[Federal Register Volume 88, Number 1 (Tuesday, January 3, 2023)]
[Proposed Rules]
[Pages 128-245]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-27617]



[[Page 127]]

Vol. 88

Tuesday,

No. 1

January 3, 2023

Part II





Securities and Exchange Commission





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17 CFR Parts 240 and 242





 Order Competition Rule; Proposed Rule

  Federal Register / Vol. 88 , No. 1 / Tuesday, January 3, 2023 / 
Proposed Rules  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242

[Release No. 34-96495; File No. S7-31-22]
RIN 3235-AM57


Order Competition Rule

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing to amend the regulation governing the national market system 
(``NMS'') under the Securities Exchange Act of 1934 (``Exchange Act'') 
to add a new rule designed to promote competition as a means to protect 
the interests of individual investors and to further the objectives of 
an NMS. The proposed rule would prohibit a restricted competition 
trading center from internally executing certain orders of individual 
investors at a price unless the orders are first exposed to competition 
at that price in a qualified auction operated by an open competition 
trading center. The proposed rule would also include limited exceptions 
to this general prohibition. In addition, the Commission is proposing 
to amend the regulation governing the NMS to add new defined terms 
included in the proposed rule.

DATES: Comments should be received on or before March 31, 2023.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
     Send an email to [email protected]. Please include 
File Number S7-31-22 on the subject line.

Paper Comments

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

All submissions should refer to File Number S7-31-22. This file number 
should be included on the subject line if email 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 website (http://www.sec.gov/rules/proposed.shtml). 
Comments are also available for website 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. Operating conditions may limit access to the Commission's Public 
Reference Room. All comments received will be posted without change. 
Persons submitting comments are cautioned that the Commission does not 
redact or edit personal identifying information from comment 
submissions. You should submit only information that you wish to make 
available publicly.
    Studies, memoranda, or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any materials will 
be made available on the Commission's website. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Dan Gray, Senior Special Counsel, 
Jennifer Dodd, Special Counsel, or Stacia Sowerby, Special Counsel, at 
(202) 551-5500, Office of Market Supervision, Division of Trading and 
Markets, Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public 
comment amendments to Regulation NMS [17 CFR 242.600 through 242.614] 
(``Regulation NMS'') that would add new 17 CFR 242.615 (``Proposed Rule 
615''), add new defined terms to 17 CFR 242.600 (``Rule 600'') that are 
used in Proposed Rule 615, and make conforming amendments to defined 
terms in 17 CFR 242.602, 17 CFR 242.611, and 17 CFR 242.614; and 
conforming amendments to defined terms in 17 CFR 240.3a51-1, 17 CFR 
240.13h-1, 17 CFR 242.105, 17 CFR 242.201, 17 CFR 242.204, and 17 CFR 
242.1000.

Table of Contents

I. Introduction
II. Overview of Market Structure for NMS Stocks
    A. Investors
    B. Trading Centers
    C. Order Types and Trading Costs
    D. Quantitative Measures of Order Execution Quality and Trading 
Costs
    1. Description of Quantitative Measures
    2. Examples of Calculating Measures of Order Execution Quality 
and Trading Costs
III. Statutory and Regulatory Background
    A. Statutory Framework for an NMS
    B. Current Regulatory Components of the NMS for NMS Stocks
    1. Rules Addressing Consolidated Market Data
    2. Rules Addressing Order Handling and Execution
    3. Rules Addressing Access to Trading Centers
    4. Disclosure of Order Routing Practices and Order Execution 
Statistics
IV. Description of Proposed Rule 615
    A. Overview of Order Competition Requirement
    B. Coverage of Proposed Rule 615
    1. Definition of Segmented Order
    2. Definition of Open Competition Trading Center
    3. Definition of Restricted Competition Trading Center
    4. Definition of Originating Broker
    5. Exceptions
    C. Qualified Auction Requirements
    1. Auction Messages
    2. Auction Responses
    3. Pricing Increment
    4. Fees and Rebates
    5. Auction Execution Priority
    D. Open Competition Trading Center Requirements
    E. Originating Broker Requirements
    F. Broker-Dealer Requirements
    G. National Securities Exchange Requirements
V. Request for Comment
VI. Paperwork Reduction Act Analysis
    A. Summary of Collection of Information
    1. Auction Messages
    2. Identifying and Marking Segmented Orders
    3. Originating Broker Certification
    4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    B. Proposed Use of Information
    1. Auction Messages
    2. Identifying and Marking Segmented Orders
    3. Originating Broker Certification
    4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    C. Respondents
    1. Auction Messages
    2. Identifying and Marking Segmented Orders
    3. Originating Broker Certification
    4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    D. Burdens
    1. Auction Messages
    2. Identifying and Marking Segmented Orders
    3. Originating Broker Certification
    4. NMS Stock ATS Policies and Procedures for Excluding 
Subscribers
    E. Collection of Information Is Mandatory
    F. Confidentiality of Information Collected
    1. Auction Messages
    2. Identifying and Marking Segmented Orders
    3. Originating Broker Certification
    4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    G. Retention Period for Recordkeeping Requirements
    H. Request for Comments
VII. Economic Analysis
    A. Introduction
    B. Baseline
    1. Competition for Liquidity Provision in NMS Stocks

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    2. Segmentation of Individual Investor Order Flow
    3. Institutional Investor Interactions With Retail Orders
    4. Execution Quality of Individual Investor Marketable Orders in 
NMS Stocks
    5. Variation in Wholesaler Execution Quality
    6. Retail Broker Services
    7. Rules Addressing Consolidated Market Data
    C. Economic Effects
    1. Benefits
    2. Costs
    3. Competition
    4. Efficiency
    5. Capital Formation
    D. Reasonable Alternatives
    1. Variation in Provisions Regarding Segmentation and Routing
    2. Alternate Definitions of Segmented Orders
    3. Variation in Auction Design
    4. Variation in Exceptions to the Order Competition Requirement
    5. Variation in the Definition of Open Competition Trading 
Centers
    6. Wholesaler Information Barriers
    7. Display Quotes in Retail Liquidity Programs
    8. Creation of a Retail Best Bid and Offer
    9. Disclosure of Execution Quality of Individual Investor Orders
    E. Request for Comments
VIII. Regulatory Flexibility Act Certification
IX. Consideration of Impact on the Economy
Statutory Authority

I. Introduction

    The Commission is proposing a new rule, Proposed Rule 615 of 
Regulation NMS, entitled the ``Order Competition Rule,'' to promote a 
more competitive, transparent, and efficient market structure for NMS 
stocks, with resulting benefits to investors. Proposed Rule 615 would 
require that certain orders of individual investors be exposed to 
competition in fair and open auctions, before such orders could be 
executed internally by trading centers that restrict order-by-order 
competition.\1\ The Commission believes that the proposal would better 
advance each of the five Congressional objectives for an NMS set forth 
in section 11A of the Exchange Act.\2\ In particular, Proposed Rule 615 
is designed to benefit individual investors by promoting competition 
and transparency as means to enhance the opportunity for their orders 
to receive more favorable prices than they receive in the current 
market structure, as well as to benefit investors generally by giving 
them an opportunity to interact directly with a large volume of 
individual investor orders that are mostly inaccessible to them in the 
current market structure. This section provides an overview of that 
market structure and how that market structure may impact investors.
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    \1\ ``Order-by-order'' competition in this context means an 
opportunity to compete to trade with individual investor orders by 
offering the most favorable price for each order based on the 
particular characteristics of the order, including the nature of the 
NMS stock, the size of the order, and market conditions at the time 
the order is submitted. Section II below provides an overview of the 
current market structure for NMS stocks, including descriptions of 
key terms used in this release that readers may find useful to 
assess and comment on the Commission's proposal. Among many others, 
these terms include ``individual investors,'' ``trading centers,'' 
and ``wholesalers.''
    \2\ 15 U.S.C. 78k-1 (``section 11A''). These objectives are: (1) 
economically efficient execution of securities transactions; (2) 
fair competition among brokers and dealers, among exchange markets, 
and between exchange markets and markets other than exchange 
markets; (3) the availability to brokers, dealers, and investors of 
information with respect to quotations for and transactions in 
securities; (4) the practicability of brokers executing investors' 
orders in the best market; and (5) an opportunity, consistent with 
objectives 1 and 4, for investors' orders to be executed without the 
participation of a dealer. 15 U.S.C. 78k-1(a)(1)(C).
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    As discussed in sections II and VII below, individual investors 
primarily use market orders and marketable limit orders (collectively 
known as ``marketable orders'') to trade in NMS stocks. Market 
participants who use these orders seek to trade immediately at the best 
available prices in the market. Broker-dealers route more than 90% of 
marketable orders of individual investors in NMS stocks to a small 
group of six off-exchange dealers, often referred to as 
``wholesalers.'' \3\ The wholesaling business is highly concentrated, 
with two firms capturing approximately 66% of the executed share volume 
of wholesalers as of the first quarter of 2022.\4\ The practice of 
separately identifying and routing the marketable orders of individual 
investors to wholesalers is a form of ``segmentation.'' The term 
``segmentation'' can refer to any practice by which a certain category 
of orders is identified and treated differently for execution than 
other categories of orders.
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    \3\ Table 3, infra, section VII.B.2.a.
    \4\ See infra note 372.
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    As discussed in the economic analysis in section VII.B.2 below, 
individual investor orders are segmented because they are ``low-cost'' 
flow--they impose lower adverse selection costs on liquidity providers 
than the unsegmented order flow routed to national securities 
exchanges. ``Adverse selection'' involves situations where buyers and 
sellers have different information, and specifically for a liquidity 
provider, refers to the extent to which prices move against it after a 
trade. For example, if the price of a stock drops right after a 
liquidity provider buys it, the liquidity provider has suffered from 
adverse selection. Generally, the more severe the adverse selection, 
the larger the ``effective spread'' that would be expected for a trade 
because liquidity providers require a wider effective spread to 
compensate them for the higher cost of adverse selection.\5\ In this 
respect, the size of effective spreads can be interpreted as a measure 
of the average adverse selection that liquidity providers expect to 
suffer when trading with incoming orders. Data analysis conducted for 
this proposal reveals that the average adverse selection costs of 
orders routed to wholesalers are far lower than the average adverse 
selection costs of orders routed to national securities exchanges.\6\
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    \5\ As explained in more detail in section II.D below, the 
``effective spread'' of a trade is measured as double the difference 
between the trade's execution price and the midpoint of the national 
best bid and offer at the time of order receipt. Adverse selection 
reflects the ``price impact'' of a trade, which is measured as the 
difference between the midpoint of the national best bid and offer 
at the time of the trade and the midpoint of the national best bid 
and offer at a specified time (e.g., one minute or five minutes) 
after the time of the trade.
    \6\ Table 7, infra, section VII.B.4 (adverse selection costs, as 
measured by price impact, of marketable orders of individual 
investors in all NMS stocks are 71% lower at wholesalers (1.26 basis 
points) than on exchanges (4.40 basis points)).
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    The primary benefit of segmentation for individual investors is 
that it can provide an opportunity for their low-cost orders to be 
executed at better prices than those generally available on national 
securities exchanges, a practice known as ``price improvement.'' \7\ As 
discussed in section VII below, wholesalers often provide some price 
improvement relative to the best publicly quoted prices for round lot 
sizes on national securities exchanges.\8\
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    \7\ Section VII.B.4 below discusses an analysis of wholesaler 
trading data indicating the relationship between segmentation, 
adverse selection costs, and order execution quality.
    \8\ Table 5, infra, section VII.B.4 (83.17% of marketable orders 
routed to wholesalers receive price improvement when compared to the 
best publicly quoted prices for round lot sizes on national 
securities exchanges, and 8.78% of marketable orders routed to 
national securities exchanges receive such price improvement). These 
better prices are due in large part to the ability of wholesalers to 
offer sub-penny prices that are not permitted on national securities 
exchanges and other trading centers. The current rules that govern 
sub-penny trading are discussed in section III.B.2.c below.
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    Price improvement, however, is not the same as competitive order 
execution. Today, the primary business model of wholesalers is to trade 
bilaterally as principal with individual investor orders (a form of 
``internalization''). Typically, the way broker-dealers choose a 
wholesaler for any particular order is not based on the

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price the wholesaler is willing to provide for that order, as 
wholesalers do not display or otherwise indicate in real-time the 
prices at which they are willing to trade with individual investor 
orders. Instead, a wholesaler is often chosen by a formula that depends 
on past execution quality of the wholesaler, its relationship with the 
broker-dealer, and other factors. In addition, the bilateral nature of 
the wholesaler business model not only restricts contemporaneous 
competition among wholesalers, it also restricts opportunities for 
other market participants to trade with the low-cost flow. Once a 
wholesaler receives an individual investor's marketable order, the 
wholesaler's execution of the order does not face competition at all--
the wholesaler typically executes the order internally without 
providing any opportunity for other market participants, including 
institutional investors, to compete to provide more favorable prices 
for the order.\9\ This lack of order-by-order competition among market 
participants is particularly significant in the market for NMS stocks, 
which is an order-driven market in which a wide range of market 
participants, including institutional investors, seek to provide 
liquidity on national securities exchanges by posting orders for the 
approximately 12,000 NMS stocks. In contrast, the listed options market 
is a quote-driven market in which professional market makers dominate 
liquidity provision by displaying quotes in the more than 1,000,000 
different options series. In sum, in the current market structure for 
NMS stocks, individual investor orders are not merely segmented; they 
also are isolated from order-by-order competition by a wide range of 
market participants, which, as discussed below, can affect the prices 
that individual investors receive for their orders.
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    \9\ As shown in Table 7, infra, section VII.B.4, wholesalers 
execute internally (in ``principal transactions'') 90.44% of the 
dollar volume of executed marketable orders routed to them. As 
discussed in section VII.B.2.b below, wholesalers primarily obtain 
external executions of the remaining volume of the marketable orders 
in ``riskless principal'' transactions.
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    Data analysis suggests that opening up individual investor orders 
to order-by-order competition would lead to significantly better prices 
for those investors. In a fully competitive market, competition among 
liquidity providers would be expected to drive the amount of price 
improvement that an order receives to a level commensurate with its 
adverse selection cost (setting aside other relevant costs). All else 
equal, the lower an order's expected adverse selection cost, the 
greater would be the order's expected price improvement. However, as 
discussed in section VII.C.1.b below, the current isolation of 
individual investor orders from order-by-order competition results in 
suboptimal price improvement for such orders. The Commission labels 
this forgone price improvement ``competitive shortfall.'' Based on an 
analysis of trading data from the wholesalers and national securities 
exchanges in the first quarter of 2022, the competitive shortfall is 
estimated to be approximately 1.08 basis points per dollar traded by 
wholesalers or 1.08 cents for every $100 traded, with an estimated 
total annual competitive shortfall of $1.5 billion.\10\
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    \10\ Table 18 and Table 19, infra, section VII.C.1.b (figures in 
text are for the CAT rebate base competitive shortfall estimates).
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    In addition to this competitive shortfall, the isolation of 
individual investor orders at wholesalers prevents other investors from 
having an opportunity to trade with this low-cost flow. Institutional 
investors that currently submit their own marketable orders on national 
securities exchanges and other trading centers potentially could trade 
at better prices if given an opportunity to interact with the 
marketable orders of individual investors in fair and open 
auctions.\11\ For example, data analysis indicates that undisplayed 
liquidity often is available at trading centers other than wholesalers 
when a wholesaler executes marketable orders of individual investors at 
prices less favorable for the individual investor than the prices of 
the undisplayed liquidity.\12\ Moreover, if institutional investors 
that currently pay a full ``spread'' (that is, the difference between 
the highest price bid and the lowest price offer) to access liquidity 
were able instead to interact in auctions with the marketable orders of 
individual investors that currently are mostly inaccessible to them, 
these institutional investors could benefit from lower spread 
costs.\13\
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    \11\ See, e.g., section VII.B.3, infra, discussing institutional 
investor interactions with retail orders.
    \12\ Table 20, infra, section VII.C.1.b.
    \13\ See, e.g., Section VII.C.1.c, infra, discussing potential 
improved execution quality for institutional investor orders.
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    The Commission is proposing Rule 615 to encourage greater 
competition for individual investor order execution. Proposed Rule 615 
generally would require that individual investor orders be exposed to 
order-by-order competition in fair and open auctions designed to obtain 
the best prices before such orders could be internalized by wholesalers 
or any other type of trading center that restricts order-by-order 
competition. As a result, individual investor orders could continue to 
receive the benefits of segmentation (i.e., better prices that reflect 
the low adverse selection costs of those orders), but without the 
negative effects of those orders being isolated from order-by-order 
competition (i.e., such better prices not fully reflecting the low 
adverse selection costs of those orders; and a substantial percentage 
of those orders seldom being accessible to institutional investors and 
other market participants). In sum, the auctions required by Proposed 
Rule 615 are intended to enhance competitive forces as a means to 
protect the interests of investors in the NMS.
    In developing the specific elements of Proposed Rule 615, the 
Commission has been guided by this goal of benefiting investors by 
enhancing competition. The overriding objective of these elements of 
Proposed Rule 615 is to maximize the opportunity for a wide range of 
market participants to participate in auctions on terms that will 
promote the best possible prices for the orders of individual 
investors. In this respect, the Commission has drawn from its 
experience with the operation of existing auctions for orders in listed 
options and tailored Proposed Rule 615 to promote fair and open 
auctions that reflect the particular nature of the market for NMS 
stocks. As discussed in section IV below, these elements would include 
the wide dissemination of auction messages in consolidated market data, 
requirements that any fees and rebates be capped at a low level 
($0.0005 per share for auction prices of $1 or more) and be flat across 
all market participants, and requirements for execution priority of 
auction responses that give no advantage to the broker-dealer that 
routed the marketable order of an individual investor to the auction.
    In addition, the Commission has limited the scope of Proposed Rule 
615 to contexts in which an auction could be most beneficial for 
individual investors. For example, individual investors that trade many 
times per day tend to use marketable orders that pose higher adverse 
selection risk for liquidity providers; hence, their orders would be 
outside the scope of the rule.\14\ In addition, proposed exceptions are 
provided for orders with a market value of $200,000 or more and for 
orders with execution prices (including prices constrained by non-
marketable limit prices) that are very favorable for individual 
investors (i.e., the midpoint of the best displayed round lot

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quotations or better).\15\ These exceptions would not be mandatory, 
however, which means that broker-dealers could choose whether or not to 
route orders with these characteristics to an auction.
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    \14\ See infra section IV.B.1; section VII.D.2.c.
    \15\ As discussed in section IV.B.1 below, a subset of non-
marketable limit orders with prices not as favorable for individual 
investors (i.e., beyond the midpoint of the best displayed round lot 
quotations) would not qualify for the proposed exceptions.
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    As discussed in section VII.D, the Commission assessed several 
alternatives to Proposed Rule 615, both to the design of the required 
auctions and to the auction approach itself. The Commission 
preliminarily considers Proposed Rule 615 to be the best approach for 
investors. As described throughout this release, and in more detail in 
section IV, Proposed Rule 615 is designed to maintain the price 
improvement benefits of the segmentation of individual investor orders 
and to enhance those benefits through the introduction of order-by-
order competition with a wide range of market participants, including 
institutional investors, through an auction mechanism that is fast, 
low-cost, transparent, and fair.
    The next two sections of this release are intended to provide 
background information on the current structure and regulation of the 
market for NMS stocks that will help promote understanding of the 
details of the Commission's proposal. Section II provides a general 
overview of the current market structure for NMS stocks, and section 
III provides background on the statutory and regulatory framework for 
NMS stocks. Section IV then describes the proposal in detail, and 
section V consolidates all Commission requests for comment on the 
proposal.

II. Overview of Market Structure for NMS Stocks

    This section provides an overview of the market structure for NMS 
stocks,\16\ particularly focusing on the types of market participants, 
order types, and trading costs that will be referred to throughout this 
release.\17\ An understanding of the current market structure, 
particularly the trading costs of different types of market 
participants, including liquidity takers and liquidity providers, is 
critically important when assessing the rationale and objectives of 
Proposed Rule 615.
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    \16\ NMS stocks generally include equity securities other than 
options that are listed on a national securities exchange. Rule 
600(b)(55) of Regulation NMS defines ``NMS stock'' as any NMS 
security other than an option, and Rule 600(b)(54) defines ``NMS 
security'' to mean any security or class of securities for which 
transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan, or an effective 
NMS plan for reporting transactions in listed options. The 
definition of NMS stock does not include securities that are not 
listed on a national securities exchange, sometimes referred to as 
``over-the-counter'' or ``OTC'' securities.
    \17\ A much more extensive discussion of the ``market 
microstructure'' of securities markets is provided by treatises on 
the subject. See, e.g., Larry Harris, Trading and Exchanges: Market 
Microstructure for Practitioners (Oxford University Press 2003) 
(``Harris Treatise''); Joel Hasbrouck, Empirical Market 
Microstructure: The Institutions, Economics, and Econometrics of 
Securities Trading (Oxford University Press 2007) (``Hasbrouck 
Treatise'').
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A. Investors

    Section 11A(a)(2) of the Exchange Act \18\ provides that the 
Commission should have due regard for the protection of ``investors'' 
when facilitating the establishment of an NMS. As used in this release, 
the term ``individual investor'' will refer to natural persons that 
trade relatively infrequently for their own or closely related 
accounts.\19\ Individual investors generally trade in relatively small 
sizes that can be executed against immediately available liquidity.
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    \18\ 15 U.S.C. 78k-1(a)(2).
    \19\ For a discussion of the specific orders covered by Proposed 
Rule 615, see Proposed Rule 600(b)(91) (defining the term 
``segmented order'') and section IV.B.1 below (discussing the 
proposed definition of ``segmented order''). As discussed in section 
IV.B, the Commission is proposing to add definitions to Rule 600(b) 
of Regulation NMS and adjust the numbering of current definitions 
accordingly. Throughout this release, unless otherwise noted, 
references to existing Rule 600(b) definitions are to the 
definitions as they are currently numbered. References to proposed 
new definitions are designated with ``Proposed Rule 600(b)'' and 
reflect the proposed adjusted numbering.
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    The term ``institutional investor'' as used in this release refers 
to investors that trade in much larger sizes and much more frequently 
than individual investors. Many institutional investors, such as 
pension funds and mutual funds, operate on behalf of a large number of 
individuals. Because institutional investors need to trade in large 
sizes that can exceed immediately available liquidity, their large 
``parent'' orders typically will be broken into smaller ``child'' 
orders. Institutional investors typically are focused primarily on 
obtaining the best price for their large parent orders as a whole.\20\ 
The child orders will be fed into the market gradually so as to 
minimize the extent to which market prices move away before the full 
size of a parent order is executed, which is known as ``slippage.'' One 
means for institutional investors to minimize slippage is to limit 
``information leakage'' concerning the unexecuted portions of their 
large parent orders by closely controlling the impact of the execution 
of their child orders on market prices.
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    \20\ See, e.g., Securities Exchange Act Release No. 61358 (Jan. 
14, 2010), 75 FR 3594, 3604-3605 (Jan. 21, 2010) (``Equity Market 
Structure Concept Release'') (measuring the transaction costs of 
institutional investors ``can be extremely complex'' because their 
``large orders often are broken up into smaller child orders and 
executed in a series of transactions'' and ``[m]etrics that apply to 
small order executions may miss how well or poorly the large order 
traded overall.'').
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B. Trading Centers

    Trades in NMS stocks are executed at a number of different types of 
trading centers.\21\ As discussed below, trading centers that currently 
trade NMS stocks can be divided into five categories: (1) national 
securities exchanges operating SRO trading facilities; \22\ (2) 
alternative trading systems (``ATSs'') that trade NMS stocks (``NMS 
Stock ATSs''); (3) exchange market makers; (4) wholesalers; and (5) any 
other broker-dealer that executes orders internally by trading as 
principal or crossing orders as agent.\23\
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    \21\ Rule 600(b)(95) of Regulation NMS defines ``trading 
center'' as a national securities exchange or national securities 
association that operates a self-regulatory organization (``SRO'') 
trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker or dealer that 
executes orders internally by trading as principal or crossing 
orders as agent.
    \22\ Rule 600(b)(89) of Regulation NMS defines ``SRO trading 
facility'' as, among other things, a facility operated by a national 
securities exchange that executes orders in a security.
    \23\ ``Broker'' is generally defined in section 3(a)(4)(A) of 
the Exchange Act as any person engaged in the business of effecting 
transactions in securities for the account of others. 15 U.S.C. 
78c(a)(4)(A). ``Dealer,'' in turn, is generally defined in section 
3(a)(5)(A) of the Exchange Act as any person engaged in the business 
of buying and selling securities for such person's own account 
through a broker or otherwise. 15 U.S.C. 78c(a)(5)(A). The term 
``broker-dealer'' is used in this release to encompass all brokers, 
all dealers, and firms that are both brokers and dealers.
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    National securities exchanges, among other things, operate SRO 
trading facilities that bring together purchasers and sellers of NMS 
stocks and execute their trades, fall within the definition of an 
exchange in section 3(a)(1) of the Exchange Act,\24\ and are required 
to register under section 6 of the Exchange Act.\25\ As discussed 
further in section III.A below, national securities exchanges are 
subject to a comprehensive regulatory regime that, among other things, 
requires that their rules not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act and not be designed to permit unfair discrimination between 
customers,

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issuers, and broker-dealers. All national securities exchanges publicly 
display quotations for NMS stocks in consolidated market data and are 
known as ``lit'' trading centers. As discussed in section III.B.1 
below, the best-priced quotations of round lots of national securities 
exchanges (highest priced bids to buy and lowest priced offers to sell) 
are included in the consolidated market data feeds currently 
disseminated by centralized securities information processors 
(``SIPs''). In the first quarter of 2022, 16 national securities 
exchanges executed 59.7% of share volume in NMS stocks.\26\
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    \24\ Section 3(a)(1) of the Exchange Act defines ``exchange'' 
as, among other things, any organization that provides facilities 
for bringing together purchasers and sellers of securities. 15 
U.S.C. 78c(1).
    \25\ 15 U.S.C. 78f.
    \26\ Table 1, infra, section VII.B.1.
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    NMS Stock ATSs operate facilities that fall within the definition 
of an exchange in section 3(a)(1) of the Exchange Act, but, as 
discussed in section III.B.3.b below, they are exempted from that 
definition if they register as broker-dealers and otherwise comply with 
Regulation ATS under the Exchange Act.\27\ No NMS Stock ATS currently 
displays quotations in NMS stocks in consolidated market data. The 
trading centers that do not display quotations are known as ``dark'' 
trading centers or ``dark pools.'' An NMS Stock ATS is required to 
provide fair access to its services if it had 5% or more of the average 
daily volume with respect to an NMS stock during four of the preceding 
six calendar months,\28\ and as of November 30, 2022, one NMS Stock ATS 
discloses on its Form ATS-N that it is subject to these fair access 
requirements for securities that are available for trading on its 
platform.\29\ In the first quarter of 2022, 32 ATSs executed 10.2% of 
volume in NMS stocks.\30\
---------------------------------------------------------------------------

    \27\ 17 CFR 240.3a1-1(a)(2); see also Securities Exchange Act 
Release No. 40760 (Dec. 8, 1998), 63 FR 70844, 70858 (Dec. 22, 1998) 
(``Regulation ATS Adopting Release'') (stating that the Commission 
would not consider making an assessment whether a particular system 
should register as an exchange unless such system exceeded the 
volume thresholds specified in 17 CFR 240.3a1-1(b): during three of 
preceding four calendar quarters, the system had (1) 50% or more of 
the average daily dollar trading volume in any security and 5% or 
more of the average daily dollar trading volume in any class of 
security; or (2) 40% or more of the average daily dollar trading 
volume in any class of securities).
    \28\ See Rule 301(b)(5); infra section III.B.3.b (discussing 
fair access requirements for NMS Stock ATSs).
    \29\ See Dealerweb Inc., Form ATS-N/OFA, Part III, Items 11 
(Trading Services, Facilities and Rules) and Item 25 (Fair Access) 
(filed Oct. 24, 2022), https://www.sec.gov/Archives/edgar/data/817462/000081746222000015/0000817462-22-000015-index.htm (disclosing 
that the NMS Stock ATS is subject to the fair access requirements in 
symbols SPY and QQQ). This NMS Stock ATS generally limits its 
eligible subscribers to market makers, banks, broker-dealers, and 
asset managers with at least $10 under management. See id. at Part 
III, Item 1 (Types of Subscribers) and Item 2 (Eligibility for ATS 
Services). Access to Form ATS-Ns filed by NMS Stock ATSs are 
available on the Commission's website at https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm.
    \30\ Table 1, infra, section VII.B.1.
---------------------------------------------------------------------------

    An exchange market maker is defined in Rule 600(b)(32) of 
Regulation NMS as any member of a national securities exchange that is 
registered as a specialist or market maker pursuant to the rules of 
such exchange. Exchange rules typically require exchange market makers 
to provide liquidity by displaying quotations at which they are willing 
to buy and sell NMS stocks for their own account.\31\ In this respect, 
exchange market makers fall within the definition of a ``dealer'' in 
section 3(a)(5) of the Exchange Act as buying and selling NMS stocks 
for their own accounts as part of a regular business. The on-exchange 
volume of exchange market makers in NMS stocks is included in the 
volume for national securities exchanges referenced above because it is 
reported by such exchanges.
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    \31\ See, e.g., New York Stock Exchange LLC (``NYSE'') Rule 104 
(Dealing and Responsibilities of DMMs) (requiring the exchange's 
Designated Market Makers (``DMMs'') to maintain a continuous two-
sided quote for securities in which the DMM unit is registered with 
the exchange) available at https://nyseguide.srorules.com/rules.
---------------------------------------------------------------------------

    Wholesalers fall within the definition of an OTC market maker in 
Rule 600(b)(64) of Regulation NMS--any dealer that holds itself out as 
being willing to buy from and sell to its customers, or others, in the 
United States, an NMS stock for its own account on a regular or 
continuous basis otherwise than on a national securities exchange in 
amounts of less than block size. The term ``wholesaler'' is not defined 
in Regulation NMS, but commonly refers to an OTC market maker that 
seeks to attract orders from broker-dealers that service the accounts 
of individual investors,\32\ referred to in this release as ``retail 
brokers.'' \33\ The public order-routing reports required by 17 CFR 
242.606 (``Rule 606'') \34\ show that the six largest wholesalers 
collectively paid retail brokers $235 million in payment for order flow 
(``PFOF'') in the first quarter of 2022 for orders in NMS stocks.\35\ 
Many retail brokers do not accept PFOF for marketable orders in NMS 
stocks routed to wholesalers, though the retail brokers that do accept 
PFOF represent 73.88% of the dollar volume of marketable orders of 
retail brokers routed to wholesalers.\36\
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    \32\ Another type of business operated by some OTC market makers 
is known as a ``single dealer platform,'' which primarily seeks to 
attract the orders of institutional investors for internal 
execution. Infra section VII.B.3.
    \33\ As discussed in section VII.B.1.a below, the Commission has 
identified six firms as wholesalers based on the public order 
routing disclosures of retail brokers. Retail broker services are 
discussed in section VII.B.6 below.
    \34\ Rule 606 is discussed in section III.B.4 below.
    \35\ See infra section VII.B.6.a.
    \36\ See Table 14, infra section VII.B.5.c.
---------------------------------------------------------------------------

    Wholesalers do not display or otherwise reveal the prices at which 
they are willing to execute individual investor orders internally. 
Moreover, as discussed in section III.B.3 below, while they are subject 
to Commission and SRO requirements as broker-dealers, wholesalers are 
not subject to a statutory or regulatory requirement to provide fair 
access. They are not required to provide an opportunity for other 
market participants, including institutional investors and other 
exchange market makers, to compete on an order-by-order basis to 
provide the best prices for the individual investor orders that the 
wholesalers internalize. Some institutional investors, for example, 
consider this order flow to be ``inaccessible.'' \37\ In the first 
quarter of 2022, six large wholesalers internally executed 23.9% of 
share volume in NMS stocks.\38\
---------------------------------------------------------------------------

    \37\ See, e.g., Cowen, Inc., ``Cowen Market Structure: Retail 
Trading--What's going on, what may change, and what can you do about 
it?'' (Mar. 23, 2021), available at https://www.cowen.com/insights/retail-trading-whats-going-on-what-may-change-and-what-can-institutional-traders-do-about-it/ (``Market makers print most of 
these shares internally at their firm, so they trade off-exchange. 
One way we have for isolating retail volume is to look at the share 
of volume that trades off-exchange, but not in a dark pool. We refer 
to this as `inaccessible liquidity.' This is because most 
institutional orders--whether they are executed via algos directly 
or by high touch desks--primarily go to exchanges and dark 
pools.'').
    \38\ Table 1, infra, section VII.B.1.
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    The fifth and final category of trading center that executes trades 
in NMS stocks is a catchall category encompassing broker-dealers that 
execute orders internally by trading as principal or crossing orders as 
agent. In the first quarter of 2022, over 230 broker-dealers (other 
than NMS Stock ATSs and OTC market makers) reported trades in NMS 
stocks, which accounted for the remaining 6.3% of share volume in NMS 
stocks.\39\
---------------------------------------------------------------------------

    \39\ Table 1, infra, section VII.B.1.
---------------------------------------------------------------------------

C. Order Types and Trading Costs

    When seeking to buy and sell NMS stocks, investors submit orders 
through the broker-dealers that service their accounts. The order type 
most frequently used to trade by individual investors is a ``market'' 
order, which simply instructs a broker-dealer to seek an execution of 
the order at the best available price in the market. In contrast to 
market orders, a ``limit order'' specifies a ``limit price''--a price

[[Page 133]]

beyond which the investor is not willing to trade. Limit prices reflect 
an intention to ``buy low and sell high.'' For example, a buy order 
with a limit price of $20 means the investor would like to buy as soon 
as possible, but only at a price that is $20 or less. Conversely, a 
sell order with a limit price of $20 means the investor would like to 
sell as soon as possible, but only at a price that is $20 or more.
    In practice, the likelihood and speed of execution of limit orders 
can vary greatly depending primarily on the relation between their 
limit prices and the best-priced quotations that are displayed by 
national securities exchanges in the consolidated market data feeds. As 
discussed in section III.B.1 below, these quotations are in ``round 
lot'' sizes, which currently are 100 shares or more for nearly all NMS 
stocks. The highest price bid for an NMS stock is known as the national 
best bid (``NBB''), and the lowest price offer for an NMS stock is 
known as the national best offer (``NBO''). Collectively, the NBB and 
NBO are known as the national best bid and offer (``NBBO''). When a 
limit order to buy has a limit price that is equal to or greater than 
the NBO, it is known as a ``marketable'' limit order because it can be 
executed immediately at the best displayed quote to sell. Similarly, a 
limit order to sell is marketable when it has a limit price that is 
equal to or less than the NBB.\40\
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    \40\ Rule 600(b)(47) of Regulation NMS defines a ``marketable 
limit order'' as any buy order with a limit price equal to or 
greater than the NBO at the time of order receipt, or any sell order 
with a limit price equal to or less than the NBB at the time of 
order receipt.
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    For example, assume the NBB is $20.00 and the NBO is $20.10. A buy 
limit order with a price of $20.10 or higher is marketable, and a sell 
limit order with $20.00 or lower is marketable. Marketable limit orders 
are similar to market orders with respect to their willingness to trade 
immediately at the best displayed prices or better and will be referred 
to collectively in this release as ``marketable orders.''
    Investors that use marketable orders to trade immediately at the 
best available prices are known as ``liquidity takers'' and generally 
incur a trading cost for the service, known as a ``spread.'' In the 
example above, when the NBBO is $20.00 and $20.10, the quoted spread is 
10 cents. An investor that wished to avoid paying a spread could use a 
``non-marketable'' limit order in an attempt to become a ``liquidity 
provider.'' A non-marketable limit order to buy has a limit price that 
is less than the NBO, and a non-marketable limit order to sell has a 
limit price that is greater than the NBB.\41\ For example, again using 
the example when the NBBO is $20.00 and $20.10, an investor could 
submit a buy limit order with a limit price of $20.00. This buy order 
is not marketable because it is priced less than the NBO of $20.10 and 
therefore cannot be executed immediately against the best displayed 
offer. A non-marketable limit order generally will ``rest'' on the 
continuous order book of a trading center awaiting the arrival of a 
contra-side marketable order against which it can execute. In the 
example, if the resting non-marketable limit order to buy were able to 
obtain an execution at its limit price of $20.00 (e.g., by interacting 
with a contra-side marketable order to sell), the investor would have 
succeeded in trading at a price that was 10 cents lower than if the 
investor had used a marketable order and traded at the NBO of $20.10. 
The risk, however, of using a non-marketable limit order is that it may 
not execute at all if market prices move away from the order (i.e., 
prices increase for buy orders and decrease for sell orders). If this 
happens, the investor will incur an opportunity cost by missing a 
trade.
---------------------------------------------------------------------------

    \41\ Rule 600(b)(57) of Regulation NMS defines ``non-marketable 
limit order'' as any limit order other than a marketable limit 
order.
---------------------------------------------------------------------------

    Using the example of an NBBO of $20.00 and $20.10, assume the 
investor submitted a non-marketable order to buy with a limit price of 
$20.00, but did not obtain an execution and the NBBO then rose to 
$20.15 and $20.25. Seeing that the market was moving away, the investor 
decided to cancel the unexecuted non-marketable order and replace it 
with a marketable order to buy, which then was executed at the new NBO 
price of $20.25. In this case, the investor incurred an opportunity 
cost of 15 cents--the difference between (1) the original NBO price of 
$20.10 that the investor likely could have obtained if the investor 
first had used a marketable order to buy at $20.10 rather than using 
the non-marketable order in an unsuccessful attempt to buy at $20.00, 
and (2) the price of $20.25 at which the investor actually obtained an 
execution.
    In sum, an investor's decision of whether to use marketable orders 
or non-marketable orders to trade can depend on an often complex 
judgment of whether prices are likely to move in the short-term future. 
Individual investors, who typically do not follow market prices closely 
throughout a trading day, often will not feel in the best position to 
make this judgment and generally choose to be liquidity takers by using 
marketable orders to obtain the certainty of an immediate execution at 
a displayed price or better.\42\ Accordingly, a key source of trading 
costs for individual investors are the spreads they pay when using 
marketable orders. The narrower the spreads, the lower the prices at 
which they will buy and the higher the prices at which they will sell, 
which translate into lower trading costs and higher investment returns. 
Conversely, wider spreads mean higher trading costs and lower 
investment returns.
---------------------------------------------------------------------------

    \42\ Rule 606 order-routing reports reveal that customers of 
retail brokers used marketable orders for approximately 39-40% of 
their trades and used ``other'' orders for approximately 26-27% of 
their trades. Table 3, infra, section VII.B.2.a. As presented in 
Table 2 in section VII.B.2.a below, however, the PFOF rates received 
from wholesalers for these ``other'' orders almost exactly matched 
the rates received from wholesalers for marketable limit orders. 
Accordingly, it is likely that most of these other orders were 
marketable (i.e., immediately executable at the best available 
prices), although the orders may have had particular characteristics 
that led them to be classified as other orders.
---------------------------------------------------------------------------

    The spread costs of individual investors highlight the role played 
by liquidity providers in determining spreads. Liquidity providers 
determine spreads by setting the prices at which they are willing to 
trade with marketable orders as such orders are submitted by liquidity 
takers. Liquidity providers can include professional market 
intermediaries, such as exchange market makers and OTC market makers 
(including wholesalers), as well as investors that use non-marketable 
limit orders. For example, national securities exchanges, which display 
the quotations that determine the NBBO, all operate continuous order 
books. Unexecuted non-marketable orders that have been routed to an 
exchange rest on its continuous order book awaiting an opportunity for 
interaction with incoming contra-side orders. Using the NBBO example of 
$20.00 and $20.10, assume a national securities exchange has displayed 
limit orders resting on its continuous order book with limit prices 
that equal the NBBO, but then an institutional investor submits a buy 
order with a limit price of $20.02 for display on the continuous order 
book. At this point, there will be a new NBB of $20.02 and the NBBO 
spread will have been reduced from 10 cents to 8 cents. If an 
individual investor's market order to sell was routed to the exchange, 
the order would execute at the new NBB of $20.02, saving the individual 
investor two cents per share compared to the old NBB of $20.00.
    For liquidity providers, the adverse selection costs of trading 
with a given

[[Page 134]]

marketable order flow are a key factor for determining the prices at 
which they are willing to trade with such flow, particularly for 
professional market intermediaries. These market intermediaries 
generally seek to generate short-term trading profits by buying and 
selling on a continuous basis and capturing a spread between their buys 
and sells. Adverse selection costs reflect the extent to which prices 
move against the liquidity provider in the seconds and minutes after a 
trade, which increases the difficulty faced by the liquidity provider 
in successfully capturing a spread between buys and sells.
    For example, assume an NBBO of $20.00 and $20.10, and a market 
maker provides liquidity by trading with a contra-side marketable sell 
order at the $20.00 NBB. The market maker may hope to profit by quickly 
providing liquidity to a contra-side marketable buy order at the $20.10 
NBO and thereby earning a 10 cent spread. Seconds later, however, and 
before the market maker is able to liquidate the buy position, the NBBO 
declines to $19.85 and $19.95. In this case, the market maker has 
bought immediately prior to a 15 cent decline in the NBBO. This 
subsequent move in the NBBO is known as ``price impact.'' Instead of 
earning a 10 cent spread as it hoped by providing liquidity when the 
NBBO was $20.00 and $20.10, the market maker would realize a loss of 5 
cents on its position if it then provided liquidity to a contra-side 
marketable buy order by selling at the new NBO of $19.95. Therefore, 
the market maker had an adverse selection cost of 15 cents. 
Accordingly, market makers assess the potential adverse selection costs 
of the liquidity-taking order flow with which they are likely to 
interact when setting the spreads at which they are willing to provide 
liquidity to such flow. Segmentation of marketable orders with low 
adverse selection costs is a means for liquidity providers to control 
such costs. As discussed in section VII,\43\ the marketable orders of 
individual investors routed to wholesalers have adverse selection costs 
(as measured by price impact) that are approximately 71% lower than the 
adverse selection costs of orders routed to national securities 
exchanges. The low adverse selection costs of the segmented marketable 
orders of individual investors generally enable wholesalers to offer 
better prices for such orders than would be available for unsegmented 
orders routed to national securities exchanges.
---------------------------------------------------------------------------

    \43\ See Table 7, infra, section VII.B.4.
---------------------------------------------------------------------------

    The trading examples thus far have assumed that trades occur at the 
NBBO prices, which are determined by round lot quotations displayed on 
national securities exchanges. In fact, however, trades can be executed 
on national securities exchanges at prices that are better than NBBO 
prices (``NBBO price improvement''). Marketable orders routed to access 
the NBBO at a national securities exchange can obtain NBBO price 
improvement in two primary contexts. First, a national securities 
exchange may have displayed orders on its continuous order book with 
sizes less than round lots, known as ``odd lot quotations,'' that are 
priced better than the NBBO. If a contra-side marketable order is 
routed to a national securities exchange with such an odd lot 
quotation, the contra-side marketable order will interact with the odd-
lot quotation and receive a better price than the NBBO. Second, there 
may be undisplayed non-marketable limit orders resting on the 
continuous order book of a national securities exchange with prices 
that are better than such exchange's displayed quotations. One common 
example is an NBBO midpoint order. An NBBO midpoint order has an 
execution price that is pegged to, and accordingly fluctuates with, the 
midpoint of the NBBO. If the NBBO is $20.00 and $20.10, and an NBBO 
midpoint order to sell is resting on the continuous order book of a 
national securities exchange, a marketable order to buy that is routed 
to such exchange will execute at the NBBO midpoint price of $20.05 
rather than the NBO of $20.10. By trading at the NBBO midpoint, the 
incoming marketable buy order has obtained an immediate execution 
without paying any spread, and the resting NBBO midpoint order to sell 
has not earned any spread. Institutional investors may use undisplayed 
NBBO midpoint orders because they provide an opportunity to trade with 
contra-sided marketable flow, but without the information leakage (and 
potential slippage) that could occur if their orders were displayed.

D. Quantitative Measures of Order Execution Quality and Trading Costs

    A variety of quantitative measures can be used to assess the 
quality of order executions that broker-dealers obtain for their 
individual investor customers, as well as more generally the trading 
costs of liquidity takers and liquidity providers. 17 CFR 242.605 
(``Rule 605'') of Regulation NMS,\44\ for example, requires many 
trading centers, including national securities exchanges and 
wholesalers, to make data files publicly available on a monthly basis 
that include detailed measures of execution quality for marketable and 
non-marketable orders in NMS stocks. This section will describe some of 
the quantitative measures included in Rule 605 data, as well as provide 
concrete examples illustrating specifically how the measures are 
calculated. These quantitative measures are referenced extensively 
throughout this release to explain the rationale for and the potential 
economic effects of Proposed Rule 615.
---------------------------------------------------------------------------

    \44\ Rule 605 is discussed in section III.B.4 below.
---------------------------------------------------------------------------

1. Description of Quantitative Measures
    The following is a list, with brief descriptions, of quantitative 
measures of order execution quality and trading costs in NMS stocks 
that are included in, or can be derived from, Rule 605 data files. 
Specific examples of how the measures are calculated will be provided 
in section II.D.2 below.
    As stated above, NBBO price improvement is the amount by which the 
execution price of a marketable order is better than the relevant NBBO 
quotation at the time a marketable order is received by a trading 
center.\45\ For marketable buy orders, it is the amount by which the 
buy order received a price lower than the NBO at the time of order 
receipt. For marketable sell orders, it is the amount by which the sell 
order received a price higher than the NBB at the time of order 
receipt.
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    \45\ Rule 600(b)(36) of Regulation NMS defines ``executed with 
price improvement'' as, for buy orders, execution at a price lower 
than the NBO at the time of order receipt and, for sell orders, 
execution at a price higher than the NBB at the time of order 
receipt.
---------------------------------------------------------------------------

    ``NBBO quoted half-spread'' is one-half of the difference between 
the NBO and NBB, as measured at the time when a marketable order is 
received by a trading center. The full quoted spread is halved to 
reflect the spread cost for establishing or liquidating a position 
(long or short). For example, if an investor uses a marketable order to 
buy at the NBO (incurring a half-spread to establish a long position), 
but then is able to use a non-marketable order to sell at the NBO 
(earning a half-spread to liquidate the long position), the investor 
would have paid a net spread of 0 cents on the ``round-trip'' 
transaction.
    ``Effective half-spread'' is the half-spread actually paid by a 
marketable order. It is calculated by comparing execution prices with 
the NBBO midpoint, rather than the relevant NBB or NBO, at the time of 
order receipt.\46\

[[Page 135]]

Accordingly, a trading center's average effective half-spread for 
marketable orders may be narrower or wider than the NBBO quoted half-
spread, depending on the extent to which execution prices at a trading 
center are inside, at, or outside NBBO prices.
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    \46\ Rule 600(b)(8) of Regulation NMS defines ``average 
effective spread'' as the share-weighted average of effective 
spreads for order executions calculated, for buy orders, as double 
the amount of difference between the execution price and the 
midpoint of the NBB and NBO at the time of order receipt and, for 
sell orders, as double the amount of difference between the midpoint 
of the NBB and NBO at the time of order receipt and the execution 
price.
---------------------------------------------------------------------------

    ``Price impact'' is the extent to which the NBBO midpoint moves 
against the liquidity provider for a marketable order in a short time 
period after the order execution. For Rule 605 reporting, the time 
period is five minutes after the time of order execution. For the 
analyses of CAT data provided in section VII.B.4 below, the time period 
is one minute after the time of order execution.\47\ Price impact 
measures the extent of adverse selection costs faced by a liquidity 
provider and is closely related to realized half-spread (described 
next). When price impact and realized half-spread are calculated using 
the same post-trade time period, the difference between the effective 
half-spread and the realized half-spread on a trade will equal the 
price impact of the trade.\48\
---------------------------------------------------------------------------

    \47\ The analysis in section VII.B.4 below uses one minute to 
reflect the increase in trading speed in the years since Rule 605 
was adopted.
    \48\ See, e.g., Hasbrouck Treatise at 147 (``The execution cost 
based on the pretrade bid-ask midpoint (BAM) is also known as the 
effective cost. Since 2001, the U.S. SEC has required U.S. equity 
markets to compute effective costs and make summary statistics 
available on the Web . . . . The rule . . . also requires 
computation of the realized cost . . . . The difference between 
effective and realized costs is sometimes used as an estimate of the 
price impact of the trade. The realized cost can also be interpreted 
as the revenue of the dealer who sold to the customer . . . and then 
covered his position at the subsequent BAM.'').
---------------------------------------------------------------------------

    ``Realized half-spread'' is calculated similarly to the effective 
half-spread, but, instead of using the NBBO midpoint at the time of 
order receipt, the realized spread calculation uses the NBBO midpoint a 
short time period after the execution of a marketable order.\49\ For 
Rule 605 reporting, the time period is five minutes after the time of 
order execution. For the analyses of CAT data provided in section 
VII.B.4 below, the time period is one minute after the time of order 
execution.\50\ When deciding to include realized spread statistics in 
Rule 605 reports, the Commission stated that the smaller the average 
realized spread, ``the more market prices have moved adversely to the 
market center's liquidity providers after the order was executed,'' 
which shrinks the spread ``realized'' by the liquidity providers.\51\ 
The Commission further stated that the average realized spread 
statistic for market and marketable limit orders potentially could help 
``to spur more vigorous competition to provide the best prices to these 
orders to the benefit of many retail investors.'' \52\ In sum, by 
capturing the extent of adverse selection costs faced by liquidity 
providers, realized spreads are designed to provide a more accurate 
measure of the potential profitability of trading for liquidity 
providers than do effective spreads.\53\
---------------------------------------------------------------------------

    \49\ Rule 600(b)(9) of Regulation NMS generally defines 
``average realized spread'' as the share-weighted average of 
realized spreads for order executions calculated, for buy orders, as 
double the amount of difference between the execution price and the 
midpoint of the NBB and NBO five minutes after the time of order 
execution and, for sell orders, as double the amount of difference 
between the midpoint of the NBB and NBO five minutes after the time 
of order execution and the execution price.
    \50\ The analysis in section VII.B.4 below uses a one-minute 
period to reflect the increase in trading speed in the years since 
Rule 605 was adopted.
    \51\ Securities Exchange Act Release No. 43590 (Nov. 17, 2000), 
65 FR 75414, 75424 (Dec. 1, 2000).
    \52\ Id.
    \53\ See, e.g., Harris Treatise at 286 (``Informed traders buy 
when they think that prices will rise and sell otherwise. If they 
are correct, they profit, and whoever is on the other side of their 
trade loses. When dealers trade with informed traders, prices tend 
to fall after the dealer buys and rise after the dealer sells. These 
price changes make it difficult for dealers to complete profitable 
round-trip trades. When dealers trade with informed traders, their 
realized spreads are often small or negative. Dealers therefore must 
be very careful when trading with traders they suspect are well 
informed.'').
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2. Examples of Calculating Measures of Order Execution Quality and 
Trading Costs
    When the execution quality and trading cost measures described 
above are calculated and averaged for a large volume of orders at 
different trading centers, the results can reveal important information 
about the nature of the order execution quality and trading costs 
across different trading centers. Section VII below, which provides an 
economic analysis of Proposed Rule 615, makes extensive use of data 
analyses using these measures.
    The following two examples are patterned on those analyses, 
particularly the empirical finding that the marketable orders of 
individual investors routed to wholesalers have adverse selection costs 
(as measured by price impact) that, on average, are approximately 71% 
lower than the marketable orders routed to national securities 
exchanges. The examples are intended to illustrate how quantitative 
measures of order execution quality and trading costs are calculated in 
these two contexts that are most relevant for understanding the 
empirical basis for Proposed Rule 615. The examples show how a 
difference in the adverse selection costs of order flow routed to two 
different trading centers can result in more price improvement and 
narrower effective spreads at the trading center with lower adverse 
selection costs (the wholesaler) than at the trading center with higher 
adverse selection costs (the exchange), yet still result in wider 
realized spreads (i.e., spreads realized by the liquidity provider 
after estimating for adverse selection costs) at the wholesaler than at 
the exchange.
    The first example below (``Exchange Example'') presents the 
execution of an unsegmented marketable order to buy at a national 
securities exchange at a price that matches the NBBO, and the second 
example below (``Wholesaler Example'') presents the execution of a 
segmented marketable order to buy of an individual investor at a 
wholesaler at a price better than the NBBO. The examples use the 
calculation methodology prescribed by Rule 605 of Regulation NMS, 
except that statistics are presented for the half-spread associated 
with a single buy or sell order rather than the full spread statistics 
prescribed for Rule 605, which are doubled to reflect estimates of 
round-trip (offsetting buy and sell) trading costs.\54\ Half-spreads 
are used to more clearly present the calculations for the single order 
in each of the examples.
---------------------------------------------------------------------------

    \54\ The definitions of ``average effective spread'' and 
``average realized spread'' provided in Rule 600(b)(8) and (9) of 
Regulation NMS, which are incorporated in Rule 605, prescribe 
doubling of the amounts by which an order execution price differs 
from the NBBO midpoint at the time of order receipt (for effective 
spreads) and five minutes after the time of order execution (for 
realized spreads).
---------------------------------------------------------------------------

    The data used for the two examples are labeled as follows: 
execution price of marketable order (``ExP''), NBB at time of order 
receipt (``NBBt0''), NBO at time of order receipt 
(``NBOt0''), NBBO midpoint at time of order receipt 
(``MPt0''), and NBBO midpoint 5 minutes after time of order 
execution (``MPt5'').
    The execution quality and trading cost measures for the two 
examples of marketable orders to buy are calculated as follows:

NBBO quoted half-spread: \1/2\ x (NBOt0-NBBt0)
NBBO price improvement: NBOt0-ExP
Effective half-spread: ExP-MPt0
Price impact: MPt5-MPt0
Realized half-spread: ExP-MPt5

    The data and calculations for the two examples are as follows:

[[Page 136]]



------------------------------------------------------------------------
                                   Exchange example   Wholesaler example
------------------------------------------------------------------------
EXP.............................  $110.05...........  $110.04.
NBBT0...........................  $110.00...........  $110.00.
NBOT0...........................  $110.05...........  $110.05.
MPT0............................  $110.025..........  $110.025.
MPT5............................  $110.055..........  $110.035.
NBBO PRICE IMPROVEMENT..........  0 cents...........  1 cent.
NBBO QUOTED HALF-SPREAD.........  2.5 cents.........  2.5 cents.
EFFECTIVE HALF-SPREAD...........  2.5 cents.........  1.5 cents.
PRICE IMPACT....................  3 cents...........  1 cent.
REALIZED HALF-SPREAD............  <0.5 cents>.......  0.5 cents.
------------------------------------------------------------------------

    In the Exchange Example and Wholesaler Example, the NBBO is the 
same at the time of order receipt for both marketable buy orders, but 
the national securities exchange in the Exchange Example executes the 
order at the NBO with no NBBO price improvement, while the wholesaler 
in the Wholesaler Example executes the marketable buy order with NBBO 
price improvement of one cent. Consequently, the NBBO quoted half-
spread is the same for both trades (2.5 cents), but the effective half-
spread is wider for the liquidity provider on the national securities 
exchange (2.5 cents) than for the wholesaler (1.5 cents) because of the 
1 cent NBBO price improvement provided by the wholesaler. The price 
impact of the order routed to the national securities exchange is 3 
cents, while the price impact of the order routed to the wholesaler is 
only 1 cent. Accordingly, the adverse selection cost for the liquidity 
provider on the national securities exchange was 3 cents, while the 
adverse selection cost for the wholesaler was 1 cent.
    The difference in adverse selection costs leaves the liquidity 
provider on the national securities exchange in the Exchange Example 
with a narrower realized half-spread of negative 0.5 cents, while the 
wholesaler in the Wholesaler Example preserves a positive realized 
half-spread of 0.5 cents. Stated another way, the wholesaler provided 
some NBBO price improvement (1 cent), but its adverse selection cost 
savings compared to the liquidity provider on the national securities 
exchange was 2 cents, and as a result the wholesaler was able to 
capture a realized half-spread that was one cent wider than the 
liquidity provider on the national securities exchange. If, however, 
the wholesaler had provided NBBO price improvement that matched its 
cost savings, the individual investor would have received NBBO price 
improvement of 2 cents rather than 1 cent. In this case, the realized 
half-spread for both the wholesaler and the liquidity provider on the 
national securities exchange would have been the same--negative 0.5 
cents.
    In this respect, the Exchange Example and Wholesaler Example 
highlight the key order-by-order competition objective of Proposed Rule 
615. As discussed in section VII.C.2.b below, competition among a wide 
range of liquidity providers on national securities exchanges is 
intense and results in realized spreads for unsegmented orders that are 
narrower than the realized spreads captured by wholesalers for the 
segmented orders of individual investors. Another way of stating the 
same point is that wholesalers do not provide average NBBO price 
improvement that matches their savings in average adverse selection 
costs from securing the opportunity to trade first with the segmented 
orders of individual investors. Proposed Rule 615 would enable order-
by-order competition to provide the best prices to the segmented 
marketable orders of individual investors. By providing an opportunity 
for a wide variety of liquidity providers to compete to provide the 
best prices for the segmented marketable orders of individual 
investors, Proposed Rule 615 is designed to expand the level of NBBO 
price improvement currently provided by wholesalers to match the low 
adverse selection costs of such orders.

III. Statutory and Regulatory Background

    The development of today's market structure for NMS stocks has been 
guided by the Congressional determination set forth in section 11A of 
the Exchange Act that the United States should have an NMS in which 
multiple competing markets are linked together through communications 
and data processing facilities. This section III first will discuss the 
Exchange Act framework for an NMS. It then will summarize the rules 
that the Commission has adopted over the years to facilitate the 
development of an NMS, with particular focus on rules that address the 
handling and execution of investor orders in NMS stocks. Many aspects 
of Proposed Rule 615, as described in section IV below, are designed to 
build on the existing statutory framework and Commission rules 
discussed in this section III.

A. Statutory Framework for an NMS

    Section 11A of the Exchange Act, enacted as part of the Securities 
Acts Amendments of 1975,\55\ sets forth the statutory framework for an 
NMS. Section 11A(a)(2) directs the Commission, having due regard for 
the public interest, the protection of investors, and the maintenance 
of fair and orderly markets, to use its authority under the Exchange 
Act to facilitate the establishment of an NMS for securities in 
accordance with the Congressional findings and objectives set forth in 
section 11A(a)(1) of the Exchange Act.\56\ Section 11A(a)(1)(C) sets 
forth the finding of Congress that it is in the public interest and 
appropriate for the protection of investors and the maintenance of fair 
and orderly markets to assure five objectives:
---------------------------------------------------------------------------

    \55\ Public Law 94-29, 89 Stat. 97 (1975).
    \56\ Section 11A(a)(3)(B) also provides the Commission the 
authority to require the SROs, by rule or order, ``to act jointly . 
. . in planning, developing, operating, or regulating [an NMS] (or a 
subsystem thereof).''
---------------------------------------------------------------------------

    (1) economically efficient execution of securities transactions;
    (2) fair competition among brokers and dealers, among exchange 
markets, and between exchange markets and markets other than exchange 
markets;
    (3) the availability to brokers, dealers, and investors of 
information with respect to quotations for and transactions in 
securities;
    (4) the practicability of brokers executing investors' orders in 
the best market; and
    (5) an opportunity, consistent with the foregoing objectives of 
efficient execution of securities transactions and practicability of 
brokers executing investors' orders in the best market, for investors' 
orders to be executed without the participation of a dealer.\57\
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    \57\ Section 11A(a)(1) of the Exchange Act.
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    A variety of Exchange Act provisions grant the Commission specific

[[Page 137]]

rulemaking authority in different contexts to fulfill its 
responsibility to facilitate the establishment of an NMS that assures 
the five objectives. Three of these Exchange Act authorizations are 
particularly relevant in the context of rules to address the handling 
and execution of investor orders in NMS stocks.
    First, section 11A(c)(1)(E) addresses the routing of orders by 
broker-dealers. It authorizes the Commission to prescribe rules, as 
necessary or appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the Exchange Act to assure 
that all exchange members and brokers-dealers transmit and direct 
orders for the purchase or sale of NMS stocks in a manner consistent 
with the establishment and operation of an NMS.\58\
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78k-1(c)(1)(E).
---------------------------------------------------------------------------

    Second, section 11A(c)(1)(F) grants rulemaking authority to assure 
equal regulation of all markets for NMS stocks, as well as of all 
exchange members and broker-dealers effecting transactions in NMS 
stocks.\59\ The meaning of the term ``equal regulation'' is specified 
in section 3(b)(36), which provides that a class of persons or markets 
is subject to equal regulation if no member of the class has a 
competitive advantage over any other member thereof resulting from a 
disparity in their regulation under the Exchange Act which the 
Commission determines is unfair and not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \59\ 15 U.S.C. 78k-1(c)(1)(F).
---------------------------------------------------------------------------

    Third, section 15(c)(5) addresses the practices of dealers, such as 
wholesalers. It authorizes the Commission to prescribe rules setting 
forth specified and appropriate standards with respect to dealing for 
dealers (other than specialists registered on a national securities 
exchange) acting in the capacity of a market maker or otherwise that 
are necessary or appropriate in the public interest and for the 
protection of investors, to maintain fair and orderly markets, or to 
remove impediments to and perfect the mechanism of an NMS.\60\
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    \60\ 15 U.S.C. 78o(c)(5).
---------------------------------------------------------------------------

    In addition to these grants of rulemaking authority to facilitate 
the development of an NMS, section 6 of the Exchange Act \61\ 
specifically addresses the types of access to trading services that one 
type of market--a national securities exchange--is required to provide 
to broker-dealers and market participants. Access to the trading 
services of a market is essential for that market to be linked together 
with other markets in an NMS.
---------------------------------------------------------------------------

    \61\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

    First, section 6(b)(2) requires that, subject to the provisions of 
section 6(c) relating to statutory disqualification and other concerns, 
the rules of the exchange must provide that any registered broker-
dealer may become a member of such exchange.\62\ Broker-dealers 
generally need to become exchange members, as an initial matter, to 
obtain access to many of the trading services of an exchange.
---------------------------------------------------------------------------

    \62\ 15 U.S.C. 78f(b)(2).
---------------------------------------------------------------------------

    Second, section 6(b)(4) requires that the rules of the exchange 
provide for the equitable allocation of reasonable dues, fees, and 
other charges among its members and issuers and other persons using its 
facilities.\63\ This provision recognizes that the opportunity for 
different market participants to access trading services at a market 
can be greatly affected by the charges for those services.
---------------------------------------------------------------------------

    \63\ 15 U.S.C. 78f(b)(4).
---------------------------------------------------------------------------

    Third, section 6(b)(5) requires that the rules of the exchange are 
designed to, among other things, ``remove impediments to and perfect 
the mechanism of a free and open market and [an NMS], and, in general, 
to protect investors and the public interest.'' \64\ Section 6(b)(5) 
further requires that the rules of the exchange are not designed ``to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers.'' \65\ These provisions broadly help ensure fair and efficient 
access to the trading services of national securities exchanges, both 
by requiring them to act affirmatively to promote high quality markets 
and by prohibiting them from acting negatively by unfairly 
discriminating between customers, issuers, or broker-dealers.
---------------------------------------------------------------------------

    \64\ 15 U.S.C. 78f(b)(5).
    \65\ Id.
---------------------------------------------------------------------------

    Finally, section 6(b)(8) requires that ``the rules of the exchange 
do not impose any burden on competition not necessary or appropriate in 
furtherance of the purposes'' of the Exchange Act.\66\ This provision 
further restricts a national securities exchange's ability to limit 
access to its trading services in an anti-competitive manner.
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    To help ensure that national securities exchanges operate according 
to rules consistent with their statutory obligations, section 19(b)(1) 
of the Exchange Act \67\ requires SROs,\68\ including national 
securities exchanges, to file with the Commission any proposed rule 
change.\69\ The Commission publishes for public comment all SRO 
proposed rule changes.\70\ For new or materially modified trading 
services, a proposed rule change generally cannot become effective, and 
the national securities exchange cannot implement such rule change, 
until the Commission has approved it as consistent with the 
requirements of the Exchange Act.\71\
---------------------------------------------------------------------------

    \67\ 15 U.S.C. 78s(b)(1).
    \68\ See 15 U.S.C. 78c(b)(26) (defining ``self-regulatory 
organization'' to include, among other things, any national 
securities exchange or registered securities association).
    \69\ Section 19(b)(1) of the Exchange Act defines a ``proposed 
rule change'' to be any proposed change in, addition to, or deletion 
from the rules of an SRO. 15 U.S.C. 78s(b)(1). Section 3(a)(27) of 
the Exchange Act generally defines ``rules'' to include the 
constitution, articles of incorporation, bylaws, and rules, or 
instruments corresponding to the foregoing and the stated policies, 
practices, and interpretations of an exchange, association, or 
clearing agency as the Commission, by rule, may determine to be 
necessary or appropriate in the public interest or for the 
protection of investors to be deemed to be rules of such exchange, 
association, or clearing agency. 15 U.S.C. 78c(a)(27). Rule 19b-4(b) 
under the Exchange Act defines ``stated policy, practice, or 
interpretation'' to mean, in part, any material aspect of the 
operation of the facilities of the SRO or any statement made 
generally available that establishes or changes any standard, limit, 
or guideline with respect to the rights, obligations, or privileges 
of persons or the meaning, administration, or enforcement of an 
existing rule. 17 CFR 240.19b-4(b).
    \70\ See 15 U.S.C. 78s(b)(1).
    \71\ If the Commission does not approve or disapprove a proposed 
rule change within the required timeframe prescribed by section 19 
of the Exchange Act, it is ``deemed to have been approved.'' 15 
U.S.C. 78s(b)(2)(D).
---------------------------------------------------------------------------

    Section 15A of the Exchange Act \72\ includes many requirements for 
the rules of a national securities association that are analogous to 
those prescribed for national securities exchanges. FINRA is currently 
the only registered national securities association. Broker-dealers 
that handle customer orders in NMS stocks or trade NMS stocks in the 
off-exchange market generally must become FINRA members.\73\ Section 
15A does not, however, impose fair access requirements on the broker-
dealer members of FINRA. Accordingly, broker-dealers that trade 
internally are not subject to the statutory access requirements that 
apply to national securities exchanges under section 6 of the Exchange 
Act.
---------------------------------------------------------------------------

    \72\ 15 U.S.C. 78o-3.
    \73\ See 15 U.S.C. 78o(b)(8). The Commission has proposed to 
amend 17 CFR 240.15b9-1, which provides an exemption from 
association membership for certain exchange members. Securities 
Exchange Act Release No. 95388 (July 29, 2022), 87 FR 49930 (Aug. 
12, 2022) (proposing to replace a de minimis allowance with narrower 
exemptions from association membership).
---------------------------------------------------------------------------

B. Current Regulatory Components of the NMS for NMS Stocks

    Over the years since 1975, the Commission has used its Exchange Act

[[Page 138]]

authority to adopt a series of rules to fulfill its regulatory 
responsibility to facilitate the establishment of an NMS. In doing so, 
it particularly has emphasized the importance of promoting competition 
as a means to protect investors and to achieve the five statutory 
objectives for an NMS. In its request for comment on issues relating to 
market fragmentation in 2000,\74\ for example, the Commission stated 
that the section 11A findings and objectives can be summed up in two 
fundamental principles. First, the interests of investors (both large 
and small) are preeminent, ``especially the efficient execution of 
their securities transactions at prices established by vigorous 
competition.'' \75\ Second, investor interests are best served by a 
market structure that, to the greatest extent possible, maintains the 
benefits of ``both an opportunity for interaction of all buying and 
selling interest'' in individual securities and ``fair competition 
among all types of market centers'' seeking to provide a forum for the 
execution of securities transactions.\76\ The Commission further stated 
that competition among multiple competing markets can isolate investor 
orders and that this ``may reduce competition on price, which is one of 
the most important benefits of greater interaction of buying and 
selling interest in an individual security.'' \77\
---------------------------------------------------------------------------

    \74\ Securities Exchange Act Release No. 42450 (Feb. 23, 2000), 
65 FR 10577 (Feb. 28, 2000) (``Market Fragmentation Concept 
Release'').
    \75\ Id. at 10580.
    \76\ Id. (emphasis in original).
    \77\ Id. (emphasis in original).
---------------------------------------------------------------------------

    In 2005, the Commission adopted Regulation NMS to consolidate the 
NMS rules it had previously adopted under section 11A and to include 
new rules designed to modernize and strengthen equity market 
structure.\78\ It again emphasized the importance of competition among 
orders to obtain the best prices for investors, stating that this basic 
principle was recognized in the legislative history of section 11A: 
``Investors must be assured that they are participants in a system 
which maximizes the opportunities for the most willing seller to meet 
the most willing buyer.'' \79\ The Commission summed up its approach to 
achieving an NMS as resisting suggestions that it adopt an approach 
focusing on a single form of competition that, while perhaps easier to 
administer, ``would forfeit the distinct, but equally vital, benefits 
associated with both competition among markets and competition among 
orders.'' \80\
---------------------------------------------------------------------------

    \78\ Securities Exchange Act Release No. 51808 (June 9, 2005), 
70 FR 37496 (June 29, 2005) (``Regulation NMS Adopting Release'').
    \79\ Id. at 37499 (quoting H.R. Rep. 94-123, 94th Cong., 1st 
Sess. 50 (1975)). The Commission further quoted this legislative 
history for section 11A of the Exchange Act to emphasize the 
importance of ensuring that investor orders are able to be executed 
in a market with the best price: ```market fragmentation becomes of 
increasing concern in the absence of mechanisms designed to assure 
that public investors are able to obtain the best price for 
securities regardless of the type or physical location of the market 
upon which his transaction may be executed.''' Id. at 37499 n.13.
    \80\ Id.
---------------------------------------------------------------------------

    Four categories of the Regulation NMS rules are particularly 
important in the context of Proposed Rule 615: (1) consolidated market 
data; (2) order handling and execution; (3) access to trading centers; 
and (4) disclosure of order routing practices and order execution 
statistics.
1. Rules Addressing Consolidated Market Data
    Several rules under Regulation NMS set forth requirements for 
consolidated market data, which, as defined in Rule 600(b)(19) and (21) 
of Regulation NMS, includes information concerning quotations and 
transactions in NMS stocks. 17 CFR 242.601 (``Rule 601'') provides for 
the dissemination of transaction information; 17 CFR 242.602 (``Rule 
602'') provides for the dissemination of quotation information; 17 CFR 
242.603 (``Rule 603'') requires, among other things, the national 
securities exchanges and national securities associations to act 
jointly for disseminating consolidated market data; and 17 CFR 242.608 
(``Rule 608'') addresses the joint-NMS plans that currently are 
responsible for operating the facilities for collecting and 
disseminating consolidated market data in NMS stocks.
    In 2020, the Commission adopted a new rule and amended existing 
rules to establish a new infrastructure for consolidated market data 
and to update and significantly expand the content of consolidated 
market data (``MDI Rules'').\81\ The MDI Rules have not yet been 
implemented and, as discussed below, given their unimplemented status, 
the description of Proposed Rule 615 in section IV below reflects the 
regulatory structure currently in place for consolidated market data. 
Section VII below addresses the economic effects of Proposed Rule 615, 
taking into account both the regulatory structure currently in place 
and the unimplemented MDI Rules. This section III.B.1 first will 
briefly summarize the currently implemented regulatory structure for 
consolidated market data. It then will discuss the status of the 
implementation of MDI Rules and how it would not affect the operation 
of and need for Proposed Rule 615.
---------------------------------------------------------------------------

    \81\ Securities Exchange Act Release No. 90610 (Dec. 9, 2020), 
86 FR 18596 (Apr. 9, 2021) (``MDI Adopting Release''); see also The 
Nasdaq Stock Market LLC, et al v. SEC, No. 21-1100 (D.C. Cir. May 
24, 2022) (upholding these Commission amendments to market data 
rules adopted in the MDI Adopting Release). The MDI Adopting Release 
provides a comprehensive discussion of the current arrangements for 
consolidated market data, as well as the adopted but unimplemented 
rules to change these current arrangements.
---------------------------------------------------------------------------

a. Current Regulatory Structure for Consolidated Market Data
    As stated in section II.B above, consolidated market data currently 
is collected and disseminated by the centralized SIPs. For quotation 
information, only the 16 exchanges that currently trade NMS stocks 
provide quotation information to the SIPs for dissemination in 
consolidated market data.\82\ FINRA has the only SRO display-only 
facility (the ADF) for quotations. No broker-dealer, however, currently 
uses the ADF to display quotations in NMS stocks in consolidated market 
data. For transaction information, all of the national securities 
exchanges that trade NMS stocks and FINRA provide real-time transaction 
information to the SIPs for dissemination in consolidated market data. 
Such information includes the symbol, price, and size of the 
transaction. A notable difference, however, between the transaction 
information provided by the national securities exchanges and the 
transaction information provided by FINRA is that the identity of the 
particular exchange that executed a trade is included in consolidated 
market data, while the

[[Page 139]]

identity of the particular FINRA member responsible for reporting a 
trade, such as a wholesaler or other type of broker-dealer, is not 
included in consolidated market data.\83\
---------------------------------------------------------------------------

    \82\ Currently, these national securities exchanges are: Cboe 
BYX Exchange, Inc. (``Cboe BYX''); Cboe BZX Exchange, Inc. (``Cboe 
BZX''); Cboe EDGA Exchange, Inc. (``Cboe EDGA''); Cboe EDGX 
Exchange, Inc. (``Cboe EDGX''); Investors Exchange LLC (``IEX''); 
Long-Term Stock Exchange, Inc. (``LTSE''); MEMX LLC (``MEMX''); MIAX 
Pearl, LLC (``MIAX PEARL''); Nasdaq BX, Inc. (``Nasdaq BX''); Nasdaq 
PHLX LLC (``Nasdaq Phlx''); The Nasdaq Stock Market LLC 
(``Nasdaq''); NYSE; NYSE American LLC (``NYSE American''); NYSE 
Arca, Inc. (``NYSE Arca''); NYSE Chicago, Inc. (``NYSE CHX''); and 
NYSE National, Inc. (``NYSE National''). The Commission approved 
rules proposed by BOX Exchange LLC (``BOX'') for the listing and 
trading of certain equity securities that would be NMS stocks on a 
facility of BOX known as BSTX LLC (``BSTX''), but BSTX is not yet 
operational. See Securities Exchange Act Release Nos. 94092 (Jan. 
27, 2022), 87 FR 5881 (Feb. 2, 2022) (SR-BOX-2021-06) (approving the 
trading of equity securities on the exchange through a facility of 
the exchange known as BSTX); 94278 (Feb. 17, 2022), 87 FR 10401 
(Feb. 24, 2022) (SR-BOX-2021-14) (approving the establishment of 
BSTX as a facility of BOX). BSTX cannot commence operations as a 
facility of BOX until, among other things, the BSTX Third Amended 
and Restated Limited Liability Company Agreement approved by the 
Commission as rules of BOX is adopted. Id. at 10407.
    \83\ Separate from the dissemination of real-time transaction 
information in consolidated market data, FINRA publishes statistics 
on trading volume at member firms, including ATSs and wholesalers, 
that are aggregated on a weekly basis. Publication of the aggregate 
volume statistics is delayed by two weeks for some NMS stocks and by 
four weeks for others. The statistics are available at https://www.finra.org/filing-reporting/otc-transparency.
---------------------------------------------------------------------------

b. Unimplemented MDI Rules
    When implemented, the MDI Rules will modify the current regulatory 
structure for consolidated market data in two respects. First, they 
will enhance the content of consolidated market data by defining three 
new data elements as ``core data'' \84\--(1) information about better 
priced quotations in higher priced stocks (to be implemented through a 
new definition of ``round lot'' \85\ and the inclusion of certain 
``odd-lot information''),\86\ (2) information about quotations that are 
outside of the best-priced quotations (to be implemented through a new 
``depth of book data'' definition),\87\ and (3) information about 
orders that are participating in auctions (to be implemented through a 
new definition of ``auction information'').\88\ As discussed below in 
section III.B.1.b.ii, the MDI Rules will enhance the content of 
consolidated market data, but the enhanced content of consolidated 
market data still will not include all of the quotation information 
currently available to market participants that purchase proprietary 
data feeds that are disseminated individually by national securities 
exchanges. Second, the MDI Rules will enhance the provision of 
consolidated market data by adopting a new decentralized model that 
replaces the SIPs with ``competing consolidators'' \89\ and ``self-
aggregators.'' \90\ Under the decentralized model, the relevant SROs 
(national securities exchanges that trade NMS stocks and FINRA) will be 
required to provide their data directly to multiple competing 
consolidators and self-aggregators rather than to a centralized 
SIP.\91\
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    \84\ The term ``core data'' is defined in section 600(b)(21) of 
Regulation NMS.
    \85\ The term ``round lot'' is defined in section 600(b)(82) of 
Regulation NMS.
    \86\ The term ``odd lot information'' is defined in section 
600(b)(59) of Regulation NMS.
    \87\ The term ``depth of book data'' is defined in section 
600(b)(26) of Regulation NMS.
    \88\ The term ``auction information'' is defined in section 
600(b)(5) of Regulation NMS.
    \89\ The term ``competing consolidator'' is defined in section 
600(b)(16) of Regulation NMS.
    \90\ The term ``self-aggregator'' is defined in section 
600(b)(83) of Regulation NMS.
    \91\ Rule 603(b) of Regulation NMS requires, among other things, 
every national securities exchange on which an NMS stock is traded 
and national securities association to make available to all 
competing consolidators and self-aggregators its information with 
respect to quotations for and transactions in NMS stocks.
---------------------------------------------------------------------------

i. Implementation of the MDI Rules
    In the MDI Adopting Release in 2020, the Commission outlined a 
phased transition plan for the implementation of the MDI Rules.\92\ The 
first step was the filing of amendments to the effective NMS market 
data plan(s) as required under Rule 614(e) of Regulation NMS.\93\ The 
Commission's approval of such amendments will be the starting point for 
the rest of the implementation schedule. While the Commission can 
approve NMS plan amendments within 90 days of the date of their 
publication in the Federal Register if the Commission finds them to be 
consistent with the standards set forth in Rule 608 of Regulation 
NMS,\94\ the Commission may, under rule 608(b)(2)(i), institute 
proceedings to determine whether to approve or disapprove proposed 
amendments, which proceedings must conclude within 180 days of notice 
publication of the proposed amendments but can be extended by an 
additional 120 days.\95\ Therefore, the maximum time permitted under 
rule 608 for Commission action is 300 days.
---------------------------------------------------------------------------

    \92\ MDI Adopting Release, supra note 81, 86 FR at 18698-18701.
    \93\ 17 CFR 242.614(e). The participants of the effective NMS 
market data plan(s) filed proposed amendments on Nov. 5, 2021, which 
were published for comment in the Federal Register. Securities 
Exchange Act Release Nos. 93615 (Nov. 19, 2021), 86 FR 67800 (Nov. 
29, 2021); 93625 (Nov. 19, 2021), 86 FR 67517 (Nov. 26, 2021); 93620 
(Nov. 19, 2021), 86 FR 67541 (Nov. 26, 2021); 93618 (Nov. 19, 2021), 
86 FR 67562 (Nov. 26, 2021) (``MDI Plan Amendments'').
    \94\ 17 CFR 242.608(b)(2).
    \95\ 17 CFR 242.608(b)(2). The Commission instituted proceedings 
to determine whether to approve or disapprove the MDI Plan 
Amendments. Securities Exchange Act Release Nos. 94310 (Feb. 24, 
2022), 87 FR 11748 (Mar. 2, 2022); 94309 (Feb. 24, 2022), 87 FR 
11763 (Mar. 2, 2022); 94308 (Feb. 24, 2022), 87 FR 11755 (Mar. 2, 
2022); 94307 (Feb. 24, 2022), 87 FR 11787 (Mar. 2, 2022).
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    After the Commission finds that the plan amendments required under 
Rule 614(e) are consistent with the Rule 608 standards and approves 
such amendments, the next step will be a 180-day development period, 
during which competing consolidators can register with the Commission. 
The development period is followed by a 90-day testing period.\96\ Once 
the testing period concludes, a 180-day parallel operation period will 
begin during which the SIPs and the decentralized consolidation model 
will operate in parallel.\97\
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    \96\ MDI Adopting Release, supra note 81, 86 FR at 18699-700.
    \97\ During the parallel operation period, the SIPs will 
continue to disseminate the data that they currently disseminate and 
competing consolidators will be permitted to offer consolidated 
market data products, including odd-lot information. Because the 
round lot definition will be implemented during a later phase 
consistent with the MDI Adopting Release, the SIPs and competing 
consolidators will collect, consolidate and disseminate NMS data 
that will be based on the current national securities exchange 
definitions of round lot. Id. at 18699-18701.
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    Within 90 days of the end of the parallel operation period, the 
operating committee(s) of the effective NMS plan(s), in consultation 
with relevant market participants, will make a recommendation to the 
Commission as to whether the SIPs should be decommissioned. The SIPs 
will only cease operations to the extent that the Commission approves 
an amendment pursuant to Rule 608 to the effective NMS plan(s) to 
effectuate such a cessation.\98\
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    \98\ Id. at 18701. Following the cessation of the operations of 
the SIPs, the changes necessary to implement the new round lot sizes 
will be tested for 90 days and then implemented. Id. The Commission 
also is proposing to accelerate implementation of the round lot 
sizes. See Securities Exchange Act Release No. 96494 (Dec. 14, 2022) 
(File No. S7-30-22) (Regulation NMS: Minimum Pricing Increments, 
Access Fees, and Transparency of Better Priced Orders) (``Minimum 
Pricing Increments Proposal''). The Commission encourages commenters 
to review that proposal to determine whether it might affect their 
comments on this proposing release.
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    The plan participants of two effective NMS plans filed the MDI Plan 
Amendments on November 5, 2021.\99\ On September 21, 2022, the 
Commission disapproved the proposed amendments.\100\ As a result, new 
proposed amendments pursuant to Rule 608 will need to be developed and 
filed for implementation of the MDI Rules.
---------------------------------------------------------------------------

    \99\ See supra note 93.
    \100\ Securities Exchange Act Release Nos. 95848 (Sept. 21, 
2022), 87 FR 58544 (Sept. 27, 2022); 95849 (Sept. 21, 2022), 87 FR 
58592 (Sept. 27, 2022); 95850 (Sept. 21, 2022), 87 FR 58560 (Sept. 
27, 2022); 95851 (Sept. 21, 2022), 87 FR 58613 (Sept. 27, 2022).
---------------------------------------------------------------------------

    The Commission does not believe that the subsequent implementation 
of the MDI Rules would substantially affect the operation of Proposed 
Rule 615. In the existing regulatory structure, the national securities 
exchanges and FINRA would be required to provide the SIPs with the 
necessary data (including the auction messages specified in Proposed 
Rule 615(c)(1)) and the quotation and transaction information specified 
in the proposed definition of ``open competition trading center'' in 
Proposed Rule 600(b)(64) of Regulation NMS). When the MDI Rules are 
subsequently implemented, a

[[Page 140]]

decentralized model would replace the SIPs, and the national securities 
exchanges and FINRA would provide this information directly to the 
competing consolidators and self-aggregators pursuant to Rule 603(b) of 
Regulation NMS.\101\
---------------------------------------------------------------------------

    \101\ The MDI Adopting Release states that the benefits of a 
decentralized model for consolidated market data are gains in 
efficiency and innovation for delivering consolidated market data, 
reduced content and latency differentials between consolidated 
market data and proprietary market data, and increased market 
resiliency. MDI Adopting Release, supra note 81, 86 FR at 18778. As 
discussed in section III.B.1.b.ii below, the Commission does not 
believe that these benefits of the MDI Rules substantially reduce 
the need to propose Rule 615 to address the goals stated herein.
---------------------------------------------------------------------------

    As noted above, auction information is to be included in the 
expanded content of consolidated market data that can be disseminated 
by competing consolidators under the MDI Rules. Market participants in 
the decentralized model will have a choice of whether to purchase 
consolidated market data products that include auction information, as 
well as any of the other components of consolidated market data.\102\ 
The fees that ultimately are approved for the different components of 
consolidated market data will affect the extent to which market 
participants choose to purchase auction information,\103\ but, as 
discussed above, the fees are not known at this time. Any fees for 
auction information will be required to be fair, reasonable, and not 
unreasonably discriminatory,\104\ and, as such, the Commission does not 
anticipate that such fees would be so high as to deter a substantial 
number of market participants interested in participating in auctions 
under Proposed Rule 615 from purchasing consolidated data products that 
include auction information.
---------------------------------------------------------------------------

    \102\ See, e.g., id. at 18751 (competing consolidators will not 
be required to offer consolidated market products that ``include all 
of the content of expanded core data'' and market participants ``may 
choose not to take in all of the new core data elements in every 
instance.'').
    \103\ See, e.g., id. at 18764 (because fees will depend on 
future action by the effective NMS system plans, the Commission 
``cannot be certain of the level of those fees or whether such fees 
would provide discounts'' for those end users who wish to receive 
subsets of consolidated market data).
    \104\ See, e.g., id. at 18773 (the fees for the data content 
underlying consolidated market data must be ``fair, reasonable and 
not unreasonably discriminatory'').
---------------------------------------------------------------------------

ii. Implementation of the MDI Rules Will Not Substantially Reduce the 
Need To Propose Rule 615 To Address the Goals Stated Herein
    As stated in section I above, Proposed Rule 615 is designed to 
promote order-by-order competition and thereby achieve two primary 
goals for the benefit of investors--(1) obtain better prices for the 
execution of the marketable orders of individual investors that 
currently are segmented at wholesalers, and (2) expand opportunities 
for such individual investor orders to meet directly with other 
investor orders without the participation of a dealer (such as a 
wholesaler). The MDI Rules would not substantially reduce the need to 
propose Rule 615 to address the goals stated herein.
    The MDI Rules will enhance the content of consolidated market data 
and thereby benefit those market participants that currently use SIP 
data and decide to purchase the enhanced elements of consolidated 
market data. As the MDI Adopting Release stated, however, 
implementation of the MDI Rules will not expand the content of data 
already available to sophisticated market participants that purchase 
the proprietary data feeds that are individually disseminated by the 
national securities exchanges.\105\ The Commission stated its 
understanding that ``approximately 50 to 100 firms purchase all of the 
proprietary [depth-of-book] feeds from the exchanges and do not rely on 
the SIP data for their trading.'' \106\ Moreover, these 50 to100 firms 
that currently use proprietary data feeds play a significant role in 
the current market structure.\107\ For example, the MDI Adopting 
Release stated that ``nearly all orders entered in the [NMS], including 
retail orders, touch a component (typically the order router of the 
executing broker) that uses proprietary data in order to reduce 
execution costs and improve execution quality.'' \108\ Furthermore, the 
Commission understands that the wholesalers, as six of the highest 
volume trading firms in the U.S. equity markets, currently pay for and 
use the proprietary data feeds. One wholesaler submitted a comment on 
the MDI Rules stating that it would be unable to remain competitive, 
even after the MDI Rules were implemented, without continuing to 
purchase proprietary data feeds.\109\
---------------------------------------------------------------------------

    \105\ See, e.g., id. at 18752 (``[a]lthough expanded core data 
will not contain all of the data contained in proprietary [depth of 
book] feeds, the Commission believes that it will contain data that 
will be useful for market participants''); id. at 18754 (the 
potentially lower cost of consolidated market data ``will come at 
the expense of losing the full set of data currently available via 
proprietary feeds,'' because the consolidated market data definition 
``does not include all data elements currently available via 
proprietary data feeds.'').
    \106\ Id. at 18728.
    \107\ See, e.g., id. at 18734 n. 1724 (Commission analysis 
showed that 91.6% of the message volume on exchanges in a sample 
week came from just 50 firms that use proprietary data feeds).
    \108\ Id. at 18734.
    \109\ Id. at 18793 n. 2386 (commenters agreed that ``switching 
to new consolidated market data would come with this expense of 
losing some data compared to the proprietary data feeds,'' with one 
stating that it would be ``unable to remain competitive even after 
the final amendments are in place without continuing to purchase 
proprietary data feeds.''); see also id. at 18795 (stating 
possibility that potential participants in automated market making 
and other latency sensitive trading businesses could not ``compete 
effectively without using the data that would remain exclusive to 
proprietary feeds'').
---------------------------------------------------------------------------

    Statements in the MDI Adopting Release addressing the benefits of 
the MDI Rules are consistent with a conclusion that the MDI Rules can 
benefit SIP data users that currently do not purchase the proprietary 
data feeds, but will not substantially reduce the need to propose Rule 
615 to address the goals stated herein. For example, the MDI Adopting 
Release stated that the ``odd-lot aggregation methodology'' of the MDI 
Rules ``would benefit market participants by promoting tighter spreads 
in all stocks, especially high priced ones.'' \110\ All of the odd lot 
quotations that will be aggregated, however, were already included in 
an order-by-order basis in the proprietary data feeds that the 
Commission understands the wholesalers use. As the MDI Adopting Release 
stated, the inclusion of odd-lot quote information in core data will 
improve transparency and ``reduce information asymmetry between market 
participants who already receive this information through proprietary 
[depth-of-book] feeds and market participants who choose to subscribe 
to this aspect of core data and previously did not receive this 
information.\111\
---------------------------------------------------------------------------

    \110\ MDI Adopting Release, supra note 81, 86 FR at 18615.
    \111\ Id. at 18753.
---------------------------------------------------------------------------

    In addition, the MDI Adopting Release states that ``because richer, 
more timely consolidated market data may enhance the ability of broker-
dealers to obtain the most favorable terms reasonably available under 
the circumstances, including the best reasonably available price and 
other factors, for their customer orders, broker-dealers should 
consider the availability of consolidated market data for purposes of 
evaluating best execution.'' \112\ The availability of additional 
quotation information in consolidated market data, however, is unlikely 
to affect the wholesalers' and retail brokers' evaluation of best 
execution because the Commission understands that wholesalers already 
would be expected, under FINRA

[[Page 141]]

guidance,\113\ to use a more complete set of quotation information 
(i.e., proprietary data feeds) than will be available in the expanded 
MDI data when evaluating best execution today, and retail brokers use 
wholesalers as executing brokers to obtain the best terms reasonably 
available.
---------------------------------------------------------------------------

    \112\ Id. at 18605 (footnotes omitted).
    \113\ The MDI Adopting Release referred to this FINRA guidance 
concerning the relevance of proprietary data feeds to a broker-
dealer's best execution efforts under FINRA rules. Id. at 18605 n. 
94 (quoting FINRA Notice to Members 15-46, Guidance on Best 
Execution Obligations in Equity, Options and Fixed Income Markets at 
3 n. 12 (Nov. 2015), available at https://www.finra.org/rules-guidance/notices/15-46 (``FINRA Notice 15-46''). The relevant 
portion of FINRA Notice 15-46 provides the following guidance on 
compliance with FINRA Rule 5310: ``[A] firm that regularly accesses 
proprietary data feeds, in addition to the consolidated SIP feed, 
for its proprietary trading, would be expected to also be using 
these data feeds to determine the best market under prevailing 
market conditions when handling customer orders to meet its best 
execution obligations.''
---------------------------------------------------------------------------

    The MDI Adopting Release also stated that ``as a result of the new 
round lot definition and the inclusion of odd-lot quotations in core 
data, retail investors will be able to see, and more readily access, 
better-priced quotations.'' \114\ Such information will, depending on 
the fees yet to be determined for such information (as stated above), 
enable those retail investors that purchase such information (or for 
those retail investors whose broker-dealers purchase it for them) to 
see and more readily access better-priced quotations than the current 
NBBO disseminated by the SIPs. To do so, retail investors will need to 
direct their own orders to the particular trading center that is 
displaying a better-priced quotation. As stated in the MDI Adopting 
Release, however, most retail investors rely on their broker-dealers 
for execution of their orders, and the additional quotation information 
will likely be used by more sophisticated retail investors that are 
able to process quotation information and self-direct their 
orders.\115\
---------------------------------------------------------------------------

    \114\ Id. at 18601.
    \115\ See, e.g., id. at 18753 (``the Commission believes, as 
suggested by commenters, that retail brokers may allow some 
sophisticated retail investors to directly utilize the expanded 
content of core data and realize the benefits discussed below'').
---------------------------------------------------------------------------

    The MDI Adopting Release also stated that ``through the addition of 
depth of book data and auction information in core data, the scope of 
NMS information will, to a greater extent, allow some market 
participants to trade in a more informed, competitive, and efficient 
manner.'' \116\ The phrase ``some market participants'' as discussed 
above, refers to those market participants that currently rely on SIP 
data for trading and not the proprietary data feeds. For the marketable 
orders of individual investors that currently are routed to 
wholesalers, the expansion of depth of book data in consolidated market 
data will not affect the information used for their execution because 
the Commission understands that wholesalers currently use proprietary 
data feeds for evaluating the best execution of their orders, which 
include more information than the expanded consolidated market data of 
the MDI Rules.
---------------------------------------------------------------------------

    \116\ Id. at 18601.
---------------------------------------------------------------------------

    An aspect of the MDI Rules that will affect the public evaluation 
of wholesaler order execution quality is smaller round lot sizes for 
quotations in NMS stocks with prices greater than $250 per share. These 
quotations determine the NBBO, and smaller round lot sizes can lead to 
narrower NBBO spreads. As discussed in section II above, the NBBO is a 
benchmark used to assess the market for an NMS stock, as well as to 
retrospectively assess the level of execution quality for an order. 
Accordingly, although implementation of the MDI Rules will not increase 
the information available to wholesalers in proprietary data feeds, 
changes in the round lot definition could narrow the NBBO as a public 
benchmark for the execution quality of the marketable orders of 
individual investors.
    The Commission does not believe, however, the smaller round lot 
sizes for NMS stocks with prices that exceed $250 per share will 
substantially affect the need for Proposed Rule 615 in terms of 
improved order execution quality for the marketable orders of 
individual investors. In particular, Proposed Rule 615 would encompass 
all NMS stocks, while the new round lot definition will encompass a 
much smaller range of NMS stocks and trading volume. In the MDI 
Adopting Release, for example, Table 3 and Table 4 set out the range of 
stocks and volume estimated to be affected by the new round lot 
definition. This information is summarized below:

----------------------------------------------------------------------------------------------------------------
                                                                     % Average       % Average
                 Round lot tier                    Number of NMS    daily share    daily dollar   % Instances of
                                                      stocks          volume          volume       smaller NBBO
----------------------------------------------------------------------------------------------------------------
$0-$250.........................................           9,023           97.12           71.93             n/a
$250.01-$1,000..................................             117            2.79           23.24            26.6
$1,000.01-$10,000...............................              16            0.09            4.82            47.7
$10,000+........................................               1            0.00            0.02             n/a
----------------------------------------------------------------------------------------------------------------

    First, as stated in the MDI Adopting Release, ``most stocks, 
approximately 98.5%, will remain unaffected'' by the new round lot 
definition.\117\ The 98.5% of unaffected NMS stocks with prices of $250 
or less represented 97.12% of total NMS stock share volume and 71.93% 
of total NMS stock dollar volume. Thus, the great majority of NMS 
stocks and their volume would not be affected by the narrowing of the 
NBBO benchmark that will result from the new round lot definition in 
the MDI Rules.\118\
---------------------------------------------------------------------------

    \117\ MDI Adopting Release, supra note 81, 86 FR at 18743 (Table 
4).
    \118\ Id. at 18753 (``Even though the new round lot definition 
would expand information on odd-lots that may be priced better than 
the current NBBO in some stocks, most stocks would not be affected 
by the new round lot definition.'') (footnotes omitted).
---------------------------------------------------------------------------

    Second, for the estimated 1.5% of high-priced NMS stocks (over 
$250) that will be affected by the reduction in round lot sizes, the 
Commission estimated that most of the dollar volume (23.24% of total 
NMS stock dollar volume) will occur within the $250.01-$1,000 tier, but 
in this tier, the NBBO spread will be reduced for only 26.6% of the 
trading day.\119\ For the remaining 73.4% of the trading day in these 
NMS stocks, the NBBO spread in these NMS stocks will be 
unaffected.\120\ Accordingly, even for the 1.5% of NMS stocks that will 
be affected by the revised round lot definition, NBBO spreads were 
estimated to remain unaffected for the most of the trading day.
---------------------------------------------------------------------------

    \119\ Id. at 18743 (Table 3).
    \120\ Id. (Table 4). For NMS stocks with prices of $1000.01 to 
$10,000, which represented 4.82% of trading volume, the Commission 
estimated that, taking into account the new round lot definition, 
the NBBO spread would be reduced to some extent for 47.7% of the 
trading day. Id. (Tables 3-4).
---------------------------------------------------------------------------

    This conclusion is consistent with statements in the MDI Adopting 
Release. For example, the MDI Adopting Release states that ``the size 
of the change in the NBBO spread, conditional

[[Page 142]]

on the NBBO being smaller, will also be substantial.'' \121\ The phrase 
``conditional on the NBBO being smaller'' \122\ means that the 
reduction in size of the half spread is limited to the 1.5% of stocks 
and their volume that, as discussed above, will be affected by the new 
odd lot definition. As a result, there will be a significant reduction 
in half spread of the NBBO for those stocks, but this reduction is 
conditional on the minority of the trading day for 1.5% of NMS stocks 
when NBBO spreads actually will be affected by the new round lot 
definition.
---------------------------------------------------------------------------

    \121\ Id. at 18744.
    \122\ Similarly, the following statement in the MDI Adopting 
Release is conditional on those instances where the NBBO spread is 
smaller: ``The Commission believes that, in particular, for 
securities with a significant amount of dollar trading volume, there 
will be significant changes to (tightening of) the quoted spread 
displayed under the new round lot definition.'' Id. at 18743.
---------------------------------------------------------------------------

    Third and finally, the NBBO as a benchmark for order execution 
quality does not, as discussed in section II.C above, reflect the 
availability of prices better than round lot displayed quotations. Such 
better prices include displayed odd lot quotations and undisplayed 
orders at national securities exchanges, as well as the availability of 
NBBO price improvement at wholesalers that is enabled by the low 
adverse selection costs of the marketable orders of individual 
investors. In the MDI Adopting Release, the Commission considered 
whether a narrowing of the NBBO spread would affect the order execution 
quality of retail investors.\123\ While it stated that a narrowing of 
the NBBO spread would, by definition, reduce the level of NBBO price 
improvement if execution prices for retail investors remained the 
same,\124\ the Commission stated that ``retail investors might or might 
not'' experience an improvement in execution quality, ``as measured by 
execution prices,'' from wholesalers.\125\ The Commission stated that a 
retail broker commented that retail investors would not receive better 
execution prices under the new round lot sizes because wholesalers 
already offer price improvement to retail investors that exceeds the 
potential improvements in the NBBO from the new round lot size.\126\ 
Another commenter stated that all investors, including retail 
investors, would experience reduced execution costs from a tighter NBBO 
no matter where the execution took place.\127\ The Commission concluded 
that it was ``uncertain'' whether the execution quality that retail 
investors receive from wholesalers would change if the NBBO spread 
narrows because the effect ``would depend on how the change in the NBBO 
compared to the current price improvement offered by wholesalers,'' as 
well as on ``changes in the degree of price improvement wholesalers 
will offer in stocks with tighter NBBOs, which is uncertain.'' \128\
---------------------------------------------------------------------------

    \123\ Id. at 18747 (section addressing ``effects of 
internalization on retail order flow'').
    \124\ Id. (``it may become more difficult for the retail 
execution business of wholesalers to provide price improvement and 
other execution quality metrics at levels similar to those provided 
under the 100 share round lot definition today'').
    \125\ Id.
    \126\ Id.
    \127\ Id.
    \128\ Id.
---------------------------------------------------------------------------

    As stated above, the Commission understands that wholesalers 
already would be expected, under FINRA guidance, to use proprietary 
data feeds, which contain a fuller set of quotations than will be 
included in the new round lot definition, when, among other things, 
evaluating best execution. Consequently, the new round lot definition 
will not change the quotation data used by wholesalers to determine 
prices for executing the orders of individual investors, but rather 
will change the NBBO as benchmark for analysis of order execution 
quality at wholesalers.\129\ Moreover, narrowing the NBBO as a 
benchmark for execution quality of wholesalers will affect all 
wholesalers equally. For example, if the average NBO for an NMS stock 
declined by two cents, the NBO as a benchmark would reduce the 
calculation of NBBO price improvement by two cents for all wholesalers 
and therefore leave them in the same relative position when compared to 
each other. The Commission does not believe that implementation of the 
new round lot definition in the MDI Rules will substantially affect the 
need for Proposed Rule 615 in terms of an improvement in the order 
execution quality of the marketable orders of individual investors.
---------------------------------------------------------------------------

    \129\ Id. at 18745 (``the new round lot definition will also 
improve transaction cost analysis and best execution analysis in 
higher priced stocks, which are benchmarked against the NBBO'').
---------------------------------------------------------------------------

2. Rules Addressing Order Handling and Execution
    Broker-dealers owe their customers a duty of best execution when 
handling and executing customer orders.\130\ This duty of best 
execution derives from common law agency principles and fiduciary 
obligations, and is incorporated in SRO rules and enforced through the 
antifraud provisions of the Federal securities laws.\131\ The 
Commission has stated that ``the duty of best execution generally 
requires broker-dealers to execute customers' trades at the most 
favorable terms reasonably available under the circumstances, i.e., at 
the best reasonably available price.'' \132\ Broker-dealers should 
periodically assess the quality of competing markets to assure that 
order flow is directed to the markets providing the most beneficial 
terms for their customer orders.\133\ In doing so, broker-dealers must 
take into account price improvement opportunities, and whether 
different markets may be more suitable for different types of orders or 
particular securities.\134\
---------------------------------------------------------------------------

    \130\ The Commission also is proposing a new rule addressing the 
best execution obligations of broker-dealers. See Securities 
Exchange Act Release No. 96496 (Dec. 14, 2022) (File No. S7-32-22) 
(Regulation Best Execution) (``Regulation Best Execution 
Proposal''). The Commission encourages commenters to review that 
proposal to determine whether it might affect their comments on this 
proposal.
    \131\ See MDI Adopting Release, supra note 81, 86 FR at 18605. 
In addition, FINRA has codified a duty of best execution in its 
rules, requiring a broker-dealer to ``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.'' FINRA 
Rule 5310, ``Best Execution and Interpositioning.''
    \132\ See MDI Adopting Release, supra note 81, 86 FR at 18605 
(quoting Regulation NMS Adopting Release, supra note 78, 70 FR at 
37538); see also Geman v. SEC, 334 F.3d 1183, 1186 (10th Cir. 2003) 
(quoting Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 
F.3d 266, 270 (3d Cir. 1998)) (``[T]he duty of best execution 
requires that a broker-dealer seek to obtain for its customer orders 
the most favorable terms reasonably available under the 
circumstances.''); and Kurz v. Fidelity Management & Research Co., 
556 F.3d 639, 640 (7th Cir. 2009) (describing the ``duty of best 
execution'' as ``getting the optimal combination of price, speed, 
and liquidity for a securities trade'').
    \133\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37538.
    \134\ See id.
---------------------------------------------------------------------------

    After the enactment of section 11A in 1975, which included as an 
objective the practicability of brokers' executing investor orders in 
the best market,\135\ the Commission adopted rules that prescribe 
requirements for the handling and execution of orders in NMS stocks in 
certain contexts. These rules were often designed, at least in part, to 
promote best execution of investors' orders. Three rules in Regulation 
NMS, discussed below, specifically address the handling and execution 
of orders in NMS stocks--17 CFR 242.604 (``Rule 604,'' also known as 
the ``Limit Order Display Rule''), 17 CFR 242.611 (``Rule 611,'' also 
known as the ``Order Protection Rule''), and 17 CFR 242.612 (``Rule 
612,'' also known as the ``Sub-Penny Rule'').
---------------------------------------------------------------------------

    \135\ Section 11A(a)(1)(C)(iv) of the Exchange Act; see also 
supra note 57 and accompanying text.

---------------------------------------------------------------------------

[[Page 143]]

a. Limit Order Display Rule
    The Limit Order Display Rule was originally adopted in 1996 as Rule 
11Ac1-4 and redesignated as Rule 604 with the adoption of Regulation 
NMS in 2005.\136\ It establishes minimum display requirements for 
customer limit orders that are not executed immediately, which, as 
discussed in section II.C above, can be referred to as ``non-
marketable'' limit orders. In contrast to marketable limit orders, non-
marketable limit orders cannot be executed immediately at the NBBO. 
Rule 604 requires specialists and OTC market makers to display the 
price and full size of customer limit orders when these orders 
represent buying and selling interest that is at a better price than a 
specialist's or OTC market maker's public quotation.\137\ Specialists 
and OTC market makers also must increase the size of their quotation 
for a particular security to reflect a limit order of greater than de 
minimis size when the limit order is priced equal to the specialist's 
or OTC market maker's disseminated quotation and that quotation is 
equal to the NBBO.\138\
---------------------------------------------------------------------------

    \136\ Regulation NMS Adopting Release, supra note 78, 70 FR at 
37570. Modifications included conforming terms to those adopted with 
Regulation NMS, such as changing references from ``covered 
security'' to ``NMS stock.'' Id. at 37572.
    \137\ Rule 604(b)(1) provides exceptions for, among other 
things, orders executed immediately upon receipt and odd lot orders.
    \138\ See Securities Exchange Act Release No. 37619A (Sep. 6, 
1996), 61 FR 48290, 48290 (Sep. 12, 1996) (Order Execution 
Obligations) (adopting final rules to require the display of 
customer limit orders and amending a rule governing publication of 
quotations) (``1996 Order Handling Release''); Rule 604(a).
---------------------------------------------------------------------------

    In adopting Rule 604, the Commission observed that the enhanced 
transparency of such orders would increase the likelihood that customer 
limit orders would be executed because contra-side market participants 
would have a more accurate picture of trading interest in a given 
security, and that the increased visibility would enable market 
participants to interact directly with limit orders, rather than rely 
on the participation of a dealer for execution.\139\ The Commission 
also stated that the display requirement (together with other 
amendments being made at the time) would help ensure the disclosure of 
customer and market maker buying and selling interest that had, prior 
to adoption of Rule 604, been hidden from many market 
participants.\140\
---------------------------------------------------------------------------

    \139\ See 1996 Order Handling Release, supra note 138, 61 FR at 
48293.
    \140\ Id. at 48292. The Commission also adopted amendments to 
require a market maker to publish quotations for any listed security 
when it is responsible for more than 1% of the aggregate trading 
volume for that security and to make publicly available any superior 
prices that a market maker privately quotes through certain 
electronic communications networks (``ECNs''). Id. at 48292. Also, 
at the same time it adopted the Limit Order Display Rule in 1996, 
the Commission deferred action on a proposed rule to address the 
handling of customer market orders of less than block size, referred 
to as the ``Price Improvement Rule.'' Id. at 48322. This proposed 
rule would have required specialists and OTC market makers to 
provide their customer market orders an opportunity for price 
improvement. The proposal included a non-exclusive safe harbor to 
satisfy the price improvement obligation that included exposing the 
customer order for 30 seconds at an improved price in a published 
quotation. The proposal sought to improve opportunities in auction 
and dealer markets for market orders to interact directly with other 
market orders and public limit orders, consistent with the goals of 
an NMS. Id.
---------------------------------------------------------------------------

b. Order Protection Rule
    In 2005, the Commission adopted the Order Protection Rule as Rule 
611 of Regulation NMS. Rule 611(a) applies to ``trading centers,'' 
which is defined broadly in Rule 600(b)(95) as a national securities 
exchange or national securities association that operates an SRO 
trading facility, an ATS, an exchange market maker, an OTC market 
maker, or any other broker or dealer that executes orders internally by 
trading as principal or crossing orders as agent.
    Rule 611(a)(1) requires trading centers to implement written 
policies and procedures reasonably designed to prevent trade-throughs--
the execution of an order at a price that is inferior to the price of a 
``protected quotation.'' \141\ To be protected, a quotation must be 
immediately and automatically accessible up to its full displayed size, 
must be the best-priced quotation (highest bid to buy and lowest offer 
to sell) in round lot sizes of an exchange or FINRA, and must be 
disseminated in consolidated market data.\142\ Accordingly, Rule 611 
provides for intermarket price protection only of an exchange's or 
FINRA's best bid and offer (``BBO''). It does not establish time 
priority among the same-priced quotations at different trading centers, 
nor does it protect ``depth-of-book'' quotations (quotations with 
prices outside an exchange's or FINRA's BBO) or odd lot quotations 
(quotations with sizes of less than one round lot).
---------------------------------------------------------------------------

    \141\ Rule 600(b)(70) defines ``protected bid'' or ``protected 
offer'' as a quotation in an NMS stock that: (i) is displayed by an 
automated trading center; (ii) is disseminated pursuant to an 
effective NMS plan; and (iii) is an automated quotation that is the 
best bid or best offer of a national securities exchange, or the 
best bid or best offer of a national securities association.
    \142\ Rule 600(b)(71) defines ``protected quotation'' as a 
protected bid or a protected offer. As stated in section II.B.1 
above, no FINRA member currently uses the ADF, its facility for 
displaying quotations, to disseminate quotations in consolidated 
market data. Today, only exchanges display protected quotations 
under Rule 611.
---------------------------------------------------------------------------

    In adopting Rule 611, the Commission stated that strong intermarket 
price protection offers greater assurance, on an order-by-order basis, 
to investors who submit market orders that their orders in fact will be 
executed at the best readily available prices, which can be difficult 
for investors, particularly individual investors, to monitor.\143\ One 
of the Commission's concerns when adopting Rule 611 was the 
internalization of individual investor orders by broker-dealers. The 
Commission observed that the great majority of internalized trades are 
the small trades of individual investors, and that, in 2003, nearly 1 
out of every 30 of these trades, of which there are millions, appears 
to have been executed at a price inferior to an automated and 
accessible quotation.\144\ The Commission stated that Nasdaq's data 
submitted in response to the Rule 611 proposal appeared to indicate a 
need for regulatory action to reinforce the fundamental principle of 
best price for all NMS stocks.\145\
---------------------------------------------------------------------------

    \143\ Regulation NMS Adopting Release, supra note 78, 70 FR at 
37505.
    \144\ Id. at 37508.
    \145\ Id. In response to the Commission's proposal to adopt 
Regulation NMS, The Nasdaq Stock Market, Inc. (n.k.a. Nasdaq) 
submitted data to show that the trade-through rates for Nasdaq 
stocks in some trading centers had dropped from the Fall of 2003 to 
the Fall of 2004, and that the reduction during that time was a 
result of fewer independently operating ECNs. The Commission stated 
``[i]t is unlikely that ECN consolidation could have caused such a 
major reduction in trade-through rates at securities dealers when 
they execute their customer orders internally.'' Id. (footnote 
omitted).
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c. Sub-Penny Rule
    Also in 2005, the Commission adopted the Sub-Penny Rule as Rule 612 
of Regulation NMS to establish a minimum pricing increment for NMS 
stocks. Specifically, paragraph (a) of Rule 612 provides that no 
national securities exchange, national securities association, ATS, 
vendor, or broker or dealer shall display, rank, or accept from any 
person a bid or offer, an order, or an indication of interest in any 
NMS stock priced in an increment smaller than $0.01 if that bid or 
offer, order, or indication of interest is priced equal to or greater 
than $1.00 per share.\146\ Rule 612 does not, however, prohibit a sub-
penny trade by a wholesaler or other internalizing broker-dealer, as 
long as the trade did not result from an impermissible sub-penny 
quotation,

[[Page 144]]

order, or indication of interest.\147\ For example, Rule 612 does not 
prevent wholesalers, after they receive an order from a broker, from 
choosing to execute that order in a transaction at a sub-penny price. 
This includes a trade executed at a price that is a sub-penny increment 
better than the best displayed quotation in consolidated market 
data.\148\ This sub-penny trading exception is not available to market 
participants on exchanges and ATSs,\149\ in contrast, because those 
trading centers operate by accepting, matching, and executing orders 
from market participants. Exchanges and ATSs, with limited exceptions, 
may only execute orders at a sub-penny price if the price is the NBBO 
midpoint.\150\ Also, exchanges with retail liquidity programs 
(``RLPs'') have been granted an exemption from Rule 612 to provide 
executions in tenths of a penny.\151\ The Commission has granted 
exemptions for these programs to promote competition between exchanges 
and OTC market makers (which, as discussed above, includes 
wholesalers).\152\ As discussed in section VII below, however, the 
great majority of marketable orders of individual investors continue to 
be routed first to wholesalers.
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    \146\ 17 CFR 242.612(a). Paragraph (b) of Rule 612 sets forth a 
minimum increment of $0.0001 for prices less than $1.00 per share.
    \147\ The Commission also is proposing to amend Rule 612 
regarding sub-penny trading. See Minimum Pricing Increments 
Proposal, supra note 98. The Commission encourages commenters to 
review that proposal to determine whether it might affect their 
comments on this proposing release.
    \148\ Regulation NMS Adopting Release, supra note 78, 70 FR at 
37556 (the Commission stated that sub-penny executions due to price 
improvement are generally beneficial to retail investors).
    \149\ The regulatory framework for ATSs is discussed in section 
III.B.3 below.
    \150\ Neither Rule 612 nor any other Commission rule or 
interpretation states that exchanges and ATSs may execute midpoint 
orders at a sub-penny amount (e.g., if the NBBO is 10.00-10.01 to 
execute at the mid-point price of 10.005). However, the Commission 
has stated that Rule 612 will not prohibit a sub-penny execution 
resulting from a midpoint or volume-weighted algorithm or from price 
improvement, so long as the execution did not result from an 
impermissible sub-penny order or quotation. Regulation NMS Adopting 
Release, supra note 78, 70 FR at 37556. Undisplayed ``floating'' 
midpoint orders (i.e., orders that re-price when the exchange BBO 
changes), for example, are permissible under Rule 612, and the 
Commission has approved numerous rule proposals by national 
securities exchanges for their use. See, e.g., Securities Exchange 
Act Release Nos. 89563 (Aug. 14, 2020), 85 FR 51510 (Aug. 20, 2020) 
(SR-PEARL-2020-03) (order approving proposed rule change by MIAX 
PEARL to establish rules governing the trading of equity securities, 
including a midpoint peg order type); and 78101 (June 17, 2016), 81 
FR 41142 (June 23, 2016) (File No. 10-222) (order approving IEX's 
registration as a national securities exchange, including the 
exchange's inclusion of a midpoint pegged order type in its 
rulebook).
    \151\ Several exchanges operate RLPs. These are programs for 
retail orders seeking liquidity that allow market participants to 
supply liquidity to such retail orders by submitting undisplayed 
orders priced at least $0.001 better than the exchange's protected 
best bid or offer. Each program results from a Commission approval 
of a proposed rule change made on Form 19b-4 combined with a 
conditional exemption, pursuant to section 36 of the Exchange Act, 
from Rule 612 to enable the exchange to accept and rank (but not 
display) the sub-penny orders. See, e.g., Securities Exchange Act 
Release Nos. 85160 (Feb. 15, 2019), 84 FR 5754 (Feb. 22, 2019) (SR-
NYSE-2018-28) (approving the NYSE RLP on a permanent basis and 
granting the exchange a limited exemption from the Sub-Penny Rule to 
operate the program); 86194 (June 25, 2019), 84 FR 31385 (July 1, 
2019) (SR-BX-2019-011) (approving Nasdaq BX's retail price 
improvement program on a permanent basis and granting the exchange a 
limited exemption from the Sub-Penny Rule to operate the program).
    \152\ Id. See also Securities Exchange Act Release No. 73702 
(Nov. 28, 2014), 79 FR 72049 (Dec. 4, 2014) (SR-BX-2014-048) 
(approving Nasdaq BX's (f/k/a NASDAQ OMX BX Inc.) establishment of 
its retail price improvement program on a pilot basis). In granting 
the original exemption from Rule 612, the Commission stated that the 
vast majority of ``marketable retail orders'' are internalized by 
OTC market makers, and that retail investors can benefit from such 
arrangements to the extent that OTC market makers offer them price 
improvement over the NBBO. This price improvement is typically 
offered in sub-penny amounts. The Commission explained that OTC 
market makers typically select a sub-penny price for a trade without 
quoting at that exact amount or accepting orders from retail 
customers seeking that exact price; and that exchanges--and exchange 
member firms that submit orders and quotations to exchanges--cannot 
compete for ``marketable retail order flow'' on the same basis, 
because it would be impractical for exchange electronic systems to 
generate sub-penny executions without exchange liquidity providers 
or retail brokerage firms having first submitted sub-penny orders or 
quotations, which the Sub-Penny Rule expressly prohibits. The 
Commission explained that the limited exemption granted to operate 
the retail price improvement program should promote competition 
between exchanges and OTC market makers in a manner reasonably 
designed to minimize the problems that the Commission identified 
when adopting the Sub-Penny Rule. Id. at 72053.
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3. Rules Addressing Access to Trading Centers
    As stated above, access to trading centers and their services is a 
critically important component of the NMS as a means to link trading 
centers together in a unified system. For example, the Regulation NMS 
rules addressing the display of quotations, the display of customer 
limit orders, and protection of customer orders cannot achieve their 
objectives if market participants do not have fair and efficient means 
to access those trading centers that display quotations and execute 
orders.\153\
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    \153\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37538. The rules discussed in this section address requirements 
that apply to trading centers providing access to their services. 
Exchange Act Rule 15c3-5, in contrast, addresses access, but in the 
context of risk management controls for broker-dealers with market 
access.
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    For purposes of assessing access requirements in today's NMS, 
trading centers for NMS stocks can be divided into three distinct 
regulatory categories: national securities exchanges, NMS Stock ATSs, 
and internalizing broker-dealers (including wholesalers). As discussed 
below, the statutory access requirements and the Commission's access 
rules currently apply to exchanges and ATSs, as well as to FINRA 
members that display quotations in consolidated market data through 
FINRA's ADF (of which there currently are none). In contrast, broker-
dealers that do not display quotations in consolidated market data and 
that trade outside of an ATS, such as wholesalers, are not subject to 
any fair access requirements under the Exchange Act or Commission 
rules. While subject to Commission and SRO rules for broker-dealers, 
internalizing broker-dealers are not prohibited from restricting access 
to their trading mechanisms and the investor orders that they 
internalize. An internalizing broker-dealer is not required, for 
example, to provide other market participants, including institutional 
investors and liquidity providers on exchanges, with any opportunity to 
compete to provide the best prices to the individual investor orders 
that the broker-dealer executes internally.
a. Access Rules for National Securities Exchanges
    As stated in section III.A above, the Exchange Act directly 
requires national securities exchanges to provide fair access in four 
contexts.\154\ Section 6(b)(2) specifies that exchange rules must allow 
``any'' broker-dealer registered with the Commission, unless subject to 
a specified disqualification, to become a member of the exchange. 
Section 6(b)(4) requires that exchange rules provide for the 
``equitable'' allocation of ``reasonable'' dues, fees, and other 
charges among members, issuers, and other persons using exchange 
facilities. Section 6(b)(5) broadly requires that exchange rules be 
designed, among other things, to remove impediments to and perfect the 
mechanism of a free and open market and an NMS, and that exchange rules 
are not designed to permit unfair discrimination between customers, 
issuers, brokers, or dealers. And section 6(b)(8) requires that 
exchange rules do not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act.
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    \154\ See supra notes 61-66 and accompanying text.
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    In addition to these broad statutory requirements for all national 
securities exchanges, the Commission has adopted 17 CFR 242.610 (``Rule 
610'') of Regulation NMS, which addresses access to displayed 
quotations.

[[Page 145]]

Specifically, Rule 610(a) prohibits any national securities exchange 
that operates an SRO trading facility \155\ from imposing unfairly 
discriminatory terms that would prevent or inhibit any person from 
obtaining efficient access through a member of the national securities 
exchange to the quotations in an NMS stock displayed through its SRO 
trading facility. This provision is designed to prohibit national 
securities exchanges from limiting ``piggyback access'' as a means by 
which non-members obtain access to exchange quotations through the 
services of an exchange member.\156\ Piggyback access, for example, 
allows non-members to obtain access to a national securities exchange's 
quotations without the need to obtain (and pay for) direct connectivity 
to the exchange.
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    \155\ Rule 600(b)(89) defines an ``SRO trading facility'' as a 
facility operated by or on behalf of a national securities exchange 
or a national securities association that executes orders in a 
security or presents orders to members for execution.
    \156\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37539. Rule 610(c) also limits the fees that can be charged for 
accessing an exchange's best-priced displayed quotations, and Rule 
610(d) addresses locking and crossing quotations.
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b. Access Rules for NMS Stock ATSs
    In 1998, the Commission initiated a new regulatory regime for ATSs 
with the adoption of Regulation ATS.\157\ An ATS is a trading system 
that falls within the definition of exchange in Section 3(b)(1) of the 
Exchange Act, but is exempted from such definition by Rule 3a1-1 under 
the Exchange Act if the trading system complies with Regulation 
ATS.\158\ For an NMS Stock ATS,\159\ Regulation ATS requires, among 
other things, that the NMS Stock ATS must register with the Commission 
as a broker-dealer and must file a Form ATS-N, a publicly available 
document that includes detailed disclosures about the NMS Stock ATS's 
operations.
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    \157\ See Regulation ATS Adopting Release, 63 FR 70844, supra 
note 27. ``Regulation ATS'' consists of 17 CFR 242.300 through 
242.304 (``Rule 300'' through ``Rule 304'' under the Exchange Act).
    \158\ 17 CFR 240.3a1-1.
    \159\ In 2018, the Commission amended Regulation ATS with 
respect to the requirements that apply to NMS Stock ATSs. Securities 
Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768 (Aug. 7, 
2018) (``ATS-N Adopting Release'').
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    In addition, Regulation ATS includes two separate types of access 
requirements that potentially can apply to an NMS Stock ATS. First, 
Rule 301(b)(3) imposes order display and execution access requirements 
on an NMS Stock ATS that displays orders to any person and had 5% or 
more of average daily volume reported in an NMS stock during four of 
the preceding six calendar months. Similar to Rule 610, the ``execution 
access'' requirement of Rule 301(b)(3) is limited to access to 
displayed quotations in consolidated market data. As stated above in 
section III.B.1, FINRA's ADF is a facility for broker-dealers 
(including ATSs) to display quotations in consolidated market data. 
Currently, no NMS Stock ATS that displays quotations uses the ADF to 
display its quotations in consolidated market data, and no NMS Stock 
ATS is subject to the execution access requirement of Rule 301(b)(3).
    Second, Rule 301(b)(5) imposes ``fair access'' requirements with 
respect to an NMS stock in which the NMS Stock ATS had 5% or more of 
the average daily volume reported during four of the preceding six 
calendar months. This fair access requirement requires an NMS Stock ATS 
(1) to establish written standards for granting access to trading on 
its systems, (2) to not unreasonably prohibit or limit any person in 
respect to access to services offered by such ATS by applying the 
written access standards in an unfair or discriminatory manner, (3) to 
maintain records of grants, denials, and limitations of access, and (4) 
to report the information required by Form ATS-R on grants, denials, 
and limitations of access. When it adopted Regulation ATS, the 
Commission emphasized that the fair access requirements of Rule 
301(b)(5) apply to a far broader range of services than the ``execution 
access'' requirements of Rule 301(b)(3), which are limited to access to 
quotations. Specifically, the Commission stated that although it was 
adopting rules to require ATSs with significant trading volume to 
publicly display their best bid and offer and provide equal access to 
those orders, direct participation in ATSs offers benefits in addition 
to execution against the best bid and offer. The Commission gave as an 
example that direct participants could enter limit orders into the 
system, rather than just execute against existing orders on a fill-or-
kill basis,\160\ and that direct participants could view all orders, 
not just the best bid or offer, which provides important information 
about the depth of interest in a particular security. The Commission 
further observed that some ATSs also allowed direct participants to 
enter ``reserve'' orders which hide the full size of an order from 
view. Because of these advantages to direct participants in an ATS, 
access to the best bid and offer through an SRO provided an incomplete 
substitute. Therefore, the Commission adopted rules to require most 
ATSs that have a significant percentage of overall trading volume in a 
particular security to comply with fair access standards.\161\
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    \160\ A fill-or-kill order is an order with instructions to 
cancel the order if it cannot be executed in its full size.
    \161\ Regulation ATS Adopting Release, supra note 27, 63 FR at 
70872 (footnote omitted).
---------------------------------------------------------------------------

    In sum, the fair access requirements of Rule 301(b)(5) encompass 
all of the trading services of an NMS Stock ATS. When adopting these 
requirements, the Commission emphasized that an ``alternative trading 
system must apply [fair access] standards fairly and is prohibited from 
unreasonably prohibiting or limiting any person with respect to trading 
in any equity securities.'' \162\
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    \162\ See id. at 70873.
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    Currently, only a single NMS Stock ATS discloses on its Form ATS-N 
that it is subject to these fair access requirements for securities 
that are available for trading on its platform.\163\ NMS Stock ATSs 
that are not subject to fair access requirements are not prohibited 
from unfairly discriminating with respect to the trading services they 
offer broker-dealers and other market participants.
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    \163\ See supra note 29 and accompanying text.
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c. Access Rules for ADF Participants
    As stated in section III.B.2 above, Rule 611 protects the best-
priced displayed quotations of FINRA members that use the ADF to 
display quotations in consolidated market data (though no FINRA member 
currently uses the ADF to do so). In adopting Rule 611, the Commission 
recognized that assuring fair and efficient access to FINRA members 
displaying quotations in the ADF would be essential, given that other 
market participants were required by rule to not trade through such 
quotations.\164\ The ADF falls within the definition of an ``SRO 
display-only facility'' in Rule 600(b)(88) because it merely displays 
the quotations of its participants and neither executes orders itself 
nor presents orders to ADF participants for execution. Instead, market 
participants must obtain their own means of access to ADF participants 
to trade with ADF protected quotations. Accordingly, the Commission 
adopted Rule 610(b) to promote such access to ADF participants.\165\ 
Rule 610(b)(2) imposes

[[Page 146]]

the same piggyback access requirement that applies to exchanges under 
Rule 610(a), thereby assuring that market participants can obtain 
indirect access to an ATS's or broker-dealer's quotations in the ADF.
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    \164\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37540 (discussing Rule 610, which addresses means of access to 
quotations). The Regulation NMS Adopting Release refers to National 
Association of Securities Dealers (``NASD'') members. NASD was the 
predecessor association to what today is FINRA.
    \165\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37502-03; see also id. at 37539-43.
---------------------------------------------------------------------------

    In addition, however, Rule 610(b)(1) imposes an access requirement 
that is particularly tailored to address concerns presented by FINRA 
members (including NMS Stock ATSs) displaying quotations in the ADF. 
Specifically, Rule 610(b)(1) requires that any trading center that 
displays quotations in NMS stocks through an SRO display-only facility 
must provide a level and cost of access to such quotations that is 
substantially equivalent to the level and cost of access to quotations 
displayed by SRO trading facilities (such as national securities 
exchanges). The Commission emphasized that the phrase ``level and cost 
of access'' would encompass both (1) the policies, procedures, and 
standards that govern access to quotations of the trading center, and 
(2) the connectivity through which market participants can obtain 
access and the cost of such connectivity.\166\ The Commission further 
stated that trading centers that choose to display quotations in an SRO 
display-only facility would be required to bear the responsibility of 
establishing the necessary connections to afford fair and efficient 
access to their quotations, and the nature and cost of these 
connections for market participants seeking to access the trading 
center's quotations would need to be substantially equivalent to the 
nature and cost of connections to SRO trading facilities.\167\
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    \166\ Regulation NMS Adopting Release, supra note 78, 70 FR at 
37549.
    \167\ Id.
---------------------------------------------------------------------------

    In addition to these heightened access requirements for FINRA 
members (including NMS Stock ATSs) that display quotations in the ADF, 
the Commission stated that FINRA, as the self-regulatory authority 
responsible for enforcing compliance by ADF participants with the 
requirements of the Exchange Act, would need to evaluate the 
connectivity of ADF participants to determine whether they meet the 
requirements of Rule 610(b)(1).\168\ The Commission also stated that 
the addition of a new ADF participant would constitute a material 
aspect of the operation of FINRA's facilities, and thus require the 
filing of a proposed rule change pursuant to section 19(b) of the 
Exchange Act that would offer an opportunity for public notice and 
comment.\169\
---------------------------------------------------------------------------

    \168\ Id.
    \169\ Id.
---------------------------------------------------------------------------

4. Disclosure of Order Routing Practices and Order Execution Statistics
    Rule 606 of Regulation NMS requires broker-dealers to publish 
quarterly reports on their routing of customer orders in NMS stocks, 
and Rule 605 of Regulation NMS requires market centers to make data 
files publicly available on a monthly basis that include a variety of 
statistics on their execution of orders in NMS stocks.\170\ When it 
originally adopted the two rules in 2000, the Commission stated that, 
by increasing the visibility of order execution and routing practices, 
the rules were ``intended to empower market forces with the means to 
achieve a more competitive and efficient [NMS] for public investors.'' 
\171\
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    \170\ The rules that the Commission originally adopted were 
designated as Rule 11Ac1-6 and Rule 11Ac1-5. The Commission re-
designated Rule 11Ac1-6 as Rule 606 and Rule 11Ac1-5 as Rule 605 
when it adopted Regulation NMS in 2005. Regulation NMS Adopting 
Release, supra note 78, 70 FR at 37538. The term ``market center,'' 
as defined in Rule 600(b)(46) of Regulation NMS, is somewhat 
narrower than trading center. Market centers include, for example, 
national securities exchanges, ATSs, and OTC market makers 
(including wholesalers), but do not include the broad catch-all 
category of trading center that encompasses any broker-dealer that 
executes orders internally as principal or agent.
    \171\ Securities Exchange Act Release No. 43590 (Nov. 17, 2000), 
65 FR 75414, 75427 (Dec. 1, 2000). The Commission enhanced the order 
routing disclosure requirements of Rule 606 when it amended the rule 
in 2018. Securities Exchange Act Release No. 84528 (Nov. 2, 2018), 
83 FR 58338 (Nov. 19, 2018).
---------------------------------------------------------------------------

    Rule 606 requires broker-dealers to disclose, among other things, 
the percentage of non-directed customer orders routed to different 
trading centers, as well as the financial inducements offered by these 
trading centers to attract order flow.\172\ Information must be 
provided for four types of orders--market orders, marketable limit 
orders, non-marketable limit orders, and other orders. The enhanced 
disclosures include a requirement to disclose net aggregate amounts of 
PFOF received from trading centers or amounts paid to them (such as 
transaction fees on exchanges), both as a total dollar amount and an 
amount per 100 shares.
---------------------------------------------------------------------------

    \172\ A ``non-directed order'' is defined in Rule 600(b)(56) of 
Regulation NMS to mean any order from a customer other than a 
directed order, and a ``directed order'' is defined in Rule 
600(b)(27) of Regulation NMS to mean an order from a customer that 
the customer specifically instructed the broker-dealer to route to a 
particular venue for execution.
---------------------------------------------------------------------------

    Rule 605 requires market centers to disclose standardized 
statistics about the execution quality they achieve for ``covered 
orders,'' as defined in Rule 600(b)(22) of Regulation NMS.\173\ In 
general, the definition of covered orders excludes order types for 
which the customer requests special handling that could detract from 
the goal of achieving comparable statistics for similar order types 
across different market centers. Unlike the Rule 606 disclosures, the 
Rule 605 data files are not designed to be human-readable and instead 
consist of a large volume of detailed statistics for each of the NMS 
stocks in which a market center receives covered orders. The data files 
are published in a format that is designed to be downloaded and 
processed with analysis software, such as a spreadsheet program, which 
then can be used to generate summary reports for viewing.
---------------------------------------------------------------------------

    \173\ Rule 605(a)(1). The Commission also is proposing to amend 
the order execution quality disclosures required by Rule 605. See 
Securities Exchange Act Release No. 96493 (Dec. 14, 2022) (File No. 
S7-29-22) (Disclosure of Order Execution Information). The 
Commission encourages commenters to review that proposal to 
determine whether it might affect their comments on this proposing 
release.
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IV. Description of Proposed Rule 615

A. Overview of Order Competition Requirement

    Paragraph (a) of Proposed Rule 615 sets forth the rule's core 
competition requirement. It states that a restricted competition 
trading center shall not execute a segmented order internally \174\ 
until after a broker-dealer has exposed such order to competition at a 
specified limit price in a qualified auction operated by an open 
competition trading center. As discussed below in this section IV: (1) 
segmented order, open competition trading center, restricted 
competition trading center, and qualified auction are new terms 
proposed to be defined in Rule 600(b) of Regulation NMS; (2) certain 
exceptions to the order competition requirement are set forth in 
paragraph (b) of Proposed Rule 615; (3) the requirements for a 
qualified auction are specified in paragraph (c) of Proposed Rule 615; 
and (4) the requirements with respect to segmented orders that would be 
imposed on open competition trading centers, originating brokers, all 
broker-dealers, and national securities exchanges are set forth in 
paragraphs (d) through (g) of Proposed Rule 615.
---------------------------------------------------------------------------

    \174\ The applicability of paragraph (a) of Proposed Rule 615 to 
``internally'' executed transactions is designed to accommodate the 
practice of some trading centers that both execute orders internally 
and obtain executions of orders externally by seeking liquidity at 
other trading centers. Cf. Rule 600(b)(95) of Regulation NMS 
(definition of ``trading center'' includes ``any other broker or 
dealer that executes orders internally by trading as principal or 
crossing orders as agent'').
---------------------------------------------------------------------------

    The term ``segmented order,'' as proposed to be defined in Proposed 
Rule 600(b)(91) of Regulation NMS, is a

[[Page 147]]

key term determining the scope of Proposed Rule 615 and is designed to 
encompass those orders of individual investors with relatively low 
adverse selection costs.\175\ In addition, paragraphs (b)(2) and (b)(3) 
of Proposed Rule 615 would provide exceptions for larger orders 
($200,000 or more) and orders that are executed at favorable prices for 
individual investors (orders executed at the NBBO midpoint or better); 
paragraph (b)(4) would provide an exception for limit orders that have 
a limit price that is equal to or more favorable for the segmented 
order than the NBBO midpoint (i.e., non-marketable segmented orders 
with a limit price that is equal to or lower than the midpoint for buy 
orders and equal to or higher than the NBBO midpoint for sell orders); 
and paragraph (b)(5) would provide an exception for orders sized less 
than one share and for the fractional component, if any, of a segmented 
order if no qualified auction is available to execute the fractional 
share or fractional component.\176\
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    \175\ As discussed in IV.B.1 below, the proposed definition of 
``segmented order'' would exclude very active traders whose orders 
are likely to impose a much higher level of adverse selection costs 
on liquidity providers than the less-active accounts that are more 
typical of individual investors. This is done by limiting the 
proposed definition of ``segmented orders'' to orders for accounts 
in which the average daily number of trades executed in NMS stocks 
was less than 40 in each of the six preceding calendar months.
    \176\ As discussed in section IV.B.1 below, the proposed 
definition of ``segmented order'' does not include a limit price 
component. Compliance with the order competition requirement for 
limit orders would vary depending on the relation of any limit price 
and an execution price to the NBBO. For example, segmented orders 
that have a limit price, or are executed at a price, equal to or 
more favorable for the segmented order than the NBBO midpoint or 
better, would have an exception under paragraph (b)(3) or (b)(4) of 
Proposed Rule 615(b). Segmented orders with a limit price beyond the 
NBBO midpoint (higher for segmented orders to buy and lower for 
segmented orders to sell) could still qualify for the exception in 
Proposed Rule 615(b)(3) if they were executed at the NBBO midpoint 
or better (i.e., such an order would have been executed at a more 
favorable price for the segmented order than its limit price).
---------------------------------------------------------------------------

    The purpose of the order competition requirement is to expose 
segmented orders to competition to provide the best prices on an order-
by-order basis and thereby minimize the transaction costs incurred by 
individual investors when they use marketable orders. Proposed Rule 615 
would allow flexibility for broker-dealers, wholesalers, and other 
restricted competition trading centers in how they comply with the 
rule. A broker-dealer could choose, subject to its best execution 
responsibilities as discussed further below, to route a segmented order 
directly to a qualified auction, to an open competition trading center, 
or to a national securities exchange. Alternatively, a broker-dealer 
could route such segmented order to another destination, such as a 
routing broker-dealer, a wholesaler, or other restricted competition 
trading center, which, in turn, could route the segmented order to a 
qualified auction, to an open competition trading center, or to a 
national securities exchange.
    For illustrative purposes, the following is one example of how a 
segmented order could be handled and executed in compliance with 
Proposed Rule 615. Assume that a broker-dealer routed a customer's 
segmented order to a wholesaler. The wholesaler that received the 
segmented order could select a price at which it was willing to execute 
a segmented order internally. Before executing internally, however, the 
wholesaler would be required to submit the segmented order to a 
qualified auction with a specified limit price. As discussed further 
below, the specified limit price is not a price at which the wholesaler 
is guaranteeing to execute (i.e., it is not a ``reserve'' price or a 
``backstop'' of the segmented order).\177\ Rather, the specified limit 
price would inform auction responders on how to price their orders and 
also, if the segmented order did not receive an execution in the 
qualified auction, would be the price (or better) at which the 
wholesaler or other restricted competition trading center subsequently 
could execute the segmented order as soon as reasonably possible.
---------------------------------------------------------------------------

    \177\ If the segmented order is not executed in the qualified 
auction, however, the wholesaler could choose to execute the 
segmented order internally at the specified limit price or better.
---------------------------------------------------------------------------

    The wholesaler that submitted the segmented order to a qualified 
auction would have a choice of whether to participate in the qualified 
auction by submitting its own auction response. The wholesaler could, 
for example, use its selected price for execution of the segmented 
order as the specified limit price in the qualified auction or, 
alternatively, the wholesaler could pick a less aggressive price as the 
specified limit price for the qualified auction and participate in the 
qualified auction by submitting an auction response with its more 
aggressive selected price. The open competition trading center 
operating the qualified auction would widely disseminate an auction 
message, which would include the specified limit price, in consolidated 
market data that would invite auction responses. During the qualified 
auction, the full range of market participants with the technological 
capability of responding to a fast (sub-second) auction, such as 
exchange market makers and institutional investors through their 
broker-dealers' smart order routers (``SORs''), would have an 
opportunity to compete to provide the best price for the segmented 
order by submitting auction responses. If all or part of the segmented 
order could be executed in the qualified auction at the specified limit 
price or better, the open competition trading center operating the 
qualified auction would execute the segmented order pursuant to the 
execution priority rules set by the open competition trading center 
running the qualified auction, consistent with the execution priority 
requirements of Proposed Rule 615(c)(5). If the segmented order did not 
receive a full execution in the qualified auction, the unexecuted 
order, or unexecuted portion thereof, would be canceled back to the 
wholesaler, who could, as soon as reasonably possible, execute the 
segmented order, or unexecuted portion thereof, internally at a price 
that was equal to or better for the segmented order than the specified 
limit price. As discussed below, the wholesaler would not, however, be 
required to execute the unexecuted segmented order or unexecuted 
portion of the segmented order at the specified limit price. Any 
unexecuted segmented order, or any unexecuted portion thereof, would 
continue to be subject to the order competition requirements of 
Proposed Rule 615(a).
    Given the absence of a ``reserve price'' or ``backstop'' 
requirement, a segmented order would not have certainty of an execution 
in a qualified auction at a price equal to the NBBO or better, but the 
marketable orders of individual investors orders today also do not have 
certainty of execution for orders routed to wholesalers. As shown in 
Table 7 in section VII.B.4 below, 1.67% of marketable order shares in 
NMS stocks (and 3.61% of marketable order shares in non-S&P 500 stocks) 
receive executions at prices that are outside the NBBO at the time the 
wholesaler received the order. This low percentage of orders executed 
outside the NBBO when routed to wholesalers is consistent with the low 
probability that the NBBO will move away from individual investor 
orders in the very short time period of a qualified auction.\178\ For 
the reasons discussed in section VII.C.2.b.i below, the Commission does 
not believe that

[[Page 148]]

segmented orders would have significantly greater risk of inferior 
execution prices under Proposed Rule 615 than currently provided by 
wholesalers, but the variability of execution prices could increase.
---------------------------------------------------------------------------

    \178\ See infra section VII.C.2.b.i (the fade probability of the 
NBBO prices goes from an average of 1.8% at 25 milliseconds after an 
internalized individual investor order, to 2.8% at 100 milliseconds, 
and to 4.6% at 300 milliseconds).
---------------------------------------------------------------------------

    In sum, Proposed Rule 615 would allow segmented orders to continue 
to be executed internally by a wholesaler or other restricted 
competition trading center, but not until after the execution price had 
been exposed to order-by-order competition in a fair and open qualified 
auction. In addition, qualified auctions would give the trading 
interest of other investors, particularly institutional investors, an 
opportunity to interact directly (without the participation of a 
dealer) with, and thus execute against, the marketable orders of 
individual investors. When investor orders are able to interact 
directly at a fully competitive price without the intermediation of a 
wholesaler or other dealer, two investors (both the buyer and the 
seller) are able to benefit mutually from a single trade, thereby 
promoting the NMS objective that, consistent with the objectives of 
economically efficient execution of securities transactions and the 
practicability of brokers executing investors' orders in the best 
market, investors' orders have an opportunity to be executed without 
the participation of a dealer.\179\
---------------------------------------------------------------------------

    \179\ See Section 11A(a)(1)(C)(v) of the Exchange Act.
---------------------------------------------------------------------------

    Proposed Rule 615 does not limit the types of broker-dealers that 
would be permitted to submit segmented orders for execution in a 
qualified auction. For example, a retail broker that currently routes 
segmented orders directly to a wholesaler could instead route such 
orders directly to a qualified auction with a specified limit price 
selected by the retail broker. Such specified limit price would need to 
be consistent with its best execution responsibilities and the terms of 
the order as set by the customer. If the segmented order did not 
receive an execution in the auction at the specified limit price, the 
retail broker could, as soon as reasonably possible, route the 
segmented order to a wholesaler with a representation that the 
segmented order had cleared (i.e., not received an execution in) a 
qualified auction at that price. The wholesaler then could, in 
compliance with Proposed Rule 615, as soon as reasonably possible, 
execute the segmented order internally at the specified limit price or 
better.
    If a segmented order did not receive an execution in a qualified 
auction (regardless of whether submitted to the auction by a retail 
broker, a wholesaler, or other broker-dealer), a wholesaler that 
received such order following the conclusion of a qualified auction 
would not be required by Proposed Rule 615 to execute the order 
internally. If a wholesaler chose not to execute the order internally 
following the conclusion of a qualified auction, the segmented order, 
as with all segmented orders, would need to be further handled in 
compliance with Proposed Rule 615. For example, (1) the wholesaler 
could return the order to the retail broker or other broker-dealer for 
further handling (such as resubmission to a qualified auction with a 
revised specified limit price); (2) the wholesaler itself could 
resubmit the segmented order to a qualified auction with a revised 
specified limit price; \180\ or (3) the wholesaler could route the 
order directly to an open competition trading center or national 
securities exchange (as national securities exchanges are not 
restricted competition trading centers subject to Proposed Rule 615(a)) 
for an immediate execution on its continuous order book. The decision 
on how to handle segmented orders that clear qualified auctions without 
executions also would be governed by the relevant best execution 
responsibilities of retail brokers and wholesalers.
---------------------------------------------------------------------------

    \180\ The revised specified limit price set by the wholesaler 
would have to be consistent with the terms of the order, such as the 
limit price set by the customer, if any, as well as with the 
wholesaler's best execution responsibilities.
---------------------------------------------------------------------------

    As indicated in the above example and subject to relevant best 
execution responsibilities, a broker-dealer responsible for obtaining 
the execution of a segmented order has the option of routing the order 
directly to the continuous order book \181\ of an open competition 
trading center or national securities exchange for execution, without 
exposure in a qualified auction. The definition of restricted 
competition trading center would exclude all open competition trading 
centers and all national securities exchanges.\182\ They would be 
excluded because both of these types of trading centers either are not 
permitted by the Exchange Act currently, or would not be permitted by 
Proposed Rule 615, to unfairly restrict access to their continuous 
order books.\183\ Consequently, segmented orders routed directly to the 
continuous order books of open competition trading centers and national 
securities exchanges would be subject to competition to provide the 
best prices on an order-by-order basis, and thus would not be 
isolated.\184\
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    \181\ See infra section IV.B.2 (discussing the proposed 
definition of ``continuous order book'').
    \182\ See Proposed Rule 600(b)(87) and discussion in section 
IV.B.3 below.
    \183\ Section III.B.2 above discusses the Exchange Act 
provisions that currently prohibit a national securities exchange 
from unfairly restricting access. Section IV.B.2 below discusses the 
proposed access requirement for any open competition trading center 
that is not a national securities exchange (i.e., an NMS Stock ATS). 
In many cases, an open competition trading center also would be a 
national securities exchange. As discussed in section IV.B.2 below, 
however, some national securities exchanges would not meet the 
definition of an open competition trading center.
    \184\ As discussed in sections IV.D and IV.G below, open 
competition trading centers and national securities exchanges would 
not be allowed to operate a mechanism limited, in whole or in part, 
to segmented orders, including RLPs, barring an exception from 
Proposed Rule 615. See infra notes 258, 259 and accompanying text.
---------------------------------------------------------------------------

    Importantly, however, all relevant broker-dealer best execution 
responsibilities would govern the extent to which segmented orders 
could be routed to an open competition trading center or national 
securities exchange without first clearing a qualified auction. As 
discussed in section III.B.2 above, best execution generally requires a 
broker-dealer to obtain the best terms reasonably available for 
customer orders. Because liquidity providers can profitably offer 
better prices to segmented orders of individual investors with low 
adverse selection costs as compared to the prices they can offer other 
types of order flow, trading mechanisms that offer such segmentation, 
as would a qualified auction, are quite likely to obtain better prices 
for segmented orders than other trading mechanisms, such as the 
continuous order book of an open competition trading center or national 
securities exchange, that commingle all types of order flow.\185\ A 
broker-dealer would need to consider the opportunity for better prices 
in its best execution analysis.
---------------------------------------------------------------------------

    \185\ See, e.g., infra section VII.C.1.b (discussing anticipated 
benefits of improved execution quality for retail orders exposed in 
qualified auctions).
---------------------------------------------------------------------------

    There may be market conditions when a best execution analysis could 
indicate that a broker-dealer should route segmented orders directly to 
the continuous order book of an open competition trading center or 
national securities exchange. One example could be a ``fast market''--
when publicly quoted prices are moving rapidly away when a broker-
dealer receives a marketable order (that is, rapidly up in price for 
orders to buy or rapidly down in price for orders to sell). In these 
market conditions, the broker-dealer could determine that best prices 
could be obtained by immediately attempting to execute segmented orders 
against the NBBO on an open competition trading center or national 
securities exchange,

[[Page 149]]

rather than first submitting segmented orders to qualified auctions 
when market conditions suggest that auction would be unlikely to 
generate better prices than the NBBO. Proposed Rule 615 is designed to 
give broker-dealers sufficient flexibility to obtain best execution of 
individual investor orders in the full range of market conditions.

B. Coverage of Proposed Rule 615

1. Definition of Segmented Order
    The term ``segmented order,'' as proposed to be defined in Proposed 
Rule 600(b)(91) \186\ of Regulation NMS, would have two parts. First, 
the order for an NMS stock must be for an account of a natural person, 
or an account held in legal form on behalf of a natural person or group 
of related family members. Second, for such an account, the average 
daily number of trades executed in NMS stocks must be less than 40 in 
each of the preceding six calendar months. The intent of the proposed 
definition is to encompass the marketable orders of individual 
investors with expected low adverse selection costs that retail brokers 
currently route to wholesalers for handling and execution. These orders 
already are segmented in practice.
---------------------------------------------------------------------------

    \186\ Rule 600(b) of Regulation NMS sets forth defined terms. 
Rule 600(b) would be amended to insert new defined terms used in 
Proposed Rule 615, and existing defined terms would be renumbered 
accordingly. Cross references to Rule 600(b) throughout the rules 
and regulations under the Exchange Act would also be amended to 
reflect the new numbering.
---------------------------------------------------------------------------

    The proposed definition's limitation to ``natural persons'' draws 
on the approach in existing rules designed to identify the orders of 
individual investors. For example, the definition of ``retail 
customer'' in the Commission's Regulation Best Interest (``Regulation 
BI'') is limited to a ``natural person.'' \187\ Moreover, several 
national securities exchanges operate programs for trading ``retail'' 
orders that are limited to accounts of natural persons or certain 
accounts on behalf of natural persons.\188\ The proposed definition of 
segmented order is closely related to these rules,\189\ as well as to 
FINRA's fee schedule for Nasdaq's Trade Repository Facility.\190\ 
Patterning the definition of segmented order on existing SRO rules is 
designed to leverage market knowledge and to facilitate compliance with 
Proposed Rule 615. This would help reduce the costs of compliance 
because broker-dealers would already be familiar with identifying 
orders as for the accounts of natural persons, or for related accounts, 
in these other contexts. In addition to the accounts of natural persons 
themselves, the definition would, again consistent with SRO rules, 
cover accounts held in legal form on behalf of natural persons or 
groups of related family members.
---------------------------------------------------------------------------

    \187\ 17 CFR 240.15l 1(b)(1) (defining ``retail customer'' as, 
among other things, as a natural person who receives a 
recommendation of any securities transaction from a broker-dealer 
and uses the recommendation primarily for personal, family, or 
household purposes). Proposed Rule 615 does not incorporate all of 
the definition of ``retail customer'' in Regulation BI, because that 
definition is limited to when there is a recommendation to a retail 
customer. Proposed Rule 615, in contrast, is designed to promote 
competition for individual investor orders, regardless of whether 
such investor is self-directed. Moreover, Proposed Rule 615 is 
focused on limiting the extent to which an account may generate 
orders with a high level of adverse selection costs. As discussed 
below, Proposed Rule 615 includes a trading activity threshold 
designed to address this policy concern. The definition of ``retail 
investor'' for purposes of 17 CFR 249.641 (``Form CRS'') 
(Relationship Summary for Brokers and Dealers Providing Services to 
Retail Investors) is also limited to ``natural persons'' and defines 
``retail investor'' as a natural person, or the legal representative 
of such natural person, who seeks to receive or receives services 
primarily for personal, family or household purposes. In the context 
of Form CRS, the term ``retail investor'' is used in connection with 
disclosures to prospective customers, and as in the context of 
Regulation BI, relates to the relationship between an investor and a 
financial professional. See Securities Exchange Act Release No. 
86031 (June 5, 2019), 84 FR 33318, 33345 (July 12, 2019) (adopting 
Regulation Best Interest: The Broker-Dealer Standard of Conduct) 
(''Regulation BI Adopting Release''). Because Proposed Rule 615 is 
intended to improve competition for individual investor orders, and 
is not related to the relationship between an investor and a 
financial professional, the Commission is not proposing to include 
the phrase ``primarily for personal, family, or household purposes'' 
in the definition of segmented order. For purposes of Proposed Rule 
615, limiting segmented orders to orders for the accounts of natural 
persons, and specifically those with less than 40 trades in NMS 
stocks in each of the preceding 6 months, is intended to address 
adverse selection costs and is not related to the purposes for which 
a natural persons may be seeking the services of a broker-dealer.
    \188\ See supra note 151 (generally describing exchange RLPs).
    \189\ E.g., IEX Rule 11.190(b)(15) (providing, among other 
things, that ``[a] Retail order must reflect trading interest of a 
natural person'' and that ``[a]n order from a retail customer can 
include orders submitted on behalf of accounts that are held in a 
corporate legal form--such as an Individual Retirement Account, 
Corporation, or a Limited Liability Company--that have been 
established for the benefit of an individual or group of related 
family members, provided that the order is submitted by an 
individual.''); and Nasdaq, Equity 7, section 118 (defining a 
``Designated Retail Order'' as originating from a ``natural person'' 
and explaining that ``[a]n order from a `natural person' can include 
orders on behalf of accounts that are held in a corporate legal 
form--such as an Individual Retirement Account, Corporation, or a 
Limited Liability Company--that has been established for the benefit 
of an individual or group of related family members, provided that 
the order is submitted by an individual'').
    \190\ FINRA Rule 7620A (defining a ``Retail Order'' as 
originating from a ``natural person'' and explaining that ``[a]n 
order from a `natural person' can include orders on behalf of 
accounts that are held in a corporate legal form, such as an 
Individual Retirement Account, Corporation, or a Limited Liability 
Corporation that has been established for the benefit of an 
individual or group of related family members, provided that the 
order is submitted by an individual'').
---------------------------------------------------------------------------

    For purposes of the definition of ``segmented order,'' a ``group of 
related family members'' would be defined broadly to include a group of 
natural persons with any of the following relationships: child, 
stepchild, grandchild, great grandchild, parent, stepparent, 
grandparent, great grandparent, domestic partner, spouse, sibling, 
stepbrother, stepsister, niece, nephew, aunt, uncle, mother-in-law, 
father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-
in-law, including adoptive and foster relationships; and any other 
natural person (other than a tenant or employee) sharing a household 
with any of the foregoing natural persons.\191\ This definition is 
designed to be broad so as not to restrict the types of arrangements 
that may be set up to benefit family groups, including individual 
retirement accounts, corporations, and limited liability companies for 
the benefit of related family members.\192\
---------------------------------------------------------------------------

    \191\ Proposed Rule 600(b)(91)(iii).
    \192\ Given the proposed broad definition of ``group of related 
family members'' in Proposed Rule 600(b)(91), an account held in 
legal form on behalf of a group of related family members could 
include some accounts with an extensive portfolio of NMS stocks. The 
second prong of the definition of segmented order, however, would 
exclude accounts with average daily trades of 40 or more and likely 
would exclude many accounts with large portfolios.
---------------------------------------------------------------------------

    The second part of the proposed definition of segmented orders 
focuses on the frequency of trading in an account. It would limit the 
average daily number of trades executed in NMS stocks in an account to 
less than 40 for each of the six preceding calendar months. This part 
of the proposed definition would exclude very active traders whose 
orders are likely to impose a much higher level of adverse selection 
costs on liquidity providers than the less-active accounts that are 
more typical of individual investors. For example, very active traders 
may use sophisticated trading tools, such as application programming 
interfaces (APIs) and computer algorithms, to submit their orders. 
These tools can enable highly active trading strategies that impose 
much higher adverse selection costs on liquidity providers than the 
manual placement of orders by a natural person. Rather than prohibiting 
any opportunity for investors to use potentially beneficial trading 
tools,\193\ however, the proposed

[[Page 150]]

definition specifies a maximum level of trading activity as a means to 
limit the level of adverse selection costs.
---------------------------------------------------------------------------

    \193\ Some SRO rules, for example, prohibit the use of any 
computerized technology for submitting retail orders. See, e.g., 
NYSE Rule 7.44(a)(3) (defining ``retail order'' in the context of 
NYSE's RLP to require that ``the order does not originate from a 
trading algorithm or any other computerized methodology'').
---------------------------------------------------------------------------

    The proposed level is supported by an analysis of the distribution 
of order activity across accounts reported to the Consolidated Audit 
Trail as being held for the benefit of an ``Individual Customer'' for 
the first six months of 2022.\194\ Across this period, slightly more 
than 99.9% of Individual Customer accounts originated, on an average 
daily basis, 40 or fewer orders associated with a trade. The median 
number of daily-average orders associated with a trade from accounts at 
or below this threshold was less than one.\195\ The median number of 
daily-average orders associated with a trade from accounts above this 
threshold was approximately 68.\196\ Accordingly, the threshold in the 
proposed rule is designed to capture the overwhelming majority of 
individual investor accounts that could benefit from strengthened 
competition for their orders, while excluding accounts that might 
impose a high level of adverse selection costs on liquidity providers. 
Including orders highly likely to impact short-term price changes in 
qualified auctions could detract from the quality of execution prices 
for segmented orders as a whole.\197\ Specifically, including orders 
with high adverse selection costs in qualified auctions would increase 
the overall level of adverse selection costs of the order flow 
submitted to qualified auctions. Because auction responders could not 
know in advance whether any particular order was likely to impose high 
adverse selection costs, they would need to adjust the prices of all 
their auction responses to reflect the higher level of adverse 
selection costs of qualified auction order flow as a whole.
---------------------------------------------------------------------------

    \194\ Analysis of Consolidated Audit Trail data for all orders 
originated from an account marked as held for the benefit of an 
Individual Customer, Jan. 1, 2022, through June 30, 2022. This 
analysis counted any order associated with one or more trades or 
fills in an order lifecycle. For the Consolidated Audit Trail, 
account type definitions are available in Appendix G to the CAT 
Reporting Technical Specifications for Industry Members (https://catnmsplan.com), for the field name ``accountHolderType.'' Account 
types represent the beneficial owner of the account for which an 
order was received or originated, or to which the shares or 
contracts are allocated. Possible types are: Institutional Customer, 
Employee, Foreign, Individual Customer, Market Making, Firm Agency 
Average Price, Other Proprietary, and Error. An Institutional 
Customer account is defined by FINRA Rule 4512(c) as a bank, 
investment adviser, or any other person with total assets of at 
least $50 million. An Individual Customer account means an account 
that does not meet the definition of an ``institution'' and is also 
not a proprietary account. Therefore, the CAT account type 
``Individual Customer'' includes natural persons as well as 
corporate entities that do not meet the definitions for other 
account types.
    \195\ Id.
    \196\ Id.
    \197\ In other contexts, national securities exchanges currently 
characterize certain types of orders according to the level of 
activity associated with a market participant's account. With 
respect to trading in listed options, several exchanges include the 
concept of ``Professional'' order, and these orders, which must be 
identified as such, are distinguished from other customer orders. 
For example, pursuant to Cboe Exchange, Inc. (``CBOE'') Rule 1.1, 
``Professional'' means any person or entity that is not a broker or 
dealer in securities and places more than 390 orders in listed 
options per day on average during a calendar month for its own 
beneficial account(s). Under CBOE's rules, all Professional orders 
are distinguished from other public customer orders (i.e., orders 
for persons other than broker-dealers), must be marked as such, and 
are handled by CBOE's trading platform in the same manner as broker-
dealer orders unless otherwise specified. See CBOE Rule 1.1. See 
also NYSE Arca Rule 1.1; Nasdaq, Options 1, section 1(a)(47); and 
BOX Rule 100(a)(52).
---------------------------------------------------------------------------

    The proposed definition of segmented order does not have a size 
limitation and therefore encompasses orders of all sizes, whether large 
or small. As discussed in section IV.B.5 below, however, the execution 
of large orders with sizes of $200,000 or more would be eligible for an 
exception from the order competition requirement of Proposed Rule 
615(a). Such orders would, however, remain segmented orders and, if 
consistent with a broker-dealer's best execution responsibilities, 
could be submitted for execution in a qualified auction.
    Orders with small sizes would also be included in the proposed 
definition of segmented orders and would be subject to the order 
competition requirement. These include both odd lot orders with a size 
of less than one round lot (generally less than 100 shares) and orders 
with a fractional share component (less than one share). As discussed 
further below, while orders for less than one share and orders for more 
than one share with a fractional share component would also fall within 
the proposed definition of a segmented order, Proposed Rule 615 would 
include an exception for orders for less than one share and for the 
fractional component of a segmented order, if there is no qualified 
auction available for such orders.\198\
---------------------------------------------------------------------------

    \198\ See infra section IV.B.5.
---------------------------------------------------------------------------

    Finally, the proposed definition of a segmented order does not 
include a limit price component. All segmented orders that are market 
orders would be subject to the order competition requirement prior to 
execution because, by definition, such orders are instructed to be 
executed immediately at the best available prices. For segmented orders 
that are limit orders, compliance with the order competition 
requirement would depend on the relation of the segmented order's limit 
price to the NBBO at the time it was received by the restricted 
competition trading center. For segmented orders with limit prices that 
are equal to or more favorable for the segmented order than the NBBO 
midpoint at the time of receipt (lower for buy orders and higher for 
sell orders), execution of the order would qualify for the exceptions 
from the order competition requirement in paragraphs (b)(3) and (b)(4) 
of Proposed Rule 615. Given the favorable price at which these non-
marketable orders would be executed, however, they often may be 
publicly displayed as a means to attract contra-side trading interest 
(as well as to comply with Rule 604 of Regulation NMS).
    Segmented orders with a limit price that is less favorable for the 
segmented order than the NBBO midpoint at the time of receipt (i.e., 
segmented buy orders with a limit price higher than the NBBO midpoint 
and segmented sell orders with a limit price lower than the NBBO 
midpoint) often would not be executed at the NBBO midpoint or better 
(and therefore would not qualify for the exceptions in paragraphs 
(b)(3) or (b)(4) of Proposed Rule 615(b)(3)). Those orders not executed 
at the NBBO midpoint or better necessarily will pay a half-spread of 
some amount on the transaction (i.e., orders executed beyond the NBBO 
midpoint, by definition, are paying a spread), even if it is less than 
the full NBBO half-spread. These include segmented orders that are 
marketable and a subset of non-marketable limit orders with limit 
prices that are beyond the NBBO midpoint but within the far-side NBBO 
(lower than the national best offer for segmented orders to buy and 
higher than the national best bid for segmented orders to sell) 
(hereinafter referred to as ``beyond-the-midpoint non-marketable limit 
orders''). A broker-dealer responsible for handling this subset of 
segmented orders that are non-marketable would need to determine how to 
achieve best execution of such orders. Under the limit order display 
requirements of Rule 604 of Regulation NMS, as discussed in section 
III.B.2.a above, such an order generally would need to be immediately 
displayed (which would narrow the NBBO spread) or immediately executed. 
To immediately execute the order, a restricted competition trading 
center would need to comply with the order competition requirement of 
Proposed Rule 615(a).

[[Page 151]]

2. Definition of Open Competition Trading Center
    The term ``open competition trading center,'' as proposed to be 
defined in Rule 600(b)(64), determines the scope of coverage of 
Proposed Rule 615 in two important respects. First, it identifies those 
trading centers that would be authorized to operate qualified auctions. 
Second, it conversely specifies those trading centers that would be 
subject to the order competition requirement of paragraph (a) of 
Proposed Rule 615 because a ``restricted competition trading center'' 
is defined as any trading center other than an open competition trading 
center or a national securities exchange.
    The proposed definition of open competition trading center is 
designed to address three primary concerns. First and foremost, trading 
centers that operate qualified auctions must offer sufficient access, 
transparency, and trading by a wide range of market participants to 
support the goal of fair competition in auctions to provide the best 
prices for investor orders. Second, the proposed definition of open 
competition trading center seeks to establish as level a regulatory 
playing field as possible regarding Proposed Rule 615 between the 
national securities exchanges and NMS Stock ATSs \199\ that are 
eligible to operate a qualified auction, while recognizing the distinct 
regulatory regimes for national securities exchanges under the Exchange 
Act and for NMS Stock ATSs under Regulation ATS.\200\ As described in 
section III.A above, section 11A(c)(1)(F) of the Exchange Act grants 
rulemaking authority to the Commission to assure equal regulation of 
all markets for NMS stocks, with equal regulation defined in section 
3(a)(36) to mean that no member of a class has a competitive advantage 
over any other member of a class resulting from a regulatory disparity 
that the Commission determines is unfair and not necessary or 
appropriate in furtherance of the purposes of the Exchange Act.\201\ 
Qualified auctions would be a new trading mechanism, mandated by rule 
in some contexts, that could be operated by both national securities 
exchanges and NMS Stock ATSs, and open competition trading centers 
would be a new class of market participants. Because national 
securities exchanges and NMS Stock ATSs operating as open competition 
trading centers would fall within the same class of market participant, 
and given the functional similarity between these two types of trading 
centers, neither type should have a competitive advantage in operating 
qualified auctions that is attributable to an unfair and unnecessary 
regulatory disparity.\202\ Third, the proposed definition of open 
competition trading center is designed to address a concern that 
qualified auctions, as a new mandatory mechanism for execution of 
segmented orders, should not further exacerbate the fragmentation of 
trading interest in NMS stocks among different trading centers that 
already characterizes the NMS. As discussed in section VII.B.1 below, 
trading centers for NMS stocks include 16 national securities 
exchanges, 32 NMS Stock ATSs,\203\ 6 wholesalers, and more than 230 
other broker-dealers. Allowing only national securities exchanges and 
NMS Stock ATSs that meet the prescribed transparency and volume 
thresholds to meet the proposed definition of open competition trading 
center is also designed to prevent additional complexity and 
connectivity costs to market participants arising from the introduction 
of qualified auctions. Such trading centers that meet the proposed 
definition are likely to have already attracted a wide variety of 
market participants with the established connectivity necessary to 
promote vigorous competition in qualified auctions.
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    \199\ The Commission is proposing that for purposes of 
Regulation NMS, which would include Proposed Rule 615, NMS Stock 
ATS, as would be defined in Proposed Rule 600(b)(59), will have the 
meaning provided in 17 CFR 242.300(k) (Rule 300(k) of Regulation 
ATS).
    \200\ A trading center that operates a qualified auction for 
segmented orders necessarily would fall within the definition of an 
exchange under section 3(a)(1) of the Exchange Act [15 U.S.C. 
78c(a)(1)], and 17 CFR 240.3b-16(a) (``Rule 3b-16(a)'') thereunder, 
because it would be bringing together the orders of multiple buyers 
and sellers using established non-discretionary methods (i.e., the 
qualified auction trading facility) under which such orders would 
interact and the buyers and sellers would agree upon terms of a 
trade. If a trading center falls within the definition of an 
exchange, it either must register as an exchange or comply with an 
exemption to such registration, such as the exemption for ATSs under 
Regulation ATS.
    \201\ 15 U.S.C. 78c(a)(36). In discussing equal regulation in 
the context of Exchange Act Section 11A(c)(1), the Commission stated 
that the legislative history of section 3(a)(36) emphasizes that 
equal regulation ``is a competitive concept intended to guide the 
Commission in its oversight and regulation of the trading markets 
and the conduct of the [s]ecurities industry.'' See Securities 
Exchange Act Release No. 42208 (Dec. 1999), 64 FR 70613, 70623 n.80 
(Dec. 17, 1999) at 70623 n.80 (Concept Release on Market Information 
Fees and Revenues) (quoting S. Rep. No. 94-75, 94th Cong., 1st Sess. 
7 (1975) at 94).
    \202\ The Commission has expressed, in other contexts, its 
belief that the regulatory differences between NMS Stock ATSs and 
national securities exchanges may create a competitive imbalance 
between two functionally similar trading centers, and sought to 
address those concerns by more closely aligning certain requirements 
for NMS Stock ATSs with those of national securities exchanges. See, 
e.g., ATS-N Adopting Release, supra note 159, 83 FR at 38775-76.
    \203\ As of Sept. 30, 2022, there were 32 NMS Stock ATSs that 
had filed an effective Form ATS-N with the Commission.
---------------------------------------------------------------------------

    Given the differing regulatory regimes for national securities 
exchanges and NMS Stock ATS that were described in section III above, 
the elements of the proposed definition of open competition trading 
center vary for national securities exchanges and NMS Stock ATSs. As 
discussed in section IV.D below, paragraph (d) of Proposed Rule 615 
would prohibit both national securities exchanges and NMS Stock ATSs 
from operating a qualified auction if they do not meet the elements of 
the definition of an open competition trading center.
a. National Securities Exchanges
    As discussed in section III.A above, the Exchange Act sets forth a 
comprehensive regulatory regime for national securities exchanges with 
a variety of requirements that address, among other things, access and 
competition. For example, national securities exchanges must allow any 
registered broker-dealer to become a member, subject to the limitations 
of section 6(c) of the Exchange Act, and their rules cannot impose a 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. The Commission has crafted the 
proposed definition of open competition trading center for national 
securities exchanges having taken into account that such exchanges 
already are subject by statute to this regulatory regime.
    The proposed definition of open competition trading center for 
national securities exchanges has four elements. First, such an 
exchange would be required to operate a trading facility that is an 
automated trading center and displays automated quotations that are 
disseminated in consolidated market data pursuant to Rule 603(b) of 
Regulation NMS. The terms ``automated trading center'' and ``automated 
quotation'' are defined in Rule 600(b)(8) and Rule 600(b)(7) of 
Regulation NMS. Each is an element of the definition of a ``protected 
bid or protected offer'' in Rule 600(b)(70), which are eligible for 
protection against trade-throughs pursuant to Rule 611 of Regulation 
NMS. Rule 603(b) provides for the dissemination of consolidated market 
data by SROs. This element of the proposed definition of an open 
competition trading center would help ensure transparency of quotations 
and fair and efficient access to such quotations. It is also designed 
to ensure that qualified auctions are held on lit

[[Page 152]]

trading centers, and that the requirements for open competition trading 
centers are consistent between national securities exchanges and NMS 
Stock ATSs. Also, incorporating the requirements for an automated 
trading center and automated quotations would help ensure that such 
exchange has the necessary technology to run qualified auctions 
efficiently.
    Second, a national securities exchange would be required to provide 
transaction reports identifying it as the venue of execution that are 
disseminated in consolidated market data pursuant to Rule 603(b). 
Identifying the venue of execution would help market participants 
assess where liquidity for an NMS stock can be found in the NMS, 
including for qualified auctions. Current arrangements for 
disseminating consolidated market data provide this execution venue 
information for exchanges, but not, as discussed below, for NMS Stock 
ATSs. This requirement is designed to provide a parallel requirement 
for national securities exchanges and NMS Stock ATSs operating 
qualified auctions, and require the identification of the venue of 
execution by rule for national securities exchanges operating as open 
competition trading centers.
    Third, a national securities exchange would be required to have had 
an average daily share volume of 1.0 percent or more of the aggregate 
average daily share volume for all NMS stocks as reported by an 
effective transaction reporting plan during at least four of the 
preceding six calendar months.\204\ The proposed 1.0 percent threshold 
across all NMS stocks, and not merely for a single NMS stock, is 
designed to help ensure that, prior to operating a qualified auction, 
the national securities exchange has attracted a wide range of market 
participants with connectivity to such exchange already in place that 
would be sufficient to support vigorous competition in qualified 
auctions to provide the best prices for segmented orders. As of 
September 30, 2022, 6 of the 16 national securities exchanges trading 
NMS stocks reported less than 1% of share volume in NMS stocks.\205\ 
Five of these (Nasdaq BX, Nasdaq Phlx, NYSE American, NYSE CHX, and 
NYSE National), however, were part of exchange groups with other 
national securities exchanges that reported more than 1% of share 
volume in NMS stocks. Any exchange that was below the 1% threshold, 
even if it were part of a group of exchanges with some exchanges that 
meet the threshold, would not meet the definition of an open 
competition trading center and could not operate a qualified auction. 
The one remaining national securities exchange that reported less than 
1% of share volume in NMS stocks was LTSE, with less than 0.01% of 
share volume in NMS stocks.
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    \204\ As discussed in section IV.B.2.b below, NMS Stock ATSs 
operating as open competition trading centers would be subject to 
the same volume threshold.
    \205\ See, e.g., Cboe, U.S. Historical Market Volume Data, 
available at https://cboe.com/us/equities/market_statistics/historical_market_volume/.
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    The 1% threshold also would impose a hurdle for a new entrant that 
wished to register as a national securities exchange to become an open 
competition trading center. In the absence of a minimum volume 
threshold, however, the introduction of qualified auctions as a new 
trading mechanism mandated by regulation could lead to the entry of 
multiple new national securities exchanges intended solely to operate 
qualified auctions, which could result in either (1) a substantial 
increase of connectivity costs and complexity for market participants 
to connect to every open competition trading center, or (2) a refusal 
of many market participants to incur such costs and complexity, which 
could detract from the level of competition to provide the best prices 
for segmented orders at open competition trading centers with 
relatively few connected market participants. The 1% threshold is 
designed to be low enough to help ensure that the core competition 
objective of Proposed Rule 615 is achieved through qualified auctions 
operated by multiple national securities exchanges, while being high 
enough to demonstrate that a national securities exchange has attracted 
a sufficient level of interest from market participants to avoid unduly 
exacerbating the already substantial level of fragmentation in NMS 
stocks.
    Given that only a small percentage of marketable orders of 
individual investors currently are routed to national securities 
exchanges, the competitive opportunity to operate qualified auctions 
that would enable their members and members' customers to interact with 
low-cost marketable order flow is likely to be an attractive new line 
of business. If, for example, a single national securities exchange 
began operating qualified auctions, it would have a monopoly on the 
business, which would be quite likely to attract multiple additional 
competitors. It therefore is likely that each of the three exchange 
groups associated with CBOE, Nasdaq and NYSE would select one of their 
national securities exchanges to operate qualified auctions,\206\ and 
the three non-group national securities exchanges that exceed the 1% 
threshold would operate qualified auctions as well.
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    \206\ See infra note 276 and accompanying text.
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    Fourth and finally, a national securities exchange would be 
required to operate pursuant to its own rules providing that such 
exchange will comply with the proposed requirements for qualified 
auctions in paragraph (c) of Proposed Rule 615. This element would help 
to ensure that the operation of a qualified auction would be fully 
described in the exchange's rules and that the exchange's compliance 
with those rules would be subject to the examination and enforcement 
tools in place for exchange rules.\207\ Market participants therefore 
would be able to reference the rules of a national securities exchange 
to determine whether it operates a qualified auction and the material 
terms of such auctions, including the hours of operation.
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    \207\ Also, because national securities exchanges must file with 
the Commission proposed changes to their rules, an exchange's 
adoption of rules for operating qualified auctions would be subject 
to public notice, comment, and Commission review, as well as 
Commission oversight. See 15 U.S.C. 78s(b).
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b. NMS Stock ATSs
    As discussed above in section III.B, NMS Stock ATSs are subject to 
a quite different set of statutory and regulatory requirements than 
national securities exchanges. The definition of open competition 
trading center for NMS Stock ATSs would reflect these differences and 
includes seven elements.
    First, an NMS Stock ATS would be required to display quotations 
through an SRO display-only facility (currently, the only such facility 
is FINRA's ADF) in compliance with Rule 610(b) of Regulation NMS.\208\ 
To add an NMS Stock ATS as a new ADF participant, FINRA would need to 
file a proposed rule change that, after an opportunity for public 
notice and comment and review by the Commission, became effective 
pursuant to section 19(b) of the Exchange Act and Rule 19b-4 
thereunder.\209\ An NMS Stock ATS, by displaying quotations in the ADF 
that

[[Page 153]]

FINRA provides to the SIPs, would have established an ability to 
disseminate information in consolidated market data, as would be 
required for auction messages under Proposed Rule 615(c)(1). In 
addition, as discussed in section III.B above, Rule 610(b) imposes 
heightened connectivity obligations on an NMS Stock ATS that displays 
quotations in the ADF, which would help assure that market participants 
have fair and efficient access to any NMS Stock ATS that wished to 
operate a qualified auction. This requirement is not needed for 
national securities exchanges, which, as discussed in section III.A 
above, are subject to a series of Exchange Act access requirements.
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    \208\ Under Rule 600(b)(88), the term ``SRO display-only 
facility'' means a facility operated by or on behalf of a national 
securities exchange or national securities association that displays 
quotations in a security, but does not execute orders against such 
quotations or present orders to members for execution. As discussed 
above in section III.B.3, FINRA's ADF is the only SRO display-only 
facility, but currently has no participating members.
    \209\ See Regulation NMS Adopting Release, supra note 78, 70 FR 
at 37543 (addition of ADF participant would constitute a change to a 
material aspect of FINRA's facilities that would require the filing 
of a proposed rule change).
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    Second, an NMS Stock ATS would be required to operate as an 
automated trading center and display automated quotations that are 
disseminated in consolidated market data pursuant to Rule 603(b) of 
Regulation NMS. This element matches an element of the proposed 
definition of open competition trading center for national securities 
exchanges and is proposed for the same reason.
    Third, an NMS Stock ATS would be required to identify the NMS Stock 
ATS as the venue of execution in transaction reports that are 
disseminated in consolidated market data pursuant to Rule 603(b). As 
discussed above, this element also would be required for national 
securities exchanges and is designed to help market participants assess 
where liquidity can be found in the NMS for a particular NMS stock. In 
contrast to the transaction reports of national securities exchanges, 
the transaction reports of off-exchange venues that FINRA currently 
provides for dissemination in consolidated market data do not identify 
the particular FINRA member (including both NMS Stock ATSs and broker-
dealers) that reported the trade. For NMS Stock ATSs that display 
quotations in the ADF and operate qualified auctions, full post-trade 
transparency concerning the identity of the NMS Stock ATS that executed 
trades, including the execution of segmented orders in qualified 
auctions, would be needed to promote fair competition among markets and 
the practicability of broker-dealers determining the best market for 
executing customer orders. For example, real-time dissemination of a 
transaction report indicating that an NMS Stock ATS had executed a 
segmented order in an NMS stock in a qualified auction could assist 
broker-dealers in identifying where to route segmented orders, as well 
as market participants in identifying where they could interact with 
segmented orders in qualified auctions. Accordingly, if Proposed Rule 
615 were adopted, an NMS Stock ATS would not be able to meet the 
definition of an open competition trading center unless the effective 
NMS plans for NMS stocks were conformed to provide for the collection 
and dissemination of an identification of the NMS Stock ATS as the 
venue of execution in its transaction reports.
    Fourth, an NMS Stock ATS would be required to permit any registered 
broker-dealer to become a subscriber,\210\ except those with statutory 
disqualifications or financial responsibility or operational capability 
concerns. This element parallels the Exchange Act section 6(b)(2) 
requirement that, subject to the provisions of section 6(c), a national 
securities exchange must permit any registered broker-dealer to become 
a member. It thereby would help ensure that all market participants 
seeking to trade on an NMS Stock ATS, whether they be broker-dealers 
trading proprietarily or investors trading through the services of a 
broker-dealer, would have access to the NMS Stock ATS in the same 
manner as they have access to national securities exchanges. An NMS 
Stock ATS could not, however, permit a registered broker-dealer subject 
to a statutory disqualification to become a subscriber.\211\ In 
contrast, national securities exchanges may, subject to Commission 
oversight, allow a registered broker-dealer with a statutory 
disqualification to become a member.\212\ The stricter standard for NMS 
Stock ATSs is appropriate because, as non-SROs, they are not subject to 
the same level of Commission oversight as national securities 
exchanges.\213\ For example, section 6(c)(2) of the Exchange Act 
provides that a national securities exchange must file notice with the 
Commission not less than thirty days prior to admitting any person to 
membership, if the exchange knew, or in the exercise of reasonable care 
should have known, that such person was subject to a statutory 
disqualification. An NMS Stock ATS is not subject to this notice 
requirement. An NMS Stock ATS could, however, pursuant to written 
policies and procedures, prohibit any registered broker-dealer from 
becoming a subscriber, or impose conditions upon such a subscriber, 
that did not meet specified standards of financial responsibility and 
operational capability.\214\ This ability to prohibit or limit 
subscribers is patterned on the ability of national securities 
exchanges under section 6(c)(3)(A) of the Exchange Act,\215\ which also 
permits a national securities exchange to deny or condition membership 
to a broker-dealer that has engaged, and is reasonably likely to engage 
again, in acts or practices inconsistent with just and equitable 
principles of trade. It would not be appropriate for NMS Stock ATSs, as 
non-SROs, to have this disciplinary authority over its subscribers.
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    \210\ NMS Stock ATSs generally have subscribers, unlike national 
securities exchanges with self-regulatory responsibilities for 
members. The proposed definition of ``subscriber'' in Rule 
600(b)(100) of Regulation NMS is a cross-reference to the definition 
of ``subscriber'' in 17 CFR 242.300(b) (Rule 300(b) of Regulation 
ATS). The Regulation ATS definition is being proposed to be used in 
this context to leverage industry experience and help minimize 
compliance costs.
    \211\ Proposed Rule 600(b)(64)(ii)(D)(1).
    \212\ Pursuant to Exchange Act section 6(c)(2), a national 
securities exchange may, and in cases in which the Commission, by 
order, directs as necessary or appropriate in the public interest or 
for the protection of investors shall, deny membership to any 
registered broker or dealer or natural person associated with a 
registered broker or dealer, and bar from becoming associated with a 
member any person, who is subject to a statutory disqualification. 
If a national securities exchange knowingly allows a registered 
broker-dealer with a statutory disqualification to become a member, 
or should have known in the exercise of reasonable care, section 
6(c)(2) further requires the national securities exchange to file 
notice with the Commission.
    \213\ See, e.g., Regulation ATS Adopting Release, 63 FR at 70858 
(discussing when ATS regulation may not be appropriate and stating 
that ``it may be necessary for the Commission's greater oversight 
authority over registered exchanges to apply'').
    \214\ An NMS Stock ATS must disclose on its Form ATS-N whether 
it can exclude, in whole or in part, any subscriber from the ATS's 
services, and if so, it must provide a summary of the conditions for 
excluding, in whole or in part, a subscriber from those services. 
Form ATS-N, Part III, Item 3.a. Consequently, an NMS Stock ATS would 
be required to disclose its policies and procedures for excluding a 
broker-dealer on its Form ATS-N. Additionally, an NMS Stock ATS that 
is subject to the fair access requirements of Rule 301(b)(5) (see 
supra section III.B.3), must also disclose a list of all persons 
granted, denied, or limited access to the ATS during the quarterly 
period covered by the report, and, among other things, the nature of 
any denial or limitation of access. Form ATS-R, Instruction 8 and 
Item 7.
    \215\ Pursuant to Exchange Act section 6(c)(3), a national 
securities exchange may deny membership to, or condition the 
membership of, a registered broker or dealer if such broker or 
dealer does not meet such standards of financial responsibility or 
operational capability or such broker or dealer or any natural 
person associated with such broker or dealer does not meet such 
standards of training, experience, and competence as are prescribed 
by the rules of the exchange.
---------------------------------------------------------------------------

    Fifth, an NMS Stock ATS would be required to provide equal access 
among all subscribers of the NMS Stock ATS and the registered broker-
dealer of the NMS Stock ATS to all services that are related to a 
qualified auction operated by the NMS Stock ATS under Proposed Rule 
615(c) and to any continuous order book operated by the NMS Stock ATS.

[[Page 154]]

This equal access element would require an NMS Stock ATS to provide 
access on the same terms and conditions among all subscribers and the 
registered broker-dealer of the NMS Stock ATS. It therefore would 
impose a more stringent standard on NMS Stock ATSs than the ``no unfair 
discrimination'' standard for national securities exchanges under 
section 6(b)(5) of the Exchange Act. The more stringent standard is 
designed to reflect the different statutory and regulatory regimes for 
NMS Stock ATSs and national securities exchanges and particularly to 
help achieve the goal of equal regulation, as defined in section 
3(b)(36) of the Exchange Act and described in section III.A above.
    For example, as discussed in section III above, national securities 
exchanges must comply with a variety of statutory requirements that are 
not applicable to NMS Stock ATSs. While they fall within the statutory 
definition of an exchange, NMS Stock ATSs have been exempted from 
compliance with the statutory requirements for registered national 
securities exchanges if they are registered as a broker-dealer and 
comply with Regulation ATS. Among other things, the rules for all 
national securities exchanges (1) must be designed affirmatively to 
remove impediments to and perfect the mechanism of a free and open 
market and an NMS; (2) must not be designed to permit unfair 
discrimination between customers, issuers, or broker-dealers; and (3) 
must not impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Exchange Act.\216\
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    \216\ As discussed above, in comparison, national securities 
exchanges are also required to file proposed rule changes to 
establish or modify trading services, which must be published for 
public comment. See supra notes 68-71, 207, and accompanying text.
---------------------------------------------------------------------------

    Each of the foregoing requirements promotes the objective of 
ensuring fair and efficient access to the trading services of national 
securities exchanges, which is essential for promoting fully 
competitive pricing in qualified auctions, but none applies to NMS 
Stock ATSs. While they must file amendments to Form ATS-N, the 
amendments are not published for public comment and do not require 
Commission approval prior to implementation. Moreover, the standards 
for access to NMS Stock ATSs are much more limited than those that 
apply to national securities exchanges.\217\ An NMS Stock ATS must 
comply with the fair access requirement of Rule 301(b)(5) only for a 
particular NMS stock in which it exceeds 5% of volume.\218\ As 
discussed above in sections II.B and III.B.3.b, only one NMS Stock ATS 
discloses on its Form ATS-N that it is subject to this fair access 
requirement for securities that are available for trading on its 
platform. Most importantly, in light of the core order competition 
requirement of Proposed Rule 615, Regulation ATS does not impose any 
requirement on NMS Stock ATSs that is equivalent to section 6(b)(8) of 
the Exchange Act, which prohibits national securities exchanges from 
imposing any burden on competition not necessary or appropriate in 
furtherance of the provisions of the Exchange Act.
---------------------------------------------------------------------------

    \217\ See, e.g., ATS-N Adopting Release, supra note 159, 83 FR 
at 38841.
    \218\ 17 CFR 242.301(b)(5)(i).
---------------------------------------------------------------------------

    Given that NMS Stock ATSs currently are subject to different 
requirements for promoting fair and efficient access to their trading 
services than are national securities exchange, the Commission believes 
an NMS Stock ATS should be required to meet a more stringent standard 
to help ensure equal regulation regarding Proposed Rule 615 and 
sufficient access and transparency for a wide range of market 
participants. Accordingly, an NMS Stock ATS would, if it wished to 
operate a qualified auction under Proposed Rule 615, be required to 
provide equal access to all trading services related to its qualified 
auctions, as well as to all trading services related to a continuous 
order book operated by the NMS Stock ATS. The extension of equal access 
to services related to a continuous order book is needed because, as 
discussed in section IV.C below, such a book would be required to be 
integrated with qualified auctions.\219\ The proposed equal access 
requirement is designed to help ensure a level playing field regarding 
Proposed Rule 615 for competition among national securities exchanges 
and NMS Stock ATSs and thereby promote the Exchange Act principle of 
equal regulation. Specifically, consistent with the NMS objective in 
section 11A(1)(C)(ii) of promoting fair competition among markets, 
neither type of trading center should have a significant regulatory 
advantage for operating qualified auctions that could drive volume in 
such auctions to either type, whether it be national securities 
exchanges or NMS Stock ATSs.
---------------------------------------------------------------------------

    \219\ As discussed below in section IV.C.5, a displayed order 
resting on the continuous order book would have priority over an 
equally-priced auction response, and an undisplayed order resting on 
the continuous order books would have priority if it provided a 
better price for a segmented orders than an auction response.
---------------------------------------------------------------------------

    Sixth, an NMS Stock ATS would be required to have had an average 
daily share volume of 1.0 percent or more of the aggregate average 
daily share volume for NMS stocks as reported by an effective 
transaction reporting plan during at least four of the preceding six 
calendar months.\220\ The methodology for this calculation would be the 
same as prescribed for application of the fair access requirements of 
ATSs by Rule 301(b)(5)(i)(A) of Regulation ATS, except that the 
numerator and denominator in the percent calculation is volume in all 
NMS stocks, rather than in any particular NMS stock. As with the fair 
access requirement, the proposed methodology is designed to encompass 
NMS Stock ATSs that have demonstrated a consistent historical level of 
volume. To promote fair competition and equal regulation, this proposed 
element is the same as that proposed for national securities exchanges 
and is proposed for the same primary reasons--(1) to help ensure that 
an NMS Stock ATS has attracted a wide range of market participants with 
connectivity already in place that would be sufficient to support 
vigorous competition in qualified auctions to provide the best prices 
for segmented orders; and (2) to avoid exacerbating the costs and 
complexity of fragmentation that already exists of trading interest in 
NMS stocks.
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    \220\ A 1% volume threshold in NMS stocks is also one of the 
thresholds used to determine whether an NMS Stock ATS is an SCI 
entity subject to the requirements of 17 CFR 242.1000 through 
242.1007 (``Regulation SCI''). See 17 CFR 242.1000 paragraph (1)(ii) 
of ``SCI alternative trading system or SCI ATS'' definition, and 
``SCI entity'' definition. Among other things, each SCI entity is 
required to comply with the capacity, integrity, resiliency, 
availability, and security requirements of Rule 1001 of Regulation 
SCI. In adopting a volume threshold for NMS Stock ATSs for purposes 
of Regulation SCI, the Commission recognized that certain ATSs play 
an important role in today's securities markets, and that higher 
volume ATSs collectively represent a significant source of liquidity 
for NMS stocks, with some ATSs having similar and, in some cases, 
greater trading volume than some national securities exchanges. See 
Securities Exchange Act Release No. (Nov. 19, 2014), 73639 79 FR 
72252, 72262 (Dec. 5, 2014) (adopting Regulation SCI and related 
amendments to Regulation ATS).
---------------------------------------------------------------------------

    Seventh and finally, an NMS Stock ATS would be required to operate 
pursuant to an effective Form ATS-N that sets forth the operations of 
the qualified auction and compliance by the NMS Stock ATS with the 
requirements of Proposed Rule 615(c) for a qualified auction, as well 
as with all of the other elements of the definition of open competition 
trading center for NMS Stock ATSs that are discussed above. This 
proposed disclosure element is designed to ensure that an NMS Stock ATS 
fully discloses material operating

[[Page 155]]

practices to the public on Form ATS-N, and that these operating 
practices are subject to the examination and enforcement tools in place 
for NMS Stock ATSs. Market participants therefore would be able to 
reference the Form ATS-N of an NMS Stock ATS to determine whether it 
operates a qualified auction and the material terms of such auctions, 
including the hours of operation.
3. Definition of Restricted Competition Trading Center
    The proposed definition of restricted competition trading center 
\221\ encompasses any trading center that is neither an open 
competition trading center nor a national securities exchange. Some 
national securities exchanges may not meet all of the elements of the 
proposed definition of an open competition trading center, such as the 
minimum 1% volume threshold. Nevertheless, all national securities 
exchanges, as well as open competition trading centers, would be 
excluded from the definition of restricted competition trading center 
because both these types of trading centers either are not permitted by 
the Exchange Act (in the case of all national securities exchanges) or 
would not be permitted by Proposed Rule 615(d)(1) and its incorporation 
of the proposed definition of an open competition trading center (in 
the case of NMS Stock ATSs) to unfairly restrict access to their 
platforms.
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    \221\ Proposed Rule 600(b)(87).
---------------------------------------------------------------------------

    Currently, no NMS Stock ATS displays quotations in the ADF. Unless 
this changes,\222\ no NMS Stock ATS would meet the proposed definition 
of an open competition trading center, and therefore all would be 
restricted competition trading centers. The three other types of 
broker-dealer trading centers are exchange market makers, OTC market 
makers (including wholesalers), and internalizing broker-dealers.\223\ 
These broker-dealers, as stated in section IV.B.2 above, could not 
operate a qualified auction without falling within the Exchange Act 
definition of exchange.\224\ Unless such a broker-dealer became an NMS 
Stock ATS and met all of the elements of the proposed definition of an 
open competition trading center, it would fall within the definition of 
a restricted competition trading center and would be subject to the 
order competition requirements of Proposed Rule 615(a).
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    \222\ See supra note 208.
    \223\ See supra section II.B.
    \224\ See supra note 200 and accompanying text.
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4. Definition of Originating Broker
    As discussed in section IV.E below, originating brokers would 
perform several vital functions under Proposed Rule 615, including 
making the original determination that an order falls within the 
definition of a segmented order and identifying the order as such when 
routed for execution. The proposed definition of originating broker 
\225\ reflects these important functions. It would cover any broker 
with responsibility for handling a customer account, including, but not 
limited to, opening and monitoring the customer account and accepting 
and transmitting orders for the customer account.\226\ As such and as 
discussed further below, there may be more than one originating broker 
for a particular customer account.
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    \225\ Proposed Rule 600(b)(69).
    \226\ The broker-dealer functions specifically enumerated in the 
proposed definition of originating broker are included in the list 
of responsibilities that FINRA requires its members to allocate for 
accounts that are carried on an omnibus or fully disclosed basis. 
See infra note 227. See also Securities Investment Advisers Act 
Release No. 5429 (June 5, 2019), 84 FR 33681 (July 12, 2019) 
(clarifying the scope of the broker-dealer exclusion from the 
definition of ``investment adviser'' under the Investment Advisers 
Act of 1940 for broker-dealers whose performance of advisory 
services is ``solely incidental'' to the conduct of its business as 
a broker-dealer and for which the broker-dealer ``receives no 
special compensation''); and Regulation BI Adopting Release, supra 
note 187, at 33358 (discussing disclosure requirements for broker-
dealers related to ``monitoring the performance of the retail 
customer's account'').
---------------------------------------------------------------------------

    The Commission understands that broker business practices can vary 
widely in terms of how customer accounts are handled. Some brokers may 
perform this entire function internally, while others may work with 
additional brokers to handle customer orders. A single broker that is 
solely responsible for the handling of a customer account would be an 
originating broker. To the extent that multiple brokers perform 
different functions for a customer account (sometimes referred to as 
``introducing brokers,'' ``carrying brokers,'' or ``clearing 
brokers''), each such broker would be an originating broker. In 
addition, as discussed further in section IV.E below, different types 
of brokers enter into agreements with one another to allocate certain 
responsibilities with respect to their handling of customer 
accounts.\227\ As discussed in section IV.C.1 below, paragraph 
(c)(1)(ii) of Proposed Rule 615 specifies that, if multiple brokers for 
a segmented order fall within the proposed definition of originating 
broker, the broker responsible for approving the opening of accounts 
for customers (commonly performed by an introducing broker) would be 
required to be identified in auction messages under Proposed Rule 
615(c)(1).
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    \227\ FINRA Rule 4311 addresses the allocation of 
responsibilities between members for accounts that are carried on an 
omnibus or fully disclosed basis. FINRA Rule 4311(c)(1) specifies 
the minimum requirements for carrying agreements in which accounts 
are carried on a fully disclosed basis. FINRA Rule 4311(c)(1) 
(``Each carrying agreement in which accounts are to be carried on a 
fully disclosed basis shall specify the responsibilities of each 
party to the agreement, including at a minimum the allocation of the 
responsibilities set forth in paragraphs (c)(1)(A) through (I) and 
(c)(2) of this Rule.''); FINRA Rules 4311(c)(1)(A) through (I) 
(``(A) Opening and approving accounts. (B) Acceptance of orders. (C) 
Transmission of orders for execution. (D) Execution of orders. (E) 
Extension of credit. (F) Receipt and delivery of funds and 
securities. (G) Preparation and transmission of confirmations. (H) 
Maintenance of books and records. (I) Monitoring of accounts.''); 
FINRA Rule 4311(c)(2) (prescribing the requirements for how each 
carrying agreement in which accounts are to be carried on a fully 
disclosed basis must allocate responsibility for the safeguarding of 
funds and securities, and the preparing and transmitting of 
statements of accounts to customers). FINRA Rules are available at 
https://www.finra.org/rules-guidance/rulebooks/finra-rules.
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5. Exceptions
    Paragraph (b) of Proposed Rule 615 sets forth five exceptions from 
the order competition requirement of paragraph (a). The first exception 
is for a segmented order that is received and executed by a restricted 
competition trading center during a time period when no open 
competition trading center is operating a qualified auction for the 
segmented order. This exception would be necessary to enable segmented 
orders to trade during such a time period, since compliance with 
Proposed Rule 615 would otherwise be impossible if no qualified auction 
were available. Proposed Rule 615 does not specify any particular time 
period during which an open competition trading center must operate a 
qualified auction. Given, however, the requirement in paragraph (c)(3) 
of Proposed Rule 615 that auction messages must be provided for 
dissemination in consolidated market data,\228\ a qualified auction 
could not operate at any time when the facilities for disseminating 
consolidated market data were not operating. As discussed in section 
III.B above, such facilities currently are operated by the SIPs. The 
current SIP hours of operation are from 4 a.m. to 8 p.m. eastern time 
on trading days for the U.S. equity markets. While the trade-through 
restrictions of Rule 611 of Regulation NMS apply only

[[Page 156]]

during regular trading hours of 9:30 a.m. to 4:00 p.m. eastern 
time,\229\ the order competition requirement of Proposed Rule 615(a) is 
needed for additional hours given the enhanced risks for individual 
investors. Unlike Rule 611, Proposed Rule 615 is narrowly targeted on 
protecting the interests of individual investors and the risks they 
face when using marketable orders to trade in NMS stocks. These include 
the risks of lower liquidity and wider spreads that are particularly 
significant in after-hours trading and that qualified auctions could 
address effectively.\230\
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    \228\ The phrase ``provided for dissemination in consolidated 
market data'' reflects that, while national securities exchanges 
send quotation and transaction information directly to the SIPs, NMS 
Stock ATSs would provide such information to the ADF operated by 
FINRA, which would send the information to the SIPs.
    \229\ See Rule 600(b)(94) of Regulation NMS (limiting definition 
of trade-through to regular trading hours); Rule 600(b)(77) of 
Regulation NMS (defining regular trading hours).
    \230\ See FINRA Rule 2265 (Extended Hours Trading Risk 
Disclosure) (requiring disclosure to customers of the risks of 
extended hours trading, including the risks of lower liquidity and 
wider spreads).
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    The second exception from Proposed Rule 615 would be for large 
orders with a market value of at least $200,000 calculated with 
reference to the NBBO midpoint when the order is received by a 
restricted competition trading center. This exception is designed to 
address the heightened liquidity need of large orders that often may be 
more appropriately addressed outside of a qualified auction. The 
$200,000 threshold is the same dollar amount as in other Regulation NMS 
rules to exclude orders or trades that are so large as to warrant 
different treatment than smaller orders.\231\ A specific methodology 
for calculating market value (NBBO midpoint at time of order receipt) 
is prescribed to provide additional clarity for restricted competition 
trading centers on complying with Proposed Rule 615 that should be 
readily implementable when qualified auctions are operating. The 
$200,000 threshold is designed to except orders that may be difficult 
to execute efficiently in qualified auctions at prices that generally 
would be at or within the NBBO. While these large orders are eligible 
for an exception, they still would meet the definition of a ``segmented 
order'' and could be routed for execution in a qualified auction if the 
broker-dealer handling the order determines that such routing would 
promote best execution of the segmented order.
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    \231\ See, e.g., Rule 604(b)(4) of Regulation NMS (providing an 
exception for orders of block size from required limit order 
display) and Rule 600(b)(12) of Regulation NMS (defining ``block 
size'' as, in part, an order for a quantity of stock having a market 
value of at least $200,000).
---------------------------------------------------------------------------

    The third exception, provided by Proposed Rule 615(b)(3), is for 
segmented orders that are executed by a restricted competition trading 
center at a price that is equal to the NBBO midpoint or more favorable 
for the segmented order (i.e., the NBBO midpoint or lower for segmented 
orders to buy or the NBBO midpoint or higher for segmented orders to 
sell), as determined with reference to the NBBO at the time the 
segmented order was received by the restricted competition trading 
center. For trades at these prices, an investor would either be paying 
no spread (with a price at the NBBO midpoint) or earning a spread (with 
a buy order executed at a price lower than the NBBO midpoint and a sell 
order executed at a price higher than the NBBO midpoint). In such 
circumstances, the submission of a segmented order to a qualified 
auction would not be necessary to obtain a competitive price for such 
order.
    The fourth exception, provided by Proposed Rule 615(b)(4), is for 
segmented orders that are limit orders with a limit price selected by 
the customer that is equal to or more favorable for the segmented order 
than the midpoint of the national best bid and national best offer when 
the segmented order is received by the restricted competition trading 
center. This exception is designed so that when the customer has 
selected a limit price that will result in a favorable execution, 
submission of the segmented order to a qualified auction would not be 
necessary to obtain a competitive price. This exception would work in 
conjunction with the third exception for executions of segmented orders 
at a price equal to the midpoint or more favorable to the segmented 
order. As discussed above in section IV.B.1, this exception would not 
apply to beyond-the-midpoint non-marketable limit orders.
    Finally, the fifth exception, provided by Proposed Rule 615(b)(5), 
is for the fractional share component of a segmented order. Fractional 
share orders typically are submitted by individual investors in dollar 
sizes rather than share sizes, and often are referred to as ``cash 
orders.'' If the dollar size of an order is less than the share price 
for an NMS stock (such as a $200 order for a $450 stock), the size of 
the order will be less than one share. If the dollar size of the order 
is greater than the share price for an NMS stock (such as a $1000 order 
for a $450 stock), the size of the order will be greater than one share 
and have a fractional share component. While these orders for less than 
one share and orders for more than one share or with a fractional share 
component would fall within the definition of segmented order, they 
raise practical difficulties for executing in qualified auctions 
because currently, most trading centers, including all national 
securities exchanges, only accept orders with whole share sizes and do 
not accept orders for less than one share or orders with a fractional 
share component. The Commission is concerned that applying the 
requirements of Proposed Rule 615 to orders for less than one share and 
orders for more than one share with a fractional component would 
interfere with broker-dealers willingness to accept such customer 
orders. For these reasons, Proposed Rule 615 would provide an exception 
for orders less than one share and the fractional component of a 
segmented order, if no qualified auction is available for such orders. 
Specifically, the rule would provide an exception if the segmented 
order is received and executed by the restricted competition trading 
center during a time period when no open competition trading center is 
operating a qualified auction for the segmented order that accepts 
orders that are not entirely in whole shares, and the customer selected 
a size for a segmented order that is not entirely in whole shares of an 
NMS stock, in which case any portion of such segmented order that is 
less than one whole share of the NMS stock, and only such portion, 
would not be subject to the order competition requirement of Proposed 
Rule 615(a).\232\ As is the case with each of the exceptions, a broker-
dealer's responsibilities with respect to best execution of a segmented 
order, including the fractional share portion of a segmented order, 
would remain in effect. The exception would only address whether the 
segmented order, or fractional portion thereof, is required to be 
exposed in a qualified auction.
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    \232\ Proposed Rule 615(b)(5).
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    Proposed Rule 615 does not provide an exception for orders directed 
by a customer to a particular restricted competition trading center for 
execution. Currently, 98% of the marketable orders of individual 
investors routed to wholesalers are not directed to any particular 
trading center, with the investor instead relying on their broker-
dealer, and their broker-dealer's best execution responsibilities, for 
order routing.\233\ Moreover, because the rule would only apply to the 
internalization of segmented orders by a restricted competition trading 
center, customers could continue to direct segmented orders to any 
trading center

[[Page 157]]

that was not a restricted competition trading center (i.e., an open 
competition trading center or national securities exchange, which are 
excluded from the definition of restricted competition trading center) 
without their orders being subject to the requirement for exposure in a 
qualified auction. Segmented orders directed to a restricted 
competition trading center would need to comply with Proposed Rule 615 
and, absent an exception, be exposed to competition in a qualified 
auction. Any delay would be limited, however, to a very short, sub-
second time period (as specified in Proposed Rule 615(c)(2)) and would 
give individual investors an opportunity to obtain fully competitive 
prices for their segmented order, as well as give other market 
participants, including institutional investors, an opportunity to 
interact with segmented orders.
---------------------------------------------------------------------------

    \233\ See infra section VII.B.2.a for a discussion of the 
routing of individual investor orders in today's market structure.
---------------------------------------------------------------------------

C. Qualified Auction Requirements

    The term ``qualified auction'' is proposed to be defined in 
Proposed Rule 600(b) of Regulation NMS as an auction that is operated 
by an open competition trading center pursuant to paragraph (c) of 
Proposed Rule 615.\234\ Paragraph (c), in turn, sets forth a series of 
specific requirements for qualified auctions, which could be operated 
only by national securities exchanges and NMS Stock ATSs that meet the 
definition of an open competition trading center. Given that routing 
segmented orders to qualified auctions would be mandated by rule in 
some contexts, these auctions should be operated in a manner that 
primarily promotes the core order competition objective of Proposed 
Rule 615.\235\ The proposed requirements for qualified auctions are 
designed to achieve this competition objective.
---------------------------------------------------------------------------

    \234\ Proposed Rule 600(b)(81).
    \235\ A number of exchanges, for example, currently operate 
auctions for orders in listed options. See, e.g., CBOE Rule 5.37 
(Automated Improvement Mechanism (``AIM'' or ``AIM Auction'')). 
These auctions are not mandated by Commission rule, and trading in 
listed options varies in important respects from trading in NMS 
stocks. For example, there are far more series of listed options 
than NMS stocks, which contributes to a market structure in which 
market makers dominate liquidity provision (a ``quote-driven'' 
market), rather than the ``order-driven'' market that characterizes 
NMS stocks. Proposed Rule 615 is designed to achieve policy 
objectives that are particular to mandatory auctions in NMS stocks. 
See also supra section I (discussing the difference between the 
markets for listed options and NMS stocks).
---------------------------------------------------------------------------

1. Auction Messages
    Proposed Rule 615(c)(1) specifies the requirements for an auction 
message that announces the initiation of a qualified auction for a 
segmented order. The first is that the message must be provided for 
dissemination in consolidated market data pursuant to Rule 603(b) of 
Regulation NMS. As stated in section III.B.1 above, the Commission has 
adopted amendments to Regulation NMS that expand the information 
required to be included in consolidated market data, which would 
include auction information.\236\ Because these amendments have not yet 
been implemented, if Proposed Rule 615 is adopted, the effective NMS 
plans for NMS stocks would need to be conformed to provide for the 
collection and dissemination of auction messages pursuant to Proposed 
Rule 615(c)(1)(i). The wide dissemination of qualified auction messages 
in consolidated market data would help ensure the broadest possible 
participation of market participants in qualified auctions and the best 
prices for segmented orders.
---------------------------------------------------------------------------

    \236\ Rule 600(b)(19) defines consolidated market data to 
include, among other things, core data, consolidated across all 
national securities exchanges and national securities associations. 
Rule 600(b)(21) defines core data to include, among other things, 
auction information with respect to quotations for, and transactions 
in, NMS stocks.
---------------------------------------------------------------------------

    The phrase ``provided for dissemination in consolidated market 
data'' reflects that, while national securities exchanges send 
quotation and transaction information directly to the SIPs, NMS Stock 
ATSs would provide such information to the ADF operated by FINRA, which 
would send the information to the SIPs.\237\ The primary purpose of an 
auction message is to promote competition by soliciting potential 
auction responses from a wide spectrum of market participants. The 
inclusion of the auction messages in consolidated market data, rather 
than being limited to the proprietary data feed of a national 
securities exchange or NMS Stock ATS, is designed to help achieve this 
purpose. In addition, wide dissemination of auction messages would help 
address some of the problems raised by the current level of fragmented 
trading interest in NMS stocks. For example, market participants that 
wish to interact with segmented orders would not need to predict the 
trading center to which segmented orders are likely to be routed and 
post a resting order in that trading center in advance of the arrival 
of a segmented order. Rather, market participants would be able to 
direct their auction responses to the particular open competition 
trading center that disseminated the auction message signaling that a 
segmented order was available for interaction.
---------------------------------------------------------------------------

    \237\ See supra section III.B.1 (discussing rules addressing 
dissemination of consolidated market data).
---------------------------------------------------------------------------

    Qualified auctions therefore may be useful, for example, to 
institutional investors that currently seek to trade with marketable 
order flow using resting undisplayed orders, often priced at the NBBO 
midpoint, that are intended to minimize information leakage concerning 
the typically large trading interest of institutional investors. Today, 
these market participants must select one or more trading centers on 
which to rest their orders based on predictions of the frequency and 
level of adverse selection costs of the marketable order flow with 
which they may interact at a particular trading center. With qualified 
auctions, such market participants would know the specific open 
competition trading centers where they could interact directly with 
segmented order flow that had low adverse selection costs. The 
Commission anticipates that qualified auctions thereby could benefit 
investors on both sides of the trades in qualified auctions--segmented 
orders could receive highly favorable prices (such as a ``no spread'' 
execution at the NBBO midpoint) and institutional investors would have 
a much greater opportunity to interact with the low-cost order flow of 
individual investors than they have today.\238\ Information leakage 
would be limited because, as discussed below, an institutional 
investor's auction response would not be displayed, and, if the 
institutional investor traded in a qualified auction, the only 
displayed information would be a transaction report that maintained the 
anonymity of the parties to the transaction.
---------------------------------------------------------------------------

    \238\ In addition to participating in qualified auctions by 
submitting auction responses, institutional investors could interact 
with segmented orders by submitting orders, including undisplayed 
NBBO midpoint orders, to the continuous order book of an open 
competition trading center that operates qualified auctions. As 
discussed below in section IV.C.5, any better-priced order resting 
on the continuous order book would have priority over lesser-priced 
auction responses to trade with segmented orders in a qualified 
auction.
---------------------------------------------------------------------------

    Proposed Rule 615(c)(1) also specifies the information content of 
an auction message, including disclosure that the auction is for a 
segmented order, the identity of the open competition trading center, 
NMS stock symbol, side (buy or sell), size, limit price, and identity 
of the originating broker for the segmented order. For auction 
responders, all of this information is necessary or useful in deciding 
whether to respond to the auction message and, if so, at what price. 
The fact that the order is a segmented order would indicate that the 
order is likely to have low adverse

[[Page 158]]

selection costs compared to other marketable order flow, such as orders 
routed to the continuous order books of national securities exchanges. 
Moreover, the identity of the originating broker likely would convey 
additional information concerning the level of adverse selection costs 
that an auction responder could expect. Data analysis indicates that 
adverse selection costs can vary substantially among different retail 
brokers.\239\ Knowing the identity of the originating broker would 
therefore be a significant piece of information in pricing an auction 
response. Accordingly, if only some market participants knew the 
identity of the originating broker, other potential responders may not 
participate due to fear of the winner's curse (winning the least 
advantageous auctions and losing the most advantageous auctions because 
of an information disadvantage). Limited participation could harm the 
competitiveness of qualified auctions.
---------------------------------------------------------------------------

    \239\ Table 12, infra, section VII.B.5.
---------------------------------------------------------------------------

    Paragraph (c)(1)(ii) of Proposed Rule 615 specifies that, if 
multiple broker-dealers fall within the proposed definition of 
originating broker, it would be the broker-dealer responsible for 
approving the opening of accounts with customers \240\ (commonly 
performed by an introducing broker) that would be required to be 
identified by an open competition trading center in auction messages 
under Proposed Rule 615(c)(1). The business model of broker-dealers 
(including the types of services they offer and the nature of the 
commissions and fees they charge) determines the types of customers 
that broker-dealers will attract, and different business models may be 
associated with lower or higher adverse selection costs. As between an 
introducing broker and a clearing broker, it is the introducing broker 
that typically determines the business model for attracting customers. 
For this reason, knowing the identity of the introducing broker 
associated with a segmented order (i.e., the broker typically with 
responsibility for approving the opening of the customer account) 
likely would be more important for market participants in assessing the 
potential adverse selection costs of trading with a segmented order 
than knowing the identity of other broker-dealers that may handle the 
segmented order during its lifecycle. Because the types of orders that 
would meet the definition of ``segmented order'' are generally 
associated with lower adverse selection costs,\241\ most originating 
brokers with responsibility for approving the opening of customer 
accounts likely would choose to have their identity disclosed in 
auction message.
---------------------------------------------------------------------------

    \240\ See, e.g., FINRA Rule 4311(c)(1)(A); supra note 227 and 
accompanying text.
    \241\ See infra section VII.B.2 discussing why certain orders 
are segmented because they are low-cost flow.
---------------------------------------------------------------------------

    The Commission recognizes, however, that some originating brokers 
or their customers may not wish to have the identity of the originating 
broker for a segmented order publicly disseminated. Proposed Rule 
615(c)(1)(iii) therefore would provide a choice for the originating 
broker. It could either allow its identity to be disclosed in an 
auction message or it could withhold this information by certifying 
that it has established, maintained, and enforced written policies and 
procedures reasonably designed to assure that its identity will not be 
disclosed, directly or indirectly, to any person that potentially could 
participate in the qualified auction or otherwise trade with the 
segmented order. If the originating broker makes this certification, 
paragraph (c)(1)(iii) would prohibit disclosure of the identity of the 
originating broker in the auction message.\242\ Proposed paragraph 
(c)(1)(iii) would also require that the certification be communicated 
to the open competition trading center conducting the auction. In 
addition, proposed paragraph (e)(3), discussed in section IV.E below, 
specifies the requirements for an originating broker that makes the 
certification, and proposed paragraph (f)(2), discussed in section IV.F 
below, specifies certain trading prohibitions for any broker-dealer 
with knowledge of where a segmented order is to be routed for 
execution. The overriding purpose of these proposed requirements is to 
help ensure fair competition among auction responders and persons that 
could otherwise trade with the segmented order. If one or more auction 
responders or persons that could otherwise trade with the segmented 
order knew the identity of the originating broker, but others did not, 
those that knew would have a substantial information advantage in 
pricing their orders over those that did not. The proposed requirements 
would give originating brokers a choice on whether to disclose their 
identity, while at the same time promoting fair competition among 
auction responders and persons that could otherwise trade with the 
segmented order, both when such identity is disclosed and when it is 
not. Under Proposed Rule 615(c)(1), (e)(3), and (f)(2), either all 
auction responders and persons that could otherwise trade with the 
segmented order would know the identity of the originating broker, or 
no auction responder or person that could otherwise trade with the 
segmented order would be permitted to know the identity of the 
originating broker. In either event, the fairness of qualified auctions 
would not be impacted.
---------------------------------------------------------------------------

    \242\ See infra section IV.E discussing potential procedures for 
an originating broker to assure that its identity will not be 
disclosed.
---------------------------------------------------------------------------

2. Auction Responses
    Proposed Rule 615(c)(2) specifies that the time period for a 
qualified auction must be no shorter than 100 milliseconds (1/10th of a 
second) and no longer than 300 milliseconds (3/10ths of a second) after 
an auction message is provided for dissemination in consolidated market 
data. The intent of these limits is to help ensure that a wide variety 
of market participants will have the technological capacity to submit 
responses to fast automated auctions, while also helping to assure that 
the execution of segmented orders is not unduly delayed. Several 
national securities exchanges operate auctions that fall within these 
time periods, which indicates that the time periods are workable with 
technologies that currently are available to market participants (i.e., 
the fact that multiple national securities exchanges already operate 
auctions in these time frames indicates that market participants 
generally would be able to submit auction responses within the 
specified time periods).\243\ The Commission anticipates individual 
investors would manually submit to their brokers the great majority of 
segmented orders. Proposing to limit the auction length to no more than 
300 milliseconds is designed to promote competition to obtain the best 
prices for segmented orders, but without a delay long enough to be 
inconsistent with an investor's intent to trade immediately at the best 
available prices.
---------------------------------------------------------------------------

    \243\ See, e.g., Securities Exchange Act Release No. 91423 (Mar. 
26, 2021), 86 FR 17230 (Apr. 1, 2021) (SR-CboeBYX-2020-021) (order 
approving Cboe BYX's proposed rule change for periodic auctions in 
NMS stocks with a 100 millisecond auction period); Nasdaq PHLX Rule 
3, section 13(b)(1)(D) (providing that the time period for PHLX's 
Price Improvement XL Mechanism (``PIXL'') auctions in listed options 
will be no less than 100 milliseconds and no more than one second).
---------------------------------------------------------------------------

    Paragraph (c)(2) would further require that auction responses 
remain undisplayed during the time frame of the auction and not be 
disseminated thereafter. This proposed requirement is designed to 
prevent the market participants with the fastest systems

[[Page 159]]

from obtaining an advantage by observing the pricing of auction 
responses and submitting their auction responses near the end of the 
time period for the auction. It also is designed to prevent information 
leakage, both during auctions themselves and by analyzing historical 
auction data, concerning the trading interest of market participants, 
particularly institutional investors, that submit auction responses.
3. Pricing Increment
    Under Proposed Rule 615(c)(3), segmented orders and auction 
responses must be priced in an increment of no less than $0.001 (or 0.1 
cent) if their prices are $1.00 or more per share, in an increment of 
no less than $0.0001 (or 0.01 cent) if their prices are less than $1.00 
per share, or at the midpoint of the NBBO.
    These proposed increments are designed to balance the objectives of 
being sufficiently narrow to allow frequent price improvement for 
segmented orders (the wider the pricing increment, the greater the 
minimum amount of price improvement that is required, which could limit 
the frequency of price improvement), while being sufficiently wide to 
prevent market participants from attempting to gain execution priority 
by pricing their auction responses in very small increments. An 
analysis of current wholesaler trading in NMS stocks indicates that 
18.64% of the price improved shares of wholesaler principal 
transactions received price improvement of less than 0.1 cent.\244\ 
Accordingly, the 0.1 cent price increment for qualified auctions would 
allow much of the existing price improvement to continue in qualified 
auctions. Moreover, as discussed in section IV.C.5 below, one of the 
prescribed execution priority requirements for qualified auctions in 
paragraph (c)(5) of Proposed Rule 615 is that the auction responses of 
customers, including institutional investors, would have priority over 
the auction responses of broker-dealers at the same price, thereby 
furthering the NMS objective of promoting direct interaction of 
investor orders without the participation of a dealer. A smaller 
pricing increment (such as 0.05 cent per share (or 1/20th of a cent per 
share) would allow more price improvement, but also would double the 
number of increments at which auction responses could be priced, which 
would enable execution priority advantages at the larger number of 
increments. The objective of promoting direct interaction of investor 
orders could be undermined if broker-dealers with the most 
sophisticated algorithmic trading strategies could submit auction 
responses with very small pricing increments designed to obtain 
execution priority.
---------------------------------------------------------------------------

    \244\ Table 7, infra, section VII.B.4.
---------------------------------------------------------------------------

4. Fees and Rebates
    Proposed Rule 615(c)(4) sets forth a number of requirements that 
would govern the fees and rebates of open competition trading centers 
with respect to qualified auctions.\245\ In general, these requirements 
are designed to provide reasonable compensation for operating a 
qualified auction, while maximizing an opportunity for competitive 
forces to generate the best possible prices for segmented orders. 
Qualified auctions would be a new business line for open competition 
trading centers (both national securities exchanges and NMS Stock 
ATSs), which would provide them an opportunity to compete to attract 
the marketable orders of individual investors that, as discussed in 
section VII.B.2 below, are mostly routed to, and executed by, 
wholesalers in the current market structure. Accordingly, the proposed 
requirements for fees and rebates are designed to provide sufficient 
financial incentives for open competition trading centers to operate 
qualified auctions, but the primary objective of such requirements is 
to promote the regulatory objectives of Proposed Rule 615--better 
prices for individual investors and an enhanced opportunity for 
investors to interact directly with the marketable orders of individual 
investors.
---------------------------------------------------------------------------

    \245\ The Commission also is proposing to amend rules addressing 
fees and rebates more generally. See Minimum Pricing Increments 
Proposal, supra note 98. The Commission encourages commenters to 
review that proposal to determine whether it might affect their 
comments on this proposing release.
---------------------------------------------------------------------------

    First, no fee could be charged for submission or execution of a 
segmented order, or for submission of an auction response. Second, the 
fee for execution of an auction response could not exceed $0.0005 per 
share for auction responses priced at $1.00 per share or more, could 
not exceed 0.05% of the auction response price per share for auction 
responses priced at less than $1.00 per share, and otherwise would have 
to be the same rate for executed auction responses in all auctions. 
Third and similarly, any rebate for the submission or execution of a 
segmented order or for the submission or execution of an auction 
response could not exceed $0.0005 per share for segmented orders or 
auction responses priced at $1.00 per share or more, cannot exceed 
0.05% of the segmented order or auction response price per share for 
segmented orders or auction responses priced at less than $1.00 per 
share, and otherwise must be the same rate for segmented orders in all 
auctions and must be the same rate for auction responses in all 
auctions.
    Proposed Rule 615 would prohibit fees for the submission or 
execution of segmented orders in a qualified auction. As discussed in 
section II above, the trading economics of executing segmented orders, 
particularly their low adverse selection costs, has led to a market 
structure where restricted competition trading centers generally do not 
charge fees to the broker-dealers that route such orders and, indeed, 
often offer PFOF to retail brokers in return for routing such orders. 
With Proposed Rule 615, routing segmented orders to qualified auctions 
would often, absent an exception, be mandated by rule--a restricted 
competition trading center generally would be prohibited from executing 
a segmented order internally without first routing such order to a 
qualified auction. The Commission believes that broker-dealer 
compliance with a new rule requiring the routing of segmented orders to 
qualified auctions in certain circumstances should not lead to the 
imposition of fees by trading centers on broker-dealers that are not 
charged for the execution of such orders today. Instead, as discussed 
below, open competition trading centers could fund their operation of 
qualified auctions by imposing fees on auction responses that execute 
against segmented orders. In this respect, the market participants that 
benefit from the opportunity to trade with segmented orders, with their 
low adverse selection costs, would pay the open competition trading 
center for that trading service.
    With respect to auction responses, no fee could be charged for the 
submission of an auction response that is not executed. Such a practice 
potentially could be used to deter a wide range of market participants 
from participating in qualified auctions and thereby dampen competition 
to provide the best prices for segmented orders. Fees could be charged 
for executed auction responses, consistent with the cap on such fees, 
which, for most NMS stocks, would be 0.05 cent per share, also known as 
5 ``mils.'' The proposed 5 mils cap on fees is designed to be 
sufficient to provide reasonable compensation to an open competition 
trading center. For example, an analysis of financial data for national 
securities exchanges indicates that average total net capture (the 
difference between fees levied and rebates paid) for such exchanges is

[[Page 160]]

currently around 4 mils for all trading types.\246\ Accordingly, the 
proposed 5 mils fee cap would provide a revenue source to fund 
qualified auctions that is consistent with their revenue to fund their 
other trading services, particularly their services during continuous 
trading hours.\247\ In addition, pursuant to Proposed Rule 615(c)(4), 
any fee charged for execution of an auction response must be the same 
rate for all auctions (i.e., an open competition trading center would 
not be permitted to charge different fees for auctions for different 
securities, nor would an open competition trading center be permitted 
to charge different fees to different market participants or different 
classes of market participants, such as preferential fees based on 
volume). This proposed uniform rate for fees is designed to promote a 
level playing field among all potential market participants that may 
wish to trade with segmented orders. It would, for example, prohibit 
any volume discount that could give the largest participants an 
economic advantage in pricing their auction responses compared to other 
market participants. The uniform rate also would prevent a fee discount 
for the executed auction response of a broker-dealer that routed the 
segmented order to the qualified auction.
---------------------------------------------------------------------------

    \246\ See infra section VII.C.1.a (discussing effects of 5 mils 
cap on competition to supply liquidity to the marketable orders of 
individual investors).
    \247\ Id. (net capture for the executions of orders during 
continuous trading hours (but not opening or closing auctions) 
priced at $1.00 per share or greater is likely close to 2 mils).
---------------------------------------------------------------------------

    The proposed requirements for rebates mirror the requirements for 
fees in terms of the 5 mils cap and the requirement of a uniform rate 
for all auctions. In particular, rebates could not exceed the maximum 
fee for qualified auctions. The equivalent proposed 5 mils cap on 
rebates is designed to limit cross-subsidization of qualified auctions 
by the largest open competition trading centers in ways that would not 
be available to smaller competitors, because larger competitors may 
have more or larger alternative revenue sources. The uniform rate of 
rebates for all auctions is designed, as with the uniform rate of fees, 
to level the playing field among larger and smaller broker-dealers. The 
proposed requirements for rebates differ from those for fees, however, 
in that open competition trading centers would have discretion on 
whether to offer rebates for the submission of segmented orders and of 
auction responses, as well as the execution of segmented orders and of 
auction responses. If such rebates were offered, however, they would 
have to be a uniform rate among all auctions to promote a level playing 
field and fair competition among broker-dealers and among auction 
responders.
5. Auction Execution Priority
    Proposed Rule 615(c)(5) would specify five requirements for the 
execution priority of auction responses and orders resting on the 
continuous order book of an open competition trading center, which can 
be divided into three categories. The first two would specify 
affirmative requirements for how priority among auction responses must 
be handled; the second two would specify negative requirements for how 
priority among auction responses cannot be handled; and the fifth 
requirement would address how qualified auctions must be integrated 
with a continuous order book operated by an open competition trading 
center. These five requirements would not exhaust all possible contexts 
for which additional priority rules may be needed, and, as discussed 
below, open competition trading centers would have flexibility to 
develop additional priority rules as long as such rules are consistent 
with the requirements in Proposed Rule 615(c)(5).
    Pursuant to Proposed Rule 615(c)(5)(i), the first affirmative 
requirement would be price priority--the most favorable price for a 
segmented order would have priority of execution (the lowest priced 
auction response to a segmented order to buy and the highest priced 
auction response to a segmented order to sell). Price priority 
maximizes competitive incentives to obtain the best prices for 
segmented orders.
    Pursuant to Proposed Rule 615(c)(5)(ii), the second affirmative 
requirement would be customer priority. ``Customer'' is defined in Rule 
600(b)(23) of Regulation NMS to mean any person that is not a broker-
dealer. When two auction responses have the best price, and one is 
submitted for the account of a customer and one is submitted for the 
account of a broker-dealer, the customer's auction response would be 
required to have priority. In such a case, the segmented order of an 
investor would interact directly with the auction response of another 
investor without the participation of a dealer, thereby promoting the 
NMS objective set forth in section 11A(a)(1)(C)(v) of the Exchange Act.
    Pursuant to Proposed Rule 615(c)(5)(iii), the first negative 
requirement for execution priority would be the prohibition of time 
priority, subject only to an auction response being received by an open 
competition trading center within the time period prescribed in 
paragraph (c)(2) of Proposed Rule 615. Prohibiting time priority for 
equally priced auction responses eliminates the incentive for a speed 
race that otherwise could reward market participants with resources to 
spend the most on sophisticated, low-latency trading systems and 
connectivity.
    Pursuant to Proposed Rule 615(c)(5)(iv), the second negative 
requirement for execution priority would be a prohibition against 
favoring the broker-dealer that routed the segmented order to the 
auction, the originating broker for the segmented order, the open 
competition trading center operating the auction, or any affiliate of 
the foregoing persons.\248\ This requirement is designed to help 
maintain a level playing field among market participants submitting 
auction

[[Page 161]]

responses and thereby focus competition in the auctions on providing 
the best prices for segmented orders. Assigning priority to any firm 
associated with the handling of the orders or their affiliates would be 
one means for an open competition trading center to attempt to attract 
order flow by rewarding the firms that control such flow coming from 
the customer, which could undermine competition among auction 
responders to provide the best prices in qualified auctions. Given that 
Proposed Rule 615 would require segmented orders to be routed to 
qualified auctions in some contexts, the competition among open 
competition trading centers to attract segmented orders should be 
focused on generating the best prices for investors.
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    \248\ ``Affiliate'' is proposed to be defined in Proposed Rule 
600(b)(3) of Regulation NMS to mean, with respect to a specified 
person, any person that, directly or indirectly, controls, is under 
common control with, or is controlled by, the specified person. 
``Control'' is proposed to be defined in Proposed Rule 600(b)(23) of 
Regulation NMS to mean the power, directly or indirectly, to direct 
the management or policies of a broker, dealer, or open competition 
trading center, whether through ownership of securities, by 
contract, or otherwise. A person is presumed to control a broker, 
dealer, or open competition trading center if that person: (1) is a 
director, general partner, or officer exercising executive 
responsibility (or having similar status or performing similar 
functions); (2) directly or indirectly has the right to vote 25% or 
more of a class of voting securities or has the power to sell or 
direct the sale of 25% or more of a class of voting securities of 
the broker, dealer, or open competition trading center; or (3) in 
the case of a partnership, has contributed, or has the right to 
receive upon dissolution, 25% or more of the capital of the broker, 
dealer, or open competition trading center. Proposed Rule 600(b)(3) 
and Proposed Rule 600(b)(23). These definitions are substantially 
the same as the definitions of ``affiliate'' and ``control'' 
prescribed for purposes of an NMS Stock ATS's disclosures about its 
operations on Form ATS-N with the following modifications: the Form 
ATS-N definition of ``affiliate'' uses a separately defined term 
``Person'' instead of the statutory definition of ``person,'' and 
Form ATS-N defines ``control'' as applicable to the ``broker-dealer 
of the alternative trading system'' instead of as applicable to a 
``broker, dealer, or open competition trading center.'' It is 
appropriate to use substantially similar definitions of 
``affiliate'' and ``control'' in the context of Proposed Rule 615 
because, for purposes of Form ATS-N, the Commission defined such 
terms for use with respect to disclosures designed to enable market 
participants to better evaluate how relationships between certain 
persons could affect the handling of orders on a particular NMS 
Stock ATS. See ATS-N Adopting Release, supra note 159, 83 FR at 
88318. The substantially similar proposed definitions, as used in 
the context of Proposed Rule 615, are similarly designed to 
recognize that relationships among certain persons may impact the 
handling of orders, and are designed to help ensure that the 
execution priority rules of an open competition trading center do 
not undermine full competition among auction responders in qualified 
auctions by favoring related parties that were involved in routing 
and executing the order at the open competition trading center.
---------------------------------------------------------------------------

    Finally, the execution priority requirements set forth in paragraph 
(c)(5)(v) of Proposed Rule 615 address how auction responses would be 
required to be integrated with the continuous order book of an open 
competition trading center. A continuous order book is proposed to be 
defined in Rule 600(b) of Regulation NMS as a system that allows orders 
for NMS stocks to be accepted and executed on a continuous basis.\249\ 
This definition would exclude single-priced auctions that are limited 
to a specified time, such as the opening and closing auctions of the 
primary listing exchanges, and that are not continuously available for 
trading based on the initiative of market participants or the open 
competition trading center. As discussed above, all open competition 
trading centers would operate as automated trading centers displaying 
automated quotations and therefore would have facilities in which 
orders from market participants are accepted and executed on a 
continuous basis.
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    \249\ Proposed Rule 600(b)(22).
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    The proposed execution priority requirements primarily are designed 
to balance the objectives of obtaining the best prices for segmented 
orders and maintaining fair competition both in qualified auctions and 
on continuous order books.\250\ The first such requirement is that 
orders resting on the continuous order book of the open competition 
trading center operating the qualified auction, whether displayed or 
undisplayed, would have priority over auction responses at a less 
favorable price for the segmented order. This is another application of 
the principle of price priority that underlies proposed paragraph 
(c)(5)(i).
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    \250\ Trades executed in qualified auctions would not qualify 
for an exception from the trade-through requirements of Rule 611 of 
Regulation NMS, which are discussed in section III above. 
Accordingly, if a qualified auction did not generate a price that 
was at or within the best-priced protected quotations, the open 
competition trading center would, absent an exception, be prohibited 
by Rule 611 from executing the segmented order. If a restricted 
competition trading center subsequently decided to execute such 
segmented order, it would need, absent an exception, to comply both 
with the trade-through requirements of Rule 611 and with Proposed 
Rule 615(a) by immediately executing the segmented order at a price 
that was equal to or better for the segmented order than the 
specified limit price in the qualified auction.
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    The second requirement is that displayed orders resting on the 
continuous order book would be required to have priority at the same 
price over auction responses, while, in turn, auction responses would 
be required to have priority at the same price over undisplayed orders 
resting on the continuous order book. Rewarding the display of orders 
serves the purpose of promoting public price transparency, consistent 
with the NMS objective in section 11A(a)(1)(C)(iii) of the Exchange 
Act. As between undisplayed orders and auction responses, however, 
giving priority to auction responses at the same price would encourage 
participation in qualified auctions, thereby promoting the core order 
competition objective of Proposed Rule 615. Moreover, unlike displayed 
orders that can be executed immediately because they present a known 
opportunity to trade for market participants, undisplayed orders on 
continuous order books are not known to other market participants and 
potentially create a risk of gaming behavior by broker-dealers with 
knowledge of segmented orders that could undermine competition in 
qualified auctions. As discussed in section IV.F below, this potential 
gaming behavior is prohibited in paragraph (f) of Proposed Rule 615. 
Assigning priority to auction responses over undisplayed orders at the 
same price would help address the root incentives for such behavior.
    While Proposed Rule 615(c) sets forth a series of execution 
priority requirements for qualified auctions, open competition trading 
centers also would have flexibility to develop additional execution 
priority rules for their auction mechanism, as long as they were 
consistent with the proposed requirements. As one example, Proposed 
Rule 615(c) does not prescribe execution priority when an open 
competition trading center receives multiple best priced responses for 
the account of customers because multiple possibilities would be 
consistent with the objectives of Proposed Rule 615. An open 
competition trading center would be free to develop rules for assigning 
execution priority among such customer responses, as long as they were 
consistent with Proposed Rule 615(c).\251\
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    \251\ As discussed above in section IV.B.2, national securities 
exchanges must file proposed rules with the Commission to reflect 
material changes in their rules, while NMS Stock ATSs must update 
their Form ATS-Ns to reflect material changes in their rules.
---------------------------------------------------------------------------

    Moreover, Proposed Rule 615 allows flexibility for open competition 
trading centers in a variety of other contexts. For example, it does 
not specify whether an open competition trading center may or may not 
simultaneously operate multiple qualified auctions for the same NMS 
stock, and if so, the execution priority required for auction responses 
across such auctions. Proposed Rule 615 also would not impose 
requirements for auction responses, other than the requirement in 
paragraph (c)(1) that an auction message initiating a qualified auction 
would be required to invite ``priced'' auction responses.

D. Open Competition Trading Center Requirements

    Paragraph (d) of Proposed Rule 615 sets forth requirements for 
national securities exchanges and NMS Stock ATSs that intend to act as 
open competition trading centers that operate qualified auctions for 
segmented orders. First, it would prohibit a national securities 
exchange or NMS Stock ATS from operating a qualified auction unless the 
exchange or ATS meets the definition of open competition trading center 
and complies with the provisions of Proposed Rule 615 for qualified 
auctions, which were discussed in section IV.B.2 and IV.C above. 
Second, it would prohibit an open competition trading center from 
operating a system, other than a qualified auction, that is limited in 
whole or in part to the execution of segmented orders, unless any 
segmented order executed through the system meets requirements that 
parallel those specified for an exception in paragraph (b) of Proposed 
Rule 615.\252\ This proposed prohibition is

[[Page 162]]

identical to the prohibition in paragraph (g) of Proposed Rule 615 that 
would apply to all national securities exchanges, regardless of whether 
they meet the definition of an open competition trading center, and is 
discussed further in section V.G below.
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    \252\ Proposed Rule 615(b); Proposed Rule 615(d)(2)(i) through 
(v). Specifically, a segmented order executed through such system of 
an open competition trading center would be required to: (1) be 
received and executed during a time period when no open competition 
trading center is operating a qualified auction for the segmented 
order; (2) have a market value of at least $200,000 calculated with 
reference to the midpoint of the NBBO when the segmented order was 
received by the open competition trading center; (3) be executed by 
the open competition trading center at a price that is equal to or 
more favorable for the segmented order than the midpoint of the NBBO 
when the segmented order was received by the open competition 
trading center; (4) be a limit order with a limit price selected by 
the customer that is equal to or more favorable for the segmented 
order than the midpoint of the national best bid and national best 
offer when the segmented order is received by the open competition 
trading center; or (5) be received and executed by the open 
competition trading center during a time period when no open 
competition trading center is operating a qualified auction for the 
segmented order that accepts orders that are not entirely in whole 
shares, and be a size, selected by the customer, that is not 
entirely in whole shares of an NMS stock, in which case any portion 
of such segmented order that is less than one whole share of the NMS 
stock, and only such portion, may be executed through such system.
---------------------------------------------------------------------------

E. Originating Broker Requirements

    Paragraph (e) of Proposed Rule 615 sets forth three requirements 
for originating brokers. First, an originating broker would be required 
to establish, maintain, and enforce written policies and procedures 
reasonably designed to identify the orders of customers as segmented 
orders. Given that the order competition requirement of paragraph (a) 
would apply solely to segmented orders, it is imperative that customer 
orders be properly identified as such by the originating broker, which 
will have the knowledge of its customer accounts necessary to make such 
identification. As discussed above in section IV.B.1, the first part of 
the proposed definition of segmented order relating to the nature of 
the account is based on existing SRO rules and, accordingly, is 
designed to facilitate ease of compliance by originating brokers. The 
second part of the proposed definition relating to frequency of trading 
in an account would be based on customer trading information that 
originating brokers are required to maintain.\253\
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    \253\ See 17 CFR 240.17a-3(a) (requiring broker-dealers to make 
and keep, among other things, current blotters containing an 
itemized daily record of all purchases and sales of securities and 
the account for which each such purchase and sale was effected).
---------------------------------------------------------------------------

    Second, an originating broker would be prohibited from routing a 
customer order identified as a segmented order without also identifying 
the order to the routing destination as a segmented order.\254\ This 
requirement would work together with an analogous requirement in 
paragraph (f) of Proposed Rule 615 for all broker-dealers that route 
segmented orders that is discussed in section IV.F below. Together, the 
proposed requirements are designed to ensure that a segmented order 
continues to be identified as such throughout the routing chain from 
origination through execution. Proper marking of segmented orders would 
be essential for a restricted competition trading center to know that 
it must comply with the order competition requirement of paragraph (a). 
The proposed identification requirements of paragraph (e) for 
originating brokers and paragraph (f) for all broker-dealers are 
designed to assure that no segmented order reaches a restricted 
competition trading center without the proper identification. If there 
is more than one originating broker for a segmented order, the broker 
that carries the individual investor's customer account would likely be 
the originating broker that maintains the policies and procedures to 
identify segmented orders as such, as well as identifies and marks the 
orders.
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    \254\ 17 CFR 242.613 (Rule 613 of Regulation NMS) requires each 
national securities exchange and national securities association to 
jointly file an NMS plan governing the creation, implementation, and 
maintenance of a consolidated audit trail (``CAT'') which is 
reported to a central repository. The rule specifies the type of 
data to be collected and reported. Pursuant to Rule 613(c)(7), any 
CAT plan participant or broker-dealer that receives, originates, or 
handles orders in NMS stocks must report certain information 
regarding those orders, including the ``material terms'' of each 
order. Rule 613(j)(7) defines ``material terms of an order'' to 
include ``any special handling instructions.'' Because Proposed Rule 
615 would mandate special handling for segmented orders, the 
identification of the order as a segmented order, any exceptions 
applicable to its handling, and the identity of the originating 
broker or an indication of a certification of anonymity would be 
required by current Rule 613 to be reported as material terms in 
each event in the lifecycle.
---------------------------------------------------------------------------

    Third, an originating broker that makes the certification referred 
to in paragraph (c)(1)(iii) of Proposed Rule 615 would be required to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to assure that the identity of the originating 
broker will not be disclosed, directly or indirectly, to any person 
that potentially could participate in the qualified auction or 
otherwise trade with the segmented order. As discussed in section 
IV.C.1 above, knowing the identity of an originating broker could 
provide a significant information advantage to a market participant 
when pricing an auction response if other market participants did not 
have this information. The effect of the certification referred to in 
paragraph (c)(1)(iii) of Proposed Rule 615 would be that either all 
responders in a qualified auction would know the identity of the 
originating broker (if the certification is not made) or no responders 
in a qualified auction would know the identity of the originating 
broker (if the certification is made). In the absence of an appropriate 
certification from an originating broker, an open competition trading 
center would be required to identify the originating broker in the 
auction message disseminated in consolidated market data. The ``written 
policies and procedures'' requirement of proposed paragraph (e)(3) 
specifies the responsibility of an originating broker in making such a 
certification. As one potential example of such policies and 
procedures, an originating broker could provide that such originating 
broker will route all the segmented orders of its customers directly to 
an open competition trading center for a qualified auction, without 
disclosing the existence of such orders to any other person. Another 
potential example would be for the originating broker to use a single 
broker for routing segmented orders to open competition trading centers 
for qualified auctions, and the single executing broker represents in 
writing that it will not participate in any qualified auction for the 
segmented orders or otherwise trade with the segmented orders, and that 
it will not disclose the existence of such segmented orders to any 
other person.
    As mentioned in section IV.B.4 above, broker business practices can 
vary in terms of how customer accounts are handled, and there may be 
multiple originating brokers for a segmented order. In addition, such 
brokers currently enter into agreements with one another to allocate 
certain responsibilities with respect to the handling of customer 
accounts, such as those referred to as carrying agreements. The 
Commission has designed Proposed Rule 615 to preserve brokers' existing 
flexibility to allocate responsibilities among themselves. Accordingly, 
paragraph (e)(4) of Proposed Rule 615 provides that, where there are 
multiple originating brokers for a segmented order, an originating 
broker shall not be deemed to be in violation of the provisions of 
paragraph (e)(1) through (3) arising solely from a failure to meet a 
responsibility that was specifically allocated by prior written 
agreement to another originating broker.

F. Broker-Dealer Requirements

    Paragraph (f) of Proposed Rule 615 sets forth two requirements for 
all broker-dealers with respect to segmented orders. First, pursuant to 
proposed paragraph (f)(1), a broker-dealer that receives an order 
identified as a segmented order would be prohibited from routing such 
order without identifying the order to the routing destination as a 
segmented order. As discussed in section IV.E above, this requirement 
is designed to work together with an analogous requirement for 
originating brokers to

[[Page 163]]

help assure that no segmented order reaches a restricted competition 
trading center, even if routed through multiple broker-dealers or 
trading centers, without being properly identified as a segmented 
order.
    Second, paragraph (f)(2) of Proposed Rule 615 sets forth a 
requirement for all broker-dealers, which includes originating brokers, 
that is designed to prevent gaming behavior that could undermine fair 
competition in qualified auctions and on continuous order books. In 
particular, it would prohibit a broker-dealer with knowledge of where a 
segmented order is to be routed from submitting an order, or enabling 
an order to be submitted by any other person, to the continuous order 
book of an open competition trading center or of a national securities 
exchange that could have priority to trade with the segmented order at 
such open competition trading center or national securities exchange.
    The prohibition of paragraph (f)(2) is designed to address two 
types of potential gaming behavior by broker-dealers. First, absent 
this proposed prohibition, a broker-dealer with knowledge that a 
segmented order is to be routed to a qualified auction could submit, or 
enable another person to submit (such as by providing information to 
another person), to the open competition trading center conducting such 
auction a displayed contra-side order that was priced at or better than 
the specified limit price of the segmented order. As discussed in 
section IV.C above, displayed orders on the continuous order book of an 
open competition trading center could have priority to trade with a 
segmented order ahead of equally priced auction responses. The 
submission of contra-side orders to a continuous order book to avoid 
participating in a qualified auction, however, could undermine fair 
competition in the qualified auction and therefore would be prohibited 
by paragraph (f)(2).
    A second type of gaming behavior prohibited by paragraph (f)(2) of 
Proposed Rule 615 relates to segmented orders that are not routed to 
qualified auctions, but rather to a continuous order book of an open 
competition trading center or a national securities exchange. As stated 
in section IV.A above, the order competition requirement of paragraph 
(a) of Proposed Rule 615 does not apply to an open competition trading 
center or to a national securities exchange, regardless of whether such 
exchange is an open competition trading center, and therefore, a 
broker-dealer could route a segmented order directly to an open 
competition trading center or a national securities exchange.\255\ 
However, there remains an incentive for a broker-dealer to seek to 
trade with a segmented order outside of the fair competition of a 
qualified auction by submitting a contra-side order at the same time it 
submits the segmented order (i.e., a ``paired order'') to a continuous 
order book of an open competition trading center or national securities 
exchange with the expectation of executing against the segmented order. 
Paragraph (f)(2) is designed to address this potential by prohibiting a 
broker-dealer with knowledge of where a segmented order is to be routed 
from submitting, or enabling any other person to submit (such as by 
providing information to another person), an order to an open 
competition trading center or a national securities exchange that could 
have priority to trade with the segmented order.
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    \255\ As discussed elsewhere in this release, both of these 
types of trading centers are subject to rigorous requirements for 
access and competition, and they therefore would not be prohibited 
from executing a segmented order without it being submitted to a 
qualified auction. In addition to the applicable proposed 
requirements under Proposed Rule 615, a broker-dealer still would be 
required to satisfy its best execution responsibilities if bypassing 
a qualified auction and routing a segmented order directly to an 
open competition trading center or a national securities exchange.
---------------------------------------------------------------------------

    In addition to the requirements for broker-dealers set forth in 
Proposed Rule 615, all other existing obligations of broker-dealers for 
customer orders, including best execution discussed in section III.B 
above, would continue to apply. For example, an important consideration 
for broker-dealers in handling a segmented order would be the relative 
performance of qualified auctions at different open competition trading 
centers in terms of their order execution quality. Broker-dealers with 
best execution responsibilities for segmented orders generally should 
consider the available information on execution quality for segmented 
orders at different qualified auctions. To provide broker-dealers with 
relevant information on qualified auctions, if Proposed Rule 615 is 
adopted, the effective NMS plans for NMS stocks would need to be 
conformed to provide for the collection and dissemination of a sale 
condition in transaction reports for national securities exchanges and 
NMS Stock ATSs indicating that the transaction was executed in a 
qualified auction under Proposed Rule 615(c).\256\
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    \256\ The technical specifications of the NMS plans for 
disseminating consolidated market data include sale condition 
modifiers for trade reports that specify various types of trades, 
including some auction trades.
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G. National Securities Exchange Requirements

    Exchanges are excluded from the proposed definition of a restricted 
competition trading center because, as discussed in section III.B 
above, they are subject to the extensive Exchange Act requirements for 
access and competition. Accordingly, the order competition requirement 
of paragraph (a) of Proposed Rule 615 does not apply to a national 
securities exchange, regardless of whether such exchange meets the 
definition of an open competition trading center. To the extent 
consistent with their best execution responsibilities, broker-dealers 
would be permitted to route segmented orders directly to any national 
securities exchange without first routing the order to a qualified 
auction. One potential example of when such a direct route could be 
consistent with best execution is a fast market when prices are moving 
rapidly away from a segmented order (prices increasing for buy orders 
and prices decreasing for sell orders). In this example, a broker-
dealer could determine that obtaining a better price in a qualified 
auction than a displayed quotation is unlikely, and the broker-dealer 
could route a segmented order directly to execute against the best 
available price available at a national securities exchange or an open 
competition trading center. Competition in qualified auctions, however, 
could be undermined if national securities exchanges and open 
competition trading centers were permitted to siphon segmented order 
flow away from qualified auctions by operating trading mechanisms that 
were limited, in whole or in part, to segmented orders.
    Accordingly, paragraphs (d)(2) (as discussed above) and (g) of 
Proposed Rule 615 would prohibit all open competition trading centers 
and national securities exchanges from operating a system, other than a 
qualified auction, that is limited, in whole or in part, to the 
execution of segmented orders, unless any segmented order executed 
through such system qualifies for exceptions that are the same as those 
in Proposed Rule 615(b).\257\ This prohibition would apply

[[Page 164]]

to many of the RLPs currently operated by national securities 
exchanges.\258\ An example of a trading system that would not be 
prohibited under paragraphs (d)(2) and (g), however, would be one that 
is limited to the execution of segmented orders at prices equal to the 
NBBO midpoint, which would qualify for the exception in Proposed Rule 
615(g)(3).\259\
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    \257\ Proposed Rule 615(b); Proposed Rule 615(d)(2)(i) through 
(v); Proposed Rule 615(g)(1) through (5); and supra note 252 and 
accompanying text. Specifically, a segmented order executed through 
such system of a national securities exchange would be required to: 
(1) be received during a time period when no open competition 
trading center is operating a qualified auction for the segmented 
order; (2) have a market value of at least $200,000 calculated with 
reference to the midpoint of the NBBO when the segmented order was 
received by the national securities exchange; (3) be executed by the 
national securities exchange at a price that is equal to or more 
favorable for the segmented order than the midpoint of the NBBO when 
the segmented order was received by the national securities 
exchange; (4) be a limit order with a limit price selected by the 
customer that is equal to or more favorable for the segmented order 
than the midpoint of the national best bid and national best offer 
when the segmented order is received by the national securities 
exchange; or (5) be received and executed by the national securities 
exchange during a time period when no open competition trading 
center is operating a qualified auction for the segmented order that 
accepts orders that are not entirely in whole shares, and be a size, 
selected by the customer, that is not entirely in whole shares of an 
NMS stock, in which case any portion of such segmented order that is 
less than one whole share of the NMS stock, and only such portion, 
may be executed through such system.
    \258\ As discussed in section III.B.2.c, RLPs are exchange 
trading mechanisms limited to retail orders, as defined in the 
exchanges' rules.
    \259\ IEX's RLP, for example, only permits retail liquidity 
provider orders to be midpoint peg orders. See Securities Exchange 
Act Release No. 93217 (Sep. 30, 2021), 86 FR 55663 (Oct. 6, 2021) 
(order approving an exemption from Rule 602 of Regulation NMS for 
IEX's retail price improvement program and describing that IEX's 
program is different because retail liquidity provider orders can 
only be midpoint peg orders); IEX Rules 11.190(b)(14) (Retail 
Liquidity Provider Order) and 11.232 (Retail Price Improvement 
Program). IEX has rules that will also permit orders in its RLP to 
be executed at prices better than the NBBO midpoint. See Securities 
Exchange Act Release No. 94884 (May 10, 2022), 87 FR 29768 (May 16, 
2022) (SR-IEX-2022-04).
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V. Request for Comment

    The Commission generally requests comment from the public on all 
aspects of Proposed Rule 615, including its objectives and its terms to 
achieve those objectives. The Commission also generally requests 
comment on the proposed definitions to be added to Rule 600 and their 
use in the context of Proposed Rule 615. More specific requests for 
comment are set forth below. With respect to any comments, the 
Commission notes that they are of the greatest assistance to this 
rulemaking initiative if accompanied by supporting data and analysis of 
the issues addressed in those comments.
    1. The Commission requests comment on the operation and 
effectiveness of Proposed Rule 615. Would exposing segmented orders to 
competition in qualified auctions be likely to generate better prices 
for individual investors than are provided by current broker-dealer 
routing practices? Would the likelihood of better prices vary across 
different types of NMS stocks, such as those with different levels of 
liquidity and trading volume? Do commenters believe that the wide 
dissemination of auction messages for qualified auctions in NMS stocks 
would be likely to affect trading or quoting behavior in NMS stocks 
during the time period of the auction and, if so, would such an effect 
promote or detract from obtaining the best possible price for segmented 
orders in the qualified auctions?
    2. Proposed Rule 615(c)(2) would prohibit display of auction 
responses. In the case of an execution in a qualified auction, a 
transaction report maintaining the anonymity of the parties would be 
displayed in consolidated market data. Does the proposed prohibition 
sufficiently mitigate the possibility of information leakage for 
participants in a qualified auction? Are there different or additional 
requirements that would better mitigate the possibility of information 
leakage?
    3. Is focusing on the accounts of natural persons, as well as 
accounts held in legal form on behalf of a natural person or group of 
related family members, and the level of trading activity in such 
accounts an appropriate approach to identify orders that are included, 
and those that are excluded, from the proposed definition of a 
segmented order?
    4. Should the proposed definition of ``group of related family 
members'' be more or less inclusive, and if so, in what regard?
    5. Should the level of trading activity used to determine which 
accounts are associated with segmented orders be lower or higher than 
40 trades per day? Is the six-month time frame is appropriate? If other 
metrics would be more appropriate, please explain why and, if possible, 
provide data to support your position.
    6. Should any large orders be entirely excluded from the definition 
of segmented order and therefore not eligible to trade in qualified 
auctions, as opposed to the rule proposal which would provide an 
exception for orders of $200,000 or more and that allows a choice of 
whether to submit such orders to qualified auctions?
    7. The proposed definition of an open competition trading center 
would require national securities exchanges to operate as an SRO 
trading facility that is an automated trading center and displays 
automated quotations that are disseminated in consolidated market data? 
Is this requirement appropriate or should it be modified in any 
respect?
    8. Is requiring a minimum level of trading volume for national 
securities exchanges to qualify as open trading competition centers an 
appropriate means to achieve the objectives of Proposed Rule 615? If 
so, should the 1% level should be lower or higher? For example, should 
the 1% level be lowered to enable additional national securities 
exchanges to compete for segmented orders by operating qualified 
auctions, or should the 1% be increased to help limit the potential 
costs of market fragmentation? Are the other parameters of the volume 
threshold appropriate to achieve the objective of ensuring that 
qualified auctions are offered by trading centers that have sufficient 
volume to provide vigorous competition? Is average daily volume during 
at least 4 of the preceding 6 calendar months an appropriate parameter, 
or are there more appropriate parameters? Is there another approach 
that would be more effective to help limit the potential costs of 
market fragmentation that could be associated with the requirements of 
Proposed Rule 615?
    9. Under the proposal, national securities exchanges would be 
required to operate pursuant to their own rules providing that such 
exchanges would comply with the requirements for qualified auctions. 
Would this requirement provide sufficient notice to market participants 
concerning the operation of qualified auctions by national securities 
exchanges?
    10. Should an NMS Stock ATS, to meet the proposed definition of an 
open competition trading center, be required to display quotes through 
an SRO display-only facility? Also, should an NMS Stock ATS be required 
to operate as an automated trading center and display automated 
quotations that are disseminated in consolidated market data?
    11. Do commenters believe that identifying an NMS Stock ATS as the 
venue of execution in transaction reports that are disseminated in 
consolidated market data would be helpful to market participants when 
assessing qualified auctions?
    12. Should an NMS Stock ATS be required to permit any registered 
broker-dealer to become a subscriber, except for a broker-dealer that 
is subject to a statutory disqualification or, pursuant to written 
policies and procedures, does not meet standards of financial 
responsibility or operational capability?
    13. Is an equal access standard appropriate for NMS Stock ATSs to 
meet the definition of an open competition trading center and operate 
qualified auctions? Alternatively,

[[Page 165]]

should other approaches be used to achieve the objective of a level 
playing field regarding Proposed Rule 615 between NMS Stock ATSs and 
national securities exchanges, given their different statutory and 
regulatory regimes? For example, should the existing fair access 
requirement in Rule 301(b)(5) of Regulation ATS be used instead of the 
proposed equal access requirement? Are there other aspects of access to 
an NMS Stock ATS operating as an open competition trading center 
offering qualified auctions that should be addressed by Proposed Rule 
615?
    14. Is requiring a minimum level of trading volume for NMS Stock 
ATSs an appropriate means to achieve the objectives of Proposed Rule 
615? If so, should the 1% volume threshold should be lower or higher? 
Are the other parameters of the volume threshold appropriate to achieve 
the objective of ensuring that qualified auctions are offered by 
trading centers that have sufficient volume to provide vigorous 
competition? Is average daily volume during at least 4 of the preceding 
6 calendar months an appropriate parameter, or are there more 
appropriate parameters? Is there another approach that would be more 
effective to help limit the potential costs of market fragmentation 
that could be associated with the requirements of Proposed Rule 615?
    15. Would market participants have sufficient notice concerning the 
operation of qualified auctions by NMS Stock ATSs if they operate 
pursuant to an effective Form ATS-N that evidences compliance with the 
requirements for a qualified auction in Proposed Rule 615(c) and with 
the other provisions of the proposed definition of an open competition 
trading center?
    16. Are there any other requirements, beyond those specified in the 
proposed definition of an open competition trading center, that 
national securities exchanges or NMS Stock ATSs should meet to be 
eligible to qualify as open competition trading centers and operate 
qualified auctions?
    17. Should national securities exchanges that do not meet the 
proposed definition of an open competition trading center be excluded, 
as proposed, from the definition of a restricted competition trading 
center based on their statutory requirements relating to access and 
competition?
    18. Does the proposed definition of originating broker 
appropriately capture the brokers that would make the determination of 
whether an order falls within the definition of a segmented order, as 
well as the broker that would be required to be identified in auction 
messages? Instead of allowing originating brokers to choose whether to 
be identified in auction messages, should Proposed Rule 615, as a means 
to promote greater uniformity of execution quality for segmented orders 
from different originating brokers, prohibit any identification of the 
originating broker in auction messages and require originating brokers 
to certify that their identity will not be disclosed for all segmented 
orders? Should originating brokers for a segmented order, other than 
the broker responsible for approving the opening of accounts with 
customers, be identified in the auction message? Should carrying or 
clearing brokers that are an originating broker for a segmented order 
also be disclosed in an auction message? Would such information be 
useful to market participants' decisions whether to submit auction 
responses and at what prices?
    19. Are the five proposed exceptions in paragraph (b) of Proposed 
Rule 615 appropriate? Should additional exceptions be included, such as 
an exception for orders directed by the customer to a particular 
trading center?
    20. Instead of providing an exception for executions of segmented 
orders during a time period when no open competition trading center is 
operating a qualified auction, should the execution of segmented orders 
during such a time period be prohibited? Is market value an appropriate 
approach to identifying large trades that should be excepted from 
Proposed Rule 615? If so, should the threshold amount of $200,000 be 
lower or higher? For example, do commenters believe that segmented 
orders in NMS stocks with a market value of up to $200,000 could be 
executed efficiently in qualified auctions at prices that mostly would 
be at or within the NBBO? If not, what market value should be used to 
achieve this objective and should it vary based on the trading 
characteristics of a particular NMS stock?
    21. Would it be appropriate for Proposed Rule 615(b) to include an 
exception for executions at a price less favorable to the segmented 
order than a midpoint execution, so long as the segmented order is 
executed at a price with a specified amount of price improvement? If 
so, what would be the appropriate level of price improvement?
    22. Is it appropriate for Proposed Rule 615(b) to include an 
exception for executions of a segmented order with a limit price 
selected by the customer that is equal to or more favorable for the 
segmented order than the midpoint of the national best bid and national 
best offer when the segmented order is received by the restricted 
competition trading center? Should there be an exception for a wider 
range of limit orders, in addition to, or instead of this proposed 
exception? For example, should there be an exception for all non-
marketable limit orders (i.e., any buy limit order with a price less 
than the NBO and any sell limit order with a price greater than the 
NBB)?
    23. Is it appropriate for Proposed Rule 615(b) to include the 
exception for executions of segmented orders where no qualified 
auctions are being offered for orders that are not entirely in whole 
shares, and the customer selected a size for a segmented order that is 
not entirely in whole shares of an NMS stock, in which case any portion 
of such segmented order that is less than one whole share of the NMS 
stock, and only such portion, would not be subject to the order 
competition requirement of paragraph (a) of Proposed Rule 615? Would a 
broker-dealer's best execution responsibilities be sufficient to ensure 
that the fractional portion of the segmented order is executed in the 
best market available? Do commenters believe that, if Proposed Rule 615 
were adopted, open competition trading centers would offer qualified 
auctions that accommodate fractional shares? If not, should a broker-
dealer be required to round up a segmented order with a fractional 
component before submitting the order to a qualified auction, with the 
broker-dealer required to accept the rounded up portion of the order? 
Or would broker-dealers be less willing to offer their customers 
transactions in fractional shares if rounding up were required?
    24. Should auction messages be required to include the side (buy or 
sell) of a segmented order? For example, if side were not included in 
auction messages, market participants could be allowed to provide 
auction responses for one or both sides, with only auction responses on 
the opposite side of the segmented order considered for execution. Do 
commenters believe that such an approach would limit the extent to 
which quoted price might move away from segmented orders during the 
pendency of a qualified auction?
    25. Should the minimum or maximum time periods for qualified 
auctions be shorter or longer? Should a restricted competition trading 
center be permitted to execute a segmented order that was not executed 
in a qualified auction at the specified limit price as soon as 
reasonably possible, or should there be a specified time period for 
execution?
    26. Should the pricing increment be smaller or larger than the 
proposed 0.1

[[Page 166]]

cent for segmented orders and auction responses with prices of $1.00 or 
more per share? Would, for example, the potential benefit for segmented 
orders of a smaller pricing increment, such as 0.05 cent, outweigh the 
potential cost of less direct interaction of investor orders without 
the participation of a dealer?
    27. Does Proposed Rule 615(c)(4) appropriately address the fees and 
rebates for qualified auctions? Is the proposed prohibition of any fee 
for the submission or execution of segmented orders appropriate? Should 
the proposed 5 mil cap on fees for executed auction responses priced at 
$1.00 per share or more be higher or lower? Should the proposed 5 mil 
cap on rebates for segmented orders priced at $1.00 per share or more 
be higher or lower? Is it appropriate to require that the rates for 
fees and rebates be flat in all auctions?
    28. Are the execution priority requirements specified in Proposed 
Rule 615(c)(5) appropriate? Should auction responses of customers have 
priority over auction responses of broker-dealers at the same price? Is 
it appropriate to prohibit execution priority terms that favor the 
broker-dealer that routed the segmented order, the originating broker 
for the segmented order, and the open competition trading center 
operating the auction, as well as affiliates of the foregoing persons? 
Should the requirements for execution priority of orders resting on the 
continuous order book of an open competition trading center be 
modified? Should displayed orders on the continuous order book have 
priority over auction responses at the same price? Should auction 
responses have priority over undisplayed orders on the continuous order 
book at the same price?
    29. Should an open competition trading center be permitted to give 
execution priority advantages to market makers that accept objective 
affirmative obligations, such as public quoting obligations or an 
obligation to fill segmented orders at the relevant NBBO if such orders 
do not otherwise receive an execution in qualified auctions? For 
example, Table 7 in section VII.B.4 below shows that 1.67% of 
marketable order shares are executed by wholesalers at prices outside 
the NBBO at the time the wholesaler received the order. Do commenters 
believe that, if Rule 615 were adopted as proposed, a larger percentage 
of marketable orders of individual investors would be executed at 
prices outside the NBBO when the order is received by a trading center?
    30. Should the broker routing a segmented order to a qualified 
auction be required to execute the order, or any unexecuted portion 
thereof, at the specified limit price or some other price if the 
segmented order is not executed in full in the auction?
    31. Should there be parameters for what the specified limit price 
selected by a broker routing a segmented order to a qualified auction 
could be? For example, should the specified limit price be required to 
be within a range that is tied to the midpoint of the NBBO at the time 
the segmented order is received?
    32. Should an open competition trading center be permitted to 
operate multiple qualified auctions in the same NMS stock 
simultaneously?
    33. Should open competition trading centers have flexibility to 
determine aspects of qualified auctions that are not specified by 
Proposed Rule 615? Are there additional aspects for qualified auctions 
that should be specified by rule? For example, are there additional 
aspects of execution priority that should be specified by rule or, 
alternatively, that open competition trading centers should have 
greater flexibility to determine?
    34. Should open competition trading centers and national securities 
exchanges be allowed to continue to operate trading systems, other than 
qualified auctions, that are limited, in whole or in part, to the 
execution of segmented orders and that do not fall within one of the 
five exceptions in Proposed Rule 615(d)(2) and (g)? For example, should 
national securities exchanges be permitted to continue to operate RLPs 
that do not qualify for one of the exceptions in Proposed Rule 615(g)? 
Are there other types of limited trading facilities operated by 
national securities exchanges or open competition trading centers that 
should be permitted?
    35. Is it appropriate, as provided in Proposed Rule 615(f)(4), to 
prohibit broker-dealers with knowledge of where a segmented order is to 
be routed for execution from submitting, or enabling the submission, of 
an order to the continuous order book of an open competition trading 
center that could trade with that segmented order? Do commenters 
believe that this prohibition could significantly interfere with 
broker-dealer handling of customer orders and, if so, would limiting 
the prohibition to the proprietary orders of a broker-dealer and its 
affiliates be consistent with the purposes of Proposed Rule 615?
    36. Does Proposed Rule 615(e)(4) provide sufficient clarification 
as to which broker-dealer would be subject to the obligations of 
Proposed Rule 615(e) when there are multiple originating brokers for a 
segmented order and such originating brokers have in place a written 
agreement that allocates their responsibilities with respect to 
customer orders?
    37. Does Rule 613 of Regulation NMS and the Consolidated Audit 
Trail NMS Plan require adequate reporting of all elements of this 
proposed rule so that regulators can evaluate compliance and study its 
effectiveness?\260\
---------------------------------------------------------------------------

    \260\ See supra note 254 (discussing the type of data to be 
collected and reported pursuant to the CAT NMS Plan).
---------------------------------------------------------------------------

VI. Paperwork Reduction Act Analysis

    Certain provisions of Proposed Rule 615 contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\261\ The Commission is submitting 
these collections of information to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless the agency 
displays a currently valid control number. The title of the new 
collection of information is ``Order Competition Rule.'' The 
requirements of this collection of information would be mandatory for 
originating brokers, brokers and dealers that route segmented orders, 
national securities exchanges and NMS Stock ATSs that operate qualified 
auctions as open competition trading centers, and national securities 
associations that provide auction message information for dissemination 
in consolidated market data.
---------------------------------------------------------------------------

    \261\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

A. Summary of Collection of Information

    Proposed Rule 615 and the proposed related amendments would create 
burdens under the PRA by creating the new collections of information 
described below for market participants that handle or execute 
segmented orders, or operate qualified auctions to provide competition 
for segmented orders.
1. Auction Messages
    Proposed Rule 615 would require an open competition trading center 
to comply with the requirements of paragraph (c) for operation of a 
qualified auction for segmented orders.\262\ Pursuant to paragraph 
(c)(1), an open competition trading center operating a qualified 
auction would be required to provide an auction message announcing

[[Page 167]]

the initiation of a qualified auction for a segmented order for 
dissemination in consolidated market data. Each auction message shall 
invite priced auction responses to trade with a segmented order and 
shall include, among other things, the identity of the originating 
broker.\263\
---------------------------------------------------------------------------

    \262\ Supra section IV.C.
    \263\ As discussed above in section IV.C.1, the identity of the 
originating broker is not required to be disclosed, however, if the 
originating broker makes the requisite certification.
---------------------------------------------------------------------------

2. Identifying and Marking Segmented Orders
a. Identification of Segmented Orders
    Paragraph (e)(1) would require originating brokers to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to identify the orders of customers as segmented orders.
b. Marking Segmented Orders
    Paragraph (e)(2) of Proposed Rule 615 would require originating 
brokers to identify a segmented order as such to any destination the 
broker routes the order. Additionally, pursuant to paragraph (f)(1) of 
Proposed Rule 615, no broker-dealer that receives an order identified 
as a segmented order shall route the order without identifying the 
order as a segmented order to the routing destination. Thus, 
originating brokers and other broker-dealers that route segmented 
orders would be required to mark segmented orders as such.
3. Originating Broker Certification
    Pursuant to paragraph (e)(3), if the originating broker for a 
segmented order that is the originating broker responsible for 
approving the opening of accounts with customers determines to make the 
certification referenced in paragraph (c)(1)(iii) of Proposed Rule 615, 
the originating broker shall establish, maintain, and enforce the 
required policies and procedures reasonably designed to assure that the 
identity of the originating broker will not be disclosed.\264\ As 
discussed above, the certification must also be communicated to the 
open competition trading center operating the qualified auction.\265\ 
The Commission believes that broker-dealers would likely use order 
marking systems to communicate to an open competition trading center 
whether an originating broker has made the certification referenced in 
Proposed Rule 615(c)(1)(iii). Accordingly, the originating broker with 
responsibility for transmitting orders for a customer's account would 
mark segmented orders to indicate that the certification has been made, 
and other broker-dealers that receive and route such orders would also 
mark such orders accordingly. As discussed below, the Commission 
believes that broker-dealers would have an initial burden to modify 
their systems to be able to mark segmented orders as such, and an 
ongoing burden to mark segmented orders. The Commission also believes 
that broker-dealers would include in those systems modifications, the 
ability to communicate whether an originating broker has made the 
referenced certification, and on an ongoing basis would include the 
certification information, as applicable, when marking segmented 
orders. Thus, the Commission believes that the initial burden for 
broker-dealers to modify their systems to mark orders as segmented 
orders and the ongoing burden to mark segmented orders as such, as 
discussed below, would subsume the burden to mark orders to communicate 
when the certification has been made and therefore estimates no 
additional costs associated with communication of the certification.
---------------------------------------------------------------------------

    \264\ Supra section IV.E.
    \265\ Supra section IV.C.1.
---------------------------------------------------------------------------

4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    Pursuant to paragraph (d)(1) of Proposed Rule 615, a national 
securities exchange or NMS Stock ATS shall not operate a qualified 
auction for segmented orders unless it meets the definition of open 
competition trading center in Proposed Rule 600(b)(64).\266\ For an NMS 
Stock ATS to qualify as an open competition trading center eligible to 
operate a qualified auction, Proposed Rule 600(b)(64)(ii)(D) would 
require the NMS Stock ATS to permit any registered broker or dealer 
(other than a broker or dealer subject to a statutory disqualification) 
to become a subscriber of the ATS. The NMS Stock ATS could, however, 
pursuant to written policies and procedures, prohibit a broker or 
dealer from being or becoming a subscriber, or impose conditions on a 
broker or dealer subscriber, that does not meet standards of financial 
responsibility or operational capability, as are prescribed by the 
written policies and procedures. Thus, to be able to exclude a broker-
dealer from becoming a subscriber (other than a broker or dealer 
subject to a statutory disqualification), or imposing conditions on 
such a subscriber, the NMS Stock ATS would be required to have written 
policies and procedures.
---------------------------------------------------------------------------

    \266\ Supra section IV.B.2, and IV.D.
---------------------------------------------------------------------------

B. Proposed Use of Information

    As discussed above,\267\ Proposed Rule 615 is designed to benefit 
individual investors by enhancing the opportunity for their orders to 
receive more favorable prices than they receive in the current market 
structure, as well as to benefit investors generally by giving them an 
opportunity to interact directly with a large volume of individual 
investor orders that are mostly inaccessible to them in the current 
market structure, by requiring that individual investor orders be 
exposed to order-by-order competition in fair and open auctions 
designed to obtain the best prices before such orders could be 
internalized by wholesalers or any other type of trading center that 
restricts order-by-order competition.
---------------------------------------------------------------------------

    \267\ Supra section I.
---------------------------------------------------------------------------

1. Auction Messages
    The auction messages provided under paragraph (c)(1) of Proposed 
Rule 615 would be disseminated in consolidated market data and would be 
used by market participants to determine whether to submit auction 
responses. As discussed above, the wide dissemination of these auction 
messages would promote competition by soliciting potential auction 
responses from a wide spectrum of market participants.\268\
---------------------------------------------------------------------------

    \268\ Supra section IV.C.1.
---------------------------------------------------------------------------

2. Identifying and Marking Segmented Orders
a. Identification of Segmented Orders
    The requirements of paragraph (e)(1) of Proposed Rule 615 are 
designed to ensure that originating brokers are able to properly 
identify segmented orders. Specifically, written policies and 
procedures established pursuant to Proposed Rule 615(e)(1) would help a 
broker develop a process, relevant to its customers and the nature of 
its business, for properly identifying the orders of its customers as 
segmented orders. Further, the maintenance of written policies and 
procedures would generally: (1) assist a broker-dealer in supervising 
and assessing its compliance with Proposed Rule 615; and (2) assist the 
Commission and SRO staff in connection with examinations and 
investigations.
b. Marking Segmented Orders
    Marking segmented orders as such pursuant to paragraphs (e)(2) and 
(f)(1) of Proposed Rule 615 would inform other market participants that 
the orders must be handled in accordance with the requirements of 
Proposed Rule 615, which, as discussed above, is designed

[[Page 168]]

to provide competition for individual investor orders in fair and open 
auctions.
3. Originating Broker Certification
    Written policies and procedures established pursuant to Proposed 
Rule 615(e)(3) would help a broker develop a process, relevant to the 
nature of its business, to ensure that its identity will not be 
disclosed and to support its certification. Further, the maintenance of 
written policies and procedures would generally: (1) assist a broker in 
supervising and assessing its compliance with Proposed Rule 615(e)(3); 
and (2) assist the Commission and SRO staff in connection with 
examinations and investigations.
    Communication of the certification to the relevant open competition 
trading center would enable the open competition trading center to 
comply with the requirements of Proposed Rule 615(c)(1) that an auction 
message disclose the identity of the originating broker for a segmented 
order, unless the originating broker has made the requisite 
certification.\269\
---------------------------------------------------------------------------

    \269\ As discussed above, the disclosure of the identity of the 
originating broker in an auction message, absent the corresponding 
certification, is designed to help ensure fair competition among 
auction responders and persons that could otherwise trade with the 
segmented order, while giving originating brokers a choice as to 
whether or not to disclose their identity. Supra section IV.C.1.
---------------------------------------------------------------------------

4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    To qualify as an open competition trading center, an NMS Stock ATS 
would be required to permit any registered broker-dealer (other than a 
broker-dealer subject to a statutory disqualification) to become a 
subscriber of the NMS Stock ATS, and must provide equal access among 
all subscribers of the NMS Stock ATS.\270\ These requirements are 
designed to help ensure a level playing field regarding Proposed Rule 
615 for competition among NMS Stock ATSs and national securities 
exchanges, in light of the different regulatory regimes for each. 
Similar to the requirements for national securities exchanges, under 
Proposed Rule 600(b)(64)(ii)(D), NMS Stock ATSs could exclude a 
registered broker-dealer, or impose conditions on a broker-dealer 
becoming a subscriber, that does not meet certain standards of 
financial responsibility or operational capability, but may only do so 
pursuant to written policies and procedures. While national securities 
exchanges must prescribe rules, consistent with the Exchange Act, for 
denying membership to a broker-dealer, the requirements applicable to 
NMS Stock ATSs are less stringent.\271\ Requiring NMS Stock ATSs to 
establish written policies and procedures would help an NMS Stock ATS 
to develop a process for identifying registered broker-dealers that 
should be excluded because they do not meet certain standards, and 
would help level the competitive playing field regarding Proposed Rule 
615 between NMS Stock ATSs and national securities exchanges. Further, 
the written policies and procedures would generally: (1) assist an NMS 
Stock ATS in supervising and assessing its compliance with the access 
requirements of proposed Rule 600(b)(64)(ii)(D); and (2) assist the 
Commission and SRO staff in connection with examinations and 
investigations.
---------------------------------------------------------------------------

    \270\ Supra section IV.B.2.
    \271\ Id.
---------------------------------------------------------------------------

C. Respondents

    A summary of the Commission's initial estimates of the number of 
respondents for each collection of information requirement is set forth 
below:

                                Collection of Information--Order Competition Rule
----------------------------------------------------------------------------------------------------------------
                                                                                                     Number of
        Description of burden                        Rule                 Applicable respondents    respondents
----------------------------------------------------------------------------------------------------------------
Dissemination of Auction Messages...  Rule 615(c)(1)...................  National securities                   6
                                                                          exchanges operating
                                                                          qualified auctions.
                                                                         National securities                   1
                                                                          associations.
                                                                         NMS Stock ATSs                        3
                                                                          operating qualified
                                                                          auctions.
                                                                                                 ---------------
    Total...........................  .................................  .......................              10
Policies and Procedures to Identify   Rule 615(e)(1)...................  Originating broker-                 157
 Segmented Orders.                                                        dealers with
                                                                          responsibility for
                                                                          identifying segmented
                                                                          orders.
Identification of Segmented Orders    Rule 615(e)(2)...................  Originating broker-                 157
 by Originating Brokers.                                                  dealers with
                                                                          responsibility for
                                                                          identifying segmented
                                                                          orders.
Marking of Segmented Orders:
    Marking of Segmented Orders by    Rule 615(e)(2)...................  Originating broker-                 157
     Originating Brokers.                                                 dealers with
                                                                          responsibility for
                                                                          marking segmented
                                                                          orders.
    Marking of Segmented Orders by    Rule 615(f)(1)...................  Broker-dealers that                  25
     Broker-Dealers.                                                      route orders
                                                                          identified as
                                                                          segmented orders.
                                                                                                 ---------------
        Total.......................  .................................  .......................             182
Policies and Procedures for Rule      Rule 615(e)(3)...................  Originating broker-                  20
 615(c) Certification.                                                    dealers certifying
                                                                          that they established,
                                                                          maintained, and
                                                                          enforced policies and
                                                                          procedures reasonably
                                                                          designed to assure
                                                                          that their identity
                                                                          will not be disclosed.
NMS Stock ATS Policies and            Rule 615(d)(1)...................  NMS Stock ATSs                        3
 Procedures to Exclude Subscribers.                                       operating qualified
                                                                          auctions that may
                                                                          exclude subscribers.
----------------------------------------------------------------------------------------------------------------

1. Auction Messages
    As discussed above,\272\ the open competition trading centers that 
would be required to provide auction messages for dissemination in 
consolidated market data pursuant to paragraph (c)(1) of Proposed Rule 
615 would be national securities exchanges and NMS Stock ATSs that meet 
certain requirements and are eligible to operate qualified auctions for 
segmented orders. As is currently the case for quotation and trading 
information in NMS stocks, auction information would be provided by 
national securities exchanges and FINRA, as the only national 
securities association, to the SIPs for

[[Page 169]]

dissemination in consolidated market data.\273\
---------------------------------------------------------------------------

    \272\ Supra section IV.B.2.
    \273\ Supra sections III.B.1 and IV.C.1.
---------------------------------------------------------------------------

    Given that all national securities exchanges already have systems 
and processes for providing information for dissemination in 
consolidated market data as well as systems and processes for 
disseminating certain auction information,\274\ the Commission 
estimates that it is likely that 6 of the 16 national securities 
exchanges that trade NMS stocks would choose to qualify as open 
competition trading centers and operate qualified auctions. Of the 16 
registered national securities exchanges currently trading NMS 
stocks,\275\ 12 are part of one of 3 corporate affiliate groups, and 
the Commission estimates that one of the national securities exchanges 
from each of the three corporate groups would likely choose to operate 
qualified auctions.\276\ Of the four other national securities 
exchanges that currently trade NMS stocks, the Commission estimates 
that three exchanges would likely choose to operate qualified 
auctions.\277\
---------------------------------------------------------------------------

    \274\ Supra section IV.B.1. In addition to providing 
consolidated market data, national securities exchanges also sell 
their individual proprietary market data products, and their depth 
of book (``DOB'') products typically include, among other things, 
information about orders participating in auctions, including 
auction order imbalances. See, e.g., Nasdaq Rule 123(a)(1)(B) 
available at https://listingcenter.nasdaq.com/rulebook/nasdaq/rules/Nasdaq%20Equity%207#section_123_nasdaq_depth-of-book_data (defining 
Nasdaq's ``Nasdaq TotalView'' data product); and https://www.nyse.com/market-data/real-time/integrated-feed (describing 
NYSE's ``NYSE Integrated'' data product).
    \275\ Supra note 82 and accompanying text.
    \276\ CBOE Holdings, Inc. is the parent company of Cboe BYX, 
Cboe BZX, Cboe EDGA, and Cboe EDGX; Nasdaq, Inc. is the parent 
company of Nasdaq BX, Nasdaq PhlX, and Nasdaq; Intercontinental 
Exchange, Inc. is the parent company of NYSE, NYSE American, NYSE 
Arca, NYSE CHX, and NYSE National.
    \277\ The remaining four national securities exchanges that 
trade NMS stocks are IEX, LTSE, MEMX, and MIAX PEARL, which is a 
subsidiary of MIAX International Holdings, Inc. Of these, based on 
examination of data related to national securities exchanges, for 
the month ended Nov. 30, 2022, only LTSE did not report more than 1% 
of share volume in NMS stocks. Proposed Rule 600(b)(64) requires a 
national securities exchange to have had an average daily share 
volume for NMS stocks of 1% or more during at least four of the 
preceding 6 calendar months to qualify as an open competition 
trading center eligible to operate a qualified auction. See Cboe, 
U.S. Historical Market Volume Data, available at: https://cboe.com/us/equities/market_statistics/historical_market_volume/.
---------------------------------------------------------------------------

    The Commission also estimates that some, but not all NMS Stock ATSs 
would chose to operate qualified auctions for segmented orders. One of 
the requirements of Proposed Rule 615 is that an open competition 
trading center must meet the definition set forth in Proposed Rule 
600(b)(64), which would require that an NMS Stock ATS permit any 
registered broker or dealer (other than a broker or dealer subject to a 
statutory disqualification) to become a subscriber and provide equal 
access among all subscribers. To qualify as an open competition trading 
center, Proposed Rule 600(b)(64) would also require an NMS Stock ATS to 
display quotations through an SRO display-only facility and operate as 
an automated trading center that displays automated quotations 
disseminated in consolidated market data. Given that NMS Stock ATSs 
often differentiate between groups or classes of subscribers with 
respect to access to services and most have adopted a ``dark'' trading 
model,\278\ of the 32 NMS Stock ATSs, the Commission estimates that 
approximately three are likely to make the business model modifications 
necessary to meet the open competition trading center definition and be 
eligible to operate qualified auctions.\279\
---------------------------------------------------------------------------

    \278\ NMS Stock ATSs must publicly disclose information about 
their trading system and services, including differences in access, 
on Form ATS-N. Links to Form ATS-N filings are available on the 
Commission's website at https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm. See also ATS-N Adopting Release, supra note 
159, 83 FR at 38886 n.1292 and accompanying text (discussing the 
dark trading model adopted by most NMS Stock ATSs).
    \279\ The Commission bases this estimate on the following 
considerations. While currently no NMS Stock ATS would qualify as an 
Open Competition Trading Center, there is currently one NMS Stock 
ATS that discloses that it crosses the 5% volume threshold for fair 
access under Regulation ATS for securities that are available for 
trading on its platform. This NMS Stock ATS may choose to make the 
necessary modifications to operate as an Open Competition Trading 
Center. In addition, given the low-cost nature of segmented order 
flow that is likely to be attractive to market participants, the 
Commission estimates that two additional NMS Stock ATSs would choose 
to make the necessary modifications to operate as Open Competition 
Trading Centers.
---------------------------------------------------------------------------

    As discussed above, broker-dealers provide certain NMS stock 
information to FINRA through its facilities, and FINRA provides 
information for dissemination in consolidated market data. To qualify 
as open competition trading centers, the three NMS Stock ATSs would 
have systems and processes in place to display quotations disseminated 
in consolidated market data. These ATSs would provide auction message 
information to FINRA, and FINRA would transmit the information for 
dissemination in consolidated market data.
    The Commission requests comment on its estimates of the number of 
exchanges and NMS Stock ATSs that would become open competition trading 
centers operating qualified auctions, including whether the estimates 
should be lower or higher.
2. Identifying and Marking Segmented Orders
    As discussed above, Proposed Rule 615 would impose certain 
obligations on originating brokers, and all other broker-dealers, with 
respect to their handling of segmented orders. Proposed Rule 600(b)(69) 
defines ``originating broker'' to mean any broker with responsibility 
for handling a customer account,\280\ and Proposed Rule 600(b)(91) 
defines ``segmented order'' as an order for the account of a natural 
person (or an account held on behalf of a natural person or group of 
related family members) that meets certain trading volume 
thresholds.\281\ Most segmented orders are handled by large, customer-
facing broker-dealers that accept orders from customers and then route 
these orders to various execution centers. Also, as discussed above, in 
section IV.B.4, broker business practices can vary widely in terms of 
how customer accounts are handled, with some brokers performing the 
entire function internally and others allocating various 
responsibilities of an originating broker to other brokers-dealers such 
as carrying or clearing brokers. Those originating brokers who have 
been assigned responsibilities that include the transmission of orders 
for execution would need to identify and mark segmented orders as such 
to comply with Proposed Rule 615.\282\
---------------------------------------------------------------------------

    \280\ Supra section IV.B.4.
    \281\ Supra section IV.B.1.
    \282\ Supra section IV.B.4.
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    Based on FOCUS Report data,\283\ the Commission estimates that as 
of June 30, 2022 there were 3,498 registered broker-dealers,\284\ and 
of these there were 157 reporting that they carry public customer 
accounts \285\ that would likely be subject to the requirements of 
paragraphs (e)(1) and (2) of Proposed Rule 615.
---------------------------------------------------------------------------

    \283\ FOCUS Reports, or ``Financial and Operational Combined 
Uniform Single'' Reports, are monthly, quarterly, and annual reports 
that broker-dealers are generally required to file with the 
Commission and/or SROs pursuant to Exchange Act Rule 17a-5. See 17 
CFR 240.17a-5.
    \284\ The data is obtained from FOCUS Reports, Part II filed for 
the second quarter of 2022.
    \285\ Information on the number broker-dealers that carry public 
customer accounts is from broker-dealers' responses on their most 
recently available FOCUS Report Form X-17A-5 Schedule I. Because 
``public customer accounts'' may hold orders other than segmented 
orders, for example institutional customers would also fall within 
the definition of ``public customer'' for purposes of FOCUS Report 
Form X-17A-5 Schedule I, 157 is likely an overestimate.
---------------------------------------------------------------------------

    Paragraph (f)(1) of Proposed Rule 615 would also require every 
broker-dealer that receives a segmented order and routes that order to 
identify the order as such. This would include broker-dealers

[[Page 170]]

that act as wholesalers that would be required to route a segmented 
order to be exposed in a qualified auction at a price prior to 
executing it, or that route the order to another execution center; and 
any other broker-dealer, including originating broker-dealers assigned 
responsibilities that include identifying and marking orders, that 
routes segmented orders. The Commission estimates that approximately 25 
broker-dealers that do not also carry customer accounts would route 
retail orders.\286\
---------------------------------------------------------------------------

    \286\ This estimate is based broker-dealers' responses on their 
most recently available FOCUS Report Form X-17A-5 Schedule I, 
showing that there are 25 broker-dealers that effect public customer 
transactions in equity securities on a national securities exchange 
or OTC that do not carry public customer accounts.
---------------------------------------------------------------------------

a. Identification of Segmented Orders
    As discussed above, the Commission estimates that there are 157 
originating brokers that would be required to establish, maintain, and 
enforce written policies and procedures reasonably designed to identify 
customer orders as segmented orders pursuant to paragraph (e)(1) of 
Proposed Rule 615. While there are additional broker-dealers, such as 
introducing brokers, that would meet the definition of ``originating 
broker,'' only those broker-dealers carrying customer accounts are 
likely to have been allocated responsibility for routing orders and 
therefore would have burdens and costs associated with implementing the 
requirements of paragraph (e)(1) of Proposed Rule 615.
    The Commission requests comment on whether its estimate of the 
number of brokers that would fall within the scope of Proposed Rule 
615(e)(1), including whether the estimate should be higher or lower.
b. Marking Segmented Orders
    As discussed above, the Commission estimates that there would be 
157 originating brokers that would be required to identify segmented 
orders as such prior to routing those orders pursuant to Proposed Rule 
615(e)(2). Additionally, the Commission estimates that there would be 
an additional 25 broker-dealers that route customer orders, and would 
not also be originating brokers in the scope of paragraph (e)(2), that 
would be required, pursuant to Proposed Rule 615(f)(1) to identify any 
segmented orders received as such, when routing the order to a routing 
destination.
    The Commission requests comment on its estimate of the number of 
broker-dealers that would fall within the scope of paragraphs (e)(2) 
and (f)(1) of Proposed Rule 615, including whether the estimate should 
be higher or lower.
3. Originating Broker Certification
    It is likely that most originating brokers with segmented orders 
would choose to be identified as the originating broker of a segmented 
order because that information would be used by market participants to 
help predict the level of adverse selection costs associated with order 
flow from a given originating broker. Thus, originating brokers known 
to be associated with lower adverse selection costs would likely want 
auction responders to know their identity. Based on a review of data 
related to broker-dealers, the Commission estimates that there are 
approximately 1,267 broker-dealers that would meet the definition of 
``originating broker'' and that have responsibility for monitoring 
customer accounts.\287\ These broker-dealers would be required to 
maintain the policies and procedures required by paragraph(e)(3) of 
Proposed Rule 615 if they choose not to have their identity disclosed 
in auction messages. While it is very difficult for the Commission to 
know how many originating brokers would choose to certify that they 
established, maintained, and enforced written policies and procedures 
reasonably designed to assure that their identity will not be disclosed 
to any person that potentially could participate in the qualified 
auction or otherwise trade with the segmented order routed by the 
originating broker, the Commission preliminarily estimates that 20 of 
the 1,267 originating brokers would choose not to disclose their 
identity and would be required to establish, maintain and enforce the 
written policies and procedures required by paragraph (e)(3) of 
Proposed Rule 615. While segmented orders, by definition, are limited 
to orders for accounts with an average daily number of trades in NMS 
stocks of less than 40 in each of the six preceding months, and thereby 
likely associated with lower adverse selection costs, there may be some 
broker-dealers that have order flow associated with higher levels of 
adverse selection costs or who have customers or business models that 
preference anonymity.\288\
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    \287\ The Commission estimates that there are approximately 157 
broker-dealers that carry at least one customer account trading in 
NMS stocks, and 1,110 broker-dealers that introduce at least one 
customer account trading in NMS stocks. The estimate of 157 broker-
dealers that carry at least one customer account trading in NMS 
stocks and options is based on the number of broker-dealers that 
report carrying at least one customer account on their 2021 FOCUS 
Report Form X-17A-5 Schedule I; and the estimate of 1,110 broker-
dealers that introduce at least one customer account trading in NMS 
stocks and options is based on estimates using broker-dealers' FDIDs 
identified in CAT data during the 2021 calendar year. As CAT data 
includes information only about NMS stocks and options, broker-
dealers that introduce or carry customer accounts trading in other 
assets classes are not included in these numbers.
    \288\ These broker-dealers are likely to be larger broker-
dealers that have customers who are more informed traders. Lower-
volume broker-dealers with fewer orders are not likely to have this 
type of customer.
---------------------------------------------------------------------------

    As discussed above, the originating broker with responsibility for 
transmitting orders for a customer's account would likely also mark 
segmented orders to indicate that the certification has been made, and 
other broker-dealers that receive and route such orders would also need 
to mark such orders accordingly. The same broker-dealers that would 
mark orders as segmented orders pursuant to paragraphs (e)(2) and 
(f)(1) of Proposed Rule 615, discussed above in section VI.C.2.b, would 
also likely mark orders, as applicable, to communicate the 
certification to the open competition trading center.
    The Commission requests comment on its estimate of the number of 
originating brokers that would certify that they have established, 
maintained, and enforced written policies and procedures reasonably 
designed to assure that the identity of the originating broker will not 
be disclosed, including whether the estimate should be higher or lower. 
The Commission also requests comment on whether it is reasonable to 
estimate that such certifications would be communicated to open 
competition trading centers via order marking and that the same broker-
dealers that would mark orders as segmented orders would also mark 
orders for the purpose of communicating such certifications to the open 
competition trading centers operating qualified auctions.
4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    As discussed above, of the 32 NMS Stock ATSs, the Commission 
estimates that approximately 3 would operate qualified auctions. To do 
so, those NMS Stock ATSs would need to meet the definition of open 
competition trading center, and as such, would be required to have 
written policies and procedures to prohibit any registered broker or 
dealer from being or becoming a subscriber, or impose conditions upon a 
such a subscriber, that does not meet the standards of financial 
responsibility or operational capability of the NMS Stock ATS. The 
Commission anticipates that all three NMS Stock ATSs operating 
qualified auctions would have standards

[[Page 171]]

for financial responsibility or operational capability for their 
subscribers.\289\
---------------------------------------------------------------------------

    \289\ This estimate is based on a review of NMS Stock ATS 
disclosures on Form ATS-N.
---------------------------------------------------------------------------

    The Commission requests comment on whether its estimate that all 
NMS Stock ATSs operating qualified auctions would have standards for 
financial responsibility or operational capability for their 
subscribers is reasonable.

D. Burdens

1. Auction Messages
    As discussed above, the estimated six national securities exchanges 
operating as open competition trading centers operating qualified 
auctions would be required to collect and provide the information 
necessary to generate auction messages in consolidated market data. 
These entities currently operate auctions for which messages are 
disseminated in their proprietary data feeds, and already provide other 
information regarding NMS stocks for dissemination in consolidated 
market data. The auction messages would be a new data element that the 
national securities exchanges would have to make available for 
inclusion in the dissemination of consolidated market data. Because the 
national securities exchanges currently collect and calculate data 
necessary to generate other elements of consolidated market data, and 
also currently provide auction information to subscribers of 
proprietary data, the requirements of Rule 615(c)(1) would likely 
impose minimal initial and ongoing burdens on these respondents, 
including any changes to their systems.
    The Commission estimates that a national securities exchange would 
require an average of 220 initial burden hours of legal, compliance, 
information technology, and business operations personnel time to 
prepare and implement a system to collect and provide the information 
necessary to generate auction messages for dissemination in 
consolidated market data, at a monetized cost per exchange of 
$78,580.\290\ And each national securities exchange would incur an 
annual average burden on an ongoing basis of 336 hours to collect and 
provide auction messages, at a monetized cost per exchange of 
$118,560.\291\
---------------------------------------------------------------------------

    \290\ The Commission estimates the monetized initial burden for 
this requirement to be $78,580: (Compliance Manager at $344 for 105 
hours) + (Attorney at $462 for 70 hours) + (Sr. Systems Analyst at 
$316 for 20 hours) + (Operations Specialist at $152 for 25 hours) = 
220 initial burden hours, at a monetized cost of $78,580. Throughout 
this section VI.D, the Commission derived estimates for in-house 
personnel costs on per hour figures from SIFMA's Management & 
Professional Earnings in the Securities Industry 2013, modified to 
account for an 1,800-hour work-year and inflation, and multiplied by 
5.35 to account for bonuses, firm size, employee benefits and 
overhead.
    \291\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be $118,560: (Compliance Manager at 
$344 for 192 hours) + (Attorney at $462 for 48 hours) + (Sr. Systems 
Analyst at $316 for 96 hours) = 336 initial burden hours, at a 
monetized cost of $118,560.
---------------------------------------------------------------------------

    Proposed Rule 615(c)(1) would also require auction messages 
initiating qualified auctions held on NMS Stock ATSs operating as open 
competition trading centers to be provided for dissemination in 
consolidated market data. As discussed above, like national securities 
exchanges, FINRA already collects information from broker-dealers for 
dissemination in consolidated market data, and the addition of auction 
message information as a new data element would impose approximately 
the same burdens and costs on FINRA as for national securities 
exchanges.\292\
---------------------------------------------------------------------------

    \292\ Supra notes 290 and 291.
---------------------------------------------------------------------------

    To qualify as an open competition trading center eligible to 
operate qualified auctions, an NMS Stock ATS would need to display 
quotations through an SRO display-only facility in compliance with Rule 
610(b); display automated quotations disseminated in consolidated 
market data pursuant to Rule 603(b); \293\ and provide trade reports 
identifying the NMS Stock ATS as the venue of execution that are 
disseminated in consolidated market data pursuant to Rule 603(b).\294\ 
These ATSs would need to have systems in place to collect and calculate 
such information and transmit the information to FINRA for 
dissemination in consolidated market data. It is likely that NMS Stock 
ATSs that run qualified auctions would be operated by large, 
sophisticated broker-dealers that have in place systems that could be 
modified to collect and disseminate auction message information. The 
Commission estimates that the burdens and costs to these NMS Stock ATSs 
to modify their systems to also provide auction information for 
dissemination in consolidated data would be minimal, and would be the 
same as those for national securities exchanges and FINRA.\295\
---------------------------------------------------------------------------

    \293\ The requirements of Rule 610(b) for trading centers that 
choose to display quotations in NMS stock are existing requirements 
under Regulation NMS, and the requirements of Rule 603(b) pertaining 
to the display of quotations from trading centers that qualify as 
automated trading centers, are existing requirements that are not 
modified by Proposed Rule 615 and the proposed new definitions under 
Rule 600 and do not constitute new collections of information.
    \294\ Proposed Rule 600(b)(64)(ii).
    \295\ Supra notes 290 and 291.
---------------------------------------------------------------------------

    The Commission estimates the initial total aggregate burden and 
cost for all 10 respondents would be 2,220 hours, at a monetized cost 
of $785,800,\296\ and the ongoing total burden and cost would be 3,360 
hours, at a monetized cost of $1.12 million.\297\
---------------------------------------------------------------------------

    \296\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be $785,800: $78,580 x (6 national 
securities exchange + 1 registered securities association + 3 NMS 
stock ATSs) = $785,800.
    \297\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be $1,185,600: $118,560 x (6 national 
securities exchange + 1 registered securities association + 3 NMS 
stock ATSs) = $1,185,600.
---------------------------------------------------------------------------

    A summary of the initial and ongoing burdens and costs described 
above is set forth below:

          Total Estimated Burden Associated With Providing Auction Messages In Consolidated Market Data
----------------------------------------------------------------------------------------------------------------
                                                   Burden hours
                                    Respondents         per          Aggregate    Monetized cost     Aggregate
                                                    respondent     burden hours   per respondent  monetized cost
----------------------------------------------------------------------------------------------------------------
Total Initial Burden............              10             220           2,220         $78,580        $785,800
Total Ongoing Burden............              10             336           3,360         118,560       1,185,600
----------------------------------------------------------------------------------------------------------------

    The Commission requests comment on whether there would be different 
or additional burdens or costs for open competition trading centers to 
provide the information necessary to generate auction messages in 
consolidated market data. The Commission also requests comment on 
whether the burdens and costs for NMS Stock ATSs to provide the 
information necessary to generate auction messages in consolidated 
market data would be different from those for national securities 
exchanges.

[[Page 172]]

2. Identifying and Marking Segmented Orders
a. Policies and Procedures To Identify Segmented Orders
    As discussed above, the 157 broker-dealers that would need to 
identify and mark orders to comply with paragraphs (e)(1) and (e)(2) of 
Proposed Rule 615 likely already would have policies and procedures to 
classify orders for compliance with SRO rules and other regulatory 
requirements, and would have access to the information that would 
enable them to identify orders as being for the account of a natural 
person or a group of related family members and to monitor the level of 
trading activity in the accounts of their customers, as well as systems 
and processes for marking orders.\298\ For example, these broker-
dealers either themselves collect data from their customers, or receive 
such information through an introducing broker for whom they are 
providing services. These broker-dealers will also be familiar with how 
to adapt their systems and processes to identify which customer 
accounts meet the proposed volume requirements that would cause their 
orders to meet the definition of segmented order in Proposed Rule 
600(b)(89) and to accommodate the new order marks.
---------------------------------------------------------------------------

    \298\ Supra section IV.B.1 (discussing the definition of 
segmented order, which is designed to facilitate compliance and 
minimize the costs of compliance) and note 253 and accompanying 
text.
---------------------------------------------------------------------------

    While most broker-dealers likely have capabilities to identify the 
characteristics of their customers' orders that would be necessary to 
identify orders as segmented orders, they would not have written 
policies and procedures regarding the identification of segmented 
orders, which would be a new classification for a subset of customer 
orders, as would be required by Proposed Rule 615(e)(1). The Commission 
estimates that, to initially comply with this obligation, broker-
dealers would employ a combination of in-house and outside legal and 
compliance counsel to update existing policies and procedures.
Initial Burdens and Costs
    The Commission estimates that each of the 157 broker-dealers that 
would be subject to the collection of information under Proposed Rule 
615(e)(1) would incur an initial average internal burden of 40 hours 
for in-house legal and 10 hours for in-house compliance counsel to 
update existing policies and procedures to comply with paragraph (e)(1) 
of Proposed Rule 615, and an initial in-house burden of 5 hours each 
for a General Counsel and a Chief Compliance Officer to review and 
approve the updated policies and procedures, for a total of 60 burden 
hours, at a monetized cost of $28,800.\299\ In addition, the Commission 
estimates a cost of $4,960 for outside counsel to review the updated 
policies and procedures on behalf of a broker-dealer.\300\ The 
Commission therefore estimates the aggregate initial burden for 
originating brokers to be 9,420 burden hours \301\ at a monetized cost 
of $4.52 million,\302\ and the aggregate initial cost for outside 
counsel to be $778,720 to establish policies and procedures as required 
by Proposed Rule 615(e)(1).\303\
---------------------------------------------------------------------------

    \299\ The Commission estimates the monetized initial burden for 
this requirement to be: (Attorney at $462 for 40 hours) + 
(Compliance Counsel at $406 for 10 hours) + (Deputy General Counsel 
at $663 for 5 hours) + (Chief Compliance Officer at $589 for 5 
hours) = 60 initial burden hours and a monetized cost of $28,800.
    \300\ The Commission's estimates of the relevant wage rates for 
outside legal services takes into account staff experience, a 
variety of sources including general information websites, and 
adjustments for inflation. The Commission estimates that the average 
hourly rate for legal services is $496/hour. This cost estimate is 
therefore based on the following calculation: (10 hours of review) x 
($496/hour for outside counsel service) = $4,960 in outside counsel 
costs.
    \301\ This estimate is based on the following calculation: (60 
burden hours of review per broker-dealer) x (157 broker-dealers) = 
9,420 aggregate burden hours.
    \302\ This estimate is based on the following calculation: 
($28,800 per broker-dealer) x (157 broker-dealers) = $4,521,600.
    \303\ This estimate is based on the following calculation: 
($4,960 for outside costs per broker-dealer) x (157 broker-dealers) 
= $778,720 in outside counsel costs.
---------------------------------------------------------------------------

Ongoing Burdens and Costs
    The Commission estimates that broker-dealers would review and 
update their policies and procedures for compliance with Proposed Rule 
615 on an annual basis, and that they would perform the review and 
update using in-house personnel. The Commission estimates that each 
broker-dealer would annually incur an internal burden of twelve hours 
to review and update existing policies and procedures of 4 hours for 
legal personnel, 4 hours for compliance personnel, and 4 hours for 
business-line personnel at a monetized cost of $4,476.\304\ The 
Commission therefore estimates an ongoing, aggregate burden for broker-
dealers of 1,884 hours, at a monetized cost of $702,732.\305\
---------------------------------------------------------------------------

    \304\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be: (Attorney at $462 for 4 hours) + 
(Compliance Counsel at $406 for 4 hours) + (Intermediate Business 
Analyst at $251 for 4 hours) = 12 ongoing burden hours and $4,476.
    \305\ These estimates are based on the following calculations: 
(12 burden hours per broker-dealer) x (157 broker-dealers) = 1,884 
aggregate ongoing burden hours; and $4,476 per broker-dealer x 157 
broker-dealers = $702,732.
---------------------------------------------------------------------------

    A summary of the initial and ongoing burdens and costs described 
above is set forth below:

         Total Estimated Outside Costs To Establish Policies and Procedures To Identify Segmented Orders
----------------------------------------------------------------------------------------------------------------
                                                                                  Outside cost      Aggregate
                                                                 Respondents    per  respondent    outside cost
----------------------------------------------------------------------------------------------------------------
Total Initial Outside Costs..................................             157           $4,960         $778,720
----------------------------------------------------------------------------------------------------------------


      Total Estimated Burden To Establish and Maintain Policies and Procedures To Identify Segmented Orders
----------------------------------------------------------------------------------------------------------------
                                                                                  Monetized cost
                                    Respondents    Burden hours      Aggregate          per          Aggregate
                                                  per respondent   burden hours     respondent    monetized cost
----------------------------------------------------------------------------------------------------------------
Total Initial Burden............             157              60           9,420         $28,800      $4,521,600
Total Ongoing Burden............             157              12           1,884           4,476         702,732
----------------------------------------------------------------------------------------------------------------


[[Page 173]]

    The Commission requests comment on whether there would be different 
or additional burdens or costs for originating brokers to establish and 
maintain written policies and procedures to identify segmented orders.
b. Identifying and Marking Segmented Orders
    As discussed above, the Commission estimates that there are 157 
broker-dealers that would need to mark segmented orders as such to 
comply with paragraph (e)(2) of Proposed Rule 615, and an additional 25 
broker-dealers that would not be required to comply with the marking 
requirements of paragraph (e)(2) of Proposed Rule 615, but would be 
required to mark orders prior to routing as required by paragraph 
(f)(1) of Proposed Rule 615.\306\
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    \306\ As discussed above, these broker-dealers would also mark 
orders, as applicable, to communicate that an originating broker 
certifies that it established, maintained, and enforced the 
requisite policies and procedures to assure that its identity would 
not be disclosed.
---------------------------------------------------------------------------

Initial Burdens and Costs
    For purposes of complying with Proposed Rule 615(e)(2), for an 
originating broker to identify whether a customer order meets the 
definition of ``segmented order'' and must be marked accordingly, a 
broker-dealer would first need to establish mechanisms to proactively 
and systematically identify which orders for NMS stocks are for the 
account of customers that are natural persons or held in a legal form 
on behalf of a natural person or group of related family members; and 
of those, which are orders for an account in which the average daily 
number of trades in NMS stocks was less than 40 in each of the six 
preceding months.\307\ For purposes of this analysis, and as discussed 
above, the Commission believes that most broker-dealers already collect 
information about their customers' accounts, or receive information 
about customer accounts from an introducing broker, and would already 
have an existing technological infrastructure in place, and the 
Commission assumes that such infrastructure would need to be modified 
to effect compliance with Proposed Rule 615.
---------------------------------------------------------------------------

    \307\ Supra sections IV.B.1 and IV.E.
---------------------------------------------------------------------------

    Acknowledging that costs and burdens may vary greatly according to 
the size or complexity of the broker-dealer and that some broker-
dealers would implement the changes in-house, while others would engage 
a third party vendor. The Commission estimates that approximately one 
third of the 157 broker-dealers (or 52) would implement the changes in-
house, while the remaining 105 would engage a third-party vendor. The 
Commission expects that the modification of a broker-dealer's existing 
technology performed in-house would require 260 hours at a monetized 
cost of $95,480.\308\ The Commission estimates that the burden for a 
broker-dealer engaging a third-party to implement the modifications 
would be 50 hours at a monetized cost of $18,385,\309\ and $35,000 for 
the third-party service provider to perform the necessary work.\310\ 
The aggregate burden for those broker-dealers to modify existing 
technology to identify segmented orders that perform the modification 
in-house would therefore be 13,520 burden hours, at a monetized cost of 
$4,964,960; \311\ and the aggregate costs and burdens for those broker-
dealers employing a third-party service provider would be $3,675,000 
\312\ and 5,250 burden hours, at a monetized cost of $1,930,425.\313\
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    \308\ The Commission estimates the monetized initial burden for 
this requirement to be: (Sr. Programmer at $368 for 160 hours) + 
(Sr. Database Administrator at $379 for 40 hours) + (Sr. Business 
Analyst at $305 for 40 hours) + (Attorney at $462 for 20 hours) = 
260 initial burden hours and a monetized cost of $95,480.
    \309\ The Commission estimates the monetized initial burden for 
this requirement to be: (Sr. Business Analyst for 15 hours at $305 
per hour) + (Compliance Manager for 20 hours at $344 per hour) + 
(Attorney for 15 hours at $462 per hour) = 50 initial burden hours 
at a monetized cost of $18,385.
    \310\ The Commission's estimate is based on prior estimates for 
the cost of systems modifications to capture additional order 
handling information. Securities Exchange Act Release No. 84528 
(Nov. 2, 2018) 83 FR 58338 (Nov. 19, 2018) at 58383, n.492 and 
accompanying text.
    \311\ This cost estimate is based on the following calculation: 
(260 initial burden hours at a monetized cost of $95,480) x (52 
broker-dealers) = 13,520 initial burden hours and a monetized cost 
of $4,964,960.
    \312\ This cost estimate is based on the following calculation: 
($35,000 in third-party service provider costs per broker-dealer) x 
(105 broker-dealers) = $3,675,000 in aggregate outside third-party 
provider costs.
    \313\ The Commission estimates the aggregate monetized initial 
burden for this requirement to be: (50 initial burden hours at a 
monetized cost of $18,385) x (105 broker-dealers) = 5,250 initial 
burden hours and a monetized cost of $1,930,425.
---------------------------------------------------------------------------

    For purposes of compliance with Proposed Rule 615(f)(1), a 
segmented order received by a routing broker-dealer would already have 
been identified as such by the originating broker pursuant to Proposed 
Rule 615(e)(2). Like originating broker-dealers, these 25 broker-
dealers, would however, need to modify their systems to enable them to 
mark orders as segmented orders prior to routing such orders to a 
routing destination.
    The Commission estimates that the 157 originating brokers and the 
additional 25 routing broker-dealers would each incur ongoing burdens 
to mark orders as ``segmented orders'' (and as applicable to 
communicate an originating broker's certification), which are discussed 
further below, as well as initial, one-time technology project costs to 
update their existing order marking systems. The Commission estimates 
the initial one-time technology project costs for originating brokers 
to add the ``segmented order'' and certification marks to their 
existing marking systems to comply with paragraph (e)(2) of Proposed 
Rule 615, and the initial one-time technology project costs for routing 
broker-dealers to add the ``segmented order'' and certification marks 
to their existing marking systems to comply with paragraph (f)(1) of 
Proposed Rule 615, to be $170,000 per broker-dealer,\314\ for a an 
aggregate total cost of $30.94 million.\315\
---------------------------------------------------------------------------

    \314\ This estimate is based on industry sources of the cost to 
program systems to add a new marking classification and adjusted for 
inflation. See, e.g., Securities Exchange Act Release No. 94313 
(Feb. 25, 2022), 87 FR 14950, 14976 (Mar. 16, 2022) (proposing 
amendments to Regulation SHO) (``Regulation SHO Amendment 
Proposal'').
    \315\ This cost estimate is based on the following calculation: 
($170,000 system project costs per broker-dealer) x (157 originating 
broker-dealers + 25 routing broker-dealers) = $30,940,000 in 
aggregate system project costs.
---------------------------------------------------------------------------

Ongoing Burdens and Costs
    The Commission estimates that a total of approximately 2.2 billion 
``segmented orders'' would be entered annually.\316\ This would make 
the average number of annual ``segmented order'' order marks by each of 
the 182 broker-dealers to be 11.9 million.\317\ Each instance of 
marking an order as a ``segmented order,'' and as applicable to 
communicate that an originating broker has certified that it has 
established, maintained, and enforced the requisite policies and 
procedures to assure that its identity will not be disclosed, is 
estimated to take between approximately 0.00001158 and 0.000139 hours 
(0.042 and 0.5 seconds) to

[[Page 174]]

complete.\318\ Thus, it would take each of the 182 broker-dealers 
between approximately 138 to 1,658 hours to mark segmented orders 
annually; \319\ and the Commission estimates the aggregate burden to be 
between approximately 25,134 and 301,697 hours.\320\ This estimate is 
based on a number of factors, including: previously estimated burdens 
for the current marking requirements of other Federal securities rules 
and regulations; \321\ that broker-dealers should already have the 
necessary mechanisms and procedures in place and already be familiar 
with processes and procedures to comply with other marking requirements 
under Federal securities rules and regulations (such as the 
requirements of Rule 200(g) of Regulation SHO); and that broker-dealers 
should be able to continue to use the same or similar mechanisms, 
processes and procedures to comply with Proposed Rule 615.
---------------------------------------------------------------------------

    \316\ This estimate is based on CAT data for individual investor 
stock orders handled by wholesalers during Q1 2022. See Tables 7 and 
10, infra, sections VII.B.4 and VII.B.5 (showing a total of 
approximately 271,310,000 orders handled during the period). Because 
as discussed in section VII.B.4 below, this number excludes certain 
orders, it likely significantly understates the total number of 
individual investor orders handled by wholesalers. We have therefore 
doubled the number for purposes of our estimate, and multiplied by 
four to arrive at an estimated annual number of segmented orders of 
2,170,480,000.
    \317\ This figure was calculated as follows: 2,170,480,000 
``segmented orders'' orders requiring order marking divided by 182 
broker-dealers.
    \318\ The upper end of this estimate--0.5 seconds--is based on 
the same time estimate for marking sell orders ``long'' or ``short'' 
under Rule 200(g) of Regulation SHO. See Regulation SHO Amendment 
Proposal, supra note 314, 87 FR at 14975 (citing Securities Exchange 
Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48023 (Aug. 6, 
2004) (``Regulation SHO Adopting Release''). See also Securities 
Exchange Act Release No. 48709 (Oct. 28, 2003) 68 FR 62972, 63000 n. 
232 (Nov. 6, 2003) and Securities Exchange Act Release No. 59748 
(Apr. 10, 2009), 74 FR 18042, 18089 (Apr. 20, 2009) (providing the 
same estimate--0.5 seconds--for marking sell orders ``short exempt'' 
under Rule 200(g) of Regulation SHO)). The lower end of this 
estimate--0.042 seconds--is based on a Commission estimate that 
computing speeds are twelve times faster today than they were in 
2007. Regulation SHO Amendment Proposal, supra note 314, 87 FR at 
14975, 15000 (stating that according to an industry performance 
evaluation for server processors, computing speed has increased by 
at least 12 times since 2007 (the earliest year in the data and 
citing Year on Year Performance (for server processors), PassMark 
Software Pty. Ltd., available at https://www.cpubenchmark.net/year-on-year.html).
    \319\ These figures were calculated as follows: (11,925,714 
``segmented orders'' orders per broker-dealer) x (0.00001158 hours) 
= 138.10 hours; and (11,925,714 ``segmented orders'' orders per 
broker-dealer) x (0.000139 hours) = 1,657.67 hours.
    \320\ These figures were calculated as follows: (2,170,480,000 
``segmented orders'' orders requiring order marking) x (0.00001158 
hours) = 25,134.16 hours; and (2,170,480,000 ``segmented orders'' 
orders) x (0.000139 hours) = 301,696.70 hours.
    \321\ See, e.g., Regulation SHO Amendment Proposal, supra note 
314, 87 FR at 14975 (discussing estimated marking requirements to 
comply with Rule 200(g) of Regulation SHO which requires broker-
dealers to mark sell orders ``long,'' ``short,'' or ``short 
exempt'').
---------------------------------------------------------------------------

    A summary of the estimated initial and ongoing burdens and costs 
described above is set forth below:

                     Total Estimated Initial Burdens and Costs To Identify Segmented Orders
----------------------------------------------------------------------------------------------------------------
                                                         Monetized
                                Respondents    Burden     cost per   Third-party     Aggregate    Aggregate cost
                                                hours    respondent      cost      burden hours
----------------------------------------------------------------------------------------------------------------
Initial Burden to Modify In-              52       260      $95,480  ...........          13,520      $4,964,960
 house......................
Initial In-house Burden in               105        50       18,385  ...........           5,250       1,930,425
 connection with use of
 Third-party................
Outside Costs for Third-                 105  ........  ...........      $35,000  ..............       3,675,000
 party Services.............
----------------------------------------------------------------------------------------------------------------


                   Total Estimated Initial System Modification Costs To Mark Segmented Orders
----------------------------------------------------------------------------------------------------------------
                                                                                    Cost per
                                                                 Respondents       respondent     Aggregate cost
----------------------------------------------------------------------------------------------------------------
Initial Technology Costs.....................................             182         $170,000      $30,940,000
----------------------------------------------------------------------------------------------------------------


                                                 Total Estimated Ongoing Burden To Mark Segmented Orders
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                      Annual
    Originating brokers with          Annual         segmented
 individual accounts and routing     segmented      orders per      Estimated burden hours     Total annual industry     Annual burden per originating
             brokers                  orders        originating      per segmented order           burden hours                      broker
                                                      broker
--------------------------------------------------------------------------------------------------------------------------------------------------------
182.............................   2,170,480,000      11,925,714  0.00001158 to 0.000139...  25,134 to 301,697.......  138.10 to 1,657.68.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The Commission requests comment on whether there would be different 
or additional burdens or costs for brokers to identify and mark 
segmented orders as such. Would the burdens and be lower or higher? Are 
broker-dealers more likely to perform these function in-house, or use 
third-party service providers? Should the estimated cost to employ a 
third-party service provider be lower or higher?
3. Originating Broker Certification
    Those originating brokers that do not want their identity to be 
disclosed in the auction message initiating a qualified auction would 
be required to establish, maintain and enforce written policies and 
procedures reasonably designed to assure that the identity of the 
originating broker will not be disclosed, directly or indirectly, to 
any person that potentially could participate in the qualified auction 
or otherwise trade with the segmented order. The Commission believes 
that originating brokers choosing to make certifications referred to in 
Proposed Rule 615(c)(1)(iii) would be familiar with how to adapt their 
systems and processes to assure that the identity of the originating 
broker is not disclosed, in compliance with the requirements of 
Proposed Rule 615(e)(3). The Commission acknowledges that policies and 
procedures may vary greatly by broker-dealer, given the differences in 
size and the complexity of broker-dealer business models. Accordingly, 
the Commission believes that the need to update policies and 
procedures, as well as the ongoing compliance costs, might also vary 
greatly.
Initial Burdens and Costs
    The Commission estimates that there would be 20 broker-dealers that 
would chose to make a Proposed Rule 615(c)(1)(iii) certification. To 
initially comply with the obligation to establish written policies and 
procedures to comply with Proposed Rule 615(e)(3), broker-dealers would 
employ a combination of in-house and outside

[[Page 175]]

legal and compliance counsel to update their existing policies and 
procedures. The Commission estimates that each of these 20 broker-
dealers would incur a one-time average internal burden of 40 hours for 
in-house legal and 10 hours for in-house compliance counsel to update 
existing policies and procedures to comply with paragraph (e)(3) of 
Proposed Rule 615, and a one-time burden of 5 hours each for a General 
Counsel and a Chief Compliance Office to review and approve the updated 
policies and procedures, for a total of 60 burden hours.\322\ In 
addition, the Commission estimates a cost of $4,960 for outside counsel 
to review the updated policies and procedures on behalf of a broker-
dealer.\323\ The Commission therefore estimates the aggregate initial 
burden for originating brokers to be 1,200 burden hours \324\ at a 
monetized cost of $576,000,\325\ and the aggregate total cost for 
outside counsel to be $99,200 to establish policies and procedures as 
required by Proposed Rule 615(e)(3).\326\
---------------------------------------------------------------------------

    \322\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be: (Attorney at $462 for 40 hours) + 
(Compliance Counsel at $406 for 10 hours) + (Deputy General Counsel 
at $663 for 5 hours) + (Chief Compliance Officer at $589 for 5 
hours) = 60 initial burden hours and $28,800.
    \323\ This cost estimate is based on the following calculation: 
(10 hours of review) x ($496 per hour for outside counsel service) = 
$4,960 in outside counsel costs.
    \324\ This estimate is based on the following calculation: (60 
burden hours of review per broker-dealer) x (20 broker-dealers) = 
1,200 aggregate burden hours.
    \325\ This estimate is based on the following calculation: 
($28,800 per broker-dealer) x (20 broker-dealers) = $576,000.
    \326\ This estimate is based on the following calculation: 
($4,960 for outside costs per broker-dealer) x (20 broker-dealers) = 
$99,200 in outside counsel costs.
---------------------------------------------------------------------------

Ongoing Burdens and Costs
    The Commission estimates that broker-dealers would review and 
update their policies and procedures for compliance with Proposed Rule 
615 on an annual basis, and that they would perform the review and 
update using in-house personnel. The Commission estimates that each 
broker-dealer would annually incur an internal burden of twelve hours 
to review and update existing policies and procedures: four hours for 
legal personnel, four hours for compliance personnel, and four hours 
for in-line business personnel, at a monetized cost of $4,476.\327\ The 
Commission therefore estimates an ongoing, aggregate burden for broker-
dealers of approximately 240 hours \328\ and a monetized cost of 
$89,520.\329\ The ongoing burden to communicate certifications is 
included with the cost for ``segmented order'' marking discussed above 
in section VI.D.2.b. A summary of the estimated initial and ongoing 
burdens and costs described above in this section VI.D.3 are set forth 
below:
---------------------------------------------------------------------------

    \327\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be: (Attorney at $462 for 4 hours) + 
(Compliance Counsel at $406 for 4 hours) + (Compliance Counsel at 
$406 for 4 hours) + (Intermediate Business Analyst at $251 for 4 
hours) = 12 ongoing burden hours and $4,476.
    \328\ This estimate is based on the following calculation: (12 
burden hours of review per broker-dealer) x (20 broker-dealers) = 
240 aggregate burden hours.
    \329\ The Commission estimates the monetized ongoing, annual 
burden for this requirement to be: ($4,476 per broker-dealer) x 20 
broker-dealers = $89,520.

    Total Estimated Outside Costs To Establish Policies and Procedures Reasonably Designed to Assure That the
                          Originating Broker of a Segmented Order Will Not Be Disclosed
----------------------------------------------------------------------------------------------------------------
                                                                           Outside cost per   Outside  aggregate
                                                           Respondents        respondent             cost
----------------------------------------------------------------------------------------------------------------
Initial Outside Costs..................................              20              $4,960             $99,200
----------------------------------------------------------------------------------------------------------------


 Total Estimated Burden To Establish and Maintain Policies and Procedures Reasonably Designed To Assure That the
                          Originating Broker of a Segmented Order Will Not Be Disclosed
----------------------------------------------------------------------------------------------------------------
                                                   Burden hours                   Monetized cost
                                    Respondents         per          Aggregate          per          Aggregate
                                                    respondent     burden hours     respondent    monetized cost
----------------------------------------------------------------------------------------------------------------
Initial Burden..................              20              60           1,200         $28,800        $576,000
Ongoing Burden..................              20              12             160           4,476          89,520
----------------------------------------------------------------------------------------------------------------

    The Commission requests comment on whether there would be different 
or additional burdens or costs for originating brokers to establish and 
maintain written policies and procedures reasonably designed to assure 
that its identity will not be disclosed. For example, do brokers have 
existing policies and procedures related to ensuring confidentiality in 
other contexts that could be expanded upon or are there are additional 
burdens and costs associated with review of a broker's internal systems 
that should be factored into the Commission's estimate? Are originating 
broker's likely to perform the function of establishing and maintaining 
these policies and procedures in-house or would they employ third-party 
service providers, such as outside counsel? Would originating brokers 
also have costs to modify their internal systems to prevent disclosure 
of the identity of the originating broker in support of a Proposed Rule 
615(c)(1)(iii) certification or other costs in support of such a 
certification?
4. NMS Stock ATS Policies and Procedures for Excluding Subscribers
    The Commission believes that NMS Stock ATSs--in particular those 
whose broker-dealer operators are large, multi-service broker-dealers--
generally have,\330\ and likely maintain in writing, standards of 
financial responsibility and operational capability for subscribers to 
their system, and also generally have policies and procedures for 
admitting new persons as subscribers or limiting access to services. 
NMS Stock ATSs are not, however, currently required to have written 
policies and procedures for granting access to their trading system, 
unless they meet the fair access threshold of Rule 301(b)(5).\331\ NMS 
Stock ATSs are, however, required to disclose on Form ATS-N whether 
there are any conditions the ATSs requires a person to satisfy to 
become a subscriber and whether there are any limitations

[[Page 176]]

on access to services.\332\ The Commission therefore estimates that the 
burdens and cost for an NMS Stock ATS to comply with Proposed Rule 
600(b)(64)(ii)(D) to qualify as an open competition trading center 
eligible to operate a qualified auction pursuant to Proposed Rule 
615(d)(1) to be minimal. The Commission acknowledges that policies and 
procedures may vary greatly by NMS Stock ATS, given the differences in 
size and the complexity of business models. Accordingly, the Commission 
would expect that the need to update policies and procedures, as well 
as the ongoing compliance costs, might also vary. As discussed above, 
the Commission estimates that three NMS Stock ATSs may determine to 
modify their systems to operate as open competition trading centers and 
operate qualified auctions. To comply with this obligation, these NMS 
Stock ATSs would likely employ in-house legal and compliance 
counsel.\333\
---------------------------------------------------------------------------

    \330\ This belief is based on a review of NMS Stock ATS 
disclosures on Form ATS-N.
    \331\ See supra note 214 and accompanying text. As discussed 
above, currently only one NMS Stock ATS discloses that it meets the 
fair access threshold. Supra section IV.B.2.b.
    \332\ See supra note 214.
    \333\ The Commission based its estimate on the burden hour 
estimate provided in connection with the adoption of amendments to 
Rule 301(b)(10), which as amended requires all ATSs to maintain in 
writing their safeguards and procedures to protect subscribers' 
confidential trading information, as well as the oversight 
procedures to ensure such safeguards and procedures are followed. 
See ATS-N Adopting Release, supra note 278, 83 FR at 38868.
---------------------------------------------------------------------------

Initial Burdens and Costs
    For NMS Stock ATSs that have not recorded in writing their policies 
and procedures to prohibit any registered broker or dealer from being 
or becoming a subscriber, or impose conditions upon such a subscriber, 
that does not meet the standards of financial responsibility or 
operational capability as are prescribed by such written policies and 
procedures, the Commission estimates the initial burden and cost for an 
NMS Stock ATS that choses to comply with Proposed Rule 
600(b)(64)(ii)(D) to be minimal. The Commission estimates that the 
initial burden for an NMS Stock ATS to review its existing policies and 
procedures for consistency with the proposed rule, to make 
modifications as appropriate, and to put the policies and procedures in 
writing would be approximately 8 hours, at a monetized cost of 
$3,106.\334\ Thus, the Commission estimates the aggregate initial 
burden to be 24 hours, at a monetized cost of $9,318.\335\
---------------------------------------------------------------------------

    \334\ This estimate is based on the following: (Compliance 
Attorney at $406 for 7 hours) + (Sr. Compliance Examiner at $264 for 
1 hour) = 8 burden hours and a monetized cost of $3,106.
    \335\ These estimates are based on the following calculations: 
(8 burden hours per NMS Stock ATS) x (3 NMS Stock ATSs) = 24 burden 
hours; and ($3,106 per NMS Stock ATS) x (3 NMS Stock ATSs) = $9,318.
---------------------------------------------------------------------------

Ongoing Burdens and Costs
    For purposes of this analysis, the Commission has assumed that NMS 
Stock ATSs would review and update their policies and procedures for 
compliance with Proposed Rule 600(b)(64)(ii) on an annual basis, and 
that they would perform the review and update using in-house personnel. 
The Commission estimates that each NMS Stock ATS would annually incur 
an internal burden of 8 hours to review and update existing policies 
and procedures, made up of four hours for legal personnel and four 
hours for compliance personnel, at a monetized cost of $2,680.\336\ The 
Commission therefore estimates an ongoing, aggregate burden for NMS 
Stock ATSs of approximately 24 hours at a monetized cost of 
$8,040.\337\
---------------------------------------------------------------------------

    \336\ The Commission estimates the monetized ongoing burden for 
this requirement to be: (Compliance Attorney at $406 for 4 hours) + 
(Sr. Compliance Examiner at $264 for 4 hours) = 8 initial burden 
hours and a monetized cost of $2,680).
    \337\ These estimates are based on the following calculations: 
(8 burden hours per NMS Stock ATS) x (3 NMS Stock ATSs) = 24 burden 
hours; and at ($2,680 per NMS Stock ATS) x 3 NMS Stock ATSs = 
$8,040.
---------------------------------------------------------------------------

    A summary of the estimated initial and ongoing burdens and costs 
described above is set forth below:

    Total Estimated Burden To Establish and Maintain Policies and Procedures To Exclude Subscribers Based on
                          Financial Responsibility or Operational Capability Standards
----------------------------------------------------------------------------------------------------------------
                                                   Burden hours
                                    Respondents         per          Aggregate    Monetized cost     Aggregate
                                                    respondent     burden hours   per respondent  monetized cost
----------------------------------------------------------------------------------------------------------------
Initial Burden..................               3               8              24          $3,106          $9,318
Ongoing Burden..................               3               8              24           2,680           8,040
----------------------------------------------------------------------------------------------------------------

    The Commission is requesting comment on whether NMS Stock ATSs that 
would operate as open competition trading centers operating qualified 
auctions would have different or additional burdens and costs to 
maintain written policies and procedures to exclude a broker-dealer 
subscriber, or impose conditions on such a subscriber, that does not 
meet standards of financial responsibility and operational capability.

E. Collection of Information Is Mandatory

    The collections of information required by Proposed Rule 615(c)(1) 
would be mandatory for national securities exchanges and NMS Stock ATSs 
that operate qualified auctions, and the one national securities 
association. The collections of information required by Proposed Rule 
615(e)(1) and (2) would be mandatory for broker-dealers that meet the 
proposed definition of ``originating broker.'' The collection of 
information required by Proposed Rule 615(e)(3) would be mandatory for 
originating brokers that communicate a certification to an open 
competition trading center pursuant to Proposed Rule 615(c)(1). The 
collection of information required by Proposed Rule 615(f)(1) would be 
mandatory for broker-dealers that receive and route segmented orders. 
The collection of information required by Proposed Rule 615(d)(1), in 
conjunction with Proposed Rule 600(b)(64)(ii)(D), would be mandatory 
for NMS Stock ATSs that operate as open competition trading centers and 
prohibit any broker or dealer from becoming a subscriber, or impose 
conditions upon such a subscriber, based on standards of financial 
responsibility or operational capability.

F. Confidentiality of Information Collected

    The Commission would not typically receive confidential information 
as a result of Proposed Rule 615 or the related proposed amendments. To 
the

[[Page 177]]

extent that the Commission receives--through its examination and 
oversight program, through an investigation, or by some other means 
records or disclosures from a broker-dealer that relate to or arise 
from Proposed Rule 615 or the related amendments that are not publicly 
available, such information would be kept confidential, subject to the 
provisions of applicable law.\338\
---------------------------------------------------------------------------

    \338\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing 
the public availability of information obtained by the Commission).
---------------------------------------------------------------------------

1. Auction Messages
    As discussed above, auction messages initiating a qualified auction 
would be publicly disseminated in consolidated market data. These 
messages would include the identity of the open competition trading 
center, symbol, side, size, limit price, and identify of the 
originating broker, unless the originating broker made the 
certification specified in paragraph (c)(1)(iii) of Proposed Rule 615.
2. Identifying and Marking Segmented Orders
    The identification of an order as a segmented order would be made 
available to any destination to which the order has been routed. The 
information would also be available to the Commission and its staff, 
and to other regulators.
3. Originating Broker Certification
    If an originating broker determines to make a certification 
referred to in paragraph (c)(1)(iii) of Proposed Rule 615, such 
certification must be communicated to the open competition trading 
center operating the applicable qualified auction, and any interim 
broker-dealer routing a segmented order associated with a certification 
would also need to be made aware of the certification for purposes of 
communicating the certification to the open competition trading center. 
The information would also be available to the Commission and its 
staff, and to other regulators. Also, the originating broker's written 
policies and procedures pursuant to Proposed Rule 615(e)(3) would be 
available to the Commission and its staff, and to other regulators.
4. NMS Stock ATS Policies and Procedures To Exclude Subscribers
    An NMS Stock ATSs' written policies and procedures to comply with 
Proposed Rule 600(b)(64)(ii)(D), if necessary, to qualify as an open 
competition trading center eligible to operate a qualified auction 
pursuant to Proposed Rule 615(d)(1) would be available to the 
Commission and its staff, and to other regulators. As described above, 
NMS Stock ATSs are also required to publicly disclose certain 
information on Form ATS-N.\339\
---------------------------------------------------------------------------

    \339\ Supra note 278.
---------------------------------------------------------------------------

G. Retention Period for Recordkeeping Requirements

    Proposed Rule 615 and the related amendments, would not establish 
any new record retention requirements. National securities exchanges 
and national securities associations are required to retain records and 
information pursuant to 17 CFR 240.17a-1 (``Rule 17a-1''), and broker-
dealers are required to retain records and information pursuant to 17 
CFR 240.17a-4 (``Rule 17a-4'').

H. Request for Comments

    The Commission requests comment on whether the estimates for burden 
hours and costs are reasonable. Pursuant to 44 U.S.C. 3506(c)(2)(B), 
the Commission solicits comments to: (1) evaluate whether the proposed 
collections of information are necessary for the proper performance of 
the functions of the Commission, including whether the information 
would have practical utility; (2) evaluate the accuracy of the 
Commission's estimate of the burden of the proposed collections of 
information; (3) determine whether there are ways to enhance the 
quality, utility, and clarity of the information to be collected; and 
(4) determine whether there are ways to minimize the burden of the 
collections of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Secretary, Securities and 
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090, with 
reference to File Number S7-31-22. Requests for materials submitted to 
OMB by the Commission with regard to this collection of information 
should be in writing, with reference to File Number S7-31-22 and be 
submitted to the Securities and Exchange Commission, Office of FOIA/PA 
Services, 100 F Street NE, Washington, DC 20549-2736. As OMB is 
required to make a decision concerning the collection of information 
between 30 and 60 days after publication, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

[[Page 178]]

VII. Economic Analysis

A. Introduction

    The Commission is mindful of the economic effects that may result 
from Proposed Rule 615, and the amendments proposed in this release 
(the ``Proposal''), including the benefits, costs, and the effects on 
efficiency, competition, and capital formation. Exchange Act section 
3(f) requires the Commission, when it is engaged in rulemaking pursuant 
to the Exchange Act and is required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.\340\ In 
addition, Exchange Act section 23(a)(2) requires the Commission, when 
making rules pursuant to the Exchange Act, to consider among other 
matters the impact that any such rule would have on competition and not 
to adopt any rule that would impose a burden on competition that is not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\341\ The following economic analysis identifies and considers the 
costs and benefits--including the effects on efficiency, competition, 
and capital formation--that may result from the Proposal.
---------------------------------------------------------------------------

    \340\ See 15 U.S.C. 78c(f).
    \341\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    Investors participate in capital markets to save for the future, to 
diversify, and to maximize returns given a desired level of risk, among 
other reasons. This participation can involve both trades based on 
information and trades based on liquidity needs. Many individuals 
participate indirectly in equity markets, such as through mutual funds 
or through pension funds. However, many individuals participate 
directly in equity markets, and this direct participation has grown in 
recent years.\342\ While some of this direct participation may be 
transitory, forces operating over the long run, such as technological 
improvements, may lead the trend to continue.
---------------------------------------------------------------------------

    \342\ See, e.g., SIFMA Insights, Gauging the New Normal for 
Volatility, Volumes, Market Levels & Retail Investor Participation 
(May 2021), available at https://www.sifma.org/wp-content/uploads/2021/05/SIFMA-Insights-Market-Structure-Survey-FINAL-FOR-WEB.pdf; 
see also Jennifer J. Schulp, GameStop and the Rise of Retail 
Trading, 41 Cato J. 511 (2021). For example, one study estimates 
that retail market share has increased from around 23% (as a 
percentage of share volume) in Jan. 2020 to around 34% by July 2021; 
see Rosenblatt Securities, How Can the Buy Side Interact with Retail 
Flow? (Feb. 14, 2022), available at https://www.rblt.com/market-reports/how-can-the-buy-side-interact-with-retail-flow.
---------------------------------------------------------------------------

    This increase in participation, coming on top of various other 
trends discussed below, motivates concern over the current isolation of 
retail orders. At present, the vast majority of retail orders (over 90% 
of marketable NMS stock orders) are routed to wholesalers, where they 
are frequently executed in isolation, on a captive basis.\343\ This 
execution is subject to competitive forces that apply at the level of 
average execution quality. Execution of these orders is not subject to 
order-by-order competition that occurs when order interactions are 
subject to exchange protocols. The empirical analysis below suggests 
that this results in suboptimal execution quality compared to an 
alternative market structure in which the marketable orders of 
individual investors were subject to order-by-order competition.\344\ 
While wholesalers generally achieve price improvement relative to the 
NBBO, Commission analysis indicates that there is the potential for 
individual investors to receive additional price improvement in line 
with the low adverse selection risk of individual investor order flow. 
While acknowledging there is substantial uncertainty in the eventual 
outcome, the Commission estimates that qualified auctions as designed 
by the Proposal would result in additional price improvement for the 
marketable orders of individual investors that could reduce the average 
transactions costs of these orders by 0.86 basis points (``bps'') to 
1.31 bps.\345\ The Commission estimates that segmented orders that 
would be eligible to be included in qualified auctions could account 
for 7.3% \346\ to 10.1%\347\ of total executed dollar volume. Given 
this estimate, the Commission preliminarily estimates that the Proposal 
could potentially result in a total average annual savings in 
individual investor transaction costs ranging from $1.12 billion to 
$2.35 billion.\348\ These estimated gains would be generated primarily 
through increased competition to supply liquidity to marketable orders 
of individual investors, which in turn would lower transaction costs 
for individual investors, potentially enhance order execution quality 
for institutional investors, and improve price discovery. More 
generally, it would broaden the set of market participants that 
directly interact with individual investor orders of NMS stocks.\349\ 
For example, Commission analysis indicates that there is often 
liquidity available at the NBBO midpoint on exchanges or NMS Stock ATSs 
when a wholesaler executes the marketable orders of individual 
investors at prices less favorable (for the customer) than the NBBO 
midpoint.\350\ Qualified auctions would act as a coordination mechanism 
and make the submitters of these resting midpoint orders aware there 
was an individual investor order they could potentially trade with. By 
increasing competition and enhancing the direct exposure of individual 
investor orders to a broader spectrum of market participants, the 
Proposal would help achieve the objectives for an NMS set forth in 
section 11A of the Exchange Act.\351\
---------------------------------------------------------------------------

    \343\ See analysis in infra Table 3. In the current market 
structure, retail brokers provide wholesalers with large blocks of 
orders, leaving it to the discretion of wholesalers how to execute 
each order, consistent with their best execution responsibilities. 
Broker-dealers are required to provide best execution for customer 
orders, both pursuant to common law and FINRA rules. See discussion 
of broker-dealer best execution responsibilities in supra section 
III.B.2. The obligation for wholesalers to provide best execution is 
required under FINRA Rule 5310 (Best Execution and 
Interpositioning). See also supra note 133. The Commission is also 
separately proposing a new rule addressing the best execution 
obligations of broker-dealers. See Regulation Best Execution 
Proposal, supra note 130. The Commission encourages commenters to 
review that proposal to determine whether it might affect their 
comments on this proposal.
    \344\ See infra section VII.B.4 for analysis and discussion of 
the potential adverse execution quality effects from the isolation 
of individual investor marketable orders.
    \345\ See analysis in Table 19 and corresponding discussion in 
infra section VII.C.1.b. This estimate accounts only for potential 
changes in individual order transaction costs and assumes the PFOF 
wholesalers currently pay to retail brokers would be converted into 
additional price improvement for the individual investor order, and 
does not include costs that may arise in the form of potential 
increases in (or the return of) commissions retail brokers charge to 
individual investors or other reductions in the services that retail 
brokers currently offer. See infra note 514 for further discussion.
    \346\ See infra note 533.
    \347\ See infra note 535.
    \348\ See analysis in Table 19 and corresponding discussion in 
infra section VII.C.1.b.
    \349\ As discussed above, Proposed Rule 615 covers only NMS 
stocks, and as such, the economic analysis includes quantitative and 
qualitative analysis of only NMS stocks.
    \350\ Commission analysis of CAT data in infra Table 20 found 
that, on average, 51% of the shares of individual investor 
marketable orders internalized by wholesalers are executed at prices 
less favorable than the NBBO midpoint. Out of these individual 
investors shares that were executed at prices less favorable than 
the midpoint, on average, 75% of these shares could have 
hypothetically executed at a better price against the non-displayed 
liquidity resting at the NBBO midpoint on exchanges and NMS Stock 
ATSs. See infra section VII.C.1.b for further discussion on the 
analysis in Table 20.
    \351\ See discussion in supra section III.A.
---------------------------------------------------------------------------

    The Proposal could have additional benefits with respect to trading 
costs, liquidity, and capital formation, though the Commission 
acknowledges that these are uncertain. The large

[[Page 179]]

percentage of individual investor orders executed off-exchange confers 
a substantial competitive advantage on wholesalers and other market 
makers with a significant presence both on and off-exchange, as they 
observe order flow more quickly and in a more granular fashion than 
others. This advantage contributes to asymmetric information and 
increased adverse selection on exchanges. Such adverse selection may 
reduce market quality for all participants and may ultimately reduce 
efficiency and lower capital formation.
    The Commission acknowledges considerable uncertainty in the costs 
that would arise from Proposed Rule 615, due to whether the current 
market practice of routing through wholesalers would persist. First, 
the Proposal would likely cause wholesalers and some retail brokers to 
incur significant adjustment costs to their operations, as well as a 
possible decline in profitability. The Proposal could also result in 
costs to individual investors, such as some retail brokers potentially 
resuming charging commissions for NMS stock trades, although the 
likelihood of this may be low.\352\ There may also be an increase in 
trading costs for retail broker customers that carry greater adverse 
selection risks and individual investors whose orders would not meet 
the definition of a segmented order because they averaged 40 or more 
daily trades in NMS stocks over the six preceding calendar months.\353\ 
Retail brokers could also experience costs from wholesalers reducing 
the amount of PFOF they pay to retail brokers or from reducing or 
charging for the order handling services they offer to retail brokers, 
which could ultimately be passed on to individual investors.
---------------------------------------------------------------------------

    \352\ See discussion of potential changes in retail broker 
commissions in infra section VII.C.2.b.ii.
    \353\ See supra note 186 and corresponding text discussing the 
definition of ``segmented order.''
---------------------------------------------------------------------------

    Open competition trading centers would also face costs associated 
with creating qualified auctions, as would broker-dealers and trading 
centers that would incur costs related to establishing policies and 
procedures for identifying and handling segmented orders and 
identifying the originating retail brokers that submit segmented 
orders.\354\ There would also be compliance costs faced by the 
respective NMS plans and FINRA to update the consolidated market data 
feed and ADF to broadcast qualified auction messages. There may also be 
a decrease in displayed liquidity if qualified auctions attract 
liquidity away from exchange Limit Order Books (``LOBs''). However, 
because the majority of individual investor orders are already 
segmented from exchange LOBs, there is the potential that the effect of 
qualified auctions on LOB liquidity may not be significant.\355\
---------------------------------------------------------------------------

    \354\ If NMS Stock ATSs opted to operate qualified auctions, 
they may also incur costs to update their business models and 
systems in order to meet the requirements to be an open competition 
trading center. See infra section VII.C.2.e.
    \355\ See discussion on the effects of the Proposal on exchange 
LOB liquidity in infra section VII.C.2.g.
---------------------------------------------------------------------------

    The Commission recognizes that there would likely be significant 
competitive effects associated with the introduction of qualified 
auctions as mandated by Proposed Rule 615. Qualified auctions could 
reduce wholesaler market share for the execution of the orders of 
individual investors, which could result in the transfer of revenue and 
profit from wholesalers to other market participants that end up 
supplying more liquidity to the marketable orders of individual 
investors. Proposed Rule 615 could also affect competition in the 
market for trading services by enhancing the competitive position of 
exchanges and ATSs that operate qualified auctions relative to 
wholesalers as well as exchanges and ATSs that do not meet the criteria 
to operate qualified auctions. The introduction of qualified auctions 
would likely lead to a reduction of PFOF in equity markets, which in 
turn may weaken the competitive position of retail brokers that are 
dependent on PFOF revenue but strengthen the competitive position of 
retail brokers that are not. In addition, Proposed Rule 615 could also 
increase competition for market access among routing broker-dealers if 
the competitive position of wholesalers declines, and retail brokers 
that had previously relied on wholesalers for routing services, choose 
to route their own orders to qualified auctions.
    The Commission has considered the economic effects of the Proposal 
and wherever possible, the Commission has quantified the likely 
economic effects of the Proposal. The Commission is providing both a 
qualitative assessment and quantified estimates of the potential 
economic effects of the Proposal where feasible. The Commission has 
incorporated data and other information to assist it in the analysis of 
the economic effects of the Proposal. However, as explained in more 
detail below, because the Commission does not have, and in certain 
cases does not believe it can reasonably obtain, data that may inform 
the Commission on certain economic effects, the Commission is unable to 
quantify certain economic effects. Further, even in cases where the 
Commission has some data, quantification is not practicable due to the 
number and type of assumptions necessary to quantify certain economic 
effects, which render any such quantification unreliable. The 
Commission's inability to quantify certain costs, benefits, and effects 
does not imply that the Commission believes such costs, benefits, or 
effects are less significant. The Commission requests that commenters 
provide relevant data and information to assist the Commission in 
quantifying the economic consequences of the Proposal.

B. Baseline

    The baseline against which the costs, benefits, and the effects on 
efficiency, competition, and capital formation of the Proposal are 
measured consists of the existing routing practices and execution 
quality for the marketable orders of individual investors, the current 
state of interactions between institutional investors and the orders of 
individual investors, and the current business practices of retail 
brokers. These aspects of the baseline are framed by the statutory and 
regulatory baseline described above.\356\
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    \356\ The regulatory baseline includes the changes to the 
current arrangements for consolidated market data in the MDI Rules; 
but those amendments have not been implemented, so they likely have 
not affected market practice. See supra section III.B.1 and infra 
section VII.B.7. Where implementation of the changes may affect 
certain numbers in the baseline, the description of the baseline 
below notes those effects.

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[[Page 180]]

    Retail brokers route most of their customers' marketable order flow 
to wholesalers.\357\ Wholesalers do not typically directly charge 
retail brokers for their order routing and execution services. In fact, 
they may pay some retail brokers for the opportunity to handle their 
order flow with PFOF. Typically, wholesalers' vertical integration of 
routing and execution services for the orders of individual investors 
provides them flexibility with regard to their handling of order flow. 
They utilize sophisticated algorithmic trading technology to deliver 
their services.\358\ In particular, wholesalers determine which orders 
to internalize (i.e., execute in a principal capacity) and which to 
execute in a riskless principal or agency capacity.\359\ Commission 
analysis indicates that wholesalers internalize over 90% of the dollar 
volume from individual investor marketable orders that are routed to 
them and executed.\360\
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    \357\ Commission analysis of broker-dealer Rule 606 report order 
routing data in infra Table 3 indicates that retail brokers route 
over 90% of their marketable orders to wholesalers.
    \358\ Wholesalers, similar to OTC market makers and exchange 
liquidity suppliers must establish connections with the numerous 
venues in which they wish to operate and provide liquidity. They 
also typically design smart order routers that can locate and 
provide liquidity in real time, as well as maintain fast data 
processing capabilities that enable them to respond to market 
conditions while abiding by the relevant trade execution 
regulations. Wholesalers also face the costs associated with price 
risk. As wholesalers trade against market participants, they takes 
positions at the opposite side, accumulating inventory. Holding 
inventory exposes wholesaler profits to inventory (price) risk, 
where the value of inventory, and hence, that of the wholesaler's 
holdings may fluctuate as security prices vary. Scaling up the size 
of the business to ensure steady incoming flow from opposite sides 
of the markets is a common strategy pursued by wholesalers. This 
strategy enables them to execute buy and sell transactions, 
offsetting order flow from opposite sides, reducing the possibility 
of accumulating prolonged unwanted inventory. However, among other 
costs, scaling up requires more comprehensive, efficient 
connectivity networks and adds to the costs of establishing and 
maintaining such networks.
    \359\ See discussion in infra section VII.B.5.a.
    \360\ See analysis in infra Table 10.
---------------------------------------------------------------------------

    The wholesaler business model relies in part on the ability to 
segment the order flow of individual investors, which typically have 
lower adverse selection risk than the orders of other types of market 
participants.\361\ Wholesalers are market makers that can identify 
orders with low adverse selection risk.\362\ Through segmentation, 
wholesalers typically internalize marketable orders with lower adverse 
selection risk and generally execute them at prices better than the 
current NBBO, i.e., because of segmentation, wholesalers are typically 
able to execute the marketable orders of individual investors at better 
prices than these orders would receive if they were routed to an 
exchange. An analysis of marketable NMS stock orders presented in Table 
10 below indicates that the orders that wholesalers internalize present 
lower adverse selection risk and receive higher execution quality 
relative to marketable orders wholesalers receive and execute in a 
riskless principal or agency capacity.\363\ Furthermore, results from 
Table 13 below show that wholesalers internalize a lower share of 
orders from retail brokers with the highest adverse selection risk. 
Additional results \364\ show that, relative to orders executed on 
exchanges, orders internalized by wholesalers are associated with lower 
price impacts (i.e., lower adverse selection risk),\365\ lower 
effective half-spreads (i.e., higher price improvement),\366\ and 
higher realized half-spreads (i.e., higher potential 
profitability).\367\
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    \361\ Wholesalers and other liquidity providers (including other 
market-makers) face adverse selection risk when they accumulate 
inventory, for example by providing liquidity to more informed 
traders, because of the risk of market prices moving away from 
wholesalers and other market makers before they are able to unwind 
their positions. Wholesalers and other market makers are usually not 
privy to the motives or information of the investors with whom they 
are trading. As such, should the liquidity provider trade with an 
investor possessing short-lived price information about the security 
price, it is exposing its inventory to adverse selection risk. 
Hence, liquidity providers, including wholesalers and other market-
makers normally choose their trading strategies to minimize their 
interaction with order flow with increased adverse selection risk. 
Wholesalers do this by attracting marketable orders of individual 
investors, known to be the order flow with the lowest adverse 
selection risk.
    \362\ See infra note 405 and corresponding discussion. Adverse 
selection risk is based on various characteristics of the order, 
including the identity of the originating broker.
    \363\ See analysis in infra Table 10.
    \364\ See infra Table 6 and infra Table 7 and corresponding 
discussion in section VII.B.4 for a comparison of exchange and 
wholesaler execution quality.
    \365\ See supra notes 47-48 and accompanying text for a 
definition and discussion of price impact as a measure of adverse 
selection risk. By measuring the difference between the NBBO 
midpoint at the time of execution and the NBBO midpoint some fixed 
period of time after the transaction (e.g., one minute), price 
impact measures the extent of adverse selection costs faced by a 
liquidity provider. For example, if a liquidity provider provides 
liquidity by buying shares from a trader who wants to sell, thereby 
accumulating a positive inventory position, and then wants to unwind 
this inventory position by selling shares in the market, it will 
incur a loss if the price has fallen in the meantime. In this case, 
the price impact measure will be positive, reflecting the liquidity 
provider's exposure to adverse selection costs.
    \366\ See also results in Thomas Ernst & Chester Spatt, Payment 
for Order Flow and Asset Choice (last revised Mar. 13, 2022) 
(unpublished manuscript), available at https://ssrn.com/abstract=4056512 (retrieved from SSRN Elsevier database) 
(hereinafter ``Ernst and Spatt Working Paper''). See supra note 46 
and accompanying text for a definition and discussion of effective 
half-spreads. The effective half-spread is calculated by comparing 
the trade execution price to an estimate of the stock's value (i.e., 
the midpoint of the prevailing NBBO at the time of order receipt) 
and thus captures how much more than the stock's estimated value a 
trader has to pay for the immediate execution of their order. The 
effective spread will be smaller (or less positive) when the 
execution price is closer to the NBBO midpoint, reflecting price 
improvement received on that order. See, e.g., Bjorn 
Hagstr[ouml]mer, Bias in the Effective Bid-Ask Spread, 142 J. Fin. 
Econ. 314 (2021). For the remainder of this analysis, we will use 
the term ``effective spread'' to refer to the ``effective half-
spread'' as defined in supra section II.D.1.
    \367\ See supra notes 49-50 and accompanying text for a 
definition and discussion of realized half-spreads. See, e.g., 
Securities Exchange Act Release No. 43590 (Nov. 17, 2000), 65 FR 
75423-75424 (Dec. 1, 2000) (Disclosure of Order Execution and 
Routing Practices) (``The smaller the average realized spread, the 
more market prices have moved adversely to the market center's 
liquidity providers after the order was executed, which shrinks the 
spread `realized' by the liquidity providers. In other words, a low 
average realized spread indicates that the market center was 
providing liquidity even though prices were moving against it for 
reasons such as news or market volatility.''); see also Larry 
Harris, Trading and Exchanges: Market Microstructure for 
Practitioners (2003) at 286. See infra note 420 discussing the 
limitations of realized spreads for estimating the profits earned by 
market makers. For the remainder of this analysis, we will use the 
term ``realized spread'' to refer to the ``realized half-spread'' as 
defined in supra section II.D.1.
---------------------------------------------------------------------------

    Though wholesaler internalization generates price improvement for 
individual investors relative to the NBBO, the Commission posits that 
the potential isolation of marketable order flow routed to wholesalers 
results in suboptimal price improvement for individual investor orders 
relative to what the Commission estimates would be achieved under the 
Proposal. Specifically, due to the isolation of this order flow by 
wholesalers from order-by-order competition, the amount of price 
improvement individual investors receive does not fully compensate for 
the lower adverse selection risk of their orders. Commission analyses 
presented below provide results that support this point.\368\
---------------------------------------------------------------------------

    \368\ See infra sections VII.B.4 and VII.B.5.
---------------------------------------------------------------------------

    The baseline section below is organized as follows. The baseline 
first discusses relevant features of trading services, including 
segmentation and interactions between institutional and retail order 
flows. Next, the baseline presents the Commission's empirical findings 
on execution quality. The

[[Page 181]]

section ends with a discussion of retail broker services and rules 
addressing consolidated market data.
1. Competition for Liquidity Provision in NMS Stocks
    Investors trade for a variety of reasons, whether because of 
informational advantages or because of hedging and liquidity needs. In 
an idealized competitive market, these investors would meet and trade 
amongst themselves, without the need of an intermediary. In such cases, 
trades would occur at the midpoint and neither side would pay the 
spread. In real-life markets, not all investors meet at the same time. 
Furthermore, investors may avoid trading with one another if they 
believe their counterparty has information that they do not, as opposed 
to trading for liquidity reasons. Moreover, investors often utilize the 
technology and services of a broker-dealer in order to find and 
interact efficiently with the trading interest of other investors. For 
these reasons, there are broker-dealers who incur fixed costs for 
routing orders and charge a spread for acting as a dealer and supplying 
liquidity when end investors are not available to directly trade with 
each other.
    Market centers compete to attract order flow from these broker-
dealers. As shown in Table 1, in Q1 of 2022, NMS stocks were traded on 
16 registered securities exchanges,\369\ and off-exchange at 32 NMS 
Stock ATSs and at over 230 other FINRA members, including OTC market 
makers.\370\ OTC market makers include the 6 wholesalers that 
internalize the majority of individual investor marketable orders.\371\ 
These numerous market centers match traders with counterparties, 
provide a framework for price negotiation and/or provide liquidity to 
those seeking to trade.
---------------------------------------------------------------------------

    \369\ Most of these 16 registered securities exchanges are owned 
by three exchange groups. Currently, the CBOE exchange group owns: 
Cboe BYX Exchange, Inc. (``Cboe BYX''), Cboe BZX Exchange, Inc. 
(``Cboe BZX''), Cboe EDGA Exchange, Inc. (``Cboe EDGA''), and Cboe 
EDGX Exchange, Inc. (``Cboe EDGX''); the Nasdaq exchange group owns: 
Nasdaq BX, Inc. (``Nasdaq BX''), Nasdaq PHLX LLC (``Nasdaq Phlx''), 
and The Nasdaq Stock Market LLC (``Nasdaq''); and the NYSE exchange 
group owns: NYSE, NYSE American LLC (``NYSE American''), NYSE Arca, 
Inc. (``NYSE Arca''), NYSE Chicago, Inc. (``NYSE CHX''), and NYSE 
National, Inc. (``NYSE National''). Other registered securities 
exchanges that trade NMS stocks and do not belong to one of these 
exchange groups include: Investors Exchange LLC (``IEX''), Long-Term 
Stock Exchange, Inc. (``LTSE''), MEMX LLC (``MEMX''), and MIAX 
Pearl, LLC (``MIAX PEARL'').The Commission approved rules proposed 
by BOX Exchange LLC (``BOX'') for the listing and trading of certain 
equity securities that would be NMS stocks on a facility of BOX 
known as BSTX LLC (``BSTX''), but BSTX is not yet operational. See 
Securities Exchange Act Release Nos. 94092 (Jan. 27, 2022), 87 FR 
5881 (Feb. 2, 2022) (SR-BOX-2021-06) (approving the trading of 
equity securities on the exchange through a facility of the exchange 
known as BSTX); 94278 (Feb. 17, 2022), 87 FR 10401 (Feb. 24, 2022) 
(SR-BOX-2021-14) (approving the establishment of BSTX as a facility 
of BOX). BSTX cannot commence operations as a facility of BOX until, 
among other things, the BSTX Third Amended and Restated Limited 
Liability Company Agreement approved by the Commission as rules of 
BOX is adopted. Id. at 10407.
    \370\ See supra section II.B for further details on the types of 
trading centers that execute trades in NMS stocks. See also Form 
ATS-N Filings and Information (for a list of ATSs that trade NMS 
stocks and have a Form ATS-N filed with the Commission), available 
at https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm. 
Some academic studies attribute the fragmented nature of the market 
for NMS stocks, in part, to certain provisions of Regulation NMS. 
See, e.g., Maureen O'Hara & Mao Ye, Is Market Fragmentation Harming 
Market Quality?, 100 J. Fin. 459 (2011); Amy Kwan, Ronald Masulis & 
Thomas H. McInish, Trading Rules, Competition for Order Flow and 
Market Fragmentation, 115 J. Fin. 330 (2015).
    \371\ The six OTC market makers that are classified as 
wholesalers for purposes of this release are the OTC market makers 
to which the majority of marketable orders originating from retail 
brokers were routed as identified from information from retail 
broker Rule 606(a)(1) reports from Q1 2022. These market makers also 
reported executing a significant percentage of shares routed to them 
on their Rule 605 reports. Rule 606(a)(1) requires broker-dealers to 
produce quarterly public reports containing information about the 
venues to which the broker-dealer regularly routed non-directed 
orders for execution, including any payment relationship between the 
broker-dealer and the venue, such as any PFOF arrangements. See 17 
CFR 242.606(a)(1).

            Table 1--NMS Stock Traded Share Volume Percentage of All NMS Stocks by Market Center Type
----------------------------------------------------------------------------------------------------------------
                                                                                                   Off-exchange
                       Market center type                            Venue cnt     Share volume    share volume
                                                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Exchanges.......................................................              16            59.7  ..............
NMS Stock ATSs..................................................              32            10.2            25.2
Wholesalers \a\.................................................               6            23.9            59.4
Other FINRA Members.............................................             232             6.3            15.6
----------------------------------------------------------------------------------------------------------------
This table reports the percentage of all NMS stock executed share volume and the percentage of NMS stock share
  volume executed off-exchange for different types of market centers for Q1 2022. Venue Cnt lists the number of
  venues in each market center category. Share Volume Pct is the percentage of all NMS stock share volume (on
  plus off-exchange) executed by the type of market center. Off-Exchange Share Volume Pct is the percentage of
  off-exchange share volume executed by the type of market center. Exchange share volume and total market volume
  are based on CBOE Market Volume Data on monthly share volume executed on each exchange and share volume
  reported in FINRA Trade Reporting Facilities (TRFs).\b\ NMS Stock ATS, wholesaler and FINRA member share
  volume are based on monthly FINRA OTC Transparency data on aggregated NMS stock trading volume executed on
  individual ATSs and over-the-counter at Non-ATS FINRA members.\c\ Off-Exchange Share Volume Pct is calculated
  by dividing the NMS Stock ATS, wholesaler and FINRA member share volume from the FINRA Transparency Data by
  the total TRF share volume reported in CBOE Market Volume Data.
\a\ See supra note 371 for details regarding how FINRA member OTC market makers are classified as wholesalers
  for purposes of this release.
\b\ Cboe, U.S. Historical Market Volume Data, available at https://cboe.com/us/equities/market_statistics/historical_market_volume/. Trade Reporting Facilities (TRFs) are facilities through which FINRA members report
  off-exchange transactions in NMS stocks, as defined in SEC Rule 600(b)(47) of Regulation NMS. See https://www.finra.org/filing-reporting/trade-reporting-facility-trf.
\c\ FINRA OTC (Non-ATS) Transparency Data Monthly Statistics, available at https://otctransparency.finra.org/otctransparency/OtcData otctransparency/OtcData; FINRA ATS Transparency Data Monthly Statistics, available at https://otctransparency.finra.org/otctransparency/AtsBlocksDownload. The FINRA OTC (Non-ATS) Transparency Data may not
  contain all share volume transacted by a wholesaler or FINRA member because FINRA aggregates security-specific
  information for firms with ``de minimis'' volume outside of an ATS and publishes it on a non-attributed basis.

    Market centers' primary customers are broker-dealers that route 
their own orders or their customers' orders for execution. Market 
centers may compete with each other for these broker-dealers' order 
flow on a number of dimensions, including execution quality. They also 
may innovate to differentiate themselves from other trading centers to 
attract more order flow. While registered exchanges cater to a broader 
spectrum of investors, ATSs and OTC market makers, including 
wholesalers, tend to focus more on providing trading services to either 
institutional or individual investor orders.
    Table 1 displays NMS stock share volume percentage by market center

[[Page 182]]

type for Q1 2022. Exchanges execute approximately 60% of total share 
volume in NMS stocks, while off-exchange market centers execute 
approximately 40%. The majority of off-exchange share volume is 
executed by wholesalers, who execute almost one quarter of total share 
volume (23.9%) \372\ and about 60% of off-exchange share volume.\373\ 
NMS Stock ATSs execute approximately 10% of total NMS stock share 
volume and 25% of off-exchange share volume. Other FINRA members, 
besides wholesalers and ATSs, execute approximately 15% of off-exchange 
share volume.
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    \372\ Of the six wholesalers identified in Q1 2022, two 
accounted for approximately 66% of wholesalers' total executed share 
volume of NMS stocks. One study finds that the concentration of 
wholesaler internalization, as measured by the Herfindahl-Hirschman 
Index (HHI) of share volume executed across wholesalers, has 
increased from 2018 to 2021. See Edwin Hu & Dermot Murphy, 
Competition for Retail Order Flow and Market Quality (last revised 
Oct. 7, 2022) (unpublished manuscript), available at https://ssrn.com/abstract=4070056 (retrieved from Elsevier database).
    \373\ The share volume reported for wholesalers in FINRA OTC 
Transparency Data includes both individual investor orders executed 
by wholesalers in a principal capacity as well as other orders 
executed by wholesalers in a principal capacity, such as 
institutional orders executed on their SDPs. It does not include 
share volume that they executed in a riskless principal capacity or 
share volume that was routed and executed at another market center.
---------------------------------------------------------------------------

    There is evidence that the percentage of trading volume executed 
off-exchange has been increasing over time. One industry group study 
found that volume traded off-exchange as a percent of total volume has 
increased since 2018, when off-exchange trading was 36.8% of total 
volume.\374\ According to another study by an exchange, an increase in 
orders executed by off-exchange venues other than ATSs has been the 
driving factor behind this increase in off-exchange trading, which has 
been particularly significant for lower-priced stocks.\375\ At the same 
time, some have highlighted a decline in liquidity displayed at or near 
the NBBO on exchanges.\376\ Industry participants have raised concerns 
regarding a ``monopolistic environment,'' in which information off-
exchange becomes sufficiently concentrated and determinative as to 
widen spreads on exchange.\377\ For example, a liquidity provider 
deciding whether to rest an order on the book would face the 
possibility of a wholesaler or other off-exchange market maker gleaning 
information from the posted liquidity to determine a price to execute 
off-exchange that accounts for the lack of adverse selection risk in 
off-exchange flow.\378\ This limits the execution possibilities on 
exchange. On the other hand, any posted liquidity (which grants an 
option to liquidity demanders or to those engaged in latency arbitrage) 
is vulnerable to being ``picked off''--namely executed against exactly 
when the price is (in the case of a resting buy order) moving lower or 
(in the case of a sell order) moving higher. These dynamics lower the 
incentives to post liquidity on exchange.
---------------------------------------------------------------------------

    \374\ See SIFMA Insights, Analyzing the Meaning Behind the Level 
of Off-Exchange Trading (Sept. 2021), available at https://www.sifma.org/wp-content/uploads/2021/09/SIFMA-Insights-Analyzing-Off-Exchange-Trading-09-2021.pdf. The study found off-exchange 
trading to be 44.2% of total YTD trading volume as of Sept. 2021.
    \375\ See NYSE Data Insights, Market Volume and Off-Exchange 
Trading: More than a Retail Story (June 15, 2020), available at 
https://www.nyse.com/data-insights/market-volume-and-off-exchange-trading. In particular, the study found that, for stocks priced 
lower than $5, off-exchange trading market share increased from 
45.4% in Oct. 2019 to 54.8% in June 2020, and that ATS market share 
decreased from 14.2% to 11.5% of consolidated average daily volume 
and non-ATS OTC market share increased from 20.5% to 27.8% over the 
same time period.
    \376\ See, e.g., Gunjan Banerji, Buying or Selling Stocks? It 
Isn't Always Easy, Wall St., J., Jan. 2, 2020, showing a greater 
than 90% reduction in the number of shares available at the best 
prices in the SPDR S&P 500 ETF from 2007 to 2018, as one example of 
the overall reduction in market liquidity. Furthermore, in a comment 
letter to the Commission responding to comments on an SRO proposed 
rule change, an exchange found that the COVID crisis lead to a 
further substantial decrease in the depth of liquidity at the NBBO, 
as the average displayed quote size declined by 69% from Jan. to 
Mar. 2020 for S&P 500 stocks. See Letter from John Ramsay, Chief 
Market Policy Officer, Investors Exchange LLC to Ms. Vanessa 
Countryman, Secretary, U.S. Securities and Exchange Commission, 
dated May 10, 2020 (File No. SR-IEX-2019-15), available at https://www.sec.gov/comments/sr-iex-2019-15/sriex201915-7169827-216633.pdf.
    \377\ See Hitesh Mittal & Kathryn Berkow, The Good, The Bad & 
The Ugly of Payment for Order Flow (May 3, 2021), available at 
https://bestexresearch.com/the-good-the-bad-the-ugly-of-payment-for-order-flow/.
    \378\ Mitigating this information asymmetry is that off-exchange 
trades also print to a consolidated post-trade tape, though with 
latency compared with on-exchange trades.
---------------------------------------------------------------------------

    Exchanges (via their rules) and ATSs determine how orders compete 
with each other, wherein liquidity suppliers set prices and wait for 
execution at their prices by liquidity demanders. This interaction 
between liquidity providers and demanders encompasses order-by-order 
competition. Unlike exchanges, for which each exchange's rules 
determine competition in a non-discretionary fashion, wholesalers 
execute or route orders in a discretionary fashion.\379\ While some 
orders may be routed to a central limit order book against which 
institutional investors may execute (on the discretion of the 
wholesaler), institutional investors generally consider order flow 
routed to a wholesaler to be ``inaccessible.'' \380\
---------------------------------------------------------------------------

    \379\ A study estimates that the volume of individual investor 
orders executed by wholesalers accounted for approximately 16% to 
17% of consolidated share volume during Q1 2022. See Rosenblatt 
Securities, An Update on Retail Market Share in US Equities (June 
24, 2022), available at https://www.rblt.com/market-reports/trading-talk-an-update-on-retail-market-share-in-us-equities. However, 
wholesalers are not completely focused on individual investor order 
flow and some do offer services to institutional order flow. See 
infra section VII.B.3 for a discussion of their interaction with 
institutional order flow.
    \380\ See supra note 37 (citing Jennifer Hadiaris, Cowen Market 
Structure: Retail Trading--What's going on, what may change, and 
what can you do about it?, Cowen (Mar. 23, 2021), available at 
https://www.cowen.com/insights/retail-trading-whats-going-on-what-may-change-and-what-can-institutional-traders-do-about-it/). 
Further, wholesalers are also not subject to a statutory or 
regulatory requirement to provide fair access. See supra section 
III.B.3 for further discussion of requirements that do and do not 
apply to wholesalers.
---------------------------------------------------------------------------

    As a proxy for expected execution quality, quoted prices are a 
dimension on which exchanges compete to attract order flow. 
Specifically, exchanges are required to post the best bid and ask 
prices available on the exchange at that time,\381\ and broker-dealers 
can observe those prices and choose to route orders to the exchange 
posting the best prices at a given point in time. However, others who 
provide trading services, such as ATSs and OTC market makers, do not 
usually compete on this dimension.\382\ In other words, wholesalers 
generally do not compete for order flow by posting competitive prices 
the way exchanges do. They do not display or otherwise advertise the 
prices at which they are willing to internalize individual investor 
orders at a given point in time. This suggests that wholesalers attract 
order flow by offering retail brokers more than just competitive prices 
at a point in time on a specific order. Instead, wholesalers generally 
attract order flow by offering to on average execute orders at prices 
that are better than displayed prices. Additionally, wholesalers bundle 
their market access services with execution services, thereby 
vertically fully integrating order handling and execution services for 
their retail broker customers.
---------------------------------------------------------------------------

    \381\ See Rule 602 of Regulation NMS.
    \382\ ATSs typically compete for institutional order flow by 
offering innovative trading features such as distinct trading 
protocols and segmentation options. They may also compete on fees. 
In addition, they could include their ATS access in the broader set 
of bundled services that the broker-dealer director of the ATS 
offers to their institutional investors.
---------------------------------------------------------------------------

2. Segmentation of Individual Investor Order Flow
    Individual investor orders typically carry lower adverse selection 
risk, in part because individual investors may

[[Page 183]]

have less information on market conditions than other market 
participants and in part because their orders tend to be small. Both of 
these factors make individual investor orders less likely to be 
followed by orders in the same direction.\383\ The lower adverse 
selection risk of individual investor orders makes them more valuable 
for segmentation by liquidity providers that want to execute these 
orders in a principal capacity, since they are less costly to liquidity 
providers such as wholesalers to execute (i.e., have lower price 
impacts) than orders with higher adverse selection risk. Due to this 
lower cost, wholesalers are able to provide price improvement to these 
orders and still earn higher profits, as discussed in supra section 
II.D.2.
---------------------------------------------------------------------------

    \383\ While this characterization of individual orders is 
generally true, there are also individual investors that are highly 
sophisticated and informed of market conditions. See infra section 
VII.B.5.b for an empirical analysis and discussion of variation in 
execution quality based on variation in adverse selection risk of 
retail broker order flow.
---------------------------------------------------------------------------

    Regulation NMS allows an order to be executed off-exchange, 
provided that an off-exchange trading venue executes the order at a 
price equal to the NBBO or better.\384\ To the extent that a liquidity 
provider is able to segment \385\ low-risk individual investor order 
flow, this order flow can be executed against with higher profitability 
for the liquidity provider. Since exchanges are limited in their 
ability to segment order flow (with the exception of retail liquidity 
programs),\386\ the ability of off-exchange venues to segment orders is 
one reason why orders are routed off-exchange. Furthermore, off-
exchange trading venues are often more flexible in determining prices 
than national securities exchanges.\387\
---------------------------------------------------------------------------

    \384\ See supra section III.B.2.b.
    \385\ See supra section I for a definition of segmentation.
    \386\ See infra section VII.B.2.c.
    \387\ For example, Rule 612 does not prevent wholesalers, after 
they receive an order from a broker, from choosing to execute that 
order in a transaction at a sub-penny price. See supra note 148 and 
corresponding discussion.
---------------------------------------------------------------------------

    The ability to segment is one reason why many individual investor 
orders are executed off-exchange. Another reason is potential 
efficiency in outsourcing routing services. Maintaining market access 
at many venues is costly, so broker-dealers have an incentive to use 
the services of other broker-dealers who maintain market access at 
most, if not all, market centers. Wholesalers are the dominant 
providers of market access for retail brokers and bundle their market 
access services with execution services. Yet another reason arises from 
economies of scale stemming from the information that can be gleaned 
from large quantities of individual orders.\388\ Because of the 
profitability in these segmented orders, wholesalers will sometimes pay 
for them, a practice known as payment for order flow. For some retail 
brokers, this may create an additional incentive for routing to the 
wholesalers.
---------------------------------------------------------------------------

    \388\ See infra note 406 for a discussion of the informational 
advantages that routing can provide to wholesalers.
---------------------------------------------------------------------------

a. Routing and Market Access
    Most individual investor orders are non-directed, so individual 
investor order routing choices are largely made by retail brokers. 
Specifically, retail brokers choose how to access the market in order 
to fill their individual investor customers' orders. Many broker-
dealers that handle customer accounts, including many retail brokers, 
do not directly access national securities exchanges or ATSs for their 
orders, relying on other broker-dealers to facilitate market access for 
them.\389\ For example, only members of exchanges or subscribers to (or 
owners of) ATSs can directly access those particular market 
centers.\390\ As a result, some broker-dealers that are exchange 
members or ATS subscribers/owners provide access to other brokers-
dealers by rerouting their customer orders to these market centers. The 
broker-dealers (including wholesalers) who provide market access can 
choose to compete on a number of dimensions, such as by charging lower 
fees or paying for order flow, by facilitating better execution 
quality, and by providing other valued services.\391\
---------------------------------------------------------------------------

    \389\ Providing market access can mean rerouting customer orders 
and it can also involve sponsoring access for the broker to send 
customer orders directly to a market center.
    \390\ The number of broker-dealers providing access is thus 
limited due to the expenses of being an exchange member and ATS 
subscriber. In addition, membership on an exchange also gives the 
broker-dealer access to exchange-provided order routers that re-
route orders to other exchanges at a per-order fee. Thus, membership 
on one exchange can effectively provide access, though not directly, 
to all exchanges.
    \391\ Although some retail brokers are members of exchanges, 
they may still prefer to rely on wholesalers' expertise for the 
handling and routing of their customers' orders.
---------------------------------------------------------------------------

    Retail brokers may route to wholesalers because the cost of sending 
orders to wholesalers is lower than the various alternatives available 
to their customers for market access. While some broker-dealers have 
SORs,\392\ exchange memberships, and ATS subscriptions, and are thus 
able to provide market access to retail brokers, these other broker-
dealers incur costs in handling order flow for retail brokers in the 
form of exchange access fees, ATS access fees, and administrative and 
regulatory costs such as recordkeeping and the risk management controls 
of Rule 15c3-5. While wholesalers could incur some of these marginal 
costs as well, they benefit on the margin from individual investor 
order flow because they have the option to internalize the most 
profitable of that order flow, i.e., the individual investor orders 
with the lowest adverse selection risk.\393\ This ability to capture, 
identify, and internalize profitable orders from individual investors 
allows wholesalers to provide market access to retail brokers at low 
explicit cost, either by providing PFOF or by not charging retail 
brokers explicitly for market access. This service of obtaining market 
access on behalf of retail brokers assists retail brokers by allowing 
them to avoid routing expenses (even in cases where the wholesaler 
further routes the order instead of internalizing) or costly liquidity 
searches, and may increase retail brokers' reliance on wholesalers 
beyond any payment they receive for routing their order flow to 
wholesalers.
---------------------------------------------------------------------------

    \392\ Individual investors and professional traders relying on 
displayed screens to access financial markets generally do not have 
access to these low-latency (algorithmic, high speed) technologies.
    \393\ See infra section VII.B.2.b for further discussion of 
wholesaler internalization.
---------------------------------------------------------------------------

    Indeed, Table 2 shows that retail brokers who accept PFOF (``PFOF 
brokers'') pay less to route their orders to wholesalers than to route 
them elsewhere.\394\ In fact, they are paid to route their order flow 
to wholesalers for every order type reported in the table. On average, 
rates paid by wholesalers for both market and marketable limit orders 
are higher than those paid by alternative venues, with wholesalers 
paying an average of 13 cents per 100 shares for market orders and 12.6 
cents for marketable limit orders across S&P 500 and non-S&P 500 stocks 
during Q1 2022. In contrast, exchanges, on average, charged PFOF 
brokers when they routed their marketable order flow to exchanges. This 
likely indicates that most of the volume that PFOF brokers sent to 
exchanges was routed to maker-taker exchanges (where fees are assessed 
on marketable orders).\395\ Furthermore,

[[Page 184]]

since retail brokers that do not accept PFOF (``non-PFOF brokers'') 
also incur fees when they route marketable orders to exchanges, they 
are also incentivized to route their marketable order flow to 
wholesalers, who do not charge them explicit costs to route and execute 
their orders.
---------------------------------------------------------------------------

    \394\ In Table 2, average payment rates reported in Rule 606 
reports for PFOF brokers in S&P 500 stocks and non-S&P 500 stocks in 
Q1 2022 are broken down by trading venue and order type, with rates 
given in cents per 100 shares.
    \395\ Furthermore, wholesaler rates for non-marketable orders 
are more than double the rates for marketable orders, averaging 27.1 
cents per hundred shares compared to 13 cents for market orders and 
12.6 cents for marketable limit orders. Additionally, Table 2 shows 
that the average payment rates PFOF brokers receive from routing 
non-marketable limit orders to wholesalers is greater than the 
average rates they receive from routing them to exchanges. This may 
be driven by wholesalers passing through exchange rebates for these 
orders, for which they may receive higher volume-based tiering rates 
compared to retail brokers, back to broker-dealers.

                                Table 2--Average Rule 606 Payment Rates for Q1 2022 to PFOF Brokers by Trading Venue Type
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                               Non-
                                                                                           Market orders    Marketable      marketable     Other orders
                                                                                                           limit orders    limit orders
--------------------------------------------------------------------------------------------------------------------------------------------------------
S&P 500........................................  Exchange...............................            -5.9           -23.9            30.9            20.8
                                                 OTC Market Maker--Wholesaler...........            15.2            21.8            41.1            24.1
                                                 Other..................................             4.5            -0.6            -0.6             7.5
Non-S&P 500....................................  Exchange...............................           -14.9           -15.3            17.9            16.5
                                                 OTC Market Maker--Wholesaler...........            12.5            11.8            24.6            10.1
                                                 Other..................................             1.5            -3.7            -4.6             1.5
Combined.......................................  Exchange...............................           -12.4           -15.7            19.3            17.1
                                                 OTC Market Maker--Wholesaler...........            13.0            12.6            27.1            11.9
                                                 Other..................................             1.7            -3.7            -4.5             2.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table shows the average payment rates (in cents per 100 shares) made from different types of trading venues in Q1 2022 to 14 retail PFOF brokers
  from wholesalers based on their Rule 606 reports. The table breaks out average rates from exchanges, wholesalers, and other trading venues for market
  orders, marketable limit orders, non-marketable limit orders, and other orders in S&P 500 stocks and non-S&P 500 stocks. Other venues include any
  other venue to which a retail broker routes an order other than a wholesaler or an exchange. The 43 broker-dealers were identified from the 54 retail
  brokers used in the CAT retail analysis (see infra note 466). This analysis uses the retail broker's Rule 606 report if it publishes one or the Rule
  606 report of its clearing broker if it did not publish a Rule 606 report itself (the sample of 43 broker-dealer Rule 606 reports include some broker-
  dealers that were not included in the CAT analysis because some clearing broker Rule 606 reports are included). Some broker-dealers reported handling
  orders only on a not held basis and did not have any Rule 606.

    Table 3 reflects that wholesalers dominate the business of 
providing market access for retail brokers and indicates that PFOF is a 
factor in retail broker routing decisions.\396\ Data from Table 3 
indicates that orders of individual investors for NMS stocks are 
primarily routed to wholesalers, although a small fraction of 
individual investor orders are routed to exchanges and other broker-
dealers providing market access or other market centers (i.e., ATSs), 
some of which may be affiliated with the broker that received the 
original order.
---------------------------------------------------------------------------

    \396\ Table 3 summarizes order routing decisions of 43 of the 
most active retail brokers about non-directed orders; see infra note 
466. Routing choices are summarized separately for 14 PFOF brokers 
in equity markets and non-PFOF brokers. Note that some brokers do 
not accept PFOF for orders in equities but do accept PFOF for orders 
in options. Consistent with Rule 606, routing statistics are 
aggregated together in Rule 606 reports based on whether the stock 
is listed in the S&P500 index. Rule 606 reports collect routing and 
PFOF statistics based on four different order types for NMS stocks: 
(1) market orders, resulting in immediate execution at the best 
available price; (2) marketable limit orders, resulting in immediate 
execution at the best price that is not worse that the order's 
quoted limit price; (3) non-marketable limit orders whose quoted 
limit price less aggressive than the NBBO, often preventing 
immediate execution; and (4) all other orders. See supra note 371 
for a summary of the requirements of Rule 606(a)(1) of Regulation 
NMS

       Table 3--Retail Broker Order Routing in NMS Stocks for Q1 2022, Combining PFOF and Non-PFOF Brokers
----------------------------------------------------------------------------------------------------------------
                                                                       Non-
                                      Market        Marketable      marketable         Other           Total
           Venue type                (percent)         limit           limit         (percent)       (percent)
                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
                                           Panel A: Non S&P 500 Stocks
----------------------------------------------------------------------------------------------------------------
Other...........................             6.0             4.7             3.1             1.5             3.6
Exchange........................             0.2             5.5            22.5             0.8             8.5
Wholesaler......................            93.9            89.8            74.4            97.6            87.9
                                 -------------------------------------------------------------------------------
    Total.......................            26.5            12.6            33.6            27.3           100.0
----------------------------------------------------------------------------------------------------------------
                                             Panel B: S&P 500 Stocks
----------------------------------------------------------------------------------------------------------------
Other...........................             6.6             5.9             1.8             1.7             3.6
Exchange........................             0.2             4.6            25.1             0.8             9.1
Wholesaler......................            93.3            89.6            73.1            97.5            87.3
                                 -------------------------------------------------------------------------------
    Total.......................            30.6             9.6            33.5            26.4           100.0
----------------------------------------------------------------------------------------------------------------
This table aggregates Rule 606 reports from retail brokers and shows the percentage of market orders, marketable
  limit orders, non-marketable limit orders, and other orders that retail brokers route to different types of
  venues in Q1 2022. Other venues include any other venue to which a retail broker routes an order other than a
  wholesaler or an exchange. Order type classifications are based on the order types broker-dealers are required
  to include in their Rule 606 reports.

[[Page 185]]

 
Table 3 aggregates routing information from 43 broker-dealer Rule 606 reports from Q1 2022. The 43 broker-
  dealers were identified from the 54 retail brokers used in the CAT retail analysis (see infra note 466). This
  analysis uses the retail broker's Rule 606 report if it publishes one or the Rule 606 report of its clearing
  broker if it did not publish a Rule 606 report itself (the sample of 43 broker-dealer Rule 606 reports include
  some broker-dealers that were not included in the CAT analysis because some clearing broker Rule 606 reports
  are included). Some broker-dealers reported handling orders only on a not held basis and did not have any Rule
  606 reports. Because Rule 606 only include percentages of where their order flow is routed and not statistics
  on the number of orders, the reports are aggregated together using a weighting factor based on an estimate of
  the number of non-directed orders each broker-dealer routes each month. The number of orders is estimated by
  dividing the number of non-directed market orders originating from a retail broker in a given month (based on
  estimates from CAT data) by the percentage of market orders as a percent of non-directed orders in the retail
  broker's Rule 606 report (the weight for a clearing broker consists of the aggregated orders from the
  introducing brokers in the CAT retail analysis that utilize that clearing broker).


                        Table 4--Retail Broker Order Routing in NMS Stocks for March 2022
----------------------------------------------------------------------------------------------------------------
                                                                       Non-
                                      Market        Marketable      marketable         Other           Total
           Venue type                (percent)         limit           limit         (percent)       (percent)
                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
                                           Panel A: Non-S&P 500 Stocks
                                                Non-PFOF Brokers
----------------------------------------------------------------------------------------------------------------
Other...........................            24.1            22.3             4.2            41.6            16.0
Exchange........................            <0.1            25.3            80.8            19.7            39.8
Wholesaler......................            76.0            52.4            15.0            38.8            44.2
                                 -------------------------------------------------------------------------------
    Total.......................            38.4            12.4            44.2             5.0           100.0
----------------------------------------------------------------------------------------------------------------
                                                  PFOF Brokers
----------------------------------------------------------------------------------------------------------------
Other...........................            <0.1             1.2             2.8             0.3             1.1
Exchange........................             0.2             1.5             5.8             0.2             2.1
Wholesaler......................            99.7            97.3            91.4            99.5            96.8
                                 -------------------------------------------------------------------------------
    Total.......................            24.1            12.7            31.5            31.8           100.0
----------------------------------------------------------------------------------------------------------------
                                             Panel B: S&P 500 Stocks
                                                Non-PFOF Brokers
----------------------------------------------------------------------------------------------------------------
Other...........................            24.8            27.0             3.2            23.4            15.4
Exchange........................            <0.1            19.6            83.2             8.2            39.0
Wholesaler......................            75.2            53.4            13.6            68.3            45.6
                                 -------------------------------------------------------------------------------
    Total.......................            39.0             9.2            43.8             8.0           100.0
----------------------------------------------------------------------------------------------------------------
                                                  PFOF Brokers
----------------------------------------------------------------------------------------------------------------
Other...........................            <0.1             0.5             1.3             0.3             0.6
Exchange........................             0.2             0.9             3.4             0.3             1.3
Wholesaler......................            99.8            98.6            95.3            99.5            98.2
                                 -------------------------------------------------------------------------------
    Total.......................            28.4             9.7            30.7            31.2           100.0
----------------------------------------------------------------------------------------------------------------
This table aggregates Rule 606 reports from PFOF and non-PFOF retail brokers and separately shows the percentage
  of market orders, marketable limit orders, non-marketable limit orders, and other orders PFOF brokers and non-
  PFOF brokers route to different types of venues in Q1 2022. PFOF brokers are retail brokers that receive
  payments for routing marketable orders to wholesalers. Other venues include any other venue to which a retail
  broker routes an order other than a wholesaler or an exchange. Order type classifications are based on the
  order types broker-dealers are required to include in their Rule 606 reports.
Table 4 aggregates routing information from PFOF and non-PFOF broker-dealer Rule 606 reports from Q1 2022.
  Fourteen retail brokers are identified as PFOF brokers that receive payments for routing orders in NMS stocks
  to wholesalers. Non-PFOF brokers are identified as retail brokers that do not receive monetary compensation
  when they route orders in NMS stocks to wholesalers. The 43 broker-dealers were identified from the 54 retail
  brokers used in the CAT retail analysis (see infra note 466). This analysis uses the retail broker's Rule 606
  report if it publishes one or the Rule 606 report of its clearing broker if it did not publish a Rule 606
  report itself (the sample of 43 broker-dealer Rule 606 reports include some broker-dealers that were not
  included in the CAT analysis because some clearing broker Rule 606 reports are included). Some broker-dealers
  reported handling orders only on a not held basis and did not have any Rule 606 reports. Because Rule 606 only
  include percentages of where their order flow is routed and not statistics on the number of orders, the
  reports are aggregated together using a weighting factor based on an estimate of the number of non-directed
  orders each broker-dealer routes each month. The number of orders is estimated by dividing the number of non-
  directed market orders originating from a retail broker in a given month (based on estimates from CAT data) by
  the percentage of market orders as a percent of non-directed orders in the retail broker's Rule 606 report
  (the weight for a clearing broker consists of the aggregated orders from the introducing brokers in the CAT
  analysis that utilize that clearing broker).

    CAT data analysis indicates that about 80% of the share volume and 
about 74% of the dollar volume of individual investor marketable orders 
that were routed to wholesalers and executed comes from PFOF 
brokers.\397\ Data from Table 4 indicate that, while retail brokers who 
accept PFOF from wholesalers tend to send more of their orders to those 
wholesalers, wholesalers even dominate the market access services for 
non-PFOF brokers, though non-PFOF brokers route a significantly lower 
fraction (i.e., 75.2% to 76%) of their market orders to wholesalers, 
compared to 99.7% to 99.8% of market orders for PFOF brokers. Moreover, 
non-PFOF brokers route 24.1% to 24.8% of their market orders to other 
non-exchange market centers, e.g., ATSs,

[[Page 186]]

while PFOF brokers route less than 1% of their market orders to these 
market centers. However, regardless of whether the retail broker 
accepts PFOF, the order type, or the S&P500 index inclusion of the 
stock,\398\ Table 3 shows that retail brokers route over 87% of their 
customer orders to wholesalers.
---------------------------------------------------------------------------

    \397\ See infra Table 14.
    \398\ Rule 606 reports require that broker-dealers separate 
their disclosure information for S&P 500 stocks, non-S&P 500 stocks, 
and options.
---------------------------------------------------------------------------

    This result suggests that, while PFOF is an important factor in 
retail brokers routing decisions, wholesalers likely also compare 
favorably to other market access centers (including retail brokers 
pursuing their own market access) along other dimensions. The routing 
behavior in Table 4 may, in part, reflect a tendency of non-PFOF 
brokers to route individual investor orders to market centers such as 
their own ATSs for mid-point execution and the lack of an affiliated 
ATS for PFOF brokers. However, even broker-dealers with their own ATSs 
do not route the majority of their individual investor order flow to 
those ATSs and typically do not internalize order flow. Further, retail 
brokers with membership on multiple exchanges primarily route their 
marketable orders to wholesalers. These results could point to a lower 
marginal cost of routing to wholesalers relative to other routing and 
execution alternatives. Table 5 below shows that wholesalers appear to 
compare favorably to exchanges in the execution quality of orders 
routed to them, suggesting that execution quality could be another key 
factor in the decision of retail brokers to route to wholesalers.\399\ 
In particular, marketable orders routed to wholesalers appear to have 
higher fill rates, lower effective spreads, and lower E/Q ratios.\400\ 
These orders are also more likely to receive price improvement and, 
conditional on receiving price improvement, receive greater price 
improvement when routed to wholesalers as compared to exchanges.
---------------------------------------------------------------------------

    \399\ See infra section VII.B.4 for a full discussion of Table 5 
and section VII.B.5 for a discussion of how the Commission 
preliminarily believes that the execution quality of orders routed 
to wholesalers could be even better if most of such orders were not 
isolated from order-by-order competition.
    \400\ The E/Q ratio is the ratio of a stock's effective spread 
over quoted spread. A lower value indicates smaller effective 
spreads (i.e., trading costs) as a percentage of the quoted spread.
---------------------------------------------------------------------------

    In addition, wholesalers may provide additional valuable services 
to retail brokers that route order flow to them. Based on staff 
experience, the Commission understands that wholesalers are more 
responsive to retail brokers that provide them with order flow, 
including, for example, following customer instructions not to 
internalize particular orders. More broadly, wholesalers appear to 
provide retail brokers with a high degree of consistency with regard to 
execution quality. More specifically, while wholesalers receive order 
flow from retail brokers that contains variation in quoted spreads and 
adverse selection risk, wholesalers can target an average level of 
price improvement across this heterogeneous order flow, resulting in a 
relatively consistent degree of execution quality.
b. Wholesaler Internalization
    Wholesalers provide market access for retail brokers and generally 
choose to internalize the order flow they receive from these 
brokers,\401\ thereby vertically integrating (i.e., bundling) their 
market access and execution services. This vertical integration helps 
wholesalers achieve a competitive advantage in both market access and 
execution services. Wholesalers are distinct from other broker-dealers 
that provide market access and execution services, in that they focus 
on marketable order flow from individual investors and internalize the 
large majority of orders routed to them.
---------------------------------------------------------------------------

    \401\ See analysis in infra Table 10.
---------------------------------------------------------------------------

    Wholesalers determine which orders to execute internally and which 
to reroute to other trading venues, often using a riskless principal 
transaction. For example, after receiving an order from a retail 
broker, a wholesaler may send a principal marketable order similar to 
the retail broker order to an exchange and, upon execution of the 
principal order at the exchange, provide the same execution terms to 
the original retail broker order. Alternatively, a wholesaler can 
achieve the same economic result by rerouting the original order in an 
agency capacity as well. In this way, the wholesaler is providing the 
market access service, but another market center is providing the 
execution service.
    Commission analysis shows that wholesalers internalize over 90% of 
the executed dollar value in NMS stocks from the marketable order flow 
routed to them by retail brokers, which amounts to more than 80% of 
share volume.\402\ Results also show that the marketable NMS stock 
orders wholesalers choose to internalize have less adverse selection 
risk: orders that wholesalers execute in a principal capacity have a 
price impact of 0.9 bps, compared to a price impact of 4.6 bps for 
those executed via other methods.\403\ These results stem from the 
incentives wholesalers face. As dealers, wholesalers will wish to hold 
inventory that is not subject to short-term adverse price moves. 
Because orders with greater adverse selection risk will, on average, be 
followed by adverse price moves, wholesalers will on average 
internalize fewer of these orders.\404\
---------------------------------------------------------------------------

    \402\ See analysis in infra Table 10.
    \403\ Id. See also supra note 365 for a definition and 
discussion of price impact as a measure of adverse selection risk.
    \404\ See infra Table 10 in section VII.B.5.a for analysis 
indicating that individual investor orders wholesalers internalize 
have lower adverse selection risk and earn higher economic profits, 
as measured by price impacts and realized spreads, than orders 
wholesalers effectively reroute.
---------------------------------------------------------------------------

    Wholesalers employ algorithms to predict price impact using 
information to which only they have access, such as the identity of the 
retail broker, and information any market center would have, such as 
order characteristics and stock or market characteristics.\405\ Indeed, 
Table 12 shows significant variation in average price impacts across 
retail brokers. Because wholesalers know which retail brokers sent them 
the order, they can use that information in combination with other 
information to make internalization and pricing decisions.\406\ The 
results in Table 13 support this conclusion, indicating that 
wholesalers internalize a higher percentage of individual investor 
orders from retail brokers whose customers' orders on average exhibit 
lower price impact.
---------------------------------------------------------------------------

    \405\ While these provide a few examples of information that 
could be used by wholesalers, the Commission lacks information on 
what information wholesalers actually use. Further, while the 
analysis presented here shows associations between characteristics, 
price impacts, and internalization, the analysis cannot determine 
that the expected price impact based on a particular characteristic 
caused the wholesaler to internalize the order.
    \406\ Having aggregate information on retail order flow could 
help the wholesaler assess the direction of the market, which could 
also be beneficial for business lines beyond the firm's wholesaler 
business.
---------------------------------------------------------------------------

c. Exchange Retail Liquidity Programs
    Retail liquidity programs provide an on-exchange means of 
segmentation. Indeed, the RLPs offered by many registered exchanges are 
specifically set up to segment the marketable order flow of individual 
investors,\407\ allowing liquidity suppliers to interact with this 
order flow without the risk that their orders will trade against the 
marketable orders of other market participants that may impose greater 
adverse selection risk. The pricing increments, both for quoting and 
trading, in RLPs, are usually 0.1 cents,\408\ although some

[[Page 187]]

exchanges have RLP programs that allow liquidity suppliers to quote 
only at the midpoint.\409\ RLP programs typically do not charge an 
access fee to individual investor orders executed in RLP programs.\410\ 
Quotes in RLP programs are not displayed.\411\ Instead, the SIP 
disseminates a flag indicating the side of the market for which an 
exchange has an RLP quote available at a price better than the NBBO 
available. However, the SIP does not make known the price or the size 
of the RLP quote, which creates opacity in the liquidity available in 
RLP programs. The goal of these programs is to compete with wholesalers 
and to attract marketable order flow of individual investors to trade 
on national securities exchanges.\412\
---------------------------------------------------------------------------

    \407\ See, e.g., NYSE Rule 7.44 (concerning RLPs).
    \408\ See, e.g., description of NYSE Retail Liquidity program, 
available at https://www.nyse.com/publicdocs/nyse/markets/liquidity-programs/RLP_Fact_Sheet.pdf.
    \409\ See, e.g., IEX retail liquidity program, available at 
https://exchange.iex.io/products/retail-program/.
    \410\ See, e.g., NYSE Price List, available at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf; NYSE 
Arca Trading Fee, available at https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf; and IEX Exchange 
Fee Schedule, available at https://exchange.iex.io/resources/trading/fee-schedule/.
    \411\ RLPs operate under an exemption from Rule 612, and are 
therefore allowed to use sub-penny pricing. As part of this 
exemption, however, they are only eligible for individual investors 
to execute against and cannot display quotes. See supra note 152 for 
further discussion.
    \412\ See supra note 151 regarding the purpose and operation of 
RLPs.
---------------------------------------------------------------------------

    However, it is the Commission's understanding that the share of 
individual investor trading volume executed through RLPs is small. For 
example, in 2021, less than 0.2% of consolidated volume executed in 
exchange RLP programs.\413\ This low market share could be the result 
of several factors. For example, many retail brokers lack direct access 
to exchanges offering RLPs and the means of indirect access may be too 
costly for RLPs compared to routing to wholesalers. Further, 
wholesalers who compete with RLPs lack the incentives to route the 
individual investor order flow with lower adverse selection risk to the 
RLPs. If only the individual investor order flow with higher adverse 
selection risk goes to RLPs, the liquidity providers in RLPs would 
widen spreads to reflect the increased adverse selection.\414\ This in 
turn, makes RLPs less competitive relative to wholesalers. Thus, even 
retail brokers with exchange membership may find wholesalers more 
attractive than RLPs for cost or execution quality reasons.
---------------------------------------------------------------------------

    \413\ See Rosenblatt Securities, How Can the Buy Side Interact 
With Retail Flow? (Feb. 14, 2022) available at https://www.rblt.com/market-reports/how-can-the-buy-side-interact-with-retail-flow.
    \414\ Unlike wholesalers, liquidity suppliers in RLP programs 
are not aware of the identity of the retail broker that the 
individual investor originated from. Therefore, they are not able to 
offer tighter spreads to individual investor orders from retail 
brokers whose orders on average have lower adverse selection risk. 
Instead, liquidity suppliers in RLP need to price their quotes based 
on the average expected adverse selection risk of all orders routed 
to the RLP. See, e.g., Lawrence R. Glosten & Paul R. Milgrom, Bid, 
Ask, and Transaction Prices in a Specialist Market With 
Heterogeneously Informed Traders, 14 J. Fin. Econ. 71 (1985).
---------------------------------------------------------------------------

3. Institutional Investor Interactions With Retail Orders
    Several wholesalers operate SDPs through which they execute 
institutional orders in NMS stocks against their own inventory.\415\ 
Because wholesalers also execute individual investor orders against 
their own inventory, the use of SDPs amounts to an indirect interaction 
between institutional and individual investor orders. The trading 
volume on SDPs is economically significant. For example, a study found 
that in Q1 2022, the SDPs affiliated with the two highest-volume 
wholesalers accounted for around 3% of consolidated average daily 
trading volume in NMS stocks.\416\ Institutional clients often 
communicate their trading interest to SDPs using Immediate or Cancel 
Orders (``IOCs'') or respond to Indication of Interest (``IOIs'') 
issued by the SDP.
---------------------------------------------------------------------------

    \415\ Wholesalers and OTC market makers can execute orders 
themselves or instead further route the orders to other venues. An 
SDP always acts as the counterparty to any trade that occurs on the 
SDP. See Where Do Stocks Trade?, FINRA (Dec. 3, 2021), available at 
https://www.finra.org/investors/insights/where-do-stocks-trade for 
further discussion.
    \416\ See Rosenblatt Securities, Rosenblatt's 2022 US Equity 
Trading Venue Guide (May 24, 2022), available at https://www.rblt.com/market-reports/rosenblatts-2021-us-equity-trading-venue-guide-2. The study also found that SDPs accounted for 
approximately 10% of off-exchange trading volume in Q1 2022.
---------------------------------------------------------------------------

    On an SDP, the single dealer, i.e., the wholesaler, is privy to the 
identities of the counterparties, i.e., institutional investors. One 
academic paper has found that this information revelation may have 
adverse execution consequences for the institutional investor.\417\ On 
the other hand, there also may be benefits relative to other trading 
venues. The trading interest of investors who submit IOCs to an SDP for 
liquidity are only exposed to the single dealer operating a platform. 
In contrast, submission of the same order to an exchange or an ATS may 
alert many other market participants to the underlying trade interest, 
triggering reactions. As such, institutional investors may view SDPs as 
an opportunity to tap into a pool of liquidity that reduces their 
orders' price impact and avoids triggering significant reactions by 
other market participants.
---------------------------------------------------------------------------

    \417\ See, e.g., Robert H. Battalio, Brian C. Hatch & Mehmet 
Saglam, The Cost of Exposing Large Institutional Orders to 
Electronic Liquidity Providers (last revised Nov. 7, 2022) 
(unpublished manuscript), available at https://ssrn.com/abstract=3281324 (retrieved from Elsevier database).
---------------------------------------------------------------------------

4. Execution Quality of Individual Investor Marketable Orders in NMS 
Stocks

[[Page 188]]

    The wholesaler business model relies in part on segmentation and 
internalization of marketable order flow of individual investors, which 
is characterized by low adverse selection risk. An analysis of the 
execution quality of market and marketable limit orders handled by 
wholesalers retrieved from Rule 605 reports \418\ and presented in 
Table 5 \419\ shows that orders in NMS stocks handled by wholesalers 
are associated with lower price impact \420\ compared to those executed 
on exchanges, indicating that orders handled by wholesalers on average 
have lower adverse selection costs.\421\ This lower adverse selection 
cost allows wholesalers to provide these orders with better execution 
quality, manifested in lower effective spreads \422\ and E/Q ratios 
compared to exchanges. The realized spreads \423\ observed in Table 5 
\424\ adjust effective spreads for adverse selection costs (i.e., price 
impact).\425\ Thus orders handled by wholesalers have higher realized 
spreads, despite the fact that they may execute at better prices than 
those received by and executed on exchanges, as observed by their lower 
effective spreads in Table 5.
---------------------------------------------------------------------------

    \418\ Rule 605 requires market centers to make available, on a 
monthly basis, standardized information concerning execution quality 
for covered orders in NMS stocks that they received for execution. 
See 17 CFR 242.605. Covered orders are defined in 17 CFR 
242.600(b)(22) to include orders (including immediate-or-cancel 
orders) received by market centers during regular trading hours at a 
time when a national best bid and national best offer is being 
disseminated, and, if executed, is executed during regular trading 
hours, and excludes orders for which the customer requests special 
handling for execution (such as not held orders). Rule 605 reports 
are required to contain a number of execution quality metrics for 
covered orders, including statistics for all NMLOs with limit prices 
within ten cents of the NBBO at the time of order receipt as well as 
separate statistics for market orders and marketable limit orders. 
Under the Rule, the information is categorized by individual 
security, one of five order type categories (see 17 CFR 
242.600(b)(14)), and one of four order size categories, which does 
not include orders for less than 100 shares or orders greater than 
or equal to 10,000 shares (see 17 CFR 242.600(b)(11)). As such, Rule 
605 does not require reporting for orders smaller than 100 shares, 
including odd-lot orders. Rule 605 requires market centers to report 
execution quality information for all covered orders that the market 
center receives for execution, including orders that are executed at 
another venue (i.e., because they are effectively rerouted to 
another trading center by the market center).
    \419\ The following filters were applied to the Rule 605 data to 
remove potential data errors: Observations where the total shares in 
covered orders were less than the sum of the canceled shares, share 
executed at the market center, and share executed away from the 
market center were deleted; Observations with missing order size 
code, order type code, total covered shares, or total covered orders 
were deleted; Realized and effective spread values are set to 
missing values if the total shares executed at and away from the 
market center are zero; and Per share dollar realized spreads, per 
share dollar effective spreads, and per share dollar price 
improvements were winsorized at 20% of the volume weighted average 
price of the stock for the month as calculated from NYSE Daily TAQ 
data.
    \420\ See supra note 365 and accompanying text for a definition 
and discussion of price impact. Table 5 estimates the average price 
impact associated with marketable orders routed to wholesalers to be 
1.2 bps. This means that for a $10 stock the NBBO midpoint would 
move up (down) by an average of 0.12 cents in the five minutes 
following the execution of marketable buy (sell) order.
    \421\ Once implemented, the changes to the current arrangements 
for consolidated market data in the MDI Adopting Release, 86 FR at 
18621, may impact the numbers in Table 5, including by reducing 
those for realized spread, effective spread, and amount of price 
improvement. The NBBO will narrow in stocks priced greater than $250 
because it will be calculated based off a smaller round lot size. 
This narrower NBBO will decrease price improvement statistics in 
Rule 605 reports, which is measured against the NBBO. The effects on 
effective and realized spreads is more uncertain, because they are 
measured against the NBBO midpoint, which may not change if both the 
NBB and NBO decrease by the same amount. However, if marketable 
orders are more likely to be submitted when there are imbalances on 
the opposite side of the limit order book (i.e., more marketable buy 
orders are submitted when there is more size on the offer side of 
the limit order book than the bid side), then the NBBO midpoint may 
change such that it is closer to the quote the marketable order 
executes against, which may decrease the effective and realized 
spreads in stocks above $250 when the MDI Rules are implemented. It 
is uncertain how likely this NBBO midpoint is to change. It is also 
uncertain how or to what degree these changes would differ between 
exchange and wholesaler Rule 605 reports. If both changed similarly, 
then there would not be changes in relative differences between 
their reported spread measures. See supra note 356.
    \422\ See supra note 366 for a definition and discussion of 
effective spreads.
    \423\ See supra note 367 and accompanying text for a definition 
and discussion of realized spreads as a measure of the economic 
profits earned by liquidity providers. See infra note 426 discussing 
the limitations of realized spreads for estimating the profits 
earned by market makers.
    \424\ The exception to this result is market orders executed on 
exchanges, which have average higher realized spreads than 
wholesaler market orders. However, market orders represent only 0.2% 
of the overall marketable orders executed on exchanges and therefore 
do not accurately represent exchange realized spreads. More 
specifically, marketable limit orders executed on exchanges in Q1 
2022 had a share volume of 179.10 billion shares while market orders 
executed on exchanges had a share volume of 0.39 billion shares. See 
infra Table 5.
    \425\ The execution quality information required pursuant to 
Rule 605 combines information about orders executed at a market 
center with information on orders received for execution at a market 
center but executed by another market center; see supra note 407. As 
such, the execution quality statistics presented in Table 5 include 
orders that are effectively rerouted by wholesalers. Furthermore, 
note that Rule 605 does not specifically require market centers to 
prepare separate execution quality reports for their SDPs, and as 
such these calculations reflect all covered market and marketable 
limit orders in NMS stocks received and executed by wholesalers, 
including those on SDPs.
---------------------------------------------------------------------------

    Realized spreads are a proxy for the potential economic profit that 
liquidity suppliers may earn on a trade.\426\ Therefore, the higher 
realized spreads earned by wholesalers suggest that the isolation of 
individual investor orders routed to wholesalers results in wholesalers 
potentially earning higher economic profits relative to a venue where 
market makers compete with each other and other market participants to 
supply liquidity at the individual order level (e.g., an exchange).
---------------------------------------------------------------------------

    \426\ See supra note 367 for the definition of the realized 
spread. Realized spreads do not measure the actual trading profits 
that market makers earn from supplying liquidity. In order to 
estimate the trading profits that market makers earn, we would need 
to know at what times and prices the market maker executed the off-
setting position for a trade in which it supplied liquidity (e.g., 
the price at which the market maker later sold shares that it bought 
when it was supplying liquidity). If market makers offset their 
positions at a price and time that is different from the NBBO 
midpoint at the time lag used to compute the realized spread measure 
(Rule 605 realized spread statistics are measured against the NBBO 
midpoint 5 minutes after the execution takes place), then the 
realized spread measure is an imprecise proxy for the profits market 
makers earn supplying liquidity. See Conrad and Wahal (2020) (for 
discussions showing how realized spreads decline when measured over 
time horizons and for further discussions regarding how realized 
spreads are affected when measured over different time horizons). 
Differences in inventory holding periods of different market makers 
could also create differences in the trading profits that market 
makers earn that would not be captured in the realized spread 
measure if it is estimated over the same time horizon for all market 
makers. See Lingyan Yang & Ariel Lohr, The Profitability of 
Liquidity Provision (last revised Feb. 18, 2022) (unpublished 
manuscript), available at https://ssrn.com/abstract=4033802. 
Additionally, realized spread metrics do not take into account any 
transaction rebates or fees, including PFOF, that a market maker 
might earn or pay, which would also affect the profits they earn 
when supplying liquidity. Furthermore, realized spreads also do not 
account for other costs that market makers may incur, such as fixed 
costs for setting up their trading infrastructure and costs for 
connecting to trading venues and receiving market data.
---------------------------------------------------------------------------

    Additionally, the results in Table 5 show that approximately 79% of 
the executed dollar volume in marketable orders handled by wholesalers 
are market orders. The Commission believes that these outcomes reflect 
the heavy utilization of market orders for NMS stocks by individual 
investors whose orders are primarily handled by wholesalers, contrary 
to the heavy utilization of limit orders by other market participants.
    Table 5 also highlights significantly higher fill rates, i.e., the 
percentage of the shares in an order that execute in a trade, for 
marketable orders sent to wholesalers as compared to those sent to 
exchanges.\427\ Wholesalers execute the vast majority of orders that 
they receive against their own capital, i.e., they internalize the vast 
majority of

[[Page 189]]

orders they receive.\428\ Wholesalers expose themselves to inventory 
risk when internalizing order flow, but mitigate this risk by 
internalizing orders that possess low adverse selection risks.
---------------------------------------------------------------------------

    \427\ Marketable orders may not fully execute if there isn't 
sufficient liquidity on the exchange to fill the orders within their 
limit price and/or if they contain other instructions that limit 
their execution, such as if they are designated as IOC orders or 
there are instructions not to route the orders to another exchange.
    \428\ See analysis in infra Table 10 and corresponding 
discussion.

        Table 5--Comparison of Rule 605 Execution Quality Statistics Between Exchanges and Wholesalers for NMS Common Stocks and ETFs in Q1 2022
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                            Combined marketable orders                Market                     Marketable limit
                                                         -----------------------------------------------------------------------------------------------
                                                                WH              EX              WH              EX              WH              EX
--------------------------------------------------------------------------------------------------------------------------------------------------------
Average Price...........................................          $47.89          $58.14          $56.19          $85.45          $30.66          $58.08
Share Volume (billion shares)...........................          106.97          179.49           72.20            0.39           34.77          179.10
Dollar Volume (billion $)...............................       $5,122.91      $10,436.02       $4,056.85          $33.53       $1,066.06      $10,402.49
Fill Rate (%)...........................................          69.32%          25.77%          99.79%          58.08%          34.81%          25.77%
Effective Spread (bps)..................................            1.81            2.06            1.47            3.29            3.11            2.06
Realized Spread (bps)...................................            0.61           -0.38            0.39            2.40            1.43           -0.39
Price Impact (bps)......................................            1.20            2.44            1.08            0.90            1.68            2.45
E/Q ratio...............................................            0.48            1.01            0.40            1.65            0.83            1.01
Pct of Shares Price Improved............................          83.17%           8.78%          88.99%          15.95%          61.01%           8.75%
Conditional Amount of Price Improvement (bps)...........            2.17            1.50            2.33            1.92            1.24            1.50
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table computes aggregated execution quality statistics for marketable covered orders received by exchanges and wholesalers from Rule 605 reports
  for Q1 2022 for NMS common stocks and ETFs. See supra note 418 for a definition of covered orders. Individual wholesaler and exchange Rule 605 reports
  are aggregated together at the stock-month level, into two categories, WH and EX, such that aggregate execution quality data is averaged for, (a)
  wholesalers (WH) and, (b) exchanges (EX), for each stock during each month.
The following metrics were calculated: Average Price is the stock's average execution price from the Rule 605 data (Dollar Volume/Share Volume), Share
  Volume is the total executed shares (in billions) from the Rule 605 data. Dollar Volume is the total executed dollar volume (in billions), calculated
  as the executed share volume from the Rule 605 data multiplied by the stock's monthly VWAP price, as derived from NYSE Daily Trade and Quote data
  (TAQ). Fill Rate is the weighted average of the stock-month total executed share volume/total covered shares from the Rule 605 data. Effective Spread
  is the weighted average of the stock-month percentage effective half spread in basis points (bps). Realized Spread is the weighted average of the
  stock-month percentage realized half spread in basis points (bps). Price Impact is the weighted average of the stock-month percentage price impact in
  basis points (bps). E/Q ratio is the weighted average of the stock-month ratio of the effective spread/quoted spread. Pct of Shares Price Improved is
  the weighted average of the stock-month ratio of shares executed with price improvement/total executed share volume. Conditional Amount of Price
  Improvement is the weighted average of the stock-month of the amount of percentage price improvement in basis points (bps), conditional on the
  executed share receiving price improvement.
Aggregated effective and realized percentage spreads are measured in half spreads in order to show the average cost of an individual investor order and
  are calculated by dividing the aggregated Rule 605 reported per share dollar amount by twice the stock's monthly volume weighed average price (VWAP),
  as derived from NYSE Daily Trade and Quote data (TAQ), for trades executed during regular market hours during the month. Percentage price impact is
  calculated as the aggregated Rule 605 reported per share dollar effective spreads minus per share dollar realized spreads divided by twice the stock's
  monthly volume weighed average price (VWAP), as derived from NYSE Daily Trade and Quote data (TAQ). Percentage amount of price improvement is
  calculated as the aggregated Rule 605 reported per share dollar amount of price improvement divided by the stock's monthly volume weighed average
  price (VWAP), as derived from NYSE Daily Trade and Quote data (TAQ). Percentage spreads and amount of price improvement percentages are reported in
  basis points (bps). The Combined Market and Marketable Limit order type category is constructed for each security-month-order size category by
  combining the market and marketable limit order categories and computing the total and share weighted average metrics for the order size category for
  each security-month.
The sample includes NMS common stocks and ETFs that are present in the CRSP 1925 US Stock Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch. Bus.
  (2022). The CRSP 1925 US Indices Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch. Bus. (2022), was used to identify if a stock was a member of the
  S&P 500. The stock did not have to be in the CRSP 1925 US Indices Database to be included in the analysis. NMS Common stocks and ETFs are identified,
  respectively, as securities in TAQ with a Security Type Code of `A' and `ETF'. For each stock-month-order-type (such that aggregate execution quality
  data is averaged for, (a) wholesalers and, (b) exchanges, for each stock during each month) the per dollar share weighted measures from Rule 605
  reports are aggregated together by share-weighting across different trading venues and order-size categories within the stock-month-order-type and
  venue type (i.e., trading venue Rule 605 reports for exchanges and wholesalers are aggregated into different categories). Percent values are then
  calculated for each stock month by dividing by the stock's monthly volume weighed average price (VWAP). These percentage stock-month values are
  averaged together into order-type categories (market orders, marketable limit orders, and the combined market and marketable limit order type
  category, for both wholesalers and exchanges) based on weighting by the total dollar trading volume for the wholesaler or exchange category in that
  stock-month-order type, where dollar trading volume is estimated by multiplying the Rule 605 report total executed share volume, i.e., the share
  volume executed at market center + share volume executed away from the market center, for the stock-month-order type by the stock's monthly VWAP. See
  supra note 419 for a discussion of filters that were applied to the Rule 605 data in this analysis.

    Because segmented orders valued at $200,000 and greater would be 
excepted from Proposed Rule 615,\429\ we limit our analysis to Rule 605 
order size categories where the average dollar value of orders received 
by wholesalers was under $200,000.\430\ Table 6 summarizes Rule 605 
data comparing the execution quality of marketable orders (i.e., the 
combined market and marketable limit order category in Table 5) under 
$200,000 routed to wholesalers and exchanges for different security 
types.\431\ In Table 6, the average realized spreads for marketable 
orders routed to exchanges are negative for all security types,\432\ 
while orders routed to wholesalers have positive realized spreads in 
all securities, with larger realized spreads in Non-S&P 500 stocks. The 
positive realized spreads for marketable orders routed to wholesalers 
seem to indicate that the amount of price improvement these orders 
receive in the form of lower effective spreads does not fully offset 
the lower adverse selection costs they impose on liquidity suppliers 
(as measured by lower price impacts) compared to negative realized

[[Page 190]]

spreads for orders routed to exchanges.\433\
---------------------------------------------------------------------------

    \429\ See supra section IV.B.5 discussing exceptions to the 
Proposed Rule.
    \430\ We estimated the average dollar value of the orders 
received by wholesalers based on their Rule 605 reports by 
multiplying the average order size for a stock-month-order-size-
category (estimated as the number of total covered shares divided by 
the number of total covered orders) by the stock's average monthly 
VWAP price estimated from NYSE TAQ data.
    \431\ Both the wholesaler and exchange average execution metrics 
in Table 6 are calculated based on weighting by the total wholesaler 
dollar trading volume in that stock-month. This weighting method 
calculates averages across stocks similarly for exchanges and 
wholesalers when aggregating their Rule 605 reports, which helps 
ensure the averages across stocks are comparable between exchanges 
and wholesalers.
    \432\ A negative average realized spread on exchanges does not 
necessarily mean that market makers on exchanges are not earning 
trading profits for supplying liquidity on exchanges. The realized 
spread observed on exchanges is a mix of liquidity supplied by 
market makers and limit orders submitted by other traders who may be 
interested in trading but not earning a spread (e.g., limit or 
midpoint orders of individual or institutional investors that 
potentially don't want to pay the spread to trade). Additionally, as 
discussed in supra note 426, the realized spread is a proxy and does 
not measure the actual trading profits that market makers earn from 
supplying liquidity. It does not include exchange rebates liquidity 
suppliers may earn and also makes assumptions about the time and 
price at which the liquidity suppliers exit the position. After 
accounting for exchange rebates, liquidity suppliers on exchanges 
could potentially earn average positive trading profits if they exit 
their positions at a different time or price than the estimated NBBO 
midpoint at the time horizon used to estimate the realized spread (5 
minutes for realized spreads reported in Rule 605). See Conrad and 
Wahal (2020) for discussions on how realized spreads vary when 
calculated over different time horizons.
    \433\ Other studies have also used realized spreads to examine 
competition between liquidity suppliers. See, e.g., Roger Huang & 
Hans Stoll, Dealer versus auction markets: A paired comparison of 
execution costs on NASDAQ and the NYSE, 41 J. Fin. Econ. 313 (1996) 
(finding that in 1991 realized spreads for a sample of NASDAQ stocks 
were higher than realized spreads for a matched sample of NYSE 
stocks and concluding that important explanations for the higher 
spreads observed on NASDAQ were the internalization and preferencing 
of order flow and the presence of alternative interdealer trading 
systems, factors that limited dealers' incentives to narrow 
spreads); Jonathan Brogaard & Corey Garriott, High-Frequency Trading 
Competition, 54 J. Fin. & Quantitative Analysis 1469 (2019) (looking 
at the effects of the entry of new high-frequency traders that 
compete to supply liquidity on the Canadian Alpha exchange and 
finding that realized spreads decreased for the marketable orders of 
non-high-frequency traders after new high-frequency traders entered 
the market; the study observed that the reduction in realized 
spreads was not attributable to changes in the price impact of the 
orders of non-high-frequency traders and that the reduction in 
realized spreads was attributable to increased competition among 
liquidity suppliers); and Hank Bessembinder & Herbert Kaufman, A 
cross-exchange comparison of execution costs and information flow 
for NYSE-listed stocks, 46 J. Fin. Econ. 293 (1997) (finding in 1994 
that effective bid-ask spreads for trades in NYSE issues completed 
on the NYSE are slightly smaller than for trades completed with the 
NASD dealer market and the regional stock exchanges but the realized 
bid-ask spreads for trades on the NYSE are lower by a factor of two 
to three; the authors conclude that this differential is 
attributable to the successful 'cream skimming' of uninformed trades 
by market makers off of the NYSE exchange; the authors also raise 
concerns as to whether the trades being diverted from the NYSE might 
have received better execution if they were not diverted and whether 
existing rules governing order flow effectively fostered 
competition).
---------------------------------------------------------------------------

    Table 6 also shows realized spreads adjusted to reflect share-level 
PFOF payments paid by wholesalers \434\ and rebates paid by 
exchanges.\435\ After these respective costs are netted out, although 
wholesaler realized spreads are reduced and exchange realized spreads 
increase (i.e., are less negative), wholesaler realized spreads 
continue to exceed exchange realized spreads. Adjusting for rebates on 
the one hand and PFOF on the other allows us to estimate a marginal 
profit to a liquidity supplier in each venue (note that a rebate 
substitutes one-for-one with a spread, as does PFOF, and in an 
idealized perfect-competition setting both would be zero). 
Acknowledging that there may be differences not captured by these 
measures, this calculation suggests a higher marginal profit for orders 
off-exchange versus on-exchange, and suggests greater on-exchange 
competition.\436\ While an accounting measure of profit would need to 
take, say, fixed costs into account, fixed costs alone would not 
explain the difference as liquidity suppliers on both types of venues 
may have similar fixed costs.
---------------------------------------------------------------------------

    \434\ Wholesaler realized spreads are adjusted to account for 
the PFOF they pay to retail brokers. Because we are not able to 
identify the broker-dealer from which the orders originated in Rule 
605 reports, we estimate PFOF rates for the Rule 605 data sample by 
multiplying the estimated PFOF rates retail brokers receive in Table 
2 by 74% in order to adjust for an estimated 26% of the marketable 
order flow wholesalers receive coming from retail brokers that do 
not accept PFOF, as estimated by the percentage of share volume 
received from non-PFOF brokers in infra Table 14. The estimated PFOF 
rates are 12 mils for market orders in S&P 500 stocks, 10 mils for 
market orders in ETFs and non-S&P 500 stocks, 17 mils for marketable 
limit order in S&P 500 stocks, and 9 mils for marketable limit 
orders in ETFs and non-S&P 500 stocks. For the Rule 605 data sample, 
the wholesalers' PFOF adjusted realized spread is computed by 
subtracting the relevant PFOF rate from a stock's average dollar 
realized spread for orders routed to wholesalers and then dividing 
by twice the stock's average monthly VWAP price estimated from NYSE 
TAQ data.
    \435\ Estimates of exchange rebates that liquidity suppliers 
earn on maker-taker venues and the fees they pay on inverted and 
flat fee venues are assumed as follows: exchange rebates to 
liquidity suppliers on maker-taker venues are 27 mils; exchange fees 
for supplying liquidity on inverted venues are 15 mils; exchange 
fees for supplying liquidity on flat fee venues are 7 mils; and 
there is no fee on exchanges that do not charge fees and rebates. 
Exchange rebates are assumed to be 27 mils based on the average rate 
exchanges pay retail brokers for their non-marketable limit orders 
in Table 2. Fee rates for inverted and flat fee venues (which charge 
fees to both liquidity suppliers and demanders and do not pay 
rebates) were estimated based on exchange fee and rebate tables and 
were adjusted by 3 mils to account for volume-based tiering (for 
inverted venues) or differences in fees supplying liquidity using 
displayed vs. non-displayed orders (for flat fee venues). For both 
the Rule 605 and CAT data samples (see infra Table 7), a stock's 
rebate adjusted exchange realized spread is calculated by adding/
subtracting the exchange rebate/fee to/from the average dollar 
realized spread and then dividing by twice the stock's average 
monthly VWAP price estimated from NYSE TAQ data.
    \436\ One caveat to the difference in transaction costs on and 
off-exchange is that, on-exchange execution, to the extent it is 
driven by institutional order flow, may be accompanied by 
commissions. While this should not affect the interpretation of 
realized spreads as marginal profit to liquidity provision, it does 
reflect the interpretation as either the transaction cost of the 
customer or marginal profit of the liquidity supplier handling 
customer order flow.

  Table 6--Rule 605 Wholesaler (WH) and Exchange (EX) Execution Quality Comparison for Marketable Orders Under
                                      $200,000 for Q1 2022 by Security Type
----------------------------------------------------------------------------------------------------------------
                                                  All NMS stocks      S&P 500       Non-S&P 500         ETF
----------------------------------------------------------------------------------------------------------------
Average Price...................................          $33.99          $97.03          $13.52          $51.19
WH Share Volume (billion shares)................           96.51           15.00           62.32           19.18
WH Dollar Volume (billion $)....................       $3,280.03       $1,455.40         $842.66         $981.98
EX Share Volume (billion shares)................          172.08           39.89           86.67           45.52
EX Dollar Volume (billion $)....................       $9,025.52       $3,448.64       $1,899.61       $3,677.27
WH Fill Rate (%)................................          69.06%          73.17%          66.65%          65.03%
EX Fill Rate (%)................................          27.31%          32.53%          29.56%          17.63%
WH Effective Spread (bps).......................            2.05            0.72            5.70            0.89
EX Effective Spread (bps).......................            3.11            1.45            7.86            1.49
WH Realized Spread (bps)........................            0.72            0.30            1.55            0.64
EX Realized Spread (bps)........................           -0.67           -0.30           -1.97           -0.12
WH Realized Spread Adj PFOF (bps)...............            0.43            0.17            0.86            0.45
EX Realized Spread Adj Rebate (bps).............          -0.001           -0.05           -0.24            0.28
WH Price Impact (bps)...........................            1.33            0.42            4.15            0.25
EX Price Impact (bps)...........................            3.78            1.74            9.83            1.61
WH E/Q Ratio....................................            0.42            0.35            0.49            0.45
EX E/Q Ratio....................................            1.00            0.98            1.00            1.01
WH % Pct of Shares Price Improved...............           84.7%           86.7%           82.5%           83.4%
EX % Pct of Shares Price Improved...............            8.8%           10.9%            9.5%            5.2%
WH Conditional Amount of Price Improvement (bps)            2.62            1.49            6.27            1.17

[[Page 191]]

 
EX Conditional Amount of Price Improvement (bps)            2.36            1.04            5.88            1.28
----------------------------------------------------------------------------------------------------------------
This table compares aggregated execution quality statistics broken out for different security types for
  marketable covered orders with average order size under $200,000 received by exchanges and wholesalers as
  reported from Rule 605 reports for Q1 2022 for NMS common stocks and ETFs. See supra note 418 for a definition
  of covered orders. Individual wholesaler and exchange Rule 605 reports are aggregated together at the stock-
  month level into two categories, EX and WH. EX shows aggregated statistics from Rule 605 reports from
  exchanges and WH shows aggregated statistics from Rule 605 reports from wholesalers. Marketable orders are
  constructed separately for wholesalers and exchanges by combining the Market and Marketable Limit order type
  categories in Rule 605 reports for each security-month-order size category and computing the total and share
  weighted average metrics from the combined order types for the order size category for each security-month.
See supra Table 5 for the descriptions of the reported metrics: Average Price, Share Volume, Dollar Volume, Fill
  Rate, Effective spread, Realized spread, Price Impact, E/Q Ratio, Pct Shares Price Improved, and Conditional
  Amount of Price Improvement. WH Realized Spread Adj PFOF is the weighted average of the stock-month percentage
  realized half spread in basis points (bps) from wholesaler 605 reports after adjusting for the estimated PFOF
  paid by the wholesaler using the methodology described in supra note 434. EX Realized Spread Adj Rebate is the
  weighted average of the stock-month percentage realized half spread in basis points (bps) from exchange 605
  reports after adjusting for the estimated rebates (access fees) exchanges pay (charge) to liquidity suppliers
  using the methodology described in supra note 435.
Percentage spreads are measured in half spreads in order to show the average cost of an individual investor
  order and are calculated by dividing the Rule 605 report per share dollar amount by twice the stock's monthly
  VWAP, as derived from NYSE Daily Trade and Quote data (TAQ), for trades executed during regular market hours
  during the month. Percentage spreads are reported in basis points (bps).
The sample includes NMS common stocks and ETFs that are present in the CRSP 1925 US Stock Database, Ctr. Rsch.
  Sec. Prices, U. Chi. Booth Sch. Bus. (2022). The CRSP 1925 US Indices Database, Ctr. Rsch. Sec. Prices, U.
  Chi. Booth Sch. Bus. (2022), was used to identify if a stock was a member of the S&P 500. The stock did not
  have to be in the CRSP 1925 US Indices Database to be included in the analysis. NMS Common stocks and ETFs are
  identified, respectively, as securities in TAQ with a Security Type Code of `A' and `ETF. The exchange and
  wholesaler metrics in the table are each reported for the combined marketable order type, which was
  constructed for this analysis separately for exchange and wholesalers by combining the Market and Marketable
  Limit order type categories in Rule 605 reports at the stock-month-order-size level and computing the total
  and share weighted average metrics from the combined order types. For each stock-month, share weighted metrics
  (for both exchange and wholesalers) are then calculated by share-weighting across different order-size
  categories based on the number of shares executed (at the market center + away) in wholesalers' Rule 605
  reports in that order-size category. Order size categories with wholesaler average order dollar values greater
  than or equal to $200,000 were excluded. The average order dollar values were determined for each order-size
  category stock-month by dividing the wholesaler total number of covered shares in the order size category by
  the wholesaler total number of covered orders and then multiplying by the stock-month's average VWAP, as
  derived from NYSE Daily Trade and Quote data (TAQ). Stock-month values are averaged together (for both
  wholesalers and exchanges) based on weighting by the total wholesaler dollar trading volume in that stock-
  month for the combined marketable order type (wholesaler dollar trading volume is estimated by multiplying the
  Rule 605 report wholesaler total executed share volume, i.e., the share volume executed at market center +
  share volume executed away from the market center, for the stock-month-order type by the stock's monthly
  VWAP). This weighting method calculates averages across stocks similarly for exchanges and wholesalers when
  aggregating their Rule 605 reports, which helps ensure the averages across stocks are comparable between
  exchanges and wholesalers. See supra note 419 for a discussion of filters that were applied to the Rule 605
  data in this analysis.

    Because Rule 605 requires market centers to report execution 
quality statistics only for covered orders that fall within specific 
order size and type categories,\437\ a number of order types and sizes 
that may be particularly relevant for individual investors are excluded 
from the above analyses, including orders for less than 100 
shares.\438\ Additionally Rule 605 data does not allow us to 
distinguish between orders that wholesalers execute on a principal 
basis from those they execute on riskless principal basis, since they 
are both reported as being executed at the market center. Furthermore, 
it is not possible in Rule 605 data to distinguish between orders that 
a wholesaler received from individual investors from those it received 
from other types of market participants. For example, wholesaler Rule 
605 reports may include both individual investor orders that they 
receive, as well as institutional orders they receive on their SDPs. 
Lastly, effective and realized spread measures as required to be 
reported in Rule 605 reports are calculated using a five-minute time 
horizon, which some academic literature argues has become inappropriate 
for a high-frequency environment.\439\ Therefore, to supplement the 
analyses using Rule 605 data and test for the robustness of the results 
\440\ that it generated, CAT data \441\ was analyzed to look at the 
execution

[[Page 192]]

quality of marketable orders of individual investors in NMS Common 
Stocks and ETFs that were less than $200,000 in value and that executed 
and were handled by wholesalers during Q1 2022 (``CAT retail 
analysis'').\442\ This was compared to a sample of CAT data examining 
the execution quality of executed market and marketable limit orders in 
NMS Common Stocks and ETFs received by exchanges that were less than 
$200,000 in value over the same time period (``CAT exchange 
analysis'').\443\
---------------------------------------------------------------------------

    \437\ See supra note 407 for a definition of covered orders and 
a discussion of the order type and size categories included in Rule 
605 reporting requirements.
    \438\ There is evidence that individual investors tend to use 
smaller trading sizes. See, e.g., Robert P. Bartlett, Justin McCrary 
& Maureen O'Hara, The Market Inside the Market: Odd-Lot Quotes (last 
revised Feb. 11, 2022) (unpublished manuscript), available at 
https://ssrn.com/abstract=4027099 (retrieved from Elsevier 
database); Matthew Healey, An In-Depth View Into Odd Lots, Cboe 
(Oct. 2021), available at https://www.cboe.com/insights/posts/an-in-depth-view-into-odd-lots/.
    \439\ See, e.g., Maureen O'Hara, High Frequency Market 
Microstructure, 116 J. Fin. Econ. 257 (2015) (``O'Hara 2015''); 
Maureen O'Hara, Gideon Saar & Zhuo Zhong, Relative Tick Size and the 
Trading Environment, 9 Rev. of Asset Pricing Stud. 47 (2019) 
(``O'Hara et al.''); Jennifer S. Conrad & Sunil Wahal, The Term 
Structure of Liquidity Provision, 136 J. Fin. Econ. 239 (2020) 
(``Conrad and Wahal''). Conrad and Wahal suggest that a one-minute 
horizon may be appropriate for small stocks, and a 15-second horizon 
may be appropriate for large stocks. The following analyses using 
CAT data will use a one-minute horizon for calculating the realized 
spread; see supra note 50.
    \440\ Rule 605 data is publicly available and the consistency of 
the results generated by analysis of these data supports the 
veracity of the results generated by CAT data, despite the fact that 
CAT data is not publicly available.
    \441\ This analysis used CAT data to examine the execution 
quality of marketable orders in NMS Common stocks and ETFs that 
belonged to accounts with a CAT account type of ``Individual 
Customer'' and that originated from a broker-dealer MPID that 
originated orders from 10,000 or more unique ``Individual Customer'' 
accounts during Jan. 2022. The number of unique ``Individual 
Customer'' accounts associated with each MPID was calculated as the 
number for unique customer account identifiers with an account 
customer type of ``Individual Customer'' that originated at least 
one order during the month of Jan. 2022. The Commission found that 
58 broker-dealer MPIDs associated with 54 different broker-dealers 
originated orders from 10,000 or more unique Individual Customer 
accounts in Jan. 2022. As discussed in supra note 194, the CAT 
account type ``Individual Customer'' may not be limited to 
individual investors because it includes natural persons as well as 
corporate entities that do not meet the definitions for other 
account types. The Commission restricted that analysis to MPIDs that 
originated orders from 10,000 or more ``Individual Customer'' 
accounts in order to ensure that these MPIDs are likely to be 
associated with retail brokers to help ensure that the sample is 
more likely to contain marketable orders originating from individual 
investors. NMS Common stocks and ETFs are identified, respectively, 
as securities in TAQ with a Security Type Code of ``A'' and ``ETF.''
    \442\ Fractional share orders with share quantity less than one 
share were excluded from the analysis. The analysis included market 
and marketable limit orders that originated from one of the 58 
retail broker MPIDs and were received by a market center that was 
associated with one of the six wholesalers CRD numbers (FINRA's 
Central Registration Depository number) during some point in the 
order's lifecycle. Orders that were received by the wholesaler or 
executed outside of normal market hours were excluded. Orders were 
also excluded if they had certain special handling codes so that 
execution quality statistics would not be skewed by orders being 
limited in handling by special instructions (e.g., pegged orders, 
stop orders, post only orders, etc.) Orders identified in CAT as 
Market and Limit orders with no special handling codes or one of the 
following special handling codes were included in the analysis: NH 
(not held), CASH (cash), DISQ (display quantity), RLO (retail 
liquidity order), and DNR (do not reduce). These special handling 
codes were identified based on their common use by retail brokers 
and descriptions of their special handling codes. The marketability 
of a limit order was determined based on the consolidated market 
data feed NBBO at the time a wholesaler first receives the order. 
Limit orders that were not marketable were excluded. The dollar 
value of an order was determined by multiplying the order's number 
of shares by either its limit price, in the case of a limit order, 
or by the far side quote (i.e., NBO for a market buy order and NBB 
for a market sell) of the consolidated market data feed NBBO at the 
time the order was first received by a wholesaler, in the case of a 
market order. Orders with dollar values greater than or equal to 
$200,000 were excluded from the analysis. The analysis includes NMS 
Common Stocks and ETFs (identified by security type codes of `A' and 
`ETF' in NYSE TAQ data) that are also present in CRSP data. Price 
improvement, effective spreads, realized spreads, quoted spreads, 
and price impacts were winsorized if they were greater than 20% of a 
stock's VWAP during a stock-week. See Table 7 for a detailed 
description of the analysis.
    \443\ The Commission analysis used CAT data to examine the 
execution quality of market and marketable limit orders in NMS 
Common Stocks and ETFs that were under $200,000 in value that were 
received and executed by exchanges during normal market hours in Q1 
2022. The analysis employed filters to clean the data and account 
for potential data errors. The analysis is limited to orders 
identified in CAT as market and limit orders accepted by exchanges. 
Orders were excluded from the analysis if they had certain special 
handling codes, such as post or add-liquidity only orders, midpoint 
orders, orders that can only execute in opening and closing 
auctions, orders with a minimum execution quantity, pegged orders, 
or stop order or stop-loss orders. Orders were also required to 
execute in normal trades during normal trading hours to be included 
in the analysis. Normal trades are identified in CAT data by sale 
conditions ``blank, @, E, F, I, S, Y'' which correspond to regular 
trades, intermarket sweep orders, odd lot trades, split trades, and 
yellow flag regular trades. For orders submitted to exchanges, the 
NBBO the exchange records seeing at the time of order receipt is 
used to measure the NBBO and NBBO midpoint for calculating 
statistics that are based on the time of order receipt (e.g., 
effective spreads, price improvement, quoted spreads, etc.). The 
marketability of exchange orders was determined based on the NBBO 
observed by the exchange at the time of order receipt. The dollar 
value for a market order was calculated as the price of the far side 
NBBO quote (NBO for a market buy order and NBB for a market sell) 
times the shares in the order. The dollar value for a limit order 
was calculated as the price of the limit order times the number of 
shares in the order. Orders with dollar values greater than or equal 
to $200,000 were excluded from the analysis. The consolidated market 
data feed NBBO was used to calculate statistics that use the NBBO or 
NBBO one minute after execution (e.g., realized spreads, price 
impacts, etc). The analysis includes NMS Common Stocks and ETFs 
(identified by security type codes of `A' and `ETF' in NYSE TAQ 
data) that are also present in CRSP data. Price improvement, 
effective spreads, realized spreads, quoted spreads, and price 
impacts were winsorized if they were greater than 20% of a stock's 
VWAP during a stock-week. See Table 7 for a detailed description of 
the analysis.
---------------------------------------------------------------------------

    Table 7, which reports results from CAT data, contains some 
statistics that are not available in Rule 605 reports, including 
statistics on midpoint executions and sub-penny trades.\444\ In NMS 
common stock and ETF orders, wholesalers execute approximately 44% of 
shares at prices at or better than the NBBO midpoint. However, 
wholesalers also offer less than 0.1 cents price improvement to 
approximately 18.6% of shares that they execute. Wholesalers execute 
more than 65% of shares at sub-penny prices, with over 40% of shares 
being executed at prices with four decimal points (i.e., the fourth 
decimal place is not equal to zero).
---------------------------------------------------------------------------

    \444\ Certain items in Table 7 may also be affected by the MDI 
rules once they are implemented. See supra notes 356 and 421.
---------------------------------------------------------------------------

    Results from this analysis are highly consistent with results from 
the analysis of Rule 605 data from Table 6. Specifically, wholesalers 
display lower price impacts and E/Q ratios, indicating that orders 
internalized by wholesalers receive better execution quality than 
orders executed on exchanges. Despite this enhanced execution quality, 
realized spreads of wholesalers exceed those produced by 
exchanges.\445\ This finding remains even after netting out PFOF 
payments made by wholesalers \446\ and rebates made by exchanges.\447\
---------------------------------------------------------------------------

    \445\ The relative differences between exchanges and wholesalers 
in price impacts and realized spreads are even more pronounced with 
the CAT data, which (unlike 605 data) include odd lots, exclude 
orders greater than $200,000, and measure realized spreads from 1 
minute rather than 5 minutes after execution.
    \446\ For CAT data, we estimate the PFOF each retail broker 
receives based on data from their Q1 Rule 606 reports. For each 
month we separately estimate the average per share PFOF rate they 
receive from wholesalers based on the order type (market and 
marketable limit orders) and security type (S&P500 and non-S&P500 
stocks), which we then combine with the same order and stock type in 
the CAT data. If a retail broker does not produce a Rule 606 report, 
then we use the PFOF rates from its clearing broker's Rule 606 
report, if it is available (some retail brokers' websites disclosed 
that they share in payments their clearing broker receives for their 
order flow). A PFOF rate of 20 cents per 100 shares was used for the 
introducing broker-dealers and clearing broker that reported handled 
orders on a not held basis and did not disclose PFOF information in 
their Rule 606 report but disclosed on their website that they 
received PFOF for their order flow. 20 cents per 100 shares was the 
PFOF rate that the clearing broker that handles orders on a not held 
basis disclosed on their website that they received.
    \447\ See supra note 435 for discussion of how exchange rebates 
are calculated.

 Table 7--Wholesaler CAT Analysis of Exchange Individual Investor Order Execution Quality for Marketable Orders
                                 in NMS Common Stocks and ETFs by Type of Stock
----------------------------------------------------------------------------------------------------------------
                    Variable                            All            SP500         Non-SP500          ETF
----------------------------------------------------------------------------------------------------------------
                               Panel A: Wholesaler and Exchange Execution Quality
----------------------------------------------------------------------------------------------------------------
Average Price...................................          $29.87         $110.31          $10.52          $53.14
WH Principal Execution Rate.....................          90.44%          93.07%          87.66%          88.12%
WH Share Volume (billion shares)................           87.11           11.63           63.17           12.31
EX Share Volume (billion shares)................          281.90           66.98          140.82           74.10
WH Dollar Volume (billion $)....................       $2,601.44       $1,282.62         $664.41         $654.41
EX Dollar Volume (billion $)....................      $16,194.84       $6,479.89       $3,246.09       $6,468.85
WH Effective Spread (bps).......................            2.11            0.67            6.23            0.76
EX Effective Spread (bps).......................            3.18            1.52            8.11            1.42
WH Realized Spread (bps)........................            0.85            0.42            2.00            0.51
EX Realized Spread (bps)........................           -1.22           -0.28           -3.90           -0.34
WH Realized Spread Adj PFOF (bps)...............            0.49            0.29            0.99            0.36
EX Realized Spread Adj Rebate (bps).............           -0.40           -0.06           -1.54            0.08

[[Page 193]]

 
WH Price Impact (bps)...........................            1.26            0.25            4.22            0.25
EX Price Impact (bps)...........................            4.40            1.80           12.00            1.75
WH E/Q Ratio....................................            0.39            0.32            0.50            0.41
EX E/Q Ratio....................................            1.04            1.01            0.98            1.17
----------------------------------------------------------------------------------------------------------------
                                      Panel B: Wholesaler Price Improvement
----------------------------------------------------------------------------------------------------------------
WH Pct Executed with Price Improvement..........          89.95%          93.33%          85.43%          87.93%
WH Conditional Amount Price Improvement (bps)...            2.54            1.47            6.16            0.99
WH Pct Shares Executed at Midpoint or Better....          44.57%          47.37%          39.76%          43.97%
WH Pct Shares Executed at Midpoint..............          31.69%          32.47%          28.46%          33.44%
WH Pct Shares Executed at NBBO..................           8.38%           5.86%          10.97%          10.69%
WH Pct Shares Executed Outside NBBO.............           1.67%           0.81%           3.61%           1.38%
WH Pct Shares Executed with <0.1 cent Price               18.64%          16.62%          20.58%          20.64%
 Improvement....................................
WH Pct of Shares Executed as Subpenny Prices....          66.98%          65.10%          64.16%          73.55%
WH Pct of Shares Executed at Subpenny Prices              47.60%          46.82%          47.03%          49.68%
 without Midpoint Trades........................
WH Pct of Shares Executed at Subpenny Prices              41.36%          40.80%          41.76%          42.06%
 with 4 Decimals................................
----------------------------------------------------------------------------------------------------------------
This table uses CAT data to compare aggregated execution quality statistics for Q1 2022 broken out for different
  security types for executed marketable orders with order size under $200,000 in NMS Common Stocks and ETFs
  received by wholesalers from individual investors to similar orders received by exchanges. Aggregated
  statistics in the table labeled WH are based on analysis of CAT data of executed marketable orders in NMS
  Common Stocks and ETFs from individual investors for under $200,000 in value belonging to one of 58 retail
  broker MPIDs that were handled by one of 6 wholesalers during normal market hours in Q1 2022 (see supra note
  442 for additional discussions on the CAT data used in the CAT retail analysis). Aggregated statistics in the
  table labeled EX are based on a corresponding analysis of CAT data of executed marketable orders in NMS Common
  Stocks and ETFs receive by exchanges that were under $200,000 in value and received and executed during normal
  market hours in Q1 2022 (see supra note 443 for additional discussions on the CAT data used in CAT exchange
  analysis).
The following metrics are calculated for all stocks and for each of the stock-types. EX indicates aggregated
  statistics for executed marketable orders routed to exchanges and WH indicates aggregated statistics for
  executed marketable orders from individual investors that were routed to wholesalers. Average Price is the
  average execution price. WH Principal Execution Rate is the percentage of dollar volume of individual investor
  trades that a wholesaler executed in a principal capacity. Share Volume is the total executed share volume.
  Dollar Volume is the total executed dollar volume. Effective Spread is the weighted average of the percentage
  effective half spread in basis points (bps) (measured as average (execution price--NBBO midpoint at time of
  order receipt) * average transaction price). Realized Spread is the weighted average of the percentage one
  minute realized spread in bps (measured as average (execution price--NBBO midpoint one minute after execution)
  * average transaction price). WH Realized Spread Adj PFOF is the estimated realized spread in bps earned by
  the wholesaler after adjusting the realized spread for the estimated PFOF they pay to retail brokers (see
  supra note 446 for further details on adjusting wholesaler realized spreads for PFOF in CAT data). EX Realized
  Spread Adj Rebate is the estimated realized spread in bps earned by exchange liquidity suppliers after
  adjusting the realized spread for the estimated exchange rebates they receive or access fees they pay for
  supplying liquidity (see supra note 435 for further details on adjusting realized spreads for exchange fees
  and rebates). Price Impact is the weighted average of the percentage one-minute price impact spread in bps
  (measured as average (NBBO midpoint one minute after execution--NBBO midpoint at time of order receipt)/
  average transaction price). E/Q Ratio is the weighted average of the ratio of the effective dollar spread
  divided by its quoted spread at the time of order receipt. WH Pct Executed with Price Improvement is the
  weighted average of the percentage of share volume that is routed to wholesalers and executed at a price
  better than the NBBO. WH Conditional Amount Price Improvement is the weighted average amount of percentage
  price improvement given by wholesalers conditional on the order receiving price improvement in bps (measured
  for a marketable buy order as average (NBO at time of order receipt--execution price) and measured for a
  marketable sell order as average (execution price--NBB at time of order receipt) and then dividing the
  difference by the average transaction price). WH Pct Share Executed at Midpoint or Better is the weighted
  average of the percentage of shares that are routed to a wholesaler and executed at prices equal to or better
  than the NBBO midpoint at the time of order receipt. WH Pct Share Executed at Midpoint is the weighted average
  of the percentage of shares that are routed to a wholesaler and executed at a price equal to the NBBO midpoint
  at the time of order receipt. WH Pct Shares Executed at NBBO is the weighted average of the percentage of
  share volume routed to a wholesaler and executed at the NBBO at the time of order receipt (executed at the NBB
  for marketable sell orders and the NBO for marketable buy orders). WH Pct Shares Executed Outside NBBO is the
  weighted average of the percentage of share volume routed to wholesalers and executed at prices outside the
  NBBO at the time of order receipt (executed at a price less than the NBB for marketable sell orders and a
  price greater than the NBO for marketable buy orders). WH Pct Shares Executed with <0.1 cent Price Improvement
  is the weighted average of the percentage of shares that are executed with an amount of price improvement less
  than 0.1 cents measured against the NBBO at the time of order receipt. WH Pct Shares Executed Subpenny Prices
  is the weighted average of the percentage of shares that execute at a subpenny price (a dollar execution price
  with a non-zero value in the third or fourth decimal place). WH Pct Shares Executed at Subpenny without
  Midpoint Trades is the weighted average of the percentage of shares that execute at a subpenny price (a dollar
  execution price with a non-zero value in the third or fourth decimal place), excluding executions with
  subpenny prices that occur at the NBBO midpoint. WH Pct Shares Executed at Subpenny Prices with 4 Decimals is
  the weighted average of the percentage of shares that execute at a subpenny price where there is a dollar
  execution price with a non-zero value in the fourth decimal place. Average transaction prices used in
  calculating the metrics are calculated as the total dollar trading volume divided by the total share trading
  volume in the category and time period.For the wholesaler (WH) CAT metrics used in the sample, the analysis
  includes marketable orders for under $200,000 in value that originate from a customer with a CAT account type
  of ``individual'' at one of the 58 retail broker MPIDs and are routed to a wholesaler (see supra note 441 for
  more info on CAT account types and retail broker identification methodology and supra note 442 for more
  details on how the CAT retail analysis sample was constructed). Fractional share orders with share quantity
  less than one share were excluded from the analysis. Orders were also excluded if they had certain special
  handling codes. The marketability of a limit order is determined based on the consolidated market data feed
  NBBO at the time a wholesaler first receives the order.
For the exchange (EX) CAT metrics, executed market and marketable limit orders received by exchanges during
  normal market hours over the same period were used to calculate the exchange execution quality statics (see
  supra note 443 for more details on how the CAT exchange sample was constructed). Exchange orders were filtered
  if they had certain special handling codes. The marketability of exchange orders was determined based on the
  NBBO observed by the exchange at the time of order receipt.
The dollar value of an order was determined by multiplying the order's number of shares by either its limit
  price, in the case of a limit order, or by the far-side quote of the NBBO at the time of order receipt, in the
  case of a market order. The analysis includes NMS Common Stocks and ETFs (identified by security type codes of
  `A' and `ETF' in NYSE TAQ data) that are also present in CRSP data from CRSP 1925 US Stock Database, Ctr.
  Rsch. Sec. Prices, U. Chi. Booth Sch. Bus. (2022). The CRSP 1925 US Indices Database, Ctr. Rsch. Sec. Prices,
  U. Chi. Booth Sch. Bus. (2022), was used to identify if a stock was a member of the S&P 500. The stock did not
  have to be in the CRSP 1925 US Indices Database to be included in the analysis. Time of order receipt is
  defined as the time the wholesaler or exchange first receives the order. Wholesaler metrics based on the time
  of order receipt are measured against the NBBO from the consolidated market data feed. Exchange metrics based
  on time of order receipt are measured against the NBBO the exchange reports observing. Realized spreads for
  both exchange and wholesaler metrics are calculated with respect to the NBBO midpoint from the consolidated
  market data feed observed one minute after the time of order execution.
Separately, for both the exchange and wholesaler samples, total share volume, total dollar volume, average
  transaction price, percentage volume metrics, and share weighted average dollar per share spread, price
  impact, and price improvement metrics were calculated at a stock-week-order size category level by aggregating
  together execution quality statistics calculated for individual orders. The order-size categories were defined
  as orders less than 100 shares, 100-499 shares, 500-1,999 shares, 2,000-4,999, 5,000-9,999 shares, and 10,000+
  shares. For each stock-week-order size category, percentage spread, price impact, and price improvement
  metrics were calculated by dividing the average dollar per share metric by the average transaction price
  calculated for each stock-week-order size category. E/Q ratios were calculated for each stock-week-order size
  category by dividing the average dollar per share effective spread by the average dollar per share quoted
  spread.
Exchange sample metrics for E/Q ratios and percentage spread, price impact, and price improvement metrics for
  each stock-week-order size category were then merged with the corresponding stock-week-order size category in
  the wholesaler sample. Weighted averages for both wholesaler and exchange metrics and the wholesaler
  percentage volume metrics are then calculated for the security type in the sample by averaging across stock-
  week-order size category levels based on their total dollar transaction volume during the sample period in the
  wholesaler CAT sample (i.e., for both exchanges and wholesalers, using the stock's total dollar trading volume
  in wholesaler executed transactions as the weight when averaging the share weighted average stock-week- size
  category values). Weighting the exchange and wholesaler execution metrics by the same weights helps to ensure
  the samples are comparable across stocks. Total dollar volume and share volume for the exchange and wholesaler
  samples are calculated by summing across all executions in a security type in each sample. The wholesaler
  Principal Execution Rate is calculated for a security type in the wholesaler sample by summing the total
  dollar volume in trades wholesalers executed in a principal capacity across the security type in the
  wholesaler sample and dividing by the total dollar volume in trades in the security type in the wholesaler
  sample.


[[Page 194]]

    In sum, analyses from Table 6 and Table 7 show that wholesaler 
realized spreads exceed exchange realized spreads for comparable 
marketable order transactions (e.g., similar stocks and order sizes) on 
exchanges. If orders internalized by wholesalers were subject to 
competition from multiple liquidity suppliers at the individual order 
level,\448\ we would expect realized spreads to be similar to the 
realized spreads earned by liquidity providers of similar orders routed 
to exchanges.\449\ That is, the wholesaler could respond to the lower 
price impact (adverse selection risk) of its internalized orders by 
providing large enough price improvement so that its realized spread 
(potential profits) matched exchange realized spreads generated by the 
larger price impact (adverse selection risk) and smaller price 
improvement of orders executed by liquidity suppliers on exchanges. 
Since wholesaler price improvement is not commensurate their lower 
costs (i.e., smaller price impacts due to lower adverse selection 
risk), their realized spreads exceed exchange realized spreads.
---------------------------------------------------------------------------

    \448\ The analysis in Table 7 shows that 9.6% of executed dollar 
volume from orders routed to wholesalers may be effectively rerouted 
and potentially subject to competition at the individual order 
level.
    \449\ Despite receiving more price improvement, the analyses in 
supra Table 5, Table 6, and Table 7 show that individual investor 
orders sent to wholesalers still had significantly positive realized 
spreads, indicating their price improvement does not fully offset 
the lower adverse selection costs they pose. Thus, while the higher 
price impact of orders executed on exchanges compresses exchange 
realized spreads, one might expect (under competitive conditions) 
that the lower price impact of orders internalized by wholesalers 
would pressure wholesalers to provide sufficiently high price 
improvement such that wholesaler realized spreads would face a 
similar compression.
---------------------------------------------------------------------------

    Further evidence and granularity regarding the difference between 
wholesaler and exchange realized spreads are found in Table 8 and Table 
9. Table 8 compares the execution quality between orders routed to 
wholesalers and exchanges and provides estimates of effective and 
realized spreads as well as price impacts and E/Q ratios for NMS common 
stocks and ETFs sorted into buckets based on their average dollar 
quoted spread. Realized spreads are also adjusted for per-share PFOF 
payments made by wholesalers and rebates paid by exchanges in order to 
account for the impact of these costs on potential economic profits. 
Differences in realized spreads between exchanges and wholesalers 
appear to be largest in stocks with quoted spreads less than 1.1 cents 
or stocks with quoted spreads greater than 5 cents (the buckets in 
which wholesalers earn the largest realized spreads). This appears to 
be partially driven by orders routed to wholesalers receiving the least 
price improvement (as measured by the E/Q ratio) in stocks with quoted 
spreads less than 1.1 cents and orders routed to exchanges receiving 
the most price improvement in stocks with quoted spreads greater than 5 
cents.\450\
---------------------------------------------------------------------------

    \450\ Results also indicate that, after adjusting for exchange 
rebates, average exchange realized spreads are positive for stocks 
with average quoted spreads less than 1.1 cents, unlike stocks where 
average quoted spreads exceed 1.1 cents, which still have negative 
average realized spreads after adjusting for exchange rebates. It is 
possible that one-cent minimum tick size on exchanges limits 
competition in stocks with quoted spreads less than 1.1 cents, 
leading to higher realized spreads for these stocks. Furthermore, 
PFOF-adjusted realized spreads are negative for stocks with quoted 
spreads less than 1.1 cents, unlike the realized spreads for stocks 
with wider quoted spreads, indicating that potential marginal 
economic profit is larger for these stocks.

 Table 8--Estimates of Wholesaler and Exchange Execution Quality for Marketable Orders Under $200,000 by Quoted
                                                  Spread Range
----------------------------------------------------------------------------------------------------------------
                                                               Quoted spread bucket
            Variable             -------------------------------------------------------------------------------
                                    <1.1 cents      1.1-2 cents      2-3 cents       3-5 cent        5+ cents
----------------------------------------------------------------------------------------------------------------
WH Effective Spread (bps).......            2.74            1.09            1.30            2.00            2.74
EX Effective Spread (bps).......            3.83            1.48            1.84            2.70            4.54
WH E/Q Ratio....................            0.48            0.41            0.34            0.34            0.35
EX E/Q Ratio....................            1.05            1.20            1.10            1.04            0.92
WH Price Impact (bps)...........            1.76            0.73            0.93            1.30            1.43
EX Price Impact (bps)...........            6.11            2.26            2.47            3.56            5.73
WH Realized Spread (bps)........            0.99            0.36            0.37            0.69            1.31
EX Realized Spread (bps)........           -2.28           -0.78           -0.63           -0.85           -1.20
WH Realized Spread Adj PFOF                -0.15            0.12            0.17            0.50            1.22
 (bps)..........................
EX Realized Spread Adj Rebate               0.18           -0.21           -0.16           -0.38           -0.98
 (bps)..........................
----------------------------------------------------------------------------------------------------------------
This table uses the CAT retail analysis data and CAT exchange analysis data to estimate exchange and wholesaler
  effective spreads, price impacts, realized spreads, E/Q ratios and wholesaler and exchange realized spreads
  after accounting for exchange rebates and PFOF across all NMS stocks and ETFs for marketable orders under
  $200,000 based on the stock's average quoted spread. See supra Table 7 for additional details on how the
  sample and metrics are calculated. Stocks are grouped into buckets based off of their time weighted average
  quoted spread for a week as measured in NYSE TAQ. Share-weighted percentage metrics are averaged together at
  the individual stock-week-order size category level for the exchange and wholesaler sample using the
  methodology in Table 7. Weighted averages for both wholesaler and exchange metrics are then calculated for
  each quoted spread bucket by averaging across stock-week-order size category levels based on their total
  dollar transaction volume during the sample period in the wholesaler CAT sample (i.e., for both exchanges and
  wholesalers, using the stock's total dollar trading volume in wholesaler executed transactions as the weight
  when averaging the share weighted average stock-week-order size category values). Weighting the exchange and
  wholesaler execution metrics by the same weights helps to ensure the samples are comparable across stocks.

    Table 9 compares execution quality between wholesalers and 
exchanges and provides estimates of the effective and realized spreads 
as well as price impacts and E/Q ratios for stocks sorted into buckets 
based on their security type and then sub-sorted into buckets based on 
their price and, for Non-S&P 500 stocks and ETFs, into liquidity 
buckets based on their total share trading volume in a week. Once 
again, realized spreads are adjusted for (per-share) PFOF payments made 
by wholesalers and rebates paid by exchanges in order to account for 
their impact on potential economic profits. The results show that 
differences in realized spreads are larger in stocks with lower 
liquidity. This suggests that the isolation of individual investor 
orders due to wholesaler internalizations may result in larger losses 
in potential price improvement for individual investors on their orders 
in less liquid stocks.

[[Page 195]]



                                  Table 9--Estimates of Execution Quality for Marketable Orders Under $200,000 by Stock Type, Price Group, and Liquidity Bucket
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   WH           EX                                                                   EX realized
                                                                                               effective    effective     WH E/Q     EX E/Q   WH realized  EX realized  WH realized   spread adj
                 Stock type                     Price group          Liquidity bucket            spread       spread      Ratio      Ratio       spread       spread     spread Adj     rebate
                                                                                                 (bps)        (bps)                              (bps)        (bps)      PFOF (bps)     (bps)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
S&P 500.....................................        (1) <$30  ..............................         1.18         2.47       0.45       1.01         0.67        -1.39        -0.14        -0.22
S&P 500.....................................    (2) $30-$100  ..............................         0.49         1.32       0.30       1.06         0.12        -0.62        -0.08        -0.18
S&P 500.....................................       (3) $100+  ..............................         0.67         1.50       0.31       1.00         0.46        -0.15         0.39        -0.03
Non-S&P 500.................................        (1) <$30  Low...........................        56.26        53.61       0.72       0.94        28.98        -0.43        27.66         3.52
Non-S&P 500.................................        (1) <$30  Medium........................        31.70        26.91       0.80       0.96        11.70        -8.69         9.91        -3.77
Non-S&P 500.................................        (1) <$30  High..........................         8.84        10.25       0.65       1.02         2.21        -6.61         0.12        -1.85
Non-S&P 500.................................    (2) $30-$100  Low...........................        22.91        23.60       0.54       0.92        11.83         0.12        11.71         0.57
Non-S&P 500.................................    (2) $30-$100  Medium........................         7.81        10.03       0.44       0.95         4.31        -1.03         4.19        -0.59
Non-S&P 500.................................    (2) $30-$100  High..........................         2.64         4.89       0.38       0.97         0.76        -2.48         0.58        -1.99
Non-S&P 500.................................       (3) $100+  Low...........................        14.86        17.82       0.42       0.88        11.83         2.41        11.81         2.51
Non-S&P 500.................................       (3) $100+  Medium........................         6.79        10.07       0.36       0.90         5.12         0.35         5.08         0.48
Non-S&P 500.................................       (3) $100+  High..........................         2.43         5.33       0.30       0.90         1.47        -0.56         1.41        -0.41
ETF.........................................        (1) <$30  Low...........................        14.98        19.86       0.67       0.97        12.76         8.61        12.49         9.68
ETF.........................................        (1) <$30  Medium........................        11.69        15.23       0.62       0.96         9.52         4.89         9.29         5.96
ETF.........................................        (1) <$30  High..........................         2.79         4.31       0.55       1.04         1.36        -1.39         0.62         0.20
ETF.........................................    (2) $30-$100  Low...........................         8.06        10.62       0.59       0.94         6.98         4.62         6.88         5.10
ETF.........................................    (2) $30-$100  Medium........................         4.22         6.70       0.42       0.93         3.83         1.81         3.75         2.25
ETF.........................................    (2) $30-$100  High..........................         0.66         1.43       0.40       1.12         0.51        -0.41         0.36         0.05
ETF.........................................       (3) $100+  Low...........................         2.54         4.69       0.39       0.92         2.39         1.05         2.36         1.20
ETF.........................................       (3) $100+  Medium........................         1.21         2.34       0.33       0.98         1.17         0.02         1.15         0.16
ETF.........................................       (3) $100+  High..........................         0.20         0.44       0.39       1.27         0.15        -0.10         0.12        -0.02
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
 This table uses the CAT retail analysis data and CAT exchange analysis data to estimate exchange and wholesaler effective spreads, realized spreads, E/Q ratios and wholesaler and exchange
  realized spreads after accounting for exchange rebates and PFOF across all NMS stocks and ETFs for marketable orders under $200,000 based on the stock's type, VWAP, and traded share volume.
  See supra Table 7 for additional details on how the sample and metrics are calculated. Stocks are broken out into buckets based on their security type, price, and liquidity. Stock type is
  based on whether a security is an ETF, or a common stock in the S&P 500 or Non-S&P 500. Price buckets are based on a stock's average VWAP price over a week as estimated from TAQ (see supra
  Table 7 for additional details). Stocks within each security type-price bucket, except S&P 500 stocks, are sorted into three equal liquidity buckets based on the stock's total share trading
  volume during the week estimated using TAQ data. Share-weighted percentage metrics are averaged together at the individual stock-week-order-size category level for the exchange and
  wholesaler sample using the methodology in Table 7. Weighted averages for both wholesaler and exchange metrics are then calculated for each security-type-price-liquidity bucket by averaging
  across stock-week-order size category levels based on their total dollar transaction volume during the sample period in the wholesaler CAT sample (i.e., for both exchanges and wholesalers,
  using the stock's total dollar trading volume in wholesaler executed transactions as the weight when averaging the share weighted average stock-week-order size category values). Weighting
  the exchange and wholesaler execution metrics by the same weights helps to ensure the samples are comparable across stocks.

5. Variation in Wholesaler Execution Quality
    The previous section provided evidence that wholesalers earn 
greater realized spreads relative to exchanges and these differences 
are larger in less liquid stocks. In the following section, we present 
additional evidence on the variation in execution quality that 
wholesalers provide to individual investor orders.
a. Principal vs. Non-Principal Capacity
    Table 10 uses CAT retail analysis to summarize how individual 
investor marketable NMS stock order execution quality varies based on 
whether the wholesaler executes the order in a principal capacity 
(i.e., internalizes the order) or effectively reroutes the order (i.e., 
executes in a riskless principal or handles it in an agency capacity). 
This analysis supports the interpretation that wholesalers identify and 
tend to internally execute individual investor orders associated with 
the lower adverse selection costs.\451\ Internalized orders have a 
lower price impact (0.91 bps as compared to 4.63 bps for those 
effectively rerouted), and lower effective spreads (1.77 compared to 
5.36 for other transactions). Wholesalers also earn higher realized 
spreads on the orders they execute as principal (0.86 bps for principal 
transactions compared to 0.72 bps earned by those providing liquidity 
for the riskless principal or agency transactions), despite executing 
them at lower effective spreads.
---------------------------------------------------------------------------

    \451\ Certain items in Table 10 may also be affected by MDI 
Rules once they are implemented. See supra notes 356 and 421.

Table 10--Wholesaler CAT Analysis of Individual Investor Order Execution
                Quality by Wholesaler Execution Capacity
------------------------------------------------------------------------
                                                            Effectively
                Variable                   Internalized      rerouted
------------------------------------------------------------------------
Average Price...........................          $33.48          $14.78
WH Orders (million).....................          236.95           34.36
WH Trades (millions)....................          251.32           74.36
WH Share Volume (billion shares)........           70.28           16.83
WH Pct of Executed Share Volume.........          80.68%          19.32%
WH Dollar Volume (billion $)............       $2,352.80         $248.64
WH Pct of Executed Dollar Volume........          90.44%           9.56%
WH Effective Spread (bps)...............            1.77            5.36
WH Realized Spread (bps)................            0.86            0.72
WH Price Impact (bps)...................            0.91            4.63
WH E/Q Ratio............................            0.35            0.70

[[Page 196]]

 
WH Pct Executed with Price Improvement..          93.37%          57.65%
WH Conditional Amount Price Improvement             2.45            3.74
 (bps)..................................
WH Pct Shares Executed at Midpoint or             46.05%          30.65%
 Better.................................
WH Pct Shares Executed at Midpoint......          32.23%          26.53%
WH Pct Shares Executed at NBBO..........           5.51%          35.49%
WH Pct Shares Executed Outside NBBO.....           1.12%           6.86%
WH Pct Shares Executed with <0.1 cent             20.38%           2.22%
 Price Improvement......................
------------------------------------------------------------------------
 The table summarizes execution quality statistics from the CAT retail
  analysis based on whether the wholesaler executed the individual
  investor NMS stock order in a principal capacity or in another
  capacity (i.e., in an agency or riskless principal capacity). The
  majority of the other transactions are executed by the wholesaler in a
  riskless principal capacity. See supra Table 7 for additional details
  on the sample and metrics used in the analysis. Share-weighted
  percentage metrics are averaged together at the individual execution
  capacity-stock-week-order-size category level for the wholesaler
  sample using the methodology in Table 7. Weighted averages for the
  metrics are then calculated for each execution capacity by averaging
  across execution capacity-stock-week-order size category levels based
  on their total dollar transaction volume during the sample period in
  the wholesaler CAT sample.

    Table 11 provides data on the duration of time to execution for 
orders routed to wholesalers. While there is substantial variation in 
time to execution for both internalized orders and orders routed to 
other market centers, internalized order are executed more quickly, 
especially for orders with the slowest execution times (i.e., greater 
than or equal to the 75th percentile). The median execution time for 
rerouted orders was 24 milliseconds (0.024 seconds), about seven times 
longer than the median execution time for internalized orders, which 
equaled 3.6 milliseconds (i.e., 0.0036 seconds). The execution time for 
the slowest 5% of internalized orders was under 1.3 seconds, 
substantially faster than the slowest 5% of rerouted orders, which took 
around two minutes to execute.

                                               Table 11--Distribution of Share-Weighted Time-to-Execution
                                                                    [in milliseconds]
--------------------------------------------------------------------------------------------------------------------------------------------------------
           Execution capacity                5th Pctl        10th Pctl       25th Pctl       50th Pctl       75th Pctl       90th Pctl       95th Pctl
--------------------------------------------------------------------------------------------------------------------------------------------------------
Internalized............................            0.47            0.90            1.56            3.56            8.65           80.69        1,269.03
Effectively rerouted....................            2.00            4.55           10.38           24.36        2,983.30       35,166.76      119,284.18
--------------------------------------------------------------------------------------------------------------------------------------------------------
 This table presents the time-to-execution of orders handled by wholesalers that are either internalized or effectively rerouted. Time-to-execution
  statistics are share weighed across observations. See supra Table 7 for additional details on the sample.

b. Adverse Selection Risk
    While individual investor NMS stock orders are generally viewed as 
possessing less adverse selection risk than orders of other investors, 
there is nevertheless variation in adverse selection risk across this 
order flow.\452\ Table 12 shows the distribution of the average 
percentage price impact across 58 retail broker MPIDs in the CAT retail 
analysis in NMS Common Stocks and ETFs.\453\ The results indicate there 
is substantial variation in price impact across the order flow from 
different retail brokers, with the price impact of the 90th percentile 
retail broker's orders being approximately 20 times greater than that 
of the 10th percentile retail broker's orders and more than 4 times 
greater than the median retail brokers orders.
---------------------------------------------------------------------------

    \452\ Certain retail brokers tend to have more sophisticated 
customers than other retail brokers. Order flow from these retail 
brokers carries greater adverse selection risk, while order flow 
from retail brokers with generally less sophisticated customers 
carries less adverse selection risk. For the purposes of this 
release, the Commission discusses retail brokers as carrying 
different levels of adverse selection risk, although this is 
actually a description of the order flow of the customer base of 
these retail brokers, not the actual retail brokers.
    \453\ Certain items in Table 12 may also be affected by the 
amendments in the MDI Adopting Release once they are implemented. 
See supra notes 356 and 421.

 Table 12--Distribution of Individual Retail Broker-Dealer Average Percentage Price Impact (bps) in Quality in NMS Common Stocks and ETFs During Q1 2022
--------------------------------------------------------------------------------------------------------------------------------------------------------
                 N                       Mean       Std Dev        Min       10th Pctl    25th Pctl    50th Pctl    75th Pctl    90th Pctl       Max
--------------------------------------------------------------------------------------------------------------------------------------------------------
58.................................         1.07         2.35       -12.34         0.16         0.43         0.83         1.39         3.38         7.00
--------------------------------------------------------------------------------------------------------------------------------------------------------
 This table summarizes the distribution of the retail broker MPID's average price impact for the 58 retail broker MPIDs in the CAT retail analysis in
  NMS Common Stocks and ETFs. Each Retail Broker MPID's price impact is determined by share weighting their average percentage price impact half spread
  within an individual NMS common stock or ETF and then averaging across stocks using the weighting of the dollar volume the retail broker MPID executed
  in each security (Dollar Volume weighted). See supra Table 7 for additional details on the sample and metrics used in the analysis. NMS Common stocks
  and ETFs are identified, respectively, as securities in TAQ with a Security Type Code of `A' and `ETF'.

    Analysis suggests that wholesalers tend to provide lower execution 
quality to retail brokers that have higher adverse selection costs 
(i.e., price impact). Table 13 sorts the 58 retail broker MPIDs in the 
CAT retail analysis

[[Page 197]]

in NMS Common Stocks and ETFs into quintiles based on their price 
impact.\454\ The results indicate that the orders of retail brokers in 
the higher adverse selection quintiles handled by wholesalers receive 
worse execution quality, as measured by higher effective spreads and E/
Q ratios, than the orders of retail brokers in the lower adverse 
selection quintiles.\455\ More specifically, the E/Q ratio of the 
broker-dealers with the highest price impact (quintile 5) is more than 
twice as large as the E/Q ratio of the broker-dealers with the lowest 
price impact (quintile 1).
---------------------------------------------------------------------------

    \454\ Certain items in Table 13 may also be affected MDI Rules 
once they are implemented. See supra notes 356 and 421.
    \455\ Several recent working papers also found that price 
improvement varies across retail brokers; see Christopher Schwarz et 
al., The `Actual Retail Price' of Equity Trades (last revised Sept. 
15, 2022) (unpublished manuscript), available at https://ssrn.com/abstract=4189239 (retrieved from Elsevier database) (``Schwarz et 
al. (2022)''); and Bradford Lynch, Price Improvement and Payment for 
Order Flow: Evidence from A Randomized Controlled Trial (last 
revised Oct. 3, 2022) (unpublished manuscript), available at https://ssrn.com/abstract=4189658 (retrieved from Elsevier database) 
(``Lynch (2022)''). These studies only included trades that were 
initiated by the authors, and do not include other trades that were 
handled by the brokers in their samples. In contrast, the 
Commission's analysis is based on the data reflecting all orders 
routed by 58 brokers.

   Table 13--Execution quality in NMS Common Stocks and ETFs for Retail Brokers Sorted Into Quintiles Based on
                                   Their Average Percentage Price Impact (bps)
----------------------------------------------------------------------------------------------------------------
                                                      Avg WH          Avg WH          Avg WH
BD Average price impact quintile   Avg WH price      principal       effective       realized       Avg WH E/Q
                                   impact (bps)   execution rate   spread (bps)    spread (bps)        ratio
----------------------------------------------------------------------------------------------------------------
1...............................           -1.04        88.62(%)            2.86            3.90            0.43
2...............................            0.48        86.63(%)            1.87            1.39            0.46
3...............................            0.79        88.65(%)            2.15            1.36            0.48
4...............................            1.32        83.86(%)            3.48            2.17            0.61
5...............................            3.85        64.01(%)            7.24            3.39            0.88
----------------------------------------------------------------------------------------------------------------
 This table summarizes how execution quality varies in NMS Common Stocks and ETFs based on a retail broker
  MPID's price impact by grouping the 58 retail broker MPIDs in the CAT retail analysis in NMS Common Stocks and
  ETFs into quintiles based on their average price impact. Each Retail Broker MPID's price impact is determined
  by share weighting its average percentage price impact within an individual NMS common stock or ETF and then
  averaging across stocks using the weighting of the dollar volume the retail broker executed in each security
  (Dollar Volume weighted). Average price impacts, effective spreads, realized spreads, and E/Q ratios are also
  calculated for each retail broker MPID by share weighting within an individual NMS common stock or ETF and
  then averaging across stocks using the weighting of the dollar volume the retail broker MPID executed in each
  security (Dollar Volume weighted). The E/Q ratio is the share weighted average of the ratio of each
  transaction's effective spread divided by its quoted spread at the time of order receipt. Retail broker MPIDs
  are sorted into quintiles based on their average percentage price impact (bps) and then averages for each
  quintile are determined by equally weighting the average statistic for each retail broker MPID. See supra
  Table 7 for additional details on the sample and metrics used in the analysis. NMS Common stocks and ETFs are
  identified, respectively, as securities in TAQ with a Security Type Code of `A' and `ETF'. This analysis uses
  data from prior to the implementation of the MDI Rules and specific numbers may differ following the
  implementation of the MDI Rules. See infra section VII.B.7.

c. Disparate Treatment of Broker-Dealers by PFOF
    Although wholesalers provide individual investor orders with price 
improvement relative to exchanges, the magnitude of this price 
improvement is not uniform across retail brokers. The previous section 
provided evidence of variation in execution quality based on adverse 
selection risk. There is also evidence that execution quality varies 
based on whether the retail broker receives PFOF for NMS stock orders. 
Commission analysis in this section shows that the PFOF a wholesaler 
pays to a retail broker affects the price improvement wholesalers 
provide, and wholesalers provide worse execution quality to broker-
dealers whose customers' orders pose a greater adverse selection risk. 
\456\
---------------------------------------------------------------------------

    \456\ Schwarz et. al. (2022) do not find a relationship between 
the amount of PFOF a retail broker receives and the amount of price 
improvement their customers' orders receive. However, they noted 
that the variation in the magnitude of price improvement they saw 
across retail brokers was significantly greater than the amount of 
PFOF the retail broker received, which could indicate their sample 
was not large enough to observe a statistically significant effect. 
Similarly, the difference we observe between the effective spreads 
of PFOF and non-PFOF brokers infra Table 14 is significantly smaller 
than the differences observed across broker-dealers in supra Table 
13. Lynch (2022) reports a broker deriving high PFOF revenues 
provides small price improvements to customer orders, while a broker 
deriving low PFOF revenue offers large price improvement. 
Importantly, both studies only included trades that were initiated 
by the authors and do not include other trades that were handled by 
the brokers in their samples, preventing them from examining the 
attributes of a typical retail order handled by each broker. As 
such, these studies would not observe the variation in price 
improvements that reflect differences in the adverse selection risk 
associated with the order flow of different brokers, and hence, 
would likely conflate the impacts of PFOF with that of adverse 
selection risk. That is, these studies cannot control for the 
possibility that a wholesaler would offer smaller price improvement 
to order flows with higher adverse selection risk. In contrast, the 
Commission relies on CAT data to examine the adverse selection risk 
at the broker level, which is a determinant of the amounts of price 
improvements that a given wholesaler would offer to different 
brokers. The regression framework in Table 15 controls for the 
adverse selection risk of the retail broker and finds that is has a 
negative relationship with the magnitude of price improvement their 
customers' orders receive. We also find a negative relationship 
between the amount of PFOF a broker-dealer receives and the 
magnitude of the price improvement their customers' orders receive 
after controlling for the retail broker adverse selection risk.
---------------------------------------------------------------------------

    Commission analysis presented in Table 14 compares average 
execution quality for PFOF and non-PFOF brokers for marketable orders 
of individual investors under $200,000 in NMS Common stocks and ETF 
orders that are routed to wholesalers.\457\ Results are divided between 
orders that were executed on a principal basis (i.e., internalized) and 
those executed via other methods (the majority of which are in a 
riskless principal capacity).
---------------------------------------------------------------------------

    \457\ Some brokers that do not accept PFOF for orders in 
equities accept PFOF for orders in options. Certain items in Table 
14 may also be affected by MDI Rules once they are implemented. See 
supra notes 356 and 421.

[[Page 198]]



        Table 14--Comparison of PFOF and Non-PFOF Broker Execution Quality in NMS Common Stocks and ETFs
----------------------------------------------------------------------------------------------------------------
                                                      Principal transactions            Other transactions
                                                 ---------------------------------------------------------------
                                                     Non-PFOF          PFOF          Non-PFOF          PFOF
----------------------------------------------------------------------------------------------------------------
Average Price...................................          $41.79          $31.35          $23.90          $12.47
WH Share Volume (billion shares)................           14.32           55.96            3.40           13.43
WH Dollar Volume (billion $)....................         $598.44       $1,754.36          $81.23         $167.41
Pct of Executed Dollar Volume...................          23.00%          67.44%           3.12%           6.44%
WH Effective Spread (bps).......................            1.50            1.86            4.57            5.75
WH Realized Spread (bps)........................            0.88            0.85            0.83            0.66
WH Realized Spread Adj PFOF (bps)...............            0.88            0.43            0.83           -0.55
WH Price Impact (bps)...........................            0.62            1.01            3.74            5.07
WH E/Q Ratio....................................            0.30            0.37            0.78            0.67
WH Pct Executed with Price Improvement..........          90.59%          94.32%          46.89%          62.87%
WH Conditional Amount Price Improvement (bps)...            2.75            2.34            2.31            4.30
----------------------------------------------------------------------------------------------------------------
 The table summarizes execution quality statistics from the CAT retail analysis in Common Stocks and ETFs based
  on whether the retail broker MPID receives PFOF from wholesalers (PFOF) or does not (Non-PFOF) and whether the
  wholesaler executed the individual investor order in a principal capacity or in another capacity (i.e., in an
  agency or riskless principal capacity). A broker-dealer MPID was determined to be a PFOF broker if the broker-
  dealer reported receiving PFOF on its Q1 2022 606 report, or if the report of its clearing broker reported
  receiving PFOF in the event that the broker did not publish a Rule 606 report. Broker-dealers or clearing
  brokers that handled orders on a not held basis and did not disclose PFOF information in their Rule 606 report
  were classified as PFOF brokers if disclosures on their websites indicated they received PFOF. Twenty-two
  MPIDs belonging to 19 retail brokers were classified as receiving PFOF. The majority of the other transactions
  are executed by the wholesaler in a riskless principal capacity. See supra Table 7 for additional details on
  the sample and metrics used in the analysis. Share-weighted percentage metrics are averaged together at the
  individual PFOF-execution capacity-stock-week-order-size category level for the wholesaler sample using the
  methodology in Table 7. Weighted averages for the metrics are then calculated for each PFOF-execution capacity
  category by averaging across execution capacity-stock-week-order size category levels based on their total
  dollar transaction volume during the sample period in the wholesaler CAT sample.

    The results in Table 14 show that wholesaler internalized orders 
(Principal Transactions) originating from PFOF brokers are associated 
with (1) higher effective spreads, (2) higher E/Q ratios, and (3) 
slightly smaller price improvement on orders that achieved at least 
some price improvement (WH Conditional Amount Price Improvement), 
relative to wholesaler internalized orders originating from non-PFOF 
brokers. However, the results also show that orders internalized from 
non-PFOF brokers also have lower adverse selection risk and similar 
realized spreads (before PFOF is paid), indicating the lower adverse 
selection risk could help explain differences in the observed execution 
quality.
    Because the results in Table 14 are averages across broker-dealers, 
they cannot disentangle the effects of PFOF on execution quality from 
differences in the adverse selection risk of different broker-
dealers.\458\ In order to control for these differences, the Commission 
analyzed the effects of PFOF and differences in broker-dealer adverse 
selection risk on execution quality in a regression framework that 
controls for other factors that could affect the price improvement 
provided by wholesalers.
---------------------------------------------------------------------------

    \458\ They also cannot disentangle the effects of differences in 
the stocks traded by PFOF and non-PFOF brokers.
---------------------------------------------------------------------------

    Table 15 displays regression results from Commission CAT retail 
analysis of NMS Common stock and ETF orders.\459\ The regression tests 
whether there is a statistically significant relationship between 
execution quality and the amount of PFOF a broker-dealer receives and 
includes several individual stock- and market-level controls \460\ as 
well as the retail broker's average price impact and size (as measured 
by percent of executed individual investor dollar volume). Four 
different measures of execution quality are used for the dependent 
variable, including E/Q ratio, effective spread, realized spread, and 
price improvement.\461\ The results in Table 15 show that the Table 14 
results indicating brokers that receive PFOF receive inferior execution 
quality are robust to the inclusion of controls for differences in the 
type of order flow coming from different broker-dealers.
---------------------------------------------------------------------------

    \459\ Certain items in this Table 15 may also be affected by the 
amendments in the MDI Rules once they are implemented. See supra 
notes 356 and 421.
    \460\ Broker-dealer cents per 100 shares PFOF rates (dollar PFOF 
rates) are determined from their Q1 2022 Rule 606 reports (see supra 
Table 2) or the Rule 606 reports of its clearing broker reported 
receiving PFOF in the event that the broker did not publish a Rule 
606 report. A PFOF rate of 20 cents per 100 shares was used for the 
introducing broker-dealers and clearing broker that reported handled 
orders on a not held basis and did not disclose PFOF information in 
their Rule 606 report but disclosed on their website that they 
received PFOF for their order flow. 20 cents per 100 shares was the 
PFOF rate that the clearing broker that handles orders on a not held 
basis disclosed on their website that they received. Twenty-two 
MPIDs belonging to 19 retail brokers were classified as receiving 
PFOF. Dollar PFOF rates for each retail broker were merged with the 
corresponding stock (S&P 500 and non-S&P 500) and order type in the 
CAT sample. For the regressions in Table 15, percentage PFOF rates 
are estimated in basis points by dividing the PFOF cents per 100 
share values from Rule 606 reports (after converting them to dollar 
per share values) by the stock-week VWAP for the security in the CAT 
sample. Stock-level controls include average share volume, VWAP, 
return, average effective spread, average realized spread, and 
average quote volatility during a week. Market-level controls 
include market volatility, market return, and the market's average 
daily trading volume during week.
    \461\ The regression also includes variables to control for 
differences in execution quality across different wholesalers and 
across different order size categories. The analysis examines trades 
in Q1 2022 that wholesalers execute in a principal capacity from 
market and marketable limit orders from individual investors that 
are under $200,000 in value and are in NMS Common stocks and ETFs. 
See supra Table 7 for further discussion on the sample. The unit of 
observation for the regression is the average execution quality 
provided to trades that are aggregated together based on having the 
same stock, week, order type, order size category, wholesaler, and 
retail broker MPID. The coefficients are estimated by weighting each 
observation by the total dollar volume of trades executed in that 
observation.

[[Page 199]]



 Table 15--Regression Analysis Showing Relationship Between Execution Quality and PFOF in NMS Common Stocks and
                                                      ETFs
----------------------------------------------------------------------------------------------------------------
                                                       (2) Effective     (3) Realized spread   (4) Amount price
          Variables               (1) E/Q ratio         spread (bps)            (bps)          improvement (bps)
----------------------------------------------------------------------------------------------------------------
PFOF Rate....................  0.0132***..........  0.217***...........  0.211***...........  -0.170***.
                               [2.82].............  [6.31].............  [7.13].............  [-5.52]
Stock Share Volume...........  0.0379.............  -0.0462............  -0.886*............  -0.533**.
                               [0.51].............  [-0.14]............  [-1.65]............  [-2.53].
Stock VWAP...................  -0.000028..........  0.000233...........  -0.000450..........  0.000014.
                               [-1.06]............  [0.61].............  [-0.78]............  [0.04].
Stock Return.................  -0.000273..........  -0.0200*...........  -0.0120............  0.00840.
                               [-0.21]............  [-1.93]............  [-0.36]............  [0.84].
VIX..........................  0.00968***.........  0.0122*............  0.0607***..........  -0.000256.
                               [7.29].............  [1.79].............  [2.85].............  [-0.05].
Market Return................  -0.00710**.........  0.00787............  0.00686............  -0.0150.
                               [-2.02]............  [0.36].............  [0.15].............  [-0.96].
Market Dollar Volume.........  0.0306***..........  0.0641***..........  0.164***...........  -0.0390***.
                               [9.70].............  [3.44].............  [3.07].............  [-2.69].
Stock Avg Effective spread...  0.00700***.........  0.122***...........  -0.0455*...........  0.00746.
                               [3.34].............  [6.07].............  [-1.94]............  [0.52].
Stock Avg Realized spread....  -0.00169*..........  -0.00902...........  0.0730***..........  -0.00552.
                               [-1.87]............  [-1.45]............  [2.98].............  [-1.48].
Stock Quote Volatility.......  0.457**............  2.232..............  -1.799.............  4.458**.
                               [2.09].............  [1.05].............  [-0.65]............  [2.03].
Broker-Dealer Average Price    0.145***...........  0.414***...........  0.316***...........  -0.417***.
 Impact.                       [14.74]............  [9.83].............  [8.50].............  [-10.21].
Broker-Dealer Pct Volume.....  -2.45e-05..........  -0.00207*..........  -0.00546***........  0.000124.
                               [-0.07]............  [-1.76]............  [-3.77]............  [0.12].
Average Trade Qspread........  -0.00720***........  0.517***...........  0.378***...........  0.392***.
                               [-10.12]...........  [19.78]............  [10.84]............  [21.14].
Wholesaler Fixed Effects.....  Yes................  Yes................  Yes................  Yes.
Order Size Category Fixed      Yes................  Yes................  Yes................  Yes.
 Effects.
Stock Fixed Effects..........  Yes................  Yes................  Yes................  Yes.
Observations.................  13,365,122.........  13,365,122.........  13,365,122.........  12,453,440.
Adjusted R-squared...........  0.279..............  0.574..............  0.060..............  0.594.
----------------------------------------------------------------------------------------------------------------
 This table presents the results of a regression analysis examining the effect of retail brokers receiving PFOF
  from wholesalers on levels of price improvement and the execution quality of their customers' orders when the
  wholesaler internalizes the order on a principal basis.
 The analysis examines trades in Q1 2022 that wholesalers execute in a principal capacity from market and
  marketable limit orders from individual investors that are under $200,000 in value and are in NMS Common
  stocks and ETFs. See supra Table 7 for further discussion on the CAT retail sample. The unit of observation
  for the regression is the average execution quality provided to trades that are aggregated together based on
  having the same stock, week, order type, order size category, wholesaler, and retail broker MPID. Weighted
  regression are performed based on the total dollar value executed by the wholesaler in that observation (i.e.,
  total shares executed for all orders that fit within that stock-week-retail broker-wholesaler-order type-order
  size category). This means that the regression coefficients capture the effect on execution quality on a per-
  dollar basis.
 Dependent variables include: the average E/Q ratio of the shares traded; the average percentage effective
  spread of the shares traded measured in basis points; the average percentage realized spread of the shares
  traded measured in basis points; and the average percentage value of the amount of price improvement measured
  in basis points, conditional on the order being price improved. These variables are from the CAT retail
  analysis and described in supra Table 7.
 Explanatory variables include: PFOF Rate is the retail brokers' PFOF rates in bps (the per share rates were
  determined from retail broker Rule 606 reports and divided by the VWAP of the executed shares in the sample to
  determine the PFOF rate on a percentage basis, see supra note 460); Broker-Dealer Pct Volume is the retail
  broker size (in terms of percentage total executed dollar trading volume in the sample); Stock Share Volume is
  the stock's total traded share volume during the week (from TAQ in billions of shares); Stock VWAP is the VWAP
  of stock trades during the week (from TAQ); Stock Return is the stock's return during the week (from CRSP 1925
  US Stock Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch. Bus. (2022)); VIX is the average value of the
  VIX index during the week (from CBOE VIX data); Market Return is the average CRSP value weighted market return
  during the week, Market Dollar Volume is the total market dollar trading volume during the week (from CRSP
  1925 US Stock Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch. Bus. (2022)); Stock Avg Effective spread is
  the stock's share weighted average percent effective half spread during the week measured in basis points
  (from TAQ); Stock Avg Realized spread is the stock's share weighted average percent realized half spread
  during the week measured in basis points (from TAQ); Stock Quote Volatility is the stock's average 1 second
  quote midpoint volatility measured in basis points (from TAQ); Broker-Dealer Average Price Impact is the
  retail broker's average price impact over the sample measured in basis points (see supra Table 12 for more
  details on how the metric is calculated); Average Trade Qspread is the average percentage quoted half spread
  at the time of order submission for orders in that stock-week-retail broker-wholesaler-order type-order size
  category measured in basis points; wholesaler fixed effects (i.e., indicator variables for each wholesaler
  that control for time-invariant execution quality differences related to each wholesaler); order-size category
  fixed effects (i.e., indicator variables for each order-size category that control for time-invariant
  execution quality differences related to order-size category); and individual stock fixed effects (i.e.,
  indicator variables for each stock that control for time-invariant execution quality differences related to
  individual stocks). The order size categories include less than 100 shares, 100-499 shares, 500-1,999 shares,
  2,000-4,999, 5,000-9,999 shares, and 10,000+ shares. Brackets include t-statistics for the coefficients based
  on robust standard errors that are clustered at the stock level. ***, **, and * indicate the t-statistics for
  the coefficients are statistically significant at the 0.01, 0.05, and 0.1 levels, respectively.
 This analysis uses data from prior to the implementation of the MDI Rules and specific numbers may be different
  following the implementation of the MDI Rules. See supra note 356 and section VII.B.7.


[[Page 200]]

    Regression results in Table 15 support the conclusion that 
wholesalers provide worse execution quality to brokers that receive 
more PFOF.\462\ The coefficients on the PFOF Rate variable indicates 
that, all else equal, for the orders wholesalers internalize, execution 
quality declines as the amount of PFOF paid to the retail broker 
increases. Orders from retail brokers that receive a greater amount of 
PFOF have higher E/Q ratios and effective spreads and receive less 
price improvement. The regression results (as measured by the 
coefficient on the PFOF Rate variable) indicate that, all else equal, 
wholesalers earn higher realized spreads on orders for which they pay 
more PFOF. Note that PFOF is not taken out of the realized spread 
measure, so the realized spread proxies for wholesaler's economic 
profits before any fees are taken out.
---------------------------------------------------------------------------

    \462\ While results from the regression analysis indicate that 
orders routed by PFOF-brokers receive reduced execution quality from 
wholesalers, there could be ways that PFOF is indirectly passed on 
to customers by their retail brokers. However, the Commission lacks 
evidence on the extent to which this is occurring.
---------------------------------------------------------------------------

    Regression results in Table 15 also show that the retail broker's 
adverse selection risk (as measured by the coefficient on the Broker-
Dealer Average Price Impact variable) has a statistically significant 
effect on the execution quality wholesalers give on trades they 
internalize. The positive coefficient indicates that wholesalers 
provide worse execution quality to broker-dealers whose customers' 
orders pose a greater adverse selection risk.
    In sum, Commission analysis indicates that wholesalers deliver 
execution quality that varies across broker-dealers based on their 
adverse selection risk. Wholesalers also deliver execution quality that 
varies based on characteristics of the order (lot size, principal 
capacity vs. riskless principal or agency capacity, market vs. 
marketable limit, S&P 500 vs. non-S&P 500). The business model of 
wholesalers relies on their ability to parse the adverse selection risk 
of individual investors' orders based on these numerous characteristics 
and to deliver some price improvement while still generating the 
potential for high profits for themselves in the form of a high 
realized spread. The lack of additional price improvement that could 
otherwise be provided to individual investors stems from the isolation 
of marketable orders by wholesalers, which results in a lack of order-
by-order competition.
6. Retail Broker Services
    Wholesalers do not charge retail brokers for the routing and 
execution that they provide, and pay a segment of these brokers PFOF 
for the right to handle their order flow. Proposed Rule 615 could 
therefore impact retail brokers as well as wholesalers, due to their 
interdependence. In order to analyze the economic effects of the 
Proposal on retail brokers, we first provide relevant detail of the 
retail broker industry.
    There are approximately 2,440 retail brokers in the U.S., earning 
quarterly revenues of approximately $86.7 billion and handling 228.9 
million customer accounts.\463\ Retail brokers provide a range of 
services that assist their customers in the purchase of securities, 
which include stocks, bonds, mutual funds, ETFs, options, futures, 
foreign exchange, and crypto asset securities. Proposed Rule 615, 
however, would cover only NMS stocks, and many customer accounts 
include assets that include or exclusively contain securities that are 
not NMS stocks. The Commission does not know what share of these 
accounts contain exclusively NMS stocks, but estimates that 
approximately 1,000 retail brokers originated NMS stock orders from 
individual investors in 2021.\464\
---------------------------------------------------------------------------

    \463\ Data are from Q2 2022, FOCUS Part II Schedule SSOI.
    \464\ This number is estimated using CAT data for broker-dealers 
that originated an order from an ``Individual Customer'' CAT account 
type in 2021. This larger sample is refined down to a sample of 54 
broker-dealers fort the CAT data analysis presented above, beginning 
in supra Table 7. See supra note 441 for a description of how the 
sample of 54 brokers was chosen.
---------------------------------------------------------------------------

    Retail broker services are sometimes divided into two generally 
defined categories: ``discount brokers'' and ``full-service'' brokers. 
Discount brokers typically provide commission-free trading for online 
purchases of stocks and ETFs, but often charge fees for purchases of 
other securities. Some discount brokers manage proprietary mutual funds 
and ETFs, which earn them revenue (based on the funds' ``expense 
ratio'') paid by the investors that purchase these funds. Full-service 
brokers (as they are commonly called and as used in this release) 
typically charge commissions and advisory fees, frequently as a share 
of the client's total assets under management, in exchange for more 
detailed financial guidance.
    Retail brokers distinguish themselves by the range of securities 
that they sell, as well accessibility and functionality of their 
trading platform, which can be geared towards less experienced or more 
sophisticated investors. Discount brokers can also differentiate 
themselves by providing more extensive customer service as well as 
tools for research and education on financial markets.
a. PFOF Revenue
    Most marketable orders of individual investors are routed by retail 
brokers to wholesalers. Wholesalers do not directly charge retail 
brokers for their order routing and execution and pay PFOF to some of 
these retail brokers in exchange for this order flow. Wholesalers paid 
$235 million in PFOF in NMS stocks in Q1 2022.\465\
---------------------------------------------------------------------------

    \465\ In NMS stocks in Q1 2022, wholesalers paid $94 million in 
PFOF for market orders, $53 million for marketable limit orders, $69 
million for non-marketable limit orders, and $19 million for other 
order types.
---------------------------------------------------------------------------

    Table 16 below indicates that a single firm received more than 43% 
of all PFOF stemming from NMS stock orders during Q1 2022. Furthermore, 
the number one and number four firms on this list merged in 2020, 
implying that a single firm received slightly more than 55% of all PFOF 
stemming from NMS stock orders. Along with this firm, the other three 
firms at the top of this list collectively received almost 94% of all 
PFOF from NMS stocks.

                Table 16--Top Broker-Dealer Recipients of PFOF From NMS Stocks and Total Revenue
----------------------------------------------------------------------------------------------------------------
                                                                   Total firm      PFOF share of  Share of total
                                                PFOF received  revenue (Q1 2022-      revenue     PFOF disbursed
                                                 (Q1 2022-)            )             (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
BD1..........................................    $101,509,456     $1,766,885,957             5.7           43.12
BD2..........................................      35,019,397        403,037,037             8.7           14.88
BD3..........................................      32,611,006        435,731,084             7.5           13.85
BD4..........................................      28,919,376      1,876,198,891             1.5           12.28
BD5..........................................      22,816,637         94,176,227            24.2            9.69
BD6..........................................       7,810,943         50,207,346            15.6            3.32

[[Page 201]]

 
BD7..........................................       4,123,125         64,850,454             6.4            1.75
BD8..........................................         835,652         10,855,447             7.7            0.35
BD9..........................................         696,482          9,406,401             7.4            0.30
BD10.........................................         590,124         12,341,917             4.8            0.25
BD11.........................................         268,754            499,731            53.8            0.11
BD12.........................................         145,943         38,249,831             0.4            0.06
BD13.........................................          68,552         19,462,153             0.4            0.03
BD14.........................................           4,122          4,977,874             0.1           0.002
----------------------------------------------------------------------------------------------------------------
This table includes data from Rule 606 reports and lists all PFOF payments stemming from NMS stock orders paid
  by wholesalers to broker-dealers. The Commission analyzed Rule 606 reports for the most active 50 broker-
  dealers, and the summary payments to the fourteen firms in the table above represent all PFOF payments made by
  wholesalers for NMS stock orders during Q1 2022. The table also contains the total revenue earned by these
  firms during the same period. The PFOF share of revenue is calculated by dividing PFOF by revenue for each
  broker-dealer.

    Table 16 also reveals that dependence on PFOF as a source of 
revenue is not equally shared among these firms. The average PFOF share 
of revenue of these firms is 9.6%. However, setting aside the 
disproportionately high PFOF revenue share of 53.8% from the smallest 
firm (by revenue) on this list, the average share of revenue stemming 
from PFOF falls to 6.5%. This is almost identical to the median PFOF 
revenue share of 6.4%.
    Besides receiving different overall disbursements of PFOF revenue, 
broker-dealers receive different PFOF rates. Table 17 below displays 
the distribution of PFOF rates (in cents per 100 shares) paid by 
wholesalers to retail brokers.

    Table 17--Distribution Across PFOF Brokers of Average Rule 606 Payment Rates From Wholesalers for Q1 2022
                                             [Cents per 100 shares]
----------------------------------------------------------------------------------------------------------------
                                                                                       Non-
                                   Distribution    Market orders    Marketable      marketable     Other orders
                                     statistic                     limit orders    limit orders
----------------------------------------------------------------------------------------------------------------
S&P 500.........................         Average            40.3            37.8            49.7            43.1
                                             Min             7.0             6.5             6.1             4.8
                                        25th Pct            14.4            14.4            15.0            11.5
                                          Median            15.0            16.0            28.6            16.6
                                        75th Pct            22.0            22.4            32.4            22.2
                                             Max           280.7           247.6           338.0           310.8
Non S&P 500.....................         Average            14.7            11.9            18.5            11.6
                                             Min             6.2             3.3             4.6             2.1
                                        25th Pct            11.1             9.4            13.2             8.2
                                          Median            13.7            10.9            18.2             9.9
                                        75th Pct            18.8            14.4            25.1            17.0
                                             Max            22.7            20.9            28.9            18.6
Combined........................         Average            16.2            12.7            20.1            13.2
                                             Min             6.3             3.4             4.6             2.5
                                        25th Pct            11.3             9.9            13.6             8.3
                                          Median            13.8            12.1            21.9            10.4
                                        75th Pct            21.5            15.7            28.3            19.1
                                             Max            36.4            21.0            31.0            27.2
----------------------------------------------------------------------------------------------------------------
This table displays the distribution across retail brokers (that received PFOF from wholesalers) of average PFOF
  payment rates from wholesalers for Q1 2022 (cents per 100 shares). The data were obtained by analyzing rule
  606 Reports from the 14 BDs that accepted PFOF from wholesalers. The table shows the distribution of PFOF
  rates broken down by S&P 500 and non-S&P 500 stocks, across market orders, marketable limit orders, non-
  marketable limit orders, and other orders that retail brokers route to different types of venues in Q1 2022.
  See supra Table 2 for additional details on the sample.

    PFOF rates vary along several dimensions. For marketable orders, 
including market and marketable limit orders, the combined median rate 
in Table 17 is 12-14 mils, significantly less than the median rate for 
the non-marketable orders median rate of 22 mils. In addition, 
variation is wider in non-marketable limit orders, with a wider range 
between the 25th and 75th percentile compared to market and marketable 
limit orders. It is also evident that the maximum values in S&P 500 
stocks, all of which are above 200 mils, are far greater than non-S&P 
500 stocks, all of which are below 35 mils, and those higher maximum 
values may be driven by the fact that two particular firms that get 
PFOF rates proportional to the bid-ask spread.
b. Other Revenues
    Retail brokers have numerous sources of revenue, including 
commissions, account management and advisory fees, interest income, as 
well as PFOF. Retail brokers that currently receive PFOF tend to earn a 
somewhat larger share of their revenue from interest on margin loans 
provided to clients. Lending rates tend to be highest for margin 
amounts under $25,000, and fall successively as

[[Page 202]]

the size of the loan increases, with the lowest rates on loans 
exceeding $1 million. PFOF brokers earned 12% of their income from 
margin interest in 2021, compared to only 1.6% of revenue earned by 
non-PFOF brokers during the same period.\466\ Another source of revenue 
is securities borrowing, making up 5.1% of revenues for PFOF brokers 
and 0.9% of non-PFOF brokers revenue during 2021. In contrast, other 
revenue lines are relatively underutilized by PFOF brokers, such as 
account supervision fees, which made up 1.3% of revenue for PFOF-
brokers but 26.5% of non-PFOF brokers.
---------------------------------------------------------------------------

    \466\ Statistics on broker-dealer revenues are from their FINRA 
Supplemental Statement of Income Form for 2021. The sample in this 
discussion is limited to 54 retail brokers that were identified in 
the CAT analysis in Table 7. 19 of these 54 broker-dealers were 
identified as a PFOF broker if they reported receiving PFOF on their 
Q1 2022 606 report, or if the report of their clearing broker 
reported receiving PFOF in the event that the broker did not publish 
a Rule 606 report. Broker-dealers or clearing brokers that handled 
orders on a not held basis and did not disclose PFOF information in 
their Rule 606 report were classified as PFOF brokers if disclosures 
on their websites indicated they received PFOF. The remaining 35 
firms comprise the sample of non-PFOF brokers. We use the broad 
definition of sales as we preliminarily believe that many firms will 
just mark ``sales'' if they have both retail and institutional 
activity. However, we note that this may capture some broker-dealers 
that do not have retail activity, although we are unable to estimate 
that frequency.
---------------------------------------------------------------------------

7. Rules Addressing Consolidated Market Data
    In 2020, the Commission adopted a new rule and amended existing 
rules to establish a new infrastructure for consolidated market 
data,\467\ and the regulatory baseline in this proposal includes these 
changes to the current arrangements for consolidated market data. 
However, as discussed in more detail above, the MDI Rules have not been 
implemented, and so they have not yet affected market practice.\468\ As 
a result, the data used to measure the baseline below reflects the 
regulatory structure in place for consolidated market data prior to the 
implementation of the MDI Rules.\469\ Accordingly, this section will 
discuss the Commission's assessment of the potential effects that the 
implementation of the MDI Rules could have on the baseline estimations.
---------------------------------------------------------------------------

    \467\ The MDI Rules expanded the data that will be made 
available for dissemination within the national market system (``NMS 
data''). See 17 CFR 242.600(b)(59); MDI Adopting Release, 86 FR at 
18613.
    \468\ For more information about the implementation timeline for 
the MDI Rules, see supra section III.B.1.b.i.
    \469\ For more information about the regulatory structure for 
consolidated market data prior to the implementation of the MDI 
Rules, see supra section III.B.1.a.
---------------------------------------------------------------------------

    Among other things, the unimplemented MDI Rules update and expand 
the content of consolidated market data to include: (1) certain odd-lot 
information \470\; (2) information about certain orders that are 
outside of an exchange's best bid and best offer (i.e., certain depth 
of book data) \471\; and (3) information about orders that are 
participating in opening, closing, and other auctions.\472\ The rules 
also introduced a four-tiered definition of round lot that is tied to a 
stock's average closing price during the previous month.\473\ For 
stocks with prices greater than $250, a round lot is defined as 
consisting of between 1 and 40 shares, depending on the tier.\474\ The 
rules also introduce a decentralized consolidation model under which 
competing consolidators, rather than the existing exclusive SIPs, will 
collect, consolidate, and disseminate certain NMS information.\475\
---------------------------------------------------------------------------

    \470\ See 17 CFR 242.600(b)(59); MDI Adopting Release, 86 FR at 
18613. The Commission outlined a phased transition plan for the 
implementation of the MDI Rules, including the implementation of 
odd-lot order information. See MDI Adopting Release, 86 FR at 18698-
701.
    \471\ See MDI Adopting Release, 86 FR at 18625.
    \472\ See MDI Adopting Release, 86 FR at 18630.
    \473\ See MDI Adopting Release, 86 FR at 18617.
    \474\ See id. The Commission adopted a four-tiered definition of 
round lot: 100 shares for stocks priced $250.00 or less per share, 
40 shares for stocks priced $250.01 to $1,000.00 per share, 10 
shares for stocks priced $1,000.01 to $10,000.00 per share, and 1 
share for stocks priced $10,000.01 or more per share.
    \475\ See MDI Adopting Release, 86 FR at 18637.
---------------------------------------------------------------------------

    Given that the MDI Rules have not yet been implemented, they likely 
have not affected market practice and therefore data that would be 
required for a comprehensive quantitative analysis of a baseline that 
includes the effects of the MDI Rules is not available. It is possible 
that the baseline (and therefore the economic effects relative to the 
baseline) could be different once the MDI Rules are implemented. The 
following discussion reflects the Commission's assessment of the 
anticipated economic effects of the MDI Rules as described in the MDI 
Adopting Release.\476\
---------------------------------------------------------------------------

    \476\ See MDI Adopting Release, 86 FR at 18741-18799.
---------------------------------------------------------------------------

    The Commission anticipated that, for stocks priced above $250, the 
new round lot definition will mechanically narrow NBBO spreads for most 
stocks with prices greater than $250.\477\ This could cause statistics 
that are measured against the NBBO to change because they will be 
measured against the new, narrower NBBO. For example, execution quality 
statistics on price improvement for higher priced stocks may show a 
reduction in the number of shares of marketable orders that received 
price improvement because price improvement will be measured against a 
narrower NBBO. In addition, the Commission anticipated that the NBBO 
midpoint in stocks priced higher than $250 could be different under the 
MDI Rules than it otherwise would be, resulting in changes in the 
estimates for statistics calculated using the NBBO midpoint, such as 
effective spreads. In particular, at times when bid odd-lot quotations 
exist within the current NBBO but no odd-lot offer quotations exist 
(and vice versa), the midpoint of the NBBO resulting from the rule will 
be higher than the current NBBO midpoint.\478\ More broadly, the 
Commission anticipated that the adopted rules will have these effects 
whenever the new round lot bids do not exactly balance the new round 
lot offers. However the Commission stated that it does not know to what 
extent or direction such odd-lot imbalances in higher priced stocks 
currently exist, so it is uncertain of the extent or direction of the 
change.\479\
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    \477\ An analysis in the MDI Adopting Release showed that the 
new round lot definition caused a quote to be displayed that 
improved on the current round lot quote 26.6% of the time for stocks 
with prices between $250.01 and $1,000, and 47.7% of the time for 
stocks with prices between $1,000.01 and $10,000. See MDI Adopting 
Release, 86 FR at 18743.
    \478\ For example, if the NBB is $260 and the national best 
offer is $260.10, the NBBO midpoint is $260.05. Under the adopted 
rules a 40 share buy quotation at $260.02 will increase the NBBO 
midpoint to $260.06. Using this new midpoint, effective spread 
calculations will be lower for buy orders but higher for sell 
orders.
    \479\ See MDI Adopting Release, 86 FR at 18750.
---------------------------------------------------------------------------

    The Commission also anticipated that the MDI Rules could result in 
a smaller number of shares at the NBBO for most stocks in higher-priced 
round lot tiers.\480\ To the extent that this occurs, there could be an 
increase in the frequency with which marketable orders must ``walk the 
book'' (i.e., consume available depth beyond the best quotes) to 
execute. This would affect statistics that are calculated using 
consolidated depth information, such as measures meant to capture 
information about whether orders received an execution of more than the 
displayed size at the quote, i.e., ``size improvement.''
---------------------------------------------------------------------------

    \480\ However, this effect will depend on how market 
participants adjust their order submissions. See MDI Adopting 
Release, 86 FR at 18746, for further discussion.
---------------------------------------------------------------------------

    The MDI Rules may also result in a higher number of odd-lot trades, 
as the inclusion of odd-lot quotes that may be priced better than the 
current NBBO in consolidated market data may attract more trading 
interest from market participants that previously did not

[[Page 203]]

have access to this information.\481\ However, the magnitude of this 
effect depends on the extent market participants who rely solely on SIP 
data and lack information on odd-lot quotes choose to receive the odd-
lot information and would have traded frequently against odd-lot quotes 
had they known about them. The Commission states in the MDI Adopting 
Release that it believes it is not possible to observe this willingness 
to trade with existing market data.\482\
---------------------------------------------------------------------------

    \481\ See MDI Adopting Release, 86 FR at 18754.
    \482\ See id.
---------------------------------------------------------------------------

    The MDI Rules may have implications for broker-dealers' order 
routing practices. For those market participants that rely solely on 
SIP data for their routing decisions and that choose to receive the 
expanded set of consolidated market data, the Commission anticipated 
that the additional information contained in consolidated market data 
will allow them to make more informed order routing decisions. This in 
turn would help facilitate best execution, which would reduce 
transaction costs and increase execution quality.\483\
---------------------------------------------------------------------------

    \483\ See MDI Adopting Release, 86 FR at 18725.
---------------------------------------------------------------------------

    The MDI Rules may also result in differences in the baseline 
competitive standing among different trading venues, for several 
reasons. First, for stocks with prices greater than $250, the 
Commission anticipated that the new definition of round lots may affect 
order flows as market participants who rely on consolidated data will 
be aware of quotes at better prices that are currently in odd-lot 
sizes, and these may not be on the same trading venues as the one that 
has the best 100 share quote.\484\ Similarly, it anticipated that 
adding information on odd-lot quotes priced at or better than the NBBO 
to expanded core data may cause changes to order flow as market 
participants take advantage of newly visible quotes.\485\ However, the 
Commission stated that it was uncertain about the magnitude of both of 
these effects.\486\ To the extent that it occurs, a change in the flow 
of orders across trading venues may result in differences in the 
competitive baseline in the market for trading services.
---------------------------------------------------------------------------

    \484\ See MDI Adopting Release, 86 FR at 18744.
    \485\ See MDI Adopting Release, 86 FR at 18754.
    \486\ See MDI Adopting Release, 86 FR at 18745, 18754.
---------------------------------------------------------------------------

    Second, exchanges and ATSs have a number of order types that are 
based on the national best bid and offer, and so the Commission 
anticipated that the changes in the NBBO caused by the new round lot 
definitions may affect how these order types perform and could also 
affect other orders with which they interact.\487\ The Commission 
stated that these interactions may affect relative order execution 
quality among different trading platforms, which may in turn affect the 
competitive standing among different trading venues, with trading 
venues that experience an improvement/decline in execution quality 
attracting/losing order flow.\488\ However, the Commission stated that 
it was uncertain of the magnitude of these effects.\489\
---------------------------------------------------------------------------

    \487\ See MDI Adopting Release, 86 FR at 18748.
    \488\ See id.
    \489\ See id.
---------------------------------------------------------------------------

    Third, the Commission anticipated that, as the NBBO narrows for 
securities in the smaller round lot tiers, it may become more difficult 
for the retail execution business of wholesalers to provide price 
improvement and other execution quality metrics at levels similar to 
those provided under a 100 share round lot definition.\490\ To the 
extent that wholesalers are held to the same price improvement 
standards by retail brokers in a narrower spread environment, the 
wholesalers' profits from execution of individual investor orders might 
decline,\491\ and to make up for lower revenue per order filled in a 
narrower spread environment, wholesalers may respond by changing how 
they conduct their business in a way that may affect retail brokers. 
However, the Commission stated that is was uncertain as to how 
wholesalers may respond to the change in the round lot definition, and, 
in turn, how retail brokers may respond to those changes, and so was 
uncertain as to the extent of these effects.\492\ To the extent that 
this occurs, this may impact wholesalers' competitive standing in terms 
of the execution quality offered particularly to individual investor 
orders. Where implementation of the above-described MDI Rules may 
affect certain numbers in the baseline, the description of the baseline 
below notes those effects.
---------------------------------------------------------------------------

    \490\ See MDI Adopting Release, 86 FR at 18747.
    \491\ Individual investor orders typically feature lower adverse 
selection than other types of orders, such as institutional orders. 
See supra section II.D.2 and supra section VII.B.2 for discussion of 
why it is generally more profitable for liquidity providers to 
execute against orders with lower adverse selection risk.
    \492\ See MDI Adopting Release, 86 FR at 18748.
---------------------------------------------------------------------------

C. Economic Effects

    The Commission preliminarily believes that the introduction of 
qualified auctions for NMS stocks would increase competition to supply 
liquidity to marketable orders of individual investors. This might 
enhance order execution quality for individual and institutional 
investors as well as improve price discovery. The magnitude of the 
improvements in order execution quality that individual and 
institutional investors may experience as a result of this Proposal 
might be less than indicated for a variety of reasons (though it may 
also be greater), including the implementation of MDI Rules, the effect 
of which is not yet in the data. Under the MDI Rules, the availability 
of faster consolidated market data with more data on odd-lot 
information, auctions information, and depth of book information from 
competing consolidators could result in improved execution quality for 
customer orders were their broker-dealers who currently utilize SIP 
data switch to using the expanded consolidated market data.\493\ 
Nevertheless, the Commission preliminarily believes that the Proposal 
would lead to improvements in individual and institutional investor 
order execution quality, as well as improvements in price discovery, 
relative to a baseline in which MDI Rules are implemented.
---------------------------------------------------------------------------

    \493\ See supra note 421 for further details on how the MDI 
Rules adopted in the MDI Adopting Release could affect the NBBO. It 
is unclear how benefits in execution quality will change because of 
uncertainty regarding how the price improvement wholesalers provide 
to individual investors will change as well as uncertainty regarding 
how the NBBO midpoint will change for stocks with prices above $250 
once the MDI Rules are implemented.
---------------------------------------------------------------------------

    The Commission acknowledges considerable uncertainty in the costs 
and benefits of this rule because the Commission cannot predict how 
different market participants would adjust their practices in response 
to this rule. The Proposal would likely cause wholesalers and some 
retail brokers to incur significant adjustment costs to their 
operations. It is unknown whether the current industry practice of 
routing nearly all retail order flow to wholesalers would persist were 
the Commission to adopt this rule, because wholesalers might charge for 
this service and retail brokers might find it more profitable to 
develop their own routing services. On the other hand, wholesalers may 
still find the practice of routing to be profitable were there to 
remain an information advantage, and due to the proposed exception to 
be able to execute a segmented order at a price equal to or better than 
NBBO midpoint without exposing it in a qualified auction.
    Among the possible effects are a decline in profitability for 
wholesalers. Some retail brokers could also experience costs from 
wholesalers reducing the amount of PFOF they pay

[[Page 204]]

to retail brokers or from reducing or charging for the order handling 
services they offer to retail brokers. Some of these costs could 
ultimately be passed on to individual investors, such as through the 
resumption of commissions for NMS stock trades being charged by some 
retail brokers.\494\ Market participants would also incur compliance 
costs, such as exchanges and NMS Stock ATSs incurring costs for 
creating qualified auctions, as well as broker-dealer and trading 
center compliance costs related to establishing policies and procedures 
for identifying and handling segmented orders and originating brokers 
that submit segmented orders. NMS plans and their participants 
(including the exchanges and FINRA) would incur compliance costs in 
order to update the consolidated market data feeds and to broadcast 
qualified auction messages. FINRA would incur compliance costs to 
update the ADF and to broadcast qualified auction messages.
---------------------------------------------------------------------------

    \494\ See infra section VII.C.2.b.ii for a discussion of the 
possibility of the return of commission fees.
---------------------------------------------------------------------------

    As discussed above, this section measures the economic effects of 
the proposed amendments relative to a regulatory baseline that includes 
the implementation of the MDI Rules.\495\ Furthermore, this section 
reflects the Commission's assessment of the anticipated economic 
effects of the proposed amendments, including potentially 
countervailing or confounding economic effects from the MDI Rules.\496\ 
However, given that the MDI Rules have not yet been implemented, they 
likely have not affected market practice and therefore data that would 
be required for a comprehensive quantitative analysis of the economic 
effects that includes the effects of the MDI Rules are not available. 
It is possible that the economic effects relative to the baseline could 
be different once the MDI Rules are implemented. Where implementation 
of the above-described MDI Rules may affect certain numbers, the 
description of the economic effects below notes those effects.
---------------------------------------------------------------------------

    \495\ See supra section VII.B.7.
    \496\ See supra section VII.B.7 for a discussion of the 
Commission's anticipated economic effects of the MDI Rules as stated 
in the MDI Adopting Release.
---------------------------------------------------------------------------

1. Benefits
a. Increased Competition To Supply Liquidity to Marketable Orders of 
Individual Investors
    The Commission believes that the Proposal would increase 
competition among market participants to provide liquidity to 
marketable orders of individual investors.\497\ The majority of 
individual investors' marketable orders are currently internalized by 
wholesalers without competition at the order-by-order level.\498\ The 
Commission believes that, by introducing an auction mechanism that 
allows market participants to bid for individual investor orders that 
would otherwise be internalized by wholesalers, Proposed Rule 615 and 
the proposed amendments to Rule 600 would facilitate competition to 
provide liquidity to individual investors by drawing additional 
liquidity from market participants other than the wholesalers that 
handle the majority of individual investor orders.\499\ Marketable 
orders internalized by wholesalers feature lower price impacts, i.e., 
have lower adverse selection risk.\500\ Thus, the lower adverse 
selection risk of the order flow that would be routed to qualified 
auctions would incentivize market participants to trade against this 
flow via auction participation, as market participants would find 
providing liquidity against this order flow more attractive relative to 
the LOB or to individual investor orders with greater adverse selection 
that may currently be routed to exchanges.
---------------------------------------------------------------------------

    \497\ The Proposal would also increase competition among market 
participants to supply liquidity to beyond-the-midpoint non-
marketable limit orders of individual investors because these orders 
could not be executed at restricted competition trading centers at 
prices beyond the midpoint unless they met one of the other 
exceptions to Proposed Rule 615. However, as shown below in Table 
20, the majority of beyond-the-midpoint non-marketable limit orders 
are not internalized. Additionally, Table 20 also shows that the 
executed volume of beyond-the-midpoint non-marketable limit orders 
submitted by individual investors and routed to wholesalers is 
significantly smaller than the volume of marketable limit orders. 
Therefore, an increase in competition to supply liquidity to these 
orders may be more limited than for the marketable orders of 
individual investors. The Commission does not believe that the 
Proposal would have a significant effect on the competition to 
execute the fractional share portions of individual investor orders 
that may qualify for the exception in Proposed Rule 615(b)(5).
    \498\ See supra note 454.
    \499\ Although the Proposal is predicted to improve execution 
quality for individual investors, it is likely that profits for some 
market participants would be reduced, including some wholesalers and 
some retail brokers. See infra sections VII.C.2.c and VII.C.2.d for 
a discussion of these potential costs. Potential costs to other 
market participants are discussed elsewhere in infra section 
VII.C.2.
    \500\ See supra section VII.B.2.b.
---------------------------------------------------------------------------

    The Commission is mindful of the limitations faced by investors who 
lack access to algorithmic trading technologies, e.g., individual 
investors and professional traders relying on displayed screens, to 
determine when to provide liquidity in qualified auctions. The proposed 
100-millisecond minimum auction length would be too short for such 
investors to be able to participate in these auctions unless they have 
to access algorithmic trading technology.\501\ Additionally, the 
Proposal would prohibit exchange RLPs (unless they operated via one of 
the exceptions to qualified auctions), which would further constrain 
the ability of these market participants to compete to supply liquidity 
to segmented orders by limiting their ability to quote at sub-penny 
increments.\502\ However, the Commission believes that market 
participants with access to algorithmic trading technology, including 
SORs used for trading institutional orders, would be able to 
participate in qualified auctions and thereby enhance the competition 
to provide liquidity to individual investors.
---------------------------------------------------------------------------

    \501\ The possibility of adverse price movement (``adverse 
fade'' probability) during an auction is discussed in infra section 
VII.C.2.b.
    \502\ Consequently, these market participants could only compete 
to provide liquidity to segmented orders via exchange LOBs or ATSs. 
However, quoting on exchanges and ATSs can only take place at 1-cent 
price increments and the quoted midpoint. Therefore, if these 
participants wanted to provide a more competitive price relative to 
qualified auctions, they would be required to quote at the next 
better full-penny price or at the midpoint (for a tick-constrained 
stock). In contrast, participants of qualified auctions would be 
able to compete by providing liquidity at prices that are only 0.1 
cents better than the existing auction price. As such, under 
qualified auctions, competition to provide liquidity to segmented 
order flow at better prices would be incrementally more costly for 
investors who lack access to smart order routers, placing these 
participants at a disadvantage relative to participants with access 
to smart order routers.
---------------------------------------------------------------------------

    Competition to supply liquidity through qualified auctions would 
further be enhanced by the proposed implementation of a 5 mil (i.e., 
$0.0005) per share auction fee and rebate cap for executed auction 
responses and a 5 mil per share rebate cap for segmented orders priced 
at $1.00 per share or greater.\503\
---------------------------------------------------------------------------

    \503\ Qualified auction fee and rebate caps would be limited to 
0.05% of the auction response price per share for executed auction 
responses and segmented orders priced at less than $1.00 per share 
in Proposed Rule 615(c)(4). Additionally, the Proposal would require 
that qualified auction fees and rebates be the same for all of its 
auction participants, i.e., volume-based tiering, which tends to 
advantage large liquidity suppliers who transact in sufficient 
volumes to trigger lower fees and/or higher rebates, would not apply 
to qualified auction fees and rebates. Under the proposed rule, no 
fee could be charged for submission or execution of a segmented 
order, or for submission of an auction response. See supra section 
IV.C.4.
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    First, the Commission believes that the proposed auction fee and 
rebate caps would help ensure that exchanges and ATSs have sufficient 
incentives to operate qualified auctions. Using information from the 
financial statements of the three major exchange

[[Page 205]]

groups which collectively account for the overwhelming majority of 
trading volume on exchanges, the Commission estimates that the average 
total net capture \504\ for exchanges is currently around 4 mils for 
all trading types.\505\ However, the Commission understands based on 
Staff conversations with industry members that the net capture for the 
executions of orders during continuous trading hours (but not open or 
close auctions) priced at $1.00 per share or greater is likely close to 
2 mils. The Commission expects that in response to the 5 mil auction 
fee and rebate cap for executed auction responses priced at $1.00 per 
share or greater, open competition trading could charge fees of around 
5 mils to executed auction responses and provide rebates of 
approximately 3 mils to broker-dealer submitting the segmented order to 
the qualified auction, and thus maintain a net capture of approximately 
2 mils for these transactions. For the executions of orders priced 
below $1.00 per share on exchange LOBs, the Commission estimates that 
exchanges have an average net capture of around 0.28% of the 
transaction value; \506\ thus, for these orders under $1.00, the net 
capture may be lower than what they earn on exchange LOB transactions. 
However, qualified auction hosts may be able to compensate for this 
decline, e.g., by reducing rebates for segmented orders priced at $1.00 
per share or greater to 1 mil or otherwise cross-subsidizing segmented 
orders priced below $1.00 per share with access fees charged on their 
LOB, with the overall goal to at least maintain their overall total net 
capture of around 2 mils for trading on their exchange.\507\
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    \504\ Net capture refers to the difference between average fees 
levied and rebates paid.
    \505\ Intercontinental Exchange, the parent firm of NYSE, 
reports on page 51 of its 2021 10k filing that its net capture for 
U.S. equity transactions was approximately 4.2 mils in 2021. Nasdaq 
did not report its net capture in their 10K filing, however Nasdaq 
provides information on their investor relations web page which, 
when we average the relevant 2021 volumes, indicates that the 
average net capture across all Nasdaq platforms for U.S. equity 
transactions was 5.9 mils (see Nasdaq 2022/2021 Monthly Volumes, 
available at https://ir.nasdaq.com/static-files/465d2157-c476-4546-a9f7-8d7ad0c9be77). Cboe reports in their 2021 Form 10-K filing that 
their net capture for U.S. equity transactions was approximately 2 
mils.
    \506\ The estimate for the 0.28% net capture, which is the 
difference between fees received and rebates paid out by the 
exchange, is obtained by an analysis of current fee and rebate 
schedules based on Rule 19b-4 filings with the Commission for each 
of the equity exchanges operating in the United States as of June 1, 
2022, as well as a review of the transaction prices that each 
exchange posts. This amount is because, for transactions under $1.00 
per share, most exchanges set their baseline fee at 0.30% but do not 
offer baseline rebates, and some charge fees to both sides of the 
transaction leading to more than 0.30% per trade earned by the 
exchange.
    \507\ The assumption that the exchanges earn an average 2 mil 
spread on trading behavior is discussed above in this section. The 
Commission believes that it is reasonable to assume that the 
exchanges would fund qualified auction rebates through access fees, 
either from qualified auctions or the continuous order book. The 
Commission believes that it is reasonable to assume that the 
exchanges overall would try to continue to earn approximately 2 mils 
per transaction under the Proposal, but the Commission acknowledges 
that there is some uncertainty regarding this assumption and seeks 
public comment.
---------------------------------------------------------------------------

    Second, the proposed 5 mil auction fee and rebate cap for executed 
auction responses priced at $1.00 per share or greater would likely 
result in qualified auction fees and rebates that would be unlikely to 
have a significant impact on the price improvement auction bidders 
would be able to offer because the 5 mil fee and rebate cap is smaller 
than the minimum pricing increment in qualified auctions. Since larger 
fees limit the ability of liquidity suppliers to offer better prices, 
setting a lower auction fee cap could result in improved execution 
quality for the segmented order. Furthermore, the auction rebate cap of 
5 mils for segmented orders is likely to limit the competitive bidding 
advantage of the broker-dealer submitting the segmented order to the 
qualified auction. The maximum rebate of 5 mils is smaller than the 
minimum pricing increment in the auction, which limits the ability of 
the broker-dealer submitting the segmented order to use the rebate to 
subsidize the price improvement they offer in their qualified auction 
bids.
    Third, the Commission believes that the caps on qualified auction 
fees and rebates would incentivize open competition trading centers to 
compete more on the basis of execution quality, rather than fees and 
rebates, in order to attract segmented orders. The 5 mil rebate cap for 
segmented orders priced at $1.00 per share or greater would result in 
rebates that are significantly lower than the rebates that are 
currently offered by most exchanges in these stocks. Academic 
literature has shown that the presence of high liquidity fees and 
rebates on some market centers may impact broker-dealer routing 
decisions based on where they can receive the highest rebate (or pay 
the lowest fee), rather than where they can receive better execution 
quality on behalf of their customers.\508\ In contrast, with the 5 mil 
rebate cap, the effect of rebates on qualified auction participants for 
stocks with prices greater than $1.00 may be sufficiently small as to 
have a minimal impact on overall market structure or behavior.\509\ 
This would limit the degree to which open competition trading centers 
could use rebates to attract segmented orders to their qualified 
auctions and help incentivize them to compete more on the basis of the 
execution quality of their auctions.
---------------------------------------------------------------------------

    \508\ See, e.g., Robert H. Battalio, Shane A. Corwin & Robert 
Jennings, Can Brokers Have It All? On the Relation Between Make-Take 
Fees and Limit Order Execution Quality, 71 J. Fin. 2193 (2016).
    \509\ All but two exchanges do not offer a rebate for 
transactions priced below $1.00 per share. Thus, for these 
transactions, the proposed auction fee and rebate cap for executed 
auction responses would likely not result in lower rebates.
---------------------------------------------------------------------------

    In addition, the Commission believes that proposed minimum price 
increments under Proposed Rule 615(c)(3) \510\ would further enhance 
competition to supply liquidity to marketable individual investor 
orders through qualified auctions, as smaller price increments are 
likely to encourage greater amounts of price improvement. However, 
lowering the price increment beyond that proposed may increase the 
possibility of market participants seeking to gain execution priority 
by pricing their auction responses in economically small increments. 
Thus, the size of the proposed price increment that has been chosen for 
qualified auctions is intended to increase price improvement while 
still reducing the likelihood of participants using economically 
insignificant price increments.
---------------------------------------------------------------------------

    \510\ Under proposed Rule 615(c)(3), segmented orders and 
auction responses must be priced in an increment of no less than 
$0.001 (or 0.1 cent) if their prices are $1.00 or more per share, in 
an increment of no less than $0.0001 (or 0.01 cent) if their prices 
are less than $1.00 per share, or at the midpoint of the NBBO. See 
supra section IV.C.3.
---------------------------------------------------------------------------

b. Improvements to Segmented Order Execution Quality
    The Proposal likely would reduce transaction costs for individual 
investors due to improved competition to supply liquidity to individual 
investor orders.\511\ By making marketable order flow from individual 
investors that is currently internalized by wholesalers and executed at 
prices less favorable than midpoint accessible to other market 
participants in qualified auctions, the Proposal would allow additional 
market participants an opportunity to compete to directly trade with 
these individual investor orders.\512\ The Commission estimates that 
the potential benefit to individual investors from this increased 
competition, the

[[Page 206]]

competitive shortfall rate, would range between an average of 0.86 bps 
to 1.31 bps for marketable orders that met the definition of a 
segmented order.\513\ Based on Commission estimates that between 7.3% 
to 10.1% of total executed dollar volume would be segmented orders that 
would be eligible to be included in qualified auctions, the Commission 
preliminarily estimates that this could potentially result in a total 
average annual savings in individual investor transaction costs, i.e., 
a total competitive shortfall, ranging between $1.12 billion to $2.35 
billion dollars.\514\ The Commission acknowledges that there is 
considerable uncertainty in these estimates.\515\ Additionally, these 
estimates account only for potential changes in individual order 
transaction costs and assumes that the PFOF wholesalers currently pay 
to retail brokers would be converted into additional price improvement 
for the individual investor order. Furthermore, the estimates do not 
account for the potential return of commission fees charged by retail 
brokers.\516\ As discussed in further detail below,\517\ the 
Commissioner does not believe that retail brokers will respond to the 
loss of PFOF revenue by resuming commission fees, but even in the event 
that total PFOF revenue disappears ($940 million, based on Q1 2022 
data) \518\ and PFOF brokers charge commission fees to fully replace 
this revenue, this cost increase to traders would still be less than 
the estimated $1.12 billion to $2.35 billion annual gain in price 
improvement estimated by the Commission.
---------------------------------------------------------------------------

    \511\ See supra section VII.C.1.a for discussion of improvements 
in competition to supply liquidity to segmented orders in qualified 
auctions.
    \512\ See infra section VII.C.1.c for discussions of how the 
Proposal could also enhance the order execution quality of other 
market participants that would be able to compete to supply 
liquidity to individual investor orders, including institutional 
investors.
    \513\ As discussed in supra section VII.B.7, the Commission 
believes that the implementation of qualified auctions would lead to 
improvements in execution quality relative to a baseline in which 
the MDI Rules are implemented, i.e., over and above any improvements 
in execution quality that may result from the implementation of the 
MDI Rules. Once implemented, the changes to the current arrangements 
for consolidated market data in the MDI Adopting Release may impact 
the magnitude of the benefit from the proposal for individual 
investors, but the effects are uncertain. Trading costs are measured 
against the NBBO midpoint and, as discussed in supra note 421, there 
is uncertainty regarding how the NBBO midpoint will change for 
stocks priced above $250 when the MDI Rules are implemented. It is 
also uncertain how or to what degree changes in trading costs would 
differ between trades executed at exchanges and wholesalers. Since 
the benefit is measured based on the differences in exchange and 
wholesaler realized spreads, if both realized spread measures 
changed similarly, then there would not be changes in relative 
differences between their reported spread measures and the estimated 
benefit would not change.
    \514\ See infra Table 19. The Commission preliminarily believes 
that, in order for a wholesaler to effectively compete against other 
bidders in qualified auctions, the wholesaler would have to reduce 
the PFOF it is paying to the retail broker in order to bid more 
aggressively to potentially win the qualified auction. This would 
result in the reduction in PFOF instead going to the customer as 
additional price improvement, which would be reflected in the 
competitive shortfall calculation. The competitive shortfall 
estimates do not include costs that may arise in the form of 
potential increases in (or the return of) commissions retail brokers 
charge to individual investors or other reductions in the services 
that retail brokers currently offer, both of which may occur if the 
Proposal reduces the PFOF paid to retail brokers or results in 
wholesalers charging retail brokers for their order handling 
services. See infra section VII.C.2.b for a discussion of costs to 
individual investors and infra section VII.C.2.d for a discussion of 
costs to retail brokers.
    \515\ The Commission is uncertain about these estimates because 
the Commission does not know with certainty how different market 
participants would adjust their practices in response to this rule. 
There is also uncertainty in these estimates because of limitations 
in using the realized spreads to measure the trading profits earned 
by liquidity suppliers. See supra note 426 for additional 
discussions on the limitations of realized spreads.
    \516\ Most retail brokers have continued to charge commission 
fees for (human) broker-assisted orders, including those that 
dropped online trade commission fees.
    \517\ See infra section VII.C.2.b.ii.
    \518\ However, all PFOF revenue might not disappear because 
wholesalers may continue to pay PFOF for non-marketable limit 
orders, which may not be affected by the Proposal and may be based 
on exchange rebates that wholesalers pass through to retail brokers 
(see supra note 395). The annualized PFOF revenue from non-
marketable limit orders is estimated to be approximately $275 
million, based on Q1 2022 data. See supra note 465 for additional 
information on PFOF revenue in Q1 2022.
---------------------------------------------------------------------------

    As shown by analyses in Table 6, Table 7 and Table 8, the realized 
spreads earned from supplying liquidity to individual investor 
marketable orders routed to wholesalers are greater than realized 
spreads for comparable marketable order transactions (e.g., similar 
stocks and order sizes) on exchanges, indicating that the additional 
price improvement that these individual investor orders receive does 
not fully offset the lower adverse selection risk associated with these 
orders.\519\ The Commission estimates the competitive shortfall rate, 
i.e., the potential additional price improvement (and reduction in 
transaction costs) that the marketable orders of individual investors 
would receive from having their order being exposed to greater 
competition among liquidity suppliers in qualified auctions, as the 
difference in the realized spreads between marketable orders executed 
on exchanges and individual investor marketable orders that were 
executed after being routed to wholesalers,\520\ after adjusting for 
exchange rebates that are currently paid to liquidity suppliers on 
exchanges, as well as for fees (5 mils) that would potentially be 
charged to liquidity suppliers in qualified auctions.\521\
---------------------------------------------------------------------------

    \519\ See supra sections VII.B.4 and VII.B.5 for discussions of 
the differences in realized spreads between individual investor 
marketable orders routed to wholesalers compared to marketable 
orders routed to exchanges.
    \520\ This included marketable orders that the wholesalers 
internalized and also marketable orders that were routed to 
wholesalers and then executed on a riskless principal or rerouted to 
another venue and executed on an agency basis. The Commission does 
not adjust wholesaler realized spreads for the PFOF they pay to 
retail brokers because PFOF, while a cost to wholesalers, is not a 
cost to investors. See supra note 514 for further discussions on the 
assumed effects of PFOF for purposes of this analysis.
    \521\ The realized spreads after adjusting for potential 
exchange rebates to liquidity suppliers are estimated and discussed 
in supra section VII.B.4. In estimating the competitive shortfall 
rate we also deduct a 5 mil fee from the exchange adjusted realized 
spreads to account for the potential fees charged to liquidity 
suppliers in qualified auctions. The Commission acknowledges that 
realized spreads are a proxy for the trading profits earned by 
liquidity suppliers. See supra note 426 for further discussion on 
the limitations of realized spreads.
---------------------------------------------------------------------------

    To illustrate the logic behind this calculation, it is useful to go 
through the following thought experiment. Pick a stock, a day, and a 
range of order size that is executed by wholesalers. Based on Rule 605 
data or CAT data, one can calculate the transaction costs that retail 
investors incur for this stock, on this day, and for this range of 
order size. The question is: what would be the transaction costs for 
those orders if they were sent to competitive auctions? Although such 
auctions as those being proposed here do not exist, the marginal profit 
required to incentivize provision of liquidity on exchanges' order 
books can serve as a proxy. This marginal profit to liquidity provision 
can be estimated as the on-exchange realized spread (for a given stock, 
on a given day, and within a given range of order size) plus the 
estimated rebate that exchanges pay the liquidity providers. The 
estimated transaction cost for the auction equals the estimated 
marginal profit of liquidity providers on exchange order books plus the 
maximum 5 mil fee (a lower fee would result in a higher competitive 
shortfall). The competitive shortfall is the difference between the 
current transaction cost of retail investors off-exchange wholesalers 
and the estimated transaction cost in the auction. Equivalently, one 
can view this as the difference in marginal profits to liquidity 
provision on and off-exchange (where spreads are adjusted by the 
auction fee rather than by PFOF).
    Competitive shortfall rates are calculated using three different 
estimates of exchange rebates. The first Rebate Base method is 
calculated based on Commission estimates of average exchange rebates 
paid to liquidity suppliers on maker-taker exchanges (i.e., exchanges 
that pay a rebate to orders supplying liquidity and charge a

[[Page 207]]

fee for orders demanding liquidity) and fees charged to liquidity 
suppliers on inverted exchanges (i.e., exchanges that charge a fee for 
orders supplying liquidity and pay a rebate for orders demanding 
liquidity) and flat fee exchanges (i.e., exchange that don't pay 
rebates, but may charge fees for orders both demanding and supplying 
liquidity).\522\ The other two methods, which are calculated to see how 
the competitive shortfall rates vary based on differences in estimates 
of exchange fees and rebates, are calculated by varying the exchange 
fees and rebates estimated in the Rebate Base method by 25%. The Rebate 
High method estimates higher rebates and lower fees for supplying 
liquidity and assumes exchange rebates on maker-taker venues are 25% 
greater than in the Rebate Base method and exchange fees on inverted 
and flat fee exchanges are 25% lower than in the Rebate Base 
method.\523\ The Rebate Low method estimates lower rebates and higher 
fees for supplying liquidity and assumes exchange rebates on maker-
taker venues are 25% lower than in the Rebate Base method and exchange 
fees on inverted and flat fee exchanges are 25% higher than in the 
Rebate Base method.\524\
---------------------------------------------------------------------------

    \522\ The estimated exchange rebates for orders supplying 
liquidity used to calculate the competitive shortfall exchange base 
method are the same as those used to calculate the Realized Spread 
Rebate differential in supra Table 6. See supra note 435 for a 
discussion of how these estimates of exchange rebates were 
determined. A 5 mil fee is then further deducted to account for the 
potential fee charged to liquidity suppliers in qualified auctions.
    \523\ The Rebate High method is calculated assuming that 
exchange rebates to liquidity suppliers on maker-taker exchanges are 
34 mils; that exchange fees for supplying liquidity on inverted 
exchanges are 11 mils; and that exchange fees for supplying 
liquidity on flat fee exchanges are 5 mils. A 5 mil fee is then 
further deducted to account for the potential fee charged to 
liquidity suppliers in qualified auctions.
    \524\ The Rebate Low method assumes that rebates on maker-taker 
exchanges are 25% lower and fees on inverted and flat fee exchanges 
are 25% higher. For our adjustments we assume: exchange rebates to 
liquidity suppliers on maker-taker exchanges are 20 mils; exchange 
fees for supplying liquidity on inverted exchanges are 19 mils; 
exchange fees for supplying liquidity on flat fee exchanges are 9 
mils. A 5 mil fee is then further deducted to account for the 
potential fee charged to liquidity suppliers in qualified auctions.
---------------------------------------------------------------------------

    The estimates of the overall average competitive shortfall rates 
and the competitive shortfall rates for different types of NMS stocks 
are presented below in Table 18.\525\ This analysis incorporates the 
contrasting levels of adverse selection risk (price impact) and price 
improvement provided to orders internalized by wholesalers and executed 
on exchanges. Ultimately, the increased price improvement of 
wholesalers does not match the lower price impact of individual 
investor orders, causing wholesaler realized spreads to exceed exchange 
realized spreads, and competitive shortfall rates to be positive. In 
order to ensure robustness of the results and to account for potential 
limitations of the coverage of Rule 605 reports,\526\ the analysis 
estimates competitive shortfall rates using data from Rule 605 reports, 
as well as data from CAT. All CAT and Rule 605 estimates of the 
competitive shortfall rates are positive in all three methods, which 
indicates that the realized spreads earned by wholesalers on the 
marketable orders of individual investors tend to be higher than 
realized spreads earned by liquidity suppliers on exchanges after 
adjusting for exchange rebates. However, the average competitive 
shortfall rates calculated using data from Rule 605 reports tend to be 
lower than those estimated from CAT data. Rule 605 estimated 
competitive shortfall rates using the Rebate Base, Low, and High 
methods are 0.58 bps, 0.77 bps, and 0.38 bps, respectively, while CAT 
estimated competitive shortfall rates using the Rebate Base, Low, and 
High methods are 1.08 bps, 0.86 bps, and 1.31 bps, respectively. The 
differences appear to be mainly driven by differences between the 
exchange realized spreads calculated using Rule 605 and CAT data. 
Exchange realized spreads calculated using CAT data tend to be lower 
than those calculated using Rule 605 data, with CAT data estimating an 
average exchange realized spread of -1.22 bps for all stocks and Rule 
605 data estimating an average exchange realized spread of -0.67 bps. 
This difference could be driven by the CAT data having broader coverage 
of marketable orders than Rule 605 data.\527\ The analysis in Table 7 
supports this by showing that sample from CAT data contains over $16 
trillion in trading volume from marketable orders routed to exchanges 
in Q1 2022, while Table 6 shows that the sample from Rule 605 data is 
smaller, containing over $9 trillion in trading volume from marketable 
orders routed to exchanges.\528\ Given the broader coverage of the CAT 
exchange data, the Commission believes that the estimates derived from 
sample from the CAT data provide a more complete estimate of the 
realized spreads for marketable orders executed on exchanges than the 
sample from the Rule 605 data. Therefore, the Commission believes that 
the range of the estimated competitive shortfall rate from the CAT 
data, 0.86 bps to 1.31 bps may be a more representative measurement of 
the realized spread difference between individual investor marketable 
orders executed by wholesaler and marketable orders executed on 
exchanges.\529\
---------------------------------------------------------------------------

    \525\ Competitive shortfalls are calculated using the same 
methodology for calculating realized spreads that is described in 
Table 6 and Table 7, but the amount for exchange rebates adjustments 
may be different depending on the rebate method used. Additionally, 
the competitive shortfall deducts a 5 mil fee from the exchange 
adjusted realized spreads to account for the potential fees charged 
to liquidity suppliers in qualified auctions, which is not included 
in the realized spread differential calculations.
    \526\ See supra section VII.B.4 discussing limitations of Rule 
605 coverage.
    \527\ The different time horizons used for the calculation of 
the realized spreads could also contribute to the observed 
difference in realized spreads between the samples, with the CAT 
sample calculating realized spreads at the one minute horizon and 
Rule 605 data calculating spreads at the 5 minute horizon. However, 
Conrad and Wahal (2020) examined realized spreads at different 
horizons and found that realized spreads measured at the 5 minute 
horizon tended to be lower than realized spreads measured at the 1 
minute horizon, which indicates that the different time horizons may 
not be a significant driver of the difference in realized spreads 
between the two samples.
    \528\ Note that the samples in Table 6 and Table 7 are filtered 
to be limited to orders under $200,000 in value. However, the 
trading volume for the CAT sample is still larger than the exchange 
trading volume for the unfiltered sample from Rule 605 data shown in 
Table 5.
    \529\ The Commission acknowledges that there is uncertainty in 
these estimates. See supra note 515 for additional discussions.
---------------------------------------------------------------------------

    The estimates in Table 18 indicate that the competitive shortfall 
rate appears to be higher in non-S&P 500 stocks than in S&P 500 stocks 
and ETFs, with non-S&P 500 competitive shortfall rates of 3.07 bps 
under the Rebate Base method computed using CAT data, compared to the 
competitive shortfall rates of 0.44 bps and 0.34 bps for S&P 500 stocks 
and ETFs respectively. These results are consistent with the results 
shown in Table 8, which indicate that the differences in realized 
spreads between individual investor marketable orders executed at 
wholesalers and marketable orders executed at exchanges are larger in 
less liquid stocks.\530\ Additionally, the estimates in Table 18 
indicate that exchanges' rebates tend to have a larger effect on the 
competitive shortfall rate for non-S&P 500 stocks, with these types of 
stocks showing the greatest variation in the competitive shortfall 
rates estimated by the Rebate Low and Rebate High methods.
---------------------------------------------------------------------------

    \530\ See supra section VII.B.4 for a discussion of the analysis 
in Table 8.

[[Page 208]]



                                                     Table 18--Competitive Shortfall Rates Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Data source                                   Stock type                      All           S&P 500       Non-S&P 500         ETF
--------------------------------------------------------------------------------------------------------------------------------------------------------
Rule 605.......................................  WH Realized Spread (bps)...............            0.72            0.30            1.55            0.64
Rule 605.......................................  EX Realized Spread (bps)...............           -0.67           -0.30           -1.97           -0.12
Rule 605.......................................  EX Realized Spread Adj Rebate Base               -0.001           -0.05           -0.24            0.28
                                                  (bps).
Rule 605.......................................  EX Realized Spread Adj Rebate High                 0.19            0.02            0.25            0.41
                                                  (bps).
Rule 605.......................................  EX Realized Spread Adj Rebate Low (bps)           -0.20           -0.12           -0.73            0.15
CAT............................................  WH Realized Spread (bps)...............            0.85            0.42            2.00            0.51
CAT............................................  EX Realized Spread (bps)...............           -1.22           -0.28           -3.90           -0.34
CAT............................................  EX Realized Spread Adj Rebate Base                -0.40           -0.06           -1.54            0.08
                                                  (bps).
CAT............................................  EX Realized Spread Adj Rebate High                -0.18            0.00           -0.90            0.20
                                                  (bps).
CAT............................................  EX Realized Spread Adj Rebate Low (bps)           -0.63           -0.12           -2.19           -0.05
Rule 605.......................................  Competitive Shortfall Rebate Base (bps)            0.58            0.30            1.42            0.26
Rule 605.......................................  Competitive Shortfall Rebate High (bps)            0.38            0.23            0.93            0.13
Rule 605.......................................  Competitive Shortfall Rebate Low (bps).            0.77            0.37            1.91            0.38
CAT............................................  Competitive Shortfall Rebate Base (bps)            1.08            0.44            3.07            0.34
CAT............................................  Competitive Shortfall Rebate High (bps)            0.86            0.38            2.42            0.22
CAT............................................  Competitive Shortfall Rebate Low (bps).            1.31            0.50            3.71            0.46
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table shows estimates of competitive shortfall rates, wholesaler realized spreads, and exchange realized spreads after adjusting for exchange
  rebates. Competitive shortfall is estimated by subtracting realized spreads on marketable orders routed to exchanges after adjusting for exchange
  rebates and fees for liquidity suppliers in qualified auctions from realized spreads on marketable orders routed to wholesalers. Estimates are
  calculated using three different competitive shortfall estimation methods to account for exchange rebates: (1) Competitive Shortfall Rebate Base
  (``Base'') method (see supra note 522); (2) Competitive Shortfall Rebate High (``High'') method (see supra note 523); and (3) Competitive Shortfall
  Rebate Low (``Low'') method (see supra note 524).
The competitive shortfall estimates are calculated separately for samples from Rule 605 data and CAT data and are derived from the execution quality
  stats for marketable orders under $200,000 described in detail in Table 6 (Rule 605 data) and Table 7 (CAT data). For the sample from Rule 605 data,
  the difference in dollar realized spread measures between exchanges and wholesalers are estimated by subtracting the average rebate adjusted exchange
  realized spread (using estimated exchange rebate rates from one of the competitive shortfall rebate method estimates) and also deducted a 5 mil fee
  (to account for the potential fee charged to liquidity suppliers in qualified auctions) from the adjusted wholesaler average realized spread at the
  stock-month-order size category level for the combined market and marketable limit order types with average order size category dollar values less
  than $200,000 (average order dollar values were determined for each order-size category stock-month by dividing the total number of covered shares in
  the order size category by the total number of covered orders and then multiplying by the stock-month's average VWAP), calculated from Rule 605
  reports. The share weighted averages of the wholesaler and exchange realized spread differences are then determined at the individual stock-month
  level by share-weighting across different order-size categories based on the number of shares executed (at the market center + away) in wholesalers'
  Rule 605 reports in that order-size category. Percentage realized spread differences are then calculated by dividing the dollar realized spread
  differentials by the stock-months VWAP as estimated by TAQ. The weighted average of the individual stock-month percentage realized spread
  differentials are averaged together based on weighting by the total wholesaler dollar trading volume in that stock-month for the combined marketable
  order type (wholesaler dollar trading volume is estimated by multiplying the Rule 605 report wholesaler total executed share volume, i.e., the share
  volume executed at market center + share volume executed away from the market center, for the stock-month-order type by the stock's monthly VWAP). A
  similar methodology was used to calculate the CAT competitive shortfall measures, but the share weighted volume estimates were calculated up to the
  individual stock-week-order-size level and then these values were aggregated together based on a weighted average using the total wholesaler dollar
  trade volume executed in that category. The realized spread measures reported are the average wholesaler and exchange adjusted rebates (adjusting for
  the exchange rebates reported under this method but not including the 5 mil fee deduction for the qualified auction fees) used to compute the
  competitive shortfall rates.

    Table 18 estimates the average annual total competitive shortfall 
(i.e., the average total annual estimated dollar value of improvements 
in individual investor transaction costs) by multiplying the 
competitive shortfall rate by an estimate of the total annual dollar 
volume of segmented orders that could potentially participate in 
qualified auctions. Because the Commission is uncertain about the 
volume of orders that would participate in qualified auctions, the 
analysis uses three different scenarios to estimate the dollar volume 
of individual investor orders that may participate in qualified 
auctions.\531\ Under the Base segmented order volume scenario, the 
Commission analysis assumes that all individual investor orders under 
$200,000 would be exposed in qualified auctions, which is estimated to 
constitute 7.8% of total executed dollar volume.\532\ Under the Low 
segmented order volume scenario, the Commission analysis assumes that 
only individual investor marketable orders under $200,000 would be 
exposed in qualified auctions, which is estimated to constitute 7.3% of 
total executed dollar volume.\533\ Because some broker-dealers may 
submit segmented orders over $200,000 to qualified auctions if it would 
result in the order receiving better price improvement,\534\ under the 
High segmented order volume scenario, the Commission analysis assumes 
that 50% of individual investor orders over $200,000 would also be 
exposed in qualified auctions, which is estimated to constitute 10.1% 
of total executed dollar volume.\535\ These scenarios include orders 
executed by wholesalers at prices at or better than NBBO midpoint, 
though should these orders continue to receive this execution via the 
exception to the rule then they would not be sent to qualified 
auctions. This is appropriate given that these orders are also included 
in the analysis examining the execution quality of individual investor 
marketable orders routed to

[[Page 209]]

wholesalers.\536\ Therefore, removing these orders from the analysis 
would serve to increase the realized spread for wholesalers and thus 
increase the competitive shortfall for the remaining percentage of 
total executed dollar volume.
---------------------------------------------------------------------------

    \531\ The percentage multipliers used in these volume estimates 
were estimated from an analysis of CAT data in Jan. 2022. The 
analysis found that wholesalers trading in an off-exchange principal 
capacity against orders originating from an FDID Individual customer 
account type accounted for 12.36% of the total consolidated dollar 
volume reported by the SIP during the month. Of these individual 
orders, 36.78% of the executed dollar volume originated from orders 
with dollar values of $200,000 or greater. Of the remaining orders, 
5.90% of the executed dollar volume belonged to orders that were not 
market or marketable limit orders.
    \532\ The Base Scenario estimate of 7.80% as the percentage of 
total dollar volume that could potentially be segmented orders that 
could be exposed in qualified auctions is estimated by multiplying 
the 12.36% of total executed dollar volume belonging to individual 
accounts and executed by wholesalers in a principal capacity by the 
63.22% (1-36.78%) of this executed dollar volume from orders that 
were less than $200,000.
    \533\ The Low Scenario estimate of 7.34% as the percentage of 
total dollar volume that could potentially be segmented orders that 
could be exposed in qualified auctions is estimated by multiplying 
the 12.36% of total executed dollar volume belonging to individual 
accounts and executed by wholesalers in a principal capacity by the 
63.22% (1-36.78%) of this executed dollar volume from orders that 
were less than $200,000. This was then multiplied by 94.1% (1-5.9%) 
to account for the assumption that only market and marketable limit 
orders would be submitted to qualified auctions.
    \534\ Proposed Rule 615 would create an exception in which 
segmented orders with a dollar value of $200,000 or greater may be 
executed at a restricted competition trading center without being 
exposed in a qualified auction. However, the exception still allows 
these orders to be submitted to qualified auctions.
    \535\ The High Scenario estimate of 10.08% as the percentage of 
total dollar volume that could potentially be segmented orders that 
could be exposed in qualified auctions is estimated by multiplying 
the 12.36% of total executed dollar volume belonging to individual 
accounts and executed by wholesalers in a principal capacity by 
81.61% (1-36.78%/2), which is the percentage of the remaining 
executed dollar volume of orders originating from individual 
investor that are less than $200,000 plus 50% of the executed dollar 
volume of individual orders that were $200,000 or greater, which 
would be submitted to qualified auctions under this scenario.
    \536\ Marketable orders that are routed to wholesalers and 
executed at the NBBO midpoint or a more favorable price are included 
in the analysis in Table 6, Table 7, Table 18, and Table 19, as well 
as additional analysis based on the data used in these table.
---------------------------------------------------------------------------

    Table 19 estimates the average annual total competitive shortfall 
under the three segmented order volume scenarios for each of the three 
different competitive shortfall rebate methods. The table presents 
estimates for both the sample from Rule 605 data and the sample from 
CAT data. The total competitive shortfalls estimated for the Rule 605 
sample are smaller than those estimated for the CAT sample. The Rule 
605 data sample Rebate Base method estimates total competitive 
shortfalls ranging between $800 million and $1.0 billion dollars for 
the Low and High segmented order volume scenarios, respectively, while 
the CAT data sample Rebate Base method estimates total competitive 
shortfalls ranging between $1.5 billion and $1.9 billion dollars. As 
discussed above in this section, given the broader coverage of the CAT 
exchange data, the Commission believes the estimated competitive 
shortfall rates derived from the CAT data are more representative than 
those derived from Rule 605 data. The total competitive shortfall 
estimated from the CAT data sample using the Rebate High method ranges 
between $1.1 billion and $1.5 billion dollars over the different 
segmented order volume scenarios, while the estimates from the Rebate 
Low method range between $1.7 billion to $2.3 billion dollars. Given 
the uncertainty regarding the estimates of average exchange rebates and 
the volume of segmented orders that would be exposed to qualified 
auctions, the Commission estimates that the average annual total 
competitive shortfall, i.e., the total annual average reduction in 
individual investor transactions cost, from the Proposal may range 
between $1.1 billion dollars and $2.3 billion dollars.\537\
---------------------------------------------------------------------------

    \537\ This estimate only accounts for potential changes in 
individual order transaction costs and assumes the PFOF that 
wholesalers currently pay to retail brokers would be converted into 
additional price improvement for the individual investor order. The 
competitive shortfall estimates do not include costs that may arise 
in the form of potential increases in (or the return of) commissions 
retail brokers charge to individual investors or other reductions in 
the services that retail brokers currently offer. See supra note 514 
for additional details.

           Table 19--Total Annual Competitive Shortfall Dollar Values under Different Volume Scenarios
----------------------------------------------------------------------------------------------------------------
                                                                     Segmented order volume scenario
                                                        --------------------------------------------------------
          Data source             Competitive shortfall    Base (7.80% of     Low  (7.34% of    High  (10.08% of
                                        scenario           total executed     total executed     Total Executed
                                                           dollar volume)     dollar volume)     Dollar Volume)
----------------------------------------------------------------------------------------------------------------
Rule 605.......................  Competitive Shortfall   $800 million.....  $753 million.....  $1.03 billion
                                  Rebate Base (0.58
                                  bps).
Rule 605.......................  Competitive Shortfall   $530 million.....  $499 million.....  $684 million
                                  Rebate High (0.38
                                  bps).
Rule 605.......................  Competitive Shortfall   $1.07 billion....  $1.01 billion....  $1.38 billion
                                  Rebate Low (0.77 bps).
CAT............................  Competitive Shortfall   $1.50 billion....  $1.41 billion....  $1.94 billion
                                  Rebate Base (1.08
                                  bps).
CAT............................  Competitive Shortfall   $1.20 billion....  $1.12 billion....  $1.54 billion
                                  Rebate High (0.86
                                  bps).
CAT............................  Competitive Shortfall   $1.82 billion....  $1.71 billion....  $2.35 billion
                                  Rebate Low (1.31 bps).
----------------------------------------------------------------------------------------------------------------
This table estimates the total annual competitive shortfall dollar amounts by multiplying the competitive
  shortfall rates for the different method in Table 18 by an estimate of the total annual dollar trading volume
  that could be exposed in qualified auctions under three different scenarios: The Base Volume Scenario
  (discussed in supra note 532), the Low Volume Scenario (discussed in supra note 533) and the High Volume
  Scenario (discussed in supra note 535 ). The total annual dollar trading volume that could be exposed in
  qualified auctions under a scenario is estimated by multiplying the scenario's estimate of the percentage of
  executed total dollar volume by four times the Total Executed Dollar Volume in Q1 2022, which equaled $44.54
  trillion. Total Competitive Shortfall Dollar Value is estimated by multiplying Competitive Shortfall Rate by
  the estimate of the total annual dollar trading volume that could be exposed in qualified auctions under a
  scenario.

    A proposed exception from being required to send individual 
investor orders to qualified auctions under the Proposal is if handling 
broker-dealers choose to execute individual investor orders at prices 
equal to the NBBO midpoint or better. The analysis in Table 10 presents 
evidence that wholesalers execute 46% of the shares they internalize at 
prices equal to or better than the midpoint. Analysis of CAT data 
indicates that there is often additional midpoint liquidity available 
on exchanges and NMS Stock ATSs
    Table 20 uses CAT data from March 2022 to examine the non-displayed 
liquidity available at the NBBO midpoint on exchanges and NMS Stock 
ATSs at a moment in time when a wholesaler internalizes an individual 
investor marketable order at a price less favorable (to the customer) 
than the NBBO midpoint.\538\ The results indicate that, on 
average,\539\ 51% of the shares of individual investor marketable 
orders internalized by wholesalers are executed at prices less 
favorable than the NBBO midpoint (Wholesaler Pct Exec Shares Worse Than 
Midpoint). Out of these individual investors shares that were executed 
at prices less favorable than the midpoint, on average, 75% of these 
shares could have hypothetically

[[Page 210]]

executed at a better price against the non-displayed liquidity resting 
at the NBBO midpoint on exchanges and NMS Stock ATSs. Under the current 
market structure, this liquidity is not displayed, so wholesalers may 
not have been aware of this liquidity and able to execute the 
individual investor marketable orders against it. Currently, if 
wholesalers wanted to detect this hidden liquidity, they would have had 
to ping each individual exchange or NMS Stock ATS to see if midpoint 
liquidity was available on that venue.\540\
---------------------------------------------------------------------------

    \538\ More specifically, the analysis uses CAT data to look at 
the total shares available at the NBBO midpoint that originate from 
hidden midpoint pegged orders on exchanges and NMS Stock ATSs. The 
analysis compares the size of an individual investor marketable 
order that was internalized in a principal capacity by a wholesaler 
at a price less favorable than the NBBO midpoint (measured at the 
time the wholesaler received the order) to the total shares of 
midpoint liquidity (originating from midpoint peg orders) at the 
NBBO midpoint on exchanges and NMS Stock ATSs at the time the 
individual investor order is executed in order to hypothetically see 
how many additional shares could have gotten price improvement if 
they had executed against the hidden liquidity available at the NBBO 
midpoint. A midpoint peg order is a type of hidden order whose price 
automatically adjusts with the NBBO midpoint. The analysis looks at 
midpoint peg orders on exchanges and ATSs during normal market hours 
(midpoint peg orders with an Immediate or Cancel or Fill or Kill 
modifier are excluded). The total potential shares in orders that 
were available at the NBBO midpoint from midpoint peg orders on 
exchanges and ATSs was calculated each stock day by adding shares 
when midpoint peg orders were received by an exchange or ATS and 
subtracting shares in these orders that were canceled or traded. 
Shares were also subtracted from the total when a wholesaler 
internalized an individual investor marketable order at a price 
worse than the NBBO midpoint and shares were available at the 
midpoint on exchanges and ATSs that the order could have 
hypothetically executed against. This ensures that that analysis is 
not overestimating the available midpoint liquidity (i.e., it 
ensures that we do not estimate two individual investor 100 share 
orders could have executed against the same resting 100 share 
midpoint order). The analysis also kept track of the total amount of 
dollars of additional price improvement that individual investors 
would have received if their orders had hypothetically executed 
against the liquidity available at the NBBO midpoint instead of 
being internalized by the wholesaler. Note that this analysis might 
underestimate the total non-displayed liquidity available at the 
NBBO midpoint because it only looks at orders that pegged to the 
midpoint and not other orders, such as limit orders with a limit 
price equal to the NBBO midpoint.
    \539\ As discussed in Table 20, percentages were computed at a 
stock-week level and then averaged across stock-weeks by weighting 
by the total dollar volume the wholesaler internalized during that 
stock-week.
    \540\ Pinging for midpoint liquidity at multiple venues could 
increase the risk of information leakage or that prices may move, 
possibly resulting in some market participants canceling midpoint 
orders they posted.
---------------------------------------------------------------------------

    These results shed additional light on the availability of 
liquidity at the NBBO midpoint for a large share of individual investor 
orders that currently receive executions at less favorable prices than 
the NBBO midpoint and therefore could potentially execute at a price 
equal to the NBBO midpoint under qualified auctions. Under the 
Proposal, individual investor marketable orders submitted to qualified 
auctions might execute at the NBBO against this hidden liquidity, 
assuming the added transparency does not reduce the supply of midpoint 
liquidity. The qualified auction message would act as a coordination 
mechanism and would make the broker-dealers that handle the orders 
resting at the NBBO midpoint on exchanges and NMS Stock ATSs aware 
there was a segmented order they could trade against. These broker-
dealers could cancel their midpoint orders resting on exchanges and NMS 
Stock ATSs and instead submit them as an auction response priced at the 
midpoint in the qualified auction.\541\
---------------------------------------------------------------------------

    \541\ If the midpoint liquidity is resting on the LOB of the 
open competition center running the qualified auction then it would 
be included in the qualified auction without the submitter having to 
cancel the order.
---------------------------------------------------------------------------

    Table 20 also estimates the additional dollar price improvement 
that these individual investor marketable orders would have received if 
they had executed against the available midpoint liquidity instead of 
being internalized. The total amount of additional price improvement 
that all of these individual investor orders would have received was 
about 51% of the total dollar price improvement provided by wholesalers 
to all of the individual investor marketable orders that they 
internalized (i.e. the marketable orders internalized at prices better 
or equal to the midpoint plus marketable orders internalized at prices 
worse than the midpoint).
    In addition, the results in Table 20 also indicate the availability 
of NBBO midpoint liquidity is only slightly lower for less liquid (non-
S&P 500 stocks) as liquid (S&P500) stocks. That is, while about 57% of 
the shares in individual investor marketable orders in non-S&P500 
stocks internalized by wholesalers received executions at less 
favorable prices than the NBBO midpoint, there was nevertheless hidden 
liquidity available at the NBBO midpoint for about 68% of these non-
S&P500 shares. Thus, the potential for NBBO midpoint execution for 
shares in non-S&P500 stocks from qualified auctions is similar to the 
overall market. Moreover, the potential additional price improvement 
that could have been gained if these individual investor orders had 
executed against this NBBO midpoint liquidity is almost 55% of the 
total price improvement provided by wholesalers in these stocks. In 
general, the potential for qualified auctions under the Proposal to act 
as a coordination mechanism and potentially create more opportunities 
for hidden liquidity resting at the NBBO midpoint to interact with 
segmented orders exists for both liquid and non-liquid stocks.

[[Page 211]]



               Table 20--Available Midpoint Liquidity When Wholesaler Internalizes a Retail Trade
----------------------------------------------------------------------------------------------------------------
                                                                  Wholesaler pct                    Additional
                                                                    exec shares    Pct shares MP   dollar price
          Stock type              Price group   Liquidity bucket    worse than         price        improvement
                                                                     midpoint       improvement         Pct
----------------------------------------------------------------------------------------------------------------
All...........................             All  ................           51.05           74.60           51.05
SP500.........................             All  ................           48.41           72.32           41.43
SP500.........................        (1) <$30  ................           64.36           60.08           50.00
SP500.........................    (2) $30-$100  ................           47.82           60.36           29.29
SP500.........................       (3) $100+  ................           47.69           75.69           43.27
NonSP500......................             All  ................           57.45           68.10           54.51
NonSP500......................         (1) <30  Low.............           73.30           49.52           67.63
NonSP500......................        (1) <$30  Medium..........           71.30           60.25           82.85
NonSP500......................        (1) <$30  High............           66.77           52.18           59.74
NonSP500......................    (2) $30-$100  Low.............           63.60           80.69           68.88
NonSP500......................    (2) $30-$100  Medium..........           57.71           85.24           61.80
NonSP500......................    (2) $30-$100  High............           50.24           71.79           44.58
NonSP500......................       (3) $100+  Low.............           61.62           84.32           61.49
NonSP500......................       (3) $100+  Medium..........           55.40           93.29           55.96
NonSP500......................       (3) $100+  High............           47.15           90.99           45.57
ETF...........................             All  ................           49.93           86.06           58.28
ETF...........................        (1) <$30  Low.............           66.58           39.75           31.61
ETF...........................        (1) >$30  Medium..........           57.95           54.91           38.35
ETF...........................        (1) <$30  High............           62.24           78.47           88.70
ETF...........................    (2) $30-$100  Low.............           61.01           62.00           41.78
ETF...........................    (2) $30-$100  Medium..........           53.94           77.54           46.85
ETF...........................    (2) $30-$100  High............           49.87           84.09           49.56
ETF...........................       (3) $100+  Low.............           52.45           72.28           40.13
ETF...........................       (3) $100+  Medium..........           47.51           87.20           45.35
ETF...........................       (3) $100+  High............           46.93           90.28           48.33
----------------------------------------------------------------------------------------------------------------
This table summarizes midpoint liquidity available on exchanges and ATSs during March 2022 when a wholesaler
  internalizes an individual investor marketable order less than $200,000 in an NMS common stock or ETF on a
  principal basis at a price less favorable than the NBBO midpoint (at the time of the wholesaler receives the
  order) from one of the 58 retail broker MPIDs in the CAT retail analysis. Stocks are broken out into buckets
  based on their security type, price, and liquidity. Stock type is based on whether a security is an ETF, or a
  common stock in the S&P 500 or Non-S&P 500. Price buckets are based on a stock's weekly average VWAP price as
  estimated from TAQ. Stocks within each security type-price bucket, except S&P 500 stocks, are sorted into
  three equal liquidity buckets based on the stock's total share trading volume during the week estimated using
  TAQ data (see supra Table 9 for additional details on the bucket definitions). See supra Table 7 for
  additional details on the sample and CAT analysis of wholesaler executions of the orders of individual
  investors.
Wholesaler Pct Exec Shares Worse Than Midpoint is the average percentage of individual investor shares that
  wholesalers executed on a principal basis at a price less favorable than the NBBO midpoint (measured at the
  time the wholesaler receives the order). Pct Shares MP Price Improvement is the average percentage of shares
  that the wholesaler executed at a price less favorable than the NBBO midpoint that could have executed at a
  better price against resting liquidity available at the NBBO midpoint on exchanges and NMS Stock ATSs at the
  time the wholesaler executed the order. Additional Dollar Price Improvement Pct is ratio of the total
  additional dollars of price improvement of the sample period that individual investors whose orders were
  executed at a price less favorable than midpoint would have received if their orders would have executed
  against available midpoint liquidity, divided by the total dollars in price improvement (measured relative the
  NBB or NBO at the time of order receipt) that wholesalers provided over the sample period when they
  internalized individual investor orders (i.e. the total price improvement for orders wholesalers internalized
  at prices less favorable than the midpoint plus the total price improvement for orders wholesalers
  internalized at prices more favorable than the midpoint).
Midpoint liquidity is measured based on resting midpoint peg orders on exchanges and NMS Stock ATSs during
  normal market hours identified from CAT data. Midpoint peg orders with an Immediate or Cancel or Fill or Kill
  modifier are excluded. The total potential shares in orders that were available at midpoint on exchanges and
  ATSs at a point in time were calculated keeping a running total each stock day by adding shares when midpoint
  peg orders were received by an exchange or NMS Stock ATS and subtracting shares when shares in these midpoint
  peg orders were canceled or traded. When a wholesaler executes an order at a price less favorable than the
  NBBO midpoint (at the time the wholesaler receives the order), then the executed shares are compared to the
  available resting liquidity at the NBBO midpoint. If the NBBO midpoint at the time the order is executed would
  provide price improvement over the price the wholesaler would have executed the order at, then the shares
  executed by the wholesaler are subtracted from the total resting shares available at the NBBO midpoint, up to
  the lesser of the number of shares executed by the wholesaler or the total resting shares available (i.e. the
  total resting shares will not drop below zero). These are counted as the total shares that would have received
  additional price improvement at the midpoint. This methodology ensures that that analysis is not
  overestimating the available midpoint liquidity (i.e. it ensures that we do not estimate two individual
  investor 100 share orders could have executed against the same resting 100 share midpoint order). NBBO
  midpoints for both time of order receipt and time of execution are estimated from the consolidated market data
  feed.
The additional dollars of price improvement individual investors whose orders were executed at a price less
  favorable than the midpoint would have received if their orders would have executed against available midpoint
  liquidity was calculated as the difference between the price the wholesaler executed the order at and the NBBO
  midpoint at the time the wholesaler executed the order (i.e., executed price--NBBO midpoint at the time of
  execution for a marketable buy order and midpoint--executed price for a marketable sell order ) times the
  number of shares that would have received the additional price improvement.
Weighted averages are calculated for the variables Wholesaler Pct Exec Shares Worse Than Midpoint and Pct Shares
  MP Price Improvement using the following methodology. Percentages based on share volume are calculate for each
  stock-week (e.g., total shares executed at a price worse than the midpoint during a stock-week divided by the
  total shares of individual investor marketable orders executed by a wholesaler in a principal capacity during
  the stock-week). Weighted averages are then calculated for each stock-type-price-liquidity bucket by averaging
  these stock-week percentages over the month by weighting each stock-week by the total dollar trade volume
  internalized by the wholesaler during the stock-week (i.e., using the stock's total dollar trading volume
  internalized by the wholesaler as the weight when averaging the stock-week percentage values).
The Additional Dollar Price Improvement Pct is not weighted and is calculated as the ratio of the month's total
  additional dollar price improvement orders executed at a price less favorable than the NBBO would have
  received if their orders would have executed against available midpoint liquidity, divided by the month's
  total dollars in price improvement (measured relative the NBBO at the time of order receipt) that wholesalers
  provided when they executed individual investor orders (i.e. the total price improvement for orders
  wholesalers internalized at prices less favorable than the midpoint plus the total price improvement for
  orders wholesalers internalized at prices more favorable than the midpoint).

c. Improvements to Other Market Participants' Execution Quality
    In addition to benefiting individual investors, the Proposal would 
improve order execution quality for other key market participants that 
compete to supply liquidity to individual investor orders, including 
institutional investors. For example, individual investor order flow 
that is currently accessed indirectly by institutional investors 
through wholesaler SDPs could be accessed directly at better prices 
relative to the prices charged by SDPs.\542\ As stated above, in Q1 
2022, SDPs associated with the two highest-volume wholesalers accounted 
for around 3% of the consolidated NMS stocks volume, while the volume 
of shares handled by these two wholesalers accounted for 15.9% of 
consolidated share volume in NMS stocks as of Q1 2022.\543\ If 
institutional and individual investors could directly interact via 
qualified

[[Page 212]]

auctions, then these orders could potentially receive better execution 
quality.\544\
---------------------------------------------------------------------------

    \542\ See supra section VII.B.3 for further discussions 
regarding how institutional investors indirectly interact with 
individual investor orders through wholesaler SDPs.
    \543\ See supra note 416 and corresponding discussion.
    \544\ The direct interaction between individual and 
institutional investors in qualified auctions would allow for price 
improvement for both groups of investors, the sum of which is 
currently received by the wholesaler serving as the intermediary via 
its SDP. Thus, the gains to individual and institutional investors 
would be an economic transfer from the wholesaler. The impact of the 
Proposal on the costs to wholesalers is discussed in infra section 
VII.C.2.c.
---------------------------------------------------------------------------

d. Improvements in Pre-Trade Transparency and Price Efficiency
    In addition to increasing price improvement and interaction among 
market participants, the Proposal would improve pre-trade transparency 
and price efficiency. Currently, because most individual investor 
orders are internalized by wholesalers, pre-trade transparency related 
to these orders is limited, and has very likely declined over time as a 
result of the increasing share of trading volume that is executed off-
exchange.\545\ Moreover, the fact that some of the same market-makers 
have a large presence both on and off exchange implies a skewed 
information advantage, accruing to a subset of market makers. This 
subjects on-exchange liquidity providers, which may include individual 
investors, to greater adverse selection, which may have manifested in 
spreads wider than they would be otherwise, as well as lower 
depth.\546\
---------------------------------------------------------------------------

    \545\ See supra notes 374 and 375 and accompanying text. 
Additionally, market participants have stated that liquidity 
displayed at or near the NBBO on exchanges has declined over time. 
See supra note 376 and accompanying text.
    \546\ See supra section VII.B.1 for further discussion of the 
increase in off-exchange trading volume.
---------------------------------------------------------------------------

    As a result of the Proposal, price efficiency would be improved as 
a result of the dissemination of qualified auction messages, which 
would increase transparency regarding the trading interest of 
individual investors. Because qualified auction messages would be 
included in consolidated market data,\547\ they would not only promote 
competition by soliciting potential auction responses from a wide 
spectrum of market participants, but would also enhance the pre-trade 
transparency of marketable orders of individual investors, which may 
lead to improvements in liquidity and price efficiency.\548\ As market 
participants would be better able to observe the trading interest of 
individual investors using consolidated market data, this would also 
allow them to better able to observe institutional trades.\549\ The 
overall increase in market participants' ability to observe information 
in trades reported in consolidated market data would lessen the highly 
skewed information advantage of large market makers on and off-
exchange, reducing adverse selection and potentially improving market 
quality.\550\ These improvements would also occur should order flow be 
routed directly to the limit order book rather than going to an 
auction. They would be reduced to the extent that orders would be 
internalized at midpoint or better by wholesalers rather than routed to 
an exchange.
---------------------------------------------------------------------------

    \547\ The MDI Rules required auction messages to be included in 
consolidated market data. See supra section III.B.1. NMS Stock ATSs 
operating qualified auctions would need to disseminate qualified 
auction messages via FINRA's ADF.
    \548\ Evidence shows that increasing pre-trade transparency can 
improve liquidity and price efficiency. See, e.g., Ekkehart Boehmer, 
Gideon Saar & Lei Yu, Lifting the Veil: An Analysis of Pre-Trade 
Transparency at the NYSE, 60 J. Fin. 783 (2005). However, some 
evidence suggests that extreme changes, beyond what is proposed 
here, can have detrimental effects on market quality. See Ananth 
Madhavan, David Porter & Daniel Weaver, Should Securities Markets Be 
Transparent?, 8 J. Fin. Mkt. 265 (2005).
    \549\ For example, in the most extreme case, if virtually all 
individual investor orders are routed to and executed in qualified 
auctions, market participants would be able to identify nearly all 
other off-exchange transactions as institutional trades. This may 
result in additional costs to institutional investors related to 
information leakage; see infra section VII.C.2.f for a detailed 
discussion.
    \550\ The advantage would be lessened though not completely 
eliminated, provided that retail brokers route initially through 
wholesalers rather than directly to exchanges.
---------------------------------------------------------------------------

    Additionally, the execution of more individual investor orders on 
exchanges would increase post-trade transparency because it would be 
easier to identify which transactions belonged to individual investors 
and on which venue they were executed.\551\ The effects of post-trade 
transparency would be similar in direction to that of pre-trade 
transparency, though perhaps smaller, as the incremental difference in 
the transparency is less. Overall, the proposal will likely lead to 
increased trading on national market exchanges and on alternative 
trading systems satisfying the specified conditions. Evidence suggests 
that an increase in trading on lit venues could potentially increase 
information efficiency.\552\
---------------------------------------------------------------------------

    \551\ Qualified auction messages (which would be disseminated in 
consolidated market data) could be matched with trade execution 
reports in order to identify which trades belonged to retail orders. 
Currently, SIP trade reports for trades executed on exchanges 
identify the venue on which the trade occurred. Trade reports for 
trades executed off-exchange do not.
    \552\ See, e.g., Carole Comerton-Forde & T[amacr]lis 
J.Putni[ncedil][scaron], Dark trading and price discovery, 118 J. 
Fin. Econ. 70 (2015), who find that high levels of dark trading can 
impede price discovery.
---------------------------------------------------------------------------

2. Costs
    The Commission recognizes that the Proposal would result in initial 
and ongoing compliance costs, as well as other costs to market 
participants. The Commission quantifies these costs where possible and 
provides qualitative discussion when quantifying costs is not feasible.
a. Compliance Costs
    Market participants would incur various initial and ongoing costs 
in order to comply with Proposed Rule 615. The Commission estimates in 
Table 21 that total initial PRA compliance costs would be approximately 
$48.28 million while ongoing annual PRA compliance costs would be 
approximately $1.99 million.\553\ Compliance costs would vary across 
market participants, including broker-dealers, SROs (including national 
securities exchanges and FINRA), and NMS Stock ATSs.
---------------------------------------------------------------------------

    \553\ Aggregate PRA compliance costs are calculated by summing 
up PRA compliance costs of various components of Proposed Rule 615, 
which are detailed below and also discussed in detail above in supra 
section VI.D.

                                                        Table 21--Summary of PRA Compliance Costs
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                     Implementation
              Element                 Participants      costs per     Ongoing costs      Total implementation costs            Total ongoing costs
                                                         entity        per entity
--------------------------------------------------------------------------------------------------------------------------------------------------------
Administer & regulate auctions -...              10         $79,000        $119,000  $790,000.........................  $1,190,000
Rule 615 (c)(1)....................
P&P--Identification of segmented                157          34,000           4,500  $5,301,000.......................  $703,000
 orders -.
Rule 615 (e)(1), (e)(2)............
Marking segmented orders: In-house -             52          95,500  ..............  $4,970,000.......................  ................................
 .
Rule 615 (e)(2)....................
Marking segmented orders: 3rd party             105          53,000  ..............  $5,600,000.......................  ................................
 -.
Rule 615 (e)(2)....................

[[Page 213]]

 
One-time technology project costs               182         170,000  ..............  30,940,000.......................  ................................
 to add ``segmented order'' and
 certification marks to existing
 marking systems -.
Rule 615 (e)(2), (f)(1)............
Certification that BD identity will              20          33,800           4,500  $675,000.........................  $90,000
 not be disclosed -.
Rule 615(c)(1)(iii), (e)(3)........
ATS's excluding subscribers -......               3           3,100           2,700  $9,300...........................  $8,000
Rule 615 (d)(1)....................
                                    --------------------------------------------------------------------------------------------------------------------
    Total..........................             176  ..............  ..............  $48.29 million...................  $1.99 million
 
--------------------------------------------------------------------------------------------------------------------------------------------------------

    These estimated compliance costs can be disaggregated into several 
components. First, as part of the requirement to provide qualified 
auction messages, specified in Proposed Rule 615(c)(1), national 
securities exchanges, FINRA and NMS Stock ATSs would have to utilize 
various personnel (legal, compliance, information technology, and 
business operations) to prepare and implement a system to collect and 
provide the information necessary to generate auction messages for 
dissemination in consolidated market data. In addition to the 6 
national securities exchanges and 3 NMS stock ATSs that the Commission 
believes would participate in qualified auctions,\554\ FINRA would also 
disseminate qualified auction data and would therefore incur these 
compliance costs. Thus, each of these 10 entities (6 exchanges, 3 ATSs, 
and FINRA), would each face an estimated initial compliance costs of 
$79,000, with total cost calculated at $790,000.\555\ Furthermore, each 
of these entities would have to collect and provide auction messages on 
an ongoing basis, which the Commission estimates would be $119,000 per 
entity annually, totaling $1.19 million (see Table 21 above.) \556\
---------------------------------------------------------------------------

    \554\ See supra section IV.B.2 and section VII.C.1.a for further 
discussion on the incentives for exchanges and ATSs to offer 
qualified auctions.
    \555\ See supra notes 290 and 296 for a detailed description of 
these estimated costs.
    \556\ See supra notes 291-292; 295; 297 for a detailed 
description of these estimated costs.
---------------------------------------------------------------------------

    Originating broker-dealers would face various compliance costs, 
including identifying and marking segmented orders, as specified in 
paragraphs (e)(1) and (e)(2) of Proposed Rule 615. This would involve 
utilizing in-house and outside counsel to update and review existing 
policies and procedures, as well as an in-house General Counsel and a 
Chief Compliance Officer to review and approve updated policies and 
procedures. An outside programmer would also be needed to modify 
existing technology and coordinate with the broker-dealer's compliance 
manager. The Commission estimates that the initial costs to the 157 
originating broker-dealers would be approximately $34,000 per broker 
and $5.3 million for the industry.\557\ In addition, these originating 
brokers would need to provide ongoing annual reviews and update 
existing policies, which Commission estimates would cost about $4,500 
per broker-dealer and an aggregate cost of $703,000.\558\
---------------------------------------------------------------------------

    \557\ See supra notes 301-303 for a detailed description of 
these estimated costs.
    \558\ See supra notes 304-305 for a detailed description of 
these estimated costs.
---------------------------------------------------------------------------

    The 157 originating brokers would also incur the cost of adding a 
``segmented order'' and certification mark to their existing marking 
systems, as specified in Rule 615(e)(2). The Commission predicts that 
approximately one third of the 157 originating brokers (i.e., 52 firms) 
would choose to perform the necessary systems modifications to identify 
and mark segmented orders with in-house staff, which would cost an 
estimated $95,500 per firm and $4.97 million for all 52 firms. 
Commission estimates that two-thirds of the originating brokers (i.e., 
105 firms) would hire third-party service providers to assist with 
these system modifications, which is predicted to cost $53,000 per 
broker and $5.6 million for all 105 firms.\559\
---------------------------------------------------------------------------

    \559\ See supra notes 312-313 for a detailed description of 
these estimated costs.
---------------------------------------------------------------------------

    The Commission also estimates that there would be an initial one-
time technology project costs for originating brokers to add the 
``segmented order'' and certification marks to the existing marking 
systems of all 157 originating brokers as well as 25 routing brokers 
(for a total of 182 brokers-dealers), in order to comply with paragraph 
(e)(2) of Proposed Rule 615, and the initial one-time cost for routing 
broker-dealers to mark segmented orders to comply with paragraph (f)(1) 
of Proposed Rule 615 and also mark orders to communicate certifications 
when applicable. These costs are estimated to be $170,000 per broker-
dealer, for an aggregate total cost of $30.94 million.\560\
---------------------------------------------------------------------------

    \560\ See supra notes 314-315 for a detailed description of 
these estimated costs.
---------------------------------------------------------------------------

    The ongoing task of marking segmented orders would not require new 
resources, but instead would utilize broker-dealers' existing marking 
systems. Therefore, the ongoing task of marking segmented orders would 
not cause broker-dealers to incur new monetary costs related to 
updating their systems to market orders (and is therefore not reported 
in Table 21 above).\561\
---------------------------------------------------------------------------

    \561\ The Commission estimates that around 2.1 billion orders 
would need to be marked annually, and calculates that this would 
require between approximately 24,000 and 290,000 total hours, based 
on its estimates of the duration of time used to mark each order. 
See supra notes 316-320 and corresponding discussion.
---------------------------------------------------------------------------

    The Commission estimates that 20 originating broker-dealers would 
certify and not make the mandatory identity disclosure, as specified in 
paragraph (c)(1) of Proposed Rule 615.\562\ Obtaining this 
certification would involve utilizing in-house and outside counsel to 
update and review existing policies and procedures, as well as an in-
house General Counsel and a Chief Compliance Office to review and 
approve updated policies and procedures. Outside counsel would also be 
needed to review the updated policies and procedures. These initial 
compliance costs are estimated at $33,800 per broker, totaling $675,000 
for all 20 firms.\563\
---------------------------------------------------------------------------

    \562\ See supra note 288 and corresponding discussion.
    \563\ See supra notes 322-326 for a detailed description of 
these estimated costs.
---------------------------------------------------------------------------

    These 20 broker-dealers would also incur ongoing costs to review 
and update existing policies and procedures, estimated at $4,500 per 
broker-dealer and $90,000 for all 20 firms.\564\ The various compliance 
costs involved in

[[Page 214]]

obtaining and maintaining originating broker certification (that it has 
established, maintained, and enforced written policies and procedures 
designed to assure that its identity will not be disclosed), as 
specified in paragraphs (c)(1)(iii) and (e)(3) of Proposed Rule 615, 
are summarized above in Table 21. It is uncertain how many broker-
dealers would choose to exercise this option. If fewer or greater than 
(the Commission's estimate of) 20 firms seek certification to withhold 
their identity as the originating broker during a qualified auction, 
aggregate compliance costs would be different from those found in Table 
21.
---------------------------------------------------------------------------

    \564\ See supra notes 327-329 for a detailed description of 
these estimated costs.
---------------------------------------------------------------------------

    NMS Stock ATSs that participate in qualified auctions would incur 
costs in order to comply with the requirements regarding ATS policies 
and procedures for excluding subscribers, as specified in proposed Rule 
615(d)(1). Compliance costs would initially involve reviewing existing 
policies and procedures for consistency with the proposed rule, making 
modifications as appropriate, and putting the policies and procedures 
in writing. These initial costs, which the Commission expects would 
apply to 3 NMS Stock ATSs, are predicted to cost $3,100 per firm, and 
$9,300 for all 3 firms.\565\ In addition, these ATSs would face the 
ongoing cost of reviewing and updating the relevant existing policies 
and procedures, estimated at $2,700 per firm and $8,000 for all 3 firms 
(see Table 21 above). Note that these estimated compliance costs are 
based on the Commission's assumption that at least some ATSs would 
operate qualified auctions. As discussed above, ATSs would have to make 
significant adjustments to their business models (especially with 
regards to segmenting customer orders and displaying quotes) in order 
to meet the requirements to operate a qualified auction.\566\
---------------------------------------------------------------------------

    \565\ See supra notes 334-335 for a detailed description of 
these estimated costs.
    \566\ See discussion in supra section VII.C.1.a.
---------------------------------------------------------------------------

    It should be emphasized that the estimated compliance costs 
described above and summarized in Table 21 are the Commission's best 
estimate for the required technological, operational, and legal 
services resources that would be utilized in the initiation and ongoing 
operation of qualified auctions.
b. Costs to Individual Investors
i. Greater Variation in Execution Quality
    The Commission is cognizant of concerns regarding the possibility 
of a decline in execution quality due to the implementation of 
qualified auctions. This includes the possibility that a qualified 
auction host could decide not to host an auction for a particular 
stock.\567\ However, if an order fails to execute in one auction, it 
could be directed quickly to other auctions,\568\ and/or the wholesaler 
would have the option to internalize the order at the same or better 
price at which it was exposed in the first auction. Although it is also 
possible that the quotes may move against the order during this time 
and the wholesaler would have to route it to an exchange LOB or expose 
the order in another qualified auction before it could execute. Also, 
wholesalers would have the option to internalize the trade without 
exposing it in an auction if the wholesaler were willing to execute the 
order at midpoint or better. More generally, however, the Commission 
believes that at least one open competition trading center would be 
incentivized to operate qualified auctions and serve as the qualified 
auction host for every segmented order in order to increase its volume/
market share relative to other trading venues, as well as to 
potentially earn revenue from any net capture between the fees and 
rebates the qualified auction might charge.\569\
---------------------------------------------------------------------------

    \567\ Qualified auction hosts would have the discretion to 
determine for which stocks they would run auctions.
    \568\ An additional risk is that there could be price slippage 
when the order is routed to a different qualified auction.
    \569\ See supra notes 503-507 and accompanying discussions for 
estimates of net capture rates for fees and rebates related to 
qualified auctions.
---------------------------------------------------------------------------

    An additional concern is that there could be a general lack of 
interest from liquidity suppliers to participate in a qualified 
auction. However, in cases where there was insufficient competition 
from liquidity providers, then the majority of individual investor 
orders could simply be internalized by wholesalers, similar to the 
current market, though perhaps at inferior prices compared to what they 
might have received under the current market structure. Moreover, while 
this occurrence might occur for any individual order, it would be 
extremely unlikely at the market level, because marketable order flow 
of individual investors has lower adverse selection risk than order 
flow routed to exchanges and most liquidity suppliers would profit by 
trading with it if the predicted realized spread was large enough.\570\
---------------------------------------------------------------------------

    \570\ The Commission is uncertain how liquidity would be 
impacted by increased volatility within the context of qualified 
auctions. The risk that individual investors may receive worse 
prices compared to the current market structure may not be 
significantly elevated because wholesalers could still internalize 
the trades if they cleared the auctions or route them to the LOB for 
execution.
---------------------------------------------------------------------------

    A related concern regarding the functioning of qualified auctions 
is the possibility of slippage costs. More specifically, there is the 
potential that the NBBO could change while the qualified auction was in 
process. Since Proposed Rule 615 would require an auction message to be 
disseminated once an individual investor order is brought to a 
qualified auction, the concern is that these messages would trigger a 
response in quoted prices.
    The Commission performed an empirical analysis to estimate this 
risk by observing the likelihood that that the NBBO spread moves (i.e., 
the ``fading probability'') as the time lag increases (in milliseconds) 
from the internalization of an individual investor order in comparison 
to the fade probability after NBBO quote movements.\571\ Results from 
this analysis \572\ indicate that the probability of the NBBO quotes 
adversely moving after the execution of an individual investor order 
range from 1.8% at 25 milliseconds after an internalized trade, to 2.8% 
at 100 milliseconds--an increase of 1 percentage point. Extending the 
duration to 300 milliseconds, the maximum time of the auction as 
proposed, increases the likelihood of adverse fading to 4.6%.\573\
---------------------------------------------------------------------------

    \571\ The Commission's ``fade analysis'' estimates the 
possibility of adverse price movements to individual investors. It's 
also possible to consider the likelihood of adverse price movements 
(and the resulting increase in trading costs) from the perspective 
of the bid winner. However, bidders would be much less exposed to 
risk of fade because their connectivity capacities would allow them 
to cancel bids should they expect adverse price movements. 
Individual investors, however, would have no control over where 
their orders are executed: auction vs. internally. Therefore, the 
Commission's focus is on the risk of adverse price movements from 
the perspective of individual investors.
    \572\ The Commission's ``fade analysis'' uses an algorithm from 
Boehmer et al. (2021) to identify retail trades. A recent paper by 
Barber et al. (2022) finds that the algorithm correctly identifies 
only 35% of trades as retail. However, plausibly a significant 
fraction of the retail trades unidentified by the algorithm reflects 
orders executed on a risk-less principal basis, i.e., executions 
that would not be relevant to the order flow targeted by the 
Proposal. In addition, the internalized retail trades missed by the 
algorithm are likely idiosyncratic across buy and sell orders. 
Therefore, aggregation of the data, which was performed as part of 
the Commission fade analysis, would likely have minimized any 
directional bias that these errors would have otherwise caused. 
Therefore, empirical results regarding the estimated risk of adverse 
pricing movements are likely to still be consistent despite 
limitations in identifying retail trades. See Ekkehart Boehmer et 
al., Tracking Retail Activity, 76 J. Fin. 2249 (2021), and Brad M. 
Barber et al., A (Sub)penny For Your Thoughts: Tracking Retail 
Investor Activity in TAQ (last revised Sept. 30, 2022) (unpublished 
manuscript), available at https://ssrn.com/abstract=4202874 
(retrieved from Elsevier database).
    \573\ Moreover, the substantially lower fade probability of less 
than 5% following internalized investor trades relative to the 
cross-stock fade probability of more than 16% following a given 
quote update is consistent with low adverse selection costs of 
currently internalized individual investor orders.

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[[Page 215]]

    Auction announcements would differ from SIP trade messages for 
trades executed off-exchange, which could potentially result in 
different quote movements compared to those observed in the analysis. 
Auction announcements would represent announcements of pre-trade 
interest as opposed to SIP trade messages being announcements of post-
trade interest, which could lead to different responses by the 
liquidity suppliers setting the NBBO.\574\ Additionally, auction 
announcements would disclose more information than SIP messages for 
off-exchange trades, including, among other things, the direction of 
the segmented order, the venue it was on, and, potentially, the 
identity of the originating broker.\575\ Disclosure of this information 
in qualified auctions, including the originating broker as mandated by 
the Proposal (absent a certification from the originating broker that 
its identity not be disclosed), would provide potential bidders with 
more information about an order than is currently provided by the SIP 
trade message, which in turn could lead to increased variation in the 
adverse fade that could follow auction announcements. That is, adverse 
fade could be reduced when bidders learn that an order stems from an 
originating broker with relatively low adverse selection risk, while 
announcements of orders from retail brokers with higher adverse 
selection risk could trigger greater adverse fade relative to a SIP 
trade announcement of an identical order. However, despite the likely 
increase in the variation of adverse fade, the average risk of adverse 
fade under qualified auctions may be similar to SIP trade announcements 
used to generate the estimates reported above. Overall, the results of 
the Commission's fade analysis suggest that auction messages would 
result in minimal adverse movements in best quotes due to the low 
adverse selection risk of individual investors, but, for the reasons 
discussed above, there may be greater variability in the risk of 
adverse quote movements. Because auction messages would differ from SIP 
messages, there is uncertainty regarding their overall effects on the 
risk of adverse quote movements.
---------------------------------------------------------------------------

    \574\ Although this difference may be limited given the lower 
adverse selection risk of segmented orders.
    \575\ The SIP trade message would not reveal what venue the 
trade took place on, its direction (although it may be able to be 
estimated based on the transaction price), or whether the trade 
belonged to an individual investor vs another market participant 
(although, similar to this analysis, this information may be 
inferred based on if the trade executed at a sub-penny price).
---------------------------------------------------------------------------

    Fade analysis only estimates the possibility that adverse price 
slippage will occur, not the magnitude of the adverse fade. Thus, it is 
not possible to directly compare the potential loss to individual 
investors due to adverse fading with the gains that could stem from 
qualified auctions, which the Commission estimates would range from 
0.86 bps to 1.31 bps, or in dollar terms, 0.15 to 0.47 cents per 
share.\576\ However, one way to possibly quantify the potential cost of 
fading is to consider the price impact of an auction that did not 
result in a bid, which might increase the probability that the NBBO 
would be worse after a 300 millisecond auction by (the fade analysis's 
estimate of) 4.6%. If we assume the quote moved 1 cent, which the 
Commission believes is the most frequent movement over a short time 
span, then the (expected value of the) potential average higher 
transaction cost to the order would face could be 1 cent x 4.6% = 0.046 
cents--significantly smaller than the estimated 0.15-0.47 cent per 
share gain stemming from qualified auctions.
---------------------------------------------------------------------------

    \576\ See supra section VII.C.1.b.
---------------------------------------------------------------------------

    A similar analysis could be used to estimate that the adverse fade 
that would occur during the course of a successful auction, which would 
be a minimum of 100 milliseconds, with the current duration of 
wholesaler internalized executions, which have a median duration of 
3.54 milliseconds. In other words, even successful qualified auctions 
that result in execution after the minimal duration of time will be 
(100 milliseconds--3.54 milliseconds) = 96.56 milliseconds slower than 
the median wholesaler execution. If we use the fade probability of 2.8% 
for 100 milliseconds, then the (expected value of the) adverse fade 
cost of a successful auction relative to internalization, assuming 1 
cent slippage, would be 1 cent x 2.8% = 0.028 cents. This estimated 
cost is significantly below the estimated 0.15-0.47 cent per share gain 
stemming from qualified auctions. However, this calculation relies on 
the assumption of the minimum length of a qualified auction (100 
milliseconds) and the median duration of a wholesaler internalized 
order (3.54 milliseconds). This calculation would generate different 
results if we assumed longer auction lengths, which would increase the 
fade cost of the auction, and longer (or shorter) internalization 
execution times. Given that a number of auctions in the options market 
have a duration of 100 milliseconds,\577\ the Commission preliminarily 
believes that a majority of open competition trading centers may elect 
to choose an auction duration of 100 millisecond for their qualified 
auctions. Therefore, a significant share of auctions may be 
successfully concluded within the 100 millisecond minimum auction 
duration, although some orders could take longer to conclude, while 
other orders would likely fail to have a successful outcome. Overall, 
the Commission believes the Proposal would result in price improvement 
for individual investors, although it is possible that variation in 
price improvement and overall execution quality might increase.
---------------------------------------------------------------------------

    \577\ See supra note 243 for further discussions of the duration 
of auctions in the options market.
---------------------------------------------------------------------------

    Besides potentially greater volatility stemming from a failed 
auction, an additional cost for some orders may arise to the extent 
that lower execution quality for some orders currently subsidizes 
better execution quality for others. Table 10 shows that wholesalers 
execute 13.82% of orders at prices superior to midpoint for the 
investor.\578\ On average, unless the orders have systematically 
negative price impact, the wholesaler may not be earning a positive 
marginal profit on these executions.\579\ This could imply they 
currently subsidize the additional price improvement on these trades 
with marginal profits earned on other executions. To the extent this 
occurs, if wholesalers' marginal profits decline under the Proposal, 
then customers could receive less price improvement and experience 
higher transaction costs on trades that are currently subsidized. 
However, on average, the Commission expects that execution quality for 
individual investor orders would likely improve under the 
Proposal.\580\
---------------------------------------------------------------------------

    \578\ Table 10 indicates that wholesalers executed 46.05% of 
shares at midpoint or better and 32.23% of shares at midpoint.
    \579\ For these statistics, the NBBO midpoint is measured at the 
time the wholesaler receives the order, so it is possible that 
quotes may have changed by the time the wholesaler executes the 
order. Therefore, it is possible that wholesalers execute some of 
these trades at prices worse than the NBBO midpoint at the time of 
execution, in which case the wholesaler could still earn a positive 
realized spread on these trades even if price impact measured 
against the NBBO midpoint at the time of execution was positive.
    \580\ See supra section VII.C.1.b.
---------------------------------------------------------------------------

    The Commission recognizes that wholesalers may provide consistency 
with regard to the execution quality that they deliver to individual 
investor orders.\581\ There is the concern that the Proposal would 
undermine the wholesaler business model, which in turn could hinder the 
ability of

[[Page 216]]

wholesalers to continue to provide consistency in their execution 
services. The Commission believes, however, that while bidders in 
qualified auctions may not provide as much consistency as wholesalers, 
some orders could receive improved execution quality while others would 
receive reduced execution quality (relative to wholesalers). Based on 
the competitive shortfall analysis presented in section VII.C.1.b 
above, the net result would likely be improved execution quality, but 
the standard deviation of this execution quality would likely increase.
---------------------------------------------------------------------------

    \581\ See discussion in supra section VII.B.2.b.
---------------------------------------------------------------------------

ii. Resumption of Commissions on NMS Stock Orders
    An additional concern is that if the Proposal results in a 
significant or complete loss of PFOF, then retail brokers would be 
forced to start charging commissions again for online NMS stock and ETF 
trades.\582\ There are several reasons that retail brokers would be 
unlikely to resume charging commissions for these orders. First, the 
majority of retail brokers receive relatively little or no PFOF, and 
yet they have nevertheless successfully managed to support commission-
free trading through their other revenue-generating lines of 
business.\583\ In fact, several retail brokers, including some that do 
not accept PFOF, earned record revenues and profits after zero-
commission trading was initiated.\584\ While most brokers had already 
reduced commissions to under $10, there was still considerable concern 
that the zero commissions would lower profits. Despite these concerns, 
industry profit grew in 2020.\585\
---------------------------------------------------------------------------

    \582\ Almost all retail brokers continue to charge a commission 
fee for human broker-assisted orders.
    \583\ CAT analysis shows that PFOF brokers originated about 80% 
of the share volume and about 74% of dollar volume of individual 
investor marketable orders that were routed to wholesalers and 
executed (see Table 14). The Commission notes that trading revenue 
for many discount brokers rose to record levels in 2020, shortly 
after these discount brokers dropped commissions to zero. It's 
unclear how much of this increase was due to individual investors 
being incentivized by zero commissions and new trading options such 
as fractional share trading, and how much was due to COVID-related 
factors that made online trading more appealing, including a shift 
towards remote work and a rise in discretionary funds from 
government stimulus. See Maggie Fitzgerald & Kate Rooney, E-brokers 
Defy Odds by Recording Record Trading Revenue While Dropping 
Commissions to Zero, CNBC (Aug. 20, 2020), available at https://www.cnbc.com/2020/08/20/e-brokers-defy-odds-by-recording-record-trading-revenue-while-dropping-commissions-to-zero.html. It's also 
important to note that even brokers that do not accept PFOF 
experienced increased revenue and profits, despite adopting zero 
commissions. See Kenneth Corbin, Fidelity Posts 6th Straight Record 
Profit, Barrons (Mar. 9, 2022), available at https://www.barrons.com/advisor/articles/fidelity-earnings-2021-51646853970. 
However, the recent increase in individual investor trading volume 
did not result in the loss of order-by-order competition. Isolation 
of individual investor orders by wholesalers preceded the recent 
rise in trade volume and a subsequent decline in trade volume would 
not remove the rationale for the Proposal because individual 
investor orders will continue to comprise a substantial share of 
overall trade volume with the potential for improved execution 
quality if order-by-order competition is incorporated into this 
market.
    \584\ Id.
    \585\ Pre-tax income of FINRA-registered broker-dealers rose 
from $43,943 million (2019) to $77,212 million (2020), an increase 
of 75.7%. This was substantially larger than the 2.7% increase in 
profits from 2018 to 2019 ($42,780 million to $43,943 million). See 
FINRA, 2021 FINRA Industry Snapshot (2021), available at https://www.finra.org/sites/default/files/2022-02/21_0078.1_Industry_Snapshot_v10.pdf. However, it is possible that 
this increase in industry profits was transitory because of the 
spike in individual investor trading volume related to COVID.
---------------------------------------------------------------------------

    Moreover, the average PFOF payment that brokers receive on a 100 
share order is 10-20 cents.\586\ The PFOF for a 1000 share order is 
less than the commission fees previously charged by broker-dealers, 
which had generally been $5 or more.\587\ Thus, just as the loss of 
commission fees was not offset by the receipt of PFOF, the loss of PFOF 
might not necessitate the return of commission fees.\588\
---------------------------------------------------------------------------

    \586\ See analysis in supra Table 17.
    \587\ The average retail order size has declined since the shift 
to zero commission trading. See Pankaj K. Jain et al., Trading 
Volume Shares and Market Quality: Pre- and Post-Zero Commissions 
(last revised Sept. 16, 2022) (unpublished manuscript), available at 
https://ssrn.com/abstract=3741470 (retrieved from Elsevier 
database). Assuming a PFOF rate of 20 cents per 100 shares, orders 
over 2500 shares would have lower per share revenue for the retail 
broker under a $5 fixed commission model than a PFOF model, while 
orders under 2500 shares would have higher per share revenue.
    \588\ Commission fees were reduced to zero for online NMS stock 
trades, but not broker-assisted stock trades. Therefore, commission 
revenues have continued to exceed PFOF revenues for most PFOF firms, 
excluding the two PFOF firms that are online brokers and collect no 
commission revenue.
---------------------------------------------------------------------------

    Additionally, to the extent that rebates paid for the routing of 
segmented orders to qualified auctions are passed through to retail 
brokers, it could reduce the likelihood that they resume charging 
commissions. The 5 mil cap on rebates that qualified auctions could pay 
for the submission of segmented orders under the Proposal is 
approximately 40% of the average combined PFOF rate paid by wholesalers 
for marketable orders as estimated in Table 2.\589\ If rebates paid by 
qualified auction hosts for the submission of segmented orders to the 
qualified auction are passed through to retail brokers (assuming the 
retail broker does not route the segmented order to the qualified 
auction directly), then it could supplement the revenue they may lose 
from a reduction in PFOF.\590\ This could reduce the likelihood that 
retail brokers resume charging commissions.
---------------------------------------------------------------------------

    \589\ The 5 mil rebate would not be earned unless the order was 
routed to a qualified auction. If the wholesaler chose instead to 
internalize the order at midpoint (and thereby be exempted from the 
auction), it would not earn the 5 mil rebate.
    \590\ Similarly, if a wholesaler routes a segmented order to a 
qualified auction and receives the rebate for the submission of a 
segmented order, the wholesaler may indirectly pass the rebate from 
the qualified auction through to the retail broker by using the 
rebate to subsidize PFOF payments it makes to the retail broker. See 
infra section VII.C.2.d.ii for further discussions on retail broker 
loss of PFOF revenue.
---------------------------------------------------------------------------

iii. Other Possible Costs to Investors
    The Commission is aware of other possible increases in trading 
costs stemming from the Proposal that might be experienced by some 
individual investors. For example, some individual investor orders that 
are currently eligible for RLP programs might not meet the proposed 
definition of segmented orders and might be excluded from the qualified 
auctions, which could reduce the price improvement that they currently 
receive via wholesalers or RPLs.\591\
---------------------------------------------------------------------------

    \591\ These orders could also be internalized by the wholesaler 
or executed on an ATS.
---------------------------------------------------------------------------

    Furthermore, since the Proposal would require that the identity of 
the originating retail broker be disclosed (unless the originating 
broker certifies that the identity of the originating broker will not 
be disclosed to any person that potentially could participate in the 
qualified auction or otherwise trade with the segmented order \592\), 
orders from retail brokers that do not offer this certification and 
that are perceived to have higher adverse selection costs could end up 
receiving worse execution quality (i.e., less price improvement) than 
they currently experience, but only if wholesalers today do not already 
price in such risk when interacting with each retail broker. Customers 
of retail brokers that certify they will not disclose their identity 
could potentially receive worse execution quality if non-disclosure 
signals to market participants that the adverse selection risk of the 
order flow are high relative to orders from other

[[Page 217]]

broker-dealers. However, results from supra section VII.B.5.b indicate 
that broker-dealers with higher adverse selection risk receive worse 
execution quality from wholesalers, so it is unclear whether orders 
stemming from certifying broker-dealers would receive inferior 
execution quality relative to wholesaler internalization under the 
current market structure.
---------------------------------------------------------------------------

    \592\ Proposed Rule 615 would require the identity of the 
originating broker to be disclosed unless it received certification 
that it has established, maintained, and enforced written policies 
and procedures designed to assure that its identity will not be 
disclosed, as specified in proposed Rule 615(e)(3). See supra 
section IV.B.4. The impact of this certification is uncertain. Non-
disclosure would likely signal increased adverse selection risk of 
the order to market participants. However, results from supra 
section VII.B.5.b indicate that broker-dealers with higher adverse 
selection risk receive worse execution quality from wholesalers, so 
it is unclear whether orders stemming from certified broker-dealers 
will receive inferior execution quality relative to wholesaler 
internalization under the current market structure.
---------------------------------------------------------------------------

    Currently, wholesalers may choose not to internalize individual 
investor orders with high adverse selection risk but instead pass them 
on to other market makers, where they might be pooled with other 
individual investor orders. This pooling might cause these orders to 
receive greater price improvement from RLP programs or other hidden 
liquidity on exchanges or ATSs than they would otherwise receive if 
liquidity suppliers knew the identity of the originating broker. It is 
therefore possible that the Proposal's requirement to disclose the 
identity of the originating broker (absent a certification from the 
originating broker that its identity not be disclosed) might result in 
such orders receiving reduced execution quality relative to what they 
currently receive to the extent they are pooled with orders from retail 
brokers with lower adverse selection risk. However, to the extent 
individual investor orders with high adverse selection risk orders are 
currently rerouted to exchange limit order books, where they may be 
effectively pooled with orders from other market participants with 
potentially higher adverse selection risk, then it is also possible 
that such orders could receive increased price improvement through 
execution in qualified auctions relative to what they receive in the 
current market structure. In sum, the more wholesalers already price in 
the adverse selection risk from each retail broker, the less impactful 
is the proposed requirement that retail brokers' identities be 
disclosed in the auction.
c. Cost to Wholesalers
    The Commission recognizes that the Proposal would significantly 
impact the wholesaler market/business model. Wholesalers would have to 
compete directly with other liquidity providers on an order-by-order 
basis to provide price improvement to segmented orders in order to 
execute against such individual investor orders in qualified 
auctions.\593\ This would likely result in wholesalers filling fewer 
individual investor orders than they do currently and would likely 
pressure wholesalers to provide greater price improvement in order to 
remain competitive in providing liquidity to segmented orders.\594\
---------------------------------------------------------------------------

    \593\ A wholesaler would not have to compete on an order-by-
order basis for an individual investor order if it internalized the 
individual investor order at a price equal to the midpoint or 
better, pursuant to Proposed Rule 615(b)(3).
    \594\ As specified in section VII.B, the economic baseline 
against which we measure the economic effects of this proposal, 
including its potential effects on efficiency, competition, and 
capital formation, includes the changes to the current arrangements 
for consolidated market data in the MDI Rules; but those amendments 
have not been implemented.
---------------------------------------------------------------------------

    The Commission recognizes that a wholesaler who exposes an order in 
a qualified auction would still be able to internalize the order if it 
submits the winning bid in the auction. However, because the order 
would be subject to competition from other liquidity suppliers, 
wholesalers would most likely not submit the winning bids in all of 
these auctions and thus would ultimately internalize a smaller share of 
order flow than they do now. Additionally, if a wholesaler decided to 
internalize an individual investor order at the midpoint or better, the 
order would not be required to be brought to a qualified auction. 
However, the E/Q ratios presented in Table 9 indicate that, on average, 
the execution prices of internalized individual investor orders are 
between 30% to 80% worse than the midpoint at the time of order receipt 
by the wholesaler. As such, the Commission believes that it would be 
unlikely for wholesalers to internalize all segmented order flow priced 
at the NBBO midpoint or better, although a fraction of segmented orders 
are expected to be internalized at the NBBO midpoint, as they are 
today.
    Wholesalers could still end up trading with the majority of 
marketable orders of individual investors, although more of these 
orders might be executed on exchanges. Moreover, qualified auctions 
would provide wholesalers with an opportunity to access individual 
investor orders initially sent by retail brokers to other wholesalers. 
That is, individual investor orders brought by a given wholesaler to a 
qualified auction could be filled by another wholesaler that ends up 
submitting the winning bid to the qualified auction. More generally, 
wholesalers could have competitive advantages in supplying liquidity in 
these auctions due to their economies of scale and market making 
expertise. Therefore, while institutional investors would likely take 
advantage of the opportunity to directly access low-cost order flow 
provided by qualified auctions, it is nevertheless possible that 
wholesalers would still end up frequently winning qualified auctions 
and trading against a significant share of segmented orders. However, 
individual investor order flow might end up being more spread out 
across wholesalers rather than concentrated among two leading 
firms.\595\
---------------------------------------------------------------------------

    \595\ See supra section VII.B.1.
---------------------------------------------------------------------------

    The Commission recognizes that retail brokers might consider 
routing their orders directly to a qualified auction instead of through 
wholesalers, especially if wholesalers discontinue offering PFOF.\596\ 
Furthermore, retail brokers could also route orders directly to a 
national securities exchange, which could result in access fees but 
also exchange rebate revenue.\597\ While the Commission is unable to 
quantify the net effect of these factors on the overall routing 
decisions of retail brokers, it is likely that the overall share of 
individual investor order flow initially routed to wholesalers would 
decrease, while the share initially routed to exchanges and ATSs 
operating qualified auctions would increase.
---------------------------------------------------------------------------

    \596\ The Proposal would allow retail brokers to route customer 
orders directly to a qualified auction with a specified limit price 
(such that they would not be bidding on the order). See supra 
section IV.A.
    \597\ Broker-dealers would always have the option to direct 
their orders to open competition trading centers or national 
securities exchanges instead of qualified auctions under the 
Proposal. Unlike qualified auctions, which would have auction fee 
and rebate caps of 5 mils (for orders valued at $1.00 or greater per 
share), national securities exchanges would continue to be able to 
charge tiered fees and rebate revenue, consistent with the 
requirements of Section 19(b) and Rule 19b-4.
---------------------------------------------------------------------------

    The predicted decline in wholesaler profit margins from 
internalization might force wholesalers to reduce or cease paying PFOF, 
which in turn, would remove a key incentive for some broker-dealers to 
route to wholesalers. PFOF brokers route 97-98% of their market orders 
to wholesalers, while non-PFOF brokers route around 71-72% of their 
market orders to wholesalers.\598\ PFOF brokers could reduce their 
dependence on wholesalers to usage rates similar to non-PFOF brokers if 
PFOF ceased.
---------------------------------------------------------------------------

    \598\ See analysis in supra Table 4.
---------------------------------------------------------------------------

    Furthermore, the decline in wholesaler revenue and profit could 
cause wholesalers to start charging retail brokers for the order 
handling services that they provide. This could increase competition in 
the market for exchange execution services and cause wholesalers to 
lose market share against other providers of routing and execution 
services. Alternatively, wholesalers might try to preserve their share 
in order-handling services by continuing to not charge for their 
routing and execution services to retail brokers (and thereby earn 
lower profit margins),

[[Page 218]]

especially if handling marketable order flow provides additional 
benefits, either in the qualified auctions or internalized individual 
investor orders at the midpoint.\599\ The Commission is unable to 
quantify the likelihood that wholesalers would continue to not directly 
charge retail brokers to route and execute their orders, but believes 
that it is possible that the majority of wholesalers would still not 
charge retail brokers for order-handling services.
---------------------------------------------------------------------------

    \599\ Even if wholesalers do not internalize individual investor 
orders, there might still be informational value from handling 
individual investor order flow. Wholesalers could be incentivized to 
offer free order routing to retail brokers in order to continue 
receiving this information, which would include the identity of the 
originating broker, the stock being traded and its order size, 
direction of the trade, and any handling instructions that may have 
been relayed to the broker, as well as the limit price if it's a 
limit order. All of this information could help the wholesaler 
assess the direction of the market. In addition, the wholesaler 
could choose to internalize the order at midpoint (an allowable 
exception to qualified auctions), which would provide additional 
information on the direction of order flow that other market 
participants would not have since there would be no auction message 
in this case. Besides receiving a possible informational advantage 
of having first look at individual investor orders, wholesalers 
could also receive rebate revenue for submitting the order to a 
qualified auction as well as SIP revenue, although the Commission 
expects the rebate to be under 5 mils in order to be less than the 5 
mil auction fee cap. See supra section IV.C.4 for a discussion of 
fees and rebates. Finally, wholesalers could choose to internalize 
the order if it was exposed in a qualified auction but did not 
execute.
---------------------------------------------------------------------------

    The Commission also recognizes that a decline in wholesaler market 
share would not only reduce wholesaler profits but might have spillover 
effects on wholesaler costs. For example, a reduction in the volume of 
individual investor order flow internalized by wholesalers could 
increase wholesaler inventory risk, which in turn could cause 
wholesalers to reduce the liquidity they supply as exchange market 
makers or to institutional investors via SDPs.
d. Costs to Retail Brokers
i. Potential Initiation of Order Handling Fees by Wholesalers
    Currently, wholesalers do not charge retail brokers for routing and 
execution services, and pay some retail brokers PFOF for the right to 
provide these services. If the implementation of qualified auctions 
results in a significant loss of wholesaler profits, wholesalers might 
have to begin charging for routing and execution services. If 
wholesalers begin charging a fee for routing services, retail brokers 
would have to absorb this cost and earn lower profits and/or pass on a 
share of this cost to their customers. Retail brokers could also 
respond to the initiation of wholesalers routing fees by paying the 
compliance costs necessary to serve as an originating broker, or 
instead pay fees to brokers that are able to route directly to 
qualified auctions.
    Retail brokers that certify that their identity would not be 
subject to the proposed disclosure requirement would not only face 
explicit costs for this certification (as discussed in supra section 
VI.B.3) but also would either have to route the order to the qualified 
auction themselves or use a routing service that wouldn't trade with 
the orders, as mandated by the Proposal. If instead the broker-dealer 
used a wholesaler to route its order, the wholesaler would have to 
agree not to trade with the order (as mandated by the Proposal). In 
response to this restriction, the wholesaler may offer less PFOF (if it 
was currently receiving PFOF from the wholesaler) or potentially even 
charge a fee for handling the order.
ii. Loss of PFOF Revenue
    The Commission recognizes that the implementation of qualified 
auctions, as mandated by the Proposal, could lead to a significant 
decline or perhaps disappearance of PFOF in the markets for NMS stocks. 
PFOF amounted to $235 million in Q1 2022 but was received almost 
entirely (93.8%) by four firms.\600\ One concern is that the loss of 
PFOF would cause PFOF brokers, and potentially other discount brokers, 
to resume charging commissions for online NMS stock trades.\601\ Just 
as PFOF brokers led discount brokers into zero-commission trading in 
2019, it is possible they too could lead discount brokers back to 
charging commissions if they stopped receiving PFOF.
---------------------------------------------------------------------------

    \600\ See analysis in supra Table 16 and corresponding 
discussion.
    \601\ See supra section VII.C.2.b.ii for a discussion.
---------------------------------------------------------------------------

    The Commission is unable to quantify the risk that some discount 
brokers would resume charging commissions on NMS stock and ETF trades, 
but there are a number of factors that might make this risk low. First, 
the majority of PFOF received by retail brokers comes from transactions 
in the options market.\602\ The Proposal would not have a significant 
effect on the PFOF brokers receive from options transactions because it 
applies only to transactions in NMS stocks.\603\ Additionally, 
wholesalers may also continue paying retail brokers for segmented non-
marketable limit orders in NMS stocks, which may not need to be exposed 
in qualified auctions under the Proposal if their limit price is at the 
midpoint or a more favorable price. Therefore, to the extent that 
retail brokers do rely on PFOF, they might be able to retain the 
majority of the PFOF revenue they currently receive.
---------------------------------------------------------------------------

    \602\ See supra note 586.
    \603\ There are key differences between the options market and 
the market for NMS stocks; see supra note 235 for further 
discussion. Proposed Rule 615 is designed to achieve policy 
objectives that are particular to mandatory auctions in NMS stocks.
---------------------------------------------------------------------------

    Second, retail brokers might be able to expand existing revenue 
lines or develop other lines of business to compensate for the loss of 
PFOF revenue from NMS stock transactions. This includes the possibility 
of increasing revenue from margin interest and securities lending, 
which PFOF brokers currently utilize more heavily than the average 
broker-dealer.\604\ Moreover, the retail broker industry did not 
experience a drop in profits following the end of commissions.\605\ 
This includes non-PFOF brokers, who did not choose to make up for lost 
commission revenue by charging wholesalers PFOF. The ability to 
maintain or increase profits stemmed in part from the sudden increase 
in customer accounts, due to, among other factors, increasingly 
accessible online trading platforms and the initiation of fractional 
share trading.\606\ Fractional share trading began with a single 
broker-dealer in late 2019, but has grown dramatically since that time, 
with an increasing number of broker-dealers offering this 
functionality.\607\ Thus, just

[[Page 219]]

as retail brokers adjusted to the loss of commission revenue, they 
could also adjust to the loss of PFOF revenue.
---------------------------------------------------------------------------

    \604\ See discussion in supra section VII.B.6.b.
    \605\ See supra note 505 and corresponding discussion.
    \606\ After falling during the 2016-2019 period from $229.2 
billion to $197.8 billion, the average daily value of executions 
rose in 2020 to $312 billion. See `Order Audit Trail System (OATS) 
Activity--Daily Average OATS Events, 2016-2020', available at 
https://www.finra.org/sites/default/files/2022-02/21_0078.1_Industry_Snapshot_v10.pdf. Fractional share trading allows 
individual investors to trade and enter orders for fractional shares 
of a security, e.g., an individual investor could submit an order to 
buy 0.2 shares of a stock. Fractional share orders often arise from 
retail brokers allowing individual investors to submit orders for a 
fixed dollar value. It is the Commission's understanding that retail 
or clearing brokers generally trade in a principal capacity against 
their customers' fractional share orders and in turn send out 
principal round lot sized orders for execution to manage their 
inventory risk.
    \607\ Evidence suggests that this growth is in great part due to 
the rise in direct individual investor participation in equity 
markets. See, e.g., Zhi Da, Vivian W. Fang & Wenwei Lin, Fractional 
Trading (last revised May 6, 2022) (unpublished manuscript), 
available at https://ssrn.com/abstract=3949697 (retrieved from 
Elsevier database). See also Rick Steves, Fractional Shares Experts 
Weigh In Amid Exploding Retail Trading Volumes, FinanceFeeds (June 
7, 2021) available at https://financefeeds.com/fractional-shares-experts-weigh-in-amid-exploding-retail-trading-volumes/, which shows 
that trading volume increased substantially (in one case, more than 
1,400%) for brokers after they introduced the use of fractional 
shares. Furthermore, an analysis using CAT data reveals that more 
than 46 million fractional share orders were executed in Mar. 2022, 
originating from more than 5 million unique accounts. Over 31 
million of these orders were for less than 1 share, and they 
originated from more than 3.3 million accounts. The overwhelming 
majority (92%) of fractional share orders were attributed to natural 
persons, i.e., individual investors. While fractional shares orders 
represented only a small fraction (2.1%) of total executed orders, 
they represent a much higher fraction (15.3%) of executions received 
by individual investors.
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    Third, to the extent that rebates paid on segmented orders routed 
to qualified auctions are passed through to retail brokers, it could 
supplement the revenue they may lose from a reduction in PFOF.\608\ The 
5 mil cap on rebates that qualified auctions could pay for the 
submission of segmented orders under the Proposal is approximately 40% 
of the average combined PFOF rate paid by wholesalers for marketable 
orders as estimated in Table 2.
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    \608\ Similarly, if a wholesaler routes a segmented order to a 
qualified auction and receives the rebate for the submission of a 
segmented order, the wholesaler may indirectly pass the rebate from 
the qualified auction through to the retail broker by using the 
rebate to subsidize PFOF payments it makes to the retail broker.
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    Furthermore, there is reason to believe that adjustment to the loss 
of PFOF would be much more manageable for the retail broker industry 
than the loss of commissions from online NMS stock and ETF orders. The 
average PFOF payment that brokers receive on a 100 share order is 10 to 
20 cents,\609\ far less than the commission fees previously charged by 
broker-dealers, which had generally been $5 or more.
---------------------------------------------------------------------------

    \609\ See analysis in supra Table 17.
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    While PFOF payments per order are relatively small, the small group 
of retail brokers (10 firms) that earn at least 2% of their revenue 
from PFOF on NMS stocks \610\ could be pressured to develop or increase 
other revenue lines and/or attract additional customers to make up for 
the loss of PFOF. However, the dependence on PFOF for some of the top 
recipients of PFOF stemming from NMS stock orders has diminished in 
recent years due to mergers between PFOF-dependent firms and firms with 
less reliance on PFOF. This includes the single largest recipient of 
PFOF, which was purchased by a larger (i.e., higher revenue) retail 
broker firm that had a much smaller share of its revenue stemming from 
PFOF.\611\ Moreover, the purchasing firm in this merger had a much more 
diversified revenue portfolio, including a large collection of 
proprietary mutual funds and ETFs under management and a banking unit. 
In addition, the third largest recipient of PFOF was purchased in 2020 
by a larger, full service broker with no reliance on PFOF. These 
mergers should help insulate leading recipients of PFOF from the 
financial damage that would result from the loss of PFOF due to 
Proposed Rule 615.
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    \610\ See analysis in supra Table 16.
    \611\ The largest dollar recipient of PFOF received $101.5 
million in PFOF from NMS stocks in Q1 2022, equal to 5.7% of its 
total revenue. The purchasing firm in this merger received $28.9 
million in PFOF in NMS stocks Q1 2022, equal to 1.5% of its total 
revenue.
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e. Costs to Exchanges
    The Commission is mindful that the increase in competition to 
attract and execute orders of individual investors due to the Proposal 
could significantly impact costs for some exchanges and ATSs.\612\ 
These costs would be in addition to the compliance costs estimated in 
section VII.D.2.a., and include the potential loss of market share for 
some exchanges and ATSs. The Commission believes that most marketable 
orders of individual investors would end up being exposed and executed 
in qualified auctions hosted by exchanges, which would increase the 
overall percentage of individual investor orders executed on exchanges, 
and decrease the percentage internalized by wholesalers. The market 
share of ATSs is expected to be stable because they do not handle 
significant fractions of marketable individual investor orders and thus 
are not affected by the proposed introduction of qualified auctions. 
The Commission believes that few ATSs would operate qualified auctions, 
either because it would be difficult for new ATSs to meet the 
requirements to run qualified auctions or because the requirements of 
operating a qualified auction would be incompatible with the business 
models of most currently operating ATSs.\613\
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    \612\ Retail brokers may also choose to directly route their 
orders to qualified auctions, and may therefore compete with 
wholesalers, ATSs, and exchanges in executing retail orders. 
However, the Commission believes that broker-dealers will play a 
much more minor role in this competition.
    \613\ Of the 32 NMS Stock ATSs, the Commission estimates that 
approximately 3 would operate qualified auctions. See supra section 
VI.C.4 for further discussions of the estimates of how many NMS 
Stock ATSs would operate qualified auction.
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    An NMS Stock ATS that wanted to run qualified auctions would face 
numerous requirements, including the need to: permit any registered 
broker-dealer to become a subscriber; provide equal access among all 
subscribers of the NMS Stock ATS and the registered broker-dealer of 
the NMS Stock ATS to all services that are related to a qualified 
auction operated by the NMS Stock ATS or to any continuous order book 
operated by the NMS Stock ATS; \614\ display quotes in the ADF (and 
thus in the consolidated market data feed); and reveal the identity of 
the trading venue for trades executed on the ATS and report those 
trades to the TRF (which would report the trades and identity of the 
trading venue to the consolidated market data feed); operate as an 
automated trading center pursuant to Regulation NMS Rule 603(b) and 
have an average daily share volume of 1.0 percent or more of the 
aggregate average daily share volume for NMS stocks.\615\ ATSs would 
have to make significant adjustments to their business models 
(especially with regards to segmenting customer orders and displaying 
quotes) in order to meet these requirements.\616\ Additionally, new 
ATSs that could meet the other requirements might find it difficult to 
achieve 1% market share of trading volume in four out of six months 
without being able to concurrently operate a qualified auction.
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    \614\ This would prohibit the ATS from segmenting customer 
orders outside of qualified auctions (unless the orders were 
executed at midpoint) and require it to charge the same fee to all 
subscribers (see supra section IV.C.4), thereby prohibiting them 
from charging tiered auction fees or providing tiered rebates.
    \615\ See supra section IV.B.2.b.
    \616\ The Commission estimates that 3 NMS stock ATSs would 
participate in qualified auctions. See supra section VI.C.4.
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    The Commission acknowledges that Proposed Rule 615 might improve 
the competitive position of higher volume exchanges that offer 
qualified auctions and harm the competitive position of lower volume 
exchanges that do not. Higher volume exchanges that executed 1% or more 
of the average aggregate daily share volume for NMS stocks during 4 of 
the last 6 months would be eligible to run qualified auctions for 
segmented orders.\617\ Exchanges that offered qualified auctions would 
have a competitive advantage in attracting marketable individual 
investor order flow because they would be able to segment the 
individual investor order flow and allow liquidity suppliers to trade 
against this order flow in smaller pricing increments in their 
qualified auctions.\618\ Lower volume exchanges that do not meet the 
volume thresholds to run qualified auctions would not be able to 
segment individual investor order flow, unless they did so under one of 
the exceptions, such as offering

[[Page 220]]

liquidity to individual investor orders only at the NBBO midpoint.\619\ 
Additionally, exchanges not offering qualified auctions would be unable 
to execute segmented orders at the finer 0.1 pricing increments that 
would be available in the qualified auctions. These factors could all 
limit the competitiveness of smaller exchanges.
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    \617\ The Commission estimates that six national securities 
exchanges would meet the proposed threshold. These include one 
exchange each from the NYSE, NASDAQ, and CBOE groups, as well as 
MEMX, IEX, and MIAX PEARL.
    \618\ See supra section IV.G for discussions on restrictions on 
exchanges from operating any separate trading mechanism for 
segmented orders other than qualified auctions.
    \619\ See supra section IV.B.2.a for a discussion of lower-
volume exchanges.
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    There is also the possibility that if a disproportionate share of 
order flow is routed to one or more exchanges offering qualified 
auctions, these exchanges might become the preferred trading location 
for any given stock. This, in turn, could cause a liquidity externality 
to develop, making these venues the preferred routing destination for 
all orders.\620\ Under such circumstances, while the consolidation of 
liquidity on these exchanges might benefit market participants in the 
short run, it may also lead to barriers to entry in the market for 
trading services, as new entrants would have a harder time attracting 
sufficient liquidity away from established liquidity centers. Lower 
volume exchanges could also be adversely impacted by the fact that 
under the Proposal, exchanges would have to stop offering RLP programs 
unless the program resulted in trades only at the NBBO midpoint, 
consistent with a proposed exception. This could result in a reduction 
in the trading volume and revenues received by lower-volume exchanges 
that do not meet the threshold to offer qualified auctions.\621\
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    \620\ A liquidity externality could emerge if orders tended to 
concentrate in one auction, such that it would become the preferred 
routing destination and attract more orders. Orders in more liquid 
venues would be more likely to execute at better prices, which in 
turn, would provide such venues with a competitive advantage over 
less liquid venues.
    \621\ The Commission believes that the mandated auction 
mechanism largely would remove the need for RLPs run by exchanges 
that would meet the criteria to run qualified auctions. However, 
exchanges that operate RLPs that do not serve as qualified auctions 
host would be negatively impacted by having their RLP services 
curtailed. Individual or institutional investors, however, should 
not be significantly adversely impacted by the loss of these RLP 
services. From the perspective of individual investors, it would be 
unnecessary to execute orders through RLPs because any non-directed 
retail order would have a chance to be exposed to open competition, 
either because the order would be filled on a riskless principal 
basis, or because the wholesaler who considers internalizing an 
order would first be required to bring it to a qualified auction. 
From the perspectives of other market participants, e.g., 
institutional investors, qualified auctions would provide a superior 
means, relative to RLPs, for these participants to directly interact 
with retail orders. This is the case because (1) unlike RLPs, 
qualified auctions require that characteristics of the order are 
communicated to bidders, including its price, size, and the name of 
the underlying retail broker; and (2) qualified auctions would allow 
market participants to interact with a substantially larger and more 
persistent pool of segmented retail order flow, relative to that 
available through RLPs. However the Commission acknowledges that the 
loss of RLP services may adversely impact market participants that 
may currently supply liquidity through existing RLPs but would not 
be fast enough to submit an auction response to a qualified auction 
message.
---------------------------------------------------------------------------

    The Commission is unable to quantify the likelihood that one or 
more exchanges that would be unable to offer qualified auctions would 
cease operating. However, the Commission preliminarily believes that 
this risk of this is low because the majority of individual investor 
marketable orders are not currently routed to exchanges. Therefore, 
even if they are not eligible to run qualified auctions under the 
Proposal, the reduction in trading volume that these exchanges might 
experience is unlikely to be large enough to require them to exit the 
market. Even if such an exit were to occur, the Commission does not 
believe this would significantly impact competition in the market for 
trading services because the market is served by multiple competitors. 
Consequently, if one or more lower-volume exchanges were to exit the 
market, demand would likely to be swiftly met by existing competitors. 
The Commission recognizes that lower-volume exchanges might have unique 
business models that are not currently offered by competitors, but 
believes that a competitor could create similar business models if 
demand were adequate, and if they did not do so, it seems likely new 
entrants would do so if demand were sufficient.
f. Costs to Institutional Investors
    The Commission recognizes that the Proposal could increase the risk 
of information leakage for institutional investors in at least two 
ways.
    First, the risk of information leakage may increase for those 
institutional investors that choose to supply liquidity in qualified 
auctions. Specifically, market participants could use auction message 
information \622\ to identify the trades in consolidated market data 
that correspond to executions of individual investors orders in 
qualified auctions, which could allow these market participants to back 
out information about the corresponding institutional bids.\623\ For 
example, if a market participant observes that a large volume of 
individual investor buy orders are filled in qualified auctions, they 
could correctly discern that an institutional investor may be providing 
a large sell order. However, in response to this concern, institutional 
investors could decide to route their orders to ATSs and OTC market 
makers, where information about their orders may be better 
concealed.\624\ To the extent that concerns over the risk of 
information leakage prevent institutional investors from seeking 
liquidity through qualified auctions, this could limit the benefits of 
the Proposal.
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    \622\ Proposed Rule 615(c)(1) specifies that an auction message 
announcing the initiation of a qualified auction for a segmented 
order must be provided for dissemination in consolidated market 
data, including the disclosure that the auction is for a segmented 
order, the identity of the open competition trading center, NMS 
stock symbol, side (buy or sell), size, limit price, and identity of 
the originating broker for the segmented order (unless they 
certified that no bidder in the qualified auction knew the identity 
of the originating broker). Note that institutional bids in 
qualified auctions would not be revealed unless they were the 
winning bid and resulted in an execution.
    \623\ See, e.g., Liyan Yang & Haoxiang Zhu, Back-Running: 
Seeking and Hiding Fundamental Information About Institutional Order 
Flows, 33 Rev. Fin. Studies 1484, 1487 (2020) (``. . .information 
about retail order flows is equivalent to information about 
institutional order flows, by market clearing.'').
    \624\ Trades executed off-exchange, including those executed on 
ATSs and by OTC market makers, are reported to Trade Reporting 
Facilities (TRFs), which are facilities through which members report 
transactions in NMS stocks, as defined in SEC Rule 600(b)(47) of 
Regulation NMS. See Trade Reporting Facility (TRF), FINRA, https://www.finra.org/filing-reporting/trade-reporting-facility-trf. 
However, as a result of the Proposal, it may be easier to identify 
institutional trades using TRF data; see infra this section for 
further discussion. Furthermore, it may currently be possible to 
identify institutional trades in TRF data; see infra note 627 and 
corresponding discussion.
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    Second, as individual investors' marketable orders would be 
increasingly routed to and executed in qualified auctions under the 
Proposal, and as these orders would become more easily identifiable 
through the information contained in auction messages as described 
above, it may become increasingly possible to identify information 
about off-exchange institutional trades in TRF data.\625\ In the most 
extreme case, if virtually all individual investor orders are routed to 
and executed in qualified auctions, market participants may be able to 
identify nearly all off-exchange institutional transactions reported in 
the TRF data as originating from institutional trades.\626\ In this 
way, information leakage might increase even for institutional 
investors that choose not to participate in qualified auctions.
---------------------------------------------------------------------------

    \625\ See, e.g., Yang & Zhu, supra note 623, for further 
discussions on the identifying institutional investor orders.
    \626\ For those individual investor orders that would have been 
internalized by wholesalers and reported as a trade to the TRF but 
are instead executed in qualified auctions, these trades would be 
reported as trades executed on the exchange or ATS operating the 
qualified auction, rather than reported to the TRF. This would 
reduce the number of individual investor trades reported to the TRF.
---------------------------------------------------------------------------

    However, it is possible that information on institutional order 
flow

[[Page 221]]

is already discernable through multiple means. First, there is evidence 
that institutional order flow can be inferred by first identifying 
individual investor order flow, which can be estimated using sub-penny 
trades in TRF data.\627\ In addition, wholesalers already may have the 
ability to discern institutional order flow due to their knowledge of 
individual investor order flow. Thus, while there is concern over 
information leakage for institutional order flow, it may be the case 
that much of this information is already identifiable. To the extent 
that qualified auctions would result in further information leakage, 
the Proposal may result in additional costs for institutional 
investors.\628\ However, this effect could be balanced by the increased 
price improvement that institutional traders would receive by being 
able to interact directly with individual investor order flow in 
qualified auctions.
---------------------------------------------------------------------------

    \627\ See, e.g., Boehmer et al., supra note 572, who use this 
methodology to identify individual investor activity. Specifically, 
using TRF data, the authors identify transactions as retail buys if 
the transaction price is slightly below the round penny and as 
retail sells if the transaction price is slightly above the round 
penny. Some institutional trades receive sub-penny price improvement 
as a result of midpoint trade price ends in a half-penny. Thus, 
trades at or near a half-penny are likely to be from institutions 
and are not assigned to the retail category.
    \628\ For example, in a study of the Swedish equity market, one 
academic paper found that a one-standard-deviation increase in the 
extent to which HFTs trade in the same direction as large 
institutional orders is associated with a $4,480 higher order 
execution cost for institutional investors. This result led the 
authors to conclude that the detection of large institutional orders 
is costly for institutional investors. See Vincent Van Kervel & 
Albert J. Menkveld, High-Frequency Trading Around Large 
Institutional Orders, 74 J. Fin. 1091 (2019).
---------------------------------------------------------------------------

    The Proposal may also result in wholesalers reducing the liquidity 
they supply to institutional investors via SDPs.\629\ With reduced 
wholesaler liquidity provision on SDPs, institutional investors might 
have to resort to other sources of liquidity, e.g., exchanges and ATSs 
or supplying liquidity to qualified auctions. An appealing feature of 
SDPs from an institutional investor perspective is the possibility of 
disclosing intended order size without being detected by other market 
participants competing for the same liquidity. By switching to other 
sources of liquidity, institutions would no longer enjoy this benefit. 
Hence, these institutions might find it more costly to locate liquidity 
as they need to protect their intended trade sizes to minimize price 
impact of trades.\630\
---------------------------------------------------------------------------

    \629\ See supra section VII.C.2.c.
    \630\ However, institutional investor costs could also fall when 
they are able to trade against individual investor orders in 
qualified auctions. See supra section VII.C.1.c.
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g. Effects on Exchange Limit Order Books (LOBs) Liquidity
    There is a possibility that Proposed Rule 615 could cause displayed 
LOB liquidity to decrease. The Commission believes that the Proposal 
might entice some liquidity provision to be redirected from exchange 
LOBs to qualified auctions,\631\ which could have an adverse impact on 
quoted LOB depth and the NBBO. More specifically, if liquidity is 
diverted to qualified auctions, there is the risk that the NBBO could 
widen because some market participants might reduce the frequency or 
the size of the orders they submit to the LOB, including orders that 
set the NBBO prices.\632\ However, there would be trade-offs regarding 
the execution risk and execution price that might limit the incentives 
to bid in an auction compared to supplying liquidity in the LOB.\633\ 
Moreover, the majority of marketable orders of individual investors are 
already segmented from exchanges and thus are not currently reaching 
exchange LOBs.\634\ Therefore, although LOB liquidity may decline under 
the Proposal, there is the potential that the direct effect of 
qualified auctions on LOB liquidity may not be significant.
---------------------------------------------------------------------------

    \631\ The Commission also is proposing to amend rules addressing 
minimum pricing increments. See Minimum Pricing Increments Proposal, 
supra note 98. The Commission encourages commenters to review that 
proposal to determine whether it might affect their comments on this 
proposing release.
    \632\ The submission of smaller orders might also require 
aggregation of odd-lot orders across more price levels to reach a 
round lot size, which would cause the NBBO to widen.
    \633\ See infra section VII.C.3.a.iii for further discussion on 
the trade-offs involved in supplying liquidity to a qualified 
auction vs. submitting an order to an LOB.
    \634\ See supra section VII.B.2.a for a discussion of estimates 
that appear to indicate that over 90% of individual investor 
marketable orders are routed to wholesalers and supra section 
VII.B.2.b for estimates that wholesalers internalize 90% of executed 
dollar volume in individual investor marketable orders that were 
routed to them.
---------------------------------------------------------------------------

    An additional possibility is that if the Proposal results in the 
elimination of zero-commission trading, retail trading volume could 
decline and the overall pool of liquidity could shrink due to increased 
wholesaler inventory risk.\635\ A lower overall liquidity level might 
also manifest itself in lower displayed liquidity in exchange LOBs. For 
example, the introduction of qualified auctions might induce some (more 
sophisticated) individual investors to switch from placing non-
marketable limit orders priced at or outside the NBBO to placing (a) 
marketable orders or (b) non-marketable orders priced between the 
midpoint and the NBO (NBB) for buy (sell) orders, which may participate 
as segmented orders in qualified auctions.\636\ In this sense, the pool 
of non-marketable resting orders that would be routed to exchanges 
might shrink, potentially reducing the depth at the NBBO.
---------------------------------------------------------------------------

    \635\ A reduction in retail trading volume as a result of the 
Proposal may decrease a wholesaler's ability to manage their 
inventory risk associated with their other trading activities, such 
as exchange market making or supplying liquidity through their SDPs. 
This may cause wholesalers to reduce the liquidity they supply in 
their other activities.
    \636\ A segmented order in a qualified auction could have the 
benefit of an increased likelihood of execution compared to non-
marketable limit orders submitted to a LOB because bidders may 
supply liquidity (and potentially earn part of the spread) to orders 
submitted to a qualified auction. Non-marketable limit orders 
submitted to a LOB would have to wait until an opposite side 
marketable order arrived to potentially execute, which could result 
in a greater risk of the order not executing. However this increased 
likelihood of execution would come at the cost of earning a spread 
by using a non-marketable limit order.
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3. Competition
a. The Market for Trading Services in NMS Stocks
    As discussed in more detail below, the creation of qualified 
auctions under the Proposal would result in most marketable orders of 
individual investors being exposed in qualified auctions on exchanges 
and ATSs that are eligible to serve as open competition trading 
centers.\637\ The Commission estimates that 6 exchanges and 3 ATSs 
could operate qualified auctions. Exchanges should have strong economic 
incentives to offer qualified auctions because the lower adverse 
selection risk of marketable order flow of individual investors makes 
it a valuable commodity that would attract trading interest from other 
market participants and increase the exchange's trading volume and the 
associated revenue it delivers.\638\ For this reason, it is likely that 
there would always be at least one

[[Page 222]]

exchange or ATS operating a qualified auction.\639\
---------------------------------------------------------------------------

    \637\ Proposed Rule 615 covers only NMS stocks. Qualified 
auctions would be conducted for ``segmented orders,'' which would be 
defined in Proposed Rule 600(b)(91) as an order for an NMS stock for 
an account of a natural person, or an account held in legal form on 
behalf of a natural person or group of related family members, and 
that for such an account, the average daily number of trades 
executed in NMS stocks must be less than 40 in each of the preceding 
six calendar months. See supra note 194 and corresponding text for a 
discussion of a Commission analysis indicating that during the six-
month period (Jan. 1, 2022, to June 30, 2022), slightly more than 
99.9% of individual investor accounts averaged 40 or fewer orders 
per day that resulted in a trade. Moreover, during the same period, 
99% of individual customer accounts averaged 1.86 or fewer orders 
per day that resulted in a trade; see analysis in infra Table 22.
    \638\ See supra section IV.B.2 for further discussion on the 
incentives for exchanges and ATSs to offer qualified auctions.
    \639\ In cases where no open competition trading center chose to 
operate a qualified auction for a security, the broker-dealer or 
wholesaler handling the order would have the option to internalize 
the order. See supra section IV.A for further discussion of options 
for segmented orders that did not receive an execution in a 
qualified auction. However, it's very likely that at least one 
exchange or ATS would operate a qualified auction for an order. 
Because of the low adverse selection risk associated with segmented 
orders, if a single exchange or ATS operated a qualified auction, 
the trading facility would likely attract additional order flow to 
supply liquidity to segmented orders, which would increase its 
trading volume. This could potentially increase the exchange or 
ATS's revenue because a portion of SIP revenue is allocated among 
facilities based on trading volume (FINRA also rebates SIP revenue 
it receives for the TRF back to its members based on their trading 
volume).
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    Exchanges and ATSs operating qualified auctions would significantly 
increase competition among liquidity suppliers to fill marketable 
orders of individual investors, since the majority of these orders are 
currently internalized by wholesalers without competition on the 
individual order basis.\640\ This increase in competition would have a 
significant effect on the business model of wholesalers and might 
reduce the volume of order flow that they internalize. This would 
affect the competitive dynamics between exchanges, wholesalers and ATSs 
related to how they compete for both individual and institutional order 
flow and could result in more orders being routed to exchanges that run 
qualified auctions. Additionally, there would be competitive 
implications for how qualified auctions interact with exchange LOBs. 
Additional analysis is provided below regarding the expected impact of 
the Proposal on competition: (i) in the market to supply liquidity to 
individual investor orders, (ii) between exchanges, ATSs, and 
wholesalers, and, (iii) between exchange LOBs and qualified auctions.
---------------------------------------------------------------------------

    \640\ See supra section VII.B.2.b for a discussion of wholesaler 
internalization.
---------------------------------------------------------------------------

i. Competition To Supply Liquidity to Individual Investor Orders
    Qualified auctions would enhance competition to provide liquidity 
to individual investors at the individual order level by drawing 
additional liquidity from other market participants besides the 
wholesaler handling the individual investor order, including other 
wholesalers that could bid in the auctions. Currently, once a 
wholesaler receives order flow, another wholesaler is unable to 
interact with these orders unless they are rerouted to that other 
wholesaler. Routing these orders to qualified auctions would prevent 
these orders from being isolated and instead allow them to be exposed 
to other market participants, including other wholesalers, that could 
bid for the right to execute them.
    The lower adverse selection risk of individual investor orders 
should incentivize other liquidity providers to participate in 
qualified auctions. It is the Commission's understanding that market 
participants quote significant liquidity at prices superior to the 
NBBO.\641\ This liquidity primarily includes inside-the-NBBO odd-lot 
liquidity quoted on exchanges and non-displayed liquidity quoted on 
exchanges and ATSs, originating from various market participants, 
including institutional investors, market makers, and individual 
investors. In addition, some market participants that currently use 
marketable orders to demand liquidity from intermediaries might benefit 
from participating in qualified auctions, i.e., quote liquidity at 
prices better than the NBBO, to satisfy their liquidity needs. Proposed 
Rule 615 would provide an opportunity for these participants to 
potentially trade with individual orders with lower adverse selection 
by redirecting their liquidity provision to open qualified auctions or 
to switching from demanding to supplying liquidity through qualified 
auctions.
---------------------------------------------------------------------------

    \641\ See supra Table 20 and accompanying discussion in supra 
section VII.C.1.b for estimates of liquidity available at the NBBO 
midpoint on exchanges and NMS Stock ATSs when a wholesaler 
internalizes a trade.
---------------------------------------------------------------------------

    It would also give institutional investors a chance to directly 
interact with individual investor orders with a minimal degree of 
intermediation. For example, institutional investors with pressing 
liquidity demand typically rely on optimal trade execution algorithms 
that split their trades into child orders, which may demand liquidity, 
including on SDPs, where they may potentially end up paying the full 
spread.\642\ The availability of marketable individual investor order 
flow at qualified auctions would likely draw institutional trade 
execution algorithms to supply liquidity in qualified auctions, where 
they might trade at the quote midpoint or at least inside the NBBO. By 
doing so, institutional orders would be filled without paying the full 
spread. This would not only increase the competition in liquidity 
provision against individual investor orders, but would also reduce 
institutional trading costs.
---------------------------------------------------------------------------

    \642\ See supra section VII.B.3 for further discussions on how 
institutional investors may indirectly interact with individual 
investor orders via trading on SDPs.
---------------------------------------------------------------------------

    Some auction features would also enhance competition to supply 
liquidity to individual investor orders. The Proposal would facilitate 
finer price improvements for inside-NBBO orders by allowing a 0.1-cent 
quoting increment for shares priced at $1.00 or more per share. This 
would enhance competition by improving the ability of market 
participants to be able to compete on price in their auction responses, 
since they could quote in finer increments than they could on exchange 
or ATS LOBs.\643\ An additional source of increased competition to 
supply liquidity would stem from the implementation of a 5 mil auction 
fee and rebate cap for shares priced at $1.00 and above and 0.05% for 
share prices under $1.00. Mandating low, flat fees and rebates in 
qualified auctions should promote a level playing field among all 
potential market participants that may wish to trade with segmented 
orders and therefore serve to increase competition among liquidity 
suppliers.\644\
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    \643\ See supra section VII.C.1.a for further discussions on how 
the auction pricing increment could improve competition among 
liquidity suppliers.
    \644\ See id. and supra section IV.C.4 for additional 
discussions on the auction fee and rebate caps.
---------------------------------------------------------------------------

    The Commission is uncertain what effect the proposed requirement to 
give customer orders priority if auction responses are at the same 
price would have overall on the competition to supply liquidity to 
individual investor orders. On the one hand, giving priority to 
customer orders may encourage more customers, including institutional 
investors, to participate in qualified auctions, potentially increasing 
competition to supply liquidity to segmented orders. On the other hand, 
it could discourage liquidity provision by broker-dealers in qualified 
auctions, potentially decreasing competition to supply liquidity to 
segmented orders. However, qualified auctions overall would still 
enhance competition among broker-dealers to supply liquidity to 
individual investor marketable orders, because a significant portion of 
these would be exposed to multiple broker-dealers in a qualified 
auction instead of being execution in isolated at a wholesaler.
    The Commission acknowledges that there could be some limitations on 
the increases in competition to supply liquidity to individual investor 
orders. The Commission recognizes that there are some institutional 
investors that may currently source liquidity from SDPs in order to 
avoid triggering reactions by market participants who would observe 
institutional trades might avoid qualified auctions and instead 
continue to access liquidity via other

[[Page 223]]

methods. Additionally, due to the sub-second duration of the auctions 
mandated by the Proposal, participation would require access to 
algorithmic trading technology, which could prevent some potential 
providers of liquidity from participating in qualified auctions.\645\ 
In sum, however, the net effect of qualified auctions would be an 
increase in competition to supply liquidity to the orders of individual 
investors.
---------------------------------------------------------------------------

    \645\ See supra section VII.C.1.a for further discussion on the 
effect of not having access to algorithmic technology on qualified 
auction participation.
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ii. Competition Among Exchanges, ATSs, and OTC Market Makers
    Proposed Rule 615 would increase competition among wholesalers, 
ATSs, and exchanges in attracting and executing order flow of 
individual investors.\646\ It is likely that the share of order flow 
currently internalized by wholesalers or executed on ATSs that do not 
serve as auction hosts would decline. Wholesalers receiving order flow 
from retail brokers could still end up internalizing a substantial 
portion of orders that they route to qualified auctions. However, 
because the orders would be subject to competition from other liquidity 
suppliers, wholesalers would likely win a smaller share of auctions 
compared to the share of orders that they currently internalize, for 
which they do not face competition at the individual order level.
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    \646\ Retail brokers might also choose to directly route their 
orders to qualified auctions, and might therefore compete with 
wholesalers, ATSs, and exchanges in executing individual investor 
orders. However, the Commission believes that broker-dealers would 
play a much more minor role in this competition.
---------------------------------------------------------------------------

    The Proposal might improve the competitive position of higher 
volume exchanges that offer qualified auctions and harm the competitive 
position of lower volume exchanges that do not. Higher volume exchanges 
that execute 1% or more of the average daily share volume for NMS 
stocks during 4 of the last 6 months would be eligible to run qualified 
auctions for segmented orders.\647\ Exchanges that offered qualified 
auctions would have a competitive advantage in attracting marketable 
individual investor order flow because they would be able to segment 
this order flow and allow liquidity suppliers to trade against it in 
smaller pricing increments ($0.001) in the qualified auctions that they 
host compared to the minimum price increment on national exchanges 
($0.01).\648\ The Commission is unable to quantify the likelihood that 
one or more exchanges that would be unable to offer qualified auctions 
would cease operating. Even if such an exit were to occur, the 
Commission does not believe this would significantly impact competition 
in the market for trading services because the market is served by 
multiple competitors.\649\
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    \647\ The Commission estimates that six national securities 
exchanges would meet the proposed threshold. These include one 
exchange each from the NYSE, NASDAQ, and CBOE groups, as well as 
MEMX, IEX and MIAX PEARL.
    \648\ Qualified auctions would have a price increment of $0.001 
for shares priced at $1.00 or greater and 0.1% for shares under 
$1.00, in contrast to national exchanges, which have a minimum price 
increment of $0.01.
    \649\ See supra VII.B.1 for a discussion of the market for 
trading services in NMS stocks. See also supra section VII.C.2.e for 
additional discussion on the effects of the Proposal on small and 
large exchanges.
---------------------------------------------------------------------------

    The Proposal would also likely increase competition between 
exchanges, ATSs, and OTC market makers to attract institutional order 
flow. The requirement to expose segmented orders in qualified auctions 
could improve the competitive position of exchanges and ATSs that run 
qualified auctions relative to most ATSs \650\ and all OTC market 
makers, including SDPs, which would not be allowed to host auctions. 
The resulting increase in marketable orders of individual investors 
routed to exchanges and ATSs that operate qualified auctions, relative 
to other venues, would entice institutional investors to seek to supply 
liquidity to marketable individual investor orders through these 
auctions.
---------------------------------------------------------------------------

    \650\ As discussed in supra section VI.C.4, the Commission 
believes that 3 ATSs would operate a qualified auction.
---------------------------------------------------------------------------

    The Proposal would likely have an adverse impact on the competitive 
positions of wholesaler-affiliated SDPs to attract institutional order 
flow by reducing the liquidity available therein to institutional 
investors.\651\ Specifically, the Proposal might lead retail brokers to 
directly route more of their customer orders to exchanges and ATSs 
operating qualified auctions instead of directing their orders to 
wholesalers.\652\ In addition, wholesalers receiving orders from retail 
brokers that they then route to qualified auctions could lose a 
significant share of these auctions to other bidders. These effects 
would hamper the ability of wholesaler-operated SDPs and other OTC 
market makers to manage their inventory risk by internalizing incoming 
individual investor order flow. This might reduce the ability of these 
wholesalers and other market makers to provide liquidity to 
institutional investors, who might instead rely on other trading 
venues, including qualified auctions, to meet their liquidity needs. 
The Commission is unable to quantify the extent to which institutional 
order flow would migrate to exchanges or ATSs that run qualified 
auctions.
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    \651\ Institutional investors (or the brokers that represent 
them) would be able to bid in qualified auctions in order to 
directly interact with individual investor orders. This could give 
the execution of institutional orders better terms because 
institutional investors would not need to compensate the wholesaler 
for the intermediation services provided by their SDPs. As such, 
some of the institutional interest would migrate from its SDPs to 
qualified auctions due to more competitive pricing in the qualified 
auctions. Therefore, the loss of access to liquidity for 
institutional investors provided by SDPs would be mitigated by the 
ability of institutional traders to supply liquidity to marketable 
orders of individual investors in qualified auctions. See supra 
section VII.B.3 for further discussions on institutional investors 
interactions with SDPs.
    \652\ See supra section VII.C.1.a.
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    The risk of information leakage from institutional investors' 
orders participating in qualified auctions could also impact 
competition between exchanges, ATSs and OTC market makers. The 
Commission recognizes that concerns over the risk of information 
leakage could prevent institutional investors from seeking to provide 
liquidity in qualified auctions.\653\ One possible way that leakage 
could occur is if a large volume of individual investor buy orders are 
filled consecutively at the midpoint, then market participants might 
correctly discern that an institutional investor is working a large 
sell order. Because the side and venue of an institutional order 
executed off-exchange would continue not to be revealed in a TRF trade 
print under Proposed Rule 615, ATSs and OTC market makers would remain 
competitive in terms of their ability to conceal intended institutional 
trades.\654\ Institutional investors would likely weigh the trade-off 
between potentially lower trade costs provided by qualified auctions 
and the greater concealment of their trading intentions provided by 
off-exchange executions. In cases where the latter objective was 
paramount, institutional investors could decide to avoid routing some 
of their orders to qualified auctions. As such, ATSs and OTC market 
makers might remain attractive trading venues for such institutional 
orders.
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    \653\ See supra section VII.C.2.f for additional discussions on 
how the Proposal could affect information leakage of institutional 
investor orders.
    \654\ Institutional bids in qualified auctions would also have 
some ability to be concealed, because they would not be revealed 
unless they were the winning bid. If they do have the winning bid, 
the side, venue, and price of the institutional bid would be 
revealed, which may provide more information leakage than some 
trades on ATSs.
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    Overall, however, the increase in marketable order flow on 
exchanges and

[[Page 224]]

ATSs that operate qualified auctions, relative to other venues, would 
entice institutional investors to supply liquidity to marketable 
individual investor orders through these auctions. Due to the enhanced 
competition provided by qualified auctions, it is likely that execution 
costs of institutional investors' parent orders would be reduced, which 
in turn, should further the likelihood that institutional order flow 
would be attracted to exchanges and ATSs that operate auctions. The 
execution priorities of Proposed Rule 615 would reinforce this effect. 
Under paragraph (c)(5)(ii) of the proposed rule, if an institutional 
investor and a wholesaler (broker-dealer) were bidding the same price 
in a qualified auction, the investor would have execution priority. As 
such, all else constant, institutional investors would win qualified 
auctions when competing with wholesalers. This would reduce execution 
uncertainty from the perspectives of institutional investors who would 
consider bidding in qualified auctions on exchanges, as well as reduce 
their trading costs as a result of direct interactions with individual 
investor order flow. These collective effects would result in less 
institutional orders being routed to ATSs and OTC market makers, 
including SDPs.
    The Proposal would also generate competition between qualified 
auctions that are offered on different exchanges and ATSs.\655\ Open 
competition trading centers running qualified auctions might compete 
with each other by trying to offer the most price improvement in their 
auctions.\656\ They might also compete with each other through 
innovations in their auctions protocols in order to differentiate 
themselves and attract more segmented orders and liquidity suppliers. 
Open competition trading centers might also try to compete with each 
other on the basis of fees or rebates they charge in their qualified 
auctions. However, the Commission believes that this form of 
competition might be limited because of the flat 5 mil auction fee and 
rebate cap on executed auction responses and the flat 5 mil rebate cap 
on segmented orders submitted to auctions.\657\ More specifically, 
while providers of qualified auctions could compete by charging a fee 
under the 5 mil cap, this discount would provide far less latitude for 
attracting orders compared to the 30 mil fee cap on the LOB.\658\ 
Furthermore, volume-based rebate and fees, which are utilized by many 
exchanges in their transaction based fee schedules, would not be 
permitted within qualified auctions (but would remain permitted on 
exchange LOBs). Therefore, the Commission believes that competition 
based on auction fees and rebates would be minimal.
---------------------------------------------------------------------------

    \655\ The Commission includes ATSs to the degree that they would 
offer qualified auctions. See supra section VII.C.1.a.
    \656\ See supra section VII.C.1.a.
    \657\ See supra section VII.C.1.a for further discussions on the 
effects of auction fees and rebates.
    \658\ See 17 CFR 242.610(c).
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iii. Competition Between Qualified Auctions and Exchange LOBs
    The Commission believes that the Proposal might entice some 
liquidity provision from exchanges' LOB to qualified auctions. A core 
function of the mandated qualified auction mechanism under Proposed 
Rule 615 would be to segment order flow of individual investors, 
leading to a concentration of this order flow in qualified auctions. As 
a result, some market participants might consider redirecting liquidity 
provision from the LOB to qualified auctions. In doing so, market 
participants would need to consider the following under the Proposal: 
(1) Displayed orders on the LOB would have priority over auction 
responses if they were listed at the same price, and a winning auction 
response would have priority over hidden orders on the LOB; (2) for 
shares priced $1 or greater, LOB quoting is subject to a 1-cent price 
increment,\659\ while qualified auctions would accept bids using a 0.1-
cent price increment, allowing auction responses to jump in front of 
LOB quotes by quoting at sub-penny prices; and (3) broker-dealers with 
knowledge of where a segmented order is to be routed would not be 
allowed to submit LOB orders that could have priority to trade with the 
segmented order.\660\ To the extent that market participants quoting 
visible or hidden liquidity on the LOB prefer to trade against the 
individual investor segment of the order flow through qualified 
auctions, they might provide liquidity to auctions rather than quote 
liquidity on the LOB.
---------------------------------------------------------------------------

    \659\ See supra note 146.
    \660\ See Proposed Rule 615(f)(2).
---------------------------------------------------------------------------

    The Commission is unable to quantify the magnitude of this 
potentially redirected liquidity from the LOB to qualified auctions. 
However, the Commission recognizes that there would be a trade-off 
between adverse selection risk (which would be higher on an exchange 
LOB compared to qualified auctions, where individual investor orders 
would be segmented) and execution risk (i.e., the risk of non-
execution, which would be higher for auctions). In general, qualified 
auctions should provide greater price improvement due to their lower 
adverse selection risk. However, redirecting displayed liquidity to 
qualified auctions might increase the execution risk and trading costs 
associated with the order. There might be less certainty regarding 
whether a bid in a qualified auction would execute because it would be 
competing against other bids that would not be displayed.\661\ 
Additionally, bids in qualified auctions would lead to execution only 
if the market participant is willing to trade at worse prices that 
could lead to winning the auction, which may lower the spread that they 
would earn relative to executing their non-marketable limit order on a 
LOB.\662\ Thus, the execution risk of submitting a bid in a qualified 
auction could be greater than posting an order at or inside the NBBO on 
a LOB. However, these risks associated with auctions would be somewhat 
offset by the lower adverse selection risk of trading against a 
segmented order in a qualified auction. Overall, the Commission 
believes that redirection of liquidity from the LOB to qualified 
auctions would be limited and would not significantly reduce execution 
quality on the LOB.
---------------------------------------------------------------------------

    \661\ Bids in qualified auctions would not be displayed.
    \662\ Additionally, a non-marketable limit order may earn a 
greater rebate from supplying liquidity on a maker-taker exchange 
LOB compared to in a qualified auction, which would have rebate cap 
of 5 mils on executed auction responses.
---------------------------------------------------------------------------

    In addition, the name-give-up requirement could potentially reduce 
wholesaler liquidity on the LOB if a wholesaler handled a segmented 
order where the originating broker made the certification under 
proposed Rule 615(c)(1)(iii) that the identity of the originating 
broker will not be disclosed, directly or indirectly, to any person 
that potentially could participate in the qualified auction or 
otherwise trade with the segmented order. Some retail brokers may seek 
certification to not disclose their identity, which would impose 
explicit costs on these broker-dealers (as discussed above in section 
VI.C.3). In addition, it could curtail wholesaler activity if a 
wholesaler had an order resting on the limit order book and routed a 
segmented order originating from a broker that made the certification 
under proposed Rule 615(c)(1)(iii) to a qualified auction on the same 
exchange. In this case, the wholesaler would likely have to cancel its 
resting limit order if it wanted to trade against the segmented order 
in the auction, since the limit order book is included in the auctions. 
Thus,

[[Page 225]]

certification could impact wholesaler quoting on exchanges.\663\
---------------------------------------------------------------------------

    \663\ Wholesalers could indirectly pass their costs for this 
back to the originating brokers if wholesalers charged them a fee 
for handling segmented orders where the originating brokers made the 
certification under proposed Rule 615(c)(1)(iii).
---------------------------------------------------------------------------

b. Market Access
    Retail brokers choose how to access the market for trading services 
in NMS stocks in order to fill their customers' orders. Currently, 
retail brokers primarily access this market via wholesaler 
internalization, although broker-dealers with exchange memberships or 
ATS subscriptions can access the market directly.\664\ Retail brokers 
without these memberships or subscriptions must route their order to 
wholesalers or to other brokers that either have direct access to 
exchanges and ATSs, or have the routing resources to deliver orders to 
market centers. The introduction of qualified auctions would likely 
reduce the profit that wholesalers earn on internalizing marketable 
order flow, which in turn could result in the decision by wholesalers 
to start charging a fee for routing services. This would improve the 
competitive position of broker-dealers with routing access to qualified 
auctions.\665\ Retail brokers might further choose not to route to 
wholesalers if they want to avoid the requisite identity disclosure 
requirement. It is likely that other routing brokers with access to 
qualified auctions would compete to receive order flow from retail 
brokers without this access. The Commission is uncertain of the extent 
to which routing services would shift away from wholesalers towards 
other routing brokers. However, the implementation of qualified 
auctions could generally be expected to reduce the benefit of 
wholesaler vertical integration and the potential profits they get from 
internalizing individual investor orders.\666\
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    \664\ See supra section VII.B.2.a for further discussion of 
broker-dealer routing and market access.
    \665\ The Commission estimates that 182 retail brokers (157 
originating brokers and 25 routing brokers) would be able to route 
orders to qualified auctions. See supra note 286 and accompanying 
text.
    \666\ See supra section VII.C.3.a.ii for a discussion of how 
Proposed Rule 615 would increase competition among wholesalers, 
ATSs, and exchanges in attracting and executing order flow of 
individual investors.
---------------------------------------------------------------------------

c. The Market for Retail Broker Services
    Wholesalers have been able to secure larger profits by accessing 
and internalizing the majority of marketable order flow of individual 
traders, which carries less adverse selection risk. The Proposal would 
require wholesalers to route this order flow to qualified 
auctions,\667\ opening these orders to competition with other market 
participants. This competition could result in the wholesaler not 
winning the auction. In the event that the wholesaler actually wins the 
auction, it is likely that the increased competition would cause the 
realized spread (i.e., the wholesaler's profit margin) it receives from 
internalizing these orders to fall. Declining profit margins could 
reduce the financial latitude that wholesalers needed to pay PFOF to 
retail brokers.\668\ The Commission also recognizes that the decline or 
disappearance of PFOF would impact retail brokers, although this impact 
would vary widely across brokers, since only some broker-dealers 
receive PFOF, and the amount of PFOF differs across retail brokers that 
do receive it. In particular, as discussed in Section VII.B.6.a,\669\ 
four retail brokers received 94% of all PFOF in 2021, and PFOF 
represented only a fraction of these four retail brokers' total 
revenues.
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    \667\ This would be the case unless the wholesaler internalized 
the order under one of exceptions, such as executing it at the 
midpoint. If the wholesaler chose to internalize individual investor 
orders at midpoint, the marginal profit earned from supplying 
liquidity, represented by the wholesaler's realized spread, would be 
reduced. Currently, wholesalers have an average realized spread of 
0.72 (see Table 6). Midpoint execution, by definition, generates, at 
best, a zero realized spread, assuming no adverse price impact. 
While the broker-dealer may have other incentives to execute a trade 
with a negative realized spread, such as reducing inventory risk or 
as part of a hedging strategy, all else equal, a positive realized 
spread would always be preferable.
    \668\ See supra section VII.B.5.c.
    \669\ See supra Table 16 and corresponding discussion for an 
analysis of the rate of PFOF across retail brokers.
---------------------------------------------------------------------------

    The Commission acknowledges that the implementation of qualified 
auctions and the likely subsequent reduction in PFOF could pose a 
competitive threat to retail brokers that are dependent on PFOF and 
lack alternate revenue sources to compensate for this loss of revenue. 
If wholesalers reduce PFOF or begin charging a fee for routing 
services, PFOF retail brokers would have to absorb this cost and earn 
lower profits and/or pass on a share of this cost to their customers. 
This would, in particular, depend upon the competition they face. For 
instance, if PFOF retail brokers earn economic rents, then they could 
absorb some of these costs, which would come out of their profit. If 
PFOF retail brokers primarily face competition from other PFOF retail 
brokers, then these brokers could pass on the costs to their consumers. 
That said, to the extent that PFOF brokers face competition from non-
PFOF brokers, then their ability to pass on costs to their customers, 
such as in the form of higher commissions on stock and ETF trades, 
could be constrained. More specifically, non-PFOF brokers (which would 
not be harmed by the disappearance of PFOF) would be unlikely to resume 
charging commissions, which would put competitive pressure on 
commission rates that other retail brokers could charge and still 
retain customers. In this context, if the ability of smaller retail 
brokers to charge commissions is constrained by competition, it could 
increase the competitive advantage of larger retail brokers, which 
could raise the barriers to entry for new brokers and cause some 
smaller retail brokers to exit the market. The Commission is unable to 
quantify the likelihood one or more retail brokers would cease 
operating.
    Another feature of Proposed Rule 615 that could impact competition 
in the market for retail brokers is the option that allows an 
originating broker to avoid disclosure of its identity by certifying 
that its identity will not be disclosed, directly or indirectly, to any 
person that potentially could participate in the qualified auction or 
otherwise trade with the segmented order, as specified in Proposed Rule 
615(c)(1)(iii) and (e)(3).\670\ Broker-dealers carrying the greatest 
adverse selection risk could determine that their execution risk is 
improved by remaining anonymous, despite the possibility that their 
anonymity could signal that they carry above average adverse selection 
risk.\671\ However, the Commission estimates that this effect on the 
market would be relatively minor due to the modest number of retail 
brokers (20 firms) \672\ that would be expected to choose to use this 
certification.
---------------------------------------------------------------------------

    \670\ See supra note 477.
    \671\ See discussion in supra section VI.C.3. The Commission's 
estimate is based on the number of broker-dealers that are believed 
to have sufficiently large number of informed traders.
    \672\ See supra section VI.D.3.
---------------------------------------------------------------------------

4. Efficiency
    The Commission believes the Proposal might have both positive and 
negative effects on efficiency. The Proposal might have negative 
effects on the efficiency of wholesaler operations and the efficiency 
with which marketable individual investor orders are executed, but the 
Commission believes both these effects might be minimal. On the other 
hand, price efficiency might improve due to an increase in pre-trade 
and post trade transparency for the segmented orders

[[Page 226]]

that are exposed in a qualified auction.\673\
---------------------------------------------------------------------------

    \673\ See supra section VII.C.1.d for further discussion of how 
the Proposal would increase pre-trade transparency and price 
efficiency.
---------------------------------------------------------------------------

    The Proposal might decrease the overall efficiency of wholesaler 
operations, although this effect is likely to be minimal. The success 
of wholesalers typically relies in part on significant investment 
spending on high frequency trading technology. It also relies on firm-
specific expertise that has been cultivated over time on how to most 
effectively utilize this technology. However, if increased competition 
due to a mandated qualified auction system reduces the volume and/or 
profit margins of wholesalers, it is conceivable that one or more 
wholesalers might exit the business of handling and internalizing 
individual investor orders.\674\
---------------------------------------------------------------------------

    \674\ Wholesalers also have other business lines. While a 
wholesaler might stop handling and internalizing individual investor 
orders, it is possible that the wholesaler may continue to supply 
liquidity to individual orders through qualified auctions if one of 
its other business lines, such as an exchange market maker or 
proprietary trading desk, bids in qualified auctions.
---------------------------------------------------------------------------

    Assuming that the market power of the industry's most active 
wholesalers is at least partially (if not primarily) due to the 
particular efficiencies that these firms provide, the possibility of 
exit by one of these firms perhaps poses a risk of overall diminished 
efficiency. However, remaining wholesalers (or, alternatively, other 
executing brokers or OTC market makers) should be able to provide the 
routing and execution services to the customers of the exiting 
wholesaler. In fact, Rule 606 reports reveal that broker-dealers 
currently route to multiple wholesalers and do not restrict their 
routing to a single wholesaler. Moreover, the Commission's view is that 
all current wholesalers would likely remain operating, albeit possibly 
with reduced profit margins. Net profit margins among wholesalers are 
fairly high, averaging 39.9% in Q1 2022, compared to 19.9% for the 
broker-dealer industry as a whole.\675\ Finally, the Commission 
believes that retail brokers would be able to shift their orders 
towards other wholesalers without much difficulty in the event that any 
wholesalers chose to exit the business. In fact, retail brokers 
regularly re-assess whether their current allocation of trading 
interest to liquidity providers, including wholesalers, exchanges, and 
ATSs, is optimal. As a result, the Commission does not expect the 
Proposal to have a significant adverse effect on the overall efficiency 
of wholesaler operations.
---------------------------------------------------------------------------

    \675\ Profit margin data are calculated using FOCUS data, and 
calculated as [(total revenue-total expenses)/(total revenue)] x 
100. See supra Table 16 for the share of revenue stemming from PFOF 
for NMS stock orders across PFOF brokers. The two largest 
wholesalers in terms of volume earned 44% and 41% profit margins, 
respectively.
---------------------------------------------------------------------------

    Additionally, the Proposal might reduce the efficiency with which 
marketable individual investor orders are executed, but these effects 
would likely be minimal. The proposed requirement that wholesalers 
expose marketable orders of individual investors to qualified auctions 
might reduce the efficiency with which these orders are filled because 
the trade execution would become less streamlined as a new layer of 
intermediation would be added to the lifecycle of each trade. Even in 
cases where originating brokers would route customer orders directly to 
qualified auctions, this process could be more complex or time-
consuming for retail brokers than routing order flow to wholesalers 
that manage routing, market access and execution services.\676\ Any 
additional complexity or reduction in the speed of execution would tend 
to reduce the efficiency of order executions. However, the duration of 
the qualified auction would be less than or equal to 300 
milliseconds,\677\ and the process would be automated, both of which 
would serve to limit the complexity and duration of the qualified 
auction. Therefore, the Commission believes that the overall efficiency 
with which marketable orders of individual investors are executed would 
not be significantly affected by the Proposal.
---------------------------------------------------------------------------

    \676\ This is assuming that the wholesalers internalize the 
routed orders. For those individual investor orders that are re-
routed by wholesalers, it is possible that directly routing orders 
to qualified auctions may reduce complexity and time-to-execution 
for retail brokers.
    \677\ More specifically, once the proposed qualified auction 
receives the order and sends out the auction message, the duration 
of the auction is 100 to 300 milliseconds.
---------------------------------------------------------------------------

5. Capital Formation
    The Commission believes that the improvements in execution quality 
for individual investors and other market participants \678\ as well as 
improvements in price efficiency \679\ that might result from the 
Proposal would potentially promote capital formation.
---------------------------------------------------------------------------

    \678\ See supra section VII.C.1.b for a discussion of how the 
Proposal would improve execution quality for individual investors 
and supra section VII.C.1.c for how the Proposal would improve 
execution quality for other market participants, including 
institutional investors.
    \679\ See supra section VII.C.1.d for further discussion of how 
the Proposal would increase pre-trade transparency and price 
efficiency.
---------------------------------------------------------------------------

    As investors would benefit from improved execution quality as a 
result of the proposed amendments, these investors would also likely 
benefit from lower transaction costs. Higher transaction costs may 
hinder customers' trading activity that would support efficient 
adjustment of prices and, as a result, may limit prices' ability to 
reflect fundamental values. Less efficient prices may result in some 
firms experiencing a cost of capital that is higher than if their 
prices fully reflected underlying values, and in other firms 
experiencing a cost of capital that is lower than if their prices 
accurately reflected their underlying value, as a result of the 
market's incomplete information about the value of the issuer. This, in 
turn, may limit efficient allocation of capital and capital formation. 
By improving order execution quality and reducing transaction costs, 
the proposed amendments would reduce financial frictions and promote 
investor's ability to trade. Furthermore, improvements in price 
efficiency as a result of the Proposal would cause firms' prices to 
more accurately reflect their underlying values, which may also improve 
capital allocation and promote capital formation.

D. Reasonable Alternatives

    A central aim of Proposed Rule 615 is to retain the benefits of 
segmenting individual investor orders. A second concern that this 
proposal addresses involves the nature of the information transmitted 
to the market by the originating broker. The first type of reasonable 
alternatives discussed below varies by who can segment, the degree of 
segmentation, and whether prescriptive changes to routing practices are 
required. The discussion addresses these questions with options that 
vary along degrees of prescriptive rules, versus relying on market 
incentives alone. The Commission also considered additional types of 
alternatives, namely: (1) alternative definitions of segmented orders, 
(2) alternative auction designs, including the degree to which auction 
design is set by rules or determined by open competition centers, (3) 
alternative exceptions to the order competition requirement, and (4) 
variation in the definition of open competition center. Finally, the 
Commission also considered alternatives such as mandating information 
barriers within wholesaler business functions, allowing exchanges to 
display quotes in retail liquidity programs, and a separate retail NBBO 
as well as a disclosure-only alternative. These alternatives could be 
used together or in combination with each other and could also be 
paired with other elements of the Proposal. Where applicable the 
Commission has

[[Page 227]]

specified which alternatives would likely be paired together when 
considering the economic impact of the alternative.
1. Variation in Provisions Regarding Segmentation and Routing
a. Trade-at Requirement
    The first alternative to the Proposal is that the Commission could 
introduce a trade-at prohibition as part of Regulation NMS. A trade-at 
prohibition would: (1) prevent a trading center that was not quoting 
from price-matching protected quotations and (2) permit a trading 
center that was quoting at a protected quotation to execute orders at 
that level, but only up to the amount of its displayed size. Orders 
would not be able to be executed at a trading center not displaying a 
quote unless the orders were executed with at least a minimum amount of 
price improvement as established by the Commission. There could be 
exceptions for trades at the NBBO midpoint or trades based on a 
reference price, such as VWAP trades. This would mean that any trading 
center not displaying a quote, including ATSs and wholesalers, could 
not execute a trade unless it offered at least the minimum amount of 
price improvement over the NBBO. Exchanges would still be able to offer 
separate RLP programs in order to segment the marketable orders of 
individual investors. However, because quotes in RLPs would not be 
displayed, quotes in RLPs would also be restricted from executing 
orders unless they offered the minimum amount of price improvement over 
the NBBO.\680\
---------------------------------------------------------------------------

    \680\ If this alternative were combined with the alternative to 
allow exchanges to display quotes in RLPs, then displayed quotes in 
RLPs would be able to execute at NBBO without offering price 
improvement.
---------------------------------------------------------------------------

    The Commission could establish a low value for the minimum amount 
of price improvement of 0.1 cent. It could alternatively establish 
higher values for a minimum amount of price improvement ranging up to a 
full tick size (i.e., 1 cent), with exceptions for midpoint 
executions.\681\ If the Commission chose a higher value for the minimum 
amount of price improvement, then the economic effects of this 
alternative would be larger (i.e., a greater increase in displayed 
liquidity, a greater share of orders being routed to exchanges, etc.).
---------------------------------------------------------------------------

    \681\ The Commission also is proposing to amend Rule 612 
regarding the tick size. See Minimum Pricing Increments Proposal, 
supra note 98. The Commission encourages commenters to review that 
proposal to determine whether it might affect their comments on this 
proposing release.
---------------------------------------------------------------------------

    A number of markets have examined the effects of a trade-at rule. 
Studies have examined the introduction of a trade-at prohibition in 
Canada and Australia. In Canada, results indicate that dark trading 
declined and trading on lit venues increased when the trade-at 
prohibition was imposed.\682\ There were not significant changes in 
overall spreads or volatility. Displayed depth increased, but total 
market depth, i.e., hidden plus displayed depth, did not change.\683\ 
Some measures showed a decline in price efficiency.\684\ Empirical 
research has also looked at differences in trader-types and found that 
the trade-at prohibition eliminated intermediation of individual 
investor orders in dark venues and shifted individual investor orders 
onto the lit market with the lowest trading fee.\685\ Findings indicate 
that this resulted in individual investors receiving less price 
improvement, retail brokers paying higher trading fees to exchanges, 
and high-frequency traders earning higher revenues from trading 
fees.\686\ Using Australian market data, researchers found that a 
trade-at prohibition decreased off-exchange trading and 
internalization, with more off-exchange trades executing at the 
midpoint.\687\ They also found that the trade-at prohibition increased 
quoted spreads.\688\ However, because these countries had different 
market structures than the U.S. market in NMS stocks (e.g., less 
fragmentation and less trading occurring off-exchange) the effects 
observed from the trade-at-prohibitions in these studies may not be 
similar if a trade-at-prohibition were applied to NMS stocks in the US.
---------------------------------------------------------------------------

    \682\ See Baiju Devani, Lisa Anderson & Yifan Zhang, Inv. Indus. 
Regulatory Org. Can., Impact of the Dark Rule Amendments (May 7, 
2015), available at https://paperzz.com/doc/8507782/impact-of-the-dark-rule-amendments.
    \683\ Id.
    \684\ Id.
    \685\ See Carole Comerton-Forde, Katya Malinova & Andreas Park, 
Regulating Dark Trading: Order Flow Segmentation and Market Quality, 
130 J. Fin. Econ. 347 (2018).
    \686\ Id.
    \687\ See CFA Inst., Trade Rules in Australia and Canada: A 
Mixed Bag for Investors (Nov. 2014), available at https://www.cfainstitute.org/-/media/documents/issue-brief/policy-brief-trade-at-rules.ashx.
    \688\ Id.
---------------------------------------------------------------------------

    The U.S. Tick Size Pilot in NMS stocks imposed a trade-at 
requirement for one of the test groups (Test Group 3), although there 
were a number of exceptions, including for individual investor 
orders.\689\ One academic paper that examined the effects of the Tick 
Size Pilot, including the effects of the trade-at prohibition,\690\ 
found that the effects of the trade-at prohibition varied based on 
whether the stock was tick-constrained or unconstrained.\691\ The 
authors generally found that in tick-constrained stocks the trade-at 
prohibition decreased quoted and effective spreads, increased displayed 
depth at the NBBO, and increased trading volume. In contrast, 
unconstrained stocks did not experience significant changes in spreads 
or displayed depth and experienced a decrease in trading volume. Both 
tick-constrained and unconstrained stocks experienced an increase in 
quote volatility and a decrease in average trade size. Other empirical 
research indicates that the trade-at prohibition reduced the volume of 
trading off-exchange, with more trading occurring

[[Page 228]]

on inverted exchanges (i.e., those exchanges that pay a rebate for 
demanding liquidity and charge a fee for supplying liquidity).\692\ 
However, the results observed from the trade-at-prohibition in the Tick 
Size Pilot may not be similar if a trade-at-prohibition were applied to 
all stocks, because the Tick Size Pilot was limited to stocks with 
smaller market capitalizations and also involved a simultaneous 
increase in the tick size to five cents.\693\
---------------------------------------------------------------------------

    \689\ The Tick Size Pilot Program was an NMS plan designed to 
allow the Commission, market participants, and the public to study 
and assess the impact of wider minimum quoting and trading 
increments--or tick sizes--on the liquidity and trading of the 
common stocks of certain small-capitalization companies. The Tick 
Size Pilot began in Oct. 2016 and ended in Sept. 2018. The Tick Size 
Pilot included NMS common stocks that had a market capitalization of 
$3.0 billion or less, a closing price of at least $2.00, and a 
consolidated average daily volume of one million shares or less 
(``Pilot Securities''). The Pilot Securities were divided into one 
control group and three test groups. Each test group contained 
approximately 400 Pilot Securities and the remaining Pilot 
Securities were in the control group. The Pilot Securities assigned 
to Test Group One (``TG1'') were quoted in $0.05 per share 
increments but continued to trade at the current price increments, 
subject to limited exceptions. The Pilot Securities assigned to Test 
Group Two (``TG2'') were quoted in $0.05 per share increments like 
those in TG1, but were traded in $0.05 per share increments, subject 
to certain exceptions, including exceptions that permit executions 
that were the (1) midpoint between the national or protected best 
bid and the national or best protected offer, (2) retail investor 
orders with price improvement of at least $0.005 per share, and (3) 
negotiated trades. The Pilot Securities assigned to Test Group Three 
(``TG3'') were quoted in $0.05 per share increments and traded in 
$0.05 per share increments consistent with TG2. TG3 Pilot Securities 
were also subject to a Trade-at Prohibition, which generally 
prevented price matching by a trading center that was not displaying 
the best price unless an exception applied. The Trade-at Prohibition 
had exceptions that were similar to those provided in Rule 611 of 
Regulation NMS. Pilot Securities in the control group continued to 
quote and trade at the current tick size increment of $0.01 per 
share. See Order Approving the National Market System Plan to 
Implement a Tick Size Pilot Program, Securities Exchange Act Release 
No. 74892 (May 6, 2013), 80 FR 27541.
    \690\ See Barbara Rindi & Ingrid M. Werner, U.S. Tick Size Pilot 
(Fisher Coll. Bus. Working Paper No. 2017-03-018, Charles A. Dice 
Ctr. Working Paper No. 2017-18, last revised Mar. 17, 2019), 
available at https://ssrn.com/abstract=3041644 (retrieved from 
Elsevier database) (hereinafter ``Rindi and Werner (2019)'').
    \691\ Rindi and Werner (2019) defined tick-constrained as a 
stock having an average quoted spread of five cents or less during 
the time period before the Tick Size Pilot was implemented. They 
define an unconstrained stock as one having an average quoted spread 
of 10 cents or greater during the time period before the Tick Size 
Pilot was implemented.
    \692\ See Carol Comerton-Forde, Vincent Gr[eacute]goire & Zhuo 
Zhong, Inverted Fee Structures, Tick Size, and Market Quality, 134 
J. Fin. Econ.141 (2019).
    \693\ Additionally, a number of exceptions applied to the Tick 
Size Pilot trade-at prohibition, including an exception for retail 
orders.
---------------------------------------------------------------------------

    Overall, the Commission believes that a trade-at prohibition would 
result in more orders being routed from ATSs to exchanges and an 
increase in displayed depth on the LOB compared to the Proposal.\694\ 
However, it is uncertain to what degree total depth would increase 
because the increase in displayed depth could mostly come from market 
participants choosing to display orders they currently hide on LOBs. If 
most of the increase in displayed depth came from market participants 
choosing to display orders they currently hide, then total depth in the 
LOB (i.e., hidden plus displayed depth) under this alternative may be 
similar to total depth in the LOB under the Proposal. However, LOB 
depth may increase if OTC market makers that currently internalize 
trades off-exchange increased their liquidity supplied to the LOB in 
order to be able to trade without offering the minimum amount of price 
improvement.\695\ There is also uncertainty about what would happen to 
spreads under this alternative. Based on the evidence from implementing 
a trade-at rule in other countries, spreads (both quoted and effective) 
may not significantly change compared to the Proposal. However, it is 
also possible that quoted and effective spreads could decline on 
exchanges if more orders from individual investors are routed for 
execution to exchange LOBs.\696\ More trading volume (including more 
orders from institutional investors) may also shift from ATSs to 
exchanges because the trade-at rule may prevent ATSs not displaying 
quotes from executing a trade unless they provide a minimum amount of 
price improvement to the NBBO.\697\ This shift in order flow from ATSs 
to exchanges could increase transparency and may further lower spreads, 
increase liquidity, and improve price efficiency relative to the 
Proposal.
---------------------------------------------------------------------------

    \694\ This may help reverse a decline in pre-trade transparency. 
Market participants have stated that liquidity displayed at or near 
the NBBO on exchanges has declined over time. An analysis by an 
exchange separately finds off-exchange trading has also increased 
over a similar time period. See supra notes 375 and 376 and 
accompanying text.
    \695\ If the minimum pricing increment were larger, then OTC 
market makers may submit more liquidity to a LOB.
    \696\ Because individual investor orders exhibit lower adverse 
selection risk, the average adverse selection risk faced by 
liquidity suppliers on exchanges could decrease, which may cause 
them to quote at more aggressive prices, resulting in a reduction in 
quoted and effective spreads. See Glosten and Milgrom (1985) for a 
discussion of how adverse selection risk affects quoted spreads. 
However it is also possible that this effect may be limited if 
tighter quoted spreads also cause market participants that pose 
greater adverse selection risk to increase their liquidity demanding 
orders, which could potentially increase the adverse selection risk 
faced by liquidity suppliers on exchange LOBs.
    \697\ The shift in volume from ATSs to exchanges would be 
greater if the Commission set a larger threshold for the minimum 
amount of price improvement needed to execute the order.
---------------------------------------------------------------------------

    Under this alternative, wholesalers would likely internalize more 
individual investor marketable orders compared to the Proposal. 
However, the threshold the Commission selects for the minimum amount of 
price improvement would affect to what degree wholesalers internalize 
the marketable orders of individual investors.\698\ If the Commission 
selected a smaller threshold, e.g., a threshold of 0.1 cents or 0.2 
cents, then this would result in more marketable orders of individual 
investors being internalized by wholesalers.\699\ Because these orders 
would not be exposed to order-by-order competition when they are 
internalized by wholesalers, the average price improvement individual 
investors receive on their marketable orders would likely be reduced, 
and the transaction costs of these orders would be higher, relative to 
the Proposal.
---------------------------------------------------------------------------

    \698\ This effect would also vary based on the quoted spread of 
the stock. For stocks with quoted spreads above two cents, even if 
the minimum threshold price improvement threshold was set at a full 
tick, wholesalers would likely internalize more order flow compared 
to the Proposal because they would have had to offer more than 1 
cent of price improvement in order to internalize individual 
investor orders at the midpoint without having to expose them in 
qualified auctions. If the Commission selected a minimum price 
improvement threshold of a full tick, then stocks with quoted 
spreads less than two cents may have wholesalers internalize less 
individual investor orders under this alternative compared to the 
Proposal. These effects would vary if the minimum tick size for a 
stock was different. The Commission also is proposing to amend Rule 
612 regarding the minimum tick size. See Minimum Pricing Increments 
Proposal, supra note 98. The Commission encourages commenters to 
review that proposal to determine whether it might affect their 
comments on this proposing release.
    \699\ The proportion of individual investor order flow 
internalized by wholesalers would decline as the threshold for the 
minimum amount of price improvement increases, because wholesalers 
would have to offer more price improvement to internalize these 
orders.
---------------------------------------------------------------------------

    Under this alternative, broker-dealers and trading centers would 
not have the costs associated with identifying and handling segmented 
orders, but they would have additional costs associated with developing 
policies and procedures and adjusting their systems to implement the 
trade-at requirements.
b. Permit Exchanges To Offer Auctions in Smaller Pricing Increments
    As an alternative to mandating segmented orders be routed to 
qualified auctions, the Commission could allow exchanges to run 
auctions with 0.1 cent pricing increments that the orders of all market 
participants would be eligible to trade in.\700\ Exchanges would be 
able to run separate auctions for their RLPs and for orders that were 
not eligible to be submitted to their RLPs, which would allow exchanges 
to maintain some degree of segmentation (alternatively, the Commission 
could permit a greater degree of segmentation as in the alternative 
below). This less prescriptive alternative would allow exchanges to 
offer sub-penny price improvement to a wider set of market participants 
outside of their RLP programs. As in the trade-at alternative 
considered above, it would maintain the current separation between how 
market entities are allowed to segment orders, and the relative 
anonymity of orders on exchange. By not contributing to further 
segmentation of orders, relative to the Proposal, this alternative 
might lower the cost for trading for investors currently identified as 
having order flow with greater price impact. Because broker-dealers and 
trading centers would not have to establish policies and procedures for 
identifying and handling segmented orders, this alternative would have 
significantly lower costs than the Proposal. However, it offers no 
clear mechanism for creating significantly greater competition for 
segmented orders, nor in improving execution quality for segmented 
orders as defined in the Proposal.
---------------------------------------------------------------------------

    \700\ Currently, exchanges are able to offer smaller pricing 
increments in their RLPs, but Rule 612 still applies to other 
auctions that they run (e.g., open and closing auctions and auctions 
following a trading halt). This alternative would allow exchanges to 
offer smaller pricing increments for these other auctions.
---------------------------------------------------------------------------

c. Trade-at Requirement for Segmented Orders Only
    As a variation on the Trade-at Requirement alternative discussed 
above, the Commission could only establish a trade-at requirement for 
segmented orders, as defined by the Proposal or in combination with an 
alternative definition of segmented

[[Page 229]]

orders as discussed below. This alternative would limit both the 
potential positive and negative effects of the Trade-at alternative 
because it would apply to a smaller set of orders. Relative to the two 
alternatives above, it would maintain the definition of segmented 
orders, thereby still contributing to the complexity that these two 
alternatives seek to avoid. However, like the Proposal, it would 
potentially expose segmented orders to order-by-order competition. The 
degree of this competition would depend on the minimum price 
improvement threshold selected because a higher threshold would result 
in less internalization and more routing of orders to exchanges, where 
they would be exposed to order-by-order competition. It would also 
depend on whether these orders were revealed to be segmented orders--
given a flag, or sent to an existing RLP program--and whether they also 
identify the originating broker. The less information, the lower the 
degree of segmentation, which may help liquidity in general and 
segmented orders presenting more adverse selection risk, but might 
limit the ability for segmented orders presenting less adverse 
selection risk to gain price improvement. Unlike the Trade-at 
Requirement alternative discussed above, this alternative is explicitly 
compatible with the provision in the Proposal to prevent a routing 
broker to post a quote in a way that has priority, thereby potentially 
lessening the information asymmetry and increasing competition if it 
works as intended.
d. Create a Segmented Order Definition but Not Require Segmented Orders 
To Be Exposed in Qualified Auctions
    As an alternative, the Commission could introduce the proposed 
definition of a segmented order and permit exchanges to offer separate 
auction mechanisms for segmented orders with finer trading increments, 
but not introduce a requirement for segmented orders to be exposed in 
these auctions. There would be no minimum trading volume requirement in 
order for exchanges to be able to run these segmented auctions and 
exchanges would have greater flexibility in designing these auctions, 
similar to the alternative discussed in section VII.D.3.a below. 
Similar to the Proposal, this alternative would introduce the 
definition of segmented orders and with it the additional complexity. 
Relative to the Proposal, it contains no prescriptive requirements for 
auctions, and thus may have lower costs for implementing them, similar 
to the alternative in section VII.D.1.b. Because more exchanges would 
be able to offer segmented auctions, there may be greater competition 
among market centers that are able to offer segmented auctions compared 
to the Proposal.
e. Continue To Permit National Securities Exchanges To Offer Separate 
Trading Mechanisms for Segmented Orders in Addition to Qualified 
Auctions
    As an alternative, the Commission could allow national securities 
exchanges to offer separate trading mechanisms for segmented orders in 
addition to qualified auctions, such as allowing exchanges to continue 
to operate RLPs. In addition to being able to submit a segmented order 
to an exchange LOB or a qualified auction, broker-dealers could also 
submit a segmented order to execute in other exchange trading 
mechanisms designed for segmented orders.\701\ Separate trading 
mechanisms for segmented orders could also be priced in 0.1 cents 
increments, but, similar to current market practices, quotes in 
exchange RLP programs would not be displayed in exchange proprietary 
feeds or consolidated market data.\702\
---------------------------------------------------------------------------

    \701\ Exchanges could either adjust the definitions of orders 
they accepted to their RLPs to conform with the definition of 
segmented orders or they could allow a broader set of individual 
investor orders of which segmented orders would be a subset.
    \702\ A flag would still be disseminated next to an exchange 
quote in consolidated market data indicating that there was 
liquidity present in an exchange's RLP program at a price better 
than the NBBO.
---------------------------------------------------------------------------

    Compared to the Proposal, this alternative might improve 
competition among exchanges, and improve the competitive position of 
lower-volume exchanges, because they would be allowed to offer trading 
mechanisms for segmented orders even if they fell below the 1% average 
daily volume requirement necessary to run a qualified auction. This 
might result in less trading volume in segmented orders concentrating 
on larger exchanges, which could reduce the risk that one or more small 
exchanges might exit the market. It would also improve the ability of 
market participants that might not possess the speed necessary to 
respond to qualified auction messages, e.g., individual investors or 
professional traders that do not utilize algorithmic trading 
technology, to compete to supply liquidity to segmented orders. There 
may be more methods available for them to supply liquidity to segmented 
orders that do not require the speed necessary to respond to qualified 
auction messages, such as posting quotes in exchange RLP programs.\703\
---------------------------------------------------------------------------

    \703\ If an exchange operated both a qualified auction and an 
RLP program, liquidity supplying orders submitted to the exchange's 
RLP program could be incorporated into qualified auctions. Because 
they could submit resting orders to RLP programs, liquidity 
suppliers that were not fast enough to submit bids in qualified 
auctions would still be able to submit an order in 0.1 cent pricing 
increments that would only supply liquidity to a segmented order. 
However, they may not be able to factor in information on the 
originating broker submitting the segmented order into the liquidity 
supplying orders they submit to qualified auctions.
---------------------------------------------------------------------------

    However, compared to the Proposal, this alternative may increase 
the ability of wholesalers or other broker-dealers handling segmented 
orders to indirectly internalize an order by executing it against a 
quote they are posting in another trading mechanism for segmented 
orders, such as an RLP program. In these other trading mechanisms, the 
broker-dealer may maintain a larger information advantage than it would 
have with qualified auctions, because these other trading mechanisms 
may not require identity disclosure of the originating retail-broker. 
However, since qualified auctions would still be available and there 
may be additional competition from liquidity on smaller exchanges, the 
average price improvement and trading costs for marketable orders of 
individual investors may not be significantly different under this 
alternative compared to the Proposal.
    This alternative could also allow quotes in RLPs to be displayed in 
proprietary feeds and in consolidated market data. This would 
potentially increase the transparency of liquidity available to 
segmented orders and may further improve their order routing and 
execution quality compared to not displaying RLP quotes under this 
alternative. Displaying quotes in RLP programs may also further enhance 
the competitive position of smaller exchanges and new exchanges that 
enter the market that do not meet the criteria for an open competition 
trading center but may operate an RLP. Displaying exchange RLP quotes 
would provide more transparency into the liquidity available to the 
orders of individual investors on these exchanges, which might result 
in more individual investor orders being routed to these exchanges when 
the prices of displayed quotes are equal to or better than the expected 
execution prices individual investor orders may expect to receive in 
qualified auctions (e.g., if the RLP is posting a quote at the NBBO 
midpoint).

[[Page 230]]

2. Alternate Definitions of Segmented Orders
a. Current Market Practice as a Definition of Segmented Order
    The Commission understands that current market practices concerning 
definitions of retail orders often relies on brokers representing 
retail flow as coming from natural persons.\704\ In addition, a number 
of SRO rules prohibit the use of trading algorithms or computerized 
technology for the eligibility of retail orders for their RLP 
programs.\705\ As an alternative to the proposed definition of 
segmented order, the Commission could adopt a definition of segmented 
order that consisted of these two elements, i.e., the order must be 
submitted by a natural person and does not originate from a trading 
algorithm or any other computerized methodology,\706\ but without any 
thresholds based on the number of trades executed or orders submitted 
by the account.
---------------------------------------------------------------------------

    \704\ See supra notes 188, 189, and 190 and related discussions 
(discussing natural person in context of definitions of retail 
orders).
    \705\ See supra note 193 (discussing restrictions on retail 
orders originating from a trading algorithm).
    \706\ Similar to the proposed definition 600(b)(91)(i), the 
order could originate from a natural person or an account held in 
legal form on behalf of a natural person or group of related family 
members.
---------------------------------------------------------------------------

    Compared to the Proposal, this could result in fewer orders meeting 
the definition of a segmented order. Although a small number of 
additional individual investor accounts would now meet the definition 
of segmented order because there would be no minimum trade 
threshold,\707\ a number of orders that previously would have been 
included under the Proposal could be excluded because they originate 
from a trading algorithm or any other computerized methodology.\708\ 
The Commission does not have data on how many retail orders originate 
from trading algorithms or any other computerized methodology, but the 
Commission understands that a number of retail brokers allow individual 
investors to trade through APIs and that a number of retail brokers may 
use trading algorithms to generate orders for individual accounts.\709\ 
To the extent that orders originating from a trading algorithm or 
computerized methodology have larger adverse selection risk than other 
orders originating from individual investors that met the definition of 
a segmented order, then the adverse selection risk of segmented orders 
in qualified auctions may decrease and liquidity suppliers might offer 
slightly greater price improvement to segmented orders in qualified 
auctions under this alternative compared to the Proposal. The costs to 
originating brokers for identifying segmented orders under this 
alternative may be similar to the Proposal.\710\
---------------------------------------------------------------------------

    \707\ See analysis and discussion of the distribution of 
individual investors' average daily number of orders resulting in a 
trade in infra Table 22.
    \708\ It is also possible that the orders from individual 
investor accounts that average 40 or more trades a day could also be 
excluded under this alternative if the orders originate from a 
trading algorithm or any other computerized methodology.
    \709\ For example, if a retail broker has automated methods for 
rebalancing an individual investor's account, it may generate orders 
using a trading algorithm.
    \710\ Although originating brokers may not need to keep track of 
the average number of trades each individual investor account 
executes under this alternative, they would need to have systems to 
track if an order submitted by an account originated from a trading 
algorithm or computerized methodology.
---------------------------------------------------------------------------

b. Use a Quantitative Threshold Other Than Trades To Identify Segmented 
Orders
    Rather than using average number of trades, the Commission could 
rely on an alternative metric, such as average number of orders 
submitted by an individual investor's account to identify the threshold 
for the definition of segmented orders. The Commission understands that 
some exchanges in the options market have designed definitions of 
retail orders that rely on a criteria based on the average number of 
orders an account originates per day, as opposed to the average number 
of trades.\711\
---------------------------------------------------------------------------

    \711\ See supra note 197 for a discussion of how the average 
number of orders submitted per day from a customer's account is 
included in the definition of a ``Professional'' order.
---------------------------------------------------------------------------

    The economic effects of using an average order threshold would 
largely depend on the threshold selected. If the Commission selected an 
average order threshold that corresponded to a similar percentage of 
accounts being excluded as the proposed trade threshold, i.e., if the 
Commission selected an average orders per day cutoff so that 99.9% of 
individual investor accounts were below the threshold, then the 
economic effects of this alternative would likely be similar to those 
described in the Proposal. If the Commission varied the threshold, then 
the economic effects would likely be similar to the effects of varying 
the average trade threshold discussed below in section VII.D.2.c. 
Similar to the Proposal, originating brokers would have to develop 
systems to identify individual investor accounts that meet definition 
of a segmented order. However, these costs may be higher if it is more 
difficult for an originating broker to develop systems that track the 
average number of orders that originate from a customer's account 
compared to the number of trades.
c. Vary the Daily Trade Threshold of Individual Investors Covered by 
the Proposal
    The Commission could adopt alternative definitions of a segmented 
order by varying the threshold for the average daily number of trades 
in NMS stocks that a natural person or group of related family members 
would need to be under in order for their orders to qualify as 
segmented orders, including not having a maximum number of trades per 
day threshold.\712\
---------------------------------------------------------------------------

    \712\ If there were no trade threshold, then the segmented order 
definition would be similar to the criteria that some exchanges use 
to determine which investor orders are eligible to execute in their 
RLP programs. Although some exchanges also have criteria using the 
average number of orders submitted by the natural person as a 
threshold for determining which orders are eligible to be submitted 
to their RLP programs. See supra note 188 and accompanying text for 
discussions of the orders that are eligible to be submitted to RLPs.
---------------------------------------------------------------------------

    Table 22 estimates the distribution of the average daily number of 
orders that an individual investor's account originates and results in 
a trade (conditional on the individual investor submitting an order 
during the observation period). The analysis shows that 99.9% of 
individual investor accounts average 14.3 or fewer orders that result 
in a trade each day and that 99% of individual investor accounts 
average 1.86 or fewer orders that result in a trade each day.

[[Page 231]]



                           Table 22--Distribution of Individual Investors' Average Daily Number of Orders Resulting in a Trade
--------------------------------------------------------------------------------------------------------------------------------------------------------
                     Mean                         Std       Min       25%       50%       75%       99%      99.9%    99.99%    99.999%        Max
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.20.........................................   118.74      0.00      0.01      0.02      0.06      1.86     14.30     83.92    318.83       667,289.34
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table uses CAT data to estimate the distribution of the average daily number of orders that an individual investor's account originates and are
  associated with a trade. This is estimated from CAT identified Individual Customer accounts that originated an order during the six month period from
  Jan. 1, 2022, through June 30, 2022. Because this analysis only includes Individual Customer Accounts that originated an order during this time
  period, it may overestimate the value at a given percentile because accounts originating zero orders are not included in the distribution. See supra
  note 194 for additional details on the analysis.

    If the average trade threshold were lowered, fewer individual 
investors would meet the definition of a segmented order and be 
eligible to have their orders be routed to qualified auctions. 
Individual investors that no longer met the definition of segmented 
orders would experience lower execution quality than under the Proposal 
because their orders would not be eligible to be segmented and 
participate in qualified auctions. Instead, these orders would likely 
either be internalized by wholesalers without being subject to order by 
order competition if they have lower adverse selection risk or routed 
and executed on an exchange LOB or ATS if wholesalers don't want to 
internalize them. If these orders have larger adverse selection risk 
than the average orders of individual investors that fall below the 
average trade threshold, then the average adverse selection risk of 
segmented orders in qualified auctions may decrease and liquidity 
suppliers might offer slightly greater price improvement to segmented 
orders in qualified auctions under this alternative compared to the 
Proposal. However, as long as the average trade threshold remained 
above 15 trades per day, then the effects of this alternative may not 
be that significant, because it would affect less than 0.1% of 
individual investors.
    If the average trade threshold were increased or eliminated, then 
orders of more individual investors would be included in qualified 
auctions. However, the proportion of individual investors that meet the 
definition of segmented orders under this alternative, but do not under 
the Proposal would be small because more than 99.9% of individual 
customer accounts average less than 40 trades per day. The marketable 
orders of individual investors that average more than 40 trades per day 
and meet the definition of segmented order under this alternative may 
receive more price improvement and lower transaction costs compared to 
the Proposal because their orders would now be eligible to be included 
in qualified auctions. However, the orders of these individual 
investors that trade more frequently may have greater adverse selection 
risk compared to orders from individual investors that trade less 
frequently. Compared to the Proposal, this may result in the average 
adverse selection risk increasing in qualified auctions and liquidity 
suppliers bidding in auctions may offer less price improvement on 
average. This would result in the orders of individual investors that 
average less than 40 trades per day receiving less price improvement on 
their marketable orders and paying higher transactions costs than they 
would under the Proposal. This would effectively result in a transfer 
from individual investors that average less than 40 trades per day to 
the ones that average more than 40 trades per day. Institutional 
investors may also see increased transactions costs compared to the 
Proposal because they may be more likely to supply liquidity to 
individual investors with higher adverse selection risk. However, if 
individual investors with more than 40 trades per day are limited to a 
few broker-dealers, then the potential disclosure of the originating 
broker in qualified auctions may limit the effect to these broker-
dealers.
3. Variation in Auction Design
a. Allow Open Competition Trading Centers More Flexibility in Designing 
Qualified Auctions
    As one alternative, the Commission could allow open competition 
trading centers more flexibility in designing qualified auctions. This 
would include allowing open competition trading centers more 
flexibility in setting matching protocols, priority structure, auction 
duration, disclosure of the identity of the originating broker, and 
auction fees and rebates. However, the Commission could still specify a 
minimum auction duration (open competition centers could choose greater 
times). The Commission could also still specify that execution priority 
shall not be based on time of receipt of the auction response 
(otherwise, it is not clear how an auction might differ significantly 
from the limit order book).
    Compared to the Proposal, this alternative could lead to greater 
innovation in the design of qualified auctions and foster greater 
competition among open competition trading centers that run qualified 
auctions. However, it could also lead to the design of qualified 
auctions with mechanisms that could provide a greater advantage to 
certain liquidity suppliers, which could result in less competition 
among liquidity suppliers, and reduced benefits that come from it, 
including less improvement in individual investor and institutional 
investor execution quality compared to the Proposal.
    Allowing more flexibility in the design of qualified auctions could 
enhance innovation compared to the Proposal by allowing open 
competition trading centers to incorporate auction features that better 
fit the needs of different market participants, which in turn could 
improve order execution quality for some market participants compared 
to the Proposal. More flexibility in the design of qualified auctions 
could also promote further competition among open competition trading 
centers and lead to greater differentiation among qualified auction 
mechanisms in order to attract segmented orders and liquidity 
suppliers. It could also lead to more open market trading centers 
operating qualified auctions, since an exchange group might be more 
likely to operate multiple qualified auctions if it has the flexibility 
to implement different designs at different exchanges. This, however, 
could result in greater fragmentation of individual investor order flow 
and liquidity supply across qualified auctions compared to the Proposal 
and result in decreased competition among liquidity suppliers to 
individual qualified auctions and less price improvement for individual 
investors relative to the Proposal.
    Compared to the Proposal, allowing greater flexibility in qualified 
auction designs could result in some open competition trading centers 
designing auction mechanisms that provide a greater competitive 
advantage to some types of bidders over others. For example, an open 
competition trading center could design an auction that includes an 
auto-match pricing feature (where the order automatically adjusts

[[Page 232]]

to match the price of the best auction bid), and an allocation 
guarantee to the participant that initially brought the order to the 
auction if it provided the best bid. This would provide a competitive 
advantage to whichever market participant brought the order to the 
auction and increase the likelihood that it would trade with the 
individual investor order. This could result in market participants 
directing individual orders to qualified auctions that offered them a 
greater competitive advantage, which would result in less competition 
among market participants to supply liquidity to individual investor 
orders and worse execution quality for individual investor orders 
compared to the Proposal.
    Additionally, because this alternative would not require qualified 
auctions to ensure customer priority if multiple bids are at the same 
price, it could reduce the likelihood of other investors trading 
directly with individual investor orders compared to the Proposal 
(e.g., it could increase the chance of broker-dealers bidding in 
qualified auctions getting priority over institutional orders at the 
same price compared to the Proposal). This could result in less 
improvement in the execution quality for the orders of institutional 
investors compared to the Proposal.\713\
---------------------------------------------------------------------------

    \713\ See supra section VII.C.1.c discussing improvements in 
execution quality for institutional investors.
---------------------------------------------------------------------------

b. Variation in the Duration of Qualified Auctions
    As an alternative, the Commission could vary the minimum and 
maximum durations for the qualified auction, making both larger or 
smaller. Variations in the duration of qualified auctions results in a 
trade-off between NBBO slippage and the exposure of the auctioned order 
flow to potential bidders. Because the NBBO may vary over short time 
horizons, auctioned orders may become stale or priced outside the NBBO 
as best quotes move. This effect calls for shorter auction durations. 
However, longer auction durations provide a longer opportunity, after 
observing the auction message through the SIP, for other participants 
to interact with the auctioned order flow, potentially raising the 
number of bidders in qualified auctions.
    The Commission performed analysis to estimate the risk of quote 
slippage for different auction lengths by observing the likelihood that 
that the NBBO spread moves (i.e., the ``fading probability'') as the 
time lag increases (in milliseconds) after internalization of an 
individual investor order.\714\ Research indicates there is a few-
millisecond gap between an off-exchange trade and the reporting of that 
trade to the SIP.\715\ Assuming this lag applies to internalized 
individual investor orders as well, NBBO movements were measured during 
the initial moments following internalization of an individual investor 
order. This analysis is performed on 600 randomly selected stocks that 
are divided into three groups: high, medium, and low activity 
stocks.\716\ The probability of fading is calculated at the stock level 
as the overall likelihood that the NBO (NBB) will be higher (lower) 
than the current NBO (NBB) for increasing durations of time after 
internalization. These probabilities are then averaged across stocks in 
each of the three groups of stocks. Figure 1 below indicates slippage 
probabilities for different periods of delay after internalization: 
\717\
---------------------------------------------------------------------------

    \714\ From Daily TAQ's NBBO and Quote files, NBBO updates are 
constructed based on nanoseconds time-stamps. Each quote update is 
matched up with the NBBO that is in effect for different durations 
of time (in milliseconds) after internalization. These durations 
include 25, 50, 75, 100, 200, 300, and 500 milliseconds.
    \715\ See Thomas Ernst & Chester S. Spratt, Payment for Order 
Flow and Asset Choice (last revised May 16, 2022) (unpublished 
manuscript), available at https://ssrn.com/abstract=4056512 
(retrieved from Elsevier database).
    \716\ Six hundred stocks were randomly selected from the 
population of all NMS common shares and ETFs in Mar. 2022. Three 
buckets were formed from the population of stocks based on trading 
volume: top-500 (high activity), 501-1,000 (medium activity), and 
1,001-3,000 (low activity). Then 200 stocks were randomly selected 
from each bucket in a stratified manner, such that the final sample 
included stocks from all levels of quoted spread.
    \717\ Filters were used to identify off-exchange transactions 
(sub-penny trades) that are attributable to individual investors. An 
algorithm from Boehmer et al., supra note 572, was then used to 
identify buyer vs. seller initiated such trades. See supra note 572 
for further discussions of this algorithm.

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[[Page 233]]

[GRAPHIC] [TIFF OMITTED] TP03JA23.000

    Results indicate that the fade probability goes from a cross-stock 
average of 12% at 25 milliseconds after a quote update, to 14% at 100 
milliseconds--an increase of only 2 percentage points. Focusing on 
individual investor orders, the fade probability goes from an average 
of 1.7% at 25 milliseconds after an internalized individual investor 
order, to 2.9% at 100 milliseconds--an increase of only 1.2 percentage 
points.
    These findings suggest that changing qualified auction lengths 
relative to the proposed 100 milliseconds length would not 
significantly change the chance of ``adverse'' price movements when an 
auction message is disseminated. The Commission believes, based on this 
analysis, that the chance of the quotes moving against the individual 
investor order does not significantly increase over horizons from 20 
milliseconds to 500 milliseconds long. However, the Commission observes 
that the likelihood of slippage may be greater in volatile markets.
    In addition to the low risk of slippage within the Proposal's 
auction durations, the Commission does not believe that changing the 
qualified auction length would materially substantially impact the 
number of potential bidders. Trading algorithms used by most market 
participants may be fast enough to respond to an auction message in the 
SIP in 10 milliseconds, so reducing or increasing the auction length 
from the proposed 100 to 300 millisecond range may not have a 
significant effect on the number of bidders. The Commission

[[Page 234]]

also observes that, even at 1 second most traders using screens would 
not be fast enough to participate, limiting the additional market 
participants that could potentially join the auctions as bidders. 
However, auctions below 10 milliseconds may prevent some participants 
that utilize algorithms from responding timely to SIP auction messages. 
These limitations likely reflect geographical delay in the SIP, which 
is estimated to be up to one millisecond between trading centers in New 
York and New Jersey and up four milliseconds from Chicago to New York/
New Jersey.\718\
---------------------------------------------------------------------------

    \718\ See MDI Adopting Release, supra note 81, note 1692 and 
accompanying text.
---------------------------------------------------------------------------

c. Vary the Minimum Pricing Increment in Qualified Auctions
    The Proposal sets the minimum pricing increment at 0.10 cents in a 
qualified auction. As an alternative, the Commission could lower the 
minimum pricing increment requirement to 0.01 cents in the qualified 
auctions. Concern about a minimum pricing increment tends to occur 
around pennying on a limit order book, which economically acts as an 
erosion of time priority. However, auctions as required do not have 
time priority, and so this is less of a concern. Lowering the minimum 
pricing increments would allow bidding at more competitive prices. It 
could, however, increase the possibility of de minimis price 
improvement relative to the limit order book. This would drain 
liquidity from the limit order book with little benefit to investors. 
Varying the minimum pricing increment could affect the competitiveness 
among liquidity suppliers in qualified auctions and also the potential 
price improvement that segmented orders may receive.
d. Qualified Auctions With Liquidity Provider Backstop
    As another alternative, the Commission could require qualified 
auction operators to have a designated liquidity provider (DLP) for 
each security to serve as a backstop and guarantee execution of a 
portion of the segmented order at the NBBO if an auction does not 
produce any bids. For each symbol, the number of shares a DLP would be 
obligated to guarantee execution for in an order could be set at the 
minimum of some percentage of the average quoted size at the NBBO or 
some percentage of the average daily executed share volume, whichever 
is smaller.\719\ In return for the DLP backstopping the qualified 
auction, if the DLP were tied with other bidders at the best price, the 
DLP would be given an allocation guarantee of some percentage of the 
size of the segmented order or the size of their bid, whichever is 
smaller.\720\ If there were multiple bidders besides the DLP at the 
best price, each liquidity supplying order at the same price level 
would be assigned a random priority and, after the DLP received its 
allocation guarantee, any remaining shares would be filled based on the 
random priority ranking. However, qualified auction features that gave 
the DLP additional advantages, such as allowing it to automatically 
match the best price, would not be allowed.
---------------------------------------------------------------------------

    \719\ For example, the Commission could require the DLP to 
guarantee execution of a number of shares that would be equal to 25% 
of the average quoted size at the NBBO in a security or 0.1% of the 
average daily executed share volume in a security, whichever is 
smaller.
    \720\ For example, the Commission could guarantee that a DLP 
would have priority to execute 25% of the shares in the segmented 
order if it were tied with other bidders at the same price.
---------------------------------------------------------------------------

    Compared to the Proposal, this alternative would provide more 
certainty regarding individual investor orders executing in qualified 
auctions, particularly in less liquid securities where there may be a 
higher chance that no liquidity suppliers bid in the auctions. This 
execution certainty would be greater if the DLP's percentage execution 
guarantee were higher. However, the DLP would also be taking on greater 
risk, because they might have a larger inventory position, which would 
put them at greater risk if prices moved against them.
    Giving allocation guarantees to DLPs may reduce the incentive for 
other market participants to compete to supply liquidity to segmented 
orders compared to the Proposal, because they would be less likely to 
execute against the segmented order if they submitted an order at the 
same price as the DLP.\721\ The incentives of other market participants 
to compete to supply liquidity may be reduced more if the percentage of 
the segmented order the DLP is guaranteed priority to execute (i.e., 
the DLPs allocation guarantee) is greater.
---------------------------------------------------------------------------

    \721\ The reduction in incentives to compete to supply liquidity 
to segmented orders compared to the Proposal may be larger for 
customer orders, including the orders of institutional investors, 
because, in addition to the DLP allocation guarantee, the random 
priority structure would further reduce their chance of executing 
against an order when their order is tied with others at the same 
price compared to the Proposal (in which customer orders had 
priority in the event of a tie).
---------------------------------------------------------------------------

e. Two-Sided Auctions
    Under this alternative, qualified auction messages would not 
include information on the direction of the segmented order (i.e., 
whether it was a buy or sell order). Bidders would be able to submit a 
one sided bid (i.e., a directional bid to either buy or sell) or a two 
sided bid (i.e., a bid indicating the bidder was willing to both buy 
and sell).\722\
---------------------------------------------------------------------------

    \722\ A two sided bid could be submitted as providing some sort 
of price improvement over the NBBO. For example, a market 
participant supplying liquidity in the qualified auction could 
submit a two-sided response specifying that they were willing to 
execute the segmented order (i.e., they were willing to both buy and 
sell to the individual investor) at 0.2 cents better than the NBBO.
---------------------------------------------------------------------------

    On the one hand, not disclosing the direction of the segmented 
order may reduce bidding from some market participants,\723\ 
potentially resulting in less competition to supply liquidity to the 
segmented order, which may result in segmented orders receiving less 
price improvement compared to the Proposal. On the other hand, not 
disclosing the direction of the segmented order may also reduce the 
risk of information leakage if an institutional investor was bidding in 
the auction compared to the Proposal, because it would be more 
difficult to discern the direction of the trade.\724\ This could 
incentivize more bids from institutional investors, which could 
increase the competition to supply liquidity to segmented orders and 
potentially provide more improvement in institutional investor 
execution quality compared to the Proposal.
---------------------------------------------------------------------------

    \723\ For example, not knowing the direction of the segmented 
order may reduce the willingness of some market participants to 
cancel a resting order with queue position on another venue and 
submit it as a bid in the qualified auction because it is more 
difficult to know if their order was going to execute.
    \724\ See supra section VII.C.2.f for a discussion on the risk 
of information leakage from institutional investors supplying 
liquidity in qualified auctions.
---------------------------------------------------------------------------

    Not disclosing the direction of the segmented order may also reduce 
the risk of the NBBO slippage during the qualified auction, i.e., the 
risk of the NBBO quotes moving against the individual investor order 
(e.g., the probability of an increase in the NBO for a segmented buy 
order or a decrease in the NBB for a segmented sell order).\725\ 
Because market participants setting the NBBO quotes would not know the 
direction of the segmented order, to the extent they would have 
adjusted their quotes in response to an auction announcement under the 
Proposal, they may be less likely to adjust their quotes under this 
alternative.
---------------------------------------------------------------------------

    \725\ See supra section VII.C.2.b for a further discussion on 
individual investor slippage costs in qualified auctions.

---------------------------------------------------------------------------

[[Page 235]]

f. Alternative Maximum Fee for Auctions
    The Proposal imposes a 5 mil access fee cap on executed auction 
responses and does not allow a fee to be charged for submitting auction 
responses or the submission or execution of segmented orders. The 
alternative discussed in section VII.D.3.a allows more flexibility in 
designing auctions, which could include more flexibility for exchanges 
to charge greater fees (and offer greater rebates), both from those 
routing orders to an exchange and from those bidding in an exchange. As 
exchanges compete to offer auctions, it is possible that access fees 
would be competed down to levels that make a cap unnecessary. However, 
because the auctions are required for certain segmented orders prior to 
internalization, there remains the possibility that this requirement 
could lead to access fees being set above those that would occur in the 
absence of such a requirement. Due to this market failure, setting a 
maximum fee may be necessary. Alternatively the Commission could raise 
the 5 mil qualified auction access fee cap to, for example, 10 mils, 
and could allow a capped fee on auction respondents and on those 
routing segmented orders to qualified auctions. This could raise the 
access fees charged to auction responses and lower the price 
improvement received by segmented orders, but it would raise the 
incentives for exchanges to offer auctions.
g. No Requirement for Customer Priority in Case of Auction Responses at 
Same Price
    The Proposal currently requires qualified auctions to give priority 
to auction responses for the account of a customer over auction 
responses for the account of a broker or dealer at the same price. 
Under this alternative, the Commission could not specify priority rules 
requiring giving priority to customer auction responses. The Commission 
could still maintain priority restrictions prohibiting time priority 
and prohibiting priority rules favoring the broker-dealer that routed 
the segmented order to the auction, the originating broker for the 
segmented order, the open competition trading center operating the 
auction, or any affiliate of the foregoing persons.\726\ Additionally, 
the Commission could also still maintain the proposed priority rules 
regarding how qualified auctions would interact with the continuous 
limit order book.\727\
---------------------------------------------------------------------------

    \726\ See supra section IV.C.5 for further discussions on these 
priority restrictions.
    \727\ See id. (discussing proposed Rule 615(c)(5)(v)).
---------------------------------------------------------------------------

    While one of the goals of the Proposal is to promote the NMS 
objective set forth in section 11A(a)(1)(C)(v) of the Exchange Act and 
maximize the potential for customer orders to interact with other 
customer orders,\728\ giving priority to customer orders may discourage 
liquidity provision by broker-dealers in qualified auctions. Compared 
to the Proposal, this alternative could encourage greater participation 
by traditional liquidity providers, such as exchange market makers and 
other OTC dealers, in qualified auctions. However, it might discourage 
other customers, including institutional investors, from participating 
in qualified auctions, which may be contrary to one of the goals of the 
proposal.
---------------------------------------------------------------------------

    \728\ See id. (discussing proposed Rule 615(c)(5)(ii)).
---------------------------------------------------------------------------

h. Do Not Reveal Identity of Originating Broker in Qualified Auction 
Message
    As an alternative, the Commission could not permit the identity of 
the originating broker to be disclosed in qualified auction messages. 
If the identity of the originating broker were not revealed to bidders 
in qualified auctions, then they would need to price their auction 
responses based on the average adverse selection risk of the segmented 
orders in the qualified auctions. Relative to the proposal, this has 
the potential to improve pricing and liquidity for the individual 
investor orders from retail brokers presenting greater adverse 
selection risk, thereby increasing incentives for information 
production and potentially improving price efficiency. However, it may 
also potentially reduce the price improvement and increase transaction 
costs for individual investor orders of retail brokers presenting lower 
adverse selection risk, since their orders could not be distinguished 
from the orders of customers of retail brokers that imposed greater 
adverse selection risk. Additionally, if wholesalers continue to route 
segmented orders and bid in qualified auctions, then they would have a 
larger information advantage relative to other participants in 
qualified auctions because they would be aware of the identity of the 
originating broker of a segmented order they submit to the qualified 
auction. This could reduce the incentives of other market participants 
to supply liquidity in qualified auctions, because they may be more 
likely to suffer from winner's curse, i.e., they would be more likely 
to only win qualified auction in which the wholesaler submitting the 
segmented order to the auction didn't want to bid aggressively because 
the individual investor order posed greater adverse selection risk. 
This could reduce competition among liquidity suppliers in qualified 
auctions and result in less price improvement and higher transactions 
costs for segmented orders compared to the Proposal.
4. Variation in Exceptions to the Order Competition Requirement
a. Vary the Market Value of the Segmented Order Exception for Executing 
a Segmented Order at a Restricted Competition Trading Center
    As an alternative, the Commission could consider varying the 
proposed $200,000 threshold of the order dollar value exception for 
having to expose a segmented order in a qualified auction by either 
increasing or decreasing the threshold. Table 23 estimates the 
distribution of the dollar value of executed orders submitted by 
individual investors. Approximately 98.9% of individual investor orders 
have a dollar value less than $200,000 and more than 95% of individual 
investor orders have a dollar value less than $55,000. Therefore, 
unless the proposed order dollar value exception threshold is reduced 
significantly, the vast majority of individual investor orders would 
remain below the threshold level. Similarly, increasing the threshold 
level would not significantly increase the percentage of orders that 
would be required to be exposed in qualified auctions.

[[Page 236]]



                                    Table 23--Distribution of Dollar Value of Orders Submitted by Individual Investor
--------------------------------------------------------------------------------------------------------------------------------------------------------
       10 Pct                25 Pct                50 Pct                75 Pct                90 Pct                95 Pct                99 Pct
--------------------------------------------------------------------------------------------------------------------------------------------------------
           $21.21               $136.13             $1,019.01             $6,232.51            $25,243.63            $54,728.69           $209,281.75
--------------------------------------------------------------------------------------------------------------------------------------------------------
 This table presents analysis of CAT data showing the distribution of the original dollar value of orders that resulted in trades and originated from
  CAT Individual Customer accounts at one of the 58 MPIDs in the CAT retail analysis identified in Table 7 during March 2022. The distribution is
  calculated from all market and limit orders that originated from CAT Individual Customer accounts and resulted in a trade. Dollar values for limit
  orders were calculated based on the limit price of the order (limit price times shares in the order). Dollar values of market orders were calculated
  based on the far side NBBO quote at the time of order entry and then multiplying that by the number of shares in the order. The execution price was
  used in the rare instances when the NBBO wasn't available. See supra Table 7 for details on how the broker-dealers were identified.

    A smaller threshold value would result in more segmented orders 
potentially being excepted from qualified auctions. Orders above this 
value and below $200,000 would be more likely to not be exposed in a 
qualified auction and would instead be more likely to be internalized 
by a wholesaler without the wholesaler being subject to competition at 
the individual order level. This may decrease price improvement offered 
to these orders compared to the Proposal. It would also reduce the 
chance that other market participants could interact with these 
individual investor orders, potentially increasing their transaction 
costs compared to the Proposal. However, it may also result in less of 
a reduction in wholesaler revenue compared to the Proposal, which may 
result in wholesalers not reducing PFOF as much. It may also increase 
the likelihood of wholesalers continuing to not charge retail brokers 
for their routing services. Both of these changes may also reduce the 
chance retail brokers would resume charging commissions compared to the 
Proposal.
    A larger threshold value would result in more individual investor 
orders potentially being included in qualified auctions. This could 
result in more individual investors orders over $200,000 receiving 
greater price improvement compared to the Proposal, because they would 
be more likely to be exposed in qualified auctions. However, this 
benefit may be limited, because the auctions may be less likely to 
attract sufficient liquidity to fill the entire order.
b. Exception of Beyond-the-Midpoint Non-Marketable Limit Orders
    As another alternative, the Commission could create an additional 
exception to Proposed Rule 615 that would apply to all segmented orders 
that were classified as non-marketable limit orders at the time of 
order receipt. Proposed Rule 615 includes beyond-the-midpoint non-
marketable limit orders but exempts non-marketable limit orders with 
limit prices at and below the midpoint. Under this alternative, beyond-
the-midpoint non-marketable limit orders that met the other criteria to 
be considered a segmented order would also be exempted from Proposed 
Rule 615.
    Table 24 below provides a break-down of the share of different 
order types for individual investors during Q1 2022. The data indicates 
that beyond-the-midpoint non-marketable orders only accounted for 1.9% 
of the executed dollar volume of orders individual investors routed to 
wholesalers.\729\ Furthermore, only 17.7% of the dollar volume in these 
orders were executed in a principle capacity, equaling 0.3% of total 
executed dollar volume.\730\ Thus, the share of non-marketable limit 
orders that is currently isolated at the order-by-order level is an 
extremely small share of overall individual investor order flow.
---------------------------------------------------------------------------

    \729\ Over 95% of the executed dollar volume individual 
investors routed to wholesalers came from marketable orders.
    \730\ The majority of the executed dollar volume in beyond-the-
midpoint non-marketable orders was executed in a riskless principal 
capacity or was rerouted and executed on an agency basis.

   Table 24--Distribution of Individual Investor Order Types, Q1 2022
------------------------------------------------------------------------
                                                             Share of
                       Order type                         dollar trading
                                                            volume (%)
------------------------------------------------------------------------
Marketable Order (% of total)...........................            80.6
Marketable Orders--Principle Execution (% of total).....            73.5
Principle Share % of Marketable Orders..................            91.1
Marketable Limit Orders (% of total)....................            14.7
Marketable Limit Orders--Principle Execution (% of                  12.7
 total).................................................
Principle Share % of Marketable Limit Orders............            86.4
Beyond-the-Midpoint Non-Marketable Limit Orders (% of                1.9
 total).................................................
Beyond-the-Midpoint Non-Marketable Limit Orders--                    0.3
 Principle Execution (% of total).......................
Principle Share % of Beyond-the-Midpoint Non-Marketable             17.7
 Limit Orders...........................................
Midpoint or below Non-Marketable Limit Orders (mp and                2.8
 farside) (% of total)..................................
Midpoint or below Non-Marketable Limit Orders (mp and                0.3
 farside)--Principle Execution (% of total).............
Principle Share of Midpoint or below Non-Marketable                 10.5
 Orders (mp and farside)................................
------------------------------------------------------------------------
 This table looks at the percentage of dollar trading volume in NMS
  stocks and ETFs of different market and limit (as measured by
  marketability) order types that were routed to wholesalers from the 58
  broker-dealer MPIDs in the CAT retail analysis in Q1 2022. See supra
  Table 7 for additional information on the sample.
 The analysis shows the order type's percentage of dollar trading
  volume, i.e. the dollar trading volume belonging to a particular order
  type (out of the total dollar trading volume across all order types).
  The Principle Execution for an order type is the percentage of dollar
  trading volume executed in a principal capacity by a wholesaler
  belonging to a particular order type (out of the total dollar trading
  volume executed in a principal capacity by a wholesaler across all
  order types). The Principle Share % for a particular order type is the
  percentage of dollar trading volume that was executed by a wholesaler
  in a principal capacity (out of the total dollar trading volume in
  that order type).

[[Page 237]]

 
 Marketability of a limit order was determined using the NBBO from the
  consolidated market data feed at the time the wholesaler received the
  order. Marketable limit orders are limit orders where the limit price
  is greater than or equal to the opposite side quote (NBB for sell
  orders and NBO for buy orders). Beyond-the-midpoint Non-marketable
  limit orders are limit orders with limit prices between the midpoint
  and the opposite side quote (NBB for sell orders and NBO for buy
  orders). Midpoint or below non-marketable limit orders are limit
  orders with limit prices between the midpoint and the same side quote.

    Given the small volume of beyond-the-midpoint non-marketable limit 
orders, the costs and benefits of this alternative could be similar to 
the Proposal. However, fewer beyond-the-midpoint non-marketable limit 
orders would be submitted to qualified auctions. Instead, more of them 
may be internalized or executed on a riskless principal basis, which 
may reduce the price improvement they receive relative to the 
Proposal.\731\
---------------------------------------------------------------------------

    \731\ Both the Proposal and this alternative would allow beyond-
the-midpoint non-marketable limit orders to be routed to an exchange 
LOB instead of being submitted to qualified auctions. Therefore, 
this alternative may result in a similar portion of individual 
investor beyond-the-midpoint non-marketable limit orders being 
routed to exchange LOBs as under the Proposal.
---------------------------------------------------------------------------

5. Variation in the Definition of Open Competition Trading Centers
a. Vary Threshold To Become an Open Competition Trading Center
    In addition to other requirements, the Proposal requires a trading 
center to have an average daily share volume of 1.0 percent or more of 
the aggregate average daily share volume for NMS stocks during at least 
four of the preceding 6 calendar months in order to qualify as an open 
competition trading center. As an alternative, the Commission could 
choose to require a higher or a lower percentage, including zero 
percent, of the average daily share volume in NMS stocks as the 
threshold to qualify as an open competition trading center.
    If the threshold were higher, then fewer exchanges and ATSs would 
meet the definition of an open competition and be eligible to run 
qualified auctions. It could result in reduced competition between 
venues running qualified auctions. This may reduce innovation and, to 
the extent it occurs within the 5 mil fee and rebate caps, result in 
reduced competition between qualified auctions on the basis of access 
fees and rebates, which could increase the net capture rate open 
competition centers earn from their qualified auctions. However, the 
reduced number of qualified auctions could result in more liquidity 
suppliers competing in individual qualified auctions (i.e., there would 
be less fragmentation of liquidity suppliers across qualified 
auctions), which may provide more price improvement to segmented orders 
submitted to these auctions.
    If the threshold were lower, more exchanges and ATSs would be able 
to meet the definition of an open market trading center and be able to 
operate qualified auctions. More exchanges and ATSs might operate 
qualified auctions, which could enhance competition between venues 
running qualified auctions. This could encourage more innovation in 
qualified auctions. For example, exchange groups may be more likely to 
run multiple qualified auctions on different exchanges with different 
structures, priority rules, or fees. It would also reduce the 
competitive disadvantage of exchanges and ATSs that would be too small 
to run qualified auctions under the Proposal but would be under this 
alternative. However, it may result in greater fragmentation of 
liquidity suppliers across different qualified auctions, which may 
reduce competition between liquidity suppliers in individual qualified 
auctions and reduce price improvement to segmented orders submitted to 
these auctions. Additionally, greater fragmentation in qualified 
auctions could increase the risk that a broker-dealer could route a 
segmented order to a qualified auction with less competition from other 
liquidity suppliers so that the routing broker-dealer may have a 
greater chance to trade with the segmented order.
b. Only National Securities Exchanges as Open Competition Trading 
Centers
    As an alternative, the Commission could limit the definition of an 
open competition trading center to only include national securities 
exchanges. This alternative could be in combination with the 1% average 
daily share volume in NMS stocks that the Proposal specifies, or some 
other threshold (including no threshold) as discussed in section 
VII.D.5.a. This would mean that NMS Stock ATSs would not be able to 
operate qualified auctions.
    Compared to the Proposal, this alternative would put NMS Stock ATSs 
at a competitive disadvantage to exchanges. NMS Stock ATSs that would 
have met the criteria to be considered open competition trading centers 
under the Proposal would be considered restricted trading centers under 
this alternative and would not be able to execute segmented orders, 
unless it is via one of the exceptions.\732\ More segmented orders 
would be routed to qualified auctions on exchanges, which could lead to 
these exchanges attracting additional order flow and result in a 
greater share of orders being executed on exchanges. This could raise 
the barriers to entry for new NMS Stock ATSs and increase the chance 
that a smaller NMS Stock ATS exits the market.
---------------------------------------------------------------------------

    \732\ Under the Proposal, NMS stock ATSs operating qualified 
auctions may have had a competitive advantage over exchanges in the 
sense that they would have more flexibility in making changes to 
their qualified auctions, because their changes would not be subject 
to notice, comment, and Commission approval, like exchanges would.
---------------------------------------------------------------------------

    However, relative to the Proposal, this alternative could result in 
increased investor protection. Because qualified auctions would be 
limited to being operated by national securities exchanges, proposed 
rule changes to all qualified auctions would be subject to notice, 
comment and Commission approval. This would give the Commission greater 
ability to review and disapprove qualified auctions designs to ensure 
they met standards of the Proposal, which may increase investor 
protection.
c. Eliminate the Requirements for NMS Stock ATSs To Be Open Competition 
Trading Centers
    As an alternative, the Commission could choose to allow NMS Stock 
ATSs to qualify as open competition trading centers and be eligible to 
run qualified auctions without imposing the requirements of proposed 
Rule 600(b)(64)(ii). However, any average daily NMS stock volume 
threshold that would apply to exchanges for being able to run qualified 
auctions would also apply to NMS Stock ATSs.\733\ This would mean that 
the NMS Stock ATS would not be required to display quotes that are 
disseminated in consolidated market data, although it would still need 
to subscribe to the ADF so that its qualified auction messages are 
included in consolidated data. Additionally, if the NMS Stock ATS was 
not subject to the fair access requirements of Rule 301(b)(5), then it 
would be allowed to limit subscriber access to its ATS and to its 
qualified auction mechanisms. However, the NMS Stock ATS's

[[Page 238]]

qualified auction would still be limited by any of the qualified 
auction requirements, either proposed Rule 615(c) or one of the 
alternatives discussed in section VII.D.3.
---------------------------------------------------------------------------

    \733\ Either the proposed 1% average daily volume threshold or a 
higher or lower threshold (including zero percent) as discussed in 
supra section VII.D.5.a.
---------------------------------------------------------------------------

    This alternative would make it easier for an NMS Stock ATS to 
operate a qualified auction and result in more NMS Stock ATSs operating 
qualified auctions compared to the Proposal. On the one hand, this 
could enhance competition between venues running qualified auctions and 
encourage more innovation in qualified auctions. However, NMS Stock 
ATSs operating qualified auctions would have a greater competitive 
advantage over exchanges. Compared to exchanges, they could limit 
access to their platform and the market participants that would be 
eligible to participate in qualified auctions.\734\ Although they would 
have to charge the same fees and rebates to all bidders in the 
qualified auctions, they would have more flexibility in bundling other 
aspects of their ATS or services to give an advantage to some 
subscribers over others, which may allow these subscribers an indirect 
advantage in bidding in qualified auctions. This may limit competition 
among liquidity suppliers in these qualified auctions. NMS Stock ATSs 
that operate qualified auctions may also be a more attractive 
destination for some broker-dealers to route segmented orders because 
they may give the broker-dealer routing the order an increased chance 
of being able to trade with the segmented order compared to qualified 
auctions operated by exchanges. These competitive advantages of NMS 
Stock ATSs operating qualified auctions may limit the incentives for 
exchanges to operate qualified auctions, which could reduce competition 
between venues running qualified auctions.
---------------------------------------------------------------------------

    \734\ Additionally, NMS stock ATSs would have more flexibility 
in making changes to their qualified auctions, because their changes 
would not be subject to notice, comment, and Commission approval, 
like exchanges would.
---------------------------------------------------------------------------

6. Wholesaler Information Barriers
    As an alternative, the Commission could establish a new information 
barrier rule specifying new policies and procedures for wholesalers 
that must be part of the policies and procedures for protecting 
material, non-public information that Exchange Act Section 15(g) 
requires of all broker-dealers. The new rule would require wholesalers 
to not share information on customer order flow, either on individual 
orders or in aggregate, outside of the wholesaler business functions 
that were responsible for the handling and execution of the customer 
orders. This would prevent wholesalers from sharing this information 
with other business units and affiliates that may engage in proprietary 
trading or other business functions not related to the handling or 
execution of the customer order. The rule particularly would focus on 
assuring that customer order information is not used in a way that 
would detract from the interests of customers in obtaining best 
execution of their orders.
    A wholesaler information barrier rule would result in greater 
protection of customer order information at wholesalers, which would 
improve investor protection. It may also improve customer order 
execution quality by reducing the chance that another trader will be 
able to use customer order information to trade ahead of or adjust 
liquidity to disadvantage the customer order. This rule may reduce the 
profits of other wholesaler lines of business or affiliates that may 
have benefited from customer order information. This may reduce the 
incentives for wholesalers to handle individual investor orders, which 
may reduce the amount of price improvement they offer to individual 
investor orders or the PFOF they pay to retail brokers. To the extent 
that the use of this information by other wholesaler business lines 
increases information asymmetries and adverse selection risk for other 
market participants, the rule may reduce adverse selection risk faced 
by other liquidity providers, which could improve market quality.
7. Display Quotes in Retail Liquidity Programs
    As an alternative the Commission could allow national securities 
exchanges to display the price and size of quotes in their RLP programs 
on their proprietary feeds and in the consolidated market data feed. 
Under this alternative, exchanges would not execute as large a share of 
marketable individual investor orders as under the Proposal. Instead, 
the majority of marketable individual investor orders would still be 
internalized by wholesalers. This would occur because liquidity 
providers quoting in exchange RLP programs would not know the identity 
of the retail broker of the marketable individual investor orders they 
are trading against. Therefore, they would usually need to set their 
quotes in the RLP programs wider to account for the risk of trading 
with individual investor order flow that imposed greater adverse 
selection risk. However, wholesalers would know the identity of the 
retail broker of the order they were handling. This means wholesalers 
could avoid internalizing individual investor order flow that posed 
greater adverse selection risk and give greater price improvement to 
individual investor orders with less adverse selection risk.
    On average, marketable individual investor orders would receive 
less price improvement under this alternative than the Proposal because 
wholesalers would not need to compete on an order by order basis when 
they internalize an individual investor order. Institutional investor 
transaction costs would also be higher than under the Proposal because 
they would not be able to trade with marketable individual investor 
orders as frequently. A lack of order-by-order competition would also 
allow wholesalers to pay more PFOF to retail brokers than under the 
proposal, since wholesalers would be able to internalize order flow at 
more profitable spreads relative to those that would emerge under 
qualified auctions. From this increased profitability, wholesalers 
would be able to pay more PFOF. Increased PFOF revenue would reduce the 
incentive for broker-dealers to generate new revenue lines or expand 
existing revenue lines. Therefore, under this alternative there would 
not be as significant a change in retail broker business models.
    Compared to the baseline, there would be greater transparency in 
the liquidity available to the marketable orders of individual 
investors. This could increase competition between exchange RLPs and 
wholesalers for the execution of individual investor marketable orders 
and result in more individual investor orders being executed in 
exchange RLPs (although the majority of individual investor orders 
would still likely be internalized by wholesalers). Because broker-
dealers would be able to see the displayed quotes in RLPs, when 
marketable orders of individual investors are routed to execute in 
RLPs, it may be because the quoted prices in the RLP were better than 
the prices the wholesaler would have been willing to internalize the 
individual investor order at. Additionally, the increase in competition 
may result in wholesalers offering more price improvement to the 
marketable orders of individual investors to attract order flow from 
retail brokers. Both of these effects may result in lower trading costs 
for marketable orders of individual investors compared to the baseline. 
However, if wholesalers earn lower marginal profits from internalizing 
the orders of individual investors, they may reduce the amount of PFOF 
they pay to retail brokers that accept PFOF, which could indirectly get 
passed through to the retail brokers'

[[Page 239]]

customers in the form of reduced services or an increased risk of the 
retail broker charging commissions.
8. Creation of a Retail Best Bid and Offer
    As an alternative, in addition to displaying quotes in RLPs, the 
Commission could introduce a new, smaller-sized benchmark from the NBBO 
for segmented orders. The new benchmark would be called the Retail Best 
Bid and Offer (``RBBO''). It would be constructed similar to the NBBO, 
but the threshold for determining when an exchange's quotes qualified 
for the RBBO would be based on a $500 notional value. It would also 
incorporate information from smaller odd lot quotations and quotes from 
exchange RLPs, which would be aggregated up across multiple price 
levels by individual exchanges until they exceeded a value of $500 or 
greater. The least aggressive price level from this aggregation would 
be sent to the SIP for the purposes of determining the RBBO. The RBBO 
would be a protected quote for the purposes of executing segmented 
orders and would also be added as a benchmark in Rule 605 reports for 
calculating price improvements statistics for segmented orders.
    Compared to the Proposal, this alternative would result in 
wholesalers internalizing a larger share of marketable orders of 
individual investors and fewer such orders being executed on exchanges. 
Although quotes in RLPs and smaller odd-lot quotes would be protected 
with respect to segmented orders, liquidity providers quoting in 
exchange RLPs would usually need to set their quotes in the RLPs wider 
than the prices at which wholesalers might internalize individual 
investor orders to account for the risk of trading with individual 
investor order flow that imposed greater adverse selection risk.\735\
---------------------------------------------------------------------------

    \735\ Wholesalers would still know the identity of the retail 
broker whose orders they internalize. Compared to liquidity 
suppliers in exchange RLP programs, they would likely be able to 
further sub-segment individual investor order flow when considering 
how much price improvement to offer.
---------------------------------------------------------------------------

    On average, marketable orders of individual investors would receive 
less price improvement under this alternative than the Proposal because 
wholesalers would not need to compete on an order by order basis when 
they internalize an individual investor order. Institutional investor 
trading costs would also be higher than under the Proposal because they 
would not be able to trade with marketable orders of individual 
investors as frequently. A lack of order by order competition would 
also allow wholesalers to pay more PFOF to retail brokers than under 
the Proposal. Therefore, there would not be as significant improvements 
in retail broker business models.
    However, compared to the baseline, there would be more price 
improvement and lower trading costs for marketable orders of individual 
investors. This would occur because wholesalers would need to offer 
price improvement against a tighter benchmark in order to internalize a 
segmented order. The disclosure of price improvement against the NBBO 
in Rule 605 reports might also enhance competition among wholesalers to 
offer greater price improvement in order to attract more order flow 
from retail brokers.
9. Disclosure of Execution Quality of Individual Investor Orders
    Instead of requiring that segmented orders be routed to qualified 
auctions, the Commission could require that execution quality 
information concerning an individual investor's order be disclosed on 
their transaction confirmations. Specifically, under this alternative 
retail brokers would be required to disclose information on the number 
of shares executed, the price improvement relative to the NBBO, the 
effective-to-quoted spread ratio, and time to execution. This 
information would be provided along with the confirmation of each trade 
to the customer who had placed the order, enhancing transparency on 
each individual investor's own execution quality.
    The Commission believes that this disclosure would not 
significantly increase transparency regarding how execution quality 
varies across retail brokers for two reasons. First, reflecting their 
small scale of trading activity, most individual investors rely on a 
single retail broker that executes orders on their behalf. As such, 
most customers would never have a chance to compare the execution 
quality of their trades via a given retail broker to similar executions 
at another retail broker. Second, even if a customer used services of 
more than one retail broker contemporaneously, the small sample of that 
individual investor's execution quality metrics as well as differences 
between the orders of the customer that were handled by different 
retail brokers may lead to misleading inferences about execution 
quality differences across brokers.
    The Commission also believes that the benefits of this alternative 
are limited relative to the Proposal because marketable individual 
investor orders would remain mostly isolated, i.e., mostly executed by 
the wholesaler handling these orders. A lack of interaction with 
trading interest from other market participants would prevent the 
execution quality improvements that would otherwise obtain under the 
Proposal. As such, there would be less of an increase in price 
improvement (and reduction in transaction costs) for individual 
investors compared to the Proposal. Additionally, compared to the 
Proposal, this alternative would not provide other market participants, 
including institutional investors, as great a chance to directly 
interact with order flow from individual investors, which may result in 
institutional investors receiving worse order execution quality 
compared to the Proposal.

E. Request for Comments

    The Commission requests comment on all aspects of this initial 
economic analysis, including whether the analysis has: (1) identified 
all benefits and costs, including all effects on efficiency, 
competition, and capital formation; (2) given due consideration to each 
benefit and cost, including each effect on efficiency, competition, and 
capital formation; and (3) identified and considered reasonable 
alternatives to the proposed new rules and rule amendments. The 
Commission requests and encourages any interested person to submit 
comments regarding the proposed rules, the Commission's analysis of the 
potential effects of the proposed rules and proposed amendments, and 
other matters that may have an effect on the proposed rules. The 
Commission requests that commenters identify sources of data and 
information as well as provide data and information to assist us in 
analyzing the economic consequences of the proposed rules and proposed 
amendments. The Commission also is interested in comments on the 
qualitative benefits and costs identified and any benefits and costs 
that may have been overlooked. In addition to our general request for 
comments on the economic analysis associated with the proposed rules 
and proposed amendments, the Commission requests specific comment on 
certain aspects of the proposal:
    38. Do commenters believe the Commission has adequately described 
the market failures due to the existing structure of U.S. stock 
markets? Why or why not?
    39. Do commenters agree with the Commission's qualitative and 
quantitative baseline descriptions of the structure of trading for NMS 
stocks, including trading service, broker services, and access to 
market centers? Why or why not?

[[Page 240]]

    40. Do commenters agree with the Commission's qualitative and 
quantitative baseline descriptions of order routing behavior of retail 
brokers? Why, or why not?
    41. Do commenters agree with the Commission's assessment of 
execution quality and fill rates of individual investor orders in NMS 
stocks? Why, or why not?
    42. Do commenters agree with the Commission's assessment of 
brokers' handling of fractional individual investor orders? Why or why 
not?
    43. Do commenters agree with the Commission's characterization of 
individual investor order flow segmentation by wholesalers? Why, or why 
not?
    44. Do commenters agree with the Commission's characterization of 
the interaction between wholesalers and institutional investors? Please 
explain why, or why not?
    45. Do commenters agree with the Commission's description of market 
making expenses of wholesalers? What other types of such market making 
costs should be considered? Please provide conceptual and quantitative 
context.
    46. Do commenters agree with the Commission's description of the 
trade-off between PFOF and execution quality of individual investor 
orders faced by PFOF receiving retail brokers, driven by the business 
models of these brokers and the wholesalers who offer PFOF? Why, or why 
not?
    47. Do commenters agree with the Commission's descriptions of 
different aspects of retail brokers' business models? Why, or why not?
    48. Do commenters agree the Commission's assessment of conflict of 
interests on the parts of wholesalers and PFOF receiving brokers? 
Please explain your reasoning.
    49. Do commenters agree with the Commission's assessment of the 
impacts of such conflicts of interest on the execution quality of 
individual investor orders? Why or why not?
    50. Do commenters agree with the Commission that a lack of order-
by-order competition is a key missing component in the individual 
investor order execution process? Please explain why or why not.
    51. Do commenters agree with Commission's assessment that retail 
brokers' use of past execution quality metrics to determine the 
allocation of current individual investor order flow across wholesalers 
may lead to poor execution quality for some individual investor orders? 
Why or why not?
    52. Do commenters agree with the Commission that the existing 
execution practices for individual investor orders makes the portion of 
individual investor order flow with the least adverse selection risk 
inaccessible to other market participants, including institutional 
investors? Please explain why or why not.
    53. Do commenters agree with the Commission's assessment that the 
ability of wholesalers to choose which orders to internalize and which 
ones to allow to interact with trading interest with other market 
participants places wholesalers at a competitive advantage? Why or why 
not?
    54. Do commenters agree that the proposed Rule would improve 
competition, including in the market for trading service and the market 
for broker-dealer services? Why or why not?
    55. Do you agree with the Commission that the proposed Rule would 
lower trading costs to individual and institutional investors, enhance 
individual investor order execution quality and price discovery, and 
improve efficiency in the operations of retail brokers? Please explain 
why or why not?
    56. Does the Economic Analysis in this release account for all 
compliance costs? If not, what other compliance cost would market 
participants or exchanges incur? Please provide estimates of the 
additional compliance costs that you believe should be considered.
    57. Does the Economic Analysis in this release account for all 
relevant costs? If not, which other costs should the economic analysis 
consider? Please provide estimates of additional costs, other than 
compliance costs, that you believe should be considered.
    58. Do commenters agree with the Commission's assessment of how the 
Proposed Rule would impact efficiency and capital formation? Why, or 
why not? Please explain.
    59. Do commenters agree with the Commission's analysis of the 
benefits and costs of the reasonable alternatives to the Proposed Rule? 
Why, or why not? Please explain.
    60. Are there any additional reasonable alternatives the Commission 
should consider? If so, please describe that alternative and provide 
the benefits and costs of that alternative relative to the baseline and 
to the proposed Rule.
    61. Should the Commission specify a minimum set of auction 
standards as part of the reasonable alternative to allow open 
competition trading centers more flexibility in designing qualified 
auctions? If so, what minimum set of auction standards should the 
Commission specify and why? Please explain. What would be the costs and 
benefits or other economic effects of specifying this minimum set of 
auctions standards? Should the Commission specify a minimum auction 
duration as part of this alternative? Why or why not? If so, what 
minimum auction duration should the Commission specify? Please explain 
and provide as much analysis and discussion as possible. Should the 
Commission specify that execution priority shall not be based on time 
of receipt of the auction response as part of this alternative? Why or 
why not? Please explain.
    62. Instead of requiring the consolidated tapes to amend their 
plans to include qualified auction messages, should the Commission 
accelerate the inclusion of all auction information in NMS data from 
the MDI Rules? What would be the costs and benefits or other economic 
effects of accelerating the inclusion of all auction information in NMS 
data? How would such an acceleration impact eventual competition among 
competing consolidators or the realization of the anticipated costs and 
benefits of the MDI Rules? Please explain.

VIII. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \736\ requires Federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities. Section 603(a) of the Administrative Procedure 
Act,\737\ as amended by the RFA, generally requires the Commission to 
undertake an initial regulatory flexibility analysis of the impact of 
the proposed rule amendments on ``small entities.'' \738\ Section 
605(b) of the RFA states that this requirement shall not apply to any 
proposed rule or proposed rule amendment which, if adopted, would not 
have a significant impact on a substantial number of small 
entities.\739\
---------------------------------------------------------------------------

    \736\ 5 U.S.C. 601 et seq.
    \737\ 5 U.S.C. 603(a).
    \738\ Although section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
proposed rulemaking, are set forth in Rule 0-10 under the Exchange 
Act, 17 CFR 240.0-10.
    \739\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

Certification for Proposed Rule 615 and the Related Amendments

    Proposed Rule 615 and the proposed related amendments are discussed 
in detail in section IV (Description of Proposed Rule 615) above. The 
economic impact, including the estimated compliance costs and burdens, 
of Proposed Rule 615 are

[[Page 241]]

discussed in section VI (Paperwork Reduction Act Analysis) and section 
VII (Economic Analysis). As discussed above in those sections, Proposed 
Rule 615 and the proposed related amendments would have an impact on 
certain broker-dealers, NMS Stock ATSs, national securities exchanges, 
and national securities associations.

Impact on Broker-Dealers

    Although section 601(b) of the RFA defines the term ``small 
business,'' as stated above, the statute permits agencies to formulate 
their own definitions, and for purposes of Commission rulemaking in 
connection with the RFA, a small business includes a broker or dealer 
that: (1) had total capital (net worth plus subordinated liabilities) 
of less than $500,000 on the date in the prior fiscal year as of which 
its audited financial statements were prepared pursuant to Rule 17a-
5(d) under the Exchange Act,\740\ or, if not required to file such 
statements, a broker-dealer with total capital (net worth plus 
subordinated liabilities) of less than $500,000 on the last day of the 
preceding fiscal year (or in the time that it has been in business, if 
shorter); and (2) is not affiliated with any person (other than a 
natural person) that is not a small business or small 
organization.\741\ Applying this test and based on a review of data 
relating to broker-dealers,\742\ the Commission estimates, as discussed 
below, that of the 3,498 broker-dealers, there are only 4 that would be 
``small entities'' and also in the scope of Proposed Rule 615.
---------------------------------------------------------------------------

    \740\ 17 CFR 240.17a-5(d).
    \741\ See 17 CFR 240.0-10(c); see also 17 CFR 240.0-10(i) 
(providing that a broker or dealer is affiliated with another person 
if: such broker or dealer controls, is controlled by, or is under 
common control with such other person; a person shall be deemed to 
control another person if that person has the right to vote 25% or 
more of the voting securities of such other person or is entitled to 
receive 25% or more of the net profits of such other person or is 
otherwise able to direct or cause the direction of the management or 
policies of such other person; or such broker or dealer introduces 
transactions in securities, other than registered investment company 
securities or interests or participations in insurance company 
separate accounts, to such other person, or introduces accounts of 
customers or other brokers or dealers, other than accounts that hold 
only registered investment company securities or interests or 
participations in insurance company separate accounts, to such other 
person that carries accounts on a fully disclosed basis).
    \742\ The Commission considered FOCUS data and information about 
broker-dealers made publicly available by FINRA through reports 
available at https://brokercheck.finra.org/.
---------------------------------------------------------------------------

    Proposed Rule 615(a) would apply to any restricted competition 
center that executes internally segmented orders in NMS stocks. 
Restricted competition trading centers would include NMS Stock ATSs 
that do not meet the definition of open competition trading center, 
and, with the exception of national securities exchanges, any other 
trading center that executes segmented orders, which would include 
certain broker-dealers. The Commission has identified no broker-dealers 
that likely execute internally orders for customer accounts that would 
be ``small entities.''
    Proposed Rule 615 and the related amendments would also apply to 
any broker or dealer that could potentially handle segmented orders. As 
discussed in section VI, this would include the 157 broker-dealers that 
the Commission has identified that carry customer accounts, and would 
be in the scope of Proposed Rule 615. Of these, the Commission has 
identified 1 that may be a ``small entity.'' Also as discussed in 
section VI, the Commission has identified 25 broker-dealers that may 
fall within the scope of Proposed Rule 615 because, although they 
report that do not carry customer accounts, they report that they do 
effect public customer transactions in equity securities on a national 
securities exchange or OTC and likely are acting as ``executing 
brokers.'' Of these, the Commission has identified 3 that may 
potentially be engaged in lines of business that would make them within 
the scope of Proposed Rule 615 and that may also be ``small entities.'' 
Finally, as discussed in section VI, the Commission has identified 
1,267 broker-dealers that would likely be ``originating brokers'' with 
responsibility for monitoring customer accounts that could potentially 
fall within the scope of Proposed Rule 615. Of these, however, the 
Commission concludes that none of the approximately 20 broker-dealers 
that the Commission estimates would fall within the scope of Proposed 
Rule 615, because they may make the certification referred to in 
paragraph (c)(1) of Proposed Rule 615,\743\ would be ``small 
entities.''
---------------------------------------------------------------------------

    \743\ Supra section VI.C.3 (discussing which broker-dealers 
would likely certify that they established, maintained, and enforced 
policies and procedures reasonably designed to assure that the 
identity of the originating broker will not be disclosed, directly 
or indirectly, to any person that potentially could participate in 
the qualified auction or otherwise trade with the segmented order).
---------------------------------------------------------------------------

Impact on National Securities Exchanges, National Securities 
Associations, and NMS Stock ATSs

    Also as discussed above in sections IV, VI and VII, Proposed Rule 
615 and the proposed related amendments would impose requirements on 
national securities exchanges, national securities associations, and 
NMS Stock ATSs. With respect to national securities exchanges, the 
Commission's definition of a small entity is an exchange that has been 
exempt from the reporting requirements of Rule 601 of Regulation NMS, 
and is not affiliated with any person (other than a natural person) 
that is not a small business or small organization.\744\ Applying this 
test, no national securities exchange is a small entity. The only 
national securities association, is also not a ``small entity.'' \745\
---------------------------------------------------------------------------

    \744\ See 17 CFR 240.0-10(e) (providing that when used with 
reference to an exchange, means any exchange that: (1) has been 
exempted from the reporting requirements of Rule 601; and (2) is not 
affiliated with any person (other than a natural person) that is not 
a small business or small organization); see also 17 CFR 240.0-10(i) 
(providing that a person is affiliated with another person if that 
person controls, is controlled by, or is under common control with 
such other person; and a person shall be deemed to control another 
person if that person has the right to vote 25% or more of the 
voting securities of such other person or is entitled to receive 25% 
or more of the net profits of such other person or is otherwise able 
to direct or cause the direction of the management or policies of 
such other person).
    \745\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    With respect to NMS Stock ATSs, all ATSs, including NMS Stock ATSs, 
are required to register as broker-dealers.\746\ The Commission 
examined recent FOCUS data for the broker-dealers that operate the 32 
NMS Stock ATSs and applying the test for broker-dealers described above 
\747\ believes that none of the NMS Stock ATSs currently trading were 
operated by a broker-dealer that is a ``small entity.''
---------------------------------------------------------------------------

    \746\ Rule 301(b)(1) of Regulation ATS. Also, while a national 
securities exchanges can operate an ATS, subject to certain 
conditions, such an ATS would have to be registered as a broker-
dealer. See Regulation ATS Adopting Release, supra note 27, at 
70891. Currently, no national securities exchange operates an ATS 
that trades NMS stocks.
    \747\ Supra note 741 and accompanying text.
---------------------------------------------------------------------------

    For the above reasons, the Commission certifies that Proposed Rule 
615 and the proposed related amendments would not have a significant 
economic impact on a substantial number of small entities for purposes 
of the RFA.
    The Commission requests written comments regarding this 
certification. The Commission invites commenters to address whether the 
proposed rules would have a significant impact on a substantial number 
of small entities, and requests that commenters describe the nature of 
any impact on small entities and provide empirical data to support the 
extent of the impact.

IX. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of

[[Page 242]]

1996, or ``SBREFA,'' \748\ the Commission must advise OMB whether a 
proposed regulation constitutes a ``major'' rule. Under SBREFA, a rule 
is considered ``major'' where, if adopted, it results in or is likely 
to result in (1) an annual effect on the economy of $100 million or 
more; (2) a major increase in costs or prices for consumers or 
individual industries; or (3) significant adverse effects on 
competition, investment, or innovation. The Commission requests comment 
on the potential effect of the proposed amendments on the U.S. economy 
on an annual basis; any potential increase in costs or prices for 
consumers or individual industries; and any potential effect on 
competition, investment, or innovation. Commenters are requested to 
provide empirical data and other factual support for their views to the 
extent possible.
---------------------------------------------------------------------------

    \748\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

Statutory Authority

    Pursuant to the Exchange Act (15 U.S.C. 78a et seq.), and 
particularly sections 3(b), 5, 6, 11A, 15, 15C, 17(a), 17(b), 19, 
23(a), and 36 thereof (15 U.S.C. 78c(b), 78e, 78f, 78k-1, 78o, 78o-5, 
78q(a), 78q(b), 78s, 78w(a), and 78mm), the Commission proposes to 
amend parts 240 and 242 of chapter II of title 17 of the Code of 
Federal Regulations as follows:

List of Subjects in 17 CFR Parts 240 and 242

    Brokers, Reporting and recordkeeping requirements, Securities.

Text of the Proposed Rule and Amendments

    For the reasons stated in the preamble, the Commission is proposing 
to amend title 17, chapter II of the Code of Federal Regulations:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT of 
1934

0
 1. The general authority citation for part 240 continues to read as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm, 
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et 
seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 
1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-
106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *


Sec.  240.3a51-1  [Amended]

0
2. Amend Sec.  240.3a51-1 by, in paragraph (a), removing the text 
``Sec.  242.600(b)(55)'' and adding in its place ``Sec.  
242.600(b)(58)''.


Sec.  240.13h-1  [Amended]

0
3. Amend Sec.  240.13h-1 by, in paragraph (a)(5), removing the text 
``Sec.  242.600(b)(54)'' and adding in its place ``Sec.  
242.600(b)(57)''.

PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER 
MARGIN REQUIREMENTS FOR SECURITY FUTURES

0
4. The authority for part 242 continues to read as follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.


Sec.  242.105  [Amended]

0
5. Amend Sec.  242.105 by:
0
a. In paragraph (b)(1)(i)(C), removing the text ``Sec.  
242.600(b)(30)'' and adding in its place ``Sec.  242.600(b)(33)''.
0
b. In paragraph (b)(1)(ii), removing the text ``Sec.  242.600(b)(77)'' 
and adding in its place ``Sec.  242.600(b)(84)''.


Sec.  242.201  [Amended]

0
6. Amend Sec.  242.201 by:
0
a. In paragraph (a)(1), removing the text ``Sec.  242.600(b)(55)'' and 
adding in its place ``Sec.  242.600(b)(58)''.
0
b. In paragraph (a)(2), removing the text ``Sec.  242.600(b)(30)'' and 
adding in its place ``Sec.  242.600(b)(33)''.
0
c. In paragraph (a)(3), removing the text ``Sec.  242.600(b)(68)'' and 
adding in its place ``Sec.  242.600(b)(74)''.
0
d. In paragraph (a)(4), removing the text ``Sec.  242.600(b)(50)'' and 
adding in its place ``Sec.  242.600(b)(53)''.
0
e. In paragraph (a)(5), removing the text ``Sec.  242.600(b)(58)'' and 
adding in its place ``Sec.  242.600(b)(62)''.
0
f. In paragraph (a)(6), removing the text ``Sec.  242.600(b)(67)'' and 
adding in its place ``Sec.  242.600(b)(73)''.
0
g. In paragraph (a)(7), removing the text ``Sec.  242.600(b)(77)'' and 
adding in its place ``Sec.  242.600(b)(84)''.
0
h. In paragraph (a)(9), removing the text ``Sec.  242.600(b)(95)'' and 
adding in its place ``Sec.  242.600(b)(105)''.


Sec.  242.204  [Amended]

0
7. Amend Sec.  242.204 by:
0
a. In paragraph (g)(2), removing the text ``Sec.  242.600(b)(77) (Rule 
600(b)(77) of Regulation NMS)'' and adding in its place ``Sec.  
242.600(b)(84) (Rule 600(b)(84) of Regulation NMS)''.
0
8. Amend Sec.  242.600 by:
0
a. In paragraph (b) introductory text, removing the text ``(Sec. Sec.  
242.600 through 242.612)'' and adding in its place ``(Sec. Sec.  
242.600 through 242.615)'';
0
b. Redesignating paragraphs (b)(3) through (100) as follows:

------------------------------------------------------------------------
               Old paragraph                        New paragraph
------------------------------------------------------------------------
(b)(3)....................................  (b)(4)
(b)(4)....................................  (b)(5)
(b)(5)....................................  (b)(6)
(b)(6)....................................  (b)(7)
(b)(7)....................................  (b)(8)
(b)(8)....................................  (b)(9)
(b)(9)....................................  (b)(10)
(b)(10)...................................  (b)(11)
(b)(11)...................................  (b)(12)
(b)(12)...................................  (b)(13)
(b)(13)...................................  (b)(14)
(b)(14)...................................  (b)(15)
(b)(15)...................................  (b)(16)
(b)(16)...................................  (b)(17)
(b)(17)...................................  (b)(18)
(b)(18)...................................  (b)(19)
(b)(19)...................................  (b)(20)
(b)(20)...................................  (b)(21)
(b)(21)...................................  (b)(24)
(b)(22)...................................  (b)(25)
(b)(23)...................................  (b)(26)
(b)(24)...................................  (b)(27)
(b)(25)...................................  (b)(28)
(b)(26)...................................  (b)(29)
(b)(27)...................................  (b)(30)
(b)(28)...................................  (b)(31)
(b)(29)...................................  (b)(32)
(b)(30)...................................  (b)(33)
(b)(31)...................................  (b)(34)
(b)(32)...................................  (b)(35)
(b)(33)...................................  (b)(36)
(b)(34)...................................  (b)(37)
(b)(35)...................................  (b)(38)
(b)(36)...................................  (b)(39)
(b)(37)...................................  (b)(40)
(b)(38)...................................  (b)(41)
(b)(39)...................................  (b)(42)
(b)(40)...................................  (b)(43)
(b)(41)...................................  (b)(44)
(b)(42)...................................  (b)(45)
(b)(43)...................................  (b)(46)
(b)(44)...................................  (b)(47)
(b)(45)...................................  (b)(48)
(b)(46)...................................  (b)(49)
(b)(47)...................................  (b)(50)
(b)(48)...................................  (b)(51)
(b)(49)...................................  (b)(52)
(b)(50)...................................  (b)(53)
(b)(51)...................................  (b)(54)
(b)(52)...................................  (b)(55)
(b)(53)...................................  (b)(56)
(b)(54)...................................  (b)(57)
(b)(55)...................................  (b)(58)
(b)(56)...................................  (b)(60)
(b)(57)...................................  (b)(61)
(b)(58)...................................  (b)(62)
(b)(59)...................................  (b)(63)
(b)(60)...................................  (b)(65)
(b)(61)...................................  (b)(66)
(b)(62)...................................  (b)(67)
(b)(63)...................................  (b)(68)
(b)(64)...................................  (b)(70)
(b)(65)...................................  (b)(71)
(b)(66)...................................  (b)(72)
(b)(67)...................................  (b)(73)
(b)(68)...................................  (b)(74)
(b)(69)...................................  (b)(75)
(b)(70)...................................  (b)(76)
(b)(71)...................................  (b)(77)

[[Page 243]]

 
(b)(72)...................................  (b)(78)
(b)(73)...................................  (b)(79)
(b)(74)...................................  (b)(80)
(b)(75)...................................  (b)(82)
(b)(76)...................................  (b)(83)
(b)(77)...................................  (b)(84)
(b)(78)...................................  (b)(85)
(b)(79)...................................  (b)(86)
(b)(80)...................................  (b)(88)
(b)(81)...................................  (b)(89)
(b)(82)...................................  (b)(90)
(b)(83)...................................  (b)(92)
(b)(84)...................................  (b)(93)
(b)(85)...................................  (b)(94)
(b)(86)...................................  (b)(95)
(b)(87)...................................  (b)(96)
(b)(88)...................................  (b)(97)
(b)(89)...................................  (b)(98)
(b)(90)...................................  (b)(99)
(b)(91)...................................  (b)(101)
(b)(92)...................................  (b)(102)
(b)(93)...................................  (b)(103)
(b)(94)...................................  (b)(104)
(b)(95)...................................  (b)(105)
(b)(96)...................................  (b)(106)
(b)(97)...................................  (b)(107)
(b)(98)...................................  (b)(108)
(b)(99)...................................  (b)(109)
(b)(100)..................................  (b)(110)
------------------------------------------------------------------------

0
c. Adding new paragraphs (b)(3), (b)(22), (b)(23), (b)(59), (b)(64), 
(b)(69), (b)(81), (b)(87), (b)(91), and (b)(100).
    The additions read as follows:


Sec.  242.600  NMS security designation and definitions.

* * * * *
    (b) * * *
    (3) Affiliate means, with respect to a specified person, any person 
that, directly or indirectly, controls, is under common control with, 
or is controlled by, the specified person.
* * * * *
    (22) Continuous order book means a system that allows orders for 
NMS stocks to be accepted and executed on a continuous basis.
    (23) Control means the power, directly or indirectly, to direct the 
management or policies of a broker, dealer, or open competition trading 
center, whether through ownership of securities, by contract, or 
otherwise. A person is presumed to control a broker, dealer, or open 
competition trading center if that person:
    (i) Is a director, general partner, or officer exercising executive 
responsibility (or having similar status or performing similar 
functions);
    (ii) Directly or indirectly has the right to vote 25 percent or 
more of a class of voting securities or has the power to sell or direct 
the sale of 25 percent or more of a class of voting securities of the 
broker, dealer, or open competition trading center; or
    (iii) In the case of a partnership, has contributed, or has the 
right to receive upon dissolution, 25 percent or more of the capital of 
the broker, dealer, or open competition trading center.
* * * * *
    (59) NMS Stock ATS has the meaning provided in Sec.  242.300(k).
* * * * *
    (64) Open competition trading center means either:
    (i) A national securities exchange that:
    (A) Operates an SRO trading facility that is an automated trading 
center and displays automated quotations that are disseminated in 
consolidated market data pursuant to Sec.  242.603(b);
    (B) Provides transaction reports identifying the national 
securities exchange as the venue of execution that are disseminated in 
consolidated market data pursuant to Sec.  242.603(b);
    (C) During at least four of the preceding 6 calendar months, had an 
average daily share volume of 1.0 percent or more of the aggregate 
average daily share volume for NMS stocks as reported by an effective 
transaction reporting plan; and
    (D) Operates pursuant to its own rules providing that the national 
securities exchange will comply with the requirements of Sec.  
242.615(c) for a qualified auction; or
    (ii) An NMS Stock ATS that:
    (A) Displays quotations through an SRO display-only facility in 
compliance with Sec.  242.610(b);
    (B) Operates as an automated trading center and displays automated 
quotations that are disseminated in consolidated market data pursuant 
to Sec.  242.603(b);
    (C) Provides transaction reports identifying the NMS Stock ATS as 
the venue of execution that are disseminated in consolidated market 
data pursuant to Sec.  242.603(b);
    (D) Permits any registered broker or dealer to become a subscriber 
of the NMS Stock ATS; provided, however, the NMS Stock ATS:
    (1) Shall not permit any registered broker or dealer subject to a 
statutory disqualification to be or become a subscriber; and
    (2) May, pursuant to written policies and procedures, prohibit any 
registered broker or dealer from being or becoming a subscriber, or 
impose conditions upon such a subscriber, that does not meet the 
standards of financial responsibility or operational capability as are 
prescribed by such written policies and procedures;
    (E) Provides equal access among all subscribers of the NMS Stock 
ATS and the registered broker-dealer of the NMS Stock ATS to all 
services that are related to:
    (1) A qualified auction operated by the NMS Stock ATS under Sec.  
242.615(c); and
    (2) Any continuous order book operated by the NMS Stock ATS;
    (F) During at least four of the preceding six calendar months, had 
an average daily share volume of 1.0 percent or more of the aggregate 
average daily share volume for NMS stocks as reported by an effective 
transaction reporting plan; and
    (G) Operates pursuant to an effective Form ATS-N under Sec.  
242.304, and such Form ATS-N evidences compliance by the NMS Stock ATS 
with the requirements of Sec.  242.615(c) for a qualified auction and 
with the provisions of paragraphs (b)(64)(ii)(A) through (b)(64)(ii)(F) 
of this section.
* * * * *
    (69) Originating broker means any broker with responsibility for 
handling a customer account, including, but not limited to, opening and 
monitoring the customer account and accepting and transmitting orders 
for the customer account.
* * * * *
    (81) Qualified auction means an auction that is operated by an open 
competition trading center pursuant to Sec.  242.615(c).
* * * * *
    (87) Restricted competition trading center means any trading center 
that is not an open competition trading center and is not a national 
securities exchange.
* * * * *
    (91) Segmented order means an order for an NMS stock that is for an 
account:
    (i) Of a natural person or an account held in legal form on behalf 
of a natural person or group of related family members; and
    (ii) In which the average daily number of trades executed in NMS 
stocks was less than 40 in each of the six preceding calendar months.
    (iii) For purposes of this paragraph (b)(91), group of related 
family members means a group of natural persons with any of the 
following relationships: child, stepchild, grandchild, great 
grandchild, parent, stepparent, grandparent, great grandparent, 
domestic partner, spouse, sibling, stepbrother, stepsister, niece, 
nephew, aunt, uncle, mother-in-law, father-in-law, son-in-law, 
daughter-in-law, brother-in-law, or sister-in-law, including adoptive 
and foster relationships; and any other natural person (other than a 
tenant or employee)

[[Page 244]]

sharing a household with any of the foregoing natural persons.
* * * * *
    (100) Subscriber has the meaning provided in Sec.  242.300(b).
* * * * *


Sec.  242.602  [Amended]

0
9. Amend Sec.  242.602 by, in paragraphs (a)(5)(i) and (ii), removing 
the text ``Sec.  242.600(b)(90)'' and adding in its place ``Sec.  
242.600(b)(99)''.


Sec.  242.611  [Amended]

0
10. Amend Sec.  242.611 by, in paragraph (c), removing the text ``Sec.  
242.600(b)(38)'' and adding in its place ``Sec.  242.600(b)(41)''.


Sec.  242.614  [Amended]

0
11. Amend Sec.  242.614 by, in paragraphs (d)(1), (2), and (3), 
removing the text ``Sec.  242.600(b)(20)'' and adding in its place 
``Sec.  242.600(b)(21)''.
0
12. Add Sec.  242.615 to read as follows:


Sec.  242.615  Order competition rule.

    (a) Order competition requirement. A restricted competition trading 
center shall not execute internally a segmented order for an NMS stock 
until after a broker or dealer has exposed such order to competition at 
a specified limit price in a qualified auction that meets the 
requirements of paragraph (c) of this section and is operated by an 
open competition trading center. If the segmented order is not executed 
in the qualified auction, a restricted competition trading center may, 
as soon as reasonably possible, execute the segmented order internally 
at a price that is equal to or more favorable for the segmented order 
than the specified limit price in the qualified auction.
    (b) Exceptions. The order competition requirement of paragraph (a) 
of this section shall not apply if:
    (1) The segmented order is received and executed by the restricted 
competition trading center during a time period when no open 
competition trading center is operating a qualified auction for the 
segmented order;
    (2) The market value of the segmented order is at least $200,000 
calculated with reference to the midpoint of the national best bid and 
national best offer when the segmented order is received by the 
restricted competition trading center;
    (3) The segmented order is executed by the restricted competition 
trading center at a price that is equal to or more favorable for the 
segmented order than the midpoint of the national best bid and national 
best offer when the segmented order is received by the restricted 
competition trading center;
    (4) The segmented order is a limit order with a limit price 
selected by the customer that is equal to or more favorable for the 
segmented order than the midpoint of the national best bid and national 
best offer when the segmented order is received by the restricted 
competition trading center; or
    (5) The segmented order is received and executed by the restricted 
competition trading center during a time period when no open 
competition trading center is operating a qualified auction for the 
segmented order that accepts orders that are not entirely in whole 
shares, and the customer selected a size for a segmented order that is 
not entirely in whole shares of an NMS stock, in which case any portion 
of such segmented order that is less than one whole share of the NMS 
stock, and only such portion, shall not be subject to the order 
competition requirement of paragraph (a) of this section.
    (c) Qualified auction requirements. An open competition trading 
center shall comply with the following requirements for operation of a 
qualified auction for segmented orders.
    (1) Auction message. (i) An auction message announcing the 
initiation of a qualified auction for a segmented order shall be 
provided for dissemination in consolidated market data pursuant to 
Sec.  242.603(b). Each such auction message shall invite priced auction 
responses to trade with a segmented order and shall include the 
identity of the open competition trading center and the symbol, side, 
size, limit price, and identity of the originating broker for the 
segmented order.
    (ii) If more than one broker is an originating broker for a 
segmented order, the originating broker identified pursuant to 
paragraph (c)(1)(i) of this section shall be the broker responsible for 
approving the opening of accounts with customers.
    (iii) Notwithstanding the provisions of paragraph (c)(1)(i) of this 
section, the identity of the originating broker shall not be disclosed 
in the auction message if such originating broker certifies that it has 
established, maintained, and enforced written policies and procedures 
reasonably designed to assure that the identity of the originating 
broker will not be disclosed, directly or indirectly, to any person 
that potentially could participate in the qualified auction or 
otherwise trade with the segmented order, and the originating broker's 
certification is communicated to the open competition trading center 
conducting the qualified auction.
    (2) Auction responses. An open competition trading center shall 
accept auction responses for a period of at least 100 milliseconds 
after an auction message is provided for dissemination in consolidated 
market data and shall end the auction not more than 300 milliseconds 
after an auction message is provided for dissemination in consolidated 
market data. Auction responses shall remain undisplayed during the 
auction period and not disseminated at any time thereafter.
    (3) Pricing increments. Segmented orders and auction responses 
shall be priced in an increment of no less than $0.001 for segmented 
orders and auction responses with prices of $1.00 or more per share, in 
an increment of no less than $0.0001 for segmented orders and auction 
responses with prices of less than $1.00 per share, or at the midpoint 
of the national best bid and national best offer.
    (4) Fees and rebates. No fee shall be charged for submission or 
execution of a segmented order. No fee shall be charged for submission 
of an auction response. The fee for execution of an auction response 
shall not exceed $0.0005 per share for auction responses priced at 
$1.00 per share or more, shall not exceed 0.05% of the auction response 
price per share for auction responses priced at less than $1.00 per 
share, and otherwise shall be the same rate for executed auction 
responses in all auctions. Any rebate for the submission or execution 
of a segmented order or for the submission or execution of an auction 
response shall not exceed $0.0005 per share for segmented orders or 
auction responses priced at $1.00 per share or more, shall not exceed 
0.05% of the segmented order or auction response price per share for 
segmented orders or auction responses priced at less than $1.00 per 
share, and otherwise shall be the same rate for segmented orders in all 
auctions and shall be the same rate for auction responses in all 
auctions.
    (5) Execution priority of auction responses and resting orders. (i) 
The highest priced auction responses to buy and the lowest priced 
auction responses to sell shall have priority of execution.
    (ii) Auction responses for the account of a customer shall have 
priority over auction responses for the account of a broker or dealer 
at the same price.
    (iii) As long as an auction response is received within the 
prescribed time period, execution priority shall not be based on time 
of receipt of the auction response.
    (iv) The terms of execution priority shall not favor the broker or 
dealer that routed the segmented order to the auction, the originating 
broker for the segmented order, the open competition

[[Page 245]]

trading center operating the auction, or any affiliate of the foregoing 
persons.
    (v) Orders resting on a continuous order book of the open 
competition trading center operating the qualified auction at the 
conclusion of an auction period shall have priority over auction 
responses at a less favorable price for the segmented order. Displayed 
orders resting on a continuous order book of the open competition 
trading center operating the qualified auction shall have priority over 
auction responses at the same price. Auction responses shall have 
priority over undisplayed orders resting on a continuous order book of 
the open competition trading center operating the qualified auction at 
the same price.
    (d) Open competition trading centers. (1) A national securities 
exchange or NMS Stock ATS shall not operate a qualified auction for 
segmented orders unless it complies with the provisions of this section 
and meets the definition of open competition trading center in Sec.  
242.600(b)(64).
    (2) An open competition trading center shall not operate a system, 
other than a qualified auction, that is limited, in whole or in part, 
to the execution of segmented orders unless any segmented order 
executed through such system:
    (i) Is received and executed by the open competition trading center 
during a time period when no open competition trading center is 
operating a qualified auction for the segmented order;
    (ii) Has a market value of at least $200,000 calculated with 
reference to the midpoint of the national best bid and national best 
offer when the segmented order is received by the open competition 
trading center; or
    (iii) Is executed by the open competition trading center at a price 
that is equal to or more favorable for the segmented order than the 
midpoint of the national best bid and national best offer when the 
segmented order is received by the open competition trading center.
    (iv) Is a limit order with a limit price selected by the customer 
that is equal to or more favorable for the segmented order than the 
midpoint of the national best bid and national best offer when the 
segmented order is received by the open competition trading center; or
    (v) Is received and executed by the open competition trading center 
during a time period when no open competition trading center is 
operating a qualified auction for the segmented order that accepts 
orders that are not entirely in whole shares, and is a size, selected 
by the customer, that is not entirely in whole shares of an NMS stock, 
in which case any portion of such segmented order that is less than one 
whole share of the NMS stock, and only such portion, may be executed 
through such system.
    (e) Originating brokers. (1) An originating broker shall establish, 
maintain, and enforce written policies and procedures reasonably 
designed to identify the orders of customers as segmented orders as 
defined in Sec.  242.600(b)(91).
    (2) An originating broker shall not route a customer order 
identified as a segmented order without also identifying such order as 
a segmented order to the routing destination.
    (3) An originating broker that makes a certification referred to in 
paragraph (c)(1)(iii) of this section shall establish, maintain, and 
enforce written policies and procedures reasonably designed to assure 
that the identity of the originating broker will not be disclosed, 
directly or indirectly, to any person that potentially could 
participate in the qualified auction or otherwise trade with the 
segmented order.
    (4) Where there are multiple originating brokers for a segmented 
order, an originating broker shall not be deemed to be in violation of 
the provisions of paragraphs (e)(1) through (3) of this section arising 
solely from a failure to meet a responsibility that was specifically 
allocated by prior written agreement to another originating broker.
    (f) Brokers or dealers. (1) No broker or dealer that receives an 
order identified as a segmented order shall route such order without 
identifying such order as a segmented order to the routing destination.
    (2) No broker or dealer with knowledge of where a segmented order 
is to be routed for execution shall submit an order, or enable an order 
to be submitted by any other person, to the continuous order book of an 
open competition trading center or of a national securities exchange 
that could have priority to trade with the segmented order at such open 
competition trading center or national securities exchange.
    (g) National securities exchanges. A national securities exchange 
shall not operate a system, other than a qualified auction, that is 
limited, in whole or in part, to the execution of segmented orders 
unless any segmented order executed through such system:
    (1) Is received and executed by the national securities exchange 
during a time period when no open competition trading center is 
operating a qualified auction for the segmented order;
    (2) Has a market value of at least $200,000 calculated with 
reference to the midpoint of the national best bid and national best 
offer when the segmented order is received by the national securities 
exchange;
    (3) Is executed by the national securities exchange at a price that 
is equal to or more favorable for the segmented order than the midpoint 
of the national best bid and national best offer when the segmented 
order is received by the national securities exchange.
    (4) Is a limit order with a limit price selected by the customer 
that is equal to or more favorable for the segmented order than the 
midpoint of the national best bid and national best offer when the 
segmented order is received by the national securities exchange; or
    (5) Is received and executed by the national securities exchange 
during a time period when no open competition trading center is 
operating a qualified auction for the segmented order that accepts 
orders that are not entirely in whole shares, and is a size, selected 
by the customer, that is not entirely in whole shares of an NMS stock, 
in which case any portion of such segmented order that is less than one 
whole share of the NMS stock, and only such portion, may be executed 
through such system.


Sec.  242.1000  [Amended]

0
13. Amend Sec.  242.1000, in the definition Plan processor, by removing 
the text ``Sec.  242.600(b)(67)'' and adding in its place ``Sec.  
242.600(b)(73)''.

    By the Commission.

    Dated: December 14, 2022.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-27617 Filed 12-30-22; 8:45 am]
 BILLING CODE 8011-01-P