Proposed Rule2022-16711
Exemption for Certain Exchange Members
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Published
August 12, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is re- proposing amendments to a rule under the Securities Exchange Act of 1934 ("Act" or "Exchange Act") that exempts certain registered brokers or dealers from membership in a registered national securities association ("Association"). The re-proposed amendments would replace the rule's de minimis allowance, including the exclusion therefrom for proprietary trading, with narrower exemptions from Association membership for any registered broker or dealer that is a member of a national securities exchange, carries no customer accounts, and effects transactions in securities otherwise than on a national securities exchange of which it is a member. The re-proposed amendments would create exemptions for such a registered broker or dealer that effects transactions off an exchange of which it is a member that result solely from orders that are routed by a national securities exchange of which it is a member to comply with order protection regulatory requirements, or are solely for the purpose of executing the stock leg of a stock- option order.
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[Federal Register Volume 87, Number 155 (Friday, August 12, 2022)]
[Proposed Rules]
[Pages 49930-49973]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-16711]
[[Page 49929]]
Vol. 87
Friday,
No. 155
August 12, 2022
Part II
Securities and Exchange Commission
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17 CFR Part 240
Exemption for Certain Exchange Members; Proposed Rule
Federal Register / Vol. 87, No. 155 / Friday, August 12, 2022 /
Proposed Rules
[[Page 49930]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-95388; File No. S7-05-15]
RIN 3235-AN17
Exemption for Certain Exchange Members
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is re-
proposing amendments to a rule under the Securities Exchange Act of
1934 (``Act'' or ``Exchange Act'') that exempts certain registered
brokers or dealers from membership in a registered national securities
association (``Association''). The re-proposed amendments would replace
the rule's de minimis allowance, including the exclusion therefrom for
proprietary trading, with narrower exemptions from Association
membership for any registered broker or dealer that is a member of a
national securities exchange, carries no customer accounts, and effects
transactions in securities otherwise than on a national securities
exchange of which it is a member. The re-proposed amendments would
create exemptions for such a registered broker or dealer that effects
transactions off an exchange of which it is a member that result solely
from orders that are routed by a national securities exchange of which
it is a member to comply with order protection regulatory requirements,
or are solely for the purpose of executing the stock leg of a stock-
option order.
DATES: Comments should be received on or before September 27, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.html">https://www.sec.gov/rules/submitcomments.html</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#5e2c2b323b733d3133333b302a2d1e2d3b3d70393128"><span class="__cf_email__" data-cfemail="453730292068262a2828202b3136053620266b222a33">[email protected]</span></a>. Please include
File Number S7-05-15 on the subject line; or
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-05-15. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>). Comments also are available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Operating conditions may limit access to the
Commission's public reference room. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director,
at (202) 551-5594; David Michehl, Special Counsel, at (202) 551-5627;
Nicholas Shwayri, Special Counsel, at (202) 551-5667; Vince Vuong,
Special Counsel, at (202) 551-3742; or Mark Sater, Attorney-Advisor, at
(202) 551-4729, Division of Trading and Markets, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Background
A. Current Regulatory Framework
B. Need for Amendment
C. 2015 Proposal
III. Discussion of Amendments to Rule 15b9-1
A. Elimination of the De Minimis Allowance and Proprietary
Trading Exclusion
B. Narrowed Criteria for Exemption From Association Membership
1. Routing Exemption
2. Stock-Option Order Exemption
C. No Floor-Member Hedging Exemption
IV. Effective Date and Implementation
V. General Requests for Comments
VI. Economic Analysis
A. Baseline
1. Regulatory Structure and Activity Levels of Non-FINRA Member
Firms
2. Current Market Oversight
3. Current Competition To Provide Liquidity
B. Effects on Efficiency, Competition, and Capital Formation
1. Firm Response and Effects on Market Activity and Efficiency
2. Effect on Competition To Provide Liquidity
3. Competitive Effects on Off-Exchange Market Regulation
C. Consideration of Costs and Benefits
1. Benefits
2. Costs
a. Costs of Joining an Association
b. Cost of Maintaining an Association Membership
c. Costs of TRACE Reporting for Non-FINRA Member Firms That
Trade U.S. Treasury Securities
d. Costs of Joining Additional Exchanges Under the Rule as
Amended
e. Policies and Procedures Related to the Narrowed Criteria for
Exemption From Association Membership
f. Indirect Costs
D. Alternatives
1. Include a Floor Member Hedging Exemption
2. Exchange Membership Alternative
3. Retaining the De Minimis Allowance
4. Eliminate the Rule 15b9-1 Exemption
E. Request for Comment on Economic Analysis
VII. Paperwork Reduction Act
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Initial and Annual Reporting and Recordkeeping Burdens
E. Collection of Information is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
H. Request for Comments
VIII. Consideration of Impact on Economy
IX. Regulatory Flexibility Act Certification
X. Statutory Authority
I. Introduction
Section 15(b)(8) of the Act \1\ prohibits any registered broker or
dealer from effecting transactions in securities unless it is a member
of an Association or effects transactions in securities solely on an
exchange of which it is a member.\2\ Section 15(b)(9) of the Act \3\
provides the Commission with authority to exempt any broker or dealer
from Section 15(b)(8), if that exemption is consistent with the public
interest and the protection of investors. Pursuant to the authority
conferred by Section 15(b)(9), Rule 15b9-1 provides that any broker or
dealer required by Section 15(b)(8) of the Act to become a member of an
Association shall be exempt from such requirement if it is a member of
a national securities exchange, carries no customer accounts, and has
annual
[[Page 49931]]
gross income derived from purchases and sales of securities otherwise
than on a national securities exchange of which it is a member in an
amount no greater than $1,000 (this $1,000 gross income allowance is
referred to herein as the ``de minimis allowance'').\4\ Under Rule
15b9-1, the de minimis allowance does not apply to income derived from
transactions for a registered dealer's own account with or through
another registered broker or dealer (referred to herein as the
``proprietary trading exclusion'').\5\ Accordingly, a registered dealer
can rely on Rule 15b9-1 to remain exempt from Association membership
while engaging in unlimited proprietary trading of securities on any
national securities exchange of which it is not a member or in the off-
exchange market,\6\ so long as it is a member of a national securities
exchange, carries no customer accounts, and its proprietary trading is
conducted with or through another registered broker-dealer.
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\1\ 15 U.S.C. 78o(b)(8).
\2\ Section 15(b)(8) applies to any security other than
commercial paper, bankers' acceptances, or commercial bills. Id.
\3\ 15 U.S.C. 78o(b)(9).
\4\ 17 CFR 240.15b9-1(a).
\5\ 17 CFR 240.15b9-1(b). The current rule also states that the
de minimis allowance does not apply to income derived from
transactions through the Intermarket Trading System, and defines the
term ``Intermarket Trading System'' for purposes of the rule. 17 CFR
240.15b9-1(b)(2) and (c).
\6\ ``Off-exchange'' as used herein means any securities
transaction that is covered by Section 15(b)(8) of the Exchange Act
that is not effected, directly or indirectly, on a national
securities exchange. See 17 CFR 240.600(b)(45) (defining ``national
securities exchange''). Off-exchange trading includes securities
transactions that occur through alternative trading systems
(``ATSs'') or with another broker or dealer that is not a registered
ATS, and is also referred to as over-the-counter (``OTC'') trading.
The Commission previously proposed to amend Rule 15b9-1 in 2015. See
Securities Exchange Act Release No. 74581 (March 25, 2015), 80 FR
18036 (April 2, 2015) (``2015 Proposing Release'' or ``2015
Proposal''). There, the Commission defined the term ``off-exchange''
differently, such that it applied only to transactions in exchange-
listed securities that were not effected, directly or indirectly, on
a national securities exchange. Id. at 80 FR 18037, n. 3. Here, the
definition of ``off-exchange'' encompasses transactions that are not
effected, directly or indirectly, on a national securities exchange
in both exchange-listed securities and securities that are not
listed on a national securities exchange, such as U.S. Treasury
securities and OTC equity securities, in order to more closely align
the definition with the full scope of securities transactions that
are covered by Section 15(b)(8) of the Exchange Act.
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The securities markets have evolved dramatically in the forty-plus
years since the Commission adopted Rule 15b9-1. During that span, the
securities markets have transformed from being floor-based to being
mostly electronic, and registered dealers have emerged that engage in
significant, computer-based, cross-market proprietary trading activity.
Several proprietary trading firms that are registered dealers and
exchange members are not members of an Association, in reliance on Rule
15b9-1. These firms may effect significant securities transaction
volume elsewhere than on an exchange of which they are a member but are
not subject to Association oversight.
Self-regulatory organization (``SRO'') \7\ regulation of each
broker or dealer is dependent upon the broker or dealer's individual
SRO membership status. Each SRO that operates an exchange has
responsibility for overseeing trading that occurs on the exchange it
operates. Because of this, SROs that operate an exchange possess
expertise in supervising members who specialize in trading the products
and utilizing the order types that may be unique or specialized within
the exchange. This expertise complements the expertise of an
Association in supervising its members' cross-exchange and off-exchange
securities trading activity. Indeed, the Exchange Act's statutory
framework places SRO oversight responsibility with an Association for
trading that occurs elsewhere than an exchange to which a broker or
dealer belongs as a member.\8\ Individual exchanges have expertise in
regulating their markets and historically have monitored market
activity specific to their own exchanges or have outsourced that
function to a third party. The Financial Industry Regulatory Authority,
Inc. (``FINRA''), the only Association currently, historically has
overseen cross-exchange and off-exchange securities trading
activity.\9\ But brokers and dealers that are not FINRA members are not
subject to FINRA's rules.\10\
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\7\ An SRO is defined, in relevant part, as ``any national
securities exchange, registered securities association, or
registered clearing agency. . . .'' 15 U.S.C. 78c(a)(26).
\8\ See Sections 15(b)(8), 15A, 17(d), 19(g) of the Act. 15
U.S.C. 78o(b)(8); 15 U.S.C. 78o-3; 15 U.S.C. 78q(d); 15 U.S.C.
78s(g). Under the self-regulatory structure, the SRO where a broker-
dealer is registered conducts regulatory oversight and assumes
responsibility for that oversight. For example, section 19(g)(1) of
the Act, among other things, requires every SRO to examine for and
enforce compliance by its members and associated persons with the
Act, the rules and regulations thereunder, and the SRO's own rules,
unless the SRO is relieved of this responsibility pursuant to
section 17(d) or section 19(g)(2) of the Act. 15 U.S.C. 78q(d); 15
U.S.C. 78s(g). Section 17(d)(1) of the Act provides that the
Commission, in allocating authority among SROs pursuant to Section
17(d)(1), shall ``take into consideration the regulatory
capabilities and procedures of the self-regulatory organizations,
availability of staff, convenience of location, unnecessary
regulatory duplication, and such other factors as the Commission may
consider germane to the protection of investors, cooperation and
coordination among self-regulatory organizations, and the
development of a national market system . . .'' 15 U.S.C. 78q(d)(1).
Section 15A of the Act provides for the creation of national
securities associations of broker-dealers, with powers to adopt and
enforce rules to regulate the off-exchange market. 15 U.S.C. 78o-3.
And as described above, section 15(b)(8) of the Exchange Act further
implements this construct of effective regulatory oversight by
requiring Association membership of a broker-dealer unless it
effects transactions solely on an exchange of which it is a member.
15 U.S.C. 78o(b)(8).
\9\ The National Futures Association (``NFA''), as specified in
section 15A(k) of the Act, also is registered as a national
securities association, but only for the limited purpose of
regulating the activities of NFA members that are registered as
brokers or dealers in security futures products under Section
15(b)(11) of the Act.
\10\ See FINRA Rule 0140.
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As a result, when broker-dealer firms that are not FINRA members
effect securities transactions otherwise than on an exchange of which
they are a member, such as off-exchange or on exchanges where they are
not a member (collectively referred to herein as ``off-member-
exchange''),\11\ these firms are not all subject to the same set of
exchange rules and interpretations of those rules, which can vary
between exchanges. As discussed below,\12\ there are regulatory service
agreements (``RSAs'') among exchange SROs and FINRA, which have
provided benefits to SROs such as lower regulatory costs and have been
a component of FINRA's cross-market regulatory program. Importantly,
FINRA has the expertise regarding off-exchange trading, but under these
RSAs, for non-FINRA members that trade off-exchange and are members of
different exchanges, FINRA applies the rules of the different exchanges
using the exchanges' interpretations of those rules. This can result in
different interpretations and FINRA registration would promote
consistent interpretations and efficiencies in enforcement and
regulation with respect to this growing part of the market. The rise in
electronic proprietary trading and the increasingly fragmented market
where trading takes place across many active markets have put pressure
on the status quo and persuaded the Commission of the need for there to
be more consistent regulation of such trading.
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\11\ To be consistent with Rule 15b9-1, off-member-exchange
securities trading must occur with or through another registered
broker-dealer, such as, in the case of trading on an exchange where
the firm is not a member, through a broker-dealer that is a member
of the exchange.
\12\ See Section II.B infra.
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In addition, SROs retain responsibility for regulatory oversight
under the RSAs; however, RSAs are voluntary, privately negotiated
agreements that can expire or be terminated, and accordingly, these
agreements may not in the future provide the stability of FINRA
oversight. Further, the Commission, of course, may bring enforcement
actions, including pursuant to referrals made by SROs, to
[[Page 49932]]
enforce compliance with the Exchange Act and applicable rules. But as
is also discussed below,\13\ the Exchange Act requires a robust layer
of SRO oversight over broker-dealers in addition to the Commission's
regulatory role. In light of the extent to which off-member-exchange
proprietary trading occurs today, the Commission believes that the SRO
layer of oversight should be enhanced by ensuring, as mandated by
Section 15(b)(8) of the Act, that an Association generally has direct,
membership-based oversight over broker-dealers that effect securities
transactions elsewhere than on an exchange where they are a member and
the jurisdiction to directly enforce their compliance with Federal
securities laws, Commission rules, and Association rules.
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\13\ See sections II.A and II.B infra.
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The Commission adopted Rule 15b9-1 several decades ago so that an
exchange member's limited proprietary trading activity ancillary to its
exchange activity--which, at that time, typically was a floor business
conducted on a single national securities exchange--would not
necessitate Association membership in addition to exchange
membership.\14\ The Commission deemed it an appropriate exercise of its
statutory authority to subject such an exchange member to exchange-only
SRO oversight. But as stated above and described below, the securities
markets have transformed dramatically and have evolved to include
significant, cross-market electronic proprietary trading as a primary
business model, and firms engaging in such trading activity that are
exempt from Association membership, including important transaction
reporting requirements, by virtue of Rule 15b9-1. In this regard, the
Commission previously proposed to amend Rule 15b9-1 in 2015.\15\ After
the 2015 Proposal, FINRA established a transaction reporting regime
under which broker-dealers that are FINRA members must report U.S.
Treasury securities transactions. Some broker-dealer firms that are not
FINRA members are significantly involved in trading U.S. Treasury
securities proprietarily but are not required to report these
transactions since they are not FINRA members. Moreover, U.S. Treasury
securities trading occurs entirely off-exchange, thus these non-FINRA
members conduct their U.S. Treasury securities trading activities
outside of the direct SRO oversight of any exchange and, since they are
not FINRA members, outside of FINRA's direct jurisdiction despite the
fact that FINRA is the SRO responsible for the off-exchange market.\16\
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\14\ See infra note 60 and accompanying text (discussing the
adoption of Rule 15b8-1, which was later renumbered to Rule 15b9-1).
\15\ See 2015 Proposing Release, supra note 6.
\16\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities.
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The evolution of the markets--since Rule 15b9-1 was adopted and
since the Commission's proposed changes to Rule 15b9-1 in 2015--
presents a need to realign Rule 15b9-1 with the current market so that
the regulatory scheme more appropriately effectuates Exchange Act
principles regarding complementary exchange SRO and Association
oversight in today's market, including Section 15(b)(9)'s mandate that
any exemption from Section 15(b)(8) be consistent with the public
interest and protection of investors. Accordingly, the Commission is
re-proposing amendments to Rule 15b9-1 that would rescind the de
minimis allowance and proprietary trading exclusion, which generally
would require Association membership, pursuant to Section 15(b)(8) of
the Act, for any registered broker or dealer that effects securities
transactions elsewhere than on a national securities exchange of which
it is a member, subject to narrowed exemptions from Section 15(b)(8)'s
Association membership requirement that are applicable to trading
activity that is ancillary to the registered broker's or dealer's
trading activity on a national securities exchange of which it is a
member.\17\
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\17\ This proposal re-proposes, with certain modifications, the
amendments to Rule 15b9-1 that the Commission proposed in 2015. See
2015 Proposal, supra note 6. The 2015 Proposal contains additional
background information regarding the regulatory history in this area
and Rule 15b9-1. See 2015 Proposal, supra note 6, 80 FR at 18036-45.
Comments received in response to the 2015 Proposing Release are
available at <a href="https://www.sec.gov/comments/s7-05-15/s70515.shtml">https://www.sec.gov/comments/s7-05-15/s70515.shtml</a>.
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II. Background
A. Current Regulatory Framework
Self-regulation is a longstanding, key component of U.S. securities
industry regulation.\18\ All broker-dealers are required to be members
of an SRO, which sets standards, conducts examinations, and enforces
rules regarding its members.\19\ The Exchange Act sets forth a
framework for broker-dealer regulation that, in addition to Commission
oversight, requires this layer of SRO oversight, pursuant to which SROs
act as front-line regulators of their broker-dealer members.\20\
Although the Exchange Act provides a limited and targeted exception to
Association membership requirements for broker-dealers, its approach to
effecting supervision is relatively uniform: broker-dealers must be
members of the SROs that regulate the venues upon which they
transact.\21\ A related, overarching principle in the Exchange Act is
that the SRO best positioned to conduct regulatory oversight should
assume that responsibility.\22\ Correspondingly, SRO oversight of an
exchange's members and their trading on the exchange is primarily the
responsibility of the exchange, whereas SRO oversight of other trading
activity, such as off-exchange trading,\23\ is primarily the
responsibility of an Association.\24\
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\18\ See Securities Exchange Act Release No. 50700 (November 18,
2004), 69 FR 71256 (December 8, 2004) (``Concept Release Concerning
Self-Regulation'').
\19\ Id. (citing Section 15(b)(8) of the Act (15 U.S.C.
78o15(b)(8))). Congress historically has favored self-regulation for
a variety of reasons, including that effectively regulating the
inner-workings of the securities industry at the federal level was
viewed as cost prohibitive and inefficient; the complexity of
securities practices made it desirable for SRO regulatory staff to
be intimately involved with SRO rulemaking and enforcement; and the
SROs could set standards such as just and equitable principles of
trade and detailed proscriptive business conduct standards. Id.
(citing, generally, S. Rep. No. 1455, 73d Cong., 2d Sess. (1934);
H.R. Doc. No. 1383, 73d Cong., 2d Sess. (1934); S. Rep. No. 1455,
73d Cong., 2d Sess. (1934)); see also id., 69 FR at 71257-58.
\20\ Broker-dealers registered with the Commission are subject
to the Commission's jurisdiction and oversight and must comply with
Commission rules applicable to registered broker-dealers. See, e.g.,
15 U.S.C. 78o, 17 CFR 240.15a-6--240.15b11-1, and 17 CFR 240.17a-1--
240.17a-25. Matters related to SRO actions or their broker-dealer
members also may be referred to the Commission or subject to
Commission review. See, e.g., 15 U.S.C. 78s(d) and 15 U.S.C. 78s(e).
But the Exchange Act also requires that SROs enforce their members'
compliance with the Exchange Act, the rules and regulations
thereunder, and the SRO's own rules. See, e.g., sections 6(b)(1),
19(g)(1), and 15A(b)(2) of the Act (15 U.S.C. 78f(b)(1), 78s(g)(1),
78o-3(b)(2)); see also section 11A(a)(3)(B) of the Act (15 U.S.C.
78k-1(a)(3)(B)) (authorizing the Commission to require SROs to act
jointly in planning, developing, operating, or regulating the
national market system).
\21\ See 2015 Proposal, supra note 6, 80 FR at 18039.
\22\ See supra note 8.
\23\ See supra note 6.
\24\ References herein to ``exchange'' or ``national securities
exchange'' are to a national securities exchange that is registered
with the Commission pursuant to section 6 of the Exchange Act.
References herein to ``broker'' or ``dealer'' or ``broker-dealer''
are to a broker or dealer that is registered with the Commission
pursuant to section 15 of the Exchange Act.
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This framework is embodied by several Exchange Act statutory
provisions. When the Exchange Act was adopted in 1934, the exchanges
were the only SROs and were charged with regulating the activities of
their broker-dealer members. Congress soon recognized, however, that
the benefit of exchange regulation could be undermined by the absence
of a
[[Page 49933]]
complementary regulatory framework for the off-exchange market.
Consequently, in 1938, the Maloney Act established the concept of and
regulatory framework for Associations under Section 15A of the Exchange
Act. The Maloney Act states in its preamble that its purpose is ``[t]o
provide for the establishment of a mechanism of regulation among over-
the-counter brokers and dealers operating in interstate and foreign
commerce or through the mails, to prevent acts and practices
inconsistent with just and equitable principles of trade, and for other
purposes.'' \25\ In 1964, Congress passed Section 15(b)(8) of the
Exchange Act, which currently requires that a registered broker or
dealer join an Association unless it effects transactions solely on an
exchange of which it is a member.\26\
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\25\ See Public Law 75-719, 52 Stat. 1070 (1938).
\26\ As discussed in greater detail in the 2015 Proposal,
section 15(b)(8) as originally enacted, and Rule 15b9-1 as
originally adopted by the Commission (which was Rule 15b8-1 at that
time and later re-designated as Rule 15b9-1) provided for direct
Commission oversight of broker-dealers that effected transactions
off-exchange as an alternative to joining an Association. In 1983,
Congress amended the Act to eliminate the direct oversight of
broker-dealers by the Commission and affirmed the benefits of self-
regulation of broker-dealers directly by an Association. See 2015
Proposal, 63 FR at 18039-41; see also 15 U.S.C. 78o(b)(8), as
amended by Public Law 98-38, 97 Stat. 205, 206 (1983); H.R. Rep. No.
98-106, at 597 (1983) (citing a preference for self-regulation over
direct regulation by the Commission and noting, among other benefits
of self-regulation, that the National Association of Securities
Dealers (``NASD''), FINRA's predecessor, had available a broader and
more effective range of disciplinary sanctions to employ against
broker-dealers than had the Commission).
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Additional statutory provisions contemplate coordination of broker-
dealer oversight among SROs. Section 19(g)(1) of the Exchange Act
requires every SRO to examine for and enforce compliance by its members
and associated persons with the Exchange Act, the rules and regulations
thereunder, and the SRO's own rules, unless the SRO is relieved of this
responsibility pursuant to Section 17(d) or Section 19(g)(2) of the
Act.\27\ With respect to a broker or dealer that is a member of more
than one SRO (``common member''), Section 17(d)(1) authorizes the
Commission, by rule or order, to relieve an SRO of the responsibility
to receive regulatory reports, to examine for and enforce compliance
with the applicable statutes, rules, and regulations, or to perform
other specified regulatory functions.\28\ Without this relief, the
statutory obligation of each SRO would result in duplicative
examinations and oversight of common members.\29\ Section 17(d)(1) of
the Act provides that the Commission, in allocating authority among
SROs, shall ``take into consideration the regulatory capabilities and
procedures of the self-regulatory organizations, availability of staff,
convenience of location, unnecessary regulatory duplication, and such
other factors as the Commission may consider germane to the protection
of investors, cooperation and coordination among self-regulatory
organizations, and the development of a national market system . . .
.'' \30\ Among the SROs to which oversight responsibility is allocated
pursuant to 17d-2 plans, FINRA, as the only registered Association
currently, has coordinated with exchanges in the exercise of SRO
oversight over broker-dealers that are common members of FINRA and the
exchanges on which they trade securities.\31\
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\27\ 15 U.S.C. 78q(d) and 78s(g)(2).
\28\ 15 U.S.C. 78q(d)(1).
\29\ In the Exchange Act Amendments of 1975 (Pub. L. 94-29, 89
Stat. 97 (1975), the ``1975 Amendments''), Congress recognized that,
at the time, the allocation of self-regulatory responsibilities
among SROs resulted in some cases in duplicative regulation of firms
that were members of multiple SROs and varying standards, both in
substance and enforcement, among SROs. S. Doc. No. 93-13 at 164-165
(1973). As a result, Congress adopted Section 17(d) of the Act,
which provides the Commission with the authority to allocate
regulatory responsibilities among SROs with respect to matters as to
which, in the absence of such allocation, such SROs would share
authority. 15 U.S.C. 78q(d).
\30\ 15 U.S.C. 78q(d)(1). To implement section 17(d)(1), the
Commission adopted Rules 17d-1 and 17d-2 under the Act. 17 CFR
240.17d-1 and 17 CFR 240.17d-2. Rule 17d-1 authorizes the Commission
to name a single SRO as the designated examining authority (``DEA'')
to examine common members for compliance with the financial
responsibility requirements imposed by the Act, or by Commission or
SRO rules. See Exchange Act Release No. 12352 (April 20, 1976), 41
FR 18808 (May 7, 1976). To address regulatory duplication in areas
other than financial responsibility, including sales practices and
trading practices, the Commission adopted Rule 17d-2 under the Act.
See Exchange Act Release No. 12935 (October 28, 1976), 41 FR 49091
(November 8, 1976). Rule 17d-2 permits SROs to propose joint plans
among two or more SROs for the allocation of regulatory
responsibility with respect to their common members. 17 CFR 240.17d-
2. The regulatory responsibility allocated among SROs only extends
to matters for which the SROs would share authority, which means
that only common rules among SROs can be allocated under Rule 17d-2.
Under paragraph (c) of Rule 17d-2, the Commission may declare such a
plan effective if, after appropriate notice and opportunity for
comment, it finds that the plan is necessary or appropriate in the
public interest and for the protection of investors, to foster
cooperation and coordination among SROs, or to remove impediments to
and foster the development of a national market system and a
national clearance and settlement system and in conformity with the
factors set forth in Section 17(d) of the Act. Id. Commission
approval of a plan filed pursuant to Rule 17d-2 relieves an SRO of
those regulatory responsibilities allocated by the plan to another
SRO.
\31\ See Staff of the Division of Trading and Markets, ``Staff
Paper on Cross-Market Regulatory Coordination,'' (Dec. 15, 2020)
(available at <a href="https://www.sec.gov/tm/staff-paper-cross-market-regulatory-coordination">https://www.sec.gov/tm/staff-paper-cross-market-regulatory-coordination</a>) (``Cross-Market Regulatory Coordination
Staff Paper''). Staff reports and other staff documents (including
those cited herein) represent the views of Commission staff and are
not a rule, regulation, or statement of the Commission. The
Commission has neither approved nor disapproved the content of these
staff documents and, like all staff statements, they have no legal
force or effect, do not alter or amend applicable law, and create no
new or additional obligations for any person.
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FINRA, however, is primarily responsible for exercising SRO
oversight over broker-dealers' off-member-exchange securities trading
activities, such as when broker-dealers effect securities transactions
across markets that include exchanges where they are not a member or
the off-exchange market.\32\ In particular, FINRA regulates off-
exchange trading of equities, fixed income (including U.S. Treasury)
securities, and other products, and investigates and brings enforcement
actions against members for violations of its rules, the rules of the
Municipal Securities Rulemaking Board, and the Exchange Act and the
Commission rules thereunder.\33\ FINRA also conducts the vast majority
of broker and dealer examinations,\34\ and mandates broker and dealer
disclosures.\35\ FINRA also has developed rules and guidance tailored
to trading activity,\36\ and has developed surveillance technology and
specialized regulatory personnel to provide surveillance, supervision,
and enforcement of FINRA rules and the federal securities laws
applicable to activity occurring off-exchange.\37\
[[Page 49934]]
Further, FINRA has a detailed set of member conduct rules that apply to
all activities of a FINRA member firm, whether on- or off-exchange.\38\
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\32\ See Public Law 75-719, 52 Stat. 1070 (1938). Although FINRA
is the sole Association, the statute does not limit the number of
Associations.
\33\ 15 U.S.C. 78o-3.
\34\ Routine broker and dealer examinations are conducted by the
exchange SROs as well, and the Commission staff oversees the
examination efforts of all SROs. In addition, the Commission staff
also conducts risk-based examinations of brokers and dealers.
\35\ 15 U.S.C. 78o-3. See, e.g., FINRA Rules 3130 (Annual
Certification of Compliance and Supervisory Processes), 4120
(Regulatory Notification and Business Curtailment), 4530 (Reporting
Requirements), 4540 (Reporting Requirements for Clearing Firms),
4560 (Short-Interest Reporting), and 6439 (Requirements for Member
Inter-Dealer Quotation Systems).
\36\ See, e.g., FINRA Rules 5240 (Anti-Intimidation/
Coordination), 5250 (Payments for Market Making), 5210.02
(Publication of Transactions and Quotations--Self-Trades), and 6140
(Other Trading Practices). Exchanges have similar rules. See, e.g.,
NYSE Rules 4560 and 6140; Nasdaq Rules 5240 and 5250.
\37\ See <a href="http://FINRA.org">FINRA.org</a>, FINRA 2021 Annual Financial Report,
available at <a href="https://www.finra.org/sites/default/files/2022-06/2021-FINRA-Financial-Annual-Report.pdf">https://www.finra.org/sites/default/files/2022-06/2021-FINRA-Financial-Annual-Report.pdf</a> (last visited July 22, 2022).
\38\ See FINRA Rule 2000 Series--Duties and Conflicts.
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In addition, FINRA has rules that support a comprehensive public
transparency regime with respect to off-exchange securities
transactions. One element of this regime is the requirement that FINRA
members report to FINRA all OTC Equity Security trades \39\ and off-
exchange NMS stock trades,\40\ in connection with which FINRA has
developed a detailed set of trade reporting rules.\41\ This transaction
information then becomes publicly available.\42\ FINRA also maintains
the Trade Reporting and Compliance Engine (``TRACE'') reporting system
for fixed income securities.\43\ FINRA introduced TRACE reporting
requirements for U.S. Treasury securities transactions in 2017, which
has enhanced the regulatory audit trail in that market.\44\ FINRA
publishes weekly aggregated transaction information and statistics on
U.S. Treasury securities on its website.\45\
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\39\ See FINRA Rule 6420(f) (defining ``OTC Equity Security'' to
mean any equity security that is not an ``NMS stock'' as that term
is defined in Rule 600(b) of SEC Regulation NMS; provided, however,
that the term ``OTC Equity Security'' shall not include any
Restricted Equity Security). See also FINRA Rule 6420(k) (defining
``Restricted Equity Security'' to mean any equity security that
meets the definition of ``restricted security'' as contained in
Securities Act Rule 144(a)(3)); 17 CFR 242.600(b) (defining ``NMS
stock'' as any NMS security other than an option, and defining ``NMS
security'' as any security or class of securities for which
transaction reports are collected, processed, and made available
pursuant to an effective transaction reporting plan, or an effective
national market system plan for reporting transactions in listed
options). FINRA members are required to report transactions (other
than transactions executed on or through an exchange) in OTC Equity
Securities and Restricted Equity Securities to FINRA's OTC Reporting
Facility (``ORF''). See FINRA Rules 6410 and 6610; see also FINRA
Rule 6420(n) (defining ``OTC Reporting Facility'' as the service
provided by FINRA that accommodates reporting for trades in OTC
Equity Securities executed other than on or through an exchange and
for trades in Restricted Equity Securities effected under Securities
Act Rule 144A and dissemination of last sale reports).
\40\ See FINRA Rule 6110 and the FINRA Rule 6000 Series
generally--Quotation, Order, and Transaction Reporting Facilities.
FINRA operates two Trade Reporting Facilities (``TRFs''), one
jointly with Nasdaq and another with the NYSE. The TRFs are FINRA
facilities for FINRA members to report NMS stock transactions
effected otherwise than on an exchange. See Exchange Act Release No.
54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) (order approving
the Nasdaq TRF); Exchange Act Release No. 55325 (February 21, 2007),
72 FR 8820 (February 27, 2007) (notice of filing and immediate
effectiveness of a proposed rule change to establish the NYSE TRF).
In addition, FINRA operates the Alternative Display Facility
(``ADF'') for NMS stocks, which is a FINRA facility for posting
quotes and reporting trades governed by FINRA's trade reporting
rules. See Exchange Act Release No. 46249 (July 24, 2002), 67 FR
49821 (July 31, 2002) (order approving the ADF); see also Exchange
Act Release No. 71467 (February 3, 2014), 79 FR 7485 (February 7,
2014) (order approving a proposed rule change to update the rules
governing the ADF).
\41\ See FINRA Rule 6000 Series--Quotation, Order, and
Transaction Reporting Facilities, supra note 40; and FINRA Rule 7000
Series--Clearing, Transaction and Order Data Requirements, and
Facility Charges.
\42\ Pursuant to effective national market system plans which
are also effective transaction reporting plans (as both terms are
defined in Rule 600(b) of Regulation NMS), namely the Nasdaq UTP
Plan and the CTA Plan, FINRA reports to the Securities Information
Processors (``SIPs'') information for off-exchange NMS stock
transactions that are reported to FINRA's TRFs, and the SIPs in turn
distribute the information in the public consolidated market data
feeds. See section VIII(a) of the CTA Plan and section VIII.B of the
Nasdaq UTP Plan. In addition, currently, Nasdaq UTP Plan Level 1
subscribers can obtain the OTC Equity Security transaction
information that is reported to FINRA's ORF and disseminated under
the FINRA--Trade Data Dissemination Service (TDDS). See <a href="http://UTPPlan.com">UTPPlan.com</a>,
UTP Plan Administration Data Request Form, available at <a href="https://www.utpplan.com/DOC/UTP_Data_Feed_Request.pdf">https://www.utpplan.com/DOC/UTP_Data_Feed_Request.pdf</a> (last visited July 22,
2022) (stating that direct access subscribers may request FINRA OTC
Data (FINRA OTC Equity Securities Rule 6400) as part of the Nasdaq
UTP Plan Level 1 service).
\43\ See FINRA Rule 6700 Series.
\44\ See Securities Exchange Act Release No. 79116 (October 18,
2016), 81 FR 73167 (October 24, 2016) (File No. SR-FINRA-2016-027).
\45\ See <a href="http://FINRA.org">FINRA.org</a>, Treasury Aggregate Statistics, available at
<a href="https://www.finra.org/finra-data/browse-catalog/treasury-weekly-aggregates">https://www.finra.org/finra-data/browse-catalog/treasury-weekly-aggregates</a> (last visited July 22, 2022). The information is
aggregated by security subtype: Bills, Floating Rate Notes (FRN),
Nominal Coupons and Treasury Inflation-Protected Securities (TIPS).
The data is further grouped into ``ATS and Interdealer,'' ``Dealer-
to-Customer,'' and ``Total'' categories. For Nominal Coupons and
TIPS, the report also shows remaining maturity and on-the-run/off-
the-run groupings. See also FINRA Rule 6750--Dissemination of
Transaction Information, Supplementary Material .01(b). FINRA
recently proposed to publish aggregated U.S. Treasury securities
transaction information and statistics more frequently, such as on a
daily basis. See Securities Exchange Act Release No. 95165 (June 27,
2022), 87 FR 39573 (July 1, 2022) (File No. SR-FINRA-2022-017).
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In contrast to FINRA, the regulatory focus of national securities
exchanges, which are also SROs, is generally on trading by their
members on their respective exchanges.\46\ Exchanges generally monitor
market activity specific to their own exchanges and have expertise in
regulating unique aspects of their markets.\47\ For example, exchange
rules typically regulate, among other things, the opening and closing
of trading on the exchange; \48\ exchange order types and order
handling; \49\ member application processes and ongoing member
requirements; \50\ listings; \51\ investigations, complaints,
disciplinary action and the related appeals process; \52\ as well as
member conduct generally.\53\ In many cases, exchange rules are similar
to FINRA rules or incorporate FINRA rules by reference.\54\
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\46\ Congress saw the codification of regulations requiring the
registration of off-exchange brokers and dealers as ``an essential
supplement to regulation of the exchanges.'' H.R. Rep. No. 74-2601,
at 4 (1936). In addition, in advance of the 1975 Amendments,
Congress contemplated reforms to the regulatory structure of the
securities markets in which an Association's role would be expanded,
while exchanges would focus their regulatory activities on their
respective markets: ``the time has come to begin planning a
framework which will guide the development of the self-regulatory
system in the future. In the revised system, a single nationwide
entity [an Association] would be responsible for regulation of the
retail end of the securities business, including such matters as
financial responsibility and selling practices, while each exchange
would concentrate on regulating the use of its own trading
facilities . . . the regulatory activities of the NASD (the only
organization presently registered as a national securities
association) would encompass many of the present regulatory
activities of the NYSE and other exchanges over retail activities of
their members. This `expanded' NASD would have direct
responsibility, subject to SEC oversight, for enforcing SEC rules
and its own rules . . .'' S. Doc. No. 93-13 at 16, 169 (1973). See
also 2015 Proposing Release, supra note 6, 80 FR 18039 at note 28
and accompanying text. In 2007, the Commission approved changes that
consolidated the member firm regulatory functions of the NASD, an
Association, and NYSE Regulation, Inc., and changed the name of the
combined entity to FINRA. See Exchange Act Release No. 56145 (July
26, 2007), 72 FR 42169 (August 1, 2007).
\47\ See Cross-Market Regulatory Coordination Staff Paper, supra
note 31.
\48\ See, e.g., NYSE Rule 7.35 Series--Auctions.
\49\ See, e.g., Nasdaq Rule 4702--Order Types and Nasdaq Rule
4703--Order Attributes.
\50\ See, e.g., Cboe Rulebook Chapter 3--TPH Membership,
Registration, and Participants.
\51\ See, e.g., IEX Rulebook Chapter 14--IEX Listing Rules.
\52\ Typically, exchange rules regarding investigations,
complaints, disciplinary actions, and appeals apply to the conduct
of members (and associated persons) for violations of exchange rules
and federal securities laws and regulations that the exchange has
jurisdiction to enforce. See, e.g., Cboe Rule 13.1; IEX Rule
9.110(a); MIAX Chapter X, Rule 1000; Nasdaq Rule General 5, 9110(d);
and Nasdaq PHLX Rule General 5, Section 1.
\53\ See, e.g., NYSE Rules 2010--7470--Conduct Rules.
\54\ See, e.g., NYSE Rules 4110 and 4140, and FINRA Rules 4110
and 4140; and Nasdaq General 9 (Regulation) (incorporating by
reference various FINRA rules).
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In addition, exchanges have entered into 17d-2 plans that allocate
to FINRA examination and enforcement responsibility relating to
compliance by common members with Federal securities laws, Commission
rules, and common exchange and FINRA rules, allowing the exchanges to
focus on trading on their own markets. For example, under a 17d-2 plan
for the allocation of regulatory responsibility relating to Regulation
NMS rules, FINRA is responsible for overseeing and enforcing compliance
with certain Regulation NMS rules by common members of FINRA and any
exchange participant in the agreement, while each exchange retains
responsibility for surveillance and enforcement with respect to trading
activities or practices
[[Page 49935]]
involving its own marketplace.\55\ Most exchanges and FINRA also have
entered into RSAs, which are privately negotiated agreements between
two SROs whereby one SRO agrees to perform regulatory services on
behalf of another SRO in exchange for compensation.\56\
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\55\ See, e.g., Exchange Act Release Nos. 63220 (November 2,
2010), 75 FR 68632 (November 8, 2010) and 63430 (December 3, 2010),
75 FR 76758 (December 9, 2010). In addition, generally, FINRA is the
DEA for financial responsibility rules for exchange members that
also are members of FINRA. See infra notes 227-228 and accompanying
text (discussing DEAs). See also Cross-Market Regulatory
Coordination Staff Paper, supra note 31 (stating that ``FINRA serves
as the Designated Regulation NMS Examining Authority (``DREA'') and
Designated CAT Surveillance Authority (``DCSA'') for common exchange
members that are also members of FINRA, and assumes certain
examination and enforcement responsibilities for those members with
respect to specified Regulation NMS rules (i.e., 606, 607, 611, 612
and 613(g)(2)), and for the cross-market surveillance, examination,
investigation and enforcement of Rule 613 and the rules of the SROs
regarding compliance with the CAT NMS Plan.'').
\56\ See Cross-Market Regulatory Coordination Staff Paper, supra
note 31.
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In addition to regulatory coordination that occurs through 17d-2
plans and RSAs, SROs also coordinate regulatory efforts through forums
provided by the Intermarket Surveillance Group (``ISG''). The ISG,
created in 1981, is an international group of exchanges, market
centers, and regulators that perform market surveillance in their
respective jurisdictions.\57\ The ISG's focus is regulatory information
sharing and coordination for both domestic and foreign regulators.\58\
Pursuant to its charter, one of the ISG's purposes is ``the
coordination and development of programs and procedures designed to
assist in identifying possible fraudulent and manipulative acts and
practices across markets, where possible, particularly between markets
which trade the same or related or derivative Financial
Instruments[.]'' \59\
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\57\ See id.
\58\ See id.
\59\ See id.
---------------------------------------------------------------------------
B. Need for Amendment
The Commission originally adopted Rule 15b8-1 in 1965 (renumbered
to Rule 15b9-1 in 1983 and generally referred to herein as Rule 15b9-1)
to allow exchange specialists and other floor members to receive a
portion of the commissions paid on occasional off-exchange transactions
referred to other broker-dealers, up to a nominal amount.\60\ The
original version of Rule 15b9-1 included the de minimis allowance but
not the proprietary trading exclusion. The Commission adopted the
proprietary trading exclusion in 1976 to accommodate regional exchange
specialists that, as part of their floor-based business, might have
needed to lay off positions and hedge risk on the primary listing
exchange through a member of that exchange.\61\ These exchange
specialists and floor brokers typically were members of a single
exchange, and the circumstances under which they would trade
proprietarily off-exchange were quite limited.\62\ Taken together, the
historical purpose of Rule 15b9-1's de minimis allowance and
proprietary trading exclusion was to accommodate limited broker-dealer
trading activities that were ancillary to a floor-based business on a
single exchange while preserving the traditional role of the exchange
as the entity best suited to regulate member conduct on the exchange.
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\60\ See Qualifications and Fees Relating to Brokers or Dealers
Who Are Not Members of National Security [sic] Association, Exchange
Act Release No. 7697 (September 7, 1965), 30 FR 11673 (September 11,
1965) (``Qualifications and Fees Release''). The Commission stated:
``Among the broker-dealers that are not members of a registered
national securities association are several specialists and other
floor members of national securities exchanges, some of whom
introduce accounts to other members. The over-the-counter business
of these broker-dealers may be limited to receipt of a portion of
the commissions paid on occasional over-the-counter transactions in
these introduced accounts, and to certain other transactions
incidental to their activities as specialists. In most cases, the
income derived from these activities is nominal.'' Id. at 11675.
\61\ See Extension of Temporary Rules 23a-1(T) and 23a-2(T);
Adoption of Amendments to SECO Rules, Securities Exchange Act
Release No. 12160 (March 3, 1976), 41 FR 10599 (March 12, 1976)
(``Adoption of Amendments to SECO Rules''). In adopting the
proprietary trading exclusion, the Commission indicated that an
exchange floor broker, through another broker or dealer, could
effect transactions for its own account on an exchange of which it
was not a member. Id. at 10600. The Commission noted that such
transactions ultimately would be effected by a member of that
exchange. In 1983, the Commission further amended Rule 15b9-1 to
accommodate transactions effected through the new Intermarket
Trading System linkage, and eliminated references to, and
requirements under, the SECO Program. See SECO Programs; Direct
Regulation of Certain Broker-Dealers; Elimination, Exchange Act
Release No. 20409 (November 22, 1983), 48 FR 53688 (November 29,
1983) (``SECO Programs Release'').
\62\ In the Special Study of the Securities Markets in 1963, the
Commission described how regional exchange specialists reduced their
exposure, including by offsetting positions on other exchanges. The
Commission noted that ``[s]pecialists on the Boston, Philadelphia-
Baltimore-Washington, Pittsburgh, and Montreal stock exchange are in
communication with each other by direct wires linking their floors
and each may trade on the other exchanges at member rates'' and
``[s]pecialists who are sole members [of an exchange] also offset
[their positions] with over-the-counter houses dealing in listed
securities. Many of the offsetting transactions are done on the
primary market, the NYSE, with the [specialist] buying or selling on
that exchange as his needs dictate.'' Report of Special Study of
Securities Markets of the Securities and Exchange Commission, H.R.
Doc. No. 88-95, at 935 (1963) (``Special Study''). The Commission
believes that the business of regional exchange specialists was
substantially the same when the proprietary trading exclusion in
Rule 15b9-1 was adopted in 1976.
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Since that time, the securities markets have undergone a
substantial transformation that has been driven primarily by rapid and
ongoing evolution of technologies for generating, routing, and
executing orders, and the impact of regulatory changes.\63\ Today,
trading in the U.S. securities markets is highly automated, dispersed
among myriad trading centers, and substantially more complex.\64\
Trading is spread among a number of highly automated trading centers--
24 registered exchanges,\65\ 33 ATSs that trade NMS stocks,\66\ at
least 2 ATSs that trade U.S. Treasury securities,\67\ and nearly 200
OTC market-makers \68\--and the routing and re-routing of orders to
multiple venues is common. Moreover, new types of proprietary trading
firms have emerged, including those that engage in so-called high-
frequency trading strategies. These firms tend to effect transactions
across the full range of exchange and off-exchange markets, including
ATSs. They also typically use complex electronic trading strategies and
sophisticated technology to generate a large volume of orders and
[[Page 49936]]
transactions throughout the national market system.\69\
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\63\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (Concept Release on Equity
Market Structure) (``Equity Market Structure Concept Release''), at
3594 (``Changes in market structure also reflect the markets'
response to regulatory actions such as Regulation NMS, adopted in
2005, the Order Handling Rules, adopted in 1996, as well as
enforcement actions, such as those addressing anti-competitive
behavior by market makers in NASDAQ stocks.'').
\64\ See Equity Market Structure Concept Release, supra note 63.
See also 2015 Proposing Release, supra note 6.
\65\ There are 8 registered exchanges that only trade equities
and 8 registered exchanges that only trade options. In addition,
there are 8 registered exchanges that trade both equities and
options.
\66\ See 17 CFR 242.300 (defining the terms ``alternative
trading system'' and ``NMS Stock ATS''). This data was compiled from
Forms ATS-N filed with the Commission as of July 22, 2022, available
at <a href="https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm">https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm</a>.
\67\ See U.S. Dep't of the Treasury et al., Joint Staff Report:
The U.S. Treasury Market on October 15, 2014 (July 13, 2015) (the
``Joint Staff Report''). The Joint Staff Report noted that SEC rules
applicable to ATSs do not apply to ATSs through which only
government securities are traded, although such venues may
voluntarily adopt such standards. Since the Joint Staff Report was
issued, however, the Commission has proposed to amend Regulation ATS
to include ATSs through which only government securities are traded.
See Securities Exchange Act Release No. 94062 (January 26, 2022), 87
FR 15496 (March 18, 2022).
\68\ Nearly 200 brokers or dealers (excluding ATSs) have
identified themselves to FINRA as market centers that must provide
monthly reports on order execution quality under Rule 605 of
Regulation NMS (list available at <a href="http://www.finra.org/industry/market-centers">http://www.finra.org/industry/market-centers</a>).
\69\ Many, but not all, proprietary trading firms are often
characterized by: (1) the use of extraordinarily high-speed and
sophisticated computer programs for generating, routing, and
executing orders; (2) the use of co-location services and individual
data feeds offered by exchanges and others to minimize network and
other types of latencies; (3) the use of very short time-frames for
establishing and liquidating positions; (4) the submission of
numerous orders that are cancelled shortly after submission; and (5)
ending the trading day in as close to a flat position as possible
(that is, not carrying significant, unhedged positions overnight).
See Equity Market Structure Concept Release, supra note 63, 75 FR at
3606. See also Staff of the Division of Trading and Markets,
``Equity Market Structure Literature Review, Part II: High Frequency
Trading,'' at 4-5 (March 18, 2014) (available at <ls-thn-eq><a href="http://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf">http://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf</a>).
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In fact, the large-scale proprietary trading that occurs in the
securities markets today is not confined to equities and options. For
example, there is significant automated proprietary trading in U.S.
Treasury securities, which are not traded on any national securities
exchange.\70\ As noted in the Joint Staff Report, proprietary trading
firms, or principal trading firms (``PTF(s)'') as they are also called,
account for a majority of trading and market depth in the electronic
interdealer U.S. Treasury securities market.\71\ The Joint Staff Report
called for certain U.S. Treasury securities market reforms such as an
assessment of the public reporting on U.S. Treasury securities market
venue policies and services and a review of possible post-trade
transaction reporting by government securities broker-dealers and
banks. In 2016, an inter-agency working group comprising staff of the
Treasury Department, Commission, Commodity Futures Trading Commission,
Federal Reserve Bank of New York, and Board of Governors of the Federal
Reserve System stated that it ``will continue to assess effective means
to ensure that the collection of data regarding Treasury cash
securities market transactions is comprehensive and includes
information from institutions that are that not FINRA members.'' \72\
Subsequently, FINRA introduced TRACE reporting for U.S. Treasury
securities in 2017.\73\
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\70\ The secondary market for U.S. Treasury securities
(sometimes referred to as the U.S. Treasury cash market) is
generally bifurcated between the dealer-to-customer market and the
interdealer market. Trading in the U.S. Treasury securities dealer-
to-customer market is generally conducted through bilateral
transactions. Trading often occurs either over the phone or on
trading venues that facilitate the matching of buy and sell orders
through electronic systems. In the interdealer market, the majority
of trading in on-the-run U.S. Treasury securities currently occurs
on ATSs using electronic central limit order books. For off-the-run
U.S. Treasury securities, the majority of interdealer trading occurs
via bilateral transactions through voice-assisted brokers and
electronic trading platforms. See Securities Exchange Act Release
No. 90019 (September 28, 2020), 85 FR 87106, 87108 (December 21,
2020). On-the-run U.S. Treasury securities are the most recently
issued U.S Treasury securities of a particular maturity. Off-the-run
U.S. Treasury securities include all U.S. Treasury securities that
have been issued before the most recent issuance and are still
outstanding.
\71\ See Joint Staff Report, supra note 67, at 36. In addition,
in 2020, staff at the Board of Governors of the Federal Reserve
published a paper estimating that PTFs account for 61% of the
trading activity on interdealer broker platforms. See FEDS Notes,
``Principal Trading Firm Activity in Treasury Cash Markets,'' James
Collin Harkrader and Michael Puglia (Aug. 4, 2020) (citing data
presented at the 2019 U.S. Treasury Market Conference showing that
PTFs averaged approximately 61% of total trading volume on
electronic interdealer broker platforms).
\72\ See press release, U.S. Dep't of the Treasury et al.,
Statement Regarding Progress on the Review of the U.S. Treasury
Market Structure since the July 2015 Joint Staff Report (August 2,
2016) available at <a href="https://www.sec.gov/news/pressrelease/2016-155.html">https://www.sec.gov/news/pressrelease/2016-155.html</a>.
\73\ See supra note 44.
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The Commission estimates that, as of the end of 2021, there were 66
firms that were Commission-registered broker-dealers and exchange
members but not FINRA members, and that there were 65 such firms as of
April 2022.\74\ Many of these firms were members of just one exchange
while others were members of multiple exchanges.\75\ Specifically, as
of April 2022, 21 of the 65 identified firms were single exchange
members; 10 of the firms were members of two exchanges; 13 of the firms
were members of more than two but 10 or fewer exchanges; and the
remainder were members of more than 10 exchanges.\76\
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\74\ See <a href="http://FINRA.org">FINRA.org</a>, Non-Member List, available at <a href="https://nonmembers.finra.org/ReportableNonMembersList.txt">https://nonmembers.finra.org/ReportableNonMembersList.txt</a> or <a href="http://web.archive.org/web/20210722022409/https:/nonmembers.finra.org/ReportableNonMembersList.txt">http://web.archive.org/web/20210722022409/https:/nonmembers.finra.org/ReportableNonMembersList.txt</a> (last visited July 22, 2022). The
Commission notes that the figures set forth herein are impacted by
changes in FINRA membership. For example, a registered broker-dealer
that was not a FINRA member as of 2021 joined FINRA in early 2022
and is not included among the 65 firms identified as registered
broker-dealers and exchange members but not FINRA members as of
April 2022.
\75\ Source: FINRA Central Registration Depository (CRD).
\76\ Id.
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Several of these firms--both single-exchange and multiple-exchange
members--engage in cross-market and off-exchange proprietary securities
trading. These firms account for a significant portion of off-exchange
securities trading volume and initiate a significant number of
securities transactions on exchanges other than exchanges to which they
belong as a member.\77\ They forgo FINRA membership presumably in
reliance on Rule 15b9-1, as their effectuation of transactions in
securities elsewhere than on exchanges to which they belong as a member
would trigger Section 15(b)(8)'s Association membership requirement but
for the exemption provided by Rule 15b9-1.
---------------------------------------------------------------------------
\77\ Source: Consolidated Audit Trail.
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For example, of the estimated 66 broker-dealers that were exchange
members but not FINRA members as of the end of 2021, 47 initiated
orders in listed equities in September 2021 that were executed on or
off an exchange.\78\ These firms' September 2021 off-exchange listed
equities dollar volume executed was approximately $789 billion,\79\
which was approximately 9.8% of total off-exchange volume of listed
equities executed that month.\80\ Moreover, these firms' September 2021
listed equities dollar volume executed on exchanges of which they are
not a member was approximately $592 billion.\81\
---------------------------------------------------------------------------
\78\ Id. A firm ``initiating'' an order is the firm that reports
the origination of the order as a New Order Event (MENO) to the
Consolidated Audit Trail. The other 19 firms did not initiate orders
in listed equities in September 2021.
\79\ Id. Dollar volumes set forth in this section represent the
sum of bought and sold volume during the specified time period.
\80\ Id. The Commission estimates that there was approximately
$8 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in September 2021.
\81\ Id. The Commission also estimates that, in 2021, 50 of the
66 firms identified as registered broker-dealers and exchange
members but not FINRA members initiated options order executions
accounting for approximately 15-20% of daily options contract volume
traded. The Commission further estimates that 36 of these 50 firms
initiated executions on an exchange where they are not a member, and
that this transaction volume represented approximately 3% of these
36 firms' total options contract transaction volume reported in
2021, and approximately 1% of all options contract transaction
volume reported in 2021. Id.
---------------------------------------------------------------------------
Of the estimated 65 broker-dealers that were exchange members but
not FINRA members as of April 2022, 43 initiated orders in listed
equities in April 2022 that were executed on or off an exchange.\82\
These firms' April 2022 off-exchange listed equities dollar volume
executed was approximately $441 billion,\83\ which was approximately
4.6% of total off-exchange volume of listed equities executed that
month.\84\ Moreover, these firms' April 2022 listed equities dollar
volume executed on exchanges of which they are not a member was
approximately $475 billion.\85\
---------------------------------------------------------------------------
\82\ Id. The other 22 firms did not initiate orders in listed
equities in April 2022.
\83\ Id.
\84\ Id. The Commission estimates that there was approximately
$9.5 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in April 2022.
\85\ Source: Consolidated Audit Trail. See also Table 1, Section
VI.A.1, infra, for additional detail regarding these firms' trading
activity during the noted time periods.
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[[Page 49937]]
There is also a high degree of concentration of this volume among a
subset of the identified firms. In this regard, the Commission
estimates that, as of September 2021, 13 of the 47 identified firms
that initiated orders in listed equities then accounted for
approximately 9.3% of total off-exchange listed equities volume
executed in September 2021 and 94% of the off-exchange listed equities
transaction volume attributable to the 47 identified firms that
month.\86\ Two of the 13 firms initiated $528 billion in off-exchange
listed equities executions in September 2021, which was 6.6% of total
off-exchange listed equities transaction volume that month and
approximately two-thirds of the off-exchange volume executions
attributable to the 47 identified firms.\87\ With respect to the 47
firms' listed equities transaction volume on exchanges of which they
are not a member, just one firm accounted for approximately 78% of the
$592 billion in volume attributable to the 47 identified firms in
September 2021; four firms (including the aforementioned one) accounted
for approximately 90% of that volume; and 18 firms (including the
aforementioned four firms) accounted for approximately 99% of that
volume.\88\
---------------------------------------------------------------------------
\86\ Source: Consolidated Audit Trail.
\87\ Id.
\88\ Id.
---------------------------------------------------------------------------
The Commission also estimates that, as of April 2022, 12 of the 43
identified firms that initiated orders in listed equities then
accounted for approximately 4.25% of total off-exchange listed equities
volume executed in April 2022 and 91.6% of the off-exchange listed
equities transaction volume attributable to the 43 identified firms
that month.\89\ One of the 12 firms initiated $241 billion in off-
exchange listed equities executions in April 2022, which was 2.54% of
total off-exchange listed equities transaction volume that month and
approximately one-half of the off-exchange volume executions
attributable to the 43 identified firms.\90\ With respect to the 43
firms' listed equities transaction volume on exchanges of which they
are not a member, just one firm accounted for approximately 72% of the
$475 billion in volume attributable to the 43 identified firms in April
2022; five firms (including the aforementioned one) accounted for
approximately 91% of that volume; and 18 firms (including the
aforementioned four firms) accounted for approximately 99% of that
volume.\91\
---------------------------------------------------------------------------
\89\ Id.
\90\ Id.
\91\ Id.
---------------------------------------------------------------------------
With respect to trading in U.S. Treasury securities, all of which
occurs off-exchange,\92\ the Commission estimates that four of the 66
broker-dealers that were exchange members but not FINRA members
accounted for over $7 trillion in U.S. Treasury securities volume
executed on ``covered ATSs'' in 2021 that was reported to TRACE,\93\
which was over 2% of total U.S Treasury securities volume traded in
2021 that was reported to TRACE.\94\ In April 2022, the Commission
estimates that three of the 65 broker-dealers that were exchange
members but not FINRA members accounted for over $700 billion in U.S.
Treasury securities volume executed on covered ATSs that was reported
to TRACE,\95\ which was approximately 2.5% of total U.S Treasury
securities volume traded in April 2022 that was reported to TRACE.\96\
---------------------------------------------------------------------------
\92\ See Joint Staff Report, supra note 67, at 2; see also supra
note 70.
\93\ See FINRA Rule 6730(a)(1) (requiring FINRA members to
report transactions in TRACE-Eligible Securities, including U.S.
Treasury securities).
\94\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities, supra note 16 (among
other things, defining the term ``covered ATS'' as an ATS that
executed transactions in U.S. Treasury securities against non-FINRA
member subscribers of $10 billion or more in monthly par value,
computed by aggregating buy and sell transactions, for any two
months in the preceding calendar quarter). U.S. Treasury securities
market share is calculated as the sum of the identified entities'
buy and sell volume divided by twice the market-wide volume for the
period.
\95\ See supra note 93.
\96\ Id.
---------------------------------------------------------------------------
Due to the evolution of the securities markets since Rule 15b9-1
was adopted, the Commission preliminarily believes that the rule's
effect has become dislodged from the rule's intended purpose. The
underlying presumption built into Rule 15b9-1's de minimis allowance
and proprietary trading exclusion was that Association membership
should not be required where a broker-dealer engaged in limited trading
activities elsewhere than its member exchange that were ancillary to
its trading business on its member exchange.\97\ Since the Commission
adopted Rule 15b9-1 in 1965 and then the proprietary trading exclusion
in 1976, the securities markets have transformed dramatically,
securities trading has become dispersed among myriad trading centers,
and firms today frequently trade securities proprietarily and
electronically across those trading centers, including on exchanges
where they are not a member and off-exchange. Moreover, today, unlike
forty years ago, there is extensive off-exchange proprietary trading
activity conducted electronically in the U.S. Treasury securities
market, and a transaction reporting regime for U.S. Treasury securities
transactions that stems from Association membership. Put simply, the
underlying tenet of Rule 15b9-1's de minimis allowance and proprietary
trading exclusion no longer holds true in light of the emergence of the
modern-day broker-dealer that trades securities proprietarily.
---------------------------------------------------------------------------
\97\ See supra notes 60-62 and accompanying text.
---------------------------------------------------------------------------
Indeed, as reflected by the figures set forth above, some dealer
firms are able to engage in substantial proprietary securities trading
activity elsewhere than their member exchange(s) without becoming FINRA
members, in reliance on Rule 15b9-1. These firms are not all subject to
the same set of rules and interpretations, which can vary between
exchanges. Importantly, FINRA has the expertise regarding off-exchange
trading, but under the current regulatory structure underpinning Rule
15b9-1, for non-FINRA members that trade off-exchange and are members
of different exchanges, FINRA applies the rules of the different
exchanges using the exchanges' interpretations of those rules. This can
result in different interpretations and FINRA registration would
promote consistent interpretations and efficiencies in enforcement and
regulation with respect to this growing part of the market. The rise in
electronic proprietary trading and an increasingly fragmented market
where trading takes place across many active markets have put pressure
on the status quo and presented a need for there to be more consistent
regulation of such trading. As a result, the Commission preliminarily
believes that the exemption from FINRA oversight provided by Rule 15b9-
1 should be limited.
In particular, there are Federal securities laws, Commission rules,
and SRO rules that prohibit various forms of improper activity by
broker-dealers.\98\ SROs are required to examine for and enforce
compliance by their members
[[Page 49938]]
and associated persons with the Exchange Act, the rules and regulations
thereunder, and the SROs' own rules.\99\ FINRA traditionally has been
the SRO that primarily oversees cross-exchange and off-exchange
securities trading activity. In the specific context of broker-dealer
firms that are not FINRA members and effect off-member-exchange
securities transactions, FINRA is unable to directly enforce such
firms' compliance with Federal securities laws and Commission rules, or
apply its own rules to such firms, because they are not FINRA members.
Without direct, membership-based FINRA oversight, the Commission
believes that SRO oversight of off-member-exchange securities trading
activity by non-FINRA members is largely a function of cooperative
regulatory arrangements among SROs, which, as explained below, do not
confer membership-based jurisdiction to FINRA to enforce compliance
with the Exchange Act and applicable rules.
---------------------------------------------------------------------------
\98\ See, e.g., sections 10(b), 15(c), and 15(g) of the Exchange
Act; 15 U.S.C. 78j(b), 15 U.S.C. 78o(c), and 15 U.S.C. 78o(g);
section 17(a) of the Securities Act of 1933; 15 U.S.C. 77q(a); 17
CFR 240.10b-5; FINRA Rules 2020 (Use of Manipulative, Deceptive, or
Other Fraudulent Devices), 4530 (Reporting Requirements), 5210
(Publication of Transactions and Quotations); NYSE Rules 2020 (Use
of Manipulative, Deceptive or Other Fraudulent Devices) and 5220
(Disruptive Quoting and Trading Activity Prohibited); Nasdaq General
9, Section 1 (General Standards) and Nasdaq General 9, Section 53
(Disruptive Quoting and Trading Activity Prohibited); and Cboe Rule
8.6 (Manipulation).
\99\ See section 19(g) of the Act; 15 U.S.C. 78s(g).
---------------------------------------------------------------------------
In this regard, exchange SROs and FINRA are able to perform cross-
market surveillance of trading activity in NMS and OTC securities using
the Consolidated Audit Trail (``CAT'') data.\100\ But access to CAT
data does not confer jurisdiction to FINRA over a firm that is not a
FINRA member and that trades those securities off-exchange.\101\ As a
result, a case regarding such a firm may be referred to the Commission
or an exchange where the firm is a member for further investigation
because access to CAT data alone does not enable FINRA to conduct
additional investigative methods, such as collecting documents,
interviewing witnesses, and otherwise investigating the firm to
generate evidence.\102\ Moreover, trading activity in U.S. Treasury
securities is not reported to CAT, so CAT is not a tool that can be
used by SROs to surveil that activity, which, as reflected by the
figures set forth above, is engaged in extensively by some broker-
dealers that are not FINRA members.
---------------------------------------------------------------------------
\100\ Exchange rules require their members to report to CAT,
which is operated by FINRA CAT, LLC, a subsidiary of FINRA. See,
e.g., Cboe BYX Rules 4.5-4.17; Nasdaq General 7; and NYSE Rule 6800.
\101\ See Concept Release Concerning Self-Regulation, supra note
18, 69 FR at 71266 (stating that ``[w]hile the full implementation
of robust intermarket order audit trails would be a significant step
forward, an order audit trail is simply a tool that can be used by
regulators to better surveil for illicit trading activity'' and that
``the SRO regulatory function would still play a critical role in
the regulation of intermarket trading.''). Likewise, the ISG is a
valuable forum for the coordination of regulatory efforts and
sharing of information and serves an important function, but it does
not confer jurisdiction to FINRA over a broker-dealer that is not a
FINRA member and effects off-member-exchange securities
transactions. The ISG also does not create rules or impose
disciplinary actions; rather, the information sharing between
members allows for the proper authority, regulator, or exchange to
pursue appropriate rule changes or pursue legal action on market
participants based on evidence gathered.
\102\ See infra note 140.
---------------------------------------------------------------------------
Exchange SROs and FINRA also have entered into 17d-2 plans \103\
and RSAs. Under these arrangements, as of 2020, FINRA operated a cross-
market regulatory program that covered 100% of U.S. equity market
activity and approximately 45% of options contract volume, and FINRA
also provided market-specific regulatory services to several
exchanges.\104\ The Commission understands that these arrangements have
enhanced regulatory outcomes.\105\ However, neither of these
arrangements creates a requirement for broker-dealers that are not
FINRA members to report their U.S. Treasury securities activity to
TRACE. Moreover, 17d-2 plans are valuable, Commission-approved
arrangements in the context of common members of more than one SRO. A
17d-2 plan among one or more exchange SROs and FINRA would not provide
FINRA with jurisdiction over a firm that is not a FINRA member, as 17d-
2 plans are designed to mitigate duplicative SRO oversight over common
members of more than one SRO with respect to rules that are common
among the SROs. In other words, for FINRA to be named as the DEA for a
firm under a 17d-2 plan, the firm would have to be a FINRA member.\106\
---------------------------------------------------------------------------
\103\ There are 19 effective bilateral plans and 4 multiparty
plans. The 17d-2 plans can be found on the Commission's website at:
<a href="https://www.sec.gov/rules/sro/17d-2.htm">https://www.sec.gov/rules/sro/17d-2.htm</a>.
\104\ See Cross-Market Regulatory Coordination Staff Paper,
supra note 31 (stating that ``[t]he exchanges have relied on FINRA
to perform regulatory functions, including surveillance,
examinations, investigations, and enforcement functions, pursuant to
RSAs and Rule 17d-2 plans. Under these arrangements, FINRA has
developed a cross-market program that covers 100% of U.S. equity
market activity and approximately 45% of options contract volume. In
addition to these cross-market supervision services, FINRA provides
market-specific regulatory services to several exchanges.'') (citing
Letter from Marcia E. Asquith, Executive Vice President, FINRA, to
Vanessa Countryman, Secretary, Commission, dated November 30, 2020).
\105\ See Cross-Market Regulatory Coordination Staff Paper,
supra note 31.
\106\ For example, under a 17d-2 plan among exchange SROs and
FINRA, FINRA is the Designated CAT Surveillance Authority (DCSA) for
members of the exchange SROs and FINRA, and in that capacity assumes
surveillance, investigation and enforcement responsibility relating
to compliance by common members with Rule 613 and the rules of the
SROs regarding compliance with the CAT NMS Plan. See Securities
Exchange Act Release No. 89042 (June 10, 2020), 85 FR 36450 (June
16, 2020) (File No. 4-618). But FINRA is not the DCSA for firms that
are not FINRA members.
---------------------------------------------------------------------------
The Commission therefore understands FINRA's cross-market
regulatory program for equities and options relies on RSAs insofar as
it covers broker-dealers that are not FINRA members.\107\ RSAs can be
used to cover matters or firms that may fall outside the scope of a
17d-2 plan.\108\ While RSAs can serve useful purposes, they generally
are not publicly available, are not subject to Commission approval, and
are voluntary private agreements between SROs that are not mandated by
any Commission rule or statutory obligation and that may expire or be
terminated by the parties.\109\ As a result, to the extent FINRA
oversight is applied to non-FINRA member firms' off-member-exchange
securities trading activity based on RSAs, such oversight relies upon
arrangements between exchanges and FINRA that are discretionary. In
addition, under an RSA, FINRA examines for compliance with the rules of
the exchange that has entered into the RSA. Thus, non-FINRA members
that are members of different exchanges may be subject to different
exchange rules and interpretations when they effect off-member-exchange
securities transactions to the extent these rules and interpretations
are different. This approach is less stable and consistent than a
regulatory regime in which Association membership and oversight is
mandated.
---------------------------------------------------------------------------
\107\ See, e.g., Securities Exchange Act Release No. 89972
(September 23, 2020), 85 FR 61062, 61063 (September 29, 2020)
(amending the 17d-2 plan among exchange SROs and FINRA relating to
the surveillance, investigation, and enforcement of insider trading
rules, which allocates regulatory responsibility to FINRA over
common FINRA members (members of FINRA and at least one of the
exchange SRO participants in the plan), and stating that the
participating exchange SROs will also enter into an RSA to provide
for the investigation and enforcement of suspected insider trading
against broker-dealers that are not common FINRA members).
\108\ See Cross-Market Regulatory Coordination Staff Paper,
supra note 31.
\109\ Unlike with Commission-approved 17d-2 plans, the SRO
paying for regulatory services under an RSA retains ultimate legal
responsibility for and control over the functions allocated to the
service-providing SRO under the RSA. Further, in the context of an
RSA in which an exchange SRO contracts with FINRA for FINRA to
provide regulatory services on behalf of the exchange SRO, FINRA's
oversight of the off-member-exchange trading activity of a non-FINRA
member firm that is a member of the exchange is for compliance with
the exchange's rules, not FINRA's rules.
---------------------------------------------------------------------------
Further, the continued availability of the Rule 15b9-1 exemption
from Association membership detracts from FINRA's off-exchange
securities transaction reporting regime, and in particular, TRACE
reporting for U.S. Treasury securities transactions. The ``covered
ATS'' U.S. Treasury security volumes set forth above may not capture
[[Page 49939]]
all of those firms' U.S. Treasury securities transaction volume.\110\
Broker-dealers that are not FINRA members are not required to report
their U.S. Treasury securities transactions to FINRA's TRACE system
because TRACE reporting obligations for U.S. Treasury securities
transactions apply only to broker-dealers that are FINRA members.\111\
When a non-FINRA member broker-dealer trades U.S. Treasury securities
through a covered ATS, the covered ATS is obligated in its TRACE report
to identify the non-FINRA member via its MPID,\112\ thus providing
visibility to regulators as to what transactions on covered ATSs are
attributable to non-FINRA members. But regulators have no such
visibility when non-FINRA member broker-dealers trade U.S. Treasury
securities on an ATS that is not a covered ATS or otherwise than on an
ATS with a counterparty that also is not a FINRA member. In the former
case, the transaction still must be reported to TRACE but the non-FINRA
member is not specifically identified via a MPID and instead is
identified only as a ``customer''; in the latter case, there is no
TRACE reporting obligation whatsoever.\113\ These circumstances detract
from the comprehensiveness of U.S. Treasury securities TRACE data and
regulators' ability to utilize that data to detect and deter improper
trading activity in the U.S. Treasury securities market. The Commission
cannot quantify total secondary market trading in U.S. Treasury
securities due to the current lack of comprehensive data in U.S.
Treasury securities in TRACE. Moreover, broker-dealers that are not
FINRA members have a potential competitive advantage over those that
are FINRA members and thus incur the costs of reporting transactions in
U.S. Treasury securities transactions.
---------------------------------------------------------------------------
\110\ In the proposal the Commission issued in January 2022 to,
among other things, amend Regulation ATS for ATSs that trade U.S.
government securities, the Commission estimated that there would be
7 trading systems that trade only government securities or
repurchase or reverse repurchase agreements on government securities
and operate pursuant to the Exchange Act Rule 3a1-1(a)(3) exemption
and which would be required to comply with Regulation ATS under the
proposal. See Securities Exchange Act Release No. 94062 (January 26,
2022), 87 FR 15496, 15523 (March 18, 2022).
\111\ See FINRA Rule 6720--Participation in TRACE. Beginning
September 1, 2022, certain depository institutions will be required
to report to TRACE transactions in U.S. Treasury securities, agency
debt securities and agency mortgage-backed securities. See
<a href="http://FINRA.org">FINRA.org</a>, Federal Reserve Depository Institution Reporting to
TRACE, available at <a href="https://www.finra.org/filing-reporting/trace/federal-reserve-depository-institution-reporting">https://www.finra.org/filing-reporting/trace/federal-reserve-depository-institution-reporting</a> (last visited July
22, 2022).
\112\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities, supra note 16.
\113\ In addition, in the context of an NMS stock transaction
effected between a FINRA member and a non-FINRA member otherwise
than on an exchange, only the FINRA member is obligated to report
the transaction to the FINRA TRF and the non-FINRA member generally
is not identified on the trade report as the contra party to the
trade. See Trade Reporting Frequently Asked Questions, Reporting
Relationships and Responsibilities, Section 202: Reporting Trades
with a Non-FINRA Member, available at: <a href="https://www.finra.org/filing-reporting/market-transparency-reporting/trade-reporting-faq#202">https://www.finra.org/filing-reporting/market-transparency-reporting/trade-reporting-faq#202</a>
(last visited July 22, 2022). The non-FINRA member is, however,
identified in CAT in this context.
---------------------------------------------------------------------------
Accordingly, the Commission is proposing to update Rule 15b9-1 such
that proprietary trading firms that are registered broker-dealers
generally must join FINRA, pursuant to Section 15(b)(8) of the Act, if
they effect securities transactions otherwise than on an exchange of
which they are a member. The Commission preliminarily believes that
amending Rule 15b9-1 so that broker-dealer proprietary trading firms
generally would be required to join FINRA if they trade elsewhere than
on an exchange where they are a member would address the above-
described issues by subjecting such firms to FINRA's direct,
membership-based jurisdiction and rules, including FINRA's TRACE
reporting regime for U.S. Treasury security transactions. This would be
consistent with the Exchange Act's statutory framework for
complementary exchange SRO and Association oversight of broker-dealer
trading activity, in which Section 15(b)(8) requires broker-dealers to
join an Association if they effect securities transactions elsewhere
than an exchange where they are a member. Amending Rule 15b9-1 in this
way also would modernize the rule in a manner that is consistent with
how proprietary trading occurs today and that promotes Section
15(b)(9)'s requirement that any exemption from Section 15(b)(8) be
consistent with the public interest and protection of investors. The
Commission believes that direct, membership-based FINRA oversight over
and the application of FINRA's securities transaction reporting
requirements to firms that effect off-member-exchange securities
transactions would create more effective SRO oversight over their off-
member-exchange securities trading activity and therefore promote the
protection of investors and the public interest.
As discussed above,\114\ the Exchange Act requires dual SRO and
Commission oversight of registered broker-dealers, with SROs acting as
robust, front-line regulators of their broker-dealer members. The
Commission may bring enforcement actions, including pursuant to
referrals made by SROs, to enforce broker-dealers' compliance with the
Exchange Act and applicable rules, and SROs have regulatory authority
over their members pursuant to the Exchange Act. Moreover, Section
15(b)(8)'s complementary SRO oversight structure generally has enabled
exchange SROs to specialize in oversight of securities trading activity
that occurs on the exchange, and FINRA to specialize in oversight of
cross-market, off-member-exchange securities trading activity. The
Commission believes that rescinding Rule 15b9-1's de minimis allowance
and proprietary trading exclusion would better enable robust and
consistent FINRA oversight in the area of its expertise through direct,
membership-based jurisdiction of broker-dealers that effect off-member-
exchange securities transactions proprietarily. This, in turn, could
strengthen the front-line layer of SRO regulatory oversight that is
applied to off-member-exchange proprietary securities trading in
today's market.
---------------------------------------------------------------------------
\114\ See section II.A, supra.
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Requests for Comment
The Commission requests comment on all aspects of the foregoing
background discussion as well as, in particular, on the following
questions:
1. Is the Commission's estimate of the number of broker-dealers
that are exchange members but not FINRA members still accurate as of
the time of publication of this re-proposal? Is it too high or too low?
Are there broker-dealers that were not FINRA members as of April 2022
that have since joined FINRA? Please explain.
2. Are the Commission's estimates of the securities transaction
volumes attributable to non-FINRA member broker-dealers accurate? If
not, why are they inaccurate? Are there any uncertainties associated
with such estimates?
3. Do exchange SROs directly exercise their SRO authority with
respect to off-member-exchange securities trading activity by their
members? If so, how have exchange SROs exercised their authority in
this regard? In particular, how, if at all, have exchange SROs sought
to exercise SRO authority over off-member-exchange securities trading
activity conducted by their broker-dealer members that are not FINRA
members? Have exchange SROs sought to exercise authority over U.S.
Treasury securities trading activity by their members? Please explain
and provide examples, if possible.
4. Do RSAs or other cooperative arrangements among SROs cover the
[[Page 49940]]
U.S. Treasury securities trading activity conducted by broker-dealers
that are exchange members but not FINRA members? If so, please specify
the arrangements and how they work, including any limitations
associated with such arrangements.
5. Is the Commission's understanding correct that FINRA's cross-
market regulatory program for equities and options is based on RSAs
insofar as it covers broker-dealers that are not FINRA members? If not,
how are broker-dealers that are not FINRA members covered?
C. 2015 Proposal
The Commission previously proposed to amend Rule 15b9-1 in March
2015.\115\ The 2015 Proposal would have eliminated the de minimis
allowance and proprietary trading exclusion from the rule, and added
language to the rule that more closely tracked Section 15(b)(8) in
providing an exemption from Section 15(b)(8)'s Association membership
requirement only for a broker or dealer that carries no customer
accounts and effects transactions in securities solely on a national
securities exchange of which it is a member except in certain limited
circumstances.\116\ The Commission did not adopt the 2015 Proposal but,
as discussed above, remains concerned that proprietary trading dealer
firms' reliance on the Rule 15b9-1 exemption from Association
membership undermines the effectiveness of the SRO regulatory structure
and SRO oversight of the securities markets as envisioned by Congress
in the Exchange Act. Therefore, today the Commission is re-proposing
amendments to Rule 15b9-1 that are similar to what was proposed in
2015, but modified in certain respects in light of the Commission's
further consideration of what set of circumstances would continue to be
appropriate for an exemption from Association membership in today's
market, which consideration is informed by comments on the 2015
Proposal.\117\
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\115\ See 2015 Proposing Release, supra note 6, 80 FR 18036-37.
\116\ The 2015 Proposal would have provided exemptions from
Association membership for a dealer that is an exchange member,
carries no customer accounts, and effects transactions elsewhere
than an exchange of which it is a member solely for the purpose of
hedging the risks of its floor-based activity; or for a broker or
dealer that is an exchange member, carries no customer accounts, and
effects transactions elsewhere than an exchange of which it is a
member that result from orders that are routed by a national
securities exchange of which it is a member to prevent trade-
throughs, consistent with the provisions of Rule 611 of Regulation
NMS. As discussed below, the Commission is re-proposing herein that
amended Rule 15b9-1 set forth a modified version of that routing
exemption but is not including in this re-proposal a hedging
exemption outside the context of stock-option orders.
\117\ See supra note 17.
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III. Discussion of Amendments to Rule 15b9-1
As a general matter, the result under the amended version of Rule
15b9-1 being proposed today would be the same as under the 2015
Proposal: a broker or dealer would be required to join an Association
if it effects transactions in securities elsewhere than on an exchange
to which it belongs as a member, unless it can rely upon one of the
amended rule's narrow exceptions.\118\ Conversely, a broker or dealer
would not need to become a member of an Association if it effects
securities transactions only on an exchange of which it is a
member.\119\ The Commission preliminarily believes that these outcomes
would enhance SRO regulatory oversight in a manner that promotes
Section 15(b)(8) of the Act and the public interest and investor
protection requirements of Section 15(b)(9) of the Act by enabling
direct Association oversight of off-member-exchange broker-dealer
proprietary trading activity. Several commenters supported the 2015
Proposal.\120\ Some commenters questioned the necessity of expanded
FINRA oversight.\121\
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\118\ See proposed Rule 15b9-1; see also 2015 Proposing Release,
supra note 6.
\119\ See section 15(b)(8) of the Act. If a broker or dealer is
a member of multiple exchanges and effects securities transactions
only on those exchanges, those exchanges could enter into an RSA to
ensure effective cross-market supervision of this activity. The
Commission acknowledges that in the future another SRO could assume
these responsibilities pursuant to 17d-2 plans, subject to
Commission approval. In addition, a given exchange may choose to
enter into an RSA with an Association, as some exchanges have now.
In those cases, the exchange maintains the ultimate responsibility
for the contracted regulatory responsibilities.
\120\ See, e.g., Letters from: Ryan W. Porter, Founder, High
Amplitude Capital Trading (March 28, 2015) (``Porter Letter'') at 1;
Chris Barnard (May 20, 2015) (``Barnard Letter'') at 1 (stating that
the proposal would ``improve the consistency and effectiveness of
regulatory supervision; reduce the existing differential regulatory
burden of Member Firms and Non-Member Firms; and promote firms to
compete more equitably to supply liquidity both on exchanges and
off-exchange.''); Claudia Crowley, Chief Regulatory Officer, IEX
Group, Inc. (May 22, 2015) (``IEX Letter'') at 2 (stating that there
is a need to update the exemption in Rule 15b9-1 to better align it
with its original intent and ``better reflect current market
technology and practices'' which would result in ``more
comprehensive and consistent regulatory oversight of off-exchange
market activity.''); Marcia E. Asquith, Senior Vice President and
Corporate Secretary, FINRA (June 2, 2015) (``FINRA Letter'') at 9-
10; Theodore R. Lazo, Managing Director and Associate General
Counsel, SIFMA (June 1, 2015) (``SIFMA Letter'') at 1; Angelo
Evangelou, Associate General Counsel, Legal Division, Cboe (June 10,
2015) (``Cboe Letter'') at 1 (supporting the proposal ``insofar as
the rulemaking seeks to require FINRA membership of proprietary
firms whose primary business is executing transactions off-
exchange.''); and Elliot Grossman, Managing Director, Dinosaur
Securities (Sep. 15, 2015) (``Dinosaur Letter'') at 2.
\121\ See infra notes 125-127 and accompanying text.
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As noted above, Rule 15b9-1 currently exempts any broker or dealer
from membership in an Association if it is a member of a national
securities exchange, carries no customer accounts, and has annual gross
income of no more than $1,000 that is derived from purchases or sales
of securities effected otherwise than on an exchange of which it is a
member.\122\ Under the rule's proprietary trading exclusion, income
derived from transactions for a dealer's own account with or through
another registered broker or dealer is excluded from the de minimis
allowance.\123\
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\122\ 17 CFR 240.15b9-1(a).
\123\ 17 CFR 240.15b9-1(b)(1). The current rule also states that
the de minimis allowance does not apply to income derived from
transactions through the Intermarket Trading System (``ITS''), and
defines the term ``Intermarket Trading System'' for purposes of the
rule. 17 CFR 240.15b9-1(b)(2) and (c). ITS was a national market
system plan (``NMS Plan'') that was eliminated in 2007 because it
was superseded by Regulation NMS. See infra notes 159-168 and
accompanying text. Since Rule 15b9-1's references to ITS are now
obsolete, as in the 2015 Proposal, the Commission is re-proposing to
eliminate these references from the rule.
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The Commission is proposing to eliminate the de minimis allowance
and the proprietary trading exclusion, and continue to allow an
exemption from Association membership only for a registered broker or
dealer that is an exchange member, carries no customer accounts, and
effects securities transactions solely on a national securities
exchange of which it is a member except in two narrow circumstances:
(1) a broker or dealer effects transactions in securities otherwise
than on an exchange to which it belongs as a member that result solely
from orders that are routed by an exchange of which it is a member in
order to comply with Rule 611 of Regulation NMS or the Options Order
Protection and Locked/Crossed Market Plan; or (2) a broker or dealer
effects transactions in securities otherwise than on an exchange to
which it belongs as a member that are solely for the purpose of
executing the stock leg of a stock-option order. In the subsections
below, the Commission discusses each element of the re-proposed rule in
detail.
A. Elimination of the De Minimis Allowance and Proprietary Trading
Exclusion
As in the 2015 Proposal, today the Commission is re-proposing to
delete paragraphs (a)(3) and (b) from Rule
[[Page 49941]]
15b9-1.\124\ This would eliminate the de minimis allowance and
proprietary trading exclusion. As a result, under Rule 15b9-1 as
amended, any broker or dealer required by Section 15(b)(8) of the Act
to become a member of an Association would be exempt from that
requirement only if it is a member of a national securities exchange,
carries no customer accounts, and any securities transactions that it
effects elsewhere than on an exchange of which it is a member meet the
limited criteria set forth in proposed paragraph (c) of the amended
rule, which are discussed in detail below. The re-proposed elimination
of the de minimis allowance and proprietary trading exclusion would
generally preclude proprietary trading firms that are registered with
the Commission pursuant to Section 15 of the Act and conduct off-
member-exchange securities trading from relying on Rule 15b9-1 as an
exemption from Section 15(b)(8)'s Association membership requirement.
Therefore, pursuant to Section 15(b)(8), they would be required to
become a member of an Association unless they effect transactions in
securities solely on an exchange of which they are a member.
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\124\ The Commission also is proposing to renumber the
paragraphs that remain in the amended rule.
---------------------------------------------------------------------------
Some commenters on the 2015 Proposal questioned the necessity and
appropriateness of the expanded FINRA oversight that would result from
the then-proposed elimination of the de minimis allowance and
proprietary trading exclusion. Their concerns centered on assertions
that exchange oversight may be more effective than FINRA
oversight,\125\ FINRA membership would result in duplicative regulation
for certain firms,\126\ and FINRA regulation is customer-focused and
therefore not appropriate for proprietary trading firms that do not
carry customer accounts.\127\
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\125\ See, e.g., Letters from: Mary Ann Burns, Chief Operating
Officer, FIA Principal Traders Group (June 1, 2015) (``FIA 2
Letter'') at 4; Joanne Moffic-Silver, Executive Vice President,
General Counsel and Corporate Secretary, Cboe, Elizabeth K. King,
Secretary and General Counsel, NYSE, Joan C. Conley, Senior Vice
President and Corporate Secretary, NASDAQ OMX Group, Inc., (June 1,
2015) (``Cboe/NYSE/Nasdaq Letter'') at 2; James Ongena, Senior Vice
President and General Counsel, Chicago Stock Exchange (June 1, 2015)
(``CHX Letter'') at 2; Jay Coppoletta, Chief Legal Officer, PEAK6
Capital Management LLC (June 1, 2015) (``PEAK6 Letter'') at 2; Frank
A. Bednarz, Global Co-Head of Trading, CTC Trading Group, LLC (June
1, 2015) (``CTC Letter'') at 2-3.
\126\ See, e.g., Letters from: Mark E. Gannon, Chief Compliance
Officer, Lakeshore Securities, LP (June 4, 2015) (``Lakeshore
Letter'') at 2-3; Mark Schepps, General Counsel and Senior Director
of Compliance, D&D Securities, Inc. (May 29, 2015) (``D&D Letter'')
at 3.
\127\ See, e.g., CTC Letter at 2-3; PEAK6 Letter at 2; Letter
from Gregory F. Hold, CEO, Hold Brothers Capital LLC (June 1, 2015)
(``Hold Brothers Capital Letter'') at 2.
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The Commission continues to believe, however, that in today's
market the de minimis allowance and proprietary trading exclusion are
no longer appropriate, and that direct Association regulation generally
of broker-dealers' off-member-exchange securities trading activity,
consistent with what Congress envisioned in Section 15(b)(8) of the
Act, would promote the protection of investors and the public interest
pursuant to Section 15(b)(9) of the Act. As discussed above, the de
minimis allowance and proprietary trading exclusion originally were
intended to permit a type of off-exchange activity that no longer
occurs today.\128\ When the Commission adopted Rule 15b9-1 and then the
proprietary trading exclusion, virtually all trading activity was
conducted manually on the floors of national securities exchanges.\129\
Today's market structure is dramatically different--proprietary, cross-
market order routing and trading strategies are a significant component
of the markets, and exchange floor-based businesses represent only a
fraction of market activity. Despite this transformative shift in how
trading is conducted, the de minimis allowance and proprietary trading
exclusion set forth in Rule 15b9-1 have never been adjusted.
---------------------------------------------------------------------------
\128\ See supra note 60 and accompanying text. The Commission is
unaware of any floor members today that refer accounts to other
broker-dealers in exchange for a share of commission revenues.
\129\ See, e.g., Special Study, supra note 62, at 98 (``Trading
by NYSE members on the Exchange but from off the floor accounts for
approximately 5 percent of total Exchange purchases and sales . .
.'').
---------------------------------------------------------------------------
Rule 15b9-1's stasis notwithstanding the market's transformation
has led to a misalignment in the complementary regulatory structure
contemplated by Congress since FINRA does not have direct, membership-
based jurisdiction over off-member-exchange securities trading activity
by broker-dealers that are not FINRA members. The Exchange Act
established the concept of an Association as the regulator of such
trading activity,\130\ a role currently fulfilled by FINRA, which also
is the SRO to which off-exchange trades are reported.\131\ As noted
above, as of April 2022 there were approximately 65 brokers or dealers
that were not FINRA members, including active proprietary trading
firms, which accounted for a significant percentage of off-exchange
equities and U.S. Treasury securities transaction volumes, as well as a
significant amount of transaction volume on exchanges where they are
not a member.\132\ The Commission is concerned that the current cross-
market regulatory program applied to such firms' off-member-exchange
securities trading activity--which the Commission understands is
dependent on RSAs--is not as stable or consistent as direct,
membership-based Association oversight through FINRA membership in
addressing any such trading activity and does not trigger FINRA's off-
exchange transaction reporting obligations for such firms. Under the
amended rule, the 65 firms identified above generally would not be
exempt from Section 15(b)(8) of the Act and therefore would be required
to join FINRA (unless they qualify for one of the amended rule's
exceptions), the only Association currently, to the extent that they
effect securities transactions elsewhere than an exchange where they
are a member. The Commission believes that direct, membership-based
FINRA oversight over and the application of FINRA's securities
transaction reporting requirements to such firms would create more
effective SRO oversight over their off-member-exchange securities
trading activity and therefore promote the protection of investors and
the public interest.
---------------------------------------------------------------------------
\130\ See 15 U.S.C. 78o(b)(8).
\131\ See supra notes 40-43 and accompanying text.
\132\ See supra notes 79-94 and accompanying text.
---------------------------------------------------------------------------
Contrary to certain commenters' suggestion that FINRA oversight of
proprietary trading firms is not necessary since they do not carry
customer accounts, FINRA has established a regulatory regime for
broker-dealers that effect off-member-exchange securities transactions
that applies to FINRA members regardless of whether they handle
customer orders or carry customer accounts. For example, FINRA has
developed a detailed set of rules in core areas such as trading
practices,\133\ business conduct,\134\
[[Page 49942]]
financial condition and operations,\135\ and supervision,\136\ many of
which apply to FINRA members regardless of whether they handle customer
orders or carry customer accounts.\137\ FINRA's ability to create a
consistent regulatory framework for all such broker-dealers that effect
securities transactions elsewhere than on exchanges where they are a
member, including the off-exchange market, is undermined by the subset
of such broker-dealers that are not FINRA members in reliance on Rule
15b9-1. Moreover, part of FINRA's regulatory framework is its
transaction reporting regime, and it is not customer-focused--it
applies to FINRA members regardless of whether they handle customer
orders or carry customer accounts.\138\ Continuing to permit an
exemption from FINRA membership on the basis that dealers that, for
example, trade U.S. Treasury securities proprietarily do not have
customers would not help improve the comprehensiveness of U.S. Treasury
securities transaction reporting to TRACE or address the potential
competitive advantage of non-FINRA members that, unlike FINRA members,
may trade U.S. Treasury securities without reporting those
transactions.
---------------------------------------------------------------------------
\133\ See FINRA Rule 5000 Series--Securities Offerings and
Trading Standards and Practices. For instance, FINRA prohibits
members from coordinating prices and intimidating other members. See
FINRA Rule 5240(a), providing, among other things, that ``[n]o
member or person associated with a member shall: (1) coordinate the
prices (including quotations), trades or trade reports of such
member with any other member or person associated with a member, or
any other person; (2) direct or request another member to alter a
price (including a quotation); or (3) engage, directly or
indirectly, in any conduct that threatens, harasses, coerces,
intimidates or otherwise attempts improperly to influence another
member, a person associated with a member, or any other person.''
\134\ See FINRA Rule 2000 Series--Duties and Conflicts, supra
note 38.
\135\ See FINRA Rule 4000 Series--Financial and Operational
Rules. For example, FINRA Rule 4370(a) provides, among other things,
that ``[e]ach member must create and maintain a written business
continuity plan identifying procedures relating to an emergency or
significant business disruption. Such procedures must be reasonably
designed to enable the member to meet its existing obligations to
customers. In addition, such procedures must address the member's
existing relationships with other broker-dealers and counter-
parties. The business continuity plan must be made available
promptly upon request to FINRA staff.''
\136\ See FINRA Rule 3000 Series--Supervision and
Responsibilities Relating to Associated Persons. This rule series
generally requires FINRA member firms, among other things, to
establish, maintain, and enforce written procedures to supervise the
types of business in which the firm engages and the activities of
its associated persons that are reasonably designed to achieve
compliance with applicable securities laws and regulations, and with
applicable FINRA rules. See e.g., FINRA Rules 3110 (Supervision),
3120 (Supervisory Control System), and 3170 (Tape Recording of
Registered Persons by Certain Firms). See also FINRA By-Laws Article
III--Qualifications of Members and Associated Persons. Any person
associated with a member firm who is engaged in the securities
business of the firm--including partners, officers, directors,
branch managers, department supervisors, and salespersons--must
register with FINRA.
\137\ See, e.g., the FINRA rules set forth in notes 38-43 and
133-136 supra and accompanying text.
\138\ See FINRA Rule 6000 Series (Quotation, Order, and
Transaction Reporting Facilities), supra note 40.
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In addition, an Association's regulatory responsibility, like
exchange SROs', includes an obligation to monitor for operational and
regulatory issues, as well as issues relating to market
disruptions.\139\ The inability of FINRA to directly enforce regulatory
compliance by non-FINRA member proprietary trading firms--whether or
not they handle customer orders or carry customer accounts--may create
a risk to the fair and orderly operation of the market because, for
example, if FINRA were to detect that a non-FINRA member is effecting
off-member-exchange securities transactions that are not in compliance
with the Exchange Act or applicable rules, FINRA would not have direct,
membership-based jurisdiction to directly address the behavior.\140\
This is the case regardless of whether the firm has customers. And as
discussed above,\141\ the Commission believes that RSA-based regulatory
efforts among exchange SROs and FINRA, while beneficial in many
contexts, are a less stable and consistent mechanism for SRO oversight
than the Association membership required by the Exchange Act in the
context presented here.
---------------------------------------------------------------------------
\139\ 15 U.S.C. 78o-3.
\140\ FINRA could refer such a matter to the Commission. See,
e.g., Statement of Robert W. Cook, President and CEO, FINRA,
``Equity Market Surveillance Today and the Path Ahead'' (Sep. 20,
2017), available at <a href="https://www.finra.org/media-center/speeches-testimony/equity-market-surveillance-today-and-path-ahead">https://www.finra.org/media-center/speeches-testimony/equity-market-surveillance-today-and-path-ahead</a> (stating
that FINRA makes referrals to the Commission or other authorities if
the target of an investigation is beyond the collective jurisdiction
of FINRA and the exchanges, and that in a prior year FINRA's market
regulation department made over 500 referrals to the Commission on
behalf of FINRA and its exchange clients related to potential
abusive trading strategies or other rule violations). FINRA also
could refer such a matter to an exchange where the firm is a member
or, as discussed above, potentially address the matter through an
RSA if covered by the terms of the RSA.
\141\ See supra Section II.B. As is also discussed above, while
the Commission can bring enforcement actions, including pursuant to
SRO referrals, that Commission layer of regulatory oversight is
meant to work in tandem with, not in place of, a robust front-line
layer of SRO oversight. See supra Sections II.A and II.B.
---------------------------------------------------------------------------
Moreover, contrary to commenters' assertions, the Commission does
not preliminarily believe that exchange oversight alone would be more
effective at remedying the above-described issues than direct FINRA
oversight of off-member-exchange securities trading activity through
the Association membership envisioned by Congress, or that FINRA
membership would result in duplicative regulation for broker-dealer
proprietary trading firms. The imposition of FINRA rules on such firms
would require them to report their U.S. Treasury securities
transactions under FINRA's TRACE reporting regime. It also would
require that such firms be identified in off-exchange NMS stock
transaction reports to FINRA's TRFs,\142\ and thus promote broader
public market transparency in NMS stocks.\143\ Firms that are not FINRA
members generally are not identified in TRF transaction reports.\144\
Moreover, FINRA registration would confer jurisdiction to FINRA to
regulate directly off-member-exchange trading activity as Congress
envisioned in Section 15(b)(8) of the Act, to apply a more consistent
regulatory framework to such trading activity, and to mitigate the
risks to the fair and orderly operation of the market that stem from
FINRA's current lack of direct oversight of non-FINRA members. Further,
due to FINRA's experience and expertise in cross-market supervision,
the Commission preliminarily believes that FINRA is well-positioned to
assume direct jurisdiction over dealer firms that currently are not
FINRA members and effect securities transactions elsewhere than
exchanges where they are a member.\145\ As for the potential for
[[Page 49943]]
duplicative SRO oversight, to the extent such firms also effect
securities transactions on exchanges where they are a member, 17d-2
plans are designed to mitigate duplicative SRO oversight over common
members.
---------------------------------------------------------------------------
\142\ See supra note 42 and accompanying text.
\143\ See FINRA Rule 6000 Series--Quotation, Order, and
Transaction Reporting Facilities and FINRA Rule 7000 Series--
Clearing, Transaction and Order Data Requirements, and Facility
Charges, supra note 40; see also note 112 and accompanying text.
\144\ See supra note 113.
\145\ One commenter stated that the costs of cross-market
surveillance ``are appropriately funded by exchanges as regulators
of their markets and FINRA as the regulator of the off-exchange
market.'' See Letter from Adam Nunes, Head of Business Development,
Hudson River Trading LLC (June 1, 2015) (``HRT Letter'') at 9. This
commenter further stated that the Commission should not ``attempt to
address cross-market surveillance by forcing all broker-dealers to
become members of FINRA'' and should attempt to ``ensure that cross-
market surveillance is not dependent on exchanges outsourcing
exchange regulation to FINRA, as it leads to the possibility that
changes to RSAs and 17d-2 agreements could substantially degrade the
ability to perform appropriate cross-market surveillance.'' Id. This
commenter also weighed the appropriateness of subjecting all broker-
dealers to FINRA oversight and the benefits of regulatory
standardization against potential negatives associated with having a
single regulator. Id. at 9-11. See also CHX Letter at 1-2 (stating
concern about a single point of failure in regulatory surveillance
and oversight practices). As discussed above, in the specific
context of broker-dealers that are not FINRA members and that effect
off-member-exchange securities transactions, the Commission believes
that cross-market surveillance is not performed via 17d-2 plans and
should not be dependent on RSAs. See supra Sections II.A and II.B
(discussing, among other things, that Commission approval of a 17d-2
plan relieves an SRO of the regulatory responsibilities allocated by
the plan to another SRO but only with respect to common members of
the participating SROs, and that RSAs' coverage is not limited to
common members of the participating SROs but RSAs are discretionary
arrangements among SROs that do not relieve the SRO contracting for
regulatory services of ultimate regulatory responsibility over its
members). Moreover, consistent with section 15(b)(8) of the Act,
broker-dealers that do not effect securities transactions otherwise
than on an exchange where they are a member would not be required to
join FINRA. In addition, as re-proposed and discussed below, Rule
15b9-1 would continue to provide certain narrow exemptions from
section 15(b)(8)'s Association membership requirement for broker-
dealers that do effect securities transactions otherwise than on an
exchange where they are a member. Thus, the Commission does not
believe it is necessarily the case that all broker-dealers would be
required to join FINRA as a result of the proposal.
---------------------------------------------------------------------------
Some commenters on the 2015 Proposal also contended that the
availability of CAT data would mitigate the need to subject proprietary
trading firms to FINRA SRO oversight.\146\ As discussed above, the
Commission preliminarily believes that the NMS and OTC securities data
available to SROs through the CAT NMS Plan are helpful tools, but such
access does not confer jurisdiction to FINRA over a firm that is not a
FINRA member and that trades those securities off-exchange, or ensure
that an individual exchange SRO of which such a firm is a member would
seek to enforce compliance with its rules, Commission rules or Federal
securities laws with respect to the firm's off-member-exchange
activity.\147\ Even if one or more exchanges of which a broker-dealer
is a member and FINRA could coordinate SRO oversight of the non-FINRA
member firm's off-member-exchange securities trading activity through
the use of CAT data and RSAs, performing SRO oversight in this manner
is less certain and stable than direct Association oversight of such
trading activity due to the discretionary nature of RSAs, and
frustrates the regulatory scheme established by Congress in which an
Association directly regulates broker-dealers that effect securities
transactions elsewhere than exchanges where they are a member.\148\
Further, CAT reporting obligations do not apply to U.S. Treasury
securities, U.S. Treasury securities are not traded on any exchange,
and to the Commission's knowledge, unlike FINRA,\149\ no exchange SRO
possesses the expertise or proclivity to exert SRO oversight over their
members' U.S. Treasury securities trading activity. Access to CAT data
would not shed light on firms' U.S. Treasury securities trading
activity or provide exchanges or FINRA with any ability to monitor that
activity.
---------------------------------------------------------------------------
\146\ See, e.g., CHX Letter at 2.
\147\ See supra Section II.B.
\148\ See 2015 Proposing Release, supra note 6, 80 FR 18039 at
notes 28-33 and accompanying text describing the regulatory history
of off-exchange trading. See also Cross-Market Regulatory
Coordination Staff Paper, supra note 31 (stating that ``[w]hile
multiple SROs reviewing the same securities activities can have
benefits, in that the resources and expertise from several
organizations can be brought to bear on assessing these activities,
it also can lead to duplication and inefficiencies in the regulatory
process and increased burdens on member firms.''). FINRA and the
exchange SROs have a history of coordinating and can work together
to address concerns of firms that are receiving duplicative
regulatory requests such as through the Cross Market Regulatory
Working Group. Id.
\149\ See supra notes 32-33 and accompanying text.
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As is discussed in more detail in the Economic Analysis, firms that
must become FINRA members would become subject to the fees charged by
FINRA to all of its member firms. FINRA charges each member firm
certain regulatory fees designed to recover the costs to FINRA of the
supervision and regulation of members, including performing
examinations, financial monitoring, and policy, rulemaking,
interpretive, and enforcement activities.\150\ These regulatory fees
include a Trading Activity Fee (``TAF''),\151\ which, at the time of
the 2015 Proposal, was a primary source of commenter concern over the
costs of FINRA membership that would be borne by proprietary trading
firms.\152\
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\150\ FINRA Schedule A to the By-Laws of the Corporation
(``FINRA Schedule A''), at Section 1.
\151\ FINRA uses the TAF to recover the costs to FINRA of the
supervision and regulation of members, including performing
examinations, financial monitoring, and policy, rulemaking,
interpretive, and enforcement activities. See FINRA Schedule A,
Section 1(a), available at <a href="https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees">https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees</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). Many of the broker-dealers that could be required to join
FINRA if the proposed amendments to Rule 15b9-1 are adopted effect
securities transactions in large volumes throughout the national
market system, and often in a capacity other than as a registered
market-maker. See also infra note 241 and accompanying text for
further discussion of the TAF.
\152\ See, e.g., Letter from Mary Ann Burns, Chief Operating
Officer, FIA (May 6, 2015) (``FIA 1 Letter'') at 1, PEAK6 Letter at
2, Hold Brothers Capital Letter at 2, Lakeshore Letter at 2, CTC
Letter at 5-6, D&D Letter at 2, Mark Schepps, General Counsel and
Senior Director of Compliance, PTR, Inc. (May 29, 2015) (``PTR
Letter'') at 2, Letter from Eric Chern, CEO, CTC Trading Group,
L.L.C., Andrew Killion, CEO, Akuna Capital LLC, Thomas Hutchinson,
President, Belvedere Trading LLC, Steven J. Gaston, Chief Compliance
Officer, Consolidated Trading LLC, Trent Cutler, CEO, Cutler Group
LP, John Kinahan, CEO, Group One Trading, L.P., Marc Liu, CEO,
Integral Derivatives LLC, Craig S. Donohue, Executive Chairman, The
Options Clearing Corporation, Sebastiaan Koeling, CEO, Optiver US,
LLC, Andrew Tourney, Chief Compliance Officer, Peak6 Investments,
L.P., Brian Donnelly, CEO, Volant Trading (July 13, 2016) (``Options
Market Makers Letter'') at 6, and FIA 2 Letter at 5.
---------------------------------------------------------------------------
Shortly after the Commission published the 2015 Proposal, FINRA
issued a Regulatory Notice proposing to amend the TAF such that it
would not apply to transactions by a proprietary trading firm effected
on exchanges of which the firm is a member.\153\ FINRA stated in its
Regulatory Notice that it would implement the TAF amendments to
coincide with the compliance date of amendments to Rule 15b9-1. Given
FINRA's prior consideration of amendments to its TAF, FINRA may again
evaluate its TAF to ensure that it appropriately reflects the
activities of, and regulatory responsibilities towards, broker-dealer
proprietary trading firms that would be required to join FINRA if the
proposed amendments to Rule 15b9-1 are adopted.\154\
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\153\ See FINRA Regulatory Notice 15-13, Trading Activity Fee
(May 2015), available at <a href="http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-13.pdf">http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-13.pdf</a>. FINRA, in its
Regulatory Notice, stated that it analyzed the potential application
and impact of the TAF to proprietary trading firms and believed it
could result in a significant TAF obligation for these firms that
may be disproportionate to FINRA's anticipated costs associated with
the financial monitoring and trading surveillance of these firms, in
large part because these firms do not have customers. Id. By way of
example, FINRA stated that it conducts reviews for best execution
(FINRA Rule 5310), trading ahead of customer orders (FINRA Rule
5320), and display of customer limit orders (Exchange Act Rule 604),
all of which are directed at firms that have customers or receive
orders from customers of another broker-dealer. Id. To the extent
that firms that join FINRA do not carry customer accounts, FINRA
would not have to surveil such firms for compliance with these
rules. The objective of the contemplated TAF amendment, according to
FINRA, would be to tailor the TAF to FINRA's anticipated costs
associated with the financial monitoring and trading surveillance of
those firms that would be required to become FINRA members as a
result of the Commission's proposed amendments.
\154\ Commenters on the 2015 Proposal addressed the costs of
FINRA membership, with some suggesting that the costs would be
burdensome for proprietary trading firms. See, e.g., FIA 1 Letter at
1 (``FINRA Membership would be costly to most proprietary trading
firms''); PEAK6 Letter at 2 (``[FINRA registration is] overly costly
and burdensome''); Hold Brothers Capital Letter at 2 (``[Costs of
FINRA membership] would be unduly burdensome to smaller, less well
funded Proprietary Traders''); Lakeshore Letter at 2-3; CTC Letter
at 5-6; D&D Letter at 2; PTR Letter at 2; Options Market Makers
Letter at 6; FIA 2 Letter at 5. Commenters also previously expressed
concern that the application of the TAF in its current form to
proprietary trading firms would be overly burdensome, but suggested
that FINRA's proposed TAF amendment would mitigate this concern.
See, e.g., HRT Letter at 5-6; FIA 1 Letter at 2; IEX Letter at 3;
CTC Letter at 5; PEAK6 Letter at 3. Some commenters suggested a
modification to FINRA's proposed amendment that would exclude from
the TAF all of a firm's proprietary trading activity on an exchange
of which it is a member. See, e.g., HRT Letter at 11. Apart from the
TAF as it currently exists, the Commission does not believe that
broker-dealer firms that join FINRA if proposed Rule 15b9-1 is
adopted would be disproportionately impacted by the costs of FINRA
membership compared to existing FINRA members that already incur
those costs, and as discussed in the Economic Analysis, the
Commission preliminarily believes that the costs would be justified
by the considerable benefits of this proposal. In addition, some
firms that could rely on Rule 15b9-1 nevertheless join FINRA
voluntarily, which suggests that there are business interests
satisfied by and benefits derived from FINRA membership that
outweigh the costs of being a FINRA member, for at least some firms.
Some commenters also raised the concern that FINRA may get paid
twice for its regulatory oversight--once, directly from the FINRA
membership, and again from the SROs that have outsourced regulatory
oversight to FINRA through RSA agreements. See, e.g., SIFMA Letter
at 3 and Lakeshore Letter at 3. The Commission notes that, as
privately negotiated agreements between SROs, the fees set forth in
RSAs are not subject to FINRA's rules or Commission review, and RSAs
may be revised or terminated by the SRO parties thereto. By
contrast, FINRA's rule-based fees are governed by Section 15A of the
Act, which requires that they be equitably allocated among FINRA
members and reasonable.
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[[Page 49944]]
On March 28, 2022, the Commission proposed changes to the
definition of ``dealer'' and ``government securities dealer,'' within
the meaning of Sections 3(a)(5) and 3(a)(44) of the Exchange Act,
respectively.\155\ We encourage commenters to review that proposal to
determine whether it might affect their comments on this proposing
release.
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\155\ See Securities Exchange Act Release No. 94524 (March 28,
2022), 87 FR 23054 (April 18, 2022).
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Requests for Comment
The Commission requests comment on all aspects of the proposed
elimination of the de minimis allowance and proprietary trading
exclusion as well as, in particular, on the following questions:
6. Are there exchange floor members that currently rely on the
$1,000 de minimis allowance but not the proprietary trading exclusion?
Are there exchange floor members that currently rely on the proprietary
trading exclusion? If so, please describe the number and types of any
such exchange floor members, and the nature and extent of their
reliance. Also, please provide any available data on the amount and
frequency of commissions or referral fees that floor members may
continue to receive with respect to off-exchange transactions.
7. Should the Commission retain the de minimis allowance but
eliminate the proprietary trading exclusion? If so, should the $1,000
threshold be changed? Why or why not? What should the threshold be?
Should the de minimis allowance be modified in some other way? Would
exchanges be able to appropriately monitor their members for compliance
with an increased de minimis allowance? Would an increased de minimis
allowance be an appropriate means of permitting hedging transactions
that exchange members may effect elsewhere than their member
exchange(s) without triggering Section 15(b)(8)'s Association
requirement?
8. Instead of eliminating the proprietary trading exclusion, should
the Commission retain a modified version of it? If so, how should it be
modified and why? How could the proprietary trading exclusion be
modified such that there is appropriate and comprehensive SRO oversight
of firms that trade securities otherwise than on an exchange of which
they are member and that trading activity? For example, could the
proprietary trading exclusion be modified such that a firm's reliance
on it is contingent on the firm reporting its off-exchange securities
transactions to the appropriate FINRA facility or TRACE? Would this
suffice to enable the Commission to achieve the goals expressed herein,
despite not providing FINRA with direct regulatory oversight of the
firms?
9. If the de minimis allowance and proprietary trading exclusion
are eliminated, as proposed, would some exchange floor members be
required to become members of an Association? If so, how many? Please
provide the basis of any estimate. What would be the effect on those
firms?
10. To what extent do dealer firms that are not FINRA members and
that trade securities otherwise than on an exchange of which they are a
member rely on the proprietary trading exclusion? Where, other than an
exchange where they are a member, do they typically effect securities
transactions? On ATSs? Off-exchange otherwise than on an ATS? Another
exchange where they are not a member? In what sort of dealer activity
do these firms engage? For example, do they typically provide liquidity
or make markets? Do they typically remove liquidity? Do they engage in
other types of trading activities?
11. If the de minimis allowance and proprietary trading exclusion
are eliminated, as proposed, what would be the effect on dealer firms
that currently rely on the proprietary trading exclusion? What, if
anything, would be the impact on their businesses if they are required
to register with an Association? Would business incentives change such
that firms might adjust their business model by exiting the off-
exchange market, moving transactions on-exchange, or leaving the
markets altogether? Would firms alter their organizational structure or
shift their proprietary trading activities to different or new
affiliates? Would the effects on firms be different depending on what
types of securities they trade?
12. Do commenters agree that some exchange member dealer firms
trade proprietarily in U.S. Treasury securities as well as exchange-
traded securities, and are not FINRA members in reliance on the
proprietary trading exclusion? If the de minimis allowance and
proprietary trading exclusion are eliminated, as proposed, what would
be the effects on such firms? What, if anything, would be the impact on
their U.S. Treasury securities trading business? Do commenters expect
that these firms would alter their business model or organizational
structure if the amendments proposed herein are adopted? If so, how?
Would these firms shift their proprietary trading activities to
different or new affiliates? Would increased price discovery reduce any
competitive advantages these firms have by observing other firms'
trades and not reporting their own trades? Would this impact market
costs borne by the investing public?
13. Do commenters believe that most exchange member dealer firms
that effect proprietary securities transactions otherwise than on an
exchange of which they are member would need to join FINRA as a result
of the elimination of the de minimis allowance and proprietary trading
exclusion? If so, would it help address the Commission's concerns
regarding FINRA's lack of direct jurisdiction over such firms' off-
member-exchange securities trading activity when they are not FINRA
members? What are commenters' views as to the extent of FINRA's current
ability to oversee off-member-exchange securities trading activity by
dealer firms that are not FINRA members?
14. How do exchange SROs currently surveil or regulate their
members' securities trading activity and conduct elsewhere than the
exchange? Do exchange SRO efforts in this regard mitigate any need to
rescind the de minimis allowance and proprietary trading exclusion? How
would such an approach address the fact that TRACE reporting
obligations apply only to FINRA members?
15. Are there concerns regarding how the TAF would apply to
proprietary trading broker-dealer firms?
16. Are there concerns regarding the applicability of certain FINRA
rules to solely proprietary trading broker-dealers, as opposed to those
who face customers? Which rules, and why? Are there benefits to
applying FINRA rules to these broker-dealers?
B. Narrowed Criteria for Exemption From Association Membership
The Commission is proposing to add to Rule 15b9-1 a new paragraph
(c) that would set forth two narrow circumstances in which a broker or
dealer could continue to be exempt from Section 15(b)(8)'s Association
[[Page 49945]]
membership requirement if it effects transactions in securities
otherwise than on an exchange of which it is a member.\156\
Specifically, following the existing paragraphs of Rule 15b9-1 that
require that a broker or dealer be a member of a national securities
exchange and carry no customer accounts (both of which paragraphs would
be retained), the Commission proposes to add language that would state:
``and, (c) Effects transactions in securities solely on a national
securities exchange of which it is a member, except that with respect
to this paragraph (c) . . .'' The two proposed exceptions would follow
in new paragraphs (c)(1) and (c)(2), and are discussed in turn below.
Proposed paragraphs (c)(1) and (c)(2) of the amended rule are intended
to provide more focused exemptions from Association membership for
types of off-member-exchange activity that are similar to the off-
member-exchange activities that Rule 15b9-1 was originally intended to
cover, and that are consistent with the public interest and the
protection of investors in accordance with Section 15(b)(9) of the Act.
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\156\ See proposed Rule 15b9-1(c). Relatedly, existing paragraph
(a) of Rule 15b9-1 would remain the same except it would no longer
be numbered as paragraph (a); existing paragraph (a)(1) would be
renumbered as paragraph (a); and existing paragraph (a)(2) would be
renumbered as paragraph (b). See proposed Rule 15b9-1.
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1. Routing Exemption
In paragraph (c)(1) of Rule 15b9-1, the Commission proposes to
provide an exemption from Association membership if a broker or dealer
that meets the criteria of paragraphs (a) and (b) of the rule effects
transactions in securities otherwise than on a national securities
exchange of which it is a member that result solely from orders that
are routed by a national securities exchange of which it is a member to
comply with Rule 611 of Regulation NMS \157\ or the Options Order
Protection and Locked/Crossed Market Plan.\158\ Relatedly, the
Commission also proposes to eliminate from Rule 15b9-1 outdated
references to the ``Intermarket Trading System.'' \159\
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\157\ 17 CFR 242.611.
\158\ See proposed Rule 15b9-1(c)(1). See also Securities
Exchange Act Release No. 60405 (July 30, 2009), 74 FR 39362 (August
6, 2009) (``Options Linkage Plan''). In the 2015 Proposal, the
Commission proposed to apply this exemption to orders routed to
comply with Rule 611 but did not propose to apply this exemption to
orders routed to comply with the Options Linkage Plan. Several
commenters on the 2015 Proposal supported this proposed exemption
for compliance with Rule 611. See, e.g., HRT Letter at 7; D&D Letter
at 3; PTR Letter at 3; CHX Letter at 3-4; SIFMA Letter at 3-4.
Commenters also suggested that the routing exemption should covers
orders routed to comply with the Options Linkage Plan. See, e.g.,
Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3.
\159\ The Intermarket Trading System was an NMS plan, the full
title of which was ``Plan for the Purpose of Creating and Operating
an Intermarket Communications Linkage Pursuant to section
11A(c)(3)(B) of the Exchange Act of 1934'' (``ITS Plan''). The ITS
Plan was initially approved by the Commission in 1978. Exchange Act
Release No. 14661 (April 14, 1978), 43 FR 17419 (April 24, 1978)
(``ITS Plan Approval Order''). All national securities exchanges
that traded exchange-listed stocks and the NASD were participants in
the ITS Plan.
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The ITS Plan required each participant to provide electronic access
to its displayed best bid and offer, and provided an electronic
mechanism for routing orders, called commitments to trade, to access
those displayed prices.\160\ The ITS Plan provided each market limited
access to the other markets for the purpose of avoiding a trade-through
\161\ and locked or crossed markets.\162\ The ITS Plan was eliminated
in 2007 because it was superseded by Regulation NMS.\163\ Thus, the
references to the ``Intermarket Trading System'' in current paragraphs
(b)(2) and (c) of Rule 15b9-1 are obsolete.
---------------------------------------------------------------------------
\160\ See ITS Plan Approval Order, supra note 159.
\161\ See 17 CFR 242.600(b)(94) (defining a ``trade-through''
under Regulation NMS); see also Options Linkage Plan, supra note 158
(defining ``trade-through'' in the options context).
\162\ A locked or crossed market occurs when a trading center
displays an order to buy at a price equal to or higher than an order
to sell, or an order to sell at a price equal to or lower than an
order to buy, that is displayed on another trading center.
\163\ Notice of Filing and Immediate Effectiveness of the Twenty
Fourth Amendment to the ITS Plan Relating to the Elimination of the
ITS Plan, Exchange Act Release No. 55397 (March 5, 2007), 72 FR
11066 (March 12, 2007). Today, Regulation NMS contains an updated
trade-through rule, and contemplates the use of private linkages by
trading centers to route orders to avoid trade-throughs. 17 CFR
242.610-611.
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Today, Rule 611 of Regulation NMS requires trading centers, such as
national securities exchanges, to establish, maintain, and enforce
written policies and procedures reasonably designed to prevent trade-
throughs in exchange-listed stocks, subject to certain exceptions.\164\
In general, Rule 611 protects automated quotations that are the best
bid or offer of a national securities exchange or an Association.\165\
To facilitate compliance with Rule 611, national securities exchanges
have developed the capability to route orders through brokers or
dealers (many of which are affiliated with the exchanges) to other
trading centers with protected quotations.\166\ Similarly, in the
options market, the Options Linkage Plan is a national market system
plan that requires linkages between the options exchanges to protect
the best-priced displayed quotes in the market and to avoid locked and
crossed markets.\167\ The Options Linkage Plan includes written
policies and procedures that provide for order protection and address
locked and crossed markets in eligible options classes.\168\
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\164\ 17 CFR 242.611. See also 17 CFR 240.600(b)(95) (defining
``trading center'').
\165\ 17 CFR 242.611.
\166\ See 17 CFR 242.600(b)(71) (defining ``protected
quotation'' under Regulation NMS) and 17 CFR 242.600(b)(70)
(defining ``protected bid'' and ``protected offer'' under Regulation
NMS); see also Options Linkage Plan, supra note 158 (defining
``protected bid'' and protected offer'' in the options context).
\167\ See Options Linkage Plan, supra note 158.
\168\ Id.
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The proposed rule would continue to accommodate securities
transactions away from a broker's or dealer's member exchange(s) that
are to comply with these regulatory requirements. An exchange member
may at times seek to effect a securities transaction on that exchange
at a price that would trade through a protected quotation displayed on
another trading center, such as another exchange or FINRA's ADF. In
such a case, the exchange may route the member's order (if the exchange
does not reject it), through a routing broker-dealer, to that other
trading center to access the protected quotation. Moreover, if, for
example, an ATS were to display a protected quotation on FINRA's ADF,
absent the proposed exemption, a broker or dealer would have to join
FINRA in order to have access to all protected quotations, even if the
broker or dealer already is a member of every exchange on which it
effects securities transactions.\169\
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\169\ See HRT Letter at 7 (stating that ``if an ATS were to
display a protected quote on FINRA's ADF, absent an exemption, a
Non-Member would not have access to the protected quotations without
registering with FINRA'' and asserting that allowing exempt firms to
have access to all protected quotations is critical because it
affects their ability to trade on exchanges of which they are
members). See also SIFMA Letter at 3 (suggesting that the Commission
clarify the exemption and whether it applies to non-floor exchange
members whose orders are routed by the exchange to an off-exchange
venue).
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In essence, a broker or dealer may, as a necessary part of its
business trading on exchanges of which it is a member and in light of
today's market structure, effect securities transactions elsewhere than
an exchange where it is a member solely as a consequence of routing by
its member exchange(s) to comply with the requirements of Rule 611 of
Regulation NMS or the Options Linkage Plan. The proposed rule would not
require Association membership as a result of such transactions. On the
contrary, it
[[Page 49946]]
would be consistent with Section 15(b)(9)'s goal of protecting
investors and the public interest if transactions effected solely to
comply with these regulatory requirements, via routing by the broker's
or dealer's member exchange(s), do not trigger Section 15(b)(8)'s
Association membership requirement for a broker or dealer that
otherwise limits its securities transactions to an exchange of which it
is a member (or to stock transactions that are covered by the stock-
option order exemption discussed below). The proposed routing exemption
would serve the limited, narrowly defined purpose of facilitating
compliance with intermarket order protection requirements.\170\
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\170\ One commenter stated that the routing exemption should be
``expanded to include all exchange-based routing activity,
including, but not limited to, routing effected for Regulation NMS-
compliance and best execution purposes'' and that the proposal
``does not contemplate the full array of legitimate and necessary
exchange-based routing activity.'' See CHX Letter at 3. The
commenter asserted that because all exchange routing functionalities
must be approved by the Commission, any type of exchange routing
would be consistent with the purposes of the Act and should be
covered by the proposed exemption. Id. at 3-4. In response to this
comment, the Commission preliminarily believes that many exchange-
offered routing functionalities are not necessary to facilitate an
exchange member's trading on the exchange. In addition, the
Commission is unaware of any exchange-offered routing options that
are specifically designated as being for best execution purposes. An
exchange member may utilize the exchange's routing functionality to
assist in meeting its best execution obligations, but this would not
appear limited to any particular exchange-offered routing option.
The commenter's suggested expansion of the proposed routing
exemption could create a gap in the FINRA oversight intended to be
achieved under the proposal if the exchange member could rely on its
member exchange's router to execute significant volume on other
markets where it is not a member without joining FINRA.
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The Commission also believes that it would be consistent with the
protection of investors and the public interest to permit reliance on
this exemption only where the routing is performed by a national
securities exchange of which the broker or dealer is a member. This
limitation would help ensure that the broker's or dealer's member
exchange has visibility into these routing transactions and thus is
better able to provide effective SRO oversight of its member's activity
that is related to its trading on the exchange and may not be overseen
by another SRO if the member is exempt from Association membership
under amended Rule 15b9-1.\171\ In this context, the exemption would be
applicable where the broker's or dealer's member exchange utilizes the
services of a designated broker-dealer (which could be affiliated or
unaffiliated with the exchange) to perform the exchange's outbound
routing, as the Commission understands that this type of arrangement is
typical among exchanges.
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\171\ Some commenters on the 2015 Proposal suggested that the
routing exemption should not be limited to where the broker's or
dealer's member exchange's routing mechanism is utilized, and that
the Commission also should provide relief to broker-dealers that
route orders to access protected quotations on away exchanges
without utilizing the linkage routing mechanism offered by a home
exchange. See Cboe Letter at 4; Cboe/NYSE/Nasdaq Letter at 3. The
Commission does not believe this would be appropriate because it
could permit scenarios in which there is insufficient SRO oversight
of the entirety of the broker-dealer's trading activity. By way of
example, if a broker-dealer were a member of some exchanges but not
others and not a FINRA member, and the broker-dealer could rely on
the exemption when routing orders to access protected quotations on
non-member exchanges or off-exchange in order to prevent a trade-
through on one of its member exchanges, the Commission believes that
it is possible that there would not be an SRO responsible for and
that could exercise jurisdiction over the broker-dealer's trading
activity away from its member exchange(s).
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A commenter on the 2015 Proposal sought clarity as to whether the
exemption would apply to routing broker-dealers that are affiliated
with national securities exchanges that are used by exchanges to
conduct routing to other trading centers.\172\ The commenter pointed
out that the Commission has required these affiliated routing broker-
dealers to operate as ``facilities'' of their respective exchanges,
which set forth rules that require the exchange to arrange for the
routing broker-dealer to be overseen by a non-affiliated SRO, and which
in practice is FINRA.\173\ The commenter requested that the Commission
clarify that the exemption from FINRA registration under Rule 15b9-1
would not apply to a broker-dealer affiliated with a national
securities exchange that routes orders on behalf of the exchange for
the purpose of accessing quotations in other trading centers.\174\ In
response, proposed Rule 15b9-1 would provide an exemption from Section
15(b)(8) of the Act's Association membership requirement for routing
broker-dealers that meet the conditions for the exemption. However,
proposed Rule 15b9-1 would not provide routing broker-dealers with an
exemption from the rules of an exchange that are applicable to routing
broker-dealers that operate as facilities of that exchange (and that
the exchange uses to conduct routing to other trading centers). As is
the case today, if an exchange's routing broker-dealer is covered by
amended Rule 15b9-1, if adopted, then the routing broker-dealer would
qualify for the exemption from Section 15(b)(8) afforded by the rule.
But the routing broker-dealer would still be required to comply with
the applicable rules of any exchange for which it performs outbound
routing services, including those requiring the routing broker-dealer
to be overseen by an unaffiliated SRO such as FINRA.\175\
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\172\ See SIFMA Letter at 3-4.
\173\ Id.
\174\ Id. (expressing concern as to whether ``an exchange-
affiliated routing broker-dealer could restrict its activities to
accessing protected quotations on other exchanges and could
therefore avoid FINRA membership'').
\175\ See, e.g., Cboe BZX Exchange, Inc. Rule 2.11 (Cboe
Trading, Inc. as Outbound Router); NYSE Rule 17(c) (Operation of
Routing Broker); Nasdaq Rule 4758(b) (Routing Broker).
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The Commission requests comment on all aspects of the proposed
routing exemption in amended Rule 15b9-1. In particular, the Commission
seeks responses to the following questions:
17. What are commenters' views on the proposed routing exemption?
How, if at all, should the proposed routing exemption be modified?
18. Is the scope of the proposed routing exemption sufficient to
provide relief for all securities transactions effected elsewhere than
on an exchange of which a broker or dealer is a member that might be
effected to comply with Rule 611 of Regulation NMS and the Options
Linkage Plan? If not, how should it be changed?
19. Should the proposed routing exemption be broadened to cover
transactions beyond those that are to comply with Rule 611 of
Regulation NMS and the Options Linkage Plan? If so, what types of
additional transactions should be covered and why? For example, should
the proposed routing exemption be broadened such that it covers routing
by an exchange for any purpose and pursuant to any of the exchange's
available routing functionalities? Should the proposed routing
exemption be narrowed so that it does not cover transactions to comply
with Rule 611 or the Options Linkage Plan? Should the proposed routing
exemption be eliminated in its entirety?
20. Are there other off-exchange transactions that a broker or
dealer might effect in order to comply with regulatory requirements? If
so, please describe those transactions and the relevant regulatory
requirements. Should there be an exemption in amended Rule 15b9-1 that
applies to any such transactions?
21. Should the proposed routing exemption also cover broker-dealer
routing to access protected quotations without using the member
exchange's routing mechanisms? Why or why not?
22. As discussed above, the Commission preliminarily believes that
[[Page 49947]]
the proposed routing exemption from Section 15(b)(8)'s Association
membership requirement does not exclude a routing broker that operates
as the facility of an exchange, but such a routing broker would still
be required to comply with the rules of the exchange, including
exchange rules requiring that the routing broker be overseen by an SRO
that is not affiliated with the exchange. Do commenters agree with
this? Should Rule 15b9-1 be amended in some way such that it excludes
or applies differently to routing brokers that operate as the facility
of an exchange? Why or why not? Should the proposed routing exemption
apply where the exchange uses a routing broker, whether affiliated or
unaffiliated? Should the routing exemption apply only where the
exchange uses an affiliated routing broker? Should the routing
exemption apply only where the exchange uses an unaffiliated routing
broker?
2. Stock-Option Order Exemption
In paragraph (c)(2) of amended Rule 15b9-1, the Commission proposes
to provide an exemption from Association membership if a broker or
dealer that meets the criteria of paragraphs (a) and (b) of the rule
effects transactions in securities otherwise than on a national
securities exchange of which it is a member, with or through another
registered broker or dealer, that are solely for the purpose of
executing the stock leg of a stock-option order.\176\ Proposed
paragraph (c)(2) also would require that a broker or dealer seeking to
rely on this proposed exemption establish, maintain, and enforce
written policies and procedures reasonably designed to ensure and
demonstrate that such transactions are solely for the purpose of
executing the stock leg of a stock-option order, and that the broker or
dealer preserve a copy of its policies and procedures in a manner
consistent with 17 CFR 240.17a-4 until three years after the date the
policies and procedures are replaced with updated policies and
procedures.\177\
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\176\ See proposed Rule 15b9-1(c)(2). The 2015 Proposal did not
include this type of exemption. Several commenters suggested that it
be added to the amended rule. See, e.g., Letter from Elizabeth K.
King, Secretary and General Counsel, NYSE and Joan C. Conley, Senior
Vice President and Corporate Secretary, NASDAQ OMX Group, Inc. (June
4, 2015) (``NYSE/Nasdaq Letter'') at 2-4; D&D Letter at 1-2; PTR
Letter at 1-2; Cboe Letter at 3; Cboe/NYSE/Nasdaq Letter at 4;
Lakeshore Letter at 2.
\177\ See proposed Rule 15b9-1(c)(2).
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The Commission understands that there are firms that trade stock-
option orders whose business is focused on one or more options
exchanges of which they are a member, and whose trading elsewhere is
primarily to effect the execution of stock orders to facilitate their
stock-option order business. In the Commission's preliminary view,
these firms' stock trading activity is for a limited purpose and
ancillary to their primary business handling stock-option orders on an
options exchange of which they are member. As discussed below, there is
a close link between the stock component transaction of a stock-option
order and the relevant options exchange. As such, the proposed rule
would permit these types of firms to continue their stock-option order
trading business without being required to join stock exchanges or an
Association solely in order to effect the execution of the stock legs
of stock-option orders that they handle.
As noted above, the Commission estimates that, in 2021, 50 of the
66 firms identified as registered broker-dealers and exchange members
but not FINRA members initiated options order executions.\178\ The
Commission estimates that seven of the firms that initiated options
order executions also effected the execution of stock leg transactions,
and therefore could potentially rely on the proposed stock-option order
exemption to the extent that they effect the stock leg executions off-
exchange or on an exchange where they are not a member. Because the
broker or dealer relying on proposed Rule 15b9-1(c)(2) would not itself
be a member of an exchange on which such stock transactions are
executed, or a member of an Association, such stock leg transactions
would need to be effected with or through another registered broker or
dealer that is a member of the exchange where the transactions are
executed or a member of an Association (or both).
---------------------------------------------------------------------------
\178\ See supra note 81.
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Options exchanges define the term ``stock-option order'' in their
rules.\179\ Further, as far as the Commission is aware, all options
exchanges accept a stock-option order only if it complies with the
Qualified Contingent Trade (``QCT'') Exemption (``QCT Exemption'') from
Rule 611(a) of Regulation NMS.\180\ For purposes of relying on the
exemption provided by proposed Rule 15b9-1(c)(2), a broker or dealer
should adhere to the stock-option order definition of the options
exchange where the stock-option order is handled and of which the
broker or dealer is a
[[Page 49948]]
member.\181 \Specifically, the broker or dealer could rely on that
definition to determine whether, for purposes of amended Rule 15b9-
1(c)(2), an order is in fact a stock-option order and a stock order is
in fact the stock leg of a stock-option order. Moreover, the exemption
would apply regardless of whether the component legs of a stock-option
order are executed electronically, on the physical exchange floor, or
through a combination of both. The Commission believes that approaching
the proposed stock-option order exemption in this way should minimize
disruptions to the markets for stock-option orders by minimizing the
degree to which brokers and dealers that trade such orders would need
to alter their business in order to rely on the proposed exemption.
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\179\ See, e.g., Cboe Rule 1.1 (defining ``stock-option order''
as ``an order to buy or sell a stated number of units of an
underlying or a related security coupled with either (a) the
purchase or sale of option contract(s) on the opposite side of the
market representing either the same number of units of the
underlying or related security or the number of units of the
underlying security necessary to create a delta neutral position or
(b) the purchase or sale of an equal number of put and call option
contracts, each having the same exercise price and expiration date,
and each representing the same number of units of stock as, and on
the opposite side of the market from, the underlying or related
security portion of the order. For purposes of electronic trading,
the term ``stock-option order'' has the meaning set forth in Rule
5.33.''); Cboe Rule 5.33(b)(5) (defining a ``stock-option order'' as
``the purchase or sale of a stated number of units of an underlying
stock or a security convertible into the underlying stock
(``convertible security'') coupled with the purchase or sale of
options contract(s) on the opposite side of the market representing
either (i) the same number of units of the underlying stock or
convertible security or (ii) the number of units of the underlying
stock necessary to create a delta neutral position, but in no case
in a ratio greater than eight-to-one (8.00), where the ratio
represents the total number of units of the underlying stock or
convertible security in the option leg(s) to the total number of
units of the underlying stock or convertible security in the stock
leg''). See also, e.g., MIAX Rule 518(a)(5); MIAX Emerald Rule
518(a)(5); Nasdaq Options 3, Section 14(a)(i); Nasdaq PHLX Options
3, Section 7(b)(13); Nasdaq ISE Options 3, Section 14(a)(5); Nasdaq
MRX Options 3, Section 14(a)(5); Nasdaq BX Chapter 5, Section
27(a)(v)(1) of the ``Grandfathered Rules'' of the Boston Stock
Exchange, Inc.; NYSE Arca Rule 6.62-O(h)(1); and NYSE American Rule
900.3NY(h)(1).
\180\ See, e.g., Cboe Rule 5.33, Interpretations and Policies
.04 Stock Option Orders (stating that a user may only submit a
stock-option order if it complies with the QCT Exemption and that a
user submitting a stock-option order represents that it complies
with the QCT Exemption); Supplementary Material to Nasdaq ISE
Options 3, Section 14 (stating that ``[m]embers may only submit
Complex Orders in Stock-Option Strategies and Stock-Complex
Strategies if such Complex Orders comply with the Qualified
Contingent Trade Exemption from Rule 611(a) of Regulation NMS under
the Exchange Act'' and that ``[m]embers submitting Complex Orders in
Stock-Option Strategies and Stock-Complex Strategies represent that
they comply with the Qualified Contingent Trade Exemption'') and
Commentary .01 to MIAX Rule 518 (stating that ``[m]embers may only
submit stock-option orders if such orders comply with the Qualified
Contingent Trade Exemption from Rule 611(a) of Regulation NMS under
the Securities Exchange Act of 1934'' and that ``[m]embers
submitting such complex orders represent that such orders comply
with the Qualified Contingent Trade Exemption''). A qualified
contingent trade is ``a transaction consisting of two or more
component orders, executed as agent or principal where: (1) at least
one component order is in an NMS stock; (2) all components are
effected with a product or price contingency that either has been
agreed to by the respective counterparties or arranged for by a
broker-dealer as principal or agent; (3) the execution of one
component is contingent upon the execution of all other components
at or near the same time; (4) the specific relationship between the
component orders (e.g., the spread between the prices of the
component orders) is determined at the time the contingent order is
placed; (5) the component orders bear a derivative relationship to
one another, represent different classes of shares of the same
issuer, or involve the securities of participants in mergers or with
intentions to merge that have been announced or since cancelled; and
(6) the transaction is fully hedged (without regard to any prior
existing position) as a result of the other components of the
contingent trade.'' Securities Exchange Act Release No. 54389
(August 31, 2006), 71 FR 52829 (September 7, 2006); see also
Securities Exchange Act Release No. 57620 (April 4, 2008), 73 FR
19271 (April 9, 2008).
\181\ Presumably, an options exchange would accept only those
stock-option orders that meet the exchange's definition thereof. In
addition, the Commission's understanding is that, currently,
consistent with options exchange definitions, a stock-option order
contains only one stock leg. See supra note 179. Therefore, the
proposed stock-option order exemption is designed to cover stock-
option orders with only one stock leg.
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Relying on the options exchange's definition also should enhance an
exchange's ability to monitor whether its members are appropriately
relying on the proposed exemption and thereby enhance its ability to
provide effective SRO oversight of its members' stock-option order
trading activity. Under options exchange rules, an exchange member
submitting a stock-option order to the exchange must designate to the
exchange one or more specific broker-dealers: (i) that are not
affiliated with the exchange; (ii) with which the exchange member has
entered into a brokerage agreement; (iii) that the exchange has
identified as having connectivity to electronically communicate the
stock components of stock-option orders to stock trading venues; and
(iv) to which the exchange will electronically communicate the stock
component of the stock-option order on behalf of the member.\182\ The
option exchange's execution of the stock-option order is contingent on
the exchange's receipt from the designated broker-dealer of an
execution report for the stock component transaction confirming that
the transaction has occurred.\183\ In light of these rules, the
Commission preliminarily believes that there is a close link between
the stock component transaction of a stock-option order and the
relevant options exchange. Accordingly, the Commission believes that
this proposed exemption would serve the limited, narrowly defined
purpose of facilitating the execution of stock-option orders consistent
with options exchange rules and that the options exchange would be able
to monitor and oversee the totality of the securities trading activity
of any of its members that rely on the exemption.
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\182\ See, e.g., Cboe Rule 5.33(l) and Interpretations and
Policies .04; Nasdaq ISE Options 3, Section 7 and Supplementary
Material .01, Options 3, Section 14 and Supplementary Material .07;
and MIAX Rule 518 and Commentary .01.
\183\ See, e.g., Cboe Rule 5.33(l); Nasdaq ISE Options 3,
Section 7 and Supplementary Material .01, Options 3, Section 14 and
Supplementary Material .07; and MIAX Rule 518 and Commentary .01.
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The Commission preliminarily believes that the exchange's oversight
capabilities will be further enhanced, consistent with the public
interest and protection of investors, by requiring written policies and
procedures in connection with the stock-option exemption in proposed
paragraph (c)(2) of the amended rule. This requirement would help
facilitate exchange SRO supervision of brokers and dealers relying on
the stock-option order exemption because it would provide an efficient
and effective way for the relevant options exchange to assess
compliance with the proposed exemption. Moreover, the Commission
preliminarily believes that requiring brokers and dealers to develop
written policies and procedures would provide sufficient flexibility to
accommodate potentially varying business models of brokers and dealers
that effect stock-option orders and may seek to rely on this exemption.
Such written policies and procedures must be reasonably designed to
ensure and demonstrate that the broker's or dealer's securities
transactions elsewhere than on an exchange of which it is a member are
solely for the purpose of executing the stock leg of a stock-option
order. Accordingly, a broker or dealer seeking to rely upon the
proposed stock-option order exemption must establish, maintain, and
enforce written policies and procedures reasonably designed to ensure
and demonstrate that such transactions are solely for the purpose of
executing the stock leg of a stock-option order. For example, the
broker or dealer could maintain documentation that demonstrates its
compliance with the stock-option order requirements of any options
exchange of which it is a member and where it effects the execution of
stock-option orders. Indeed, in addition to the Commission, the options
exchange of which the broker or dealer is a member and where the stock-
option order is handled would be able to enforce compliance with the
stock-option order exemption. In the context of routine examinations of
its members, the options exchange generally would review the adequacy
of its members' written policies and procedures and assess whether its
members' off-member-exchange transactions comply with those written
policies and procedures as well as the terms of the exemption itself,
as set forth in amended Rule 15b9-1.\184\
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\184\ Section 19(g)(1) of the Act, 15 U.S.C. 78s(g), among other
things, requires every SRO to examine for and enforce compliance by
its members and associated persons with the Act, the rules and
regulations thereunder, and the SRO's own rules, unless the SRO is
relieved of this responsibility pursuant to section 17(d), 15 U.S.C.
78q(d) or section 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act.
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Finally, a broker or dealer seeking to rely on the stock-option
order exemption would be required to preserve a copy of its policies
and procedures in a manner consistent with Rule 17a-4 under the
Exchange Act until three years after the date the policies and
procedures are replaced with updated policies and procedures.\185\
Accordingly, a broker or dealer would be required to keep the policies
and procedures relating to its use of this proposed exemption as part
of its books and records while they are in effect, and for three years
after they are updated.
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\185\ See, e.g., 17 CFR 240.17a-4(e)(7).
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The Commission requests comment on all aspects of the proposed
stock-option order exemption in Rule 15b9-1. In particular, the
Commission seeks responses to the following questions:
23. Is the proposed stock-option order exemption necessary and
appropriate? Why or why not? How, if at all, should this proposed
exemption be modified?
24. Is the scope of the proposed stock-option order exemption
sufficient to provide for all off-member-exchange transactions that
might be effected by a broker or dealer as a necessary component of
handling stock-option orders? If not, how should it be changed?
25. Should the proposed stock-option order exemption be broadened
to cover transactions beyond those necessary to complete stock-option
orders? If so, what types of additional transactions should be covered
and why? Should the proposed exemption be narrowed in some way? Should
the proposed stock-option order exemption be eliminated in its
entirety?
26. Is the Commission's understanding correct that all stock-option
orders must be QCTs? If not, what types of stock-option orders are not
required to be QCTs? Should they be covered by the proposed exemption?
27. The proposed stock-option order exemption is limited to
transactions
[[Page 49949]]
effected with or through another registered broker-dealer. Are there
circumstances where a broker or dealer that is not a FINRA member might
not need to effect the execution of the stock leg of a stock-option
order with or through another registered broker-dealer? Are there
circumstances in which a broker or dealer that is not a FINRA member
might need to effect the execution of the stock leg of a stock-option
order with or through a party that is a registered broker-dealer but
not a member of an exchange where the stock leg is executed, or not a
member of an Association if the stock leg is not executed on an
exchange? If so, please describe the nature and extent of such
transactions.
28. Stock transactions effected in reliance on the exemption would
still be subject to required transaction reporting. Would such reliance
impede required transaction reporting in any way?
29. As proposed, the stock-option order exemption would cover
stock-option orders with one stock leg and any number of options legs.
Is this appropriate? Should the proposed stock-option order exemption
be limited to two-leg stock-option orders where one leg is a stock and
the other leg is an option? Why or why not? Do firms execute stock-
option orders that contain multiple stock legs? If so, should the stock
legs of such stock-option orders be covered by the proposed exemption?
C. No Floor-Member Hedging Exemption
As discussed above, the Commission adopted Rule 15b9-1 so that an
exchange member's limited trading activity ancillary to its floor
business on a single national securities exchange would not necessitate
Association membership in addition to exchange membership.\186\ Since
that time, the securities markets have evolved to include significant,
cross-market and off-exchange electronic proprietary trading as a
primary business model. This business model did not exist when the
Commission adopted Rule 15b9-1 in its current form, nor did firms
engage in extensive off-member-exchange proprietary trading activity
while exempt from Association membership by virtue of Rule 15b9-1.
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\186\ See supra notes 60-62 and accompanying text.
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Unlike today's proposed amendments, the 2015 Proposal would have
provided an exemption from Association membership for a dealer that is
an exchange member, carries no customer accounts, conducts business on
the floor of a national securities exchange, and effects transactions
off the exchange, for the dealer's own account with or through another
registered broker or dealer, that are solely for the purpose of hedging
the risks of its floor-based activity.\187\ The Commission proposed
that the hedging exemption be limited to a dealer's floor-based trading
on a national securities exchange, and understood then that dealers
that limit their activities to an exchange's physical trading floor
tend to be specialists or floor brokers based on the floor of an
individual exchange.\188\ That proposed hedging exemption was intended
to be consistent with the original intent of Rule 15b9-1 to accommodate
only limited proprietary trading activity elsewhere than a broker's or
dealer's member exchange(s) that is ancillary to the broker's or
dealer's primary trading activity on its member exchange(s). But based
on data available to the Commission today that was not available in
2015, the Commission believes that no dealers currently trade in a
manner that would enable reliance on the hedging exemption as proposed
in the 2015 Proposal, i.e., no dealer's trading on an exchange of which
it is a member is solely on the exchange's floor. Accordingly, the re-
proposed rule does not include the hedging exemption included in the
2015 Proposal.\189\
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\187\ Currently, NYSE Arca Options, NYSE American Options,
Nasdaq Phlx, Cboe, NYSE, and BOX Exchange have physical exchange
floors.
\188\ See 2015 Proposing Release, supra note 6, 80 FR at 18047.
\189\ As described above, to the extent a stock transaction is a
component of a stock-option order, and the broker or dealer handling
the stock-option order otherwise meets the requirements of the
proposed amended rule, that stock transaction would not trigger
Section 15(b)(8)'s Association membership requirement.
---------------------------------------------------------------------------
Some commenters supported the proposed hedging exemption in the
2015 Proposal, but suggested that the exemption should not be limited
to a dealer operating solely on a physical exchange floor, and also
should cover off-member-exchange hedging transactions by dealers that
trade electronically on their member exchange(s).\190\ The Commission
preliminarily believes that an exemption of this nature might swallow
the amended rule, as proposed, and would not be appropriate. As
discussed above, electronic trading dealer firms effect securities
transactions proprietarily across market centers as a primary business
model, including to a significant degree in the off-exchange market and
on exchanges of which they are not a member.\191\ The Commission
acknowledges that it is unlikely that all of these firms' securities
trading activity away from their member exchanges is to hedge their
securities trading activity on their member exchanges. Thus, the off-
member-exchange transaction volume attributable to these firms likely
overstates the volume of transactions that would be attributable to
firms who could rely on a hedging exemption that covered electronic
trading activity as contemplated by commenters. The Commission cannot
reliably discern from available data what off-member-exchange
securities transactions effected by these firms are for hedging
purposes and what transactions are not. But the Commission
preliminarily believes that there are proprietary trading dealer firms
that trade electronically and in significant volumes, including off any
exchange where they are a member, which could potentially meet the
criteria of a hedging exemption that covered electronic trading
activity. Indeed, in light of the concentration of off-member-exchange
securities transaction volume among certain firms, as discussed above,
even if only a small number of firms could rely on a hedging exemption
that covered electronic trading activity, it could translate into
significant trading activity that would not be subject to direct FINRA
oversight. This would not be consistent with the protection of
investors or the public interest, or with the historical rationale for
Rule 15b9-1.
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\190\ See, e.g., CHX Letter at 3; CTC Letter at 7; Cboe Letter
at 2-3; Options Market Makers Letter at 4; and Cboe/NYSE/Nasdaq
Letter at 2-3.
\191\ See supra Section II.B.
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Commenters more broadly suggested that the 2015 Proposal did not
adequately consider options market makers or their hedging needs.\192\
Some of these commenters' concerns appear to center on firms' needs in
relation to their handling of stock-option orders.\193\ As such, these
concerns could be mitigated by the stock-option order
[[Page 49950]]
exemption that the Commission is proposing to include in amended Rule
15b9-1.\194\
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\192\ See, e.g., Options Market Makers Letter at 1; CTC Letter
at 1; CHX Letter at 3; Cboe Letter at 2-3; Cboe/NYSE/Nasdaq Letter
at 2-3; NYSE/Nasdaq Letter at 2-4; Letter from Reps. Bill Foster and
Randy Hultgren, Members of U.S. Congress (Nov. 15, 2016) at 2.
\193\ See, e.g., NYSE/Nasdaq Letter at 2-4; Cboe Letter at 3;
Cboe/NYSE/Nasdaq Letter at 4. For example, one commenter expressed
concern that the 2015 Proposal would ``unintentionally require
[options] floor brokers, which have a business focused on the floor
of an exchange in which they are members, to become members of
FINRA'' and specifically noted that this ``could restrict floor
brokers from fulfilling stock-option orders. . .[b]ecause the stock
component of a stock-option order cannot be executed on the options
exchange of which a floor broker is a member.'' NYSE/Nasdaq Letter
at 2. This commenter suggested that any amendment ``maintain floor
brokers' ability to route the stock leg of a stock-option order for
execution on another market by a member of the away market without
requiring the floor broker to become a member of FINRA.'' NYSE/
Nasdaq Letter at 4; see also Lakeshore Letter at 2.
\194\ In addition, Section 15(b)(9) of the Act provides the
Commission with the authority, by rule or order, and as it deems
consistent with the public interest and the protection of investors,
to conditionally or unconditionally exempt from the requirements of
Section 15(b)(8) any broker or dealer or class of brokers or
dealers. Accordingly, if a dealer or class of dealers believes that
it should be exempted from the requirements of Section 15(b)(8) in a
manner that is not provided by amended Rule 15b9-1, it may seek an
exemption from the Commission, by order, pursuant to Section
15(b)(9). For example, the Commission may consider granting such an
exemption, where appropriate, if a dealer or class of dealers
chooses to limit its exchange trading activity to the physical floor
of an exchange of which it is a member, but must effect limited
securities transactions elsewhere for its own account in order to
facilitate its exchange-floor business.
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The Commission requests comment on its re-proposed approach of not
providing a hedging exemption in amended Rule 15b9-1. In particular,
the Commission seeks responses to the following questions:
30. Should the Commission adopt a hedging exemption outside the
context of the proposed stock-option order exemption? Why or why not?
Would it be apparent whether a securities transaction is for hedging
purposes?
31. Should the Commission adopt a hedging exemption (in addition to
the proposed stock-option order exemption) that applies to a dealer
that is a member of multiple exchanges? Why or why not? Should the
Commission allow firms to rely on any such exemption only if they
effect hedging transactions in securities on exchanges where they are
not a member (i.e., off-exchange transactions, even if solely for
purposes of hedging a single exchange member's trading activity on that
exchange, would not be covered by the exemption)? Why or why not?
32. Should the Commission adopt a hedging exemption that covers
off-member-exchange transactions to hedge on-member-exchange electronic
transactions and physical exchange floor transactions, just on-member-
exchange physical exchange floor transactions or just on-member-
exchange electronic transactions? Why would one of these possible
approaches be preferable to another? Under each possible approach, how
difficult would it be to discern what off-member-exchange securities
transactions by electronic trading firms are for hedging purposes? The
Commission specifically seeks data that demonstrates the extent to
which exchange member dealer firms trade elsewhere than on their member
exchange(s) in order to hedge the risks of their trading activities on
their member exchange(s).
33. Are there non-floor-based exchange members that today focus
their business activities on a single exchange? Are there floor-based
exchange members that today focus their business activities on a single
exchange? If so, what is the nature of each firm's business activities?
34. Should the Commission adopt a hedging exemption in the amended
rule that requires a dealer seeking to rely on the exemption to
establish, maintain, and enforce written policies and procedures
reasonably designed to ensure and demonstrate that its off-member-
exchange hedging transactions reduce or otherwise mitigate the risks of
the financial exposure the dealer incurs as a result of its on-member-
exchange activity? Why or why not? What would be the costs of
establishing, maintaining, and enforcing the policies and procedures,
and any related record-keeping requirements? How are such costs
determined? Please provide evidence of the nature, timing, and extent
of such costs. Would such costs deter dealers from relying on the
hedging exemption? Are there more efficient and effective alternatives
to a policies and procedures approach? If so, what are they? Please
describe in detail.
35. Would current exchange surveillance and enforcement mechanisms
be effective to monitor off-member-exchange trades that would be
executed pursuant to a possible hedging exemption? Could this be
accomplished through 17d-2 plans and RSAs? Please explain. Would
exchanges otherwise have the ability to assess dealers' compliance with
a hedging exemption? If not, should the Commission require additional
reporting by registered broker-dealers acting as an agent for dealers
relying on a hedging exemption? Please explain.
36. Should the Commission adopt a hedging exemption that is subject
to quantitative limits on the volume of hedging transactions that a
firm may execute in reliance on such an exemption? Could qualitative or
quantitative requirements assist in identifying off-member-exchange
activity that is solely for the purpose of hedging? Please explain.
37. Should the Commission adopt a hedging exemption that requires
the exchange member to retain records demonstrating how each off-
member-exchange transaction complies with its policies and procedures?
Why or why not? What would be the associated costs, and what is the
basis for those costs? Would the cost associated with recordkeeping on
a transaction-by-transaction basis be overly burdensome, impractical,
or unnecessary?
38. Should the Commission adopt a hedging exemption that requires
dealers to make a certification in connection with their reliance on
the hedging exemption? Why or why not? If a certification should be
required, what would be the key elements thereof? How frequently should
the certification be made? Who should make it? What qualifications, if
any, to such certification might be appropriate? For example, should
firms be required to certify that they have a reasonable basis to
believe that they are in compliance with a hedging exemption? Or should
they be required to make such a certification to the best of their
knowledge? Is there a different standard that would be appropriate?
Should the certification be made in conjunction with an internal
compliance review? If so, what type of internal compliance review
should be conducted?
39. Would not adopting a hedging exemption affect liquidity on any
national securities exchange?
IV. Effective Date and Implementation
The Commission recognizes that firms may need time to comply with
any amended Rule 15b9-1 if adopted. In particular, they may need time
to become a member of an Association. As noted previously, FINRA is
currently the only Association. To become a FINRA member, a broker or
dealer must complete FINRA's New Member Application and participate in
a pre-membership interview.\195\ The broker or dealer and its
associated persons must comply with FINRA's registration and
qualification requirements.\196\ The amount of time that it takes to
become a FINRA member depends on a number of factors, including the
nature of the broker's or dealer's business, the level of complexity or
uniqueness of the firm's business plan, the number of associated
persons that the firm employs, and whether the firm has an affiliate
that is already a member of FINRA.\197\ The Commission understands
that, on average, the FINRA membership application process takes
approximately six months.
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\195\ See <a href="http://FINRA.org">FINRA.org</a>, How to Apply, available at <a href="https://www.finra.org/registration-exams-ce/broker-dealers/how-apply">https://www.finra.org/registration-exams-ce/broker-dealers/how-apply</a> (last
visited on July 22, 2022).
\196\ See FINRA Rule 1010--Electronic Filing Requirements and
Uniform Forms, which sets out the substantive standards and
procedural guidelines for the FINRA membership application and
registration process.
\197\ See Section VI.C.2, infra, discussing the costs of joining
FINRA.
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Alternatively, broker-dealer firms that currently rely on Rule
15b9-1 and carry no customer accounts may choose to adjust their
business model or
[[Page 49951]]
organizational structure such that they effect securities transactions
solely on national securities exchanges of which they are a member, and
therefore comply with Section 15(b)(8) without needing to join FINRA or
rely on any amended version of Rule 15b9-1 if adopted. This may require
such firms to become a member of additional exchanges upon which they
trade. Or, firms may need time to adjust their business models such
that their securities transactions elsewhere than exchanges of which
they are a member comply with the proposed amendments to paragraphs
(c)(1) or (c)(2) if adopted, including establishing policies and
procedures that would be required by proposed paragraph (c)(2). More
broadly, broker-dealer firms may need to modify their systems or take
other steps to achieve compliance with any amended rule if adopted.
The Commission preliminarily believes that one year after
publication in the Federal Register of any amended version of Rule
15b9-1 that the Commission may adopt should provide firms with enough
time to comply.\198\ Therefore, the Commission proposes that the
compliance date for amended Rule 15b9-1 would be one year after
publication of any final rule in the Federal Register. The Commission
solicits comment on the adequacy of this proposed implementation
timeline. In particular, the Commission seeks responses to the
following questions:
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\198\ In the 2015 Proposal, supra note 6, the Commission
solicited comment on the appropriate length of time that it should
provide firms to comply with the then-proposed amended version of
Rule 15b9-1. In this regard, the Commission also solicited comment
on the FINRA membership process. Some commenters stated that one
year generally is sufficient to join FINRA. See, e.g., IEX Letter at
3. Other commenters requested more time or requested that the
Commission require FINRA to develop a ``fast track'' application
process. See, e.g., FIA 2 Letter at 5. Another commenter suggested a
waiver process for a proprietary trading firm that is registered
with the Commission and an SRO, if the firm's information has not
materially changed from the time it registered with such entities,
and so long as the firm remains in good standing with the Commission
and other regulators. See Peak6 Letter at 2. FINRA stated that it
tentatively believed that most broker-dealer firms that are not
FINRA members ``are already members of an exchange and are engaged
solely in proprietary trading activity'' and would be candidates for
its ``fast track/triage program'' which has a
[…truncated; see source link]Indexed from Federal Register on August 12, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.