Securities industry self-regulation, including through self-regulatory organizations (“SROs”) such as FINRA, has a long tradition in the U.S. markets.[1]  Congress favored self-regulation for a variety of reasons, including that effectively regulating the inner-workings of the securities industry at the federal level was viewed as cost-prohibitive and inefficient, and the complexity of securities trading practices made it desirable for SRO regulatory staff to be closely involved with SRO rulemaking and enforcement.[2]  In brief, Congress determined that the securities industry self-regulatory system would provide an effective balance between federal and industry regulation,[3] and the Exchange Act requires a layer of SRO oversight so that SROs can act as front-line regulators of their broker-dealer members.[4]

Today the Commission considers adopting amendments designed to maintain this balance by extending FINRA oversight to potentially dozens of broker-dealers,[5] including firms that currently effect significant securities transaction volume in the off-exchange market, or on exchanges of which they are not a member (in other words, firms that are carrying out these transactions “off-member-exchange”).

These firms have been able to engage in unlimited proprietary trading of securities off-member-exchange without FINRA oversight as a result of an exemption adopted several decades ago.[6]  The exemption was originally adopted so that such limited proprietary trading activity, ancillary to the firm’s exchange activity, would not require FINRA membership in addition to exchange membership.[7]  However, at that time, firms’ ancillary activity typically involved a floor business conducted on a single national securities exchange.[8]

Today, little trading in the U.S. securities markets is floor-based, and broker-dealer firms no longer trade primarily on a single exchange.[9]  To the contrary, securities trading has evolved to be highly automated, significantly more complex, and to take place across many trading centers—this includes trading across  24 registered exchanges as well as a multitude of off-exchange venues such as alternative trading systems and over-the-counter market makers.[10]  In addition, some firms now use sophisticated high-frequency trading strategies to effect transactions for their own account across the full range of exchange and off-exchange markets.  These firms typically use complex electronic trading strategies and sophisticated technology to generate a large volume of orders and transactions throughout the national market system.[11] In other words, this activity is no longer ancillary.

Nevertheless, Rule 15b9-1 has remained static as these types of firms have multiplied and securities trading has proliferated off-member exchange.  As a result, firms effecting significant securities transaction volume off-member-exchange have continued to rely on this historic carve out – now functioning as more of a loophole—to avoid being subject to FINRA’s jurisdiction and, thus, its rules.  Such inconsistent oversight is exacerbated by varying rules among exchanges, virtually ensuring that these firms are not all subject to a uniform set of rules, which could lead to inconsistent outcomes with respect to rule violations even though firms may be engaging in the same conduct.

To address this discrepancy, the amendments will help ensure that FINRA generally has direct, membership-based oversight over broker-dealers that effect securities transactions off-member-exchange, as well as the jurisdiction to directly enforce their compliance with federal securities laws, Commission rules, and FINRA rules.[12]  In other words, to ensure like behavior is treated alike.  Moreover, such FINRA authority is necessary notwithstanding the Commission’s authority over broker-dealers in order to strengthen the SRO layer of oversight with respect to off-member-exchange securities trading, consistent with the dual Commission and SRO oversight of broker-dealers required by the Exchange Act.[13]

Thanks to the staff in the Divisions of Trading and Markets, Economic and Risk Analysis, and the Office of the General Counsel.  I am deeply appreciative of your hard work on these rule amendments, and I am pleased to provide my support.