Rule2023-18658
Exemption for Certain Exchange Members
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
September 7, 2023
Effective
November 6, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is adopting amendments to a rule under the Securities Exchange Act of 1934 ("Act" or "Exchange Act") that exempts certain Commission- registered brokers or dealers from membership in a registered national securities association ("Association"). The amendments replace rule provisions that provide an exemption for proprietary trading with narrower exemptions from Association membership for any registered broker or dealer that is a member of a national securities exchange, carries no customer accounts, and effects transactions in securities otherwise than on a national securities exchange of which it is a member. The amendments create exemptions for such a registered broker or dealer that effects securities transactions otherwise than on an exchange of which it is a member that result solely from orders that are routed by a national securities exchange of which it is a member to comply with order protection regulatory requirements, or are solely for the purpose of executing the stock leg of a stock-option order.
Full Text
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<title>Federal Register, Volume 88 Issue 172 (Thursday, September 7, 2023)</title>
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[Federal Register Volume 88, Number 172 (Thursday, September 7, 2023)]
[Rules and Regulations]
[Pages 61850-61893]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-18658]
[[Page 61849]]
Vol. 88
Thursday,
No. 172
September 7, 2023
Part V
Securities and Exchange Commission
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17 CFR Part 240
Exemption for Certain Exchange Members; Final Rule
Federal Register / Vol. 88, No. 172 / Thursday, September 7, 2023 /
Rules and Regulations
[[Page 61850]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-98202; File No. S7-05-15]
RIN 3235-AN17
Exemption for Certain Exchange Members
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to a rule under the Securities Exchange Act of 1934
(``Act'' or ``Exchange Act'') that exempts certain Commission-
registered brokers or dealers from membership in a registered national
securities association (``Association''). The amendments replace rule
provisions that provide an exemption for proprietary trading with
narrower exemptions from Association membership for any registered
broker or dealer that is a member of a national securities exchange,
carries no customer accounts, and effects transactions in securities
otherwise than on a national securities exchange of which it is a
member. The amendments create exemptions for such a registered broker
or dealer that effects securities transactions otherwise than on an
exchange of which it is a member that result solely from orders that
are routed by a national securities exchange of which it is a member to
comply with order protection regulatory requirements, or are solely for
the purpose of executing the stock leg of a stock-option order.
DATES:
Effective date: November 6, 2023.
Compliance date: The compliance date is September 6, 2024.
FOR FURTHER INFORMATION CONTACT: Michael Bradley, Assistant Director,
David Michehl, Special Counsel, Nicholas Shwayri, Special Counsel,
Vince Vuong, Special Counsel, or Alba Baze, Attorney-Advisor, at (202)
551-5500, Office of Market Supervision, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
II. Background
A. Regulatory Framework
B. Updated Background Statistics
III. Discussion of Amendments to Rule 15b9-1
A. Elimination of the De Minimis Allowance and Proprietary
Trading Exclusion
B. Narrowed Criteria for Exemption From Association Membership
1. Routing Exemption
2. Stock-Option Order Exemption
IV. Effective Date and Implementation
V. Economic Analysis
A. Baseline
1. Regulatory Structure and Activity Levels of Non-FINRA Member
Firms
2. Current Market Oversight
3. Current Competition To Provide Liquidity
B. Effects on Efficiency, Competition, and Capital Formation
1. Firm Response and Effects on Market Activity and Efficiency
2. Effect on Competition To Provide Liquidity
3. Competitive Effects on Off-Exchange Market Regulation
C. Consideration of Costs and Benefits
1. Benefits
2. Costs
D. Alternatives
1. Include a Floor Member Hedging Exemption
2. Exchange Membership Alternative
3. Retaining the De Minimis Allowance
4. Eliminate the Rule 15b9-1 Exemption
5. Mandate TRACE U.S. Treasury Securities Reporting Without
Requiring Association Membership
VI. Paperwork Reduction Act
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Initial and Annual Reporting and Recordkeeping Burdens
E. Collection of Information Is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
VII. Regulatory Flexibility Act Certification
VIII. Other Matters
I. Introduction
On July 29, 2022, the Commission re-proposed amendments to 17 CFR
240.15b9-1 (``Rule 15b9-1'').\1\ The Commission is adopting those
amendments as re-proposed.
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\1\ See Securities Exchange Act Release No. 95388 (July 29,
2022), 87 FR 49930 (Aug. 12, 2022) (``2022 Re-Proposing Release'' or
``2022 Re-Proposal''). The 2022 Re-Proposal re-proposed amendments
that the Commission proposed on Mar. 25, 2015. See Securities
Exchange Act Release No. 74581 (Mar. 25, 2015), 80 FR 18036 (Apr. 2,
2015) (``2015 Proposing Release'' or ``2015 Proposal'').
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Rule 15b9-1 sets forth an exemption from section 15(b)(8) of the
Act pursuant to which a Commission-registered dealer can engage in
unlimited proprietary trading of securities on any exchange of which it
is not a member or in the off-exchange market (collectively referred to
herein as ``off-member-exchange'') without joining an Association, so
long as the dealer is a member of a national securities exchange,
carries no customer accounts, and its proprietary trading is conducted
with or through another registered broker-dealer.\2\ The Commission
adopted this exemption several decades ago so that an exchange member's
limited off-member-exchange proprietary trading activity ancillary to
its exchange activity--which, at that time, typically was a floor
business conducted on a single national securities exchange--would not
necessitate Association membership in addition to exchange
membership.\3\
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\2\ Section 15(b)(8) of the Act prohibits any registered broker
or dealer from effecting transactions in securities unless it is a
member of an Association or effects transactions in securities
solely on an exchange of which it is a member. Section 15(b)(8)
applies to any security other than commercial paper, bankers'
acceptances, or commercial bills. 15 U.S.C. 78o(b)(8). References
herein to ``exchange'' or ``national securities exchange'' are to a
national securities exchange that is registered with the Commission
pursuant to section 6 of the Act. See 17 CFR 240.600(b)(45)
(defining ``national securities exchange''). ``Off-exchange'' as
used herein means any securities transaction that is covered by
section 15(b)(8) of the Act that is not effected, directly or
indirectly, on a national securities exchange. Off-exchange trading
includes securities transactions that occur through alternative
trading systems (``ATSs'') or with another broker or dealer that is
not a registered ATS, and is also referred to as over-the-counter
(``OTC'') trading.
\3\ See infra notes 33-34 and accompanying text (discussing the
adoption of 17 CFR 240.15b8-1 (``Rule 15b8-1''), which was later
renumbered to Rule 15b9-1).
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The adopted amendments update Rule 15b9-1 by rescinding the
proprietary trading exemption from the rule such that, subject to two
narrow exemptions, Commission-registered broker-dealers that effect
off-member-exchange securities transactions must comply with section
15(b)(8) of the Act by joining an Association. The amended rule's two
exemptions apply when a broker or dealer that does not carry customer
accounts and is a member of at least one exchange effects off-member-
exchange securities transactions that: (1) result solely from orders
that are routed by an exchange of which the broker or dealer is a
member in order to comply with 17 CFR 242.611 (Rule 611 of Regulation
NMS) or the Options Order Protection and Locked/Crossed Market Plan;
\4\ or (2) are solely for the purpose of executing the stock leg of a
stock-option order.\5\
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\4\ See Securities Exchange Act Release No. 60405 (July 30,
2009), 74 FR 39362 (Aug. 6, 2009) (``Options Linkage Plan'').
\5\ See amended Rule 15b9-1, under ``Text of Amendments,''
infra. Consistent with section 15(b)(8) of the Act, and unchanged by
the adopted amendments, a broker or dealer is not required to become
a member of an Association if the broker or dealer effects
securities transactions only on an exchange of which it is a member.
See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
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In the decades since the adoption of the proprietary trading
exemption, the securities markets have undergone a substantial
transformation that has been
[[Page 61851]]
driven primarily by rapid and ongoing evolution of technologies for
generating, routing, and executing orders, and the impact of regulatory
changes.\6\ Today, little trading in the U.S. securities markets is
floor-based and broker-dealer firms no longer trade primarily on a
single exchange. Rather, securities trading today is highly automated,
substantially more complex, and dispersed among many trading centers
including 24 registered exchanges and a myriad off-exchange venues such
as ATSs and OTC market makers.\7\ Proprietary trading broker-dealer
firms have emerged that engage in significant, computer-based or
algorithmic, securities trading activity for their own account across
the full range of these exchange and off-exchange venues, often at
lightning speeds.\8\
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\6\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594 (Jan. 21, 2010) (Concept Release on Equity Market
Structure) (``Equity Market Structure Concept Release''), at 3594
(``Changes in market structure also reflect the markets' response to
regulatory actions such as Regulation NMS, adopted in 2005, the
Order Handling Rules, adopted in 1996, as well as enforcement
actions, such as those addressing anti-competitive behavior by
market makers in NASDAQ stocks.'').
\7\ See 2015 Proposing Release, supra note 1, 80 FR 18038; 2022
Re-Proposal, supra note 1, 87 FR 49935. See also Equity Market
Structure Concept Release, supra note 6.
\8\ Proprietary trading firms that engage in so-called high-
frequency trading strategies tend to effect transactions across the
full range of exchange and off-exchange markets, including ATSs.
They also typically use complex electronic trading strategies and
sophisticated technology to generate a large volume of orders and
transactions throughout the national market system. See 2015
Proposal, supra note 1, 80 FR 18038; 2022 Re-Proposal, supra note 1,
87 FR 49935-36. Many, but not all, proprietary trading firms are
often characterized by: (1) the use of extraordinarily high-speed
and sophisticated computer programs for generating, routing, and
executing orders; (2) the use of co-location services and individual
data feeds offered by exchanges and others to minimize network and
other types of latencies; (3) the use of very short time-frames for
establishing and liquidating positions; (4) the submission of
numerous orders that are cancelled shortly after submission; and (5)
ending the trading day in as close to a flat position as possible
(that is, not carrying significant, unhedged positions overnight).
See Equity Market Structure Concept Release, supra note 6, 75 FR
3606; see also Staff of the Division of Trading and Markets,
``Equity Market Structure Literature Review, Part II: High Frequency
Trading,'' at 4-5 (Mar. 18, 2014) (available at <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>). Staff
reports, Investor Bulletins, and other staff documents (including
those cited herein) represent the views of Commission staff and are
not a rule, regulation, or statement of the Commission. The
Commission has neither approved nor disapproved the content of these
staff documents and, like all staff statements, they have no legal
force or effect, do not alter or amend applicable law, and create no
new or additional obligations for any person.
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Rule 15b9-1 has remained static, however, as these types of firms
have emerged and off-member-exchange securities trading has
proliferated. As detailed in the 2022 Re-Proposal and section II.B
below, several of these firms effect significant off-member-exchange
securities transaction volume yet, in reliance on Rule 15b9-1, they are
not members of the Financial Industry Regulatory Authority, Inc.
(``FINRA''), the only Association currently.\9\ Broker-dealers that are
not FINRA members are not subject to FINRA's rules or FINRA's direct,
membership-based jurisdiction.\10\ As a result, when broker-dealer
firms that are members of one or more exchanges but not FINRA members
effect proprietary off-member-exchange securities transactions,\11\
these firms are not subject to FINRA's rules or its membership-based
jurisdiction over such activity and are not all subject to the same set
of exchange rules and interpretations of those rules, which can vary
between exchanges.
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\9\ See 2022 Re-Proposal, supra note 1, 87 FR 49936-37. See also
section III, infra. The National Futures Association (``NFA''), as
specified in section 15A(k) of the Act, also is registered as a
national securities association, but only for the limited purpose of
regulating the activities of NFA members that are registered as
brokers or dealers in security futures products under section
15(b)(11) of the Act.
\10\ See FINRA Rule 0140.
\11\ To be consistent with current Rule 15b9-1's proprietary
trading exemption, off-member-exchange securities trading must occur
with or through another registered broker-dealer, such as, in the
case of trading on an exchange where the firm is not a member,
through a broker-dealer that is a member of the exchange. See 17 CFR
240.15b9-1(b)(1).
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Because such exempt firms are not subject to FINRA's direct,
membership-based jurisdiction when they engage in off-member-exchange
securities trading activity, there is less stability and consistency in
the oversight that is applied to such activity than there would be if
such firms were Association members. To address this concern, the
amendments to Rule 15b9-1 help ensure, as mandated by section 15(b)(8)
of the Act, that an Association (currently, FINRA) generally has
direct, membership-based oversight over broker-dealers that effect off-
member-exchange securities transactions and the jurisdiction to
directly enforce their compliance with Federal securities laws,
Commission rules, and Association rules. Requiring broker-dealers that
engage in off-member-exchange securities transactions to become
Association members will provide FINRA with, among other things, the
ability to apply with a greater degree of autonomy its expertise in
supervising the firms' off-member-exchange securities trading activity
and investigating potential misconduct in that market segment. With
respect to FINRA members, FINRA can determine whether to pursue
examinations and investigations, and the parameters thereof, in a way
that it cannot with respect to non-FINRA members.
Some commenters expressed broad support for the 2022 Re-Proposal,
while other commenters expressed opposition primarily based on the
argument that direct, membership-based FINRA oversight of proprietary
trading broker-dealers is unnecessary in light of existing regulatory
mechanisms and that the costs of FINRA membership would be unduly
burdensome.\12\ As discussed in the 2022 Re-Proposal and section III
below, direct, membership-based jurisdiction by an Association over
broker-dealers that are not FINRA members cannot be achieved through
existing self-regulatory organization (``SRO'') oversight mechanisms
such as joint SRO plans pursuant to 17 CFR 240.17d-2 (``Rule 17d-2'')
\13\ or regulatory service agreements (``RSA(s)''),\14\ or through
reliance on the
[[Page 61852]]
Consolidated Audit Trail (``CAT'').\15\ Those regulatory measures are
useful in many respects but, nevertheless, firms that are not FINRA
members remain outside FINRA's direct, membership-based jurisdiction,
and FINRA therefore cannot apply its expertise in supervising these
firms' off-member-exchange securities trading activity and
investigating potential misconduct with the same degree of autonomy
that it can for FINRA members.\16\
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\12\ Comments received in response to the 2022 Re-Proposing
Release are available at <a href="https://www.sec.gov/comments/s7-05-15/s70515.htm">https://www.sec.gov/comments/s7-05-15/s70515.htm</a>. The 2022 Re-Proposal re-proposed amendments to Rule
15b9-1 that the Commission proposed in 2015, with certain
modifications informed by comments received on the 2015 Proposal,
which comments the Commission addressed in the 2022 Re-Proposal. See
2015 Proposal, supra note 1. Comments received in response to the
2015 Proposing Release are available at <a href="https://www.sec.gov/comments/s7-05-15/s70515.shtml">https://www.sec.gov/comments/s7-05-15/s70515.shtml</a>.
\13\ See 17 CFR 240.17d-2. With respect to a broker or dealer
that is a member of more than one SRO (``common member''), section
17(d)(1) of the Act authorizes the Commission, by rule or order, to
relieve an SRO of the responsibility to receive regulatory reports,
to examine for and enforce compliance with the applicable statutes,
rules, and regulations, or to perform other specified regulatory
functions. See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1). To
implement section 17(d)(1), the Commission adopted 17 CFR 240.17d-1
(``Rule 17d-1'') and Rule 17d-2 under the Act. See 17 CFR 240.17d-1
and 240.17d-2. Rule 17d-1 authorizes the Commission to name a single
SRO as the designated examining authority (``DEA'') to examine
common members for compliance with the financial responsibility
requirements imposed by the Act, or by Commission or SRO rules. See
Securities Exchange Act Release No. 12352 (Apr. 20, 1976), 41 FR
18808 (May 7, 1976). To address regulatory duplication in areas
other than financial responsibility, including sales practices and
trading practices, the Commission adopted Rule 17d-2 under the Act.
See Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR
49091 (Nov. 8, 1976). Rule 17d-2 permits SROs to propose joint plans
among two or more SROs for the allocation of regulatory
responsibility with respect to their common members. 17 CFR 240.17d-
2. The regulatory responsibility allocated among SROs only extends
to matters for which the SROs would share authority, which means
that only common rules among SROs can be allocated under Rule 17d-2.
Commission approval of a plan filed pursuant to Rule 17d-2 relieves
an SRO of those regulatory responsibilities allocated by the plan to
another SRO.
\14\ In contrast to Rule 17d-2 plans, RSAs are privately
negotiated agreements between two SROs that can expire or be
terminated. Under an RSA, one SRO agrees to perform regulatory
services on behalf of another SRO in exchange for compensation.
Unlike Rule 17d-2 plans, the SRO paying for regulatory services
under an RSA retains ultimate legal responsibility for and control
over the regulatory functions allocated to the SRO providing the
services. There are RSAs between exchange SROs and FINRA, but under
these RSAs, for firms that are members of different exchanges but
not FINRA members, FINRA applies to such firm's off-member-exchange
trading activity the rules of their different member exchanges using
the exchanges' interpretations of their rules. See Staff of the
Division of Trading and Markets, ``Staff Paper on Cross-Market
Regulatory Coordination,'' (Dec. 15, 2020) (available at <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''). In addition
to regulatory coordination that occurs through Rule 17d-2 plans and
RSAs, SROs also coordinate regulatory efforts through forums
provided by the Intermarket Surveillance Group (``ISG''). See id.;
see also 2022 Re-Proposal, section II.A.
\15\ See 17 CFR 242.613; Securities Exchange Act Release No.
79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016) (``CAT NMS Plan
Approval Order''); notes 90, 107, and 108, infra, and accompanying
text. See also 2022 Re-Proposal, 87 FR 49934, 49939. For proprietary
trading broker-dealer firms that become FINRA members due to the
amendments to Rule 15b9-1, regulatory coordination mechanisms such
as Rule 17d-1 DEA designations and Rule 17d-2 plans would be
available to mitigate the potential for duplicative exchange SRO and
FINRA oversight.
\16\ See supra note 14.
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Moreover, other regulatory developments have heightened the need
for Rule 15b9-1 to be updated. In particular, FINRA has established a
transaction reporting regime under which broker-dealers that are FINRA
members must report U.S. Treasury securities transactions into the
Trade Reporting and Compliance Engine (``TRACE'').\17\ Some Commission-
registered dealer firms that are not FINRA members are significantly
involved in trading U.S. Treasury securities proprietarily but are not
required to report these transactions since they are not FINRA members
(although if the transaction involves a FINRA member, then the FINRA
member must report the transaction to TRACE).\18\ In addition, U.S.
Treasury securities trading occurs entirely off-exchange, thus these
non-FINRA members conduct their U.S. Treasury securities trading
activities outside of the direct SRO oversight of any exchange and,
since they are not FINRA members, outside of FINRA's direct
jurisdiction despite the fact that FINRA is the SRO responsible for the
off-exchange market.
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\17\ See FINRA Rule 6700 Series; see also Securities Exchange
Act Release No. 79116 (Oct. 18, 2016), 81 FR 73167 (Oct. 24, 2016)
(File No. SR-FINRA-2016-027). In addition, FINRA requires its
members to report all OTC Equity Security and Restricted Equity
Security transactions (other than transactions executed on or
through an exchange) to FINRA's OTC Reporting Facility (``ORF'').
See FINRA Rules 6410 and 6610; see also FINRA Rules 6420(f)
(defining ``OTC Equity Security''); 6420(k) (defining ``Restricted
Equity Security''); 6420(n) (defining ``OTC Reporting Facility'').
FINRA also requires its members to report off-exchange NMS stock
trades to two Trade Reporting Facilities (``TRFs'') that FINRA
operates, one jointly with Nasdaq and the other jointly with the
NYSE. See FINRA Rule 6110 and the FINRA Rule 6000 Series generally;
see also 17 CFR 242.600(b) (defining ``NMS stock''). Further, FINRA
operates the Alternative Display Facility (``ADF'') for NMS stocks,
which is a FINRA facility for posting quotes and reporting trades
governed by FINRA's trade reporting rules. See Securities Exchange
Act Release No. 46249 (July 24, 2002), 67 FR 49821 (July 31, 2002)
(order approving the ADF); see also Securities Exchange Act Release
No. 71467 (Feb. 3, 2014), 79 FR 7485 (Feb. 7, 2014) (order approving
a proposed rule change to update the rules governing the ADF).
\18\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities.
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The rise in electronic proprietary trading and the increasingly
fragmented market where trading takes place across many active markets
have put pressure on the status quo and persuaded the Commission of the
need for there to be more consistent regulation of such trading.
Accordingly, after considering the comments received in response to the
2022 Re-Proposal, the Commission is adopting amended Rule 15b9-1 as re-
proposed. The Commission continues to believe that oversight of off
member-exchange securities trading must be enhanced in light of how
securities trading occurs today, by narrowing the extent to which
broker-dealer firms can effect off-member-exchange securities
transactions--in significant volumes in many cases--while exempt from
FINRA membership.
II. Background
A. Regulatory Framework
Broker-dealers generally must register with the Commission and
become members of a SRO.\19\ Self-regulation is a longstanding, key
component of U.S. securities industry regulation.\20\ The Exchange Act
defines SRO to include each national securities exchange or
Association.\21\ An SRO sets standards, conducts examinations, and
enforces rules regarding its members.\22\ In addition to Commission
oversight, the Exchange Act requires this layer of SRO oversight,
pursuant to which SROs act as front-line regulators of their broker-
dealer members.\23\ In particular, there are Federal securities laws,
Commission rules, and SRO rules that prohibit various forms of improper
activity by broker-dealers.\24\
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\19\ See section 15(a)(1) of the Act, 15 U.S.C. 78o(a)(1). For a
more detailed background regarding the relevant regulatory
environment, including the complementary SRO oversight performed by
exchanges and FINRA, see 2022 Re-Proposal, supra note 1, section II,
87 FR 49932-39; see also 2015 Proposal, supra note 1, section I, 80
FR 18036-45.
\20\ See Securities Exchange Act Release No. 50700 (Nov. 18,
2004), 69 FR 71256 (Dec. 8, 2004) (``Concept Release Concerning
Self-Regulation'').
\21\ See section 3(a)(26) of the Act, 15 U.S.C. 78c(a)(26).
\22\ See Concept Release Concerning Self-Regulation, supra note
20 (citing section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8)).
Congress historically has favored self-regulation for a variety of
reasons, including that effectively regulating the inner-workings of
the securities industry at the Federal level was viewed as cost
prohibitive and inefficient; the complexity of securities practices
made it desirable for SRO regulatory staff to be intimately involved
with SRO rulemaking and enforcement; and the SROs could set
standards such as just and equitable principles of trade and
detailed proscriptive business conduct standards. Id. (citing,
generally, S. Rep. No. 1455, 73d Cong., 2d Sess. (1934); H.R. Doc.
No. 1383, 73d Cong., 2d Sess. (1934); S. Rep. No. 1455, 73d Cong.,
2d Sess. (1934)); see also id., 69 FR 71257-58.
\23\ Broker-dealers registered with the Commission are subject
to the Commission's jurisdiction and oversight and must comply with
Commission rules applicable to registered broker-dealers. See, e.g.,
section 15 of the Act, 15 U.S.C. 78o; 17 CFR 240.15a-6 through
240.15b11-1; 17 CFR 240.17a-1 through 240.17a-25. Matters related to
SRO actions or their broker-dealer members also may be referred to
the Commission or subject to Commission review. See, e.g., sections
19(d), 15 U.S.C. 78(s)(d), and 19(e), 15 U.S.C. 78s(e), of the Act.
But the Exchange Act also requires that SROs enforce their members'
compliance with the Exchange Act, the rules and regulations
thereunder, and the SRO's own rules. See, e.g., sections 6(b)(1), 15
U.S.C. 78f(b)(1); 19(g)(1), 15 U.S.C. 78s(g)(1); and 15A(b)(2), 15
U.S.C. 78o-3(b)(2), of the Act; see also section 11A(a)(3)(B) of the
Act, 15 U.S.C. 78k-1(a)(3)(B) (authorizing the Commission to require
SROs to act jointly in planning, developing, operating, or
regulating the national market system).
\24\ See, e.g., sections 10(b), 15 U.S.C. 78j(b); 15(c), 15
U.S.C. 78o(c); and 15(g), 15 U.S.C. 78o(g), of the Act; section
17(a) of the Securities Act of 1933, 15 U.S.C. 77q(a); 17 CFR
240.10b-5; FINRA Rules 2020 (Use of Manipulative, Deceptive, or
Other Fraudulent Devices), 4530 (Reporting Requirements), 5210
(Publication of Transactions and Quotations); NYSE Rules 2020 (Use
of Manipulative, Deceptive or Other Fraudulent Devices) and 5220
(Disruptive Quoting and Trading Activity Prohibited); Nasdaq General
9, section 1 (General Standards) and Nasdaq General 9, section 53
(Disruptive Quoting and Trading Activity Prohibited); Cboe Rule 8.6
(Manipulation).
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As SROs, exchanges and Associations are required to examine for and
enforce compliance by their members and associated persons with the
Exchange Act, the rules and regulations thereunder, and the SROs' own
rules.\25\
[[Page 61853]]
Because of this, SROs that operate an exchange generally possess
expertise in supervising members who specialize in trading the products
and utilizing the order types that may be unique or specialized within
the exchange. This expertise complements the expertise of an
Association in supervising its members' cross-exchange and off-exchange
securities trading activity. Indeed, the Exchange Act's statutory
framework places SRO oversight responsibility with an Association for
off-member-exchange securities trading.\26\
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\25\ See section 19(g) of the Act, 15 U.S.C. 78s(g).
\26\ See sections 15(b)(8), 15 U.S.C. 78o(b)(8); 15A, 15 U.S.C.
78o-3; 17(d), 15 U.S.C. 78q(d); and 19(g), 15 U.S.C. 78s(g), of the
Act. Under the self-regulatory structure, the SRO where a broker-
dealer is registered conducts regulatory oversight and assumes
responsibility for that oversight. For example, section 19(g)(1) of
the Act, among other things, requires every SRO to examine for and
enforce compliance by its members and associated persons with the
Act, the rules and regulations thereunder, and the SRO's own rules,
unless the SRO is relieved of this responsibility pursuant to
section 17(d) or section 19(g)(2) of the Act. See sections 17(d), 15
U.S.C. 78q(d); and 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act.
Section 17(d)(1) of the Act enables the Commission to allocate
authority among SROs when a person is a member of more than one SRO.
Section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1). Section 15A of the
Act provides for the creation of national securities associations of
broker-dealers, with powers to adopt and enforce rules to regulate
the off-exchange market. Section 15A of the Act, 15 U.S.C. 78o-3.
And as described above, section 15(b)(8) of the Act further
implements this construct of effective regulatory oversight by
requiring Association membership of a broker-dealer unless it
effects transactions solely on an exchange of which it is a member.
Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
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Specifically, section 15(b) of the Act provides that Commission
registration is generally not effective until the broker-dealer becomes
a member of an Association or a national securities exchange if the
broker-dealer effects transactions solely on that exchange.\27\
Additionally, section 15(b)(8) of the Act prohibits any registered
broker or dealer from effecting transactions in securities unless it is
a member of an Association or effects transactions in securities solely
on an exchange of which it is a member. Section 15(b)(9) of the Act
provides the Commission with authority to exempt any broker or dealer
from section 15(b)(8), if that exemption is consistent with the public
interest and the protection of investors.\28\ Rule 15b9-1 sets forth an
exemption from section 15(b)(8) of the Act \29\ pursuant to authority
conferred to the Commission by section 15(b)(9) of the Act.\30\
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\27\ See section 15(b) of the Act, 15 U.S.C. 78o(b).
\28\ Section 15(b)(9) of the Act, 15 U.S.C. 78o(b)(9).
\29\ Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
\30\ Section 15(b)(9) of the Act, 15 U.S.C. 78o(b)(9).
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Rule 15b9-1 provides that any broker or dealer required by section
15(b)(8) of the Act to become a member of an Association shall be
exempt from such requirement if it is (1) a member of a national
securities exchange, (2) carries no customer accounts, and (3) has
annual gross income derived from purchases and sales of securities
otherwise than on a national securities exchange of which it is a
member in an amount no greater than $1,000 (this $1,000 gross income
allowance is referred to herein as the ``de minimis allowance'').\31\
Under Rule 15b9-1, the de minimis allowance does not apply to income
derived from transactions for a registered dealer's own account with or
through another registered broker or dealer (referred to herein as the
``proprietary trading exclusion'').\32\ The Commission adopted the
original version of Rule 15b9-1 (then Rule 15b8-1 but generally
referred to herein as Rule 15b9-1) in 1965,\33\ which included the de
minimis allowance but not the proprietary trading exclusion; the
Commission adopted the proprietary trading exclusion in 1976.\34\
Relying on the de minimis allowance and proprietary trading exclusion,
a registered dealer can remain exempt from Association membership while
engaging in unlimited off-member-exchange proprietary trading of
securities, so long as the dealer is a member of a national securities
exchange, carries no customer accounts, and its proprietary trading is
conducted with or through another registered broker-dealer.
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\31\ 17 CFR 240.15b9-1(a).
\32\ 17 CFR 240.15b9-1(b)(1). Rule 15b9-1 also states that the
de minimis allowance does not apply to income derived from
transactions through the Intermarket Trading System (``ITS''), and
defines the term ``Intermarket Trading System'' for purposes of the
rule. 17 CFR 240.15b9-1(b)(2) and (c). As discussed below, the
Commission proposed to eliminate from amended Rule 15b9-1 references
to the ITS because they are obsolete, and the Commission is adopting
those eliminations by deleting current paragraphs (b)(2) and (c)
from the amended rule. See infra note 192 and accompanying text.
\33\ The rule was renumbered to Rule 15b9-1 in 1983. See SECO
Programs; Direct Regulation of Certain Broker-Dealers; Elimination,
Securities Exchange Act Release No. 20409 (Nov. 22, 1983), 48 FR
53688 (Nov. 29, 1983) (``SECO Programs Release''). See also
Qualifications and Fees Relating to Brokers or Dealers Who Are Not
Members of National Security [sic] Association, Securities Exchange
Act Release No. 7697 (Sept. 7, 1965), 30 FR 11673 (Sept. 11, 1965)
(``Qualifications and Fees Release''). The Commission stated in the
Qualifications and Fees Release: ``Among the broker-dealers that are
not members of a registered national securities association are
several specialists and other floor members of national securities
exchanges, some of whom introduce accounts to other members. The
over-the-counter business of these broker-dealers may be limited to
receipt of a portion of the commissions paid on occasional over-the-
counter transactions in these introduced accounts, and to certain
other transactions incidental to their activities as specialists. In
most cases, the income derived from these activities is nominal.''
Id. at 11675.
\34\ See Extension of Temporary Rules 23a-1(T) and 23a-2(T);
Adoption of Amendments to SECO Rules, Securities Exchange Act
Release No. 12160 (Mar. 3, 1976), 41 FR 10599 (Mar. 12, 1976)
(``Adoption of Amendments to SECO Rules''). In adopting the
proprietary trading exclusion, the Commission indicated that an
exchange floor broker, through another broker or dealer, could
effect transactions for its own account on an exchange of which it
was not a member. Id. at 10600. The Commission stated that such
transactions ultimately would be effected by a member of that
exchange. In 1983, the Commission further amended Rule 15b9-1 to
accommodate transactions effected through the then-new ITS, and
eliminated references to, and requirements under, the SECO Program,
which was the Commission's program of direct regulation of certain
broker-dealers at that time. See SECO Programs Release, supra note
33.
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B. Updated Background Statistics
The 2022 Re-Proposal set forth statistics regarding off-member-
exchange securities trading activity by firms that were Commission-
registered broker-dealers and exchange members but not FINRA members
during the time periods reviewed by the Commission in the 2022 Re-
Proposal.\35\ Those statistics are updated below for corresponding
year-over-year time periods.\36\
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\35\ See 2022 Re-Proposal, supra note 1, section II, 87 FR
49932-39.
\36\ While some updated figures set forth below in this section
differ from figures set forth in the 2022 Re-Proposal, the
Commission believes that its conclusions are supported by the
updated figures as well as the 2022 Re-Proposal's figures.
---------------------------------------------------------------------------
The Commission estimates that, as of the end of September 2022,
there were 73 firms that were Commission-registered broker-dealers and
exchange members but not FINRA members, and that there were 64 such
firms as of April 2023.\37\ Many of these firms were members of just
one exchange while others were members of multiple exchanges.\38\
Specifically, as of April 2023, 22 of the 64 identified firms were
single exchange members; 9 of the firms were members of two exchanges;
15 of the firms were members of more than two but 10 or fewer
exchanges; and the remainder were members of more than 10
exchanges.\39\
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\37\ Sources: SEC FOCUS Reports (Form X-17A-5); FINRA's Central
Registration Depository (``CRD'').
\38\ Source: CRD.
\39\ Id. 35 out of the 64 identified firms in April 2023 were
members of a Nasdaq group exchange, 34 firms were members of Nasdaq
PHLX LLC (``PHLX'') specifically, and five firms were members of
only PHLX. The Commission believes these figures are consistent with
one commenter's statement in October 2022 that 39 non-FINRA firms
were Nasdaq members, 13 of which designated PHLX as their DEA, as
minor differences in the Commission's and the commenter's figures
could be explained by changes in firms' Nasdaq membership or
Commission registration status during the passage of time between
October 2022 and April 2023. See letter from Erik Wittman, Deputy
Head of Enforcement, The Nasdaq Stock Market LLC (Oct. 6, 2022)
(``Nasdaq Letter'') at 4.
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[[Page 61854]]
Several of these firms--both single-exchange and multiple-exchange
members--engage in cross-market and off-exchange proprietary securities
trading. These firms account for a significant portion of off-exchange
securities trading volume and initiate a significant number of
securities transactions on exchanges other than exchanges to which they
belong as a member.\40\ They forgo FINRA membership presumably in
reliance on Rule 15b9-1, as their effectuation of transactions in
securities elsewhere than on exchanges to which they belong as a member
would trigger section 15(b)(8)'s Association membership requirement but
for the exemption provided by Rule 15b9-1.
---------------------------------------------------------------------------
\40\ Source: CAT.
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For example, of the estimated 73 broker-dealers that were exchange
members but not FINRA members as of the end of September 2022, 53
initiated orders in listed equities in September 2022 that were
executed on or off an exchange.\41\ These firms' September 2022 off-
exchange listed equities dollar volume executed was approximately $440
billion,\42\ which was approximately 5.1% of total off-exchange volume
of listed equities executed that month.\43\ Moreover, these firms'
September 2022 listed equities dollar volume executed on exchanges of
which they are not a member was approximately $311 billion.\44\
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\41\ Id. A firm ``initiating'' an order is the firm that reports
the origination of the order as a New Order Event (MENO) to the CAT.
The other 20 firms did not initiate orders in listed equities in
Sept. 2022.
\42\ Id. Dollar volumes set forth in this section represent the
sum of bought and sold volume during the specified time period.
\43\ Id. The Commission estimates that there was approximately
$8.6 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in Sept. 2022.
\44\ Id. The Commission also estimates that, in 2022, 48 of the
73 firms identified as registered broker-dealers and exchange
members but not FINRA members initiated options order executions
accounting for approximately 16-27% of daily options contract volume
traded. The Commission further estimates that 35 of these 48 firms
initiated executions on an exchange where they are not a member, and
that this transaction volume represented approximately 3% of these
35 firms' total options contract transaction volume reported in
2022, and approximately 1% of all options contract transaction
volume reported in 2022. Id. These figures, like the other figures
set forth herein, have been updated from what was set forth in the
2022 Re-Proposal.
---------------------------------------------------------------------------
Of the estimated 64 broker-dealers that were exchange members but
not FINRA members as of April 2023, 45 initiated orders in listed
equities in April 2023 that were executed on or off an exchange.\45\
These firms' April 2023 off-exchange listed equities dollar volume
executed was approximately $405 billion,\46\ which was approximately
5.6% of total off-exchange volume of listed equities executed that
month.\47\ Moreover, these firms' April 2023 listed equities dollar
volume executed on exchanges of which they are not a member was
approximately $262 billion.\48\
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\45\ Id. The other 19 firms did not initiate orders in listed
equities in Apr. 2023.
\46\ Id.
\47\ Id. The Commission estimates that there was approximately
$7.2 trillion in total off-exchange transaction volume in listed
equities reported by buying and selling firms in Apr. 2023.
\48\ Id. See also Tables 1 and 2, section V.A.1, infra, for
additional detail regarding these firms' trading activity during the
noted time periods.
---------------------------------------------------------------------------
A subset of the identified firms that traded during September 2022
and April 2023 accounted for the large majority of the identified
firms' aggregate trading volume. In this regard, the Commission
estimates that, as of September 2022, 12 of the 53 identified firms
that initiated orders in listed equities accounted for approximately
4.5% of total off-exchange listed equities volume executed in September
2022 and 89% of the off-exchange listed equities transaction volume
attributable to the 53 identified firms that month.\49\ One of the 12
firms initiated $180 billion in off-exchange listed equities executions
in September 2022, which was over 2% of total off-exchange listed
equities transaction volume that month and approximately one-half of
the off-exchange volume executions attributable to the 53 identified
firms.\50\ With respect to the 53 firms' listed equities transaction
volume on exchanges of which they are not a member, one firm accounted
for approximately 66% of the $311 billion in volume attributable to the
53 identified firms in September 2022; six firms (including the
aforementioned one) accounted for over 90% of that volume; and 22 firms
(including the aforementioned six firms) accounted for over 99% of that
volume.\51\
---------------------------------------------------------------------------
\49\ Id.
\50\ Id.
\51\ Id.
---------------------------------------------------------------------------
The Commission also estimates that, as of April 2023, 12 of the 45
identified firms that initiated orders in listed equities then
accounted for approximately 5.1% of total off-exchange listed equities
volume executed in April 2023 and 90% of the off-exchange listed
equities transaction volume attributable to the 45 identified firms
that month.\52\ One of the 12 firms initiated $222 billion in off-
exchange listed equities executions in April 2023, which was 3.1% of
total off-exchange listed equities transaction volume that month and
approximately 55% of the off-exchange volume executions attributable to
the 45 identified firms.\53\ With respect to the 45 firms' listed
equities transaction volume on exchanges of which they are not a
member, one firm accounted for approximately 72% of the $262 billion in
volume attributable to the 45 identified firms in April 2023; five
firms (including the aforementioned one) accounted for over 90% of that
volume; and 21 firms (including the aforementioned six firms) accounted
for approximately 99% of that volume.\54\
---------------------------------------------------------------------------
\52\ Id.
\53\ Id.
\54\ Id.
---------------------------------------------------------------------------
With respect to trading in U.S. Treasury securities, all of which
occurs off-exchange,\55\ the Commission estimates that seven broker-
dealers that were exchange members but not FINRA members accounted for
over $6 trillion in U.S. Treasury securities volume executed on
``covered ATSs'' in 2022 that was reported to TRACE,\56\ which was
approximately 3.67% of total U.S Treasury securities volume traded in
2022 that was reported to TRACE.\57\ In
[[Page 61855]]
April 2023, the Commission estimates that five broker-dealers that were
exchange members but not FINRA members accounted for approximately $302
billion in U.S. Treasury securities volume executed on covered ATSs
that was reported to TRACE,\58\ which was approximately 2.65% of total
U.S Treasury securities volume traded in April 2023 that was reported
to TRACE.\59\
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\55\ See U.S. Dep't of the Treasury et al., Joint Staff Report:
The U.S. Treasury Market on Oct. 15, 2014 (July 13, 2015) (``Joint
Staff Report'') at 2. The secondary market for U.S. Treasury
securities (sometimes referred to as the U.S. Treasury cash market)
is generally bifurcated between the dealer-to-customer market and
the interdealer market. Trading in the U.S. Treasury securities
dealer-to-customer market is generally conducted through bilateral
transactions. Trading often occurs either over the phone or on
trading venues that facilitate the matching of buy and sell orders
through electronic systems. In the interdealer market, the majority
of trading in on-the-run U.S. Treasury securities currently occurs
on ATSs using electronic central limit order books. For off-the-run
U.S. Treasury securities, the majority of interdealer trading occurs
via bilateral transactions through voice-assisted brokers and
electronic trading platforms. See Securities Exchange Act Release
No. 90019 (Sept. 28, 2020), 85 FR 87106, 87108 (Dec. 21, 2020). On-
the-run U.S. Treasury securities are the most recently issued U.S
Treasury securities of a particular maturity. Off-the-run U.S.
Treasury securities include all U.S. Treasury securities that have
been issued before the most recent issuance and are still
outstanding.
\56\ See FINRA Rule 6730(a)(1) (requiring FINRA members to
report transactions in TRACE-Eligible Securities, including U.S.
Treasury securities).
\57\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities (among other things,
defining the term ``covered ATS'' as an ATS that executed
transactions in U.S. Treasury securities against non-FINRA member
subscribers of $10 billion or more in monthly par value, computed by
aggregating buy and sell transactions, for any two months in the
preceding calendar quarter). U.S. Treasury securities market share
is calculated as the sum of the identified entities' buy and sell
volume divided by twice the market-wide volume for the period.
Approximately $165 trillion total U.S. Treasury securities
transaction volume was reported to TRACE in 2022, of which
approximately $64 trillion was reported as executed on a covered
ATS. Beginning in September 2022, a new form of trade reports from
depository institutions were added to TRACE. These transactions,
which amounted to $4.5 trillion, are excluded.
\58\ See supra note 56.
\59\ Id. One broker-dealer that was not a FINRA member and
traded U.S. Treasury securities in 2022 joined FINRA prior to April
2023, and another broker-dealer that was not a FINRA member and
traded U.S. Treasury securities in 2022 did not appear to trade U.S.
Treasury securities in April 2023.
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III. Discussion of Amendments to Rule 15b9-1
Under the amendments to Rule 15b9-1 being adopted, a broker or
dealer registered with the Commission pursuant to section 15 of the Act
will be required by section 15(b)(8) of the Act to join an Association
if the broker or dealer effects off-member-exchange securities
transactions, unless it can rely upon one of the amended rule's narrow
exemptions.\60\ Conversely, and unchanged by these amendments, a broker
or dealer will not be required to become a member of an Association if
it effects securities transactions only on an exchange of which it is a
member.\61\
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\60\ See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8);
amended Rule 15b9-1, infra.
\61\ See section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8).
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Specifically, Rule 15b9-1, as amended, no longer provides a de
minimis allowance or proprietary trading exclusion, and allows an
exemption from Association membership only for a registered broker or
dealer that is an exchange member, carries no customer accounts, and
effects securities transactions solely on a national securities
exchange of which it is a member except in two narrow circumstances:
(1) a broker or dealer effects off-member-exchange securities
transactions that result solely from orders that are routed by an
exchange of which it is a member in order to comply with Rule 611 of
Regulation NMS or the Options Order Protection and Locked/Crossed
Market Plan; or (2) a broker or dealer effects off-member-exchange
securities transactions that are solely for the purpose of executing
the stock leg of a stock-option order.\62\ In the subsections below,
the Commission discusses each element of the amended rule in detail.
---------------------------------------------------------------------------
\62\ See amended Rule 15b9-1, under ``Text of Amendments,''
infra.
---------------------------------------------------------------------------
A. Elimination of the De Minimis Allowance and Proprietary Trading
Exclusion
The adopted amendments to Rule 15b9-1 eliminate the de minimis
allowance and proprietary trading exclusion. Rescinding these
provisions generally eliminates (subject to the exemptions in the
amended rule) the ability for proprietary trading dealer firms to rely
on Rule 15b9-1 to effect off-member-exchange securities transactions
without joining an Association. The Commission proposed these
rescissions to update Rule 15b9-1 so that it more appropriately
effectuates Exchange Act principles of complementary exchange SRO and
Association oversight in today's market, including section 15(b)(9)'s
mandate that any exemption from section 15(b)(8) be consistent with the
public interest and protection of investors.\63\
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\63\ See 2022 Re-Proposal, supra note 1, 87 FR 49932.
---------------------------------------------------------------------------
Some commenters on the 2022 Re-Proposal broadly agreed that Rule
15b9-1 should be updated in this way.\64\ They stated that the proposed
amendments are appropriate and necessary to modify and modernize Rule
15b9-1 such that it is consistent with the protection of investors and
the public interest in today's market.\65\ They also stated that the
current regulatory framework, which includes RSAs, Rule 17d-2 plans,
and the CAT, among other things, does not provide the full scope of
regulatory coverage appropriate for comprehensive and consistent
oversight of proprietary trading activities because an Association
still lacks regulatory jurisdiction over certain trading activity.\66\
FINRA stated that performing regulatory work with respect to broker-
dealer firms that are not FINRA members pursuant to RSAs is less
certain and stable than direct Association oversight of such firms
because of the discretionary nature of RSAs.\67\ FINRA also emphasized
that access to audit trail data does not confer jurisdiction to FINRA
over such firms, and that FINRA does not have the independent ability
to examine for, investigate, or enforce potential violations of the
Federal securities laws or FINRA rules with respect to such firms when
they are identified through surveillance or other means.\68\ FINRA
stated that jurisdictional limitations impede comprehensive off-
exchange and cross-market oversight in equities, options, and fixed
income markets.\69\ Another commenter stated that the proposal would
help ensure that high-frequency trading firms, which trade large
volumes of equities and U.S. Treasury securities across and off
exchanges without being required to join an Association, i.e., FINRA,
are subject to consistent and robust oversight through FINRA as opposed
to only being subject to complying with the more narrow regulatory
requirements specific to each exchange, and that such firms do not take
advantage of exclusions provided by Rule 15b9-1 that were intended to
accommodate limited broker-dealer activities.\70\
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\64\ See letters from: Marcia E. Asquith, Corporate Secretary,
EVP, Board of External Relations, FINRA (Sept. 27, 2022) (``FINRA
Letter'') at 1-2; Stephen W. Hall, Legal Director and Securities
Specialist, and Scott Farmin, Legal Counsel, Better Markets, Inc.
(Sept. 27, 2022) (``Better Markets Letter'') at 6-7.
\65\ See FINRA Letter at 1-2; Better Markets Letter at 6-7;
letter from Henry M. Phillip (Aug. 1, 2022) (``Phillip Letter'').
See also Nasdaq Letter at 2 (expressing support for broker-dealers
being required to join an Association if they effect securities
transactions off-exchange and/or in the fixed income space).
\66\ See, e.g., FINRA Letter at 5; memorandum dated June 20,
2023, regarding a call between Commission staff and FINRA (``6/20/23
Meeting Memorandum'') (stating that FINRA identified non-FINRA
member broker-dealer firms as potential respondents in 5% of the
market regulation investigations it conducted in 2020 and 2021,
which ranged across asset types and included both cross-exchange and
off-exchange conduct).
\67\ See FINRA Letter at 6.
\68\ Id.
\69\ Id.
\70\ See Better Markets Letter at 5, 7-8; see also note 8,
supra, for a description of high-frequency trading firms. This
commenter also stated that high-frequency trading represents roughly
50% of the trading volume in U.S. equities markets and 48% of the
total U.S. Treasury securities interdealer market, and that recent
liquidity crises in both the U.S. equities and Treasury securities
markets have shown the effects on markets dominated by, and heavily
reliant on, high-frequency trading firms. See Better Markets Letter
at 3.
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Other commenters questioned the necessity and appropriateness of
the application of FINRA oversight to proprietary trading broker-dealer
firms that are not FINRA members. They stated that, in light of
existing regulatory mechanisms that apply to such firms, including, in
particular, proprietary options trading firms, FINRA membership for
such firms would be unnecessary and duplicative.\71\ In this
[[Page 61856]]
regard, they stated that exchange SROs, including where appointed as
DEA over certain of their members, already possess and exercise
authority and can cooperate on regulatory matters to ensure compliance
with the securities laws.\72\ They also stated that the CAT provides
exchanges with sufficient visibility into proprietary broker-dealers'
off-member-exchange securities trading activity, which, they contended,
obviates the need for proprietary trading broker-dealers to be required
to join FINRA.\73\
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\71\ See, e.g., Nasdaq Letter at 3; and letters from: John
Kinahan, CEO, Group One Trading, LP (Sept. 26, 2022) (``Group One
Letter) at 1-2; Tom Simpson, CEO, PEAK6 Capital Management LLC
(Sept. 26, 2022) (``PEAK6 Letter'') at 2; Akuna Securities LLC,
Belvedere Trading, Chicago Trading Company, and Volant Trading
(Sept. 27, 2022) (``ABCV Letter'') at 3; Angelo Evangelou, Chief
Policy Officer, and Greg Hoogasian, Chief Regulatory Officer, Cboe
Global Markets, Inc. (Sept. 27, 2022) (``Cboe Letter'') at 4-7;
Kirsten Wegner, CEO, Modern Markets Initiative (Sept. 27, 2022)
(``MMI Letter'') at 2; Thomas M. Merritt, Deputy General Counsel,
Virtu Financial, Inc. (Sept. 30, 2022) (``Virtu Letter'') at 2-3;
Joanna Mallers, Secretary, FIA Principal Traders Group (Sept. 27,
2022) (``FIA PTG Letter''), at 4. See also letter from Chasse R.
Thomas (Sept. 26, 2022) (``Thomas Letter'') at 2 (stating that the
proposal should not be adopted because FINRA's ability to monitor
complex financial market is inefficient and unreliable). Some
commenters also stated that the FINRA membership application process
requires information that is duplicative of information already
provided to the Commission and other SROs. See PEAK6 Letter at 2;
FIA PTG Letter at 4. The Commission does not believe that the
submission of information in connection with the FINRA membership
application process that is duplicative of information already
provided to the Commission or exchange SROs is a reason to forgo the
amendments to Rule 15b9-1 being adopted. To the extent information
requested by FINRA is duplicative, firms may be able to leverage
their prior submissions when applying for FINRA membership.
Moreover, it is important that each SRO of which a broker-dealer is
a member, including FINRA, have the requisite information required
by its membership application, regardless of any duplication of the
information, because each SRO has regulatory responsibilities over
the broker-dealer. FINRA may require the same information that is
provided to exchange SROs so that it may be able to review the
information in order to approve the membership application and
effectively regulate the firm. Additionally, Commission-registered
broker-dealers that are exchange members and that join FINRA as
result of these rule amendments would not be situated any
differently from the many Commission-registered broker-dealers that
are exchange members and already FINRA members. In addition, see
discussion below in this section as well as in section V, infra,
regarding FINRA membership costs for broker-dealer firms that must
join FINRA as a result of the adopted amendments.
\72\ See, e.g., Group One Letter at 1-2; PEAK6 Letter at 2; ABCV
Letter at 3; Cboe Letter at 4-7; Nasdaq Letter at 3; FIA PTG Letter
at 4; MMI Letter at 2; Virtu Letter at 2-3.
\73\ See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe
Letter at 2-3; STA Letter at 2-3; ABCV Letter at 3; PEAK6 Letter at
3; Group One Letter at 2; letter from Eric Chern, Co-Founder,
Chicago Trading Company, LLC (Sept. 27. 2022) (``CTC Letter'') at 4.
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As explained below in this section, the Commission continues to
believe that, in today's market, the de minimis allowance and
proprietary trading exclusion must be eliminated from Rule 15b9-1 such
that there is direct, membership-based Association SRO oversight of
broker-dealers' off-member-exchange securities trading activity, in
accordance with section 15(b)(8) of the Act and with the section
15(b)(9) requirement that any exemption from section 15(b)(8) be
consistent with the protection of investors and the public
interest.\74\
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\74\ Commenters' critiques of the 2022 Re-Proposal are largely
the same as those that the Commission received in response to the
2015 Proposal, and the Commission continues to disagree with them
for many of the same reasons expressed in the 2022 Re-Proposal. See
2022 Re-Proposal, supra note 1, 87 FR 49941.
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Requiring broker-dealers that engage in off-member-exchange
securities transactions to become FINRA members will provide FINRA with
direct jurisdiction and the ability to apply with a greater degree of
autonomy its expertise to the firms' off-member-exchange securities
trading activity and investigate potential misconduct in that market
segment. With respect to FINRA members, FINRA can determine whether to
pursue examinations and investigations, and the parameters thereof, in
a way that it cannot with respect to non-FINRA members, as FINRA's
oversight over the latter depends on RSA arrangements, pursuant to
which exchange SROs retain legal responsibility and final decision-
making authority with respect to the covered exchange members.\75\ In
contrast, for FINRA member broker-dealer firms that effect off-member-
exchange securities transactions, FINRA possesses legal responsibility
and decision-making authority with respect to exercising SRO oversight
because FINRA can directly apply its own jurisdiction and rules to such
firms. As such, FINRA can unilaterally decide whether and how to
examine and investigate off-member-exchange activity by a FINRA member
firm for compliance with FINRA rules, and what course of action to
pursue if potential FINRA rule violations are identified.
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\75\ See supra note 14.
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Moreover, due to FINRA's experience and expertise in cross-market
and off-exchange oversight, FINRA is well-positioned to perform direct,
membership-based oversight over broker-dealer firms that effect off-
member-exchange securities transactions, as FINRA could bring such
broker-dealers within the applicable regulatory operations that FINRA
already has in place for its direct oversight of FINRA members that
trade across markets. And this FINRA oversight extends to U.S. Treasury
securities trading activity, unlike RSA-based SRO oversight, which does
not extend to such activity.\76\
---------------------------------------------------------------------------
\76\ See FINRA Letter at 8. FINRA has taken an active role in
overseeing trading activity in U.S. Treasury securities by, for
example, requiring U.S. Treasury securities to be reported to TRACE,
and by publishing daily files of aggregated U.S. Treasury securities
transactions data reported to TRACE. See FINRA Rules 6730 and 6750;
see also Treasury Daily Aggregate Statistics, available at <a href="https://www.finra.org/finra-data/browse-catalog/about-treasury/daily-file">https://www.finra.org/finra-data/browse-catalog/about-treasury/daily-file</a>.
In addition, FINRA has taken enforcement action regarding U.S.
Treasury securities trading activity and reporting. See, e.g., FINRA
Department of Enforcement v. BGC Financial, L.P., FINRA Letter of
Acceptance, Waiver, and Consent No. 2020068558701 (Jan. 20, 2023),
available at <a href="https://www.finra.org/sites/default/files/fda_documents/2020068558701%20BGC%20Financial%2C%20L.P.%20CRD%2019801%20AWC%20va%20%282023-1676852400276%29.pdf">https://www.finra.org/sites/default/files/fda_documents/2020068558701%20BGC%20Financial%2C%20L.P.%20CRD%2019801%20AWC%20va%20%282023-1676852400276%29.pdf</a>.
---------------------------------------------------------------------------
While FINRA traditionally has been the SRO that primarily oversees
off-member-exchange securities trading activity, in the context
relevant here--proprietary trading broker-dealer firms with exchange-
only SRO membership that effect off-member-exchange securities
transactions--FINRA is unable to directly enforce such firms'
compliance with Federal securities laws and Commission rules applicable
to broker-dealers, or apply its own rules to such firms, because they
are not FINRA members. Without direct, membership-based FINRA
oversight, SRO oversight of such firms' off-member-exchange securities
trading activity is largely a function of cooperative regulatory
arrangements among SROs, but those arrangements do not confer
membership-based jurisdiction to FINRA to enforce compliance with the
Exchange Act and applicable rules. These arrangements include those
discussed in the 2022 Re-Proposal and highlighted by commenters, such
as exchange SRO oversight through being appointed as DEA for certain
exchange members pursuant to Rule 17d-1 and through Rule 17d-2 plans,
indirect FINRA oversight pursuant to RSAs with exchange SROs, and the
CAT.\77\ As discussed below in this section, while these arrangements
serve useful purposes and enhance regulatory outcomes, the Commission
continues to believe that, in today's market, they are inadequate
substitutes for direct, membership-based FINRA jurisdiction over firms
that effect off-member-exchange securities transactions.
---------------------------------------------------------------------------
\77\ See CAT NMS Plan Approval Order, supra note 15, 81 FR
84836-41, for a discussion of the benefits provided to SROs by the
CAT with regard to surveillance, examinations, enforcement
investigations, and tips and complaints.
---------------------------------------------------------------------------
Commenters described the general proficiency of direct exchange SRO
oversight over exchange members.\78\ As
[[Page 61857]]
discussed in the 2022 Re-Proposal, in contrast to FINRA, the regulatory
focus of exchange SROs is generally on trading by their members on
their respective exchanges.\79\ Exchange SROs generally monitor market
activity specific to their own exchanges and have expertise in
regulating unique aspects of their markets.\80\ The focus of the
amendments being adopted here, however, is different. Here, the
Commission is concerned with off-member-exchange securities trading
activity, SRO oversight of which traditionally has been and remains
primarily FINRA's responsibility. As discussed above and in the 2022
Re-Proposal, several broker-dealer firms that are exchange members but
not FINRA members effect off-member-exchange securities
transactions.\81\ This includes firms that trade options proprietarily
and are engaged in proprietary options market making. While some
commenters stated that membership-based FINRA oversight over such firms
would be unnecessary and would duplicate existing exchange SRO
oversight, the Commission continues to believe that direct, membership-
based FINRA oversight over these firms (and therefore the amendments
being adopted here) is necessary because they effect securities
transactions off-member-exchange and thus generally outside the
expertise of any exchange where they are a member and within FINRA's
primary area of expertise.
---------------------------------------------------------------------------
\78\ See Nasdaq Letter at 2 (citing traditional operational
responsibilities such as real-time surveillance, and the
establishment of an investigation and enforcement team in 2017
dedicated to prosecuting member misconduct on its equities and
options markets); Cboe Letter at 6 (stating that SROs operate
comprehensive in-house regulatory programs which include cross
market surveillance, such as CAT).
\79\ See 2022 Re-Proposal, supra note 1, 87 at 49934 n. 46.
\80\ See 2022 Re-Proposal, supra note 1, 87 FR 49934; Cross-
Market Regulatory Coordination Staff Paper, supra note 14. See also
Cboe Letter at 4 (stating that the exchanges know their markets
best, including the products traded, the intricacies of the trading
mechanics, and their members' business models).
\81\ See supra section II.B; see also 2022 Re-Proposal, supra
note 1, 87 FR 49935-40.
---------------------------------------------------------------------------
Moreover, the Exchange Act provides a way to help address commenter
concerns regarding regulatory duplication. Specifically, with respect
to common members, section 17(d) of the Act authorizes the Commission
to relieve an SRO of the responsibility to receive regulatory reports;
to examine for and enforce compliance with applicable statutes, rules,
and regulations; or to perform other specified regulatory
functions.\82\ Section 17(j)(1) of the Act also requires the SROs'
cooperation and coordination of broker-dealer examination and oversight
activities and elimination of any unnecessary and burdensome
duplication in the examination process.\83\
---------------------------------------------------------------------------
\82\ Section 17(d) of the Act, 15 U.S.C. 78q(d).
\83\ Section 17(j)(1) of the Act, 15 U.S.C. 78q(j)(1).
---------------------------------------------------------------------------
To implement section 17(d)(1) of the Act, the Commission adopted
two rules thereunder: Rule 17d-1 and Rule 17d-2. Rule 17d-1 authorizes
the Commission to name a single SRO as the DEA to examine a common SRO
member (i.e., a broker-dealer that is a member of the DEA SRO as well
as other SROs) for compliance with the financial responsibility
requirements imposed by the Act, Commission rules, or the rules of the
SROs where the broker-dealer is a member.\84\ When an SRO has been
named as a common member's DEA, all other SROs to which the common
member belongs are relieved of the responsibility to examine the firm
for compliance with the applicable financial responsibility rules. Rule
17d-1 addresses only an SRO's obligations to enforce member compliance
with financial responsibility requirements. Rule 17d-1 does not relieve
an SRO from its obligation to examine a common member for compliance
with its own rules and provisions of the Federal securities laws
governing matters other than financial responsibility, including sales
practices and trading activities and practices.
---------------------------------------------------------------------------
\84\ 17 CFR 240.17d-1. See supra note 13; see also 2022 Re-
Proposal, supra note 1, 87 FR 49933; Securities Exchange Act Release
No. 12352 (Apr. 20, 1976), 41 FR 18808 (May 7, 1976).
---------------------------------------------------------------------------
To further address regulatory duplication, the Commission also
adopted Rule 17d-2 under the Act. Rule 17d-2 permits SROs to propose
joint plans for the allocation of regulatory responsibilities with
respect to their common members. Commission approval of a plan filed
pursuant to Rule 17d-2 relieves an SRO of those regulatory
responsibilities allocated by the plan to another SRO. FINRA has
experience coordinating with exchanges in the oversight of broker-
dealers that are common members of FINRA and the exchanges on which
they trade securities pursuant to such plans.\85\ Such coordination
among FINRA and exchange SROs pursuant to Rule 17d-2 plans cannot
occur, however, with respect to broker-dealer firms that are not FINRA
members.\86\
---------------------------------------------------------------------------
\85\ See Staff Paper on Cross-Market Regulatory Coordination,
supra note 14.
\86\ RSAs are mechanisms through which such coordination can
occur, but they are subject to limitations including that they do
not relieve the contracting SRO of its legal responsibilities to
provide SRO oversight or provide FINRA with jurisdiction. See supra
note 14 and the discussion infra in this section.
---------------------------------------------------------------------------
Rule 17d-1 DEA arrangements and Rule 17d-2 plans are relevant with
respect to commenters' concern that direct, membership-based FINRA
oversight of broker-dealer firms would duplicate exchange SRO
oversight.\87\ Mitigating duplicative SRO oversight is the primary
purpose of these regulatory arrangements.\88\ To the extent broker-
dealer firms join FINRA as a result of the amendments to Rule 15b9-1
\89\ and are members of one or more exchanges, Rule 17d-1 could be
utilized to mitigate duplicative oversight with respect to financial
responsibility by exchange SROs and FINRA over these common members.
And Rule 17d-2 plans could similarly be utilized by exchange SROs and
FINRA to mitigate the potential for duplicative SRO oversight over
their common members in areas other than financial responsibility. This
is what occurs today with common SRO members, and therefore the
Commission believes the same will likely occur for proprietary trading
broker-dealer firms that are exchange members and newly join FINRA as a
result of these amendments.\90\
---------------------------------------------------------------------------
\87\ See supra note 13. See also Group One Letter at 3 (stating
that the Commission should ensure that FINRA serves as the DEA for
options market making firms that newly join FINRA as a result of the
amendments to Rule 15b9-1 so that these firms do not pay DEA fees
that are duplicative of their current DEA fees paid to an exchange).
\88\ See Securities Exchange Act Release No. 12935 (Oct. 28,
1976), 41 FR 49091 (Nov. 8, 1976); see also note 13, supra.
\89\ See infra sections V.B.1 and V.C.2.d (discussing firms'
options for complying with the amendments, and that a firm may
choose to join additional exchanges rather than FINRA when the costs
of joining FINRA exceed the costs of joining additional exchanges to
cover all of the exchanges on which the firm currently trades).
\90\ Generally, FINRA is the DEA for financial responsibility
rules for exchange members that also are members of FINRA. See 2022
Re-Proposal, supra note 1, 87 FR 49935 n. 55; see also Cross-Market
Regulatory Coordination Staff Paper, supra note 14 (stating that
``FINRA serves as the Designated Regulation NMS Examining Authority
(`DREA') and Designated CAT Surveillance Authority (`DCSA') for
common exchange members that are also members of FINRA, and assumes
certain examination and enforcement responsibilities for those
members with respect to specified Regulation NMS rules (i.e., 606,
607, 611, 612 and 613(g)(2)), and for the cross-market surveillance,
examination, investigation and enforcement of Rule 613 and the rules
of the SROs regarding compliance with the CAT NMS Plan''). Some
exchanges serve as DEA for certain of their members, but these cases
mostly involve firms that have specialized business models that
focus on a particular exchange that is judged to be best situated to
supervise the member firm's activity. See 2022 Re-Proposal, supra
note 1, 87 FR 49956 and n. 228.
---------------------------------------------------------------------------
FINRA has entered into RSAs with certain exchange SROs, which allow
for some SRO oversight of off-member-exchange equities and options
trading activity by proprietary trading broker-dealer firms that are
exchange members
[[Page 61858]]
but not FINRA members.\91\ RSAs can serve useful purposes, but they
generally are not publicly available and are not subject to Commission
approval. Rather, they are voluntary private agreements between SROs
that are not mandated by any Commission rule or statutory obligation,
and that may expire or be terminated by the parties. As a result, to
the extent oversight is performed on non-FINRA member firms' off-
member-exchange securities trading activity based on RSAs, such
oversight relies upon discretionary arrangements between exchanges and
FINRA insofar as equities and options are concerned; and such
agreements to date have not covered U.S. Treasury securities trading
activity.\92\ In addition, under an RSA, FINRA examines for compliance
with the rules of the exchange with which it has entered into the
RSA.\93\ Thus, non-FINRA members that are members of different
exchanges may be subject to different exchange rules and
interpretations when they effect off-member-exchange securities
transactions to the extent these rules and interpretations are
different. This approach provides the potential for a less stable and
consistent regulatory regime for the covered off-member-exchange
securities transactions than one in which Association membership and
oversight is mandated.\94\ Moreover, there is no regulatory requirement
that any RSA pursuant to which FINRA oversight currently is applied to
a non-FINRA member broker-dealer's off-member-exchange securities
trading activity must continue to exist.\95\
---------------------------------------------------------------------------
\91\ See FINRA Letter at 4 (stating that Rule 17d-2 plans and
RSAs are not without their limitations).
\92\ See id. at 8.
\93\ In the context of an RSA in which an exchange SRO contracts
with FINRA for FINRA to provide regulatory services on behalf of the
exchange SRO, FINRA's oversight of the off-member-exchange trading
activity of a firm that is a member of the exchange but not a FINRA
member is for compliance with the exchange's rules, not FINRA's
rules, since FINRA's rules apply only to its members.
\94\ See FINRA Letter at 5 (stating that RSAs are privately
negotiated contracts, vary in their scope of regulatory coverage,
and can be terminated by the parties thereto; that FINRA examines
for compliance with the rules of certain individual exchanges under
RSAs and, therefore, firms that are not FINRA members may be subject
to different exchange rules and interpretations with respect to the
same activity; and that RSAs do not provide FINRA with membership-
based jurisdiction to directly enforce such firms' compliance with
the Federal securities laws or subject such firms to FINRA's rules
for their OTC trading, even where such trading may not be
comprehensively addressed by exchange rules or RSAs). As a result of
amended Rule 15b9-1, any broker-dealer that effects off-member-
exchange securities transactions will need to join an Association,
pursuant to section 15(b)(8) of the Act, unless the broker-dealer's
off-member-exchange securities transactions are covered by an
exemption in the amended rule.
\95\ See infra section V (setting forth expiration dates for
RSAs).
---------------------------------------------------------------------------
One commenter stated that firms still will be subject to multiple
sets of rules and interpretations if amended Rule 15b9-1 is adopted as
re-proposed, and that it will be important for FINRA to continue to
work collaboratively as part of the Cross-Market Regulation Working
Group (``CMRWG''), a subgroup of the ISG.\96\ The ISG was established
in 1981 and is an international group of exchanges, market centers, and
market regulators that perform front-line market surveillance in their
respective jurisdictions. The group was formed to facilitate the
coordination and development of programs and procedures to identify
possible fraudulent and manipulative activities across markets and to
facilitate information sharing related to those efforts. In 2020, the
CMRWG was established with U.S. SROs as a working group of the ISG's
U.S. Subgroup to focus on ways to reduce unnecessary regulatory
duplication.\97\ The Commission agrees that continued collaboration
will be important.
---------------------------------------------------------------------------
\96\ See Nasdaq Letter at 3; see also Cboe Letter at 5
(discussing the formation of the ISG and CMRWG to facilitate
coordination among the SROs).
\97\ See FINRA Information Notice--4/8/20 available at <a href="https://www.finra.org/rules-guidance/notices/information-notice-040820">https://www.finra.org/rules-guidance/notices/information-notice-040820</a>
(informing members of the existence and role of the CMRWG).
---------------------------------------------------------------------------
One commenter stated that an exchange can take action against its
member for exchange rule violations associated with the conduct of a
non-member broker-dealer that accessed the exchange through the member,
or the exchange may refer the activity to another SRO.\98\ This
commenter also stated that the access-providing exchange member is
likely to be a FINRA member.\99\ Similarly, other commenters stated
that options trading firms that are members of exchanges where they
trade options do not need to be FINRA members because, when they
conduct off-member-exchange trading activity, they do so through a
FINRA member broker-dealer.\100\ In the same vein, one commenter stated
that volume effected by options trading firms in the equities markets
is often processed through FINRA members and, thus, options trading
firms effectively trade like customers, making a requirement that they
join FINRA no more useful than requiring FINRA registration for any
non-broker-dealer customers that trade in the equities market through a
FINRA registered broker-dealer.\101\
---------------------------------------------------------------------------
\98\ See Cboe Letter at 4.
\99\ See id. at 2-3.
\100\ See, e.g., CTC Letter at 3; Group One Letter at 2.
\101\ See Cboe Letter at 2-3.
---------------------------------------------------------------------------
In response, the Commission does not believe that its concerns
regarding non-FINRA member broker-dealers that effect off-member-
exchange securities transactions are addressed when such broker-dealers
act in the capacity of a customer of another broker-dealer that is a
FINRA member. A broker-dealer acting in a customer capacity does not
provide a basis for regulatory oversight of that broker-dealer's off-
member-exchange activities as required by section 15(b)(8) when the
broker-dealer is not a FINRA member. The Commission believes that such
activities should be subject to direct, membership-based FINRA
oversight, which carries with it an obligation to comply with FINRA's
rules and FINRA's direct examination authority. This is not
accomplished when a broker-dealer acts as a customer of a FINRA member
but is not itself a FINRA member.
In addition, in the scenarios presented by commenters, neither the
exchange where the violative conduct occurred nor FINRA would have
direct authority to address the conduct of the broker-dealer that is
not a member of the exchange (and is not a FINRA member). If the
exchange referred the matter to another exchange SRO where the broker-
dealer is a member, the two exchanges could have different rules or
different interpretations of their respective existing rules. In other
words, there would be separate recourse by separate exchanges with
potentially different rules or rule interpretations against different
broker-dealers for the same conduct on one of the exchanges. The
Commission believes this presents the potential for inconsistent
outcomes, as the exchange where the conduct occurred could choose to
pursue recourse against its member but the referred-to exchange could,
for the same conduct, choose not to pursue recourse against its member.
A requirement that all broker-dealers that effect off-member-exchange
securities transactions become FINRA members (if not exempt under
amended Rule 15b9-1) is more consistent with the protection of
investors and the public interest. If both broker-dealers were FINRA
members in the scenarios presented by
[[Page 61859]]
commenters, FINRA could take a consistent approach in addressing both
broker-dealers' involvement in the conduct.
Exchange SRO rules would, of course, continue to apply to broker-
dealer firms that are exchange members and become FINRA members as a
result of the amendments to Rule 15b9-1.\102\ The potential for
inconsistent recourse by exchanges where such firms are a member could,
therefore, continue to exist. But such firms would be common members of
FINRA and their member exchanges, and SROs have a statutory obligation
to eliminate unnecessarily duplicative oversight of their common
members.\103\ While FINRA rules and exchange rules would apply to such
firms, the Commission believes that Rule 17d-1 DEA designations and
Rule 17d-2 plans will likely be utilized in areas of overlap to
mitigate duplicative application of exchange SRO and FINRA oversight,
in the same fashion as they already are utilized for the many broker-
dealer firms that are exchange members and FINRA members. As a result,
with respect to broker-dealer firms that become FINRA members and are
exchange members, the Commission believes that FINRA likely will be the
only SRO with regulatory responsibility regarding these firms'
compliance with rules that FINRA and their member exchange(s) have in
common.\104\ Moreover, FINRA already directly regulates cross-market
and off-exchange trading activity by FINRA members for compliance with
FINRA rules, and would extend that direct oversight to new FINRA
members' off-member-exchange activity (without needing to rely on RSAs
to do so). Exchange SROs would remain primarily responsible for their
members' on exchange activity (subject to Rule 17d-1 DEA designations,
Rule 17d-2 plans, or RSAs). This complementary structure with FINRA as
the SRO primarily responsible for off-member-exchange activity by FINRA
members and exchange SROs primarily responsible for member exchange
activity is consistent with the Exchange Act's statutory framework,
which places SRO oversight responsibility with an Association for off-
member-exchange securities trading.\105\
---------------------------------------------------------------------------
\102\ See, e.g., Cboe Letter at 6 (stating that requiring FINRA
membership for non-member FINRA firms would add regulatory
duplication and administrative burden to the firms and SROs with
whom the firm is already a member).
\103\ See section 17(d)(1) of the Act, 15 U.S.C. 78q(d)(1).
\104\ See infra note 275 (stating that FINRA serves as the DEA
for the majority of member firms).
\105\ See supra note 26 and accompanying text.
---------------------------------------------------------------------------
The Commission also does not believe that the CAT mitigates the
need for proprietary trading broker-dealer firms that effect off-
member-exchange securities transactions to be required to join FINRA,
as was asserted by some commenters.\106\ The CAT is an important audit
trail tool through which exchange SROs and FINRA are able to perform
surveillance of trading activity in NMS and OTC securities using CAT
data.\107\ In addition, FINRA has stated that it surveils 100% of the
equities and options markets with CAT data.\108\ But access to CAT data
does not confer jurisdiction to FINRA over a firm that is not a FINRA
member and that trades securities off-member-exchange.\109\ As a
result, when FINRA encounters potentially problematic conduct by firms
that are not FINRA members,\110\ it lacks the independent ability to
examine for and investigate potential violations of, or enforce
compliance with, the Federal securities laws, Commission rules, or
FINRA rules.\111\ Moreover, access to CAT data alone does not enable
FINRA to conduct additional investigative methods, such as collecting
documents, interviewing witnesses, and otherwise investigating the
firm.\112\ Even if one or more exchanges of which a broker-dealer is a
member and FINRA could coordinate SRO oversight of the non-FINRA member
firm's off-member-exchange securities trading activity through the use
of CAT data and RSAs, performing SRO oversight pursuant to RSAs is, as
discussed above in this section, a less certain and stable approach
than direct Association oversight of such trading activity due to the
discretionary nature of RSAs, and frustrates the regulatory scheme
established by Congress in which an Association directly regulates
broker-dealers that effect off-member-exchange securities
transactions.\113\ And any such coordinated efforts would not apply to
U.S. Treasury securities trading activity, which is not reported to the
CAT and not covered by RSAs. In short, even with this coordination,
FINRA would still not have direct membership-based jurisdiction over
the firm. This limitation impedes stable and consistent SRO oversight
of off-member-exchange securities trading activity through direct,
membership-based FINRA jurisdiction by continuing the dependence upon
RSAs for such oversight,\114\ and impedes comprehensive SRO oversight
of off-member-exchange securities trading activity since RSAs, the CAT,
and coordinated regulatory efforts using these tools do not cover U.S.
Treasury securities trading activity.\115\
---------------------------------------------------------------------------
\106\ See, e.g., MMI Letter at 2; FIA PTG Letter at 2; Cboe
Letter at 2-3; STA Letter at 2-3; ABCV Letter at 3; PEAK6 Letter at
3; Group One Letter at 2; CTC Letter at 4.
\107\ Exchange rules require their members to report to CAT.
See, e.g., Cboe BYX Rules 4.5 through 4.17; Nasdaq General 7; NYSE
Rule 6800.
\108\ See FINRA Letter at 6.
\109\ Id. See also Concept Release Concerning Self-Regulation,
supra note 20, 69 FR 71266 (stating that ``[w]hile the full
implementation of robust intermarket order audit trails would be a
significant step forward, an order audit trail is simply a tool that
can be used by regulators to better surveil for illicit trading
activity'' and that ``the SRO regulatory function would still play a
critical role in the regulation of intermarket trading''). Likewise,
the ISG is a valuable forum for the coordination of regulatory
efforts and sharing of information and serves an important function,
but it does not confer jurisdiction to FINRA over a broker-dealer
that is not a FINRA member and effects off-member-exchange
securities transactions. The ISG also does not create rules or
impose disciplinary actions; rather, the information sharing between
members allows for the proper authority, regulator, or exchange to
pursue appropriate rule changes or pursue legal action on market
participants based on evidence gathered.
\110\ See, e.g., FINRA Letter at 5; 6/20/23 Meeting Memorandum
(stating that FINRA identified non-FINRA member broker-dealer firms
as potential respondents in 5% of the market regulation
investigations it conducted in 2020 and 2021, which ranged across
asset types and included both cross-exchange and off-exchange
conduct).
\111\ See FINRA Letter at 6. Such a case may be referred to the
Commission or an exchange where the firm is a member for further
investigation.
\112\ See 2022 Re-Proposal, supra note 1, 87 FR 49938.
\113\ See Section 15(b)(8) of the Act, 15 U.S.C. 78o(b)(8); 2015
Proposing Release, supra note 1, 80 FR 18039 at notes 28-33 and
accompanying text describing the regulatory history of off-exchange
trading. See also Cross-Market Regulatory Coordination Staff Paper,
supra note 14 (stating that ``[w]hile multiple SROs reviewing the
same securities activities can have benefits, in that the resources
and expertise from several organizations can be brought to bear on
assessing these activities, it also can lead to duplication and
inefficiencies in the regulatory process and increased burdens on
member firms''). FINRA and the exchange SROs have a history of
coordinating and can work together to address concerns of firms that
are receiving duplicative regulatory requests such as through the
Cross Market Regulatory Working Group. Id.
\114\ As discussed above in this section, if FINRA has an RSA
with a given exchange, FINRA is able to apply that exchange's rules
to off-member-exchange activity by members of that exchange, even if
they are not FINRA members, assuming that the RSA assigned to FINRA
the oversight of those rules. But RSAs are not required to continue
to exist pursuant to any regulatory requirement, and exchanges with
potentially different rules and interpretations thereof retain legal
responsibility and decision-making authority under RSAs, which could
lead to inconsistent outcomes. FINRA does not need to rely on RSAs
for its oversight of FINRA members, and so it can apply its
jurisdiction directly to FINRA members' off-member-exchange trading
activity. Further, for FINRA member firms that also are exchange
members, Rule 17d-1 DEA designations and Rule 17d-2 plans could be
utilized in areas of overlap to mitigate duplicative application of
exchange and FINRA oversight.
\115\ See FINRA Letter at 6 (stating that ``there are key
regulatory limitations that remain when FINRA encounters potentially
problematic Non-Member Firm conduct'' via audit trail data and that
the limitations posed by RSAs ``impede comprehensive OTC and cross-
market oversight in the equities, options, and fixed income
markets'').
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[[Page 61860]]
Relatedly, the Commission continues to believe that direct,
membership-based FINRA jurisdiction is necessary for proprietary
trading broker-dealer firms that effect transactions in U.S. Treasury
securities, and that FINRA oversight would not duplicate any exchange
SRO oversight in this area.\116\ U.S. Treasury securities are not
traded on any exchange, and to the Commission's knowledge, unlike
FINRA,\117\ no exchange SRO possesses expertise on U.S. Treasury
securities trading activity. Further, as discussed above in this
section, U.S. Treasury securities trading activity also is not covered
by RSAs between exchange SROs and FINRA, so RSAs are not a mechanism
through which FINRA currently could apply exchange rules (to the extent
any would be applicable) to U.S. Treasury securities trading activity
by proprietary trading broker-dealer firms that are exchange members
but not FINRA members. Thus, aside from certain surveillances (other
than the CAT),\118\ no SRO oversight is performed with respect to the
U.S. Treasury securities trading activity of proprietary trading
broker-dealer firms that are not FINRA members.
---------------------------------------------------------------------------
\116\ Some commenters agreed with the Commission. See, e.g.,
Cboe Letter at 2 (stating that Cboe believes it is appropriate for
broker-dealers that are not FINRA members that effect fixed income
transactions to register with FINRA to ensure FINRA insight into,
and sufficient regulatory coverage of, those transactions).
\117\ See FINRA Letter at 8 (stating that individual fixed
income securities generally are not traded on exchange and their
markets rely exclusively on FINRA oversight); see also supra note
76.
\118\ See FINRA Letter at 10 (stating that FINRA surveils and
examines for manipulative or other illegal activity in the fixed
income market, including with respect to U.S. Treasury securities
trading). As discussed above in this section, trading activity in
U.S. Treasury securities is not reported to the CAT, so the CAT is
not a tool that can be used by SROs to surveil that activity. A
commenter suggested that the Commission could require that TRACE
data and other securities trading data be reported to the CAT. See
Phillip Letter. Such an undertaking would not, however, provide
FINRA with needed, membership-based jurisdiction over broker-dealers
that trade U.S. Treasury securities.
---------------------------------------------------------------------------
For example, FINRA stated that, subject to audit trail limitations,
it has observed that firms that are not FINRA members were identified
in 17 percent of the surveillance alerts generated by its U.S. Treasury
security manipulation pattern surveillance in 2020 and 2021.\119\ FINRA
has no jurisdiction over such firms and, therefore, no authority to
address their involvement in potential market misconduct that is
identified.\120\ Since, to the Commission's knowledge, no exchange SRO
has expertise or performs oversight in this area, broker-dealer firms
that are not FINRA members may participate in the U.S. Treasury
securities market effectively without SRO oversight applied to their
activity in that market (other than, as discussed below, what can be
discerned by regulators when non-FINRA member broker-dealer U.S.
Treasury securities transactions are reported to TRACE by FINRA
members).\121\ This rulemaking would facilitate oversight consistent
with the protection of investors and the public interest.
---------------------------------------------------------------------------
\119\ See FINRA Letter at 10; see also Better Markets Letter at
9. The 17% figure reflects an upper bound of the rate at which
Commission-registered broker-dealers that are not FINRA members
appeared in the alerts generated by FINRA's U.S. Treasury security
manipulation pattern surveillance in 2020 and 2021. See 6/20/23
Meeting Memorandum. The Commission understands that the actual rate
at which Commission-registered broker-dealers that are not FINRA
members appeared in these alerts is likely lower than 17%, as some
portion of the alerts may have involved non-FINRA member proprietary
trading firm entities that are not Commission-registered broker-
dealers. Id. More precise estimates are not possible in light of the
way proprietary trading firms are identified under current audit
trail rules and the way FINRA evaluates conduct by potentially
affiliated entities. Id.
\120\ See FINRA Letter at 10.
\121\ As discussed below in this section, the Commission retains
authority over broker-dealers, but the Exchange Act contemplates
dual layers of oversight of broker-dealers through such Commission
authority working in tandem with SRO authority. The focus here is on
strengthening the SRO layer of oversight.
---------------------------------------------------------------------------
Insofar as U.S. Treasury securities transaction reporting and
transparency in particular are concerned, FINRA's TRACE system is the
regulatory vehicle that facilitates mandatory reporting of OTC
transactions in U.S. Treasury securities, among other eligible fixed
income securities.\122\ But as discussed in the 2022 Re-Proposal,
proprietary trading broker-dealer firms that are not FINRA members are
not required to report their U.S. Treasury securities transactions to
FINRA's TRACE system because TRACE reporting obligations for U.S.
Treasury securities transactions apply only to broker-dealers that are
FINRA members.\123\ Thus, exchange SRO membership alone is not enough
to subject proprietary trading broker-dealer firms that effect U.S.
Treasury securities transactions to FINRA's reporting requirement for
such transactions.
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\122\ See FINRA Rule 6700 series. FINRA publishes aggregated
transaction information and statistics on U.S. Treasury securities
on its website. See <a href="http://FINRA.org">FINRA.org</a>, Treasury Aggregate Statistics,
available at <a href="https://www.finra.org/finra-data/browse-catalog/about-treasury">https://www.finra.org/finra-data/browse-catalog/about-treasury</a> (last visited Aug. 9, 2023); FINRA Rule 6750, Supplementary
Material .01(b); see also Securities Exchange Act Release No. 95438
(Aug. 5, 2022), 87 FR 49626 (Aug. 11, 2022) (File No. SR-FINRA-2022-
017) (order approving FINRA publication of aggregated U.S. Treasury
securities transactions more frequently than weekly, such as on a
daily basis). Also, pursuant to effective national market system
plans which are also effective transaction reporting plans (as both
terms are defined in 17 CFR 242.600(b) (Rule 600(b) of Regulation
NMS)), namely the Nasdaq UTP Plan and the CTA Plan, FINRA reports to
the Securities Information Processors (``SIPs'') information for
off-exchange NMS stock transactions that are reported to FINRA's
TRFs, and the SIPs in turn distribute the information in the public
consolidated market data feeds. See section VIII(a) of the CTA Plan;
section VIII.B of the Nasdaq UTP Plan.
\123\ See FINRA Rule 6720--Participation in TRACE; see also 2022
Re-Proposal, supra note 1, 87 FR 49938. Since Sept. 1, 2022, certain
depository institutions (``covered depository institutions'') have
been required to report to TRACE transactions in U.S. Treasury
securities, agency debt securities and agency mortgage-backed
securities. See <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 Aug. 8, 2023). In addition, in order to enhance the
regulatory audit trail and ensure data is reported in a more timely
manner, FINRA adopted amendments to Rule 6730 to require members to
report U.S. Treasury securities transaction data in the smallest
increment available to the member and as soon as practicable, but no
later than 60 minutes following a transaction. See Securities
Exchange Act Release No. 95635 (Aug. 30, 2022), 87 FR 54579 (Sept.
6, 2022).
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When a non-FINRA member broker-dealer trades U.S. Treasury
securities through a ``covered ATS,'' the covered ATS is obligated in
its TRACE report to identify the non-FINRA member broker-dealer via its
Market Participant ID (``MPID''),\124\ thus providing visibility to
regulators as to what transactions on covered ATSs are attributable to
non-FINRA members.\125\ But regulators have no such visibility when
non-FINRA member broker-dealers trade U.S. Treasury securities
otherwise than on a covered ATS. If non-FINRA member broker-dealers
trade on a non-covered ATS or bilaterally with a counterparty that is a
FINRA member or covered depository institution, the ATS or FINRA member
or covered depository institution reports the trade, but the non-FINRA
member is not specifically identified via a MPID and instead is
identified only as a ``customer.'' \126\ If
[[Page 61861]]
non-FINRA member broker-dealers trade U.S. Treasury securities
otherwise than on an ATS and with a counterparty that is not a FINRA
member and not a covered depository institution, there is no TRACE
reporting obligation and the trade is not reported.\127\
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\124\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities.
\125\ In the proposal the Commission issued in Jan. 2022 to,
among other things, amend Regulation ATS for ATSs that trade U.S.
government securities, and the reopening release issued in Apr.
2023, which provides supplemental information and economic analysis
on the Jan. 2022 proposal, the Commission estimated that there would
be a number of trading systems that would be required to comply with
Regulation ATS under the proposal. See Securities Exchange Act
Release Nos. 94062 (Jan. 26, 2022), 87 FR 15496, 15585 (Mar. 18,
2022); 97309 (Apr. 14, 2023), 88 FR 29448, 29466 (May 5, 2023).
\126\ In 2022, there were approximately 60 million transactions
reported in U.S. Treasury securities, totaling $165 trillion in
dollar volume. Approximately 35.7 million of those transactions,
representing approximately $64 trillion in dollar volume, were
executed on ATSs. The balance of approximately 24.3 million reported
transactions, or $100 trillion in dollar volume, that was not traded
on an ATS was reported by FINRA members with a counterparty that, if
not a FINRA member, was identified as a ``customer'' in the reported
data. The Commission estimates that approximately 12.7 million
transactions and $60 trillion in dollar volume not executed on an
ATS had a counterparty identified as a ``customer'' in the reported
data. This represents 52% of the 24.3 million transactions and 60%
of the $100 trillion in dollar volume not executed on an ATS, or 21%
of the 60 million total transactions and 36% of the $165 trillion
total dollar volume. Further, the Commission estimates that, of the
35.7 million transactions and $64 trillion in dollar volume executed
on an ATS, approximately 98.2% of that transaction volume and 99% of
that dollar volume was executed on a covered ATS; approximately 1.8%
of the 35.7 million transactions and 1% of the $64 trillion dollar
volume, representing approximately 0.6 million transactions and $536
billion, respectively, was executed on a non-covered ATS; and
approximately 4.8% of the 0.6 million transactions and 22% of the
$536 billion in dollar volume executed on a non-covered ATS,
representing approximately 15,000 transactions and $59 billion,
respectively, was reported with a counterparty identified as a
``customer.'' Customer volume and transaction counts are calculated
as half the sum of ATS-to-customer buys and ATS-to-customer sells.
\127\ In addition, in the context of an NMS stock transaction
effected between a FINRA member and a non-FINRA member otherwise
than on an exchange, only the FINRA member is obligated to report
the transaction to the FINRA TRF and the non-FINRA member generally
is not identified on the trade report as the contra party to the
trade. See Trade Reporting Frequently Asked Questions, Reporting
Relationships and Responsibilities, section 202: Reporting Trades
with a Non-FINRA Member, available at <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 Aug. 9, 2023). The non-FINRA member is, however,
identified in CAT in this context.
---------------------------------------------------------------------------
The Commission continues to believe that regulators' lack of
visibility into U.S. Treasury securities transactions effected by
proprietary trading broker-dealer firms that are not FINRA members, in
the circumstances described above in which such firms are not
identified by MPID in TRACE data, detracts from the comprehensiveness
of U.S. Treasury securities TRACE data and regulators' ability to
utilize that data to reconstruct market events, and detect and deter
improper trading activity in the U.S. Treasury securities market.\128\
The Commission does not know if all U.S. Treasury securities
transactions by non-FINRA member broker-dealer firms are reported to
TRACE, and for those that are reported, any non-FINRA member broker-
dealer firm that is a counterparty remains anonymous if the transaction
did not occur on a covered ATS. As a result, the Commission cannot
quantify total secondary market trading by broker-dealers in U.S.
Treasury securities, and regulators cannot readily identify from TRACE
when a non-FINRA member broker-dealer is the source of reported U.S.
Treasury securities order flows executed otherwise than on a covered
ATS and cannot link any such order flows to any particular non-FINRA
member broker-dealer.\129\ Moreover, broker-dealers that are not FINRA
members have a potential competitive advantage over those that are
FINRA members, as FINRA members incur the costs of reporting
transactions in U.S. Treasury securities transactions but non-FINRA
members do not.\130\
---------------------------------------------------------------------------
\128\ For example, in a Nov. 2021 report, an inter-agency
working group comprised of staff of the U.S. Department of the
Treasury, Commission, Commodity Futures Trading Commission, Federal
Reserve Bank of New York, and Board of Governors of the Federal
Reserve System stated that ``[i]n March 2020, large flows from
investors were captured by TRACE data but were not identifiable
beyond the FINRA-member dealer intermediary that facilitated the
trade. Understanding the source of these flows required the official
sector to contact dealers, wait for other datasets that are
significant lagged, and rely on separate sources of information.''
See U.S. Dep't of the Treasury et al., Recent Disruptions and
Potential Reforms in the U.S. Treasury Market: A Staff Progress
Report (Nov. 8, 2021) (``2021 Interagency Report'') available at
<a href="https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf">https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf</a>.
\129\ See id.
\130\ See supra section V.C.2 for estimated costs of TRACE
reporting.
---------------------------------------------------------------------------
Some commenters broadly agreed with the Commission's concern,
expressed in the 2022 Re-Proposal, regarding transparency and reporting
of U.S. Treasury securities transactions by proprietary trading broker-
dealer firms that are not FINRA members.\131\ Other commenters stated
that there is no reporting gap that must be addressed with respect to
U.S. Treasury securities transactions by proprietary trading broker-
dealer firms that are not FINRA members because, according to the
commenters, existing TRACE reporting requirements meaningfully capture
effectively all proprietary broker-dealer U.S. Treasury securities
transactions.\132\ One of these commenters also stated that potential
concerns around the identification of non-FINRA member counterparties
to U.S. Treasury securities transactions on non-covered ATSs are not
implicated by proprietary broker-dealer transactions in any meaningful
way, or could be remedied by requiring that such transactions be
reported with account ownership identifiers, which, according to the
commenter, would not necessitate FINRA membership.\133\ Similarly,
other commenters suggested, as an alternative to what the Commission
has proposed, an approach under which proprietary trading broker-dealer
firms could remain exempt from section 15(b)(8)'s Association
membership requirement so long as they report their U.S. Treasury
securities transactions to FINRA's TRACE system.\134\
---------------------------------------------------------------------------
\131\ See FINRA Letter at 9 (stating that FINRA has no
visibility into the identity of non-FINRA firms for U.S. Treasury
securities transactions that occur otherwise than on a covered ATS
or on any other non-ATS platform); Better Markets Letter at 9
(stating that a significant proportion of U.S. Treasury securities
transaction activity is performed on a bilateral basis without data
reporting requirements, and that this lack of visibility undermines
regulators' ability to monitor risks, understand how those risks
evolve into potentially systemic risks, and react to them in real-
time, and inhibits robust price discovery) (citing 2021 Interagency
Report, supra note 128); Cboe Letter at 9.
\132\ See FIA/PTG Letter at 3 (acknowledging concerns regarding
the identification of non-FINRA member counterparties but noting
they are not aware of the situation applying to proprietary broker-
dealer transactions in a ``meaningful'' way); MMI Letter at 2
(arguing CAT and TRACE data ``effectively captures'' all proprietary
broker-dealer transactions). It is difficult to assess the accuracy
of the commenter statement that there is no reporting gap with
respect to U.S. Treasury securities transactions by proprietary
trading broker-dealer firms that are not FINRA members because, as
discussed above in this section, if non-FINRA member broker-dealers
trade U.S. Treasury securities otherwise than on an ATS and with a
counterparty that is not a FINRA member and not a covered depository
institution, there is no TRACE reporting obligation and the trade is
not reported. And even when a non-FINRA member broker-dealer's
transactions in U.S. Treasury securities are reported by a
counterparty that does have a TRACE reporting obligation, such as a
FINRA member or covered depository institution, the non-FINRA member
is identified only as ``customer'' in the reported data unless the
transaction occurred on a covered ATS.
\133\ See FIA/PTG Letter at 3.
\134\ See, e.g., PEAK6 Letter at 6; Group One Letter at 2; CTC
Letter at 3; Cboe Letter at 7; Virtu Letter at 7.
---------------------------------------------------------------------------
The reporting requirements suggested by commenters could help
address the potential anonymity of proprietary trading broker-dealer
firms in TRACE data. But as discussed above in this section, a lack of
transparency to regulators when non-FINRA member broker-dealers trade
U.S. Treasury securities--and the resulting difficulty it poses for
regulators when trying to identify the source of U.S. Treasury
securities order flows, detect and deter improper trading activity, and
reconstruct market events--is not the full scope of what the Commission
believes must be addressed. There also is the necessity, described
above in this section, for FINRA to have the authority to allow it to
independently examine for, investigate, or address potential off-
member-exchange misconduct by proprietary trading broker-dealer firms
in the securities markets, including the
[[Page 61862]]
markets for U.S. Treasury securities, equities and options. Such FINRA
authority is necessary notwithstanding the Commission's authority over
broker-dealers in order to strengthen the SRO layer of oversight of
off-member-exchange securities trading, consistent with the dual
Commission and SRO oversight of broker-dealers required by the Exchange
Act.\135\ As a membership-based organization, FINRA's jurisdiction, and
thus its authority, is limited to its members and their associated
persons. As such, authority to independently examine, investigate, or
enforce potential violations against non-FINRA member broker-dealers is
not conferred to FINRA through reporting requirements without FINRA
membership. For example, FINRA stated that it identified non-FINRA
member broker-dealer firms as potential respondents in five percent of
the market regulation investigations it conducted in 2020 and 2021,
which ranged across asset types and included both cross-exchange and
off-exchange conduct), and FINRA identified non-FINRA member firms in
17 percent of the surveillance alerts generated by its U.S. Treasury
security manipulation pattern surveillance in 2020 and 2021.\136\ If
those non-FINRA member firms could remain exempt from section
15(b)(8)'s Association membership requirement as long as they report
their U.S. Treasury securities transactions to TRACE, FINRA would
continue to lack the independent ability to examine and investigate
those firms to generate evidence, such as by collecting documents and
interviewing witnesses.
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\135\ See supra note 22 (stating that Congress historically has
favored self-regulation for a variety of reasons, including that
effectively regulating the inner-workings of the securities industry
at the Federal level was viewed as cost prohibitive and inefficient;
the complexity of securities practices made it desirable for SRO
regulatory staff to be intimately involved with SRO rulemaking and
enforcement; and the SROs could set standards such as just and
equitable principles of trade and detailed proscriptive business
conduct standards).
\136\ See FINRA Letter at 5, 10; see also 6/20/23 Meeting
Memorandum (specifying that non-FINRA member broker-dealer firms
made up the 5% of the market regulation investigations that FINRA
conducted in 2020 and 2021, and that the 17% figure reflects an
upper bound of the rate at which Commission-registered broker-
dealers that are not FINRA members appeared in the alerts generated
by FINRA's U.S. Treasury security manipulation pattern surveillance
in 2020 and 2021).
---------------------------------------------------------------------------
In contrast, the rescission of the de minimis allowance and
proprietary trading exclusion helps solve both for the need for FINRA
authority over off-member-exchange securities trading activity and for
the anonymity in TRACE data of proprietary trading broker-dealer firms
when they trade U.S. Treasury securities otherwise than on a covered
ATS. Under the adopted approach, proprietary trading broker-dealer
firms that effect off-member-exchange securities transactions and that
become FINRA members will be subject to direct, membership-based FINRA
jurisdiction. Further, those that effect U.S. Treasury securities
transactions otherwise than on a covered ATS will be specifically
identified by MPID in TRACE.\137\
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\137\ See FINRA Rule 6730--Transaction Reporting, Supplementary
Material .07--ATS Identification of Non-FINRA Member Counterparties
for Transactions in U.S. Treasury Securities. FINRA membership also
would require that such firms be identified in off-exchange NMS
stock transaction reports to FINRA's TRFs, and thus promote broader
public market transparency in NMS stocks. See FINRA Rule 6000
Series--Quotation, Order, and Transaction Reporting Facilities and
FINRA Rule 7000 Series--Clearing, Transaction and Order Data
Requirements, and Facility Charges; see also supra note 17; 2022 Re-
Proposal, supra note 1, 87 FR 49942.
---------------------------------------------------------------------------
In addition to discussing existing regulatory mechanisms and
suggesting reporting-specific requirements as alternatives to FINRA
membership, commenters addressed the Commission's position, set forth
in the 2022 Re-Proposal, that it is appropriate for FINRA to exercise
direct, membership-based oversight over firms that do not carry
customer accounts.\138\ FINRA agreed with the Commission that direct,
membership-based FINRA oversight over proprietary trading broker-dealer
firms would be appropriate even though they typically do not carry
customer accounts.\139\ FINRA stated that active trading firms have the
potential to introduce risk into the markets even where they do not
have customers, and for that reason, FINRA's rules and regulatory
programs cover a cross section of activity and risks beyond sale
practices.\140\ FINRA stated that certain member risk controls overseen
by FINRA are particularly relevant to proprietary trading dealer firms,
such as controls for credit risk to counterparties, market risk, market
integrity risk, and liquidity risk.\141\ FINRA also observed that while
non-FINRA members may not have customers of their own, they nonetheless
can have a significant role executing customer orders routed to them by
other broker-dealers.\142\ Other commenters stated that FINRA
regulation is customer-focused and not appropriate for proprietary
trading firms that do not carry customer accounts.\143\
---------------------------------------------------------------------------
\138\ See, e.g., FINRA Letter at 11; ABCV Letter at 2; PEAK6
Letter at 2; Group One Letter at 1-2; letter from James Toes,
President & CEO, and Kate McAllister, Chair of the Board, Securities
Traders Association (Oct. 5, 2022) (``STA Letter'') at 3-4.
\139\ See FINRA Letter at 11 (stating that certain proprietary
trading dealer firms that are not FINRA members have a significant
market footprint and the scope of their activities introduces a
moderate to high degree of risk to the market and market
counterparties).
\140\ See id.
\141\ Id.
\142\ See id. at 7-8.
\143\ See, e.g., ABCV Letter at 2; PEAK6 Letter at 2; Group One
Letter at 1-2; STA Letter at 3-4.
---------------------------------------------------------------------------
The Commission continues to believe that it is appropriate for
FINRA to have direct, membership-based jurisdiction over proprietary
trading broker-dealer firms that effect off-member-exchange securities
transactions even though such firms typically do not carry customer
accounts. As discussed above,\144\ several non-FINRA member broker-
dealer firms that do not carry customer accounts effect significant
volumes of off-member-exchange securities transactions. The Commission
believes that such firms--and such trading activity--should not remain
exempt from FINRA's direct, membership-based oversight on the basis
that such firms do not carry customer accounts. FINRA's ability to
create a consistent regulatory framework for all broker-dealers that
effect off-member-exchange securities transactions is undermined by the
subset of such broker-dealers that do not carry customer accounts and
are not FINRA members in reliance on Rule 15b9-1.\145\ The rescission
of the de minimis allowance and proprietary trading exclusion will help
address this by eliminating the legal basis upon which such firms
generally are able to effect off-member-exchange securities
transactions without joining FINRA.
---------------------------------------------------------------------------
\144\ See section II.B, supra.
\145\ See FINRA Letter at 11 (stating that FINRA jurisdiction
over proprietary trading dealer firms and the ability to identify
their activity in all of FINRA's audit trails would further enable
FINRA to assess individual entities' impacts on the market and
market counterparties, and that the 2022 Re-Proposal would enable
FINRA to directly and more comprehensively oversee such firms and
their trading activity, which, in turn, would enhance market
integrity and foster the maintenance of fair, orderly, and efficient
markets); Better Markets Letter at 5 (stating that the amendments to
Rule 15b9-1 would ``help ensure that dealers such as high-frequency
trading firms, which conduct an enormous volume of trading, are
subject to consistent and robust oversight through FINRA, not only
the more narrow regulatory requirements that are specific to each
exchange'').
---------------------------------------------------------------------------
In particular, as discussed in the 2022 Re-Proposal, FINRA is well-
positioned to exercise direct oversight over such firms. FINRA has
established a regulatory regime for broker-dealers that effect off-
member-exchange securities transactions that applies to FINRA members
regardless of whether they handle customer orders or carry customer
accounts.\146\ For example,
[[Page 61863]]
FINRA, not unlike exchanges, has developed a detailed set of rules in
core areas such as trading practices,\147\ business conduct,\148\
financial condition and operations,\149\ and supervision,\150\ many of
which apply to FINRA members regardless of whether they handle customer
orders or carry customer accounts.\151\ As another example, FINRA's
transaction reporting regime is not limited to broker-dealers with
customers and applies to FINRA members regardless of whether they
handle customer orders or carry customer accounts.\152\ Continuing to
permit an exemption from FINRA membership on the basis that broker-
dealers that, for example, trade U.S. Treasury securities proprietarily
do not have customers would not help improve the comprehensiveness of
U.S. Treasury securities transaction TRACE data or address the
potential competitive advantage of non-FINRA member broker-dealers
that, unlike FINRA member broker-dealers, may trade U.S. Treasury
securities without incurring the costs of reporting those trades to
TRACE.
---------------------------------------------------------------------------
\146\ Many broker-dealer firms that derive all or most of their
revenue from proprietary trading already are FINRA members. See
Securities Exchange Act Release No. 97798 (June 26, 2023), 88 FR
42404, 42406 (June 30, 2023) (``TAF Amendment'') (stating that FINRA
estimates that approximately 66 member firms derive all or most of
their revenue from proprietary trading). As FINRA members, these
broker-dealers are subject to FINRA's rules and FINRA's direct
jurisdiction even though they effect securities transactions for
their own account and not on behalf of customers.
\147\ See FINRA Rule 5000 Series--Securities Offerings and
Trading Standards and Practices. For instance, FINRA prohibits
members from coordinating prices and intimidating other members. See
FINRA Rule 5240(a) (stating, among other things, that ``[n]o member
or person associated with a member shall: (1) coordinate the prices
(including quotations), trades or trade reports of such member with
any other member or person associated with a member, or any other
person; (2) direct or request another member to alter a price
(including a quotation); or (3) engage, directly or indirectly, in
any conduct that threatens, harasses, coerces, intimidates or
otherwise attempts improperly to influence another member, a person
associated with a member, or any other person'').
\148\ See FINRA Rule 2000 Series--Duties and Conflicts.
\149\ See FINRA Rule 4000 Series--Financial and Operational
Rules. For example, FINRA Rule 4370(a) provides, among other things,
that ``[e]ach member must create and maintain a written business
continuity plan identifying procedures relating to an emergency or
significant business disruption. Such procedures must be reasonably
designed to enable the member to meet its existing obligations to
customers. In addition, such procedures must address the member's
existing relationships with other broker-dealers and counter-
parties. The business continuity plan must be made available
promptly upon request to FINRA staff.''
\150\ See FINRA Rule 3000 Series--Supervision and
Responsibilities Relating to Associated Persons. This rule series
generally requires FINRA member firms, among other things, to
establish, maintain, and enforce written procedures to supervise the
types of business in which the firm engages and the activities of
its associated persons that are reasonably designed to achieve
compliance with applicable securities laws and regulations, and with
applicable FINRA rules. See, e.g., FINRA Rules 3110 (Supervision),
3120 (Supervisory Control System), and 3170 (Tape Recording of
Registered Persons by Certain Firms). See also FINRA By-Laws Article
III--Qualifications of Members and Associated Persons. Any person
associated with a member firm who is engaged in the securities
business of the firm--including partners, officers, directors,
branch managers, department supervisors, and salespersons--must
register with FINRA.
\151\ See, e.g., the FINRA rules set forth in notes 17-18, 56-
57, 122-124, 137 and 147-150, and accompanying text, supra. In
addition, FINRA has regulatory programs and staff dedicated to fixed
income regulation. See <a href="http://FINRA.org">FINRA.org</a>, Key Topics--Fixed Income,
available at <a href="https://www.finra.org/rules-guidance/key-topics/fixed-income#overview">https://www.finra.org/rules-guidance/key-topics/fixed-income#overview</a>.
\152\ See FINRA Rule 6000 Series (Quotation, Order, and
Transaction Reporting Facilities).
---------------------------------------------------------------------------
The Commission also continues to believe that it is important to
the protection of investors and the public interest that FINRA has
direct, membership-based jurisdiction over proprietary trading broker-
dealer firms that effect off-member-exchange securities transactions
regardless of whether they carry customer accounts. An Association's
regulatory responsibility, like exchange SROs', includes an obligation
to enforce compliance with the Federal securities laws and rules
thereunder and the SRO's rules. As an Association, the Exchange Act's
statutory framework places SRO oversight responsibility with FINRA for
off-member-exchange securities trading, and FINRA is well-positioned to
carry out this responsibility with respect to its members.
For example, FINRA gains familiarity with a member's operational
risk by assigning dedicated staff members to each firm (e.g., a Risk
Monitoring Analyst to act as the primary point of contact and a Risk
Monitoring Director) and having staff with subject matter expertise
relevant to a member's business model conduct examinations and carry
out monitoring duties.\153\ Firms are classified into five primary
business models and then further sorted into various subgroups overseen
by exam and risk monitoring staff.\154\ Risk monitoring teams seek to
understand the unique aspects of each firm monitored, and use that
expertise to inform exam staff in the preparation of exams. Employing a
risk-based approach, FINRA examines firms on a one, two or four-year
frequency and makes use of specialist teams (e.g., anti-money
laundering, cybersecurity or fixed income). Further, FINRA gains
familiarity with a member's operational risk through customer
complaints and regulatory tips or calls, which may trigger a ``cause''
exam (in contrast to the routine exams described above) focusing on the
issues raised in the complaints.\155\ Finally, FINRA staff is informed
of changes in operational risk associated with a material change in
business operations or change of control through FINRA Rule 1017.\156\
The Continuing Member Application triggered under FINRA Rule 1017,
among other things, reviews if the member's contractual and business
relationships support the proposed change, if communications and
operational systems are appropriate, financial and internal controls,
and the adequacy of the member's supervisory system to prevent and
detect violations.\157\
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\153\ See FINRA Risk Monitoring Program, FINRA, available at
<a href="https://www.finra.org/contact-finra/risk-monitoring-program">https://www.finra.org/contact-finra/risk-monitoring-program</a>; FINRA
Examination and Risk Monitoring Programs, FINRA, available at
<a href="https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview">https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview</a>.
\154\ See FINRA Examination and Risk Monitoring Programs, FINRA,
available at <a href="https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview">https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview</a>.
\155\ Id.
\156\ See FINRA Rule 1017; Form CMA, FINRA, available at <a href="https://www.finra.org/registration-exams-ce/broker-dealers/registration-forms/form-cma">https://www.finra.org/registration-exams-ce/broker-dealers/registration-forms/form-cma</a>.
\157\ See Filing a Change in Membership Application, The ``What
to Expect'' Webcast Series (2010), FINRA, available at <a href="https://www.finra.org/sites/default/files/Education/p018711.pdf">https://www.finra.org/sites/default/files/Education/p018711.pdf</a>.
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The inability of FINRA to directly enforce regulatory compliance by
proprietary trading broker-dealer firms that are not FINRA members--
whether or not they handle customer orders or carry customer accounts--
may create a risk to the fair and orderly operation of the market
because FINRA may not be as familiar with the firm's operational risks
or other risks posed by the firm's off-member-exchange securities
trading activity as FINRA would be with a FINRA member firm, and FINRA
may not be as well positioned potentially to mitigate those risks. In
addition, if FINRA were to detect that a non-FINRA member is effecting
off-member-exchange securities transactions that are not in compliance
with the Exchange Act or applicable rules, FINRA would not have direct,
membership-based jurisdiction to directly address the behavior.\158\
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\158\ FINRA could refer such a matter to the Commission or to an
exchange where the firm is a member or, as discussed above in this
section, potentially address the matter through an RSA if covered by
the terms of the RSA. See also supra note 14. But FINRA may lack
certain investigative tools, discussed above in this section, with
respect to non-FINRA member broker-dealers that it possesses with
respect to FINRA members, which could help FINRA further investigate
potentially violative behavior before making a referral to the
Commission or an exchange, or help prevent FINRA from failing to
make referrals when they are warranted. See also section V, infra.
Further, the Commission believes that regulatory efforts based on
discretionary RSA arrangements among exchange SROs and FINRA, while
beneficial in many contexts, are a less stable and consistent
mechanism for SRO oversight than the FINRA membership required by
the Exchange Act in the context presented here, and are less
comprehensive than membership-based FINRA oversight because they do
not cover U.S. Treasury securities trading activity.
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[[Page 61864]]
As is discussed in the 2022 Re-Proposal and in more detail in the
Economic Analysis, infra section V, firms that become FINRA members as
a result of the adopted rule amendments will be required to apply for
membership with FINRA and become subject to the fees charged by FINRA
to all of its member firms. FINRA charges each member firm certain
regulatory fees designed to recover the costs to FINRA of the
supervision and regulation of members, including performing
examinations, financial monitoring, and policy, rulemaking,
interpretive, and enforcement activities.\159\ These regulatory fees
include a Trading Activity Fee (``TAF'').\160\ FINRA issued a
Regulatory Notice in 2015 in which it proposed to amend the TAF such
that it would not apply to transactions by a proprietary trading firm
effected on exchanges of which the firm is a member.\161\ In June 2023,
after the 2022 Re-Proposal, FINRA filed a proposed rule change with the
Commission, pursuant to section 19 of the Act, to amend the TAF such
that it does not apply to transactions by a proprietary trading firm
effected on exchanges of which the firm is a member.\162\ FINRA
designated this proposed rule change as ``establishing or changing a
due, fee or other charge'' under section 19(b)(3)(A)(ii) of the Act and
17 CFR 240.19b-4(f)(2) (``Rule 19b-4(f)(2)'') thereunder, which renders
the rule effective upon filing with the Commission.
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\159\ See FINRA Schedule A to the By-Laws of the Corporation
(``FINRA Schedule A''), at section 1, 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>.
\160\ FINRA uses the TAF to recover the costs to FINRA of the
supervision and regulation of members, including performing
examinations, financial monitoring, and policy, rulemaking,
interpretive, and enforcement activities. See FINRA Schedule A, at
section 1(a). The TAF is generally assessed on FINRA member firms
for all equity sales transactions that are not performed in the
capacity of a registered exchange specialist or market maker. See
id. at section 1(b). FINRA charges its members other fees as well,
such as an annual Gross Income Assessment (``GIA''). See id. at
section 1.
\161\ See FINRA Regulatory Notice 15-13, Trading Activity Fee
(May 2015), available at <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 re-opened the
comment period on its 2015 Regulatory Notice after the 2022 Re-
Proposal. See FINRA Regulatory Notice 22-30, Trading Activity Fee
(Dec. 15, 2022) available at <a href="https://www.finra.org/sites/default/files/2022-12/Regulatory-Notice-22-30.pdf">https://www.finra.org/sites/default/files/2022-12/Regulatory-Notice-22-30.pdf</a>.
\162\ See TAF Amendment. The TAF Amendment's implementation
date, which FINRA will announce in a Regulatory Notice, will be no
earlier than the date of the Commission's adoption of amended Rule
15b9-1 and no later than the effective date of amended Rule 15b9-1.
Id.
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Comments on the 2022 Re-Proposal, submitted prior to the TAF
Amendment, stated that the costs of applying for FINRA membership, as
well as ongoing costs of FINRA membership such as the TAF, are high and
burdensome and could affect liquidity provision.\163\ In particular,
commenters stated that proprietary options trading firms should remain
exempt from section 15(b)(8)'s Association membership requirement
because they do not trade U.S. Treasury securities and the equities
transaction volume that they effect is hedging activity.\164\
Commenters urged the Commission to adopt an exemption for proprietary
options trading broker-dealer firms, such that their off-member-
exchange securities trading activity would not trigger section
15(b)(8)'s Association membership requirement if such activity is to
hedge or in furtherance of their options trading activity on their
member exchange(s).\165\ If proprietary options trading firms do not
remain exempt, commenters stated, there could be a negative impact on
options market liquidity and smaller options trading firms could cease
trading, which could lead to consolidation and decreased
competition.\166\ FINRA stated that most proprietary trading dealer
firms that newly join FINRA would not incur membership application fees
exceeding $12,500.\167\ FINRA also stated (prior to filing the TAF
Amendment with the Commission) that it is committed to amending the TAF
to lessen its impact on such firms.\168\
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\163\ See, e.g., MMI Letter at 3; PEAK6 Letter at 4-5; FIA PTG
Letter at 4; Group One Letter at 2-3; ABCV Letter at 2-3; CTC Letter
at 4; Cboe Letter at 7. One commenter estimated that some
proprietary broker-dealers would incur TAF fees greater than
$1,000,000 per year under the current TAF structure. See FIA PTG
Letter at 4. Another commenter opined on the substance of FINRA's
contemplated TAF amendment. See PEAK6 Letter at 4. Some commenters
also stated that FINRA must amend the TAF before the Rule 15b9-1
amendments are adopted so firms can assess the fee-related costs of
FINRA membership on proprietary trading firms. See PEAK6 Letter at
4; FIA PTG Letter at 4.
\164\ See, e.g., Cboe Letter at 3; see also ABCV Letter at 2
(stating that any trading by options market makers in the underlying
cash equities markets is related to legitimate hedging of their
options positions).
\165\ See Cboe Letter at 2-3; ABCV Letter at 3-4; CTC Letter at
5; PEAK6 Letter at 4; Nasdaq Letter at 2. Commenters also stated
that options trading firms' equities volume often is processed
through a FINRA member, and stated that a hedging exemption would be
particularly appropriate if the routing away from a member exchange
is through a broker-dealer that is a FINRA member. See Cboe Letter
at 2-3; ABCV Letter at 2-4; CTC Letter at 5; PEAK6 Letter at 4. As
discussed supra in this section, the Commission does not agree. See
supra notes 98-101 and accompanying text.
\166\ See STA Letter at 3-4; Cboe Letter at 2-3, 7; ABCV Letter
at 2-4; CTC Letter at 5; PEAK6 Letter at 4-6.
\167\ See FINRA Letter at 12 n. 40 (also stating that FINRA does
not anticipate that new member proprietary trading dealer firms
would incur the one-time clearing surcharge that applies to new
applicants engaged in clearing and carrying activity).
\168\ See id. at 14. See also note 170 and accompanying text,
infra.
---------------------------------------------------------------------------
The Commission believes that a hedging exemption for broker-dealers
that are proprietary options trading firms, like that sought by
commenters, could continue to result in a significant volume of off-
member-exchange trading activity not being subject to direct,
membership-based FINRA oversight. Proprietary options trading firms
make up the majority of the 12 firms that the Commission identified
above as accounting for 5.1% of all off-exchange listed equities volume
in April 2023 and the majority of the 21 firms that the Commission
identified as accounting for approximately 99% of the $262 billion in
listed equities transaction volume executed on exchanges where they are
not a member.\169\ As a result, significant off-member-exchange trading
activity could continue not to be subject to direct FINRA oversight
under commenters' suggested exemption. The Commission continues to
believe that this would not be consistent with the protection of
investors or the public interest, or with the historical rationale for
Rule 15b9-1 of accommodating limited off-member-exchange trading
activities.\170\
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\169\ See section II.B, supra.
\170\ See 2022 Re-Proposal, supra note 1, sections III.B.2 and
III.C, 87 FR 49947-50. Section 15(b)(9) of the Act provides the
Commission with the authority, by rule or order, and as it deems
consistent with the public interest and the protection of investors,
to conditionally or unconditionally exempt from the requirements of
section 15(b)(8) any broker or dealer or class of brokers or
dealers. Accordingly, if a broker or dealer or class of brokers or
dealers believes that it should be exempted from the requirements of
section 15(b)(8) in a manner that is not provided by amended Rule
15b9-1, it may seek an exemption from the Commission, by order,
pursuant to section 15(b)(9). For example, the Commission may
consider granting such an exemption, where appropriate, if a dealer
or class of dealers chooses to limit its exchange trading activity
to the physical floor of an exchange of which it is a member, but
must effect limited securities transactions elsewhere for its own
account in order to facilitate its exchange-floor business.
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[[Page 61865]]
The effect of not including a hedging exemption in Rule 15b9-1 will
be that proprietary options trading broker-dealer firms (among other
types of proprietary trading broker-dealer firms) will no longer be
exempt from section 15(b)(8)'s Association membership requirement if
they effect off-member-exchange securities transactions (unless they
are covered by one of the exemptions in the amended rule). Therefore,
these firms will be required by section 15(b)(8) of the Act to join
FINRA in order to continue any off-member-exchange securities trading
activity. The Commission is mindful of the FINRA membership costs,
including application and TAF fees, that would be incurred by
proprietary trading broker-dealer firms, including options trading
firms, that join FINRA as a result of the rescission of the de minimis
allowance and proprietary trading exclusion, and the Commission is
mindful of the potential impact of those costs on options market
liquidity.
The Commission believes it is unlikely, however, that such firms
would be unable to continue operating their trading businesses or
providing liquidity in their normal course due to the costs of FINRA
membership. Insofar as the costs of joining FINRA are concerned, the
Commission believes that a $12,500 FINRA membership application fee
would be manageable for proprietary trading options firms that newly
join FINRA, and is small enough such that it should not materially
impact their ability to provide liquidity.\171\ As for concerns
regarding the TAF, an ongoing FINRA cost, FINRA, after considering the
potential impact of the TAF on proprietary trading firms that join
FINRA, has amended its rules to provide an exemption from the TAF for
all proprietary trading firms for transactions executed on an exchange
of which the proprietary trading firm is a member.
---------------------------------------------------------------------------
\171\ See infra section V.C.2 (stating that the Commission
believes that the median application fee for the 12 largest (by
volume traded) non-FINRA member broker-dealer firms would be
$12,500).
---------------------------------------------------------------------------
In addition, commenters stated that small options trading firms
could be adversely affected by the rule amendments to the point of
providing less liquidity or ceasing to trade.\172\ While commenters did
not indicate how they are defining ``small'' options firms, the
Commission believes that smaller firms should be able to absorb the
ongoing costs of FINRA membership, such as the GIA and TAF.\173\ As
discussed in the Economic Analysis below,\174\ the estimated aggregate
costs for the 12 largest non-FINRA member broker-dealer firms as of
April 2023 represent the majority of the aggregate costs stemming from
the amendments to Rule 15b9-1. Therefore, the Commission believes that
smaller non-FINRA member broker-dealer firms as well as new entrants
will experience much lower initial and ongoing costs and that these
FINRA membership costs would not materially impede their ability to
continue their trading businesses, which may include providing
liquidity in the options market, if they join FINRA.\175\
---------------------------------------------------------------------------
\172\ See STA Letter at 3-4; ABCV Letter at 2-3; Cboe Letter at
7; Nasdaq Letter at 3-4.
\173\ See infra section V.C.2 (stating that the 12 largest non-
FINRA member broker-dealer firms (as measured by off-exchange
equities volume traded in April 2023) had average and median annual
total revenues of approximately $1.2 billion and $491 million,
respectively, in 2022; would incur an estimated median GIA of
$327,870; and would incur an estimated median and average TAF of
approximately $119,256 and $304,994, respectively).
\174\ See infra section V.C.2.
\175\ The Commission believes that the potential FINRA
membership costs that could be incurred by firms not among the 12
largest non-FINRA member broker-dealers is the best data point
available to the Commission to assess commenters' assertion. As
discussed in section V.B.2, infra, the Commission cannot, however,
rule out the possibility that the addition of FINRA costs will serve
as a catalyst for one or more small non-FINRA member options market
makers to exit the market, although FINRA's exemption of TAF fees
should reduce the likelihood that firms will choose to exit in
response to the adopted rule amendments. In addition, as discussed
in section VII, infra, the Commission estimates that not more than
three of the 64 non-FINRA member broker-dealer firms that the
Commission identified as of April 2023 have total capital of less
than $500,000 and are not affiliates of any person (other than a
natural person) that is not a small business or small organization
and would, as a result, be considered small entities under
Regulatory Flexibility Act (``RFA'') standards. These three small
firms--by RFA standards--could be significantly impacted by the
adopted rule amendments because they could be required to become a
member of FINRA under section 15(b)(8) of the Act, if they effect
off-member-exchange securities transactions and do not qualify for
one of the adopted exemptions. These three firms are not among the
12 largest non-FINRA member broker-dealer firms identified by the
Commission, and so, as discussed in the paragraph above and in
section V.C.2 infra, their initial and ongoing FINRA membership
costs, should they join FINRA, likely would be low. This suggests
that, while they could be significantly impacted by the adopted rule
amendments in that they may no longer be exempt from FINRA
membership, their trading businesses nevertheless might not be
materially impeded by the costs of FINRA membership.
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Further, since the 2015 Proposal, as commenters observed, there has
been a decrease in the number of Commission-registered broker-dealers
that are exchange members but not FINRA members.\176\ There also has
been significant consolidation among broker-dealers generally over the
past decade.\177\ Meanwhile, despite this decline in the number of
firms, options market liquidity has remained robust, as reflected by
data suggesting that options quoted spreads have remained flat or
slightly declined in recent years as overall option trading volumes
have continued to hit record highs.\178\ Therefore, as discussed in the
Economic Analysis below,\179\ the Commission does not believe that the
adopted rule amendments will undermine options market liquidity
provision. In addition, as discussed in the Economic Analysis
below,\180\ the Commission believes that amended Rule 15b9-1 is not
likely to have an economically meaningful effect on direct capital
formation, and that changes in the allocation of regulatory fees and
direct FINRA supervision within the off-member-exchange market may
result in improved efficiency of capital allocation by the financial
industry, as current FINRA members might commit additional capital to
liquidity provision when the trading environment has more uniform
regulatory requirements.
---------------------------------------------------------------------------
\176\ See STA Letter at 3-4; ABCV Letter at 2-3. See also infra
section V.B.2. The decrease is largely the result of such firms
ceasing their broker-dealer operations and withdrawing their
registration as broker-dealers with the Commission.
\177\ See <a href="http://FINRA.org">FINRA.org</a>, 2022 Industry Snapshot, at 13, available at
<a href="https://www.finra.org/sites/default/files/2022-03/2022-industry-snapshot.pdf">https://www.finra.org/sites/default/files/2022-03/2022-industry-snapshot.pdf</a> (last visited Aug. 8, 2023) (reflecting the following
number of FINRA-registered firms in 2017-2021: 3,726 in 2017; 3,607
in 2018; 3,517 in 2019; 3,435 in 2020; and 3,394 in 2021); compare
2015 Proposal, supra note 1, 80 FR 18042, with section II.B supra
(reflecting a decrease in the Commission's estimate of the number of
broker-dealers registered with the Commission that are exchange
members but not FINRA members from 125 in the 2015 Proposal to 64 as
of Apr. 2023). This trend began well before the amendments being
adopted in this release, and may or may not continue regardless of
the adopted rule amendments. In other words, if options trading
firms ceased operating in the future, the Commission does not
believe the cause necessarily would be the amendments to Rule 15b9-1
as other factors have caused this trend before these amendments and
likely would continue to be relevant.
\178\ See section V.B, infra (among other things, citing an
academic study showing that options bid-ask spreads have remained
flat since 2015, and citing NYSE Data Insights 2021 Options Year in
Review, available at <a href="https://www.nyse.com/data-insights/2021-options-year-in-review">https://www.nyse.com/data-insights/2021-options-year-in-review</a>, which reflects that options quoted spreads
have remained flat or slightly declined in recent years as overall
option trading volumes have continued to hit record highs).
\179\ See id.
\180\ See 2022 Re-Proposal, supra note 1, 87 FR 49960; section
V.B.1, infra.
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Finally, commenters stated that the Commission already possesses
and can exercise authority over Commission-registered broker-dealers
that are not FINRA members.\181\ While this is
[[Page 61866]]
true,\182\ as discussed above and in the 2022 Re-Proposal,\183\ the
Exchange Act requires dual SRO and Commission oversight of registered
broker-dealers, with SROs acting as robust, front-line regulators of
their broker-dealer members. While the Commission retains examination
authority over the SROs and can bring enforcement actions, including
pursuant to SRO referrals, that Commission layer of regulatory
oversight is meant to work in tandem with, not in place of, a robust
front-line layer of SRO oversight. The Commission continues to believe
that the front-line layer of SRO oversight must be strengthened with
respect to proprietary trading broker-dealer firms that effect off-
member-exchange securities transactions notwithstanding the
Commission's plenary jurisdiction over Commission-registered broker-
dealers. Section 15(b)(8)'s complementary SRO oversight structure
generally has enabled exchange SROs to specialize in oversight of
securities trading activity that occurs on the exchange, and FINRA to
specialize in oversight of off-member-exchange securities trading
activity. The Commission continues to believe that rescinding Rule
15b9-1's de minimis allowance and proprietary trading exclusion would
better enable robust and consistent FINRA oversight in the area of its
expertise through direct, membership-based jurisdiction of broker-
dealers that effect off-member-exchange securities transactions
proprietarily. This, in turn, could strengthen the front-line layer of
SRO regulatory oversight that is applied to off-member-exchange
proprietary securities trading in today's market.\184\
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\181\ See, e.g., Virtu Letter at 2.
\182\ See section I, supra; 2022 Re-Proposal, supra note 1, 87
FR 49931-32 (stating that the Commission may bring enforcement
actions, including pursuant to referrals made by SROs, to enforce
compliance with the Exchange Act and applicable rules).
\183\ See section I, supra; 2022 Re-Proposal, supra note 1, 87
FR 49932.
\184\ One commenter stated that, ``by adopting a Commission rule
requiring certain broker-dealers to register with FINRA, FINRA will
become, at least as to those broker-dealers, a `part of the
Government' under the standard set forth by the U.S. Supreme Court
in Free Enterprise Fund v. Public Company Accounting Board, 561 U.S.
477 (2010).'' Letter from W. Hardy Callcott (Sept. 3, 2022). FINRA
disputed this. See FINRA Letter at 15-20. The Commission disagrees
that the amendments to Rule 15b9-1 would make FINRA ``part of the
Government'' under Free Enterprise. In that case, the Supreme Court
reasoned that, ``[u]nlike the self-regulatory organizations,'' the
Public Company Accounting Oversight Board was ``a Government-
created, Government appointed entity.'' 561 U.S. at 485. These
distinctions between FINRA and the PCAOB remain unchanged by the
amendments to Rule 15b9-1. See also, e.g., Desiderio v. Nat'l Ass'n
of Sec. Dealers, Inc., 191 F.3d 198, 206 (2d Cir. 1999) (NASD ``is a
private actor, not a state actor,'' because it is a ``private
corporation that receives no federal or state funding,'' ``[i]ts
creation was not mandated by statute, nor does the government
appoint its members or serve on any NASD board or committee.'').
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On March 28, 2022, the Commission proposed new rules to further
define certain language as used in the definition of ``dealer'' and
``government securities dealer'' under sections 3(a)(5) and 3(a)(44) of
the Exchange Act, respectively.\185\ Some commenters stated that the
amendments to Rule 15b9-1 may affect proprietary trading firms that are
not Commission-registered dealers, but could be required to register as
such if the definition of ``dealer'' is amended.\186\ To the extent the
Commission amends the definition of ``dealer'' in the future, the
adopted amendments to Rule 15b9-1 would become part of the baseline
from which the effects of any such new rule on the definition of
``dealer'' are measured.
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\185\ See Securities Exchange Act Release No. 94524 (Mar. 28,
2022), 87 FR 23054 (Apr. 18, 2022).
\186\ See, e.g., MMI Letter at 3; STA Letter at 2; Virtu Letter
at 4.
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B. Narrowed Criteria for Exemption From Association Membership
The Commission proposed to add to Rule 15b9-1 a new paragraph (c)
that would set forth two narrow circumstances in which a broker or
dealer would continue to be exempt from section 15(b)(8)'s Association
membership requirement if it effects transactions in securities
otherwise than on an exchange of which it is a member.\187\
Specifically, following the existing paragraphs of Rule 15b9-1 that
require that a broker or dealer be a member of a national securities
exchange and carry no customer accounts (both of which paragraphs would
be retained), the Commission proposed to add language that states:
``and, (c) Effects transactions in securities solely on a national
securities exchange of which it is a member, except that with respect
to this paragraph (c) . . .'' \188\ The two proposed exemptions
followed in new paragraphs (c)(1) and (2).
---------------------------------------------------------------------------
\187\ See 2022 Re-Proposal, supra note 1, 87 FR 49944-49.
Relatedly, the Commission proposed that existing paragraph (a) of
Rule 15b9-1 would remain the same except it would no longer be
numbered as paragraph (a); existing paragraph (a)(1) would be
renumbered as paragraph (a); and existing paragraph (a)(2) would be
renumbered as paragraph (b). See 2022 Re-Proposal, supra note 1, 87
FR 49945 n. 156.
\188\ See 2022 Re-Proposal, supra note 1, 87 FR 49945.
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As discussed in turn below, the Commission is adopting as proposed
new paragraphs (c)(1) and (2) (as well as the above-quoted
language).\189\ Paragraphs (c)(1) and (2) of the amended rule are
intended to provide more focused exemptions from Association membership
for types of off-member-exchange activity that are similar to the off-
member-exchange activities that Rule 15b9-1 was originally intended to
cover, and that are consistent with the protection of investors and the
public interest in accordance with section 15(b)(9) of the Act.
---------------------------------------------------------------------------
\189\ See amended Rule 15b9-1(c), under ``Text of Amendments,''
infra. The Commission also is adopting the proposed renumbering of
paragraphs (a) and (b) in the amended rule. See supra note 187.
---------------------------------------------------------------------------
1. Routing Exemption
The Commission proposed to add a new paragraph (c)(1) to Rule 15b9-
1 that sets forth an exemption from Association membership if a broker
or dealer that meets the criteria of paragraphs (a) and (b) of the rule
effects transactions in securities otherwise than on a national
securities exchange of which it is a member that result solely from
orders that are routed by a national securities exchange of which it is
a member to comply with Rule 611 of Regulation NMS \190\ or the Options
Order Protection and Locked/Crossed Market Plan.\191\ Relatedly, the
Commission also proposed to eliminate from Rule 15b9-1 outdated
references to the ``Intermarket Trading System,'' \192\ which is a now-
obsolete NMS plan that was discontinued in 2007 because it was
superseded by Regulation NMS.\193\ The Commission is adopting these
aspects of the 2022 Re-Proposal by adding new paragraph (c)(1), as re-
proposed, to Rule 15b9-1, and by removing from Rule 15b9-1 the ITS
provisions in pre-existing paragraphs (b)(2) and (c).
---------------------------------------------------------------------------
\190\ 17 CFR 242.611.
\191\ See 2022 Re-Proposal, supra note 1, 87 FR 49945. See also
Options Linkage Plan, supra note 22.
\192\ The ITS was an NMS plan, the full title of which was
``Plan for the Purpose of Creating and Operating an Intermarket
Communications Linkage Pursuant to Section 11A(c)(3)(B) of the
Exchange Act of 1934'' (``ITS Plan''). The ITS Plan was
provisionally approved by the Commission in 1978 and finally
approved by the Commission in 1983. See Securities Exchange Act
Release Nos. 14661 (Apr. 14, 1978), 43 FR 17419 (Apr. 24, 1978)
(``Initial ITS Plan Approval Order''); 19456 (Jan. 27, 1983), 48 FR
4938 (Feb. 3, 1983) (``Final ITS Plan Approval Order''). All
national securities exchanges that traded exchange-listed stocks and
the National Association of Securities Dealers (``NASD'') were
participants in the ITS Plan.
\193\ See 2022 Re-Proposal, supra note 1, 87 FR 49945; see also
Notice of Filing and Immediate Effectiveness of the Twenty Fourth
Amendment to the ITS Plan Relating to the Elimination of the ITS
Plan, Securities Exchange Act Release No. 55397 (Mar. 5, 2007), 72
FR 11066 (Mar. 12, 2007).
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As discussed in the 2022 Re-Proposal, Rule 611 of Regulation NMS
requires trading centers, such as national securities exchanges, to
establish, maintain, and enforce written policies
[[Page 61867]]
and procedures reasonably designed to prevent trade-throughs in
exchange-listed stocks, subject to certain exceptions.\194\ In general,
Rule 611 protects automated quotations that are the best bid or offer
of a national securities exchange or an Association.\195\ To facilitate
compliance with Rule 611, national securities exchanges have developed
the capability to route orders through brokers or dealers (many of
which are affiliated with the exchanges) to other trading centers with
protected quotations.\196\ Similarly, in the options market, the
Options Linkage Plan is an NMS plan that requires linkages between the
options exchanges to protect the best-priced displayed quotes in the
market and to avoid locked and crossed markets.\197\ The Options
Linkage Plan includes written policies and procedures that provide for
order protection and address locked and crossed markets in eligible
options classes.\198\
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\194\ 17 CFR 242.611. See also 17 CFR 242.600(b)(94) (defining a
``trade-through'' under Regulation NMS); 17 CFR 240.600(b)(95)
(defining ``trading center''); Options Linkage Plan, supra note 4
(defining ``trade-through'' in the options context).
\195\ 17 CFR 242.611.
\196\ See 17 CFR 242.600(b)(71) (defining ``protected
quotation'' under Regulation NMS); 17 CFR 242.600(b)(70) (defining
``protected bid'' and ``protected offer'' under Regulation NMS); see
also Options Linkage Plan, supra note 4 (defining ``protected bid''
and protected offer'' in the options context).
\197\ See Options Linkage Plan, supra note 4. A locked or
crossed market occurs when a trading center displays an order to buy
at a price equal to or higher than an order to sell, or an order to
sell at a price equal to or lower than an order to buy, that is
displayed on another trading center.
\198\ Id.
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The Commission proposed the routing exemption in paragraph (c)(1)
to accommodate securities transactions away from a broker's or dealer's
member exchange(s) that are to comply with these regulatory
requirements.\199\ In essence, a broker or dealer may, as a necessary
part of its business trading on exchanges of which it is a member and
in light of today's market structure, effect securities transactions
elsewhere than an exchange where it is a member solely as a consequence
of routing by its member exchange(s) to comply with the requirements of
Rule 611 of Regulation NMS or the Options Linkage Plan.\200\ The
Commission continues to believe that it would be consistent with
section 15(b)(9)'s goal of protecting investors and the public interest
if transactions effected solely to comply with these regulatory
requirements, via routing by the broker's or dealer's member
exchange(s), do not trigger section 15(b)(8)'s Association membership
requirement for a broker or dealer that otherwise limits its securities
transactions to an exchange of which it is a member (or to stock
transactions that are covered by the stock-option order exemption
discussed below). The routing exemption is intended to serve the
limited, narrowly defined purpose of facilitating compliance with
intermarket order protection requirements.
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\199\ See 2022 Re-Proposal, supra note 1, 87 FR 49945.
\200\ Amended Rule 15b9-1 provides an exemption from section
15(b)(8) of the Act's Association membership requirement for routing
broker-dealers that meet the conditions for the exemption, but it
does not provide routing broker-dealers with an exemption from the
rules of an exchange that are applicable to routing broker-dealers
that operate as facilities of that exchange (and that the exchange
uses to conduct routing to other trading centers). As discussed in
the 2022 Re-Proposal, a routing broker-dealer continues to be
required to comply with the applicable rules of any exchange for
which it performs outbound routing services, including those
requiring the routing broker-dealer to be overseen by an
unaffiliated SRO such as FINRA. See, e.g., Cboe BZX Exchange, Inc.
Rule 2.11 (Cboe Trading, Inc. as Outbound Router); NYSE Rule 17(c)
(Operation of Routing Broker); Nasdaq Options 5, section 4 (Order
Routing).
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The Commission also stated in the 2022 Re-Proposal that it would be
consistent with the protection of investors and the public interest to
permit reliance on the routing exemption only where the routing is
performed by a national securities exchange of which the broker or
dealer is a member.\201\ The Commission stated that this limitation
would help ensure that the broker's or dealer's member exchange has
visibility into the routing transactions and thus is better able to
provide effective SRO oversight of its member's trading activity that
is related to its trading on the exchange and may not be overseen by
another SRO if the member is exempt from Association membership under
amended Rule 15b9-1.\202\
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\201\ As stated in the 2022 Re-Proposal, the routing exemption
is applicable where the broker's or dealer's member exchange
utilizes the services of a designated broker-dealer (which could be
affiliated or unaffiliated with the exchange) to perform the
exchange's outbound routing. See 2022 Re-Proposal, supra note 1, 87
FR 49946. An exchange's routing fees must be consistent with the
Act, including sections 6(b)(4) and 6(b)(5), which require an
equitable allocation of reasonable dues, fees and other charges
among members and issuers and other persons using any facility of
the exchange, and require that the exchange's fees not be designed
to permit unfair discrimination between customers, issuers, brokers,
or dealers.
\202\ See 2022 Re-Proposal, supra note 1, 87 FR 49946.
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Some commenters stated that the routing exemption should be
broadened for proprietary options trading broker-dealer firms so that
it covers routing that is not performed by member-exchange
routers.\203\ The Commission stated in the 2022 Re-Proposal that this
would not be consistent with the protection of investors and the public
interest because it could permit scenarios in which there is
insufficient SRO oversight of the broker-dealer's off-member-exchange
securities trading activity.\204\ Commenters suggested that the
Commission's concerns in this regard are mitigated in the context of
options trading firms because they typically route to non-member
exchanges via another broker-dealer,\205\ and are especially mitigated
where that routing broker-dealer is a FINRA member.\206\
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\203\ See Cboe Letter at 3; ABCV Letter at 4. It appeared to the
Commission that commenters intertwined this point with a different
point, and for the sake of completeness, the Commission has
addressed both. Specifically, in this section, the Commission
interprets and addresses these comments as a request that the
routing exemption cover off-member-exchange securities transactions
to comply with intermarket order protection requirements that are
effected via routers other than a member exchange router. These and
other commenters also requested an exemption for proprietary options
trading broker-dealer firms under which their off-member-exchange
securities trading activity would not trigger section 15(b)(8)'s
Association membership requirement if such activity is to hedge or
in furtherance of their options trading activity on their member
exchange(s). See supra note 165 and accompanying text. This request
is addressed in section III.A, supra.
\204\ See 2022 Re-Proposal, supra note 1, 87 FR 49946.
\205\ See Cboe Letter at 3.
\206\ See ABCV Letter at 4. Likewise, commenters suggested that
it would be particularly appropriate to continue to exempt options
trading firms from section 15(b)(8)'s Association membership
requirement where their routing away from a member exchange is
through a broker-dealer that is a FINRA member. See Cboe Letter at
2-3; ABCV Letter at 3-4; CTC Letter at 5; PEAK6 Letter at 4. As
discussed supra in section III.A, the Commission does not agree. See
supra notes 98-101 and accompanying text.
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The Commission does not agree. As stated previously, consistent
with the original design of Rule 15b9-1, the narrowed exemptions from
section 15(b)(8)'s Association membership requirement set forth in
amended Rule 15b9-1 are designed to apply to limited off-member-
exchange securities trading activity that is ancillary to the
registered broker's or dealer's trading activity on a national
securities exchange of which it is a member. As stated above, Rule
15b9-1 previously exempted securities transactions effected through the
ITS. The ITS Plan required each participant--exchanges and the NASD--to
provide electronic access to its displayed best bid and offer, and
provided an electronic mechanism for routing orders, called
``commitments to trade,'' to access those displayed
[[Page 61868]]
prices.\207\ The ITS Plan provided each participant market limited
access to the other participant markets for the purpose of avoiding a
trade-through or a locked or crossed market.\208\ Specifically, the ITS
enabled a broker or dealer that was physically present in (and a member
of) one market center to transmit its own or its customer's commitment
to trade in an ITS-traded stock to another market center, which could
then be accepted by a broker or dealer at the receiving market
center.\209\ When a broker or dealer initiated a commitment to trade
from an exchange where it was a member, it did so to prevent orders on
its member exchange from trading through or locking or crossing
quotations displayed on away market centers, and the member exchange
was inextricably involved in the routing activity covered by the
exemption.
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\207\ See Initial ITS Plan Approval Order, supra note 192.
\208\ Id.
\209\ Id.
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In contrast, if the routing exemption were expanded, as suggested
by commenters, to cover routing for intermarket order protection
purposes performed by a non-exchange-designated router on behalf of a
broker-dealer trading firm, the exemption could cover trading activity
that is not ancillary to the firm's trading activity on any exchange
where it is a member. Under the commenters' approach, the trading firm
could remain exempt from Association membership while utilizing a non-
exchange-designated routing broker-dealer to effect securities
transactions solely on off-member-exchange venues without any nexus to
an exchange where the trading firm is a member. The Commission remains
concerned that, in this type of scenario, there would not be an
exchange where the trading firm is a member that has visibility into
the routing transactions and that is able to provide effective SRO
oversight of the trading firm's order routing activity. Among other
things, no exchange where the trading firm is a member would be
positioned to assess whether the routing transactions complied with the
terms of the exemption. This would be the case even if the routing is
performed by a routing broker-dealer that also is a FINRA member.\210\
This would be inconsistent with the Commission's intention to continue
to permit exemptions from section 15(b)(8)'s Association membership
requirement that are narrowly tailored to limited off-member-exchange
securities trading activity that is ancillary to the registered
broker's or dealer's trading activity on a national securities exchange
of which it is a member and, in the Commission's view, would be
inconsistent with the protection of investors and the public interest.
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\210\ While there could be direct exchange SRO or FINRA
oversight over the routing broker-dealer in this scenario, the
Commission does not believe this is adequate, as discussed above,
due to the lack of direct FINRA oversight over the broker-dealer
initiating the order. See supra notes 98-101 and accompanying text
(discussing that separate exchange SRO recourse against different
broker-dealers for the same conduct can present the potential for
inconsistent outcomes).
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To be clear, nothing in amended Rule 15b9-1 prohibits broker-dealer
firms from effecting securities transactions away from their member
exchange(s) by utilizing routing services provided by non-exchange-
designated broker-dealers, so long as they comply with section 15(b)(8)
of the Act. Any broker-dealer firm may continue to route orders away
from its member exchange(s) for order protection or any other
appropriate purposes using non-exchange-designated routing broker-
dealers. But a broker-dealer firm cannot do so without joining FINRA,
as such trading activity is not exempt from, and therefore would
trigger, section 15(b)(8) (assuming the trading activity is not
otherwise covered by the stock option order exemption discussed below),
which would require Association membership for the firm.\211\
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\211\ Alternatively, a firm wishing to route orders to exchanges
using a non-exchange-designated routing broker-dealer could comply
with section 15(b)(8) by becoming a member of all exchanges to which
it routes orders. But any such firm would still be required to join
FINRA to the extent it effects off-exchange securities transactions
(unless exempted by the stock-option order exemption). See section
V.D, infra.
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2. Stock-Option Order Exemption
The Commission proposed to add a new paragraph (c)(2) to Rule 15b9-
1 that sets forth an exemption from Association membership if a broker
or dealer that meets the criteria of paragraphs (a) and (b) of the rule
effects off-member-exchange securities transactions, with or through
another registered broker or dealer, that are solely for the purpose of
executing the stock leg of a stock-option order.\212\ The Commission
also proposed to require in new paragraph (c)(2) that a broker or
dealer seeking to rely on the exemption establish, maintain, and
enforce written policies and procedures reasonably designed to ensure
and demonstrate that such transactions are solely for the purpose of
executing the stock leg of a stock-option order, and that the broker or
dealer preserve a copy of its policies and procedures in a manner
consistent with 17 CFR 240.17a-4 (``Rule 17a-4'') until three years
after the date the policies and procedures are replaced with updated
policies and procedures.\213\ One commenter referenced the stock-option
order exemption.\214\ The Commission is adopting paragraph (c)(2) as
proposed.
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\212\ See 2022 Re-Proposal, supra note 1, 87 FR 49947.
\213\ See id.
\214\ See Cboe Letter at 3 (stating that the existence of a
stock-option exemption in the 2022 Re-Proposal is an acknowledgment
that activity critical to the functioning of the options market
should not be adversely impacted).
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As the Commission stated in the 2022 Re-Proposal, the Commission
understands that there are firms that trade stock-option orders whose
business is focused on one or more options exchanges of which they are
a member, and whose trading elsewhere is primarily to effect the
execution of stock orders to facilitate their stock-option order
business. These firms' stock trading activity is for a limited purpose
and ancillary to their primary business handling stock-option orders on
an options exchange of which they are member. Moreover, there is a
close link between the stock component transaction of a stock-option
order and the relevant options exchange. As such, the stock-option
order exemption permits these types of firms to continue their stock-
option order trading business without being required to join stock
exchanges or an Association solely in order to effect the execution of
the stock legs of stock-option orders that they handle.
As stated above, the Commission estimates that, in 2022, 48 of the
73 firms identified as registered broker-dealers and exchange members
but not FINRA members initiated options order executions.\215\ The
Commission estimates that 17 of the firms that initiated options order
executions also effected the execution of stock leg transactions, and
therefore could potentially rely on the proposed stock-option order
exemption to the extent that they effect the stock leg executions off-
exchange or on an exchange where they are not a member.\216\ Because
the
[[Page 61869]]
broker or dealer relying on Rule 15b9-1(c)(2) would not itself be a
member of an exchange on which such stock transactions are executed, or
a member of an Association, such stock leg transactions must be
effected with or through another registered broker or dealer that is a
member of the exchange where the transactions are executed or a member
of an Association (or both).
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\215\ See supra note 44.
\216\ Source: CAT. The Commission previously estimated that, in
2021, seven such firms effected stock leg transactions and could
potentially rely on the stock-option order exemption to the extent
that they effect the stock leg transactions off-exchange or on an
exchange where they are not a member. See 2022 Re-Proposal, supra
note 1, 87 FR 49947. The Commission attributes the increase from
2021 to 2022 of its estimated number of broker-dealers that are not
FINRA members and that executed stock leg transactions mainly to an
increase in the percentage of stock leg transactions that are
captured in the CAT in a manner that enables the Commission to
identify the firms that initiated the transactions.
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Options exchanges define the term ``stock-option order'' in their
rules.\217\ Further, the Commission stated in the 2022 Re-Proposal that
its understanding is that all options exchanges accept a stock-option
order only if it complies with the Qualified Contingent Trade (``QCT'')
Exemption (``QCT Exemption'') from Rule 611(a) of Regulation NMS.\218\
For purposes of relying on the exemption provided by Rule 15b9-1(c)(2),
a broker or dealer should adhere to the stock-option order definition
of the options exchange where the stock-option order is handled and of
which the broker or dealer is a member.\219\ Specifically, the broker
or dealer could rely on that definition to determine whether, for
purposes of amended Rule 15b9-1(c)(2), an order is in fact a stock-
option order and a stock order is in fact the stock leg of a stock-
option order. Moreover, the exemption applies regardless of whether the
component legs of a stock-option order are executed electronically, on
a physical exchange floor, or through a combination of both.
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\217\ See, e.g., Cboe Rules 1.1 and 5.33(b)(5); MIAX Rule
518(a)(5); MIAX Emerald Rule 518(a)(5); Nasdaq Options 5, section
1(4) (defining ``Complex Trade''); Nasdaq PHLX Options 5, section
1(d) (defining ``Complex Trade''); Nasdaq ISE Options 5, section
1(d) (defining ``Complex Trade''); Nasdaq BX Chapter 5, section
27(a)(v)(1) of the ``Grandfathered Rules'' of the Boston Stock
Exchange, Inc.; NYSE Arca Rule 6.62-O(h)(1); NYSE American Rule
900.3NY(h)(1).
\218\ See, e.g., Cboe Rule 5.33, Interpretations and Policies
.04 Stock Option Orders; Supplementary Material .07 to Nasdaq ISE
Options 3, section 14; Commentary .01 to MIAX Rule 518. A qualified
contingent trade is ``a transaction consisting of two or more
component orders, executed as agent or principal where: (1) at least
one component order is in an NMS stock; (2) all components are
effected with a product or price contingency that either has been
agreed to by the respective counterparties or arranged for by a
broker-dealer as principal or agent; (3) the execution of one
component is contingent upon the execution of all other components
at or near the same time; (4) the specific relationship between the
component orders (e.g., the spread between the prices of the
component orders) is determined at the time the contingent order is
placed; (5) the component orders bear a derivative relationship to
one another, represent different classes of shares of the same
issuer, or involve the securities of participants in mergers or with
intentions to merge that have been announced or since cancelled; and
(6) the transaction is fully hedged (without regard to any prior
existing position) as a result of the other components of the
contingent trade.'' Securities Exchange Act Release No. 54389 (Aug.
31, 2006), 71 FR 52829 (Sept. 7, 2006); see also Securities Exchange
Act Release No. 57620 (Apr. 4, 2008), 73 FR 19271 (Apr. 9, 2008).
\219\ Presumably, an options exchange would accept only those
stock-option orders that meet the exchange's definition thereof. In
addition, the Commission's understanding is that, currently,
consistent with options exchange definitions, a stock-option order
contains only one stock leg. See supra note 217. Therefore, the
stock-option order exemption currently covers stock-option orders
with only one stock leg.
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The Commission continues to believe, as discussed in the 2022 Re-
Proposal, that the stock-option order exemption's reliance on the
options exchange's ``stock-option order'' definition should enhance an
exchange's ability to monitor whether its members are appropriately
relying on the exemption and thereby enhance its ability to provide
effective SRO oversight of its members' stock-option order trading
activity. Under options exchange rules, an exchange member submitting a
stock-option order to the exchange must designate to the exchange one
or more specific broker-dealers: (i) that are not affiliated with the
exchange; (ii) with which the exchange member has entered into a
brokerage agreement; (iii) that the exchange has identified as having
connectivity to electronically communicate the stock components of
stock-option orders to stock trading venues; and (iv) to which the
exchange will electronically communicate the stock component of the
stock-option order on behalf of the member.\220\ The option exchange's
execution of the stock-option order is contingent on the exchange's
receipt from the designated broker-dealer of an execution report for
the stock component transaction confirming that the transaction has
occurred.\221\ In light of these rules, the Commission continues to
believe that there is a close link between the stock component
transaction of a stock-option order and the relevant options exchange.
Accordingly, the Commission continues to believe that this exemption
would serve the limited, narrowly defined purpose of facilitating the
execution of stock-option orders consistent with options exchange rules
and that the options exchange would be able to monitor and oversee the
totality of the securities trading activity of any of its members that
rely on the exemption.
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\220\ See, e.g., Cboe Rule 5.33(l) and Interpretations and
Policies .04; Nasdaq ISE Options 3, section 7 and Supplementary
Material .01, Options 3, section 14 and Supplementary Material .07;
MIAX Rule 518 and Commentary .01.
\221\ See, e.g., Cboe Rule 5.33(l); Nasdaq ISE Options 3,
section 7 and Supplementary Material .01, Options 3, section 14 and
Supplementary Material .07; MIAX Rule 518 and Commentary .01.
---------------------------------------------------------------------------
The Commission also continues to believe that the exchange's
oversight capabilities will be further enhanced, consistent with the
public interest and protection of investors, by requiring brokers and
dealers to develop written policies and procedures in connection with
the stock-option exemption in paragraph (c)(2) of the amended rule.
This requirement should help facilitate exchange SRO supervision of
brokers and dealers relying on the stock-option order exemption because
it would provide an efficient and effective way for the relevant
options exchange to assess compliance with the exemption. Moreover, the
Commission continues to believe that requiring brokers and dealers to
develop written policies and procedures would provide sufficient
flexibility to accommodate potentially varying business models of
brokers and dealers that effect stock-option orders and may seek to
rely on this exemption.
Such written policies and procedures must be reasonably designed to
ensure and demonstrate that the broker's or dealer's securities
transactions elsewhere than on an exchange of which it is a member are
solely for the purpose of executing the stock leg of a stock-option
order. Accordingly, a broker or dealer seeking to rely upon the stock-
option order exemption must establish, maintain, and enforce written
policies and procedures reasonably designed to ensure and demonstrate
that such transactions are solely for the purpose of executing the
stock leg of a stock-option order. For example, the broker or dealer
could maintain documentation that demonstrates its compliance with the
stock-option order requirements of any options exchange of which it is
a member and where it effects the execution of stock-option orders.
Indeed, in addition to the Commission, the options exchange of which
the broker or dealer is a member and where the stock-option order is
handled would be able to enforce compliance with the stock-option order
exemption. In the context of routine examinations of its members, the
options exchange generally would review the adequacy of its members'
written policies and procedures and assess whether its members' off-
member-exchange transactions comply with those written policies and
procedures as well as the terms of the exemption itself, as set forth
in amended Rule 15b9-1.\222\
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\222\ Section 19(g)(1) of the Act, 15 U.S.C. 78s(g), among other
things, requires every SRO to examine for and enforce compliance by
its members and associated persons with the Act, the rules and
regulations thereunder, and the SRO's own rules, unless the SRO is
relieved of this responsibility pursuant to section 17(d), 15 U.S.C.
78q(d), or section 19(g)(2), 15 U.S.C. 78s(g)(2), of the Act.
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[[Page 61870]]
Finally, a broker or dealer seeking to rely on the stock-option
order exemption is required to preserve a copy of its policies and
procedures in a manner consistent with Rule 17a-4 under the Exchange
Act until three years after the date the policies and procedures are
replaced with updated policies and procedures.\223\ Accordingly, a
broker or dealer is required to keep the policies and procedures
relating to its use of this exemption as part of its books and records
while they are in effect, and for three years after they are updated.
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\223\ See, e.g., 17 CFR 240.17a-4(e)(7).
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IV. Effective Date and Implementation
The Commission proposed that the compliance date for amended Rule
15b9-1 be one year after publication of any final rule in the Federal
Register.\224\ In proposing this compliance date, the Commission
considered various factors that impact the time that it takes to become
a FINRA member, as well as that firms that choose to adjust their
business models such that they are not required to join FINRA would
need time to do so.\225\ The Commission understood that, on average,
the FINRA membership application process takes approximately six
months.\226\
---------------------------------------------------------------------------
\224\ See 2022 Re-Proposal, supra note 1, 87 FR 49951.
\225\ Id.
\226\ Id.
---------------------------------------------------------------------------
Some commenters on the 2022 Re-Proposal characterized the FINRA
membership application process as lengthy.\227\ One commenter stated
that it understood FINRA's membership application process to take more
than a year, and suggested a revised compliance period in which firms
must only submit their FINRA registration application within 360 days
of adoption of amended Rule 15b9-1, and allow for 540 days from
adoption for FINRA approval of the application.\228\ FINRA stated that
it typically has 180 days to issue a decision after the filing of a new
membership application, but that, depending on the characteristics of
an application, FINRA may issue a ``fast-track'' decision within 100
days.\229\ FINRA also stated that, based on the types of proprietary
trading dealer firms that would be likely to join FINRA as a result of
the Rule 15b9-1 amendments, it intends to implement an expedited
membership application process for these applicants pursuant to which
it anticipates processing their applications within 60 days after
submission.\230\
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\227\ See, e.g., FIA PTG Letter at 4-5; PEAK6 Letter at 2.
\228\ See FIA PTG Letter at 4-5.
\229\ See FINRA Letter at 12.
\230\ See id. at 12-13.
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The Commission believes that a compliance date for amended Rule
15b9-1 that is 365 days after publication of amended Rule 15b9-1 in the
Federal Register would provide a sufficient period of time for
proprietary trading broker-dealer firms to comply with the amended
rule. Based on FINRA's statements regarding its ability to issue a
``fast-track'' decision within 100 days and expectation that it would
process proprietary trading dealer firm applications within 60 days
after submission,\231\ for any FINRA membership application submitted
by such a firm in a timely manner, the Commission expects FINRA to be
able to process the application and render a decision within the
compliance period. Additionally, some commenters stated that the FINRA
membership application process requires information that is duplicative
of information already provided to the Commission and other SROs as
part of their prior Commission registration and exchange SRO
application process.\232\ Accordingly, the Commission believes that
when applying to be FINRA members, firms in this situation may be able
to leverage their prior submissions to the Commission and exchange SROs
to be able to have a more expedient application process with FINRA than
they would otherwise if they had not already prepared such information
for submission to the Commission and exchange SROs. More broadly, any
existing broker-dealer firm that applies for FINRA membership as a
result of the amendments to Rule 15b9-1 would have already completed
the application processes for becoming a Commission-registered broker-
dealer and a member of at least one exchange and, the Commission
believes, should be able to leverage those experiences to expedite
their application process with FINRA.
---------------------------------------------------------------------------
\231\ See supra notes 229-230 and accompanying text.
\232\ See PEAK6 Letter at 2; FIA PTG Letter at 4.
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V. Economic Analysis
The Commission is amending Rule 15b9-1 to help ensure that an
Association generally has direct, membership-based oversight over
broker-dealers that effect off-member-exchange securities transactions
and the jurisdiction to directly enforce their compliance with Federal
securities laws, Commission rules, and Association rules. In addition,
these amendments will provide a more consistent regulatory framework
for broker-dealers,\233\ which in turn should enhance competition and
result in potential efficiency gains for market participants.
---------------------------------------------------------------------------
\233\ See section III.A, supra.
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The Exchange Act's statutory framework places SRO oversight
responsibility with an Association for trading that occurs elsewhere
than on an exchange to which a broker or dealer belongs as a
member.\234\ However, currently pursuant to Rule 15b9-1, a broker or
dealer may engage in unlimited off-member-exchange \235\ proprietary
trading without becoming a member of an Association, so long as its
proprietary trading activity is conducted with or through another
registered broker or dealer. Currently, off-exchange equity activity
and exchange listed options trading of non-FINRA member broker-dealers
is surveilled by FINRA through CAT data and supervised in part via the
use of RSAs.\236\ However, RSAs are voluntary, privately negotiated
agreements that can expire or be terminated, and accordingly, these
agreements do not provide the consistent and stable oversight that
direct Association oversight of such trading activity does.\237\ For
example, of the current FINRA RSA contracts: one RSA contract expires
at the end of 2023, seven RSA contracts expire at the end of 2024, and
three RSA c
[…truncated; see source link]Indexed from Federal Register on September 7, 2023.
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.