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Request for Comment
    The Commission requests comment on all aspects of proposed Rules
1101(b)(1) and (2), and in particular:
    76. Do proposed Rules 1101(b)(1) and (2) represent an appropriate
approach to addressing conflicted transactions? Why or why not?
    77. Should a broker-dealer be required to establish, maintain, and
enforce best execution policies and procedures for conflicted
transactions that address the additional requirements under proposed
Rules 1101(b)(1) and (2)? Why or why not?
    78. Should a broker-dealer's policies and procedures for conflicted
transactions be required to address how it will obtain and assess
information beyond what it would obtain and assess for non-conflicted
transactions, including additional information about price, volume, and
execution quality, in identifying a broader range of markets beyond the
material potential liquidity sources? Why or why not?
    79. Should a broker-dealer's policies and procedures for conflicted
transactions be required to address how it will evaluate a broader
range of markets beyond material potential liquidity sources, including
a broader range of order exposure opportunities and markets that may be
smaller or less accessible? Why or why not?
    80. Would retail customers benefit from potentially having their
orders exposed by a broker-dealer to a broader array of liquidity
sources where the broker-dealer would have a conflict of interest? Why
or why not?
    81. Should proposed Rules 1101(b)(1) and (2) include different or
additional requirements for conflicted transactions in different asset
classes? Please explain.
    82. What challenges, if any, would broker-dealers encounter in
implementing proposed Rules 1101(b)(1) and (2)? Please explain.
    83. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rules 1101(b)(1) and (2) for
broker-dealers of different sizes, if the Commission adopts proposed
Regulation Best Execution? For example, should the Commission provide
longer compliance dates for smaller broker-dealers? If so, should the
Commission define a smaller broker-dealer as a broker-dealer that
qualifies as a ``small entity'' under the Regulatory Flexibility Act
pursuant to 17 CFR 240.0-10(c) for this purpose? \193\

Or should the Commission define a smaller broker-dealer in a different
way? Please explain.
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    \193\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
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2. Proposed Rule 1101(b)(3)--Documentation for Conflicted Transactions
    Proposed Rule 1101(b)(3) would require a broker-dealer to document
its compliance with the best execution standard for conflicted
transactions, including all efforts taken to enforce its policies and
procedures for conflicted transactions and the basis and information
relied on for its determination that such conflicted transactions would
comply with the best execution standard. Proposed Rule 1101(b)(3) would
require that such documentation be done in accordance with written
procedures.
    The Commission understands that broker-dealers currently differ in
documentation practices relating to their compliance with their duty of
best execution, and some broker-dealers currently retain information
that allows them to recreate the prices that were available at the time
of an execution. While proposed Rule 1101(b)(3) would not require a
broker-dealer to document its compliance with the best execution
standard with respect to its conflicted transactions in any specific
way, the broker-dealer would need to document all efforts taken to
enforce its policies and procedures for its conflicted transactions
\194\ and to demonstrate the basis and information relied on for its
determination that its conflicted transactions would comply with the
best execution standard.\195\ Proposed Rule 1101(b)(3) also would not
prescribe the manner in which a broker-dealer would need to document
its compliance with the proposed best execution standard, and the
Commission preliminarily believes that the manner of documentation may
vary depending on various considerations specific to the broker-dealer,
such as the nature of its customers and the characteristics of the
securities traded. The Commission preliminarily believes that, in
connection with documenting its compliance with the proposed best
execution standard and its best execution determinations for conflicted
transactions, the broker-dealer could document the prices received from
those markets that it checked pursuant to its policies and procedures.
The Commission preliminarily believes that such information could serve
as a basis for demonstrating a broker-dealer's best execution efforts
and determinations, and broker-dealers already maintain much of this
information pursuant to existing regulatory or operational
requirements.\196\
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    \194\ A failure to have the policies and procedures required by
proposed Rule 1101(b) that are applicable to all conflicted
transactions, or a failure to enforce such policies and procedures,
would be a violation of proposed Regulation Best Execution.
    \195\ This proposed documentation requirement would differ from
proposed Rule 1101(a), which would more generally require the
broker-dealer's policies and procedures to be reasonably designed to
comply with the best execution standard and to address a number of
specified elements.
    \196\ The Commission preliminarily believes that this
documentation would be similar to many of the records that broker-
dealers currently maintain pursuant to regulatory requirements, such
as trade-through prohibitions and the National Market System Plan
Governing the Consolidated Audit Trail (``CAT Plan'') reporting. For
example, the CAT Plan requires a broker-dealer to report the entire
lifecycle of an order. See CAT Plan, Appendix C, Section A. 2 (3);
See also Rule 613(c)(1) of Regulation NMS, 17 CFR 242.613(c)(1)
(stating that the CAT plan must provide for an accurate, time-
sequenced record of orders beginning with the receipt or origination
of an order by a member of a national securities exchange or
national securities association, and document the life of the order
through the process of routing, modification, cancellation, and
execution (in whole or in part) of the order). This order lifecycle
information that today is reported to the CAT Plan could include
information that is relevant for the documentation provision of
proposed Rule 1101(b). For example, in documenting the markets
checked, a broker-dealer that routes customer orders to markets in
an attempt to access midpoint liquidity could retain records
concerning the markets it pinged for potential midpoint executions.
---------------------------------------------------------------------------

    The proposed documentation requirement, including the obligation to
document pursuant to written procedures, would assist broker-dealers in
complying with proposed Regulation Best Execution and regulators in
overseeing broker-dealers' compliance. As stated above in this section,
while the Commission understands that some broker-dealers retain
information that allows them to recreate the prices that were available
at the time of an execution (for example, in response to a regulatory
inquiry), the Commission understands that broker-dealers have varying
degrees of documentation with respect to their best execution
practices. By specifically requiring all broker-dealers that engage in
conflicted transactions to document their compliance with the proposed
best execution standard, including all efforts to enforce their
policies and procedures, and the basis and information relied on for
their determinations that the conflicted transactions would comply with
the best execution standard, such broker-dealers would be required to
collect important information concerning the application of their best
execution process. This information may help broker-dealers better
evaluate the effectiveness of their best execution policies and
procedures, including their order handling practices. Moreover, by
requiring that the documentation be conducted pursuant to written
procedures, the proposed rule would help ensure that all broker-dealers
that engage in conflicted transactions (and any applicable associated
persons of such broker-dealers) document their compliance with the best
execution standard in a consistently robust manner.\197\ Similarly, the
proposed documentation requirement would help ensure that regulators
have access to a consistent and minimum level of information in
overseeing broker-dealers' efforts to satisfy the best execution
standard in proposed Rule 1100 with respect to conflicted transactions
with retail customers.
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    \197\ For example, the written procedures concerning
documentation could describe the obligations of various personnel
within the broker-dealer with respect to this documentation
requirement.
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    Proposed Rule 1101(b)(3) would also require a broker-dealer to
document any arrangement, whether written or oral, concerning payment
for order flow, including but not limited to the parties to the
arrangement, all qualitative and quantitative terms concerning the
arrangement,\198\ and the date and terms of any changes\199\ to the
arrangement.\200\ This proposed documentation requirement would
complement the other requirements of proposed Rule 1101(b), and could
facilitate a broker-dealer's understanding of the effect of such
arrangements on its order handling and execution practices, and more
broadly, on its compliance with the best execution standard and
proposed Rules

1100-1102. This proposed requirement would also help ensure that
regulators have fuller and more efficient access to details regarding
broker-dealers' payment for order flow arrangements,\201\ which in turn
should facilitate regulators' oversight of broker-dealers' compliance
with the proposed rules by providing more context with respect to
broker-dealers' operations, business model, and order handling and
execution practices.
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    \198\ Qualitative and quantitative terms would include any terms
that impact the variability or establish a condition concerning
payment for order flow. These could include, for example, any terms
based on the characteristics of an order (e.g., size, marketability,
held or not held, special order handling instructions, whether the
order is a complex options order) and the type of security involved
(e.g., whether the security is in the S&P 500 Index, ETF) or the
price of a security.
    \199\ The proposed rule would require a broker-dealer to
document the date and terms of any changes to an existing payment
for order flow arrangement.
    \200\ This proposed requirement would apply whether or not there
is any contractual obligation associated with the payment for order
flow arrangement, and is intended to capture payment for order flow
arrangements between broker-dealers and between broker-dealers and
other markets, such as exchanges. Such documentation would be
required in any scenario where payment for order flow is actually
made or received by a broker-dealer. This proposed documentation
requirement would also apply to rebates paid by an exchange to a
broker-dealer in return for routing orders to the exchange. For
example, a broker-dealer must document the specific rebate tiers
that it qualifies for with respect to each exchange from which it
receives payment for order flow. Furthermore, should a broker-dealer
have an arrangement with an exchange for the establishment of a tier
aimed at earning that broker-dealer's order flow, the broker-dealer
must document that arrangement.
    \201\ Existing Commission rules, such as Rule 10b-10(d)(8), 17
CFR 240.10b-10(d)(8), and Rule 606 under Regulation NMS, 17 CFR
242.606, do not require the same level of detail with respect to the
payment for order flow practices of broker-dealers that would be
required under proposed Rule 1101(b)(3).
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Request for Comment
    The Commission requests comment on all aspects of the proposed
documentation requirement under proposed Rule 1101(b)(3), and in
particular:
    84. Are the proposed documentation requirements appropriate? Why or
why not?
    85. Should such documentation requirements apply only to broker-
dealers' conflicted transactions? Alternatively, should they apply to
all transactions, including non-conflicted transactions? Or should they
apply to all conflicted transactions and to a subset of non-conflicted
transactions? Please explain.
    86. Should such documentation be required to be done pursuant to
written procedures? Please explain.
    87. As proposed, a broker-dealer would need to document, for its
conflicted transactions, its compliance with the best execution
standard, including all efforts taken to enforce its best execution
policies and procedures for conflicted transactions and the basis and
information relied on for its determinations that the conflicted
transactions would comply with the best execution standard. What
challenges, if any, would a broker-dealer encounter in complying with
the proposed documentation requirements? Would such challenges differ
based on the type of security being traded or the type of broker-dealer
engaging in the conflicted transactions? Please explain.
    88. Do commenters agree with the Commission's understanding that
broker-dealers have varying degrees of documentation with respect to
their best execution practices? Why or why not?
    89. Should the proposed documentation requirements apply only to
certain types of conflicted transactions or for all types of conflicted
transactions? Please explain.
    90. Should broker-dealers in the NMS stock and listed options
markets be subject to the documentation requirements for the orders
they execute on a principal basis, or for which they have paid or
received payment for order flow, or routed to an affiliate, as
proposed? Why or why not?
    91. Should broker-dealers in the corporate and municipal bond
markets and government securities markets be subject to the
documentation requirements for the orders they execute on a principal
basis, as proposed? Why or why not?
    92. Are there other aspects of the proposed additional requirements
for a broker-dealer's policies and procedures for conflicted
transactions that should also be required to be documented? Please
explain.
    93. Are there practices other than the proposed additional
requirements for conflicted transactions that should be required to be
documented? Please explain.
    94. Should a broker-dealer be required to document any payment for
order flow arrangement, whether written or oral, as proposed? Why or
why not? If so, should such documentation requirements include the
parties to the arrangement, all qualitative and quantitative terms
concerning the arrangement, and the date and terms of any changes to
the arrangement? Why or why not? Are there other aspects of the
arrangements that should also be included in the documentation
requirement? If so, please describe.
    95. Are there other types of arrangements involving conflicted
transactions that should also be subject to a documentation
requirement? Please explain.
    96. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1101(b)(3) for broker-
dealers of different sizes, if the Commission adopts proposed
Regulation Best Execution? For example, should the Commission provide
longer compliance dates for smaller broker-dealers? If so, should the
Commission define a smaller broker-dealer as a broker-dealer that
qualifies as a ``small entity'' under the Regulatory Flexibility Act
pursuant to 17 CFR 240.0-10(c) for this purpose? \202\ Or should the
Commission define a smaller broker-dealer in a different way? Please
explain.
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    \202\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
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3. Application of Proposed Rule 1101(b) to NMS Stock Market Conflicts
of Interest
    Broker-dealers that engage in conflicted transactions for or with
retail customers in NMS stocks would be required to comply with the
additional policies and procedures requirements under proposed Rule
1101(b). For example, a retail broker-dealer that receives payment for
order flow from a wholesaler would need to establish, maintain, and
enforce policies and procedures to address how it will evaluate
additional liquidity sources that the broker-dealer would not need to
evaluate if it did not receive payment for order flow. Therefore, in
connection with a determination of whether to route customer orders to
the wholesaler that pays for order flow, the retail broker-dealer could
evaluate other exchanges, ATSs, or order exposure opportunities that
may not have been determined by the retail broker-dealer to be material
potential liquidity sources for non-conflicted transactions under
proposed Rule 1101(a)(1).
    Retail broker-dealers that receive payment for order flow for
retail customer orders must also comply with the documentation
requirement under proposed Rule 1101(b)(3). For example, to the extent
a retail broker-dealer attempts to execute customer orders prior to
sending them to a wholesaler in return for payment, it could document
such efforts by, for example, retaining a record of the markets at
which it attempted to execute customer orders at prices better than the
NBBO (e.g., markets pinged for midpoint liquidity),\203\ or documenting
how it otherwise used reasonable diligence in assessing whether those
markets may be the best market for customer orders. For retail
nonmarketable orders routed to markets (e.g., exchanges) that pay
rebates for those orders, a retail broker-dealer would need to document
its basis for determining that routing orders to such markets would
comply with the best execution standard, as well as the information
relied on for such determination. It could do so by, for example,
documenting its assessment of fill rates and the likelihood of
execution for nonmarketable orders at such

markets as compared to other markets that do not provide such rebates.
---------------------------------------------------------------------------

    \203\ See supra note 196 (describing records and documentations
under the CAT Plan). As discussed above in section IV.C.2, proposed
Rule 1101(b)(3) would not require a broker-dealer to document its
efforts to comply with the best execution standard with respect to
its conflicted transactions in any specific way. However, the
broker-dealer would need to document in accordance with its written
procedures the basis and information relied on for its determination
that its conflicted transactions would comply with the best
execution standard.
---------------------------------------------------------------------------

    Furthermore, in documenting its determination that transactions
that are conflicted due to payment for order flow from a wholesaler
would comply with the best execution standard, a retail broker-dealer
could document its process for evaluating and routing to wholesalers
that pay it for order flow, including its assessment of wholesaler
performance and any price improvement commitments. Additionally, a
retail broker-dealer would be required to document its determination
that customer transactions for which it receives payment for order flow
would comply with the best execution standard.\204\ A retail broker-
dealer could do this by, for example, soliciting price improvement
commitments from wholesalers for customer orders in the absence of
payment for order flow and comparing those commitments to the price
improvement commitments that the wholesaler would make if it were to
pay the retail broker-dealer for order flow, and documenting these
efforts. Finally, as described above in section IV.C.2, a retail
broker-dealer would be required to document any arrangement concerning
payment for order flow.
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    \204\ Similarly, FINRA has stated that broker-dealers may not
negotiate the terms of order routing arrangements for customer
orders in a manner that reduces the price improvement opportunities
that, absent payment for order flow, otherwise would be available to
those customer orders. See FINRA Regulatory Notice 21-23.
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    A wholesaler that executes customer orders in a principal capacity
or pays a retail broker-dealer for order flow would also be required to
document its compliance with the best execution standard for conflicted
transactions.\205\ For example, a wholesaler could document the prices
received from those markets that it checked pursuant to its policies
and procedures, such as by retaining a record of the markets at which
it attempted to execute customer orders at prices better than the NBBO
(e.g., markets pinged for midpoint liquidity) \206\ and by retaining
records of market data feeds that the wholesaler uses when handling
retail customer orders. A wholesaler could also document how it
otherwise used reasonable diligence in its best execution
determinations. For retail nonmarketable orders routed to markets that
pay rebates for those orders, a wholesaler could document its basis for
determining that routing to such markets would comply with the best
execution standard and the information relied on for such determination
by, for example, documenting its assessment of fill rates and the
likelihood of execution for nonmarketable orders at such markets as
compared to other markets that do not provide such rebates.
---------------------------------------------------------------------------

    \205\ See supra note 200.
    \206\ See supra note 203.
---------------------------------------------------------------------------

    The wholesaler would also be required to document any arrangement
concerning payment for order flow as described above in section IV.C.2.
Furthermore, the wholesaler would be required to document its
determination that its transactions with customer orders that were sent
to it in return for payment would comply with the best execution
standard. For example, a wholesaler could document that it provides the
same price improvement to the customers of retail broker-dealers to
which it does not pay for order flow that it provides to the customers
of broker-dealers to which it pays for order flow.
4. Application of Proposed Rule 1101(b) to the Options Market
    As discussed above, payment for order flow, principal trading, and
affiliated routing conflicts of interest in the execution of retail
customer orders also exist in the options market.\207\ Under proposed
Rule 1101(b), a wholesaler that pays for order flow or transacts with
retail customers in a principal capacity would need to establish,
maintain, and enforce policies and procedures for conflicted
transactions that address how it will obtain and assess information
beyond that required by proposed Rule 1101(a)(1)(i) and evaluate a
broader range of liquidity sources, including a broader range of order
exposure opportunities, which could include an evaluation of whether
any price improvement auctions may provide an opportunity to execute a
customer order at a price that is better than the displayed best bid
and offer.\208\
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    \207\ See supra section III.A.2 (discussing the payment for
order flow, affiliated routing and principal trading conflicts of
interest in the options market).
    \208\ As discussed above, the wholesaler's policies and
procedures that would be required by proposed Rule 1101(a)(1) could
address how the wholesaler assesses price improvement auctions,
including their relative competitiveness, when identifying material
potential liquidity sources. A similar assessment would be required
under proposed Rule 1101(b)(2) for a broader range of order exposure
opportunities that may result in the most favorable price for
customer orders. A wholesaler's best execution policies and
procedures that favor one price improvement auction when other, more
competitive, price improvement auctions exist may be relevant to an
assessment of whether such policies and procedures are reasonably
designed to identify material potential liquidity sources or to
evaluate a broader range of order exposure opportunities that may
result in the most favorable price for the customer order, as
required by proposed Rules 1101(a) and 1101(b).
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    Under proposed Rule 1101(b)(3), a wholesaler that engages in
conflicted transactions would also be required to document, in
accordance with written procedures, its compliance with the best
execution standard for such conflicted transactions, including all
efforts to enforce its policies and procedures for conflicted
transactions and the basis and information relied on for its
determinations that such conflicted transactions would comply with the
best execution standard. For example, as with conflicted transactions
in NMS stocks, a wholesaler could document the prices received from
those markets that it checked pursuant to its policies and procedures,
such as by retaining records of market data feeds that the wholesaler
uses when handling retail customer orders. The wholesaler's
documentation could also include a description of its decision making
process for routing retail customer orders to execute against the
wholesaler's or its affiliates' displayed prices on exchanges and when
it chooses to execute through a price improvement auction that may
provide an opportunity for price improvement. For retail nonmarketable
orders routed to markets that pay rebates for those orders, a
wholesaler would need to document its basis for determining that
routing to such markets would comply with the best execution standard
and the information relied on for such determination. It could do so
by, for example, documenting its assessment of fill rates and the
likelihood of execution for nonmarketable orders at such markets as
compared to other markets that do not provide such rebates.
    The wholesaler would also be required to document any arrangement
concerning payment for order flow as described above in section IV.C.2.
Furthermore, the wholesaler would be required to document its
determination that its transactions with the customer orders that were
sent to it in return for payment would comply with the best execution
standard. For example, a wholesaler could document that it provides the
same execution quality to the customers of retail broker-dealers to
which it does not pay for order flow that it provides to the customers
of broker-dealers to which it pays for order flow.
    A retail broker-dealer in the listed options market would be
engaged in a conflicted transaction under proposed Rule 1101(b) if it
receives payment for order flow and its policies and procedures would
have to address how it evaluates a broader range of markets, including
opportunities to expose customer orders for the most favorable price. A
retail broker-dealer's policies

and procedures could evaluate wholesaler practices concerning the use
of price improvement auctions and whether such wholesalers are
appropriately considering a broader range of opportunities to expose
customer orders and identifying exposure opportunities that are
designed to enhance competition for customer orders.
    Retail broker-dealers that accept payment for order flow for retail
customer orders would also be required to comply with the documentation
requirement under proposed Rule 1101(b)(3). To the extent a retail
broker-dealer routes retail customer nonmarketable orders to markets
that pay rebates for those orders, a retail broker-dealer would need to
document its basis for determining that routing to such markets would
comply with the best execution standard and the information relied on
for such determination. It could do so by, for example, documenting its
assessment of fill rates and the likelihood of execution for
nonmarketable orders at such markets as compared to other markets that
do not provide such rebates.
    Furthermore, in documenting its determination that transactions
conflicted due to payment for order flow from a wholesaler would comply
with the best execution standard, a retail broker-dealer could document
its process for evaluating and routing to wholesalers that pay it for
order flow, including its assessment of wholesaler performance and any
price improvement commitments. Additionally, under proposed Rule
1101(b)(3), a retail broker-dealer would need to document its
determination that customer transactions for which it receives payment
for order flow would comply with the best execution standard and the
information relied on for such determination. A retail broker-dealer
could do this by, for example, soliciting price improvement commitments
from wholesalers for customer orders in the absence of payment for
order flow and comparing those commitments to the price improvement
commitments that the wholesaler would make if it were to pay the retail
broker-dealer for order flow. Finally, a retail broker-dealer would be
required to document any arrangement concerning payment for order flow,
as described above in section IV.C.2.
5. Application of Proposed Rule 1101(b) to the Corporate and Municipal
Bond Markets and Government Securities Markets
    Many broker-dealers in the corporate and municipal bond markets and
government securities markets trade with retail customers in a
principal capacity and therefore engage in conflicted transactions.
Such broker-dealers would also be subject to proposed Rule 1101(b) with
respect to their conflicted transactions. A broker-dealer's policies
and procedures for conflicted transactions would be required to address
how it will evaluate a broader range of markets, including a broader
range of order exposure opportunities. This could include evaluation of
a broader range of ATSs, broker's brokers, RFQ systems, and other
broker-dealers that trade corporate and municipal bonds and government
securities, than the markets that the broker-dealer identifies as
material potential liquidity sources under proposed Rule 1101(a)(1).
    Under proposed Rule 1101(b)(3), a retail broker-dealer that trades
in a principal capacity with retail customers would be required to
document, in accordance with written procedures, its compliance with
the best execution standard for conflicted transactions, including all
efforts taken to enforce its policies and procedures for conflicted
transactions and the basis and information relied on for its
determinations that such conflicted transactions would comply with the
best execution standard. In doing so, a retail broker-dealer could
retain records of any data feeds or other pricing information that the
retail broker-dealer uses when handling retail customer orders,
including ATS data feeds, responses to RFQs, transaction prices, and
evaluated pricing information.\209\ In documenting its efforts to
comply with the best execution standard, a retail broker-dealer could
also document its order handling practices that can impact whether
customer orders are executed in compliance with the best execution
standard. This could include, for example, its practices concerning the
use of RFQ systems, including its filtering, response time, and last
look practices and how those practices promote the execution of retail
customer orders in a manner that complies with the best execution
standard. Finally, broker-dealers could document their markup policies
for principal trades, including documenting how the broker-dealer
assesses markups for trades with customers and any variation in its
markups depending on the nature of the transaction (e.g., riskless
principal trades versus trades with the broker-dealer's inventory).
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    \209\ As discussed above in section IV.C.2, proposed Rule
1101(b)(3) would not require a broker-dealer to document its efforts
to comply with the best execution standard with respect to its
conflicted transactions in any specific way. However, the broker-
dealer would need to document the basis and information relied on
for its determination that its conflicted transactions would comply
with the best execution standard, and the Commission preliminarily
believes that the manner of documentation may vary depending on
asset class. For example, a broker-dealer's best execution policies
and procedures may provide for more individualized handling of
customer orders in corporate and municipal bonds and government
securities than in equities securities. Accordingly, the broker-
dealer's documentation for conflicted retail transactions in
corporate and municipal bonds and government securities would need
to reflect the more individualized best execution process.
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Request for Comment
    The Commission requests comment on the application of proposed Rule
1101(b) to the NMS stock, options, corporate and municipal bond
markets, and government securities markets, and in particular:
    97. Has the Commission appropriately described the various
practices in sections IV.C.3-5 that should be addressed in a broker-
dealer's policies and procedures for conflicted transactions? Please
explain.
    98. Are there other practices not described in sections IV.C.3-5
that should be addressed in a broker-dealer's policies and procedures
for conflicted transactions, or any that are described that should be
not be addressed? Please explain.

D. Proposed Rule 1101(c)--Regular Review of Execution Quality

    Proposed Rule 1101(c) would require a broker-dealer, no less
frequently than quarterly, to review the execution quality of its
transactions for or with its customers or customers of another broker-
dealer, and how such execution quality compares with the execution
quality the broker-dealer might have obtained from other markets, and
to revise its best execution policies and procedures, including its
order handling and routing practices, accordingly. Proposed Rule
1101(c) would also require a broker-dealer to document the results of
this review.
    While the Commission understands that broker-dealers generally
currently conduct certain execution quality reviews,\210\ including
pursuant to

FINRA's best execution rule, the scope of proposed Rule 1101(c) differs
from FINRA's best execution rule in that it would apply to a broader
range of broker-dealers.\211\ Specifically, while FINRA's execution
quality review requirement applies only to a broker-dealer that routes
customer orders to other broker-dealers for execution on an automated,
nondiscretionary basis or that internalizes customer order flow,\212\
proposed Rule 1101(c) would apply to all broker-dealers that are not
introducing brokers (discussed in section IV.E below) that transact for
or with customers. The Commission preliminarily believes that it would
be beneficial to customers for a broader range of broker-dealers to
regularly review the execution quality that their customer orders
receive. Aside from this distinction in scope, proposed Rule 1101(c) is
designed to be consistent with FINRA Rule 5310.09.
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    \210\ FINRA describes the findings from its best execution exams
in an annual report. See, e.g., 2022 Report on FINRA's Examination
and Risk Monitoring Program, supra note 185, at 44-45 (describing
FINRA exam findings, including: not comparing the quality of the
execution obtained via firms' existing order-routing and execution
arrangements against the quality of execution they could have
obtained from competing markets; not conducting adequate reviews on
a type-of-order basis, including, for example, on market, marketable
limit, or non-marketable limit orders; not considering certain
factors set forth in FINRA Rule 5310 when conducting a ``regular and
rigorous review,'' including, among other things, speed of
execution, price improvement and the likelihood of execution of
limit orders; and using routing logic that was not necessarily based
on quality of execution).
    \211\ The MSRB rule does not require broker-dealers to conduct
quarterly (or more frequent) comparative analysis of execution
quality. Rather, MSRB Rule G-18 requires an annual review of the
broker-dealer's policies and procedures that takes ``into account
the quality of the executions the [broker-dealer] is obtaining under
its current policies and procedures, changes in market structure,
new entrants, the availability of additional pre-trade and post-
trade data, and the availability of new technologies'' and requires
the broker-dealer ``to make promptly any necessary modifications to
such policies and procedures as may be appropriate in light of such
reviews.'' See MSRB Rule G-18.08(a).
    \212\ See FINRA Rule 5310.09.
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    The requirements of proposed Rule 1101(c) would complement a
broker-dealer's policies and procedures concerning how it will comply
with the proposed best execution standard and the determination of the
best market for customer orders, as well as the additional policies and
procedures for conflicted transactions. As proposed, a broker-dealer
must compare the execution quality it obtains via its current order
routing and execution arrangements (including through the
internalization of its order flow or executing its order flow through
another broker-dealer in a wholesaler or other arrangement) to the
execution quality it might have obtained from other markets. A broker-
dealer would not meet the requirements of proposed Rule 1101(c) if it
solely conducted its review based on the markets to which it currently
routes customer orders without considering other markets or trading
venues.\213\ Rather, a broker-dealer would be required to consider the
potential execution quality at trading venues that it does not
currently use to execute customer orders, including new markets to the
extent they become available, and consider whether it needs to access
such markets in order to attain best execution for its customer
orders.\214\
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    \213\ This is consistent with FINRA's rule concerning the review
of execution quality. See FINRA Rule 5310.09(b) (``To assure that
order flow is directed to markets providing the most beneficial
terms for their customers' orders, the member must compare, among
other things, the quality of the executions the member is obtaining
via current order routing and execution arrangements (including the
internalization of order flow) to the quality of the executions that
the member could obtain from competing markets.'').
    \214\ FINRA has pursued enforcement against broker-dealers
relating to compliance with FINRA Rule 5310.09 concerning the
regular and rigorous review of execution quality. See, e.g.,
TradeStation Securities, Inc., Letter of Acceptance, Waiver and
Consent (FINRA Case No.<PHONE_NUMBER>501) (Mar. 2021) (describing
violations of FINRA's best execution rule where the firm ``did not
exercise reasonable diligence to ascertain whether the venues where
it routed certain equity and option customer orders provided the
best market for the subject securities as compared to the execution
quality that was being provided at competing markets''); Robinhood
FINRA, supra note 69 (describing violations of FINRA's best
execution rule where the firm routed its customers' orders to four
broker-dealers that all paid for order flow and ``did not exercise
reasonable diligence to ascertain whether these four broker-dealers
provided the best market for the subject securities to ensure its
customers received the best execution quality from these as compared
to other execution venues''); E*Trade Securities LLC, Letter of
Acceptance, Waiver, and Consent (FINRA Case No.<PHONE_NUMBER>5-01)
(June 2016) (describing violations of FINRA's best execution rule
where the firm lacked sufficient information to reasonably assess
the execution quality it provided to its customer because, among
other things, the firm ``did not take into account the
internalization model employed by the firm'' and ``was overly
reliant on comparisons of the firm's overall execution quality with
industry and custom averages, rather than focusing on comparisons to
the actual execution quality provided by the market centers to which
the firm routed orders'').
---------------------------------------------------------------------------

    In reviewing and comparing the execution quality of its customer
transactions to the execution quality that might have been obtained
from other markets, a broker-dealer could consider various factors,
including price improvement opportunities, differences in price
disimprovement,\215\ likelihood of execution of limit orders, speed of
execution, size of execution, transaction costs, customer needs and
expectations, and the existence of internalization or payment for order
flow arrangements.\216\ Furthermore, a broker-dealer that routinely
routes customer orders to multiple trading centers, whether internal or
external, could evaluate the latency impacts, fill rates, information
leakage, and resulting execution quality harms.\217\ And when
conducting these reviews, a broker-dealer could consider the procedures
it uses or would use for executing the same or similar transactions for
its own accounts.\218\ The Commission believes that, when compared to
the execution quality that the broker-dealer might have obtained from
other markets, the review could help the broker-dealer evaluate the
effectiveness of its current best execution policies and procedures,
including its order handling practices, and enable the broker-dealer to
make informed judgments regarding whether these policies and procedures
and practices need to be modified.
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    \215\ Price disimprovement occurs when a customer receives a
worse price than the best quotes prevailing at the time the order is
received by the market. See, e.g., FINRA Rule 5310.09(b)(2).
    \216\ These considerations are consistent with FINRA's rule
regarding the review of execution quality. See FINRA Rule 5310.09(b)
(providing that, in reviewing and comparing the execution quality of
its current order routing and execution arrangements to the
execution quality of other markets, a member should consider: (1)
price improvement opportunities; (2) differences in price
disimprovement; (3) the likelihood of execution of limit orders; (4)
the speed of execution; (5) the size of execution; (6) transaction
costs; (7) customer needs and expectations; and (8) the existence of
internalization or payment for order flow arrangements).
    \217\ This is also consistent with existing FINRA guidance
concerning these types of reviews. See FINRA Regulatory Notice 15-
46, at 4-5.
    \218\ This is consistent with existing FINRA guidance. See FINRA
Regulatory Notice 15-46, at 4-5. FINRA states that ``firms should
consider the risk of information leakage by routing orders to a
particular venue in light of the fill rates achieved at that venue
and carefully assess whether the risks outweigh the potential for an
execution.'' Id. at 5.
---------------------------------------------------------------------------

    As described in this section IV.D above, proposed Rule 1101(c)
would apply to a broader range of broker-dealers than FINRA Rule
5310.09. However, the substantive review requirements of proposed Rule
1101(c) are similar to FINRA Rule 5310.09, which requires a broker-
dealer to compare, among other things, the quality of the executions it
is obtaining via current order routing and execution arrangements to
the quality of the executions that the broker-dealer could obtain from
competing markets.
    While the review under FINRA Rule 5310.09 must be conducted on a
security-by-security, type-of-order basis (e.g., limit order, market
order, and market on open order), proposed Rule 1101(c) does not
provide this level of specificity concerning the manner of execution
quality reviews. The Commission believes that execution quality reviews
would differ based on the characteristics of a market or of a broker-
dealer's business, and the methods for conducting execution quality
reviews would evolve over time

based on the availability of data and advancements in technology. A
broker-dealer generally should conduct such reviews in a manner that
will provide it with robust information concerning its customer orders'
execution quality so that it can assess whether it needs to revise its
best execution policies and procedures. In doing so, a broker-dealer
should exercise its expertise and judgment in this regard and the
manner of its execution quality reviews may be tailored to reflect
various factors (e.g., whether the broker-dealer engages in conflicted
transactions, the sizes of customer orders).\219\
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    \219\ Under FINRA Rule 5310.09, a broker-dealer must have
procedures in place to ensure it periodically conducts regular and
rigorous reviews of the quality of the executions of its customers'
orders if it does not conduct an order-by-order review. FINRA has
stated in a regulatory notice that broker-dealers must conduct
order-by-order best execution reviews rather than relying on regular
and rigorous reviews in certain circumstances. In particular, FINRA
has stated that a ``regular and rigorous review alone (as opposed to
an order-by-order review) may not satisfy best execution
requirements, given that the execution of larger-size orders `often
requires more judgment in terms of market timing and capital
commitment.' '' FINRA has also stated that ``[o]rders that a firm
determines to execute internally are subject to an order-by-order
best execution analysis.'' Finally, FINRA has recognized that
advances in order routing technology make order-by-order reviews of
execution quality for a range of orders in all equity and
standardized options increasingly possible. See FINRA Regulatory
Notice 15-46, at 3-4. As stated above, proposed Regulation Best
Execution would not affect a broker-dealer's obligation to comply
with the FINRA or MSRB best execution rule. Accordingly, a broker-
dealer would be required to comply with proposed Regulation Best
Execution, in addition to the FINRA and MSRB best execution rules,
as applicable. See supra note 109 and accompanying text. To the
extent FINRA or the MSRB impose more specific requirements than
proposed Regulation Best Execution, broker-dealers must continue to
comply with those requirements, as applicable.
---------------------------------------------------------------------------

    FINRA Rule 5310.09 also requires a broker-dealer to determine
whether any material differences in execution quality exist among the
markets trading the security and, if so, modify its routing
arrangements or justify why it is not modifying its routing
arrangements. While proposed Rule 1101(c) does not include
``materiality'' language or require a broker-dealer to justify why it
is not modifying its routing arrangements, these concepts are
consistent with the language of proposed Rule 1101(c). Proposed Rule
1101(c) states that a broker-dealer would be obligated to ``revise its
best execution policies and procedures, including its order handling
practices, accordingly'' after it has conducted its comparative
execution quality analysis. The Commission preliminarily believes that
revisions to the broker-dealer's policies and procedures, including its
order handling practices, would be appropriate if there were material
differences in execution quality that were not otherwise justifiable.
Moreover, proposed amendments to Rule 17a-4 would require a broker-
dealer to retain documentation of the results of its execution quality
review, which could include any justifications for not modifying its
policies and procedures if a comparative analysis revealed material
differences in execution quality.\220\
---------------------------------------------------------------------------

    \220\ For a discussion of recordkeeping requirements of the
proposed rules, see infra section IV.G.
---------------------------------------------------------------------------

    MSRB rules do not require broker-dealers to conduct comparative
analysis of execution quality.\221\ Rather, MSRB Rule G-18.08 states
that, when conducting its periodic reviews, a broker-dealer must assess
whether its policies and procedures are reasonably designed to achieve
best execution, taking into account the quality of the executions the
broker-dealer is obtaining under its current policies and procedures,
changes in market structure, new entrants, the availability of
additional pre-trade and post-trade data, and the availability of new
technologies, and make promptly any necessary modifications to such
policies and procedures as may be appropriate in light of such reviews.
While MSRB Rule G-18.08 reflects an execution quality review by broker-
dealers, proposed Rule 1101(c) would impose a specific requirement for
review of execution quality on at least a quarterly basis, including a
comparative analysis requirement, for all broker-dealers regardless of
whether they are currently subject to MSRB or FINRA rules.
---------------------------------------------------------------------------

    \221\ See supra note 211.
---------------------------------------------------------------------------

    Proposed Rule 1101(c) would require a broker-dealer to review the
execution quality of customer orders no less frequently than
quarterly.\222\ In complying with the proposed rule, a broker-dealer
should determine the appropriate frequency of review by considering,
for example: the nature of its business; the asset class transacted;
new pools of liquidity, trading protocols, or sources of data that have
emerged; the availability of technology needed to conduct execution
quality reviews; and the level of transparency in a particular market.
In doing so, the Commission believes that, in many cases, broker-
dealers may determine that a more frequent review of execution quality
than quarterly is appropriate. For example, market participants subject
to Rule 605 of Regulation NMS are required to disclose on a monthly
basis certain execution quality statistics in NMS stocks. These Rule
605 reports provide a broker-dealer with information that it could use
to evaluate the execution quality of customer transactions in NMS
stocks more frequently than quarterly.\223\ In contrast, a broker-
dealer may determine that it is appropriate to review the execution
quality of customer transactions in non-NMS stocks less frequently due
to the characteristics of those other markets.\224\
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    \222\ FINRA also requires a broker-dealer to conduct regular and
rigorous reviews of its customer execution quality at least
quarterly, but has specified that a broker-dealer should consider,
based on its business, whether more frequent reviews are needed. See
FINRA Rule 5310.09; FINRA Regulatory Notice 15-46, at 4. MSRB Rule
G-18 requires a broker-dealer to, at a minimum, conduct annual
reviews of its policies and procedures for determining the best
available market for the executions of its customers' transactions,
but the broker-dealer should consider a frequency reasonably related
to the nature of its municipal securities business, including but
not limited to its level of sales and trading activity. See MSRB
Rule G-18.08(a).
    \223\ FINRA has stated that some broker-dealers conduct monthly
reviews of execution quality, recognizing that market participants
are required to publish Rule 605 execution quality statistics on a
monthly basis. See FINRA Regulatory Notice 15-46, at 4, 15 n.21.
    \224\ FINRA has also stated that orders in the fixed income
market may be handled and executed differently than in equity and
options markets. Because of these differences, FINRA stated that
broker-dealers may determine to conduct execution quality reviews of
such securities under FINRA's rule less frequently than for equities
and options. See FINRA Regulatory Notice 15-46, at 8.
---------------------------------------------------------------------------

    Finally, proposed Rule 1101(c) would require a broker-dealer to
document the results of its execution quality reviews.\225\ By
documenting its execution quality reviews, a broker-dealer would
maintain and preserve a robust record of its order execution quality
over time that could assist the broker-dealer to better evaluate the
effectiveness of its best execution policies and procedures, including
its order handling practices, on an ongoing basis. Similarly, such
documentation would allow regulators to more effectively oversee the
broker-dealer's efforts to meet the best execution standard of proposed
Rule 1100 and the requirements of proposed Rules 1101 and 1102.
---------------------------------------------------------------------------

    \225\ See proposed amendments to Rule 17a-4; infra section IV.G
(describing the recordkeeping obligations applicable to any
documentation made pursuant to proposed Regulation Best Execution).
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of proposed Rule
1101(c), and in particular:
    99. Should broker-dealers be required to conduct reviews of
execution quality of their transactions for or with customers at least
quarterly, including how such execution quality compares with the
execution quality that might

have been obtained from other markets, as required by proposed Rule
1101(c)? Why or why not? Should broker-dealers document the results of
their execution quality reviews, as required by proposed Rule 1101(c)?
Why or why not?
    100. Should a review of execution quality include factors similar
to those identified in FINRA rules and guidance, such as price
improvement opportunities, differences in price disimprovement,
likelihood of execution of customer limit orders, speed of execution,
size of execution, transaction costs, customer needs and expectations,
and the existence of internalization or payment for order flow
arrangements? Why or why not? Are there other factors that should also
be included in a review of execution quality? If so, please explain.
Should these factors be specified in proposed Rule 1101(c)? Please
explain.
    101. Would the proposed documentation requirement improve the
utility of the reviews of execution quality by a broker-dealer? Please
explain. Should the proposed rule include other specific documentation
requirements to supplement the documentation of the execution quality
reviews? If so, please explain.
    102. Should proposed Rule 1101(c) apply to broker-dealers that
currently rely on their executing brokers to conduct such reviews, if
they otherwise would not qualify as introducing brokers as defined in
proposed Rule 1101(d) and discussed in section IV.E below? Please
explain. Would broker-dealers that currently rely on the execution
quality reviews of their executing brokers (and do not qualify as
introducing brokers as defined in proposed Rule 1101(d) and discussed
in section IV.E below) have the resources and expertise to conduct the
reviews required by proposed Rule 1101(c)? Would such broker-dealers
have the information necessary to compare the executions received for
their customers and the customers of other broker-dealers with the
execution quality that could have been obtained on other markets to
which they did not route customer orders? Please explain.
    103. Should the Commission require a different frequency for the
reviews of execution quality? If so, how frequently should such reviews
be required and should the frequency be different for different asset
classes? Should the frequency be monthly, semi-annually, annually, or
another time period? Please explain.
    104. Should the frequency of such reviews be dependent on any
unique characteristics of the broker-dealer, its customers, its order
flow, or the securities traded? For example, should the frequency
standard be at least monthly for reviews of execution quality for NMS
stocks because broker-dealers and market centers are required to
disclose execution quality on a monthly basis under Rules 605 of
Regulation NMS? Or does the availability of Rule 605 reports suggest
that reviews of execution quality in NMS stocks should be less
frequent? Please explain.
    105. Should broker-dealers that handle and execute customer
municipal bond orders be required to conduct reviews of execution
quality at least quarterly as required by proposed Rule 1101(c)? Please
explain. Is there a different frequency for these reviews that would be
more appropriate for the municipal bond market? If so, please explain.
Is there a frequency standard that would be more appropriate for other
fixed income markets, such as the corporate bond and government
securities markets? Is it appropriate to require that a broker-dealer's
best execution policies and procedures, including its order handling
practices, be revised based on the outcome of the proposed execution
quality reviews? Please explain. Should there be more specificity
concerning when a broker-dealer would be required to revise its best
execution policies and procedures, including its order handling
practices? For example, should the rule specify that best execution
policies and procedures, including order handling practices, must be
revised if the broker-dealer identifies material differences in
execution quality among the various markets and trading venues that
trade the applicable security? Please explain.
    106. Should the proposed requirement that a broker-dealer revise
its best execution policies and procedures, including its order
handling practices, based on its review of execution quality apply
differently depending on the type of asset class or any unique
characteristics of the broker-dealer, its customers, its order flow, or
the securities traded? Please explain.
    107. Do commenters agree with the Commission's understanding that
broker-dealers currently conduct certain execution quality reviews and
those reviews vary in rigor? Please describe the frequency and rigor of
any such reviews and whether broker-dealers document the results of
such reviews.
    108. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1101(c) for broker-dealers
of different sizes, if the Commission adopts proposed Regulation Best
Execution? For example, should the Commission provide longer compliance
dates for smaller broker-dealers? If so, should the Commission define a
smaller broker-dealer as a broker-dealer that qualifies as a ``small
entity'' under the Regulatory Flexibility Act pursuant to 17 CFR 240.0-
10(c) for this purpose? \226\ Or should the Commission define a smaller
broker-dealer in a different way? Please explain.
---------------------------------------------------------------------------

    \226\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
---------------------------------------------------------------------------

E. Proposed Rule 1101(d)--Introducing Brokers

    Proposed Rule 1101(d) would permit a broker-dealer that qualifies
as an introducing broker to rely on its executing broker to comply with
proposed Rules 1101(a), (b), and (c), subject to certain review
requirements.
    Broker-dealers have different business models, including whether
they accept, and the extent to which they handle and execute, customer
orders. Certain broker-dealers commit their own capital by executing
customer transactions on a principal basis, while some broker-dealers
employ an agency model that requires them to find another buyer or
seller in order to execute a customer order. The sizes and resources of
broker-dealers also vary, with some broker-dealers carrying the
accounts of millions of customers, while others carry few customer
accounts and employ significantly fewer in-house personnel.
    Many broker-dealers do not provide the service of holding customer
funds and securities and instead enter into agreements with other
broker-dealers to provide such services and handle and execute their
customers' orders. Such agreements generally allocate various functions
among the broker-dealers, including the opening and approval of
accounts, acceptance of orders, transmission of orders for execution,
execution of orders, extension of credit, receipt and delivery of funds
and securities, preparation and transmission of confirmations,
maintenance of books and records, and monitoring of accounts.\227\
Typically, a broker-dealer that does not carry customer accounts enters
into an agreement with another broker-dealer that would require the
initial broker-dealer to transmit all of its customer orders to the
other broker-dealer for order handling and execution. In this
circumstance, the second broker-dealer, which accepts the
responsibility to handle and execute the customer orders, would be
subject to the full obligations of proposed Regulation Best

Execution. On the other hand, the first broker-dealer is not making any
decisions or exercising discretion regarding the manner in which its
customer orders will be handled and executed, beyond its determination
to engage the services of the second broker-dealer, and it would not be
subject to the full obligations of proposed Regulation Best Execution.
---------------------------------------------------------------------------

    \227\ See FINRA Rule 4311 (establishing standards for carrying
agreements between executing firms and introducing firms).
---------------------------------------------------------------------------

    FINRA Rule 5310.09(c) provides that a broker-dealer that routes its
order flow to another broker-dealer that has agreed to handle that
order flow as agent for the customer can rely on that broker-dealer's
regular and rigorous review, as long as the statistical results and
rationale of the review are fully disclosed to the first broker-dealer
and the first broker-dealer periodically reviews how the review is
conducted, as well as the results of the review.\228\ MSRB Rule G-
18.08(b) provides that a broker-dealer that routes its customers'
transactions to another broker-dealer that has agreed to handle those
transactions as agent or riskless principal for the customer may rely
on that other broker-dealer's periodic reviews as long as the results
and rationale of the review are fully disclosed to the first broker-
dealer and the first broker-dealer periodically reviews how the other
broker-dealer's review is conducted and the results of the review.\229\
As discussed in section IV.E.1 below, the exemption under proposed Rule
1101(d) would be provided to a narrower group of broker-dealers than
contemplated by FINRA and MSRB rules, because it would apply only to
broker-dealers that meet the proposed definition of ``introducing
broker.'' Accordingly, certain broker-dealers that qualify under the
current FINRA and MSRB exemptions may not similarly qualify for the
exemption under proposed Rule 1101(d), absent a change in business
practices that would allow them to meet the additional criteria
described below in section IV.E.1. Moreover, as discussed in section
IV.E.2 below, the exemption under proposed Rule 1101(d) would require
the introducing broker's policies and procedures to provide for
comparisons between the execution quality obtained from its executing
broker and the execution quality it might have obtained from other
executing brokers, which would be a more specific policies and
procedures obligation for introducing brokers than required under the
current FINRA and MSRB rules. Finally, a broker-dealer that qualifies
as an introducing broker under proposed Rule 1101(d) would be exempt
from the requirement to separately comply with proposed Rules 1101(a),
(b), and (c), while the FINRA and MSRB rules only provide certain
broker-dealers with exemptions from conducting either the regular and
rigorous execution quality review under the FINRA rule or the periodic
review under the MSRB rule.
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    \228\ See FINRA Rule 5310.09(c).
    \229\ See MSRB Rule G-18.08(b). The MSRB has further interpreted
the obligations of introducing brokers under this provision. See
MSRB Implementation Guidance on MSRB Rule G-18, on Best Execution,
at Section II.1 (last updated Feb. 7, 2019) (``Under this provision,
introducing dealers may rely on the best-execution policies and
procedures of their clearing firms or other executing dealers, all
of which are subject to their own best-execution obligations under
the rule. An introducing dealer, however, is not relieved of its
obligations to establish written policies and procedures of its own.
For example, such an introducing dealer's policies and procedures
could provide for the reliance on another dealer's policies and
procedures and periodic reviews by the introducing dealer of the
other dealer's reviews of its policies and procedures.'').
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1. Definition of Introducing Broker and Executing Broker
    For purpose of proposed Rule 1101(d), the Commission would define
an ``introducing broker'' as a broker-dealer that: (1) does not carry
customer accounts and does not hold customer funds or securities; (2)
has entered into an arrangement with an unaffiliated broker-dealer that
has agreed to handle and execute on an agency basis all of the
introducing broker's customer orders (``executing broker''); and (3)
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.\230\ Broadly, these
proposed conditions are designed to identify those entities that, due
to their business models, expertise, and resources, need to be able to
rely on their executing brokers, and to ensure that these entities do
not have order handling conflicts of interest such that their reliance
on their executing brokers would be appropriate.
---------------------------------------------------------------------------

    \230\ This proposed definition of ``introducing broker'' would
be used only for purposes of proposed Rule 1101(d), and would not
affect the use of this term under existing Exchange Act rules. See,
e.g., 17 CFR 240.15c3-3 (defining introducing broker as a broker-
dealer that ``clears all transactions with and for customers on a
fully disclosed basis with a clearing broker or dealer, and who
promptly transmits all customer funds and securities to the clearing
broker or dealer which carries all of the accounts of such customers
and maintains and preserves such books and records pertaining
thereto . . . as are customarily made and kept by a clearing broker
or dealer''). While the term ``introducing broker'' is defined
differently for purposes of other Commission rules, the Commission
preliminarily believes the definition in proposed Rule 1101(d) is
appropriately tailored for application in the best execution
context. As discussed in this section, the proposed definition is
designed to identify introducing brokers that rely on their
executing brokers and to ensure that they do not have order handling
conflicts of interest in their reliance on their executing brokers.
See also section IV.E.1 (describing FINRA Rule 5310.09(c), MSRB Rule
G-18.08(b), and the definition of introducing broker in proposed
Rule 1101(d)).
---------------------------------------------------------------------------

    The first proposed condition of this definition (in proposed
paragraph (d)(1)) would require that an introducing broker not carry
customer accounts or hold customer funds or securities. This proposed
condition is designed to identify those broker-dealers that do not
handle or execute customer orders and therefore need to enter into
arrangements with other broker-dealers to provide those services. The
Commission preliminarily believes that this proposed condition would
identify broker-dealers that do not exercise any discretion with
respect to how their customer orders are handled and executed, beyond
the selection of the executing broker. Because these introducing
brokers do not handle or execute customer orders in a manner that would
warrant the application of the proposed best execution rules, the
Commission proposes to permit these broker-dealers to rely on their
executing brokers for purposes of complying with proposed Rules
1101(a), (b), and (c). In addition, these introducing brokers may not
be in a position to implement certain of the proposed best execution
rules because they have chosen to outsource order handling and
execution functions to another broker-dealer.
    The second proposed condition in the definition (in proposed
paragraph (d)(2)) would require an introducing broker to enter into an
arrangement with an unaffiliated broker-dealer that has agreed to
handle and execute on an agency basis all of the introducing broker's
customer orders. This proposed condition contains several elements.
First, the proposed requirement that an arrangement be in place for the
handling and execution of all customer orders by another broker-dealer
would help ensure that the introducing broker does not exercise
discretion concerning the routing and execution of customer orders in a
manner that would otherwise necessitate the application of all of the
provisions of proposed Regulation Best Execution.\231\ Second, the
introducing broker would be required to have an order handling and
execution arrangement with an unaffiliated broker-dealer. Because the

introducing broker would be permitted to rely on the executing broker
rather than having policies and procedures that address independently
many of the operative provisions of proposed Regulation Best Execution
(including the additional obligations for conflicts of interest with
retail customers), the introducing broker should not be permitted to be
subject to a conflict of interest by selecting an affiliated executing
broker. Such conflict of interest could impede the introducing broker's
efforts to achieve best execution by providing the introducing broker
an incentive to act in manner that benefits its own or its affiliate's
interests. Third, the executing broker that has been selected by the
introducing broker would be required to agree to handle all of the
introducing broker's customer orders on an agency basis. If an
executing broker could trade with the introducing broker's customers in
a principal capacity, the introducing broker would effectively be
making a determination concerning how its customer order should be
executed, and the introducing broker should be subject to the full
requirements of proposed Regulation Best Execution.
---------------------------------------------------------------------------

    \231\ The broker-dealer that has agreed to handle all of the
introducing broker's customer orders on an agency basis would be
subject to proposed Regulation Best Execution, including proposed
Rules 1101(a)-(c).
---------------------------------------------------------------------------

    There are two principal trading scenarios that, under proposed Rule
1101(d)(2), would be considered to be orders handled on an agency basis
solely for the purposes of proposed Rule 1101(d)(2): fractional share
trading in NMS stocks and riskless principal trading in corporate and
municipal bonds and government securities. The Commission understands
that many broker-dealers permit their customers to submit orders for
fractional shares of a stock. These orders are often the result of a
retail customer submitting an order for a security for a certain dollar
amount, rather than for a specific number of shares. In order for an
executing broker to fill the fractional share orders of an introducing
broker's customer buy orders, for example, the executing broker may buy
a whole share into its inventory and allocate a portion of that share
to fill the customer's fractional share order. This scenario involves a
principal trade between the executing broker and the customer that is
necessary to fill the customer's fractional share order. The Commission
preliminarily believes that an executing broker filling the fractional
share components of an introducing broker's customer orders in this
manner should not disqualify the initial broker-dealer from meeting
prong (2) of the definition of an introducing broker, because the
executing broker is filling the fractional share components on a
principal basis solely for the purpose of completing transactions that
otherwise would be executed on an agency basis. Therefore, in this
context, the executing broker filling a customer's fractional share
order would be considered to be acting on an agency basis.
    In the corporate and municipal bond markets and government
securities markets, the Commission understands that executing brokers
most often execute an introducing broker's customer orders on a
riskless principal basis.\232\ In these transactions, the executing
broker does not fill a customer order out of its own inventory, but
rather finds a counterparty for the customer order prior to executing
the customer order.\233\ The bond simply flows through the executing
broker's account for transaction processing before ultimately being
transferred to the appropriate customer. For purposes of proposed Rule
1101(d)(2), riskless principal would be defined as proposed under Rule
1101(b)(4)(ii). In particular, a transaction would be riskless
principal if, after having received an order to buy from the
introducing broker on behalf of its customer, the executing broker
purchased the security from another person to offset a contemporaneous
sale to such introducing broker on behalf of a customer or, after
having received an order to sell, the executing broker sold the
security to another person to offset a contemporaneous purchase from
such introducing broker on behalf of its customer.\234\ The Commission
preliminarily believes that this riskless principal transaction
scenario in the corporate and municipal bond markets and government
securities markets should not disqualify the initial broker-dealer from
meeting the definition of an introducing broker in proposed Rule
1101(d), as the riskless principal trading in this context is analogous
to the executing broker trading on an agency basis.
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    \232\ The MSRB best execution rule recognizes that introducing
brokers may have a relationship with clearing firms that handle and
execute customer orders on a riskless principal basis. See, e.g.,
MSRB Rule G-18.08(b) (``A dealer that routes its customers'
transactions to another dealer that has agreed to handle those
transactions as agent or riskless principal for the customer (e.g.,
a clearing firm or other executing dealer) may rely on that other
dealer's periodic reviews as long as the results and rationale of
the review are fully disclosed to the dealer and the dealer
periodically reviews how the other dealer's review is conducted and
the results of the review.'').
    \233\ As the Commission has stated, ``[t]rading on a riskless
principal basis is similar, conceptually, to a municipal bond dealer
trading on an agency basis. In these transactions, the municipal
bond dealer is not putting its capital at risk. For example, when it
receives a customer order to buy, the [dealer] will offset the sale
to the customer by contemporaneously purchasing the security sold to
the customer.'' See U.S. Securities and Exchange Commission, Report
on the Municipal Securities Market (2012), available at https://www.sec.gov/news/studies/2012/munireport073112.pdf. See also 17 CFR
240.3a5-1(b) (defining the term ``riskless principal transaction''
for purposes of a bank's exemption from the definition of dealer).
    \234\ This riskless principal trading scenario would be limited
to these types of transactions in the corporate and municipal bond
markets and government securities markets and is consistent with the
concept in MSRB Rule G-18.08(b) and with the Commission's defined
term of riskless principal in Exchange Act Rule 3a5-1, which exempts
banks from the definition of ``dealer'' under the Exchange Act when
acting in a riskless principal capacity. See 17 CFR 240.3a5-1
(defining riskless principal as a transaction in which, after having
received an order to buy from a customer, the bank purchased the
security from another person to offset a contemporaneous sale to
such customer or, after having received an order to sell from a
customer, the bank sold the security to another person to offset a
contemporaneous purchase from such customer). Furthermore, the
Commission believes that this definition of a riskless principal
trade is a commonly used and understood definition of the term. But
see 17 CFR 240.10b-18 (defining a riskless principal transaction in
the context of a safe harbor for issuers from liability under the
Exchange Act fraud provisions as a transaction in which a broker or
dealer after having received an order from an issuer to buy its
security, buys the security as principal in the market at the same
price to satisfy the issuer's buy order, where the issuer's buy
order must be effected at the same price per share at which the
broker or dealer bought the shares to satisfy the issuer's buy
order, exclusive of any explicitly disclosed markup or markdown,
commission equivalent, or other fee).
---------------------------------------------------------------------------

    The third proposed condition in the definition of introducing
broker (in proposed paragraph (d)(3)) is that the introducing broker
may not accept 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.\235\ Similar to the
second proposed condition concerning the use of unaffiliated executing
brokers, the Commission preliminarily believes that this proposed
condition is appropriate because the introducing broker, which would be
exempt from many of the operative provisions of proposed Regulation
Best Execution, should not be subject to a conflict of interest that
could influence its selection of a broker-dealer that will handle and
execute its customers' orders.
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    \235\ This proposed condition is based on the definition of
payment for order flow in Exchange Act Rule 10b-10(d)(8), 17 CFR
240.10b-10(d)(8). See supra note 43 (stating the definition of
payment for order flow under Rule 10b-10(d)(8)).
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2. Review of Executing Broker's Execution Quality
    Proposed Rule 1101(d) would provide that an introducing broker that
routes customer orders to an executing broker

does not need to separately comply with proposed Rules 1101(a), (b),
and (c) so long as the introducing broker establishes, maintains, and
enforces policies and procedures that require the introducing broker to
regularly review the execution quality obtained from such executing
broker, compare it with the execution quality it might have obtained
from other executing brokers, and revise its order handling practices,
accordingly. The introducing broker would also be required to document
the results of this review.
    Because proposed Rule 1101(d) would require the introducing broker
to establish, maintain, and enforce policies and procedures that
provide for regular reviews of the execution quality obtained from its
executing broker, as part of its agreement with the executing broker,
an introducing broker may wish to consider requiring the executing
broker to fully disclose its execution quality reviews of the
introducing broker's customer orders to the introducing broker, in lieu
of conducting its own independent analysis of the execution quality
ultimately received from the executing broker.\236\ This aspect of
proposed Rule 1101(d) would impose a direct obligation on introducing
brokers to regularly review the execution quality obtained from their
executing brokers, in addition to what is required under current FINRA
and MSRB rules.\237\
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    \236\ The executing broker's review of execution quality that
the introducing broker relies on would be required to be an
execution quality review specific to the introducing broker's
customer orders. The Commission preliminarily believes that it would
not be appropriate for the introducing broker to rely on the
executing broker's execution quality review if that review involved
the executing broker's aggregate executions, including those of
other introducing brokers' customers. As a result, proposed Rule
1101(d) would require the introducing broker to evaluate the
execution quality its customers received from the executing broker.
    \237\ See FINRA Rule 5310.09(c); MSRB Rule G-18.08(b) (providing
that an introducing broker can ``rely on'' its executing broker's
execution quality reviews as long as the results and rationale of
the review are fully disclosed to the introducing broker and the
introducing broker periodically reviews how the review is conducted
and the results of the review). Under these rules, broker-dealers
are permitted to rely on the execution quality reviews of their
executing brokers and are required only to periodically review how
the review is conducted and the results of the review. These broker-
dealers are not required to compare the execution quality they are
receiving to the execution quality that might have been received
from another executing broker.
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    In addition, because proposed Rule 1101(d) would require the
introducing broker's policies and procedures to provide for comparisons
of its executing broker's execution quality with the execution quality
it might have obtained from other executing brokers, the introducing
broker would need to obtain execution quality information concerning
other executing brokers that could handle and execute the introducing
broker's customer orders.\238\ While the information concerning the
execution quality that might be obtained from other executing brokers
would not include information concerning the execution of the
introducing broker's customer orders, this information would
nevertheless better inform the introducing broker's decisions
concerning the selection of an executing broker. This aspect of
proposed Rule 1101(d) would impose a direct obligation on introducing
brokers to conduct comparisons of execution quality, in addition to
what is required under current FINRA and MSRB rules.\239\ While the
broker-dealer would be afforded discretion in how it evaluates the
execution quality that could be provided by other executing brokers,
the Commission believes that introducing brokers could consider the
execution quality and order routing disclosures of these executing
brokers along with the information that these executing brokers might
provide to the introducing broker directly in connection with this
obligation.
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    \238\ The Commission preliminarily believes that other executing
brokers would have an incentive to provide the introducing broker
with accurate and comparable execution quality information that the
introducing broker could use to evaluate its existing arrangement
due to their financial interest in potentially providing the
introducing broker with order handling and execution services.
    \239\ See supra note 236.
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    Proposed Rule 1101(d) would also require an introducing broker's
policies and procedures to address how it would revise its order
handling practices, if its execution quality comparison shows that a
change is warranted. This aspect of proposed Rule 1101(d) would
establish an obligation for an introducing broker to revise its
policies and procedures following an execution quality comparison,
which is not explicitly required under the current FINRA and MSRB
rules.\240\ An introducing broker may consider it appropriate to change
its routing practices to the extent a material difference exists
between the execution quality provided by its existing executing broker
and the execution quality that might have been obtained from other
executing brokers. Alternatively, the Commission preliminarily believes
that an introducing broker could discuss the results of its review with
its executing broker and whether it is appropriate for the executing
broker to modify its order handling and execution practices in order to
provide better execution quality for the introducing broker's
customers.\241\ If the executing broker were to either provide a
reasonable explanation for the execution quality disparity identified
by the introducing broker or agree to modify its order handling and
execution practices in order to provide better execution quality, it
could be appropriate for the introducing broker to continue to retain
the services of its executing broker. Should the introducing broker's
regular review demonstrate persistent execution quality issues that are
not justifiable by the executing broker, the introducing broker should
consider retaining the services of another executing broker. As a
result, the Commission preliminarily believes that this regular review
process would promote competition among executing brokers and help
ensure that customer orders are executed consistently with the proposed
best execution standard.
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    \240\ See FINRA Rule 5310.09(c) (``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) can rely on that member's regular and
rigorous review as long as the statistical results and rationale of
the review are fully disclosed to the member and the member
periodically reviews how the review is conducted, as well as the
results of the review.''). See also MSRB Rule G-18.08(b) (``A dealer
that routes its customers' transactions to another dealer that has
agreed to handle those transactions as agent or riskless principal
for the customer (e.g., a clearing firm or other executing dealer)
may rely on that other dealer's periodic reviews as long as the
results and rationale of the review are fully disclosed to the
dealer and the dealer periodically reviews how the other dealer's
review is conducted and the results of the review.''). These
provisions do not obligate the broker-dealers that rely on the
regular and rigorous review of other broker-dealer under FINRA Rule
5310.09(c) and MSRB Rule G-18.08(b) to modify the order handling
arrangements if execution quality analysis merits modification.
    \241\ As part of this process, the introducing broker and
executing broker could assess why execution quality may be different
as between the executing broker and other executing brokers, and the
reason for these differences may inform the introducing broker's
decision as to whether to retain the executing broker or change
executing brokers. As discussed above with respect to proposed Rule
1101(c), an executing broker would be required to revise its best
execution policies and procedures, including its order handling and
routing practices, if warranted by its regular review of the
execution quality of the introducing broker's customer orders.
---------------------------------------------------------------------------

    Moreover, proposed Rule 1101(d) would require an introducing broker
to document the results of its execution quality review,\242\ which
would assist the introducing broker and regulators by helping to ensure
that the introducing broker maintains and retains a robust record of
the execution quality its customers receive from its executing

broker over time. This documentation should enable the introducing
broker to better evaluate the effectiveness of its executing broker on
an ongoing basis. This documentation would also help ensure that
regulators have access to information to effectively oversee the
introducing broker's efforts to satisfy its obligations under proposed
Rule 1101(d).
---------------------------------------------------------------------------

    \242\ See proposed amendments to Rule 17a-4; infra section IV.G
(describing the recordkeeping obligations applicable to any
documentation made pursuant to proposed Regulation Best Execution).
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on proposed Rule 1101(d) relating
to the proposed definitions of introducing broker and executing broker,
and the proposed exemptions for introducing brokers, and in particular:
    109. Are the proposed definitions of introducing broker (including
the three proposed conditions to qualify as an introducing broker) and
executing broker appropriate? If not, please explain whether and how
the definitions should be more broadly or narrowly drawn, including
whether certain market participants should be included or excluded from
the definitions.
    110. Do commenters believe the use of the term ``introducing
broker'' in proposed Regulation Best Execution is appropriate? Should
the Commission use an alternative term to describe the types of
entities contemplated by proposed Rule 1101(d)? If so, what alternative
term would be appropriate?
    111. Does an introducing broker typically exercise any discretion
with respect to how its customer orders are handled and executed by its
executing broker, beyond the selection of the executing broker? If so,
should the definition of introducing broker be modified in any manner
to account for this discretion by the introducing broker? Please
describe.
    112. Does an introducing broker typically have multiple executing
brokers or does it typically have an arrangement with only one
executing broker to handle and execute all of its customer orders?
    113. Are the proposed conditions concerning the arrangement between
the introducing broker and its executing broker appropriate? Please
explain.
    114. Is it appropriate to require the executing broker to handle
and execute all of the introducing broker's customer orders on an
agency basis in order for the introducing broker to meet the definition
of introducing broker under proposed Rule 1101(d)? Please explain.
    115. Do executing brokers, which can include many clearing firms
that provide these types of services to other broker-dealers, typically
execute transactions to fill an introducing broker's customer orders in
a riskless principal capacity? Do these executing brokers often use
inventory to fill the introducing broker's customer orders?
    116. Would the proposed condition that an executing broker execute
customer orders on an agency basis harm liquidity for the introducing
broker's customer orders for any asset class or classes? If so, please
explain. For example, is the principal trading desk of an executing
broker (e.g., clearing firm) in the corporate or municipal bond markets
and government securities markets an important source of potential
liquidity for the customers of an introducing broker?
    117. Does the proposed introducing broker definition and the
proposed approach concerning riskless principal trading appropriately
capture the manner in which introducing brokers and executing brokers
do business in the corporate and municipal bond markets and government
securities markets? Please explain.
    118. Should riskless principal transactions by an executing broker
disqualify the introducing broker from meeting the definition of
introducing broker under proposed Rule 1101(d)? Please explain.
    119. Is the description of a riskless principal trade in section
IV.E.1 above appropriate? Why or why not?
    120. In contrast to the discussion of riskless principal trades in
section IV.E.1 above, would it be more appropriate to require the two
legs of a riskless principal trade to be executed at the same price,
exclusive of any explicitly disclosed markup or markdown, commission
equivalent, or other fee? For example, should a riskless principal
trade for purposes of proposed Rule 1101(d)(2) be defined to mean: a
transaction in which the executing broker, after having received an
order from the introducing broker on behalf of its customer to buy a
security, buys the security from another person as principal to offset
a contemporaneous sale to such introducing broker on behalf of a
customer at the same price, or after having received an order to sell,
the executing broker sold the security to another person to offset a
contemporaneous purchase from the introducing broker on behalf of its
customer at the same price? Please explain. Would a potential benefit
of this alternative definition of riskless principal transaction be
that the bond transaction between the introducing broker and its
customer would reflect the entire markup or markdown on the customer's
trade, which would be disclosed to the customer pursuant to existing
FINRA and MSRB confirmation disclosure rules?
    121. Do commenters agree that principal trades by an executing
broker to fill fractional share orders in NMS stocks and riskless
principal trades by an executing broker in fixed income securities
should be order handling on an agency basis for purposes of proposed
Rule 1101(d)(2)? Why or why not? Are there additional types of
principal transactions that should also be considered order handling on
an agency basis for purposes of proposed Rule 1101(d)(2)? If so, please
describe.
    122. Do commenters agree with the proposed requirement that there
be no affiliation between an introducing broker and its executing
broker in order for the introducing broker to meet the definition of
introducing broker under proposed Rule 1101(d)? Why or why not?
    123. What is the typical relationship between an introducing broker
and its executing broker for handling and executing customer orders in
different asset classes?
    124. The proposal would prohibit a broker-dealer from receiving any
payment for order flow from its executing broker in order to qualify as
an introducing broker under proposed Rule 1101(d). Currently, to what
extent do introducing brokers accept payment for order flow for their
customer orders from an executing broker? What are the common payment
for order flow arrangements between introducing brokers and their
executing brokers?
    125. Do commenters agree with the proposed requirement that there
be no payment for order flow between an introducing broker and its
executing broker in order for the introducing broker to meet the
definition of introducing broker under proposed Rule 1101(d)? Please
explain. What are the implications for introducing brokers resulting
from the requirement that they not accept payment for order flow from
their executing brokers in order to qualify as introducing brokers
under proposed Rule 1101(d)?
    126. Should an executing broker be prohibited from accepting
payment for order flow from other broker-dealers that the executing
broker uses to execute the introducing broker's customer orders? Why or
why not?
    127. Do commenters agree that the proposed exemptions for
introducing brokers from proposed Rule 1101(a), (b), and (c) are
appropriate? Why or why not?
    128. Do commenters believe that the approaches taken by FINRA and
the MSRB with respect to the definition of introducing broker are
preferable to the

Commission's proposal? \243\ Please explain. Would an approach that is
more restrictive than the FINRA and MSRB approach but less restrictive
than the Commission's proposal be preferable? If so, please explain.
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    \243\ See supra notes 228-230 and accompanying text.
---------------------------------------------------------------------------

    The Commission also seeks comment on the proposed requirement that,
to avail itself of the exemptions under proposed Rule 1101(d), an
introducing broker must establish, maintain, and enforce policies and
procedures that require it to regularly review the execution quality
obtained from its executing broker, compare such execution quality with
the execution quality it might have obtained from other executing
brokers, and revise its routing practices accordingly. In particular:
    129. How do introducing brokers currently evaluate the execution
quality of their executing brokers? How often is this evaluation
typically performed?
    130. Would introducing brokers be able to obtain execution quality
information concerning other executing brokers? If so, how? Would
executing brokers have an incentive to share execution quality
information with introducing brokers for which they do not handle
orders or handle few orders?
    131. Would an introducing broker be able to perform a comparison of
execution quality received with execution quality that it might have
obtained from other executing brokers? Please explain any challenges in
making such a comparison and whether any challenges depend on the asset
class or classes involved. Please describe any distinctions that should
be drawn among executing brokers handling and executing orders in
various asset classes.
    132. Should the Commission require that an introducing broker
compare the execution quality received with the execution quality it
might have obtained from other executing brokers only to the extent
that such execution quality information is reasonably accessible to the
introducing broker? Please explain.
    133. Would introducing brokers have the capacity and resources to
independently compare the quality of executions received from their
executing brokers to the quality of executions that they might have
received from other executing brokers? Are introducing brokers likely
to rely on third parties to facilitate this comparison? Please explain.
    134. How frequently should an introducing broker be required to
perform a comparative analysis of execution quality as proposed in Rule
1101(d)? For example, should it be required quarterly, similar to what
FINRA requires under FINRA Rule 5310.09? Alternatively, should the
review be required with a different frequency, such as on a monthly,
semiannual, or annual basis, instead of quarterly? Please explain.
    135. Should introducing brokers be required to evaluate the
execution quality of a minimum number of alternative executing brokers
when they compare the execution quality received from their own
executing brokers? If so, how many and why?
    136. Would the proposed documentation requirement improve the
utility of an introducing broker's execution quality comparison? Why or
why not? Should the Commission require additional documentation to
supplement the documentation of the introducing broker's review? If so,
please explain.
    137. Rather than conducting the execution quality review under
proposed Rule 1101(d), should introducing brokers be subject to the
regular review of execution quality requirement under proposed Rule
1101(c)? Are there other factors that would make one more appropriate
for introducing brokers than the other? Please explain.
    138. Do commenters believe there are any concerns with the proposed
requirement that an introducing broker's policies and procedures
require it to revise its order handling practices to the extent
justified by its execution quality reviews? If so, please explain.
Should the Commission provide more specificity concerning when order
handling practices would be required to be revised? For example, should
the Commission specify that order handling practices be revised if
there are material differences between the execution quality received
from the executing broker and the execution quality that could have
been obtained from another executing broker?
    139. How do introducing brokers currently address execution quality
concerns relating to their executing brokers' order handling? Please
describe.
    140. Do introducing brokers have a number of executing brokers to
choose from when determining the firm they will use to handle and
execute their customer orders?
    141. Is the approach in FINRA Rule 5310.09(c) and MSRB Rule G-
18.08(b) preferable to the Commission's proposal? Why or why not? Would
some combination of the FINRA and MSRB approaches and the Commission's
proposal be preferable to either? Please explain.
    142. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1101(d) for broker-dealers
of different sizes, if the Commission adopts proposed Regulation Best
Execution? For example, should the Commission provide longer compliance
dates for smaller broker-dealers? If so, should the Commission define a
smaller broker-dealer as a broker-dealer that qualifies as a ``small
entity'' under the Regulatory Flexibility Act pursuant to 17 CFR 240.0-
10(c) for this purpose? \244\ Or should the Commission define a smaller
broker-dealer in a different way? Please explain.
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    \244\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
---------------------------------------------------------------------------

F. Proposed Rule 1102--Annual Report

    Proposed Rule 1102 would require a broker-dealer that effects any
transaction for or with a customer or a customer of another broker-
dealer to, no less frequently than annually, review and assess the
design and overall effectiveness of its best execution policies and
procedures, including its order handling practices. Such review and
assessment would be required to be conducted in accordance with written
procedures and would be required to be documented.\245\ The broker-
dealer also would be required to prepare a written report detailing the
results of such review and assessment, including a description of all
deficiencies found and any plan to address such deficiencies. The
report would be required to be presented to the board of directors (or
equivalent governing body) of the broker-dealer. The proposed annual
review requirement is designed to require broker-dealers to evaluate
whether their best execution policies and procedures continue to work
as designed and whether changes are needed to ensure their continued
effectiveness.
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    \245\ The Commission believes that broker-dealers currently have
written compliance procedures reasonably designed to review their
business activity, which a broker-dealer could update to document
the method in which the broker-dealer plans to conduct its review
pursuant to proposed Rule 1102.
---------------------------------------------------------------------------

    In assessing the overall effectiveness of its best execution
policies and procedures, a broker-dealer should consider its policies
and procedures holistically, and may utilize its execution quality
reviews and any documentation with respect to conflicted transactions
prepared during

the course of the review period.\246\ Although proposed Rule 1101(c),
as discussed in section IV.D above, would require a broker-dealer to
implement an at least quarterly review of the execution quality of its
customer transactions, the annual review requirement in proposed Rule
1102 would be a broader, more holistic review of the broker-dealer's
policies and procedures not focused solely on execution quality. As
part of its annual review, a broker-dealer may review the findings of
its execution quality reviews in conjunction with its overall review of
its policies and procedures, to the extent it would assist the broker-
dealer in identifying any inadequacies and supporting any revisions to
its best execution policies and procedures, including its order
handling practices, as appropriate.\247\ Ongoing changes in order
handling technology and differing broker-dealer trading models and
practices may present a need for a broker-dealer to reconsider its best
execution policies and procedures in a way that is not identified
during the course of a broker-dealer's regular execution quality
reviews conducted pursuant to proposed Rule 1101(c). For example, the
proposed annual review process may encourage the broker-dealer to
consider investments in new technologies to improve its overall best
execution process, despite the fact that the broker-dealer has not
identified any issues with its existing execution quality. Accordingly,
the Commission believes that the proposed annual review requirement,
including the associated written report that would be presented to the
broker-dealer's board of directors or equivalent governing body, would
create a robust internal compliance process under the oversight of the
highest level of a broker-dealer's internal governance to help ensure
the broker-dealer maintains robust best execution policies and
procedures and complies with proposed Regulation Best Execution. The
written report prepared pursuant to proposed Rule 1102 would also help
regulators better understand the broker-dealer's compliance with
proposed Regulation Best Execution.
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    \246\ While a broker-dealer that qualifies as an introducing
broker under proposed Rule 1101(d) would need to conduct a review
and prepare a written report pursuant to proposed Rule 1102, an
introducing broker's review should appropriately reflect its
obligations under proposed Rule 1101(d), rather than the aspects of
proposed Rules 1101(a), (b), and (c) that would be considered as
part of the executing broker's annual review.
    \247\ By utilizing its regular reviews of execution quality as
part of its annual review, a broker-dealer may avoid any duplication
of efforts to the extent it needs to conduct any execution quality
analysis in order to assess the overall effectiveness of its best
execution policies and procedures as required by proposed Rule 1102.
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    FINRA's best execution rule does not require a periodic review of a
broker-dealer's best execution policies and procedures.\248\ However,
FINRA Rule 3130(c) requires a broker-dealer to have a report that
describes its processes to: establish, maintain, and review its
policies and procedures reasonably designed to achieve compliance with
applicable FINRA rules, MSRB rules, and Federal securities laws and
regulations; modify such policies and procedures as changes and events
dictate; and test the effectiveness of such policies and procedures on
a periodic basis, the timing and extent of which is reasonably designed
to ensure continuing compliance with FINRA rules, MSRB rules, and
Federal securities laws and regulations. FINRA Rule 3130(c) further
requires the broker-dealer's chief executive officer(s) (or equivalent
officer(s)) to certify to the existence of such processes, and to
certify that the report of such processes has been submitted to the
broker-dealer's board of directors and audit committee (or equivalent
bodies). The Commission understands that, currently, broker-dealers
periodically review their policies and procedures (including those
related to best execution), although the frequency of review may vary.
However, because the Commission is proposing its own best execution
rule, proposed Rule 1102 would help ensure the effectiveness of the
broker-dealer's best execution policies and procedures that it adopts
pursuant to the proposed rules.
---------------------------------------------------------------------------

    \248\ FINRA Rule 5310.
---------------------------------------------------------------------------

    MSRB Rule G-18.08(a) requires a broker-dealer to, at a minimum,
conduct annual reviews of its policies and procedures for determining
the best available market for the executions of its customers'
transactions. In conducting these reviews, a dealer must assess whether
its policies and procedures are reasonably designed to achieve best
execution, taking into account the quality of the executions the dealer
is obtaining under its current policies and procedures, changes in
market structure, new entrants, the availability of additional pre-
trade and post-trade data, and the availability of new technologies,
and to make promptly any necessary modifications to such policies and
procedures as may be appropriate in light of such reviews. As described
above in connection with the FINRA rules, because the Commission is
proposing its own best execution rule, proposed Rule 1102 would help
ensure the effectiveness of the broker-dealer's best execution policies
and procedures that it adopts pursuant to the proposed rules. Moreover,
as compared to MSRB Rule G-18.08(a), proposed Rule 1102 would include a
specific requirement that a broker-dealer review its order handling
practices, require that a report be maintained of this annual review,
and require that the broker-dealer provide the annual report to its
governing body.
Request for Comment
    The Commission requests comment on all aspects of proposed Rule
1102, and in particular:
    143. Should a broker-dealer be required to have written procedures
for annual (or more frequent) reviews of the overall effectiveness of
its best execution policies and procedures, including its order
handling practices, and be required to document such review, as
proposed? Why or why not?
    144. Would the proposed requirement for written procedures for
annual (or more frequent) reviews help to ensure the overall
effectiveness of a broker-dealer's best execution policies and
procedures? Why or why not?
    145. Should a broker-dealer be required to prepare a written report
detailing the results of its review, including any plan to address
deficiencies, as proposed? Why or why not? Should the Commission
require specific information to be included in the written report? If
so, what specific information should be required?
    146. Should the written report of the review be presented to the
broker-dealer's board of directors (or equivalent governing body), as
proposed? Why or why not?
    147. Would the proposed requirement for annual (or more frequent)
reviews and for presenting written reports of the reviews to the board
of directors help to ensure a broker-dealer's compliance with proposed
Regulation Best Execution? Why or why not?
    148. Should a broker-dealer's board of directors (or governing
body) also be required to approve the best execution policies and
procedures that would initially be established under proposed
Regulation Best Execution? Please explain.
    149. Do commenters agree with the Commission's understanding that,
currently, broker-dealers periodically review their best execution
policies and procedures? Please describe the rigor of any such reviews,
whether broker-dealers document such reviews, and whether broker-
dealers present the results of such reviews to their boards of
directors (or equivalent governing bodies).

    150. Do commenters agree with the Commission's understanding that
such reviews vary in frequency among broker-dealers? Please describe
the frequency of such reviews. Does the frequency of review vary
depending on whether the broker-dealer is subject to the FINRA rules or
the MSRB rules? Please explain.
    151. Should management, a committee, or an expert be designated to
conduct the annual review and prepare the report? Should specific
experience or expertise be required to conduct the annual review and
prepare the report? Would additional specificity in the rule promote
accountability over the annual review and report and ensure that
adequate resources are devoted to such review and report? Why or why
not?
    152. Does the annual review raise any particular challenges for
smaller broker-dealers? If so, what could the Commission do to mitigate
those challenges?
    153. Are there any conflicts of interest if the same personnel that
designs or implements the policies and procedures also conduct the
annual reviews? If so, how can those conflicts be mitigated or
eliminated? Should broker-dealers be required to have their policies
and procedures periodically audited by an unaffiliated third party to
assess their design and effectiveness? Why or why not? If so, should
the rule define the term ``affiliate'' to specify the entities that
would be eligible to perform such an audit and should the Commission
use the definition of ``affiliate'' in proposed Rule 1101(b)(4)(iii)
for this purpose? Please explain. What types of unaffiliated third
parties might have the necessary specific experience and expertise to
review a broker-dealer's best execution policies and procedures? For
example, should an unaffiliated consulting firm, accounting firm, or
law firm be permitted to provide this service, if required? Should the
rule prescribe the types of unaffiliated third parties that would have
the requisite experience and expertise? Please explain.
    154. Do commenters believe that the Commission should provide
staggered compliance dates for proposed Rule 1102 for broker-dealers of
different sizes, if the Commission adopts proposed Regulation Best
Execution? For example, should the Commission provide longer compliance
dates for smaller broker-dealers? If so, should the Commission define a
smaller broker-dealer as a broker-dealer that qualifies as a ``small
entity'' under the Regulatory Flexibility Act pursuant to 17 CFR 240.0-
10(c) for this purpose? \249\ Or should the Commission define a smaller
broker-dealer in a different way? Please explain.
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    \249\ See supra note 151 and accompanying text (describing the
broker-dealers that qualify as small entities under the Regulatory
Flexibility Act).
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G. Recordkeeping Requirements Under Rule 17a-4

    In connection with proposed Regulation Best Execution, the
Commission is proposing new recordkeeping requirements for broker-
dealers. Section 17(a)(1) of the Exchange Act requires registered
broker-dealers to keep for prescribed periods such records as the
Commission prescribes as necessary or appropriate in the public
interest, for the protection of investors, or otherwise in furtherance
of the purposes of the Exchange Act.\250\ Rule 17a-4 under the Exchange
Act specifies how long broker-dealers must preserve required records
and other documents.\251\
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    \250\ 15 U.S.C. 78q(a)(1).
    \251\ 17 CFR 240.17a-4.
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    Proposed Regulation Best Execution would require broker-dealers to
make the following records:
     Policies and procedures under proposed Rules 1101(a), (b),
and (d) and Rule 1102;
     Documentation of compliance with the best execution
standard for conflicted transactions under proposed Rule 1101(b);
     Documentation of payment for order flow arrangements under
proposed Rule 1101(b);
     Documentation of the results of the regular review of
execution quality under proposed Rule 1101(c);
     Documentation of the results of the regular review of
execution quality by introducing brokers under proposed Rule 1101(d);
     Documentation of the annual review under proposed Rule
1102; and
     Annual report under proposed Rule 1102.
    Current Rule 17a-4(e)(7) under the Exchange Act would apply to the
policies and procedures required by proposed Regulation Best
Execution.\252\ The Commission proposes to amend Rule 17a-4 to add new
paragraph (b)(17) to require broker-dealers to preserve all other
records made pursuant to proposed Rules 1101 and 1102 for a period of
not less than three years, the first two years in a readily accessible
place.
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    \252\ Rule 17a-4(e)(7) requires broker-dealers to maintain and
preserve in an easily accessible place compliance, supervisory, and
procedures manuals (and any updates, modifications, and revisions
thereto) describing the policies and practices of the broker-dealer
with respect to compliance with applicable laws and rules, and
supervision of the activities of associated persons until three
years after the termination of the use of the manual. 17 CFR
240.17a-4(e)(7).
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    The Commission preliminarily believes that the preservation of
records made pursuant to proposed Regulation Best Execution for this
time period would assist broker-dealers in ensuring that they continue
to maintain robust best execution practices for an appropriate amount
of time. In addition, the preservation and availability of records that
support and document broker-dealers' compliance with proposed
Regulation Best Execution would also assist the Commission and SROs in
assessing the broker-dealer's efforts to comply with proposed
Regulation Best Execution.
Request for Comment
    The Commission requests comment on the proposed record preservation
requirements related to proposed Regulation Best Execution:
    155. Should all records made pursuant to proposed Regulation Best
Execution be required to be preserved? Please explain.
    156. Do commenters agree that the policies and procedures required
by proposed Regulation Best Execution should be subject to Rule 17a-
4(e)(7) and preserved until three years after the termination of their
use? Please explain.
    157. Do commenters agree that all other records required by
proposed Regulation Best Execution should be subject to Rule 17a-4(b)
and preserved for a period of not less than three years, the first two
years in a readily accessible place? Please explain.
    158. Should the Commission impose additional record preservation
requirements related to proposed Regulation Best Execution? Why or why
not? If the Commission were to impose additional requirements, what
specific records should broker-dealers be required to preserve? Please
explain.

V. Economic Analysis

A. Introduction

    The Commission is mindful of the economic effects that may result
from proposed Regulation Best Execution, including the benefits, costs,
and the effects on efficiency, competition, and capital formation.\253\
This section

analyzes the expected economic effects of proposed Regulation Best
Execution relative to the current baseline, which consists of the
current market and regulatory framework in existence today.
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    \253\ Exchange Act Section 3(f) requires the Commission, when it
is engaged in rulemaking pursuant to the Exchange Act, and is
required to consider or determine whether an action is necessary or
appropriate in the public interest, to consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f). In
addition, Exchange Act Section 23(a)(2) requires the Commission,
when making rules pursuant to the Exchange Act, to consider among
other matters, the impact that any such rule would have on
competition, and not to adopt any rule that would impose a burden on
competition that is not necessary or appropriate in furtherance of
the purposes of the Exchange Act. See 15 U.S.C. 78w(a)(2).
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    A broker-dealer's duty of best execution predates the Federal
securities laws and, as noted previously, has ``its roots in the common
law agency obligations of undivided loyalty and reasonable care that an
agent owes to his principal.'' \254\ In general terms, the Commission
position is, and has been, that ``the duty of best execution requires
broker-dealers to execute customers' trades at the most favorable terms
reasonably available under the circumstances, i.e., at the best
reasonably available price.''\255\ FINRA Rule 5310(a) and MSRB Rule G-
18(a) codify essentially the same requirement that members must ``use
reasonable diligence to ascertain the best market for the subject
security and buy or sell [there] so that the resultant price to the
customer is as favorable as possible under prevailing market
conditions.''
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    \254\ Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc.,
135 F.3d 266, 270, n. 30 (3rd Cir. 1998). As the Commission
explained when adopting rules governing payment for order flow
almost three decades ago, ``[a] broker-dealer's duty to seek to
obtain best execution of customer orders derives, in part, from the
common law agency duty of loyalty, which obligates an agent to act
exclusively in the principal's best interest. Restatement (Second)
of Agency section 387 (1958). Thus, when an agent acts on behalf of
a customer in a transaction, the agent is under a duty to exercise
reasonable care to obtain the most advantageous terms for the
customer. Id. at section 424.'' Payment For Order Flow Release,
supra note 33, at n. 15.
    \255\ Regulation NMS Adopting Release, supra note 21, at 37538
(citations omitted). See also, Special Study, supra note 10, at 623
(``A broker-dealer acting as an agent for a customer in the
execution of a transaction assumes the obligations of a fiduciary .
. . . A corollary of the fiduciary's duty of loyalty to his
principal is his duty to obtain or dispose of property for his
principal at the best price discoverable in the exercise of
reasonable diligence.'') (citations omitted), available athttps://www.sechistorical.org/collection/papers/1960/1963_SSMkt_Chapter_07_2.pdf
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    The duty of best execution is a foundational component of the
current best execution regulatory framework that helps protect
investors in a setting of imperfect markets. The duty serves to
counteract market failures that arise, for example, when an agent (in
this case, a broker or broker-dealer) has different incentives than a
principal (investor), and the principal, particularly the retail
investor, is not in a position to monitor the agent. This is known in
economics as a principal-agent problem.\256\ A principal-agent problem
arises when a broker-dealer undertakes costly actions to achieve best
execution and the principal (investor) cannot observe the broker-
dealer's actions. The broker-dealer in this situation has financial
incentives to take (or not take) certain actions to reduce its costs or
increase its profits.
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    \256\ See Joseph E. Stiglitz, Principal and Agent, in
Allocation, Information and Markets 241 (John Eatwell et al. eds.,
1989).
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    The principal-agent problem can be exacerbated by a specific
conflict of interest that arises when the broker-dealer executes a
customer order in a principal capacity.\257\ In these instances, the
broker-dealer acting as principal on the trade has a financial
incentive to maximize its gains from the trade, which would be at the
expense of the counterparty, here the broker-dealer's customer, in a
zero-sum game.\258\ This conflict of interest should be mitigated
because the broker-dealer as agent for its customer also has a duty to
ensure that the order was executed at the most favorable terms
reasonably available to the customer under the circumstances. However,
retail customers typically lack access to the information that would