Opinion ID: 2140882
Heading Depth: 1
Heading Rank: 1

Heading: Federal Regulation of Order Flow Payments

Text: The SEC has monitored and studied securities industry assessments of the practice of order flow payments for over a decade (Securities Exchange Act Release No. 34-33026, 58 Fed Reg 52935). The agency conducted a round table discussion on the subject in 1989 ( id. ). The SEC consistently applied the confirmation statement remuneration disclosure mandate of the original rule 10b-10 to order flow payments (Securities Exchange Act Release No. 34-33026, 58 Fed Reg, at 52936-52937 [Thus, Rule 10b-10 currently requires a broker-dealer to indicate specifically if it is receiving payment for order flow in connection with a particular customer trade.]). It is uncontested that Schwab and Fidelity complied with the applicable disclosure requirements of then rule 10b-10 on the confirmation statements they sent to all of the putative plaintiff class members here. In 1993, the SEC proposed to amend and add to its disclosure regulations in order to address with more particularity the practice of order flow payments (Securities Exchange Act Release No. 34-33026, op. cit. ). The SEC's decision-making process entailed the same interest balancing and cost/benefit analysis as was utilized in initially adopting rule 10b-10. The SEC reviewed the potential detrimental effects of order flow payments, including potential conflicts of interest between customer and broker (Securities Exchange Act Release No. 34-33026, 58 Fed Reg 52936), possible breach of duty of best execution of orders under common-law agency principles and possible commission of commercial bribery under Federal and State law ( id. , 58 Fed Reg 52937-52939, 52941). Thus, the agency recognized that there were critics who advocated drastic restrictions on order flow payments, if not outright elimination of the practice ( id. , 58 Fed Reg 52941). Conversely, the SEC's 1993 proposed rule making on order flow payments recognized that the securities industry gained economic advantages from the practice, which ultimately benefitted the investor public ( id. , 58 Fed Reg 52939-52940). The SEC rejected any extreme approach in favor of a proposed rule to expand disclosure of the receipt of order flow payments. The agency proposed to amend rule 10b-10: (1) to include a broad definition of the practice itself, that would also cover various commonly employed forms of nonmonetary remuneration; and (2) to require confirmation statement disclosure of the receipt of order flow payments and the specific dollar amount of any monetary payment, discount, rebate or reduction of fee received (Securities Exchange Act Release No. 34-33026, 58 Fed Reg 52940). Additionally, the SEC proposed a new rule 11Ac1-3 to require disclosure on each new customer's account statement and annually thereafter as to the broker-dealer's policies concerning the receipt of order flow payments and annual disclosure of the aggregate dollar amount of such payments, rebates, etc. ( id. , 58 Fed Reg 52940). The agency invited comment on its proposal and upon more drastic alternative regulation of order flow payments, including outright elimination of the practice or requiring dealers to pass onto customers the order flow payment received ( id. , 58 Fed Reg 52941-52942). Approximately a year later, the SEC announced adoption of its final rule for regulation of order flow payments (Payment For Order Flow, Securities Exchange Act Release No. 34-34902 [Oct. 27, 1994], reprinted in 59 Fed Reg 55006). [6] It explained that it rejected elimination of order flow payments entirely because the practice did not necessarily violate a broker-dealer's best execution obligation, and that the practice benefitted the securities industry in lowering execution costs, in facilitating technological advances in retail customer order handling practices and in enhancing competition among broker-dealers and the various exchange and nonexchange securities markets and, thus, also worked to the advantage of investors ( id. , 59 Fed Reg 55007-55011). The SEC also noted the serious enforcement problems that elimination of the practice would entail and the drastic impact that an outright ban would have on the securities industry ( id. , 59 Fed Reg 55011). The SEC's 1994 final rule regulating the practice of order flow payments largely followed the disclosure requirements it had proposed a year earlier. However, the agency  again employing cost/benefit analysis  eliminated the proposed disclosure requirements that confirmation statements and annual account statements show dollar amounts received for order routing. The SEC was apprehensive that mandatory disclosure of specific monetary receipts might be unworkable ( id. , 59 Fed Reg 55010) and would, at the least, impose an extreme burden upon broker-dealers to determine the amount of order flow received for each order in time for a confirmation and would entail expenses disproportionately high in relation to the potential benefits to customers ( id. , 59 Fed Reg 55010, n 39).