[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