On November 18, 2015, the U.S. Securities and Exchange Commission (the "Commission") voted to propose amendments to Regulation ATS under the Securities Exchange Act of 1934 (the "Exchange Act") that would adopt new Rule 304 of Regulation ATS, which would require an "NMS Stock ATS" to file new Form ATS-N with the Commission.¹  Proposed Rule 304 and new Form ATS-N would significantly expand upon the current disclosure requirements of Rule 301(b)(2) of Regulation ATS.  Comment on the proposed amendments must be submitted to the Commission within 60 days of publication of the Proposing Release in the Federal Register. We present the following summary of the Commission's lengthy proposal that will have a significant impact on alternative trading systems ("ATSs"), including so-called "dark pools."

Concerns Addressed by Proposal

The Commission's proposal is meant to address two concerns: (1) the operational transparency of an ATS and (2) the potential conflicts of interest between an ATS's subscribers and its broker-dealer operator ("BD operator") or affiliate.  The Commission's concerns with regard to operational transparency primarily relate to market participants' ability to assess properly the operation of ATSs.  The Commission also noted what it views as the competitive imbalance between ATSs and National Securities Exchanges due to differing disclosure regimes.  With regard to potential conflicts of interest, the Commission cited the recent string of cases against ATSs in which ATSs were alleged to have either failed to disclose a BD operator's or an affiliate’s interaction with the ATS or the BD operator or an affiliate improperly used confidential trading information of the ATS's subscribers.

Scope of Proposal

Rule 3a1-1 under the Exchange Act exempts an entity from the definition of "exchange" set out in Section 3(a)(1) of the Exchange Act if the entity complies with Rules 300 through 303 of Regulation ATS which, among other things, impose order display, execution access, fair access, systems, and recordkeeping requirements on ATSs.  The proposal would amend Rule 3a1-1(a)(2) to require that an NMS Stock ATS also comply with proposed new Rule 304.  An "NMS Stock ATS" would be defined as an ATS that facilitates transactions in NMS stocks.

Proposed new Rule 304 would require an NMS Stock ATS to file Form ATS-N with the Commission to maintain its exemption from the definition of "exchange" under Rule3a1-1.  NMS Stock ATSs would no longer be subject to Rule 301(b)(2), which requires an ATS to file Form ATS with the Commission and file amendments to the form in the circumstances identified in Regulation ATS.  If, however, an ATS effects transactions in both NMS stocks and non-NMS stocks, that ATS would be subject to dual filing requirements.  With respect to non-NMS stocks, the ATS would need to file a Form ATS, and any required amendments, pursuant to Rule 301(b)(2).  Separately, with respect to NMS stocks, the ATS would need to file a Form ATS-N, and any required amendments, pursuant to proposed new Rule 304.

New Disclosure Requirements

Proposed Form ATS-N would significantly expand upon the current disclosures required by an ATS that effects transactions in NMS stocks.  For example, Part III of Form ATS-N would require disclosures regarding the activities of the NMS Stock ATS’s BD operator and affiliates, including:

• The operation of non-ATS trading centers and other NMS Stock ATSs;
• Products or services offered to subscribers used in connection with trading on the NMS Stock ATS;
• Arrangements with unaffiliated trading centers;
• Trading activities on the NMS Stock ATS by the BD operator or affiliates;
• Use of smart order routers (or similar functionality) or algorithms to send or receive subscriber orders to or from NMS Stock ATS;
• Shared employees that service the operations of the NMS Stock ATS and any other business unit or affiliate of the BD operator;
• Service providers to the NMS Stock ATS;
• Differences in the availability of services, functionalities, or procedures available to subscribers, as compared to the BD operator and its affiliates; and
• Written safeguards and procedures to protect confidential trading information.

Additionally, Part IV of Form ATS-N would require disclosures regarding the operation of the NMS Stock ATS, including information related to:

• Subscribers;
• Hours of operations;
• Permitted order types;
• Connectivity, order entry, and co-location services;
• Segmentation of order flow;
• Display of order and trading interest;
• Trading rules, such as matching logic, priority, and order allocation;
• Suspension of trading or system disruption/malfunction;
• Opening/reopening/closing processes and after-hours trading;
• Outbound routing;
• Source and use of market data;
• Fees and rebates;
• Trade reporting, clearance, and settlement;
• Order display and execution access (if NMS Stock ATS meets volume thresholds);
• Fair access (if NMS Stock ATS meets volume thresholds; and
• Market quality statistics.

Filing of Form ATS-N

To facilitate a transition to Form ATS-N, currently existing NMS Stock ATSs would need to file Form ATS-N no later than 120 calendar days after the effective date of proposed Rule 304.  An existing NMS Stock ATS’s operations could continue during Commission review of a filed Form ATS-N, but an ATS must continue to comply with Rule 301(b)(2) during the interim period, including filing any required amendments to Form ATS.  Once the Form ATS-N was declared effective, an NMS Stock ATS would no longer be subject to Rule 301(b)(2).

The Commission would be required to declare Form ATS-N effective or ineffective within 120 calendar days from filing with Commission.  Declaring Form ATS-N effective or ineffective is a departure from requirements under current Regulation ATS.  Under Rule 301(b)(2), an ATS may commence operations so long as it files an initial operation report on Form ATS at least 20 days before commencing operation as an ATS.

The Commission could extend the review period  (1) for an additional 120 calendar days (90 calendar days for an NMS Stock ATS not currently operating)  if the Form ATS-N was unusually lengthy or raised novel or complex issues or (2) for any amount of time to which the NMS Stock ATS agreed in writing.

In its proposal, the Commission listed a number of reasons for which it could declare a Form ATS-N ineffective:

• The entity did not meet definition of an NMS Stock ATS;
• One or more disclosures on the Form ATS-N were materially deficient with respect to accuracy, currency, or completeness, such as:
  1. The Form ATS-N disclosed an order type but did not describe key attributes of the order type such as time-in-force limitations, treatment of unfilled portions of an order, or conditions for cancelling orders in whole or in part;
  2. The Form ATS-N described priority rules but failed to describe conditions or exceptions to priority rules, or failed to describe priority overlays (customer vs. non-customer priority);
  3. The Form ATS-N failed to disclose multiple classes of subscribers or if different classes were charged different fees; or
  4. The Form ATS-N contained inconsistent information.
• The Commission also would conduct a "red flag" review to see if Form ATS-N would obviously not comply with federal securities laws or rules or regulations thereunder.

If declared ineffective, the NMS Stock ATS could file new Form ATS-N; there would be no waiting period before the new form could be filed.

Form ATS-N Amendments

An NMS Stock ATS would need to file amendments to Form ATS-N under three circumstances:

• At least 30 calendar days prior to date of implementation of material change to operations of NMS Stock ATS or to activities of BD operator or affiliates that are subject to disclosure on Form ATS-N;
• Within 30 calendar days after end of each calendar quarter to correct any other information that has become inaccurate for any reason and has not been previously reported to Commission; or
• Promptly, to correct information in any previous disclosure on Form ATS-N that  was inaccurate or incomplete when filed.

The Commission would have 30 calendar days to declare ineffective any Form ATS-N Amendment.  If the Commission declared a Form ATS-N Amendment ineffective, the NMS Stock ATS could not operate pursuant to the ineffective Form ATS-N Amendment but could continue to operate pursuant to a previously filed Form ATS-N or Form ATS-N Amendment that was previously declared effective.

The Commission stated in the proposal that an amendment would be material if there was a substantial likelihood that a reasonable market participant would consider the change important when evaluating the NMS Stock ATS as a potential trading venue.  Although not an exhaustive list, the Commission provided examples of when an amendment would be considered material:

• A BD operator or an affiliate beginning to trade on the NMS Stock ATS;
• Changes to BD operator’s policies and procedures governing written safeguards and written procedures to protect confidential trading information of subscribers;
• Changes to types of participants on the NMS Stock ATS;
• Introduction or removal of a new order type on the NMS Stock ATS;
• Changes to order interaction and priority procedures;
• Changes to segmentation of orders and participants;
• Changes to manner in which NMS Stock ATS displays orders or quotes; or
• Change of service provider to operations of an NMS Stock ATS that has access to confidential subscriber trading information.

Amendments to Form ATS-N are effected by filing a Form ATS-N, checking the appropriate box, and providing red-lined responses to the disclosure items on the Form ATS-N.

Notice of Cessation

An NMS Stock ATS must provide notice of cessation at least 10 business days before the date the NMS Stock ATS ceases to operate as NMS Stock ATS.  The notice of cessation would be submitted via Form ATS-N.

Commission Authority to Suspend, Limit, or Revoke Exemption

Under proposed Rule 304, the Commission could, after notice and opportunity for a hearing, suspend for period not exceeding 12 months, limit, or revoke NMS Stock ATS's exemption from definition of term "exchange."  In so doing, the Commission would consider whether the entity no longer met the definition of NMS Stock ATS, did not comply with conditions to the exemption from the definition of an "exchange," or otherwise violated any provision of federal securities laws.

Public Disclosure of Form ATS-N

To address concerns over operational transparency, the Commission would make public on its website the following documents:

• Order of effectiveness of Form ATS-N;
• Order of ineffectiveness of Form ATS-N;
• Effective Form ATS-N;
• Filed Form ATS-N Amendment;
• Order of ineffectiveness of Form ATS-N Amendment;
• Notice of Cessation; and
• Order suspending, limiting, or revoking exemption from definition of "exchange."

Additionally, each NMS Stock ATS would need to make public, via posting on its website, a direct URL hyperlink to the Commission's website that contains the above documents.

Written Procedures for Protection of Confidential Trading Information

In addition to proposing Rule 304, the Commission would amend Rule 301(b)(10) with regards to the protection of confidential trading information. Specifically, the Commission would require all ATSs (not just NMS Stock ATSs) to establish written safeguards and procedures to protect subscribers' confidential trading information, including written safeguards and procedures that limit access to confidential trading information to those employees of the ATS who are operating the system or are responsible for compliance with Reg. ATS or any other applicable rules.  Additionally, the oversight procedures currently required by Rule 301(b)(10)(ii) would also need to be in written form.

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¹Securities Exchange Act Release No. 76474 (November 18, 2015), available at https://www.sec.gov/rules/proposed/2015/34-76474.pdf  (the "Proposing Release").