Exemption for Certain Exchange Members

Federal RegisterSep 7, 2023

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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.

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”).

The Commission is adopting those amendments as re-proposed.

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”).

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.

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.

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. 78

(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.

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).

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;

or (2) are solely for the purpose of executing the stock leg of a stock-option order.

See

Securities Exchange Act Release No. 60405 (July 30, 2009), 74 FR 39362 (Aug. 6, 2009) (“Options Linkage Plan”).

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. 78

(b)(8).

In the decades since the adoption of the proprietary trading exemption, the securities markets have undergone a substantial transformation that has been

driven primarily by rapid and ongoing evolution of technologies for generating, routing, and executing orders, and the impact of regulatory changes.

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.

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.

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.”).

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.

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 http://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf

). Staff reports, Investor Bulletins, and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these staff documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person.

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.

Broker-dealers that are not FINRA members are not subject to FINRA's rules or FINRA's direct, membership-based jurisdiction.

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,

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.

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.

See

FINRA Rule 0140.

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).

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.

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”)

or regulatory service agreements (“RSA(s)”),

or through reliance on the

Consolidated Audit Trail (“CAT”).

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.

Comments received in response to the 2022 Re-Proposing Release are

available at https://www.sec.gov/comments/s7-05-15/s70515.htm

. The 2022 Re-Proposal re-proposed amendments to Rule 15b9-1 that the Commission proposed in 2015, with certain modifications informed by comments received on the 2015 Proposal, which comments the Commission addressed in the 2022 Re-Proposal.

See

2015 Proposal,

supra

note 1. Comments received in response to the 2015 Proposing Release are

available at https://www.sec.gov/comments/s7-05-15/s70515.shtml

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.

In contrast to Rule 17d-2 plans, RSAs are privately negotiated agreements between two SROs

that can expire or be terminated. Under an RSA, one SRO agrees to perform regulatory services on behalf of another SRO in exchange for compensation. Unlike Rule 17d-2 plans, the SRO paying for regulatory services under an RSA retains ultimate legal responsibility for and control over the regulatory functions allocated to the SRO providing the services. There are RSAs between exchange SROs and FINRA, but under these RSAs, for firms that are members of different exchanges but not FINRA members, FINRA applies to such firm's off-member-exchange trading activity the rules of their different member exchanges using the exchanges' interpretations of their rules.

See

Staff of the Division of Trading and Markets, “Staff Paper on Cross-Market Regulatory Coordination,” (Dec. 15, 2020) (

available at https://www.sec.gov/tm/staff-paper-cross-market-regulatory-coordination

) (“Cross-Market Regulatory Coordination Staff Paper”). In addition to regulatory coordination that occurs through Rule 17d-2 plans and RSAs, SROs also coordinate regulatory efforts through forums provided by the Intermarket Surveillance Group (“ISG”).

See id.; see also

2022 Re-Proposal, section II.A.

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.

See supra

note 14.

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”).

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).

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.

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).

See

FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities.

The rise in electronic proprietary trading and the increasingly fragmented market where trading takes place across many active markets have put pressure on the status quo and persuaded the Commission of the need for there to be more consistent regulation of such trading. Accordingly, after considering the comments received in response to the 2022 Re-Proposal, the Commission is adopting amended Rule 15b9-1 as re-proposed. The Commission continues to believe that oversight of off member-exchange securities trading must be enhanced in light of how securities trading occurs today, by narrowing the extent to which broker-dealer firms can effect off-member-exchange securities transactions—in significant volumes in many cases—while exempt from FINRA membership.

II. Background

A. Regulatory Framework

Broker-dealers generally must register with the Commission and become members of a SRO.

Self-regulation is a longstanding, key component of U.S. securities industry regulation.

The Exchange Act defines SRO to include each national securities exchange or Association.

An SRO sets standards, conducts examinations, and enforces rules regarding its members.

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.

In particular, there are Federal securities laws, Commission rules, and SRO rules that prohibit various forms of improper activity by broker-dealers.

See

section 15(a)(1) of the Act, 15 U.S.C. 78

(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.

See

Securities Exchange Act Release No. 50700 (Nov. 18, 2004), 69 FR 71256 (Dec. 8, 2004) (“Concept Release Concerning Self-Regulation”).

See

section 3(a)(26) of the Act, 15 U.S.C. 78c(a)(26).

See

Concept Release Concerning Self-Regulation,

supra

note 20 (citing section 15(b)(8) of the Act, 15 U.S.C. 78

(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

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).

See, e.g.,

sections 10(b), 15 U.S.C. 78j(b); 15(c), 15 U.S.C. 78

(c); and 15(g), 15 U.S.C. 78

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

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

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.

See

section 19(g) of the Act, 15 U.S.C. 78s(g).

See

sections 15(b)(8), 15 U.S.C. 78

(b)(8); 15A, 15 U.S.C. 78

-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. 78

-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. 78

(b)(8).

Specifically, section 15(b) of the Act provides that Commission registration is generally not effective until the broker-dealer becomes a member of an Association or a national securities exchange if the broker-dealer effects transactions solely on that exchange.

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.

Rule 15b9-1 sets forth an exemption from section 15(b)(8) of the Act

pursuant to authority conferred to the Commission by section 15(b)(9) of the Act.

See

section 15(b) of the Act, 15 U.S.C. 78

(b).

Section 15(b)(9) of the Act, 15 U.S.C. 78

(b)(9).

Section 15(b)(8) of the Act, 15 U.S.C. 78

(b)(8).

Section 15(b)(9) of the Act, 15 U.S.C. 78

(b)(9).

Rule 15b9-1 provides that any broker or dealer required by section 15(b)(8) of the Act to become a member of an Association shall be exempt from such requirement if it is (1) a member of a national securities exchange, (2) carries no customer accounts, and (3) has annual gross income derived from purchases and sales of securities otherwise than on a national securities exchange of which it is a member in an amount no greater than $1,000 (this $1,000 gross income allowance is referred to herein as the “

de minimis

allowance”).

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”).

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,

which included the

de minimis

allowance but not the proprietary trading exclusion; the Commission adopted the proprietary trading exclusion in 1976.

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.

17 CFR 240.15b9-1(a).

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.

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.

See

Extension of Temporary Rules 23a-1(T) and 23a-2(T); Adoption of Amendments to SECO Rules, Securities Exchange Act Release No. 12160 (Mar. 3, 1976), 41 FR 10599 (Mar. 12, 1976) (“Adoption of Amendments to SECO Rules”). In adopting the proprietary trading exclusion, the Commission indicated that an exchange floor broker, through another broker or dealer, could effect transactions for its own account on an exchange of which it was not a member.

Id.

at 10600. The Commission stated that such transactions ultimately would be effected by a member of that exchange. In 1983, the Commission further amended Rule 15b9-1 to accommodate transactions effected through the then-new ITS, and eliminated references to, and requirements under, the SECO Program, which was the Commission's program of direct regulation of certain broker-dealers at that time.

See

SECO Programs Release,

supra

note 33.

B. Updated Background Statistics

The 2022 Re-Proposal set forth statistics regarding off-member-exchange securities trading activity by firms that were Commission-registered broker-dealers and exchange members but not FINRA members during the time periods reviewed by the Commission in the 2022 Re-Proposal.

Those statistics are updated below for corresponding year-over-year time periods.

See

2022 Re-Proposal,

supra

note 1, section II, 87 FR 49932-39.

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.

Many of these firms were members of just one exchange while others were members of multiple exchanges.

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.

Sources: SEC FOCUS Reports (Form X-17A-5); FINRA's Central Registration Depository (“CRD”).

Source: CRD.

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.

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.

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.

Source: CAT.

For example, of the estimated 73 broker-dealers that were exchange members but not FINRA members as of the end of September 2022, 53 initiated orders in listed equities in September 2022 that were executed on or off an exchange.

These firms' September 2022 off-exchange listed equities dollar volume executed was approximately $440 billion,

which was approximately 5.1% of total off-exchange volume of listed equities executed that month.

Moreover, these firms' September 2022 listed equities dollar volume executed on exchanges of which they are not a member was approximately $311 billion.

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.

Id.

Dollar volumes set forth in this section represent the sum of bought and sold volume during the specified time period.

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.

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.

These firms' April 2023 off-exchange listed equities dollar volume executed was approximately $405 billion,

which was approximately 5.6% of total off-exchange volume of listed equities executed that month.

Moreover, these firms' April 2023 listed equities dollar volume executed on exchanges of which they are not a member was approximately $262 billion.

Id.

The other 19 firms did not initiate orders in listed equities in Apr. 2023.

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.

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.

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.

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.

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.

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.

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.

Id.

With respect to trading in U.S. Treasury securities, all of which occurs off-exchange,

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,

which was approximately 3.67% of total U.S Treasury securities volume traded in 2022 that was reported to TRACE.

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,

which was approximately 2.65% of total U.S Treasury securities volume traded in April 2023 that was reported to TRACE.

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.

See

FINRA Rule 6730(a)(1) (requiring FINRA members to report transactions in TRACE-Eligible Securities, including U.S. Treasury securities).

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.

See supra

note 56.

Id.

One broker-dealer that was not a FINRA member and traded U.S. Treasury securities in 2022 joined FINRA prior to April 2023, and another broker-dealer that was not a FINRA member and traded U.S. Treasury securities in 2022 did not appear to trade U.S. Treasury securities in April 2023.

III. Discussion of Amendments to Rule 15b9-1

Under the amendments to Rule 15b9-1 being adopted, a broker or dealer registered with the Commission pursuant to section 15 of the Act will be required by section 15(b)(8) of the Act to join an Association if the broker or dealer effects off-member-exchange securities transactions, unless it can rely upon one of the amended rule's narrow exemptions.

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.

See

section 15(b)(8) of the Act, 15 U.S.C. 78

(b)(8); amended Rule 15b9-1,

infra.

See

section 15(b)(8) of the Act, 15 U.S.C. 78

(b)(8).

Specifically, Rule 15b9-1, as amended, no longer provides a

de minimis

allowance or proprietary trading exclusion, and allows an exemption from Association membership only for a registered broker or dealer that is an exchange member, carries no customer accounts, and effects securities transactions solely on a national securities exchange of which it is a member except in two narrow circumstances: (1) a broker or dealer effects off-member-exchange securities transactions that result solely from orders that are routed by an exchange of which it is a member in order to comply with Rule 611 of Regulation NMS or the Options Order Protection and Locked/Crossed Market Plan; or (2) a broker or dealer effects off-member-exchange securities transactions that are solely for the purpose of executing the stock leg of a stock-option order.

In the subsections below, the Commission discusses each element of the amended rule in detail.

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.

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.

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.

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.

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.

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.

FINRA stated that jurisdictional limitations impede comprehensive off-exchange and cross-market oversight in equities, options, and fixed income markets.

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.

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.

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).

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).

See

FINRA Letter at 6.

Id.

See

Better Markets Letter at 5, 7-8;

see also

note 8,

supra,

for a description of high-frequency trading firms. This commenter also stated that high-frequency trading represents roughly 50% of the trading volume in U.S. equities markets and 48% of the total U.S. Treasury securities interdealer market, and that recent liquidity crises in both the U.S. equities and Treasury securities markets have shown the effects on markets dominated by, and heavily reliant on, high-frequency trading firms.

See

Better Markets Letter at 3.

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

In this

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.

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.

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.

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.

See, e.g.,

MMI Letter at 2; FIA PTG Letter at 2; Cboe Letter at 2-3; STA Letter at 2-3; ABCV Letter at 3; PEAK6 Letter at 3; Group One Letter at 2; letter from Eric Chern, Co-Founder, Chicago Trading Company, LLC (Sept. 27. 2022) (“CTC Letter”) at 4.

As explained below in this section, the Commission continues to believe that, in today's market, the

de minimis

allowance and proprietary trading exclusion must be eliminated from Rule 15b9-1 such that there is direct, membership-based Association SRO oversight of broker-dealers' off-member-exchange securities trading activity, in accordance with section 15(b)(8) of the Act and with the section 15(b)(9) requirement that any exemption from section 15(b)(8) be consistent with the protection of investors and the public interest.

Commenters' critiques of the 2022 Re-Proposal are largely the same as those that the Commission received in response to the 2015 Proposal, and the Commission continues to disagree with them for many of the same reasons expressed in the 2022 Re-Proposal.

See

2022 Re-Proposal,

supra

note 1, 87 FR 49941.

Requiring broker-dealers that engage in off-member-exchange securities transactions to become FINRA members will provide FINRA with direct jurisdiction and the ability to apply with a greater degree of autonomy its expertise to the firms' off-member-exchange securities trading activity and investigate potential misconduct in that market segment. With respect to FINRA members, FINRA can determine whether to pursue examinations and investigations, and the parameters thereof, in a way that it cannot with respect to non-FINRA members, as FINRA's oversight over the latter depends on RSA arrangements, pursuant to which exchange SROs retain legal responsibility and final decision-making authority with respect to the covered exchange members.

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.

See supra

note 14.

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

See

FINRA Letter at 8. FINRA has taken an active role in overseeing trading activity in U.S. Treasury securities by, for example, requiring U.S. Treasury securities to be reported to TRACE, and by publishing daily files of aggregated U.S. Treasury securities transactions data reported to TRACE.

See

FINRA Rules 6730 and 6750;

see also

Treasury Daily Aggregate Statistics, available at

https://www.finra.org/finra-data/browse-catalog/about-treasury/daily-file.

In addition, FINRA has taken enforcement action regarding U.S. Treasury securities trading activity and reporting.

See, e.g., FINRA Department of Enforcement

BGC Financial, L.P.,

FINRA Letter of Acceptance, Waiver, and Consent No. 2020068558701 (Jan. 20, 2023),

available at https://www.finra.org/sites/default/files/fda_documents/2020068558701%20BGC%20Financial%2C%20L.P.%20CRD%2019801%20AWC%20va%20%282023-1676852400276%29.pdf.

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

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.

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.

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.

Exchange SROs generally monitor market activity specific to their own exchanges and have expertise in regulating unique aspects of their markets.

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.

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.

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).

See

2022 Re-Proposal,

supra

note 1, 87 at 49934 n. 46.

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).

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.

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.

Section 17(d) of the Act, 15 U.S.C. 78q(d).

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.

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.

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.

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.

See

Staff Paper on Cross-Market Regulatory Coordination,

supra

note 14.

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.

Mitigating duplicative SRO oversight is the primary purpose of these regulatory arrangements.

To the extent broker-dealer firms join FINRA as a result of the amendments to Rule 15b9-1

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.

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).

See

Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR 49091 (Nov. 8, 1976);

see also

note 13,

supra.

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).

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

but not FINRA members.

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.

In addition, under an RSA, FINRA examines for compliance with the rules of the exchange with which it has entered into the RSA.

Thus, non-FINRA members that are members of different exchanges may be subject to different exchange rules and interpretations when they effect off-member-exchange securities transactions to the extent these rules and interpretations are different. This approach 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.

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.

See

FINRA Letter at 4 (stating that Rule 17d-2 plans and RSAs are not without their limitations).

See id.

at 8.

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.

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.

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.

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.

The Commission agrees that continued collaboration will be important.

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).

See

FINRA Information Notice—4/8/20 available at

https://www.finra.org/rules-guidance/notices/information-notice-040820

(informing members of the existence and role of the CMRWG).

One commenter stated that an exchange can take action against its member for exchange rule violations associated with the conduct of a non-member broker-dealer that accessed the exchange through the member, or the exchange may refer the activity to another SRO.

This commenter also stated that the access-providing exchange member is likely to be a FINRA member.

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

See

Cboe Letter at 4.

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

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. 78

(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”).

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

Better Markets Letter at 9. The 17% figure reflects an upper bound of the rate at which Commission-registered broker-dealers that are not FINRA members appeared in the alerts generated by FINRA's U.S. Treasury security manipulation pattern surveillance in 2020 and 2021.

See

6/20/23 Meeting Memorandum. The Commission understands that the actual rate at which Commission-registered broker-dealers that are not FINRA members appeared in these alerts is likely lower than 17%, as some portion of the alerts may have involved non-FINRA member proprietary trading firm entities that are not Commission-registered broker-dealers.

Id.

More precise estimates are not possible in light of the way proprietary trading firms are identified under current audit trail rules and the way FINRA evaluates conduct by potentially affiliated entities.

Id.

120

See

FINRA Letter at 10.

121

As discussed below in this section, the Commission retains authority over broker-dealers, but the Exchange Act contemplates dual layers of oversight of broker-dealers through such Commission authority working in tandem with SRO authority. The focus here is on strengthening the SRO layer of oversight.

Insofar as U.S. Treasury securities transaction reporting and transparency in particular are concerned, FINRA's TRACE system is the regulatory vehicle that facilitates mandatory reporting of OTC transactions in U.S. Treasury securities, among other eligible fixed income securities.

122

But as discussed in the 2022 Re-Proposal, proprietary trading broker-dealer firms that are not FINRA members are not required to report their U.S. Treasury securities transactions to FINRA's TRACE system because TRACE reporting obligations for U.S. Treasury securities transactions apply only to broker-dealers that are FINRA members.

123

Thus, exchange SRO membership alone is not enough to subject proprietary trading broker-dealer firms that effect U.S. Treasury securities transactions to FINRA's reporting requirement for such transactions.

122

See

FINRA Rule 6700 series. FINRA publishes aggregated transaction information and statistics on U.S. Treasury securities on its website.

See FINRA.org,

Treasury Aggregate Statistics,

available at https://www.finra.org/finra-data/browse-catalog/about-treasury

(last visited Aug. 9, 2023); FINRA Rule 6750, Supplementary Material .01(b);

see also

Securities Exchange Act Release No. 95438 (Aug. 5, 2022), 87 FR 49626 (Aug. 11, 2022) (File No. SR-FINRA-2022-017) (order approving FINRA publication of aggregated U.S. Treasury securities transactions more frequently than weekly, such as on a daily basis). Also, pursuant to effective national market system plans which are also effective transaction reporting plans (as both terms are defined in 17 CFR 242.600(b) (Rule 600(b) of Regulation NMS)), namely the Nasdaq UTP Plan and the CTA Plan, FINRA reports to the Securities Information Processors (“SIPs”) information for off-exchange NMS stock transactions that are reported to FINRA's TRFs, and the SIPs in turn distribute the information in the public consolidated market data feeds.

See

section VIII(a) of the CTA Plan; section VIII.B of the Nasdaq UTP Plan.

123

See

FINRA Rule 6720—Participation in TRACE;

see also

2022 Re-Proposal,

supra

note 1, 87 FR 49938. Since Sept. 1, 2022, certain depository institutions (“covered depository institutions”) have been required to report to TRACE transactions in U.S. Treasury securities, agency debt securities and agency mortgage-backed securities.

See FINRA.org,

Federal Reserve Depository Institution Reporting to TRACE,

available at https://www.finra.org/filing-reporting/trace/federal-reserve-depository-institution-reporting

(last visited Aug. 8, 2023). In addition, in order to enhance the regulatory audit trail and ensure data is reported in a more timely manner, FINRA adopted amendments to Rule 6730 to require members to report U.S. Treasury securities transaction data in the smallest increment available to the member and as soon as practicable, but no later than 60 minutes following a transaction.

See

Securities Exchange Act Release No. 95635 (Aug. 30, 2022), 87 FR 54579 (Sept. 6, 2022).

When a non-FINRA member broker-dealer trades U.S. Treasury securities through a “covered ATS,” the covered ATS is obligated in its TRACE report to identify the non-FINRA member broker-dealer via its Market Participant ID (“MPID”),

124

thus providing visibility to regulators as to what transactions on covered ATSs are attributable to non-FINRA members.

125

But regulators have no such visibility when non-FINRA member broker-dealers trade U.S. Treasury securities otherwise than on a covered ATS. If non-FINRA member broker-dealers trade on a non-covered ATS or bilaterally with a counterparty that is a FINRA member or covered depository institution, the ATS or FINRA member or covered depository institution reports the trade, but the non-FINRA member is not specifically identified via a MPID and instead is identified only as a “customer.”

126

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

127

124

See

FINRA Rule 6730—Transaction Reporting, Supplementary Material .07—ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities.

125

In the proposal the Commission issued in Jan. 2022 to, among other things, amend Regulation ATS for ATSs that trade U.S. government securities, and the reopening release issued in Apr. 2023, which provides supplemental information and economic analysis on the Jan. 2022 proposal, the Commission estimated that there would be a number of trading systems that would be required to comply with Regulation ATS under the proposal.

See

Securities Exchange Act Release Nos. 94062 (Jan. 26, 2022), 87 FR 15496, 15585 (Mar. 18, 2022); 97309 (Apr. 14, 2023), 88 FR 29448, 29466 (May 5, 2023).

126

In 2022, there were approximately 60 million transactions reported in U.S. Treasury securities, totaling $165 trillion in dollar volume. Approximately 35.7 million of those transactions,

representing approximately $64 trillion in dollar volume, were executed on ATSs. The balance of approximately 24.3 million reported transactions, or $100 trillion in dollar volume, that was not traded on an ATS was reported by FINRA members with a counterparty that, if not a FINRA member, was identified as a “customer” in the reported data. The Commission estimates that approximately 12.7 million transactions and $60 trillion in dollar volume not executed on an ATS had a counterparty identified as a “customer” in the reported data. This represents 52% of the 24.3 million transactions and 60% of the $100 trillion in dollar volume not executed on an ATS, or 21% of the 60 million total transactions and 36% of the $165 trillion total dollar volume. Further, the Commission estimates that, of the 35.7 million transactions and $64 trillion in dollar volume executed on an ATS, approximately 98.2% of that transaction volume and 99% of that dollar volume was executed on a covered ATS; approximately 1.8% of the 35.7 million transactions and 1% of the $64 trillion dollar volume, representing approximately 0.6 million transactions and $536 billion, respectively, was executed on a non-covered ATS; and approximately 4.8% of the 0.6 million transactions and 22% of the $536 billion in dollar volume executed on a non-covered ATS, representing approximately 15,000 transactions and $59 billion, respectively, was reported with a counterparty identified as a “customer.” Customer volume and transaction counts are calculated as half the sum of ATS-to-customer buys and ATS-to-customer sells.

127

In addition, in the context of an NMS stock transaction effected between a FINRA member and a non-FINRA member otherwise than on an exchange, only the FINRA member is obligated to report the transaction to the FINRA TRF and the non-FINRA member generally is not identified on the trade report as the contra party to the trade.

See

Trade Reporting Frequently Asked Questions, Reporting Relationships and Responsibilities, section 202: Reporting Trades with a Non-FINRA Member,

available at https://www.finra.org/filing-reporting/market-transparency-reporting/trade-reporting-faq#202

(last visited Aug. 9, 2023). The non-FINRA member is, however, identified in CAT in this context.

The Commission continues to believe that regulators' lack of visibility into U.S. Treasury securities transactions effected by proprietary trading broker-dealer firms that are not FINRA members, in the circumstances described above in which such firms are not identified by MPID in TRACE data, detracts from the comprehensiveness of U.S. Treasury securities TRACE data and regulators' ability to utilize that data to reconstruct market events, and detect and deter improper trading activity in the U.S. Treasury securities market.

128

The Commission does not know if all U.S. Treasury securities transactions by non-FINRA member broker-dealer firms are reported to TRACE, and for those that are reported, any non-FINRA member broker-dealer firm that is a counterparty remains anonymous if the transaction did not occur on a covered ATS. As a result, the Commission cannot quantify total secondary market trading by broker-dealers in U.S. Treasury securities, and regulators cannot readily identify from TRACE when a non-FINRA member broker-dealer is the source of reported U.S. Treasury securities order flows executed otherwise than on a covered ATS and cannot link any such order flows to any particular non-FINRA member broker-dealer.

129

Moreover, broker-dealers that are not FINRA members have a potential competitive advantage over those that are FINRA members, as FINRA members incur the costs of reporting transactions in U.S. Treasury securities transactions but non-FINRA members do not.

130

128

For example, in a Nov. 2021 report, an inter-agency working group comprised of staff of the U.S. Department of the Treasury, Commission, Commodity Futures Trading Commission, Federal Reserve Bank of New York, and Board of Governors of the Federal Reserve System stated that “[i]n March 2020, large flows from investors were captured by TRACE data but were not identifiable beyond the FINRA-member dealer intermediary that facilitated the trade. Understanding the source of these flows required the official sector to contact dealers, wait for other datasets that are significant lagged, and rely on separate sources of information.”

See

U.S. Dep't of the Treasury et al., Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report (Nov. 8, 2021) (“2021 Interagency Report”)

available at https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf.

129

See id.

130

See supra

section V.C.2 for estimated costs of TRACE reporting.

Some commenters broadly agreed with the Commission's concern, expressed in the 2022 Re-Proposal, regarding transparency and reporting of U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members.

131

Other commenters stated that there is no reporting gap that must be addressed with respect to U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members because, according to the commenters, existing TRACE reporting requirements meaningfully capture effectively all proprietary broker-dealer U.S. Treasury securities transactions.

132

One of these commenters also stated that potential concerns around the identification of non-FINRA member counterparties to U.S. Treasury securities transactions on non-covered ATSs are not implicated by proprietary broker-dealer transactions in any meaningful way, or could be remedied by requiring that such transactions be reported with account ownership identifiers, which, according to the commenter, would not necessitate FINRA membership.

133

Similarly, other commenters suggested, as an alternative to what the Commission has proposed, an approach under which proprietary trading broker-dealer firms could remain exempt from section 15(b)(8)'s Association membership requirement so long as they report their U.S. Treasury securities transactions to FINRA's TRACE system.

134

131

See

FINRA Letter at 9 (stating that FINRA has no visibility into the identity of non-FINRA firms for U.S. Treasury securities transactions that occur otherwise than on a covered ATS or on any other non-ATS platform); Better Markets Letter at 9 (stating that a significant proportion of U.S. Treasury securities transaction activity is performed on a bilateral basis without data reporting requirements, and that this lack of visibility undermines regulators' ability to monitor risks, understand how those risks evolve into potentially systemic risks, and react to them in real-time, and inhibits robust price discovery) (citing 2021 Interagency Report,

supra

note 128); Cboe Letter at 9.

132

See

FIA/PTG Letter at 3 (acknowledging concerns regarding the identification of non-FINRA member counterparties but noting they are not aware of the situation applying to proprietary broker-dealer transactions in a “meaningful” way); MMI Letter at 2 (arguing CAT and TRACE data “effectively captures” all proprietary broker-dealer transactions). It is difficult to assess the accuracy of the commenter statement that there is no reporting gap with respect to U.S. Treasury securities transactions by proprietary trading broker-dealer firms that are not FINRA members because, as discussed above in this section, if non-FINRA member broker-dealers trade U.S. Treasury securities otherwise than on an ATS and with a counterparty that is not a FINRA member and not a covered depository institution, there is no TRACE reporting obligation and the trade is not reported. And even when a non-FINRA member broker-dealer's transactions in U.S. Treasury securities are reported by a counterparty that does have a TRACE reporting obligation, such as a FINRA member or covered depository institution, the non-FINRA member is identified only as “customer” in the reported data unless the transaction occurred on a covered ATS.

133

See

FIA/PTG Letter at 3.

134

See, e.g.,

PEAK6 Letter at 6; Group One Letter at 2; CTC Letter at 3; Cboe Letter at 7; Virtu Letter at 7.

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

markets for U.S. Treasury securities, equities and options. Such FINRA authority is necessary notwithstanding the Commission's authority over broker-dealers in order to strengthen the SRO layer of oversight of off-member-exchange securities trading, consistent with the dual Commission and SRO oversight of broker-dealers required by the Exchange Act.

135

As a membership-based organization, FINRA's jurisdiction, and thus its authority, is limited to its members and their associated persons. As such, authority to independently examine, investigate, or enforce potential violations against non-FINRA member broker-dealers is not conferred to FINRA through reporting requirements without FINRA membership. For example, FINRA stated that it identified non-FINRA member broker-dealer firms as potential respondents in five percent of the market regulation investigations it conducted in 2020 and 2021, which ranged across asset types and included both cross-exchange and off-exchange conduct), and FINRA identified non-FINRA member firms in 17 percent of the surveillance alerts generated by its U.S. Treasury security manipulation pattern surveillance in 2020 and 2021.

136

If those non-FINRA member firms could remain exempt from section 15(b)(8)'s Association membership requirement as long as they report their U.S. Treasury securities transactions to TRACE, FINRA would continue to lack the independent ability to examine and investigate those firms to generate evidence, such as by collecting documents and interviewing witnesses.

135

See supra

note 22 (stating that Congress historically has favored self-regulation for a variety of reasons, including that effectively regulating the inner-workings of the securities industry at the Federal level was viewed as cost prohibitive and inefficient; the complexity of securities practices made it desirable for SRO regulatory staff to be intimately involved with SRO rulemaking and enforcement; and the SROs could set standards such as just and equitable principles of trade and detailed proscriptive business conduct standards).

136

See

FINRA Letter at 5, 10;

see also

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

In contrast, the rescission of the

de minimis

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

137

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

FINRA By-Laws Article III—Qualifications of Members and Associated Persons. Any person associated with a member firm who is engaged in the securities business of the firm—including partners, officers, directors, branch managers, department supervisors, and salespersons—must register with FINRA.

151

See, e.g.,

the FINRA rules set forth in notes 17-18, 56-57, 122-124, 137 and 147-150, and accompanying text,

supra.

In addition, FINRA has regulatory programs and staff dedicated to fixed income regulation.

See

FINRA.org, Key Topics—Fixed Income,

available at https://www.finra.org/rules-guidance/key-topics/fixed-income#overview.

152

See

FINRA Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities).

The Commission also continues to believe that it is important to the protection of investors and the public interest that FINRA has direct, membership-based jurisdiction over proprietary trading broker-dealer firms that effect off-member-exchange securities transactions regardless of whether they carry customer accounts. An Association's regulatory responsibility, like exchange SROs', includes an obligation to enforce compliance with the Federal securities laws and rules thereunder and the SRO's rules. As an Association, the Exchange Act's statutory framework places SRO oversight responsibility with FINRA for off-member-exchange securities trading, and FINRA is well-positioned to carry out this responsibility with respect to its members.

For example, FINRA gains familiarity with a member's operational risk by assigning dedicated staff members to each firm (

e.g.,

a Risk Monitoring Analyst to act as the primary point of contact and a Risk Monitoring Director) and having staff with subject matter expertise relevant to a member's business model conduct examinations and carry out monitoring duties.

153

Firms are classified into five primary business models and then further sorted into various subgroups overseen by exam and risk monitoring staff.

154

Risk monitoring teams seek to understand the unique aspects of each firm monitored, and use that expertise to inform exam staff in the preparation of exams. Employing a risk-based approach, FINRA examines firms on a one, two or four-year frequency and makes use of specialist teams (

e.g.,

anti-money laundering, cybersecurity or fixed income). Further, FINRA gains familiarity with a member's operational risk through customer complaints and regulatory tips or calls, which may trigger a “cause” exam (in contrast to the routine exams described above) focusing on the issues raised in the complaints.

155

Finally, FINRA staff is informed of changes in operational risk associated with a material change in business operations or change of control through FINRA Rule 1017.

156

The Continuing Member Application triggered under FINRA Rule 1017, among other things, reviews if the member's contractual and business relationships support the proposed change, if communications and operational systems are appropriate, financial and internal controls, and the adequacy of the member's supervisory system to prevent and detect violations.

157

153

See

FINRA Risk Monitoring Program, FINRA,

available at https://www.finra.org/contact-finra/risk-monitoring-program;

FINRA Examination and Risk Monitoring Programs, FINRA,

available at https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview.

154

See

FINRA Examination and Risk Monitoring Programs, FINRA,

available at https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#overview.

155

Id.

156

See

FINRA Rule 1017; Form CMA, FINRA,

available at https://www.finra.org/registration-exams-ce/broker-dealers/registration-forms/form-cma.

157

See

Filing a Change in Membership Application, The “What to Expect” Webcast Series (2010), FINRA,

available at https://www.finra.org/sites/default/files/Education/p018711.pdf.

The inability of FINRA to directly enforce regulatory compliance by proprietary trading broker-dealer firms that are not FINRA members—whether or not they handle customer orders or carry customer accounts—may create a risk to the fair and orderly operation of the market because FINRA may not be as familiar with the firm's operational risks or other risks posed by the firm's off-member-exchange securities trading activity as FINRA would be with a FINRA member firm, and FINRA may not be as well positioned potentially to mitigate those risks. In addition, if FINRA were to detect that a non-FINRA member is effecting off-member-exchange securities transactions that are not in compliance with the Exchange Act or applicable rules, FINRA would not have direct, membership-based jurisdiction to directly address the behavior.

158

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

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.

As is discussed in the 2022 Re-Proposal and in more detail in the Economic Analysis,

infra

section V, firms that become FINRA members as a result of the adopted rule amendments will be required to apply for membership with FINRA and become subject to the fees charged by FINRA to all of its member firms. FINRA charges each member firm certain regulatory fees designed to recover the costs to FINRA of the supervision and regulation of members, including performing examinations, financial monitoring, and policy, rulemaking, interpretive, and enforcement activities.

159

These regulatory fees include a Trading Activity Fee (“TAF”).

160

FINRA issued a Regulatory Notice in 2015 in which it proposed to amend the TAF such that it would not apply to transactions by a proprietary trading firm effected on exchanges of which the firm is a member.

161

In June 2023, after the 2022 Re-Proposal, FINRA filed a proposed rule change with the Commission, pursuant to section 19 of the Act, to amend the TAF such that it does not apply to transactions by a proprietary trading firm effected on exchanges of which the firm is a member.

162

FINRA designated this proposed rule change as “establishing or changing a due, fee or other charge” under section 19(b)(3)(A)(ii) of the Act and 17 CFR 240.19b-4(f)(2) (“Rule 19b-4(f)(2)”) thereunder, which renders the rule effective upon filing with the Commission.

159

See

FINRA Schedule A to the By-Laws of the Corporation (“FINRA Schedule A”), at section 1,

available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees.

160

FINRA uses the TAF to recover the costs to FINRA of the supervision and regulation of members, including performing examinations, financial monitoring, and policy, rulemaking, interpretive, and enforcement activities.

See

FINRA Schedule A, at section 1(a). The TAF is generally assessed on FINRA member firms for all equity sales transactions that are not performed in the capacity of a registered exchange specialist or market maker.

See id.

at section 1(b). FINRA charges its members other fees as well, such as an annual Gross Income Assessment (“GIA”).

See id.

at section 1.

161

See

FINRA Regulatory Notice 15-13, Trading Activity Fee (May 2015),

available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-13.pdf.

FINRA re-opened the comment period on its 2015 Regulatory Notice after the 2022 Re-Proposal.

See

FINRA Regulatory Notice 22-30, Trading Activity Fee (Dec. 15, 2022)

available at https://www.finra.org/sites/default/files/2022-12/Regulatory-Notice-22-30.pdf.

162

See

TAF Amendment. The TAF Amendment's implementation date, which FINRA will announce in a Regulatory Notice, will be no earlier than the date of the Commission's adoption of amended Rule 15b9-1 and no later than the effective date of amended Rule 15b9-1.

Id.

Comments on the 2022 Re-Proposal, submitted prior to the TAF Amendment, stated that the costs of applying for FINRA membership, as well as ongoing costs of FINRA membership such as the TAF, are high and burdensome and could affect liquidity provision.

163

In particular, commenters stated that proprietary options trading firms should remain exempt from section 15(b)(8)'s Association membership requirement because they do not trade U.S. Treasury securities and the equities transaction volume that they effect is hedging activity.

164

Commenters urged the Commission to adopt an exemption for proprietary options trading broker-dealer firms, such that their off-member-exchange securities trading activity would not trigger section 15(b)(8)'s Association membership requirement if such activity is to hedge or in furtherance of their options trading activity on their member exchange(s).

165

If proprietary options trading firms do not remain exempt, commenters stated, there could be a negative impact on options market liquidity and smaller options trading firms could cease trading, which could lead to consolidation and decreased competition.

166

FINRA stated that most proprietary trading dealer firms that newly join FINRA would not incur membership application fees exceeding $12,500.

167

FINRA also stated (prior to filing the TAF Amendment with the Commission) that it is committed to amending the TAF to lessen its impact on such firms.

168

163

See, e.g.,

MMI Letter at 3; PEAK6 Letter at 4-5; FIA PTG Letter at 4; Group One Letter at 2-3; ABCV Letter at 2-3; CTC Letter at 4; Cboe Letter at 7. One commenter estimated that some proprietary broker-dealers would incur TAF fees greater than $1,000,000 per year under the current TAF structure.

See

FIA PTG Letter at 4. Another commenter opined on the substance of FINRA's contemplated TAF amendment.

See

PEAK6 Letter at 4. Some commenters also stated that FINRA must amend the TAF before the Rule 15b9-1 amendments are adopted so firms can assess the fee-related costs of FINRA membership on proprietary trading firms.

See

PEAK6 Letter at 4; FIA PTG Letter at 4.

164

See, e.g.,

Cboe Letter at 3;

see also

ABCV Letter at 2 (stating that any trading by options market makers in the underlying cash equities markets is related to legitimate hedging of their options positions).

165

See

Cboe Letter at 2-3; ABCV Letter at 3-4; CTC Letter at 5; PEAK6 Letter at 4; Nasdaq Letter at 2. Commenters also stated that options trading firms' equities volume often is processed through a FINRA member, and stated that a hedging exemption would be particularly appropriate if the routing away from a member exchange is through a broker-dealer that is a FINRA member.

See

Cboe Letter at 2-3; ABCV Letter at 2-4; CTC Letter at 5; PEAK6 Letter at 4. As discussed

supra

in this section, the Commission does not agree.

See supra

notes 98-101 and accompanying text.

166

See

STA Letter at 3-4; Cboe Letter at 2-3, 7; ABCV Letter at 2-4; CTC Letter at 5; PEAK6 Letter at 4-6.

167

See

FINRA Letter at 12 n. 40 (also stating that FINRA does not anticipate that new member proprietary trading dealer firms would incur the one-time clearing surcharge that applies to new applicants engaged in clearing and carrying activity).

168

See id.

at 14.

See also

note 170 and accompanying text,

infra.

The Commission believes that a hedging exemption for broker-dealers that are proprietary options trading firms, like that sought by commenters, could continue to result in a significant volume of off-member-exchange trading activity not being subject to direct, membership-based FINRA oversight. Proprietary options trading firms make up the majority of the 12 firms that the Commission identified above as accounting for 5.1% of all off-exchange listed equities volume in April 2023 and the majority of the 21 firms that the Commission identified as accounting for approximately 99% of the $262 billion in listed equities transaction volume executed on exchanges where they are not a member.

169

As a result, significant off-member-exchange trading activity could continue not to be subject to direct FINRA oversight under commenters' suggested exemption. The Commission continues to believe that this would not be consistent with the protection of investors or the public interest, or with the historical rationale for Rule 15b9-1 of accommodating limited off-member-exchange trading activities.

170

169

See

section II.B,

supra.

170

See

2022 Re-Proposal,

supra

note 1, sections III.B.2 and III.C, 87 FR 49947-50. Section 15(b)(9) of the Act provides the Commission with the authority, by rule or order, and as it deems consistent with the public interest and the protection of investors, to conditionally or unconditionally exempt from the requirements of section 15(b)(8) any broker or dealer or class of brokers or dealers. Accordingly, if a broker or dealer or class of brokers or dealers believes that it should be exempted from the requirements of section 15(b)(8) in a manner that is not provided by amended Rule 15b9-1, it may seek an exemption from the Commission, by order, pursuant to section 15(b)(9). For example, the Commission may consider granting such an exemption, where appropriate, if a dealer or class of dealers chooses to limit its exchange trading activity to the physical floor of an exchange of which it is a member, but must effect limited securities transactions elsewhere for its own account in order to facilitate its exchange-floor business.

The effect of not including a hedging exemption in Rule 15b9-1 will be that proprietary options trading broker-dealer firms (among other types of proprietary trading broker-dealer firms) will no longer be exempt from section 15(b)(8)'s Association membership requirement if they effect off-member-exchange securities transactions (unless they are covered by one of the exemptions in the amended rule). Therefore, these firms will be required by section 15(b)(8) of the Act to join FINRA in order to continue any off-member-exchange securities trading activity. The Commission is mindful of the FINRA membership costs, including application and TAF fees, that would be incurred by proprietary trading broker-dealer firms, including options trading firms, that join FINRA as a result of the rescission of the

de minimis

allowance and proprietary trading exclusion, and the Commission is mindful of the potential impact of those costs on options market liquidity.

The Commission believes it is unlikely, however, that such firms would be unable to continue operating their trading businesses or providing liquidity in their normal course due to the costs of FINRA membership. Insofar as the costs of joining FINRA are concerned, the Commission believes that a $12,500 FINRA membership application fee would be manageable for proprietary trading options firms that newly join FINRA, and is small enough such that it should not materially impact their ability to provide liquidity.

171

As for concerns regarding the TAF, an ongoing FINRA cost, FINRA, after considering the potential impact of the TAF on proprietary trading firms that join FINRA, has amended its rules to provide an exemption from the TAF for all proprietary trading firms for transactions executed on an exchange of which the proprietary trading firm is a member.

171

See infra

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

In addition, commenters stated that small options trading firms could be adversely affected by the rule amendments to the point of providing less liquidity or ceasing to trade.

172

While commenters did not indicate how they are defining “small” options firms, the Commission believes that smaller firms should be able to absorb the ongoing costs of FINRA membership, such as the GIA and TAF.

173

As discussed in the Economic Analysis below,

174

the estimated aggregate costs for the 12 largest non-FINRA member broker-dealer firms as of April 2023 represent the majority of the aggregate costs stemming from the amendments to Rule 15b9-1. Therefore, the Commission believes that smaller non-FINRA member broker-dealer firms as well as new entrants will experience much lower initial and ongoing costs and that these FINRA membership costs would not materially impede their ability to continue their trading businesses, which may include providing liquidity in the options market, if they join FINRA.

175

172

See

STA Letter at 3-4; ABCV Letter at 2-3; Cboe Letter at 7; Nasdaq Letter at 3-4.

173

See infra

section V.C.2 (stating that the 12 largest non-FINRA member broker-dealer firms (as measured by off-exchange equities volume traded in April 2023) had average and median annual total revenues of approximately $1.2 billion and $491 million, respectively, in 2022; would incur an estimated median GIA of $327,870; and would incur an estimated median and average TAF of approximately $119,256 and $304,994, respectively).

174

See infra

section V.C.2.

175

The Commission believes that the potential FINRA membership costs that could be incurred by firms not among the 12 largest non-FINRA member broker-dealers is the best data point available to the Commission to assess commenters' assertion. As discussed in section V.B.2,

infra,

the Commission cannot, however, rule out the possibility that the addition of FINRA costs will serve as a catalyst for one or more small non-FINRA member options market makers to exit the market, although FINRA's exemption of TAF fees should reduce the likelihood that firms will choose to exit in response to the adopted rule amendments. In addition, as discussed in section VII,

infra,

the Commission estimates that not more than three of the 64 non-FINRA member broker-dealer firms that the Commission identified as of April 2023 have total capital of less than $500,000 and are not affiliates of any person (other than a natural person) that is not a small business or small organization and would, as a result, be considered small entities under Regulatory Flexibility Act (“RFA”) standards. These three small firms—by RFA standards—could be significantly impacted by the adopted rule amendments because they could be required to become a member of FINRA under section 15(b)(8) of the Act, if they effect off-member-exchange securities transactions and do not qualify for one of the adopted exemptions. These three firms are not among the 12 largest non-FINRA member broker-dealer firms identified by the Commission, and so, as discussed in the paragraph above and in section V.C.2

infra,

their initial and ongoing FINRA membership costs, should they join FINRA, likely would be low. This suggests that, while they could be significantly impacted by the adopted rule amendments in that they may no longer be exempt from FINRA membership, their trading businesses nevertheless might not be materially impeded by the costs of FINRA membership.

Further, since the 2015 Proposal, as commenters observed, there has been a decrease in the number of Commission-registered broker-dealers that are exchange members but not FINRA members.

176

There also has been significant consolidation among broker-dealers generally over the past decade.

177

Meanwhile, despite this decline in the number of firms, options market liquidity has remained robust, as reflected by data suggesting that options quoted spreads have remained flat or slightly declined in recent years as overall option trading volumes have continued to hit record highs.

178

Therefore, as discussed in the Economic Analysis below,

179

the Commission does not believe that the adopted rule amendments will undermine options market liquidity provision. In addition, as discussed in the Economic Analysis below,

180

the Commission believes that amended Rule 15b9-1 is not likely to have an economically meaningful effect on direct capital formation, and that changes in the allocation of regulatory fees and direct FINRA supervision within the off-member-exchange market may result in improved efficiency of capital allocation by the financial industry, as current FINRA members might commit additional capital to liquidity provision when the trading environment has more uniform regulatory requirements.

176

See

STA Letter at 3-4; ABCV Letter at 2-3.

See also

Options Linkage Plan,

supra

note 22.

192

The ITS was an NMS plan, the full title of which was “Plan for the Purpose of Creating and Operating an Intermarket Communications Linkage Pursuant to Section 11A(c)(3)(B) of the Exchange Act of 1934” (“ITS Plan”). The ITS Plan was provisionally approved by the Commission in 1978 and finally approved by the Commission in 1983.

See

Securities Exchange Act Release Nos. 14661 (Apr. 14, 1978), 43 FR 17419 (Apr. 24, 1978) (“Initial ITS Plan Approval Order”); 19456 (Jan. 27, 1983), 48 FR 4938 (Feb. 3, 1983) (“Final ITS Plan Approval Order”). All national securities exchanges that traded exchange-listed stocks and the National Association of Securities Dealers (“NASD”) were participants in the ITS Plan.

193

See

2022 Re-Proposal,

supra

note 1, 87 FR 49945;

see also

Notice of Filing and Immediate Effectiveness of the Twenty Fourth Amendment to the ITS Plan Relating to the Elimination of the ITS Plan, Securities Exchange Act Release No. 55397 (Mar. 5, 2007), 72 FR 11066 (Mar. 12, 2007).

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

and procedures reasonably designed to prevent trade-throughs in exchange-listed stocks, subject to certain exceptions.

194

In general, Rule 611 protects automated quotations that are the best bid or offer of a national securities exchange or an Association.

195

To facilitate compliance with Rule 611, national securities exchanges have developed the capability to route orders through brokers or dealers (many of which are affiliated with the exchanges) to other trading centers with protected quotations.

196

Similarly, in the options market, the Options Linkage Plan is an NMS plan that requires linkages between the options exchanges to protect the best-priced displayed quotes in the market and to avoid locked and crossed markets.

197

The Options Linkage Plan includes written policies and procedures that provide for order protection and address locked and crossed markets in eligible options classes.

198

194

17 CFR 242.611.

See also

17 CFR 242.600(b)(94) (defining a “trade-through” under Regulation NMS); 17 CFR 240.600(b)(95) (defining “trading center”); Options Linkage Plan,

supra

note 4 (defining “trade-through” in the options context).

195

17 CFR 242.611.

196

See

17 CFR 242.600(b)(71) (defining “protected quotation” under Regulation NMS); 17 CFR 242.600(b)(70) (defining “protected bid” and “protected offer” under Regulation NMS);

see also

Options Linkage Plan,

supra

note 4 (defining “protected bid” and protected offer” in the options context).

197

See

Options Linkage Plan,

supra

note 4. A locked or crossed market occurs when a trading center displays an order to buy at a price equal to or higher than an order to sell, or an order to sell at a price equal to or lower than an order to buy, that is displayed on another trading center.

198

Id.

The Commission proposed the routing exemption in paragraph (c)(1) to accommodate securities transactions away from a broker's or dealer's member exchange(s) that are to comply with these regulatory requirements.

199

In essence, a broker or dealer may, as a necessary part of its business trading on exchanges of which it is a member and in light of today's market structure, effect securities transactions elsewhere than an exchange where it is a member solely as a consequence of routing by its member exchange(s) to comply with the requirements of Rule 611 of Regulation NMS or the Options Linkage Plan.

200

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

199

See

2022 Re-Proposal,

supra

note 1, 87 FR 49945.

200

Amended Rule 15b9-1 provides an exemption from section 15(b)(8) of the Act's Association membership requirement for routing broker-dealers that meet the conditions for the exemption, but it does not provide routing broker-dealers with an exemption from the rules of an exchange that are applicable to routing broker-dealers that operate as facilities of that exchange (and that the exchange uses to conduct routing to other trading centers). As discussed in the 2022 Re-Proposal, a routing broker-dealer continues to be required to comply with the applicable rules of any exchange for which it performs outbound routing services, including those requiring the routing broker-dealer to be overseen by an unaffiliated SRO such as FINRA.

See, e.g.,

Cboe BZX Exchange, Inc. Rule 2.11 (Cboe Trading, Inc. as Outbound Router); NYSE Rule 17(c) (Operation of Routing Broker); Nasdaq Options 5, section 4 (Order Routing).

The Commission also stated in the 2022 Re-Proposal that it would be consistent with the protection of investors and the public interest to permit reliance on the routing exemption only where the routing is performed by a national securities exchange of which the broker or dealer is a member.

201

The Commission stated that this limitation would help ensure that the broker's or dealer's member exchange has visibility into the routing transactions and thus is better able to provide effective SRO oversight of its member's trading activity that is related to its trading on the exchange and may not be overseen by another SRO if the member is exempt from Association membership under amended Rule 15b9-1.

202

201

As stated in the 2022 Re-Proposal, the routing exemption is applicable where the broker's or dealer's member exchange utilizes the services of a designated broker-dealer (which could be affiliated or unaffiliated with the exchange) to perform the exchange's outbound routing.

See

2022 Re-Proposal,

supra

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

202

See

2022 Re-Proposal,

supra

note 1, 87 FR 49946.

Some commenters stated that the routing exemption should be broadened for proprietary options trading broker-dealer firms so that it covers routing that is not performed by member-exchange routers.

203

The Commission stated in the 2022 Re-Proposal that this would not be consistent with the protection of investors and the public interest because it could permit scenarios in which there is insufficient SRO oversight of the broker-dealer's off-member-exchange securities trading activity.

204

Commenters suggested that the Commission's concerns in this regard are mitigated in the context of options trading firms because they typically route to non-member exchanges via another broker-dealer,

205

and are especially mitigated where that routing broker-dealer is a FINRA member.

206

203

See

Cboe Letter at 3;

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