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-

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.
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    \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-

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\
---------------------------------------------------------------------------

    \139\ See Section V.C. for further discussion of the
difficulties in estimating market quality effects likely to result
from the proposed amendments.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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

    \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

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

    \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-

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

and operation, and supervision that may differ materially from exchange
SRO rule sets.\166\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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

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

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

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

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.

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

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\
---------------------------------------------------------------------------

    \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<EMAIL_ADDRESS>---------------------------------------------------------------------------

    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<EMAIL_ADDRESS>---------------------------------------------------------------------------

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

be a member of FINRA. Some firms 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.
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    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

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

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).
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    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.
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    \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).
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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.
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    \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