of executions in the form of fill rates and average shorter time to
execution rather than to the exchanges that pay the highest liquidity
rebates.
---------------------------------------------------------------------------

    \553\ 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.
    \554\ See supra section V.B.3.(a).ii for discussion of the
handling of retail orders in the options markets.
---------------------------------------------------------------------------

(b) Fixed Income Securities
    The Commission preliminarily believes that the proposed
documentation requirement with respect to conflicted transactions could
facilitate regulatory oversight and enforcement and promote broker-
dealer compliance with best execution standards, promoting investor
protection in the fixed income securities markets. For introducing
brokers that utilize trading services of executing brokers, the
requirement to review and compare execution quality of various
executing brokers could result in better execution quality for retail
customer trades to the extent that brokers choose to change their
executing brokers to those that offer better execution quality. In
general, the proposal would improve execution quality to the extent
that the proposal results in enhancements to broker-dealers' order
handling procedures. The extent to which customer order execution
quality would improve depends on how many and to what extent broker-
dealers would adjust their order handling procedures as a result of
this proposal. However, the Commission cannot ascertain the extent to
which this benefit would be realized because the Commission lacks data
on how many broker-dealers would change order handling procedures in
response to the proposal.
    For very illiquid fixed income securities, execution quality
improvement resulting from changes in order handling procedures with
respect to conflicted transactions could be limited. Because a broker-
dealer transacting in illiquid fixed income securities will only have a
few potential counterparties, exposing retail orders to a greater
number of trading venues (e.g., through RFQs) may not result in more
responses nor more competitive responses. On the other end of the
spectrum, the Commission expects little impact on the execution quality
of on-the-run U.S. Treasury securities because transaction costs for
such securities are already low. The impact is most likely to
materialize in fixed income securities that have moderate liquidity, as
discussed further below.
    The Commission preliminarily believes that the documentation
requirement for conflicted transactions under the proposal could
facilitate regulatory oversight and promote broker-dealer compliance
with best execution standards, promoting investor protection in the
fixed income securities markets.\555\ To the extent that broker-dealers
do not currently document efforts to obtain the most favorable price in
conflicted transactions, these broker-dealers would be required to
document such information. Compared to the markets for equities and
listed options where quotes and trades are widely disseminated, in most
fixed income markets only transactions are reported and disseminated
publicly. The extent to which the proposed documentation requirement
would help facilitate regulatory oversight depends on the types of
documented information. To the extent that the documented information
includes information or data that is not currently documented nor
available through public or regulatory data sources, such as the
markets checked, internal and external quotes, and other factors (e.g.,
trading protocols, prices, immediacy, trade size) considered for the
basis of best execution, the proposed documentation requirement would
help facilitate regulators' enforcement and examination of a broker-
dealer for compliance, and thus, result in better investor protection.
Furthermore, the Commission believes that documentation could enhance
internal review process (e.g., a review by best the execution
committee). Documented information could inform the broker-dealer in
adjusting order handling procedures with respect to conflicted
transactions, which would result in better execution quality.
---------------------------------------------------------------------------

    \555\ FINRA members are currently required to conduct regular
and rigorous review of execution quality under FINRA Rule 5310.09.
However, the Commission does not know the types of information that
broker-dealers document for the purpose of regular and rigorous
review of execution quality under FINRA Rule 5310 and MSRB Rule G-
18.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the execution quality of
retail customer trades in fixed income securities effected by brokers
that qualified for relief under the FINRA/MSRB rules by relying on
their executing brokers for trading services could improve. Under the
proposal, introducing brokers,\556\ as defined in proposed Rule
1101(d), and carrying

brokers that currently avail themselves of the relief under the FINRA/
MSRB rules and hence rely on their executing brokers for retail
customer trading services, would be required to review and compare the
execution quality of their executing brokers with the execution quality
they might have obtained from other executing brokers and adjust their
routing practices accordingly.\557\ To the extent that some of these
brokers change their executing brokers for trading services to those
that offer better execution quality, retail customer trades of the
brokers would receive better execution quality.\558\ Furthermore, the
requirement to review and compare execution quality of executing
brokers could promote competition among executing brokers, which could
result in better execution quality for retail customer trades.\559\
---------------------------------------------------------------------------

    \556\ These brokers are non-carrying brokers that qualified for
relief under the FINRA/MSRB rules.
    \557\ Carrying brokers that qualified for relief under the
FINRA/MSRB rules would not have relief from the requirements of the
proposal unless these brokers restructure their business to become
non-carrying brokers. Under the proposed rule 1101(c) with respect
to regular review of execution quality, these carrying brokers would
be required to review and compare the execution quality of their
executing brokers with the execution quality they might have
obtained from other executing brokers, and adjust their order
handling and routing practices accordingly.
    \558\ The Commission acknowledges that some brokers could
already be reviewing and comparing the execution quality, of which
various executing brokers offer, in the selection of their executing
brokers.
    \559\ Executing brokers would compete on, among other things,
fees, markups/markdowns, and the quality of trading services.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed
requirements with respect to conflicted transactions could result in
better execution quality for internalized trades in fixed income
securities. To the extent that broker-dealers make changes to order
handling procedures (upon reviewing and comparing execution quality
across competing markets) and connect to additional trading venues to
expose retail customer orders (e.g., via RFQs and BWICs) more broadly
across multiple trading venues for the purpose of internalization, the
execution quality of internalized trades could improve. Sending RFQ
messages more broadly across multiple trading venues may result in
better execution quality for internalized trades if a broader exposure
of customer order results in more competitive prices for the purpose of
internalization (i.e., price-matching using more competitive price).
For example, exposing a customer order via RFQs on multiple trading
venues could result in more competitive responses to be used as the
reference price to match or improve for the purpose of internalization.
However, to the extent that broker-dealers continue to engage in last-
look practices in RFQs for the purpose of internalization, conducting
RFQs on more trading venues may not necessarily result in more
responses nor more competitive responses as discussed below.
    To the extent that a broker-dealer determines, upon reviewing data,
that the use of last-look in RFQs impedes attracting competitive
responses, the broker-dealer could discontinue last-look practices or
limit the use of last-look to meaningfully improve price in an occasion
when RFQ responses are not reflective of the market. For example, a
broker-dealer handling a retail customer order may participate in an
RFQ by blind bidding/offering and internalize the order only if the
broker-dealer is the best bid/offer in the RFQ, or otherwise give up
the order to another responder with the best bid/offer. Such RFQ
practice could attract more competitive responses thereby improving the
execution quality of internalized trades via RFQs.\560\ However, the
Commission believes that this benefit is not likely to be realized.
Broker-dealers would continue to use last-look in conducting RFQs for
the purpose of internalization so long as such internalization practice
continues to provide profit incentive for those broker-dealers.
---------------------------------------------------------------------------

    \560\ See infra section V.C.2.b for the discussion about how the
proposal might adversely impact market liquidity. The Commission
preliminarily believes that this benefit in the execution quality
improvement for retail customer trades may be reduced to the extent
that eliminating last-look practices in RFQ for the purpose of
internalization adversely affects the principal trading activities
of inventory carrying broker-dealers.
---------------------------------------------------------------------------

    In order to justify the continued use of last-look in fixed income
securities trading, broker-dealers could provide meaningful price
improvement by exercising last-look in RFQs for the purpose of
internalization, which would result in better execution quality. To the
extent that a broker-dealer's review or assessment reveals that the use
of last-look in RFQs impedes attracting competitive responses, the
broker-dealer could respond by providing price improvements to the best
response bids/offers to compensate for receiving less competitive bids/
offers in RFQs as compared to, for instance, in a blind auction as
described above.
    Broker-dealers' assessment of last-look practices in fixed income
securities trading may not affect execution quality for internalized
trades via RFQs. Unless a broker-dealer's review or assessment shows a
negative impact of last-look practices on the execution quality of
internalized trades, the Commission does not expect the broker-dealer
to alter nor discontinue last-look practices in RFQs for the purpose of
internalization. If the broker-dealer makes no changes, the rule would
produce no improvement in the execution quality for internalized trades
via RFQs. Specifically, in exercising last-look, a broker-dealer that
currently applies trade desk spreads (in the form of markdown/markup)
to external bids/offers but not to internal bids/offers, which results
in more favorable comparisons for the internal bids/offers, to win
RFQs, may continue to apply such practice so long as the execution
quality of external trades would be worse than that of internalized
trades.
    The Commission preliminarily believes that the proposed
requirements with respect to conflicted transactions could result in
better execution quality for riskless principal trades in fixed income
securities. To the extent that broker-dealers make changes to order
handling procedures (upon reviewing and comparing execution quality
across competing markets) and connect to additional trading venues in
order to search or expose retail customer orders more broadly across
multiple trading venues, the execution quality of riskless principal
trades for retail customers could improve. Broker-dealers could
increase the use of RFQs across multiple trading venues to expose
retail customer orders in order to obtain competitive prices.
Furthermore, as another way to expose retail customer orders more
broadly, broker-dealers could represent retail customer orders on limit
order systems across multiple trading venues. For example, in case of a
retail customer sell order, instead of conducting an RFQ on the bid
side of the market, a broker-dealer could represent the customer order
by placing a limit order on the offer side of the market for certain
fixed income securities (e.g., liquid on-the-run Treasury securities,
liquid corporate debt securities) should the broker-dealer determine
that the characteristics of the customer order are consistent with this
type of order handling (e.g., the customer is not demanding immediacy
of execution). This would lower transaction costs of the retail
customer because this customer would not pay the bid ask spread if the
order is executed at the offer price (compared to executing at the bid
price obtained via an RFQ).
    In response to the proposed requirements with respect to conflicted
transactions, retail broker-dealers could stop executing retail
customer fixed income securities orders on a riskless principal basis.
To the extent that it is

more cost effective for broker-dealers to handle retail customer orders
on an agency basis rather than a riskless principal basis under the
proposal, broker-dealers could change business practices to handle
retail customer orders on agency basis and not incur the costs
associated with the requirements under conflicted transactions (e.g.,
trading venue subscription fees and implementation costs associated
with changing order handling procedures).\561\ In such case, execution
quality may not change. In particular, a broker-dealer, whose primary
business is retail self-directed trading conducted on riskless
principal basis, could change its business practices to handle retail
self-directed trading on agency basis to the extent that conducting its
self-directed trading business on an agency basis would be less costly
compared to doing so on a riskless principal basis.
---------------------------------------------------------------------------

    \561\ See infra section V.C.2.(a) for discussions about trading
venue subscription fees and costs associated with making changes to
order handling procedures.
---------------------------------------------------------------------------

(c) Non-NMS Stock Equity Securities
    There are three possible channels through which benefits of the
proposal to the non-NMS stock equities market may derive: (1)
requirements with respect to conflicted transactions; (2) the regular
review of execution quality of executing brokers used by introducing
brokers; and (3) some broker-dealers implementing policies and
procedures to comply with this proposal, which may offer improved
execution quality to transactions effected by these broker-
dealers.\562\
---------------------------------------------------------------------------

    \562\ See section V.C.1 introduction for more explanation of the
general benefit to execution quality that retail customers could
experience. In the non-NMS stock equity securities market, the
Commission believes a majority of transactions would be subject to
the Conflicts of Interest provisions in proposed Rule 1101(b);
however, there may be some broker-dealers who could improve
execution quality while implementing policies and procedures as
explained in section V.C.1.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the documentation
requirement with respect to conflicted transactions could help
facilitate regulatory oversight and enforcement, as well as promote
broker-dealer compliance, and thus, enhance investor protection in the
non-NMS stock equity securities market. To the extent that the
documented information includes additional information beyond what
broker-dealers currently record, and which may not be currently
available through public or regulatory data sources (e.g., CAT), such
as non-firm quotes on trading venues and factors (e.g., immediacy,
trade size) considered for the basis of best execution, the proposed
documentation requirement would help facilitate Commission and SRO
enforcement and examinations, and thus, result in better investor
protection. Similarly, the Commission believes that documentation could
enhance the internal review process (e.g., a review by best execution
committee). Documented information could inform broker-dealers in
adjusting order handling procedures with respect to conflicted
transactions, which could result in better execution quality.
    The proposal would require additional policies and procedures,
beyond FINRA Rule 5310 and related FINRA notices \563\ that currently
address non-NMS stock equities transactions, when engaging in
transactions that are executed in a principal capacity, routed to an
affiliate for execution, or involve PFOF. Conflicted transactions are
ubiquitous in the non-NMS stock equities market. These enhanced
policies and procedures may induce broker-dealers to more carefully
consider and change routing behavior in handling customer orders. While
this proposal does not mandate changes, the changes could arise as
broker-dealers are required to maintain policies and procedures that
dictate the handling of conflicted transactions. In some cases, this
could induce broker-dealers to reduce or eliminate conflicted
transactions they participate in due to heightened costs of procedures,
such as the documentation requirement. While in other cases, there
could be no such inducement of broker-dealers to change order routing
behavior. Trading in non-NMS stock equity securities is heavily
concentrated in two platforms; however, there are other sources of
liquidity beyond those two. This proposal could induce broker-dealers
to connect to additional liquidity sources due to the requirements of
conflicted transactions of this proposal. To the extent that broker-
dealers' enhanced policies and procedures determine that they should
connect to additional liquidity sources for conflicted transactions,
customers' transaction costs could be lowered through better prices
found on the additional sources. Additionally, to the extent that
broker-dealers are either no longer routing to wholesalers or
internalizing orders based on policies and procedures that resulted in
different routing decisions, customer orders could experience price
improvement opportunities, as their orders would be exposed to external
competition.
---------------------------------------------------------------------------

    \563\ See supra section II.C for details on FINRA rules and
notices with respect to the concept of ``best execution.''
---------------------------------------------------------------------------

    Introducing brokers, as defined in proposed Rule 1101(d), would be
required to conduct regular reviews of executing brokers they use for
their retail customer transactions. This review, which differs from the
quarterly review \564\ required by FINRA Rule 5310 for all brokers,
could cause introducing brokers to seek out additional executing
brokers to develop business relationships with. These additional
options, from which introducing brokers could choose to route their
customer orders, could promote competition among executing brokers in
the non-NMS stock equities market. This increased competition could
result in better execution quality to the introducing brokers' retail
customers in the form of lower transaction costs and increased fill
rates for illiquid securities.
---------------------------------------------------------------------------

    \564\ When transacting in municipal securities, broker-dealers
are subject to MSRB Rule G-18. The rule requires an annual review of
policies and procedures, which could take into account execution
quality review. The rule in this proposal is substantively different
from FINRA Rule 5310 or MSRB Rule G-18.
---------------------------------------------------------------------------

(d) Crypto Asset Securities \565\
---------------------------------------------------------------------------

    \565\ For purposes of measuring the benefits and costs of the
proposed rule on a broker-dealer's duty of best execution in the
crypto market, this analysis assumes that market participants are
compliant with existing applicable Commission, FINRA, and MSRB
rules, including those directly addressing the duty of best
execution for the handling and execution of customer orders in
securities and government securities. See supra section III.A.3. To
the extent that some entities engaged in broker-dealer activities
with regard to crypto asset securities are not FINRA or Commission
registered entities, they may incur additional costs to comply with
existing registration obligations that are distinct from the costs
associated with the proposed rule and are not discussed in this
analysis. Similarly, any benefits from coming into compliance with
existing registration obligations are also not discussed in this
analysis. See id.
---------------------------------------------------------------------------

    As mentioned above in Section V.B.3.c, the Commission lacks data on
broker-dealer routing behavior, the frequency of crypto asset
securities trading in both non-conflicted and conflicted transactions,
and many details of trading protocols and crypto asset securities
trading platforms. Also, as noted in Section V.B.3.c, this market
features many vertically integrated trading platforms, which makes
analogous comparison to other asset markets less exact. To the extent
that broker-dealers operate in a fashion similar to other asset
markets,\566\ the Commission preliminarily believes the proposal could
drive benefits in the crypto asset securities market through three
possible channels: (1) the requirements with respect to conflicted

transactions; (2) the regular review of execution quality of executing
brokers used by introducing brokers \567\; and (3) some broker-dealers
implementing policies and procedures to comply with this proposal,
which could offer improved execution quality to all transactions
conducted by these broker-dealers.
---------------------------------------------------------------------------

    \566\ The Commission preliminarily believes the closest market
comparison may be the non-NMS stock equity securities market;
though, no exact comparison to any other asset market is likely with
crypto asset securities.
    \567\ The Commission understands the crypto asset securities
market has several large, vertically integrated platforms. The
Commission lacks the data to determine whether entities analogous to
introducing brokers are prevalent in this market. However, the
discussed benefits are those which the Commission believes could
accrue in cases where such market structure exists.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the documentation
requirement with respect to conflicted transactions could help
facilitate regulatory oversight and enforcement, as well as promote
broker-dealer compliance, and thus, enhance investor protection in the
crypto asset securities market. To the extent that documented
information includes information or data that is not currently
documented nor available through public or regulatory data sources, the
proposed documentation requirement would help facilitate enforcement
and examination, and thus, result in better investor protection.
Furthermore, the Commission believes that 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 proposal would also require written policies and procedures
beyond those required under FINRA Rule 5310,\568\ when engaging in
transactions that are executed in a principal capacity, routed to an
affiliate for execution, or involve PFOF. While this proposal does not
mandate changes, the enhanced policies and procedures required by this
proposal may induce brokers to more carefully consider and change
routing behavior in handling customer orders. Specifically, as broker-
dealers are directed to write and maintain policies and procedures that
dictate the handling of currently conflicted transactions, they may
review their existing routing behavior. In some cases, this could
induce broker-dealers to reduce or eliminate conflicted transactions,
in which they participate due to heightened costs of procedures, such
as the documentation requirement. To the extent that broker-dealers
with enhanced policies and procedures determine that they should
connect to additional liquidity sources for conflicted transactions,
investors' transaction costs could be lowered through better prices
being found on the additional sources. Additionally, to the extent that
broker-dealers are either no longer routing to wholesalers or
internalizing based on policies and procedures that resulted in
different routing decisions, customer orders could experience price
improvement opportunities, as their orders would be exposed to external
competition.
---------------------------------------------------------------------------

    \568\ See supra section II.C for details on FINRA rules and
notices surrounding the concept of ``best execution.''
---------------------------------------------------------------------------

    Introducing brokers,\569\ as defined in the proposed Rule 1101(d),
would be required to conduct regular review of executing brokers they
use to for their customer transactions. This review, which differs from
the quarterly review \570\ required by FINRA Rule 5310 for all brokers,
could cause introducing brokers to seek out additional executing
brokers with whom to develop business relationships. These additional
options, from which introducing brokers could choose to route their
customer orders, could promote competition among executing brokers in
the crypto asset securities market. This increased competition could
result in better execution quality to the introducing brokers' retail
customers in the form of lower transaction costs and increased fill
rates for illiquid securities.
---------------------------------------------------------------------------

    \569\ As noted in the introduction of this section, the
Commission lacks data on broker-dealer activities in this market. In
this instance, the Commission does not have data on the prevalence
of introducing brokers in the crypto asset securities market. This
discussion applies to the extent these entities operate in this
market.
    \570\ When transacting in municipal securities, broker-dealers
are compelled by MSRB Rule G-18. The rule requires an annual review
of policies and procedures, which could take into account execution
quality review. The rule in this proposal is substantively different
from FINRA Rule 5310 or MSRB Rule G-18.
---------------------------------------------------------------------------

2. Costs
    In order to comply with the proposal, broker-dealers would
collectively incur costs to: update their policies and procedures;
review and update those policies and procedures annually; conduct and
document regular reviews of best execution compliance; and possibly
make operational changes in response to those regular reviews. Assuming
all broker-dealers will need to perform each of these activities and do
not do so already, and do not have policies and procedures in place
that would be consistent with the proposed rules, the Commission
estimates one-time compliance costs of up to $165.4 million and annual
costs of $128.9 million. To the extent that broker-dealers already have
policies and procedures and practices that are consistent with the
proposed rules, aggregate implementation costs would be less than these
estimates, and based on the Commission's experience, the Commission
preliminarily believes these estimates overstate costs broker-dealers
would bear in implementing the proposed rules.\571\
---------------------------------------------------------------------------

    \571\ The one-time costs average $47,298 per broker-dealer;
ongoing costs average $36,843 per broker-dealer annually. Again,
these estimates assume that all broker-dealers will need to
implement new or updated policies and procedures or practices to be
consistent with the proposed rules. Based on its experience, the
Commission preliminarily believes that some broker-dealers may
already have policies and procedures and other practices that are
consistent with proposed Rule 1101. If, for example, all 3,273 of
the broker-dealers that the Commission estimates would choose to not
engage in conflicted transactions have policies and procedures and
other practices consistent with proposed Rule 1101, the aggregate
total cost of the proposal to all broker-dealers would be $38.8
million in one-time costs and $48.1 million in annual costs. Because
not all broker-dealers are likely to already have policies and
procedures and other practices that are consistent with proposed
Rule 1101, aggregate implementation costs would be higher than these
estimates. Accordingly, it is likely that actual costs would fall
between these estimates and those cited above.
---------------------------------------------------------------------------

    The proposal would entail other costs as well, as discussed below.
Where possible, the Commission has attempted to estimate these costs.
Other costs are discussed qualitatively. The Commission believes it is
likely these costs would be passed to broker-dealer customers, and
would ultimately be borne by customers.
(a) Compliance Costs for Broker-Dealers
i. Carrying Broker-Dealers
    Under the proposal, broker-dealers would fall into three groups:
(1) those that qualified for relief from the FINRA Regular and Rigorous
Review of Execution Quality under FINRA Rule 5310.09(c) from primary
analysis requirements under FINRA/MSRB rules previously and would meet
the introducing broker requirements to qualify for the proposed relief
under proposed Rule 1101(d); \572\ (2) those that did not qualify for
relief under FINRA Rule 5310.09(c) and would not qualify for the
proposed relief under proposed Rule 1101(d); and (3) those that
qualified for relief under FINRA Rule 5310.09(c) previously but would
not qualify for the proposed relief under proposed Rule 1101(d). The
third group, which may include as many as 144 \573\ broker-dealers that
carry customer accounts, would be required under the

proposed rule to comply with the policies and procedures and regular
review provisions of proposed Rules 1101(a), (b), and (c) because these
broker-dealers would not qualify for the introducing broker exemption
(because they carry customer accounts). Under the proposal, a broker-
dealer that qualified for relief under FINRA Rule 5310.09(c) that does
not meet the definition of introducing broker under proposed Rule
1101(d) would be required to incur costs to set up their own best
execution policies and procedures, and it would likely no longer be
able to rely on an executing broker for its analysis of execution
quality, unless the broker-dealer were to revise their business model
to no longer carry customer accounts. The Commission's cost estimates
below assume that all broker-dealers will implement this review under
the proposal. Based on the Commission's experience, the Commission
preliminarily believes that many broker-dealers in the first two groups
already conduct reviews of execution quality consistent with the
requirements of the proposal. Consequently, the Commission believes its
cost estimates for compliance overestimate costs broker-dealers will
collectively bear to implement the proposal.
---------------------------------------------------------------------------

    \572\ See supra section II.C for the discussion about FINRA Rule
5310.09(c) and supra Section IV.E for the discussion about
introducing broker requirements under proposed Rule 1101(d).
    \573\ Based on April-June 2022 FOCUS data.
---------------------------------------------------------------------------

ii. Conflicted Broker-Dealers
    Conflicted broker-dealers may comply with the proposed requirements
in a number of ways. First, they may choose to engage in more rigorous
analysis of the execution quality their orders receive than is required
of unconflicted broker-dealers, comparing the execution quality of
multiple possible broker-dealers that they could route order flow to
for execution, as well as execution quality available on other venues
where liquidity is reasonably available, and regularly update routing
practices based on these analyses. Based on the Commission's
experience, the Commission preliminarily believes that some broker-
dealers already engage in these practices. However, particularly
smaller broker-dealers who continue \574\ to accept PFOF from an
executing broker-dealer may have previously relied on the best
execution obligations of broker-dealers they route to, and under the
proposal, would no longer qualify for the relief from such analyses
previously provided under FINRA/MSRB rules. For these broker-dealers,
performing such analyses might require engaging external consultants to
provide such analyses if the broker-dealer's staff does not possess the
necessary expertise or if the broker-dealer's staffing is not adequate
to support the additional duties required, and might also require
engaging external consultants to obtain analyses incorporating the
necessary data (such as information on alternative trading system
liquidity) to which they may not currently have access. The
Commission's cost estimates below assumes that smaller broker-dealers
(those carrying less than $100MM in total assets) will incur costs to
engage external parties for this review.
---------------------------------------------------------------------------

    \574\ Resolving conflicts is discussed below.
---------------------------------------------------------------------------

    The Commission preliminarily believes that due to the prevalence of
exchange rebates, many of the 2,440 retail broker-dealers \575\ are
likely to qualify as conflicted under the proposal. The Commission is
able to preliminarily estimate an upper bound on potential
implementation costs from these broker-dealers by assuming that all
2,440 retail broker-dealers would remain conflicted after
implementation of the proposal,\576\ but the Commission preliminarily
believes the implementation costs for many broker-dealers are likely to
be lower than this estimate because some conflicted broker-dealers
receive payments from their conflicted order flow that are less than
the implementation costs they would incur under the proposed rule;
consequently, the Commission preliminarily believes that some broker-
dealers will choose to de-conflict to avoid incurring these costs. For
purposes of its analysis, the Commission assumes that broker-dealers
with less than $100MM in total assets will comply with the proposal by
removing their conflicts.\577\ The Commission preliminarily believes
that some broker-dealers may continue to use one or more clearing
broker-dealers that have previously paid to receive their order flow,
and in such cases the primary cost to the broker-dealer would be the
lost PFOF revenue. However, if a broker-dealer needed to change the
broker-dealer it routed to, or engage the services of another
intermediary to handle its order flow in order to remove conflicts, the
broker-dealer would likely incur switching costs such as staff time
allocated to researching and negotiating with alternative providers of
services.\578\
---------------------------------------------------------------------------

    \575\ Based on Q2 2022 FOCUS data.
    \576\ If all 2,440 broker-dealers were to implement the more
rigorous requirements required for broker-dealers engaging in
conflicted transactions, these broker-dealers would collectively
incur $155.3MM in implementation costs averaging $63,637 per broker-
dealer. The Commission also assumes each would incur $9,000 per year
in costs to update order-handling procedures in response to its
annual review of execution quality, for ongoing annual costs of
$22.0 MM.
    \577\ If a broker-dealer has revenue from conflicted
transactions that over time sufficiently exceeds the $24,935 in
additional implementation costs the Commission estimates conflicted
broker-dealers will incur and the $9,000 annual cost to update
order-handling procedures, the broker-dealer is likely to choose to
continue to engage in conflicted transactions since its revenue from
such activities exceeds the additional implementation and ongoing
costs necessary to comply while engaging in conflicted transactions.
Because the majority of PFOF revenues accrue to a small number of
broker-dealers, the Commission preliminarily believes that smaller
broker-dealers are unlikely to receive significant PFOF revenue that
would justify the additional implementation costs. For some of these
broker-dealers, passing the PFOF they receive on to their customers
may suffice to de-conflict. See note 183, supra.
    \578\ See infra note 581 and text for discussion of related
costs the broker-dealer would likely incur to operationalize
changing a routing destination.
---------------------------------------------------------------------------

    The Commission preliminarily believes that each broker-dealer that
would be required under the proposed rules to comply with provisions of
the proposal applicable to conflicted broker-dealers would consider its
options under the proposed rules strategically. For some firms, the
costs of staffing the activities required for compliance would exceed
their expected profits from conflicted transactions. The Commission
expects these firms would choose to alter their business models to
reduce conflicts so compliance changes necessary for conflicted
transactions are not required under the proposed rules. It is possible
that a consolidation of business would result: some broker-dealers may
exit the market, while others would invest further and compete to serve
the customers of exiting broker-dealers. Some broker-dealers may reduce
conflicts identified under the proposed rules and compete for customer
order flow on the basis of their less-conflicted status. To the extent
that exiting broker-dealers were able to offer lower-costs than broker-
dealers that either reduce conflicts or comply with provisions of the
proposal required of conflicted broker-dealers, direct costs such as
commissions and fees for these firms' investor customers may increase.

iii. All Broker-Dealers
    Broker-dealers would incur costs to update policies and procedures
to reflect the proposal. They would incur other costs to regularly
review the execution quality of venues or other broker-dealers to which
they route customer orders. To the extent that broker-dealers already
have policies and procedures that comply with the proposal, aggregate
implementation costs would be less than this estimate, and based on the
Commission's experience, the Commission preliminarily believes these
estimates overstate costs broker-dealers would bear in implementing the
proposal. Implementation costs are summarized in Table 23 below.\579\
---------------------------------------------------------------------------

    \579\ See infra Section VI.7 for detailed discussion of these
estimates.

                                                          Table 23--Total Implementation Costs
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Per registrant ($)                                      Industry-wide ($)
     Required Policies and Procedures      -------------------------------------------------------------------------------------------------------------
                                                                          Internal labor     External     Internal labor     External          Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
BDs excluding conflicted retail (3273):
    Update policies and procedures........  One time....................           6,462          32,240      21,150,126     105,521,520     126,671,646
    Annual review and update of P&P.......  Annual......................           2,154           8,800       7,050,042      28,802,400      35,852,442
    Conduct and document review of          Annual......................           7,642           6,080      25,012,266      19,899,840      44,912,106
     execution quality.
Conflicted BDs (225):
    Update policies and procedures........  One time....................          55,701           7,936      12,532,725       1,785,600      14,318,325
    Annual review and update of P&P.......  Annual......................           6,421  ..............       1,444,725  ..............       1,444,725
    Conduct and document review of          Annual......................          20,840  ..............       4,689,000  ..............       4,689,000
     execution quality.
               Annual Report
Unconflicted BDs (3273):
    Update procedures for reviewing best    One time....................           1,795           4,960       5,875,035      16,234,080      22,109,115
     ex policies and procedures.
    Conduct and document regular reviews..  Annual......................           4,062           7,920      13,294,926      25,922,160      39,217,086
Conflicted BDs (225):
    Update procedures for reviewing best    One time....................           8,952           1,488       2,014,200         334,800       2,349,000
     ex policies and procedures.
    Conduct and document regular reviews..  Annual......................          12,278  ..............       2,762,550  ..............       2,762,550
                                                                                -----------------------------------------------
        Total Implementation Costs........  ............................  ..............  ..............      41,572,086     123,876,000     165,448,086
                                                                                -----------------------------------------------
        Total Annual Costs................  ............................  ..............  ..............      54,253,509      74,624,400     128,877,909
--------------------------------------------------------------------------------------------------------------------------------------------------------
Costs in this table are constructed from estimates in Section VI.D. In its economic analysis, the Commission assumes that the 225 retail broker-dealers
  with over $100MM in total assets are large and will continue to engage in conflicted transactions if the proposed rules are adopted, and follows the
  Section VI.D estimates for large broker-dealers. The remaining 3,273 broker-dealers are assumed to be unconflicted for purposes of the proposed rules,
  and this analysis follows the Section VI.D estimates for small broker-dealers. Section VI.D assumes that smaller broker-dealers are less likely to
  engage in conflicted transactions, but acknowledges some costs associated with conflicted transactions. Furthermore, Section VI.D cost estimates
  assume broker-dealers will outsource many compliance tasks and thus relies more upon external costs. To the extent that these broker-dealers elect to
  perform these tasks with internal personnel, their implementation costs are likely to be over-stated in this analysis. Consequently, this analysis is
  likely to over-estimate compliance costs for unconflicted broker-dealers.
Where internal burden hours appear in Section VI.D, the Commission employed hourly rates to monetize these costs. These hourly rates are based on
  SIFMA's Management & Professional Earnings in the Securities Industry 2013, modified by Commission staff to account for an 1,800-hour work-year and
  multiplied by 5.35 to account for bonuses, firm size, employee benefits and overhead, and adjusted with a factor of 1.27 for inflation based on the
  27% change in the Consumer Price Index from December 2013 to September 2022. The Commission employed the following hourly rates, with the description
  employed in Section VI.D in parenthesis: Attorney (legal counsel) $483 per hour; Compliance Attorney (compliance counsel) $424 per hour; General
  Counsel (general counsel) $693 per hour; CCO (CCO) $616 per hour; Compliance Manager (compliance manager) $359 per hour; Paralegal (legal personnel)
  $253 per hour; Compliance Manager (compliance personnel) $359 per hour; Operational Specialist (business-line personnel) $159 per hour.

    The previous table discusses the costs broker-dealers would incur
to comply with the proposal.\580\ In the case of conflicted broker-
dealers that would be newly required to evaluate execution quality from
multiple sources in evaluating execution quality, it is possible they
would periodically need to change their routing practices to reflect
changes they observe in their data analysis. The Commission
preliminarily estimates that each conflicted broker-dealer that changes
its routing practices will incur costs of approximately $9,000.\581\
The Commission cannot estimate the number of broker-dealers that would
need to make this change periodically,

but the Commission preliminarily estimates that the changes will be no
more than $2 million \582\ annually in aggregate.
---------------------------------------------------------------------------

    \580\ See infra section VI.D.
    \581\ The Transaction Fee Pilot required re-programming of SORs
as well. For that pilot, the Commission estimated that the costs of
a one-time adjustment to the order routing systems of a broker-
dealer would $9,000 per broker-dealer. The Commission preliminarily
believes that this estimate remains a reasonable estimate of costs
associated with changes that broker-dealers would incur from having
to update their routing systems. See Securities Exchange Act Release
No. 84875 (Dec. 19, 2018), 84 FR 5202 (Feb. 20, 2019) (Transaction
Fee Pilot for NMS Stocks).
    \582\ 225 conflicted broker-dealers x $9,000 per order-handling
change = $2.025MM annually. The Commission assumes that order-
handling changes would be annual because the proposal requires the
annual review of the best execution policies and procedures,
including order handling practices. Based on the Commission's
experience, the Commission preliminarily believes that many broker-
dealers, including many that the Commission believes will be
unconflicted if the proposal is adopted and implemented, already
change order-handling practices regularly for both best-execution
and other operational reasons, such as reducing costs. Consequently,
the Commission preliminarily believes that this estimate exceeds the
annual costs that broker-dealers would bear under the proposal.
---------------------------------------------------------------------------

iv. Additional Compliance Costs for NMS Stocks and Options
    For NMS stocks, a broker-dealer engaging in conflicted transactions
would currently be required to subscribe to SIP data under current SRO
best execution rules. To consider a broader range of markets, such
broker-dealers might add connections to one or more ATSs, subscribe to
more detailed data or consider connecting to ``ping'' destinations
(automated systems run by OTC liquidity providers that may elect to
internalize any order routed to their system).\583\ In making this
choice, some broker-dealers may compare their current routing practices
to a hypothetical competitor that does the bare minimum and consider
their practices compliant with the proposal even if all competitors
currently do more than this hypothetical minimum.\584\ To the extent
broker-dealers believe that their current routing practices are in
compliance and do not make changes to routing practices, both the
benefits and the costs of the proposed rules would be less than they
would be otherwise.
---------------------------------------------------------------------------

    \583\ The Commission preliminarily believes that larger broker-
dealers that are likely to continue engaging in conflicted
transaction if the proposed rules are adopted are likely to already
connect to a broader range of venues than would be represented by
SIP data. The Commission cannot predict how many broker-dealers that
elect to engage in conflicted transactions would increase the range
of venues to which they connect and what costs they would incur to
do so because broker-dealers are diverse in business models and
practices and each broker-dealer would need to evaluate its own
operational procedures to make such a determination.
    \584\ Based on staff discussion with market participants, the
Commission preliminarily believes that broker-dealers are often not
certain what their competitors' routing practices are. Such
information is proprietary and generally not publicly available.
---------------------------------------------------------------------------

v. Additional Compliance Costs Associated With Fixed Income Securities
    With respect to fixed income securities trading, broker-dealers
that engage in conflicted transactions could add subscription to one or
more trading venues (e.g., ATSs, RFQ platforms, single dealer
platforms) to the extent that the benefit (i.e., improvement in
execution quality) from adding subscription to trading venue outweighs
the costs (e.g., venue subscription fees).\585\ The Commission expects
that a broker-dealer would subscribe to additional trading venues to
take liquidity (as opposed to provide liquidity by posting quotes or
responding to RFQs) in executing retail customer orders on riskless
principal basis or to discover prices for the purpose of
internalization. The Commission understands that subscription fees for
liquidity takers are not significant. Furthermore, the broker-dealer
would choose to connect to a trading venue via low cost means, for
example, web-based graphical user interface (GUI) rather than via more
costly application programming interface (API), which may include the
costs associated with connectivity and systems reconfiguration (e.g.,
reconfiguring to adjust API), to the extent that the broker-dealer does
not expect to maintain constant connection to execute a large number of
customer orders on the venue. To the extent that making changes to
business practices to handle customer orders on an agency basis in
fixed income securities trading is less costly than incurring costs to
comply with the requirements with respect to conflicted transactions,
broker-dealers may choose to handle retail customer orders on an agency
basis rather than a riskless principal basis. In particular, a broker-
dealer whose primary business is retail self-directed trading conducted
on a riskless principal basis could change its business practices to
convert its self-directed trading business to handling orders on an
agency basis. The Commission preliminarily believes that the costs
associated with such a conversion could include the costs related to
changing risk management practices for intraday capital commitment,
compliance systems, recordkeeping practices for orders and
transactions, and accounting practices. However, the Commission is
uncertain about these costs associated with the business practice
changes needed to convert a self-directed trading business from a
riskless principal to agency based model and requests comments on the
costs.
---------------------------------------------------------------------------

    \585\ In their Form ATS submissions, 15 of 33 ATSs state they
have no access, connectivity and/or subscription fees. The
Commission preliminarily believes that most ATSs charge fees
primarily based on transactions, and subscribers are responsible for
any costs related to providing their connectivity. To the extent an
ATS does charge subscription fees, broker-dealers are likely to
consider those fees in making a determination of whether the
liquidity on such an ATS is reasonably available.
---------------------------------------------------------------------------

vi. Additional Compliance Costs for Non-NMS Stock Equity Securities
    In the case of non-NMS stock equities, liquidity on ATSs beyond
those that specialize in non-NMS stock equities may be rare. For a
broker-dealer that currently participates in the non-NMS stock market,
adding additional markets may mean subscribing to additional ATSs, or
possibly, contacting other broker-dealers that act as liquidity
providers of last resort through direct messages thus seeking
additional sources of liquidity manually. To the extent that broker-
dealers are able to bear the costs of seeking this additional liquidity
(through ATS subscriptions or manual negotiation) while maintaining a
profitable trading service, broker-dealers in the non-NMS stock
equities market could pursue these actions and pass on the costs to
customers. In the case of very illiquid non-NMS stock equities, broker-
dealers may be left with either no apparent options to add additional
markets, or with markets which are prohibitively expensive to consider
as additional liquidity sources (such as contacting other broker-
dealers or block holders of the security to inquire about their
interest in being a counterparty). In such cases, there may not be
additional implementation costs for conflicted transactions because
alternative markets may not be available.
vii. Additional Compliance Costs Associated With Crypto Asset
Securities
    Broker-dealers trading crypto assets that are securities may incur
costs to comply with the proposed rule.\586\ Because the Commission
lacks data and other information on existing broker-dealers and their
practices in the crypto asset securities market, it is difficult to
precisely determine the costs of compliance for such broker-dealers.
Generally, the Commission expects the costs of compliance to be most
similar

to costs associated with trading non-NMS stocks. To the extent that the
current market practices of market participants that would need to
comply with the proposed rule differ significantly from the practices
required under the proposed rule, the costs for compliance with the
proposal may be large; this may be the case, for example, for market
participants whose practices are not currently consistent with FINRA
Rule 5310. On the other hand, market participants with existing best
execution policies and procedures, such as those that operate across
other asset classes (e.g., NMS securities), may bear incremental lower
costs of compliance.
---------------------------------------------------------------------------

    \586\ Affected parties that effect transactions in the crypto
market may include some market participants that may not be
currently registered as a broker-dealer but should be under existing
regulations. As noted above, this analysis does not account for
costs of such market participants to register as broker-dealers or
otherwise come into compliance with existing applicable regulation.
---------------------------------------------------------------------------

    For crypto asset securities that are traded on multiple platforms,
conflicted broker-dealers may need to connect to additional platforms
to comply with the proposal. In the case of crypto asset securities
that are not traded on multiple platforms, broker-dealers would incur
costs to directly contact liquidity providers of last resort, such as
broker-dealers that might agree to trade the asset if contacted
directly. Because transacting manually in this manner involves the time
of a professional trader, the cost to make these additional inquiries
required by the proposal might be uneconomical, particularly in the
case of small trades.
(b) Other Costs
    As discussed previously, currently many retail orders in NMS
securities are executed without paying commissions.\587\ The Commission
preliminarily believes that the proportion of retail order flow being
executed under PFOF agreements may decrease, although the Commission is
uncertain of the magnitude of this reduction.\588\ It is possible that
reductions in the proportion of retail order flow being executed under
such agreements could cause the prevalence of retail commissions to
increase because revenues from these agreements may have previously
offset retail broker dealer costs that would otherwise be covered by
commissions collected from retail investors. This effect may be
mitigated if broker-dealers elect to pass exchange rebates to their
customers. The Commission preliminarily believes that it is unlikely
that the proposal would significantly increase the prevalence of retail
commissions because the market to provide retail broker-dealer services
is competitive and many of the broker-dealers that the Commission
believes will remove their conflicts receive relatively small payments
for their order flow.\589\
---------------------------------------------------------------------------

    \587\ See supra Section V.B.3.a
    \588\ See supra Section V.C.1.
    \589\ In the case of larger broker-dealers that derive
significant revenue from PFOF, the Commission preliminarily believes
that they will continue to do so and incur the additional compliance
costs discussed previously in Table 23.
---------------------------------------------------------------------------

    The Commission further believes that the costs of the rule could
advantage larger broker-dealers and may increase barriers to entry and
disadvantage smaller broker-dealers, potentially resulting in some of
them exiting the market. To the extent that smaller broker-dealers are
more likely to provide specialized services and provide innovation,
there may be less competition to provide specialized services and less
innovation if the proposal is adopted. Investors whose broker-dealers
exit the market would face search costs to find alternative broker-
dealers that offer the same services; those services may be offered at
inferior prices by remaining competitors. Some services may no longer
be offered by any competitors if a specialized broker-dealer exits the
market, although the Commission preliminarily believes that if there is
sufficient demand for such a service, a broker-dealer may make it
available to customers when demand is sufficient, as may be the case
after one or more broker-dealers exit the market.
    While the Commission cannot predict how many retail broker dealers
will terminate PFOF arrangements, the Commission preliminarily believes
that under the proposal, retail broker-dealers are likely to reduce
their use of PFOF agreements for both NMS stocks and listed options
because engaging in such agreements would cause the broker dealer to
incur heightened best execution obligations under the proposal and
satisfying those obligations may cause broker-dealers to incur costs in
excess of their PFOF revenue.\590\ Since most broker dealers that
receive PFOF receive relatively small payments for routing their order
flow,\591\ smaller broker-dealers in particular may consider curtailing
this practice to avoid incurring the additional compliance costs.
Furthermore, broker-dealers that currently pay to receive order flow
may adjust their business models \592\ to rely less on these
arrangements. The Commission preliminarily believes this is likely to
reduce the share of retail customer order flow that is internalized
because some broker-dealers that currently receive PFOF are likely to
stop receiving it to become de-conflicted, and some broker-dealers that
pay PFOF will internalize fewer of the orders they receive to comply
with the proposal. If this occurs, broker-dealers that reduce their
reliance on PFOF arrangements would also be likely to see commensurate
decreases in their revenue. This increase in costs to execute customer
orders may be passed on to retail investors as additional fees to
trade, or in the form of commissions.
---------------------------------------------------------------------------

    \590\ The Commission lacks data on many broker-dealers' PFOF
revenue, but acknowledges that some broker-dealers will realize an
indirect cost from forgone PFOF revenue. In the case where a broker-
dealer receives PFOF from another broker-dealer or trading venue,
this will constitute a transfer from one registrant to another, and
will not increase industry costs in aggregate. In cases where a
broker-dealer passes PFOF on to its customers to avoid conflicts,
this payment may reduce investor trading costs and increase industry
costs in aggregate.
    \591\ Many broker-dealers receive PFOF, but the majority of PFOF
is received by a small group of broker-dealers. Consequently, many
broker-dealers receive relatively small PFOF payments, although for
some broker-dealers these small payments may contribute
significantly to profits, depending on other revenue sources.
Regardless of this relative magnitude, the costs to comply with the
proposal's heightened standards may be prohibitive for broker-
dealers that receive relatively modest PFOF revenue, and their
compliance costs may exceed the revenue the broker-dealer receives
for engaging in conflicted transactions. See supra Section V.B.3 and
Section V.C.2.(a)i.
    \592\ If broker-dealers choose to pass exchange rebates on to
their customers, they may incur additional costs associated with
updating systems to account for these payments.
---------------------------------------------------------------------------

    Similarly, the Commission preliminarily believes that firms that
currently pay to receive retail order flow would likely receive less of
such directed order flow. While this may be a cost savings to those
firms, it is likely to represent a reduction in what was previously a
profitable business operation, and the lost profit opportunities are
not likely to offset any cost savings. It is possible such firms may
choose to compete on other venues (ATSs and exchanges) to participate
in this order flow, but the Commission preliminarily believes that
profits from such a venture are unlikely to be comparable to the
profits of internalization because, on other venues, other broker-
dealers would be able to compete with these broker-dealers to provide
liquidity to these orders which should reduce the cost of that
liquidity to investors.\593\ If these firms reduce the capital they
currently allocate to providing liquidity, spreads could increase
particularly in the short-term because fewer market participants would
be competing to provide liquidity. However, the Commission
preliminarily believes that the market to provide liquidity to retail
orders is competitive and other competitors are

likely to increase their capital provision over time to satisfy
demand.\594\
---------------------------------------------------------------------------

    \593\ See supra Section V.C.1.
    \594\ See infra Section V.D.3.
---------------------------------------------------------------------------

    In addition to costs discussed previously, broker-dealers that
engage in conflicted transactions would face heightened standards under
the proposal. These standards would require them to obtain and assess
information beyond what would be required of a broker-dealer that is
not conflicted, including price, volume, and execution quality, in
identifying a broader range of markets beyond those identified as
material potential liquidity sources. The Commission preliminarily
believes that this requirement may be interpreted very differently by
different broker-dealers, and may prove challenging in markets for some
asset classes where the number of potential markets is limited and
broker-dealers may effectively be checking all reasonably available
prices in current practice.
i. Additional Other Costs in NMS Stocks and Options
    In equities, the Commission preliminarily believes that firms that
internalize retail order flow provide liquidity to a wide range of
securities, including those that are very thinly traded. In fact,
fulfillment of these more difficult to fill orders may be part of a
service bundle that internalizers provide to broker-dealers that route
them their order flow. Generally, thinly traded securities are more
risky for liquidity providers because quotation data are relatively
sparse compared to more heavily traded securities, such quotations are
more likely to be stale, and there may be no market makers that have a
duty to maintain two-sided quotes in these securities.\595\ It is
possible that execution prices may be less favorable for retail
investors under the proposal if liquidity providers that previously
paid for order flow and fulfilled these difficult to execute orders
under such arrangements dedicate less capital to making markets in
these securities. It is possible that execution times for these
securities may be significantly delayed as broker-dealers would need to
search for liquidity to fill these orders, and this delay is an
additional factor that a broker-dealer would need to consider in the
order's execution quality. It is also possible that execution prices
for these transactions may be less favorable than they might be under a
PFOF arrangement because the price improvement statistics on these
orders are currently included in the criteria retail broker dealers
evaluate in choosing executing broker dealers.\596\ However, the
Commission preliminarily believes that the market to provide liquidity
to retail orders, including orders in less liquid securities is
competitive. If the proportion of such orders entering the market
beyond internalizers increases, it is likely other broker-dealers that
provide liquidity to asset markets would increase liquidity provision
to this segment of the equities market. The costs realized by investors
transacting in these securities may increase, however, because broker-
dealers are unlikely to provide additional liquidity unless they can
cover their costs and earn appropriate risk-adjusted returns.\597\
---------------------------------------------------------------------------

    \595\ See, for example, Menkveld, Albert J. and Wang, Ting, How
do designated market makers create value for small-caps?, 16 Journal
of Financial Markets 571 (2013), available at https://www.sciencedirect.com/science/article/pii/S1386418112000535#aep-abstract-id6; Craig, Louis, Kim, Abby, and Won Woo, Seung, Pre-trade
Information in the Municipal Bond Market, (SEC Working Paper, July
2018), available at dera_wp_pre-
trade_information_in_the_municipal_bond_market.pdf (sec.gov)https://www.sec.gov/files/dera_wp_pre-trade_information_in_the_municipal_bond_market.pdf and Craig et al,
supra note 471.
    \596\ Broker-dealers that pay to receive order flow may be
providing better execution to difficult to fill orders because the
execution in such orders is an element upon which their clients
evaluate them. Consequently, outside of PFOF arrangements, such
orders might receive inferior execution quality to what they would
receive under such an arrangement.
    \597\ Securities for which it is more difficult to find trading
counterparties often are characterized by infrequent trades, less
frequent quotations and lower market capitalization. These factors
are likely to increase the adverse selection risk liquidity
providers face when providing liquidity to the market for these
securities.
---------------------------------------------------------------------------

    In addition to the costs discussed above, the Commission
preliminarily believes that in the market for listed options, the NBBO
spreads set by resting best displayed liquidity could be wider and the
depths at the best market prices could be thinner because of the
increasing order flow segmentation under the proposal. Specifically,
liquidity providers could deploy less capital to provide the resting
displayed liquidity in the limit order books in favor of price
improvement auctions or price improving inside the NBBO. Because the
proposed rules could result in potentially more efficient price
improvement auctions and/or potentially more retail orders being routed
to the auctions for price improvement opportunities, order flow routed
there could become less impactful and more profitable. At the same
time, the orders filled by the lit quotes would become more impactful
and impose relatively more adverse selection risk on the liquidity
providers who provide resting displayed liquidity, in part due to the
increased level of order segmentation. Less capital from liquidity
suppliers would make the liquidity in order books thinner and
potentially widen the NBBO. Wider NBBO spread and thinner depth would
inevitably lead to worse execution quality to the orders that are not
exposed to price improvement opportunities. To the extent that the
proposal would make a subset of retail customers better off by
improving the prices those customers receive, it would correspondingly
adversely affect other customers by harming prices and liquidity in
displayed quotes.
ii. Additional Other Costs in Fixed Income Securities
    With respect to fixed income securities trading, the Commission
preliminarily believes that the proposal could adversely affect
liquidity. To the extent that broker-dealers no longer practice last-
look in conducting RFQs for the purpose of internalization, these
broker-dealers could earn less profits from principal trading that
relies on broker-dealers' capacity to commit capital for carrying
inventory. A reduction in capital commitment for fixed income
securities intermediation could result in lower liquidity, particularly
for those trades that rely on broker-dealers' capacity to provide
immediacy by trading on a principal basis (by taking fixed income
securities into inventory). This would result in an increase in pre-
arranged trades between a buyer and a seller (so that the broker-dealer
can quickly offset its position in the opposite direction), which take
a longer time to execute, increasing transaction costs of market
participants.
    To the extent that broker-dealers handling retail customer orders
choose to conduct RFQs to fulfill the proposed requirements with
respect to conflicted transactions, this could result in an increase of
RFQs to a degree that RFQ messages would overwhelm market participants
(e.g., broker-dealers responding to RFQs). This could increase the
number of RFQs with no or few responses resulting in less competitive
prices and worse execution quality for retail customer trades. However,
the Commission preliminarily believes that this effect would be
mitigated as more market participants adopt automation in the process
for responding to RFQ messages to be responsive to RFQs, and thus,
attract more order flow.
3. Efficiency, Competition, and Capital Formation
    The Commission has considered the effects of the proposed
amendments on

efficiency, competition, and capital formation, and discussed these
effects below.
(a) Competition
i. Market for Trading Services
    The Commission preliminarily believes that the proposal would
improve competition among trading venues. The proposal requires that
broker-dealers consider a wider range of trading venues. In the equity
and option markets, the Commission also preliminarily believes that the
proposal would reduce the proportion of retail order flow that is
internalized. The Commission preliminarily believes that this would
increase competitive opportunities for exchanges and other trading
venues because more broker-dealers will consider exchanges and ATSs as
potential execution venues. In the fixed income securities markets, the
proposal could promote competition among trading venues to the extent
that broker-dealers expose retail customer orders broadly across
multiple trading venues for the purpose of executing riskless principal
trades and for the purpose of internalization.
    In the market for NMS stock and options trading services, the
Commission preliminarily believes that competition would increase. To
the extent that the proposal's requirement that broker-dealers
incorporate material sources of liquidity into their order handling
practices causes broker-dealers to consider additional execution venues
such as additional exchanges or ATSs for their orders, competition
between trading venues may increase. Other factors that may encourage
broker-dealers to more frequently use exchanges and ATSs for trading
include the heightened standards for conflicted transactions and the
heightened standards for transactions where a PFOF arrangement is in
place.
    By considering more sources of liquidity and the heightened
standards for broker-dealers in conflicted transactions, it allows for
venues such as exchanges and ATSs to compete for order flow that may
have been internalized by wholesalers before the effects of this rule.
The requirement to consider price improvement from midpoint liquidity
before internalizing a retail trade could increase competition by
resulting in more trading venues competing to offer programs that offer
midpoint liquidity to retail orders. There will be increased demand for
the services of trading service venues. Given this increased demand,
the venues will compete to acquire as much of it as possible. Given
this increased demand, it is possible that the fees venues charge may
rise, particularly if large venues capture most of the increased order
flow.
    The Commission preliminarily believes that the proposal would
increase competition between broker-dealers to provide liquidity to
retail orders by requiring broker-dealers that route to executing
brokers to consider a wider range of executing venues. Currently, most
retail order flow for which the customer has not specified an execution
venue is routed first to an internalizer. Under the proposal, broker-
dealers would need to consider a wider range of trading venues and
programs (such as retail liquidity programs \598\) before routing
customer orders.
---------------------------------------------------------------------------

    \598\ See supra Section V.B.3(a).i.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposal would have
limited impact on the market to provide liquidity to unlisted stocks
and thinly traded NMS stocks. As the proposal requires brokers to check
material sources of liquidity, there will be little change if these
sources of liquidity are few to begin with.
    The Commission preliminarily believes that the proposal would
promote price competition and competition in price improvement
mechanisms for listed options. Under current practice, in order to
attract order flow from wholesalers, the exchanges that provide the
price improvement auction mechanisms often establish asymmetric fee
schedules charging the competing liquidity providers higher fees than
the wholesaler for participating in the auction. This limits the
ability of competing liquidity providers to provide more favorable
pricing to compete with the wholesaler in those auctions, resulting in
less than fully efficient price improvement offered to the customer.
Under the proposal, when considering a price improvement auction, the
wholesaler would be required to consider a broad range of price
improvement auctions across the exchanges and evaluate the execution
quality that may be received from these auctions and how that might be
impacted by auction features such as asymmetric fee schedules after
controlling for all the other factors such as the allocation model.
Therefore, the option exchanges would have incentives to level the
playing field by reducing the existing auction transaction fee gap to
enhance competition in those auctions to attract the retail order flow.
    Currently, there is no mid-point liquidity protocol available
across the limit order books operated by the exchanges for listed
options, but the Commission is aware that there is at least one option
exchange which provides a protocol allowing market participants to
provide liquidity on the limit order book within the NBBO prices to
interact with incoming marketable orders and provide price improvement
against NBBO at the same time. The Commission preliminarily believes
that, under this proposal, more exchanges would have incentives to
develop protocols which would facilitate liquidity provision within the
prevailing NBBO spread because broker-dealers would be required to have
policies and procedures that specifically address opportunities for
price improvement and other order exposure opportunities. Thus, the
wholesaler would need to check or reasonably estimate whether there
could be substantial midpoint or within-NBBO liquidity available on the
limit order books operated by other exchanges. Some exchanges may even
consider establishing protocols to allow customer order flow executed
at the midpoint of NBBO prices, which would further increase
opportunities for retail orders to receive price improvements.
ii. Market for Broker-Dealer Services
    The Commission preliminarily believes that the proposal could have
mixed effects on competition in the market for broker-dealer services.
Changes in order handling practices that could occur as part of the
rule could promote competition between broker-dealers to attract
customers. However, the costs of the rule could advantage larger
broker-dealers and may increase barriers to entry and disadvantage
smaller broker-dealers, potentially resulting in some of them exiting
the market.
    While modifying their policies and procedures, broker-dealers could
change their order handling practices and also the services they
utilize from other broker-dealers while handling customer orders. These
changes in order handling practices could promote competition among
broker-dealers, especially on the basis of execution quality, to
attract customers. It could also promote competition among broker-
dealers offering services to other broker-dealers to attract new
clients.\599\
---------------------------------------------------------------------------

    \599\ See infra Section V.B.3.a.i for discussion about
competition about market for market access.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposal may
increase barriers to entry and disadvantage smaller broker-dealers
because of the increased compliance costs and resulting economies of
scale that would result under the proposal. Furthermore,

the proposal could result in consolidation among smaller broker-dealers
or these broker-dealers being absorbed (via merger) by larger broker-
dealers to take advantage of the economies of scale. Such a change to
the competitive landscape could also reduce competition in the market
for trading services. In the case of broker-dealers that meet the
definition of introducing broker under FINRA rules but do not do so
under the proposal, compliance costs may be high.\600\ Some of these
broker-dealers may adjust their business models to no longer compete as
introducing brokers, and new entrants may be discouraged due to
elevated costs of complying with the proposal.
---------------------------------------------------------------------------

    \600\ See supra Section V.C.2.
---------------------------------------------------------------------------

    Additionally, the proposed rules for conflicted transactions for
retail orders and on introducing brokers accepting PFOF may reduce the
PFOF retail brokers receive in the equity and options markets. To the
extent that these firms do experience a major reduction in their PFOF
revenue, they may face pressure to develop other lines of revenue,
including the addition of commissions and/or fees for trading and
advisory services, although broker dealers that have heavily promoted
their commission-free business model would be more reticent to add
commissions and/or fees, despite the loss of PFOF.
    To the extent that some retail brokers do resume charging
commissions, they may be constrained by competitive pressures in the
commission rates they can charge. Larger retail brokers that do not
accept equity PFOF could continue to provide commission-free trading.
This, in turn, would put competitive pressure on the extent to which
retail broker-dealers could charge commissions and still retain
customers. If the ability of smaller retail brokers to charge
commissions is constrained by competition, it could increase the
competitive advantage of larger retail brokers, which could raise the
barriers to entry for new brokers and cause some smaller retail brokers
to exit the market.
    The Commission is unable to quantify the likelihood that one or
more smaller brokers would cease operating. Even if one or more small
brokers were to exit, while the Commission acknowledges that services
to niche markets more likely served by smaller broker-dealers might
decline, the Commission does not believe this would significantly
impact competition in the larger market for generalized broker services
because the market is served by multiple large competitors.
Additionally, the market would likely still be served by many small
competitors. Consequently, if a smaller retail broker were to exit the
market, demand is likely to be swiftly met by existing competitors. The
Commission recognizes that small brokers may have unique business
models that are not currently offered by competitors, but the
Commission believes a competitor could create similar business models
previously offered by exiting firms if demand were adequate. Moreover,
if the services generated by these business models are not provided by
existing competitors, it seems likely new entrants would provide them
if demand were sufficient.
iii. Market for Market Access
    The Commission preliminarily believes that the proposal would
increase competition in the market for market access. A number of
aspects of the proposal could result in more broker-dealers utilizing
the services of a routing or executing broker or engaging in more
extensive comparisons of the services and execution quality of
different routing or executing brokers. This would increase competition
among broker-dealers offering order routing and execution services to
other broker-dealers in order to attract new customers.
    The introducing broker requirements under Rule 1101(d) would
enhance competition the market for market access in two ways. The
requirement for introducing brokers to regularly compare the execution
quality of their executing broker to that of other executing brokers
would promote competition between executing brokers. Broker-dealers
that carry customer accounts that currently route their order flow to
an executing broker to handle in an principal capacity would not be
eligible for the introducing broker relief under Rule 1101(d) and would
have to develop policies and procedures for handling customer orders.
If they utilized a routing broker as part of developing these policies
they would need to compare different routing brokers and develop the
criteria for selecting a routing broker as part of their policies and
procedures. They would have to also compare their routing broker to the
other routing brokers as part of their regular review of their policies
and procedures. This could enhance competition among routing brokers in
order to attract these broker-dealers as clients.
    The heightened standards for broker-dealers handling retail orders
engaging in conflicted transactions may also promote competition in the
market for market access. The additional requirements for broker-
dealers handling retail orders engaging in conflicted transactions may
lead to some retail brokers that currently route orders to wholesalers
to instead utilize the services of a routing broker to handle their
orders.\601\ There could be increased competition among routing brokers
to provide these conflict-free routing services to retail brokers.
Additionally, the heightened standards for broker-dealers that accept
PFOF may foster competition between broker-dealers to provide best-
execution services 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,
this could increase competition among broker-dealers that pay for order
flow to provide adequate information to broker-dealers routing to them,
allowing those broker-dealers to improve their customers' execution
quality. Without such assistance from broker-dealers that pay for order
flow, the broker-dealers that provide order flow may be faced with the
need to perform significant data analysis on multiple executing broker-
dealers if they intend to continue receiving PFOF. For some broker-
dealers, the expense of conducting such analysis is likely to exceed
the revenue they receive for directing their order flow to executing
broker-dealers that pay to receive their order flow. These broker-
dealers may choose to stop receiving PFOF or pass all PFOF they receive
through to their customers in order to avoid these expenses.
Consequently, broker-dealers that pay for order flow are likely to be
incentivized to assist their customer broker-dealers in complying with
the rule to avoid losing their order flow. It is also possible that
broker-dealers that currently receive PFOF may simply maintain their
routing practices and stop accepting PFOF to reduce their compliance
burden under the proposal.
---------------------------------------------------------------------------

    \601\ See supra Section V.C.1.a.
---------------------------------------------------------------------------

    With respect to fixed income securities trading, the proposed
requirements with respect to introducing brokers and regular review of
execution quality could promote competition in the market for market
access (i.e., amongst executing brokers). Brokers that outsource
execution services for fixed income securities

would conduct regular reviews and compare execution quality in the
selection of their executing brokers, which would promote competition
and innovation in the fixed income market for market access. Executing
brokers would compete on fees, efficiency in order handling procedures,
and efficiency in the selection of trading venues or counterparties,
which in turn, would result in better execution quality for retail
customer trades.
(b) Efficiency
    The Commission preliminarily believes the proposal would improve
price efficiency in asset markets because broker-dealers will need to
consider a wider range of markets and execution methodologies when
routing customer orders. By facilitating competition between a larger
pool of liquidity providers, more liquidity providers may be
incentivized to compete to provide liquidity. This would provide a
wider range of quotes and facilitate price efficiency to the extent
that the expanded liquidity pool provides more informative quotes.
    While the Commission preliminarily believes the proposal could
improve retail order execution prices,\602\ the Commission recognizes
that it could take longer for conflicted orders to be executed because
broker-dealers might need to consider additional venues before routing
an order, and they may need to perform more routings before the order
is fulfilled. It is possible that market prices could move unfavorably
during this time.
---------------------------------------------------------------------------

    \602\ See supra Section V.C.1.
---------------------------------------------------------------------------

(c) Capital Formation
    The Commission preliminarily believes that the proposal may improve
capital formation by incentivizing broker-dealers to allocate
additional capital to the provision of liquidity. The proposal's
requirement that broker-dealers consider additional pricing information
and execution venues before routing customer orders and heightened
standards for best execution for conflicted transactions may result in
more order flow being routed to venues with competitive quotations. If
such quotations are more likely to result in executions, particularly
with retail order flow that usually carries lower adverse selection
costs to broker-dealers,\603\ broker-dealers would have greater
incentives to provide such quotations.
---------------------------------------------------------------------------

    \603\ See, e.g., Barber, Brad M., and Terrance Odean, Trading is
hazardous to your wealth: The common stock investment performance of
individual investors?, 55 J. Fin. 773 (2000).
---------------------------------------------------------------------------

    The Commission also recognizes that liquidity provision in thinly
traded and unlisted securities may decrease. Currently, broker-dealers
with business models that specialize in internalizing retail order flow
may be providing liquidity in very thinly traded securities as part of
a bundle of services that they provide to their customers. If the
internalization of retail orders decreases as the Commission
preliminarily believes it might, broker-dealers may be faced with
difficult liquidity searches when their customers wish to trade thinly
traded or unlisted securities. It is possible that an increase in
retail demand for liquidity in these securities may be met with an
increase in liquidity supply from firms that are more willing under the
proposal to make markets in these securities than they were when a
greater proportion of retail flow was internalized. To the extent that
broker-dealers' willingness to make markets in these securities
decreases overall, this may increase trading costs for these securities
and make it more difficult for companies to go public before they are
eligible to be listed on registered exchanges.

D. Reasonable Alternatives

1. SEC Adopts FINRA Rule 5310 and MSRB Rule G-18 Best Execution Rules
    As an alternative, the Commission could adopt existing FINRA Rule
5310 and MSRB Rule G-18 rules and associated guidance. This alternative
would have lower costs and benefits compared to the proposal, because
changes \604\ in order handling practices would be unlikely to occur
under this alternative compared to the proposal. Under this
alternative, improvements to investor protection might be less than
those from the proposed rules.
---------------------------------------------------------------------------

    \604\ See supra Sections V.C.1, V.C.2, and V.C.3 for the
Commission's projections on the effect of broker-dealers' order
handling practices.
---------------------------------------------------------------------------

    This alternative would not include the enhanced requirements within
proposed Rule 1101(b) related to transactions with broker-dealer
subject to specified conflicts of interest, which represent the
majority of retail transactions in the equity, options, and fixed
income markets.\605\ Proposed Rule 1101(b) would require a broker-
dealer engaging in conflicted transactions to address additional
considerations in its best execution policies and procedures, and to
document its compliance with the best execution standard for such
transactions. To the extent that the proposal would have resulted in
improved execution quality for the retail orders by reducing the
inefficiencies \606\ present in existing conflicted transactions, this
alternative would result in less improvement in retail investor
execution quality compared to the proposal.
---------------------------------------------------------------------------

    \605\ See supra Section IV.C.1 and Section IV.C.2.
    \606\ The inefficiencies associated with existing conflicts of
interest include, but are not limited to, the trade-off between
payment for order flow and price improvement for equities (See supra
Section V.B.3.a.iii.) and the less than fully competitive price
improvement auction mechanisms for options (See supra Section
V.B.3.a.II.b.).
---------------------------------------------------------------------------

    Under this alternative, broker-dealers would still qualify for
relief under FINRA Rule 5310.09(c), instead of having to meet the
introducing broker requirements to qualify for the propose relief under
proposed Rule 1101(d). Broker-dealers that meet the requirements of
FINRA's relief but would not have met the requirements of proposed Rule
1101(d) would experience lower compliance costs under this alternative
because they would not have to develop or update their own policies or
procedures or adjust their business model to de-conflict from their
executing broker.\607\ The costs of the proposal could advantage larger
broker-dealers, increase barriers to entry for new broker-dealers, and
disadvantage smaller broker-dealers, which could potentially result in
some of them existing the market.\608\ The lower compliance costs under
this alternative would increase competition among broker-dealers
compared to the proposal by lowering barriers to entry for new broker
dealers and decreasing the likelihood that smaller broker-dealers would
exit the market.\609\
---------------------------------------------------------------------------

    \607\ See supra Section V.C.1.
    \608\ See supra Section V.C.3.(a).ii for a discussion of the
effects of the proposal on competition between broker-dealers.
    \609\ See id.
---------------------------------------------------------------------------

2. Require Order Execution Quality Disclosure for Other Asset Classes
    Standardized information on the execution quality available at
different market centers and for different executing brokers could aid
broker-dealers in their best execution reviews. However, only market
centers executing trades in NMS stocks are required to report
standardized execution quality statistics under Rule 605.\610\ This
alternative would require execution quality disclosures from market
centers and large broker-dealers in the options and fixed income
markets. In addition to execution quality data at the individual
security-level, similar to Rule 605 data, the execution quality
disclosures would include aggregated

standardized summary reports of key execution quality statistics, which
would allow smaller and less sophisticated investors to analyze and
make comparisons between their own broker-dealers and other broker-
dealers. Compared to the proposal, these disclosures may better allow
investors to evaluate execution quality for their orders within their
broker-dealer's overall executions in a given security and facilitate
broker-to-broker comparison of order execution beyond equities markets.
Although the proposed rule would require each broker-dealer to
establish policies and procedures with greater specificity, this does
not necessarily mean that the order handling practices reach the same
level of efficiency across the broker-dealers. It is possible that some
broker-dealers would handle the customer orders less efficiently than
others. Under the alternative, broker-dealers, which engage in less
efficient order handling practices may recognize the inadequacy when
comparing their own execution quality statistics with those disclosed
by the more efficient broker-dealers, and improve the order handling
practices accordingly to attract order flow. Therefore, increased
transparency may reduce differences in execution quality within
specific security-time intervals, particularly in the corporate and
municipal bond markets. Broker-dealers may be able to incorporate these
execution quality statistics into their best execution policies and
procedures, which could improve their ability to identify market
centers that offer better execution quality, resulting in potentially
greater improvements in order handling compared to proposal. This
alternative may increase competition among broker-dealers and trading
centers in asset classes other than NMS stocks compared to the proposal
by promoting competition based more on the basis of publicly available
execution quality and less on other inducements to attract more
customers/order flow.
---------------------------------------------------------------------------

    \610\ The Commission also is proposing to amend the order
execution quality disclosures required by Rule 605. See Securities
Exchange Act Release No. 96494 (Dec. 14, 2022). The Commission
encourages commenters to review that proposal to determine whether
it might affect their comments on this proposing release.
---------------------------------------------------------------------------

    However, developing these execution quality disclosures may cause
market centers and large broker-dealers in the options and fixed income
markets to incur higher startup costs relative to the proposal as
market centers would need to develop systems to produce and post such
reports. To the extent that certain market centers already have systems
or infrastructures in place to produce execution quality metrics, they
would incur costs to modify the current systems and/or the format of
the reports in order to comply with the standards set forth in the
execution quality disclosure requirements. Additionally, execution
quality disclosures for the options and fixed income markets may be
complex and difficult to produce for a number of reasons. First, the
number of individual securities in the options and fixed income markets
is significantly larger than in the equity markets. The corporate bond
market has approximately 58,000 outstanding issues, more than fourteen
times the number of NMS listed equities.\611\ This number is small in
comparison to the municipal bond market which has approximately one
million outstanding issues.\612\ Individual equities can have hundreds
of individual outstanding options contract identifiers. Second, fixed
income and options securities have defined maturities, which might be
shorter than a disclosure interval (i.e., a contract with a week
expiration relative to a monthly reporting period). This security-level
inconsistency may present complications in evaluating time series
changes in execution quality. Finally, a broad lack of pre-trade
information in fixed income markets make execution quality statistics
such as effective-quoted spread ratios difficult, if not impossible, to
calculate for many securities.
---------------------------------------------------------------------------

    \611\ See O'Hara and Zhou, supra note 469.
    \612\ See Muni Facts, Municipal Securities Rulemaking Board,
available at https://www.msrb.org/News-and-Events/Muni-Facts.
---------------------------------------------------------------------------

3. Utilize FINRA and MSRB Approach To Introducing Broker
    The Commission could alternatively propose to remove the
requirements for introducing and executing brokers related to PFOF,
carrying firm status, and affiliation. This definition would more
closely align with FINRA and MSRB approach to introducing brokers.
FINRA Rule 5310.09(c) applies to a member that routes its order flow to
another member that has agreed to handle that order flow as agent for
the customer (e.g., a clearing firm or other executing broker-dealer),
whereas the proposal would additionally require the firm not to be a
carrying firm, accept PFOF from an executing broker, or route customer
orders to an affiliated executing broker. Under this alternative, it is
likely that most brokers that qualify under FINRA Rule 5310(c) would
qualify as introducing brokers under proposed Rule 1101(d). By
categorizing more broker-dealers as ``introducing brokers,'' the
overall compliance cost carried by the market would be lower as
compared to the proposed rule. This alternative would likely cause
fewer small broker-dealers, which currently qualify for relief under
FINRA Rule 5310.09(c) and MSRB Rule G-18.08(b) and wish to remain
conflicted or still carry customer accounts, to change business models
to comply with the alternative rule.\613\
---------------------------------------------------------------------------

    \613\ See supra Section V.C.1.
---------------------------------------------------------------------------

    The brokers who benefit under this alternative are those who
currently qualify for relief under FINRA Rule 5310.09(c) and MSRB Rule
G-18.08(b) but fail at least one of the following criteria include in
proposed Rule 1101(d): (i) does not carry customer accounts and does
not hold customer funds or securities, (ii) has entered into an
arrangement with an unaffiliated broker or dealer that has agreed to
handle and execute on an agency basis the introducing broker's customer
orders (``executing broker''), and (iii) has not accepted any monetary
payment, service, property, or other benefit that results in
remuneration, compensation, or consideration from the executing broker
in return for the routing of the introducing broker's customer orders
to the executing broker. Thus, many current broker-dealers that qualify
for relief under the FINRA and MSRB rules, and to some extent their
executing brokers, would have lower costs of compliance since there
would be no need for those broker-dealers to change their business
models. Also, this alternative may lower barriers to entry for some
potential introducing brokers. However, under this alternative, the
benefits of the proposal would also be diminished. With more broker-
dealers meeting the proposal's definition of introducing broker, the
benefits compared to the proposal would be lower. Specifically under
this alternative, the Commission preliminarily believes that instead of
changing their business models to stop being conflicted, introducing
brokers and their executing brokers would be more likely to engage in
conflicted transactions, and more introducing brokers would receive
PFOF. Therefore, the execution quality benefits would be lower since
the incentive created by the PFOF would persist, potentially leading to
less efficient order routing which may benefit broker-dealers at the
expense of retail customers.
4. Ban or Restrict Off-Exchange PFOF
    Rather than requiring heightened best execution standards for
transactions involving PFOF, alternatively the Commission could ban or
restrict off-exchange PFOF in the equity and options markets. Under
this alternative, registered exchanges would still be allowed to pay
rebates.

    Compared to the proposal, this alternative may further reduce
conflicts of interest within and improve order handling practices by
retail broker-dealers. A 2016 study sponsored by CFA Institute examined
changes in equity market execution quality following the Financial
Services Authority (FSA) 2012 guidance banning PFOF in the United
Kingdom.\614\ The study describes internalization under PFOF as a
scenario that can increase the probability of conflicted equity and
options transactions, particularly for retail investors, in the United
Kingdom. The study finds that over the time period from 2010 to 2014,
the proportion of retail-sized trades executing at the best quoted
price increased from around 65% to more than 90%. The authors claim
these findings suggest that the integrity of the order book improved.
---------------------------------------------------------------------------

    \614\ See Sviatoslav Rosov, Payment for Order Flow in the United
Kingdom: Internalisation [sic], Retail Trading, Trade-Through
Protection, and Implications for Market Structure, CFA Institute
(2016), available at https://www.cfainstitute.org/en/advocacy/policy-positions/payment-for-order-flow-in-the-united-kingdom.
---------------------------------------------------------------------------

    Alternatively, rather than an outright ban on PFOF, the Commission
could impose specific restrictions on PFOF that could allow retail
broker-dealers to pass through payments to end customers in cases where
it would permit best execution. For example, a retail broker-dealer may
consider two order execution venues with different executable prices:
the first venue has a more favorable price, and the second venue
provides PFOF to the retail broker-dealer. If the difference in price
between the two venues is smaller than the PFOF for the order in
question, the retail-broker could return to the customer the portion of
PFOF, which is greater than the venue price difference.
    A ban or restriction on PFOF would increase the likelihood of
higher commissions for retail investors or an increase in the cost of
other services offered by retail broker-dealers compared to the
proposal. It may also further reduce competition between broker-dealers
compared to the proposal. Larger broker-dealers with more diversified
business models may be more likely to expand their market share and
smaller broker-dealers who are more dependent on PFOF revenue streams
may be more likely to exit the market.
5. Require Broker-Dealers To Utilize Best Execution Committees
    The Commission considered requiring each broker-dealer to maintain
a best execution committee to regularly review the broker-dealer's best
execution policies, procedures and the results of its efforts to secure
best execution for its customers.
    Requiring such a committee and defining its membership might
improve execution quality by ensuring sufficient expertise is recruited
to establish and monitor the broker-dealer's best execution efforts.
Furthermore, requiring such a committee might increase executive
attention to best execution, potentially improving execution quality
for the broker-dealer's customers.
    Requiring such a committee and defining its membership would entail
certain costs in addition to those resulting from the proposed rules.
First, if the Commission were to define the membership of the
committee, it is likely that individual broker-dealers' organizational
structures would vary in ways that would make a defined membership
structure a poor fit because of, for instance, a single employee
performing multiple roles, or individual roles handled by groups rather
than a single individual. In addition, broker-dealers are diverse in
their business plans and operations and a role that might be considered
critical at one broker-dealer (such as managing fixed income executing
brokers in thinly traded bonds) might be inapplicable at another
broker-dealer that does not trade in these instruments.
    If the Commission were to require the committee and not define its
membership, broker-dealers might assign to the committee less senior
staff or staff whose roles are not germane to achieving best execution
for customer orders, significantly limiting the benefits of
establishing such a committee. Furthermore, based on the its
experience, the Commission believes that broker-dealers, particularly
large broker-dealers that are more likely to continue to engage in
conflicted transactions if the proposed rules are adopted, may have
such a committee already established, further limiting the potential
benefits of such a provision.
6. Require Order-by-Order Documentation for Conflicted or All
Transactions
    The Commission considered requiring each broker-dealer to document
on an order-by-order basis, for conflicted or all transactions, the
data that it considered as it handled the order. Such a requirement
might offer two benefits beyond the benefits of the proposed rules.
First, it might improve the quality of the broker-dealer's regular
review of its execution practices compared to the proposed rules.
Because the broker-dealer would analyze orders on a case-by-case basis,
it might identify routing practices that could be changed to improve
customer order execution quality. Second, it might improve regulators'
ability to oversee the broker-dealer's efforts to provide best
execution to its customers relative to the proposed rules as such
records would be available to regulators during examinations of the
broker-dealer or upon request.
    The Commission preliminarily believes that such a requirement would
offer greater potential benefits for conflicted transactions because
broker-dealers engaging in such transactions have greater incentives to
route orders in a manner that might not result in the best execution
for customers.
    Based on its experience, the Commission believes that some broker-
dealers, particularly the largest broker-dealers that are likely to
continue to engage in conflicted transactions if the proposed rules are
adopted, already maintain this type of documentation for both internal
review and operational purposes. Nevertheless, the requirement would be
costly. Broker-dealers that do not already retain this data likely have
chosen not to do so because the data are not operationally valuable to
them for business purposes, and they believe that they are satisfying
their best-execution obligations based on other data that they have
available. For these broker-dealers, the requirement could impose
considerable costs. They would need to alter information technology
systems to capture this data, including contemporaneous pricing data
and routing records, some of which (such as prices offered in response
to a RFQ and much information related to fixed income and digital
crypto assets) is not incorporated into other regulatory data sources
such as CAT and thus might be stored on systems not integrated with
other order routing systems, or systems that capture regulatory data.
Processing this data might be computationally demanding, particularly
for options, that have very high quotation traffic. Furthermore,
creating and maintaining software to produce this documentation would
require significant effort by highly skilled programmers, which would
further increase the costs associated with such a requirement. As
discussed previously,\615\ the Commission preliminarily believes that
broker-dealers that elect to refrain from conflicted transactions if
the proposed rules are adopted are more likely to be smaller broker-
dealers and these costs, many of which are fixed, are more likely to
result in the broker-dealer changing

its business model or exiting the market, while the aggregate benefits
to investors of such a requirement for smaller broker-dealers is likely
to be smaller than for larger broker-dealers that handle more customer
orders.
---------------------------------------------------------------------------

    \615\ See Section V.C.2.ii, supra.
---------------------------------------------------------------------------

7. Staggered Compliance Dates
    The Commission considered an alternative approach where smaller
broker-dealers would be given more time to comply with the proposed
rules. Having longer to comply might ease implementation for smaller
broker-dealers that are less likely to have specialized staff to
conduct tasks required for compliance. However, the later compliance
date for smaller broker-dealers would also delay the realization of the
proposed rules' benefits for investors.
    The Commission preliminarily believes that the cost savings of the
alternative could be small. Specifically, under the proposed rules,
smaller broker-dealers would likely qualify as introducing brokers and
would likely de-conflict rather than continue to engage in conflicted
transactions and incur the additional costs associated with the rule
requirements that introducing brokers are exempt from under Rule
1101(d).\616\ Consequently, the Commission preliminarily believes
smaller broker-dealers would have fewer requirements to implement under
the proposal, mitigating the burden of implementation relative to
larger broker-dealers. In addition, the Commission believes that
smaller broker-dealers would likely engage external parties for review
of proposed policies and procedures and for assistance in conducting
annual reviews; this reliance on external resources for implementation
activities would likely mitigate the burden of implementation on
current staff.\617\ These mitigations would limit the potential cost
savings of delaying implementation for smaller broker-dealers.
---------------------------------------------------------------------------

    \616\ See supra section V.C.2.a for discussion of carrying and
conflicted broker-dealer costs.
    \617\ See supra section V.C.2.a).ii for the discussion about the
cost associated with small broker-dealers utilizing external
sources.
---------------------------------------------------------------------------

E. Request for Comments

    The Commission is sensitive to the potential economic effects,
including costs and benefits, of the proposed rule. The Commission has
identified certain costs and benefits associated with the proposal and
requests comment on all aspects of its preliminary economic analysis,
including with respect to the specific questions below. The Commission
encourages commenters to identify, discuss, analyze, and supply
relevant data, information, or statistics regarding any such costs or
benefits. In addition to our general request for comments on the
economic analysis associated with the proposed rules and proposed
amendments, we request specific comment on certain aspects of the
proposal:
    159. What are commenters' views of the Commission's economic
rationale for the proposed rule?
    160. What are commenters' views of the Commission's
characterization of the relevant baseline, against which it considered
the effects of the proposal?
    161. What are commenters' views of the Commission's
characterization of the current legal and regulatory framework?
    162. What are commenters' views of the Commission's
characterization of the conflicts of interest in order handling and a
need for heightened best execution requirements with respect to
conflicted transactions?
    163. What are commenters' views of the Commission's
characterization of the conflicts of interest in order handling with
respect to PFOF?
    164. What are commenters' views of the Commission's
characterization of the conflicts of interest in order handling with
respect to principal trading?
    165. What are commenters' views of the Commission's
characterization of order handling and execution?
    166. What are commenters' views of the Commission's
characterization of retail customer order handling and execution for
NMS stocks?
    167. What are commenters' views of the Commission's
characterization of retail customer order handling and execution for
listed options? Do commenters believe that the majority of retail
orders are routed to the wholesalers in exchange of payment for order
flow by the retail brokers? Do commenters believe whether there is a
trade-off between price improvement received for those retail orders
and payment for order flow?
    168. What are commenters' views of the Commission's
characterization of retail customer order handling and execution for
fixed income securities? The Commission requests information on the
number of trading venues (e.g., ATSs, RFQ platforms, broker's broker
platforms, single platforms), to which broker-dealers currently
maintain access, for the purpose of executing and exposing retail
customer orders. The Commission requests information with respect to
how broadly broker-dealers expose retail customer orders. The
Commission requests information with respect to how many executing
brokers, to which broker-dealers outsource their fixed income
securities trading services. The Commission requests information on
what broker-dealers currently document (e.g., efforts to apply its best
execution policies and procedures for conflicted transactions, the
basis and information relied on for its determinations that such
conflicted transactions would comply with the best execution standard,
identifying the markets checked, internal quotes, external quotes,
limit orders on trading venues) with respect to retail customer orders.
    169. The Commission requests comments on retail customer order
handling and execution for non-NMS stock equity securities. Please
provide any relevant details and data on retail customer order handling
and execution of non-NMS stock equity securities for assessing the
effects of the proposal.
    170. What are commenters' views of the Commission's
characterization of retail customer order handling and execution for
crypto asset securities?
    171. What are commenters' views of the Commission's
characterization of best execution review process?
    172. What are commenters' views of the Commission's
characterization of execution quality review?
    173. What are commenters' views of the Commission's
characterization of best execution committees?
    174. What are commenters' views of the Commission's
characterization of the competition in the market for broker-dealer
services?
    175. What are commenters' views of the Commission's
characterization of the competition in the market for NMS stock trading
services?
    176. What are commenters' views of the Commission's
characterization of the competition in the market for listed options
trading services? Do commenters believe that the current features of
price improvement auctions are favoring the wholesalers that bring the
order flow and therefore not competitive?
    177. What are commenters' views of the Commission's
characterization of the competition in the market for fixed income
securities trading services?
    178. What are commenters' views of the Commission's
characterization of the competition in the market for corporate debt
securities trading services?
    179. What are commenters' views of the Commission's
characterization of the competition in the market for municipal
securities trading services?
    180. What are commenters' views of the Commission's
characterization of

the competition in the market for U.S. Treasury securities trading
services?
    181. What are commenters' views of the Commission's
characterization of the competition in the market for market access?
    182. What are commenters' views of the Commission's assessment of
the benefits of the proposal?
    183. To what extent do commenters believe that broker-dealers will
make changes to their order handling procedures due to regulatory risk?
What kind of changes might they make? Does the proposal adequately
reflect the costs they would bear? Please provide estimates of the
costs if possible.
    184. To what extent do commenters believe conflicted broker-dealers
will add additional routing destinations to expose orders to venues
beyond those identified as material potential liquidity sources for
non-conflicted transactions?
    185. Are there some markets, in which finding venues beyond those
identified as material potential liquidity sources for non-conflicted
transactions difficult? Please explain. To what extent will seeking
such additional sources of liquidity be cost efficient?
    186. What are commenters' views on the Commission's discussion of
ATS connectivity charges?
    187. What are commenters' views of the Commission's assessment of
the effects stemming from changes in order handling procedures?
    188. What are commenters' views on the extent to which investor
execution quality will change under the proposal? Please explain.
    189. To what extent will carrying broker-dealers face additional
challenges and bear additional costs to comply with the proposal beyond
those already discussed in the Economic Analysis? Will the additional
restrictions on carrying broker-dealers improve investor execution
quality?
    190. To what extent do broker-dealers that would be categorized as
``conflicted'' under the proposal already comply with the heightened
standards described by the proposal? Will these broker-dealers face
additional challenges and bear additional costs complying with the
proposal beyond those already discussed in the Economic Analysis?
Please explain.
    191. Do commenters agree with the Commission's preliminary belief
that broker-dealers that receive relatively small payments for order
flow or other incentives that would categorize them as conflicted, may
choose to stop receiving those incentives to comply with the proposal?
Does the Economic Analysis adequately reflect the cost of the proposal
to these broker-dealers? Is the Commission's assumption that broker-
dealers with less than $100MM in total assets are likely to de-conflict
to avoid the heightened standards associated with conflicted
transactions reasonable?
    192. Are some broker-dealers likely to pass exchange rebates
through to customers in order to avoid being conflicted under the
proposal? Are there other ways for broker-dealers to deal with these
rebates that would be less costly to implement? What costs would
broker-dealers bear to pass exchange rebates through to their
customers?
    193. When a broker-dealer makes changes to its order routing in
response to execution quality analysis, what costs does it incur? Are
the Commission's estimates of these costs reasonable?
    194. Do commenters believe that broker-dealers that currently pay
to receive order flow may assist their broker-dealer clients in
complying with the proposal by providing additional information on
their policies and procedures to provide best execution? What
information would they need to provide and how proprietary is this
information?
    195. Do commenters believe that broker-dealers that currently pay
to receive order flow are significant contributors to the market for
liquidity provision in thinly traded securities? Would the proposal
disrupt liquidity provision to securities that are thinly traded? In
which types of securities would these effects be most pronounced?
    196. Do commenters believe that the proposal is likely to increase
the prevalence of commissions in retail trading? In which asset classes
would such changes be most likely?
    197. What are commenters' views of the Commission's assessment of
the effects stemming from changes in order handling procedures for NMS
stocks?
    198. What are commenters' views of the Commission's assessment of
the effects stemming from changes in order handling procedures for
listed options? Do commenters believe that more retail orders would be
routed to price improvement auctions for execution? Do commenters
believe that more retail orders would be routed to the exchanges that
offer price improvement order types on the limit order books?
    199. What are commenters' views of the Commission's assessment of
the effects stemming from changes in order handling procedures for on-
the-run U.S. Treasury securities?
    200. What are commenters' views of the Commission's assessment of
the effects stemming from changes in order handling procedures for
fixed income securities (excluding on-the-run U.S. Treasury
securities)?
    201. With respect to fixed income securities trading, do commenters
believe that the proposal (e.g., the documentation requirement with
respect to conflicted transactions) would enhance internal review
(e.g., internal review by best execution committee) of execution
quality?
    202. With respect to fixed income securities trading, do commenters
believe that the proposal would improve the execution quality of retail
customer trades by executing brokers? Please explain.
    203. The Commission requests comments on the effects stemming from
changes in order handling procedures for non-NMS stock equity
securities.
    204. What are commenters' views of the Commission's description of
the non-NMS stock equity market? Please highlight any omitted or
misunderstood elements on this market.
    205. Do commenters agree with the Commission's characterization of
internalization in the non-NMS stock equities market?
    206. Do commenters agree with the assertion that the non-NMS stock
equity market can offer a high degree of transparency in liquid
securities? Please list any sources of pre-trade and post-trade
information used when transacting in this market.
    207. What are commenters' views on the necessity to connect to any
given ATS when transacting in non-NMS stock equities? Please explain
the rationale for connecting to an additional ATS in this market. If
there are other non-ATS sources of liquidity, please describe them.
    208. Do commenters believe the effects of the proposed rule on the
non-NMS equity securities market will cause any brokers (introducing or
otherwise) to reduce participation in or to exit this market? Please
describe the rationale for any response.
    209. Do commenters believe the requirements of this rule will have
effects on the liquidity in the market for non-NMS stock equities?
Please explain.
    210. Do commenters believe that execution quality can be accurately