See supra Table 6 for further discussion on the sample. The unit of
observation for the regression is the average execution quality
provided to trades that are aggregated together based on having the
same stock, week, order type, order size category, wholesaler, and
retail broker MPID. The coefficients are estimated by weighting each
observation by the total dollar volume of trades executed in that
observation.

                   Table 16--Regression Analysis Showing Relationship Between Execution Quality and PFOF in NMS Common Stocks and ETFs
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                (4) Amount price improvement
          Variables                   (1)   E/Q ratio          (2)   Effective spread (bps)   (3)   Realized spread (bps)               (bps
--------------------------------------------------------------------------------------------------------------------------------------------------------
PFOF Rate....................  0.0132 *** [2.82]............  0.217 *** [6.31].............  0.211 *** [7.13].............  -0.170 *** [-5.52].
Stock Share Volume...........  0.0379 [0.51]................  -0.0462 [-0.14]..............  -0.886 * [-1.65].............  -0.533 ** [-2.53].
Stock VWAP...................  -0.000028 [-1.06]............  0.000233 [0.61]..............  -0.000450 [-0.78]............  0.000014 [0.04].
Stock Return.................  -0.000273 [-0.21]............  -0.0200 * [-1.93]............  -0.0120 [-0.36]..............  0.00840 [0.84].
VIX..........................  0.00968 *** [7.29]...........  0.0122 * [1.79]..............  0.0607 *** [2.85]............  -0.000256 [-0.05].
Market Return................  -0.00710 ** [-2.02]..........  0.00787 [0.36]...............  0.00686 [0.15]...............  -0.0150 [-0.96].
Market Dollar Volume.........  0.0306 *** [9.70]............  0.0641 *** [3.44]............  0.164 *** [3.07].............  -0.0390 *** [-2.69].
Stock Avg Effective spread...  0.00700 *** [3.34]...........  0.122 *** [6.07].............  -0.0455 * [-1.94]............  0.00746 [0.52].
Stock Avg Realized spread....  -0.00169 * [-1.87]...........  -0.00902 [-1.45].............  0.0730 *** [2.98]............  -0.00552 [-1.48].
Stock Quote Volatility.......  0.457 ** [2.09]..............  2.232 [1.05].................  -1.799 [-0.65]...............  4.458 ** [2.03].
Broker-Dealer Average Price    0.145 *** [14.74]............  0.414 *** [9.83].............  0.316 *** [8.50].............  -0.417 *** [-10.21].
 Impact.
Broker-Dealer Pct Volume.....  -2.45e-05 [-0.07]............  -0.00207 * [-1.76]...........  -0.00546 *** [-3.77].........  0.000124 [0.12].
Average Trade Qspread........  -0.00720 *** [-10.12]........  0.517 *** [19.78]............  0.378 *** [10.84]............  0.392 *** [21.14].
Wholesaler Fixed Effects.....  Yes..........................  Yes..........................  Yes..........................  Yes.
Order Size Category Fixed      Yes..........................  Yes..........................  Yes..........................  Yes.
 Effects.
Stock Fixed Effects..........  Yes..........................  Yes..........................  Yes..........................  Yes.
Observations.................  13,365,122...................  13,365,122...................  13,365,122...................  12,453,440.

Adjusted R-squared...........  0.279........................  0.574........................  0.060........................  0.594.
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table presents the results of a regression analysis examining the effect of retail brokers receiving PFOF from wholesalers on levels of price
  improvement and the execution quality of their customers' orders when the wholesaler internalizes the order on a principal basis.
The analysis examines trades in Q1 2022 that wholesalers execute in a principal capacity from market and marketable limit orders from individual
  investors that are under $200,000 in value and are in NMS Common stocks and ETFs. See supra Table 6 for further discussion on the CAT retail sample.
  The unit of observation for the regression is the average execution quality provided to trades that are aggregated together based on having the same
  stock, week, order type, order size category, wholesaler, and retail broker MPID. Weighted regression are performed based on the total dollar value
  executed by the wholesaler in that observation (i.e., total shares executed for all orders that fit within that stock-week-retail broker-wholesaler-
  order type-order size category). This means that the regression coefficients capture the effect on execution quality on a per-dollar basis.
Dependent variables include: the average E/Q ratio of the shares traded; the average percentage effective spread of the shares traded measured in basis
  points; the average percentage realized spread of the shares traded measured in basis points; and the average percentage value of the amount of price
  improvement measured in basis points, conditional on the order being price improved. These variables are from the CAT retail analysis and described in
  supra Table 6.
Explanatory variables include: PFOF Rate is the retail brokers' PFOF rates in bps (the per share rates were determined from retail broker Rule 606
  reports and divided by the VWAP of the executed shares in the sample to determine the PFOF rate on a percentage basis, see supra note 467); Broker-
  Dealer Pct Volume is the retail broker size (in terms of percentage total executed dollar trading volume in the sample); Stock Share Volume is the
  stock's total traded share volume during the week (from TAQ in billions of shares); Stock VWAP is the VWAP of stock trades during the week (from TAQ);
  Stock Return is the stock's return during the week (from CRSP 1925 US Stock Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch. Bus. (2022)); VIX is
  the average value of the VIX index during the week (from CBOE VIX data); Market Return is the average CRSP value weighted market return during the
  week, Market Dollar Volume is the total market dollar trading volume during the week (from CRSP 1925 US Stock Database, Ctr. Rsch. Sec. Prices, U.
  Chi. Booth Sch. Bus. (2022)); Stock Avg Effective spread is the stock's share weighted average percent effective half spread during the week measured
  in basis points (from TAQ); Stock Avg Realized spread is the stock's share weighted average percent realized half spread during the week measured in
  basis points (from TAQ); Stock Quote Volatility is the stock's average 1 second quote midpoint volatility measured in basis points (from TAQ); Broker-
  Dealer Average Price Impact is calculated for each Retail Broker MPID's by share weighting their average percentage price impact half spread within an
  individual NMS common stock or ETF and then averaging across stocks using the weighting of the dollar volume the retail broker MPID executed in each
  security (see supra Table 6 for additional details on how the metric is constructed); Average Trade Qspread is the average percentage quoted half
  spread at the time of order submission for orders in that stock-week-retail broker-wholesaler-order type-order size category measured in basis points;
  wholesaler fixed effects (i.e., indicator variables for each wholesaler that control for time-invariant execution quality differences related to each
  wholesaler); order-size category fixed effects (i.e., indicator variables for each order-size category that control for time-invariant execution
  quality differences related to order-size category); and individual stock fixed effects (i.e., indicator variables for each stock that control for
  time-invariant execution quality differences related to individual stocks). The order size categories include less than 100 shares, 100-499 shares,
  500-1,999 shares, 2,000-4,999, 5,000-9,999 shares, and 10,000+ shares. Brackets include t-statistics for the coefficients based on robust standard
  errors that are clustered at the stock level. ***, **, and * indicate the t-statistics for the coefficients are statistically significant at the 0.01,
  0.05, and 0.1 levels, respectively.
This analysis uses data from prior to the implementation of the MDI Rules and specific numbers may be different following the implementation of the MDI
  Rules. See supra note 415

    Regression results in Table 16 support the conclusion that
wholesalers provide worse execution quality to brokers that receive
more PFOF. The coefficients on the PFOF Rate variable indicates that,
all else equal, for the orders wholesalers internalize, execution
quality declines as the amount of PFOF paid to the retail broker
increases. Orders from retail brokers that receive a greater amount of
PFOF have higher E/Q ratios and effective spreads and receive less
price improvement. The regression results (as measured by the
coefficient on the PFOF Rate variable) indicate that, all else equal,
wholesalers earn higher realized spreads on orders for which they pay
more PFOF. Note that PFOF is not taken out of the realized spread
measure, so the realized spread serves as a proxy for wholesaler's
economic profits before any fees are taken out.
    The regression results in Table 16 also show that the retail
broker's adverse selection risk (as measured by the coefficient on the
Broker-Dealer Average Price Impact variable) has a statistically
significant effect on the execution quality wholesalers give on trades
they internalize. The positive coefficient indicates that wholesalers
provide worse execution quality to broker-dealers whose customers'
orders pose a greater adverse selection risk.
(b) Fixed Income Securities
i. Corporate Debt Securities
    The market for corporate debt securities (``corporate bonds'')
represents a significant part of the fixed income market. In July 2022,
the average daily par value dollar volume of corporate bond trading was
$34.2 billion.\469\ Estimates put the annualized growth rate of the
corporate bond market at 5.2 percent between 2008 and 2019, a growth
rate second only to that of U.S. Treasury securities within the fixed
income space.\470\
---------------------------------------------------------------------------

    \469\ Average daily par value dollar volume is reported by FINRA
each month. See FINRA Data, TRACE Monthly Volume Files, available at
https://www.finra.org/finra-data/browse-catalog/trace-volume-reports/trace-monthly-volume-files. The corporate bond market has
over 58,000 outstanding issues. Maureen O'Hara and Xing (Alex) Zhou,
Corporate Bond Trading: Finding the Customers' Yachts, 48 J.
Portfolio Mgt Mkt Microstructure 96, 98 (June 2022), available at
https://jpm.pm-research.com/content/early/2022/06/11/jpm.2022.1.373.
    \470\ Vega Economics, Trends in the U.S. Corporate Bond Market
Since the Financial Crisis (Oct. 12, 2020), available at https://vegaeconomics.com/trends-in-the-us-corporate-bond-market-since-the-financial-crisis.

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

    Fixed income securities trading venues (e.g., ATSs, non-ATS trading
venues (RFQ platforms), voice methods) compete on fees and trading
protocols that help expose retail customer orders to attract order
flows from retail broker-dealers. Corporate bond ATSs are primarily
used by broker-dealers to trade on behalf of retail customers or to
rebalance excess inventories.\471\ In September 2021, corporate bond
trading on ATSs accounted for 7.7 percent of total TRACE-reported
corporate bond trading dollar volume (calculated using bond par
value).\472\ Currently, the Commission understands that there are 12
ATSs with a Form ATS on file trading corporate bonds.\473\ Trading
protocols offered on corporate bond ATSs include, among other things,
limit order books (LOBs), displayed and non-displayed trading
interests, and auctions (e.g., RFQ, bids-wanted-in-competition (BWIC),
and offers-wanted-in-competition (OWIC)).
---------------------------------------------------------------------------

    \471\ See, e.g., Matthew Kozora, Bruce Mizrach, Matthew Peppe,
Or Shachar & Jonathan Sokobin, Alternative Trading Systems in the
Corporate Bond Market, Fed. Res. B.N.Y. Staff Report No. 938 (Aug.
2020), available at https://www.newyorkfed.org/medialibrary/sr938.pdf. See, Louis Craig, Abby Kim & Seung Won Woo, Pre-trade
Information in the Corporate Bond Market, SEC Division of Economic
and Risk Analysis White Paper (Oct. 2020), available at https://www.sec.gov/files/corporate_bond_white_paper.pdf. White papers and
analyses are prepared by SEC staff in the course of rulemaking and
other Commission initiatives. The U.S. Securities and Exchange
Commission disclaims responsibility for any private publication or
statement of any employee or Commissioner. White papers express the
authors' views and do not necessarily reflect those of the
Commission, the Commissioners, or other members of the staff. This
staff white paper on corporate bond ATSs finds that large dealers
(i.e., those in the highest quartile of trading volume and number of
bonds traded) are more likely to provide corporate bond quotes on
ATSs than smaller dealers.
    \472\ See FINRA, TRACE Monthly Volume Files, available at
https://www.finra.org/finra-data/browse-catalog/trace-volume-reports/trace-monthly-volume-files. One commenter referenced similar
numbers for 2020, stating that corporate bond trades (including both
investment-grade and high-yield bonds) on all ATSs represented 6.4
percent of the trade volume and 18.7 percent of the trade count
reported to TRACE. See MarketAxess Letter, at 1.
    \473\ In addition, a small percentage of corporate bonds are
exchange-traded on trading systems such as NYSE Bonds and the Nasdaq
Bond Exchange. See generally, https://www.nyse.com/markets/bonds.
Trading volume in exchange-traded bonds was reported to be around
$19 billion as of January 2020. See Eric Uhlfelder, A Forgotten
Investment Worth Considering: Exchange-Traded Bonds, Wall St. J.
(Jan. 6, 2020) available at https://www.wsj.com/articles/a-forgotten-investment-worth-considering-exchange-traded-bonds-11578279781. (Retrieved from Factiva database).
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

Table 17--Estimated Transaction Costs and Trade Price Dispersion Across
Fixed Income Categories

[GRAPHIC] [TIFF OMITTED] TP27JA23.000

BILLING CODE 8011-01-C
    The aforementioned changes in bond market structure have
fundamentally lowered the cost of trading. Though the corporate bond
market remains subject to periodic and security-specific illiquidity
constraints, one recent academic study finds that corporate bond
transactions costs have decreased by 70% over the past decade.\474\
According to Commission analyses, par volume-weighted average effective

spreads \475\ calculated in the year ending July 2022 in corporate bond
markets were approximately 27 basis points. Liquidity often
concentrated in the largest and most recently issued bonds.\476\
Additional Commission analyses indicate that the top and bottom
quartile of corporate bond effective spreads differ by more than 30
bps.
---------------------------------------------------------------------------

    \474\ See O'Hara and Zhou, supra note 469.
    \475\ Effective spread calculation is defined in Table 17.
    \476\ See A Financial System That Creates Economic
Opportunities, Capital Markets, U.S. Department of the Treasury,
October 2017, available at https://www.treasury.gov/press-center/press-releases/documents/a-financial-system-capital-markets-final-final.pdf (``Treasury Report'') at 85.
---------------------------------------------------------------------------

    Effective spreads for retail-sized trades are nearly twice as wide
as larger size trades (see Panel A of Table 17).\477\ The Commission
estimates that effective spreads on riskless principal transactions are
approximately 12 bps lower for retail-sized corporate bond trades, but
the difference between large size trade effective spreads remains wide
at 26 bps.
---------------------------------------------------------------------------

    \477\ Neither FINRA TRACE nor MSRB RTRS data provide explicit
identification of trades as ``retail'' in fixed income markets. We
use the widely held convention of retail ``size'' trades of being
under $100,000 consistent with studies including Lawrence Harris &
Anindya Mehta, Riskless Principal Trades in Corporate Bond Markets
(Aug. 26, 2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3681652 (retrieved from Elsevier database)
and Griffin, supra note 66, in the corporate and municipal bond
markets, respectively.
---------------------------------------------------------------------------

    The standard deviation ratio statistics of Panel B in Table 17 show
dispersion in the execution quality for corporate bond trades. The
standard deviation ratio statistics compare interdealer trade execution
prices to those of customers within a given bond-trading day. Even for
large trades, a standard deviation ratio of 1.92 suggests that for
every dollar of price dispersion in the interdealer market customers
see almost twice the dispersion in prices. For retail trades, this
difference increases to 2.87 suggesting an even wider range of price
execution quality outcomes.\478\
---------------------------------------------------------------------------

    \478\ Commission analyses for corporate debt securities trades
with no remuneration/markups show the dispersion of customer
execution prices was 65% greater than that of interdealer trades,
suggesting that price dispersion in customer trades may not solely
be driven by disparate markups.
---------------------------------------------------------------------------

ii. Municipal Securities
    The market for municipal securities (``municipal bonds'')
represents another important part of the fixed income market. Unlike in
the markets for other fixed income securities, which are mostly owned
by institutional investors, retail investors play a prominent role in
the ownership of municipal bonds, with 40 percent of municipal bonds
held by households and nonprofits as of Q1 2022.\479\ This is largely
due to the tax-exempt status of most municipal bonds, which makes them
attractive to households but less attractive to institutional investors
such as pension funds, whose holdings are already tax-deferred or tax
exempt. Municipal bond markets also tend to be highly localized, as
investors that are located in geographic proximity to an issuer are
more likely to be informed about that issuer, and tax benefits are
often conferred on investors that are located in the same state as the
issuer.\480\ Daily trading volumes in the municipal bond market
averaged around $9 billion during the 2021 calendar year.\481\ Average
trade sizes in this market tend to be smaller than in other fixed
income markets: in July 2022, 81 percent of trades were for $100,000 or
less, reflecting the higher presence of retail investors in this
market.\482\
---------------------------------------------------------------------------

    \479\ See, John Bagley, Marcelo Vieira & Ted Hamlin, Trends in
Municipal Securities Ownership, at 6, Munic. Sec. Rulemaking Bd
(June 2022), available at https://www.msrb.org/sites/default/files/Trends-in-Municipal-Securities-Ownership.pdf. Data used by this
paper is largely from the Federal Reserve's Financial Accounts of
the United States. Id., at 2. See also infra note 495 and
accompanying text.
    \480\ See, Paul Schultz, The market for new issues of municipal
bonds: The roles of transparency and limited access to retail
investors, 106 J. Fin. Econ. 492, 492 (2012).
    \481\ See Municipal Securities Rulemaking Board, Muni Facts,
available at https://www.msrb.org/News-and-Events/Muni-Facts.
    \482\ See Municipal Securities Rulemaking Board, Municipal Trade
Statistics, available at https://emma.msrb.org/MunicipalTradeStatistics/ByTradeCharacteristic.aspx.
---------------------------------------------------------------------------

    Municipal securities trading venues (e.g., ATSs, non-ATS trading
venues (RFQ platforms), voice methods) compete on fees and trading
protocols that help expose retail customer orders in order to attract
order flows from retail broker-dealers. ATSs play an increasingly
important role in the municipal bond market. Between August 2016 and
April 2021, an estimated 56.4 percent of municipal bond interdealer
trades (26 percent in terms of par volume) were executed on ATSs.\483\
Municipal bond ATSs are primarily used by broker-dealers to execute
trades on behalf of retail customers or to rebalance excess
inventories. ATSs may help to reduce search costs. Indeed, one study
finds that dealers are more likely to access ATS systems for trades
that are more difficult to price and that face substantial search
costs, such as smaller size trades and trades involving municipal bonds
with complex features.\484\ Accordingly, 90 percent of quotes on
municipal bond ATSs are offer quotes.\485\ On the other hand, the vast
majority of RFQs on municipal bond ATSs are requests for bids,
reflecting that RFQ protocols are more likely to be used when customers
want to sell. Similar to the case of corporate bond markets, RFQs may
instead be preferred by traders that want to limit information leakage,
such as in case of large size trades. At least 43.6 percent of
interdealer trades (74.1 percent in terms of par volume) in the
municipal bond market take place via trading methods that are not ATSs,
with 38.3 percent taking place on interdealer platforms and 5.3 percent
on broker's broker platforms.\486\
---------------------------------------------------------------------------

    \483\ See Simon Z. Wu, Characteristics of Municipal Securities
Trading on Alternative Trading Systems and Broker's Broker
Platforms, Municipal Securities Rulemaking Board (Aug. 2021), (``Wu
(2021)''), available at https://msrb.org/sites/default/files/MSRB-Trading-on-Alternative-Trading-Systems.pdf. See also Letter from
Edward J. Sisk, Chair, Municipal Securities Rulemaking Board, dated
March 1, 2021 (``MSRB Letter''), stating that MSRB trade data shows
that ATSs were involved in 21 percent of all trades and 55 percent
of all inter-dealer trades in the municipal bond market.
    \484\ See Wu (2021), supra note 483.
    \485\ See Simon Z. Wu, John Bagley, & Marcelo Vieira, Municipal
Securities Pre-Trade Market Activity: What Has Changed Since 2015?,
Municipal Securities Rulemaking Board (2020), available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/msrb-staff-analysis-of-municipal-securities-pre-trade-data.pdf.
    \486\ See Wu (2021), supra note 483.
---------------------------------------------------------------------------

    Transaction costs in the municipal bond market have typically been
large compared to other markets, and academic studies have attributed
these large transaction costs to a lack of price transparency and
subsequent information asymmetry between dealers and customers.\487\
One MSRB staff report suggests that a movement away from voice trading
and towards electronic trading may have helped reduce transaction costs
for customer trades by 51 percent between 2005 and 2018.\488\ The
Commission estimates that effective spreads for retail-sized trades
remain approximately 23 basis points higher than that of larger
municipal bond trades.
---------------------------------------------------------------------------

    \487\ See, e.g., Lawrence E. Harris, & Michael S. Piwowar,
Secondary Trading Costs in the Municipal Bond Market, 61 J. Fin.
1361 (2006).
    \488\ See Simon Z. Wu, Transaction Costs for Customer Trades in
the Municipal Bond Market: What is Driving the Decline?, Municipal
Securities Rulemaking Board (July 2018), at 15, available at https://www.msrb.org/sites/default/files/Transaction-Costs-for-Customer-Trades-in-the-Municipal-Bond-Market.pdf.
---------------------------------------------------------------------------

    Commission estimates in Panel B of Table 17 show average execution
price standard deviation ratios, however, which suggest much higher
price dispersion for customers in the municipal bond market relative to
other fixed income market segments. For retail-sized trades in
municipal

securities, the Commission estimates retail-size trades have more than
four times the amount of price dispersion as dealers experience. One
recent academic specifically examines execution quality in the market
for municipal bonds.\489\ Consistent with the Commission analysis in
Table 17, the study examines bond prices for the same bond on the same
trading day and finds significant dispersion in execution quality.
Furthermore, the study finds differences in execution quality
discrepancies within each broker-dealer in the same bond trading
day.\490\
---------------------------------------------------------------------------

    \489\ See, e.g., Griffin, supra note 66.
    \490\ The study finds that the range of differences in dealer
fixed effects from the worst to best dealer markup is consistently
2% and retail-sized trades have, controlling for bond
characteristics, 75 bps higher markups relative to larger trades.
Furthermore, the study summarizes by stating that municipal bond
``markup differences represent different prices for the same
security from the same dealer at essentially the same time, which
would seem to be a clear failure of pricing fairness according to
MSRB regulations and guidance.''
---------------------------------------------------------------------------

iii. Government Securities
    The market for U.S. government securities is large both in terms of
the outstanding debt amount and trading volume. According to the
Treasury Department, the total amount outstanding for marketable
Treasury securities was approximately $23.4 trillion.\491\ The
Financial Accounts of the United States Z.1 released by the Federal
Reserve Board shows that the amount outstanding for Agency- and GSE-
Backed Securities is about $10.9 trillion, as of the end of Q1
2022.\492\ According to data published by SIFMA, in September 2021, the
average daily trading volume in government securities was about $850.1
billion, which is roughly 95 percent of all fixed income securities
trading volume in the U.S.\493\ This includes $582.1 billion average
daily trading volume in U.S. Treasury securities, $265.7 billion in
Agency MBSs, and $2.4 billion in other Agency securities.
---------------------------------------------------------------------------

    \491\ See Monthly Statement of the Public Debt of the United
States, dated July 31, 2020, available at https://fiscaldata.treasury.gov/datasets/monthly-statement-public-debt/summary-of-treasury-securities-outstanding.
    \492\ See Financial Accounts of the United States Z.1, First
Quarter 2022, at 177, available at https://www.federalreserve.gov/releases/z1/20220609/z1.pdf.
    \493\ See SIFMA Fixed Income Trading Volume, available at
https://www.sifma.org/resources/research/us-fixed-income-securities-statistics/. The stated figures include Treasury Securities, Agency
MBS, and Federal Agency Securities.
---------------------------------------------------------------------------

    Government securities are traded through a diverse set of venues,
including ATSs, RFQs, and bilateral protocols, such as voice methods.
Government securities trading venues (e.g., ATSs, non-ATS trading
venues (RFQ platforms), voice methods) compete on fees and trading
protocols that help expose retail customer orders in order to attract
order flows from retail broker-dealers. Currently, government
securities ATSs account for a significant percentage of all U.S.
Treasury securities trading activity reported to TRACE.\494\ The
Commission estimates that ATSs account for approximately 37.8% percent
of U.S. Treasury securities trading volume from April 2021 through
March 2022. Broker-dealers utilize ATSs to source liquidity in
government securities, including the liquidity needed to efficiently
fill customer orders outside ATSs. The Commission understands that this
means some portion of broker-dealer transactions on government
securities ATSs are associated with the dealers' activity in filling
customer orders.
---------------------------------------------------------------------------

    \494\ TRACE aggregation and analysis methods follow those used
by Treasury market regulators and FINRA, including adjustments for
multiple trade reports for a single transaction and counting only
one trade report for an ATS or IDB. The regulatory version of TRACE
was used in the analysis. A ``Give-Up'' ID is reported when a
principal to a transaction delegates another participant to report a
trade on its behalf. When a ``Give-Up'' ID is reported, the
corresponding reporting or contra- party is replaced with the
``Give-Up'' ID. This ensures that trades are attributed to the
principals to each transaction. System control numbers are used to
link corrected, canceled, and reversed trade messages with original
new trade messages. In these cases, only corrected trades are kept
and all cancellation and reversal messages and their corresponding
new trade messages are removed. Special care must be taken when
counting market volume. When a FINRA registered broker directly
purchases from another FINRA member, two trade messages are created.
If those FINRA registered brokers transact through an inter-dealer
broker (IDB), four trade messages are created, two for the IDB and
one for each member. In both cases, the volume from only one report
is needed. To ensure that double counting of transactions does not
occur, only the following trade messages are summed to calculate
market volume: sales to non-IDB members, sales to identified
customers, such as banks, hedge funds, asset managers, and PTFs, and
purchases from and sales to customers and affiliates. Any trade in
which the contra-party is an IDB is excluded. Thus, in the case of
trades involving IDBs, only the IDBs' sale message is added to
overall volume.
---------------------------------------------------------------------------

    Effective spreads for Treasuries in Table 17 are the lowest among
all of the presented fixed income securities categories. Effective
spreads for retail-sized trades are only 3 bps higher relative to
larger trades. Agency securities exhibit relatively higher effective
spreads in comparison to U.S. Treasury securities but remain the second
least costly fixed income securities category in terms of transaction
costs. There is less dispersion in execution quality for U.S. Treasury
securities trades. Price dispersion in large size customer trades is
small relative to that of interdealer trades (1.11) but is somewhat
larger, albeit at an overall level less than other fixed income
securities categories, for retail-sized trades (1.38).
iv. Market Access
    With respect to fixed income securities trading, executing brokers
provide market access to other broker-dealers including retail broker-
dealers that qualify as introducing brokers under the FINRA/MSRB rules.
The Commission understands executing broker-dealers that provide market
access to retail introducing brokers under the FINRA and MSRB rules do
not engage in conflicted transactions as defined under the proposal.
Furthermore, the Commission understands that these executing brokers
would consider factors, such as contemporaneous trade prices (e.g.,
interdealer prices), quotes, trade prices and quotes of similar fixed
income securities, yield curve, matrix prices, and different types of
trading protocols (e.g., RFQs and BWICs) in handling orders from other
retail broker-dealers and also supply execution quality statistics to
their customers. These executing brokers compete on the basis of fees,
efficiency in order handling procedures, and efficiency in the
selection of trading venues or counterparties, which determine overall
execution quality.
v. Retail Order Handling and Execution
    Retail investors transacting in fixed income securities most often
trade municipal securities, and to a smaller extent, corporate debt
securities and U.S. Treasury securities. As of 2021, household holdings
of municipal securities hovered above 40 percent \495\ of outstanding
municipal securities,\496\ but this share has been declining.\497\
Households owned only roughly one percent of outstanding corporate debt
securities in 2021.\498\ U.S. Treasury securities have slightly higher
household participation, at approximately three percent.

Households own a similar amount of U.S. agency securities, also at
approximately two percent.\499\ In general, retail investors do not
trade in the market for other fixed income securities, such as asset-
backed securities, although broker-dealers offer trading services for
these fixed income securities to their retail customers.
---------------------------------------------------------------------------

    \495\ See Financial Accounts of the United States Z.1, Fourth
Quarter 2021, available at https://www.federalreserve.gov/releases/z1/20220310/z1.pdf.
    \496\ In the Z.1 Financial Accounts of the United States,
estimates for the `household' sector include non-profits and
domestic hedge funds. See Financial Accounts of the United States
Z.1, Technical Q&As (September 23, 2022), available at https://www.federalreserve.gov/releases/z1/z1_technical_qa.htm.
    \497\ See Heather Gillers, Municipal Bonds Increasingly Held by
Funds, Not Individuals, Wall St. J. (Jun. 29, 2022). Available at
https://www.wsj.com/articles/municipal-bonds-increasingly-held-by-funds-instead-of-individuals-11656408601.
    \498\ See id.
    \499\ See id.
---------------------------------------------------------------------------

    The Commission understands that retail investors generally use one
broker-dealer for fixed income securities trading services. Broker-
dealers execute retail customer orders mostly on a principal basis
(e.g., riskless principal trades, internalized trades). Broker-dealers
may execute against resting orders (e.g., limit orders displayed on
ATSs), conduct RFQs/BWICs/OWICs,\500\ and utilize voice methods (e.g.,
telephone) in handling retail customer orders. For executing small or
medium size retail customer orders, a broker-dealer may utilize limit
orders or RFQs, while it might utilize voice methods for executing
large retail customer orders or orders on illiquid fixed income
securities. Only a few broker-dealers offer a trading service to
represent a retail customer order in a limit order book. The Commission
does not know the number of trading venues (e.g., ATSs, RFQ platforms,
broker's broker platforms, single dealer platforms) to which broker-
dealers maintain access/connection for executing retail customer
orders. The Commission also does not know the number of broker-dealers
that access or connect to these venues through each type of interface
(e.g., via application programming interface (API), graphical user
interface (GUI)). Furthermore, the Commission does not know how broadly
broker-dealers expose retail customer orders, for example, via RFQs or
limit order books for the purpose of riskless principal transactions
and internalization.
---------------------------------------------------------------------------

    \500\ Bid wanted in competition (BWIC) is a request for bids on
a single security or a list of securities, submitted by a market
participant (a broker-dealer or an institutional investor) to a
number of broker-dealers. Offer wanted in competition (OWIC) is a
request for offers on a single security or a list of securities,
submitted by a market participant (a broker-dealer or an
institutional investor) to a number of broker-dealers.
---------------------------------------------------------------------------

    The Commission understands that retail customer order handling
practices for fixed income securities vary across retail broker-dealers
offering different types of trading services and between the sides of
the market (customer buy order vs. customer sell order). Some broker-
dealers offer self-directed trading to their retail customers, whereas
for some broker-dealers, the firm's brokers handle retail customer
orders, and some offer both self-directed and broker-assisted trading
services. Furthermore, some broker-dealers make only internal
inventory, only external inventory (for brokers that do not carry
inventory), or both internal and external inventory of fixed income
securities available for retail customer trading. The Commission
understands that some broker-dealers whose primary service is not
focused on fixed income securities trading outsource fixed income
securities execution services to another broker (i.e., executing
broker). The Commission does not know how many executing brokers
perform fixed income securities trading services on behalf of these
brokers. The Commission understands that executing brokers maintain
access to multiple trading venues (e.g., ATSs, RFQ platforms, broker's
broker platforms, single dealer platforms) and generally handle orders
from other broker-dealers, for which they provide execution services,
on agency or riskless principal basis.
    Some broker-dealers ingest offer quotes from internal inventory
and/or trading venues (e.g., ATSs, electronic venues) and then display
them to their self-directed retail customers or the firm's brokers who
handle retail customer orders. These offer quotes displayed to self-
directed retail customers typically embed markup. Self-directed retail
customers are able to submit buy orders to execute against offer quotes
displayed on their systems. The Commission understands that some
broker-dealers do not assess the competitiveness of ingested quotes or
filter out quotes that may not be reflective of the prevailing market
before displaying them to self-directed retail customers. Furthermore,
the Commission does not have information about how orders submitted by
self-directed retail customers are handled: the Commission does not
know how a broker-dealer ensures the displayed quote, against which a
self-directed retail customer submitted an order to execute, is
reflective of the current market. For a broker-assisted customer buy
trade, a broker handling a retail customer order would follow order
handling procedures based on the FINRA/MSRB best execution rules. The
broker may consider, among other things, prices, such as trade prices,
trade prices of similar fixed income securities, internal and/or
external offer quotes, offer quotes of similar fixed income securities,
matrix prices, and prices derived from yield curve, as well as trading
protocols, such as limit order, RFQ, and OWIC, in handling the retail
customer buy order. The Commission understands that broker-dealers that
carry inventory of fixed income securities may internalize retail
customer buy orders by executing them against internal inventory after
charging a markup. Broker-dealers may use offer quotes resting on
trading venues and/or offer responses to RFQ/OWIC as reference prices
to match or improve (via last-look practice) for the purpose of
internalization.
    Only a few retail broker-dealers display external and/or internal
bid quotes of fixed income securities to their self-directed retail
customers or the firm's brokers who handle retail customer orders. To
the extent that these retail broker-dealers display external and/or
internal bid quotes of fixed income securities to their self-directed
retail customers, self-directed retail customers are able to submit
sell orders to execute against bid quotes displayed on their systems.
For a broker-assisted customer sell trade, a broker handling a retail
customer order would typically conduct RFQ or BWIC to collect multiple
bids. A broker would also consider other pricing sources, such as trade
prices, trade prices of similar fixed income securities, bid quotes of
similar fixed income securities, matrix prices, and prices derived from
yield curve in handling the retail customer sell order. For broker-
dealers that carry inventory of fixed income securities, these broker-
dealers may internalize customer sell orders by buying the bond from
their customer into inventory after charging a markdown to have an
opportunity to resell the bond to another customer (earning the bid-ask
spread and markup when the broker-dealer resells the bond to another
customer). In conducting RFQs or BWICs for the purpose of
internalization, the Commission understands that some broker-dealers
may use last-look to apply trade desk spreads (in the form of markdown)
to external bids but not to internal bids, which results in more
favorable comparisons for the internal bids, to win RFQs/BWICs.\501\
---------------------------------------------------------------------------

    \501\ See infra Section V.C.1.b for the discussion of last look
practices and application of trade desk spreads.
---------------------------------------------------------------------------

vi. Principal Trading
    With respect to fixed income securities trading, principal
transactions \502\ with retail customers, in which broker-dealers
engage, include riskless principal \503\ and internalized

trades. With limited transparency in the fixed income securities
markets, an internalized trade may represent conflicts of interest
between a broker-dealer and its retail customer because the retail
customer may not be able to assess broker-dealer compensation (e.g.,
markup/markdown). Provided that transaction costs of riskless principal
transactions are disclosed on a post-trade basis in customer
confirmations, these riskless principal transactions represent
potentially fewer conflicts of interest compared to internalization.
When the transaction costs of riskless principal transactions are
disclosed on a pre-trade basis via a markup/markdown schedule, there
would be even fewer conflicts of interest between retail customers and
broker-dealers handling their orders.\504\ A significant portion of
customer trades are executed on a principal basis. Table 18 shows that
87% and 80% of the corporate debt securities and municipal securities
customer par volume trades, respectively, are executed on a principal
basis. Furthermore, Table 18 shows that riskless principal transactions
represent 31% and 48% of principal trades in the corporate debt
securities and municipal securities markets, respectively.\505\ An
academic study has found a persistent increase in the frequency of
riskless principal trades in the corporate debt securities market since
2014.\506\
---------------------------------------------------------------------------

    \502\ Principal transactions with retail customers would be
subject to the requirements of the proposed rule 1101(b). See also
supra section IV.E.
    \503\ These riskless principal trades would include retail
customer self-directed trades. Some broker-dealers execute self-
directed trades of retail customers on a riskless principal basis
and charge markups/markdowns for their trading services. Retail
customer self-directed trades would not be considered unsolicited
instructions from customers under FINRA Rule 5310.08.
    \504\ Some broker-dealers disclose a markup/markdown schedule
broken out by trade size on a pre-trade basis for retail customer
self-directed trading on customer facing websites.
    \505\ Principal trading represents a relatively smaller
proportion of retail-sized customer trades in the U.S. Treasury
securities market. Commission analyses show trades executed in an
agency capacity represent approximately 36.7% of all retail-sized
U.S. Treasury securities trades. The commission estimates that
riskless principal trades represent 7.9% of principal trades in the
U.S. Treasury securities market, whereas the share of riskless
principal trades for retail-sized trades is 10.2%.
    \506\ See O'Hara and Zhou, supra note 469. The study suggests
that implementation of the Volcker Rule in 2014 led to a large
increase in riskless principal capacity trading, particularly among
bank broker-dealers who are subject to proprietary trading
restrictions under the rule.

                                              Table 18--Fixed Income Dealer Trading Capacity and Trade Size
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                           Panel A: Corporate Debt Securities
---------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Total distinct                  Trade    Par volume (in   Par volume
        Corporate bond                Trade size                   Type                 MPIDs          Trades     percent      billions)       percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Dealer Buy...................  Retail Trades (<=$100k).  Agency.................               446      782,685        7.9           11.82           0.2
                                                         Principal..............               465    1,466,145       14.8           42.63           0.6
                                                         Riskless Principal.....               474      553,908        5.6           12.39           0.2
                               Large Trades (>$100k)...  Agency.................               241      163,505        1.6          201.03           2.7
                                                         Principal..............               413    1,596,162       16.1        3,164.41          43.3
                                                         Riskless Principal.....               392      183,391        1.8          235.28           3.2
Dealer Sell..................  Retail Trades (<=$100k).  Agency.................               338    1,052,845       10.6           18.40           0.3
                                                         Principal..............               460    1,341,692       13.5           47.88           0.7
                                                         Riskless Principal.....               475      704,699        7.1           19.71           0.3
                               Large Trades (>$100k)...  Agency.................               475      172,630        1.7          213.28           2.9
                                                         Principal..............               458    1,698,176       17.1        3,140.93          43.0
                                                         Riskless Principal.....               474      209,196        2.1          203.39           2.8
                                                                                -----------------------------------------------------------------------
    Total....................  ........................  .......................  ................    9,925,034        100           7,311           100
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              Panel B: Municipal Securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
Municipal                      Trade size..............  Type...................    Total distinct       Trades      Trade      Par volume    Par volume
bond                                                                                MPIDs                 percent   (in billions)       percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Dealer Buy...................  Retail Trades (<=$100k).  Agency.................               331      263,505        5.1            6.49           0.3
                                                         Principal..............               325      737,050       14.4           24.56           1.2
                                                         Riskless Principal.....               458      847,353       16.5           24.80           1.2
                               Large Trades (>$100k)...  Agency.................               188       19,119        0.4            7.16           0.4
                                                         Principal..............               284      244,097        4.8          458.28          22.5
                                                         Riskless Principal.....               354      138,851        2.7          194.91           9.6
Dealer Sell..................  Retail Trades (<=$100k).  Agency.................               237      319,597        6.2            9.28           0.5
                                                         Principal..............               339    1,037,384       20.2           35.86           1.8
                                                         Riskless Principal.....               365      817,050       15.9           24.16           1.2
                               Large Trades (>$100k)...  Agency.................               365       34,090        0.7           16.04           0.8
                                                         Principal..............               384      558,594       10.9        1,115.44          54.7
                                                         Riskless Principal.....               440      119,447        2.3          123.77           6.1
                                                                                -----------------------------------------------------------------------
    Total....................  ........................  .......................  ................    5,136,137        100           2,041           100
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table presents summary statistics for dealer trading capacity across corporate (using FINRA TRACE data) and municipal (MSRB RTRS) fixed income
  categories from April 1, 2021 through March 31, 2022. We drop all interdealer trades keeping only customer trades from TRACE and RTRS main data files.
  We then collapse this file by Buy/Sell indicator, Agency/Principal/Riskless Principal indicator and Trade size bucket. The table reports the total
  distinct MPIDs in each group the total trade count (with percentage), total Par volume (with percentage), the weighted markup of riskless principal
  trades, and unweighted markup of riskless principal trades. Riskless principal trade indicators are not provided in the main data but are inferred
  using trade pairs matched by MPID and trade size over a 15-minute window.

    The Commission understands that there may be conflicts of interest
in handling retail customer orders in fixed income securities markets,
which could result in retail customers not receiving the most favorable
prices under

prevailing market conditions. A broker-dealer that submits an RFQ \507\
on behalf of a retail customer typically has the option of selecting
potential counterparties, from which it is requesting prices, on behalf
of its customer. Applying counterparty filtering or limiting the number
of counterparties in RFQs could result in less competitive prices for
retail customer orders.\508\ An academic study links competitiveness
(i.e., the number of bids and difference between winning and second
best bid) directly to price improvement.\509\ Another market practice
is price matching using the best response to RFQ via ``last look'' or
``pennying'' for the purpose of internalization rather than customer
benefit.\510\ Such practice would discourage market participants from
submitting competitive prices because responders to RFQs are not
compensated for submitting competitive quotes (i.e., selected to
trade).
---------------------------------------------------------------------------

    \507\ The Commission understands that, in general, responding to
RFQs is a manual process. Recently, some market participants (e.g.,
large broker-dealers) automated responses to RFQs for small order
sizes.
    \508\ While filtering practices might be conducted by broker-
dealer for order execution efficiency purposes (i.e., evaluating
only counterparties who provide firm indications), a broker-dealer
must evaluate any efficiency gains directly against filtering quotes
that may be more favorable to the end customer. Filtering
counterparties to reduce information leakages is likely to produce
little benefit for retail trades.
    \509\ See Terrence J. Hendershott, Dmitry Livdan & Norman
Schuerhoff, All-to-All Liquidity in Corporate Bonds, Swiss Finance
Institute Research Paper No. 21-43 (October 27, 2021), available at
https://ssrn.com/abstract=3895270 or https://dx.doi.org/10.2139/ssrn.3895270.
    \510\ The Commission understands that such practice is more
common in RFQs on the bid side of the market.
---------------------------------------------------------------------------

(c) Crypto Asset Securities
    As discussed Section III.A.3, crypto asset securities, also called
digital asset securities, refer to a range of assets that are issued
and/or transferred using distributed ledger technology and that meet
the definition of a security.\511\ The Commission has provided a
statement regarding broker-dealers engaging in custody and transactions
of crypto asset securities.\512\ Broker-dealers transacting in crypto
asset securities would be subject to the requirements of this
proposal.\513\
---------------------------------------------------------------------------

    \511\ See, e.g., Report of Investigation Pursuant to Section
21(a) of the Securities Exchange Act of 1934: The DAO, Exchange Act
Release No. 81207 (July 25, 2017). See SEC v. W. J. Howey Co., 328
U.S. 293 (1946). See Framework for ``Investment Contract'' Analysis
of Digital Assets, available at https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets.
    \512\ See supra III.A.3. Since 2013, the Commission has brought
a significant number of enforcement actions against issuers of
crypto asset securities and crypto asset security market
participants. Such enforcement investigations and actions have been
brought for, among other things, violations of the registration
requirements of the Securities Act of 1933 for offers and sales of
crypto assets to the public as securities, violations of the
exchange registration requirements of the Securities Exchange Act of
1934 for operating trading platforms for digital assets that are
securities, and violations of the anti-fraud and other provisions of
Federal securities laws. See, e.g., Crypto Assets and Cyber
Enforcement Actions, available at https://www.sec.gov/spotlight/cybersecurity-enforcement-actions for more information about these
enforcement actions.
    \513\ See supra section III.A.3 for criteria of applicability to
crypto asset securities.
---------------------------------------------------------------------------

    Because transaction data and other information on the crypto asset
securities market is limited,\514\ the Commission does not have a
complete understanding of market participants' current practices with
respect to order handling and best execution for crypto asset
securities, including the extent to which current practices in the
market for crypto asset securities are consistent with FINRA Rule
5310.\515\
---------------------------------------------------------------------------

    \514\ See, e.g., FSOC Report, supra note 95, at 119, which notes
that the digital asset ``ecosystem is characterized by opacity that
creates challenges for the assessment of financial stability risks.
Collection and sharing of data, as appropriate, could help reduce
this opacity.'' See also Raphael Auer et al., supra at note 95
(discussing data gaps in the crypto market).
    \515\ As noted in supra Section III.A.3, circumstances have made
it difficult for the Commission to have a full picture of the
current market for crypto assets.
---------------------------------------------------------------------------

    Most known, off-chain trading activity for crypto asset securities
occurs on online, openly accessible centralized platforms. These
platforms are typically vertically integrated, combining account
holding and trading services. The prevalence of vertically integrated
trading platforms distinguishes the crypto asset securities market from
other asset markets. These platforms often operate using a centralized
limit order book, similar to exchanges for stocks and futures, but the
volume is not audited or verified in any known manner.\516\ Some
platforms that trade crypto asset securities are domiciled and operated
outside the U.S.\517\ To trade on a centralized crypto asset securities
platform, the only prerequisites for a retail investor are to sign up
for an account with a location-accessible platform and link his or her
bank account or digital asset wallet.\518\
---------------------------------------------------------------------------

    \516\ See, for example, Le Pennec, G., Fiedler, I., and Ante,
L., Wash trading at cryptocurrency exchanges, 43 Finance Research
Letters 101982 (2021).
    \517\ Some platforms that purport to be located outside of US
nevertheless seek to cater to US customers, among other ways, by
complying with certain requirements set by the CFTC and FinCEN. As
of August 30, 2022, only three of the top 25 trading platforms
(according to CoinMarketCap) have registered FINRA entities. See
CoinMarketCap's Top Cryptocurrency Spot Exchanges, available at
https://coinmarketcap.com/rankings/exchanges/ for further exchange
level information.
    \518\ A digital asset wallet is a software, algorithm, or
storage medium to store the public and private keys of the digital
asset transactions. See, for example the definition of wallet in
Cryptocurrencies glossary, Fidelity Investments, available at
https://www.fidelity.ca/en/investor/cryptocurrencies-glossary/.
---------------------------------------------------------------------------

    The Commission understands that retail customers represent
approximately 30% of trading in crypto asset securities at the largest
centralized trading platforms.\519\ Instead of trading directly on
centralized platforms, some retail customers may choose to place crypto
asset securities orders with retail businesses, which could be
affiliates of SEC registrants, fintech firms, or even payment
applications.\520\ Those businesses typically route the order flow to
unregistered third-party wholesalers, proprietary traders, or market
makers for execution. Some of them provide zero or low commissions for
trading crypto assets, and obtain all or a significant portion of their
compensation through payments from the wholesalers for directed order
flow. The Commission is not certain how these orders are handled (i.e.,
internalized, routed to centralized platforms, etc.), given the lack of
reporting in the crypto asset securities market. It is possible that
crypto asset wholesalers internalize most of the order flow they
purchased within their own proprietary trading desks and they may route
any remaining order flow perceived to be from informed traders to a lit
(i.e., transparent order book driven) venue.
---------------------------------------------------------------------------

    \519\ This estimate comes from two different sources: (1)
disclosures from Coinbase's 2021 10-K filings; and (2) a direct
statement made by Binance US's CEO at the 2022 Georgetown Financial
Market Quality Conference.
    \520\ Payment apps allow individuals and businesses to transfer
funds outside of the traditional banking and payment processing
systems. Many of these fintech or payment app entities are not
registered with the Commission in any capacity. Thus, this activity
is not visible to the Commission.
---------------------------------------------------------------------------

    The Commission lacks knowledge on the prevalence of broker-dealer
activity in this market and the routing behavior of broker-dealers in
this market. The Commission likewise has limited information about the
pervasiveness of payment for order flow in the crypto asset securities
market.\521\
---------------------------------------------------------------------------

    \521\ The Commission understands PFOF rates from wholesalers for
crypto assets are significantly higher than the PFOF rates from
wholesalers for NMS securities.
---------------------------------------------------------------------------

(d) Non-NMS Stock Equity Securities
    Non-NMS stock equity securities trade in a market that appears to
be a hybrid of the NMS securities market and the fixed income market.
The non-NMS stock equities market is informally

referred to as the ``OTC market.'' The securities traded in the non-NMS
stock equities market are typically unregistered equities; however,
many non-NMS equities traded were formerly registered and formerly
exchange listed. Analogous to the fixed income market, there are some
securities which are very liquid, and also many securities that are
difficult to trade. For FINRA members, non-NMS stock equities trading
is subject to FINRA Rule 5310 for execution standards; however, there
are other standards that also affect this market (i.e., state law and/
or platform/venue requirements). Academic studies have found that
differences in regulation can impact market quality.\522\ Trading in
non-NMS stock equities primarily takes place via dealer-to-dealer
trades or on one of several ATSs that specialize in non-NMS stock
equities. In the interdealer market, broker-dealers interact directly
with one another to fill customer orders or manage inventory. ATSs in
the non-NMS stock equities market offer opportunities for broker-
dealers to interact in either a traditional limit order book or in a
negotiation feature somewhat similar to RFQs in fixed income markets.
Some ATSs in this market allow direct participation by any client,
including retail clients; however, as the Commission understands, most
ATSs are accessible only by dealers.
---------------------------------------------------------------------------

    \522\ See, e.g., Ulf Br[uuml]ggemann, Aditya Kaul, Christian
Leuz & Ingrid M. Werner, The Twilight Zone: OTC Regulatory Regimes
and Market Quality, 31 Rev. Fin. Stud. 898 (March 2018), available
at https://doi.org/10.1093/rfs/hhx102. The authors find that
increased regulation of OTC trading improves market quality in US
OTC stocks.
---------------------------------------------------------------------------

    From the perspective of order handling, retail orders are processed
in a manner very similar to NMS stocks. Retail broker-dealers that
offer the ability \523\ to trade in the non-NMS stock equities market
typically route an order to a wholesaler, who may internalize the
order, or if the broker-dealer is directly connected to a non-NMS stock
equities liquidity source, such as an ATS, may trade in a principal
capacity with the customer. Orders that are not routed to wholesalers
or internalized directly by the retail broker-dealer may be routed to
an ATS to expose the order. From the Commission's analysis of non-NMS
stock equities trades in March 2022, 63.2% of non-institutional trades
were traded in a principal capacity. As noted in this section, some
ATSs allow direct participation of any trader who registers and
connects to their platform. Thus, some retail investors may be able to
access liquidity without the aid of a broker-dealer in this market. In
terms of pricing orders, non-NMS stock equities are not protected by a
trade-through rule. Thus, pricing could be highly variable from one
trade to the next in a given security. The non-NMS stock equities
market is not required by regulation to report individual trades for
public dissemination. This market frequently lacks quotes entirely, or
lacks displayed quotes that are frequently updated. Despite this lack
of mandated transparency, the largest \524\ ATS serving this market
offers pre-trade and post-trade information (e.g., quotes, transaction
prices).\525\
---------------------------------------------------------------------------

    \523\ This ability often costs a premium compared to trading in
NMS stocks. Many brokers will still charge commissions for trades in
this market.
    \524\ See ATS Transparency Data Quarterly Statistics, FINRA.org,
available at https://www.finra.org/filing-reporting/otc-transparency/ats-quarterly-statistics. This ATS is largest by number
of OTC Stocks traded in Q2 2022. FINRA posts records on a quarterly
basis listing ATSs trading OTC Stocks and the share volume traded on
the ATS.
    \525\ See Anna-Louise Jackson, What is the OTC Market?, Forbes
Advisor (Jun. 9, 2022), available at https://www.forbes.com/advisor/investing/otc-market/. See generally, OTC Markets Group, Inc. and
OTC Link ATS, available at https://www.otcmarkets.com/.
---------------------------------------------------------------------------

(e) Institutional Customer Order Handling
    The Commission understands that institutional investors generally
use multiple broker-dealers for NMS stock and options trading services.
Institutional broker-dealers typically engage in order splitting when
handling large institutional customer orders, often utilizing SORs to
break up large, institutional ``parent'' orders into multiple smaller
``child'' orders.\526\ 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.\527\ A significant portion of
institutional customer orders in NMS stocks and options is not
held.\528\ The Commission understands that institutional customer
orders handled on a not held basis may sometimes be executed based on
customer-specified standards that may prioritize outcomes other than
execution prices, such as reducing the price impact of an order or
matching volume weighted average price (VWAP) over a certain time
horizon. An academic study looked at order routing by institutional
brokers in the equity markets and found that institutional brokers who
route more orders to affiliated ATSs are associated with lower
execution quality in the form of lower fill rates and higher
implementation shortfall costs than institution brokers that route more
orders to non-affiliated ATSs.\529\
---------------------------------------------------------------------------

    \526\ The small-sized and mid-sized institutional customer
orders for options are typically routed to electronic order routing
platforms. These platforms allow order entry and provide smart
routers and order and position management. Furthermore, these
platforms offer customized execution algorithms on an order-by-order
basis. See also Tyler Beason & Sunil Wahal, The Anatomy of Trading
Algorithms, (working paper Jan. 21, 2021), available at https://ssrn.com/abstract=3497001 (retrieved from SSRN Elsevier database)
for a discussion of institutional investor parent and child order
handling in NMS stocks.
    \527\ See supra note 169.
    \528\ An analysis in the Rule 606 Adopting Release 83 FR 58338
(Jan 2019), studied orders submitted from customer accounts of 120
randomly selected NMS stocks listed on NYSE during the sample period
between December 5, 2016 and December 9, 2016, consisting of 40
large-cap stocks, 40 mid-cap stocks, and 40 small-cap stocks. The
analysis found that among the orders received from the institutional
accounts, about 69% of total shares and close to 39% of total number
of orders in the sample are not held orders, whereas among the
orders received from the individual accounts, about 19% of total
shares and about 12% of total number of orders in the sample are not
held orders. See Rule 606 Adopting Release, 83 FR 58393.
    \529\ See Anand, supra note 91.
---------------------------------------------------------------------------

    With respect to fixed income securities trading, the Commission
understands that institutional investors, such as mutual funds, pension
funds, insurance companies, and banks, in general directly trade with
market participants (e.g., broker-dealers) by accessing RFQs, platform-
wide RFQs, firm quotes, and indicative quotes on trading venues.
Institutional investors generally trade large blocks of fixed income
securities via voice with broker-dealers. Furthermore, the Commission
understands that institutional investors generally use multiple broker-
dealers for trading services. Based on customers' instructions, broker-
dealers may represent institutional customer orders by posting firm
quotes on many-to-many and one-to-many platforms, or conduct RFQs on
behalf of institutional customers.
    Institutional investors may utilize third-party vendors to conduct
transaction cost analysis and evaluate the performance of their broker-
dealers based on those reports. If an institutional investor uses
multiple brokers-dealers, it may direct more orders to broker-dealers
that have better performance. This may reduce the

switching costs for institutional investors related to changing broker-
dealers and increase competition among broker-dealers to attract
institutional orders.
4. Broker-Dealer Services and Revenue
    A small subset of broker-dealers hold most customer accounts and
control a significant portion of broker-dealer assets. Table 19 shows
statistics on broker-dealer customers and total assets. Based on FOCUS
data as of Q2 2022, there were approximately 3,498 broker-dealers, 162
of which carry their own customer accounts. These broker-dealers
reported carrying over 240 million public customer accounts. Of the
total population of these broker-dealers, approximately 2,440 reported
retail customer activity.\530\ Of the broker-dealers that reported
retail customer activity, 144 reported carrying their own customer
accounts.\531\ A small set of 23 broker-dealers report more than 50
billion dollars in total assets and 119 report between 1 billion and 50
billion in assets. The majority of broker-dealers have less than 10
million dollars in assets, with 1,613 having less than 1 million
dollars in assets. However, most customer accounts are concentrated in
the 142 large broker-dealers with 1 billion dollars or more in assets:
119 of them are from the category of broker-dealers with assets greater
than 1 billion dollars and less than 50 billion dollars and 23 of them
are from the category of broker-dealers with assets greater than 50
billion dollars. Ninety eight broker-dealers carry non-customer
accounts for other broker-dealers. The majority of these, 66, are large
broker-dealers with 1 billion dollars or more in assets. On average,
they carry accounts for over 50 other broker-dealers.
---------------------------------------------------------------------------

    \530\ See item 8080 on FOCUS Report Form X-17A-5 Schedule I for
additional information on the number of reported public customer
accounts.
    \531\ Retail sales activity is identified from Form BR, which
categorizes retail activity broadly (by marking the ``sales'' box)
or narrowly (by marking the ``retail'' or ``institutional'' boxes as
types of sales activity). We use the broad definition of sales as we
believe that many firms will just mark ``sales'' if they have both
retail and institutional activity. However, we note that this may
capture some broker-dealers that do not have retail activity,
although we are unable to estimate that frequency.

                                                             Table 19--Number of Broker-Dealers and Customer Accounts by Asset Size
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Size of broker-dealer (total assets)
                            Variable                             -------------------------------------------------------------------------------------------------------------------------------
                                                                       >50bn         1bn-50bn        500mn-1bn      100mn-500mn     10mn-100mn       1mn-10mn          <1mn            Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Panel A: All Broker-Dealers
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Number of Broker-Dealers........................................              23             119              30             136             523           1,054           1,613           3,498
Number of Broker-Dealers Registered as Investment Advisers......              11              22               4              35              95             179             134             480
Number of Broker-Dealers with Investment Adviser Affiliate......              19              74              17              87             274             401             445           1,317
Number of Broker-Dealers Carrying Own Customer Accounts.........              19              59               8              22              26              21               7             162
Total Number of Public Customer Accounts........................      75,834,917     153,216,558       6,045,929       3,555,383         606,606         887,833           6,668     240,153,894
Total Number of Omnibus Accounts................................         421,583             525              12               4              33              19               0         422,176
Number of Broker-Dealers Carrying Non-Customer Accounts.........              18              48               7               9              11               5               0              98
Avg Number Other Broker-Dealers Carrying Customer Accounts For              57.5            50.7            30.5             9.0             2.5             1.0  ..............  ..............
 Fully Disclosed Basis..........................................
Avg Number Other Broker-Dealers Carrying Accounts for Omnibus               19.2            26.3            15.3             3.5             2.5  ..............             1.0  ..............
 Basis..........................................................
                                                                 -------------------------------------------------------------------------------------------------------------------------------
                                                                                Panel B: Retail Broker-Dealers
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Number of Retail Broker-Dealers.................................              19              76              21             109             393             750           1,072           2,440
Number of Broker-Dealers Registered as Investment Advisers......              11              21               4              34              92             171             128             461
Number of Broker-Dealers with Investment Adviser Affiliate......              17              56              12              76             228             331             350           1,070
Number of Broker-Dealers Carrying Own Customer Accounts.........              18              51               7              20              22              19               7             144
Total Number of Public Customer Accounts........................      75,829,888     142,899,902       6,012,125       2,641,879         606,447         880,021           6,668     228,876,930
Total Number of Omnibus Accounts................................         421,583             524              12               1              33              15               0         422,168
Number of Broker-Dealers Carrying Non-Customer Accounts.........              17              44               7               8               8               5               0              89
Avg Number Other Broker-Dealers Carrying Customer Accounts For              60.9            55.4            30.5             8.0             2.0             1.0  ..............  ..............
 Fully Disclosed Basis..........................................

Avg Number Other Broker-Dealers Carrying Accounts for Omnibus               19.2            28.5            15.3             2.0             2.5  ..............             1.0  ..............
 Basis..........................................................
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
This table summarizes the number broker-dealers (Panel A) and retail broker-dealers (Panel B), their investment adviser status, their customer account carrying status, and the number of
  customer and omnibus accounts they carry broken out into groups based on their total assets. The number of Broker-dealers comprises the broker-dealers that had a valid FOCUS Report for Q2
  2022 and a valid Form Custody and Form BD for Q2 2022. Total Assets are estimated by Total Assets (allowable and non-allowable) from Part II/IIA of the FOCUS filings (Form X-17A-5 Part II/
  IIA) from Q4 2021 and correspond to balance sheet total assets for the broker-dealer. The numbers of public and omnibus accounts are from FOCUS Schedule I from Q4 2021. Broker-dealer
  registration as an investment adviser is from Form Custody from Q2 2022 and includes broker-dealers that are registered as an investment adviser with the Commission or with a state. Broker-
  dealers carrying customer accounts and non-customer accounts is identified from Form Custody from Q2 2022. Average number of other broker-dealer carrying accounts on a fully disclosed or
  omnibus basis is the average number of other broker-dealers for which a broker-dealer carrying non-customer accounts holds accounts for and it is determined from Form Custody from Q2 2022.
  Retail brokers are identified based on retail sales activity from Form BR in Q2 2022, which categorizes retail activity broadly (by marking the ``sales'' box) or narrowly (by marking the
  ``retail'' or ``institutional'' boxes as types of sales activity). We use the broad definition of sales as we believe that many firms will just mark ``sales'' if they have both retail and
  institutional activity. However, we note that this may capture some broker-dealers that do not have retail activity, although we are unable to estimate how often it does so.

    A small number of broker-dealers with more than 1 billion dollars
in revenue account for the majority of broker-dealer assets, revenue,
and expenses. Table 20 shows statistics on total assets, total
revenues, total expenses, and net income based on broker-dealer asset
size. The top 23 brokers, each with assets over $50 billion, have more
than 3.8 trillion dollars in assets out of a total of 5.4 trillion
dollars across all broker-dealers. The top 142 brokers account for the
majority of revenue, earning over 71 billion dollars in Q2 2022 out of
total of 97 billion dollars for all broker-dealers. Similarly, the top
142 broker-dealers accounted for the majority of expenses and net
income.

                                                             Table 20--Assets, Revenue and Expenses of Broker-Dealers by Asset Size
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Size of broker-dealer (total assets)
                 Variable                             Statistic            ---------------------------------------------------------------------------------------------------------------------
                                                                                >50bn             1bn-50bn         500mn-1bn      100mn-500mn     10mn-100mn       1mn-10mn          <1mn
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                      Total Number of Broker-Dealers                                       23                119              30             136             523           1,054           1,613
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Assets ($1,000s)...................  Mean...........................       $168,631,851        $12,226,934        $737,161        $207,753         $34,340          $3,580            $299
                                           Median.........................        $85,750,282         $6,628,584        $737,598        $181,812         $25,645          $2,757            $207
                                           Total..........................     $3,878,532,570     $1,455,005,108     $22,114,818     $28,254,392     $17,959,877      $3,773,694        $481,530
                                                                           ---------------------------------------------------------------------------------------------------------------------
Total Revenue ($1,000s)..................  Mean...........................         $1,495,923           $315,344         $84,500         $76,247         $17,310          $2,622            $378
                                           Median.........................           $841,321            $81,517         $25,232         $30,703          $7,638          $1,396             $99
                                           Total..........................        $34,406,232        $37,525,938      $2,535,011     $10,369,565      $9,036,076      $2,695,264        $508,546
                                                                           ---------------------------------------------------------------------------------------------------------------------
Total Expenses ($1,000s).................  Mean...........................         $1,263,904           $283,825         $75,088         $66,749         $15,760          $2,349            $293
                                           Median.........................           $973,919            $67,638         $22,577         $25,153          $6,213          $1,064             $78
                                           Total..........................        $29,069,788        $33,775,125      $2,252,648      $9,077,875      $8,242,340      $2,473,435        $470,898
                                                                           ---------------------------------------------------------------------------------------------------------------------
Net Income ($1,000s).....................  Mean...........................           $219,406            $30,564         $12,941          $9,243          $1,470            $206             $24
                                           Median.........................            $33,372             $5,377          $4,553          $3,032            $417             $29             -$6
                                           Total..........................         $5,046,337         $3,637,137        $388,236      $1,257,046        $769,031        $217,453         $37,856
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
This table estimates average, median and total values for broker-dealer assets, total revenue, total expenses, and net income broken out into groups based on their total assets. Number of
  Broker-dealers is based on the broker-dealers that had a valid FOCUS Report for Q2 2022. Statistics for Total Assets (allowable and non-allowable), Total Revenue, Total Expenses, and Net
  Income (after Federal income taxes) are computed from the corresponding items in Part II and Part IIA of the FOCUS filings (Form X-17A-5 Part II/IIA) from Q2 2022.

    From the perspective of the number of individual customer accounts,
the broker-dealer market appears to be somewhat concentrated, with the
top four brokers handling about 106 million accounts, equal to 44% of
the industry, while the top eight firms have about 159 million
accounts, or 66% of the industry. From the perspective of total assets,
the level of concentration is slighter lower, with the top four
brokerages having a total of around $2.1 trillion, equal to 39% of all
assets held by broker-dealers, and the top eight firms about $2.8
trillion, or 52% of total industry assets. The broker-dealer industry
looks less concentrated from the perspective of revenue, with the top
four firms earning more than $18 billion, or 19% of the market, and the
top eight firms earning $28 billion, or 29% of total industry revenues.

              Table 21--Broker Dealer Market Concentration--Assets, Revenues, and Customer Accounts
----------------------------------------------------------------------------------------------------------------
                                                         Total assets        Total revenue
                                                           (1,000s)            (1,000s)        Customer accounts
----------------------------------------------------------------------------------------------------------------
4-firm total........................................      $2,112,685,000         $18,039,203         106,463,445
8-firm total........................................      $2,834,007,000         $28,402,354         158,609,487
All broker dealers..................................      $5,406,121,988         $97,076,632         240,153,894
4-firm concentration................................              39.08%              18.58%              44.33%

8-firm concentration................................              52.42%              29.26%              66.04%
----------------------------------------------------------------------------------------------------------------
This table uses FOCUS data analyzed in the previous table to calculate the market share of broker dealers based
  on firm total assets, total revenue, and customer accounts. The sum of the top four and eight firms for each
  of these variables is compared to the sum of all broker dealers for each of these three variables (assets,
  revenue, total accounts) that submitted a Form FOCUS PART II for Q2 2022. Total accounts are from FOCUS Report
  Schedule I for Q4-2021.

    There is significant variation in the sources of broker-dealer
revenue. Table 22 reports sources of broker-dealer revenue along with
the revenue as a percentage of the broker-dealer's total revenue in Q1
2022. A broker-dealer reports a source of revenue on its supplemental
statement of income (SSOI) if it is more than 5% of its total revenue.
Larger broker-dealers tend to have more diversified sources of revenue
than smaller broker-dealers, with the majority of broker-dealers with 1
billion or more in assets reporting earning revenue in a number of
categories. Smaller broker-dealers appear to earn more of their revenue
from a limited number of sources, with some broker-dealers with under
10 million dollars in assets on average earning more than 50% of their
revenue from one source. Larger broker-dealers appear to earn more
money from fees and interest, rebate, and dividend income. Smaller
broker-dealers appear to earn more money from fees and commissions and
other revenue sources.

                                             Table 22--Sources of Broker-Dealer Revenue as a Percentage of Broker-Dealer Total Revenue by Asset Size
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Size of Broker-Dealer (Total Assets)
                Revenue source                             Statistic             ---------------------------------------------------------------------------------------------------------------
                                                                                >50bn         1bn-50bn        500mn-1bn      100mn-500mn     10mn-100mn       1mn-10mn          <1mn
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                     Total Broker-Dealers Reporting Revenue                                   21             100              27             127             511           1,042           1,588
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Commissions............................  Count............................              18              69              21              86             299             518             428
                                               Mean.............................          10.75%           4.28%          26.47%          27.05%          30.03%          29.40%          26.48%
Revenue from Sale of Investment Company        Count............................              11              33               6              54             166             305             375
 Shares.                                       Mean.............................           0.79%           3.53%           0.40%           6.97%           6.41%           6.39%          13.80%
Total Revenue From Sale of Insurance Based     Count............................               9              34               5              44             145             278             320
 Products.                                     Mean.............................           0.22%           3.08%           7.65%          17.10%          24.81%          22.93%          30.67%
Total Net Gains or Losses on Principal         Count............................              18              80              19              66             201             224              86
 Trading.                                      Mean.............................           4.40%           7.81%          16.42%           3.76%          20.16%          29.47%          50.26%
Capital Gains (Losses on Firm Investments)...  Count............................               8              42              11              43             123             189             141
                                               Mean.............................          -3.10%          -3.41%          14.38%          -7.26%          -4.97%          19.70%           5.34%
Total Interest/Rebate/Dividend Income........  Count............................              21              90              22             109             370             604             520
                                               Mean.............................          43.20%          31.27%          14.99%           5.42%           4.54%           2.68%          14.05%
Total Revenue From Underwritings and Selling   Count............................              17              65              12              62             187             272             231
 Group Participation.                          Mean.............................           9.49%          10.67%          14.94%          18.03%          37.33%          39.07%          46.40%
Total Fees Earned............................  Count............................              19              82              24             114             434             812             897
                                               Mean.............................          32.01%          37.00%          42.37%          58.92%          52.46%          56.79%          69.35%
Other Revenue................................  Count............................              17              75              18              85             307             513             469
                                               Mean.............................           3.37%           1.20%           2.88%           8.96%           7.47%          16.93%          30.82%
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
This table estimates the number of broker-dealers reporting different sources of revenue and the average percentage of the reported revenue source as a percentage of broker-dealer total
  revenue for Q2 2022 broken out into groups based on the broker-dealer's total assets. The different sources of revenue and total revenue are reported by each broker-dealer during Q2 2022 in
  their FINRA Supplemental Statement of Income Form (Form SSOI). Form SSOI does not require a broker-dealer to report a revenue or expense section source if the revenue or expenses for that
  section is less than the greater of $5,000 or 5% of the broker-dealer's total revenue or total expenses, as applicable. Total Assets are estimated by Total Assets (allowable and non-
  allowable) from Part II of the FOCUS filings (Form X-17A-5 Part II) from Q2 2022 and correspond to balance sheet total assets for the broker-dealer.

    Retail brokers compete for customers by providing a range of
services that assist their clients in transacting in securities
including stocks, bonds, mutual funds, ETFs, options, futures, and
crypto asset securities. Retail broker services can broadly be divided
into ``discount brokers'' and ``full-service'' brokers. Discount
brokers typically provide commission-free trading for online purchases
of stocks and ETFs, but often charge fees for purchases of other
securities, such as mutual funds, options, and futures. Some discount
brokers' affiliates manage proprietary mutual funds and ETFs, which
earn them management fees paid by the investors that purchase these
funds. Compared to discount brokers, ``full-service'' brokers charge
higher commissions that may include compensations for other services,
such as investment research and personalized financial guidance.
    Some brokers seek to differentiate themselves from other broker-
dealers by providing increased access to crypto asset securities
futures, forex, or fractional share trading. Brokers also distinguish
themselves by the accessibility and functionality of their trading
platform, which can be geared towards less experienced or more
sophisticated investors. Discount retail brokers can also differentiate
themselves by providing more extensive customer service as well as
tools for research and education on financial markets. Full-service
brokers compete by developing a personalized broker-customer
relationship and providing guidance based on the detailed knowledge of
the customer's financial goals.
    Broker-dealers may incur costs \532\ or earn rebates in seeking to
fill their

customers' orders. These costs and rebates may be passed on to
customers in whole or in part. Some of these costs are indirect: an
illiquid or unlisted security may require the broker to search for
liquidity either by attempting multiple routings to find a
counterparty, or by contacting broker-dealers that may formally (in
association with an ATS that specializes in unlisted securities) or
informally make markets in unlisted or hard to trade securities. For
some unlisted securities, there may be no market maker expected to
continually provide two-sided quotes.
---------------------------------------------------------------------------

    \532\ Some exchanges pay rebates to orders that either provide
or remove liquidity from their limit order books. Some trading
venues charge fees to one or both counterparties to the trade.
---------------------------------------------------------------------------

C. Economic Effects and Effects on Efficiency, Competition, and Capital
Formation

    The Commission preliminarily believes that the proposed
requirements with respect to introducing brokers could result in better
execution quality for retail customer orders to the extent that the
proposal leads to changes in broker-dealers' order handling practices.
Furthermore, the proposal would enable the Commission to exercise
additional enforcement capabilities \533\ that the Commission believes
would enhance investor protection and improve specific deterrence.\534\
The Commission also believes that the documentation requirement with
respect to conflicted transactions could help enhance regulatory
oversight, as well as promote broker-dealer compliance, and thus,
improve investor protection to the extent that the documented
information includes information or data that is not currently
documented nor available through public or regulatory data sources.
However, the Commission lacks detailed data on broker-dealers' current
order handling practices and documentation practices that would allow
it to predict the extent of changes as a result of this proposal.\535\
The Commission therefore cannot ascertain the extent to which these
benefits would be realized, as discussed below.
---------------------------------------------------------------------------

    \533\ This full complement of enforcement capabilities is not
available to the Commission to enforce FINRA rules.
    \534\ See also infra section V.C.1.
    \535\ Considering broker-dealers are diverse in business models
and practices, the Commission lacks quantifiable data that
summarizes how order handling data are currently documented, which
might serve as a baseline in assessing the effects of the proposed
rule. While CAT includes routing data for NMS securities, no similar
database exists for fixed income or other assets covered by the
proposed rules. Although the Commission could discuss current
routing practices through an analysis of CAT data, it would not
capture the information set that a broker-dealer evaluated in making
its routing decisions, such as what pricing information it had when
it made the routing choice, what venues were considered for the
order, or why those venues were considered for the order. The
Commission also has no information regarding the broker-dealer's
assessment as to how the specific customer and order characteristics
affected its decision to handle a customer order in a certain way.
Based on its experience, the Commission believes that some larger
broker-dealers already maintain documentation on their transactions
that exceeds what would be required under the proposed rules, but
the Commission does not know the extent to which other broker-
dealers also maintain such documentation. Consequently, some broker-
dealers would incur fewer costs (and their compliance would result
in fewer benefits) than others.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposal would
result in costs associated with reviewing, updating, and establishing
policies and procedures, and to the extent that the proposal leads to
changes in broker-dealers' order handling practices, could result in
costs associated with implementing changes to order handling practices
according to the updated policies and procedures. The proposed
requirements for broker-dealers that engage in conflicted transactions
could result in further changes to order handling practices, but the
extent of those changes is unknown. Due to the diversity of broker-
dealer business models and operations and the lack of quantifiable data
on how practices vary across broker-dealers, the Commission cannot
reasonably estimate how many of these broker-dealers would choose to
de-conflict \536\ to avoid the costs associated with the proposed
requirements that apply solely to conflicted transactions.
---------------------------------------------------------------------------

    \536\ To de-conflict, a broker-dealer might need to deal with
the treatment of exchange rebates, payment for order flow, or the
nature of its executing brokers' business (i.e., principal versus
agency capacity), among other factors.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposal could
promote competition in the market for trading services (e.g.,
exchanges, ATSs, non-ATS trading venues) and also in the market for
market access. However, the Commission believes that the proposal could
have mixed effects on competition in the market for broker-dealer
services. While it could promote competition among broker-dealers,
especially on the basis of execution quality, it could also result in
higher barriers to entry and potential exit of small broker-dealers.
    The Commission assesses the economic effects of the proposed
amendments in NMS stocks relative to a regulatory baseline in NMS
stocks that includes the implementation of the MDI Rules.\537\
Furthermore, the Commission's analysis reflects the Commission's
assessment of the anticipated economic effects, including potentially
countervailing or confounding economic effects from the MDI Rules in
NMS stocks.\538\ However, given that the MDI Rules have not yet been
implemented, they have not affected market practice and therefore data
that would be required for a comprehensive quantitative analysis of the
economic effects in NMS stocks that includes the effects of the MDI
Rules is not available. It is possible that the economic effects in NMS
stocks relative to the baseline could be different once the MDI Rules
are implemented.
---------------------------------------------------------------------------

    \537\ See supra section V.B.3.(a).d.
    \538\ See id. for a discussion of the Commission's anticipated
economic effects of the MDI Rules as stated in the MDI Adopting
Release.
---------------------------------------------------------------------------

1. Benefits
    The Commission preliminarily believes the proposal, which
incorporates and goes beyond the existing best execution regulatory
regime set forth by FINRA and MSRB, could promote investor protection
(e.g., better execution quality for retail customer orders) by
facilitating regulatory oversight and enforcement.\539\ The Commission
believes that benefits could result from, among other things, the
requirements with respect to introducing brokers, the documentation
requirements for conflicted transactions, and additional enforcement
capabilities of the Commission.
---------------------------------------------------------------------------

    \539\ See the discussion of enforcement mechanisms in supra
section V.B.1.(a). In enforcement situations limited to violations
of proposed Regulation Best Execution, the Commission would gain the
ability to (i) obtain civil money penalties against defendants in
injunctive actions; (ii) order respondents to cease-and-desist and
obtain related relief and sanctions; and (iii) in situations limited
to violations of proposed Regulation Best Execution involving
broker-dealers and associated persons that would not potentially be
subject to MSRB best execution rules, obtain relief available under
Sections 15(b)(4) and (6).
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposal would
enhance investor protection and improve retail customer order execution
quality to the extent that the proposal improves broker-dealers' order
handling practices. Specifically, broker-dealers could improve their
customer order handling practices, resulting from documentation,
updates and reviews of both existing and the best execution policies
and procedures that would be required under the proposal including the
reductions in conflicts of interest when handling retail customer
orders. The Commission also believes the proposal would enhance
investor protection by enabling the Commission to exercise additional
enforcement capabilities and improving specific deterrence through the
ability to bring

injunctive actions for violations of this rule, issue cease-and-desist
proceedings for allegations of violations of this rule, and, among
other things, order remedial actions and sanctions against a broader
group of registered persons pursuant to Exchange Act Section 15(b)(4)
for willful violations of this rule. Furthermore, improvements in
investor protection could result from increased documentation
requirements for conflicted transactions, particularly in fixed income
and thinly traded non-NMS stock equity securities. The extent of this
improvement depends on whether the documented information include
information or data that is neither currently documented nor available
through public or regulatory data sources. The proposed documentation
requirement would help facilitate the Commission's and SRO's
enforcement and examinations, as well as promote broker-dealer
compliance, and thus, result in better investor protection.
    The Commission preliminarily believes the proposal could lead to
changes in order handling practices, and in turn, improve the execution
quality of retail customer orders, through four mechanisms. First, the
proposal would require that introducing brokers that route their orders
to executing brokers compare that broker's execution quality to what
might have been received from competing executing brokers.\540\ The
Commission believes that some broker-dealers that currently rely on
executing brokers already compare their executing broker's execution
quality to the execution quality of competing executing brokers, so
these broker-dealers are unlikely to be affected by this element of the
proposal. Introducing brokers that do not currently implement rigorous
comparison of executing brokers are expected to adjust their routing
practices in response to this newly required analysis, or justify in
their policies and procedures how they fulfill their best execution
duties in light of these analyses. Because FINRA's and MSRB's current
policies and procedures requirements do not require this level of
detail, the Commission cannot ascertain how many brokers already
conduct such a comparison with alternative executing brokers and how
many would need to make adjustments. However, any such adjustments
could improve the execution quality that retail customers receive for
their orders.
---------------------------------------------------------------------------

    \540\ While FINRA Rule 5310.09(c) allows an introducing broker,
instead of conducting its own regular and rigorous review, to review
the methodology and results of its executing broker's regular and
rigorous review of its execution quality on a quarterly basis, it
does not specifically require the introducing broker to compare the
execution quality of its executing broker to what it would have
received from other executing brokers. See supra section V.B.2.(a)
for a discussion on introducing broker best execution review
requirements. See also FINRA Rule 5310.09(c), Regular and Rigorous
Review of Execution Quality.
---------------------------------------------------------------------------

    Second, the Commission preliminarily believes that the proposal's
heightened standards for conflicted transactions could lead to improved
prices for retail customers.\541\ Under the proposal, broker-dealers
that handle retail customer orders and that choose to accept PFOF, to
participate in transactions on a principal basis, or to route to
affiliated broker-dealers that execute orders would be subject to
heightened standards. In response to this proposed requirement, the
Commission believes that some broker-dealers that route to executing
broker dealers that engage in conflicted transactions could seek to
remove such conflicts, for example by no longer accepting payment for
order flow or selecting executing brokers that do not execute on a
principal basis.\542\ The Commission also believes that executing
brokers (e.g., wholesalers) in NMS stocks and options could adjust
their order handling practices under the proposal in anticipation of
increased execution quality analysis by retail broker-dealers, from
whom they receive order flow. These executing brokers in NMS stocks and
options that routinely pay for retail order flow and/or engage with it
on a principal basis could adjust their order handling practices to
access additional venues to seek midpoint liquidity, additional price
improvement, or offer more price improvement to the orders routed by
those retail broker-dealers.\543\ Although the Commission cannot
quantify the degree of reduction in conflicted transactions that would
occur under the proposal because it cannot predict how individual
broker-dealers would adjust their business models to comply with the
proposal, the Commission preliminarily believes that any resulting
reduction in conflicted transactions could improve the prices retail
customers realize for their transactions. That said, the Commission
acknowledges that some retail customers could pay more for their
transactions when in reducing its conflicted transactions, a broker-
dealer changes order handling practices to route to destinations, which
may not always provide the same price improvement that was previously
realized for conflicted transactions.
---------------------------------------------------------------------------

    \541\ See supra section IV.C about the discussion for the
requirements involving conflicted transactions for retail orders and
supra sections V.C.2.a and V.C.2.b.i describing the conflicts of
interest in retail order handling.
    \542\ See infra section V.C.2 for the discussion about costs of
broker-dealer efforts to de-conflict versus comply with requirements
of conflicted transactions.
    \543\ See infra section V.C.2.b for the discussion of wholesaler
costs with respect to conflicted transactions.
---------------------------------------------------------------------------

    Third, the Commission preliminarily believes the proposal could
result in better execution quality for retail customer orders to the
extent that the proposal leads to changes in broker-dealers' order
handling practices. Compared to the FINRA and MSRB rules, the
Commission believes that the proposal would require greater specificity
in the policies and procedures with respect to best execution. Upon
reviewing its existing policies and procedures, a broker-dealer could
be required to update its policies and procedures to comply with the
proposed requirements. To the extent that updated policies and
procedures would require corresponding changes in order handling
practices, the broker-dealer would adjust its order handling practices
for retail customer orders. The Commission acknowledges that many
broker-dealers currently may have order handling practices that are
consistent with the requirements under the proposed Rule 1101(a).\544\
In this case, the Commission does not expect the order handling
practices of these broker-dealers to change.\545\ On the other hand,
many broker-dealers could be required to adjust order handling
practices, including conducting more detailed reviews of their
practices, under the proposal. However, the Commission lacks detailed
information on broker-dealers' current policies and procedures with
respect to best execution standards and order handling practices to
determine how many broker-dealers would be required to change their
order handling practices under the proposal.\546\
---------------------------------------------------------------------------

    \544\ See infra section IX for proposed Rule 1101(a).
    \545\ As previously discussed in supra section IV.B, the factors
that must be included in a broker-dealer's policies and procedures
under proposed Rule 1101(a) are generally consistent with the
factors that FINRA and the MSRB have identified as relevant to a
broker-dealer's best execution determinations.
    \546\ See supra note 535 for the discussion about data
availability on broker-dealers' current order handling practices.
---------------------------------------------------------------------------

    Fourth, the Commission preliminarily believes that the proposal
could help ensure the effectiveness of broker-dealers' best execution
policies and procedures, and thus, result in better execution quality
for retail customer orders to the extent that the requirements under
the proposed Rule 1102 enhances broker-dealers' current review process
with respect to order

handling practices. The Commission acknowledges that many broker-
dealers currently may conduct reviews that are consistent with the
requirements under the proposed Rule 1102, which includes a specific
requirement to review order handling practices. In this case, the
Commission does not expect the order handling practices of these
broker-dealers to change, and there would thus be no change in
execution quality for their retail customer orders.
    The Commission does not believe that the order handling practices
or execution quality of institutional customer orders would be
significantly impacted by the proposal. The Commission understands that
institutional customers often utilize multiple broker-dealers in the
handling of their orders, which lowers the costs of switching brokers
if they exhibit poor execution quality. Furthermore, in general, the
Commission believes that there is less conflict in institutional
customer order handling because institutional customers have better
access (compared to retail customers) to data, which they utilize to
monitor and analyze the execution quality that various broker-dealers
offer.\547\ The Commission believes that (compared to retail brokers)
institutional monitoring and lower switching costs encourage broker-
dealers to provide increased execution quality in order to compete to
attract institutional orders. Thus, the Commission does not expect that
broker-dealers would make significant adjustments to their order
handling practices for institutional customer orders under the
proposal.
---------------------------------------------------------------------------

    \547\ The Commission understands that institutional customers
also utilize third-party vendors to conduct transaction cost
analysis and evaluate the performance of their broker-dealers based
on those reports. See also supra section V.B.3.e) for a discussion
about institutional customer order handling practices.
---------------------------------------------------------------------------

(a) NMS Stocks and Options
    The Commission preliminarily believes the proposed documentation
requirement with respect to conflicted transactions could result in
benefits in the NMS stock and options markets. However, a significant
amount of information that would help reconstruct market conditions
(e.g., NBBO, size at NBBO, trade prices, volume, order level
information in CAT) around the time of conflicted transactions is
currently available through public and regulatory data sources (e.g.,
SIP, CAT, OPRA), so those benefits may be small. To the extent that the
documented information includes information that is not currently
documented nor available through public or regulatory data sources ,
the proposed documentation requirement would help promote broker-dealer
compliance and facilitate enforcement and examination, and thus, result
in better investor protection. Furthermore, the Commission believes
that any additional documentation could enhance internal review process
(e.g., a review by the best execution committee). Documented
information could inform broker-dealers in adjusting order handling
procedures with respect to conflicted transactions, which would result
in better execution quality.
    The Commission preliminarily believes that retail customer
execution prices in NMS stocks and options could improve to the extent
that there is a trade-off between the amount of PFOF a retail broker
receives and the price improvement, which wholesalers provide to its
customers' orders.\548\ Under the proposal, retail broker-dealers
accepting PFOF would be subject to the proposed Rule 1101(b), which
would require a broker-dealer to establish additional policies and
procedures and retain certain documentation with respect to conflicted
transactions.\549\ The proposed Rule 1101(b) would also require them to
document any arrangement, whether written or oral, concerning PFOF,
including the parties to the arrangement, all qualitative and
quantitative terms concerning the arrangement, and the date and terms
of any changes to the arrangement. Additionally, broker-dealers that
accept PFOF would not qualify as introducing brokers under the proposed
Rule 1101(d), which otherwise would permit these broker-dealers to rely
on their executing broker's compliance with the proposed Rules 1101(a),
(b), and (c).\550\ Some broker-dealers, particularly those with
business models that do not rely extensively on payment for retail
order flow, could elect to pass any PFOF on to customers rather than
complying with provisions of the proposal that apply only to broker-
dealers that do not qualify for the relief provided to introducing
brokers.\551\
---------------------------------------------------------------------------

    \548\ See supra section V.B.3.(a).b.
    \549\ See supra section IV.C.
    \550\ Under proposed Rule 1101(d), principal trades by an
executing broker with the introducing broker's customer to fill
fractional share orders in NMS stocks would be considered to be
handled on an agency basis, and thus, allow it to rely on its
executing broker's compliance with the proposed Rules 1101(a), (b),
and (c). See supra section IV.E. for a discussion on proposed Rule
1101(d) and supra section V.B.3.(a).i.d for additional discussion on
fractional share orders in NMS stocks.
    \551\ As explained in supra note 183, 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. See also
infra section V.C.2.a for the discussion about the costs of broker-
dealer efforts to de-conflict versus comply with requirements of
conflicted transactions.
---------------------------------------------------------------------------

    The requirement for a broker-dealer to engage in additional due
diligence if it engages in a conflicted transaction for or with a
retail customer order could improve execution quality to the extent the
requirement promotes competition between broker-dealers to provide best
execution to retail broker-dealers that continue to accept PFOF.
Because the proposal would require these retail broker-dealers to
document their compliance with the best execution standard for
conflicted transactions, including all efforts to enforce their best
execution policies and procedures for conflicted transactions and the
basis and information relied on for their determinations that such
conflicted transactions would comply with the best execution standard,
broker-dealers that pay for order flow could be incentivized to both
improve the execution prices of orders routed to them for execution and
to provide more information to broker-dealers routing to them, allowing
those broker-dealers to improve their customers' execution prices and
more easily comply with the provisions of the proposal that require
more extensive documentation of their best execution standards.
    To the extent broker-dealers that receive PFOF change their order
handling practices to comply with the heightened standards in the
proposal, these changes are likely to reduce the profitability of their
business model because the orders they are routing may be more likely
to be executed on venues that charge for providing liquidity, or do not
provide compensation for order flow, or that provide compensation that
is less than what these broker-dealers could realize by internalizing
order flow, or routing elsewhere under existing procedures. Faced with
potentially lower revenues from changing order handling procedures,
broker-dealers that pay to receive order flow could choose to make few
or no changes to their routing practices and could instead focus on
maintaining arrangements with specific broker-dealers \552\ (from whom
they are already

receiving orders or could determine that their current PFOF arrangement
meets the requirements under the proposal) to meet their obligations
under the proposal without significant changes. Some broker-dealers
that make payments for order flow could compete on the basis of
providing service and information to their broker-dealer customers that
help those broker-dealers satisfy their own requirements under the
proposal, such as providing additional information on routing practices
and data on how they provide the best execution possible. Competition
between these broker-dealers could foster innovation that improves
prices received by retail customer orders executed under PFOF
agreements.
---------------------------------------------------------------------------

    \552\ See infra section V.C.2.a for the discussion of how
broker-dealers who route to other broker-dealers for execution may
choose to comply with the proposal. The Commission recognizes that
it is possible under the proposal that these broker dealers would
reduce their payments for order flow because broker-dealers who
route orders to them may choose to stop accepting PFOF in order to
meet the definition of ``introducing broker'' in proposed Rule
1101(d). However, the Commission preliminarily believes this would
not increase the profitability of broker-dealers that currently pay
to receive order flow because presumably their payments to secure
order flow are less than the profits they earn to execute that order
flow often in a principal capacity.
---------------------------------------------------------------------------

    With respect to listed options, the Commission preliminarily
believes that retail order execution quality could improve to the
extent that the proposal results in broker-dealers adjusting their
customer order handling practices consistent with the heightened
standards required of conflicted transactions.\553\ Some broker-dealers
that handle retail options orders and engage in conflicted
transactions, such as executing orders on a principal basis or routing
to affiliates, may adjust their routing practices to access additional
venues or consider additional opportunities for price improvement. This
could be driven both by the requirements of proposed Rule 1101(b) to
consider additional opportunities for price improvement and in
anticipation of increased execution quality analysis by other broker-
dealers, for whom they route orders. For example, these broker-dealers
may adjust their routing practices to further consider the
possibilities of exposing a smaller customer order of 5 contracts or
less for price improvement opportunities in auctions or look for
liquidity within the NBBO spread instead of routing the customer order
to a venue that would allow a market maker to internalize 100% of a
given customer order with 5 contracts or less on the limit order book
at the best displayed prices without competition from other liquidity
providers.\554\ Additionally, broker-dealers may route more customer
orders to price improvement auctions that are more competitive rather
than ones that provide the broker-dealer a better chance at
internalizing a larger share of the customers' orders. Furthermore,
with regards to non-marketable limit orders, broker-dealers may
consider routing more orders to exchanges that have higher likelihood