8. Do commenters agree that the proposed best execution standard
should apply to natural persons who are associated persons of a broker-
dealer? Why or why not?
    9. Are there alternative definitions of ``natural person who is an
associated person'' that the Commission should use instead? Is the
application of proposed Rule 1100 appropriately limited to ``a natural
person who is an associated person'' of a broker-dealer? Please
explain.
    10. Would the proposed best execution standard pose any challenges
or burdens for entities that are dually-registered broker-dealers and
investment advisers? As discussed above,\123\ an investment adviser has
its own duty to seek best execution of a client's transactions where
the adviser has the responsibility to select broker-dealers to execute
client trades. What effect, if any, would the proposed best execution
standard have on investment advisers and their duty to seek best
execution?
---------------------------------------------------------------------------

    \123\ See supra note 11.
---------------------------------------------------------------------------

    11. Are there elements of an investment adviser's duty to seek best
execution that are relevant in assessing the proposed best execution
standard for a broker-dealer?
    12. Is it appropriate to provide an exemption from the proposed
best execution standard to a broker-dealer when another broker-dealer
is executing a customer order against the first broker-dealer's quote?
Why or why not?
    13. Is it appropriate to provide an exemption from the proposed
best execution standard to a broker-dealer when an institutional
customer, exercising independent judgment, executes its order against
the broker-dealer's quotations? Why or why not?
    14. Should the Commission define ``institutional customer'' for
purposes of proposed Rule 1100? If so, how should ``institutional
customer'' be defined? For example, should the Commission define
``institutional customer'' as any person that is a qualified
institutional buyer (``QIB'') as defined in Rule 144A under the
Securities Act of 1933?\124\ Why or why not?
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    \124\ 17 CFR 230.144A (defining ``QIB'' to mean a variety of
entities such as insurance companies, investment companies
registered under the Investment Company Act of 1940, and investment
advisers registered under the Investment Advisers Act of 1940, among
others, that in the aggregate own or invest on a discretionary basis
at least $100 million).
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    15. Should the Commission define ``institutional customer'' to
include a broader set of institutional customers than the QIB
definition, such as those entities that are included in the FINRA
definition of ``institutional account'' under FINRA Rule 4512(c)?\125\
Please explain.
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    \125\ FINRA Rule 4512(c) defines ``institutional account'' as
the account of: (1) a bank, savings and loan association, insurance
company or registered investment company; (2) an investment adviser
registered either with the Commission under section 203 of the
Investment Advisers Act or with a state securities commission (or
any agency or office performing like functions); or (3) any other
person (whether a natural person, corporation, partnership, trust or
otherwise) with total assets of at least $50 million.
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    16. Should the exemption concerning institutional customers in
proposed Rule 1100 be limited to situations where the broker-dealer
seeking the exemption has a reasonable basis to believe that the
institutional customer (i) has the capacity to evaluate independently
the prices offered by the broker-dealer and (ii) is exercising
independent judgment in deciding to enter into the transaction, such as
is provided for in FINRA Rule 2121 concerning suitability for
institutional customers? Please explain.
    17. Should the Commission define ``institutional customer'' for
purposes of

the proposed exemption in Rule 1100 to be consistent with the MSRB's
definition of SMMP? For example, should an institutional customer be
required to make an affirmation to the broker-dealer concerning its
exercise of independent judgment in evaluating the quality of execution
of its transaction with the broker-dealer? Are there other affirmations
relevant to best execution that should be required?\126\ Please
explain.
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    \126\ For example, the MSRB's definition of SMMP requires a
variety of other affirmations (e.g., relating to suitability, access
to timely information, fair pricing for agency transactions) as
broker-dealers are also exempt from other non-best execution related
obligations in transactions with SMMPs pursuant to MSRB Rules G-
48(a)-(d).
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    18. If an institutional customer affirmation should be required,
how should such affirmation be provided? Should an institutional
customer be permitted to provide the affirmation to the broker-dealer
orally or in writing? Should an institutional customer be permitted to
provide its affirmation on a trade-by-trade basis, a type-of-
transaction basis, a type-of-security basis (e.g., municipal security,
including general obligation, revenue, variable rate municipal
security; corporate bond, including investment grade and non-investment
grade; OTC equity; NMS security), or an account-wide basis? Please
explain.
    19. Should a broker-dealer seeking the exemption in proposed Rule
1100 in transactions with institutional customers be required to
disclose to the institutional customer that it is not required to
comply with the best execution standard of proposed Rule 1100 for the
relevant transactions? Should this disclosure be provided in lieu of or
in addition to a customer affirmation, if such affirmation should be
provided by the institutional customer? Please explain. If disclosure
should be required, what standards should apply to the disclosure? For
example, should a broker-dealer be required to make a disclosure to the
institutional customer on a transaction-by-transaction basis? If not,
what would be the appropriate manner for this disclosure? Please
explain. Should the disclosure be in writing or should a broker-dealer
be permitted to provide the disclosure orally to the institutional
customer? Please explain.
    20. Should the proposed exemption concerning institutional
customers in Rule 1100 be limited to only certain types of securities
or only certain types of trading protocols where the institutional
customer is executing against the broker-dealer's quote? For example,
should the exemption be limited only to transactions in fixed income
securities? Should it be limited to transactions that occur through
multilateral RFQ systems where the institutional customer is able to
put multiple broker-dealers and other market participants in
competition when soliciting quotes? Should the exemption be available
to a broker-dealer that is responding to a request for quote by an
institutional customer in a bilateral communication, whether over the
phone or through another communication protocol? Please explain.
    21. Should the Commission provide a broader exemption from the
proposed best execution standard for a broker-dealer when it engages in
any transaction for or with institutional customers, similar to the
exemption provided to broker-dealers under MSRB Rule G-48(e) for SMMPs?
Please explain why such exemption should or should not be provided.
    22. If a broader exemption for transactions with institutional
customers should be provided, how should the Commission define
``institutional customer''? Similar to the requests for comment above,
should the Commission define institutional customer as ``QIB'' as
defined in Rule 144A under the Securities Act of 1933, an
``institutional account'' as defined in FINRA Rule 4512(c), or an SMMP
as defined in MSRB Rule D-15? Is there another definition that would be
appropriate? Please explain. Should other conditions apply to the
exemption, as requested above, such as broker-dealer disclosure to the
institutional customer, broker-dealer assessment of the institutional
customer's ability to evaluate the transaction, and institutional
customer affirmations? Please explain.
    23. What are the typical order handling practices of broker-dealers
for the municipal bond orders of SMMPs? Do these order handling
practices vary depending on the type of SMMP under MSRB Rule D-15(a)?
Do SMMPs typically provide broker-dealers with orders to handle and
execute, or do SMMPs typically handle and execute their own orders?
Please explain. Do broker-dealers exercise any discretion in handling
the orders of SMMPs, whether executing such order on an agency or
principal basis? Please explain.
    24. Do commenters agree that the proposed rules are designed to
mitigate the regulatory burdens for broker-dealers that transact for or
with SMMP customers, while providing the benefit of the protections
offered by the proposed rules under appropriate circumstances? Why or
why not?
    25. Should the Commission provide an exemption from the proposed
best execution standard for a broker-dealer that engages in
transactions for or with sophisticated market professionals in asset
classes other than municipal securities? Please explain why such
exemption should or should not be provided.
    26. Is it appropriate to provide an exemption from the proposed
best execution standard to a broker-dealer that receives an unsolicited
instruction from a customer to route that customer's order to a
particular market for execution, where the broker-dealer processes that
customer's order promptly and in accordance with the terms of the
order? Why or why not?
    27. Should the Commission provide an exemption from the proposed
best execution standard for transactions in municipal fund securities
(which include interests in 529 college savings plans)? Should such
exemption only apply to municipal fund securities that are interests in
529 college savings plans? If the Commission were to provide an
exemption, should it apply similarly or differently to direct-sold and
advisor-sold municipal fund securities? Please explain why such
exemption should or should not be provided.
    28. Should the Commission provide an exemption for mutual fund
securities, such as equity and corporate bond mutual funds? Should the
Commission provide an exemption for any other type of security? Please
explain why such exemption should or should not be provided.
    29. Should the Commission provide any other exemptions from the
proposed best execution standard? If so, please explain.
    30. Should proposed Regulation Best Execution be the sole best
execution rule applicable to broker-dealers? Why or why not?

B. Proposed Rule 1101(a)--Best Execution Policies and Procedures

    Proposed Rule 1101(a) would require a broker-dealer that effects
any transaction for or with a customer or a customer of another broker-
dealer to establish, maintain, and enforce written policies and
procedures reasonably designed to comply with the best execution
standard under proposed Rule 1100 (``best execution policies and
procedures''). As discussed in sections IV.B.1 and 2 below, a broker-
dealer's best execution policies and procedures would be required to
address: (1) how the broker-dealer would comply with the best execution
standard; and (2) how the broker-dealer would determine the

best market for the customer orders that it receives.
    Proposed Rule 1101 does not include specific requirements regarding
the manner in which broker-dealers would comply with the best execution
standard. Rather, proposed Rule 1100 would require a broker-dealer to
use reasonable diligence to ascertain the best market for a security,
and buy or sell in such market so that the resultant price to the
customer is as favorable as possible under prevailing market
conditions, and proposed Rule 1101 would additionally require a broker-
dealer to establish and maintain written policies and procedures
reasonably designed to comply with the proposed standard. The policies
and procedures would be required to reflect the elements specified in
proposed Rule 1101(a) (e.g., best displayed prices, opportunities for
price improvement including midpoint executions, attributes of
particular customer orders, the trading characteristics of the
security). For example, a broker-dealer could have policies and
procedures that are tailored for different types of customers (e.g.,
retail customers, institutional customers) or for securities with
different trading characteristics (e.g., NMS stocks, municipal
securities).\127\ All customer orders must be covered by a broker-
dealer's best execution policies and procedures, and the broker-dealer
would be required to enforce such policies and procedures.
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    \127\ Similar to this proposal, FINRA and MSRB rules also
recognize that broker-dealers' best execution practices would be
tailored for securities with different characteristics. For example,
FINRA Rule 5310 recognizes that the markets for different securities
can vary and the standard of reasonable diligence must be assessed
by examining specific factors, such as the character of the market
for the security and the accessibility of the quotation. See, e.g.,
FINRA Rules 5310.03 (Best Execution and Debt Securities); 5310.06
(Orders Involving Securities with Limited Quotations or Pricing
Information); 5310.07 (Orders Involving Foreign Securities). See
also MSRB Rule G-18.06 (Securities with Limited Quotations or
Pricing Information) (recognizing that markets for municipal
securities may differ dramatically and referring to heightened
diligence with respect to customer transactions involving securities
with limited pricing information or quotations).
---------------------------------------------------------------------------

    While FINRA's best execution rule does not require broker-dealers
to have the same type of detailed best execution policies and
procedures as proposed Rule 1101,\128\ FINRA Rule 3110(b)(1) \129\
requires broker-dealers to have procedures for compliance with FINRA
rules and Federal securities laws and regulations. The MSRB's best
execution rule reflects a requirement for broker-dealers to have
policies and procedures for determining the best available market for
the executions of their customers' transactions.\130\ In addition, MSRB
Rule G-28 requires broker-dealers to have procedures for compliance
with MSRB rules and the Exchange Act and rules thereunder.\131\ The
Commission understands that broker-dealers currently have policies and
procedures relating to their compliance with the FINRA and MSRB best
execution rules, as applicable. However, unlike the FINRA and MSRB
rules, proposed Rule 1101(a)(1) would require broker-dealers' best
execution policies and procedures to include specific elements, as
discussed in sections IV.B.1 and 2 below.
---------------------------------------------------------------------------

    \128\ FINRA Rule 5310.
    \129\ FINRA Rule 3110(b)(1) requires a FINRA member to
establish, maintain, and enforce written procedures to supervise the
types of business in which it engages and the activities of its
associated persons that are reasonably designed to achieve
compliance with applicable securities laws and regulations, and with
applicable FINRA rules. Separately, FINRA Rules 3130(b) and (c)
require the chief executive officer (or equivalent officer) of a
FINRA member to certify annually that the member has in place
processes to establish, maintain, review, test and modify written
compliance policies and written supervisory procedures reasonably
designed to achieve compliance with applicable FINRA rules, MSRB
rules, and Federal securities laws and regulations.
    \130\ MSRB Rule G-18.08 states that a broker-dealer must, at a
minimum, conduct annual reviews of its policies and procedures for
determining the best available market for the executions of its
customers' transactions, including assessing whether its policies
and procedures are reasonably designed to achieve best execution,
taking into account the quality of the executions the broker-dealer
is obtaining under its current policies and procedures, among other
things.
    \131\ MSRB Rule G-28 requires broker-dealers to adopt, maintain
and enforce written supervisory procedures reasonably designed to
ensure that the conduct of the municipal securities activities of
the broker-dealer and its associated persons are in compliance with
MSRB rules and the applicable provisions of the Exchange Act and
rules thereunder.
---------------------------------------------------------------------------

1. Proposed Rule 1101(a)(1)--Framework for Compliance With the Best
Execution Standard
    Proposed Rule 1101(a)(1) would require a broker-dealer's best
execution policies and procedures to address how it will comply with
the proposed best execution standard by: (i) obtaining and assessing
reasonably accessible information, including information about price,
volume, and execution quality, concerning the markets trading the
relevant securities; (ii) identifying markets that may be reasonably
likely to provide material potential liquidity sources (as defined
above); and (iii) incorporating material potential liquidity sources
into its order handling practices and ensuring that it can efficiently
access each such material potential liquidity source.
    Proposed Rule 1101(a)(1)(i) would require a broker-dealer to have
policies and procedures for obtaining and assessing reasonably
accessible information regarding the markets trading the relevant
securities.\132\ Market information is relevant to a broker-dealer's
best execution analysis,\133\ and the Commission has previously
identified price and execution quality information as among the factors
relevant to that analysis.\134\ The Commission believes that the
ability of markets to attract trading interest as measured by trading
volume would also be relevant to a broker-dealer's best execution
analysis, because trading volume can be an indicator of whether
sufficient interest exists on a particular market to execute customer
orders.\135\
---------------------------------------------------------------------------

    \132\ Proposed Rule 1101 would not establish minimum data
elements needed to comply with the proposed best execution standard.
Rather, it would require broker-dealers to establish, maintain, and
enforce policies and procedures reasonably designed to comply with
the proposed best execution standard. In implementing its policies
and procedures (both for non-conflicted and conflicted
transactions), including policies and procedures that address how
the broker-dealer would obtain and assess reasonably accessible
information or how the broker-dealer would obtain and assess other
information for conflicted transactions (as discussed in section
IV.C below), a broker-dealer may determine that it is appropriate to
purchase certain proprietary data. See also supra note 38
(describing the Commission's statements in the MDI Adopting Release
that the Commission was not establishing minimum data elements
needed to achieve best execution nor mandating consumption of
certain data content, and acknowledging that different market
participants and different trading applications have different
market data needs).
    \133\ See, e.g., Order Execution Obligations Adopting Release,
supra note 10, 61 FR at 48322-23 (stating that a broker-dealer's
practices for achieving best execution, including the data,
technology, and types of markets it accesses, must constantly be
updated as markets evolve); Order Execution and Routing Practice
Release, supra note 22, 65 FR at 75418 (stating that quotation
information contained in the public quotation system must be
considered in seeking best execution of customer orders); MDI
Adopting Release, supra note 38, 86 FR at 18605 (stating that
broker-dealers should consider the availability of consolidated
market data, including the various elements of data content and the
timeliness, accuracy, and reliability of the data in developing and
maintaining their best execution policies and procedures).
    \134\ See, e.g., Order Execution Obligations Adopting Release,
supra note 10, 61 FR 48323 (identifying price improvement and
execution quality as among the relevant factors for a best execution
analysis); MDI Adopting Release, supra note 38, 86 FR 18605
(identifying order size, trading characteristics of the security,
speed of execution, clearing costs, and the cost and difficulty of
executing an order in a particular market as relevant factors for a
best execution analysis).
    \135\ FINRA Rule 5310(a)(1) and MSRB Rule G-18(a) set forth
similar factors that are relevant to a best execution analysis,
including the character of the market for the security (e.g., price,
volatility, relative liquidity, and pressure on available
communications). However, unlike proposed Rule 1101(a), FINRA and
MSRB rules do not explicitly require relevant factors to be included
in a broker-dealer's best execution policies and procedures. The
considerations in FINRA and MSRB rules concerning volatility,
relative liquidity, and pressure on available communications could
be included as part of the best market policies and procedures in
proposed Rule 1101(a)(2), which requires consideration of the
trading characteristics of a security. See also FINRA Rule 5310.09
(requiring a member to conduct regular and rigorous reviews of the
quality of the executions of its customers' orders); MSRB Rule G-
18.08 (requiring a dealer to conduct periodic reviews of its best
execution policies and procedures, taking into account the quality
of the executions the dealer is obtaining under its current policies
and procedures, among other things).

---------------------------------------------------------------------------

    More specifically with respect to execution quality, the Commission
believes that the level of competition within a market can impact the
execution quality of that market and, therefore, broker-dealers should
generally consider including the level of competition of a market as an
element of its best execution policies and procedures.\136\
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    \136\ This could include considerations of auction features,
such as allocation guarantees and fees, the types of market
participants that can participate in an auction, the breadth of
participation in an auction, and the accessibility of auction
processes. This assessment of auction mechanisms would apply to a
broker-dealer that is handling a customer order that is subject to
the proposed requirements in the Order Competition Rule (known as a
``segmented order''). See Securities Exchange Act Release No. 34-
96495 (Dec. 14, 2022). Were the Commission to adopt the proposed
Order Competition Rule, a broker-dealer that desires to trade as
principal with a segmented order would, absent an exception, be
required to expose certain orders to competition through use of
``qualified auctions,'' as defined by the proposed Order Competition
Rule. If the proposed Order Competition Rule were adopted, a broker-
dealer when evaluating which qualified auction to use for segmented
orders under proposed Regulation Best Execution (if adopted) would
have to have policies and procedures addressing how the broker-
dealer will assess the execution quality of different qualified
auctions and identify those that are likely to result in the most
favorable price for customer orders.
---------------------------------------------------------------------------

    With respect to price improvement auctions offered by options
exchanges, while the Commission believes that such auctions could
provide better executions for customer orders than routing such orders
to execute at the prevailing best bid or offer on an exchange, the
selection of a particular price improvement auction could impact the
execution quality of customer orders. A broker-dealer should generally
consider addressing in its policies and procedures how it would assess
the features of options price improvement auctions, how those features
might affect the level of competition and the execution quality offered
by the auctions, and whether those features would allow an auction to
provide the most favorable prices under prevailing market conditions.
For example, price improvement auctions have features, which have been
implemented pursuant to proposed rule changes filed with the
Commission, that allow a wholesaler to trade with much or all of the
customer orders represented in an auction.\137\ The current fee
structures for price improvement auctions may also affect market
participants' determination of whether to compete with a wholesaler for
customer orders and provide more favorable prices.\138\ As reflected in
the table below, as of May 25, 2022, the vast majority of options
exchanges charge market participants that may desire to compete for
customer orders response fees of $0.50 per contract (for options
classes priced in $0.01 increments (``penny classes'')) and $1.00 or
more per contract (for options classes priced in $0.05 increments
(``non-penny classes'')). These response fees are not charged to
wholesalers that initiate the price improvement auctions.
---------------------------------------------------------------------------

    \137\ See, e.g., Nasdaq ISE, LLC Options 3, Section 13; Nasdaq
Phlx LLC Options 3, Section 13; Miami International Securities
Exchange LLC Rule 515A; BOX Exchange LLC Rule 7150; NYSE American
LLC Rule 971.1NY; Cboe Exchange, Inc. Rule 5.37.
    \138\ See Nasdaq ISE LLC Options 7, Section 3; Nasdaq GEMX LLC
Options 7, Section 3; Nasdaq MRX LLC Options 7, Section 3.A.; Nasdaq
Phlx LLC Options 7, Section 6.A.; BOX Exchange LLC Fee Schedule
Section IV.B.; Miami International Securities Exchange LLC Fee
Schedule Section (1)(a)(v); NYSE American LLC Options Fee Schedule
Section I.G.; Cboe Exchange, Inc. Fee Schedule; Cboe EDGX Exchange,
Inc. Options Fee Schedule n.6.

----------------------------------------------------------------------------------------------------------------
                                                                               Auction  market   Auction  market
                                                                Fees for       maker  response   maker  response
                         Exchange                              initiating       fees  (penny    fees  (non-penny
                                                                 orders           classes)           classes)
----------------------------------------------------------------------------------------------------------------
CBOE......................................................              0.07              0.50              1.05
EDGX......................................................              0.05              0.50              1.05
PHLX......................................................              0.07              0.25              0.40
MRX.......................................................              0.02              0.50              1.10
ISE.......................................................              0.10              0.50              1.10
GEMX......................................................              0.05              0.50              0.94
AMEX......................................................              0.05              0.50              1.05
MIAX......................................................              0.05              0.50              1.10
BOX.......................................................              0.05              0.50              1.15
----------------------------------------------------------------------------------------------------------------

    In addition, allocation guarantees, which permit the wholesaler to
trade with a significant portion of the customer order, may affect
competing market participants' determinations of whether and how to
participate in price improvement auctions.\139\ Likewise, ``auto-
match'' features, which enable the wholesaler to automatically match
the best prices submitted by competing market participants, may affect
competing market participants' determinations of whether and how to
participate in price improvement auctions.\140\
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    \139\ See supra note 137.
    \140\ See, e.g., Nasdaq ISE, LLC Options 3, Section 13(d)(3);
Nasdaq Phlx LLC Options 3, Section 13(b)(1); Miami International
Securities Exchange LLC Rule 515A(a)(2)(i)(A); BOX Exchange LLC Rule
7150(f); NYSE American LLC Rule 971.1NY(c)(1); Cboe Exchange, Inc.
Rule 5.37(b)(5).
---------------------------------------------------------------------------

    As another example, in considering RFQ systems as material
potential liquidity sources for corporate and municipal bonds and
government securities, a broker-dealer's policies and procedures could
assess the filtering practices that may be applied by the RFQ system
operator and the impact that those practices may have on the execution
quality of those markets. If an RFQ system applies an automatic filter
that prevents a broker-dealer that initiates the RFQ from sending that
request to all participants on the RFQ system, a broker-dealer could
evaluate the potential impact that may have on that market's execution
quality. To the extent other RFQ systems do not apply such filters to
the broker-dealer's request, a broker-dealer could evaluate whether
these other RFQ systems would be a better alternative for executing
customer orders, taking into consideration other relevant information
that the broker-dealer may obtain concerning the RFQ systems.

    Proposed Rule 1101(a)(1)(ii) would require a broker-dealer's
policies and procedures to address how it will identify material
potential liquidity sources, but it would not require a broker-dealer
to include in its policies and procedures a minimum number of markets
that it would need to identify as material potential liquidity sources.
Rather, under proposed Rules 1101(a)(1)(i) and (ii), a broker-dealer
would be required to follow its policies and procedures in assessing
reasonably accessible information and determining material potential
liquidity sources. The Commission believes a broker-dealer's
identification of material potential liquidity sources could be
influenced by the nature of the broker-dealer's business operation and
customer order flow. For example, some broker-dealers focus on the
handling and execution of institutional orders or large-size orders,
while some broker-dealers handle and execute retail orders or small-
size orders. These considerations may be relevant to the types of
markets or market information that the broker-dealer assesses for
purposes of identifying material potential liquidity sources. The
Commission further believes a broker-dealer's assessment of market
information and identification of material potential liquidity sources
could vary depending on the trading characteristics of the relevant
security, the level of transparency in the applicable market, and
accessibility of a market, including the cost of maintaining
connectivity, receiving market data, and transacting on the market. For
example, if a market charges unreasonably high fees for connectivity,
market data, or transactions, a broker-dealer could consider whether
such market's information is reasonably accessible and whether such
market should be identified as a material potential liquidity
source.\141\
---------------------------------------------------------------------------

    \141\ The Commission has previously described a non-exhaustive
list of factors that may be relevant to broker-dealers' best
execution analysis. These factors include the size of the order,
speed of execution, clearing costs, the trading characteristics of
the security involved, the availability of accurate information
affecting choices as to the most favorable market center for
execution and the availability of technological aids to process such
information, and the cost and difficulty associated with achieving
an execution in a particular market center. See supra note 23 and
accompanying text.
---------------------------------------------------------------------------

    While proposed Rules 1101(a)(1)(i) and (ii) do not include an
exhaustive list of the markets that might be considered material
potential liquidity sources, or the potential sources of reasonably
accessible information for different types of securities, some examples
may be helpful. For the NMS stock market, material potential liquidity
sources could include exchanges, ATSs, and broker-dealers, including
market makers and wholesalers. It could also include trading protocols
and auction mechanisms operated by these entities, including those that
may provide price improvement opportunities, such as exchange limit
order books, retail liquidity programs, midpoint liquidity, and
wholesaler price improvement guarantees. Concerning potential sources
of reasonably accessible information, the Commission has stated that
quotation data made publicly available must be considered by a broker-
dealer when seeking best execution of customer orders.\142\ In
addition, a broker-dealer generally should consider whether
consolidated trade information, exchange proprietary data feeds, odd
lot market data, and execution quality and order routing information
contained in reports made pursuant to Rules 605 and 606 of Regulation
NMS are readily accessible and needed in order for the broker-dealer to
identify material potential liquidity sources for its customers'
orders.\143\
---------------------------------------------------------------------------

    \142\ See Order Execution Obligations Adopting Release, supra
note 10, 61 FR 48324.
    \143\ In a regulatory notice concerning its best execution rule,
FINRA has provided guidance regarding the relevance of proprietary
data feeds to a broker-dealer's best execution assessment. See FINRA
Regulatory Notice 15-46, at 13 n.12 (``[A] firm that regularly
accesses proprietary data feeds, in addition to consolidated data
from the Securities Information Processors (SIPs), for its
proprietary trading, would be expected to also use these data feeds
to determine the best market under prevailing market conditions when
handling customer orders.'').
---------------------------------------------------------------------------

    In the OTC equities market, a broker-dealer could consider whether
ATSs, wholesalers, and other OTC market makers may be potential
material liquidity sources. With regard to reasonably accessible
information, a broker-dealer could consider obtaining data from ATSs
and OTC market makers, in addition to obtaining the data concerning
transaction prices in OTC equities made publicly available through the
FINRA Over-the-Counter Reporting Facility (``ORF'').
    In the options market, material potential liquidity sources could
include the options exchanges and the range of trading protocols and
auction mechanisms made available by them. These could include quotes
from market makers resting on exchange limit order books, price
improvement auctions, liquidity resting between the best bid and offer
that may be available on exchange limit order books, and floor trading
facilities that may provide a broker-dealer with the opportunity to
seek competitive prices from floor participants for larger or complex
options orders. Other broker-dealers in the options market could also
represent a type of market that generally should be considered when
assessing material potential liquidity sources. Specifically, many
options trades are arranged away from the exchanges by broker-dealers
and are often brought to the exchanges for order exposure and potential
price improvement prior to execution.\144\ Because options trades may
be arranged in this fashion, a broker-dealer would need to consider
whether other broker-dealers may represent material potential liquidity
sources for its customers' options orders. With regard to reasonably
accessible information, a broker-dealer should consider whether
proprietary data feeds and quarterly Rule 606 order routing reports are
readily accessible and needed to identify material potential liquidity
sources, in addition to consolidated trade and quotation data that is
made publicly available.
---------------------------------------------------------------------------

    \144\ See, e.g., Nasdaq ISE, LLC, Options 3, Section 11(b)-(e)
(providing exchange functionality for facilitation and solicitation
auctions, which permit an exchange member to attempt to execute
large-sized orders it represents as agent against principal interest
or contra-side orders it has solicited). See also, e.g., Miami
International Securities Exchange LLC Rule 515A(b); Cboe Exchange,
Inc. Rule 5.39. The ability to attempt to execute an agency order
against principal or solicited interest is also permitted in the
options exchange price improvement auctions. See supra note 137.
---------------------------------------------------------------------------

    In addition, a number of markets could be considered for purposes
of identifying material potential liquidity sources in the corporate
and municipal bond markets and government securities markets. These may
include, for example, ATS and non-ATS electronic trading systems, RFQ
systems, and other auction mechanisms. Material potential liquidity
sources in these fixed income markets could also include interdealer
brokers and other broker-dealers willing to be a counterparty upon
request.\145\ A broker-dealer's own principal trading desk could also
be a market for purposes of identifying material potential liquidity
sources.\146\ With respect to reasonably accessible information, a
broker-dealer could consider whether to obtain data from ATSs and other
trading platforms, such as RFQ systems, interdealer brokers, and
dealers that

handle and execute customer orders, in addition to obtaining
consolidated trade data in the corporate bond and municipal bond
markets made publicly available through FINRA's Trade Reporting and
Compliance Engine (``TRACE'') and the MSRB's Real-time Transaction
Reporting System (``RTRS'').\147\ A broker-dealer could also consider
obtaining relevant data from information sources that do not provide
execution services, such as price aggregator services or evaluated
pricing services.
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    \145\ For example, for less widely-traded securities, broker-
dealers that have previously traded such securities or that are
otherwise known to trade in the securities can be markets for
certain segments of the fixed income market. See, e.g., MSRB
Implementation Guidance on MSRB Rule G-18, on Best Execution at Item
VI.1. (updated as of Feb. 7, 2019).
    \146\ Principal trading with a customer by a broker-dealer would
be subject to more robust policies and procedures requirements under
proposed Rule 1101(b).
    \147\ See, e.g., https://www.finra.org/filing-reporting/trace/data and https://emma.msrb.org/.
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    Proposed Rule 1101(a)(1)(iii) would require a broker-dealer to have
policies and procedures that address how the broker-dealer will
incorporate material potential liquidity sources into its order
handling practices and ensure that it can efficiently access each such
material potential liquidity source. This requirement is designed to
enhance a broker-dealer's ability meet the proposed best execution
standard by helping to ensure that the broker-dealer incorporates the
identified material potential liquidity sources into its order handling
practices so that it can execute customer orders in those markets as
appropriate.\148\
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    \148\ FINRA Rule 5310(c) provides that a failure to maintain or
adequately staff an OTC order room or other department assigned to
execute customers' orders is not a justification for a broker-dealer
executing away from the best available market. The provision further
states that channeling orders through a third party as reciprocation
for service or business does not relieve a broker-dealer of its
obligation under FINRA Rule 5310. FINRA Rule 5310(d) also provides
that a broker-dealer through which orders are channeled and that
knowingly is a party to an arrangement whereby the initiating member
has not fulfilled its obligations under FINRA Rule 5310 will be
deemed to have violated the rule. Similarly, MSRB Rule G-18.02
states that a broker-dealer's failure to maintain adequate resources
is not a justification for executing away from the best available
market. The proposed rules likewise would not exempt these scenarios
from the proposed best execution standard. The Commission also
believes that these provisions reflect the concept of efficient
access to the best market so that the resulting price to a customer
is as favorable as possible under prevailing market conditions, and
therefore are consistent with the Commission's proposal to require a
broker-dealer's best execution policies and procedures to address
how the broker-dealer will efficiently access material potential
liquidity sources.
---------------------------------------------------------------------------

    Efficient access to each material potential liquidity source, as
specified by proposed Rule 1101(a)(1)(iii), may require different order
handling processes and arrangements in different markets, and would not
necessarily require that a broker-dealer directly connect to a market,
as it may be efficient in some circumstances for a broker-dealer to use
another broker-dealer to access a particular market for a customer
order. However, interposing a third-party between the broker-dealer and
the market reasonably likely to provide the most favorable price for
its customer would not be consistent with the concept of ``efficient
access,'' if the broker-dealer could access the market directly but
chose instead to access the market indirectly resulting in a worse
execution for the customer.\149\ As stated above, interpositioning can
violate the broker-dealer's duty of best execution when it results in
unnecessary transaction costs at the expense of the customer.\150\
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    \149\ The proposed requirement that a broker-dealer's policies
and procedures address how it will be able to efficiently access any
material potential liquidity source is consistent with FINRA and
MSRB rules concerning interpositioning. Specifically, FINRA Rule
5310(a)(2) states that no broker-dealer or person associated with a
broker-dealer may interject a third party between the broker-dealer
and the best market for the subject security in a manner that would
be inconsistent with FINRA's best execution standard. FINRA Rule
5310(b) states that when a broker-dealer cannot execute directly
with a market but must employ a broker's broker or some other means
in order to ensure an execution advantageous to the customer, the
burden of showing the acceptable circumstances for doing so is on
the broker-dealer. And FINRA Rule 5310.05 states that examples of
acceptable circumstances are where a customer's order is ``crossed''
with another firm that has a corresponding order on the other side,
or where the identity of the firm, if known, would likely cause
undue price movements adversely affecting the cost or proceeds to
the customer. MSRB Rule G-18(b) similarly prohibits a broker-dealer
from interjecting a third party between itself and the best market
for the subject security in a manner inconsistent with the MSRB's
best execution standard. However, unlike proposed Rule 1101(a),
FINRA and MSRB rules do not require a broker-dealer's best execution
policies and procedures to explicitly address the incorporation of
liquidity sources into its order handling practices or the efficient
access of liquidity sources.
    \150\ See supra notes 29-30 and accompanying text.
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Request for Comment
    The Commission requests comment on all aspects of proposed Rule
1101(a)(1), and in particular:
    31. Do commenters believe that proposed Rule 1101(a)(1)(i)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will obtain and assess reasonably accessible
information, including information about price, volume, and execution
quality, concerning the markets trading the relevant securities? Why or
why not?
    32. What factors would a broker-dealer consider in determining
whether information is ``reasonably accessible'' for purposes of its
best execution policies and procedures under the proposed rules? Please
explain.
    33. Should the Commission specify the types of information that
would be ``reasonably accessible'' under proposed Rule 1101(a)(1)(i)?
For example, should the Commission specify that consolidated market
data distributed by the securities information processors is a type of
``reasonably accessible'' information under the proposed rule? Please
explain.
    34. Do commenters agree that proposed Rule 1101(a)(1) is consistent
with prior Commission statements, including those described in section
II.B above? Why or why not? If not, should the Commission revise any of
its statements in light of the proposal? Please explain.
    35. Do commenters believe that proposed Rule 1101(a)(1)(ii)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will identify material potential liquidity sources? Why
or why not?
    36. Do commenters believe the Commission has appropriately defined
material potential liquidity sources in proposed Rule 1101(a)(1)(ii)?
Please explain.
    37. What factors would a broker-dealer consider in identifying
material potential liquidity sources under the proposed rules? Please
explain.
    38. In identifying material potential liquidity sources, do broker-
dealers consider market connectivity fees and other access and
transaction fees? Please explain.
    39. Do commenters agree that proposed Rule 1101(a)(1)(ii) is
consistent with prior Commission statements, including those described
in section II.B above? Why or why not? If not, should the Commission
revise any of its statements in light of the proposal? Please explain.
    40. Do commenters believe that proposed Rule 1101(a)(1)(iii)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will incorporate material potential liquidity sources
into its order handling practices? Why or why not?
    41. Do commenters believe that proposed Rule 1101(a)(1)(iii)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will ensure efficient access to each material potential
liquidity source? Why or why not?
    42. What factors would a broker-dealer consider to ensure that it
can efficiently access a material potential liquidity source under the
proposed rules? Please explain.
    43. Do commenters agree that proposed Rule 1101(a)(1)(iii) is
consistent with prior Commission statements, including those described
in section II.B above? Why or why not? If not, should the Commission
revise any of its statements in light of the proposal? Please explain.

    44. Do commenters agree with the Commission's understanding that
broker-dealers currently have policies and procedures for how they
comply with the FINRA and MSRB best execution rules, as applicable?
Please describe the types of best execution policies and procedures
that broker-dealers currently have. In particular, do broker-dealers'
policies and procedures address how they obtain and assess reasonably
accessible information, including information about price, volume, and
execution quality, concerning the markets trading the relevant
securities? Do broker-dealers' policies and procedures address how they
identify material potential liquidity sources? Do broker-dealers'
policies and procedures address how they incorporate material potential
liquidity sources into their order handling practices, and how they
ensure that they can efficiently access each such material potential
liquidity source?
    45. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1101(a)(1) for broker-
dealers of different sizes, if the Commission adopts proposed
Regulation Best Execution? For example, should the Commission provide
longer compliance dates for smaller broker-dealers? If so, should the
Commission define a smaller broker-dealer as a broker-dealer that
qualifies as a ``small entity'' under the Regulatory Flexibility Act
pursuant to 17 CFR 240.0-10(c) for this purpose? \151\ Or should the
Commission define a smaller broker-dealer in a different way? Please
explain.
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    \151\ 17 CFR 240.0-10(c) defines a smaller broker-dealer as one
that: (1) had total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal
year as of which its audited financial statements were prepared
pursuant to Rule 17a-5(d) under the Exchange Act, or, if not
required to file such statements, had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the last business
day of the preceding fiscal year (or in the time that it has been in
business, if shorter); and (2) is not affiliated with any person
(other than a natural person) that is not a small business or small
organization.
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2. Proposed Rule 1101(a)(2)--Best Market Determination
    Proposed Rule 1101(a)(2) would require a broker-dealer's best
execution policies and procedures to address how it will determine the
best market and make routing or execution decisions for customer orders
that it receives by: (i) assessing reasonably accessible and timely
information with respect to the best displayed prices, opportunities
for price improvement, including midpoint executions, and order
exposure opportunities that may result in the most favorable price;
(ii) assessing the attributes of customer orders and considering the
trading characteristics of the security, the size of the order, the
likelihood of execution, the accessibility of the market, and any
customer instructions in selecting the market most likely to provide
the most favorable price; and (iii) in determining the number and
sequencing of markets to be assessed, reasonably balancing the
likelihood of obtaining better prices with the risk that delay could
result in worse prices.
    In determining the best market for customer orders, the assessment
of reasonably accessible and timely information \152\ with respect to
the best displayed prices and opportunities for price improvement would
vary depending on the trading characteristics of particular securities.
Displayed prices can provide a useful reference price for a broker-
dealer to consider when assessing the best market in which to execute
customer orders, particularly in an asset class where there are
consolidated displays of the best prices across the market, or for
securities that are considered liquid and have firm prices that are
accessible. Accordingly, under proposed Rule 1101(a)(2)(i), a broker-
dealer's policies and procedures would be required to address how it
will assess reasonably accessible and timely information with respect
to the best displayed prices in any given market or security.\153\ In
addition, the Commission has previously stated that, when reviewing
their procedures for seeking to obtain best execution, ``broker-dealers
must take into account price improvement opportunities, and whether
different markets may be more suitable for different types of orders or
particular securities.'' \154\ Accordingly, under proposed Rule
1101(a)(2)(i), a broker-dealer's policies and procedures would be
required to specifically address how it will assess price improvement
opportunities,\155\ including midpoint execution opportunities.\156\
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    \152\ See supra notes 132 and 141 and accompanying text.
    \153\ For fixed income securities, FINRA has also recognized
that while a broker-dealer should consider using displayed prices on
electronic trading platforms as part of its reasonable diligence in
determining the best market for a security, executing a customer
order at the displayed price may not necessarily fulfill the broker-
dealer's best execution obligations. See FINRA Regulatory Notice 15-
46, at 8 (stating that displayed prices on electronic trading
platforms may not be the presumptive best prices, especially for
securities that are illiquid or trade infrequently). Accordingly,
the Commission believes that the concept of ``best displayed
prices'' is applicable to the fixed income securities market.
    \154\ Regulation NMS Adopting Release, supra note 21, 70 FR
37538. See also Order Execution Obligations Adopting Release, supra
note 10, 61 FR 48323 n.357 (stating that any evaluation of price
improvement opportunities would have to consider not only the extent
to which orders are executed at prices better than the prevailing
quotes, but also the extent to which orders are executed at inferior
prices).
    \155\ Price improvement is the execution of an order at a price
that is better than the best displayed buy or sell prices in the
market, and an execution between the best displayed bid and offer is
a form of price improvement. See, e.g., Order Execution Obligations
Adopting Release, supra note 10, 61 FR 48323 n.357 (stating that
price improvement means the difference between execution price and
the best quotes prevailing in the market at the time the order
arrived at the market or market maker); FINRA Rule 5310.09(b)(1)
(describing price improvement opportunities to mean the difference
between the execution price and the best quotes prevailing at the
time the order is received by the market).
    \156\ These executions occur at the midpoint of the best
displayed buy and sell prices and may represent a significant amount
of price improvement as compared to executing at the best displayed
prices for customers seeking to trade immediately.
---------------------------------------------------------------------------

    In addition to displayed prices and opportunities for price
improvement, there may be other order exposure opportunities for
customer orders (e.g., order handling and execution protocols that may
provide exposure to a competitive process for customer orders). For
example, markets that operate limit order books and enable broker-
dealers to post customer limit orders could represent a best market for
customer orders. These markets may provide an opportunity for
executions at the prevailing best bid for customer buy orders or at the
prevailing best offer for customer sell orders, rather than executing
customer orders by crossing the prevailing bid-offer spread. As another
example, auctions may offer an opportunity to expose marketable
customer orders to prices that are more favorable than prices that
would be achieved by crossing the spread. Accordingly, under proposed
Rule 1101(a)(2)(i), a broker-dealer's policies and procedures would be
required to address how it will assess order exposure opportunities
that may result in the most favorable price.
    FINRA Rule 5310(a)(1) and MSRB Rule G-18(a) also identify price
information as relevant when ascertaining the best market for a
security.\157\ MSRB Rule G-18(a) also includes as an additional factor:
the information reviewed to determine the current market for the
subject security

or similar securities.\158\ As described in section IV.B.1 above, FINRA
and MSRB rules reflect requirements for broker-dealers to have policies
and procedures for compliance with relevant laws and rules. However,
FINRA and MSRB rules do not require a broker-dealer's policies and
procedures to specifically address the elements that are relevant to
its best market determinations. The Commission understands that broker-
dealers currently generally have policies and procedures to ascertain
the best market for a security, although such policies and procedures
may need to be updated to address the elements specified in proposed
Rule 1101(a)(2).
---------------------------------------------------------------------------

    \157\ FINRA has also recognized the importance of considering
midpoint liquidity. See FINRA Regulatory Notice 15-46 at 4 n.25
(``For example, if a firm obtains price improvement at one venue of
$0.0005 per share, and it could obtain mid-point price improvement
at another venue of $0.025 per share, the firm should consider the
opportunity of such midpoint price improvement on that other venue
as part of its best execution analysis.''). In addition, FINRA Rule
5310.09(b)(1) recognizes the relevance of price improvement
opportunities.
    \158\ This factor is consistent with proposed Rule 1101(a)(2)
because a broker-dealer's policies and procedures regarding the
assessment of reasonably accessible and timely best displayed prices
in the municipal bond market could include an assessment of
information to determine the current market for the subject security
or similar securities.
---------------------------------------------------------------------------

    For a retail broker-dealer in NMS stocks, its policies and
procedures for the best market determination could include assessments
of any assurances from a wholesaler that certain orders routed by the
retail broker-dealer to the wholesaler would be guaranteed midpoint
executions by the wholesaler or otherwise exposed to opportunities for
midpoint executions.\159\ If midpoint executions were not guaranteed by
a wholesaler, a retail broker-dealer's policies and procedures could
provide for assessments of whether customer orders would best be
executed with midpoint liquidity that may be available on an exchange,
ATS, or other market. Following an assessment of the opportunities for
midpoint executions, a broker-dealer's policies and procedures could
provide for an assessment of whether other price improvement
opportunities might be available, such as from wholesalers,\160\ from
resting liquidity between the best bid and offer on exchanges, through
auctions, or otherwise.
---------------------------------------------------------------------------

    \159\ If wholesalers do not have a practice of routinely seeking
and accessing midpoint liquidity as appropriate, the retail broker-
dealer's policies and procedures could address how it takes that
into account when assessing whether a wholesaler is the best market
for customer orders.
    \160\ In considering wholesalers, such policies and procedures
could address how the retail broker-dealer assesses the price
improvement opportunities that may be available from different
wholesalers, including an assessment of guarantees for price
improvement that might be provided by wholesalers and the
performance of wholesalers, such as the execution quality that the
retail broker-dealer's customers received from the wholesalers in
the past.
---------------------------------------------------------------------------

    With respect to listed options, the Commission recognizes that
midpoint liquidity is not as commonly available on options exchanges as
it is in the NMS stock market.\161\ A broker-dealer's policies and
procedures nevertheless would be required to address how it will assess
potential midpoint executions, including to the extent additional
midpoint liquidity emerges. Following an assessment of potential
opportunities for midpoint executions, the Commission preliminarily
believes that a broker-dealer's policies and procedures could provide
for an assessment of other price improvement opportunities that might
be available. These price improvement opportunities could include
potential resting liquidity on exchange limit order books priced
between the best bid and offer. Price improvement opportunities may
also be available through exchange price improvement auctions.\162\ A
broker-dealer's policies and procedures could also address how it will
assess price improvement opportunities that may be available from
different wholesalers, including an assessment of guarantees for price
improvement that might be provided by wholesalers and the performance
of the wholesalers, including the execution quality that the retail
broker-dealer's customers received from the wholesalers in the past. In
doing so, a broker-dealer's policies and procedures could address how
it will assess the exchanges and exchange mechanisms that wholesalers
use, why they use those exchanges and mechanisms, and the relative
competitiveness of those exchanges and mechanisms in light of fee
differentials and functionality that can affect competitive responses
and facilitate internalization.
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    \161\ Given the lack of order types concerning midpoint
liquidity, midpoint liquidity is not prevalent in the listed options
market.
    \162\ Price improvement auctions currently available on options
exchanges are two-sided and thus may not be directly accessible by
many retail broker-dealers because they do not commit capital to
trade with customers. Specifically, options price improvement
auctions guarantee that a customer order will be executed by
requiring the broker-dealer initiating the auction to commit to
trade in a principal capacity with the customer order at a certain
price, with exposure to potential price improvement from competitive
responders. See, e.g., Nasdaq ISE, LLC Options 3, Section 13; Nasdaq
Phlx LLC Options 3, Section 13; Miami International Securities
Exchange LLC Rule 515A; BOX Exchange LLC Rule 7150; NYSE American
LLC Rule 971.1NY; Cboe Exchange, Inc. Rule 5.37. However, to the
extent one-sided auctions (or other trading protocols providing a
competitive process for exposing customer orders for the most
favorable price) exist or emerge, a broker-dealer's policies and
procedures generally should consider addressing whether such price
improvement opportunities represent the best market for customer
orders when making a routing or execution decision.
---------------------------------------------------------------------------

    The policies and procedures requirements under proposed Rule
1101(a)(2)(i) would also apply to wholesalers in the NMS stock and
options markets. For customer orders that a wholesaler intends to
execute at prices worse than the midpoint, its policies and procedures
could provide for an assessment of whether those orders would best be
executed with midpoint liquidity that may be available on an exchange,
ATS, or other market. A wholesaler's policies and procedures would also
need to address how it will consider other opportunities for price
improvement, which could include liquidity available on exchanges or
other markets priced between the best bid and offer. Finally, these
policies and procedures would need to address how the wholesaler will
assess order exposure opportunities for customer orders that may result
in the most favorable price for those orders.
    In the corporate and municipal bond markets and government
securities markets, some broker-dealers display executable prices to
customers through proprietary customer-facing systems that enable
customers to transact at the displayed prices. Sometimes these prices
represent securities that are available on other venues such as ATSs,
interdealer brokers or otherwise, while other times these prices
represent securities held in inventory by the broker-dealer. The
policies and procedures of a broker-dealer in the corporate and
municipal bond markets and government securities markets would need to
address how it will assess reasonably accessible and timely information
with respect to the best displayed prices.
    Information with respect to the best displayed prices would be
different between the corporate and municipal bond markets and
government securities markets, and the equities and options markets. In
particular, timely consolidated best prices are readily accessible in
the equities and options markets, but there are no similar consolidated
best prices in the corporate and municipal bond markets and government
securities markets. A broker-dealer's policies and procedures generally
should therefore be tailored to reflect best displayed price
information that is ``reasonably accessible and timely'' in the
corporate and municipal bond markets and government securities
markets.\163\
---------------------------------------------------------------------------

    \163\ FINRA Rule 5310 also states that ``when quotations are
available, FINRA will consider the accessibility of such quotations
when examining whether a member has used reasonable diligence.'' See
FINRA Rule 5310.03. FINRA has also discussed the importance of a
broker-dealer evaluating the quality of displayed prices in fixed
income securities. See FINRA Regulatory Notice 15-46, at 8 (``FINRA
also notes that prices of a fixed income security displayed on an
electronic trading platform may not be the presumptive best price of
that security for best execution purposes, especially for securities
that are illiquid or trade infrequently. Thus, although a firm
should consider using this information as part of its reasonable
diligence in determining the best market for the security, executing
a customer order at the displayed price may not fulfill the firm's
obligations, particularly if other sources of information indicate
the displayed price may not be the best price available. For
example, if . . . a firm regularly uses a reliable similar security
analysis to establish prices, that firm may need to use particular
care before executing a trade at a price that is displayed by a
trading system if its similar security analysis suggests that the
displayed price is not reflective of the market.'').

---------------------------------------------------------------------------

    The proposed rule requires policies and procedures of a broker-
dealer in the corporate and municipal bond markets and government
securities markets to also address how it will assess order exposure
opportunities that may result in the most favorable price, which could
include how it will assess RFQ mechanisms. These mechanisms may
represent the best market for customer orders in light of the trading
characteristics of these securities, where there may be limited
quotation or transaction pricing information available. In the absence
of reliable pricing information, such as bid, offer, or transaction
data for a security, a competitive auction mechanism may result in the
most favorable prices reasonably available.
    The policies and procedures of a broker-dealer in the corporate and
municipal bond markets and government securities markets could also
assess how its use of RFQ systems may affect the opportunity to expose
a customer order to the most favorable price. For example, when a
customer wishes to buy or sell a bond, a broker-dealer may use an
electronic RFQ system to solicit prices from other participants on the
system.\164\ In this scenario, a broker-dealer's policies and
procedures could address how it will use ``filters'' and assess whether
the use of filters would affect the exposure for customer orders.
Specifically, a broker-dealer that submits an RFQ on behalf of a
customer typically has the option of deciding which participants it
wants to request prices from. While a broker-dealer may use filters in
a way that is consistent with its duty of best execution, a broker-
dealer could also potentially use filters to prevent certain market
participants from receiving and participating in the RFQ in a way that
prevents a customer order from being exposed to opportunities to
receive the most favorable price (e.g., the participants that might
have been willing to provide that price may have been precluded from
the RFQ by the broker-dealer).\165\
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    \164\ It is the Commission's understanding that a broker-dealer
typically uses RFQ systems to solicit prices when customers are
selling bonds and that RFQ systems are used less for customers that
are buying bonds.
    \165\ FINRA and the MSRB have recognized the potential misuse of
filters as well. See FINRA Regulatory Notice 15-46, at 5 (``If a
firm uses filters on counterparties or filters on specific
securities intended to limit accessing bids and offers in those
securities, they may be used only for a legitimate purpose
consistent with obtaining the most favorable executions for
customers, and should be reviewed on a periodic basis and adjusted
as needed.''). See MSRB Interpretive Guidance Section III.1 (``Some
dealers may employ `filters,' which generally refer to automated
tools that allow the dealer to limit its trading, with, for example,
specific parties or parties with specified attributes with which it
does not want to interact. If a dealer uses filters on
counterparties or filters on specific securities intended to limit
accessing bids or offers in those securities, they may be used only
for a legitimate purpose consistent with obtaining the most
favorable executions for non-SMMP customers, and should be reviewed
on a periodic basis and adjusted as needed. The dealer, accordingly,
should have policies and procedures in place that govern when and
how to: reasonably use filters without negatively impacting the
quality of execution of non-SMMP customer transactions; periodically
reevaluate their use; and determine whether to lift them upon
request.'').
---------------------------------------------------------------------------

    As another example, the policies and procedures of a broker-dealer
in the corporate and municipal bond markets and government securities
markets could address the use of ``last look'' functionalities. When a
broker-dealer uses an RFQ system, it will often receive responses in
the form of bids (most common) or offers, and it typically has a
certain amount of time to decide whether or not it chooses to execute
the transaction with the best price or to match or improve that price
in a principal trade with the customer. One effect of this ``last
look'' practice may be to deter market participants that might
otherwise vigorously compete to trade with the customer's order from
submitting their most favorable prices, in light of the possibility
that the broker-dealer is simply using the RFQ system for price
discovery and ultimately intends to trade with its customer in a
principal capacity.\166\ A broker-dealer's policies and procedures
could address how the broker-dealer uses ``last look'' in connection
with its RFQs and whether this practice affects the extent to which
customer orders are exposed to opportunities to receive the most
favorable price.\167\
---------------------------------------------------------------------------

    \166\ See Recommendation Regarding the Practice of Pennying in
the Corporate and Municipal Bond Markets, SEC Fixed Income Market
Structure Advisory Committee (June 11, 2019), available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-pennying-recommendations.pdf (describing that the abusive use of the
last look practice ``harms competitiveness'' and ``deters aggressive
pricing or participation in the auction process by other dealers who
fear that the submitting dealer is going to `step in front of' their
winning prices or is otherwise using the auction process solely for
price discovery purposes''). See also FINRA Regulatory Notice 20-29
(Aug. 17, 2020) (requesting comment on the impact of the broker-
dealer practice of trading with a customer as principal by matching
or slightly improving on the best auction responses without
participating in the auction); MSRB Notice 2018-22 (Sept. 7, 2018)
(requesting comment on the abusive practice of last look known as
pennying and stating ``[i]n recent outreach to a broad range of
market participants, it has been suggested that pennying is
prevalent in the municipal market and that widespread pennying does
indeed disincentivize participation in the bid-wanted process,
discourages bidders from giving their best price in a bid-wanted and
may impact the efficiency of the market'').
    \167\ Last look practices can also be beneficial to customers.
For example, there could be situations where the responses received
by the broker-dealer all reflect prices that the broker-dealer has
reason to believe are not reflective of the most favorable price. In
these cases, last look enables the broker-dealer to evaluate those
prices, determine not to execute the customer order at those prices,
and either internalize the order at a price the broker-dealer
believes is the most favorable price or seek additional liquidity
for the customer order.
---------------------------------------------------------------------------

    As a third example, the policies and procedures of a broker-dealer
in the corporate and municipal bond markets and government securities
markets could address the response times that a broker-dealer may
require for responses to an RFQ. Broker-dealers frequently request
quotes and include a time limit by which all quotes must be received.
This practice permits market participants time to consider the request
and provide a price for the security, while establishing a time limit
so that the broker-dealer can execute its customer order in a timely
manner. The appropriate amount of time for responses can be influenced
by important and variable considerations for different customer orders.
Response times that are too short, however, can prevent market
participants that may otherwise be interested in competing for the
customer order from being able to submit prices in response to the
request. A broker-dealer's policies and procedures could address how
the broker-dealer uses response times in connection with its RFQs and
how its use might impact the exposure of a customer order to
opportunities to receive the most favorable price.
    In addition to assessing reasonably accessible and timely
information regarding displayed prices and price improvement and order
exposure opportunities, proposed Rule 1101(a)(2)(ii) would require a
broker-dealer's policies and procedures to address how it will assess
the attributes of its customers' orders and consider the trading
characteristics of the security, the size of the orders, the likelihood
of execution, the accessibility of the market, and any customer
instructions in selecting the market most likely to

provide the most favorable price for the order.
    Not all customer orders have the same attributes or size and a
broker-dealer's best market determination is affected by the attributes
of customer orders and the size of customer orders.\168\ For example,
when a broker-dealer is handling and executing large orders, it may
likely be more sensitive to the possibility of information leakage and
price impact that could harm the execution quality of such orders.
Therefore, the broker-dealer may make a best market determination
designed to minimize the risk of information leakage and price impact
concerns.\169\ In contrast, a broker-dealer handling and executing
small orders may not be as concerned with information leakage,
resulting in a different best market determination for execution of
such orders.\170\ Other relevant customer order attributes could
include whether or not the order is a market order or limit order. A
broker-dealer's assessment of the best market to execute customer
orders is different for customers interested in trading immediately
\171\ and customers willing to execute orders over a longer period of
time. Moreover, the likelihood of execution is a relevant consideration
for a broker-dealer, as the failure to receive an execution for orders
from a particular market may negatively impact the ultimate execution
quality received by customers.
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    \168\ FINRA Rule 5310(a)(1) also recognizes the ``size and
type'' of transactions as factors relevant to a broker-dealer's
exercise of reasonable diligence to ascertain the best market,
although FINRA rules do not require a broker-dealer's policies and
procedures to explicitly address how it would assess these factors.
    \169\ It is the Commission's understanding that when an
institutional customer gives a large order to be executed on behalf
of one account (e.g., a single mutual fund or pension fund), it
expects the broker-dealer that handles and executes such large order
to do so in a manner that ensures best execution is provided to the
``parent'' order. In other words, to the extent that a parent order
is split into smaller ``child'' orders, the institutional customer
expects the best execution analysis to evaluate whether the parent
order was executed at the most favorable price possible under
prevailing market conditions according to customer instructions.
See, e.g., Concept Release on Equity Market Structure, supra note
49, 75 FR at 3604-3605 (measuring the transaction costs of
institutional investors ``can be extremely complex'' because their
``large orders often are broken up into smaller child orders and
executed in a series of transactions'' and ``[m]etrics that apply to
small order executions may miss how well or poorly the large order
traded overall.'').
    \170\ While the Commission has long-acknowledged a range of
factors relevant for a best execution analysis, it has recognized
price as a critical concern. See supra note 22 and accompanying
text. The Commission has stated, for example, that it ``strongly
believes, however, that most investors care a great deal about the
quality of prices at which their orders are executed . . . .'' See
Order Execution and Routing Practice Release supra note 22, 65 FR at
75418. Additionally, the Commission has stated that broker-dealers
handling small orders in listed and OTC equities should look for
price improvement opportunities when executing these orders. See
Order Execution Obligations Adopting Release, supra note 10, 61 FR
48323.
    \171\ FINRA Rule 5310.01 requires a broker-dealer to make every
effort to execute marketable customer orders fully and promptly.
Similarly, MSRB Rule G-18.03 requires a broker-dealer to make every
effort to execute a customer transaction promptly, taking into
account prevailing market conditions, and recognizes that in certain
market conditions a broker-dealer may need more time to use
reasonable diligence to ascertain the best market for the subject
security. The MSRB has stated that while a broker-dealer must make
every effort to execute a customer transaction promptly, the
determination as to whether a firm exercised reasonable diligence
necessarily involves a ``facts and circumstances'' analysis, and
actions that in one instance may meet a broker-dealer's best-
execution obligation may not satisfy that obligation under another
set of circumstances. MSRB Interpretative Guidance, V1.1: Execution
timing (Nov. 20, 2015). Similarly, when assessing the attributes of
a customer order under proposed Rule 1101(a)(2), a broker-dealer
would be required to assess how it will execute marketable customer
orders fully and promptly, taking into account prevailing
conditions, given that the customer expectation when submitting a
market order is to have the order executed immediately at the
prevailing market price or better.
---------------------------------------------------------------------------

    A broker-dealer's best market determination is also affected by the
trading characteristics of a security and the accessibility of a
market. For example, some securities may not have readily available or
accessible quotation data or may trade in OTC markets.\172\ These
characteristics affect how a broker-dealer would identify the best
market for customer orders, and a broker-dealer may need to seek out
pricing information that may not otherwise be available or accessible
at the time it receives a customer order, such as by soliciting buy or
sell interest from market participants through auction mechanisms,
interdealer brokers, or otherwise.\173\ Furthermore, extreme market
conditions that result in heightened volatility or impact the liquidity
for a security may affect a broker-dealer's best market determination
for customer orders as trading in those conditions may merit different
order handling than in more normal market conditions.\174\
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    \172\ See also FINRA Rule 5310(a)(1) (recognizing the relevance
of the pressure on available communications as relevant for a
broker-dealer's best market determination). A broker-dealer's
assessment of the accessibility of a market could vary depending on
the cost of maintaining connectivity, receiving market data, and
transacting on the market.
    \173\ These considerations are consistent with FINRA and MSRB
rules concerning orders involving securities with limited quotations
or pricing information. See FINRA Rule 5310.06 (providing that a
broker-dealer must be especially diligent in ensuring that it has
met its best execution obligations with respect to customer orders
involving securities for which there is limited pricing information
or quotations available; requiring each member to have written
policies and procedures that address how it will determine the best
inter-dealer market for such a security in the absence of pricing
information or multiple quotations and document its compliance with
those policies and procedures; providing as an example that a
broker-dealer should analyze pricing information based on other
data, such as previous trades in the security, to determine whether
the resultant price to the customer is as favorable as possible
under prevailing market conditions; and providing that a broker-
dealer should generally seek out other sources of pricing
information or potential liquidity, which may include obtaining
quotations from other sources (e.g., other firms with which the
member previously has traded in the security)); MSRB Rule G-18.06
(providing that a broker-dealer must be especially diligent in
ensuring that it has met its best-execution obligations with respect
to customer transactions involving securities for which there is
limited pricing information or quotations available; requiring each
broker-dealer to have written policies and procedures in place to
address how it will make its best execution determinations with
respect to such a security in the absence of pricing information or
multiple quotations and document its compliance with those policies
and procedures; and providing as an example that a broker-dealer
generally should seek out other sources of pricing information and
potential liquidity for such a security, including other broker-
dealers with which the broker-dealer previously has traded in the
security; and providing that a broker-dealer generally should, in
determining whether the resultant price to the customer is as
favorable as possible under prevailing market conditions, analyze
other data to which it reasonably has access).
    \174\ See also FINRA Regulatory Notice 21-12 (discussing the
best execution obligations of broker-dealers handling and executing
customer orders during extreme market conditions); FINRA Rule
5310(a)(1) (discussing the relevance of volatility and liquidity to
a broker-dealer's best market determination).
---------------------------------------------------------------------------

    Moreover, customer instructions are relevant for a broker-dealer's
best market determination. Customers may provide a broker-dealer with
specific instructions regarding how the broker-dealer should handle and
execute their orders, including institutional customers that also owe
their clients a duty to seek best execution. A broker-dealer's policies
and procedures generally should address how the broker-dealer will
assess the factors in proposed Rule 1101(a)(2) within the context of
and consistent with customer instructions.\175\ For example, some
institutional customers may instruct their broker-dealer to handle and
execute their orders with regard being given to the fees and rebates
that may be charged or paid by a particular market,\176\ and a broker-
dealer's policies

and procedures generally should address how it would assess the
relevant factors in proposed Rule 1101(a)(2) while taking into account
the customer instructions in determining the best market for the
customers' orders.\177\
---------------------------------------------------------------------------

    \175\ A broker-dealer that receives an unsolicited instruction
from a customer to route that customer's order to a particular
market for execution and otherwise qualifies for the exemption from
the proposed best execution standard in Rule 1100(c) would not be
subject to the requirements of proposed Rule 1101, including the
requirement to have policies and procedures that address how the
broker-dealer would consider customer instructions in selecting the
market most likely to provide the most favorable price.
    \176\ The Commission understands that these customers often pay
the broker-dealer a lower commission or service fee for handling
their orders, and the fees and rebates that are charged or paid by a
market are often passed through to the customers.
    \177\ To the extent rebates cause certain transactions to be
``conflicted transactions'' as defined in proposed Rule 1101(b), a
broker-dealer's policies and procedures must also address how it
would assess the relevant factors in proposed Rule 1101(b) while
taking into account the customer instructions.
---------------------------------------------------------------------------

    Proposed Rule 1101(a)(2)(iii) would require a broker-dealer's
policies and procedures to address how it will reasonably balance the
likelihood of obtaining better prices with the risk that delay could
result in worse prices in determining the number and sequencing of
markets to be assessed for its customers' orders.\178\ An undue delay
in execution of customer orders may detrimentally impact the execution
of those orders, if there was a change in the price or liquidity
available at the time of execution that was not favorable to the
customer. For example, in a volatile market, executing customer orders
quickly may be necessary for the customer to receive the most favorable
prices or to receive an execution at all. Doing so may require the
broker-dealer to execute customer orders using fewer or different
execution methods than it might otherwise use in a less volatile
market. Similarly, a broker-dealer that is handling large customer
orders may determine that preventing information leakage is necessary
in order for the large orders to be executed at the most favorable
prices, which may affect the number and sequencing of the markets that
it assesses. Accordingly, the broker-dealer's best execution policies
and procedures generally should be tailored for the different
circumstances in order to reflect a reasonable balance between the
likelihood of obtaining better prices with the risk that delay could
result in worse prices.
---------------------------------------------------------------------------

    \178\ For example, a broker-dealer could develop an automated
process for determining the specific markets to which it routes
orders and the sequence in which the orders are routed.
---------------------------------------------------------------------------

    FINRA Rule 5310(a)(1) and MSRB Rule G-18(a) set forth similar
factors that are relevant to ascertaining the best market for customer
orders, including the character of the market for the security (e.g.,
price, volatility, relative liquidity, and pressure on available
communications), the size and type of transaction, the number of
markets checked, the accessibility of the quotation,\179\ and the terms
and conditions of the order that result in the transaction as
communicated to the broker-dealer. As described in section IV.B.1
above, FINRA and MSRB rules require broker-dealers to have policies and
procedures for compliance with relevant laws and rules. In addition,
the FINRA and MSRB rules specifically require a broker-dealer to
establish written policies and procedures that address how it will
determine the best market for a security in the absence of pricing
information or multiple quotations and document its compliance with
those policies and procedures.\180\ However, FINRA and MSRB rules do
not require a broker-dealer's policies and procedures to specifically
address the elements that are relevant to its best market
determinations. The Commission understands that broker-dealers
generally have policies and procedures to ascertain the best market for
a security, although such policies and procedures may need to be
updated to address the elements specified in proposed Rule 1101(a)(2).
---------------------------------------------------------------------------

    \179\ FINRA Rule 5310.03 provides that, for purposes of debt
securities, the term ``quotation'' refers to either dollar (or other
currency) pricing or yield pricing. It also states that
accessibility is only one of the non-exhaustive reasonable diligence
factors, and in the absence of accessibility, members are not
relieved from taking reasonable steps and employing their market
expertise in achieving the best execution of customer orders.
Proposed Rule 1101(a) similarly provides a list of non-exhaustive
reasonable diligence factors that would be addressed in a broker-
dealer's best execution policies and procedures.
    \180\ See supra note 173.
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of proposed Rule
1101(a)(2), and in particular:
    46. Has the Commission appropriately identified the considerations
for determining the best market for customer orders? Why or why not?
    47. Do commenters believe that proposed Rule 1101(a)(2)(i)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will assess reasonably accessible and timely information
with respect to the best displayed prices, opportunities for price
improvement, including midpoint executions, and order exposure
opportunities that may result in the most favorable price? Why or why
not?
    48. Do commenters believe that proposed Rule 1101(a)(2)(ii)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will assess the attributes of customer orders and
consider the trading characteristics of the security, the size of the
order, the likelihood of execution, the accessibility of the market,
and any customer instructions in selecting the market most likely to
provide the most favorable price? Why or why not?
    49. Do commenters believe that proposed Rule 1101(a)(2)(iii)
appropriately requires a broker-dealer's policies and procedures to
reflect how it will reasonably balance the likelihood of obtaining
better prices with the risk that delay could result in a worse price,
in determining the number and sequencing of markets to be assessed? Why
or why not?
    50. Do commenters agree that proposed Rule 1101(a)(2) is consistent
with prior Commission statements, including those described in section
II.B above? Why or why not? If not, should the Commission revise any of
its statements in light of the proposal? Please explain.
    51. While the considerations for determining the best market
included in proposed Rule 1101(a)(2) are non-exhaustive, should the
Commission explicitly include other considerations in the rule? If so,
please explain.
    52. Is the list of considerations for determining the best market
included in proposed Rule 1101(a)(2) consistent with the considerations
included in FINRA Rule 5310 and MSRB Rule G-18? If not, please explain
any differences and whether the considerations should be consistent.
    53. Do commenters agree with the Commission's understanding that
midpoint liquidity is not as commonly available in the options market
as it is in the NMS stock market? Why or why not?
    54. Should the Commission specify transaction fees in the rule text
as considerations for determining the best market? If so, please
explain how fees may be relevant to the best execution standard and a
broker-dealer's best market determination. Do broker-dealers route and
execute customer orders based on a favorable transaction fee and does
that impact the execution quality of customer orders? Please explain.
    55. What factors should a broker-dealer consider in determining the
number and sequencing of markets to be assessed, in addition to the
likelihood of obtaining better prices and the risk that a delay could
result in a worse price? Please explain.
    56. Do commenters agree with the Commission's understanding that
institutional customers expect broker-dealers that handle and execute
their large orders for a single account to do so in a manner that
ensures best execution is provided to the ``parent'' order?

    57. Do commenters agree with the Commission's understanding that
broker-dealers currently generally have policies and procedures to
ascertain the best market for a security? Please describe the types of
best market policies and procedures that broker-dealers currently have.
In particular, do broker-dealers' policies and procedures address how
they assess reasonably accessible and timely information with respect
to the best displayed prices, opportunities for price improvement,
including midpoint executions, and order exposure opportunities that
may result in the most favorable price? Do broker-dealers' policies and
procedures address how they assess the attributes of customer orders
and consider the trading characteristics of the security, the size of
the order, the likelihood of execution, the accessibility of the
market, and any customer instructions in selecting the market most
likely to provide the most favorable price? Do broker-dealers' policies
and procedures address how they reasonably balance the likelihood of
obtaining better prices with the risk that delay could result in a
worse price, in determining the number and sequencing of markets to be
assessed?
    58. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1101(a)(2) for broker-
dealers of different sizes, if the Commission adopts proposed
Regulation Best Execution? For example, should the Commission provide
longer compliance dates for smaller broker-dealers? If so, should the
Commission define a smaller broker-dealer as a broker-dealer that
qualifies as a ``small entity'' under the Regulatory Flexibility Act
pursuant to 17 CFR 240.0-10(c) for this purpose? \181\ Or should the
Commission define a smaller broker-dealer in a different way? Please
explain.
---------------------------------------------------------------------------

    \181\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
---------------------------------------------------------------------------

C. Proposed Rule 1101(b)--Policies and Procedures and Documentation for
Conflicted Transactions

    Proposed Rule 1101(b) would require a broker-dealer's best
execution policies and procedures to address additional considerations
with respect to ``conflicted transactions.'' It would also require a
broker-dealer to document its compliance with the proposed best
execution standard for conflicted transactions and document any
arrangement concerning payment for order flow.
    Proposed Rule 1101(b) would define a ``conflicted transaction'' for
purposes of proposed Regulation Best Execution as any ``transaction for
or with a retail customer'' where a broker-dealer: (i) executes an
order as principal, including riskless principal; \182\ (ii) routes an
order to, or receives an order from, an affiliate for execution; or
(iii) provides or receives payment for order flow as defined in Rule
10b-10(d)(8) under the Exchange Act.\183\ For purposes of paragraph
(b), ``affiliate'' would be defined by proposed Rule 1101(b)(4)(iii)
as, with respect to a specified person, any person that, directly or
indirectly, controls, is under common control with, or is controlled
by, the specified person. ``Control'' would be defined for purposes of
the proposed definition of ``affiliate'' by proposed Rule
1101(b)(4)(iii) as the power, directly or indirectly, to direct the
management or policies of the broker-dealer whether through ownership
of securities, by contract, or otherwise. A person is presumed to
control a broker-dealer if that person is a director, general partner,
or officer exercising executive responsibility (or having similar
status or performing similar functions); directly or indirectly has the
right to vote 25 percent or more of a class of voting securities or has
the power to sell or direct the sale of 25 percent or more of a class
of voting securities of the broker-dealer; or in the case of a
partnership, has contributed, or has the right to receive upon
dissolution, 25 percent or more of the capital of the broker-
dealer.\184\ In each of these types of conflicted transactions, the
broker-dealer has a financial interest that could disincentivize the
broker-dealer from achieving best execution for its customer's
orders.\185\ Accordingly, the Commission proposes to require more
robust policies and procedures, as well as documentation, for
conflicted transactions with retail customers to better address these
disincentives.
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    \182\ For purposes of proposed Rule 1101(b), a broker-dealer
would be executing an order as ``riskless principal'' if, after
having received an order to buy from a customer, the broker-dealer
purchases the security from another person to offset a
contemporaneous sale to the customer or, after having received an
order to sell, the broker-dealer sells the security to another
person to offset a contemporaneous purchase from the customer. See
also, Exchange Act Rule 3a5-1; U.S. Securities and Exchange
Commission, Report on the Municipal Securities Market (July 31,
2012) available at https://www.sec.gov/news/studies/2012/munireport073112.pdf. The Commission preliminarily believes that it
is appropriate to include riskless principal transactions as a type
of conflicted transactions because of the variability of markups and
markdowns associated with riskless principal transactions, which
impacts the ultimate price paid by the customer (i.e., the ultimate
execution received by the customer) and often is not known to the
customer prior to transacting. See, e.g., John M. Griffin, et al.,
supra note 66.
    \183\ See supra note 43 (setting forth the definition of
``payment for order flow'' under Rule 10b-10(d)(8)). Given the
widespread use of the Rule 10b-10(d)(8) definition of ``payment for
order flow'' and the collective understanding of the term by market
participants, the Commission proposes to use the existing Rule 10b-
10(d)(8) definition in proposed Regulation Best Execution. As
reflected in this definition, payment for order flow would include
any payments from a wholesaler to a retail broker-dealer in return
for order flow. It would also include any exchange rebates paid to a
broker-dealer in return for sending orders to the exchange. When all
payment for order flow for a customer order from a particular market
is passed through to the customer and the broker-dealer retains no
part of the payment for order flow associated with that customer
order, the broker-dealer would not be engaging in a conflicted
transaction under proposed Rule 1101(b) with respect to that
customer order.
    \184\ These definitions are substantially the same as the
definitions of ``affiliate'' and ``control'' prescribed for purposes
of the disclosures required of an ATS that trades NMS stocks (``NMS
Stock ATS'') about its operations on Form ATS-N with the following
modifications: the Form ATS-N definition of ``affiliate'' uses a
separately-defined term ``Person'' instead of the statutory
definition of ``person,'' and Form ATS-N defines ``control'' as
applicable to the ``broker-dealer of the alternative trading
system'' instead of as applicable to a ``broker or dealer.'' The
Commission believes that it would be appropriate to use
substantially similar definitions of ``affiliate'' and ``control''
in the context of proposed Rule 1101(b) because, for purposes of
Form ATS-N, the Commission defined such terms for use with respect
to disclosures designed to enable market participants to better
evaluate how relationships between certain persons could affect the
handling of orders on a particular NMS Stock ATS. See Securities
Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768 (Aug. 7,
2018). The substantially similar proposed definitions, as used in
the context of proposed Rule 1101(b), are similarly designed to
recognize that relationships among certain persons may impact the
handling of orders, and are designed to help ensure that broker-
dealers that have conflicts of interest in their order handing are
subject to additional obligations under proposed Rule 1101(b).
    \185\ See generally section III.A.2 (discussing in more detail
these conflicts of interest); see also 2022 Report on FINRA's
Examination and Risk Monitoring Program 45 (Feb. 2022), available at
https://www.finra.org/sites/default/files/2022-02/2022-report-finras-examination-risk-monitoring-program.pdf (describing FINRA
exam findings, including firms not considering and addressing
potential conflicts of interest relating to routing orders to
affiliated broker-dealers, affiliated ATSs, or market centers that
provide routing inducements, such as payment for order flow from
wholesale market makers and exchange liquidity rebates).
---------------------------------------------------------------------------

    Proposed Rule 1101(b) would apply to conflicted transactions for or
with a retail customer, and proposed Rule 1101(b)(4)(i) would define a
``transaction for or with a retail customer'' as any transaction for or
with the account of a natural person or held in legal form on behalf of
a natural person or group of related family members. The proposed
definition's limitation to accounts of natural persons is consistent
with existing rules that are designed to identify the orders of
individual investors. For example, the definition of ``retail
customer'' in the

Commission's Regulation Best Interest rule is limited to a ``natural
person.'' \186\ Moreover, several national securities exchanges operate
programs for trading ``retail'' orders that are limited to accounts of
natural persons or certain accounts on behalf of natural persons.\187\
The proposed definition of retail customer is also consistent with
FINRA's rule for certain trade reporting.\188\ Proposing a definition
of retail customer that is similar to existing Commission and SRO rules
would facilitate compliance with proposed Rule 1101(b) and help
mitigate the costs of compliance because broker-dealers would already
be familiar with identifying orders for the accounts of natural
persons, or for related accounts, in these other contexts.
---------------------------------------------------------------------------

    \186\ 17 CFR 240.15l-1(b)(1) (defining ``retail customer'' to
mean, among other things, a natural person who receives a
recommendation of any securities transaction from a broker or dealer
and uses the recommendation primarily for personal, family, or
household purposes). Proposed Rule 1101(b) does not incorporate all
of the definition of ``retail customer'' in Regulation Best Interest
because that definition is limited to scenarios where a person
receives and uses a recommendation. In contrast, proposed Rule
1101(b) and the proposed standard of best execution are not limited
to scenarios where a person receives and uses a recommendation.
    \187\ See, e.g., Investors Exchange LLC Rule 11.190(b)(15)
(providing, among other things, that ``[a] Retail order must reflect
trading interest of a natural person'' and that ``[a]n order from a
retail customer can include orders submitted on behalf of accounts
that are held in a corporate legal form--such as an Individual
Retirement Account, Corporation, or a Limited Liability Company--
that have been established for the benefit of an individual or group
of related family members, provided that the order is submitted by
an individual''); The Nasdaq Stock Market LLC, Equity 7, Section 118
(defining a ``Designated Retail Order'' as originating from a
``natural person'' and explaining that ``[a]n order from a `natural
person' can include orders on behalf of accounts that are held in a
corporate legal form--such as an Individual Retirement Account,
Corporation, or a Limited Liability Company--that has been
established for the benefit of an individual or group of related
family members, provided that the order is submitted by an
individual'').
    \188\ FINRA Rule 7620A.01 (defining a ``retail order'' as
originating from a ``natural person'' and explaining that ``[a]n
order from a `natural person' can include orders on behalf of
accounts that are held in a corporate legal form, such as an
Individual Retirement Account, Corporation, or a Limited Liability
Corporation that has been established for the benefit of an
individual or group of related family members, provided that the
order is submitted by an individual'').
---------------------------------------------------------------------------

    In addition to the accounts of natural persons, the proposed
definition of ``transaction for or with a retail customer'' would cover
accounts held in legal form on behalf of a natural person or a group of
related family members. A ``group of related family members'' would be
defined broadly in proposed Rule 1101(b)(4)(i) to include a group of
natural persons with any of the following relationships: child,
stepchild, grandchild, great grandchild, parent, stepparent,
grandparent, great grandparent, spouse, domestic partner, sibling,
stepbrother, stepsister, niece, nephew, aunt, uncle, mother-in-law,
father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-
in-law, including adoptive and foster relationships; and any other
natural person (other than a tenant or employee) sharing a household
with any of the foregoing natural persons. This proposed definition is
broad so as not to restrict the types of arrangements that may be set
up to benefit family groups, including individual retirement accounts,
corporations, and limited liability companies for the benefit of
related family members.
    Proposed Rule 1101(b) would create new requirements for broker-
dealers' conflicted transactions that are not currently required by
FINRA or the MSRB. Because a broker-dealer engaging in conflicted
transactions for or with retail customers has an incentive to handle
those orders in a manner that prioritizes its own interests over its
customers' interests, the Commission preliminarily believes that,
correspondingly, additional policies and procedures elements and
documentation requirements should apply to such transactions in order
to help mitigate the potential for these incentives to negatively
affect the broker-dealer's best execution determinations. The
Commission preliminarily believes that proposed Rule 1101(b) would help
broker-dealers to comply with the proposed best execution standard with
respect to conflicted transactions, because it would require heightened
attention by broker-dealers for conflicted transactions and would
require broker-dealers to document the basis for their determinations
that, despite the conflicts of interest, they have complied with the
best execution standard for their conflicted transactions.
    The Commission also preliminarily believes that retail customers
generally would benefit more than non-retail customers from the more
robust conflicted transactions requirements because retail customers
are likely to have fewer resources for evaluating the best execution
practices of their broker-dealers than non-retail customers. For
example, institutional customers likely have additional knowledge,
experience, and analytical resources as compared to retail customers
and, thus, are more readily able to evaluate the impact of their
broker-dealers' conflicted transactions. In contrast, retail customers
are less likely to have the same level of knowledge, experience, and
resources to make such evaluations.
Request for Comment
    The Commission requests comment on the types of conflicted
transactions under proposed Rule 1101(b), and in particular:
    59. Is it appropriate for proposed Rule 1101(b) to incorporate the
definition of ``payment for order flow'' from Exchange Act Rule 10b-
10(d)(8)? Why or why not? If not, how should ``payment for order flow''
be defined for purposes of proposed Regulation Best Execution? Please
describe any alternative definition and explain why such definition
would be appropriate.
    60. Does proposed Rule 1101(b) appropriately identify the conflicts
of interest of broker-dealers that are most relevant to the handling of
retail customer orders? If not, why not? Are there other conflicted
transactions that should be included in proposed Rule 1101(b) or are
there transactions that are included that should be omitted? If so,
please explain.
    61. Should the principal trading conflict identified in proposed
Rule 1101(b) include riskless principal trades with customers, as
proposed? Why or why not? If riskless principal trades should be
included, should they be defined as proposed--after having received an
order to buy from a customer, the broker-dealer purchases the security
from another person to offset a contemporaneous sale to the customer
or, after having received an order to sell, the broker-dealer sells the
security to another person to offset a contemporaneous purchase from
the customer--similar to the definition of riskless principal in
Exchange Act Rule 3a5-1? Why or why not?
    62. Should the Commission provide an exemption from the definition
of conflicted transactions for certain types of riskless principal
trades? For example, should the Commission exempt from the definition
of ``riskless principal'' in proposed Rule 1101 (b)(4)(ii) trades where
the broker-dealer discloses to its customer the markup or markdown that
it charges on these trades on a pre-trade basis? Please explain. If
this type of exemption should be provided, what would be an appropriate
method of pre-trade markup or markdown disclosure by the broker-dealer?
For example, would it be appropriate for the broker-dealer to disclose
a markup or markdown schedule in a readily accessible place such as its
website? Please explain.
    63. Alternatively, should the Commission exempt from the definition
of ``riskless principal'' in proposed Rule

1101(b)(4)(ii) trades where the contemporaneous purchases and sales are
executed at the same price resulting in a transaction with the customer
that does not include any markup or markdown? Please explain. In these
types of transactions, how would the broker-dealer be compensated by
the customer? Would it charge a commission that is separately disclosed
to the customer on the confirmation? Would the customer know the
commission that it would pay the broker-dealer prior to engaging in the
transaction?
    64. Is the proposed definition of a ``transaction for or with a
retail customer'' in Rule 1101(b)(4)(i), which would include accounts
held in legal form on behalf of a natural person or a group of related
family members, appropriate? Why or why not? Should the proposed
definition be broadened or narrowed? If so, please explain how the
definition should be broadened or narrowed and why.
    65. Is the proposed definition of ``group of related family
members'' in proposed Rule 1101(b)(4)(i) appropriate? Why or why not?
Should it be more or less inclusive, and if so, in what regard? Please
explain. For example, instead of capturing a group of natural persons
with ``any'' of the relationships in the proposed definition (child,
stepchild, grandchild, great grandchild, parent, stepparent,
grandparent, great grandparent, spouse, domestic partner, sibling,
stepbrother, stepsister, niece, nephew, aunt, uncle, mother-in-law,
father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister
in law, including adoptive and foster relationships; and any other
natural person (other than a tenant or employee) sharing a household
with any of the foregoing natural persons), should the proposed
definition be limited to a group of natural persons consisting ``only''
of those relationships?
    66. Should the definition of a ``transaction for or with a retail
customer'' exclude a transaction with a ``family office,'' which is
defined in Rule 202(a)(11)(G)-1(b) under the Investment Advisers Act of
1940 as a company (including its directors, partners, members,
managers, trustees, and employees acting within the scope of their
position or employment) that: (1) has no clients other than family
clients (as defined in the rule) (provided that if a person that is not
a family client becomes a client of the family office as a result of
the death of a family member or key employee (as defined in the rule)
or other involuntary transfer from a family member or key employee,
that person shall be deemed to be a family client for purposes of the
rule for one year following the completion of the transfer of legal
title to the assets resulting from the involuntary event); (2) is
wholly owned by family clients and is exclusively controlled (directly
or indirectly) by one or more family members and/or family entities;
and (3) does not hold itself out to the public as an investment
adviser? Why or why not?
    67. Alternatively, should the definition of a ``transaction for or
with a retail customer'' only exclude a subset of ``family offices''?
For example, should it exclude a family office (as defined above) that
(1) has one or more experienced securities or financial services
professionals, (2) manages a threshold level of total assets (e.g., $50
million or more) that are indicative of an institutional account, (3)
has the capacity to evaluate independently the execution quality
received from the broker-dealer, and (4) has professionals who are
independent representatives of their family clients? Please explain.
    68. Is the proposed definition of an ``affiliate'' in proposed Rule
1101(b)(4)(iii) appropriate? Why or why not? Should the proposed
definition be broadened or narrowed? If so, please explain how the
definition should be broadened or narrowed and why.
    69. Is the proposed definition of ``control'' for purposes of the
proposed definition of ``affiliate'' in proposed Rule 1101(b)(4)(iii)
appropriate? Why or why not? Should the proposed definition be
broadened or narrowed? If so, please explain how the definition should
be broadened or narrowed and why.
    70. Should some or all institutional customers' orders also have
the protections afforded by proposed Rule 1101(b)? Please explain. If
only certain categories of institutional customers' orders should also
have the protections afforded by proposed Rule 1101(b), how should the
Commission identify and define the institutional customers' orders that
should benefit?
    71. Should the size of institutional customers be considered when
determining whether or not they should be afforded the protections of
proposed Rule 1101(b)? If so, what would be the appropriate metric to
identify such institutional customers? For example, should the
Commission consider the amount of assets under management when
determining which institutional customers should be afforded the
protections of proposed Rule 1101(b)?
    72. If the Commission were to apply the protections of proposed
Rule 1101(b) to conflicted transactions for or with institutional
customers, should it define ``institutional customer'' as any person
that does not qualify as a QIB?\189\ Should it define ``institutional
customer'' to include any person that qualifies as a QIB? Or should it
define ``institutional customer'' to include a broader set of
institutional customers than the QIB definition, such as those entities
that are included in the FINRA definition of ``institutional account''
under FINRA Rule 4512(c)?\190\
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    \189\ See supra note 124 (providing the definition of QIB under
Rule 144A under the Securities Act of 1933).
    \190\ See supra note 125 and accompanying text (describing the
definition of institutional account in FINRA Rule 4512(c)).
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    73. Do commenters believe there is another definition of
``institutional customer'' that would be more appropriate if the
Commission were to apply the protections of proposed Rule 1101(b) to
conflicted transactions for or with institutional customers? Please
explain.
    74. If institutional customers' orders should be afforded the
additional protections, are some or all of the conflicts of interest
identified in proposed Rule 1101(b) also relevant for institutional
customers? Are there other conflicts of interest relevant for
institutional customers that should be included in proposed Rule
1101(b)? Please explain.
    75. If institutional customers' orders should be afforded the
additional protections, should all the requirements under proposed Rule
1101(b) be extended to institutional customers' orders, or should only
certain of the requirements be extended to institutional customers'
orders? Should the Commission include other requirements for the
protection of institutional customers' orders? Please explain.
1. Proposed Rules 1101(b)(1) and (2)--Policies and Procedures for
Conflicted Transactions
    Proposed Rules 1101(b)(1) and (2) would require a broker-dealer's
best execution policies and procedures to address the following with
respect to conflicted transactions: (1) how the broker-dealer will
obtain and assess information beyond that required by proposed Rule
1101(a)(1)(i), including additional information about price, volume,
and execution quality, in identifying a broader range of markets beyond
those identified as material potential liquidity sources; and (2) how
the broker-dealer will evaluate a broader range of markets, beyond
those identified as material potential liquidity sources, that might
provide the most favorable price for customer orders,

including a broader range of order exposure opportunities and markets
that may be smaller or less accessible.
    Proposed Rule 1101(b) is not designed to eliminate order handling
conflicts of interest, and does not ban conflicted transactions.
However, because a broker-dealer engaging in conflicted transactions
for or with retail customers has an incentive to handle those orders in
a manner that prioritizes its own interests over its customers'
interests, the Commission preliminarily believes that, correspondingly,
such transactions should be subject to more robust policies and
procedures in order to help mitigate the potential for these incentives
to negatively affect the broker-dealer's best execution determinations.
Specifically, to help ensure that a broker-dealer exercises the
reasonable diligence required by proposed Rule 1100 despite its
incentives not to, a broker-dealer would be required to have policies
and procedures that are specific to conflicted transactions to address
how it will assess information beyond what is required for non-
conflicted transactions and how it will identify and evaluate of a
broader set of liquidity sources than for non-conflicted transactions.
These policies and procedures are designed to help ensure that a
broker-dealer exercises additional diligence in considering relevant
information and identifying the best market for customer orders,
despite their conflicts of interest.
    Specifically, proposed Rule 1101(b)(1) would require a broker-
dealer's policies and procedures for conflicted transactions to address
how it will obtain and assess information beyond what it would obtain
and assess for non-conflicted transactions, including additional
information about price, volume, and execution quality, in identifying
a broader range of markets beyond those identified as material
potential liquidity sources. While a broker-dealer would use reasonably
accessible information in identifying material potential liquidity
sources for non-conflicted transactions, a broker-dealer would
additionally be required to consider how it would use information
beyond what it used for non-conflicted transactions in identifying a
broader range of markets beyond material potential liquidity sources
for conflicted transactions.\191\
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    \191\ Proposed Rule 1101(b) would require a broker-dealer to
consider a broader range of markets for conflicted transactions than
non-conflicted transactions. In doing so, the broker-dealer may need
to obtain and assess information beyond what it obtains and assesses
for non-conflicted transactions. It is possible, however, that a
broker-dealer obtains and assesses information beyond what is needed
to identify material potential liquidity sources for non-conflicted
transactions, including information concerning markets that it did
not identify as material potential liquidity sources. Under these
circumstances, the information the broker-dealer obtained and
assessed for non-conflicted transactions may include information
beyond what is required by proposed Rule 1101(a)(1), and this
information may be sufficient for it to identify a broader set of
markets beyond those identified as material potential liquidity
sources. See also supra note 132 and accompanying text.
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    Proposed Rule 1101(b)(2) would require a broker-dealer's policies
and procedures for conflicted transactions to address how it will
evaluate a broader range of markets, beyond those identified as
material potential liquidity sources, that might provide the most
favorable price for retail customer orders, including a broader range
of order exposure opportunities and markets that may be smaller or less
accessible than those identified as material potential liquidity
sources. Because a broker-dealer may have a financial incentive to
engage in conflicted transactions, it may have an incentive to more
quickly conclude that the conflicted transactions represent the best
market and thus execute the trade in a conflicted transaction.
Accordingly, the proposed rule would require a broker-dealer to have
policies and procedures that reflect additional efforts to identify a
broader range of markets, including a broader range of order exposure
opportunities, that may provide retail customers with the most
favorable price and the establishment of order handling, routing, and
execution arrangements with this broader range of potential liquidity
sources.\192\
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    \192\ For example, a retail broker-dealer, in accordance with
its policies and procedures related to the identification of
material potential liquidity sources as required by proposed Rule
1101(a), may have evaluated a certain number of markets and
identified a subset of those markets as material potential liquidity
sources for non-conflicted transactions. For conflicted
transactions, the broker-dealer, in accordance with its policies and
procedures for conflicted transactions, would additionally evaluate
some of the markets that it did not identify as material potential
liquidity sources for non-conflicted transactions. Conflicted
transactions, such as routing orders to an affiliated ATS for
execution, may involve financial incentives for the broker-dealer
and could result in the broker-dealer prioritizing its own interests
over its customers' interests. The additional requirements of
proposed Rule 1101(b) are designed to help ensure that the broker-
dealer exercises reasonable diligence for conflicted transactions in
light of these incentives. As stated above, proposed Rule
1101(a)(1)(ii) would not prescribe the minimum number of markets
that a broker-dealer would need to identify as material potential
liquidity sources. See supra section IV.B.1. Rather, as stated
above, the Commission believes that the identification of these
markets could be influenced by the nature of the broker-dealer's
business operation and customer order flow, such as whether it
handles institutional or retail orders. See id.