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SEC Open Meeting

Securities and Exchange Commission

Open Meeting

Wednesday, December 14, 2022

Topline

  • The Commission voted to advance all five agenda items, with the first three approved unanimously and the last two by a vote of 3-2.
  • The comment period for all four of the proposals will be open until March 31 or 60 days after publication in the Federal Register, whichever is later.

Agenda

  • ITEM 1: Insider Trading Arrangements and Related Disclosures
  • ITEM 2: Disclosure of Order Execution Information
  • ITEM 3: Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders
  • ITEM 4: Order Competition Rule
  • ITEM 5: Regulation Best Execution

ITEM 1: Insider Trading Arrangements and Related Disclosures

The Commission voted 5-0 to adopt amendments to Rule 10b5-1 under the Securities Exchange Act, and new disclosure regarding Rule 10b5-1 trading arrangements and insider trading policies and procedures, as well as amendments regarding the disclosure of the timing of certain equity compensation awards and reporting of gifts on Form 4.

Staff Discussion

Renee Jones introduced the proposal, explaining how insider trading harms individuals and erodes investor confidence. She expressed concern that the SEC’s existing requirements do not provide investors with adequate disclosure. The recommended amendments to the affirmative defense provided by Rule 10b5-1 would add a condition that traders other than the issuer must satisfy, including a minimum cooling off period before trading can commence under Rule 10b5-1 plans. Jones noted that the amendments would also restrict traders from maintaining multiple overlapping trading plans, and would limit the ability to rely on the affirmative defense to one single trade during a 12-month period. The amendments would add new disclosure requirements as well, including quarterly disclosures by issuers about the use of 10b5-1 plans by directors and officers and annual disclosures about insider trading policies and procedures. Finally, Jones noted that the amendments will require relevant filers to identify transactions that are made pursuant to a plan intended to satisfy the defense to Rule 10b5-1 on Forms 4 and 5.

Sean Harrison explained the recommended amendments further. He noted again that these changes are designed to address, among other things, potentially abusive practices associated with Rule 10b5-1 trading arrangements, and to provide greater transparency to investors about options close in time to an issuer’s disclosure of non-public information. He noted that the proposal include: a cooling off period before any trading can begin under the plan, annual disclosure of a registrant’s insider trading policies and procedures, corresponding amendments for Form 20-F to provide similar annual disclosure of insider trading policies and procedures, and amendments to Item 402 of Regulation S-K to require registrants to provide new narrative disclosures. Finally, he explained four amendments to rules and forms under Section 16 of the Exchange Act. First, the proposal would add an amendment to Rule 16a-3 to require the reporting of dispositions of equities securities of bona-fide gifts on Form 4, rather than Form 5. As a result, an officer, director, or beneficial owner of more than 10% of an issuer’s equities securities making a gift of equity securities will be required to report the gift on Form 4 before the second business day following the date of execution of the transactions. Second, Harrison said the proposal would add a Rule 10b5-1(c) check box to Forms 4 and 5, which will require filers to indicate whether a sale of purchase reported was intended to satisfy conditions of 10b5-1 and also disclose the date of adoption of the 10b5-1 trading arrangement. Third, it will provide a phase in period for new disclosure requirements, as Section 16 reported persons will be required to comply with the changes to Forms 4 and 5 on reports filed on or after April 1, 2023. Finally, Harrison noted that smaller companies will be required to comply with the disclosure requirements on Forms 10-K, 10-Q, or 20-F.

Commissioner Discussion

Commissioner Hester Peirce stated that while the proposal is more prescriptive than she would have preferred, she will support it for “likely doing more good than bad.” She noted that it should allow insiders to trade, while also making it more difficult to abuse 10b5-1 plans. In particular, Peirce highlighted the cooling off period for entering and exiting plans and the limitation of overlapping plans.

She appreciated that the final rule improves the definition of non 10b5-1 plans and contains fewer costly disclosure requirements than the proposed rule, but argued that it is still unnecessarily restrictive. Specifically, Peirce said that the rule’s narrative requirement would suffice to address any concerns about executive compensation, and that the Commission should have allowed companies to list their policies on insider trading on their website to reduce cost (as opposed to publication on EDGAR). Finally, she said the rule applies unreasonable deadlines for bona-fide gifts.

Commissioner Caroline Crenshaw said that while executives and other corporate insiders are routinely exposed to material, non-published information, trading on that before it becomes public undermines confidence in our markets. She explained that in light of this fact, but knowing that sometimes these individuals need to trade, the SEC allowed for 10b5-1 plans. She noted, however, that over time these rules have ceased to provide appropriate investor protection and have been abused. Crenshaw said she is pleased that the committee is addressing this issue, adding that these protections should help limit the scope of 10b5-1 plans and bolster investor confidence in the market.

Commissioner Mark Uyeda stated the amendments are intended to address concerns and strike a balance between eliminating opportunistic behavior and creating a rule that can be implemented on a practical basis. He said he would support the final amendments, but expressed his hope that market participants will provide feedback on whether the right balance has been struck. Uyeda argued that the cooling-off period is the most effective mechanism to ensure insiders are not trading based on NMPI. The commissioner did have a few concerns with the proposal, including: (1) that it may unnecessarily restrict the use of overlapping plans or single-trade plans for legitimate reasons; (2) that the use of “good faith” as a determination may cause confusion or uncertainty; (3) the lack of a plan to implement structured data reporting; and (4) that this proposal includes the third change to Item 402 of regulation S-K since he joined the SEC.

Commissioner Jaime Lizarraga stated that reforms will strengthen investor confidence in securities markets. He noted that the proposed amendments are designed to fulfill the intent of the original rule, and they will reduce opportunities for corporate insiders to abuse 10b5-1 plans. He argued that cooling off periods will deter insider trading, but that they are not sufficient by themselves. He also said the current information gap about policies related to insider trading undercuts the rule’s effectiveness, as investors must understand how issuers protect material information from misuse.

Chair Gary Gensler explained that given that company insiders regularly have this information, and because of the importance of stock-based compensation, these amendments are important to meet policy goals. He noted that the proposals are addressing gaps that have been found over the last 20 years. He closed by noting that the updates to the forms are appropriate, and that these reforms speak to the confidence of the public in the market.

ITEM 2: Disclosure of Order Execution Information

The Commission voted 5-0 to propose rule amendments to update the disclosure required by Rule 605 under Regulation NMS of the Securities Exchange Act of 1934.

Staff Discussion

Haoxiang Zhu introduced the proposal and noted that Rule 605 was adopted to facilitate the ability of the public to compare and evaluate execution quality among different market centers. In the two decades since its adoption, Zhu said, Rule 605 disclosures have provided valuable insight into market centers, and the equity market itself has evolved dramatically. The proposal includes recommended updates to broaden the coverage of Rule 605 and add more information to the disclosures. He then went on to explain the three aspects of the proposal: (1) expand the scope of entities subject to the rule to require broker dealers with a large number of customer accounts to make execution quality reports and amend Rule 605 to require separate reports for single dealer platforms and market centers; (2) update and require execution quality metrics to make information granular, useful, and relevant, to and better reflect the increased speed of trading; (3) require that all entities subject to Rule 605 also make available summary execution quality reports that provide more access and “human-readable” data.

Lauren Yates further explained that the proposed amendments to Rule 605 would expand the scope of entities to include broker dealers with 100,000 or more accounts, and would also require separate reports required for each function. Yates argue that expanding the scope of reported entities would increase transparency into difference of execution quality. She said requiring separate reports would also allow market participants to assess the execution quality of each market individually. She further explained that the changes would require all entities to make a monthly report available, with a focus on price-based information and execution speed. Providing this information in a standard format would improve the accessibility of Rule 605 data so market participants and investors can compare execution quality across reporting entities.

Kathleen Gross said that the proposed rule would update the scope of the order and the content of monthly reports. She said the updates would better reflect the speed of the marketplace and increase the usefulness of the report. She outlined three updates to the scope of the order, noting that: (1) the amendments would expand the definition of covered order to include certain orders submitted outside of trading hours; (2) the existing order categories would be modified to base them on round laws, rather than the number of shares, to better group orders of similar size; (3) the proposal would modify how orders are categorized by order type and add new order type categories. Gross then explained the recommendations to the content contained in the reports under Rule 605, including: (1) eliminating the current time to execute reporting categories and replacing it with average, medium, and 99% time to execution; (2) making average realized spread statistics calculated after 15 seconds and one minute as opposed to current the current five minute horizon; (3) adding new statistical measures of execution quality, including average effective over quoted spread, performing effective and realized spread, and a size improvement benchmark; and (4) adding price improvement statistics that show price improvements relative to the best price in the market.

Finally, Jessica Wachter said that execution quality at the level of individual broker dealers is an important piece of information about markets that has been missing. She said that evidence shows quality differs between brokers, and that market center level execution statistics do not tell the entire story. She explained that the proposal is an important step forward in market transparency, and that the amendments would make important modifications to the reporting itself. Wachter also noted that markets are faster than they used to be, so the updated time stamp conventions would shrink the time frame used to capture realized spreads. Finally, she said these measures would come with compliance costs, which would be greatest for those reporting for first time.

Commissioner Discussion

Commissioner Hester Peirce stated that the four remaining rules will interact with existing rules and each other in complex ways. She also noted that other rules the Commission previously adopted have not taken effect. She warned that effective regulation requires prudence and humility on behalf of the regulator, and cautioned her fellow commissioners against being overconfident about the SEC’s ability to make market structure overhauls in a market that is functioning well for retail investors. Peirce, however, signaled her support for the smaller proposed changes, including the amendments to Rule 605. She said that Rule 605 does not currently provide sufficient information to judge execution quality, and added that these proposals appear to be a reasonable attempt to address deficiencies. She also expressed her eagerness to hear from the public on questions including: Who will use the data? Does it make sense to have broker dealers report this data? Have we targeted the right broker dealers? Are monthly summaries going to be informative? Should we allow these changes to take effect before the more fundamental changes being proposed today?

Finally, Peirce questioned Zhu about the combined impact of the rules being proposed. She asked whether staff had considered the impact of all five rules being adopted at the same time. Zhu said they believe the rules stand on their own and deliver their own benefits. Peirce also asked if the Commission and the public will be able to compare execution quality before and after the rules have been adopted. Zhu responded that because of the additional information broker dealers will have to put in, it is impossible to make that comparison. He also noted, however, that broker dealers will be incentivized to provide better execution because of the additional transparency.

Commissioner Caroline Crenshaw opened by noting that equity market structures are a place where Americans can invest and grow their savings. She said that to serve this purpose, inventors must have confidence in trading venues and intermediaries. The package of new rules and amendments, in her opinion, is designed to improve outcomes for all investors, and retail investors in particular. She also noted that public comment is vital to these rules, and that she hopes to hear about whether this approach is optimal. Crenshaw continued by explaining that while Rule 605 has provided valuable information about execution quality provided by different market centers, the amendments would provide common sense updates. She also posed questions to the public, including: (1) should Rule 605 should include all broker dealers; (2) should formatting of reports be standardized; and (3) should reports be located in one central location.

Commissioner Mark Uyeda concurred with Peirce, stating that the combined effects of all four proposals should be considered. However, despite not agreeing with the entire proposal, he supported it because it will provide a good opportunity for public comment. He is particularly looking forward to hearing if there are alternative ways to update the metrics and requirements. Uyeda also asked Zhu whether they be considering the effects of the various compliance dates. He noted that the Commission just approved 10b5-1 changes (which will affect broker dealers), updated Rule 144 filings earlier this year, and anticipates doing something on T+1. Zhu said staff will consider the comments on all compliance dates. Uyeda asked him to keep track of when the various compliance dates go into effect, especially since some are triggered by the date of upload to the federal register.

Commissioner Jaime Lizarraga said that shedding more light on best execution of trade and fees will lower costs for retail investors. He added that payment for order flow is an area for concern, as it often conflicts with the obligation for best order execution. He also noted that the SEC’s rules need to keep up with current market realities, including ensuring that the order routing and execution is transparent, competitive, and governed. He closed by expressing his support for the reforms being considered, as they will offer direct and indirect benefits to retail investors.

Chair Gary Gensler also noted his support for this rule and the other four being discussed. He said this specific rule improves transparency on execution quality, and will help both institutional and retail investors. He noted that, while Rule 605 requires important monthly disclosures from market centers, equity markets have been transformed since the rule was first adopted 22 years ago. As a result, the current rule gives an incomplete picture of execution quality. Gensler explained that the proposal would add metrics to execution quality, which currently lacks context about how price improvement is calculated versus percent of the stock price and percent of bid ask spread. He added that to help investors compare, disclosures will be needed by larger broker dealers, not just market centers. Finally, he highlighted a small but important change to provide summary reports on execution quality that everyday investors can actually read.

ITEM 3: Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders

The Commission voted 5-0 to propose amendments to certain rules under Regulation NMS of the Securities Exchange Act of 1934 to adopt variable minimum pricing increments for the quoting and trading of NMS stocks, reduce access fee caps, and enhance the transparency of better priced orders.

Staff Discussion

Zhu introduced the proposal and explained the three main elements: (1) amend the minimum price increments (tick sizes) to establish a variable minimum price increment model that would apply to the quotes and the trading of stocks regardless of venue); (2) reduce access fee caps under Rule 610 and require national security changes; and (3) accelerate the limitation of round lot and information definitions adopted in 2020 in the market data infrastructure rules.

Kelly Riley explained the three areas of change to NMS in more detail. The first change is the amended tick sizes under Rule 612. Currently, stock prices equal to or greater than $1 a share may not be quoted in increments smaller than one penny, while quotations for NMS may not be quoted inside increments smaller than 100.  The proposal recommends a new variable minimum pricing increment model to reflect differences in trading characteristics for stocks. She explained that it would amend 612 to adopt four potential minimum pricing increments for quotations and NMS stocks priced equal to or greater than a share, and it would vary based on the time weighted average spread for stocks, which would be calculated by the primary exchanges. As a result, she said, stocks could have different minimum pricing increments from quarter to quarter. The four minimum pricing increments would be 1/10th of a cent, 2/10th of a cent, .5 of a cent, and 1 cent.

Next, Riley explained the second change in the proposal, to reduce access fee caps in Rule 610. In light of the proposed changes to Rule 612, as well as market innovations and technological efficiency since Rule 610 was implemented, the division proposed to reduce the access fee caps for protected quotations in NMS stocks priced $1.00 or more to $0.0005 per share for those NMS stocks that have a minimum pricing increment of $0.001, and to $0.001 per share for those NMS stocks that have a minimum pricing increment greater than $0.001 per share. For protected quotations in NMS stocks priced less than $1.00 per share, the proposal would cap access fees at 0.05 percent of the quotation price. She also explained that the proposal amends Rule 610 to require the exchanges to make the amount of fees and rebates determinable at the time of execution.

Finally, she said the proposal would accelerate the implementation of round lot and odd lot information definitions. It revises the odd lot information definition by including identification of the best odd lot orders to enhance transparency and provide a benchmark to assess the execution of an order.

Wachter explained that by lowering the tick sizes, the proposal provides more room for liquidity providers to compete. She noted that it only changes the increment for stocks with low spreads. She said that the proposal sets a minimum increment for trading as well as quoting, and added that there will be compliance costs to implement the new tick regime. Wachter said those transacting large orders may find it more expensive to trade.

Commissioner Discussion

Commissioner Hester Peirce noted that the proposal would amend discreet elements of NMS that have received scrutiny from market participants. She added that it would accelerate certain elements of market data infrastructure rules, and establish a consolidated best odd lot order that would provide information about the price size and market. Peirce supported putting this proposal out for public comment, as commenters can help the Commissioners answer whether they have the tick sizes right. Despite her support, Peirce also noted a few reservations. She said it could be easier for commenters to perform analyses and provide feedback, but the proposal does not lay out how the rule will interact with other proposals being considered. She added that mandating uniform trading increments across the market for NMS stocks also gives her pause, and said the proposal does not explain why variety in different market centers is a bad thing.

Peirce also had multiple questions for staff. First, she asked how the minimum trade price increments will impact the 605 rules, and whether it will be evident in 605 reports what the tick size is. Zhu said that the statistics in 605 are aggregated across the sample people, so it would be hard to infer. Gross responded that since it will be symbol by symbol, one could use that to figure out the tick size. Peirce noted that this will be confusing since the tick size can change over time, and added that the Commission may want to think about how to flag that.

She also noted that the release suggests that proposed changes could be good for enhancing competition for retail orders. Since the Commission is hoping that Rule 605 reforms will have similar effects, she asked Zhu if it would make sense to wait on the final proposals. The director responded by highlighting that 605 is about competition across market centers and broker dealers, while tick increments are meant to level the playing field so no market center can price at an increment that others cannot provide.

Commissioner Caroline Crenshaw said that with respect to specific pricing increments in the proposal, many participants have suggested that smaller tick sizes would be helpful. She noted that smaller tick size adds complexity, and that commenter feedback will be vital to address these concerns. She continued by explaining that while the proposal would require that all exchange fees and rebates to be determinable at the time an order is executed, she still has concerns about fees and rebates model more generally.  Finally, Crenshaw said that odd lot quotes and higher price stocks provide better prices than round lot NBBO, and that the amendment builds on proposed changes that the commission adopted as part of market infrastructure rulemaking. She said the reduction of round lot size and the inclusion of odd lot information data will help investors take advantage of better priced liquidity available in the markets. In her opinion, given the increasing prevalence of odd lot orders in the markets, these are necessary changes that are long overdue.

Commissioner Mark Uyeda said tick size ought to be reconsidered, as having an established tick size that is a minimum price increment may make sense to preserve liquidity. He noted, however, that if an established tick size is too large, it may place an effective price floor on the provision of liquidity and preclude competition. There is an optimal range for tick sizes. Overall, Uyeda said, the benefits of applying a minimum tick size to executions is less obvious, and he look forward to public comments on this point.

Uyeda also said that while the reduction of access fee caps may make sense in the context of smaller tick sizes, the overall lowering of fees will likely result in a reduction of rebates, which could have unintended consequences and shift the competitive playing field in unpredictable ways. He hopes for public comment on all of these issues.

Commissioner Jaime Lizarraga said that the Commission is proposing important amendments and rules that enhance liquidity and strengthen markets. He said the updates to NMS rules to reflect the current environment are long overdue.

Chair Gary Gensler said that as of September, as much as 42% of share value is executed off exchange. He explained that off exchange market centers benefit from using a different set of rules than securities exchanges, which may hurt competition. Gensler argued that the proposal will help drive better efficiency, competition, and fairness in our markets. He said off exchange market centers can execute trades at narrower increments at the sub-penny level than lit markets, adding that harmonizing tick sizes would help level the playing field between off exchange and lit markets. He continued by stating that the access fee cap is not aligned with current trading volumes and technology, and the proposal brings greater transparency to the access fee changes and rebates. He said traders need to be able to determine the fees and rebates at the time of the trade. As it relates to round lots and odd lots, Gensler said it is appropriate to accelerate what a prior commission had voted on.

Finally, Gensler reaffirmed that all of these proposals are consistent with the Commission’s mandate. In response to Peirce, he said this package is separate from the other rules, and the disclosure in Rule 605 stands on its own. These reforms address the marketplace structure put in place in 2005.

ITEM 4: Order Competition Rule

The Commission voted 3-2 to propose a new rule under Regulation NMS of the Securities Exchange Act of 1934 titled the Order Competition Rule, which would require certain equity orders of retail investors to be exposed to competition in fair and open auctions before such orders could be executed internally by any trading center that restricts order-by-order competition.

Staff Discussion

Zhu introduced the proposed new “Order Competition Rule” to promote a more competitive, transparent, and efficient market for stocks. The rule would require that certain orders of individual investors be exposed to competition in fair and open auctions. He said the elements attract broad participation by market participants, including wide dissemination of auction messages into consolidated market data and requirements that any fees and rebates be capped at a low level and flat across all market participants. He continued, noting that many elements of the rule would be different (by design) from existing options in the listed options market and would provide exceptions. Specifically, retail orders that have a value of $200,000 or more and orders for investors who average 40 trades or more per day would be excluded from auctions. Finally, Zhu highlighted two major benefits. First, the auction would enhance the opportunity for individual investors to receive competitive prices for their market orders. Second, it would give institutional investors opportunity to interact directly with a large number of individual investors.

Daniel Gray followed up on Zhu’s testimony, saying that absent an exception, the rule generally would prohibit a restricted competition trade center from internally executing the order of an individual investor without exposing the order to competition and a qualified auction. He said that segmented order is the key term tying the orders that would be covered by rules. The second key definition according to Gray is restricted competition trading center, which covers any trading center that is not a national securities exchange or an ATS (alternative trading center). These would be excluded, but all others would be covered by the requirement. Gray noted that there are additional exceptions that further limit the rule’s scope.

He continued by noting that segmentation allows any open competition trading center to operate qualified auctions for an NMS stock. In this way, broker dealers would have a choice of qualified auctions when routing a segment order with their best execution responsibilities.

Gray explained that only national securities exchanges and ATS that meet the definition of open trade center could operate qualified actions. Additionally, prior to operating a qualified auction, each exchange and ATS has to have market participants with established connections to the trading center. Finally, the continuous order book for an open trading center would need to be integrated with qualified orders. Gray closed by saying that this rule is designed to achieve the five objectives for a national market system.

Wachter said the main principals of the rule are to ensure fair and open auctions. She estimated that it would apply to 7-10% of total orders as modified by total volume, but noted that not every order would improve. In fact, she said retail orders may prefer the structure that wholesale orders provide.

Commissioner Discussion

Commissioner Hester Peirce opened by stating that too often, the SEC has sought to order competition instead of facilitating orderly competition. She said this proposal is an effort to order competition, and she cannot support it. She noted that, while couched in the language of competition, this rule overrides the national market system, and added that the SEC has not done the work necessary to justify the extensive changes being discussed. Peirce said the proposed rule would replace the practice of routing individuals to wholesalers by routing them to auctions accessible to the broader market. As a result, she mentioned five main concerns: (1) competition need not be order by order to be real, as retail brokers do not choose among wholesalers on an order by order basis; (2) the Commission’s analysis about the competitive shortfall ignores the fact that the current market is not static, and new competitors are entering to compete with the largest wholesalers which will bring price improvements; (3) the rule would integrate auction responses with the trading venue holding the qualified options, which means there is no guarantee that any of these orders will be resting on the trading book of the wholesalers holding the auction; (4) there is a possibility that this could increase retail investors’ costs through higher commission; and (5) the rule could create bigger problems and add new steps to the execution of retail orders.

Peirce also asked multiple questions. First, she asked Gray why the rule made these auctions mandatory. Gray said that the main issue is that a small group of wholesalers has right to first trade of 90% of the marketable orders of institution investors. He said empirical data shows that here is a strong reason to believe individual investors could get much better prices than they do currently. He noted that the strength of this release is that it provides data and will be a strong basis for an informed public debate on whether there is a problem and whether this solution addresses it. Peirce responded that she thinks it would be better to allow voluntary experiments to occur before handling the issue in a mandatory way.

Next, Peirce asked if staff had concerns about the design for qualified auctions. Zhu said the auction design is a quintessential sealed bid auction that has been tested many times, and Gray added that they are looking forward to hearing from the public about the design. Finally, she asked if Gray thinks particular exchanges will become the home for particular stocks over time as a result of the rule. He noted that concentration has not happened on continuous order books, but added that he is interested in what other market participants think.

Commissioner Caroline Crenshaw said the current retail trading model lacks competition and transparency, which raises serious questions about investor protection. She said the proposal is designed to make the trading of NMS stocks more competitive, efficient, and transparent. Crenshaw said she hopes the public comments on whether the other alternatives discussed in the release could be better and less complex.

Commissioner Mark Uyeda said that wholesalers are part of a competitive ecosystem. He argued that the proposal asserts that retail investors would receive a better deal, and that the current isolation of orders results in suboptimal price improvements. He further stated that the proposing release proceeds from the incorrect premise that realized spreads are a proxy for potential economic profit. As a result, Uyeda said the proposal’s reasoning is circular, since it argues that the higher economic profits are caused by the isolation of orders from order-by-order competition, and therefore order-by-order competition is needed to eliminate the economic profits that have not been demonstrated. Finally, he noted that the Commission does not know whether the mandated order by order competition will provide a better outcome for retail investors. Because of that and the potential risks and unintended consequences associated with the proposal, he was unable to support it.

Commissioner Jaime Lizarraga said the new rule is designed to promote competition in retail order flow, and argued that it will benefit retail investors by increasing opportunities to receive better prices. He noted that he shares concerns about excess concentration in the wholesaling business.

Chair Gary Gensler said that marketable orders of individual investors have grown a fair bit in the last two decades, so he believes it is important to expose them to greater competition. He stated that today’s markets are not as fair and competitive as possible for retail investors. Gensler continued by noting that markets have become increasingly hidden from view for the investing public, stating that individual investors do not necessarily get the best price they could if all the institutional investors could systematically compete for their orders. He also pointed out that this proposal is about a segmented piece – individuals trading less than $200,000 trades, fewer than 40 times a day. Finally, he acknowledged that wholesalers, exchanges, banks, and others may have a different view, which is why the Commission benefits from public comment.

ITEM 5: Regulation Best Execution

The Commission voted 3-2 to propose new rules under the Securities Exchange Act of 1934 titled Regulation Best Execution, which would establish a best execution standard and require detailed policies and procedures for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers and more robust policies and procedures for entities engaging in certain conflicted transactions with retail customers, as well as related review and documentation requirements.

Staff Discussion

Zru introduced the proposal to create new rules relating to broker dealers’ duty of best execution. He said the proposal would establish a comprehensive and detailed Commission-level ruleset addressing best execution, which would result in vigorous efforts by broker dealers to establish best execution practices. He expanded on the three proposed rules. First, Rule 1100 would set forth a best execution standard for brokers dealers and government securities brokers. Second, Rule 1101 would require broker dealers to establish, maintain, and enforce written policies and procedures. Rule 1102 would require broker dealers to conduct annual reviews and prepare written reports of such reviews to be presented to their governing body.

David Dimitrious expanded on the three rules. He said Rule 1100 sets forth best execution standards, but also contains three exemptions: (1) when another broker dealer is executing a customer order against the broker dealer’s quote; (2) when a customer has provided an instruction to route its order to market for execution (as long as the broker processes the order promptly); and (3) when institutional customers execute the order. Proposed Rule 1101 would require a broker dealer to establish, maintain, and enforce written policies reasonably designed to comply with the best execution standard.

1101-A would require a broker dealer to address how they will obtain and assess reasonably accessible market information, identify material potential liquidity sources, and incorporate liquidity sources into its order handling and ensure efficient access. 1101-B would address additional elements relating to how it will obtain information and evaluate markets for potentially executing customer orders. 1101-C would address the review of the execution quality of its customer transactions and how it might compare to what they would receive with other markets. 1101-D would exempt those that qualify as introducing brokers from 1101-A, 1101-B, and 1101-C. Finally, Dimitrious explained that proposed Rule 1102 would require broker dealers to review and assess the design and overall effectiveness of their policies and procedures less frequently than annually.

Wachter said the proposal offers potential of improved execution quality of retail trades. She said the rule would impose costs that would have detrimental effects on competition.

Commissioner Discussion

Commissioner Hester Peirce said the Commission is proposing to supplant broker’s judgment with its own step-by-step guide to achieving best execution. She said she could have supported a principles-based best execution rulemaking, but not this proposal. She also noted that monitoring tools for best execution quality are improving, which make it easier for dealers to be held accountable. Peirce said the proposed rule provides a handy checklist for SEC examiners and enforcement attorneys, but argued that best execution cannot be reduced to a checklist. That would invite a culture of checklist compliance, according to Peirce. She also said that retail brokers will be subject to a heightened standard for conflicted transactions because they receive PFOF, and said the release does not seriously account for the increased compliance. Finally, Peirce noted that while the proposing release covers lots of territory, including an asset-class specific discussion, it is thinner on assessing how the rule will change markets and affect investors.

Peirce also asked if it will be confusing to have three separate rules from FINRA, MSRB, and the SEC. Zru said this rule is consistent with those rules and even strengthens them. Dimitrious concurred and said the rule is designed to complement the others and is consistent with them. He noted, however, that this rule is different as well, and said the proposal goes through areas where they are meant to be consistent and areas where they are different. The proposal has asked for comment about this interaction.

Commissioner Caroline Crenshaw said the changes to market structure that have been discussed also have implications for best execution. She noted that the SEC has never established its own comprehensive and detailed best execution requirements, so this rule is long overdue and should improve oversight and investor protection outcomes. She also expressed interest in knowing if commenters think the Commission should further strengthen the rules. She asked if requirements for conflicted transactions should apply to all transactions and whether there is too much flexibility for brokers.

Commissioner Mark Uyeda stated that the central question should be whether this addresses an important problem or a failure in the markets. He noted that there seems to be an evidentiary hiatus for any real need for this proposal. He added that there are already existing best execution regulator regimes that appear to be working well, and this would just add a third rule in additional FINRA and the MSRB. Uyeda continued by noting that the rule may leave broker dealers feeling compelled to purchase more market data and said the rule appears to significantly increase costs for many market participants.

Uyeda also asked if it is better to have three regulatory regimes or one single universal best execution regime. Zhu responded that it is difficult to imagine parallel universes, but added that it is not uncommon for SEC to have its own ruleset.

Commissioner Jaime Lizarraga said that this would be the first time the Commission developed its own detailed best execution rule. He argued that the proposal would encourage better execution for customer orders and facilitate enhanced regulatory oversight and enforcement by the Commission.

Chair Gary Gensler stated that the proposal would help to ensure brokers have policies and procedures in place to uphold one of the most important obligations—seeking the best executions when trading securities. He noted his surprise upon learning that the SEC did not already have its own best execution rule. He then commented on how the rule will enhance investor protection and provide additional enforcement capabilities, while also bolstering the enforcement efforts of other SROs who have their own rules. Gensler highlighted three important enhancements: (1) heighten requirements for transactions which involve conflicts of interest for retail investors; (2) narrow the scope of introducing brokers that are exempt from best execution requirements; (3) specify greater detail on policies and procedures that brokers need to adopt. Finally, the chair noted that he is glad this proposal also addresses crypto security tokens so that the Commission can receive public comment on that.

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