Proposed Regulation Best Execution

**Status: PROPOSED — not currently in effect.**

Release No. 34-96496 (December 14, 2022) proposes a new best-execution framework applicable to broker-dealers. The proposed framework consists of three rules: proposed Rule 1100 (the best-execution standard), proposed Rule 1101 (policies and procedures), and proposed Rule 1102 (documentation). The proposal would, if adopted, be a Commission rule parallel to — and in many respects more prescriptive than — FINRA Rule 5310 and the analogous MSRB Rule G-18.

As of the retrieved_at date of this excerpt, the proposal has not been adopted. No compliance obligations arise from the text of the proposal. Kestrel Securities references this document solely to track developments that could affect future policy design.

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Proposed § 242.1100 — Best execution standard.

(a) General.

No broker or dealer, including a government securities broker or dealer, shall execute, or route for execution, a transaction in any security for or on behalf of a customer unless the broker or dealer, in connection with the execution or routing of the transaction, has used reasonable diligence to ascertain the best market for the security and bought or sold in such market so that the price to the customer is as favorable as possible under prevailing market conditions.

(b) Factors bearing on reasonable diligence.

Factors that bear on "reasonable diligence" include, but are not limited to:

1. The character of the market for the security, including price, volatility, and relative liquidity; 2. The size and type of transaction; 3. The number of markets or venues checked; 4. The accessibility of the quotation; 5. The terms and conditions of the customer's order, including any customer instructions; 6. The existence of any actual or potential conflicts of interest of the broker or dealer with respect to the execution or routing of the transaction, including any incentives or inducements created by payment for order flow, internalization, or routing to an affiliate; and 7. For transactions in equity securities, the quality of executions provided by competing market centers, as reflected in statistics published pursuant to § 242.605 and equivalent information.

(c) Conflicted transactions with retail customers.

A conflicted transaction with a retail customer warrants enhanced scrutiny. A "conflicted transaction" is a transaction in which the broker or dealer:

1. Executes the transaction as principal, including riskless principal, for the broker or dealer's own account; 2. Receives payment for order flow in connection with the transaction, including any remuneration, compensation, rebate, or other consideration that creates or may be seen to create a financial incentive for the broker or dealer to route the order in a particular manner; 3. Routes or executes the transaction through an affiliated broker or dealer; or 4. Routes the transaction to a venue in which the broker or dealer has a financial or ownership interest.

For conflicted transactions with retail customers, the broker or dealer must, in addition to satisfying the general standard in paragraph (a):

- Conduct an assessment of reasonably accessible markets and evaluate whether any such market could provide a more favorable price; - Document that assessment, including the markets considered and the basis for the routing decision; and - Adopt and enforce policies and procedures reasonably designed to comply with the enhanced requirement.

(d) Retail customer.

A "retail customer" for purposes of this section means a natural person, or the legal representative of such natural person, who receives order-handling or execution services from a broker or dealer and who uses such services primarily for personal, family, or household purposes. The definition is intended to align with "retail customer" under § 240.15l-1 (Regulation Best Interest).

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Proposed § 242.1101 — Best execution policies and procedures.

(a) Written policies and procedures.

Each broker or dealer shall establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with the best-execution standard in § 242.1100. The policies and procedures shall, at a minimum, address:

1. How the broker or dealer will comply with the best-execution standard with respect to different asset classes, order types, and order sizes; 2. The identification of markets and counterparties from which the broker or dealer will execute, or to which the broker or dealer will route, customer orders, and the criteria used to select such markets and counterparties; 3. The handling of conflicted transactions under § 242.1100(c), including the enhanced assessment, documentation, and review procedures required for such transactions; and 4. The periodic review of the broker-dealer's compliance with the policies and procedures, including identification of and response to deviations.

(b) Introducing brokers.

An introducing broker that routes 100% of its order flow to one or more clearing brokers or other executing broker-dealers may rely on the clearing or executing broker's policies and procedures to satisfy paragraphs (a)(1) and (a)(2) of this section, provided the introducing broker:

1. Has a reasonable basis to believe that the clearing or executing broker has established policies and procedures reasonably designed to comply with § 242.1100; 2. Periodically reviews the execution quality provided by the clearing or executing broker and takes responsive action where execution quality falls short; and 3. Maintains records of its review and any responsive action.

An introducing broker that directs any portion of its flow based on its own routing determinations, or that receives payment for order flow with respect to such flow, cannot rely on paragraph (b) with respect to that flow.

(c) Review.

The broker or dealer shall review its best-execution policies and procedures, and the execution quality it obtains, at least annually, and shall promptly amend its policies and procedures in response to any material change in market structure, order-handling practices, or performance.

The broker or dealer shall also review, at least quarterly, the execution quality obtained for retail customers in conflicted transactions and shall document the review and any changes in routing practices resulting from the review.

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Proposed § 242.1102 — Best execution documentation.

(a) General documentation requirement.

Each broker or dealer shall make and keep current:

1. A record of the policies and procedures required by § 242.1101; 2. Documentation of the periodic reviews required by § 242.1101(c), including findings, conclusions, and any actions taken; and 3. Documentation of the enhanced assessment required by § 242.1100(c) for each conflicted transaction with a retail customer, sufficient to demonstrate the basis for the routing decision.

(b) Retention.

Records required by paragraph (a) shall be preserved in accordance with § 240.17a-4(e) for a period of at least six years, the first two years in an easily accessible place.

(c) Availability to the Commission.

Records required by paragraph (a) shall be made available promptly upon request to the Commission or its staff.

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Key comment-letter themes (informational)

The proposal received extensive comments during its 60-day (subsequently extended) comment period. Principal themes raised by broker-dealer commenters include:

1. **Duplication with FINRA Rule 5310.** Many commenters argued that the Commission already relies on FINRA to enforce a functionally equivalent best-execution rule, and that adoption of § 242.1100 would create overlapping and potentially inconsistent obligations. The Commission's release responds that the federal rule would "fortify" the existing SRO framework by adding a statutory antifraud foundation. 2. **Conflicted-transaction definition.** Commenters objected to treating principal execution, internalization, and PFOF each as a "conflicted transaction" triggering enhanced review. Commenters noted that principal execution in fixed-income markets is pervasive and that mechanical application of the enhanced requirement would impose disproportionate costs without a corresponding benefit. 3. **Introducing-broker reliance.** The conditional reliance provision in § 242.1101(b) was generally welcomed, but commenters asked for further clarification of what constitutes "periodic review" sufficient to support reliance. 4. **Documentation burden.** The per-transaction documentation requirement in § 242.1102(a)(3) for conflicted retail transactions was identified as the most costly element of the proposal. Commenters requested that documentation be allowed at the policy or batch level rather than the per-transaction level, particularly for high-volume retail flow.

These themes are provided for context only; the Commission has not yet issued an adopting release, and the proposal may be adopted with modifications, re-proposed, or withdrawn.

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Comparison with current framework

| Topic | FINRA Rule 5310 (current) | Proposed Reg Best Ex (§§ 1100–1102) | |---|---|---| | General standard | Reasonable diligence / best market / most favorable price under prevailing conditions. | Substantially identical general standard, codified at the federal level with antifraud implications. | | Scope | FINRA member broker-dealers for transactions in most securities. | All broker-dealers, including government securities brokers and dealers; applicable to all securities including those not subject to FINRA jurisdiction. | | Review cadence | Quarterly minimum, per Supplementary Material .02. | Annual general review; quarterly review of conflicted transactions for retail customers; ad-hoc review on material change. | | Documentation | Committee minutes, findings, conclusions, routing changes. | All of the FINRA-equivalent documentation plus per-transaction assessment for retail conflicted transactions. | | Conflicted-transaction enhancement | None as such; PFOF arrangements addressed under Supplementary Material .07 and disclosed under Rule 606. | Explicit enhanced assessment and documentation for retail conflicted transactions. | | Introducing-broker reliance | Implicit — introducing broker that routes 100% of flow to clearing broker satisfies general standard through clearing broker's review. | Explicit conditional safe harbor at § 242.1101(b). | | Retention | SEA Rule 17a-4 generally applies. | SEA Rule 17a-4(e) — six years, first two accessible. |

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Compliance notes for Kestrel Securities

Kestrel tracks the proposed rule but has not yet implemented changes in anticipation of adoption. Internal planning assumptions:

- If adopted substantially as proposed, the largest operational impact is likely to be the per-transaction documentation requirement for retail conflicted transactions. Kestrel's two wholesale PFOF relationships and its principal market-making in a small set of OTC equities collectively implicate the conflicted-transaction definition. - Kestrel's current regular-and-rigorous review process under Rule 5310 is quarterly; proposed § 242.1101(c) would also require quarterly review specifically for retail conflicted transactions, which is operationally compatible. - The introducing-broker conditional reliance at § 242.1101(b) is not applicable to Kestrel because Kestrel self-clears. - No policy drafting should occur against the proposed text until an adopting release is published. Staff should continue to monitor the Commission's rulemaking agenda.