-------------------- BEGINNING OF PAGE #1 ------------------- SECURITIES AND EXCHANGE COMMISSION (17 CFR Part 240) (Release No. 34-34903; File No. S7-30-94). RIN 3235-AG00 Internalized/Affiliate Practices, Payment for Order Flow and Order Routing Practices. AGENCY: Securities and Exchange Commission. ACTION: Proposed Rulemaking. SUMMARY: The Securities and Exchange Commission is proposing to revise its rules governing disclosure to customers by broker- dealers of practices related to the routing of order flow, including payment for order flow, internalization of order flow, and affiliate practices. The proposed amendments are intended to provide customers with more useful information in evaluating the quality of executions. DATES: Comments should be submitted on or before December 15, 1994. ADDRESSES: Interested persons should submit three copies of their written data, views and opinions to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and should refer to File No. S7- 30-94. All submissions will be made available for public inspection and copying at the Commission's Public Reference Room, Room 1024, 450 Fifth Street, N.W., Washington D.C. 20549. FOR FURTHER INFORMATION CONTACT: Jill W. Ostergaard, 202/942- 3197, Attorney, Office of Market Supervision, Division of Market Regulation, Securities and Exchange Commission, (Mail Stop 5-1) 450 5th Street, N.W., Washington D.C. 20549. SUPPLEMENTARY INFORMATION: I. Introduction and Background The Securities and Exchange Commission ("SEC" or "Commission") is proposing to amend its rules governing disclosure of broker-dealer payment for order flow and the practice of executing orders as principal or routing orders to an affiliated broker-dealer or exchange specialist ("internalized/affiliate practices"), Rule 10b-10 (17 CFR 240.10b-10) and Rule 11Ac1-3 (17 CFR 240.11Ac1-3) under the Securities Exchange Act of 1934 ("Act"). As described below and in a related release, both payment for order flow and internalized/affiliate practices have been the subject of extensive debate. -[1]- The proposed Rule amendments regarding payment for order flow also are intended to enhance disclosure to customers of compensation their broker-dealer may receive from market centers -[2]- in return for routing customer orders to them for execution. -[3]- The amendments would require broker-dealers receiving payment for order flow to provide customers additional information regarding the value of the compensation received. The proposed additional disclosures would include, for monetary payment for order flow, the range of payments received on a per share basis and on an aggregate basis annually, and for non- -[1]- See Securities Exchange Act Release No. 34902 (October 27, 1994) ("Adopting Release"). -[2]- As used in this release, the term market center includes exchanges and dealers acting as market makers. See 17 CFR 240.11Ac1-2(a)(14) (defining "reporting market center"). -[3]- The Commission is also soliciting comment whether certain inducements to routing order flow should be included in the definition of payment for order flow. -------------------- BEGINNING OF PAGE #2 ------------------- monetary payment for order flow, an estimate of the range of payment for order flow on a per share basis and on an aggregate basis annually. These disclosures would be required when a customer opens an account, on an annual basis thereafter, and in abbreviated fashion on required confirmations. The proposed amendments would require similar disclosure with respect to the value of order flow subject to internalized/affiliate practices. The Commission also is proposing that broker-dealers disclose to their customers information regarding their order routing practices generally, regardless of whether they receive payment for order flow or engage in internalized/affiliate practices. The proposed amendments regarding internalized/affiliate practices are intended to address comments the Commission received in connection with its consideration of payment for order flow practices and to elicit further discussion regarding their implications. In connection with the Adopting Release, six commenters indicated that the internalization of order flow by broker-dealers presents issues similar to those commonly associated with payment for order flow. These commenters argued that the opportunity to capture the spread through internalized/affiliate practices encourages broker-dealers to execute orders in house or to send orders to an affiliated broker-dealer or exchange specialist. At the most basic level, under each practice the broker-dealer is influenced with respect to where it will route customer orders. The proposed amendments would require broker-dealers to inform customers on new account and annual disclosure statements whether they execute orders as principal or route those orders to affiliated firms. These amendments are designed to provide customers with more information about firms' order routing decisions, especially in light of changes that might result from requiring additional disclosure of payment for order flow practices. Finally, the proposed rule amendments would extend confirmation and account statement disclosure of payment for order flow to transactions in standardized options. In the Adopting Release issued today, the Commission adopted requirements for additional disclosure of payment for order flow practices. -[4]- Commenters are encouraged to review the Adopting Release in considering the amendments proposed today. The discussion that follows describes the proposed amendments and solicits views regarding those amendments. II. Discussion A. Definition and Quantification of Payment for Order Flow The proposed amendments would require broker-dealers to provide more detailed information to customers regarding payment for order flow. The proposed amendments would require broker- dealers receiving monetary payment for order flow to disclose the range of payments received on a per share basis and the aggregate amount of payment for order flow received on an annual basis, and, for non-monetary payment for order flow, to disclose an estimate of the range of non-monetary payment for order flow received by the broker-dealer on a per share basis and on an aggregate basis annually. 1. Definition of Payment for Order Flow The Commission, in the Adopting Release, adopted a definition of payment for order flow that includes monetary -[4]- See Adopting Release, supra note 1. -------------------- BEGINNING OF PAGE #3 ------------------- payments, services, property or any other benefit offered for order flow that results in remuneration to the firm in return for the routing of customer orders for execution. As discussed below, the proposed amendments would establish definitions of monetary and non-monetary payment for order flow, defining monetary payment for order flow as any monetary payment, discount, rebate or reduction of fee to the extent that the payment, discount, rebate or reduction exceeds the fee charged. At the same time, however, the Commission is concerned that other practices used by market centers are designed to induce broker- dealers to direct order flow, and, therefore, may present issues similar to those practices currently defined as payment for order flow in the Adopting Release. The Commission is soliciting comment on whether to expand the definition of payment for order flow. Specifically, the Commission is considering expanding the definition to include volume discounts, rebates, reductions or other inducements for order flow, even if not in excess of the execution fee charged by a market center. -[5]- Commenters should specifically indicate which practices should be included in the definition to provide the maximum benefit to investors and encourage equivalent regulatory treatment among competing market centers consistent with the purposes of the Act. The Commission also requests the views of commenters as to whether a differential in fees between competing market centers should be considered as the economic equivalent of payment for order flow for either or both general disclosure and quantification purposes. This differential might be viewed as affecting the order routing determination of a broker-dealer in a manner similar to payment for order flow. Commenters also are asked to address why payment for order flow should exist in certain instances, but not others, when the inducement for order flow to be routed to one market center or another is identical in both instances. For example, assume that one market center currently pays $.02 per share for order flow, while a competing market center charges a fee of $.05 per share to handle customer orders, resulting in an overall differential of $.07 per share. Under the current definition, the first market center would be deemed to be paying for order flow, quantified as $.02 per share. Why should payment for order flow be deemed to no longer exist where, as a result of a $.02 per share increase in costs uniformly incurred by all market centers, the first market center simply ceased paying for order flow in favor of handling customer orders without charge, while its competitor proportionately increased the fees charged for handling customer orders to $.07 per share? In this instance, the first market center maintains the identical differential in terms of the inducement to broker-dealers to direct order flow to the first market center, as opposed to the second. In a related manner, commenters are requested to indicate whether the proposed quantification of payment for order flow (discussed more fully in the next Section) accurately reflects the inducement to a broker-dealer to route orders to a particular market center. For instance, in the example noted above, is the amount of the inducement that should be disclosed in connection with payment for order flow paid by the first market center $.02 per share, as would be the case under the current definition of payment for order flow in Rule 11Ac1-3, or does the $.07 per -[5]- Some commenters have suggested that there is no distinction between cash payment for order flow and these inducements. See "Inducements for Order Flow," A Report to the Board of Governors, NASD, July 1991. -------------------- BEGINNING OF PAGE #4 ------------------- share differential more accurately reflect the level of inducement for order flow? 2. Quantification of Payment for Order Flow The proposed amendments would establish definitions of "monetary payment for order flow" and "non-monetary payment for order flow." The term monetary payment for order flow would be defined in Section 10b-10(e)(10) to mean "any monetary payment, discount, rebate or reduction of fee to the extent that the payment, discount, rebate or reduction exceeds the fee charged." The term non-monetary payment for order flow would be defined in Section 10b-10(e)(11) to mean "any payment for order flow received other than monetary payment for order flow." The Adopting Release, while requiring additional disclosure of payment for order flow practices, does not require disclosure of the amount of any payment for order flow. Certain of the proposed amendments to Rule 11Ac1-3 would focus on this disclosure. For monetary payment for order flow, the broker- dealer would be required by Rule 11Ac1-3(a)(3) and (4) to disclose the aggregate amount of monetary payment for order flow received annually, and the range of monetary payment for order flow received on a per share basis. The proposed amendments to Rule 11Ac1-3(a)(5) and (6) would require broker-dealers to disclose to customers at account opening and annually thereafter, an estimate of the aggregate value of non-monetary payment for order flow received by the broker-dealer in return for directing order flow on an annual basis, and an estimate of the range of non-monetary payment for order flow received on a per share basis. The proposal calls for an estimate of non-monetary payment for order flow, recognizing that precision may not be possible. To the extent that a broker-dealer finds it difficult to estimate the per share value of non-monetary payment for order flow, the Commission would envision permitting the broker-dealer to assume the value of the non-monetary compensation was equal to the cash per share payment for order flow received from the same source, or, if none, similar sources. The assumption would be that a broker-dealer, in choosing the form of payment for order flow, would demand a value that is commensurate with the amount of cash that could be received from the same or competing market maker or specialist. Commenters are requested to identify alternative methods by which firms might arrive at an estimate of the value of non-monetary payment for order flow. -[6]- The proposed rule would require an estimate of the range of non-monetary payment for order flow received by the broker- dealer expressed on a per share basis. To comply with this requirement, broker-dealers would be expected to use the estimate required by Rule 11Ac1-3(a)(5) in calculating the range of values to be disclosed. The proposed rule would recognize expressly that the calculation of values represents an estimate. -[7]- -[6]- Commenters are also requested to indicate the extent to which valuations may vary depending on the form of non- monetary compensation or other factors, and whether this would pose problems for estimating and disclosing the valuations. -[7]- One commenter believes that value estimates of non- monetary compensation may be based on fair value as determined in good faith by the management of the broker-dealer. See letter from Alan B. Levenson, Fulbright & Jaworski L.L.P. and Irving M. Pollack (on (continued...) -------------------- BEGINNING OF PAGE #5 ------------------- The Commission also is proposing to require broker-dealers who receive payment for routing orders to include information on the confirmation. Proposed Rule 10b-10(a)(7)(B) would require, for any monetary payment for order flow received, confirmation disclosure of the range of payments received on a per share basis. Proposed Rule 10b-10(a)(7)(iii)(C) would require, for any non-monetary payment for order flow received, an estimate by the broker-dealer of the range in value of non-monetary compensation on a per share basis. Because it may not be possible to identify immediately after execution which orders are subject to payment for order flow arrangements or the pro rata value of a specific order, the Commission is proposing to require disclosure of an estimate of the range in value of compensation that may have been received, stated on a per share basis. Proposed Rule 10b- 10(a)(7)(iii)(B) and (C) also would require, for any non-monetary payment for order flow received, a statement that the nature and source of such compensation will be furnished upon written request of the customer. In crafting the proposed amendments, the Commission is mindful of the concern that requiring quantification of monetary but not non-monetary payment for order flow could result in broker-dealers moving toward potentially undisclosed compensatory practices, such as non-monetary payment for order flow. -[8]- Thus, it has sought to require disclosure of non-monetary payment for order flow similar to the disclosure requirements established for monetary payment for order flow. This is intended to provide customers with equivalent information to evaluate a broker- dealer's order routing arrangements, and to remove any regulatory disparity between monetary and non-monetary payments. The Commission invites commenters to address whether the proposed amendments would accomplish these goals, and whether there are other ways to accomplish these goals. The Commission specifically requests comment on the ability of broker-dealers to determine whether a non-monetary payment is in return for order flow, and their ability to estimate the value of the various forms of non-monetary payments. B. Internalized/Affiliate Practices Rule 11Ac1-3, as adopted, requires broker-dealers who receive payment for order flow to disclose their policies for determining where to route orders that are subject to payment for order flow absent specific instructions from customers. That Rule would not expressly require broker-dealers to provide information about their order routing policies if instead of receiving payment for order flow in return for routing orders, they simply executed the orders for their own account. -[9]- -[7]-(...continued) behalf of Herzog, Heine, Geduld, Inc.), to Jonathan G. Katz, Secretary, SEC, dated December 9, 1993. -[8]- Some commenters argue that treating monetary and non- monetary payment for order flow differently creates an incentive for dealers to restructure cash payment arrangements into payments in kind. -[9]- In recent years, multi-service broker-dealers, clearing firms, and others have acquired interests in specialist units, particularly on regional exchanges, although several specialists on the New York Stock Exchange ("NYSE") and American Stock Exchange ("Amex") are (continued...) -------------------- BEGINNING OF PAGE #6 ------------------- The Commission is concerned that internalized/affiliate practices may raise questions similar to payment for order flow practices regarding the obligations of brokers to their customers, such as whether firms that internalize order flow are providing best execution of customer orders. -[10]- In proposing Rule 11Ac1-3 in October 1993, the Commission invited comment on the implications of these practices and whether additional disclosure would be desirable. -[11]- Seven commenters addressed internalization/affiliate practices; six favored a regulatory response -[12]- and one opposed it. -[13]- -[9]-(...continued) affiliated with upstairs firms. These firms then route small customer orders for execution to their affiliated specialist. See Division of Market Regulation, Securities and Exchange Commission, Market 2000: An Examination of Current Equity Market Developments (Jan. 1994) ("Market 2000"), Study II at 9 and Exhibit 29. The Commission recently discussed the potential implications of internalization for the structure of the national market system in the context of proposals by two national securities exchanges to establish or extend marketplace programs that might facilitate internalization practices. See Securities Exchange Act Release Nos. 34078 (May 18, 1994), 59 FR 27082 (May 25, 1994) (File No. SR-BSE-93-12); 34493 (August 5, 1994), 59 FR 41531 (August 12, 1994) (File No. SR-CSE-94-06). Internalized/affiliate practices also were discussed in Congressional hearings on market structure a few months ago and, earlier this year, the Division of Market Regulation discussed this topic in its Market 2000 Report. See Market 2000, Study II at 9 and Exhibit 29; Oversight Hearing on the Structure of the Marketplace with a Focus on the Market 2000 Report and the Unlisted Trading Privileges Act of 1994 Before the Subcomm. on Telecommunications and Finance of the House Comm. on Energy and Commerce, 103d Cong., 2d Sess. (1994). -[10]- An extensive discussion of the "best execution" obligation appears in the Adopting Release as well as the release proposing Rule 11Ac1-3 for comment. See Adopting Release, supra note 1 at nn.26-36 and accompanying text; Securities Exchange Act Release No. 33026 (October 6, 1993) 58 FR 52934, 52937-52938 (October 13, 1993)("October 1993 Proposing Release"). -[11]- See Id. at n.38. -[12]- Letters to Jonathan G. Katz, Secretary, SEC, from: Jules L. Winters, Chief Operating Officer, American Stock Exchange ("Amex"), dated December 21, 1993 ("Amex letter"); Robert F. Price, Managing Director, Alex. Brown & Sons, Inc., dated December 23, 1993; George A. Brown, Brown & Company, dated December 2, 1993; John N. Tognino, Executive Vice President, Capital Markets and Trading, Charles Schwab & Co. Inc., dated December 8, 1993; Chris A. Hynes, President, State Street Brokerage Services, Inc., dated December 1, 1993 ("State Street letter"); and Thomas W. Clegg, Sr., Vice President, Wheat First Securities, Inc., dated November 30, 1993. (continued...) -------------------- BEGINNING OF PAGE #7 ------------------- The Commission is proposing to amend Rule 11Ac1-3 to require broker-dealers who choose to internalize or route orders to affiliated organizations to provide information about this policy parallel to the information that Rule 11Ac1-3 requires them to provide concerning the routing of orders in return for payment for order flow. As defined in proposed Rule 10b-10(e)(12), internalized/affiliate order routing practices shall mean the execution of an order by a broker-dealer as principal, or the routing of an order by the broker-dealer to an affiliated broker- dealer or exchange member. Specifically, the amendment to Rule 11Ac1-3(a)(2) would require firms to disclose their policies for determining where to route customers' orders, absent specific instructions from customers, including whether orders are executed as principal, orders are routed to an affiliated broker- dealer, or to an unaffiliated broker-dealer or market center, including a description of the extent to which orders can be executed at prices superior to the NBBO. The Commission also is proposing to extend the confirmation and account statement valuation requirements to internalized/affiliate order flow practices. The Commission requests comment on this aspect of the proposed rule and the ability of broker-dealers to estimate the value of internalized/affiliate order flow. The Commission realizes that, as in the case of non-monetary payment for order flow, precision in this area may not be possible. Therefore, the Commission seeks the views of commenters as to whether the value of internalized order flow may be reasonably approximated by reference to the monetary amount per share that a broker-dealer could have received for such order flow from a competing market center, or by other methods, such as by measuring the difference between the spread received by a broker-dealer engaging in internalized/affiliate practices and the amount that the broker- dealer could have received for the order flow from another market center. -[14]- -[12]-(...continued) The Amex stated that internalization impedes price discovery and makes best execution less likely, and because internalized order flow provides the executing market maker with a dealer spread on every internalized trade, there is little incentive for the dealer to narrow the quoted spread. See Amex letter. One brokerage firm argued that the failure to regulate internalization creates a competitive advantage for large integrated firms. See State Street letter. -[13]- This commenter noted that in an exchange environment, "the continuous affirmative obligations imposed on exchange specialists and the auction-type trading process inherent in trading on exchanges limit the extent to which internalization can be accomplished." See letter from John I. Fitzgerald, Executive Vice President, Legal Affairs and Trading Services, Boston Stock Exchange, Inc., to Jonathan G. Katz, Secretary, SEC, dated December 10, 1993. -[14]- The Commission is concerned that to the extent that the value of monetary and non-monetary payment for order flow are quantified but the value of orders subject to internalized/affiliate practices are not, broker- dealers may be encouraged to engage in the latter practices to a greater degree. -------------------- BEGINNING OF PAGE #8 ------------------- The Commission invites commenters to address whether the proposed amendment would provide customers with meaningful information and would further the goals of Section 11A of the Act. To the extent that they believe payment for order flow and internalized/affiliate practices should be treated differently for regulatory purposes, commenters are requested to indicate why concerns with respect to internalization are less compelling than those frequently associated with payment for order flow practices. Similarly, the Commission recognizes that the unequal regulatory treatment of internalized order flow may result in an increase in the amount of customer orders that are executed directly by a broker-dealer or its affiliates. C. Order Routing Disclosure As proposed, Rule 11Ac1-3(a)(2) would require all broker- dealers to disclose their policies for determining where to route customer orders absent specific instructions from the customer, as well as a description of the extent to which orders may receive price improvement. If adopted, this disclosure currently required under Rule 11Ac1-2 would be required for all orders, regardless of whether the broker-dealer received payment for order flow or engaged in internalized/affiliate order routing practices. The Commission believes that the proposed disclosure of order routing practices is consistent with its goal of providing customers with information to enhance their ability to evaluate the quality of execution received, and to make informed decisions with respect to the selection of broker-dealers. Under Rule 10b- 10 of the Act, the Commission currently requires broker-dealers to disclose their capacity as agent or principal with respect to customer transactions, the agency commission received in connection with a particular transaction, and the source and amount of any additional remuneration to be received in connection with a transaction, among other matters. -[15]- As a result of these disclosures, investors have a better understanding of commissions and other costs associated with the execution of a transaction. The Commission believes that proposed Rule 11Ac1-3(a)(2) will further facilitate the ability of investors to understand order routing possibilities and the decisions made by broker-dealers in this regard. The Commission believes that such information would be of significant benefit to investors. For example, a broker-dealer's decision regarding the routing of orders involving securities listed for trading on national securities exchanges raises the issue of price improvement. Orders in such securities that are routed to certain exchange facilities typically will receive an opportunity for price improvement, -[16]- while similar orders routed to other market centers -- and, currently, generally with respect to all non-listed securities -- may forgo this possibility. In addition to enhancing the ability of customers to evaluate the costs and benefits of a broker-dealer's order routing determinations, the Commission believes that the proposed amendment to Rule 11Ac1-3(a)(2) will help obviate some of the difficulty in identifying those practices that involve conflicts between the interests of broker-dealers and their customers. In light of the complexity and the perceived economic similarity between payment for order flow and other market practices designed to induce or influence order flow, or that present the same concerns -- such as internalization practices -- the -[15]- 17 C.F.R. 240.10b-10. -[16]- But see Adopting Release, supra note 1, at n.33. -------------------- BEGINNING OF PAGE #9 ------------------- Commission believes that the requirement that all broker-dealers disclose their order routing practices will help facilitate equal regulation, reduce investor confusion, and further empower investors to make informed decisions in their own best interests. Broker-dealers making disclosure under the proposed rule are encouraged to explain how their order routing determinations are in the overall best interests of their customers. Finally, the Commission also solicits the views of commenters regarding whether the disclosure of broker and dealer order routing policies should be set forth in a standardized format on the confirmation involving, for example, general categories of order routing practices such as internalized/affiliate order flow, order flow subject to payment for order flow, and order flow routed to unaffiliated market centers, thereby facilitating customer understanding and ease of comprehension. D. Expanding the Scope of Covered Securities to Include Standardized Options Rule 11Ac1-3 does not apply to exchange-traded options. Although the October 1993 Proposing Release did not request comment on whether payment for order flow disclosures should be extended to these securities, two exchanges expressed support for such a change, but otherwise no comments were received on this subject. -[17]- In light of the favorable, albeit limited comments, the Commission proposes to amend Rules 11Ac1-3 and 10b- 10 to include standardized options. The Commission particularly invites comment on whether the disclosure requirements would result in unique problems for firms effecting transactions in options. III. Request for Comment The Commission invites comment on all the issues raised in this release including expanding the definition of payment for order flow, the proposed amendments to Rule 10b-10, the amendments to Rule 11Ac1-3 regarding disclosure of the value of payment for order flow and internalization/affiliate practices, inclusion of standardized options, and other approaches that address internalization/affiliate practices and payment for order flow, including a requirement that broker-dealers describe their order routing practices for all orders. The Commission also requests commenters to address the feasibility of adopting the proposed amendments to become effective on April 3, 1995, the date newly adopted Rule 11Ac1-3 and amendments to Rule 10b-10 are to take effect. In addition to the specific requests for comment set forth above, the Commission requests comment on whether the proposed rule amendments, if adopted, would have an adverse effect on competition or would impose a burden on competition that is neither necessary nor appropriate in furthering the purposes of the Exchange Act. Comments on the inquiry will be considered by the Commission in complying with its responsibilities under Section 23(a)(2) of the Exchange Act. -[17]- One exchange suggested that the Commission consider the ramifications that payment for order flow may have on the options marketplace, especially once multiple trading of options is taken into consideration. See letter from Leopold Korins, Chairman and Chief Executive Officer, Pacific Stock Exchange, Inc., to Jonathan G. Katz, Secretary, SEC, dated December 9, 1993. -------------------- BEGINNING OF PAGE #10 ------------------- IV. Initial Regulatory Flexibility Analysis The Commission has prepared an Initial Regulatory Flexibility Analysis ("IRFA") in accordance with 5 U.S.C. sec. 603 regarding the proposed rules. The following summarizes the conclusions of the IRFA. The IRFA uses certain definitions of "small entities" adopted by the Commission for purposes of the Regulatory Flexibility Act. The Analysis notes that the proposed rule amendments would require at the time an account is opened and on an annual basis thereafter, broker-dealers to disclose their policies for routing customer orders in exchange listed securities, provide the range of monetary payment for order flow received on a per share basis on the confirmation, the aggregate value of monetary payment for order flow, an estimate of the aggregate value of non-monetary payment for order flow and internalized/affiliate orders, and an estimate of the range of non-monetary payment for order flow and internalized/affiliate orders received by the broker-dealer on a per share basis on the confirmation. The proposals could necessitate changes to broker- dealer confirmation systems that generally do not provide that specific information now. Broker-dealers would need to keep records of payment for order flow to fulfill the disclosure requirements of the proposed rule amendments. A copy of the Initial Regulatory Flexibility Analysis may be obtained by contacting Jill W. Ostergaard, Attorney, Office of Market Supervision, Division of Market Regulation, Securities and Exchange Commission, Washington, DC 20549, 202/942-3197. V. Text of the Amendments List of Subjects in 17 CFR Part 240 Brokers; Reporting and recordkeeping requirements; Securities For the reasons set out in the preamble, the Commission proposes to amend Part 240 of Chapter II of Title 17 of the Code of Federal Regulations to read 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, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted. * * * * * 2. By amending 240.10b-10 by revising paragraph (a)(7)(iii), and adding paragraphs (e)(10), (e)(11), and (e)(12) to read as follows: 240.10b-10 Confirmation of transactions. (a) * * * (7) * * * (iii) For a transaction in any subject security as defined in 240.11Ac1-2, a security authorized for quotation on an automated interdealer quotation system that has the characteristics set forth in Section 17B of the Act (15 U.S.C. 78q-2), or a standardized option as defined in 240.9b-1: (A) A statement whether payment for order flow is received by the broker or dealer for transactions in such securities; (B) For monetary payment for order flow received, the range of payments received for such securities on a per share basis and a statement that the source and amount received in connection with the particular transaction will be furnished upon written request of the customer; -------------------- BEGINNING OF PAGE #11 ------------------- (C) For non-monetary payment for order flow received, an estimate of the range of non-monetary payment for order flow received by the broker or dealer on a per share basis and a statement that the nature and source of such compensation will be furnished upon written request of the customer; and (D) A statement whether transactions in such securities are subject to internalized/affiliate order routing practices and an estimate of the range in value of such order flow on a per share basis, and that additional information will be furnished upon written request of the customer; and * * * * * (e) * * * (10) Monetary payment for order flow shall mean any monetary payment, discount, rebate or reduction of fee to the extent that the payment, discount, rebate or reduction exceeds the fee charged. (11) Non-monetary payment for order flow shall mean any payment for order flow received other than monetary payment for order flow. (12) Internalized/affiliate order routing practices shall mean the execution of an order by the broker or dealer as principal, or the routing of an order by the broker or dealer to an affiliated broker, dealer, or exchange member. * * * * * 3. By amending 240.11Ac1-3 by revising the introductory text of paragraph (a), paragraph (a)(2) and adding paragraphs (a)(3) through (a)(8) to read as follows: 240.11Ac1-3 Customer account statements. (a) No broker acting as agent for a customer may effect any transaction in, induce or attempt to induce the purchase or sale of, or direct orders for purchase or sale of, any subject security as defined in 240.11Ac1-2, a security authorized for quotation on an automated interdealer quotation system that has the characteristics set forth in Section 17B of the Act (15 U.S.C. 78q-2), or a standardized option as defined in 240.9b- 1, unless such broker or dealer informs such customer, in writing, upon opening a new account and on an annual basis thereafter, of the following: (1) * * * (2) The broker's or dealer's policies for determining where to route customers' orders, absent specific instructions from customers, including: (i) A statement whether the broker or dealer executes orders as principal, routes orders to an affiliated broker, dealer, or exchange member, or to another broker, dealer, exchange member, or an exchange; and (ii) A description of the extent to which orders in such securities can be executed at prices superior to the best bid or offer as defined in 240.11Ac1-2(a)(15); (3) The aggregate amount of monetary payment for order flow as defined in 240.10b-10(e)(10) received by the broker or dealer in return for directing order flow on an annual basis; (4) The range of monetary payment for order flow received by the broker or dealer on a per share basis; (5) An estimate of the aggregate value of non-monetary payment for order flow, as defined in 240.10b-10(e)(11), received by the broker or dealer in return for directing order flow on an annual basis; (6) An estimate of the range of non-monetary payment for order flow, as defined in 240.10b-10(e)(11), received by the broker or dealer on a per share basis; -------------------- BEGINNING OF PAGE #12 ------------------- (7) An estimate of the aggregate value of the order flow of internalized/affiliate order routing practices, as defined in 240.10b-10(e)(12), on an annual basis; and (8) An estimate of the range in value of the order flow of internalized/affiliate order routing practices, as defined in 240.10b-10(e)(12) on a per share basis. * * * * * By the Commission. Jonathan G. Katz Secretary Dated: October 27, 1994