefully parse what functions are part of their NMS Stock ATSs and from those that are distinct from its other operations. Unlike the current Form ATS disclosure regime, however, NMS Stock ATSs are not required to submit copies of all materials provided to subscribers under the new rules.9 NMS Stock ATSs do remain subject to quarterly Form ATS-R submissions to report their transaction volumes, subscribers and securities traded.10
SEC Review Process
Rule 304 sets forth a new structure for the SEC’s review process for NMS Stock ATSs. In the proposed rules, the SEC contemplated issuing an order of effectiveness that would indicate that the NMS Stock ATS could permissibly operate. The SEC declined to adopt this approach, and a Form ATS-N submission now becomes effective upon the SEC publishing it on its website. However, the SEC will issue orders of ineffectiveness when it takes issue with a Form ATS-N submission, which it must generally do within 120 days for initial Form ATS-N filings (subject to certain extensions) or within 30 days with respect to Form ATS-N amendments.
The SEC has also provided itself with more specific disciplinary authority over NMS Stock ATSs. Under Rule 304, the SEC may, after notice and opportunity for hearing, suspend (for a period of up to 12 months), limit or revoke the NMS Stock ATS exemption from the definition of an exchange and will publish such notice on its website. The SEC presently has this authority over ATSs but must bring an enforcement action against an ATS to invoke these disciplinary measures.
SEC Review Process of Form ATS-N
- Defective – The SEC can reject a Form ATS-N filing outright if it is “defective,” such as where it is missing sections or responses or does not comply with e-filing requirements.11
- Timing – The SEC must issue an order declaring a Form ATS-N submission ineffective within the following timeframes:
- Initial Form ATS-N: For new NMS Stock ATSs – 120 days with an extension of up to 90 days for new NMS Stock ATSs. For Legacy NMS Stock ATSs – 120 days with an extension of up to 120 days.12
- Amendment to Effective Form ATS-N: 30 days from the date of filing.13
- Standard of Review and Notice – To declare a Form ATS-N or any type of Form ATS-N amendment ineffective, the SEC must issue an order finding that such action is necessary or appropriate in the public interest, and is consistent with the protection of investors.14
- To declare an initial Form ATS-N ineffective, the SEC must also provide the NMS Stock ATS with notice and an opportunity for hearing.
- Initial Form ATS-N: The entity cannot operate as an NMS Stock ATS.15
- Amendment to Effective Form ATS-N: The Form ATS-N amendment may not go into effect, but the NMS Stock ATS may continue to operate pursuant to its currently effective Form ATS-N.16
- Effective – The SEC will not issue orders declaring a Form ATS-N effective. Rather, publication of the Form ATS-N submission indicates that it is effective, subject to the SEC issuing an order declaring the submission ineffective within 30 days of the date of filing in the case of a Form ATS-N amendment or 120 days (subject to extension) in the case of an initial Form ATS-N.
- Suspension/Limitation/Revocation – The SEC may, after notice and opportunity for hearing, issue an order that suspends, limits or revokes the NMS Stock ATS exemption from the definition of an “exchange.”
- The SEC must do this pursuant to a written order making findings that such action is necessary or appropriate in the public interest, and is consistent with the protection of investors.
- Suspensions can last 12 months at most.
Form ATS-N Filing Types
- Initial Form ATS-N
- New NMS Stock ATSs – 120 calendar day review period from the date of filing for the SEC that can be extended to 90 days or such longer period as the NMS Stock ATS consents.18
- Legacy NMS Stock ATSs (i.e., those operating pursuant to an effective Form ATS before Jan. 7, 2019) – 120 calendar day review period from the date of filing for the SEC that can be extended to an additional 120 days or such longer period as the NMS Stock ATS consents.19
- Must file Form ATS-N no earlier than Jan. 7, 2019, and no later than Feb. 8, 2019, to be able to operate on a provisional basis during the SEC’s review period.20
- Public Notice – The SEC will publish the initial Form ATS-N on its website once it has completed its review, at which time the published Form ATS-N becomes effective.
- Amendments to Initial Form ATS-N – An NMS Stock ATS may amend its Form ATS-N during the SEC’s review period. Such amendments are not made public, and the SEC will publish an effective initial Form ATS-N “as amended.”
- Material Amendment to Form ATS-N21
- Use – Required for changes to an effective Form ATS-N for which there is a substantial likelihood that a reasonable market participant would consider the change important when evaluating the NMS Stock ATS as a potential trading venue.22
- Examples – (i) an affiliate of the broker-dealer operator begins trading on the ATS; (ii) changes to policies/procedures relating to the confidential trading information of subscribers; (iii) changes to the types of participants that can trade on the ATS; (iv) changes to order interaction and priority procedures; (v) the cumulative effect of a series of discrete changes.23
- Considerations to Help Inform Materiality Determination – NMS Stock ATSs should consider whether the change would affect (i) competitive dynamics, (ii) execution quality, (iii) the nature and composition of counterparties and (iv) the relative speed and access of subscribers.24
- Timing – Required 30 calendar days in advance of implementation.
- The material amendment becomes effective upon the publication of the Form ATS-N or after 30 days from the date of filing, subject to the SEC issuing an order of ineffectiveness.
- Public Notice – The SEC will publish the cover page, which includes a brief description of the material change, upon filing. The SEC publishes the full amendment once it has become effective.
- Updating Amendment25
- Use – Used when information has become inaccurate or incomplete and to make updates that do not constitute a material change, correcting amendment or order display and fair access amendment.
- Timing – Required within 30 calendar days after the end of each calendar quarter.
- Public Notice – Published upon filing, unless submitted as an amendment to a material amendment during the SEC’s review period.
- Correcting Amendment26
- Use – Filing required “promptly” after discovery that any information previously filed on Form ATS-N was “materially inaccurate or incomplete when filed.”27
- Timing – “Promptly,” which generally means within five business days after discovery.28
- Public Notice – Published upon filing, unless submitted as an amendment to a material amendment during the SEC’s review period.
- Order Display and Fair Access Amendment 29
- Use – Required to be filed if the NMS Stock ATS triggers the order display and execution access volume thresholds30 or the fair access thresholds.31
- Timing – Required within seven days after information required to be regarding fair access/order display requirements are triggered.
- Public Notice – Published upon filing.
- Cessation of Operations32
- Use – Required upon an intent to cease operations as an NMS Stock ATS. The NMS Stock ATS may specify the intended cessation date, at which time the Form ATS-N becomes ineffective.
- Timing – Must be filed at least 10 business days before the NMS Stock ATS ceases operations.
- Public Notice – Published upon filing.
Amending a Form ATS-N Amendment During SEC Review Period
- Correcting/Updating Amendments – An NMS Stock ATS can make correcting or updating amendments to its Form ATS-N amendment during the SEC’s 30 calendar day review period.33
- The SEC makes public material amendments “as amended,” meaning that the effective material amendment incorporates updating and correcting amendments submitted during the SEC’s review period.
- The 30 calendar day review period of the material amendment is not affected.
- However, the SEC can still deem the correcting/updating amendment to the material amendment ineffective within 30 calendar days after its filing.34
- Material Amendments – If an NMS Stock ATS needs to materially amend its Form ATS-N material amendment, it must first withdraw its current material amendment and resubmit a new material amendment.35
- This resets the 30 calendar day implementation delay and SEC review period.
Form ATS-N Disclosures
- Part I – Identifying Information
- General Information – Requires basic information about the broker-dealer operator (name, website link, address, Form BD information).
- Redline (Item 10) – For Form ATS-N amendments, Item 10 of Part I requires that the NMS Stock ATS provide as Exhibit 3 a marked version of its Form ATS-N that shows changes from the previous Form ATS-N.
- Materials Provided to Subscribers – Form ATS-N does not require that the NMS Stock ATS attach a copy of materials provided to subscribers (e.g., user manual; marketing materials; Financial Information eXchange (FIX) specifications).36
- Part II – Activities of the Broker-Dealer Operator and Its Affiliates
- Broker-Dealer Operator and/or Affiliates Trading on the NMS Stock ATS (Items 1 and 2) – Generally requires disclosure of whether the broker-dealer operator or its affiliates37 trade on the NMS Stock ATS, the capacity in which they trade (e.g., agency, principal) and whether their terms of access are the same as for other subscribers.38
- Business units or affiliates that submit orders “indirectly” to the NMS Stock ATS (e.g., through the smart order router (SOR) of the broker-dealer operator or using directed orders through a third-party broker-dealer) are included in this disclosure requirement.39
- Routing to Another Trading Center of the Broker-Dealer Operator/Affiliates (Items 1.d and 2.d) – To the extent that orders can be routed to another trading center operated by the broker-dealer operator or its affiliates, additional disclosures are required in Item 16 of Part III.
- Opt-Outs for Subscribers (Item 3) – To the extent subscribers may elect to opt out of interacting with orders of the broker-dealer operator and/or its affiliates, the process for doing this must be disclosed.
- Arrangements with other Trading Centers (Item 4) – Disclosure required regarding any formal or informal arrangements between the broker-dealer operator, or one of its affiliates, with other trading centers40 (e.g., reciprocal access arrangements) and a summary of the terms and conditions of such arrangements.
- Other Products and Services (Item 5) – Disclosure of any other products or services offered by the broker-dealer operator and/or its affiliates that are used to effect transactions or submit orders to the NMS Stock ATS, including any differences in access to these products or services among subscribers.
- This may include the use of a SOR or algorithm to the extent the SOR or algorithm performs a function of the NMS Stock ATS (e.g., bringing together the orders of multiple buyers and sellers using nondiscretionary means) and is therefore considered part of the NMS Stock ATS.41
- Shared Employees (Item 6) – Disclosure regarding whether there are “shared employees”42 that have access to confidential trading information and support another business unit/affiliate of the broker-dealer operator.
- Service Providers (Item 6) – Disclosure of any service provider used to support the services or functionalities of the NMS Stock ATS and whether and how such service provider or its affiliates can trade on the NMS Stock ATS.
- The disclosure is meant to capture the extent to which a third party may be able to influence or control the NMS Stock ATS (e.g., operating a proprietary data feed sent to subscribers) and excludes purely administrative service providers (e.g., phone services).43
- Confidential Trading Information of Subscribers (Item 7) – NMS Stock ATSs must describe their written safeguards and procedures to protect the confidential trading information of subscribers, disclose whether subscribers can consent or withdraw consent to disclosure of their information, and describe the roles of persons with access to confidential trading information.
- Part III – Manner of Operations
- Difference Among Subscribers (Global) – Virtually all of the questions in Part III require disclosure as to whether there are differences in the availability of certain services or features of the NMS Stock ATS among subscribers.
- Types of Subscribers ¬ (Items 1-3) – Disclosure required regarding the different types of subscribers (e.g., broker-dealers, hedge funds, retail investors), subscriber eligibility conditions and any exclusions of subscribers to certain services.
- This disclosure covers any types of subscribers that can use the NMS Stock ATS (i.e., are eligible) rather than only those that currently do.44
- Hours of Operations (Items 4 and 18) – Disclosure of the NMS Stock ATS’s hours of operation (including when orders may be entered), whether trading outside of regular trading hours is permitted and any differences in trading outside of regular hours.
- Means of Entry (Item 5) – Disclosure of the means by which subscribers can submit orders to the NMS Stock ATS.
- This item distinguishes between direct access (e.g., FIX protocol) and indirect access (e.g., SOR, algorithm, sales desk) where access is intermediated in some way.45Disclosure is also required of who (e.g., an affiliate) provides indirect access.
- Connectivity and Co-Location (Item 6) – Disclosure of any available co-location or other services to increase or decrease (e.g., a speed bump) the speed of communication with the NMS Stock ATS.
- Order Types and Attributes (Item 7) – Disclosure of the order types available on the NMS Stock ATS, conditions (e.g., time in force), priority of orders, routing of orders and the circumstances under which orders may be modified, canceled, removed etc.
- Order Sizes (Item 8) – Disclosure of any minimum or maximum order or trading interest size requirements and whether the NMS Stock ATS supports trading in odd-lot or mixed-lot orders.
- Conditional Orders and Indications of Interest (Item 9) – Disclosure of the availability and use of conditional orders, indications of interest (IOIs), actionable IOIs46 or other messages indicating trading interest.
- Disclosure is also required of the type of person or entity (e.g., subscriber, another trading center) that receives the condition order or IOI, which is aimed at informing subscribers as to who can see their trading interest.47
- Opening and Reopening; Closing (Items 10, 17) – Disclosure of opening procedures and any reopening procedures following a trading halt, including how unexecuted trading interest is handled, allowed order types and how orders are prioritized. Separately, Item 17 requires disclosure of any closing procedures and any differences during the closing process relative to regular trading hours.
- Trading Services, Facilities and Rules (Item 11) – Requires a summary of the NMS Stock ATS marketplace (e.g., crossing system, auction mechanism) and the nondiscretionary rules governing order interaction, priority, allocation, and other procedures governing trading (e.g., price improvement mechanisms, order handling during locked or crossed markets, price sliding etc.).
- Information regarding how an NMS Stock ATS complies with marketwide initiatives (e.g., the Tick Size Pilot) would be disclosed here.
- Disclosure of features of the NMS Stock ATS that, for example, are designed to deter price manipulation and other disruptive trading practices would not be required to be disclosed.48
- Liquidity Providers (Item 12) – Disclosure of any formal or informal arrangements with subscribers or the broker-dealer operator to provide liquidity to the NMS Stock ATS.49
- Segmentation (Item 13) – Disclosure relating to whether and how orders may be segmented (e.g., by market participant; tiering of subscribers), the process by which orders are segmented, the effect of segmentation on order interaction and any procedures to change or override a segmented category.
- This item requires a “summary” of the criteria used to segment order flow, so an NMS Stock ATS need not describe all of the specific criteria it might use to segment, for example, high-frequency trading order flow.50
- Counter-Party Selection (Item 14) – Disclosure relating to whether trading interest can be designated to interact or not interact with certain other orders or trading interest on the NMS Stock ATS (e.g., self-matching prevention; avoiding trading against a type of market participant).
- Display (Item 15) – Disclosures relating to whether the NMS Stock ATS operates as an electronic communications network or otherwise displays subscriber orders or trading interest to any person (other than an employee operating the system) and the type of market participant with which the orders/trading interest is shared.
- This includes disclosure of whether orders “bound for the ATS” are displayed or made known to any person, including a business unit or affiliate of the broker-dealer operator.
- To the extent orders pass through the broker-dealer operator’s SOR, common gateway or algorithm, disclosure would be required here.51
- Routing (Item 16) – Disclosures relating to where orders or other trading interest may be routed to another trading center and whether affirmative instructions are required to facilitate routing.
- Fees (Item 19) – Disclosure relating to the fees or charges for use of the NMS Stock ATS services, any rebates or discounts and any bundling of fees52 with other services provided by the broker-dealer operator or its affiliates.
- Differences in fees among different types of subscribers (not individual subscribers) must be disclosed along with a range of such fees.
- Suspension of Trading (Item 20) – Disclosure of any items relating to the suspension of trading or stopping of trading on the NMS Stock ATS.
- Trade Reporting (Item 21) – Disclosure of the procedures and material arrangements for reporting transactions that occur on the NMS Stock ATS (e.g., the self-regulatory organization to which it reports trades).
- Clearance and Settlement (Item 22) – Disclosure of any procedures and material arrangements undertaken to facilitate clearance and settlement of trades that occur on the NMS Stock ATS (e.g., if subscribers are required to have a separate clearing firm).
- Market Data (Item 23) – Disclosure of the sources of market data (e.g., proprietary exchange feeds, securities information processors) and how the NMS Stock ATS uses that market data to determine the national best bid and offer and facilitate trades on the NMS Stock ATS.
- Order Display/Execution Access and Fair Access (Items 24 and 25) – These disclosures are required only where the NMS Stock ATS triggers the order display and execution access volume thresholds53 or the fair access thresholds.
- Aggregate Platform Data (Item 26) – Disclosure regarding any aggregate platformwide order flow and execution statistics of the NMS Stock ATS that are not otherwise required disclosures under Rule 605.