Sec Speeches Cryptocurrency Statement on Proposed Rule Regarding Best Execution

Thank you, Chair Gensler.  As with any proposed rule, a central question should be: does this rule address an important problem or failure in the markets?  If not, then given that government regulation typically imposes costs, and often has unintended negative consequences, we should be circumspect. 

This particular proposal uses the phrase “the Commission believes” 77 times.  What does that phrase mean?  If the phrase is employed as a reasoned conclusion of the Commission after a discussion of supportive evidence and relevant analysis, then I suppose that is fine.  However, when the expression—“the Commission believes”—is employed as a substitute for evidence, like spackling used to fill a hole, then that is a problem.  Indeed, “the Commission believes” seems to be used as another regulatory shortcut for situations when the Commission has no hard evidence or data, but nonetheless has a theoretical concern.[1] 

In the context of best execution—a concept already developed by the courts and specific rules from the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB)[2]—there should be something more than a theory.  The Commission’s proposal should describe the best evidence that can be mustered.  The weaker that evidence, the more skepticism we should deploy.  And for this particular proposal, there seems to be an evidentiary hiatus regarding any real need for it.  The Commission’s mere “beliefs” constitute a poor substitute.

An obvious issue with this proposal is that there are already existing best execution regulatory regimes, which appear to be working well.  This rule proposal would add a third best execution regime layered on top of the ones already imposed by FINRA and the MSRB.  Do we need another one?

Among other things, self-regulatory organization (“SRO”) rules require broker-dealers to have written policies and procedures that cover compliance, which captures best execution obligations.[3]  FINRA Rule 3130 requires an annual certification process to ensure that “the member has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable FINRA rules, MSRB rules and the federal securities laws and regulations.”[4]    

Yet the proposal introduces a redundant policies and procedures requirement.[5]  Redundant regulation will increase costs without corresponding benefits to investors.  The proposing release recognizes that increased costs “could be passed through to customers in the form of higher commissions or reduced services”[6] and “could … result in higher barriers to entry and potential exit of small broker-dealers.”[7]  In other words, the proposed rule may further increase the market share held by large Wall Street brokers at the expense of smaller Main Street brokers.      

In requiring that a broker-dealer has written policies and procedures that indicate how it will comply with a requirement that it obtain and assess “reasonably accessible information” with respect to a wide number of market variables,[8] the proposed rule does not take a position on whether the market data infrastructure (“MDI”) core information alone (as amended by the MDI rule) will satisfy this obligation.  And while, tucked in a footnote, the proposal proclaims that the proposed rule “would not establish minimum data elements needed to comply with the proposed best execution standard,”[9] the rule may well result in broker-dealers feeling compelled to purchase more market data than they otherwise might from the exchanges and alternative trading systems, because of uncertainty in satisfying their best execution obligations.  

Even more troubling, for the so-called “conflicted transactions,” the proposal requires acquisition of information “beyond” that required normally but does not detail what that means.  How much information properly constitutes “beyond”?  Buzz Lightyear’s motto of “[t]o infinity, and beyond”[10] comes to mind, but hopefully that is not what is meant. 

This proposed rule appears to substantially increase costs for many market participants and may render otherwise efficient order routing outsourcing by retail broker-dealers less economic.  This increased burden, at least in respect to payment for order flow as a so-called “conflicted transaction,” may unduly impact the retailer/wholesaler model, while it remains unclear whether there will be any benefits for retail investors.  Some broker-dealers may choose to de-conflict to avoid the costs that apply solely to conflicted transactions.

The proposal would re-make the relationship between certain introducing brokers and executing brokers. As stated in the proposing release, “the exemption under proposed Rule 1101(d) would require the introducing broker’s policies and procedures to provide for comparisons between the execution quality obtained from its executing broker and the execution quality it might have obtained from other executing brokers, which would be a more specific policies and procedures obligation for introducing brokers not required under the current FINRA and MSRB rules.”[11]  In some instances, this provision may preclude an introducing broker from effectively and efficiently outsourcing certain scalable functions to executing brokers. 

Finally, this proposal fails to analyze the interaction with the potential adoption of the order execution disclosure, tick size, and order competition proposals that are being considered at the same time.  For instance, the adoption of the order execution disclosure proposal could significantly impact how broker-dealers conduct their best execution obligations under existing obligations and SRO rules, which would sharply reduce the benefits of this proposal.

Given the uncertainties and the lack of a clearly identified problem, I am unable to support the rule proposal.  I do thank the staff in the Divisions of Trading and Markets and Economic and Risk Analysis as well as the Office of General Counsel for their efforts.  I look forward to the public comments.