Exemption for Certain Exchange Members, 61850-61893 [2023-18658]

Download as PDF 61850 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34–98202; File No. S7–05–15] RIN 3235–AN17 Exemption for Certain Exchange Members Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’) is adopting amendments to a rule under the Securities Exchange Act of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) that exempts certain Commission-registered brokers or dealers from membership in a registered national securities association (‘‘Association’’). The amendments replace rule provisions that provide an exemption 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 amendments create exemptions for such a registered broker or dealer that effects securities transactions otherwise than on 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: Effective date: November 6, 2023. Compliance date: The compliance date is September 6, 2024. FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director, David Michehl, Special Counsel, Nicholas Shwayri, Special Counsel, Vince Vuong, Special Counsel, or Alba Baze, Attorney-Advisor, at (202) 551– 5500, Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: ddrumheller on DSK120RN23PROD with RULES2 SUMMARY: I. Introduction II. Background A. Regulatory Framework B. Updated Background Statistics III. Discussion of Amendments to Rule 15b9– 1 A. Elimination of the De Minimis Allowance and Proprietary Trading Exclusion VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 B. Narrowed Criteria for Exemption From Association Membership 1. Routing Exemption 2. Stock-Option Order Exemption IV. Effective Date and Implementation V. 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 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 5. Mandate TRACE U.S. Treasury Securities Reporting Without Requiring Association Membership VI. 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 VII. Regulatory Flexibility Act Certification VIII. Other Matters I. Introduction On July 29, 2022, the Commission reproposed amendments to 17 CFR 240.15b9–1 (‘‘Rule 15b9–1’’).1 The Commission is adopting those amendments as re-proposed. Rule 15b9–1 sets forth an exemption from section 15(b)(8) of the Act pursuant to which a Commissionregistered dealer can engage in unlimited proprietary trading of securities on any exchange of which it is not a member or in the off-exchange market (collectively referred to herein as ‘‘off-member-exchange’’) without joining an Association, so long as the dealer is a member of a national securities exchange, carries no customer accounts, and its proprietary trading is conducted with or through another 1 See Securities Exchange Act Release No. 95388 (July 29, 2022), 87 FR 49930 (Aug. 12, 2022) (‘‘2022 Re-Proposing Release’’ or ‘‘2022 Re-Proposal’’). The 2022 Re-Proposal re-proposed amendments that the Commission proposed on Mar. 25, 2015. See Securities Exchange Act Release No. 74581 (Mar. 25, 2015), 80 FR 18036 (Apr. 2, 2015) (‘‘2015 Proposing Release’’ or ‘‘2015 Proposal’’). PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 registered broker-dealer.2 The Commission adopted this exemption several decades ago so that an exchange member’s limited off-member-exchange 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.3 The adopted amendments update Rule 15b9–1 by rescinding the proprietary trading exemption from the rule such that, subject to two narrow exemptions, Commission-registered broker-dealers that effect off-memberexchange securities transactions must comply with section 15(b)(8) of the Act by joining an Association. The amended rule’s two exemptions apply when a broker or dealer that does not carry customer accounts and is a member of at least one exchange effects offmember-exchange securities transactions that: (1) result solely from orders that are routed by an exchange of which the broker or dealer is a member in order to comply with 17 CFR 242.611 (Rule 611 of Regulation NMS) or the Options Order Protection and Locked/ Crossed Market Plan; 4 or (2) are solely for the purpose of executing the stock leg of a stock-option order.5 In the decades since the adoption of the proprietary trading exemption, the securities markets have undergone a substantial transformation that has been 2 Section 15(b)(8) of the Act 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. Section 15(b)(8) applies to any security other than commercial paper, bankers’ acceptances, or commercial bills. 15 U.S.C. 78o(b)(8). 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 Act. See 17 CFR 240.600(b)(45) (defining ‘‘national securities exchange’’). ‘‘Offexchange’’ as used herein means any securities transaction that is covered by section 15(b)(8) of the Act that is not effected, directly or indirectly, on a 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. 3 See infra notes 33–34 and accompanying text (discussing the adoption of 17 CFR 240.15b8–1 (‘‘Rule 15b8–1’’), which was later renumbered to Rule 15b9–1). 4 See Securities Exchange Act Release No. 60405 (July 30, 2009), 74 FR 39362 (Aug. 6, 2009) (‘‘Options Linkage Plan’’). 5 See amended Rule 15b9–1, under ‘‘Text of Amendments,’’ infra. Consistent with section 15(b)(8) of the Act, and unchanged by the adopted amendments, a broker or dealer is not required to become a member of an Association if the broker or dealer effects securities transactions only on an exchange of which it is a member. See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8). E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 driven primarily by rapid and ongoing evolution of technologies for generating, routing, and executing orders, and the impact of regulatory changes.6 Today, little trading in the U.S. securities markets is floor-based and broker-dealer firms no longer trade primarily on a single exchange. Rather, securities trading today is highly automated, substantially more complex, and dispersed among many trading centers including 24 registered exchanges and a myriad off-exchange venues such as ATSs and OTC market makers.7 Proprietary trading broker-dealer firms have emerged that engage in significant, computer-based or algorithmic, securities trading activity for their own account across the full range of these exchange and off-exchange venues, often at lightning speeds.8 Rule 15b9–1 has remained static, however, as these types of firms have emerged and off-member-exchange 6 See Securities Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 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.’’). 7 See 2015 Proposing Release, supra note 1, 80 FR 18038; 2022 Re-Proposal, supra note 1, 87 FR 49935. See also Equity Market Structure Concept Release, supra note 6. 8 Proprietary trading firms that engage in socalled high-frequency trading strategies 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 transactions throughout the national market system. See 2015 Proposal, supra note 1, 80 FR 18038; 2022 ReProposal, supra note 1, 87 FR 49935–36. Many, but not all, proprietary trading firms are often characterized by: (1) the use of extraordinarily highspeed 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 6, 75 FR 3606; see also Staff of the Division of Trading and Markets, ‘‘Equity Market Structure Literature Review, Part II: High Frequency Trading,’’ at 4–5 (Mar. 18, 2014) (available at https:// www.sec.gov/marketstructure/research/hft_lit_ review_march_2014.pdf). Staff reports, Investor Bulletins, 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. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 securities trading has proliferated. As detailed in the 2022 Re-Proposal and section II.B below, several of these firms effect significant off-member-exchange securities transaction volume yet, in reliance on Rule 15b9–1, they are not members of the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’), the only Association currently.9 Brokerdealers that are not FINRA members are not subject to FINRA’s rules or FINRA’s direct, membership-based jurisdiction.10 As a result, when broker-dealer firms that are members of one or more exchanges but not FINRA members effect proprietary off-member-exchange securities transactions,11 these firms are not subject to FINRA’s rules or its membership-based jurisdiction over such activity and are not all subject to the same set of exchange rules and interpretations of those rules, which can vary between exchanges. Because such exempt firms are not subject to FINRA’s direct, membershipbased jurisdiction when they engage in off-member-exchange securities trading activity, there is less stability and consistency in the oversight that is applied to such activity than there would be if such firms were Association members. To address this concern, the amendments to Rule 15b9–1 help ensure, as mandated by section 15(b)(8) of the Act, that an Association (currently, FINRA) generally has direct, membership-based oversight over broker-dealers that effect off-memberexchange securities transactions and the jurisdiction to directly enforce their compliance with Federal securities laws, Commission rules, and Association rules. Requiring brokerdealers that engage in off-memberexchange securities transactions to become Association members will provide FINRA with, among other things, the ability to apply with a greater degree of autonomy its expertise in supervising the firms’ off-memberexchange securities trading activity and investigating potential misconduct in that market segment. With respect to 9 See 2022 Re-Proposal, supra note 1, 87 FR 49936–37. See also section III, infra. 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 current Rule 15b9–1’s proprietary trading exemption, off-memberexchange 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. See 17 CFR 240.15b9– 1(b)(1). PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 61851 FINRA members, FINRA can determine whether to pursue examinations and investigations, and the parameters thereof, in a way that it cannot with respect to non-FINRA members. Some commenters expressed broad support for the 2022 Re-Proposal, while other commenters expressed opposition primarily based on the argument that direct, membership-based FINRA oversight of proprietary trading brokerdealers is unnecessary in light of existing regulatory mechanisms and that the costs of FINRA membership would be unduly burdensome.12 As discussed in the 2022 Re-Proposal and section III below, direct, membership-based jurisdiction by an Association over broker-dealers that are not FINRA members cannot be achieved through existing self-regulatory organization (‘‘SRO’’) oversight mechanisms such as joint SRO plans pursuant to 17 CFR 240.17d–2 (‘‘Rule 17d–2’’) 13 or regulatory service agreements (‘‘RSA(s)’’),14 or through reliance on the 12 Comments received in response to the 2022 ReProposing Release are available at https:// www.sec.gov/comments/s7-05-15/s70515.htm. The 2022 Re-Proposal re-proposed amendments to Rule 15b9–1 that the Commission proposed in 2015, with certain modifications informed by comments received on the 2015 Proposal, which comments the Commission addressed in the 2022 Re-Proposal. See 2015 Proposal, supra note 1. Comments received in response to the 2015 Proposing Release are available at https://www.sec.gov/comments/s7-0515/s70515.shtml. 13 See 17 CFR 240.17d–2. With respect to a broker or dealer that is a member of more than one SRO (‘‘common member’’), section 17(d)(1) of the Act 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. See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1). To implement section 17(d)(1), the Commission adopted 17 CFR 240.17d–1 (‘‘Rule 17d–1’’) and Rule 17d–2 under the Act. See 17 CFR 240.17d–1 and 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 Securities Exchange Act Release No. 12352 (Apr. 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 Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR 49091 (Nov. 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. 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. 14 In contrast to Rule 17d–2 plans, RSAs are privately negotiated agreements between two SROs E:\FR\FM\07SER2.SGM Continued 07SER2 61852 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 Consolidated Audit Trail (‘‘CAT’’).15 Those regulatory measures are useful in many respects but, nevertheless, firms that are not FINRA members remain outside FINRA’s direct, membershipbased jurisdiction, and FINRA therefore cannot apply its expertise in supervising these firms’ off-member-exchange securities trading activity and investigating potential misconduct with the same degree of autonomy that it can for FINRA members.16 Moreover, other regulatory developments have heightened the need for Rule 15b9–1 to be updated. In particular, FINRA has established a transaction reporting regime under which broker-dealers that are FINRA members must report U.S. Treasury securities transactions into the Trade Reporting and Compliance Engine (‘‘TRACE’’).17 Some Commissionthat can expire or be terminated. Under an RSA, one SRO agrees to perform regulatory services on behalf of another SRO in exchange for compensation. Unlike Rule 17d–2 plans, the SRO paying for regulatory services under an RSA retains ultimate legal responsibility for and control over the regulatory functions allocated to the SRO providing the services. There are RSAs between exchange SROs and FINRA, but under these RSAs, for firms that are members of different exchanges but not FINRA members, FINRA applies to such firm’s offmember-exchange trading activity the rules of their different member exchanges using the exchanges’ interpretations of their rules. 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/staffpaper-cross-market-regulatory-coordination) (‘‘Cross-Market Regulatory Coordination Staff Paper’’). In addition to regulatory coordination that occurs through Rule 17d–2 plans and RSAs, SROs also coordinate regulatory efforts through forums provided by the Intermarket Surveillance Group (‘‘ISG’’). See id.; see also 2022 Re-Proposal, section II.A. 15 See 17 CFR 242.613; Securities Exchange Act Release No. 79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016) (‘‘CAT NMS Plan Approval Order’’); notes 90, 107, and 108, infra, and accompanying text. See also 2022 Re-Proposal, 87 FR 49934, 49939. For proprietary trading broker-dealer firms that become FINRA members due to the amendments to Rule 15b9–1, regulatory coordination mechanisms such as Rule 17d–1 DEA designations and Rule 17d–2 plans would be available to mitigate the potential for duplicative exchange SRO and FINRA oversight. 16 See supra note 14. 17 See FINRA Rule 6700 Series; see also Securities Exchange Act Release No. 79116 (Oct. 18, 2016), 81 FR 73167 (Oct. 24, 2016) (File No. SR–FINRA– 2016–027). In addition, FINRA requires its members to report all OTC Equity Security and Restricted Equity Security transactions (other than transactions executed on or through an exchange) to FINRA’s OTC Reporting Facility (‘‘ORF’’). See FINRA Rules 6410 and 6610; see also FINRA Rules 6420(f) (defining ‘‘OTC Equity Security’’); 6420(k) (defining ‘‘Restricted Equity Security’’); 6420(n) (defining ‘‘OTC Reporting Facility’’). FINRA also requires its members to report off-exchange NMS stock trades to two Trade Reporting Facilities (‘‘TRFs’’) that FINRA operates, one jointly with Nasdaq and the other jointly with the NYSE. See FINRA Rule 6110 and the FINRA Rule 6000 Series generally; see also 17 CFR 242.600(b) (defining VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 registered 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 (although if the transaction involves a FINRA member, then the FINRA member must report the transaction to TRACE).18 In addition, U.S. Treasury securities trading occurs entirely offexchange, 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 offexchange 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. Accordingly, after considering the comments received in response to the 2022 Re-Proposal, the Commission is adopting amended Rule 15b9–1 as reproposed. The Commission continues to believe that oversight of off memberexchange securities trading must be enhanced in light of how securities trading occurs today, by narrowing the extent to which broker-dealer firms can effect off-member-exchange securities transactions—in significant volumes in many cases—while exempt from FINRA membership. II. Background A. Regulatory Framework Broker-dealers generally must register with the Commission and become members of a SRO.19 Self-regulation is a longstanding, key component of U.S. ‘‘NMS stock’’). Further, 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 Securities Exchange Act Release No. 46249 (July 24, 2002), 67 FR 49821 (July 31, 2002) (order approving the ADF); see also Securities Exchange Act Release No. 71467 (Feb. 3, 2014), 79 FR 7485 (Feb. 7, 2014) (order approving a proposed rule change to update the rules governing the ADF). 18 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities. 19 See section 15(a)(1) of the Act, 15 U.S.C. 78o(a)(1). For a more detailed background regarding the relevant regulatory environment, including the complementary SRO oversight performed by exchanges and FINRA, see 2022 Re-Proposal, supra note 1, section II, 87 FR 49932–39; see also 2015 Proposal, supra note 1, section I, 80 FR 18036–45. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 securities industry regulation.20 The Exchange Act defines SRO to include each national securities exchange or Association.21 An SRO sets standards, conducts examinations, and enforces rules regarding its members.22 In addition to Commission oversight, the Exchange Act requires this layer of SRO oversight, pursuant to which SROs act as front-line regulators of their brokerdealer members.23 In particular, there are Federal securities laws, Commission rules, and SRO rules that prohibit various forms of improper activity by broker-dealers.24 As SROs, exchanges and Associations are required to examine for and enforce compliance by their members and associated persons with the Exchange Act, the rules and regulations thereunder, and the SROs’ own rules.25 20 See Securities Exchange Act Release No. 50700 (Nov. 18, 2004), 69 FR 71256 (Dec. 8, 2004) (‘‘Concept Release Concerning Self-Regulation’’). 21 See section 3(a)(26) of the Act, 15 U.S.C. 78c(a)(26). 22 See Concept Release Concerning SelfRegulation, supra note 20 (citing section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8)). Congress historically has favored self-regulation for a variety of reasons, including that effectively regulating the innerworkings 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 71257–58. 23 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., section 15 of the Act, 15 U.S.C. 78o; 17 CFR 240.15a–6 through 240.15b11–1; 17 CFR 240.17a– 1 through 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., sections 19(d), 15 U.S.C. 78(s)(d), and 19(e), 15 U.S.C. 78s(e), of the Act. 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), 15 U.S.C. 78f(b)(1); 19(g)(1), 15 U.S.C. 78s(g)(1); and 15A(b)(2), 15 U.S.C. 78o–3(b)(2), of the Act; 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). 24 See, e.g., sections 10(b), 15 U.S.C. 78j(b); 15(c), 15 U.S.C. 78o(c); and 15(g), 15 U.S.C. 78o(g), of the Act; 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); Cboe Rule 8.6 (Manipulation). 25 See section 19(g) of the Act, 15 U.S.C. 78s(g). E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 Because of this, SROs that operate an exchange generally 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 off-member-exchange securities trading.26 Specifically, section 15(b) of the Act provides that Commission registration is generally not effective until the brokerdealer becomes a member of an Association or a national securities exchange if the broker-dealer effects transactions solely on that exchange.27 Additionally, section 15(b)(8) of the Act 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. Section 15(b)(9) of the Act 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.28 Rule 15b9– 1 sets forth an exemption from section 15(b)(8) of the Act 29 pursuant to authority conferred to the Commission by section 15(b)(9) of the Act.30 Rule 15b9–1 provides that any broker or dealer required by section 15(b)(8) of the Act to become a member of an 26 See sections 15(b)(8), 15 U.S.C. 78o(b)(8); 15A, 15 U.S.C. 78o–3; 17(d), 15 U.S.C. 78q(d); and 19(g), 15 U.S.C. 78s(g), of the Act. Under the selfregulatory 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. See sections 17(d), 15 U.S.C. 78q(d); and 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act. Section 17(d)(1) of the Act enables the Commission to allocate authority among SROs when a person is a member of more than one SRO. Section 17(d)(1) of the Act, 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. Section 15A of the Act, 15 U.S.C. 78o–3. And as described above, section 15(b)(8) of the 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. Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8). 27 See section 15(b) of the Act, 15 U.S.C. 78o(b). 28 Section 15(b)(9) of the Act, 15 U.S.C. 78o(b)(9). 29 Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8). 30 Section 15(b)(9) of the Act, 15 U.S.C. 78o(b)(9). VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 Association shall be exempt from such requirement if it is (1) a member of a national securities exchange, (2) carries no customer accounts, and (3) has annual 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’’).31 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’’).32 The Commission adopted the original version of Rule 15b9–1 (then Rule 15b8– 1 but generally referred to herein as Rule 15b9–1) in 1965,33 which included the de minimis allowance but not the proprietary trading exclusion; the Commission adopted the proprietary trading exclusion in 1976.34 Relying on 31 17 CFR 240.15b9–1(a). CFR 240.15b9–1(b)(1). Rule 15b9–1 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). As discussed below, the Commission proposed to eliminate from amended Rule 15b9–1 references to the ITS because they are obsolete, and the Commission is adopting those eliminations by deleting current paragraphs (b)(2) and (c) from the amended rule. See infra note 192 and accompanying text. 33 The rule was renumbered to Rule 15b9–1 in 1983. See SECO Programs; Direct Regulation of Certain Broker-Dealers; Elimination, Securities Exchange Act Release No. 20409 (Nov. 22, 1983), 48 FR 53688 (Nov. 29, 1983) (‘‘SECO Programs Release’’). See also Qualifications and Fees Relating to Brokers or Dealers Who Are Not Members of National Security [sic] Association, Securities Exchange Act Release No. 7697 (Sept. 7, 1965), 30 FR 11673 (Sept. 11, 1965) (‘‘Qualifications and Fees Release’’). The Commission stated in the Qualifications and Fees Release: ‘‘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. 34 See Extension of Temporary Rules 23a–1(T) and 23a–2(T); Adoption of Amendments to SECO Rules, Securities Exchange Act Release No. 12160 (Mar. 3, 1976), 41 FR 10599 (Mar. 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 stated that such transactions ultimately would be effected by a member of that exchange. In 1983, the Commission 32 17 PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 61853 the de minimis allowance and proprietary trading exclusion, a registered dealer can remain exempt from Association membership while engaging in unlimited off-memberexchange proprietary trading of securities, so long as the dealer 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. B. Updated Background Statistics The 2022 Re-Proposal set forth statistics regarding off-memberexchange securities trading activity by firms that were Commission-registered broker-dealers and exchange members but not FINRA members during the time periods reviewed by the Commission in the 2022 Re-Proposal.35 Those statistics are updated below for corresponding year-over-year time periods.36 The Commission estimates that, as of the end of September 2022, there were 73 firms that were Commissionregistered broker-dealers and exchange members but not FINRA members, and that there were 64 such firms as of April 2023.37 Many of these firms were members of just one exchange while others were members of multiple exchanges.38 Specifically, as of April 2023, 22 of the 64 identified firms were single exchange members; 9 of the firms were members of two exchanges; 15 of the firms were members of more than two but 10 or fewer exchanges; and the remainder were members of more than 10 exchanges.39 further amended Rule 15b9–1 to accommodate transactions effected through the then-new ITS, and eliminated references to, and requirements under, the SECO Program, which was the Commission’s program of direct regulation of certain brokerdealers at that time. See SECO Programs Release, supra note 33. 35 See 2022 Re-Proposal, supra note 1, section II, 87 FR 49932–39. 36 While some updated figures set forth below in this section differ from figures set forth in the 2022 Re-Proposal, the Commission believes that its conclusions are supported by the updated figures as well as the 2022 Re-Proposal’s figures. 37 Sources: SEC FOCUS Reports (Form X–17A–5); FINRA’s Central Registration Depository (‘‘CRD’’). 38 Source: CRD. 39 Id. 35 out of the 64 identified firms in April 2023 were members of a Nasdaq group exchange, 34 firms were members of Nasdaq PHLX LLC (‘‘PHLX’’) specifically, and five firms were members of only PHLX. The Commission believes these figures are consistent with one commenter’s statement in October 2022 that 39 non-FINRA firms were Nasdaq members, 13 of which designated PHLX as their DEA, as minor differences in the Commission’s and the commenter’s figures could be explained by changes in firms’ Nasdaq membership or Commission registration status during the passage of time between October 2022 and April 2023. See letter from Erik Wittman, Deputy Head E:\FR\FM\07SER2.SGM Continued 07SER2 61854 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 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.40 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. For example, of the estimated 73 broker-dealers that were exchange members but not FINRA members as of the end of September 2022, 53 initiated orders in listed equities in September 2022 that were executed on or off an exchange.41 These firms’ September 2022 off-exchange listed equities dollar volume executed was approximately $440 billion,42 which was approximately 5.1% of total offexchange volume of listed equities executed that month.43 Moreover, these firms’ September 2022 listed equities dollar volume executed on exchanges of which they are not a member was approximately $311 billion.44 Of the estimated 64 broker-dealers that were exchange members but not FINRA members as of April 2023, 45 initiated orders in listed equities in April 2023 that were executed on or off an exchange.45 These firms’ April 2023 of Enforcement, The Nasdaq Stock Market LLC (Oct. 6, 2022) (‘‘Nasdaq Letter’’) at 4. 40 Source: CAT. 41 Id. A firm ‘‘initiating’’ an order is the firm that reports the origination of the order as a New Order Event (MENO) to the CAT. The other 20 firms did not initiate orders in listed equities in Sept. 2022. 42 Id. Dollar volumes set forth in this section represent the sum of bought and sold volume during the specified time period. 43 Id. The Commission estimates that there was approximately $8.6 trillion in total off-exchange transaction volume in listed equities reported by buying and selling firms in Sept. 2022. 44 Id. The Commission also estimates that, in 2022, 48 of the 73 firms identified as registered broker-dealers and exchange members but not FINRA members initiated options order executions accounting for approximately 16–27% of daily options contract volume traded. The Commission further estimates that 35 of these 48 firms initiated executions on an exchange where they are not a member, and that this transaction volume represented approximately 3% of these 35 firms’ total options contract transaction volume reported in 2022, and approximately 1% of all options contract transaction volume reported in 2022. Id. These figures, like the other figures set forth herein, have been updated from what was set forth in the 2022 Re-Proposal. 45 Id. The other 19 firms did not initiate orders in listed equities in Apr. 2023. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 off-exchange listed equities dollar volume executed was approximately $405 billion,46 which was approximately 5.6% of total offexchange volume of listed equities executed that month.47 Moreover, these firms’ April 2023 listed equities dollar volume executed on exchanges of which they are not a member was approximately $262 billion.48 A subset of the identified firms that traded during September 2022 and April 2023 accounted for the large majority of the identified firms’ aggregate trading volume. In this regard, the Commission estimates that, as of September 2022, 12 of the 53 identified firms that initiated orders in listed equities accounted for approximately 4.5% of total offexchange listed equities volume executed in September 2022 and 89% of the off-exchange listed equities transaction volume attributable to the 53 identified firms that month.49 One of the 12 firms initiated $180 billion in offexchange listed equities executions in September 2022, which was over 2% of total off-exchange listed equities transaction volume that month and approximately one-half of the offexchange volume executions attributable to the 53 identified firms.50 With respect to the 53 firms’ listed equities transaction volume on exchanges of which they are not a member, one firm accounted for approximately 66% of the $311 billion in volume attributable to the 53 identified firms in September 2022; six firms (including the aforementioned one) accounted for over 90% of that volume; and 22 firms (including the aforementioned six firms) accounted for over 99% of that volume.51 The Commission also estimates that, as of April 2023, 12 of the 45 identified firms that initiated orders in listed equities then accounted for approximately 5.1% of total offexchange listed equities volume executed in April 2023 and 90% of the off-exchange listed equities transaction volume attributable to the 45 identified firms that month.52 One of the 12 firms initiated $222 billion in off-exchange listed equities executions in April 2023, which was 3.1% of total off-exchange 46 Id. 47 Id. The Commission estimates that there was approximately $7.2 trillion in total off-exchange transaction volume in listed equities reported by buying and selling firms in Apr. 2023. 48 Id. See also Tables 1 and 2, section V.A.1, infra, for additional detail regarding these firms’ trading activity during the noted time periods. 49 Id. 50 Id. 51 Id. 52 Id. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 listed equities transaction volume that month and approximately 55% of the off-exchange volume executions attributable to the 45 identified firms.53 With respect to the 45 firms’ listed equities transaction volume on exchanges of which they are not a member, one firm accounted for approximately 72% of the $262 billion in volume attributable to the 45 identified firms in April 2023; five firms (including the aforementioned one) accounted for over 90% of that volume; and 21 firms (including the aforementioned six firms) accounted for approximately 99% of that volume.54 With respect to trading in U.S. Treasury securities, all of which occurs off-exchange,55 the Commission estimates that seven broker-dealers that were exchange members but not FINRA members accounted for over $6 trillion in U.S. Treasury securities volume executed on ‘‘covered ATSs’’ in 2022 that was reported to TRACE,56 which was approximately 3.67% of total U.S Treasury securities volume traded in 2022 that was reported to TRACE.57 In 53 Id. 54 Id. 55 See U.S. Dep’t of the Treasury et al., Joint Staff Report: The U.S. Treasury Market on Oct. 15, 2014 (July 13, 2015) (‘‘Joint Staff Report’’) at 2. The secondary market for U.S. Treasury securities (sometimes referred to as the U.S. Treasury cash market) is generally bifurcated between the dealerto-customer market and the interdealer market. Trading in the U.S. Treasury securities dealer-tocustomer 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 (Sept. 28, 2020), 85 FR 87106, 87108 (Dec. 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. 56 See FINRA Rule 6730(a)(1) (requiring FINRA members to report transactions in TRACE-Eligible Securities, including U.S. Treasury securities). 57 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities (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. Approximately $165 trillion total U.S. Treasury securities transaction volume was reported to TRACE in 2022, of which approximately $64 trillion was reported as executed E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations April 2023, the Commission estimates that five broker-dealers that were exchange members but not FINRA members accounted for approximately $302 billion in U.S. Treasury securities volume executed on covered ATSs that was reported to TRACE,58 which was approximately 2.65% of total U.S Treasury securities volume traded in April 2023 that was reported to TRACE.59 ddrumheller on DSK120RN23PROD with RULES2 III. Discussion of Amendments to Rule 15b9–1 Under the amendments to Rule 15b9– 1 being adopted, a broker or dealer registered with the Commission pursuant to section 15 of the Act will be required by section 15(b)(8) of the Act to join an Association if the broker or dealer effects off-member-exchange securities transactions, unless it can rely upon one of the amended rule’s narrow exemptions.60 Conversely, and unchanged by these amendments, a broker or dealer will not be required to become a member of an Association if it effects securities transactions only on an exchange of which it is a member.61 Specifically, Rule 15b9–1, as amended, no longer provides a de minimis allowance or proprietary trading exclusion, and allows 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 off-member-exchange securities transactions 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 off-member-exchange securities transactions that are solely for the purpose of executing the stock leg of a stock-option order.62 In the on a covered ATS. Beginning in September 2022, a new form of trade reports from depository institutions were added to TRACE. These transactions, which amounted to $4.5 trillion, are excluded. 58 See supra note 56. 59 Id. One broker-dealer that was not a FINRA member and traded U.S. Treasury securities in 2022 joined FINRA prior to April 2023, and another broker-dealer that was not a FINRA member and traded U.S. Treasury securities in 2022 did not appear to trade U.S. Treasury securities in April 2023. 60 See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8); amended Rule 15b9–1, infra. 61 See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8). 62 See amended Rule 15b9–1, under ‘‘Text of Amendments,’’ infra. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 subsections below, the Commission discusses each element of the amended rule in detail. A. Elimination of the De Minimis Allowance and Proprietary Trading Exclusion The adopted amendments to Rule 15b9–1 eliminate the de minimis allowance and proprietary trading exclusion. Rescinding these provisions generally eliminates (subject to the exemptions in the amended rule) the ability for proprietary trading dealer firms to rely on Rule 15b9–1 to effect off-member-exchange securities transactions without joining an Association. The Commission proposed these rescissions to update Rule 15b9– 1 so that it more appropriately effectuates Exchange Act principles of 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.63 Some commenters on the 2022 ReProposal broadly agreed that Rule 15b9– 1 should be updated in this way.64 They stated that the proposed amendments are appropriate and necessary to modify and modernize Rule 15b9–1 such that it is consistent with the protection of investors and the public interest in today’s market.65 They also stated that the current regulatory framework, which includes RSAs, Rule 17d–2 plans, and the CAT, among other things, does not provide the full scope of regulatory coverage appropriate for comprehensive and consistent oversight of proprietary trading activities because an Association still lacks regulatory jurisdiction over certain trading activity.66 FINRA stated that performing regulatory work with respect to broker-dealer firms that are not FINRA members pursuant to RSAs is less certain and stable than direct Association oversight of such firms because of the discretionary nature of RSAs.67 FINRA also emphasized that access to audit trail data does not confer jurisdiction to FINRA over such firms, and that FINRA does not have the independent ability to examine for, investigate, or enforce potential violations of the Federal securities laws or FINRA rules with respect to such firms when they are identified through surveillance or other means.68 FINRA stated that jurisdictional limitations impede comprehensive off-exchange and cross-market oversight in equities, options, and fixed income markets.69 Another commenter stated that the proposal would help ensure that highfrequency trading firms, which trade large volumes of equities and U.S. Treasury securities across and off exchanges without being required to join an Association, i.e., FINRA, are subject to consistent and robust oversight through FINRA as opposed to only being subject to complying with the more narrow regulatory requirements specific to each exchange, and that such firms do not take advantage of exclusions provided by Rule 15b9–1 that were intended to accommodate limited broker-dealer activities.70 Other commenters questioned the necessity and appropriateness of the application of FINRA oversight to proprietary trading broker-dealer firms that are not FINRA members. They stated that, in light of existing regulatory mechanisms that apply to such firms, including, in particular, proprietary options trading firms, FINRA membership for such firms would be unnecessary and duplicative.71 In this 67 See 63 See 2022 Re-Proposal, supra note 1, 87 FR 49932. 64 See letters from: Marcia E. Asquith, Corporate Secretary, EVP, Board of External Relations, FINRA (Sept. 27, 2022) (‘‘FINRA Letter’’) at 1–2; Stephen W. Hall, Legal Director and Securities Specialist, and Scott Farmin, Legal Counsel, Better Markets, Inc. (Sept. 27, 2022) (‘‘Better Markets Letter’’) at 6– 7. 65 See FINRA Letter at 1–2; Better Markets Letter at 6–7; letter from Henry M. Phillip (Aug. 1, 2022) (‘‘Phillip Letter’’). See also Nasdaq Letter at 2 (expressing support for broker-dealers being required to join an Association if they effect securities transactions off-exchange and/or in the fixed income space). 66 See, e.g., FINRA Letter at 5; memorandum dated June 20, 2023, regarding a call between Commission staff and FINRA (‘‘6/20/23 Meeting Memorandum’’) (stating that FINRA identified nonFINRA member broker-dealer firms as potential respondents in 5% of the market regulation investigations it conducted in 2020 and 2021, which ranged across asset types and included both cross-exchange and off-exchange conduct). PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 61855 FINRA Letter at 6. 68 Id. 69 Id. 70 See Better Markets Letter at 5, 7–8; see also note 8, supra, for a description of high-frequency trading firms. This commenter also stated that highfrequency trading represents roughly 50% of the trading volume in U.S. equities markets and 48% of the total U.S. Treasury securities interdealer market, and that recent liquidity crises in both the U.S. equities and Treasury securities markets have shown the effects on markets dominated by, and heavily reliant on, high-frequency trading firms. See Better Markets Letter at 3. 71 See, e.g., Nasdaq Letter at 3; and letters from: John Kinahan, CEO, Group One Trading, LP (Sept. 26, 2022) (‘‘Group One Letter) at 1–2; Tom Simpson, CEO, PEAK6 Capital Management LLC (Sept. 26, 2022) (‘‘PEAK6 Letter’’) at 2; Akuna Securities LLC, Belvedere Trading, Chicago Trading Company, and Volant Trading (Sept. 27, 2022) (‘‘ABCV Letter’’) at 3; Angelo Evangelou, Chief Policy Officer, and Greg Hoogasian, Chief Regulatory Officer, Cboe Global Markets, Inc. (Sept. 27, 2022) (‘‘Cboe Letter’’) at 4–7; Kirsten Wegner, E:\FR\FM\07SER2.SGM Continued 07SER2 61856 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 regard, they stated that exchange SROs, including where appointed as DEA over certain of their members, already possess and exercise authority and can cooperate on regulatory matters to ensure compliance with the securities laws.72 They also stated that the CAT provides exchanges with sufficient visibility into proprietary brokerdealers’ off-member-exchange securities trading activity, which, they contended, obviates the need for proprietary trading broker-dealers to be required to join FINRA.73 As explained below in this section, the Commission continues to believe that, in today’s market, the de minimis allowance and proprietary trading exclusion must be eliminated from Rule 15b9–1 such that there is direct, membership-based Association SRO oversight of broker-dealers’ off-memberexchange securities trading activity, in accordance with section 15(b)(8) of the CEO, Modern Markets Initiative (Sept. 27, 2022) (‘‘MMI Letter’’) at 2; Thomas M. Merritt, Deputy General Counsel, Virtu Financial, Inc. (Sept. 30, 2022) (‘‘Virtu Letter’’) at 2–3; Joanna Mallers, Secretary, FIA Principal Traders Group (Sept. 27, 2022) (‘‘FIA PTG Letter’’), at 4. See also letter from Chasse R. Thomas (Sept. 26, 2022) (‘‘Thomas Letter’’) at 2 (stating that the proposal should not be adopted because FINRA’s ability to monitor complex financial market is inefficient and unreliable). Some commenters also stated that the FINRA membership application process requires information that is duplicative of information already provided to the Commission and other SROs. See PEAK6 Letter at 2; FIA PTG Letter at 4. The Commission does not believe that the submission of information in connection with the FINRA membership application process that is duplicative of information already provided to the Commission or exchange SROs is a reason to forgo the amendments to Rule 15b9–1 being adopted. To the extent information requested by FINRA is duplicative, firms may be able to leverage their prior submissions when applying for FINRA membership. Moreover, it is important that each SRO of which a broker-dealer is a member, including FINRA, have the requisite information required by its membership application, regardless of any duplication of the information, because each SRO has regulatory responsibilities over the brokerdealer. FINRA may require the same information that is provided to exchange SROs so that it may be able to review the information in order to approve the membership application and effectively regulate the firm. Additionally, Commissionregistered broker-dealers that are exchange members and that join FINRA as result of these rule amendments would not be situated any differently from the many Commission-registered brokerdealers that are exchange members and already FINRA members. In addition, see discussion below in this section as well as in section V, infra, regarding FINRA membership costs for brokerdealer firms that must join FINRA as a result of the adopted amendments. 72 See, e.g., Group One Letter at 1–2; PEAK6 Letter at 2; ABCV Letter at 3; Cboe Letter at 4–7; Nasdaq Letter at 3; FIA PTG Letter at 4; MMI Letter at 2; Virtu Letter at 2–3. 73 See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe Letter at 2–3; STA Letter at 2–3; ABCV Letter at 3; PEAK6 Letter at 3; Group One Letter at 2; letter from Eric Chern, Co-Founder, Chicago Trading Company, LLC (Sept. 27. 2022) (‘‘CTC Letter’’) at 4. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 Act and with the section 15(b)(9) requirement that any exemption from section 15(b)(8) be consistent with the protection of investors and the public interest.74 Requiring broker-dealers that engage in off-member-exchange securities transactions to become FINRA members will provide FINRA with direct jurisdiction and the ability to apply with a greater degree of autonomy its expertise to the firms’ off-memberexchange securities trading activity and investigate potential misconduct in that market segment. With respect to FINRA members, FINRA can determine whether to pursue examinations and investigations, and the parameters thereof, in a way that it cannot with respect to non-FINRA members, as FINRA’s oversight over the latter depends on RSA arrangements, pursuant to which exchange SROs retain legal responsibility and final decision-making authority with respect to the covered exchange members.75 In contrast, for FINRA member brokerdealer firms that effect off-memberexchange securities transactions, FINRA possesses legal responsibility and decision-making authority with respect to exercising SRO oversight because FINRA can directly apply its own jurisdiction and rules to such firms. As such, FINRA can unilaterally decide whether and how to examine and investigate off-member-exchange activity by a FINRA member firm for compliance with FINRA rules, and what course of action to pursue if potential FINRA rule violations are identified. Moreover, due to FINRA’s experience and expertise in cross-market and offexchange oversight, FINRA is wellpositioned to perform direct, membership-based oversight over broker-dealer firms that effect offmember-exchange securities transactions, as FINRA could bring such broker-dealers within the applicable regulatory operations that FINRA already has in place for its direct oversight of FINRA members that trade across markets. And this FINRA oversight extends to U.S. Treasury securities trading activity, unlike RSAbased SRO oversight, which does not extend to such activity.76 74 Commenters’ critiques of the 2022 Re-Proposal are largely the same as those that the Commission received in response to the 2015 Proposal, and the Commission continues to disagree with them for many of the same reasons expressed in the 2022 ReProposal. See 2022 Re-Proposal, supra note 1, 87 FR 49941. 75 See supra note 14. 76 See FINRA Letter at 8. FINRA has taken an active role in overseeing trading activity in U.S. Treasury securities by, for example, requiring U.S. Treasury securities to be reported to TRACE, and PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 While FINRA traditionally has been the SRO that primarily oversees offmember-exchange securities trading activity, in the context relevant here— proprietary trading broker-dealer firms with exchange-only SRO membership that effect off-member-exchange securities transactions—FINRA is unable to directly enforce such firms’ compliance with Federal securities laws and Commission rules applicable to broker-dealers, or apply its own rules to such firms, because they are not FINRA members. Without direct, membershipbased FINRA oversight, SRO oversight of such firms’ off-member-exchange securities trading activity is largely a function of cooperative regulatory arrangements among SROs, but those arrangements do not confer membership-based jurisdiction to FINRA to enforce compliance with the Exchange Act and applicable rules. These arrangements include those discussed in the 2022 Re-Proposal and highlighted by commenters, such as exchange SRO oversight through being appointed as DEA for certain exchange members pursuant to Rule 17d–1 and through Rule 17d–2 plans, indirect FINRA oversight pursuant to RSAs with exchange SROs, and the CAT.77 As discussed below in this section, while these arrangements serve useful purposes and enhance regulatory outcomes, the Commission continues to believe that, in today’s market, they are inadequate substitutes for direct, membership-based FINRA jurisdiction over firms that effect off-memberexchange securities transactions. Commenters described the general proficiency of direct exchange SRO oversight over exchange members.78 As by publishing daily files of aggregated U.S. Treasury securities transactions data reported to TRACE. See FINRA Rules 6730 and 6750; see also Treasury Daily Aggregate Statistics, available at https:// www.finra.org/finra-data/browse-catalog/abouttreasury/daily-file. In addition, FINRA has taken enforcement action regarding U.S. Treasury securities trading activity and reporting. See, e.g., FINRA Department of Enforcement v. BGC Financial, L.P., FINRA Letter of Acceptance, Waiver, and Consent No. 2020068558701 (Jan. 20, 2023), available at https://www.finra.org/sites/ default/files/fda_documents/ 2020068558701%20BGC%20Financial% 2C%20L.P.%20CRD%2019801%20AWC% 20va%20%282023-1676852400276%29.pdf. 77 See CAT NMS Plan Approval Order, supra note 15, 81 FR 84836–41, for a discussion of the benefits provided to SROs by the CAT with regard to surveillance, examinations, enforcement investigations, and tips and complaints. 78 See Nasdaq Letter at 2 (citing traditional operational responsibilities such as real-time surveillance, and the establishment of an investigation and enforcement team in 2017 dedicated to prosecuting member misconduct on its equities and options markets); Cboe Letter at 6 (stating that SROs operate comprehensive in-house regulatory programs which include cross market surveillance, such as CAT). E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations discussed in the 2022 Re-Proposal, in contrast to FINRA, the regulatory focus of exchange SROs is generally on trading by their members on their respective exchanges.79 Exchange SROs generally monitor market activity specific to their own exchanges and have expertise in regulating unique aspects of their markets.80 The focus of the amendments being adopted here, however, is different. Here, the Commission is concerned with offmember-exchange securities trading activity, SRO oversight of which traditionally has been and remains primarily FINRA’s responsibility. As discussed above and in the 2022 ReProposal, several broker-dealer firms that are exchange members but not FINRA members effect off-memberexchange securities transactions.81 This includes firms that trade options proprietarily and are engaged in proprietary options market making. While some commenters stated that membership-based FINRA oversight over such firms would be unnecessary and would duplicate existing exchange SRO oversight, the Commission continues to believe that direct, membership-based FINRA oversight over these firms (and therefore the amendments being adopted here) is necessary because they effect securities transactions off-member-exchange and thus generally outside the expertise of any exchange where they are a member and within FINRA’s primary area of expertise. Moreover, the Exchange Act provides a way to help address commenter concerns regarding regulatory duplication. Specifically, with respect to common members, section 17(d) of the Act authorizes the Commission to relieve an SRO of the responsibility to receive regulatory reports; to examine for and enforce compliance with applicable statutes, rules, and regulations; or to perform other specified regulatory functions.82 Section 17(j)(1) of the Act also requires the SROs’ cooperation and coordination of broker-dealer examination and oversight activities and elimination of any unnecessary and burdensome duplication in the examination process.83 To implement section 17(d)(1) of the Act, the Commission adopted two rules thereunder: Rule 17d–1 and Rule 17d– 2. Rule 17d–1 authorizes the Commission to name a single SRO as the DEA to examine a common SRO member (i.e., a broker-dealer that is a member of the DEA SRO as well as other SROs) for compliance with the financial responsibility requirements imposed by the Act, Commission rules, or the rules of the SROs where the broker-dealer is a member.84 When an SRO has been named as a common member’s DEA, all other SROs to which the common member belongs are relieved of the responsibility to examine the firm for compliance with the applicable financial responsibility rules. Rule 17d–1 addresses only an SRO’s obligations to enforce member compliance with financial responsibility requirements. Rule 17d–1 does not relieve an SRO from its obligation to examine a common member 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. To further address regulatory duplication, the Commission also adopted Rule 17d–2 under the Act. Rule 17d–2 permits SROs to propose joint plans for the allocation of regulatory responsibilities with respect to their common members. 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. FINRA has experience coordinating with exchanges in the oversight of broker-dealers that are common members of FINRA and the exchanges on which they trade securities pursuant to such plans.85 Such coordination among FINRA and exchange SROs pursuant to Rule 17d–2 plans cannot occur, however, with respect to broker-dealer firms that are not FINRA members.86 Rule 17d–1 DEA arrangements and Rule 17d–2 plans are relevant with respect to commenters’ concern that 83 Section 17(j)(1) of the Act, 15 U.S.C. 78q(j)(1). CFR 240.17d–1. See supra note 13; see also 2022 Re-Proposal, supra note 1, 87 FR 49933; Securities Exchange Act Release No. 12352 (Apr. 20, 1976), 41 FR 18808 (May 7, 1976). 85 See Staff Paper on Cross-Market Regulatory Coordination, supra note 14. 86 RSAs are mechanisms through which such coordination can occur, but they are subject to limitations including that they do not relieve the contracting SRO of its legal responsibilities to provide SRO oversight or provide FINRA with jurisdiction. See supra note 14 and the discussion infra in this section. ddrumheller on DSK120RN23PROD with RULES2 84 17 79 See 2022 Re-Proposal, supra note 1, 87 at 49934 n. 46. 80 See 2022 Re-Proposal, supra note 1, 87 FR 49934; Cross-Market Regulatory Coordination Staff Paper, supra note 14. See also Cboe Letter at 4 (stating that the exchanges know their markets best, including the products traded, the intricacies of the trading mechanics, and their members’ business models). 81 See supra section II.B; see also 2022 ReProposal, supra note 1, 87 FR 49935–40. 82 Section 17(d) of the Act, 15 U.S.C. 78q(d). VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 61857 direct, membership-based FINRA oversight of broker-dealer firms would duplicate exchange SRO oversight.87 Mitigating duplicative SRO oversight is the primary purpose of these regulatory arrangements.88 To the extent brokerdealer firms join FINRA as a result of the amendments to Rule 15b9–1 89 and are members of one or more exchanges, Rule 17d–1 could be utilized to mitigate duplicative oversight with respect to financial responsibility by exchange SROs and FINRA over these common members. And Rule 17d–2 plans could similarly be utilized by exchange SROs and FINRA to mitigate the potential for duplicative SRO oversight over their common members in areas other than financial responsibility. This is what occurs today with common SRO members, and therefore the Commission believes the same will likely occur for proprietary trading broker-dealer firms that are exchange members and newly join FINRA as a result of these amendments.90 FINRA has entered into RSAs with certain exchange SROs, which allow for some SRO oversight of off-memberexchange equities and options trading activity by proprietary trading brokerdealer firms that are exchange members 87 See supra note 13. See also Group One Letter at 3 (stating that the Commission should ensure that FINRA serves as the DEA for options market making firms that newly join FINRA as a result of the amendments to Rule 15b9–1 so that these firms do not pay DEA fees that are duplicative of their current DEA fees paid to an exchange). 88 See Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR 49091 (Nov. 8, 1976); see also note 13, supra. 89 See infra sections V.B.1 and V.C.2.d (discussing firms’ options for complying with the amendments, and that a firm may choose to join additional exchanges rather than FINRA when the costs of joining FINRA exceed the costs of joining additional exchanges to cover all of the exchanges on which the firm currently trades). 90 Generally, FINRA is the DEA for financial responsibility rules for exchange members that also are members of FINRA. See 2022 Re-Proposal, supra note 1, 87 FR 49935 n. 55; see also CrossMarket Regulatory Coordination Staff Paper, supra note 14 (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’’). Some exchanges serve as DEA for certain of their members, but these cases mostly involve 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. See 2022 Re-Proposal, supra note 1, 87 FR 49956 and n. 228. E:\FR\FM\07SER2.SGM 07SER2 61858 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 but not FINRA members.91 RSAs can serve useful purposes, but they generally are not publicly available and are not subject to Commission approval. Rather, they 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. As a result, to the extent oversight is performed on non-FINRA member firms’ off-member-exchange securities trading activity based on RSAs, such oversight relies upon discretionary arrangements between exchanges and FINRA insofar as equities and options are concerned; and such agreements to date have not covered U.S. Treasury securities trading activity.92 In addition, under an RSA, FINRA examines for compliance with the rules of the exchange with which it has entered into the RSA.93 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 provides the potential for a less stable and consistent regulatory regime for the covered off-memberexchange securities transactions than one in which Association membership and oversight is mandated.94 Moreover, there is no regulatory requirement that any RSA pursuant to which FINRA oversight currently is applied to a non91 See FINRA Letter at 4 (stating that Rule 17d– 2 plans and RSAs are not without their limitations). 92 See id. at 8. 93 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 firm that is a member of the exchange but not a FINRA member is for compliance with the exchange’s rules, not FINRA’s rules, since FINRA’s rules apply only to its members. 94 See FINRA Letter at 5 (stating that RSAs are privately negotiated contracts, vary in their scope of regulatory coverage, and can be terminated by the parties thereto; that FINRA examines for compliance with the rules of certain individual exchanges under RSAs and, therefore, firms that are not FINRA members may be subject to different exchange rules and interpretations with respect to the same activity; and that RSAs do not provide FINRA with membership-based jurisdiction to directly enforce such firms’ compliance with the Federal securities laws or subject such firms to FINRA’s rules for their OTC trading, even where such trading may not be comprehensively addressed by exchange rules or RSAs). As a result of amended Rule 15b9–1, any broker-dealer that effects off-member-exchange securities transactions will need to join an Association, pursuant to section 15(b)(8) of the Act, unless the broker-dealer’s offmember-exchange securities transactions are covered by an exemption in the amended rule. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 FINRA member broker-dealer’s offmember-exchange securities trading activity must continue to exist.95 One commenter stated that firms still will be subject to multiple sets of rules and interpretations if amended Rule 15b9–1 is adopted as re-proposed, and that it will be important for FINRA to continue to work collaboratively as part of the Cross-Market Regulation Working Group (‘‘CMRWG’’), a subgroup of the ISG.96 The ISG was established in 1981 and is an international group of exchanges, market centers, and market regulators that perform front-line market surveillance in their respective jurisdictions. The group was formed to facilitate the coordination and development of programs and procedures to identify possible fraudulent and manipulative activities across markets and to facilitate information sharing related to those efforts. In 2020, the CMRWG was established with U.S. SROs as a working group of the ISG’s U.S. Subgroup to focus on ways to reduce unnecessary regulatory duplication.97 The Commission agrees that continued collaboration will be important. One commenter stated that an exchange can take action against its member for exchange rule violations associated with the conduct of a nonmember broker-dealer that accessed the exchange through the member, or the exchange may refer the activity to another SRO.98 This commenter also stated that the access-providing exchange member is likely to be a FINRA member.99 Similarly, other commenters stated that options trading firms that are members of exchanges where they trade options do not need to be FINRA members because, when they conduct off-member-exchange trading activity, they do so through a FINRA member broker-dealer.100 In the same vein, one commenter stated that volume effected by options trading firms in the equities markets is often processed through FINRA members and, thus, options trading firms effectively trade like customers, making a requirement 95 See infra section V (setting forth expiration dates for RSAs). 96 See Nasdaq Letter at 3; see also Cboe Letter at 5 (discussing the formation of the ISG and CMRWG to facilitate coordination among the SROs). 97 See FINRA Information Notice—4/8/20 available at https://www.finra.org/rules-guidance/ notices/information-notice-040820 (informing members of the existence and role of the CMRWG). 98 See Cboe Letter at 4. 99 See id. at 2–3. 100 See, e.g., CTC Letter at 3; Group One Letter at 2. PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 that they join FINRA no more useful than requiring FINRA registration for any non-broker-dealer customers that trade in the equities market through a FINRA registered broker-dealer.101 In response, the Commission does not believe that its concerns regarding nonFINRA member broker-dealers that effect off-member-exchange securities transactions are addressed when such broker-dealers act in the capacity of a customer of another broker-dealer that is a FINRA member. A broker-dealer acting in a customer capacity does not provide a basis for regulatory oversight of that broker-dealer’s off-memberexchange activities as required by section 15(b)(8) when the broker-dealer is not a FINRA member. The Commission believes that such activities should be subject to direct, membership-based FINRA oversight, which carries with it an obligation to comply with FINRA’s rules and FINRA’s direct examination authority. This is not accomplished when a broker-dealer acts as a customer of a FINRA member but is not itself a FINRA member. In addition, in the scenarios presented by commenters, neither the exchange where the violative conduct occurred nor FINRA would have direct authority to address the conduct of the brokerdealer that is not a member of the exchange (and is not a FINRA member). If the exchange referred the matter to another exchange SRO where the broker-dealer is a member, the two exchanges could have different rules or different interpretations of their respective existing rules. In other words, there would be separate recourse by separate exchanges with potentially different rules or rule interpretations against different broker-dealers for the same conduct on one of the exchanges. The Commission believes this presents the potential for inconsistent outcomes, as the exchange where the conduct occurred could choose to pursue recourse against its member but the referred-to exchange could, for the same conduct, choose not to pursue recourse against its member. A requirement that all broker-dealers that effect offmember-exchange securities transactions become FINRA members (if not exempt under amended Rule 15b9– 1) is more consistent with the protection of investors and the public interest. If both broker-dealers were FINRA members in the scenarios presented by 101 See E:\FR\FM\07SER2.SGM Cboe Letter at 2–3. 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 commenters, FINRA could take a consistent approach in addressing both broker-dealers’ involvement in the conduct. Exchange SRO rules would, of course, continue to apply to broker-dealer firms that are exchange members and become FINRA members as a result of the amendments to Rule 15b9–1.102 The potential for inconsistent recourse by exchanges where such firms are a member could, therefore, continue to exist. But such firms would be common members of FINRA and their member exchanges, and SROs have a statutory obligation to eliminate unnecessarily duplicative oversight of their common members.103 While FINRA rules and exchange rules would apply to such firms, the Commission believes that Rule 17d–1 DEA designations and Rule 17d–2 plans will likely be utilized in areas of overlap to mitigate duplicative application of exchange SRO and FINRA oversight, in the same fashion as they already are utilized for the many broker-dealer firms that are exchange members and FINRA members. As a result, with respect to broker-dealer firms that become FINRA members and are exchange members, the Commission believes that FINRA likely will be the only SRO with regulatory responsibility regarding these firms’ compliance with rules that FINRA and their member exchange(s) have in common.104 Moreover, FINRA already directly regulates cross-market and off-exchange trading activity by FINRA members for compliance with FINRA rules, and would extend that direct oversight to new FINRA members’ off-memberexchange activity (without needing to rely on RSAs to do so). Exchange SROs would remain primarily responsible for their members’ on exchange activity (subject to Rule 17d–1 DEA designations, Rule 17d–2 plans, or RSAs). This complementary structure with FINRA as the SRO primarily responsible for off-member-exchange activity by FINRA members and exchange SROs primarily responsible for member exchange activity is consistent with the Exchange Act’s statutory framework, which places SRO oversight responsibility with an Association for off-member-exchange securities trading.105 102 See, e.g., Cboe Letter at 6 (stating that requiring FINRA membership for non-member FINRA firms would add regulatory duplication and administrative burden to the firms and SROs with whom the firm is already a member). 103 See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1). 104 See infra note 275 (stating that FINRA serves as the DEA for the majority of member firms). 105 See supra note 26 and accompanying text. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 61859 The Commission also does not believe that the CAT mitigates the need for proprietary trading broker-dealer firms that effect off-member-exchange securities transactions to be required to join FINRA, as was asserted by some commenters.106 The CAT is an important audit trail tool through which exchange SROs and FINRA are able to perform surveillance of trading activity in NMS and OTC securities using CAT data.107 In addition, FINRA has stated that it surveils 100% of the equities and options markets with CAT data.108 But access to CAT data does not confer jurisdiction to FINRA over a firm that is not a FINRA member and that trades securities off-member-exchange.109 As a result, when FINRA encounters potentially problematic conduct by firms that are not FINRA members,110 it lacks the independent ability to examine for and investigate potential violations of, or enforce compliance with, the Federal securities laws, Commission rules, or FINRA rules.111 Moreover, 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.112 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 pursuant to RSAs is, as discussed above in this section, a less certain and stable approach 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 off-memberexchange securities transactions.113 And any such coordinated efforts would not apply to U.S. Treasury securities trading activity, which is not reported to the CAT and not covered by RSAs. In short, even with this coordination, FINRA would still not have direct membershipbased jurisdiction over the firm. This limitation impedes stable and consistent SRO oversight of off-member-exchange securities trading activity through direct, membership-based FINRA jurisdiction by continuing the dependence upon RSAs for such oversight,114 and impedes comprehensive SRO oversight of offmember-exchange securities trading activity since RSAs, the CAT, and coordinated regulatory efforts using these tools do not cover U.S. Treasury securities trading activity.115 106 See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe Letter at 2–3; STA Letter at 2–3; ABCV Letter at 3; PEAK6 Letter at 3; Group One Letter at 2; CTC Letter at 4. 107 Exchange rules require their members to report to CAT. See, e.g., Cboe BYX Rules 4.5 through 4.17; Nasdaq General 7; NYSE Rule 6800. 108 See FINRA Letter at 6. 109 Id. See also Concept Release Concerning SelfRegulation, supra note 20, 69 FR 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. 110 See, e.g., FINRA Letter at 5; 6/20/23 Meeting Memorandum (stating that FINRA identified nonFINRA member broker-dealer firms as potential respondents in 5% of the market regulation investigations it conducted in 2020 and 2021, which ranged across asset types and included both cross-exchange and off-exchange conduct). 111 See FINRA Letter at 6. Such a case may be referred to the Commission or an exchange where the firm is a member for further investigation. 112 See 2022 Re-Proposal, supra note 1, 87 FR 49938. 113 See Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8); 2015 Proposing Release, supra note 1, 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 14 (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. 114 As discussed above in this section, if FINRA has an RSA with a given exchange, FINRA is able to apply that exchange’s rules to off-memberexchange activity by members of that exchange, even if they are not FINRA members, assuming that the RSA assigned to FINRA the oversight of those rules. But RSAs are not required to continue to exist pursuant to any regulatory requirement, and exchanges with potentially different rules and interpretations thereof retain legal responsibility and decision-making authority under RSAs, which could lead to inconsistent outcomes. FINRA does not need to rely on RSAs for its oversight of FINRA members, and so it can apply its jurisdiction directly to FINRA members’ off-member-exchange trading activity. Further, for FINRA member firms that also are exchange members, Rule 17d–1 DEA designations and Rule 17d–2 plans could be utilized in areas of overlap to mitigate duplicative application of exchange and FINRA oversight. 115 See FINRA Letter at 6 (stating that ‘‘there are key regulatory limitations that remain when FINRA encounters potentially problematic Non-Member PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 E:\FR\FM\07SER2.SGM Continued 07SER2 61860 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 Relatedly, the Commission continues to believe that direct, membership-based FINRA jurisdiction is necessary for proprietary trading broker-dealer firms that effect transactions in U.S. Treasury securities, and that FINRA oversight would not duplicate any exchange SRO oversight in this area.116 U.S. Treasury securities are not traded on any exchange, and to the Commission’s knowledge, unlike FINRA,117 no exchange SRO possesses expertise on U.S. Treasury securities trading activity. Further, as discussed above in this section, U.S. Treasury securities trading activity also is not covered by RSAs between exchange SROs and FINRA, so RSAs are not a mechanism through which FINRA currently could apply exchange rules (to the extent any would be applicable) to U.S. Treasury securities trading activity by proprietary trading broker-dealer firms that are exchange members but not FINRA members. Thus, aside from certain surveillances (other than the CAT),118 no SRO oversight is performed with respect to the U.S. Treasury securities trading activity of proprietary trading broker-dealer firms that are not FINRA members. For example, FINRA stated that, subject to audit trail limitations, it has observed that firms that are not FINRA members were identified in 17 percent of the surveillance alerts generated by its U.S. Treasury security manipulation pattern surveillance in 2020 and 2021.119 FINRA has no jurisdiction over Firm conduct’’ via audit trail data and that the limitations posed by RSAs ‘‘impede comprehensive OTC and cross-market oversight in the equities, options, and fixed income markets’’). 116 Some commenters agreed with the Commission. See, e.g., Cboe Letter at 2 (stating that Cboe believes it is appropriate for broker-dealers that are not FINRA members that effect fixed income transactions to register with FINRA to ensure FINRA insight into, and sufficient regulatory coverage of, those transactions). 117 See FINRA Letter at 8 (stating that individual fixed income securities generally are not traded on exchange and their markets rely exclusively on FINRA oversight); see also supra note 76. 118 See FINRA Letter at 10 (stating that FINRA surveils and examines for manipulative or other illegal activity in the fixed income market, including with respect to U.S. Treasury securities trading). As discussed above in this section, trading activity in U.S. Treasury securities is not reported to the CAT, so the CAT is not a tool that can be used by SROs to surveil that activity. A commenter suggested that the Commission could require that TRACE data and other securities trading data be reported to the CAT. See Phillip Letter. Such an undertaking would not, however, provide FINRA with needed, membership-based jurisdiction over broker-dealers that trade U.S. Treasury securities. 119 See FINRA Letter at 10; see also Better Markets Letter at 9. The 17% figure reflects an upper bound of the rate at which Commissionregistered broker-dealers that are not FINRA members appeared in the alerts generated by FINRA’s U.S. Treasury security manipulation VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 such firms and, therefore, no authority to address their involvement in potential market misconduct that is identified.120 Since, to the Commission’s knowledge, no exchange SRO has expertise or performs oversight in this area, broker-dealer firms that are not FINRA members may participate in the U.S. Treasury securities market effectively without SRO oversight applied to their activity in that market (other than, as discussed below, what can be discerned by regulators when non-FINRA member broker-dealer U.S. Treasury securities transactions are reported to TRACE by FINRA members).121 This rulemaking would facilitate oversight consistent with the protection of investors and the public interest. Insofar as U.S. Treasury securities transaction reporting and transparency in particular are concerned, FINRA’s TRACE system is the regulatory vehicle that facilitates mandatory reporting of OTC transactions in U.S. Treasury securities, among other eligible fixed income securities.122 But as discussed in the 2022 Re-Proposal, proprietary trading broker-dealer firms that are not FINRA members are not required to pattern surveillance in 2020 and 2021. See 6/20/23 Meeting Memorandum. The Commission understands that the actual rate at which Commission-registered broker-dealers that are not FINRA members appeared in these alerts is likely lower than 17%, as some portion of the alerts may have involved non-FINRA member proprietary trading firm entities that are not Commissionregistered broker-dealers. Id. More precise estimates are not possible in light of the way proprietary trading firms are identified under current audit trail rules and the way FINRA evaluates conduct by potentially affiliated entities. Id. 120 See FINRA Letter at 10. 121 As discussed below in this section, the Commission retains authority over broker-dealers, but the Exchange Act contemplates dual layers of oversight of broker-dealers through such Commission authority working in tandem with SRO authority. The focus here is on strengthening the SRO layer of oversight. 122 See FINRA Rule 6700 series. FINRA publishes aggregated transaction information and statistics on U.S. Treasury securities on its website. See FINRA.org, Treasury Aggregate Statistics, available at https://www.finra.org/finra-data/browse-catalog/ about-treasury (last visited Aug. 9, 2023); FINRA Rule 6750, Supplementary Material .01(b); see also Securities Exchange Act Release No. 95438 (Aug. 5, 2022), 87 FR 49626 (Aug. 11, 2022) (File No. SR– FINRA–2022–017) (order approving FINRA publication of aggregated U.S. Treasury securities transactions more frequently than weekly, such as on a daily basis). Also, pursuant to effective national market system plans which are also effective transaction reporting plans (as both terms are defined in 17 CFR 242.600(b) (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 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; section VIII.B of the Nasdaq UTP Plan. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 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.123 Thus, exchange SRO membership alone is not enough to subject proprietary trading broker-dealer firms that effect U.S. Treasury securities transactions to FINRA’s reporting requirement for such transactions. When a non-FINRA member brokerdealer trades U.S. Treasury securities through a ‘‘covered ATS,’’ the covered ATS is obligated in its TRACE report to identify the non-FINRA member brokerdealer via its Market Participant ID (‘‘MPID’’),124 thus providing visibility to regulators as to what transactions on covered ATSs are attributable to nonFINRA members.125 But regulators have no such visibility when non-FINRA member broker-dealers trade U.S. Treasury securities otherwise than on a covered ATS. If non-FINRA member broker-dealers trade on a non-covered ATS or bilaterally with a counterparty that is a FINRA member or covered depository institution, the ATS or FINRA member or covered depository institution reports the trade, but the non-FINRA member is not specifically identified via a MPID and instead is identified only as a ‘‘customer.’’ 126 If 123 See FINRA Rule 6720—Participation in TRACE; see also 2022 Re-Proposal, supra note 1, 87 FR 49938. Since Sept. 1, 2022, certain depository institutions (‘‘covered depository institutions’’) have been 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-reservedepository-institution-reporting (last visited Aug. 8, 2023). In addition, in order to enhance the regulatory audit trail and ensure data is reported in a more timely manner, FINRA adopted amendments to Rule 6730 to require members to report U.S. Treasury securities transaction data in the smallest increment available to the member and as soon as practicable, but no later than 60 minutes following a transaction. See Securities Exchange Act Release No. 95635 (Aug. 30, 2022), 87 FR 54579 (Sept. 6, 2022). 124 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities. 125 In the proposal the Commission issued in Jan. 2022 to, among other things, amend Regulation ATS for ATSs that trade U.S. government securities, and the reopening release issued in Apr. 2023, which provides supplemental information and economic analysis on the Jan. 2022 proposal, the Commission estimated that there would be a number of trading systems that would be required to comply with Regulation ATS under the proposal. See Securities Exchange Act Release Nos. 94062 (Jan. 26, 2022), 87 FR 15496, 15585 (Mar. 18, 2022); 97309 (Apr. 14, 2023), 88 FR 29448, 29466 (May 5, 2023). 126 In 2022, there were approximately 60 million transactions reported in U.S. Treasury securities, totaling $165 trillion in dollar volume. Approximately 35.7 million of those transactions, E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 non-FINRA member broker-dealers trade U.S. Treasury securities otherwise than on an ATS and with a counterparty that is not a FINRA member and not a covered depository institution, there is no TRACE reporting obligation and the trade is not reported.127 The Commission continues to believe that regulators’ lack of visibility into U.S. Treasury securities transactions effected by proprietary trading brokerdealer firms that are not FINRA members, in the circumstances described above in which such firms are not identified by MPID in TRACE data, detracts from the comprehensiveness of U.S. Treasury securities TRACE data and regulators’ ability to utilize that data to reconstruct market events, and detect and deter improper trading activity in the U.S. Treasury securities market.128 The Commission does not representing approximately $64 trillion in dollar volume, were executed on ATSs. The balance of approximately 24.3 million reported transactions, or $100 trillion in dollar volume, that was not traded on an ATS was reported by FINRA members with a counterparty that, if not a FINRA member, was identified as a ‘‘customer’’ in the reported data. The Commission estimates that approximately 12.7 million transactions and $60 trillion in dollar volume not executed on an ATS had a counterparty identified as a ‘‘customer’’ in the reported data. This represents 52% of the 24.3 million transactions and 60% of the $100 trillion in dollar volume not executed on an ATS, or 21% of the 60 million total transactions and 36% of the $165 trillion total dollar volume. Further, the Commission estimates that, of the 35.7 million transactions and $64 trillion in dollar volume executed on an ATS, approximately 98.2% of that transaction volume and 99% of that dollar volume was executed on a covered ATS; approximately 1.8% of the 35.7 million transactions and 1% of the $64 trillion dollar volume, representing approximately 0.6 million transactions and $536 billion, respectively, was executed on a noncovered ATS; and approximately 4.8% of the 0.6 million transactions and 22% of the $536 billion in dollar volume executed on a non-covered ATS, representing approximately 15,000 transactions and $59 billion, respectively, was reported with a counterparty identified as a ‘‘customer.’’ Customer volume and transaction counts are calculated as half the sum of ATS-to-customer buys and ATS-tocustomer sells. 127 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 Aug. 9, 2023). The non-FINRA member is, however, identified in CAT in this context. 128 For example, in a Nov. 2021 report, an interagency working group comprised of staff of the U.S. Department of the Treasury, Commission, Commodity Futures Trading Commission, Federal Reserve Bank of New York, and Board of Governors of the Federal Reserve System stated that ‘‘[i]n March 2020, large flows from investors were captured by TRACE data but were not identifiable VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 know if all U.S. Treasury securities transactions by non-FINRA member broker-dealer firms are reported to TRACE, and for those that are reported, any non-FINRA member broker-dealer firm that is a counterparty remains anonymous if the transaction did not occur on a covered ATS. As a result, the Commission cannot quantify total secondary market trading by brokerdealers in U.S. Treasury securities, and regulators cannot readily identify from TRACE when a non-FINRA member broker-dealer is the source of reported U.S. Treasury securities order flows executed otherwise than on a covered ATS and cannot link any such order flows to any particular non-FINRA member broker-dealer.129 Moreover, broker-dealers that are not FINRA members have a potential competitive advantage over those that are FINRA members, as FINRA members incur the costs of reporting transactions in U.S. Treasury securities transactions but non-FINRA members do not.130 Some commenters broadly agreed with the Commission’s concern, expressed in the 2022 Re-Proposal, regarding transparency and reporting of U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members.131 Other commenters stated that there is no reporting gap that must be addressed with respect to U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members because, according to the commenters, existing TRACE reporting requirements meaningfully capture effectively all proprietary broker-dealer U.S. Treasury securities transactions.132 beyond the FINRA-member dealer intermediary that facilitated the trade. Understanding the source of these flows required the official sector to contact dealers, wait for other datasets that are significant lagged, and rely on separate sources of information.’’ See U.S. Dep’t of the Treasury et al., Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report (Nov. 8, 2021) (‘‘2021 Interagency Report’’) available at https://home.treasury.gov/system/files/136/IAWGTreasury-Report.pdf. 129 See id. 130 See supra section V.C.2 for estimated costs of TRACE reporting. 131 See FINRA Letter at 9 (stating that FINRA has no visibility into the identity of non-FINRA firms for U.S. Treasury securities transactions that occur otherwise than on a covered ATS or on any other non-ATS platform); Better Markets Letter at 9 (stating that a significant proportion of U.S. Treasury securities transaction activity is performed on a bilateral basis without data reporting requirements, and that this lack of visibility undermines regulators’ ability to monitor risks, understand how those risks evolve into potentially systemic risks, and react to them in real-time, and inhibits robust price discovery) (citing 2021 Interagency Report, supra note 128); Cboe Letter at 9. 132 See FIA/PTG Letter at 3 (acknowledging concerns regarding the identification of non-FINRA PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 61861 One of these commenters also stated that potential concerns around the identification of non-FINRA member counterparties to U.S. Treasury securities transactions on non-covered ATSs are not implicated by proprietary broker-dealer transactions in any meaningful way, or could be remedied by requiring that such transactions be reported with account ownership identifiers, which, according to the commenter, would not necessitate FINRA membership.133 Similarly, other commenters suggested, as an alternative to what the Commission has proposed, an approach under which proprietary trading broker-dealer firms could remain exempt from section 15(b)(8)’s Association membership requirement so long as they report their U.S. Treasury securities transactions to FINRA’s TRACE system.134 The reporting requirements suggested by commenters could help address the potential anonymity of proprietary trading broker-dealer firms in TRACE data. But as discussed above in this section, a lack of transparency to regulators when non-FINRA member broker-dealers trade U.S. Treasury securities—and the resulting difficulty it poses for regulators when trying to identify the source of U.S. Treasury securities order flows, detect and deter improper trading activity, and reconstruct market events—is not the full scope of what the Commission believes must be addressed. There also is the necessity, described above in this section, for FINRA to have the authority to allow it to independently examine for, investigate, or address potential offmember-exchange misconduct by proprietary trading broker-dealer firms in the securities markets, including the member counterparties but noting they are not aware of the situation applying to proprietary broker-dealer transactions in a ‘‘meaningful’’ way); MMI Letter at 2 (arguing CAT and TRACE data ‘‘effectively captures’’ all proprietary broker-dealer transactions). It is difficult to assess the accuracy of the commenter statement that there is no reporting gap with respect to U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members because, as discussed above in this section, if non-FINRA member broker-dealers trade U.S. Treasury securities otherwise than on an ATS and with a counterparty that is not a FINRA member and not a covered depository institution, there is no TRACE reporting obligation and the trade is not reported. And even when a non-FINRA member brokerdealer’s transactions in U.S. Treasury securities are reported by a counterparty that does have a TRACE reporting obligation, such as a FINRA member or covered depository institution, the non-FINRA member is identified only as ‘‘customer’’ in the reported data unless the transaction occurred on a covered ATS. 133 See FIA/PTG Letter at 3. 134 See, e.g., PEAK6 Letter at 6; Group One Letter at 2; CTC Letter at 3; Cboe Letter at 7; Virtu Letter at 7. E:\FR\FM\07SER2.SGM 07SER2 61862 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 markets for U.S. Treasury securities, equities and options. Such FINRA authority is necessary notwithstanding the Commission’s authority over brokerdealers in order to strengthen the SRO layer of oversight of off-memberexchange securities trading, consistent with the dual Commission and SRO oversight of broker-dealers required by the Exchange Act.135 As a membershipbased organization, FINRA’s jurisdiction, and thus its authority, is limited to its members and their associated persons. As such, authority to independently examine, investigate, or enforce potential violations against non-FINRA member broker-dealers is not conferred to FINRA through reporting requirements without FINRA membership. For example, FINRA stated that it identified non-FINRA member broker-dealer firms as potential respondents in five percent of the market regulation investigations it conducted in 2020 and 2021, which ranged across asset types and included both cross-exchange and off-exchange conduct), and FINRA identified nonFINRA member firms in 17 percent of the surveillance alerts generated by its U.S. Treasury security manipulation pattern surveillance in 2020 and 2021.136 If those non-FINRA member firms could remain exempt from section 15(b)(8)’s Association membership requirement as long as they report their U.S. Treasury securities transactions to TRACE, FINRA would continue to lack the independent ability to examine and investigate those firms to generate evidence, such as by collecting documents and interviewing witnesses. In contrast, the rescission of the de minimis allowance and proprietary trading exclusion helps solve both for the need for FINRA authority over offmember-exchange securities trading activity and for the anonymity in TRACE data of proprietary trading broker-dealer firms when they trade U.S. Treasury securities otherwise than 135 See supra note 22 (stating that 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). 136 See FINRA Letter at 5, 10; see also 6/20/23 Meeting Memorandum (specifying that non-FINRA member broker-dealer firms made up the 5% of the market regulation investigations that FINRA conducted in 2020 and 2021, and that the 17% figure reflects an upper bound of the rate at which Commission-registered broker-dealers that are not FINRA members appeared in the alerts generated by FINRA’s U.S. Treasury security manipulation pattern surveillance in 2020 and 2021). VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 on a covered ATS. Under the adopted approach, proprietary trading brokerdealer firms that effect off-memberexchange securities transactions and that become FINRA members will be subject to direct, membership-based FINRA jurisdiction. Further, those that effect U.S. Treasury securities transactions otherwise than on a covered ATS will be specifically identified by MPID in TRACE.137 In addition to discussing existing regulatory mechanisms and suggesting reporting-specific requirements as alternatives to FINRA membership, commenters addressed the Commission’s position, set forth in the 2022 Re-Proposal, that it is appropriate for FINRA to exercise direct, membership-based oversight over firms that do not carry customer accounts.138 FINRA agreed with the Commission that direct, membership-based FINRA oversight over proprietary trading broker-dealer firms would be appropriate even though they typically do not carry customer accounts.139 FINRA stated that active trading firms have the potential to introduce risk into the markets even where they do not have customers, and for that reason, FINRA’s rules and regulatory programs cover a cross section of activity and risks beyond sale practices.140 FINRA stated that certain member risk controls overseen by FINRA are particularly relevant to proprietary trading dealer firms, such as controls for credit risk to counterparties, market risk, market integrity risk, and liquidity risk.141 FINRA also observed that while nonFINRA members may not have customers of their own, they nonetheless can have a significant role executing customer orders routed to 137 See FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities. FINRA membership also would require that such firms be identified in off-exchange NMS stock transaction reports to FINRA’s TRFs, and thus promote broader public market transparency in NMS stocks. 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; see also supra note 17; 2022 Re-Proposal, supra note 1, 87 FR 49942. 138 See, e.g., FINRA Letter at 11; ABCV Letter at 2; PEAK6 Letter at 2; Group One Letter at 1–2; letter from James Toes, President & CEO, and Kate McAllister, Chair of the Board, Securities Traders Association (Oct. 5, 2022) (‘‘STA Letter’’) at 3–4. 139 See FINRA Letter at 11 (stating that certain proprietary trading dealer firms that are not FINRA members have a significant market footprint and the scope of their activities introduces a moderate to high degree of risk to the market and market counterparties). 140 See id. 141 Id. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 them by other broker-dealers.142 Other commenters stated that FINRA regulation is customer-focused and not appropriate for proprietary trading firms that do not carry customer accounts.143 The Commission continues to believe that it is appropriate for FINRA to have direct, membership-based jurisdiction over proprietary trading broker-dealer firms that effect off-member-exchange securities transactions even though such firms typically do not carry customer accounts. As discussed above,144 several non-FINRA member broker-dealer firms that do not carry customer accounts effect significant volumes of offmember-exchange securities transactions. The Commission believes that such firms—and such trading activity—should not remain exempt from FINRA’s direct, membership-based oversight on the basis that such firms do not carry customer accounts. FINRA’s ability to create a consistent regulatory framework for all broker-dealers that effect off-member-exchange securities transactions is undermined by the subset of such broker-dealers that do not carry customer accounts and are not FINRA members in reliance on Rule 15b9–1.145 The rescission of the de minimis allowance and proprietary trading exclusion will help address this by eliminating the legal basis upon which such firms generally are able to effect off-member-exchange securities transactions without joining FINRA. In particular, as discussed in the 2022 Re-Proposal, FINRA is well-positioned to exercise direct oversight over such firms. 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.146 For example, 142 See id. at 7–8. e.g., ABCV Letter at 2; PEAK6 Letter at 2; Group One Letter at 1–2; STA Letter at 3–4. 144 See section II.B, supra. 145 See FINRA Letter at 11 (stating that FINRA jurisdiction over proprietary trading dealer firms and the ability to identify their activity in all of FINRA’s audit trails would further enable FINRA to assess individual entities’ impacts on the market and market counterparties, and that the 2022 ReProposal would enable FINRA to directly and more comprehensively oversee such firms and their trading activity, which, in turn, would enhance market integrity and foster the maintenance of fair, orderly, and efficient markets); Better Markets Letter at 5 (stating that the amendments to Rule 15b9–1 would ‘‘help ensure that dealers such as high-frequency trading firms, which conduct an enormous volume of trading, are subject to consistent and robust oversight through FINRA, not only the more narrow regulatory requirements that are specific to each exchange’’). 146 Many broker-dealer firms that derive all or most of their revenue from proprietary trading already are FINRA members. See Securities 143 See, E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 FINRA, not unlike exchanges, has developed a detailed set of rules in core areas such as trading practices,147 business conduct,148 financial condition and operations,149 and supervision,150 many of which apply to FINRA members regardless of whether they handle customer orders or carry customer accounts.151 As another example, FINRA’s transaction reporting regime is not limited to broker-dealers with customers and applies to FINRA members regardless of whether they Exchange Act Release No. 97798 (June 26, 2023), 88 FR 42404, 42406 (June 30, 2023) (‘‘TAF Amendment’’) (stating that FINRA estimates that approximately 66 member firms derive all or most of their revenue from proprietary trading). As FINRA members, these broker-dealers are subject to FINRA’s rules and FINRA’s direct jurisdiction even though they effect securities transactions for their own account and not on behalf of customers. 147 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) (stating, 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’’). 148 See FINRA Rule 2000 Series—Duties and Conflicts. 149 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.’’ 150 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. 151 See, e.g., the FINRA rules set forth in notes 17–18, 56–57, 122–124, 137 and 147–150, and accompanying text, supra. In addition, FINRA has regulatory programs and staff dedicated to fixed income regulation. See FINRA.org, Key Topics— Fixed Income, available at https://www.finra.org/ rules-guidance/key-topics/fixed-income#overview. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 handle customer orders or carry customer accounts.152 Continuing to permit an exemption from FINRA membership on the basis that brokerdealers 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 TRACE data or address the potential competitive advantage of non-FINRA member broker-dealers that, unlike FINRA member broker-dealers, may trade U.S. Treasury securities without incurring the costs of reporting those trades to TRACE. The Commission also continues to believe that it is important to the protection of investors and the public interest that FINRA has direct, membership-based jurisdiction over proprietary trading broker-dealer firms that effect off-member-exchange securities transactions regardless of whether they carry customer accounts. An Association’s regulatory responsibility, like exchange SROs’, includes an obligation to enforce compliance with the Federal securities laws and rules thereunder and the SRO’s rules. As an Association, the Exchange Act’s statutory framework places SRO oversight responsibility with FINRA for off-member-exchange securities trading, and FINRA is wellpositioned to carry out this responsibility with respect to its members. For example, FINRA gains familiarity with a member’s operational risk by assigning dedicated staff members to each firm (e.g., a Risk Monitoring Analyst to act as the primary point of contact and a Risk Monitoring Director) and having staff with subject matter expertise relevant to a member’s business model conduct examinations and carry out monitoring duties.153 Firms are classified into five primary business models and then further sorted into various subgroups overseen by exam and risk monitoring staff.154 Risk monitoring teams seek to understand the unique aspects of each firm monitored, and use that expertise to inform exam staff in the preparation of exams. Employing a risk-based 152 See FINRA Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities). 153 See FINRA Risk Monitoring Program, FINRA, available at https://www.finra.org/contact-finra/ risk-monitoring-program; FINRA Examination and Risk Monitoring Programs, FINRA, available at https://www.finra.org/rules-guidance/key-topics/ finra-examination-risk-monitoringprograms#overview. 154 See FINRA Examination and Risk Monitoring Programs, FINRA, available at https:// www.finra.org/rules-guidance/key-topics/finraexamination-risk-monitoring-programs#overview. PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 61863 approach, FINRA examines firms on a one, two or four-year frequency and makes use of specialist teams (e.g., antimoney laundering, cybersecurity or fixed income). Further, FINRA gains familiarity with a member’s operational risk through customer complaints and regulatory tips or calls, which may trigger a ‘‘cause’’ exam (in contrast to the routine exams described above) focusing on the issues raised in the complaints.155 Finally, FINRA staff is informed of changes in operational risk associated with a material change in business operations or change of control through FINRA Rule 1017.156 The Continuing Member Application triggered under FINRA Rule 1017, among other things, reviews if the member’s contractual and business relationships support the proposed change, if communications and operational systems are appropriate, financial and internal controls, and the adequacy of the member’s supervisory system to prevent and detect violations.157 The inability of FINRA to directly enforce regulatory compliance by proprietary trading broker-dealer firms that are not FINRA members—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 FINRA may not be as familiar with the firm’s operational risks or other risks posed by the firm’s off-member-exchange securities trading activity as FINRA would be with a FINRA member firm, and FINRA may not be as well positioned potentially to mitigate those risks. In addition, 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.158 155 Id. 156 See FINRA Rule 1017; Form CMA, FINRA, available at https://www.finra.org/registrationexams-ce/broker-dealers/registration-forms/formcma. 157 See Filing a Change in Membership Application, The ‘‘What to Expect’’ Webcast Series (2010), FINRA, available at https://www.finra.org/ sites/default/files/Education/p018711.pdf. 158 FINRA could refer such a matter to the Commission or to an exchange where the firm is a member or, as discussed above in this section, potentially address the matter through an RSA if covered by the terms of the RSA. See also supra note 14. But FINRA may lack certain investigative tools, discussed above in this section, with respect to non-FINRA member broker-dealers that it possesses with respect to FINRA members, which could help FINRA further investigate potentially violative behavior before making a referral to the E:\FR\FM\07SER2.SGM Continued 07SER2 61864 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 As is discussed in the 2022 ReProposal and in more detail in the Economic Analysis, infra section V, firms that become FINRA members as a result of the adopted rule amendments will be required to apply for membership with FINRA and 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.159 These regulatory fees include a Trading Activity Fee (‘‘TAF’’).160 FINRA issued a Regulatory Notice in 2015 in which it proposed 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.161 In June 2023, after the 2022 Re-Proposal, FINRA filed a proposed rule change with the Commission, pursuant to section 19 of the Act, to amend the TAF such that it does not apply to transactions by a proprietary trading firm effected on exchanges of which the firm is a member.162 FINRA Commission or an exchange, or help prevent FINRA from failing to make referrals when they are warranted. See also section V, infra. Further, the Commission believes that regulatory efforts based on discretionary RSA arrangements among exchange SROs and FINRA, while beneficial in many contexts, are a less stable and consistent mechanism for SRO oversight than the FINRA membership required by the Exchange Act in the context presented here, and are less comprehensive than membership-based FINRA oversight because they do not cover U.S. Treasury securities trading activity. 159 See FINRA Schedule A to the By-Laws of the Corporation (‘‘FINRA Schedule A’’), at section 1, available at https://www.finra.org/rules-guidance/ rulebooks/corporate-organization/section-1member-regulatory-fees. 160 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, at section 1(a). 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). FINRA charges its members other fees as well, such as an annual Gross Income Assessment (‘‘GIA’’). See id. at section 1. 161 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 re-opened the comment period on its 2015 Regulatory Notice after the 2022 Re-Proposal. See FINRA Regulatory Notice 22–30, Trading Activity Fee (Dec. 15, 2022) available at https://www.finra.org/sites/default/ files/2022-12/Regulatory-Notice-22-30.pdf. 162 See TAF Amendment. The TAF Amendment’s implementation date, which FINRA will announce in a Regulatory Notice, will be no earlier than the date of the Commission’s adoption of amended Rule 15b9–1 and no later than the effective date of amended Rule 15b9–1. Id. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 designated this proposed rule change as ‘‘establishing or changing a due, fee or other charge’’ under section 19(b)(3)(A)(ii) of the Act and 17 CFR 240.19b–4(f)(2) (‘‘Rule 19b–4(f)(2)’’) thereunder, which renders the rule effective upon filing with the Commission. Comments on the 2022 Re-Proposal, submitted prior to the TAF Amendment, stated that the costs of applying for FINRA membership, as well as ongoing costs of FINRA membership such as the TAF, are high and burdensome and could affect liquidity provision.163 In particular, commenters stated that proprietary options trading firms should remain exempt from section 15(b)(8)’s Association membership requirement because they do not trade U.S. Treasury securities and the equities transaction volume that they effect is hedging activity.164 Commenters urged the Commission to adopt an exemption for proprietary options trading brokerdealer firms, such that their off-memberexchange securities trading activity would not trigger section 15(b)(8)’s Association membership requirement if such activity is to hedge or in furtherance of their options trading activity on their member exchange(s).165 If proprietary options trading firms do not remain exempt, commenters stated, there could be a negative impact on options market liquidity and smaller options trading firms could cease trading, which could lead to consolidation and decreased 163 See, e.g., MMI Letter at 3; PEAK6 Letter at 4– 5; FIA PTG Letter at 4; Group One Letter at 2–3; ABCV Letter at 2–3; CTC Letter at 4; Cboe Letter at 7. One commenter estimated that some proprietary broker-dealers would incur TAF fees greater than $1,000,000 per year under the current TAF structure. See FIA PTG Letter at 4. Another commenter opined on the substance of FINRA’s contemplated TAF amendment. See PEAK6 Letter at 4. Some commenters also stated that FINRA must amend the TAF before the Rule 15b9–1 amendments are adopted so firms can assess the fee-related costs of FINRA membership on proprietary trading firms. See PEAK6 Letter at 4; FIA PTG Letter at 4. 164 See, e.g., Cboe Letter at 3; see also ABCV Letter at 2 (stating that any trading by options market makers in the underlying cash equities markets is related to legitimate hedging of their options positions). 165 See Cboe Letter at 2–3; ABCV Letter at 3–4; CTC Letter at 5; PEAK6 Letter at 4; Nasdaq Letter at 2. Commenters also stated that options trading firms’ equities volume often is processed through a FINRA member, and stated that a hedging exemption would be particularly appropriate if the routing away from a member exchange is through a broker-dealer that is a FINRA member. See Cboe Letter at 2–3; ABCV Letter at 2–4; CTC Letter at 5; PEAK6 Letter at 4. As discussed supra in this section, the Commission does not agree. See supra notes 98–101 and accompanying text. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 competition.166 FINRA stated that most proprietary trading dealer firms that newly join FINRA would not incur membership application fees exceeding $12,500.167 FINRA also stated (prior to filing the TAF Amendment with the Commission) that it is committed to amending the TAF to lessen its impact on such firms.168 The Commission believes that a hedging exemption for broker-dealers that are proprietary options trading firms, like that sought by commenters, could continue to result in a significant volume of off-member-exchange trading activity not being subject to direct, membership-based FINRA oversight. Proprietary options trading firms make up the majority of the 12 firms that the Commission identified above as accounting for 5.1% of all off-exchange listed equities volume in April 2023 and the majority of the 21 firms that the Commission identified as accounting for approximately 99% of the $262 billion in listed equities transaction volume executed on exchanges where they are not a member.169 As a result, significant off-member-exchange trading activity could continue not to be subject to direct FINRA oversight under commenters’ suggested exemption. The Commission continues to believe that this would not be consistent with the protection of investors or the public interest, or with the historical rationale for Rule 15b9–1 of accommodating limited off-member-exchange trading activities.170 166 See STA Letter at 3–4; Cboe Letter at 2–3, 7; ABCV Letter at 2–4; CTC Letter at 5; PEAK6 Letter at 4–6. 167 See FINRA Letter at 12 n. 40 (also stating that FINRA does not anticipate that new member proprietary trading dealer firms would incur the one-time clearing surcharge that applies to new applicants engaged in clearing and carrying activity). 168 See id. at 14. See also note 170 and accompanying text, infra. 169 See section II.B, supra. 170 See 2022 Re-Proposal, supra note 1, sections III.B.2 and III.C, 87 FR 49947–50. 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 broker or dealer or class of brokers or 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. E:\FR\FM\07SER2.SGM 07SER2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations The effect of not including a hedging exemption in Rule 15b9–1 will be that proprietary options trading brokerdealer firms (among other types of proprietary trading broker-dealer firms) will no longer be exempt from section 15(b)(8)’s Association membership requirement if they effect off-memberexchange securities transactions (unless they are covered by one of the exemptions in the amended rule). Therefore, these firms will be required by section 15(b)(8) of the Act to join FINRA in order to continue any offmember-exchange securities trading activity. The Commission is mindful of the FINRA membership costs, including application and TAF fees, that would be incurred by proprietary trading brokerdealer firms, including options trading firms, that join FINRA as a result of the rescission of the de minimis allowance and proprietary trading exclusion, and the Commission is mindful of the potential impact of those costs on options market liquidity. The Commission believes it is unlikely, however, that such firms would be unable to continue operating their trading businesses or providing liquidity in their normal course due to the costs of FINRA membership. Insofar as the costs of joining FINRA are concerned, the Commission believes that a $12,500 FINRA membership application fee would be manageable for proprietary trading options firms that newly join FINRA, and is small enough such that it should not materially impact their ability to provide liquidity.171 As for concerns regarding the TAF, an ongoing FINRA cost, FINRA, after considering the potential impact of the TAF on proprietary trading firms that join FINRA, has amended its rules to provide an exemption from the TAF for all proprietary trading firms for transactions executed on an exchange of which the proprietary trading firm is a member. In addition, commenters stated that small options trading firms could be adversely affected by the rule amendments to the point of providing less liquidity or ceasing to trade.172 While commenters did not indicate how they are defining ‘‘small’’ options firms, the Commission believes that smaller firms should be able to absorb the ongoing costs of FINRA membership, 171 See infra section V.C.2 (stating that the Commission believes that the median application fee for the 12 largest (by volume traded) non-FINRA member broker-dealer firms would be $12,500). 172 See STA Letter at 3–4; ABCV Letter at 2–3; Cboe Letter at 7; Nasdaq Letter at 3–4. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 such as the GIA and TAF.173 As discussed in the Economic Analysis below,174 the estimated aggregate costs for the 12 largest non-FINRA member broker-dealer firms as of April 2023 represent the majority of the aggregate costs stemming from the amendments to Rule 15b9–1. Therefore, the Commission believes that smaller nonFINRA member broker-dealer firms as well as new entrants will experience much lower initial and ongoing costs and that these FINRA membership costs would not materially impede their ability to continue their trading businesses, which may include providing liquidity in the options market, if they join FINRA.175 Further, since the 2015 Proposal, as commenters observed, there has been a decrease in the number of Commissionregistered broker-dealers that are exchange members but not FINRA members.176 There also has been 173 See infra section V.C.2 (stating that the 12 largest non-FINRA member broker-dealer firms (as measured by off-exchange equities volume traded in April 2023) had average and median annual total revenues of approximately $1.2 billion and $491 million, respectively, in 2022; would incur an estimated median GIA of $327,870; and would incur an estimated median and average TAF of approximately $119,256 and $304,994, respectively). 174 See infra section V.C.2. 175 The Commission believes that the potential FINRA membership costs that could be incurred by firms not among the 12 largest non-FINRA member broker-dealers is the best data point available to the Commission to assess commenters’ assertion. As discussed in section V.B.2, infra, the Commission cannot, however, rule out the possibility that the addition of FINRA costs will serve as a catalyst for one or more small non-FINRA member options market makers to exit the market, although FINRA’s exemption of TAF fees should reduce the likelihood that firms will choose to exit in response to the adopted rule amendments. In addition, as discussed in section VII, infra, the Commission estimates that not more than three of the 64 non-FINRA member broker-dealer firms that the Commission identified as of April 2023 have total capital of less than $500,000 and are not affiliates of any person (other than a natural person) that is not a small business or small organization and would, as a result, be considered small entities under Regulatory Flexibility Act (‘‘RFA’’) standards. These three small firms—by RFA standards—could be significantly impacted by the adopted rule amendments because they could be required to become a member of FINRA under section 15(b)(8) of the Act, if they effect off-member-exchange securities transactions and do not qualify for one of the adopted exemptions. These three firms are not among the 12 largest non-FINRA member brokerdealer firms identified by the Commission, and so, as discussed in the paragraph above and in section V.C.2 infra, their initial and ongoing FINRA membership costs, should they join FINRA, likely would be low. This suggests that, while they could be significantly impacted by the adopted rule amendments in that they may no longer be exempt from FINRA membership, their trading businesses nevertheless might not be materially impeded by the costs of FINRA membership. 176 See STA Letter at 3–4; ABCV Letter at 2–3. See also infra section V.B.2. The decrease is largely the result of such firms ceasing their broker-dealer PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 61865 significant consolidation among brokerdealers generally over the past decade.177 Meanwhile, despite this decline in the number of firms, options market liquidity has remained robust, as reflected by data suggesting that options quoted spreads have remained flat or slightly declined in recent years as overall option trading volumes have continued to hit record highs.178 Therefore, as discussed in the Economic Analysis below,179 the Commission does not believe that the adopted rule amendments will undermine options market liquidity provision. In addition, as discussed in the Economic Analysis below,180 the Commission believes that amended Rule 15b9–1 is not likely to have an economically meaningful effect on direct capital formation, and that changes in the allocation of regulatory fees and direct FINRA supervision within the off-member-exchange market may result in improved efficiency of capital allocation by the financial industry, as current FINRA members might commit additional capital to liquidity provision when the trading environment has more uniform regulatory requirements. Finally, commenters stated that the Commission already possesses and can exercise authority over Commissionregistered broker-dealers that are not FINRA members.181 While this is operations and withdrawing their registration as broker-dealers with the Commission. 177 See FINRA.org, 2022 Industry Snapshot, at 13, available at https://www.finra.org/sites/default/ files/2022-03/2022-industry-snapshot.pdf (last visited Aug. 8, 2023) (reflecting the following number of FINRA-registered firms in 2017–2021: 3,726 in 2017; 3,607 in 2018; 3,517 in 2019; 3,435 in 2020; and 3,394 in 2021); compare 2015 Proposal, supra note 1, 80 FR 18042, with section II.B supra (reflecting a decrease in the Commission’s estimate of the number of brokerdealers registered with the Commission that are exchange members but not FINRA members from 125 in the 2015 Proposal to 64 as of Apr. 2023). This trend began well before the amendments being adopted in this release, and may or may not continue regardless of the adopted rule amendments. In other words, if options trading firms ceased operating in the future, the Commission does not believe the cause necessarily would be the amendments to Rule 15b9–1 as other factors have caused this trend before these amendments and likely would continue to be relevant. 178 See section V.B, infra (among other things, citing an academic study showing that options bidask spreads have remained flat since 2015, and citing NYSE Data Insights 2021 Options Year in Review, available at https://www.nyse.com/datainsights/2021-options-year-in-review, which reflects that options quoted spreads have remained flat or slightly declined in recent years as overall option trading volumes have continued to hit record highs). 179 See id. 180 See 2022 Re-Proposal, supra note 1, 87 FR 49960; section V.B.1, infra. 181 See, e.g., Virtu Letter at 2. E:\FR\FM\07SER2.SGM 07SER2 61866 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 true,182 as discussed above and in the 2022 Re-Proposal,183 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. While the Commission retains examination authority over the SROs and 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. The Commission continues to believe that the front-line layer of SRO oversight must be strengthened with respect to proprietary trading broker-dealer firms that effect off-member-exchange securities transactions notwithstanding the Commission’s plenary jurisdiction over Commission-registered broker-dealers. 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 off-memberexchange securities trading activity. The Commission continues to believe 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-memberexchange 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.184 182 See section I, supra; 2022 Re-Proposal, supra note 1, 87 FR 49931–32 (stating that the Commission may bring enforcement actions, including pursuant to referrals made by SROs, to enforce compliance with the Exchange Act and applicable rules). 183 See section I, supra; 2022 Re-Proposal, supra note 1, 87 FR 49932. 184 One commenter stated that, ‘‘by adopting a Commission rule requiring certain broker-dealers to register with FINRA, FINRA will become, at least as to those broker-dealers, a ‘part of the Government’ under the standard set forth by the U.S. Supreme Court in Free Enterprise Fund v. Public Company Accounting Board, 561 U.S. 477 (2010).’’ Letter from W. Hardy Callcott (Sept. 3, 2022). FINRA disputed this. See FINRA Letter at 15–20. The Commission disagrees that the amendments to Rule 15b9–1 would make FINRA ‘‘part of the Government’’ under Free Enterprise. In that case, the Supreme Court reasoned that, ‘‘[u]nlike the self-regulatory organizations,’’ the Public Company Accounting Oversight Board was ‘‘a Government-created, Government appointed entity.’’ 561 U.S. at 485. These distinctions between FINRA and the PCAOB remain unchanged by the amendments to Rule 15b9–1. See also, e.g., Desiderio v. Nat’l Ass’n of Sec. Dealers, Inc., 191 F.3d 198, 206 (2d Cir. 1999) (NASD ‘‘is a private actor, not a state actor,’’ because it is a ‘‘private VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 On March 28, 2022, the Commission proposed new rules to further define certain language as used in the definition of ‘‘dealer’’ and ‘‘government securities dealer’’ under sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively.185 Some commenters stated that the amendments to Rule 15b9–1 may affect proprietary trading firms that are not Commissionregistered dealers, but could be required to register as such if the definition of ‘‘dealer’’ is amended.186 To the extent the Commission amends the definition of ‘‘dealer’’ in the future, the adopted amendments to Rule 15b9–1 would become part of the baseline from which the effects of any such new rule on the definition of ‘‘dealer’’ are measured. B. Narrowed Criteria for Exemption From Association Membership The Commission proposed to add to Rule 15b9–1 a new paragraph (c) that would set forth two narrow circumstances in which a broker or dealer would continue to be exempt from section 15(b)(8)’s Association membership requirement if it effects transactions in securities otherwise than on an exchange of which it is a member.187 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 proposed to add language that states: ‘‘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) . . .’’ 188 The two proposed exemptions followed in new paragraphs (c)(1) and (2). As discussed in turn below, the Commission is adopting as proposed new paragraphs (c)(1) and (2) (as well as the above-quoted language).189 corporation that receives no federal or state funding,’’ ‘‘[i]ts creation was not mandated by statute, nor does the government appoint its members or serve on any NASD board or committee.’’). 185 See Securities Exchange Act Release No. 94524 (Mar. 28, 2022), 87 FR 23054 (Apr. 18, 2022). 186 See, e.g., MMI Letter at 3; STA Letter at 2; Virtu Letter at 4. 187 See 2022 Re-Proposal, supra note 1, 87 FR 49944–49. Relatedly, the Commission proposed that 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 2022 Re-Proposal, supra note 1, 87 FR 49945 n. 156. 188 See 2022 Re-Proposal, supra note 1, 87 FR 49945. 189 See amended Rule 15b9–1(c), under ‘‘Text of Amendments,’’ infra. The Commission also is PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 Paragraphs (c)(1) and (2) of the amended rule are intended to provide more focused exemptions from Association membership for types of off-memberexchange 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 protection of investors and the public interest in accordance with section 15(b)(9) of the Act. 1. Routing Exemption The Commission proposed to add a new paragraph (c)(1) to Rule 15b9–1 that sets forth 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 190 or the Options Order Protection and Locked/Crossed Market Plan.191 Relatedly, the Commission also proposed to eliminate from Rule 15b9–1 outdated references to the ‘‘Intermarket Trading System,’’ 192 which is a now-obsolete NMS plan that was discontinued in 2007 because it was superseded by Regulation NMS.193 The Commission is adopting these aspects of the 2022 Re-Proposal by adding new paragraph (c)(1), as reproposed, to Rule 15b9–1, and by removing from Rule 15b9–1 the ITS provisions in pre-existing paragraphs (b)(2) and (c). As discussed in the 2022 Re-Proposal, Rule 611 of Regulation NMS requires trading centers, such as national securities exchanges, to establish, maintain, and enforce written policies adopting the proposed renumbering of paragraphs (a) and (b) in the amended rule. See supra note 187. 190 17 CFR 242.611. 191 See 2022 Re-Proposal, supra note 1, 87 FR 49945. See also Options Linkage Plan, supra note 22. 192 The ITS 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 provisionally approved by the Commission in 1978 and finally approved by the Commission in 1983. See Securities Exchange Act Release Nos. 14661 (Apr. 14, 1978), 43 FR 17419 (Apr. 24, 1978) (‘‘Initial ITS Plan Approval Order’’); 19456 (Jan. 27, 1983), 48 FR 4938 (Feb. 3, 1983) (‘‘Final ITS Plan Approval Order’’). All national securities exchanges that traded exchange-listed stocks and the National Association of Securities Dealers (‘‘NASD’’) were participants in the ITS Plan. 193 See 2022 Re-Proposal, supra note 1, 87 FR 49945; see also Notice of Filing and Immediate Effectiveness of the Twenty Fourth Amendment to the ITS Plan Relating to the Elimination of the ITS Plan, Securities Exchange Act Release No. 55397 (Mar. 5, 2007), 72 FR 11066 (Mar. 12, 2007). E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 and procedures reasonably designed to prevent trade-throughs in exchangelisted stocks, subject to certain exceptions.194 In general, Rule 611 protects automated quotations that are the best bid or offer of a national securities exchange or an Association.195 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.196 Similarly, in the options market, the Options Linkage Plan is an NMS 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.197 The Options Linkage Plan includes written policies and procedures that provide for order protection and address locked and crossed markets in eligible options classes.198 The Commission proposed the routing exemption in paragraph (c)(1) to accommodate securities transactions away from a broker’s or dealer’s member exchange(s) that are to comply with these regulatory requirements.199 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.200 194 17 CFR 242.611. See also 17 CFR 242.600(b)(94) (defining a ‘‘trade-through’’ under Regulation NMS); 17 CFR 240.600(b)(95) (defining ‘‘trading center’’); Options Linkage Plan, supra note 4 (defining ‘‘trade-through’’ in the options context). 195 17 CFR 242.611. 196 See 17 CFR 242.600(b)(71) (defining ‘‘protected quotation’’ under Regulation NMS); 17 CFR 242.600(b)(70) (defining ‘‘protected bid’’ and ‘‘protected offer’’ under Regulation NMS); see also Options Linkage Plan, supra note 4 (defining ‘‘protected bid’’ and protected offer’’ in the options context). 197 See Options Linkage Plan, supra note 4. 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. 198 Id. 199 See 2022 Re-Proposal, supra note 1, 87 FR 49945. 200 Amended Rule 15b9–1 provides 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, but it does 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 VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 The Commission continues to believe that it 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 routing exemption is intended to serve the limited, narrowly defined purpose of facilitating compliance with intermarket order protection requirements. The Commission also stated in the 2022 Re-Proposal that it would be consistent with the protection of investors and the public interest to permit reliance on the routing exemption only where the routing is performed by a national securities exchange of which the broker or dealer is a member.201 The Commission stated that this limitation would help ensure that the broker’s or dealer’s member exchange has visibility into the routing transactions and thus is better able to provide effective SRO oversight of its member’s trading 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– 1.202 Some commenters stated that the routing exemption should be broadened for proprietary options trading brokerdealer firms so that it covers routing that is not performed by member-exchange discussed in the 2022 Re-Proposal, a routing brokerdealer continues to 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. 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 Options 5, section 4 (Order Routing). 201 As stated in the 2022 Re-Proposal, the routing exemption is 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. See 2022 ReProposal, supra note 1, 87 FR 49946. An exchange’s routing fees must be consistent with the Act, including sections 6(b)(4) and 6(b)(5), which require an equitable allocation of reasonable dues, fees and other charges among members and issuers and other persons using any facility of the exchange, and require that the exchange’s fees not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers. 202 See 2022 Re-Proposal, supra note 1, 87 FR 49946. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 61867 routers.203 The Commission stated in the 2022 Re-Proposal that this would not be consistent with the protection of investors and the public interest because it could permit scenarios in which there is insufficient SRO oversight of the broker-dealer’s offmember-exchange securities trading activity.204 Commenters suggested that the Commission’s concerns in this regard are mitigated in the context of options trading firms because they typically route to non-member exchanges via another broker-dealer,205 and are especially mitigated where that routing broker-dealer is a FINRA member.206 The Commission does not agree. As stated previously, consistent with the original design of Rule 15b9–1, the narrowed exemptions from section 15(b)(8)’s Association membership requirement set forth in amended Rule 15b9–1 are designed to apply to limited off-member-exchange securities 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. As stated above, Rule 15b9–1 previously exempted securities transactions effected through the ITS. The ITS Plan required each participant—exchanges and the NASD— 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 203 See Cboe Letter at 3; ABCV Letter at 4. It appeared to the Commission that commenters intertwined this point with a different point, and for the sake of completeness, the Commission has addressed both. Specifically, in this section, the Commission interprets and addresses these comments as a request that the routing exemption cover off-member-exchange securities transactions to comply with intermarket order protection requirements that are effected via routers other than a member exchange router. These and other commenters also requested an exemption for proprietary options trading broker-dealer firms under which their off-member-exchange securities trading activity would not trigger section 15(b)(8)’s Association membership requirement if such activity is to hedge or in furtherance of their options trading activity on their member exchange(s). See supra note 165 and accompanying text. This request is addressed in section III.A, supra. 204 See 2022 Re-Proposal, supra note 1, 87 FR 49946. 205 See Cboe Letter at 3. 206 See ABCV Letter at 4. Likewise, commenters suggested that it would be particularly appropriate to continue to exempt options trading firms from section 15(b)(8)’s Association membership requirement where their routing away from a member exchange is through a broker-dealer that is a FINRA member. See Cboe Letter at 2–3; ABCV Letter at 3–4; CTC Letter at 5; PEAK6 Letter at 4. As discussed supra in section III.A, the Commission does not agree. See supra notes 98–101 and accompanying text. E:\FR\FM\07SER2.SGM 07SER2 61868 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 prices.207 The ITS Plan provided each participant market limited access to the other participant markets for the purpose of avoiding a trade-through or a locked or crossed market.208 Specifically, the ITS enabled a broker or dealer that was physically present in (and a member of) one market center to transmit its own or its customer’s commitment to trade in an ITS-traded stock to another market center, which could then be accepted by a broker or dealer at the receiving market center.209 When a broker or dealer initiated a commitment to trade from an exchange where it was a member, it did so to prevent orders on its member exchange from trading through or locking or crossing quotations displayed on away market centers, and the member exchange was inextricably involved in the routing activity covered by the exemption. In contrast, if the routing exemption were expanded, as suggested by commenters, to cover routing for intermarket order protection purposes performed by a non-exchangedesignated router on behalf of a brokerdealer trading firm, the exemption could cover trading activity that is not ancillary to the firm’s trading activity on any exchange where it is a member. Under the commenters’ approach, the trading firm could remain exempt from Association membership while utilizing a non-exchange-designated routing broker-dealer to effect securities transactions solely on off-memberexchange venues without any nexus to an exchange where the trading firm is a member. The Commission remains concerned that, in this type of scenario, there would not be an exchange where the trading firm is a member that has visibility into the routing transactions and that is able to provide effective SRO oversight of the trading firm’s order routing activity. Among other things, no exchange where the trading firm is a member would be positioned to assess whether the routing transactions complied with the terms of the exemption. This would be the case even if the routing is performed by a routing broker-dealer that also is a FINRA member.210 This would be inconsistent 207 See Initial ITS Plan Approval Order, supra note 192. 208 Id. 209 Id. 210 While there could be direct exchange SRO or FINRA oversight over the routing broker-dealer in this scenario, the Commission does not believe this is adequate, as discussed above, due to the lack of direct FINRA oversight over the broker-dealer initiating the order. See supra notes 98–101 and accompanying text (discussing that separate exchange SRO recourse against different broker- VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 with the Commission’s intention to continue to permit exemptions from section 15(b)(8)’s Association membership requirement that are narrowly tailored to limited off-memberexchange securities 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 and, in the Commission’s view, would be inconsistent with the protection of investors and the public interest. To be clear, nothing in amended Rule 15b9–1 prohibits broker-dealer firms from effecting securities transactions away from their member exchange(s) by utilizing routing services provided by non-exchange-designated brokerdealers, so long as they comply with section 15(b)(8) of the Act. Any brokerdealer firm may continue to route orders away from its member exchange(s) for order protection or any other appropriate purposes using nonexchange-designated routing brokerdealers. But a broker-dealer firm cannot do so without joining FINRA, as such trading activity is not exempt from, and therefore would trigger, section 15(b)(8) (assuming the trading activity is not otherwise covered by the stock option order exemption discussed below), which would require Association membership for the firm.211 2. Stock-Option Order Exemption The Commission proposed to add a new paragraph (c)(2) to Rule 15b9–1 that sets forth an exemption from Association membership if a broker or dealer that meets the criteria of paragraphs (a) and (b) of the rule effects off-member-exchange securities transactions, with or through another registered broker or dealer, that are solely for the purpose of executing the stock leg of a stock-option order.212 The Commission also proposed to require in new paragraph (c)(2) that a broker or dealer seeking to rely on the 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 dealers for the same conduct can present the potential for inconsistent outcomes). 211 Alternatively, a firm wishing to route orders to exchanges using a non-exchange-designated routing broker-dealer could comply with section 15(b)(8) by becoming a member of all exchanges to which it routes orders. But any such firm would still be required to join FINRA to the extent it effects off-exchange securities transactions (unless exempted by the stock-option order exemption). See section V.D, infra. 212 See 2022 Re-Proposal, supra note 1, 87 FR 49947. PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 or dealer preserve a copy of its policies and procedures in a manner consistent with 17 CFR 240.17a–4 (‘‘Rule 17a–4’’) until three years after the date the policies and procedures are replaced with updated policies and procedures.213 One commenter referenced the stock-option order exemption.214 The Commission is adopting paragraph (c)(2) as proposed. As the Commission stated in the 2022 Re-Proposal, 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 stockoption order business. 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. Moreover, there is a close link between the stock component transaction of a stock-option order and the relevant options exchange. As such, the stock-option order exemption permits 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 stated above, the Commission estimates that, in 2022, 48 of the 73 firms identified as registered brokerdealers and exchange members but not FINRA members initiated options order executions.215 The Commission estimates that 17 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.216 Because the 213 See id. Cboe Letter at 3 (stating that the existence of a stock-option exemption in the 2022 ReProposal is an acknowledgment that activity critical to the functioning of the options market should not be adversely impacted). 215 See supra note 44. 216 Source: CAT. The Commission previously estimated that, in 2021, seven such firms effected stock leg transactions and could potentially rely on the stock-option order exemption to the extent that they effect the stock leg transactions off-exchange or on an exchange where they are not a member. See 2022 Re-Proposal, supra note 1, 87 FR 49947. The Commission attributes the increase from 2021 to 2022 of its estimated number of broker-dealers that are not FINRA members and that executed stock leg transactions mainly to an increase in the percentage of stock leg transactions that are captured in the CAT in a manner that enables the 214 See E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 broker or dealer relying on 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 must 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.217 Further, the Commission stated in the 2022 Re-Proposal that its understanding is that 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.218 For purposes of relying on the exemption provided by Rule 15b9– 1(c)(2), a broker or dealer should adhere to the stock-option order definition of the options exchange where the stockoption order is handled and of which the broker or dealer is a member.219 Specifically, the broker or dealer could Commission to identify the firms that initiated the transactions. 217 See, e.g., Cboe Rules 1.1 and 5.33(b)(5); MIAX Rule 518(a)(5); MIAX Emerald Rule 518(a)(5); Nasdaq Options 5, section 1(4) (defining ‘‘Complex Trade’’); Nasdaq PHLX Options 5, section 1(d) (defining ‘‘Complex Trade’’); Nasdaq ISE Options 5, section 1(d) (defining ‘‘Complex Trade’’); 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); NYSE American Rule 900.3NY(h)(1). 218 See, e.g., Cboe Rule 5.33, Interpretations and Policies .04 Stock Option Orders; Supplementary Material .07 to Nasdaq ISE Options 3, section 14; Commentary .01 to MIAX Rule 518. 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 (Aug. 31, 2006), 71 FR 52829 (Sept. 7, 2006); see also Securities Exchange Act Release No. 57620 (Apr. 4, 2008), 73 FR 19271 (Apr. 9, 2008). 219 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 217. Therefore, the stock-option order exemption currently covers stock-option orders with only one stock leg. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 rely on that definition to determine whether, for purposes of amended Rule 15b9–1(c)(2), an order is in fact a stockoption order and a stock order is in fact the stock leg of a stock-option order. Moreover, the exemption applies regardless of whether the component legs of a stock-option order are executed electronically, on a physical exchange floor, or through a combination of both. The Commission continues to believe, as discussed in the 2022 Re-Proposal, that the stock-option order exemption’s reliance on the options exchange’s ‘‘stock-option order’’ definition should enhance an exchange’s ability to monitor whether its members are appropriately relying on the 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 stockoption 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.220 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.221 In light of these rules, the Commission continues to believe that there is a close link between the stock component transaction of a stock-option order and the relevant options exchange. Accordingly, the Commission continues to believe that this 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. 220 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; MIAX Rule 518 and Commentary .01. 221 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; MIAX Rule 518 and Commentary .01. PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 61869 The Commission also continues to believe that the exchange’s oversight capabilities will be further enhanced, consistent with the public interest and protection of investors, by requiring brokers and dealers to develop written policies and procedures in connection with the stock-option exemption in paragraph (c)(2) of the amended rule. This requirement should 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 exemption. Moreover, the Commission continues to believe 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 stockoption order. Accordingly, a broker or dealer seeking to rely upon the stockoption 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 15b9–1.222 222 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 E:\FR\FM\07SER2.SGM Continued 07SER2 61870 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations Finally, a broker or dealer seeking to rely on the stock-option order exemption is 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.223 Accordingly, a broker or dealer is required to keep the policies and procedures relating to its use of this exemption as part of its books and records while they are in effect, and for three years after they are updated. ddrumheller on DSK120RN23PROD with RULES2 IV. Effective Date and Implementation The Commission proposed that the compliance date for amended Rule 15b9–1 be one year after publication of any final rule in the Federal Register.224 In proposing this compliance date, the Commission considered various factors that impact the time that it takes to become a FINRA member, as well as that firms that choose to adjust their business models such that they are not required to join FINRA would need time to do so.225 The Commission understood that, on average, the FINRA membership application process takes approximately six months.226 Some commenters on the 2022 ReProposal characterized the FINRA membership application process as lengthy.227 One commenter stated that it understood FINRA’s membership application process to take more than a year, and suggested a revised compliance period in which firms must only submit their FINRA registration application within 360 days of adoption of amended Rule 15b9–1, and allow for 540 days from adoption for FINRA approval of the application.228 FINRA stated that it typically has 180 days to issue a decision after the filing of a new membership application, but that, depending on the characteristics of an application, FINRA may issue a ‘‘fasttrack’’ decision within 100 days.229 FINRA also stated that, based on the types of proprietary trading dealer firms that would be likely to join FINRA as a result of the Rule 15b9–1 amendments, it intends to implement an expedited membership application process for these applicants pursuant to which it 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. 223 See, e.g., 17 CFR 240.17a–4(e)(7). 224 See 2022 Re-Proposal, supra note 1, 87 FR 49951. 225 Id. 226 Id. 227 See, e.g., FIA PTG Letter at 4–5; PEAK6 Letter at 2. 228 See FIA PTG Letter at 4–5. 229 See FINRA Letter at 12. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 anticipates processing their applications within 60 days after submission.230 The Commission believes that a compliance date for amended Rule 15b9–1 that is 365 days after publication of amended Rule 15b9–1 in the Federal Register would provide a sufficient period of time for proprietary trading broker-dealer firms to comply with the amended rule. Based on FINRA’s statements regarding its ability to issue a ‘‘fast-track’’ decision within 100 days and expectation that it would process proprietary trading dealer firm applications within 60 days after submission,231 for any FINRA membership application submitted by such a firm in a timely manner, the Commission expects FINRA to be able to process the application and render a decision within the compliance period. Additionally, some commenters stated that the FINRA membership application process requires information that is duplicative of information already provided to the Commission and other SROs as part of their prior Commission registration and exchange SRO application process.232 Accordingly, the Commission believes that when applying to be FINRA members, firms in this situation may be able to leverage their prior submissions to the Commission and exchange SROs to be able to have a more expedient application process with FINRA than they would otherwise if they had not already prepared such information for submission to the Commission and exchange SROs. More broadly, any existing broker-dealer firm that applies for FINRA membership as a result of the amendments to Rule 15b9–1 would have already completed the application processes for becoming a Commissionregistered broker-dealer and a member of at least one exchange and, the Commission believes, should be able to leverage those experiences to expedite their application process with FINRA. V. Economic Analysis The Commission is amending Rule 15b9–1 to help ensure that an Association generally has direct, membership-based oversight over broker-dealers that effect off-memberexchange securities transactions and the jurisdiction to directly enforce their compliance with Federal securities laws, Commission rules, and Association rules. In addition, these amendments will provide a more consistent regulatory framework for 230 See 231 See id. at 12–13. supra notes 229–230 and accompanying text. 232 See PO 00000 PEAK6 Letter at 2; FIA PTG Letter at 4. Frm 00022 Fmt 4701 Sfmt 4700 broker-dealers,233 which in turn should enhance competition and result in potential efficiency gains for market participants. 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.234 However, currently pursuant to Rule 15b9–1, a broker or dealer may engage in unlimited off-member-exchange 235 proprietary trading without becoming a member of an Association, so long as its proprietary trading activity is conducted with or through another registered broker or dealer. Currently, off-exchange equity activity and exchange listed options trading of non-FINRA member broker-dealers is surveilled by FINRA through CAT data and supervised in part via the use of RSAs.236 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.237 For example, of the current FINRA RSA contracts: one RSA contract expires at the end of 2023, seven RSA contracts expire at the end of 2024, and three RSA contracts expire at the end of 2025 unless extended or terminated early.238 The amendments will provide consistency and stability of oversight.239 In the case of U.S. Treasury securities and other fixed income securities (other than municipal bonds) 240 that trade offexchange, surveillance relies on TRACE data which is collected by FINRA from 233 See section III.A, supra. section I, supra. 235 ‘‘Off-member-exchange’’ trading of securities refers to trading by a broker-dealer on any national securities exchange of which it is not a member or in the off-exchange market. See supra note 2 and accompanying text. 236 See section V.A.2, infra. 237 See sections I and III.A, supra. 238 Based on information provided by FINRA. 239 Current non-FINRA members that choose to join FINRA in response to the amendments will face direct Association oversight of their offmember exchange trading instead of oversight that occurs and is based on an RSA. The Exchange Act’s statutory framework places SRO oversight responsibility with an Association for off-memberexchange securities trading, and FINRA’s role with respect to non-FINRA member broker-dealers is limited to what is covered in RSAs it enters into with the exchanges. See supra section III for a discussion of issues related to RSA-administered oversight of off-member exchange trading. 240 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. 234 See E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations its members.241 Some dealer firms that are not FINRA members are significantly involved in trading U.S. Treasury securities 242 proprietarily but are not required to report these transactions because they are not FINRA members. Consequently, trades that do not occur on an ATS or with a covered depository institution,243 and that are between two non-FINRA member broker-dealers, are not reported to TRACE at all, and trades that occur otherwise than on a covered ATS do not specifically identify the non-FINRA member in the information reported by the ATS to TRACE.244 The amendments will provide for all fixed income trading by broker-dealers to be subject to FINRA’s rules, including its rules requiring reporting to TRACE. 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 off-memberexchange securities trading activity. The amendments will 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.245 For brokerdealers relying on the exemption that ddrumheller on DSK120RN23PROD with RULES2 241 Non-FINRA member depository institutions also report U.S. Treasury securities trades to TRACE. See supra note 123. 242 The Commission can observe and quantify some of this activity through the reporting of U.S. Treasury securities on covered ATSs as discussed in supra section III.A. See supra note 59. It is likely that non-member broker-dealers also trade fixedincome 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 nonFINRA 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. See infra section V.C.2.c for information on the costs of TRACE reporting for non-FINRA member firms. 243 These trades do not include those with depository institutions that are mandated for TRACE reporting. 244 See section III.A, supra. The Commission believes this is a small fraction of U.S. Treasury securities trading. In Apr. 2023, the Commission estimates that non-FINRA member broker-dealers’ U.S. Treasury securities transactions executed on covered ATSs accounted for 2.65% of total U.S. Treasury securities transaction volume reported to TRACE that month. See supra note 57. 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. 245 See section III.A, supra. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 will be required to register with FINRA under the amendments, joining FINRA will expose these firms to additional costs that they previously did not incur.246 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 cross-exchange and offexchange trading of both listed and unlisted securities. When FINRA detects potentially violative behavior by a nonFINRA member firm,247 it can and does refer such cases to other SROs or the SEC. However, it may lack certain investigative tools which could help it further investigate potentially violative behavior before making such referrals. The Commission believes that, particularly in the case of fixed income trading, FINRA is well positioned to efficiently investigate such instances of violative behavior 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 adoption of these amendments.248 As discussed in detail below, the effects are quantified to the extent practicable. Although the Commission is providing estimates of direct compliance costs where practicable, the Commission also anticipates that brokers and dealers affected by the amendments, as well as competitors of those broker and dealers, might modify their business practices regarding the provision of liquidity in both off-exchange markets and on exchanges. Consequently, much of the 246 FINRA member firms that compete with these firms may currently be at a cost disadvantage due to this fee disparity. 247 The term ‘‘non-FINRA member firm’’ refers to a broker-dealer that is not a FINRA member. 248 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. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 61871 discussion below is qualitative in nature, but where possible, the Commission has provided quantified estimates.249 To the extent that nonFINRA member firms change their business practices, such as reducing or eliminating their off-member-exchange trading activity or joining FINRA and increasing their off-member-exchange activity, the amendments may impact competition and liquidity, particularly in the off-member-exchange markets. The adoption would increase costs for non-FINRA member firms that will have to register with FINRA, which might result in decreased liquidity provision by these non-FINRA member firms to certain markets. Additionally, the amendments to Rule 15b9–1 might create incentives for non-FINRA member firms that are impacted by the amendments to form a new Association. The creation of such a new Association would entail large startup costs but could spur competition with the existing Association and might lower general self-regulatory financial burdens. The amendments may also result in potential benefits to competition, since current FINRA members will be operating on a more level regulatory playing field relative to non-FINRA members. 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 their 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.’’ 250 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.’’ 251 Generally, any brokerdealer 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,252 and broker-dealers generally must become members of an Association to trade securities elsewhere than on an exchange to which 249 See infra section V.B.1 for further discussion of the difficulties in estimating market quality effects likely to result from the amendments. 250 15 U.S.C. 78c(a)(4)(A). 251 15 U.S.C. 78c(5)(A). 252 A firm that wishes to transact business upon an exchange without becoming a broker or dealer generally can do so by engaging a broker-dealer that is a member of that exchange to provide market access and settlement services. E:\FR\FM\07SER2.SGM 07SER2 61872 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations a broker or dealer belongs as a member.253 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, which handle the clearance and settlement aspects of customer trades. In contrast, introducing brokers provide services to customers, but do not hold customers funds or execute or clear trades themselves. However, of 3,515 registered brokers and dealers, only 210 were classified as carrying or clearing brokers and dealers and around 1,200 firms were classified as introducing brokers at the end of 2022.254 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. Sixty-six percent of brokers and dealers employ 15 or fewer associated persons and only 10% of brokers and dealers employ over 100 associated persons.255 Further, while there are many registered brokers and dealers, a small minority of brokers and dealers controls the majority of broker and dealer capital.256 The Commission has identified 64 firms that, as of April 2023, 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 amendments.257 In September 2022, there were 73 registered broker-dealers that were exchange members but not FINRA members.258 Because of Rule 253 See supra note 19. on the number of firms that answered yes to items I8084 or I8085 on Schedule I in December 2022. The number of introducing broker dealers was estimated from the question ‘‘Does applicant refer or introduce customers to any other broker or dealer?’’, as reported on Form BD. 255 Based on Dec. 2022 Annual FOCUS data filings. See also supra note 150. 256 See infra section VII. 257 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. 258 See supra note 37. Some commenters, citing the Commission’s proposal to amend the definition ddrumheller on DSK120RN23PROD with RULES2 254 Based VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 15b9–1’s exclusion of proprietary trading, a dealer that had not carried customer accounts might not be required to join an Association as long as it had been a member of an exchange SRO, even when that dealer had substantial off-member-exchange trading activity. 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 2022, seven of the 64 non-FINRA member firms had $6 trillion in U.S. Treasury securities volume reported to TRACE by covered ATSs. This accounts for approximately 3.67% of U.S. Treasury volume as reported to TRACE throughout the year. In April 2023, there were five nonFINRA member firms with approximately $302 billion in U.S. Treasury securities volume executed on covered ATSs or approximately 2.65% 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.259 However, FINRA does make public aggregate U.S. Treasury securities data on a daily basis.260 Non-FINRA member firms are not required to report their trading activity to TRACE, but if their transactions involve FINRA members or covered depository institutions, the FINRA members or covered depository institutions would report. With respect to trading activity in U.S. Treasury securities markets on a covered ATS, non-FINRA member counterparties are of ‘‘dealer,’’ stated that number of firms affected by the amendments to Rule 15b9–1 could increase if the definition of ‘‘dealer’’ is amended. See, e.g., STA Letter at 2. The economic analysis appropriately considers existing regulatory requirements, including recently adopted rules but not proposed rules, as part of its economic baseline against which the costs and benefits of the final rule are measured. To the extent the Commission amends the definition of ‘‘dealer’’ in the future, the adopted amendments to Rule 15b9–1 would become part of the baseline from which the effects of any such new rule on the definition of ‘‘dealer’’ are measured. See supra note 186 and accompanying text. 259 See Stephanie Dumont & Ola Persson, TRACE at 20—Reflecting on Advances in Transparency in Fixed Income (FINRA.org), Jun. 28, 2022, available at https://www.finra.org/media-center/blog/trace-at20-reflecting-advances-transparency-fixed-income (last visited July 20, 2023). See also FINRA Rule 6750(c). 260 See supra note 122 and accompanying text. PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 identified in TRACE.261 With respect to trading activity in other TRACE-eligible securities, non-FINRA member counterparties are not identified in TRACE.262 Therefore, the Commission is unable to estimate the level of trading activity of non-FINRA member firms for other fixed income securities. In September 2022, of the 73 nonFINRA member firms, 53 initiated equity orders that were not executed on an exchange, accounting for $440 billion (approximately 5.1%) in off-exchange traded dollar volume in listed equities.263 In April 2023, of the 64 nonFINRA member firms, 45 initiated equity orders that were not executed on an exchange, accounting for $405 billion (approximately 5.6%) 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 in NMS stocks. Off-exchange equity trading occurs across many trading venues. In the fourth quarter of 2022, 32 ATSs actively traded NMS stocks, comprising 10.5% of NMS stock share volume. Furthermore, 214 named 264 brokerdealers transacted a further 32.4% 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.265 While some non-FINRA member firms trade actively cross-exchange and/or offexchange, 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 2022 and April 2023 for the non-FINRA member firms. Table 2 261 See supra note 124 and accompanying text. stated that it does not have visibility into the activity of PTFs in non-U.S. Treasury security fixed-income products. See FINRA Letter at 9. 263 See supra section II.B for further discussion of trading activities of non-FINRA member firms. 264 ATSs report counterparties that are not FINRA members, allowing such activity to be identified in CAT data. 265 See Table 1 for information on trading activities on ATSs. 262 FINRA E:\FR\FM\07SER2.SGM 07SER2 61873 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations below shows the executed dollar volume, number of trades, and number of contracts in options during September 2022 and April 2023 for the non-FINRA member firms. TABLE 1—NON-FINRA MEMBERS NMS EQUITY TRADING VOLUME BY VENUE TYPE Traded dollar volume Sept 2022 Billions ($) I. All Non-FINRA Member Firms 1 Trading Venue: Off-Exchange: ATS ................................................................................... Off-Exchange: Non-ATS ........................................................................... On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Not Exchange Member ..................................................... April 2023 Billions ($) % of total % of total 369.59 70.63 2,183.14 311.62 12.6 2.4 74.4 10.6 352.38 52.41 1,746.53 261.91 14.6 2.2 72.4 10.9 Total ................................................................................................... II. Largest Non-FINRA Member Firms 3 Trading Venue: Off-Exchange: ATS ................................................................................... Off-Exchange: Non-ATS ........................................................................... On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Not Exchange Member ..................................................... 2,934.98 100.0 2,413.23 100.0 333.48 57.60 1,639.34 248.40 14.6 2.5 71.9 10.9 322.16 41.62 1,415.99 219.46 16.1 2.1 70.8 11.0 Total ................................................................................................... 2,278.82 100.0 1,999.22 100.0 Data Source: CAT. 1 Non-FINRA Member firms that initiated NMS equity orders that were executed either on or off-exchange. There were 53 firms in September 2022 and 45 firms in April 2023. 2 Exchange Member refers to trades executed on an exchange where the non-FINRA member is a registered member. 3 The largest 12 non-FINRA member firms ranked by equity off-exchange traded dollar volume. TABLE 2—NON-FINRA MEMBERS OPTIONS TRADING VOLUME BY VENUE TYPE Traded dollar volume Sept 2022 Billions ($) April 2023 Billions ($) % of total % of total Panel A: Option Dollar Volume I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 50.01 3.31 93.8 6.2 44.62 2.65 94.4 5.6 Total ................................................................................................... II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 53.33 100.0 47.27 100 45.56 2.80 94.2 5.8 40.43 2.44 94.3 5.7 Total ................................................................................................... 48.37 100.00 42.87 100 Trades Sept 2022 Millions April 2023 % of total Millions % of total ddrumheller on DSK120RN23PROD with RULES2 Panel B: Number of Option Trades I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. Total ................................................................................................... II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 18.41 1.00 94.8 5.2 19.60 0.95 95.4 4.6 19.41 100 20.55 100 16.41 95.4 17.09 95.8 E:\FR\FM\07SER2.SGM 07SER2 61874 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations TABLE 2—NON-FINRA MEMBERS OPTIONS TRADING VOLUME BY VENUE TYPE—Continued Traded dollar volume Sept 2022 Billions ($) April 2023 % of total Billions ($) % of total On-Exchange: Cross-Exchange 3 ............................................................. 0.79 4.6 0.75 4.2 Total ................................................................................................... 17.20 100 17.84 100 Contracts Sept 2022 Millions April 2023 % of total Millions % of total Panel C: Number of Option Contracts I. All Non-FINRA Member Firms 1 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 147.31 8.58 94.5 5.5 179.13 8.20 95.6 4.4 Total ................................................................................................... II. Largest Non-FINRA Member Firms 4 Trading Venue: On-Exchange: Exchange Member 2 ......................................................... On-Exchange: Cross-Exchange 3 ............................................................. 155.88 100.0 187.34 100.0 129.67 6.66 95.1 4.9 158.01 6.62 96.0 4.0 Total ................................................................................................... 136.33 100.0 164.64 100.0 ddrumheller on DSK120RN23PROD with RULES2 Data Source: CAT. 1 Non-FINRA Member firms that initiated options orders that were executed. There were 53 firms in September 2022 and 45 firms in April 2023. While these are the same numbers of non-FINRA member firms that initiated NMS equity orders as reflected in Table 1, they are not all the same firms as there is not 100% overlap. Some firms that initiated NMS equity orders did not initiate options orders. Some firms that initiated options orders did not initiate NMS equity orders. The number of firms in these two groups is the same. 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 12 non-FINRA member firms ranked by equity off-exchange traded dollar volume. Nine of the largest 12 firms in September 2022 and eleven of the largest 12 firms in April 2023 initiated options orders that were executed. Table 1 shows that in April 2023 nonFINRA member firms executed approximately 72.4% of their NMS equity trading volume 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 offexchange. Table 2 shows data for nonFINRA member firms that also executed trades in the options market and their total dollar, trades, and contract volume. In September 2022, 53 non-FINRA member firms and nine of the 12 largest firms 266 executed trades on options exchanges. Seven of the nine largest firms executed trades on five or more options exchanges. In April 2023, 45 non-FINRA member firms and eleven of the 12 largest firms executed trades on options exchanges. Table 2 indicates that a larger share of options trading by non-FINRA members (relative to equities trading) takes place on exchanges wherein the firm is a registered member, ranging from 94%– 96%. Therefore, about 5% of nonFINRA member options trading occurs on exchanges where the firm is not a member, the volume of which accounts for around 1% of overall options trading volume.267 One commenter indicated that because non-FINRA members’ offmember-exchange transactions represent a relatively small proportion of total options market volume, mandating FINRA membership will not promote regulatory efficiency, since (in the commenter’s assessment) the costs of Association membership will exceed any benefits provided by FINRA oversight of ‘‘a relatively small amount of trading activity, especially if this activity is already being conducted through a FINRA broker-dealer.’’ 268 The Commission, however, believes that the 267 See note 269, infra. commenter stated that the proposed rule would not promote regulatory efficiency, since the costs of FINRA membership would be disproportionate to gains from membership. See CTC Letter at 4. Consideration of costs and benefits of the amendments are presented in section V.C. 268 The 266 The largest non-FINRA member firms are ranked by equity off-exchange traded dollar volume. Nine of the largest 12 firms in September 2022 and eleven of the largest 12 firms in April 2023 initiated options orders that were executed. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 benefits stemming from Association oversight of these flows are not trivial and justify their accompanying costs. More specifically, while the Commission agrees that off-memberexchange options volume is not large relative to the size of the overall options market, it is nonetheless economically large, representing between $133 to $165 million of daily options dollar volume.269 2. Current Market Oversight The surveillance and regulation of each broker or dealer is partially dependent upon its individual SRO 269 More specifically, in September 2022, 53 of the 73 non-FINRA member firms initiated options orders that were executed off-member-exchange, valued at $3.31 billion and equal to about 0.3% of total options market volume. In April 2023, 45 of the 64 non-FINRA member firms initiated options orders that were executed off-member-exchange, valued at $2.65 billion, approximately 0.4% of total options market volume. See supra Table 2 for additional detail. One commenter raised a similar concern regarding the equities market. See STA Letter at 3. As equities trading represents a much larger portion (more than 25%) of non-FINRA member volume relative to options trading, the Commission views an even greater need for FINRA supervision in equities markets. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 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. Exchange SROs generally possess expertise in supervising members who specialize in trading on their exchange and in using the order types that may be unique or specialized on the exchange. This expertise complements the expertise of an Association in supervising off-memberexchange trading activity.270 In the markets for NMS equities and listed options, while all exchanges are SROs and have access to CAT data covering trading activity by their members both on and off exchanges, nearly all cross-market and off-exchange equity activity and much options activity of non-FINRA member brokerdealers is surveilled by FINRA through 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,271 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 or covered depository institution that is party to the trade or the trade occurs on an ATS because such reporting results from a FINRA rule.272 Where no FINRA member or covered depository institution is party to the transaction, and the transaction does not take place on an ATS, it goes unreported to TRACE.273 Some exchanges serve as DEA for certain of their members.274 Financial and operational requirements share many commonalities across SROs, such as net capital requirements and books 270 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. 271 Municipal bond trades are not reported to TRACE. See supra note 240. 272 All ATSs are operated by FINRA member firms. 273 These reporting gaps were noted by FINRA, which indicated that it could not identify nonFINRA member firm transactions in U.S. Treasury securities that do not occur on a covered ATS. Similarly, FINRA stated that it has no visibility into the activity of non-member firms in transactions of non-U.S. Treasury fixed income securities. See FINRA Letter at 9. Beginning in Sept. 2022, FINRA began collecting transactions by certain banks in government securities. See supra note 123. 274 See supra note 13. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 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.275 The exchange serving as DEA has regulatory responsibility for their common members’ compliance with the applicable financial responsibility rules.276 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 exempt from the membership requirement pursuant to Rule 15b9–1. The vast majority of broker-dealers join an Association and, because FINRA is the only Association, broker-dealers are subject to relatively uniform regulatory requirements and levels of surveillance and supervision for their activities overseen by FINRA. Supervision by FINRA covers a market that is fragmented across many trading venues, including the more opaque off-exchange market.277 Additionally, FINRA oversees its members’ activity in equity, fixed income, and derivative markets and thus has the ability to surveil asset classes that may be outside the expertise of certain exchange SROs (e.g., options 275 See supra note 13. 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 which FINRA does act as DEA, and the DEA stipulates which SRO has responsibility to supervise the firm but does not allow for less supervision. 276 Under the amendments, non-FINRA member firms that join FINRA may or may not be assigned to FINRA for DEA supervision. See supra section III.A. 277 Comprehensive reporting requirements for all member firms that trade equities off-exchange give FINRA information on market activity levels and market conditions off-exchange. Because most offexchange equity trading 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 note 17. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 61875 exchanges may lack expertise in fixed income securities).278 The existing Association, FINRA, serves crucial functions in the current regulatory structure.279 The Exchange Act’s statutory framework generally places responsibility for off-memberexchange trading with an Association.280 Accordingly, FINRA has established a regulatory regime for FINRA members, including FINRA members conducting business in the offmember-exchange market for various asset classes, and developed surveillance technology and specialized regulatory personnel to provide surveillance, supervision, and enforcement of activity occurring offmember-exchange. Consequently, the current regulatory structure achieves off-member-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 jurisdiction over non-FINRA member firms or provide regulatory oversight services to nonFINRA member firms that are not covered by RSAs, FINRA surveils 100% of the equities and options markets with CAT data as well as other data sources.281 Moreover, where it identifies potential concerns relating non-FINRA member firms’ activities, 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.282 However, each RSA is independently negotiated and thus not standardized. Therefore, FINRA’s ability to provide oversight can vary based on the nature of its RSA with the exchange SRO. Additionally, the ultimate responsibility for that regulatory oversight under an RSA still rests with the exchange SRO, not with FINRA.283 SROs may also use 17d–2 plans which allow SROs with common members to designate a single SRO to 278 For example, FINRA has extensive specific rules and dedicated staff applicable to fixed income markets. See FINRA.org, Key Topics: Fixed Income, available at https://www.finra.org/rules-guidance/ key-topics/fixed-income. 279 See supra section II for further discussion of the role of Associations in market oversight. 280 See supra note 26. 281 CAT data is available to all SROs. FINRA utilizes other data sources for their surveillance as well as CAT data. 282 In most but not all cases, FINRA is empowered to take such actions. 283 See supra note 84. E:\FR\FM\07SER2.SGM 07SER2 61876 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations examine common members. However, 17d–2 plans do not confer jurisdiction to FINRA as they apply only to common firms of which each SRO would already have jurisdiction.284 Exchange SROs may not be efficient, relative to FINRA, at monitoring off-member-exchange activity. Some non-FINRA member firms trade significantly in the course of their normal business activities on exchanges of which they are not members. This activity is not limited to equities and options; non-FINRA member firms play a large role in U.S. Treasury securities markets as well.285 In 2022, there were seven non-FINRA member firms that together traded more than $6 trillion in U.S. Treasury securities volume on covered ATSs, which accounted for 3.67% of total U.S. Treasury securities trading volume 286 reported to TRACE. The Commission estimates that in April 2023, five non-FINRA member firms totaled $302 billion in U.S. Treasury securities volume executed on covered ATSs, accounting for 2.65% 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, when firms’ exchange activity typically was a floor business conducted on a single national securities exchange.287 While the Act provides for regulation of exchange trading by the exchanges themselves, it additionally grants regulatory oversight of off-exchange trading by an Association.288 FINRA, currently the sole Association, has specific tools and expertise to provide oversight to offexchange activity. However, FINRA’s regulatory jurisdiction is limited to its membership. Some commenters have suggested that the current regulatory structure already subjects non-FINRA member firms to robust SRO oversight because exchange SROs have access to both on- and offmember-exchange equity and options trading data of their members via CAT.289 Indeed, SRO rules require their members to report CAT data daily.290 ddrumheller on DSK120RN23PROD with RULES2 284 See supra note 13. 285 See supra section V.A.1 and accompanying text for more information on trading in U.S. Treasury securities markets. 286 The Commission estimates from 2023 TRACE data that in Apr. 2023 there were 916 total firms that traded U.S. Treasury securities. 287 See 2022 Re-Proposal, supra note 1, 87 FR 49932; see also Qualifications and Fees Release, supra note 33. 288 See supra note 66. 289 See, e.g., Cboe Letter at 2; ABCV Letter at 3; CTC Letter at 3; Group One Letter at 1; MMI Letter at 2; PEAK6 Letter at 2. 290 These data record the origination, receipt, execution, routing, modification, or cancellation of every order a member firm handles for NMS stocks VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 One commenter noted that this has helped dramatically improve the ability of regulators to identify violative activity which is initiated off-memberexchange, across both the equity and options markets.291 Some commenters also stated that option exchange SROs have specialized expertise that makes them well suited for effectively overseeing options trading.292 In addition, one commenter stated that there are existing mechanisms for SROs to coordinate surveillance of cross-exchange options trading, such as the ISG and its subgroups.293 The commenter further stated that the ISG ‘‘provides a nonexclusive forum for discussions and referrals to occur and/or to coordinate on matters of joint interest to its members, while preserving each SRO’s independent decision-making and enforcement authority.’’ However, with regard to off-member-exchange activity, which in the case of options firms, also includes equity trading activity, SRO oversight is based on RSAs, which are subject to certain limitations. For example, RSAs can expire or be terminated.294 Some commenters stated that nonFINRA member off-member-exchange activity is frequently conducted through FINRA member broker-dealers,295 and is therefore already accessible to FINRA surveillance. However, trading through FINRA members does not confer direct authority to FINRA over these nonmembers. This is relevant given that FINRA stated that it identified nonmember firms as potential respondents in five percent of its 2020 and 2021 market regulation investigations.296 In addition, FINRA stated that ‘‘for certain products and exchanges, some nonmember firm conduct may not fully be subject to exchange rules that provide for important protections in connection with the execution of customer orders (e.g., not all exchanges have comparable best execution rules).’’ 297 Non-FINRA member firms that are exempt from the Exchange Act’s and options, with the exception of primary market transactions. See generally FINRA Rule 6800 Series and 17 CFR 242.613. 291 See STA Letter at 2. 292 See ABCV Letter at 3; Cboe Letter at 6; FIA PTG Letter at 2. Commenters also stated that options exchanges surveil the equities trading of their members. However, non-FINRA members conduct 15 to 17 percent of equity trades offexchange, instances where FINRA surveillance is more efficient than exchange SROs. See supra Table 1. 293 See Nasdaq Letter at 3. 294 See supra notes 237–238. 295 See Cboe Letter at 3; CTC Letter at 5; Group One Letter at 2; PEAK6 Letter at 4. 296 See FINRA Letter at 5. 297 See id. at 7–8. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 Association membership requirement are not required to pay the costs of Association membership, which might be significant, especially for firms with substantial trading activity (e.g., they would incur TAF and other expenses if they chose to join FINRA in response to the amendments). Fees associated with FINRA membership include the annual Gross Income Assessment (GIA), the annual personnel assessment, and the TAF and section 3 fees.298 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.299 In particular, transactions in U.S. Treasury securities are not part of the ‘‘covered securities’’ for the purpose of TAF fee. 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 transaction by or through a FINRA member. Under section 31 of the Act,300 SROs must pay transaction fees based 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 a 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.301 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 298 See infra section V.C.2.b. for more information on these fees. 299 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 2022 Re-proposal, FINRA proposed an amendment that would exempt from the TAF transactions executed by proprietary trading firms on an exchange of which the firm is a member. See TAF Amendment, supra note 146. 300 15 U.S.C. 78ee. 301 The seller’s clearing broker may pass that fee on to the non-FINRA member firm. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations includes a member firm counterparty or a member firm acting as clearing broker for a non-FINRA member firm buy side counterparty. Any broker-dealer that carries customer accounts is required to be a member of an Association and thus 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. ddrumheller on DSK120RN23PROD with RULES2 3. Current Competition To Provide Liquidity The market for liquidity provision on equity and options exchanges is competitive. In September 2022 across all exchanges, each equity security had a registered market maker providing liquidity, and some had as many as 48 registered market makers. The median equity security had 4 registered market makers and twenty-five percent of equity securities had 5 or more registered market makers. Sixty percent of equity securities have at least two registered market makers and forty percent had one registered market maker. In addition to these registered market makers, the Commission believes that other market participants effectively provide liquidity in equity securities through their trading activities. In the options market, each exchange had as many as 24 market makers providing liquidity. The average number of market makers per options security across exchanges is approximately 5.9. While counting the number of market makers does not necessarily indicate whether each market maker is an active competitor, it does provide a good indication as to the number of firms in the business of providing liquidity, and the Commission believes that many market makers do actively compete, both with other registered market makers and market participants generally, 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 in equities, options, and fixed income markets.302 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. 302 One commenter agreed that the amendments ‘‘will safeguard against certain market participants, in this case high-frequency trading firms, from retaining a competitive advantage in the market due to outdated regulations.’’ See Better Markets Letter at 8. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 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 5.1% and 5.6% of off-exchange dollar volume in equities from September 2022 through April 2023. Additionally, nearly 16.8% of all non-FINRA member equity trading activity occurs in offexchange markets. Approximately 5.0% of non-FINRA member options trading activity involves a non-member exchange. In U.S. Treasury securities markets, non-FINRA broker-dealer trading activity that is reported by covered ATSs accounts for 3.67% 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 might have varying effects on efficiency, competition, and capital formation. These potential effects are described in this section. The amendments will likely result in improved efficiency of capital allocation. To the extent that liquidity provision changes as a result of the amendments, market efficiency might be impacted. Additionally, the amendments will have mixed effects on competition to provide liquidity, as current non-FINRA member firms might 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 achieve compliance with the amendments in multiple ways, each route might involve changes to firms’ business models. Some non-FINRA member firms might limit their trading to exchanges of which they are members, and the Commission believes that some may not trade off-memberexchange other than to comply with Rule 611 of Regulation NMS or the Options Linkage Plan,303 or to execute the stock leg of a stock-option order.304 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.305 Other firms would no 303 See supra section III.B.1. supra section III.B.2. 305 Changes to the exclusion are discussed in section III.B, supra. 304 See PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 61877 longer be exempt, and would need to take action to comply with the amended rule. Under the amended rule, a nonFINRA member firm that trades equities, options, or fixed income securities offexchange, or upon exchanges of which it is not a member, can comply in at least 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 offmember-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).306 Finally, a non-FINRA member firm could cease trading securities entirely. The changes non-FINRA member firms make to their business model to comply with the amendments may affect competition in the equity, options, and fixed income securities markets, particularly for off-memberexchange liquidity provision.307 The Commission believes that the amendments will result in a more level regulatory playing field between current FINRA and non-FINRA members, as well as enhanced oversight and transparency of the markets in which these firms compete. In response, it is possible that current FINRA member firms might choose to commit additional capital to liquidity provision when the trading environment has more uniform regulatory requirements. If this results in an increased overall commitment of liquidity both to exchanges and the off-exchange market, there are likely to be 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 amendments may result in improved efficiency of capital allocation 306 15 U.S.C. 78o(b)(8). sentiment was echoed by one commenter who stated that FINRA registration ‘‘represents a significant barrier to entry’’ for market making firms. See Group One Letter at 3. Some proprietary trading firms, however, are already members of FINRA. As a result, FINRA has experience addressing these issues regarding registration barriers by facilitating new members’ registration processes. Additionally, the rule amendments would provide FINRA and the Commission with greater visibility into the activities of these firms. 307 This E:\FR\FM\07SER2.SGM 07SER2 61878 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 by the financial industry.308 While the Commission acknowledges that FINRA membership could act as an entry deterrent to new proprietary trading firms, there are benefits to ensuring a certain level of oversight for proprietary trading firms. The Commission believes that the adopted amendments to Rule 15b9–1 are 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 amendments, the Commission believes that the costs are justified by the benefits of regulatory oversight. While the amendments might reduce the capital commitment of non-FINRA member firms to liquidity provision, 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. Additionally, any subsequent removal of liquidity from the market may improve execution quality on offexchange markets.309 Some institutional investors transacting in off-exchange markets might seek institutional investor counterparties and avoid transacting with proprietary trading firms. To this extent, the removal of non-FINRA member firm liquidity might be seen as improving liquidity quality within ATSs by some institutional investors.310 308 Direct capital formation is the assignment of financial resources to meet the funding requirements of a profitable capital project, is in this case, the provision of liquidity to financial markets. 309 Non-FINRA member firms may also reduce their off-exchange trading outside of ATSs, such as on single-dealer platforms, as part of an effort to avoid being required to join FINRA. However, nonFINRA member firms currently 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. 310 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 VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 It is also possible that reducing the activity of non-FINRA member firms within ATSs might result in more ATS liquidity if non-FINRA member firms are acting as net takers of liquidity within these systems.311 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. If this occurs, it is possible that this will result in a transfer of volume from offexchange venues to exchanges, but it is also possible that overall market trading volume will diminish if decreased volume from off-exchange trading does not migrate to exchanges.312 The Commission acknowledges that nonFINRA member firms, in response to the amendments, may become less willing to compete to provide liquidity offmember-exchange, decreasing liquidity off-exchange and on exchanges where such firms are not members. For example, non-FINRA member firms may choose to cease their off-memberexchange activity rather than join an Association—although it is likely that firms that trade heavily off-memberexchange may find it more costly to cease their off-member-exchange activity than to join an Association.313 In addition, non-FINRA member firms that choose to join an Association may reduce their off-member-exchange trading because joining an Association ATSs. See Terry Flanagan, High-Speed Traders Go Dark, Markets Media Commentary (2012), available at https://www.marketsmedia.com/high-speedtraders-go-dark/. 311 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). 312 Several commenters expressed concerns that the amendments would negatively impact market liquidity in this respect. See Cboe Letter at 7; PEAK6 Letter at 4; ABCV Letter at 3. 313 Firms with very low ATS activity are unlikely to directly connect to an ATS, instead accessing ATSs through a FINRA-member firm. For firms with very limited off-member-exchange activity, ceasing off-member-exchange activity is likely to be less costly than joining an Association. The costs of joining FINRA are discussed in detail in infra section V.C.2; for firms with very limited offmember-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-member-exchange activities that exceed FINRA membership costs, it may be less costly to join FINRA than to cease their off-member-exchange activity. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 would increase variable costs to trade in the off-member-exchange market, as these trades would incur section 3 and possibly additional fees, although some section 3 fees may already be passed on from FINRA member firms to nonFINRA member firms.314 An increase in costs would reduce the profitability of off-member-exchange trading and thus potentially reduce aggregate offmember-exchange trading. The Commission believes that required membership in an Association, consistent with section 15(b)(8) of the Act and amended Rule 15b9–1, could facilitate an appropriate level of oversight. The Commission also recognizes that the loss of liquidity provision in off-member-exchange trading might 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 brokerdealers 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 might 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 competition to provide liquidity decreases, investor costs to trade U.S. Treasury securities could increase. Several commenters expressed liquidity concerns with regard to options markets.315 One commenter stated that FINRA membership costs 314 After the 2015 Proposal and again following the 2022 Re-proposal, FINRA evaluated the structure of the TAF to assure that it appropriately considered the business model of certain nonFINRA member firms that might have joined FINRA as a result of the proposed amendments. FINRA has proposed an amendment that would exempt from the TAF transactions executed by proprietary trading firms on an exchange of which the firm is a member. See TAF Amendment, supra note 146. The Commission’s analysis of TAF is based on the proposed TAF structure as outlined in the FINRA By-Laws, Schedule A. TAF and section 3 fees are discussed further in section V.C.2.b, infra. Firms would also face additional fixed costs both to establish and maintain Association membership; those costs are discussed in section V.C.2, infra. 315 See, e.g., MMI Letter at 1; ABCV Letter at 3; PEAK6 Letter at 5. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations might have ‘‘the potential for impaired liquidity, especially during times of market stress.’’ 316 Another commenter indicated that the FINRA TAF fee structure is disproportionally burdensome for proprietary trading firms and risks stifling liquidity in options markets.317 The commenter also stated 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.318 The Commission, however, believes that options market liquidity provision will not be impaired even if these amendments cause options market makers to exit. The Commission observes that bid-ask spreads have remained consistent since 2015 even though, over that same period of time, options market makers have entered and exited the market through varying market conditions.319 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 in response to the amendments might lead to less exchange liquidity for several reasons. First, non-FINRA member firms that choose not to join an Association will 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.320 Second, non-FINRA member firms that do not join an Association will no longer be able to access off-member-exchange liquidity to unwind positions acquired on exchanges, which might reduce their willingness to provide liquidity on 316 See ABCV Letter at 3. PEAK6 Letter at 5. According to the commenter, FINRA fees are partially based on the number of transactions in order to provide protection that is proportional to the number of customer orders of a broker-dealer. This is theoretically at odds with the business model of proprietary traders, which do not have customers. For this reason, the commenter asserts that FINRA fees are ‘‘imbalanced,’’ i.e., disproportionately costly to proprietary trading firms relative to the benefits provided by FINRA oversight of these firms. 318 Id. 319 See infra note 330 and discussion in infra section V.B.2. 320 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. ddrumheller on DSK120RN23PROD with RULES2 317 See VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 exchanges.321 Third, non-FINRA member firms that choose to join an Association might be subject to additional variable costs (primarily regulatory fees) on their exchange-based trading as well as on their off-memberexchange trading.322 These firms might respond by trading less actively on exchanges. Finally, non-FINRA member firms might 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. Overall, however, the Commission believes that the amendments will most likely not result in a disturbance of liquidity provision due to the robust competitive conditions of the current market landscape. 2. Effect on Competition To Provide Liquidity The amendments might impact competition to provide liquidity by increasing the regulatory cost for current non-FINRA member firms. 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 nonFINRA member firms including a number of regulatory fees and indirect costs that are assessed or imposed upon member firms.323 These costs are a part 321 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 sources, including off-exchange liquidity, were available. 322 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. 323 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 might be lower than a broker-dealer that cannot or does not avoid FINRA membership. The Commission believes that many non-FINRA member firms would retain their exchange membership when the 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 its membership on exchanges where it no longer wishes to trade after joining FINRA, because maintaining exchange memberships is costly and firms are unlikely to maintain membership on PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 61879 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’ off-exchange securities sales. There are indirect costs of disparate regulatory regimes as well.324 Under the amendments current non-FINRA members that choose to join FINRA will 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 might change competitive forces in the market for providing liquidity as the current nonFINRA member broker-dealers have lower regulatory costs, which might make it less costly for non-FINRA member broker-dealers to provide liquidity.325 To the extent that nonFINRA member firms do have lower costs for providing liquidity than FINRA member firms, the amendments might eliminate such an advantage, and lead to a reduction in liquidity provided by current non-FINRA member firms. However, to the extent that these negative effects on liquidity occur, the Commission believes they will be minor in light of several factors. First, while non-FINRA members have been able to avoid direct costs associated with Association membership, in reality, they may have already been bearing a portion of these costs, as FINRA member firms may pass through their fees to nonFINRA member counterparties. In addition, following the implementation of the amendments, current FINRA members will be operating on a more level regulatory cost playing field, which may expand their own provision of liquidity and perhaps balance out any reduction in liquidity from current nonFINRA members. Finally, the provision of liquidity appears to be somewhat resilient to changing market conditions, and more specifically, appears to have been unaffected by the exit of numerous non-member firms since the 2015 Proposal, as discussed below. Several commenters expressed concern about decreased competition among options market makers.326 One commenter specifically noted that ‘‘[s]maller options market makers may not have the economies of scale to exchanges where they do not plan to have activity. See infra section V.C.2, for more information on the fees associated with FINRA membership. 324 See section V.C.2.f, infra. 325 See section V.B.1, supra for discussion of competitive effects and investor costs. 326 See ABCV Letter at 3–4; Cboe Letter at 7; Group One Letter at 3; Nasdaq Letter at 3. E:\FR\FM\07SER2.SGM 07SER2 61880 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations adequately absorb [FINRA registration] costs, which could lead to consolidation and decreased competition.’’ 327 On the other hand, another commenter suggested that the amendments might increase competition and that they ‘‘will safeguard against certain market participants, in this case high frequency trading firms, from retaining a competitive advantage in the market due to outdated regulations.’’ 328 Despite a recent decline in the number of non-FINRA member options liquidity providers, the Commission does not believe that the amendments will negatively impact options market liquidity provision. Since the 2015 Proposal, the number of non-FINRA member firms has declined from 125 to 64. One commenter pointed out that while some non-members may have since become FINRA members or have been acquired by other market makers, most of the decline in option market making non-members are firms that have ceased trading securities.329 However, despite this decline in the number of firms, options market liquidity has remained robust. One academic study shows that options bidask spreads have remained flat since 2015.330 NYSE Data Insights similarly suggests that options quoted spreads have remained flat or slightly declined in recent years as overall option trading volumes have continued to hit record highs.331 While a decrease in the number of competitors can lead to a decline in competition, these data do not appear to suggest that options market liquidity conditions have weakened with the increased industry consolidation. The Commission does not believe that the costs imposed by these amendments will be large enough to undermine options market liquidity provision or the overall degree of competition in the market. The Commission cannot rule out the possibility, however, that the addition of FINRA costs will serve as catalyst for one or more small nonmember options market makers to exit the market,332 although FINRA’s 327 See Cboe Letter at 7. Better Markets Letter at 8. 329 See STA Letter at 3–4. 330 See Figure 1 of Jefferson Duarte, et al., Very Noisy Option Prices and Inferences Regarding the Volatility Premium, J. Fin., Forthcoming. 331 See NYSE Data Insights, 2021 Options Year in Review, available at https://www.nyse.com/datainsights/2021-options-year-in-review. 332 These broker-dealers could also choose to remain exempt by joining any remaining exchanges on which they currently trade but are not members. Additionally, they could remain exempt by retaining their current exchange memberships and only discontinue trading on the exchanges for which they currently do not carry membership. ddrumheller on DSK120RN23PROD with RULES2 328 See VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 exemption of TAF fees for non-member firms,333 which several commenters supported, should reduce the likelihood that firms will choose to exit in response to the rule. To the extent that options market makers exit, competition to provide liquidity in options markets may be adversely impacted. The impact on equity liquidity due to non-FINRA members joining FINRA in response to the amendments is uncertain. 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 nonFINRA member firms, all else equal, currently face lower variable costs of trading compared to member firms, nonFINRA 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.334 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.335 It is possible, however, for new Associations to enter the regulatory oversight market and 333 The TAF exemption will be for trading on exchanges at which the proprietary firm is a member. See supra note 162 and accompanying text. 334 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. 335 See supra note 9 and accompanying text. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 compete with FINRA. The amendments to Rule 15b9–1 might 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 might consider forming 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 might 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.336 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.337 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.338 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.339 The ability to form an Association is characterized by barriers to entry. The amendments include a 365-day implementation period, which might provide a significant time constraint to form a new Association. A new 336 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.’’ 338 See 15 U.S.C. 78o–3(b)(11). 339 See 15 U.S.C. 78o–3(b)(2). 337 See E:\FR\FM\07SER2.SGM 07SER2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations 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 might also incur substantial costs, including personnel, training, travel, and other costs to provide for effective surveillance and supervision of the off-exchange equity, cross-exchange options, and U.S. Treasury securities markets. Indeed, the only existing Association, FINRA, has resources that enable it to surveil and oversee the off-exchange market.340 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.341 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 will have incentives to reduce fees to attract members. This might result in cost savings to brokers and dealers. Second, a new Association might innovate to develop different surveillance and supervision methods that could be more efficient than FINRA’s methods. Competition among Associations might also entail substantial costs. If the market for Associations is characterized by economies of scale, aggregate costs for the same level of regulation might 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.’’ 342 Furthermore, some of the benefits of the amendments will be diminished if current non-FINRA member firms created a new Association as opposed to joining FINRA. For example, the new 340 See supra note 9. CAT NMS Plan Approval Order, supra note 15, 81 FR 84836–39, for a discussion on the benefits provided by CAT with regard to surveillance by SROs. 342 See sections 19(g) and (h) of the Exchange Act, 15 U.S.C. 78s(g) and (h). 341 See VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 Association will not have the experience or expertise of FINRA in overseeing off-member-exchange market activity. Additionally, the members of a new Association will not be required to report their U.S. Treasury securities market trading activity to TRACE if they are not FINRA members. 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. The amendments bring nearly all offexchange 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 might 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 FINRA, a new Association might face increased difficulties attracting members in the future. If the new Association is introduced after implementation of the rule, these stated effects might become more likely as the current non-FINRA member firms would have already joined FINRA. 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 might lower the costs of forming an Association and alter the barriers to entry.343 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 the amendments for a number of reasons. The overall benefits of the amendments relate to more stable and 343 Some limitations on Association membership or operations would require exemptive relief for the Association to register with the Commission. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 61881 uniform surveillance of off-memberexchange 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 will 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-memberexchange market. Consequently, compliance costs will 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 will 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.344 At the other end of the spectrum, the minority of non-FINRA member firms that are large and contribute significantly to both member exchange and off-memberexchange trading are unlikely to remain exempt.345 For the 64 non-FINRA member firms, the Commission believes that most will lose their exempt status, and, while most firms will likely join FINRA, some firms may seek other ways to comply with the amendments (e.g., remaining exempt by expanding their exchange memberships to cover all of the exchanges on which they currently trade or reducing their trading activity to the exchanges on which they currently trade).346 344 Non-FINRA member firms that provide liquidity on multiple exchanges and trade heavily off-member-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 V.A.1, many non-FINRA member firms are members of a single exchange. Such firms are more likely to have limited exposure to off-memberexchange markets. Such firms will 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 stockoption order exemption to continue their limited off-member-exchange trading related to their exchange-based brokerage activities. 345 The diversity of non-FINRA member firms is discussed in supra section V.A.1. 346 See supra section V.B.1., which discusses how firms might change their business models in response to the rule. E:\FR\FM\07SER2.SGM 07SER2 61882 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations 1. Benefits As discussed above,347 some of the firms relying on the Rule 15b9–1 exemption are significant participants in both on and off-member-exchange markets.348 For example, in September of 2022, $440 billion in listed equities was traded off-exchange by non-FINRA member firms, and $311 billion in listed equities was traded on an exchange to which the firm did not belong.349 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 offexchange activity. Although FINRA has the ability to surveil 100% of crossmarket and off-exchange equity trading activity via CAT, it does not have jurisdiction for firms that are not FINRA members. Association membership will supplement the existing oversight of the exchanges, to the extent a firm remains an exchange member, and provide consistent and ongoing application of rules, which vary between exchanges. Regarding off-member-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.350 As discussed above,351 the Commission believes the inclusion of more nonFINRA member firms in an Association 352 will improve such Association’s ability to supervise offmember-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 347 See supra section I. supra section V.A.1. 349 See supra Table 1. 350 Exchange SRO rules would continue to apply to broker-dealer firms that are exchange members and become FINRA members as a result of the amendments to Rule 15b9–1. The Commission believes that Rule 17d–1 DEA designations and Rule 17d–2 plans will likely be utilized in areas of overlapping rules to mitigate duplicative application of exchange SRO and FINRA oversight, in the same fashion as they already are utilized for the many broker-dealer firms that are exchange members and FINRA members. 351 See supra section I. 352 This discussion presumes that the most likely response by non-members to the amendments will be to join FINRA, rather than choosing another option, such as remaining exempt from Association membership by joining every exchange on which the broker-dealer trades, ceasing trading operations, or forming a new Association. ddrumheller on DSK120RN23PROD with RULES2 348 See VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 oversee regulation of trading on equity, fixed income, and option markets. Some commenters expressed concern that there are no clear benefits resulting from the amendments because they believe that exchange SROs provide sufficient regulatory functions.353 The Commission, however, believes that the amendments to Rule 15b9–1 would improve supervision of non-FINRA member firms by leveraging FINRA’s experience and investigative tools, particularly those targeted at offmember-exchange markets. FINRA, currently the only Association, has considerable experience and expertise from overseeing a large number of brokers and dealers that trade offexchange or across exchanges. This makes FINRA’s potential regulation of non-FINRA member firms with offexchange or cross-market trading activity particularly efficient. FINRA stated that ‘‘[d]irect FINRA jurisdiction would yield a number of benefits including ensuring that PTFs are subject to FINRA rules and providing for more consistent regulatory treatment across entities engaging in similar trading activity, which would result in more thorough oversight and stronger crossmarket and cross-product surveillance.’’ 354 In addition, the amendments, as adopted, would enhance the supervision and enforcement for equities and options beyond the benefits from the CAT NMS Plan.355 While CAT improves data accessibility for all SROs, it does not address FINRA’s lack of jurisdiction over non-FINRA member firms with off-member-exchange trading activity. Several commenters 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 of off-memberexchange trading activity.356 However, FINRA stated that even with non-FINRA member firm trading activity information, ‘‘FINRA does not have the independent ability to examine for, investigate, or enforce potential violations of the federal securities laws or FINRA rules with respect to nonmember firms it identifies through 353 See, e.g., ABCV Letter at 2; Cboe Letter at 7; FIA PTG Letter at 2; Group One Letter at 1; MMI Letter at 3; Nasdaq Letter at 4. 354 See FINRA Letter at 7. 355 See CAT NMS Approval Order, supra note 341. 356 See, e.g., Cboe Letter at 2; ABCV Letter at 3; CTC Letter at 3; Group One Letter at 1; PEAK6 Letter at 2; STA Letter at 2. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 surveillance or other means.’’ 357 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 amendments would provide such jurisdiction, thereby leading to expanded supervision and enforcement of existing FINRA rules and regulations.358 In particular, offmember-exchange trading by current non-FINRA members will receive more efficient oversight following implementation of the amendments.359 Some commenters stated that Association membership should not be mandated for options market makers because FINRA regulation is focused on protecting customers and options market makers do not carry customer accounts.360 However, non-FINRA member firms play a significant role in the execution of retail customer orders routed to them by introducing brokerdealers. Commission data indicate that two of the three largest options consolidators, which handled approximately 43% of wholesaled retail customer options orders in 2022, are presently not FINRA members.361 Further, FINRA stated that ‘‘for certain products and exchanges, some nonmember firm conduct may not fully be subject to exchange rules that provide for important protections in connection with the execution of customer orders (e.g., not all exchanges have comparable best execution rules).’’ 362 Commenters also stated that FINRA membership was unwarranted for options market makers since offmember-exchange trading represents only a very small share of the overall trading activity of these firms.363 However, Commission analysis reveals that the overall level of off-memberexchange options activity by non-FINRA member firms involves non-trivial trading volume, exceeding $130 million per day, and therefore warrants Association oversight or exemption via mandated membership on all exchanges on which the broker-dealer trades.364 In addition, options market makers 357 See FINRA Letter at 6. FINRA also stated that it identified non-member firms as potential respondents in five percent of its market regulation investigations conducted in 2020 and 2021. 358 See supra section III.A. 359 Currently, oversight of off-member exchange trading is coordinated through RSAs, which are subject to certain limitations. See supra note 294. 360 See, e.g., ABCV Letter at 2; PEAK6 Letter at 2; Group One Letter at 1–2; STA Letter at 3–4. 361 Based on 2022 filings under 17 CFR 242.606 (‘‘Rule 606’’). 362 See FINRA Letter at 7–8. 363 See Nasdaq Letter at 3; PEAK6 Letter at 2. 364 See supra note 269. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 comprise the majority of the twelve nonFINRA firms among which off-exchange equity volume is concentrated. Therefore, mandating Association membership for non-FINRA member options market makers will also result in enhanced oversight of the offexchange equity trading of these firms, which is currently covered by RSAs. Some commenters stated that offmember-exchange activity was frequently carried out for general hedging purposes, which, they stated, is trading activity that does not justify mandatory FINRA oversight and its associated costs,365 especially if this activity serves to facilitate options market making.366 While the Commission is cognizant of the critical role played by market makers, it nevertheless believes that such trading activity is not immune to violative behavior and therefore does not justify exemption from the amendments.367 The benefits of the adopted amendments will 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 are likely to be required to become FINRA members as a result of the amendments.368 If these broker-dealers become FINRA members, they will be required to comply with FINRA rules, including TRACE reporting requirements. This will have a positive impact on market quality by increasing coverage of data reported to TRACE for trades not occurring on a covered ATS.369 The amendments will also provide additional market oversight by bringing non-FINRA member trading in the Treasury markets under FINRA jurisdiction.370 Non-FINRA member 365 See Cboe Letter at 3; Nasdaq Letter at 4; CTC Letter at 5; PEAK6 Letter at 4. 366 See Cboe Letter at 3; ABCV Letter at 4, PEAK6 Letter at 4. 367 One commenter stated that a general hedging exemption would ‘‘increase fraudulent activity in the market by obfuscating risk activities in the options market.’’ See letter from Cullin Coyle (Oct. 31, 2022). 368 The Commission estimates that seven such firms accounted for $6 trillion in U.S. Treasury securities volume executed on covered ATSs in 2022 that was reported to TRACE, which was more than 3.67% of the total U.S. Treasury securities volume traded in 2022 that was reported to TRACE, and that five such firms’ U.S. Treasury securities volume executed on covered ATSs in Apr. 2023 that was reported to TRACE accounted for approximately 2.65% of total U.S. Treasury securities volume in Apr. 2023 that was reported to TRACE. See supra section II.B. 369 Or trades not involving certain depository institutions, which are mandated to report U.S. Treasury securities trades to TRACE. See supra note 123. 370 FINRA agreed that the benefits of additional U.S. Treasury securities market oversight are likely to be substantial and reported that non-FINRA member broker-dealer firms and non-broker-dealer VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 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.371 Thus, the amendments will improve the quality and complete the coverage of TRACE data to include all non-FINRA member firm transactions and increase regulatory transparency into the U.S. Treasury securities markets.372 One commenter suggested that current TRACE reporting captures effectively all non-FINRA member U.S. Treasury securities transactions and that no present gap in U.S. Treasury securities transaction reporting exists.373 The Commission believes that, while the majority of U.S. Treasury securities transactions are already reported to TRACE,374 there are coverage gaps—even as the Commission cannot estimate the actual amount of U.S. Treasury securities trading activity not currently reported to TRACE.375 The Commission believes that the amendments could provide more substantial benefits to the market for other TRACE-reported (e.g., non-U.S. Treasury securities fixed income) securities, since transactions by nonFINRA members in these securities are completely hidden from FINRA oversight.376 Moreover, unlike U.S. firms were identified in 17% of the FINRA surveillance alerts generated by its Treasuries manipulation patterns in 2020 and 2021. See FINRA Letter at 10; see also supra note 119. 371 FINRA stated that ‘‘non-member firms’ activity accounts for a very significant portion of trading in Treasuries securities.’’ See FINRA Letter at 9. 372 One commenter stated that the amendments ‘‘will help to enhance transparency in the Treasury markets by increasing the percentage of transactions being reported to the TRACE reporting system.’’ See Better Markets Letter at 10. 373 See FIA PTG Letter at 3. The commenter also stated that to the extent that any reporting gaps in U.S. Treasuries exist, it would be preferable to implement a more targeted solution requiring nonmembers to report these transactions via account ownership identifiers rather than mandating FINRA membership. See FIA PTG Letter at 3. 374 See id. 375 See supra note 55. 376 See supra section V.A.1. Non-U.S. Treasury fixed income securities that are TRACE-reported include corporate debt, agency debt, and asset backed securities (such as student and auto loans). See FINRA, Frequently Asked Questions (FAQ) about the Trade Reporting and Compliance Engine (TRACE), available at https://www.finra.org/filingreporting/trace/faq#Reporting. In May 2023, average daily trading volume reported to TRACE for nonconvertible corporate debt was $39.9 billion; agency debt, $3.7 billion; asset back securities, $1.2 billion. See FINRA, TRACE Volume Reports—Total Trades, available at https://www.finra.org/finra-data/ browse-catalog/trace-volume-reports/trace-volumetotal-trades. These are predominantly over-thecounter markets. For example, for information PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 61883 Treasury securities, transactions data on several non-U.S. Treasury TRACEreported securities, including corporate bonds and agency debt securities, are disseminated immediately to the public.377 This immediate dissemination has allowed non-FINRA member firms to observe other firms’ anonymized trades in non-U.S. Treasury fixed income securities 378 without facing the burden of reporting their own trades, potentially providing non-FINRA members a competitive advantage, the cost of which is borne by the investing public through reduced price discovery. Therefore, an increase in FINRA membership due to the amendments could be particularly beneficial to the transparency of these markets, although the trading volume in these securities by non-FINRA members, and thus the full extent of these benefits, remains uncertain since non-FINRA members do not have to report their trades in these securities. While current members of an Association would not be directly affected by this rule, they will benefit by having a more level playing field in reporting trades in the U.S. Treasury securities markets. With more uniform regulatory requirements, firms might compete more equitably to supply liquidity both on exchanges and in the off-exchange market. Two commenters raised concerns about exchanges acting as SROs and potential conflict of interest in regulating effectively versus catering to the exchange’s customers.379 In this scenario, switching from exchange SROs to FINRA serving as DEA should reduce concerns held by these commenters regarding conflict of interest. Although fewer firms will be able to rely on the narrower exemptions, the narrower exemptions will continue to provide the existing benefits for nonFINRA members as well as other market about corporate bond trading see Maureen O’Hara and Xing (Alex) Zhou Corporate Bond Trading: Finding the Customers’ Yachts J. Portfolio Management (2022). For a recent study on fixed income markets, see Understanding Fixed Income Markets in 2023 available at https://www.sifma.org/ resources/research/understanding-fixed-incomemarkets-in-2023/. 377 See supra note 259 for information on the difference between the dissemination of TRACE for U.S. Treasury securities and TRACE for other TRACE eligible securities. See also FINRA, TRACE Reporting Timeframes and Transparency Protocols, available at https://www.finra.org/filing-reporting/ trade-reporting-and-compliance-engine-trace/tracereporting-timeframes. 378 FINRA publishes aggregate TRACE U.S. Treasury security data. See About TRACE Treasury Aggregate Statistics, available at https:// www.finra.org/filing-reporting/trace/data/tracetreasury-aggregates/about. 379 See letters from: Joseph Crowe (Aug. 12, 2022) and Joe Edwards (Aug. 12, 2022). E:\FR\FM\07SER2.SGM 07SER2 61884 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 participants. These exemptions will continue to provide the current cost savings for non-FINRA members as they will continue to not be required to join FINRA and thus avoid the costs of doing so. Additionally, the routing exemption will facilitate regulatory compliance designed to improve market quality.380 The Commission also believes that the stock-option order exemption will facilitate liquidity in both stock and options markets, which is likely to improve market quality.381 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) of the Exchange Act 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, nonFINRA 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 might incur costs related to membership in an Association or costs necessitated by additional exchange memberships. Additionally, some non-FINRA member firms might incur the costs of losing the benefits of trading in the off-memberexchange market if they decide not to join an Association. There might also be indirect costs associated with the amendments, depending on whether 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, some non-FINRA member firms might comply by ceasing their offmember-exchange trading activity, avoiding many of these costs but forgoing the opportunity to trade profitably in some venues. The Commission estimates that, if all 12 of the non-FINRA member firms that had the most significant off-memberexchange trading volume in equities in April 2023 were to join FINRA, the median initial cost 382 of the amendments for these firms would be about $95,000 and the median ongoing annual costs would be about $1.07 380 See supra section III.B.1 for more information on the purpose of the routing exemption. 381 See supra section III.B.2 for more information on the stock-option order exemption. 382 Initial costs include the FINRA membership application fee and fees associated with employing outside counsel to assist with the application, See Table 3, infra. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 million. The Commission estimates that, if all 64 non-FINRA member firms as of April 2023 were to join FINRA, the median initial costs would be about $95,000 and median ongoing annual costs would be about $103,416.383 Some commenters stated that the costs of FINRA registration are substantial and are likely to have a profound economic impact on small non-FINRA member firms.384 While the Commission agrees that the costs of FINRA membership are significant, the aggregate costs for the subset of 12 largest non-FINRA member firms represent the majority (approximately 76%) of the aggregate ongoing costs potentially stemming from the amendments, and these large non-member firms are more readily able to bear such costs through economies of scale and greater economic profits. The Commission believes that smaller nonFINRA member firms as well as new entrants will experience much lower costs. In particular, the initial costs for such firms will be close to the lower estimates discussed below, because these costs are largely dependent on the size and complexity of the firms. Additionally, because smaller firms and new entrants have lower trading activity, the ongoing costs will also be significantly lower as ongoing costs are highly impacted by said trading activity. Finally, any non-FINRA member could choose to avoid these costs and remain exempt from Association membership by joining all exchanges on which they trade but do not currently carry membership. a. Costs of Joining an Association Based on discussions with FINRA,385 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 383 See Table 3 and Table 4, infra, for a breakdown of these costs. The Commission estimates that the total aggregate initial and ongoing annual cost of the amendments across the 12 largest non-FINRA member firms (all 64 non-FINRA member firms) is approximately $31 million ($45 million), not inclusive of potential TRACE reporting costs set forth in section V.C.2.c, infra. Firms with no trading volume in April 2023 are included in these estimates. See supra section II.B. They are unlikely to join FINRA because generally firms that do not effect transactions in, or induce or attempt to induce the purchase or sale of, any security other than transactions they effect in securities solely on a national securities exchange of which they are members are not required to join FINRA under section 15(b)(8) of the Act. Therefore, these firms are less likely to incur initial and/or ongoing FINRA membership costs, and by including them in the costs estimates, the Commission likely has overestimated significantly the total initial and ongoing annual costs. 384 See, e.g., Nasdaq Letter at 4; Cboe Letter at 7. 385 See also FINRA Letter at 5–7. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 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 $55,000.386 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.387 Based on its knowledge of the size and business models of nonFINRA member firms, the Commission believes that the median application fee would be $12,500 and that most nonFINRA member firms would not incur FINRA application fees exceeding $20,000.388 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 might 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 will 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 or the Commission. 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. FINRA stated in a comment letter that ‘‘FINRA anticipates being able to process most of these new membership applications pursuant to the expedited process within 60 days after submission of the application.’’ 389 Factors affecting the specific costs and anticipated timeframe 386 See FINRA By-Laws, Schedule A, section 4. 387 Id. 388 Based on 2022 FOCUS data, no non-FINRA member firm has more than 150 registered representatives. FINRA stated that ‘‘FINRA believes that most non-member firms would not incur application fees exceeding $12,500.’’ See FINRA Letter at 12. 389 See id. at 12–13. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations The annual GIA generally requires members to pay a percentage of the member firm’s total annual revenue based on a graduated scale.391 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 TABLE 3—MEDIAN FIRM or IIA.392 Based on 2022 FOCUS Form 1 data from the 12 aforementioned nonIMPLEMENTATION COSTS FINRA member firms, the Commission Cost Median has determined that the average annual total revenue of non-FINRA member Application to join FINRA ............. $12,500 firms is approximately $1.2 billion, with Legal consulting ............................ 82,500 a median of $491 million.393 FINRA’s Total ....................................... 95,000 graduated GIA scale results in a median GIA of $327,870 for the 12 large non1 Medians are used where possible. Cost FINRA member firms and a median GIA estimates are reported as ranges for legal consulting and compliance work; for these es- of $33,655.65 for all 64 non-FINRA member firms as of April 2023.394 timates, the midpoint is used. The magnitude of the TAF depends b. Costs of Maintaining an Association on the transaction volume of a FINRA Membership member that is covered by the TAF as described in the FINRA By-Laws.395 The With respect to ongoing costs, three Commission estimates that off-membercomponents of such costs are any exchange equity and options trading by ongoing fees associated with FINRA membership, costs of legal work relating the 12 large non-FINRA member firms would generate a median incurred TAF to FINRA membership, and costs associated with additional compliance of around $119,255.85 with an average activities. The ongoing membershipTAF of $304,994.44.396 The related fees associated with FINRA 391 See FINRA By-Laws, Schedule A. For membership include the annual GIA; example, FINRA imposes a 2023 GIA as follows: (1) and the TAF and section 3 fees, among $1,200 on a member firm’s annual gross revenue up others.390 to $1 million; (2) a charge of 0.1511% on a member With certain assumptions, the firm’s annual gross revenue between $1 million and Commission attempted to estimate $25 million; (3) a charge of 0.3232% on a member firm’s annual gross revenue between $25 million direct compliance costs that a nonand $50 million; and so on as provided in Schedule FINRA member firm is likely to face to A. When a firm’s annual gross revenue exceeds $25 comply with the amendments. The million, the maximum of current year’s revenue and estimates apply primarily to the 12 non- average of the last three years’ revenue is used as the basis for the income assessment. FINRA member firms that have 392 See FINRA By-Laws, Schedule A, section 2. significant off-member-exchange trading See also FOCUS Report Form X–17A–5, Part II and activities in equities; smaller firms will IIA. face lower costs compared to these 12 393 Based on 2022 Quarterly Part II/IIA FOCUS firms because they have less revenue data. 394 ($1,200 for the first $1 million of revenue) + and trading volume that would be (0.1511% × annual revenue greater than $1 million subject to GIA, TAF, and section 3 fees. up to $25 million) + (0.3232% × annual revenue However, non-FINRA member firms greater than $25 million up to $50 million) + may already indirectly bear some of (0.0644% of annual revenue greater than $50 these costs, as they may be passed million up top $100 million) + (0.0454% of annual revenue greater than $100 million to $5 billion) + through by FINRA member (0.0494% of annual revenue greater than $5 billion counterparties or executing brokers. up to $25 billion) + (0.1063% of annual revenue Ongoing annual cost estimates are greater than $25 billion). Although the average broken down in Table 4. annual total revenue exceeds the median annual 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. ddrumheller on DSK120RN23PROD with RULES2 390 There are additional fees associated with maintaining a FINRA membership (e.g., CAT fees). 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 V.C.2.d. These additional fees are not quantified since their estimation requires unavailable specialized firm data. Nonetheless, the Commission believes that the fees specified in Table 4 represent the vast majority of ongoing FINRA membership costs. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 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 remaining smaller non-FINRA member firms. See FINRA By-Laws, Schedule A, section 1(c). The total ongoing annual GIA cost for the 12 largest non-FINRA member firms (all 64 non-FINRA member firms) is approximately $8 million ($11.5 million). 395 See FINRA By-Laws, Schedule A, section 1(b). 396 Insofar as options trading is concerned, the estimated TAF includes trading activity on an exchange where a firm is not a member. If a firm’s equity or options trading activity is on an exchange where it is a member, it does not incur the TAF, and if a firm’s activity is on an exchange where it PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 61885 Commission believes that the TAF for non-FINRA member firms not among the 12 identified large non-FINRA member firms 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.397 Specifically, the Commission estimates that the median (average) annual TAF for all 64 nonFINRA member firms would be $6,746.92 ($68,433.18).398 Some off-member-exchange trading by non-FINRA member firms may no longer be profitable when TAF is incurred. Several commenters expressed concerns that TAF costs would be significant.399 Consequently, nonFINRA member firms may reduce their trading both on exchanges and offexchange after joining an Association.400 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 Rule 15b9–1. FINRA re-opened the comment period on its Regulatory Notice in December 2022, after the 2022 Re-Proposal.401 And in June 2023, FINRA filed its TAF Amendment.402 FINRA’s TAF Amendment will exempt proprietary trading firms when they trade securities on exchanges of which they are a member, which several is not a member the activity incurs the TAF unless it is covered by an exemption in FINRA’s By-Laws. See infra note 403 and accompanying test; see also FINRA By-Laws, Schedule A, section (1)(b)(2)(F). The Commission does not have information on what proportion of non-FINRA member firm activity on any exchange where such a firm is not a member would qualify for exemption from the TAF under FINRA By-Laws. To the extent that such activity would qualify for a TAF exemption, the TAF estimates set forth herein may overestimate the actual TAF that firms would incur if they join FINRA. In addition, firms that join FINRA may be able to reduce their TAF cost by joining additional exchanges. Estimates of the TAF are based on the off-member-exchange sell volume reported to CAT for non-FINRA member firms. The estimated TAF is equal to estimated off-exchange equity sell volume × $0.000145 and options contract volume × $0.00244. The $0 minimum is associated with firms that have almost no off-member-exchange volume. 397 See supra section III.A. 398 The total ongoing annual TAF cost for the 12 largest non-FINRA member firms (all 64 non-FINRA member firms) is approximately $3.7 million ($4.4 million). 399 See, e.g., CTC Letter at 4; FIA PTG Letter at 4; PEAK6 Letter at 4; STA Letter at 4. 400 See supra section V.B.1 for more information on how firms may change their trading practices in response to the rule. 401 See supra note 161. 402 See supra note 146; see also supra note 162 and accompanying text. E:\FR\FM\07SER2.SGM 07SER2 61886 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations commenters supported.403 This change to the TAF will likely lower the cost for non-FINRA member firms to join an Association.404 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 equities trading during April 2023, the Commission estimated that section 3 fees incurred by the 12 large non-FINRA member firms due to their off-exchange trading would have a median incurred section 3 fee of $564,217.42 annually, with an average incurred section 3 fee of $1,455,114.27.405 The median (average) section 3 fee for all 64 nonFINRA member firms as of April 2023 is estimated to be $3,013.56 ($303,595.36).406 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 passthrough a portion of the fee to the nonFINRA member counterparty or executing broker. 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.407 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.408 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 $60,000.409 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 Personnel Assessment fee.410 The annual Personnel Assessment fee ranges from $160 to $180 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 $2,400, and the median non-FINRA member firm would incur a Personnel Assessment fee of $0.411 The Commission further estimates that the maximum Personnel Assessment fee incurred by one of these non-FINRA member firms would be $22,250. The Commission estimates that the median ongoing cost for the identified largest 12 non-FINRA member firms would be $1,071,344 and the median ongoing cost for all 64 non-FINRA member firms would be $103,416. 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. However, FINRA members currently pay section 3 fees and TAF when transacting on the buyside with non-FINRA members. To the extent that these costs are currently passed on to non-FINRA members, both section 3 fees and TAF are likely to be overestimated.412 TABLE 4—MEDIAN FIRM ONGOING ANNUAL COSTS 1 Median (12 largest non-member firms) Cost Median (all non-member firms) Gross Income Assessment .......................................................................................................................... Trading Activity Fee ..................................................................................................................................... Personnel Assessment ................................................................................................................................ Section 3 Fee .............................................................................................................................................. Compliance Work ........................................................................................................................................ $327,870.00 119,255.85 0 564,217.42 60,000 $33,655.65 6,746.92 0 3,013.56 60,000 Total ...................................................................................................................................................... 1,071,344 103,416 ddrumheller on DSK120RN23PROD with RULES2 1 Non-FINRA members are recognized as of April 2023. See supra note 394 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 410. 403 See, e.g., MMI Letter at 3; PEAK6 Letter at 4; STA Letter at 4. 404 In the 2015 Proposing Release, supra note 1, 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 ‘‘[t]he potentially most significant impact from a transaction cost perspective is FINRA’s Trading Activity Fee.’’ See FIA PTG at 4. The Commission believes that proposed changes to TAF fees to exempt on-member-exchange trading activity might reduce the associated fees by as much as 75% (95%) for some firms trading in equity (options) markets. Based on discussions with FINRA, TAF relief could amount to nearly $9 million for some current non-member firms. 405 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 VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 Volume × $8.00/$1,000,000. The $8.00/$1,000,000 is the FINRA fee rate for Fiscal Year 2023. See FINRA By-Laws of the Corporation, Schedule A to the By-Laws of the Corporation, section 3— Regulatory Transaction Fee. See also Securities Exchange Act Release No. 96724 (Jan. 23, 2023) and press release, Commission, Fee Rate Advisory #2 for Fiscal Year 2023 (Jan. 23, 2023), available at https:// www.sec.gov/news/press-release/2023-15. 406 The total ongoing annual section 3 cost for the 12 largest non-FINRA member firms (all 64 nonFINRA member firms) is approximately $17.5 million ($19.5 million). 407 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 V.A.2, supra, for more information. 408 Ongoing compliance activities may include core accounting functions, updating policies and procedures, and updating forms filed with regulators. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 409 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. 410 See FINRA By-Laws, Schedule A, section 1(e). 411 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. 412 Furthermore, to the extent that section 3 fees and TAF are not currently being passed on to nonmembers, the implementation of the amendments will result in a reduction of such fees for current members transacting on the buy-side that have been paying these fees in lieu of their non-member counterparties. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations 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. 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. Alternatively, one commenter stated that if FINRA is not assigned as their DEA, then existing DEA fees paid to an SRO might be duplicative upon joining an Association.413 The Commission acknowledges the possibility of duplicate DEA fees in these circumstances but believes that Rule 17d–1 could be utilized by FINRA and the exchange SROs to mitigate duplicative DEA financial responsibility oversight over their common members and Rule 17d–2 plans could similarly be utilized to mitigate the potential for duplicative SRO oversight over their common members in areas other than financial responsibility.414 To the extent that they do not already do so, firms would face additional costs related to coming into compliance with Association rules. Additional costs would include actions that are required to accommodate normal supervision and examination by an Association. The Commission was not able to estimate these costs, although the costs would vary among non-FINRA member firms. Several commenters submitted estimates for the cost of becoming FINRA members.415 In addition, many commenters stated that FINRA fees would be substantial and constitute a considerable sum, believing that FINRA fees would be unduly burdensome and 413 See Group One Letter at 3. example, Rule 17d–1 authorizes the Commission to name a single SRO as the DEA to examine a common SRO member. 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. See supra section III.A. 415 See CTC Letter at 4 (‘‘estimates the one-time costs to join FINRA, and the ongoing annual compliance costs for FINRA membership, to each be millions of dollars’’), and FIA PTG Letter at 4 (‘‘it is very difficult to estimate the annual cost, but we would not be surprised if it is greater than $1,000,000 per year for some firms’’). These estimates are higher than those presented by the Commission in Table 4, in part because these estimates do not incorporate FINRA’s TAF relief amendment. As the estimates in Table 4 are only for the 12 largest non-FINRA member firms, the cost for the average non-FINRA member firm is expected to be much lower. ddrumheller on DSK120RN23PROD with RULES2 414 For VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 outweigh perceived benefits.416 Several commenters believed in particular that FINRA membership would be costly to proprietary trading firms with no customer business.417 One commenter stated that the Commission did not consider other costs associated with FINRA membership, including opportunity costs associated with FINRA examinations.418 The Commission evaluated the most significant costs of FINRA membership but acknowledges that being subject to regular examination by FINRA is an additional cost of FINRA membership. One commenter noted that additional regulatory costs associated with FINRA membership would be manageable compared to the cost of the TAF.419 As stated above, given that FINRA has amended the TAF, the ongoing costs could be lower than prior estimates. However, FINRA fees must be filed with the Commission and such fees must be consistent with the Exchange Act. 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 will also have implementation and ongoing costs associated with TRACE reporting. The Commission believes that seven non-FINRA member firms have had significant trading activities in U.S. Treasury securities markets and, since they do not presently incur the costs of reporting U.S. Treasury (or non-U.S. Treasury) securities to TRACE, may currently have a competitive cost advantage over FINRA member brokerdealers. The Commission estimates that these non-member 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.420 The 416 See, e.g., ABCV Letter at 2; Cboe Letter at 7; CTC Letter at 4; FIA PTG Letter at 4; Group One Letter at 3; Nasdaq Letter at 2; STA Letter at 4; Virtu Letter at 5. 417 See, e.g., ABCV Letter at 2; Cboe Letter at 7; CTC Letter at 4; FIA PTG Letter at 4; Group One Letter at 3; Nasdaq Letter at 3; PEAK6 Letter at 4– 5; STA Letter at 4. 418 See MMI Letter at 3. 419 See FIA PTG Letter at 4. 420 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 PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 61887 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 Table 5. The Commission estimates the cost of third-party reporting to TRACE to be approximately $2,000 per month.421 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 might 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 are included in the Commission’s estimates above and they will incur only the additional marginal costs caused by their volume in other TRACE-reportable securities. However, to the extent that some nonFINRA member firms trade in other TRACE reportable securities but not U.S. Treasury securities, those firms will each incur implementation costs as described above. The Commission cannot estimate how many firms are in this group of non-FINRA member firms that trade TRACE-reportable securities but not U.S. Treasury securities because the Commission can identify nonFINRA member counterparties in TRACE only for U.S. Treasury securities transactions that occur on covered ATSs, as discussed previously.422 TABLE 5—AVERAGE FIRM TRACE REPORTING IMPLEMENTATION COSTS Cost FIX Port Fee ............................. Direct Circuit Connectivity Fee for TRACE Reporting through Nasdaq .................................. Median or average 1 $575 1,500 par value; $2.375/trade for trade size of $1,000,000 par value or more. 421 See FINRA Rule 7730, available at https:// www.finra.org/rules-guidance/rulebooks/finrarules/7730. Firms may incur additional fees for trade cancellations or corrections. 422 See supra section V.A.1. E:\FR\FM\07SER2.SGM 07SER2 61888 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations TABLE 5—AVERAGE FIRM TRACE RE- take less time than the time required to PORTING IMPLEMENTATION COSTS— complete an application with FINRA. However, the aggregate cost of joining Continued Cost Total ................................... Median or average 1 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 Systems Fees ........................... Data Fee ................................... Nasdaq Connection Fee ........... Rule 7730 Service Fee ............. Total ................................... Median or average 1 $4,800 90,000 30,000 300 125,100 ddrumheller on DSK120RN23PROD with RULES2 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. d. Costs of Joining Additional Exchanges Under the Rule as Amended Under the amendments, 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 certain off-exchange activity, some nonFINRA member firms might choose to join additional exchanges to be excluded from the requirement to become a member of an Association. Alternatively, these firms might 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. 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 VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 multiple exchanges would likely be more costly than the cost of joining FINRA. In addition to the registration costs, non-FINRA member firms joining additional exchanges as a result of the amendments will 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 will vary depending on the type of access sought and the exchanges of which non-FINRA member firms choose to become members. The exchange membership fees that apply to non-FINRA member firms joining such exchanges will 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,423 they will have already completed a Form U4, to register associated persons.424 Non-FINRA member firms will not need to register additional associated persons because the exchange SRO rules already require them to register associated persons. All exchanges can access the Form U4 filings within the CRD which is maintained by FINRA. The estimates of the cost of joining additional exchanges are based on a review of membership-related fee structures of all twenty-four national securities exchanges. The view that the potential burden of joining additional exchanges will likely be less than that of joining FINRA includes the assumption that the costs imposed on non-FINRA member firms by the amendments will be membership fees, and not costs relating to trading, such as trading permit fees and connectivity 423 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. 424 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 00040 Fmt 4701 Sfmt 4700 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 might 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. The estimates of the cost of joining additional exchanges aggregate all 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, a range for both the initial fee and the annual fee across exchanges is obtained. The initial fee is as low as $0 for some exchanges. Most exchanges have an initial fee that is greater than $0 and no more than $5,000.425 Regarding monthly or annual membership fees, most exchanges’ 425 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 20, 2023) (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 20, 2023) (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_Application_for_Membership.pdf (last visited July 20, 2023) (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 20, 2023) (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 20, 2023) (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. E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations ongoing monthly or annual membership fees generally range from $1,500 to $7,200.426 Again, these ongoing exchange membership costs are generally much lower than the annual costs estimated for being a member of FINRA. The costs of the amendments associated with joining additional exchanges are included in the total cost estimates for joining an Association provided above in this section.427 This is because, in the event that a nonFINRA member firm chooses to join one or more exchanges and not become a FINRA member, that firm would not incur any of the costs for joining an Association. The Commission believes that a firm may make this choice when the costs of joining FINRA exceed the costs of joining additional exchanges to cover all of the exchanges on which they currently trade. Consequently, the costs for such firms are expected to be no higher than the costs they are estimated to incur in joining FINRA. Thus, all firms will either join FINRA and incur the costs described above or join one or more exchanges and instead incur costs no higher than those described above, so that the total Association costs can be taken as an upper bound on the total costs over both possibilities. ddrumheller on DSK120RN23PROD with RULES2 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 amendments will require non-FINRA member firms to establish, maintain, and enforce policies and procedures as discussed above.428 The Commission estimates that firms would incur a 426 See, e.g., Cboe BYX Exchange, Inc. Fee Schedule (eff. Nov. 1, 2022), available at https:// www.cboe.com/us/equities/membership/fee_ schedule/byx/ (last visited July 20, 2023) (noting an annual membership fee of $2,500); Cboe EDGA Exchange, Inc. Fee Schedule (eff. Nov. 30, 2022), https://www.cboe.com/us/equities/membership/fee_ schedule/edga/ (last visited July 20, 2023) (same); NYSE Chicago, Inc. Fee Schedule (updated Jan. 3, 2023), available at https://www.nyse.com/ publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf (last visited July 20, 2023) (assessing an annual membership fee of $7,200); MIAX Fee Schedule at 20 (Sept. 1, 2022), available at https:// www.miaxoptions.com/sites/default/files/fee_ schedule-files/MIAX_Options_Fee_Schedule_ 09012022.pdf (last visited July 20, 2023) (assessing a monthly trading permit fee for an ‘‘Electronic Exchange Member’’ of $1,500). 427 See supra note 383. 428 See supra section III.B.2. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 burden of 8 hours in initially preparing these policies and procedures.429 Furthermore, the burden of maintaining and enforcing such policies and procedures, including a review of such policies at least annually, will be approximately 48 hours.430 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.431 Firms that choose to join FINRA will 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 will 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 $391 billion in off-exchange equity volume in September 2022, while the remaining non-FINRA member firms executed $49 billion. The Commission cannot estimate the likelihood of these firms choosing to cease off-exchange activity rather than joining an Association. However, given the large 429 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 446. 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 447. 430 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 448. 431 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 00041 Fmt 4701 Sfmt 4700 61889 volume in off-exchange equity volume traded by non-FINRA members, the Commission believes that the probability of non-FINRA members ceasing off-exchange activity is very small. 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.432 Their transactions will have to be routed by an exchange of which they are a member or routed by a broker-dealer exclusively to 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-dealer may have a telecommunications infrastructure that is inferior to that of the broker-dealer that previously provided connectivity between the exchange and the non-FINRA member firm.433 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 might be limited to firms that trade on the floor of a national securities exchange. Specifically, the alternative would provide that a dealer that conducts 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. This alternative also could require a dealer seeking to rely on this exemption to establish, maintain, and enforce written policies and procedures 432 The exemption related to routing to comply with Regulation NMS and the Options Linkage Plan is discussed in supra section III.B.1. 433 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\07SER2.SGM 07SER2 ddrumheller on DSK120RN23PROD with RULES2 61890 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations 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. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 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. 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.434 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.435 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’’). 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. 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 amendments, which would impose additional costs. In particular, some non-FINRA member firms that would become member firms under the amendments would also need to become members of additional exchanges or cease trading on those exchanges. In addition, some current 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,436 the Commission continues to believe that the magnitude of the de minimis allowance is no longer economically meaningful.437 Furthermore, the 436 See 434 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. 435 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 00042 Fmt 4701 Sfmt 4700 supra section III.A. agreed that the de minimis exception should be eliminated in part because ATSs are ‘‘typically interposed between [non-members] and other ATS subscribers, non-member PTFs can engage in substantial OTC trading, including with orders from ATS subscribers or other brokerdealers, without technically triggering the gross income limitation.’’ See FINRA Letter at 3. 437 FINRA E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations Commission continues to believe that the commission sharing arrangements discussed previously 438 are rarely, if ever, used. 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 off-member-exchange, as well as investigate potentially violative behavior.439 This improvement in FINRA’s abilities may not be large relative to the adopted amendments due to the fact that the adopted 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. 5. Mandate TRACE U.S. Treasury Securities Reporting Without Requiring Association Membership In order to address the reporting gap within U.S. Treasury securities trading by non-FINRA members, the Commission could require that all last sale U.S. Treasury securities transaction data be reported to and disseminated by TRACE. Some commenters suggested that this reporting requirement could improve transparency in the U.S. Treasury securities markets without imposing costs of Association membership.440 However, since U.S. Treasury securities trade predominantly offexchange, the Commission believes that U.S. Treasury securities markets will benefit from enhanced regulatory supervision that comes with Association membership.441 FINRA stated that ddrumheller on DSK120RN23PROD with RULES2 438 See supra note 33. 439 One commenter suggested, as an alternative to the amendments, that the Commission could impose ‘‘a more limited FINRA membership that would provide for limited oversight covering the reporting of over-the-counter transactions to FINRA and related surveillance’’ if said exemption were to be eliminated. See Virtu Letter at 3. 440 See CTC Letter at 3; FIA PTG Letter at 3; Virtu Letter at 2. 441 Although most trading in U.S. Treasury securities is reported to TRACE and therefore surveilled by FINRA, this surveillance is not VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 although non-FINRA member brokerdealers and non-broker-dealer firms were identified in 17 percent of the surveillance alerts generated by FINRA’s Treasuries manipulation patterns in 2020 and 2021, FINRA has no authority to address any potential market misconduct by non-FINRA members in these instances.442 Accordingly, the Commission agrees that Association membership will benefit U.S. Treasury securities and other fixed income markets under these circumstances by providing more effective oversight relative to the alternative of simply mandating TRACE reporting. VI. 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’’).443 The Commission requested comment on the collection of information requirements in the 2022 Re-Proposal and submitted relevant information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA and its implementing regulations.444 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 OMB control number. The Commission has received an OMB control number (3235–0743) for this collection of information. As discussed in section III.B, the amendments to Rule 15b9–1 require brokers or dealers relying on the stock-option order exemption to establish, maintain, and enforce certain written policies and procedures. Compliance with these collection of information requirements is mandatory for firms relying on the amended rule. The Commission received no comments on the estimates for the collection of information requirements included in the 2022 ReProposing Release. equivalent to the more extensive oversight that FINRA has over its members. Therefore, when FINRA encounters potentially problematic conduct by firms that are not FINRA members, its ability to investigate potential violations of, or enforce compliance with Federal securities laws, Commission rules, or FINRA rules is limited. See discussion in supra section III.A. 442 See FINRA Letter at 10; supra note 119; see also Better Markets Letter at 7. 443 44 U.S.C. 3501 et seq. 444 44 U.S.C. 3507; 5 CFR 1320.11. PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 61891 A. Summary of Collection of Information The amendments to Rule 15b9–1 include a collection of information within the meaning of the PRA for brokers or dealers relying on the stockoption order exemption under the amended rule. The stock-option order exemption under the amendments to Rule 15b9–1 permits a qualifying broker or dealer to effect off-member-exchange securities transactions, 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 are 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 are 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 will be used by the Commission and SROs to understand how brokers and dealers relying on the exemption evaluate whether the off-member-exchange securities transactions that they effect 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 will be used generally by the Commission as part of its ongoing efforts to examine 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 will rely on the stock-option order exemption. The Commission estimates that, based on publicly available information reviewed covering the end of April 2023, there are approximately 64 brokerdealers registered with the Commission that are members of an exchange but not members of an Association. The Commission believes that some, but not all, of these broker-dealers will likely E:\FR\FM\07SER2.SGM 07SER2 61892 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations 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 an exchange where they are a member. The Commission estimates that 17 firms could potentially rely on the stockoption order exemption and would therefore be required to comply with the policies and procedures requirement.445 The Commission believes that some of these 17 firms could want the ability to effect off-member-exchange securities transactions that are not for the purpose of executing the stock leg of a stockoption order, and may, accordingly, choose to join an Association as a result of the amendments to Rule 15b9–1. ddrumheller on DSK120RN23PROD with RULES2 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 will be approximately 8 hours.446 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 policies and procedures 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, will be approximately 48 hours for each broker or dealer.447 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 will be 56 hours per broker or dealer, which corresponds to an initial aggregate burden of 952 445 See supra section III.B.2. 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. 447 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. 446 This VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 hours.448 The Commission estimates that the ongoing annualized burden associated with Rule 15b9–1 will be 48 hours per broker or dealer, which corresponds to an ongoing annualized aggregate burden of 816 hours.449 E. Collection of Information is Mandatory All of the collection of information discussed above is 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.450 G. Retention Period for Recordkeeping Requirements Brokers or dealers seeking to take advantage of the stock-option order exemption will be required to preserve a copy of their policies and procedures in a manner consistent with Rule 17a– 4 451 until three years after the date the policies and procedures are replaced with updated policies and procedures. 448 This figure is based on the following: ((8 burden hours per broker or dealer) + (48 burden hours per broker or dealer)) × (17 brokers and dealers) = 952 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 Securities Exchange Act Release No. 74244 (Feb. 11, 2015) 80 FR 14564, 14683 (Mar. 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 amended Rule 15b9–1 are much more limited in nature. 449 This figure is based on the following: (48 burden hours per broker or dealer) × (17 brokers and dealers) = 816 ongoing, annualized aggregate burden hours. 450 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). 451 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. PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 VII. Regulatory Flexibility Act Certification The RFA requires that Federal agencies, in promulgating rules, consider the impact of those rules on small entities.452 Section 3(a) of the RFA requires the Commission to undertake a regulatory flexibility analysis of the impact of the rule amendments on small entities unless the Commission certifies that the rule amendments would not have a significant economic impact on a substantial number of small entities.453 For purposes of Commission rulemaking in connection with the RFA,454 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 17 CFR 240.17a–5(d) (‘‘Rule 17a–5(d)’’),455 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.456 In the 2022 Re-Proposal, after an examination of FOCUS data for the then-active broker-dealers registered with the Commission, the Commission certified, pursuant to section 605(b) of the RFA, that amended Rule 15b9–1 would not, if adopted, have a significant impact on a substantial number of small entities.457 One commenter disagreed with the Commission’s certification, stating that there are 39 non-FINRA members of Nasdaq exchanges, 13 of which are overseen by Nasdaq PHLX LLC as the DEA.458 The commenter further stated that certain of those members trade off-exchange and would not be eligible for the re-proposed exemptions in amended Rule 15b9–1, and that the economic impact of the rule amendments on these members would 452 5 U.S.C. 601 et seq. U.S.C. 605(b). 454 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 17 CFR 240.0–10 (Rule 0–10 under the Exchange Act). See Securities Exchange Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982) (File No. AS–305). 455 Rule 17a–5(d) under the Exchange Act. 456 See 17 CFR 240.0–10(c). 457 See 5 U.S.C. 605(b). See also 2022 ReProposal, supra note 1, 87 FR 49972–73. 458 See Nasdaq Letter at 4. 453 5 E:\FR\FM\07SER2.SGM 07SER2 Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 / Rules and Regulations be significant based on the Commission’s estimate of the costs of FINRA membership.459 However, the commenter did not specify whether any of its 39 non-FINRA members are small entities under RFA standards or identify those non-FINRA members. Specifically, the commenter did not assert that any of these non-FINRA members have total capital of less than $500,000 and are not affiliates of any person (other than a natural person) that is not a small business or small organization. The Commission re-examined recent FOCUS data for the approximately 3,500 active broker-dealers registered with Commission as of April 2023, including the 64 non-FINRA member brokerdealer firms that the Commission identified as of April 2023.460 Based on this re-examination, the Commission estimates that not more than three of the non-FINRA member broker-dealer firms have total capital of less than $500,000 and are not affiliates of any person (other than a natural person) that is not a small business or small organization and would, as a result, be considered small entities under RFA standards. These three small firms could be significantly impacted by the adopted rule amendments because they could be required to become a member of FINRA under section 15(b)(8) of the Act, if they effect off-member-exchange securities transactions and do not qualify for one of the adopted exemptions.461 Of the approximately 3,500 brokerdealers registered with the Commission, 786 qualify as small entities because they have total capital of less than $500,000 and are not affiliates of any person (other than a natural person) that is not a small business or small organization.462 Since three of these small broker-dealer entities were not FINRA members as of April 2023, the Commission estimates that approximately 783 of these small broker-dealer entities are already registered with FINRA. The activities of ddrumheller on DSK120RN23PROD with RULES2 459 See id. 460 See supra section II.B. 461 See supra section III. The costs of FINRA membership are discussed in detail section V, supra. In addition, section V.D, supra, discusses the alternatives considered by the Commission. As discussed supra in section III.A, these three firms are not among the 12 largest non-FINRA member broker-dealer firms identified by the Commission as of April 2023, and so, as discussed in that section as well as section V.C.2 supra, their initial and ongoing FINRA membership costs, should they join FINRA, likely would be low, suggesting that, while they would be significantly impacted if they are required to join FINRA as a result of the adopted rule amendments, their trading businesses nevertheless might not be materially impeded by the costs of FINRA membership. 462 Data from FOCUS for Quarter 2 of 2023. VerDate Sep<11>2014 21:08 Sep 06, 2023 Jkt 259001 these 783 FINRA member broker-dealers could be impacted by the amendments to Rule 15b9–1 because the amendments have changed the terms upon which they could deregister from FINRA. Specifically, they will not be able to deregister with FINRA unless they comply with Rule 15b9–1, as amended, which, compared to the pre-amendment rule, sets forth much narrower grounds upon which a broker-dealer may be exempt from FINRA membership. Because the Commission estimates that not more than three small entities will be significantly impacted by the amendments to Rule 15b9–1, compared to 786 total small entities that could be impacted by the rule amendments, the Commission does not believe that a substantial number of small entities will be significantly impacted by the amendments to Rule 15b9–1. Therefore, the Commission certifies that the amendments to Rule 15b9–1 will not have a significant economic impact on a substantial number of small entities. VIII. Other Matters If any of the provisions of this rule, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. Pursuant to the Congressional Review Act, the Office of Information and Regulatory Affairs has designated these rules as not a major rule, as defined by 5 U.S.C. 804(2). Statutory Authority The Commission is adopting the final amendments contained in this release under the authority set forth in 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. Text of Amendments For the reasons set out in the preamble, the Commission is amending 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, PO 00000 Frm 00045 Fmt 4701 Sfmt 9990 61893 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78j–4, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78dd, 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 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 § 242.611 of this chapter 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 § 240.17a–4 until three years after the date the policies and procedures are replaced with updated policies and procedures. By the Commission. Dated: August 23, 2023. Sherry R. Haywood, Assistant Secretary. [FR Doc. 2023–18658 Filed 9–6–23; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\07SER2.SGM 07SER2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 88, Number 172 (Thursday, September 7, 2023)]
[Rules and Regulations]
[Pages 61850-61893]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-18658]

[[Page 61849]]

Vol. 88

Thursday,

No. 172

September 7, 2023

Part V

Securities and Exchange Commission

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17 CFR Part 240

Exemption for Certain Exchange Members; Final Rule

Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 /
Rules and Regulations

[[Page 61850]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-98202; File No. S7-05-15]
RIN 3235-AN17

Exemption for Certain Exchange Members

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to a rule under the Securities Exchange Act of 1934
(``Act'' or ``Exchange Act'') that exempts certain Commission-
registered brokers or dealers from membership in a registered national
securities association (``Association''). The amendments replace rule
provisions that provide an exemption 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 amendments create exemptions for such a registered broker
or dealer that effects securities transactions otherwise than on 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:
Effective date: November 6, 2023.
Compliance date: The compliance date is September 6, 2024.

FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director,
David Michehl, Special Counsel, Nicholas Shwayri, Special Counsel,
Vince Vuong, Special Counsel, or Alba Baze, Attorney-Advisor, at (202)
551-5500, Office of Market Supervision, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549.

SUPPLEMENTARY INFORMATION:
I. Introduction
II. Background
A. Regulatory Framework
B. Updated Background Statistics
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
IV. Effective Date and Implementation
V. 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
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
5. Mandate TRACE U.S. Treasury Securities Reporting Without
Requiring Association Membership
VI. 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
VII. Regulatory Flexibility Act Certification
VIII. Other Matters

I. Introduction

On July 29, 2022, the Commission re-proposed amendments to 17 CFR
240.15b9-1 (``Rule 15b9-1'').\1\ The Commission is adopting those
amendments as re-proposed.
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\1\ See Securities Exchange Act Release No. 95388 (July 29,
2022), 87 FR 49930 (Aug. 12, 2022) (``2022 Re-Proposing Release'' or
``2022 Re-Proposal''). The 2022 Re-Proposal re-proposed amendments
that the Commission proposed on Mar. 25, 2015. See Securities
Exchange Act Release No. 74581 (Mar. 25, 2015), 80 FR 18036 (Apr. 2,
2015) (``2015 Proposing Release'' or ``2015 Proposal'').
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Rule 15b9-1 sets forth an exemption from section 15(b)(8) of the
Act pursuant to which a Commission-registered dealer can engage in
unlimited proprietary trading of securities on any exchange of which it
is not a member or in the off-exchange market (collectively referred to
herein as ``off-member-exchange'') without joining an Association, so
long as the dealer 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.\2\ The Commission
adopted this exemption several decades ago so that an exchange member's
limited off-member-exchange 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.\3\
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\2\ Section 15(b)(8) of the Act 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. Section 15(b)(8)
applies to any security other than commercial paper, bankers'
acceptances, or commercial bills. 15 U.S.C. 78o(b)(8). 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 Act. See 17 CFR 240.600(b)(45)
(defining ``national securities exchange''). ``Off-exchange'' as
used herein means any securities transaction that is covered by
section 15(b)(8) of the Act that is not effected, directly or
indirectly, on a 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.
\3\ See infra notes 33-34 and accompanying text (discussing the
adoption of 17 CFR 240.15b8-1 (``Rule 15b8-1''), which was later
renumbered to Rule 15b9-1).
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The adopted amendments update Rule 15b9-1 by rescinding the
proprietary trading exemption from the rule such that, subject to two
narrow exemptions, Commission-registered broker-dealers that effect
off-member-exchange securities transactions must comply with section
15(b)(8) of the Act by joining an Association. The amended rule's two
exemptions apply when a broker or dealer that does not carry customer
accounts and is a member of at least one exchange effects off-member-
exchange securities transactions that: (1) result solely from orders
that are routed by an exchange of which the broker or dealer is a
member in order to comply with 17 CFR 242.611 (Rule 611 of Regulation
NMS) or the Options Order Protection and Locked/Crossed Market Plan;
\4\ or (2) are solely for the purpose of executing the stock leg of a
stock-option order.\5\
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\4\ See Securities Exchange Act Release No. 60405 (July 30,
2009), 74 FR 39362 (Aug. 6, 2009) (``Options Linkage Plan'').
\5\ See amended Rule 15b9-1, under ``Text of Amendments,''
infra. Consistent with section 15(b)(8) of the Act, and unchanged by
the adopted amendments, a broker or dealer is not required to become
a member of an Association if the broker or dealer effects
securities transactions only on an exchange of which it is a member.
See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
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In the decades since the adoption of the proprietary trading
exemption, the securities markets have undergone a substantial
transformation that has been

[[Page 61851]]

driven primarily by rapid and ongoing evolution of technologies for
generating, routing, and executing orders, and the impact of regulatory
changes.\6\ Today, little trading in the U.S. securities markets is
floor-based and broker-dealer firms no longer trade primarily on a
single exchange. Rather, securities trading today is highly automated,
substantially more complex, and dispersed among many trading centers
including 24 registered exchanges and a myriad off-exchange venues such
as ATSs and OTC market makers.\7\ Proprietary trading broker-dealer
firms have emerged that engage in significant, computer-based or
algorithmic, securities trading activity for their own account across
the full range of these exchange and off-exchange venues, often at
lightning speeds.\8\
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\6\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594 (Jan. 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.'').
\7\ See 2015 Proposing Release, supra note 1, 80 FR 18038; 2022
Re-Proposal, supra note 1, 87 FR 49935. See also Equity Market
Structure Concept Release, supra note 6.
\8\ Proprietary trading firms that engage in so-called high-
frequency trading strategies 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
transactions throughout the national market system. See 2015
Proposal, supra note 1, 80 FR 18038; 2022 Re-Proposal, supra note 1,
87 FR 49935-36. 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 6, 75 FR
3606; see also Staff of the Division of Trading and Markets,
``Equity Market Structure Literature Review, Part II: High Frequency
Trading,'' at 4-5 (Mar. 18, 2014) (available at https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf). Staff
reports, Investor Bulletins, 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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Rule 15b9-1 has remained static, however, as these types of firms
have emerged and off-member-exchange securities trading has
proliferated. As detailed in the 2022 Re-Proposal and section II.B
below, several of these firms effect significant off-member-exchange
securities transaction volume yet, in reliance on Rule 15b9-1, they are
not members of the Financial Industry Regulatory Authority, Inc.
(``FINRA''), the only Association currently.\9\ Broker-dealers that are
not FINRA members are not subject to FINRA's rules or FINRA's direct,
membership-based jurisdiction.\10\ As a result, when broker-dealer
firms that are members of one or more exchanges but not FINRA members
effect proprietary off-member-exchange securities transactions,\11\
these firms are not subject to FINRA's rules or its membership-based
jurisdiction over such activity and are not all subject to the same set
of exchange rules and interpretations of those rules, which can vary
between exchanges.
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\9\ See 2022 Re-Proposal, supra note 1, 87 FR 49936-37. See also
section III, infra. 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 current Rule 15b9-1's proprietary
trading exemption, 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. See 17 CFR
240.15b9-1(b)(1).
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Because such exempt firms are not subject to FINRA's direct,
membership-based jurisdiction when they engage in off-member-exchange
securities trading activity, there is less stability and consistency in
the oversight that is applied to such activity than there would be if
such firms were Association members. To address this concern, the
amendments to Rule 15b9-1 help ensure, as mandated by section 15(b)(8)
of the Act, that an Association (currently, FINRA) generally has
direct, membership-based oversight over broker-dealers that effect off-
member-exchange securities transactions and the jurisdiction to
directly enforce their compliance with Federal securities laws,
Commission rules, and Association rules. Requiring broker-dealers that
engage in off-member-exchange securities transactions to become
Association members will provide FINRA with, among other things, the
ability to apply with a greater degree of autonomy its expertise in
supervising the firms' off-member-exchange securities trading activity
and investigating potential misconduct in that market segment. With
respect to FINRA members, FINRA can determine whether to pursue
examinations and investigations, and the parameters thereof, in a way
that it cannot with respect to non-FINRA members.
Some commenters expressed broad support for the 2022 Re-Proposal,
while other commenters expressed opposition primarily based on the
argument that direct, membership-based FINRA oversight of proprietary
trading broker-dealers is unnecessary in light of existing regulatory
mechanisms and that the costs of FINRA membership would be unduly
burdensome.\12\ As discussed in the 2022 Re-Proposal and section III
below, direct, membership-based jurisdiction by an Association over
broker-dealers that are not FINRA members cannot be achieved through
existing self-regulatory organization (``SRO'') oversight mechanisms
such as joint SRO plans pursuant to 17 CFR 240.17d-2 (``Rule 17d-2'')
\13\ or regulatory service agreements (``RSA(s)''),\14\ or through
reliance on the

[[Page 61852]]

Consolidated Audit Trail (``CAT'').\15\ Those regulatory measures are
useful in many respects but, nevertheless, firms that are not FINRA
members remain outside FINRA's direct, membership-based jurisdiction,
and FINRA therefore cannot apply its expertise in supervising these
firms' off-member-exchange securities trading activity and
investigating potential misconduct with the same degree of autonomy
that it can for FINRA members.\16\
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\12\ Comments received in response to the 2022 Re-Proposing
Release are available at https://www.sec.gov/comments/s7-05-15/s70515.htm. The 2022 Re-Proposal re-proposed amendments to Rule
15b9-1 that the Commission proposed in 2015, with certain
modifications informed by comments received on the 2015 Proposal,
which comments the Commission addressed in the 2022 Re-Proposal. See
2015 Proposal, supra note 1. Comments received in response to the
2015 Proposing Release are available at https://www.sec.gov/comments/s7-05-15/s70515.shtml.
\13\ See 17 CFR 240.17d-2. With respect to a broker or dealer
that is a member of more than one SRO (``common member''), section
17(d)(1) of the Act 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. See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1). To
implement section 17(d)(1), the Commission adopted 17 CFR 240.17d-1
(``Rule 17d-1'') and Rule 17d-2 under the Act. See 17 CFR 240.17d-1
and 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
Securities Exchange Act Release No. 12352 (Apr. 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 Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR
49091 (Nov. 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.
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.
\14\ In contrast to Rule 17d-2 plans, RSAs are privately
negotiated agreements between two SROs that can expire or be
terminated. Under an RSA, one SRO agrees to perform regulatory
services on behalf of another SRO in exchange for compensation.
Unlike Rule 17d-2 plans, the SRO paying for regulatory services
under an RSA retains ultimate legal responsibility for and control
over the regulatory functions allocated to the SRO providing the
services. There are RSAs between exchange SROs and FINRA, but under
these RSAs, for firms that are members of different exchanges but
not FINRA members, FINRA applies to such firm's off-member-exchange
trading activity the rules of their different member exchanges using
the exchanges' interpretations of their rules. 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''). In addition
to regulatory coordination that occurs through Rule 17d-2 plans and
RSAs, SROs also coordinate regulatory efforts through forums
provided by the Intermarket Surveillance Group (``ISG''). See id.;
see also 2022 Re-Proposal, section II.A.
\15\ See 17 CFR 242.613; Securities Exchange Act Release No.
79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016) (``CAT NMS Plan
Approval Order''); notes 90, 107, and 108, infra, and accompanying
text. See also 2022 Re-Proposal, 87 FR 49934, 49939. For proprietary
trading broker-dealer firms that become FINRA members due to the
amendments to Rule 15b9-1, regulatory coordination mechanisms such
as Rule 17d-1 DEA designations and Rule 17d-2 plans would be
available to mitigate the potential for duplicative exchange SRO and
FINRA oversight.
\16\ See supra note 14.
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Moreover, other regulatory developments have heightened the need
for Rule 15b9-1 to be updated. In particular, FINRA has established a
transaction reporting regime under which broker-dealers that are FINRA
members must report U.S. Treasury securities transactions into the
Trade Reporting and Compliance Engine (``TRACE'').\17\ Some Commission-
registered 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
(although if the transaction involves a FINRA member, then the FINRA
member must report the transaction to TRACE).\18\ In addition, 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.
---------------------------------------------------------------------------

\17\ See FINRA Rule 6700 Series; see also Securities Exchange
Act Release No. 79116 (Oct. 18, 2016), 81 FR 73167 (Oct. 24, 2016)
(File No. SR-FINRA-2016-027). In addition, FINRA requires its
members to report all OTC Equity Security and Restricted Equity
Security transactions (other than transactions executed on or
through an exchange) to FINRA's OTC Reporting Facility (``ORF'').
See FINRA Rules 6410 and 6610; see also FINRA Rules 6420(f)
(defining ``OTC Equity Security''); 6420(k) (defining ``Restricted
Equity Security''); 6420(n) (defining ``OTC Reporting Facility'').
FINRA also requires its members to report off-exchange NMS stock
trades to two Trade Reporting Facilities (``TRFs'') that FINRA
operates, one jointly with Nasdaq and the other jointly with the
NYSE. See FINRA Rule 6110 and the FINRA Rule 6000 Series generally;
see also 17 CFR 242.600(b) (defining ``NMS stock''). Further, 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 Securities Exchange
Act Release No. 46249 (July 24, 2002), 67 FR 49821 (July 31, 2002)
(order approving the ADF); see also Securities Exchange Act Release
No. 71467 (Feb. 3, 2014), 79 FR 7485 (Feb. 7, 2014) (order approving
a proposed rule change to update the rules governing the ADF).
\18\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities.
---------------------------------------------------------------------------

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.
Accordingly, after considering the comments received in response to the
2022 Re-Proposal, the Commission is adopting amended Rule 15b9-1 as re-
proposed. The Commission continues to believe that oversight of off
member-exchange securities trading must be enhanced in light of how
securities trading occurs today, by narrowing the extent to which
broker-dealer firms can effect off-member-exchange securities
transactions--in significant volumes in many cases--while exempt from
FINRA membership.

II. Background

A. Regulatory Framework

Broker-dealers generally must register with the Commission and
become members of a SRO.\19\ Self-regulation is a longstanding, key
component of U.S. securities industry regulation.\20\ The Exchange Act
defines SRO to include each national securities exchange or
Association.\21\ An SRO sets standards, conducts examinations, and
enforces rules regarding its members.\22\ In addition to Commission
oversight, the Exchange Act requires this layer of SRO oversight,
pursuant to which SROs act as front-line regulators of their broker-
dealer members.\23\ In particular, there are Federal securities laws,
Commission rules, and SRO rules that prohibit various forms of improper
activity by broker-dealers.\24\
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\19\ See section 15(a)(1) of the Act, 15 U.S.C. 78o(a)(1). For a
more detailed background regarding the relevant regulatory
environment, including the complementary SRO oversight performed by
exchanges and FINRA, see 2022 Re-Proposal, supra note 1, section II,
87 FR 49932-39; see also 2015 Proposal, supra note 1, section I, 80
FR 18036-45.
\20\ See Securities Exchange Act Release No. 50700 (Nov. 18,
2004), 69 FR 71256 (Dec. 8, 2004) (``Concept Release Concerning
Self-Regulation'').
\21\ See section 3(a)(26) of the Act, 15 U.S.C. 78c(a)(26).
\22\ See Concept Release Concerning Self-Regulation, supra note
20 (citing section 15(b)(8) of the Act, 15 U.S.C. 78o(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 71257-58.
\23\ 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.,
section 15 of the Act, 15 U.S.C. 78o; 17 CFR 240.15a-6 through
240.15b11-1; 17 CFR 240.17a-1 through 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., sections
19(d), 15 U.S.C. 78(s)(d), and 19(e), 15 U.S.C. 78s(e), of the Act.
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), 15
U.S.C. 78f(b)(1); 19(g)(1), 15 U.S.C. 78s(g)(1); and 15A(b)(2), 15
U.S.C. 78o-3(b)(2), of the Act; 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).
\24\ See, e.g., sections 10(b), 15 U.S.C. 78j(b); 15(c), 15
U.S.C. 78o(c); and 15(g), 15 U.S.C. 78o(g), of the Act; 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); Cboe Rule 8.6
(Manipulation).
---------------------------------------------------------------------------

As SROs, exchanges and Associations are required to examine for and
enforce compliance by their members and associated persons with the
Exchange Act, the rules and regulations thereunder, and the SROs' own
rules.\25\

[[Page 61853]]

Because of this, SROs that operate an exchange generally 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
off-member-exchange securities trading.\26\
---------------------------------------------------------------------------

\25\ See section 19(g) of the Act, 15 U.S.C. 78s(g).
\26\ See sections 15(b)(8), 15 U.S.C. 78o(b)(8); 15A, 15 U.S.C.
78o-3; 17(d), 15 U.S.C. 78q(d); and 19(g), 15 U.S.C. 78s(g), of the
Act. 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. See sections 17(d), 15
U.S.C. 78q(d); and 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act.
Section 17(d)(1) of the Act enables the Commission to allocate
authority among SROs when a person is a member of more than one SRO.
Section 17(d)(1) of the Act, 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. Section 15A of the Act, 15 U.S.C. 78o-3.
And as described above, section 15(b)(8) of the 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.
Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
---------------------------------------------------------------------------

Specifically, section 15(b) of the Act provides that Commission
registration is generally not effective until the broker-dealer becomes
a member of an Association or a national securities exchange if the
broker-dealer effects transactions solely on that exchange.\27\
Additionally, section 15(b)(8) of the Act 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. Section 15(b)(9) of the Act
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.\28\ Rule 15b9-1 sets forth an
exemption from section 15(b)(8) of the Act \29\ pursuant to authority
conferred to the Commission by section 15(b)(9) of the Act.\30\
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\27\ See section 15(b) of the Act, 15 U.S.C. 78o(b).
\28\ Section 15(b)(9) of the Act, 15 U.S.C. 78o(b)(9).
\29\ Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
\30\ Section 15(b)(9) of the Act, 15 U.S.C. 78o(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 (1) a member of a national
securities exchange, (2) carries no customer accounts, and (3) has
annual 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'').\31\
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'').\32\ The Commission adopted the
original version of Rule 15b9-1 (then Rule 15b8-1 but generally
referred to herein as Rule 15b9-1) in 1965,\33\ which included the de
minimis allowance but not the proprietary trading exclusion; the
Commission adopted the proprietary trading exclusion in 1976.\34\
Relying on the de minimis allowance and proprietary trading exclusion,
a registered dealer can remain exempt from Association membership while
engaging in unlimited off-member-exchange proprietary trading of
securities, so long as the dealer 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.
---------------------------------------------------------------------------

\31\ 17 CFR 240.15b9-1(a).
\32\ 17 CFR 240.15b9-1(b)(1). Rule 15b9-1 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). As discussed below, the
Commission proposed to eliminate from amended Rule 15b9-1 references
to the ITS because they are obsolete, and the Commission is adopting
those eliminations by deleting current paragraphs (b)(2) and (c)
from the amended rule. See infra note 192 and accompanying text.
\33\ The rule was renumbered to Rule 15b9-1 in 1983. See SECO
Programs; Direct Regulation of Certain Broker-Dealers; Elimination,
Securities Exchange Act Release No. 20409 (Nov. 22, 1983), 48 FR
53688 (Nov. 29, 1983) (``SECO Programs Release''). See also
Qualifications and Fees Relating to Brokers or Dealers Who Are Not
Members of National Security [sic] Association, Securities Exchange
Act Release No. 7697 (Sept. 7, 1965), 30 FR 11673 (Sept. 11, 1965)
(``Qualifications and Fees Release''). The Commission stated in the
Qualifications and Fees Release: ``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.
\34\ See Extension of Temporary Rules 23a-1(T) and 23a-2(T);
Adoption of Amendments to SECO Rules, Securities Exchange Act
Release No. 12160 (Mar. 3, 1976), 41 FR 10599 (Mar. 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 stated 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 then-new ITS, and
eliminated references to, and requirements under, the SECO Program,
which was the Commission's program of direct regulation of certain
broker-dealers at that time. See SECO Programs Release, supra note
33.
---------------------------------------------------------------------------

B. Updated Background Statistics

The 2022 Re-Proposal set forth statistics regarding off-member-
exchange securities trading activity by firms that were Commission-
registered broker-dealers and exchange members but not FINRA members
during the time periods reviewed by the Commission in the 2022 Re-
Proposal.\35\ Those statistics are updated below for corresponding
year-over-year time periods.\36\
---------------------------------------------------------------------------

\35\ See 2022 Re-Proposal, supra note 1, section II, 87 FR
49932-39.
\36\ While some updated figures set forth below in this section
differ from figures set forth in the 2022 Re-Proposal, the
Commission believes that its conclusions are supported by the
updated figures as well as the 2022 Re-Proposal's figures.
---------------------------------------------------------------------------

The Commission estimates that, as of the end of September 2022,
there were 73 firms that were Commission-registered broker-dealers and
exchange members but not FINRA members, and that there were 64 such
firms as of April 2023.\37\ Many of these firms were members of just
one exchange while others were members of multiple exchanges.\38\
Specifically, as of April 2023, 22 of the 64 identified firms were
single exchange members; 9 of the firms were members of two exchanges;
15 of the firms were members of more than two but 10 or fewer
exchanges; and the remainder were members of more than 10
exchanges.\39\
---------------------------------------------------------------------------

\37\ Sources: SEC FOCUS Reports (Form X-17A-5); FINRA's Central
Registration Depository (``CRD'').
\38\ Source: CRD.
\39\ Id. 35 out of the 64 identified firms in April 2023 were
members of a Nasdaq group exchange, 34 firms were members of Nasdaq
PHLX LLC (``PHLX'') specifically, and five firms were members of
only PHLX. The Commission believes these figures are consistent with
one commenter's statement in October 2022 that 39 non-FINRA firms
were Nasdaq members, 13 of which designated PHLX as their DEA, as
minor differences in the Commission's and the commenter's figures
could be explained by changes in firms' Nasdaq membership or
Commission registration status during the passage of time between
October 2022 and April 2023. See letter from Erik Wittman, Deputy
Head of Enforcement, The Nasdaq Stock Market LLC (Oct. 6, 2022)
(``Nasdaq Letter'') at 4.

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[[Page 61854]]

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.\40\ 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.
---------------------------------------------------------------------------

\40\ Source: CAT.
---------------------------------------------------------------------------

For example, of the estimated 73 broker-dealers that were exchange
members but not FINRA members as of the end of September 2022, 53
initiated orders in listed equities in September 2022 that were
executed on or off an exchange.\41\ These firms' September 2022 off-
exchange listed equities dollar volume executed was approximately $440
billion,\42\ which was approximately 5.1% of total off-exchange volume
of listed equities executed that month.\43\ Moreover, these firms'
September 2022 listed equities dollar volume executed on exchanges of
which they are not a member was approximately $311 billion.\44\
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\41\ Id. A firm ``initiating'' an order is the firm that reports
the origination of the order as a New Order Event (MENO) to the CAT.
The other 20 firms did not initiate orders in listed equities in
Sept. 2022.
\42\ Id. Dollar volumes set forth in this section represent the
sum of bought and sold volume during the specified time period.
\43\ Id. The Commission estimates that there was approximately
$8.6 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in Sept. 2022.
\44\ Id. The Commission also estimates that, in 2022, 48 of the
73 firms identified as registered broker-dealers and exchange
members but not FINRA members initiated options order executions
accounting for approximately 16-27% of daily options contract volume
traded. The Commission further estimates that 35 of these 48 firms
initiated executions on an exchange where they are not a member, and
that this transaction volume represented approximately 3% of these
35 firms' total options contract transaction volume reported in
2022, and approximately 1% of all options contract transaction
volume reported in 2022. Id. These figures, like the other figures
set forth herein, have been updated from what was set forth in the
2022 Re-Proposal.
---------------------------------------------------------------------------

Of the estimated 64 broker-dealers that were exchange members but
not FINRA members as of April 2023, 45 initiated orders in listed
equities in April 2023 that were executed on or off an exchange.\45\
These firms' April 2023 off-exchange listed equities dollar volume
executed was approximately $405 billion,\46\ which was approximately
5.6% of total off-exchange volume of listed equities executed that
month.\47\ Moreover, these firms' April 2023 listed equities dollar
volume executed on exchanges of which they are not a member was
approximately $262 billion.\48\
---------------------------------------------------------------------------

\45\ Id. The other 19 firms did not initiate orders in listed
equities in Apr. 2023.
\46\ Id.
\47\ Id. The Commission estimates that there was approximately
$7.2 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in Apr. 2023.
\48\ Id. See also Tables 1 and 2, section V.A.1, infra, for
additional detail regarding these firms' trading activity during the
noted time periods.
---------------------------------------------------------------------------

A subset of the identified firms that traded during September 2022
and April 2023 accounted for the large majority of the identified
firms' aggregate trading volume. In this regard, the Commission
estimates that, as of September 2022, 12 of the 53 identified firms
that initiated orders in listed equities accounted for approximately
4.5% of total off-exchange listed equities volume executed in September
2022 and 89% of the off-exchange listed equities transaction volume
attributable to the 53 identified firms that month.\49\ One of the 12
firms initiated $180 billion in off-exchange listed equities executions
in September 2022, which was over 2% of total off-exchange listed
equities transaction volume that month and approximately one-half of
the off-exchange volume executions attributable to the 53 identified
firms.\50\ With respect to the 53 firms' listed equities transaction
volume on exchanges of which they are not a member, one firm accounted
for approximately 66% of the $311 billion in volume attributable to the
53 identified firms in September 2022; six firms (including the
aforementioned one) accounted for over 90% of that volume; and 22 firms
(including the aforementioned six firms) accounted for over 99% of that
volume.\51\
---------------------------------------------------------------------------

\49\ Id.
\50\ Id.
\51\ Id.
---------------------------------------------------------------------------

The Commission also estimates that, as of April 2023, 12 of the 45
identified firms that initiated orders in listed equities then
accounted for approximately 5.1% of total off-exchange listed equities
volume executed in April 2023 and 90% of the off-exchange listed
equities transaction volume attributable to the 45 identified firms
that month.\52\ One of the 12 firms initiated $222 billion in off-
exchange listed equities executions in April 2023, which was 3.1% of
total off-exchange listed equities transaction volume that month and
approximately 55% of the off-exchange volume executions attributable to
the 45 identified firms.\53\ With respect to the 45 firms' listed
equities transaction volume on exchanges of which they are not a
member, one firm accounted for approximately 72% of the $262 billion in
volume attributable to the 45 identified firms in April 2023; five
firms (including the aforementioned one) accounted for over 90% of that
volume; and 21 firms (including the aforementioned six firms) accounted
for approximately 99% of that volume.\54\
---------------------------------------------------------------------------

\52\ Id.
\53\ Id.
\54\ Id.
---------------------------------------------------------------------------

With respect to trading in U.S. Treasury securities, all of which
occurs off-exchange,\55\ the Commission estimates that seven broker-
dealers that were exchange members but not FINRA members accounted for
over $6 trillion in U.S. Treasury securities volume executed on
``covered ATSs'' in 2022 that was reported to TRACE,\56\ which was
approximately 3.67% of total U.S Treasury securities volume traded in
2022 that was reported to TRACE.\57\ In

[[Page 61855]]

April 2023, the Commission estimates that five broker-dealers that were
exchange members but not FINRA members accounted for approximately $302
billion in U.S. Treasury securities volume executed on covered ATSs
that was reported to TRACE,\58\ which was approximately 2.65% of total
U.S Treasury securities volume traded in April 2023 that was reported
to TRACE.\59\
---------------------------------------------------------------------------

\55\ See U.S. Dep't of the Treasury et al., Joint Staff Report:
The U.S. Treasury Market on Oct. 15, 2014 (July 13, 2015) (``Joint
Staff Report'') at 2. 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 (Sept. 28, 2020), 85 FR 87106, 87108 (Dec. 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.
\56\ See FINRA Rule 6730(a)(1) (requiring FINRA members to
report transactions in TRACE-Eligible Securities, including U.S.
Treasury securities).
\57\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities (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.
Approximately $165 trillion total U.S. Treasury securities
transaction volume was reported to TRACE in 2022, of which
approximately $64 trillion was reported as executed on a covered
ATS. Beginning in September 2022, a new form of trade reports from
depository institutions were added to TRACE. These transactions,
which amounted to $4.5 trillion, are excluded.
\58\ See supra note 56.
\59\ Id. One broker-dealer that was not a FINRA member and
traded U.S. Treasury securities in 2022 joined FINRA prior to April
2023, and another broker-dealer that was not a FINRA member and
traded U.S. Treasury securities in 2022 did not appear to trade U.S.
Treasury securities in April 2023.
---------------------------------------------------------------------------

III. Discussion of Amendments to Rule 15b9-1

Under the amendments to Rule 15b9-1 being adopted, a broker or
dealer registered with the Commission pursuant to section 15 of the Act
will be required by section 15(b)(8) of the Act to join an Association
if the broker or dealer effects off-member-exchange securities
transactions, unless it can rely upon one of the amended rule's narrow
exemptions.\60\ Conversely, and unchanged by these amendments, a broker
or dealer will not be required to become a member of an Association if
it effects securities transactions only on an exchange of which it is a
member.\61\
---------------------------------------------------------------------------

\60\ See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8);
amended Rule 15b9-1, infra.
\61\ See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
---------------------------------------------------------------------------

Specifically, Rule 15b9-1, as amended, no longer provides a de
minimis allowance or proprietary trading exclusion, and allows 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 off-member-exchange securities
transactions 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 off-member-exchange
securities transactions that are solely for the purpose of executing
the stock leg of a stock-option order.\62\ In the subsections below,
the Commission discusses each element of the amended rule in detail.
---------------------------------------------------------------------------

\62\ See amended Rule 15b9-1, under ``Text of Amendments,''
infra.
---------------------------------------------------------------------------

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

The adopted amendments to Rule 15b9-1 eliminate the de minimis
allowance and proprietary trading exclusion. Rescinding these
provisions generally eliminates (subject to the exemptions in the
amended rule) the ability for proprietary trading dealer firms to rely
on Rule 15b9-1 to effect off-member-exchange securities transactions
without joining an Association. The Commission proposed these
rescissions to update Rule 15b9-1 so that it more appropriately
effectuates Exchange Act principles of 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.\63\
---------------------------------------------------------------------------

\63\ See 2022 Re-Proposal, supra note 1, 87 FR 49932.
---------------------------------------------------------------------------

Some commenters on the 2022 Re-Proposal broadly agreed that Rule
15b9-1 should be updated in this way.\64\ They stated that the proposed
amendments are appropriate and necessary to modify and modernize Rule
15b9-1 such that it is consistent with the protection of investors and
the public interest in today's market.\65\ They also stated that the
current regulatory framework, which includes RSAs, Rule 17d-2 plans,
and the CAT, among other things, does not provide the full scope of
regulatory coverage appropriate for comprehensive and consistent
oversight of proprietary trading activities because an Association
still lacks regulatory jurisdiction over certain trading activity.\66\
FINRA stated that performing regulatory work with respect to broker-
dealer firms that are not FINRA members pursuant to RSAs is less
certain and stable than direct Association oversight of such firms
because of the discretionary nature of RSAs.\67\ FINRA also emphasized
that access to audit trail data does not confer jurisdiction to FINRA
over such firms, and that FINRA does not have the independent ability
to examine for, investigate, or enforce potential violations of the
Federal securities laws or FINRA rules with respect to such firms when
they are identified through surveillance or other means.\68\ FINRA
stated that jurisdictional limitations impede comprehensive off-
exchange and cross-market oversight in equities, options, and fixed
income markets.\69\ Another commenter stated that the proposal would
help ensure that high-frequency trading firms, which trade large
volumes of equities and U.S. Treasury securities across and off
exchanges without being required to join an Association, i.e., FINRA,
are subject to consistent and robust oversight through FINRA as opposed
to only being subject to complying with the more narrow regulatory
requirements specific to each exchange, and that such firms do not take
advantage of exclusions provided by Rule 15b9-1 that were intended to
accommodate limited broker-dealer activities.\70\
---------------------------------------------------------------------------

\64\ See letters from: Marcia E. Asquith, Corporate Secretary,
EVP, Board of External Relations, FINRA (Sept. 27, 2022) (``FINRA
Letter'') at 1-2; Stephen W. Hall, Legal Director and Securities
Specialist, and Scott Farmin, Legal Counsel, Better Markets, Inc.
(Sept. 27, 2022) (``Better Markets Letter'') at 6-7.
\65\ See FINRA Letter at 1-2; Better Markets Letter at 6-7;
letter from Henry M. Phillip (Aug. 1, 2022) (``Phillip Letter'').
See also Nasdaq Letter at 2 (expressing support for broker-dealers
being required to join an Association if they effect securities
transactions off-exchange and/or in the fixed income space).
\66\ See, e.g., FINRA Letter at 5; memorandum dated June 20,
2023, regarding a call between Commission staff and FINRA (``6/20/23
Meeting Memorandum'') (stating that FINRA identified non-FINRA
member broker-dealer firms as potential respondents in 5% of the
market regulation investigations it conducted in 2020 and 2021,
which ranged across asset types and included both cross-exchange and
off-exchange conduct).
\67\ See FINRA Letter at 6.
\68\ Id.
\69\ Id.
\70\ See Better Markets Letter at 5, 7-8; see also note 8,
supra, for a description of high-frequency trading firms. This
commenter also stated that high-frequency trading represents roughly
50% of the trading volume in U.S. equities markets and 48% of the
total U.S. Treasury securities interdealer market, and that recent
liquidity crises in both the U.S. equities and Treasury securities
markets have shown the effects on markets dominated by, and heavily
reliant on, high-frequency trading firms. See Better Markets Letter
at 3.
---------------------------------------------------------------------------

Other commenters questioned the necessity and appropriateness of
the application of FINRA oversight to proprietary trading broker-dealer
firms that are not FINRA members. They stated that, in light of
existing regulatory mechanisms that apply to such firms, including, in
particular, proprietary options trading firms, FINRA membership for
such firms would be unnecessary and duplicative.\71\ In this

[[Page 61856]]

regard, they stated that exchange SROs, including where appointed as
DEA over certain of their members, already possess and exercise
authority and can cooperate on regulatory matters to ensure compliance
with the securities laws.\72\ They also stated that the CAT provides
exchanges with sufficient visibility into proprietary broker-dealers'
off-member-exchange securities trading activity, which, they contended,
obviates the need for proprietary trading broker-dealers to be required
to join FINRA.\73\
---------------------------------------------------------------------------

\71\ See, e.g., Nasdaq Letter at 3; and letters from: John
Kinahan, CEO, Group One Trading, LP (Sept. 26, 2022) (``Group One
Letter) at 1-2; Tom Simpson, CEO, PEAK6 Capital Management LLC
(Sept. 26, 2022) (``PEAK6 Letter'') at 2; Akuna Securities LLC,
Belvedere Trading, Chicago Trading Company, and Volant Trading
(Sept. 27, 2022) (``ABCV Letter'') at 3; Angelo Evangelou, Chief
Policy Officer, and Greg Hoogasian, Chief Regulatory Officer, Cboe
Global Markets, Inc. (Sept. 27, 2022) (``Cboe Letter'') at 4-7;
Kirsten Wegner, CEO, Modern Markets Initiative (Sept. 27, 2022)
(``MMI Letter'') at 2; Thomas M. Merritt, Deputy General Counsel,
Virtu Financial, Inc. (Sept. 30, 2022) (``Virtu Letter'') at 2-3;
Joanna Mallers, Secretary, FIA Principal Traders Group (Sept. 27,
2022) (``FIA PTG Letter''), at 4. See also letter from Chasse R.
Thomas (Sept. 26, 2022) (``Thomas Letter'') at 2 (stating that the
proposal should not be adopted because FINRA's ability to monitor
complex financial market is inefficient and unreliable). Some
commenters also stated that the FINRA membership application process
requires information that is duplicative of information already
provided to the Commission and other SROs. See PEAK6 Letter at 2;
FIA PTG Letter at 4. The Commission does not believe that the
submission of information in connection with the FINRA membership
application process that is duplicative of information already
provided to the Commission or exchange SROs is a reason to forgo the
amendments to Rule 15b9-1 being adopted. To the extent information
requested by FINRA is duplicative, firms may be able to leverage
their prior submissions when applying for FINRA membership.
Moreover, it is important that each SRO of which a broker-dealer is
a member, including FINRA, have the requisite information required
by its membership application, regardless of any duplication of the
information, because each SRO has regulatory responsibilities over
the broker-dealer. FINRA may require the same information that is
provided to exchange SROs so that it may be able to review the
information in order to approve the membership application and
effectively regulate the firm. Additionally, Commission-registered
broker-dealers that are exchange members and that join FINRA as
result of these rule amendments would not be situated any
differently from the many Commission-registered broker-dealers that
are exchange members and already FINRA members. In addition, see
discussion below in this section as well as in section V, infra,
regarding FINRA membership costs for broker-dealer firms that must
join FINRA as a result of the adopted amendments.
\72\ See, e.g., Group One Letter at 1-2; PEAK6 Letter at 2; ABCV
Letter at 3; Cboe Letter at 4-7; Nasdaq Letter at 3; FIA PTG Letter
at 4; MMI Letter at 2; Virtu Letter at 2-3.
\73\ See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe
Letter at 2-3; STA Letter at 2-3; ABCV Letter at 3; PEAK6 Letter at
3; Group One Letter at 2; letter from Eric Chern, Co-Founder,
Chicago Trading Company, LLC (Sept. 27. 2022) (``CTC Letter'') at 4.
---------------------------------------------------------------------------

As explained below in this section, the Commission continues to
believe that, in today's market, the de minimis allowance and
proprietary trading exclusion must be eliminated from Rule 15b9-1 such
that there is direct, membership-based Association SRO oversight of
broker-dealers' off-member-exchange securities trading activity, in
accordance with section 15(b)(8) of the Act and with the section
15(b)(9) requirement that any exemption from section 15(b)(8) be
consistent with the protection of investors and the public
interest.\74\
---------------------------------------------------------------------------

\74\ Commenters' critiques of the 2022 Re-Proposal are largely
the same as those that the Commission received in response to the
2015 Proposal, and the Commission continues to disagree with them
for many of the same reasons expressed in the 2022 Re-Proposal. See
2022 Re-Proposal, supra note 1, 87 FR 49941.
---------------------------------------------------------------------------

Requiring broker-dealers that engage in off-member-exchange
securities transactions to become FINRA members will provide FINRA with
direct jurisdiction and the ability to apply with a greater degree of
autonomy its expertise to the firms' off-member-exchange securities
trading activity and investigate potential misconduct in that market
segment. With respect to FINRA members, FINRA can determine whether to
pursue examinations and investigations, and the parameters thereof, in
a way that it cannot with respect to non-FINRA members, as FINRA's
oversight over the latter depends on RSA arrangements, pursuant to
which exchange SROs retain legal responsibility and final decision-
making authority with respect to the covered exchange members.\75\ In
contrast, for FINRA member broker-dealer firms that effect off-member-
exchange securities transactions, FINRA possesses legal responsibility
and decision-making authority with respect to exercising SRO oversight
because FINRA can directly apply its own jurisdiction and rules to such
firms. As such, FINRA can unilaterally decide whether and how to
examine and investigate off-member-exchange activity by a FINRA member
firm for compliance with FINRA rules, and what course of action to
pursue if potential FINRA rule violations are identified.
---------------------------------------------------------------------------

\75\ See supra note 14.
---------------------------------------------------------------------------

Moreover, due to FINRA's experience and expertise in cross-market
and off-exchange oversight, FINRA is well-positioned to perform direct,
membership-based oversight over broker-dealer firms that effect off-
member-exchange securities transactions, as FINRA could bring such
broker-dealers within the applicable regulatory operations that FINRA
already has in place for its direct oversight of FINRA members that
trade across markets. And this FINRA oversight extends to U.S. Treasury
securities trading activity, unlike RSA-based SRO oversight, which does
not extend to such activity.\76\
---------------------------------------------------------------------------

\76\ See FINRA Letter at 8. FINRA has taken an active role in
overseeing trading activity in U.S. Treasury securities by, for
example, requiring U.S. Treasury securities to be reported to TRACE,
and by publishing daily files of aggregated U.S. Treasury securities
transactions data reported to TRACE. See FINRA Rules 6730 and 6750;
see also Treasury Daily Aggregate Statistics, available at https://www.finra.org/finra-data/browse-catalog/about-treasury/daily-file.
In addition, FINRA has taken enforcement action regarding U.S.
Treasury securities trading activity and reporting. See, e.g., FINRA
Department of Enforcement v. BGC Financial, L.P., FINRA Letter of
Acceptance, Waiver, and Consent No. 2020068558701 (Jan. 20, 2023),
available at https://www.finra.org/sites/default/files/fda_documents/2020068558701%20BGC%20Financial%2C%20L.P.%20CRD%2019801%20AWC%20va%20%282023-1676852400276%29.pdf.
---------------------------------------------------------------------------

While FINRA traditionally has been the SRO that primarily oversees
off-member-exchange securities trading activity, in the context
relevant here--proprietary trading broker-dealer firms with exchange-
only SRO membership that effect off-member-exchange securities
transactions--FINRA is unable to directly enforce such firms'
compliance with Federal securities laws and Commission rules applicable
to broker-dealers, or apply its own rules to such firms, because they
are not FINRA members. Without direct, membership-based FINRA
oversight, SRO oversight of such firms' off-member-exchange securities
trading activity is largely a function of cooperative regulatory
arrangements among SROs, but those arrangements do not confer
membership-based jurisdiction to FINRA to enforce compliance with the
Exchange Act and applicable rules. These arrangements include those
discussed in the 2022 Re-Proposal and highlighted by commenters, such
as exchange SRO oversight through being appointed as DEA for certain
exchange members pursuant to Rule 17d-1 and through Rule 17d-2 plans,
indirect FINRA oversight pursuant to RSAs with exchange SROs, and the
CAT.\77\ As discussed below in this section, while these arrangements
serve useful purposes and enhance regulatory outcomes, the Commission
continues to believe that, in today's market, they are inadequate
substitutes for direct, membership-based FINRA jurisdiction over firms
that effect off-member-exchange securities transactions.
---------------------------------------------------------------------------

\77\ See CAT NMS Plan Approval Order, supra note 15, 81 FR
84836-41, for a discussion of the benefits provided to SROs by the
CAT with regard to surveillance, examinations, enforcement
investigations, and tips and complaints.
---------------------------------------------------------------------------

Commenters described the general proficiency of direct exchange SRO
oversight over exchange members.\78\ As

[[Page 61857]]

discussed in the 2022 Re-Proposal, in contrast to FINRA, the regulatory
focus of exchange SROs is generally on trading by their members on
their respective exchanges.\79\ Exchange SROs generally monitor market
activity specific to their own exchanges and have expertise in
regulating unique aspects of their markets.\80\ The focus of the
amendments being adopted here, however, is different. Here, the
Commission is concerned with off-member-exchange securities trading
activity, SRO oversight of which traditionally has been and remains
primarily FINRA's responsibility. As discussed above and in the 2022
Re-Proposal, several broker-dealer firms that are exchange members but
not FINRA members effect off-member-exchange securities
transactions.\81\ This includes firms that trade options proprietarily
and are engaged in proprietary options market making. While some
commenters stated that membership-based FINRA oversight over such firms
would be unnecessary and would duplicate existing exchange SRO
oversight, the Commission continues to believe that direct, membership-
based FINRA oversight over these firms (and therefore the amendments
being adopted here) is necessary because they effect securities
transactions off-member-exchange and thus generally outside the
expertise of any exchange where they are a member and within FINRA's
primary area of expertise.
---------------------------------------------------------------------------

\78\ See Nasdaq Letter at 2 (citing traditional operational
responsibilities such as real-time surveillance, and the
establishment of an investigation and enforcement team in 2017
dedicated to prosecuting member misconduct on its equities and
options markets); Cboe Letter at 6 (stating that SROs operate
comprehensive in-house regulatory programs which include cross
market surveillance, such as CAT).
\79\ See 2022 Re-Proposal, supra note 1, 87 at 49934 n. 46.
\80\ See 2022 Re-Proposal, supra note 1, 87 FR 49934; Cross-
Market Regulatory Coordination Staff Paper, supra note 14. See also
Cboe Letter at 4 (stating that the exchanges know their markets
best, including the products traded, the intricacies of the trading
mechanics, and their members' business models).
\81\ See supra section II.B; see also 2022 Re-Proposal, supra
note 1, 87 FR 49935-40.
---------------------------------------------------------------------------

Moreover, the Exchange Act provides a way to help address commenter
concerns regarding regulatory duplication. Specifically, with respect
to common members, section 17(d) of the Act authorizes the Commission
to relieve an SRO of the responsibility to receive regulatory reports;
to examine for and enforce compliance with applicable statutes, rules,
and regulations; or to perform other specified regulatory
functions.\82\ Section 17(j)(1) of the Act also requires the SROs'
cooperation and coordination of broker-dealer examination and oversight
activities and elimination of any unnecessary and burdensome
duplication in the examination process.\83\
---------------------------------------------------------------------------

\82\ Section 17(d) of the Act, 15 U.S.C. 78q(d).
\83\ Section 17(j)(1) of the Act, 15 U.S.C. 78q(j)(1).
---------------------------------------------------------------------------

To implement section 17(d)(1) of the Act, the Commission adopted
two rules thereunder: Rule 17d-1 and Rule 17d-2. Rule 17d-1 authorizes
the Commission to name a single SRO as the DEA to examine a common SRO
member (i.e., a broker-dealer that is a member of the DEA SRO as well
as other SROs) for compliance with the financial responsibility
requirements imposed by the Act, Commission rules, or the rules of the
SROs where the broker-dealer is a member.\84\ When an SRO has been
named as a common member's DEA, all other SROs to which the common
member belongs are relieved of the responsibility to examine the firm
for compliance with the applicable financial responsibility rules. Rule
17d-1 addresses only an SRO's obligations to enforce member compliance
with financial responsibility requirements. Rule 17d-1 does not relieve
an SRO from its obligation to examine a common member 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.
---------------------------------------------------------------------------

\84\ 17 CFR 240.17d-1. See supra note 13; see also 2022 Re-
Proposal, supra note 1, 87 FR 49933; Securities Exchange Act Release
No. 12352 (Apr. 20, 1976), 41 FR 18808 (May 7, 1976).
---------------------------------------------------------------------------

To further address regulatory duplication, the Commission also
adopted Rule 17d-2 under the Act. Rule 17d-2 permits SROs to propose
joint plans for the allocation of regulatory responsibilities with
respect to their common members. 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. FINRA has
experience coordinating with exchanges in the oversight of broker-
dealers that are common members of FINRA and the exchanges on which
they trade securities pursuant to such plans.\85\ Such coordination
among FINRA and exchange SROs pursuant to Rule 17d-2 plans cannot
occur, however, with respect to broker-dealer firms that are not FINRA
members.\86\
---------------------------------------------------------------------------

\85\ See Staff Paper on Cross-Market Regulatory Coordination,
supra note 14.
\86\ RSAs are mechanisms through which such coordination can
occur, but they are subject to limitations including that they do
not relieve the contracting SRO of its legal responsibilities to
provide SRO oversight or provide FINRA with jurisdiction. See supra
note 14 and the discussion infra in this section.
---------------------------------------------------------------------------

Rule 17d-1 DEA arrangements and Rule 17d-2 plans are relevant with
respect to commenters' concern that direct, membership-based FINRA
oversight of broker-dealer firms would duplicate exchange SRO
oversight.\87\ Mitigating duplicative SRO oversight is the primary
purpose of these regulatory arrangements.\88\ To the extent broker-
dealer firms join FINRA as a result of the amendments to Rule 15b9-1
\89\ and are members of one or more exchanges, Rule 17d-1 could be
utilized to mitigate duplicative oversight with respect to financial
responsibility by exchange SROs and FINRA over these common members.
And Rule 17d-2 plans could similarly be utilized by exchange SROs and
FINRA to mitigate the potential for duplicative SRO oversight over
their common members in areas other than financial responsibility. This
is what occurs today with common SRO members, and therefore the
Commission believes the same will likely occur for proprietary trading
broker-dealer firms that are exchange members and newly join FINRA as a
result of these amendments.\90\
---------------------------------------------------------------------------

\87\ See supra note 13. See also Group One Letter at 3 (stating
that the Commission should ensure that FINRA serves as the DEA for
options market making firms that newly join FINRA as a result of the
amendments to Rule 15b9-1 so that these firms do not pay DEA fees
that are duplicative of their current DEA fees paid to an exchange).
\88\ See Securities Exchange Act Release No. 12935 (Oct. 28,
1976), 41 FR 49091 (Nov. 8, 1976); see also note 13, supra.
\89\ See infra sections V.B.1 and V.C.2.d (discussing firms'
options for complying with the amendments, and that a firm may
choose to join additional exchanges rather than FINRA when the costs
of joining FINRA exceed the costs of joining additional exchanges to
cover all of the exchanges on which the firm currently trades).
\90\ Generally, FINRA is the DEA for financial responsibility
rules for exchange members that also are members of FINRA. See 2022
Re-Proposal, supra note 1, 87 FR 49935 n. 55; see also Cross-Market
Regulatory Coordination Staff Paper, supra note 14 (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''). Some
exchanges serve as DEA for certain of their members, but these cases
mostly involve 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. See 2022 Re-Proposal, supra
note 1, 87 FR 49956 and n. 228.
---------------------------------------------------------------------------

FINRA has entered into RSAs with certain exchange SROs, which allow
for some SRO oversight of off-member-exchange equities and options
trading activity by proprietary trading broker-dealer firms that are
exchange members

[[Page 61858]]

but not FINRA members.\91\ RSAs can serve useful purposes, but they
generally are not publicly available and are not subject to Commission
approval. Rather, they 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. As a result, to
the extent oversight is performed on non-FINRA member firms' off-
member-exchange securities trading activity based on RSAs, such
oversight relies upon discretionary arrangements between exchanges and
FINRA insofar as equities and options are concerned; and such
agreements to date have not covered U.S. Treasury securities trading
activity.\92\ In addition, under an RSA, FINRA examines for compliance
with the rules of the exchange with which it has entered into the
RSA.\93\ 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 provides the potential for a less stable and
consistent regulatory regime for the covered off-member-exchange
securities transactions than one in which Association membership and
oversight is mandated.\94\ Moreover, there is no regulatory requirement
that any RSA pursuant to which FINRA oversight currently is applied to
a non-FINRA member broker-dealer's off-member-exchange securities
trading activity must continue to exist.\95\
---------------------------------------------------------------------------

\91\ See FINRA Letter at 4 (stating that Rule 17d-2 plans and
RSAs are not without their limitations).
\92\ See id. at 8.
\93\ 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 firm that is a member of the exchange but not a FINRA
member is for compliance with the exchange's rules, not FINRA's
rules, since FINRA's rules apply only to its members.
\94\ See FINRA Letter at 5 (stating that RSAs are privately
negotiated contracts, vary in their scope of regulatory coverage,
and can be terminated by the parties thereto; that FINRA examines
for compliance with the rules of certain individual exchanges under
RSAs and, therefore, firms that are not FINRA members may be subject
to different exchange rules and interpretations with respect to the
same activity; and that RSAs do not provide FINRA with membership-
based jurisdiction to directly enforce such firms' compliance with
the Federal securities laws or subject such firms to FINRA's rules
for their OTC trading, even where such trading may not be
comprehensively addressed by exchange rules or RSAs). As a result of
amended Rule 15b9-1, any broker-dealer that effects off-member-
exchange securities transactions will need to join an Association,
pursuant to section 15(b)(8) of the Act, unless the broker-dealer's
off-member-exchange securities transactions are covered by an
exemption in the amended rule.
\95\ See infra section V (setting forth expiration dates for
RSAs).
---------------------------------------------------------------------------

One commenter stated that firms still will be subject to multiple
sets of rules and interpretations if amended Rule 15b9-1 is adopted as
re-proposed, and that it will be important for FINRA to continue to
work collaboratively as part of the Cross-Market Regulation Working
Group (``CMRWG''), a subgroup of the ISG.\96\ The ISG was established
in 1981 and is an international group of exchanges, market centers, and
market regulators that perform front-line market surveillance in their
respective jurisdictions. The group was formed to facilitate the
coordination and development of programs and procedures to identify
possible fraudulent and manipulative activities across markets and to
facilitate information sharing related to those efforts. In 2020, the
CMRWG was established with U.S. SROs as a working group of the ISG's
U.S. Subgroup to focus on ways to reduce unnecessary regulatory
duplication.\97\ The Commission agrees that continued collaboration
will be important.
---------------------------------------------------------------------------

\96\ See Nasdaq Letter at 3; see also Cboe Letter at 5
(discussing the formation of the ISG and CMRWG to facilitate
coordination among the SROs).
\97\ See FINRA Information Notice--4/8/20 available at https://www.finra.org/rules-guidance/notices/information-notice-040820
(informing members of the existence and role of the CMRWG).
---------------------------------------------------------------------------

One commenter stated that an exchange can take action against its
member for exchange rule violations associated with the conduct of a
non-member broker-dealer that accessed the exchange through the member,
or the exchange may refer the activity to another SRO.\98\ This
commenter also stated that the access-providing exchange member is
likely to be a FINRA member.\99\ Similarly, other commenters stated
that options trading firms that are members of exchanges where they
trade options do not need to be FINRA members because, when they
conduct off-member-exchange trading activity, they do so through a
FINRA member broker-dealer.\100\ In the same vein, one commenter stated
that volume effected by options trading firms in the equities markets
is often processed through FINRA members and, thus, options trading
firms effectively trade like customers, making a requirement that they
join FINRA no more useful than requiring FINRA registration for any
non-broker-dealer customers that trade in the equities market through a
FINRA registered broker-dealer.\101\
---------------------------------------------------------------------------

\98\ See Cboe Letter at 4.
\99\ See id. at 2-3.
\100\ See, e.g., CTC Letter at 3; Group One Letter at 2.
\101\ See Cboe Letter at 2-3.
---------------------------------------------------------------------------

In response, the Commission does not believe that its concerns
regarding non-FINRA member broker-dealers that effect off-member-
exchange securities transactions are addressed when such broker-dealers
act in the capacity of a customer of another broker-dealer that is a
FINRA member. A broker-dealer acting in a customer capacity does not
provide a basis for regulatory oversight of that broker-dealer's off-
member-exchange activities as required by section 15(b)(8) when the
broker-dealer is not a FINRA member. The Commission believes that such
activities should be subject to direct, membership-based FINRA
oversight, which carries with it an obligation to comply with FINRA's
rules and FINRA's direct examination authority. This is not
accomplished when a broker-dealer acts as a customer of a FINRA member
but is not itself a FINRA member.
In addition, in the scenarios presented by commenters, neither the
exchange where the violative conduct occurred nor FINRA would have
direct authority to address the conduct of the broker-dealer that is
not a member of the exchange (and is not a FINRA member). If the
exchange referred the matter to another exchange SRO where the broker-
dealer is a member, the two exchanges could have different rules or
different interpretations of their respective existing rules. In other
words, there would be separate recourse by separate exchanges with
potentially different rules or rule interpretations against different
broker-dealers for the same conduct on one of the exchanges. The
Commission believes this presents the potential for inconsistent
outcomes, as the exchange where the conduct occurred could choose to
pursue recourse against its member but the referred-to exchange could,
for the same conduct, choose not to pursue recourse against its member.
A requirement that all broker-dealers that effect off-member-exchange
securities transactions become FINRA members (if not exempt under
amended Rule 15b9-1) is more consistent with the protection of
investors and the public interest. If both broker-dealers were FINRA
members in the scenarios presented by

[[Page 61859]]

commenters, FINRA could take a consistent approach in addressing both
broker-dealers' involvement in the conduct.
Exchange SRO rules would, of course, continue to apply to broker-
dealer firms that are exchange members and become FINRA members as a
result of the amendments to Rule 15b9-1.\102\ The potential for
inconsistent recourse by exchanges where such firms are a member could,
therefore, continue to exist. But such firms would be common members of
FINRA and their member exchanges, and SROs have a statutory obligation
to eliminate unnecessarily duplicative oversight of their common
members.\103\ While FINRA rules and exchange rules would apply to such
firms, the Commission believes that Rule 17d-1 DEA designations and
Rule 17d-2 plans will likely be utilized in areas of overlap to
mitigate duplicative application of exchange SRO and FINRA oversight,
in the same fashion as they already are utilized for the many broker-
dealer firms that are exchange members and FINRA members. As a result,
with respect to broker-dealer firms that become FINRA members and are
exchange members, the Commission believes that FINRA likely will be the
only SRO with regulatory responsibility regarding these firms'
compliance with rules that FINRA and their member exchange(s) have in
common.\104\ Moreover, FINRA already directly regulates cross-market
and off-exchange trading activity by FINRA members for compliance with
FINRA rules, and would extend that direct oversight to new FINRA
members' off-member-exchange activity (without needing to rely on RSAs
to do so). Exchange SROs would remain primarily responsible for their
members' on exchange activity (subject to Rule 17d-1 DEA designations,
Rule 17d-2 plans, or RSAs). This complementary structure with FINRA as
the SRO primarily responsible for off-member-exchange activity by FINRA
members and exchange SROs primarily responsible for member exchange
activity is consistent with the Exchange Act's statutory framework,
which places SRO oversight responsibility with an Association for off-
member-exchange securities trading.\105\
---------------------------------------------------------------------------

\102\ See, e.g., Cboe Letter at 6 (stating that requiring FINRA
membership for non-member FINRA firms would add regulatory
duplication and administrative burden to the firms and SROs with
whom the firm is already a member).
\103\ See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1).
\104\ See infra note 275 (stating that FINRA serves as the DEA
for the majority of member firms).
\105\ See supra note 26 and accompanying text.
---------------------------------------------------------------------------

The Commission also does not believe that the CAT mitigates the
need for proprietary trading broker-dealer firms that effect off-
member-exchange securities transactions to be required to join FINRA,
as was asserted by some commenters.\106\ The CAT is an important audit
trail tool through which exchange SROs and FINRA are able to perform
surveillance of trading activity in NMS and OTC securities using CAT
data.\107\ In addition, FINRA has stated that it surveils 100% of the
equities and options markets with CAT data.\108\ But access to CAT data
does not confer jurisdiction to FINRA over a firm that is not a FINRA
member and that trades securities off-member-exchange.\109\ As a
result, when FINRA encounters potentially problematic conduct by firms
that are not FINRA members,\110\ it lacks the independent ability to
examine for and investigate potential violations of, or enforce
compliance with, the Federal securities laws, Commission rules, or
FINRA rules.\111\ Moreover, 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.\112\ 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 pursuant to RSAs is, as
discussed above in this section, a less certain and stable approach
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 off-member-exchange securities
transactions.\113\ And any such coordinated efforts would not apply to
U.S. Treasury securities trading activity, which is not reported to the
CAT and not covered by RSAs. In short, even with this coordination,
FINRA would still not have direct membership-based jurisdiction over
the firm. This limitation impedes stable and consistent SRO oversight
of off-member-exchange securities trading activity through direct,
membership-based FINRA jurisdiction by continuing the dependence upon
RSAs for such oversight,\114\ and impedes comprehensive SRO oversight
of off-member-exchange securities trading activity since RSAs, the CAT,
and coordinated regulatory efforts using these tools do not cover U.S.
Treasury securities trading activity.\115\
---------------------------------------------------------------------------

\106\ See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe
Letter at 2-3; STA Letter at 2-3; ABCV Letter at 3; PEAK6 Letter at
3; Group One Letter at 2; CTC Letter at 4.
\107\ Exchange rules require their members to report to CAT.
See, e.g., Cboe BYX Rules 4.5 through 4.17; Nasdaq General 7; NYSE
Rule 6800.
\108\ See FINRA Letter at 6.
\109\ Id. See also Concept Release Concerning Self-Regulation,
supra note 20, 69 FR 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.
\110\ See, e.g., FINRA Letter at 5; 6/20/23 Meeting Memorandum
(stating that FINRA identified non-FINRA member broker-dealer firms
as potential respondents in 5% of the market regulation
investigations it conducted in 2020 and 2021, which ranged across
asset types and included both cross-exchange and off-exchange
conduct).
\111\ See FINRA Letter at 6. Such a case may be referred to the
Commission or an exchange where the firm is a member for further
investigation.
\112\ See 2022 Re-Proposal, supra note 1, 87 FR 49938.
\113\ See Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8); 2015
Proposing Release, supra note 1, 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 14 (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.
\114\ As discussed above in this section, if FINRA has an RSA
with a given exchange, FINRA is able to apply that exchange's rules
to off-member-exchange activity by members of that exchange, even if
they are not FINRA members, assuming that the RSA assigned to FINRA
the oversight of those rules. But RSAs are not required to continue
to exist pursuant to any regulatory requirement, and exchanges with
potentially different rules and interpretations thereof retain legal
responsibility and decision-making authority under RSAs, which could
lead to inconsistent outcomes. FINRA does not need to rely on RSAs
for its oversight of FINRA members, and so it can apply its
jurisdiction directly to FINRA members' off-member-exchange trading
activity. Further, for FINRA member firms that also are exchange
members, Rule 17d-1 DEA designations and Rule 17d-2 plans could be
utilized in areas of overlap to mitigate duplicative application of
exchange and FINRA oversight.
\115\ See FINRA Letter at 6 (stating that ``there are key
regulatory limitations that remain when FINRA encounters potentially
problematic Non-Member Firm conduct'' via audit trail data and that
the limitations posed by RSAs ``impede comprehensive OTC and cross-
market oversight in the equities, options, and fixed income
markets'').

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

[[Page 61860]]

Relatedly, the Commission continues to believe that direct,
membership-based FINRA jurisdiction is necessary for proprietary
trading broker-dealer firms that effect transactions in U.S. Treasury
securities, and that FINRA oversight would not duplicate any exchange
SRO oversight in this area.\116\ U.S. Treasury securities are not
traded on any exchange, and to the Commission's knowledge, unlike
FINRA,\117\ no exchange SRO possesses expertise on U.S. Treasury
securities trading activity. Further, as discussed above in this
section, U.S. Treasury securities trading activity also is not covered
by RSAs between exchange SROs and FINRA, so RSAs are not a mechanism
through which FINRA currently could apply exchange rules (to the extent
any would be applicable) to U.S. Treasury securities trading activity
by proprietary trading broker-dealer firms that are exchange members
but not FINRA members. Thus, aside from certain surveillances (other
than the CAT),\118\ no SRO oversight is performed with respect to the
U.S. Treasury securities trading activity of proprietary trading
broker-dealer firms that are not FINRA members.
---------------------------------------------------------------------------

\116\ Some commenters agreed with the Commission. See, e.g.,
Cboe Letter at 2 (stating that Cboe believes it is appropriate for
broker-dealers that are not FINRA members that effect fixed income
transactions to register with FINRA to ensure FINRA insight into,
and sufficient regulatory coverage of, those transactions).
\117\ See FINRA Letter at 8 (stating that individual fixed
income securities generally are not traded on exchange and their
markets rely exclusively on FINRA oversight); see also supra note
76.
\118\ See FINRA Letter at 10 (stating that FINRA surveils and
examines for manipulative or other illegal activity in the fixed
income market, including with respect to U.S. Treasury securities
trading). As discussed above in this section, trading activity in
U.S. Treasury securities is not reported to the CAT, so the CAT is
not a tool that can be used by SROs to surveil that activity. A
commenter suggested that the Commission could require that TRACE
data and other securities trading data be reported to the CAT. See
Phillip Letter. Such an undertaking would not, however, provide
FINRA with needed, membership-based jurisdiction over broker-dealers
that trade U.S. Treasury securities.
---------------------------------------------------------------------------

For example, FINRA stated that, subject to audit trail limitations,
it has observed that firms that are not FINRA members were identified
in 17 percent of the surveillance alerts generated by its U.S. Treasury
security manipulation pattern surveillance in 2020 and 2021.\119\ FINRA
has no jurisdiction over such firms and, therefore, no authority to
address their involvement in potential market misconduct that is
identified.\120\ Since, to the Commission's knowledge, no exchange SRO
has expertise or performs oversight in this area, broker-dealer firms
that are not FINRA members may participate in the U.S. Treasury
securities market effectively without SRO oversight applied to their
activity in that market (other than, as discussed below, what can be
discerned by regulators when non-FINRA member broker-dealer U.S.
Treasury securities transactions are reported to TRACE by FINRA
members).\121\ This rulemaking would facilitate oversight consistent
with the protection of investors and the public interest.
---------------------------------------------------------------------------

\119\ See FINRA Letter at 10; see also Better Markets Letter at
9. The 17% figure reflects an upper bound of the rate at which
Commission-registered broker-dealers that are not FINRA members
appeared in the alerts generated by FINRA's U.S. Treasury security
manipulation pattern surveillance in 2020 and 2021. See 6/20/23
Meeting Memorandum. The Commission understands that the actual rate
at which Commission-registered broker-dealers that are not FINRA
members appeared in these alerts is likely lower than 17%, as some
portion of the alerts may have involved non-FINRA member proprietary
trading firm entities that are not Commission-registered broker-
dealers. Id. More precise estimates are not possible in light of the
way proprietary trading firms are identified under current audit
trail rules and the way FINRA evaluates conduct by potentially
affiliated entities. Id.
\120\ See FINRA Letter at 10.
\121\ As discussed below in this section, the Commission retains
authority over broker-dealers, but the Exchange Act contemplates
dual layers of oversight of broker-dealers through such Commission
authority working in tandem with SRO authority. The focus here is on
strengthening the SRO layer of oversight.
---------------------------------------------------------------------------

Insofar as U.S. Treasury securities transaction reporting and
transparency in particular are concerned, FINRA's TRACE system is the
regulatory vehicle that facilitates mandatory reporting of OTC
transactions in U.S. Treasury securities, among other eligible fixed
income securities.\122\ But as discussed in the 2022 Re-Proposal,
proprietary trading broker-dealer firms 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.\123\ Thus, exchange SRO membership alone is not enough
to subject proprietary trading broker-dealer firms that effect U.S.
Treasury securities transactions to FINRA's reporting requirement for
such transactions.
---------------------------------------------------------------------------

\122\ See FINRA Rule 6700 series. FINRA publishes aggregated
transaction information and statistics on U.S. Treasury securities
on its website. See FINRA.org, Treasury Aggregate Statistics,
available at https://www.finra.org/finra-data/browse-catalog/about-treasury (last visited Aug. 9, 2023); FINRA Rule 6750, Supplementary
Material .01(b); see also Securities Exchange Act Release No. 95438
(Aug. 5, 2022), 87 FR 49626 (Aug. 11, 2022) (File No. SR-FINRA-2022-
017) (order approving FINRA publication of aggregated U.S. Treasury
securities transactions more frequently than weekly, such as on a
daily basis). Also, pursuant to effective national market system
plans which are also effective transaction reporting plans (as both
terms are defined in 17 CFR 242.600(b) (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;
section VIII.B of the Nasdaq UTP Plan.
\123\ See FINRA Rule 6720--Participation in TRACE; see also 2022
Re-Proposal, supra note 1, 87 FR 49938. Since Sept. 1, 2022, certain
depository institutions (``covered depository institutions'') have
been 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 Aug. 8, 2023). In addition, in order to enhance the
regulatory audit trail and ensure data is reported in a more timely
manner, FINRA adopted amendments to Rule 6730 to require members to
report U.S. Treasury securities transaction data in the smallest
increment available to the member and as soon as practicable, but no
later than 60 minutes following a transaction. See Securities
Exchange Act Release No. 95635 (Aug. 30, 2022), 87 FR 54579 (Sept.
6, 2022).
---------------------------------------------------------------------------

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 broker-dealer via its
Market Participant ID (``MPID''),\124\ thus providing visibility to
regulators as to what transactions on covered ATSs are attributable to
non-FINRA members.\125\ But regulators have no such visibility when
non-FINRA member broker-dealers trade U.S. Treasury securities
otherwise than on a covered ATS. If non-FINRA member broker-dealers
trade on a non-covered ATS or bilaterally with a counterparty that is a
FINRA member or covered depository institution, the ATS or FINRA member
or covered depository institution reports the trade, but the non-FINRA
member is not specifically identified via a MPID and instead is
identified only as a ``customer.'' \126\ If

[[Page 61861]]

non-FINRA member broker-dealers trade U.S. Treasury securities
otherwise than on an ATS and with a counterparty that is not a FINRA
member and not a covered depository institution, there is no TRACE
reporting obligation and the trade is not reported.\127\
---------------------------------------------------------------------------

\124\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities.
\125\ In the proposal the Commission issued in Jan. 2022 to,
among other things, amend Regulation ATS for ATSs that trade U.S.
government securities, and the reopening release issued in Apr.
2023, which provides supplemental information and economic analysis
on the Jan. 2022 proposal, the Commission estimated that there would
be a number of trading systems that would be required to comply with
Regulation ATS under the proposal. See Securities Exchange Act
Release Nos. 94062 (Jan. 26, 2022), 87 FR 15496, 15585 (Mar. 18,
2022); 97309 (Apr. 14, 2023), 88 FR 29448, 29466 (May 5, 2023).
\126\ In 2022, there were approximately 60 million transactions
reported in U.S. Treasury securities, totaling $165 trillion in
dollar volume. Approximately 35.7 million of those transactions,
representing approximately $64 trillion in dollar volume, were
executed on ATSs. The balance of approximately 24.3 million reported
transactions, or $100 trillion in dollar volume, that was not traded
on an ATS was reported by FINRA members with a counterparty that, if
not a FINRA member, was identified as a ``customer'' in the reported
data. The Commission estimates that approximately 12.7 million
transactions and $60 trillion in dollar volume not executed on an
ATS had a counterparty identified as a ``customer'' in the reported
data. This represents 52% of the 24.3 million transactions and 60%
of the $100 trillion in dollar volume not executed on an ATS, or 21%
of the 60 million total transactions and 36% of the $165 trillion
total dollar volume. Further, the Commission estimates that, of the
35.7 million transactions and $64 trillion in dollar volume executed
on an ATS, approximately 98.2% of that transaction volume and 99% of
that dollar volume was executed on a covered ATS; approximately 1.8%
of the 35.7 million transactions and 1% of the $64 trillion dollar
volume, representing approximately 0.6 million transactions and $536
billion, respectively, was executed on a non-covered ATS; and
approximately 4.8% of the 0.6 million transactions and 22% of the
$536 billion in dollar volume executed on a non-covered ATS,
representing approximately 15,000 transactions and $59 billion,
respectively, was reported with a counterparty identified as a
``customer.'' Customer volume and transaction counts are calculated
as half the sum of ATS-to-customer buys and ATS-to-customer sells.
\127\ 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 Aug. 9, 2023). The non-FINRA member is, however,
identified in CAT in this context.
---------------------------------------------------------------------------

The Commission continues to believe that regulators' lack of
visibility into U.S. Treasury securities transactions effected by
proprietary trading broker-dealer firms that are not FINRA members, in
the circumstances described above in which such firms are not
identified by MPID in TRACE data, detracts from the comprehensiveness
of U.S. Treasury securities TRACE data and regulators' ability to
utilize that data to reconstruct market events, and detect and deter
improper trading activity in the U.S. Treasury securities market.\128\
The Commission does not know if all U.S. Treasury securities
transactions by non-FINRA member broker-dealer firms are reported to
TRACE, and for those that are reported, any non-FINRA member broker-
dealer firm that is a counterparty remains anonymous if the transaction
did not occur on a covered ATS. As a result, the Commission cannot
quantify total secondary market trading by broker-dealers in U.S.
Treasury securities, and regulators cannot readily identify from TRACE
when a non-FINRA member broker-dealer is the source of reported U.S.
Treasury securities order flows executed otherwise than on a covered
ATS and cannot link any such order flows to any particular non-FINRA
member broker-dealer.\129\ Moreover, broker-dealers that are not FINRA
members have a potential competitive advantage over those that are
FINRA members, as FINRA members incur the costs of reporting
transactions in U.S. Treasury securities transactions but non-FINRA
members do not.\130\
---------------------------------------------------------------------------

\128\ For example, in a Nov. 2021 report, an inter-agency
working group comprised of staff of the U.S. Department of the
Treasury, Commission, Commodity Futures Trading Commission, Federal
Reserve Bank of New York, and Board of Governors of the Federal
Reserve System stated that ``[i]n March 2020, large flows from
investors were captured by TRACE data but were not identifiable
beyond the FINRA-member dealer intermediary that facilitated the
trade. Understanding the source of these flows required the official
sector to contact dealers, wait for other datasets that are
significant lagged, and rely on separate sources of information.''
See U.S. Dep't of the Treasury et al., Recent Disruptions and
Potential Reforms in the U.S. Treasury Market: A Staff Progress
Report (Nov. 8, 2021) (``2021 Interagency Report'') available at
https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf.
\129\ See id.
\130\ See supra section V.C.2 for estimated costs of TRACE
reporting.
---------------------------------------------------------------------------

Some commenters broadly agreed with the Commission's concern,
expressed in the 2022 Re-Proposal, regarding transparency and reporting
of U.S. Treasury securities transactions by proprietary trading broker-
dealer firms that are not FINRA members.\131\ Other commenters stated
that there is no reporting gap that must be addressed with respect to
U.S. Treasury securities transactions by proprietary trading broker-
dealer firms that are not FINRA members because, according to the
commenters, existing TRACE reporting requirements meaningfully capture
effectively all proprietary broker-dealer U.S. Treasury securities
transactions.\132\ One of these commenters also stated that potential
concerns around the identification of non-FINRA member counterparties
to U.S. Treasury securities transactions on non-covered ATSs are not
implicated by proprietary broker-dealer transactions in any meaningful
way, or could be remedied by requiring that such transactions be
reported with account ownership identifiers, which, according to the
commenter, would not necessitate FINRA membership.\133\ Similarly,
other commenters suggested, as an alternative to what the Commission
has proposed, an approach under which proprietary trading broker-dealer
firms could remain exempt from section 15(b)(8)'s Association
membership requirement so long as they report their U.S. Treasury
securities transactions to FINRA's TRACE system.\134\
---------------------------------------------------------------------------

\131\ See FINRA Letter at 9 (stating that FINRA has no
visibility into the identity of non-FINRA firms for U.S. Treasury
securities transactions that occur otherwise than on a covered ATS
or on any other non-ATS platform); Better Markets Letter at 9
(stating that a significant proportion of U.S. Treasury securities
transaction activity is performed on a bilateral basis without data
reporting requirements, and that this lack of visibility undermines
regulators' ability to monitor risks, understand how those risks
evolve into potentially systemic risks, and react to them in real-
time, and inhibits robust price discovery) (citing 2021 Interagency
Report, supra note 128); Cboe Letter at 9.
\132\ See FIA/PTG Letter at 3 (acknowledging concerns regarding
the identification of non-FINRA member counterparties but noting
they are not aware of the situation applying to proprietary broker-
dealer transactions in a ``meaningful'' way); MMI Letter at 2
(arguing CAT and TRACE data ``effectively captures'' all proprietary
broker-dealer transactions). It is difficult to assess the accuracy
of the commenter statement that there is no reporting gap with
respect to U.S. Treasury securities transactions by proprietary
trading broker-dealer firms that are not FINRA members because, as
discussed above in this section, if non-FINRA member broker-dealers
trade U.S. Treasury securities otherwise than on an ATS and with a
counterparty that is not a FINRA member and not a covered depository
institution, there is no TRACE reporting obligation and the trade is
not reported. And even when a non-FINRA member broker-dealer's
transactions in U.S. Treasury securities are reported by a
counterparty that does have a TRACE reporting obligation, such as a
FINRA member or covered depository institution, the non-FINRA member
is identified only as ``customer'' in the reported data unless the
transaction occurred on a covered ATS.
\133\ See FIA/PTG Letter at 3.
\134\ See, e.g., PEAK6 Letter at 6; Group One Letter at 2; CTC
Letter at 3; Cboe Letter at 7; Virtu Letter at 7.
---------------------------------------------------------------------------

The reporting requirements suggested by commenters could help
address the potential anonymity of proprietary trading broker-dealer
firms in TRACE data. But as discussed above in this section, a lack of
transparency to regulators when non-FINRA member broker-dealers trade
U.S. Treasury securities--and the resulting difficulty it poses for
regulators when trying to identify the source of U.S. Treasury
securities order flows, detect and deter improper trading activity, and
reconstruct market events--is not the full scope of what the Commission
believes must be addressed. There also is the necessity, described
above in this section, for FINRA to have the authority to allow it to
independently examine for, investigate, or address potential off-
member-exchange misconduct by proprietary trading broker-dealer firms
in the securities markets, including the

[[Page 61862]]

markets for U.S. Treasury securities, equities and options. Such FINRA
authority is necessary notwithstanding the Commission's authority over
broker-dealers in order to strengthen the SRO layer of oversight of
off-member-exchange securities trading, consistent with the dual
Commission and SRO oversight of broker-dealers required by the Exchange
Act.\135\ As a membership-based organization, FINRA's jurisdiction, and
thus its authority, is limited to its members and their associated
persons. As such, authority to independently examine, investigate, or
enforce potential violations against non-FINRA member broker-dealers is
not conferred to FINRA through reporting requirements without FINRA
membership. For example, FINRA stated that it identified non-FINRA
member broker-dealer firms as potential respondents in five percent of
the market regulation investigations it conducted in 2020 and 2021,
which ranged across asset types and included both cross-exchange and
off-exchange conduct), and FINRA identified non-FINRA member firms in
17 percent of the surveillance alerts generated by its U.S. Treasury
security manipulation pattern surveillance in 2020 and 2021.\136\ If
those non-FINRA member firms could remain exempt from section
15(b)(8)'s Association membership requirement as long as they report
their U.S. Treasury securities transactions to TRACE, FINRA would
continue to lack the independent ability to examine and investigate
those firms to generate evidence, such as by collecting documents and
interviewing witnesses.
---------------------------------------------------------------------------

\135\ See supra note 22 (stating that 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).
\136\ See FINRA Letter at 5, 10; see also 6/20/23 Meeting
Memorandum (specifying that non-FINRA member broker-dealer firms
made up the 5% of the market regulation investigations that FINRA
conducted in 2020 and 2021, and that the 17% figure reflects an
upper bound of the rate at which Commission-registered broker-
dealers that are not FINRA members appeared in the alerts generated
by FINRA's U.S. Treasury security manipulation pattern surveillance
in 2020 and 2021).
---------------------------------------------------------------------------

In contrast, the rescission of the de minimis allowance and
proprietary trading exclusion helps solve both for the need for FINRA
authority over off-member-exchange securities trading activity and for
the anonymity in TRACE data of proprietary trading broker-dealer firms
when they trade U.S. Treasury securities otherwise than on a covered
ATS. Under the adopted approach, proprietary trading broker-dealer
firms that effect off-member-exchange securities transactions and that
become FINRA members will be subject to direct, membership-based FINRA
jurisdiction. Further, those that effect U.S. Treasury securities
transactions otherwise than on a covered ATS will be specifically
identified by MPID in TRACE.\137\
---------------------------------------------------------------------------

\137\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities. FINRA membership also
would require that such firms be identified in off-exchange NMS
stock transaction reports to FINRA's TRFs, and thus promote broader
public market transparency in NMS stocks. 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; see also supra note 17; 2022 Re-
Proposal, supra note 1, 87 FR 49942.
---------------------------------------------------------------------------

In addition to discussing existing regulatory mechanisms and
suggesting reporting-specific requirements as alternatives to FINRA
membership, commenters addressed the Commission's position, set forth
in the 2022 Re-Proposal, that it is appropriate for FINRA to exercise
direct, membership-based oversight over firms that do not carry
customer accounts.\138\ FINRA agreed with the Commission that direct,
membership-based FINRA oversight over proprietary trading broker-dealer
firms would be appropriate even though they typically do not carry
customer accounts.\139\ FINRA stated that active trading firms have the
potential to introduce risk into the markets even where they do not
have customers, and for that reason, FINRA's rules and regulatory
programs cover a cross section of activity and risks beyond sale
practices.\140\ FINRA stated that certain member risk controls overseen
by FINRA are particularly relevant to proprietary trading dealer firms,
such as controls for credit risk to counterparties, market risk, market
integrity risk, and liquidity risk.\141\ FINRA also observed that while
non-FINRA members may not have customers of their own, they nonetheless
can have a significant role executing customer orders routed to them by
other broker-dealers.\142\ Other commenters stated that FINRA
regulation is customer-focused and not appropriate for proprietary
trading firms that do not carry customer accounts.\143\
---------------------------------------------------------------------------

\138\ See, e.g., FINRA Letter at 11; ABCV Letter at 2; PEAK6
Letter at 2; Group One Letter at 1-2; letter from James Toes,
President & CEO, and Kate McAllister, Chair of the Board, Securities
Traders Association (Oct. 5, 2022) (``STA Letter'') at 3-4.
\139\ See FINRA Letter at 11 (stating that certain proprietary
trading dealer firms that are not FINRA members have a significant
market footprint and the scope of their activities introduces a
moderate to high degree of risk to the market and market
counterparties).
\140\ See id.
\141\ Id.
\142\ See id. at 7-8.
\143\ See, e.g., ABCV Letter at 2; PEAK6 Letter at 2; Group One
Letter at 1-2; STA Letter at 3-4.
---------------------------------------------------------------------------

The Commission continues to believe that it is appropriate for
FINRA to have direct, membership-based jurisdiction over proprietary
trading broker-dealer firms that effect off-member-exchange securities
transactions even though such firms typically do not carry customer
accounts. As discussed above,\144\ several non-FINRA member broker-
dealer firms that do not carry customer accounts effect significant
volumes of off-member-exchange securities transactions. The Commission
believes that such firms--and such trading activity--should not remain
exempt from FINRA's direct, membership-based oversight on the basis
that such firms do not carry customer accounts. FINRA's ability to
create a consistent regulatory framework for all broker-dealers that
effect off-member-exchange securities transactions is undermined by the
subset of such broker-dealers that do not carry customer accounts and
are not FINRA members in reliance on Rule 15b9-1.\145\ The rescission
of the de minimis allowance and proprietary trading exclusion will help
address this by eliminating the legal basis upon which such firms
generally are able to effect off-member-exchange securities
transactions without joining FINRA.
---------------------------------------------------------------------------

\144\ See section II.B, supra.
\145\ See FINRA Letter at 11 (stating that FINRA jurisdiction
over proprietary trading dealer firms and the ability to identify
their activity in all of FINRA's audit trails would further enable
FINRA to assess individual entities' impacts on the market and
market counterparties, and that the 2022 Re-Proposal would enable
FINRA to directly and more comprehensively oversee such firms and
their trading activity, which, in turn, would enhance market
integrity and foster the maintenance of fair, orderly, and efficient
markets); Better Markets Letter at 5 (stating that the amendments to
Rule 15b9-1 would ``help ensure that dealers such as high-frequency
trading firms, which conduct an enormous volume of trading, are
subject to consistent and robust oversight through FINRA, not only
the more narrow regulatory requirements that are specific to each
exchange'').
---------------------------------------------------------------------------

In particular, as discussed in the 2022 Re-Proposal, FINRA is well-
positioned to exercise direct oversight over such firms. 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.\146\ For example,

[[Page 61863]]

FINRA, not unlike exchanges, has developed a detailed set of rules in
core areas such as trading practices,\147\ business conduct,\148\
financial condition and operations,\149\ and supervision,\150\ many of
which apply to FINRA members regardless of whether they handle customer
orders or carry customer accounts.\151\ As another example, FINRA's
transaction reporting regime is not limited to broker-dealers with
customers and applies to FINRA members regardless of whether they
handle customer orders or carry customer accounts.\152\ Continuing to
permit an exemption from FINRA membership on the basis that broker-
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 TRACE data or address the
potential competitive advantage of non-FINRA member broker-dealers
that, unlike FINRA member broker-dealers, may trade U.S. Treasury
securities without incurring the costs of reporting those trades to
TRACE.
---------------------------------------------------------------------------

\146\ Many broker-dealer firms that derive all or most of their
revenue from proprietary trading already are FINRA members. See
Securities Exchange Act Release No. 97798 (June 26, 2023), 88 FR
42404, 42406 (June 30, 2023) (``TAF Amendment'') (stating that FINRA
estimates that approximately 66 member firms derive all or most of
their revenue from proprietary trading). As FINRA members, these
broker-dealers are subject to FINRA's rules and FINRA's direct
jurisdiction even though they effect securities transactions for
their own account and not on behalf of customers.
\147\ 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) (stating, 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'').
\148\ See FINRA Rule 2000 Series--Duties and Conflicts.
\149\ 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.''
\150\ 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.
\151\ See, e.g., the FINRA rules set forth in notes 17-18, 56-
57, 122-124, 137 and 147-150, and accompanying text, supra. In
addition, FINRA has regulatory programs and staff dedicated to fixed
income regulation. See FINRA.org, Key Topics--Fixed Income,
available at https://www.finra.org/rules-guidance/key-topics/fixed-income#overview.
\152\ See FINRA Rule 6000 Series (Quotation, Order, and
Transaction Reporting Facilities).
---------------------------------------------------------------------------

The Commission also continues to believe that it is important to
the protection of investors and the public interest that FINRA has
direct, membership-based jurisdiction over proprietary trading broker-
dealer firms that effect off-member-exchange securities transactions
regardless of whether they carry customer accounts. An Association's
regulatory responsibility, like exchange SROs', includes an obligation
to enforce compliance with the Federal securities laws and rules
thereunder and the SRO's rules. As an Association, the Exchange Act's
statutory framework places SRO oversight responsibility with FINRA for
off-member-exchange securities trading, and FINRA is well-positioned to
carry out this responsibility with respect to its members.
For example, FINRA gains familiarity with a member's operational
risk by assigning dedicated staff members to each firm (e.g., a Risk
Monitoring Analyst to act as the primary point of contact and a Risk
Monitoring Director) and having staff with subject matter expertise
relevant to a member's business model conduct examinations and carry
out monitoring duties.\153\ Firms are classified into five primary
business models and then further sorted into various subgroups overseen
by exam and risk monitoring staff.\154\ Risk monitoring teams seek to
understand the unique aspects of each firm monitored, and use that
expertise to inform exam staff in the preparation of exams. Employing a
risk-based approach, FINRA examines firms on a one, two or four-year
frequency and makes use of specialist teams (e.g., anti-money
laundering, cybersecurity or fixed income). Further, FINRA gains
familiarity with a member's operational risk through customer
complaints and regulatory tips or calls, which may trigger a ``cause''
exam (in contrast to the routine exams described above) focusing on the
issues raised in the complaints.\155\ Finally, FINRA staff is informed
of changes in operational risk associated with a material change in
business operations or change of control through FINRA Rule 1017.\156\
The Continuing Member Application triggered under FINRA Rule 1017,
among other things, reviews if the member's contractual and business
relationships support the proposed change, if communications and
operational systems are appropriate, financial and internal controls,
and the adequacy of the member's supervisory system to prevent and
detect violations.\157\
---------------------------------------------------------------------------

\153\ See FINRA Risk Monitoring Program, FINRA, available at
https://www.finra.org/contact-finra/risk-monitoring-program; FINRA
Examination and Risk Monitoring Programs, FINRA, available at
https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview.
\154\ See FINRA Examination and Risk Monitoring Programs, FINRA,
available at https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview.
\155\ Id.
\156\ See FINRA Rule 1017; Form CMA, FINRA, available at https://www.finra.org/registration-exams-ce/broker-dealers/registration-forms/form-cma.
\157\ See Filing a Change in Membership Application, The ``What
to Expect'' Webcast Series (2010), FINRA, available at https://www.finra.org/sites/default/files/Education/p018711.pdf.
---------------------------------------------------------------------------

The inability of FINRA to directly enforce regulatory compliance by
proprietary trading broker-dealer firms that are not FINRA members--
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 FINRA may not be as familiar with the firm's operational risks
or other risks posed by the firm's off-member-exchange securities
trading activity as FINRA would be with a FINRA member firm, and FINRA
may not be as well positioned potentially to mitigate those risks. In
addition, 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.\158\
---------------------------------------------------------------------------

\158\ FINRA could refer such a matter to the Commission or to an
exchange where the firm is a member or, as discussed above in this
section, potentially address the matter through an RSA if covered by
the terms of the RSA. See also supra note 14. But FINRA may lack
certain investigative tools, discussed above in this section, with
respect to non-FINRA member broker-dealers that it possesses with
respect to FINRA members, which could help FINRA further investigate
potentially violative behavior before making a referral to the
Commission or an exchange, or help prevent FINRA from failing to
make referrals when they are warranted. See also section V, infra.
Further, the Commission believes that regulatory efforts based on
discretionary RSA arrangements among exchange SROs and FINRA, while
beneficial in many contexts, are a less stable and consistent
mechanism for SRO oversight than the FINRA membership required by
the Exchange Act in the context presented here, and are less
comprehensive than membership-based FINRA oversight because they do
not cover U.S. Treasury securities trading activity.

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

[[Page 61864]]

As is discussed in the 2022 Re-Proposal and in more detail in the
Economic Analysis, infra section V, firms that become FINRA members as
a result of the adopted rule amendments will be required to apply for
membership with FINRA and 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.\159\ These regulatory fees
include a Trading Activity Fee (``TAF'').\160\ FINRA issued a
Regulatory Notice in 2015 in which it proposed 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.\161\ In June 2023,
after the 2022 Re-Proposal, FINRA filed a proposed rule change with the
Commission, pursuant to section 19 of the Act, to amend the TAF such
that it does not apply to transactions by a proprietary trading firm
effected on exchanges of which the firm is a member.\162\ FINRA
designated this proposed rule change as ``establishing or changing a
due, fee or other charge'' under section 19(b)(3)(A)(ii) of the Act and
17 CFR 240.19b-4(f)(2) (``Rule 19b-4(f)(2)'') thereunder, which renders
the rule effective upon filing with the Commission.
---------------------------------------------------------------------------

\159\ See FINRA Schedule A to the By-Laws of the Corporation
(``FINRA Schedule A''), at section 1, available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees.
\160\ 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, at
section 1(a). 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). FINRA charges its members other fees as well,
such as an annual Gross Income Assessment (``GIA''). See id. at
section 1.
\161\ 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 re-opened the
comment period on its 2015 Regulatory Notice after the 2022 Re-
Proposal. See FINRA Regulatory Notice 22-30, Trading Activity Fee
(Dec. 15, 2022) available at https://www.finra.org/sites/default/files/2022-12/Regulatory-Notice-22-30.pdf.
\162\ See TAF Amendment. The TAF Amendment's implementation
date, which FINRA will announce in a Regulatory Notice, will be no
earlier than the date of the Commission's adoption of amended Rule
15b9-1 and no later than the effective date of amended Rule 15b9-1.
Id.
---------------------------------------------------------------------------

Comments on the 2022 Re-Proposal, submitted prior to the TAF
Amendment, stated that the costs of applying for FINRA membership, as
well as ongoing costs of FINRA membership such as the TAF, are high and
burdensome and could affect liquidity provision.\163\ In particular,
commenters stated that proprietary options trading firms should remain
exempt from section 15(b)(8)'s Association membership requirement
because they do not trade U.S. Treasury securities and the equities
transaction volume that they effect is hedging activity.\164\
Commenters urged the Commission to adopt an exemption for proprietary
options trading broker-dealer firms, such that their off-member-
exchange securities trading activity would not trigger section
15(b)(8)'s Association membership requirement if such activity is to
hedge or in furtherance of their options trading activity on their
member exchange(s).\165\ If proprietary options trading firms do not
remain exempt, commenters stated, there could be a negative impact on
options market liquidity and smaller options trading firms could cease
trading, which could lead to consolidation and decreased
competition.\166\ FINRA stated that most proprietary trading dealer
firms that newly join FINRA would not incur membership application fees
exceeding $12,500.\167\ FINRA also stated (prior to filing the TAF
Amendment with the Commission) that it is committed to amending the TAF
to lessen its impact on such firms.\168\
---------------------------------------------------------------------------

\163\ See, e.g., MMI Letter at 3; PEAK6 Letter at 4-5; FIA PTG
Letter at 4; Group One Letter at 2-3; ABCV Letter at 2-3; CTC Letter
at 4; Cboe Letter at 7. One commenter estimated that some
proprietary broker-dealers would incur TAF fees greater than
$1,000,000 per year under the current TAF structure. See FIA PTG
Letter at 4. Another commenter opined on the substance of FINRA's
contemplated TAF amendment. See PEAK6 Letter at 4. Some commenters
also stated that FINRA must amend the TAF before the Rule 15b9-1
amendments are adopted so firms can assess the fee-related costs of
FINRA membership on proprietary trading firms. See PEAK6 Letter at
4; FIA PTG Letter at 4.
\164\ See, e.g., Cboe Letter at 3; see also ABCV Letter at 2
(stating that any trading by options market makers in the underlying
cash equities markets is related to legitimate hedging of their
options positions).
\165\ See Cboe Letter at 2-3; ABCV Letter at 3-4; CTC Letter at
5; PEAK6 Letter at 4; Nasdaq Letter at 2. Commenters also stated
that options trading firms' equities volume often is processed
through a FINRA member, and stated that a hedging exemption would be
particularly appropriate if the routing away from a member exchange
is through a broker-dealer that is a FINRA member. See Cboe Letter
at 2-3; ABCV Letter at 2-4; CTC Letter at 5; PEAK6 Letter at 4. As
discussed supra in this section, the Commission does not agree. See
supra notes 98-101 and accompanying text.
\166\ See STA Letter at 3-4; Cboe Letter at 2-3, 7; ABCV Letter
at 2-4; CTC Letter at 5; PEAK6 Letter at 4-6.
\167\ See FINRA Letter at 12 n. 40 (also stating that FINRA does
not anticipate that new member proprietary trading dealer firms
would incur the one-time clearing surcharge that applies to new
applicants engaged in clearing and carrying activity).
\168\ See id. at 14. See also note 170 and accompanying text,
infra.
---------------------------------------------------------------------------

The Commission believes that a hedging exemption for broker-dealers
that are proprietary options trading firms, like that sought by
commenters, could continue to result in a significant volume of off-
member-exchange trading activity not being subject to direct,
membership-based FINRA oversight. Proprietary options trading firms
make up the majority of the 12 firms that the Commission identified
above as accounting for 5.1% of all off-exchange listed equities volume
in April 2023 and the majority of the 21 firms that the Commission
identified as accounting for approximately 99% of the $262 billion in
listed equities transaction volume executed on exchanges where they are
not a member.\169\ As a result, significant off-member-exchange trading
activity could continue not to be subject to direct FINRA oversight
under commenters' suggested exemption. The Commission continues to
believe that this would not be consistent with the protection of
investors or the public interest, or with the historical rationale for
Rule 15b9-1 of accommodating limited off-member-exchange trading
activities.\170\
---------------------------------------------------------------------------

\169\ See section II.B, supra.
\170\ See 2022 Re-Proposal, supra note 1, sections III.B.2 and
III.C, 87 FR 49947-50. 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 broker or dealer or class of brokers or
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.

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

[[Page 61865]]

The effect of not including a hedging exemption in Rule 15b9-1 will
be that proprietary options trading broker-dealer firms (among other
types of proprietary trading broker-dealer firms) will no longer be
exempt from section 15(b)(8)'s Association membership requirement if
they effect off-member-exchange securities transactions (unless they
are covered by one of the exemptions in the amended rule). Therefore,
these firms will be required by section 15(b)(8) of the Act to join
FINRA in order to continue any off-member-exchange securities trading
activity. The Commission is mindful of the FINRA membership costs,
including application and TAF fees, that would be incurred by
proprietary trading broker-dealer firms, including options trading
firms, that join FINRA as a result of the rescission of the de minimis
allowance and proprietary trading exclusion, and the Commission is
mindful of the potential impact of those costs on options market
liquidity.
The Commission believes it is unlikely, however, that such firms
would be unable to continue operating their trading businesses or
providing liquidity in their normal course due to the costs of FINRA
membership. Insofar as the costs of joining FINRA are concerned, the
Commission believes that a $12,500 FINRA membership application fee
would be manageable for proprietary trading options firms that newly
join FINRA, and is small enough such that it should not materially
impact their ability to provide liquidity.\171\ As for concerns
regarding the TAF, an ongoing FINRA cost, FINRA, after considering the
potential impact of the TAF on proprietary trading firms that join
FINRA, has amended its rules to provide an exemption from the TAF for
all proprietary trading firms for transactions executed on an exchange
of which the proprietary trading firm is a member.
---------------------------------------------------------------------------

\171\ See infra section V.C.2 (stating that the Commission
believes that the median application fee for the 12 largest (by
volume traded) non-FINRA member broker-dealer firms would be
$12,500).
---------------------------------------------------------------------------

In addition, commenters stated that small options trading firms
could be adversely affected by the rule amendments to the point of
providing less liquidity or ceasing to trade.\172\ While commenters did
not indicate how they are defining ``small'' options firms, the
Commission believes that smaller firms should be able to absorb the
ongoing costs of FINRA membership, such as the GIA and TAF.\173\ As
discussed in the Economic Analysis below,\174\ the estimated aggregate
costs for the 12 largest non-FINRA member broker-dealer firms as of
April 2023 represent the majority of the aggregate costs stemming from
the amendments to Rule 15b9-1. Therefore, the Commission believes that
smaller non-FINRA member broker-dealer firms as well as new entrants
will experience much lower initial and ongoing costs and that these
FINRA membership costs would not materially impede their ability to
continue their trading businesses, which may include providing
liquidity in the options market, if they join FINRA.\175\
---------------------------------------------------------------------------

\172\ See STA Letter at 3-4; ABCV Letter at 2-3; Cboe Letter at
7; Nasdaq Letter at 3-4.
\173\ See infra section V.C.2 (stating that the 12 largest non-
FINRA member broker-dealer firms (as measured by off-exchange
equities volume traded in April 2023) had average and median annual
total revenues of approximately $1.2 billion and $491 million,
respectively, in 2022; would incur an estimated median GIA of
$327,870; and would incur an estimated median and average TAF of
approximately $119,256 and $304,994, respectively).
\174\ See infra section V.C.2.
\175\ The Commission believes that the potential FINRA
membership costs that could be incurred by firms not among the 12
largest non-FINRA member broker-dealers is the best data point
available to the Commission to assess commenters' assertion. As
discussed in section V.B.2, infra, the Commission cannot, however,
rule out the possibility that the addition of FINRA costs will serve
as a catalyst for one or more small non-FINRA member options market
makers to exit the market, although FINRA's exemption of TAF fees
should reduce the likelihood that firms will choose to exit in
response to the adopted rule amendments. In addition, as discussed
in section VII, infra, the Commission estimates that not more than
three of the 64 non-FINRA member broker-dealer firms that the
Commission identified as of April 2023 have total capital of less
than $500,000 and are not affiliates of any person (other than a
natural person) that is not a small business or small organization
and would, as a result, be considered small entities under
Regulatory Flexibility Act (``RFA'') standards. These three small
firms--by RFA standards--could be significantly impacted by the
adopted rule amendments because they could be required to become a
member of FINRA under section 15(b)(8) of the Act, if they effect
off-member-exchange securities transactions and do not qualify for
one of the adopted exemptions. These three firms are not among the
12 largest non-FINRA member broker-dealer firms identified by the
Commission, and so, as discussed in the paragraph above and in
section V.C.2 infra, their initial and ongoing FINRA membership
costs, should they join FINRA, likely would be low. This suggests
that, while they could be significantly impacted by the adopted rule
amendments in that they may no longer be exempt from FINRA
membership, their trading businesses nevertheless might not be
materially impeded by the costs of FINRA membership.
---------------------------------------------------------------------------

Further, since the 2015 Proposal, as commenters observed, there has
been a decrease in the number of Commission-registered broker-dealers
that are exchange members but not FINRA members.\176\ There also has
been significant consolidation among broker-dealers generally over the
past decade.\177\ Meanwhile, despite this decline in the number of
firms, options market liquidity has remained robust, as reflected by
data suggesting that options quoted spreads have remained flat or
slightly declined in recent years as overall option trading volumes
have continued to hit record highs.\178\ Therefore, as discussed in the
Economic Analysis below,\179\ the Commission does not believe that the
adopted rule amendments will undermine options market liquidity
provision. In addition, as discussed in the Economic Analysis
below,\180\ the Commission believes that amended Rule 15b9-1 is not
likely to have an economically meaningful effect on direct capital
formation, and that changes in the allocation of regulatory fees and
direct FINRA supervision within the off-member-exchange market may
result in improved efficiency of capital allocation by the financial
industry, as current FINRA members might commit additional capital to
liquidity provision when the trading environment has more uniform
regulatory requirements.
---------------------------------------------------------------------------

\176\ See STA Letter at 3-4; ABCV Letter at 2-3. See also infra
section V.B.2. The decrease is largely the result of such firms
ceasing their broker-dealer operations and withdrawing their
registration as broker-dealers with the Commission.
\177\ See FINRA.org, 2022 Industry Snapshot, at 13, available at
https://www.finra.org/sites/default/files/2022-03/2022-industry-snapshot.pdf (last visited Aug. 8, 2023) (reflecting the following
number of FINRA-registered firms in 2017-2021: 3,726 in 2017; 3,607
in 2018; 3,517 in 2019; 3,435 in 2020; and 3,394 in 2021); compare
2015 Proposal, supra note 1, 80 FR 18042, with section II.B supra
(reflecting a decrease in the Commission's estimate of the number of
broker-dealers registered with the Commission that are exchange
members but not FINRA members from 125 in the 2015 Proposal to 64 as
of Apr. 2023). This trend began well before the amendments being
adopted in this release, and may or may not continue regardless of
the adopted rule amendments. In other words, if options trading
firms ceased operating in the future, the Commission does not
believe the cause necessarily would be the amendments to Rule 15b9-1
as other factors have caused this trend before these amendments and
likely would continue to be relevant.
\178\ See section V.B, infra (among other things, citing an
academic study showing that options bid-ask spreads have remained
flat since 2015, and citing NYSE Data Insights 2021 Options Year in
Review, available at https://www.nyse.com/data-insights/2021-options-year-in-review, which reflects that options quoted spreads
have remained flat or slightly declined in recent years as overall
option trading volumes have continued to hit record highs).
\179\ See id.
\180\ See 2022 Re-Proposal, supra note 1, 87 FR 49960; section
V.B.1, infra.
---------------------------------------------------------------------------

Finally, commenters stated that the Commission already possesses
and can exercise authority over Commission-registered broker-dealers
that are not FINRA members.\181\ While this is

[[Page 61866]]

true,\182\ as discussed above and in the 2022 Re-Proposal,\183\ 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. While the Commission retains examination
authority over the SROs and 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. The Commission continues to believe
that the front-line layer of SRO oversight must be strengthened with
respect to proprietary trading broker-dealer firms that effect off-
member-exchange securities transactions notwithstanding the
Commission's plenary jurisdiction over Commission-registered broker-
dealers. 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 off-member-exchange securities trading
activity. The Commission continues to believe 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.\184\
---------------------------------------------------------------------------

\181\ See, e.g., Virtu Letter at 2.
\182\ See section I, supra; 2022 Re-Proposal, supra note 1, 87
FR 49931-32 (stating that the Commission may bring enforcement
actions, including pursuant to referrals made by SROs, to enforce
compliance with the Exchange Act and applicable rules).
\183\ See section I, supra; 2022 Re-Proposal, supra note 1, 87
FR 49932.
\184\ One commenter stated that, ``by adopting a Commission rule
requiring certain broker-dealers to register with FINRA, FINRA will
become, at least as to those broker-dealers, a `part of the
Government' under the standard set forth by the U.S. Supreme Court
in Free Enterprise Fund v. Public Company Accounting Board, 561 U.S.
477 (2010).'' Letter from W. Hardy Callcott (Sept. 3, 2022). FINRA
disputed this. See FINRA Letter at 15-20. The Commission disagrees
that the amendments to Rule 15b9-1 would make FINRA ``part of the
Government'' under Free Enterprise. In that case, the Supreme Court
reasoned that, ``[u]nlike the self-regulatory organizations,'' the
Public Company Accounting Oversight Board was ``a Government-
created, Government appointed entity.'' 561 U.S. at 485. These
distinctions between FINRA and the PCAOB remain unchanged by the
amendments to Rule 15b9-1. See also, e.g., Desiderio v. Nat'l Ass'n
of Sec. Dealers, Inc., 191 F.3d 198, 206 (2d Cir. 1999) (NASD ``is a
private actor, not a state actor,'' because it is a ``private
corporation that receives no federal or state funding,'' ``[i]ts
creation was not mandated by statute, nor does the government
appoint its members or serve on any NASD board or committee.'').
---------------------------------------------------------------------------

On March 28, 2022, the Commission proposed new rules to further
define certain language as used in the definition of ``dealer'' and
``government securities dealer'' under sections 3(a)(5) and 3(a)(44) of
the Exchange Act, respectively.\185\ Some commenters stated that the
amendments to Rule 15b9-1 may affect proprietary trading firms that are
not Commission-registered dealers, but could be required to register as
such if the definition of ``dealer'' is amended.\186\ To the extent the
Commission amends the definition of ``dealer'' in the future, the
adopted amendments to Rule 15b9-1 would become part of the baseline
from which the effects of any such new rule on the definition of
``dealer'' are measured.
---------------------------------------------------------------------------

\185\ See Securities Exchange Act Release No. 94524 (Mar. 28,
2022), 87 FR 23054 (Apr. 18, 2022).
\186\ See, e.g., MMI Letter at 3; STA Letter at 2; Virtu Letter
at 4.
---------------------------------------------------------------------------

B. Narrowed Criteria for Exemption From Association Membership

The Commission proposed to add to Rule 15b9-1 a new paragraph (c)
that would set forth two narrow circumstances in which a broker or
dealer would continue to be exempt from section 15(b)(8)'s Association
membership requirement if it effects transactions in securities
otherwise than on an exchange of which it is a member.\187\
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 proposed to add language that states:
``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) . . .'' \188\ The two proposed exemptions
followed in new paragraphs (c)(1) and (2).
---------------------------------------------------------------------------

\187\ See 2022 Re-Proposal, supra note 1, 87 FR 49944-49.
Relatedly, the Commission proposed that 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 2022 Re-Proposal, supra note 1, 87
FR 49945 n. 156.
\188\ See 2022 Re-Proposal, supra note 1, 87 FR 49945.
---------------------------------------------------------------------------

As discussed in turn below, the Commission is adopting as proposed
new paragraphs (c)(1) and (2) (as well as the above-quoted
language).\189\ Paragraphs (c)(1) and (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 protection of investors and the
public interest in accordance with section 15(b)(9) of the Act.
---------------------------------------------------------------------------

\189\ See amended Rule 15b9-1(c), under ``Text of Amendments,''
infra. The Commission also is adopting the proposed renumbering of
paragraphs (a) and (b) in the amended rule. See supra note 187.
---------------------------------------------------------------------------

1. Routing Exemption
The Commission proposed to add a new paragraph (c)(1) to Rule 15b9-
1 that sets forth 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 \190\ or the Options
Order Protection and Locked/Crossed Market Plan.\191\ Relatedly, the
Commission also proposed to eliminate from Rule 15b9-1 outdated
references to the ``Intermarket Trading System,'' \192\ which is a now-
obsolete NMS plan that was discontinued in 2007 because it was
superseded by Regulation NMS.\193\ The Commission is adopting these
aspects of the 2022 Re-Proposal by adding new paragraph (c)(1), as re-
proposed, to Rule 15b9-1, and by removing from Rule 15b9-1 the ITS
provisions in pre-existing paragraphs (b)(2) and (c).
---------------------------------------------------------------------------

\190\ 17 CFR 242.611.
\191\ See 2022 Re-Proposal, supra note 1, 87 FR 49945. See also
Options Linkage Plan, supra note 22.
\192\ The ITS 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
provisionally approved by the Commission in 1978 and finally
approved by the Commission in 1983. See Securities Exchange Act
Release Nos. 14661 (Apr. 14, 1978), 43 FR 17419 (Apr. 24, 1978)
(``Initial ITS Plan Approval Order''); 19456 (Jan. 27, 1983), 48 FR
4938 (Feb. 3, 1983) (``Final ITS Plan Approval Order''). All
national securities exchanges that traded exchange-listed stocks and
the National Association of Securities Dealers (``NASD'') were
participants in the ITS Plan.
\193\ See 2022 Re-Proposal, supra note 1, 87 FR 49945; see also
Notice of Filing and Immediate Effectiveness of the Twenty Fourth
Amendment to the ITS Plan Relating to the Elimination of the ITS
Plan, Securities Exchange Act Release No. 55397 (Mar. 5, 2007), 72
FR 11066 (Mar. 12, 2007).
---------------------------------------------------------------------------

As discussed in the 2022 Re-Proposal, Rule 611 of Regulation NMS
requires trading centers, such as national securities exchanges, to
establish, maintain, and enforce written policies

[[Page 61867]]

and procedures reasonably designed to prevent trade-throughs in
exchange-listed stocks, subject to certain exceptions.\194\ In general,
Rule 611 protects automated quotations that are the best bid or offer
of a national securities exchange or an Association.\195\ 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.\196\ Similarly, in the options market, the
Options Linkage Plan is an NMS 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.\197\ The Options
Linkage Plan includes written policies and procedures that provide for
order protection and address locked and crossed markets in eligible
options classes.\198\
---------------------------------------------------------------------------

\194\ 17 CFR 242.611. See also 17 CFR 242.600(b)(94) (defining a
``trade-through'' under Regulation NMS); 17 CFR 240.600(b)(95)
(defining ``trading center''); Options Linkage Plan, supra note 4
(defining ``trade-through'' in the options context).
\195\ 17 CFR 242.611.
\196\ See 17 CFR 242.600(b)(71) (defining ``protected
quotation'' under Regulation NMS); 17 CFR 242.600(b)(70) (defining
``protected bid'' and ``protected offer'' under Regulation NMS); see
also Options Linkage Plan, supra note 4 (defining ``protected bid''
and protected offer'' in the options context).
\197\ See Options Linkage Plan, supra note 4. 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.
\198\ Id.
---------------------------------------------------------------------------

The Commission proposed the routing exemption in paragraph (c)(1)
to accommodate securities transactions away from a broker's or dealer's
member exchange(s) that are to comply with these regulatory
requirements.\199\ 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.\200\ The
Commission continues to believe that it 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 routing exemption is intended to serve the
limited, narrowly defined purpose of facilitating compliance with
intermarket order protection requirements.
---------------------------------------------------------------------------

\199\ See 2022 Re-Proposal, supra note 1, 87 FR 49945.
\200\ Amended Rule 15b9-1 provides 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, but it
does 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 discussed in
the 2022 Re-Proposal, a routing broker-dealer continues to 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. 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 Options 5, section 4 (Order
Routing).
---------------------------------------------------------------------------

The Commission also stated in the 2022 Re-Proposal that it would be
consistent with the protection of investors and the public interest to
permit reliance on the routing exemption only where the routing is
performed by a national securities exchange of which the broker or
dealer is a member.\201\ The Commission stated that this limitation
would help ensure that the broker's or dealer's member exchange has
visibility into the routing transactions and thus is better able to
provide effective SRO oversight of its member's trading 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.\202\
---------------------------------------------------------------------------

\201\ As stated in the 2022 Re-Proposal, the routing exemption
is 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. See 2022 Re-Proposal, supra note 1, 87
FR 49946. An exchange's routing fees must be consistent with the
Act, including sections 6(b)(4) and 6(b)(5), which require an
equitable allocation of reasonable dues, fees and other charges
among members and issuers and other persons using any facility of
the exchange, and require that the exchange's fees not be designed
to permit unfair discrimination between customers, issuers, brokers,
or dealers.
\202\ See 2022 Re-Proposal, supra note 1, 87 FR 49946.
---------------------------------------------------------------------------

Some commenters stated that the routing exemption should be
broadened for proprietary options trading broker-dealer firms so that
it covers routing that is not performed by member-exchange
routers.\203\ The Commission stated in the 2022 Re-Proposal that this
would not be consistent with the protection of investors and the public
interest because it could permit scenarios in which there is
insufficient SRO oversight of the broker-dealer's off-member-exchange
securities trading activity.\204\ Commenters suggested that the
Commission's concerns in this regard are mitigated in the context of
options trading firms because they typically route to non-member
exchanges via another broker-dealer,\205\ and are especially mitigated
where that routing broker-dealer is a FINRA member.\206\
---------------------------------------------------------------------------

\203\ See Cboe Letter at 3; ABCV Letter at 4. It appeared to the
Commission that commenters intertwined this point with a different
point, and for the sake of completeness, the Commission has
addressed both. Specifically, in this section, the Commission
interprets and addresses these comments as a request that the
routing exemption cover off-member-exchange securities transactions
to comply with intermarket order protection requirements that are
effected via routers other than a member exchange router. These and
other commenters also requested an exemption for proprietary options
trading broker-dealer firms under which their off-member-exchange
securities trading activity would not trigger section 15(b)(8)'s
Association membership requirement if such activity is to hedge or
in furtherance of their options trading activity on their member
exchange(s). See supra note 165 and accompanying text. This request
is addressed in section III.A, supra.
\204\ See 2022 Re-Proposal, supra note 1, 87 FR 49946.
\205\ See Cboe Letter at 3.
\206\ See ABCV Letter at 4. Likewise, commenters suggested that
it would be particularly appropriate to continue to exempt options
trading firms from section 15(b)(8)'s Association membership
requirement where their routing away from a member exchange is
through a broker-dealer that is a FINRA member. See Cboe Letter at
2-3; ABCV Letter at 3-4; CTC Letter at 5; PEAK6 Letter at 4. As
discussed supra in section III.A, the Commission does not agree. See
supra notes 98-101 and accompanying text.
---------------------------------------------------------------------------

The Commission does not agree. As stated previously, consistent
with the original design of Rule 15b9-1, the narrowed exemptions from
section 15(b)(8)'s Association membership requirement set forth in
amended Rule 15b9-1 are designed to apply to limited off-member-
exchange securities 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. As stated above, Rule
15b9-1 previously exempted securities transactions effected through the
ITS. The ITS Plan required each participant--exchanges and the NASD--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

[[Page 61868]]

prices.\207\ The ITS Plan provided each participant market limited
access to the other participant markets for the purpose of avoiding a
trade-through or a locked or crossed market.\208\ Specifically, the ITS
enabled a broker or dealer that was physically present in (and a member
of) one market center to transmit its own or its customer's commitment
to trade in an ITS-traded stock to another market center, which could
then be accepted by a broker or dealer at the receiving market
center.\209\ When a broker or dealer initiated a commitment to trade
from an exchange where it was a member, it did so to prevent orders on
its member exchange from trading through or locking or crossing
quotations displayed on away market centers, and the member exchange
was inextricably involved in the routing activity covered by the
exemption.
---------------------------------------------------------------------------

\207\ See Initial ITS Plan Approval Order, supra note 192.
\208\ Id.
\209\ Id.
---------------------------------------------------------------------------

In contrast, if the routing exemption were expanded, as suggested
by commenters, to cover routing for intermarket order protection
purposes performed by a non-exchange-designated router on behalf of a
broker-dealer trading firm, the exemption could cover trading activity
that is not ancillary to the firm's trading activity on any exchange
where it is a member. Under the commenters' approach, the trading firm
could remain exempt from Association membership while utilizing a non-
exchange-designated routing broker-dealer to effect securities
transactions solely on off-member-exchange venues without any nexus to
an exchange where the trading firm is a member. The Commission remains
concerned that, in this type of scenario, there would not be an
exchange where the trading firm is a member that has visibility into
the routing transactions and that is able to provide effective SRO
oversight of the trading firm's order routing activity. Among other
things, no exchange where the trading firm is a member would be
positioned to assess whether the routing transactions complied with the
terms of the exemption. This would be the case even if the routing is
performed by a routing broker-dealer that also is a FINRA member.\210\
This would be inconsistent with the Commission's intention to continue
to permit exemptions from section 15(b)(8)'s Association membership
requirement that are narrowly tailored to limited off-member-exchange
securities 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 and, in the Commission's view, would be
inconsistent with the protection of investors and the public interest.
---------------------------------------------------------------------------

\210\ While there could be direct exchange SRO or FINRA
oversight over the routing broker-dealer in this scenario, the
Commission does not believe this is adequate, as discussed above,
due to the lack of direct FINRA oversight over the broker-dealer
initiating the order. See supra notes 98-101 and accompanying text
(discussing that separate exchange SRO recourse against different
broker-dealers for the same conduct can present the potential for
inconsistent outcomes).
---------------------------------------------------------------------------

To be clear, nothing in amended Rule 15b9-1 prohibits broker-dealer
firms from effecting securities transactions away from their member
exchange(s) by utilizing routing services provided by non-exchange-
designated broker-dealers, so long as they comply with section 15(b)(8)
of the Act. Any broker-dealer firm may continue to route orders away
from its member exchange(s) for order protection or any other
appropriate purposes using non-exchange-designated routing broker-
dealers. But a broker-dealer firm cannot do so without joining FINRA,
as such trading activity is not exempt from, and therefore would
trigger, section 15(b)(8) (assuming the trading activity is not
otherwise covered by the stock option order exemption discussed below),
which would require Association membership for the firm.\211\
---------------------------------------------------------------------------

\211\ Alternatively, a firm wishing to route orders to exchanges
using a non-exchange-designated routing broker-dealer could comply
with section 15(b)(8) by becoming a member of all exchanges to which
it routes orders. But any such firm would still be required to join
FINRA to the extent it effects off-exchange securities transactions
(unless exempted by the stock-option order exemption). See section
V.D, infra.
---------------------------------------------------------------------------

2. Stock-Option Order Exemption
The Commission proposed to add a new paragraph (c)(2) to Rule 15b9-
1 that sets forth an exemption from Association membership if a broker
or dealer that meets the criteria of paragraphs (a) and (b) of the rule
effects off-member-exchange securities transactions, with or through
another registered broker or dealer, that are solely for the purpose of
executing the stock leg of a stock-option order.\212\ The Commission
also proposed to require in new paragraph (c)(2) that a broker or
dealer seeking to rely on the 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 (``Rule 17a-4'') until three years
after the date the policies and procedures are replaced with updated
policies and procedures.\213\ One commenter referenced the stock-option
order exemption.\214\ The Commission is adopting paragraph (c)(2) as
proposed.
---------------------------------------------------------------------------

\212\ See 2022 Re-Proposal, supra note 1, 87 FR 49947.
\213\ See id.
\214\ See Cboe Letter at 3 (stating that the existence of a
stock-option exemption in the 2022 Re-Proposal is an acknowledgment
that activity critical to the functioning of the options market
should not be adversely impacted).
---------------------------------------------------------------------------

As the Commission stated in the 2022 Re-Proposal, 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. 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. Moreover, there is a
close link between the stock component transaction of a stock-option
order and the relevant options exchange. As such, the stock-option
order exemption permits 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 stated above, the Commission estimates that, in 2022, 48 of the
73 firms identified as registered broker-dealers and exchange members
but not FINRA members initiated options order executions.\215\ The
Commission estimates that 17 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.\216\ Because
the

[[Page 61869]]

broker or dealer relying on 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 must 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).
---------------------------------------------------------------------------

\215\ See supra note 44.
\216\ Source: CAT. The Commission previously estimated that, in
2021, seven such firms effected stock leg transactions and could
potentially rely on the stock-option order exemption to the extent
that they effect the stock leg transactions off-exchange or on an
exchange where they are not a member. See 2022 Re-Proposal, supra
note 1, 87 FR 49947. The Commission attributes the increase from
2021 to 2022 of its estimated number of broker-dealers that are not
FINRA members and that executed stock leg transactions mainly to an
increase in the percentage of stock leg transactions that are
captured in the CAT in a manner that enables the Commission to
identify the firms that initiated the transactions.
---------------------------------------------------------------------------

Options exchanges define the term ``stock-option order'' in their
rules.\217\ Further, the Commission stated in the 2022 Re-Proposal that
its understanding is that 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.\218\
For purposes of relying on the exemption provided by 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 member.\219\ 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 applies regardless of whether the
component legs of a stock-option order are executed electronically, on
a physical exchange floor, or through a combination of both.
---------------------------------------------------------------------------

\217\ See, e.g., Cboe Rules 1.1 and 5.33(b)(5); MIAX Rule
518(a)(5); MIAX Emerald Rule 518(a)(5); Nasdaq Options 5, section
1(4) (defining ``Complex Trade''); Nasdaq PHLX Options 5, section
1(d) (defining ``Complex Trade''); Nasdaq ISE Options 5, section
1(d) (defining ``Complex Trade''); 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); NYSE American Rule
900.3NY(h)(1).
\218\ See, e.g., Cboe Rule 5.33, Interpretations and Policies
.04 Stock Option Orders; Supplementary Material .07 to Nasdaq ISE
Options 3, section 14; Commentary .01 to MIAX Rule 518. 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 (Aug.
31, 2006), 71 FR 52829 (Sept. 7, 2006); see also Securities Exchange
Act Release No. 57620 (Apr. 4, 2008), 73 FR 19271 (Apr. 9, 2008).
\219\ 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 217. Therefore, the
stock-option order exemption currently covers stock-option orders
with only one stock leg.
---------------------------------------------------------------------------

The Commission continues to believe, as discussed in the 2022 Re-
Proposal, that the stock-option order exemption's reliance on the
options exchange's ``stock-option order'' definition should enhance an
exchange's ability to monitor whether its members are appropriately
relying on the 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.\220\ 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.\221\ In light of these rules, the Commission continues to
believe that there is a close link between the stock component
transaction of a stock-option order and the relevant options exchange.
Accordingly, the Commission continues to believe that this 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.
---------------------------------------------------------------------------

\220\ 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;
MIAX Rule 518 and Commentary .01.
\221\ 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; MIAX Rule 518 and Commentary .01.
---------------------------------------------------------------------------

The Commission also continues to believe that the exchange's
oversight capabilities will be further enhanced, consistent with the
public interest and protection of investors, by requiring brokers and
dealers to develop written policies and procedures in connection with
the stock-option exemption in paragraph (c)(2) of the amended rule.
This requirement should 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 exemption. Moreover, the
Commission continues to believe 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 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.\222\
---------------------------------------------------------------------------

\222\ 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.

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

[[Page 61870]]

Finally, a broker or dealer seeking to rely on the stock-option
order exemption is 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.\223\ Accordingly, a
broker or dealer is required to keep the policies and procedures
relating to its use of this exemption as part of its books and records
while they are in effect, and for three years after they are updated.
---------------------------------------------------------------------------

\223\ See, e.g., 17 CFR 240.17a-4(e)(7).
---------------------------------------------------------------------------

IV. Effective Date and Implementation

The Commission proposed that the compliance date for amended Rule
15b9-1 be one year after publication of any final rule in the Federal
Register.\224\ In proposing this compliance date, the Commission
considered various factors that impact the time that it takes to become
a FINRA member, as well as that firms that choose to adjust their
business models such that they are not required to join FINRA would
need time to do so.\225\ The Commission understood that, on average,
the FINRA membership application process takes approximately six
months.\226\
---------------------------------------------------------------------------

\224\ See 2022 Re-Proposal, supra note 1, 87 FR 49951.
\225\ Id.
\226\ Id.
---------------------------------------------------------------------------

Some commenters on the 2022 Re-Proposal characterized the FINRA
membership application process as lengthy.\227\ One commenter stated
that it understood FINRA's membership application process to take more
than a year, and suggested a revised compliance period in which firms
must only submit their FINRA registration application within 360 days
of adoption of amended Rule 15b9-1, and allow for 540 days from
adoption for FINRA approval of the application.\228\ FINRA stated that
it typically has 180 days to issue a decision after the filing of a new
membership application, but that, depending on the characteristics of
an application, FINRA may issue a ``fast-track'' decision within 100
days.\229\ FINRA also stated that, based on the types of proprietary
trading dealer firms that would be likely to join FINRA as a result of
the Rule 15b9-1 amendments, it intends to implement an expedited
membership application process for these applicants pursuant to which
it anticipates processing their applications within 60 days after
submission.\230\
---------------------------------------------------------------------------

\227\ See, e.g., FIA PTG Letter at 4-5; PEAK6 Letter at 2.
\228\ See FIA PTG Letter at 4-5.
\229\ See FINRA Letter at 12.
\230\ See id. at 12-13.
---------------------------------------------------------------------------

The Commission believes that a compliance date for amended Rule
15b9-1 that is 365 days after publication of amended Rule 15b9-1 in the
Federal Register would provide a sufficient period of time for
proprietary trading broker-dealer firms to comply with the amended
rule. Based on FINRA's statements regarding its ability to issue a
``fast-track'' decision within 100 days and expectation that it would
process proprietary trading dealer firm applications within 60 days
after submission,\231\ for any FINRA membership application submitted
by such a firm in a timely manner, the Commission expects FINRA to be
able to process the application and render a decision within the
compliance period. Additionally, some commenters stated that the FINRA
membership application process requires information that is duplicative
of information already provided to the Commission and other SROs as
part of their prior Commission registration and exchange SRO
application process.\232\ Accordingly, the Commission believes that
when applying to be FINRA members, firms in this situation may be able
to leverage their prior submissions to the Commission and exchange SROs
to be able to have a more expedient application process with FINRA than
they would otherwise if they had not already prepared such information
for submission to the Commission and exchange SROs. More broadly, any
existing broker-dealer firm that applies for FINRA membership as a
result of the amendments to Rule 15b9-1 would have already completed
the application processes for becoming a Commission-registered broker-
dealer and a member of at least one exchange and, the Commission
believes, should be able to leverage those experiences to expedite
their application process with FINRA.
---------------------------------------------------------------------------

\231\ See supra notes 229-230 and accompanying text.
\232\ See PEAK6 Letter at 2; FIA PTG Letter at 4.
---------------------------------------------------------------------------

V. Economic Analysis

The Commission is amending Rule 15b9-1 to help ensure that an
Association generally has direct, membership-based oversight over
broker-dealers that effect off-member-exchange securities transactions
and the jurisdiction to directly enforce their compliance with Federal
securities laws, Commission rules, and Association rules. In addition,
these amendments will provide a more consistent regulatory framework
for broker-dealers,\233\ which in turn should enhance competition and
result in potential efficiency gains for market participants.
---------------------------------------------------------------------------

\233\ See section III.A, supra.
---------------------------------------------------------------------------

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.\234\ However, currently pursuant to Rule 15b9-1, a broker or
dealer may engage in unlimited off-member-exchange \235\ proprietary
trading without becoming a member of an Association, so long as its
proprietary trading activity is conducted with or through another
registered broker or dealer. Currently, off-exchange equity activity
and exchange listed options trading of non-FINRA member broker-dealers
is surveilled by FINRA through CAT data and supervised in part via the
use of RSAs.\236\ 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.\237\ For
example, of the current FINRA RSA contracts: one RSA contract expires
at the end of 2023, seven RSA contracts expire at the end of 2024, and
three RSA contracts expire at the end of 2025 unless extended or
terminated early.\238\ The amendments will provide consistency and
stability of oversight.\239\
---------------------------------------------------------------------------

\234\ See section I, supra.
\235\ ``Off-member-exchange'' trading of securities refers to
trading by a broker-dealer on any national securities exchange of
which it is not a member or in the off-exchange market. See supra
note 2 and accompanying text.
\236\ See section V.A.2, infra.
\237\ See sections I and III.A, supra.
\238\ Based on information provided by FINRA.
\239\ Current non-FINRA members that choose to join FINRA in
response to the amendments will face direct Association oversight of
their off-member exchange trading instead of oversight that occurs
and is based on an RSA. The Exchange Act's statutory framework
places SRO oversight responsibility with an Association for off-
member-exchange securities trading, and FINRA's role with respect to
non-FINRA member broker-dealers is limited to what is covered in
RSAs it enters into with the exchanges. See supra section III for a
discussion of issues related to RSA-administered oversight of off-
member exchange trading.
---------------------------------------------------------------------------

In the case of U.S. Treasury securities and other fixed income
securities (other than municipal bonds) \240\ that trade off-exchange,
surveillance relies on TRACE data which is collected by FINRA from

[[Page 61871]]

its members.\241\ Some dealer firms that are not FINRA members are
significantly involved in trading U.S. Treasury securities \242\
proprietarily but are not required to report these transactions because
they are not FINRA members. Consequently, trades that do not occur on
an ATS or with a covered depository institution,\243\ and that are
between two non-FINRA member broker-dealers, are not reported to TRACE
at all, and trades that occur otherwise than on a covered ATS do not
specifically identify the non-FINRA member in the information reported
by the ATS to TRACE.\244\ The amendments will provide for all fixed
income trading by broker-dealers to be subject to FINRA's rules,
including its rules requiring reporting to TRACE.
---------------------------------------------------------------------------

\240\ 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.
\241\ Non-FINRA member depository institutions also report U.S.
Treasury securities trades to TRACE. See supra note 123.
\242\ The Commission can observe and quantify some of this
activity through the reporting of U.S. Treasury securities on
covered ATSs as discussed in supra section III.A. See supra note 59.
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. See infra section V.C.2.c
for information on the costs of TRACE reporting for non-FINRA member
firms.
\243\ These trades do not include those with depository
institutions that are mandated for TRACE reporting.
\244\ See section III.A, supra. The Commission believes this is
a small fraction of U.S. Treasury securities trading. In Apr. 2023,
the Commission estimates that non-FINRA member broker-dealers' U.S.
Treasury securities transactions executed on covered ATSs accounted
for 2.65% of total U.S. Treasury securities transaction volume
reported to TRACE that month. See supra note 57. 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.
---------------------------------------------------------------------------

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 off-member-exchange securities trading activity. The
amendments will 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.\245\ For broker-dealers relying on the
exemption that will be required to register with FINRA under the
amendments, joining FINRA will expose these firms to additional costs
that they previously did not incur.\246\ 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 cross-
exchange and off-exchange trading of both listed and unlisted
securities. When FINRA detects potentially violative behavior by a non-
FINRA member firm,\247\ it can and does refer such cases to other SROs
or the SEC. However, it may lack certain investigative tools which
could help it further investigate potentially violative behavior before
making such referrals. The Commission believes that, particularly in
the case of fixed income trading, FINRA is well positioned to
efficiently investigate such instances of violative behavior 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.
---------------------------------------------------------------------------

\245\ See section III.A, supra.
\246\ FINRA member firms that compete with these firms may
currently be at a cost disadvantage due to this fee disparity.
\247\ The term ``non-FINRA member firm'' refers to a broker-
dealer that is not a FINRA member.
---------------------------------------------------------------------------

The Commission discusses below a number of economic effects that
are likely to result from the adoption of these amendments.\248\ As
discussed in detail below, the effects are quantified to the extent
practicable. Although the Commission is providing estimates of direct
compliance costs where practicable, the Commission also anticipates
that brokers and dealers affected by the amendments, as well as
competitors of those broker and dealers, might 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.\249\ To the extent that non-FINRA member firms
change their business practices, such as reducing or eliminating their
off-member-exchange trading activity or joining FINRA and increasing
their off-member-exchange activity, the amendments may impact
competition and liquidity, particularly in the off-member-exchange
markets. The adoption would increase costs for non-FINRA member firms
that will have to register with FINRA, which might result in decreased
liquidity provision by these non-FINRA member firms to certain markets.
Additionally, the amendments to Rule 15b9-1 might create incentives for
non-FINRA member firms that are impacted by the amendments to form a
new Association. The creation of such a new Association would entail
large startup costs but could spur competition with the existing
Association and might lower general self-regulatory financial burdens.
The amendments may also result in potential benefits to competition,
since current FINRA members will be operating on a more level
regulatory playing field relative to non-FINRA members.
---------------------------------------------------------------------------

\248\ 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.
\249\ See infra section V.B.1 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 their 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.'' \250\ 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.'' \251\ 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,\252\ and broker-dealers generally must become members of
an Association to trade securities elsewhere than on an exchange to
which

[[Page 61872]]

a broker or dealer belongs as a member.\253\
---------------------------------------------------------------------------

\250\ 15 U.S.C. 78c(a)(4)(A).
\251\ 15 U.S.C. 78c(5)(A).
\252\ A firm that wishes to transact business upon an exchange
without becoming a broker or dealer generally can do so by engaging
a broker-dealer that is a member of that exchange to provide market
access and settlement services.
\253\ See supra note 19.
---------------------------------------------------------------------------

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, which handle the
clearance and settlement aspects of customer trades. In contrast,
introducing brokers provide services to customers, but do not hold
customers funds or execute or clear trades themselves. However, of
3,515 registered brokers and dealers, only 210 were classified as
carrying or clearing brokers and dealers and around 1,200 firms were
classified as introducing brokers at the end of 2022.\254\ 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.
---------------------------------------------------------------------------

\254\ Based on the number of firms that answered yes to items
I8084 or I8085 on Schedule I in December 2022. The number of
introducing broker dealers was estimated from the question ``Does
applicant refer or introduce customers to any other broker or
dealer?'', as reported on Form BD.
---------------------------------------------------------------------------

Sixty-six percent of brokers and dealers employ 15 or fewer
associated persons and only 10% of brokers and dealers employ over 100
associated persons.\255\ Further, while there are many registered
brokers and dealers, a small minority of brokers and dealers controls
the majority of broker and dealer capital.\256\
---------------------------------------------------------------------------

\255\ Based on Dec. 2022 Annual FOCUS data filings. See also
supra note 150.
\256\ See infra section VII.
---------------------------------------------------------------------------

The Commission has identified 64 firms that, as of April 2023, 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 amendments.\257\ In September
2022, there were 73 registered broker-dealers that were exchange
members but not FINRA members.\258\ Because of Rule 15b9-1's exclusion
of proprietary trading, a dealer that had not carried customer accounts
might not be required to join an Association as long as it had been a
member of an exchange SRO, even when that dealer had substantial off-
member-exchange trading activity.
---------------------------------------------------------------------------

\257\ 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.
\258\ See supra note 37. Some commenters, citing the
Commission's proposal to amend the definition of ``dealer,'' stated
that number of firms affected by the amendments to Rule 15b9-1 could
increase if the definition of ``dealer'' is amended. See, e.g., STA
Letter at 2. The economic analysis appropriately considers existing
regulatory requirements, including recently adopted rules but not
proposed rules, as part of its economic baseline against which the
costs and benefits of the final rule are measured. To the extent the
Commission amends the definition of ``dealer'' in the future, the
adopted amendments to Rule 15b9-1 would become part of the baseline
from which the effects of any such new rule on the definition of
``dealer'' are measured. See supra note 186 and accompanying text.
---------------------------------------------------------------------------

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 2022, seven of the 64 non-FINRA member firms had $6
trillion in U.S. Treasury securities volume reported to TRACE by
covered ATSs. This accounts for approximately 3.67% of U.S. Treasury
volume as reported to TRACE throughout the year. In April 2023, there
were five non-FINRA member firms with approximately $302 billion in
U.S. Treasury securities volume executed on covered ATSs or
approximately 2.65% 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 TRACE-eligible securities, with a few
exceptions including U.S. Treasury securities.\259\ However, FINRA does
make public aggregate U.S. Treasury securities data on a daily
basis.\260\ Non-FINRA member firms are not required to report their
trading activity to TRACE, but if their transactions involve FINRA
members or covered depository institutions, the FINRA members or
covered depository institutions would report. With respect to trading
activity in U.S. Treasury securities markets on a covered ATS, non-
FINRA member counterparties are identified in TRACE.\261\ With respect
to trading activity in other TRACE-eligible securities, non-FINRA
member counterparties are not identified in TRACE.\262\ Therefore, the
Commission is unable to estimate the level of trading activity of non-
FINRA member firms for other fixed income securities.
---------------------------------------------------------------------------

\259\ See Stephanie Dumont & Ola Persson, TRACE at 20--
Reflecting on Advances in Transparency in Fixed Income (FINRA.org),
Jun. 28, 2022, available at https://www.finra.org/media-center/blog/trace-at-20-reflecting-advances-transparency-fixed-income (last
visited July 20, 2023). See also FINRA Rule 6750(c).
\260\ See supra note 122 and accompanying text.
\261\ See supra note 124 and accompanying text.
\262\ FINRA stated that it does not have visibility into the
activity of PTFs in non-U.S. Treasury security fixed-income
products. See FINRA Letter at 9.
---------------------------------------------------------------------------

In September 2022, of the 73 non-FINRA member firms, 53 initiated
equity orders that were not executed on an exchange, accounting for
$440 billion (approximately 5.1%) in off-exchange traded dollar volume
in listed equities.\263\ In April 2023, of the 64 non-FINRA member
firms, 45 initiated equity orders that were not executed on an
exchange, accounting for $405 billion (approximately 5.6%) in off-
exchange traded dollar volume in listed equities.
---------------------------------------------------------------------------

\263\ 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 in NMS stocks.
Off-exchange equity trading occurs across many trading venues. In
the fourth quarter of 2022, 32 ATSs actively traded NMS stocks,
comprising 10.5% of NMS stock share volume. Furthermore, 214 named
\264\ broker-dealers transacted a further 32.4% 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.\265\
---------------------------------------------------------------------------

\264\ ATSs report counterparties that are not FINRA members,
allowing such activity to be identified in CAT data.
\265\ See Table 1 for information on trading activities on ATSs.
---------------------------------------------------------------------------

While some non-FINRA member firms trade actively cross-exchange
and/or 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 2022 and April 2023 for the non-FINRA
member firms. Table 2

[[Page 61873]]

below shows the executed dollar volume, number of trades, and number of
contracts in options during September 2022 and April 2023 for the non-
FINRA member firms.

Table 1--Non-FINRA Members NMS Equity Trading Volume by Venue Type
----------------------------------------------------------------------------------------------------------------
Traded dollar volume
---------------------------------------------------------------
Sept 2022 April 2023
---------------------------------------------------------------
Billions ($) % of total Billions ($) % of total
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
Off-Exchange: ATS........................... 369.59 12.6 352.38 14.6
Off-Exchange: Non-ATS....................... 70.63 2.4 52.41 2.2
On-Exchange: Exchange Member \2\............ 2,183.14 74.4 1,746.53 72.4
On-Exchange: Not Exchange Member............ 311.62 10.6 261.91 10.9
---------------------------------------------------------------
Total................................... 2,934.98 100.0 2,413.23 100.0
II. Largest Non-FINRA Member Firms \3\
Trading Venue:
Off-Exchange: ATS........................... 333.48 14.6 322.16 16.1
Off-Exchange: Non-ATS....................... 57.60 2.5 41.62 2.1
On-Exchange: Exchange Member \2\............ 1,639.34 71.9 1,415.99 70.8
On-Exchange: Not Exchange Member............ 248.40 10.9 219.46 11.0
---------------------------------------------------------------
Total................................... 2,278.82 100.0 1,999.22 100.0
----------------------------------------------------------------------------------------------------------------
Data Source: CAT.
\1\ Non-FINRA Member firms that initiated NMS equity orders that were executed either on or off-exchange. There
were 53 firms in September 2022 and 45 firms in April 2023.
\2\ Exchange Member refers to trades executed on an exchange where the non-FINRA member is a registered member.
\3\ The largest 12 non-FINRA member firms ranked by equity off-exchange traded dollar volume.

Table 2--Non-FINRA Members Options Trading Volume by Venue Type
----------------------------------------------------------------------------------------------------------------
Traded dollar volume
---------------------------------------------------------------
Sept 2022 April 2023
---------------------------------------------------------------
Billions ($) % of total Billions ($) % of total
----------------------------------------------------------------------------------------------------------------
Panel A: Option Dollar Volume
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
On-Exchange: Exchange Member \2\............ 50.01 93.8 44.62 94.4
On-Exchange: Cross-Exchange \3\............. 3.31 6.2 2.65 5.6
---------------------------------------------------------------
Total................................... 53.33 100.0 47.27 100
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
On-Exchange: Exchange Member \2\............ 45.56 94.2 40.43 94.3
On-Exchange: Cross-Exchange \3\............. 2.80 5.8 2.44 5.7
---------------------------------------------------------------
Total................................... 48.37 100.00 42.87 100
----------------------------------------------------------------------------------------------------------------
Trades
---------------------------------------------------------------
Sept 2022
April 2023
---------------------------------------------------------------
Millions % of total Millions % of total
----------------------------------------------------------------------------------------------------------------
Panel B: Number of Option Trades
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
On-Exchange: Exchange Member \2\............ 18.41 94.8 19.60 95.4
On-Exchange: Cross-Exchange \3\............. 1.00 5.2 0.95 4.6
---------------------------------------------------------------
Total................................... 19.41 100 20.55 100
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
On-Exchange: Exchange Member \2\............ 16.41 95.4 17.09 95.8

[[Page 61874]]

On-Exchange: Cross-Exchange \3\............. 0.79 4.6 0.75 4.2
---------------------------------------------------------------
Total................................... 17.20 100 17.84 100
----------------------------------------------------------------------------------------------------------------
Contracts
---------------------------------------------------------------
Sept 2022
April 2023
---------------------------------------------------------------
Millions % of total Millions % of total
----------------------------------------------------------------------------------------------------------------
Panel C: Number of Option Contracts
----------------------------------------------------------------------------------------------------------------
I. All Non-FINRA Member Firms \1\
Trading Venue:
On-Exchange: Exchange Member \2\............ 147.31 94.5 179.13 95.6
On-Exchange: Cross-Exchange \3\............. 8.58 5.5 8.20 4.4
---------------------------------------------------------------
Total................................... 155.88 100.0 187.34 100.0
II. Largest Non-FINRA Member Firms \4\
Trading Venue:
On-Exchange: Exchange Member \2\............ 129.67 95.1 158.01 96.0
On-Exchange: Cross-Exchange \3\............. 6.66 4.9 6.62 4.0
---------------------------------------------------------------
Total................................... 136.33 100.0 164.64 100.0
----------------------------------------------------------------------------------------------------------------
Data Source: CAT.
\1\ Non-FINRA Member firms that initiated options orders that were executed. There were 53 firms in September
2022 and 45 firms in April 2023. While these are the same numbers of non-FINRA member firms that initiated NMS
equity orders as reflected in Table 1, they are not all the same firms as there is not 100% overlap. Some
firms that initiated NMS equity orders did not initiate options orders. Some firms that initiated options
orders did not initiate NMS equity orders. The number of firms in these two groups is the same.
\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 12 non-FINRA member firms ranked by equity off-exchange traded dollar volume. Nine of the
largest 12 firms in September 2022 and eleven of the largest 12 firms in April 2023 initiated options orders
that were executed.

Table 1 shows that in April 2023 non-FINRA member firms executed
approximately 72.4% of their NMS equity trading volume 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 data for non-FINRA member firms that also
executed trades in the options market and their total dollar, trades,
and contract volume. In September 2022, 53 non-FINRA member firms and
nine of the 12 largest firms \266\ executed trades on options
exchanges. Seven of the nine largest firms executed trades on five or
more options exchanges. In April 2023, 45 non-FINRA member firms and
eleven of the 12 largest firms executed trades on options exchanges.
---------------------------------------------------------------------------

\266\ The largest non-FINRA member firms are ranked by equity
off-exchange traded dollar volume. Nine of the largest 12 firms in
September 2022 and eleven of the largest 12 firms in April 2023
initiated options orders that were executed.
---------------------------------------------------------------------------

Table 2 indicates that a larger share of options trading by non-
FINRA members (relative to equities trading) takes place on exchanges
wherein the firm is a registered member, ranging from 94%-96%.
Therefore, about 5% of non-FINRA member options trading occurs on
exchanges where the firm is not a member, the volume of which accounts
for around 1% of overall options trading volume.\267\
---------------------------------------------------------------------------

\267\ See note 269, infra.
---------------------------------------------------------------------------

One commenter indicated that because non-FINRA members' off-member-
exchange transactions represent a relatively small proportion of total
options market volume, mandating FINRA membership will not promote
regulatory efficiency, since (in the commenter's assessment) the costs
of Association membership will exceed any benefits provided by FINRA
oversight of ``a relatively small amount of trading activity,
especially if this activity is already being conducted through a FINRA
broker-dealer.'' \268\ The Commission, however, believes that the
benefits stemming from Association oversight of these flows are not
trivial and justify their accompanying costs. More specifically, while
the Commission agrees that off-member-exchange options volume is not
large relative to the size of the overall options market, it is
nonetheless economically large, representing between $133 to $165
million of daily options dollar volume.\269\
---------------------------------------------------------------------------

\268\ The commenter stated that the proposed rule would not
promote regulatory efficiency, since the costs of FINRA membership
would be disproportionate to gains from membership. See CTC Letter
at 4. Consideration of costs and benefits of the amendments are
presented in section V.C.
\269\ More specifically, in September 2022, 53 of the 73 non-
FINRA member firms initiated options orders that were executed off-
member-exchange, valued at $3.31 billion and equal to about 0.3% of
total options market volume. In April 2023, 45 of the 64 non-FINRA
member firms initiated options orders that were executed off-member-
exchange, valued at $2.65 billion, approximately 0.4% of total
options market volume. See supra Table 2 for additional detail. One
commenter raised a similar concern regarding the equities market.
See STA Letter at 3. As equities trading represents a much larger
portion (more than 25%) of non-FINRA member volume relative to
options trading, the Commission views an even greater need for FINRA
supervision in equities markets.
---------------------------------------------------------------------------

2. Current Market Oversight
The surveillance and regulation of each broker or dealer is
partially dependent upon its individual SRO

[[Page 61875]]

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. Exchange SROs generally possess expertise in supervising
members who specialize in trading on their exchange and in using the
order types that may be unique or specialized on the exchange. This
expertise complements the expertise of an Association in supervising
off-member-exchange trading activity.\270\
---------------------------------------------------------------------------

\270\ 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.
---------------------------------------------------------------------------

In the markets for NMS equities and listed options, while all
exchanges are SROs and have access to CAT data covering trading
activity by their members both on and off exchanges, nearly all cross-
market and off-exchange equity activity and much options activity of
non-FINRA member broker-dealers is surveilled by FINRA through 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,\271\ 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 or covered depository institution
that is party to the trade or the trade occurs on an ATS because such
reporting results from a FINRA rule.\272\ Where no FINRA member or
covered depository institution is party to the transaction, and the
transaction does not take place on an ATS, it goes unreported to
TRACE.\273\
---------------------------------------------------------------------------

\271\ Municipal bond trades are not reported to TRACE. See supra
note 240.
\272\ All ATSs are operated by FINRA member firms.
\273\ These reporting gaps were noted by FINRA, which indicated
that it could not identify non-FINRA member firm transactions in
U.S. Treasury securities that do not occur on a covered ATS.
Similarly, FINRA stated that it has no visibility into the activity
of non-member firms in transactions of non-U.S. Treasury fixed
income securities. See FINRA Letter at 9. Beginning in Sept. 2022,
FINRA began collecting transactions by certain banks in government
securities. See supra note 123.
---------------------------------------------------------------------------

Some exchanges serve as DEA for certain of their members.\274\
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.\275\ The exchange serving as DEA has
regulatory responsibility for their common members' compliance with the
applicable financial responsibility rules.\276\ 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.
---------------------------------------------------------------------------

\274\ See supra note 13.
\275\ See supra note 13. 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 which FINRA does act as DEA, and the DEA stipulates
which SRO has responsibility to supervise the firm but does not
allow for less supervision.
\276\ Under the amendments, non-FINRA member firms that join
FINRA may or may not be assigned to FINRA for DEA supervision. See
supra section III.A.
---------------------------------------------------------------------------

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 exempt
from the membership requirement pursuant to Rule 15b9-1. The vast
majority of broker-dealers join an Association and, because FINRA is
the only Association, broker-dealers are subject to relatively uniform
regulatory requirements and levels of surveillance and supervision for
their activities overseen by FINRA. Supervision by FINRA covers a
market that is fragmented across many trading venues, including the
more opaque off-exchange market.\277\ Additionally, FINRA oversees its
members' activity in equity, fixed income, and derivative markets and
thus has the ability to surveil asset classes that may be outside the
expertise of certain exchange SROs (e.g., options exchanges may lack
expertise in fixed income securities).\278\
---------------------------------------------------------------------------

\277\ Comprehensive reporting requirements for all member firms
that trade equities off-exchange give FINRA information on market
activity levels and market conditions off-exchange. Because most
off-exchange equity trading 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 note
17.
\278\ For example, FINRA has extensive specific rules and
dedicated staff applicable to fixed income markets. See FINRA.org,
Key Topics: Fixed Income, available at https://www.finra.org/rules-guidance/key-topics/fixed-income.
---------------------------------------------------------------------------

The existing Association, FINRA, serves crucial functions in the
current regulatory structure.\279\ The Exchange Act's statutory
framework generally places responsibility for off-member-exchange
trading with an Association.\280\ Accordingly, FINRA has established a
regulatory regime for FINRA members, including FINRA members conducting
business in the off-member-exchange market for various asset classes,
and developed surveillance technology and specialized regulatory
personnel to provide surveillance, supervision, and enforcement of
activity occurring off-member-exchange. Consequently, the current
regulatory structure achieves off-member-exchange supervision through
the surveillance actions of FINRA of the market generally and its
examination of its members.
---------------------------------------------------------------------------

\279\ See supra section II for further discussion of the role of
Associations in market oversight.
\280\ See supra note 26.
---------------------------------------------------------------------------

Additionally, despite the fact that FINRA does not have
jurisdiction over non-FINRA member firms or provide regulatory
oversight services to non-FINRA member firms that are not covered by
RSAs, FINRA surveils 100% of the equities and options markets with CAT
data as well as other data sources.\281\ Moreover, where it identifies
potential concerns relating non-FINRA member firms' activities, 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.\282\ However, each RSA is independently negotiated
and thus not standardized. Therefore, FINRA's ability to provide
oversight can vary based on the nature of its RSA with the exchange
SRO. Additionally, the ultimate responsibility for that regulatory
oversight under an RSA still rests with the exchange SRO, not with
FINRA.\283\ SROs may also use 17d-2 plans which allow SROs with common
members to designate a single SRO to

[[Page 61876]]

examine common members. However, 17d-2 plans do not confer jurisdiction
to FINRA as they apply only to common firms of which each SRO would
already have jurisdiction.\284\ Exchange SROs may not be efficient,
relative to FINRA, at monitoring off-member-exchange activity.
---------------------------------------------------------------------------

\281\ CAT data is available to all SROs. FINRA utilizes other
data sources for their surveillance as well as CAT data.
\282\ In most but not all cases, FINRA is empowered to take such
actions.
\283\ See supra note 84.
\284\ See supra note 13.
---------------------------------------------------------------------------

Some non-FINRA member firms trade significantly in the course of
their normal business activities on exchanges of which they are not
members. This activity is not limited to equities and options; non-
FINRA member firms play a large role in U.S. Treasury securities
markets as well.\285\ In 2022, there were seven non-FINRA member firms
that together traded more than $6 trillion in U.S. Treasury securities
volume on covered ATSs, which accounted for 3.67% of total U.S.
Treasury securities trading volume \286\ reported to TRACE. The
Commission estimates that in April 2023, five non-FINRA member firms
totaled $302 billion in U.S. Treasury securities volume executed on
covered ATSs, accounting for 2.65% of total U.S. Treasury securities
transaction volume reported to TRACE that month.
---------------------------------------------------------------------------

\285\ See supra section V.A.1 and accompanying text for more
information on trading in U.S. Treasury securities markets.
\286\ The Commission estimates from 2023 TRACE data that in Apr.
2023 there were 916 total firms that traded U.S. Treasury
securities.
---------------------------------------------------------------------------

This is very different from when Rule 15b9-1 was first adopted,
when firms' exchange activity typically was a floor business conducted
on a single national securities exchange.\287\ While the Act provides
for regulation of exchange trading by the exchanges themselves, it
additionally grants regulatory oversight of off-exchange trading by an
Association.\288\ FINRA, currently the sole Association, has specific
tools and expertise to provide oversight to off-exchange activity.
However, FINRA's regulatory jurisdiction is limited to its membership.
---------------------------------------------------------------------------

\287\ See 2022 Re-Proposal, supra note 1, 87 FR 49932; see also
Qualifications and Fees Release, supra note 33.
\288\ See supra note 66.
---------------------------------------------------------------------------

Some commenters have suggested that the current regulatory
structure already subjects non-FINRA member firms to robust SRO
oversight because exchange SROs have access to both on- and off-member-
exchange equity and options trading data of their members via CAT.\289\
Indeed, SRO rules require their members to report CAT data daily.\290\
One commenter noted that this has helped dramatically improve the
ability of regulators to identify violative activity which is initiated
off-member-exchange, across both the equity and options markets.\291\
---------------------------------------------------------------------------

\289\ See, e.g., Cboe Letter at 2; ABCV Letter at 3; CTC Letter
at 3; Group One Letter at 1; MMI Letter at 2; PEAK6 Letter at 2.
\290\ These data record 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. See generally FINRA Rule 6800 Series and 17 CFR
242.613.
\291\ See STA Letter at 2.
---------------------------------------------------------------------------

Some commenters also stated that option exchange SROs have
specialized expertise that makes them well suited for effectively
overseeing options trading.\292\ In addition, one commenter stated that
there are existing mechanisms for SROs to coordinate surveillance of
cross-exchange options trading, such as the ISG and its subgroups.\293\
The commenter further stated that the ISG ``provides a nonexclusive
forum for discussions and referrals to occur and/or to coordinate on
matters of joint interest to its members, while preserving each SRO's
independent decision-making and enforcement authority.'' However, with
regard to off-member-exchange activity, which in the case of options
firms, also includes equity trading activity, SRO oversight is based on
RSAs, which are subject to certain limitations. For example, RSAs can
expire or be terminated.\294\
---------------------------------------------------------------------------

\292\ See ABCV Letter at 3; Cboe Letter at 6; FIA PTG Letter at
2. Commenters also stated that options exchanges surveil the
equities trading of their members. However, non-FINRA members
conduct 15 to 17 percent of equity trades off-exchange, instances
where FINRA surveillance is more efficient than exchange SROs. See
supra Table 1.
\293\ See Nasdaq Letter at 3.
\294\ See supra notes 237-238.
---------------------------------------------------------------------------

Some commenters stated that non-FINRA member off-member-exchange
activity is frequently conducted through FINRA member broker-
dealers,\295\ and is therefore already accessible to FINRA
surveillance. However, trading through FINRA members does not confer
direct authority to FINRA over these non-members. This is relevant
given that FINRA stated that it identified non-member firms as
potential respondents in five percent of its 2020 and 2021 market
regulation investigations.\296\ In addition, FINRA stated that ``for
certain products and exchanges, some non-member firm conduct may not
fully be subject to exchange rules that provide for important
protections in connection with the execution of customer orders (e.g.,
not all exchanges have comparable best execution rules).'' \297\
---------------------------------------------------------------------------

\295\ See Cboe Letter at 3; CTC Letter at 5; Group One Letter at
2; PEAK6 Letter at 4.
\296\ See FINRA Letter at 5.
\297\ See id. at 7-8.
---------------------------------------------------------------------------

Non-FINRA member firms that are exempt from the Exchange Act's
Association membership requirement are not required to pay the costs of
Association membership, which might be significant, especially for
firms with substantial trading activity (e.g., they would incur TAF and
other expenses if they chose to join FINRA in response to the
amendments). Fees associated with FINRA membership include the annual
Gross Income Assessment (GIA), the annual personnel assessment, and the
TAF and section 3 fees.\298\ 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.\299\ In particular, transactions in U.S. Treasury securities
are not part of the ``covered securities'' for the purpose of TAF fee.
FINRA members also must pay Transaction Reporting Fees for TRACE
reportable securities, with the exception of U.S. Treasury securities.
---------------------------------------------------------------------------

\298\ See infra section V.C.2.b. for more information on these
fees.
\299\ 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 2022 Re-
proposal, FINRA proposed an amendment that would exempt from the TAF
transactions executed by proprietary trading firms on an exchange of
which the firm is a member. See TAF Amendment, supra note 146.
---------------------------------------------------------------------------

The FINRA section 3 fee is the second of two primary FINRA fees
(the other being TAF) that are assessed upon each transaction by or
through a FINRA member. Under section 31 of the Act,\300\ SROs must pay
transaction fees based 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 a 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.\301\ 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

[[Page 61877]]

includes a member firm counterparty or a member firm acting as clearing
broker for a non-FINRA member firm buy side counterparty. Any broker-
dealer that carries customer accounts is required to be a member of an
Association and thus 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.
---------------------------------------------------------------------------

\300\ 15 U.S.C. 78ee.
\301\ 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 and options exchanges
is competitive. In September 2022 across all exchanges, each equity
security had a registered market maker providing liquidity, and some
had as many as 48 registered market makers. The median equity security
had 4 registered market makers and twenty-five percent of equity
securities had 5 or more registered market makers. Sixty percent of
equity securities have at least two registered market makers and forty
percent had one registered market maker. In addition to these
registered market makers, the Commission believes that other market
participants effectively provide liquidity in equity securities through
their trading activities. In the options market, each exchange had as
many as 24 market makers providing liquidity. The average number of
market makers per options security across exchanges is approximately
5.9. While counting the number of market makers does not necessarily
indicate whether each market maker is an active competitor, it does
provide a good indication as to the number of firms in the business of
providing liquidity, and the Commission believes that many market
makers do actively compete, both with other registered market makers
and market participants generally, 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 in equities,
options, and fixed income markets.\302\ 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.
---------------------------------------------------------------------------

\302\ One commenter agreed that the amendments ``will safeguard
against certain market participants, in this case high-frequency
trading firms, from retaining a competitive advantage in the market
due to outdated regulations.'' See Better Markets Letter at 8.
---------------------------------------------------------------------------

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 5.1% and 5.6% of off-exchange dollar volume in equities
from September 2022 through April 2023. Additionally, nearly 16.8% of
all non-FINRA member equity trading activity occurs in off-exchange
markets. Approximately 5.0% of non-FINRA member options trading
activity involves a non-member exchange. In U.S. Treasury securities
markets, non-FINRA broker-dealer trading activity that is reported by
covered ATSs accounts for 3.67% 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 might have
varying effects on efficiency, competition, and capital formation.
These potential effects are described in this section. The amendments
will likely result in improved efficiency of capital allocation. To the
extent that liquidity provision changes as a result of the amendments,
market efficiency might be impacted. Additionally, the amendments will
have mixed effects on competition to provide liquidity, as current non-
FINRA member firms might 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 achieve compliance with the
amendments in multiple ways, each route might involve changes to firms'
business models. Some non-FINRA member firms might limit their trading
to exchanges of which they are members, and the Commission believes
that some may not trade off-member-exchange other than to comply with
Rule 611 of Regulation NMS or the Options Linkage Plan,\303\ or to
execute the stock leg of a stock-option order.\304\ 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.\305\ 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 at least 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-member-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).\306\ Finally, a non-FINRA
member firm could cease trading securities entirely.
---------------------------------------------------------------------------

\303\ See supra section III.B.1.
\304\ See supra section III.B.2.
\305\ Changes to the exclusion are discussed in section III.B,
supra.
\306\ 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,
options, and fixed income securities markets, particularly for off-
member-exchange liquidity provision.\307\ The Commission believes that
the amendments will result in a more level regulatory playing field
between current FINRA and non-FINRA members, as well as enhanced
oversight and transparency of the markets in which these firms compete.
In response, it is possible that current FINRA member firms might
choose to commit additional capital to liquidity provision when the
trading environment has more uniform regulatory requirements. If this
results in an increased overall commitment of liquidity both to
exchanges and the off-exchange market, there are likely to be 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.
---------------------------------------------------------------------------

\307\ This sentiment was echoed by one commenter who stated that
FINRA registration ``represents a significant barrier to entry'' for
market making firms. See Group One Letter at 3. Some proprietary
trading firms, however, are already members of FINRA. As a result,
FINRA has experience addressing these issues regarding registration
barriers by facilitating new members' registration processes.
Additionally, the rule amendments would provide FINRA and the
Commission with greater visibility into the activities of these
firms.
---------------------------------------------------------------------------

The amendments may result in improved efficiency of capital
allocation

[[Page 61878]]

by the financial industry.\308\ While the Commission acknowledges that
FINRA membership could act as an entry deterrent to new proprietary
trading firms, there are benefits to ensuring a certain level of
oversight for proprietary trading firms. The Commission believes that
the adopted amendments to Rule 15b9-1 are 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 amendments, the Commission believes that the costs are justified by
the benefits of regulatory oversight.
---------------------------------------------------------------------------

\308\ Direct capital formation is the assignment of financial
resources to meet the funding requirements of a profitable capital
project, is in this case, the provision of liquidity to financial
markets.
---------------------------------------------------------------------------

While the amendments might reduce the capital commitment of non-
FINRA member firms to liquidity provision, 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. Additionally, any subsequent removal of
liquidity from the market may improve execution quality on off-exchange
markets.\309\ Some institutional investors transacting in off-exchange
markets might seek institutional investor counterparties and avoid
transacting with proprietary trading firms. To this extent, the removal
of non-FINRA member firm liquidity might be seen as improving liquidity
quality within ATSs by some institutional investors.\310\
---------------------------------------------------------------------------

\309\ Non-FINRA member firms may also reduce their off-exchange
trading outside of ATSs, such as on single-dealer platforms, as part
of an effort to avoid being required to join FINRA. However, non-
FINRA member firms currently 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.
\310\ 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/.
---------------------------------------------------------------------------

It is also possible that reducing the activity of non-FINRA member
firms within ATSs might result in more ATS liquidity if non-FINRA
member firms are acting as net takers of liquidity within these
systems.\311\ 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. If this occurs, it is possible
that this will result in a transfer of volume from off-exchange venues
to exchanges, but it is also possible that overall market trading
volume will diminish if decreased volume from off-exchange trading does
not migrate to exchanges.\312\ The Commission acknowledges that non-
FINRA member firms, in response to the amendments, may become less
willing to compete to provide liquidity off-member-exchange, decreasing
liquidity off-exchange and on exchanges where such firms are not
members. For example, non-FINRA member firms may choose to cease their
off-member-exchange activity rather than join an Association--although
it is likely that firms that trade heavily off-member-exchange may find
it more costly to cease their off-member-exchange activity than to join
an Association.\313\ In addition, non-FINRA member firms that choose to
join an Association may reduce their off-member-exchange trading
because joining an Association would increase variable costs to trade
in the off-member-exchange market, as these trades would incur section
3 and possibly additional fees, although some section 3 fees may
already be passed on from FINRA member firms to non-FINRA member
firms.\314\ An increase in costs would reduce the profitability of off-
member-exchange trading and thus potentially reduce aggregate off-
member-exchange trading.
---------------------------------------------------------------------------

\311\ 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).
\312\ Several commenters expressed concerns that the amendments
would negatively impact market liquidity in this respect. See Cboe
Letter at 7; PEAK6 Letter at 4; ABCV Letter at 3.
\313\ Firms with very low ATS activity are unlikely to directly
connect to an ATS, instead accessing ATSs through a FINRA-member
firm. For firms with very limited off-member-exchange activity,
ceasing off-member-exchange activity is likely to be less costly
than joining an Association. The costs of joining FINRA are
discussed in detail in infra section V.C.2; for firms with very
limited off-member-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-member-
exchange activities that exceed FINRA membership costs, it may be
less costly to join FINRA than to cease their off-member-exchange
activity.
\314\ After the 2015 Proposal and again following the 2022 Re-
proposal, FINRA evaluated 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. FINRA has proposed an amendment that would
exempt from the TAF transactions executed by proprietary trading
firms on an exchange of which the firm is a member. See TAF
Amendment, supra note 146. The Commission's analysis of TAF is based
on the proposed TAF structure as outlined in the FINRA By-Laws,
Schedule A. TAF and section 3 fees are discussed further in section
V.C.2.b, infra. Firms would also face additional fixed costs both to
establish and maintain Association membership; those costs are
discussed in section V.C.2, infra.
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The Commission believes that required membership in an Association,
consistent with section 15(b)(8) of the Act and amended Rule 15b9-1,
could facilitate an appropriate level of oversight. The Commission also
recognizes that the loss of liquidity provision in off-member-exchange
trading might 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 might 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
competition to provide liquidity decreases, investor costs to trade
U.S. Treasury securities could increase.
Several commenters expressed liquidity concerns with regard to
options markets.\315\ One commenter stated that FINRA membership costs

[[Page 61879]]

might have ``the potential for impaired liquidity, especially during
times of market stress.'' \316\ Another commenter indicated that the
FINRA TAF fee structure is disproportionally burdensome for proprietary
trading firms and risks stifling liquidity in options markets.\317\ The
commenter also stated 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.\318\ The Commission, however, believes
that options market liquidity provision will not be impaired even if
these amendments cause options market makers to exit. The Commission
observes that bid-ask spreads have remained consistent since 2015 even
though, over that same period of time, options market makers have
entered and exited the market through varying market conditions.\319\
---------------------------------------------------------------------------

\315\ See, e.g., MMI Letter at 1; ABCV Letter at 3; PEAK6 Letter
at 5.
\316\ See ABCV Letter at 3.
\317\ See PEAK6 Letter at 5. According to the commenter, FINRA
fees are partially based on the number of transactions in order to
provide protection that is proportional to the number of customer
orders of a broker-dealer. This is theoretically at odds with the
business model of proprietary traders, which do not have customers.
For this reason, the commenter asserts that FINRA fees are
``imbalanced,'' i.e., disproportionately costly to proprietary
trading firms relative to the benefits provided by FINRA oversight
of these firms.
\318\ Id.
\319\ See infra note 330 and discussion in infra section V.B.2.
---------------------------------------------------------------------------

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 in response to the amendments might lead to less exchange
liquidity for several reasons. First, non-FINRA member firms that
choose not to join an Association will 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.\320\ Second, non-FINRA member firms that do not join an
Association will no longer be able to access off-member-exchange
liquidity to unwind positions acquired on exchanges, which might reduce
their willingness to provide liquidity on exchanges.\321\ Third, non-
FINRA member firms that choose to join an Association might be subject
to additional variable costs (primarily regulatory fees) on their
exchange-based trading as well as on their off-member-exchange
trading.\322\ These firms might respond by trading less actively on
exchanges. Finally, non-FINRA member firms might 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. Overall, however, the
Commission believes that the amendments will most likely not result in
a disturbance of liquidity provision due to the robust competitive
conditions of the current market landscape.
---------------------------------------------------------------------------

\320\ 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.
\321\ 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 sources, including off-exchange liquidity, were available.
\322\ 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.
---------------------------------------------------------------------------

2. Effect on Competition To Provide Liquidity
The amendments might impact competition to provide liquidity by
increasing the regulatory cost for current non-FINRA member firms. 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.\323\
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' off-exchange securities sales. There are indirect costs of
disparate regulatory regimes as well.\324\ Under the amendments current
non-FINRA members that choose to join FINRA will 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 might change competitive forces in the market for
providing liquidity as the current non-FINRA member broker-dealers have
lower regulatory costs, which might make it less costly for non-FINRA
member broker-dealers to provide liquidity.\325\ To the extent that
non-FINRA member firms do have lower costs for providing liquidity than
FINRA member firms, the amendments might eliminate such an advantage,
and lead to a reduction in liquidity provided by current non-FINRA
member firms.
---------------------------------------------------------------------------

\323\ 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 might be lower than a broker-dealer that
cannot or does not avoid FINRA membership. The Commission believes
that many non-FINRA member firms would retain their exchange
membership when the 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 its membership on exchanges where it no longer wishes to trade
after joining FINRA, because maintaining exchange memberships is
costly and firms are unlikely to maintain membership on exchanges
where they do not plan to have activity. See infra section V.C.2,
for more information on the fees associated with FINRA membership.
\324\ See section V.C.2.f, infra.
\325\ See section V.B.1, supra for discussion of competitive
effects and investor costs.
---------------------------------------------------------------------------

However, to the extent that these negative effects on liquidity
occur, the Commission believes they will be minor in light of several
factors. First, while non-FINRA members have been able to avoid direct
costs associated with Association membership, in reality, they may have
already been bearing a portion of these costs, as FINRA member firms
may pass through their fees to non-FINRA member counterparties. In
addition, following the implementation of the amendments, current FINRA
members will be operating on a more level regulatory cost playing
field, which may expand their own provision of liquidity and perhaps
balance out any reduction in liquidity from current non-FINRA members.
Finally, the provision of liquidity appears to be somewhat resilient to
changing market conditions, and more specifically, appears to have been
unaffected by the exit of numerous non-member firms since the 2015
Proposal, as discussed below.
Several commenters expressed concern about decreased competition
among options market makers.\326\ One commenter specifically noted that
``[s]maller options market makers may not have the economies of scale
to

[[Page 61880]]

adequately absorb [FINRA registration] costs, which could lead to
consolidation and decreased competition.'' \327\ On the other hand,
another commenter suggested that the amendments might increase
competition and that they ``will safeguard against certain market
participants, in this case high frequency trading firms, from retaining
a competitive advantage in the market due to outdated regulations.''
\328\
---------------------------------------------------------------------------

\326\ See ABCV Letter at 3-4; Cboe Letter at 7; Group One Letter
at 3; Nasdaq Letter at 3.
\327\ See Cboe Letter at 7.
\328\ See Better Markets Letter at 8.
---------------------------------------------------------------------------

Despite a recent decline in the number of non-FINRA member options
liquidity providers, the Commission does not believe that the
amendments will negatively impact options market liquidity provision.
Since the 2015 Proposal, the number of non-FINRA member firms has
declined from 125 to 64. One commenter pointed out that while some non-
members may have since become FINRA members or have been acquired by
other market makers, most of the decline in option market making non-
members are firms that have ceased trading securities.\329\ However,
despite this decline in the number of firms, options market liquidity
has remained robust. One academic study shows that options bid-ask
spreads have remained flat since 2015.\330\ NYSE Data Insights
similarly suggests that options quoted spreads have remained flat or
slightly declined in recent years as overall option trading volumes
have continued to hit record highs.\331\ While a decrease in the number
of competitors can lead to a decline in competition, these data do not
appear to suggest that options market liquidity conditions have
weakened with the increased industry consolidation.
---------------------------------------------------------------------------

\329\ See STA Letter at 3-4.
\330\ See Figure 1 of Jefferson Duarte, et al., Very Noisy
Option Prices and Inferences Regarding the Volatility Premium, J.
Fin., Forthcoming.
\331\ See NYSE Data Insights, 2021 Options Year in Review,
available at https://www.nyse.com/data-insights/2021-options-year-in-review.
---------------------------------------------------------------------------

The Commission does not believe that the costs imposed by these
amendments will be large enough to undermine options market liquidity
provision or the overall degree of competition in the market. The
Commission cannot rule out the possibility, however, that the addition
of FINRA costs will serve as catalyst for one or more small non-member
options market makers to exit the market,\332\ although FINRA's
exemption of TAF fees for non-member firms,\333\ which several
commenters supported, should reduce the likelihood that firms will
choose to exit in response to the rule. To the extent that options
market makers exit, competition to provide liquidity in options markets
may be adversely impacted.
---------------------------------------------------------------------------

\332\ These broker-dealers could also choose to remain exempt by
joining any remaining exchanges on which they currently trade but
are not members. Additionally, they could remain exempt by retaining
their current exchange memberships and only discontinue trading on
the exchanges for which they currently do not carry membership.
\333\ The TAF exemption will be for trading on exchanges at
which the proprietary firm is a member. See supra note 162 and
accompanying text.
---------------------------------------------------------------------------

The impact on equity liquidity due to non-FINRA members joining
FINRA in response to the amendments is uncertain. 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.\334\ 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.
---------------------------------------------------------------------------

\334\ 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.\335\ It is possible,
however, for new Associations to enter the regulatory oversight market
and compete with FINRA. The amendments to Rule 15b9-1 might 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 might
consider forming 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 might 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.
---------------------------------------------------------------------------

\335\ 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.\336\ 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.\337\ 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.\338\ 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.\339\
---------------------------------------------------------------------------

\336\ See 15 U.S.C. 78o-3.
\337\ 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.''
\338\ See 15 U.S.C. 78o-3(b)(11).
\339\ See 15 U.S.C. 78o-3(b)(2).
---------------------------------------------------------------------------

The ability to form an Association is characterized by barriers to
entry. The amendments include a 365-day implementation period, which
might provide a significant time constraint to form a new Association.
A new

[[Page 61881]]

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
might also incur substantial costs, including personnel, training,
travel, and other costs to provide for effective surveillance and
supervision of the off-exchange equity, cross-exchange options, and
U.S. Treasury securities markets. Indeed, the only existing
Association, FINRA, has resources that enable it to surveil and oversee
the off-exchange market.\340\ 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.\341\
---------------------------------------------------------------------------

\340\ See supra note 9.
\341\ See CAT NMS Plan Approval Order, supra note 15, 81 FR
84836-39, for a discussion on the benefits provided by CAT with
regard to surveillance by SROs.
---------------------------------------------------------------------------

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 will
have incentives to reduce fees to attract members. This might result in
cost savings to brokers and dealers. Second, a new Association might
innovate to develop different surveillance and supervision methods that
could be more efficient than FINRA's methods.
Competition among Associations might also entail substantial costs.
If the market for Associations is characterized by economies of scale,
aggregate costs for the same level of regulation might 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.'' \342\ Furthermore, some of
the benefits of the amendments will be diminished if current non-FINRA
member firms created a new Association as opposed to joining FINRA. For
example, the new Association will not have the experience or expertise
of FINRA in overseeing off-member-exchange market activity.
Additionally, the members of a new Association will not be required to
report their U.S. Treasury securities market trading activity to TRACE
if they are not FINRA members.
---------------------------------------------------------------------------

\342\ See sections 19(g) and (h) of the Exchange Act, 15 U.S.C.
78s(g) and (h).
---------------------------------------------------------------------------

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. 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 might 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 FINRA, a new Association might face
increased difficulties attracting members in the future. If the new
Association is introduced after implementation of the rule, these
stated effects might become more likely as the current non-FINRA member
firms would have already joined FINRA. 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
might lower the costs of forming an Association and alter the barriers
to entry.\343\
---------------------------------------------------------------------------

\343\ Some limitations on Association membership or operations
would require exemptive relief for the Association to register with
the Commission.
---------------------------------------------------------------------------

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 the amendments for a number of reasons.
The overall benefits of the amendments relate to more stable and
uniform surveillance of off-member-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 will 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-member-exchange
market. Consequently, compliance costs will 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 will 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.\344\ At the other end of the
spectrum, the minority of non-FINRA member firms that are large and
contribute significantly to both member exchange and off-member-
exchange trading are unlikely to remain exempt.\345\ For the 64 non-
FINRA member firms, the Commission believes that most will lose their
exempt status, and, while most firms will likely join FINRA, some firms
may seek other ways to comply with the amendments (e.g., remaining
exempt by expanding their exchange memberships to cover all of the
exchanges on which they currently trade or reducing their trading
activity to the exchanges on which they currently trade).\346\
---------------------------------------------------------------------------

\344\ Non-FINRA member firms that provide liquidity on multiple
exchanges and trade heavily off-member-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 V.A.1, many
non-FINRA member firms are members of a single exchange. Such firms
are more likely to have limited exposure to off-member-exchange
markets. Such firms will 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-member-exchange trading
related to their exchange-based brokerage activities.
\345\ The diversity of non-FINRA member firms is discussed in
supra section V.A.1.
\346\ See supra section V.B.1., which discusses how firms might
change their business models in response to the rule.

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[[Page 61882]]

1. Benefits
As discussed above,\347\ some of the firms relying on the Rule
15b9-1 exemption are significant participants in both on and off-
member-exchange markets.\348\ For example, in September of 2022, $440
billion in listed equities was traded off-exchange by non-FINRA member
firms, and $311 billion in listed equities was traded on an exchange to
which the firm did not belong.\349\ 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
via CAT, it does not have jurisdiction for firms that are not FINRA
members. Association membership will supplement the existing oversight
of the exchanges, to the extent a firm remains an exchange member, and
provide consistent and ongoing application of rules, which vary between
exchanges. Regarding off-member-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.\350\ As discussed above,\351\ the Commission believes the
inclusion of more non-FINRA member firms in an Association \352\ will
improve such Association's ability to supervise off-member-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.
---------------------------------------------------------------------------

\347\ See supra section I.
\348\ See supra section V.A.1.
\349\ See supra Table 1.
\350\ Exchange SRO rules would continue to apply to broker-
dealer firms that are exchange members and become FINRA members as a
result of the amendments to Rule 15b9-1. The Commission believes
that Rule 17d-1 DEA designations and Rule 17d-2 plans will likely be
utilized in areas of overlapping rules to mitigate duplicative
application of exchange SRO and FINRA oversight, in the same fashion
as they already are utilized for the many broker-dealer firms that
are exchange members and FINRA members.
\351\ See supra section I.
\352\ This discussion presumes that the most likely response by
non-members to the amendments will be to join FINRA, rather than
choosing another option, such as remaining exempt from Association
membership by joining every exchange on which the broker-dealer
trades, ceasing trading operations, or forming a new Association.
---------------------------------------------------------------------------

Some commenters expressed concern that there are no clear benefits
resulting from the amendments because they believe that exchange SROs
provide sufficient regulatory functions.\353\ The Commission, however,
believes that the amendments to Rule 15b9-1 would improve supervision
of non-FINRA member firms by leveraging FINRA's experience and
investigative tools, particularly those targeted at off-member-exchange
markets. FINRA, currently the only Association, has considerable
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. FINRA stated that
``[d]irect FINRA jurisdiction would yield a number of benefits
including ensuring that PTFs are subject to FINRA rules and providing
for more consistent regulatory treatment across entities engaging in
similar trading activity, which would result in more thorough oversight
and stronger cross-market and cross-product surveillance.'' \354\
---------------------------------------------------------------------------

\353\ See, e.g., ABCV Letter at 2; Cboe Letter at 7; FIA PTG
Letter at 2; Group One Letter at 1; MMI Letter at 3; Nasdaq Letter
at 4.
\354\ See FINRA Letter at 7.
---------------------------------------------------------------------------

In addition, the amendments, as adopted, would enhance the
supervision and enforcement for equities and options beyond the
benefits from the CAT NMS Plan.\355\ While CAT improves data
accessibility for all SROs, it does not address FINRA's lack of
jurisdiction over non-FINRA member firms with off-member-exchange
trading activity. Several commenters 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 of off-member-exchange trading
activity.\356\ However, FINRA stated that even with non-FINRA member
firm trading activity information, ``FINRA does not have the
independent ability to examine for, investigate, or enforce potential
violations of the federal securities laws or FINRA rules with respect
to non-member firms it identifies through surveillance or other
means.'' \357\ 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
amendments would provide such jurisdiction, thereby leading to expanded
supervision and enforcement of existing FINRA rules and
regulations.\358\ In particular, off-member-exchange trading by current
non-FINRA members will receive more efficient oversight following
implementation of the amendments.\359\
---------------------------------------------------------------------------

\355\ See CAT NMS Approval Order, supra note 341.
\356\ See, e.g., Cboe Letter at 2; ABCV Letter at 3; CTC Letter
at 3; Group One Letter at 1; PEAK6 Letter at 2; STA Letter at 2.
\357\ See FINRA Letter at 6. FINRA also stated that it
identified non-member firms as potential respondents in five percent
of its market regulation investigations conducted in 2020 and 2021.
\358\ See supra section III.A.
\359\ Currently, oversight of off-member exchange trading is
coordinated through RSAs, which are subject to certain limitations.
See supra note 294.
---------------------------------------------------------------------------

Some commenters stated that Association membership should not be
mandated for options market makers because FINRA regulation is focused
on protecting customers and options market makers do not carry customer
accounts.\360\ However, non-FINRA member firms play a significant role
in the execution of retail customer orders routed to them by
introducing broker-dealers. Commission data indicate that two of the
three largest options consolidators, which handled approximately 43% of
wholesaled retail customer options orders in 2022, are presently not
FINRA members.\361\ Further, FINRA stated that ``for certain products
and exchanges, some non-member firm conduct may not fully be subject to
exchange rules that provide for important protections in connection
with the execution of customer orders (e.g., not all exchanges have
comparable best execution rules).'' \362\
---------------------------------------------------------------------------

\360\ See, e.g., ABCV Letter at 2; PEAK6 Letter at 2; Group One
Letter at 1-2; STA Letter at 3-4.
\361\ Based on 2022 filings under 17 CFR 242.606 (``Rule 606'').
\362\ See FINRA Letter at 7-8.
---------------------------------------------------------------------------

Commenters also stated that FINRA membership was unwarranted for
options market makers since off-member-exchange trading represents only
a very small share of the overall trading activity of these firms.\363\
However, Commission analysis reveals that the overall level of off-
member-exchange options activity by non-FINRA member firms involves
non-trivial trading volume, exceeding $130 million per day, and
therefore warrants Association oversight or exemption via mandated
membership on all exchanges on which the broker-dealer trades.\364\ In
addition, options market makers

[[Page 61883]]

comprise the majority of the twelve non-FINRA firms among which off-
exchange equity volume is concentrated. Therefore, mandating
Association membership for non-FINRA member options market makers will
also result in enhanced oversight of the off-exchange equity trading of
these firms, which is currently covered by RSAs.
---------------------------------------------------------------------------

\363\ See Nasdaq Letter at 3; PEAK6 Letter at 2.
\364\ See supra note 269.
---------------------------------------------------------------------------

Some commenters stated that off-member-exchange activity was
frequently carried out for general hedging purposes, which, they
stated, is trading activity that does not justify mandatory FINRA
oversight and its associated costs,\365\ especially if this activity
serves to facilitate options market making.\366\ While the Commission
is cognizant of the critical role played by market makers, it
nevertheless believes that such trading activity is not immune to
violative behavior and therefore does not justify exemption from the
amendments.\367\
---------------------------------------------------------------------------

\365\ See Cboe Letter at 3; Nasdaq Letter at 4; CTC Letter at 5;
PEAK6 Letter at 4.
\366\ See Cboe Letter at 3; ABCV Letter at 4, PEAK6 Letter at 4.
\367\ One commenter stated that a general hedging exemption
would ``increase fraudulent activity in the market by obfuscating
risk activities in the options market.'' See letter from Cullin
Coyle (Oct. 31, 2022).
---------------------------------------------------------------------------

The benefits of the adopted amendments will 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 are
likely to be required to become FINRA members as a result of the
amendments.\368\ If these broker-dealers become FINRA members, they
will be required to comply with FINRA rules, including TRACE reporting
requirements. This will have a positive impact on market quality by
increasing coverage of data reported to TRACE for trades not occurring
on a covered ATS.\369\ The amendments will also provide additional
market oversight by bringing non-FINRA member trading in the Treasury
markets under FINRA jurisdiction.\370\ 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.\371\ Thus, the amendments will improve the quality
and complete the coverage of TRACE data to include all non-FINRA member
firm transactions and increase regulatory transparency into the U.S.
Treasury securities markets.\372\ One commenter suggested that current
TRACE reporting captures effectively all non-FINRA member U.S. Treasury
securities transactions and that no present gap in U.S. Treasury
securities transaction reporting exists.\373\ The Commission believes
that, while the majority of U.S. Treasury securities transactions are
already reported to TRACE,\374\ there are coverage gaps--even as the
Commission cannot estimate the actual amount of U.S. Treasury
securities trading activity not currently reported to TRACE.\375\
---------------------------------------------------------------------------

\368\ The Commission estimates that seven such firms accounted
for $6 trillion in U.S. Treasury securities volume executed on
covered ATSs in 2022 that was reported to TRACE, which was more than
3.67% of the total U.S. Treasury securities volume traded in 2022
that was reported to TRACE, and that five such firms' U.S. Treasury
securities volume executed on covered ATSs in Apr. 2023 that was
reported to TRACE accounted for approximately 2.65% of total U.S.
Treasury securities volume in Apr. 2023 that was reported to TRACE.
See supra section II.B.
\369\ Or trades not involving certain depository institutions,
which are mandated to report U.S. Treasury securities trades to
TRACE. See supra note 123.
\370\ FINRA agreed that the benefits of additional U.S. Treasury
securities market oversight are likely to be substantial and
reported that non-FINRA member broker-dealer firms and non-broker-
dealer firms were identified in 17% of the FINRA surveillance alerts
generated by its Treasuries manipulation patterns in 2020 and 2021.
See FINRA Letter at 10; see also supra note 119.
\371\ FINRA stated that ``non-member firms' activity accounts
for a very significant portion of trading in Treasuries
securities.'' See FINRA Letter at 9.
\372\ One commenter stated that the amendments ``will help to
enhance transparency in the Treasury markets by increasing the
percentage of transactions being reported to the TRACE reporting
system.'' See Better Markets Letter at 10.
\373\ See FIA PTG Letter at 3. The commenter also stated that to
the extent that any reporting gaps in U.S. Treasuries exist, it
would be preferable to implement a more targeted solution requiring
non-members to report these transactions via account ownership
identifiers rather than mandating FINRA membership. See FIA PTG
Letter at 3.
\374\ See id.
\375\ See supra note 55.
---------------------------------------------------------------------------

The Commission believes that the amendments could provide more
substantial benefits to the market for other TRACE-reported (e.g., non-
U.S. Treasury securities fixed income) securities, since transactions
by non-FINRA members in these securities are completely hidden from
FINRA oversight.\376\ Moreover, unlike U.S. Treasury securities,
transactions data on several non-U.S. Treasury TRACE-reported
securities, including corporate bonds and agency debt securities, are
disseminated immediately to the public.\377\ This immediate
dissemination has allowed non-FINRA member firms to observe other
firms' anonymized trades in non-U.S. Treasury fixed income securities
\378\ without facing the burden of reporting their own trades,
potentially providing non-FINRA members a competitive advantage, the
cost of which is borne by the investing public through reduced price
discovery. Therefore, an increase in FINRA membership due to the
amendments could be particularly beneficial to the transparency of
these markets, although the trading volume in these securities by non-
FINRA members, and thus the full extent of these benefits, remains
uncertain since non-FINRA members do not have to report their trades in
these securities.
---------------------------------------------------------------------------

\376\ See supra section V.A.1. Non-U.S. Treasury fixed income
securities that are TRACE-reported include corporate debt, agency
debt, and asset backed securities (such as student and auto loans).
See FINRA, Frequently Asked Questions (FAQ) about the Trade
Reporting and Compliance Engine (TRACE), available at https://www.finra.org/filing-reporting/trace/faq#Reporting. In May 2023,
average daily trading volume reported to TRACE for non-convertible
corporate debt was $39.9 billion; agency debt, $3.7 billion; asset
back securities, $1.2 billion. See FINRA, TRACE Volume Reports--
Total Trades, available at https://www.finra.org/finra-data/browse-catalog/trace-volume-reports/trace-volume-total-trades. These are
predominantly over-the-counter markets. For example, for information
about corporate bond trading see Maureen O'Hara and Xing (Alex) Zhou
Corporate Bond Trading: Finding the Customers' Yachts J. Portfolio
Management (2022). For a recent study on fixed income markets, see
Understanding Fixed Income Markets in 2023 available at https://www.sifma.org/resources/research/understanding-fixed-income-markets-in-2023/.
\377\ See supra note 259 for information on the difference
between the dissemination of TRACE for U.S. Treasury securities and
TRACE for other TRACE eligible securities. See also FINRA, TRACE
Reporting Timeframes and Transparency Protocols, available at
https://www.finra.org/filing-reporting/trade-reporting-and-compliance-engine-trace/trace-reporting-timeframes.
\378\ FINRA publishes aggregate TRACE U.S. Treasury security
data. See About TRACE Treasury Aggregate Statistics, available at
https://www.finra.org/filing-reporting/trace/data/trace-treasury-aggregates/about.
---------------------------------------------------------------------------

While current members of an Association would not be directly
affected by this rule, they will benefit by having a more level playing
field in reporting trades in the U.S. Treasury securities markets. With
more uniform regulatory requirements, firms might compete more
equitably to supply liquidity both on exchanges and in the off-exchange
market.
Two commenters raised concerns about exchanges acting as SROs and
potential conflict of interest in regulating effectively versus
catering to the exchange's customers.\379\ In this scenario, switching
from exchange SROs to FINRA serving as DEA should reduce concerns held
by these commenters regarding conflict of interest.
---------------------------------------------------------------------------

\379\ See letters from: Joseph Crowe (Aug. 12, 2022) and Joe
Edwards (Aug. 12, 2022).
---------------------------------------------------------------------------

Although fewer firms will be able to rely on the narrower
exemptions, the narrower exemptions will continue to provide the
existing benefits for non-FINRA members as well as other market

[[Page 61884]]

participants. These exemptions will continue to provide the current
cost savings for non-FINRA members as they will continue to not be
required to join FINRA and thus avoid the costs of doing so.
Additionally, the routing exemption will facilitate regulatory
compliance designed to improve market quality.\380\ The Commission also
believes that the stock-option order exemption will facilitate
liquidity in both stock and options markets, which is likely to improve
market quality.\381\
---------------------------------------------------------------------------

\380\ See supra section III.B.1 for more information on the
purpose of the routing exemption.
\381\ See supra section III.B.2 for more information on the
stock-option 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) of the Exchange Act 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 might
incur costs related to membership in an Association or costs
necessitated by additional exchange memberships. Additionally, some
non-FINRA member firms might incur the costs of losing the benefits of
trading in the off-member-exchange market if they decide not to join an
Association. There might also be indirect costs associated with the
amendments, depending on whether 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, some non-FINRA member firms might
comply by ceasing their off-member-exchange trading activity, avoiding
many of these costs but forgoing the opportunity to trade profitably in
some venues. The Commission estimates that, if all 12 of the non-FINRA
member firms that had the most significant off-member-exchange trading
volume in equities in April 2023 were to join FINRA, the median initial
cost \382\ of the amendments for these firms would be about $95,000 and
the median ongoing annual costs would be about $1.07 million. The
Commission estimates that, if all 64 non-FINRA member firms as of April
2023 were to join FINRA, the median initial costs would be about
$95,000 and median ongoing annual costs would be about $103,416.\383\
Some commenters stated that the costs of FINRA registration are
substantial and are likely to have a profound economic impact on small
non-FINRA member firms.\384\ While the Commission agrees that the costs
of FINRA membership are significant, the aggregate costs for the subset
of 12 largest non-FINRA member firms represent the majority
(approximately 76%) of the aggregate ongoing costs potentially stemming
from the amendments, and these large non-member firms are more readily
able to bear such costs through economies of scale and greater economic
profits. The Commission believes that smaller non-FINRA member firms as
well as new entrants will experience much lower costs. In particular,
the initial costs for such firms will be close to the lower estimates
discussed below, because these costs are largely dependent on the size
and complexity of the firms. Additionally, because smaller firms and
new entrants have lower trading activity, the ongoing costs will also
be significantly lower as ongoing costs are highly impacted by said
trading activity. Finally, any non-FINRA member could choose to avoid
these costs and remain exempt from Association membership by joining
all exchanges on which they trade but do not currently carry
membership.
---------------------------------------------------------------------------

\382\ Initial costs include the FINRA membership application fee
and fees associated with employing outside counsel to assist with
the application, See Table 3, infra.
\383\ See Table 3 and Table 4, infra, for a breakdown of these
costs. The Commission estimates that the total aggregate initial and
ongoing annual cost of the amendments across the 12 largest non-
FINRA member firms (all 64 non-FINRA member firms) is approximately
$31 million ($45 million), not inclusive of potential TRACE
reporting costs set forth in section V.C.2.c, infra. Firms with no
trading volume in April 2023 are included in these estimates. See
supra section II.B. They are unlikely to join FINRA because
generally firms that do not effect transactions in, or induce or
attempt to induce the purchase or sale of, any security other than
transactions they effect in securities solely on a national
securities exchange of which they are members are not required to
join FINRA under section 15(b)(8) of the Act. Therefore, these firms
are less likely to incur initial and/or ongoing FINRA membership
costs, and by including them in the costs estimates, the Commission
likely has overestimated significantly the total initial and ongoing
annual costs.
\384\ See, e.g., Nasdaq Letter at 4; Cboe Letter at 7.
---------------------------------------------------------------------------

a. Costs of Joining an Association
Based on discussions with FINRA,\385\ 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).
---------------------------------------------------------------------------

\385\ See also 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.\386\ 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.\387\
Based on its knowledge of the size and business models of non-FINRA
member firms, the Commission believes that the median application fee
would be $12,500 and that most non-FINRA member firms would not incur
FINRA application fees exceeding $20,000.\388\
---------------------------------------------------------------------------

\386\ See FINRA By-Laws, Schedule A, section 4.
\387\ Id.
\388\ Based on 2022 FOCUS data, no non-FINRA member firm has
more than 150 registered representatives. FINRA stated that ``FINRA
believes that most non-member firms would not incur application fees
exceeding $12,500.'' See FINRA Letter at 12.
---------------------------------------------------------------------------

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 might 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 will 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 or the
Commission. 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. FINRA stated in a comment
letter that ``FINRA anticipates being able to process most of these new
membership applications pursuant to the expedited process within 60
days after submission of the application.'' \389\ Factors affecting the
specific costs and anticipated timeframe

[[Page 61885]]

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.
---------------------------------------------------------------------------

\389\ See id. at 12-13.

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 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.\390\
---------------------------------------------------------------------------

\390\ There are additional fees associated with maintaining a
FINRA membership (e.g., CAT fees). 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 V.C.2.d. These
additional fees are not quantified since their estimation requires
unavailable specialized firm data. Nonetheless, the Commission
believes that the fees specified in Table 4 represent the vast
majority of ongoing FINRA membership costs.
---------------------------------------------------------------------------

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 estimates apply primarily to the 12
non-FINRA member firms that have significant off-member-exchange
trading activities in equities; smaller firms will 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. However,
non-FINRA member firms may already indirectly bear some of these costs,
as they may be passed through by FINRA member counterparties or
executing brokers. Ongoing annual cost estimates are broken down in
Table 4.
The annual GIA generally requires members to pay a percentage of
the member firm's total annual revenue based on a graduated scale.\391\
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.\392\ Based on 2022 FOCUS Form data from the 12
aforementioned non-FINRA member firms, the Commission has determined
that the average annual total revenue of non-FINRA member firms is
approximately $1.2 billion, with a median of $491 million.\393\ FINRA's
graduated GIA scale results in a median GIA of $327,870 for the 12
large non-FINRA member firms and a median GIA of $33,655.65 for all 64
non-FINRA member firms as of April 2023.\394\
---------------------------------------------------------------------------

\391\ See FINRA By-Laws, Schedule A. For example, FINRA imposes
a 2023 GIA as follows: (1) $1,200 on a member firm's annual gross
revenue up to $1 million; (2) a charge of 0.1511% on a member firm's
annual gross revenue between $1 million and $25 million; (3) a
charge of 0.3232% 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.
\392\ See FINRA By-Laws, Schedule A, section 2. See also FOCUS
Report Form X-17A-5, Part II and IIA.
\393\ Based on 2022 Quarterly Part II/IIA FOCUS data.
\394\ ($1,200 for the first $1 million of revenue) + (0.1511% x
annual revenue greater than $1 million up to $25 million) + (0.3232%
x annual revenue greater than $25 million up to $50 million) +
(0.0644% of annual revenue greater than $50 million up top $100
million) + (0.0454% of annual revenue greater than $100 million to
$5 billion) + (0.0494% of annual revenue greater than $5 billion up
to $25 billion) + (0.1063% 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 remaining smaller non-FINRA member firms. See FINRA By-Laws,
Schedule A, section 1(c). The total ongoing annual GIA cost for the
12 largest non-FINRA member firms (all 64 non-FINRA member firms) is
approximately $8 million ($11.5 million).
---------------------------------------------------------------------------

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.\395\ The Commission estimates that off-member-exchange equity and
options trading by the 12 large non-FINRA member firms would generate a
median incurred TAF of around $119,255.85 with an average TAF of
$304,994.44.\396\ The Commission believes that the TAF for non-FINRA
member firms not among the 12 identified large non-FINRA member firms
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.\397\ Specifically, the Commission estimates that the median
(average) annual TAF for all 64 non-FINRA member firms would be
$6,746.92 ($68,433.18).\398\
---------------------------------------------------------------------------

\395\ See FINRA By-Laws, Schedule A, section 1(b).
\396\ Insofar as options trading is concerned, the estimated TAF
includes trading activity on an exchange where a firm is not a
member. If a firm's equity or options trading activity is on an
exchange where it is a member, it does not incur the TAF, and if a
firm's activity is on an exchange where it is not a member the
activity incurs the TAF unless it is covered by an exemption in
FINRA's By-Laws. See infra note 403 and accompanying test; see also
FINRA By-Laws, Schedule A, section (1)(b)(2)(F). The Commission does
not have information on what proportion of non-FINRA member firm
activity on any exchange where such a firm is not a member would
qualify for exemption from the TAF under FINRA By-Laws. To the
extent that such activity would qualify for a TAF exemption, the TAF
estimates set forth herein may overestimate the actual TAF that
firms would incur if they join FINRA. In addition, firms that join
FINRA may be able to reduce their TAF cost by joining additional
exchanges. Estimates of the TAF are based on the off-member-exchange
sell volume reported to CAT for non-FINRA member firms. The
estimated TAF is equal to estimated off-exchange equity sell volume
x $0.000145 and options contract volume x $0.00244. The $0 minimum
is associated with firms that have almost no off-member-exchange
volume.
\397\ See supra section III.A.
\398\ The total ongoing annual TAF cost for the 12 largest non-
FINRA member firms (all 64 non-FINRA member firms) is approximately
$3.7 million ($4.4 million).
---------------------------------------------------------------------------

Some off-member-exchange trading by non-FINRA member firms may no
longer be profitable when TAF is incurred. Several commenters expressed
concerns that TAF costs would be significant.\399\ Consequently, non-
FINRA member firms may reduce their trading both on exchanges and off-
exchange after joining an Association.\400\ 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 Rule 15b9-1. FINRA re-opened the comment period on
its Regulatory Notice in December 2022, after the 2022 Re-
Proposal.\401\ And in June 2023, FINRA filed its TAF Amendment.\402\
FINRA's TAF Amendment will exempt proprietary trading firms when they
trade securities on exchanges of which they are a member, which several

[[Page 61886]]

commenters supported.\403\ This change to the TAF will likely lower the
cost for non-FINRA member firms to join an Association.\404\
---------------------------------------------------------------------------

\399\ See, e.g., CTC Letter at 4; FIA PTG Letter at 4; PEAK6
Letter at 4; STA Letter at 4.
\400\ See supra section V.B.1 for more information on how firms
may change their trading practices in response to the rule.
\401\ See supra note 161.
\402\ See supra note 146; see also supra note 162 and
accompanying text.
\403\ See, e.g., MMI Letter at 3; PEAK6 Letter at 4; STA Letter
at 4.
\404\ In the 2015 Proposing Release, supra note 1, 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 ``[t]he potentially most
significant impact from a transaction cost perspective is FINRA's
Trading Activity Fee.'' See FIA PTG at 4. The Commission believes
that proposed changes to TAF fees to exempt on-member-exchange
trading activity might reduce the associated fees by as much as 75%
(95%) for some firms trading in equity (options) markets. Based on
discussions with FINRA, TAF relief could amount to nearly $9 million
for some current non-member firms.
---------------------------------------------------------------------------

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
equities trading during April 2023, the Commission estimated that
section 3 fees incurred by the 12 large non-FINRA member firms due to
their off-exchange trading would have a median incurred section 3 fee
of $564,217.42 annually, with an average incurred section 3 fee of
$1,455,114.27.\405\ The median (average) section 3 fee for all 64 non-
FINRA member firms as of April 2023 is estimated to be $3,013.56
($303,595.36).\406\ 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 or executing broker. 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.\407\
---------------------------------------------------------------------------

\405\ 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 $8.00/$1,000,000. The $8.00/$1,000,000 is the FINRA fee
rate for Fiscal Year 2023. See FINRA By-Laws of the Corporation,
Schedule A to the By-Laws of the Corporation, section 3--Regulatory
Transaction Fee. See also Securities Exchange Act Release No. 96724
(Jan. 23, 2023) and press release, Commission, Fee Rate Advisory #2
for Fiscal Year 2023 (Jan. 23, 2023), available at https://www.sec.gov/news/press-release/2023-15.
\406\ The total ongoing annual section 3 cost for the 12 largest
non-FINRA member firms (all 64 non-FINRA member firms) is
approximately $17.5 million ($19.5 million).
\407\ 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 V.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.\408\ 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.\409\ 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.
---------------------------------------------------------------------------

\408\ Ongoing compliance activities may include core accounting
functions, updating policies and procedures, and updating forms
filed with regulators.
\409\ 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 Personnel Assessment
fee.\410\ The annual Personnel Assessment fee ranges from $160 to $180
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 $2,400, and the median non-FINRA member firm would
incur a Personnel Assessment fee of $0.\411\ The Commission further
estimates that the maximum Personnel Assessment fee incurred by one of
these non-FINRA member firms would be $22,250.
---------------------------------------------------------------------------

\410\ See FINRA By-Laws, Schedule A, section 1(e).
\411\ 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 the
identified largest 12 non-FINRA member firms would be $1,071,344 and
the median ongoing cost for all 64 non-FINRA member firms would be
$103,416. 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. However, FINRA members
currently pay section 3 fees and TAF when transacting on the buy-side
with non-FINRA members. To the extent that these costs are currently
passed on to non-FINRA members, both section 3 fees and TAF are likely
to be overestimated.\412\
---------------------------------------------------------------------------

\412\ Furthermore, to the extent that section 3 fees and TAF are
not currently being passed on to non-members, the implementation of
the amendments will result in a reduction of such fees for current
members transacting on the buy-side that have been paying these fees
in lieu of their non-member counterparties.

Table 4--Median Firm Ongoing Annual Costs \1\
------------------------------------------------------------------------
Median (12
Cost largest non- Median (all non-
member firms) member firms)
------------------------------------------------------------------------
Gross Income Assessment........... $327,870.00 $33,655.65
Trading Activity Fee.............. 119,255.85 6,746.92
Personnel Assessment.............. 0 0
Section 3 Fee..................... 564,217.42 3,013.56
Compliance Work................... 60,000 60,000
-------------------------------------
Total......................... 1,071,344 103,416
------------------------------------------------------------------------
\1\ Non-FINRA members are recognized as of April 2023. See supra note
394 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 410.

[[Page 61887]]

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. 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. Alternatively,
one commenter stated that if FINRA is not assigned as their DEA, then
existing DEA fees paid to an SRO might be duplicative upon joining an
Association.\413\ The Commission acknowledges the possibility of
duplicate DEA fees in these circumstances but believes that Rule 17d-1
could be utilized by FINRA and the exchange SROs to mitigate
duplicative DEA financial responsibility oversight over their common
members and Rule 17d-2 plans could similarly be utilized to mitigate
the potential for duplicative SRO oversight over their common members
in areas other than financial responsibility.\414\
---------------------------------------------------------------------------

\413\ See Group One Letter at 3.
\414\ For example, Rule 17d-1 authorizes the Commission to name
a single SRO as the DEA to examine a common SRO member. 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. See supra section III.A.
---------------------------------------------------------------------------

To the extent that they do not already do so, firms would face
additional costs related to coming into compliance with Association
rules. Additional costs would include actions that are required to
accommodate normal supervision and examination by an Association. The
Commission was not able to estimate these costs, although the costs
would vary among non-FINRA member firms.
Several commenters submitted estimates for the cost of becoming
FINRA members.\415\ In addition, many commenters stated that FINRA fees
would be substantial and constitute a considerable sum, believing that
FINRA fees would be unduly burdensome and outweigh perceived
benefits.\416\ Several commenters believed in particular that FINRA
membership would be costly to proprietary trading firms with no
customer business.\417\ One commenter stated that the Commission did
not consider other costs associated with FINRA membership, including
opportunity costs associated with FINRA examinations.\418\ The
Commission evaluated the most significant costs of FINRA membership but
acknowledges that being subject to regular examination by FINRA is an
additional cost of FINRA membership. One commenter noted that
additional regulatory costs associated with FINRA membership would be
manageable compared to the cost of the TAF.\419\ As stated above, given
that FINRA has amended the TAF, the ongoing costs could be lower than
prior estimates. However, FINRA fees must be filed with the Commission
and such fees must be consistent with the Exchange Act.
---------------------------------------------------------------------------

\415\ See CTC Letter at 4 (``estimates the one-time costs to
join FINRA, and the ongoing annual compliance costs for FINRA
membership, to each be millions of dollars''), and FIA PTG Letter at
4 (``it is very difficult to estimate the annual cost, but we would
not be surprised if it is greater than $1,000,000 per year for some
firms''). These estimates are higher than those presented by the
Commission in Table 4, in part because these estimates do not
incorporate FINRA's TAF relief amendment. As the estimates in Table
4 are only for the 12 largest non-FINRA member firms, the cost for
the average non-FINRA member firm is expected to be much lower.
\416\ See, e.g., ABCV Letter at 2; Cboe Letter at 7; CTC Letter
at 4; FIA PTG Letter at 4; Group One Letter at 3; Nasdaq Letter at
2; STA Letter at 4; Virtu Letter at 5.
\417\ See, e.g., ABCV Letter at 2; Cboe Letter at 7; CTC Letter
at 4; FIA PTG Letter at 4; Group One Letter at 3; Nasdaq Letter at
3; PEAK6 Letter at 4-5; STA Letter at 4.
\418\ See MMI Letter at 3.
\419\ See FIA PTG Letter at 4.
---------------------------------------------------------------------------

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 will also have implementation and ongoing costs
associated with TRACE reporting. The Commission believes that seven
non-FINRA member firms have had significant trading activities in U.S.
Treasury securities markets and, since they do not presently incur the
costs of reporting U.S. Treasury (or non-U.S. Treasury) securities to
TRACE, may currently have a competitive cost advantage over FINRA
member broker-dealers. The Commission estimates that these non-member
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.\420\ 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 Table 5. The Commission estimates the
cost of third-party reporting to TRACE to be approximately $2,000 per
month.\421\ 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 might 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 are
included in the Commission's estimates above and they will 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 will each incur implementation costs
as described above. The Commission cannot estimate how many firms are
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.\422\
---------------------------------------------------------------------------

\420\ 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.
\421\ See FINRA Rule 7730, available at https://www.finra.org/rules-guidance/rulebooks/finra-rules/7730. Firms may incur
additional fees for trade cancellations or corrections.
\422\ See supra section V.A.1.

Table 5--Average Firm TRACE Reporting Implementation Costs
------------------------------------------------------------------------
Median or
Cost average \1\
------------------------------------------------------------------------
FIX Port Fee............................................... $575
Direct Circuit Connectivity Fee for TRACE Reporting through 1,500
Nasdaq....................................................

[[Page 61888]]

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
Under the amendments, 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 certain off-exchange
activity, some non-FINRA member firms might choose to join additional
exchanges to be excluded from the requirement to become a member of an
Association. Alternatively, these firms might 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. 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 registration costs, non-FINRA member firms
joining additional exchanges as a result of the amendments will 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 will vary depending on the type of access sought
and the exchanges of which non-FINRA member firms choose to become
members.
The exchange membership fees that apply to non-FINRA member firms
joining such exchanges will 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,\423\ they will have already completed a Form U4, to
register associated persons.\424\ Non-FINRA member firms will not need
to register additional associated persons because the exchange SRO
rules already require them to register associated persons. All
exchanges can access the Form U4 filings within the CRD which is
maintained by FINRA.
---------------------------------------------------------------------------

\423\ 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.
\424\ 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.
---------------------------------------------------------------------------

The estimates of the cost of joining additional exchanges are based
on a review of membership-related fee structures of all twenty-four
national securities exchanges. The view that the potential burden of
joining additional exchanges will likely be less than that of joining
FINRA includes the assumption that the costs imposed on non-FINRA
member firms by the amendments will 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 might 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.
The estimates of the cost of joining additional exchanges aggregate
all 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, a range for both the
initial fee and the annual fee across exchanges is obtained. The
initial fee is as low as $0 for some exchanges. Most exchanges have an
initial fee that is greater than $0 and no more than $5,000.\425\
---------------------------------------------------------------------------

\425\ 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 20, 2023) (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 20, 2023) (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_Application_for_Membership.pdf (last visited July 20, 2023)
(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 20, 2023)
(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 20, 2023)
(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'

[[Page 61889]]

ongoing monthly or annual membership fees generally range from $1,500
to $7,200.\426\ Again, these ongoing exchange membership costs are
generally much lower than the annual costs estimated for being a member
of FINRA.
---------------------------------------------------------------------------

\426\ See, e.g., Cboe BYX Exchange, Inc. Fee Schedule (eff. Nov.
1, 2022), available at https://www.cboe.com/us/equities/membership/fee_schedule/byx/ (last visited July 20, 2023) (noting an annual
membership fee of $2,500); Cboe EDGA Exchange, Inc. Fee Schedule
(eff. Nov. 30, 2022), https://www.cboe.com/us/equities/membership/fee_schedule/edga/ (last visited July 20, 2023) (same); NYSE
Chicago, Inc. Fee Schedule (updated Jan. 3, 2023), available at
https://www.nyse.com/publicdocs/nyse/NYSE_Chicago_Fee_Schedule.pdf
(last visited July 20, 2023) (assessing an annual membership fee of
$7,200); MIAX Fee Schedule at 20 (Sept. 1, 2022), available at
https://www.miaxoptions.com/sites/default/files/fee_schedule-files/MIAX_Options_Fee_Schedule_09012022.pdf (last visited July 20, 2023)
(assessing a monthly trading permit fee for an ``Electronic Exchange
Member'' of $1,500).
---------------------------------------------------------------------------

The costs of the amendments associated with joining additional
exchanges are included in the total cost estimates for joining an
Association provided above in this section.\427\ This is because, in
the event that a non-FINRA member firm chooses to join one or more
exchanges and not become a FINRA member, that firm would not incur any
of the costs for joining an Association. The Commission believes that a
firm may make this choice when the costs of joining FINRA exceed the
costs of joining additional exchanges to cover all of the exchanges on
which they currently trade. Consequently, the costs for such firms are
expected to be no higher than the costs they are estimated to incur in
joining FINRA. Thus, all firms will either join FINRA and incur the
costs described above or join one or more exchanges and instead incur
costs no higher than those described above, so that the total
Association costs can be taken as an upper bound on the total costs
over both possibilities.
---------------------------------------------------------------------------

\427\ See supra note 383.
---------------------------------------------------------------------------

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 amendments will require non-FINRA member firms to
establish, maintain, and enforce policies and procedures as discussed
above.\428\ The Commission estimates that firms would incur a burden of
8 hours in initially preparing these policies and procedures.\429\
Furthermore, the burden of maintaining and enforcing such policies and
procedures, including a review of such policies at least annually, will
be approximately 48 hours.\430\ 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.\431\ Firms that
choose to join FINRA will not incur these costs as the exemptions would
not be relevant.
---------------------------------------------------------------------------

\428\ See supra section III.B.2.
\429\ 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
446. 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 447.
\430\ 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 448.
\431\ 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 will 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 $391 billion in off-exchange equity volume
in September 2022, while the remaining non-FINRA member firms executed
$49 billion. The Commission cannot estimate the likelihood of these
firms choosing to cease off-exchange activity rather than joining an
Association. However, given the large volume in off-exchange equity
volume traded by non-FINRA members, the Commission believes that the
probability of non-FINRA members ceasing off-exchange activity is very
small.
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.\432\ Their transactions will have to be routed by an exchange of
which they are a member or routed by a broker-dealer exclusively to
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-dealer may have a
telecommunications infrastructure that is inferior to that of the
broker-dealer that previously provided connectivity between the
exchange and the non-FINRA member firm.\433\
---------------------------------------------------------------------------

\432\ The exemption related to routing to comply with Regulation
NMS and the Options Linkage Plan is discussed in supra section
III.B.1.
\433\ 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 might be limited to firms that trade on
the floor of a national securities exchange. Specifically, the
alternative would provide that a dealer that conducts 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. This alternative also could require a dealer seeking to
rely on this exemption to establish, maintain, and enforce written
policies and procedures

[[Page 61890]]

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.
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.\434\ 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.\435\ 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'').
---------------------------------------------------------------------------

\434\ 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.
\435\ 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. 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 amendments, which
would impose additional costs. In particular, some non-FINRA member
firms that would become member firms under the amendments would also
need to become members of additional exchanges or cease trading on
those exchanges. In addition, some current 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,\436\ the Commission continues to believe that the
magnitude of the de minimis allowance is no longer economically
meaningful.\437\ Furthermore, the

[[Page 61891]]

Commission continues to believe that the commission sharing
arrangements discussed previously \438\ are rarely, if ever, used.
---------------------------------------------------------------------------

\436\ See supra section III.A.
\437\ FINRA agreed that the de minimis exception should be
eliminated in part because ATSs are ``typically interposed between
[non-members] and other ATS subscribers, non-member PTFs can engage
in substantial OTC trading, including with orders from ATS
subscribers or other broker-dealers, without technically triggering
the gross income limitation.'' See FINRA Letter at 3.
\438\ See supra note 33.
---------------------------------------------------------------------------

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 off-member-exchange, as well as investigate potentially
violative behavior.\439\ This improvement in FINRA's abilities may not
be large relative to the adopted amendments due to the fact that the
adopted 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.
---------------------------------------------------------------------------

\439\ One commenter suggested, as an alternative to the
amendments, that the Commission could impose ``a more limited FINRA
membership that would provide for limited oversight covering the
reporting of over-the-counter transactions to FINRA and related
surveillance'' if said exemption were to be eliminated. See Virtu
Letter at 3.
---------------------------------------------------------------------------

5. Mandate TRACE U.S. Treasury Securities Reporting Without Requiring
Association Membership
In order to address the reporting gap within U.S. Treasury
securities trading by non-FINRA members, the Commission could require
that all last sale U.S. Treasury securities transaction data be
reported to and disseminated by TRACE. Some commenters suggested that
this reporting requirement could improve transparency in the U.S.
Treasury securities markets without imposing costs of Association
membership.\440\
---------------------------------------------------------------------------

\440\ See CTC Letter at 3; FIA PTG Letter at 3; Virtu Letter at
2.
---------------------------------------------------------------------------

However, since U.S. Treasury securities trade predominantly off-
exchange, the Commission believes that U.S. Treasury securities markets
will benefit from enhanced regulatory supervision that comes with
Association membership.\441\ FINRA stated that although non-FINRA
member broker-dealers and non-broker-dealer firms were identified in 17
percent of the surveillance alerts generated by FINRA's Treasuries
manipulation patterns in 2020 and 2021, FINRA has no authority to
address any potential market misconduct by non-FINRA members in these
instances.\442\ Accordingly, the Commission agrees that Association
membership will benefit U.S. Treasury securities and other fixed income
markets under these circumstances by providing more effective oversight
relative to the alternative of simply mandating TRACE reporting.
---------------------------------------------------------------------------

\441\ Although most trading in U.S. Treasury securities is
reported to TRACE and therefore surveilled by FINRA, this
surveillance is not equivalent to the more extensive oversight that
FINRA has over its members. Therefore, when FINRA encounters
potentially problematic conduct by firms that are not FINRA members,
its ability to investigate potential violations of, or enforce
compliance with Federal securities laws, Commission rules, or FINRA
rules is limited. See discussion in supra section III.A.
\442\ See FINRA Letter at 10; supra note 119; see also Better
Markets Letter at 7.
---------------------------------------------------------------------------

VI. 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'').\443\ The Commission
requested comment on the collection of information requirements in the
2022 Re-Proposal and submitted relevant information to the Office of
Management and Budget (``OMB'') for review in accordance with the PRA
and its implementing regulations.\444\ 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 OMB control
number. The Commission has received an OMB control number (3235-0743)
for this collection of information. As discussed in section III.B, the
amendments to Rule 15b9-1 require brokers or dealers relying on the
stock-option order exemption to establish, maintain, and enforce
certain written policies and procedures. Compliance with these
collection of information requirements is mandatory for firms relying
on the amended rule. The Commission received no comments on the
estimates for the collection of information requirements included in
the 2022 Re-Proposing Release.
---------------------------------------------------------------------------

\443\ 44 U.S.C. 3501 et seq.
\444\ 44 U.S.C. 3507; 5 CFR 1320.11.
---------------------------------------------------------------------------

A. Summary of Collection of Information

The 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 permits a
qualifying broker or dealer to effect off-member-exchange securities
transactions, 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 are 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 are 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 will
be used by the Commission and SROs to understand how brokers and
dealers relying on the exemption evaluate whether the off-member-
exchange securities transactions that they effect 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 will be used generally by the Commission as part of its
ongoing efforts to examine 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
will rely on the stock-option order exemption. The Commission estimates
that, based on publicly available information reviewed covering the end
of April 2023, there are approximately 64 broker-dealers registered
with the Commission that are members of an exchange but not members of
an Association. The Commission believes that some, but not all, of
these broker-dealers will likely

[[Page 61892]]

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 an exchange where they are a member. The
Commission estimates that 17 firms could potentially rely on the stock-
option order exemption and would therefore be required to comply with
the policies and procedures requirement.\445\ The Commission believes
that some of these 17 firms could want the ability to effect off-
member-exchange securities transactions 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.
---------------------------------------------------------------------------

\445\ 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 will be approximately 8 hours.\446\
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 policies and procedures 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, will be approximately 48 hours for each
broker or dealer.\447\ 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.
---------------------------------------------------------------------------

\446\ 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.
\447\ 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 will be 56 hours per broker or
dealer, which corresponds to an initial aggregate burden of 952
hours.\448\ The Commission estimates that the ongoing annualized burden
associated with Rule 15b9-1 will be 48 hours per broker or dealer,
which corresponds to an ongoing annualized aggregate burden of 816
hours.\449\
---------------------------------------------------------------------------

\448\ This figure is based on the following: ((8 burden hours
per broker or dealer) + (48 burden hours per broker or dealer)) x
(17 brokers and dealers) = 952 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 Securities
Exchange Act Release No. 74244 (Feb. 11, 2015) 80 FR 14564, 14683
(Mar. 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 amended Rule
15b9-1 are much more limited in nature.
\449\ This figure is based on the following: (48 burden hours
per broker or dealer) x (17 brokers and dealers) = 816 ongoing,
annualized aggregate burden hours.
---------------------------------------------------------------------------

E. Collection of Information is Mandatory

All of the collection of information discussed above is 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.\450\
---------------------------------------------------------------------------

\450\ 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 will be required to preserve a copy of their policies
and procedures in a manner consistent with Rule 17a-4 \451\ until three
years after the date the policies and procedures are replaced with
updated policies and procedures.
---------------------------------------------------------------------------

\451\ 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.
---------------------------------------------------------------------------

VII. Regulatory Flexibility Act Certification

The RFA requires that Federal agencies, in promulgating rules,
consider the impact of those rules on small entities.\452\ Section 3(a)
of the RFA requires the Commission to undertake a regulatory
flexibility analysis of the impact of the rule amendments on small
entities unless the Commission certifies that the rule amendments would
not have a significant economic impact on a substantial number of small
entities.\453\ For purposes of Commission rulemaking in connection with
the RFA,\454\ 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 17 CFR 240.17a-5(d)
(``Rule 17a-5(d)''),\455\ 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.\456\
---------------------------------------------------------------------------

\452\ 5 U.S.C. 601 et seq.
\453\ 5 U.S.C. 605(b).
\454\ 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 17 CFR 240.0-10 (Rule 0-10 under the
Exchange Act). See Securities Exchange Act Release No. 18451 (Jan.
28, 1982), 47 FR 5215 (Feb. 4, 1982) (File No. AS-305).
\455\ Rule 17a-5(d) under the Exchange Act.
\456\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

In the 2022 Re-Proposal, after an examination of FOCUS data for the
then-active broker-dealers registered with the Commission, the
Commission certified, pursuant to section 605(b) of the RFA, that
amended Rule 15b9-1 would not, if adopted, have a significant impact on
a substantial number of small entities.\457\ One commenter disagreed
with the Commission's certification, stating that there are 39 non-
FINRA members of Nasdaq exchanges, 13 of which are overseen by Nasdaq
PHLX LLC as the DEA.\458\ The commenter further stated that certain of
those members trade off-exchange and would not be eligible for the re-
proposed exemptions in amended Rule 15b9-1, and that the economic
impact of the rule amendments on these members would

[[Page 61893]]

be significant based on the Commission's estimate of the costs of FINRA
membership.\459\ However, the commenter did not specify whether any of
its 39 non-FINRA members are small entities under RFA standards or
identify those non-FINRA members. Specifically, the commenter did not
assert that any of these non-FINRA members have total capital of less
than $500,000 and are not affiliates of any person (other than a
natural person) that is not a small business or small organization.
---------------------------------------------------------------------------

\457\ See 5 U.S.C. 605(b). See also 2022 Re-Proposal, supra note
1, 87 FR 49972-73.
\458\ See Nasdaq Letter at 4.
\459\ See id.
---------------------------------------------------------------------------

The Commission re-examined recent FOCUS data for the approximately
3,500 active broker-dealers registered with Commission as of April
2023, including the 64 non-FINRA member broker-dealer firms that the
Commission identified as of April 2023.\460\ Based on this re-
examination, the Commission estimates that not more than three of the
non-FINRA member broker-dealer firms have total capital of less than
$500,000 and are not affiliates of any person (other than a natural
person) that is not a small business or small organization and would,
as a result, be considered small entities under RFA standards. These
three small firms could be significantly impacted by the adopted rule
amendments because they could be required to become a member of FINRA
under section 15(b)(8) of the Act, if they effect off-member-exchange
securities transactions and do not qualify for one of the adopted
exemptions.\461\
---------------------------------------------------------------------------

\460\ See supra section II.B.
\461\ See supra section III. The costs of FINRA membership are
discussed in detail section V, supra. In addition, section V.D,
supra, discusses the alternatives considered by the Commission. As
discussed supra in section III.A, these three firms are not among
the 12 largest non-FINRA member broker-dealer firms identified by
the Commission as of April 2023, and so, as discussed in that
section as well as section V.C.2 supra, their initial and ongoing
FINRA membership costs, should they join FINRA, likely would be low,
suggesting that, while they would be significantly impacted if they
are required to join FINRA as a result of the adopted rule
amendments, their trading businesses nevertheless might not be
materially impeded by the costs of FINRA membership.
---------------------------------------------------------------------------

Of the approximately 3,500 broker-dealers registered with the
Commission, 786 qualify as small entities because they have total
capital of less than $500,000 and are not affiliates of any person
(other than a natural person) that is not a small business or small
organization.\462\ Since three of these small broker-dealer entities
were not FINRA members as of April 2023, the Commission estimates that
approximately 783 of these small broker-dealer entities are already
registered with FINRA. The activities of these 783 FINRA member broker-
dealers could be impacted by the amendments to Rule 15b9-1 because the
amendments have changed the terms upon which they could deregister from
FINRA. Specifically, they will not be able to deregister with FINRA
unless they comply with Rule 15b9-1, as amended, which, compared to the
pre-amendment rule, sets forth much narrower grounds upon which a
broker-dealer may be exempt from FINRA membership. Because the
Commission estimates that not more than three small entities will be
significantly impacted by the amendments to Rule 15b9-1, compared to
786 total small entities that could be impacted by the rule amendments,
the Commission does not believe that a substantial number of small
entities will be significantly impacted by the amendments to Rule 15b9-
1. Therefore, the Commission certifies that the amendments to Rule
15b9-1 will not have a significant economic impact on a substantial
number of small entities.
---------------------------------------------------------------------------

\462\ Data from FOCUS for Quarter 2 of 2023.
---------------------------------------------------------------------------

VIII. Other Matters

If any of the provisions of this rule, or the application thereof
to any person or circumstance, is held to be invalid, such invalidity
shall not affect other provisions or application of such provisions to
other persons or circumstances that can be given effect without the
invalid provision or application.
Pursuant to the Congressional Review Act, the Office of Information
and Regulatory Affairs has designated these rules as not a major rule,
as defined by 5 U.S.C. 804(2).

Statutory Authority

The Commission is adopting the final amendments contained in this
release under the authority set forth in 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.

Text of Amendments

For the reasons set out in the preamble, the Commission is amending
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, 78j-4, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o,
78o-4, 78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 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 Sec. 242.611 of this chapter 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 Sec. 240.17a-4
until three years after the date the policies and procedures are
replaced with updated policies and procedures.

By the Commission.

Dated: August 23, 2023.
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-18658 Filed 9-6-23; 8:45 am]
BILLING CODE 8011-01-P

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