[Federal Register Volume 59, Number 211 (Wednesday, November 2, 1994)]
[Proposed Rules]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-27108]
[[Page Unknown]]
[Federal Register: November 2, 1994]
Federal Register / Vol. 59, No. 211 / Wednesday, November 2, 1994 /
Proposed Rules
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-34903; File No. S7-30-94]
RIN 3235-AG00
Internalized/Affiliate Practices, Payment for Order Flow and
Order Routing Practices
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rulemaking.
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SUMMARY: The Securities and Exchange Commission is proposing to revise
its rules governing disclosure to customers by broker-dealers of
practices related to the routing of order flow, including payment for
order flow, internalization of order flow, and affiliate practices. The
proposed amendments are intended to provide customers with more useful
information in evaluating the quality of executions.
DATES: Comments should be submitted on or before December 15, 1994.
ADDRESSES: Interested persons should submit three copies of their
written data, views and opinions to Jonathan G. Katz, Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549, and should refer to File No. S7-30-94. All submissions will
be made available for public inspection and copying at the Commission's
Public Reference Room, Room 1024, 450 Fifth Street, NW., Washington DC
20549.
FOR FURTHER INFORMATION CONTACT:
Jill W. Ostergaard, 202/942-3197, Attorney, Office of Market
Supervision, Division of Market Regulation, Securities and Exchange
Commission (Mail Stop 5-1), 450 5th Street, NW., Washington DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction and Background
The Securities and Exchange Commission (``SEC'' or ``Commission'')
is proposing to amend its rules governing disclosure of broker-dealer
payment for order flow and the practice of executing orders as
principal or routing orders to an affiliated broker-dealer or exchange
specialist (``internalized/affiliate practices''), Rule 10b-10 (17 CFR
240.10b-10) and Rule 11Ac1-3 (17 CFR 240.11Ac1-3) under the Securities
Exchange Act of 1934 (``Act''). As described below and in a related
release, both payment for order flow and internalized/affiliate
practices have been the subject of extensive debate.1
\1\See Securities Exchange Act Release No. 34902 (October 27,
1994) (``Adopting Release'').
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The proposed Rule amendments regarding payment for order flow also
are intended to enhance disclosure to customers of compensation their
broker-dealer may receive from market centers2 in return for
routing customer orders to them for execution.3 The amendments
would require broker-dealers receiving payment for order flow to
provide customers additional information regarding the value of the
compensation received. The proposed additional disclosures would
include, for monetary payment for order flow, the range of payments
received on a per share basis and on an aggregate basis annually, and
for non-monetary payment for order flow, an estimate of the range of
payment for order flow on a per share basis and on an aggregate basis
annually. These disclosures would be required when a customer opens an
account, on an annual basis thereafter, and in abbreviated fashion on
required confirmations. The proposed amendments would require similar
disclosure with respect to the value of order flow subject to
internalized/affiliate practices.
\2\As used in this release, the term market center includes
exchanges and dealers acting as market makers. See 17 CFR 240.11Ac1-
2(a)(14) (defining ``reporting market center'').
\3\The Commission is also soliciting comment whether certain
inducements to routing order flow should be included in the
definition of payment for order flow.
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The Commission also is proposing that broker-dealers disclose to
their customers information regarding their order routing practices
generally, regardless of whether they receive payment for order flow or
engage in internalized/affiliate practices.
The proposed amendments regarding internalized/affiliate practices
are intended to address comments the Commission received in connection
with its consideration of payment for order flow practices and to
elicit further discussion regarding their implications. In connection
with the Adopting Release, six commenters indicated that the
internalization of order flow by broker-dealers presents issues similar
to those commonly associated with payment for order flow. These
commenters argued that the opportunity to capture the spread through
internalized/affiliate practices encourages broker-dealers to execute
orders in house or to send orders to an affiliated broker-dealer or
exchange specialist. At the most basic level, under each practice the
broker-dealer is influenced with respect to where it will route
customer orders.
The proposed amendments would require broker-dealers to inform
customers on new account and annual disclosure statements whether they
execute orders as principal or route those orders to affiliated firms.
These amendments are designed to provide customers with more
information about firms' order routing decisions, especially in light
of changes that might result from requiring additional disclosure of
payment for order flow practices.
Finally, the proposed rule amendments would extend confirmation and
account statement disclosure of payment for order flow to transactions
in standardized options.
In the Adopting Release issued today, the Commission adopted
requirements for additional disclosure of payment for order flow
practices.4 Commenters are encouraged to review the Adopting
Release in considering the amendments proposed today. The discussion
that follows describes the proposed amendments and solicits views
regarding those amendments.
\4\See Adopting Release, supra note 1.
II. Discussion
A. Definition and Quantification of Payment for Order Flow
The proposed amendments would require broker-dealers to provide
more detailed information to customers regarding payment for order
flow. The proposed amendments would require broker-dealers receiving
monetary payment for order flow to disclose the range of payments
received on a per share basis and the aggregate amount of payment for
order flow received on an annual basis, and, for non-monetary payment
for order flow, to disclose an estimate of the range of non-monetary
payment for order flow received by the broker-dealer on a per share
basis and on an aggregate basis annually.
1. Definition of Payment for Order Flow
The Commission, in the Adopting Release, adopted a definition of
payment for order flow that includes monetary payments, services,
property or any other benefit offered for order flow that results in
remuneration to the firm in return for the routing of customer orders
for execution. As discussed below, the proposed amendments would
establish definitions of monetary and non-monetary payment for order
flow, defining monetary payment for order flow as any monetary payment,
discount, rebate or reduction of fee to the extent that the payment,
discount, rebate or reduction exceeds the fee charged. At the same
time, however, the Commission is concerned that other practices used by
market centers are designed to induce broker-dealers to direct order
flow, and, therefore, may present issues similar to those practices
currently defined as payment for order flow in the Adopting Release.
The Commission is soliciting comment on whether to expand the
definition of payment for order flow. Specifically, the Commission is
considering expanding the definition to include volume discounts,
rebates, reductions or other inducements for order flow, even if not in
excess of the execution fee charged by a market center.5
Commenters should specifically indicate which practices should be
included in the definition to provide the maximum benefit to investors
and encourage equivalent regulatory treatment among competing market
centers consistent with the purposes of the Act.
\5\Some commenters have suggested that there is no distinction
between cash payment for order flow and these inducements. See
``Inducements for Order Flow,'' A Report to the Board of Governors,
NASD, July 1991.
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The Commission also requests the views of commenters as to whether
a differential in fees between competing market centers should be
considered as the economic equivalent of payment for order flow for
either or both general disclosure and quantification purposes. This
differential might be viewed as affecting the order routing
determination of a broker-dealer in a manner similar to payment for
order flow.
Commenters also are asked to address why payment for order flow
should exist in certain instances, but not others, when the inducement
for order flow to be routed to one market center or another is
identical in both instances. For example, assume that one market center
currently pays $.02 per share for order flow, while a competing market
center charges a fee of $.05 per share to handle customer orders,
resulting in an overall differential of $.07 per share. Under the
current definition, the first market center would be deemed to be
paying for order flow, quantified as $.02 per share. Why should payment
for order flow be deemed to no longer exist where, as a result of a
$.02 per share increase in costs uniformly incurred by all market
centers, the first market center simply ceased paying for order flow in
favor of handling customer orders without charge, while its competitor
proportionately increased the fees charged for handling customer orders
to $.07 per share? In this instance, the first market center maintains
the identical differential in terms of the inducement to broker-dealers
to direct order flow to the first market center, as opposed to the
second.
In a related manner, commenters are requested to indicate whether
the proposed quantification of payment for order flow (discussed more
fully in the next Section) accurately reflects the inducement to a
broker-dealer to route orders to a particular market center. For
instance, in the example noted above, is the amount of the inducement
that should be disclosed in connection with payment for order flow paid
by the first market center $.02 per share, as would be the case under
the current definition of payment for order flow in Rule 11Ac1-3, or
does the $.07 per share differential more accurately reflect the level
of inducement for order flow?
2. Quantification of Payment for Order Flow
The proposed amendments would establish definitions of ``monetary
payment for order flow'' and ``non-monetary payment for order flow.''
The term monetary payment for order flow would be defined in section
10b-10(e)(10) to mean ``any monetary payment, discount, rebate or
reduction of fee to the extent that the payment, discount, rebate or
reduction exceeds the fee charged.'' The term non-monetary payment for
order flow would be defined in section 10b-10(e)(11) to mean ``any
payment for order flow received other than monetary payment for order
flow.''
The Adopting Release, while requiring additional disclosure of
payment for order flow practices, does not require disclosure of the
amount of any payment for order flow. Certain of the proposed
amendments to Rule 11Ac1-3 would focus on this disclosure. For monetary
payment for order flow, the broker-dealer would be required by Rule
11Ac1-3(a) (3) and (4) to disclose the aggregate amount of monetary
payment for order flow received annually, and the range of monetary
payment for order flow received on a per share basis. The proposed
amendments to Rule 11Ac1-3(a) (5) and (6) would require broker-dealers
to disclose to customers at account opening and annually thereafter, an
estimate of the aggregate value of non-monetary payment for order flow
received by the broker-dealer in return for directing order flow on an
annual basis, and an estimate of the range of non-monetary payment for
order flow received on a per share basis.
The proposal calls for an estimate of non-monetary payment for
order flow, recognizing that precision may not be possible. To the
extent that a broker-dealer finds it difficult to estimate the per
share value of non-monetary payment for order flow, the Commission
would envision permitting the broker-dealer to assume the value of the
non-monetary compensation was equal to the cash per share payment for
order flow received from the same source, or, if none, similar sources.
The assumption would be that a broker-dealer, in choosing the form of
payment for order flow, would demand a value that is commensurate with
the amount of cash that could be received from the same or competing
market maker or specialist. Commenters are requested to identify
alternative methods by which firms might arrive at an estimate of the
value of non-monetary payment for order flow.\6\
\6\Commenters are also requested to indicate the extent to which
valuations may vary depending on the form of non-monetary
compensation or other factors, and whether this would pose problems
for estimating and disclosing the valuations.
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The proposed rule would require an estimate of the range of non-
monetary payment for order flow received by the broker-dealer expressed
on a per share basis. To comply with this requirement, broker-dealers
would be expected to use the estimate required by Rule 11Ac1-3(a)(5) in
calculating the range of values to be disclosed. The proposed rule
would recognize expressly that the calculation of values represents an
estimate.\7\
\7\One commenter believes that value estimates of non-monetary
compensation may be based on fair value as determined in good faith
by the management of the broker-dealer. See letter from Alan B.
Levenson, Fulbright & Jaworski L.L.P. and Irving M. Pollack (on
behalf of Herzog, Heine, Geduld, Inc.), to Jonathan G. Katz,
Secretary, SEC, dated December 9, 1993.
The Commission also is proposing to require broker-dealers who
receive payment for routing orders to include information on the
confirmation. Proposed Rule 10b-10(a)(7)(B) would require, for any
monetary payment for order flow received, confirmation disclosure of
the range of payments received on a per share basis. Proposed Rule 10b-
10(a)(7)(iii)(C) would require, for any non-monetary payment for order
flow received, an estimate by the broker-dealer of the range in value
of non-monetary compensation on a per share basis. Because it may not
be possible to identify immediately after execution which orders are
subject to payment for order flow arrangements or the pro rata value of
a specific order, the Commission is proposing to require disclosure of
an estimate of the range in value of compensation that may have been
received, stated on a per share basis. Proposed Rule 10b-10(a)(7)(iii)
(B) and (C) also would require, for any non-monetary payment for order
flow received, a statement that the nature and source of such
compensation will be furnished upon written request of the customer.
In crafting the proposed amendments, the Commission is mindful of
the concern that requiring quantification of monetary but not non-
monetary payment for order flow could result in broker-dealers moving
toward potentially undisclosed compensatory practices, such as non-
monetary payment for order flow.\8\ Thus, it has sought to require
disclosure of non-monetary payment for order flow similar to the
disclosure requirements established for monetary payment for order
flow. This is intended to provide customers with equivalent information
to evaluate a broker-dealer's order routing arrangements, and to remove
any regulatory disparity between monetary and non-monetary payments.
\8\Some commenters argue that treating monetary and non-monetary
payment for order flow differently creates an incentive for dealers
to restructure cash payment arrangements into payments in kind.
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The Commission invites commenters to address whether the proposed
amendments would accomplish these goals, and whether there are other
ways to accomplish these goals. The Commission specifically requests
comment on the ability of broker-dealers to determine whether a non-
monetary payment is in return for order flow, and their ability to
estimate the value of the various forms of non-monetary payments.
B. Internalized/Affiliate Practices
Rule 11Ac1-3, as adopted, requires broker-dealers who receive
payment for order flow to disclose their policies for determining where
to route orders that are subject to payment for order flow absent
specific instructions from customers. That Rule would not expressly
require broker-dealers to provide information about their order routing
policies if instead of receiving payment for order flow in return for
routing orders, they simply executed the orders for their own
account.\9\
\9\In recent years, multi-service broker-dealers, clearing
firms, and others have acquired interests in specialist units,
particularly on regional exchanges, although several specialists on
the New York Stock Exchange (``NYSE'') and American Stock Exchange
(``Amex'') are affiliated with upstairs firms. These firms then
route small customer orders for execution to their affiliated
specialist. See Division of Market Regulation, Securities and
Exchange Commission, Market 2000: An Examination of Current Equity
Market Developments (Jan. 1994) (``Market 2000''), Study II at 9 and
Exhibit 29.
The Commission recently discussed the potential implications of
internalization for the structure of the national market system in
the context of proposals by two national securities exchanges to
establish or extend marketplace programs that might facilitate
internalization practices. See Securities Exchange Act Release Nos.
34078 (May 18, 1994), 59 FR 27082 (May 25, 1994) (File No. SR-BSE-
93-12); 34493 (August 5, 1994), 59 FR 41531 (August 12, 1994) (File
No. SR-CSE-94-06). Internalized/affiliate practices also were
discussed in Congressional hearings on market structure a few months
ago and, earlier this year, the Division of Market Regulation
discussed this topic in its Market 2000 Report. See Market 2000,
Study II at 9 and Exhibit 29; Oversight Hearing on the Structure of
the Marketplace with a Focus on the Market 2000 Report and the
Unlisted Trading Privileges Act of 1994 Before the Subcomm. on
Telecommunications and Finance of the House Comm. on Energy and
Commerce, 103d Cong., 2d Sess. (1994).
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The Commission is concerned that internalized/affiliate practices
may raise questions similar to payment for order flow practices
regarding the obligations of brokers to their customers, such as
whether firms that internalize order flow are providing best execution
of customer orders.\10\ In proposing Rule 11Ac1-3 in October 1993, the
Commission invited comment on the implications of these practices and
whether additional disclosure would be desirable.\11\ Seven commenters
addressed internalization/affiliate practices; six favored a regulatory
response\12\ and one opposed it.\13\
\10\An extensive discussion of the ``best execution'' obligation
appears in the Adopting Release as well as the release proposing
Rule 11Ac1-3 for comment. See Adopting Release, supra note 1 at
nn.26-36 and accompanying text; Securities Exchange Act Release No.
33026 (October 6, 1993) 58 FR 52934, 52937-52938 (October 13, 1993)
(``October 1993 Proposing Release'').
\11\See Id. at n.38.
\12\Letters to Jonathan G. Katz, Secretary, SEC, from: Jules L.
Winters, Chief Operating Officer, American Stock Exchange
(``Amex''), dated December 21, 1993 (``Amex letter''); Robert F.
Price, Managing Director, Alex. Brown & Sons, Inc., dated December
23, 1993; George A. Brown, Brown & Company, dated December 2, 1993;
John N. Tognino, Executive Vice President, Capital Markets and
Trading, Charles Schwab & Co. Inc., dated December 8, 1993; Chris A.
Hynes, President, State Street Brokerage Services, Inc., dated
December 1, 1993 (``State Street letter''); and Thomas W. Clegg,
Sr., Vice President, Wheat First Securities, Inc., dated November
30, 1993.
The Amex stated that internalization impedes price discovery and
makes best execution less likely, and because internalized order
flow provides the executing market maker with a dealer spread on
every internalized trade, there is little incentive for the dealer
to narrow the quoted spread. See Amex letter. One brokerage firm
argued that the failure to regulate internalization creates a
competitive advantage for large integrated firms. See State Street
letter.
\13\This commenter noted that in an exchange environment, ``the
continuous affirmative obligations imposed on exchange specialists
and the auction-type trading process inherent in trading on
exchanges limit the extent to which internalization can be
accomplished.'' See letter from John I. Fitzgerald, Executive Vice
President, Legal Affairs and Trading Services, Boston Stock
Exchange, Inc., to Jonathan G. Katz, Secretary, SEC, dated December
10, 1993.
The Commission is proposing to amend Rule 11Ac1-3 to require
broker-dealers who choose to internalize or route orders to affiliated
organizations to provide information about this policy parallel to the
information that Rule 11Ac1-3 requires them to provide concerning the
routing of orders in return for payment for order flow. As defined in
proposed Rule 10b-10(e)(12), internalized/affiliate order routing
practices shall mean the execution of an order by a broker-dealer as
principal, or the routing of an order by the broker-dealer to an
affiliated broker-dealer or exchange member. Specifically, the
amendment to Rule 11Ac1-3(a)(2) would require firms to disclose their
policies for determining where to route customers' orders, absent
specific instructions from customers, including whether orders are
executed as principal, orders are routed to an affiliated broker-
dealer, or to an unaffiliated broker-dealer or market center, including
a description of the extent to which orders can be executed at prices
superior to the NBBO.
The Commission also is proposing to extend the confirmation and
account statement valuation requirements to internalized/affiliate
order flow practices. The Commission requests comment on this aspect of
the proposed rule and the ability of broker-dealers to estimate the
value of internalized/affiliate order flow. The Commission realizes
that, as in the case of non-monetary payment for order flow, precision
in this area may not be possible. Therefore, the Commission seeks the
views of commenters as to whether the value of internalized order flow
may be reasonably approximated by reference to the monetary amount per
share that a broker-dealer could have received for such order flow from
a competing market center, or by other methods, such as by measuring
the difference between the spread received by a broker-dealer engaging
in internalized/affiliate practices and the amount that the broker-
dealer could have received for the order flow from another market
center.14
\14\The Commission is concerned that to the extent that the
value of monetary and non-monetary payment for order flow are
quantified but the value of orders subject to internalized/affiliate
practices are not, broker-dealers may be encouraged to engage in the
latter practices to a greater degree.
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The Commission invites commenters to address whether the proposed
amendment would provide customers with meaningful information and would
further the goals of section 11A of the Act. To the extent that they
believe payment for order flow and internalized/affiliate practices
should be treated differently for regulatory purposes, commenters are
requested to indicate why concerns with respect to internalization are
less compelling than those frequently associated with payment for order
flow practices. Similarly, the Commission recognizes that the unequal
regulatory treatment of internalized order flow may result in an
increase in the amount of customer orders that are executed directly by
a broker-dealer or its affiliates.
C. Order Routing Disclosure
As proposed, Rule 11Ac1-3(a)(2) would require all broker-dealers to
disclose their policies for determining where to route customer orders
absent specific instructions from the customer, as well as a
description of the extent to which orders may receive price
improvement. If adopted, this disclosure currently required under Rule
11Ac1-2 would be required for all orders, regardless of whether the
broker-dealer received payment for order flow or engaged in
internalized/affiliate order routing practices.
The Commission believes that the proposed disclosure of order
routing practices is consistent with its goal of providing customers
with information to enhance their ability to evaluate the quality of
execution received, and to make informed decisions with respect to the
selection of broker-dealers. Under Rule 10b-10 of the Act, the
Commission currently requires broker-dealers to disclose their capacity
as agent or principal with respect to customer transactions, the agency
commission received in connection with a particular transaction, and
the source and amount of any additional remuneration to be received in
connection with a transaction, among other matters.15 As a result
of these disclosures, investors have a better understanding of
commissions and other costs associated with the execution of a
transaction. The Commission believes that proposed Rule 11Ac1-3(a)(2)
will further facilitate the ability of investors to understand order
routing possibilities and the decisions made by broker-dealers in this
regard. The Commission believes that such information would be of
significant benefit to investors.
\15\17 CFR 240.10b-10.
For example, a broker-dealer's decision regarding the routing of
orders involving securities listed for trading on national securities
exchanges raises the issue of price improvement. Orders in such
securities that are routed to certain exchange facilities typically
will receive an opportunity for price improvement,16 while similar
orders routed to other market centers--and, currently, generally with
respect to all non-listed securities--may forgo this possibility.
\16\But see Adopting Release, supra note 1, at n.33.
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In addition to enhancing the ability of customers to evaluate the
costs and benefits of a broker-dealer's order routing determinations,
the Commission believes that the proposed amendment to Rule 11Ac1-
3(a)(2) will help obviate some of the difficulty in identifying those
practices that involve conflicts between the interests of broker-
dealers and their customers. In light of the complexity and the
perceived economic similarity between payment for order flow and other
market practices designed to induce or influence order flow, or that
present the same concerns--such as internalization practices--the
Commission believes that the requirement that all broker-dealers
disclose their order routing practices will help facilitate equal
regulation, reduce investor confusion, and further empower investors to
make informed decisions in their own best interests. Broker-dealers
making disclosure under the proposed rule are encouraged to explain how
their order routing determinations are in the overall best interests of
their customers.
Finally, the Commission also solicits the views of commenters
regarding whether the disclosure of broker and dealer order routing
policies should be set forth in a standardized format on the
confirmation involving, for example, general categories of order
routing practices such as internalized/affiliate order flow, order flow
subject to payment for order flow, and order flow routed to
unaffiliated market centers, thereby facilitating customer
understanding and ease of comprehension.
D. Expanding the Scope of Covered Securities to Include Standardized
Options
Rule 11Ac1-3 does not apply to exchange-traded options. Although
the October 1993 Proposing Release did not request comment on whether
payment for order flow disclosures should be extended to these
securities, two exchanges expressed support for such a change, but
otherwise no comments were received on this subject.17 In light of
the favorable, albeit limited comments, the Commission proposes to
amend Rules 11Ac1-3 and 10b-10 to include standardized options. The
Commission particularly invites comment on whether the disclosure
requirements would result in unique problems for firms effecting
transactions in options.
\17\One exchange suggested that the Commission consider the
ramifications that payment for order flow may have on the options
marketplace, especially once multiple trading of options is taken
into consideration. See letter from Leopold Korins, Chairman and
Chief Executive Officer, Pacific Stock Exchange, Inc., to Jonathan
G. Katz, Secretary, SEC, dated December 9, 1993.
III. Request for Comment
The Commission invites comment on all the issues raised in this
release including expanding the definition of payment for order flow,
the proposed amendments to Rule 10b-10, the amendments to Rule 11Ac1-3
regarding disclosure of the value of payment for order flow and
internalization/affiliate practices, inclusion of standardized options,
and other approaches that address internalization/affiliate practices
and payment for order flow, including a requirement that broker-dealers
describe their order routing practices for all orders.
The Commission also requests commenters to address the feasibility
of adopting the proposed amendments to become effective on April 3,
1995, the date newly adopted Rule 11Ac1-3 and amendments to Rule 10b-10
are to take effect.
In addition to the specific requests for comment set forth above,
the Commission requests comment on whether the proposed rule
amendments, if adopted, would have an adverse effect on competition or
would impose a burden on competition that is neither necessary nor
appropriate in furthering the purposes of the Exchange Act. Comments on
the inquiry will be considered by the Commission in complying with its
responsibilities under Section 23(a)(2) of the Exchange Act.
IV. Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``IRFA'') in accordance with 5 U.S.C. sec. 603 regarding the
proposed rules. The following summarizes the conclusions of the IRFA.
The IRFA uses certain definitions of ``small entities'' adopted by
the Commission for purposes of the Regulatory Flexibility Act. The
Analysis notes that the proposed rule amendments would require at the
time an account is opened and on an annual basis thereafter, broker-
dealers to disclose their policies for routing customer orders in
exchange listed securities, provide the range of monetary payment for
order flow received on a per share basis on the confirmation, the
aggregate value of monetary payment for order flow, an estimate of the
aggregate value of non-monetary payment for order flow and
internalized/affiliate orders, and an estimate of the range of non-
monetary payment for order flow and internalized/affiliate orders
received by the broker-dealer on a per share basis on the confirmation.
The proposals could necessitate changes to broker-dealer confirmation
systems that generally do not provide that specific information now.
Broker-dealers would need to keep records of payment for order flow to
fulfill the disclosure requirements of the proposed rule amendments. A
copy of the Initial Regulatory Flexibility Analysis may be obtained by
contacting Jill W. Ostergaard, Attorney, Office of Market Supervision,
Division of Market Regulation, Securities and Exchange Commission,
Washington, DC 20549, 202/942-3197.
V. Text of the Amendments
List of Subjects in 17 CFR Part 240
Brokers; Reporting and recordkeeping requirements; Securities.
For the reasons set out in the preamble, the Commission proposes to
amend part 240 of chapter II of title 17 of the Code of Federal
Regulations to read as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,
77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p,
78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-
37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
2. By amending Sec. 240.10b-10 by revising paragraph (a)(7)(iii),
and adding paragraphs (e)(10), (e)(11), and (e)(12) to read as follows:
Sec. 240.10b-10 Confirmation of transactions.
(a) * * *
(7) * * *
(iii) For a transaction in any subject security as defined in
Sec. 240.11Ac1-2, a security authorized for quotation on an automated
interdealer quotation system that has the characteristics set forth in
Section 17B of the Act (15 U.S.C. 78q-2), or a standardized option as
defined in Sec. 240.9b-1:
(A) A statement whether payment for order flow is received by the
broker or dealer for transactions in such securities;
(B) For monetary payment for order flow received, the range of
payments received for such securities on a per share basis and a
statement that the source and amount received in connection with the
particular transaction will be furnished upon written request of the
customer;
(C) For non-monetary payment for order flow received, an estimate
of the range of non-monetary payment for order flow received by the
broker or dealer on a per share basis and a statement that the nature
and source of such compensation will be furnished upon written request
of the customer; and
(D) A statement whether transactions in such securities are subject
to internalized/affiliate order routing practices and an estimate of
the range in value of such order flow on a per share basis, and that
additional information will be furnished upon written request of the
customer; and
* * * * *
(e) * * *
(10) Monetary payment for order flow shall mean any monetary
payment, discount, rebate or reduction of fee to the extent that the
payment, discount, rebate or reduction exceeds the fee charged.
(11) Non-monetary payment for order flow shall mean any payment for
order flow received other than monetary payment for order flow.
(12) Internalized/affiliate order routing practices shall mean the
execution of an order by the broker or dealer as principal, or the
routing of an order by the broker or dealer to an affiliated broker,
dealer, or exchange member.
* * * * *
3. By amending Sec. 240.11Ac1-3 by revising the introductory text
of paragraph (a), paragraph (a)(2) and adding paragraphs (a)(3) through
(a)(8) to read as follows:
Sec. 240.11Ac1-3 Customer account statements.
(a) No broker acting as agent for a customer may effect any
transaction in, induce or attempt to induce the purchase or sale of, or
direct orders for purchase or sale of, any subject security as defined
in Sec. 240.11Ac1-2, a security authorized for quotation on an
automated interdealer quotation system that has the characteristics set
forth in section 17B of the Act (15 U.S.C. 78q-2), or a standardized
option as defined in 240.9b-1, unless such broker or dealer informs
such customer, in writing, upon opening a new account and on an annual
basis thereafter, of the following:
(1) * * *
(2) The broker's or dealer's policies for determining where to
route customers' orders, absent specific instructions from customers,
including:
(i) A statement whether the broker or dealer executes orders as
principal, routes orders to an affiliated broker, dealer, or exchange
member, or to another broker, dealer, exchange member, or an exchange;
and
(ii) A description of the extent to which orders in such securities
can be executed at prices superior to the best bid or offer as defined
in Sec. 240.11Ac1-2(a)(15);
(3) The aggregate amount of monetary payment for order flow as
defined in Sec. 240.10b-10(e)(10) received by the broker or dealer in
return for directing order flow on an annual basis;
(4) The range of monetary payment for order flow received by the
broker or dealer on a per share basis;
(5) An estimate of the aggregate value of non-monetary payment for
order flow, as defined in Sec. 240.10b-10(e)(11), received by the
broker or dealer in return for directing order flow on an annual basis;
(6) An estimate of the range of non-monetary payment for order
flow, as defined in Sec. 240.10b-10(e)(11), received by the broker or
dealer on a per share basis;
(7) An estimate of the aggregate value of the order flow of
internalized/affiliate order routing practices, as defined in
Sec. 240.10b-10(e)(12), on an annual basis; and
(8) An estimate of the range in value of the order flow of
internalized/affiliate order routing practices, as defined in
Sec. 240.10b-10(e)(12) on a per share basis.
* * * * *
By the Commission.
Dated: October 27, 1994.
Jonathan G. Katz,
Secretary.
[FR Doc. 94-27108 Filed 11-1-94; 8:45 am]
BILLING CODE 8010-01-P
