Exemption for Certain Exchange Members, 49930-49973 [2022-16711]

Download as PDF 49930 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34–95388; File No. S7–05–15] RIN 3235–AN17 Exemption for Certain Exchange Members Securities and Exchange Commission. ACTION: Proposed rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’) is reproposing amendments to a rule under the Securities Exchange Act of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) that exempts certain registered brokers or dealers from membership in a registered national securities association (‘‘Association’’). The re-proposed amendments would replace the rule’s de minimis allowance, including the exclusion therefrom for proprietary trading, with narrower exemptions from Association membership for any registered broker or dealer that is a member of a national securities exchange, carries no customer accounts, and effects transactions in securities otherwise than on a national securities exchange of which it is a member. The re-proposed amendments would create exemptions for such a registered broker or dealer that effects transactions off an exchange of which it is a member that result solely from orders that are routed by a national securities exchange of which it is a member to comply with order protection regulatory requirements, or are solely for the purpose of executing the stock leg of a stock-option order. DATES: Comments should be received on or before September 27, 2022. ADDRESSES: Comments may be submitted by any of the following methods: SUMMARY: Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/submitcomments.html); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 05–15 on the subject line; or jspears on DSK121TN23PROD with PROPOSALS2 Paper Comments • Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number S7–05–15. This file number should be included on the subject line if email is used. To help the VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/proposed.shtml). Comments also are available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Operating conditions may limit access to the Commission’s public reference room. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission’s website. To ensure direct electronic receipt of such notifications, sign up through the ‘‘Stay Connected’’ option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director, at (202) 551–5594; David Michehl, Special Counsel, at (202) 551–5627; Nicholas Shwayri, Special Counsel, at (202) 551– 5667; Vince Vuong, Special Counsel, at (202) 551–3742; or Mark Sater, Attorney-Advisor, at (202) 551–4729, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–7010. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction II. Background A. Current Regulatory Framework B. Need for Amendment C. 2015 Proposal III. Discussion of Amendments to Rule 15b9– 1 A. Elimination of the De Minimis Allowance and Proprietary Trading Exclusion B. Narrowed Criteria for Exemption From Association Membership 1. Routing Exemption 2. Stock-Option Order Exemption C. No Floor-Member Hedging Exemption IV. Effective Date and Implementation V. General Requests for Comments VI. Economic Analysis A. Baseline 1. Regulatory Structure and Activity Levels of Non-FINRA Member Firms 2. Current Market Oversight 3. Current Competition To Provide Liquidity PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 B. Effects on Efficiency, Competition, and Capital Formation 1. Firm Response and Effects on Market Activity and Efficiency 2. Effect on Competition To Provide Liquidity 3. Competitive Effects on Off-Exchange Market Regulation C. Consideration of Costs and Benefits 1. Benefits 2. Costs a. Costs of Joining an Association b. Cost of Maintaining an Association Membership c. Costs of TRACE Reporting for NonFINRA Member Firms That Trade U.S. Treasury Securities d. Costs of Joining Additional Exchanges Under the Rule as Amended e. Policies and Procedures Related to the Narrowed Criteria for Exemption From Association Membership f. Indirect Costs D. Alternatives 1. Include a Floor Member Hedging Exemption 2. Exchange Membership Alternative 3. Retaining the De Minimis Allowance 4. Eliminate the Rule 15b9–1 Exemption E. Request for Comment on Economic Analysis VII. Paperwork Reduction Act A. Summary of Collection of Information B. Proposed Use of Information C. Respondents D. Total Initial and Annual Reporting and Recordkeeping Burdens E. Collection of Information is Mandatory F. Confidentiality of Responses to Collection of Information G. Retention Period for Recordkeeping Requirements H. Request for Comments VIII. Consideration of Impact on Economy IX. Regulatory Flexibility Act Certification X. Statutory Authority I. Introduction Section 15(b)(8) of the Act 1 prohibits any registered broker or dealer from effecting transactions in securities unless it is a member of an Association or effects transactions in securities solely on an exchange of which it is a member.2 Section 15(b)(9) of the Act 3 provides the Commission with authority to exempt any broker or dealer from Section 15(b)(8), if that exemption is consistent with the public interest and the protection of investors. Pursuant to the authority conferred by Section 15(b)(9), Rule 15b9–1 provides that any broker or dealer required by Section 15(b)(8) of the Act to become a member of an Association shall be exempt from such requirement if it is a member of a national securities exchange, carries no customer accounts, and has annual 1 15 U.S.C. 78o(b)(8). 15(b)(8) applies to any security other than commercial paper, bankers’ acceptances, or commercial bills. Id. 3 15 U.S.C. 78o(b)(9). 2 Section E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules gross income derived from purchases and sales of securities otherwise than on a national securities exchange of which it is a member in an amount no greater than $1,000 (this $1,000 gross income allowance is referred to herein as the ‘‘de minimis allowance’’).4 Under Rule 15b9–1, the de minimis allowance does not apply to income derived from transactions for a registered dealer’s own account with or through another registered broker or dealer (referred to herein as the ‘‘proprietary trading exclusion’’).5 Accordingly, a registered dealer can rely on Rule 15b9–1 to remain exempt from Association membership while engaging in unlimited proprietary trading of securities on any national securities exchange of which it is not a member or in the off-exchange market,6 so long as it is a member of a national securities exchange, carries no customer accounts, and its proprietary trading is conducted with or through another registered broker-dealer. The securities markets have evolved dramatically in the forty-plus years since the Commission adopted Rule 15b9–1. During that span, the securities markets have transformed from being floor-based to being mostly electronic, and registered dealers have emerged that engage in significant, computerbased, cross-market proprietary trading activity. Several proprietary trading firms that are registered dealers and exchange members are not members of an Association, in reliance on Rule 4 17 CFR 240.15b9–1(a). CFR 240.15b9–1(b). The current rule also states that the de minimis allowance does not apply to income derived from transactions through the Intermarket Trading System, and defines the term ‘‘Intermarket Trading System’’ for purposes of the rule. 17 CFR 240.15b9–1(b)(2) and (c). 6 ‘‘Off-exchange’’ as used herein means any securities transaction that is covered by Section 15(b)(8) of the Exchange Act that is not effected, directly or indirectly, on a national securities exchange. See 17 CFR 240.600(b)(45) (defining ‘‘national securities exchange’’). Off-exchange trading includes securities transactions that occur through alternative trading systems (‘‘ATSs’’) or with another broker or dealer that is not a registered ATS, and is also referred to as over-the-counter (‘‘OTC’’) trading. The Commission previously proposed to amend Rule 15b9–1 in 2015. See Securities Exchange Act Release No. 74581 (March 25, 2015), 80 FR 18036 (April 2, 2015) (‘‘2015 Proposing Release’’ or ‘‘2015 Proposal’’). There, the Commission defined the term ‘‘off-exchange’’ differently, such that it applied only to transactions in exchange-listed securities that were not effected, directly or indirectly, on a national securities exchange. Id. at 80 FR 18037, n. 3. Here, the definition of ‘‘off-exchange’’ encompasses transactions that are not effected, directly or indirectly, on a national securities exchange in both exchange-listed securities and securities that are not listed on a national securities exchange, such as U.S. Treasury securities and OTC equity securities, in order to more closely align the definition with the full scope of securities transactions that are covered by Section 15(b)(8) of the Exchange Act. jspears on DSK121TN23PROD with PROPOSALS2 5 17 VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 15b9–1. These firms may effect significant securities transaction volume elsewhere than on an exchange of which they are a member but are not subject to Association oversight. Self-regulatory organization (‘‘SRO’’) 7 regulation of each broker or dealer is dependent upon the broker or dealer’s individual SRO membership status. Each SRO that operates an exchange has responsibility for overseeing trading that occurs on the exchange it operates. Because of this, SROs that operate an exchange possess expertise in supervising members who specialize in trading the products and utilizing the order types that may be unique or specialized within the exchange. This expertise complements the expertise of an Association in supervising its members’ cross-exchange and offexchange securities trading activity. Indeed, the Exchange Act’s statutory framework places SRO oversight responsibility with an Association for trading that occurs elsewhere than an exchange to which a broker or dealer belongs as a member.8 Individual exchanges have expertise in regulating their markets and historically have monitored market activity specific to their own exchanges or have outsourced that function to a third party. The Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’), the only Association currently, historically has 7 An SRO is defined, in relevant part, as ‘‘any national securities exchange, registered securities association, or registered clearing agency. . . .’’ 15 U.S.C. 78c(a)(26). 8 See Sections 15(b)(8), 15A, 17(d), 19(g) of the Act. 15 U.S.C. 78o(b)(8); 15 U.S.C. 78o–3; 15 U.S.C. 78q(d); 15 U.S.C. 78s(g). Under the self-regulatory structure, the SRO where a broker-dealer is registered conducts regulatory oversight and assumes responsibility for that oversight. For example, section 19(g)(1) of the Act, among other things, requires every SRO to examine for and enforce compliance by its members and associated persons with the Act, the rules and regulations thereunder, and the SRO’s own rules, unless the SRO is relieved of this responsibility pursuant to section 17(d) or section 19(g)(2) of the Act. 15 U.S.C. 78q(d); 15 U.S.C. 78s(g). Section 17(d)(1) of the Act provides that the Commission, in allocating authority among SROs pursuant to Section 17(d)(1), shall ‘‘take into consideration the regulatory capabilities and procedures of the self-regulatory organizations, availability of staff, convenience of location, unnecessary regulatory duplication, and such other factors as the Commission may consider germane to the protection of investors, cooperation and coordination among self-regulatory organizations, and the development of a national market system . . .’’ 15 U.S.C. 78q(d)(1). Section 15A of the Act provides for the creation of national securities associations of broker-dealers, with powers to adopt and enforce rules to regulate the off-exchange market. 15 U.S.C. 78o–3. And as described above, section 15(b)(8) of the Exchange Act further implements this construct of effective regulatory oversight by requiring Association membership of a broker-dealer unless it effects transactions solely on an exchange of which it is a member. 15 U.S.C. 78o(b)(8). PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 49931 overseen cross-exchange and offexchange securities trading activity.9 But brokers and dealers that are not FINRA members are not subject to FINRA’s rules.10 As a result, when broker-dealer firms that are not FINRA members effect securities transactions otherwise than on an exchange of which they are a member, such as off-exchange or on exchanges where they are not a member (collectively referred to herein as ‘‘offmember-exchange’’),11 these firms are not all subject to the same set of exchange rules and interpretations of those rules, which can vary between exchanges. As discussed below,12 there are regulatory service agreements (‘‘RSAs’’) among exchange SROs and FINRA, which have provided benefits to SROs such as lower regulatory costs and have been a component of FINRA’s cross-market regulatory program. Importantly, FINRA has the expertise regarding off-exchange trading, but under these RSAs, for non-FINRA members that trade off-exchange and are members of different exchanges, FINRA applies the rules of the different exchanges using the exchanges’ interpretations of those rules. This can result in different interpretations and FINRA registration would promote consistent interpretations and efficiencies in enforcement and regulation with respect to this growing part of the market. The rise in electronic proprietary trading and the increasingly fragmented market where trading takes place across many active markets have put pressure on the status quo and persuaded the Commission of the need for there to be more consistent regulation of such trading. In addition, SROs retain responsibility for regulatory oversight under the RSAs; however, RSAs are voluntary, privately negotiated agreements that can expire or be terminated, and accordingly, these agreements may not in the future provide the stability of FINRA oversight. Further, the Commission, of course, may bring enforcement actions, including pursuant to referrals made by SROs, to 9 The National Futures Association (‘‘NFA’’), as specified in section 15A(k) of the Act, also is registered as a national securities association, but only for the limited purpose of regulating the activities of NFA members that are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Act. 10 See FINRA Rule 0140. 11 To be consistent with Rule 15b9–1, offmember-exchange securities trading must occur with or through another registered broker-dealer, such as, in the case of trading on an exchange where the firm is not a member, through a brokerdealer that is a member of the exchange. 12 See Section II.B infra. E:\FR\FM\12AUP2.SGM 12AUP2 jspears on DSK121TN23PROD with PROPOSALS2 49932 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules enforce compliance with the Exchange Act and applicable rules. But as is also discussed below,13 the Exchange Act requires a robust layer of SRO oversight over broker-dealers in addition to the Commission’s regulatory role. In light of the extent to which off-memberexchange proprietary trading occurs today, the Commission believes that the SRO layer of oversight should be enhanced by ensuring, as mandated by Section 15(b)(8) of the Act, that an Association generally has direct, membership-based oversight over broker-dealers that effect securities transactions elsewhere than on an exchange where they are a member and the jurisdiction to directly enforce their compliance with Federal securities laws, Commission rules, and Association rules. The Commission adopted Rule 15b9– 1 several decades ago so that an exchange member’s limited proprietary trading activity ancillary to its exchange activity—which, at that time, typically was a floor business conducted on a single national securities exchange— would not necessitate Association membership in addition to exchange membership.14 The Commission deemed it an appropriate exercise of its statutory authority to subject such an exchange member to exchange-only SRO oversight. But as stated above and described below, the securities markets have transformed dramatically and have evolved to include significant, crossmarket electronic proprietary trading as a primary business model, and firms engaging in such trading activity that are exempt from Association membership, including important transaction reporting requirements, by virtue of Rule 15b9–1. In this regard, the Commission previously proposed to amend Rule 15b9–1 in 2015.15 After the 2015 Proposal, FINRA established a transaction reporting regime under which broker-dealers that are FINRA members must report U.S. Treasury securities transactions. Some brokerdealer firms that are not FINRA members are significantly involved in trading U.S. Treasury securities proprietarily but are not required to report these transactions since they are not FINRA members. Moreover, U.S. Treasury securities trading occurs entirely off-exchange, thus these nonFINRA members conduct their U.S. Treasury securities trading activities outside of the direct SRO oversight of 13 See sections II.A and II.B infra. infra note 60 and accompanying text (discussing the adoption of Rule 15b8–1, which was later renumbered to Rule 15b9–1). 15 See 2015 Proposing Release, supra note 6. 14 See VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 any exchange and, since they are not FINRA members, outside of FINRA’s direct jurisdiction despite the fact that FINRA is the SRO responsible for the off-exchange market.16 The evolution of the markets—since Rule 15b9–1 was adopted and since the Commission’s proposed changes to Rule 15b9–1 in 2015—presents a need to realign Rule 15b9–1 with the current market so that the regulatory scheme more appropriately effectuates Exchange Act principles regarding complementary exchange SRO and Association oversight in today’s market, including Section 15(b)(9)’s mandate that any exemption from Section 15(b)(8) be consistent with the public interest and protection of investors. Accordingly, the Commission is re-proposing amendments to Rule 15b9–1 that would rescind the de minimis allowance and proprietary trading exclusion, which generally would require Association membership, pursuant to Section 15(b)(8) of the Act, for any registered broker or dealer that effects securities transactions elsewhere than on a national securities exchange of which it is a member, subject to narrowed exemptions from Section 15(b)(8)’s Association membership requirement that are applicable to trading activity that is ancillary to the registered broker’s or dealer’s trading activity on a national securities exchange of which it is a member.17 II. Background A. Current Regulatory Framework Self-regulation is a longstanding, key component of U.S. securities industry regulation.18 All broker-dealers are required to be members of an SRO, which sets standards, conducts examinations, and enforces rules regarding its members.19 The Exchange 16 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities. 17 This proposal re-proposes, with certain modifications, the amendments to Rule 15b9–1 that the Commission proposed in 2015. See 2015 Proposal, supra note 6. The 2015 Proposal contains additional background information regarding the regulatory history in this area and Rule 15b9–1. See 2015 Proposal, supra note 6, 80 FR at 18036–45. Comments received in response to the 2015 Proposing Release are available at https:// www.sec.gov/comments/s7-05-15/s70515.shtml. 18 See Securities Exchange Act Release No. 50700 (November 18, 2004), 69 FR 71256 (December 8, 2004) (‘‘Concept Release Concerning SelfRegulation’’). 19 Id. (citing Section 15(b)(8) of the Act (15 U.S.C. 78o15(b)(8))). Congress historically has favored selfregulation for a variety of reasons, including that effectively regulating the inner-workings of the securities industry at the federal level was viewed as cost prohibitive and inefficient; the complexity of securities practices made it desirable for SRO PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 Act sets forth a framework for brokerdealer regulation that, in addition to Commission oversight, requires this layer of SRO oversight, pursuant to which SROs act as front-line regulators of their broker-dealer members.20 Although the Exchange Act provides a limited and targeted exception to Association membership requirements for broker-dealers, its approach to effecting supervision is relatively uniform: broker-dealers must be members of the SROs that regulate the venues upon which they transact.21 A related, overarching principle in the Exchange Act is that the SRO best positioned to conduct regulatory oversight should assume that responsibility.22 Correspondingly, SRO oversight of an exchange’s members and their trading on the exchange is primarily the responsibility of the exchange, whereas SRO oversight of other trading activity, such as offexchange trading,23 is primarily the responsibility of an Association.24 This framework is embodied by several Exchange Act statutory provisions. When the Exchange Act was adopted in 1934, the exchanges were the only SROs and were charged with regulating the activities of their brokerdealer members. Congress soon recognized, however, that the benefit of exchange regulation could be undermined by the absence of a regulatory staff to be intimately involved with SRO rulemaking and enforcement; and the SROs could set standards such as just and equitable principles of trade and detailed proscriptive business conduct standards. Id. (citing, generally, S. Rep. No. 1455, 73d Cong., 2d Sess. (1934); H.R. Doc. No. 1383, 73d Cong., 2d Sess. (1934); S. Rep. No. 1455, 73d Cong., 2d Sess. (1934)); see also id., 69 FR at 71257–58. 20 Broker-dealers registered with the Commission are subject to the Commission’s jurisdiction and oversight and must comply with Commission rules applicable to registered broker-dealers. See, e.g., 15 U.S.C. 78o, 17 CFR 240.15a–6—240.15b11–1, and 17 CFR 240.17a–1—240.17a–25. Matters related to SRO actions or their broker-dealer members also may be referred to the Commission or subject to Commission review. See, e.g., 15 U.S.C. 78s(d) and 15 U.S.C. 78s(e). But the Exchange Act also requires that SROs enforce their members’ compliance with the Exchange Act, the rules and regulations thereunder, and the SRO’s own rules. See, e.g., sections 6(b)(1), 19(g)(1), and 15A(b)(2) of the Act (15 U.S.C. 78f(b)(1), 78s(g)(1), 78o–3(b)(2)); see also section 11A(a)(3)(B) of the Act (15 U.S.C. 78k– 1(a)(3)(B)) (authorizing the Commission to require SROs to act jointly in planning, developing, operating, or regulating the national market system). 21 See 2015 Proposal, supra note 6, 80 FR at 18039. 22 See supra note 8. 23 See supra note 6. 24 References herein to ‘‘exchange’’ or ‘‘national securities exchange’’ are to a national securities exchange that is registered with the Commission pursuant to section 6 of the Exchange Act. References herein to ‘‘broker’’ or ‘‘dealer’’ or ‘‘broker-dealer’’ are to a broker or dealer that is registered with the Commission pursuant to section 15 of the Exchange Act. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules complementary regulatory framework for the off-exchange market. Consequently, in 1938, the Maloney Act established the concept of and regulatory framework for Associations under Section 15A of the Exchange Act. The Maloney Act states in its preamble that its purpose is ‘‘[t]o provide for the establishment of a mechanism of regulation among over-the-counter brokers and dealers operating in interstate and foreign commerce or through the mails, to prevent acts and practices inconsistent with just and equitable principles of trade, and for other purposes.’’ 25 In 1964, Congress passed Section 15(b)(8) of the Exchange Act, which currently requires that a registered broker or dealer join an Association unless it effects transactions solely on an exchange of which it is a member.26 Additional statutory provisions contemplate coordination of brokerdealer oversight among SROs. Section 19(g)(1) of the Exchange Act requires every SRO to examine for and enforce compliance by its members and associated persons with the Exchange Act, the rules and regulations thereunder, and the SRO’s own rules, unless the SRO is relieved of this responsibility pursuant to Section 17(d) or Section 19(g)(2) of the Act.27 With respect to a broker or dealer that is a member of more than one SRO (‘‘common member’’), Section 17(d)(1) authorizes the Commission, by rule or order, to relieve an SRO of the responsibility to receive regulatory reports, to examine for and enforce compliance with the applicable statutes, rules, and regulations, or to perform other specified regulatory functions.28 Without this relief, the statutory obligation of each SRO would result in 25 See Public Law 75–719, 52 Stat. 1070 (1938). discussed in greater detail in the 2015 Proposal, section 15(b)(8) as originally enacted, and Rule 15b9–1 as originally adopted by the Commission (which was Rule 15b8–1 at that time and later re-designated as Rule 15b9–1) provided for direct Commission oversight of broker-dealers that effected transactions off-exchange as an alternative to joining an Association. In 1983, Congress amended the Act to eliminate the direct oversight of broker-dealers by the Commission and affirmed the benefits of self-regulation of brokerdealers directly by an Association. See 2015 Proposal, 63 FR at 18039–41; see also 15 U.S.C. 78o(b)(8), as amended by Public Law 98–38, 97 Stat. 205, 206 (1983); H.R. Rep. No. 98–106, at 597 (1983) (citing a preference for self-regulation over direct regulation by the Commission and noting, among other benefits of self-regulation, that the National Association of Securities Dealers (‘‘NASD’’), FINRA’s predecessor, had available a broader and more effective range of disciplinary sanctions to employ against broker-dealers than had the Commission). 27 15 U.S.C. 78q(d) and 78s(g)(2). 28 15 U.S.C. 78q(d)(1). jspears on DSK121TN23PROD with PROPOSALS2 26 As VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 duplicative examinations and oversight of common members.29 Section 17(d)(1) of the Act provides that the Commission, in allocating authority among SROs, shall ‘‘take into consideration the regulatory capabilities and procedures of the self-regulatory organizations, availability of staff, convenience of location, unnecessary regulatory duplication, and such other factors as the Commission may consider germane to the protection of investors, cooperation and coordination among self-regulatory organizations, and the development of a national market system . . . .’’ 30 Among the SROs to which oversight responsibility is allocated pursuant to 17d–2 plans, FINRA, as the only registered Association currently, has coordinated with exchanges in the exercise of SRO oversight over broker-dealers that are common members of FINRA and the 29 In the Exchange Act Amendments of 1975 (Pub. L. 94–29, 89 Stat. 97 (1975), the ‘‘1975 Amendments’’), Congress recognized that, at the time, the allocation of self-regulatory responsibilities among SROs resulted in some cases in duplicative regulation of firms that were members of multiple SROs and varying standards, both in substance and enforcement, among SROs. S. Doc. No. 93–13 at 164–165 (1973). As a result, Congress adopted Section 17(d) of the Act, which provides the Commission with the authority to allocate regulatory responsibilities among SROs with respect to matters as to which, in the absence of such allocation, such SROs would share authority. 15 U.S.C. 78q(d). 30 15 U.S.C. 78q(d)(1). To implement section 17(d)(1), the Commission adopted Rules 17d–1 and 17d–2 under the Act. 17 CFR 240.17d–1 and 17 CFR 240.17d–2. Rule 17d–1 authorizes the Commission to name a single SRO as the designated examining authority (‘‘DEA’’) to examine common members for compliance with the financial responsibility requirements imposed by the Act, or by Commission or SRO rules. See Exchange Act Release No. 12352 (April 20, 1976), 41 FR 18808 (May 7, 1976). To address regulatory duplication in areas other than financial responsibility, including sales practices and trading practices, the Commission adopted Rule 17d–2 under the Act. See Exchange Act Release No. 12935 (October 28, 1976), 41 FR 49091 (November 8, 1976). Rule 17d–2 permits SROs to propose joint plans among two or more SROs for the allocation of regulatory responsibility with respect to their common members. 17 CFR 240.17d–2. The regulatory responsibility allocated among SROs only extends to matters for which the SROs would share authority, which means that only common rules among SROs can be allocated under Rule 17d–2. Under paragraph (c) of Rule 17d–2, the Commission may declare such a plan effective if, after appropriate notice and opportunity for comment, it finds that the plan is necessary or appropriate in the public interest and for the protection of investors, to foster cooperation and coordination among SROs, or to remove impediments to and foster the development of a national market system and a national clearance and settlement system and in conformity with the factors set forth in Section 17(d) of the Act. Id. Commission approval of a plan filed pursuant to Rule 17d–2 relieves an SRO of those regulatory responsibilities allocated by the plan to another SRO. PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 49933 exchanges on which they trade securities.31 FINRA, however, is primarily responsible for exercising SRO oversight over broker-dealers’ off-memberexchange securities trading activities, such as when broker-dealers effect securities transactions across markets that include exchanges where they are not a member or the off-exchange market.32 In particular, FINRA regulates off-exchange trading of equities, fixed income (including U.S. Treasury) securities, and other products, and investigates and brings enforcement actions against members for violations of its rules, the rules of the Municipal Securities Rulemaking Board, and the Exchange Act and the Commission rules thereunder.33 FINRA also conducts the vast majority of broker and dealer examinations,34 and mandates broker and dealer disclosures.35 FINRA also has developed rules and guidance tailored to trading activity,36 and has developed surveillance technology and specialized regulatory personnel to provide surveillance, supervision, and enforcement of FINRA rules and the federal securities laws applicable to activity occurring off-exchange.37 31 See Staff of the Division of Trading and Markets, ‘‘Staff Paper on Cross-Market Regulatory Coordination,’’ (Dec. 15, 2020) (available at https:// www.sec.gov/tm/staff-paper-cross-marketregulatory-coordination) (‘‘Cross-Market Regulatory Coordination Staff Paper’’). Staff reports and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these staff documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person. 32 See Public Law 75–719, 52 Stat. 1070 (1938). Although FINRA is the sole Association, the statute does not limit the number of Associations. 33 15 U.S.C. 78o–3. 34 Routine broker and dealer examinations are conducted by the exchange SROs as well, and the Commission staff oversees the examination efforts of all SROs. In addition, the Commission staff also conducts risk-based examinations of brokers and dealers. 35 15 U.S.C. 78o–3. See, e.g., FINRA Rules 3130 (Annual Certification of Compliance and Supervisory Processes), 4120 (Regulatory Notification and Business Curtailment), 4530 (Reporting Requirements), 4540 (Reporting Requirements for Clearing Firms), 4560 (ShortInterest Reporting), and 6439 (Requirements for Member Inter-Dealer Quotation Systems). 36 See, e.g., FINRA Rules 5240 (Anti-Intimidation/ Coordination), 5250 (Payments for Market Making), 5210.02 (Publication of Transactions and Quotations—Self-Trades), and 6140 (Other Trading Practices). Exchanges have similar rules. See, e.g., NYSE Rules 4560 and 6140; Nasdaq Rules 5240 and 5250. 37 See FINRA.org, FINRA 2021 Annual Financial Report, available at https://www.finra.org/sites/ default/files/2022-06/2021-FINRA-FinancialAnnual-Report.pdf (last visited July 22, 2022). E:\FR\FM\12AUP2.SGM 12AUP2 49934 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 Further, FINRA has a detailed set of member conduct rules that apply to all activities of a FINRA member firm, whether on- or off-exchange.38 In addition, FINRA has rules that support a comprehensive public transparency regime with respect to offexchange securities transactions. One element of this regime is the requirement that FINRA members report to FINRA all OTC Equity Security trades 39 and off-exchange NMS stock trades,40 in connection with which FINRA has developed a detailed set of trade reporting rules.41 This transaction information then becomes publicly available.42 FINRA also maintains the 38 See FINRA Rule 2000 Series—Duties and Conflicts. 39 See FINRA Rule 6420(f) (defining ‘‘OTC Equity Security’’ to mean any equity security that is not an ‘‘NMS stock’’ as that term is defined in Rule 600(b) of SEC Regulation NMS; provided, however, that the term ‘‘OTC Equity Security’’ shall not include any Restricted Equity Security). See also FINRA Rule 6420(k) (defining ‘‘Restricted Equity Security’’ to mean any equity security that meets the definition of ‘‘restricted security’’ as contained in Securities Act Rule 144(a)(3)); 17 CFR 242.600(b) (defining ‘‘NMS stock’’ as any NMS security other than an option, and defining ‘‘NMS security’’ as any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options). FINRA members are required to report transactions (other than transactions executed on or through an exchange) in OTC Equity Securities and Restricted Equity Securities to FINRA’s OTC Reporting Facility (‘‘ORF’’). See FINRA Rules 6410 and 6610; see also FINRA Rule 6420(n) (defining ‘‘OTC Reporting Facility’’ as the service provided by FINRA that accommodates reporting for trades in OTC Equity Securities executed other than on or through an exchange and for trades in Restricted Equity Securities effected under Securities Act Rule 144A and dissemination of last sale reports). 40 See FINRA Rule 6110 and the FINRA Rule 6000 Series generally—Quotation, Order, and Transaction Reporting Facilities. FINRA operates two Trade Reporting Facilities (‘‘TRFs’’), one jointly with Nasdaq and another with the NYSE. The TRFs are FINRA facilities for FINRA members to report NMS stock transactions effected otherwise than on an exchange. See Exchange Act Release No. 54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) (order approving the Nasdaq TRF); Exchange Act Release No. 55325 (February 21, 2007), 72 FR 8820 (February 27, 2007) (notice of filing and immediate effectiveness of a proposed rule change to establish the NYSE TRF). In addition, FINRA operates the Alternative Display Facility (‘‘ADF’’) for NMS stocks, which is a FINRA facility for posting quotes and reporting trades governed by FINRA’s trade reporting rules. See Exchange Act Release No. 46249 (July 24, 2002), 67 FR 49821 (July 31, 2002) (order approving the ADF); see also Exchange Act Release No. 71467 (February 3, 2014), 79 FR 7485 (February 7, 2014) (order approving a proposed rule change to update the rules governing the ADF). 41 See FINRA Rule 6000 Series—Quotation, Order, and Transaction Reporting Facilities, supra note 40; and FINRA Rule 7000 Series—Clearing, Transaction and Order Data Requirements, and Facility Charges. 42 Pursuant to effective national market system plans which are also effective transaction reporting plans (as both terms are defined in Rule 600(b) of Regulation NMS), namely the Nasdaq UTP Plan and VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Trade Reporting and Compliance Engine (‘‘TRACE’’) reporting system for fixed income securities.43 FINRA introduced TRACE reporting requirements for U.S. Treasury securities transactions in 2017, which has enhanced the regulatory audit trail in that market.44 FINRA publishes weekly aggregated transaction information and statistics on U.S. Treasury securities on its website.45 In contrast to FINRA, the regulatory focus of national securities exchanges, which are also SROs, is generally on trading by their members on their respective exchanges.46 Exchanges the CTA Plan, FINRA reports to the Securities Information Processors (‘‘SIPs’’) information for offexchange NMS stock transactions that are reported to FINRA’s TRFs, and the SIPs in turn distribute the information in the public consolidated market data feeds. See section VIII(a) of the CTA Plan and section VIII.B of the Nasdaq UTP Plan. In addition, currently, Nasdaq UTP Plan Level 1 subscribers can obtain the OTC Equity Security transaction information that is reported to FINRA’s ORF and disseminated under the FINRA—Trade Data Dissemination Service (TDDS). See UTPPlan.com, UTP Plan Administration Data Request Form, available at https://www.utpplan.com/DOC/UTP_ Data_Feed_Request.pdf (last visited July 22, 2022) (stating that direct access subscribers may request FINRA OTC Data (FINRA OTC Equity Securities Rule 6400) as part of the Nasdaq UTP Plan Level 1 service). 43 See FINRA Rule 6700 Series. 44 See Securities Exchange Act Release No. 79116 (October 18, 2016), 81 FR 73167 (October 24, 2016) (File No. SR–FINRA–2016–027). 45 See FINRA.org, Treasury Aggregate Statistics, available at https://www.finra.org/finra-data/ browse-catalog/treasury-weekly-aggregates (last visited July 22, 2022). The information is aggregated by security subtype: Bills, Floating Rate Notes (FRN), Nominal Coupons and Treasury InflationProtected Securities (TIPS). The data is further grouped into ‘‘ATS and Interdealer,’’ ‘‘Dealer-toCustomer,’’ and ‘‘Total’’ categories. For Nominal Coupons and TIPS, the report also shows remaining maturity and on-the-run/off-the-run groupings. See also FINRA Rule 6750—Dissemination of Transaction Information, Supplementary Material .01(b). FINRA recently proposed to publish aggregated U.S. Treasury securities transaction information and statistics more frequently, such as on a daily basis. See Securities Exchange Act Release No. 95165 (June 27, 2022), 87 FR 39573 (July 1, 2022) (File No. SR–FINRA–2022–017). 46 Congress saw the codification of regulations requiring the registration of off-exchange brokers and dealers as ‘‘an essential supplement to regulation of the exchanges.’’ H.R. Rep. No. 74– 2601, at 4 (1936). In addition, in advance of the 1975 Amendments, Congress contemplated reforms to the regulatory structure of the securities markets in which an Association’s role would be expanded, while exchanges would focus their regulatory activities on their respective markets: ‘‘the time has come to begin planning a framework which will guide the development of the self-regulatory system in the future. In the revised system, a single nationwide entity [an Association] would be responsible for regulation of the retail end of the securities business, including such matters as financial responsibility and selling practices, while each exchange would concentrate on regulating the use of its own trading facilities . . . the regulatory activities of the NASD (the only organization presently registered as a national securities association) would encompass many of the present regulatory activities of the NYSE and other PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 generally monitor market activity specific to their own exchanges and have expertise in regulating unique aspects of their markets.47 For example, exchange rules typically regulate, among other things, the opening and closing of trading on the exchange; 48 exchange order types and order handling; 49 member application processes and ongoing member requirements; 50 listings; 51 investigations, complaints, disciplinary action and the related appeals process; 52 as well as member conduct generally.53 In many cases, exchange rules are similar to FINRA rules or incorporate FINRA rules by reference.54 In addition, exchanges have entered into 17d–2 plans that allocate to FINRA examination and enforcement responsibility relating to compliance by common members with Federal securities laws, Commission rules, and common exchange and FINRA rules, allowing the exchanges to focus on trading on their own markets. For example, under a 17d–2 plan for the allocation of regulatory responsibility relating to Regulation NMS rules, FINRA is responsible for overseeing and enforcing compliance with certain Regulation NMS rules by common members of FINRA and any exchange participant in the agreement, while each exchange retains responsibility for surveillance and enforcement with respect to trading activities or practices exchanges over retail activities of their members. This ‘expanded’ NASD would have direct responsibility, subject to SEC oversight, for enforcing SEC rules and its own rules . . .’’ S. Doc. No. 93–13 at 16, 169 (1973). See also 2015 Proposing Release, supra note 6, 80 FR 18039 at note 28 and accompanying text. In 2007, the Commission approved changes that consolidated the member firm regulatory functions of the NASD, an Association, and NYSE Regulation, Inc., and changed the name of the combined entity to FINRA. See Exchange Act Release No. 56145 (July 26, 2007), 72 FR 42169 (August 1, 2007). 47 See Cross-Market Regulatory Coordination Staff Paper, supra note 31. 48 See, e.g., NYSE Rule 7.35 Series—Auctions. 49 See, e.g., Nasdaq Rule 4702—Order Types and Nasdaq Rule 4703—Order Attributes. 50 See, e.g., Cboe Rulebook Chapter 3—TPH Membership, Registration, and Participants. 51 See, e.g., IEX Rulebook Chapter 14—IEX Listing Rules. 52 Typically, exchange rules regarding investigations, complaints, disciplinary actions, and appeals apply to the conduct of members (and associated persons) for violations of exchange rules and federal securities laws and regulations that the exchange has jurisdiction to enforce. See, e.g., Cboe Rule 13.1; IEX Rule 9.110(a); MIAX Chapter X, Rule 1000; Nasdaq Rule General 5, 9110(d); and Nasdaq PHLX Rule General 5, Section 1. 53 See, e.g., NYSE Rules 2010—7470—Conduct Rules. 54 See, e.g., NYSE Rules 4110 and 4140, and FINRA Rules 4110 and 4140; and Nasdaq General 9 (Regulation) (incorporating by reference various FINRA rules). E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules involving its own marketplace.55 Most exchanges and FINRA also have entered into RSAs, which are privately negotiated agreements between two SROs whereby one SRO agrees to perform regulatory services on behalf of another SRO in exchange for compensation.56 In addition to regulatory coordination that occurs through 17d–2 plans and RSAs, SROs also coordinate regulatory efforts through forums provided by the Intermarket Surveillance Group (‘‘ISG’’). The ISG, created in 1981, is an international group of exchanges, market centers, and regulators that perform market surveillance in their respective jurisdictions.57 The ISG’s focus is regulatory information sharing and coordination for both domestic and foreign regulators.58 Pursuant to its charter, one of the ISG’s purposes is ‘‘the coordination and development of programs and procedures designed to assist in identifying possible fraudulent and manipulative acts and practices across markets, where possible, particularly between markets which trade the same or related or derivative Financial Instruments[.]’’ 59 jspears on DSK121TN23PROD with PROPOSALS2 B. Need for Amendment The Commission originally adopted Rule 15b8–1 in 1965 (renumbered to Rule 15b9–1 in 1983 and generally referred to herein as Rule 15b9–1) to allow exchange specialists and other floor members to receive a portion of the commissions paid on occasional offexchange transactions referred to other broker-dealers, up to a nominal amount.60 The original version of Rule 55 See, e.g., Exchange Act Release Nos. 63220 (November 2, 2010), 75 FR 68632 (November 8, 2010) and 63430 (December 3, 2010), 75 FR 76758 (December 9, 2010). In addition, generally, FINRA is the DEA for financial responsibility rules for exchange members that also are members of FINRA. See infra notes 227–228 and accompanying text (discussing DEAs). See also Cross-Market Regulatory Coordination Staff Paper, supra note 31 (stating that ‘‘FINRA serves as the Designated Regulation NMS Examining Authority (‘‘DREA’’) and Designated CAT Surveillance Authority (‘‘DCSA’’) for common exchange members that are also members of FINRA, and assumes certain examination and enforcement responsibilities for those members with respect to specified Regulation NMS rules (i.e., 606, 607, 611, 612 and 613(g)(2)), and for the cross-market surveillance, examination, investigation and enforcement of Rule 613 and the rules of the SROs regarding compliance with the CAT NMS Plan.’’). 56 See Cross-Market Regulatory Coordination Staff Paper, supra note 31. 57 See id. 58 See id. 59 See id. 60 See Qualifications and Fees Relating to Brokers or Dealers Who Are Not Members of National Security [sic] Association, Exchange Act Release No. 7697 (September 7, 1965), 30 FR 11673 (September 11, 1965) (‘‘Qualifications and Fees VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 15b9–1 included the de minimis allowance but not the proprietary trading exclusion. The Commission adopted the proprietary trading exclusion in 1976 to accommodate regional exchange specialists that, as part of their floor-based business, might have needed to lay off positions and hedge risk on the primary listing exchange through a member of that exchange.61 These exchange specialists and floor brokers typically were members of a single exchange, and the circumstances under which they would trade proprietarily off-exchange were quite limited.62 Taken together, the historical purpose of Rule 15b9–1’s de minimis allowance and proprietary trading exclusion was to accommodate limited broker-dealer trading activities that were ancillary to a floor-based business on a single exchange while Release’’). The Commission stated: ‘‘Among the broker-dealers that are not members of a registered national securities association are several specialists and other floor members of national securities exchanges, some of whom introduce accounts to other members. The over-the-counter business of these broker-dealers may be limited to receipt of a portion of the commissions paid on occasional over-the-counter transactions in these introduced accounts, and to certain other transactions incidental to their activities as specialists. In most cases, the income derived from these activities is nominal.’’ Id. at 11675. 61 See Extension of Temporary Rules 23a–1(T) and 23a–2(T); Adoption of Amendments to SECO Rules, Securities Exchange Act Release No. 12160 (March 3, 1976), 41 FR 10599 (March 12, 1976) (‘‘Adoption of Amendments to SECO Rules’’). In adopting the proprietary trading exclusion, the Commission indicated that an exchange floor broker, through another broker or dealer, could effect transactions for its own account on an exchange of which it was not a member. Id. at 10600. The Commission noted that such transactions ultimately would be effected by a member of that exchange. In 1983, the Commission further amended Rule 15b9–1 to accommodate transactions effected through the new Intermarket Trading System linkage, and eliminated references to, and requirements under, the SECO Program. See SECO Programs; Direct Regulation of Certain Broker-Dealers; Elimination, Exchange Act Release No. 20409 (November 22, 1983), 48 FR 53688 (November 29, 1983) (‘‘SECO Programs Release’’). 62 In the Special Study of the Securities Markets in 1963, the Commission described how regional exchange specialists reduced their exposure, including by offsetting positions on other exchanges. The Commission noted that ‘‘[s]pecialists on the Boston, PhiladelphiaBaltimore-Washington, Pittsburgh, and Montreal stock exchange are in communication with each other by direct wires linking their floors and each may trade on the other exchanges at member rates’’ and ‘‘[s]pecialists who are sole members [of an exchange] also offset [their positions] with over-thecounter houses dealing in listed securities. Many of the offsetting transactions are done on the primary market, the NYSE, with the [specialist] buying or selling on that exchange as his needs dictate.’’ Report of Special Study of Securities Markets of the Securities and Exchange Commission, H.R. Doc. No. 88–95, at 935 (1963) (‘‘Special Study’’). The Commission believes that the business of regional exchange specialists was substantially the same when the proprietary trading exclusion in Rule 15b9–1 was adopted in 1976. PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 49935 preserving the traditional role of the exchange as the entity best suited to regulate member conduct on the exchange. Since that time, the securities markets have undergone a substantial transformation that has been driven primarily by rapid and ongoing evolution of technologies for generating, routing, and executing orders, and the impact of regulatory changes.63 Today, trading in the U.S. securities markets is highly automated, dispersed among myriad trading centers, and substantially more complex.64 Trading is spread among a number of highly automated trading centers—24 registered exchanges,65 33 ATSs that trade NMS stocks,66 at least 2 ATSs that trade U.S. Treasury securities,67 and nearly 200 OTC market-makers 68—and the routing and re-routing of orders to multiple venues is common. Moreover, new types of proprietary trading firms have emerged, including those that engage in so-called high-frequency trading strategies. These firms tend to effect transactions across the full range of exchange and off-exchange markets, including ATSs. They also typically use complex electronic trading strategies and sophisticated technology to generate a large volume of orders and 63 See Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594 (January 21, 2010) (Concept Release on Equity Market Structure) (‘‘Equity Market Structure Concept Release’’), at 3594 (‘‘Changes in market structure also reflect the markets’ response to regulatory actions such as Regulation NMS, adopted in 2005, the Order Handling Rules, adopted in 1996, as well as enforcement actions, such as those addressing anticompetitive behavior by market makers in NASDAQ stocks.’’). 64 See Equity Market Structure Concept Release, supra note 63. See also 2015 Proposing Release, supra note 6. 65 There are 8 registered exchanges that only trade equities and 8 registered exchanges that only trade options. In addition, there are 8 registered exchanges that trade both equities and options. 66 See 17 CFR 242.300 (defining the terms ‘‘alternative trading system’’ and ‘‘NMS Stock ATS’’). This data was compiled from Forms ATS– N filed with the Commission as of July 22, 2022, available at https://www.sec.gov/divisions/ marketreg/form-ats-n-filings.htm. 67 See U.S. Dep’t of the Treasury et al., Joint Staff Report: The U.S. Treasury Market on October 15, 2014 (July 13, 2015) (the ‘‘Joint Staff Report’’). The Joint Staff Report noted that SEC rules applicable to ATSs do not apply to ATSs through which only government securities are traded, although such venues may voluntarily adopt such standards. Since the Joint Staff Report was issued, however, the Commission has proposed to amend Regulation ATS to include ATSs through which only government securities are traded. See Securities Exchange Act Release No. 94062 (January 26, 2022), 87 FR 15496 (March 18, 2022). 68 Nearly 200 brokers or dealers (excluding ATSs) have identified themselves to FINRA as market centers that must provide monthly reports on order execution quality under Rule 605 of Regulation NMS (list available at https://www.finra.org/ industry/market-centers). E:\FR\FM\12AUP2.SGM 12AUP2 49936 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 transactions throughout the national market system.69 In fact, the large-scale proprietary trading that occurs in the securities markets today is not confined to equities and options. For example, there is significant automated proprietary trading in U.S. Treasury securities, which are not traded on any national securities exchange.70 As noted in the Joint Staff Report, proprietary trading firms, or principal trading firms (‘‘PTF(s)’’) as they are also called, account for a majority of trading and market depth in the electronic interdealer U.S. Treasury securities market.71 The Joint Staff Report called for certain U.S. Treasury securities market reforms such as an assessment of the public reporting on U.S. Treasury securities market venue policies and services and a review of possible posttrade transaction reporting by 69 Many, but not all, proprietary trading firms are often characterized by: (1) the use of extraordinarily high-speed and sophisticated computer programs for generating, routing, and executing orders; (2) the use of co-location services and individual data feeds offered by exchanges and others to minimize network and other types of latencies; (3) the use of very short time-frames for establishing and liquidating positions; (4) the submission of numerous orders that are cancelled shortly after submission; and (5) ending the trading day in as close to a flat position as possible (that is, not carrying significant, unhedged positions overnight). See Equity Market Structure Concept Release, supra note 63, 75 FR at 3606. See also Staff of the Division of Trading and Markets, ‘‘Equity Market Structure Literature Review, Part II: High Frequency Trading,’’ at 4–5 (March 18, 2014) (available at ≤ https://www.sec.gov/marketstructure/research/hft_ lit_review_march_2014.pdf). 70 The secondary market for U.S. Treasury securities (sometimes referred to as the U.S. Treasury cash market) is generally bifurcated between the dealer-to-customer market and the interdealer market. Trading in the U.S. Treasury securities dealer-to-customer market is generally conducted through bilateral transactions. Trading often occurs either over the phone or on trading venues that facilitate the matching of buy and sell orders through electronic systems. In the interdealer market, the majority of trading in on-the-run U.S. Treasury securities currently occurs on ATSs using electronic central limit order books. For off-the-run U.S. Treasury securities, the majority of interdealer trading occurs via bilateral transactions through voice-assisted brokers and electronic trading platforms. See Securities Exchange Act Release No. 90019 (September 28, 2020), 85 FR 87106, 87108 (December 21, 2020). On-the-run U.S. Treasury securities are the most recently issued U.S Treasury securities of a particular maturity. Off-the-run U.S. Treasury securities include all U.S. Treasury securities that have been issued before the most recent issuance and are still outstanding. 71 See Joint Staff Report, supra note 67, at 36. In addition, in 2020, staff at the Board of Governors of the Federal Reserve published a paper estimating that PTFs account for 61% of the trading activity on interdealer broker platforms. See FEDS Notes, ‘‘Principal Trading Firm Activity in Treasury Cash Markets,’’ James Collin Harkrader and Michael Puglia (Aug. 4, 2020) (citing data presented at the 2019 U.S. Treasury Market Conference showing that PTFs averaged approximately 61% of total trading volume on electronic interdealer broker platforms). VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 government securities broker-dealers and banks. In 2016, an inter-agency working group comprising staff of the Treasury Department, Commission, Commodity Futures Trading Commission, Federal Reserve Bank of New York, and Board of Governors of the Federal Reserve System stated that it ‘‘will continue to assess effective means to ensure that the collection of data regarding Treasury cash securities market transactions is comprehensive and includes information from institutions that are that not FINRA members.’’ 72 Subsequently, FINRA introduced TRACE reporting for U.S. Treasury securities in 2017.73 The Commission estimates that, as of the end of 2021, there were 66 firms that were Commission-registered brokerdealers and exchange members but not FINRA members, and that there were 65 such firms as of April 2022.74 Many of these firms were members of just one exchange while others were members of multiple exchanges.75 Specifically, as of April 2022, 21 of the 65 identified firms were single exchange members; 10 of the firms were members of two exchanges; 13 of the firms were members of more than two but 10 or fewer exchanges; and the remainder were members of more than 10 exchanges.76 Several of these firms—both singleexchange and multiple-exchange members—engage in cross-market and off-exchange proprietary securities trading. These firms account for a significant portion of off-exchange securities trading volume and initiate a significant number of securities transactions on exchanges other than exchanges to which they belong as a member.77 They forgo FINRA membership presumably in reliance on Rule 15b9–1, as their effectuation of transactions in securities elsewhere than 72 See press release, U.S. Dep’t of the Treasury et al., Statement Regarding Progress on the Review of the U.S. Treasury Market Structure since the July 2015 Joint Staff Report (August 2, 2016) available at https://www.sec.gov/news/pressrelease/2016155.html. 73 See supra note 44. 74 See FINRA.org, Non-Member List, available at https://nonmembers.finra.org/Reportable NonMembersList.txt or https://web.archive.org/web/ 20210722022409/https:/nonmembers.finra.org/ ReportableNonMembersList.txt (last visited July 22, 2022). The Commission notes that the figures set forth herein are impacted by changes in FINRA membership. For example, a registered brokerdealer that was not a FINRA member as of 2021 joined FINRA in early 2022 and is not included among the 65 firms identified as registered brokerdealers and exchange members but not FINRA members as of April 2022. 75 Source: FINRA Central Registration Depository (CRD). 76 Id. 77 Source: Consolidated Audit Trail. PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 on exchanges to which they belong as a member would trigger Section 15(b)(8)’s Association membership requirement but for the exemption provided by Rule 15b9–1. For example, of the estimated 66 broker-dealers that were exchange members but not FINRA members as of the end of 2021, 47 initiated orders in listed equities in September 2021 that were executed on or off an exchange.78 These firms’ September 2021 offexchange listed equities dollar volume executed was approximately $789 billion,79 which was approximately 9.8% of total off-exchange volume of listed equities executed that month.80 Moreover, these firms’ September 2021 listed equities dollar volume executed on exchanges of which they are not a member was approximately $592 billion.81 Of the estimated 65 broker-dealers that were exchange members but not FINRA members as of April 2022, 43 initiated orders in listed equities in April 2022 that were executed on or off an exchange.82 These firms’ April 2022 off-exchange listed equities dollar volume executed was approximately $441 billion,83 which was approximately 4.6% of total offexchange volume of listed equities executed that month.84 Moreover, these firms’ April 2022 listed equities dollar volume executed on exchanges of which they are not a member was approximately $475 billion.85 78 Id. A firm ‘‘initiating’’ an order is the firm that reports the origination of the order as a New Order Event (MENO) to the Consolidated Audit Trail. The other 19 firms did not initiate orders in listed equities in September 2021. 79 Id. Dollar volumes set forth in this section represent the sum of bought and sold volume during the specified time period. 80 Id. The Commission estimates that there was approximately $8 trillion in total off-exchange transaction volume in listed equities reported by buying and selling firms in September 2021. 81 Id. The Commission also estimates that, in 2021, 50 of the 66 firms identified as registered broker-dealers and exchange members but not FINRA members initiated options order executions accounting for approximately 15–20% of daily options contract volume traded. The Commission further estimates that 36 of these 50 firms initiated executions on an exchange where they are not a member, and that this transaction volume represented approximately 3% of these 36 firms’ total options contract transaction volume reported in 2021, and approximately 1% of all options contract transaction volume reported in 2021. Id. 82 Id. The other 22 firms did not initiate orders in listed equities in April 2022. 83 Id. 84 Id. The Commission estimates that there was approximately $9.5 trillion in total off-exchange transaction volume in listed equities reported by buying and selling firms in April 2022. 85 Source: Consolidated Audit Trail. See also Table 1, Section VI.A.1, infra, for additional detail regarding these firms’ trading activity during the noted time periods. E:\FR\FM\12AUP2.SGM 12AUP2 jspears on DSK121TN23PROD with PROPOSALS2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules There is also a high degree of concentration of this volume among a subset of the identified firms. In this regard, the Commission estimates that, as of September 2021, 13 of the 47 identified firms that initiated orders in listed equities then accounted for approximately 9.3% of total offexchange listed equities volume executed in September 2021 and 94% of the off-exchange listed equities transaction volume attributable to the 47 identified firms that month.86 Two of the 13 firms initiated $528 billion in offexchange listed equities executions in September 2021, which was 6.6% of total off-exchange listed equities transaction volume that month and approximately two-thirds of the offexchange volume executions attributable to the 47 identified firms.87 With respect to the 47 firms’ listed equities transaction volume on exchanges of which they are not a member, just one firm accounted for approximately 78% of the $592 billion in volume attributable to the 47 identified firms in September 2021; four firms (including the aforementioned one) accounted for approximately 90% of that volume; and 18 firms (including the aforementioned four firms) accounted for approximately 99% of that volume.88 The Commission also estimates that, as of April 2022, 12 of the 43 identified firms that initiated orders in listed equities then accounted for approximately 4.25% of total offexchange listed equities volume executed in April 2022 and 91.6% of the off-exchange listed equities transaction volume attributable to the 43 identified firms that month.89 One of the 12 firms initiated $241 billion in off-exchange listed equities executions in April 2022, which was 2.54% of total off-exchange listed equities transaction volume that month and approximately one-half of the off-exchange volume executions attributable to the 43 identified firms.90 With respect to the 43 firms’ listed equities transaction volume on exchanges of which they are not a member, just one firm accounted for approximately 72% of the $475 billion in volume attributable to the 43 identified firms in April 2022; five firms (including the aforementioned one) accounted for approximately 91% of that volume; and 18 firms (including the aforementioned four firms) accounted 86 Source: Consolidated Audit Trail. 87 Id. 88 Id. 89 Id. 90 Id. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 for approximately 99% of that volume.91 With respect to trading in U.S. Treasury securities, all of which occurs off-exchange,92 the Commission estimates that four of the 66 brokerdealers that were exchange members but not FINRA members accounted for over $7 trillion in U.S. Treasury securities volume executed on ‘‘covered ATSs’’ in 2021 that was reported to TRACE,93 which was over 2% of total U.S Treasury securities volume traded in 2021 that was reported to TRACE.94 In April 2022, the Commission estimates that three of the 65 broker-dealers that were exchange members but not FINRA members accounted for over $700 billion in U.S. Treasury securities volume executed on covered ATSs that was reported to TRACE,95 which was approximately 2.5% of total U.S Treasury securities volume traded in April 2022 that was reported to TRACE.96 Due to the evolution of the securities markets since Rule 15b9–1 was adopted, the Commission preliminarily believes that the rule’s effect has become dislodged from the rule’s intended purpose. The underlying presumption built into Rule 15b9–1’s de minimis allowance and proprietary trading exclusion was that Association membership should not be required where a broker-dealer engaged in limited trading activities elsewhere than its member exchange that were ancillary to its trading business on its member exchange.97 Since the Commission adopted Rule 15b9–1 in 1965 and then the proprietary trading exclusion in 1976, the securities markets have transformed dramatically, securities trading has become dispersed among myriad trading centers, and firms today frequently trade securities proprietarily and electronically across those trading centers, including on exchanges where 91 Id. 92 See Joint Staff Report, supra note 67, at 2; see also supra note 70. 93 See FINRA Rule 6730(a)(1) (requiring FINRA members to report transactions in TRACE-Eligible Securities, including U.S. Treasury securities). 94 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities, supra note 16 (among other things, defining the term ‘‘covered ATS’’ as an ATS that executed transactions in U.S. Treasury securities against non-FINRA member subscribers of $10 billion or more in monthly par value, computed by aggregating buy and sell transactions, for any two months in the preceding calendar quarter). U.S. Treasury securities market share is calculated as the sum of the identified entities’ buy and sell volume divided by twice the market-wide volume for the period. 95 See supra note 93. 96 Id. 97 See supra notes 60–62 and accompanying text. PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 49937 they are not a member and off-exchange. Moreover, today, unlike forty years ago, there is extensive off-exchange proprietary trading activity conducted electronically in the U.S. Treasury securities market, and a transaction reporting regime for U.S. Treasury securities transactions that stems from Association membership. Put simply, the underlying tenet of Rule 15b9–1’s de minimis allowance and proprietary trading exclusion no longer holds true in light of the emergence of the modernday broker-dealer that trades securities proprietarily. Indeed, as reflected by the figures set forth above, some dealer firms are able to engage in substantial proprietary securities trading activity elsewhere than their member exchange(s) without becoming FINRA members, in reliance on Rule 15b9–1. These firms are not all subject to the same set of rules and interpretations, which can vary between exchanges. Importantly, FINRA has the expertise regarding off-exchange trading, but under the current regulatory structure underpinning Rule 15b9–1, for non-FINRA members that trade offexchange and are members of different exchanges, FINRA applies the rules of the different exchanges using the exchanges’ interpretations of those rules. This can result in different interpretations and FINRA registration would promote consistent interpretations and efficiencies in enforcement and regulation with respect to this growing part of the market. The rise in electronic proprietary trading and an increasingly fragmented market where trading takes place across many active markets have put pressure on the status quo and presented a need for there to be more consistent regulation of such trading. As a result, the Commission preliminarily believes that the exemption from FINRA oversight provided by Rule 15b9–1 should be limited. In particular, there are Federal securities laws, Commission rules, and SRO rules that prohibit various forms of improper activity by broker-dealers.98 SROs are required to examine for and enforce compliance by their members 98 See, e.g., sections 10(b), 15(c), and 15(g) of the Exchange Act; 15 U.S.C. 78j(b), 15 U.S.C. 78o(c), and 15 U.S.C. 78o(g); section 17(a) of the Securities Act of 1933; 15 U.S.C. 77q(a); 17 CFR 240.10b–5; FINRA Rules 2020 (Use of Manipulative, Deceptive, or Other Fraudulent Devices), 4530 (Reporting Requirements), 5210 (Publication of Transactions and Quotations); NYSE Rules 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices) and 5220 (Disruptive Quoting and Trading Activity Prohibited); Nasdaq General 9, Section 1 (General Standards) and Nasdaq General 9, Section 53 (Disruptive Quoting and Trading Activity Prohibited); and Cboe Rule 8.6 (Manipulation). E:\FR\FM\12AUP2.SGM 12AUP2 49938 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules and associated persons with the Exchange Act, the rules and regulations thereunder, and the SROs’ own rules.99 FINRA traditionally has been the SRO that primarily oversees cross-exchange and off-exchange securities trading activity. In the specific context of broker-dealer firms that are not FINRA members and effect off-memberexchange securities transactions, FINRA is unable to directly enforce such firms’ compliance with Federal securities laws and Commission rules, or apply its own rules to such firms, because they are not FINRA members. Without direct, membership-based FINRA oversight, the Commission believes that SRO oversight of off-member-exchange securities trading activity by non-FINRA members is largely a function of cooperative regulatory arrangements among SROs, which, as explained below, do not confer membership-based jurisdiction to FINRA to enforce compliance with the Exchange Act and applicable rules. In this regard, exchange SROs and FINRA are able to perform cross-market surveillance of trading activity in NMS and OTC securities using the Consolidated Audit Trail (‘‘CAT’’) data.100 But access to CAT data does not confer jurisdiction to FINRA over a firm that is not a FINRA member and that trades those securities off-exchange.101 As a result, a case regarding such a firm may be referred to the Commission or an exchange where the firm is a member for further investigation because access to CAT data alone does not enable FINRA to conduct additional investigative methods, such as collecting documents, interviewing witnesses, and otherwise investigating the firm to generate evidence.102 Moreover, trading activity in U.S. 99 See section 19(g) of the Act; 15 U.S.C. 78s(g). rules require their members to report to CAT, which is operated by FINRA CAT, LLC, a subsidiary of FINRA. See, e.g., Cboe BYX Rules 4.5–4.17; Nasdaq General 7; and NYSE Rule 6800. 101 See Concept Release Concerning SelfRegulation, supra note 18, 69 FR at 71266 (stating that ‘‘[w]hile the full implementation of robust intermarket order audit trails would be a significant step forward, an order audit trail is simply a tool that can be used by regulators to better surveil for illicit trading activity’’ and that ‘‘the SRO regulatory function would still play a critical role in the regulation of intermarket trading.’’). Likewise, the ISG is a valuable forum for the coordination of regulatory efforts and sharing of information and serves an important function, but it does not confer jurisdiction to FINRA over a broker-dealer that is not a FINRA member and effects off-memberexchange securities transactions. The ISG also does not create rules or impose disciplinary actions; rather, the information sharing between members allows for the proper authority, regulator, or exchange to pursue appropriate rule changes or pursue legal action on market participants based on evidence gathered. 102 See infra note 140. jspears on DSK121TN23PROD with PROPOSALS2 100 Exchange VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Treasury securities is not reported to CAT, so CAT is not a tool that can be used by SROs to surveil that activity, which, as reflected by the figures set forth above, is engaged in extensively by some broker-dealers that are not FINRA members. Exchange SROs and FINRA also have entered into 17d–2 plans 103 and RSAs. Under these arrangements, as of 2020, FINRA operated a cross-market regulatory program that covered 100% of U.S. equity market activity and approximately 45% of options contract volume, and FINRA also provided market-specific regulatory services to several exchanges.104 The Commission understands that these arrangements have enhanced regulatory outcomes.105 However, neither of these arrangements creates a requirement for broker-dealers that are not FINRA members to report their U.S. Treasury securities activity to TRACE. Moreover, 17d–2 plans are valuable, Commission-approved arrangements in the context of common members of more than one SRO. A 17d– 2 plan among one or more exchange SROs and FINRA would not provide FINRA with jurisdiction over a firm that is not a FINRA member, as 17d–2 plans are designed to mitigate duplicative SRO oversight over common members of more than one SRO with respect to rules that are common among the SROs. In other words, for FINRA to be named as the DEA for a firm under a 17d–2 plan, the firm would have to be a FINRA member.106 103 There are 19 effective bilateral plans and 4 multiparty plans. The 17d–2 plans can be found on the Commission’s website at: https://www.sec.gov/ rules/sro/17d-2.htm. 104 See Cross-Market Regulatory Coordination Staff Paper, supra note 31 (stating that ‘‘[t]he exchanges have relied on FINRA to perform regulatory functions, including surveillance, examinations, investigations, and enforcement functions, pursuant to RSAs and Rule 17d–2 plans. Under these arrangements, FINRA has developed a cross-market program that covers 100% of U.S. equity market activity and approximately 45% of options contract volume. In addition to these crossmarket supervision services, FINRA provides market-specific regulatory services to several exchanges.’’) (citing Letter from Marcia E. Asquith, Executive Vice President, FINRA, to Vanessa Countryman, Secretary, Commission, dated November 30, 2020). 105 See Cross-Market Regulatory Coordination Staff Paper, supra note 31. 106 For example, under a 17d–2 plan among exchange SROs and FINRA, FINRA is the Designated CAT Surveillance Authority (DCSA) for members of the exchange SROs and FINRA, and in that capacity assumes surveillance, investigation and enforcement responsibility relating to compliance by common members with Rule 613 and the rules of the SROs regarding compliance with the CAT NMS Plan. See Securities Exchange Act Release No. 89042 (June 10, 2020), 85 FR 36450 (June 16, 2020) (File No. 4–618). But FINRA is not the DCSA for firms that are not FINRA members. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 The Commission therefore understands FINRA’s cross-market regulatory program for equities and options relies on RSAs insofar as it covers broker-dealers that are not FINRA members.107 RSAs can be used to cover matters or firms that may fall outside the scope of a 17d–2 plan.108 While RSAs can serve useful purposes, they generally are not publicly available, are not subject to Commission approval, and are voluntary private agreements between SROs that are not mandated by any Commission rule or statutory obligation and that may expire or be terminated by the parties.109 As a result, to the extent FINRA oversight is applied to non-FINRA member firms’ off-member-exchange securities trading activity based on RSAs, such oversight relies upon arrangements between exchanges and FINRA that are discretionary. In addition, under an RSA, FINRA examines for compliance with the rules of the exchange that has entered into the RSA. Thus, non-FINRA members that are members of different exchanges may be subject to different exchange rules and interpretations when they effect off-member-exchange securities transactions to the extent these rules and interpretations are different. This approach is less stable and consistent than a regulatory regime in which Association membership and oversight is mandated. Further, the continued availability of the Rule 15b9–1 exemption from Association membership detracts from FINRA’s off-exchange securities transaction reporting regime, and in particular, TRACE reporting for U.S. Treasury securities transactions. The ‘‘covered ATS’’ U.S. Treasury security volumes set forth above may not capture 107 See, e.g., Securities Exchange Act Release No. 89972 (September 23, 2020), 85 FR 61062, 61063 (September 29, 2020) (amending the 17d–2 plan among exchange SROs and FINRA relating to the surveillance, investigation, and enforcement of insider trading rules, which allocates regulatory responsibility to FINRA over common FINRA members (members of FINRA and at least one of the exchange SRO participants in the plan), and stating that the participating exchange SROs will also enter into an RSA to provide for the investigation and enforcement of suspected insider trading against broker-dealers that are not common FINRA members). 108 See Cross-Market Regulatory Coordination Staff Paper, supra note 31. 109 Unlike with Commission-approved 17d–2 plans, the SRO paying for regulatory services under an RSA retains ultimate legal responsibility for and control over the functions allocated to the serviceproviding SRO under the RSA. Further, in the context of an RSA in which an exchange SRO contracts with FINRA for FINRA to provide regulatory services on behalf of the exchange SRO, FINRA’s oversight of the off-member-exchange trading activity of a non-FINRA member firm that is a member of the exchange is for compliance with the exchange’s rules, not FINRA’s rules. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 all of those firms’ U.S. Treasury securities transaction volume.110 Broker-dealers that are not FINRA members are not required to report their U.S. Treasury securities transactions to FINRA’s TRACE system because TRACE reporting obligations for U.S. Treasury securities transactions apply only to broker-dealers that are FINRA members.111 When a non-FINRA member broker-dealer trades U.S. Treasury securities through a covered ATS, the covered ATS is obligated in its TRACE report to identify the nonFINRA member via its MPID,112 thus providing visibility to regulators as to what transactions on covered ATSs are attributable to non-FINRA members. But regulators have no such visibility when non-FINRA member broker-dealers trade U.S. Treasury securities on an ATS that is not a covered ATS or otherwise than on an ATS with a counterparty that also is not a FINRA member. In the former case, the transaction still must be reported to TRACE but the non-FINRA member is not specifically identified via a MPID and instead is identified only as a ‘‘customer’’; in the latter case, there is no TRACE reporting obligation whatsoever.113 These circumstances detract from the comprehensiveness of 110 In the proposal the Commission issued in January 2022 to, among other things, amend Regulation ATS for ATSs that trade U.S. government securities, the Commission estimated that there would be 7 trading systems that trade only government securities or repurchase or reverse repurchase agreements on government securities and operate pursuant to the Exchange Act Rule 3a1–1(a)(3) exemption and which would be required to comply with Regulation ATS under the proposal. See Securities Exchange Act Release No. 94062 (January 26, 2022), 87 FR 15496, 15523 (March 18, 2022). 111 See FINRA Rule 6720—Participation in TRACE. Beginning September 1, 2022, certain depository institutions will be required to report to TRACE transactions in U.S. Treasury securities, agency debt securities and agency mortgage-backed securities. See FINRA.org, Federal Reserve Depository Institution Reporting to TRACE, available at https://www.finra.org/filing-reporting/ trace/federal-reserve-depository-institutionreporting (last visited July 22, 2022). 112 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities, supra note 16. 113 In addition, in the context of an NMS stock transaction effected between a FINRA member and a non-FINRA member otherwise than on an exchange, only the FINRA member is obligated to report the transaction to the FINRA TRF and the non-FINRA member generally is not identified on the trade report as the contra party to the trade. See Trade Reporting Frequently Asked Questions, Reporting Relationships and Responsibilities, Section 202: Reporting Trades with a Non-FINRA Member, available at: https://www.finra.org/filingreporting/market-transparency-reporting/tradereporting-faq#202 (last visited July 22, 2022). The non-FINRA member is, however, identified in CAT in this context. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 U.S. Treasury securities TRACE data and regulators’ ability to utilize that data to detect and deter improper trading activity in the U.S. Treasury securities market. The Commission cannot quantify total secondary market trading in U.S. Treasury securities due to the current lack of comprehensive data in U.S. Treasury securities in TRACE. Moreover, broker-dealers that are not FINRA members have a potential competitive advantage over those that are FINRA members and thus incur the costs of reporting transactions in U.S. Treasury securities transactions. Accordingly, the Commission is proposing to update Rule 15b9–1 such that proprietary trading firms that are registered broker-dealers generally must join FINRA, pursuant to Section 15(b)(8) of the Act, if they effect securities transactions otherwise than on an exchange of which they are a member. The Commission preliminarily believes that amending Rule 15b9–1 so that broker-dealer proprietary trading firms generally would be required to join FINRA if they trade elsewhere than on an exchange where they are a member would address the above-described issues by subjecting such firms to FINRA’s direct, membership-based jurisdiction and rules, including FINRA’s TRACE reporting regime for U.S. Treasury security transactions. This would be consistent with the Exchange Act’s statutory framework for complementary exchange SRO and Association oversight of broker-dealer trading activity, in which Section 15(b)(8) requires broker-dealers to join an Association if they effect securities transactions elsewhere than an exchange where they are a member. Amending Rule 15b9–1 in this way also would modernize the rule in a manner that is consistent with how proprietary trading occurs today and that promotes Section 15(b)(9)’s requirement that any exemption from Section 15(b)(8) be consistent with the public interest and protection of investors. The Commission believes that direct, membership-based FINRA oversight over and the application of FINRA’s securities transaction reporting requirements to firms that effect off-member-exchange securities transactions would create more effective SRO oversight over their off-member-exchange securities trading activity and therefore promote the protection of investors and the public interest. As discussed above,114 the Exchange Act requires dual SRO and Commission oversight of registered broker-dealers, with SROs acting as robust, front-line 114 See PO 00000 section II.A, supra. Frm 00011 Fmt 4701 Sfmt 4702 49939 regulators of their broker-dealer members. The Commission may bring enforcement actions, including pursuant to referrals made by SROs, to enforce broker-dealers’ compliance with the Exchange Act and applicable rules, and SROs have regulatory authority over their members pursuant to the Exchange Act. Moreover, Section 15(b)(8)’s complementary SRO oversight structure generally has enabled exchange SROs to specialize in oversight of securities trading activity that occurs on the exchange, and FINRA to specialize in oversight of cross-market, off-memberexchange securities trading activity. The Commission believes that rescinding Rule 15b9–1’s de minimis allowance and proprietary trading exclusion would better enable robust and consistent FINRA oversight in the area of its expertise through direct, membershipbased jurisdiction of broker-dealers that effect off-member-exchange securities transactions proprietarily. This, in turn, could strengthen the front-line layer of SRO regulatory oversight that is applied to off-member-exchange proprietary securities trading in today’s market. Requests for Comment The Commission requests comment on all aspects of the foregoing background discussion as well as, in particular, on the following questions: 1. Is the Commission’s estimate of the number of broker-dealers that are exchange members but not FINRA members still accurate as of the time of publication of this re-proposal? Is it too high or too low? Are there brokerdealers that were not FINRA members as of April 2022 that have since joined FINRA? Please explain. 2. Are the Commission’s estimates of the securities transaction volumes attributable to non-FINRA member broker-dealers accurate? If not, why are they inaccurate? Are there any uncertainties associated with such estimates? 3. Do exchange SROs directly exercise their SRO authority with respect to offmember-exchange securities trading activity by their members? If so, how have exchange SROs exercised their authority in this regard? In particular, how, if at all, have exchange SROs sought to exercise SRO authority over off-member-exchange securities trading activity conducted by their brokerdealer members that are not FINRA members? Have exchange SROs sought to exercise authority over U.S. Treasury securities trading activity by their members? Please explain and provide examples, if possible. 4. Do RSAs or other cooperative arrangements among SROs cover the E:\FR\FM\12AUP2.SGM 12AUP2 49940 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules U.S. Treasury securities trading activity conducted by broker-dealers that are exchange members but not FINRA members? If so, please specify the arrangements and how they work, including any limitations associated with such arrangements. 5. Is the Commission’s understanding correct that FINRA’s cross-market regulatory program for equities and options is based on RSAs insofar as it covers broker-dealers that are not FINRA members? If not, how are brokerdealers that are not FINRA members covered? jspears on DSK121TN23PROD with PROPOSALS2 C. 2015 Proposal The Commission previously proposed to amend Rule 15b9–1 in March 2015.115 The 2015 Proposal would have eliminated the de minimis allowance and proprietary trading exclusion from the rule, and added language to the rule that more closely tracked Section 15(b)(8) in providing an exemption from Section 15(b)(8)’s Association membership requirement only for a broker or dealer that carries no customer accounts and effects transactions in securities solely on a national securities exchange of which it is a member except in certain limited circumstances.116 The Commission did not adopt the 2015 Proposal but, as discussed above, remains concerned that proprietary trading dealer firms’ reliance on the Rule 15b9–1 exemption from Association membership undermines the effectiveness of the SRO regulatory structure and SRO oversight of the securities markets as envisioned by Congress in the Exchange Act. Therefore, today the Commission is reproposing amendments to Rule 15b9–1 that are similar to what was proposed in 2015, but modified in certain respects in light of the Commission’s further consideration of what set of circumstances would continue to be appropriate for an exemption from Association membership in today’s 115 See 2015 Proposing Release, supra note 6, 80 FR 18036–37. 116 The 2015 Proposal would have provided exemptions from Association membership for a dealer that is an exchange member, carries no customer accounts, and effects transactions elsewhere than an exchange of which it is a member solely for the purpose of hedging the risks of its floor-based activity; or for a broker or dealer that is an exchange member, carries no customer accounts, and effects transactions elsewhere than an exchange of which it is a member that result from orders that are routed by a national securities exchange of which it is a member to prevent trade-throughs, consistent with the provisions of Rule 611 of Regulation NMS. As discussed below, the Commission is re-proposing herein that amended Rule 15b9–1 set forth a modified version of that routing exemption but is not including in this reproposal a hedging exemption outside the context of stock-option orders. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 market, which consideration is informed by comments on the 2015 Proposal.117 III. Discussion of Amendments to Rule 15b9–1 As a general matter, the result under the amended version of Rule 15b9–1 being proposed today would be the same as under the 2015 Proposal: a broker or dealer would be required to join an Association if it effects transactions in securities elsewhere than on an exchange to which it belongs as a member, unless it can rely upon one of the amended rule’s narrow exceptions.118 Conversely, a broker or dealer would not need to become a member of an Association if it effects securities transactions only on an exchange of which it is a member.119 The Commission preliminarily believes that these outcomes would enhance SRO regulatory oversight in a manner that promotes Section 15(b)(8) of the Act and the public interest and investor protection requirements of Section 15(b)(9) of the Act by enabling direct Association oversight of off-memberexchange broker-dealer proprietary trading activity. Several commenters supported the 2015 Proposal.120 Some 117 See supra note 17. proposed Rule 15b9–1; see also 2015 Proposing Release, supra note 6. 119 See section 15(b)(8) of the Act. If a broker or dealer is a member of multiple exchanges and effects securities transactions only on those exchanges, those exchanges could enter into an RSA to ensure effective cross-market supervision of this activity. The Commission acknowledges that in the future another SRO could assume these responsibilities pursuant to 17d–2 plans, subject to Commission approval. In addition, a given exchange may choose to enter into an RSA with an Association, as some exchanges have now. In those cases, the exchange maintains the ultimate responsibility for the contracted regulatory responsibilities. 120 See, e.g., Letters from: Ryan W. Porter, Founder, High Amplitude Capital Trading (March 28, 2015) (‘‘Porter Letter’’) at 1; Chris Barnard (May 20, 2015) (‘‘Barnard Letter’’) at 1 (stating that the proposal would ‘‘improve the consistency and effectiveness of regulatory supervision; reduce the existing differential regulatory burden of Member Firms and Non-Member Firms; and promote firms to compete more equitably to supply liquidity both on exchanges and off-exchange.’’); Claudia Crowley, Chief Regulatory Officer, IEX Group, Inc. (May 22, 2015) (‘‘IEX Letter’’) at 2 (stating that there is a need to update the exemption in Rule 15b9–1 to better align it with its original intent and ‘‘better reflect current market technology and practices’’ which would result in ‘‘more comprehensive and consistent regulatory oversight of off-exchange market activity.’’); Marcia E. Asquith, Senior Vice President and Corporate Secretary, FINRA (June 2, 2015) (‘‘FINRA Letter’’) at 9–10; Theodore R. Lazo, Managing Director and Associate General Counsel, SIFMA (June 1, 2015) (‘‘SIFMA Letter’’) at 1; Angelo Evangelou, Associate General Counsel, Legal Division, Cboe (June 10, 2015) (‘‘Cboe Letter’’) at 1 (supporting the proposal ‘‘insofar as the rulemaking seeks to require FINRA membership of proprietary firms whose primary business is executing 118 See PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 commenters questioned the necessity of expanded FINRA oversight.121 As noted above, Rule 15b9–1 currently exempts any broker or dealer from membership in an Association if it is a member of a national securities exchange, carries no customer accounts, and has annual gross income of no more than $1,000 that is derived from purchases or sales of securities effected otherwise than on an exchange of which it is a member.122 Under the rule’s proprietary trading exclusion, income derived from transactions for a dealer’s own account with or through another registered broker or dealer is excluded from the de minimis allowance.123 The Commission is proposing to eliminate the de minimis allowance and the proprietary trading exclusion, and continue to allow an exemption from Association membership only for a registered broker or dealer that is an exchange member, carries no customer accounts, and effects securities transactions solely on a national securities exchange of which it is a member except in two narrow circumstances: (1) a broker or dealer effects transactions in securities otherwise than on an exchange to which it belongs as a member that result solely from orders that are routed by an exchange of which it is a member in order to comply with Rule 611 of Regulation NMS or the Options Order Protection and Locked/Crossed Market Plan; or (2) a broker or dealer effects transactions in securities otherwise than on an exchange to which it belongs as a member that are solely for the purpose of executing the stock leg of a stockoption order. In the subsections below, the Commission discusses each element of the re-proposed rule in detail. A. Elimination of the De Minimis Allowance and Proprietary Trading Exclusion As in the 2015 Proposal, today the Commission is re-proposing to delete paragraphs (a)(3) and (b) from Rule transactions off-exchange.’’); and Elliot Grossman, Managing Director, Dinosaur Securities (Sep. 15, 2015) (‘‘Dinosaur Letter’’) at 2. 121 See infra notes 125–127 and accompanying text. 122 17 CFR 240.15b9–1(a). 123 17 CFR 240.15b9–1(b)(1). The current rule also states that the de minimis allowance does not apply to income derived from transactions through the Intermarket Trading System (‘‘ITS’’), and defines the term ‘‘Intermarket Trading System’’ for purposes of the rule. 17 CFR 240.15b9–1(b)(2) and (c). ITS was a national market system plan (‘‘NMS Plan’’) that was eliminated in 2007 because it was superseded by Regulation NMS. See infra notes 159–168 and accompanying text. Since Rule 15b9– 1’s references to ITS are now obsolete, as in the 2015 Proposal, the Commission is re-proposing to eliminate these references from the rule. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 15b9–1.124 This would eliminate the de minimis allowance and proprietary trading exclusion. As a result, under Rule 15b9–1 as amended, any broker or dealer required by Section 15(b)(8) of the Act to become a member of an Association would be exempt from that requirement only if it is a member of a national securities exchange, carries no customer accounts, and any securities transactions that it effects elsewhere than on an exchange of which it is a member meet the limited criteria set forth in proposed paragraph (c) of the amended rule, which are discussed in detail below. The re-proposed elimination of the de minimis allowance and proprietary trading exclusion would generally preclude proprietary trading firms that are registered with the Commission pursuant to Section 15 of the Act and conduct off-memberexchange securities trading from relying on Rule 15b9–1 as an exemption from Section 15(b)(8)’s Association membership requirement. Therefore, pursuant to Section 15(b)(8), they would be required to become a member of an Association unless they effect transactions in securities solely on an exchange of which they are a member. Some commenters on the 2015 Proposal questioned the necessity and appropriateness of the expanded FINRA oversight that would result from the then-proposed elimination of the de minimis allowance and proprietary trading exclusion. Their concerns centered on assertions that exchange oversight may be more effective than FINRA oversight,125 FINRA membership would result in duplicative regulation for certain firms,126 and FINRA regulation is customer-focused and therefore not appropriate for 124 The Commission also is proposing to renumber the paragraphs that remain in the amended rule. 125 See, e.g., Letters from: Mary Ann Burns, Chief Operating Officer, FIA Principal Traders Group (June 1, 2015) (‘‘FIA 2 Letter’’) at 4; Joanne MofficSilver, Executive Vice President, General Counsel and Corporate Secretary, Cboe, Elizabeth K. King, Secretary and General Counsel, NYSE, Joan C. Conley, Senior Vice President and Corporate Secretary, NASDAQ OMX Group, Inc., (June 1, 2015) (‘‘Cboe/NYSE/Nasdaq Letter’’) at 2; James Ongena, Senior Vice President and General Counsel, Chicago Stock Exchange (June 1, 2015) (‘‘CHX Letter’’) at 2; Jay Coppoletta, Chief Legal Officer, PEAK6 Capital Management LLC (June 1, 2015) (‘‘PEAK6 Letter’’) at 2; Frank A. Bednarz, Global Co-Head of Trading, CTC Trading Group, LLC (June 1, 2015) (‘‘CTC Letter’’) at 2–3. 126 See, e.g., Letters from: Mark E. Gannon, Chief Compliance Officer, Lakeshore Securities, LP (June 4, 2015) (‘‘Lakeshore Letter’’) at 2–3; Mark Schepps, General Counsel and Senior Director of Compliance, D&D Securities, Inc. (May 29, 2015) (‘‘D&D Letter’’) at 3. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 proprietary trading firms that do not carry customer accounts.127 The Commission continues to believe, however, that in today’s market the de minimis allowance and proprietary trading exclusion are no longer appropriate, and that direct Association regulation generally of broker-dealers’ off-member-exchange securities trading activity, consistent with what Congress envisioned in Section 15(b)(8) of the Act, would promote the protection of investors and the public interest pursuant to Section 15(b)(9) of the Act. As discussed above, the de minimis allowance and proprietary trading exclusion originally were intended to permit a type of off-exchange activity that no longer occurs today.128 When the Commission adopted Rule 15b9–1 and then the proprietary trading exclusion, virtually all trading activity was conducted manually on the floors of national securities exchanges.129 Today’s market structure is dramatically different—proprietary, cross-market order routing and trading strategies are a significant component of the markets, and exchange floor-based businesses represent only a fraction of market activity. Despite this transformative shift in how trading is conducted, the de minimis allowance and proprietary trading exclusion set forth in Rule 15b9–1 have never been adjusted. Rule 15b9–1’s stasis notwithstanding the market’s transformation has led to a misalignment in the complementary regulatory structure contemplated by Congress since FINRA does not have direct, membership-based jurisdiction over off-member-exchange securities trading activity by broker-dealers that are not FINRA members. The Exchange Act established the concept of an Association as the regulator of such trading activity,130 a role currently fulfilled by FINRA, which also is the SRO to which off-exchange trades are reported.131 As noted above, as of April 2022 there were approximately 65 brokers or dealers that were not FINRA members, including active proprietary trading firms, which accounted for a significant percentage of off-exchange 127 See, e.g., CTC Letter at 2–3; PEAK6 Letter at 2; Letter from Gregory F. Hold, CEO, Hold Brothers Capital LLC (June 1, 2015) (‘‘Hold Brothers Capital Letter’’) at 2. 128 See supra note 60 and accompanying text. The Commission is unaware of any floor members today that refer accounts to other broker-dealers in exchange for a share of commission revenues. 129 See, e.g., Special Study, supra note 62, at 98 (‘‘Trading by NYSE members on the Exchange but from off the floor accounts for approximately 5 percent of total Exchange purchases and sales . . .’’). 130 See 15 U.S.C. 78o(b)(8). 131 See supra notes 40–43 and accompanying text. PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 49941 equities and U.S. Treasury securities transaction volumes, as well as a significant amount of transaction volume on exchanges where they are not a member.132 The Commission is concerned that the current cross-market regulatory program applied to such firms’ off-member-exchange securities trading activity—which the Commission understands is dependent on RSAs—is not as stable or consistent as direct, membership-based Association oversight through FINRA membership in addressing any such trading activity and does not trigger FINRA’s offexchange transaction reporting obligations for such firms. Under the amended rule, the 65 firms identified above generally would not be exempt from Section 15(b)(8) of the Act and therefore would be required to join FINRA (unless they qualify for one of the amended rule’s exceptions), the only Association currently, to the extent that they effect securities transactions elsewhere than an exchange where they are a member. The Commission believes that direct, membership-based FINRA oversight over and the application of FINRA’s securities transaction reporting requirements to such firms would create more effective SRO oversight over their off-member-exchange securities trading activity and therefore promote the protection of investors and the public interest. Contrary to certain commenters’ suggestion that FINRA oversight of proprietary trading firms is not necessary since they do not carry customer accounts, FINRA has established a regulatory regime for broker-dealers that effect off-memberexchange securities transactions that applies to FINRA members regardless of whether they handle customer orders or carry customer accounts. For example, FINRA has developed a detailed set of rules in core areas such as trading practices,133 business conduct,134 132 See supra notes 79–94 and accompanying text. FINRA Rule 5000 Series—Securities Offerings and Trading Standards and Practices. For instance, FINRA prohibits members from coordinating prices and intimidating other members. See FINRA Rule 5240(a), providing, among other things, that ‘‘[n]o member or person associated with a member shall: (1) coordinate the prices (including quotations), trades or trade reports of such member with any other member or person associated with a member, or any other person; (2) direct or request another member to alter a price (including a quotation); or (3) engage, directly or indirectly, in any conduct that threatens, harasses, coerces, intimidates or otherwise attempts improperly to influence another member, a person associated with a member, or any other person.’’ 134 See FINRA Rule 2000 Series—Duties and Conflicts, supra note 38. 133 See E:\FR\FM\12AUP2.SGM 12AUP2 49942 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 financial condition and operations,135 and supervision,136 many of which apply to FINRA members regardless of whether they handle customer orders or carry customer accounts.137 FINRA’s ability to create a consistent regulatory framework for all such broker-dealers that effect securities transactions elsewhere than on exchanges where they are a member, including the offexchange market, is undermined by the subset of such broker-dealers that are not FINRA members in reliance on Rule 15b9–1. Moreover, part of FINRA’s regulatory framework is its transaction reporting regime, and it is not customerfocused—it applies to FINRA members regardless of whether they handle customer orders or carry customer accounts.138 Continuing to permit an exemption from FINRA membership on the basis that dealers that, for example, trade U.S. Treasury securities proprietarily do not have customers would not help improve the comprehensiveness of U.S. Treasury securities transaction reporting to TRACE or address the potential competitive advantage of non-FINRA members that, unlike FINRA members, may trade U.S. Treasury securities without reporting those transactions. In addition, an Association’s regulatory responsibility, like exchange SROs’, includes an obligation to monitor for operational and regulatory issues, as well as issues relating to market 135 See FINRA Rule 4000 Series—Financial and Operational Rules. For example, FINRA Rule 4370(a) provides, among other things, that ‘‘[e]ach member must create and maintain a written business continuity plan identifying procedures relating to an emergency or significant business disruption. Such procedures must be reasonably designed to enable the member to meet its existing obligations to customers. In addition, such procedures must address the member’s existing relationships with other broker-dealers and counterparties. The business continuity plan must be made available promptly upon request to FINRA staff.’’ 136 See FINRA Rule 3000 Series—Supervision and Responsibilities Relating to Associated Persons. This rule series generally requires FINRA member firms, among other things, to establish, maintain, and enforce written procedures to supervise the types of business in which the firm engages and the activities of its associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. See e.g., FINRA Rules 3110 (Supervision), 3120 (Supervisory Control System), and 3170 (Tape Recording of Registered Persons by Certain Firms). See also FINRA By-Laws Article III—Qualifications of Members and Associated Persons. Any person associated with a member firm who is engaged in the securities business of the firm—including partners, officers, directors, branch managers, department supervisors, and salespersons—must register with FINRA. 137 See, e.g., the FINRA rules set forth in notes 38–43 and 133–136 supra and accompanying text. 138 See FINRA Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities), supra note 40. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 disruptions.139 The inability of FINRA to directly enforce regulatory compliance by non-FINRA member proprietary trading firms—whether or not they handle customer orders or carry customer accounts—may create a risk to the fair and orderly operation of the market because, for example, if FINRA were to detect that a non-FINRA member is effecting off-memberexchange securities transactions that are not in compliance with the Exchange Act or applicable rules, FINRA would not have direct, membership-based jurisdiction to directly address the behavior.140 This is the case regardless of whether the firm has customers. And as discussed above,141 the Commission believes that RSA-based regulatory efforts among exchange SROs and FINRA, while beneficial in many contexts, are a less stable and consistent mechanism for SRO oversight than the Association membership required by the Exchange Act in the context presented here. Moreover, contrary to commenters’ assertions, the Commission does not preliminarily believe that exchange oversight alone would be more effective at remedying the above-described issues than direct FINRA oversight of offmember-exchange securities trading activity through the Association membership envisioned by Congress, or that FINRA membership would result in duplicative regulation for broker-dealer proprietary trading firms. The imposition of FINRA rules on such firms would require them to report their U.S. Treasury securities transactions under FINRA’s TRACE reporting regime. It also would require that such firms be identified in off-exchange NMS stock transaction reports to FINRA’s 139 15 U.S.C. 78o–3. could refer such a matter to the Commission. See, e.g., Statement of Robert W. Cook, President and CEO, FINRA, ‘‘Equity Market Surveillance Today and the Path Ahead’’ (Sep. 20, 2017), available at https://www.finra.org/mediacenter/speeches-testimony/equity-marketsurveillance-today-and-path-ahead (stating that FINRA makes referrals to the Commission or other authorities if the target of an investigation is beyond the collective jurisdiction of FINRA and the exchanges, and that in a prior year FINRA’s market regulation department made over 500 referrals to the Commission on behalf of FINRA and its exchange clients related to potential abusive trading strategies or other rule violations). FINRA also could refer such a matter to an exchange where the firm is a member or, as discussed above, potentially address the matter through an RSA if covered by the terms of the RSA. 141 See supra Section II.B. As is also discussed above, while the Commission can bring enforcement actions, including pursuant to SRO referrals, that Commission layer of regulatory oversight is meant to work in tandem with, not in place of, a robust front-line layer of SRO oversight. See supra Sections II.A and II.B. 140 FINRA PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 TRFs,142 and thus promote broader public market transparency in NMS stocks.143 Firms that are not FINRA members generally are not identified in TRF transaction reports.144 Moreover, FINRA registration would confer jurisdiction to FINRA to regulate directly off-member-exchange trading activity as Congress envisioned in Section 15(b)(8) of the Act, to apply a more consistent regulatory framework to such trading activity, and to mitigate the risks to the fair and orderly operation of the market that stem from FINRA’s current lack of direct oversight of nonFINRA members. Further, due to FINRA’s experience and expertise in cross-market supervision, the Commission preliminarily believes that FINRA is well-positioned to assume direct jurisdiction over dealer firms that currently are not FINRA members and effect securities transactions elsewhere than exchanges where they are a member.145 As for the potential for 142 See supra note 42 and accompanying text. FINRA Rule 6000 Series—Quotation, Order, and Transaction Reporting Facilities and FINRA Rule 7000 Series—Clearing, Transaction and Order Data Requirements, and Facility Charges, supra note 40; see also note 112 and accompanying text. 144 See supra note 113. 145 One commenter stated that the costs of crossmarket surveillance ‘‘are appropriately funded by exchanges as regulators of their markets and FINRA as the regulator of the off-exchange market.’’ See Letter from Adam Nunes, Head of Business Development, Hudson River Trading LLC (June 1, 2015) (‘‘HRT Letter’’) at 9. This commenter further stated that the Commission should not ‘‘attempt to address cross-market surveillance by forcing all broker-dealers to become members of FINRA’’ and should attempt to ‘‘ensure that cross-market surveillance is not dependent on exchanges outsourcing exchange regulation to FINRA, as it leads to the possibility that changes to RSAs and 17d–2 agreements could substantially degrade the ability to perform appropriate cross-market surveillance.’’ Id. This commenter also weighed the appropriateness of subjecting all broker-dealers to FINRA oversight and the benefits of regulatory standardization against potential negatives associated with having a single regulator. Id. at 9– 11. See also CHX Letter at 1–2 (stating concern about a single point of failure in regulatory surveillance and oversight practices). As discussed above, in the specific context of broker-dealers that are not FINRA members and that effect off-memberexchange securities transactions, the Commission believes that cross-market surveillance is not performed via 17d–2 plans and should not be dependent on RSAs. See supra Sections II.A and II.B (discussing, among other things, that Commission approval of a 17d–2 plan relieves an SRO of the regulatory responsibilities allocated by the plan to another SRO but only with respect to common members of the participating SROs, and that RSAs’ coverage is not limited to common members of the participating SROs but RSAs are discretionary arrangements among SROs that do not relieve the SRO contracting for regulatory services of ultimate regulatory responsibility over its members). Moreover, consistent with section 15(b)(8) of the Act, broker-dealers that do not effect securities transactions otherwise than on an exchange where they are a member would not be required to join FINRA. In addition, as re-proposed 143 See E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 duplicative SRO oversight, to the extent such firms also effect securities transactions on exchanges where they are a member, 17d–2 plans are designed to mitigate duplicative SRO oversight over common members. Some commenters on the 2015 Proposal also contended that the availability of CAT data would mitigate the need to subject proprietary trading firms to FINRA SRO oversight.146 As discussed above, the Commission preliminarily believes that the NMS and OTC securities data available to SROs through the CAT NMS Plan are helpful tools, but such access does not confer jurisdiction to FINRA over a firm that is not a FINRA member and that trades those securities off-exchange, or ensure that an individual exchange SRO of which such a firm is a member would seek to enforce compliance with its rules, Commission rules or Federal securities laws with respect to the firm’s off-member-exchange activity.147 Even if one or more exchanges of which a broker-dealer is a member and FINRA could coordinate SRO oversight of the non-FINRA member firm’s off-memberexchange securities trading activity through the use of CAT data and RSAs, performing SRO oversight in this manner is less certain and stable than direct Association oversight of such trading activity due to the discretionary nature of RSAs, and frustrates the regulatory scheme established by Congress in which an Association directly regulates broker-dealers that effect securities transactions elsewhere than exchanges where they are a member.148 Further, CAT reporting obligations do not apply to U.S. Treasury securities, U.S. Treasury securities are not traded on any and discussed below, Rule 15b9–1 would continue to provide certain narrow exemptions from section 15(b)(8)’s Association membership requirement for broker-dealers that do effect securities transactions otherwise than on an exchange where they are a member. Thus, the Commission does not believe it is necessarily the case that all broker-dealers would be required to join FINRA as a result of the proposal. 146 See, e.g., CHX Letter at 2. 147 See supra Section II.B. 148 See 2015 Proposing Release, supra note 6, 80 FR 18039 at notes 28–33 and accompanying text describing the regulatory history of off-exchange trading. See also Cross-Market Regulatory Coordination Staff Paper, supra note 31 (stating that ‘‘[w]hile multiple SROs reviewing the same securities activities can have benefits, in that the resources and expertise from several organizations can be brought to bear on assessing these activities, it also can lead to duplication and inefficiencies in the regulatory process and increased burdens on member firms.’’). FINRA and the exchange SROs have a history of coordinating and can work together to address concerns of firms that are receiving duplicative regulatory requests such as through the Cross Market Regulatory Working Group. Id. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 exchange, and to the Commission’s knowledge, unlike FINRA,149 no exchange SRO possesses the expertise or proclivity to exert SRO oversight over their members’ U.S. Treasury securities trading activity. Access to CAT data would not shed light on firms’ U.S. Treasury securities trading activity or provide exchanges or FINRA with any ability to monitor that activity. As is discussed in more detail in the Economic Analysis, firms that must become FINRA members would become subject to the fees charged by FINRA to all of its member firms. FINRA charges each member firm certain regulatory fees designed to recover the costs to FINRA of the supervision and regulation of members, including performing examinations, financial monitoring, and policy, rulemaking, interpretive, and enforcement activities.150 These regulatory fees include a Trading Activity Fee (‘‘TAF’’),151 which, at the time of the 2015 Proposal, was a primary source of commenter concern over the costs of FINRA membership that would be borne by proprietary trading firms.152 Shortly after the Commission published the 2015 Proposal, FINRA issued a Regulatory Notice proposing to 149 See supra notes 32–33 and accompanying text. Schedule A to the By-Laws of the Corporation (‘‘FINRA Schedule A’’), at Section 1. 151 FINRA uses the TAF to recover the costs to FINRA of the supervision and regulation of members, including performing examinations, financial monitoring, and policy, rulemaking, interpretive, and enforcement activities. See FINRA Schedule A, Section 1(a), available at https:// www.finra.org/rules-guidance/rulebooks/corporateorganization/section-1-member-regulatory-fees. The TAF is generally assessed on FINRA member firms for all equity sales transactions that are not performed in the capacity of a registered exchange specialist or market maker. See id. at section 1(b). Many of the broker-dealers that could be required to join FINRA if the proposed amendments to Rule 15b9–1 are adopted effect securities transactions in large volumes throughout the national market system, and often in a capacity other than as a registered market-maker. See also infra note 241 and accompanying text for further discussion of the TAF. 152 See, e.g., Letter from Mary Ann Burns, Chief Operating Officer, FIA (May 6, 2015) (‘‘FIA 1 Letter’’) at 1, PEAK6 Letter at 2, Hold Brothers Capital Letter at 2, Lakeshore Letter at 2, CTC Letter at 5–6, D&D Letter at 2, Mark Schepps, General Counsel and Senior Director of Compliance, PTR, Inc. (May 29, 2015) (‘‘PTR Letter’’) at 2, Letter from Eric Chern, CEO, CTC Trading Group, L.L.C., Andrew Killion, CEO, Akuna Capital LLC, Thomas Hutchinson, President, Belvedere Trading LLC, Steven J. Gaston, Chief Compliance Officer, Consolidated Trading LLC, Trent Cutler, CEO, Cutler Group LP, John Kinahan, CEO, Group One Trading, L.P., Marc Liu, CEO, Integral Derivatives LLC, Craig S. Donohue, Executive Chairman, The Options Clearing Corporation, Sebastiaan Koeling, CEO, Optiver US, LLC, Andrew Tourney, Chief Compliance Officer, Peak6 Investments, L.P., Brian Donnelly, CEO, Volant Trading (July 13, 2016) (‘‘Options Market Makers Letter’’) at 6, and FIA 2 Letter at 5. 150 FINRA PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 49943 amend the TAF such that it would not apply to transactions by a proprietary trading firm effected on exchanges of which the firm is a member.153 FINRA stated in its Regulatory Notice that it would implement the TAF amendments to coincide with the compliance date of amendments to Rule 15b9–1. Given FINRA’s prior consideration of amendments to its TAF, FINRA may again evaluate its TAF to ensure that it appropriately reflects the activities of, and regulatory responsibilities towards, broker-dealer proprietary trading firms that would be required to join FINRA if the proposed amendments to Rule 15b9–1 are adopted.154 153 See FINRA Regulatory Notice 15–13, Trading Activity Fee (May 2015), available at https:// www.finra.org/sites/default/files/notice_doc_file_ ref/Notice_Regulatory_15-13.pdf. FINRA, in its Regulatory Notice, stated that it analyzed the potential application and impact of the TAF to proprietary trading firms and believed it could result in a significant TAF obligation for these firms that may be disproportionate to FINRA’s anticipated costs associated with the financial monitoring and trading surveillance of these firms, in large part because these firms do not have customers. Id. By way of example, FINRA stated that it conducts reviews for best execution (FINRA Rule 5310), trading ahead of customer orders (FINRA Rule 5320), and display of customer limit orders (Exchange Act Rule 604), all of which are directed at firms that have customers or receive orders from customers of another broker-dealer. Id. To the extent that firms that join FINRA do not carry customer accounts, FINRA would not have to surveil such firms for compliance with these rules. The objective of the contemplated TAF amendment, according to FINRA, would be to tailor the TAF to FINRA’s anticipated costs associated with the financial monitoring and trading surveillance of those firms that would be required to become FINRA members as a result of the Commission’s proposed amendments. 154 Commenters on the 2015 Proposal addressed the costs of FINRA membership, with some suggesting that the costs would be burdensome for proprietary trading firms. See, e.g., FIA 1 Letter at 1 (‘‘FINRA Membership would be costly to most proprietary trading firms’’); PEAK6 Letter at 2 (‘‘[FINRA registration is] overly costly and burdensome’’); Hold Brothers Capital Letter at 2 (‘‘[Costs of FINRA membership] would be unduly burdensome to smaller, less well funded Proprietary Traders’’); Lakeshore Letter at 2–3; CTC Letter at 5–6; D&D Letter at 2; PTR Letter at 2; Options Market Makers Letter at 6; FIA 2 Letter at 5. Commenters also previously expressed concern that the application of the TAF in its current form to proprietary trading firms would be overly burdensome, but suggested that FINRA’s proposed TAF amendment would mitigate this concern. See, e.g., HRT Letter at 5–6; FIA 1 Letter at 2; IEX Letter at 3; CTC Letter at 5; PEAK6 Letter at 3. Some commenters suggested a modification to FINRA’s proposed amendment that would exclude from the TAF all of a firm’s proprietary trading activity on an exchange of which it is a member. See, e.g., HRT Letter at 11. Apart from the TAF as it currently exists, the Commission does not believe that brokerdealer firms that join FINRA if proposed Rule 15b9– 1 is adopted would be disproportionately impacted by the costs of FINRA membership compared to existing FINRA members that already incur those costs, and as discussed in the Economic Analysis, the Commission preliminarily believes that the costs would be justified by the considerable benefits E:\FR\FM\12AUP2.SGM Continued 12AUP2 49944 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules On March 28, 2022, the Commission proposed changes to the definition of ‘‘dealer’’ and ‘‘government securities dealer,’’ within the meaning of Sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively.155 We encourage commenters to review that proposal to determine whether it might affect their comments on this proposing release. jspears on DSK121TN23PROD with PROPOSALS2 Requests for Comment The Commission requests comment on all aspects of the proposed elimination of the de minimis allowance and proprietary trading exclusion as well as, in particular, on the following questions: 6. Are there exchange floor members that currently rely on the $1,000 de minimis allowance but not the proprietary trading exclusion? Are there exchange floor members that currently rely on the proprietary trading exclusion? If so, please describe the number and types of any such exchange floor members, and the nature and extent of their reliance. Also, please provide any available data on the amount and frequency of commissions or referral fees that floor members may continue to receive with respect to offexchange transactions. 7. Should the Commission retain the de minimis allowance but eliminate the proprietary trading exclusion? If so, should the $1,000 threshold be changed? Why or why not? What should the threshold be? Should the de minimis allowance be modified in some other way? Would exchanges be able to appropriately monitor their members for compliance with an increased de minimis allowance? Would an increased de minimis allowance be an appropriate means of permitting hedging transactions that exchange members may effect elsewhere than their member exchange(s) without triggering Section 15(b)(8)’s Association requirement? of this proposal. In addition, some firms that could rely on Rule 15b9–1 nevertheless join FINRA voluntarily, which suggests that there are business interests satisfied by and benefits derived from FINRA membership that outweigh the costs of being a FINRA member, for at least some firms. Some commenters also raised the concern that FINRA may get paid twice for its regulatory oversight— once, directly from the FINRA membership, and again from the SROs that have outsourced regulatory oversight to FINRA through RSA agreements. See, e.g., SIFMA Letter at 3 and Lakeshore Letter at 3. The Commission notes that, as privately negotiated agreements between SROs, the fees set forth in RSAs are not subject to FINRA’s rules or Commission review, and RSAs may be revised or terminated by the SRO parties thereto. By contrast, FINRA’s rule-based fees are governed by Section 15A of the Act, which requires that they be equitably allocated among FINRA members and reasonable. 155 See Securities Exchange Act Release No. 94524 (March 28, 2022), 87 FR 23054 (April 18, 2022). VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 8. Instead of eliminating the proprietary trading exclusion, should the Commission retain a modified version of it? If so, how should it be modified and why? How could the proprietary trading exclusion be modified such that there is appropriate and comprehensive SRO oversight of firms that trade securities otherwise than on an exchange of which they are member and that trading activity? For example, could the proprietary trading exclusion be modified such that a firm’s reliance on it is contingent on the firm reporting its off-exchange securities transactions to the appropriate FINRA facility or TRACE? Would this suffice to enable the Commission to achieve the goals expressed herein, despite not providing FINRA with direct regulatory oversight of the firms? 9. If the de minimis allowance and proprietary trading exclusion are eliminated, as proposed, would some exchange floor members be required to become members of an Association? If so, how many? Please provide the basis of any estimate. What would be the effect on those firms? 10. To what extent do dealer firms that are not FINRA members and that trade securities otherwise than on an exchange of which they are a member rely on the proprietary trading exclusion? Where, other than an exchange where they are a member, do they typically effect securities transactions? On ATSs? Off-exchange otherwise than on an ATS? Another exchange where they are not a member? In what sort of dealer activity do these firms engage? For example, do they typically provide liquidity or make markets? Do they typically remove liquidity? Do they engage in other types of trading activities? 11. If the de minimis allowance and proprietary trading exclusion are eliminated, as proposed, what would be the effect on dealer firms that currently rely on the proprietary trading exclusion? What, if anything, would be the impact on their businesses if they are required to register with an Association? Would business incentives change such that firms might adjust their business model by exiting the offexchange market, moving transactions on-exchange, or leaving the markets altogether? Would firms alter their organizational structure or shift their proprietary trading activities to different or new affiliates? Would the effects on firms be different depending on what types of securities they trade? 12. Do commenters agree that some exchange member dealer firms trade proprietarily in U.S. Treasury securities as well as exchange-traded securities, PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 and are not FINRA members in reliance on the proprietary trading exclusion? If the de minimis allowance and proprietary trading exclusion are eliminated, as proposed, what would be the effects on such firms? What, if anything, would be the impact on their U.S. Treasury securities trading business? Do commenters expect that these firms would alter their business model or organizational structure if the amendments proposed herein are adopted? If so, how? Would these firms shift their proprietary trading activities to different or new affiliates? Would increased price discovery reduce any competitive advantages these firms have by observing other firms’ trades and not reporting their own trades? Would this impact market costs borne by the investing public? 13. Do commenters believe that most exchange member dealer firms that effect proprietary securities transactions otherwise than on an exchange of which they are member would need to join FINRA as a result of the elimination of the de minimis allowance and proprietary trading exclusion? If so, would it help address the Commission’s concerns regarding FINRA’s lack of direct jurisdiction over such firms’ offmember-exchange securities trading activity when they are not FINRA members? What are commenters’ views as to the extent of FINRA’s current ability to oversee off-member-exchange securities trading activity by dealer firms that are not FINRA members? 14. How do exchange SROs currently surveil or regulate their members’ securities trading activity and conduct elsewhere than the exchange? Do exchange SRO efforts in this regard mitigate any need to rescind the de minimis allowance and proprietary trading exclusion? How would such an approach address the fact that TRACE reporting obligations apply only to FINRA members? 15. Are there concerns regarding how the TAF would apply to proprietary trading broker-dealer firms? 16. Are there concerns regarding the applicability of certain FINRA rules to solely proprietary trading brokerdealers, as opposed to those who face customers? Which rules, and why? Are there benefits to applying FINRA rules to these broker-dealers? B. Narrowed Criteria for Exemption From Association Membership The Commission is proposing to add to Rule 15b9–1 a new paragraph (c) that would set forth two narrow circumstances in which a broker or dealer could continue to be exempt from Section 15(b)(8)’s Association E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules membership requirement if it effects transactions in securities otherwise than on an exchange of which it is a member.156 Specifically, following the existing paragraphs of Rule 15b9–1 that require that a broker or dealer be a member of a national securities exchange and carry no customer accounts (both of which paragraphs would be retained), the Commission proposes to add language that would state: ‘‘and, (c) Effects transactions in securities solely on a national securities exchange of which it is a member, except that with respect to this paragraph (c) . . .’’ The two proposed exceptions would follow in new paragraphs (c)(1) and (c)(2), and are discussed in turn below. Proposed paragraphs (c)(1) and (c)(2) of the amended rule are intended to provide more focused exemptions from Association membership for types of offmember-exchange activity that are similar to the off-member-exchange activities that Rule 15b9–1 was originally intended to cover, and that are consistent with the public interest and the protection of investors in accordance with Section 15(b)(9) of the Act. jspears on DSK121TN23PROD with PROPOSALS2 1. Routing Exemption In paragraph (c)(1) of Rule 15b9–1, the Commission proposes to provide an exemption from Association membership if a broker or dealer that meets the criteria of paragraphs (a) and (b) of the rule effects transactions in securities otherwise than on a national securities exchange of which it is a member that result solely from orders that are routed by a national securities exchange of which it is a member to comply with Rule 611 of Regulation NMS 157 or the Options Order Protection and Locked/Crossed Market Plan.158 Relatedly, the Commission also 156 See proposed Rule 15b9–1(c). Relatedly, existing paragraph (a) of Rule 15b9–1 would remain the same except it would no longer be numbered as paragraph (a); existing paragraph (a)(1) would be renumbered as paragraph (a); and existing paragraph (a)(2) would be renumbered as paragraph (b). See proposed Rule 15b9–1. 157 17 CFR 242.611. 158 See proposed Rule 15b9–1(c)(1). See also Securities Exchange Act Release No. 60405 (July 30, 2009), 74 FR 39362 (August 6, 2009) (‘‘Options Linkage Plan’’). In the 2015 Proposal, the Commission proposed to apply this exemption to orders routed to comply with Rule 611 but did not propose to apply this exemption to orders routed to comply with the Options Linkage Plan. Several commenters on the 2015 Proposal supported this proposed exemption for compliance with Rule 611. See, e.g., HRT Letter at 7; D&D Letter at 3; PTR Letter at 3; CHX Letter at 3–4; SIFMA Letter at 3– 4. Commenters also suggested that the routing exemption should covers orders routed to comply with the Options Linkage Plan. See, e.g., Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 proposes to eliminate from Rule 15b9– 1 outdated references to the ‘‘Intermarket Trading System.’’ 159 The ITS Plan required each participant to provide electronic access to its displayed best bid and offer, and provided an electronic mechanism for routing orders, called commitments to trade, to access those displayed prices.160 The ITS Plan provided each market limited access to the other markets for the purpose of avoiding a trade-through 161 and locked or crossed markets.162 The ITS Plan was eliminated in 2007 because it was superseded by Regulation NMS.163 Thus, the references to the ‘‘Intermarket Trading System’’ in current paragraphs (b)(2) and (c) of Rule 15b9–1 are obsolete. Today, Rule 611 of Regulation NMS requires trading centers, such as national securities exchanges, to establish, maintain, and enforce written policies and procedures reasonably designed to prevent trade-throughs in exchange-listed stocks, subject to certain exceptions.164 In general, Rule 611 protects automated quotations that are the best bid or offer of a national securities exchange or an Association.165 To facilitate compliance with Rule 611, national securities exchanges have developed the capability to route orders through brokers or dealers (many of which are affiliated with the exchanges) to other trading centers with protected 159 The Intermarket Trading System was an NMS plan, the full title of which was ‘‘Plan for the Purpose of Creating and Operating an Intermarket Communications Linkage Pursuant to section 11A(c)(3)(B) of the Exchange Act of 1934’’ (‘‘ITS Plan’’). The ITS Plan was initially approved by the Commission in 1978. Exchange Act Release No. 14661 (April 14, 1978), 43 FR 17419 (April 24, 1978) (‘‘ITS Plan Approval Order’’). All national securities exchanges that traded exchange-listed stocks and the NASD were participants in the ITS Plan. 160 See ITS Plan Approval Order, supra note 159. 161 See 17 CFR 242.600(b)(94) (defining a ‘‘tradethrough’’ under Regulation NMS); see also Options Linkage Plan, supra note 158 (defining ‘‘tradethrough’’ in the options context). 162 A locked or crossed market occurs when a trading center displays an order to buy at a price equal to or higher than an order to sell, or an order to sell at a price equal to or lower than an order to buy, that is displayed on another trading center. 163 Notice of Filing and Immediate Effectiveness of the Twenty Fourth Amendment to the ITS Plan Relating to the Elimination of the ITS Plan, Exchange Act Release No. 55397 (March 5, 2007), 72 FR 11066 (March 12, 2007). Today, Regulation NMS contains an updated trade-through rule, and contemplates the use of private linkages by trading centers to route orders to avoid trade-throughs. 17 CFR 242.610–611. 164 17 CFR 242.611. See also 17 CFR 240.600(b)(95) (defining ‘‘trading center’’). 165 17 CFR 242.611. PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 49945 quotations.166 Similarly, in the options market, the Options Linkage Plan is a national market system plan that requires linkages between the options exchanges to protect the best-priced displayed quotes in the market and to avoid locked and crossed markets.167 The Options Linkage Plan includes written policies and procedures that provide for order protection and address locked and crossed markets in eligible options classes.168 The proposed rule would continue to accommodate securities transactions away from a broker’s or dealer’s member exchange(s) that are to comply with these regulatory requirements. An exchange member may at times seek to effect a securities transaction on that exchange at a price that would trade through a protected quotation displayed on another trading center, such as another exchange or FINRA’s ADF. In such a case, the exchange may route the member’s order (if the exchange does not reject it), through a routing brokerdealer, to that other trading center to access the protected quotation. Moreover, if, for example, an ATS were to display a protected quotation on FINRA’s ADF, absent the proposed exemption, a broker or dealer would have to join FINRA in order to have access to all protected quotations, even if the broker or dealer already is a member of every exchange on which it effects securities transactions.169 In essence, a broker or dealer may, as a necessary part of its business trading on exchanges of which it is a member and in light of today’s market structure, effect securities transactions elsewhere than an exchange where it is a member solely as a consequence of routing by its member exchange(s) to comply with the requirements of Rule 611 of Regulation NMS or the Options Linkage Plan. The proposed rule would not require Association membership as a result of such transactions. On the contrary, it 166 See 17 CFR 242.600(b)(71) (defining ‘‘protected quotation’’ under Regulation NMS) and 17 CFR 242.600(b)(70) (defining ‘‘protected bid’’ and ‘‘protected offer’’ under Regulation NMS); see also Options Linkage Plan, supra note 158 (defining ‘‘protected bid’’ and protected offer’’ in the options context). 167 See Options Linkage Plan, supra note 158. 168 Id. 169 See HRT Letter at 7 (stating that ‘‘if an ATS were to display a protected quote on FINRA’s ADF, absent an exemption, a Non-Member would not have access to the protected quotations without registering with FINRA’’ and asserting that allowing exempt firms to have access to all protected quotations is critical because it affects their ability to trade on exchanges of which they are members). See also SIFMA Letter at 3 (suggesting that the Commission clarify the exemption and whether it applies to non-floor exchange members whose orders are routed by the exchange to an offexchange venue). E:\FR\FM\12AUP2.SGM 12AUP2 49946 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 would be consistent with Section 15(b)(9)’s goal of protecting investors and the public interest if transactions effected solely to comply with these regulatory requirements, via routing by the broker’s or dealer’s member exchange(s), do not trigger Section 15(b)(8)’s Association membership requirement for a broker or dealer that otherwise limits its securities transactions to an exchange of which it is a member (or to stock transactions that are covered by the stock-option order exemption discussed below). The proposed routing exemption would serve the limited, narrowly defined purpose of facilitating compliance with intermarket order protection requirements.170 The Commission also believes that it would be consistent with the protection of investors and the public interest to permit reliance on this exemption only where the routing is performed by a national securities exchange of which the broker or dealer is a member. This limitation would help ensure that the broker’s or dealer’s member exchange has visibility into these routing transactions and thus is better able to provide effective SRO oversight of its member’s activity that is related to its trading on the exchange and may not be overseen by another SRO if the member is exempt from Association membership under amended Rule 15b9–1.171 In this 170 One commenter stated that the routing exemption should be ‘‘expanded to include all exchange-based routing activity, including, but not limited to, routing effected for Regulation NMScompliance and best execution purposes’’ and that the proposal ‘‘does not contemplate the full array of legitimate and necessary exchange-based routing activity.’’ See CHX Letter at 3. The commenter asserted that because all exchange routing functionalities must be approved by the Commission, any type of exchange routing would be consistent with the purposes of the Act and should be covered by the proposed exemption. Id. at 3–4. In response to this comment, the Commission preliminarily believes that many exchange-offered routing functionalities are not necessary to facilitate an exchange member’s trading on the exchange. In addition, the Commission is unaware of any exchange-offered routing options that are specifically designated as being for best execution purposes. An exchange member may utilize the exchange’s routing functionality to assist in meeting its best execution obligations, but this would not appear limited to any particular exchange-offered routing option. The commenter’s suggested expansion of the proposed routing exemption could create a gap in the FINRA oversight intended to be achieved under the proposal if the exchange member could rely on its member exchange’s router to execute significant volume on other markets where it is not a member without joining FINRA. 171 Some commenters on the 2015 Proposal suggested that the routing exemption should not be limited to where the broker’s or dealer’s member exchange’s routing mechanism is utilized, and that the Commission also should provide relief to broker-dealers that route orders to access protected quotations on away exchanges without utilizing the VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 context, the exemption would be applicable where the broker’s or dealer’s member exchange utilizes the services of a designated broker-dealer (which could be affiliated or unaffiliated with the exchange) to perform the exchange’s outbound routing, as the Commission understands that this type of arrangement is typical among exchanges. A commenter on the 2015 Proposal sought clarity as to whether the exemption would apply to routing broker-dealers that are affiliated with national securities exchanges that are used by exchanges to conduct routing to other trading centers.172 The commenter pointed out that the Commission has required these affiliated routing brokerdealers to operate as ‘‘facilities’’ of their respective exchanges, which set forth rules that require the exchange to arrange for the routing broker-dealer to be overseen by a non-affiliated SRO, and which in practice is FINRA.173 The commenter requested that the Commission clarify that the exemption from FINRA registration under Rule 15b9–1 would not apply to a brokerdealer affiliated with a national securities exchange that routes orders on behalf of the exchange for the purpose of accessing quotations in other trading centers.174 In response, proposed Rule 15b9–1 would provide an exemption from Section 15(b)(8) of the Act’s Association membership requirement for routing broker-dealers that meet the conditions for the exemption. However, proposed Rule 15b9–1 would not provide routing broker-dealers with an exemption from the rules of an exchange that are applicable to routing broker-dealers that operate as facilities of that exchange (and that the exchange uses to conduct routing to other trading centers). As is linkage routing mechanism offered by a home exchange. See Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3. The Commission does not believe this would be appropriate because it could permit scenarios in which there is insufficient SRO oversight of the entirety of the broker-dealer’s trading activity. By way of example, if a brokerdealer were a member of some exchanges but not others and not a FINRA member, and the brokerdealer could rely on the exemption when routing orders to access protected quotations on nonmember exchanges or off-exchange in order to prevent a trade-through on one of its member exchanges, the Commission believes that it is possible that there would not be an SRO responsible for and that could exercise jurisdiction over the broker-dealer’s trading activity away from its member exchange(s). 172 See SIFMA Letter at 3–4. 173 Id. 174 Id. (expressing concern as to whether ‘‘an exchange-affiliated routing broker-dealer could restrict its activities to accessing protected quotations on other exchanges and could therefore avoid FINRA membership’’). PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 the case today, if an exchange’s routing broker-dealer is covered by amended Rule 15b9–1, if adopted, then the routing broker-dealer would qualify for the exemption from Section 15(b)(8) afforded by the rule. But the routing broker-dealer would still be required to comply with the applicable rules of any exchange for which it performs outbound routing services, including those requiring the routing broker-dealer to be overseen by an unaffiliated SRO such as FINRA.175 The Commission requests comment on all aspects of the proposed routing exemption in amended Rule 15b9–1. In particular, the Commission seeks responses to the following questions: 17. What are commenters’ views on the proposed routing exemption? How, if at all, should the proposed routing exemption be modified? 18. Is the scope of the proposed routing exemption sufficient to provide relief for all securities transactions effected elsewhere than on an exchange of which a broker or dealer is a member that might be effected to comply with Rule 611 of Regulation NMS and the Options Linkage Plan? If not, how should it be changed? 19. Should the proposed routing exemption be broadened to cover transactions beyond those that are to comply with Rule 611 of Regulation NMS and the Options Linkage Plan? If so, what types of additional transactions should be covered and why? For example, should the proposed routing exemption be broadened such that it covers routing by an exchange for any purpose and pursuant to any of the exchange’s available routing functionalities? Should the proposed routing exemption be narrowed so that it does not cover transactions to comply with Rule 611 or the Options Linkage Plan? Should the proposed routing exemption be eliminated in its entirety? 20. Are there other off-exchange transactions that a broker or dealer might effect in order to comply with regulatory requirements? If so, please describe those transactions and the relevant regulatory requirements. Should there be an exemption in amended Rule 15b9–1 that applies to any such transactions? 21. Should the proposed routing exemption also cover broker-dealer routing to access protected quotations without using the member exchange’s routing mechanisms? Why or why not? 22. As discussed above, the Commission preliminarily believes that 175 See, e.g., Cboe BZX Exchange, Inc. Rule 2.11 (Cboe Trading, Inc. as Outbound Router); NYSE Rule 17(c) (Operation of Routing Broker); Nasdaq Rule 4758(b) (Routing Broker). E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules the proposed routing exemption from Section 15(b)(8)’s Association membership requirement does not exclude a routing broker that operates as the facility of an exchange, but such a routing broker would still be required to comply with the rules of the exchange, including exchange rules requiring that the routing broker be overseen by an SRO that is not affiliated with the exchange. Do commenters agree with this? Should Rule 15b9–1 be amended in some way such that it excludes or applies differently to routing brokers that operate as the facility of an exchange? Why or why not? Should the proposed routing exemption apply where the exchange uses a routing broker, whether affiliated or unaffiliated? Should the routing exemption apply only where the exchange uses an affiliated routing broker? Should the routing exemption apply only where the exchange uses an unaffiliated routing broker? jspears on DSK121TN23PROD with PROPOSALS2 2. Stock-Option Order Exemption In paragraph (c)(2) of amended Rule 15b9–1, the Commission proposes to provide an exemption from Association membership if a broker or dealer that meets the criteria of paragraphs (a) and (b) of the rule effects transactions in securities otherwise than on a national securities exchange of which it is a member, with or through another registered broker or dealer, that are solely for the purpose of executing the stock leg of a stock-option order.176 Proposed paragraph (c)(2) also would require that a broker or dealer seeking to rely on this proposed exemption establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that such transactions are solely for the purpose of executing the stock leg of a stock-option order, and that the broker or dealer preserve a copy of its policies and procedures in a manner consistent with 17 CFR 240.17a–4 until three years after the date the policies and procedures are replaced with updated policies and procedures.177 The Commission understands that there are firms that trade stock-option orders whose business is focused on one or more options exchanges of which they are a member, and whose trading 176 See proposed Rule 15b9–1(c)(2). The 2015 Proposal did not include this type of exemption. Several commenters suggested that it be added to the amended rule. See, e.g., Letter from Elizabeth K. King, Secretary and General Counsel, NYSE and Joan C. Conley, Senior Vice President and Corporate Secretary, NASDAQ OMX Group, Inc. (June 4, 2015) (‘‘NYSE/Nasdaq Letter’’) at 2–4; D&D Letter at 1–2; PTR Letter at 1–2; Cboe Letter at 3; Cboe/ NYSE/Nasdaq Letter at 4; Lakeshore Letter at 2. 177 See proposed Rule 15b9–1(c)(2). VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 elsewhere is primarily to effect the execution of stock orders to facilitate their stock-option order business. In the Commission’s preliminary view, these firms’ stock trading activity is for a limited purpose and ancillary to their primary business handling stock-option orders on an options exchange of which they are member. As discussed below, there is a close link between the stock component transaction of a stock-option order and the relevant options exchange. As such, the proposed rule would permit these types of firms to continue their stock-option order trading business without being required to join stock exchanges or an Association solely in order to effect the execution of the stock legs of stockoption orders that they handle. As noted above, the Commission estimates that, in 2021, 50 of the 66 firms identified as registered brokerdealers and exchange members but not FINRA members initiated options order executions.178 The Commission estimates that seven of the firms that initiated options order executions also effected the execution of stock leg transactions, and therefore could potentially rely on the proposed stockoption order exemption to the extent that they effect the stock leg executions off-exchange or on an exchange where they are not a member. Because the broker or dealer relying on proposed Rule 15b9–1(c)(2) would not itself be a member of an exchange on which such stock transactions are executed, or a member of an Association, such stock leg transactions would need to be effected with or through another registered broker or dealer that is a member of the exchange where the transactions are executed or a member of an Association (or both). Options exchanges define the term ‘‘stock-option order’’ in their rules.179 178 See supra note 81. e.g., Cboe Rule 1.1 (defining ‘‘stockoption order’’ as ‘‘an order to buy or sell a stated number of units of an underlying or a related security coupled with either (a) the purchase or sale of option contract(s) on the opposite side of the market representing either the same number of units of the underlying or related security or the number of units of the underlying security necessary to create a delta neutral position or (b) the purchase or sale of an equal number of put and call option contracts, each having the same exercise price and expiration date, and each representing the same number of units of stock as, and on the opposite side of the market from, the underlying or related security portion of the order. For purposes of electronic trading, the term ‘‘stock-option order’’ has the meaning set forth in Rule 5.33.’’); Cboe Rule 5.33(b)(5) (defining a ‘‘stock-option order’’ as ‘‘the purchase or sale of a stated number of units of an underlying stock or a security convertible into the underlying stock (‘‘convertible security’’) coupled with the purchase or sale of options contract(s) on the opposite side of the market representing either 179 See, PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 49947 Further, as far as the Commission is aware, all options exchanges accept a stock-option order only if it complies with the Qualified Contingent Trade (‘‘QCT’’) Exemption (‘‘QCT Exemption’’) from Rule 611(a) of Regulation NMS.180 For purposes of relying on the exemption provided by proposed Rule 15b9–1(c)(2), a broker or dealer should adhere to the stock-option order definition of the options exchange where the stock-option order is handled and of which the broker or dealer is a (i) the same number of units of the underlying stock or convertible security or (ii) the number of units of the underlying stock necessary to create a delta neutral position, but in no case in a ratio greater than eight-to-one (8.00), where the ratio represents the total number of units of the underlying stock or convertible security in the option leg(s) to the total number of units of the underlying stock or convertible security in the stock leg’’). See also, e.g., MIAX Rule 518(a)(5); MIAX Emerald Rule 518(a)(5); Nasdaq Options 3, Section 14(a)(i); Nasdaq PHLX Options 3, Section 7(b)(13); Nasdaq ISE Options 3, Section 14(a)(5); Nasdaq MRX Options 3, Section 14(a)(5); Nasdaq BX Chapter 5, Section 27(a)(v)(1) of the ‘‘Grandfathered Rules’’ of the Boston Stock Exchange, Inc.; NYSE Arca Rule 6.62–O(h)(1); and NYSE American Rule 900.3NY(h)(1). 180 See, e.g., Cboe Rule 5.33, Interpretations and Policies .04 Stock Option Orders (stating that a user may only submit a stock-option order if it complies with the QCT Exemption and that a user submitting a stock-option order represents that it complies with the QCT Exemption); Supplementary Material to Nasdaq ISE Options 3, Section 14 (stating that ‘‘[m]embers may only submit Complex Orders in Stock-Option Strategies and Stock-Complex Strategies if such Complex Orders comply with the Qualified Contingent Trade Exemption from Rule 611(a) of Regulation NMS under the Exchange Act’’ and that ‘‘[m]embers submitting Complex Orders in Stock-Option Strategies and Stock-Complex Strategies represent that they comply with the Qualified Contingent Trade Exemption’’) and Commentary .01 to MIAX Rule 518 (stating that ‘‘[m]embers may only submit stock-option orders if such orders comply with the Qualified Contingent Trade Exemption from Rule 611(a) of Regulation NMS under the Securities Exchange Act of 1934’’ and that ‘‘[m]embers submitting such complex orders represent that such orders comply with the Qualified Contingent Trade Exemption’’). A qualified contingent trade is ‘‘a transaction consisting of two or more component orders, executed as agent or principal where: (1) at least one component order is in an NMS stock; (2) all components are effected with a product or price contingency that either has been agreed to by the respective counterparties or arranged for by a broker-dealer as principal or agent; (3) the execution of one component is contingent upon the execution of all other components at or near the same time; (4) the specific relationship between the component orders (e.g., the spread between the prices of the component orders) is determined at the time the contingent order is placed; (5) the component orders bear a derivative relationship to one another, represent different classes of shares of the same issuer, or involve the securities of participants in mergers or with intentions to merge that have been announced or since cancelled; and (6) the transaction is fully hedged (without regard to any prior existing position) as a result of the other components of the contingent trade.’’ Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR 52829 (September 7, 2006); see also Securities Exchange Act Release No. 57620 (April 4, 2008), 73 FR 19271 (April 9, 2008). E:\FR\FM\12AUP2.SGM 12AUP2 49948 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 member.181 Specifically, the broker or dealer could rely on that definition to determine whether, for purposes of amended Rule 15b9–1(c)(2), an order is in fact a stock-option order and a stock order is in fact the stock leg of a stockoption order. Moreover, the exemption would apply regardless of whether the component legs of a stock-option order are executed electronically, on the physical exchange floor, or through a combination of both. The Commission believes that approaching the proposed stock-option order exemption in this way should minimize disruptions to the markets for stock-option orders by minimizing the degree to which brokers and dealers that trade such orders would need to alter their business in order to rely on the proposed exemption. Relying on the options exchange’s definition also should enhance an exchange’s ability to monitor whether its members are appropriately relying on the proposed exemption and thereby enhance its ability to provide effective SRO oversight of its members’ stockoption order trading activity. Under options exchange rules, an exchange member submitting a stock-option order to the exchange must designate to the exchange one or more specific brokerdealers: (i) that are not affiliated with the exchange; (ii) with which the exchange member has entered into a brokerage agreement; (iii) that the exchange has identified as having connectivity to electronically communicate the stock components of stock-option orders to stock trading venues; and (iv) to which the exchange will electronically communicate the stock component of the stock-option order on behalf of the member.182 The option exchange’s execution of the stock-option order is contingent on the exchange’s receipt from the designated broker-dealer of an execution report for the stock component transaction confirming that the transaction has occurred.183 In light of these rules, the 181 Presumably, an options exchange would accept only those stock-option orders that meet the exchange’s definition thereof. In addition, the Commission’s understanding is that, currently, consistent with options exchange definitions, a stock-option order contains only one stock leg. See supra note 179. Therefore, the proposed stockoption order exemption is designed to cover stockoption orders with only one stock leg. 182 See, e.g., Cboe Rule 5.33(l) and Interpretations and Policies .04; Nasdaq ISE Options 3, Section 7 and Supplementary Material .01, Options 3, Section 14 and Supplementary Material .07; and MIAX Rule 518 and Commentary .01. 183 See, e.g., Cboe Rule 5.33(l); Nasdaq ISE Options 3, Section 7 and Supplementary Material .01, Options 3, Section 14 and Supplementary Material .07; and MIAX Rule 518 and Commentary .01. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Commission preliminarily believes that there is a close link between the stock component transaction of a stock-option order and the relevant options exchange. Accordingly, the Commission believes that this proposed exemption would serve the limited, narrowly defined purpose of facilitating the execution of stock-option orders consistent with options exchange rules and that the options exchange would be able to monitor and oversee the totality of the securities trading activity of any of its members that rely on the exemption. The Commission preliminarily believes that the exchange’s oversight capabilities will be further enhanced, consistent with the public interest and protection of investors, by requiring written policies and procedures in connection with the stock-option exemption in proposed paragraph (c)(2) of the amended rule. This requirement would help facilitate exchange SRO supervision of brokers and dealers relying on the stock-option order exemption because it would provide an efficient and effective way for the relevant options exchange to assess compliance with the proposed exemption. Moreover, the Commission preliminarily believes that requiring brokers and dealers to develop written policies and procedures would provide sufficient flexibility to accommodate potentially varying business models of brokers and dealers that effect stockoption orders and may seek to rely on this exemption. Such written policies and procedures must be reasonably designed to ensure and demonstrate that the broker’s or dealer’s securities transactions elsewhere than on an exchange of which it is a member are solely for the purpose of executing the stock leg of a stockoption order. Accordingly, a broker or dealer seeking to rely upon the proposed stock-option order exemption must establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that such transactions are solely for the purpose of executing the stock leg of a stock-option order. For example, the broker or dealer could maintain documentation that demonstrates its compliance with the stock-option order requirements of any options exchange of which it is a member and where it effects the execution of stock-option orders. Indeed, in addition to the Commission, the options exchange of which the broker or dealer is a member and where the stock-option order is handled would be able to enforce compliance with the stock-option order exemption. In the PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 context of routine examinations of its members, the options exchange generally would review the adequacy of its members’ written policies and procedures and assess whether its members’ off-member-exchange transactions comply with those written policies and procedures as well as the terms of the exemption itself, as set forth in amended Rule 15b9–1.184 Finally, a broker or dealer seeking to rely on the stock-option order exemption would be required to preserve a copy of its policies and procedures in a manner consistent with Rule 17a–4 under the Exchange Act until three years after the date the policies and procedures are replaced with updated policies and procedures.185 Accordingly, a broker or dealer would be required to keep the policies and procedures relating to its use of this proposed exemption as part of its books and records while they are in effect, and for three years after they are updated. The Commission requests comment on all aspects of the proposed stockoption order exemption in Rule 15b9–1. In particular, the Commission seeks responses to the following questions: 23. Is the proposed stock-option order exemption necessary and appropriate? Why or why not? How, if at all, should this proposed exemption be modified? 24. Is the scope of the proposed stockoption order exemption sufficient to provide for all off-member-exchange transactions that might be effected by a broker or dealer as a necessary component of handling stock-option orders? If not, how should it be changed? 25. Should the proposed stock-option order exemption be broadened to cover transactions beyond those necessary to complete stock-option orders? If so, what types of additional transactions should be covered and why? Should the proposed exemption be narrowed in some way? Should the proposed stockoption order exemption be eliminated in its entirety? 26. Is the Commission’s understanding correct that all stockoption orders must be QCTs? If not, what types of stock-option orders are not required to be QCTs? Should they be covered by the proposed exemption? 27. The proposed stock-option order exemption is limited to transactions 184 Section 19(g)(1) of the Act, 15 U.S.C. 78s(g), among other things, requires every SRO to examine for and enforce compliance by its members and associated persons with the Act, the rules and regulations thereunder, and the SRO’s own rules, unless the SRO is relieved of this responsibility pursuant to section 17(d), 15 U.S.C. 78q(d) or section 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act. 185 See, e.g., 17 CFR 240.17a–4(e)(7). E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 effected with or through another registered broker-dealer. Are there circumstances where a broker or dealer that is not a FINRA member might not need to effect the execution of the stock leg of a stock-option order with or through another registered brokerdealer? Are there circumstances in which a broker or dealer that is not a FINRA member might need to effect the execution of the stock leg of a stockoption order with or through a party that is a registered broker-dealer but not a member of an exchange where the stock leg is executed, or not a member of an Association if the stock leg is not executed on an exchange? If so, please describe the nature and extent of such transactions. 28. Stock transactions effected in reliance on the exemption would still be subject to required transaction reporting. Would such reliance impede required transaction reporting in any way? 29. As proposed, the stock-option order exemption would cover stockoption orders with one stock leg and any number of options legs. Is this appropriate? Should the proposed stockoption order exemption be limited to two-leg stock-option orders where one leg is a stock and the other leg is an option? Why or why not? Do firms execute stock-option orders that contain multiple stock legs? If so, should the stock legs of such stock-option orders be covered by the proposed exemption? C. No Floor-Member Hedging Exemption As discussed above, the Commission adopted Rule 15b9–1 so that an exchange member’s limited trading activity ancillary to its floor business on a single national securities exchange would not necessitate Association membership in addition to exchange membership.186 Since that time, the securities markets have evolved to include significant, cross-market and off-exchange electronic proprietary trading as a primary business model. This business model did not exist when the Commission adopted Rule 15b9–1 in its current form, nor did firms engage in extensive off-member-exchange proprietary trading activity while exempt from Association membership by virtue of Rule 15b9–1. Unlike today’s proposed amendments, the 2015 Proposal would have provided an exemption from Association membership for a dealer that is an exchange member, carries no customer accounts, conducts business on the floor of a national securities exchange, and effects transactions off the exchange, for 186 See supra notes 60–62 and accompanying text. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 the dealer’s own account with or through another registered broker or dealer, that are solely for the purpose of hedging the risks of its floor-based activity.187 The Commission proposed that the hedging exemption be limited to a dealer’s floor-based trading on a national securities exchange, and understood then that dealers that limit their activities to an exchange’s physical trading floor tend to be specialists or floor brokers based on the floor of an individual exchange.188 That proposed hedging exemption was intended to be consistent with the original intent of Rule 15b9–1 to accommodate only limited proprietary trading activity elsewhere than a broker’s or dealer’s member exchange(s) that is ancillary to the broker’s or dealer’s primary trading activity on its member exchange(s). But based on data available to the Commission today that was not available in 2015, the Commission believes that no dealers currently trade in a manner that would enable reliance on the hedging exemption as proposed in the 2015 Proposal, i.e., no dealer’s trading on an exchange of which it is a member is solely on the exchange’s floor. Accordingly, the re-proposed rule does not include the hedging exemption included in the 2015 Proposal.189 Some commenters supported the proposed hedging exemption in the 2015 Proposal, but suggested that the exemption should not be limited to a dealer operating solely on a physical exchange floor, and also should cover off-member-exchange hedging transactions by dealers that trade electronically on their member exchange(s).190 The Commission preliminarily believes that an exemption of this nature might swallow the amended rule, as proposed, and would not be appropriate. As discussed above, electronic trading dealer firms effect securities transactions proprietarily across market centers as a primary business model, including to a significant degree in the off-exchange market and on exchanges of which they are not a member.191 The Commission 187 Currently, NYSE Arca Options, NYSE American Options, Nasdaq Phlx, Cboe, NYSE, and BOX Exchange have physical exchange floors. 188 See 2015 Proposing Release, supra note 6, 80 FR at 18047. 189 As described above, to the extent a stock transaction is a component of a stock-option order, and the broker or dealer handling the stock-option order otherwise meets the requirements of the proposed amended rule, that stock transaction would not trigger Section 15(b)(8)’s Association membership requirement. 190 See, e.g., CHX Letter at 3; CTC Letter at 7; Cboe Letter at 2–3; Options Market Makers Letter at 4; and Cboe/NYSE/Nasdaq Letter at 2–3. 191 See supra Section II.B. PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 49949 acknowledges that it is unlikely that all of these firms’ securities trading activity away from their member exchanges is to hedge their securities trading activity on their member exchanges. Thus, the offmember-exchange transaction volume attributable to these firms likely overstates the volume of transactions that would be attributable to firms who could rely on a hedging exemption that covered electronic trading activity as contemplated by commenters. The Commission cannot reliably discern from available data what off-memberexchange securities transactions effected by these firms are for hedging purposes and what transactions are not. But the Commission preliminarily believes that there are proprietary trading dealer firms that trade electronically and in significant volumes, including off any exchange where they are a member, which could potentially meet the criteria of a hedging exemption that covered electronic trading activity. Indeed, in light of the concentration of off-member-exchange securities transaction volume among certain firms, as discussed above, even if only a small number of firms could rely on a hedging exemption that covered electronic trading activity, it could translate into significant trading activity that would not be subject to direct FINRA oversight. This would not be consistent with the protection of investors or the public interest, or with the historical rationale for Rule 15b9–1. Commenters more broadly suggested that the 2015 Proposal did not adequately consider options market makers or their hedging needs.192 Some of these commenters’ concerns appear to center on firms’ needs in relation to their handling of stock-option orders.193 As such, these concerns could be mitigated by the stock-option order 192 See, e.g., Options Market Makers Letter at 1; CTC Letter at 1; CHX Letter at 3; Cboe Letter at 2– 3; Cboe/NYSE/Nasdaq Letter at 2–3; NYSE/Nasdaq Letter at 2–4; Letter from Reps. Bill Foster and Randy Hultgren, Members of U.S. Congress (Nov. 15, 2016) at 2. 193 See, e.g., NYSE/Nasdaq Letter at 2–4; Cboe Letter at 3; Cboe/NYSE/Nasdaq Letter at 4. For example, one commenter expressed concern that the 2015 Proposal would ‘‘unintentionally require [options] floor brokers, which have a business focused on the floor of an exchange in which they are members, to become members of FINRA’’ and specifically noted that this ‘‘could restrict floor brokers from fulfilling stock-option orders. . .[b]ecause the stock component of a stockoption order cannot be executed on the options exchange of which a floor broker is a member.’’ NYSE/Nasdaq Letter at 2. This commenter suggested that any amendment ‘‘maintain floor brokers’ ability to route the stock leg of a stockoption order for execution on another market by a member of the away market without requiring the floor broker to become a member of FINRA.’’ NYSE/ Nasdaq Letter at 4; see also Lakeshore Letter at 2. E:\FR\FM\12AUP2.SGM 12AUP2 49950 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 exemption that the Commission is proposing to include in amended Rule 15b9–1.194 The Commission requests comment on its re-proposed approach of not providing a hedging exemption in amended Rule 15b9–1. In particular, the Commission seeks responses to the following questions: 30. Should the Commission adopt a hedging exemption outside the context of the proposed stock-option order exemption? Why or why not? Would it be apparent whether a securities transaction is for hedging purposes? 31. Should the Commission adopt a hedging exemption (in addition to the proposed stock-option order exemption) that applies to a dealer that is a member of multiple exchanges? Why or why not? Should the Commission allow firms to rely on any such exemption only if they effect hedging transactions in securities on exchanges where they are not a member (i.e., off-exchange transactions, even if solely for purposes of hedging a single exchange member’s trading activity on that exchange, would not be covered by the exemption)? Why or why not? 32. Should the Commission adopt a hedging exemption that covers offmember-exchange transactions to hedge on-member-exchange electronic transactions and physical exchange floor transactions, just on-memberexchange physical exchange floor transactions or just on-memberexchange electronic transactions? Why would one of these possible approaches be preferable to another? Under each possible approach, how difficult would it be to discern what off-memberexchange securities transactions by electronic trading firms are for hedging purposes? The Commission specifically seeks data that demonstrates the extent to which exchange member dealer firms trade elsewhere than on their member exchange(s) in order to hedge the risks of their trading activities on their member exchange(s). 194 In addition, Section 15(b)(9) of the Act provides the Commission with the authority, by rule or order, and as it deems consistent with the public interest and the protection of investors, to conditionally or unconditionally exempt from the requirements of Section 15(b)(8) any broker or dealer or class of brokers or dealers. Accordingly, if a dealer or class of dealers believes that it should be exempted from the requirements of Section 15(b)(8) in a manner that is not provided by amended Rule 15b9–1, it may seek an exemption from the Commission, by order, pursuant to Section 15(b)(9). For example, the Commission may consider granting such an exemption, where appropriate, if a dealer or class of dealers chooses to limit its exchange trading activity to the physical floor of an exchange of which it is a member, but must effect limited securities transactions elsewhere for its own account in order to facilitate its exchange-floor business. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 33. Are there non-floor-based exchange members that today focus their business activities on a single exchange? Are there floor-based exchange members that today focus their business activities on a single exchange? If so, what is the nature of each firm’s business activities? 34. Should the Commission adopt a hedging exemption in the amended rule that requires a dealer seeking to rely on the exemption to establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that its offmember-exchange hedging transactions reduce or otherwise mitigate the risks of the financial exposure the dealer incurs as a result of its on-member-exchange activity? Why or why not? What would be the costs of establishing, maintaining, and enforcing the policies and procedures, and any related recordkeeping requirements? How are such costs determined? Please provide evidence of the nature, timing, and extent of such costs. Would such costs deter dealers from relying on the hedging exemption? Are there more efficient and effective alternatives to a policies and procedures approach? If so, what are they? Please describe in detail. 35. Would current exchange surveillance and enforcement mechanisms be effective to monitor offmember-exchange trades that would be executed pursuant to a possible hedging exemption? Could this be accomplished through 17d–2 plans and RSAs? Please explain. Would exchanges otherwise have the ability to assess dealers’ compliance with a hedging exemption? If not, should the Commission require additional reporting by registered broker-dealers acting as an agent for dealers relying on a hedging exemption? Please explain. 36. Should the Commission adopt a hedging exemption that is subject to quantitative limits on the volume of hedging transactions that a firm may execute in reliance on such an exemption? Could qualitative or quantitative requirements assist in identifying off-member-exchange activity that is solely for the purpose of hedging? Please explain. 37. Should the Commission adopt a hedging exemption that requires the exchange member to retain records demonstrating how each off-memberexchange transaction complies with its policies and procedures? Why or why not? What would be the associated costs, and what is the basis for those costs? Would the cost associated with recordkeeping on a transaction-bytransaction basis be overly burdensome, impractical, or unnecessary? PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 38. Should the Commission adopt a hedging exemption that requires dealers to make a certification in connection with their reliance on the hedging exemption? Why or why not? If a certification should be required, what would be the key elements thereof? How frequently should the certification be made? Who should make it? What qualifications, if any, to such certification might be appropriate? For example, should firms be required to certify that they have a reasonable basis to believe that they are in compliance with a hedging exemption? Or should they be required to make such a certification to the best of their knowledge? Is there a different standard that would be appropriate? Should the certification be made in conjunction with an internal compliance review? If so, what type of internal compliance review should be conducted? 39. Would not adopting a hedging exemption affect liquidity on any national securities exchange? IV. Effective Date and Implementation The Commission recognizes that firms may need time to comply with any amended Rule 15b9–1 if adopted. In particular, they may need time to become a member of an Association. As noted previously, FINRA is currently the only Association. To become a FINRA member, a broker or dealer must complete FINRA’s New Member Application and participate in a premembership interview.195 The broker or dealer and its associated persons must comply with FINRA’s registration and qualification requirements.196 The amount of time that it takes to become a FINRA member depends on a number of factors, including the nature of the broker’s or dealer’s business, the level of complexity or uniqueness of the firm’s business plan, the number of associated persons that the firm employs, and whether the firm has an affiliate that is already a member of FINRA.197 The Commission understands that, on average, the FINRA membership application process takes approximately six months. Alternatively, broker-dealer firms that currently rely on Rule 15b9–1 and carry no customer accounts may choose to adjust their business model or 195 See FINRA.org, How to Apply, available at https://www.finra.org/registration-exams-ce/brokerdealers/how-apply (last visited on July 22, 2022). 196 See FINRA Rule 1010—Electronic Filing Requirements and Uniform Forms, which sets out the substantive standards and procedural guidelines for the FINRA membership application and registration process. 197 See Section VI.C.2, infra, discussing the costs of joining FINRA. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 organizational structure such that they effect securities transactions solely on national securities exchanges of which they are a member, and therefore comply with Section 15(b)(8) without needing to join FINRA or rely on any amended version of Rule 15b9–1 if adopted. This may require such firms to become a member of additional exchanges upon which they trade. Or, firms may need time to adjust their business models such that their securities transactions elsewhere than exchanges of which they are a member comply with the proposed amendments to paragraphs (c)(1) or (c)(2) if adopted, including establishing policies and procedures that would be required by proposed paragraph (c)(2). More broadly, broker-dealer firms may need to modify their systems or take other steps to achieve compliance with any amended rule if adopted. The Commission preliminarily believes that one year after publication in the Federal Register of any amended version of Rule 15b9–1 that the Commission may adopt should provide firms with enough time to comply.198 Therefore, the Commission proposes that the compliance date for amended Rule 15b9–1 would be one year after publication of any final rule in the Federal Register. The Commission solicits comment on the adequacy of this proposed implementation timeline. In particular, the Commission seeks responses to the following questions: 40. Would one year after publication of any final rule in the Federal Register provide firms with sufficient time to 198 In the 2015 Proposal, supra note 6, the Commission solicited comment on the appropriate length of time that it should provide firms to comply with the then-proposed amended version of Rule 15b9–1. In this regard, the Commission also solicited comment on the FINRA membership process. Some commenters stated that one year generally is sufficient to join FINRA. See, e.g., IEX Letter at 3. Other commenters requested more time or requested that the Commission require FINRA to develop a ‘‘fast track’’ application process. See, e.g., FIA 2 Letter at 5. Another commenter suggested a waiver process for a proprietary trading firm that is registered with the Commission and an SRO, if the firm’s information has not materially changed from the time it registered with such entities, and so long as the firm remains in good standing with the Commission and other regulators. See Peak6 Letter at 2. FINRA stated that it tentatively believed that most broker-dealer firms that are not FINRA members ‘‘are already members of an exchange and are engaged solely in proprietary trading activity’’ and would be candidates for its ‘‘fast track/triage program’’ which has an average processing time of 60 days for membership. See FINRA Letter at 5–6. As reflected in the requests for comment in this section, the Commission again solicits comment from FINRA and exchanges regarding the length of time of the membership application and approval process, and from any interested parties generally regarding the appropriate length of time for compliance with the proposed amendments to Rule 15b9–1 if they are adopted. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 comply with amended Rule 15b9–1, if adopted? Would firms be in a position to comply with any final, amended rule earlier than one year after publication? Would a compliance period that is shorter or longer than one year be more appropriate? If so, how long should the revised compliance period be and why? 41. Would one year after publication of any final rule in the Federal Register provide firms with sufficient time to comply with Section 15(b)(8) of the Act by joining an Association? Would one year after publication of any final rule in the Federal Register provide firms that do not trade securities off-exchange with sufficient time to comply with Section 15(b)(8) of the Act by becoming a member of all national securities exchanges where they trade securities (if they are not already a member of all such exchanges)? 42. How long is the registration process with FINRA typically? How long would it take FINRA to process new membership applications from firms that join FINRA as a result of the proposed amendments, considering that many such firms may submit applications close in time to each other? Please include the estimated time to prepare the application as well as the estimated time for FINRA to process the application. 43. How long does it typically take to complete the application process with a national securities exchange? Please include the estimated time to prepare the application as well as the estimated time for an exchange to process the application. 44. To the extent a firm intends to rely on one or more of the exemptions in the amended rule, how long would it take such firm to make the required systems changes to comply? Are there other steps that would need to be taken to achieve compliance? If so, what is the estimated time to accomplish those steps? How long would it take a firm to establish the policies and procedures that would be necessary to rely on the stock-option order exemption? 45. To the extent a firm intends to adjust its business model or organizational structure such that it effects securities transactions only on an exchange of which it is a member, how long would it take such firm to make such an adjustment? What systems or other changes would be required? V. General Requests for Comments The Commission seeks comment on all aspects of the proposed amendments to Rule 15b9–1. Commenters should, when possible, provide the Commission with data to support their views. Commenters suggesting alternative PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 49951 approaches should provide comprehensive proposals, including any conditions or limitations that they believe should apply, the reasons for their suggested approaches, and their analysis regarding why their suggested approaches would satisfy the objectives of the proposed amendments. 46. The Commission requests comment generally on whether the proposed amendments to Rule 15b9–1 are appropriate. How, if at all, should the proposed amendments be modified? Should either of the proposed exemptions from Association membership set forth in proposed paragraphs (c)(1) and (c)(2) of the amended rule be eliminated? If so, why? For example, should the Commission maintain the proposed routing exemption, but not maintain the proposed stock-option order exemption? Why or why not? Should the Commission maintain the proposed stock-option order exemption, but not the routing exemption? Why or why not? 47. Should the Commission eliminate Rule15b9–1 in its entirety, such that there is no exemption from Section 15(b)(8) of the Act? Broker-dealers would then be statutorily required by Section 15(b)(8) of the Act, without exception, to join an Association if they effect securities transactions otherwise than on an exchange where they are a member. In other words, a broker-dealer that effects transactions in securities otherwise than on an exchange of which it is a member would have to join FINRA even if its transactions result solely from orders that are routed by an exchange of which it is a member to comply with order protection requirements or are solely for the purpose of executing the stock leg of a stock-option order. What would be the benefits or drawbacks of eliminating Rule 15b9–1 in its entirety? Please explain. 48. Should the Commission amend Rule 15b9–1 to capture only those broker-dealers that are exchange members but not FINRA members that account for the high degree of concentration of off-exchange listed equities volume? For example, the Commission estimates that, as of September 2021, 13 of the 47 identified firms that initiated orders in listed equities then accounted for approximately 94% of the off-exchange listed equities transaction volume attributable to the 47 identified firms that month. If so, what methodology should be used to select the most significant firms? 49. Other than the proposed routing exemption and stock-option order E:\FR\FM\12AUP2.SGM 12AUP2 jspears on DSK121TN23PROD with PROPOSALS2 49952 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules exemption set forth in proposed paragraphs (c)(1) and (c)(2) of the amended rule, respectively, are there other exemptions that the Commission should consider? 50. How might dealers that currently rely on Rule 15b9–1’s de minimis allowance and proprietary trading exclusion respond to the proposed elimination of these provisions from the amended rule? Might they seek to avoid Association membership in ways other than complying with the exemptions in the amended rule, i.e., are there ways they could avoid Association membership other than by ceasing all off-exchange activity and becoming a member of each exchange on which the firm effects securities transactions, or limiting the firm’s securities transactions elsewhere than an exchange where it is a member such that they comply with the routing exemption or stock-option order exemption? If so, please explain. 51. Reliance on Rule 15b9–1 is currently self-effecting (i.e., the rule does not require the reporting of such reliance to the Commission or any other regulatory authority). In lieu of the proposed amendments, should the Commission require broker-dealers relying on Rule 15b9–1 to report such reliance to the Commission or to the exchange of which the broker-dealer is a member? How frequently should such reporting occur? If so, what form should such reporting take and what information should be provided to the Commission or the exchange of which the broker-dealer is a member? For example, should a broker-dealer be required to report in writing to its member exchange and/or the Commission whether it is relying on Rule 15b9–1, and should information such as transactional volume be provided, or information on the type or categories of securities traded? If not, why not and what alternative means could be used to collect data about reliance on Rule 15b9–1? 52. If the Commission were to eliminate Rule 15b9–1 altogether, how many broker-dealers would: (i) effect securities transactions only on national securities exchanges of which they are already member; (ii) become members of additional national securities exchanges such that they are not required to join an Association; and/or (iii) become members of an Association? 53 Would the proposed amendments have an effect on market liquidity? If so, please estimate that effect. Would there be any deleterious impacts on market quality? Would there be positive impacts on market liquidity or market quality more broadly? VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 54. Should the Commission allow broker-dealers that are a member of an exchange and conduct off-exchange trading activity to remain exempt from membership in an Association? If so, why? Should the level of off-exchange activity affect the ability of a firm to be exempt from Association membership? Why or why not? 55. Does the CAT plan mitigate the need for the proposed amendments to Rule 15b9–1? If so, how? Would it be appropriate and feasible to modify CAT reporting to accomplish any of the goals of amended Rule 15b9–1? 56. Do existing 17d–2 plans and RSAs among SROs mitigate the need for the proposed amendments to Rule 15b9–1? If so, how? Do commenters agree that RSAs are subject to change and may not in the future provide the stability of FINRA oversight? How frequently are RSAs typically renegotiated? 57. Is Association membership an efficient or effective approach for the regulation of firms that trade across multiple exchanges but do not trade offexchange? Are there more effective alternatives? 58. Under the proposed amendments to Rule 15b9–1, a broker-dealer that does not effect securities transactions off an exchange, but currently effects securities transactions on an exchange of which it is not a member, would be required either to join an Association or become a member of each exchange where it effects securities transactions, unless its exchange trading is covered by an exemption in the proposed amended rule. Should the proposed amendments be revised to provide an exemption from Section 15(b)(8) of the Act to permit such a firm, with no offexchange trading, to remain exempt from membership in an Association and continue trading on exchanges of which it is not a member even if that trading activity would not satisfy one of the proposed exemptions in the amended rule? Should any such approach be based on certain conditions being met, such as any exchange of which the firm is a member entering into appropriate contractual or self-regulatory responsibility sharing arrangements such that an exchange SRO is in a position to effectively surveil all of the trading activities of that firm? 59. If the proposed rule amendments are adopted, proprietary trading brokerdealers that are not currently FINRA members may join FINRA. Would this affect FINRA’s governance or its performance of its regulatory or supervisory functions? 60. Are there other changes the Commission should make to Rule 15b9– 1? If so, why? What specifically should PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 be changed and how? How would any such changes better achieve the stated goals of the proposal? VI. Economic Analysis The Commission is proposing to amend Rule 15b9–1 to re-align it with today’s market so that the regulatory scheme more appropriately effectuates Exchange Act principles regarding complementary exchange SRO and Association oversight. Currently, a broker or dealer may engage in unlimited proprietary trading in the offexchange market without becoming a member of an Association, so long as its proprietary trading activity is conducted with or through another registered broker or dealer. However, the Exchange Act’s statutory framework places SRO oversight responsibility with an Association for trading that occurs elsewhere than on an exchange to which a broker or dealer belongs as a member.199 Currently, nearly all equity activity of non-FINRA member brokerdealers is surveilled by FINRA through the extensive use of RSAs. However, RSAs are voluntary, privately negotiated agreements that can expire or be terminated, and accordingly, these agreements do not provide the consistent and stable oversight that direct Association oversight of such trading activity does.200 For example, of the current FINRA RSA contracts: six RSA contracts expire by the end of 2023, two RSA contracts expire by the end of 2024, and three RSA contracts expire by the end of 2025 unless extended or terminated early.201 The amendments would provide consistency and stability of oversight in the future. In the case of U.S. Treasury securities and other fixed income securities (other than municipal bonds) 202 that trade offexchange, surveillance relies on TRACE data which is collected by FINRA from its members. Some dealer firms that are not FINRA members are significantly involved in trading U.S. Treasury securities 203 proprietarily but are not 199 See Section I, supra. Section I, supra. 201 Based on information provided by FINRA. 202 Municipal bond trades are reported to the MSRB but not TRACE, so the Commission does not expect the proposed amendments to affect the data collected on municipal bonds. Off-exchange trading of both listed and unlisted equities by non-FINRA member broker-dealers is already reported to CAT. 203 The Commission can observe and quantify some of this activity through the reporting of U.S. Treasury securities on covered ATSs as discussed in section II.B. See supra note 96. Because there is no analogous reporting regime in other fixed income securities, the Commission cannot similarly describe non-member broker-dealer activity in these other securities, but it is likely that non-member broker-dealers also trade fixed-income securities 200 See E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 required to report these transactions because they are not FINRA members. Consequently, trades that do not occur on an ATS that are between two nonFINRA member broker-dealers are not reported to TRACE at all and trades that occur on an ATS that is not a covered ATS do not specifically identify the non-FINRA member in the information reported by the ATS to TRACE.204 The Exchange Act presents exchange SROs and Associations as complements, providing for member-based supervision both on and off-exchange. The proposed amendments would rescind the de minimis allowance and proprietary trading exclusion so that the regulatory scheme more appropriately effectuates Exchange Act principles regarding complementary exchange SRO and Association oversight in today’s market.205 For firms currently relying on the exemption that would be required to register with FINRA under the proposed amendments, joining FINRA will expose them to additional costs that they previously did not incur.206 While reliance on the exemption may be costefficient for these firms, it introduces inefficiencies for exchange SROs, FINRA, and regulatory oversight more generally. FINRA, the sole Association, has a rulebook, surveillance infrastructure, and supervisory expertise that is targeted to off-exchange trading of both listed and unlisted securities. Without an RSA, when FINRA detects potentially violative behavior by a nonFINRA member firm, it can and does other than U.S. Treasury securities and these transactions are also not reported to TRACE. This Economic Analysis focuses on the effects on equities, options, and U.S. Treasury securities markets. To the extent that non-FINRA member broker-dealers do trade in additional asset classes, the Commission believes that the economic impacts discussed herein would also apply. In particular, if a non-FINRA member broker-dealer does trade in an asset class which requires reporting to FINRA, the proposal would improve transparency for these securities, which would enhance the regulatory oversight of such activity. 204 See section II.B, supra. The Commission preliminarily believes this is a small fraction of U.S. Treasury securities trading. In April 2022, the Commission estimates that non-FINRA member firms’ U.S. Treasury securities transactions executed on covered ATSs accounted for 2.5% of total U.S. Treasury securities transaction volume reported to TRACE that month. See supra note 94. The unreported trades involving only non-FINRA member firms that are not executed on covered ATSs might be similar but could be a lower fraction of the total U.S. Treasury securities volume. The Commission believes that all fixed income trading should be reported. The Commission also believes that firms that can observe other firms’ trades and not report their own trades may have a competitive advantage, the cost of which is borne by the investing public through reduced price discovery. 205 See section II.B, supra. 206 FINRA member firms that compete with these firms may be at a cost disadvantage due to this fee disparity. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 refer such cases to other SROs or the SEC. However, it lacks certain investigative tools, which could help it further investigate potentially violative behavior before making such referrals. As such, FINRA referrals could be premature. In addition, RSAs with FINRA are privately negotiated contracts that can differ from exchange to exchange and the administrative and operational burdens create inefficiencies in investigating potential noncompliance. As such, oversight through an RSA is not equivalent to direct oversight by FINRA of its members. The Commission believes that, particularly in the case of fixed income trading, FINRA is the SRO best positioned to efficiently investigate such instances because of its TRACE data collection and expertise in such trading, and such a role is consistent with the SRO structure mandated by the Exchange Act. The Commission discusses below a number of economic effects that are likely to result from the proposed amendments.207 As discussed in detail below, the effects are quantified to the extent practicable. Although the Commission is providing estimates of direct compliance costs where possible, the Commission also anticipates that brokers and dealers affected by the amendments, as well as competitors of those broker and dealers, may modify their business practices regarding the provision of liquidity in both offexchange markets and on exchanges. Consequently, much of the discussion below is qualitative in nature, but where possible, the Commission has provided quantified estimates.208 To the extent that non-FINRA member firms change their business practices, by reducing or eliminating their off-exchange trading activity, the proposal may impact competition and harm liquidity, particularly in the off-exchange market. 207 The Commission is sensitive to the economic effects of its rule, including the costs and benefits and effects on efficiency, competition, and capital formation. Section 3(f) of the Exchange Act requires the Commission, whenever it engages in rulemaking pursuant to the Exchange Act, to consider or determine whether an action is necessary or appropriate in the public interest, and to consider, in addition to the protection of investors, whether the action would promote efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). In addition, section 23(a)(2) of the Exchange Act requires the Commission, when making rules under the Exchange Act, to consider the effect such rules would have on competition. See 15 U.S.C. 78w(a)(2). Exchange Act Section 23(a)(2) prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. 208 See infra section VI.C. for further discussion of the difficulties in estimating market quality effects likely to result from the amendments. PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 49953 The proposal would increase costs for non-FINRA member firms that will have to register with FINRA, which may result in decreased liquidity from their orders. Additionally, the amendments to Rule 15b9–1 may create incentives for non-FINRA member firms that are impacted by the amendments to form a new Association. A. Baseline 1. Regulatory Structure and Activity Levels of Non-FINRA Member Firms The Exchange Act governs the way in which the U.S. securities markets and its brokers and dealers operate. Section 3(a)(4)(A) of the Act generally defines a ‘‘broker’’ broadly as ‘‘any person engaged in the business of effecting transactions in securities for the account of others.’’ 209 In addition, Section 3(a)(5)(A) of the Act generally defines a ‘‘dealer’’ as ‘‘any person engaged in the business of buying and selling securities . . . for such person’s own account through a broker or otherwise.’’ 210 Generally, any broker-dealer that wants to interact directly on a securities exchange must register with the Commission as a broker-dealer before applying to gain direct access to the exchange.211 There is diversity in the size and business activities of brokers and dealers. Carrying brokers and dealers hold customer funds and securities; some of these are also clearing brokers and dealers that handle the clearance and settlement aspects of customer trades, including recordkeeping activities and preparing trade confirmations.212 However, of 3,528 registered brokers and dealers, only 156 were classified as carrying or clearing brokers and dealers during the fourth quarter of 2021. Thus, the majority of brokers and dealers engage in a wide range of other activities, which may or may not include handling customer accounts. These other activities include intermediating between customers and carrying/clearing brokers; dealing in government bonds; private placement of securities; effecting transactions in mutual funds that involve transferring funds directly to the issuer; writing options; acting as a broker solely on an exchange; and providing liquidity to securities markets, which includes, but is not limited to, the activities of registered market makers. 209 15 U.S.C. 78c(a)(4)(A). U.S.C. 78c(5)(A). 211 A firm that wishes to transact business upon an exchange without becoming a broker or dealer can do so by engaging a broker-dealer that is a member of that exchange to provide market access and settlement services. 212 Based on December 2021 FOCUS data. 210 15 E:\FR\FM\12AUP2.SGM 12AUP2 49954 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules Most brokers and dealers are small, with 66% of brokers and dealers employing 15 or fewer associated persons and only 10% of brokers and dealers employing over 100 associated persons.213 Further, while there are many registered brokers and dealers, a small minority of brokers and dealers controls the majority of broker and dealer capital and each play a significant role in the allocation of capital to liquidity provision.214 The Commission has identified 65 firms that, as of April 2022, were Commission registered broker-dealers and exchange members, but not members of FINRA, that may be required to either join an Association or change their trading practices under the proposed amendments.215 To the extent that the definitions of ‘‘dealer’’ and ‘‘government securities dealer’’ might change, the number of affected firms could increase.216 Because of Rule 15b9–1’s exclusion of proprietary trading, a dealer that does not carry customer accounts may not be required to join an Association as long as they are a member of an exchange SRO, even when that dealer has substantial offexchange trading activity. In September 2021, there were 66 registered broker-dealers that were exchange members but not FINRA members.217 The Commission is aware that some non-FINRA member firms trade U.S. Treasury securities. Covered ATSs report the U.S. Treasury securities trading activity of non-FINRA-member firms to TRACE. The Commission estimates that, in 2021, four of the 66 non-FINRA member firms had $7 trillion in U.S. Treasury securities volume reported to TRACE by covered ATSs. This accounts for approximately 2% of U.S. Treasury volume as reported to TRACE throughout the year. In April 2022, there were three non-FINRA member firms with approximately $700 billion in U.S. Treasury securities volume executed on covered ATSs or approximately 2.5% of total U.S. Treasury securities transaction volume reported to TRACE that month. FINRA members are required to report transactions in TRACE-eligible securities. Market participants can gain real-time access to TRACE through market vendors, for most TRACEeligible securities, with a few exceptions including U.S. Treasury securities.218 However, FINRA does make public aggregate U.S. Treasury securities data on a weekly basis.219 Non-FINRA member firms are not required to report their trading activity to TRACE. With respect to trading activity in U.S. Treasury securities markets on a covered ATS, non-FINRA member counterparties are identified in TRACE.220 With respect to trading activity in other TRACE-eligible securities, non-FINRA member counterparties are not identified in TRACE. Therefore, the Commission is unable to estimate the level of trading activity of non-FINRA member firms for other fixed income securities, and cannot reasonably assume either significant or insignificant unreported volume. However, based on the nonFINRA member firms’ activity in U.S. Treasury securities markets, some nonFINRA member firms are likely to be active in other fixed income markets as well. In September 2021, of the 66 nonFINRA member firms, 47 initiated equity orders that were not executed on an exchange, accounting for $789 billion (approximately 9.8%) in off-exchange traded dollar volume in listed equities.221 In April 2022, of the 65 nonFINRA member firms, 43 initiated equity orders that were not executed on an exchange, accounting for $441 billion (approximately 4.6%) in off-exchange traded dollar volume in listed equities. There is significant diversity in the business models of non-FINRA member firms. Some non-FINRA member firms may limit their equity trading to a single exchange, while others trade on multiple venues including off-exchange venues such as ATSs. Some firms are significant contributors to both offexchange and exchange volume. Because CAT requires reporting of all NMS stock trades, including offexchange trades, FINRA and the Commission are able to quantify the aggregate off-exchange activity of nonFINRA member firms. Off-exchange equity trading occurs across many trading venues. In quarter 3 of 2021, 32 ATSs actively traded NMS stocks, comprising 9.6% of NMS stock share volume. Furthermore, 187 named 222 broker-dealers transacted a further 33% of NMS stock share volume off-exchange without the involvement of an ATS. Although many market participants provide liquidity within this market, non-FINRA member firms are particularly active within ATSs.223 Although non-FINRA member firms may trade in the non-ATS segment of the off-exchange market, the Commission believes they rarely act as liquidity suppliers outside of ATSs because they do not carry customer accounts that might generate orders they could fill from inventory. While some non-FINRA member firms trade actively off-exchange, some of these firms also supply and demand liquidity actively on multiple equity and options exchanges. Table 1 below shows the executed dollar volume in listed equities by trading venue type during September 2021 and April 2022 for the non-FINRA member firms. Table 2 below shows the executed dollar volume, number of trades, and number of contracts in options during September 2021 and April 2022 for the non-FINRA member firms. TABLE 1—NON-FINRA MEMBERS NMS EQUITY TRADING VOLUME BY VENUE TYPE Traded dollar volume Sept 2021 Billions ($) April 2022 % of Total Billions ($) % of Total jspears on DSK121TN23PROD with PROPOSALS2 I. All Non-FINRA Member Firms 1 Trading Venue: 213 Based on December 2021 Annual FOCUS data filings. See also supra note 136. 214 See infra section IX. 215 Historically, floor brokers had only incidental trading on exchanges of which they were not members, and limited off-exchange trading activity. The background and history of Rule 15b9–1 are discussed in section I. 216 See supra note 155 and accompanying text. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 217 See supra note 74. FINRA.org, TRACE at 20—Reflecting on Advances in Transparency in Fixed Income, available at https://www.finra.org/media-center/ blog/trace-at-20-reflecting-advances-transparencyfixed-income (last visited July 22, 2022). See also FINRA Rule 6750(c). 219 See supra note 45 and accompanying text. 220 See supra note 112 and accompanying text. 218 See PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 221 See supra section II.B for further discussion of trading activities of non-FINRA member firms. 222 ATSs often report the MPID of counterparties that are not FINRA members, allowing their activity to be partially identified in CAT data. 223 See Table 1 for information on trading activities on ATSs. E:\FR\FM\12AUP2.SGM 12AUP2 49955 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules TABLE 1—NON-FINRA MEMBERS NMS EQUITY TRADING VOLUME BY VENUE TYPE—Continued Traded dollar volume Sept 2021 Billions ($) Off-Exchange: Off-Exchange: On-Exchange: On-Exchange: April 2022 Billions ($) % of Total % of Total ATS ................................................................................... Non-ATS ........................................................................... Exchange Member 2 ......................................................... Cross-Exchange 3 ............................................................. 661.50 127.50 4,190.57 592.29 11.9 2.3 75.2 10.6 374.43 66.57 2,904.01 475.30 9.8 1.7 76.0 12.4 Total ................................................................................................... II. Largest Non-FINRA Member Firms 4 Trading Venue: Off-Exchange: ATS ................................................................................... Off-Exchange: Non-ATS ........................................................................... On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 5,571.87 100.0 3,820.32 100.0 629.41 114.59 3,622.30 520.97 12.9 2.3 74.1 10.7 345.56 58.19 2,384.36 388.48 10.9 1.8 75.1 12.2 Total ................................................................................................... 4,887.27 100.0 3,176.59 100.0 Data Source: CAT. 1 Non-FINRA Member firms that initiated orders that were executed either on or off-exchange. There were 47 firms in September 2021 and 43 firms in April 2022. 2 Exchange Member refers to trades executed on an exchange where the Non-FINRA member is a registered member. 3 Cross-Exchange refers to trades executed on an exchange where the Non-FINRA member is not a registered member. 4 The largest Non-FINRA member firms ranked by off-exchange traded dollar volume. There were 13 firms in September 2021 and 12 firms in April 2022. TABLE 2—NON-FINRA MEMBERS OPTIONS TRADING VOLUME BY VENUE TYPE Traded dollar volume Sept 2021 Millions ($) April 2022 Millions ($) % of Total % of Total Panel A: Option Dollar Volume I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 650.75 37.09 94.6 5.4 713.10 54.45 92.9 7.1 Total ................................................................................................... 687.84 100.0 767.54 100.0 II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 493.09 31.05 94.1 5.9 645.48 51.37 92.6 7.4 Total ................................................................................................... 524.14 100.0 696.85 100.0 Trades Sept 2021 Millions ($) April 2022 % of Total Millions ($) % of Total jspears on DSK121TN23PROD with PROPOSALS2 Panel B: Number of Trades I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. ........................ 28.33 1.14 ........................ 96.1 3.9 ........................ 23.04 1.67 ........................ 93.2 6.8 Total ................................................................................................... 29.47 100.0 24.71 100.0 II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 20.72 0.89 95.9 4.1 20.96 1.49 93.4 6.6 Total ................................................................................................... 21.61 100.0 22.44 100.0 VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 E:\FR\FM\12AUP2.SGM 12AUP2 49956 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules Contracts Sept 2021 Millions ($) April 2022 % of Total Millions ($) % of Total Panel C: Number of Contracts I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 197.36 9.97 95.2 4.8 185.65 10.93 94.4 5.6 Total ................................................................................................... 207.33 100.0 196.58 100.0 II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 138.33 7.65 94.8 5.2 167.37 9.57 94.6 5.4 Total ................................................................................................... 145.98 100.0 176.94 100.0 Data Source: CAT. 1 Non-FINRA Member firms that initiated options orders that were executed. There were 42 firms in September 2021 and 35 firms in April 2022. 2 Exchange Member refers to trades executed on an exchange where the Non-FINRA member is a registered member. 3 Cross-Exchange refers to trades executed on an exchange where the Non-FINRA member is not registered member. 4 The largest non-FINRA member firms ranked by equity off-exchange traded dollar volume. Nine of the largest 13 firms in September 2021 and nine of the largest 12 firms in April 2022 initiated options orders that were executed. Table 1 shows that the majority of non-FINRA member firms executed listed equity orders (approximately 75%) on exchanges where the firm was a registered member. However, they also transacted on exchanges where the firm was not a member in addition to trading off-exchange. Table 2 shows the number of non-FINRA member firms that also executed trades in the options market and the total dollar, trades, and contract volume. In September 2021, forty-two non-FINRA member firms and nine of the 13 largest firms executed trades on options exchanges. Eight of the nine largest firms executed trades on seven or more options exchanges. In April 2022, 35 non-FINRA member firms and nine of the 12 largest firms executed trades on options exchanges. jspears on DSK121TN23PROD with PROPOSALS2 2. Current Market Oversight The surveillance and regulation of each broker or dealer is partially dependent upon its individual SRO membership status. Each SRO is required to examine for and enforce compliance by its members and associated persons with the Exchange Act, the rules and regulations thereunder, and the SRO’s own rules, including, for exchange SROs, the rules on the trading that occurs on the exchange it oversees. Because of this, SROs that oversee an exchange generally possess expertise in regulating members who specialize in trading on their exchange and in using the order types that may be unique or specialized within the exchange. This expertise complements the expertise of an VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Association in supervising crossexchange and off-exchange trading activity.224 While all exchanges are SROs and have access to CAT data covering trading activity by their members both on and off exchanges, currently nearly all equity activity and much options activity of non-FINRA member brokerdealers is surveilled by FINRA through the RSAs with exchange SROs. However, RSAs are voluntary, privately negotiated agreements that can expire or be terminated, and accordingly, these agreements may not in the future provide the consistency and stability of direct FINRA oversight. U.S. Treasury security trading and other fixed income trading,225 however, is not covered by CAT; instead transactions in these securities are only reported to FINRA’s TRACE database when there is a FINRA member that is party to the trade or the trade occurs on an ATS because such reporting results from a FINRA rule.226 Where no FINRA member is party to the transaction, and the transaction does not take place on an ATS, it goes unreported to TRACE. Some exchanges serve as DEA for certain of their members.227 Financial and operational requirements share 224 See supra Section II, discussing the requirement for SROs to examine for and enforce compliance with the Exchange Act, and the rules and regulations thereunder. 225 Municipal bond trades are not reported to TRACE. 226 All ATSs are operated by FINRA member firms. 227 See supra note 30. PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 many commonalities across SROs, such as net capital requirements and books and records requirements. Because many brokers and dealers are members of multiple SROs with similar requirements, one SRO is appointed as the broker’s or dealer’s DEA to examine common members for compliance with the financial responsibility requirements imposed by the Act, or by Commission or SRO rules.228 The exchange serving as DEA has regulatory responsibility for their common members’ compliance with the applicable financial responsibility rules. However, the non-DEA exchange maintains responsibility for compliance with its own rules and provisions of the federal securities laws governing matters other than financial responsibility, including sales practices and trading activities and practices, although the SROs may also allocate other regulatory responsibilities. All registered brokers and dealers are required to join an Association unless they effect transactions in securities solely on a national securities exchange of which they are a member or are 228 See supra note 30. See 17 CFR 240.17d–1. FINRA serves as the DEA for the majority of member firms; there are exceptions, mostly involving firms that have specialized business models that focus on a particular exchange that is judged to be best situated to supervise the member firm’s activity. These firms are, however, subject to the same supervision of their trading activity as other member firms for whom FINRA does act as DEA, and the DEA stipulates which SRO has responsibility to supervise the firm but does not allow for less supervision. Under the amendments, non-FINRA member firms that join FINRA may or may not be assigned to FINRA for DEA supervision. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 exempt from the membership requirement pursuant to Rule 15b9–1. The vast majority of brokers and dealers join an Association and, because FINRA is the only Association, brokers and dealers are subject to relatively uniform regulatory requirements and levels of surveillance and supervision. Supervision by FINRA, which is currently the only Association, covers a market that is fragmented across many trading venues, including the more opaque off-exchange market.229 Additionally, FINRA oversees its member’s activity in equity, fixed income, and derivative markets and thus has the ability to supervise asset classes that may be outside the expertise of certain exchange SROs. The existing Association, FINRA, serves crucial functions in the current regulatory structure.230 The Exchange Act’s statutory framework places responsibility for off-exchange trading with an Association.231 Pursuant to that, FINRA has established a regulatory regime for FINRA members, including FINRA members conducting business in the off-exchange market for various asset classes, and developed surveillance technology and specialized regulatory personnel to provide surveillance, supervision, and enforcement of activity occurring offexchange. Consequently, the current regulatory structure achieves crossmarket and off-exchange supervision through the surveillance actions of FINRA of the market generally and its examination of its members. Additionally, despite the fact that FINRA does not have the authority to monitor non-FINRA member firms that are not covered by RSA or 17d–2 plans that include these services, the Commission understands that FINRA operates a cross-market regulatory program that covers 100% of equity trades and 45% of option trading.232 FINRA does not have direct membership-based jurisdiction over non-FINRA member firms. However, FINRA refers cases for enforcement to the SRO with jurisdiction or to the Commission. If FINRA is performing regulatory services for an exchange SRO 229 Comprehensive reporting requirements for all member firms that trade off-exchange give FINRA information on market activity levels and market conditions off-exchange. Because most off-exchange venues do not publicly disseminate information on the liquidity available in their systems, comprehensive information from all participants through CAT allows FINRA to analyze and surveil the off-exchange market. See supra notes 40–43. 230 See supra Section II for further discussion of the role of Associations in market oversight. 231 See supra note 8. 232 See Cross-Market Regulatory Coordination Staff Paper, supra note 31. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 pursuant to an RSA, FINRA may, on behalf of the exchange SRO, investigate and bring an enforcement action against an exchange SRO member that is not a FINRA member, assuming that those services are covered by the RSA.233 However, each RSA is independently negotiated and thus they are not standardized. Therefore, FINRA’s ability to provide oversight can vary based on the nature of its regulatory services agreement with the exchange SRO. Additionally, the ultimate responsibility for that regulatory oversight still rests with the exchange SRO, not with FINRA.234 SROs may also use 17d–2 plans which allow SROs with common members to designate a DEA to examine common members. However, 17d–2 plans do not confer jurisdiction as they apply only to common firms of which each SRO would already have jurisdiction.235 Exchange SROs may not be efficient at monitoring off-exchange activity. Because of the historical reliance on FINRA as the examination and surveillance authority over offexchange trading, exchanges have limited resources and may have incentives to prioritize the following up on potential violations of on-exchange activity over off-exchange activity. However, such incentives are likely curtailed by the exchange SROs’ legal responsibilities under the Exchange Act to examine and enforce compliance by their members with the Exchange Act, the rules thereunder, and the SRO’s own rules and the reputational damage they may experience if they do not. Currently, some non-FINRA member firms transact heavily in the course of normal business activities within venues regulated by SROs of which they are not members. This activity is not limited to equities; non-FINRA member firms play a large role in U.S. Treasury securities markets as well.236 In 2021, there were four non-FINRA member firms that together traded more than $7 trillion in U.S. Treasury securities volume on covered ATSs, which accounted for 2% of total U.S. Treasury securities trading volume 237 reported to TRACE. In April 2022, the Commission estimates that three non-FINRA member firms totaled $700 billion in U.S. Treasury securities volume executed on 233 In most but not all cases, FINRA is empowered to take such actions. 234 See supra note 109. 235 See supra note 30. 236 See supra Section VI.A.1 and accompanying text for more information on trading in U.S. Treasury securities markets. 237 The Commission estimated that in July 2021 there were 626 total firms that traded U.S. Treasury securities. See Table 1 of Securities Exchange Act Release No. 94524 (March 28, 2022), 87 FR 23054, 23081 (April 18, 2022). PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 49957 covered ATSs, which accounted for 2.5% of total U.S. Treasury securities transaction volume reported to TRACE that month. This is very different from when Rule 15b9–1 was first adopted. The Act provides for regulation of exchange trading by the exchanges themselves; it further generally provides for supervision of off-exchange trading by an Association.238 SRO rules require their members to report CAT data daily.239 This data records the origination, receipt, execution, routing, modification, or cancellation of every order a member firm handles for NMS stocks and options, with the exception of primary market transactions. Because non-FINRA member firms are not required to join an Association if they qualify for an exemption, they are not required to pay the costs of Association membership, which could be significant, especially for non-FINRA member firms with substantial trading activity. FINRA members currently pay fees associated with FINRA membership including the annual Gross Income Assessment (GIA), the annual personnel assessment; and the TAF and Section 3 fees.240 FINRA members pay the TAF for all sales transactions of covered securities that are not performed in the firm’s capacity as a registered specialist or market maker upon an exchange.241 FINRA members also must pay Transaction Reporting Fees for TRACE reportable securities, with the exception of U.S. Treasury securities. The FINRA Section 3 fee is the second of two primary FINRA fees (the other being TAF) that are assessed upon each off-exchange sale by or through a FINRA member. Under Section 31 of the Act,242 SROs must pay transaction fees based 238 See supra note 8. generally FINRA Rule 6800 Series and 17 CFR 242.613. 240 See infra Section VI.C.2.b. for more information on the fees. 241 Covered securities include all equity, options and U.S. Treasury securities. For an explanation of what is included and exempt from the TAF, see FINRA Rules and Guidance, available at https:// www.finra.org/rules-guidance/rulebooks/corporateorganization/section-1-member-regulatory-fees. After the 2015 Proposal, FINRA proposed an exemption that ‘‘would exempt from the TAF transactions executed by proprietary trading firms on an exchange of which the firm is a member (including non-market maker trades).’’ See FINRA Regulatory Notice 15–13, Trading Activity Fee (May 2015), at 3, available at https://www.finra.org/sites/ default/files/notice_doc_file_ref/Notice_Regulatory_ 15-13.pdf. FINRA stated that the proposed exemption ‘‘would result in a lower TAF for trades executed on an exchange for which the proprietary trading firm is a member than a trade executed elsewhere.’’ Id. at 5. The proposed exemption to the TAF is not effective. 242 15 U.S.C. 78ee. 239 See E:\FR\FM\12AUP2.SGM 12AUP2 49958 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 on the volume of their covered sales. These fees are designed to offset the costs of regulation incurred by the government—including the Commission—for supervising and regulating the securities markets and securities professionals. FINRA obtains money to pay its Section 31 fees from its membership, in accordance with Section 3 of Schedule A to the FINRA By-Laws. FINRA assesses these Section 3 fees on the sell side of each offexchange trade, when possible. When the sell side of an off-exchange transaction is a non-FINRA member firm and the seller engages the services of a clearing broker that is a member firm, FINRA can assess the Section 3 fee against the member firm clearing broker.243 When the seller is a nonFINRA member firm that self-clears, FINRA has no authority to assess the Section 3 fee against the seller. In such case, FINRA would seek to assess the fee against the buyer, if the buyer includes a member firm counterparty or a member firm acting as clearing broker for a non-FINRA member firm buy side counterparty. Firms that carry customer accounts are required to be a member of an Association and thus these firms bear the aforementioned fees. These costs may be passed on in part or in whole to the investing public or the nonFINRA member counterparty. 3. Current Competition To Provide Liquidity The market for liquidity provision on equity exchanges is competitive. In September 2021 across all exchanges, each equity security had between 1 to 47 registered market makers providing liquidity. The median equity security had 3 registered market makers, and 75% of securities had 2 or more registered market makers. Twenty-five percent of equity securities had 6 or more registered market makers. Additionally, while the number of market makers provides a good indication as to the number of firms in the business of providing liquidity, it does not necessarily indicate whether each market maker is an active competitor. However, the Commission believes that many market makers actively compete to provide liquidity. As stated above, non-FINRA member firms do not have the same regulatory costs as FINRA member firms, which may give non-FINRA member firms a competitive advantage in providing liquidity. As such, non-FINRA member firms may be able to provide liquidity at a lower cost than FINRA member firms given that non-FINRA member firms have a lower variable cost, all else equal, for trading compared to FINRA member firms. The Commission believes that nonFINRA member firms are active participants in the market to provide liquidity in off-exchange markets. The Commission estimates that non-FINRA member firms account for between 4.6% and 9.8% of off-exchange dollar volume in equities. Additionally, nearly 10% of all non-FINRA member equity trading activity occurs in off-exchange markets. In U.S. Treasury securities markets, non-FINRA member firms trading activity that is reported by covered ATSs account for 2.5% of all transaction volume. B. Effects on Efficiency, Competition, and Capital Formation In addition to the specific, individual benefits and costs discussed below, the Commission expects the amendments may have varying effects on efficiency, competition, and capital formation. These effects are described in this section. The proposal may result in improved efficiency of capital allocation. To the extent that liquidity provision changes as a result of the proposal, market efficiency might be impacted. Additionally, the proposal would have mixed effects on competition to provide liquidity, as current non-FINRA member firms may be less likely to provide liquidity but current FINRA members may be more likely to provide liquidity. The Commission believes that the amendments would not likely have a meaningful effect on capital formation. 1. Firm Response and Effect on Market Activity and Efficiency Although non-FINRA member firms could seek to comply with the amendments in multiple ways, each route could involve changes to firms’ business models. Some non-FINRA member firms may limit their trading to exchanges of which they are members, and the Commission believes that some may not trade off-exchange other than to comply with Rule 611 of Regulation NMS or the Options Linkage Plan,244 or to execute the stock leg of a stock-option order.245 These firms would remain exempt from the requirement to become a member of an Association, if they comply with Section 15(b)(8) of the Act or the Rule as amended.246 Other firms would no longer be exempt, and would 244 See supra section III.B.1. supra section III.B.2. 246 Changes to the exclusion are discussed in section III.B, supra. 245 See 243 The seller’s clearing broker may pass that fee on to the non-FINRA member firm. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 need to take action to comply with the amended rule. Under the amended Rule, a non-FINRA member firm that trades equities, options or fixed income securities off-exchange, or upon exchanges of which it is not a member, can comply in four ways. The first option would be to join an Association. The second option would be to join all exchanges upon which the non-FINRA member firm wishes to trade, and to cease any off-exchange trading, other than off-exchange trading consistent with the routing exemption and stockoption order exemption. Third, a nonFINRA member firm could comply by trading solely upon those exchanges of which it is already a member, consistent with the statutory exemption in Section 15(b)(8).247 Finally, a non-FINRA member firm could cease trading securities. The changes non-FINRA member firms make to their business model to comply with the amendments may affect competition in the equity and U.S. Treasury securities markets, particularly for off-exchange liquidity provision. Non-FINRA member firms may be less willing to compete to provide liquidity off-exchange, decreasing off-exchange liquidity. For example, non-FINRA member firms may choose to cease their off-exchange activity rather than join an Association—although it is likely that firms that trade heavily in the offexchange market may find it more costly to cease their off-exchange activity than to join an Association.248 In addition, non-FINRA member firms that choose to join an Association may reduce their off-exchange trading because joining an Association would increase variable costs to trade in the off-exchange market, as these trades would incur TAF and possibly additional Section 3 fees, although some Section 3 fees may already be passed on from FINRA member firms to non-FINRA member firms.249 An increase in cost would 247 15 U.S.C. 78o(b)(8). with very low ATS activity are unlikely to directly connect to an ATS, instead accessing ATSs through a member firm. For firms with very limited off-exchange activity, ceasing off-exchange activity is likely to be less costly than joining an Association. The costs of joining FINRA are discussed in detail in infra section VI.C.2; for firms with very limited off-exchange activity, it is unlikely that the profits generated from this activity would offset FINRA membership costs. However, for firms that generate profits from off-exchange activities that exceed FINRA membership costs, it may be less costly to join FINRA than to cease their off-exchange activity. 249 After the 2015 proposal, FINRA considered reevaluating the structure of the TAF to assure that it appropriately considered the business model of certain non-FINRA member firms that might have joined FINRA as a result of the proposed amendments. See supra note 153. The Commission’s analysis of TAF is based on current 248 Firms E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 reduce the profitability of off-exchange trading and thus potentially reduce offexchange trading. This sentiment was echoed by one commenter who stated that FINRA registration ‘‘would greatly impede’’ the entry of high frequency proprietary traders to the market.250 While the Commission agrees that FINRA membership could act as a deterrent to new high frequency trading firms entering the marketplace as broker-dealers, the Commission also believes that access to our capital markets generally requires a certain level of oversight. The Commission believes that the proposal is consistent with the Exchange Act’s statutory framework for complementary exchange SRO and Association oversight of broker-dealer trading activity and thus to the extent such firms are required to register with FINRA as a result of the proposal, the costs are justified as part of that regulatory oversight. The Commission preliminarily believes that requiring membership in an Association, consistent with Rule 15b9–1, could facilitate an appropriate level of oversight. The Commission also recognizes that the loss of liquidity provision in off-exchange trading may impose costs on investors in the form of higher trading costs than they would otherwise realize. These effects may differ across asset classes. In the case of non-FINRA member broker-dealers trading U.S. Treasury securities, costs to join an Association include the costs of establishing TRACE reporting. Depending on the firm’s activity level in that market, firms may be more likely to withdraw from that market if their anticipated profit levels from U.S. Treasury securities trading do not justify the additional reporting requirements. The impact on liquidity in U.S. Treasury securities markets is not likely to significantly impact investor costs to trade these securities because U.S. Treasury securities are generally very liquid and competition to provide this TAF structure as outlined in the FINRA By-Laws, Schedule A. TAF and Section 3 fees are discussed further in Section VI.C.2.b, infra. Firms would also face additional fixed costs both to establish and maintain Association membership; those costs are discussed in Section VI.C.2, infra. 250 See Letter from Michelle Pav (April 16, 2015) (‘‘Pav Letter’’) at 5. The commenter is concerned with how the duties of best execution and general suitability would apply to proprietary trading firms. Id. The commenter also states that the Commission ‘‘clearly does not understand’’ high frequency trading and FINRA does not have ‘‘any more insight into what is happening at [high frequency trading] firms than the SEC.’’ Id. at 2. Some proprietary trading firms are already members of FINRA. As a result, FINRA has experience addressing these issues. Additionally, the rule amendments would provide FINRA and the Commission with greater visibility into the activities of these firms. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 liquidity is robust. If some non-FINRA member broker-dealers stop competing in the market to provide this liquidity, other broker-dealers are likely to increase their activity in this market, but the Commission acknowledges that if liquidity decreases, investor costs to trade U.S. Treasury securities could increase. Additionally, the removal of liquidity from the market could either improve or degrade execution quality on offexchange markets.251 Some institutional investors transacting in off-exchange markets may seek institutional investor counterparties and avoid transacting with proprietary trading firms. To this extent, the removal of non-FINRA member firm liquidity may be seen as improving liquidity quality within ATSs by some institutional investors.252 It is also possible that reducing the activity of non-FINRA member firms within ATSs may result in more ATS liquidity, if non-FINRA member firms are acting as net takers of liquidity within these systems.253 At a minimum, liquidity levels in ATSs may change. In addition, these firms may reduce their offexchange trading outside of ATSs such as on single-dealer platforms. It is possible that this would result in a 251 Non-FINRA member firms are likely to also reduce their off-exchange trading outside of ATSs, such as on single-dealer platforms. However, nonFINRA member firms can only take (not make) liquidity on these platforms. It is possible that additional off-exchange liquidity may be available outside of ATSs for other market participants as a result of the amendments to Rule 15b9–1 due to a reduction in non-FINRA member firm trading on single-dealer platforms. 252 Industry white papers sometimes discuss the concept of natural counterparties for institutional trades. These papers may explicitly or implicitly identify proprietary automated trading firms as sources of information leakage in dark pools. The Commission understands that some ATSs segment orders so that institutional investors do not trade with PTFs. See e.g., Hitesh Mittal, Are You Playing in a Toxic Dark Pool? A Guide to Preventing Information Leakage, J. Trading, Summer 2008, at 20 (ITG white paper), available at https://jot.pmresearch.com/content/3/3/20. Other industry participants describe a more benign role for automated trading firms as liquidity providers in ATSs. See Terry Flanagan, High-Speed Traders Go Dark, Markets Media Commentary (2012), available at https://www.marketsmedia.com/high-speedtraders-go-dark/. 253 There is some evidence that some proprietary trading firms are net takers rather than net suppliers of liquidity in equity markets, although the evidence is not conclusive. Using Nasdaq data from 2008–2010, Carrion estimates that these firms supply liquidity to 41.2% of trading dollar volume and take liquidity in 42.2% of trading dollar volume. See Allen Carrion, Very fast money: Highfrequency trading on the NASDAQ, 16 J. Fin. Mkts. 680 (2013). Another study finds that electronic trading firms act as net liquidity suppliers during periods of extreme price movements. See Jonathan Brogaard, Allen Carrion, Thibaut Moyaert, Ryan Riordan, Andriy Shkilko & Konstantin Sokolov, High Frequency Trading and Extreme Price Movements, 128 J. Fin. Econ. 253 (2018). PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 49959 transfer of volume from off-exchange venues to exchanges, but it is also possible that overall market trading volume would diminish if decreased volume from off-exchange trading does not migrate to exchanges. In response to the 2015 Proposal, several commenters expressed liquidity concerns.254 One commenter stated that because it would be costly for high frequency trading firms to comply with FINRA regulations, these firms ‘‘may not trade as frequently, reducing overall market liquidity.’’ 255 Another commenter stated that proprietary traders provide liquidity and order to the markets and that disadvantaging small proprietary traders may harm the market balance.256 A third commenter stated that it believes that ‘‘unnecessary costs . . . could hinder competition among liquidity providers, which could negatively impact market liquidity and transaction costs.’’ 257 Finally, one commenter stated that the current FINRA fee structure is imbalanced and risks stifling liquidity in the markets and that there are fewer incentives to provide the same liquidity under FINRA’s proposed fee structure as there are under Cboe’s regulatory fee structure.258 Changes in business models for nonFINRA member firms may affect market quality on exchanges as well. In addition to trading extensively in the off-exchange market, many non-FINRA member firms are among the most active participants on exchanges. Business model changes by these firms may lead to less exchange liquidity for several reasons. First, non-FINRA member firms that choose not to join an Association would no longer be able to rely on the rule and trade indirectly on exchanges of which they are not members, unless they comply with the routing or stockoptions order exemptions.259 Second, non-FINRA member firms that do not join an Association would no longer be able to access off-exchange liquidity to unwind positions acquired on exchanges, which may reduce their 254 See Pav Letter, Hold Brothers Capital Letter, FIA 1 Letter, and PEAK6 Letter. 255 See Pav Latter at 3. 256 See Hold Brother Capital Letter at 4. 257 See FIA 1 Letter at 3. 258 See PEAK6 Letter at 3–4. This commenter further stated that FINRA fees ‘‘may discourage such firms from routing trades to certain markets, thereby disrupting market efficiency.’’ Id. at 4. 259 Currently, a non-FINRA member firm can indirectly access an exchange of which it is not a member through a firm that is an exchange member. In light of the elimination of the exclusion for proprietary trading, this activity would not be consistent with the amendments, unless the activity complies with the routing or stock-option order exemptions. See supra sections III.B.1 and III.B.2. E:\FR\FM\12AUP2.SGM 12AUP2 49960 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 willingness to provide liquidity upon exchanges.260 Third, non-FINRA member firms that choose to join an Association may be subject to additional variable costs (primarily regulatory fees) on their exchange-based trading as well as on their off-exchange trading.261 These firms may respond by trading less actively on exchanges. Finally, nonFINRA member firms may choose to cease trading rather than join an Association or change their business models. Reduced liquidity upon exchanges can result in higher spreads and increased volatility. Increased spreads on exchanges can lead to increased costs for off-exchange investors as well as investors transacting on exchanges, because most offexchange transactions (including many retail executions) are derivatively priced with reference to prevailing exchange prices. The Commission believes that the amendments are not likely to have an economically meaningful effect on direct capital formation, which is the assignment of financial resources to meet the funding requirements of a profitable capital project, in this case, the provision of liquidity to financial markets. However, the Commission believes that the changes in allocation of regulatory fees and direct FINRA supervision within the off-exchange market may result in improved efficiency of capital allocation by the financial industry. The proposed amendments may reduce the capital commitment of non-FINRA member firms to liquidity provision. In response, it is possible that current member firms may choose to commit additional capital to liquidity provision when the trading environment has more uniform regulatory requirements. The Commission believes that this may lead to an overall increased commitment of liquidity both to exchanges and the offexchange market. This increased commitment is likely to have some positive effects on capital market efficiency, such as lower quoted spreads on exchanges. In addition to lowering immediate execution costs on exchanges, lower exchange quoted spreads are likely to reduce transaction costs off-exchange as well, because offexchange trades are typically priced 260 These firms could unwind positions on exchanges of which they are a member, but the cost to do so may be higher than if all liquidity, including off-exchange liquidity, were available. 261 It is possible non-FINRA member firms that choose to join an Association may avoid some additional costs by registering as market makers on additional venues, mitigating these charges. Furthermore, they may see a reduction in fees that were formerly paid to their DEA if FINRA assumes that role. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 with reference to quoted exchange prices. The Commission believes these effects are not likely to be significant because the market to provide liquidity is very competitive. These markets are served by a number of liquidity providers with different business strategies and a strategic change by relatively few competitors is unlikely to disturb liquidity provision overall. 2. Effect on Competition To Provide Liquidity The proposed amendments may impact competition to provide liquidity by increasing the regulatory cost for current non-FINRA member firms. Currently, non-FINRA member firms do not bear the costs associated with FINRA membership. As such, FINRA member firms bear a number of costs not borne by non-FINRA member firms including a number of regulatory fees and indirect costs that are assessed or imposed upon member firms.262 These costs are a part of equity, options and fixed income markets and include direct costs such as trading fees that are either assigned only to member firms, such as TAF, or in the case of Section 3 fees, member firms may be assigned costs that could be assigned to non-FINRA member firms selling securities offexchange. There are indirect costs of disparate regulatory regimes as well.263 Under the proposed amendments current non-FINRA members would become subject to the regulatory costs associated with FINRA membership, including TAF, GIA and Section 3 fees. These changes to regulatory costs for non-FINRA member firms may change competitive forces in the market for providing liquidity as the current nonFINRA member broker-dealers have lower regulatory costs, which may make 262 Exchange membership also imposes costs on broker-dealers. Some non-FINRA member firms are members of many exchanges, but not FINRA, while some FINRA-member firms are members of many exchanges as well as FINRA. To the extent that a broker-dealer can avoid FINRA membership, its fee burden may be lower than a broker-dealer that cannot or does not avoid FINRA membership. The Commission preliminarily believes that many nonFINRA member firms would retain their exchange membership if the proposed amendments are adopted in order to maintain the benefits of being a member of the exchange. Therefore, the Commission only considers the additional cost to the firms that are specific to joining FINRA. The Exchange SRO fees are not considered as they are not expected to change. However, a firm may decide to drop their exchange membership on exchanges where they no longer wish to trade after joining FINRA, because maintaining exchange memberships is costly and firms are unlikely to maintain membership in exchanges where they do not plan to have activity. See infra section VI.C.2, for more information on the fees associated with FINRA membership. 263 See section VI.C.2.f, infra. PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 it less costly for non-FINRA member broker-dealers to provide liquidity.264 However, non-FINRA member firms may already bear a portion, but not all, of these costs as FINRA member firms may pass through their fees to nonFINRA member counterparties. To the extent that non-FINRA member firms do have lower cost for providing liquidity than FINRA member firms, the proposed amendments may eliminate such an advantage, and lead to a reduction in liquidity provided by current non-FINRA member firms. The existing differential regulatory cost burdens of FINRA member firms and non-FINRA member firms may have consequences with respect to market quality both for exchange-based and offexchange trading. For example, because non-FINRA member firms, all else equal, currently face lower variable costs of trading compared to member firms, non-FINRA member firms may be able to provide liquidity at a lower cost than member firms. It may also reduce direct execution costs (such as quoted and effective spreads) for both exchange and off-exchange trades, the latter of which are normally derivatively priced with reference to prevailing exchange quotes. The differential regulatory burden, however, may also reduce depth at best prices because a member firm may not be able to trade profitably at a price established by a non-FINRA member firm that faces lower regulatory costs. Lower liquidity at best exchange prices implies greater price effect of trades, which may increase trading costs, particularly for large orders. For example, if the best price on an exchange is associated with 100 shares of depth, a 200 share order will exhaust depth at the best price and the second 100 share lot may execute at an inferior price.265 If depth at the best price tends to be larger, it is less likely that an order will exceed the depth available at the best price. The change in the best price associated with an execution that exhausts the depth available at the best price is the price effect of the trade upon the exchange. 3. Competitive Effects on Off-Exchange Market Regulation Currently, FINRA is the only Association.266 It is possible, however, for new Associations to enter the regulatory oversight market and 264 See section VI.B.1, supra for discussion of competitive effects and investor costs. 265 This assumes no hidden depth at the best price. If non-displayed depth is present at the best price, the remaining 100 shares will be filled at the best price if at least 100 shares of hidden depth exist at the best price. 266 See supra note 9 and accompanying text. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules compete with FINRA. The amendments to Rule 15b9–1 may create incentives for a new Association (or Associations) to form. The large non-FINRA member firms have commonalities in business models; for example, they typically do not carry customer accounts. They may consider joining a new Association together, which would allow the member of the new Association to be subject to rules and regulations that better fit their business practices. This may allow the new Association to more efficiently provide oversight for current non-FINRA member firms. For example, because these firms collectively conduct a significant portion of off-exchange volume, the creation of a new Association tailored to these firms may be economically viable. To be registered as a new Association, in addition to requirements that parallel the requirements to be a national securities exchange, a new Association must ‘‘[b]y reason of the number and geographical distribution of its members and the scope of their transactions’’ be able to carry out the purposes of Section 15A.267 Any new Association would have to be approved by the Commission. Additionally, a new Association must permit any registered broker or dealer that meets a new Association’s qualification standards to become a member.268 It also must have rules regarding the form and content of quotations relating to securities sold otherwise than on a national securities exchange that are designed to produce fair and informative quotations, to prevent fictitious or misleading quotations, and to promote orderly procedures for collecting, distributing, and publishing quotations.269 A new Association must also be so organized and have the capacity to enforce compliance by its members and persons associated with its members with, among other things, its own rules and the Exchange Act and the rules and regulations thereunder.270 The ability to form an Association is characterized by barriers to entry. The proposed amendments include a oneyear implementation period, which may provide a significant time constraint to form a new Association. A new Association would likely incur jspears on DSK121TN23PROD with PROPOSALS2 267 See 15 U.S.C. 78o-3. 15 U.S.C. 78o-3(b)(3). Section 15A of the Exchange Act specifically states that an Association shall not be registered as a national securities association unless the Commission determines, among other things, that ‘‘the rules of the association provide that any registered broker or dealer may become a member of such association and any person may become associated with a member thereof.’’ 269 See 15 U.S.C. 78o-3(b)(11). 270 See 15 U.S.C. 78o-3(b)(2). 268 See VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 significant fixed costs to create the infrastructure needed to perform the surveillance and oversight requirements imposed on Associations by statute and regulation. It may also incur substantial costs, including personnel, training, travel, and other costs to provide for effective surveillance and supervision of the off-exchange equity and U.S. Treasury securities markets. Indeed, the only existing Association, FINRA, has resources that enable it to surveil and supervise the off-exchange market.271 Additionally, while some costs may be lower because CAT already collects information and makes it available to query; a new Association would still have to build its own infrastructure, surveillance logics, and analytical tools, which may create a substantial cost for a new Association.272 The amendments may increase barriers to entry and thus affect the potential for competition among regulators of off-exchange markets. Currently, the primary barrier to entry is the high fixed cost involved in forming and operating an Association. As proposed, the amendments bring nearly all off-exchange trading under the jurisdiction of an Association, including the trading of firms that currently are not members of an Association (nonFINRA member firms). If these firms join the only existing Association, FINRA, any newly-formed Association may have increased difficulty attracting the members needed to support the high fixed costs associated with forming an Association because every broker or dealer that participates in the offexchange market would already be a FINRA member. This increased difficulty results because many firms may be reluctant to change Associations, either because of the costs to change compliance infrastructures or uncertainty in the regulatory environment of the new Association. Thus, if the amendments result in more firms becoming members of the FINRA, a new Association could face increased difficulties attracting members in the future. If the new Association is introduced after implementation of the rule, these stated effects would become more likely as the current non-FINRA member firms would have already joined FINRA. The proposed amendments may create incentives to start a competing Association. The amendments, as proposed, could cause a number of 271 See supra note 9 and accompanying text. Exchange Act Release No. 79318 (Nov. 15, 2016), 81 FR 84696, 84836–39 (Nov. 23, 2016) (‘‘CAT NMS Approval Order’’), for a discussion on the benefits provided by CAT with regard to surveillance by SROs. 272 See PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 49961 firms with similar business models and substantial off-exchange volume to concurrently contemplate Association membership. This may provide the incentive to create a new Association and tailor it to the specific business models of these firms. If a competing Association limited the scope of its members or operations, it might not have to duplicate all of the surveillance and supervision functions required to be provided by an Association that does not have those limits. This may lower the costs of forming an Association and alter the barriers to entry.273 When the Commission previously considered these amendments, some commenters expressed their concern about a concentration of regulatory oversight.274 One commenter stated that, although subjecting all brokers and dealers to FINRA oversight could create standardized rules, which would simplify compliance and allow for better regulatory oversight and would eliminate the rationale for many exchange specific requirements, it is necessary to weigh such benefits against potential negatives associated with having a single regulator.275 A second commenter worried about an ‘‘imprudent concentration of regulatory oversight responsibility with one selfregulatory organization.’’ 276 This commenter is concerned that the rule may achieve efficient oversight but would ‘‘do so at the certain cost of regulatory resiliency and innovation.’’ This commenter is also concerned that the rule could lead to serious single point of failure concerns and discourage innovation in regulatory surveillance and oversight practices.277 One commenter believes that the proposal raises ‘‘[m]onopoly and [a]nticompetitive considerations.’’ 278 The existence of multiple Associations might provide benefits to the market as a whole. If a new Association could provide high quality services to members with a lower fee structure, all Associations would have 273 Some limitations on Association membership or operations would require exemptive relief for the Association to register with the Commission. 274 See HRT Letter at 9–11, CHX Letter at 1–2, and Hold Brothers Capital Letter at 3. 275 See HRT Letter at 9–10. HRT further believes that it is appropriate to consider the potential negatives of concentrating power in a single regulator while also considering the potential positives associated with better standardization. Id. at 11. 276 See CHX Letter at 1. 277 Id. at 2. The commenter believes that effective regulation of cross-market activity requires multiple reviews of the same data from the unique vantage points of the respective SROs as is currently done with cooperation among the SROs and statutorily delegated regulatory authority. 278 See Hold Brothers Capital Letter at 3. E:\FR\FM\12AUP2.SGM 12AUP2 49962 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 incentives to reduce fees to attract members. This could result in cost savings to brokers and dealers. Second, a new Association could innovate to develop different surveillance and supervision methods that could be more efficient than FINRA’s methods. Competition among Associations could also entail substantial costs. If the market for Associations is characterized by economies of scale, aggregate costs for the same level of regulation would be higher in a market with two Associations than in a market with a single Association. These additional costs would ultimately be borne by the broker and dealer members of either Association, and could be passed on to investors. Second, Associations might compete on the basis of providing ‘‘light touch’’ regulation, in essence surveilling less and providing less supervision. As a result, the quality of market supervision might decrease, although the Commission does itself oversee selfregulatory organizations, such as Associations, and accordingly, would not permit a ‘‘race to the bottom.’’ 279 Furthermore, some of the benefits of the proposed amendments would be diminished if current non-FINRA member firms created a new Association as opposed to joining FINRA. For example, the new Association would not have the experience or expertise of FINRA in overseeing off-exchange market activity. Additionally, the members of a new Association would not be required to report their U.S. Treasury securities market trading activity to TRACE if they are not FINRA members. C. Consideration of Costs and Benefits This section discusses costs and benefits of the amendments. While the Commission has attempted, where possible, to provide estimated quantifiable ranges, both costs and benefits are difficult to quantify for this proposal for a number of reasons. The overall benefits of the amendments relate to more stable and uniform surveillance of off-exchange activity by the direct, membershipbased Association oversight to oversee such activity. As such, the benefits the Commission anticipates from the amendments are largely qualitative and by their nature difficult to measure quantitatively. The amendments would induce initial, ongoing and indirect costs which would be similarly difficult to measure for a variety of reasons. First, market participants are heterogeneous in their 279 See Section 19(g) and Section 19(h) of the Exchange Act. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 type, existing exchange memberships, and activity level in the off-exchange market. Consequently, compliance costs would vary across firms in a number of dimensions. Second, estimating costs is complicated by the fact that non-FINRA member firms can comply with the proposal in a number of ways, and presumably each would choose to seek compliance in the manner that minimizes the sum of its direct costs (related to joining and maintaining memberships in additional SROs) and indirect costs (which include forgone opportunities to trade profitably and costs associated with revising business strategies). Furthermore, some firms are likely to remain exempt but the Commission lacks data to identify those firms with certainty.280 At the other end of the spectrum, the minority of nonFINRA member firms that are large and contribute significantly to both exchange and off-exchange trading are unlikely to remain exempt.281 For the 65 non-FINRA member firms, the Commission believes that most could lose their exempt status, but cannot estimate how those firms would seek to comply with the amendments.282 1. Benefits As discussed above,283 some of the firms relying on the Rule 15b9–1 exemption are significant participants in both on and off-exchange markets.284 For example, in September of 2021, $789 billion in listed equities was traded off-exchange by non-FINRA member firms, and $592.3 billion in listed equities was traded on an exchange that the firm did not belong to.285 Thus, a substantial amount of offexchange volume is conducted outside of the regulatory jurisdiction of FINRA, which under the Exchange Act has primary responsibility for overseeing off-exchange activity. Although FINRA 280 Non-FINRA member firms that provide liquidity on multiple exchanges and trade heavily off-exchange are unlikely to be small in terms of net capital, and are not low trading volume firms by definition. However, as discussed in supra Section VI.A.1, many non-FINRA member firms are small in terms of net capital and may be members of a single exchange. Such firms are more likely to have limited exposure to off-exchange markets. Such firms would either be exempt from the rule by virtue of having no off-exchange trading or no trading on exchanges of which they are not members, or be able to rely on the stock-option order exemption to continue their limited offexchange trading related to their exchange-based brokerage activities. 281 The diversity of non-FINRA member firms is discussed in supra Section VI.A.1. 282 See supra Section VI.B.1., which discusses how firms may change their business models in response to the rule. 283 See supra Section I. 284 See supra Section VI.A.1. 285 See supra Table 1. PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 has the ability to surveil 100% of crossmarket and off-exchange equity trading activity, it does not have enforcement jurisdiction for firms that are not FINRA members, unless enforcement responsibility is covered under an RSA. Association membership would supplement the oversight of the exchanges, to the extent a firm remained an exchange member, and provide consistent and ongoing application of rules, which could vary between exchanges. Regarding off-exchange trading, under the current regulatory structure using RSAs, FINRA applies the rules of the different exchanges and the exchanges’ interpretations of those rules to such trading. This can result in different interpretations and FINRA registration would promote consistent interpretations and efficiencies in enforcement and regulation with respect to this growing part of the market. As discussed above,286 the Commission believes the inclusion of more nonFINRA member firms in an Association would improve such Association’s ability to supervise cross-exchange trading activity, particularly in U.S. Treasury securities markets. This would enhance FINRA’s ability and—through the information FINRA shares with the Commission—the Commission’s ability to effectively oversee regulation of trading on equity, fixed income, and option markets. The Commission believes that the amendments to Rule 15b9–1 would improve supervision of non-FINRA member firms. FINRA, currently the only Association, has substantial experience and expertise from overseeing a large number of brokers and dealers that trade off-exchange or across exchanges. This makes FINRA’s potential regulation of non-FINRA member firms with off-exchange or cross-market trading activity particularly efficient. In addition, the amendments, as proposed, would enhance the supervision and enforcement for equities and options beyond the benefits from the CAT NMS Plan.287 While CAT improves data accessibility for all SROs, it does not address FINRA’s lack of jurisdiction over non-FINRA member firms participating in the off-exchange markets. Several commenters on the 2015 Proposal believed that reporting of non-FINRA member identifying information and activity pursuant to the CAT NMS Plan would eliminate the need for firms to join FINRA and would provide FINRA a near complete picture 286 See 287 See supra Section I. CAT NMS Approval Order, supra note 272. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 of off-exchange trading activity.288 However, another commenter noted that even with non-FINRA member firm information, ‘‘enforcement activities would remain the responsibility of the individual exchanges where brokerdealers are members’’ even though FINRA would be best positioned to regulate off-exchange activity.289 The Commission agrees that, although FINRA now has additional information with respect to non-FINRA member firm activity, it still lacks jurisdiction over non-FINRA member firms, and the proposed amendments would provide such jurisdiction.290 The benefits of the proposed amendments would be pronounced in the U.S. Treasury securities markets. A significant amount of volume in U.S. Treasury securities markets comes from broker-dealers that may be newly required to become FINRA members as a result of the proposed amendments.291 If these broker-dealers become FINRA members, they would be required to comply with FINRA rules, including TRACE reporting requirements. This could have a positive impact on market quality by increasing coverage of data reported to TRACE as well as providing additional market oversight. Non-FINRA member firms do not report to TRACE, and they are only specifically identified by MPID in TRACE when their U.S. Treasury securities trades occur on a covered ATS; they are not identified by MPID for other trades of U.S. Treasury securities that do not occur on covered ATSs, such as direct dealer-to-dealer transactions. Thus, the proposed amendments would improve the quality and coverage of TRACE data and increase regulatory transparency into the U.S. Treasury securities markets.292 The extent of the benefits of requiring non-FINRA members to report these transactions may be limited because the Commission believes that the majority of U.S. Treasury securities transactions 288 See HRT Letter at 3, CTC Letter at 3–4, and FIA 2 Letter at 3. 289 See FINRA Letter at 4. 290 See supra section II.B. 291 The Commission estimates that four such firms accounted for $7 trillion in U.S. Treasury securities volume executed on covered ATSs in 2021 that was reported to TRACE, which was more than 2% of the total U.S. Treasury securities volume traded in 2021 that was reported to TRACE, and that three such firms’ U.S. Treasury securities volume executed on covered ATSs in April 2022 that was reported to TRACE accounted for approximately 2.5% of total U.S. Treasury securities volume in April 2022 that was reported to TRACE. See supra Section II.B. 292 One commenter stated that all off-exchange trades are already being reported ‘‘because all offexchange trading needs to go through a FINRA member with its own reporting obligations.’’ See FIA 1 Letter at 3. See also supra note 70. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 are already reported to TRACE.293 However, the Commission is unable to estimate the extent of U.S. Treasury securities trading activity that is not reported to TRACE. The Commission believes that the proposed amendments could have similar or additional benefits for other TRACE reported securities, should current non-FINRA member firms also trade in such securities. However, the Commission lacks the information necessary to discern the degree of any such benefits because, as noted above, the Commission does not have any data or other information available, unlike with U.S. Treasury securities, to determine how many non-FINRA member firms, if any, actively trade in these securities or to predict how many additional trades would be reported under the proposal.294 In addition to the potential market oversight benefits that would be similar to U.S. Treasury securities, the potential transparency improvements of TRACE reporting for other TRACE reportable securities go further than transparency improvement in U.S. Treasury securities, because the TRACE data for other TRACE reported securities is available to the public in real time through data vendors.295 The additional transparency from more public TRACE reporting could result in improved price discovery, which would lead to lower transaction costs.296 While current members of an Association would not be directly affected by this rule, they would benefit by having a more level playing field in reporting trades in the U.S. Treasury securities markets. With more uniform regulatory requirements, firms may compete more equitably to supply liquidity both on exchanges and in the off-exchange market. Although fewer firms will be able to rely on the proposed narrower exemptions, the proposed narrower exemptions would continue to provide benefits for non-FINRA members as well as other market participants. These exemptions would continue to provide cost savings for non-FINRA members as 293 See id. information used to get a sense of the magnitude of unreported transactions in U.S. Treasury securities is not available for other fixed income securities. See supra Section VI.A.1. 295 See supra note 218, for information on the difference between the dissemination of TRACE for U.S. Treasury securities and TRACE for other TRACE eligible securities. 296 See Hendrik Bessembinder, Chester Spatt & Kumar Venkataraman, A Survey of the Microstructure of Fixed-Income Markets, 55 J. Fin. & Quantitative Anal. 1 (2020). See also infra Section VI.C.2.f. for a related discussion of potential costs which could apply to other FINRA reportable securities. 294 The PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 49963 they would continue to not be required to join FINRA and thus avoid the costs of doing so. Additionally, the routing exemption would facilitate regulatory compliance designed to improve market quality.297 The Commission also believes that the stock-option order exemption would facilitate liquidity in both stock and options markets, which could improve market quality.298 2. Costs The amendments, by narrowing the existing exemption, would result in brokers and dealers that no longer qualify for the exemption having to comply with Section 15(b)(8) by either limiting their trading to exchanges of which they are members, joining an Association or abiding by one of the stated exemptions. Under the amendments, therefore, non-FINRA member firms that choose to continue any off-member-exchange activity will be faced with choices that would involve corresponding costs. For example, non-FINRA member firms may incur costs related to membership in an Association or costs necessitated by additional exchange memberships. Additionally, some non-FINRA member firms may incur the costs of losing the benefits of trading in the off-memberexchange market if they decide not to join an Association. There could also be indirect costs associated with the proposed amendments, depending on if a non-FINRA member chooses to join an Association or not. Most of the direct costs incurred in joining an Association and maintaining membership therein are dependent on firm characteristics and activity level. Furthermore, the Commission believes that some non-FINRA member firms may comply by ceasing their offmember-exchange trading activity, avoiding many of these costs but forgoing the opportunity to trade profitably in some venues. If all 12 of the non-FINRA member firms that have significant off-member-exchange trading activities in equities were to join FINRA, the median aggregate cost of the amendment for these firms would be about $95,000 in implementation costs and median ongoing aggregate annual costs of about $2.7 million.299 The 297 See supra Section III.B.1 for more information on the purpose of the routing exemption. 298 See supra Section III.B.2 for more information on the stock-options order exemption. 299 See Table 3 and Table 4, infra, for a breakdown of these costs. The 2015 Proposing Release, supra note 6, estimated these costs to be much higher as the estimates included costs for reporting transactions for NMS stocks. These transactions are now reported to CAT and are therefore not included in our estimates here. E:\FR\FM\12AUP2.SGM 12AUP2 49964 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules aggregate costs for the subset of 12 represent the majority of the aggregate costs. The Commission believes that smaller non-FINRA member firms as well as new entrants would experience much lower costs. In particular, the initial costs for such firms would be close to the lower range discussed below, because these cost are largely dependent on the size and complexity of the firms. Additionally, because smaller firms and new entrants would have lower trading activity, the ongoing costs would also be significantly lower as ongoing costs are highly impacted by the trading activity. a. Costs of Joining an Association 300 jspears on DSK121TN23PROD with PROPOSALS2 Based on discussions with FINRA,301 and industry participants, the direct compliance costs on non-FINRA member firms of joining FINRA are composed of FINRA membership application fees and any legal or consulting costs necessary for effectively completing the application to become a member of FINRA (e.g., ensuring compliance with FINRA rules including drafting policies and procedures as may be required). The fees associated with a FINRA membership application can vary. As an initial matter, the application fee to join FINRA is tier-based according to the number of registered persons associated with the applicant. This one-time application fee ranges from $7,500 to $55,000.302 The initial membership fee for FINRA is $7,500 for firms with ten or fewer representatives registered with FINRA, $12,500 for firms with 11 to 100 representatives registered with FINRA, and $20,000 for firms with 101 to 150 representatives registered with FINRA.303 Based on its knowledge of the size and business models of nonFINRA member firms, the Commission believes that the median application fee for the 12 largest firms would be $12,500 and that most non-FINRA 300 The Commission recognizes that non-FINRA member firms would incur compliance costs on an initial and ongoing basis to comply with the proposed amendments. These costs include costs for training and hiring new employees, as well as additional costs for exams and licensing required by FINRA. The Commission does not aggregate these costs across all non-FINRA member firms because the Commission does not have necessary information about the majority of the non-FINRA member firms and expects that costs would vary widely across firms. Where possible, however, the Commission has provided estimates based on a subset of large firms on which the Commission has sufficient information. The Commission expects that smaller firms likely will face lower costs. 301 See FINRA Letter at 5–7. 302 See FINRA By-Laws, Schedule A, Section 4. 303 Id. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 member firms would not incur FINRA application fees exceeding $20,000.304 In addition to the application fees and data reporting costs, the Commission has taken into account the cost of legal and other advising necessary for effectively completing the application to be a member of FINRA. Some firms may choose to perform this legal work internally while others may use outside counsel for the initial membership application. In making this choice, nonFINRA member firms would likely take into account factors, such as the size and resources of the firm, the complexity of the firm’s business model, and whether the firm previously used outside counsel to register with any exchanges. Based on conversations with industry participants that assist with FINRA membership, for non-FINRA member firms that choose to employ outside counsel to assist with their FINRA membership application, the cost of such counsel ranges from approximately $40,000 to $125,000, with a midpoint of $82,500. Factors affecting the specific costs of a particular firm include the number of associated persons, the level of complexity or uniqueness of the firm’s business plan, and whether the firm has previously completed exchange membership applications with similar requirements. TABLE 3—MEDIAN FIRM IMPLEMENTATION COSTS 1 Cost Median Application to join: FINRA ................................ Legal consulting ................ $12,500 82,500 Total ........................... 95,000 1 Medians are used where possible. Cost estimates are for the 12 largest firms. Cost estimates are reported as ranges for legal consulting and compliance work; for these estimates, the midpoint is used. b. Costs of Maintaining an Association Membership With respect to ongoing costs, three components of such costs are any ongoing fees associated with FINRA membership, costs of legal work relating to FINRA membership, and costs associated with additional compliance activities. The ongoing membershiprelated fees associated with FINRA membership include the annual GIA; and the TAF and Section 3 fees, among others.305 304 Based on 2022 FOCUS data, no non-FINRA member firm has more than 150 registered representatives. 305 There are additional fees associated with maintaining a FINRA membership. There are also PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 With certain assumptions, the Commission attempted to estimate direct compliance costs that a nonFINRA member firm is likely to face to comply with the amendments. The estimate applies to the 12 non-FINRA member firms that have significant offmember-exchange trading activities; smaller firms should face lower costs compared to these 12 firms because they have less revenue and trading volume that would be subject to GIA, TAF and Section 3 fees. Though non-FINRA member firms may already indirectly bear some of these costs as they may be passed through by FINRA member counterparties. Ongoing annual cost estimates (one time and annual) are broken down in Table 2. The annual GIA generally requires members to pay a percentage of the member firm’s total annual revenue based on a graduated scale.306 The magnitude of the annual GIA is based on the total annual revenue, excluding commodities income, reported by the member firm on its FOCUS Form Part II or IIA.307 Based on FOCUS Form data from 12 non-FINRA member firms in 2022, the Commission has determined that the average annual total revenue of non-FINRA member firms, excluding commodities income, is approximately $1.3 billion, with a median of $906 million.308 For the 12 large firms, FINRA’s graduated GIA scale results in a median GIA of $459,849.51.309 additional continuing education and testing requirements, which will impose costs upon firms joining FINRA. Additionally, there are de minimis fees (branch registration fee and system processing fee, among others). See FINRA By-Laws, Schedule A. The Commission also believes that non-FINRA member firms would not need to register additional associated persons because the exchange SRO rules are already comprehensive in this regard. See infra Section VI.C.2.d. 306 See FINRA By-Laws, Schedule A. For example, FINRA imposes a GIA as follows: (1) $1,200 on a member firm’s annual gross revenue up to $1 million; (2) a charge of 0.1215% on a member firm’s annual gross revenue between $1 million and $25 million; (3) a charge of 0.2599% on a member firm’s annual gross revenue between $25 million and $50 million; and so on as provided in Schedule A. When a firm’s annual gross revenue exceeds $25 million, the maximum of current year’s revenue and average of the last three years’ revenue is used as the basis for the income assessment. 307 See FINRA By-Laws, Schedule A, Section 2. See also FOCUS Report Form X–17A–5, Part II and IIA. 308 Based on 2022 FOCUS data. 309 ($1,200 for the first $1 million of revenue) + (0.1346% × annual revenue greater than $1 million up to $25 million) + (0.2880% × annual revenue greater than $25 million up to $50 million) + (0.0574% of annual revenue greater than $50 million up top $100 million) + (0.0404% of annual revenue greater than $100 million to $5 billion) + (0.0440% of annual revenue greater than $5 billion up to $25 billion) + (0.0948% of annual revenue greater than $25 billion). Although the average annual total revenue exceeds the median annual total revenue, there are a number of firms that have E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules jspears on DSK121TN23PROD with PROPOSALS2 The magnitude of the TAF depends on the transaction volume of a FINRA member that is covered by the TAF as described in the FINRA By-Laws.310 To the extent FINRA changes the structure of the TAF to take into account the business models of non-FINRA member firms that may join FINRA as a result of the proposed amendments, these costs may change.311 The Commission has identified 12 non-FINRA member firms that have significant off-memberexchange trading activity in September of 2021. The Commission estimates that trading activity fees for off-memberexchange equity trading incurred by these 12 large non-FINRA member firms due to their off-member-exchange activity would have an average incurred TAF of around $273,677.87 with a median TAF of $132,744.50.312 However, this cost is likely to be underestimated, as the estimate only accounts for off-exchange equity activity, and the magnitude of the underestimate may be significant.313 The Commission believes that the TAF for non-FINRA member firms not among the 12 identified would be far lower because the median non-FINRA member low GIA, which causes the midpoint of GIA to exceed the average GIA. Non-FINRA member firms vary in size. GIA for the 12 largest firms used in these calculations, is anticipated to be far larger than for the 65 remaining non-FINRA member firms. See FINRA By-Laws, Schedule A, Section 1(c). 310 See FINRA By-Laws, Schedule A, Section 1(b). 311 FINRA proposed amendments to the TAF in May of 2015. See supra note 241. 312 Estimated TAF includes only the off-exchange equity portion of the TAF and does not include any TAF related to a firm’s exchange-based trading activity. If a firm’s activity on an exchange is related to normal market making operations, the activity does not incur the TAF. The Commission is unable to estimate the proportion of these firms’ exchange trading that would incur the TAF because the Commission does not have information on what proportion of non-FINRA member firm exchange activity would qualify for exemption from the TAF under FINRA By-Laws. Because other elements of the TAF are not included in this calculation, it underestimates the actual TAF that firms would incur if they joined FINRA. The magnitude of the underestimation may be significant, but firms that join FINRA may be able to reduce their TAF cost by registering as market makers upon additional exchanges. (The TAF is not assessed for certain trades related to registered market-making.) See FINRA By Laws, Schedule A, Section (1)(b)(2)(F). Estimates of the TAF are based on the off-exchange sell volume reported to CAT for each of the 12 large non-FINRA member firms. The estimated TAF is equal to estimated off-exchange sell volume x $0.00013. The $0 minimum is associated with a firm that has almost no off-exchange volume. 313 FINRA members are required to pay the TAF for on and off-exchange trading activity across multiple asset classes. However, there are exemptions for certain trading activity and the Commission is unable to identify all trades that are subject to such exemptions. See https:// www.finra.org/rules-guidance/rulebooks/corporateorganization/section-1-member-regulatory-fees for an explanation of the TAF and the relevant exceptions. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 firm has far lower trading volume than the typical firm of the 12 identified in the data. Some off-exchange trading that nonFINRA member firms engage in currently may no longer be profitable when TAF is incurred. Consequently, non-FINRA member firms may reduce their trading both on exchanges and offexchange after joining an Association.314 In May of 2015, FINRA issued a Regulatory Notice proposing to amend the TAF such that it would not apply to transactions by a proprietary trading firm effected on exchanges of which the firm is a member, to coincide with originally proposed changes to 15b9– 1.315 To the extent FINRA contemplates proposing similar changes to the TAF, if approved, this could lower the cost for non-FINRA member firms.316 FINRA’s previously proposed TAF amendments would exempt proprietary trading firms when they trade securities on exchanges of which they are a member, which several commenters supported.317 In addition to the TAF, non-FINRA member firms that choose to join FINRA may incur additional Section 3 fees. Using data on off-exchange trading during September 2021, the Commission estimated that Section 3 fees incurred by the 12 large non-FINRA member firms due to their off-exchange trading would have an average incurred Section 3 fee of $4,541,719.31 annually, with a median incurred Section 3 fee of $2,150,069.99.318 Some of these fees 314 See supra section VI.B.1 for more information on how firms may change their trading practices in response to the rule. 315 See supra note 153. 316 In the 2015 Proposing Release, supra note 6, the Commission solicited comment on the effect of the proposed TAF amendments, including the effect should the TAF be assessed to non-FINRA member firms that choose to become FINRA members. With regard to the TAF, one Commenter stated that ‘‘it is impossible. . . to estimate the impact of this potentially significant cost.’’ See CTC Letter at 5. Another commenter shared similar thoughts. See FIA 1 Letter at 2. However, of the commenters that discussed this issue, most were in support of the TAF amendments. See FIA 2 Letter at 2, CTC Letter at 5, IEX Letter at 3, and HRT Letter at 11. For example, one commenter believes that ‘‘[c]hanges to TAF fees alone could potentially reduce the total costs of the Proposal to some firms by 90% or more.’’ See FIA 2 Letter at 2. 317 See IEX Letter at 3, PEAK6 Letter at 3, and HRT Letter at 5. 318 Section 3 fees are estimated using non-FINRA member firm off-exchange sell dollar volume calculated in CAT. The Section 3 fee obligation is calculated as: Non-FINRA member firm Sell Dollar Volume x $22.90/$1,000,000. The $22.90/ $1,000,000 is the FINRA fee rate for Fiscal Year 2022. See FINRA By-Laws of the Corporation, Schedule A to the By-Laws of the Corporation, Section 3—Regulatory Transaction Fee. See also Exchange Act Release No. 94644 (April 8, 2022), 87 FR 21931 (April 13, 2022) and press release, Commission, Fee Rate Advisory #1 for Fiscal Year PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 49965 may already be paid by non-FINRA member firms that engage the services of a member firm clearing broker. However, FINRA lacks the authority to assess Section 3 fees against non-FINRA member firms, in which case FINRA may assess the fee to the member firm counterparty to the transaction. In these cases, the FINRA-member may passthrough a portion of the fee to the nonFINRA member counterparty. While these fees would represent a cost to nonFINRA member firms, the cost would be largely offset to the industry as a whole by a reduction of Section 3 fees incurred by member firms (or clearing brokers acting on behalf of a member firm) when they buy from a self-clearing, nonFINRA member firm.319 Ongoing compliance costs would depend on the business circumstances of each firm and the types of issues that could arise. As in the case of the initial membership, some non-FINRA member firms may choose to conduct ongoing compliance activities in-house while others may seek to outsource this work.320 Based on discussions with industry participants, the Commission estimated that the ongoing compliance cost for firms that outsource this work would range from $24,000 to $96,000 per year, with a median of $60,000.321 In the case of some non-FINRA member firms, i.e., those that are affiliates of FINRA members, this cost is likely to be lower as they may be able to leverage compliance work already being performed. FINRA members may also be required to pay the median Personnel Assessment.322 The annual Personnel Assessment fee ranges from $130 to $150 per employee and applies to principals or representatives in the FINRA member’s organization. Using FOCUS data the Commission estimates that the average non-FINRA member firm would incur a Personnel Assessment fee of no more than $1,960, and the median non-FINRA member 2022 (April 8, 2022), available at https:// www.sec.gov/news/press-release/2022-60. 319 Currently, when the sell side of an offexchange transaction is a non-FINRA member firm, FINRA may assess the Section 3 fees on the buy side counterparty. See the discussion of Section 3 fees in Section VI.A.2, supra, for more information. 320 Ongoing compliance activities may include core accounting functions, updating policies and procedures, and updating forms filed with regulators. 321 For firms that choose to do this work in-house, the Commission estimates that the costs of ongoing compliance may be less than $96,000. This figure assumes non-FINRA member firms may have experience in ongoing compliance work with SROs through their exchange membership(s) and, therefore, only captures the incremental cost of compliance with Association rules. 322 See FINRA By-Laws, Schedule A, Section 1(e). E:\FR\FM\12AUP2.SGM 12AUP2 49966 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules firm would incur a Personnel Assessment fee of $0.323 The Commission further estimates that the maximum Personnel Assessment fee incurred by one of these non-FINRA member firms would be $18,330. The Commission estimates that the median ongoing cost for non-FINRA member firms would be $2,742,664. However, as discussed above, these costs could vary. The Section 3 fees which make up a large portion of these costs are likely to be overestimated for reasons stated above. Additionally, the TAF is likely to be underestimated. TABLE 4—MEDIAN FIRM ONGOING ANNUAL COSTS 1 Cost Median or average Gross Income: Assessment ................... Trading Activity Fee ...... Personnel Assessment .. Section 3 fee ................. Compliance work ........... $459,849.51 132,744.50 0 2,150,069.99 60,000 Total ....................... $2,742,664 1 See infra note 312 and accompanying text. The TAF cost also represents a transfer from current non-FINRA member firms to current member firms. The TAF is calculated using off-exchange sell volume from CAT. The Section 3 fee estimate assumes that the firms currently pay no Section 3 fees. It is likely that firms that clear through a member firm are currently assessed these fees indirectly. Median Personnel Assessment Fees are estimated to be zero based on analysis using FOCUS data. See supra note 323. jspears on DSK121TN23PROD with PROPOSALS2 In addition to the cost estimates discussed above, the Commission recognizes that both non-FINRA member firms and SROs would incur other direct and indirect costs because of the increased regulatory requirements of the amendments. Specifically, there would be compliance costs associated with regulation by FINRA.324 Additional costs would include actions that are required to accommodate normal supervision and examination by an Association. To the extent that they do not already do so, firms would face additional costs related to coming into compliance with Association rules. The Commission was not able to estimate these costs, although the costs would vary among non-FINRA member firms. Two commenters on the 2015 Proposal submitted estimates for the 323 Based on 2022 FOCUS data, the number of registered representatives of non-FINRA member firms that connect directly to ATSs ranges from 0– 163, with an average of 29 and a median of 0. 324 However, non-FINRA member firms that choose to join an Association may have FINRA assigned as their DEA. Such an assignment could eliminate separate DEA fees that the non-FINRA member firms may pay to their current DEA. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 cost of becoming FINRA members.325 In addition, many commenters stated that FINRA fees would be substantial and constitute a considerable sum,326 believing that FINRA fees would be unduly burdensome and outweigh perceived benefits.327 Several commenters believed in particular that FINRA membership would be costly to proprietary trading firms with no customer business.328 One commenter noted generally that FINRA should review its fees to ensure that those fees are proportionate to the actual costs of regulation.329 By contrast, one commenter noted that additional regulatory costs associated with FINRA membership would be ‘‘manageable’’ compared to the cost of the TAF.330 As stated above, to the extent FINRA amends the TAF consistent with what was previously proposed, the ongoing costs could be lower than these estimates. One commenter was concerned that FINRA’s membership fees would only rise with no competitive forces to restrain the increase of such fees.331 Furthermore, another commenter stated that FINRA membership fees are substantially higher than fees charged by some of the exchanges for DEA services.332 Several commenters also raised the concern that FINRA may get paid twice for its regulatory oversight— once, directly from the FINRA membership, and again, from the SROs that have outsourced regulatory oversight to FINRA through RSA agreements.333 However, FINRA fees must be filed with the Commission and such fees must be consistent with the Exchange Act.334 325 See CTC Letter at 5 (Estimating initial costs of $3.5 million and ongoing annual costs of $1.5 million per year), and FIA 2 Letter at 5 (Estimating initial costs of between $200,000 and $250,000 and ongoing costs of $100,000 per year). 326 See FIA 1 Letter at 1 (‘‘FINRA Membership would be costly to most proprietary trading firms’’); PEAK6 Letter at 2 (‘‘FINRA registration process is overly costly and burdensome’’); Hold Brothers Capital Letter at 2 (‘‘[Costs of FINRA membership] would be unduly burdensome to smaller, less well funded Proprietary Traders’’); Lakeshore Letter at 2, CTC Letter at 6, D&D Letter at 2, and PTR Letter at 2. 327 See Peak6 Letter at 2, D&D and PTR Letters at 2, Hold Brothers Capital Letter at 2, Lakeshore Letter at 3, and FIA 1 Letter at 2. 328 See FIA 1 Letter at 1, FIA 2 Letter at 2, and Hold Brothers Capital Letter at 2. 329 See SIFMA Letter at 3. 330 See HRT Letter at 5. 331 See CTC Letter at 6. 332 See HRT Letter at 5. 333 See CTC Letter at 6, SIFMA Letter at 3, D&D Letter at 2, and Lakeshore Letter at 3. 334 See supra note 154. PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 c. Costs of TRACE Reporting for NonFINRA Member Firms That Trade U.S. Treasury Securities Additionally, to the extent that a firm trades fixed income securities, they would also have implementation and ongoing costs associated with TRACE reporting. The Commission believes that four non-FINRA member firms have significant trading activities in U.S. Treasury securities markets. The Commission estimates that these firms will each have an initial cost of $2,025, associated with setting up systems for TRACE reporting. This cost includes the Direct Circuit Connectivity Fee for TRACE reporting through Nasdaq, in which Nasdaq facilitates the reporting to TRACE. FINRA does not charge a Transaction Reporting Fee for trading activity in U.S. Treasury securities markets.335 The Commission estimates an aggregate ongoing cost for each firm of $125,100. There are three ways for firms to connect into TRACE. First, firms may directly report with the FIX protocol through Nasdaq, who is the vendor. Second, firms may use a third party service bureau with FIX protocols to submit to TRACE. The costs of reporting via FIX protocols are outlined in Tables 3 and 4. The Commission does not have estimates for the cost of third party reporting to TRACE. Finally, firms with lower reporting requirements have the option of reporting using the Secure Web Interface known as FINRA TRAQS for a fee of $20 per month, which would allow these firms to avoid port fees and connection fees to Nasdaq’s FIX reporting system. Additionally, costs for these firms could be significantly lower for firms with low volume, as the reporting cost is based on the volume. To the extent that non-FINRA member firms trade in other TRACE reportable securities, such firms would also have higher reporting costs. If those firms trade U.S. Treasury securities, their implementation costs would be included in the Commission’s estimates above and they would incur only the additional marginal costs caused by their volume in other TRACE-reportable securities. However, to the extent that some non-FINRA member firms trade in other TRACE reportable securities but not U.S. Treasury securities, those firms would each incur implementation costs as described above. The Commission 335 TRACE charges a Transaction Reporting Fee for TRACE reported securities other than U.S. Treasury securities. The fee is as follows: $0.475/ trade for trade size up to and including $200,000 par value; $0.000002375 times the par value of the transaction (i.e., $0.002375/$1000) for trade size over $200,000 and up to and including $999,999.99 par value; $2.375/trade for trade size of $1,000,000 par value or more. E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules cannot estimate how many firms would be in this group of non-FINRA member firms that trade TRACE-reportable securities but not U.S. Treasury securities because the Commission can identify non-FINRA member counterparties in TRACE only for U.S. Treasury securities transactions that occur on covered ATSs, as discussed previously.336 TABLE—AVERAGE FIRM TRACE REPORTING IMPLEMENTATION COSTS Cost Median or average 1 FIX Port fee .......................... Direct Circuit Connectivity Fee for TRACE reporting through Nasdaq ................ $575 1,500 Total ............................... 2,025 1 Medians are used where possible. Direct Circuit Connection Fees can be found at https:// nasdaqtrader.com/Trader.aspx?id= PriceListTrading2. TABLE 6—AVERAGE FIRM TRACE REPORTING ONGOING ANNUAL COSTS Cost Median or average 1 Systems Fees ....................... Data Fee ............................... Nasdaq Connection Fee ....... Rule 7730 Service Fee ......... $4,800 90,000 30,000 300 Total ...................................... 125,100 1 The systems fee is calculated using Level II Full Service Web Browser Access fee for four datasets at $140 a month plus a subscription for four additional user IDs at $260 per month for a total of $400 per month multiplied by 12 months, for an annual systems fee of $4,800. Data Fees are calculated using $7,500 per month flat fee for the professional real time data display. Connectivity fee is calculated at $2,500 a month for an annual cost of $30,000. Fees can be found at https:// www.finra.org/rules-guidance/rulebooks/finrarules/7730. Nasdaq FIX connection fees can be found at https://nasdaqtrader.com/Trader. aspx?id=PriceListTrading2. jspears on DSK121TN23PROD with PROPOSALS2 d. Costs of Joining Additional Exchanges Under the Rule as Amended Non-FINRA member firms must be members of all exchanges upon which they transact business if they decide not to join an Association. With limited exceptions for some excluded activity, some non-FINRA member firms may choose to join additional exchanges to be excluded from the requirement to become a member of an Association. Alternatively, these firms may cease trading on exchanges of which they are not members. 336 See supra Section VI.A.1. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 Based on discussions with FINRA and industry participants, the Commission understands that completing a membership application with an additional exchange is generally less complicated and time consuming than completing a membership application with FINRA. Consequently, the Commission believes that the compliance burden on non-FINRA member firms for joining an additional exchange is likely to be significantly less than that of joining FINRA as those non-FINRA member firms that choose to join an additional exchange are likely able to perform this work internally, given that they are already members of at least one exchange, and that such work should take less time than the time required to complete an application with FINRA. However, the aggregate cost of joining multiple exchanges would likely be more costly than the cost of joining FINRA. In addition to the legal burden, nonFINRA member firms joining additional exchanges as a result of the proposed amendments would incur membership and related fees. To the extent that nonFINRA member firms choose to become members of additional exchanges, the fees associated with such memberships would vary depending on the type of access sought and the exchanges of which non-FINRA member firms choose to become members. The Commission also believes that the exchange membership fees that would apply to non-FINRA member firms joining such exchanges would be those fees that apply to either introducing brokers or dealers or proprietary trading firms. This assumption is consistent with the fact that any brokers or dealers carrying customer accounts could not qualify for the current exemption of Rule 15b9–1. Thus, any exchange membership fees that apply to firms that provide clearing services or conduct a public business would not apply to nonFINRA member firms. Furthermore, because all non-FINRA member firms are members of at least one exchange,337 they would have already completed a Form U4, to register associated persons.338 The Commission believes non-FINRA 337 For a broker or dealer to possibly be exempt from the requirement to be an Association member currently or under the amendments, the broker or dealer must be a member of at least one exchange. 338 Form U4 is the Uniform Application for Securities Industry Registration or Transfer. Representatives of brokers and dealers, investment advisers, or issuers of securities use Form U4 to become registered in the appropriate jurisdictions and/or with SROs. All SROs currently use Form U4. See, e.g., Cboe BYX Rule 2.5 Interpretations and Policies .01(c), and Nasdaq PHLX Rule General 3, Section 7. PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 49967 member firms would not need to register additional associated persons because the exchange SRO rules already require them to register associated persons. The Commission understands that all exchanges can access the Form U4 filings within the CRD which is maintained by FINRA. To obtain estimates of the cost of joining additional exchanges, the Commission reviewed the membershiprelated fee structures of all twenty-four national securities exchanges. In assuming that the potential burden of joining additional exchanges would likely be less than that of joining FINRA, the Commission assumes that the costs imposed on non-FINRA member firms by the amendments would be membership fees, and not costs relating to trading, such as trading permit fees and connectivity fees. The Commission recognizes that membership alone in an exchange may not guarantee the ability to trade because many exchanges charge fees for trading rights, ports, various degrees of connectivity, and floor access and equipment, should those be desired. The fees associated with trading on an exchange are not the result of the amendments because, under the amendments, a non-FINRA member firm could continue to trade through another broker or dealer on an exchange as long as that non-FINRA member firm is a member of every exchange on which it trades or is a member of FINRA. In other words, the amendments themselves do not impose the cost of connectivity and related fees, but only the costs associated with membership on exchanges on which non-FINRA member firms could trade. To the extent, therefore, that non-FINRA member firms continue to trade through other brokers or dealers in a manner consistent with how they currently operate, the amendments impose only the costs associated with membership. To arrive at estimates of the cost of joining additional exchanges, the Commission aggregated any fees associated with a firm’s initial application to an exchange (‘‘initial fee’’) and separately aggregated the fees associated with any monthly or annual membership costs to obtain a separate annual cost (‘‘annual fee’’). Based on these aggregations, the Commission obtained a range for both the initial fee and the annual fee across exchanges. The initial fee is as low as $0 for some exchanges. Most exchanges have an E:\FR\FM\12AUP2.SGM 12AUP2 49968 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules initial fee that is greater than $0 and no more than $5,000.339 Regarding monthly or annual membership fees, most exchanges’ ongoing monthly or annual membership fees generally range from $1,500 to $7,200.340 Again, these ongoing exchange membership costs are generally lower than the annual costs estimated for being a member of FINRA. jspears on DSK121TN23PROD with PROPOSALS2 e. Policies and Procedures Related to the Narrowed Criteria for Exemption From Association Membership Non-FINRA member firms that choose not to join an Association but wish to continue to trade off-exchange (or on exchanges of which they are not members) must do so in a manner that conforms to the routing or stock-option order exemptions. To rely on the stockoption order exemption, the proposal would require non-FINRA member firms to establish, maintain, and enforce policies and procedures as discussed above.341 The Commission estimates that firms would incur a burden of 8 hours in initially preparing these 339 IEX does not assess any initial fees. See IEX Exchange Fee Schedule, available at https:// exchange.iex.io/resources/trading/fee-schedule/ (last visited July 22, 2022) (omitting any mention of an initial membership fee). Other exchanges do have initial application fees. See, e.g., Nasdaq ISE Fee Schedule, Options 7, Section 9, available at https://listingcenter.nasdaq.com/rulebook/ise/rules/ ise-options-7 (last visited July 22, 2022) (assessing a one-time application fee of $3,500 for an ‘‘Electronic Access Member’’); Membership Application for New York Stock Exchange LLC and NYSE American LLC at 2 (Oct. 2019), available at https://www.nyse.com/publicdocs/nyse/markets/ nyse/NYSE_and_American_Membership_ Application.pdf (last visited July 22, 2022) (discussing the Non-Public Firm Application Fee of $2,500); Nasdaq Price List, available at https:// www.nasdaqtrader.com/Trader.aspx?id= PriceListTrading2 (last visited July 22, 2022) (discussing the Nasdaq Application Fee of $2,000); Cboe Fee Schedule at 10 (June 30, 2022), available at https://cdn.cboe.com/resources/membership/ Cboe_FeeSchedule.pdf (last visited July 22, 2022) (typically assessing a trading permit holder organization application fee on all of its members of $5,000). If a firm is organized as a sole proprietorship, the application fee for Cboe is only $3,000. Id. 340 See, e.g., Cboe BYX Exchange, Inc. Fee Schedule (eff. May 2, 2022), available at https:// www.cboe.com/us/equities/membership/fee_ schedule/byx/ (last visited July 22, 2022) (noting an annual membership fee of $2,500); Cboe EDGA Exchange, Inc. Fee Schedule (eff. Apr. 1, 2022), https://www.cboe.com/us/equities/membership/fee_ schedule/edga/ (last visited July 22, 2022) (same); NYSE Chicago, Inc. Fee Schedule (updated Jan. 2, 2022), available at https://www.nyse.com/ publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf (last visited July 22, 2022) (assessing an annual membership fee of $7,200); MIAX Fee Schedule at 20 (Mar. 1, 2022), available at https:// www.miaxoptions.com/sites/default/files/fee_ schedule-files/MIAX_Options_Fee_Schedule_ 03012022.pdf (last visited July 22, 2022) (assessing a monthly trading permit fee for an ‘‘Electronic Exchange Member’’ of $1,500). 341 See supra section III.B.2. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 policies and procedures.342 Furthermore, the burden of maintaining and enforcing such policies and procedures, including a review of such policies at least annually, would be approximately 48 hours.343 The Commission estimated an initial implementation cost of approximately $2,561 and an annual ongoing cost of approximately $15,708 for non-FINRA member firms that wish to utilize the exemptions and perform this work internally; for firms that outsource this work, costs are likely to be higher.344 Firms that choose to join FINRA would not incur these costs as the exemptions would not be relevant. f. Indirect Costs In addition to possibly incurring costs related to joining exchanges, non-FINRA member firms that choose not to join an Association would lose the benefits of trading in off-member-exchange markets. As mentioned above, nonFINRA member firms are significant participants in off-exchange activity. Much of this trading is attributed to 12 non-FINRA member firms, and the activity level across those firms varies widely. The Commission estimates that those 12 non-FINRA member firms executed $744 billion in off-exchange volume in September of 2021, while the remaining non-FINRA member firms executed $46 billion. The Commission cannot estimate the likelihood of these firms choosing to cease off-exchange activity rather than joining an Association. One commenter echoed these concerns when it stated that non342 This figure is based on the following: (Compliance Manager at 5 hours) + (Compliance Attorney at 2.5 hours) + (Director of Compliance at 0.5 hours) = 8 burden hours per dealer. See infra note 357. As is discussed in more detail in the Paperwork Reduction Act discussion, the Commission based this estimate on the estimated burdens imposed by other rules applicable to brokers and dealers, such as Regulation SBSR. See also infra note 359. 343 This figure is based on the following: (Compliance Manager at 30 hours) + (Compliance Attorney at 12 hours) + (Director of Compliance at 6 hours) = 48 burden hours per broker or dealer. See infra note 358. 344 For firms that perform this work internally, the initial cost estimate assumes 5 hours of work performed by a Compliance Manager at an hourly rate of $293, 2.5 hours performed by Compliance Attorneys at an hourly rate of $346, and 0.5 hour of work performed by the Director of Compliance at an hourly rate of $461. The annual cost estimate assumes 30 hours of work by a Compliance Manager at an hourly rate of $293, 12 hours by Compliance Attorneys at an hourly rate of $346, and 6 hours by the Director of Compliance at an hourly rate of $461. Hourly salary figure is from SIFMA’s Management & Professional Earnings in the Securities Industry 2013, modified by Commission staff to account for an 1800 hour workyear and inflation and multiplied by 5.35 to account for bonuses, firm size, employee benefits and overhead. PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 members may ‘‘curtail all off-exchange trading’’ if the high costs of FINRA membership outweigh the profits.345 The commenter believes that some firms may withdraw their broker or dealer registration and trade as a customer of a broker or dealer in order to eliminate other membership costs.346 The Commission believes that this is a possibility and could result in less competition and could degrade market quality and regulatory oversight.347 Finally, those firms that choose not to join an Association would be limited in their ability to route their own transactions to comply with the requirements of Regulation NMS and the Options Linkage Plan.348 Their transactions would have to be routed through a broker or dealer of an exchange of which they are a member, or routed by a broker or dealer only to those exchanges of which they are members. The routing of orders of nonFINRA member firms that do not join an Association would be determined by the routing broker or dealer of the exchanges of which they are members. This loss in choice could lead to higher costs for routing and costs associated with increased latency because the exchange’s routing broker or dealer may have a telecommunications infrastructure that is inferior to that of the broker or dealer that previously provided connectivity to that exchange to the non-FINRA member firm.349 D. Alternatives 1. Include a Floor Member Hedging Exemption The Commission could provide an exemption from Association membership if a dealer that meets the criteria of paragraphs (a) and (b) of the rule, conducts business on the floor of a single exchange, and its trading elsewhere is proprietary and solely for the purpose of hedging its floor-based exchange trading activity on its member exchange. The hedging exemption could be limited to firms that trade on the floor of a national securities exchange. Specifically, the alternative would provide that a dealer that conducts 345 See HRT Letter at 10. 346 Id. 347 Id. 348 The exemption related to routing to comply with Regulation NMS and the Options Linkage Plan is discussed in supra section III.B.1. 349 Firms in the business of providing connectivity to exchanges are likely to compete on the basis of their technology. The Commission assumes that some firms that do not join FINRA will have some orders (those governed under the Regulation NMS or the Options Linkage Plan provisions to prevent trade-throughs) routed using technology inferior to the technology of their firm of choice. E:\FR\FM\12AUP2.SGM 12AUP2 jspears on DSK121TN23PROD with PROPOSALS2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules business on the floor of only a single national securities exchange may affect transactions in securities otherwise than on that exchange, for the dealer’s own account with or through another registered broker or dealer, that are solely for the purpose of hedging the risks of its floor-based exchange activity, by reducing or otherwise mitigating the risks thereof. The alternative proposal also could require a dealer seeking to rely on this exemption to establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that such hedging transactions reduce or otherwise mitigate the risks of the financial exposure the dealer incurs as a result of its floor-based activity, and to preserve a copy of its policies and procedures in a manner consistent with 17 CFR 240.17a-4 until three years after the date the policies and procedures are replaced with updated policies and procedures. The Commission believes that this alternative could provide a limited exemption from Association membership that is consistent with the original design of Rule 15b9–1’s exclusion for proprietary trading. Today, few dealers limit their quoting and other non-hedging trading activities to a particular exchange. Under this alternative, the registered dealers among this group that limit their primary trading business to a single exchange floor may continue to hedge the risk of that business by effecting securities transactions on another exchange or in the off-exchange market that are solely for the purpose of hedging the dealers’ on-exchange activity, without such transactions triggering a requirement to join an Association. The Commission also believes that this alternative approach, and in particular the limitation of its coverage to dealers that engage in floor trading and are a member of only a single exchange, could be consistent with the public interest and the protection of investors. A dealer’s hedging activity resulting from its trading activity on multiple exchanges of which the dealer is a member presents cross-market surveillance concerns as previously discussed, and therefore FINRA would be in the best position to conduct regulatory oversight to the extent that the dealer’s hedging transactions take place elsewhere than on exchanges of which it is a member. By contrast, so long as a dealer’s hedging activity results from floor trading activity that is confined to a single exchange of which the dealer is a member, that exchange could be able to adequately supervise the hedging activities of the dealer, VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 consistent with the public interest and protection of investors. In addition, requiring written policies and procedures, as described above, would facilitate exchange supervision of dealers relying on such floor member hedging exemption, as it could provide an efficient and effective way for the relevant exchange to assess compliance with the proposed exemption. This could further serve the public interest and help protect investors. Because the alternative hedging exemption for floor traders is intended to allow a dealer to reduce or otherwise mitigate its risk, such as position risk, incurred in connection with its exchange-based dealer activities, it would be limited to transactions for the dealer’s own account. In addition, because the dealer would not itself be a member of any other national securities exchange on which hedging transactions may be effected, or of an Association, such transactions would need to be conducted with or through another registered broker or dealer that is a member of such other national securities exchange or a member of an Association (or of both). However, the Commission believes that this alternative exemption would currently apply to very few and as little as zero non-FINRA member firms. Given that so few non-FINRA member firms would qualify for the exemption, the Commission believes that there is little value in including such an exemption. Additionally, by including the exemption the Commission believes that unforeseen circumstances could allow for firms to take advantage of the exemption in the future in ways that are not consistent with the original intent of the exemption, much like firms currently rely on Rule 15b9–1 in ways that are not consistent with the original intent. 2. Exchange Membership Alternative The amendments, in accordance with Section 15(b)(8), preclude any firm that is not a member of an Association from trading on exchanges of which it is not a member.350 Further, under the amendments, if a firm becomes a member of an Association, it would not have to become a member of each exchange upon which it trades.351 The Commission has also considered requiring brokers and dealers to become 350 The amendments provide limited exemptions for order routing to satisfy certain provisions of Regulation NMS and the Options Linkage Plan and for executing the stock leg of a stock-option order. 351 In order to trade on exchanges of which it is not a member, the firm would have to trade with or through another broker or dealer that is a member of that exchange. PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 49969 a member of every exchange on which they trade and to become a member of an Association to trade off-exchange (‘‘Exchange Membership Alternative’’). In considering the Exchange Membership Alternative, the Commission weighed whether the same issue of off-exchange activity not being subject to effective regulatory oversight that exists when a non-FINRA member firm trades off-exchange is present when a member or non-FINRA member firm trades on an exchange of which it is not a member (through a member of that exchange). The Commission continues to believe that the amendments adequately address the issue of establishing effective oversight of offexchange activity and that the more onerous Exchange Membership Alternative would not provide any additional regulatory benefit beyond the benefits the amendments provide for several reasons. First, while some exchanges may lack specialized regulatory personnel to directly surveil their members’ trading off-exchange, FINRA has these resources to surveil the activity of member firms both on exchanges and off-exchange. Accordingly, requiring member firms to also become members of each exchange on which they effect transactions, including indirectly, would be unnecessarily duplicative because FINRA already has the resources necessary to surveil the activity of a member firm trading on an exchange of which it is not a member. In addition, while some exchanges do not have a specialized rule set to govern their members’ activity in the off-exchange market, FINRA’s rules are often consistent with the trading rules of exchanges on which members transact.352 If a member firm were to violate an exchange rule on an exchange of which it is not a member, FINRA would have the jurisdiction needed to address the resulting violation. Therefore, not requiring that the member firm also become a member of that exchange would not prevent FINRA from exercising jurisdiction over the matter. The Exchange Membership Alternative might have required firms to become members of more SROs than required under the proposed amendments, which would impose additional costs. In particular, some non-FINRA member firms that would become member firms under the proposed amendments would also need to become members of additional exchanges or cease trading on those exchanges. In addition, some current 352 See E:\FR\FM\12AUP2.SGM supra notes 53–54 and accompanying text. 12AUP2 49970 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules member firms would also need to become members of additional exchanges. 3. Retaining the De Minimis Allowance The Commission considered retaining the $1,000 de minimis allowance for trading other than on an exchange of which the non-FINRA member firm is a member but removing the exception for proprietary trading conducted with or through another registered broker or dealer. As discussed above,353 the Commission continues to believe that the magnitude of the de minimis allowance is no longer economically meaningful. Furthermore, the Commission continues to believe that the commission sharing arrangements discussed previously 354 are rarely, if ever, used. jspears on DSK121TN23PROD with PROPOSALS2 4. Eliminate the Rule 15b9–1 Exemption The Commission could eliminate Rule 15b9–1 altogether, leaving no exemption from Section 15(b)(8) of the Act. This would cause all current non-FINRA member firms that effect off-memberexchange securities transactions to be required by Section 15(b)(8) to join FINRA, which could improve FINRA’s ability to surveil activity of member firms both on and off exchange, as well as investigate potentially violative behavior. Though, the Commission believes that such violative behavior by such firms may be easily identifiable under the proposed amendments, due to the fact that the proposed exemptions are narrow. However, eliminating the exemption for firms that would qualify for the routing exemption or the stockoption order exemption may prove to unnecessarily increase the costs for such firms. The Commission also believes that the routing exemption and stockoption order exemption will provide important avenues for providing liquidity and, therefore, eliminating the exemptions may drive these firms from the market and lead to a reduction in liquidity and market quality. E. Request for Comment on Economic Analysis The Commission requests comment on all aspects of this Economic Analysis, including whether the analysis has: (1) identified all benefits and costs, including all effects on efficiency, competition, and capital formation; (2) given due consideration to each benefit and cost, including each effect on efficiency, competition, and capital formation; and (3) identified and considered reasonable alternatives to 353 See supra section III.A. 354 Id. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 the proposed rule amendments. We request and encourage any interested person to submit comments regarding the proposed rules, our analysis of the potential effects of the proposed amendments, and other matters that may have an effect on the proposed rules. We request that commenters identify sources of data and information as well as provide data and information to assist us in analyzing the economic consequences of the proposed rules and proposed amendments. We also are interested in comments on the qualitative benefits and costs we have identified and any benefits and costs we may have overlooked. In addition to our general request for comments on the Economic Analysis associated with the proposed rules and proposed amendments, we request specific comment on certain aspects of the proposal: 61. Regulatory Structure and Activity Levels of Non-FINRA Member Firms. The Economic Analysis discusses the current landscape for non-FINRA member firms. • Is the Commission’s description of the current activity levels of non-FINRA member firms accurate? If not, can you provide additional data to better describe non-FINRA member firms’ activity levels? • Is there information or data on the trading activity level of non-FINRA member firms, in TRACE reportable securities other than U.S. Treasury securities? If so, please provide data. 62. Current Market Oversight. The Economic Analysis describes the current structure of market oversight for non-FINRA member firms: • Is the Commission’s description of current market oversight accurate? Why or why not? 63. Effects on Regulatory Supervision. Under the amendments, some nonFINRA member firms would be required to join an Association and be subject to additional market oversight. • Would the proposed amendment improve regulatory oversight of current non-FINRA member firms? If not, is there currently adequate oversight of non-FINRA member firms? • Would improved regulatory oversight improve market quality in financial markets? • Would the proposed rules improve transparency for non-FINRA member firms that have significant trading activities in U.S. Treasury securities markets? • Are there significant limitations, beyond those discussed above, in the economic analysis of the effect on regulatory supervision? PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 64. Firm Response and Effect on Market Activity. Under the proposed amendment, non-FINRA member firms would be required to either join an Association or change their trading practices to qualify for an exemption. • Will some non-FINRA member firms change their business practices, including ceasing to trade securities, as opposed to joining an Association as a result of the proposed amendments? Why or why not? • Will some non-FINRA member firms join each exchange on which they trade as opposed to joining an Association as a result of the proposed amendments? Why or why not? • Will the proposed amendments lead to a reduction of liquidity as a result of non-FINRA member firms changing their business practices as due to the proposed amendments? Why or why not? 65. Competitive Effects on OffExchange Market Regulation. The proposed amendments may create an incentive for the creation of another Association to compete with FINRA. • Could the proposed amendments provide a strong enough incentive for the creation of a second Association? Why or why not? Do you believe that there are barriers to entry that would prevent a second Association from being formed? 66. Effects on Current FINRA Member Firms. The proposed amendments are likely to have indirect effects on FINRA member firms as well. • Would the proposed amendments create a more level regulatory playing field for FINRA member firms relative to non-FINRA member firms? 67. Effects on Price Discovery • Would the proposed amendments decrease competitive advantages and reduce costs borne by the investing public through increased price discovery? Why or why not? 68. Costs. The proposed amendments will have several direct costs for nonFINRA member firms. • Has the proposal accurately described the costs to non-FINRA member firms? Why or why not? • Has the proposal accurately estimated the fees assessed by FINRA? If not, can you provide estimates? • In 2015 FINRA proposed amendments to the TAF in response to a previous Commission proposal to amend the 15b9–1 exemption. If the proposed FINRA amendments are adopted, how would this change the economic effects? 69. Alternatives. The Commission listed several reasonable alternatives. • Do you believe that the economic effects of each of the provided E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules alternatives has been accurately described and evaluated? • Are there other alternatives? • How many non-FINRA members would qualify for a floor trading hedging exemption? Is zero accurate? jspears on DSK121TN23PROD with PROPOSALS2 VII. Paperwork Reduction Act Certain provisions of the proposed amendments to Rule 15b9–1 contain ‘‘collection of information requirements’’ within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).355 As discussed in Section III.B, the proposed amendments to Rule 15b9–1, if adopted, would require brokers or dealers relying on the stockoption order exemption to establish, maintain, and enforce certain written policies and procedures. Compliance with these collections of information requirements would be mandatory for firms relying on the amended rule. The Commission is submitting these collections of information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title of this new collection of information is ‘‘Rule 15b9–1 Exemptions.’’ An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the agency displays a currently valid control number. A. Summary of Collection of Information The proposed amendments to Rule 15b9–1 include a collection of information within the meaning of the PRA for brokers or dealers relying on the stock-option order exemption under the amended rule. The stock-option order exemption under the amendments to Rule 15b9–1 would permit a qualifying broker or dealer to effect securities transactions otherwise than on an exchange where it is a member, with or through another broker or dealer, that are solely for the purpose of executing the stock leg of a stock-option order. Brokers or dealers relying on this exemption would be required to establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that such transactions are solely for the purpose of executing the stock leg of a stock-option order. In addition, such brokers or dealers would be required to preserve a copy of their policies and procedures in a manner consistent with Rule 17a–4 until three years after the date the policies and procedures are replaced with updated policies and procedures. 355 44 U.S.C. 3501 et seq. VerDate Sep<11>2014 18:07 Aug 11, 2022 B. Proposed Use of Information The policies and procedures required under amended Rule 15b9–1 would be used by the Commission and SROs to understand how brokers and dealers relying on the exemption evaluate whether the securities transactions that they effect elsewhere than an exchange where they are a member are solely for the purpose of executing the stock leg of a stock-option order and, more generally, how such brokers and dealers are complying with the requirements of the exemption and Rule 15b9–1. These policies and procedures would be used generally by the Commission as part of its ongoing efforts to monitor and enforce compliance with the federal securities laws, including Section 15(b)(8) of the Act and Rule 15b9–1 thereunder. In addition, SROs may use the information to monitor and enforce compliance by their members with applicable SRO rules and the federal securities laws. C. Respondents The Commission believes that a small number of brokers or dealers would rely on the stock-option order exemption. The Commission estimates that, based on publicly available information reviewed covering the end of April 2022, there are approximately 65 brokers-dealers registered with the Commission that are currently a member of an exchange but not a member of an Association. The Commission believes that some, but not all, of these brokers-dealers would likely choose to avail themselves of the stockoption order exemption, because not all of them handle stock-option orders or, for those that do handle stock-option orders, they may effect the execution of stock leg components of those orders on exchanges where they are a member. The Commission estimates that seven firms could potentially rely on the stock-option order exemption and would therefore be required to comply with the policies and procedures requirement.356 The Commission believes that some of these firms could want the ability to effect securities transactions elsewhere than an exchange where they are a member that are not for the purpose of executing the stock leg of a stock-option order, and may, accordingly, choose to join an Association as a result of the amendments to Rule 15b9–1. D. Total Initial and Annual Reporting and Recordkeeping Burdens The Commission estimates that the one-time, initial burden for a broker or 356 See Jkt 256001 PO 00000 supra section III.B.2. Frm 00043 Fmt 4701 Sfmt 4702 49971 dealer to establish written policies and procedures as required under amended Rule 15b9–1 would be approximately 8 hours.357 This figure is based on the estimated number of hours to develop a set of written policies and procedures, including review and approval by appropriate legal personnel. The Commission notes that the policies and procedures proposed in the amended rule are limited to those transactions that are solely for the purpose of executing the stock leg of a stock-option order. In addition, the Commission estimates that the annual burden of maintaining and enforcing such policies and procedures, including a review of such policies at least annually, would be approximately 48 hours for each broker or dealer.358 This figure includes an estimate of hours related to reviewing existing policies and procedures, making necessary updates, conducting ongoing training, maintaining relevant systems and internal controls, performing necessary testing and monitoring of stock-leg transactions as they relate to the broker’s or dealer’s activities and maintaining copies of the policies and procedures for the period of time required by the amended rule. The Commission estimates that the initial, first year burden associated with amended Rule 15b9–1 would be 56 hours per broker or dealer, which corresponds to an initial aggregate burden of 392 hours.359 The Commission estimates that the ongoing annualized burden associated with Rule 15b9–1 would be 48 hours per broker or dealer, which corresponds to an ongoing 357 This figure is based on the following: (Compliance Manager at 5 hours) + (Compliance Attorney at 2.5 hours) + (Director of Compliance at 0.5 hour) = 8 burden hours per broker or dealer. 358 This figure is based on the following: (Compliance Manager at 30 hours) + (Compliance Attorney at 12 hours) + (Director of Compliance at 6 hours) = 48 burden hours per broker or dealer. 359 This figure is based on the following: ((8 burden hours per broker or dealer) + (48 burden hours per broker or dealer)) × (7 brokers and dealers) = 392 burden hours during the first year. In estimating these burden hours, the Commission also examined the estimated initial and ongoing burden hours imposed on registered security-based swap dealers under Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information. See Exchange Act Release No. 74244 (February 11, 2015) 80 FR 14564, 14683 (March 19, 2015) (‘‘Regulation SBSR’’). Regulation SBSR requires registered security-based swap dealers to establish, maintain, and enforce written policies and procedures that are reasonably designed to ensure compliance with any security-based swap transaction reporting obligations. Id. The estimated initial and ongoing compliance burden on registered security-based swap dealers under Regulation SBSR were 216 burden hours and 120 burden hours, respectively. Id. The policies and procedures under the proposed amendments to Rule 15b9–1 are much more limited in nature. E:\FR\FM\12AUP2.SGM 12AUP2 49972 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules annualized aggregate burden of 336 hours.360 E. Collection of Information Is Mandatory All of the collection of information discussed above would be mandatory. F. Confidentiality of Responses to Collection of Information To the extent that the Commission receives confidential information pursuant to the collection of information, such information will be kept confidential, subject to the provisions of applicable law.361 G. Retention Period for Recordkeeping Requirements Brokers or dealers seeking to take advantage of the stock-option order exemption would be required to preserve a copy of their policies and procedures in a manner consistent with Rule 17a–4 362 until three years after the date the policies and procedures are replaced with updated policies and procedures. jspears on DSK121TN23PROD with PROPOSALS2 H. Request for Comments Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comment to: 70. Evaluate whether the proposed collection of information is necessary for the proper performance of our functions, including whether the information shall have practical utility; 71. Evaluate the accuracy of our estimate of the burden of the proposed collection of information; 72. Determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and 73. Evaluate whether there are ways to minimize the burden of collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology. Persons submitting comments on the collection of information requirements 360 This figure is based on the following: (48 burden hours per broker or dealer) $× (7 brokers and dealers) = 336 ongoing, annualized aggregate burden hours. 361 See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing the public availability of information obtained by the Commission). 362 17 CFR 240.17a–4. Registered brokers and dealers are already subject to existing recordkeeping and retention requirements under Rule 17a–4. However, amended Rule 15b9–1 contains a requirement that a broker or dealer relying on the stock-option order exemption preserve a copy of its policies and procedures in a manner consistent with Rule 17a–4 until three years after the date the policies and procedures are replaced with updated policies and procedures. The burdens associated with this recordkeeping obligation have been accounted for in the burden estimates discussed above for amended Rule 15b9–1. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 should direct them to the Office of Management and Budget, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Washington, DC 20503, and should also send a copy of their comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090, with reference to File Number S7–05–15. Requests for materials submitted to OMB by the Commission with regard to this collection of information should be in writing, with reference to File Number S7–05–15 and be submitted to the Securities and Exchange Commission, Office of FOIA/PA Services, 100 F Street NE, Washington, DC 20549–2736. As OMB is required to make a decision concerning the collections of information between 30 and 60 days after publication, a comment to OMB is best assured of having its full effect if OMB receives it within 30 days of publication. VIII. Consideration of Impact on Economy For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, (‘‘SBREFA’’),363 the Commission requests comment on the potential effect of the proposed amendments to Rule 15b9–1 on the United States economy on an annual basis. The Commission also requests comment on any potential increases in costs or prices for consumers or individual industries, and any potential effect on competition, investment, or innovation. Commenters are requested to provide empirical data and other factual support for their views to the extent possible. IX. Regulatory Flexibility Act Certification Section 3(a) of the Regulatory Flexibility Act of 1980 364 (‘‘RFA’’) requires the Commission to undertake an initial regulatory flexibility analysis of the impact of the rule amendments on small entities unless the Commission certifies that the rule would not have a significant economic impact on a substantial number of small entities.365 For purposes of Commission rulemaking in connection with the RFA,366 a small 363 Public Law 104–121, Title II, 110 Stat. 857 (1996) (codified in various sections of 5 U.S.C., 15 U.S.C., and as a note to 5 U.S.C. 601). 364 5 U.S.C. 603(a). 365 5 U.S.C. 605(b). 366 Although Section 601(b) of the RFA defines the term ‘‘small entity,’’ the statute permits agencies to formulate their own definitions. The Commission has adopted definitions for the term ‘‘small entity’’ for the purposes of Commission rulemaking in accordance with the RFA. Those definitions, as relevant to this rulemaking, are set forth in Rule 0– PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 entity includes a broker or dealer that: (1) had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to Rule 17a–5(d) under the Exchange Act,367 or, if not required to file such statements, a broker or dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and (2) is not affiliated with any person (other than a natural person) that is not a small business or small organization.368 The Commission examined recent FOCUS data for the 3,528 active brokers and dealers overseen by the Commission, including 3,454 brokers and dealers that are FINRA members and the 65 non-FINRA member firms as of April 2022 and estimates that not more than four of the affected entities have net capital of $500,000 or less and are not affiliates of larger organizations. The Commission oversees approximately 3,528 brokers and dealers, of which 740 have net capital of $500,000 or less and are not affiliates of larger organizations.369 Because the Commission estimates that not more than four small entities out of 740 total small entities currently registered with the Commission would be required to become FINRA members as a result of the proposed rule changes, the Commission certifies that the proposed amendments to Rule 15b9–1 would not, if adopted, have a significant economic impact on a substantial number of small entities.370 10 under the Exchange Act, 17 CFR 240.0–10. See Exchange Act Release No. 18451 (January 28, 1982), 47 FR 5215 (February 4, 1982) (File No. AS–305). 367 17 CFR 240.17a–5(d). 368 See 17 CFR 240.0–10(c). 369 Data from FOCUS for Quarter 4 of 2021. 370 One commenter to the 2015 Proposal disagreed with the Commission’s certification in the 2015 Proposal and stated that the amended rule would have a significant economic impact on a substantial number of small entities. Specifically, the commenter stated that 12 options exchange member firms that were not FINRA members in reliance on current Rule 15b9–1 conduct offexchange trading on behalf of their clients, were likely small entities, and would not be eligible for the then-proposed dealer hedging exemption. See NYSE/NASDAQ Letter at 4 and n. 5. Since the Commission no longer is including a hedging exemption in amended Rule 15b9–1, these firms could still be impacted by the amended rule. But the Commission preliminarily believes that these options exchange member firms’ off-exchange trading could be stock trading in relation to their handling of stock-option orders and, therefore, these firms may be able to rely on the stock-option order exemption that the Commission is proposing today. Moreover, as noted above, the Commission now estimates that not more than four small entities would be impacted by the proposed amendments to E:\FR\FM\12AUP2.SGM 12AUP2 Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / Proposed Rules Requests for Comment: The Commission requests comment on all aspects of the foregoing certification as well as, in particular, on the following questions: 74. We solicit comment as to whether the proposed amendments could have impacts on small entities that have not been considered. We request that commenters describe the nature of any impacts on small entities and provide empirical data to support the extent of such effect, including the magnitude of any economic impact the proposed amendments would have on small entities. 75. Do commenters believe that the proposed amendments would have a significant economic impact on a substantial number of small entities? If so, how should the Commission alter the proposed amendments to lessen the impact on these entities? Such comments will be placed in the same public file as comments on the proposed amendments to Rule 15b9–1. Persons wishing to submit written comments should refer to the instructions for submitting comments in the front of this release. X. Statutory Authority The Exchange Act, 15 U.S.C. 78a et seq., and particularly sections 3, 15, 15A, 17, 19, 23, and 36 thereof. jspears on DSK121TN23PROD with PROPOSALS2 Rule 15b9–1. As a result, the Commission believes that the proposed amendments to Rule 15b9–1 would not have a significant impact on a substantial number of small entities. VerDate Sep<11>2014 18:07 Aug 11, 2022 Jkt 256001 List of Subjects in 17 CFR Part 240 Brokers, Dealers, Registration, Securities. For the reasons set out in the preamble, the Commission proposes to amend Title 17, Chapter II of the Code of Federal Regulations as follows: PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The authority citation for part 240 continues to read in part as follows: ■ Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 80b– 11, 7201, et seq.; and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and Pub. L. 111–203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112–106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted. * * * * * 2. Section 240.15b9–1 is revised to read as follows: ■ § 240.15b9–1 Exemption for certain exchange members. Any broker or dealer required by section 15(b)(8) of the Act (15 U.S.C. 78o(b)(8)) to become a member of a registered national securities association shall be exempt from such requirement if it: (a) Is a member of a national securities exchange; (b) Carries no customer accounts; and (c) Effects transactions in securities solely on a national securities exchange PO 00000 Frm 00045 Fmt 4701 Sfmt 9990 49973 of which it is a member, except that with respect to this paragraph (c): (1) A broker or dealer may effect transactions in securities otherwise than on a national securities exchange of which the broker or dealer is a member that result solely from orders that are routed by a national securities exchange of which the broker or dealer is a member to comply with 17 CFR 242.611 or the Options Order Protection and Locked/Crossed Market Plan; or (2) A broker or dealer may effect transactions in securities otherwise than on a national securities exchange of which the broker or dealer is a member, with or through another registered broker or dealer, that are solely for the purpose of executing the stock leg of a stock-option order. A broker or dealer seeking to rely on this exception shall establish, maintain and enforce written policies and procedures reasonably designed to ensure and demonstrate that such transactions are solely for the purpose of executing the stock leg of a stock-option order. Such broker or dealer shall preserve a copy of its policies and procedures in a manner consistent with 17 CFR 240.17a–4 until three years after the date the policies and procedures are replaced with updated policies and procedures. * * * * * By the Commission. Dated: July 29, 2022. J. Matthew DeLesDernier, Deputy Secretary. [FR Doc. 2022–16711 Filed 8–11–22; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\12AUP2.SGM 12AUP2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 87, Number 155 (Friday, August 12, 2022)]
[Proposed Rules]
[Pages 49930-49973]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-16711]



[[Page 49929]]

Vol. 87

Friday,

No. 155

August 12, 2022

Part II





 Securities and Exchange Commission





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17 CFR Part 240





Exemption for Certain Exchange Members; Proposed Rule

Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 / 
Proposed Rules

[[Page 49930]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-95388; File No. S7-05-15]
RIN 3235-AN17


Exemption for Certain Exchange Members

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is re-
proposing amendments to a rule under the Securities Exchange Act of 
1934 (``Act'' or ``Exchange Act'') that exempts certain registered 
brokers or dealers from membership in a registered national securities 
association (``Association''). The re-proposed amendments would replace 
the rule's de minimis allowance, including the exclusion therefrom for 
proprietary trading, with narrower exemptions from Association 
membership for any registered broker or dealer that is a member of a 
national securities exchange, carries no customer accounts, and effects 
transactions in securities otherwise than on a national securities 
exchange of which it is a member. The re-proposed amendments would 
create exemptions for such a registered broker or dealer that effects 
transactions off an exchange of which it is a member that result solely 
from orders that are routed by a national securities exchange of which 
it is a member to comply with order protection regulatory requirements, 
or are solely for the purpose of executing the stock leg of a stock-
option order.

DATES: Comments should be received on or before September 27, 2022.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.html); or
     Send an email to [email protected]. Please include 
File Number S7-05-15 on the subject line; or

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-05-15. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method. The Commission will post all comments on the 
Commission's internet website (https://www.sec.gov/rules/proposed.shtml). Comments also are available for website viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE, 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Operating conditions may limit access to the 
Commission's public reference room. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly.
    Studies, memoranda, or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's website. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director, 
at (202) 551-5594; David Michehl, Special Counsel, at (202) 551-5627; 
Nicholas Shwayri, Special Counsel, at (202) 551-5667; Vince Vuong, 
Special Counsel, at (202) 551-3742; or Mark Sater, Attorney-Advisor, at 
(202) 551-4729, Division of Trading and Markets, Securities and 
Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
II. Background
    A. Current Regulatory Framework
    B. Need for Amendment
    C. 2015 Proposal
III. Discussion of Amendments to Rule 15b9-1
    A. Elimination of the De Minimis Allowance and Proprietary 
Trading Exclusion
    B. Narrowed Criteria for Exemption From Association Membership
    1. Routing Exemption
    2. Stock-Option Order Exemption
    C. No Floor-Member Hedging Exemption
IV. Effective Date and Implementation
V. General Requests for Comments
VI. Economic Analysis
    A. Baseline
    1. Regulatory Structure and Activity Levels of Non-FINRA Member 
Firms
    2. Current Market Oversight
    3. Current Competition To Provide Liquidity
    B. Effects on Efficiency, Competition, and Capital Formation
    1. Firm Response and Effects on Market Activity and Efficiency
    2. Effect on Competition To Provide Liquidity
    3. Competitive Effects on Off-Exchange Market Regulation
    C. Consideration of Costs and Benefits
    1. Benefits
    2. Costs
    a. Costs of Joining an Association
    b. Cost of Maintaining an Association Membership
    c. Costs of TRACE Reporting for Non-FINRA Member Firms That 
Trade U.S. Treasury Securities
    d. Costs of Joining Additional Exchanges Under the Rule as 
Amended
    e. Policies and Procedures Related to the Narrowed Criteria for 
Exemption From Association Membership
    f. Indirect Costs
    D. Alternatives
    1. Include a Floor Member Hedging Exemption
    2. Exchange Membership Alternative
    3. Retaining the De Minimis Allowance
    4. Eliminate the Rule 15b9-1 Exemption
    E. Request for Comment on Economic Analysis
VII. Paperwork Reduction Act
    A. Summary of Collection of Information
    B. Proposed Use of Information
    C. Respondents
    D. Total Initial and Annual Reporting and Recordkeeping Burdens
    E. Collection of Information is Mandatory
    F. Confidentiality of Responses to Collection of Information
    G. Retention Period for Recordkeeping Requirements
    H. Request for Comments
VIII. Consideration of Impact on Economy
IX. Regulatory Flexibility Act Certification
X. Statutory Authority

I. Introduction

    Section 15(b)(8) of the Act \1\ prohibits any registered broker or 
dealer from effecting transactions in securities unless it is a member 
of an Association or effects transactions in securities solely on an 
exchange of which it is a member.\2\ Section 15(b)(9) of the Act \3\ 
provides the Commission with authority to exempt any broker or dealer 
from Section 15(b)(8), if that exemption is consistent with the public 
interest and the protection of investors. Pursuant to the authority 
conferred by Section 15(b)(9), Rule 15b9-1 provides that any broker or 
dealer required by Section 15(b)(8) of the Act to become a member of an 
Association shall be exempt from such requirement if it is a member of 
a national securities exchange, carries no customer accounts, and has 
annual

[[Page 49931]]

gross income derived from purchases and sales of securities otherwise 
than on a national securities exchange of which it is a member in an 
amount no greater than $1,000 (this $1,000 gross income allowance is 
referred to herein as the ``de minimis allowance'').\4\ Under Rule 
15b9-1, the de minimis allowance does not apply to income derived from 
transactions for a registered dealer's own account with or through 
another registered broker or dealer (referred to herein as the 
``proprietary trading exclusion'').\5\ Accordingly, a registered dealer 
can rely on Rule 15b9-1 to remain exempt from Association membership 
while engaging in unlimited proprietary trading of securities on any 
national securities exchange of which it is not a member or in the off-
exchange market,\6\ so long as it is a member of a national securities 
exchange, carries no customer accounts, and its proprietary trading is 
conducted with or through another registered broker-dealer.
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    \1\ 15 U.S.C. 78o(b)(8).
    \2\ Section 15(b)(8) applies to any security other than 
commercial paper, bankers' acceptances, or commercial bills. Id.
    \3\ 15 U.S.C. 78o(b)(9).
    \4\ 17 CFR 240.15b9-1(a).
    \5\ 17 CFR 240.15b9-1(b). The current rule also states that the 
de minimis allowance does not apply to income derived from 
transactions through the Intermarket Trading System, and defines the 
term ``Intermarket Trading System'' for purposes of the rule. 17 CFR 
240.15b9-1(b)(2) and (c).
    \6\ ``Off-exchange'' as used herein means any securities 
transaction that is covered by Section 15(b)(8) of the Exchange Act 
that is not effected, directly or indirectly, on a national 
securities exchange. See 17 CFR 240.600(b)(45) (defining ``national 
securities exchange''). Off-exchange trading includes securities 
transactions that occur through alternative trading systems 
(``ATSs'') or with another broker or dealer that is not a registered 
ATS, and is also referred to as over-the-counter (``OTC'') trading. 
The Commission previously proposed to amend Rule 15b9-1 in 2015. See 
Securities Exchange Act Release No. 74581 (March 25, 2015), 80 FR 
18036 (April 2, 2015) (``2015 Proposing Release'' or ``2015 
Proposal''). There, the Commission defined the term ``off-exchange'' 
differently, such that it applied only to transactions in exchange-
listed securities that were not effected, directly or indirectly, on 
a national securities exchange. Id. at 80 FR 18037, n. 3. Here, the 
definition of ``off-exchange'' encompasses transactions that are not 
effected, directly or indirectly, on a national securities exchange 
in both exchange-listed securities and securities that are not 
listed on a national securities exchange, such as U.S. Treasury 
securities and OTC equity securities, in order to more closely align 
the definition with the full scope of securities transactions that 
are covered by Section 15(b)(8) of the Exchange Act.
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    The securities markets have evolved dramatically in the forty-plus 
years since the Commission adopted Rule 15b9-1. During that span, the 
securities markets have transformed from being floor-based to being 
mostly electronic, and registered dealers have emerged that engage in 
significant, computer-based, cross-market proprietary trading activity. 
Several proprietary trading firms that are registered dealers and 
exchange members are not members of an Association, in reliance on Rule 
15b9-1. These firms may effect significant securities transaction 
volume elsewhere than on an exchange of which they are a member but are 
not subject to Association oversight.
    Self-regulatory organization (``SRO'') \7\ regulation of each 
broker or dealer is dependent upon the broker or dealer's individual 
SRO membership status. Each SRO that operates an exchange has 
responsibility for overseeing trading that occurs on the exchange it 
operates. Because of this, SROs that operate an exchange possess 
expertise in supervising members who specialize in trading the products 
and utilizing the order types that may be unique or specialized within 
the exchange. This expertise complements the expertise of an 
Association in supervising its members' cross-exchange and off-exchange 
securities trading activity. Indeed, the Exchange Act's statutory 
framework places SRO oversight responsibility with an Association for 
trading that occurs elsewhere than an exchange to which a broker or 
dealer belongs as a member.\8\ Individual exchanges have expertise in 
regulating their markets and historically have monitored market 
activity specific to their own exchanges or have outsourced that 
function to a third party. The Financial Industry Regulatory Authority, 
Inc. (``FINRA''), the only Association currently, historically has 
overseen cross-exchange and off-exchange securities trading 
activity.\9\ But brokers and dealers that are not FINRA members are not 
subject to FINRA's rules.\10\
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    \7\ An SRO is defined, in relevant part, as ``any national 
securities exchange, registered securities association, or 
registered clearing agency. . . .'' 15 U.S.C. 78c(a)(26).
    \8\ See Sections 15(b)(8), 15A, 17(d), 19(g) of the Act. 15 
U.S.C. 78o(b)(8); 15 U.S.C. 78o-3; 15 U.S.C. 78q(d); 15 U.S.C. 
78s(g). Under the self-regulatory structure, the SRO where a broker-
dealer is registered conducts regulatory oversight and assumes 
responsibility for that oversight. For example, section 19(g)(1) of 
the Act, among other things, requires every SRO to examine for and 
enforce compliance by its members and associated persons with the 
Act, the rules and regulations thereunder, and the SRO's own rules, 
unless the SRO is relieved of this responsibility pursuant to 
section 17(d) or section 19(g)(2) of the Act. 15 U.S.C. 78q(d); 15 
U.S.C. 78s(g). Section 17(d)(1) of the Act provides that the 
Commission, in allocating authority among SROs pursuant to Section 
17(d)(1), shall ``take into consideration the regulatory 
capabilities and procedures of the self-regulatory organizations, 
availability of staff, convenience of location, unnecessary 
regulatory duplication, and such other factors as the Commission may 
consider germane to the protection of investors, cooperation and 
coordination among self-regulatory organizations, and the 
development of a national market system . . .'' 15 U.S.C. 78q(d)(1). 
Section 15A of the Act provides for the creation of national 
securities associations of broker-dealers, with powers to adopt and 
enforce rules to regulate the off-exchange market. 15 U.S.C. 78o-3. 
And as described above, section 15(b)(8) of the Exchange Act further 
implements this construct of effective regulatory oversight by 
requiring Association membership of a broker-dealer unless it 
effects transactions solely on an exchange of which it is a member. 
15 U.S.C. 78o(b)(8).
    \9\ The National Futures Association (``NFA''), as specified in 
section 15A(k) of the Act, also is registered as a national 
securities association, but only for the limited purpose of 
regulating the activities of NFA members that are registered as 
brokers or dealers in security futures products under Section 
15(b)(11) of the Act.
    \10\ See FINRA Rule 0140.
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    As a result, when broker-dealer firms that are not FINRA members 
effect securities transactions otherwise than on an exchange of which 
they are a member, such as off-exchange or on exchanges where they are 
not a member (collectively referred to herein as ``off-member-
exchange''),\11\ these firms are not all subject to the same set of 
exchange rules and interpretations of those rules, which can vary 
between exchanges. As discussed below,\12\ there are regulatory service 
agreements (``RSAs'') among exchange SROs and FINRA, which have 
provided benefits to SROs such as lower regulatory costs and have been 
a component of FINRA's cross-market regulatory program. Importantly, 
FINRA has the expertise regarding off-exchange trading, but under these 
RSAs, for non-FINRA members that trade off-exchange and are members of 
different exchanges, FINRA applies the rules of the different exchanges 
using the exchanges' interpretations of those rules. This can result in 
different interpretations and FINRA registration would promote 
consistent interpretations and efficiencies in enforcement and 
regulation with respect to this growing part of the market. The rise in 
electronic proprietary trading and the increasingly fragmented market 
where trading takes place across many active markets have put pressure 
on the status quo and persuaded the Commission of the need for there to 
be more consistent regulation of such trading.
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    \11\ To be consistent with Rule 15b9-1, off-member-exchange 
securities trading must occur with or through another registered 
broker-dealer, such as, in the case of trading on an exchange where 
the firm is not a member, through a broker-dealer that is a member 
of the exchange.
    \12\ See Section II.B infra.
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    In addition, SROs retain responsibility for regulatory oversight 
under the RSAs; however, RSAs are voluntary, privately negotiated 
agreements that can expire or be terminated, and accordingly, these 
agreements may not in the future provide the stability of FINRA 
oversight. Further, the Commission, of course, may bring enforcement 
actions, including pursuant to referrals made by SROs, to

[[Page 49932]]

enforce compliance with the Exchange Act and applicable rules. But as 
is also discussed below,\13\ the Exchange Act requires a robust layer 
of SRO oversight over broker-dealers in addition to the Commission's 
regulatory role. In light of the extent to which off-member-exchange 
proprietary trading occurs today, the Commission believes that the SRO 
layer of oversight should be enhanced by ensuring, as mandated by 
Section 15(b)(8) of the Act, that an Association generally has direct, 
membership-based oversight over broker-dealers that effect securities 
transactions elsewhere than on an exchange where they are a member and 
the jurisdiction to directly enforce their compliance with Federal 
securities laws, Commission rules, and Association rules.
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    \13\ See sections II.A and II.B infra.
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    The Commission adopted Rule 15b9-1 several decades ago so that an 
exchange member's limited proprietary trading activity ancillary to its 
exchange activity--which, at that time, typically was a floor business 
conducted on a single national securities exchange--would not 
necessitate Association membership in addition to exchange 
membership.\14\ The Commission deemed it an appropriate exercise of its 
statutory authority to subject such an exchange member to exchange-only 
SRO oversight. But as stated above and described below, the securities 
markets have transformed dramatically and have evolved to include 
significant, cross-market electronic proprietary trading as a primary 
business model, and firms engaging in such trading activity that are 
exempt from Association membership, including important transaction 
reporting requirements, by virtue of Rule 15b9-1. In this regard, the 
Commission previously proposed to amend Rule 15b9-1 in 2015.\15\ After 
the 2015 Proposal, FINRA established a transaction reporting regime 
under which broker-dealers that are FINRA members must report U.S. 
Treasury securities transactions. Some broker-dealer firms that are not 
FINRA members are significantly involved in trading U.S. Treasury 
securities proprietarily but are not required to report these 
transactions since they are not FINRA members. Moreover, U.S. Treasury 
securities trading occurs entirely off-exchange, thus these non-FINRA 
members conduct their U.S. Treasury securities trading activities 
outside of the direct SRO oversight of any exchange and, since they are 
not FINRA members, outside of FINRA's direct jurisdiction despite the 
fact that FINRA is the SRO responsible for the off-exchange market.\16\
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    \14\ See infra note 60 and accompanying text (discussing the 
adoption of Rule 15b8-1, which was later renumbered to Rule 15b9-1).
    \15\ See 2015 Proposing Release, supra note 6.
    \16\ See FINRA Rule 6730--Transaction Reporting, Supplementary 
Material .07--ATS Identification of Non-FINRA Member Counterparties 
for Transactions in U.S. Treasury Securities.
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    The evolution of the markets--since Rule 15b9-1 was adopted and 
since the Commission's proposed changes to Rule 15b9-1 in 2015--
presents a need to realign Rule 15b9-1 with the current market so that 
the regulatory scheme more appropriately effectuates Exchange Act 
principles regarding complementary exchange SRO and Association 
oversight in today's market, including Section 15(b)(9)'s mandate that 
any exemption from Section 15(b)(8) be consistent with the public 
interest and protection of investors. Accordingly, the Commission is 
re-proposing amendments to Rule 15b9-1 that would rescind the de 
minimis allowance and proprietary trading exclusion, which generally 
would require Association membership, pursuant to Section 15(b)(8) of 
the Act, for any registered broker or dealer that effects securities 
transactions elsewhere than on a national securities exchange of which 
it is a member, subject to narrowed exemptions from Section 15(b)(8)'s 
Association membership requirement that are applicable to trading 
activity that is ancillary to the registered broker's or dealer's 
trading activity on a national securities exchange of which it is a 
member.\17\
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    \17\ This proposal re-proposes, with certain modifications, the 
amendments to Rule 15b9-1 that the Commission proposed in 2015. See 
2015 Proposal, supra note 6. The 2015 Proposal contains additional 
background information regarding the regulatory history in this area 
and Rule 15b9-1. See 2015 Proposal, supra note 6, 80 FR at 18036-45. 
Comments received in response to the 2015 Proposing Release are 
available at https://www.sec.gov/comments/s7-05-15/s70515.shtml.
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II. Background

A. Current Regulatory Framework

    Self-regulation is a longstanding, key component of U.S. securities 
industry regulation.\18\ All broker-dealers are required to be members 
of an SRO, which sets standards, conducts examinations, and enforces 
rules regarding its members.\19\ The Exchange Act sets forth a 
framework for broker-dealer regulation that, in addition to Commission 
oversight, requires this layer of SRO oversight, pursuant to which SROs 
act as front-line regulators of their broker-dealer members.\20\ 
Although the Exchange Act provides a limited and targeted exception to 
Association membership requirements for broker-dealers, its approach to 
effecting supervision is relatively uniform: broker-dealers must be 
members of the SROs that regulate the venues upon which they 
transact.\21\ A related, overarching principle in the Exchange Act is 
that the SRO best positioned to conduct regulatory oversight should 
assume that responsibility.\22\ Correspondingly, SRO oversight of an 
exchange's members and their trading on the exchange is primarily the 
responsibility of the exchange, whereas SRO oversight of other trading 
activity, such as off-exchange trading,\23\ is primarily the 
responsibility of an Association.\24\
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    \18\ See Securities Exchange Act Release No. 50700 (November 18, 
2004), 69 FR 71256 (December 8, 2004) (``Concept Release Concerning 
Self-Regulation'').
    \19\ Id. (citing Section 15(b)(8) of the Act (15 U.S.C. 
78o15(b)(8))). Congress historically has favored self-regulation for 
a variety of reasons, including that effectively regulating the 
inner-workings of the securities industry at the federal level was 
viewed as cost prohibitive and inefficient; the complexity of 
securities practices made it desirable for SRO regulatory staff to 
be intimately involved with SRO rulemaking and enforcement; and the 
SROs could set standards such as just and equitable principles of 
trade and detailed proscriptive business conduct standards. Id. 
(citing, generally, S. Rep. No. 1455, 73d Cong., 2d Sess. (1934); 
H.R. Doc. No. 1383, 73d Cong., 2d Sess. (1934); S. Rep. No. 1455, 
73d Cong., 2d Sess. (1934)); see also id., 69 FR at 71257-58.
    \20\ Broker-dealers registered with the Commission are subject 
to the Commission's jurisdiction and oversight and must comply with 
Commission rules applicable to registered broker-dealers. See, e.g., 
15 U.S.C. 78o, 17 CFR 240.15a-6--240.15b11-1, and 17 CFR 240.17a-1--
240.17a-25. Matters related to SRO actions or their broker-dealer 
members also may be referred to the Commission or subject to 
Commission review. See, e.g., 15 U.S.C. 78s(d) and 15 U.S.C. 78s(e). 
But the Exchange Act also requires that SROs enforce their members' 
compliance with the Exchange Act, the rules and regulations 
thereunder, and the SRO's own rules. See, e.g., sections 6(b)(1), 
19(g)(1), and 15A(b)(2) of the Act (15 U.S.C. 78f(b)(1), 78s(g)(1), 
78o-3(b)(2)); see also section 11A(a)(3)(B) of the Act (15 U.S.C. 
78k-1(a)(3)(B)) (authorizing the Commission to require SROs to act 
jointly in planning, developing, operating, or regulating the 
national market system).
    \21\ See 2015 Proposal, supra note 6, 80 FR at 18039.
    \22\ See supra note 8.
    \23\ See supra note 6.
    \24\ References herein to ``exchange'' or ``national securities 
exchange'' are to a national securities exchange that is registered 
with the Commission pursuant to section 6 of the Exchange Act. 
References herein to ``broker'' or ``dealer'' or ``broker-dealer'' 
are to a broker or dealer that is registered with the Commission 
pursuant to section 15 of the Exchange Act.
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    This framework is embodied by several Exchange Act statutory 
provisions. When the Exchange Act was adopted in 1934, the exchanges 
were the only SROs and were charged with regulating the activities of 
their broker-dealer members. Congress soon recognized, however, that 
the benefit of exchange regulation could be undermined by the absence 
of a

[[Page 49933]]

complementary regulatory framework for the off-exchange market. 
Consequently, in 1938, the Maloney Act established the concept of and 
regulatory framework for Associations under Section 15A of the Exchange 
Act. The Maloney Act states in its preamble that its purpose is ``[t]o 
provide for the establishment of a mechanism of regulation among over-
the-counter brokers and dealers operating in interstate and foreign 
commerce or through the mails, to prevent acts and practices 
inconsistent with just and equitable principles of trade, and for other 
purposes.'' \25\ In 1964, Congress passed Section 15(b)(8) of the 
Exchange Act, which currently requires that a registered broker or 
dealer join an Association unless it effects transactions solely on an 
exchange of which it is a member.\26\
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    \25\ See Public Law 75-719, 52 Stat. 1070 (1938).
    \26\ As discussed in greater detail in the 2015 Proposal, 
section 15(b)(8) as originally enacted, and Rule 15b9-1 as 
originally adopted by the Commission (which was Rule 15b8-1 at that 
time and later re-designated as Rule 15b9-1) provided for direct 
Commission oversight of broker-dealers that effected transactions 
off-exchange as an alternative to joining an Association. In 1983, 
Congress amended the Act to eliminate the direct oversight of 
broker-dealers by the Commission and affirmed the benefits of self-
regulation of broker-dealers directly by an Association. See 2015 
Proposal, 63 FR at 18039-41; see also 15 U.S.C. 78o(b)(8), as 
amended by Public Law 98-38, 97 Stat. 205, 206 (1983); H.R. Rep. No. 
98-106, at 597 (1983) (citing a preference for self-regulation over 
direct regulation by the Commission and noting, among other benefits 
of self-regulation, that the National Association of Securities 
Dealers (``NASD''), FINRA's predecessor, had available a broader and 
more effective range of disciplinary sanctions to employ against 
broker-dealers than had the Commission).
---------------------------------------------------------------------------

    Additional statutory provisions contemplate coordination of broker-
dealer oversight among SROs. Section 19(g)(1) of the Exchange Act 
requires every SRO to examine for and enforce compliance by its members 
and associated persons with the Exchange Act, the rules and regulations 
thereunder, and the SRO's own rules, unless the SRO is relieved of this 
responsibility pursuant to Section 17(d) or Section 19(g)(2) of the 
Act.\27\ With respect to a broker or dealer that is a member of more 
than one SRO (``common member''), Section 17(d)(1) authorizes the 
Commission, by rule or order, to relieve an SRO of the responsibility 
to receive regulatory reports, to examine for and enforce compliance 
with the applicable statutes, rules, and regulations, or to perform 
other specified regulatory functions.\28\ Without this relief, the 
statutory obligation of each SRO would result in duplicative 
examinations and oversight of common members.\29\ Section 17(d)(1) of 
the Act provides that the Commission, in allocating authority among 
SROs, shall ``take into consideration the regulatory capabilities and 
procedures of the self-regulatory organizations, availability of staff, 
convenience of location, unnecessary regulatory duplication, and such 
other factors as the Commission may consider germane to the protection 
of investors, cooperation and coordination among self-regulatory 
organizations, and the development of a national market system . . . 
.'' \30\ Among the SROs to which oversight responsibility is allocated 
pursuant to 17d-2 plans, FINRA, as the only registered Association 
currently, has coordinated with exchanges in the exercise of SRO 
oversight over broker-dealers that are common members of FINRA and the 
exchanges on which they trade securities.\31\
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    \27\ 15 U.S.C. 78q(d) and 78s(g)(2).
    \28\ 15 U.S.C. 78q(d)(1).
    \29\ In the Exchange Act Amendments of 1975 (Pub. L. 94-29, 89 
Stat. 97 (1975), the ``1975 Amendments''), Congress recognized that, 
at the time, the allocation of self-regulatory responsibilities 
among SROs resulted in some cases in duplicative regulation of firms 
that were members of multiple SROs and varying standards, both in 
substance and enforcement, among SROs. S. Doc. No. 93-13 at 164-165 
(1973). As a result, Congress adopted Section 17(d) of the Act, 
which provides the Commission with the authority to allocate 
regulatory responsibilities among SROs with respect to matters as to 
which, in the absence of such allocation, such SROs would share 
authority. 15 U.S.C. 78q(d).
    \30\ 15 U.S.C. 78q(d)(1). To implement section 17(d)(1), the 
Commission adopted Rules 17d-1 and 17d-2 under the Act. 17 CFR 
240.17d-1 and 17 CFR 240.17d-2. Rule 17d-1 authorizes the Commission 
to name a single SRO as the designated examining authority (``DEA'') 
to examine common members for compliance with the financial 
responsibility requirements imposed by the Act, or by Commission or 
SRO rules. See Exchange Act Release No. 12352 (April 20, 1976), 41 
FR 18808 (May 7, 1976). To address regulatory duplication in areas 
other than financial responsibility, including sales practices and 
trading practices, the Commission adopted Rule 17d-2 under the Act. 
See Exchange Act Release No. 12935 (October 28, 1976), 41 FR 49091 
(November 8, 1976). Rule 17d-2 permits SROs to propose joint plans 
among two or more SROs for the allocation of regulatory 
responsibility with respect to their common members. 17 CFR 240.17d-
2. The regulatory responsibility allocated among SROs only extends 
to matters for which the SROs would share authority, which means 
that only common rules among SROs can be allocated under Rule 17d-2. 
Under paragraph (c) of Rule 17d-2, the Commission may declare such a 
plan effective if, after appropriate notice and opportunity for 
comment, it finds that the plan is necessary or appropriate in the 
public interest and for the protection of investors, to foster 
cooperation and coordination among SROs, or to remove impediments to 
and foster the development of a national market system and a 
national clearance and settlement system and in conformity with the 
factors set forth in Section 17(d) of the Act. Id. Commission 
approval of a plan filed pursuant to Rule 17d-2 relieves an SRO of 
those regulatory responsibilities allocated by the plan to another 
SRO.
    \31\ See Staff of the Division of Trading and Markets, ``Staff 
Paper on Cross-Market Regulatory Coordination,'' (Dec. 15, 2020) 
(available at https://www.sec.gov/tm/staff-paper-cross-market-regulatory-coordination) (``Cross-Market Regulatory Coordination 
Staff Paper''). Staff reports and other staff documents (including 
those cited herein) represent the views of Commission staff and are 
not a rule, regulation, or statement of the Commission. The 
Commission has neither approved nor disapproved the content of these 
staff documents and, like all staff statements, they have no legal 
force or effect, do not alter or amend applicable law, and create no 
new or additional obligations for any person.
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    FINRA, however, is primarily responsible for exercising SRO 
oversight over broker-dealers' off-member-exchange securities trading 
activities, such as when broker-dealers effect securities transactions 
across markets that include exchanges where they are not a member or 
the off-exchange market.\32\ In particular, FINRA regulates off-
exchange trading of equities, fixed income (including U.S. Treasury) 
securities, and other products, and investigates and brings enforcement 
actions against members for violations of its rules, the rules of the 
Municipal Securities Rulemaking Board, and the Exchange Act and the 
Commission rules thereunder.\33\ FINRA also conducts the vast majority 
of broker and dealer examinations,\34\ and mandates broker and dealer 
disclosures.\35\ FINRA also has developed rules and guidance tailored 
to trading activity,\36\ and has developed surveillance technology and 
specialized regulatory personnel to provide surveillance, supervision, 
and enforcement of FINRA rules and the federal securities laws 
applicable to activity occurring off-exchange.\37\

[[Page 49934]]

Further, FINRA has a detailed set of member conduct rules that apply to 
all activities of a FINRA member firm, whether on- or off-exchange.\38\
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    \32\ See Public Law 75-719, 52 Stat. 1070 (1938). Although FINRA 
is the sole Association, the statute does not limit the number of 
Associations.
    \33\ 15 U.S.C. 78o-3.
    \34\ Routine broker and dealer examinations are conducted by the 
exchange SROs as well, and the Commission staff oversees the 
examination efforts of all SROs. In addition, the Commission staff 
also conducts risk-based examinations of brokers and dealers.
    \35\ 15 U.S.C. 78o-3. See, e.g., FINRA Rules 3130 (Annual 
Certification of Compliance and Supervisory Processes), 4120 
(Regulatory Notification and Business Curtailment), 4530 (Reporting 
Requirements), 4540 (Reporting Requirements for Clearing Firms), 
4560 (Short-Interest Reporting), and 6439 (Requirements for Member 
Inter-Dealer Quotation Systems).
    \36\ See, e.g., FINRA Rules 5240 (Anti-Intimidation/
Coordination), 5250 (Payments for Market Making), 5210.02 
(Publication of Transactions and Quotations--Self-Trades), and 6140 
(Other Trading Practices). Exchanges have similar rules. See, e.g., 
NYSE Rules 4560 and 6140; Nasdaq Rules 5240 and 5250.
    \37\ See FINRA.org, FINRA 2021 Annual Financial Report, 
available at https://www.finra.org/sites/default/files/2022-06/2021-FINRA-Financial-Annual-Report.pdf (last visited July 22, 2022).
    \38\ See FINRA Rule 2000 Series--Duties and Conflicts.
---------------------------------------------------------------------------

    In addition, FINRA has rules that support a comprehensive public 
transparency regime with respect to off-exchange securities 
transactions. One element of this regime is the requirement that FINRA 
members report to FINRA all OTC Equity Security trades \39\ and off-
exchange NMS stock trades,\40\ in connection with which FINRA has 
developed a detailed set of trade reporting rules.\41\ This transaction 
information then becomes publicly available.\42\ FINRA also maintains 
the Trade Reporting and Compliance Engine (``TRACE'') reporting system 
for fixed income securities.\43\ FINRA introduced TRACE reporting 
requirements for U.S. Treasury securities transactions in 2017, which 
has enhanced the regulatory audit trail in that market.\44\ FINRA 
publishes weekly aggregated transaction information and statistics on 
U.S. Treasury securities on its website.\45\
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    \39\ See FINRA Rule 6420(f) (defining ``OTC Equity Security'' to 
mean any equity security that is not an ``NMS stock'' as that term 
is defined in Rule 600(b) of SEC Regulation NMS; provided, however, 
that the term ``OTC Equity Security'' shall not include any 
Restricted Equity Security). See also FINRA Rule 6420(k) (defining 
``Restricted Equity Security'' to mean any equity security that 
meets the definition of ``restricted security'' as contained in 
Securities Act Rule 144(a)(3)); 17 CFR 242.600(b) (defining ``NMS 
stock'' as any NMS security other than an option, and defining ``NMS 
security'' as any security or class of securities for which 
transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan, or an effective 
national market system plan for reporting transactions in listed 
options). FINRA members are required to report transactions (other 
than transactions executed on or through an exchange) in OTC Equity 
Securities and Restricted Equity Securities to FINRA's OTC Reporting 
Facility (``ORF''). See FINRA Rules 6410 and 6610; see also FINRA 
Rule 6420(n) (defining ``OTC Reporting Facility'' as the service 
provided by FINRA that accommodates reporting for trades in OTC 
Equity Securities executed other than on or through an exchange and 
for trades in Restricted Equity Securities effected under Securities 
Act Rule 144A and dissemination of last sale reports).
    \40\ See FINRA Rule 6110 and the FINRA Rule 6000 Series 
generally--Quotation, Order, and Transaction Reporting Facilities. 
FINRA operates two Trade Reporting Facilities (``TRFs''), one 
jointly with Nasdaq and another with the NYSE. The TRFs are FINRA 
facilities for FINRA members to report NMS stock transactions 
effected otherwise than on an exchange. See Exchange Act Release No. 
54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) (order approving 
the Nasdaq TRF); Exchange Act Release No. 55325 (February 21, 2007), 
72 FR 8820 (February 27, 2007) (notice of filing and immediate 
effectiveness of a proposed rule change to establish the NYSE TRF). 
In addition, FINRA operates the Alternative Display Facility 
(``ADF'') for NMS stocks, which is a FINRA facility for posting 
quotes and reporting trades governed by FINRA's trade reporting 
rules. See Exchange Act Release No. 46249 (July 24, 2002), 67 FR 
49821 (July 31, 2002) (order approving the ADF); see also Exchange 
Act Release No. 71467 (February 3, 2014), 79 FR 7485 (February 7, 
2014) (order approving a proposed rule change to update the rules 
governing the ADF).
    \41\ See FINRA Rule 6000 Series--Quotation, Order, and 
Transaction Reporting Facilities, supra note 40; and FINRA Rule 7000 
Series--Clearing, Transaction and Order Data Requirements, and 
Facility Charges.
    \42\ Pursuant to effective national market system plans which 
are also effective transaction reporting plans (as both terms are 
defined in Rule 600(b) of Regulation NMS), namely the Nasdaq UTP 
Plan and the CTA Plan, FINRA reports to the Securities Information 
Processors (``SIPs'') information for off-exchange NMS stock 
transactions that are reported to FINRA's TRFs, and the SIPs in turn 
distribute the information in the public consolidated market data 
feeds. See section VIII(a) of the CTA Plan and section VIII.B of the 
Nasdaq UTP Plan. In addition, currently, Nasdaq UTP Plan Level 1 
subscribers can obtain the OTC Equity Security transaction 
information that is reported to FINRA's ORF and disseminated under 
the FINRA--Trade Data Dissemination Service (TDDS). See UTPPlan.com, 
UTP Plan Administration Data Request Form, available at https://www.utpplan.com/DOC/UTP_Data_Feed_Request.pdf (last visited July 22, 
2022) (stating that direct access subscribers may request FINRA OTC 
Data (FINRA OTC Equity Securities Rule 6400) as part of the Nasdaq 
UTP Plan Level 1 service).
    \43\ See FINRA Rule 6700 Series.
    \44\ See Securities Exchange Act Release No. 79116 (October 18, 
2016), 81 FR 73167 (October 24, 2016) (File No. SR-FINRA-2016-027).
    \45\ See FINRA.org, Treasury Aggregate Statistics, available at 
https://www.finra.org/finra-data/browse-catalog/treasury-weekly-aggregates (last visited July 22, 2022). The information is 
aggregated by security subtype: Bills, Floating Rate Notes (FRN), 
Nominal Coupons and Treasury Inflation-Protected Securities (TIPS). 
The data is further grouped into ``ATS and Interdealer,'' ``Dealer-
to-Customer,'' and ``Total'' categories. For Nominal Coupons and 
TIPS, the report also shows remaining maturity and on-the-run/off-
the-run groupings. See also FINRA Rule 6750--Dissemination of 
Transaction Information, Supplementary Material .01(b). FINRA 
recently proposed to publish aggregated U.S. Treasury securities 
transaction information and statistics more frequently, such as on a 
daily basis. See Securities Exchange Act Release No. 95165 (June 27, 
2022), 87 FR 39573 (July 1, 2022) (File No. SR-FINRA-2022-017).
---------------------------------------------------------------------------

    In contrast to FINRA, the regulatory focus of national securities 
exchanges, which are also SROs, is generally on trading by their 
members on their respective exchanges.\46\ Exchanges generally monitor 
market activity specific to their own exchanges and have expertise in 
regulating unique aspects of their markets.\47\ For example, exchange 
rules typically regulate, among other things, the opening and closing 
of trading on the exchange; \48\ exchange order types and order 
handling; \49\ member application processes and ongoing member 
requirements; \50\ listings; \51\ investigations, complaints, 
disciplinary action and the related appeals process; \52\ as well as 
member conduct generally.\53\ In many cases, exchange rules are similar 
to FINRA rules or incorporate FINRA rules by reference.\54\
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    \46\ Congress saw the codification of regulations requiring the 
registration of off-exchange brokers and dealers as ``an essential 
supplement to regulation of the exchanges.'' H.R. Rep. No. 74-2601, 
at 4 (1936). In addition, in advance of the 1975 Amendments, 
Congress contemplated reforms to the regulatory structure of the 
securities markets in which an Association's role would be expanded, 
while exchanges would focus their regulatory activities on their 
respective markets: ``the time has come to begin planning a 
framework which will guide the development of the self-regulatory 
system in the future. In the revised system, a single nationwide 
entity [an Association] would be responsible for regulation of the 
retail end of the securities business, including such matters as 
financial responsibility and selling practices, while each exchange 
would concentrate on regulating the use of its own trading 
facilities . . . the regulatory activities of the NASD (the only 
organization presently registered as a national securities 
association) would encompass many of the present regulatory 
activities of the NYSE and other exchanges over retail activities of 
their members. This `expanded' NASD would have direct 
responsibility, subject to SEC oversight, for enforcing SEC rules 
and its own rules . . .'' S. Doc. No. 93-13 at 16, 169 (1973). See 
also 2015 Proposing Release, supra note 6, 80 FR 18039 at note 28 
and accompanying text. In 2007, the Commission approved changes that 
consolidated the member firm regulatory functions of the NASD, an 
Association, and NYSE Regulation, Inc., and changed the name of the 
combined entity to FINRA. See Exchange Act Release No. 56145 (July 
26, 2007), 72 FR 42169 (August 1, 2007).
    \47\ See Cross-Market Regulatory Coordination Staff Paper, supra 
note 31.
    \48\ See, e.g., NYSE Rule 7.35 Series--Auctions.
    \49\ See, e.g., Nasdaq Rule 4702--Order Types and Nasdaq Rule 
4703--Order Attributes.
    \50\ See, e.g., Cboe Rulebook Chapter 3--TPH Membership, 
Registration, and Participants.
    \51\ See, e.g., IEX Rulebook Chapter 14--IEX Listing Rules.
    \52\ Typically, exchange rules regarding investigations, 
complaints, disciplinary actions, and appeals apply to the conduct 
of members (and associated persons) for violations of exchange rules 
and federal securities laws and regulations that the exchange has 
jurisdiction to enforce. See, e.g., Cboe Rule 13.1; IEX Rule 
9.110(a); MIAX Chapter X, Rule 1000; Nasdaq Rule General 5, 9110(d); 
and Nasdaq PHLX Rule General 5, Section 1.
    \53\ See, e.g., NYSE Rules 2010--7470--Conduct Rules.
    \54\ See, e.g., NYSE Rules 4110 and 4140, and FINRA Rules 4110 
and 4140; and Nasdaq General 9 (Regulation) (incorporating by 
reference various FINRA rules).
---------------------------------------------------------------------------

    In addition, exchanges have entered into 17d-2 plans that allocate 
to FINRA examination and enforcement responsibility relating to 
compliance by common members with Federal securities laws, Commission 
rules, and common exchange and FINRA rules, allowing the exchanges to 
focus on trading on their own markets. For example, under a 17d-2 plan 
for the allocation of regulatory responsibility relating to Regulation 
NMS rules, FINRA is responsible for overseeing and enforcing compliance 
with certain Regulation NMS rules by common members of FINRA and any 
exchange participant in the agreement, while each exchange retains 
responsibility for surveillance and enforcement with respect to trading 
activities or practices

[[Page 49935]]

involving its own marketplace.\55\ Most exchanges and FINRA also have 
entered into RSAs, which are privately negotiated agreements between 
two SROs whereby one SRO agrees to perform regulatory services on 
behalf of another SRO in exchange for compensation.\56\
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    \55\ See, e.g., Exchange Act Release Nos. 63220 (November 2, 
2010), 75 FR 68632 (November 8, 2010) and 63430 (December 3, 2010), 
75 FR 76758 (December 9, 2010). In addition, generally, FINRA is the 
DEA for financial responsibility rules for exchange members that 
also are members of FINRA. See infra notes 227-228 and accompanying 
text (discussing DEAs). See also Cross-Market Regulatory 
Coordination Staff Paper, supra note 31 (stating that ``FINRA serves 
as the Designated Regulation NMS Examining Authority (``DREA'') and 
Designated CAT Surveillance Authority (``DCSA'') for common exchange 
members that are also members of FINRA, and assumes certain 
examination and enforcement responsibilities for those members with 
respect to specified Regulation NMS rules (i.e., 606, 607, 611, 612 
and 613(g)(2)), and for the cross-market surveillance, examination, 
investigation and enforcement of Rule 613 and the rules of the SROs 
regarding compliance with the CAT NMS Plan.'').
    \56\ See Cross-Market Regulatory Coordination Staff Paper, supra 
note 31.
---------------------------------------------------------------------------

    In addition to regulatory coordination that occurs through 17d-2 
plans and RSAs, SROs also coordinate regulatory efforts through forums 
provided by the Intermarket Surveillance Group (``ISG''). The ISG, 
created in 1981, is an international group of exchanges, market 
centers, and regulators that perform market surveillance in their 
respective jurisdictions.\57\ The ISG's focus is regulatory information 
sharing and coordination for both domestic and foreign regulators.\58\ 
Pursuant to its charter, one of the ISG's purposes is ``the 
coordination and development of programs and procedures designed to 
assist in identifying possible fraudulent and manipulative acts and 
practices across markets, where possible, particularly between markets 
which trade the same or related or derivative Financial 
Instruments[.]'' \59\
---------------------------------------------------------------------------

    \57\ See id.
    \58\ See id.
    \59\ See id.
---------------------------------------------------------------------------

B. Need for Amendment

    The Commission originally adopted Rule 15b8-1 in 1965 (renumbered 
to Rule 15b9-1 in 1983 and generally referred to herein as Rule 15b9-1) 
to allow exchange specialists and other floor members to receive a 
portion of the commissions paid on occasional off-exchange transactions 
referred to other broker-dealers, up to a nominal amount.\60\ The 
original version of Rule 15b9-1 included the de minimis allowance but 
not the proprietary trading exclusion. The Commission adopted the 
proprietary trading exclusion in 1976 to accommodate regional exchange 
specialists that, as part of their floor-based business, might have 
needed to lay off positions and hedge risk on the primary listing 
exchange through a member of that exchange.\61\ These exchange 
specialists and floor brokers typically were members of a single 
exchange, and the circumstances under which they would trade 
proprietarily off-exchange were quite limited.\62\ Taken together, the 
historical purpose of Rule 15b9-1's de minimis allowance and 
proprietary trading exclusion was to accommodate limited broker-dealer 
trading activities that were ancillary to a floor-based business on a 
single exchange while preserving the traditional role of the exchange 
as the entity best suited to regulate member conduct on the exchange.
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    \60\ See Qualifications and Fees Relating to Brokers or Dealers 
Who Are Not Members of National Security [sic] Association, Exchange 
Act Release No. 7697 (September 7, 1965), 30 FR 11673 (September 11, 
1965) (``Qualifications and Fees Release''). The Commission stated: 
``Among the broker-dealers that are not members of a registered 
national securities association are several specialists and other 
floor members of national securities exchanges, some of whom 
introduce accounts to other members. The over-the-counter business 
of these broker-dealers may be limited to receipt of a portion of 
the commissions paid on occasional over-the-counter transactions in 
these introduced accounts, and to certain other transactions 
incidental to their activities as specialists. In most cases, the 
income derived from these activities is nominal.'' Id. at 11675.
    \61\ See Extension of Temporary Rules 23a-1(T) and 23a-2(T); 
Adoption of Amendments to SECO Rules, Securities Exchange Act 
Release No. 12160 (March 3, 1976), 41 FR 10599 (March 12, 1976) 
(``Adoption of Amendments to SECO Rules''). In adopting the 
proprietary trading exclusion, the Commission indicated that an 
exchange floor broker, through another broker or dealer, could 
effect transactions for its own account on an exchange of which it 
was not a member. Id. at 10600. The Commission noted that such 
transactions ultimately would be effected by a member of that 
exchange. In 1983, the Commission further amended Rule 15b9-1 to 
accommodate transactions effected through the new Intermarket 
Trading System linkage, and eliminated references to, and 
requirements under, the SECO Program. See SECO Programs; Direct 
Regulation of Certain Broker-Dealers; Elimination, Exchange Act 
Release No. 20409 (November 22, 1983), 48 FR 53688 (November 29, 
1983) (``SECO Programs Release'').
    \62\ In the Special Study of the Securities Markets in 1963, the 
Commission described how regional exchange specialists reduced their 
exposure, including by offsetting positions on other exchanges. The 
Commission noted that ``[s]pecialists on the Boston, Philadelphia-
Baltimore-Washington, Pittsburgh, and Montreal stock exchange are in 
communication with each other by direct wires linking their floors 
and each may trade on the other exchanges at member rates'' and 
``[s]pecialists who are sole members [of an exchange] also offset 
[their positions] with over-the-counter houses dealing in listed 
securities. Many of the offsetting transactions are done on the 
primary market, the NYSE, with the [specialist] buying or selling on 
that exchange as his needs dictate.'' Report of Special Study of 
Securities Markets of the Securities and Exchange Commission, H.R. 
Doc. No. 88-95, at 935 (1963) (``Special Study''). The Commission 
believes that the business of regional exchange specialists was 
substantially the same when the proprietary trading exclusion in 
Rule 15b9-1 was adopted in 1976.
---------------------------------------------------------------------------

    Since that time, the securities markets have undergone a 
substantial transformation that has been driven primarily by rapid and 
ongoing evolution of technologies for generating, routing, and 
executing orders, and the impact of regulatory changes.\63\ Today, 
trading in the U.S. securities markets is highly automated, dispersed 
among myriad trading centers, and substantially more complex.\64\ 
Trading is spread among a number of highly automated trading centers--
24 registered exchanges,\65\ 33 ATSs that trade NMS stocks,\66\ at 
least 2 ATSs that trade U.S. Treasury securities,\67\ and nearly 200 
OTC market-makers \68\--and the routing and re-routing of orders to 
multiple venues is common. Moreover, new types of proprietary trading 
firms have emerged, including those that engage in so-called high-
frequency trading strategies. These firms tend to effect transactions 
across the full range of exchange and off-exchange markets, including 
ATSs. They also typically use complex electronic trading strategies and 
sophisticated technology to generate a large volume of orders and

[[Page 49936]]

transactions throughout the national market system.\69\
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    \63\ See Securities Exchange Act Release No. 61358 (January 14, 
2010), 75 FR 3594 (January 21, 2010) (Concept Release on Equity 
Market Structure) (``Equity Market Structure Concept Release''), at 
3594 (``Changes in market structure also reflect the markets' 
response to regulatory actions such as Regulation NMS, adopted in 
2005, the Order Handling Rules, adopted in 1996, as well as 
enforcement actions, such as those addressing anti-competitive 
behavior by market makers in NASDAQ stocks.'').
    \64\ See Equity Market Structure Concept Release, supra note 63. 
See also 2015 Proposing Release, supra note 6.
    \65\ There are 8 registered exchanges that only trade equities 
and 8 registered exchanges that only trade options. In addition, 
there are 8 registered exchanges that trade both equities and 
options.
    \66\ See 17 CFR 242.300 (defining the terms ``alternative 
trading system'' and ``NMS Stock ATS''). This data was compiled from 
Forms ATS-N filed with the Commission as of July 22, 2022, available 
at https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm.
    \67\ See U.S. Dep't of the Treasury et al., Joint Staff Report: 
The U.S. Treasury Market on October 15, 2014 (July 13, 2015) (the 
``Joint Staff Report''). The Joint Staff Report noted that SEC rules 
applicable to ATSs do not apply to ATSs through which only 
government securities are traded, although such venues may 
voluntarily adopt such standards. Since the Joint Staff Report was 
issued, however, the Commission has proposed to amend Regulation ATS 
to include ATSs through which only government securities are traded. 
See Securities Exchange Act Release No. 94062 (January 26, 2022), 87 
FR 15496 (March 18, 2022).
    \68\ Nearly 200 brokers or dealers (excluding ATSs) have 
identified themselves to FINRA as market centers that must provide 
monthly reports on order execution quality under Rule 605 of 
Regulation NMS (list available at https://www.finra.org/industry/market-centers).
    \69\ Many, but not all, proprietary trading firms are often 
characterized by: (1) the use of extraordinarily high-speed and 
sophisticated computer programs for generating, routing, and 
executing orders; (2) the use of co-location services and individual 
data feeds offered by exchanges and others to minimize network and 
other types of latencies; (3) the use of very short time-frames for 
establishing and liquidating positions; (4) the submission of 
numerous orders that are cancelled shortly after submission; and (5) 
ending the trading day in as close to a flat position as possible 
(that is, not carrying significant, unhedged positions overnight). 
See Equity Market Structure Concept Release, supra note 63, 75 FR at 
3606. See also Staff of the Division of Trading and Markets, 
``Equity Market Structure Literature Review, Part II: High Frequency 
Trading,'' at 4-5 (March 18, 2014) (available at https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf).
---------------------------------------------------------------------------

    In fact, the large-scale proprietary trading that occurs in the 
securities markets today is not confined to equities and options. For 
example, there is significant automated proprietary trading in U.S. 
Treasury securities, which are not traded on any national securities 
exchange.\70\ As noted in the Joint Staff Report, proprietary trading 
firms, or principal trading firms (``PTF(s)'') as they are also called, 
account for a majority of trading and market depth in the electronic 
interdealer U.S. Treasury securities market.\71\ The Joint Staff Report 
called for certain U.S. Treasury securities market reforms such as an 
assessment of the public reporting on U.S. Treasury securities market 
venue policies and services and a review of possible post-trade 
transaction reporting by government securities broker-dealers and 
banks. In 2016, an inter-agency working group comprising staff of the 
Treasury Department, Commission, Commodity Futures Trading Commission, 
Federal Reserve Bank of New York, and Board of Governors of the Federal 
Reserve System stated that it ``will continue to assess effective means 
to ensure that the collection of data regarding Treasury cash 
securities market transactions is comprehensive and includes 
information from institutions that are that not FINRA members.'' \72\ 
Subsequently, FINRA introduced TRACE reporting for U.S. Treasury 
securities in 2017.\73\
---------------------------------------------------------------------------

    \70\ The secondary market for U.S. Treasury securities 
(sometimes referred to as the U.S. Treasury cash market) is 
generally bifurcated between the dealer-to-customer market and the 
interdealer market. Trading in the U.S. Treasury securities dealer-
to-customer market is generally conducted through bilateral 
transactions. Trading often occurs either over the phone or on 
trading venues that facilitate the matching of buy and sell orders 
through electronic systems. In the interdealer market, the majority 
of trading in on-the-run U.S. Treasury securities currently occurs 
on ATSs using electronic central limit order books. For off-the-run 
U.S. Treasury securities, the majority of interdealer trading occurs 
via bilateral transactions through voice-assisted brokers and 
electronic trading platforms. See Securities Exchange Act Release 
No. 90019 (September 28, 2020), 85 FR 87106, 87108 (December 21, 
2020). On-the-run U.S. Treasury securities are the most recently 
issued U.S Treasury securities of a particular maturity. Off-the-run 
U.S. Treasury securities include all U.S. Treasury securities that 
have been issued before the most recent issuance and are still 
outstanding.
    \71\ See Joint Staff Report, supra note 67, at 36. In addition, 
in 2020, staff at the Board of Governors of the Federal Reserve 
published a paper estimating that PTFs account for 61% of the 
trading activity on interdealer broker platforms. See FEDS Notes, 
``Principal Trading Firm Activity in Treasury Cash Markets,'' James 
Collin Harkrader and Michael Puglia (Aug. 4, 2020) (citing data 
presented at the 2019 U.S. Treasury Market Conference showing that 
PTFs averaged approximately 61% of total trading volume on 
electronic interdealer broker platforms).
    \72\ See press release, U.S. Dep't of the Treasury et al., 
Statement Regarding Progress on the Review of the U.S. Treasury 
Market Structure since the July 2015 Joint Staff Report (August 2, 
2016) available at https://www.sec.gov/news/pressrelease/2016-155.html.
    \73\ See supra note 44.
---------------------------------------------------------------------------

    The Commission estimates that, as of the end of 2021, there were 66 
firms that were Commission-registered broker-dealers and exchange 
members but not FINRA members, and that there were 65 such firms as of 
April 2022.\74\ Many of these firms were members of just one exchange 
while others were members of multiple exchanges.\75\ Specifically, as 
of April 2022, 21 of the 65 identified firms were single exchange 
members; 10 of the firms were members of two exchanges; 13 of the firms 
were members of more than two but 10 or fewer exchanges; and the 
remainder were members of more than 10 exchanges.\76\
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    \74\ See FINRA.org, Non-Member List, available at https://nonmembers.finra.org/ReportableNonMembersList.txt or https://web.archive.org/web/20210722022409/https:/nonmembers.finra.org/ReportableNonMembersList.txt (last visited July 22, 2022). The 
Commission notes that the figures set forth herein are impacted by 
changes in FINRA membership. For example, a registered broker-dealer 
that was not a FINRA member as of 2021 joined FINRA in early 2022 
and is not included among the 65 firms identified as registered 
broker-dealers and exchange members but not FINRA members as of 
April 2022.
    \75\ Source: FINRA Central Registration Depository (CRD).
    \76\ Id.
---------------------------------------------------------------------------

    Several of these firms--both single-exchange and multiple-exchange 
members--engage in cross-market and off-exchange proprietary securities 
trading. These firms account for a significant portion of off-exchange 
securities trading volume and initiate a significant number of 
securities transactions on exchanges other than exchanges to which they 
belong as a member.\77\ They forgo FINRA membership presumably in 
reliance on Rule 15b9-1, as their effectuation of transactions in 
securities elsewhere than on exchanges to which they belong as a member 
would trigger Section 15(b)(8)'s Association membership requirement but 
for the exemption provided by Rule 15b9-1.
---------------------------------------------------------------------------

    \77\ Source: Consolidated Audit Trail.
---------------------------------------------------------------------------

    For example, of the estimated 66 broker-dealers that were exchange 
members but not FINRA members as of the end of 2021, 47 initiated 
orders in listed equities in September 2021 that were executed on or 
off an exchange.\78\ These firms' September 2021 off-exchange listed 
equities dollar volume executed was approximately $789 billion,\79\ 
which was approximately 9.8% of total off-exchange volume of listed 
equities executed that month.\80\ Moreover, these firms' September 2021 
listed equities dollar volume executed on exchanges of which they are 
not a member was approximately $592 billion.\81\
---------------------------------------------------------------------------

    \78\ Id. A firm ``initiating'' an order is the firm that reports 
the origination of the order as a New Order Event (MENO) to the 
Consolidated Audit Trail. The other 19 firms did not initiate orders 
in listed equities in September 2021.
    \79\ Id. Dollar volumes set forth in this section represent the 
sum of bought and sold volume during the specified time period.
    \80\ Id. The Commission estimates that there was approximately 
$8 trillion in total off-exchange transaction volume in listed 
equities reported by buying and selling firms in September 2021.
    \81\ Id. The Commission also estimates that, in 2021, 50 of the 
66 firms identified as registered broker-dealers and exchange 
members but not FINRA members initiated options order executions 
accounting for approximately 15-20% of daily options contract volume 
traded. The Commission further estimates that 36 of these 50 firms 
initiated executions on an exchange where they are not a member, and 
that this transaction volume represented approximately 3% of these 
36 firms' total options contract transaction volume reported in 
2021, and approximately 1% of all options contract transaction 
volume reported in 2021. Id.
---------------------------------------------------------------------------

    Of the estimated 65 broker-dealers that were exchange members but 
not FINRA members as of April 2022, 43 initiated orders in listed 
equities in April 2022 that were executed on or off an exchange.\82\ 
These firms' April 2022 off-exchange listed equities dollar volume 
executed was approximately $441 billion,\83\ which was approximately 
4.6% of total off-exchange volume of listed equities executed that 
month.\84\ Moreover, these firms' April 2022 listed equities dollar 
volume executed on exchanges of which they are not a member was 
approximately $475 billion.\85\
---------------------------------------------------------------------------

    \82\ Id. The other 22 firms did not initiate orders in listed 
equities in April 2022.
    \83\ Id.
    \84\ Id. The Commission estimates that there was approximately 
$9.5 trillion in total off-exchange transaction volume in listed 
equities reported by buying and selling firms in April 2022.
    \85\ Source: Consolidated Audit Trail. See also Table 1, Section 
VI.A.1, infra, for additional detail regarding these firms' trading 
activity during the noted time periods.

---------------------------------------------------------------------------

[[Page 49937]]

    There is also a high degree of concentration of this volume among a 
subset of the identified firms. In this regard, the Commission 
estimates that, as of September 2021, 13 of the 47 identified firms 
that initiated orders in listed equities then accounted for 
approximately 9.3% of total off-exchange listed equities volume 
executed in September 2021 and 94% of the off-exchange listed equities 
transaction volume attributable to the 47 identified firms that 
month.\86\ Two of the 13 firms initiated $528 billion in off-exchange 
listed equities executions in September 2021, which was 6.6% of total 
off-exchange listed equities transaction volume that month and 
approximately two-thirds of the off-exchange volume executions 
attributable to the 47 identified firms.\87\ With respect to the 47 
firms' listed equities transaction volume on exchanges of which they 
are not a member, just one firm accounted for approximately 78% of the 
$592 billion in volume attributable to the 47 identified firms in 
September 2021; four firms (including the aforementioned one) accounted 
for approximately 90% of that volume; and 18 firms (including the 
aforementioned four firms) accounted for approximately 99% of that 
volume.\88\
---------------------------------------------------------------------------

    \86\ Source: Consolidated Audit Trail.
    \87\ Id.
    \88\ Id.
---------------------------------------------------------------------------

    The Commission also estimates that, as of April 2022, 12 of the 43 
identified firms that initiated orders in listed equities then 
accounted for approximately 4.25% of total off-exchange listed equities 
volume executed in April 2022 and 91.6% of the off-exchange listed 
equities transaction volume attributable to the 43 identified firms 
that month.\89\ One of the 12 firms initiated $241 billion in off-
exchange listed equities executions in April 2022, which was 2.54% of 
total off-exchange listed equities transaction volume that month and 
approximately one-half of the off-exchange volume executions 
attributable to the 43 identified firms.\90\ With respect to the 43 
firms' listed equities transaction volume on exchanges of which they 
are not a member, just one firm accounted for approximately 72% of the 
$475 billion in volume attributable to the 43 identified firms in April 
2022; five firms (including the aforementioned one) accounted for 
approximately 91% of that volume; and 18 firms (including the 
aforementioned four firms) accounted for approximately 99% of that 
volume.\91\
---------------------------------------------------------------------------

    \89\ Id.
    \90\ Id.
    \91\ Id.
---------------------------------------------------------------------------

    With respect to trading in U.S. Treasury securities, all of which 
occurs off-exchange,\92\ the Commission estimates that four of the 66 
broker-dealers that were exchange members but not FINRA members 
accounted for over $7 trillion in U.S. Treasury securities volume 
executed on ``covered ATSs'' in 2021 that was reported to TRACE,\93\ 
which was over 2% of total U.S Treasury securities volume traded in 
2021 that was reported to TRACE.\94\ In April 2022, the Commission 
estimates that three of the 65 broker-dealers that were exchange 
members but not FINRA members accounted for over $700 billion in U.S. 
Treasury securities volume executed on covered ATSs that was reported 
to TRACE,\95\ which was approximately 2.5% of total U.S Treasury 
securities volume traded in April 2022 that was reported to TRACE.\96\
---------------------------------------------------------------------------

    \92\ See Joint Staff Report, supra note 67, at 2; see also supra 
note 70.
    \93\ See FINRA Rule 6730(a)(1) (requiring FINRA members to 
report transactions in TRACE-Eligible Securities, including U.S. 
Treasury securities).
    \94\ See FINRA Rule 6730--Transaction Reporting, Supplementary 
Material .07--ATS Identification of Non-FINRA Member Counterparties 
for Transactions in U.S. Treasury Securities, supra note 16 (among 
other things, defining the term ``covered ATS'' as an ATS that 
executed transactions in U.S. Treasury securities against non-FINRA 
member subscribers of $10 billion or more in monthly par value, 
computed by aggregating buy and sell transactions, for any two 
months in the preceding calendar quarter). U.S. Treasury securities 
market share is calculated as the sum of the identified entities' 
buy and sell volume divided by twice the market-wide volume for the 
period.
    \95\ See supra note 93.
    \96\ Id.
---------------------------------------------------------------------------

    Due to the evolution of the securities markets since Rule 15b9-1 
was adopted, the Commission preliminarily believes that the rule's 
effect has become dislodged from the rule's intended purpose. The 
underlying presumption built into Rule 15b9-1's de minimis allowance 
and proprietary trading exclusion was that Association membership 
should not be required where a broker-dealer engaged in limited trading 
activities elsewhere than its member exchange that were ancillary to 
its trading business on its member exchange.\97\ Since the Commission 
adopted Rule 15b9-1 in 1965 and then the proprietary trading exclusion 
in 1976, the securities markets have transformed dramatically, 
securities trading has become dispersed among myriad trading centers, 
and firms today frequently trade securities proprietarily and 
electronically across those trading centers, including on exchanges 
where they are not a member and off-exchange. Moreover, today, unlike 
forty years ago, there is extensive off-exchange proprietary trading 
activity conducted electronically in the U.S. Treasury securities 
market, and a transaction reporting regime for U.S. Treasury securities 
transactions that stems from Association membership. Put simply, the 
underlying tenet of Rule 15b9-1's de minimis allowance and proprietary 
trading exclusion no longer holds true in light of the emergence of the 
modern-day broker-dealer that trades securities proprietarily.
---------------------------------------------------------------------------

    \97\ See supra notes 60-62 and accompanying text.
---------------------------------------------------------------------------

    Indeed, as reflected by the figures set forth above, some dealer 
firms are able to engage in substantial proprietary securities trading 
activity elsewhere than their member exchange(s) without becoming FINRA 
members, in reliance on Rule 15b9-1. These firms are not all subject to 
the same set of rules and interpretations, which can vary between 
exchanges. Importantly, FINRA has the expertise regarding off-exchange 
trading, but under the current regulatory structure underpinning Rule 
15b9-1, for non-FINRA members that trade off-exchange and are members 
of different exchanges, FINRA applies the rules of the different 
exchanges using the exchanges' interpretations of those rules. This can 
result in different interpretations and FINRA registration would 
promote consistent interpretations and efficiencies in enforcement and 
regulation with respect to this growing part of the market. The rise in 
electronic proprietary trading and an increasingly fragmented market 
where trading takes place across many active markets have put pressure 
on the status quo and presented a need for there to be more consistent 
regulation of such trading. As a result, the Commission preliminarily 
believes that the exemption from FINRA oversight provided by Rule 15b9-
1 should be limited.
    In particular, there are Federal securities laws, Commission rules, 
and SRO rules that prohibit various forms of improper activity by 
broker-dealers.\98\ SROs are required to examine for and enforce 
compliance by their members

[[Page 49938]]

and associated persons with the Exchange Act, the rules and regulations 
thereunder, and the SROs' own rules.\99\ FINRA traditionally has been 
the SRO that primarily oversees cross-exchange and off-exchange 
securities trading activity. In the specific context of broker-dealer 
firms that are not FINRA members and effect off-member-exchange 
securities transactions, FINRA is unable to directly enforce such 
firms' compliance with Federal securities laws and Commission rules, or 
apply its own rules to such firms, because they are not FINRA members. 
Without direct, membership-based FINRA oversight, the Commission 
believes that SRO oversight of off-member-exchange securities trading 
activity by non-FINRA members is largely a function of cooperative 
regulatory arrangements among SROs, which, as explained below, do not 
confer membership-based jurisdiction to FINRA to enforce compliance 
with the Exchange Act and applicable rules.
---------------------------------------------------------------------------

    \98\ See, e.g., sections 10(b), 15(c), and 15(g) of the Exchange 
Act; 15 U.S.C. 78j(b), 15 U.S.C. 78o(c), and 15 U.S.C. 78o(g); 
section 17(a) of the Securities Act of 1933; 15 U.S.C. 77q(a); 17 
CFR 240.10b-5; FINRA Rules 2020 (Use of Manipulative, Deceptive, or 
Other Fraudulent Devices), 4530 (Reporting Requirements), 5210 
(Publication of Transactions and Quotations); NYSE Rules 2020 (Use 
of Manipulative, Deceptive or Other Fraudulent Devices) and 5220 
(Disruptive Quoting and Trading Activity Prohibited); Nasdaq General 
9, Section 1 (General Standards) and Nasdaq General 9, Section 53 
(Disruptive Quoting and Trading Activity Prohibited); and Cboe Rule 
8.6 (Manipulation).
    \99\ See section 19(g) of the Act; 15 U.S.C. 78s(g).
---------------------------------------------------------------------------

    In this regard, exchange SROs and FINRA are able to perform cross-
market surveillance of trading activity in NMS and OTC securities using 
the Consolidated Audit Trail (``CAT'') data.\100\ But access to CAT 
data does not confer jurisdiction to FINRA over a firm that is not a 
FINRA member and that trades those securities off-exchange.\101\ As a 
result, a case regarding such a firm may be referred to the Commission 
or an exchange where the firm is a member for further investigation 
because access to CAT data alone does not enable FINRA to conduct 
additional investigative methods, such as collecting documents, 
interviewing witnesses, and otherwise investigating the firm to 
generate evidence.\102\ Moreover, trading activity in U.S. Treasury 
securities is not reported to CAT, so CAT is not a tool that can be 
used by SROs to surveil that activity, which, as reflected by the 
figures set forth above, is engaged in extensively by some broker-
dealers that are not FINRA members.
---------------------------------------------------------------------------

    \100\ Exchange rules require their members to report to CAT, 
which is operated by FINRA CAT, LLC, a subsidiary of FINRA. See, 
e.g., Cboe BYX Rules 4.5-4.17; Nasdaq General 7; and NYSE Rule 6800.
    \101\ See Concept Release Concerning Self-Regulation, supra note 
18, 69 FR at 71266 (stating that ``[w]hile the full implementation 
of robust intermarket order audit trails would be a significant step 
forward, an order audit trail is simply a tool that can be used by 
regulators to better surveil for illicit trading activity'' and that 
``the SRO regulatory function would still play a critical role in 
the regulation of intermarket trading.''). Likewise, the ISG is a 
valuable forum for the coordination of regulatory efforts and 
sharing of information and serves an important function, but it does 
not confer jurisdiction to FINRA over a broker-dealer that is not a 
FINRA member and effects off-member-exchange securities 
transactions. The ISG also does not create rules or impose 
disciplinary actions; rather, the information sharing between 
members allows for the proper authority, regulator, or exchange to 
pursue appropriate rule changes or pursue legal action on market 
participants based on evidence gathered.
    \102\ See infra note 140.
---------------------------------------------------------------------------

    Exchange SROs and FINRA also have entered into 17d-2 plans \103\ 
and RSAs. Under these arrangements, as of 2020, FINRA operated a cross-
market regulatory program that covered 100% of U.S. equity market 
activity and approximately 45% of options contract volume, and FINRA 
also provided market-specific regulatory services to several 
exchanges.\104\ The Commission understands that these arrangements have 
enhanced regulatory outcomes.\105\ However, neither of these 
arrangements creates a requirement for broker-dealers that are not 
FINRA members to report their U.S. Treasury securities activity to 
TRACE. Moreover, 17d-2 plans are valuable, Commission-approved 
arrangements in the context of common members of more than one SRO. A 
17d-2 plan among one or more exchange SROs and FINRA would not provide 
FINRA with jurisdiction over a firm that is not a FINRA member, as 17d-
2 plans are designed to mitigate duplicative SRO oversight over common 
members of more than one SRO with respect to rules that are common 
among the SROs. In other words, for FINRA to be named as the DEA for a 
firm under a 17d-2 plan, the firm would have to be a FINRA member.\106\
---------------------------------------------------------------------------

    \103\ There are 19 effective bilateral plans and 4 multiparty 
plans. The 17d-2 plans can be found on the Commission's website at: 
https://www.sec.gov/rules/sro/17d-2.htm.
    \104\ See Cross-Market Regulatory Coordination Staff Paper, 
supra note 31 (stating that ``[t]he exchanges have relied on FINRA 
to perform regulatory functions, including surveillance, 
examinations, investigations, and enforcement functions, pursuant to 
RSAs and Rule 17d-2 plans. Under these arrangements, FINRA has 
developed a cross-market program that covers 100% of U.S. equity 
market activity and approximately 45% of options contract volume. In 
addition to these cross-market supervision services, FINRA provides 
market-specific regulatory services to several exchanges.'') (citing 
Letter from Marcia E. Asquith, Executive Vice President, FINRA, to 
Vanessa Countryman, Secretary, Commission, dated November 30, 2020).
    \105\ See Cross-Market Regulatory Coordination Staff Paper, 
supra note 31.
    \106\ For example, under a 17d-2 plan among exchange SROs and 
FINRA, FINRA is the Designated CAT Surveillance Authority (DCSA) for 
members of the exchange SROs and FINRA, and in that capacity assumes 
surveillance, investigation and enforcement responsibility relating 
to compliance by common members with Rule 613 and the rules of the 
SROs regarding compliance with the CAT NMS Plan. See Securities 
Exchange Act Release No. 89042 (June 10, 2020), 85 FR 36450 (June 
16, 2020) (File No. 4-618). But FINRA is not the DCSA for firms that 
are not FINRA members.
---------------------------------------------------------------------------

    The Commission therefore understands FINRA's cross-market 
regulatory program for equities and options relies on RSAs insofar as 
it covers broker-dealers that are not FINRA members.\107\ RSAs can be 
used to cover matters or firms that may fall outside the scope of a 
17d-2 plan.\108\ While RSAs can serve useful purposes, they generally 
are not publicly available, are not subject to Commission approval, and 
are voluntary private agreements between SROs that are not mandated by 
any Commission rule or statutory obligation and that may expire or be 
terminated by the parties.\109\ As a result, to the extent FINRA 
oversight is applied to non-FINRA member firms' off-member-exchange 
securities trading activity based on RSAs, such oversight relies upon 
arrangements between exchanges and FINRA that are discretionary. In 
addition, under an RSA, FINRA examines for compliance with the rules of 
the exchange that has entered into the RSA. Thus, non-FINRA members 
that are members of different exchanges may be subject to different 
exchange rules and interpretations when they effect off-member-exchange 
securities transactions to the extent these rules and interpretations 
are different. This approach is less stable and consistent than a 
regulatory regime in which Association membership and oversight is 
mandated.
---------------------------------------------------------------------------

    \107\ See, e.g., Securities Exchange Act Release No. 89972 
(September 23, 2020), 85 FR 61062, 61063 (September 29, 2020) 
(amending the 17d-2 plan among exchange SROs and FINRA relating to 
the surveillance, investigation, and enforcement of insider trading 
rules, which allocates regulatory responsibility to FINRA over 
common FINRA members (members of FINRA and at least one of the 
exchange SRO participants in the plan), and stating that the 
participating exchange SROs will also enter into an RSA to provide 
for the investigation and enforcement of suspected insider trading 
against broker-dealers that are not common FINRA members).
    \108\ See Cross-Market Regulatory Coordination Staff Paper, 
supra note 31.
    \109\ Unlike with Commission-approved 17d-2 plans, the SRO 
paying for regulatory services under an RSA retains ultimate legal 
responsibility for and control over the functions allocated to the 
service-providing SRO under the RSA. Further, in the context of an 
RSA in which an exchange SRO contracts with FINRA for FINRA to 
provide regulatory services on behalf of the exchange SRO, FINRA's 
oversight of the off-member-exchange trading activity of a non-FINRA 
member firm that is a member of the exchange is for compliance with 
the exchange's rules, not FINRA's rules.
---------------------------------------------------------------------------

    Further, the continued availability of the Rule 15b9-1 exemption 
from Association membership detracts from FINRA's off-exchange 
securities transaction reporting regime, and in particular, TRACE 
reporting for U.S. Treasury securities transactions. The ``covered 
ATS'' U.S. Treasury security volumes set forth above may not capture

[[Page 49939]]

all of those firms' U.S. Treasury securities transaction volume.\110\ 
Broker-dealers that are not FINRA members are not required to report 
their U.S. Treasury securities transactions to FINRA's TRACE system 
because TRACE reporting obligations for U.S. Treasury securities 
transactions apply only to broker-dealers that are FINRA members.\111\ 
When a non-FINRA member broker-dealer trades U.S. Treasury securities 
through a covered ATS, the covered ATS is obligated in its TRACE report 
to identify the non-FINRA member via its MPID,\112\ thus providing 
visibility to regulators as to what transactions on covered ATSs are 
attributable to non-FINRA members. But regulators have no such 
visibility when non-FINRA member broker-dealers trade U.S. Treasury 
securities on an ATS that is not a covered ATS or otherwise than on an 
ATS with a counterparty that also is not a FINRA member. In the former 
case, the transaction still must be reported to TRACE but the non-FINRA 
member is not specifically identified via a MPID and instead is 
identified only as a ``customer''; in the latter case, there is no 
TRACE reporting obligation whatsoever.\113\ These circumstances detract 
from the comprehensiveness of U.S. Treasury securities TRACE data and 
regulators' ability to utilize that data to detect and deter improper 
trading activity in the U.S. Treasury securities market. The Commission 
cannot quantify total secondary market trading in U.S. Treasury 
securities due to the current lack of comprehensive data in U.S. 
Treasury securities in TRACE. Moreover, broker-dealers that are not 
FINRA members have a potential competitive advantage over those that 
are FINRA members and thus incur the costs of reporting transactions in 
U.S. Treasury securities transactions.
---------------------------------------------------------------------------

    \110\ In the proposal the Commission issued in January 2022 to, 
among other things, amend Regulation ATS for ATSs that trade U.S. 
government securities, the Commission estimated that there would be 
7 trading systems that trade only government securities or 
repurchase or reverse repurchase agreements on government securities 
and operate pursuant to the Exchange Act Rule 3a1-1(a)(3) exemption 
and which would be required to comply with Regulation ATS under the 
proposal. See Securities Exchange Act Release No. 94062 (January 26, 
2022), 87 FR 15496, 15523 (March 18, 2022).
    \111\ See FINRA Rule 6720--Participation in TRACE. Beginning 
September 1, 2022, certain depository institutions will be required 
to report to TRACE transactions in U.S. Treasury securities, agency 
debt securities and agency mortgage-backed securities. See 
FINRA.org, Federal Reserve Depository Institution Reporting to 
TRACE, available at https://www.finra.org/filing-reporting/trace/federal-reserve-depository-institution-reporting (last visited July 
22, 2022).
    \112\ See FINRA Rule 6730--Transaction Reporting, Supplementary 
Material .07--ATS Identification of Non-FINRA Member Counterparties 
for Transactions in U.S. Treasury Securities, supra note 16.
    \113\ In addition, in the context of an NMS stock transaction 
effected between a FINRA member and a non-FINRA member otherwise 
than on an exchange, only the FINRA member is obligated to report 
the transaction to the FINRA TRF and the non-FINRA member generally 
is not identified on the trade report as the contra party to the 
trade. See Trade Reporting Frequently Asked Questions, Reporting 
Relationships and Responsibilities, Section 202: Reporting Trades 
with a Non-FINRA Member, available at: https://www.finra.org/filing-reporting/market-transparency-reporting/trade-reporting-faq#202 
(last visited July 22, 2022). The non-FINRA member is, however, 
identified in CAT in this context.
---------------------------------------------------------------------------

    Accordingly, the Commission is proposing to update Rule 15b9-1 such 
that proprietary trading firms that are registered broker-dealers 
generally must join FINRA, pursuant to Section 15(b)(8) of the Act, if 
they effect securities transactions otherwise than on an exchange of 
which they are a member. The Commission preliminarily believes that 
amending Rule 15b9-1 so that broker-dealer proprietary trading firms 
generally would be required to join FINRA if they trade elsewhere than 
on an exchange where they are a member would address the above-
described issues by subjecting such firms to FINRA's direct, 
membership-based jurisdiction and rules, including FINRA's TRACE 
reporting regime for U.S. Treasury security transactions. This would be 
consistent with the Exchange Act's statutory framework for 
complementary exchange SRO and Association oversight of broker-dealer 
trading activity, in which Section 15(b)(8) requires broker-dealers to 
join an Association if they effect securities transactions elsewhere 
than an exchange where they are a member. Amending Rule 15b9-1 in this 
way also would modernize the rule in a manner that is consistent with 
how proprietary trading occurs today and that promotes Section 
15(b)(9)'s requirement that any exemption from Section 15(b)(8) be 
consistent with the public interest and protection of investors. The 
Commission believes that direct, membership-based FINRA oversight over 
and the application of FINRA's securities transaction reporting 
requirements to firms that effect off-member-exchange securities 
transactions would create more effective SRO oversight over their off-
member-exchange securities trading activity and therefore promote the 
protection of investors and the public interest.
    As discussed above,\114\ the Exchange Act requires dual SRO and 
Commission oversight of registered broker-dealers, with SROs acting as 
robust, front-line regulators of their broker-dealer members. The 
Commission may bring enforcement actions, including pursuant to 
referrals made by SROs, to enforce broker-dealers' compliance with the 
Exchange Act and applicable rules, and SROs have regulatory authority 
over their members pursuant to the Exchange Act. Moreover, Section 
15(b)(8)'s complementary SRO oversight structure generally has enabled 
exchange SROs to specialize in oversight of securities trading activity 
that occurs on the exchange, and FINRA to specialize in oversight of 
cross-market, off-member-exchange securities trading activity. The 
Commission believes that rescinding Rule 15b9-1's de minimis allowance 
and proprietary trading exclusion would better enable robust and 
consistent FINRA oversight in the area of its expertise through direct, 
membership-based jurisdiction of broker-dealers that effect off-member-
exchange securities transactions proprietarily. This, in turn, could 
strengthen the front-line layer of SRO regulatory oversight that is 
applied to off-member-exchange proprietary securities trading in 
today's market.
---------------------------------------------------------------------------

    \114\ See section II.A, supra.
---------------------------------------------------------------------------

Requests for Comment
    The Commission requests comment on all aspects of the foregoing 
background discussion as well as, in particular, on the following 
questions:
    1. Is the Commission's estimate of the number of broker-dealers 
that are exchange members but not FINRA members still accurate as of 
the time of publication of this re-proposal? Is it too high or too low? 
Are there broker-dealers that were not FINRA members as of April 2022 
that have since joined FINRA? Please explain.
    2. Are the Commission's estimates of the securities transaction 
volumes attributable to non-FINRA member broker-dealers accurate? If 
not, why are they inaccurate? Are there any uncertainties associated 
with such estimates?
    3. Do exchange SROs directly exercise their SRO authority with 
respect to off-member-exchange securities trading activity by their 
members? If so, how have exchange SROs exercised their authority in 
this regard? In particular, how, if at all, have exchange SROs sought 
to exercise SRO authority over off-member-exchange securities trading 
activity conducted by their broker-dealer members that are not FINRA 
members? Have exchange SROs sought to exercise authority over U.S. 
Treasury securities trading activity by their members? Please explain 
and provide examples, if possible.
    4. Do RSAs or other cooperative arrangements among SROs cover the

[[Page 49940]]

U.S. Treasury securities trading activity conducted by broker-dealers 
that are exchange members but not FINRA members? If so, please specify 
the arrangements and how they work, including any limitations 
associated with such arrangements.
    5. Is the Commission's understanding correct that FINRA's cross-
market regulatory program for equities and options is based on RSAs 
insofar as it covers broker-dealers that are not FINRA members? If not, 
how are broker-dealers that are not FINRA members covered?

C. 2015 Proposal

    The Commission previously proposed to amend Rule 15b9-1 in March 
2015.\115\ The 2015 Proposal would have eliminated the de minimis 
allowance and proprietary trading exclusion from the rule, and added 
language to the rule that more closely tracked Section 15(b)(8) in 
providing an exemption from Section 15(b)(8)'s Association membership 
requirement only for a broker or dealer that carries no customer 
accounts and effects transactions in securities solely on a national 
securities exchange of which it is a member except in certain limited 
circumstances.\116\ The Commission did not adopt the 2015 Proposal but, 
as discussed above, remains concerned that proprietary trading dealer 
firms' reliance on the Rule 15b9-1 exemption from Association 
membership undermines the effectiveness of the SRO regulatory structure 
and SRO oversight of the securities markets as envisioned by Congress 
in the Exchange Act. Therefore, today the Commission is re-proposing 
amendments to Rule 15b9-1 that are similar to what was proposed in 
2015, but modified in certain respects in light of the Commission's 
further consideration of what set of circumstances would continue to be 
appropriate for an exemption from Association membership in today's 
market, which consideration is informed by comments on the 2015 
Proposal.\117\
---------------------------------------------------------------------------

    \115\ See 2015 Proposing Release, supra note 6, 80 FR 18036-37.
    \116\ The 2015 Proposal would have provided exemptions from 
Association membership for a dealer that is an exchange member, 
carries no customer accounts, and effects transactions elsewhere 
than an exchange of which it is a member solely for the purpose of 
hedging the risks of its floor-based activity; or for a broker or 
dealer that is an exchange member, carries no customer accounts, and 
effects transactions elsewhere than an exchange of which it is a 
member that result from orders that are routed by a national 
securities exchange of which it is a member to prevent trade-
throughs, consistent with the provisions of Rule 611 of Regulation 
NMS. As discussed below, the Commission is re-proposing herein that 
amended Rule 15b9-1 set forth a modified version of that routing 
exemption but is not including in this re-proposal a hedging 
exemption outside the context of stock-option orders.
    \117\ See supra note 17.
---------------------------------------------------------------------------

III. Discussion of Amendments to Rule 15b9-1

    As a general matter, the result under the amended version of Rule 
15b9-1 being proposed today would be the same as under the 2015 
Proposal: a broker or dealer would be required to join an Association 
if it effects transactions in securities elsewhere than on an exchange 
to which it belongs as a member, unless it can rely upon one of the 
amended rule's narrow exceptions.\118\ Conversely, a broker or dealer 
would not need to become a member of an Association if it effects 
securities transactions only on an exchange of which it is a 
member.\119\ The Commission preliminarily believes that these outcomes 
would enhance SRO regulatory oversight in a manner that promotes 
Section 15(b)(8) of the Act and the public interest and investor 
protection requirements of Section 15(b)(9) of the Act by enabling 
direct Association oversight of off-member-exchange broker-dealer 
proprietary trading activity. Several commenters supported the 2015 
Proposal.\120\ Some commenters questioned the necessity of expanded 
FINRA oversight.\121\
---------------------------------------------------------------------------

    \118\ See proposed Rule 15b9-1; see also 2015 Proposing Release, 
supra note 6.
    \119\ See section 15(b)(8) of the Act. If a broker or dealer is 
a member of multiple exchanges and effects securities transactions 
only on those exchanges, those exchanges could enter into an RSA to 
ensure effective cross-market supervision of this activity. The 
Commission acknowledges that in the future another SRO could assume 
these responsibilities pursuant to 17d-2 plans, subject to 
Commission approval. In addition, a given exchange may choose to 
enter into an RSA with an Association, as some exchanges have now. 
In those cases, the exchange maintains the ultimate responsibility 
for the contracted regulatory responsibilities.
    \120\ See, e.g., Letters from: Ryan W. Porter, Founder, High 
Amplitude Capital Trading (March 28, 2015) (``Porter Letter'') at 1; 
Chris Barnard (May 20, 2015) (``Barnard Letter'') at 1 (stating that 
the proposal would ``improve the consistency and effectiveness of 
regulatory supervision; reduce the existing differential regulatory 
burden of Member Firms and Non-Member Firms; and promote firms to 
compete more equitably to supply liquidity both on exchanges and 
off-exchange.''); Claudia Crowley, Chief Regulatory Officer, IEX 
Group, Inc. (May 22, 2015) (``IEX Letter'') at 2 (stating that there 
is a need to update the exemption in Rule 15b9-1 to better align it 
with its original intent and ``better reflect current market 
technology and practices'' which would result in ``more 
comprehensive and consistent regulatory oversight of off-exchange 
market activity.''); Marcia E. Asquith, Senior Vice President and 
Corporate Secretary, FINRA (June 2, 2015) (``FINRA Letter'') at 9-
10; Theodore R. Lazo, Managing Director and Associate General 
Counsel, SIFMA (June 1, 2015) (``SIFMA Letter'') at 1; Angelo 
Evangelou, Associate General Counsel, Legal Division, Cboe (June 10, 
2015) (``Cboe Letter'') at 1 (supporting the proposal ``insofar as 
the rulemaking seeks to require FINRA membership of proprietary 
firms whose primary business is executing transactions off-
exchange.''); and Elliot Grossman, Managing Director, Dinosaur 
Securities (Sep. 15, 2015) (``Dinosaur Letter'') at 2.
    \121\ See infra notes 125-127 and accompanying text.
---------------------------------------------------------------------------

    As noted above, Rule 15b9-1 currently exempts any broker or dealer 
from membership in an Association if it is a member of a national 
securities exchange, carries no customer accounts, and has annual gross 
income of no more than $1,000 that is derived from purchases or sales 
of securities effected otherwise than on an exchange of which it is a 
member.\122\ Under the rule's proprietary trading exclusion, income 
derived from transactions for a dealer's own account with or through 
another registered broker or dealer is excluded from the de minimis 
allowance.\123\
---------------------------------------------------------------------------

    \122\ 17 CFR 240.15b9-1(a).
    \123\ 17 CFR 240.15b9-1(b)(1). The current rule also states that 
the de minimis allowance does not apply to income derived from 
transactions through the Intermarket Trading System (``ITS''), and 
defines the term ``Intermarket Trading System'' for purposes of the 
rule. 17 CFR 240.15b9-1(b)(2) and (c). ITS was a national market 
system plan (``NMS Plan'') that was eliminated in 2007 because it 
was superseded by Regulation NMS. See infra notes 159-168 and 
accompanying text. Since Rule 15b9-1's references to ITS are now 
obsolete, as in the 2015 Proposal, the Commission is re-proposing to 
eliminate these references from the rule.
---------------------------------------------------------------------------

    The Commission is proposing to eliminate the de minimis allowance 
and the proprietary trading exclusion, and continue to allow an 
exemption from Association membership only for a registered broker or 
dealer that is an exchange member, carries no customer accounts, and 
effects securities transactions solely on a national securities 
exchange of which it is a member except in two narrow circumstances: 
(1) a broker or dealer effects transactions in securities otherwise 
than on an exchange to which it belongs as a member that result solely 
from orders that are routed by an exchange of which it is a member in 
order to comply with Rule 611 of Regulation NMS or the Options Order 
Protection and Locked/Crossed Market Plan; or (2) a broker or dealer 
effects transactions in securities otherwise than on an exchange to 
which it belongs as a member that are solely for the purpose of 
executing the stock leg of a stock-option order. In the subsections 
below, the Commission discusses each element of the re-proposed rule in 
detail.

A. Elimination of the De Minimis Allowance and Proprietary Trading 
Exclusion

    As in the 2015 Proposal, today the Commission is re-proposing to 
delete paragraphs (a)(3) and (b) from Rule

[[Page 49941]]

15b9-1.\124\ This would eliminate the de minimis allowance and 
proprietary trading exclusion. As a result, under Rule 15b9-1 as 
amended, any broker or dealer required by Section 15(b)(8) of the Act 
to become a member of an Association would be exempt from that 
requirement only if it is a member of a national securities exchange, 
carries no customer accounts, and any securities transactions that it 
effects elsewhere than on an exchange of which it is a member meet the 
limited criteria set forth in proposed paragraph (c) of the amended 
rule, which are discussed in detail below. The re-proposed elimination 
of the de minimis allowance and proprietary trading exclusion would 
generally preclude proprietary trading firms that are registered with 
the Commission pursuant to Section 15 of the Act and conduct off-
member-exchange securities trading from relying on Rule 15b9-1 as an 
exemption from Section 15(b)(8)'s Association membership requirement. 
Therefore, pursuant to Section 15(b)(8), they would be required to 
become a member of an Association unless they effect transactions in 
securities solely on an exchange of which they are a member.
---------------------------------------------------------------------------

    \124\ The Commission also is proposing to renumber the 
paragraphs that remain in the amended rule.
---------------------------------------------------------------------------

    Some commenters on the 2015 Proposal questioned the necessity and 
appropriateness of the expanded FINRA oversight that would result from 
the then-proposed elimination of the de minimis allowance and 
proprietary trading exclusion. Their concerns centered on assertions 
that exchange oversight may be more effective than FINRA 
oversight,\125\ FINRA membership would result in duplicative regulation 
for certain firms,\126\ and FINRA regulation is customer-focused and 
therefore not appropriate for proprietary trading firms that do not 
carry customer accounts.\127\
---------------------------------------------------------------------------

    \125\ See, e.g., Letters from: Mary Ann Burns, Chief Operating 
Officer, FIA Principal Traders Group (June 1, 2015) (``FIA 2 
Letter'') at 4; Joanne Moffic-Silver, Executive Vice President, 
General Counsel and Corporate Secretary, Cboe, Elizabeth K. King, 
Secretary and General Counsel, NYSE, Joan C. Conley, Senior Vice 
President and Corporate Secretary, NASDAQ OMX Group, Inc., (June 1, 
2015) (``Cboe/NYSE/Nasdaq Letter'') at 2; James Ongena, Senior Vice 
President and General Counsel, Chicago Stock Exchange (June 1, 2015) 
(``CHX Letter'') at 2; Jay Coppoletta, Chief Legal Officer, PEAK6 
Capital Management LLC (June 1, 2015) (``PEAK6 Letter'') at 2; Frank 
A. Bednarz, Global Co-Head of Trading, CTC Trading Group, LLC (June 
1, 2015) (``CTC Letter'') at 2-3.
    \126\ See, e.g., Letters from: Mark E. Gannon, Chief Compliance 
Officer, Lakeshore Securities, LP (June 4, 2015) (``Lakeshore 
Letter'') at 2-3; Mark Schepps, General Counsel and Senior Director 
of Compliance, D&D Securities, Inc. (May 29, 2015) (``D&D Letter'') 
at 3.
    \127\ See, e.g., CTC Letter at 2-3; PEAK6 Letter at 2; Letter 
from Gregory F. Hold, CEO, Hold Brothers Capital LLC (June 1, 2015) 
(``Hold Brothers Capital Letter'') at 2.
---------------------------------------------------------------------------

    The Commission continues to believe, however, that in today's 
market the de minimis allowance and proprietary trading exclusion are 
no longer appropriate, and that direct Association regulation generally 
of broker-dealers' off-member-exchange securities trading activity, 
consistent with what Congress envisioned in Section 15(b)(8) of the 
Act, would promote the protection of investors and the public interest 
pursuant to Section 15(b)(9) of the Act. As discussed above, the de 
minimis allowance and proprietary trading exclusion originally were 
intended to permit a type of off-exchange activity that no longer 
occurs today.\128\ When the Commission adopted Rule 15b9-1 and then the 
proprietary trading exclusion, virtually all trading activity was 
conducted manually on the floors of national securities exchanges.\129\ 
Today's market structure is dramatically different--proprietary, cross-
market order routing and trading strategies are a significant component 
of the markets, and exchange floor-based businesses represent only a 
fraction of market activity. Despite this transformative shift in how 
trading is conducted, the de minimis allowance and proprietary trading 
exclusion set forth in Rule 15b9-1 have never been adjusted.
---------------------------------------------------------------------------

    \128\ See supra note 60 and accompanying text. The Commission is 
unaware of any floor members today that refer accounts to other 
broker-dealers in exchange for a share of commission revenues.
    \129\ See, e.g., Special Study, supra note 62, at 98 (``Trading 
by NYSE members on the Exchange but from off the floor accounts for 
approximately 5 percent of total Exchange purchases and sales . . 
.'').
---------------------------------------------------------------------------

    Rule 15b9-1's stasis notwithstanding the market's transformation 
has led to a misalignment in the complementary regulatory structure 
contemplated by Congress since FINRA does not have direct, membership-
based jurisdiction over off-member-exchange securities trading activity 
by broker-dealers that are not FINRA members. The Exchange Act 
established the concept of an Association as the regulator of such 
trading activity,\130\ a role currently fulfilled by FINRA, which also 
is the SRO to which off-exchange trades are reported.\131\ As noted 
above, as of April 2022 there were approximately 65 brokers or dealers 
that were not FINRA members, including active proprietary trading 
firms, which accounted for a significant percentage of off-exchange 
equities and U.S. Treasury securities transaction volumes, as well as a 
significant amount of transaction volume on exchanges where they are 
not a member.\132\ The Commission is concerned that the current cross-
market regulatory program applied to such firms' off-member-exchange 
securities trading activity--which the Commission understands is 
dependent on RSAs--is not as stable or consistent as direct, 
membership-based Association oversight through FINRA membership in 
addressing any such trading activity and does not trigger FINRA's off-
exchange transaction reporting obligations for such firms. Under the 
amended rule, the 65 firms identified above generally would not be 
exempt from Section 15(b)(8) of the Act and therefore would be required 
to join FINRA (unless they qualify for one of the amended rule's 
exceptions), the only Association currently, to the extent that they 
effect securities transactions elsewhere than an exchange where they 
are a member. The Commission believes that direct, membership-based 
FINRA oversight over and the application of FINRA's securities 
transaction reporting requirements to such firms would create more 
effective SRO oversight over their off-member-exchange securities 
trading activity and therefore promote the protection of investors and 
the public interest.
---------------------------------------------------------------------------

    \130\ See 15 U.S.C. 78o(b)(8).
    \131\ See supra notes 40-43 and accompanying text.
    \132\ See supra notes 79-94 and accompanying text.
---------------------------------------------------------------------------

    Contrary to certain commenters' suggestion that FINRA oversight of 
proprietary trading firms is not necessary since they do not carry 
customer accounts, FINRA has established a regulatory regime for 
broker-dealers that effect off-member-exchange securities transactions 
that applies to FINRA members regardless of whether they handle 
customer orders or carry customer accounts. For example, FINRA has 
developed a detailed set of rules in core areas such as trading 
practices,\133\ business conduct,\134\

[[Page 49942]]

financial condition and operations,\135\ and supervision,\136\ many of 
which apply to FINRA members regardless of whether they handle customer 
orders or carry customer accounts.\137\ FINRA's ability to create a 
consistent regulatory framework for all such broker-dealers that effect 
securities transactions elsewhere than on exchanges where they are a 
member, including the off-exchange market, is undermined by the subset 
of such broker-dealers that are not FINRA members in reliance on Rule 
15b9-1. Moreover, part of FINRA's regulatory framework is its 
transaction reporting regime, and it is not customer-focused--it 
applies to FINRA members regardless of whether they handle customer 
orders or carry customer accounts.\138\ Continuing to permit an 
exemption from FINRA membership on the basis that dealers that, for 
example, trade U.S. Treasury securities proprietarily do not have 
customers would not help improve the comprehensiveness of U.S. Treasury 
securities transaction reporting to TRACE or address the potential 
competitive advantage of non-FINRA members that, unlike FINRA members, 
may trade U.S. Treasury securities without reporting those 
transactions.
---------------------------------------------------------------------------

    \133\ See FINRA Rule 5000 Series--Securities Offerings and 
Trading Standards and Practices. For instance, FINRA prohibits 
members from coordinating prices and intimidating other members. See 
FINRA Rule 5240(a), providing, among other things, that ``[n]o 
member or person associated with a member shall: (1) coordinate the 
prices (including quotations), trades or trade reports of such 
member with any other member or person associated with a member, or 
any other person; (2) direct or request another member to alter a 
price (including a quotation); or (3) engage, directly or 
indirectly, in any conduct that threatens, harasses, coerces, 
intimidates or otherwise attempts improperly to influence another 
member, a person associated with a member, or any other person.''
    \134\ See FINRA Rule 2000 Series--Duties and Conflicts, supra 
note 38.
    \135\ See FINRA Rule 4000 Series--Financial and Operational 
Rules. For example, FINRA Rule 4370(a) provides, among other things, 
that ``[e]ach member must create and maintain a written business 
continuity plan identifying procedures relating to an emergency or 
significant business disruption. Such procedures must be reasonably 
designed to enable the member to meet its existing obligations to 
customers. In addition, such procedures must address the member's 
existing relationships with other broker-dealers and counter-
parties. The business continuity plan must be made available 
promptly upon request to FINRA staff.''
    \136\ See FINRA Rule 3000 Series--Supervision and 
Responsibilities Relating to Associated Persons. This rule series 
generally requires FINRA member firms, among other things, to 
establish, maintain, and enforce written procedures to supervise the 
types of business in which the firm engages and the activities of 
its associated persons that are reasonably designed to achieve 
compliance with applicable securities laws and regulations, and with 
applicable FINRA rules. See e.g., FINRA Rules 3110 (Supervision), 
3120 (Supervisory Control System), and 3170 (Tape Recording of 
Registered Persons by Certain Firms). See also FINRA By-Laws Article 
III--Qualifications of Members and Associated Persons. Any person 
associated with a member firm who is engaged in the securities 
business of the firm--including partners, officers, directors, 
branch managers, department supervisors, and salespersons--must 
register with FINRA.
    \137\ See, e.g., the FINRA rules set forth in notes 38-43 and 
133-136 supra and accompanying text.
    \138\ See FINRA Rule 6000 Series (Quotation, Order, and 
Transaction Reporting Facilities), supra note 40.
---------------------------------------------------------------------------

    In addition, an Association's regulatory responsibility, like 
exchange SROs', includes an obligation to monitor for operational and 
regulatory issues, as well as issues relating to market 
disruptions.\139\ The inability of FINRA to directly enforce regulatory 
compliance by non-FINRA member proprietary trading firms--whether or 
not they handle customer orders or carry customer accounts--may create 
a risk to the fair and orderly operation of the market because, for 
example, if FINRA were to detect that a non-FINRA member is effecting 
off-member-exchange securities transactions that are not in compliance 
with the Exchange Act or applicable rules, FINRA would not have direct, 
membership-based jurisdiction to directly address the behavior.\140\ 
This is the case regardless of whether the firm has customers. And as 
discussed above,\141\ the Commission believes that RSA-based regulatory 
efforts among exchange SROs and FINRA, while beneficial in many 
contexts, are a less stable and consistent mechanism for SRO oversight 
than the Association membership required by the Exchange Act in the 
context presented here.
---------------------------------------------------------------------------

    \139\ 15 U.S.C. 78o-3.
    \140\ FINRA could refer such a matter to the Commission. See, 
e.g., Statement of Robert W. Cook, President and CEO, FINRA, 
``Equity Market Surveillance Today and the Path Ahead'' (Sep. 20, 
2017), available at https://www.finra.org/media-center/speeches-testimony/equity-market-surveillance-today-and-path-ahead (stating 
that FINRA makes referrals to the Commission or other authorities if 
the target of an investigation is beyond the collective jurisdiction 
of FINRA and the exchanges, and that in a prior year FINRA's market 
regulation department made over 500 referrals to the Commission on 
behalf of FINRA and its exchange clients related to potential 
abusive trading strategies or other rule violations). FINRA also 
could refer such a matter to an exchange where the firm is a member 
or, as discussed above, potentially address the matter through an 
RSA if covered by the terms of the RSA.
    \141\ See supra Section II.B. As is also discussed above, while 
the Commission can bring enforcement actions, including pursuant to 
SRO referrals, that Commission layer of regulatory oversight is 
meant to work in tandem with, not in place of, a robust front-line 
layer of SRO oversight. See supra Sections II.A and II.B.
---------------------------------------------------------------------------

    Moreover, contrary to commenters' assertions, the Commission does 
not preliminarily believe that exchange oversight alone would be more 
effective at remedying the above-described issues than direct FINRA 
oversight of off-member-exchange securities trading activity through 
the Association membership envisioned by Congress, or that FINRA 
membership would result in duplicative regulation for broker-dealer 
proprietary trading firms. The imposition of FINRA rules on such firms 
would require them to report their U.S. Treasury securities 
transactions under FINRA's TRACE reporting regime. It also would 
require that such firms be identified in off-exchange NMS stock 
transaction reports to FINRA's TRFs,\142\ and thus promote broader 
public market transparency in NMS stocks.\143\ Firms that are not FINRA 
members generally are not identified in TRF transaction reports.\144\ 
Moreover, FINRA registration would confer jurisdiction to FINRA to 
regulate directly off-member-exchange trading activity as Congress 
envisioned in Section 15(b)(8) of the Act, to apply a more consistent 
regulatory framework to such trading activity, and to mitigate the 
risks to the fair and orderly operation of the market that stem from 
FINRA's current lack of direct oversight of non-FINRA members. Further, 
due to FINRA's experience and expertise in cross-market supervision, 
the Commission preliminarily believes that FINRA is well-positioned to 
assume direct jurisdiction over dealer firms that currently are not 
FINRA members and effect securities transactions elsewhere than 
exchanges where they are a member.\145\ As for the potential for

[[Page 49943]]

duplicative SRO oversight, to the extent such firms also effect 
securities transactions on exchanges where they are a member, 17d-2 
plans are designed to mitigate duplicative SRO oversight over common 
members.
---------------------------------------------------------------------------

    \142\ See supra note 42 and accompanying text.
    \143\ See FINRA Rule 6000 Series--Quotation, Order, and 
Transaction Reporting Facilities and FINRA Rule 7000 Series--
Clearing, Transaction and Order Data Requirements, and Facility 
Charges, supra note 40; see also note 112 and accompanying text.
    \144\ See supra note 113.
    \145\ One commenter stated that the costs of cross-market 
surveillance ``are appropriately funded by exchanges as regulators 
of their markets and FINRA as the regulator of the off-exchange 
market.'' See Letter from Adam Nunes, Head of Business Development, 
Hudson River Trading LLC (June 1, 2015) (``HRT Letter'') at 9. This 
commenter further stated that the Commission should not ``attempt to 
address cross-market surveillance by forcing all broker-dealers to 
become members of FINRA'' and should attempt to ``ensure that cross-
market surveillance is not dependent on exchanges outsourcing 
exchange regulation to FINRA, as it leads to the possibility that 
changes to RSAs and 17d-2 agreements could substantially degrade the 
ability to perform appropriate cross-market surveillance.'' Id. This 
commenter also weighed the appropriateness of subjecting all broker-
dealers to FINRA oversight and the benefits of regulatory 
standardization against potential negatives associated with having a 
single regulator. Id. at 9-11. See also CHX Letter at 1-2 (stating 
concern about a single point of failure in regulatory surveillance 
and oversight practices). As discussed above, in the specific 
context of broker-dealers that are not FINRA members and that effect 
off-member-exchange securities transactions, the Commission believes 
that cross-market surveillance is not performed via 17d-2 plans and 
should not be dependent on RSAs. See supra Sections II.A and II.B 
(discussing, among other things, that Commission approval of a 17d-2 
plan relieves an SRO of the regulatory responsibilities allocated by 
the plan to another SRO but only with respect to common members of 
the participating SROs, and that RSAs' coverage is not limited to 
common members of the participating SROs but RSAs are discretionary 
arrangements among SROs that do not relieve the SRO contracting for 
regulatory services of ultimate regulatory responsibility over its 
members). Moreover, consistent with section 15(b)(8) of the Act, 
broker-dealers that do not effect securities transactions otherwise 
than on an exchange where they are a member would not be required to 
join FINRA. In addition, as re-proposed and discussed below, Rule 
15b9-1 would continue to provide certain narrow exemptions from 
section 15(b)(8)'s Association membership requirement for broker-
dealers that do effect securities transactions otherwise than on an 
exchange where they are a member. Thus, the Commission does not 
believe it is necessarily the case that all broker-dealers would be 
required to join FINRA as a result of the proposal.
---------------------------------------------------------------------------

    Some commenters on the 2015 Proposal also contended that the 
availability of CAT data would mitigate the need to subject proprietary 
trading firms to FINRA SRO oversight.\146\ As discussed above, the 
Commission preliminarily believes that the NMS and OTC securities data 
available to SROs through the CAT NMS Plan are helpful tools, but such 
access does not confer jurisdiction to FINRA over a firm that is not a 
FINRA member and that trades those securities off-exchange, or ensure 
that an individual exchange SRO of which such a firm is a member would 
seek to enforce compliance with its rules, Commission rules or Federal 
securities laws with respect to the firm's off-member-exchange 
activity.\147\ Even if one or more exchanges of which a broker-dealer 
is a member and FINRA could coordinate SRO oversight of the non-FINRA 
member firm's off-member-exchange securities trading activity through 
the use of CAT data and RSAs, performing SRO oversight in this manner 
is less certain and stable than direct Association oversight of such 
trading activity due to the discretionary nature of RSAs, and 
frustrates the regulatory scheme established by Congress in which an 
Association directly regulates broker-dealers that effect securities 
transactions elsewhere than exchanges where they are a member.\148\ 
Further, CAT reporting obligations do not apply to U.S. Treasury 
securities, U.S. Treasury securities are not traded on any exchange, 
and to the Commission's knowledge, unlike FINRA,\149\ no exchange SRO 
possesses the expertise or proclivity to exert SRO oversight over their 
members' U.S. Treasury securities trading activity. Access to CAT data 
would not shed light on firms' U.S. Treasury securities trading 
activity or provide exchanges or FINRA with any ability to monitor that 
activity.
---------------------------------------------------------------------------

    \146\ See, e.g., CHX Letter at 2.
    \147\ See supra Section II.B.
    \148\ See 2015 Proposing Release, supra note 6, 80 FR 18039 at 
notes 28-33 and accompanying text describing the regulatory history 
of off-exchange trading. See also Cross-Market Regulatory 
Coordination Staff Paper, supra note 31 (stating that ``[w]hile 
multiple SROs reviewing the same securities activities can have 
benefits, in that the resources and expertise from several 
organizations can be brought to bear on assessing these activities, 
it also can lead to duplication and inefficiencies in the regulatory 
process and increased burdens on member firms.''). FINRA and the 
exchange SROs have a history of coordinating and can work together 
to address concerns of firms that are receiving duplicative 
regulatory requests such as through the Cross Market Regulatory 
Working Group. Id.
    \149\ See supra notes 32-33 and accompanying text.
---------------------------------------------------------------------------

    As is discussed in more detail in the Economic Analysis, firms that 
must become FINRA members would become subject to the fees charged by 
FINRA to all of its member firms. FINRA charges each member firm 
certain regulatory fees designed to recover the costs to FINRA of the 
supervision and regulation of members, including performing 
examinations, financial monitoring, and policy, rulemaking, 
interpretive, and enforcement activities.\150\ These regulatory fees 
include a Trading Activity Fee (``TAF''),\151\ which, at the time of 
the 2015 Proposal, was a primary source of commenter concern over the 
costs of FINRA membership that would be borne by proprietary trading 
firms.\152\
---------------------------------------------------------------------------

    \150\ FINRA Schedule A to the By-Laws of the Corporation 
(``FINRA Schedule A''), at Section 1.
    \151\ FINRA uses the TAF to recover the costs to FINRA of the 
supervision and regulation of members, including performing 
examinations, financial monitoring, and policy, rulemaking, 
interpretive, and enforcement activities. See FINRA Schedule A, 
Section 1(a), available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees. 
The TAF is generally assessed on FINRA member firms for all equity 
sales transactions that are not performed in the capacity of a 
registered exchange specialist or market maker. See id. at section 
1(b). Many of the broker-dealers that could be required to join 
FINRA if the proposed amendments to Rule 15b9-1 are adopted effect 
securities transactions in large volumes throughout the national 
market system, and often in a capacity other than as a registered 
market-maker. See also infra note 241 and accompanying text for 
further discussion of the TAF.
    \152\ See, e.g., Letter from Mary Ann Burns, Chief Operating 
Officer, FIA (May 6, 2015) (``FIA 1 Letter'') at 1, PEAK6 Letter at 
2, Hold Brothers Capital Letter at 2, Lakeshore Letter at 2, CTC 
Letter at 5-6, D&D Letter at 2, Mark Schepps, General Counsel and 
Senior Director of Compliance, PTR, Inc. (May 29, 2015) (``PTR 
Letter'') at 2, Letter from Eric Chern, CEO, CTC Trading Group, 
L.L.C., Andrew Killion, CEO, Akuna Capital LLC, Thomas Hutchinson, 
President, Belvedere Trading LLC, Steven J. Gaston, Chief Compliance 
Officer, Consolidated Trading LLC, Trent Cutler, CEO, Cutler Group 
LP, John Kinahan, CEO, Group One Trading, L.P., Marc Liu, CEO, 
Integral Derivatives LLC, Craig S. Donohue, Executive Chairman, The 
Options Clearing Corporation, Sebastiaan Koeling, CEO, Optiver US, 
LLC, Andrew Tourney, Chief Compliance Officer, Peak6 Investments, 
L.P., Brian Donnelly, CEO, Volant Trading (July 13, 2016) (``Options 
Market Makers Letter'') at 6, and FIA 2 Letter at 5.
---------------------------------------------------------------------------

    Shortly after the Commission published the 2015 Proposal, FINRA 
issued a Regulatory Notice proposing to amend the TAF such that it 
would not apply to transactions by a proprietary trading firm effected 
on exchanges of which the firm is a member.\153\ FINRA stated in its 
Regulatory Notice that it would implement the TAF amendments to 
coincide with the compliance date of amendments to Rule 15b9-1. Given 
FINRA's prior consideration of amendments to its TAF, FINRA may again 
evaluate its TAF to ensure that it appropriately reflects the 
activities of, and regulatory responsibilities towards, broker-dealer 
proprietary trading firms that would be required to join FINRA if the 
proposed amendments to Rule 15b9-1 are adopted.\154\
---------------------------------------------------------------------------

    \153\ See FINRA Regulatory Notice 15-13, Trading Activity Fee 
(May 2015), available at https://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-13.pdf. FINRA, in its 
Regulatory Notice, stated that it analyzed the potential application 
and impact of the TAF to proprietary trading firms and believed it 
could result in a significant TAF obligation for these firms that 
may be disproportionate to FINRA's anticipated costs associated with 
the financial monitoring and trading surveillance of these firms, in 
large part because these firms do not have customers. Id. By way of 
example, FINRA stated that it conducts reviews for best execution 
(FINRA Rule 5310), trading ahead of customer orders (FINRA Rule 
5320), and display of customer limit orders (Exchange Act Rule 604), 
all of which are directed at firms that have customers or receive 
orders from customers of another broker-dealer. Id. To the extent 
that firms that join FINRA do not carry customer accounts, FINRA 
would not have to surveil such firms for compliance with these 
rules. The objective of the contemplated TAF amendment, according to 
FINRA, would be to tailor the TAF to FINRA's anticipated costs 
associated with the financial monitoring and trading surveillance of 
those firms that would be required to become FINRA members as a 
result of the Commission's proposed amendments.
    \154\ Commenters on the 2015 Proposal addressed the costs of 
FINRA membership, with some suggesting that the costs would be 
burdensome for proprietary trading firms. See, e.g., FIA 1 Letter at 
1 (``FINRA Membership would be costly to most proprietary trading 
firms''); PEAK6 Letter at 2 (``[FINRA registration is] overly costly 
and burdensome''); Hold Brothers Capital Letter at 2 (``[Costs of 
FINRA membership] would be unduly burdensome to smaller, less well 
funded Proprietary Traders''); Lakeshore Letter at 2-3; CTC Letter 
at 5-6; D&D Letter at 2; PTR Letter at 2; Options Market Makers 
Letter at 6; FIA 2 Letter at 5. Commenters also previously expressed 
concern that the application of the TAF in its current form to 
proprietary trading firms would be overly burdensome, but suggested 
that FINRA's proposed TAF amendment would mitigate this concern. 
See, e.g., HRT Letter at 5-6; FIA 1 Letter at 2; IEX Letter at 3; 
CTC Letter at 5; PEAK6 Letter at 3. Some commenters suggested a 
modification to FINRA's proposed amendment that would exclude from 
the TAF all of a firm's proprietary trading activity on an exchange 
of which it is a member. See, e.g., HRT Letter at 11. Apart from the 
TAF as it currently exists, the Commission does not believe that 
broker-dealer firms that join FINRA if proposed Rule 15b9-1 is 
adopted would be disproportionately impacted by the costs of FINRA 
membership compared to existing FINRA members that already incur 
those costs, and as discussed in the Economic Analysis, the 
Commission preliminarily believes that the costs would be justified 
by the considerable benefits of this proposal. In addition, some 
firms that could rely on Rule 15b9-1 nevertheless join FINRA 
voluntarily, which suggests that there are business interests 
satisfied by and benefits derived from FINRA membership that 
outweigh the costs of being a FINRA member, for at least some firms. 
Some commenters also raised the concern that FINRA may get paid 
twice for its regulatory oversight--once, directly from the FINRA 
membership, and again from the SROs that have outsourced regulatory 
oversight to FINRA through RSA agreements. See, e.g., SIFMA Letter 
at 3 and Lakeshore Letter at 3. The Commission notes that, as 
privately negotiated agreements between SROs, the fees set forth in 
RSAs are not subject to FINRA's rules or Commission review, and RSAs 
may be revised or terminated by the SRO parties thereto. By 
contrast, FINRA's rule-based fees are governed by Section 15A of the 
Act, which requires that they be equitably allocated among FINRA 
members and reasonable.

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[[Page 49944]]

    On March 28, 2022, the Commission proposed changes to the 
definition of ``dealer'' and ``government securities dealer,'' within 
the meaning of Sections 3(a)(5) and 3(a)(44) of the Exchange Act, 
respectively.\155\ We encourage commenters to review that proposal to 
determine whether it might affect their comments on this proposing 
release.
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    \155\ See Securities Exchange Act Release No. 94524 (March 28, 
2022), 87 FR 23054 (April 18, 2022).
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Requests for Comment
    The Commission requests comment on all aspects of the proposed 
elimination of the de minimis allowance and proprietary trading 
exclusion as well as, in particular, on the following questions:
    6. Are there exchange floor members that currently rely on the 
$1,000 de minimis allowance but not the proprietary trading exclusion? 
Are there exchange floor members that currently rely on the proprietary 
trading exclusion? If so, please describe the number and types of any 
such exchange floor members, and the nature and extent of their 
reliance. Also, please provide any available data on the amount and 
frequency of commissions or referral fees that floor members may 
continue to receive with respect to off-exchange transactions.
    7. Should the Commission retain the de minimis allowance but 
eliminate the proprietary trading exclusion? If so, should the $1,000 
threshold be changed? Why or why not? What should the threshold be? 
Should the de minimis allowance be modified in some other way? Would 
exchanges be able to appropriately monitor their members for compliance 
with an increased de minimis allowance? Would an increased de minimis 
allowance be an appropriate means of permitting hedging transactions 
that exchange members may effect elsewhere than their member 
exchange(s) without triggering Section 15(b)(8)'s Association 
requirement?
    8. Instead of eliminating the proprietary trading exclusion, should 
the Commission retain a modified version of it? If so, how should it be 
modified and why? How could the proprietary trading exclusion be 
modified such that there is appropriate and comprehensive SRO oversight 
of firms that trade securities otherwise than on an exchange of which 
they are member and that trading activity? For example, could the 
proprietary trading exclusion be modified such that a firm's reliance 
on it is contingent on the firm reporting its off-exchange securities 
transactions to the appropriate FINRA facility or TRACE? Would this 
suffice to enable the Commission to achieve the goals expressed herein, 
despite not providing FINRA with direct regulatory oversight of the 
firms?
    9. If the de minimis allowance and proprietary trading exclusion 
are eliminated, as proposed, would some exchange floor members be 
required to become members of an Association? If so, how many? Please 
provide the basis of any estimate. What would be the effect on those 
firms?
    10. To what extent do dealer firms that are not FINRA members and 
that trade securities otherwise than on an exchange of which they are a 
member rely on the proprietary trading exclusion? Where, other than an 
exchange where they are a member, do they typically effect securities 
transactions? On ATSs? Off-exchange otherwise than on an ATS? Another 
exchange where they are not a member? In what sort of dealer activity 
do these firms engage? For example, do they typically provide liquidity 
or make markets? Do they typically remove liquidity? Do they engage in 
other types of trading activities?
    11. If the de minimis allowance and proprietary trading exclusion 
are eliminated, as proposed, what would be the effect on dealer firms 
that currently rely on the proprietary trading exclusion? What, if 
anything, would be the impact on their businesses if they are required 
to register with an Association? Would business incentives change such 
that firms might adjust their business model by exiting the off-
exchange market, moving transactions on-exchange, or leaving the 
markets altogether? Would firms alter their organizational structure or 
shift their proprietary trading activities to different or new 
affiliates? Would the effects on firms be different depending on what 
types of securities they trade?
    12. Do commenters agree that some exchange member dealer firms 
trade proprietarily in U.S. Treasury securities as well as exchange-
traded securities, and are not FINRA members in reliance on the 
proprietary trading exclusion? If the de minimis allowance and 
proprietary trading exclusion are eliminated, as proposed, what would 
be the effects on such firms? What, if anything, would be the impact on 
their U.S. Treasury securities trading business? Do commenters expect 
that these firms would alter their business model or organizational 
structure if the amendments proposed herein are adopted? If so, how? 
Would these firms shift their proprietary trading activities to 
different or new affiliates? Would increased price discovery reduce any 
competitive advantages these firms have by observing other firms' 
trades and not reporting their own trades? Would this impact market 
costs borne by the investing public?
    13. Do commenters believe that most exchange member dealer firms 
that effect proprietary securities transactions otherwise than on an 
exchange of which they are member would need to join FINRA as a result 
of the elimination of the de minimis allowance and proprietary trading 
exclusion? If so, would it help address the Commission's concerns 
regarding FINRA's lack of direct jurisdiction over such firms' off-
member-exchange securities trading activity when they are not FINRA 
members? What are commenters' views as to the extent of FINRA's current 
ability to oversee off-member-exchange securities trading activity by 
dealer firms that are not FINRA members?
    14. How do exchange SROs currently surveil or regulate their 
members' securities trading activity and conduct elsewhere than the 
exchange? Do exchange SRO efforts in this regard mitigate any need to 
rescind the de minimis allowance and proprietary trading exclusion? How 
would such an approach address the fact that TRACE reporting 
obligations apply only to FINRA members?
    15. Are there concerns regarding how the TAF would apply to 
proprietary trading broker-dealer firms?
    16. Are there concerns regarding the applicability of certain FINRA 
rules to solely proprietary trading broker-dealers, as opposed to those 
who face customers? Which rules, and why? Are there benefits to 
applying FINRA rules to these broker-dealers?

B. Narrowed Criteria for Exemption From Association Membership

    The Commission is proposing to add to Rule 15b9-1 a new paragraph 
(c) that would set forth two narrow circumstances in which a broker or 
dealer could continue to be exempt from Section 15(b)(8)'s Association

[[Page 49945]]

membership requirement if it effects transactions in securities 
otherwise than on an exchange of which it is a member.\156\ 
Specifically, following the existing paragraphs of Rule 15b9-1 that 
require that a broker or dealer be a member of a national securities 
exchange and carry no customer accounts (both of which paragraphs would 
be retained), the Commission proposes to add language that would state: 
``and, (c) Effects transactions in securities solely on a national 
securities exchange of which it is a member, except that with respect 
to this paragraph (c) . . .'' The two proposed exceptions would follow 
in new paragraphs (c)(1) and (c)(2), and are discussed in turn below. 
Proposed paragraphs (c)(1) and (c)(2) of the amended rule are intended 
to provide more focused exemptions from Association membership for 
types of off-member-exchange activity that are similar to the off-
member-exchange activities that Rule 15b9-1 was originally intended to 
cover, and that are consistent with the public interest and the 
protection of investors in accordance with Section 15(b)(9) of the Act.
---------------------------------------------------------------------------

    \156\ See proposed Rule 15b9-1(c). Relatedly, existing paragraph 
(a) of Rule 15b9-1 would remain the same except it would no longer 
be numbered as paragraph (a); existing paragraph (a)(1) would be 
renumbered as paragraph (a); and existing paragraph (a)(2) would be 
renumbered as paragraph (b). See proposed Rule 15b9-1.
---------------------------------------------------------------------------

1. Routing Exemption
    In paragraph (c)(1) of Rule 15b9-1, the Commission proposes to 
provide an exemption from Association membership if a broker or dealer 
that meets the criteria of paragraphs (a) and (b) of the rule effects 
transactions in securities otherwise than on a national securities 
exchange of which it is a member that result solely from orders that 
are routed by a national securities exchange of which it is a member to 
comply with Rule 611 of Regulation NMS \157\ or the Options Order 
Protection and Locked/Crossed Market Plan.\158\ Relatedly, the 
Commission also proposes to eliminate from Rule 15b9-1 outdated 
references to the ``Intermarket Trading System.'' \159\
---------------------------------------------------------------------------

    \157\ 17 CFR 242.611.
    \158\ See proposed Rule 15b9-1(c)(1). See also Securities 
Exchange Act Release No. 60405 (July 30, 2009), 74 FR 39362 (August 
6, 2009) (``Options Linkage Plan''). In the 2015 Proposal, the 
Commission proposed to apply this exemption to orders routed to 
comply with Rule 611 but did not propose to apply this exemption to 
orders routed to comply with the Options Linkage Plan. Several 
commenters on the 2015 Proposal supported this proposed exemption 
for compliance with Rule 611. See, e.g., HRT Letter at 7; D&D Letter 
at 3; PTR Letter at 3; CHX Letter at 3-4; SIFMA Letter at 3-4. 
Commenters also suggested that the routing exemption should covers 
orders routed to comply with the Options Linkage Plan. See, e.g., 
Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3.
    \159\ The Intermarket Trading System was an NMS plan, the full 
title of which was ``Plan for the Purpose of Creating and Operating 
an Intermarket Communications Linkage Pursuant to section 
11A(c)(3)(B) of the Exchange Act of 1934'' (``ITS Plan''). The ITS 
Plan was initially approved by the Commission in 1978. Exchange Act 
Release No. 14661 (April 14, 1978), 43 FR 17419 (April 24, 1978) 
(``ITS Plan Approval Order''). All national securities exchanges 
that traded exchange-listed stocks and the NASD were participants in 
the ITS Plan.
---------------------------------------------------------------------------

    The ITS Plan required each participant to provide electronic access 
to its displayed best bid and offer, and provided an electronic 
mechanism for routing orders, called commitments to trade, to access 
those displayed prices.\160\ The ITS Plan provided each market limited 
access to the other markets for the purpose of avoiding a trade-through 
\161\ and locked or crossed markets.\162\ The ITS Plan was eliminated 
in 2007 because it was superseded by Regulation NMS.\163\ Thus, the 
references to the ``Intermarket Trading System'' in current paragraphs 
(b)(2) and (c) of Rule 15b9-1 are obsolete.
---------------------------------------------------------------------------

    \160\ See ITS Plan Approval Order, supra note 159.
    \161\ See 17 CFR 242.600(b)(94) (defining a ``trade-through'' 
under Regulation NMS); see also Options Linkage Plan, supra note 158 
(defining ``trade-through'' in the options context).
    \162\ A locked or crossed market occurs when a trading center 
displays an order to buy at a price equal to or higher than an order 
to sell, or an order to sell at a price equal to or lower than an 
order to buy, that is displayed on another trading center.
    \163\ Notice of Filing and Immediate Effectiveness of the Twenty 
Fourth Amendment to the ITS Plan Relating to the Elimination of the 
ITS Plan, Exchange Act Release No. 55397 (March 5, 2007), 72 FR 
11066 (March 12, 2007). Today, Regulation NMS contains an updated 
trade-through rule, and contemplates the use of private linkages by 
trading centers to route orders to avoid trade-throughs. 17 CFR 
242.610-611.
---------------------------------------------------------------------------

    Today, Rule 611 of Regulation NMS requires trading centers, such as 
national securities exchanges, to establish, maintain, and enforce 
written policies and procedures reasonably designed to prevent trade-
throughs in exchange-listed stocks, subject to certain exceptions.\164\ 
In general, Rule 611 protects automated quotations that are the best 
bid or offer of a national securities exchange or an Association.\165\ 
To facilitate compliance with Rule 611, national securities exchanges 
have developed the capability to route orders through brokers or 
dealers (many of which are affiliated with the exchanges) to other 
trading centers with protected quotations.\166\ Similarly, in the 
options market, the Options Linkage Plan is a national market system 
plan that requires linkages between the options exchanges to protect 
the best-priced displayed quotes in the market and to avoid locked and 
crossed markets.\167\ The Options Linkage Plan includes written 
policies and procedures that provide for order protection and address 
locked and crossed markets in eligible options classes.\168\
---------------------------------------------------------------------------

    \164\ 17 CFR 242.611. See also 17 CFR 240.600(b)(95) (defining 
``trading center'').
    \165\ 17 CFR 242.611.
    \166\ See 17 CFR 242.600(b)(71) (defining ``protected 
quotation'' under Regulation NMS) and 17 CFR 242.600(b)(70) 
(defining ``protected bid'' and ``protected offer'' under Regulation 
NMS); see also Options Linkage Plan, supra note 158 (defining 
``protected bid'' and protected offer'' in the options context).
    \167\ See Options Linkage Plan, supra note 158.
    \168\ Id.
---------------------------------------------------------------------------

    The proposed rule would continue to accommodate securities 
transactions away from a broker's or dealer's member exchange(s) that 
are to comply with these regulatory requirements. An exchange member 
may at times seek to effect a securities transaction on that exchange 
at a price that would trade through a protected quotation displayed on 
another trading center, such as another exchange or FINRA's ADF. In 
such a case, the exchange may route the member's order (if the exchange 
does not reject it), through a routing broker-dealer, to that other 
trading center to access the protected quotation. Moreover, if, for 
example, an ATS were to display a protected quotation on FINRA's ADF, 
absent the proposed exemption, a broker or dealer would have to join 
FINRA in order to have access to all protected quotations, even if the 
broker or dealer already is a member of every exchange on which it 
effects securities transactions.\169\
---------------------------------------------------------------------------

    \169\ See HRT Letter at 7 (stating that ``if an ATS were to 
display a protected quote on FINRA's ADF, absent an exemption, a 
Non-Member would not have access to the protected quotations without 
registering with FINRA'' and asserting that allowing exempt firms to 
have access to all protected quotations is critical because it 
affects their ability to trade on exchanges of which they are 
members). See also SIFMA Letter at 3 (suggesting that the Commission 
clarify the exemption and whether it applies to non-floor exchange 
members whose orders are routed by the exchange to an off-exchange 
venue).
---------------------------------------------------------------------------

    In essence, a broker or dealer may, as a necessary part of its 
business trading on exchanges of which it is a member and in light of 
today's market structure, effect securities transactions elsewhere than 
an exchange where it is a member solely as a consequence of routing by 
its member exchange(s) to comply with the requirements of Rule 611 of 
Regulation NMS or the Options Linkage Plan. The proposed rule would not 
require Association membership as a result of such transactions. On the 
contrary, it

[[Page 49946]]

would be consistent with Section 15(b)(9)'s goal of protecting 
investors and the public interest if transactions effected solely to 
comply with these regulatory requirements, via routing by the broker's 
or dealer's member exchange(s), do not trigger Section 15(b)(8)'s 
Association membership requirement for a broker or dealer that 
otherwise limits its securities transactions to an exchange of which it 
is a member (or to stock transactions that are covered by the stock-
option order exemption discussed below). The proposed routing exemption 
would serve the limited, narrowly defined purpose of facilitating 
compliance with intermarket order protection requirements.\170\
---------------------------------------------------------------------------

    \170\ One commenter stated that the routing exemption should be 
``expanded to include all exchange-based routing activity, 
including, but not limited to, routing effected for Regulation NMS-
compliance and best execution purposes'' and that the proposal 
``does not contemplate the full array of legitimate and necessary 
exchange-based routing activity.'' See CHX Letter at 3. The 
commenter asserted that because all exchange routing functionalities 
must be approved by the Commission, any type of exchange routing 
would be consistent with the purposes of the Act and should be 
covered by the proposed exemption. Id. at 3-4. In response to this 
comment, the Commission preliminarily believes that many exchange-
offered routing functionalities are not necessary to facilitate an 
exchange member's trading on the exchange. In addition, the 
Commission is unaware of any exchange-offered routing options that 
are specifically designated as being for best execution purposes. An 
exchange member may utilize the exchange's routing functionality to 
assist in meeting its best execution obligations, but this would not 
appear limited to any particular exchange-offered routing option. 
The commenter's suggested expansion of the proposed routing 
exemption could create a gap in the FINRA oversight intended to be 
achieved under the proposal if the exchange member could rely on its 
member exchange's router to execute significant volume on other 
markets where it is not a member without joining FINRA.
---------------------------------------------------------------------------

    The Commission also believes that it would be consistent with the 
protection of investors and the public interest to permit reliance on 
this exemption only where the routing is performed by a national 
securities exchange of which the broker or dealer is a member. This 
limitation would help ensure that the broker's or dealer's member 
exchange has visibility into these routing transactions and thus is 
better able to provide effective SRO oversight of its member's activity 
that is related to its trading on the exchange and may not be overseen 
by another SRO if the member is exempt from Association membership 
under amended Rule 15b9-1.\171\ In this context, the exemption would be 
applicable where the broker's or dealer's member exchange utilizes the 
services of a designated broker-dealer (which could be affiliated or 
unaffiliated with the exchange) to perform the exchange's outbound 
routing, as the Commission understands that this type of arrangement is 
typical among exchanges.
---------------------------------------------------------------------------

    \171\ Some commenters on the 2015 Proposal suggested that the 
routing exemption should not be limited to where the broker's or 
dealer's member exchange's routing mechanism is utilized, and that 
the Commission also should provide relief to broker-dealers that 
route orders to access protected quotations on away exchanges 
without utilizing the linkage routing mechanism offered by a home 
exchange. See Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3. The 
Commission does not believe this would be appropriate because it 
could permit scenarios in which there is insufficient SRO oversight 
of the entirety of the broker-dealer's trading activity. By way of 
example, if a broker-dealer were a member of some exchanges but not 
others and not a FINRA member, and the broker-dealer could rely on 
the exemption when routing orders to access protected quotations on 
non-member exchanges or off-exchange in order to prevent a trade-
through on one of its member exchanges, the Commission believes that 
it is possible that there would not be an SRO responsible for and 
that could exercise jurisdiction over the broker-dealer's trading 
activity away from its member exchange(s).
---------------------------------------------------------------------------

    A commenter on the 2015 Proposal sought clarity as to whether the 
exemption would apply to routing broker-dealers that are affiliated 
with national securities exchanges that are used by exchanges to 
conduct routing to other trading centers.\172\ The commenter pointed 
out that the Commission has required these affiliated routing broker-
dealers to operate as ``facilities'' of their respective exchanges, 
which set forth rules that require the exchange to arrange for the 
routing broker-dealer to be overseen by a non-affiliated SRO, and which 
in practice is FINRA.\173\ The commenter requested that the Commission 
clarify that the exemption from FINRA registration under Rule 15b9-1 
would not apply to a broker-dealer affiliated with a national 
securities exchange that routes orders on behalf of the exchange for 
the purpose of accessing quotations in other trading centers.\174\ In 
response, proposed Rule 15b9-1 would provide an exemption from Section 
15(b)(8) of the Act's Association membership requirement for routing 
broker-dealers that meet the conditions for the exemption. However, 
proposed Rule 15b9-1 would not provide routing broker-dealers with an 
exemption from the rules of an exchange that are applicable to routing 
broker-dealers that operate as facilities of that exchange (and that 
the exchange uses to conduct routing to other trading centers). As is 
the case today, if an exchange's routing broker-dealer is covered by 
amended Rule 15b9-1, if adopted, then the routing broker-dealer would 
qualify for the exemption from Section 15(b)(8) afforded by the rule. 
But the routing broker-dealer would still be required to comply with 
the applicable rules of any exchange for which it performs outbound 
routing services, including those requiring the routing broker-dealer 
to be overseen by an unaffiliated SRO such as FINRA.\175\
---------------------------------------------------------------------------

    \172\ See SIFMA Letter at 3-4.
    \173\ Id.
    \174\ Id. (expressing concern as to whether ``an exchange-
affiliated routing broker-dealer could restrict its activities to 
accessing protected quotations on other exchanges and could 
therefore avoid FINRA membership'').
    \175\ See, e.g., Cboe BZX Exchange, Inc. Rule 2.11 (Cboe 
Trading, Inc. as Outbound Router); NYSE Rule 17(c) (Operation of 
Routing Broker); Nasdaq Rule 4758(b) (Routing Broker).
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposed 
routing exemption in amended Rule 15b9-1. In particular, the Commission 
seeks responses to the following questions:
    17. What are commenters' views on the proposed routing exemption? 
How, if at all, should the proposed routing exemption be modified?
    18. Is the scope of the proposed routing exemption sufficient to 
provide relief for all securities transactions effected elsewhere than 
on an exchange of which a broker or dealer is a member that might be 
effected to comply with Rule 611 of Regulation NMS and the Options 
Linkage Plan? If not, how should it be changed?
    19. Should the proposed routing exemption be broadened to cover 
transactions beyond those that are to comply with Rule 611 of 
Regulation NMS and the Options Linkage Plan? If so, what types of 
additional transactions should be covered and why? For example, should 
the proposed routing exemption be broadened such that it covers routing 
by an exchange for any purpose and pursuant to any of the exchange's 
available routing functionalities? Should the proposed routing 
exemption be narrowed so that it does not cover transactions to comply 
with Rule 611 or the Options Linkage Plan? Should the proposed routing 
exemption be eliminated in its entirety?
    20. Are there other off-exchange transactions that a broker or 
dealer might effect in order to comply with regulatory requirements? If 
so, please describe those transactions and the relevant regulatory 
requirements. Should there be an exemption in amended Rule 15b9-1 that 
applies to any such transactions?
    21. Should the proposed routing exemption also cover broker-dealer 
routing to access protected quotations without using the member 
exchange's routing mechanisms? Why or why not?
    22. As discussed above, the Commission preliminarily believes that

[[Page 49947]]

the proposed routing exemption from Section 15(b)(8)'s Association 
membership requirement does not exclude a routing broker that operates 
as the facility of an exchange, but such a routing broker would still 
be required to comply with the rules of the exchange, including 
exchange rules requiring that the routing broker be overseen by an SRO 
that is not affiliated with the exchange. Do commenters agree with 
this? Should Rule 15b9-1 be amended in some way such that it excludes 
or applies differently to routing brokers that operate as the facility 
of an exchange? Why or why not? Should the proposed routing exemption 
apply where the exchange uses a routing broker, whether affiliated or 
unaffiliated? Should the routing exemption apply only where the 
exchange uses an affiliated routing broker? Should the routing 
exemption apply only where the exchange uses an unaffiliated routing 
broker?
2. Stock-Option Order Exemption
    In paragraph (c)(2) of amended Rule 15b9-1, the Commission proposes 
to provide an exemption from Association membership if a broker or 
dealer that meets the criteria of paragraphs (a) and (b) of the rule 
effects transactions in securities otherwise than on a national 
securities exchange of which it is a member, with or through another 
registered broker or dealer, that are solely for the purpose of 
executing the stock leg of a stock-option order.\176\ Proposed 
paragraph (c)(2) also would require that a broker or dealer seeking to 
rely on this proposed exemption establish, maintain, and enforce 
written policies and procedures reasonably designed to ensure and 
demonstrate that such transactions are solely for the purpose of 
executing the stock leg of a stock-option order, and that the broker or 
dealer preserve a copy of its policies and procedures in a manner 
consistent with 17 CFR 240.17a-4 until three years after the date the 
policies and procedures are replaced with updated policies and 
procedures.\177\
---------------------------------------------------------------------------

    \176\ See proposed Rule 15b9-1(c)(2). The 2015 Proposal did not 
include this type of exemption. Several commenters suggested that it 
be added to the amended rule. See, e.g., Letter from Elizabeth K. 
King, Secretary and General Counsel, NYSE and Joan C. Conley, Senior 
Vice President and Corporate Secretary, NASDAQ OMX Group, Inc. (June 
4, 2015) (``NYSE/Nasdaq Letter'') at 2-4; D&D Letter at 1-2; PTR 
Letter at 1-2; Cboe Letter at 3; Cboe/NYSE/Nasdaq Letter at 4; 
Lakeshore Letter at 2.
    \177\ See proposed Rule 15b9-1(c)(2).
---------------------------------------------------------------------------

    The Commission understands that there are firms that trade stock-
option orders whose business is focused on one or more options 
exchanges of which they are a member, and whose trading elsewhere is 
primarily to effect the execution of stock orders to facilitate their 
stock-option order business. In the Commission's preliminary view, 
these firms' stock trading activity is for a limited purpose and 
ancillary to their primary business handling stock-option orders on an 
options exchange of which they are member. As discussed below, there is 
a close link between the stock component transaction of a stock-option 
order and the relevant options exchange. As such, the proposed rule 
would permit these types of firms to continue their stock-option order 
trading business without being required to join stock exchanges or an 
Association solely in order to effect the execution of the stock legs 
of stock-option orders that they handle.
    As noted above, the Commission estimates that, in 2021, 50 of the 
66 firms identified as registered broker-dealers and exchange members 
but not FINRA members initiated options order executions.\178\ The 
Commission estimates that seven of the firms that initiated options 
order executions also effected the execution of stock leg transactions, 
and therefore could potentially rely on the proposed stock-option order 
exemption to the extent that they effect the stock leg executions off-
exchange or on an exchange where they are not a member. Because the 
broker or dealer relying on proposed Rule 15b9-1(c)(2) would not itself 
be a member of an exchange on which such stock transactions are 
executed, or a member of an Association, such stock leg transactions 
would need to be effected with or through another registered broker or 
dealer that is a member of the exchange where the transactions are 
executed or a member of an Association (or both).
---------------------------------------------------------------------------

    \178\ See supra note 81.
---------------------------------------------------------------------------

    Options exchanges define the term ``stock-option order'' in their 
rules.\179\ Further, as far as the Commission is aware, all options 
exchanges accept a stock-option order only if it complies with the 
Qualified Contingent Trade (``QCT'') Exemption (``QCT Exemption'') from 
Rule 611(a) of Regulation NMS.\180\ For purposes of relying on the 
exemption provided by proposed Rule 15b9-1(c)(2), a broker or dealer 
should adhere to the stock-option order definition of the options 
exchange where the stock-option order is handled and of which the 
broker or dealer is a

[[Page 49948]]

member.\181 \Specifically, the broker or dealer could rely on that 
definition to determine whether, for purposes of amended Rule 15b9-
1(c)(2), an order is in fact a stock-option order and a stock order is 
in fact the stock leg of a stock-option order. Moreover, the exemption 
would apply regardless of whether the component legs of a stock-option 
order are executed electronically, on the physical exchange floor, or 
through a combination of both. The Commission believes that approaching 
the proposed stock-option order exemption in this way should minimize 
disruptions to the markets for stock-option orders by minimizing the 
degree to which brokers and dealers that trade such orders would need 
to alter their business in order to rely on the proposed exemption.
---------------------------------------------------------------------------

    \179\ See, e.g., Cboe Rule 1.1 (defining ``stock-option order'' 
as ``an order to buy or sell a stated number of units of an 
underlying or a related security coupled with either (a) the 
purchase or sale of option contract(s) on the opposite side of the 
market representing either the same number of units of the 
underlying or related security or the number of units of the 
underlying security necessary to create a delta neutral position or 
(b) the purchase or sale of an equal number of put and call option 
contracts, each having the same exercise price and expiration date, 
and each representing the same number of units of stock as, and on 
the opposite side of the market from, the underlying or related 
security portion of the order. For purposes of electronic trading, 
the term ``stock-option order'' has the meaning set forth in Rule 
5.33.''); Cboe Rule 5.33(b)(5) (defining a ``stock-option order'' as 
``the purchase or sale of a stated number of units of an underlying 
stock or a security convertible into the underlying stock 
(``convertible security'') coupled with the purchase or sale of 
options contract(s) on the opposite side of the market representing 
either (i) the same number of units of the underlying stock or 
convertible security or (ii) the number of units of the underlying 
stock necessary to create a delta neutral position, but in no case 
in a ratio greater than eight-to-one (8.00), where the ratio 
represents the total number of units of the underlying stock or 
convertible security in the option leg(s) to the total number of 
units of the underlying stock or convertible security in the stock 
leg''). See also, e.g., MIAX Rule 518(a)(5); MIAX Emerald Rule 
518(a)(5); Nasdaq Options 3, Section 14(a)(i); Nasdaq PHLX Options 
3, Section 7(b)(13); Nasdaq ISE Options 3, Section 14(a)(5); Nasdaq 
MRX Options 3, Section 14(a)(5); Nasdaq BX Chapter 5, Section 
27(a)(v)(1) of the ``Grandfathered Rules'' of the Boston Stock 
Exchange, Inc.; NYSE Arca Rule 6.62-O(h)(1); and NYSE American Rule 
900.3NY(h)(1).
    \180\ See, e.g., Cboe Rule 5.33, Interpretations and Policies 
.04 Stock Option Orders (stating that a user may only submit a 
stock-option order if it complies with the QCT Exemption and that a 
user submitting a stock-option order represents that it complies 
with the QCT Exemption); Supplementary Material to Nasdaq ISE 
Options 3, Section 14 (stating that ``[m]embers may only submit 
Complex Orders in Stock-Option Strategies and Stock-Complex 
Strategies if such Complex Orders comply with the Qualified 
Contingent Trade Exemption from Rule 611(a) of Regulation NMS under 
the Exchange Act'' and that ``[m]embers submitting Complex Orders in 
Stock-Option Strategies and Stock-Complex Strategies represent that 
they comply with the Qualified Contingent Trade Exemption'') and 
Commentary .01 to MIAX Rule 518 (stating that ``[m]embers may only 
submit stock-option orders if such orders comply with the Qualified 
Contingent Trade Exemption from Rule 611(a) of Regulation NMS under 
the Securities Exchange Act of 1934'' and that ``[m]embers 
submitting such complex orders represent that such orders comply 
with the Qualified Contingent Trade Exemption''). A qualified 
contingent trade is ``a transaction consisting of two or more 
component orders, executed as agent or principal where: (1) at least 
one component order is in an NMS stock; (2) all components are 
effected with a product or price contingency that either has been 
agreed to by the respective counterparties or arranged for by a 
broker-dealer as principal or agent; (3) the execution of one 
component is contingent upon the execution of all other components 
at or near the same time; (4) the specific relationship between the 
component orders (e.g., the spread between the prices of the 
component orders) is determined at the time the contingent order is 
placed; (5) the component orders bear a derivative relationship to 
one another, represent different classes of shares of the same 
issuer, or involve the securities of participants in mergers or with 
intentions to merge that have been announced or since cancelled; and 
(6) the transaction is fully hedged (without regard to any prior 
existing position) as a result of the other components of the 
contingent trade.'' Securities Exchange Act Release No. 54389 
(August 31, 2006), 71 FR 52829 (September 7, 2006); see also 
Securities Exchange Act Release No. 57620 (April 4, 2008), 73 FR 
19271 (April 9, 2008).
    \181\ Presumably, an options exchange would accept only those 
stock-option orders that meet the exchange's definition thereof. In 
addition, the Commission's understanding is that, currently, 
consistent with options exchange definitions, a stock-option order 
contains only one stock leg. See supra note 179. Therefore, the 
proposed stock-option order exemption is designed to cover stock-
option orders with only one stock leg.
---------------------------------------------------------------------------

    Relying on the options exchange's definition also should enhance an 
exchange's ability to monitor whether its members are appropriately 
relying on the proposed exemption and thereby enhance its ability to 
provide effective SRO oversight of its members' stock-option order 
trading activity. Under options exchange rules, an exchange member 
submitting a stock-option order to the exchange must designate to the 
exchange one or more specific broker-dealers: (i) that are not 
affiliated with the exchange; (ii) with which the exchange member has 
entered into a brokerage agreement; (iii) that the exchange has 
identified as having connectivity to electronically communicate the 
stock components of stock-option orders to stock trading venues; and 
(iv) to which the exchange will electronically communicate the stock 
component of the stock-option order on behalf of the member.\182\ The 
option exchange's execution of the stock-option order is contingent on 
the exchange's receipt from the designated broker-dealer of an 
execution report for the stock component transaction confirming that 
the transaction has occurred.\183\ In light of these rules, the 
Commission preliminarily believes that there is a close link between 
the stock component transaction of a stock-option order and the 
relevant options exchange. Accordingly, the Commission believes that 
this proposed exemption would serve the limited, narrowly defined 
purpose of facilitating the execution of stock-option orders consistent 
with options exchange rules and that the options exchange would be able 
to monitor and oversee the totality of the securities trading activity 
of any of its members that rely on the exemption.
---------------------------------------------------------------------------

    \182\ See, e.g., Cboe Rule 5.33(l) and Interpretations and 
Policies .04; Nasdaq ISE Options 3, Section 7 and Supplementary 
Material .01, Options 3, Section 14 and Supplementary Material .07; 
and MIAX Rule 518 and Commentary .01.
    \183\ See, e.g., Cboe Rule 5.33(l); Nasdaq ISE Options 3, 
Section 7 and Supplementary Material .01, Options 3, Section 14 and 
Supplementary Material .07; and MIAX Rule 518 and Commentary .01.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the exchange's oversight 
capabilities will be further enhanced, consistent with the public 
interest and protection of investors, by requiring written policies and 
procedures in connection with the stock-option exemption in proposed 
paragraph (c)(2) of the amended rule. This requirement would help 
facilitate exchange SRO supervision of brokers and dealers relying on 
the stock-option order exemption because it would provide an efficient 
and effective way for the relevant options exchange to assess 
compliance with the proposed exemption. Moreover, the Commission 
preliminarily believes that requiring brokers and dealers to develop 
written policies and procedures would provide sufficient flexibility to 
accommodate potentially varying business models of brokers and dealers 
that effect stock-option orders and may seek to rely on this exemption.
    Such written policies and procedures must be reasonably designed to 
ensure and demonstrate that the broker's or dealer's securities 
transactions elsewhere than on an exchange of which it is a member are 
solely for the purpose of executing the stock leg of a stock-option 
order. Accordingly, a broker or dealer seeking to rely upon the 
proposed stock-option order exemption must establish, maintain, and 
enforce written policies and procedures reasonably designed to ensure 
and demonstrate that such transactions are solely for the purpose of 
executing the stock leg of a stock-option order. For example, the 
broker or dealer could maintain documentation that demonstrates its 
compliance with the stock-option order requirements of any options 
exchange of which it is a member and where it effects the execution of 
stock-option orders. Indeed, in addition to the Commission, the options 
exchange of which the broker or dealer is a member and where the stock-
option order is handled would be able to enforce compliance with the 
stock-option order exemption. In the context of routine examinations of 
its members, the options exchange generally would review the adequacy 
of its members' written policies and procedures and assess whether its 
members' off-member-exchange transactions comply with those written 
policies and procedures as well as the terms of the exemption itself, 
as set forth in amended Rule 15b9-1.\184\
---------------------------------------------------------------------------

    \184\ Section 19(g)(1) of the Act, 15 U.S.C. 78s(g), among other 
things, requires every SRO to examine for and enforce compliance by 
its members and associated persons with the Act, the rules and 
regulations thereunder, and the SRO's own rules, unless the SRO is 
relieved of this responsibility pursuant to section 17(d), 15 U.S.C. 
78q(d) or section 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act.
---------------------------------------------------------------------------

    Finally, a broker or dealer seeking to rely on the stock-option 
order exemption would be required to preserve a copy of its policies 
and procedures in a manner consistent with Rule 17a-4 under the 
Exchange Act until three years after the date the policies and 
procedures are replaced with updated policies and procedures.\185\ 
Accordingly, a broker or dealer would be required to keep the policies 
and procedures relating to its use of this proposed exemption as part 
of its books and records while they are in effect, and for three years 
after they are updated.
---------------------------------------------------------------------------

    \185\ See, e.g., 17 CFR 240.17a-4(e)(7).
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposed 
stock-option order exemption in Rule 15b9-1. In particular, the 
Commission seeks responses to the following questions:
    23. Is the proposed stock-option order exemption necessary and 
appropriate? Why or why not? How, if at all, should this proposed 
exemption be modified?
    24. Is the scope of the proposed stock-option order exemption 
sufficient to provide for all off-member-exchange transactions that 
might be effected by a broker or dealer as a necessary component of 
handling stock-option orders? If not, how should it be changed?
    25. Should the proposed stock-option order exemption be broadened 
to cover transactions beyond those necessary to complete stock-option 
orders? If so, what types of additional transactions should be covered 
and why? Should the proposed exemption be narrowed in some way? Should 
the proposed stock-option order exemption be eliminated in its 
entirety?
    26. Is the Commission's understanding correct that all stock-option 
orders must be QCTs? If not, what types of stock-option orders are not 
required to be QCTs? Should they be covered by the proposed exemption?
    27. The proposed stock-option order exemption is limited to 
transactions

[[Page 49949]]

effected with or through another registered broker-dealer. Are there 
circumstances where a broker or dealer that is not a FINRA member might 
not need to effect the execution of the stock leg of a stock-option 
order with or through another registered broker-dealer? Are there 
circumstances in which a broker or dealer that is not a FINRA member 
might need to effect the execution of the stock leg of a stock-option 
order with or through a party that is a registered broker-dealer but 
not a member of an exchange where the stock leg is executed, or not a 
member of an Association if the stock leg is not executed on an 
exchange? If so, please describe the nature and extent of such 
transactions.
    28. Stock transactions effected in reliance on the exemption would 
still be subject to required transaction reporting. Would such reliance 
impede required transaction reporting in any way?
    29. As proposed, the stock-option order exemption would cover 
stock-option orders with one stock leg and any number of options legs. 
Is this appropriate? Should the proposed stock-option order exemption 
be limited to two-leg stock-option orders where one leg is a stock and 
the other leg is an option? Why or why not? Do firms execute stock-
option orders that contain multiple stock legs? If so, should the stock 
legs of such stock-option orders be covered by the proposed exemption?

C. No Floor-Member Hedging Exemption

    As discussed above, the Commission adopted Rule 15b9-1 so that an 
exchange member's limited trading activity ancillary to its floor 
business on a single national securities exchange would not necessitate 
Association membership in addition to exchange membership.\186\ Since 
that time, the securities markets have evolved to include significant, 
cross-market and off-exchange electronic proprietary trading as a 
primary business model. This business model did not exist when the 
Commission adopted Rule 15b9-1 in its current form, nor did firms 
engage in extensive off-member-exchange proprietary trading activity 
while exempt from Association membership by virtue of Rule 15b9-1.
---------------------------------------------------------------------------

    \186\ See supra notes 60-62 and accompanying text.
---------------------------------------------------------------------------

    Unlike today's proposed amendments, the 2015 Proposal would have 
provided an exemption from Association membership for a dealer that is 
an exchange member, carries no customer accounts, conducts business on 
the floor of a national securities exchange, and effects transactions 
off the exchange, for the dealer's own account with or through another 
registered broker or dealer, that are solely for the purpose of hedging 
the risks of its floor-based activity.\187\ The Commission proposed 
that the hedging exemption be limited to a dealer's floor-based trading 
on a national securities exchange, and understood then that dealers 
that limit their activities to an exchange's physical trading floor 
tend to be specialists or floor brokers based on the floor of an 
individual exchange.\188\ That proposed hedging exemption was intended 
to be consistent with the original intent of Rule 15b9-1 to accommodate 
only limited proprietary trading activity elsewhere than a broker's or 
dealer's member exchange(s) that is ancillary to the broker's or 
dealer's primary trading activity on its member exchange(s). But based 
on data available to the Commission today that was not available in 
2015, the Commission believes that no dealers currently trade in a 
manner that would enable reliance on the hedging exemption as proposed 
in the 2015 Proposal, i.e., no dealer's trading on an exchange of which 
it is a member is solely on the exchange's floor. Accordingly, the re-
proposed rule does not include the hedging exemption included in the 
2015 Proposal.\189\
---------------------------------------------------------------------------

    \187\ Currently, NYSE Arca Options, NYSE American Options, 
Nasdaq Phlx, Cboe, NYSE, and BOX Exchange have physical exchange 
floors.
    \188\ See 2015 Proposing Release, supra note 6, 80 FR at 18047.
    \189\ As described above, to the extent a stock transaction is a 
component of a stock-option order, and the broker or dealer handling 
the stock-option order otherwise meets the requirements of the 
proposed amended rule, that stock transaction would not trigger 
Section 15(b)(8)'s Association membership requirement.
---------------------------------------------------------------------------

    Some commenters supported the proposed hedging exemption in the 
2015 Proposal, but suggested that the exemption should not be limited 
to a dealer operating solely on a physical exchange floor, and also 
should cover off-member-exchange hedging transactions by dealers that 
trade electronically on their member exchange(s).\190\ The Commission 
preliminarily believes that an exemption of this nature might swallow 
the amended rule, as proposed, and would not be appropriate. As 
discussed above, electronic trading dealer firms effect securities 
transactions proprietarily across market centers as a primary business 
model, including to a significant degree in the off-exchange market and 
on exchanges of which they are not a member.\191\ The Commission 
acknowledges that it is unlikely that all of these firms' securities 
trading activity away from their member exchanges is to hedge their 
securities trading activity on their member exchanges. Thus, the off-
member-exchange transaction volume attributable to these firms likely 
overstates the volume of transactions that would be attributable to 
firms who could rely on a hedging exemption that covered electronic 
trading activity as contemplated by commenters. The Commission cannot 
reliably discern from available data what off-member-exchange 
securities transactions effected by these firms are for hedging 
purposes and what transactions are not. But the Commission 
preliminarily believes that there are proprietary trading dealer firms 
that trade electronically and in significant volumes, including off any 
exchange where they are a member, which could potentially meet the 
criteria of a hedging exemption that covered electronic trading 
activity. Indeed, in light of the concentration of off-member-exchange 
securities transaction volume among certain firms, as discussed above, 
even if only a small number of firms could rely on a hedging exemption 
that covered electronic trading activity, it could translate into 
significant trading activity that would not be subject to direct FINRA 
oversight. This would not be consistent with the protection of 
investors or the public interest, or with the historical rationale for 
Rule 15b9-1.
---------------------------------------------------------------------------

    \190\ See, e.g., CHX Letter at 3; CTC Letter at 7; Cboe Letter 
at 2-3; Options Market Makers Letter at 4; and Cboe/NYSE/Nasdaq 
Letter at 2-3.
    \191\ See supra Section II.B.
---------------------------------------------------------------------------

    Commenters more broadly suggested that the 2015 Proposal did not 
adequately consider options market makers or their hedging needs.\192\ 
Some of these commenters' concerns appear to center on firms' needs in 
relation to their handling of stock-option orders.\193\ As such, these 
concerns could be mitigated by the stock-option order

[[Page 49950]]

exemption that the Commission is proposing to include in amended Rule 
15b9-1.\194\
---------------------------------------------------------------------------

    \192\ See, e.g., Options Market Makers Letter at 1; CTC Letter 
at 1; CHX Letter at 3; Cboe Letter at 2-3; Cboe/NYSE/Nasdaq Letter 
at 2-3; NYSE/Nasdaq Letter at 2-4; Letter from Reps. Bill Foster and 
Randy Hultgren, Members of U.S. Congress (Nov. 15, 2016) at 2.
    \193\ See, e.g., NYSE/Nasdaq Letter at 2-4; Cboe Letter at 3; 
Cboe/NYSE/Nasdaq Letter at 4. For example, one commenter expressed 
concern that the 2015 Proposal would ``unintentionally require 
[options] floor brokers, which have a business focused on the floor 
of an exchange in which they are members, to become members of 
FINRA'' and specifically noted that this ``could restrict floor 
brokers from fulfilling stock-option orders. . .[b]ecause the stock 
component of a stock-option order cannot be executed on the options 
exchange of which a floor broker is a member.'' NYSE/Nasdaq Letter 
at 2. This commenter suggested that any amendment ``maintain floor 
brokers' ability to route the stock leg of a stock-option order for 
execution on another market by a member of the away market without 
requiring the floor broker to become a member of FINRA.'' NYSE/
Nasdaq Letter at 4; see also Lakeshore Letter at 2.
    \194\ In addition, Section 15(b)(9) of the Act provides the 
Commission with the authority, by rule or order, and as it deems 
consistent with the public interest and the protection of investors, 
to conditionally or unconditionally exempt from the requirements of 
Section 15(b)(8) any broker or dealer or class of brokers or 
dealers. Accordingly, if a dealer or class of dealers believes that 
it should be exempted from the requirements of Section 15(b)(8) in a 
manner that is not provided by amended Rule 15b9-1, it may seek an 
exemption from the Commission, by order, pursuant to Section 
15(b)(9). For example, the Commission may consider granting such an 
exemption, where appropriate, if a dealer or class of dealers 
chooses to limit its exchange trading activity to the physical floor 
of an exchange of which it is a member, but must effect limited 
securities transactions elsewhere for its own account in order to 
facilitate its exchange-floor business.
---------------------------------------------------------------------------

    The Commission requests comment on its re-proposed approach of not 
providing a hedging exemption in amended Rule 15b9-1. In particular, 
the Commission seeks responses to the following questions:
    30. Should the Commission adopt a hedging exemption outside the 
context of the proposed stock-option order exemption? Why or why not? 
Would it be apparent whether a securities transaction is for hedging 
purposes?
    31. Should the Commission adopt a hedging exemption (in addition to 
the proposed stock-option order exemption) that applies to a dealer 
that is a member of multiple exchanges? Why or why not? Should the 
Commission allow firms to rely on any such exemption only if they 
effect hedging transactions in securities on exchanges where they are 
not a member (i.e., off-exchange transactions, even if solely for 
purposes of hedging a single exchange member's trading activity on that 
exchange, would not be covered by the exemption)? Why or why not?
    32. Should the Commission adopt a hedging exemption that covers 
off-member-exchange transactions to hedge on-member-exchange electronic 
transactions and physical exchange floor transactions, just on-member-
exchange physical exchange floor transactions or just on-member-
exchange electronic transactions? Why would one of these possible 
approaches be preferable to another? Under each possible approach, how 
difficult would it be to discern what off-member-exchange securities 
transactions by electronic trading firms are for hedging purposes? The 
Commission specifically seeks data that demonstrates the extent to 
which exchange member dealer firms trade elsewhere than on their member 
exchange(s) in order to hedge the risks of their trading activities on 
their member exchange(s).
    33. Are there non-floor-based exchange members that today focus 
their business activities on a single exchange? Are there floor-based 
exchange members that today focus their business activities on a single 
exchange? If so, what is the nature of each firm's business activities?
    34. Should the Commission adopt a hedging exemption in the amended 
rule that requires a dealer seeking to rely on the exemption to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to ensure and demonstrate that its off-member-
exchange hedging transactions reduce or otherwise mitigate the risks of 
the financial exposure the dealer incurs as a result of its on-member-
exchange activity? Why or why not? What would be the costs of 
establishing, maintaining, and enforcing the policies and procedures, 
and any related record-keeping requirements? How are such costs 
determined? Please provide evidence of the nature, timing, and extent 
of such costs. Would such costs deter dealers from relying on the 
hedging exemption? Are there more efficient and effective alternatives 
to a policies and procedures approach? If so, what are they? Please 
describe in detail.
    35. Would current exchange surveillance and enforcement mechanisms 
be effective to monitor off-member-exchange trades that would be 
executed pursuant to a possible hedging exemption? Could this be 
accomplished through 17d-2 plans and RSAs? Please explain. Would 
exchanges otherwise have the ability to assess dealers' compliance with 
a hedging exemption? If not, should the Commission require additional 
reporting by registered broker-dealers acting as an agent for dealers 
relying on a hedging exemption? Please explain.
    36. Should the Commission adopt a hedging exemption that is subject 
to quantitative limits on the volume of hedging transactions that a 
firm may execute in reliance on such an exemption? Could qualitative or 
quantitative requirements assist in identifying off-member-exchange 
activity that is solely for the purpose of hedging? Please explain.
    37. Should the Commission adopt a hedging exemption that requires 
the exchange member to retain records demonstrating how each off-
member-exchange transaction complies with its policies and procedures? 
Why or why not? What would be the associated costs, and what is the 
basis for those costs? Would the cost associated with recordkeeping on 
a transaction-by-transaction basis be overly burdensome, impractical, 
or unnecessary?
    38. Should the Commission adopt a hedging exemption that requires 
dealers to make a certification in connection with their reliance on 
the hedging exemption? Why or why not? If a certification should be 
required, what would be the key elements thereof? How frequently should 
the certification be made? Who should make it? What qualifications, if 
any, to such certification might be appropriate? For example, should 
firms be required to certify that they have a reasonable basis to 
believe that they are in compliance with a hedging exemption? Or should 
they be required to make such a certification to the best of their 
knowledge? Is there a different standard that would be appropriate? 
Should the certification be made in conjunction with an internal 
compliance review? If so, what type of internal compliance review 
should be conducted?
    39. Would not adopting a hedging exemption affect liquidity on any 
national securities exchange?

IV. Effective Date and Implementation

    The Commission recognizes that firms may need time to comply with 
any amended Rule 15b9-1 if adopted. In particular, they may need time 
to become a member of an Association. As noted previously, FINRA is 
currently the only Association. To become a FINRA member, a broker or 
dealer must complete FINRA's New Member Application and participate in 
a pre-membership interview.\195\ The broker or dealer and its 
associated persons must comply with FINRA's registration and 
qualification requirements.\196\ The amount of time that it takes to 
become a FINRA member depends on a number of factors, including the 
nature of the broker's or dealer's business, the level of complexity or 
uniqueness of the firm's business plan, the number of associated 
persons that the firm employs, and whether the firm has an affiliate 
that is already a member of FINRA.\197\ The Commission understands 
that, on average, the FINRA membership application process takes 
approximately six months.
---------------------------------------------------------------------------

    \195\ See FINRA.org, How to Apply, available at https://www.finra.org/registration-exams-ce/broker-dealers/how-apply (last 
visited on July 22, 2022).
    \196\ See FINRA Rule 1010--Electronic Filing Requirements and 
Uniform Forms, which sets out the substantive standards and 
procedural guidelines for the FINRA membership application and 
registration process.
    \197\ See Section VI.C.2, infra, discussing the costs of joining 
FINRA.
---------------------------------------------------------------------------

    Alternatively, broker-dealer firms that currently rely on Rule 
15b9-1 and carry no customer accounts may choose to adjust their 
business model or

[[Page 49951]]

organizational structure such that they effect securities transactions 
solely on national securities exchanges of which they are a member, and 
therefore comply with Section 15(b)(8) without needing to join FINRA or 
rely on any amended version of Rule 15b9-1 if adopted. This may require 
such firms to become a member of additional exchanges upon which they 
trade. Or, firms may need time to adjust their business models such 
that their securities transactions elsewhere than exchanges of which 
they are a member comply with the proposed amendments to paragraphs 
(c)(1) or (c)(2) if adopted, including establishing policies and 
procedures that would be required by proposed paragraph (c)(2). More 
broadly, broker-dealer firms may need to modify their systems or take 
other steps to achieve compliance with any amended rule if adopted.
    The Commission preliminarily believes that one year after 
publication in the Federal Register of any amended version of Rule 
15b9-1 that the Commission may adopt should provide firms with enough 
time to comply.\198\ Therefore, the Commission proposes that the 
compliance date for amended Rule 15b9-1 would be one year after 
publication of any final rule in the Federal Register. The Commission 
solicits comment on the adequacy of this proposed implementation 
timeline. In particular, the Commission seeks responses to the 
following questions:
---------------------------------------------------------------------------

    \198\ In the 2015 Proposal, supra note 6, the Commission 
solicited comment on the appropriate length of time that it should 
provide firms to comply with the then-proposed amended version of 
Rule 15b9-1. In this regard, the Commission also solicited comment 
on the FINRA membership process. Some commenters stated that one 
year generally is sufficient to join FINRA. See, e.g., IEX Letter at 
3. Other commenters requested more time or requested that the 
Commission require FINRA to develop a ``fast track'' application 
process. See, e.g., FIA 2 Letter at 5. Another commenter suggested a 
waiver process for a proprietary trading firm that is registered 
with the Commission and an SRO, if the firm's information has not 
materially changed from the time it registered with such entities, 
and so long as the firm remains in good standing with the Commission 
and other regulators. See Peak6 Letter at 2. FINRA stated that it 
tentatively believed that most broker-dealer firms that are not 
FINRA members ``are already members of an exchange and are engaged 
solely in proprietary trading activity'' and would be candidates for 
its ``fast track/triage program'' which has an average processing 
time of 60 days for membership. See FINRA Letter at 5-6. As 
reflected in the requests for comment in this section, the 
Commission again solicits comment from FINRA and exchanges regarding 
the length of time of the membership application and approval 
process, and from any interested parties generally regarding the 
appropriate length of time for compliance with the proposed 
amendments to Rule 15b9-1 if they are adopted.
---------------------------------------------------------------------------

    40. Would one year after publication of any final rule in the 
Federal Register provide firms with sufficient time to comply with 
amended Rule 15b9-1, if adopted? Would firms be in a position to comply 
with any final, amended rule earlier than one year after publication? 
Would a compliance period that is shorter or longer than one year be 
more appropriate? If so, how long should the revised compliance period 
be and why?
    41. Would one year after publication of any final rule in the 
Federal Register provide firms with sufficient time to comply with 
Section 15(b)(8) of the Act by joining an Association? Would one year 
after publication of any final rule in the Federal Register provide 
firms that do not trade securities off-exchange with sufficient time to 
comply with Section 15(b)(8) of the Act by becoming a member of all 
national securities exchanges where they trade securities (if they are 
not already a member of all such exchanges)?
    42. How long is the registration process with FINRA typically? How 
long would it take FINRA to process new membership applications from 
firms that join FINRA as a result of the proposed amendments, 
considering that many such firms may submit applications close in time 
to each other? Please include the estimated time to prepare the 
application as well as the estimated time for FINRA to process the 
application.
    43. How long does it typically take to complete the application 
process with a national securities exchange? Please include the 
estimated time to prepare the application as well as the estimated time 
for an exchange to process the application.
    44. To the extent a firm intends to rely on one or more of the 
exemptions in the amended rule, how long would it take such firm to 
make the required systems changes to comply? Are there other steps that 
would need to be taken to achieve compliance? If so, what is the 
estimated time to accomplish those steps? How long would it take a firm 
to establish the policies and procedures that would be necessary to 
rely on the stock-option order exemption?
    45. To the extent a firm intends to adjust its business model or 
organizational structure such that it effects securities transactions 
only on an exchange of which it is a member, how long would it take 
such firm to make such an adjustment? What systems or other changes 
would be required?

V. General Requests for Comments

    The Commission seeks comment on all aspects of the proposed 
amendments to Rule 15b9-1. Commenters should, when possible, provide 
the Commission with data to support their views. Commenters suggesting 
alternative approaches should provide comprehensive proposals, 
including any conditions or limitations that they believe should apply, 
the reasons for their suggested approaches, and their analysis 
regarding why their suggested approaches would satisfy the objectives 
of the proposed amendments.
    46. The Commission requests comment generally on whether the 
proposed amendments to Rule 15b9-1 are appropriate. How, if at all, 
should the proposed amendments be modified? Should either of the 
proposed exemptions from Association membership set forth in proposed 
paragraphs (c)(1) and (c)(2) of the amended rule be eliminated? If so, 
why? For example, should the Commission maintain the proposed routing 
exemption, but not maintain the proposed stock-option order exemption? 
Why or why not? Should the Commission maintain the proposed stock-
option order exemption, but not the routing exemption? Why or why not?
    47. Should the Commission eliminate Rule15b9-1 in its entirety, 
such that there is no exemption from Section 15(b)(8) of the Act? 
Broker-dealers would then be statutorily required by Section 15(b)(8) 
of the Act, without exception, to join an Association if they effect 
securities transactions otherwise than on an exchange where they are a 
member. In other words, a broker-dealer that effects transactions in 
securities otherwise than on an exchange of which it is a member would 
have to join FINRA even if its transactions result solely from orders 
that are routed by an exchange of which it is a member to comply with 
order protection requirements or are solely for the purpose of 
executing the stock leg of a stock-option order. What would be the 
benefits or drawbacks of eliminating Rule 15b9-1 in its entirety? 
Please explain.
    48. Should the Commission amend Rule 15b9-1 to capture only those 
broker-dealers that are exchange members but not FINRA members that 
account for the high degree of concentration of off-exchange listed 
equities volume? For example, the Commission estimates that, as of 
September 2021, 13 of the 47 identified firms that initiated orders in 
listed equities then accounted for approximately 94% of the off-
exchange listed equities transaction volume attributable to the 47 
identified firms that month. If so, what methodology should be used to 
select the most significant firms?
    49. Other than the proposed routing exemption and stock-option 
order

[[Page 49952]]

exemption set forth in proposed paragraphs (c)(1) and (c)(2) of the 
amended rule, respectively, are there other exemptions that the 
Commission should consider?
    50. How might dealers that currently rely on Rule 15b9-1's de 
minimis allowance and proprietary trading exclusion respond to the 
proposed elimination of these provisions from the amended rule? Might 
they seek to avoid Association membership in ways other than complying 
with the exemptions in the amended rule, i.e., are there ways they 
could avoid Association membership other than by ceasing all off-
exchange activity and becoming a member of each exchange on which the 
firm effects securities transactions, or limiting the firm's securities 
transactions elsewhere than an exchange where it is a member such that 
they comply with the routing exemption or stock-option order exemption? 
If so, please explain.
    51. Reliance on Rule 15b9-1 is currently self-effecting (i.e., the 
rule does not require the reporting of such reliance to the Commission 
or any other regulatory authority). In lieu of the proposed amendments, 
should the Commission require broker-dealers relying on Rule 15b9-1 to 
report such reliance to the Commission or to the exchange of which the 
broker-dealer is a member? How frequently should such reporting occur? 
If so, what form should such reporting take and what information should 
be provided to the Commission or the exchange of which the broker-
dealer is a member? For example, should a broker-dealer be required to 
report in writing to its member exchange and/or the Commission whether 
it is relying on Rule 15b9-1, and should information such as 
transactional volume be provided, or information on the type or 
categories of securities traded? If not, why not and what alternative 
means could be used to collect data about reliance on Rule 15b9-1?
    52. If the Commission were to eliminate Rule 15b9-1 altogether, how 
many broker-dealers would: (i) effect securities transactions only on 
national securities exchanges of which they are already member; (ii) 
become members of additional national securities exchanges such that 
they are not required to join an Association; and/or (iii) become 
members of an Association?
    53 Would the proposed amendments have an effect on market 
liquidity? If so, please estimate that effect. Would there be any 
deleterious impacts on market quality? Would there be positive impacts 
on market liquidity or market quality more broadly?
    54. Should the Commission allow broker-dealers that are a member of 
an exchange and conduct off-exchange trading activity to remain exempt 
from membership in an Association? If so, why? Should the level of off-
exchange activity affect the ability of a firm to be exempt from 
Association membership? Why or why not?
    55. Does the CAT plan mitigate the need for the proposed amendments 
to Rule 15b9-1? If so, how? Would it be appropriate and feasible to 
modify CAT reporting to accomplish any of the goals of amended Rule 
15b9-1?
    56. Do existing 17d-2 plans and RSAs among SROs mitigate the need 
for the proposed amendments to Rule 15b9-1? If so, how? Do commenters 
agree that RSAs are subject to change and may not in the future provide 
the stability of FINRA oversight? How frequently are RSAs typically 
renegotiated?
    57. Is Association membership an efficient or effective approach 
for the regulation of firms that trade across multiple exchanges but do 
not trade off-exchange? Are there more effective alternatives?
    58. Under the proposed amendments to Rule 15b9-1, a broker-dealer 
that does not effect securities transactions off an exchange, but 
currently effects securities transactions on an exchange of which it is 
not a member, would be required either to join an Association or become 
a member of each exchange where it effects securities transactions, 
unless its exchange trading is covered by an exemption in the proposed 
amended rule. Should the proposed amendments be revised to provide an 
exemption from Section 15(b)(8) of the Act to permit such a firm, with 
no off-exchange trading, to remain exempt from membership in an 
Association and continue trading on exchanges of which it is not a 
member even if that trading activity would not satisfy one of the 
proposed exemptions in the amended rule? Should any such approach be 
based on certain conditions being met, such as any exchange of which 
the firm is a member entering into appropriate contractual or self-
regulatory responsibility sharing arrangements such that an exchange 
SRO is in a position to effectively surveil all of the trading 
activities of that firm?
    59. If the proposed rule amendments are adopted, proprietary 
trading broker-dealers that are not currently FINRA members may join 
FINRA. Would this affect FINRA's governance or its performance of its 
regulatory or supervisory functions?
    60. Are there other changes the Commission should make to Rule 
15b9-1? If so, why? What specifically should be changed and how? How 
would any such changes better achieve the stated goals of the proposal?

VI. Economic Analysis

    The Commission is proposing to amend Rule 15b9-1 to re-align it 
with today's market so that the regulatory scheme more appropriately 
effectuates Exchange Act principles regarding complementary exchange 
SRO and Association oversight. Currently, a broker or dealer may engage 
in unlimited proprietary trading in the off-exchange market without 
becoming a member of an Association, so long as its proprietary trading 
activity is conducted with or through another registered broker or 
dealer.
    However, the Exchange Act's statutory framework places SRO 
oversight responsibility with an Association for trading that occurs 
elsewhere than on an exchange to which a broker or dealer belongs as a 
member.\199\ Currently, nearly all equity activity of non-FINRA member 
broker-dealers is surveilled by FINRA through the extensive use of 
RSAs. However, RSAs are voluntary, privately negotiated agreements that 
can expire or be terminated, and accordingly, these agreements do not 
provide the consistent and stable oversight that direct Association 
oversight of such trading activity does.\200\ For example, of the 
current FINRA RSA contracts: six RSA contracts expire by the end of 
2023, two RSA contracts expire by the end of 2024, and three RSA 
contracts expire by the end of 2025 unless extended or terminated 
early.\201\ The amendments would provide consistency and stability of 
oversight in the future.
---------------------------------------------------------------------------

    \199\ See Section I, supra.
    \200\ See Section I, supra.
    \201\ Based on information provided by FINRA.
---------------------------------------------------------------------------

    In the case of U.S. Treasury securities and other fixed income 
securities (other than municipal bonds) \202\ that trade off-exchange, 
surveillance relies on TRACE data which is collected by FINRA from its 
members. Some dealer firms that are not FINRA members are significantly 
involved in trading U.S. Treasury securities \203\ proprietarily but 
are not

[[Page 49953]]

required to report these transactions because they are not FINRA 
members. Consequently, trades that do not occur on an ATS that are 
between two non-FINRA member broker-dealers are not reported to TRACE 
at all and trades that occur on an ATS that is not a covered ATS do not 
specifically identify the non-FINRA member in the information reported 
by the ATS to TRACE.\204\
---------------------------------------------------------------------------

    \202\ Municipal bond trades are reported to the MSRB but not 
TRACE, so the Commission does not expect the proposed amendments to 
affect the data collected on municipal bonds. Off-exchange trading 
of both listed and unlisted equities by non-FINRA member broker-
dealers is already reported to CAT.
    \203\ The Commission can observe and quantify some of this 
activity through the reporting of U.S. Treasury securities on 
covered ATSs as discussed in section II.B. See supra note 96. 
Because there is no analogous reporting regime in other fixed income 
securities, the Commission cannot similarly describe non-member 
broker-dealer activity in these other securities, but it is likely 
that non-member broker-dealers also trade fixed-income securities 
other than U.S. Treasury securities and these transactions are also 
not reported to TRACE. This Economic Analysis focuses on the effects 
on equities, options, and U.S. Treasury securities markets. To the 
extent that non-FINRA member broker-dealers do trade in additional 
asset classes, the Commission believes that the economic impacts 
discussed herein would also apply. In particular, if a non-FINRA 
member broker-dealer does trade in an asset class which requires 
reporting to FINRA, the proposal would improve transparency for 
these securities, which would enhance the regulatory oversight of 
such activity.
    \204\ See section II.B, supra. The Commission preliminarily 
believes this is a small fraction of U.S. Treasury securities 
trading. In April 2022, the Commission estimates that non-FINRA 
member firms' U.S. Treasury securities transactions executed on 
covered ATSs accounted for 2.5% of total U.S. Treasury securities 
transaction volume reported to TRACE that month. See supra note 94. 
The unreported trades involving only non-FINRA member firms that are 
not executed on covered ATSs might be similar but could be a lower 
fraction of the total U.S. Treasury securities volume. The 
Commission believes that all fixed income trading should be 
reported. The Commission also believes that firms that can observe 
other firms' trades and not report their own trades may have a 
competitive advantage, the cost of which is borne by the investing 
public through reduced price discovery.
---------------------------------------------------------------------------

    The Exchange Act presents exchange SROs and Associations as 
complements, providing for member-based supervision both on and off-
exchange. The proposed amendments would rescind the de minimis 
allowance and proprietary trading exclusion so that the regulatory 
scheme more appropriately effectuates Exchange Act principles regarding 
complementary exchange SRO and Association oversight in today's 
market.\205\ For firms currently relying on the exemption that would be 
required to register with FINRA under the proposed amendments, joining 
FINRA will expose them to additional costs that they previously did not 
incur.\206\ While reliance on the exemption may be cost-efficient for 
these firms, it introduces inefficiencies for exchange SROs, FINRA, and 
regulatory oversight more generally. FINRA, the sole Association, has a 
rulebook, surveillance infrastructure, and supervisory expertise that 
is targeted to off-exchange trading of both listed and unlisted 
securities. Without an RSA, when FINRA detects potentially violative 
behavior by a non-FINRA member firm, it can and does refer such cases 
to other SROs or the SEC. However, it lacks certain investigative 
tools, which could help it further investigate potentially violative 
behavior before making such referrals. As such, FINRA referrals could 
be premature. In addition, RSAs with FINRA are privately negotiated 
contracts that can differ from exchange to exchange and the 
administrative and operational burdens create inefficiencies in 
investigating potential non-compliance. As such, oversight through an 
RSA is not equivalent to direct oversight by FINRA of its members. The 
Commission believes that, particularly in the case of fixed income 
trading, FINRA is the SRO best positioned to efficiently investigate 
such instances because of its TRACE data collection and expertise in 
such trading, and such a role is consistent with the SRO structure 
mandated by the Exchange Act.
---------------------------------------------------------------------------

    \205\ See section II.B, supra.
    \206\ FINRA member firms that compete with these firms may be at 
a cost disadvantage due to this fee disparity.
---------------------------------------------------------------------------

    The Commission discusses below a number of economic effects that 
are likely to result from the proposed amendments.\207\ As discussed in 
detail below, the effects are quantified to the extent practicable. 
Although the Commission is providing estimates of direct compliance 
costs where possible, the Commission also anticipates that brokers and 
dealers affected by the amendments, as well as competitors of those 
broker and dealers, may modify their business practices regarding the 
provision of liquidity in both off-exchange markets and on exchanges. 
Consequently, much of the discussion below is qualitative in nature, 
but where possible, the Commission has provided quantified 
estimates.\208\ To the extent that non-FINRA member firms change their 
business practices, by reducing or eliminating their off-exchange 
trading activity, the proposal may impact competition and harm 
liquidity, particularly in the off-exchange market. The proposal would 
increase costs for non-FINRA member firms that will have to register 
with FINRA, which may result in decreased liquidity from their orders. 
Additionally, the amendments to Rule 15b9-1 may create incentives for 
non-FINRA member firms that are impacted by the amendments to form a 
new Association.
---------------------------------------------------------------------------

    \207\ The Commission is sensitive to the economic effects of its 
rule, including the costs and benefits and effects on efficiency, 
competition, and capital formation. Section 3(f) of the Exchange Act 
requires the Commission, whenever it engages in rulemaking pursuant 
to the Exchange Act, to consider or determine whether an action is 
necessary or appropriate in the public interest, and to consider, in 
addition to the protection of investors, whether the action would 
promote efficiency, competition, and capital formation. See 15 
U.S.C. 78c(f). In addition, section 23(a)(2) of the Exchange Act 
requires the Commission, when making rules under the Exchange Act, 
to consider the effect such rules would have on competition. See 15 
U.S.C. 78w(a)(2). Exchange Act Section 23(a)(2) prohibits the 
Commission from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.
    \208\ See infra section VI.C. for further discussion of the 
difficulties in estimating market quality effects likely to result 
from the amendments.
---------------------------------------------------------------------------

A. Baseline

1. Regulatory Structure and Activity Levels of Non-FINRA Member Firms
    The Exchange Act governs the way in which the U.S. securities 
markets and its brokers and dealers operate. Section 3(a)(4)(A) of the 
Act generally defines a ``broker'' broadly as ``any person engaged in 
the business of effecting transactions in securities for the account of 
others.'' \209\ In addition, Section 3(a)(5)(A) of the Act generally 
defines a ``dealer'' as ``any person engaged in the business of buying 
and selling securities . . . for such person's own account through a 
broker or otherwise.'' \210\
---------------------------------------------------------------------------

    \209\ 15 U.S.C. 78c(a)(4)(A).
    \210\ 15 U.S.C. 78c(5)(A).
---------------------------------------------------------------------------

    Generally, any broker-dealer that wants to interact directly on a 
securities exchange must register with the Commission as a broker-
dealer before applying to gain direct access to the exchange.\211\ 
There is diversity in the size and business activities of brokers and 
dealers. Carrying brokers and dealers hold customer funds and 
securities; some of these are also clearing brokers and dealers that 
handle the clearance and settlement aspects of customer trades, 
including record-keeping activities and preparing trade 
confirmations.\212\ However, of 3,528 registered brokers and dealers, 
only 156 were classified as carrying or clearing brokers and dealers 
during the fourth quarter of 2021. Thus, the majority of brokers and 
dealers engage in a wide range of other activities, which may or may 
not include handling customer accounts. These other activities include 
intermediating between customers and carrying/clearing brokers; dealing 
in government bonds; private placement of securities; effecting 
transactions in mutual funds that involve transferring funds directly 
to the issuer; writing options; acting as a broker solely on an 
exchange; and providing liquidity to securities markets, which 
includes, but is not limited to, the activities of registered market 
makers.
---------------------------------------------------------------------------

    \211\ A firm that wishes to transact business upon an exchange 
without becoming a broker or dealer can do so by engaging a broker-
dealer that is a member of that exchange to provide market access 
and settlement services.
    \212\ Based on December 2021 FOCUS data.

---------------------------------------------------------------------------

[[Page 49954]]

    Most brokers and dealers are small, with 66% of brokers and dealers 
employing 15 or fewer associated persons and only 10% of brokers and 
dealers employing over 100 associated persons.\213\ Further, while 
there are many registered brokers and dealers, a small minority of 
brokers and dealers controls the majority of broker and dealer capital 
and each play a significant role in the allocation of capital to 
liquidity provision.\214\
---------------------------------------------------------------------------

    \213\ Based on December 2021 Annual FOCUS data filings. See also 
supra note 136.
    \214\ See infra section IX.
---------------------------------------------------------------------------

    The Commission has identified 65 firms that, as of April 2022, were 
Commission registered broker-dealers and exchange members, but not 
members of FINRA, that may be required to either join an Association or 
change their trading practices under the proposed amendments.\215\ To 
the extent that the definitions of ``dealer'' and ``government 
securities dealer'' might change, the number of affected firms could 
increase.\216\ Because of Rule 15b9-1's exclusion of proprietary 
trading, a dealer that does not carry customer accounts may not be 
required to join an Association as long as they are a member of an 
exchange SRO, even when that dealer has substantial off-exchange 
trading activity.
---------------------------------------------------------------------------

    \215\ Historically, floor brokers had only incidental trading on 
exchanges of which they were not members, and limited off-exchange 
trading activity. The background and history of Rule 15b9-1 are 
discussed in section I.
    \216\ See supra note 155 and accompanying text.
---------------------------------------------------------------------------

    In September 2021, there were 66 registered broker-dealers that 
were exchange members but not FINRA members.\217\ The Commission is 
aware that some non-FINRA member firms trade U.S. Treasury securities. 
Covered ATSs report the U.S. Treasury securities trading activity of 
non-FINRA-member firms to TRACE. The Commission estimates that, in 
2021, four of the 66 non-FINRA member firms had $7 trillion in U.S. 
Treasury securities volume reported to TRACE by covered ATSs. This 
accounts for approximately 2% of U.S. Treasury volume as reported to 
TRACE throughout the year. In April 2022, there were three non-FINRA 
member firms with approximately $700 billion in U.S. Treasury 
securities volume executed on covered ATSs or approximately 2.5% of 
total U.S. Treasury securities transaction volume reported to TRACE 
that month.
---------------------------------------------------------------------------

    \217\ See supra note 74.
---------------------------------------------------------------------------

    FINRA members are required to report transactions in TRACE-eligible 
securities. Market participants can gain real-time access to TRACE 
through market vendors, for most TRACE-eligible securities, with a few 
exceptions including U.S. Treasury securities.\218\ However, FINRA does 
make public aggregate U.S. Treasury securities data on a weekly 
basis.\219\ Non-FINRA member firms are not required to report their 
trading activity to TRACE. With respect to trading activity in U.S. 
Treasury securities markets on a covered ATS, non-FINRA member 
counterparties are identified in TRACE.\220\ With respect to trading 
activity in other TRACE-eligible securities, non-FINRA member 
counterparties are not identified in TRACE. Therefore, the Commission 
is unable to estimate the level of trading activity of non-FINRA member 
firms for other fixed income securities, and cannot reasonably assume 
either significant or insignificant unreported volume. However, based 
on the non-FINRA member firms' activity in U.S. Treasury securities 
markets, some non-FINRA member firms are likely to be active in other 
fixed income markets as well.
---------------------------------------------------------------------------

    \218\ See FINRA.org, TRACE at 20--Reflecting on Advances in 
Transparency in Fixed Income, available at https://www.finra.org/media-center/blog/trace-at-20-reflecting-advances-transparency-fixed-income (last visited July 22, 2022). See also FINRA Rule 
6750(c).
    \219\ See supra note 45 and accompanying text.
    \220\ See supra note 112 and accompanying text.
---------------------------------------------------------------------------

    In September 2021, of the 66 non-FINRA member firms, 47 initiated 
equity orders that were not executed on an exchange, accounting for 
$789 billion (approximately 9.8%) in off-exchange traded dollar volume 
in listed equities.\221\ In April 2022, of the 65 non-FINRA member 
firms, 43 initiated equity orders that were not executed on an 
exchange, accounting for $441 billion (approximately 4.6%) in off-
exchange traded dollar volume in listed equities.
---------------------------------------------------------------------------

    \221\ See supra section II.B for further discussion of trading 
activities of non-FINRA member firms.
---------------------------------------------------------------------------

    There is significant diversity in the business models of non-FINRA 
member firms. Some non-FINRA member firms may limit their equity 
trading to a single exchange, while others trade on multiple venues 
including off-exchange venues such as ATSs. Some firms are significant 
contributors to both off-exchange and exchange volume. Because CAT 
requires reporting of all NMS stock trades, including off-exchange 
trades, FINRA and the Commission are able to quantify the aggregate 
off-exchange activity of non-FINRA member firms.
    Off-exchange equity trading occurs across many trading venues. In 
quarter 3 of 2021, 32 ATSs actively traded NMS stocks, comprising 9.6% 
of NMS stock share volume. Furthermore, 187 named \222\ broker-dealers 
transacted a further 33% of NMS stock share volume off-exchange without 
the involvement of an ATS. Although many market participants provide 
liquidity within this market, non-FINRA member firms are particularly 
active within ATSs.\223\ Although non-FINRA member firms may trade in 
the non-ATS segment of the off-exchange market, the Commission believes 
they rarely act as liquidity suppliers outside of ATSs because they do 
not carry customer accounts that might generate orders they could fill 
from inventory.
---------------------------------------------------------------------------

    \222\ ATSs often report the MPID of counterparties that are not 
FINRA members, allowing their activity to be partially identified in 
CAT data.
    \223\ See Table 1 for information on trading activities on ATSs.
---------------------------------------------------------------------------

    While some non-FINRA member firms trade actively off-exchange, some 
of these firms also supply and demand liquidity actively on multiple 
equity and options exchanges. Table 1 below shows the executed dollar 
volume in listed equities by trading venue type during September 2021 
and April 2022 for the non-FINRA member firms. Table 2 below shows the 
executed dollar volume, number of trades, and number of contracts in 
options during September 2021 and April 2022 for the non-FINRA member 
firms.

                       Table 1--Non-FINRA Members NMS Equity Trading Volume by Venue Type
----------------------------------------------------------------------------------------------------------------
                                                                       Traded dollar volume
                                                 ---------------------------------------------------------------
                                                             Sept 2021                      April 2022
                                                 ---------------------------------------------------------------
                                                   Billions ($)     % of Total     Billions ($)     % of Total
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:

[[Page 49955]]

 
    Off-Exchange: ATS...........................          661.50            11.9          374.43             9.8
    Off-Exchange: Non-ATS.......................          127.50             2.3           66.57             1.7
    On-Exchange: Exchange Member \2\............        4,190.57            75.2        2,904.01            76.0
    On-Exchange: Cross-Exchange \3\.............          592.29            10.6          475.30            12.4
                                                 ---------------------------------------------------------------
        Total...................................        5,571.87           100.0        3,820.32           100.0
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
    Off-Exchange: ATS...........................          629.41            12.9          345.56            10.9
    Off-Exchange: Non-ATS.......................          114.59             2.3           58.19             1.8
    On-Exchange: Exchange Member \2\............        3,622.30            74.1        2,384.36            75.1
    On-Exchange: Cross-Exchange \3\.............          520.97            10.7          388.48            12.2
                                                 ---------------------------------------------------------------
        Total...................................        4,887.27           100.0        3,176.59           100.0
----------------------------------------------------------------------------------------------------------------
Data Source: CAT.
\1\ Non-FINRA Member firms that initiated orders that were executed either on or off-exchange. There were 47
  firms in September 2021 and 43 firms in April 2022.
\2\ Exchange Member refers to trades executed on an exchange where the Non-FINRA member is a registered member.
\3\ Cross-Exchange refers to trades executed on an exchange where the Non-FINRA member is not a registered
  member.
\4\ The largest Non-FINRA member firms ranked by off-exchange traded dollar volume. There were 13 firms in
  September 2021 and 12 firms in April 2022.


                         Table 2--Non-FINRA Members Options Trading Volume by Venue Type
----------------------------------------------------------------------------------------------------------------
                                                                       Traded dollar volume
                                                 ---------------------------------------------------------------
                                                             Sept 2021                      April 2022
                                                 ---------------------------------------------------------------
                                                   Millions ($)     % of Total     Millions ($)     % of Total
----------------------------------------------------------------------------------------------------------------
                                          Panel A: Option Dollar Volume
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
    On-Exchange: Exchange Member \2\............          650.75            94.6          713.10            92.9
    On-Exchange: Cross-Exchange \3\.............           37.09             5.4           54.45             7.1
                                                 ---------------------------------------------------------------
        Total...................................          687.84           100.0          767.54           100.0
----------------------------------------------------------------------------------------------------------------
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
    On-Exchange: Exchange Member \2\............          493.09            94.1          645.48            92.6
    On-Exchange: Cross-Exchange \3\.............           31.05             5.9           51.37             7.4
                                                 ---------------------------------------------------------------
        Total...................................          524.14           100.0          696.85           100.0
----------------------------------------------------------------------------------------------------------------


 
                                                                              Trades
                                                 ---------------------------------------------------------------
                                                             Sept 2021                      April 2022
                                                 ---------------------------------------------------------------
                                                   Millions ($)     % of Total     Millions ($)     % of Total
----------------------------------------------------------------------------------------------------------------
                                            Panel B: Number of Trades
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:                                    ..............  ..............  ..............  ..............
    On-Exchange: Exchange Member \2\............           28.33            96.1           23.04            93.2
    On-Exchange: Cross-Exchange \3\.............            1.14             3.9            1.67             6.8
                                                 ---------------------------------------------------------------
        Total...................................           29.47           100.0           24.71           100.0
----------------------------------------------------------------------------------------------------------------
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
    On-Exchange: Exchange Member \2\............           20.72            95.9           20.96            93.4
    On-Exchange: Cross-Exchange \3\.............            0.89             4.1            1.49             6.6
                                                 ---------------------------------------------------------------
        Total...................................           21.61           100.0           22.44           100.0
----------------------------------------------------------------------------------------------------------------


[[Page 49956]]


 
                                                                             Contracts
                                                 ---------------------------------------------------------------
                                                             Sept 2021                      April 2022
                                                 ---------------------------------------------------------------
                                                   Millions ($)     % of Total     Millions ($)     % of Total
----------------------------------------------------------------------------------------------------------------
                                          Panel C: Number of Contracts
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
    On-Exchange: Exchange Member \2\............          197.36            95.2          185.65            94.4
    On-Exchange: Cross-Exchange \3\.............            9.97             4.8           10.93             5.6
                                                 ---------------------------------------------------------------
        Total...................................          207.33           100.0          196.58           100.0
----------------------------------------------------------------------------------------------------------------
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
    On-Exchange: Exchange Member \2\............          138.33            94.8          167.37            94.6
    On-Exchange: Cross-Exchange \3\.............            7.65             5.2            9.57             5.4
                                                 ---------------------------------------------------------------
        Total...................................          145.98           100.0          176.94           100.0
----------------------------------------------------------------------------------------------------------------
Data Source: CAT.
\1\ Non-FINRA Member firms that initiated options orders that were executed. There were 42 firms in September
  2021 and 35 firms in April 2022.
\2\ Exchange Member refers to trades executed on an exchange where the Non-FINRA member is a registered member.
\3\ Cross-Exchange refers to trades executed on an exchange where the Non-FINRA member is not registered member.
\4\ The largest non-FINRA member firms ranked by equity off-exchange traded dollar volume. Nine of the largest
  13 firms in September 2021 and nine of the largest 12 firms in April 2022 initiated options orders that were
  executed.

    Table 1 shows that the majority of non-FINRA member firms executed 
listed equity orders (approximately 75%) on exchanges where the firm 
was a registered member. However, they also transacted on exchanges 
where the firm was not a member in addition to trading off-exchange. 
Table 2 shows the number of non-FINRA member firms that also executed 
trades in the options market and the total dollar, trades, and contract 
volume. In September 2021, forty-two non-FINRA member firms and nine of 
the 13 largest firms executed trades on options exchanges. Eight of the 
nine largest firms executed trades on seven or more options exchanges. 
In April 2022, 35 non-FINRA member firms and nine of the 12 largest 
firms executed trades on options exchanges.
2. Current Market Oversight
    The surveillance and regulation of each broker or dealer is 
partially dependent upon its individual SRO membership status. Each SRO 
is required to examine for and enforce compliance by its members and 
associated persons with the Exchange Act, the rules and regulations 
thereunder, and the SRO's own rules, including, for exchange SROs, the 
rules on the trading that occurs on the exchange it oversees. Because 
of this, SROs that oversee an exchange generally possess expertise in 
regulating members who specialize in trading on their exchange and in 
using the order types that may be unique or specialized within the 
exchange. This expertise complements the expertise of an Association in 
supervising cross-exchange and off-exchange trading activity.\224\
---------------------------------------------------------------------------

    \224\ See supra Section II, discussing the requirement for SROs 
to examine for and enforce compliance with the Exchange Act, and the 
rules and regulations thereunder.
---------------------------------------------------------------------------

    While all exchanges are SROs and have access to CAT data covering 
trading activity by their members both on and off exchanges, currently 
nearly all equity activity and much options activity of non-FINRA 
member broker-dealers is surveilled by FINRA through the RSAs with 
exchange SROs. However, RSAs are voluntary, privately negotiated 
agreements that can expire or be terminated, and accordingly, these 
agreements may not in the future provide the consistency and stability 
of direct FINRA oversight. U.S. Treasury security trading and other 
fixed income trading,\225\ however, is not covered by CAT; instead 
transactions in these securities are only reported to FINRA's TRACE 
database when there is a FINRA member that is party to the trade or the 
trade occurs on an ATS because such reporting results from a FINRA 
rule.\226\ Where no FINRA member is party to the transaction, and the 
transaction does not take place on an ATS, it goes unreported to TRACE.
---------------------------------------------------------------------------

    \225\ Municipal bond trades are not reported to TRACE.
    \226\ All ATSs are operated by FINRA member firms.
---------------------------------------------------------------------------

    Some exchanges serve as DEA for certain of their members.\227\ 
Financial and operational requirements share many commonalities across 
SROs, such as net capital requirements and books and records 
requirements. Because many brokers and dealers are members of multiple 
SROs with similar requirements, one SRO is appointed as the broker's or 
dealer's DEA to examine common members for compliance with the 
financial responsibility requirements imposed by the Act, or by 
Commission or SRO rules.\228\ The exchange serving as DEA has 
regulatory responsibility for their common members' compliance with the 
applicable financial responsibility rules. However, the non-DEA 
exchange maintains responsibility for compliance with its own rules and 
provisions of the federal securities laws governing matters other than 
financial responsibility, including sales practices and trading 
activities and practices, although the SROs may also allocate other 
regulatory responsibilities.
---------------------------------------------------------------------------

    \227\ See supra note 30.
    \228\ See supra note 30. See 17 CFR 240.17d-1. FINRA serves as 
the DEA for the majority of member firms; there are exceptions, 
mostly involving firms that have specialized business models that 
focus on a particular exchange that is judged to be best situated to 
supervise the member firm's activity. These firms are, however, 
subject to the same supervision of their trading activity as other 
member firms for whom FINRA does act as DEA, and the DEA stipulates 
which SRO has responsibility to supervise the firm but does not 
allow for less supervision. Under the amendments, non-FINRA member 
firms that join FINRA may or may not be assigned to FINRA for DEA 
supervision.
---------------------------------------------------------------------------

    All registered brokers and dealers are required to join an 
Association unless they effect transactions in securities solely on a 
national securities exchange of which they are a member or are

[[Page 49957]]

exempt from the membership requirement pursuant to Rule 15b9-1. The 
vast majority of brokers and dealers join an Association and, because 
FINRA is the only Association, brokers and dealers are subject to 
relatively uniform regulatory requirements and levels of surveillance 
and supervision. Supervision by FINRA, which is currently the only 
Association, covers a market that is fragmented across many trading 
venues, including the more opaque off-exchange market.\229\ 
Additionally, FINRA oversees its member's activity in equity, fixed 
income, and derivative markets and thus has the ability to supervise 
asset classes that may be outside the expertise of certain exchange 
SROs.
---------------------------------------------------------------------------

    \229\ Comprehensive reporting requirements for all member firms 
that trade off-exchange give FINRA information on market activity 
levels and market conditions off-exchange. Because most off-exchange 
venues do not publicly disseminate information on the liquidity 
available in their systems, comprehensive information from all 
participants through CAT allows FINRA to analyze and surveil the 
off-exchange market. See supra notes 40-43.
---------------------------------------------------------------------------

    The existing Association, FINRA, serves crucial functions in the 
current regulatory structure.\230\ The Exchange Act's statutory 
framework places responsibility for off-exchange trading with an 
Association.\231\ Pursuant to that, FINRA has established a regulatory 
regime for FINRA members, including FINRA members conducting business 
in the off-exchange market for various asset classes, and developed 
surveillance technology and specialized regulatory personnel to provide 
surveillance, supervision, and enforcement of activity occurring off-
exchange. Consequently, the current regulatory structure achieves 
cross-market and off-exchange supervision through the surveillance 
actions of FINRA of the market generally and its examination of its 
members.
---------------------------------------------------------------------------

    \230\ See supra Section II for further discussion of the role of 
Associations in market oversight.
    \231\ See supra note 8.
---------------------------------------------------------------------------

    Additionally, despite the fact that FINRA does not have the 
authority to monitor non-FINRA member firms that are not covered by RSA 
or 17d-2 plans that include these services, the Commission understands 
that FINRA operates a cross-market regulatory program that covers 100% 
of equity trades and 45% of option trading.\232\ FINRA does not have 
direct membership-based jurisdiction over non-FINRA member firms. 
However, FINRA refers cases for enforcement to the SRO with 
jurisdiction or to the Commission. If FINRA is performing regulatory 
services for an exchange SRO pursuant to an RSA, FINRA may, on behalf 
of the exchange SRO, investigate and bring an enforcement action 
against an exchange SRO member that is not a FINRA member, assuming 
that those services are covered by the RSA.\233\ However, each RSA is 
independently negotiated and thus they are not standardized. Therefore, 
FINRA's ability to provide oversight can vary based on the nature of 
its regulatory services agreement with the exchange SRO. Additionally, 
the ultimate responsibility for that regulatory oversight still rests 
with the exchange SRO, not with FINRA.\234\ SROs may also use 17d-2 
plans which allow SROs with common members to designate a DEA to 
examine common members. However, 17d-2 plans do not confer jurisdiction 
as they apply only to common firms of which each SRO would already have 
jurisdiction.\235\ Exchange SROs may not be efficient at monitoring 
off-exchange activity. Because of the historical reliance on FINRA as 
the examination and surveillance authority over off-exchange trading, 
exchanges have limited resources and may have incentives to prioritize 
the following up on potential violations of on-exchange activity over 
off-exchange activity. However, such incentives are likely curtailed by 
the exchange SROs' legal responsibilities under the Exchange Act to 
examine and enforce compliance by their members with the Exchange Act, 
the rules thereunder, and the SRO's own rules and the reputational 
damage they may experience if they do not.
---------------------------------------------------------------------------

    \232\ See Cross-Market Regulatory Coordination Staff Paper, 
supra note 31.
    \233\ In most but not all cases, FINRA is empowered to take such 
actions.
    \234\ See supra note 109.
    \235\ See supra note 30.
---------------------------------------------------------------------------

    Currently, some non-FINRA member firms transact heavily in the 
course of normal business activities within venues regulated by SROs of 
which they are not members. This activity is not limited to equities; 
non-FINRA member firms play a large role in U.S. Treasury securities 
markets as well.\236\ In 2021, there were four non-FINRA member firms 
that together traded more than $7 trillion in U.S. Treasury securities 
volume on covered ATSs, which accounted for 2% of total U.S. Treasury 
securities trading volume \237\ reported to TRACE. In April 2022, the 
Commission estimates that three non-FINRA member firms totaled $700 
billion in U.S. Treasury securities volume executed on covered ATSs, 
which accounted for 2.5% of total U.S. Treasury securities transaction 
volume reported to TRACE that month.
---------------------------------------------------------------------------

    \236\ See supra Section VI.A.1 and accompanying text for more 
information on trading in U.S. Treasury securities markets.
    \237\ The Commission estimated that in July 2021 there were 626 
total firms that traded U.S. Treasury securities. See Table 1 of 
Securities Exchange Act Release No. 94524 (March 28, 2022), 87 FR 
23054, 23081 (April 18, 2022).
---------------------------------------------------------------------------

    This is very different from when Rule 15b9-1 was first adopted. The 
Act provides for regulation of exchange trading by the exchanges 
themselves; it further generally provides for supervision of off-
exchange trading by an Association.\238\
---------------------------------------------------------------------------

    \238\ See supra note 8.
---------------------------------------------------------------------------

    SRO rules require their members to report CAT data daily.\239\ This 
data records the origination, receipt, execution, routing, 
modification, or cancellation of every order a member firm handles for 
NMS stocks and options, with the exception of primary market 
transactions.
---------------------------------------------------------------------------

    \239\ See generally FINRA Rule 6800 Series and 17 CFR 242.613.
---------------------------------------------------------------------------

    Because non-FINRA member firms are not required to join an 
Association if they qualify for an exemption, they are not required to 
pay the costs of Association membership, which could be significant, 
especially for non-FINRA member firms with substantial trading 
activity. FINRA members currently pay fees associated with FINRA 
membership including the annual Gross Income Assessment (GIA), the 
annual personnel assessment; and the TAF and Section 3 fees.\240\ FINRA 
members pay the TAF for all sales transactions of covered securities 
that are not performed in the firm's capacity as a registered 
specialist or market maker upon an exchange.\241\ FINRA members also 
must pay Transaction Reporting Fees for TRACE reportable securities, 
with the exception of U.S. Treasury securities.
---------------------------------------------------------------------------

    \240\ See infra Section VI.C.2.b. for more information on the 
fees.
    \241\ Covered securities include all equity, options and U.S. 
Treasury securities. For an explanation of what is included and 
exempt from the TAF, see FINRA Rules and Guidance, available at 
https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees. After the 2015 
Proposal, FINRA proposed an exemption that ``would exempt from the 
TAF transactions executed by proprietary trading firms on an 
exchange of which the firm is a member (including non-market maker 
trades).'' See FINRA Regulatory Notice 15-13, Trading Activity Fee 
(May 2015), at 3, available at https://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-13.pdf. FINRA stated 
that the proposed exemption ``would result in a lower TAF for trades 
executed on an exchange for which the proprietary trading firm is a 
member than a trade executed elsewhere.'' Id. at 5. The proposed 
exemption to the TAF is not effective.
---------------------------------------------------------------------------

    The FINRA Section 3 fee is the second of two primary FINRA fees 
(the other being TAF) that are assessed upon each off-exchange sale by 
or through a FINRA member. Under Section 31 of the Act,\242\ SROs must 
pay transaction fees based

[[Page 49958]]

on the volume of their covered sales. These fees are designed to offset 
the costs of regulation incurred by the government--including the 
Commission--for supervising and regulating the securities markets and 
securities professionals. FINRA obtains money to pay its Section 31 
fees from its membership, in accordance with Section 3 of Schedule A to 
the FINRA By-Laws. FINRA assesses these Section 3 fees on the sell side 
of each off-exchange trade, when possible. When the sell side of an 
off-exchange transaction is a non-FINRA member firm and the seller 
engages the services of a clearing broker that is a member firm, FINRA 
can assess the Section 3 fee against the member firm clearing 
broker.\243\ When the seller is a non-FINRA member firm that self-
clears, FINRA has no authority to assess the Section 3 fee against the 
seller. In such case, FINRA would seek to assess the fee against the 
buyer, if the buyer includes a member firm counterparty or a member 
firm acting as clearing broker for a non-FINRA member firm buy side 
counterparty. Firms that carry customer accounts are required to be a 
member of an Association and thus these firms bear the aforementioned 
fees. These costs may be passed on in part or in whole to the investing 
public or the non-FINRA member counterparty.
---------------------------------------------------------------------------

    \242\ 15 U.S.C. 78ee.
    \243\ The seller's clearing broker may pass that fee on to the 
non-FINRA member firm.
---------------------------------------------------------------------------

3. Current Competition To Provide Liquidity
    The market for liquidity provision on equity exchanges is 
competitive. In September 2021 across all exchanges, each equity 
security had between 1 to 47 registered market makers providing 
liquidity. The median equity security had 3 registered market makers, 
and 75% of securities had 2 or more registered market makers. Twenty-
five percent of equity securities had 6 or more registered market 
makers. Additionally, while the number of market makers provides a good 
indication as to the number of firms in the business of providing 
liquidity, it does not necessarily indicate whether each market maker 
is an active competitor. However, the Commission believes that many 
market makers actively compete to provide liquidity.
    As stated above, non-FINRA member firms do not have the same 
regulatory costs as FINRA member firms, which may give non-FINRA member 
firms a competitive advantage in providing liquidity. As such, non-
FINRA member firms may be able to provide liquidity at a lower cost 
than FINRA member firms given that non-FINRA member firms have a lower 
variable cost, all else equal, for trading compared to FINRA member 
firms.
    The Commission believes that non-FINRA member firms are active 
participants in the market to provide liquidity in off-exchange 
markets. The Commission estimates that non-FINRA member firms account 
for between 4.6% and 9.8% of off-exchange dollar volume in equities. 
Additionally, nearly 10% of all non-FINRA member equity trading 
activity occurs in off-exchange markets. In U.S. Treasury securities 
markets, non-FINRA member firms trading activity that is reported by 
covered ATSs account for 2.5% of all transaction volume.

B. Effects on Efficiency, Competition, and Capital Formation

    In addition to the specific, individual benefits and costs 
discussed below, the Commission expects the amendments may have varying 
effects on efficiency, competition, and capital formation. These 
effects are described in this section. The proposal may result in 
improved efficiency of capital allocation. To the extent that liquidity 
provision changes as a result of the proposal, market efficiency might 
be impacted. Additionally, the proposal would have mixed effects on 
competition to provide liquidity, as current non-FINRA member firms may 
be less likely to provide liquidity but current FINRA members may be 
more likely to provide liquidity. The Commission believes that the 
amendments would not likely have a meaningful effect on capital 
formation.
1. Firm Response and Effect on Market Activity and Efficiency
    Although non-FINRA member firms could seek to comply with the 
amendments in multiple ways, each route could involve changes to firms' 
business models. Some non-FINRA member firms may limit their trading to 
exchanges of which they are members, and the Commission believes that 
some may not trade off-exchange other than to comply with Rule 611 of 
Regulation NMS or the Options Linkage Plan,\244\ or to execute the 
stock leg of a stock-option order.\245\ These firms would remain exempt 
from the requirement to become a member of an Association, if they 
comply with Section 15(b)(8) of the Act or the Rule as amended.\246\ 
Other firms would no longer be exempt, and would need to take action to 
comply with the amended rule. Under the amended Rule, a non-FINRA 
member firm that trades equities, options or fixed income securities 
off-exchange, or upon exchanges of which it is not a member, can comply 
in four ways. The first option would be to join an Association. The 
second option would be to join all exchanges upon which the non-FINRA 
member firm wishes to trade, and to cease any off-exchange trading, 
other than off-exchange trading consistent with the routing exemption 
and stock-option order exemption. Third, a non-FINRA member firm could 
comply by trading solely upon those exchanges of which it is already a 
member, consistent with the statutory exemption in Section 
15(b)(8).\247\ Finally, a non-FINRA member firm could cease trading 
securities.
---------------------------------------------------------------------------

    \244\ See supra section III.B.1.
    \245\ See supra section III.B.2.
    \246\ Changes to the exclusion are discussed in section III.B, 
supra.
    \247\ 15 U.S.C. 78o(b)(8).
---------------------------------------------------------------------------

    The changes non-FINRA member firms make to their business model to 
comply with the amendments may affect competition in the equity and 
U.S. Treasury securities markets, particularly for off-exchange 
liquidity provision. Non-FINRA member firms may be less willing to 
compete to provide liquidity off-exchange, decreasing off-exchange 
liquidity. For example, non-FINRA member firms may choose to cease 
their off-exchange activity rather than join an Association--although 
it is likely that firms that trade heavily in the off-exchange market 
may find it more costly to cease their off-exchange activity than to 
join an Association.\248\ In addition, non-FINRA member firms that 
choose to join an Association may reduce their off-exchange trading 
because joining an Association would increase variable costs to trade 
in the off-exchange market, as these trades would incur TAF and 
possibly additional Section 3 fees, although some Section 3 fees may 
already be passed on from FINRA member firms to non-FINRA member 
firms.\249\ An increase in cost would

[[Page 49959]]

reduce the profitability of off-exchange trading and thus potentially 
reduce off-exchange trading. This sentiment was echoed by one commenter 
who stated that FINRA registration ``would greatly impede'' the entry 
of high frequency proprietary traders to the market.\250\ While the 
Commission agrees that FINRA membership could act as a deterrent to new 
high frequency trading firms entering the marketplace as broker-
dealers, the Commission also believes that access to our capital 
markets generally requires a certain level of oversight. The Commission 
believes that the proposal is consistent with the Exchange Act's 
statutory framework for complementary exchange SRO and Association 
oversight of broker-dealer trading activity and thus to the extent such 
firms are required to register with FINRA as a result of the proposal, 
the costs are justified as part of that regulatory oversight.
---------------------------------------------------------------------------

    \248\ Firms with very low ATS activity are unlikely to directly 
connect to an ATS, instead accessing ATSs through a member firm. For 
firms with very limited off-exchange activity, ceasing off-exchange 
activity is likely to be less costly than joining an Association. 
The costs of joining FINRA are discussed in detail in infra section 
VI.C.2; for firms with very limited off-exchange activity, it is 
unlikely that the profits generated from this activity would offset 
FINRA membership costs. However, for firms that generate profits 
from off-exchange activities that exceed FINRA membership costs, it 
may be less costly to join FINRA than to cease their off-exchange 
activity.
    \249\ After the 2015 proposal, FINRA considered reevaluating the 
structure of the TAF to assure that it appropriately considered the 
business model of certain non-FINRA member firms that might have 
joined FINRA as a result of the proposed amendments. See supra note 
153. The Commission's analysis of TAF is based on current TAF 
structure as outlined in the FINRA By-Laws, Schedule A. TAF and 
Section 3 fees are discussed further in Section VI.C.2.b, infra. 
Firms would also face additional fixed costs both to establish and 
maintain Association membership; those costs are discussed in 
Section VI.C.2, infra.
    \250\ See Letter from Michelle Pav (April 16, 2015) (``Pav 
Letter'') at 5. The commenter is concerned with how the duties of 
best execution and general suitability would apply to proprietary 
trading firms. Id. The commenter also states that the Commission 
``clearly does not understand'' high frequency trading and FINRA 
does not have ``any more insight into what is happening at [high 
frequency trading] firms than the SEC.'' Id. at 2. Some proprietary 
trading firms are already members of FINRA. As a result, FINRA has 
experience addressing these issues. Additionally, the rule 
amendments would provide FINRA and the Commission with greater 
visibility into the activities of these firms.
---------------------------------------------------------------------------

    The Commission preliminarily believes that requiring membership in 
an Association, consistent with Rule 15b9-1, could facilitate an 
appropriate level of oversight. The Commission also recognizes that the 
loss of liquidity provision in off-exchange trading may impose costs on 
investors in the form of higher trading costs than they would otherwise 
realize. These effects may differ across asset classes. In the case of 
non-FINRA member broker-dealers trading U.S. Treasury securities, costs 
to join an Association include the costs of establishing TRACE 
reporting. Depending on the firm's activity level in that market, firms 
may be more likely to withdraw from that market if their anticipated 
profit levels from U.S. Treasury securities trading do not justify the 
additional reporting requirements. The impact on liquidity in U.S. 
Treasury securities markets is not likely to significantly impact 
investor costs to trade these securities because U.S. Treasury 
securities are generally very liquid and competition to provide this 
liquidity is robust. If some non-FINRA member broker-dealers stop 
competing in the market to provide this liquidity, other broker-dealers 
are likely to increase their activity in this market, but the 
Commission acknowledges that if liquidity decreases, investor costs to 
trade U.S. Treasury securities could increase.
    Additionally, the removal of liquidity from the market could either 
improve or degrade execution quality on off-exchange markets.\251\ Some 
institutional investors transacting in off-exchange markets may seek 
institutional investor counterparties and avoid transacting with 
proprietary trading firms. To this extent, the removal of non-FINRA 
member firm liquidity may be seen as improving liquidity quality within 
ATSs by some institutional investors.\252\ It is also possible that 
reducing the activity of non-FINRA member firms within ATSs may result 
in more ATS liquidity, if non-FINRA member firms are acting as net 
takers of liquidity within these systems.\253\ At a minimum, liquidity 
levels in ATSs may change. In addition, these firms may reduce their 
off-exchange trading outside of ATSs such as on single-dealer 
platforms. It is possible that this would result in a transfer of 
volume from off-exchange venues to exchanges, but it is also possible 
that overall market trading volume would diminish if decreased volume 
from off-exchange trading does not migrate to exchanges.
---------------------------------------------------------------------------

    \251\ Non-FINRA member firms are likely to also reduce their 
off-exchange trading outside of ATSs, such as on single-dealer 
platforms. However, non-FINRA member firms can only take (not make) 
liquidity on these platforms. It is possible that additional off-
exchange liquidity may be available outside of ATSs for other market 
participants as a result of the amendments to Rule 15b9-1 due to a 
reduction in non-FINRA member firm trading on single-dealer 
platforms.
    \252\ Industry white papers sometimes discuss the concept of 
natural counterparties for institutional trades. These papers may 
explicitly or implicitly identify proprietary automated trading 
firms as sources of information leakage in dark pools. The 
Commission understands that some ATSs segment orders so that 
institutional investors do not trade with PTFs. See e.g., Hitesh 
Mittal, Are You Playing in a Toxic Dark Pool? A Guide to Preventing 
Information Leakage, J. Trading, Summer 2008, at 20 (ITG white 
paper), available at https://jot.pm-research.com/content/3/3/20. 
Other industry participants describe a more benign role for 
automated trading firms as liquidity providers in ATSs. See Terry 
Flanagan, High-Speed Traders Go Dark, Markets Media Commentary 
(2012), available at https://www.marketsmedia.com/high-speed-traders-go-dark/.
    \253\ There is some evidence that some proprietary trading firms 
are net takers rather than net suppliers of liquidity in equity 
markets, although the evidence is not conclusive. Using Nasdaq data 
from 2008-2010, Carrion estimates that these firms supply liquidity 
to 41.2% of trading dollar volume and take liquidity in 42.2% of 
trading dollar volume. See Allen Carrion, Very fast money: High-
frequency trading on the NASDAQ, 16 J. Fin. Mkts. 680 (2013). 
Another study finds that electronic trading firms act as net 
liquidity suppliers during periods of extreme price movements. See 
Jonathan Brogaard, Allen Carrion, Thibaut Moyaert, Ryan Riordan, 
Andriy Shkilko & Konstantin Sokolov, High Frequency Trading and 
Extreme Price Movements, 128 J. Fin. Econ. 253 (2018).
---------------------------------------------------------------------------

    In response to the 2015 Proposal, several commenters expressed 
liquidity concerns.\254\ One commenter stated that because it would be 
costly for high frequency trading firms to comply with FINRA 
regulations, these firms ``may not trade as frequently, reducing 
overall market liquidity.'' \255\ Another commenter stated that 
proprietary traders provide liquidity and order to the markets and that 
disadvantaging small proprietary traders may harm the market 
balance.\256\ A third commenter stated that it believes that 
``unnecessary costs . . . could hinder competition among liquidity 
providers, which could negatively impact market liquidity and 
transaction costs.'' \257\ Finally, one commenter stated that the 
current FINRA fee structure is imbalanced and risks stifling liquidity 
in the markets and that there are fewer incentives to provide the same 
liquidity under FINRA's proposed fee structure as there are under 
Cboe's regulatory fee structure.\258\
---------------------------------------------------------------------------

    \254\ See Pav Letter, Hold Brothers Capital Letter, FIA 1 
Letter, and PEAK6 Letter.
    \255\ See Pav Latter at 3.
    \256\ See Hold Brother Capital Letter at 4.
    \257\ See FIA 1 Letter at 3.
    \258\ See PEAK6 Letter at 3-4. This commenter further stated 
that FINRA fees ``may discourage such firms from routing trades to 
certain markets, thereby disrupting market efficiency.'' Id. at 4.
---------------------------------------------------------------------------

    Changes in business models for non-FINRA member firms may affect 
market quality on exchanges as well. In addition to trading extensively 
in the off-exchange market, many non-FINRA member firms are among the 
most active participants on exchanges. Business model changes by these 
firms may lead to less exchange liquidity for several reasons. First, 
non-FINRA member firms that choose not to join an Association would no 
longer be able to rely on the rule and trade indirectly on exchanges of 
which they are not members, unless they comply with the routing or 
stock-options order exemptions.\259\ Second, non-FINRA member firms 
that do not join an Association would no longer be able to access off-
exchange liquidity to unwind positions acquired on exchanges, which may 
reduce their

[[Page 49960]]

willingness to provide liquidity upon exchanges.\260\ Third, non-FINRA 
member firms that choose to join an Association may be subject to 
additional variable costs (primarily regulatory fees) on their 
exchange-based trading as well as on their off-exchange trading.\261\ 
These firms may respond by trading less actively on exchanges. Finally, 
non-FINRA member firms may choose to cease trading rather than join an 
Association or change their business models. Reduced liquidity upon 
exchanges can result in higher spreads and increased volatility. 
Increased spreads on exchanges can lead to increased costs for off-
exchange investors as well as investors transacting on exchanges, 
because most off-exchange transactions (including many retail 
executions) are derivatively priced with reference to prevailing 
exchange prices.
---------------------------------------------------------------------------

    \259\ Currently, a non-FINRA member firm can indirectly access 
an exchange of which it is not a member through a firm that is an 
exchange member. In light of the elimination of the exclusion for 
proprietary trading, this activity would not be consistent with the 
amendments, unless the activity complies with the routing or stock-
option order exemptions. See supra sections III.B.1 and III.B.2.
    \260\ These firms could unwind positions on exchanges of which 
they are a member, but the cost to do so may be higher than if all 
liquidity, including off-exchange liquidity, were available.
    \261\ It is possible non-FINRA member firms that choose to join 
an Association may avoid some additional costs by registering as 
market makers on additional venues, mitigating these charges. 
Furthermore, they may see a reduction in fees that were formerly 
paid to their DEA if FINRA assumes that role.
---------------------------------------------------------------------------

    The Commission believes that the amendments are not likely to have 
an economically meaningful effect on direct capital formation, which is 
the assignment of financial resources to meet the funding requirements 
of a profitable capital project, in this case, the provision of 
liquidity to financial markets. However, the Commission believes that 
the changes in allocation of regulatory fees and direct FINRA 
supervision within the off-exchange market may result in improved 
efficiency of capital allocation by the financial industry. The 
proposed amendments may reduce the capital commitment of non-FINRA 
member firms to liquidity provision. In response, it is possible that 
current member firms may choose to commit additional capital to 
liquidity provision when the trading environment has more uniform 
regulatory requirements. The Commission believes that this may lead to 
an overall increased commitment of liquidity both to exchanges and the 
off-exchange market. This increased commitment is likely to have some 
positive effects on capital market efficiency, such as lower quoted 
spreads on exchanges. In addition to lowering immediate execution costs 
on exchanges, lower exchange quoted spreads are likely to reduce 
transaction costs off-exchange as well, because off-exchange trades are 
typically priced with reference to quoted exchange prices.
    The Commission believes these effects are not likely to be 
significant because the market to provide liquidity is very 
competitive. These markets are served by a number of liquidity 
providers with different business strategies and a strategic change by 
relatively few competitors is unlikely to disturb liquidity provision 
overall.
2. Effect on Competition To Provide Liquidity
    The proposed amendments may impact competition to provide liquidity 
by increasing the regulatory cost for current non-FINRA member firms. 
Currently, non-FINRA member firms do not bear the costs associated with 
FINRA membership. As such, FINRA member firms bear a number of costs 
not borne by non-FINRA member firms including a number of regulatory 
fees and indirect costs that are assessed or imposed upon member 
firms.\262\ These costs are a part of equity, options and fixed income 
markets and include direct costs such as trading fees that are either 
assigned only to member firms, such as TAF, or in the case of Section 3 
fees, member firms may be assigned costs that could be assigned to non-
FINRA member firms selling securities off-exchange. There are indirect 
costs of disparate regulatory regimes as well.\263\ Under the proposed 
amendments current non-FINRA members would become subject to the 
regulatory costs associated with FINRA membership, including TAF, GIA 
and Section 3 fees. These changes to regulatory costs for non-FINRA 
member firms may change competitive forces in the market for providing 
liquidity as the current non-FINRA member broker-dealers have lower 
regulatory costs, which may make it less costly for non-FINRA member 
broker-dealers to provide liquidity.\264\ However, non-FINRA member 
firms may already bear a portion, but not all, of these costs as FINRA 
member firms may pass through their fees to non-FINRA member 
counterparties. To the extent that non-FINRA member firms do have lower 
cost for providing liquidity than FINRA member firms, the proposed 
amendments may eliminate such an advantage, and lead to a reduction in 
liquidity provided by current non-FINRA member firms.
---------------------------------------------------------------------------

    \262\ Exchange membership also imposes costs on broker-dealers. 
Some non-FINRA member firms are members of many exchanges, but not 
FINRA, while some FINRA-member firms are members of many exchanges 
as well as FINRA. To the extent that a broker-dealer can avoid FINRA 
membership, its fee burden may be lower than a broker-dealer that 
cannot or does not avoid FINRA membership. The Commission 
preliminarily believes that many non-FINRA member firms would retain 
their exchange membership if the proposed amendments are adopted in 
order to maintain the benefits of being a member of the exchange. 
Therefore, the Commission only considers the additional cost to the 
firms that are specific to joining FINRA. The Exchange SRO fees are 
not considered as they are not expected to change. However, a firm 
may decide to drop their exchange membership on exchanges where they 
no longer wish to trade after joining FINRA, because maintaining 
exchange memberships is costly and firms are unlikely to maintain 
membership in exchanges where they do not plan to have activity. See 
infra section VI.C.2, for more information on the fees associated 
with FINRA membership.
    \263\ See section VI.C.2.f, infra.
    \264\ See section VI.B.1, supra for discussion of competitive 
effects and investor costs.
---------------------------------------------------------------------------

    The existing differential regulatory cost burdens of FINRA member 
firms and non-FINRA member firms may have consequences with respect to 
market quality both for exchange-based and off-exchange trading. For 
example, because non-FINRA member firms, all else equal, currently face 
lower variable costs of trading compared to member firms, non-FINRA 
member firms may be able to provide liquidity at a lower cost than 
member firms. It may also reduce direct execution costs (such as quoted 
and effective spreads) for both exchange and off-exchange trades, the 
latter of which are normally derivatively priced with reference to 
prevailing exchange quotes. The differential regulatory burden, 
however, may also reduce depth at best prices because a member firm may 
not be able to trade profitably at a price established by a non-FINRA 
member firm that faces lower regulatory costs. Lower liquidity at best 
exchange prices implies greater price effect of trades, which may 
increase trading costs, particularly for large orders. For example, if 
the best price on an exchange is associated with 100 shares of depth, a 
200 share order will exhaust depth at the best price and the second 100 
share lot may execute at an inferior price.\265\ If depth at the best 
price tends to be larger, it is less likely that an order will exceed 
the depth available at the best price. The change in the best price 
associated with an execution that exhausts the depth available at the 
best price is the price effect of the trade upon the exchange.
---------------------------------------------------------------------------

    \265\ This assumes no hidden depth at the best price. If non-
displayed depth is present at the best price, the remaining 100 
shares will be filled at the best price if at least 100 shares of 
hidden depth exist at the best price.
---------------------------------------------------------------------------

3. Competitive Effects on Off-Exchange Market Regulation
    Currently, FINRA is the only Association.\266\ It is possible, 
however, for new Associations to enter the regulatory oversight market 
and

[[Page 49961]]

compete with FINRA. The amendments to Rule 15b9-1 may create incentives 
for a new Association (or Associations) to form. The large non-FINRA 
member firms have commonalities in business models; for example, they 
typically do not carry customer accounts. They may consider joining a 
new Association together, which would allow the member of the new 
Association to be subject to rules and regulations that better fit 
their business practices. This may allow the new Association to more 
efficiently provide oversight for current non-FINRA member firms. For 
example, because these firms collectively conduct a significant portion 
of off-exchange volume, the creation of a new Association tailored to 
these firms may be economically viable.
---------------------------------------------------------------------------

    \266\ See supra note 9 and accompanying text.
---------------------------------------------------------------------------

    To be registered as a new Association, in addition to requirements 
that parallel the requirements to be a national securities exchange, a 
new Association must ``[b]y reason of the number and geographical 
distribution of its members and the scope of their transactions'' be 
able to carry out the purposes of Section 15A.\267\ Any new Association 
would have to be approved by the Commission. Additionally, a new 
Association must permit any registered broker or dealer that meets a 
new Association's qualification standards to become a member.\268\ It 
also must have rules regarding the form and content of quotations 
relating to securities sold otherwise than on a national securities 
exchange that are designed to produce fair and informative quotations, 
to prevent fictitious or misleading quotations, and to promote orderly 
procedures for collecting, distributing, and publishing 
quotations.\269\ A new Association must also be so organized and have 
the capacity to enforce compliance by its members and persons 
associated with its members with, among other things, its own rules and 
the Exchange Act and the rules and regulations thereunder.\270\
---------------------------------------------------------------------------

    \267\ See 15 U.S.C. 78o-3.
    \268\ See 15 U.S.C. 78o-3(b)(3). Section 15A of the Exchange Act 
specifically states that an Association shall not be registered as a 
national securities association unless the Commission determines, 
among other things, that ``the rules of the association provide that 
any registered broker or dealer may become a member of such 
association and any person may become associated with a member 
thereof.''
    \269\ See 15 U.S.C. 78o-3(b)(11).
    \270\ See 15 U.S.C. 78o-3(b)(2).
---------------------------------------------------------------------------

    The ability to form an Association is characterized by barriers to 
entry. The proposed amendments include a one-year implementation 
period, which may provide a significant time constraint to form a new 
Association. A new Association would likely incur significant fixed 
costs to create the infrastructure needed to perform the surveillance 
and oversight requirements imposed on Associations by statute and 
regulation. It may also incur substantial costs, including personnel, 
training, travel, and other costs to provide for effective surveillance 
and supervision of the off-exchange equity and U.S. Treasury securities 
markets. Indeed, the only existing Association, FINRA, has resources 
that enable it to surveil and supervise the off-exchange market.\271\ 
Additionally, while some costs may be lower because CAT already 
collects information and makes it available to query; a new Association 
would still have to build its own infrastructure, surveillance logics, 
and analytical tools, which may create a substantial cost for a new 
Association.\272\
---------------------------------------------------------------------------

    \271\ See supra note 9 and accompanying text.
    \272\ See Exchange Act Release No. 79318 (Nov. 15, 2016), 81 FR 
84696, 84836-39 (Nov. 23, 2016) (``CAT NMS Approval Order''), for a 
discussion on the benefits provided by CAT with regard to 
surveillance by SROs.
---------------------------------------------------------------------------

    The amendments may increase barriers to entry and thus affect the 
potential for competition among regulators of off-exchange markets. 
Currently, the primary barrier to entry is the high fixed cost involved 
in forming and operating an Association. As proposed, the amendments 
bring nearly all off-exchange trading under the jurisdiction of an 
Association, including the trading of firms that currently are not 
members of an Association (non-FINRA member firms). If these firms join 
the only existing Association, FINRA, any newly-formed Association may 
have increased difficulty attracting the members needed to support the 
high fixed costs associated with forming an Association because every 
broker or dealer that participates in the off-exchange market would 
already be a FINRA member. This increased difficulty results because 
many firms may be reluctant to change Associations, either because of 
the costs to change compliance infrastructures or uncertainty in the 
regulatory environment of the new Association. Thus, if the amendments 
result in more firms becoming members of the FINRA, a new Association 
could face increased difficulties attracting members in the future. If 
the new Association is introduced after implementation of the rule, 
these stated effects would become more likely as the current non-FINRA 
member firms would have already joined FINRA.
    The proposed amendments may create incentives to start a competing 
Association. The amendments, as proposed, could cause a number of firms 
with similar business models and substantial off-exchange volume to 
concurrently contemplate Association membership. This may provide the 
incentive to create a new Association and tailor it to the specific 
business models of these firms. If a competing Association limited the 
scope of its members or operations, it might not have to duplicate all 
of the surveillance and supervision functions required to be provided 
by an Association that does not have those limits. This may lower the 
costs of forming an Association and alter the barriers to entry.\273\
---------------------------------------------------------------------------

    \273\ Some limitations on Association membership or operations 
would require exemptive relief for the Association to register with 
the Commission.
---------------------------------------------------------------------------

    When the Commission previously considered these amendments, some 
commenters expressed their concern about a concentration of regulatory 
oversight.\274\ One commenter stated that, although subjecting all 
brokers and dealers to FINRA oversight could create standardized rules, 
which would simplify compliance and allow for better regulatory 
oversight and would eliminate the rationale for many exchange specific 
requirements, it is necessary to weigh such benefits against potential 
negatives associated with having a single regulator.\275\ A second 
commenter worried about an ``imprudent concentration of regulatory 
oversight responsibility with one self-regulatory organization.'' \276\ 
This commenter is concerned that the rule may achieve efficient 
oversight but would ``do so at the certain cost of regulatory 
resiliency and innovation.'' This commenter is also concerned that the 
rule could lead to serious single point of failure concerns and 
discourage innovation in regulatory surveillance and oversight 
practices.\277\ One commenter believes that the proposal raises 
``[m]onopoly and [a]nticompetitive considerations.'' \278\
---------------------------------------------------------------------------

    \274\ See HRT Letter at 9-11, CHX Letter at 1-2, and Hold 
Brothers Capital Letter at 3.
    \275\ See HRT Letter at 9-10. HRT further believes that it is 
appropriate to consider the potential negatives of concentrating 
power in a single regulator while also considering the potential 
positives associated with better standardization. Id. at 11.
    \276\ See CHX Letter at 1.
    \277\ Id. at 2. The commenter believes that effective regulation 
of cross-market activity requires multiple reviews of the same data 
from the unique vantage points of the respective SROs as is 
currently done with cooperation among the SROs and statutorily 
delegated regulatory authority.
    \278\ See Hold Brothers Capital Letter at 3.
---------------------------------------------------------------------------

    The existence of multiple Associations might provide benefits to 
the market as a whole. If a new Association could provide high quality 
services to members with a lower fee structure, all Associations would 
have

[[Page 49962]]

incentives to reduce fees to attract members. This could result in cost 
savings to brokers and dealers. Second, a new Association could 
innovate to develop different surveillance and supervision methods that 
could be more efficient than FINRA's methods.
    Competition among Associations could also entail substantial costs. 
If the market for Associations is characterized by economies of scale, 
aggregate costs for the same level of regulation would be higher in a 
market with two Associations than in a market with a single 
Association. These additional costs would ultimately be borne by the 
broker and dealer members of either Association, and could be passed on 
to investors. Second, Associations might compete on the basis of 
providing ``light touch'' regulation, in essence surveilling less and 
providing less supervision. As a result, the quality of market 
supervision might decrease, although the Commission does itself oversee 
self-regulatory organizations, such as Associations, and accordingly, 
would not permit a ``race to the bottom.'' \279\ Furthermore, some of 
the benefits of the proposed amendments would be diminished if current 
non-FINRA member firms created a new Association as opposed to joining 
FINRA. For example, the new Association would not have the experience 
or expertise of FINRA in overseeing off-exchange market activity. 
Additionally, the members of a new Association would not be required to 
report their U.S. Treasury securities market trading activity to TRACE 
if they are not FINRA members.
---------------------------------------------------------------------------

    \279\ See Section 19(g) and Section 19(h) of the Exchange Act.
---------------------------------------------------------------------------

C. Consideration of Costs and Benefits

    This section discusses costs and benefits of the amendments. While 
the Commission has attempted, where possible, to provide estimated 
quantifiable ranges, both costs and benefits are difficult to quantify 
for this proposal for a number of reasons.
    The overall benefits of the amendments relate to more stable and 
uniform surveillance of off-exchange activity by the direct, 
membership-based Association oversight to oversee such activity. As 
such, the benefits the Commission anticipates from the amendments are 
largely qualitative and by their nature difficult to measure 
quantitatively.
    The amendments would induce initial, ongoing and indirect costs 
which would be similarly difficult to measure for a variety of reasons. 
First, market participants are heterogeneous in their type, existing 
exchange memberships, and activity level in the off-exchange market. 
Consequently, compliance costs would vary across firms in a number of 
dimensions. Second, estimating costs is complicated by the fact that 
non-FINRA member firms can comply with the proposal in a number of 
ways, and presumably each would choose to seek compliance in the manner 
that minimizes the sum of its direct costs (related to joining and 
maintaining memberships in additional SROs) and indirect costs (which 
include forgone opportunities to trade profitably and costs associated 
with revising business strategies). Furthermore, some firms are likely 
to remain exempt but the Commission lacks data to identify those firms 
with certainty.\280\ At the other end of the spectrum, the minority of 
non-FINRA member firms that are large and contribute significantly to 
both exchange and off-exchange trading are unlikely to remain 
exempt.\281\ For the 65 non-FINRA member firms, the Commission believes 
that most could lose their exempt status, but cannot estimate how those 
firms would seek to comply with the amendments.\282\
---------------------------------------------------------------------------

    \280\ Non-FINRA member firms that provide liquidity on multiple 
exchanges and trade heavily off-exchange are unlikely to be small in 
terms of net capital, and are not low trading volume firms by 
definition. However, as discussed in supra Section VI.A.1, many non-
FINRA member firms are small in terms of net capital and may be 
members of a single exchange. Such firms are more likely to have 
limited exposure to off-exchange markets. Such firms would either be 
exempt from the rule by virtue of having no off-exchange trading or 
no trading on exchanges of which they are not members, or be able to 
rely on the stock-option order exemption to continue their limited 
off-exchange trading related to their exchange-based brokerage 
activities.
    \281\ The diversity of non-FINRA member firms is discussed in 
supra Section VI.A.1.
    \282\ See supra Section VI.B.1., which discusses how firms may 
change their business models in response to the rule.
---------------------------------------------------------------------------

1. Benefits
    As discussed above,\283\ some of the firms relying on the Rule 
15b9-1 exemption are significant participants in both on and off-
exchange markets.\284\ For example, in September of 2021, $789 billion 
in listed equities was traded off-exchange by non-FINRA member firms, 
and $592.3 billion in listed equities was traded on an exchange that 
the firm did not belong to.\285\ Thus, a substantial amount of off-
exchange volume is conducted outside of the regulatory jurisdiction of 
FINRA, which under the Exchange Act has primary responsibility for 
overseeing off-exchange activity. Although FINRA has the ability to 
surveil 100% of cross-market and off-exchange equity trading activity, 
it does not have enforcement jurisdiction for firms that are not FINRA 
members, unless enforcement responsibility is covered under an RSA. 
Association membership would supplement the oversight of the exchanges, 
to the extent a firm remained an exchange member, and provide 
consistent and ongoing application of rules, which could vary between 
exchanges. Regarding off-exchange trading, under the current regulatory 
structure using RSAs, FINRA applies the rules of the different 
exchanges and the exchanges' interpretations of those rules to such 
trading. This can result in different interpretations and FINRA 
registration would promote consistent interpretations and efficiencies 
in enforcement and regulation with respect to this growing part of the 
market. As discussed above,\286\ the Commission believes the inclusion 
of more non-FINRA member firms in an Association would improve such 
Association's ability to supervise cross-exchange trading activity, 
particularly in U.S. Treasury securities markets. This would enhance 
FINRA's ability and--through the information FINRA shares with the 
Commission--the Commission's ability to effectively oversee regulation 
of trading on equity, fixed income, and option markets.
---------------------------------------------------------------------------

    \283\ See supra Section I.
    \284\ See supra Section VI.A.1.
    \285\ See supra Table 1.
    \286\ See supra Section I.
---------------------------------------------------------------------------

    The Commission believes that the amendments to Rule 15b9-1 would 
improve supervision of non-FINRA member firms. FINRA, currently the 
only Association, has substantial experience and expertise from 
overseeing a large number of brokers and dealers that trade off-
exchange or across exchanges. This makes FINRA's potential regulation 
of non-FINRA member firms with off-exchange or cross-market trading 
activity particularly efficient.
    In addition, the amendments, as proposed, would enhance the 
supervision and enforcement for equities and options beyond the 
benefits from the CAT NMS Plan.\287\ While CAT improves data 
accessibility for all SROs, it does not address FINRA's lack of 
jurisdiction over non-FINRA member firms participating in the off-
exchange markets. Several commenters on the 2015 Proposal believed that 
reporting of non-FINRA member identifying information and activity 
pursuant to the CAT NMS Plan would eliminate the need for firms to join 
FINRA and would provide FINRA a near complete picture

[[Page 49963]]

of off-exchange trading activity.\288\ However, another commenter noted 
that even with non-FINRA member firm information, ``enforcement 
activities would remain the responsibility of the individual exchanges 
where broker-dealers are members'' even though FINRA would be best 
positioned to regulate off-exchange activity.\289\ The Commission 
agrees that, although FINRA now has additional information with respect 
to non-FINRA member firm activity, it still lacks jurisdiction over 
non-FINRA member firms, and the proposed amendments would provide such 
jurisdiction.\290\
---------------------------------------------------------------------------

    \287\ See CAT NMS Approval Order, supra note 272.
    \288\ See HRT Letter at 3, CTC Letter at 3-4, and FIA 2 Letter 
at 3.
    \289\ See FINRA Letter at 4.
    \290\ See supra section II.B.
---------------------------------------------------------------------------

    The benefits of the proposed amendments would be pronounced in the 
U.S. Treasury securities markets. A significant amount of volume in 
U.S. Treasury securities markets comes from broker-dealers that may be 
newly required to become FINRA members as a result of the proposed 
amendments.\291\ If these broker-dealers become FINRA members, they 
would be required to comply with FINRA rules, including TRACE reporting 
requirements. This could have a positive impact on market quality by 
increasing coverage of data reported to TRACE as well as providing 
additional market oversight. Non-FINRA member firms do not report to 
TRACE, and they are only specifically identified by MPID in TRACE when 
their U.S. Treasury securities trades occur on a covered ATS; they are 
not identified by MPID for other trades of U.S. Treasury securities 
that do not occur on covered ATSs, such as direct dealer-to-dealer 
transactions. Thus, the proposed amendments would improve the quality 
and coverage of TRACE data and increase regulatory transparency into 
the U.S. Treasury securities markets.\292\ The extent of the benefits 
of requiring non-FINRA members to report these transactions may be 
limited because the Commission believes that the majority of U.S. 
Treasury securities transactions are already reported to TRACE.\293\ 
However, the Commission is unable to estimate the extent of U.S. 
Treasury securities trading activity that is not reported to TRACE.
---------------------------------------------------------------------------

    \291\ The Commission estimates that four such firms accounted 
for $7 trillion in U.S. Treasury securities volume executed on 
covered ATSs in 2021 that was reported to TRACE, which was more than 
2% of the total U.S. Treasury securities volume traded in 2021 that 
was reported to TRACE, and that three such firms' U.S. Treasury 
securities volume executed on covered ATSs in April 2022 that was 
reported to TRACE accounted for approximately 2.5% of total U.S. 
Treasury securities volume in April 2022 that was reported to TRACE. 
See supra Section II.B.
    \292\ One commenter stated that all off-exchange trades are 
already being reported ``because all off-exchange trading needs to 
go through a FINRA member with its own reporting obligations.'' See 
FIA 1 Letter at 3. See also supra note 70.
    \293\ See id.
---------------------------------------------------------------------------

    The Commission believes that the proposed amendments could have 
similar or additional benefits for other TRACE reported securities, 
should current non-FINRA member firms also trade in such securities. 
However, the Commission lacks the information necessary to discern the 
degree of any such benefits because, as noted above, the Commission 
does not have any data or other information available, unlike with U.S. 
Treasury securities, to determine how many non-FINRA member firms, if 
any, actively trade in these securities or to predict how many 
additional trades would be reported under the proposal.\294\ In 
addition to the potential market oversight benefits that would be 
similar to U.S. Treasury securities, the potential transparency 
improvements of TRACE reporting for other TRACE reportable securities 
go further than transparency improvement in U.S. Treasury securities, 
because the TRACE data for other TRACE reported securities is available 
to the public in real time through data vendors.\295\ The additional 
transparency from more public TRACE reporting could result in improved 
price discovery, which would lead to lower transaction costs.\296\
---------------------------------------------------------------------------

    \294\ The information used to get a sense of the magnitude of 
unreported transactions in U.S. Treasury securities is not available 
for other fixed income securities. See supra Section VI.A.1.
    \295\ See supra note 218, for information on the difference 
between the dissemination of TRACE for U.S. Treasury securities and 
TRACE for other TRACE eligible securities.
    \296\ See Hendrik Bessembinder, Chester Spatt & Kumar 
Venkataraman, A Survey of the Microstructure of Fixed-Income 
Markets, 55 J. Fin. & Quantitative Anal. 1 (2020). See also infra 
Section VI.C.2.f. for a related discussion of potential costs which 
could apply to other FINRA reportable securities.
---------------------------------------------------------------------------

    While current members of an Association would not be directly 
affected by this rule, they would benefit by having a more level 
playing field in reporting trades in the U.S. Treasury securities 
markets. With more uniform regulatory requirements, firms may compete 
more equitably to supply liquidity both on exchanges and in the off-
exchange market.
    Although fewer firms will be able to rely on the proposed narrower 
exemptions, the proposed narrower exemptions would continue to provide 
benefits for non-FINRA members as well as other market participants. 
These exemptions would continue to provide cost savings for non-FINRA 
members as they would continue to not be required to join FINRA and 
thus avoid the costs of doing so. Additionally, the routing exemption 
would facilitate regulatory compliance designed to improve market 
quality.\297\ The Commission also believes that the stock-option order 
exemption would facilitate liquidity in both stock and options markets, 
which could improve market quality.\298\
---------------------------------------------------------------------------

    \297\ See supra Section III.B.1 for more information on the 
purpose of the routing exemption.
    \298\ See supra Section III.B.2 for more information on the 
stock-options order exemption.
---------------------------------------------------------------------------

2. Costs
    The amendments, by narrowing the existing exemption, would result 
in brokers and dealers that no longer qualify for the exemption having 
to comply with Section 15(b)(8) by either limiting their trading to 
exchanges of which they are members, joining an Association or abiding 
by one of the stated exemptions. Under the amendments, therefore, non-
FINRA member firms that choose to continue any off-member-exchange 
activity will be faced with choices that would involve corresponding 
costs. For example, non-FINRA member firms may incur costs related to 
membership in an Association or costs necessitated by additional 
exchange memberships. Additionally, some non-FINRA member firms may 
incur the costs of losing the benefits of trading in the off-member-
exchange market if they decide not to join an Association. There could 
also be indirect costs associated with the proposed amendments, 
depending on if a non-FINRA member chooses to join an Association or 
not.
    Most of the direct costs incurred in joining an Association and 
maintaining membership therein are dependent on firm characteristics 
and activity level. Furthermore, the Commission believes that some non-
FINRA member firms may comply by ceasing their off-member-exchange 
trading activity, avoiding many of these costs but forgoing the 
opportunity to trade profitably in some venues. If all 12 of the non-
FINRA member firms that have significant off-member-exchange trading 
activities in equities were to join FINRA, the median aggregate cost of 
the amendment for these firms would be about $95,000 in implementation 
costs and median ongoing aggregate annual costs of about $2.7 
million.\299\ The

[[Page 49964]]

aggregate costs for the subset of 12 represent the majority of the 
aggregate costs. The Commission believes that smaller non-FINRA member 
firms as well as new entrants would experience much lower costs. In 
particular, the initial costs for such firms would be close to the 
lower range discussed below, because these cost are largely dependent 
on the size and complexity of the firms. Additionally, because smaller 
firms and new entrants would have lower trading activity, the ongoing 
costs would also be significantly lower as ongoing costs are highly 
impacted by the trading activity.
---------------------------------------------------------------------------

    \299\ See Table 3 and Table 4, infra, for a breakdown of these 
costs. The 2015 Proposing Release, supra note 6, estimated these 
costs to be much higher as the estimates included costs for 
reporting transactions for NMS stocks. These transactions are now 
reported to CAT and are therefore not included in our estimates 
here.
---------------------------------------------------------------------------

a. Costs of Joining an Association \300\
---------------------------------------------------------------------------

    \300\ The Commission recognizes that non-FINRA member firms 
would incur compliance costs on an initial and ongoing basis to 
comply with the proposed amendments. These costs include costs for 
training and hiring new employees, as well as additional costs for 
exams and licensing required by FINRA. The Commission does not 
aggregate these costs across all non-FINRA member firms because the 
Commission does not have necessary information about the majority of 
the non-FINRA member firms and expects that costs would vary widely 
across firms. Where possible, however, the Commission has provided 
estimates based on a subset of large firms on which the Commission 
has sufficient information. The Commission expects that smaller 
firms likely will face lower costs.
---------------------------------------------------------------------------

    Based on discussions with FINRA,\301\ and industry participants, 
the direct compliance costs on non-FINRA member firms of joining FINRA 
are composed of FINRA membership application fees and any legal or 
consulting costs necessary for effectively completing the application 
to become a member of FINRA (e.g., ensuring compliance with FINRA rules 
including drafting policies and procedures as may be required).
---------------------------------------------------------------------------

    \301\ See FINRA Letter at 5-7.
---------------------------------------------------------------------------

    The fees associated with a FINRA membership application can vary. 
As an initial matter, the application fee to join FINRA is tier-based 
according to the number of registered persons associated with the 
applicant. This one-time application fee ranges from $7,500 to 
$55,000.\302\ The initial membership fee for FINRA is $7,500 for firms 
with ten or fewer representatives registered with FINRA, $12,500 for 
firms with 11 to 100 representatives registered with FINRA, and $20,000 
for firms with 101 to 150 representatives registered with FINRA.\303\ 
Based on its knowledge of the size and business models of non-FINRA 
member firms, the Commission believes that the median application fee 
for the 12 largest firms would be $12,500 and that most non-FINRA 
member firms would not incur FINRA application fees exceeding 
$20,000.\304\
---------------------------------------------------------------------------

    \302\ See FINRA By-Laws, Schedule A, Section 4.
    \303\ Id.
    \304\ Based on 2022 FOCUS data, no non-FINRA member firm has 
more than 150 registered representatives.
---------------------------------------------------------------------------

    In addition to the application fees and data reporting costs, the 
Commission has taken into account the cost of legal and other advising 
necessary for effectively completing the application to be a member of 
FINRA. Some firms may choose to perform this legal work internally 
while others may use outside counsel for the initial membership 
application. In making this choice, non-FINRA member firms would likely 
take into account factors, such as the size and resources of the firm, 
the complexity of the firm's business model, and whether the firm 
previously used outside counsel to register with any exchanges. Based 
on conversations with industry participants that assist with FINRA 
membership, for non-FINRA member firms that choose to employ outside 
counsel to assist with their FINRA membership application, the cost of 
such counsel ranges from approximately $40,000 to $125,000, with a 
midpoint of $82,500. Factors affecting the specific costs of a 
particular firm include the number of associated persons, the level of 
complexity or uniqueness of the firm's business plan, and whether the 
firm has previously completed exchange membership applications with 
similar requirements.

              Table 3--Median Firm Implementation Costs \1\
------------------------------------------------------------------------
                            Cost                                Median
------------------------------------------------------------------------
Application to join:
    FINRA..................................................      $12,500
    Legal consulting.......................................       82,500
                                                            ------------
        Total..............................................       95,000
------------------------------------------------------------------------
\1\ Medians are used where possible. Cost estimates are for the 12
  largest firms. Cost estimates are reported as ranges for legal
  consulting and compliance work; for these estimates, the midpoint is
  used.

b. Costs of Maintaining an Association Membership
    With respect to ongoing costs, three components of such costs are 
any ongoing fees associated with FINRA membership, costs of legal work 
relating to FINRA membership, and costs associated with additional 
compliance activities. The ongoing membership-related fees associated 
with FINRA membership include the annual GIA; and the TAF and Section 3 
fees, among others.\305\
---------------------------------------------------------------------------

    \305\ There are additional fees associated with maintaining a 
FINRA membership. There are also additional continuing education and 
testing requirements, which will impose costs upon firms joining 
FINRA. Additionally, there are de minimis fees (branch registration 
fee and system processing fee, among others). See FINRA By-Laws, 
Schedule A. The Commission also believes that non-FINRA member firms 
would not need to register additional associated persons because the 
exchange SRO rules are already comprehensive in this regard. See 
infra Section VI.C.2.d.
---------------------------------------------------------------------------

    With certain assumptions, the Commission attempted to estimate 
direct compliance costs that a non-FINRA member firm is likely to face 
to comply with the amendments. The estimate applies to the 12 non-FINRA 
member firms that have significant off-member-exchange trading 
activities; smaller firms should face lower costs compared to these 12 
firms because they have less revenue and trading volume that would be 
subject to GIA, TAF and Section 3 fees. Though non-FINRA member firms 
may already indirectly bear some of these costs as they may be passed 
through by FINRA member counterparties. Ongoing annual cost estimates 
(one time and annual) are broken down in Table 2.
    The annual GIA generally requires members to pay a percentage of 
the member firm's total annual revenue based on a graduated scale.\306\ 
The magnitude of the annual GIA is based on the total annual revenue, 
excluding commodities income, reported by the member firm on its FOCUS 
Form Part II or IIA.\307\ Based on FOCUS Form data from 12 non-FINRA 
member firms in 2022, the Commission has determined that the average 
annual total revenue of non-FINRA member firms, excluding commodities 
income, is approximately $1.3 billion, with a median of $906 
million.\308\ For the 12 large firms, FINRA's graduated GIA scale 
results in a median GIA of $459,849.51.\309\
---------------------------------------------------------------------------

    \306\ See FINRA By-Laws, Schedule A. For example, FINRA imposes 
a GIA as follows: (1) $1,200 on a member firm's annual gross revenue 
up to $1 million; (2) a charge of 0.1215% on a member firm's annual 
gross revenue between $1 million and $25 million; (3) a charge of 
0.2599% on a member firm's annual gross revenue between $25 million 
and $50 million; and so on as provided in Schedule A. When a firm's 
annual gross revenue exceeds $25 million, the maximum of current 
year's revenue and average of the last three years' revenue is used 
as the basis for the income assessment.
    \307\ See FINRA By-Laws, Schedule A, Section 2. See also FOCUS 
Report Form X-17A-5, Part II and IIA.
    \308\ Based on 2022 FOCUS data.
    \309\ ($1,200 for the first $1 million of revenue) + (0.1346% x 
annual revenue greater than $1 million up to $25 million) + (0.2880% 
x annual revenue greater than $25 million up to $50 million) + 
(0.0574% of annual revenue greater than $50 million up top $100 
million) + (0.0404% of annual revenue greater than $100 million to 
$5 billion) + (0.0440% of annual revenue greater than $5 billion up 
to $25 billion) + (0.0948% of annual revenue greater than $25 
billion). Although the average annual total revenue exceeds the 
median annual total revenue, there are a number of firms that have 
low GIA, which causes the midpoint of GIA to exceed the average GIA. 
Non-FINRA member firms vary in size. GIA for the 12 largest firms 
used in these calculations, is anticipated to be far larger than for 
the 65 remaining non-FINRA member firms. See FINRA By-Laws, Schedule 
A, Section 1(c).

---------------------------------------------------------------------------

[[Page 49965]]

    The magnitude of the TAF depends on the transaction volume of a 
FINRA member that is covered by the TAF as described in the FINRA By-
Laws.\310\ To the extent FINRA changes the structure of the TAF to take 
into account the business models of non-FINRA member firms that may 
join FINRA as a result of the proposed amendments, these costs may 
change.\311\ The Commission has identified 12 non-FINRA member firms 
that have significant off-member-exchange trading activity in September 
of 2021. The Commission estimates that trading activity fees for off-
member-exchange equity trading incurred by these 12 large non-FINRA 
member firms due to their off-member-exchange activity would have an 
average incurred TAF of around $273,677.87 with a median TAF of 
$132,744.50.\312\ However, this cost is likely to be underestimated, as 
the estimate only accounts for off-exchange equity activity, and the 
magnitude of the underestimate may be significant.\313\ The Commission 
believes that the TAF for non-FINRA member firms not among the 12 
identified would be far lower because the median non-FINRA member firm 
has far lower trading volume than the typical firm of the 12 identified 
in the data.
---------------------------------------------------------------------------

    \310\ See FINRA By-Laws, Schedule A, Section 1(b).
    \311\ FINRA proposed amendments to the TAF in May of 2015. See 
supra note 241.
    \312\ Estimated TAF includes only the off-exchange equity 
portion of the TAF and does not include any TAF related to a firm's 
exchange-based trading activity. If a firm's activity on an exchange 
is related to normal market making operations, the activity does not 
incur the TAF. The Commission is unable to estimate the proportion 
of these firms' exchange trading that would incur the TAF because 
the Commission does not have information on what proportion of non-
FINRA member firm exchange activity would qualify for exemption from 
the TAF under FINRA By-Laws. Because other elements of the TAF are 
not included in this calculation, it underestimates the actual TAF 
that firms would incur if they joined FINRA. The magnitude of the 
underestimation may be significant, but firms that join FINRA may be 
able to reduce their TAF cost by registering as market makers upon 
additional exchanges. (The TAF is not assessed for certain trades 
related to registered market-making.) See FINRA By Laws, Schedule A, 
Section (1)(b)(2)(F). Estimates of the TAF are based on the off-
exchange sell volume reported to CAT for each of the 12 large non-
FINRA member firms. The estimated TAF is equal to estimated off-
exchange sell volume x $0.00013. The $0 minimum is associated with a 
firm that has almost no off-exchange volume.
    \313\ FINRA members are required to pay the TAF for on and off-
exchange trading activity across multiple asset classes. However, 
there are exemptions for certain trading activity and the Commission 
is unable to identify all trades that are subject to such 
exemptions. See https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees for an 
explanation of the TAF and the relevant exceptions.
---------------------------------------------------------------------------

    Some off-exchange trading that non-FINRA member firms engage in 
currently may no longer be profitable when TAF is incurred. 
Consequently, non-FINRA member firms may reduce their trading both on 
exchanges and off-exchange after joining an Association.\314\
---------------------------------------------------------------------------

    \314\ See supra section VI.B.1 for more information on how firms 
may change their trading practices in response to the rule.
---------------------------------------------------------------------------

    In May of 2015, FINRA issued a Regulatory Notice proposing to amend 
the TAF such that it would not apply to transactions by a proprietary 
trading firm effected on exchanges of which the firm is a member, to 
coincide with originally proposed changes to 15b9-1.\315\ To the extent 
FINRA contemplates proposing similar changes to the TAF, if approved, 
this could lower the cost for non-FINRA member firms.\316\ FINRA's 
previously proposed TAF amendments would exempt proprietary trading 
firms when they trade securities on exchanges of which they are a 
member, which several commenters supported.\317\
---------------------------------------------------------------------------

    \315\ See supra note 153.
    \316\ In the 2015 Proposing Release, supra note 6, the 
Commission solicited comment on the effect of the proposed TAF 
amendments, including the effect should the TAF be assessed to non-
FINRA member firms that choose to become FINRA members. With regard 
to the TAF, one Commenter stated that ``it is impossible. . . to 
estimate the impact of this potentially significant cost.'' See CTC 
Letter at 5. Another commenter shared similar thoughts. See FIA 1 
Letter at 2. However, of the commenters that discussed this issue, 
most were in support of the TAF amendments. See FIA 2 Letter at 2, 
CTC Letter at 5, IEX Letter at 3, and HRT Letter at 11. For example, 
one commenter believes that ``[c]hanges to TAF fees alone could 
potentially reduce the total costs of the Proposal to some firms by 
90% or more.'' See FIA 2 Letter at 2.
    \317\ See IEX Letter at 3, PEAK6 Letter at 3, and HRT Letter at 
5.
---------------------------------------------------------------------------

    In addition to the TAF, non-FINRA member firms that choose to join 
FINRA may incur additional Section 3 fees. Using data on off-exchange 
trading during September 2021, the Commission estimated that Section 3 
fees incurred by the 12 large non-FINRA member firms due to their off-
exchange trading would have an average incurred Section 3 fee of 
$4,541,719.31 annually, with a median incurred Section 3 fee of 
$2,150,069.99.\318\ Some of these fees may already be paid by non-FINRA 
member firms that engage the services of a member firm clearing broker. 
However, FINRA lacks the authority to assess Section 3 fees against 
non-FINRA member firms, in which case FINRA may assess the fee to the 
member firm counterparty to the transaction. In these cases, the FINRA-
member may pass-through a portion of the fee to the non-FINRA member 
counterparty. While these fees would represent a cost to non-FINRA 
member firms, the cost would be largely offset to the industry as a 
whole by a reduction of Section 3 fees incurred by member firms (or 
clearing brokers acting on behalf of a member firm) when they buy from 
a self-clearing, non-FINRA member firm.\319\
---------------------------------------------------------------------------

    \318\ Section 3 fees are estimated using non-FINRA member firm 
off-exchange sell dollar volume calculated in CAT. The Section 3 fee 
obligation is calculated as: Non-FINRA member firm Sell Dollar 
Volume x $22.90/$1,000,000. The $22.90/$1,000,000 is the FINRA fee 
rate for Fiscal Year 2022. See FINRA By-Laws of the Corporation, 
Schedule A to the By-Laws of the Corporation, Section 3--Regulatory 
Transaction Fee. See also Exchange Act Release No. 94644 (April 8, 
2022), 87 FR 21931 (April 13, 2022) and press release, Commission, 
Fee Rate Advisory #1 for Fiscal Year 2022 (April 8, 2022), available 
at https://www.sec.gov/news/press-release/2022-60.
    \319\ Currently, when the sell side of an off-exchange 
transaction is a non-FINRA member firm, FINRA may assess the Section 
3 fees on the buy side counterparty. See the discussion of Section 3 
fees in Section VI.A.2, supra, for more information.
---------------------------------------------------------------------------

    Ongoing compliance costs would depend on the business circumstances 
of each firm and the types of issues that could arise. As in the case 
of the initial membership, some non-FINRA member firms may choose to 
conduct ongoing compliance activities in-house while others may seek to 
outsource this work.\320\ Based on discussions with industry 
participants, the Commission estimated that the ongoing compliance cost 
for firms that outsource this work would range from $24,000 to $96,000 
per year, with a median of $60,000.\321\ In the case of some non-FINRA 
member firms, i.e., those that are affiliates of FINRA members, this 
cost is likely to be lower as they may be able to leverage compliance 
work already being performed.
---------------------------------------------------------------------------

    \320\ Ongoing compliance activities may include core accounting 
functions, updating policies and procedures, and updating forms 
filed with regulators.
    \321\ For firms that choose to do this work in-house, the 
Commission estimates that the costs of ongoing compliance may be 
less than $96,000. This figure assumes non-FINRA member firms may 
have experience in ongoing compliance work with SROs through their 
exchange membership(s) and, therefore, only captures the incremental 
cost of compliance with Association rules.
---------------------------------------------------------------------------

    FINRA members may also be required to pay the median Personnel 
Assessment.\322\ The annual Personnel Assessment fee ranges from $130 
to $150 per employee and applies to principals or representatives in 
the FINRA member's organization. Using FOCUS data the Commission 
estimates that the average non-FINRA member firm would incur a 
Personnel Assessment fee of no more than $1,960, and the median non-
FINRA member

[[Page 49966]]

firm would incur a Personnel Assessment fee of $0.\323\ The Commission 
further estimates that the maximum Personnel Assessment fee incurred by 
one of these non-FINRA member firms would be $18,330.
---------------------------------------------------------------------------

    \322\ See FINRA By-Laws, Schedule A, Section 1(e).
    \323\ Based on 2022 FOCUS data, the number of registered 
representatives of non-FINRA member firms that connect directly to 
ATSs ranges from 0-163, with an average of 29 and a median of 0.
---------------------------------------------------------------------------

    The Commission estimates that the median ongoing cost for non-FINRA 
member firms would be $2,742,664. However, as discussed above, these 
costs could vary. The Section 3 fees which make up a large portion of 
these costs are likely to be overestimated for reasons stated above. 
Additionally, the TAF is likely to be underestimated.

              Table 4--Median Firm Ongoing Annual Costs \1\
------------------------------------------------------------------------
                                                             Median or
                          Cost                                average
------------------------------------------------------------------------
Gross Income:
    Assessment..........................................     $459,849.51
    Trading Activity Fee................................      132,744.50
    Personnel Assessment................................               0
    Section 3 fee.......................................    2,150,069.99
    Compliance work.....................................          60,000
                                                         ---------------
        Total...........................................      $2,742,664
------------------------------------------------------------------------
\1\ See infra note 312 and accompanying text. The TAF cost also
  represents a transfer from current non-FINRA member firms to current
  member firms. The TAF is calculated using off-exchange sell volume
  from CAT. The Section 3 fee estimate assumes that the firms currently
  pay no Section 3 fees. It is likely that firms that clear through a
  member firm are currently assessed these fees indirectly. Median
  Personnel Assessment Fees are estimated to be zero based on analysis
  using FOCUS data. See supra note 323.

    In addition to the cost estimates discussed above, the Commission 
recognizes that both non-FINRA member firms and SROs would incur other 
direct and indirect costs because of the increased regulatory 
requirements of the amendments. Specifically, there would be compliance 
costs associated with regulation by FINRA.\324\ Additional costs would 
include actions that are required to accommodate normal supervision and 
examination by an Association. To the extent that they do not already 
do so, firms would face additional costs related to coming into 
compliance with Association rules. The Commission was not able to 
estimate these costs, although the costs would vary among non-FINRA 
member firms.
---------------------------------------------------------------------------

    \324\ However, non-FINRA member firms that choose to join an 
Association may have FINRA assigned as their DEA. Such an assignment 
could eliminate separate DEA fees that the non-FINRA member firms 
may pay to their current DEA.
---------------------------------------------------------------------------

    Two commenters on the 2015 Proposal submitted estimates for the 
cost of becoming FINRA members.\325\ In addition, many commenters 
stated that FINRA fees would be substantial and constitute a 
considerable sum,\326\ believing that FINRA fees would be unduly 
burdensome and outweigh perceived benefits.\327\ Several commenters 
believed in particular that FINRA membership would be costly to 
proprietary trading firms with no customer business.\328\ One commenter 
noted generally that FINRA should review its fees to ensure that those 
fees are proportionate to the actual costs of regulation.\329\ By 
contrast, one commenter noted that additional regulatory costs 
associated with FINRA membership would be ``manageable'' compared to 
the cost of the TAF.\330\ As stated above, to the extent FINRA amends 
the TAF consistent with what was previously proposed, the ongoing costs 
could be lower than these estimates.
---------------------------------------------------------------------------

    \325\ See CTC Letter at 5 (Estimating initial costs of $3.5 
million and ongoing annual costs of $1.5 million per year), and FIA 
2 Letter at 5 (Estimating initial costs of between $200,000 and 
$250,000 and ongoing costs of $100,000 per year).
    \326\ See FIA 1 Letter at 1 (``FINRA Membership would be costly 
to most proprietary trading firms''); PEAK6 Letter at 2 (``FINRA 
registration process is overly costly and burdensome''); Hold 
Brothers Capital Letter at 2 (``[Costs of FINRA membership] would be 
unduly burdensome to smaller, less well funded Proprietary 
Traders''); Lakeshore Letter at 2, CTC Letter at 6, D&D Letter at 2, 
and PTR Letter at 2.
    \327\ See Peak6 Letter at 2, D&D and PTR Letters at 2, Hold 
Brothers Capital Letter at 2, Lakeshore Letter at 3, and FIA 1 
Letter at 2.
    \328\ See FIA 1 Letter at 1, FIA 2 Letter at 2, and Hold 
Brothers Capital Letter at 2.
    \329\ See SIFMA Letter at 3.
    \330\ See HRT Letter at 5.
---------------------------------------------------------------------------

    One commenter was concerned that FINRA's membership fees would only 
rise with no competitive forces to restrain the increase of such 
fees.\331\ Furthermore, another commenter stated that FINRA membership 
fees are substantially higher than fees charged by some of the 
exchanges for DEA services.\332\ Several commenters also raised the 
concern that FINRA may get paid twice for its regulatory oversight--
once, directly from the FINRA membership, and again, from the SROs that 
have outsourced regulatory oversight to FINRA through RSA 
agreements.\333\ However, FINRA fees must be filed with the Commission 
and such fees must be consistent with the Exchange Act.\334\
---------------------------------------------------------------------------

    \331\ See CTC Letter at 6.
    \332\ See HRT Letter at 5.
    \333\ See CTC Letter at 6, SIFMA Letter at 3, D&D Letter at 2, 
and Lakeshore Letter at 3.
    \334\ See supra note 154.
---------------------------------------------------------------------------

c. Costs of TRACE Reporting for Non-FINRA Member Firms That Trade U.S. 
Treasury Securities
    Additionally, to the extent that a firm trades fixed income 
securities, they would also have implementation and ongoing costs 
associated with TRACE reporting. The Commission believes that four non-
FINRA member firms have significant trading activities in U.S. Treasury 
securities markets. The Commission estimates that these firms will each 
have an initial cost of $2,025, associated with setting up systems for 
TRACE reporting. This cost includes the Direct Circuit Connectivity Fee 
for TRACE reporting through Nasdaq, in which Nasdaq facilitates the 
reporting to TRACE. FINRA does not charge a Transaction Reporting Fee 
for trading activity in U.S. Treasury securities markets.\335\ The 
Commission estimates an aggregate ongoing cost for each firm of 
$125,100. There are three ways for firms to connect into TRACE. First, 
firms may directly report with the FIX protocol through Nasdaq, who is 
the vendor. Second, firms may use a third party service bureau with FIX 
protocols to submit to TRACE. The costs of reporting via FIX protocols 
are outlined in Tables 3 and 4. The Commission does not have estimates 
for the cost of third party reporting to TRACE. Finally, firms with 
lower reporting requirements have the option of reporting using the 
Secure Web Interface known as FINRA TRAQS for a fee of $20 per month, 
which would allow these firms to avoid port fees and connection fees to 
Nasdaq's FIX reporting system. Additionally, costs for these firms 
could be significantly lower for firms with low volume, as the 
reporting cost is based on the volume. To the extent that non-FINRA 
member firms trade in other TRACE reportable securities, such firms 
would also have higher reporting costs. If those firms trade U.S. 
Treasury securities, their implementation costs would be included in 
the Commission's estimates above and they would incur only the 
additional marginal costs caused by their volume in other TRACE-
reportable securities. However, to the extent that some non-FINRA 
member firms trade in other TRACE reportable securities but not U.S. 
Treasury securities, those firms would each incur implementation costs 
as described above. The Commission

[[Page 49967]]

cannot estimate how many firms would be in this group of non-FINRA 
member firms that trade TRACE-reportable securities but not U.S. 
Treasury securities because the Commission can identify non-FINRA 
member counterparties in TRACE only for U.S. Treasury securities 
transactions that occur on covered ATSs, as discussed previously.\336\
---------------------------------------------------------------------------

    \335\ TRACE charges a Transaction Reporting Fee for TRACE 
reported securities other than U.S. Treasury securities. The fee is 
as follows: $0.475/trade for trade size up to and including $200,000 
par value; $0.000002375 times the par value of the transaction 
(i.e., $0.002375/$1000) for trade size over $200,000 and up to and 
including $999,999.99 par value; $2.375/trade for trade size of 
$1,000,000 par value or more.
    \336\ See supra Section VI.A.1.

        Table--Average Firm TRACE Reporting Implementation Costs
------------------------------------------------------------------------
                                                             Median or
                          Cost                              average \1\
------------------------------------------------------------------------
FIX Port fee............................................            $575
Direct Circuit Connectivity Fee for TRACE reporting                1,500
 through Nasdaq.........................................
                                                         ---------------
    Total...............................................           2,025
------------------------------------------------------------------------
\1\ Medians are used where possible. Direct Circuit Connection Fees can
  be found at https://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2.


       Table 6--Average Firm TRACE Reporting Ongoing Annual Costs
------------------------------------------------------------------------
                                                             Median or
                          Cost                              average \1\
------------------------------------------------------------------------
Systems Fees............................................          $4,800
Data Fee................................................          90,000
Nasdaq Connection Fee...................................          30,000
Rule 7730 Service Fee...................................             300
                                                         ---------------
Total...................................................         125,100
------------------------------------------------------------------------
\1\ The systems fee is calculated using Level II Full Service Web
  Browser Access fee for four datasets at $140 a month plus a
  subscription for four additional user IDs at $260 per month for a
  total of $400 per month multiplied by 12 months, for an annual systems
  fee of $4,800. Data Fees are calculated using $7,500 per month flat
  fee for the professional real time data display. Connectivity fee is
  calculated at $2,500 a month for an annual cost of $30,000. Fees can
  be found at https://www.finra.org/rules-guidance/rulebooks/finra-rules/7730 7730. Nasdaq FIX connection fees can be found at https://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2.

d. Costs of Joining Additional Exchanges Under the Rule as Amended
    Non-FINRA member firms must be members of all exchanges upon which 
they transact business if they decide not to join an Association. With 
limited exceptions for some excluded activity, some non-FINRA member 
firms may choose to join additional exchanges to be excluded from the 
requirement to become a member of an Association. Alternatively, these 
firms may cease trading on exchanges of which they are not members.
    Based on discussions with FINRA and industry participants, the 
Commission understands that completing a membership application with an 
additional exchange is generally less complicated and time consuming 
than completing a membership application with FINRA. Consequently, the 
Commission believes that the compliance burden on non-FINRA member 
firms for joining an additional exchange is likely to be significantly 
less than that of joining FINRA as those non-FINRA member firms that 
choose to join an additional exchange are likely able to perform this 
work internally, given that they are already members of at least one 
exchange, and that such work should take less time than the time 
required to complete an application with FINRA. However, the aggregate 
cost of joining multiple exchanges would likely be more costly than the 
cost of joining FINRA.
    In addition to the legal burden, non-FINRA member firms joining 
additional exchanges as a result of the proposed amendments would incur 
membership and related fees. To the extent that non-FINRA member firms 
choose to become members of additional exchanges, the fees associated 
with such memberships would vary depending on the type of access sought 
and the exchanges of which non-FINRA member firms choose to become 
members.
    The Commission also believes that the exchange membership fees that 
would apply to non-FINRA member firms joining such exchanges would be 
those fees that apply to either introducing brokers or dealers or 
proprietary trading firms. This assumption is consistent with the fact 
that any brokers or dealers carrying customer accounts could not 
qualify for the current exemption of Rule 15b9-1. Thus, any exchange 
membership fees that apply to firms that provide clearing services or 
conduct a public business would not apply to non-FINRA member firms.
    Furthermore, because all non-FINRA member firms are members of at 
least one exchange,\337\ they would have already completed a Form U4, 
to register associated persons.\338\ The Commission believes non-FINRA 
member firms would not need to register additional associated persons 
because the exchange SRO rules already require them to register 
associated persons. The Commission understands that all exchanges can 
access the Form U4 filings within the CRD which is maintained by FINRA.
---------------------------------------------------------------------------

    \337\ For a broker or dealer to possibly be exempt from the 
requirement to be an Association member currently or under the 
amendments, the broker or dealer must be a member of at least one 
exchange.
    \338\ Form U4 is the Uniform Application for Securities Industry 
Registration or Transfer. Representatives of brokers and dealers, 
investment advisers, or issuers of securities use Form U4 to become 
registered in the appropriate jurisdictions and/or with SROs. All 
SROs currently use Form U4. See, e.g., Cboe BYX Rule 2.5 
Interpretations and Policies .01(c), and Nasdaq PHLX Rule General 3, 
Section 7.
---------------------------------------------------------------------------

    To obtain estimates of the cost of joining additional exchanges, 
the Commission reviewed the membership-related fee structures of all 
twenty-four national securities exchanges. In assuming that the 
potential burden of joining additional exchanges would likely be less 
than that of joining FINRA, the Commission assumes that the costs 
imposed on non-FINRA member firms by the amendments would be membership 
fees, and not costs relating to trading, such as trading permit fees 
and connectivity fees. The Commission recognizes that membership alone 
in an exchange may not guarantee the ability to trade because many 
exchanges charge fees for trading rights, ports, various degrees of 
connectivity, and floor access and equipment, should those be desired. 
The fees associated with trading on an exchange are not the result of 
the amendments because, under the amendments, a non-FINRA member firm 
could continue to trade through another broker or dealer on an exchange 
as long as that non-FINRA member firm is a member of every exchange on 
which it trades or is a member of FINRA. In other words, the amendments 
themselves do not impose the cost of connectivity and related fees, but 
only the costs associated with membership on exchanges on which non-
FINRA member firms could trade. To the extent, therefore, that non-
FINRA member firms continue to trade through other brokers or dealers 
in a manner consistent with how they currently operate, the amendments 
impose only the costs associated with membership.
    To arrive at estimates of the cost of joining additional exchanges, 
the Commission aggregated any fees associated with a firm's initial 
application to an exchange (``initial fee'') and separately aggregated 
the fees associated with any monthly or annual membership costs to 
obtain a separate annual cost (``annual fee''). Based on these 
aggregations, the Commission obtained a range for both the initial fee 
and the annual fee across exchanges. The initial fee is as low as $0 
for some exchanges. Most exchanges have an

[[Page 49968]]

initial fee that is greater than $0 and no more than $5,000.\339\
---------------------------------------------------------------------------

    \339\ IEX does not assess any initial fees. See IEX Exchange Fee 
Schedule, available at https://exchange.iex.io/resources/trading/fee-schedule/(last visited July 22, 2022) (omitting any mention of 
an initial membership fee). Other exchanges do have initial 
application fees. See, e.g., Nasdaq ISE Fee Schedule, Options 7, 
Section 9, available at https://listingcenter.nasdaq.com/rulebook/ise/rules/ise-options-7 (last visited July 22, 2022) (assessing a 
one-time application fee of $3,500 for an ``Electronic Access 
Member''); Membership Application for New York Stock Exchange LLC 
and NYSE American LLC at 2 (Oct. 2019), available at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_and_American_Membership_Application.pdf (last visited July 22, 
2022) (discussing the Non-Public Firm Application Fee of $2,500); 
Nasdaq Price List, available at https://www.nasdaqtrader.com/Trader.aspx?id=PriceListTrading2 (last visited July 22, 2022) 
(discussing the Nasdaq Application Fee of $2,000); Cboe Fee Schedule 
at 10 (June 30, 2022), available at https://cdn.cboe.com/resources/membership/Cboe_FeeSchedule.pdf (last visited July 22, 2022) 
(typically assessing a trading permit holder organization 
application fee on all of its members of $5,000). If a firm is 
organized as a sole proprietorship, the application fee for Cboe is 
only $3,000. Id.
---------------------------------------------------------------------------

    Regarding monthly or annual membership fees, most exchanges' 
ongoing monthly or annual membership fees generally range from $1,500 
to $7,200.\340\ Again, these ongoing exchange membership costs are 
generally lower than the annual costs estimated for being a member of 
FINRA.
---------------------------------------------------------------------------

    \340\ See, e.g., Cboe BYX Exchange, Inc. Fee Schedule (eff. May 
2, 2022), available at https://www.cboe.com/us/equities/membership/fee_schedule/byx/ (last visited July 22, 2022) (noting an annual 
membership fee of $2,500); Cboe EDGA Exchange, Inc. Fee Schedule 
(eff. Apr. 1, 2022), https://www.cboe.com/us/equities/membership/fee_schedule/edga/ (last visited July 22, 2022) (same); NYSE 
Chicago, Inc. Fee Schedule (updated Jan. 2, 2022), available at 
https://www.nyse.com/publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf 
(last visited July 22, 2022) (assessing an annual membership fee of 
$7,200); MIAX Fee Schedule at 20 (Mar. 1, 2022), available at 
https://www.miaxoptions.com/sites/default/files/fee_schedule-files/MIAX_Options_Fee_Schedule_03012022.pdf (last visited July 22, 2022) 
(assessing a monthly trading permit fee for an ``Electronic Exchange 
Member'' of $1,500).
---------------------------------------------------------------------------

e. Policies and Procedures Related to the Narrowed Criteria for 
Exemption From Association Membership
    Non-FINRA member firms that choose not to join an Association but 
wish to continue to trade off-exchange (or on exchanges of which they 
are not members) must do so in a manner that conforms to the routing or 
stock-option order exemptions. To rely on the stock-option order 
exemption, the proposal would require non-FINRA member firms to 
establish, maintain, and enforce policies and procedures as discussed 
above.\341\ The Commission estimates that firms would incur a burden of 
8 hours in initially preparing these policies and procedures.\342\ 
Furthermore, the burden of maintaining and enforcing such policies and 
procedures, including a review of such policies at least annually, 
would be approximately 48 hours.\343\ The Commission estimated an 
initial implementation cost of approximately $2,561 and an annual 
ongoing cost of approximately $15,708 for non-FINRA member firms that 
wish to utilize the exemptions and perform this work internally; for 
firms that outsource this work, costs are likely to be higher.\344\ 
Firms that choose to join FINRA would not incur these costs as the 
exemptions would not be relevant.
---------------------------------------------------------------------------

    \341\ See supra section III.B.2.
    \342\ This figure is based on the following: (Compliance Manager 
at 5 hours) + (Compliance Attorney at 2.5 hours) + (Director of 
Compliance at 0.5 hours) = 8 burden hours per dealer. See infra note 
357. As is discussed in more detail in the Paperwork Reduction Act 
discussion, the Commission based this estimate on the estimated 
burdens imposed by other rules applicable to brokers and dealers, 
such as Regulation SBSR. See also infra note 359.
    \343\ This figure is based on the following: (Compliance Manager 
at 30 hours) + (Compliance Attorney at 12 hours) + (Director of 
Compliance at 6 hours) = 48 burden hours per broker or dealer. See 
infra note 358.
    \344\ For firms that perform this work internally, the initial 
cost estimate assumes 5 hours of work performed by a Compliance 
Manager at an hourly rate of $293, 2.5 hours performed by Compliance 
Attorneys at an hourly rate of $346, and 0.5 hour of work performed 
by the Director of Compliance at an hourly rate of $461. The annual 
cost estimate assumes 30 hours of work by a Compliance Manager at an 
hourly rate of $293, 12 hours by Compliance Attorneys at an hourly 
rate of $346, and 6 hours by the Director of Compliance at an hourly 
rate of $461. Hourly salary figure is from SIFMA's Management & 
Professional Earnings in the Securities Industry 2013, modified by 
Commission staff to account for an 1800 hour work-year and inflation 
and multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead.
---------------------------------------------------------------------------

f. Indirect Costs
    In addition to possibly incurring costs related to joining 
exchanges, non-FINRA member firms that choose not to join an 
Association would lose the benefits of trading in off-member-exchange 
markets. As mentioned above, non-FINRA member firms are significant 
participants in off-exchange activity. Much of this trading is 
attributed to 12 non-FINRA member firms, and the activity level across 
those firms varies widely. The Commission estimates that those 12 non-
FINRA member firms executed $744 billion in off-exchange volume in 
September of 2021, while the remaining non-FINRA member firms executed 
$46 billion. The Commission cannot estimate the likelihood of these 
firms choosing to cease off-exchange activity rather than joining an 
Association. One commenter echoed these concerns when it stated that 
non-members may ``curtail all off-exchange trading'' if the high costs 
of FINRA membership outweigh the profits.\345\ The commenter believes 
that some firms may withdraw their broker or dealer registration and 
trade as a customer of a broker or dealer in order to eliminate other 
membership costs.\346\ The Commission believes that this is a 
possibility and could result in less competition and could degrade 
market quality and regulatory oversight.\347\
---------------------------------------------------------------------------

    \345\ See HRT Letter at 10.
    \346\ Id.
    \347\ Id.
---------------------------------------------------------------------------

    Finally, those firms that choose not to join an Association would 
be limited in their ability to route their own transactions to comply 
with the requirements of Regulation NMS and the Options Linkage 
Plan.\348\ Their transactions would have to be routed through a broker 
or dealer of an exchange of which they are a member, or routed by a 
broker or dealer only to those exchanges of which they are members. The 
routing of orders of non-FINRA member firms that do not join an 
Association would be determined by the routing broker or dealer of the 
exchanges of which they are members. This loss in choice could lead to 
higher costs for routing and costs associated with increased latency 
because the exchange's routing broker or dealer may have a 
telecommunications infrastructure that is inferior to that of the 
broker or dealer that previously provided connectivity to that exchange 
to the non-FINRA member firm.\349\
---------------------------------------------------------------------------

    \348\ The exemption related to routing to comply with Regulation 
NMS and the Options Linkage Plan is discussed in supra section 
III.B.1.
    \349\ Firms in the business of providing connectivity to 
exchanges are likely to compete on the basis of their technology. 
The Commission assumes that some firms that do not join FINRA will 
have some orders (those governed under the Regulation NMS or the 
Options Linkage Plan provisions to prevent trade-throughs) routed 
using technology inferior to the technology of their firm of choice.
---------------------------------------------------------------------------

D. Alternatives

1. Include a Floor Member Hedging Exemption
    The Commission could provide an exemption from Association 
membership if a dealer that meets the criteria of paragraphs (a) and 
(b) of the rule, conducts business on the floor of a single exchange, 
and its trading elsewhere is proprietary and solely for the purpose of 
hedging its floor-based exchange trading activity on its member 
exchange. The hedging exemption could be limited to firms that trade on 
the floor of a national securities exchange. Specifically, the 
alternative would provide that a dealer that conducts

[[Page 49969]]

business on the floor of only a single national securities exchange may 
affect transactions in securities otherwise than on that exchange, for 
the dealer's own account with or through another registered broker or 
dealer, that are solely for the purpose of hedging the risks of its 
floor-based exchange activity, by reducing or otherwise mitigating the 
risks thereof. The alternative proposal also could require a dealer 
seeking to rely on this exemption to establish, maintain, and enforce 
written policies and procedures reasonably designed to ensure and 
demonstrate that such hedging transactions reduce or otherwise mitigate 
the risks of the financial exposure the dealer incurs as a result of 
its floor-based activity, and to preserve a copy of its policies and 
procedures in a manner consistent with 17 CFR 240.17a-4 until three 
years after the date the policies and procedures are replaced with 
updated policies and procedures.
    The Commission believes that this alternative could provide a 
limited exemption from Association membership that is consistent with 
the original design of Rule 15b9-1's exclusion for proprietary trading. 
Today, few dealers limit their quoting and other non-hedging trading 
activities to a particular exchange. Under this alternative, the 
registered dealers among this group that limit their primary trading 
business to a single exchange floor may continue to hedge the risk of 
that business by effecting securities transactions on another exchange 
or in the off-exchange market that are solely for the purpose of 
hedging the dealers' on-exchange activity, without such transactions 
triggering a requirement to join an Association.
    The Commission also believes that this alternative approach, and in 
particular the limitation of its coverage to dealers that engage in 
floor trading and are a member of only a single exchange, could be 
consistent with the public interest and the protection of investors. A 
dealer's hedging activity resulting from its trading activity on 
multiple exchanges of which the dealer is a member presents cross-
market surveillance concerns as previously discussed, and therefore 
FINRA would be in the best position to conduct regulatory oversight to 
the extent that the dealer's hedging transactions take place elsewhere 
than on exchanges of which it is a member. By contrast, so long as a 
dealer's hedging activity results from floor trading activity that is 
confined to a single exchange of which the dealer is a member, that 
exchange could be able to adequately supervise the hedging activities 
of the dealer, consistent with the public interest and protection of 
investors.
    In addition, requiring written policies and procedures, as 
described above, would facilitate exchange supervision of dealers 
relying on such floor member hedging exemption, as it could provide an 
efficient and effective way for the relevant exchange to assess 
compliance with the proposed exemption. This could further serve the 
public interest and help protect investors.
    Because the alternative hedging exemption for floor traders is 
intended to allow a dealer to reduce or otherwise mitigate its risk, 
such as position risk, incurred in connection with its exchange-based 
dealer activities, it would be limited to transactions for the dealer's 
own account. In addition, because the dealer would not itself be a 
member of any other national securities exchange on which hedging 
transactions may be effected, or of an Association, such transactions 
would need to be conducted with or through another registered broker or 
dealer that is a member of such other national securities exchange or a 
member of an Association (or of both).
    However, the Commission believes that this alternative exemption 
would currently apply to very few and as little as zero non-FINRA 
member firms. Given that so few non-FINRA member firms would qualify 
for the exemption, the Commission believes that there is little value 
in including such an exemption. Additionally, by including the 
exemption the Commission believes that unforeseen circumstances could 
allow for firms to take advantage of the exemption in the future in 
ways that are not consistent with the original intent of the exemption, 
much like firms currently rely on Rule 15b9-1 in ways that are not 
consistent with the original intent.
2. Exchange Membership Alternative
    The amendments, in accordance with Section 15(b)(8), preclude any 
firm that is not a member of an Association from trading on exchanges 
of which it is not a member.\350\ Further, under the amendments, if a 
firm becomes a member of an Association, it would not have to become a 
member of each exchange upon which it trades.\351\ The Commission has 
also considered requiring brokers and dealers to become a member of 
every exchange on which they trade and to become a member of an 
Association to trade off-exchange (``Exchange Membership 
Alternative'').
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    \350\ The amendments provide limited exemptions for order 
routing to satisfy certain provisions of Regulation NMS and the 
Options Linkage Plan and for executing the stock leg of a stock-
option order.
    \351\ In order to trade on exchanges of which it is not a 
member, the firm would have to trade with or through another broker 
or dealer that is a member of that exchange.
---------------------------------------------------------------------------

    In considering the Exchange Membership Alternative, the Commission 
weighed whether the same issue of off-exchange activity not being 
subject to effective regulatory oversight that exists when a non-FINRA 
member firm trades off-exchange is present when a member or non-FINRA 
member firm trades on an exchange of which it is not a member (through 
a member of that exchange). The Commission continues to believe that 
the amendments adequately address the issue of establishing effective 
oversight of off-exchange activity and that the more onerous Exchange 
Membership Alternative would not provide any additional regulatory 
benefit beyond the benefits the amendments provide for several reasons. 
First, while some exchanges may lack specialized regulatory personnel 
to directly surveil their members' trading off-exchange, FINRA has 
these resources to surveil the activity of member firms both on 
exchanges and off-exchange. Accordingly, requiring member firms to also 
become members of each exchange on which they effect transactions, 
including indirectly, would be unnecessarily duplicative because FINRA 
already has the resources necessary to surveil the activity of a member 
firm trading on an exchange of which it is not a member. In addition, 
while some exchanges do not have a specialized rule set to govern their 
members' activity in the off-exchange market, FINRA's rules are often 
consistent with the trading rules of exchanges on which members 
transact.\352\ If a member firm were to violate an exchange rule on an 
exchange of which it is not a member, FINRA would have the jurisdiction 
needed to address the resulting violation. Therefore, not requiring 
that the member firm also become a member of that exchange would not 
prevent FINRA from exercising jurisdiction over the matter.
---------------------------------------------------------------------------

    \352\ See supra notes 53-54 and accompanying text.
---------------------------------------------------------------------------

    The Exchange Membership Alternative might have required firms to 
become members of more SROs than required under the proposed 
amendments, which would impose additional costs. In particular, some 
non-FINRA member firms that would become member firms under the 
proposed amendments would also need to become members of additional 
exchanges or cease trading on those exchanges. In addition, some 
current

[[Page 49970]]

member firms would also need to become members of additional exchanges.
3. Retaining the De Minimis Allowance
    The Commission considered retaining the $1,000 de minimis allowance 
for trading other than on an exchange of which the non-FINRA member 
firm is a member but removing the exception for proprietary trading 
conducted with or through another registered broker or dealer. As 
discussed above,\353\ the Commission continues to believe that the 
magnitude of the de minimis allowance is no longer economically 
meaningful. Furthermore, the Commission continues to believe that the 
commission sharing arrangements discussed previously \354\ are rarely, 
if ever, used.
---------------------------------------------------------------------------

    \353\ See supra section III.A.
    \354\ Id.
---------------------------------------------------------------------------

4. Eliminate the Rule 15b9-1 Exemption
    The Commission could eliminate Rule 15b9-1 altogether, leaving no 
exemption from Section 15(b)(8) of the Act. This would cause all 
current non-FINRA member firms that effect off-member-exchange 
securities transactions to be required by Section 15(b)(8) to join 
FINRA, which could improve FINRA's ability to surveil activity of 
member firms both on and off exchange, as well as investigate 
potentially violative behavior. Though, the Commission believes that 
such violative behavior by such firms may be easily identifiable under 
the proposed amendments, due to the fact that the proposed exemptions 
are narrow. However, eliminating the exemption for firms that would 
qualify for the routing exemption or the stock-option order exemption 
may prove to unnecessarily increase the costs for such firms. The 
Commission also believes that the routing exemption and stock-option 
order exemption will provide important avenues for providing liquidity 
and, therefore, eliminating the exemptions may drive these firms from 
the market and lead to a reduction in liquidity and market quality.

E. Request for Comment on Economic Analysis

    The Commission requests comment on all aspects of this Economic 
Analysis, including whether the analysis has: (1) identified all 
benefits and costs, including all effects on efficiency, competition, 
and capital formation; (2) given due consideration to each benefit and 
cost, including each effect on efficiency, competition, and capital 
formation; and (3) identified and considered reasonable alternatives to 
the proposed rule amendments. We request and encourage any interested 
person to submit comments regarding the proposed rules, our analysis of 
the potential effects of the proposed amendments, and other matters 
that may have an effect on the proposed rules. We request that 
commenters identify sources of data and information as well as provide 
data and information to assist us in analyzing the economic 
consequences of the proposed rules and proposed amendments. We also are 
interested in comments on the qualitative benefits and costs we have 
identified and any benefits and costs we may have overlooked. In 
addition to our general request for comments on the Economic Analysis 
associated with the proposed rules and proposed amendments, we request 
specific comment on certain aspects of the proposal:
    61. Regulatory Structure and Activity Levels of Non-FINRA Member 
Firms. The Economic Analysis discusses the current landscape for non-
FINRA member firms.
     Is the Commission's description of the current activity 
levels of non-FINRA member firms accurate? If not, can you provide 
additional data to better describe non-FINRA member firms' activity 
levels?
     Is there information or data on the trading activity level 
of non-FINRA member firms, in TRACE reportable securities other than 
U.S. Treasury securities? If so, please provide data.
    62. Current Market Oversight. The Economic Analysis describes the 
current structure of market oversight for non-FINRA member firms:
     Is the Commission's description of current market 
oversight accurate? Why or why not?
    63. Effects on Regulatory Supervision. Under the amendments, some 
non-FINRA member firms would be required to join an Association and be 
subject to additional market oversight.
     Would the proposed amendment improve regulatory oversight 
of current non-FINRA member firms? If not, is there currently adequate 
oversight of non-FINRA member firms?
     Would improved regulatory oversight improve market quality 
in financial markets?
     Would the proposed rules improve transparency for non-
FINRA member firms that have significant trading activities in U.S. 
Treasury securities markets?
     Are there significant limitations, beyond those discussed 
above, in the economic analysis of the effect on regulatory 
supervision?
    64. Firm Response and Effect on Market Activity. Under the proposed 
amendment, non-FINRA member firms would be required to either join an 
Association or change their trading practices to qualify for an 
exemption.
     Will some non-FINRA member firms change their business 
practices, including ceasing to trade securities, as opposed to joining 
an Association as a result of the proposed amendments? Why or why not?
     Will some non-FINRA member firms join each exchange on 
which they trade as opposed to joining an Association as a result of 
the proposed amendments? Why or why not?
     Will the proposed amendments lead to a reduction of 
liquidity as a result of non-FINRA member firms changing their business 
practices as due to the proposed amendments? Why or why not?
    65. Competitive Effects on Off-Exchange Market Regulation. The 
proposed amendments may create an incentive for the creation of another 
Association to compete with FINRA.
     Could the proposed amendments provide a strong enough 
incentive for the creation of a second Association? Why or why not? Do 
you believe that there are barriers to entry that would prevent a 
second Association from being formed?
    66. Effects on Current FINRA Member Firms. The proposed amendments 
are likely to have indirect effects on FINRA member firms as well.
     Would the proposed amendments create a more level 
regulatory playing field for FINRA member firms relative to non-FINRA 
member firms?
    67. Effects on Price Discovery
     Would the proposed amendments decrease competitive 
advantages and reduce costs borne by the investing public through 
increased price discovery? Why or why not?
    68. Costs. The proposed amendments will have several direct costs 
for non-FINRA member firms.
     Has the proposal accurately described the costs to non-
FINRA member firms? Why or why not?
     Has the proposal accurately estimated the fees assessed by 
FINRA? If not, can you provide estimates?
     In 2015 FINRA proposed amendments to the TAF in response 
to a previous Commission proposal to amend the 15b9-1 exemption. If the 
proposed FINRA amendments are adopted, how would this change the 
economic effects?
    69. Alternatives. The Commission listed several reasonable 
alternatives.
     Do you believe that the economic effects of each of the 
provided

[[Page 49971]]

alternatives has been accurately described and evaluated?
     Are there other alternatives?
     How many non-FINRA members would qualify for a floor 
trading hedging exemption? Is zero accurate?

VII. Paperwork Reduction Act

    Certain provisions of the proposed amendments to Rule 15b9-1 
contain ``collection of information requirements'' within the meaning 
of the Paperwork Reduction Act of 1995 (``PRA'').\355\ As discussed in 
Section III.B, the proposed amendments to Rule 15b9-1, if adopted, 
would require brokers or dealers relying on the stock-option order 
exemption to establish, maintain, and enforce certain written policies 
and procedures. Compliance with these collections of information 
requirements would be mandatory for firms relying on the amended rule. 
The Commission is submitting these collections of information to the 
Office of Management and Budget (``OMB'') for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. The title of this new collection 
of information is ``Rule 15b9-1 Exemptions.'' An agency may not conduct 
or sponsor, and a person is not required to respond to, a collection of 
information unless the agency displays a currently valid control 
number.
---------------------------------------------------------------------------

    \355\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

A. Summary of Collection of Information

    The proposed amendments to Rule 15b9-1 include a collection of 
information within the meaning of the PRA for brokers or dealers 
relying on the stock-option order exemption under the amended rule. The 
stock-option order exemption under the amendments to Rule 15b9-1 would 
permit a qualifying broker or dealer to effect securities transactions 
otherwise than on an exchange where it is a member, with or through 
another broker or dealer, that are solely for the purpose of executing 
the stock leg of a stock-option order. Brokers or dealers relying on 
this exemption would be required to establish, maintain, and enforce 
written policies and procedures reasonably designed to ensure and 
demonstrate that such transactions are solely for the purpose of 
executing the stock leg of a stock-option order. In addition, such 
brokers or dealers would be required to preserve a copy of their 
policies and procedures in a manner consistent with Rule 17a-4 until 
three years after the date the policies and procedures are replaced 
with updated policies and procedures.

B. Proposed Use of Information

    The policies and procedures required under amended Rule 15b9-1 
would be used by the Commission and SROs to understand how brokers and 
dealers relying on the exemption evaluate whether the securities 
transactions that they effect elsewhere than an exchange where they are 
a member are solely for the purpose of executing the stock leg of a 
stock-option order and, more generally, how such brokers and dealers 
are complying with the requirements of the exemption and Rule 15b9-1. 
These policies and procedures would be used generally by the Commission 
as part of its ongoing efforts to monitor and enforce compliance with 
the federal securities laws, including Section 15(b)(8) of the Act and 
Rule 15b9-1 thereunder. In addition, SROs may use the information to 
monitor and enforce compliance by their members with applicable SRO 
rules and the federal securities laws.

C. Respondents

    The Commission believes that a small number of brokers or dealers 
would rely on the stock-option order exemption. The Commission 
estimates that, based on publicly available information reviewed 
covering the end of April 2022, there are approximately 65 brokers-
dealers registered with the Commission that are currently a member of 
an exchange but not a member of an Association. The Commission believes 
that some, but not all, of these brokers-dealers would likely choose to 
avail themselves of the stock-option order exemption, because not all 
of them handle stock-option orders or, for those that do handle stock-
option orders, they may effect the execution of stock leg components of 
those orders on exchanges where they are a member. The Commission 
estimates that seven firms could potentially rely on the stock-option 
order exemption and would therefore be required to comply with the 
policies and procedures requirement.\356\ The Commission believes that 
some of these firms could want the ability to effect securities 
transactions elsewhere than an exchange where they are a member that 
are not for the purpose of executing the stock leg of a stock-option 
order, and may, accordingly, choose to join an Association as a result 
of the amendments to Rule 15b9-1.
---------------------------------------------------------------------------

    \356\ See supra section III.B.2.
---------------------------------------------------------------------------

D. Total Initial and Annual Reporting and Recordkeeping Burdens

    The Commission estimates that the one-time, initial burden for a 
broker or dealer to establish written policies and procedures as 
required under amended Rule 15b9-1 would be approximately 8 hours.\357\ 
This figure is based on the estimated number of hours to develop a set 
of written policies and procedures, including review and approval by 
appropriate legal personnel. The Commission notes that the policies and 
procedures proposed in the amended rule are limited to those 
transactions that are solely for the purpose of executing the stock leg 
of a stock-option order. In addition, the Commission estimates that the 
annual burden of maintaining and enforcing such policies and 
procedures, including a review of such policies at least annually, 
would be approximately 48 hours for each broker or dealer.\358\ This 
figure includes an estimate of hours related to reviewing existing 
policies and procedures, making necessary updates, conducting ongoing 
training, maintaining relevant systems and internal controls, 
performing necessary testing and monitoring of stock-leg transactions 
as they relate to the broker's or dealer's activities and maintaining 
copies of the policies and procedures for the period of time required 
by the amended rule.
---------------------------------------------------------------------------

    \357\ This figure is based on the following: (Compliance Manager 
at 5 hours) + (Compliance Attorney at 2.5 hours) + (Director of 
Compliance at 0.5 hour) = 8 burden hours per broker or dealer.
    \358\ This figure is based on the following: (Compliance Manager 
at 30 hours) + (Compliance Attorney at 12 hours) + (Director of 
Compliance at 6 hours) = 48 burden hours per broker or dealer.
---------------------------------------------------------------------------

    The Commission estimates that the initial, first year burden 
associated with amended Rule 15b9-1 would be 56 hours per broker or 
dealer, which corresponds to an initial aggregate burden of 392 
hours.\359\ The Commission estimates that the ongoing annualized burden 
associated with Rule 15b9-1 would be 48 hours per broker or dealer, 
which corresponds to an ongoing

[[Page 49972]]

annualized aggregate burden of 336 hours.\360\
---------------------------------------------------------------------------

    \359\ This figure is based on the following: ((8 burden hours 
per broker or dealer) + (48 burden hours per broker or dealer)) x (7 
brokers and dealers) = 392 burden hours during the first year. In 
estimating these burden hours, the Commission also examined the 
estimated initial and ongoing burden hours imposed on registered 
security-based swap dealers under Regulation SBSR--Reporting and 
Dissemination of Security-Based Swap Information. See Exchange Act 
Release No. 74244 (February 11, 2015) 80 FR 14564, 14683 (March 19, 
2015) (``Regulation SBSR''). Regulation SBSR requires registered 
security-based swap dealers to establish, maintain, and enforce 
written policies and procedures that are reasonably designed to 
ensure compliance with any security-based swap transaction reporting 
obligations. Id. The estimated initial and ongoing compliance burden 
on registered security-based swap dealers under Regulation SBSR were 
216 burden hours and 120 burden hours, respectively. Id. The 
policies and procedures under the proposed amendments to Rule 15b9-1 
are much more limited in nature.
    \360\ This figure is based on the following: (48 burden hours 
per broker or dealer) $x (7 brokers and dealers) = 336 ongoing, 
annualized aggregate burden hours.
---------------------------------------------------------------------------

E. Collection of Information Is Mandatory

    All of the collection of information discussed above would be 
mandatory.

F. Confidentiality of Responses to Collection of Information

    To the extent that the Commission receives confidential information 
pursuant to the collection of information, such information will be 
kept confidential, subject to the provisions of applicable law.\361\
---------------------------------------------------------------------------

    \361\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing 
the public availability of information obtained by the Commission).
---------------------------------------------------------------------------

G. Retention Period for Recordkeeping Requirements

    Brokers or dealers seeking to take advantage of the stock-option 
order exemption would be required to preserve a copy of their policies 
and procedures in a manner consistent with Rule 17a-4 \362\ until three 
years after the date the policies and procedures are replaced with 
updated policies and procedures.
---------------------------------------------------------------------------

    \362\ 17 CFR 240.17a-4. Registered brokers and dealers are 
already subject to existing recordkeeping and retention requirements 
under Rule 17a-4. However, amended Rule 15b9-1 contains a 
requirement that a broker or dealer relying on the stock-option 
order exemption preserve a copy of its policies and procedures in a 
manner consistent with Rule 17a-4 until three years after the date 
the policies and procedures are replaced with updated policies and 
procedures. The burdens associated with this recordkeeping 
obligation have been accounted for in the burden estimates discussed 
above for amended Rule 15b9-1.
---------------------------------------------------------------------------

H. Request for Comments

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comment to:
    70. Evaluate whether the proposed collection of information is 
necessary for the proper performance of our functions, including 
whether the information shall have practical utility;
    71. Evaluate the accuracy of our estimate of the burden of the 
proposed collection of information;
    72. Determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected; and
    73. Evaluate whether there are ways to minimize the burden of 
collection of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Secretary, Securities and 
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090, with 
reference to File Number S7-05-15. Requests for materials submitted to 
OMB by the Commission with regard to this collection of information 
should be in writing, with reference to File Number S7-05-15 and be 
submitted to the Securities and Exchange Commission, Office of FOIA/PA 
Services, 100 F Street NE, Washington, DC 20549-2736. As OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

VIII. Consideration of Impact on Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, (``SBREFA''),\363\ the Commission requests comment on the 
potential effect of the proposed amendments to Rule 15b9-1 on the 
United States economy on an annual basis. The Commission also requests 
comment on any potential increases in costs or prices for consumers or 
individual industries, and any potential effect on competition, 
investment, or innovation. Commenters are requested to provide 
empirical data and other factual support for their views to the extent 
possible.
---------------------------------------------------------------------------

    \363\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C., and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

IX. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \364\ 
(``RFA'') requires the Commission to undertake an initial regulatory 
flexibility analysis of the impact of the rule amendments on small 
entities unless the Commission certifies that the rule would not have a 
significant economic impact on a substantial number of small 
entities.\365\ For purposes of Commission rulemaking in connection with 
the RFA,\366\ a small entity includes a broker or dealer that: (1) had 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to Rule 17a-5(d) under the 
Exchange Act,\367\ or, if not required to file such statements, a 
broker or dealer with total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last day of the preceding 
fiscal year (or in the time that it has been in business, if shorter); 
and (2) is not affiliated with any person (other than a natural person) 
that is not a small business or small organization.\368\
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    \364\ 5 U.S.C. 603(a).
    \365\ 5 U.S.C. 605(b).
    \366\ Although Section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
rulemaking, are set forth in Rule 0-10 under the Exchange Act, 17 
CFR 240.0-10. See Exchange Act Release No. 18451 (January 28, 1982), 
47 FR 5215 (February 4, 1982) (File No. AS-305).
    \367\ 17 CFR 240.17a-5(d).
    \368\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    The Commission examined recent FOCUS data for the 3,528 active 
brokers and dealers overseen by the Commission, including 3,454 brokers 
and dealers that are FINRA members and the 65 non-FINRA member firms as 
of April 2022 and estimates that not more than four of the affected 
entities have net capital of $500,000 or less and are not affiliates of 
larger organizations. The Commission oversees approximately 3,528 
brokers and dealers, of which 740 have net capital of $500,000 or less 
and are not affiliates of larger organizations.\369\ Because the 
Commission estimates that not more than four small entities out of 740 
total small entities currently registered with the Commission would be 
required to become FINRA members as a result of the proposed rule 
changes, the Commission certifies that the proposed amendments to Rule 
15b9-1 would not, if adopted, have a significant economic impact on a 
substantial number of small entities.\370\
---------------------------------------------------------------------------

    \369\ Data from FOCUS for Quarter 4 of 2021.
    \370\ One commenter to the 2015 Proposal disagreed with the 
Commission's certification in the 2015 Proposal and stated that the 
amended rule would have a significant economic impact on a 
substantial number of small entities. Specifically, the commenter 
stated that 12 options exchange member firms that were not FINRA 
members in reliance on current Rule 15b9-1 conduct off-exchange 
trading on behalf of their clients, were likely small entities, and 
would not be eligible for the then-proposed dealer hedging 
exemption. See NYSE/NASDAQ Letter at 4 and n. 5. Since the 
Commission no longer is including a hedging exemption in amended 
Rule 15b9-1, these firms could still be impacted by the amended 
rule. But the Commission preliminarily believes that these options 
exchange member firms' off-exchange trading could be stock trading 
in relation to their handling of stock-option orders and, therefore, 
these firms may be able to rely on the stock-option order exemption 
that the Commission is proposing today. Moreover, as noted above, 
the Commission now estimates that not more than four small entities 
would be impacted by the proposed amendments to Rule 15b9-1. As a 
result, the Commission believes that the proposed amendments to Rule 
15b9-1 would not have a significant impact on a substantial number 
of small entities.

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[[Page 49973]]

    Requests for Comment:
    The Commission requests comment on all aspects of the foregoing 
certification as well as, in particular, on the following questions:
    74. We solicit comment as to whether the proposed amendments could 
have impacts on small entities that have not been considered. We 
request that commenters describe the nature of any impacts on small 
entities and provide empirical data to support the extent of such 
effect, including the magnitude of any economic impact the proposed 
amendments would have on small entities.
    75. Do commenters believe that the proposed amendments would have a 
significant economic impact on a substantial number of small entities? 
If so, how should the Commission alter the proposed amendments to 
lessen the impact on these entities?
    Such comments will be placed in the same public file as comments on 
the proposed amendments to Rule 15b9-1. Persons wishing to submit 
written comments should refer to the instructions for submitting 
comments in the front of this release.

X. Statutory Authority

    The Exchange Act, 15 U.S.C. 78a et seq., and particularly sections 
3, 15, 15A, 17, 19, 23, and 36 thereof.

List of Subjects in 17 CFR Part 240

    Brokers, Dealers, Registration, Securities.

    For the reasons set out in the preamble, the Commission proposes to 
amend Title 17, Chapter II of the Code of Federal Regulations as 
follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The authority citation for part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78o-10, 
78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 
80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201, et seq.; and 8302; 7 
U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and Pub. L. 
111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106, sec. 503 
and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
2. Section 240.15b9-1 is revised to read as follows:


Sec.  240.15b9-1  Exemption for certain exchange members.

    Any broker or dealer required by section 15(b)(8) of the Act (15 
U.S.C. 78o(b)(8)) to become a member of a registered national 
securities association shall be exempt from such requirement if it:
    (a) Is a member of a national securities exchange;
    (b) Carries no customer accounts; and
    (c) Effects transactions in securities solely on a national 
securities exchange of which it is a member, except that with respect 
to this paragraph (c):
    (1) A broker or dealer may effect transactions in securities 
otherwise than on a national securities exchange of which the broker or 
dealer is a member that result solely from orders that are routed by a 
national securities exchange of which the broker or dealer is a member 
to comply with 17 CFR 242.611 or the Options Order Protection and 
Locked/Crossed Market Plan; or
    (2) A broker or dealer may effect transactions in securities 
otherwise than on a national securities exchange of which the broker or 
dealer is a member, with or through another registered broker or 
dealer, that are solely for the purpose of executing the stock leg of a 
stock-option order. A broker or dealer seeking to rely on this 
exception shall establish, maintain and enforce written policies and 
procedures reasonably designed to ensure and demonstrate that such 
transactions are solely for the purpose of executing the stock leg of a 
stock-option order. Such broker or dealer shall preserve a copy of its 
policies and procedures in a manner consistent with 17 CFR 240.17a-4 
until three years after the date the policies and procedures are 
replaced with updated policies and procedures.
* * * * *

    By the Commission.

    Dated: July 29, 2022.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-16711 Filed 8-11-22; 8:45 am]
BILLING CODE 8011-01-P

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