
[Federal Register Volume 80, Number 63 (Thursday, April 2, 2015)]
[Proposed Rules]
[Pages 18035-18070]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-07293]



[[Page 18035]]

Vol. 80

Thursday,

No. 63

April 2, 2015

Part VI





 Securities and Exchange Commission





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17 CFR Part 240





Exemption for Certain Exchange Members; Proposed Rule

  Federal Register / Vol. 80 , No. 63 / Thursday, April 2, 2015 / 
Proposed Rules  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-74581; File No. S7-05-15]
RIN 3235-AL65


Exemption for Certain Exchange Members

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing to amend Rule 15b9-1 (``Rule'') under the Securities Exchange 
Act of 1934 (``Act'' or ``Exchange Act''), which exempts certain 
brokers or dealers from membership in a registered national securities 
association (``Association''). The proposed amendments would replace 
the current gross income allowance in the Rule with a narrower 
exemption from Association membership for a broker or dealer that 
carries no customer accounts and effects transactions on a national 
securities exchange. The proposed amendments would create an exemption 
for a dealer that effects transactions off the exchange of which it is 
a member solely for the purpose of hedging the risks of its floor-based 
activity, or a broker or dealer that effects transactions off the 
exchange resulting from orders that are routed by a national securities 
exchange of which it is a member, to prevent trade-throughs consistent 
with the provisions of Rule 611 of Regulation NMS.

DATES: Comments should be received on or before June 1, 2015.

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number S7-05-15 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

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

All submissions should refer to File Number S7-05-15. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE., Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.
    Studies, memoranda or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's Web site. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: David Michehl, Special Counsel, at 
(202) 551-5627; Nicholas Shwayri, Special Counsel, at (202) 551-5667; 
or Charles Sommers, Attorney-Adviser, at (202) 551-5787, Division of 
Trading and Markets, Securities and Exchange Commission, 100 F Street 
NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. Regulatory History
    B. Regulatory Oversight of Off-Exchange Trading Activity
II. Discussion of Amendments to Rule 15b9-1
    A. Prior Comments on Association Membership
    B. Overview of Amendments
    C. Elimination of the De Minimis Allowance
    D. Floor Member Hedging Exemption
    E. Regulation NMS Routing Exemption
III. Effective Date and Implementation
IV. General Request for Comments
V. Economic Analysis
    A. Baseline
    1. Regulatory Structure and Activity Levels of Non-Member Firms
    2. Current Market Oversight
    B. Broad Economic Considerations, Including Effects on 
Efficiency, Competition and Capital Formation
    1. Effects on Regulatory Supervision
    2. Firm Response and Effect on Market Activity
    3. Competition To Provide Liquidity Is Distorted by Regulatory 
Costs Borne by Only a Subset of Competitors, Member Firms
    4. Competitive Effects on Off-Exchange Market Regulation
    C. Consideration of Costs and Benefits
    1. Benefits
    2. Costs
    D. Alternatives
    1. Elimination of the Floor Member Hedging Exemption
    2. Improve Off-Exchange Supervision Through Action of Other SROs 
With or Without CAT
    3. Exchange Membership Alternative
    4. Retaining the De Minimis Allowance
    5. The Commission Assumes Regulatory Oversight Role for Non-
Member Firms
    E. Request for Comment on Economic Analysis
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
    H. Request for Comments
VII. Consideration of Impact on Economy
VIII. Regulatory Flexibility Act Certification
IX. Statutory Authority--Text of the Proposed Amendments

I. Background

    Rule 15b9-1generally provides an exemption for certain broker-
dealers from the Exchange Act requirement to become a member of an 
Association. However, the equities markets have undergone a substantial 
transformation since the Commission previously considered the Rule. 
Over time, active, cross-market proprietary trading firms began relying 
on the Rule 15b9-1 exemption in ways that were not envisioned when the 
Rule was adopted or amended. The Commission is proposing to amend Rule 
15b9-1 to better align the scope of its exemption, in light of today's 
market activity, with Section 15(b)(8) of the Exchange Act and the 
Commission's purposes underlying the adoption of Rule 15b9-1.
    When the Exchange Act was adopted in 1934, the exchanges were the 
only self-regulatory organizations (``SROs'') \1\ and were charged with 
regulating the activities of their broker-dealer members.\2\ Congress 
soon recognized, however, that the benefit of exchange regulation could 
be undermined by the absence of a complementary regulatory

[[Page 18037]]

framework for the off-exchange market \3\ and, in 1938, Congress 
provided for the creation of national securities associations.\4\ 
Congress later mandated Association membership for all off-exchange 
market participants through Section 15(b)(8) of the Exchange Act,\5\ 
which requires a broker-dealer to become a member of an Association 
unless it effects transactions solely on an exchange of which it is a 
member. This provision, among others, reflects an overarching principle 
in the Exchange Act that the SRO best positioned to conduct regulatory 
oversight should assume those responsibilities \6\ and, 
correspondingly, that off-exchange trading is primarily the 
responsibility of an Association or Associations.
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    \1\ An SRO is defined, in relevant part, as ``any national 
securities exchange, registered securities association, or 
registered clearing agency. . . .'' 15 U.S.C. 78c(a)(26). See also 
infra notes 26-28 and accompanying text.
    \2\ See, e.g., 15 U.S.C. 78f(b) (requiring exchanges to be so 
organized as to enforce compliance by their members and persons 
associated with their members with the provisions of the Exchange 
Act).
    \3\ ``Off-exchange'' trading as used herein means any securities 
transaction in an exchange-listed security that is not effected, 
directly or indirectly, on a national securities exchange. See 17 
CFR 240.600(b)(45) (defining ``national securities exchange''). Off-
exchange trading includes securities transactions that occur on 
alternative trading systems and directly with a broker-dealer, 
acting either as agent or principal, and is also referred to as 
over-the-counter (``OTC'') trading. The term ``off-exchange'' as 
used herein does not refer, as it does in some contexts, to 
transactions in securities, either in equities or other instruments, 
that are not listed on a national securities exchange.
    \4\ See infra notes 31-33 and accompanying text (describing the 
early history and background behind the creation of national 
securities associations).
    \5\ 15 U.S.C. 78o(b)(8). Section 15(b)(8) of the Exchange Act 
was adopted in 1964. See infra notes 36-37 and accompanying text. 
Notably, however, from 1976-1983, broker-dealers engaged in off-
exchange trading could either join an Association or be subject to 
direct regulation by the Commission under the SEC Only (``SECO'') 
Program. See infra notes 38-48 and accompanying text.
    \6\ As originally adopted in 1934, the regulation of broker-
dealer activities on national securities exchanges was excluded from 
the Commission's authority. See Section 15 as adopted in 1934, 
Public Law 73-291, 48 Stat. 881, 895-96 (1934), infra note 27. 
Rather, regulation of broker-dealer activities on exchanges 
continued to be conducted by the exchanges themselves, many of which 
existed prior to the enactment of the Exchange Act. Consequently, 
this left regulation of the off-exchange market with the Commission, 
until passage of the Maloney Act in 1938, providing for the creation 
of voluntary, self-regulating Associations with powers to adopt and 
enforce rules to regulate the off-exchange market. Public Law 75-
719, 52 Stat. 1070 (1938) (the ``Maloney Act''); see also infra note 
23 and accompanying text.
     In the Exchange Act Amendments of 1975 (Pub. L. 94-29, 89 Stat. 
97 (1975), the ``1975 Amendments''), Congress recognized that, at 
the time, the allocation of self-regulatory responsibilities among 
SROs resulted in some cases in duplicative regulation of firms that 
were members of multiple SROs and varying standards, both in 
substance and enforcement, among SROs. S. Doc. No. 93-13 at 164-165 
(1973). As a result, Congress adopted Section 17(d) of the Act, 
which provides the Commission with the authority to allocate 
regulatory responsibilities among SROs with respect to matters as to 
which, in the absence of such allocation, such SROs would share 
authority. 15 U.S.C. 78q(d). In adopting Section 17(d), a Senate 
Report accompanying the 1975 Amendments expressed the view that 
``the Commission should play an affirmative role in allocating 
inspection and enforcement responsibilities among the self-
regulatory organizations'' and that ``for reporting purposes each 
broker-dealer [should] be assigned to a designated principal self-
regulator or government regulator who will be responsible for 
determining the broker-dealer's operating and financial status.'' 
See 1975 Amendments, Report of the Senate Committee on Banking, 
Housing, and Urban Affairs to Accompany S. 249, S. Rep. No. 94-75, 
94th Cong., 1st Session 33 (1975).
     As a general matter, SROs and the Commission have used the 
flexibility provided by Section 17(d) of the Act to allocate 
regulatory responsibilities in such a manner. 15 U.S.C. 78q(d). See, 
e.g., Exchange Act Release No. 63750 (January 21, 2011), 76 FR 4948 
(January 27, 2011) (order approving 17d-2 plan to allocate 
regulatory responsibility to FINRA relating to surveillance, 
investigation, and enforcement of insider trading rules); Exchange 
Act Release No. 70052 (July 26, 2013), 78 FR 46665 (August 1, 2013) 
(order approving 17d-2 plan to add Topaz Exchange, LLC to existing 
plan with all other options exchanges to allocate regulatory 
responsibility to FINRA relating to, among other things, opening of 
accounts, supervision, suitability, discretionary accounts, 
advertising, customer complaints, customer statements, disclosure 
documents, and certification of personnel); Exchange Act Release No. 
73641 (November 19, 2014), 79 FR 70230 (November 25, 2014) (order 
approving 17d-2 plan to allocate regulatory responsibility to FINRA 
for the Miami International Securities Exchange, LLC (``MIAX''), 
with respect to examination and enforcement responsibility relating 
to compliance by common members with the substantially similar rules 
of the two SROs and applicable provisions of the federal securities 
laws). See also infra notes 62-63 and accompanying text (discussing 
the allocation of regulatory responsibilities among SROs).
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    Section 15(b)(9) of the Exchange Act,\7\ provides the Commission 
with authority to exempt any broker-dealer from the requirements of 
Section 15(b)(8), if that exemption is consistent with the public 
interest and the protection of investors. Pursuant to that authority, 
the Commission adopted Rule 15b9-1,\8\ which was last substantively 
updated in 1983.\9\ That Rule was intended to address the limited 
activities of exchange-based specialists and floor brokers that were 
conducted off the exchange of which they were a member and that were 
ancillary to their floor-based business.\10\ Specifically, the Rule 
exempts a broker-dealer from the requirement to become a member of an 
Association if it is a member of a national securities exchange, 
carries no customer accounts, and has annual gross income of no more 
than $1,000 that is derived from securities transactions effected 
otherwise than on a national securities exchange of which it is a 
member (the ``de minimis allowance''). Importantly, the Rule permits 
income derived from transactions for the dealer's own account with or 
through another registered broker-dealer, to not count toward the 
$1,000 de minimis allowance (hereinafter, the ``exclusion for 
proprietary trading'').\11\ As discussed more fully below, the de 
minimis allowance originally was designed to permit broker-dealers 
doing business on exchange floors to share in the commissions paid on 
occasional off-exchange transactions in customer accounts they 
introduced to other broker-dealers, up to a nominal amount.\12\ In 
addition, when the exclusion for proprietary trading was adopted in 
1976,\13\ the circumstances under which an exchange specialist or floor 
broker would trade proprietarily off-exchange remained quite limited, 
such as when a regional exchange specialist would hedge risk on the 
primary listing market.\14\
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    \7\ The Commission by rule or order, as it deems consistent with 
the public interest and the protection of investors, may 
conditionally or unconditionally exempt from paragraph (8) of this 
subsection any broker or dealer or class of brokers or dealers 
specified in such rule or order. See 15 U.S.C. 78o(b)(9); Public Law 
98-38, 97 Stat. 205 (1983).
    \8\ 17 CFR 240.15b9-1. See also infra notes 38-48 and 
accompanying text for a discussion on Rule 15b8-1, the predecessor 
to Rule 15b9-1.
    \9\ See SECO Programs; Direct Regulation of Certain Broker-
Dealers; Elimination, Exchange Act Release No. 20409 (November 22, 
1983), 48 FR 53688 (November 29, 1983) (``SECO Programs Release'').
    \10\ See infra note 22 and accompanying text (explaining that 
the Rule is limited to receipt of a portion of the commissions paid 
on occasional over-the-counter transactions and certain other 
activities incidental to their activities as specialists).
    \11\ The exclusion for proprietary trading (conducted with or 
through another registered broker-dealer) was not part of the 
original exemption, but was added in 1976. See infra notes 43-44 and 
accompanying text.
    \12\ See Qualifications and Fees Relating to Brokers or Dealers 
Who Are Not Members of National Security [sic] Association, Exchange 
Act Release No. 7697 (September 7, 1965), 30 FR 11673, 11675 
(September 11, 1965) (``Qualifications and Fees Release'') 
(describing specialist or floor broker's proprietary off-exchange 
activity as generally limited to occasional commissions on 
introduced accounts and other transactions incidental to their 
activity as specialists or floor brokers). See also infra note 22.
    \13\ In adopting the exclusion for proprietary trading, the 
Commission indicated that an exchange floor broker, through another 
broker-dealer, could effect transactions for its own account on an 
exchange of which it was not a member. The Commission noted that 
such transactions ultimately would be effected by a member of that 
exchange. See Extension of Temporary Rules 23a-1(T) and 23a-2(T); 
Adoption of Amendments to SECO Rules, Securities Exchange Act 
Release No. 12160 (March 3, 1976), 41 FR 10599, 10600 (March 12, 
1976) (``Adoption of Amendments to SECO Rules''). See also infra 
note 44.
    \14\ In the Special Study of the Securities Markets in 1963, the 
Commission described how regional exchange specialists reduced their 
exposure, including by offsetting those positions on other 
exchanges. The Commission noted that ``[s]pecialists on the Boston, 
Philadelphia-Baltimore-Washington, Pittsburgh, and Montreal stock 
exchange are in communication with each other by direct wires 
linking their floors and each may trade on the other exchanges at 
member rates'' and ``[s]pecialists who are sole members [of an 
exchange] also offset [their positions] with over-the-counter houses 
dealing in listed securities. Many of the offsetting transactions 
are done on the primary market, the NYSE, with the [specialist] 
buying or selling on that exchange as his needs dictate.'' Report of 
Special Study of Securities Markets of the Securities and Exchange 
Commission, H.R. Doc. No. 88-95, at 935 (1963) (``Special Study''). 
The Commission believes that the business of regional exchange 
specialists was substantially the same when the exclusion for 
proprietary trading in Rule 15b9-1 was adopted in 1976.

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    Accordingly, those broker-dealers exempt from Association 
membership pursuant to Rule 15b9-1 when it was first adopted were 
broker-dealers with a business focused on the floor of an exchange of 
which they were a member.\15\ The Commission crafted Rule 15b9-1 to 
accommodate limited activities ancillary to that floor-based business, 
and thereby left it to the exchange of which the specialist or floor 
broker was a member to continue to regulate the entirety of that 
broker-dealer's activities. Therefore, the scope of Rule 15b9-1 
originally was consistent with the principle underlying Section 
15(b)(8) of the Exchange Act, noted above, that the SRO best positioned 
to conduct regulatory oversight should assume those responsibilities.
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    \15\ See infra note 22.
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    However, the equities markets have undergone a substantial 
transformation since the Commission previously considered Rule 15b9-1, 
evolving from markets with both manual and automated features and 
trading volumes concentrated on the primary listing exchanges, to a 
highly electronic, decentralized market with substantial competition 
among a large number and great variety of trading venues.\16\ New types 
of proprietary trading firms have emerged, including those that engage 
in so-called high-frequency trading strategies. These firms tend to 
effect transactions across the full range of exchange and off-exchange 
markets, including alternative trading systems (``ATSs'').\17\ They 
also tend to use complex electronic trading strategies and 
sophisticated technology to generate a large volume of orders and 
transactions throughout the national market system.\18\
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    \16\ See Concept Release Concerning Equity Market Structure, 
Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594, 3594-
3596 (January 21, 2010) (``Concept Release'') (discussing the 
evolution from ``a market structure with primarily manual trading to 
a market structure with primarily automated trading'').
    \17\ ATSs fall within the statutory definition of national 
securities exchange, but are exempt from having to register as an 
exchange if they comply with Regulation ATS. See Regulation of 
Exchanges and Alternative Trading Systems, Exchange Act Release No. 
40760 (December 8, 1998), 63 FR 70844, 70856 (December 22, 1998). 
Regulation ATS requires ATSs to be registered as broker-dealers with 
the Commission, which entails becoming a member of an Association 
and complying with the broker-dealer regulatory regime. 17 CFR 
242.301(b)(1). Unlike a registered national securities exchange, an 
ATS is not required to file proposed rule changes with the 
Commission. ATSs include both dark pools and electronic 
communications networks (``ECNs''). ECNs provide their best-priced 
orders for inclusion in the consolidated quotation data, while dark 
pools do not. See Concept Release, supra note 16 at 3599. See also 
infra notes 158--161 and accompanying text (describing some of these 
firms' activity on exchanges). ATSs did not exist when Rule 15b9-1 
was last amended in 1983.
    \18\ Many, but not all, such 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 over night). 
See Concept Release, supra note 16, at 3606. See also Staff of the 
Division of Trading and Markets, Commission, ``Equity Market 
Structure Literature Review, Part II: High Frequency Trading,'' at 
4-5 (March 18, 2014) (available at http://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf).
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    Over time, active, cross-market proprietary trading firms began 
relying on the Rule 15b9-1 exemption in ways that were not envisioned 
when the Rule was adopted or amended.\19\ As noted above, the de 
minimis allowance of Rule 15b9-1, and the subsequent exclusion of 
income derived from proprietary transactions conducted with or through 
another registered broker-dealer from such allowance, were designed to 
permit exchange-based specialists or floor brokers to conduct limited 
activities off-exchange. However, because the Rule does not explicitly 
limit this exclusion from the de minimis allowance to dealer activities 
ancillary to a floor-based business, a broker-dealer, with or without a 
floor presence, may engage in unlimited proprietary trading in the off-
exchange market without becoming a member of an Association. 
Consequently, many of the most active, cross-market proprietary trading 
firms have been able to rely on the exemption from Association 
membership, despite effecting a significant volume of transactions off-
exchange.
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    \19\ These firms are registered with the Commission as broker-
dealers but have elected to avail themselves of the Rule 15b9-1 
exemption from membership in an Association.
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    As a result, an exemption that was developed to address limited 
off-exchange activity by exchange-based specialists or floor brokers is 
today being used by many broker-dealers without a floor-based business, 
and that conduct a substantial percentage of the volume of off-exchange 
trading in the U.S. securities markets. Specifically, during the fourth 
quarter of 2014, broker-dealers that are not Association \20\ members 
(``Non-Member Firms'') accounted for 45% of orders sent directly to 
ATSs, a significant category of off-exchange trading venue.\21\ 
Preliminarily, the Commission does not believe the public interest 
finding that originally supported the adoption and amendments of Rule 
15b9-1continues to apply today in this context.
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    \20\ Financial Industry Regulatory Authority, Inc. (``FINRA'') 
is currently the sole Association. See infra note 34. In 1939, the 
Commission approved the National Association of Securities Dealers, 
Inc. (``NASD'') as the first national securities association. See 4 
FR 3564 (August 9, 1939). In 2007, the Commission approved changes 
that consolidated the member firm regulatory functions of the NASD, 
an Association, and NYSE Regulation, Inc., and changed the name of 
the combined entity to FINRA. See Exchange Act Release No. 56145 
(July 26, 2007), 72 FR 42169 (August 1, 2007).
    \21\ ATSs received approximately 230 billion orders during 2014 
that were sent directly to an ATS (i.e., orders received by a 
broker-dealer that are then sent to another trading desk of that 
broker-dealer (so called ``desk-reports'') are generally excluded 
from these order totals). Orders from Non-Member Firms accounted for 
49% of orders sent directly to ATSs during the first quarter of 
2014, 49% of orders sent directly to ATSs during the second quarter 
of 2014, 48% of orders sent directly to ATSs during the third 
quarter of 2014, and 45% of orders sent directly to ATSs during the 
fourth quarter of 2014. In 2013, ATSs received approximately 163 
billion orders that were sent directly to an ATS. Orders from Non-
Member Firms accounted for 34% of orders sent directly to ATSs 
during the first quarter of 2013, 38% of orders sent directly to 
ATSs during the second quarter of 2013, 42% of orders sent directly 
to ATSs during the third quarter of 2013, and 45% of orders sent 
directly to ATSs during the fourth quarter of 2013. On a volume-
weighted basis (i.e., accounting for variations in total order 
volume sent to ATSs), Non-Member Firms accounted for 48% of orders 
sent directly to ATSs in 2014, 40% in 2013, and 32% in 2012. This 
information is from data obtained from FINRA's Order Audit Trail 
System (``OATS'').
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    Accordingly, the Commission is proposing to amend Rule 15b9-1 to 
better align the scope of its exemption, in light of today's market 
activity, with Section 15(b)(8) of the Exchange Act and the 
Commission's original purpose in adopting Rule 15b9-1, which was to 
accommodate broker-dealer activities ancillary to a floor-based 
business while preserving the traditional role of the exchange as the 
entity best suited to regulate member conduct on the exchange.\22\ A 
broker-dealer that

[[Page 18039]]

conducts off-exchange transactions outside the limited scope of Rule 
15b9-1, as proposed to be amended, would be required to become a member 
of an Association. Consequently, such a broker-dealer would be subject, 
with respect to its off-exchange transactions, to the oversight and 
rules of an Association, the category of SRO primarily responsible for 
regulating trading in the off-exchange market in accordance with 
Section 15(b)(8).\23\ Further, as a result of the proposal, a broker-
dealer that does not trade off-exchange but that trades indirectly on 
multiple exchanges would be required in accordance with Section 
15(b)(8), to become a member of an Association, or alternatively, a 
member of each exchange where it effects transactions other than 
transactions to hedge the risks of its floor-based activities.
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    \22\ In adopting Rule 15b8-1, the Commission stated: ``Among the 
broker-dealers that are not members of a registered national 
securities association are several specialists and other floor 
members of national securities exchanges, some of whom introduce 
accounts to other members. The over-the-counter business of these 
broker-dealers may be limited to receipt of a portion of the 
commissions paid on occasional over-the-counter transactions in 
these introduced accounts, and to certain other transactions 
incidental to their activities as specialists. In most cases, the 
income derived from these activities is nominal.'' See 
Qualifications and Fees Release, supra note 12, at 11675.
    \23\ See Public Law 75-719, 52 Stat. 1070 (1938) (The Maloney 
Act, which established the concept of and framework for 
Associations, states in its preamble that its purpose was to provide 
for the establishment of a mechanism of regulation [Associations] 
among over-the-counter brokers and dealers operating in interstate 
and foreign commerce or through the mails, to prevent acts and 
practices inconsistent with just and equitable principles of trade, 
and for other purposes). See also infra notes 26, 28-33 and 
accompanying text (describing the early history of the Maloney Act).
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A. Regulatory History

    The primary purpose of an SRO is to regulate its members.\24\ 
Although the Act provides a limited and targeted exception to 
Association membership requirements for broker-dealers, its approach to 
effecting supervision is relatively uniform: Broker-dealers must be 
members of the SROs that regulate the venues upon which they transact. 
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.\25\ A primary 
purpose of an Association as an SRO, among other things, is to regulate 
the off-exchange market.\26\ Under the Exchange Act, as adopted in 
1934, the direct regulation of broker-dealer activities on national 
securities exchanges was to be conducted by the exchanges themselves. 
As there was no SRO for the off-exchange market, regulation of the off-
exchange market was to be the Commission's responsibility.\27\ Congress 
recognized that the benefits of exchange regulation could be undermined 
in the absence of a complementary regulatory framework for the off-
exchange market \28\ and provided the Commission the authority to adopt 
rules and regulations concerning the off-exchange market to achieve 
investor protections comparable to those on exchanges.\29\ After 
further study,\30\ however, in 1938 Congress imposed a comprehensive 
regulatory framework for the off-exchange market through the Maloney 
Act.\31\ The Maloney Act added Section 15A to the Act,\32\ providing 
for the creation of national securities associations of broker-dealers, 
with powers to adopt and enforce rules to regulate the off-exchange 
market.\33\ This led to the creation of NASD, the predecessor of FINRA, 
and the only Association \34\ registered to date.\35\
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    \24\ See, e.g., S. Doc. No. 93-13 at 147 (1973) (describing the 
structure of the self-regulatory system in which SROs ``are 
delegated governmental power in order to enforce, at their own 
initiative, compliance by members of the industry with legal and 
ethical standards going beyond the basic requirements laid down in 
the Act.'').
    \25\ 15 U.S.C. 78q(d); 15 U.S.C. 78s(g).
    \26\ The Maloney Act authorizes an Association to, among other 
things, establish rules designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, 
to protect investors and the public interest. See 15 U.S.C 78o-
3(b)(6). See also First Jersey Sec., Inc. v. Bergen, 605 F.2d 690, 
692 (3d Cir. 1979) (``The purpose of [NASD] is to provide self-
regulation of the over-the-counter securities market.''); Special 
Study, supra note 14, at 65 (describing the NASD as ``the agency 
with primary self-regulatory responsibility for over-the-counter 
markets.'').
    \27\ As adopted in 1934, Section 15 of the Exchange Act read, in 
relevant part: ``It shall be unlawful, in contravention of such 
rules and regulations as the Commission may prescribe as necessary 
or appropriate in the public interest and to insure to investors 
protection comparable to that provided by and under authority of 
this title in the case of national securities exchanges, (1) for any 
broker or dealer . . . to make or create, a market, otherwise than 
on a national securities exchange, for both the purchase and sale of 
any security . . . or (2) for any broker or dealer to use any 
facility of any such market. Such rules and regulations may provide 
for the regulation of all transactions by brokers and dealers on any 
such market, for the registration with the Commission of dealers 
and/or brokers making or creating such a market, and for the 
registration of the securities for which they make or create a 
market and may make special provision with respect to securities or 
specified classes thereof listed, or entitled to unlisted trading 
privileges, upon any exchange on the date of the enactment of this 
title, which securities are not registered under the provisions of 
section 12 of this title.'' Public Law 73-291, 48 Stat. 881, 895-96 
(1934).
    \28\ In considering adopting the Maloney Act, the House noted 
that: ``The committee has been convinced that effective regulation 
of the exchanges requires as a corollary a measure of control over 
the over-the-counter markets. The problem is clearly put in the 
recent report of the Twentieth Century Fund on `Stock Market 
Control': `The benefits that would accrue as the result of raising 
the standards of security exchanges might be nullified if the over-
the-counter markets were left unregulated and uncontrolled. . . . To 
leave the over-the-counter markets out of a regulatory system would 
be to destroy the effects of regulating the organized exchanges.''' 
H.R. Doc No. 1383, 73d Cong. 2d Sess. at 4 (1934) (quoting report on 
``Stock Market Control'' by the Twentieth Century Fund).
    \29\ Id.
    \30\ See Statement of Senator Francis T. Maloney, Hearings 
before Committee on Banking and Currency on S. 3255, 75th Cong., 3d 
Sess. (1938) (noting that the Maloney Act came after ``a long-time 
effort on the part of the Securities and Exchange Commission in 
rather close cooperation with members of the investment banking 
business and over-the-counter dealers and brokers.'').
    \31\ Public Law 75-719, 52 Stat. 1070 (1938).
    \32\ 15 U.S.C. 78o-3.
    \33\ Id.; see also S. Rep. No. 75-1455, at 3-4 (1938) (``The 
committee believes that there are two alternative programs by which 
this problem [of regulation of the off-exchange market] could be 
met. The first would involve a pronounced expansion of the 
organization of the Securities and Exchange Commission; the 
multiplication of branch offices; a large increase in the 
expenditure of public funds; an increase in the problem of avoiding 
the evils of bureaucracy; and a minute, detailed, and rigid 
regulation of business conduct by law. . . . The second of these 
alternative programs, which the committee believes distinctly 
preferable to the first . . . is based upon cooperative regulation, 
in which the task will be largely performed by representative 
organizations of investment bankers, dealers, and brokers, with the 
Government exercising appropriate supervision in the public 
interest, and exercising supplementary powers of direct 
regulation.''). See also S. Rep. No. 74-1455, at 2-3 (1938) (``It 
has been deemed advisable to authorize the Commission to subject 
such activities [i.e., trading in the over-the-counter markets] to 
regulation similar to that prescribed for transactions on organized 
exchanges. This power is vitally necessary to forestall the 
widespread evasion of stock-exchange regulation by the withdrawal of 
securities from listing on exchanges, and by transferring trading 
therein to `over-the-counter' markets where manipulative evils could 
continue to flourish, unchecked by any regulatory authority'') 
(quoting S. Rep. No. 73-792, at 6 (1934)). See also supra note 26.
    \34\ See supra note 20. 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.
    \35\ The existing self-regulatory structure in which an 
Association serves as the regulator of the off-exchange market and 
exchanges focus their regulatory supervision on their respective 
markets has not been materially altered from a statutory perspective 
since its establishment. See Concept Release Concerning Self-
Regulation, Exchange Act Release No. 50700 (November 18, 2004), 69 
FR 71256, 71258 (December 8, 2004).
---------------------------------------------------------------------------

    Section 15(b)(8) of the Act, enacted in 1964,\36\ further 
strengthened regulatory

[[Page 18040]]

oversight of the off-exchange market by prohibiting a broker-dealer 
from effecting any transaction ``otherwise than on a national 
securities exchange'' unless the broker-dealer was either a member of 
an Association, or met the Commission's standards with respect to 
training, experience, and other relevant qualifications.\37\ In 1965, 
the Commission adopted Rule 15b8-1 to establish the SECO Program, which 
provided for the direct regulation by the Commission of broker-dealers 
that effected transactions off-exchange and that chose not to join an 
Association.\38\
---------------------------------------------------------------------------

    \36\ Section 15(b)(8) as enacted provided that no broker or 
dealer registered under section 15 of this title shall, during any 
period when it is not a member of a securities association 
registered with the Commission under section 15A of this title, 
effect any transaction in, or induce the purchase or sale of, any 
security (otherwise than on a national securities exchange) unless 
such broker or dealer and all natural persons associated with such 
broker or dealer meet such specified and appropriate standards with 
respect to training, experience, and such other qualifications as 
the Commission finds necessary or desirable. See Public Law 88-467, 
78 Stat. 565, 572-73 (1964).
    \37\ In the Special Study, the Commission explained that the 
controls over entry into the securities business were inadequate, 
allowing entry by unqualified persons. Special Study, supra note 14, 
at 1, 23 (1963). Congress' amendments in 1964 responded to these 
findings.
    \38\ Under the SECO Program, every associated person engaged 
directly or indirectly in securities activities for or on behalf of 
a non-member broker-dealer, and every associated person who 
supervised others engaged in any securities activities, was required 
to successfully complete either the general securities examination 
prescribed by the Commission or an alternative examination deemed 
satisfactory by the Commission. See Qualifications and Fees Release, 
supra note 12, at 11676 (defining the term ``nonmember broker or 
dealer'' as ``any broker or dealer, including a sole proprietor, 
registered under section 15 of the Act, who is not a member of a 
national securities association registered with the Commission under 
section 15A of the Act.''). Any broker-dealer could choose to join 
an Association or be regulated by the Commission directly under the 
SECO Program.
---------------------------------------------------------------------------

    Rule 15b8-1 provided for an exemption from the SECO Program, and by 
extension from Association membership, for those broker-dealers that: 
(1) Were members of a national securities exchange; (2) did not carry 
customer accounts; and (3) had annual gross income derived from off-
exchange activity that amounted to no greater than $1,000.\39\ This set 
the basic framework for the Rule 15b9-1 exemption from Association 
membership that exists today. The Commission recognized that, at that 
time, exchange-based specialists and other floor brokers, which were 
comprehensively regulated by the exchange of which they were a member, 
occasionally introduced accounts to other members and shared in the 
commission revenues.\40\ Rule 15b8-1 permitted these broker-dealers, 
who were not required to register with the Commission as broker-dealers 
at the time,\41\ to receive a portion of the commissions paid on 
occasional off-exchange transactions on these introduced accounts 
without becoming subject to the SECO rules and broker-dealer 
registration, so long as the income derived from those activities was 
nominal.\42\
---------------------------------------------------------------------------

    \39\ ``Under Rule 15b8-1 (17 CFR 240.15b8-1), any broker-dealer 
who is a member of a national securities exchange is exempt from the 
rule if he does not carry customers' accounts and if his annual 
gross income derived from his over-the-counter business is no more 
than $1,000. Should a broker-dealer's over-the-counter income exceed 
these limits for an accounting year, such broker-dealer and all 
persons associated with him become subject to the requirements of 
the rule.'' Id. at 11675.
    \40\ See supra note 22.
    \41\ Until 1975, broker-dealers who traded exclusively on the 
floor of a national securities exchange were exempt from 
registration with the Commission. The 1975 Amendments required all 
broker-dealers, including exchange specialists and floor brokers, to 
register with the Commission, and extended the Commission's SECO 
rulemaking authority to any exchange member trading on an exchange 
other than an exchange of which it was a member. 1975 Amendments, 
supra note 6, at 121. The 1975 Amendments revised Section 15(b) such 
that the substance of then existing Section 15(b)(8) was captured in 
Sections 15(b)(7) through (9). See id. at 131. One purpose of the 
1975 Amendments was to assure that the Commission could regulate and 
recoup the costs of regulating transactions of exchange members 
conducted on exchanges of which they were not a member. See 1975 
Amendments, supra note 6, at 125 (amending Section 15 of the 
Exchange Act to provide the Commission with authority to ``prescribe 
reasonable fees and charges to defray its costs'' of regulation).
    \42\ See Adoption of Amendments to SECO Rules, supra note 13. 
See also supra note 22 (noting that the over-the-counter business of 
these broker-dealers may be limited and the income derived from 
these activities is nominal).
---------------------------------------------------------------------------

    In 1976, the Commission amended Rule 15b8-1 to provide that income 
derived from transactions for the dealer's own account effected with or 
through another registered broker-dealer would not count towards the 
$1,000 de minimis allowance.\43\ In adopting this amendment to Rule 
15b8-1, the Commission noted that an exchange-based floor broker could 
effect transactions through another broker-dealer for its own account 
on an exchange of which it was not a member, and indicated that such 
transactions ultimately would be effected by a member of that 
exchange.\44\ At the time this provision was adopted, the circumstances 
under which an exchange specialist or floor broker would trade 
proprietarily off the exchange were quite limited, such as when a 
regional exchange specialist would hedge risk on the primary listing 
market.\45\
---------------------------------------------------------------------------

    \43\ ``Any nonmember broker or dealer who is a member of a 
national securities exchange shall be exempt from this rule if (1) 
he carries no accounts of customers, and (2) his annual gross income 
derived from purchases and sales of securities otherwise than on a 
national securities exchange of which he is a member is an amount no 
greater than $1,000. Provided however, [t]hat gross income derived 
from transactions otherwise than on such national securities 
exchange which are effected for his own account with or through 
another registered broker or dealer shall not be subject to such 
limitation.'' See Adoption of Amendments to SECO Rules, supra note 
13, at 10601. Thus, broker-dealers registering with the Commission 
as a result of the 1975 Amendments became subject to the SECO rules 
in 1976, but could remain exempt from such rules pursuant to Rule 
15b8-1 and its exclusion for proprietary trading.
    \44\ The Commission provided the following example to describe 
the application of the exclusion for proprietary trading: ``a broker 
who is acting as a floor broker on a particular exchange, and who 
effects transactions for his own account otherwise than on that 
exchange through another broker-dealer who acts as a clearing member 
for the floor broker, would be permitted to effect transactions on 
exchanges of which neither he nor his clearing broker are members 
without becoming subject to the SECO rules.'' Id. In this example, 
``[t]he clearing broker would, of course, effect transactions on an 
exchange of which he was not a member through a member of that 
exchange.'' Id. at 10602, n. 8.
    \45\ See supra note 14.
---------------------------------------------------------------------------

    In 1983, Congress amended the Act to eliminate the direct oversight 
of broker-dealers by the Commission.\46\ Congress maintained the 
exception from membership in an Association in Section 15(b)(8) of the 
Act for those broker-dealers that effected transactions in securities 
only on an exchange of which they were a member. Congress also left 
unchanged the ability of the Commission to expand upon the statutory 
exception in Section 15(b)(8) through exemptive authority in Section 
15(b)(9) of the Act.\47\ When the SECO rules were abolished in 1983, 
the Commission amended and renumbered Rule 15b8-1.\48\ The substance of 
newly renumbered Rule 15b9-1 remained largely the same as Rule 15b8-1, 
with modifications that primarily accommodated transactions effected 
through the new Intermarket Trading System (``ITS'') linkage,\49\ and 
eliminated references to, and requirements under, the SECO Program.
---------------------------------------------------------------------------

    \46\ At that time, direct oversight of broker-dealers by the 
Commission was conducted through the SECO Program. 15 U.S.C. 
78o(b)(8), as amended by Pub. L. 98-38, 97 Stat. 205, 206 (1983). 
See also H.R. Rep. No. 98-106, at 597 (1983) (citing a preference 
for self-regulation over direct regulation by the Commission. Among 
other benefits of self-regulation, the report noted that NASD had 
available a broader and more effective range of disciplinary 
sanctions to employ against broker-dealers than had the Commission).
    Section 15(b)(8) is virtually the same as it was in 1983: ``It 
shall be unlawful for any registered broker or dealer to effect any 
transaction in, or induce or attempt to induce the purchase or sale 
of, any security (other than or commercial paper, bankers' 
acceptances, or commercial bills), unless such broker or dealer is a 
member of a securities association registered pursuant to section 
15A of this title or effects transactions in securities solely on a 
national securities exchange of which it is a member.'' 15 U.S.C. 
78o(b)(8). In 1986, Congress enacted non-substantive amendments 
modifying a few terms in the statute. Public Law 99-571, 100 Stat. 
3208, 3218 (1986). 15 U.S.C. 78o(b)(8).
    \47\ See supra note 7.
    \48\ See supra note 9.
    \49\ See infra notes 126-130 and accompanying text.
---------------------------------------------------------------------------

    Under the Rule as amended in 1983, a broker-dealer was not required 
to become a member of an Association if:

[[Page 18041]]

(1) It was a member of a national securities exchange, (2) carried no 
customer accounts, and (3) had annual gross income no greater than 
$1,000 that was derived from securities transactions effected otherwise 
than on a national securities exchange of which the broker-dealer was a 
member.\50\ As under the SECO rules, income derived from transactions 
effected for a broker-dealer's own account with or through another 
broker or dealer was not included in the $1,000 de minimis 
allowance.\51\
---------------------------------------------------------------------------

    \50\ Any broker or dealer required by Section 15(b)(8) of the 
Act to become a member of a registered national securities 
association shall be exempt from such requirement if it is a member 
of a national securities exchange, carries no customer accounts, and 
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. See 17 CFR 
240.15b9-1(a); see also SECO Programs Release, supra note 9, at 
53690.
    \51\ The gross income limitation contained in paragraph (a) of 
17 CFR 240.15b9-1, shall not apply to income derived from 
transactions for the dealer's own account with or through another 
registered broker or dealer, or through the Intermarket Trading 
System. See 17 CFR 240.15b9-1(b); SECO Programs Release, supra note 
9, at 53690.
---------------------------------------------------------------------------

    Since 1983, Rule 15b9-1 has remained unchanged, except for a 
technical amendment in 2005 to update cross-references when the 
Commission adopted Regulation NMS.\52\
---------------------------------------------------------------------------

    \52\ Regulation NMS, Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37618 (June 29, 2005).
---------------------------------------------------------------------------

B. Regulatory Oversight of Off-Exchange Trading Activity

    Section 19(g)(1) of the Act 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.\53\ Without this relief, the statutory 
obligation of each individual SRO would result in duplicative 
examinations and oversight of broker-dealers that are members of more 
than one SRO (``common members''). Section 17(d)(1) of the Act is 
intended, in part, to eliminate overlapping examinations and regulatory 
functions.\54\ With respect to a common member, Section 17(d)(1) 
authorizes the Commission, by rule or order, to relieve an SRO of the 
responsibility to receive regulatory reports, to examine for and 
enforce compliance with the applicable statutes, rules, and 
regulations, or to perform other specified regulatory functions.\55\
---------------------------------------------------------------------------

    \53\ 15 U.S.C. 78s(g).
    \54\ See 1975 Amendments, Report of the Senate Committee on 
Banking, Housing, and Urban Affairs to Accompany S. 249, S. Rep. No. 
94-75, 94th Cong., 1st Session 32 (1975).
    \55\ 15 U.S.C. 78q(d)(1).
---------------------------------------------------------------------------

    To implement Section 17(d)(1), the Commission adopted two rules: 
Rule 17d-1 and Rule 17d-2 under the Act.\56\ 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 the Commission or 
SRO rules.\57\ 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.\58\ 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.\59\ The regulatory responsibility allocated among SROs 
only extends to matters for which the SROs would share authority, which 
means that only common rules among SROs can be allocated under Rule 
17d-2. Under paragraph (c) of Rule 17d-2, the Commission may declare 
such a plan effective if, after appropriate notice and opportunity for 
comment, it finds that the plan is necessary or appropriate in the 
public interest and for the protection of investors, to foster 
cooperation and coordination among SROs, or to remove impediments to 
and foster the development of a national market system and a national 
clearance and settlement system and in conformity with the factors set 
forth in Section 17(d) of the Act.\60\ 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.\61\
---------------------------------------------------------------------------

    \56\ 17 CFR 240.17d-1; 17 CFR 240.17d-2.
    \57\ See Exchange Act Release No. 12352 (April 20, 1976), 41 FR 
18808 (May 7, 1976).
    \58\ See Exchange Act Release No. 12935 (October 28, 1976), 41 
FR 49091 (November 8, 1976).
    \59\ Any two or more self-regulatory organizations may file with 
the Commission a plan . . . for allocating among the self-regulatory 
organizations the responsibility to receive regulatory reports from 
persons who are members or participants of more than one of such 
self-regulatory organizations to examine such persons for 
compliance, or to enforce compliance by such persons, with specified 
provisions of the Securities Exchange Act of 1934, the rules and 
regulations thereunder, and the rules of such self-regulatory 
organizations, or to carry out other specified regulatory functions 
with respect to such persons. See 17 CFR 240.17d-2.
    \60\ Id.
    \61\ Id. Exchanges also enter into Regulatory Services 
Agreements (``RSAs'') whereby one SRO contractually agrees to 
perform regulatory services for another. See, e.g., FINRA News 
Release, FINRA Signs Regulatory Services Agreement with the Chicago 
Board Options Exchange, Incorporated (``CBOE'') and C2 Options 
Exchange, Incorporated (``C2'') (December 22, 2014), available at 
http://www.finra.org/newsroom/newsreleases/2014/p602174. However, 
RSAs do not relieve the contracting SRO from regulatory 
responsibility for the performance of any regulatory services 
allocated pursuant to the RSA and are not filed with the Commission 
for approval.
---------------------------------------------------------------------------

    The principle underlying the self-regulatory structure in the 
Exchange Act is the concept that the SRO best positioned to conduct 
regulatory oversight should assume responsibility for that 
oversight.\62\ As a general matter, the SROs and the Commission have 
used the flexibility provided by Section 17 to allocate 
responsibilities in such a manner.\63\ Section 15(b)(8) of the Exchange 
Act further implements this construct of effective regulatory oversight 
by requiring Association membership of a broker-dealer unless it 
effects transactions solely on an exchange of which it is a member. 
Those exempt from Association membership pursuant to Rule 15b9-1 
originally were exchange specialists and other floor members, and the 
off-exchange activity permitted under Rule 15b9-1 (including its 
predecessor rule) was intended only to accommodate limited activities 
ancillary to that floor-based business.
---------------------------------------------------------------------------

    \62\ Section 17(d)(1) of the Act provides that the Commission, 
in allocating authority among SROs pursuant to Section 17(d)(1), 
shall take into consideration the regulatory capabilities and 
procedures of the self-regulatory organizations, availability of 
staff, convenience of location, unnecessary regulatory duplication, 
and such other factors as the Commission may consider germane to the 
protection of investors, cooperation and coordination among self-
regulatory organizations, and the development of a national market 
system. See 15 U.S.C. 78q(d)(1).
    \63\ See supra note 6; infra note 69.
---------------------------------------------------------------------------

    As the sole currently registered Association, FINRA is the SRO 
primarily responsible for regulating trading in the off-exchange 
market.\64\ FINRA also conducts the vast majority of broker-dealer 
examinations,\65\ mandates broker-dealer disclosures, and writes and 
enforces rules governing broker-dealer conduct.\66\ FINRA regulates 
trading in non-listed equities, fixed income, and other traded 
products, and investigates and brings enforcement actions against 
members for violations of its rules, the rules of the Municipal 
Securities Rulemaking Board, and the Exchange Act and the rules 
thereunder.\67\ As noted above, the regulatory focus of national 
securities exchanges, which are also SROs, has been more narrow, with 
primary

[[Page 18042]]

responsibility to regulate trading by their members on their respective 
exchanges,\68\ enforce conduct rules (if they have not been relieved of 
that responsibility by 17d-2 Agreements), and otherwise perform member 
regulation for their members that are not also members of FINRA. Most 
exchanges have entered into 17d-2 Agreements with FINRA that allocate 
regulatory responsibility over common members to FINRA for compliance 
with common conduct rules.\69\
---------------------------------------------------------------------------

    \64\ See supra note 31.
    \65\ The Commission staff also conducts risk-based examinations 
of broker-dealers. However, routine broker-dealer examinations are 
conducted by the SROs, and the Commission staff oversees the 
examination efforts of the SROs.
    \66\ 15 U.S.C. 78o-3.
    \67\ Id.
    \68\ Congress saw the codification of the regulations requiring 
the registration of off-exchange broker-dealers as ``an essential 
supplement to regulation of the exchanges.'' H.R. Rep. No. 74-2601, 
at 4 (1936). See also supra note 28 and accompanying text.
    \69\ See, e.g., Exchange Act Release No. 63430 (December 3, 
2010), 75 FR 76758 (December 9, 2010) (order approving Rule 17d-2 
plan to allocate regulatory responsibility to FINRA for certain 
Regulation NMS rules by 13 exchanges). Generally, FINRA is also the 
DEA for financial responsibility rules for exchange members that 
also are members of FINRA. See infra note 164 (discussing DEAs).
---------------------------------------------------------------------------

    FINRA has developed a transparency and regulatory regime for the 
off-exchange market. All off-exchange trades are reported to FINRA,\70\ 
and as a result FINRA has developed a set of trade reporting rules to 
support that transparency regime.\71\ FINRA also has developed a 
regulatory audit trail, which provides regulatory data on orders, 
quotes, routes, cancellations, and executions.\72\ FINRA has developed 
rules and guidance tailored to trading activity \73\ and has developed 
surveillance technology and specialized regulatory personnel to provide 
surveillance, supervision, and enforcement of activity occurring off-
exchange.\74\ Furthermore, FINRA has a detailed set of member conduct 
rules that apply to all activities of a firm, whether on- or off-
exchange.\75\
---------------------------------------------------------------------------

    \70\ FINRA operates two Trade Reporting Facilities (``TRFs''), 
one jointly with NASDAQ and another with the NYSE. The TRFs are 
FINRA facilities for FINRA members to report transactions effected 
otherwise than on an exchange. See Exchange Act Release No. 54084 
(June 30, 2006), 71 FR 38935 (July 10, 2006) (order approving the 
NASDAQ TRF); Exchange Act Release No. 55325 (February 21, 2007), 72 
FR 8820 (February 27, 2007) (notice of filing and immediate 
effectiveness of a proposed rule change to establish the NYSE TRF). 
In addition, FINRA operates the Alternative Display Facility 
(``ADF''), which is a FINRA facility for posting quotes and 
reporting trades governed by FINRA's trade reporting rules. See 
Exchange Act Release No. 46249 (July 24, 2002), 67 FR 49822 (July 
31, 2002) (order approving the ADF); see also Exchange Act Release 
No. 71467 (February 3, 2014), 79 FR 7485 (February 7, 2014) (order 
approving a proposed rule change to update the rules governing the 
ADF).
    \71\ See FINRA Rule 7000 Series--Clearing, Transactions and 
Order Data Requirements, and Facility Charges.
    \72\ FINRA operates the OATS system, which is an integrated 
audit trail of order, quote, and trade information for all NMS 
stocks and OTC equity securities required to be submitted by FINRA 
members. See e.g., Exchange Act Release No. 54585 (October 10, 
2006), 71 FR 61112 (October 17, 2006) (order approving a proposed 
rule change relating to the expansion of OATS reporting requirements 
to OTC equity securities). FINRA uses the OATS audit trail system to 
recreate events in the life cycle of orders and more completely 
monitor the trading practices of FINRA member firms. See FINRA.org, 
Order Audit Trail System (OATS), available at http://www.finra.org/industry/oats (last visited March 19, 2015).
    \73\ See e.g., FINRA Rules 5240 (Anti-Intimidation/
Coordination), 5250 (Payments for Market-Making), 5210.02 
(Publication of Transactions and Quotations--Self-Trades), and 6140 
(Other Trading Practices).
    \74\ See FINRA.org, FINRA 2013 Year in Review and Annual 
Financial Report, available at http://www.finra.org/sites/default/files/Corporate/p534386.pdf (last visited March 19, 2015).
    \75\ See Part V.B.4 discussing the competitive effects of off-
exchange market regulation.
---------------------------------------------------------------------------

    As noted, Rule 15b9-1 in its current form allows a broker-dealer to 
engage in unlimited proprietary trading in the off-exchange market 
without becoming a member of an Association, so long as its proprietary 
trading activity is conducted with or through another registered 
broker-dealer (i.e., not with a customer). In practice, this allows 
many cross-market proprietary trading firms to avoid Association 
membership, despite their effecting a significant volume of 
transactions in the off-exchange market. Non-Member Firms are not 
subject to oversight by an Association and their off-exchange 
transactions typically are not overseen by the exchanges of which they 
may be members. Exchanges traditionally have not assumed the role of 
regulating the totality of the trading of their member-broker-dealers, 
and exchanges are currently not well-positioned to assume that role, in 
light of the statutory scheme and, among other things, their limited 
access to data \76\ and the proper rule set to regulate off-exchange 
trading. Exchanges generally do not have a detailed set of member 
conduct rules and non-exchange-specific trading rules, thus allowing 
such broker-dealers and their personnel to conduct business under a 
less specific regulatory regime than FINRA members. In this context and 
consistent with the statutory framework that places responsibility for 
off-exchange trading with an Association, therefore, the Commission 
preliminarily believes that an Association is better suited to regulate 
off-exchange trading.
---------------------------------------------------------------------------

    \76\ See Exchange Act Release No. 67457 (July 18, 2012), 77 FR 
45722, 45728-30 (August 1, 2012) (discussing the use and limitations 
of current SRO audit trails and noting that ``[m]ost SROs maintain 
their own specific audit trails applicable to their members'' and 
``each SRO only has direct access to its own audit trails . . .'').
---------------------------------------------------------------------------

    The Commission estimates that, today, there are approximately 125 
broker-dealers exempt from Association membership.\77\ This group 
includes some of the most active cross-market proprietary trading 
firms, which generate a substantial volume of orders and transactions 
in the off-exchange market. For example, the Commission estimates that 
orders from Non-Member Firms represented a volume-weighted average of 
approximately 32% of all orders sent directly to ATSs during 2012.\78\ 
By 2014, these Non-Member Firms represented a volume-weighted average 
of approximately 48% of orders sent directly to ATSs.\79\
---------------------------------------------------------------------------

    \77\ The Commission believes that the majority of these firms 
rely on the Rule 15b9-1 exemption rather than the statutory 
exception from Association membership under Section 15(b)(8) of the 
Act, 15 U.S.C. 78o(b)(8), because the Rule-based exemption is more 
permissive than the statute, allowing, for example, unlimited 
proprietary trading on an exchange of which a broker-dealer is not a 
member. The estimate of 125 firms is based on publicly available 
data reviewed by staff during March of 2015. See infra note 148.
    \78\ This estimate is based on data from OATS. See supra note 
21.
    \79\ This information is based on data from OATS. In 2013, these 
Non-Member Firms represented a volume-weighted average of 
approximately 40% of orders sent directly to ATSs. Id.
---------------------------------------------------------------------------

    Accordingly, the Commission believes that many of the broker-
dealers today that rely on the Rule 15b9-1 exemption are very different 
from those for which the Rule originally was intended--exchange-based 
specialists and other floor members that focused their business on a 
single exchange of which they were a member. The presumption built into 
Section 15(b)(8) and further extended by Rule 15b9-1, namely that the 
exchange of which the firm is a member is in the optimal position to 
provide self-regulatory oversight, does not appear to hold for those 
firms that avail themselves of the exemption but are engaged in a 
significant amount of off-exchange trading.\80\ For broker-dealers that 
conduct business only on one exchange, the exchange SRO is well-
positioned to oversee the activities of those broker-dealers and write 
and enforce rules tailored to their business model and conduct. For a 
broker-dealer that trades electronically across a range of exchange and 
off-exchange venues, however, the individual exchange or exchanges of 
which the broker-dealer may be a member are not able to as effectively 
regulate the off-exchange activity of the broker-dealer because such 
exchange(s) today has neither the

[[Page 18043]]

resources nor the necessary expertise to oversee such off-exchange 
activity.\81\ The Commission is concerned that the reliance on the Rule 
15b9-1 exemption by cross-market proprietary trading firms, given that 
exchanges focus their regulatory oversight on their respective 
exchanges, undermines the effectiveness of the regulatory structure of 
the off-exchange market and the equities markets more broadly.
---------------------------------------------------------------------------

    \80\ For example, based on disclosures on Form BD as of March 
2015, there were 13 Non-Member Firms that are members of only CBOE, 
an options exchange, that do not disclose as part of their business 
activities on Form BD being a ``put and call broker or dealer or 
option writer.'' Similarly, five Non-Member Firms disclose on Form 
BD that they are a ``broker or dealer making inter-dealer markets in 
corporate securities over-the-counter'' and are not members of 
FINRA.
    \81\ The Commission notes that, while today an exchange may not 
be able to effectively regulate off-exchange activity, it may be 
able to acquire the resources and expertise to do so.
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    As noted, FINRA currently is the SRO to which off-exchange trades 
are reported.\82\ However, because it does not have jurisdiction over 
Non-Member Firms, it is unable to enforce compliance with the federal 
securities laws and rules, or apply its own rules, to broker-dealers 
that conduct a significant amount of off-exchange trading activity, 
including those that engage in so-called high-frequency trading 
strategies. As a result, FINRA's ability to perform comprehensive 
market surveillance, especially for violations of Commission rules, as 
well as its ability to understand and reconstruct activity in the off-
exchange market generally, is limited because Non-Member Firms are not 
consistently identified in trade reports to the TRFs \83\ or the ADF, 
and their order activity is not captured by OATS.\84\ Accordingly, 
FINRA is unable to monitor the off-exchange market activity of Non-
Member Firms, and detect potentially manipulative or other illegal 
behavior, as efficiently or effectively as it can with FINRA 
members.\85\ Obtaining additional data, such as through the 
Consolidated Audit Trail (``CAT''),\86\ or the assumption of post-trade 
surveillance and investigation by the Non-Member Firm's member 
exchange, would neither confer jurisdiction nor provide needed 
oversight tools to FINRA over Non-Member Firms that participate in the 
off-exchange market. No exchange currently is positioned to regulate 
its members' conduct in the off-exchange market, as the exchanges 
generally have access only to order and trade data for transactions 
effected on their markets.\87\ Moreover, even if exchanges were able to 
access the necessary trading data (a possibility that would increase 
with the deployment of CAT),\88\ the Commission believes that piecemeal 
regulation of the off-exchange market by multiple SROs based on the 
membership status of the participants and a web of regulatory 
allocations among SROs, through the use of multiple 17d-2 agreements, 
is significantly less efficient and frustrates the structure 
established by Congress that an Association regulate the off-exchange 
market.\89\ In addition, an Association's regulatory responsibility for 
the off-exchange market includes an obligation to monitor those markets 
for operational and regulatory issues, as well as issues relating to 
market disruptions.\90\ The Commission is concerned that the inability 
of an Association to reliably identify and enforce regulatory 
compliance by cross-market proprietary trading firms that are Non-
Member Firms in the off-exchange market, creates a risk to the fair and 
orderly operations of the market.
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    \82\ See supra note 70.
    \83\ Reports to the TRFs can only be made by FINRA members. See 
FINRA Rules 7210A(k) and 7210B(i) (defining the term ``Trade 
Reporting Participant'' or ``Participant'' as ``any member of FINRA 
in good standing that uses the System'').
    \84\ When a Non-Member Firm routes an order to a FINRA member 
which then routes the order to an exchange or off-exchange for 
execution, OATS data would indicate only that the FINRA member 
received an order from a Non-Member Firm. The identity of the Non-
Member Firm is often not captured because such Non-Member Firms are 
not required to use a unique Market Participant Identifier 
(``MPID'') or other identifier when routing orders to a FINRA 
member. In some cases, FINRA is able to identify the Non-Member Firm 
that participated in a transaction if, for example, it has an MPID 
and provides it to the firm to which it routed an order and that 
firm reports it to FINRA. FINRA has solicited comment from its 
members on a proposed FINRA rule change that would require FINRA 
members to identify Non-Member Firms in off-exchange transactions 
reported to OATS. See FINRA Regulatory Notice 14-51, Equity Trading 
Initiatives: OATS and ATS Reporting Requirements (November 2014), 
available at https://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p601681.pdf. This proposal has not yet 
been filed with the Commission pursuant to Section 19(b)(1) of the 
Act. 15 U.S.C. 78s(b)(1).
    \85\ Non-Member Firms that engage in off-exchange transactions 
are not required to submit audit trail data to FINRA. See FINRA 
Rules 6610 and 6622(a)(i). The Commission believes that this lack of 
audit trail reporting is problematic because an Association has 
statutory responsibility for regulatory oversight of the off-
exchange market. Although the Commission understands some off-
exchange trades between Non-Member Firms are voluntarily reported by 
clearing firms, clearing firms are not obligated to report such 
transactions. Lack of comprehensive reporting of off-exchange 
transactions to FINRA, among other things, undermines FINRA's 
ability to effectively surveil the off-exchange market. By 
extension, this also undermines the ability of the Commission and 
investors to fully benefit from the self-regulatory model envisioned 
by Congress in the Exchange Act.
    \86\ Rule 613 under the Act requires SROs to jointly submit to 
the Commission a national market system plan (``NMS Plan'') to 
create, implement, and maintain a consolidated order tracking 
system, or consolidated audit trail, with respect to NMS securities, 
that would capture customer and order event information for NMS 
securities, across all markets, from the time of order inception 
through routing, cancellation, modification, or execution. See 
Exchange Act Release No. 67457 (July 19, 2012), 77 FR 45721 (August 
1, 2012) (``CAT Release''); 17 CFR 242.613.
    \87\ While some exchanges have rules requiring the reporting of 
certain off-exchange transactions by their members, these rules, as 
they currently exist, would not provide the exchanges with the 
complete view of the market that the Commission believes is 
necessary to effectively regulate the off-exchange market. For 
example, NYSE MKT LLC (``NYSE MKT'') Rule 410B--Equities (Reports of 
Listed Securities Transactions Effected Off the Exchange) only 
requires reporting of off-exchange transactions in securities listed 
on NYSE MKT that are not reported to the Consolidated Tape. See 
Exchange Act Release No. 58705 (October 1, 2008), 73 FR 58995 
(October 8, 2008) (order approving, among other things, NYSE MKT 
Rule 410B); see also, e.g., CBOE Rule 6.49 (Transactions Off the 
Exchange) (requiring that CBOE members executing transactions in 
options listed on the exchange other than on CBOE merely keep a 
record of such transaction for a period of one year).
    \88\ The Commission notes that the CAT NMS plan would not be 
implemented for several years. In accordance with Rule 613, the SROs 
would be required to report the required data to the central 
repository within one year after effectiveness of the NMS plan; 
broker-dealers, other than small broker-dealers, would be required 
to report the required data to the central repository within two 
years after effectiveness of the NMS plan; and small broker-dealers 
would be required to report the required data within three years 
after effectiveness of the NMS plan. 17 CFR 242.613.
    \89\ See supra notes 28-33 and accompanying text.
    \90\ 15 U.S.C. 78o-3.
---------------------------------------------------------------------------

    Further, because FINRA is unable to apply the rules it has 
developed for the off-exchange market to Non-Member Firms, its ability 
to create a consistent regulatory framework for the off-exchange market 
is undermined. FINRA has sought to establish a robust regulatory regime 
for broker-dealers, including broker-dealers conducting business in the 
off-exchange market, and has developed a detailed set of rules in core 
areas such as trading practices,\91\ business conduct,\92\ financial 
condition

[[Page 18044]]

and operations,\93\ and supervision.\94\ Because Non-Member Firms are 
not subject to these or other FINRA rules, they may be subject to a 
less robust regulatory framework than FINRA members that themselves 
trade off-exchange. Non-Member Firms also are not subject to the costs 
associated with FINRA membership.\95\
---------------------------------------------------------------------------

    \91\ See FINRA Rule 5000 Series--Securities Offerings and 
Trading Standards and Practices. For instance, FINRA has rules 
prohibiting members from coordinating prices and intimidating other 
members. See FINRA Rule 5240(a), providing, among other things, that 
``[n]o member or person associated with a member shall: (1) 
Coordinate the prices (including quotations), trades or trade 
reports of such member with any other member or person associated 
with a member, or any other person; (2) direct or request another 
member to alter a price (including a quotation); or (3) engage, 
directly or indirectly, in any conduct that threatens, harasses, 
coerces, intimidates or otherwise attempts improperly to influence 
another member, a person associated with a member, or any other 
person.'' The Commission notes that CBOE has stated that it views 
any collusion, intimidation and harassment by a CBOE member as 
``inconsistent with the just and equitable principles of trade.'' 
See CBOE Regulatory Circular RG97-167 (February 7, 2000) and CBOE 
Rule 4.1. See also supra note 73 and accompanying text.
    \92\ See FINRA Rule 2000 Series--Duties and Conflicts.
    \93\ See FINRA Rule 4000 Series--Financial and Operational 
Rules. See e.g., FINRA Rule 4370(a) providing, among other things, 
that ``[e]ach member must create and maintain a written business 
continuity plan identifying procedures relating to an emergency or 
significant business disruption. Such procedures must be reasonably 
designed to enable the member to meet its existing obligations to 
customers. In addition, such procedures must address the member's 
existing relationships with other broker-dealers and counter-
parties.'' Although NYSE MKT LLC Equities Rule 4370 is similar to 
FINRA Rule 4370(a), for example, a number of other exchanges do not 
have such a rule.
    \94\ See FINRA Rule 3000 Series--Supervision and 
Responsibilities Relating to Associated Persons. This rule series 
generally requires FINRA member firms to, among other things, 
establish, maintain, and enforce written procedures to supervise the 
types of business in which the firm engages and the activities of 
its associated persons that are reasonably designed to achieve 
compliance with applicable securities laws and regulations, and with 
applicable FINRA rules. See e.g., FINRA Rules 3110 (Supervision), 
3120 (Supervisory Control System), and 3170 (Tape Recording of 
Registered Persons by Certain Firms). See also FINRA By-Laws Article 
III--Qualifications of Members and Associated Persons. Any person 
associated with a member firm who is engaged in the securities 
business of the firm--including partners, officers, directors, 
branch managers, department supervisors, and salespersons--must 
register with FINRA. Other SROs do not have similar standards for 
associated persons of member broker-dealers.
    \95\ The Commission notes that FINRA may need to consider 
reassessing the structure of its fees, including its Trading 
Activity Fee, in order to assure that it is fairly and equitably 
applied to many of the Non-Member Firms that, as a result of the 
amendments to Rule 15b9-1, may join FINRA. 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 to the By-Laws of the Corporation, Section 
1(a), available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=4694 (``FINRA Schedule A''). 
The TAF is generally assessed on FINRA member firms for all equity 
sales transactions that are not performed in a broker-dealer's 
capacity as a registered exchange specialist or market maker. See 
id. at Section 1(b). As discussed above, many of the broker-dealers 
that may be required to join FINRA if the proposed amendments are 
adopted effect transactions in large volumes throughout the national 
market system, and often in a capacity other than as a registered 
market-maker. Accordingly, the Commission notes that FINRA may need 
to consider reevaluating the structure of the TAF to assure that it 
appropriately takes into account this business model. See also infra 
notes 174-175 and accompanying text for further discussion of the 
TAF.
---------------------------------------------------------------------------

    As is discussed in more detail in the Economic Analysis, firms that 
become FINRA members would become subject to the fees charged by FINRA 
to all of its member firms. FINRA charges each member firm certain 
regulatory fees designed to recover the costs to FINRA of the 
supervision and regulation of members, including performing 
examinations, financial monitoring, and policy, rulemaking, 
interpretive, and enforcement activities.\96\ FINRA's regulatory fees 
include a Trading Activity Fee (``TAF'').\97\
---------------------------------------------------------------------------

    \96\ FINRA Schedule A, supra note 95, at Section 1.
    \97\ FINRA assesses each member a TAF on the sale of all covered 
securities. For the purposes of determining the TAF, covered 
securities include, among other things, all exchange-registered 
securities wherever executed and all other equity securities traded 
otherwise than on an exchange. FINRA last adjusted the TAF rate for 
sales of covered equity securities effective July 2012. FINRA's 
regulatory fees also include a Gross Income Assessment (``GIA'') and 
a Personnel Assessment.
    In addition, Section 3 of Schedule A to the FINRA By-Laws states 
that each member will be assessed a regulatory transaction fee that 
is determined periodically in accordance with Section 31 of the 
Exchange Act. Section 31(c) generally requires each national 
securities association to pay the Commission a fee based on the 
aggregate dollar amount of sales of certain securities transacted by 
or through any member of such association otherwise than on a 
national securities exchange. 15 U.S.C. 78ee(c). The Commission 
preliminarily believes that FINRA's Section 3 fees will not change 
as a result of the proposed amendments to Rule 15b9-1. The fees 
collected by FINRA under Section 3 are intended to correspond to its 
obligations to the SEC under Section 31(c) of the Act. However, if 
the proposal is adopted, as Non-Member Firms become FINRA members, 
FINRA could seek to reallocate Section 3 fees among FINRA members. 
Nonetheless, because the Commission generally believes that Section 
3 fees are passed through by FINRA members to the parties to covered 
transactions, we do not expect the burden of Section 3 fees to 
materially change.
---------------------------------------------------------------------------

    The number of trades subject to the TAF in the off-exchange 
market--and thus the aggregate fees collected by FINRA for that market 
segment--would not be expected to materially change if the proposed 
amendments are adopted because, in general, the TAF currently is 
assessed on the ATSs where Non-Member Firms effect off-exchange 
transactions, rather than on the Non-Member Firms. However, it is 
likely that certain on-exchange trades by Non-Member Firms that 
currently are not covered by the TAF would be captured.\98\ As such, 
the Commission preliminarily believes that FINRA may need to consider 
reevaluating its fee structure to ensure that it appropriately reflects 
the activities of, and regulatory responsibilities towards, these FINRA 
members, if the proposal is adopted.
---------------------------------------------------------------------------

    \98\ As is discussed in more detail in the Economic Analysis, 
the Commission preliminarily estimates that some firms could be 
subject to a TAF of up to $3.2 million based on their current sales 
of covered securities. See Section V.C.2.
---------------------------------------------------------------------------

    In addition, under the proposal a broker-dealer that effects 
transactions on multiple exchanges, and not on ATSs or elsewhere in the 
off-exchange market, would need to become a member of an Association if 
it effects transactions indirectly on exchanges of which it is not a 
member (i.e., through another broker-dealer that is a member of that 
exchange) in accordance with Section 15(b)(8), unless one of the 
specified exceptions in the proposed amendment is available.\99\ The 
Commission believes that this is consistent with the statutory 
framework and would address an activity potentially not subject to 
effective regulatory oversight in today's market. Specifically, if such 
a broker-dealer were a member of one exchange but conducted a 
significant amount of activity indirectly on other exchanges of which 
it was not a member, the exchange of which it was a member would not be 
well-positioned to regulate the member's activity on those other 
exchanges. As with the off-exchange market, individual exchanges today 
lack access to data,\100\ the proper rule set and the necessary 
expertise to regulate trading on other exchanges. Under these 
circumstances--where the broker-dealer would not be conducting ``off-
exchange'' activity but would be effecting transactions on an exchange 
of which it is not a member, the Commission believes that an 
Association is best-positioned to oversee this activity.\101\ As 
discussed elsewhere in this release, FINRA currently

[[Page 18045]]

conducts cross-market surveillance and is provided exchange audit trail 
data pursuant to existing RSAs and 17d-2 agreements.\102\ In contrast, 
exchanges generally do not conduct cross-market surveillance and most 
have allocated this responsibility to FINRA. Accordingly, the 
Commission believes that, as a practical matter and consistent with 
Section 15(b)(8), FINRA is currently in the best position to regulate 
cross-market activity \103\ by broker-dealers that effect transactions 
on exchanges other than those of which the broker-dealer is a member, 
even if they do not effect transactions in the off-exchange 
market.\104\
---------------------------------------------------------------------------

    \99\ The Commission is not currently aware of any broker-dealer 
with such a business model.
    \100\ See supra note 76.
    \101\ The Commission also believes that this would be consistent 
with the statutory framework, which subjected broker-dealers that 
effect transactions on an exchange of which they are not a member 
first to Commission, and then to Association, oversight. In amending 
Rule 15b8-1 in 1976 to add the exclusion for proprietary trading, 
the Commission also revised the text of Rule 15b8-1 by substituting 
the phrase ``otherwise than on a national securities exchange of 
which he is a member'' to replace the phrase ``otherwise than on a 
national securities exchange.'' See Adoption of Amendments to SECO 
Rules, supra note 13, at 10600. The Commission made this revision 
``to conform the scope of the SECO rules to the Commission's 
authority'' under Section 15(b)(8) and 15(b)(9) (as revised in 1975) 
to subject ``broker-dealers who effect transactions on exchanges 
other than those of which they are members to the SECO rules.'' Id. 
This change reflected the Commission's understanding that broker-
dealers effecting transactions on exchanges of which they were not a 
member should be subject to the then-existing regulatory framework 
(i.e., either Association membership or direct Commission regulation 
under the SECO program) governing off-exchange trading. As noted 
above, Congress amended the Act in 1983 ``to eliminate direct 
regulation of broker-dealers by the Commission through the SECO 
Program and to require any broker-dealer engaged in an over-the-
counter (`OTC') securities business to join a registered securities 
association.'' See SECO Programs Release, supra note 9, at 53688. 
Consistent with the Commission's rationale in 1976, the Commission 
believes that broker-dealers that effect transactions on exchanges 
of which they are not a member should be subject to the current 
regulatory framework governing off-exchange trading, namely, 
membership in an Association.
    \102\ See, e.g., News Release, FINRA, BATS Global Markets, FINRA 
Enter Regulatory Service Agreement (February, 6, 2014), available at 
https://www.finra.org/Newsroom/NewsReleases/2014/P443474. Such 
agreements provide detailed data that allow FINRA to comprehensively 
identify the market-wide activity of broker-dealers, and to surveil 
behavior for violative activity that might otherwise go undetected 
if surveillance were only being conducted on an exchange-specific 
basis.
    \103\ In advance of the 1975 Amendments, Congress contemplated 
reforms to the regulatory structure of the securities markets in 
which an Association's role would be expanded, while exchanges would 
focus their regulatory activities on their respective markets: ``. . 
. the time has come to begin planning a framework which will guide 
the development of the self-regulatory system in the future. In the 
revised system, a single nationwide entity [an Association] would be 
responsible for regulation of the retail end of the securities 
business, including such matters as financial responsibility and 
selling practices, while each exchange would concentrate on 
regulating the use of its own trading facilities . . . the 
regulatory activities of the NASD (the only organization presently 
registered as a national securities association) would encompass 
many of the present regulatory activities of the NYSE and other 
exchanges over retail activities of their members. This `expanded' 
NASD would have direct responsibility, subject to SEC oversight, for 
enforcing SEC rules and its own rules . . .'' S. Doc. No. 93-13 at 
16, 169 (1973).
    \104\ A broker-dealer would not need to become a member of an 
Association if it conducts no activity in the off-exchange market 
and it becomes a member of each exchange upon which it effects 
transactions. Although the Commission is not aware of such broker-
dealer business model existing today, if one were to arise, the 
Commission notes that the exchanges upon which such broker-dealer 
directly effects transactions could enter into an RSA to ensure 
effective cross-market supervision of this activity. The Commission 
acknowledges that in the future another SRO could assume these 
responsibilities pursuant to 17d-2 Agreements, subject to Commission 
approval, and RSAs.
---------------------------------------------------------------------------

    In sum, the Commission is concerned that some of the most active 
cross-market proprietary trading firms may not be subject to effective 
regulatory oversight by an exchange or Association with respect to the 
full range of their market activity. Accordingly, the Commission is 
proposing to amend Rule 15b9-1, as described below, to appropriately 
tailor the exemption from Association membership for today's markets.

II. Discussion of Amendments to Rule 15b9-1

A. Prior Comments on Association Membership

    In 2010, the Commission issued a Concept Release that, among other 
things, solicited comment on whether all proprietary trading firms 
should be required to register as broker-dealers and become members of 
FINRA to help assure that their operations were subject to full 
regulatory oversight.\105\ The Commission received six comment letters 
that directly addressed the question as it relates to FINRA membership, 
including one comment letter from FINRA.\106\ The six comment letters 
offered contrasting views. Three commenters expressed their support for 
enhanced oversight of proprietary trading firms, including a 
requirement to become members of FINRA, generally asserting that 
because proprietary trading firms are not all members of FINRA there is 
a lack of uniform regulation among registered broker-dealers.\107\ 
Three commenters expressed opposition to the idea of requiring 
proprietary trading firms to become FINRA members, asserting their 
belief that such firms are already subject to full regulatory 
oversight,\108\ requiring such firms to join FINRA would be costly and 
burdensome,\109\ and that, because proprietary trading firms do not 
have customers, there would be no benefit to requiring such firms to 
become members of FINRA.\110\ The Commission has considered these 
comments, and, for the reasons set forth throughout this release, is 
proposing to amend Rule 15b9-1 as described herein.
---------------------------------------------------------------------------

    \105\ See Concept Release, supra note 16, at 3612.
    \106\ See letters to Elizabeth M. Murphy, Secretary, Commission, 
from Kimberly Unger, Executive Director, Security Traders 
Association of New York, Inc., dated April 30, 2010 (``STANY 
Letter''); from Liam Connell, Chief Executive Officer, Allston 
Trading, LLC, and Richard B. Gorelick, Chief Executive Officer, RGM 
Advisors, LLC, and Adam Nunes, President, HRT Financial LLC, Hudson 
River Trading, LLC, and Cameron Smith, General Counsel, Quantlab 
Financial, LLC, dated April 23, 2010 (``Allston Letter''); from 
Donald R. Wilson, Jr., DRW Trading Group, dated April 21, 2010 
(``DRW Letter''); from Marcia E. Asquith, Senior Vice President and 
Corporate Secretary, Financial Industry Regulatory Authority, dated 
April 23, 2010 (``FINRA Letter''); letter to the Commission from 
Berkowitz, Trager & Trager, LLC, dated April 21, 2010 (``Berkowitz 
Letter''); and from Stephen M. Barnes, J.D., Salt Lake City, Utah, 
received October 3, 2011 (``Barnes Letter'').
    \107\ See FINRA Letter, supra note 106, at 4-5; Barnes Letter, 
supra note 106, at 32-33 (suggesting that, to level the regulatory 
playing field, high-frequency trading firms should be required to 
register as broker-dealers with the Commission and become members of 
an SRO such as FINRA or an exchange); and STANY Letter, supra note 
106, at 14 (suggesting that the Commission review and consider 
registration requirements of market participants that are not 
required to be registered with FINRA and noting that enhanced 
surveillance and enforcement should improve investor confidence in 
the markets). See also letter to the Honorable Mary Schapiro, 
Chairman, Commission, from Kimberly Unger, Executive Director, 
Security Traders Association of New York, Inc., dated May 10, 2010, 
at 14 (urging the Commission to work towards a more harmonized 
regulatory structure, which the commenter believes will put FINRA in 
a better position to address regulatory gaps through a holistic, 
cross-market approach to regulation that can detect problematic 
activity across multiple markets and products).
    \108\ See Allston Letter, supra note 106, at 14-15 (stating that 
it is inaccurate to say that proprietary trading Non-Member Firms 
are not subject to full regulatory oversight and noting that such 
firms are generally members of several exchanges and are 
consequently subject to multiple regulators).
    \109\ See Berkowitz Letter, supra note 106, at 1 (stating that 
requiring proprietary trading firms to register as broker-dealers 
and become members of FINRA would add significant costs and burdens 
to those firms).
    \110\ See DRW Letter, supra note 106, at 4 (stating that FINRA's 
focus is on investor protection and not proprietary trading, and, 
therefore, there would be no benefit to requiring proprietary 
trading firms that do not undertake a customer business to become 
members of FINRA).
---------------------------------------------------------------------------

B. Overview of Amendments

    As noted above, Section 15(b)(8) \111\ of the Act \112\ generally 
prohibits any registered broker or dealer from effecting transactions 
in securities unless it (1) is a member of an Association or (2) 
effects transactions in securities solely on an exchange of which it is 
a member. Section 15(b)(9) \113\ of the Act provides the Commission 
authority to exempt any broker or dealer from the requirements of 
Section 15(b)(8). The Commission has, by rule, exercised its exemptive 
authority. Specifically, Rule 15b9-1 \114\ generally exempts any broker 
or dealer from membership in an Association if it: (1) is a member of a 
national securities exchange; (2) carries no customer accounts; and (3) 
has annual gross income of no more than $1,000 that is derived from 
purchases or sales of securities effected otherwise than on an exchange 
of which it is a member. However, income derived from transactions for 
the dealer's own account with or through another registered broker or 
dealer,\115\ or through the ITS, is excluded from such de minimis 
allowance.
---------------------------------------------------------------------------

    \111\ See supra note 46.
    \112\ 15 U.S.C. 78a et seq.
    \113\ See supra note 7.
    \114\ See supra notes 50-51.
    \115\ See supra note 51.
---------------------------------------------------------------------------

    The Commission is proposing to eliminate the existing de minimis 
allowance (including the exclusion for proprietary trading) and replace 
it with a more targeted exemption from Association membership for a 
broker-dealer that conducts business on a

[[Page 18046]]

national securities exchange, to the extent it effects transactions 
off-exchange for the dealer's own account with or through another 
registered broker-dealer, that are solely for the purpose of hedging 
the risks of its floor-based activities, by reducing or otherwise 
mitigating the risks thereof. The proposed amendments also include an 
exemption for a broker-dealer to the extent it executes orders that are 
routed by a national securities exchange of which it is a member, to 
prevent trade-throughs on such national securities exchange consistent 
with the provisions of Rule 611 of Regulation NMS.

C. Elimination of the De Minimis Allowance

    The Commission proposes to eliminate the de minimis allowance in 
its entirety. Specifically, the Commission is proposing to delete the 
following language from Rule 15b9-1(a): ``and (3) has annual gross 
income derived from purchases and sales of securities otherwise on a 
national securities exchange of which it is a member in an amount no 
greater than $1000.'' The Commission also is proposing to delete 
paragraphs (b) and (c) of the Rule, as they set forth two exceptions to 
the de minimis allowance.\116\ Paragraph (b) provides that income 
derived from (1) transactions for the dealer's own account with or 
through another registered broker-dealer, and (2) transactions through 
the ITS, do not count toward the $1,000 de minimis allowance, and 
paragraph (c) defines the ITS.
---------------------------------------------------------------------------

    \116\ See supra notes 50-51.
---------------------------------------------------------------------------

    As discussed above, the $1,000 de minimis allowance originally was 
intended to permit exchange specialists and other floor members to 
receive a nominal amount of commissions on occasional off-exchange 
transactions for accounts referred to other members, without subjecting 
them to SECO rules and broker-dealer registration and, later, 
Association membership.\117\ Since the de minimis allowance was first 
adopted in 1965, the securities markets have undergone a significant 
transformation. At that time, virtually all trading activity was 
conducted manually on the floors of national securities exchanges.\118\ 
Today, however, electronic cross-market order routing and trading 
strategies are a significant component of the markets, and exchange 
floor-based businesses represent only a small fraction of market 
activity. The $1,000 de minimis allowance has never been adjusted, and 
the Commission is unaware of any floor members today that refer 
accounts to other broker-dealers in exchange for a share of the 
broker's commission revenues. Although the Commission is proposing to 
eliminate the de minimis allowance, it is soliciting comment on whether 
the de minimis allowance might continue to be appropriate in today's 
markets. In particular, the Commission seeks responses to the following 
questions:
---------------------------------------------------------------------------

    \117\ See supra note 39 and accompanying text.
    \118\ See, e.g., Special Study, supra note 14, at 98 (``Trading 
by NYSE members on the Exchange but from off the floor accounts for 
approximately 5 percent of total Exchange purchases and sales . . 
.'').
---------------------------------------------------------------------------

    1. Do exchange floor members currently rely on the $1,000 de 
minimis allowance? If so, how? Please describe the number and types of 
floor members that rely on the allowance. Please provide the nature and 
extent of reliance on the allowance. Also, please provide any available 
data on the amount and frequency of commissions or referral fees that 
floor members may continue to receive with respect to off-exchange 
transactions.
    2. If the de minimis allowance is being used by exchange floor 
members, is it being relied upon for its original purposes (i.e., 
accommodating occasional commission splitting or referrals by such 
members)? If not, for what purposes are floor members today relying on 
the de minimis allowance?
    3. If exchange floor members currently rely on the de minimis 
allowance and the Commission retains that allowance, should the $1,000 
limit be changed? Why or why not? What should the limit be?
    4. If the de minimis allowance were eliminated, as proposed, would 
some exchange floor members be required to become members of an 
Association? If so, how many? Please provide the basis of any estimate. 
What would be the effect on those firms?
    5. Do other broker-dealers that are not floor members rely on the 
de minimis allowance? If so, for what activities? Specifically, do 
cross-market proprietary trading firms, as discussed above, rely on the 
allowance? If so, why? Are there other types of businesses that use the 
allowance? If so, please describe them. How and why do they rely on the 
allowance?
    6. If the de minimis allowance were eliminated, what would be the 
effect on these non-floor-based broker-dealer firms? For example, if 
the allowance were eliminated, would there be effects on the business 
of firms that would be required to register with an Association, and if 
so what would they be? Would business incentives change such that firms 
might adjust their business model or their trading volume by leaving 
the off-exchange market, moving transactions on-exchange, or leaving 
the markets altogether? Would the effects be different on broker-
dealers trading equities from those trading options?

D. Floor Member Hedging Exemption

    Although the Commission proposes to eliminate the de minimis 
allowance in its entirety, it also proposes to replace the allowance 
with an exemption from Association membership for exchange member 
broker-dealers that operate on the floor of the exchange, to the extent 
they effect transactions off-exchange solely for the purpose of hedging 
the risks of their floor-based activities. The Commission proposes the 
hedging exemption be limited to firms that trade on the floor of a 
national securities exchange, as the Commission understands that 
currently, broker-dealers that trade exclusively on a single exchange 
do so on a physical exchange floor.\119\ Accordingly, the Commission is 
proposing to add the following language to Rule 15b9-1: ``and, (c) 
Effects transactions solely on a national securities exchange of which 
it is a member, except that . . . (1) A dealer that conducts business 
on the floor of a national securities exchange may effect transactions, 
for the dealer's own account with or through another registered broker 
or dealer, that are solely for the purpose of hedging the risks of its 
floor-based activities, by reducing or otherwise mitigating the risks 
thereof. A dealer seeking to rely on this exception shall establish, 
maintain and enforce written policies and procedures reasonably 
designed to ensure and demonstrate that such hedging transactions 
reduce or otherwise mitigate the risks of the financial exposure the 
dealer incurs as a result of its floor-based activity. Such dealer 
shall preserve a copy of its policies and procedures in a manner 
consistent with 17 CFR 240.17a-4 until three years after the date the 
policies and procedures are replaced with updated policies and 
procedures.''
---------------------------------------------------------------------------

    \119\ Currently, NYSE Arca Options, NYSE Amex Options, NASDAQ 
OMX Phlx, CBOE, NYSE, and NYSE MKT have physical exchange floors.
---------------------------------------------------------------------------

    The Commission understands that today there are some broker-dealers 
that continue to limit their activities to exchange floors, 
particularly in the options markets.\120\ As discussed above,

[[Page 18047]]

at the time Rule 15b9-1 was adopted, the circumstances under which an 
exchange specialist or floor broker would trade proprietarily off-
exchange were quite limited, such as where a regional exchange 
specialist would hedge risk on the primary listing market. The 
Commission believes that those broker-dealers that today continue to 
limit their trading activities to an exchange floor may seek to hedge 
the risks of their floor-based activities on other markets, both on 
national securities exchanges and off-exchange.\121\ Therefore, the 
Commission proposes to retain a more focused exemption from Association 
membership for the type of activity for which the Commission believes 
the exclusion for proprietary trading in Rule 15b9-1 was originally 
designed.\122\
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    \120\ Based on disclosures on Form BD, as of February 2015, the 
Commission understands that there are approximately 43 Non-Member 
Firms that are members of one national securities exchange and that 
disclose being engaged in floor activities on Form BD. The business 
model of these firms varies widely, and may include market making, 
other proprietary trading and agency business.
    \121\ For example, a broker-dealer may operate a floor-based 
business on one or more options exchanges. As a result of this 
activity, the broker-dealer may need to mitigate the risk of its 
options positions, resulting from such activity, on other options 
markets or in the equities markets. The proposed floor member 
hedging exemption would allow the broker-dealer to enter into 
transactions on other markets solely for the purpose of hedging this 
risk.
    \122\ See supra note 39 and accompanying text.
---------------------------------------------------------------------------

    The availability of the proposed hedging exemption would be limited 
to dealers that conduct business on the floor of a national securities 
exchange and are members of that exchange. Section 15(b)(8) requires 
Association membership for all registered broker-dealers other than 
those that effect transactions solely on an exchange of which they are 
a member. Broker-dealers that limit their activities in this manner 
generally are specialists or floor brokers based on the floor of an 
individual exchange. In exercising its exemptive authority when it 
adopted Rule 15b8-1 in 1965, the Commission sought to accommodate off-
exchange activities ancillary to that floor-based business. The 
Commission believes that, today, few broker-dealers limit their 
activities to a particular exchange. Those broker-dealers that do limit 
their business to an exchange floor, however, may continue to seek to 
hedge the risk of their floor-based activities by effecting 
transactions on another exchange or in the off-exchange market.
    The Commission preliminarily believes that a floor-based dealer 
seeking to rely on the proposed hedging exemption in Rule 15b9-1 should 
be required to establish, maintain and enforce written policies and 
procedures reasonably designed to ensure and demonstrate that its off-
exchange transactions are solely for the purpose of hedging the risks 
of its floor-based activities, by reducing or otherwise mitigating the 
risks thereof. Such hedging should reduce or otherwise mitigate the 
risks of the financial exposure the dealer incurs as a result of its 
business on the floor of an exchange of which it is a member. Because 
such hedging transactions must be solely for the purpose of hedging the 
risks of the dealer's floor-based activities, the transactions, of 
course, should not be for the purpose of increasing the aggregate risk 
of the dealer. The Commission notes that whether a transaction or 
transactions entered into to reduce or otherwise mitigate risk results 
in a profit or loss is not dispositive of whether or not such a 
transaction or transactions meets the terms of the proposed floor 
member hedging exemption. A floor-based dealer seeking to rely on the 
proposed hedging exemption would be required to preserve a copy of its 
policies and procedures in a manner consistent with Rule 17a-4 until 
three years after the date the policies and procedures are replaced 
with updated policies and procedures.\123\
---------------------------------------------------------------------------

    \123\ 17 CFR 240.17a-4.
---------------------------------------------------------------------------

    The Commission preliminarily believes that requiring written 
policies and procedures, as described above, would facilitate SRO 
supervision of broker-dealers relying on the proposed hedging 
exemption, as it would provide an efficient and effective way for 
regulators to assess compliance with the proposed exemption. The 
determination of whether an off-exchange transaction by a floor-based 
dealer reduces or otherwise mitigates the risk of the financial 
exposure incurred as a result of the dealer's floor-based business may 
vary depending on the nature of the business of the floor-based dealer, 
its financial position, and the particular transactions effected. 
Consequently, the Commission preliminarily believes that requiring 
floor-based dealers to develop written policies and procedures will 
provide sufficient flexibility to accommodate the varying business 
models of floor-based dealers and appropriate hedging activities.
    The Commission notes, however, that such written policies and 
procedures must be reasonably designed to ensure and demonstrate that 
the floor-based dealer's off-exchange hedging transactions reduce or 
otherwise mitigate the risks of the financial exposure it incurs as a 
result of its floor-based activity. Accordingly, a dealer seeking to 
rely upon the proposed hedging exemption should maintain documentation 
that, in the context of an SRO or Commission examination, would enable 
it to show how the hedging transactions it effects off the exchange 
reduce or otherwise mitigate the risks of its floor-based business.
    The Commission notes that the exchange of which the dealer is a 
floor member would be responsible for enforcing compliance with the 
hedging exemption, including reviewing the adequacy of the dealer's 
written policies and procedures and whether the dealer's off-exchange 
transactions comply with those written policies and procedures, 
including the requirement that the hedging transactions reduce or 
otherwise mitigate the risks of financial exposure the dealer incurs as 
a result of its floor-based activity and that the policies and 
procedures are reasonably designed to so demonstrate.\124\
---------------------------------------------------------------------------

    \124\ See 15 U.S.C. 78f(b)(1) which requires that an exchange is 
so organized and has the capacity to be able to carry out the 
purposes of the Exchange Act and to comply, and to enforce 
compliance by its members and persons associated with its members, 
with the provisions of the Exchange Act, the rules and regulations 
thereunder, and the rules of the exchange.
---------------------------------------------------------------------------

    Because the proposed hedging exemption is intended to allow a 
dealer to reduce or otherwise mitigate risk incurred in connection with 
its floor-based activities, it would be limited to transactions for the 
dealer's own account. In addition, because the floor-based dealer would 
not itself be a member of the national securities exchange on which 
transactions may be effected, or an Association, such transactions 
would need to be conducted with or through another registered broker-
dealer that is a member of such other national securities exchange or a 
member of an Association (or both).
    Finally, a dealer seeking to rely on the proposed hedging exemption 
would be required to preserve a copy of its policies and procedures in 
a manner consistent with Rule 17a-4 under the Exchange Act until three 
years after the date the policies and procedures are replaced with 
updated policies and procedures. Accordingly, a dealer must keep the 
policies and procedures relating to its use of the hedging exemption as 
part of its books and records while they are in effect, and for three 
years after they are updated.
    The Commission requests comment on all aspects of the proposed 
hedging exemption in Rule 15b9-1. In particular, the Commission seeks 
responses to the following questions:
    7. To what extent do exchange floor members that are Non-Member 
Firms today effect transactions in the off-exchange market to hedge the 
risk of their floor-based activities? What is the nature and extent of 
such off-exchange market activities? Do these activities

[[Page 18048]]

tend to focus on particular products? The Commission specifically seeks 
data from exchange floor members that demonstrates the extent to which 
they trade off the exchange floor and how such off-exchange trading 
relates to their floor-based business, including to hedge the risks 
thereof, as such data may be particularly helpful in assessing a 
potential floor member hedging exemption when the Commission considers 
adoption of the proposed amendments.
    8. Is the Commission's proposed description of hedging transactions 
appropriate? Is it sufficiently defined? If not, how should it be 
modified or supplemented? Is the phrase ``solely for the purpose of 
hedging the risks of its floor-based activities,'' as used in the 
proposed amendments, sufficiently precise that broker-dealers will know 
what activities are allowed under the proposed floor member hedging 
exemption from Association membership? If not, what should be changed 
or what guidance should be provided?
    9. Will broker-dealers seeking to rely on the floor member hedging 
exemption be able to evaluate whether, and demonstrate that, off-
exchange transactions are ``solely for the purpose of hedging the risks 
of floor-based activities''? Please provide specific examples. What 
would be the associated costs?
    10. Should there be a hedging exemption at all? Why or why not?
    11. Should the Commission narrow or broaden the proposed floor 
member hedging exemption in any way? If so, how and why?
    12. Do exchange floor members that are Non-Member Firms effect 
transactions in the off-exchange market, or on exchanges of which they 
are not a member, for purposes other than hedging the risk of their 
floor-based activities? If so, please describe the nature and extent of 
such activities. Should there be an exemption for these activities? Why 
or why not?
    13. Are there non-floor-based exchange members that today focus 
their business activities on a single exchange? If so, what is the 
nature of their business activity? Should there be an exemption for 
such activities? Why or why not?
    14. The proposed floor member hedging exemption is limited to 
transactions effected with or through another registered broker-dealer. 
Are there circumstances where an exchange floor member that is a Non-
Member Firm, might need to hedge the risk of its floor-based activities 
through a transaction with a non-registered broker-dealer counterparty? 
If so, please describe the nature and extent of such transactions and 
the particular reason(s) that such transactions should be covered.
    15. The proposed floor member hedging exemption is limited to 
transactions for the dealer's own account. Are there circumstances 
where an exchange floor member that is a Non-Member Firm might need to 
hedge the risk of customer activity on the exchange, as agent, in the 
off-exchange market or on exchanges of which it is not a member? If so, 
please describe.
    16. Is the proposed policies and procedures requirement appropriate 
for the floor member hedging exemption? What would be the costs of 
establishing, maintaining and enforcing the policies and procedures, 
and the related record-keeping requirements? How are such costs 
determined? Please provide evidence of the nature, timing, and extent 
of such costs. Would such costs deter dealers from relying on the floor 
member hedging exemption? Are there more efficient and effective 
alternatives to a policies and procedures approach? If so, what are 
they? Have the transactions executed by floor members pursuant to the 
current Rule's exclusion for proprietary trading posed issues of 
regulatory compliance, market surveillance, or enforcement? If so, 
please describe in detail.
    17. Will the proposed requirement to establish, maintain, and 
enforce written policies and procedures enable floor members to 
efficiently hedge their floor-based activities while effectively 
ensuring the floor member hedging exemption is used as intended? Is 
there another approach that would better achieve these goals?
    18. Would the proposed floor member hedging exemption present 
compliance risks or otherwise raise concerns regarding the protection 
of investors or the maintenance of fair, orderly, and efficient 
markets? If so, please describe.
    19. Would current exchange surveillance and enforcement mechanisms 
be effective to monitor trades that would be executed pursuant to the 
proposed floor member hedging exemption? Please explain.
    a. If not, should the Commission require additional reporting by 
registered broker-dealers acting as agent for dealers relying on the 
floor member hedging exemption? For example, should they report to an 
exchange or an Association (i) the identity of the floor member 
effecting the hedging transaction; and (ii) the fact that the 
transaction was a hedging transaction? Is such a requirement necessary 
to assure the adequacy of market surveillance and compliance? Or, 
alternatively, is the registered broker-dealer acting as agent on 
behalf of the dealer subject to sufficient rules and regulations 
(including Rule 15c3-5 under the Exchange Act,\125\ known as the 
Commission's ``Market Access Rule'')? Please explain.
---------------------------------------------------------------------------

    \125\ 17 CFR 240.15c3-5.
---------------------------------------------------------------------------

    b. Could a Non-Member Firm execute a hedging transaction directly 
with another Non-Member Firm? If so, how would the transaction be 
subject to surveillance? How would this activity affect the enforcement 
of the exemption? Please explain.
    c. Would exchanges otherwise have the ability to assess compliance 
of broker-dealers relying on the Rule?
    20. Should the proposed floor member hedging exemption be subject 
to any quantitative or qualitative limitations, or to special reporting 
obligations? Please explain.
    21. Should the proposed floor member hedging exemption require the 
floor member to retain records demonstrating how each off-exchange 
transaction complies with its policies and procedures? Why or why not? 
What would be the associated costs, and what is the basis for those 
costs? Would the cost associated with recordkeeping on a transaction by 
transaction basis be overly burdensome, or unnecessary given the 
Commission's proposed policies and procedures requirement?
    22. Should the Rule contain an anti-evasion provision to prevent 
floor members from attempting to circumvent the limitations in the 
floor member hedging exemption? Is there a better method than the 
proposed policies and procedures approach to ensure that floor members 
do not misuse the proposed floor member hedging exemption? If so, what 
is it? Alternatively, are the existing Commission anti-fraud and anti-
manipulation rules sufficient to prevent misuse of the proposed floor 
member hedging exemption?
    23. Should floor members have to make a certification in connection 
with their reliance on the floor member hedging exemption? Why or why 
not? If a certification should be required, what would be the key 
elements thereof? How frequently should the certification be made? Who 
should make it? What qualifications, if any, to such certification 
might be appropriate (e.g., reasonable basis to believe, best of my 
knowledge)? Should the certification be made in conjunction with an 
internal compliance review? If so, what type of internal compliance 
review should be conducted?

[[Page 18049]]

    24. Are certifications an appropriate way to promote compliance 
with the hedging exemption? Do certifications bring more 
accountability, or do they create compliance costs and therefore a 
barrier to entry?
    25. Is data currently available that could be used by regulators to 
monitor the use of the proposed floor member hedging exemption? Are 
there other approaches that would do more to enhance regulatory 
surveillance, protect investors, or ensure fair, orderly, and efficient 
markets?
    26. Are there other mechanisms the Commission could consider to 
monitor compliance with the floor member hedging exemption? If so, 
please explain.

E. Regulation NMS Routing Exemption

    The Commission proposes to eliminate a portion of subparagraphs 
(b)(2) and all of subparagraph (c) from Rule 15b9-1, because both 
contain outdated references to the ``Intermarket Trading System.'' 
\126\ ITS was a national market system plan (``ITS Plan'') operated by 
the national securities exchanges and NASD that required each 
participant to provide electronic access to its displayed best bid and 
offer to other participants and provided an electronic mechanism for 
routing orders, called commitments to trade, to access those displayed 
prices.\127\ This permitted ITS Plan members at each market to have 
limited access to the other markets for the purpose of avoiding trade-
throughs \128\ and locked markets.\129\ However, the ITS Plan was 
eliminated in 2007, when it was superseded by Regulation NMS.\130\ 
Accordingly, the Commission is proposing to eliminate the following 
language, which creates an additional exception to the de minimis 
allowance, from Rule 15b9-1 (b): ``Or (2) through the Intermarket 
Trading System.'' In addition, the Commission is eliminating in its 
entirety subparagraph (c) of the Rule, which defines the ITS as 
follows: ``(c) For purposes of this section, the term Intermarket 
Trading System shall mean the intermarket communications linkage 
operated jointly by certain self-regulatory organizations pursuant to a 
plan filed with, and approved by, the Commission pursuant to Sec.  
242.608 of this chapter.''
---------------------------------------------------------------------------

    \126\ The full title of the ITS Plan 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.'' The 
ITS Plan was initially approved by the Commission in 1978. Exchange 
Act Release No. 14661 (April 14, 1978), 43 FR 17419 (April 24, 
1978). All national securities exchanges that traded exchange-listed 
stocks and the NASD were participants in the ITS Plan.
    \127\ Id.
    \128\ See 17 CFR 242.600(b)(77) defining a ``trade-through'' 
under Regulation NMS.
    \129\ A ``locked market'' occurs when a trading center displays 
an order to buy at a price equal to an order to sell, or an order to 
sell at a price equal to an order to buy, displayed on another 
trading center.
    \130\ Notice of Filing and Immediate Effectiveness of the Twenty 
Fourth Amendment to the ITS Plan Relating to the Elimination of the 
ITS Plan, Exchange Act Release No. 55397 (March 5, 2007), 72 FR 
11066 (March 12, 2007). Today, Regulation NMS contains an updated 
trade-through rule, and contemplates the use of private linkages by 
trading centers to route orders to avoid trade-throughs. 17 CFR 
242.610-611.
---------------------------------------------------------------------------

    Today, Rule 611 of Regulation NMS requires trading centers to 
establish, maintain and enforce policies and procedures reasonably 
designed to prevent trade-throughs in exchange-listed stocks, subject 
to certain exceptions.\131\ In general, Rule 611 protects automated 
quotes that are the best bid or offer of a national securities exchange 
or Association.\132\ To facilitate compliance with Rule 611 of 
Regulation NMS, national securities exchanges have developed the 
capability to route orders through broker-dealers (many of which are 
affiliated with the exchanges) to other trading centers with protected 
quotations.
---------------------------------------------------------------------------

    \131\ Exchange Act Rule 611 states, in part, that ``a trading 
center shall establish, maintain, and enforce written policies and 
procedures that are reasonably designed to prevent trade-throughs on 
that trading center of protected quotations in NMS stocks. . . .'' 
17 CFR 242.611.
    \132\ Id.
---------------------------------------------------------------------------

    As discussed above, the Commission understands that some broker-
dealers today continue to limit their activities to exchange floors, 
and believes that Rule 15b9-1 should continue to accommodate 
transactions away from the exchange of which they are a member that are 
necessary to comply with regulatory requirements. A floor-based member 
may at times seek to effect a transaction on the exchange at a price 
that would trade-through a protected quotation on another trading 
center. In such a case, the exchange would need to route the member's 
order, through a routing broker-dealer, to that other trading center 
before it could execute any remainder of the floor-based member's order 
on the exchange. Therefore, a broker-dealer may be required, as a 
necessary part of its business, to effect transactions otherwise than 
on the exchange of which it is a member as a consequence of the 
requirements of Rule 611 of Regulation NMS.
    The Commission preliminarily believes that transactions effected 
solely to comply with Rule 611 regulatory requirements should not 
require membership in an Association by a broker-dealer that otherwise 
limits its activities to an exchange of which it is a member. 
Accordingly, the Commission proposes to add the following language to 
create a second exemption from the requirement under proposed Rule 
15b9-1(c) that a broker-dealer effect transactions solely on an 
exchange of which it is a member: ``(2) a broker or dealer may effect 
transactions off the exchange resulting from orders that are routed by 
a national securities exchange of which it is a member, to prevent 
trade-throughs on that national securities exchange consistent with 17 
CFR 242.611.'' The Commission believes that permitting such routing 
only by a national securities exchange of which the broker-dealer is a 
member will provide the exchange with visibility into the routing of 
transactions by its members to other exchanges, and thus maintain the 
exchange's ability to effectively oversee the entirety of its member's 
activity.
    The Commission requests comment on all aspects of the proposed 
Regulation NMS routing exemption in Rule 15b9-1. In particular, the 
Commission seeks responses to the following questions:
    27. Is the proposed routing exemption necessary and appropriate? 
Why or why not?
    28. Is the scope of the proposed routing exemption sufficient to 
provide for all off-exchange transactions that might be effected by 
floor members as a necessary consequence of compliance with Rule 611 of 
Regulation NMS? If not, how should it be changed?
    29. Does the proposed routing exemption allow transactions beyond 
those necessary to comply with Rule 611 of Regulation NMS? If so, is 
that appropriate and should it be narrowed or broadened?
    30. Are there other off-exchange transactions that a floor member 
might need to effect in order to comply with regulatory requirements? 
If so, please describe those transactions and the relevant regulatory 
requirements.

III. Effective Date and Implementation

    The Commission recognizes that firms will require time to comply 
with Rule 15b9-1 if the amendments are adopted in order to become a 
member of an Association, or modify the firm's business practices to 
conform to the requirements of the Rule, as amended. As noted 
previously, FINRA is currently the only Association. To become a FINRA 
member, a broker-dealer must complete FINRA's New Member Application 
and participate in a pre-

[[Page 18050]]

membership interview.\133\ The broker-dealer and its associated persons 
must comply with FINRA's registration and qualification 
requirements.\134\ The amount of time that it takes to become a FINRA 
member would depend on a number of factors, including the nature of the 
broker-dealer's business, the level of complexity or uniqueness of the 
firm's business plan, the number of associated persons the firm 
employs, and whether the firm has an affiliate that is already a member 
of FINRA.\135\ The Commission understands, based on conversations with 
FINRA that, on average, the FINRA membership application process 
generally takes approximately four months.
---------------------------------------------------------------------------

    \133\ See How to Become a Member, FINRA, http://www.finra.org/Industry/Compliance/Registration/MemberApplicationProgram/HowtoBecomeaMember/index.htm (last visited on March 9, 2015).
    \134\ See NASD Rule 1010--Membership Proceedings, which sets out 
the substantive standards and procedural guidelines for the FINRA 
membership application and registration process.
    \135\ See Section V.C. discussing the costs of joining FINRA.
---------------------------------------------------------------------------

    Alternatively, if the proposed amendments are adopted, a Non-Member 
Firm not eligible for, or choosing not to rely on, an exemption may 
become a member of additional exchanges upon which it trades or 
otherwise modify its business model to conform with the proposed 
amendments to the Rule. The Non-Member Firm may also need to modify its 
systems or take other steps to achieve compliance.
    The Commission preliminarily believes that 360 days after 
publication in the Federal Register of any final rules that the 
Commission may adopt should provide firms enough time to comply with 
the amended Rule. Therefore, the Commission proposes that the 
compliance date for the proposed amendments to Rule 15b9-1 would be 360 
days after publication of the final rule in the Federal Register. The 
Commission solicits comment on the adequacy of this proposed 
implementation timeline. In particular, the Commission seeks responses 
to the following questions:
    31. Does 360 days after publication in the Federal Register provide 
firms with sufficient time to comply with the revised Rule? Would firms 
be in a position to comply with the revised Rule earlier than 360 days 
after publication?
    32. How long does the registration process with FINRA, should a 
firm decide to register, typically take? Please include the estimated 
time to prepare the application as well as the estimated time for FINRA 
to process the application.
    33. Do commenters believe that a longer or shorter period is 
appropriate to determine whether becoming a member of an Association is 
preferable to changing a firm's business model to remain within the 
exemptions provided by the Rule, as amended (i.e., ceasing all off-
exchange activity and becoming a member of each exchange on which the 
firm trades, or limiting the firm's off-exchange activity to comply 
with the floor member hedging exemption and/or NMS routing exemption)?
    34. How long does it typically take to complete the application 
process with a national securities exchange? Please include the 
estimated time to prepare the application as well as the estimated time 
for an exchange to process it.
    35. To the extent a firm intends to rely on one or more of the 
proposed exemptions, how long would it take such firm to make the 
required systems changes to comply? Are there other steps that would 
need to be taken to achieve compliance? If so, what is the estimated 
time to accomplish those steps?

IV. General Request for Comments

    The Commission seeks comment on all aspects of the proposed 
amendments to Rule 15b9-1. Commenters should, when possible, provide 
the Commission with data to support their views. Commenters suggesting 
alternative approaches should provide comprehensive proposals, 
including any conditions or limitations that they believe should apply, 
the reasons for their suggested approaches, and their analysis 
regarding why their suggested approaches would satisfy the objectives 
of the proposed amendments.
    36. The Commission requests comment generally on whether narrowing 
or broadening the current exemption is appropriate. In particular, the 
Commission seeks comment on whether the fact that Non-Member Firms 
currently must use an Association member firm to report off-exchange 
trades gives an Association sufficient information and jurisdiction to 
effectively regulate the off-exchange market. Are there off-exchange 
transactions between two Non-Member Firms that occur that are not 
reported?
    37. The Commission requests comment on whether the current 
exemption should be eliminated entirely. What would be the benefits or 
drawbacks of doing so?
    38. Other than the proposed hedging exemption and Regulation NMS 
routing exemption, are there any other exemptions that the Commission 
should consider?
    39. Have transactions effected pursuant to the current Rule posed 
compliance issues in the past? If so, please describe in detail.
    40. In addition, the Commission is interested in data indicating 
how many entities rely either on Rule 15b9-1 in its current form, or 
exclusively on the statutory exception in Section 15(b)(8) of the 
Exchange Act. Reliance on Rule 15b9-1 is currently self-effecting 
(i.e., does not require the reporting of such reliance to the 
Commission or any other regulatory authority). In lieu of the proposed 
amendments, should the Commission require broker-dealers relying on 
Rule 15b9-1 to report such reliance to the Commission or to the 
exchange of which the broker-dealer is a member? If so, what form 
should such reporting take and what information should be provided to 
the Commission or the exchange of which the broker-dealer is a member? 
If not, why not and what alternative means could be used to collect 
data about reliance on Rule 15b9-1?
    41. If the Commission were instead to eliminate Rule 15b9-1 
altogether, how many broker-dealers would: (i) Restrict their business 
to only those national securities exchanges of which they are a member; 
(ii) become members of other national securities exchanges; and/or 
(iii) become members of an Association? Would implementation of the 
proposed amendments have an effect on market liquidity? If so, please 
estimate that effect. Could broker-dealers that currently rely on the 
Rule respond to its elimination in other ways to avoid Association 
membership? If so, please explain.
    42. Should the Commission allow Non-Member Firms that conduct off-
exchange trading activity to remain exempt from membership in an 
Association? If so, why? Would membership by Non-Member Firms in 
multiple exchanges prove an efficient and effective substitute for 
Association membership? Should the level of off-exchange activity 
affect the ability of a firm to be exempt from Association membership? 
Why or why not?
    43. Should the Commission require the exchanges to engage in joint 
plans to ensure that the on-exchange cross-market activity of their 
members is effectively regulated? How might this improve the oversight 
of on-exchange trading activity? What problems or inefficiencies would 
relying on joint plans for the regulation of on-exchange trading 
activity by exchanges create?
    44. Is Association membership an efficient or effective approach 
for the regulation of firms that trade across multiple exchanges but do 
not trade off-

[[Page 18051]]

exchange? Are there more effective alternatives?
    45. Under the proposed amendments to the Rule, a Non-Member Firm 
that conducts no off-exchange trading, but trades on an exchange of 
which it is not currently a member, would, in accordance with Section 
15(b)(8), have to either join an Association or become a member of each 
exchange upon which it trades. Should the proposed amendments be 
revised to provide an exemption from Section 15(b)(8) to permit such a 
Non-Member Firm, with no off-exchange trading, to remain exempt from 
membership in an Association and continue trading on exchanges of which 
it is not a member, so long as certain conditions are met, such as the 
exchange of which it is a member entering into appropriate contractual 
arrangements such that the exchange is in a position to effectively 
surveil all of the trading activities of that firm?
    46. Should the Commission consider other changes to Rule 15b9-1? If 
so, why? What specifically should be changed and how?

V. Economic Analysis

    As discussed above, the Commission is proposing to amend Rule 15b9-
1 to better align the scope of its exemption, in light of today's 
market activity, with Section 15(b)(8) of the Exchange Act and the 
Commission's original purpose in adopting Rule 15b9-1. Currently, a 
broker-dealer can engage in unlimited proprietary trading in the off-
exchange market without becoming a member of an Association, so long as 
its proprietary trading activity is conducted with or through another 
registered broker-dealer. For a broker-dealer that trades 
electronically across a range of exchange and off-exchange venues, 
however, the individual exchanges of which the broker-dealer may be a 
member are not well-positioned to oversee the off-exchange activity of 
the broker-dealer, as was previously discussed. The Commission 
preliminarily believes that this oversight role can best be fulfilled 
by an Association, which is the SRO intended and authorized by Congress 
to regulate the trading activity of off-exchange market participants, 
monitor their financial and operational condition, and enforce their 
compliance with federal securities laws and Association rules.
    The Commission is sensitive to the economic effects of its rule, 
including the costs and benefits and effects on efficiency, 
competition, and capital formation. Section 3(f) of the Exchange Act 
requires the Commission, whenever it engages in rulemaking pursuant to 
the Exchange Act, and is required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action would 
promote efficiency, competition, and capital formation.\136\ In 
addition, Section 23(a)(2) of the Exchange Act requires the Commission, 
when making rules under the Exchange Act, to consider the effect such 
rules would have on competition.\137\ Exchange Act Section 23(a)(2) 
prohibits the Commission from adopting any rule that would impose a 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act.\138\
---------------------------------------------------------------------------

    \136\ 15 U.S.C. 78c(f).
    \137\ 15 U.S.C. 78w(a)(2).
    \138\ Id.
---------------------------------------------------------------------------

    The Commission discusses below a number of economic effects that 
are likely to result from the proposed amendments. As discussed in 
detail below, many of the effects are difficult to quantify with any 
degree of certainty. Although the Commission is providing estimates of 
direct compliance costs where possible, the Commission also anticipates 
that broker-dealers affected by the proposed amendments, as well as 
competitors of those broker-dealers, may modify their business 
practices regarding the provision of liquidity in both off-exchange 
markets and on exchanges. Consequently, much of the discussion below is 
qualitative in nature, but where possible, the Commission has provided 
quantified estimates.\139\
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    \139\ See Section V.C. for further discussion of the 
difficulties in estimating market quality effects likely to result 
from the proposed amendments.
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A. Baseline

1. Regulatory Structure and Activity Levels of Non-Member Firms
    The Exchange Act governs the way in which the U.S. securities 
markets and its broker-dealers operate. Section 3(a)(4)(A) of the Act 
generally defines a ``broker'' broadly as ``any person engaged in the 
business of effecting transactions in securities for the account of 
others.'' \140\ In addition, Section 3(a)(5)(A) of the Act generally 
defines a ``dealer'' as: ``any person engaged in the business of buying 
and selling securities for . . . such person's own account through a 
broker or otherwise.'' \141\ The Commission oversees approximately 
4,209 broker-dealers, of which approximately 4,057 are members of 
FINRA, currently the only Association.\142\
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    \140\ 15 U.S.C. 78c(4)(A).
    \141\ 15 U.S.C. 78c(5)(A).
    \142\ There were approximately 4,209 broker-dealers registered 
with the Commission as of March 2015.
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    Generally, any firm that interacts directly with a securities 
exchange must register with the Commission as a broker-dealer to gain 
direct access to the exchange. Consequently, there is diversity in the 
size and business activities of broker-dealers.\143\ Carrying broker-
dealers hold customer funds and securities; some of these are also 
clearing broker-dealers that handle the clearance and settlement 
aspects of customer trades, including record-keeping activities and 
preparing trade confirmations.\144\ However, during the fourth quarter 
of 2014, only 284 of the 4,184 registered broker-dealers were 
classified as carrying or clearing broker-dealers. Thus, the majority 
of broker-dealers engage in a wide range of other activities, which may 
or may not include handling customer accounts. These other activities 
include intermediating between customers and carrying/clearing brokers; 
dealing in government bonds; private placement of securities; effecting 
transactions in mutual funds that involve transferring funds directly 
to the issuer; writing options; acting as an exchange floor broker; and 
the provision of liquidity to securities markets, which includes, but 
is not limited to, the activities of registered market makers.
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    \143\ A firm that wishes to transact business upon an exchange 
without becoming a broker-dealer can do so by engaging a broker-
dealer to provide market access and settlement services. While 
effecting transactions in the off-exchange market does not require 
registering as a broker-dealer, it does require obtaining the 
services of a broker-dealer to handle settlement at a minimum.
    \144\ Based on December 2014 FOCUS data.
---------------------------------------------------------------------------

    Broker-dealers are diverse in size as well as scope of activity. 
Most broker-dealers are small, with 67% of broker-dealers employing 10 
or fewer registered individuals and only 4% of broker-dealers employing 
over 151 registered individuals.\145\ Although the majority of broker-
dealers are small, there are a few very large broker-dealers as well. 
Further, while there are many registered broker-dealers, a small 
minority of broker-dealers controls the majority of broker-dealer 
capital and has the ability to affect the allocation of capital to 
liquidity provision. As of December 31, 2014, the majority of broker-
dealers each had total capital of less than $500,000, while the ten 
largest broker-dealers in terms of capital accounted for more than 53% 
of total broker-dealer

[[Page 18052]]

capital, with each disclosing more than $10 billion in total 
capital.\146\
---------------------------------------------------------------------------

    \145\ Id.
    \146\ Id.
---------------------------------------------------------------------------

    As of March 2015, 125 of the approximately 4,209 registered broker-
dealers were not members of FINRA, currently the only Association. The 
Commission believes the majority of Non-Member Firms rely on the Rule's 
exemption from Association membership.\147\ Because of the exclusion 
for proprietary trading, a broker-dealer that does not carry customer 
accounts is not required to join an Association, even when that broker-
dealer has substantial off-exchange trading activity.
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    \147\ See supra note 77. Historically, these floor brokers had 
only incidental trading on exchanges of which they were not members, 
and limited off-exchange trading activity. The background and 
history of Rule 15b9-1 are discussed in Section I.
---------------------------------------------------------------------------

    Non-Member Firms are diverse in their types and activities. Of the 
125 Non-Member Firms, 77 disclose engaging in floor activities on a 
national securities exchange, as reported on Form BD.\148\
---------------------------------------------------------------------------

    \148\ See Form BD data for Non-Member Firms during March of 
2015. Of the 125 Non-Member Firms, 77 Non-Member Firms disclose 
engaging in floor activities on a national securities exchange; 76 
firms disclose acting as a put and call broker or dealer or option 
writer; and 89 firms disclose trading securities for their own 
account. Other businesses cited by multiple Non-Member Firms 
include: National securities exchange commission business other than 
floor activities (6); making inter-dealer markets in corporate 
securities off-exchange (5); selling corporate debt securities (2); 
dealing in government securities (4); and other business (18).
    Currently, a Non-Member Firm that is a member of a single 
exchange but is not engaged in floor-broker activity may engage in 
trading upon other exchanges using access provided by a broker-
dealer that is an exchange member of the destination exchange. These 
single-exchange member Non-Member Firms may also engage in off-
exchange trading with or without the intermediation of a Member 
Firm. Under the proposed amendments, both of these activities would 
be disallowed except as outlined in the Floor Member Hedging 
Exemption (see Section II.D.) and the Regulation NMS Routing 
Exemption (see Section II.E.).
---------------------------------------------------------------------------

    There is significant diversity in the business models of Non-Member 
Firms. Some Non-Member Firms may limit their trading to a single 
exchange, while others trade on multiple venues possibly including off-
exchange venues like ATSs. Some firms are significant contributors to 
both off-exchange and exchange volume. Because any off-exchange 
activity that involves a FINRA member firm (``Member Firm'') generates 
certain audit trail data, FINRA and the Commission are able to quantify 
the aggregate off-exchange activity of Non-Member Firms.\149\ During 
the fourth quarter of 2014, there were 104.5 billion orders reported in 
the off-exchange market. Of these 104.5 billion orders, 36.9 billion 
(35.31%) were received from Non-Member Firms.\150\ Non-Member Firms 
submitted 44.99% of all orders within ATSs in the fourth quarter of 
2014.
---------------------------------------------------------------------------

    \149\ Most off-exchange interactions involve a Member Firm at 
some point in the order audit trail for routing, and therefore 
produce OATS data, although identification of the firm that submits 
the order is not required by OATS. Interactions between Non-Member 
Firms without the involvement of a Member Firm are possible and 
would not generate audit trail data, but the Commission believes 
these interactions are infrequent for two reasons. First, all ATSs 
are operated by Member Firms, so all orders submitted to ATSs are 
reported to OATS. Second, although two Non-Member Firms could 
theoretically interact on a Non-Member Firm operated single dealer 
platform, the Commission is unaware of any single dealer platform 
that is operated by a Non-Member Firm. Such a platform would be 
visible in OATS data as a routing and execution destination if it 
were accessed by Member Firms. Although it is possible that a Non-
Member Firm could approach another Non-Member Firm directly to 
negotiate a transaction outside of an automated venue, the 
Commission believes large Non-Member Firms transact with each other 
almost exclusively through ATSs and do not seek each other out as 
trading partners. Further information about off-exchange trading 
outside of ATSs is provided by Tuttle, Laura, 2014, Over-the-Counter 
Trading: Description of Non-ATS OTC Trading in National Market 
System Stocks, available at http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
    \150\ Data provided by FINRA. This does not include activity 
submitted by firms not registered as broker-dealers, including data 
on buy-side activity because the data was screened to include only 
Non-Member Firms.
---------------------------------------------------------------------------

    Although the Commission can observe the aggregate off-exchange 
trading of Non-Member Firms, it is unable to quantify the off-exchange 
trading of all Non-Member Firms on an individual basis because Member 
Firms currently are not required to report the identifiers of Non-
Member Firms with whom they transact to OATS.\151\ However, some Member 
Firms voluntarily report the exchange-issued identifiers of the Non-
Member Firms with which they interact.\152\ Using this data, the 
Commission can estimate the ATS activity level of the 14 Non-Member 
Firms that connected to ATSs directly without the intermediation of 
another broker-dealer during the fourth quarter of 2014.\153\ Based on 
this data, at least 19.31% of all ATS orders is attributable to the 
Non-Member Firm that was the most active in ATS orders during the 
review period.\154\ The least active of the 14 identifiable Non-Member 
Firms has almost no order activity. In total, five of the 14 Non-Member 
Firms are each responsible for 1% or more of all orders sent directly 
to an ATS for the review period.
---------------------------------------------------------------------------

    \151\ See supra note 84.
    \152\ Data provided by FINRA. This does not include activity 
submitted by firms not registered as broker-dealers, including data 
on buy-side activity. In the fourth quarter of 2014, approximately 
46.42% of ATS orders from Non-Member Firms included an exchange-
issued identifier that allows identification of the Non-Member Firm 
submitting an order. The set of ATS clients that are not FINRA 
members also includes substantial buy-side activity, but this 
analysis is limited to firms that are also registered broker-
dealers: The 125 Non-Member Firms.
    Although the analysis here focuses on ATS activity, Non-Member 
Firms interact with Member Firms outside of ATSs as well, primarily 
on single-dealer platforms. Across all off-exchange executions, in 
the fourth quarter of 2014, 3.26% of share volume (10.56% of dollar 
volume) was attributable to the trading of Non-Member Firms.
    \153\ Although these 14 Non-Member Firms connect to ATSs 
directly without the assistance of another broker-dealer, the ATSs 
are operated by Member Firms and these orders are therefore 
permitted under the current rule.
    The Commission believes that these 14 Non-Member Firms represent 
a subset of the largest Non-Member Firms that actively trade across 
multiple exchanges and off-exchange and thus may not be 
representative of the broader set of 125 Non-Member Firms. As such, 
estimates of these 14 firms' ATS activity levels and the regulatory 
fees that the activity would generate exceed those expected from 
typical Non-Member Firms.
    \154\ Non-Member Firms submitted 32.9 billion of the 66.8 
billion ATS orders during the fourth quarter of 2014. ATSs reported 
Non-Member MPIDs for 15.3 billion of these Non-Member Firm orders. 
The Non-Member Firm most frequently identified as the source of ATS 
orders submitted 4.9 billion ATS orders (7.30% of all orders and 
39.20% of all Non-Member Firm ATS orders for which a Non-Member Firm 
MPID is reported). With the assumption that this firm also submitted 
39.20% of the Non-Member Firm ATS orders to ATSs that do not report 
Non-Member Firm MPIDs, this firm would account for 19.31% of all ATS 
orders.
    ATSs generally provide the exchange-issued MPIDs of Non-Member 
Firms submitting orders either for all orders or for none of the 
orders received directly from Non-Member Firms. For purposes of our 
analysis, we assume that the proportion of orders submitted by 
individual Non-Member Firms to ATSs that report identifiers is equal 
to that proportion for ATSs that do not report Non-Member Firm 
MPIDs. It is possible that some Non-Member Firms transact only in 
ATSs that do not report these identifiers to FINRA; if that is true, 
our estimate of the activity level of the 14 identified Non-Member 
Firms would be upwardly biased because we would attribute the ATS 
volume of the unidentified Non-Member Firms to those that have been 
identified. Furthermore, our estimate that 14 Non-Member Firms 
connect to ATSs directly would be downward biased. It is also 
possible that the proportions of orders attributable to individual 
Non-Member Firms are materially different on ATSs that do not report 
Non-Member Firm identifiers, although any error introduced by this 
would likely not be directional. Additionally, some Non-Member Firms 
may submit orders to Member Firms that are then routed to ATSs or 
elsewhere off-exchange. Such activity would cause us to 
underestimate the activity of these 14 Non-Member Firms within ATSs, 
although such activity would still be counted at the aggregate Non-
Member Firm level.
---------------------------------------------------------------------------

    The business of providing liquidity off-exchange is competitive. 
Off-exchange equity trading occurs across many trading venues. In May 
2012, 44 ATSs actively traded NMS stocks, comprising 12.12% of NMS 
share volume.\155\ Furthermore, 255 broker-

[[Page 18053]]

dealers transacted a further 18.75% of NMS share volume off-exchange 
without the involvement of an ATS.\156\ Although many market 
participants provide liquidity within this market, Non-Member Firms are 
particularly active within ATSs, as discussed above. Although Non-
Member Firms may trade in the Non-ATS segment of the off-exchange 
market, the Commission preliminarily believes they rarely act as 
liquidity suppliers outside of ATSs.\157\
---------------------------------------------------------------------------

    \155\ Tuttle, Laura, October 2013, Alternative Trading Systems: 
Description of ATS Trading in National Market System Stocks, 
available at http://www.sec.gov/marketstructure/research/alternative-trading-systems-march-2014.pdf (revised March 2014).
    \156\ Transaction volume off-exchange outside of ATSs includes 
internalization, in which a broker-dealer fills orders from its own 
inventory without interacting directly with an exchange. Tuttle, 
Laura, March 2014, OTC Trading: Description of Non-ATS OTC Trading 
in National Market System Stocks, available at http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
    \157\ OATS data suggests that Non-Member Firms do not supply 
off-exchange liquidity to Member Firms outside of ATSs and the 
Commission believes that Non-Member Firms rarely transact with each 
other outside of ATSs. See supra note 149.
---------------------------------------------------------------------------

    While some Non-Member Firms trade actively off-exchange, some of 
these firms also supply and demand liquidity actively on multiple 
exchanges.\158\ The Commission is able to identify the activity of 13 
of the 14 Non-Member Firms identified as connecting directly with ATSs 
on exchanges operated by BATS, NASDAQ-OMX, and NYSE during May of 2014. 
The data show that these Non-Member Firms contribute substantially to 
exchange volume.\159\ On these exchanges, during May 2014, these 13 
large Non-Member Firms that connect directly to ATSs participate in at 
least 17.25% of all exchange trading volume. The highest Non-Member 
Firm participation rate in the data is on BATS-Y, where 27.31% of trade 
volume involves Non-Member Firms that also connect directly to ATSs. 
The lowest participation rate is on NYSE, where 5.54% of trading 
involves Non-Member Firms that connect directly with ATSs. One of the 
Non-Member Firms that connects directly with ATSs cannot be identified 
in exchange data.\160\ The 13 Non-Member Firms that are observed 
trading on exchanges tend to trade across the majority of exchanges 
represented in the exchange data sample.\161\
---------------------------------------------------------------------------

    \158\ See Section V.D.3 for discussion of SRO cross-monitoring 
capabilities.
    \159\ The estimates include only Non-Member Firms that connect 
directly to at least one ATS that reports Non-Member Firm MPIDs in 
OATS. Consequently, some Non-Member Firms are not included in these 
estimates. Therefore, the estimates underestimate the importance of 
Non-Member Firms to exchange-based activity in aggregate.
    \160\ Data from off-exchange markets and exchanges is matched on 
a firm-name basis in this analysis. It is possible that one firm 
that cannot be identified in the exchange data is present under a 
name that is not readily linked to the firm name cited in the off-
exchange data.
    \161\ Data for Nasdaq-OMX is not broken down by exchange, but is 
instead aggregated at the holding company level. Exchange-level data 
was provided by BATS and NYSE.
---------------------------------------------------------------------------

    The market for liquidity provision on equity exchanges is also 
competitive. For example, Nasdaq-listed equities, for which the 
Commission has relevant data,\162\ each had 13 to 80 market makers 
registered to provide liquidity on Nasdaq as of December 2014. The 
median Nasdaq-listed equity had 36 registered market makers, and 95% of 
securities had 20 or more registered market makers. Because Nasdaq is 
not the only exchange trading its listed equities, these statistics 
underrepresent the number of firms in the market that provide liquidity 
in Nasdaq-listed equities. Although the Commission does not have 
readily available data to count the number of market makers in equities 
listed on other exchanges, the Commission preliminarily believes that 
the figures for Nasdaq-listed equities illustrate the magnitude of 
market makers in equities more generally. Additionally, the Commission 
notes that while the number of market makers represents the number of 
firms in the business of providing liquidity, it does not necessarily 
indicate whether each market maker is an active competitor. However, 
the Commission believes that many market makers actively compete to 
provide liquidity. The Commission currently lacks data to quantify the 
liquidity provision activity attributable to Non-Member Firms.
---------------------------------------------------------------------------

    \162\ Data from Center in Research in Security Prices (CRSP).
---------------------------------------------------------------------------

2. Current Market Oversight
    The surveillance and regulation of each broker-dealer is dependent 
upon its individual SRO membership status. Each SRO that operates an 
exchange has responsibility for overseeing trading that occurs on the 
exchange it operates. Because of this, SROs that operate an exchange 
possess expertise in supervising members who specialize in trading the 
products and order types that may be unique or specialized within the 
exchange. This expertise complements the expertise of an Association in 
supervising cross-exchange and off-exchange trading activity.\163\ 
Exchanges generally have not monitored trading that their members 
conduct on other venues.
---------------------------------------------------------------------------

    \163\ See Section I.B. discussing the requirement for SROs to 
examine for and enforce compliance with the Exchange Act, and the 
rules and regulations thereunder.
---------------------------------------------------------------------------

    Approximately 68 Non-Member Firm broker-dealers are members of a 
single exchange that supervises their activity overall. Exchanges 
regulate trading by broker-dealers on their exchange and generally may 
focus examinations on the financial and operational requirements 
associated with their membership. These requirements share many 
commonalities across SROs, such as net capital requirements and books 
and records requirements. Because many broker-dealers are members of 
multiple SROs with similar requirements, one SRO is appointed as the 
broker-dealer's DEA.\164\
---------------------------------------------------------------------------

    \164\ A DEA is an SRO assigned by the SEC that has certain 
specific supervisory responsibility for a broker-dealer. The DEA 
usually performs financial and operations examination activities on 
behalf of all SROs of which the broker-dealer is a member, although 
SROs may also allocate other regulatory responsibilities under Rule 
17d-2. See supra note 69. These examinations, however, do not 
generally extend to compliance with trading rules imposed by other 
SROs; nor do they facilitate surveillance for activity across market 
centers. DEAs therefore cannot substitute for the surveillance of 
cross-market and off-exchange trading provided by an Association. 
See 17 CFR 240.17d-1. FINRA serves as the DEA for the majority of 
Member Firms; there are exceptions, mostly involving firms that have 
specialized business models that focus on a particular exchange that 
is judged to be best situated to supervise the Member Firm's 
activity. These firms are, however, subject to the same supervision 
of their trading activity as other Member Firms for whom FINRA does 
act as DEA. Under the proposed amendments, Non-Member Firms that 
join FINRA may or may not be assigned to FINRA for DEA supervision. 
A firm with a specialized business model focusing on a single 
exchange with floor activity may be able to continue trading off-
exchange under the proposed floor member hedging exemption without 
joining FINRA.
---------------------------------------------------------------------------

    All registered broker-dealers are required to join an Association 
unless they comply with Section 15(b)(8) of the Act or Rule 15b9-1. The 
vast majority of broker-dealers join an Association and, since there is 
currently a single Association, with the exception of Non-Member Firms, 
broker-dealers are subject to relatively uniform regulatory 
requirements and levels of surveillance and supervision. The 
supervision by FINRA, which is currently the only Association, is more 
robust than that of individual exchange SROs because its rule set 
addresses its need to supervise a market that is fragmented across many 
trading venues and more opaque than exchange trading.\165\ 
Specifically, FINRA's rule set has provisions related to business 
conduct, financial condition

[[Page 18054]]

and operation, and supervision that may differ materially from exchange 
SRO rule sets.\166\
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    \165\ Comprehensive reporting requirements for all Member Firms 
that trade off-exchange give FINRA information on market activity 
levels and market conditions off-exchange. Because most off-exchange 
venues do not disseminate information on the liquidity available in 
their systems, comprehensive information from all participants is 
necessary for FINRA to analyze and surveil the off-exchange market. 
See infra note 204 for a discussion of the off-exchange trading 
environment; see also Section I.B. for a discussion of the differing 
scope of exchange SRO and Association rule sets.
    \166\ See supra notes 91-94 and accompanying text.
---------------------------------------------------------------------------

    The existing Association, FINRA, serves crucial functions in the 
current regulatory structure.\167\ FINRA has primary responsibility for 
overseeing off-exchange trading.\168\ Furthermore, FINRA provides 
cross-market trading supervision of broker-dealers that the exchanges 
currently are not well-positioned to provide in light of the statutory 
framework that places responsibility for off-exchange trading with an 
Association. Exchanges generally do not have a detailed set of member 
conduct rules and non-exchange-specific trading rules and have limited 
access to data,\169\ thus allowing such broker-dealers and their 
personnel to conduct business under a less specific regulatory regime 
than FINRA members. On the other hand, FINRA has sought to establish a 
robust regulatory regime for broker-dealers, including broker-dealers 
conducting business in the off-exchange market, and developed 
surveillance technology and specialized regulatory personnel to provide 
surveillance, supervision, and enforcement of activity occurring off-
exchange. Consequently, the current regulatory structure achieves 
cross-market and off-exchange supervision through the surveillance 
actions of FINRA and its examination of its members.
---------------------------------------------------------------------------

    \167\ See Section I.A. for further discussion of the role of 
Associations in market oversight.
    \168\ See Section I.B. for further discussion of the 
responsibilities of an Association.
    \169\ See supra note 76.
---------------------------------------------------------------------------

    Currently, Non-Member Firms transact heavily in the course of 
normal business activities within venues regulated by SROs of which 
they are not members. This is very different from when Rule 15b9-1 was 
first adopted. The Act provides for regulation of exchange trading by 
the exchanges themselves; it further provides for supervision of off-
exchange trading by an Association. Although the Act provides a limited 
and targeted exception to Association membership requirements for 
broker-dealers, its approach to effecting supervision is relatively 
uniform: Broker-dealers must be members of the SROs that regulate the 
venues upon which they transact. For each trading venue, whether an 
exchange or the off-exchange market as a whole, the responsible SRO (an 
exchange SRO or FINRA) is obligated and empowered to fulfill its 
regulatory responsibilities through its authority to adopt rules, 
surveil the markets, examine its members' activities and bring 
enforcement actions when necessary. To the extent that the current 
regulatory structure undermines this functional approach, the ability 
of SROs to fulfill their responsibilities to protect investors and 
promote fair and orderly markets may be compromised.
    Comprehensive supervision of cross-market and off-exchange activity 
requires data on off-exchange activity, but this data for Non-Member 
Firms is often not readily available to regulators.\170\ FINRA's rules 
require that nearly all Member Firms report order audit trail data 
daily.\171\ This data records the origination, receipt, execution, 
routing, modification or cancellation of every order a Member Firm 
handles, with limited exceptions for certain activities including 
market-making. Additionally, FINRA currently has RSAs with most 
exchanges \172\ that provide FINRA with detailed data that often allow 
FINRA to comprehensively identify the market-wide activity of broker-
dealers, and to surveil behavior for violative activity that might 
otherwise go undetected on an exchange-specific surveillance basis. 
However, a significant amount of activity remains missing from FINRA's 
existing audit trail data (OATS) because it does not include the orders 
that otherwise would be reported by Non-Member Firms if they were 
members, and does not identify executions as those of a broker-dealer. 
Non-Member Firm activity that involves a Member Firm (such as an ATS 
order or an order routed through a Member Firm) does appear in OATS, 
although the identity of the Non-Member Firm sending the order is not 
required to be reported.\173\ Furthermore, some off-exchange activity 
that does not involve a Member Firm (and thus creates no OATS data 
record) may be entirely unsurveiled by FINRA and possibly not subject 
to rules that were intended to universally govern off-exchange 
activity. In particular, an off-exchange trade between two Non-Member 
Firms is not subject to FINRA's audit trail and trade reporting rules.
---------------------------------------------------------------------------

    \170\ If the Commission approves the NMS Plan submitted by the 
SROs to create, implement, and maintain a CAT, the CAT would be able 
to provide the SROs and the Commission with such data on Non-Member 
Firms. See Exchange Act Release No. 67457 (July 19, 2012), 77 FR 
45721 (August 1, 2012).
    \171\ See generally FINRA Rule 7400 Series--Order Audit Trail 
System.
    \172\ FINRA has RSAs with all exchanges operated by 
Intercontinental Exchange, Nasdaq-OMX, and BATS. Together, these 
exchanges accounted for 99.6% of exchange-based share volume in Tape 
A, B, and C securities during October 2014, based on data available 
on the BATS Web site. See http://www.batstrading.com/market_data/market_volume_history/ (last visited March 9, 2015).
    \173\ FINRA has proposed amendments to its rules pertaining to 
identification of Non-Member Firms in OATS data. See supra note 84.
---------------------------------------------------------------------------

    Because Non-Member Firms are not required to join an Association, 
they are not required to pay the costs of Association membership, which 
could be significant, especially for Non-Member Firms with substantial 
trading activity. FINRA members currently pay a TAF for all equity 
sales transactions that are not performed in the firm's capacity as a 
registered specialist or market maker upon an exchange. The Commission 
estimates that the annual TAF associated with ATS trading for some Non-
Member Firms would be as high as $3.2 million per year.\174\ 
Additionally, a substantial portion of Non-Member Firms' exchange-based 
activity may be subject to TAF as well.\175\ These estimates of TAF 
have substantial uncertainty. As discussed previously, the Commission 
believes that FINRA may need to consider revising its fee structure to 
reflect the business model of these firms and this may significantly 
affect their potential FINRA fee burden.\176\
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    \174\ TAF incurred for off-exchange activity for Non-Member 
firms would be unavoidable as the fee is currently structured. FINRA 
assesses it directly on FINRA members. TAF is discussed further in 
Section V.C.2.b.
    \175\ Schedule A of the FINRA By-Laws outlines which 
transactions are subject to the TAF. Generally, equity sales both on 
and off-exchange are subject to the TAF unless the member is acting 
in the capacity of a specialist or market maker on the exchange 
where the transaction was effected.
    \176\ See supra note 95. Under the current TAF schedule, Member 
Firms may realize some cost savings because they would no longer be 
assessed TAF when they buy shares from a Non-Member Firm off-
exchange. This is discussed further in Section V.B.3.
---------------------------------------------------------------------------

    Furthermore, FINRA currently cannot assess Non-Member Firms Section 
3 fees for off-exchange trading. The Section 3 fee is the second of two 
primary FINRA fees (the other being TAF) that are assessed upon each 
off-exchange sale by or through a FINRA member. Under Section 31 of the 
Act,\177\ SROs must pay transaction fees based on the volume of their 
covered sales. These fees are designed to offset the costs of 
regulation incurred by the government--including the Commission--for 
supervising and regulating the securities markets and securities 
professionals. FINRA obtains money to pay its Section 31 fees from its 
membership, in accordance with Section 3 of Schedule A to the FINRA By-
Laws. FINRA assesses these Section 3 fees on the sell side of each off-
exchange trade, when possible. When the sell side of an off-exchange 
transaction is a Non-Member Firm and the seller engages the services of 
a

[[Page 18055]]

clearing broker that is a Member Firm, FINRA can assess the Section 3 
fee against the Member Firm clearing broker.\178\ When the seller is a 
Non-Member Firm that self-clears, FINRA has no authority to assess the 
Section 3 fee against the seller. In such case, FINRA will seek to 
assess the fee against the buyer, if the buyer includes a Member Firm 
counterparty or a Member Firm acting as clearing broker for a Non-
Member Firm buy side counterparty. Given that any firm that carries 
customer accounts is required to be a member of an Association, firms 
that represent the trading of the investing public may bear the fees 
that would be otherwise assigned to Non-Member Firms trading 
proprietarily in the off-exchange market. These costs may be passed on 
to the investing public in whole or in part. Regardless of who 
ultimately bears the Section 3 fees, these Non-Member Firms may face 
lower off-exchange trading costs than Member Firms due to the 
allocation of these fees.
---------------------------------------------------------------------------

    \177\ 15 U.S.C. 78ee.
    \178\ The seller's clearing broker may pass that fee on to the 
Non-Member Firm.
---------------------------------------------------------------------------

B. Broad Economic Considerations, Including Effects on Efficiency, 
Competition and Capital Formation

    As discussed above, the Commission is proposing amendments to Rule 
15b9-1 to address the off-exchange trading activity that may not 
currently be subject to effective regulatory oversight that has 
developed with the advent of cross-market proprietary trading. In 
addition to the specific, individual benefits and costs discussed 
below, the Commission expects the proposed amendments to have several 
broad economic effects, including effects on efficiency, competition, 
and capital formation. These effects are described in this section.
1. Effects on Regulatory Supervision
    Non-Member Firms are significant contributors to off-exchange order 
and trade activity, yet are not under the jurisdiction of an 
Association that supervises off-exchange trading activity. The 
Commission preliminarily believes the current exemption of Non-Member 
Firms from Association membership undermines the effectiveness of 
regulatory supervision. For example, reliance by Non-Member Firms on 
the Rule 15b9-1 exemption leaves FINRA charged with responsibility for 
the off-exchange market without jurisdiction over broker-dealers that 
conduct a substantial amount of off-exchange trading activity. It also 
undermines the ability of an Association to apply a consistent set of 
conduct, supervisory, and other rules to off-exchange market 
participants, and to effectively surveil the trading activity of 
broker-dealers with a significant presence in the off-exchange 
market.\179\
---------------------------------------------------------------------------

    \179\ See supra notes 91-94 and accompanying text.
---------------------------------------------------------------------------

    As discussed further below, the Commission believes the proposed 
amendments will have a beneficial effect on the efficiency of 
regulation of the equity markets.\180\ In particular, some broker-
dealers are currently overseen by individual exchanges, which are not 
well-positioned to oversee the off-exchange and cross-market activity 
of the broker-dealer. Under the proposal, these broker-dealers would be 
supervised by an Association that has this expertise. This improvement 
in regulatory oversight of the off-exchange market should achieve more 
uniform and effective regulatory supervision of off-exchange and cross-
exchange trading practices by broker-dealers.
---------------------------------------------------------------------------

    \180\ See Section V.C.1.
---------------------------------------------------------------------------

    The Commission is aware that some of the 125 Non-Member Firms trade 
primarily on a single exchange in a floor-based capacity. For these 
firms, especially those with specialized business models that operate 
primarily on one exchange, their current exchange (not an Association) 
may be best equipped to provide efficient supervision. The Commission 
believes that many of these firms will not need to join an Association 
to comply with the proposed amendments.
2. Firm Response and Effect on Market Activity
    Although Non-Member Firms could seek to comply with the proposed 
amendments in multiple ways, each route could involve changes to firms' 
business models. Some Non-Member Firms limit their trading to exchanges 
of which they are members, and the Commission believes they do not 
trade off-exchange other than to hedge positions gained through floor 
broker activity. These firms will remain exempt from the requirement to 
become a member of an Association, if they comply with the Rule as 
proposed to be amended.\181\ Other firms will no longer be exempt, and 
will need to take action to comply with the amended rule. Under the 
revised Rule, a Non-Member Firm that trades off-exchange, or upon 
exchanges of which it is not a member, can comply in four ways. The 
first option would be to join an Association. This option does not 
require the Non-Member Firm to restrict its current trading practices 
beyond those necessary to comply with the rules of FINRA. The second 
option would be to join all exchanges upon which the Non-Member Firm 
wishes to trade, and to cease any off-exchange trading, other than off-
exchange trading consistent with the floor-broker hedging exemption. 
Third, a Non-Member Firm could comply by trading solely upon those 
exchanges of which it is already a member, consistent with the 
statutory exception in Section 15(b)(8).\182\ Finally, a Non-Member 
Firm could cease trading equity securities.
---------------------------------------------------------------------------

    \181\ Changes to the exclusion for proprietary trading are 
discussed in Section II.C. Changes to the proposed floor member 
hedging exemption are discussed in Section II.D.
    \182\ 15 U.S.C. 78o(b)(8).
---------------------------------------------------------------------------

    The changes Non-Member Firms make to their business model in order 
to comply with the amendments may affect competition in the market for 
off-exchange liquidity provision. In particular, Non-Member Firms may 
be less willing to compete to provide liquidity off-exchange, 
decreasing off-exchange liquidity. For example, Non-Member Firms may 
choose to cease their off-exchange activity rather than join an 
Association--although it seems likely that firms that trade heavily in 
the off-exchange market may find it less costly to join an 
Association.\183\ In addition, Non-Member Firms that choose to join an 
Association may reduce their off-exchange trading because joining an 
Association would increase variable costs to trade in the off-exchange 
market, as these trades will incur TAF and possibly additional Section 
3 fees.\184\ An increase in cost

[[Page 18056]]

would reduce the profitability of off-exchange trading and thus 
potentially reduce off-exchange trading.
---------------------------------------------------------------------------

    \183\ Firms that do not connect directly may trade on ATSs 
through a Member Firm at much lower activity levels. For firms with 
very limited off-exchange activity, ceasing off-exchange activity is 
likely to be less costly than joining an Association. The costs of 
joining FINRA are discussed in detail in Section V.C.2; for firms 
with very limited off-exchange activity, it is unlikely that the 
profits generated from this activity would offset FINRA membership 
costs. However, for firms that generate profits from off-exchange 
activities that exceed FINRA membership costs, it may be less costly 
for these firms to join FINRA than to cease their off-exchange 
activity. Firms with very low ATS activity are unlikely to directly 
connect to an ATS, instead accessing ATSs through a Member Firm.
     The Commission is unaware of any Non-Member Firms operating 
single dealer platforms upon which such firms could provide 
liquidity to orders routed by Member Firms outside of an ATS.
    \184\ As previously noted, FINRA may need to consider 
reevaluating the structure of the TAF to assure that it 
appropriately takes into account the business model of certain Non-
Member Firms that may join FINRA as a result of the proposed 
amendments. See supra note 95. The Commission's analysis of TAF is 
based on current TAF structure as outlined in the FINRA By-Laws, 
Schedule A. TAF and Section 3 fees are discussed further in Section 
V.C.2.b. Firms will also face additional fixed costs both to 
establish and maintain Association membership; those costs are 
discussed in Section V.C.2.
---------------------------------------------------------------------------

    The removal of this liquidity could either improve or degrade 
execution quality on ATSs.\185\ To the extent that institutional 
investors transacting in ATSs are seeking institutional investor 
counterparties that are not proprietary trading firms for their 
transactions, the removal of Non-Member Firm liquidity may be seen by 
some institutional investors as improving liquidity quality within 
ATSs.\186\ It is also possible that reducing the activity of Non-Member 
Firms within ATSs may result in more ATS liquidity, if Non-Member Firms 
are acting as net takers of liquidity within these systems.\187\ 
Regardless, liquidity levels in ATSs may change. In addition, these 
firms may reduce their off-exchange trading outside of ATSs such as on 
single-dealer platforms. It is possible that this will result in a 
transfer of volume from off-exchange venues to exchanges, but it is 
also possible that overall market trading volume will diminish if 
decreased volume from off-exchange trading does not migrate to 
exchanges.
---------------------------------------------------------------------------

    \185\ Non-Member Firms are likely to also reduce their off-
exchange trading outside of ATSs, such as on single-dealer 
platforms. However, Non-Member Firms can only take (not make) 
liquidity on these platforms. It is possible that additional off-
exchange liquidity may be available outside of ATSs as a result of 
the proposed amendments to Rule 15b9-1 due to a reduction in Non-
Member Firm trading on single dealer platforms.
    \186\ Industry white papers sometimes discuss the concept of 
natural counterparties for institutional trades. These papers may 
explicitly or implicitly identify proprietary automated trading 
firms as sources of information leakage in dark pools. See e.g., 
Mittal, Hitesh, Are You Playing in a Toxic Dark Pool? A Guide to 
Preventing Information Leakage, 2008 ITG white paper, available at 
http://www.itg.com/news_events/papers/ITGResearch_Toxic_Dark_Pool_070208.pdf, and Dark Pools and Toxicity 
Assessment, 2014, EY White Paper, available at http://www.ey.com/
Publication/vwLUAssets/Dark_pools_and_toxicity_assessment/$FILE/
Dark%20pools%20and%20toxicity%20assessment_FINAL_LR.pdf. Other 
industry participants describe a more benign role for automated 
trading firms as liquidity providers in ATSs. See High-Speed Traders 
Go Dark, 2012, Markets Media Commentary, available at http://marketsmedia.com/high-speed-traders-go-dark/.
    \187\ There is some evidence that proprietary electronic trading 
firms are net takers of liquidity in equity markets, although the 
evidence is not conclusive. Using NASDAQ data from 2008-2010, 
Carrion estimates that these firms supply liquidity to 41.2% of 
trading dollar volume and take liquidity in 42.2% of trading dollar 
volume. See Carrion, Al, 2013, ``Very fast money: High-frequency 
trading on the NASDAQ,'' Journal of Financial Markets 16, 680-711. 
Al Carrion currently serves as an Economic Fellow within the 
Division of Economic and Risk Analysis. Another study finds that 
electronic trading firms act as net liquidity suppliers during 
periods of extreme price movements. See Brogaard, Moyaert, Riordan, 
Shkilko and Sokolov, 2015, ``High Frequency Trading and Extreme 
Price Movements,'' working paper.
---------------------------------------------------------------------------

    Changes in business models for Non-Member Firms may affect market 
quality on exchanges as well. In addition to trading extensively in the 
off-exchange market, many Non-Member Firms are among the most active 
participants on exchanges. Business model changes by these firms may 
lead to less exchange liquidity for several reasons. First, Non-Member 
Firms that choose not to join an Association would no longer be able to 
rely on the rule and trade indirectly on exchanges of which they are 
not members.\188\ Second, Non-Member Firms that do not join an 
Association would no longer be able to access off-exchange liquidity to 
unwind positions acquired on exchanges, except as outlined in the floor 
member hedging exemption. This may reduce their willingness to provide 
liquidity upon exchanges.\189\ Third, Non-Member Firms that choose to 
join an Association may be subject to additional variable costs 
(primarily regulatory fees) on their exchange-based trading as well as 
on their off-exchange trading.\190\ These firms may respond by trading 
less actively on exchanges. Finally, Non-Member Firms may choose to 
cease trading equity securities rather than join an Association or 
change their business models. Reduced liquidity upon exchanges can 
result in higher spreads and increased volatility. Increased spreads on 
exchanges can lead to increased costs for off-exchange investors as 
well as investors transacting on exchanges, because most off-exchange 
transactions (including many retail executions) are derivatively priced 
with reference to prevailing exchange prices.
---------------------------------------------------------------------------

    \188\ Currently, a Non-Member Firm can indirectly access an 
exchange of which it is not a member through a firm that is an 
exchange member. In light of the proposed elimination of the 
exclusion for proprietary trading, this activity would not be 
consistent with the proposed amendments, unless the floor member 
hedging exemption or Regulation NMS routing exemption applies.
    \189\ These firms could unwind positions on other exchanges, but 
the cost to do so may be higher than if all liquidity, including 
off-exchange liquidity, were available.
    \190\ It is possible Non-Member Firms that choose to join an 
Association may avoid some additional costs by registering as market 
makers on additional venues, mitigating these charges. Furthermore, 
they may see a reduction in fees that were formerly paid to their 
DEA if FINRA assumes that role.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed amendments 
are not likely to have an economically meaningful effect on direct 
capital formation (the assignment of financial resources to meet the 
funding requirements of a profitable capital project, in this case, the 
provision of liquidity to financial markets). However, the Commission 
believes that the changes in allocation of regulatory fees and more 
efficient supervision within the off-exchange market may result in 
improved efficiency of capital allocation by the financial industry. 
Currently, Non-Member Firms face lower regulatory costs and a lower 
degree of regulatory scrutiny of their off-exchange trading activity 
than Member Firms. While the Commission believes that this imposes 
certain costs on other market intermediaries and the investors they 
represent, there is another externality as well: Over-commitment of 
liquidity both to exchanges and the off-exchange market.\191\ This 
over-commitment is likely to have some positive effects on capital 
markets, such as lower quoted spreads on exchanges. In addition to 
lowering immediate execution costs on exchanges, lower exchange quoted 
spreads are likely to reduce transaction costs off-exchange as well, 
because off-exchange trades are typically priced with reference to 
quoted exchange prices. Adoption of the proposed amendments may reduce 
the capital commitment of Non-Member Firms to equity market liquidity 
provision. It is possible that in response current Member Firms may 
choose to commit additional capital to liquidity provision when the 
trading environment has more uniform regulatory requirements. These 
reallocations of capital may improve or degrade levels of liquidity, 
spreads and volatility measures on exchanges and within the off-
exchange market.
---------------------------------------------------------------------------

    \191\ There is likely to be a corresponding underinvestment of 
capital somewhere else.
---------------------------------------------------------------------------

    The magnitude of these competitive effects is impossible for the 
Commission to determine at this time for a number of reasons. First, 
these effects involve strategic decisions by Non-Member Firms that the 
Commission cannot predict, and a competitive response that the 
Commission lacks information to anticipate. Second, even if the 
Commission could predict the likely changes in capital commitment by 
market participants, the Commission lacks information on how capital 
commitment by financial firms maps into market quality measures such as 
spreads, levels of liquidity, and execution costs.\192\ Due to the

[[Page 18057]]

complexity of the economic relationship between capital commitment and 
market quality measures, and inadequate information on individual 
firm's strategies, cost structures and likely competitive responses, 
the Commission cannot estimate the likely magnitude of these effects.
---------------------------------------------------------------------------

    \192\ The Commission has considered whether it is possible to 
model this response using current data to estimate these effects. 
Even if CAT data were available today, the Commission believes it 
would not have sufficient information for this estimation because 
information on the daily and perhaps intra-day change in committed 
capital levels is not available. Although the Commission has 
quarterly data on the net capital of broker-dealers, broker-dealers 
do not commit all of this capital to liquidity provision in equity 
markets. Furthermore, on a daily or more frequent basis, a liquidity 
provider may choose to fully or partially withdraw from the market 
for any reason.
---------------------------------------------------------------------------

3. Competition To Provide Liquidity Is Distorted by Regulatory Costs 
Borne by Only a Subset of Competitors, Member Firms
    Currently, Member Firms bear a number of costs not borne by Non-
Member Firms including a number of regulatory fees and indirect costs 
that are assessed or imposed upon Member Firms. These costs include 
direct costs such as trading fees that are either assigned only to 
Member Firms, such as TAF, or in the case of Section 3 fees, Member 
Firms may be assigned costs that potentially could be assigned to Non-
Member Firms selling securities off-exchange. There are indirect costs 
of disparate regulatory regimes as well. For example, Member Firms bear 
costs of interacting with regulators to accommodate supervision, and 
must comply with the rules of an Association as well as rules adopted 
by the Commission. This inequality in regulatory requirements may 
distort competitive forces in the market and these potential 
distortions may be mitigated by the proposed amendments to Rule 15b9-1, 
to the extent that Non-Member Firms join an Association and subject 
themselves to comparable fees and regulatory costs imposed on all other 
Member Firms.
    The existing differential regulatory burden of Member Firms and 
Non-Member Firms may have consequences with respect to market quality 
both for exchange-based and off-exchange trading. For example, because 
Non-Member Firms, ceteris paribus, currently face lower variable costs 
of trading compared to Member Firms, Non-Member Firms may be able to 
provide liquidity at a lower cost than Member Firms. Because a low-cost 
competitor may be able to quote at a price superior to that of his 
competitors, investors may incur lower transaction costs than if Non-
Member Firms faced the same costs as Member Firms. It may also reduce 
direct execution costs (such as quoted and effective spreads) for both 
exchange and off-exchange trades, the latter of which are normally 
derivatively priced with reference to prevailing exchange quotes. The 
differential regulatory burden, however, may also reduce depth at best 
prices because a Member Firm may not be able to trade profitably at a 
price established by a Non-Member Firm that faces lower regulatory 
costs. Lower liquidity at best exchange prices implies greater price 
effect of trades, which may increase trading costs, particularly for 
large orders. For example, if the best price on an exchange is 
associated with 100 shares of depth, a 200 share order will exhaust 
depth at the best price and the second 100 share lot will execute at an 
inferior price.\193\ If depth at best price tends to be larger, it is 
less likely that an order will exceed the depth available at the best 
price. The change in best price associated with an execution that 
exhausts the depth available at the best price is the price effect of 
the trade upon the exchange. Because the Commission does not have 
access to consolidated audit trail data, the Commission lacks data to 
quantify the percent of inside depth provided by Non-Member Firms and 
the frequency with which only Non-Member Firms are quoting the best 
price on an exchange. However, the high participation rate of Non-
Member Firms in exchange trading suggests they provide a significant 
fraction of exchange liquidity.\194\
---------------------------------------------------------------------------

    \193\ This assumes no hidden depth at the best price. If non-
displayed depth is present at the best price, the remaining 100 
shares will be filled at the best price if at least 100 shares of 
hidden depth exists at the best price.
    \194\ Participation rates of Non-Member Firms in exchange 
trading are discussed more fully in Section V.A.1.
---------------------------------------------------------------------------

4. Competitive Effects on Off-Exchange Market Regulation
    Currently, FINRA is the only Association. It is possible, however, 
for new Associations to enter the regulatory oversight market and 
compete with FINRA. The proposed amendments to Rule 15b9-1 may create 
incentives for a new Association (or Associations) to form. The large 
Non-Member Firms have commonalities in business models, for example, 
they typically do not carry customer accounts. They may consider 
joining an Association concurrently. Because these firms collectively 
conduct a significant portion of off-exchange volume, the creation of 
an Association tailored to these firms may be economically viable.
    To be registered as an Association, in addition to requirements 
that parallel the requirements to be a national securities exchange, an 
Association must ``[b]y reason of the number and geographical 
distribution of its members and the scope of their transactions'' be 
able to carry out the purposes of Section 15A.\195\ Additionally, for 
example, the Association must permit any registered broker-dealer that 
meets the Association's qualification standards to become a 
member,\196\ and it must have rules regarding the form and content of 
quotations relating to securities sold otherwise than on a national 
securities exchange that are designed to produce fair and informative 
quotations, to prevent fictitious or misleading quotations, and to 
promote orderly procedures for collecting, distributing and publishing 
quotations.\197\ The Association must also be so organized and have the 
capacity to enforce compliance by its members and persons associated 
with its members with, among other things, its own rules and the 
Exchange Act and the rules and regulations thereunder.\198\
---------------------------------------------------------------------------

    \195\ See 15 U.S.C. 78o-3.
    \196\ See 15 U.S.C. 78o-3(b)(3). Section 15A of the Exchange Act 
specifically states that an Association shall not be registered as a 
national securities association unless the Commission determines, 
among other things, that ``(3) . . . the rules of the association 
provide that any registered broker or dealer may become a member of 
such association and any person may become associated with a member 
thereof.''
    \197\ See 15 U.S.C. 78o-3(b)(11).
    \198\ See 15 U.S.C. 78o-3(b)(2).
---------------------------------------------------------------------------

    The ability to form an Association is characterized by barriers to 
entry. A new Association would likely incur significant fixed costs to 
create the infrastructure needed to perform the surveillance and 
oversight requirements imposed on Associations by statute and 
regulation. It may also incur substantial costs, including personnel, 
training, travel, and other costs to provide for an effective 
surveillance and supervision of the off-exchange market. Indeed, as 
previously discussed, the only existing Association, FINRA, has 
resources and demonstrated expertise that enable it to surveil and 
supervise the off-exchange market. Duplication of that infrastructure 
could be costly for a new Association.
    The proposed amendments may alter barriers to entry and thus affect 
the potential for competition among regulators of off-exchange markets. 
Currently the primary barrier to entry is the high fixed-cost involved 
in forming and operating an Association. If adopted, the amendments 
would bring nearly all off-exchange trading under the jurisdiction of 
an Association, including the trading of firms that currently are not 
members of an Association (Non-Member Firms). If these firms join the 
only existing Association, FINRA, an Association newly formed after 
this point may have increased difficulty attracting the members needed 
to support the high

[[Page 18058]]

fixed-costs associated with forming an Association because every 
broker-dealer that participates in the off-exchange market would 
already be a FINRA member. This increased difficulty results because 
many firms may be reluctant to change Associations, either because of 
the costs to change compliance infrastructures or uncertainty in the 
regulatory environment of the new Association. Thus, if the proposal 
results in more firms becoming members of the existing Association, a 
new Association could face increased difficulties attracting members in 
the future.
    The proposed amendments do, however, temporarily lower the barriers 
to entry for a competing Association. If these amendments are adopted, 
a number of firms with similar business models and substantial off-
exchange volume could contemplate Association membership concurrently. 
This may provide the incentive to create and tailor a new Association 
to specific business models of these firms. If a competing Association 
limited the scope of its members or operations, it might not have to 
duplicate all of the surveillance and supervision functions required to 
be provided by an Association that does not have those limits. This may 
lower the costs of forming an Association and alter the barriers to 
entry.\199\
---------------------------------------------------------------------------

    \199\ Some limitations on Association membership or operations 
would require exemptive relief for the Association to register with 
the Commission.
---------------------------------------------------------------------------

    The existence of multiple Associations might provide benefits to 
the market as a whole. If a new Association could provide high quality 
services to members with a lower fee structure, all Associations would 
have incentives to reduce fees to attract members. This could result in 
cost savings to broker-dealers. Second, a new Association could 
innovate to develop different surveillance and supervision methods that 
could be more efficient than FINRA's methods.
    Competition among Associations could also entail substantial costs. 
If a new Association were to form, the necessary regulatory 
infrastructure including Information Technology (``IT'') systems and 
personnel would need to be duplicated in the new Association. If the 
market for Associations is characterized by economies of scale, 
aggregate costs for the same level of regulation would be higher in a 
market with two Associations than in a market with a single 
Association. These additional costs would ultimately be borne by 
Associations' broker-dealer members. Second, Associations might compete 
on the basis of providing ``light touch'' regulation, in essence 
surveiling less and providing less supervision. As a result, the 
quality of market supervision might decrease, although the Commission 
does itself oversee self-regulatory organizations, such as 
Associations, and accordingly, would not permit a ``race to the 
bottom.'' \200\
---------------------------------------------------------------------------

    \200\ See Section 19(g) and Section 19(h) of the Exchange Act.
---------------------------------------------------------------------------

C. Consideration of Costs and Benefits

    This section discusses costs and benefits of the proposed 
amendments. While the Commission has attempted, where possible, to 
provide estimated quantifiable ranges, both costs and benefits are 
difficult to quantify for this proposal for a number of reasons. First, 
market participants are heterogeneous in their type, existing exchange 
memberships, and activity level in the off-exchange market. 
Consequently, compliance costs will vary across firms in a number of 
dimensions. Second, estimating costs is complicated by the fact that 
Non-Member Firms can comply with the proposal in a number of ways, and 
presumably each will choose to seek compliance in the manner that 
minimizes the sum of its direct costs (related to joining and 
maintaining memberships in additional SROs) and indirect costs (which 
include forgone opportunities to trade profitably and costs associated 
with revising business strategies). Furthermore, some firms are likely 
to remain exempt upon adoption of the proposed amendments, but the 
Commission lacks data to identify those firms with certainty.\201\ At 
the other end of the spectrum, the minority of Non-Member Firms that 
are large and contribute significantly to both exchange and off-
exchange trading are unlikely to remain exempt.\202\ For the 14 large 
firms that connect directly to ATSs, the Commission believes that all 
will lose their exempt status, but cannot predict how those firms will 
seek to comply with the proposed amendments. The Commission is unable 
to more precisely quantify the number of Non-Member Firms that will 
lose their exemption from Association membership upon adoption of the 
proposed amendments because it is unable to estimate the level of off-
exchange trading for the majority of the 125 Non-Member Firms. OATS 
reporting rules do not require Member Firms to disclose the identities 
of broker-dealers that submit orders to a Member Firm, making it 
infeasible to more precisely estimate non-ATS off-exchange trading for 
Non-Member Firms.
---------------------------------------------------------------------------

    \201\ Non-Member Firms that provide liquidity on multiple 
exchanges and trade heavily off-exchange are unlikely to be small in 
terms of net capital, and are not low trading volume firms by 
definition. However, as discussed in Section V.A.1, many Non-Member 
Firms are small in terms of net capital and may be members of a 
single exchange. Such firms are more likely to have a floor-
brokerage business model, or have limited exposure to off-exchange 
markets. Such firms would either be exempt from the rule by virtue 
of having no off-exchange trading or no trading on exchanges of 
which they are not members, or be able to rely on the floor member 
hedging exemption to continue their limited off-exchange trading 
related to floor brokerage activities.
    \202\ The diversity of Non-Member Firms is discussed in Section 
V.A.1.
---------------------------------------------------------------------------

    Quantifying costs is further complicated because Non-Member Firms 
do not report order audit trail data. It is difficult to measure the 
trading of individual firms, although their activity as a group is 
observable within audit trail data. Consequently, the Commission can 
measure the approximate overall contribution of Non-Member Firms to 
off-exchange volume, but cannot fully partition that volume across Non-
Member Firms.
    Some firms with substantial off-exchange trading activity may 
choose to change their business models rather than join an Association. 
If such firms ceased off-exchange activity, they would remain outside 
the supervision of an Association, and their decision to change 
business models may affect market quality both on and off-exchange. The 
Commission does not have ready access to statistics on the liquidity 
provision of Non-Member Firms on and off exchanges. As such, the 
Commission cannot quantify the potential changes in transaction costs, 
even under broad assumptions about how Non-Member Firms will change 
their business models. This is discussed further in Section V.B.2.
    The overall benefits of the proposed amendments relate to more 
comprehensive and uniform surveillance of off-exchange activity by the 
regulator best positioned to oversee such activity. The benefits the 
Commission anticipates from the amendments are largely qualitative and 
by their nature difficult to measure.
1. Benefits
    As discussed above,\203\ some of the firms using the existing Rule 
15b9-1 exemption are significant participants in overall off-exchange 
market volume. Thus, a substantial share of off-exchange volume is 
conducted outside of the regulatory jurisdiction of an Association that 
has primary responsibility for overseeing off-exchange activity.

[[Page 18059]]

Association membership would supplement the oversight of the exchanges, 
which typically do not examine the off-exchange activity of their 
members. This would further assist the Commission in obtaining a more 
complete picture of the activity that occurs on ATSs and elsewhere in 
the off-exchange market by entities that are not currently members of 
an Association. Investors and intermediaries benefit when a specialized 
expert regulates and oversees the off-exchange market.\204\ Investors 
participating in the off-exchange market currently do not fully realize 
the benefits of such expertise and regulatory oversight.
---------------------------------------------------------------------------

    \203\ See Section I.
    \204\ The off-exchange market is diverse and less transparent 
than exchanges. An exchange typically has a single matching engine 
for a given security and a limited number of order types that 
interact to create transactions while disseminating quote 
information publicly. The off-exchange market encompasses over 40 
ATS matching engines while more than half of off-exchange volume 
occurs outside of ATSs with transactions reported by more than 200 
market participants. Only a few of these ATS venues disseminate 
quote information. Surveillance and oversight of the off-exchange 
market requires proprietary data from thousands of market 
participants, and regulatory personnel with knowledge of the 
institutional detail of the workings of dozens of trading venues. At 
present, only FINRA possesses those resources. Further detail on 
off-exchange market trading is provided by Tuttle, Laura, 2014, 
Over-the-Counter Trading: Description of Non-ATS OTC Trading in 
National Market System Stocks, available at http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
---------------------------------------------------------------------------

    As discussed above,\205\ the Commission preliminarily believes the 
inclusion of more Non-Member Firms in an Association would improve such 
Association's ability to supervise cross-exchange trading activity. 
This would enhance regulators' ability and--through the information 
FINRA shares with the Commission--the Commission's ability to 
effectively oversee regulation of trading on multiple markets and of 
financial products.
---------------------------------------------------------------------------

    \205\ See supra Section I.B.
---------------------------------------------------------------------------

    The Commission also preliminarily believes that the proposed 
amendments to Rule 15b9-1 would improve supervision of Non-Member 
Firms. FINRA, currently the only Association, has substantial 
experience and expertise from overseeing a large number of broker-
dealers. This makes FINRA's potential regulation of Non-Member Firms 
with off-exchange or cross-market trading activity particularly 
efficient.
    The Commission preliminarily believes that this proposal provides 
significant benefits even in the event that the Commission approves the 
CAT NMS Plan.\206\ The CAT eventually may address the regulatory audit 
trail data deficiencies discussed previously,\207\ but the CAT will not 
address FINRA's lack of jurisdiction over Non-Member Firms 
participating in the off-exchange markets, which FINRA is charged with 
overseeing, and the need for that enhanced oversight.
---------------------------------------------------------------------------

    \206\ See CAT Release, supra note 86.
    \207\ See supra note 170.
---------------------------------------------------------------------------

    While current members of an Association would not be directly 
affected by this rule, they would benefit by having a more level 
playing field in terms of their regulatory requirements relative to 
Non-Member Firms. Currently, competition in liquidity provision in 
equity markets is distorted by inequalities in regulatory 
requirements.\208\ With more uniform regulatory requirements and 
oversight, firms may compete more equitably to supply liquidity both on 
exchanges and off-exchange.
---------------------------------------------------------------------------

    \208\ See Section V.B.3.
---------------------------------------------------------------------------

2. Costs
    The proposed amendments, by narrowing the existing exemption, would 
result in broker-dealers that no longer qualify for the exemption 
having to comply with Section 15(b)(8) by either limiting their trading 
to exchanges of which they are members or joining an Association. Under 
the proposed amendments, therefore, Non-Member Firms that choose to 
continue any off-exchange activity will be faced with choices that 
would involve corresponding costs. For example, Non-Member Firms may 
incur costs related to membership in an Association or costs 
necessitated by additional exchange memberships. Additionally, some 
Non-Member Firms may incur the costs of losing the benefits of trading 
in the off-exchange market if they decide not to join an Association.
    Most of the costs incurred in joining an Association and 
maintaining membership therein are dependent on firm characteristics 
and activity level. Furthermore, the Commission believes that some Non-
Member Firms may comply by ceasing their off-exchange trading activity, 
avoiding many of these costs but forgoing the opportunity to trade 
profitably in some venues. With certain assumptions, the Commission has 
attempted to estimate direct compliance costs that a Non-Member Firm is 
likely to face to comply with the proposed amendments. The estimate 
applies to the 14 Non-Member Firms that connect directly to ATSs; 
smaller firms that choose to join an Association should face lower 
costs because they have less revenue and trading volume that would be 
subject to GIA, TAF and Section 3 fees. The 14 Non-Member Firms that 
connect directly to ATSs, assuming that trading volumes and gross 
income levels remain unchanged, would face implementation costs of 
approximately $3.3 million per firm, with ongoing annual costs ranging 
from about $2.3 million to $23 million depending on the firms' off-
exchange trading volume.\209\ Cost estimates (one time and annual) are 
broken down in the following tables and are discussed in detail below:
---------------------------------------------------------------------------

    \209\ The largest contributor to the estimate of implementation 
and ongoing costs is the cost of OATS reporting. Estimates for OATS 
reporting costs are taken from the CAT NMS Plan and relate to 
implementing CAT reporting, which is expected to be more complex and 
have more stringent requirements related to technology, such as more 
stringent clock synchronization, than OATS reporting requires. 
Consequently, the Commission believes these likely are overestimates 
of actual costs firms will face to implement OATS reporting. See 
infra note 221 for further information on CAT NMS Plan cost 
estimates. Each of the 14 firms is assumed to have implementation 
costs of $3,160,000 to initiate OATS reporting, $82,500 in legal 
consulting costs, and an application fee ranging from $7,500 to 
$12,500 depending on the number of registered persons. The 
Commission derived these estimates from the CAT NMS Plan. See infra 
note 221 and accompanying text for qualifiers on these estimates.

          Table 1--Median or Average Firm Implementation Costs
------------------------------------------------------------------------
                                                             Median or
                          Cost                             average \210\
------------------------------------------------------------------------
Application to join FINRA...............................          $7,500
Implement OATS reporting................................       3,160,000
Legal consulting........................................          82,500
                                                         ---------------
    Total...............................................       3,250,000
------------------------------------------------------------------------


       Table 2--Median or Average Firm Ongoing Annual Costs \211\
------------------------------------------------------------------------
                                                             Median or
                          Cost                                average
------------------------------------------------------------------------
OATS reporting..........................................      $2,280,300
Gross Income Assessment.................................         113,000
Trading Activity Fee....................................          40,000
Personnel Assessment....................................               0
Section 3 fee...........................................         212,000
Compliance work.........................................          60,000
                                                         ---------------
    Total...............................................       2,705,300
------------------------------------------------------------------------

    If all 14 of those Non-Member Firms that connect directly to ATSs 
were to

[[Page 18060]]

join FINRA, the aggregate cost of the proposal for these firms would be 
$42.5 million in implementation costs and ongoing aggregate annual 
costs of $85.2 million, with the majority of the costs related to 
implementing OATS reporting.\212\ While the Commission is unable to 
aggregate the costs of the proposal for the remaining 111 firms, the 
Commission believes that the aggregate costs for the subset of 14 
represent the majority of the aggregate costs, even assuming that all 
125 firms will join FINRA.\213\
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    \210\ Medians are used where possible. For OATS-related costs, 
median values are zero, so averages are used. This data is discussed 
further in note 219, infra. Cost estimates are reported as ranges 
for legal consulting and compliance work; for these estimates, the 
midpoint is used.
    \211\ TAF is underestimated because it accounts for only ATS 
volume. See infra note 231 and accompanying text. This TAF cost also 
represents a transfer from current Non-Member Firms to current 
Member Firms. The Section 3 fee estimate assumes that the firms 
currently pay no Section 3 fees. It is likely that firms that clear 
through a Member Firm are currently assessed these fees indirectly.
    \212\ See supra note 209 and infra note 221 related to OATS 
reporting costs derived from the CAT NMS Plan. The total cost 
calculation assumes range midpoint costs for FINRA application, 
legal consulting, and compliance work, as well as maximum costs for 
implementation of OATS reporting. GIA, TAF, and Section 3 fees are 
calculated using firm share and dollar volume activity estimates 
from FINRA data discussed further in Section V.A.1.
    \213\ The data provided to the Commission by FINRA describes the 
aggregate ATS activity level of all 125 Non-Member firms. Further 
firm-level data for the 14 firms that directly connect to ATSs can 
be inferred using exchange MPIDs that are reported by some ATSs. 
Because these 14 direct-connecting firms account for the majority of 
Non-Member Firm ATS activity, the Commission believes that the 111 
remaining firms have much lower ATS (and presumably other off-
exchange) activity levels. Since transacted volume is the primary 
driver of the variation in costs across firms that join FINRA, the 
Commission believes that the remaining 111 firms will face far lower 
costs if they choose to join FINRA.
---------------------------------------------------------------------------

a. Costs of Joining an Association \214\
---------------------------------------------------------------------------

    \214\ The Commission recognizes that Non-Member Firms would 
incur compliance costs on an initial and ongoing basis to comply 
with the proposed amendments. See Section V.C.2.a. The Commission 
does not aggregate these costs across all Non-Member Firms because 
the Commission does not have necessary information about the 
majority of the Non-Member Firms and expects that costs would vary 
widely across firms. Where possible, however, the Commission has 
provided estimates based on a subset of large firms on which the 
Commission has sufficient information. The Commission expects that 
smaller firms likely will face lower costs.
---------------------------------------------------------------------------

    Based on discussions with FINRA, currently the only Association, 
and industry participants, the Commission preliminarily believes that 
the direct compliance costs on Non-Member Firms of joining FINRA are 
composed of the FINRA membership application fees, costs associated 
with adapting IT infrastructure for regulatory data reporting 
requirements, and any legal or consulting costs necessary for 
effectively completing the application to be a member of FINRA (e.g., 
ensuring compliance with FINRA rules including drafting policies and 
procedures as may be required).
    The fees associated with a FINRA membership application can vary. 
As an initial matter, the application fee to join FINRA is tier-based 
according to the number of registered persons associated with the 
applicant. This one-time application fee ranges from $7,500 to 
$55,000.\215\ The initial membership fee for FINRA is $7,500 for firms 
with ten or fewer representatives registered with FINRA and $12,500 for 
firms with eleven to one hundred representatives registered with 
FINRA.\216\ Based on its knowledge of the size and business models of 
Non-Member Firms, the Commission preliminarily believes that most Non-
Member Firms would not incur FINRA application fees exceeding 
$12,500.\217\
---------------------------------------------------------------------------

    \215\ See FINRA By-Laws, Schedule A, Section 4.
    \216\ Id.
    \217\ Based on current FOCUS data, the Commission believes no 
Non-Member Firm has more than 100 registered representatives.
---------------------------------------------------------------------------

    Because most FINRA members have OATS reporting obligations, Non-
Member Firms that choose to join FINRA will incur costs related to 
initiating and maintaining data reporting.\218\ Costs to initiate and 
maintain OATS reporting \219\ will vary widely among firms, depending 
on many factors including current IT infrastructure, complexity, and 
affiliation with a firm that already reports OATS data. While we are 
unable to quantify these costs precisely, one point of reference for 
the possible costs associated with OATS reporting obligations is the 
CAT NMS Plan, that provides estimates of these costs for reporting CAT 
data. There are limitations, however, to those estimates in this 
context in that CAT is an order audit system that will be significantly 
more complex and larger in scope than OATS.\220\ Because the projected 
scope of CAT exceeds substantially the scope of OATS reporting, and 
implementation of CAT reporting is expected to include technical 
requirements such as more stringent clock synchronization requirements 
than OATS, the Commission believes these estimates provide (at best) an 
upper-bound for OATS reporting costs. Furthermore, Non-Member Firms 
that are members of NASDAQ or NYSE are already required to produce OATS 
data and report it to FINRA upon request. Consequently, implementation 
costs likely overstate the costs these firms would face in initiating 
OATS reporting because the Non-Member Firms may have already 
established some of the necessary infrastructure. In addition, the 
Commission recognizes that the CAT NMS Plan estimates are based on 
voluntary survey responses by a small number of broker-dealers. 
Finally, the CAT NMS Plan has not yet been published for comment. 
Nevertheless, the Commission believes that those estimates give a sense 
of the potential magnitude of initiating OATS reporting.
---------------------------------------------------------------------------

    \218\ See FINRA Rule 7400 Series--Order Audit Trail System.
    \219\ Pursuant to Rule 613 under the Exchange Act, the SROs have 
submitted a plan to eliminate existing rules and systems that will 
be rendered duplicative by the CAT. 17 CFR 242.613(a)(1)(ix). To the 
extent that OATS is rendered duplicative by CAT, the CAT NMS Plan 
proposes its elimination, and the Commission approves the CAT NMS 
Plan, the OATS system may eventually be eliminated. If this occurs, 
the costs of OATS reporting to Non-Member Firms may cease, but may 
be supplanted by other costs related to order and transaction 
reporting requirements under the CAT NMS Plan.
    \220\ The CAT NMS Plan proposal discusses OATS reporting 
requirement. These requirements include having revenue of less than 
two million dollars. The Commission believes that large Non-Member 
Firms would not qualify for OATS reporting exemptions, were the 
Commission to approve the CAT NMS Plan as submitted on February 27, 
2015. See CAT NMS Plan, available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p602500.pdf.
---------------------------------------------------------------------------

    The CAT NMS Plan details cost estimates for two types of broker-
dealers. The first type already reports OATS data; the second type does 
not. The Commission focuses on costs for large firms that do not 
currently report OATS data. In these estimates, the average large firm 
estimated CAT implementation costs are approximately $3,160,000; 
average implementation costs for a small firm are estimated at 
approximately $131,200. The average large firm estimated annual CAT 
reporting costs are $3,160,000 annually; average small firm reporting 
costs are $121,200.\221\ As discussed previously, these are, at best, 
upper-bounds on OATS reporting costs because of differences in 
complexity and technical requirements for OATS and CAT reporting.
---------------------------------------------------------------------------

    \221\ Costs estimates are the sum of hardware/software costs, 
full time employee costs, and third party/outsourcing costs for 
firms that do not currently report to OATS. Within these firms, 
median implementation and annual ongoing costs were estimated at 
zero. The CAT NMS plan discusses interpretation of the zero medians, 
saying ``It is the participants' understanding that this is likely 
due to current operational practices among broker-dealers that do 
not differentiate between technology and headcount costs that 
support business functionality and regulatory reporting.'' 
Consequently, the Commission believes these estimates do not reflect 
the opportunity costs associated with assigning employees to 
regulatory reporting tasks instead of other tasks they could be 
performing. See the amended CAT NMS Plan, available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p602500.pdf.
---------------------------------------------------------------------------

    In addition to the application fees and data reporting costs, the 
Commission has taken into account the cost of legal and other advising 
necessary for effectively completing the application to

[[Page 18061]]

be a member of FINRA. Some firms may choose to perform this legal work 
internally while others may use outside counsel for the initial 
membership application. In making this choice, Non-Member Firms will 
likely take into account factors, such as the size and resources of the 
firm, the complexity of the firm's business model, and whether the firm 
previously used outside counsel to register with any exchanges. Based 
on conversations with industry participants that assist with FINRA 
membership, for Non-Member Firms that choose to employ outside counsel 
to assist with their FINRA membership application, the cost of such 
counseling ranges from approximately $40,000 to $125,000. Factors 
affecting the specific costs of a particular firm include the number of 
associated persons, the level of complexity or uniqueness of the firm's 
business plan, and whether the firm has previously completed exchange 
membership applications with similar requirements.
b. Costs of Maintaining an Association Membership
    With respect to ongoing costs, the Commission preliminarily 
believes that the three components of such costs are any ongoing fees 
associated with FINRA membership, costs of legal work relating to FINRA 
membership, and costs associated with additional compliance activities.
    The ongoing membership related fees associated with FINRA 
membership include the annual gross income assessment; the annual 
personnel assessment; and the TAF and Section 3 fees, among others. The 
more significant fees are discussed below.\222\
---------------------------------------------------------------------------

    \222\ There are additional fees associated with maintaining an 
Association membership. There is an annual Personnel Assessment fee 
ranging from $130 to $150 per employee that applies to principals or 
representatives in the FINRA member's organization. See FINRA By-
Laws, Schedule A, Section 1(e). Based on 2014 FOCUS reports, the 
number of registered representatives of Non-Member Firms that 
connect directly to ATSs ranges from 0-91, with an average of 18 and 
a median of 0. The Commission estimates that the average Non-Member 
Firm would incur a Personnel Assessment fee of no more than $2,520, 
and the median Non-Member Firm would incur a Personnel Assessment 
fee of $0. The Commission further estimates that the maximum 
Personnel Assessment fee that one of these Non-Member Firms would 
incur would be $11,830. There are also additional continuing 
education and testing requirements which will impose costs upon 
firms joining an Association. Additionally, there are de minimis 
fees (branch registration fee and system processing fee, among 
others). See FINRA By-Laws, Schedule A.
---------------------------------------------------------------------------

    The annual Gross Income Assessment generally requires members to 
pay a percentage of the Member Firm's total annual revenue based on a 
graduated scale.\223\ The magnitude of the annual Gross Income 
Assessment is based on the total annual revenue, excluding commodities 
income, reported by the Member Firm on its FOCUS Form Part II or 
IIA.\224\ Based on FOCUS Form data from Non-Member Firms in 2014, the 
Commission has determined that the average annual total revenue of Non-
Member Firms, excluding commodities income, is approximately $93 
million, with a median of $86 million.\225\ For the 14 large firms that 
connect directly to ATSs, FINRA's graduated Gross Income Assessment 
scale results in an average Gross Income Assessment for these Non-
Member Firms of $91,784 and a median Gross Income Assessment of 
$113,824.\226\
---------------------------------------------------------------------------

    \223\ Id. For example, FINRA imposes a Gross Income Assessment 
as follows: (1) $1,200 on a Member Firm's annual gross revenue up to 
$1 million; (2) a charge of 0.1215% on a Member Firm's annual gross 
revenue between $1 million and $25 million; (3) a charge of 0.2599% 
on a Member Firm's annual gross revenue between $25 million and $50 
million; and so on as provided in Schedule A. When a firm's annual 
gross revenue exceeds $25 million, the maximum of current year's 
revenue and average of the last three years' revenue is used as the 
basis for the income assessment. Id.
    \224\ See FINRA By-Laws, Schedule A, Section 2. See also FOCUS 
Report Form X-17A-5, Part II and IIA.
    \225\ Based on 2012-2014 FOCUS data.
    \226\ ($1,200 for the first $1 million of revenue) + (0.1215% x 
annual revenue greater than $1 million up to $25 million) + (0.2599% 
x annual revenue greater than $25 million up to $50 million) + 
(0.0518% of annual revenue greater than $50 million up top $100 
million) + (0.0365% of annual revenue greater than $100 million to 
$5 billion). As discussed previously, Non-Member Firms vary in size. 
GIA for large firms used in these calculations (the 14 that connect 
directly to ATSs), is anticipated to be far larger than for the 111 
remaining Non-Member Firms. See FINRA By-Laws, Schedule A, Section 
1(c).
---------------------------------------------------------------------------

    The magnitude of the TAF depends on the transaction volume of a 
FINRA member that is covered by TAF as described in the FINRA 
Bylaws.\227\ The Commission notes that FINRA may need to consider 
reevaluating the structure of the TAF to assure that it appropriately 
takes into account the business models of Non-Member Firms that may 
join FINRA as a result of the proposed amendments.\228\ Although the 
Commission lacks the data to comprehensively estimate TAF that Non-
Member Firms are likely to incur, data on ATS trading during the fourth 
quarter of 2014 provided by FINRA allows the Commission to estimate the 
fees associated with ATS activity for Non-Member Firms that connect 
directly to an ATS.\229\ The Commission has identified 14 Non-Member 
Firms that traded on ATSs directly without the intermediation of a 
Member Firm during the fourth quarter of 2014.\230\ The Commission 
estimates that trading activity fees incurred by these 14 large Non-
Member Firms due to their ATS activity would range from $0 to 
approximately $3.2 million annually, with a median incurred TAF of 
around $40,000.\231\ The Commission believes that TAF for Non-Member 
Firms not among the 14 identified will be far lower because the median 
Non-Member Firm has far lower trading volume than the typical firm of 
the 14 identified in the data.
---------------------------------------------------------------------------

    \227\ See FINRA By-Laws, Schedule A, Section 1(b).
    \228\ See supra notes 95 and 184.
    \229\ Some Non-Member Firms may trade on ATSs indirectly using 
the services of a Member Firm. The Commission cannot identify the 
magnitude of these firms' trading on an individual basis because 
Non-Member Firms are not required to be identified in Member Firms' 
OATS data. The Commission thus cannot estimate the TAF that these 
firms would incur as FINRA members.
    \230\ These 14 firms do not represent typical Non-Member Firms: 
they represent the largest of the Non-Member Firms in terms of 
trading volume. Consequently, the median TAF discussed here far 
exceeds what the majority of Non-Member Firms would pay if they were 
to join FINRA.
    \231\ Estimated TAF does not include any TAF related to firm's 
exchange-based trading activity, or off-exchange activity that 
occurs outside of an ATS. If a firm's activity on an exchange is 
related to normal market making operations, the activity does not 
incur TAF. The Commission is unable to estimate the proportion of 
these firms' exchange trading that would incur TAF because the 
Commission does not have information on what proportion of Non-
Member Firm exchange activity would qualify for exemption from TAF 
fees under FINRA By-Laws. Because other elements of the TAF are not 
included in this calculation, it underestimates the actual TAF that 
firms would incur if they joined FINRA. The magnitude of the 
underestimation may be significant, but firms that join FINRA may be 
able to reduce their TAF cost by registering as Market Makers upon 
additional exchanges. (TAF is not assessed for certain trades 
related to registered market-making. See FINRA By Laws, Schedule A, 
Section (1)(b)(2)(F).) Estimates of TAF are based on the percentage 
of ATS orders received by Member Firms that operate an ATS and 
report the exchange-issued MPIDs of Non-Member Firms that place 
orders within that system. The calculation assumes that these 
proportions are representative of the trading of Non-Member Firms on 
all ATSs, and that the orders placed by these firms are equally 
likely to be executed within ATSs. It also assumes that half of all 
executed volume is sell volume, which incurs a TAF. The estimated 
TAF is equal to estimated sell volume x $0.000119. The $0 minimum is 
associated with a firm that has almost no ATS volume.
---------------------------------------------------------------------------

    Some off-exchange trading that Non-Member Firms engage in currently 
may no longer be profitable when TAF is incurred. Consequently, Non-
Member Firms may reduce their trading both on exchanges and off-
exchange after joining an Association.
    In addition to TAF, Non-Member Firms that choose to join FINRA may 
incur additional Section 3 fees. Using data on ATS trading during the 
fourth quarter of 2014 provided by FINRA, the Commission estimates that 
Section 3 fees incurred by the 14 large Non-Member Firms due to their 
off-exchange

[[Page 18062]]

trading would range from $0 to approximately $16.9 million dollars 
annually, with a median incurred Section 3 fee \232\ of $212,000.\233\ 
As discussed in Section V.A.2 above, some of these fees may already be 
paid by Non-Member Firms that engage the services of a Member Firm 
clearing broker. However, FINRA lacks the authority to assess Section 3 
fees against Non-Member Firms that self-clear, in which case FINRA may 
assess the fee to the Member Firm counterparty to the transaction. 
While these fees will represent a cost to Non-Member Firms, the cost 
will be largely offset to the industry as a whole by a reduction of 
Section 3 fees incurred by Member Firms (or clearing brokers acting on 
behalf of a Member Firm) when they buy from a self-clearing, Non-Member 
Firm.
---------------------------------------------------------------------------

    \232\ These estimates do not include fees related to off-
exchange trading outside of an ATS; the Commission is unable to 
estimate the magnitude of such fees that Non-Member Firms would 
incur if they were to continue trading off-exchange upon adoption of 
these amendments because in the absence of a consolidated audit 
trail, the Commission lacks data on Non-Member Firm off-exchange 
activity outside of ATSs.
    \233\ Section 3 fees are estimated using Non-Member Firm off-
exchange dollar volume reported by FINRA. Half of volume is assumed 
to be sell volume that would be subject to Section 3 fees. Aggregate 
estimated sell volume is estimated across firms by assuming that all 
non-member orders are equally likely to generate executions. For 
example, assume firm ABC submitted 10% of all off-exchange orders 
submitted by Non-Member Firms. Section 3 Fee obligation is 
calculated as: Non-Member Firm Dollar Volume x \1/2\ x 10% x $18.40/
$1,000,000.
---------------------------------------------------------------------------

    Ongoing compliance costs would depend on the business circumstances 
of each firm and the types of issues that could arise. As in the case 
of the initial membership, some Non-Member Firms may choose to conduct 
ongoing compliance activities other than regulatory data reporting work 
(such as core accounting functions, updating policies and procedures, 
and updating forms filed with regulators) in-house while others may 
seek to outsource this work. The Commission estimates, based on 
discussions with industry participants, that the ongoing compliance 
cost for firms that outsource this work will range from $24,000 to 
$96,000 per year.\234\ In the case of some Non-Member Firms, i.e., 
those that are affiliates of FINRA members, this cost is likely to be 
lower as they may be able to leverage compliance work already being 
performed.
---------------------------------------------------------------------------

    \234\ For firms that choose to do this work in-house, the 
Commission preliminarily believes that the costs of ongoing 
compliance may be less than $96,000. This figure assumes Non-Member 
Firms may have experience in ongoing compliance work with SROs 
through their exchange membership(s) and, therefore, only captures 
the incremental cost of compliance with Association rules.
---------------------------------------------------------------------------

    In addition to the cost estimates discussed above, the Commission 
recognizes that both Non-Member Firms and SROs will incur other direct 
and indirect costs because of the increased regulatory requirements of 
the proposed amendments. Specifically, there will be compliance costs 
associated with regulation by FINRA.\235\ Generally, the SROs that 
supervise Non-Member Firms are unable to provide the level of 
supervision of cross-market and off-exchange activity that FINRA 
provides to its Member Firms. Consequently, firms that join an 
Association will face costs associated with greater regulatory 
scrutiny, including the costs of comprehensive examinations of activity 
that was previously subject to less regulatory review. To the extent 
that this activity is permissible under Association rules, additional 
costs will be limited to those activities that are required to 
accommodate normal supervision and examination by an Association. To 
the extent that their activity does not already do so, firms will face 
additional costs related to bringing activity into compliance with 
Association rules. For the reasons discussed above, the Commission is 
not able to estimate these costs, although the Commission believes they 
will vary among Non-Member Firms.
---------------------------------------------------------------------------

    \235\ However, Non-Member Firms that choose to join an 
Association may have FINRA assigned as their DEA. Such an assignment 
could eliminate separate DEA fees that the Non-Member Firms may pay 
to their current DEA.
---------------------------------------------------------------------------

c. Costs of Joining Additional Exchanges Under the Rule as Proposed To 
Be Amended
    Non-Member Firms must be members of all exchanges upon which they 
transact business if they decide not to join an Association. With 
limited exceptions for some excluded activity previously discussed, 
some Non-Member Firms may choose to join additional exchanges to be 
excluded from the requirement to become a member of an Association. 
Alternatively, these firms may cease trading on exchanges of which they 
are not members.
    Based on discussions with FINRA and industry participants, the 
Commission understands that completing a membership application with an 
additional exchange is generally less complicated and time consuming 
than completing a membership application with FINRA. Consequently, the 
Commission preliminarily believes that the compliance burden on Non-
Member Firms for joining an additional exchange is likely to be 
significantly less than that of joining FINRA as those Non-Member Firms 
that choose to join an additional exchange are likely able to perform 
this work internally, given that they are already members of at least 
one exchange, and that such work should take less time than the time 
required to complete an application with FINRA.
    In addition to the legal burden, Non-Member Firms joining 
additional exchanges as a result of the proposed amendments would incur 
membership and related fees. To the extent that Non-Member Firms choose 
to become members of additional exchanges, the fees associated with 
such memberships would vary depending on the type of access sought and 
the exchanges of which Non-Member Firms choose to become members.
    The Commission also believes that the exchange membership fees that 
would apply to Non-Member Firms joining such exchanges would be those 
fees that apply to either introducing broker-dealers or proprietary 
trading firms. This assumption is consistent with the fact that any 
broker-dealers carrying customer accounts could not qualify for the 
current exemption of Rule 15b9-1. Thus, any exchange membership fees 
that apply to firms that provide clearing services or conduct a public 
business would not apply to Non-Member Firms.
    Furthermore, because all Non-Member Firms are members of at least 
one exchange,\236\ they would have already completed a Form U4, to 
register associated persons.\237\ Although FINRA's rules regarding 
registration of associated persons tend to be more specific than 
exchange SRO rules regarding associated persons, the Commission 
believes Non-Member Firms will not need to register additional 
associated persons because the exchange SRO rules are already 
comprehensive in this regard. The Commission understands that all 
exchanges can access the Form U4 filings within the CRD which is 
maintained by FINRA.
---------------------------------------------------------------------------

    \236\ For a broker-dealer to possibly be exempt from the 
requirement to be an Association member currently or under the 
proposed amendments, the broker-dealer must be a member of at least 
one exchange.
    \237\ Form U4 is the Uniform Application for Securities Industry 
Registration or Transfer. Representatives of broker-dealers, 
investment advisers, or issuers of securities use Form U4 to become 
registered in the appropriate jurisdictions and/or with SROs. The 
Commission understands that all SROs currently use Form U4. See, 
e.g., BATS Rule 2.5.01(c), ISE Rule 304(b), Phlx Rule 600(b).
---------------------------------------------------------------------------

    In order to obtain estimates of the cost of joining additional 
exchanges, the Commission reviewed the membership

[[Page 18063]]

related fee structures of all eighteen national securities exchanges. 
In assuming that the potential burden of joining additional exchanges 
would likely be less than that of joining FINRA, the Commission assumes 
that the costs imposed on Non-Member Firms by the proposed amendments 
would be membership fees, not costs relating to trading, such as 
trading permit fees and connectivity. The Commission recognizes that 
membership in an exchange, alone, may not guarantee the ability to 
trade because many exchanges charge fees for trading rights, ports, 
various degrees of connectivity, and floor access and equipment, should 
those be desired. The Commission believes that the fees associated with 
trading on an exchange are not the result of the proposed amendments 
because, under the proposed amendments, a Non-Member Firm could 
continue to trade through another broker-dealer on an exchange as long 
as that Non-Member Firm is a member of every exchange on which it 
trades or is a member of FINRA. In other words, the proposed amendments 
themselves do not impose the cost of connectivity and related fees, but 
only the costs associated with membership on exchanges on which Non-
Member Firms will trade. To the extent, therefore, that Non-Member 
Firms continue to trade through other broker-dealers in a manner 
consistent with how they currently operate, the proposed amendments 
impose only the costs associated with membership.
    The Commission also recognizes that connectivity fees to additional 
exchanges can range from the very low--approximately $500 a month for a 
workstation at NASDAQ--to upwards of $100,000 monthly, depending on 
factors such as latency, distance, bandwidth, and co-location, among 
others. Again, however, these costs are not a result of the proposed 
amendments because the proposed amendments do not impose any 
connectivity requirements. They simply impose membership requirements 
to facilitate regulatory supervision.
    To arrive at preliminary estimates of the cost of joining 
additional exchanges, the Commission aggregated any fees associated 
with a firm's initial application to an exchange (``initial fee'') and 
separately aggregated the fees associated with any monthly or annual 
membership costs to obtain a separate annual cost (``annual fee''). 
Based on these aggregations, the Commission obtained a preliminary 
range for both the initial fee and the annual fee across exchanges. The 
initial fee is as low as $0 for some exchanges. Most exchanges have an 
initial fee that is greater than $0 and no more than $5,000.\238\
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    \238\ The BATS Exchanges do not assess any initial fees. See 
BATS BYX Exchange Fee Schedule, available at http://www.batstrading.com/support/fee_schedule/byx/ (last visited February 
18, 2015) (omitting any mention of an initial membership fee); BATS 
BZX Exchange Fee Schedule, available at http://www.batstrading.com/support/fee_schedule/bzx/ (last visited February 18, 2015) (same); 
BATS EDGA Exchange Fee Schedule, available at http://www.batstrading.com/support/fee_schedule/edga/ (last visited 
February 18, 2015) (same); BATS EDGX Exchange Fee Schedule, 
available at http://www.batstrading.com/support/fee_schedule/edgx/ 
(last visited February 18, 2015) (same).
     Other exchanges do have initial application fees. See, e.g., 
ISE Fee Schedule at 19, available at http://www.ise.com/assets/documents/OptionsExchange/legal/fee/ISE_fee_schedule.pdf (last 
visited February 18, 2015) (assessing a one-time application fee of 
$3,500 for an ``Electronic Access Member''); application for NYSE 
and NYSE MKT Equity Membership for Non-FINRA Members at 2, available 
at http://usequities.nyx.com/sites/usequities.nyx.com/files/nyse__mkt_equity_membership_application_for_non-finra_members.pdf 
(last visited February 18, 2015) (discussing the Non-Public Firm 
Application Fee of $2,500); NASDAQ Price List, available at http://www.nasdaqtrader.com/Trader.aspx?id=PriceListTrading2 (last visited 
February 18, 2015) (discussing the NASDAQ Application Fee of 
$2,000); CBOE Fee Schedule at 10, available at http://www.cboe.com/publish/feeschedule/CBOEFeeSchedule.pdf (last visited February 18, 
2015) (typically assessing a trading permit holder organization 
application fee on all of its members of $5,000). If a firm is 
organized as a sole proprietorship, the application fee for CBOE is 
only $3,000. Id. See also CBOE TPH Organization Application Timeline 
and Needs List, available at https://www.cboe.org/publish/TPHForms/TPHOrganizationApplicationTimelineandNeeds.pdf (last visited 
February 18, 2015).
---------------------------------------------------------------------------

    Regarding monthly or annual membership fees, most exchanges' 
ongoing monthly or annual membership fees generally range from $1,500 
to $7,200.\239\ Again, these ongoing exchange membership costs are 
generally lower than the annual costs estimated for being a member of 
FINRA.
---------------------------------------------------------------------------

    \239\ See, e.g., BATS BYX Exchange Fee Schedule, available at 
http://www.batstrading.com/support/fee_schedule/byx/ (last visited 
February 18, 2015) (noting an annual membership fee of $2,500); BATS 
EDGA Exchange Fee Schedule, http://www.batstrading.com/support/fee_schedule/edga/ (last visited February 18, 2015) (same); CHX Fee 
Schedule at 3, available at http://www.chx.com/_literature_119763/CHX_Fee_Schedule (last visited February 18, 2015) (assessing an 
annual membership fee of $7,200); MIAX Fee Schedule at 9, available 
at http://www.miaxoptions.com/sites/default/files/MIAX_Options_Fee_Schedule_02012015.pdf (last visited February 18, 
2015) (assessing a monthly trading permit fee for an ``Electronic 
Exchange Member'' of $1,500).
---------------------------------------------------------------------------

d. Policies and Procedures Related to the Hedging Exemption
    Non-Member Firms that choose not to join an Association but wish to 
continue to trade off-exchange (or on exchanges of which they are not 
members) must do so in a manner that conforms to the hedging exemption. 
To do so, the proposal would require Non-Member Firms to establish, 
maintain and enforce policies and procedures as discussed above. The 
Commission estimates that firms will incur a burden of 16 hours in 
initially preparing these policies and procedures.\240\ Furthermore, 
the burden of maintaining and enforcing such policies and procedures, 
including a review of such policies at least annually, would be 
approximately 96 hours.\241\ The Commission estimates an initial 
implementation cost of approximately $5,000 and an annual ongoing cost 
of approximately $18,000 for Non-Member Firms that wish to utilize the 
hedging exemption and perform this work internally; for firms that 
outsource this work, costs are likely to be higher.\242\ For firms that 
choose to join FINRA, the hedging exemption is not relevant. They will 
not incur these costs.
---------------------------------------------------------------------------

    \240\ This figure is based on the following: (Compliance Manager 
at 10 hours) + (Compliance Attorney at 5 hours) + (Director of 
Compliance at 1 hour) = 16 burden hours per dealer. See infra note 
271. As is discussed in more detail in the Paperwork Reduction Act 
discussion, the Commission based this estimate on the estimated 
burdens imposed by other rules applicable to broker-dealers, such as 
Regulation SHO. However, the Commission preliminarily believes that 
the policies and procedures under the proposed floor member hedging 
exemption will be substantially less burdensome than those required 
by the Amendments to Regulation SHO because those policies and 
procedures require certain technology and real-time monitoring 
components. In contrast, the policies and procedures under the 
proposed amendments to Rule 15b9-1 do not involve a real-time 
monitoring or technology component. See infra note 273.
    \241\ See Section VI.D.
    \242\ For firms that perform this work internally, the initial 
cost estimate assumes 4 hours of work performed by a Compliance 
Manager at an hourly rate of $283 and 12 hours performed by 
Compliance Attorneys at an hourly rate of $334. The annual cost 
estimate assumes 48 hours of work by Compliance Clerks at an hourly 
rate of $64, 32 hours by Compliance Attorneys, and 16 hours by 
Compliance Managers. Hourly salary figure is from SIFMA's Management 
& Professional Earnings in the Securities Industry 2013, modified by 
Commission staff to account for an 1800-hour work-year and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead.
---------------------------------------------------------------------------

e. Indirect Costs
    In addition to possibly incurring costs related to joining 
exchanges, Non-Member Firms that choose not to join an Association will 
lose the benefits of trading in the off-exchange market, unless they 
meet the exemption for hedging. As mentioned above, Non-Member Firms 
are significant participants in ATS activity. Much of this trading is 
attributed to 14 Non-Member Firms, and the activity level across those 
firms varies widely. Assuming that order volume is proportional to 
trade volume, the

[[Page 18064]]

Commission estimates that the smallest of the 14 firms executed 11 
shares on ATSs during the fourth quarter of 2014.\243\ The largest firm 
executed 13.3 billion shares. The median firm in the group of 14 large 
Non-Member Firms is estimated to have executed 167.6 million shares. 
Although these share volumes are large, the Commission does not have 
adequate data on these firms to estimate the proportion of their 
trading activity and revenues that occurs on exchanges versus off-
exchange. The Commission cannot judge the likelihood of these firms 
choosing to cease off-exchange activity rather than joining an 
Association.
---------------------------------------------------------------------------

    \243\ The composition of the list of Non-Member Firms that are 
identified in ATS trading data changes across time periods. It is 
possible that the number of Non-Member Firms trading directly on 
ATSs is higher than estimated here. Additional Non-Member Firms may 
access ATSs through Member Firms, which would also exclude them from 
this analysis.
     To address data limitation, the Commission assumes that ATS 
orders from each of the 14 Non-Member Firms observable in the data 
are equally likely to be executed.
---------------------------------------------------------------------------

    Finally, those firms that choose not to join an Association would 
be limited in their ability to route their own transactions in a manner 
so as to comply with the requirements of Regulation NMS.\244\ Their 
transactions would have to be routed through a broker-dealer of an 
exchange of which they are a member, or routed by a broker-dealer only 
to those exchanges of which they are members. The routing of orders of 
Non-Member Firms that do not join an Association will be determined by 
the routing broker-dealer of the exchanges of which they are members. 
This loss in choice could lead to higher costs for routing and costs 
associated with increased latency because the exchange's routing 
broker-dealer may have a telecommunications infrastructure that is 
inferior to that of the broker-dealer that previously provided 
connectivity to that exchange to the Non-Member Firm.\245\
---------------------------------------------------------------------------

    \244\ The exemption related to routing to comply with Regulation 
NMS is discussed in Section II.E.
    \245\ Firms in the business of providing connectivity to 
exchanges are likely to compete on the basis of their technology. 
The Commission assumes that some firms that do not join FINRA will 
have some orders (those governed under the Regulation NMS provisions 
to prevent trade-throughs) routed using technology inferior to the 
technology of their firm of choice.
---------------------------------------------------------------------------

D. Alternatives

1. Elimination of the Floor Member Hedging Exemption
    Although the proposed amendments would eliminate the exclusion for 
proprietary trading activity for broker-dealers wishing to continue 
availing themselves of the exemption from Association membership under 
Rule 15b9-1, it would maintain a limited exception for hedging of 
floor-based activity.\246\ Currently, Non-Member Firms are able to 
hedge their floor-based activity through the exclusion for proprietary 
trading in Rule 15b9-1. The Commission does not have data to estimate 
the number of Non-Member Firms that use the proprietary trading 
exemption in this manner, or the dollar-value of trading that they 
hedge through the exemption.
---------------------------------------------------------------------------

    \246\ The floor member hedging exemption is discussed more fully 
in Section II.D.
---------------------------------------------------------------------------

    One alternative considered by the Commission was the elimination of 
the hedging exemption entirely. Elimination of the floor member hedging 
exemption would require any firm that wished to hedge through off-
exchange transactions to join an Association or become a member of each 
exchange on which it trades and cease off-exchange trading. This would 
improve the Association's ability to monitor cross-market hedging 
activity that was conducted off-exchange. The Commission recognizes, 
however, that there may be challenges for the Commission, firms, and 
exchanges in proving compliance with the exemption. For example, some 
broker-dealers may label activity as hedging activity that is not 
covered by the exemption. A firm could establish a limited floor-based 
business and then inadvertently or deliberately claim the hedging 
exemption covers significant trading off-exchange (and trading on 
exchange of which the firm is not a member) that did not reduce or 
otherwise mitigate the risk of its floor-based activity. Further, firms 
that wish to avail themselves of the hedging exemption will incur costs 
to establish, maintain and enforce written policies and procedures 
related to its use.\247\ Without the hedging exemption, firms would not 
incur these costs, but would incur other costs. In particular, without 
a hedging exemption, floor brokers on some exchanges might find that 
hedging positions obtained through their normal activity limited to the 
floor of a single exchange is less cost-effective. For example, a floor 
broker on an options exchange is currently exempt from FINRA membership 
if he trades off-exchange under the exclusion for proprietary trading. 
After entering an options position, the floor broker can enter an 
offsetting equity position by trading on an exchange of which he is not 
a member (through a member broker-dealer) or in the off-exchange 
market. Under the proposed amendments without the hedging exemption, 
the floor broker would not be able to make such a hedging transaction 
without joining at least one additional SRO (FINRA or another exchange 
where he could transact in equities). If participants have less 
opportunity to hedge their positions, they may be less willing to 
provide liquidity in their capacity as floor brokers. Therefore, the 
Commission is proposing a narrow hedging exemption that covers only the 
activity it intends to exclude.
---------------------------------------------------------------------------

    \247\ See Section V.C.2.d.
---------------------------------------------------------------------------

2. Improve Off-Exchange Supervision Through Action of Other SROs With 
or Without CAT
    The Commission also considered whether an alternative approach to 
achieving the objectives of the proposed amendments would be to address 
the limitations in regulatory oversight of off-exchange activity of 
Non-Member Firms through exchanges that act as their DEAs or all 
exchanges of which they are members. The Commission preliminarily 
believes either of these alternatives would frustrate the regulatory 
structure established by Congress and would be inefficient. As 
discussed in detail above, exchanges traditionally have not assumed the 
role of regulating the totality of the trading of their member-broker-
dealers, and exchanges are currently not well-positioned to assume that 
role, in light of the statutory framework and, among other things, 
their limited access to data and the lack of a proper rule set to 
regulate off-exchange trading.\248\ Exchanges generally do not have as 
detailed a set of member conduct rules and do not have non-exchange-
specific trading rules, thus allowing such broker-dealers and their 
personnel to conduct business under a less specific regulatory regime 
than FINRA members.\249\ As discussed above, in this context and 
consistent with the statutory framework, the Commission preliminarily 
believes that an Association is better suited to regulate off-exchange 
trading.\250\
---------------------------------------------------------------------------

    \248\ See supra notes 82-95 and accompanying text.
    \249\ See supra note 75 and accompanying text.
    \250\ See supra notes 82-95 and accompanying text.
---------------------------------------------------------------------------

    With respect to having Non-Member Firms' DEAs assume the regulatory 
oversight responsibilities, the Commission could require the Non-Member 
Firm's DEA to oversee the off-exchange activity of the firm. This 
alternative may offer some benefit in terms of providing efficient 
supervision. Non-Member Firms' DEAs may have specialized knowledge of 
Non-Member Firms' businesses and operations that would facilitate 
efficient supervision of

[[Page 18065]]

their off-exchange activity.\251\ Similarly, requiring all SROs to 
supervise the off-exchange activity of their members might bring 
certain benefits. First, there might be innovation in surveillance 
methodology because exchange SROs could need new surveillance systems 
and procedures tailored to current market structure and practice. 
Second, this could foster competition among SROs to provide regulatory 
services, which could lower costs to members.
---------------------------------------------------------------------------

    \251\ See Allston Letter, supra note 106.
---------------------------------------------------------------------------

    However, with respect to DEAs, the supervision of trading activity 
is outside the scope of typical DEA oversight responsibilities \252\ 
and the Commission believes most exchanges contract with FINRA to 
perform these examinations. Consequently, if exchange SROs were 
expected to supervise the off-exchange activities of firms assigned to 
them for DEA examinations, the exchanges would need to acquire the 
resources to provide this supervision.
---------------------------------------------------------------------------

    \252\ See supra note 164.
---------------------------------------------------------------------------

    Requiring all SROs to supervise their members' off-exchange trading 
would also entail substantial costs and create inefficiencies. As 
discussed previously, exchange SROs have not generally supervised their 
members' activity outside of the markets they operate.\253\ As 
discussed above, FINRA has invested in the technological 
infrastructure, cooperative agreements with other SROs, and specialized 
regulatory personnel to provide surveillance and supervision of 
activity in off-exchange markets.\254\ If each of the exchanges were 
required to supervise the off-exchange activities of some or all of 
their members, the exchanges each would need to invest in similar 
regulatory infrastructure. This investment would be costly to the 
exchanges; presumably these costs would be passed on to exchange 
members and ultimately the investing public through higher trading 
costs. In addition, assigning regulatory responsibility to an exchange 
SRO, which may in turn contract with FINRA to provide those services, 
would be costly and inefficient. Further, notwithstanding the potential 
benefits to innovation, the duplication in regulatory oversight would 
also be duplication in regulatory resources as multiple SROs would 
surveil the off-exchange trading of some firms. This approach also 
could be inconsistent with the allocation of regulatory 
responsibilities contemplated by Section 17(d) of the Exchange 
Act.\255\
---------------------------------------------------------------------------

    \253\ See supra note 68-69 and accompanying text.
    \254\ Id.
    \255\ 15 U.S.C. 78q(d).
---------------------------------------------------------------------------

    Furthermore, FINRA has adopted rules that govern off-exchange 
trading, recognizing the complexity and opacity of the off-exchange 
marketplace. If exchanges were required to supervise the off-exchange 
activity of their members, exchanges would need to adopt rules that 
were tailored to the institutional detail of the off-exchange market. 
This could result in off-exchange trading rules that varied depending 
on the exchange membership status of individual participants, resulting 
in inconsistent rules governing the same off-exchange trading activity.
    Finally, the Commission has also considered whether the possibility 
that the exchanges could obtain additional data through the CAT, or 
through a FINRA rule change if implemented,\256\ affects the 
Commission's preliminary belief that an Association is better suited to 
regulate off-exchange trading. Although there may thereby be additional 
data, these changes would not address the underlying statutory scheme 
and resource issues that make FINRA well-positioned to regulate off-
exchange trading.
---------------------------------------------------------------------------

    \256\ See supra note 84.
---------------------------------------------------------------------------

3. Exchange Membership Alternative
    The proposed amendments would, in accordance with Section 15(b)(8), 
preclude any firm that is not a member of an Association from trading 
on exchanges of which it is not a member.\257\ Further, under the 
proposed amendments, if a firm becomes a member of an Association, it 
would not have to become a member of each exchange upon which it 
trades.\258\ The Commission has also considered requiring broker-
dealers to become a member of every exchange on which they trade and to 
become a member of an Association in order to trade off-exchange 
(``Exchange Membership Alternative''). In other words, under this 
alternative, becoming a member of an Association would not alone allow 
firms to trade on exchanges of which they are not members (as would be 
permitted under the proposed amendments).
---------------------------------------------------------------------------

    \257\ The proposed amendments provide limited exemptions for 
hedging of floor-based activity and order routing to satisfy certain 
provisions of Regulation NMS.
    \258\ In order to trade on exchanges of which it is not a 
member, the firm would have to trade with or through another broker-
dealer that is a member of that exchange.
---------------------------------------------------------------------------

    In considering the Exchange Membership Alternative, the Commission 
weighed whether the same issue of off-exchange activity not being 
subject to effective regulatory oversight that exists when a Non-Member 
Firm trades off-exchange is present when a Member or Non-Member Firm 
trades on an exchange of which it is not a member (through a member of 
that exchange). The Commission preliminarily believes that the proposed 
amendments adequately address the issue of establishing effective 
oversight of off-exchange activity and that the more onerous Exchange 
Membership Alternative would not provide any additional regulatory 
benefit beyond the proposed amendments for several reasons. First, 
while exchanges lack the data, surveillance technology and specialized 
regulatory personnel to surveil their members' trading off-exchange, 
FINRA has these resources to surveil the activity of Member Firms both 
on exchanges and off-exchange. Accordingly, requiring Member Firms to 
also become members of each exchange on which they effect transactions, 
including indirectly, would be unnecessarily duplicative because FINRA 
can already surveil the activity of a Member Firm trading on an 
exchange of which it is not a member. In addition, while exchanges do 
not have a specialized rule set to govern their members' activity in 
the off-exchange market, FINRA's rules are consistent with requiring 
Member Firms to adhere to the trading rules of exchanges on which they 
transact. If a Member Firm were to violate an exchange rule on an 
exchange of which it is not a member, FINRA would have the jurisdiction 
needed to address the resulting violation. Therefore, requiring that 
the Member Firm also become a member of that exchange would not prevent 
FINRA from exercising jurisdiction over the matter.
    The Commission notes that the Exchange Membership Alternative might 
require firms to become members of more SROs than required under the 
proposed amendments, which would impose additional costs. In 
particular, some Non-Member Firms that would become Member Firms under 
the Proposal would also need to become members of additional exchanges 
or cease trading on these exchanges. In addition, some current Member 
Firms would also need to become members of additional exchanges.
4. Retaining the De Minimis Allowance
    The Commission considered retaining the $1,000 de minimis allowance 
for trading other than on an exchange of which the Non-Member Firm is a 
member. The Commission also considered retaining the $1,000 de minimis 
allowance, but removing the exception for proprietary trading conducted 
with or through another registered broker-dealer. As discussed

[[Page 18066]]

above,\259\ the Commission believes that the magnitude of the de 
minimis allowance is no longer economically meaningful. Furthermore, 
the Commission believes that the commission sharing arrangements 
discussed previously \260\ are rarely if ever used. However, the 
Commission believes that floor members on some exchanges may rely upon 
the exception for proprietary trading conducted with or through another 
registered broker-dealer to hedge risks associated with floor-based 
activities. Consequently, the proposed amendments include a hedging 
exemption for floor-based activity but no longer include a de minimis 
dollar amount associated with transactions that do not fall under the 
limited hedging exemption.
---------------------------------------------------------------------------

    \259\ See Section II.C.
    \260\ Id.
---------------------------------------------------------------------------

5. The Commission Assumes Regulatory Oversight Role for Non-Member 
Firms
    The Commission considered assuming the role of providing direct 
primary regulatory oversight for Non-Member Firms. We do not believe, 
however, that this is a reasonably available alternative because of the 
judgments reflected in Congress's determinations over time about where 
to locate that oversight function and our own understanding of the 
entity best suited to that role. As discussed in detail above, the 
Exchange Act, as originally adopted in 1934, left regulation of the 
off-exchange market to the Commission.\261\ In 1938, Congress provided 
for the creation of Associations,\262\ and from 1965 until 1983, 
broker-dealers engaged in off-exchange trading could become members of 
NASD or opt to be regulated directly by the Commission under the SECO 
program.\263\ In 1983, the Commission recommended that Congress 
eliminate the SECO program because, among other things, only a limited 
number of broker-dealers chose to be regulated under the SECO program 
\264\ and maintaining the program disproportionately affected the 
Commission's resources. Congress then amended the Act to eliminate the 
SECO program,\265\ which had the effect of making the regulation of 
off-exchange trading under the Exchange Act the responsibility of an 
Association.\266\ Consistent with this, in this rulemaking the 
Commission is proposing to modify the Rule 15b9-1 exemption so that, 
with limited exceptions, the off-exchange transactions of broker-
dealers will be subject to the oversight and rules of an Association, 
the SRO primarily responsible for regulating trading in the off-
exchange market. As discussed throughout, we believe an Association is 
best positioned to regulate that trading. Based on the foregoing, 
including the Congress's determination to eliminate the SECO 
Program,\267\ the Commission does not view assumption of direct 
responsibility for off-exchange broker-dealer oversight by the 
Commission as a reasonably available alternative.
---------------------------------------------------------------------------

    \261\ See supra note 27 and accompanying text
    \262\ See supra notes 31-33 and accompanying text.
    \263\ As previously noted, broker-dealers that traded 
exclusively on the floor of an exchange were exempt from broker-
dealer registration with the Commission until the 1975 Amendments, 
which extended the Commission's SECO rulemaking authority to any 
exchange member trading on an exchange other than an exchange of 
which it was a member. See supra note 41 and accompanying text. 
Broker-dealers registering with the Commission as a result of the 
1975 Amendments became subject to the SECO rules in 1976, but could 
remain exempt from such rules pursuant to Rule 15b8-1. See supra 
note 43 and accompanying text.
    \264\ Because many broker-dealers chose to become members of 
NASD rather than participating in the SECO Program, only 12 percent 
of all active Commission-registered broker-dealers effecting 
transactions off-exchange were SECO broker-dealers by May 1982. 
House Comm. on Energy and Commerce, ``Authorization of 
Appropriations for the Securities and Exchange Commission,'' H.R. 
Rep. No. 98-106, at 597 (1983).
    \265\ Pub. L. 98-38, 97 Stat. 205 (1983).
    \266\ See supra note 31 and accompanying text.
    \267\ The report accompanying the amendments made to the Act in 
1983 cited a preference for self-regulation over direct regulation 
by the Commission. See supra note 46 and accompanying text.
---------------------------------------------------------------------------

E. Request for Comment on Economic Analysis

    The Commission has identified above economic effects associated 
with the proposal and requests comment on all aspects of its 
preliminary economic analysis. The Commission encourages commenters to 
identify, discuss, analyze, and supply relevant data, information, or 
statistics regarding any such economic effects. In particular, the 
Commission seeks comment on the following:
    47. Do commenters agree with the Commission's analysis of the 
potential economic effects of the proposed amendments? Why or why not?
    48. Do commenters agree with the Commission's assessment of the 
baseline for the economic effects?
    49. Is the supervision and surveillance of Non-Member Firms with 
substantial cross-market or off-exchange trading sufficient under 
current rules? Why or why not?
    50. How would further changes to the scope of existing Regulatory 
Services Agreements between SROs affect regulators' ability to 
effectively surveil cross-market and off-exchange trading?
    51. Do commenters believe that there are additional categories of 
benefits or costs that could be quantified or otherwise monetized? If 
so, please identify these categories and, if possible, provide specific 
estimates or data.
    52. Are there any additional benefits that may arise from the 
proposed amendments? Or are there benefits described above that would 
not likely result from the proposed amendments? If so, please explain 
these benefits or lack of benefits in detail.
    53. Are there any additional costs that may arise from the proposed 
amendments? Are there methods by which the Commission could reduce the 
costs imposed by the proposed amendments enabling effective regulatory 
oversight of Non-Member Firms? Please explain. Are there any other 
potential consequences of the proposed amendments? Or are there costs 
described above that would not likely result from the proposed 
amendments? If so, please explain these costs or lack of costs in 
detail.
    54. Does the release appropriately describe the potential effects 
of the proposed amendments on the promotion of efficiency, competition, 
and capital formation? Why or why not? If possible, commenters should 
provide analysis and empirical data to support their views on the 
competitive or anticompetitive effects, as well as the efficiency and 
capital formation effects, of the proposed amendments.
    55. Are there alternative mechanisms for achieving the Commission's 
goal of improving regulatory oversight while promoting competition and 
capital formation?
    56. To the extent that there are reasonable alternatives to the 
proposed amendments, what are the potential costs and benefits of those 
reasonable alternatives relative to the proposed amendments? What are 
the potential effects on the promotion of efficiency, competition, and 
capital formation of those reasonable alternatives?
    57. Would the cost of FINRA or exchange membership cause some Non-
Member Firms to alter their activities in any way? If so, how would 
Non-Member Firms alter their business? How would these changes affect 
competition and market efficiency? How would these changes affect 
market quality?
    58. Would the proposed amendments cause Non-Member Firms to exit 
the marketplace? If so, how many Non-Member Firms would elect to 
restrict their operations rather that become members of FINRA or one or 
more exchanges? How would these changes affect competition and market 
efficiency? How would these changes

[[Page 18067]]

affect market quality? What would be the effect on liquidity of Non-
Members Firms exiting the marketplace?
    59. Are there costs related to FINRA membership for Non-Member 
Firms that the Commission has not considered? What are these costs? 
Please be specific.
    60. For Non-Member Firms, how much will the cost of FINRA 
membership vary? Will the cost of FINRA membership cause some firms to 
change the scope of their business? If so, in what manner?
    61. Do commenters agree with the assumptions underlying the 
Commission's estimates of the range for membership costs for exchanges?
    62. Do commenters agree with the Commission's preliminarily belief 
that the TAF collected by FINRA would not be expected to materially 
change if the proposed amendments were adopted? What would the effect 
of the proposed amendments be on the TAF assessed to current FINRA 
members? What would the effect of the proposed amendments be on the TAF 
assessed to Non-Member Firms that choose to become FINRA members?
    63. Has the Commission properly accounted for the compliance cost 
burden required to achieve the access to exchanges necessary to comply 
with the proposed amendments? Would any costs beyond basic membership 
be the direct result of the proposed amendments?
    64. If Non-Member Firms were to elect to join additional exchanges 
rather than becoming members of FINRA, how many exchanges would they 
expect to join?
    65. Is the Commission correct in assuming that the cost of 
membership is the relevant compliance cost burden and that connectivity 
or trading related costs are optional for most to all of the exchanges? 
Are there any exchanges on which connectivity or trading rights costs 
are mandatory even if a broker-dealer trades through another member 
broker-dealer that is paying the connectivity or trading rights costs?
    66. Are the Commission's assumptions on the manner in which Section 
3 fees are allocated in off-exchange transactions with Non-Member Firms 
correct? Are there mechanisms in place already that result in these 
fees being passed on to Non-Member Firms that transact in ATSs, or 
elsewhere in the off-exchange market?
    67. Would a Non-Member Firm elect to become a member of one or more 
exchanges rather than become a member of FINRA? If so, please discuss 
in detail why a Non-Member Firm would make such an election. Which 
exchanges, in particular, are Non-Member Firms likely to join, if they 
join additional exchanges, as a result of the proposed amendments? How 
would these changes affect competition and market efficiency? How would 
these changes affect market quality?
    68. Has the Commission articulated all reasonable alternatives for 
the proposed rule? If not, please provide additional alternatives and 
how their costs and benefits would compare to the proposed rule. For 
the alternatives described above, has the Commission accurately 
described the costs and benefits? If not, please provide more accurate 
costs and benefits, including any data or statistics that support those 
costs and benefits.
    69. One alternative discussed is to effect improved off-exchange 
supervision through the action of exchanges. Is this alternative 
practical? What resources would exchanges have to acquire to provide 
efficient and effective supervision of their members' off-exchange 
trading activity?
    70. What effects could the proposed amendments have on FINRA's 
oversight of the off-exchange market? How could FINRA's revenues and 
cost of regulation be affected? What changes should FINRA consider 
implementing should the Commission approve the proposed amendments to 
Rule 15b9-1? Please be specific.
    71. Would the proposed amendments create a barrier to entry for new 
prospective Associations? Would there be benefits to competition among 
Associations?

VI. Paperwork Reduction Act

    Certain provisions of these proposed amendments to Rule 15b9-1 
contain ``collection of information requirements'' within the meaning 
of the Paperwork Reduction Act of 1995 (``PRA'').\268\ As discussed in 
Part II.D, the proposed amendments to Rule 15b9-1 would require dealers 
relying on the floor member hedging exemption under Rule 15b9-1 to 
establish, maintain, and enforce certain written policies and 
procedures. Compliance with these collections of information 
requirements would be mandatory for firms relying on the rule. The 
Commission is submitting these collections of information to the Office 
of Management and Budget (``OMB'') for review in accordance with 44 
U.S.C. 3507(d) and 5 CFR 1320.11. The title of new collection of 
information is ``Rule 15b9-1 Floor Member Hedging Exemption.'' An 
agency may not conduct or sponsor, and a person is not required to 
respond to, a collection of information unless the agency displays a 
currently valid control number.
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    \268\ 44 U.S.C. 3501 et seq.
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A. Summary of Collection of Information

    The proposed amendments to Rule 15b9-1 would include a collection 
of information within the meaning of the PRA for broker-dealers relying 
on the floor member hedging exemption under the proposed Rule. The 
floor member hedging exemption under the proposed amendments to Rule 
15b9-1 would permit a qualifying dealer \269\ that conducts business on 
the floor of a national securities exchange to effect transactions for 
its own account with or through another registered broker or dealer 
that are solely for the purpose of hedging the risks of its floor-based 
activities, by reducing or otherwise mitigating the risks thereof. 
Broker-dealers relying on the floor member hedging exemption must 
establish, maintain, and enforce written policies and procedures 
reasonably designed to ensure and demonstrate that such hedging 
transactions reduce or otherwise mitigate the risks of the financial 
exposure the dealer incurs as a result of its floor-based activity. In 
addition, such dealers would be required to preserve a copy of their 
policies and procedures in a manner consistent with Rule 17a-4 until 
three years after the date the policies and procedures are replaced 
with updated policies and procedures.
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    \269\ A broker-dealer would have to meet the threshold 
requirements of proposed Rule 15b9-1. Specifically, such broker-
dealer would have to: (1) Be a member of a national securities 
exchange; (2) carry no customer accounts; and (3) effect 
transactions in securities solely on a national securities exchange 
of which it is a member, except for transactions complying with the 
floor member hedging exemption or the Regulation NMS routing 
exemption.
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B. Proposed Use of Information

    The policies and procedures required under Rule 15b9-1 would be 
used by the Commission and SROs to understand how dealers relying on 
the floor member hedging exemption evaluate whether their off-exchange 
transactions are conducted solely for the purpose of hedging risks 
incurred from the dealer's floor-based business and that such dealers 
are complying with the requirements of Rule 15b9-1. These policies and 
procedures will be used generally by the Commission as part of its 
ongoing efforts to monitor and enforce compliance with the federal 
securities laws, including Section 15(b)(8) and Rule 15b9-1 thereunder. 
In addition, SROs may use the information to monitor and enforce 
compliance by

[[Page 18068]]

their members with applicable SRO rules and the federal securities 
laws.

C. Respondents

    The Commission estimates that up to 100 dealers may rely on the 
floor member hedging exemption contained in Rule 15b9-1. The Commission 
notes that, based on publicly available information reviewed in the 
first quarter of 2015, there are currently 125 broker-dealers 
registered with the Commission that are not members of an Association. 
Of those 125 broker-dealers, 77 broker-dealers currently disclose being 
an exchange member engaged in floor activities on Form BD.\270\ The 
Commission believes that while not all of these dealers will choose to 
avail themselves of the floor member hedging exemption contained in 
Rule 15b9-1 because the exemption restricts off-exchange transactions 
solely to those that hedge risks incurred as a result of their floor-
based activity, some firms not included in this number may decide to 
avail themselves of the floor member hedging exemption. The Commission 
preliminarily believes, however, that more of these firms are likely to 
want the ability to engage in off-exchange transactions other than 
those that hedge the risk of their floor-based activity, and may, 
accordingly, choose to join an Association as a result of the proposed 
amendments to Rule 15b9-1.
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    \270\ Of the approximately 4,209 total registered broker-dealers 
as of March 2015, 182 broker-dealers in total disclose being an 
exchange member engaged in floor activities on Form BD (note: The 
182 broker-dealers includes the 77 broker-dealers engaged in floor 
activities that are not members of an Association). The Commission 
preliminarily believes that broker-dealers engaged in floor 
activities that are currently members of an Association are unlikely 
to withdraw from Association membership and begin relying on the 
floor member hedging exemption because such broker-dealers have 
already elected to join an Association and reliance on the floor 
member hedging exemption would limit their permissible off-exchange 
activity solely to hedging risks incurred as a result of their 
floor-based business.
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D. Total Initial and Annual Reporting and Recordkeeping Burdens

    The Commission estimates that the one-time, initial burden for a 
dealer to establish written policies and procedures as required under 
Rule 15b9-1 would be approximately 16 hours.\271\ This figure is based 
on the estimated number of hours to develop a set of written policies 
and procedures, including review and approval by appropriate legal 
personnel. The Commission notes that the policies and procedures 
required by the proposed Rule are limited to hedging transactions that 
reduce or otherwise mitigate the risks of the financial exposure the 
dealer incurs as a result of its floor-based activity. In addition, the 
Commission estimates the annual burden of maintaining and enforcing 
such policies and procedures, including a review of such policies at 
least annually, would be approximately 96 hours for each dealer.\272\ 
This figure includes an estimate of hours related to reviewing existing 
policies and procedures, making necessary updates, conducting ongoing 
training, maintaining relevant systems and internal controls, 
performing necessary testing and monitoring of off-exchange hedging 
transactions as they relate to the broker-dealer's floor-based 
activities and maintaining copies of the policies and procedures for 
the period of time required by the proposed rule.
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    \271\ This figure is based on the following: (Compliance Manager 
at 10 hours) + (Compliance Attorney at 5 hours) + (Director of 
Compliance at 1 hour) = 16 burden hours per dealer.
    \272\ This figure is based on the following: (Compliance Manager 
at 60 hours) + (Compliance Attorney at 24 hours) + (Director of 
Compliance at 12 hours) = 96 burden hours per dealer.
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    The Commission estimates that the initial burden associated with 
Rule 15b9-1 would be 112 hours per dealer, which corresponds to an 
initial aggregate burden of 11,200 hours.\273\ The Commission estimates 
that the ongoing annualized burden associated with Rule 15b9-1 would be 
96 hours per dealer, which corresponds to an ongoing annualized 
aggregate burden of 9,600 hours.\274\
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    \273\ This figure is based on the following: ((16 burden hours 
per dealer) + (96 burden hours per dealer)) x (100 dealers) = 11,200 
burden hours during the first year. In estimating these burden 
hours, the Commission examined the estimated burdens imposed by 
other rules applicable to broker-dealers. For example, amendments to 
Regulation SHO adopted in 2010 required broker-dealers to establish, 
maintain, and enforce written policies and procedures relating to 
Rule 201(c) and Rule 201(d)(6) to ensure short-sale orders are, 
among other things, properly marked, are submitted at the proper 
price, or are properly off-set (in the case of Rule 201(d)(6). See 
Exchange Act Release No. 61595 (February 26, 2010) 75 FR 11232, 
11286 (March 10, 2010) (``Amendments to Regulation SHO''). The 
policies and procedures relating to Rule 201(c) and Rule 201(d)(6) 
required under the Amendments to Regulation SHO estimated an average 
initial one-time burden of 160 burden hours per broker-dealer and 
ongoing compliance cost of 60 hours annually to ensure the policies 
and procedures are up-to-date and remain in compliance as well as an 
additional 336 hours annual to monitor, surveil, and enforce trading 
in compliance with Rule 201. Id. The Commission preliminarily 
believes that the policies and procedures under the proposed floor 
member hedging exemption will be substantially less burdensome than 
those required by the Amendments to Regulation SHO because those 
policies and procedures require certain technology and real-time 
monitoring components. For example, under the Amendments to 
Regulation SHO described above, broker-dealers' policies and 
procedures must be reasonably designed to enable a broker-dealer to 
monitor, on a real-time basis, the national best bid so as to 
determine the price at which a broker-dealer may submit a short sale 
order to a trading center in compliance with Rule 201(c), and off-
setting transactions under the riskless principal provision under 
Rule 201(d)(6) must be allocated to a riskless principal or customer 
account within 60 seconds of execution. Id. at 11284. In contrast, 
the policies and procedures under the proposed amendments to Rule 
15b9-1 do not involve a real-time monitoring or technology 
component.
    \274\ This figure is based on the following: (96 burden hours 
per dealer) x (100 dealers) = 9,600 ongoing, annualized aggregate 
burden hours. In estimating these burden hours, the Commission also 
examined the estimated initial and ongoing burden hours imposed on 
registered security-based swap dealers under Regulation SBSR--
Reporting and Dissemination of Security-Based Swap Information. See 
Exchange Act Release No. 74244 (February 11, 2015) 80 FR 14564, 
14683 (March 19, 2015) (``Regulation SBSR''). Regulation SBSR 
requires registered security-based swap dealers to establish, 
maintain, and enforce written policies and procedures that are 
reasonably designed to ensure compliance with any security-based 
swap transaction reporting obligations. Id. The estimated initial 
and ongoing compliance burden on registered security-based swap 
dealers under Regulation SBSR were 216 burden hours and 120 burden 
hours respectively. Id. The Commission preliminarily believes that 
the initial and ongoing burden hours under the proposed floor member 
hedging exemption will be substantially less than for registered 
security-based swap dealers under Regulation SBSR, because the 
policies and procedures under Regulation SBSR require programing 
certain systems for transaction reporting and performing testing of 
such systems. Id. In contrast, the proposed floor member hedging 
exemption would not necessarily require programming or testing of 
certain systems and is a much more discrete set of policies and 
procedures as compared to the more comprehensive policies and 
procedures required by Regulation SBSR, which cover, among other 
things, the full scope of reporting security-based swap transactions 
by registered security-based swap dealers and others.
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E. Collection of Information Is Mandatory

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

F. Confidentiality of Responses to Collection of Information

    To the extent that the Commission receives confidential information 
pursuant to the collection of information, such information will be 
kept confidential, subject to the provisions of applicable law.\275\
---------------------------------------------------------------------------

    \275\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing 
the public availability of information obtained by the Commission).
---------------------------------------------------------------------------

G. Retention Period for Recordkeeping Requirements

    Dealers seeking to take advantage of the proposed hedging exemption 
would be required to preserve a copy of their policies and procedures 
in a manner consistent with Rule 17a-4 \276\ until

[[Page 18069]]

three years after the date the policies and procedures are replaced 
with updated policies and procedures.
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    \276\ 17 CFR 240.17a-4. Registered brokers and dealers are 
already subject to existing recordkeeping and retention requirements 
under Rule 17a-4. However, proposed Rule 15b9-1 contains a 
requirement that a dealer relying on the floor member hedging 
exemption preserve a copy of its policies and procedures in a manner 
consistent with Rule 17a-4 until three years after the date the 
policies and procedures are replaced with updated policies and 
procedures. The burdens associated with this recordkeeping 
obligation have been accounted for in the burden estimates discussed 
above for Rule 15b9-1.
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H. Request for Comments

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

VII. Consideration of Impact on Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\277\ the Commission requests comment on the potential 
effect of the proposed amendments to Rule 15b9-1 on the United States 
economy on an annual basis. The Commission also requests comment on any 
potential increases in costs or prices for consumers or individual 
industries, and any potential effect on competition, investment, or 
innovation. Commenters are requested to provide empirical data and 
other factual support for their views to the extent possible.
---------------------------------------------------------------------------

    \277\ 5 U.S.C. 603.
---------------------------------------------------------------------------

VIII. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \278\ 
(``RFA'') requires the Commission to undertake an initial regulatory 
flexibility analysis of the impact of the proposed rule amendments on 
small entities unless the Commission certifies that the rule, if 
adopted, would not have a significant economic impact on a substantial 
number of small entities.\279\ For purposes of Commission rulemaking in 
connection with the RFA,\280\ a small entity includes a broker or 
dealer that: (1) Had total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the date in the prior fiscal year 
as of which its audited financial statements were prepared pursuant to 
Rule 17a-5(d) under the Exchange Act,\281\ or, if not required to file 
such statements, a broker-dealer with total capital (net worth plus 
subordinated liabilities) of less than $500,000 on the last day of the 
preceding fiscal year (or in the time that it has been in business, if 
shorter); and is not affiliated with any person (other than a natural 
person) that is not a small business or small organization.\282\ With 
regard to exchanges, a small entity is an exchange that has been exempt 
from the reporting requirements of Rule 601 under Regulation NMS, and 
is not affiliated with any person (other than a natural person) that is 
not a small business or small organization.\283\
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    \278\ 5 U.S.C. 603(a).
    \279\ 5 U.S.C. 605(b).
    \280\ Although Section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
proposed rulemaking, are set forth in Rule 0-10 under the Exchange 
Act, 17 CFR 240.0-10. See Exchange Act Release No. 18451 (January 
28, 1982), 47 FR 5215 (February 4, 1982) (File No. AS-305).
    \281\ 17 CFR 240.17a-5(d).
    \282\ See 17 CFR 240.0-10(c).
    \283\ See 17 CFR 240.0-10(e).
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    The Commission examined recent FOCUS data for the 125 Non-Member 
Firms and concluded that at most 11 of the affected entities have net 
capital of $500,000 or less, and some of those might not be small 
entities because they might be affiliates of larger organizations.
    Although the Commission lacks the data to quantify these firms' 
off-exchange activity, it does have FOCUS information on the firms' 
disclosed activities. Based on this disclosure, the Commission believes 
that many of these firms may be able to trade off-exchange under the 
proposed floor member hedging exemption for a number of reasons. First, 
a number of firms disclose floor-based activity that may allow them to 
trade off-exchange under the floor member hedging exemption: five 
report writing options and six disclose floor activity.\284\ Second, 
one discloses only trading in government debt securities, so is 
unlikely to be affected by the proposed amendments. Finally, only two 
of the eleven firms disclose proprietary trading activity. These firms 
would be affected only by the elimination of the de minimis allowance, 
unless the firms can rely on the floor member hedging exemption for 
such activity.\285\ Therefore, the Commission certifies that the 
proposed amendments to Rule 15b9-1 would not, if adopted, have a 
significant economic impact on a substantial number of small entities.
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    \284\ Firms often disclose multiple activities, so the number of 
disclosed activities in this discussion exceeds the number of firms.
    \285\ Hedging activity is proprietary trading activity.
---------------------------------------------------------------------------

    76. We encourage written comments regarding this certification. We 
solicit comment as to whether the proposed amendments could have 
impacts on small entities that have not been considered. We request 
that commenters describe the nature of any impacts on small entities 
and provide empirical data to support the extent of such effect.
    Such comments will be placed in the same public file as comments on 
the proposed amendments to Rule 15b9-1. Persons wishing to submit 
written comments should refer to the instructions for submitting 
comments in the front of this release.

IX. Statutory Authority--Text of the Proposed Amendments

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and 
particularly Sections 3, 15(b)(9), 15A, 17, 19, 23, and 36 thereof, the 
Commission is proposing amendments to Title 17, Chapter II of the Code 
of Federal Regulations as follows.

List of Subjects in 17 CFR Part 240

    Brokers, Dealers, Registration, Securities.


[[Page 18070]]


    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

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

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

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


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

    Any broker or dealer required by section 15(b)(8) of the Act (15 
U.S.C. 78o(b)(8)) to become a member of a registered national 
securities association shall be exempt from such requirement if it:
    (a) Is a member of a national securities exchange;
    (b) Carries no customer accounts; and
    (c) Effects transactions in securities solely on a national 
securities exchange of which it is a member, except that with respect 
to this paragraph (c):
    (1) A dealer that conducts business on the floor of a national 
securities exchange may effect transactions off the exchange, for the 
dealer's own account with or through another registered broker or 
dealer, that are solely for the purpose of hedging the risks of its 
floor-based activities, by reducing or otherwise mitigating the risks 
thereof. A dealer seeking to rely on this exception shall establish, 
maintain and enforce written policies and procedures reasonably 
designed to ensure and demonstrate that such hedging transactions 
reduce or otherwise mitigate the risks of the financial exposure the 
dealer incurs as a result of its floor-based activity. Such dealer 
shall preserve a copy of its policies and procedures in a manner 
consistent with 17 CFR 240.17a-4 until three years after the date the 
policies and procedures are replaced with updated policies and 
procedures; and
    (2) A broker or dealer may effect transactions off the exchange 
resulting from orders that are routed by a national securities exchange 
of which it is a member, to prevent trade-throughs on that national 
securities exchange consistent with 17 CFR 242.611.

    By the Commission.

    Dated: March 25, 2015.
Brent J. Fields,
Secretary.
[FR Doc. 2015-07293 Filed 4-1-15; 8:45 am]
 BILLING CODE 8011-01-P


