Thank you, Chair Gensler. Establishing a regulatory framework that is generally consistent across similarly situated firms is an objective that should inform our rulemaking process. Pursuing this objective, however, is not the same as seeking to impose regulatory uniformity for its own sake, particularly when there are alternative and less burdensome ways to fill regulatory and reporting gaps. Because today’s recommendation rejects a common sense approach, I cannot support it.

The final amendments to Exchange Act Rule 15b9-1 would dramatically narrow an exemption that has long permitted a registered broker-dealer to forgo registration with FINRA as long as it is a member of a national securities exchange, carries no customer accounts, and uses another broker-dealer to conduct any proprietary trading off an exchange where it is a member. This exemption permits certain proprietary trading firms, options market makers, and certain other broker-dealers—64 firms in all, as of April of this year—to do business as a broker-dealer without incurring the potentially significant costs of FINRA membership.

It is true, as the adopting release explains, that this exemption creates different regulatory requirements and reporting burdens for broker-dealers engaged in different types of activities. Although the exempted firms are generally subject to the jurisdiction and rules of the one or more exchange SROs to which they belong, the rules of these exchanges can vary and do not necessarily extend to off-member exchange trading. Unlike FINRA, these SROs generally do not have expertise in monitoring over-the-counter trading. FINRA relies on regulatory service agreements (“RSAs”) to monitor off-member-exchange activity, and the exchange SRO has the last say in determining whether to bring an enforcement action against a member firm. FINRA, unsurprisingly, says that this reliance on RSAs makes its “regulatory work” with these firms “less certain and stable”[1] than it would be if FINRA had direct oversight. In addition, only firms that are FINRA members are required to report their Treasury trades to TRACE, the FINRA fixed-income reporting system.

The release fails, however, to make a persuasive case that the best way to address any concerns that arise from these differences is to subject firms that have no customers and that provide valuable liquidity in several of the markets that we regulate to the same SRO that oversees broker-dealers that perform very different functions in these markets. It is tautologically true that subjecting these firms to FINRA oversight will make it easier for FINRA to oversee them. The release hammers that point home and then goes on at great length to note the importance of having “stability and consistency”[2] in the regulation and oversight of these firms. Not addressed is why regulation by FINRA as opposed to direct regulation and oversight by the Commission (which we already have) is the answer. Even if, as the release asserts, the current exemption “undermine[s]” “FINRA’s ability to create a consistent regulatory framework for all broker-dealers that effect off-member exchange securities transactions,”[3] why should FINRA be the one to impose this “consistent regulatory framework,” as opposed to the Commission or even another SRO?

The release asserts that the Exchange Act requires SRO regulation. The SRO membership requirement sits next to a provision that gives the Commission exemptive authority, which refutes any argument that the Commission is acting under statutory compulsion in adopting these amendments.

The release also asserts that FINRA has expertise in overseeing off-member-exchange activity of broker-dealers, but it never offers any convincing explanation why the Commission itself cannot perform this oversight function. Instead, the release simply asserts that “the Commission layer of regulatory oversight is meant to work in tandem with, not in place of, a robust front-line layer of SRO oversight.”[4] That assertion is undermined by the exemptive authority granted to the Commission in the Exchange Act. Moreover, the Commission itself has the necessary tools (including the dastardly Consolidated Audit Trail (“CAT”)) to monitor the activity of these firms, as well as the personnel to examine, investigate, and bring enforcement actions against them. The Commission is fully capable of providing “consistent” and “stable” regulation to broker-dealers that do not belong to FINRA.

The release asserts that other regulatory tools, such as RSAs, do not make FINRA’s job easy enough, but it provides no concrete explanation of how this has harmed market quality or allowed exempted firms to engage in unlawful conduct. RSAs are private agreements between SROs, but they do permit FINRA to oversee the activity of many non-FINRA-member firms, and the Commission should not dismiss their value merely because they are privately negotiated. The exchange SROs retain ultimate authority over their member firms and can choose not to bring an action for misconduct identified by FINRA, but if that discretion is problematic here, it is a bigger problem since all SROs, including FINRA, have enforcement discretion against their members. In any event, the Commission may choose to bring an enforcement action if an SRO declines to do so.

In sum, the release provides no compelling reason to impose the significant burden of FINRA membership on these firms. We could have added a condition to the exemption to capture Treasury trades by non-FINRA members, and then we could have waited to see whether we needed to do more. Other initiatives, such as the CAT, will further enhance the ability of the Commission and the SROs to oversee off-exchange activity involving equity securities. However, rather than waiting to determine whether any gaps in regulators’ ability to monitor this activity remain (notwithstanding the enormous and ever-increasing costs of the CAT), the Commission has chosen to impose additional costs on a subset of firms for some non-quantifiable enhancement not necessarily in oversight, but in FINRA’s ability to oversee them.

The release recognizes that these amendments and the attendant expense could reduce competition to supply liquidity in various markets, especially if firms decide to exit the market in response to increased regulatory costs. In particular, options market makers raised concern that they would lose the benefits of the exemption because they hedge their options positions by taking equity positions on exchanges of which they are not members. The Commission has responded by retaining the proposal’s limited exemption for the stock leg of a stock-option order. To the extent that this exemption is insufficient, the Commission suggests that, although market exits may hurt liquidity in options markets, industry consolidation over the past eight years has not led to widening bid-ask spreads. The Commission makes no effort to determine what, if any, level of consolidation in the options market—or any other market for that matter—would lead to a decline in competition.

A running theme through this release is the importance of consistent, stable, and uniform regulatory requirements. As I noted at the beginning of my remarks, these qualities can be an important feature of a regulatory program, particularly when applied to similarly situated firms. But an insistence on uniformity for uniformity’s sake, even when firms are not similarly situated, can be pernicious and stifling. SROs that actually have the freedom and authority to engage in self-regulation can provide different types of regulation in response to the needs of different types of businesses against a common baseline of rules adopted by the Commission. RSAs and the 17d-2 plans discussed in the release can help facilitate this diversity by promoting cooperation between SROs in the oversight of their members.

This release’s repeated emphasis on the importance of “a consistent regulatory framework” at the SRO level[5] undermines the rationale for having multiple SROs. The economic analysis notes that there may be benefits from a new national securities association “tailored to” the needs of firms affected by these amendments,[6] but it is difficult to see how this could even be possible on the timeline and under the rationale the Commission gives for repealing this exemption. The year-long implementation period is far too short to reasonably permit the organization and registration of an alternative to FINRA, and any new association would necessarily lack the expertise in overseeing off-exchange trading that the release insists is critical to effective oversight. But most importantly, if a consistent regulatory framework for broker-dealers is essential—as the release implies it is—and this consistency is undermined when a subset of broker-dealers is subject to different SRO rules, how would a new association be approved by the Commission unless it replicated FINRA’s rules in every relevant respect? Given this imperative, how an association could be “tailored to” the needs of these firms is a mystery. More generally, if this insistence on uniformity reflects the Commission’s new understanding of how the regulatory framework for our markets is supposed to work, I fear that we are about to enter a period of decreased diversity, experimentation, and innovation, the costs of which will far exceed the immediate costs of these particular amendments.

Before I conclude, I do want to thank the staff in Trading and Markets and DERA for your engagement with my office on this release. Even when I cannot get to a yes, I enjoy the conversations we have and appreciate the hard work that you and your colleagues across the Commission put into formulating the recommendations. I have a few questions for the staff:

1. Several options market makers expressed concern that the absence of a hedging exception would reduce liquidity on options markets, as some market makers may be required to register with FINRA only because of their hedging activity in equities on exchanges where they are not a member. The final rule includes a narrow exemption for the stock leg of a stock-option trade. Is this likely to provide meaningful relief to options market makers? Why did you not recommend that hedging transactions more generally be excluded for purposes of determining eligibility for the exemption?


2. For DERA, the release, noting that the bid-ask spreads have not increased notwithstanding a decline in the number of such market makers since 2015, suggests that a further decrease in the number of options market makers may not affect liquidity on options markets. How do you view the relationship between consolidation and competition? At what point would you expect consolidation to result in a decrease in competition?


3. The release notes that FINRA has filed a proposed rule change to amend its transaction activity fee to exempt transactions by a proprietary trading firm effected on exchanges of which the firm is a member. On average, how much, in percentage terms, do you expect this proposed rule change to reduce the ongoing costs of FINRA membership for firms affected by the amendments to Rule 15b9-1? What about for the largest firms?