[Federal Register Volume 76, Number 204 (Friday, October 21, 2011)]
[Notices]
[Pages 65549-65555]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-27277]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65579; File No. SR-FINRA-2011-052]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change to Adopt NASD 
Rule 2320 (Best Execution and Interpositioning) and Interpretive 
Material (``IM'') 2320 as FINRA Rule 5310 in the Consolidated Rulebook

October 17, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 4, 2011, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt NASD Rule 2320 (Best Execution and 
Interpositioning) and Interpretive Material (``IM'') 2320 (Interpretive 
Guidance with Respect to Best Execution Requirements) as a FINRA rule 
in the consolidated FINRA rulebook with four notable changes. The 
proposed rule change would combine and renumber NASD Rule 2320 and IM-
2320 as FINRA Rule 5310 in the consolidated FINRA rulebook.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA, at the 
Commission's Public Reference Room, and at the Commission's Web site at 
http://www.sec.gov.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    As part of the process of developing a new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing to adopt NASD 
Rule 2320 (Best Execution and Interpositioning) and IM-2320 
(Interpretive Guidance with Respect to Best Execution Requirements) as 
a FINRA rule in the Consolidated FINRA Rulebook with several changes, 
which are described below.
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    \3\ The current FINRA rulebook consists of (1) FINRA Rules; (2) 
NASD Rules; and (3) rules incorporated from NYSE (``Incorporated 
NYSE Rules'') (together, the NASD Rules and Incorporated NYSE Rules 
are referred to as the ``Transitional Rulebook''). While the NASD 
Rules generally apply to all FINRA members, the Incorporated NYSE 
Rules apply only to those members of FINRA that are also members of 
the NYSE (``Dual Members''). The FINRA Rules apply to all FINRA 
members, unless such rules have a more limited application by their 
terms. For more information about the rulebook consolidation 
process, see Information Notice, March 12, 2008 (Rulebook 
Consolidation Process).
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    NASD Rule 2320 requires a member, in any transaction for or with a 
customer or a customer of another broker-dealer, to use ``reasonable 
diligence'' to ascertain the best market for a security and to buy or 
sell in such market so that the resultant price to the customer is as 
favorable as possible under prevailing market conditions. The rule 
identifies five factors that are among those to be considered in 
determining whether the member has used reasonable diligence: (1) The 
character of the market for the security; (2) the size and type of 
transaction; (3) the number of markets checked; (4) the accessibility 
of the quotation; and (5) the terms and conditions of the order as 
communicated to the member. The rule also includes provisions related 
to interpositioning (i.e., interjecting a third party between the 
member and the best available market), the use of a broker's broker,\4\ 
the staffing of order rooms, and the application of the best execution 
requirements to other parties.
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    \4\ The proposed rule change moves part of the provision 
concerning the use of a broker's broker from paragraph (b) of the 
rule to Supplementary Material .05.
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    In addition to these provisions, NASD Rule 2320(f) (commonly 
referred to as the ``Three Quote Rule'') generally requires members 
that execute transactions in non-exchange-listed securities on behalf 
of customers to contact a minimum of three dealers (or all dealers if 
three or fewer) and obtain quotations from those dealers if there are 
fewer than two quotations displayed on an inter-dealer quotation system 
that permits quotation updates on a real-time basis. The Three Quote 
Rule was adopted in 1988 to further define a firm's best execution 
obligation to customers by setting forth additional requirements for 
transactions in non-exchange-listed securities, particularly 
transactions involving securities with non-transparent prices.\5\ Since 
that time, the Three Quote Rule has been amended on multiple occasions 
to exclude certain securities and transactions.\6\ The Three Quote Rule 
establishes a minimum standard, and compliance with the Three Quote 
Rule, in and of itself, does not mean that a member has met its best

[[Page 65550]]

execution obligations under NASD Rule 2320.\7\
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    \5\ See Securities Exchange Act Release No. 25637 (May 2, 1988), 
53 FR 16488 (May 9, 1988).
    \6\ See NASD Rule 2320(f)(3)(B), (C). See also Securities 
Exchange Act Release No. 56004 (July 2, 2007), 72 FR 37285 (July 9, 
2007); Securities Exchange Act Release No. 43319 (September 21, 
2000), 65 FR 58589 (September 29, 2000).
    \7\ See NASD Notice to Members 00-78 (November 2000).
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    IM-2320 was adopted in 2006 to codify interpretive guidance that 
FINRA staff had provided involving compliance with NASD Rule 2320.\8\ 
Specifically, IM-2320 addresses issues involving the term ``market'' 
for purposes of the rule as well as the application of the rule to debt 
securities and to broker-dealers that are executing a customer's order 
against the broker-dealer's quote.
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    \8\ See Securities Exchange Act Release No. 54339 (August 21, 
2006), 71 FR 50959 (August 28, 2006).
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    FINRA is proposing to adopt new FINRA Rule 5310, which is based 
largely on NASD Rule 2320. IM-2320 will be adopted, in substantially 
the same form, as Supplementary Material to Rule 5310. FINRA is also 
proposing several changes, which are described below, to the rule.
    (1) The Three Quote Rule
    Since the adoption of the Three Quote Rule over twenty years ago, 
the market for non-exchange-listed securities has changed 
dramatically.\9\ FINRA has found that in certain circumstances the 
Three Quote Rule can hinder, rather than further, investor protection 
by causing significant delays in obtaining execution of customer 
orders. As a result, FINRA has created several exclusions to the Three 
Quote Rule since it was adopted. For example, in 2000, FINRA determined 
that where there were two transparent, firm quotes for a security, the 
costs associated with delayed executions resulting from Three Quote 
Rule compliance outweighed the benefits of obtaining three telephone 
quotes.\10\ Consequently, the Three Quote Rule currently applies only 
to non-exchange-listed securities with one or no public quotation.\11\ 
More recently, in 2007, the SEC approved amendments to the Three Quote 
Rule to exclude certain transactions in non-exchange-listed securities 
of foreign issuers that are part of the FTSE All-World Index and to 
exclude certain transactions in Canadian securities executed on a 
Canadian exchange.\12\
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    \9\ For purposes of the Three Quote Rule, a ``non-exchange-
listed security'' is any equity security that is not traded on any 
national securities exchange, but does not include restricted 
securities. See NASD Rule 2320(f)(4)(C).
    \10\ See NASD Notice to Members 00-78 (November 2000); see also 
Securities Exchange Act Release No. 43319 (September 21, 2000), 65 
FR 58589 (September 29, 2000).
    \11\ See NASD Rule 2320(f)(3)(A).
    \12\ Securities Exchange Act Release No. 56004 (July 2, 2007), 
72 FR 37285 (July 9, 2007). See Regulatory Notice 07-40 (August 
2007).
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    Although the original concerns the Three Quote Rule was designed to 
address are still valid, FINRA believes that the current requirements 
in the Three Quote Rule, even with the various exclusions, are overly 
prescriptive and can often result in unnecessary delay in the execution 
of a customer's order or impose requirements that do not benefit the 
customer. Accordingly, rather than maintain the Three Quote Rule and 
the various exclusions in their current format, the proposed rule 
change replaces the Three Quote Rule with Supplementary Material 
emphasizing a member's best execution obligations when handling an 
order involving any security, equity or debt, for which there is 
limited pricing information available.\13\ The Supplementary Material 
emphasizes that members must be especially diligent with respect to 
best execution obligations where there is limited quotation or other 
pricing information available regarding the security that is the 
subject of the order and requires members to have written policies and 
procedures in place to address the steps the member will take to 
determine the best market for such a security in the absence of 
multiple quotations or pricing information and to document how they 
have complied with those policies and procedures.\14\ The Supplementary 
Material specifically notes that, when handling orders for such 
securities, members should generally seek out other sources of pricing 
information or potential liquidity, which may include obtaining 
quotations from other sources (e.g., other firms that the member 
previously has traded with in the security). For example, in many 
instances, particularly in the context of equity securities with 
limited quotation information available, contacting other broker-
dealers may be necessary to comply with a member's best execution 
obligations.\15\
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    \13\ NASD Rule 2320(f)(2), which is a subparagraph within the 
Three Quote Rule, generally requires members that display priced 
quotations on a real-time basis for a non-exchange-listed security 
in two or more quotation mediums that permit quotation updates on a 
real-time basis to display the same priced quotation in each medium 
except for certain customer limit orders displayed on an electronic 
communications network. Paragraph (f)(4) of the rule includes 
definitions of terms used in paragraph (f)(2). At this time, FINRA 
is proposing to move paragraph (f)(2) into the FINRA Rule 6400 
Series (Quoting and Trading in OTC Equity Securities) as FINRA Rule 
6438. FINRA is also proposing to replace the term ``non-exchange-
listed security'' with the term ``OTC Equity Security'' to conform 
the rule language to other FINRA rules addressing non-NMS stocks. 
The terms ``OTC Equity Security'' and ``quotation medium'' are 
defined in FINRA Rule 6420. Because the provisions relate to the 
quotation of OTC Equity Securities, FINRA believes that they should 
be relocated into the FINRA rule series concerning quoting and 
trading OTC Equity Securities rather than remain part of the Best 
Execution Rule.
    \14\ NASD Rule 3110(b) (Books and Records) generally requires 
members to indicate on the customer order ticket how they complied 
with the Three Quote Rule, if applicable. FINRA is proposing to 
replace this provision with a more general documentation requirement 
in the Supplementary Material to proposed FINRA Rule 5310. Under 
that provision, members would be required to retain records 
sufficient to demonstrate that they had handled orders covered by 
the rule in accordance with their policies and procedures.
    \15\ As noted above, FINRA believes that requiring compliance 
with the Three Quote Rule in all circumstances covered by the rule 
can cause unnecessary delay in the handling of some customer orders. 
However, as the Supplementary Material recognizes, contacting other 
broker-dealers can often be necessary for a firm to meet its best 
execution obligations. In recognizing the importance of contacting 
other broker-dealers for pricing or liquidity information, FINRA 
notes that many firms may choose to adopt policies and procedures 
that are substantially similar to the current Three Quote Rule but 
may, for example, allow for firms to adapt their procedures for 
certain situations if the firm reasonably concludes that those 
requirements would result in unnecessary delay or otherwise not 
benefit the customer. Firms must also continue to take into account 
when developing their procedures that the Three Quote Rule is a 
minimum standard, and contacting other dealers does not guarantee 
that a firm has met its best execution obligations in all cases.
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(2) Regular and Rigorous Review of Execution Quality
    The proposed rule change includes Supplementary Material to 
proposed FINRA Rule 5310 codifying a member's obligations when it 
undertakes a regular and rigorous review of execution quality likely to 
be obtained from different market centers. These longstanding 
obligations are set forth and explained in various SEC releases and 
NASD Notices to Members.\16\ The proposed rule change codifies this 
guidance as Supplementary Material and does not alter existing 
requirements regarding regular and rigorous review.
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    \16\ See, e.g., Securities Exchange Act Release No. 37619A 
(September 6, 1996), 61 FR 48290 (September 12, 1996); NASD Notice 
to Members 01-22 (April 2001).
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(3) Orders for Foreign Securities With No U.S. Market
    While the determination as to whether a member has satisfied its 
best execution obligations must take into account the market for a 
security, NASD Rule 2320 does not specifically distinguish between 
orders for domestic securities and orders for foreign securities, even 
if there is no U.S. market for the security. Markets in foreign 
jurisdictions often do not have identical best execution requirements 
as those imposed by NASD Rule 2320 and, in many cases, may not have 
comparable pre-trade or post-trade transparency standards. Thus, the 
handling of orders for foreign securities with no U.S. market can 
differ substantially from the handling of

[[Page 65551]]

orders in securities that trade in the U.S. Consequently, the proposed 
rule change includes new Supplementary Material concerning members' 
best execution obligations when handling orders for foreign securities, 
and in particular foreign securities with no U.S. trading activity.\17\
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    \17\ As discussed more fully in Section 2(C)(2) below, in 
Regulatory Notice 08-80 FINRA had proposed a different approach 
regarding orders for foreign securities with no U.S. market.
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    The new Supplementary Material recognizes that markets for 
different securities can vary dramatically and that the standard of 
``reasonable diligence'' must be assessed by examining specific 
factors, including ``the character of the market for the security'' and 
the ``accessibility of the quotation.'' Accordingly, the determination 
as to whether a member has satisfied its best execution obligations 
necessarily involves a ``facts and circumstances'' analysis.
    The new Supplementary Material notes that even though a foreign 
security may not trade in the U.S., members still have an obligation to 
seek best execution for customer orders involving the security. 
Consequently, a member that handles customer orders for foreign 
securities that do not trade in the U.S. must have specific written 
policies and procedures in place regarding its handling of customer 
orders for these securities that are reasonably designed to obtain the 
most favorable terms available for the customer, taking into account 
differences that may exist between U.S. markets and foreign markets. 
The Supplementary Material further notes that a member's best execution 
obligations also must evolve as changes occur in the market that may 
give rise to improved executions, including opportunities to trade at 
more advantageous prices. Members must therefore regularly review their 
policies and procedures to assess the quality of executions received 
and update or revise the policies and procedures as necessary.
(4) Customer Instructions Regarding the Routing of Orders
    When placing an order with a member, customers may specifically 
instruct the member to route the order to a particular market for 
execution.\18\ The proposed rule change includes Supplementary Material 
to proposed FINRA Rule 5310 addressing situations where the customer 
has, on an unsolicited basis, specifically instructed the member to 
route its order to a particular market.\19\ Under those circumstances, 
the member would not be required to make a best execution determination 
beyond that specific instruction; however, the Supplementary Material 
mandates that members process the customer's order promptly and in 
accordance with the terms of the order. The Supplementary Material also 
makes clear that where a customer has directed the member to route an 
order to another broker-dealer that is also a FINRA member, the 
exception would not apply to the receiving broker-dealer to which the 
order was directed.\20\
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    \18\ When the order is for an NMS security, these orders are 
often referred to as ``directed orders.'' See 17 CFR 242.600(b)(19). 
Of note, directed orders are excluded from the order routing 
statistics required to be produced under Rule 606 of SEC Regulation 
NMS. See 17 CFR 242.606.
    \19\ FINRA also has proposed technical amendments to paragraph 
(e) of the rule to clarify that a member's best execution 
obligations extend to all customer orders and to avoid the potential 
misimpression that the paragraph limits the scope of the rule's 
requirements.
    \20\ For example, if a customer of Member Firm A directs Member 
Firm A to route an order to Member Firm B, Member Firm B would 
continue to have best execution obligations to that customer order 
received from Member Firm A.
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    FINRA will announce the implementation date of the proposed rule 
change in a Regulatory Notice to be published no later than 90 days 
following Commission approval. The implementation date will be no later 
than 90 days following publication of the Regulatory Notice announcing 
Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\21\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change adds 
needed clarification and provisions to the existing best execution 
requirements that enhance investor protection and promote just and 
equitable principles of trade. FINRA believes that codifying members' 
obligations regarding directed orders, regular and rigorous review, and 
orders involving foreign securities will bring needed clarification to 
these areas and ensure that all members are aware of their obligations. 
As discussed above, FINRA believes that replacing the Three Quote Rule 
with the proposed Supplementary Material will improve the handling of 
customer orders involving securities with limited quotation or pricing 
information by decreasing the likelihood that execution of these orders 
will be unnecessarily delayed while still ensuring that members 
recognize that their best execution obligations apply to these orders. 
FINRA believes that each of these provisions will help promote just and 
equitable principles of trade and will protect investors and the public 
interest.
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    \21\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in Regulatory 
Notice 08-80 (December 2008). A copy of Regulatory Notice 08-80 is 
attached as Exhibit 2a. The comment period expired on February 27, 
2009. FINRA received nine comment letters in response to the Regulatory 
Notice.\22\ A list of the comment letters received in response to 
Regulatory Notice 08-80 is attached as Exhibit 2b. Copies of the 
comment letters received in response to Regulatory Notice 08-80 are 
attached as Exhibit 2c.
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    \22\ Letter from first allied (``First Allied''), dated January 
27, 2009; Letter from Sidley Austin LLP (``Sidley''), dated January 
28, 2009; Letter from Scottrade, Inc. (``Scottrade''), dated January 
29, 2009; Letter from National Association of Independent Broker-
Dealers, Inc. (``NAIBD''), dated February 16, 2009; Letter from 
Cutter & Company, Inc. (``Cutter''), dated February 17, 2009; Letter 
from Securities Industry and Financial Markets Association 
(``SIFMA''), dated February 26, 2009; Letter from Financial Services 
Institute (``FSI''), dated February 27, 2009; Letter from Pink OTC 
Markets, Inc. (``Pink OTC''), dated March 20, 2009; Letter from 
Liquidnet, Inc. (``Liquidnet''), dated April 24, 2009.
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(1) General Comments on the Proposed Rule Change
    Although most commenters addressed particular issues in the rule 
changes proposed in Regulatory Notice 08-80, some commenters raised 
broader concerns regarding best execution obligations and NASD Rule 
2320 in general. SIFMA expressed concerns about the application of the 
Best Execution Rule to debt securities and reiterated the concerns 
previously expressed by the Bond Market Association in response to 
prior amendments to NASD Rule 2320.\23\ In essence, SIFMA asserts that 
fundamental differences in the operation of the equity and fixed

[[Page 65552]]

income markets render the Best Execution Rule inappropriate for the 
fixed income market. SIFMA states that the current Best Execution Rule, 
as well as many of the amendments in the proposed rule change, may be 
appropriate for the equity markets but ``create problems of 
interpretation, application and enforcement'' in the context of the 
fixed income markets.
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    \23\ See SIFMA.
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    FINRA disagrees. As SIFMA's letter notes, these concerns have been 
raised numerous times in recent years, and for the same reasons FINRA 
has noted before, FINRA believes that the Best Execution Rule is broad 
enough to apply to both the equity and fixed income markets. As FINRA 
stated in 2005:

    [The] Best Execution Rule looks at a number of factors, 
including the character of the market for the security, to determine 
whether a member or associated person(s) has used reasonable 
diligence. Accordingly, it can be applied in a variety of different 
markets that can possess divergent characteristics, including the 
U.S. debt market.\24\
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    \24\ See Securities Exchange Act Release No. 52637 n.15 (October 
19, 2005), 70 FR 61861, 61863 n.15 (October 26, 2005).

    The Best Execution Rule requires the use of ``reasonable 
diligence'' when handling a customer order. One of the enumerated 
factors in assessing whether reasonable diligence has been used is 
``the character of the market for the security.'' \25\ This language 
makes readily apparent that a determination of best execution must take 
into account the specific facts and circumstances surrounding the 
market in which a security trades, whether that is an exchange market, 
the over-the-counter equity market, or the fixed income market. 
Different securities trade in myriad ways, and no single rule can 
address each and every nuance of various types of markets. Moreover, 
market structure is itself subject to continuous evolution and 
development; a rule focused on a specific market structure would 
quickly become outdated. For all of these reasons, the Best Execution 
Rule is intentionally broad and encompasses all market types by its 
recognition that a best execution determination cannot be made without 
first determining the type of market in which the security that is the 
subject of the order trades.
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    \25\ See NASD Rule 2320(a)(1)(A).
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    One commenter suggested that proposed Supplementary Material .01 
regarding prompt execution of a marketable customer order \26\ be 
clarified to note that a firm's acceptance of an order ``starts the 
clock'' as opposed to the time a customer enters an order or the time 
an order is received.\27\ The Supplementary Material requires 
``prompt'' execution and does not dictate a specific timeframe because 
FINRA believes the principle-based standard of acting promptly would 
encompass all reasonable factors that a prescriptive standard could not 
address in all cases. Best execution requires firms to minimize the 
time between order receipt, order acceptance, and order entry. Firms 
may not defend their failure to act promptly in respect of an order 
because such an order languished between its receipt and entry. In 
addition, FINRA has already codified the obligation to handle and 
execute marketable customer orders promptly in FINRA Rule 5320.07.
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    \26\ In Regulatory Notice 08-80, FINRA proposed to apply the 
prompt requirement in Supplementary Material .01 to customer market 
orders. The proposed rule change applies the prompt requirement in 
proposed Supplementary Material .01 to ``marketable customer 
orders'' to clarify that the requirement applies to both market 
orders and marketable limit orders.
    \27\ See Scottrade.
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(2) Comments Regarding Orders for Foreign Securities With No U.S. 
Market
    In Regulatory Notice 08-80, FINRA proposed to adopt a new provision 
regarding a member's best execution obligations for foreign securities 
with no U.S. market. Under that provision, a member would have been 
deemed to have exercised reasonable diligence pursuant to Rule 5310(a) 
with respect to an order if:
    (i) The order was for a non-U.S. traded security; \28\
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    \28\ For purposes of the provision, FINRA proposed to define a 
``non-U.S. traded security'' as any non-exchange-listed security 
issued by a corporation or other entity incorporated or organized 
under the laws of any foreign country for which there is no 
quotation or indication of interest displayed in any inter-dealer 
quotation system generally available in the United States at the 
time the member receives the order.
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    (ii) The member had adopted written policies and procedures 
regarding its handling of orders for non-U.S. traded securities that 
are reasonably designed to obtain the most favorable terms available 
for the customer;
    (iii) The member reviewed those policies and procedures at least 
annually, or more frequently as appropriate, to assess the quality of 
the execution venues included in the member's policies and procedures 
to determine whether they provide for the most favorable terms 
reasonably available and whether the policies and procedures needed to 
be updated or revised;
    (iv) The member had obtained its customers' consent to its policies 
and procedures regarding the handling of orders for non-U.S. traded 
securities; and
    (v) The member handled the order in accordance with its policies 
and procedures.
    The proposed provision did not except these orders from the 
reasonable diligence requirement; rather, in recognition of the 
differences in how such orders are handled, it provided an alternative 
mechanism, other than the current list of factors in the rule, in 
determining whether a firm had met the reasonable diligence obligation.
    Although several commenters generally supported the proposed 
provision addressing foreign securities with no U.S. market, commenters 
raised numerous issues with specific aspects of the provision. Multiple 
commenters questioned the requirement that a customer consent to the 
member's policies and procedures.\29\ In addition, commenters also 
requested guidance on several of the provision's terms and 
requirements, including asking for additional guidance of ``a non-
exclusive list of elements for what a typical set of execution 
protocols might cover,'' \30\ clarification that the presence of 
American Depositary Receipts with an active market in the U.S. would 
not affect the analysis with respect to the issuer's ordinary 
shares,\31\ and questioning portions of the definition of non-U.S. 
traded security.\32\
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    \29\ See First Allied, Scottrade, SIFMA.
    \30\ SIFMA.
    \31\ See Sidley.
    \32\ See Sidley, Pink OTC.
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    FINRA continues to believe it is appropriate to address 
specifically as part of the Best Execution Rule issues involving 
members' best execution obligations when handling orders for foreign 
securities with no U.S. market; however, as noted above, FINRA has 
replaced the proposed provision with Supplementary Material that more 
generally describes the obligations members have regarding these 
orders.
(3) Comments on Proposed Supplementary Material .06 (Orders Involving 
Securities With Limited Quotations or Pricing Information)
    Six commenters addressed the proposal to replace the Three Quote 
Rule with more general Supplementary Material regarding a member's 
obligations when handling an order for a security for which there is 
limited pricing information available. Of the six commenters, five 
supported the proposal,\33\ and one commenter opposed the proposed 
change because

[[Page 65553]]

the commenter believed that the current Three Quote Rule promotes 
``straightforward best execution compliance.'' \34\ As FINRA has 
stressed in the past, the Three Quote Rule is a minimum standard that 
members are required to meet with respect to non-exchange-listed 
securities with one or no public quotation; compliance with the Three 
Quote Rule does not, in and of itself, mean that a member has met its 
best execution obligations.\35\ Thus, contrary to the commenter's 
assertion that the Three Quote Rule established a straight-forward 
compliance standard, it sets forth only a non-exhaustive minimum 
standard.
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    \33\ See Cutter, First Allied, Liquidnet, NAIBD, SIFMA.
    \34\ Pink OTC.
    \35\ See, e.g., NASD Notice to Members 00-84 (December 2000).
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    As noted above, best execution requires the exercise of reasonable 
diligence. If a security has little or no price transparency, FINRA 
agrees that a member with an order for such a security should generally 
seek out other sources of pricing information or potential liquidity, 
which could include contacting other dealers. Consequently, the 
Supplementary Material specifically notes that members ``should 
generally seek out other sources of pricing information or potential 
liquidity, which may include obtaining quotations from other sources * 
* *.'' However, FINRA believes that there continue to be instances 
where contacting additional dealers may not be in the customer's best 
interest (and, indeed, may be detrimental to the customer).\36\ 
Although the proposed Supplementary Material gives members the ability 
to determine when that is the case, members continue to have best 
execution obligations in handling the order.
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    \36\ For example, one commenter asserted that contacting 
multiple dealers regarding an order in a fixed income security could 
have the effect of moving the market away from the customer in some 
circumstances. See SIFMA.
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    The commenter also requested that FINRA ``state, whether in the 
text of the Rule or the Supplementary Material, that member firms must 
execute customer orders at an equal or better price as displayed in any 
Inter-Dealer Quotation System that permits quotation updates on a real-
time basis.'' \37\ FINRA does not believe it is necessary to 
specifically address this point with respect to the types of orders 
currently covered under the Three Quote Rule. As is already the case 
today, paragraph (a)(1) of the proposed rule requires that members use 
reasonable diligence to ascertain the best market for the subject 
security and buy or sell in such market so that ``the resultant price 
to the customer is as favorable as possible under prevailing market 
conditions.'' That standard has always applied to orders covered by the 
Three Quote Rule (indeed, it applies to all customer orders) and will 
continue to apply under the proposed rule.
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    \37\ Pink OTC.
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    As noted above, as part of replacing the Three Quote Rule with 
Supplementary Material, FINRA has proposed replacing the specific 
recordkeeping requirements in NASD Rule 3110(b) with a more general 
recordkeeping requirement. One commenter requested additional guidance 
on the documentation requirement; \38\ however, FINRA is unable to 
provide specific guidance to a recordkeeping requirement that will vary 
with the adaptive practices of firms in meeting the principle-based 
requirements of the rule. Each member must retain sufficient 
documentation to demonstrate that it has complied with the policies and 
procedures that it has in place. Because there will no longer be 
uniform treatment of these types of orders and different firms will 
have different procedures under the proposal, there can be no uniform 
recordkeeping requirement.
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    \38\ See SIFMA.
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(4) Comments on Proposed Supplementary Material .09 (Regular and 
Rigorous Review of Execution Quality)
    Five commenters addressed proposed Supplementary Material .09, 
which codifies the obligations of some firms to regularly and 
rigorously review execution quality.\39\ One commenter questioned the 
rationale of codifying these obligations, which are already ``well 
understood'' by the industry and asserted that codification would take 
them away from being ``fluid and evolving'' standards and make them 
more rigid and difficult to change.\40\ FINRA disagrees. As noted 
above, the proposed Supplementary Material does not alter existing 
obligations or standards, and the language of the proposed provision is 
sufficiently flexible to allow the obligations to evolve along with the 
markets. Although the commenter expressed concern about the ability to 
change or amend the provision once it is codified within a FINRA rule, 
the general obligations of regular and rigorous review have not changed 
substantially since FINRA issued Notice to Members 01-22 in 2001. 
Moreover, FINRA retains the ability to continue to publish interpretive 
guidance on the requirements or amend the requirements through 
rulemaking even if their general contours are codified.
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    \39\ Cutter, First Allied, NAIBD, Pink OTC, SIFMA.
    \40\ SIFMA.
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    Two commenters suggested that the requirement to periodically 
review the execution quality of orders not apply to introducing firms 
with respect to those orders placed through their clearing firm.\41\ 
One commenter stated that, because of the lack of expertise among 
introducing firms, the requirement leads to a ``pro forma review 
process'' that does not meaningfully enhance investor protection.\42\ 
These commenters seem to suggest that, because the clearing firm itself 
has a best execution obligation with respect to the order, the 
introducing firm should be relieved of its best execution obligation. 
FINRA does not find these comments persuasive and has consistently 
rejected this rationale. Every member has an obligation to ensure that 
each customer order it handles receives best execution, and regular and 
rigorous review is one method by which firms that route orders to other 
members (or execute orders internally) can meet their best execution 
obligations. That is, regular and rigorous reviews are one way for 
order entry firms and firms that internalize order flow to satisfy 
their best execution obligations in lieu of an order-by-order best 
execution analysis.
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    \41\ See Cutter, FSI.
    \42\ FSI.
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    Three commenters requested that FINRA provide more specific 
guidance about the types of information introducing firms should review 
(and clearing firms should provide) and the frequency of the reviews so 
that introducing firms can ensure they meet their obligations if they 
choose to rely on their clearing firm.\43\ One of these commenters 
asked FINRA to confirm whether a review of ``those reports prepared and 
disclosed by executing firms in meeting their obligations under order 
routing regulations will suffice for the purposes of this review.'' 
\44\ FINRA has previously provided guidance on these questions, and the 
guidance will continue to be applicable. For example, in Notice to 
Members 01-22, FINRA stated:
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    \43\ See FSI, NAIBD, SIFMA.
    \44\ NAIBD.

    In cases where the introducing broker/dealer is relying on the 
review conducted by its clearing firm or other executing broker/
dealer, the introducing firm must ensure that such analysis is 
thorough, considers the execution quality of a broad range of market 
centers, measures the execution quality provided by the clearing or 
executing firm for the introducing firm's own orders, and considers 
market centers to which the

[[Page 65554]]

clearing or executing firm currently routes its order flow as well 
as market centers other than those to which the clearing or 
---------------------------------------------------------------------------
executing firm currently routes its order flow.

As is the case currently, an introducing firm must review information 
sufficient to conclude that its clearing firm is providing best 
execution and is conducting a thorough regular and rigorous review. 
While in some instances a review of required regulatory reports may 
suffice, in other instances such a review may not. For example, if a 
review of required regulatory order routing reports raised concerns or 
issues, then FINRA would expect the introducing firm to conduct a 
further inquiry and review. This is currently the case under existing 
FINRA rules and would remain the case under the proposed rule change. 
As FINRA stated in Regulatory Notice 08-80, in codifying regular and 
rigorous review standards, FINRA did not intend to alter existing 
requirements or obligations.
    One commenter asked FINRA to state that regular and rigorous review 
is only required with respect to ``retail-sized, held orders in equity 
securities for which execution quality statistics are required to be 
published by market centers pursuant to Rule 605 of Regulation NMS.'' 
\45\ The commenter further stated that regular and rigorous reviews are 
not appropriate for not held orders and that ``the assessment of 
execution quality for not held orders is effectively done on an 
individual, order-by-order basis, in real-time and/or on a post-trade 
basis.'' FINRA does not view regular and rigorous review as ever being 
``required.'' Rather, regular and rigorous review permits order entry 
firms and firms that internalize order flow to meet their best 
execution obligations through the use of a periodic regular and 
rigorous review of execution quality; this review stands in the place 
of an order-by-order review. Therefore, conducting an order-by-order, 
individual review for not held orders would eliminate the need for a 
regular and rigorous review of those order types.
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    \45\ SIFMA.
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    One commenter stated that ``efficiency of execution'' should be 
added as a factor for members to consider when conducting their regular 
and rigorous review.\46\ FINRA views ``efficiency of execution,'' not 
as a separate factor, but rather as a term that would encompass several 
of the existing listed factors (e.g., speed and size of execution). 
Moreover, the list in the Supplementary Material is intended to be 
illustrative, not exhaustive.
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    \46\ Scottrade.
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    This commenter also suggests that the factors of speed, size, and 
transaction costs should be qualified by a materiality standard. These 
factors are already qualified by a materiality standard under proposed 
Supplementary Material .09(b), which requires that, ``[i]n conducting 
its regular and rigorous review, a member must determine whether any 
material differences in execution quality exist among the markets 
trading the security * * *.'' The Supplementary Material then goes on 
to identify a number of factors a member should consider when reviewing 
and comparing execution quality. However, as proposed in Regulatory 
Notice 08-80, the first two factors identified included an additional 
reference to ``materiality.'' To avoid confusion, FINRA has removed the 
additional reference to materiality in the first two factors to avoid 
the misimpression that the other factors do not have a materiality 
standard.
(5) Comments on Proposed Supplementary Material .08 (Customer 
Instructions Regarding Order Handling)
    Proposed Supplementary Material .08 addresses a member's 
obligations when a customer directs, on an unsolicited basis, the 
member to execute the order in a specific market. Only one commenter 
opposed the proposed Supplementary Material, stating that ``it is the 
firm's responsibility to always make a best execution determination in 
all cases whether specifically instructed to route its order to a 
particular market or not.'' \47\ FINRA agrees that members have best 
execution responsibilities with respect to each and every customer 
order the member accepts; however, when a customer directs a member to 
execute an order in a specific market, the construct of paragraph 
(a)(1) of the rule is no longer applicable. As noted above, paragraph 
(a)(1) of the rule requires a member to use reasonable diligence to 
ascertain the best market for the subject security. When a customer 
specifies the market, that is no longer a determination that the member 
can make. However, the Supplementary Material makes clear that members 
are still required to handle the order promptly and in accordance with 
its terms.
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    \47\ First Allied.
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    One commenter suggested that the ``unsolicited'' requirement not 
apply to orders involving foreign securities.\48\ The commenter 
suggested that a customer should not be deprived of the firm's advice 
in this area. The rule was not intended to, and does not, deprive a 
customer of a firm's advice regarding routing decisions; rather, it 
simply recognizes that in those cases where a customer has made its own 
routing decision, the member cannot choose a different market for 
execution without violating the terms of the order. If a member, by 
contrast, undertakes to advise the customer on routing venues, it 
should be bound by general best execution obligations with respect to 
the execution of that order. In addition, however, the commenter stated 
that a firm and a customer ``may on the basis of long usage and course 
of dealing have concluded that the customer's orders for foreign 
securities are most effectively executed in the principal market for 
such securities in the issuer's home country.'' In the alternative, the 
commenter suggested that the exception could be available when a 
customer has instructed that an order for a foreign security be 
executed in the security's principal market. FINRA agrees with the 
commenter to the extent that a customer need not provide the direction 
on an order-by-order basis. Thus, for example, the rule would apply if 
a customer has made a more general instruction with respect to 
particular types of orders or securities.
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    \48\ See Sidley.
---------------------------------------------------------------------------

    One commenter, while supporting the proposal, suggested that it be 
broadened to include orders where the broker's judgment and discretion 
are considerably restricted because of other order terms and 
conditions.\49\ FINRA does not agree that the exception should be so 
broadened. Paragraph (a)(1)(E) of the proposed rule already notes that 
one of the factors in any analysis of best execution is the terms and 
conditions of the order. FINRA believes that the exception should only 
apply in those circumstances where the ultimate decision that must be 
made with respect to the order (i.e., execution venue) is specifically 
directed by the customer. All other terms and conditions are adequately 
addressed in the rule itself.
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    \49\ See SIFMA.
---------------------------------------------------------------------------

(6) Comments on Proposed FINRA Rule 6438
    FINRA received several comments regarding the proposal to move the 
same quote requirements in NASD Rule 2320(f)(2) into a separate 
rule.\50\ One commenter suggested that FINRA amend the provision to 
require ``similar,'' rather than the ``same,'' quotes and questioned 
the application of the provision if a member has multiple trading desks 
that quote the

[[Page 65555]]

same security.\51\ Another commenter \52\ suggested that FINRA not 
alter the definitions of the terms ``quotation medium'' and ``inter-
dealer quotation system'' from the way these terms are laid out in 
Exchange Act Rule 15c2-11(e).\53\ This commenter also suggested that 
the same quote requirements apply to inter-dealer quotation systems 
rather than quotation mediums. As noted above, at this time, FINRA is 
proposing to transfer the provisions into a separate rule without 
change; FINRA believes that the objectives behind adopting this 
requirement are still valid and is not proposing to amend this 
provision at this time. In addition, by relocating the provision into 
the FINRA Rule 6400 Series, the defined terms at issue are already 
defined in existing FINRA Rule 6420.
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    \50\ See Pink OTC, SIFMA.
    \51\ SIFMA.
    \52\ Pink OTC.
    \53\ 17 CFR 240.15c2-11(e).
---------------------------------------------------------------------------

(7) Other Comments
    Some commenters provided comments on portions of the rule that 
FINRA has not proposed to change. For example, one commenter requested 
that the language in proposed Rule 5310(d) be updated to refer to 
defined industry terms (e.g., ``clearing firm'') rather than 
descriptions (e.g., ``third party pursuant to established correspondent 
relationships under which executions are confirmed directly to the 
member acting as agent for the customer'').\54\ Although the term 
``clearing firm'' is generally understood, it is not defined in any 
FINRA rule; consequently, FINRA determined to retain the existing 
descriptions to avoid any unintended changes in the scope of the rule 
or any misunderstandings regarding the use of the term. In light of 
this comment, however, FINRA has replaced the references to 
``introducing firms'' and ``clearing firms'' in Supplementary Material 
.09(c) in addition to clarifying the scope of that provision as 
proposed in Regulatory Notice 08-80.\55\
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    \54\ FSI.
    \55\ See SIFMA.
---------------------------------------------------------------------------

    Finally, one commenter asked FINRA to clarify the meaning of 
proposed FINRA Rule 5310(c) (current NASD Rule 2320(c)) regarding costs 
borne by a customer.\56\ That provision states that ``the channeling of 
customers' orders through a broker's broker or third party pursuant to 
established correspondent relationships under which executions are 
confirmed directly to the member acting as agent for the customer * * * 
are not prohibited if the cost of such service is not borne by the 
customer.'' The commenter asked whether the provision applied to all 
costs or, rather, to additional or undue costs. In light of this 
comment, and the fact that the SEC has approved revisions to the 
interpositioning provisions in the Best Execution Rule that address 
sending orders through third parties,\57\ FINRA is proposing to delete 
the sentence from the Best Execution Rule. FINRA believes that the 
issues the provision covers are adequately addressed in the revised 
interpositioning provision.
---------------------------------------------------------------------------

    \56\ NAIBD.
    \57\ See Securities Exchange Act Release No. 60635 (September 8, 
2009), 74 FR 47302 (September 15, 2009).
---------------------------------------------------------------------------

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which FINRA consents, the Commission shall: (a) By order approve or 
disapprove such proposed rule change, or (b) institute proceedings to 
determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-FINRA-2011-052 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2011-052. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for Web site 
viewing and printing in the Commission's Public Reference Room, 100 F 
Street, NE., Washington, DC 20549, on official business days between 
the hours of 10 a.m. and 3 p.m. Copies of such filing also will be 
available for inspection and copying at the principal office of FINRA. 
All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make publicly 
available. All submissions should refer to File Number SR-FINRA-2011-
052 and should be submitted on or before November 14, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\58\
---------------------------------------------------------------------------

    \58\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-27277 Filed 10-20-11; 8:45 am]
BILLING CODE 8011-01-P