Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 4007 

disaster related repairs and restoration. 

FEMA recently created a draft document 

titled ‘‘FEMA Disaster Assistance Fact 

Sheet 9580.6 (Electric Utility Repair 

(Public and Private Nonprofit)). This 

document contains sections on 

contracting, conductor replacement, 

hazard mitigation, and repair of 

collateral damage that outline FEMA 

requirements in these areas. When 

FEMA denies grant relief there is an 

adverse impact on the financial health 

of RUS borrowers and increased costs to 

the rural ratepayer. Accordingly, the 

Agency proposes to amend the ERP 

regulatory requirements to add that the 

ERP reflect compliance with all 

requirements imposed by FEMA for 

reimbursement of the cost of repairs and 

restoration of the borrower’s electric 

system incurred as the result of a 

declared disaster. 

List of Subjects 

Electric power; Loan program— 

energy; Reporting and recordkeeping 

requirements; Rural areas. 

For reasons set forth in the preamble, 

the Agency proposes to amend 7 CFR, 

Chapter XVII, part 1730 as follows: 

PART 1730—ELECTRIC SYSTEM 

OPERATIONS AND MAINTENANCE 

1. The authority citation for part 1730 

continues to read as follows: 

Authority: 7 U.S.C. 901 et seq., 1921 et 

seq., 6941 et seq. 

2. Amend § 1730.28 by adding a new 

paragraph (k) to read as follows: 

§ 1730.28 Emergency Restoration Plan 

(ERP). 

* * * * * 

(k) The ERP must comply with all 

requirements imposed by FEMA for 

reimbursement by FEMA of repairs and 

restoration of electrical systems in cases 

where the service territory falls within 

a declared disaster area. 

Dated: January 15, 2010. 

Jonathan Adelstein, 

Administrator, Rural Utilities Service. 

[FR Doc. 2010–1401 Filed 1–25–10; 8:45 am] 

BILLING CODE P 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 240 

[Release No. 34–61379; File No. S7–03–10] 

RIN 3235–AK53 

Risk Management Controls for Brokers 

or Dealers With Market Access 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’ or ‘‘SEC’’) is 

proposing for comment new Rule 15c3– 

5 under the Securities Exchange Act of 

1934 (‘‘Exchange Act’’) that would 

require brokers or dealers with access to 

trading directly on an exchange or 

alternative trading system (‘‘ATS’’), 

including those providing sponsored or 

direct market access to customers or 

other persons, to implement risk 

management controls and supervisory 

procedures reasonably designed to 

manage the financial, regulatory, and 

other risks of this business activity. 

Given the increased speed and 

automation of trading on securities 

exchanges and ATSs today, and the 

growing popularity of sponsored or 

direct market access arrangements 

where broker-dealers allow customers to 

trade in those markets electronically 

using the broker-dealers’ market 

participant identifiers, the Commission 

is concerned that the various financial 

and regulatory risks that arise in 

connection with such access may not be 

appropriately and effectively controlled 

by all broker-dealers. The Commission 

believes it is critical that broker-dealers, 

which under the current regulatory 

structure are the only entities that may 

be members of exchanges and, as a 

practical matter, constitute the majority 

of subscribers to ATSs, appropriately 

control the risks associated with market 

access, so as not to jeopardize their own 

financial condition, that of other market 

participants, the integrity of trading on 

the securities markets, and the stability 

of the financial system. 

DATES: Comments should be received on 

or before March 29, 2010. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

No. S7–03–10 on the subject line; or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File No. 

S7–03–10. This file number should be 

included on the subject line if e-mail is 

used. To help us process and review 

your comments more efficiently, please 

use only one method. The Commission 

will post all comments on the 

Commission’s Internet Web site (http:// 

www.sec.gov/rules/proposed.shtml). 

Comments are also available for public 

inspection and copying 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. All 

comments received will be posted 

without change; we do not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Marc F. McKayle, Special Counsel, at 

(202) 551–5633; Theodore S. Venuti, 

Special Counsel, at (202) 551–5658; and 

Daniel Gien, Attorney, at (202) 551– 

5747, Division of Trading and Markets, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–7010. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Introduction 

II. SRO Rules and Guidance 

III. Proposed Rule 15c3–5 

IV. Request for Comments 

V. Paperwork Reduction Act 

VI. Consideration of Costs and Benefits 

VII. Consideration of Burden on Competition, 

and Promotion of Efficiency, 

Competition and Capital Formation 

VIII. Consideration of Impact on the 

Economy 

IX. Initial Regulatory Flexibility Analysis 

X. Statutory Authority 

XI. Text of Proposed Rule 

Appendix 

I. Introduction 

The Commission has long recognized 

that beneficial innovations in trading 

and technology can significantly 

improve the efficiency and quality of 

our nation’s securities markets. At the 

same time, the Commission must ensure 

that the regulatory framework keeps 

pace with market developments and 

effectively addresses any emerging risks. 

In recent years, the development and 

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4008 Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 

1The Commission notes that high frequency 

trading has been estimated to account for more than 

60 percent of the U.S. equities market volume. See, 

e.g., Nina Mehta, Naked Access Bashed at 

Roundtable, Trader’s Magazine, August 6, 2009 

(citing a report by Aite Group). 

2 It has been reported that sponsored access 

trading volume accounts for 50 percent of overall 

average daily trading volume in the U.S. equities 

market. See, e.g., Carol E. Curtis, Aite: More 

Oversight Inevitable for Sponsored Access, 

Securities Industry News, December 14, 2009 

(citing a report by Aite Group). In addition, 

sponsored access has been reported to account for 

15 percent of Nasdaq volume. See, e.g., Nina Mehta, 

Sponsored Access Comes of Age, Traders Magazine, 

February 11, 2009 (quoting Brian Hyndman, Senior 

Vice President for Transaction Services, Nasdaq 

OMX Group, Inc. ‘‘[direct sponsored access to 

customers is] a small percentage of our overall 

customer base, but it could be in excess of 15 

percent of our overall volume.’’). 

3 Generally, direct market access refers to an 

arrangement whereby a broker-dealer permits 

customers to enter orders into a trading center but 

such orders are filtered through the broker-dealer’s 

trading systems prior to reaching the trading center. 

See, e.g., Nasdaq Rule 4611(d)(1)(B). 

4 Generally, sponsored access refers to an 

arrangement whereby a broker-dealer permits its 

customers to enter orders into a trading center that 

bypass the broker-dealer’s trading system and are 

routed directly to a trading market via a dedicated 

port, in some cases supported by a service bureau 

or other third party technology provider. See, e.g., 

Nasdaq Rule 4611(d)(1)(A). ‘‘Unfiltered’’ or ‘‘naked’’ 

access is generally understood to be a subset of 

sponsored access where pre-trade filters or controls 

are not applied to orders before such orders are 

submitted to an exchange or ATS. The Commission 

notes that the proposed rule would effectively 

prohibit any access to trading on an exchange or 

ATS, whether sponsored or otherwise, where pretrade controls are not applied. 

5Under Proposed Rule 15c3–5(a)(1), the term 

‘‘market access’’ is defined as access to trading in 

securities on an exchange or ATS as a result of 

being a member or subscriber of the exchange or 

ATS, respectively. See infra Section III.C. 

6See, e.g., NYSE IM–89–6 (January 25, 1989); and 

Securities Exchange Act Release No. 40354 (August 

24, 1998), 63 FR 46264 (August 31, 1998) (NASD 

NTM–98–66). 

7For example, broker-dealers may receive market 

access from other broker-dealers to an exchange 

where they do not have a membership. 

8The Commission notes that exchanges offer 

various discounts on transaction fees that are based 

on the volume of transactions by a member firm. 

See, e.g., Nasdaq Rule 7018 and NYSE Arca, Inc. 

(‘‘NYSE Arca’’) Fee Schedule. Exchange members 

may use access arrangements as a means to 

aggregate order flow from multiple market 

participants under one MPID to achieve higher 

transaction volume and thereby qualify for more 

favorable pricing tiers. 

9Proposed Rule 15c3–5 would not apply to nonbroker-dealers, including non-broker-dealers that 

are subscribers of an ATS. 

10 It has been reported that ‘‘unfiltered’’ access 

accounts for an estimated 38 percent of the average 

daily volume of the U.S. stock market. See, e.g., 

Scott Patterson, Big Slice of Market Is Going 

‘‘Naked,’’ Wall Street Journal, December 14, 2009 

(citing a report by Aite Group). 

growth of automated electronic trading 

has allowed ever increasing volumes of 

securities transactions across the 

multitude of trading systems that 

constitute the U.S. national market 

system. In fact, much of the order flow 

in today’s marketplace is typified by 

high-speed, high-volume, automated 

algorithmic trading, and orders are 

routed for execution in milliseconds or 

even microseconds. 

Over the past decade, the proliferation 

of sophisticated, high-speed trading 

technology has changed the way brokerdealers trade for their own accounts and 

as agent for their customers.1 In 

addition, customers—particularly 

sophisticated institutions—have 

themselves begun using technological 

tools to place orders and trade on 

markets with little or no substantive 

intermediation by their broker-dealers. 

This, in turn, has given rise to the 

increased use and reliance on ‘‘direct 

market access’’ or ‘‘sponsored access’’ 

arrangements.2 Under these 

arrangements, the broker-dealer allows 

its customer—whether an institution 

such as a hedge fund, mutual fund, bank 

or insurance company, an individual, or 

another broker-dealer—to use the 

broker-dealer’s market participant 

identifier (‘‘MPID’’) or other mechanism 

for the purposes of electronically 

accessing the exchange or ATS. With 

‘‘direct market access,’’ 3 as commonly 

understood, the customer’s orders flow 

through the broker-dealer’s systems 

before passing into the markets, while 

with ‘‘sponsored access’’ 4 the customer’s 

orders flow directly into the markets 

without first passing through the brokerdealer’s systems. In all cases, however, 

whether the broker-dealer is trading for 

its own account, is trading for customers 

through more traditionally 

intermediated brokerage arrangements, 

or is allowing customers direct market 

access or sponsored access, the brokerdealer with market access 5 is legally 

responsible for all trading activity that 

occurs under its MPID.6

Certain market participants may find 

the wide range of access arrangements 

beneficial. For instance, facilitating 

electronic access to markets can provide 

broker-dealers, as well as exchanges and 

ATSs, opportunities to compete for 

greater volumes and a wider variety of 

order flow. For a broker-dealer’s 

customers, which could include hedge 

funds, institutional investors, individual 

investors, and other broker-dealers, such 

arrangements may reduce latencies and 

facilitate more rapid trading, help 

preserve the confidentiality of 

sophisticated, proprietary trading 

strategies, and reduce trading costs by 

lowering operational costs,7

commissions, and exchange fees.8

Current self-regulatory organization 

(‘‘SRO’’) rules and interpretations 

governing electronic access to markets 

have sought to address the risks of this 

activity, as discussed below. However, 

the Commission preliminarily believes 

that more comprehensive and effective 

standards that apply consistently across 

the markets are needed to effectively 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, associated with 

market access. These risks—whether 

they involve the potential breach of a 

credit or capital limit, the submission of 

erroneous orders as a result of computer 

malfunction or human error, the failure 

to comply with SEC or exchange trading 

rules, the failure to detect illegal 

conduct, or otherwise—are present 

whenever a broker-dealer trades as a 

member of an exchange or subscriber to 

an ATS, whether for its own proprietary 

account or as agent for its customers, 

including traditional agency brokerage 

and through direct market access or 

sponsored access arrangements. 

Accordingly, to effectively address these 

risks and the vulnerability they present 

to the U.S. national market system, the 

Commission has designed the proposed 

rule to apply broadly to all access to 

trading on an exchange or ATS provided 

directly by a broker-dealer.9

The Commission, however, is 

particularly concerned about the quality 

of broker-dealer risk controls in 

sponsored access arrangements, where 

the customer order flow does not pass 

through the broker-dealer’s systems 

prior to entry on an exchange or ATS. 

The Commission understands that, in 

some cases, the broker-dealer providing 

sponsored access may not utilize any 

pre-trade risk management controls (i.e., 

‘‘unfiltered’’ or ‘‘naked’’ access),10 and 

thus could be unaware of the trading 

activity occurring under its market 

identifier and have no mechanism to 

control it. The Commission also 

understands that some broker-dealers 

providing sponsored access may simply 

rely on assurances from their customers 

that appropriate risk controls are in 

place. 

Appropriate controls to manage 

financial and regulatory risk for all 

forms of market access are essential to 

assure the integrity of the broker-dealer, 

the markets, and the financial system. 

The Commission preliminarily believes 

that risk management controls and 

supervisory procedures that are not 

applied on a pre-trade basis or that are 

not under the exclusive control of the 

broker-dealer are inadequate to 

effectively address the risks of market 

access arrangements, and pose a 

particularly significant vulnerability in 

the U.S. national market system. 

The securities industry itself has 

begun to recognize the risks associated 

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Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 4009 

11See letter to Elizabeth M. Murphy, Secretary, 

Commission, from Ann Vlcek, Managing Director 

and Associate General Counsel, Securities Industry 

and Financial Markets Association (‘‘SIFMA’’), 

February 26, 2009. In commenting on a NASDAQ 

Stock Exchange LLC (‘‘Nasdaq’’) proposed rule 

change to establish a new Nasdaq market access 

rule, SIFMA urged that ‘‘without clear guidelines for 

the establishment and maintenance of both 

counterparty-specific and enterprise-wide credit 

and risk controls * * * some [broker-dealers] may 

allow * * * trad[ing] well in excess of [a] client’s 

traditional risk limits as well as the [broker-dealer’s] 

own capital maintenance requirements;’’ and 

concluded that such unencumbered trading activity 

and market access could lead to a potential ‘‘disaster 

scenario.’’ 

12See letter to Elizabeth M. Murphy, Secretary, 

Commission, from John Jacobs, Director of 

Operations, Lime Brokerage LLC, February 17, 

2009. 

13For example, information from Nasdaq 

indicates that in 2008 and 2009 Nasdaq granted 

approximately 4,000 requests and approximately 

1,600 requests to break trades as erroneous trades, 

respectively. 

14Ben Rooney, Google Price Corrected After 

Trading Snafu, CNNMoney.com, September 30, 

2008, http://money.cnn.com/2008/09/30/news/ 

companies/google_nasdaq/ 

?postversion=2008093019 (‘‘Google Trading 

Incident’’). 

15 John Hintze, Risk Revealed in Post-Trade 

Monitoring, Securities Industry News, September 8, 

2009 (‘‘SWS Trading Incident’’). 16Erroneous Trade to Cost Japan’s Mizuho 

Securities at Least $225 Million, Associated Press, 

December 8, 2005 (‘‘Mizuho Trading Incident’’). 17See Whitney Kisling and Ian King, Rambus 

Trades Cancelled by Exchanges on Error Rule, 

BusinessWeek, January 4, 2010, http:// 

www.businessweek.com/news/2010-01-04/rambustrading-under-investigation-as-potential-errorupdate1-.html (stating ‘‘[a] series of Rambus Inc. 

trades that were executed about $5 below today’s 

average price were canceled under rules that govern 

stock transactions that are determined to be ‘clearly 

erroneous.’ ’’ (‘‘Rambus Trading Incident’’). 

18See Securities Exchange Act Release No. 61345 

(January 13, 2010) (SR–NASDAQ–2008–104) 

(‘‘Nasdaq Market Access Approval Order’’), 

discussed in greater detail in the Appendix. 

19The Commission notes that brokers-dealers 

typically access exchanges and ATSs through the 

use of unique MPIDs or other identifiers, which are 

assigned by the market. 

with sponsored access, and to call for 

guidelines on appropriate credit and 

risk controls in order to avert a potential 

‘‘disaster scenario.’’ 11 Today, order 

placement rates can exceed 1,000 orders 

per second with the use of high-speed, 

automated algorithms.12 If, for example, 

an algorithm such as this malfunctioned 

and placed repetitive orders with an 

average size of 300 shares and an 

average price of $20, a two-minute delay 

in the detection of the problem could 

result in the entry of, for example, 

120,000 orders valued at $720 million. 

In sponsored access arrangements, as 

well as other access arrangements, 

appropriate pre-trade credit and risk 

controls could prevent this outcome 

from occurring by blocking unintended 

orders from being routed to an exchange 

or ATS. 

Incidents involving algorithmic or 

other trading errors in connection with 

market access occur with some 

regularity.13 For example, it was 

reported that, on September 30, 2008, 

trading in Google became extremely 

volatile toward the end of the day, 

dropping 93% in value at one point, due 

to an influx of erroneous orders onto an 

exchange from a single market 

participant. As a result, Nasdaq had to 

cancel numerous trades, and adjust the 

closing price for Google and the closing 

value for the Nasdaq 100 Index.14 In 

addition, it was reported that, in 

September 2009, Southwest Securities 

announced a $6.3 million quarterly loss 

resulting from deficient market access 

controls with respect to one of its 

correspondent brokers that vastly 

exceeded its credit limits. Despite 

receiving intra-day alerts from the 

exchange, Southwest Securities’ 

controls proved insufficient to allow it 

to respond in a timely manner, and 

trading by the correspondent continued 

for the rest of the day, resulting in a 

significant loss.15 Another example, 

although not in the U.S., which 

highlights the need for appropriate 

controls in connection with market 

access occurred in December 2005, 

when Mizuho Securities, one of Japan’s 

largest brokerage firms, sustained a 

significant loss due to a manual order 

entry error that resulted in a trade that, 

under the applicable exchange rules, 

could not be canceled. Specifically, it 

was reported that a trader at Mizuho 

Securities intended to enter a customer 

sell order for one share of a security at 

price of 610,000 Yen, but the numbers 

were mistakenly transposed and an 

order to sell 610,000 shares of the 

security at price of one Yen was entered 

instead.16 A system-driven, pre-trade 

control reasonably designed to reject 

orders that are not reasonably related to 

the quoted price of the security, would 

have prevented this order from reaching 

the market. Most recently, on January 4, 

2010, it was reported that shares of 

Rambus, Inc. suffered an intra-day price 

drop of approximately thirty-five 

percent due to erroneous trades causing 

stock and options exchanges to break 

trades.17

While incidents such as these 

involving trading errors in connection 

with market access occur with some 

regularity, the Commission also is 

concerned about preventing any 

potentially more severe, widespread 

incidents that could arise as a result of 

inadequate risk controls on market 

access. As trading in the U.S. securities 

markets has become more automated 

and high-speed trading more prevalent, 

the potential impact of a trading error or 

a rapid series of errors, caused by a 

computer or human error, or a malicious 

act, has become more severe. The 

Commission believes it must be 

proactive in addressing these concerns, 

by proposing requirements designed to 

help assure that broker-dealers that 

provide access to markets implement 

effective controls to minimize the 

likelihood of severe events that could 

have systemic implications. 

As discussed in Section II below, the 

SROs have, over time, issued a variety 

of guidance and rules that, among other 

things, address proper risk controls by 

broker-dealers providing electronic 

access to the securities markets. In 

addition, the Commission has just 

approved via delegated authority a new 

Nasdaq rule that requires broker-dealers 

offering direct market access or 

sponsored access to Nasdaq to establish 

controls regarding the associated 

financial and regulatory risks, and to 

obtain a variety of contractual 

commitments from sponsored access 

customers.18 Although these rules and 

guidance, and particularly Nasdaq’s 

new rule, have been a step in the right 

direction, as discussed throughout this 

release, the Commission preliminarily 

believes that more should be done to 

assure that comprehensive and effective 

risk management controls on market 

access are imposed by broker-dealers 

whether they are trading on Nasdaq or 

another exchange or ATS. 

Proposed Rule 15c3–5 would require 

a broker or dealer with market access, or 

that provides a customer or any other 

person with access to an exchange or 

ATS through use of its MPID or 

otherwise,19 to establish, document, and 

maintain a system of risk management 

controls and supervisory procedures 

reasonably designed to manage the 

financial, regulatory, and other risks, 

such as legal and operational risks, 

related to market access. The proposed 

rule would apply to trading in all 

securities on an exchange or ATS, 

including equities, options, exchangetraded funds, and debt securities. 

Specifically, the proposed rule would 

require that brokers or dealers with 

access to trading securities on an 

exchange or ATS, as a result of being a 

member or subscriber thereof, establish, 

document, and maintain a system of risk 

management controls and supervisory 

procedures that, among other things, are 

reasonably designed to (1) 

systematically limit the financial 

exposure of the broker or dealer that 

could arise as a result of market access, 

and (2) ensure compliance with all 

regulatory requirements that are 

applicable in connection with market 

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4010 Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 

20See infra Section III.F. 

21For example, a system-driven, pre-trade control 

designed to reject orders that are not reasonably 

related to the quoted price of the security would 

prevent erroneously entered orders from reaching 

the securities markets, which should lead to fewer 

broken trades and thereby enhance the integrity of 

trading on the securities markets. 

22See, e.g., letters to Elizabeth M. Murphy, 

Secretary, Commission, from Manisha Kimmel, 

Executive Director, Financial Information Forum, 

February 19, 2009 (‘‘The [Nasdaq] proposal to 

establish a well-defined set of rules governing 

sponsored access is a positive step towards 

addressing consistency in sponsored access 

requirements.’’); and Ted Myerson, President, 

FTEN, Inc., February 19, 2009 (‘‘[I]t is imperative 

that Congress and regulators, together with the 

private sector, work together to encourage effective 

real-time, pre-trade, market-wide systemic risk 

solutions that help prevent [sponsored access] 

errors from occurring in the first place.’’). 

23See, e.g., FINRA Rules 3010, 3012, and 3130. 

24 In 2007, the NASD and the member-related 

functions of New York Stock Exchange Regulation, 

Inc., the NYSE’s regulatory subsidiary, were 

consolidated. As part of this regulatory 

consolidation, the NASD changed its name to 

FINRA. 

25The Commission notes that the collective 

NASD and NYSE guidance now constitutes 

FINRA’s current guidance on market access. 

26See, e.g., NYSE Rule 123B.30, NYSE Alternext 

Equities Rule 123B.30, NYSE Amex Rule 86, NYSE 

Arca Rules 7.29 and 7.30, NYSE Rule 86, CBOE 

Rule 6.20A, CHX Article 5, Rule 3, NSX Rule 11.9, 

BATS Rule 11.3(b), ISE Rule 706, NASDAQ Rule 

4611(d), NASDAQ OMX BX Rule 4611(d), 

NASDAQ OMX PHLX Rule 1094(b)(ii). 

27See Nasdaq Market Access Approval Order, 

supra note 18. 

access. The required financial risk 

management controls and supervisory 

procedures must be reasonably designed 

to prevent the entry of orders that 

exceed appropriate pre-set credit or 

capital thresholds, or that appear to be 

erroneous. The required regulatory risk 

management controls and supervisory 

procedures must be reasonably designed 

to prevent the entry of orders that fail 

to comply with any regulatory 

requirements that must be satisfied on a 

pre-order entry basis, prevent the entry 

of orders that the broker-dealer or 

customer is restricted from trading, 

restrict market access technology and 

systems to authorized persons, and 

assure appropriate surveillance 

personnel receive immediate post-trade 

execution reports. For instance, such 

systems would block orders that do not 

comply with exchange trading rules 

relating to special order types and oddlot orders, among others.20 The 

requirement that a broker-dealer’s 

financial and regulatory risk 

management controls and procedures be 

reasonably designed to prevent the entry 

of orders that fail to comply with the 

specified conditions would necessarily 

require the controls be applied on an 

automated, pre-trade basis before orders 

route to an exchange or ATS. This 

requirement would effectively prohibit 

the practice of ‘‘unfiltered’’ or ‘‘naked’’ 

access to an exchange or ATS. 

The risk management controls and 

supervisory procedures required by 

Proposed Rule 15c3–5 must be under 

the direct and exclusive control of the 

broker or dealer with market access. In 

addition, a broker or dealer with market 

access would be required to establish, 

document, and maintain a system for 

regularly reviewing the effectiveness of 

the risk management controls and 

supervisory procedures required by 

Proposed Rule 15c3–5 and for promptly 

addressing any issues. Among other 

things, the broker or dealer would be 

required to review, no less frequently 

than annually and in accordance with 

written procedures, the business activity 

of the broker or dealer in connection 

with market access to assure the overall 

effectiveness of such risk management 

controls and supervisory procedures. 

The broker-dealer also would be 

required to document that review. When 

establishing the specifics of this regular 

review, the Commission expects that 

each broker or dealer with market access 

would establish written procedures that 

are effective to provide that the brokerdealer’s controls and procedures are 

adjusted, as necessary, to assure their 

continued effectiveness in light of any 

changes in the broker-dealer’s business 

or weaknesses that have been revealed. 

Finally, the Chief Executive Officer (or 

equivalent officer) of the broker or 

dealer would be required, on an annual 

basis, to certify that such risk 

management controls and supervisory 

procedures comply with Proposed Rule 

15c3–5, and that the regular review 

described above has been conducted. 

The Commission believes that 

Proposed Rule 15c3–5 would reduce the 

risks faced by broker-dealers, as well as 

the markets and the financial system as 

a whole, as a result of various market 

access arrangements, by requiring 

effective financial and regulatory risk 

management controls to be 

implemented on a market-wide basis. 

These financial and regulatory risk 

management controls should reduce 

risks associated with market access and 

thereby enhance market integrity and 

investor protection in the securities 

markets.21 Proposed Rule 15c3–5 is 

intended to complement and bolster 

existing rules and guidance issued by 

the exchanges and the Financial 

Industry Regulatory Authority 

(‘‘FINRA’’) with respect to market access. 

Moreover, by establishing a single set of 

broker-dealer obligations with respect to 

market access risk management controls 

across markets, the proposed rule would 

provide uniform standards that would 

be interpreted and enforced in a 

consistent manner and, as a result, 

reduce the potential for regulatory 

arbitrage.22

II. SRO Rules and Guidance 

Over time, the SROs have issued a 

variety of guidance and rules designed 

to address the risks associated with 

broker-dealers providing electronic 

access to the securities markets to other 

persons.23 The Commission believes 

that the SRO efforts have been 

productive steps in the right direction. 

As noted above, however, the 

Commission preliminarily believes that 

a more comprehensive and effective set 

of rules is needed to more effectively 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, associated with 

market access. To provide context for 

the Commission’s proposed rulemaking, 

the SRO efforts to address electronic 

access to markets are briefly 

summarized below. A more detailed 

discussion is in the Appendix. 

The NYSE and FINRA (formerly 

known as the National Association of 

Securities Dealers, Inc. (‘‘NASD’’)) 24

have each issued several Information 

Memoranda (‘‘IM’’) and Notices to 

Members (‘‘NTM’’), respectively, that are 

designed to provide guidance to their 

members that provide market access to 

customers. The guidance provided by 

the NYSE and the NASD is primarily 

advisory, as opposed to compulsory, 

and is similar in many respects. As 

discussed in more detail in the 

Appendix, both SROs emphasize that 

members are required to implement and 

maintain internal procedures and 

controls to manage the financial and 

regulatory risks associated with market 

access, and recommend certain best 

practices be followed.25

In addition, the exchanges each have 

adopted rules that, in general, permit 

non-member ‘‘sponsored participants’’ to 

obtain direct access to the exchange’s 

trading facilities, so long as a sponsoring 

broker-dealer that is a member of the 

exchange takes responsibility for the 

sponsored participant’s trading, and 

certain contractual commitments are 

made.26 In addition, the Commission 

has just approved by delegated authority 

a new Nasdaq rule that requires brokerdealers offering direct market access or 

sponsored access to Nasdaq to establish 

controls regarding the associated 

financial and regulatory risks, and to 

obtain a variety of contractual 

commitments from sponsored access 

customers.27 The key elements of that 

rule are described in the Appendix. The 

Commission preliminarily believes, 

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28 15 U.S.C. 78o(c)(3). 

29See 17 CFR 240.17a–4(e)(7). Pursuant to Rule 

17a–4(e)(7), every broker or dealer subject to Rule 

17a–3 is required to maintain and preserve in an 

easily accessible place each compliance, 

supervisory, and procedures manual, including any 

updates, modifications, and revisions to the 

manual, describing the policies and practices of the 

broker or dealer with respect to compliance with 

applicable laws and rules, and supervision of the 

activities of each natural person associated with the 

broker or dealer until three years after the 

termination of the use of the manual. 

however, that a more comprehensive 

and effective set of rules is needed to 

help assure that effective risk controls 

on market access are established and 

implemented by broker-dealers whether 

trading occurs on Nasdaq or another 

exchange or ATS. Specifically, the 

Commission preliminarily believes 

significant strengthening of the 

requirements beyond the Nasdaq rule is 

warranted, in particular to assure that 

rules are applied on a market-wide basis 

to effectively prohibit ‘‘naked’’ access. 

III. Proposed Rule 15c3–5 

A. Introduction 

As discussed above, SRO rules and 

interpretations governing market access 

have, over the years, sought to address 

the risks associated with broker-dealers 

providing electronic access to the 

securities markets. However, the 

Commission preliminarily believes that 

more comprehensive and effective 

standards, applied uniformly at the 

Commission level, are needed to 

appropriately manage the financial, 

regulatory, and other risks, such as legal 

and operational risks, associated with 

this activity. These risks—whether they 

involve the potential breach of a credit 

or capital limit, the submission of 

erroneous orders as a result of computer 

malfunction or human error, the failure 

to comply with SEC or exchange trading 

rules, the failure to detect illegal 

conduct, or otherwise—are present 

whenever a broker-dealer trades as a 

member of an exchange or subscriber to 

an ATS, whether for its own proprietary 

account or as agent for its customers. 

The Commission, however, is 

particularly concerned about the quality 

of broker-dealer risk controls in 

sponsored access arrangements, where 

the customer order flow does not pass 

through the broker-dealer’s systems 

prior to entry on an exchange or ATS. 

The Commission understands that, in 

some cases, the broker-dealer providing 

sponsored access may not utilize any 

pre-trade risk management controls (i.e., 

‘‘unfiltered’’ or ‘‘naked’’ access), and thus 

could be unaware of the trading activity 

occurring under its market identifier 

and have no mechanism to control it. 

The Commission also understands that 

some broker-dealers providing 

sponsored access may simply rely on 

assurances from their customers that 

appropriate risk controls are in place. 

Appropriate controls to manage 

financial and regulatory risk for all 

forms of market access are essential to 

assure the integrity of the broker-dealer, 

the markets, and the financial system. 

The Commission preliminarily believes 

that risk management controls and 

supervisory procedures that are not 

applied on a pre-trade basis or that are 

not under the exclusive control of the 

broker-dealer are inadequate to 

effectively address the risks of market 

access arrangements, and pose a 

particularly significant vulnerability in 

the U.S. national market system. 

Section 15(c)(3) of the Exchange 

Act 28 enables the Commission to adopt 

rules and regulations regarding the 

financial responsibility and related 

practices of broker-dealers that the 

Commission shall prescribe as necessary 

or appropriate in the public interest or 

for the protection of investors. Pursuant 

to this authority, the Commission is 

proposing Rule 15c3–5—Risk 

Management Controls for Brokers or 

Dealers with Market Access—to reduce 

the risks faced by broker-dealers, as well 

as the markets and the financial system 

as a whole, as a result of various market 

access arrangements, by requiring 

effective financial and regulatory risk 

management controls to be 

implemented on a market-wide basis. 

These financial and regulatory risk 

management controls should reduce 

risks associated with market access and 

thereby enhance market integrity and 

investor protection in the securities 

markets. Proposed Rule 15c3–5 is 

intended to strengthen the controls with 

respect to market access and, because it 

will apply to trading on all exchanges 

and ATSs, reduce regulatory 

inconsistency and the potential for 

regulatory arbitrage. Finally—and 

importantly—because it would require 

direct and exclusive control by the 

broker or dealer of the risk management 

controls and supervisory procedures, 

and further require those controls to be 

implemented on a pre-trade basis, 

Proposed Rule 15c3–5 would have the 

effect of eliminating the practice of 

broker-dealers providing ‘‘unfiltered’’ or 

‘‘naked’’ access to any exchange or ATS. 

As a result, the Commission 

preliminarily believes the proposed rule 

should substantially mitigate a 

particularly serious vulnerability of the 

U.S. securities markets. 

B. General Description of Proposed Rule 

Proposed Rule 15c3–5 would require 

a broker or dealer that has market 

access, or that provides a customer or 

any other person with access to an 

exchange or ATS through use of its 

MPID or otherwise, to establish, 

document, and maintain a system of risk 

management controls and supervisory 

procedures reasonably designed to 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, related to such market 

access. Specifically, the proposed rule 

would require that brokers or dealers 

with access to trading securities on an 

exchange or ATS, as a result of being a 

member or subscriber thereof, establish, 

document, and maintain a system of risk 

management controls and supervisory 

procedures that, among other things, are 

reasonably designed to (1) 

systematically limit the financial 

exposure of the broker or dealer that 

could arise as a result of market access, 

and (2) ensure compliance with all 

regulatory requirements that are 

applicable in connection with market 

access. The required financial risk 

management controls and supervisory 

procedures must be reasonably designed 

to prevent the entry of orders that 

exceed appropriate pre-set credit or 

capital thresholds, or that appear to be 

erroneous. The proposed regulatory risk 

management controls and supervisory 

procedures must also be reasonably 

designed to prevent the entry of orders 

unless there has been compliance with 

all regulatory requirements that must be 

satisfied on a pre-order entry basis, 

prevent the entry of orders that the 

broker-dealer or customer is restricted 

from trading, restrict market access 

technology and systems to authorized 

persons, and assure appropriate 

surveillance personnel receive 

immediate post-trade execution reports. 

Each such broker or dealer would be 

required to preserve a copy of its 

supervisory procedures and a written 

description of its risk management 

controls as part of its books and records 

in a manner consistent with Rule 

17a 4(e)(7) under the Exchange Act.29

The financial and regulatory risk 

management controls and supervisory 

procedures required by Proposed Rule 

15c3–5 must be under the direct and 

exclusive control of the broker or dealer 

with market access. In addition, a broker 

or dealer with market access would be 

required to establish, document, and 

maintain a system for regularly 

reviewing the effectiveness of the risk 

management controls and supervisory 

procedures and for promptly addressing 

any issues. Among other things, the 

broker or dealer would be required to 

review, no less frequently than 

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30 Id. 

31See 17 CFR 240.17a–4(b). Pursuant to Rule 

17a–4(b), every broker or dealer subject to Rule 

17a–3 is required to preserve for a period of not less 

than three years, the first two years in an easily 

accessible place, certain records of the broker or 

dealer. 

32 Id. 

33The Commission estimates that 1,295 brokers 

or dealers would have market access as defined 

under the proposed rule. Of these 1,295 brokers or 

dealers, the Commission estimates that at year-end 

2008 there were 1,095 brokers-dealers that were 

members of an exchange. This estimate is based on 

broker-dealer responses to FOCUS report filings 

with the Commission. The Commission estimates 

that the remaining 200 broker-dealers were 

subscribers to an ATS but were not members of an 

exchange. This estimate is based on a sampling of 

subscriber information contained in Exhibit A to 

Form ATS–R filed with the Commission. 

34The specific content of the ‘‘regulatory 

requirements’’ would, of course, adjust over time as 

laws, rules and regulations are modified. 

35Proposed Rule 15c3–5 would not apply to nonbroker-dealers, including non-broker-dealers that 

are subscribers of an ATS. 

annually, the business activity of the 

broker or dealer in connection with 

market access to assure the overall 

effectiveness of such risk management 

controls and supervisory procedures 

and document that review. Such review 

would be required to be conducted in 

accordance with written procedures and 

would be required to be documented. 

The broker or dealer would be required 

to preserve a copy of such written 

procedures, and documentation of each 

such review, as part of its books and 

records in a manner consistent with 

Rule 17a–4(e)(7) under the Exchange 

Act,30 and Rule 17a–4(b) under the 

Exchange Act, respectively.31

In addition, the Chief Executive 

Officer (or equivalent officer) of the 

broker or dealer would be required, on 

an annual basis, to certify that the risk 

management controls and supervisory 

procedures comply with Proposed Rule 

15c3–5, and that the regular review 

described above has been conducted. 

Such certifications would be required to 

be preserved by the broker or dealer as 

part of its books and records in a 

manner consistent with Rule 17a–4(b) 

under the Exchange Act.32

Proposed Rule 15c3–5 is divided into 

the following provisions: (1) Relevant 

definitions, as set forth in Proposed 

Rule 15c3–5(a); (2) the general 

requirement to maintain risk 

management controls and supervisory 

procedures in connection with market 

access, as set forth in Proposed Rule 

15c3–5(b); (3) the more specific 

requirements to maintain certain 

financial risk management controls and 

supervisory procedures and regulatory 

risk management controls and 

supervisory procedures, as set forth in 

Proposed Rule 15c3–5(c); (4) the 

mandate that those controls and 

supervisory procedures be under the 

direct and exclusive control of the 

broker-dealer with market access, as set 

forth in Proposed Rule 15c3–5(d); and 

(5) the requirement that the brokerdealer regularly review the effectiveness 

of the risk management controls and 

supervisory procedures, as set forth in 

Proposed Rule 15c3–5(e). 

C. Definitions 

For the purpose of Proposed Rule 

15c3–5, there are two defined terms: 

‘‘market access’’ and ‘‘regulatory 

requirements.’’ Under Proposed Rule 

15c3–5(a)(1), the term ‘‘market access’’ is 

defined as access to trading in securities 

on an exchange or ATS as a result of 

being a member or subscriber of the 

exchange or ATS, respectively. The 

proposed definition is intentionally 

broad, so as to include not only direct 

market access or sponsored access 

services offered to customers of brokerdealers, but also access to trading for the 

proprietary account of the broker-dealer 

and for more traditional agency 

activities.33 The Commission believes 

any broker-dealer with such direct 

access to trading on an exchange or ATS 

should establish effective risk 

management controls to protect against 

breaches of credit or capital limits, 

erroneous trades, violations of SEC or 

exchange trading rules, and the like. 

These risk management controls should 

reduce risks associated with market 

access and thereby enhance market 

integrity and investor protection in the 

securities markets. While today the 

more significant vulnerability in brokerdealer risk controls appears to be in the 

area of ‘‘unfiltered’’ or ‘‘naked’’ access, 

the Commission believes a broker-dealer 

with market access should assure the 

same basic types of controls are in place 

whenever it uses its special position as 

a member of an exchange, or subscriber 

to an ATS, to access those markets. The 

proposed definition encompasses 

trading in all securities on an exchange 

or ATS, including equities, options, 

exchange-traded funds, and debt 

securities. 

Under Proposed Rule 15c3–5(a)(2), 

the term ‘‘regulatory requirements’’ is 

defined as all Federal securities laws, 

rules and regulations, and rules of 

SROs, that are applicable in connection 

with market access. The Commission 

intends this definition to encompass all 

of a broker-dealer’s regulatory 

requirements that arise in connection 

with its access 036trading on an 

exchange or ATS by virtue of its being 

a member or subscriber thereof. As 

discussed below in Section III.F, these 

regulatory requirements would include, 

for example, exchange trading rules 

relating to special order types, trading 

halts, odd-lot orders, SEC rules under 

Regulation SHO and Regulation NMS, 

as well as applicable margin 

requirements. The Commission 

emphasizes that the term ‘‘regulatory 

requirements’’ references existing 

regulatory requirements applicable to 

broker-dealers in connection with 

market access, and is not intended to 

substantively expand upon them.34

D. General Requirement To Maintain 

Risk Controls 

As noted above, the Commission 

believes the financial and regulatory 

risk management controls described in 

the proposed rule should apply broadly 

to all forms of market access by brokerdealers that are exchange members or 

ATS subscribers, including sponsored 

access, direct market access, and more 

traditional agency brokerage 

arrangements with customers, as well as 

proprietary trading.35 Accordingly, the 

proposed term ‘‘market access’’ includes 

all such activities, and the proposed 

required risk management controls and 

supervisory procedures set forth in 

Proposed Rule 15c3–5 must encompass 

them. In many cases, particularly with 

respect to proprietary trading and more 

traditional agency brokerage activities, 

the proposed rule may be substantially 

satisfied by existing risk management 

controls and supervisory procedures 

already implemented by broker-dealers. 

In other cases, particularly with respect 

to sponsored access arrangements, the 

proposed rule is designed to assure that 

broker-dealer controls and procedures 

are appropriately strengthened on a 

market-wide basis to meet that standard. 

Among other things, Proposed Rule 

15c3–5 would require that certain risk 

management controls be applied on an 

automated, pre-trade basis. Therefore, 

Proposed Rule 15c3–5 would effectively 

prohibit broker-dealers from providing 

‘‘unfiltered’’ or ‘‘naked’’ access to any 

exchange or ATS. By requiring all forms 

of market access by broker-dealers that 

are exchange members or ATS 

subscribers to meet standards for 

financial and regulatory risk 

management controls, Proposed Rule 

15c3–5 should reduce risks and thereby 

enhance market integrity and investor 

protection. 

Proposed Rule 15c3–5(b) provides 

that a broker or dealer with market 

access, or that provides a customer or 

any other person with access to an 

exchange or ATS through use of its 

MPID or otherwise, shall establish, 

document, and maintain a system of risk 

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36See 17 CFR 240.17a–4(e)(7). 

37See, e.g., Google Trading Incident, supra note 

14. See also SWS Trading Incident, supra note 15; 

Mizuho Trading Incident, supra note 16; and 

Rambus Trading Incident, supra note 17. 

management controls and supervisory 

procedures reasonably designed to 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, of this business 

activity. This provision sets forth the 

general requirement that any brokerdealer with access to trading on an 

exchange or ATS, by virtue of its special 

status as a member or subscriber thereof, 

must establish risk management 

controls and supervisory procedures 

reasonably designed to manage the 

financial, regulatory, and other risks, 

such as legal and operational risks, of 

this business activity. The proposed rule 

allows flexibility for the details of the 

controls and procedures to vary from 

broker-dealer to broker-dealer, 

depending on the nature of the business 

and customer base, so long as they are 

reasonably designed to achieve the goals 

articulated in the proposed rule. The 

controls and procedures would be 

required to be documented in writing, 

and the broker or dealer would be 

required to preserve a copy of its 

supervisory procedures and a written 

description of its risk management 

controls as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7) under the Exchange Act.36

E. Financial Risk Management Controls 

and Supervisory Procedures 

Under Proposed Rule 15c3–5(c), a 

broker-dealer’s risk management 

controls and supervisory procedures are 

required to include certain elements. 

Proposed Rule 15c3–5(c)(1) requires that 

the risk management controls and 

supervisory procedures be reasonably 

designed to systematically limit the 

financial exposure of the broker-dealer 

that could arise as a result of market 

access. The Commission believes that, 

in today’s fast electronic markets, 

effective controls against financial 

exposure should be required to be 

systematized and automated and should 

be required to be applied on a pre-trade 

basis. These pre-trade controls should 

protect investors by blocking orders that 

do not comply with such controls from 

being routed to a securities market. In 

addition, the risk management controls 

and supervisory procedures must be 

reasonably designed to limit the brokerdealer’s financial exposure. As noted 

above, this standard allows flexibility 

for the details of the controls and 

procedures to vary from broker-dealer to 

broker-dealer, depending on the nature 

of the business and customer base, so 

long as they are reasonably designed to 

achieve the goals articulated in the 

proposed rule. In many cases, 

particularly with respect to proprietary 

trading and more traditional agency 

brokerage activities, the proposed rule 

may be substantially satisfied by 

existing financial risk management 

controls and supervisory procedures 

already implemented by broker-dealers. 

However, the Commission believes that 

the proposed rule would assure a 

consistent standard applies to all 

broker-dealers providing any type of 

market access and, importantly, will 

address the serious gap that exists with 

those broker-dealers that today offer 

‘‘unfiltered’’ access. 

Under Proposed Rule 15c3–5(c)(1)(i), 

the broker-dealer’s controls and 

procedures must be reasonably designed 

to prevent the entry of orders that 

exceed appropriate pre-set credit or 

capital thresholds in the aggregate for 

each customer and the broker or dealer, 

and where appropriate more finelytuned by sector, security, or otherwise, 

by rejecting orders if such orders exceed 

the applicable credit or capital 

thresholds. Under this provision, a 

broker or dealer would be required to 

set appropriate credit thresholds for 

each customer for which it provides 

market access and appropriate capital 

thresholds for proprietary trading by the 

broker-dealer itself. Such controls and 

procedures should help ensure that 

market participants do not exceed their 

allowable credit or capital thresholds. In 

designing its risk management controls 

and supervisory procedures, the brokerdealer would be required to set an 

aggregate exposure threshold for each 

account and, where appropriate, at more 

granular levels such as by sector or 

security. The broker-dealer must 

establish the credit threshold for each 

customer. The Commission expects 

broker-dealers would make such 

determinations based on appropriate 

due diligence as to the customer’s 

business, financial condition, trading 

patterns, and other matters, and 

document that decision. In addition, the 

Commission expects the broker-dealer 

would monitor on an ongoing basis 

whether the credit thresholds remain 

appropriate, and promptly make 

adjustments to them, and its controls 

and procedures, as warranted. 

In addition, because the proposed 

controls and procedures must prevent 

the entry of orders that exceed the 

applicable credit or capital thresholds 

by rejecting them, the broker-dealer’s 

controls must be applied on an 

automated, pre-trade basis, before orders 

are routed to the exchange or ATS. 

Furthermore, because rejection must 

occur if such orders would exceed the 

applicable credit or capital thresholds, 

the broker-dealer must assess 

compliance with the applicable 

threshold on the basis of exposure from 

orders entered on an exchange or ATS, 

rather than waiting for executions to 

make that determination. The 

Commission believes that, because 

financial exposure through rapid order 

entry can be incurred very quickly in 

today’s fast electronic markets, controls 

should measure compliance with 

appropriate credit or capital thresholds 

on the basis of orders entered rather 

than executions obtained. Brokerdealers also should consider 

establishing ‘‘early warning’’ credit or 

capital thresholds to alert them and 

their customers when the firm limits are 

being approached, so there is an 

opportunity to adjust trading behavior. 

Under Proposed Rule 15c3–5(c)(1)(ii), 

the broker-dealer’s controls and 

procedures must be reasonably designed 

to prevent the entry of erroneous orders, 

by rejecting orders that exceed 

appropriate price or size parameters, on 

an order-by-order basis or over a short 

period of time, or that indicate 

duplicative orders. Given the prevalence 

today of high-speed automated trading 

algorithms and other technology, and 

the fact that malfunctions periodically 

occur with those systems,37 the 

Commission believes that broker-dealer 

risk management controls should be 

reasonably designed to detect 

malfunctions and prevent orders from 

erroneously being entered as a result, 

and that identifying and blocking 

erroneously entered orders on an orderby-order basis or over a short period of 

time would accomplish this. These 

controls also should be reasonably 

designed to prevent orders from being 

entered erroneously as a result of 

manual errors (e.g., erroneously entering 

a buy order of 2,000 shares at $2.00 as 

a buy order of 2 shares at $2,000.00). For 

example, a system-driven, pre-trade 

control reasonably designed to reject 

orders that are not reasonably related to 

the quoted price of the security would 

prevent erroneously-entered orders from 

reaching the market. As with the risk 

controls and procedures applying preset credit or capital thresholds, the 

broker-dealer also would be required to 

monitor on a regular basis whether its 

systematic controls and procedures are 

effective in preventing the entry of 

erroneous orders, and promptly make 

adjustments to them as warranted. 

The Commission emphasizes that the 

financial risk management controls and 

supervisory procedures described above 

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38The specific content of the ‘‘regulatory 

requirements’’ will, of course, adjust over time as 

laws, rules and regulations are modified. 

should not be viewed as a 

comprehensive list of the financial risk 

management controls and supervisory 

procedures that should be utilized by 

broker-dealers. Instead, the proposed 

rule simply is intended to set forth 

standards for the types of financial risk 

management controls and supervisory 

procedures that a broker-dealer with 

market access should implement. A 

broker-dealer may very well find it 

necessary to establish and implement 

financial risk management controls and 

supervisory procedures beyond those 

specifically described in the proposed 

rule based on its specific circumstances. 

F. Regulatory Risk Management 

Controls and Supervisory Procedures 

Under Proposed Rule 15c3–5(c)(2), a 

broker-dealer’s risk management 

controls and supervisory procedures 

must be reasonably designed to ensure 

compliance with all regulatory 

requirements that are applicable in 

connection with market access. As 

noted above, the Commission intends 

these controls and procedures to 

encompass existing regulatory 

requirements applicable to brokerdealers in connection with market 

access, and not to substantively expand 

upon them.38 As with the risk 

management controls and procedures 

for financial exposure, this provision 

would allow flexibility for the details of 

the regulatory risk management controls 

and procedures to vary from brokerdealer to broker-dealer, depending on 

the nature of the business and customer 

base, so long as they are reasonably 

designed to achieve the goals articulated 

in the proposed rule. In many cases, 

particularly with respect to proprietary 

trading and more traditional agency 

brokerage activities, the proposed rule 

should reinforce existing regulatory risk 

management controls already 

implemented by broker-dealers. 

However, the Commission believes that 

the proposed rule would assure a 

consistent standard applies to all 

broker-dealers providing any type of 

market access and, importantly, will 

address the serious gap that exists with 

those broker-dealers that today offer 

‘‘unfiltered’’ access. 

Under Proposed Rule 15c3–5(c)(2)(i), 

the broker-dealer’s controls and 

procedures must be reasonably designed 

to prevent the entry of orders unless 

there has been compliance with all 

regulatory requirements that must be 

satisfied on a pre-order entry basis. 

Proposed Rule 15c3–5(c)(2)(ii) also 

would require the broker-dealer’s 

controls and procedures to prevent the 

entry of orders for securities that the 

broker-dealer, customer, or other 

person, as applicable, is restricted from 

trading. 

By requiring the regulatory risk 

management controls and procedures to 

be reasonably designed to prevent the 

entry of orders that fail to comply with 

regulatory requirements that apply on a 

pre-order entry basis, the proposed rule 

would have the effect of requiring the 

broker-dealer’s controls be applied on 

an automated, pre-trade basis, before 

orders route to the exchange or ATS. 

These pre-trade, system-driven controls 

would therefore prevent orders from 

being sent to the securities markets, if 

such orders fail to meet certain 

conditions. The pre-trade controls must, 

for example, be reasonably designed to 

assure compliance with exchange 

trading rules relating to special order 

types, trading halts, odd-lot orders, SEC 

rules under Regulation SHO and 

Regulation NMS, as well as applicable 

margin requirements. They also must be 

reasonably designed to prevent the 

broker-dealer or customer or other 

person from entering orders for 

securities it is restricted from trading. 

For example, if the broker-dealer is 

restricted from trading options because 

it is not qualified to trade options, its 

regulatory risk management controls 

must automatically prevent it from 

entering orders in options, either for its 

own account or as agent for a customer. 

In addition, if a broker-dealer is 

obligated to restrict a customer from 

trading in a particular security, then the 

broker-dealer’s controls must 

automatically prevent orders in such 

security from being submitted to an 

exchange or ATS for the account of that 

customer. 

Under Proposed Rule 15c3– 

5(c)(2)(iii), the broker-dealer’s controls 

and procedures also must be reasonably 

designed to restrict access to trading 

systems and technology that provide 

market access to persons and accounts 

pre-approved and authorized by the 

broker-dealer. The Commission believes 

that effective security procedures such 

as these are necessary for controlling the 

risks associated with market access. The 

Commission expects that elements of 

these controls and procedures would 

include: (1) An effective process for 

vetting and approving persons at the 

broker-dealer or customer, as applicable, 

who will be permitted to use the trading 

systems or other technology; (2) 

maintaining such trading systems or 

technology in a physically secure 

manner; and (3) restricting access to 

such trading systems or technology 

through effective passwords or other 

mechanisms that validate identity. 

Among other things, effective security 

procedures help assure that only 

authorized, appropriately-trained 

personnel have access to a brokerdealer’s trading systems, thereby 

minimizing the risk that order entry 

errors or other inappropriate or 

malicious trading activity might occur. 

Finally, Proposed Rule 15c3– 

5(c)(2)(iv) would require the brokerdealer’s controls and procedures to 

assure that appropriate surveillance 

personnel receive immediate post-trade 

execution reports that result from 

market access. Among other things, the 

Commission expects that broker-dealers 

would be able to identify the applicable 

customer associated with each such 

execution report. The Commission 

believes that immediate reports of 

executions would provide surveillance 

personnel with important information 

about potential regulatory violations, 

and better enable them to investigate, 

report, or halt suspicious or 

manipulative trading activity. In 

addition, these immediate execution 

reports should provide the broker-dealer 

with more definitive data regarding the 

financial exposure faced by it at a given 

point in time. This should provide a 

valuable supplement to the systematic 

pre-trade risk controls and other 

supervisory procedures required by the 

proposed rule. 

G. Direct and Exclusive Broker-Dealer 

Control Over Financial and Regulatory 

Risk Management Controls and 

Supervisory Procedures 

Proposed Rule 15c3–5(d) would 

require the financial and regulatory risk 

management controls and supervisory 

procedures described above to be under 

the direct and exclusive control of the 

broker-dealer that is subject to 

paragraph (b) of the proposed rule. This 

provision is designed to eliminate the 

practice, which the Commission 

understands exists today under current 

SRO rules, whereby the broker-dealer 

providing market access relies on its 

customer, a third party service provider, 

or others, to establish and maintain the 

applicable risk controls. The 

Commission believes the risks presented 

by market access—and in particular 

‘‘naked’’ or ‘‘unfiltered’’ access—are too 

great to permit a broker-dealer to 

delegate the power to control those risks 

to the customer or to a third party, 

either of whom may be an unregulated 

entity. In addition, because the brokerdealer providing market access assumes 

the immediate financial risks of all 

orders, the Commission believes that 

such broker-dealer should have direct 

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39See, e.g., NASD NTM–05–48, Members’ 

Responsibilities When Outsourcing Activities to 

Third-Party Service Providers. 

40The Commission’s understanding is based on 

discussions with various industry participants. 41See supra note 6. 

and exclusive control of the risk 

management controls and supervisory 

procedures even if the market access is 

provided to another broker-dealer. 

Under the proposal, appropriate 

broker-dealer personnel should be able 

to directly monitor the operation of the 

financial and regulatory risk 

management controls in real-time.39

Broker-dealers would have the 

flexibility to seek out risk management 

technology developed by third parties, 

but the Commission expects that the 

third parties would be independent of 

customers provided with market access. 

The broker-dealer would also be 

expected to perform appropriate due 

diligence to help assure controls are 

effective and otherwise consistent with 

the provisions of the proposed rule. The 

Commission understands that such 

technology allows the broker or dealer 

to exclusively manage such controls.40

The broker-dealer also could allow a 

third party that is independent of 

customers to supplement its own 

monitoring of the operation of its 

controls. In addition, the broker-dealer 

could permit third parties to perform 

routine maintenance or implement 

technology upgrades on its risk 

management controls, so long as the 

broker-dealer conducts appropriate due 

diligence regarding any changes to such 

controls and their implementation. Of 

course, in all circumstances, the brokerdealer would remain fully responsible 

for the effectiveness of the risk 

management controls. 

The Commission preliminarily 

believes it is important for appropriate 

broker-dealer personnel to have the 

direct and exclusive obligation to assure 

the effectiveness of, and the direct and 

exclusive ability to make appropriate 

adjustments to, the financial and 

regulatory risk management controls. 

This would allow the broker-dealer to 

more effectively make, for example, 

intra-day adjustments to risk 

management controls to appropriately 

manage a customer’s credit limit. The 

Commission expects that, by requiring 

the financial and regulatory risk 

management controls and supervisory 

procedures be under the direct and 

exclusive control of the broker or dealer, 

any changes would be made only by 

appropriate broker-dealer personnel. 

Accordingly, the proposed rule should 

help assure the integrity of the controls 

and that the broker-dealer takes 

responsibility for them. Accordingly, 

the broker-dealer could not delegate the 

oversight of its controls to a third party, 

or allow any third party to adjust them. 

The broker-dealer, as the member of the 

exchange or subscriber of the ATS, is 

responsible for all trading that occurs 

under its MPID or other market 

identifier.41 If the broker-dealer does not 

effectively control the risks associated 

with that activity, it jeopardizes not 

only its own financial viability, but also 

the stability of the markets and, 

potentially, the financial system. The 

Commission believes this responsibility 

is too great to allow the requisite risk 

management controls to be controlled 

by a third party, and in particular the 

customer which, in effect, would be 

policing itself. The Commission notes 

that this risk exists even if the third 

party is another broker-dealer, as the 

broker-dealer providing the market 

access is liable intra-day, at a minimum, 

for the financial risks incurred as a 

result of trading under its MPID or other 

identifier and, in any event, is uniquely 

positioned to prevent erroneous trades 

and comply with exchange rules and 

other regulatory requirements. 

H. Regular Review of Risk Management 

Controls and Supervisory Procedures 

Under Proposed Rule 15c3–5(e), a 

broker-dealer that is subject to 

paragraph (b) of the proposed rule 

would be required to establish, 

document, and maintain a system for 

regularly reviewing the effectiveness of 

its risk management controls and 

supervisory procedures required by 

paragraphs (b) and (c) of the proposed 

rule and for promptly addressing any 

issues. Among other things, the broker 

or dealer would be required to review, 

no less frequently than annually, the 

business activity of the broker or dealer 

in connection with market access to 

assure the overall effectiveness of such 

risk management controls and 

supervisory procedures. The brokerdealer would be required to conduct the 

review in accordance with written 

procedures and document each such 

review. When establishing the specifics 

of this regular review, the Commission 

expects that each broker or dealer with 

market access would establish written 

procedures that are reasonably designed 

to assure that the broker-dealer’s 

controls and procedures are adjusted, as 

necessary, to help assure their 

continued effectiveness in light of any 

changes in the broker-dealer’s business 

or weaknesses that have been revealed. 

The broker or dealer would be required 

to preserve a copy of such written 

procedures, and documentation of each 

such review, as part of its books and 

records in a manner consistent with 

Rule 17a–4(e)(7) under the Exchange 

Act, and Rule 17a–4(b) under the 

Exchange Act, respectively. 

Finally, the Chief Executive Officer 

(or equivalent officer) of the broker or 

dealer would be required, on an annual 

basis, to certify that such risk 

management controls and supervisory 

procedures comply with Proposed Rule 

15c3–5 and that the broker or dealer 

conducted the regular review. Such 

certifications would be required to be 

preserved by the broker or dealer as part 

of its books and records in a manner 

consistent with Rule 17a-4(b) under the 

Exchange Act. 

Proposed Rule 15c3–5(e) is intended 

to assure that a broker-dealer that is 

subject to paragraph (b) of the proposed 

rule implements supervisory review 

mechanisms to support the effectiveness 

of its risk management controls and 

supervisory procedures on an ongoing 

basis. Because of the potential risks 

associated with market access, and the 

dynamic nature of both the securities 

markets and the businesses of 

individual broker-dealers, the 

Commission believes it is critical that 

broker-dealers with market access 

charge their most senior management 

with the responsibility to review and 

certify the efficacy of its controls and 

procedures at regular intervals. The 

Commission also believes that the 

requirements under Proposed Rule 

15c3–5(e) should serve to bolster brokerdealer compliance programs, and 

promote meaningful and purposeful 

interaction between business and 

compliance personnel. 

IV. Request for Comments 

The Commission seeks comment on 

all aspects of the proposed rule. Does 

the proposed rule serve to appropriately 

and adequately mitigate the financial 

and regulatory risks associated with 

market access? If not, how should the 

Commission change the proposed rule 

to address these risks? Should the 

Commission address other risks in its 

proposed rule? Should these risks be 

addressed with additional specific 

controls in the rule text? Are there other 

feasible alternatives that the 

Commission should consider in order to 

achieve the goals of the proposed rule? 

Would the proposed rule affect trading 

volume? If so, what impact would the 

proposed rule have on trading volume? 

Would the proposed rule affect market 

quality? If so, what impact would the 

proposed rule have on market quality? 

Would the proposed rule impact trading 

volume or market quality differently in 

equities, options, fixed-income or other 

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securities? Please explain response and 

provide any appropriate data. 

Under the proposed rule, market 

access means access to trading in 

securities on an exchange or ATS as a 

result of being a member or subscriber 

of the exchange or ATS, respectively. 

The proposed rule would apply equally 

to brokers or dealers with market access, 

whether they are proprietary traders, 

conduct traditional brokerage services, 

or provide direct market access or 

sponsored access. Should the proposed 

rule apply to all types of market access 

similarly? Should market access 

arrangements be treated differently 

under the proposed rule depending on 

the type of market participants that are 

party to the arrangement? 

The proposed rule would require a 

broker or dealer with market access, or 

that provides a customer or any other 

person with access to an exchange or 

ATS through use of its market 

participant identifier or otherwise, to 

establish, document, and maintain a 

system of risk management controls and 

supervisory procedures reasonably 

designed to manage the financial, 

regulatory, and other risks related to 

market access. Generally, are there 

access arrangements that warrant 

different requirements? If so, please 

state which ones and why. If a broker or 

dealer provides another broker or dealer 

with market access, should such an 

arrangement be treated differently under 

the proposed rule? In this situation, 

should the proposed rule permit an 

allocation of responsibilities for 

implementing the appropriate financial 

and regulatory risk management 

controls between those brokers or 

dealers? If so, to what extent, and on 

what basis? Should the Commission 

require broker-dealers that provide other 

persons with sponsored access to an 

exchange or ATS to have separate 

identifiers for each such person? Are 

there any circumstances in which a 

broker-dealer ought not to be 

responsible for trading conducted by 

other persons under its MPID or 

otherwise? Should an ATS in its 

capacity as broker-dealer be required to 

implement appropriate risk 

management controls and supervisory 

procedures reasonably designed to 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, associated with nonbroker-dealer subscriber’s access to its 

ATS? 

The proposed rule encompasses 

trading in all securities on an exchange 

or ATS. Should the proposed rule apply 

equally to trading in all securities? For 

example, should the Commission 

consider alternatives to the proposed 

rule in which trading in debt securities, 

equities, and options are treated 

differently? If so, to what extent and on 

what basis? 

Under the proposed rule, brokers or 

dealers would be required to implement 

controls that are reasonably designed to 

prevent the entry of orders that are not 

in compliance with financial controls 

and regulatory requirements and 

thereby effectively prohibit the practice 

of broker-dealers allowing for 

‘‘unfiltered’’ or ‘‘naked’’ access to an 

exchange or ATS. What are the benefits 

and costs to the securities markets 

associated with ‘‘unfiltered’’ or ‘‘naked’’ 

access to an exchange or ATS? 

Specifically, what impact would 

effectively prohibiting ‘‘unfiltered’’ or 

‘‘naked’’ access have on broker-dealers 

providing such access? What impact 

would it have on the markets? What 

impact would it have on customers that 

use such access? What percentage of 

volume is directed to the exchanges 

through ‘‘unfiltered’’ or ‘‘naked’’ access? 

Should the Commission consider 

alternatives to a prohibition on ‘‘naked’’ 

access? Would the proposed rule affect 

the way market participants use market 

access arrangements? 

Are pre-trade controls the preferred 

method for adequately mitigating all the 

risks associated with market access? 

Should the method for managing risk be 

particular to the specific risk? Are there 

acceptable alternative modeling 

techniques that a broker-dealer may use 

to manage its financial and regulatory 

risks that would be functionally similar 

to the methods required by the rule? 

Please explain response and provide 

any appropriate data. 

Would the proposed rule affect the 

speed or efficiency of trading? Would 

market participants be required to 

change their business models or 

practices in ways not contemplated by 

this release if the Commission were to 

adopt the proposed rule? Would the 

proposed rule potentially impact 

competition among, or innovation by, 

market participants? If so, in what way? 

Which market participants would be 

impacted? Would such changes be 

beneficial or detrimental? Are there 

other internal or external costs not 

identified by the Commission that could 

result from the proposed rule? Which 

market participants are the most 

common or active users of sponsored 

access, generally, and ‘‘unfiltered’’ 

access, in particular? How many small 

broker-dealers have or use sponsored 

access arrangements? 

The proposed rule would require 

broker-dealers with market access to 

implement risk management controls 

and supervisory procedures that prevent 

the entry of orders that, among other 

things, exceed appropriate pre-set credit 

or capital thresholds in the aggregate for 

each customer and the broker or dealer, 

exceed appropriate price or size 

parameters on an order-by-order basis or 

over a short period of time, are 

indicative of duplicative orders, are not 

in compliance with a regulatory 

requirement that must be satisfied on a 

pre-order entry basis, or that is for a 

security that a broker or dealer, 

customer, or other person is restricted 

from trading. Should the Commission 

include additional financial and 

regulatory risk management controls in 

the proposed rule? If so, what additional 

financial and regulatory risk 

management controls should be 

included? Would the additional 

standards apply to all brokers or dealers, 

or to a subset? Conversely, if there are 

too many financial and regulatory 

standards, which ones are unnecessary? 

Would these standards be unnecessary 

for all parties, or should they still apply 

in certain specific cases? Should the 

Commission specify more precise 

details regarding the financial and 

regulatory risk management controls? 

Should the proposed rule specify 

financial and regulatory risk 

management controls that would apply 

after an order has been entered on 

exchange or ATS? 

The proposed rule would require 

broker-dealers to establish an 

appropriate credit threshold for each 

customer. The Commission expects that 

broker-dealers would establish such 

threshold based on appropriate due 

diligence as to the customer’s business, 

financial condition, trading patterns, 

and other matters, and document that 

decision. Should the criteria for 

determining the appropriate threshold 

be explicitly listed in the proposed rule? 

Are there specific factors broker-dealers 

should consider in conducting due 

diligence? Should the proposed rule 

require broker-dealers to establish ‘‘early 

warning’’ credit or capital thresholds to 

alert them and their customers when the 

firm limits are being approached, so 

there is an opportunity to adjust trading 

behavior? Should the proposed rule 

require a broker-dealer to establish an 

aggregate credit threshold for all of its 

customers? 

Should the Commission provide 

additional guidance on the short period 

of time in the prevention of entering 

erroneous orders requirement? Is there a 

common understanding among market 

participants regarding the timeframe 

used to prevent the entry of erroneous 

orders? 

The proposed rule would require 

broker-dealers with market access to 

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42 44 U.S.C. 3501 et seq. 

43See supra note 29. 

44 Id. 

45See supra note 31. 

implement risk management controls 

and supervisory procedures that are 

reasonably designed to restrict access to 

trading systems and technology that 

provide market access to permit access 

only to persons and accounts preapproved and authorized by the brokerdealer. Could the goal of this provision, 

the preservation of system and market 

integrity, be achieved in another way? If 

so, how? 

The proposed rule would require 

broker-dealers with market access to 

implement risk management controls 

and supervisory procedures that are 

reasonably designed to assure that 

appropriate surveillance personnel 

receive immediate post-trade execution 

reports that result from market access. 

Should the Commission expand on or 

clarify the requirement that risk 

management controls and supervisory 

procedures be reasonably designed to 

assure that appropriate surveillance 

personnel receive immediate post-trade 

execution reports that result from 

market access? Is there a common 

understanding among market 

participants as to what constitutes 

immediate post-trade execution reports? 

The Commission seeks comment on 

whether broker-dealers could effectively 

comply with the proposed rule—in 

particular, the requirement that the 

financial and regulatory risk 

management controls and supervisory 

procedures be under the direct and 

exclusive control of the broker-dealer 

with market access—by using risk 

management technology developed by 

third parties. Are there any 

circumstances where a broker or dealer 

would not be able to comply with the 

proposed rule using risk management 

technology developed by third parties? 

Are there additional considerations that 

the Commission should evaluate if a 

broker-dealer outsources the 

development of its risk management 

system and supervisory procedures? 

The proposed rule would require the 

broker-dealer to periodically review its 

risk management controls and 

supervisory procedures. Among other 

things, the broker-dealer would be 

required to review in accordance with 

written procedures, and document that 

review, no less frequently than 

annually, its business activity in 

connection with market access to assure 

the overall effectiveness of such risk 

management controls and supervisory 

procedures. Should this review be 

conducted more or less frequently? In 

addition, the Chief Executive Officer (or 

equivalent officer) of the broker-dealer 

would be required, on an annual basis, 

to certify that such risk management 

controls and supervisory procedures 

comply with paragraphs (b) and (c) and 

that the regular review was conducted. 

Should the certification be conducted 

more or less frequently? The proposed 

rule would require a broker or dealer to 

preserve a copy of its supervisory 

procedures, a written description of its 

risk management controls, and written 

supervisory procedures for its regular 

review as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7). Is this proposed record retention 

requirement clear? The proposed rule 

would require documentation of each 

regular review and Chief Executive 

Officer certifications be preserved by the 

broker or dealer as part of its books and 

records in a manner consistent with 

Rule 17a–4(b). Is this proposed record 

retention requirement clear? 

The Commission strongly encourages 

commenters to respond within the 

designated comment period. It intends 

to act quickly in reviewing the 

comments and assessing further action. 

V. Paperwork Reduction Act 

Certain provisions of Proposed Rule 

15c3–5 contain ‘‘collection of 

information’’ requirements within the 

meaning of the Paperwork Reduction 

Act of 1995 (‘‘PRA’’).42 In accordance 

with 44 U.S.C. 3507 and 5 CFR 1320.11, 

the Commission has submitted the 

provisions to the Office of Management 

and Budget (‘‘OMB’’) for review. The 

title for the proposed new collection of 

information requirement is ‘‘Rule 15c3– 

5, Market Access.’’ An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number. 

A. Summary of Collection of 

Information 

Proposed Rule 15c3–5 would require 

a broker or dealer with market access, or 

that provides a customer or any other 

person with access to an exchange or 

ATS through use of its MPID or 

otherwise, to establish, document, and 

maintain a system of risk management 

controls and supervisory procedures to 

assist it in managing the financial, 

regulatory, and other risks, such as legal 

and operational risks, of this business 

activity. The system of risk management 

controls and supervisory procedures, 

among other things, shall be reasonably 

designed to (1) systematically limit the 

financial exposure of the broker or 

dealer that could arise as a result of 

market access, and (2) ensure 

compliance with all regulatory 

requirements that are applicable in 

connection with market access. The 

financial risk management controls and 

supervisory procedures must be 

reasonably designed to prevent the entry 

of orders that exceed appropriate pre-set 

credit or capital thresholds, or that 

appear to be erroneous. As a practical 

matter, the proposed rule would require 

a respondent to set appropriate credit 

thresholds for each customer for which 

it provides market access and 

appropriate capital thresholds for 

proprietary trading by the broker-dealer 

itself. The regulatory risk management 

controls and supervisory procedures 

must be reasonably designed to prevent 

the entry of orders that do not comply 

with regulatory requirements that must 

be satisfied on a pre-order entry basis, 

prevent the entry of orders that the 

broker-dealer or customer is restricted 

from trading, restrict market access 

technology and systems to authorized 

persons, and assure appropriate 

surveillance personnel receive 

immediate post-trade execution reports. 

Each such broker or dealer would be 

required to preserve a copy of its 

supervisory procedures and a written 

description of its risk management 

controls as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7) under the Exchange Act.43

In addition, the proposed rule would 

require a broker or dealer with market 

access, or that provides a customer or 

any other person with access to an 

exchange or ATS through use of its 

MPID or otherwise, to establish, 

document, and maintain a system for 

regularly reviewing the effectiveness of 

the risk management controls and 

supervisory procedures required under 

the proposed rule and for promptly 

addressing any issues. Among other 

things, the broker or dealer would be 

required to review, no less frequently 

than annually, the business activity of 

the broker or dealer in connection with 

market access to assure the overall 

effectiveness of such risk management 

controls and supervisory procedures 

and document that review. Such review 

would be required to be conducted in 

accordance with written procedures and 

would be required to be documented. 

The broker or dealer would be required 

to preserve a copy of such written 

procedures, and documentation of each 

such review, as part of its books and 

records in a manner consistent with 

Rule 17a–4(e)(7) under the Exchange 

Act,44 and Rule 17a–4(b) under the 

Exchange Act, respectively.45

In addition, the Chief Executive 

Officer (or equivalent officer) of the 

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46 Id. 47See supra note 23. 

broker or dealer, on an annual basis, 

would be required to certify that such 

risk management controls and 

supervisory procedures comply with the 

proposed rule, that the broker or dealer 

conducted such review, and such 

certifications shall be preserved by the 

broker or dealer as part of its books and 

records in a manner consistent with 

Rule 17a–4(b) under the Exchange 

Act.46

B. Proposed Use of Information 

The proposed requirement that a 

broker or dealer with market access, or 

that provides a customer or any other 

person with access to an exchange or 

ATS through use of its MPID or 

otherwise, establish, document, and 

maintain a system of risk management 

controls and supervisory procedures 

that, among other things, shall be 

reasonably designed to (1) 

systematically limit the financial 

exposure of the broker or dealer that 

could arise as a result of market access, 

and (2) ensure compliance with all 

regulatory requirements that are 

applicable in connection with market 

access, would serve to ensure that such 

brokers or dealers have sufficiently 

effective controls and procedures in 

place to appropriately manage the risks 

associated with market access. The 

proposed requirement to preserve a 

copy of its supervisory procedures and 

a written description of its risk 

management controls as part of its books 

and records in a manner consistent with 

Rule 17a–4(e)(7) under the Exchange 

Act would help assure that appropriate 

written records were made, and would 

be used by the Commission staff and 

SRO staff during an examination of the 

broker or dealer for compliance with the 

proposed rule. 

The proposed requirement to 

maintain a system for regularly 

reviewing the effectiveness of the risk 

management controls and supervisory 

procedures required under the proposed 

rule would serve to ensure that the risk 

management controls and supervisory 

procedures remain effective. A brokerdealer would use these risk management 

controls and supervisory procedures to 

fulfill its obligations under the proposed 

rule, as well as to evaluate and ensure 

its financial integrity more generally. 

The Commission and SROs would use 

this information in their exams of the 

broker or dealer, as well as for 

regulatory purposes. The proposed 

requirement that a broker or dealer 

preserve a copy of written procedures, 

and documentation of each such regular 

review, as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7) under the Exchange Act, and 

Rule 17a–4(b) under the Exchange Act, 

respectively, would help assure that the 

regular review was in fact completed, 

and would be used by the Commission 

staff and SRO staff during an 

examination of the broker or dealer for 

compliance with the proposed rule. The 

proposed requirement that the Chief 

Executive Officer (or equivalent officer) 

of the broker or dealer, on an annual 

basis, certify that such risk management 

controls and supervisory procedures 

comply with proposed Rule 15c3–5, that 

the annual review was conducted, and 

that such certifications be preserved by 

the broker or dealer as part of its books 

and records in a manner consistent with 

Rule 17a–4(b) under the Exchange Act 

would help ensure that senior 

management review the efficacy of its 

controls and procedures at regular 

intervals and that such review is 

documented. This certification would 

be used internally by the broker or 

dealer as evidence that it complied with 

the proposed rule and possibly for 

internal compliance audit purposes. The 

certification also would be used by 

Commission staff and SRO staff during 

an examination of the broker or dealer 

for compliance with the proposed rule 

or more generally with regard to 

evaluation of a broker or dealer’s risk 

management control procedures and 

controls. 

The proposed rule would require a 

broker or dealer with market access to 

assure that appropriate surveillance 

personnel receive immediate post-trade 

execution reports that result from 

market access. The broker or dealer 

would use these post-trade execution 

reports in reviewing for potential 

regulatory violations. In addition, these 

reports would better enable the broker 

or dealer to investigate, report, or halt 

suspicious or manipulative trading 

activity. In addition, the Commission 

and SROs may review these reports 

when examining the broker or dealer. 

C. Respondents 

The proposed ‘‘collection of 

information’’ contained in Proposed 

Rule 15c3–5 would apply to 

approximately 1,295 brokers and dealers 

that have market access or provide a 

customer or any other person with 

market access. Of these 1,295 brokers 

and dealers, the Commission estimates 

that there are 1,095 brokers or dealers 

that are members of an exchange. This 

estimate is based on broker-dealer 

responses to FOCUS report filings with 

the Commission. The Commission 

estimates that the remaining 200 brokerdealers are subscribers to ATSs but are 

not exchange members. This estimate is 

based on a sampling of subscriber 

information contained in Exhibit A to 

Form ATS–R filed with the 

Commission. The Commission requests 

comment on the accuracy of these 

estimated figures. 

D. Total Initial and Annual Reporting 

and Recordkeeping Burdens 

As discussed above, brokers and 

dealers are currently subject to a variety 

of SRO guidance and rules related to 

market access. Currently, most brokers 

or dealers, when accessing an exchange 

or ATS in the ordinary course of their 

business, already have risk management 

controls and supervisory procedures in 

place, although these controls and 

procedures will differ based on each 

broker or dealer’s unique business 

model.47 For the purposes of the PRA, 

the Commission must consider the 

burden on respondents to bring their 

risk management controls and 

supervisory procedures into compliance 

with the proposed rule. The 

Commission notes that among brokers 

or dealers with market access, there is 

currently no uniform standard for risk 

management controls and supervisory 

procedures. The extent to which a 

respondent would be burdened by the 

proposed collection of information 

under the proposed rule would depend 

significantly on the financial and 

regulatory risk management controls 

that already exist in the respondent’s 

system as well as the respondent’s 

business model. In many cases, 

particularly with respect to proprietary 

trading, more traditional agency 

brokerage activities, and direct market 

access, the proposed rule may be 

substantially satisfied by a respondent’s 

pre-existing financial and regulatory 

risk management controls and current 

supervisory procedures. These brokers 

or dealers likely would only require 

limited updates to their systems to meet 

the requisite risk management controls 

specified in the proposed rule. 

The Commission believes that the 

majority of respondents has order 

management systems with pre-trade 

financial and regulatory controls, 

although the use and range of those 

controls may vary among firms. As 

noted above, certain pre-trade controls, 

such as pre-set trading limits or filters 

to prevent erroneous trades may already 

be in place within a respondent’s risk 

management system. Similarly, the 

extent to which receipt of immediate 

post-trade execution reports creates a 

burden on respondents would depend 

on whether a respondent already 

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48 Id. 

49This estimate is based on discussions with 

various industry participants. Specifically, the 

modification and upgrading of hardware and 

software for a pre-existing risk control management 

system, with few substantial changes required, 

would take approximately two weeks, while the 

development of a risk control management system 

from scratch would take approximately three 

months. 

Based on discussions with industry participants, 

the Commission estimates that a dedicated team of 

1.5 people would be required for the system 

development. The team may include one or more 

programmer analysts, senior programmers, or senior 

systems analysts. Each team member would work 

approximately 20 days per month, or 8 hours × 20 

days = 160 hours per month. Therefore, the total 

number of hours per month for one system 

development team would be 240 hours. 

A two-week project to modify and upgrade a preexisting risk control management system would 

require 240 hours/month × 0.5 months = 120 hours, 

while a three-month project to develop a risk 

control management system from scratch would 

require 240 hours/month × 3 months = 720 hours. 

Based on discussions with industry participants, 

the Commission estimates that 95% of all 

respondents would require modifications and 

upgrades only, and 5% would require development 

of a system from scratch. Therefore, the total 

average number of burden hours for an initial 

internal development project would be 

approximately (0.95 × 120 hours) + (0.05 × 720 

hours) = 150 hours. 

50See infra note 61. 

51 12 months × $4,000 (estimated monthly cost for 

two connections to a trading venue) × 2 trading 

venues = $96,000. This estimate is based on 

discussions with various industry participants. For 

purposes of this estimate, ‘‘connection’’ is defined 

as up to 1000 messages per second inbound, 

regardless of the connection’s actual capacity. 

For the conservative estimate above, the 

Commission chose two connections to a trading 

venue, the number required to accommodate 1,500 

to 2,000 messages per second. The estimated 

number of messages per second is based on 

discussions with various industry participants. 

52Based on discussions with industry 

participants, the Commission estimates that a 

dedicated team of 1.5 people would be used for the 

ongoing maintenance of all technology systems. The 

team may include one or more programmer 

analysts, senior programmers, or senior systems 

analysts. In-house system staff size varies 

depending on, among other things, the business 

model of the broker or dealer. Each staff member 

would work 160 hours per month, or 12 months × 

160 hours = 1,920 hours per year. A team of 1.5 

people therefore would work 1,920 hours × 1.5 

people = 2,880 hours per year. Based on discussions 

with industry participants, the Commission 

estimates that 4% of the team’s total work time 

would be used for ongoing risk management 

maintenance. Accordingly, the total number of 

burden hours for this task, per year, is 0.04 × 2,880 

hours = 115.2 hours. 

53See infra note 62. 

54 Industry sources estimate that to build a risk 

control management system from scratch, hardware 

would cost $44,500 and software would cost 

$58,000, while to upgrade a pre-existing risk control 

management system, hardware would cost $5,000 

and software would cost $6,517. Based on 

discussions with industry participants, the 

Commission estimates that 95% of all respondents 

would require modifications and upgrades only, 

and 5% would require development of a system 

from scratch. Therefore, the total average hardware 

and software cost for an initial internal 

development project would be approximately (0.95 

× $11,517) + (0.05 × $102,500) = $16,066, or 

$16,000. 

55 Industry sources estimate that for ongoing 

maintenance, hardware would cost $8,900 on 

average and software would cost $11,600 on 

average. The total average hardware and software 

cost for ongoing maintenance would be $8,900 + 

$11,600 = $20,500. 

receives such reports on an immediate, 

post-trade basis or on an end-of-day 

basis. For broker-dealers that rely 

largely on ‘‘unfiltered’’ or ‘‘naked’’ 

access, the proposed rule could require 

the development or significant upgrade 

of a new risk management system, 

which would be a significantly larger 

burden on a potential respondent. 

Therefore, the burden imposed by the 

proposed rule would differ vastly 

depending on a broker-dealer’s current 

risk management system and business 

model. 

Proposed Rule 15c3–5 would also 

require a respondent to update its 

review and compliance procedures to 

comply with the proposed rule’s 

requirement to regularly review its risk 

management controls and supervisory 

procedures, including a certification 

annually by the Chief Executive Officer 

(or equivalent officer). The Commission 

notes that a respondent should currently 

have written compliance procedures 

reasonably designed to review its 

business activity.48 Proposed Rule 

15c3–5 would initially require a 

respondent to update its written 

compliance procedures to document the 

method in which the respondent plans 

to comply with the proposed rule. 

1. Technology Development and 

Maintenance 

The Commission estimates that the 

initial burden for a potential respondent 

to comply with the proposed 

requirement to establish, document, and 

maintain a system for regularly 

reviewing the effectiveness of the risk 

management controls and supervisory 

procedures, on average, would be 150 

hours if performed in-house,49 or 

approximately $35,000 if outsourced.50

This figure is based on the estimated 

number of hours for initial internal 

development and implementation by a 

respondent to program its system to add 

the controls needed to comply with the 

requirements of the proposed rule, 

expand system capacity, if necessary, 

and establish the ability to receive 

immediate post-trade execution reports. 

Based on discussion with various 

industry participants, the Commission 

expects that brokers or dealers with 

market access currently have the means 

to receive post-trade executions reports, 

at a minimum, on an end-of-day basis. 

If the broker-dealer decides to forego 

internal technology development and 

instead opts to purchase technology 

from a third-party technology provider 

or service bureau, the technology costs 

would also depend on the risk 

management controls that are already in 

place, as well as the business model of 

the broker or dealer. Based on 

discussions with various industry 

participants, the Commission 

understands that technology for risk 

management controls is generally 

purchased on a monthly basis. Based on 

discussions with various industry 

participants, the Commission’s staff 

estimates that the cost to purchase 

technology from a third-party 

technology provider or service bureau 

would be approximately $3,000 per 

month for a single connection to a 

trading venue, plus an additional $1,000 

per month for each additional 

connection to that exchange. For a 

conservative estimate of the annual 

outsourcing cost, the Commission notes 

that for two connections to each of two 

different trading venues, the annual cost 

would be $96,000.51 The potential range 

of costs would vary considerably, 

depending upon the business model of 

the broker-dealer. 

On an ongoing basis, a respondent 

would have to maintain its risk 

management system by monitoring its 

effectiveness and updating its systems 

to address any issues detected. In 

addition, a respondent would be 

required to preserve a copy of its written 

description of its risk management 

controls as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7) under the Exchange Act. The 

Commission estimates that the ongoing 

annualized burden for a potential 

respondent to maintain its risk 

management system would be 

approximately 115 burden hours if 

performed in-house,52 or approximately 

$26,800 if outsourced.53 The 

Commission believes the ongoing 

burden of complying with the proposed 

rule’s collection of information would 

include, among other things, updating 

systems to address any issues detected, 

updating risk management controls to 

reflect any change in its business model, 

and documenting and preserving its 

written description of its risk 

management controls. 

For hardware and software expenses, 

the Commission estimates that the 

average initial cost would be 

approximately $16,000 per brokerdealer,54 while the average ongoing cost 

would be approximately $20,500 per 

broker-dealer.55

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56See supra note 23. 

57The Commission estimates that one compliance 

attorney and one compliance manager would each 

require 5 hours, for a total initial burden of 10 

hours. 

58The Commission estimates that one compliance 

attorney and one compliance manager would each 

require 10 hours, and one Chief Executive Officer 

would require 5 hours, for a total initial burden of 

25 hours. 

2. Legal and Compliance 

The Commission provides a separate 

set of estimates for legal and compliance 

obligations. The Commission 

preliminarily believes that the majority 

of broker-dealers should already have 

compliance policies and supervisory 

procedures in place.56 Accordingly, the 

Commission believes that the initial 

burden to comply with the proposed 

compliance requirements should not be 

substantial. Based on discussions with 

various industry participants and the 

Commission’s prior experience with 

broker-dealers, the Commission 

estimates that the initial legal and 

compliance burden on average for a 

potential respondent to comply with the 

proposed requirement to establish, 

document, and maintain compliance 

policies and supervisory procedures 

would be approximately 35 hours. 

Specifically, the setting of credit and 

capital thresholds for each customer 

would require approximately 10 

hours,57 and the modification or 

establishment of applicable compliance 

policies and procedures would require 

approximately 25 hours,58 which 

includes establishing written 

procedures for reviewing the overall 

effectiveness of the risk management 

controls and supervisory procedures. 

On an ongoing basis, a respondent 

would have to maintain and review its 

risk management controls and 

supervisory procedures to assure their 

effectiveness as well as to address any 

deficiencies found. The broker or dealer 

would have to review, no less frequently 

than annually, its business activity in 

connection with market access to assure 

the overall effectiveness of the risk 

management controls and supervisory 

procedures and would be required to 

make changes to address any problems 

or deficiencies found through this 

review. Such review would be required 

to be conducted in accordance with 

written procedures and would be 

required to be documented. The broker 

or dealer would be required to preserve 

a copy of such written procedures, and 

documentation of each such review, as 

part of its books and records in a 

manner consistent with Rule 17a–4(e)(7) 

under the Exchange Act, and Rule 

17a–4(b) under the Exchange Act, 

respectively. On an annual basis, the 

Chief Executive Officer (or equivalent 

officer) of the broker or dealer would be 

required to certify that such risk 

management controls and supervisory 

procedures comply with the proposed 

rule, that the broker or dealer conducted 

such review, and that such certifications 

are preserved by the broker or dealer as 

part of its books and records in a 

manner consistent with Rule 17a–4(b) 

under the Exchange Act. The ongoing 

burden of complying with the proposed 

rule’s collection of information would 

include documentation for compliance 

with its risk management controls and 

supervisory procedures, modification to 

procedures to address any deficiencies 

in such controls or procedures, and the 

required preservation of such records. 

Based on discussions with industry 

participants and the Commission’s prior 

experience with broker-dealers, the 

Commission estimates that a brokerdealer’s implementation of an annual 

review, modification of its risk 

management controls and supervisory 

procedures to address any deficiencies, 

and preservation of such records would 

require 45 hours per year. Specifically, 

compliance attorneys who review, 

document, and update written 

compliance policies and procedures 

would require an estimated 20 hours per 

year; a compliance manager who 

reviews, documents, and updates 

written compliance policies and 

procedures is expected to require 20 

hours per year; and the Chief Executive 

Officer, who certifies the policies and 

procedures, is expected to require 

another 5 hours per year. 

Based on discussions with industry 

participants and the Commission’s prior 

experience with broker-dealers, the 

Commission believes that the ongoing 

legal and compliance obligations under 

the proposed rule would be handled 

internally because compliance with 

these obligations is consistent with the 

type of work that a broker-dealer 

typically handles internally. The 

Commission does not believe that a 

broker-dealer would have any recurring 

external costs associated with legal and 

compliance obligations. 

3. Total Burden 

Under the proposed rule, the total 

initial burden for all respondents would 

be approximately 239,575 hours ([150 

hours (for technology) + 35 hours (for 

legal and compliance)] × 1,295 brokers 

and dealers = 239,575 hours) and the 

total ongoing annual burden would be 

approximately 207,200 hours ([115 

hours (for technology) + 45 hours (for 

legal and compliance)] × 1,295 brokers 

and dealers = 207,200 hours). For 

hardware and software expenses, the 

total initial cost for all respondents 

would be $20,720,000 ($16,000 per 

broker-dealer × 1,295 brokers and 

dealers = $20,720,000) and the total 

ongoing cost for all respondents would 

be $26,547,500 ($20,500 per brokerdealer × 1,295 brokers and dealers = 

$26,547,500). The estimates of the 

initial and annual burdens are based on 

discussions with potential respondents. 

The Commission seeks comment on 

the reporting and recordkeeping 

collection of information burdens 

associated with the proposed rule. In 

particular: 

1. How many broker-dealers would 

incur collection of information burdens 

if the proposed rule were adopted by the 

Commission? 

2. What are the burdens, both initial 

and annual, that a broker-dealer would 

incur for programming, expanding 

systems capacity, establishing 

compliance programs, and maintaining 

post-trade reporting if the Commission 

were to adopt the proposed rule? Would 

there be additional burdens associated 

with the collection of information under 

this proposed rule? 

3. How much work would it take for 

brokers or dealers with existing risk 

management control systems and 

supervisory procedures to comply with 

the proposed rule? Would brokers or 

dealers generally perform the work 

internally or outsource the work? What 

would be the hardware and software 

costs for brokers or dealers that 

complete the work internally? What 

about those that outsource the work? 

E. General Information About Collection 

of Information 

The collection of information would 

be mandatory. The collection of 

information would not be required to be 

made public but would not be 

confidential. 

F. Request for Comment 

Pursuant to 44 U.S.C. 3505(c)(2)(B), 

the Commission solicits comment to: 

1. Evaluate whether the proposed 

collection of information is necessary 

for the performance of the functions of 

the agency, including whether the 

information shall have practical utility; 

2. Evaluate the accuracy of the 

agency’s estimate of the burden of the 

proposed collection of information; 

3. Enhance the quality, utility, and 

clarity of the information to be 

collected; and 

4. Minimize the burden of collection 

of information on those who are to 

respond, including through the use of 

automated collection techniques or 

other forms of information technology. 

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59See Google Trading Incident, supra note 14. 

See also SWS Trading Incident, supra note 15; 

Mizuho Trading Incident, supra note 16; and 

Rambus Trading Incident, supra note 17. 60See supra note 10. 

Persons wishing to submit 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, Room 3208, New Executive 

Office Building, Washington, DC 20503; 

and should send a copy to Elizabeth M. 

Murphy, Secretary, Securities and 

Exchange Commission, 100 F Street, 

NE., Washington, DC 20549–1090 with 

reference to File No. S7–03–10. OMB is 

required to make a decision concerning 

the collection of information between 30 

and 60 days after publication, so a 

comment to OMB is best assured of 

having its full effect if OMB receives it 

within 30 days of publication. The 

Commission has submitted the 

proposed collection of information to 

OMB for approval. Requests for the 

materials submitted to OMB by the 

Commission with regard to this 

collection of information should be in 

writing, refer to File No. S7–03–10, and 

be submitted to the Securities and 

Exchange Commission, Office of 

Investor Education and Advocacy, 100 F 

Street, NE., Washington, DC 20549– 

0213. 

VI. Consideration of Costs and Benefits 

The Commission is sensitive to the 

costs and benefits of the proposed rule 

and requests comment on the costs and 

benefits of the proposed Rule 15c3–5 

discussed above. The Commission 

encourages commenters to identify, 

discuss, analyze, and supply relevant 

data regarding any such costs or 

benefits. 

A. Benefits 

Proposed Rule 15c3–5 should benefit 

investors, brokers-dealers, their 

counterparties, and the national market 

system as a whole by reducing the risks 

faced by broker-dealers and other 

market participants as a result of various 

market access arrangements by requiring 

financial and regulatory risk 

management controls to be 

implemented on a uniform, market-wide 

basis. The proposed financial and 

regulatory risk management controls 

should reduce risks to broker-dealers 

and markets, as well as systemic risk 

associated with market access and 

enhance market integrity and investor 

protection in the securities markets by 

effectively prohibiting the practice of 

‘‘unfiltered’’ or ‘‘naked’’ access to an 

exchange or ATS. The proposed rule 

would establish a uniform standard for 

a broker or dealer with market access 

with respect to risk management 

controls and procedures which should 

reduce the potential for regulatory 

arbitrage and lead to consistent 

interpretation and enforcement of 

applicable regulatory requirements 

across markets. 

One of the benefits of the proposed 

rule should be the reduction of systemic 

risk associated with market access 

through the elimination of ‘‘unfiltered’’ 

or ‘‘naked’’ access. As discussed above, 

due in large part to technological 

advancements, the U.S. markets have 

experienced a rise in the use and 

reliance of ‘‘sponsored access’’ 

arrangements where customers place 

orders that are routed to markets with 

little or no substantive intermediation 

by a broker or dealer. The risk of 

unmonitored trading is heightened with 

the increased prominence of high-speed, 

high-volume, automated algorithmic 

trading, where orders can be routed for 

execution in milliseconds. If a brokerdealer does not implement strong 

systematic controls, the broker or dealer 

may be unaware of customer trading 

activity that is occurring under its MPID 

or otherwise. In the ‘‘unfiltered’’ or 

‘‘naked’’ access context, as well as with 

all market access generally, the 

Commission is concerned that order 

entry errors could suddenly and 

significantly make a broker or dealer 

and other market participants 

financially vulnerable within mere 

minutes or seconds. Real examples of 

such potential catastrophic events have 

already occurred. For instance, as 

discussed earlier, on September 30, 

2008, trading in Google became 

extremely volatile toward the end of the 

day trading, dropping 93% in value at 

one point, due to an influx of erroneous 

orders onto an exchange from a single 

market participant which resulted in the 

cancellation of numerous trades.59

Without systematic risk protection, 

erroneous trades, whether resulting 

from manual errors or a faulty 

automated, high-speed algorithm, could 

potentially expose a broker or dealer to 

enormous financial burdens and disrupt 

the markets. Because the impact of such 

errors may be most profound in the 

‘‘unfiltered’’ access context, but are not 

unique to it, it is clearly in a broker or 

dealer’s financial interest, and the 

interest of the U.S. markets as whole, to 

be shielded from such a scenario 

regardless of the form of market access. 

The mitigation of significant systemic 

risks should help ensure the integrity of 

the U.S. markets and provide the 

investing public with greater confidence 

that intentional, bona fide transactions 

are being executed across the national 

market system. Proposed Rule 15c3–5 

should promote confidence as well as 

participation in the market by 

enhancing the fair and efficient 

operation of the U.S. securities markets. 

The national market system is 

currently exposed to risk that can result 

from unmonitored order flow, as a 

recent report has estimated that ‘‘naked’’ 

access accounts for 38 percent of the 

daily volume for equities traded in the 

U.S. markets.60 The Commission is 

aware that a certain segment of the 

broker-dealer community has declined 

to incorporate ‘‘naked’’ access 

arrangements into their business models 

because of the inherent risks of the 

practice. In the absence of a 

Commission rule that would prohibit 

such market access, these brokers or 

dealers could be compelled by 

competitive and economic pressures to 

offer ‘‘naked’’ access to their customers 

and thereby significantly increase a 

systemic vulnerability of the national 

market system. 

Finally, the Commission believes that 

in many cases broker or dealers whose 

business activities include proprietary 

trading, traditional agency brokerage 

activities, and direct market access, 

would find that their current risk 

management controls and supervisory 

procedures may substantially satisfy the 

requirements of the proposed rule, and 

require minimal material modifications. 

Such broker or dealers would 

experience the market-wide benefits of 

the proposal with limited additional 

costs related to their own compliance. 

The Commission seeks comment on 

the anticipated benefits of the proposed 

rule, including the following: Would the 

proposed rule provide market benefits 

that the Commission has not discussed? 

Would the proposed rule help level the 

playing field for broker-dealer 

competition? Would the proposed rule 

serve to reduce systemic risks to the US 

markets? Would the proposed rule serve 

to promote trading volumes? Would the 

proposed rule enhance market integrity, 

promote investor protection, and protect 

the public interest? 

B. Costs 

1. Technology Development and 

Maintenance 

Broker-dealers with market access 

may comply with the proposed rule in 

several ways. Specifically, a brokerdealer may choose to internally develop 

risk management controls from scratch, 

or upgrade its existing systems; each of 

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4022 Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 

61See supra note 49. The Commission estimates 

that the average initial cost of $51,000 per brokerdealer consists of $35,000 for technology personnel 

and $16,000 for hardware and software. As stated 

in the PRA section, industry sources estimate that 

the average system development team consists of 

one or more programmer analysts, senior 

programmers, and senior systems analysts. The 

Commission estimates that the programmer analyst 

would work 40% of the total hours required for 

initial development, or 150 hours × 0.40 = 60 hours; 

the senior programmer would work 20% of the total 

hours, or 150 hours × 0.20 = 30 hours; and the 

senior systems analyst would work 40% of the total 

hours, or 150 hours × 0.40 = 60 hours. The total 

initial development cost for staff is estimated to be 

60 hours × $193 (hourly wage for a programmer 

analyst) + 30 hours × $292 (hourly wage for a senior 

programmer) + 60 hours × $244 (hourly wage for a 

senior systems analyst) = $34,980, or $35,000. 

The $193, $292, and $244 per hour estimates for 

a programmer analyst, senior programmer, and 

senior systems analyst, respectively is from 

SIFMA’s Office Salaries in the Securities Industry 

2008, modified by Commission staff to account for 

an 1,800-hour work-year and multiplied by 5.35 to 

account for bonuses, firm size, employee benefits 

and overhead. 

The Commission estimates that the average initial 

hardware and software cost is $16,000 per brokerdealer. Industry sources estimate that to build a risk 

control management system from scratch, hardware 

would cost $44,500 and software would cost 

$58,000, while to upgrade a pre-existing risk control 

management system, hardware would cost $5,000 

and software would cost $6,517. Based on 

discussions with industry participants, the 

Commission estimates that 95% of all respondents 

would require modifications and upgrades only, 

and 5% would require development of a system 

from scratch. Therefore, the total average hardware 

and software cost for an initial internal 

development project would be approximately (0.95 

× $11,517) + (0.05 × $102,500) = $16,066, or 

$16,000. 

62See supra note 52. The Commission estimates 

that the average annual ongoing cost of $47,300 per 

broker-dealer consists of $26,800 for technology 

personnel and $20,500 for hardware and software. 

The Commission estimates that the programmer 

analyst would work 40% of the total hours required 

for ongoing maintenance, or 115 hours × 0.40 = 46 

hours; the senior programmer would work 20% of 

the total hours, or 115 hours × 0.20 = 23 hours; and 

the senior systems analyst would work 40% of the 

total hours, or 115 hours × 0.40 = 46 hours. The 

total ongoing maintenance cost for staff is estimated 

to be 46 hours × $193 (hourly wage for a 

programmer analyst) + 23 hours × $292 (hourly 

wage for a senior programmer) + 46 hours × $244 

(hourly wage for a senior systems analyst) = 

$26,818, or $26,800. 

The $193, $292, and $244 per hour estimates for 

a programmer analyst, senior programmer, and 

senior systems analyst, respectively is from 

SIFMA’s Office Salaries in the Securities Industry 

2008, modified by Commission staff to account for 

an 1,800-hour work-year and multiplied by 5.35 to 

account for bonuses, firm size, employee benefits 

and overhead. 

The Commission estimates that the average 

annual ongoing hardware and software cost is 

$20,500 per broker-dealer. Industry sources 

estimate that for ongoing maintenance, hardware 

would cost $8,900 on average and software would 

cost $11,600 on average. The total average hardware 

and software cost for ongoing maintenance would 

be $8,900 + $11,600 = $20,500. 

63See supra Section V.D.1. 64As stated previously, the Commission estimates 

that 5% of all broker-dealers will require 

development of a system from scratch. See supra 

note 49. The Commission believes that a total of 65 

broker-dealers is a reasonable estimate here. 

these approaches has potential costs 

that are divided into initial costs and 

annual ongoing costs. Alternatively, a 

broker-dealer may choose to purchase a 

risk management solution from an 

outside vendor. As stated above, it is 

likely many broker-dealers with market 

access would be able to substantially 

satisfy the proposed rule with their 

current risk management controls and 

supervisory procedures, requiring few 

material changes. However, for others, 

the costs of upgrading and introducing 

the required systems would vary 

considerably based on their current 

controls and procedures, as well as their 

particular business models. For 

instance, the needs of a broker-dealer 

would vary based on its current systems 

and controls in place, the 

comprehensiveness of its controls and 

procedures, the sophistication of its 

client base, the types of trading 

strategies that it utilizes, the number of 

trading venues it connects to, the 

number of connections that it has to 

each trading market, and the volume 

and speed of its trading activity. 

Commission staff’s discussions with 

industry participants found that brokerdealers who must develop or 

substantially upgrade existing systems 

could face several months of work 

requiring considerable time and effort. 

For example, the Commission 

conservatively estimates that developing 

a system from scratch could take 

approximately three months, while 

upgrading a pre-existing risk control 

management system could take 

approximately two weeks. Overall, 

Commission staff estimates that the 

initial cost for an internal development 

team to develop or substantially 

upgrade an existing risk control system 

would be $51,000 per broker-dealer,61

or $66.0 million for 1,295 brokerdealers. The Commission further 

estimates that the total annual ongoing 

cost to maintain an in-house risk control 

management system is $47,300 per 

broker-dealer, or $61.3 million for 1,295 

broker-dealers.62

We note that the potential range of 

costs would vary considerably, 

depending upon the needs of the brokerdealer. For example, if 65 brokerdealers—i.e., 5% of the 1,295 brokerdealers affected under the rule—were to 

build risk control management systems 

from scratch, the total initial technology 

cost would be approximately $17.6 

million. A team of 1.5 people, working 

full-time for 3 months, would work an 

estimated total of 720 burden hours on 

the project. The resulting personnel cost 

to build such a risk control management 

system would be approximately 

$167,904 per broker-dealer, or 

$10,913,760 for 65 broker-dealers. The 

hardware and software cost to build a 

risk control management system from 

scratch would be $102,500 per brokerdealer, or $6,662,500 for 65 brokerdealers. The combined personnel, 

hardware, and software cost would be 

$17.6 million. 

By contrast, if the remaining 1,230 

broker-dealers were to upgrade and 

modify their pre-existing risk control 

management systems, the total initial 

technology cost for those 1,230 brokerdealers would be approximately $48.6 

million. A team of 1.5 people, working 

full-time for 2 weeks, would work an 

estimated total of 120 burden hours on 

the project. The resulting staff cost to 

upgrade and modify a pre-existing risk 

control management system would be 

approximately $27,984 per brokerdealer, or $34.4 million for 1,230 brokerdealers. The hardware and software cost 

to upgrade and modify a risk control 

management system would be $11,517 

per broker-dealer, or $14.2 million for 

1,230 broker-dealers. The combined 

personnel, hardware, and software cost 

would be $48.6 million. The 

Commission welcomes comments on 

these estimates. 

Rather than developing or upgrading 

systems, broker-dealers may choose to 

purchase a risk management solution 

from a third-party vendor. Potential 

costs of contracting with such a vendor 

were obtained from industry 

participants. Here again, the potential 

range of costs would vary considerably, 

depending upon the needs of the brokerdealer. For instance, the needs of a 

broker-dealer would vary based on its 

current systems and controls in place, 

the comprehensiveness of its controls 

and procedures, the sophistication of its 

client base, the types of trading 

strategies that it utilizes, the number of 

trading venues it connects to, the 

number of connections that it has to 

each trading market, and the volume 

and speed of its trading activity. As 

discussed previously, a broker-dealer is 

estimated to pay as much as 

approximately $4,000 per month per 

trading venue for a startup contract 

depending on its particular needs. The 

Commission conservatively estimates 

$8,000 per month (i.e., connection to 

two trading venues), or $96,000 

annually, for a startup contract.63 For 

instance, the Commission estimates that 

if 65 broker-dealers choose to purchase 

systems from a third-party vendor as an 

alternative to building a risk control 

management system from scratch,64 the 

cost to the industry for initial startup 

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65 65 broker-dealers × $96,000 (annual cost for a 

startup contract with a third-party technology 

provider or service bureau) = $6,240,000. 

66The Commission estimates that one compliance 

attorney and one compliance manager would each 

require 5 hours, for a total initial burden of 10 

hours. See supra Section V.B.2. The total initial cost 

for staff is estimated to be 5 hours × $270 (hourly 

wage for a compliance attorney) + 5 hours × $258 

(hourly wage for a compliance manager) = $2,640. 

The $270 and $258 per hour estimates for a 

compliance attorney and compliance manager, 

respectively, is from SIFMA’s Office Salaries in the 

Securities Industry 2008, modified by Commission 

staff to account for an 1,800-hour work-year and 

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits and overhead. 

67The Commission estimates that one compliance 

attorney and one compliance manager would each 

require 10 hours, while the Chief Executive Officer 

would require 5 hours, for a total initial burden of 

25 hours. See supra Section V.B.2. The total initial 

cost for staff is estimated to be 10 hours × $270 

(hourly wage for a compliance attorney) + 10 hours 

× $258 (hourly wage for a compliance manager) + 

5 hours × $4,055 (hourly wage for a Chief Executive 

Officer) = $25,555. 

The $270 and $258 per hour estimates for a 

compliance attorney and compliance manager, 

respectively, is from SIFMA’s Office Salaries in the 

Securities Industry 2008, modified by Commission 

staff to account for an 1,800-hour work-year and 

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits and overhead. The $4,055 per 

hour figure for a broker-dealer Chief Executive 

Officer comes from the median of June 2008 Large 

Bank Executive Compensation data from 

TheCorporateLibrary.com, divided by 1800 hours 

per work-year. We invite comments on whether 

large bank Chief Executive Officer total 

compensation is an appropriate proxy for brokerdealer Chief Executive Officer total compensation. 

68 20 hours (total annual ongoing compliance 

hourly burden for a compliance attorney) × $270 

(hourly wage for a compliance attorney) = $5,400. 

The $270 per hour estimate for a compliance 

attorney is from SIFMA’s Office Salaries in the 

Securities Industry 2008, modified by Commission 

staff to account for an 1,800-hour work-year and 

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits and overhead. 

69 20 hours (total annual ongoing compliance 

hourly burden for a compliance manager) × $258 

(hourly wage for a compliance manager) = $5,160. 

The $258 per hour estimate for a compliance 

manager is from SIFMA’s Office Salaries in the 

Securities Industry 2008, modified by Commission 

staff to account for an 1,800-hour work-year and 

multiplied by 5.35 to account for bonuses, firm size, 

employee benefits and overhead. 

70 5 hours (total annual ongoing compliance 

hourly burden for a Chief Executive Officer) × 

$4,055 (hourly wage for a Chief Executive Officer) 

= $20,275. The $4,055 per hour figure for a brokerdealer Chief Executive Officer comes from the 

median of June 2008 Large Bank Executive 

Compensation data from TheCorporateLibrary.com, 

divided by 1800 hours per work-year. We invite 

comments on whether large bank Chief Executive 

Officer total compensation is an appropriate proxy 

for broker-dealer Chief Executive Officer total 

compensation. 

71See supra Section VI.B.1. 

72See supra Section VI.B.2. 

73See supra Section VI.B.1. 

74See supra Section VI.B.2. 

contracts could be approximately 

$6,240,000.65 The Commission 

preliminarily believes that the annual 

ongoing cost would be significantly less 

than the initial startup cost; however, to 

be conservative, we estimate that the 

annual ongoing cost for 65 brokerdealers would be the same as the startup 

estimate of $6,240,000 per year. The 

Commission welcomes comments on 

the reasonableness of these estimates. 

2. Legal and Compliance 

Like today, a broker or dealer would 

be obligated to comply with all 

applicable regulatory requirements such 

as exchange trading rules relating to 

special order types, trading halts, oddlot orders, SEC rules under Regulation 

SHO and Regulation NMS, and 

applicable margin requirements. 

Accordingly, the Commission believes 

that the overall cost increase associated 

with developing and maintaining 

compliance policies and procedures is 

not expected to be significant because 

the proposed rule may be substantially 

satisfied by existing risk management 

controls and supervisory procedures 

already implemented by brokers-dealer 

that conduct proprietary trading, 

traditional brokerage activities, direct 

market access, and sponsored access. 

Therefore, many of the financial and 

regulatory risk management controls 

specified in the proposed rule—such as 

prevention of trading restricted 

products, or setting of trade limits— 

should already be in place and should 

not require significant additional 

expenditure of resources. 

The Commission estimates that the 

initial cost for a broker or dealer to 

comply with the proposed requirement 

to establish, document, and maintain 

compliance policies and supervisory 

procedures would be approximately 

$28,200 per broker-dealer, or $36.5 

million for 1,295 broker-dealers. 

Specifically, the costs for setting credit 

and capital thresholds would be 

approximately $2,640; 66 and the 

modification or establishment of 

applicable compliance policies and 

procedures would be approximately 

$25,555 per broker-dealer.67

The Commission further estimates 

that the costs of the annual review, 

modification of applicable compliance 

policies and supervisory procedures, 

and preservation of such records would 

be approximately $30,800 per brokerdealer, or $39.9 million for 1,295 brokerdealers. Specifically, compliance 

attorneys who review, document, and 

update written compliance policies and 

procedures would cost an estimated 

$5,400 per year; 68 a compliance 

manager who reviews, documents, and 

updates written compliance policies 

and procedures is expected to cost 

$5,160; 69 and the Chief Executive 

Officer, who certifies the policies and 

procedures, would cost $20,275.70

The Commission believes that the 

ongoing legal and compliance 

obligations under the proposed rule 

would be handled internally because 

compliance with these obligations is 

consistent with the type of work that a 

broker-dealer typically handles 

internally. The Commission does not 

believe that a broker-dealer would likely 

have any recurring external costs 

associated with legal and compliance 

obligations. 

3. Total Cost 

The Commission believes that this 

proposed rule would have its greatest 

impact on broker-dealers that provide 

‘‘naked’’ access, and that the majority of 

broker-dealers with market access are 

likely to be able to substantially satisfy 

the requirements of the proposed rule 

change with much of their current 

existing risk management controls and 

supervisory procedures. However, for 

broker-dealers that would need to 

develop or substantially upgrade their 

systems the cost would vary 

considerably. 

We note that the potential range of 

costs would vary considerably, 

depending upon the needs of the brokerdealer and its current risk management 

controls and supervisory procedures. 

For example, the Commission estimates 

that if 65 broker-dealers build risk 

management systems from scratch and 

modify their compliance procedures 

accordingly, the total initial cost could 

be approximately as much as $19.4 

million. The cost to build the risk 

control management systems would be 

$17.6 million for 65 broker-dealers,71

while the cost to initially develop or 

modify compliance procedures for the 

same would be approximately $28,200 

per broker-dealer,72 or $1,833,000 for 65 

broker-dealers. The total initial cost to 

build systems from scratch is thus 

estimated to be approximately $19.4 

million. 

By contrast, the Commission 

estimates that if the remaining 1,230 

broker-dealers would upgrade their preexisting risk control management 

systems and modify their compliance 

procedures accordingly, the total initial 

cost would be approximately as much as 

$83.3 million. The cost to upgrade the 

risk control management systems would 

be $48.6 million for 1,230 brokerdealers,73 while the cost to initially 

develop or modify compliance 

procedures for the same would be 

approximately $28,200 per brokerdealer,74 or $34.7 million for 1,230 

broker-dealers. The total initial cost is 

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75 $19.4 million (initial cost for 65 broker-dealers 

building a system from scratch) + $83.3 million 

(initial cost for 1,230 broker-dealers upgrading preexisting systems) = approximately $102.6 million. 

76See supra note 62. 

77See supra notes 68, 69, and 70. 

78 15 U.S.C. 78c(f). 

79 15 U.S.C. 78w(a)(2). 

80These numbers are based on the Commission’s 

staff review of 2007 and 2008 FOCUS Report filings 

reflecting registered broker-dealers, and discussions 

with SRO staff. The number does not include 

broker-dealers that are delinquent on FOCUS 

Report filings. 

81See supra note 33. 

thus estimated to be approximately 

$83.3 million. 

The total annual initial cost for 1,295 

broker-dealers is estimated to be 

approximately $102.6 million.75

The total annual ongoing cost for 

1,295 broker-dealers to maintain a risk 

management control system and annual 

review and modification of applicable 

compliance policies and procedures 

could be approximately as much as 

$101.1 million. The annual technology 

cost to maintain a risk management 

control system would be approximately 

$47,300 per broker-dealer,76 or $61.3 

million for 1,295 broker-dealers, while 

the cost for annual review and 

modification of applicable compliance 

policies and procedures would be 

approximately $30,800 per brokerdealer,77 or $39.9 million for 1,295 

broker-dealers. The total annual ongoing 

cost is estimated to be approximately 

$101.1 million. 

The estimates of the initial and 

annual burdens are based on 

discussions with industry participants. 

The Commission welcomes comments 

on these estimates. 

Based on discussions with industry 

participants, the Commission is aware 

that, if the Commission were to adopt 

the proposed rule, there is a potential 

for latency, ranging approximately from 

200 to 500 microseconds, for orders that 

currently route to exchanges or ATSs 

via ‘‘naked’’ access arrangements. The 

Commission however preliminarily 

believes that the potential costs 

associated with the elimination of 

‘‘unfiltered’’ access, including the 

potential for latency, are justified by the 

overall benefit to the U.S. markets. We 

solicit comment on the Commission’s 

view. Would the controls imposed by 

the rule substantially increase latency? 

To what extent would broker-dealers 

have greater incentives to reduce any 

such latency? Would broker-dealers 

incur additional costs in reducing any 

such latency? What would be the costs 

to market participants of any additional 

latency? Can these costs be quantified? 

The Commission is also aware that 

some broker-dealers may benefit from 

offering sponsored access because they 

receive volume discounts offered by 

exchanges and other market centers due 

to the trades entered under the brokerdealer’s MPID or otherwise. How much 

would the proposed rules affect the 

volume discounts enjoyed by brokerdealers? Would this effect differ across 

broker-dealers? What characteristics 

impact a broker-dealer’s reliance on 

sponsored access for these volume 

discounts? How would any effect alter 

a broker-dealer’s business? Can any 

such costs be quantified? 

The Commission seeks comment on 

any other potential costs to brokers or 

dealers that may result from the 

proposed rule. While the Commission 

does not anticipate that there would be 

significant adverse consequences to a 

broker or dealer’s business, activities, or 

financial condition as a result of the 

proposed rule, it seeks commenters’ 

views regarding the possibility of any 

such impact. For instance, would the 

proposed rule impact a broker or 

dealer’s ability to attract or retain its 

market access customers? Could a 

broker or dealer lose order flow, because 

its customer might seek other 

arrangements in order to access the 

securities markets, such as becoming a 

member of a particular exchange or 

becoming a broker or dealer? The 

Commission requests for commenters to 

quantify those costs, where possible. 

The Commission preliminarily 

believes that any additional burden or 

costs on brokers and dealers who 

provide market access as a result of the 

proposed amendments would be 

justified by the improved market 

security to brokers, dealers, market 

participants, the self-regulatory 

organizations, and the public generally, 

all of which contribute to investor 

protection and market integrity. To 

assist the Commission in evaluating the 

costs that could result from the 

proposed rule, the Commission requests 

comments on the potential costs 

identified in this proposal, as well as 

any other costs that could result from 

the proposed rule. In particular, 

comments are requested on whether 

there are costs to any entity not 

identified above. Commenters should 

provide analysis and data to support 

their views on the costs. In particular, 

the Commission requests comment on 

the costs of the proposed rule on 

brokers, dealers, market participants, 

self-regulatory organizations, as well as 

any costs on others, including the 

investor public. 

The Commission also requests 

comment on the following: Would the 

proposed rule impair the ability of 

market participants that currently rely 

on ‘‘unfiltered’’ access to compete? 

Would the proposed rule have any 

unintended, negative consequences for 

the U.S. markets? Would the proposed 

rule decrease the propensity of market 

participants that currently rely on 

‘‘unfiltered’’ access to provide liquidity 

to the U.S. markets? Would the 

proposed rule stifle or impact certain 

trading strategies that may add value to 

the market? Would the proposed rule 

limit price discovery mechanisms? 

VII. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition and Capital 

Formation 

Section 3(f) of the Exchange Act 78

requires the Commission, whenever it 

engages in rulemaking 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 would promote efficiency, 

competition, and capital formation. In 

addition, Section 23(a)(2) of the 

Exchange Act 79 requires the 

Commission, when making rules under 

the Exchange Act, to consider the 

impact of such rules on competition. 

Section 23(a)(2) also prohibits the 

Commission from adopting any rule that 

would impose a burden on competition 

not necessary or appropriate in 

furtherance of the purposes of the 

Exchange Act. 

A. Competition 

We consider in turn the impacts of 

Proposed Rule 15c3–5 on the market 

center and broker-dealer industries. 

Information provided by market centers 

and broker-dealers in their registrations 

and filings with us and with FINRA 

informs our views on the structure of 

the markets in these industries. We 

begin our consideration of potential 

competitive impacts with observations 

of the current structure of these markets. 

The broker-dealer industry, including 

market makers, is a highly competitive 

industry, with most trading activity 

concentrated among several dozen large 

participants and with thousands of 

small participants competing for niche 

or regional segments of the market. 

There are approximately 5,178 

registered broker-dealers, of which 890 

are small broker-dealers.80 The 

Commission estimates that 1,295 

brokers or dealers would have market 

access as defined under the proposed 

rule.81 Of these 1,295 brokers or dealers, 

the Commission estimates that 

approximately 21 of those were small 

broker-dealers. To limit costs and make 

business more viable, small brokerWReier-Aviles on DSKGBLS3C1PROD with PROPOSALS

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82 17 CFR 242.611. 

83 17 CFR 242.605. 

84 17 CFR 242.606. 

dealers often contract with larger 

broker-dealers to handle certain 

functions, such as clearing and 

execution, or to update their technology. 

Larger broker-dealers typically enjoy 

economies of scale over small brokerdealers and compete with each other to 

service the small broker-dealers, who 

are both their competitors and their 

customers. 

Proposed Rule 15c3–5 is intended to 

address a broker-dealer’s obligations 

generally with respect to market access 

risk management controls across 

markets, to prohibit the practice of 

‘‘unfiltered’’ or ‘‘naked’’ access to an 

exchange or an ATS where customer 

order flow does not pass through the 

broker-dealer’s systems or filters prior or 

to entry on an exchange or ATS, and to 

provide uniform standards that would 

be interpreted and enforced in a 

consistent manner. Such proposed 

requirements may promote competition 

by establishing a level playing field for 

broker-dealers in market access, in that 

each broker or dealer would be subject 

to the same requirements in providing 

access. 

The proposed rule would require 

brokers or dealers that offer market 

access, including those providing 

sponsored or direct market access to 

customers, to implement appropriate 

risk management controls and 

supervisory procedures to manage the 

financial and regulatory risks of this 

business activity. As noted above, we 

expect there to be costs of implementing 

and monitoring these systems. However, 

we do not believe that these costs will 

create or increase any burdens of entry 

into the broker-dealer industry. 

The Commission seeks comment on 

whether or how the proposed rule 

would affect the competitive landscape 

in the broker-dealer industry and on 

whether or how the proposed rule might 

create new barriers to entry or increase 

existing barriers to entry in the brokerdealer industry. 

The costs to implement appropriate 

risk management controls and 

supervisory procedures to manage the 

financial and regulatory risks may 

disproportionately impact small- or 

medium-sized broker-dealers. In 

particular, the costs of instituting such 

controls and procedures could be a 

larger portion of revenues for small- and 

medium-sized broker-dealers than for 

larger broker dealers. In addition, to the 

extent that the cost of obtaining 

sponsored access increases, the 

increases could be a larger portion of the 

revenues of small and medium-sized 

broker-dealers. This could impair the 

ability of small- and medium-sized 

broker-dealers to compete for order 

routing business with larger firms, 

limiting choice and incentives for 

innovation in the broker dealers 

industry. However, the effect on smaller 

broker-dealers could be mitigated, to 

some extent, by purchasing a risk 

management solution from a third-party 

vendor. 

We do not believe that the proposed 

rule will alter the competitive landscape 

in the competition between large brokerdealers and small and medium brokerdealers. However, we request comment 

on the following questions: 

How common is it for smaller brokerdealers to offer sponsored access or 

direct market access? If smaller brokerdealers provide this service, would costs 

of implementing and complying with 

the proposed rule be particularly 

burdensome for them? Could the 

proposed rule impair the ability of 

small- and medium-sized broker-dealers 

to compete for order routing business 

with larger firms, limiting choice and 

incentives for innovation in the brokerdealer industry, because it would not be 

cost effective for them to implement the 

required risk management controls and 

supervisory procedures? 

How common is it for smaller brokerdealers to be the sponsored participants 

for larger broker-dealers? If this is 

common, would the rule affect the 

ability of these smaller broker-dealers to 

access markets? If so, in what ways and 

to what extent? How would any such 

effects impact the securities markets 

more generally? If it is common for 

smaller broker-dealers to offer or 

purchase market access, would the rule 

adversely affect the ability of smaller 

broker-dealers to compete or the level of 

service that they can provide to their 

customers? 

Would the Proposed Rule 15c3–5 

create vertical integration in the 

industry, by inducing large customers 

(non-members) to acquire and integrate 

with broker-dealers? Would this 

potential outcome have an impact on 

competition in the industry? 

What are the types of customers who 

use sponsored access or direct market 

access? Would this rule affect the 

competitive landscape for any of these 

customer types? Would the rule affect 

the competitive landscape for any other 

market participants, including market 

makers? 

In addition, the Commission is 

mindful of a potential race-to-thebottom issue in which broker-dealers 

competing for sponsored access or 

direct market access clients with low 

prices will skimp on spending for risk 

controls. Will the proposed rule help to 

halt or encourage such a ‘‘race to the 

bottom’’? 

The trading industry is a highly 

competitive one, characterized by ease 

of entry. In fact, the intensity of 

competition across trading platforms in 

this industry has increased dramatically 

in the past decade as a result of market 

reforms and technological advances. 

This increase in competition has 

resulted in substantial decreases in 

market concentration, effective 

competition for the securities 

exchanges, a proliferation of trading 

platforms competing for order flow, and 

significant decreases in trading fees. The 

low barriers to entry for equity trading 

venues are shown by new entities, 

primarily ATSs, continuing to enter the 

market. Currently, there are 

approximately 50 registered ATSs that 

trade equity securities. In addition, the 

Commission within the past few years 

has approved applications by two 

entities—BATS and Nasdaq—to become 

registered as national securities 

exchanges for trading equities, and 

approved proposed rule changes by two 

existing exchanges—ISE and CBOE—to 

add equity trading facilities to their 

existing options business. We believe 

that competition among trading centers 

has been facilitated by Rule 611 of 

Regulation NMS,82 which encourages 

quote-based competition between 

trading centers; Rule 605 of Regulation 

NMS,83 which empowers investors and 

broker-dealers to compare execution 

quality statistics across trading centers; 

and Rule 606 of Regulation NMS,84

which enables customers to monitor 

order routing practices. 

Market centers compete with each 

other in several ways. National 

exchanges compete to list securities; 

market centers compete to attract order 

flow to facilitate executions; and market 

centers compete to offer access to their 

markets to members or subscribers. In 

this last area of competition, one could 

argue that the ability to access a market 

through sponsored access or direct 

market access could substitute for 

becoming a member or subscriber. Of 

course, there are both benefits and 

responsibilities in being a member or 

subscriber that do not accrue directly to 

someone using sponsored access or 

direct market access. Nonetheless, to the 

extent that these forms of market access 

are substitutes for membership, an 

increase in the costs of sponsored access 

or direct market access may make a 

potential member more likely to decide 

to become a member or subscriber. At 

the same time, market centers may 

reduce the cost of access to members or 

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4026 Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 

85Pub. L. 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). 86 5 U.S.C. 603(a). 

subscribers in order to attract trading 

flow to their venue. 

We request comment on the following 

questions: Would the Proposed Rule 

15c3–5 modify the competition among 

market centers and broker-dealers to 

obtain members or offer sponsored 

access? What are the benefits of being a 

member or subscriber to a market center 

that would not be available to someone 

with sponsored access or direct market 

access? Would the proposed rule 

increase or decrease the propensity of 

broker-dealers and others to become 

members or subscribers? Would the 

proposed rule increase or decrease the 

propensity of non-broker-dealer market 

participants to register to become 

broker-dealers? How would the 

proposed rule affect overall access to 

markets? Would the proposed rule affect 

any other type of competition between 

market centers? 

B. Capital Formation 

The Commission believes that the 

proposed rule would have a minimal 

impact on the promotion of capital 

formation. We request comment on the 

following questions: By requiring 

financial and regulatory controls to be 

implemented on a market-wide basis to 

reduce the risks faced by broker-dealers, 

and by prohibiting ‘‘unfiltered’’ or 

‘‘naked’’ access, would Proposed Rule 

15c3–5 promote capital formation? If so, 

to what extent? Would the proposed 

rule promote investor protection, which 

could, in turn, make investors more 

willing to invest and promote capital 

formation? Are there any other impacts 

of the proposed rule on capital 

formation? To the extent that the 

proposed requirements impact trading 

strategies or other behavior, how might 

that impact capital formation? 

C. Efficiency 

By proposing to address broker-dealer 

obligations with respect to market 

access risk controls across markets, and 

by having the effect of prohibiting 

‘‘unfiltered’’ or ‘‘naked’’ access, the 

proposed rule would provide uniform 

standards that would be interpreted and 

enforced in a consistent manner. 

Proposed Rule 15c3–5 would help to 

facilitate and maintain stability in the 

markets and help ensure that they 

function efficiently. 

In recent years, the development and 

growth of automated electronic trading 

has allowed ever increasing volumes of 

securities transactions across the 

multitude of trading centers that 

constitute the U.S. national market 

system. The Commission believes that 

the risk management controls and 

procedures that brokers and dealers 

would be required to include as part of 

their compliance systems should 

prevent erroneous and unintended 

trades from occurring and thereby 

contribute to overall market efficiency. 

While the Commission has 

consistently sought to encourage 

innovations that enhance the efficiency 

and quality of the markets, it also must 

assure that the regulatory framework 

keeps pace with market developments 

so that emerging risks are effectively 

addressed. The Commission believes 

that safer transactions—and the 

anticipated increased confidence in the 

markets—should promote greater 

efficiency in the long run. The 

Commission is aware of concerns that 

pre-trade controls potentially could 

slow down the speed of order routing 

and the incorporation of information 

into prices, but the Commission notes 

that such concerns should be balanced 

against the Commission’s goals, as 

mandated by the Exchange Act, 

including to promote the integrity of the 

markets and investor protection. We 

request comment on the following 

questions: 

How would Proposed Rule 15c3–5 

affect price efficiency? Would pre-trade 

reviews limit unlawful or erroneous 

trading? To what extent would limits on 

erroneous trading improve price 

efficiency? To what extent would the 

pre-trade reviews reveal other trading 

that could affect price efficiency? To 

what extent would the controls imposed 

by the rule create latency that can slow 

the incorporation of information into 

prices? To what extent would brokerdealers have greater incentives to reduce 

any such latency? 

VIII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 85 the Commission 

must advise OMB as to whether the 

proposed regulation constitutes a 

‘‘major’’ rule. Under SBREFA, a rule is 

considered ‘‘major’’ where, if adopted, it 

results or is likely to result in: (1) An 

annual effect on the economy of $100 

million or more (either in the form of an 

increase or a decrease); (2) a major 

increase in costs or prices for consumers 

or individual industries; or (3) 

significant adverse effect on 

competition, investment or innovation. 

If a rule is ‘‘major,’’ its effectiveness will 

generally be delayed for 60 days 

pending Congressional review. 

The Commission requests comment 

on the potential impact of the proposed 

rule on the economy on an annual basis, 

on the costs or prices for consumers or 

individual industries, and on 

competition, investment or innovation. 

Commenters are requested to provide 

empirical data and other factual support 

for their view to the extent possible. 

IX. Initial Regulatory Flexibility 

Analysis 

The Commission has prepared the 

following Initial Regulatory Flexibility 

Analysis (‘‘IRFA’’), in accordance with 

the provisions of the Regulatory 

Flexibility Act (‘‘RFA’’),86 regarding 

proposed new Rule 15c3–5 under the 

Securities Exchange Act of 1934. 

A. Reasons for the Proposed Action 

Over the past decade, the proliferation 

of sophisticated, high-speed trading 

technology has changed the way brokerdealers trade for their accounts and as 

an agent for their customers. Current 

SRO rules and interpretations governing 

electronic access to markets have sought 

to address the risks of this activity. 

However, the Commission preliminarily 

believes that more comprehensive 

standards that apply consistently across 

the markets are needed to effectively 

manage the financial, regulatory, and 

other risks, such as legal and 

operational risks, associated with 

market access. 

The Commission notes that these risks 

are present whenever a broker-dealer 

trades as a member of an exchange or 

subscriber to an ATS, whether for its 

own proprietary account or as agent for 

its customers, including traditional 

agency brokerage and through direct 

market access or sponsored access 

arrangements. For this reason, proposed 

new Rule 15c3–5 is drafted broadly to 

cover all forms of access to trading on 

an exchange or ATS provided directly 

by a broker-dealer. The Commission 

believes a broker-dealer with market 

access should assure the same basic 

types of controls are in place whenever 

it uses its special position as a member 

of an exchange, or subscriber to an ATS, 

to access those markets. The 

Commission, however, is particularly 

concerned about the quality of brokerdealer risk controls in sponsored access 

arrangements, where the customer order 

flow does not pass through the brokerdealer’s systems prior to entry on an 

exchange or ATS. 

B. Objectives 

Proposed Rule 15c3–5 would apply to 

any broker or dealer that has access to 

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87 17 CFR 240.0–10(c). 

88See supra note 33. 

89 Id. 

90The Commission’s understanding is based on 

discussions with various industry participants. 

trading in securities on an exchange or 

ATS as a result of being a member or 

subscriber of the exchange or ATS, 

respectively. As noted above, the 

proposed rule would include not only 

direct market access or sponsored access 

services offered to customers of brokerdealers, but also access to trading for the 

proprietary account of the broker-dealer 

and for more traditional agency 

activities. The Commission believes that 

any broker-dealer with market access 

should establish effective risk 

management controls to protect against 

breaches of credit or capital limits, 

erroneous trades, violations of SEC or 

exchange trading rules, and the like. 

Proposed Rule 15c3–5 would require 

a broker or dealer with market access, or 

that provides a customer or any other 

person with access to an exchange or 

ATS through use of its MPID or 

otherwise, to establish, document, and 

maintain a system of risk management 

controls and supervisory procedures 

reasonably designed to manage the 

financial, regulatory, and other risks 

related to market access. The proposed 

rule would apply to trading in all 

securities on an exchange or ATS, 

including equities, options, exchangetraded funds, and debt securities. 

Specifically, the proposed rule would 

require that brokers or dealers with 

access to trading securities on an 

exchange or ATS, as a result of being a 

member or subscriber thereof, establish, 

document, and maintain a system of risk 

management controls and supervisory 

procedures that, among other things, are 

reasonably designed to (1) 

systematically limit the financial 

exposure of the broker or dealer that 

could arise as a result of market access, 

and (2) ensure compliance with all 

regulatory requirements that are 

applicable in connection with market 

access. 

The required financial risk 

management controls would be required 

to be reasonably designed to prevent the 

entry of orders that exceed appropriate 

pre-set credit or capital thresholds, or 

that appear to be erroneous. The 

required regulatory risk management 

controls and supervisory procedures 

would also be required to be reasonably 

designed to prevent the entry of orders 

that fail to comply with any regulatory 

requirements that must be satisfied on a 

pre-order entry basis, prevent the entry 

of orders that the broker-dealer or 

customer is restricted from trading, 

restrict market access technology and 

systems to authorized persons, and 

assure appropriate surveillance 

personnel receive immediate post-trade 

execution reports. For example, such 

systems would block orders that do not 

comply with exchange trading rules 

relating to special order types and oddlot orders, among others. 

The proposed requirement that a 

broker-dealer’s financial and regulatory 

risk management controls and 

procedures be reasonably designed to 

prevent the entry of orders that fail to 

comply with the specified conditions 

would necessarily require the controls 

be applied on an automated, pre-trade 

basis before orders route to an exchange 

or ATS, thereby effectively prohibiting 

the practice of ‘‘unfiltered’’ or ‘‘naked’’ 

access to an exchange or ATS. 

The risk management controls and 

supervisory procedures required by 

proposed Rule 15c3–5 must be under 

the direct and exclusive control of the 

broker or dealer with market access. 

This provision is designed to eliminate 

the practice, which the Commission 

understands exists today under current 

SRO rules, whereby the broker-dealer 

providing market access relies on its 

customer, a third party service provider, 

or others, to establish and maintain the 

applicable risk controls. The 

Commission believes the risks presented 

by market access—and in particular 

‘‘naked’’ access—are too great to permit 

a broker-dealer to delegate the power to 

control those risks to the customer or to 

a third party, either of whom may be an 

unregulated entity. 

C. Legal Basis 

Pursuant to the Exchange Act and 

particularly, Sections 2, 3(b), 11A, 15, 

17(a) and (b), and 23(a) thereof, 15 

U.S.C. 78b, 78c(b), 78k–1, 78o, 78q(a) 

and (b), and 78w(a), the Commission is 

proposing new Rule 15c3–5. 

D. Small Entities Subject to the Rule 

For purposes of Commission 

rulemaking in connection with the RFA, 

a broker-dealer is a small business if its 

total capital (net worth plus 

subordinated liabilities) on the last day 

of its most recent fiscal year was 

$500,000 or less, and is not affiliated 

with any entity that is not a ‘‘small 

business.’’ 87 The Commission staff 

estimates that at year-end 2008 there 

were 1,095 broker or dealers which were 

members of an exchange, and 21 of 

those were classified as ‘‘small 

businesses.’’ 88 In addition, the 

Commission estimates that there were 

200 brokers or dealers that were 

subscribers to ATSs but not members of 

an exchange.89 The Commission 

estimates that, of those 200 brokers or 

dealers, only a small number would be 

classified as ‘‘small businesses.’’ 

Currently, most small brokers or 

dealers, when accessing an exchange or 

ATS in the ordinary course of their 

business, should already have risk 

management controls and supervisory 

procedures in place. The extent to 

which such small brokers or dealers 

would be affected economically under 

the proposed rule would depend 

significantly on the financial and 

regulatory risk management controls 

that already exist in the broker or 

dealer’s system, as well as the nature of 

the broker or dealer’s business. In many 

cases, the proposed rule may be 

substantially satisfied by a small brokerdealer’s pre-existing financial and 

regulatory risk management controls 

and current supervisory procedures. 

Further, staff discussions with various 

industry participants indicated that very 

few, if any, small broker-dealers with 

market access provide other persons 

with ‘‘unfiltered’’ access, which may 

require more significant systems 

upgrades to comply with the proposed 

rule. Therefore, these brokers or dealers 

should only require limited updates to 

their systems to meet the requisite risk 

management controls and other 

requirements in the proposed rule. The 

proposed rule also would impact small 

brokers or dealers that utilize risk 

management technology provided by a 

vendor or some other third party; 

however, the proposed requirement to 

directly monitor the operation of the 

financial and regulatory risk 

management controls should not impose 

a significant cost or burden because the 

Commission understands that such 

technology allows the broker or dealer 

to exclusively manage such controls.90

E. Reporting, Recordkeeping, and Other 

Compliance Requirements 

The proposed rule would require 

brokers or dealers to establish, 

document, and maintain certain risk 

management controls and supervisory 

procedures as well as regularly review 

such controls and procedures, and 

document the review, and remediate 

issues discovered to assure overall 

effectiveness of such controls and 

procedures. Each such broker or dealer 

would be required to preserve a copy of 

its supervisory procedures and a written 

description of its risk management 

controls as part of its books and records 

in a manner consistent with Rule 17a– 

4(e)(7) under the Exchange Act. Such 

regular review would be required to be 

conducted in accordance with written 

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91See supra Section V.D.2. 

92 5 U.S.C. 603(c). 

procedures and would be required to be 

documented. The broker or dealer 

would be required to preserve a copy of 

such written procedures, and 

documentation of each such review, as 

part of its books and records in a 

manner consistent with Rule 17a–4(e)(7) 

under the Exchange Act, and Rule 17a– 

4(b) under the Exchange Act, 

respectively. 

In addition, the Chief Executive 

Officer (or equivalent officer) would be 

required to certify annually that the 

broker or dealer’s risk management 

controls and supervisory procedures 

comply with the proposed rule, and that 

the broker-dealer conducted such 

review. Such certifications would be 

required to be preserved by the broker 

or dealer as part of its books and records 

in a manner consistent with Rule 17a– 

4(b) under the Exchange Act. Most small 

brokers or dealers currently should 

already have supervisory procedures 

and record retention systems in place. 

The proposed rule would require small 

brokers or dealers to update their 

procedures and perform additional 

internal compliance functions. Based on 

discussions with industry participants 

and the Commission’s prior experience 

with broker-dealers, the Commission 

estimates that implementation of a 

regular review, modification of 

applicable compliance policies and 

procedures, and preservation of such 

records would require, on average, 45 

hours of compliance staff time for 

brokers or dealers depending on their 

business model.91 The Commission 

believes that the business models of 

small brokers or dealers would 

necessitate less than the average of 45 

hours. We request comments on these 

estimates. 

F. Duplicative, Overlapping, or 

Conflicting Federal Rules 

The Commission believes that there 

are no Federal rules that duplicate, 

overlap, or conflict with the proposed 

rule amendments and the proposed new 

rule. 

G. Significant Alternatives 

Pursuant to Section 3(a) of the 

Regulatory Flexibility Act,92 the 

Commission must consider certain types 

of alternatives, including: (1) The 

establishment of differing compliance or 

recording requirements or timetables 

that take into account the resources 

available to small entities; (2) the 

clarification, consolidation, or 

simplification of compliance and 

reporting requirements under the rule 

for small entities; (3) the use of 

performance rather than design 

standards; and (4) an exemption from 

coverage of the rule, or any part of the 

rule, for small entities. 

The Commission considered whether 

it would be necessary or appropriate to 

establish different compliance or 

reporting requirements or timetables; or 

to clarify, consolidate, or simplify 

compliance and reporting requirements 

under the rule for small entities. 

Because the proposed rule is designed 

to mitigate, as discussed in detail 

throughout this release, significant 

financial and regulatory risks, the 

Commission preliminarily believes that 

small entities should be covered by the 

rule. The proposed rule includes 

performance standards. The 

Commission also preliminarily believes 

that the proposed rule is flexible enough 

for small brokers and dealers to comply 

with the proposed rule without the need 

for the establishment of differing 

compliance or reporting requirements 

for small entities, or exempting them 

from the proposed rule’s requirements. 

H. Request for Comments 

The Commission encourages written 

comments on matters discussed in this 

IRFA. In particular, the Commission 

seeks comment on the number of small 

entities that would be affected by the 

proposed new rule, and whether the 

effect on small entities would be 

economically significant. Commenters 

are asked to describe the nature of any 

impact on small entities, including 

broker-dealers or other small businesses 

or small organizations, and provide 

empirical data to support their views. 

X. Statutory Authority 

Pursuant to the Exchange Act and 

particularly, Sections 2, 3(b), 11A, 15, 

17(a) and (b), and 23(a) thereof, 15 

U.S.C. 78b, 78c(b), 78k–1, 78o, 78q(a) 

and (b), and 78w(a), the Commission 

proposes a new Rule 15c3–5 under the 

Exchange Act that would require brokerdealers with market access, or that 

provide a customer or any other person 

with market access through use of its 

market participant identifier or 

otherwise, to establish appropriate risk 

management controls and supervisory 

systems. 

XI. Text of Proposed Rule 

List of Subjects in 17 CFR Part 240 

Brokers, Reporting and recordkeeping 

requirements, Securities. 

For the reasons set out in the 

preamble, 17 CFR Part 240 is proposed 

to be amended as follows. 

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

1. The authority citation for Part 240 

continues to read in part as follows: 

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 

77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 

78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p, 

78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a– 

20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 

80b–11, and 7201 et seq.; and 18 U.S.C. 1350, 

unless otherwise noted. 

* * * * * 

2. Section 240.15c3–5 is added to read 

as follows: 

§ 240.15c3–5 Risk management controls 

for brokers or dealers with market access. 

(a) For the purpose of this section: 

(1) The term market access shall mean 

access to trading in securities on an 

exchange or alternative trading system 

as a result of being a member or 

subscriber of the exchange or alternative 

trading system, respectively. 

(2) The term regulatory requirements 

shall mean all Federal securities laws, 

rules and regulations, and rules of selfregulatory organizations, that are 

applicable in connection with market 

access. 

(b) A broker or dealer with market 

access, or that provides a customer or 

any other person with access to an 

exchange or alternative trading system 

through use of its market participant 

identifier or otherwise, shall establish, 

document, and maintain a system of risk 

management controls and supervisory 

procedures reasonably designed to 

manage the financial, regulatory, and 

other risks of this business activity. 

Such broker or dealer shall preserve a 

copy of its supervisory procedures and 

a written description of its risk 

management controls as part of its books 

and records in a manner consistent with 

§ 240.17a–4(e)(7). 

(c) The risk management controls and 

supervisory procedures required by 

paragraph (b) of this section shall 

include the following elements: 

(1) Financial risk management 

controls and supervisory procedures. 

The risk management controls and 

supervisory procedures shall be 

reasonably designed to systematically 

limit the financial exposure of the 

broker or dealer that could arise as a 

result of market access, including being 

reasonably designed to: 

(i) Prevent the entry of orders that 

exceed appropriate pre-set credit or 

capital thresholds in the aggregate for 

each customer and the broker or dealer 

and, where appropriate, more finelytuned by sector, security, or otherwise 

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Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 4029 

1 In 2007, the NASD and the member-related 

functions of New York Stock Exchange Regulation, 

Inc., the NYSE’s regulatory subsidiary, were 

consolidated. As part of this regulatory 

consolidation, the NASD changed its name to 

FINRA. For clarity, this release uses the term 

‘‘NASD’’ to refer to matters that occurred prior to the 

consolidation and the term ‘‘FINRA’’ to refer to 

matters that occurred after the consolidation. 

2The Commission notes that the collective NASD 

and NYSE guidance described below now 

constitutes FINRA’s current guidance on market 

access. 

3See NYSE IM–89–6 (January 25, 1989). 

4The NYSE specifically referenced NYSE Rule 

405 pertaining to Diligence as to Accounts, and 

NYSE Rule 382, pertaining to Carrying Agreements. 

The NYSE also stated that a member’s ‘‘know your 

customer’’ obligations had to be satisfied either 

through conventional methods or through 

automated system parameters. In NYSE IM–89–6, 

the NYSE required its members to provide a written 

statement acknowledging their responsibility for 

electronic customer orders retransmitted to the 

NYSE. Id. 

5NYSE IM–92–15 (May 28, 1992). In NYSE IM– 

92–15, the NYSE recognized that the ‘‘ongoing need 

to enhance efficiency and to facilitate the swift and 

orderly processing and execution of orders * * * 

[had] led to the development and increased usage 

of electronic order routing systems by member 

organizations.’’ However, the NYSE also warned 

that while technological developments facilitated 

the handling of a significantly higher order volume, 

it also increased the prospect of order errors and 

concerns regarding sufficient internal controls. 

Accordingly, the NYSE advised that internal control 

procedures were important elements of any 

electronic trading system and reaffirmed that 

members must adhere to certain regulatory 

requirements and business practices when 

permitting access to electronic order routing 

systems. 

6NYSE IM–92–43 (December 29, 1992). 

7NYSE IM–92–43 emphasized that the member 

was responsible for assuring that control 

procedures, whether established by the customer or 

the member, were reasonably expected to monitor 

and supervise the entry of orders and minimize the 

potential for errors. The NYSE also clarified that 

members should obtain and maintain, as part of 

their books and records, a copy of their customer’s 

written control procedures pertaining to electronic 

order entry. If the control procedures were 

established by the member, the customer should 

sign an undertaking committing to adhere to them. 

The NYSE also noted that built-in system checks, 

such as pre-set size and dollar limits, were an 

alternative way to satisfy the control requirements. 

Id. 

8NYSE IM–02–48 (November 7, 2002). NYSE 

noted that there were a number of erroneous orders 

submitted via electronic order entry systems as a 

result of human error or defective commercial or 

proprietary software systems, and that the errors 

most commonly involved an incorrect quantity of 

shares being submitted, or the inadvertent release 

of files containing previously transmitted orders. 

Moreover, the NYSE emphasized the need for 

safeguards to prevent the disabling of the systemic 

controls or the system whether the system was 

provided by the member, a vendor, the customer or 

another third party. Id. 

by rejecting orders if such orders would 

exceed the applicable credit or capital 

thresholds; and 

(ii) Prevent the entry of erroneous 

orders, by rejecting orders that exceed 

appropriate price or size parameters, on 

an order-by-order basis or over a short 

period of time, or that indicate 

duplicative orders. 

(2) Regulatory risk management 

controls and supervisory procedures. 

The risk management controls and 

supervisory procedures shall be 

reasonably designed to ensure 

compliance with all regulatory 

requirements, including being 

reasonably designed to: 

(i) Prevent the entry of orders unless 

there has been compliance with all 

regulatory requirements that must be 

satisfied on a pre-order entry basis; 

(ii) Prevent the entry of orders for 

securities for a broker or dealer, 

customer, or other person if such person 

is restricted from trading those 

securities; 

(iii) Restrict access to trading systems 

and technology that provide market 

access to permit access only to persons 

and accounts pre-approved and 

authorized by the broker or dealer; and 

(iv) Assure that appropriate 

surveillance personnel receive 

immediate post-trade execution reports 

that result from market access. 

(d) The financial and regulatory risk 

management controls and supervisory 

procedures described in paragraph (c) of 

this section shall be under the direct 

and exclusive control of the broker or 

dealer that is subject to paragraph (b) of 

this section. 

(e) A broker or dealer that is subject 

to paragraph (b) of this section shall 

establish, document, and maintain a 

system for regularly reviewing the 

effectiveness of the risk management 

controls and supervisory procedures 

required by paragraphs (b) and (c) of 

this section and for promptly addressing 

any issues. 

(1) Among other things, the broker or 

dealer shall review, no less frequently 

than annually, the business activity of 

the broker or dealer in connection with 

market access to assure the overall 

effectiveness of such risk management 

controls and supervisory procedures. 

Such review shall be conducted in 

accordance with written procedures and 

shall be documented. The broker or 

dealer shall preserve a copy of such 

written procedures, and documentation 

of each such review, as part of its books 

and records in a manner consistent with 

§ 240.17a–4(e)(7) and § 240.17a–4(b), 

respectively. 

(2) The Chief Executive Officer (or 

equivalent officer) of the broker or 

dealer shall, on an annual basis, certify 

that such risk management controls and 

supervisory procedures comply with 

paragraphs (b) and (c) of this section, 

and that the broker or dealer conducted 

such review, and such certifications 

shall be preserved by the broker or 

dealer as part of its books and records 

in a manner consistent with § 240.17a– 

4(b). 

By the Commission. 

Dated: January 19, 2010. 

Florence E. Harmon, 

Deputy Secretary. 

Note: This Appendix to the Preamble will 

not appear in the Code of Federal Regulation. 

Appendix 

A. Current SRO Guidance 

The New York Stock Exchange (‘‘NYSE’’) 

and the Financial Industry Regulatory 

Authority (‘‘FINRA’’) (formerly known as the 

National Association of Securities Dealers, 

Inc. (‘‘NASD’’)) 1 have issued several 

Information Memoranda (‘‘IM’’) and Notices 

to Members (‘‘NTM’’), respectively, that are 

designed to provide guidance to their 

members that provide market access to 

customers. The guidance provided by the 

NYSE and the NASD is primarily advisory, 

as opposed to compulsory, and is similar in 

many respects. As discussed in more detail 

below, both SROs emphasize the need for 

members to implement and maintain internal 

procedures and controls to manage the 

financial and regulatory risks associated with 

market access, and recommend certain best 

practices.2

1. NYSE Guidance 

In 1989, the NYSE first issued an IM to 

provide guidance for its members that 

permitted customers to access the NYSE 

SuperDot System.3 NYSE IM–89–6 stated 

that it was permissible for members to 

receive electronic orders directly from their 

customers and re-transmit those orders to the 

NYSE’s SuperDot system, but that members 

providing such access must satisfy all 

regulatory requirements relating to those 

orders.4

In 1992, the NYSE issued NYSE IM–92– 

15 5 which stated that members should have 

written procedures and controls for the 

monitoring and supervision of electronic 

orders, including those that limit access to 

electronic order entry systems to authorized 

users, validate order accuracy, and check the 

order against established credit limits. The 

NYSE indicated that either the customer or 

the member could establish the necessary 

controls, but that the member would be 

ultimately responsible for maintaining and 

implementing them. Later that year, NYSE 

IM–92–43,6 was issued and stressed the 

importance of effective policies and 

procedures designed to minimize errors 

associated with electronic order entry.7

In 2002, NYSE IM–02–48 was issued to reemphasize member obligations related to the 

submission of electronic orders.8 The NYSE 

noted that electronic order entry systems 

could lead to increased market volatility and 

significant exposure to financial risk for 

members, and thus members were required to 

have written internal control and supervisory 

procedures addressing those risks. The NYSE 

indicated that these should, at a minimum, 

incorporate controls to: (1) Limit the use of 

the system to authorized persons; (2) validate 

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9See Securities Exchange Act Release No. 40354 

(August 24, 1998), 63 FR 46264 (August 31, 1998) 

(NASD NTM–98–66). 

10NASD NTM–98–66 elaborated on the NASD’s 

April 1998 Nasdaq interpretive letter regarding nonmember access to SelectNet. In particular, NASD 

expanded the discussion to address non-member 

access to Nasdaq’s Small Order Execution System 

(‘‘SOES’’). The systems were discussed separately 

because SOES was an automatic execution facility 

while SelectNet was an order-delivery facility. Id. 

11The NASD required its members to provide a 

letter to Nasdaq acknowledging responsibility for 

non-member orders submitted through the 

member’s system. Id. 

12Formerly, NASD Rule 3370(b)(2)(A) stated, in 

part, that ‘‘[n]o member or person associated with 

a member shall accept a ‘short’ sale order for any 

customer * * * in any security unless the member 

or person associated with a member makes an 

affirmative determination that the member will 

receive delivery of the security from the customer 

* * * or that the member can borrow the security 

on behalf of the customer * * * for delivery by 

settlement date.’’ See former NASD Rule 

3370(b)(2)(A). In 2004, NASD Rule 3370(b) was 

repealed because it was deemed to overlap with and 

be duplicative of Rule 203 of Regulation SHO. See 

Securities Exchange Act Release No. 50822 

(December 8, 2004), 69 FR 74554 (December 14, 

2004) (Notice of Filing and Immediate Effectiveness 

of Proposed Rule Change by National Association 

of Securities Dealers, Inc. Relating to Repeal of 

Existing NASD Short Sale Rules in Light of SEC 

Regulation SHO). 

13The NASD also required that members provide 

a description of the system that permitted a nonmember’s access to Nasdaq execution facilities, 

including details on how orders were received and 

re-transmitted, the system’s security and capacity, 

the manner that the system connected to Nasdaq, 

and any internal system protocols designed to fulfill 

the member’s ‘‘know your customer’’ obligations 

and other regulatory obligations. See supra note 10. 

14Among other things, the agreement informed 

the customer of its potential liability under Federal 

securities laws for any illegal trading activity, and 

of NASD surveillance to detect any illegal trading 

activity. Id. 

15NASD NTM–04–66 (September 2004). 

16The NASD noted that order entry errors 

typically resulted from mistakes in data entry or 

malfunctioning software. Id. 

17NASD Rule 3010 has not yet been consolidated 

as a FINRA rule; it is currently included in the 

FINRA Transitional Rulebook. 

18See NASD NTMs 88–84 (November 1988), 89– 

34 (April 1989), 98–96 (December 1998), and 99– 

45 (June 1999). A FINRA Information Notice, dated 

December 8, 2008, clarified that the NASD Rules 

generally apply to all FINRA member firms. 

19NASD further suggested members consider, 

among other things, safeguards that ensure that the 

testing or maintenance of a firm’s trading system 

does not result in inadvertent errors. See supra note 

15. 

20See, e.g., NYSE Rule 123B.30, NYSE Alternext 

Equities Rule 123B.30, NYSE Amex Rule 86, NYSE 

Arca Rules 7.29 and 7.30, NYSE Rule 86, CBOE 

Rule 6.20A, CHX Article 5, Rule 3, NSX Rule 11.9, 

BATS Rule 11.3(b), ISE Rule 706, NASDAQ Rule 

4611(d), NASDAQ OMX BX Rule 4611(d), 

NASDAQ OMX PHLX Rule 1094(b)(ii). 

21See Securities Exchange Act Release No. 59275 

(January 22, 2009), 74 FR 5193 (January 29, 2009) 

(File No. SR–NASDAQ–2008–104). After 

publication the Commission received thirteen 

comment letters on the proposal. The majority of 

commenters supported the proposal conceptually, 

but critiqued certain aspects of it. A few 

commenters wholly opposed Nasdaq’s proposal 

because they believed Nasdaq’s current rule was 

sufficient. One commenter opposed the current 

proposal because it lacked rigor. The various 

comments addressed: (1) The scope of the proposed 

Nasdaq rule and the definitions contained therein; 

(2) the required contracts; (3) compliance with 

financial and regulatory controls, and (4) 

confidentiality and regulatory propriety. Letters to 

Elizabeth M. Murphy, Secretary, Commission, from 

Harvey Cloyd, Chief Executive Officer, Electronic 

Transaction Clearing, Inc., dated February 5, 2009; 

John Jacobs, Director of Operations, Lime Brokerage 

LLC, dated February 17, 2009 (‘‘Lime Letter’’); 

Manisha Kimmel, Executive Director, Financial 

Information Forum, dated February 19, 2009 (‘‘FIF 

Letter’’); Ted Myerson, President, FTEN, Inc., dated 

February 19, 2009 (‘‘FTEN Letter’’); Michael A. 

Barth, Executive Vice President, OES Market Group, 

dated February 23, 2009; Jeff Bell, Executive Vice 

President, Clearing and Technology Group, 

Wedbush Morgan Securities, dated February 23, 

2009; Stuart J. Kaswell, Executive Vice President & 

General Counsel, Managed Funds Association, 

dated February 24, 2009; Ann Vlcek, Managing 

Director and Associate General Counsel, Securities 

Industry and Financial Markets Association 

(‘‘SIFMA’’), dated February 26, 2009 (‘‘SIFMA 

Letter’’), Nicole Harner Williams, Vice President, 

Associate General Counsel, Penson Financial 

order accuracy; (3) establish credit limits or 

systematically prevent the transmission of 

orders exceeding preset credit or order size 

parameters; and (4) monitor for duplicative 

orders. If a member used a vendor’s order 

entry system, the NYSE stressed that it was 

the member’s responsibility to ensure that 

the requisite controls were in place. If relying 

on the customer’s controls, members were 

reminded that they had to obtain, for books 

and records purposes, the customer’s written 

control procedures and a written undertaking 

to provide the member with written 

notification of any significant changes to 

such procedures. 

2. NASD Guidance 

The NASD offered its initial guidance on 

market access in 1998, when it issued NASD 

NTM–98–66 9 to address a variety of issues 

for NASD members to consider if they chose 

to allow customers to route orders to Nasdaq 

through member systems.10 Among other 

things, the NASD affirmed that members 

were responsible for honoring all executions 

that occurred as a result of market access,11

and should perform appropriate due 

diligence of customers for which they offer 

this service. 

The NASD also stated that members should 

have adequate written procedures and 

controls to effectively monitor and supervise 

order entry by customers. Specifically, the 

NASD indicated that members’ controls 

should address: (1) The entry of 

unauthorized orders; (2) orders that exceed or 

attempt to exceed pre-set credit or other 

parameters, such as order size, established by 

the member; (3) potentially manipulative 

activity by electronic access customers; (4) 

potential violations of affirmative 

determination requirements 12 and short-sale 

rules. More generally, NASD stated that 

members should ensure compliance with 

SEC and NASD rules, and that ‘‘whenever 

possible * * * controls should be automated 

and system driven.’’ 13 Finally, the NASD 

required a signed agreement setting forth the 

responsibilities of both the member and the 

non-member customer with respect to the 

access arrangement.14

In 2004, in response to an increase in order 

entry errors by non-member customers, 

NASD issued NTM–04–66 15 to remind 

members of their responsibility for all orders 

entered under their MPID, and that 

reasonable steps should be taken to address 

order entry errors.16 The NASD advised that 

a member’s supervisory system and written 

supervisory procedures should be consistent 

with the NASD’s supervision rule, Rule 

3010,17 and related guidance provided in a 

variety of NTMs.18 The NASD further noted 

that members should consider, when 

developing a supervisory system and written 

supervisory procedures, controls that: (1) 

Limit the use of electronic order entry 

systems to authorized persons; (2) check for 

order accuracy; (3) prevent orders that exceed 

preset credit- and order-size parameters from 

being transmitted to a trading system; and (4) 

prevent the unwanted generation, 

cancellation, re-pricing, resizing, duplication, 

or re-transmission of orders.19 Finally, the 

NASD reminded members that it would 

closely examine the supervisory systems and 

written supervisory procedures of members 

with respect to the review and detection of 

potential order-entry errors and, where 

appropriate, initiate disciplinary action 

against firms and their supervisory 

personnel. 

B. Exchange Rules 

The exchanges each have adopted rules 

that, in general, permit non-member 

‘‘sponsored participants’’ to obtain direct 

access to the exchange’s trading facilities, so 

long as a sponsoring broker-dealer that is a 

member of the exchange takes responsibility 

for the sponsored participant’s trading, and 

certain contractual commitments are made.20

The required contractual commitments 

typically entail agreements by the sponsored 

participant to: (1) Comply with exchange 

rules as if it were a member; (2) provide the 

sponsoring broker-dealer a current list of all 

‘‘authorized traders’’ who may submit orders 

to the exchange, and restrict access to the 

order entry system to those persons; (3) take 

responsibility for all trading by its authorized 

traders (and anyone else using their 

passwords); (4) establish adequate 

procedures to effectively monitor and control 

its access to the exchange through its 

employees, agents, or customers; and (5) pay 

when due all amounts payable to the 

exchange, the sponsoring broker-dealer, or 

others that arise from its access to the 

exchange’s trading facilities. 

C. New Nasdaq Rule 

As noted above, to address the increasing 

risks associated with market access, 

Commission staff has been urging the 

securities industry, the exchanges, FINRA 

and other market participants to enhance 

exchange and FINRA rules by requiring more 

robust broker-dealer financial and regulatory 

risk controls. In December 2008, Nasdaq filed 

a proposed rule change to require brokerdealers offering direct market access or 

sponsored access to Nasdaq to establish 

controls regarding the associated financial 

and regulatory risks, and to obtain a variety 

of contractual commitments from sponsored 

access customers.21 The Commission 

WReier-Aviles on DSKGBLS3C1PROD with PROPOSALS

Federal Register / Vol. 75, No. 16 / Tuesday, January 26, 2010 / Proposed Rules 4031 

Services, Inc., dated February 27, 2009; Samuel F. 

Lek, Chief Executive Officer, Lek Securities 

Corporation, dated June 15, 2009; letter to David S. 

Shillman, Associate Director, Division of Trading 

and Markets (‘‘Division’’) Commission, from Gary 

LaFever, Chief Corporate Development Officer, 

FTEN, Inc., dated April 29, 2009; letter to James 

Brigagliano, Co-Acting Director, Division, 

Commission, from John Jacobs, Chief Operations 

Officer, Lime Brokerage LLC, dated June 30, 2009; 

and letter to David S. Shillman, Associate Director, 

Division, from Ann Vlcek, Managing Director and 

Associate General Counsel, SIFMA, dated 

November 23, 2009. Nasdaq amended the filing and 

responded to comments. See File No. SR– 

NASDAQ–2008–104, Amendments No. 2 and 3, 

received respectively on October 19 and 23, 2009. 

A more extensive summary of comments and 

NASDAQ’s response to comments is contained in 

the Nasdaq Market Access Approval Order. See 

Securities Exchange Act Release No. 61345 (January 

13, 2010) (‘‘Nasdaq Market Access Approval 

Order’’). 22See Nasdaq Market Access Approval Order, 

supra note 21. 23For sponsored access arrangements, the Nasdaq 

rule also requires sponsoring members to obtain 

certain contractual commitments from sponsored 

participants that echo those required by current 

exchange rules, and go further by requiring the 

sponsored participant (1) provide access to books 

and records, financial information and otherwise 

cooperate with the sponsoring member for 

regulatory purposes; (2) maintain its trading activity 

within the credit thresholds set by the sponsoring 

member; and (3) allow immediate termination of 

the access arrangement if it poses serious risk to the 

sponsoring member or the integrity of the market. 

See Nasdaq Rule 4611(d)(3)(A). In addition, if a 

service bureau or other third party provides the 

sponsored access system, the sponsoring member 

must obtain contractual commitments from the 

third party analogous to clauses (1) and (3) above, 

as well as to restrict access to authorized persons. 

See Nasdaq Rule 4611(d)(3)(B). 

24See Nasdaq Rule 4611(d)(4). 

25See Nasdaq Rule 4611(d)(4)(A)–(C). 

26The Nasdaq rule defines ‘‘regulatory 

requirements’’ to include all applicable Federal 

securities laws and rules and Nasdaq rules, 

including but not limited to the Nasdaq Certificate 

of Incorporation, Bylaws, Rules and Nasdaq Market 

Center procedures. See Nasdaq Rule 4611(d)(3)(i). 

27The immediate post-trade execution reports 

should include the identity of the applicable 

sponsored customer. In addition, appropriate 

supervisory personnel of the sponsoring member 

should receive all required audit trail information 

no later than the end of the trading day; and all 

information necessary to create and maintain the 

trading records required by regulatory 

requirements, no later than the end of the trading 

day. See Nasdaq Rule 4611(d)(5). 

approved Nasdaq’s improved market access 

rule on January 13, 2010.22

The Nasdaq rule requires a combination of 

contractual provisions, financial controls, 

and regulatory controls for Nasdaq members 

providing direct market access or sponsored 

access. Nasdaq’s rule differs from its previous 

access rule, and other SRO access rules, by: 

(1) Clearly defining ‘‘direct market access’’ 

and ‘‘sponsored access;’’ (2) requiring by rule 

that broker-dealers providing those services 

establish controls designed to address 

specified financial and regulatory risks; (3) 

requiring that appropriate supervisory 

personnel of the sponsoring member receive 

immediate post-trade execution reports for 

all direct market access and sponsored access 

customers.23

With respect to controls for financial risk, 

Nasdaq’s rule requires members offering 

direct market access or sponsored access to 

establish procedures and controls designed to 

systemically limit the sponsoring member’s 

financial exposure.24 At a minimum, these 

procedures and controls must be designed to 

prevent sponsored customers from: (1) 

Entering orders that exceed appropriate 

preset credit thresholds; (2) trading products 

that the sponsored customer or sponsoring 

member is restricted from trading; and (3) 

submitting erroneous orders, by rejecting 

orders that exceed certain price or size 

parameters or that indicate duplicative 

orders.25

With respect to controls for regulatory risk, 

Nasdaq’s rule requires members offering 

direct market access or sponsored access to 

establish systemic controls designed to 

ensure compliance with applicable 

regulatory requirements.26 In addition, 

Nasdaq’s rule requires a sponsoring member 

to ensure that appropriate supervisory 

personnel receive and review timely reports 

of all trading activity by its sponsored 

customers, including immediate post-trade 

execution reports.27

[FR Doc. 2010–1269 Filed 1–25–10; 8:45 am] 

BILLING CODE 8011–01–P 

POSTAL SERVICE 

39 CFR Part 111 

Streamlining Hard-Copy Postage 

Statement Processing 

AGENCY: Postal ServiceTM. 

ACTION: Proposed rule. 

SUMMARY: The Postal ServiceTM is 

proposing to revise Mailing Standards 

of the United States Postal Service, 

Domestic Mail Manual (DMM®), to 

reflect changes in the processing of 

hard-copy postage statements 

accompanying commercial and permit 

imprint mailings at PostalOne! ®

facilities. 

DATES: We must receive your comments 

on or before February 25, 2010. 

ADDRESSES: Mail or deliver written 

comments to the Manager, Mailing 

Standards, U.S. Postal Service, 475 

L’Enfant Plaza, SW., Room 3436, 

Washington, DC, 20260–3436. You may 

inspect and photocopy all written 

comments at USPS Headquarters 

Library, 475 L’Enfant Plaza, SW., 11th 

Floor N, Washington, DC, between 9 

a.m. and 4 p.m., Monday through 

Friday. E-mail comments concerning the 

proposed rule, containing the name and 

address of the commenter, may be sent 

to: MailingStandards@usps.gov, with a 

subject line of ‘‘Postage Statement 

Processing.’’ Faxed comments are not 

accepted. 

FOR FURTHER INFORMATION CONTACT: Cher 

Rupp-Ruggeri at 202–268–4019, 

Anthony Frost at 202–268–8093, or 

Michael F. Lee at 202–268–7263. 

SUPPLEMENTARY INFORMATION: In 

coordination with ongoing efforts to 

improve efficiencies of USPS® business 

mail acceptance operations, the Postal 

Service proposes to revise its 

procedures and policies relating to the 

processing of postage statements in 

facilities with PostalOne! ® capability. 

The PostalOne! system, which can be 

accessed by business customers as well 

as by postal employees, is an automated, 

streamlined method of managing the 

business mail acceptance process. 

Expanded use of PostalOne! allows the 

Postal Service to contain costs and 

provide greater visibility and ease of use 

to the mailing community. 

With this proposal, the Postal Service 

would not complete the ‘‘USPS Use 

Only’’ section of, or round date, hardcopy postage statements (including 

duplicates) accompanying mailings 

accepted at PostalOne! facilities. 

Mailers with PostalOne! access would 

obtain documentation of their mailings 

by accessing their account via the 

Business Customer Gateway. Additional 

information on the Business Customer 

Gateway is found at https:// 

gateway.usps.com/bcg or by contacting 

their district Manager, Business Mail 

Entry. 

In the upcoming March 15, 2010 

release of PostalOne!, PS Form 3607, 

Weighing and Dispatch Certificate, 

would be revised and re-titled PS Form 

3607–R, Mailing Transaction Receipt. 

Any mailing entered at other than 

single-piece prices and all permit 

imprint mailings must be accompanied 

by a postage statement. In accordance 

with current mailing standards, hardcopy postage statements must be 

completed and signed by the mailer or 

agent. Postal facilities with PostalOne! 

capability would enter mailing data 

electronically and produce a PS Form 

3607–R to document the mailing. Upon 

request, a mailer could obtain a copy of 

PS Form 3607–R after acceptance and 

verification are completed. PS Form 

3607–R would not be mailed. 

There would be no changes in 

acceptance/postage statement processes 

for mailings accepted at Post Offices TM

without PostalOne! access. 

Although we are exempt from the 

notice and comment requirements of the 

Administrative Procedure Act [5 U.S.C. 

of 553(b), (c)] regarding proposed 

rulemaking by 39 U.S.C. 410 (a), we 

invite public comments on the 

following proposed revisions to Mailing 

Standards of the United States Postal 

Service, Domestic Mail Manual (DMM), 

incorporated by reference in the Code of 

WReier-Aviles on DSKGBLS3C1PROD with PROPOSALS