Proposed Rule2022-27614
Disclosure of Order Execution Information
Primary source
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Published
January 20, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission" or "SEC") is proposing to amend existing requirements under the Securities Exchange Act of 1934 ("Exchange Act") to update the disclosure required for order executions in national market system ("NMS") stocks. First, the Commission is proposing to expand the scope of reporting entities subject to the rule that requires market centers to make available to the public monthly execution quality reports to encompass broker-dealers with a larger number of customers. Next, the Commission is proposing to modify the definition of "covered order" to include certain orders submitted outside of regular trading hours and certain orders submitted with stop prices. In addition, the Commission is proposing modifications to the information required to be reported under the rule, including changing how orders are categorized by order size as well as how they are categorized by order type. As part of the changes to these categories, the Commission is proposing to capture execution quality information for fractional share orders, odd- lot orders, and larger-sized orders. Additionally, the Commission is proposing to modify reporting requirements for non-marketable limit orders ("NMLOs") in order to capture more relevant execution quality information for these orders by requiring statistics to be reported from the time such orders become executable. The Commission is also proposing to eliminate time-to-execution categories in favor of average time to execution, median time to execution, and 99th percentile time to execution, each as measured in increments of a millisecond or finer and calculated on a share-weighted basis. In order to better reflect the speed of the marketplace, the Commission is proposing that the time of order receipt and time of order execution be measured in increments of a millisecond or finer, and that realized spread be calculated at both 15 seconds and one minute. Finally, the Commission is proposing to enhance the accessibility of the required reports by requiring all reporting entities to make a summary report available.
Full Text
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[Federal Register Volume 88, Number 13 (Friday, January 20, 2023)]
[Proposed Rules]
[Pages 3786-3905]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-27614]
[[Page 3785]]
Vol. 88
Friday,
No. 13
January 20, 2023
Part II
Securities and Exchange Commission
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17 CFR Part 242
Disclosure of Order Execution Information; Proposed Rule
Federal Register / Vol. 88, No. 13 / Friday, January 20, 2023 /
Proposed Rules
[[Page 3786]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-96493; File No. S7-29-22]
RIN 3235-AN22
Disclosure of Order Execution Information
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing to amend existing requirements under the
Securities Exchange Act of 1934 (``Exchange Act'') to update the
disclosure required for order executions in national market system
(``NMS'') stocks. First, the Commission is proposing to expand the
scope of reporting entities subject to the rule that requires market
centers to make available to the public monthly execution quality
reports to encompass broker-dealers with a larger number of customers.
Next, the Commission is proposing to modify the definition of ``covered
order'' to include certain orders submitted outside of regular trading
hours and certain orders submitted with stop prices. In addition, the
Commission is proposing modifications to the information required to be
reported under the rule, including changing how orders are categorized
by order size as well as how they are categorized by order type. As
part of the changes to these categories, the Commission is proposing to
capture execution quality information for fractional share orders, odd-
lot orders, and larger-sized orders. Additionally, the Commission is
proposing to modify reporting requirements for non-marketable limit
orders (``NMLOs'') in order to capture more relevant execution quality
information for these orders by requiring statistics to be reported
from the time such orders become executable. The Commission is also
proposing to eliminate time-to-execution categories in favor of average
time to execution, median time to execution, and 99th percentile time
to execution, each as measured in increments of a millisecond or finer
and calculated on a share-weighted basis. In order to better reflect
the speed of the marketplace, the Commission is proposing that the time
of order receipt and time of order execution be measured in increments
of a millisecond or finer, and that realized spread be calculated at
both 15 seconds and one minute. Finally, the Commission is proposing to
enhance the accessibility of the required reports by requiring all
reporting entities to make a summary report available.
DATES: Comments should be received on or before March 31, 2023.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/submitcomments.htm">http://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#daa8afb6bff7b9b5b7b7bfb4aea99aa9bfb9f4bdb5ac"><span class="__cf_email__" data-cfemail="d3a1a6bfb6feb0bcbebeb6bda7a093a0b6b0fdb4bca5">[email protected]</span></a>. Please include
File Number S7-29-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-29-22. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>). Comments are also available for website viewing and
printing 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. Operating conditions may limit access to the
Commission's Public Reference Room. All comments received will be
posted without change. Persons submitting comments are cautioned that
we do not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Kathleen Gross, Senior Special
Counsel, Lauren Yates, Senior Special Counsel, Christopher Chow,
Special Counsel, or David Michehl, Special Counsel, at (202) 551-5500,
Division of Trading and Markets, Commission, 100 F Street NE,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to 17
CFR 242.600 of Regulation National Market System (``Regulation NMS'')
under the Exchange Act (``Rule 600'') to add new defined terms to and
modify certain existing defined terms in Rule 600 that are used in 17
CFR 242.605 of Regulation NMS under the Exchange Act (``Rule 605'' or
``Rule'') as proposed to be amended; as well as amendments to Rule 605.
Table of Contents
I. Introduction
II. Current Reporting of Execution Quality Statistics
A. Adoption of Rule 11Ac1-5
B. Scope and Content of Rule 605
1. Scope
2. Required Information
3. Procedures for Making Reports Available to the Public
C. Other Relevant Rules
D. Overview of Need for Modernization
E. EMSAC Recommendations, Petition for Rulemaking, and Other
Comments
III. Proposed Modifications to Reporting Entities
A. Larger Broker-Dealers
B. Qualified Auction Mechanisms
C. ATSs and Single-Dealer Platforms
IV. Proposed Modifications to Scope of Orders Covered and Required
Information
A. Covered Order
1. Orders Submitted Pre-Opening/Post-Closing
2. Stop Orders
3. Non-Exempt Short Sale Orders
B. Required Information
1. Categorization by Order Size
2. Categorization by Order Type
3. Timestamp Conventions
4. Changes to Information Required for All Types of Orders
5. Additional Required Information for Market, Marketable Limit,
Marketable IOC, and Beyond-the-Midpoint Limit Orders
6. Additional Required Information for Executable NMLOs,
Executable Stop Orders, and Beyond-the-Midpoint Limit Orders
V. Proposed Summary Execution Quality Reports
VI. Paperwork Reduction Act
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total PRA Burdens
E. Request for Comment
VII. Economic Analysis
A. Introduction
B. Market Failure
C. Baseline
1. Regulatory Baseline
2. Current Rule 605 Disclosure Requirements
3. Markets for Brokerage and Trading Services for NMS Stocks
Under Current Rule 605 Disclosure Requirements
D. Economic Effects
1. Benefits
2. Costs
[[Page 3787]]
3. Economic Effects on Efficiency, Competition, and Capital
Formation
E. Reasonable Alternatives
1. Reasonable Alternative Modifications to Reporting Entities
2. Reasonable Alternative Modifications to Scope of Covered
Orders
3. Reasonable Alternative Modifications to Required Information
4. Reasonable Alternative Modifications to Accessibility
5. Other Reasonable Alternatives
F. Request for Comment
VIII. Consideration of Impact on the Economy
IX. Initial Regulatory Flexibility Analysis
Statutory Authority and Text of Proposed Rule
I. Introduction
The Commission is proposing to update the requirements to disclose
order execution information under Rule 605. Currently, market centers
that execute investor orders are required to make monthly disclosures
of basic information concerning their quality of executions. The
required disclosures have provided significant insight into execution
quality at different market centers; however, both the scope and the
content of Rule 605 reports have not kept pace with technological and
market developments. The proposal would require broker-dealers with a
larger number of customers (``larger broker-dealers'') \1\ to prepare
execution quality reports, would capture execution quality information
for more order types and sizes, and would require time-based metrics to
be recorded at a more granular level that reflects current market
speed. By providing more relevant and accessible metrics, the proposal
would better promote competition among market centers and broker-
dealers on the basis of execution quality and ultimately improve the
efficiency of securities transactions, consistent with the national
market system objectives.\2\
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\1\ Throughout the release, the term ``larger broker-dealer''
refers to a broker-dealer that meets or exceeds the ``customer
account threshold,'' as defined in proposed Rule 605(a)(7). See also
infra section III.A (discussing proposed Rule 605(a)(7)).
\2\ 15 U.S.C. 78k-1.
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The national market system objectives of section 11A of the
Exchange Act include the economically efficient executions of
securities transactions; fair competition among brokers and dealers,
among exchange markets, and between exchange markets and markets other
than exchange markets; the availability of information on securities
quotations and transactions; and the practicability of brokers
executing investor orders in the best market.\3\ These objectives guide
the Commission as it seeks to ensure market structure rules keep pace
with continually changing economic conditions and technological
advancements. However, these objectives, in particular the goal of
promoting opportunities for the most willing seller to meet the most
willing buyer (i.e., order interaction) and the goal of promoting
competition among markets, can be difficult to reconcile.\4\ The Rule,
along with 17 CFR 242.606 (``Rule 606'') of Regulation NMS, was adopted
in 2000 and together these rules required the public disclosure of
execution quality and order routing practices.\5\ In adopting these
rules, the Commission recognized the importance of vigorous competition
among buyers and sellers in an individual security.\6\ However, the
Commission also recognized the importance of competition among market
centers, which entails some fragmentation of order flow.\7\ Such
competition has benefits to investors including the development of
innovative trading services, lower fees, and faster executions.\8\ The
Commission characterized the rules as a ``minimum step necessary to
address fragmentation'' \9\ and stated that by making visible the
execution quality of the securities markets, the rules are intended to
spur more vigorous competition among market participants to provide the
best possible prices for investor orders.\10\
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\3\ See 15 U.S.C. 78k-1(a)(1)(C).
\4\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594, 3597 (Jan. 21, 2010) (``Concept Release on Equity
Market Structure'').
\5\ See Securities Exchange Act Release No. 43590 (Nov. 17,
2000), 65 FR 75414, 75416 (Dec. 1, 2000) (Disclosure of Order
Execution and Routing Practices) (``Adopting Release'').
\6\ See id. at 75415.
\7\ See id. at 75416.
\8\ See id.
\9\ Id.
\10\ See id. at 75414.
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Although the Rule has provided visibility into execution quality at
different market centers, the content of the disclosures required by
the Rule has not been substantively updated since the Rule was adopted
in 2000.\11\ Changed equity market conditions and technological
advancements have eroded the utility of the Rule. The speed and nature
of trading have changed dramatically as a result of technological
improvements and the markets' response to the changing regulatory
landscape.\12\ Trading has moved from being concentrated on a given
security's listing exchange \13\ to being spread across a highly
fragmented market where national securities exchanges, alternative
trading systems (``ATSs''), single-dealer platforms (``SDPs''), off-
exchange market makers, and others compete for order flow. Orders may
be matched, routed, or cancelled in microseconds and market information
is transmitted nearly instantaneously. At the same time, individual
investor \14\ participation in the equity markets has increased.\15\
Further, the average share prices of certain stocks have continued to
increase over time.\16\
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\11\ In 2018, the Commission amended Rule 600, 605, and 606 of
Regulation NMS (``the 2018 Rule 606 Amendments''). The 2018 Rule 606
Amendments modified Rule 605 to require that the public order
execution quality reports be kept publicly available for a period of
three years. See Securities Exchange Act Release No. 84528 (Nov. 2,
2018), 83 FR 58338 (Nov. 19, 2018) (``2018 Rule 606 Amendments
Release'').
\12\ For example, since the adoption of the Rule in 2000, the
Commission has periodically revised certain of its NMS rules,
including the adoption of Regulation NMS in 2005. See, e.g.,
Securities Exchange Act Release Nos. 51808 (June 9, 2005), 70 FR
37496 (June 29, 2005) (``Regulation NMS Adopting Release''); and
90610 (Dec. 9, 2020), 86 FR 18596 (Apr. 9, 2021) (``MDI Adopting
Release'').
\13\ For example, in January 2005, the New York Stock Exchange
Inc. (``NYSE'') executed approximately 79.1% of the consolidated
share volume in its listed stocks, compared to 25.1% in October
2009. See Concept Release on Equity Market Structure, 75 FR 3594
(Jan. 21, 2010) at 3595.
\14\ As used in this release, the term ``individual investor''
will refer to natural persons that trade relatively infrequently for
their own or closely related accounts.
\15\ See, e.g., Caitlin McCabe, ``New Army of Individual
Investors Flexes Its Muscle,'' The Wall Street Journal (Dec. 30,
2020), available at <a href="https://www.wsj.com/articles/new-army-of-individual-investors-flexes-its-muscle-11609329600">https://www.wsj.com/articles/new-army-of-individual-investors-flexes-its-muscle-11609329600</a>.
\16\ See MDI Adopting Release, 86 FR at 18606-07 (citing
Securities Exchange Act Release No. 88216 (Feb. 14, 2020), 85 FR
16726, 16739 (Mar. 24, 2020) (``MDI Proposing Release'') (stating
that ``between 2004 and 2019, the average price of a stock in the
Dow Jones Industrial Average nearly quadrupled'')).
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The Commission continues to believe that facilitating the ability
of the public to compare and evaluate execution quality among different
market centers is an effective means of reconciling the need to promote
both vigorous price competition and fair competition among market
centers. Providing increased visibility into the execution quality of
larger broker-dealers would similarly encourage competition among
market participants. It is the Commission's task continually to monitor
market conditions and competitive forces and to evaluate whether the
structure of the national market system as it evolves is achieving its
Exchange Act objectives.\17\ Section 11A of the Exchange Act \18\
grants the Commission authority to promulgate rules necessary or
appropriate to assure the fairness and usefulness of information on
securities
[[Page 3788]]
transactions \19\ and to assure that broker-dealers transmit and direct
orders for the purchase or sale of qualified securities in a manner
consistent with the establishment and operation of a national market
system.\20\ Through the proposed updates to Rule 605, the Commission
seeks to promote increased transparency of order execution quality,
increase the information available to investors, and help to promote
competition among market centers and broker-dealers, while ameliorating
the potentially adverse effects of fragmentation on efficiency, price
transparency, best execution of investor orders, and order
interaction.\21\
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\17\ See Securities Exchange Act Release No. 42450 (Feb. 23,
2000), 65 FR 10577, 10585 (Feb. 28, 2000) (``Fragmentation
Release'').
\18\ 15 U.S.C. 78k-1.
\19\ 15 U.S.C. 78k-1(c)(1)(B).
\20\ 15 U.S.C. 78k-1(c)(1)(E).
\21\ See Concept Release on Equity Market Structure, 75 FR 3594
(Jan. 20, 2010) at 3597.
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II. Current Reporting of Execution Quality Statistics
A. Adoption of Rule 11Ac1-5
When the Commission adopted Rule 11Ac1-5, which was later re-
designated as Rule 605, in 2000, there was little publicly available
information to enable investors to compare and evaluate execution
quality among different market centers.\22\ The Commission proposed and
adopted Rule 11Ac1-5 together with Rule 11Ac1-6, which was later re-
designated as Rule 606, requiring broker-dealers to disclose the
identity of market centers to which they route orders on behalf of
customers. When adopting these rules, the Commission stated that, taken
together, they should significantly improve the opportunity for
investors to evaluate what happens to their orders after they submit
them to a broker-dealer for execution.\23\ The Commission reasoned that
competitive forces could then be brought to bear on broker-dealers both
with respect to the explicit trading costs associated with brokerage
commissions and the implicit trading costs associated with execution
quality.\24\ Rule 11Ac1-5 was intended to remedy an absence of public
information about how broker-dealers responded to trade-offs between
price and other factors, such as speed or reliability, and establish a
baseline level of disclosure in order to facilitate cross-market
comparisons of execution quality.\25\
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\22\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75416.
For clarity, when this release discusses the adoption of Rule 605,
it is referring to the Adopting Release, supra note 5.
\23\ See id. at 75414.
\24\ See id. at 75419. Although it is difficult to isolate the
effects of the Rule given the evolution of the equity markets over
time, one academic study examining the introduction of Rule 605
found that the routing of marketable order flow by broker-dealers
became more sensitive to changes in execution quality across market
centers after Rule 605 reports became available. See Ekkehart
Boehmer, Robert Jennings & Li Wei, Public Disclosure and Private
Decisions: Equity Market Execution Quality and Order Routing, 20
Rev. Fin. Stud. 315 (2007) (``Boehmer et al.''). Another study
attributed a significant decline in effective and quoted spreads
following the implementation of Rule 605 to an increase in
competition between market centers, who improved the execution
quality that they offered in order to attract more order flow. See
Xin Zhao & Kee H. Chung, Information Disclosure and Market Quality:
The Effect of SEC Rule 605 on Trading Costs, 42 J. Fin. Quantitative
Analysis, 657 (Sept. 2007) (``Zhao & Chung'').
\25\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75418,
75419. Data obtained from Rule 605 reports are used by the third
parties including academics and the financial press to study a
variety of topics related to execution quality, including liquidity
measurement, exchange competition, zero commission trading, and
broker-dealer execution quality. See infra notes 545-547 and
accompanying text.
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B. Scope and Content of Rule 605
1. Scope
Currently, Rule 605 requires market centers to make available, on a
monthly basis, standardized information concerning execution quality
for covered orders in NMS stocks that they received for execution.
Market centers must provide specified measures of execution quality,
including effective spread, average amount of price improvement, number
of shares executed, and speed of execution.\26\
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\26\ See 17 CFR 242.605.
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(a) Market Centers
Regulation NMS defines the term ``market center'' to mean any
exchange market maker,\27\ OTC market maker,\28\ ATS,\29\ national
securities exchange,\30\ or national securities association.\31\ This
definition was intended to cover entities that hold themselves out as
willing to accept and execute orders in NMS securities.\32\ Further, a
market center must report on orders that it ``received for execution
from any person,'' which was intended to assign the disclosure
obligation to an entity that controls whether and when an order will be
executed.\33\
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\27\ ``Exchange market maker'' means any member of a national
securities exchange that is registered as a specialist or market
maker pursuant to the rules of such exchange. See 17 CFR
242.600(b)(32).
\28\ ``OTC market maker'' means any dealer that holds itself out
as being willing to buy from and sell to its customers, or others,
in the United States, an NMS stock for its own account on a regular
or continuous basis otherwise than on a national securities exchange
in amounts of less than a block size. See 17 CFR 242.600(b)(64).
\29\ ``Alternative trading system'' or ``ATS'' means any
organization, association, person, group of persons, or system: (1)
That constitutes, maintains, or provides a market place or
facilities for bringing together purchasers and sellers of
securities or for otherwise performing with respect to securities
the functions commonly performed by a stock exchange within the
meaning of 17 CFR 240.3b-16; and (2) That does not: (i) Set rules
governing the conduct of subscribers other than the conduct of such
subscribers' trading on such organization, association, person,
group of persons, or system; or (ii) Discipline subscribers other
than by exclusion from trading. See 17 CFR 242.300(a). See also 17
CFR 242.600(b)(4) (stating that ``alternative trading system'' has
the meaning provided in 17 CFR 242.300(a)).
\30\ ``National securities exchange'' means any exchange
registered pursuant to section 6 of the Exchange Act. See 17 CFR
242.600(b)(53).
\31\ See 17 CFR 242.600(b)(46). ``National securities
association'' means any association of brokers and dealers
registered pursuant to section 15A of the Exchange Act. See 17 CFR
242.600(b)(52).
\32\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75421.
\33\ See id.
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In many instances, broker-dealers accept orders from customers for
execution and then route these customer orders to various execution
venues, but do not execute customer orders directly. These broker-
dealers generally do not fall within the definition of ``market
center'' and therefore fall outside of the scope of Rule 605's
reporting requirements.\34\
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\34\ See, e.g., 17 CFR 242.605(a) (monthly electronic reports by
market centers). In some instances, broker-dealers accept orders
from customers for execution and execute a small portion of their
order flow internally (e.g., fractional share orders), and therefore
would fall within the definition of ``market center'' in Rule
600(b)(46) with respect to the portion of their order flow for which
they hold themselves out as being willing to buy or sell for their
own account on a regular or continuous basis. However, if, for
example, they only act as a market center for orders smaller than
100 shares, then these market centers would not be required to
prepare Rule 605 reports currently because the portion of their
order flow for which they act as a market center would include only
orders that fall below the smallest order size category (i.e., 100
to 499 shares). See 17 CFR 242.600(b)(defining ``categorized by
order size''); 17 CFR 242.605)(a)(1) (stating that a market center's
monthly report ``shall be categorized by security, order type, and
order size'').
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(b) Covered Orders
The covered order definition is limited by several conditions and
exclusions in order to include those orders that provide a basis for
meaningful and comparable statistical measures of execution quality. A
``covered order'' is defined to include any market order or any limit
order (including immediate-or-cancel orders) received by a market
center during regular trading hours at a time when the national best
bid and national best offer is being disseminated, and, if executed, is
executed during regular trading hours.\35\ This definition serves two
purposes: (1) because the nature and execution quality for regular and
after-hours trading differs, it avoids blending statistics for orders
executed after-hours with those executed during the regular
[[Page 3789]]
trading day; and (2) because many of the statistical measures included
in the rule rely on the availability of the national best bid and offer
(``NBBO'') at the time of order receipt, it excludes orders for which
execution quality metrics could not be calculated.
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\35\ See 17 CFR 242.600(b)(22).
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Covered orders do not include any orders for which the customer
requests special handling, which include, but are not limited to,
market on open and market on close orders, stop orders, all or none
orders, and ``not held'' orders.\36\ The Commission reasoned that
special handling instructions could skew general execution quality
measures.\37\
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\36\ See id. Generally, a ``not held'' order provides the
broker-dealer with price and time discretion in handling the order,
whereas a broker-dealer must attempt to execute a ``held'' order
immediately. See 2018 Rule 606 Amendments Release, 83 FR 58338 (Nov.
19, 2018) at 58340. As a general matter, if a customer submits an
order for an NMS stock to its broker-dealer, whether it be for a
fractional share, whole shares, or whole shares with a fractional
share component, and the customer reasonably expects its broker-
dealer to attempt to execute such order immediately, then the
broker-dealer generally should categorize the order as a held order.
\37\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75421.
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2. Required Information
Rule 605 reports contain a number of execution quality metrics for
covered orders, including statistics for all NMLOs with limit prices
within ten cents of the NBBO at the time of order receipt as well as
separate statistics for market orders and marketable limit orders.
Under the Rule, the information is categorized by (1) individual
security,\38\ (2) one of five order types,\39\ and (3) one of four
order sizes.\40\ These categories provide users flexibility in
determining how to summarize and analyze the information.\41\
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\38\ See 17 CFR 242.605(a)(1).
\39\ See id. ``Categorized by order type'' refers to
categorization by whether an order is a market order, a marketable
limit order, an inside-the-quote limit order, an at-the-quote limit
order, or a near-the-quote limit order. See 17 CFR 242.600(b)(14).
\40\ See 17 CFR 242.605(a)(1). The current size categories are:
100 to 499 shares; 500 to 1999 shares; 2000 to 4999 shares, and 5000
or greater shares. See 17 CFR 242.600(b)(11). On June 22, 2001, the
Commission granted exemptive relief to any order with a size of
10,000 shares or greater, reasoning that the exclusion of very large
orders would help assure greater comparability of statistics in the
largest size category of 5,000 or greater shares. See Letter from
Annette L. Nazareth, Director, Division of Market Regulation to
Darla C. Stuckey, Assistant Secretary, NYSE, dated June 22, 2001
(``Large Order Exemptive Letter'').
\41\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75417.
For instance, a user could analyze execution quality for a group of
securities and by size and order type.
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Within each of the three categories, the reports are required to
include statistics about the total number of orders submitted as well
as the total number of shares submitted, shares cancelled prior to
execution, shares executed at the receiving market center, shares
executed at another venue, shares executed within different time-to-
execution buckets, and average realized spread.\42\ For market and
marketable limit orders, the reports also must include average
effective spread; number of shares executed better than the quote, at
the quote, or outside the quote; average time to execution when
executed better than the quote, at the quote, or outside the quote; as
well as average dollar amount per share that orders were executed
better than the quote or outside the quote.\43\ In addition, time of
order execution and time of order receipt are required to be measured
to the nearest second.\44\
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\42\ See 17 CFR 242.605(a)(1)(i).
\43\ See 17 CFR 242.605(a)(1)(ii).
\44\ See 17 CFR 242.600(b)(91), (92).
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The categorization by order type does not currently include away-
from-the-quote NMLOs, i.e., those orders with a limit price more than
ten cents away from the NBBO. In proposing to exclude these orders in
2000, the Commission indicated that the execution quality statistics
for these types of orders may be less meaningful because execution of
these types of orders may be more dependent on the extent to which the
orders' limit prices were outside the consolidated best bid and offer
(``BBO'') and price movement in the market than on their handling by
the market center.\45\
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\45\ See Securities Exchange Act Release No. 43084 (July 28,
2000), 65 FR 48406, 48414 (Aug. 8, 2000) (File No. S7-16-00)
(Disclosure of Order Execution and Routing Practices) (``Proposing
Release'') (stating that the Commission preliminarily believed that
the rule's statistical measures (e.g., fill rates and speed of
execution) for this type of order may be less meaningful because
they would be more dependent on the extent to which the orders'
limit prices were outside the consolidated BBO (and movements in
market prices) than on their handling by a market center).
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3. Procedures for Making Reports Available to the Public
The Rule 605 NMS Plan establishes procedures for market centers to
make data available to the public in a uniform, readily accessible, and
usable electronic form.\46\ The Plan also requires market centers to
post their monthly reports on an internet website that is free of
charge and readily accessible to the public.\47\ Generally, reports are
posted on market centers' own websites; however, they may be posted on
a third-party vendor site if a market center uses a vendor to prepare
its reports.\48\ In addition, formatting for Rule 605 data is governed
by the Plan. Among other things, the Plan sets forth the file type and
structure of the reports and the order and format of fields, yielding
reports that are structured and machine-readable.\49\
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\46\ See 17 CFR 242.605(a)(2) and Securities and Exchange
Commission File No. 4-518 (National Market System Plan Establishing
Procedures Under Rule 605 of Regulation NMS) (``Rule 605 NMS Plan''
or ``Plan''). See also Securities Exchange Act Release No. 44177
(Apr. 12, 2001), 66 FR 19814 (Apr. 17, 2001) (order approving the
Plan).
\47\ Currently, the parties to the Plan are the 16 registered
national securities exchanges trading NMS stocks and 1 national
securities association (the ``Participants''). Although not all
market centers are Participants, the Participants are required to
enforce compliance with the terms of the Plan by their members and
person associated with their members. See 17 CFR 242.608(c). Market
centers that are not Participants must make arrangements with a
Participant to act as their ``Designated Participant.'' See Plan at
IV. Each market center must notify its Designated Participant of the
website where its reports may be downloaded, and each Designated
Participant must maintain a comprehensive list of links for all
market centers for which it functions as a Designated Participant.
See Plan at IV, VIII(c).
\48\ See Plan at n.3.
\49\ See id. at 2 (``Section V . . . provides that market center
files must be in standard, pipe-delimited ASCII format'').
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C. Other Relevant Rules
Rule 606 reports address order handling information and Rule 606's
reporting requirements differ for held orders versus not held orders.
With respect to held orders, Rule 606(a)(1) requires broker-dealers to
produce quarterly public reports regarding their routing of non-
directed orders \50\ in NMS stocks that are submitted on a held basis.
These reports must identify certain regularly-used venues to which the
broker-dealer routed non-directed orders for execution and provide data
on the percentage of orders routed to each venue.\51\ These reports
also must provide information, for each venue identified, about the
payment relationship between the broker-dealer and the venue, including
any payments made by a venue to a broker-dealer for the right to trade
with its customer order flow (i.e., payment for order flow or ``PFOF'')
or rebates,\52\ and a description of the material aspects of the
broker-dealer's relationship with the venue and the terms of
arrangements that may influence a broker-dealer's order routing
[[Page 3790]]
decision.\53\ In addition, Rule 606(b)(1) requires broker-dealers to
provide to their customers, upon request, reports that include high-
level customer-specific order routing information, such as the identity
of the venues to which the customer orders were routed for execution in
the prior six months and the time of the transactions, if any, that
resulted from such orders.\54\ For orders submitted on a held basis,
the reports required by Rule 606 do not contain any execution quality
information. However, a customer of a reporting broker-dealer may
access the execution quality reports produced pursuant to Rule 605 by
each venue identified as a routing destination in the broker-dealer's
Rule 606 reports, to the extent that venue is a market center.\55\
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\50\ A ``non-directed order'' means any order from a customer
other than a directed order. See 17 CFR 242.600(b)(56). A ``directed
order'' means an order from a customer that the customer
specifically instructed the broker or dealer to route to a
particular venue for execution. See 17 CFR 242.600(b)(27).
\51\ See 17 CFR 242.606(a)(1)(ii) (stating that each section in
the required report shall include the identity of the ten venues to
which the largest number of total non-directed orders for the
section were routed for execution and of any venue to which five
percent or more of non-directed orders were routed).
\52\ See 17 CFR 242.606(a)(1)(iii).
\53\ See 17 CFR 242.606(a)(1)(iv).
\54\ See 17 CFR 242.606(b)(1).
\55\ See supra note 23 and accompanying text.
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In contrast, Rule 606 requires broker-dealers to produce reports
that provide detail regarding execution quality in connection with not
held orders, which are typically used by institutional investors.\56\
Specifically, Rule 606(b)(3) requires broker-dealers to produce reports
pertaining to order routing upon the request of a customer that places,
directly or indirectly, one or more orders in NMS stocks that are
submitted on a not held basis.\57\ These customer-specific reports
generally must include detailed information, by venue, including
metrics pertaining to the broker-dealer's routing of the customer's
orders and the execution of such orders.\58\ In particular, the venue-
by-venue order execution information must include aggregated metrics
such as fill rate, percentage of shares executed at the midpoint, and
percentages of total shares executed that were priced on the side of
the spread more favorable to the order and on the side of the spread
less favorable to the order.\59\
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\56\ See 2018 Rule 606 Amendments Release, 83 FR 58338 (Nov. 19,
2018) at 58345 (stating that by using the not held order
distinction, Rule 606(b)(3) as adopted will likely result in more
Rule 606(b)(3) disclosures for order flow that is typically
characteristic of institutional customers--not retail customers--and
will likely cover all or nearly all of the institutional order
flow). In contrast, held orders are typically used by individual
investors. See, e.g., id. at 58372 (stating that retail investors'
orders are typically submitted on a held basis and are typically
smaller in size).
\57\ See 17 CFR 240.606(b)(3).
\58\ See 17 CFR 240.606(b)(3).
\59\ See 17 CFR 240.606(b)(3)(ii).
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Current Rule 606 reflects significant changes that were made in the
2018 Rule 606 Amendments.\60\ When adopting the 2018 Rule 606
Amendments, the Commission identified intensified competition for
customer orders, the rise in the number of trading centers, and the
introduction of new fee models for execution services as the main
concerns with held orders for NMS stocks that it sought to address with
the proposal.\61\ The Commission stated that the more prevalent use of
financial inducements to attract order flow from broker-dealers that
handle retail investor orders created new, and in many cases
significant, potential conflicts of interests for these broker-
dealers.\62\ Further, the Commission stated that enhanced public
disclosures for held orders should focus on providing more detailed
information regarding these financial inducements, as opposed to the
different information geared towards not held orders from customers
that is set forth in Rule 606(b)(3).\63\ Therefore, the Commission
adopted enhanced public disclosures pursuant to Rule 606(a)(1) that
focused on increased transparency for the financial inducements that
broker-dealers face when determining where to route held order
flow.\64\ The Commission stated that this enhancement would allow
customers to better assess the nature and quality of broker-dealers'
order handling services, including the potential for broker-dealer
conflicts of interest, and would also benefit customers to the extent
that broker-dealers were spurred to compete further by providing
enhanced order routing services and better execution quality.\65\
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\60\ See generally 2018 Rule 606 Amendments Release.
\61\ See 2018 Rule 606 Amendments Release, 83 FR 58338 (Nov. 19,
2018) at 58372.
\62\ See id.
\63\ See id. The Commission also considered but did not adopt an
aspect of the proposal that would have required broker-dealers to
make publicly available a report that would have aggregated Rule
606(b)(3) order handling information pertaining to not held orders.
See id. at 58369-70. The Commission stated that its decision stemmed
from fundamental differences between held order flow and not held
order flow, because held orders are typically non-directed orders
with no specific order-handling instructions for the broker-dealer.
See id. at 58371 (stating that held order flow is handled similarly
by broker-dealers--held orders are generally small orders that are
internalized or sent to OTC market makers if marketable or fully
executed on a single trading center if not marketable). The
Commission further stated that, by contrast, not held order flow is
diverse and customers may provide specific order handling
instructions to their broker-dealers, limit the order handling
discretion of their broker-dealers, or have specific needs that
impact the broker-dealers' handling of these orders. See id.
Therefore, the Commission concluded that the disparate behavior of
customers when using not held orders limited the potential ability
for customers and broker-dealers to use aggregated Rule 606(b)(3)
order handling information to better understand broker-dealers'
routing behavior or compare broker-dealers' order routing
performance. See id.
\64\ See 2018 Rule 606 Amendments Release, 83 FR 58338 (Nov. 19,
2018) at 58373.
\65\ See id. In comparison, with respect to the addition of
customer-specific order-handling disclosures in Rule 606(b)(3), the
Commission stated that these disclosures are particularly suited to
customers that submit not held NMS stock orders because the
disclosures set forth detailed order handling information that is
useful in evaluating how broker-dealers exercise the discretion
attendant to not held orders and, in the process, carry out their
best execution obligations and manage the potential for information
leakage and conflicts of interest. See id. at 58344. As part of the
2018 Rule 606 Amendments, the Commission added Rule 606(b)(3) to
require broker-dealers to make detailed, customer-specific order
handling disclosures available to institutional customers, in
particular, who previously were not entitled to disclosures under
the rule for their order flow, or were entitled to disclosures that
had become inadequate in a highly automated and more complex market.
See id.
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At the time of the 2018 Rule 606 Amendments, the Commission
considered suggestions from the Equity Market Structure Advisory
Committee (``EMSAC'') and other commenters that the Commission include
more or different execution quality statistics in the required
disclosures.\66\ But the Commission stated that the limited
modifications to Rule 606(a) that it was adopting were reasonably
designed to further the goal of enhancing transparency regarding
broker-dealers' order routing practices and customers' ability to
assess the quality of those practices, and that the suggested execution
quality statistics were not necessary to achieve that goal.\67\
However, the Commission noted that its determination not to adopt the
additional specific disclosures was not an indication that the
Commission had formed a decision on the validity or usefulness of the
suggested execution quality statistics.\68\
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\66\ See id. at 58379. See also EMSAC III at 2-3 (suggesting
that the Commission modify the enhancements to Rule 606 to include,
among other things, execution quality statistics by routing
destination).
\67\ See 2018 Rule 606 Amendments Release, 83 FR 58338 (Nov. 19,
2018) at 58379.
\68\ See id.
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Separately, each broker-dealer has a legal duty to seek to obtain
best execution of customer orders.\69\ The
[[Page 3791]]
duty of best execution requires broker-dealers to execute customers'
trades at the most favorable terms reasonably available under the
circumstances.\70\ When adopting Rule 605 and Rule 606, the Commission
stated that these rules do not address and therefore do not change the
existing legal standards that govern a broker-dealer's duty of best
execution.\71\ The Commission recognized that the information contained
in the Rule 605 reports (and Rule 606 reports) will not, by itself, be
sufficient to support conclusions regarding a broker-dealer's
compliance with its legal responsibility to obtain the best execution
of customer orders.\72\ As the Commission stated, any such conclusions
would require a more in-depth analysis of the broker-dealer's order
routing practices than will be available from the disclosures required
by the rules.\73\
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\69\ See, e.g., Regulation NMS Adopting Release, 70 FR at 37537;
Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d
266, 269-70, 274 (3d Cir.), cert. denied, 525 U.S. 811 (1998);
Certain Market Making Activities on Nasdaq, Securities Exchange Act
Release No. 40900, 53 SEC 1150, 1162 (1999) (settled case) (citing
Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971); Arleen Hughes, 27 SEC
629, 636 (1948), aff'd sub nom. Hughes v. SEC, 174 F.2d 969 (D.C.
Cir. 1949)). In addition, the Commission is separately proposing a
rule concerning broker-dealers' duty of best execution. See
Securities Exchange Act Release No. 96496 (Dec. 14, 2022) (File No.
S7-32-22) (Regulation Best Execution). The Commission encourages
commenters to review that proposal to determine whether it might
affect their comments on this proposing release.
\70\ See Regulation NMS Adopting Release, 70 FR 37496 (Jun. 29,
2005) at 37538 (referring to the best reasonably available price and
citing Newton, 135 F.3d at 266, 269-70, 274). Newton also specified
certain other factors relevant to best execution--order size,
trading characteristics of the security, speed of execution,
clearing costs, and the cost and difficulty of executing an order in
a particular market. See Newton, 135 F.3d at 270 n.2.
\71\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75420.
\72\ See id.
\73\ See id. For example, the execution quality statistics
included in Rule 605 do not encompass every factor that may be
relevant in determining whether a broker-dealer has obtained best
execution, and the statistics in a market center's reports typically
will reflect orders received from a number of different routing
broker-dealers. See id. See also infra notes 564-565 and
accompanying text for discussion of an investment adviser's
fiduciary duty, including the duty to seek best execution of a
client's transactions where the investment adviser has the
responsibility to select broker-dealers to execute client trades.
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D. Overview of Need for Modernization
The U.S. equity markets have evolved significantly since the
Commission adopted the Rule in 2000. For instance, the equities markets
have become increasingly fragmented, as both the market shares of
individual national securities exchanges became less concentrated and
an increased percentage of order flow moved off-exchange. In 2000,
there were 9 registered national securities exchanges and one
registered national securities association.\74\ A large proportion of
the order flow in listed equity securities was routed to a few, mostly
manual, trading centers,\75\ and the primary listing exchanges retained
a high percentage of the order flow for exchange-listed equities.\76\
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\74\ See Securities and Exchange Commission, Annual Report for
fiscal year 2000, at 38 available at <a href="https://www.sec.gov/pdf/annrep00/ar00full.pdf">https://www.sec.gov/pdf/annrep00/ar00full.pdf</a>.
\75\ See Securities Exchange Act Release No. 78309 (July 13,
2016), 81 FR 49432, 49436 (July 27, 2016) (``Rule 606 Proposing
Release''); Fragmentation Release, 65 FR 10577 (Feb. 28, 2000) at
10579-80.
\76\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75415
(stating that in September 2000, for example, NYSE accounted for
83.3% of the share volume in NYSE equities and that the American
Stock Exchange, LLC (``Amex'') accounted for 69.9% of share volume
in Amex equities). See also Concept Release on Equity Market
Structure, 75 FR 3594 (Jan. 21, 2010) at 3595 (stating that in
January 2005, NYSE executed approximately 79.1% of the consolidated
share volume in its listed stocks, as compared to 25.1% in October
2009). In addition, NYSE-listed stocks were traded primarily on the
floor of the NYSE in a manual fashion until October 2006, at which
time NYSE began to offer fully automated access to its displayed
quotations. See Concept Release on Equity Market Structure, 75 FR
3594 (Jan. 21, 2010) at 3594-95. However, stocks traded on the
NASDAQ Stock Market LLC (``NASDAQ''), which in 2000 was owned and
operated by a national securities association, were already trading
in a highly automated fashion at many different trading centers. See
id. at 3595; Fragmentation Release, 65 FR 10577 (Feb. 28, 2000) at
10580.
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In contrast, trading in the U.S. equity markets today is highly
automated and spread among different types of trading centers, allowing
even more choices about where orders may be routed. The types of
trading centers that currently trade NMS stocks are: (1) national
securities exchanges operating SRO trading facilities; \77\ (2) ATSs
that trade NMS stocks (``NMS Stock ATSs''); \78\ (3) exchange market
makers; (4) wholesalers; \79\ and (5) any other broker-dealer that
executes orders internally by trading as principal or crossing orders
as agent.\80\ In the first quarter of 2022, NMS stocks were traded on
16 national securities exchanges, and off-exchange at 32 NMS Stock ATSs
and at over 230 other FINRA members.\81\ National securities exchanges
executed approximately 60% of NMS share volume.\82\ The majority of
off-exchange volume was executed by wholesalers, who executed almost
one quarter of total volume (23.9%) and about 60% of off-exchange
volume.\83\ Some OTC market makers, such as wholesalers, operate SDPs
through which they execute institutional orders in NMS stocks against
their own inventory.\84\
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\77\ See 17 CFR 242.600(b)(89) (defining ``SRO trading
facility'' as, among other things, a facility operated by a national
securities exchange that executes orders in a security).
\78\ An ``NMS Stock ATS'' as used in this release is an ATS that
has filed an effective Form ATS-N with the Commission.
\79\ The term ``wholesaler'' is not defined in Regulation NMS,
but is commonly used to refer to an OTC market maker that seeks to
attract orders from broker-dealers that service the accounts of a
large number of individual investors.
\80\ See 15 U.S.C. 78c(a)(4)(A) (defining ``broker'' generally
as any person engaged in the business of effecting transactions in
securities for the account of others); 15 U.S.C. 78c(a)(5)(A)
(defining ``dealer'' generally as any person engaged in the business
of buying and selling securities for such person's own account
through a broker or otherwise). The term ``broker-dealer'' is used
in this release to encompass all brokers, all dealers, and firms
that are both brokers and dealers. See also 17 CFR 242.600(b)(95)
(defining ``trading center'').
\81\ See infra note 766 and accompanying text; Table 7.
\82\ See infra note 767 and accompanying text; Table 7.
\83\ See infra Table 7.
\84\ See infra note 768 and accompanying text.
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Broker-dealers that primarily service the accounts of individual
investors (referred to in this release as ``retail brokers'') often
route the marketable orders of individual investors in NMS stocks to
wholesalers.\85\ The primary business model of wholesalers is to trade
internally as principal with individual investor orders. They do not
publicly display or otherwise reveal the prices at which they are
willing to trade internally as a means to attract individual investor
orders from broker-dealers. Moreover, it is generally more profitable
for liquidity providers such as wholesalers to execute against orders
with lower adverse selection risk because of the reduced risk that
prices will move against the liquidity provider.\86\ Wholesalers may
provide different execution quality to different broker-dealers,
depending on factors including the level of adverse selection risk of
their order flow.\87\
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\85\ There are six wholesalers that internalize the majority of
individual investors' marketable orders. See infra note 766 and
accompanying text.
\86\ See infra note 608 and accompanying text.
\87\ Analysis of Consolidated Audit Trail (``CAT'') data from
the first five months of 2022 found that wholesalers provide
different execution quality to different retail brokers, and in
particular that broker-dealers with higher adverse selection risk
systematically receive higher effective spreads and lower price
improvement than broker-dealers with lower adverse selection risk.
See infra notes 609-613 and accompanying text; Table 3. For further
discussion of differences in execution quality across broker-
dealers, see infra section VII.C.1.a).
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Some retail brokers may face conflicts of interest when making
order routing decisions, including whether to route to a particular
wholesaler.\88\ For example, broker-dealers could face conflicts of
interest when making routing decisions due to their own affiliation
with market centers (e.g., if the broker-dealer operates its own ATS),
from the presence of liquidity fees and rebates on some market centers,
or from payments that some retail brokers receive from wholesalers to
attract the order flow of
[[Page 3792]]
their individual investor customers (PFOF).\89\
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\88\ See infra section VII.C.3.a)(2). See also 2018 Rule 606
Amendments Release, 83 FR 58338 (Nov. 19, 2018) at 58372 (stating
that financial inducements to attract order flow from broker-dealers
that handle retail investor orders have become more prevalent and
for some broker-dealers such inducements may be a significant source
of revenue); supra note 62 and accompanying text (stating that these
financial inducements have created new, and in many cases
significant, potential conflicts of interest for these broker-
dealers).
\89\ See infra notes 759-762 and accompanying text.
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The Commission is concerned that variations in execution quality
across broker-dealers may be difficult to assess using current Rule 605
and Rule 606 reports. In particular, broker-dealers that route customer
orders externally, rather than executing customer orders internally,
are not required to prepare Rule 605 reports because they do not meet
the definition of market center. Customers of a broker-dealer can use
Rule 606 reports to identify market centers to which the broker-dealer
routes, and then access those market centers' Rule 605 reports to
review the execution quality that the market center provides to all
orders that the market center received for execution. However, to the
extent that the market center may provide different execution quality
to orders based on different order routing arrangements with different
broker-dealers, current Rule 605 and 606 do not require reports that
provide investors with a way to assess these differences.
In addition, developments in trading, including the increased speed
of trading, further necessitate proposing updates to the Rule. Average
stock prices have continued to increase over time,\90\ and odd-lots
\91\ and fractional shares \92\ continue to trade with increasing
frequency. Similarly, odd-lot quotes in higher-priced stocks continue
to offer prices that are frequently better than the round lot NBBO for
these stocks,\93\ and this better-priced odd-lot liquidity is
distributed across multiple price levels.\94\ In addition, odd-lot
rates have increased among lower priced stocks.\95\ Because current
Rule 605 size categories exclude orders smaller than 100 shares, a
significant proportion of market activity is currently excluded.\96\ An
analysis of Rule 605 data shows that Rule 605 coverage has likely
declined in the decades since the initial adoption of Rule 605.\97\
Further, because order size categories are tied to the number of
shares, the categories may group orders of very different notional
values, which may complicate comparisons of aggregate execution
quality. Finally, the speed of the market has increased exponentially
since 2000,\98\ rendering the Rule's current one-second timestamp
conventions less meaningful.
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\90\ See supra note 16.
\91\ See MDI Adopting Release, 85 FR 18612 (Apr. 2, 2020) at
18616 (describing analyses included in the MDI Adopting Release
confirming observations made in the MDI Proposing Release that a
significant proportion of quotation and trading activity occurs in
odd-lots, particularly for frequently traded, high-priced stocks).
Analysis using the NYSE Trade and Quote database (obtained via
Wharton Research Data Services (WRDS) (``TAQ data'' or ``NYSE TAQ
data'') found that odd-lots increased from around 15% of trades in
January 2014 to more than 55% of trades in March 2022. An analysis
of data from the SEC's MIDAS analytics tool available at <a href="https://www.sec.gov/marketstructure/datavis.html#.YoPskqjMKUk">https://www.sec.gov/marketstructure/datavis.html#.YoPskqjMKUk</a> shows that, in
Q1 2022, odd-lots made up 81.2% of on-exchange trades (40% of
volume) for stocks in the highest price decile and 25% of on-
exchange trades (2.72% of volume) for stocks in the lowest price
decile. See dataset ``Summary Metrics by Decile and Quartile''
available at <a href="https://www.sec.gov/marketstructure/downloads.html">https://www.sec.gov/marketstructure/downloads.html</a>.
\92\ Analysis using CAT data for executed orders in March 2022
found that an estimated 46.63 million originating orders with a
fractional share component were eventually executed on- or off-
exchange. This represents approximately 2% of all executed orders
and 14% of executed orders from individual accounts. Generally,
accounts classified as ``individual'' in CAT are attributed to
natural persons. See also infra note 647 and accompanying text.
\93\ See MDI Adopting Release, 86 FR 18596 (Apr. 9, 2021) at
18729. In addition, a recent academic working paper shows that odd-
lots offer better prices than the NBBO 18% of the time for bids and
16% of the time for offers. This percentage increases monotonically
in the stock price, for example, for bid prices, increasing from 5%
for the group of lowest-price stocks in their sample, to 42% for the
group of highest-priced stocks. See Robert P. Bartlett, Justin
McCrary, and Maureen O'Hara, The Market Inside the Market: Odd-Lot
Quotes (Feb. 1, 2022), available at SSRN: <a href="https://ssrn.com/abstract=4027099">https://ssrn.com/abstract=4027099</a> (``Bartlett, et al.''). See also Elliot Banks, BMLL
Technologies, Inside the SIP and the Microstructure of Odd-Lot
Quotes (observing an upward trend in odd-lot trading inside the NBBO
from January 2019 to January 2022).
\94\ See MDI Adopting Release, 86 FR 18596 (Apr. 9, 2021) at
18613 n.202 (describing analysis included in the MDI Adopting
Release that examined quotation data for the week of May 22-29, 2020
for stocks priced from $250.01 to $1000.00 and found that there is
odd-lot interest priced better than the new round lot NBBO 28.49% of
the time, and, in 48.49% of those cases, there are better priced
odd-lots at multiple price levels).
\95\ For example, odd-lot rates for corporate stock price
deciles 1-3 (the lowest priced corporate stocks comprising 30% of
all corporate stocks) have been higher on average in 2021 and June
2022 (34%, 39%) as compared to 2019 and 2020 (26%, 29%). Similarly,
exchange-traded products (``ETPs'') also exhibit higher average odd-
lot rates in price quartiles 1 and 2 (the lowest priced ETPs
comprising 50% of all ETPs) on average in 2021 and June 2022 (26%,
29%) compared to 2019 and 2020 (20%, 23%). See SEC market structure
analytics data, available at <a href="https://www.sec.gov/marketstructure/midas.html">https://www.sec.gov/marketstructure/midas.html</a>.
\96\ See supra notes 91-92. See also infra notes 619-622 and
accompanying text (estimating, based on analysis of Tick Size Pilot
data, coverage of current Rule 605 reporting requirements).
\97\ Analysis comparing one market center's volume (NYSE) to TAQ
data shows that an estimated 50% of shares executed during regular
market hours were included in Rule 605 reports as of February 2021,
and shows that this number has been on a slightly downward trend
since around mid-2012. See infra section VII.C.2.b) and infra Figure
3.
\98\ Analysis of data from the SEC's MIDAS analytics tool shows
that the percent of on-exchange NMLOs that are fully executed within
one millisecond (as a percentage of all fully executed on-exchange
NMLOs) has increased from 2.1% in Q1 2012 to 10.3% in Q1 2022 for
small cap stocks, and from 5.9% in Q1 2012 to 15.7% in Q1 2022 for
large cap stocks. Further, in Q1 2022 more than half (51.6%) of
NMLOs executed in less than one second in large market cap stocks.
See dataset ``Conditional Cancel and Trade Distribution,'' available
at <a href="https://www.sec.gov/marketstructure/downloads.html">https://www.sec.gov/marketstructure/downloads.html</a>. See also
infra note 692 and accompanying text.
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E. EMSAC Recommendations, Petition for Rulemaking, and Other Comments
The EMSAC \99\ as well as commenters responding to the Commission's
Concept Release on Equity Market Structure \100\ and to the 2018 Rule
606 Amendments,\101\ have recommended
[[Page 3793]]
that the Commission amend Rule 605 to modernize the Rule and increase
the usefulness of available execution quality disclosures. In addition,
one broker-dealer petitioned the Commission to make ``modest rule
amendments'' to Rule 605 and further stated that ``[i]mproving these
metrics is essential for a market participant to quantitatively and
qualitatively assess whether any particular broker-dealer obtained the
most favorable terms under the circumstances for customer orders.''
\102\
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\99\ See Transcript from EMSAC Meeting (Aug. 2, 2016), available
at <a href="https://www.sec.gov/spotlight/emsac/emsac-080216-transcript.txt">https://www.sec.gov/spotlight/emsac/emsac-080216-transcript.txt</a>
(``EMSAC I''); Transcript from EMSAC Meeting (Nov. 29, 2016),
available at <a href="https://www.sec.gov/spotlight/equity-market-structure/emsac-transcript-112916.txt">https://www.sec.gov/spotlight/equity-market-structure/emsac-transcript-112916.txt</a> (``EMSAC II''); EMSAC Recommendations
Regarding Modifying Rule 605 and Rule 606 (``EMSAC III''), Nov. 29,
2016, available at <a href="https://www.sec.gov/spotlight/emsac/emsac-recommendations-rules-605-606.pdf">https://www.sec.gov/spotlight/emsac/emsac-recommendations-rules-605-606.pdf</a>.
\100\ See, e.g., Letter from Christopher Nagy, CEO, and Dave
Lauer, President, KOR Group LLC (Apr. 4, 2014) (``KOR Group I'');
Letter from Citigroup Global Markets Inc. and its affiliates re
Concept Release on Equity Market Structure (Release No. 34-61358;
File No. S7-02-10) (Aug. 7, 2014) (``Citigroup Letter''); Letter
from Consumer Federation of America re File Number S7-02-10,
Comments on Concept Release on Equity Market Structure (Sept. 9,
2014) (``Consumer Federation I''); Letter from BlackRock, Inc. re
Equity Market Structure Recommendations; Concept Release on Equity
Market Structure, File No. S7-02-10; Regulation Systems Compliance
and Integrity, File No. S7-01-13; and Equity Market Structure Review
(Sept. 12, 2014) (``BlackRock Letter''); Letter from Financial
Information Forum re Rule 605/606 Enhancements from a Retail
Perspective (Oct. 22, 2014) (``FIF I''); Letter from Securities
Industry and Financial Markets Association re Recommendations for
Equity Market Structure Reforms (Oct. 24, 2014) (``SIFMA Letter'');
Healthy Markets Proposal re SEC Rule 605/606 Reform (referenced in
Aug. 2, 2016 statement of Christopher Nagy before the EMSAC)
(``Healthy Markets II'') at 2; Letter from Healthy Markets re Notice
of Meeting of Equity Market Structure Advisory Committee Meeting
(File No. 265-29); List of Rules to be Reviewed Pursuant to the
Regulatory Flexibility Act (File No. S7-21-16); Concept Release on
Equity Market Structure (File No. S7-02-10) (Apr. 3, 2017)
(``Healthy Markets III''); Letter from Healthy Markets re Potential
Reforms Regarding the Provision of Market Data, Concept Release on
Equity Market Structure (Rel. No. 34-61358; File No. S7-02-10), and
Market Data and Market Access Roundtable (Rel. No. 4-729) (Jan. 3,
2020) (``Healthy Markets IV''). Comments on the Commission's 2010
Concept Release on Equity Market Structure are available at <a href="https://www.sec.gov/comments/s7-02-10/s70210.shtml">https://www.sec.gov/comments/s7-02-10/s70210.shtml</a>. As with various other
comments referenced herein, including, without limitation, comments
received in connection with the Concept Release, the comments were
not provided with reference to the proposals discussed in this
release.
\101\ See, e.g., Letter from James J. Angel, Ph.D., CFA,
Georgetown University re Disclosure of Order Handling Information,
File S7-14-16 (Aug. 26, 2016) (``Angel Letter''); Letter from
Consumer Federation of America re File Number S7-14-16, Disclosure
of Order Handling Information (Sept. 26, 2016) (``Consumer
Federation II''); Letter from Fidelity Investments re Disclosure of
Order Handling Information; File No. S7-14-16 (Sept. 26, 2016)
(``Fidelity Letter''); Letter from Financial Information Forum re
Release No. 34-78309; File No. S7-14-16; Disclosure of Order
Handling Information (Sept. 26, 2016) (``FIF II''); Letter from
Financial Services Roundtable re Disclosure of Order Handling
Information Proposal [File No. S7-14-16] (Sept. 26, 2016)
(``Financial Services Roundtable Letter''); Letter from Healthy
Markets Association re Disclosure of Order Handling Information (S7-
14-16) (Sept. 26, 2016) (``Healthy Markets I''); Letter from IHS
Markit re Disclosure of Order Handling Information; Proposed Rule,
Release No. 34-78309; File No. S7-14-16 (Sept. 26, 2016) (``IHS
Markit Letter''). Comments receiving in connection with the 2018
Rule 606 Amendments are available at <a href="https://www.sec.gov/comments/s7-14-16/s71416.htm">https://www.sec.gov/comments/s7-14-16/s71416.htm</a>.
\102\ Letter from Virtu Financial re Petition for Rulemaking to
Amend SEC Rule 605 (Sept. 20, 2021) (``Virtu Petition'') at 2,
available at <a href="https://www.sec.gov/rules/petitions/2021/petn4-775.pdf">https://www.sec.gov/rules/petitions/2021/petn4-775.pdf</a>.
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The EMSAC and commenters generally support expanding the Rule's
scope beyond market centers.\103\ In particular, in November 2016, the
EMSAC recommended that the Commission ``[e]xpand the scope of Rule 605
by requiring every broker-dealer to report with an exemption for
broker[-]dealers with de minimis order flow, aligning the scope of Rule
605 reporting with Rule 606.'' \104\ The EMSAC's recommendation
acknowledged that there would be compliance and implementation costs
associated with this expansion, but stated that the use of third-party
vendors may mitigate some of these concerns.\105\ Further, the EMSAC's
recommendation stated that having all broker-dealers provide Rule 605
data would create an opportunity for market participants, academics,
and the press to evaluate these statistics in a consistent manner.\106\
---------------------------------------------------------------------------
\103\ See EMSAC III at 2; IHS Markit Letter at 2; Healthy
Markets II at 2.
\104\ EMSAC III at 2 (adopting recommendations of the Customer
Issues Subcommittee).
\105\ See id.
\106\ See id.
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When the EMSAC met to consider this recommendation, panelists
provided some explanation of the gaps in current execution quality
disclosures. One panelist stated that the current reporting regime
``miss[es] important information about the overall execution quality of
a covered order'' because Rule 605 reports only pertain to order
routing handled by market centers.\107\ This panelist explained that
orders are handled by smart order routers that may not be located
within a market center, and the Rule 605 data does not capture price
slippage or delays that may occur as these orders are received by
multiple non-executing market centers or broker-dealers.\108\ Another
panelist described the difficulties that he encountered when trying to
compare the execution quality of brokers using data available under the
existing rules.\109\ According to the panelist, he ``had to make very
rough inferences about the brokers' executions because of the gaps in
the disclosure requirements.'' \110\ Moreover, this panelist stated
that one fundamental problem with making these inferences was that a
market maker's average execution quality across all of its orders
received from brokers may be better or worse than its execution quality
with respect to a particular broker's order flow.\111\
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\107\ See EMSAC I at 0103:23-0104:7 (Frank Hatheway, NASDAQ).
\108\ See id. at 0104:7-12 (Frank Hatheway, NASDAQ).
\109\ See id. at 0094:6-0100:12 (Bill Alpert, Barron's).
\110\ Id. at 0096:12-15 (Bill Alpert, Barron's). See also id. at
0097:3-8 (Bill Alpert, Barron's) (stating that ``the only effective,
objective way to use the available disclosures was to score each
broker with a weighted sum of their order flow fractions from the
routing reports and then weight those with the effective over quoted
measures of the market makers that they were sending their orders
to''); 0096:25-0097:3 (stating that some brokers voluntarily
disclose execution quality information, but they use different
information and so the information is not comparable).
\111\ See EMSAC I at 0097:14-22 (Bill Alpert, Barron's). See
also id. at 0096:18-22 (Bill Alpert, Barron's) (stating that
``almost every broker'' claimed that the execution quality that it
received at a particular market maker was above average). This
panelist also argued, based on the introduction of voluntary
disclosures regarding price improvement for odd-lot orders by a few
brokers and market makers, that disclosure improves behavior. See
id. at 0098:6-0099:9 (Bill Alpert, Barron's) (stating the price
improvement on odd-lot orders improved within a year after voluntary
disclosures started). See also id. at 0132:6-11 (Brad Katsuyama,
IEX) (stating that improving disclosures leads to improved
performance).
---------------------------------------------------------------------------
One EMSAC committee member acknowledged that retail brokerage firms
did not favor the recommendation to expand Rule 605 reporting to
broker-dealers, and stated that these firms would argue that aggregate
statistics are more important for retail investors, who they claim are
not going to look at the Rule 605 reports.\112\ This committee member
stated that the counter-argument to this position is that if everyone
is preparing Rule 605 reports, it would be possible to do various types
of aggregation using that data.\113\ When the EMSAC met later to
approve the recommendation, one committee member stated that the goal
is to make data publicly available so that ``experts can help people
make better decisions'' and that different groups would turn the data
into usable reports, so it is not necessary to scale back the
disclosures for the consumer.\114\
---------------------------------------------------------------------------
\112\ See id. at 0136:24-0137:7 (Manisha Kimmel, Thomson
Reuters). But see id. at 0102:22-0103:2) (Frank Hatheway, NASDAQ)
(``While individual retail investors generally don't review 605
statistics themselves, . . . the existence of the reports appears to
provide precisely the form of discipline that the Commission
envisioned when it adopted Rule 605 and 606.'').
\113\ See EMSAC I at 0137:7-10 (Manisha Kimmel, Thomson
Reuters). See also Statement of Christopher Nagy, Healthy Markets
Association, at 6 (suggesting that the Commission mandate reporting
of some execution quality statistics for retail orders); Healthy
Markets I at 5-6 (recommending that the Commission modify Rule 606
to include select execution quality statistics from Rule 605 for
each identified routing destination).
\114\ EMSAC II at 0065:1-16 (Brad Katsuyama, IEX). But see id.
at 0064:18-24 (Jamil Nazarali, Citadel) (stating that his firm's
retail broker clients expressed concerns with the recommendation
that Rule 606 include the execution quality of the market makers
that they route to, because there is a lot of important criteria
that goes into routing and the reports could be misleading).
---------------------------------------------------------------------------
When the Commission solicited comment on the 2018 Rule 606
Amendments, several commenters recommended that the Commission expand
the required reporting of execution quality statistics to better cover
retail investors.\115\ One commenter stated that the type of
standardized execution statistics that several firms voluntarily
publish on a quarterly basis measure the quality of trade executions on
retail investor orders in exchange-listed stocks and help investors
evaluate their particular retail brokerage firm.\116\ Another commenter
stated that there is a ``fundamental flaw'' in the logic of Rule 605
and Rule 606 because ``[t]he structure of the rules implicitly assumes
[[Page 3794]]
that execution quality is solely a function of the market center and
that the brokerage firm has no impact on execution quality.'' \117\
According to this commenter, execution quality is a product of both the
broker's skill and the quality of the market center's execution, and
therefore requiring brokers to show where they route orders does not
provide retail investors with useful information about the actual
execution quality that their orders receive.\118\ Another commenter
stated that even though most retail investors may not use the
disclosures directly, disclosures provide indirect benefits by
promoting competition and by facilitating use by third-party analysts
and academic researchers that provide an in-depth review of the
disclosures.\119\
---------------------------------------------------------------------------
\115\ See Angel Letter at 3 (recommending that brokers should be
required to provide execution quality statistics by providing
information on individual trade confirmations and displaying summary
statistics on their websites); Fidelity Letter at 7-8 (recommending
that the Commission require brokers to make publicly available
certain execution quality statistics); Healthy Markets I at 7, 11
(recommending that execution quality metrics should be provided to
retail customers); IHS Markit Letter at 2 (recommending that all
brokers that receive client orders and subsequently route orders on
behalf of the client should provide information on the execution
quality received at each venue). See also Consumer Federation II at
10; Financial Services Roundtable Letter at 4-5.
\116\ See Fidelity Letter at 7-8. For additional discussion
about this voluntary effort to provide aggregated execution quality
statistics, see infra notes 450-451 and accompanying text. See also
Consumer Federation II at 10 (stating that voluntary disclosures by
several market participants show that such disclosures are possible,
and undercut arguments that doing so is too costly or burdensome).
\117\ Angel Letter at 3.
\118\ See id. However, this commenter also stated that the Rule
605 data on execution quality is too raw for most investors to
interpret. See id. at 2. See also Consumer Federation II at 10
(stating that the only way to assess whether customers are being
best served by their broker-dealer's routing decisions is by
requiring execution quality statistics); Financial Services
Roundtable Letter at 4-5 (stating that currently Rule 605 reports
require investors to draw an inference that they will achieve the
same performance as the average order sent to that venue, and
additional data would help an investor compare the execution quality
that various broker-dealers obtain at a particular execution venue).
\119\ See Consumer Federation II at 10. See also IHS Markit
Letter at 29-30 (stating that large retail routing brokers use
private, internal versions of Rule 605 reports to calculate
execution quality metrics for different market centers, leading to
significant improvement in execution quality statistics for covered
orders, and that voluntary reporting of execution quality metrics
has also improved execution quality).
---------------------------------------------------------------------------
One market participant, in a letter recommending that the
Commission require broker-dealers to publish monthly cost of execution
statistics, stated that Rule 605 and Rule 606 statistics published by
market centers and broker-dealers do not provide a means for customers
to judge how their brokers have performed with respect to keeping
commissions low without adversely affecting execution quality.\120\
This commenter further remarked that matching a broker's routing
statistics up with a receiving market center's execution quality
statistics is ``essentially impossible.'' \121\
---------------------------------------------------------------------------
\120\ See Letter from Thomas Peterffy, Chairman, Interactive
Brokers Group (Aug. 1, 2014), at 3 (``Interactive Brokers Letter''),
available at <a href="https://www.interactivebrokers.com/download/execution_stats_comment_letter.pdf">https://www.interactivebrokers.com/download/execution_stats_comment_letter.pdf</a> (``Payment for order flow has
often been justified by its advocates based on the claim that the
receipt of such payments allows brokers to keep commissions low and
does not affect execution quality (or if it does, such costs are
passed back to customers in the form of lower commissions). . . .
[T]he current Rule 605 and 606 statistics published by market
centers and brokers . . . do not provide a basis for regulators to
judge these claims, or for customers to judge their broker's
performance.'').
\121\ Interactive Brokers Letter at 3.
---------------------------------------------------------------------------
Commenters have also suggested various ways to expand or modify the
definition of covered order, including broadening its scope to capture
additional order types.\122\ In particular, the petitioner for
rulemaking recommended including short sales, stop orders, and pre-
market orders in Rule 605 reports.\123\ The petitioner stated that
these order types are ``critical to a complete assessment of execution
quality,'' and stated that many retail brokers include these orders
when measuring the execution quality provided by market centers.\124\ A
commenter to the 2018 Rule 606 Amendments also recommended including
orders submitted prior to the market open in Rule 605 reports and
stated that the marketable or non-marketable characteristics of such
orders cannot be determined under the current framework.\125\
---------------------------------------------------------------------------
\122\ See Letter from Financial Information Forum re Request for
Comment--FIF Rule 605 Modernization Recommendations (Jan. 30, 2019)
(``FIF III''), available at <a href="https://www.sec.gov/comments/s7-02-10/s70210-5002077-182848.pdf">https://www.sec.gov/comments/s7-02-10/s70210-5002077-182848.pdf</a>; EMSAC III; IHS Markit Letter; Healthy
Markets II; FIF Letter I; KOR Group I.
\123\ See Virtu Petition at 5.
\124\ Id.
\125\ See FIF II at 11-12.
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The EMSAC and commenters have also suggested bringing smaller and
larger order sizes within scope.\126\ The petitioner stated that
bucketing orders solely by numbers of shares is skewing
comparisons.\127\ Another commenter, responding to the Commission's
Concept Release on Equity Market Structure, recommended the following
order size buckets: one share to 99 shares; 100 shares up to 9,999
shares, divided into 100 share increments; 10,000 shares to 24,999
shares; greater than 25,000 shares.\128\ One commenter that offered
recommendations to modify Rule 605 suggested including a $500,000
notional cap on all share size buckets.\129\ Another market participant
expressed support for that cap or a different one.\130\ The market
participant suggested that a cap of $200,000, consistent with the
definition of ``block size'' in 17 CFR 242.600(b)(12)(ii), would make
sense, but noted that benchmark has not changed with inflation.\131\
The market participant also stated that the use of notional buckets in
the ``categorized by order size'' definition would account for
fractional share and odd-lot orders.\132\
---------------------------------------------------------------------------
\126\ See EMSAC III at 2; FIF III at 4; Healthy Markets II at 3;
IHS Markit Letter at 9-10, 34.
\127\ See Virtu Petition at 5.
\128\ See Healthy Markets II at 4.
\129\ See FIF III at 4.
\130\ See ``Would 605 Work Better in Dollars?'', Phil
Mackintosh, Chief Economist and Senior Vice President, Nasdaq (Sept.
16, 2021), available at: <a href="https://www.nasdaq.com/articles/would-605-work-better-in-dollars-2021-09-16">https://www.nasdaq.com/articles/would-605-work-better-in-dollars-2021-09-16</a>.
\131\ See id. The market participant stated that ``a lower [than
$500,000] notional cap makes sense too, given the small sizes of
retail orders, especially when we consider the limits of the typical
depth of book to fill covered orders.'' Id.
\132\ See id.
---------------------------------------------------------------------------
Commenters have also raised concerns about the current provisions
in the Rule for timestamps, especially given the speed of today's
marketplace.\133\ Others have also suggested modifications to improve
the accessibility and standardizations of reports, including
centralizing report creation and requiring summary statistics.\134\ In
several contexts in which the Commission has received general feedback
on equity market structure, commenters have suggested that the
Commission require a simplified execution quality report, particularly
for retail investors.\135\ One commenter on the Concept Release on
Equity Market Structure stated that if the Commission's goal was for
execution quality statistics to make the markets more transparent for
retail investors, the commenter did not believe that was occurring, and
the average retail investor might benefit more from a simplified
version of the report.\136\ One EMSAC committee member stated that some
retail firms have argued that aggregate statistics are more important
for the retail investor, and that retail investors are not going to
look at Rule 605 reports.\137\ This EMSAC committee member further
stated that an issue with aggregation is what to include in the
aggregate statistics, and depending on a firm's business model, the
firm may want to
[[Page 3795]]
put in different things.\138\ Separately, the EMSAC, as well as a
commenter to the 2018 Rule 606 Amendments, recommended that the
Commission incorporate Rule 605 and 606 data into the Commission's data
visualization tool.\139\
---------------------------------------------------------------------------
\133\ See KOR Group I at 2, FIF I at 2.
\134\ See EMSAC I at 0099:25-0100:3, 0106:14-25; EMSAC III at 2;
Healthy Markets II at 3; BlackRock Letter at 3; Citi Letter at 8;
Consumer Federation II at 6.
\135\ See, e.g., Citigroup Letter at 8 (suggesting in connection
with the Concept Release on Equity Market Structure that a
simplified execution quality report geared towards retail investors
should contain a simple chart or graph showing how often a
customer's trades are executed at the NBBO or better, how fast the
trade is done, and whether the customer received enhanced
liquidity); SIFMA Letter at 12 (stating in providing recommendations
for equity market structure reforms that regulators should direct
broker-dealers to provide public reports of order routing and
execution quality metrics that are geared towards retail investors,
and these reports should include relevant information in a uniform
format that is easy to understand).
\136\ See Citigroup Letter at 8.
\137\ See EMSAC I at 0137:4-7 (Manisha Kimmel, Thomson Reuters).
See also id. at 0137:7-10 (``The counter argument to that is, if
everybody is doing the 605 [reports], then you could have all sorts
of aggregation based on that . . .'').
\138\ See id. at 0137:11-16 (Manisha Kimmel, Thomson Reuters).
\139\ See EMSAC III at 2; FIF II at 13. See also EMSAC I at
0139:20-0140:11 (Gary Stone) (stating that individual investors need
the Commission to provide the data, because they cannot rely on
vendors that will charge for that service); EMSAC I at 0105:20-
0106:7 (Frank Hatheway, NASDAQ) (stating that before replacing these
existing offerings by data vendors of data visualization tools for
Rule 605 and 606 data, the Commission may want to consider
alternatives for making the data widely available and accessible);
EMSAC I at 0140:12-15 (Bill Alpert, Barron's) (stating that it would
be salutary to have competition between vendors, the Commission, and
the press to develop easier to use tools and better presentations).
---------------------------------------------------------------------------
III. Proposed Modifications to Reporting Entities
A. Larger Broker-Dealers
Rule 605 of Regulation NMS requires market centers, such as
national securities exchanges, OTC market makers, and ATSs, to produce
publicly available, monthly execution quality reports. However, broker-
dealers are not included within the scope of Rule 605's reporting
requirements unless they are market centers. Although Rule 606 requires
broker-dealers to identify the venues, including market centers, to
which they route customer orders for execution, customers of those
broker-dealers do not have access to comprehensive information about
execution quality. For example, to the extent that a market center's
execution quality differs for orders received from one broker-dealer
versus another broker-dealer, that difference would not be apparent
from currently available execution quality statistics.
The Commission is proposing to expand the scope of entities that
must prepare Rule 605 reports to include larger broker-dealers, which
have a customer-facing line of business. As proposed, Rule 605 would
include broker-dealers as reporting entities, in addition to market
centers, but exclude from that expanded requirement broker-dealers that
do not introduce or carry at least 100,000 customer \140\ accounts.
This expansion of the scope of Rule 605 would improve the usefulness of
execution quality statistics, promote fair competition, and enhance
transparency by providing investors with information that they could
use to compare the execution quality provided by customer-facing
broker-dealers. Further, limiting these reporting obligations to
broker-dealers that have a larger number of customers would focus the
associated implementation costs on those broker-dealers for which the
availability of more specific execution quality statistics would
provide a greater benefit.
---------------------------------------------------------------------------
\140\ ``Customer'' means any person that is not a broker or
dealer. See 17 CFR 242.600(b)(23).
---------------------------------------------------------------------------
Rule 605 and Rule 606 operate together to allow investors to
evaluate what happens to their orders after investors submit their
orders to a broker-dealer for execution.\141\ In the current regulatory
environment, customers that submit held orders (in many cases,
individual investors) have a limited ability to assess the execution
quality that their broker-dealers are providing. A customer of a
broker-dealer can use a broker-dealer's Rule 606 reports to identify
certain regularly-used venues to which the broker-dealer routes orders
for execution. However, with respect to held orders, these Rule 606
reports are not required to include any detailed execution quality
information.\142\ Moreover, Rule 605 reports prepared by market centers
commingle orders from all broker-dealers that send covered order flow
to the reporting market center. Yet a market center may provide
different execution quality to customers of different broker-dealers,
and in some cases this difference may be substantial.\143\ Therefore, a
customer of that broker-dealer must make an inference about the
execution quality achieved by that particular broker-dealer at a market
center based on a Rule 605 report that covers all orders received by
the market center, even though that inference may not be accurate.\144\
---------------------------------------------------------------------------
\141\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75414.
\142\ See supra notes 50-55 and accompanying text.
\143\ See supra notes 108-110 and accompanying text (discussing
an EMSAC panelist's observations after trying to infer execution
quality based on available data that one ``fundamental problem''
with making these inferences was that a market maker's execution
quality may vary according to each broker's order flow). See also
supra note 87 and accompanying text.
\144\ See supra notes 107-111, 115-118, and 120-121 and
accompanying text.
---------------------------------------------------------------------------
Due to this gap in the reporting requirements, variations in
execution quality provided by a market center to a particular broker-
dealer submitting the order are not observable by market participants
and other interested parties using publicly available execution quality
reports.\145\ When requiring each market center to report on all orders
that it received for execution, the Commission intended to assign the
disclosure obligation to the entity that would control whether and when
the order would be executed.\146\ The Commission required market
centers to include in their Rule 605 reports those orders that they
routed to another venue for execution, thereby recognizing that market
centers' decisions about whether and how to route orders can affect
execution quality.\147\ Likewise, broker-dealers that route customer
orders make decisions that affect the execution quality that their
customers' orders receive.
---------------------------------------------------------------------------
\145\ The Commission preliminarily believes that many
institutional customers regularly conduct, directly or through a
third-party vendor, transaction cost analysis of their orders to
assess execution quality against various benchmarks, but this
information is not publicly available. The Commission believes that
some institutional investors may currently use aggregated statistics
or summaries of Rule 605 reports prepared by third parties, who make
these reports available for a fee. See infra section VII.C.1.(c)(2).
\146\ See supra note 33 and accompanying text (citing Adopting
Release, 65 FR 75414 (Dec. 1, 2000) at 75421).
\147\ When adopting Rule 605, the Commission stated that from
the perspective of the customer who submitted the order, the fact
that a market center chooses to route the order away ``does not
reduce the customer's interest in a fast execution that reflects the
consolidated BBO'' that is ``as close to the time of order
submission as possible,'' and that, consequently, in evaluating the
quality of order routing and execution, it is important for
customers to know how the market center handles ``all orders that it
receives, not just those it chooses to execute.'' Adopting Release,
65 FR 75414 (Dec. 1, 2000) at 75423.
---------------------------------------------------------------------------
In addition, while the Commission adopted Rule 605 in 2000 as a
``minimum step necessary to address fragmentation,'' \148\ the equities
markets have grown even more fragmented since that time.\149\ Broker-
dealers have many choices about where to route customer orders for
execution. But broker-dealers may face conflicts of interest when
discussing arrangements regarding the outsourcing of customer order
flow, including those that involve PFOF, and making routing
decisions.\150\ With respect to orders submitted on a held basis,
broker-dealers must include information about their payment
relationships with execution venues in quarterly reports prepared
pursuant to Rule 606(a)(1).\151\ Without information
[[Page 3796]]
about the execution quality that broker-dealers in the business of
routing customer orders obtain for those orders, market participants
and other interested parties lack key information that would facilitate
their ability to evaluate how these payment relationships may affect
execution quality. Recognizing these and other concerns, the EMSAC and
other commenters in multiple contexts have suggested that the
Commission expand the scope of Rule 605 to require reporting by broker-
dealers.\152\
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\148\ See supra note 9 and accompanying text.
\149\ See supra notes 74-84 and accompanying text.
\150\ See supra notes 88-89 and accompanying text.
\151\ See supra notes 50-52 and accompanying text. As discussed
above (supra section II.D), Rule 606 requires broker-dealers to
identify and report data according to execution venue, rather than
by market center. Not all execution venues reflected on Rule 606
reports will necessarily fall within Regulation NMS's definition of
``market center.'' See, e.g., 2018 Rule 606 Amendments Release, 83
FR 58338 (Nov. 19, 2018) at 58365 (stating that the Commission's
reference to ``venues'' for purposes of Rule 606(b)(3) is meant to
refer to external liquidity providers to which the broker-dealer may
send actionable indications of interest (``IOIs''), and that this
category of market participants likely would include market centers
as defined in Rule 600(b)(38), but may not be limited to such market
centers).
\152\ See generally supra section II.E.
---------------------------------------------------------------------------
Consequently, the Commission is now proposing to require larger
broker-dealers to prepare and publish execution quality reports
pursuant to Rule 605, through the proposed revisions to Rule 605 and
the addition of proposed Rule 605(a)(7). This expansion of the scope of
reporting entities would increase transparency into the differences in
execution quality achieved by broker-dealers when they route customer
orders to execution venues, and thereby would make the execution
quality statistics more useful to market participants and other
interested parties.\153\ This change would increase competition among
broker-dealers that accept customer orders for execution by providing
information that market participants can use to evaluate and compare
broker-dealers' execution quality. This could lead to faster
executions, better price improvement, and a shift in order flow to
those broker-dealers offering the best execution quality for their
customers. This would further the national market system objectives set
forth in section 11A(a)(1) of the Exchange Act, including the efficient
execution of securities transactions, fair competition among market
participants, the public availability of information on securities
transactions, and the best execution of investor orders.\154\
---------------------------------------------------------------------------
\153\ Among the commenters that raised concerns about the lack
of available information regarding the execution broker-dealers
provide to their customers' orders, one commenter stated that there
is a ``fundamental flaw'' in the logic of Rule 605 and Rule 606
because these rules assume that execution quality is solely the
function of the market center, but instead execution quality is a
product of a combination of the broker's skill and the quality of
the market center's execution. See supra notes 117-118 and
accompanying text. The proposal would address this concern by
requiring larger broker-dealers to produce execution quality
reports, rather than leaving market participants and other
interested parties to rely solely on the execution quality reports
produced by the market centers to which a particular broker-dealer
routes orders.
\154\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75414
n.1, 75417 (citing 15 U.S.C. 78k-1).
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Specifically, the Commission is proposing to amend Rule 605 to
apply the reporting requirements contained therein to brokers and
dealers, in addition to market centers. Where current Rule 605 refers
to ``market centers,'' the Commission is proposing to insert references
to ``brokers'' and ``dealers.'' \155\ The proposed expansion of Rule
605's reporting requirements to cover broker-dealers would also affect
Rule 600 of Regulation NMS. Specifically, the definition of ``covered
order'' in Rule 600(b)(22) refers to ``any market order or any limit
order (including immediate-or-cancel orders) received by a market
center.'' \156\ The Commission is proposing to amend this provision to
refer to orders ``received by a market center, broker, or dealer.''
\157\ Further, as noted above, the Plan establishes procedures for
market centers to follow in making available to the public the monthly
reports required by the Rule.\158\ Because of the proposed amendments
to the Rule, the existing Plan would no longer comply with proposed
Rule 605(a)(3) and thus would need to be updated in order to
incorporate references to broker-dealers subject to the Rule.\159\ As
is currently the case for market centers that are not Participants, the
Participants would be required to enforce compliance with the terms of
the Plan by their members and person associated with their
members.\160\
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\155\ See proposed Rules 605 (introductory paragraph), 605(a)
(caption), 605(a)(1), 605(a)(1)(i)(D), 605(a)(3), 605(a)(4),
605(a)(5), and 605(a)(6).
\156\ 17 CFR 242.600(b)(22). The Commission is proposing to
renumber the definition of ``covered order'' as proposed Rule
600(b)(30).
\157\ See proposed Rule 600(b)(30).
\158\ See supra section II.B.3.
\159\ The Plan details procedures for market centers to follow
and, among other things, specifies the order and format of fields in
a manner that aligns with current Rule 605(a)(1). See Plan generally
and section VI(a) of the Plan. Under current Rule 605(a)(2), every
national securities exchange trading NMS stocks and each national
securities association is required to act jointly in establishing
procedures for market centers to follow in making the reports
required by Rule 605(a)(1) available to the public in a uniform,
readily accessible, and usable electronic form. See 17 CFR
242.605(a)(2). The proposal would add brokers and dealers to the
scope of entities to be covered by the Plan's procedures and
renumber Rule 605(a)(2) as Rule 605(a)(3). See proposed Rule
605(a)(3). The Plan would also need to be updated to accommodate any
new data elements in the order and format of fields.
\160\ See 17 CFR 242.608(c). See also supra note 47 (describing
Participants and Designated Participants under the Plan).
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The Commission is mindful that Rule 605's execution quality reports
contain a large volume of statistical data, and as a result it may be
difficult for individual investors to review and digest the reports.
The Commission considered the volume of execution quality statistics
that would be produced when adopting Rule 605, and stated that the
large volume of statistics reflects a deliberate decision by the
Commission to avoid the dangers of overly general statistics that could
hide significant differences in execution quality.\161\ By requiring
brokers-dealers to report stock-by-stock order execution information in
a uniform manner, the proposal would make it possible for market
participants and other interested parties to make their own
determinations about how to group stocks or orders when comparing
execution quality across broker-dealers.\162\ Further, to the extent
that certain market participants may not have the means to directly
analyze the detailed statistics,\163\ the Commission expects that
independent analysts, consultants, broker-dealers, the financial press,
and market centers will respond to the needs of investors by analyzing
the disclosures and producing more digestible information using the
data, as the Commission anticipated when approving the predecessor to
Rule 605 and has observed since that time.\164\ As discussed further
below, the Commission also is proposing to require all market centers
and broker-dealers that would be subject to Rule 605's reporting
requirements to produce summary reports with aggregated execution
quality information.\165\ Requiring broker-dealers to produce more
detailed execution quality data would help ameliorate potential
concerns about overly general statistics, or about the specific
categorization of orders and selection of metrics in the summary
reports, by allowing market participants and other interested parties
to conduct their own analysis based on
[[Page 3797]]
alternative categorizations of the underlying data.
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\161\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75419.
See also id. (stating that after this basic information is disclosed
by all market centers in a uniform manner, market participants and
other interested parties will be able to determine the most
appropriate classes of stocks and orders to use in comparing
execution quality across market centers).
\162\ See, e.g., supra note 113 and accompanying text.
\163\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75419,
text accompanying n.27 (stating that most individual investors
likely would not obtain and digest the reports themselves). See also
supra note 112 and accompanying text (EMSAC committee member stating
that retail investors will not look at the Rule 605 reports); note
118 (commenter stating that Rule 605 data is too raw for most
investors to interpret); note 119 and accompanying text (commenter
stating that most retail investors may not use the disclosures
directly).
\164\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75419.
See also supra notes 106, 114, 116 and accompanying text; infra
notes 544-546 and accompanying text.
\165\ See infra section V.
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Proposed Rule 605(a)(7) states that a broker or dealer that is not
a market center shall not be subject to the requirements of Rule 605
unless that broker or dealer introduces or carries 100,000 or more
customer accounts through which transactions are effected for the
purchase or sale of NMS stocks (the ``customer account
threshold'').\166\ The Commission is mindful of the additional costs
that broad expansion of the rule to broker-dealers would entail. The
relative benefit of having a broker-dealer prepare Rule 605 reports
increases when the broker-dealer has more customers. The Commission is
proposing a minimum reporting threshold of 100,000 customers to balance
the benefits of having broker-dealers produce execution quality
statistics with the costs of implementation and continued
reporting.\167\
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\166\ In addition, as discussed further below, proposed Rule
605(a)(7) states that any broker or dealer that meets or exceeds
this customer account threshold and is also a market center shall
produce separate reports pertaining to each function.
\167\ See infra section VII.D.2 for a discussion of the costs of
the proposed amendments to Rule 605. As discussed further below,
broker-dealers that were previously not required to publish Rule 605
reports would incur initial costs to develop the policies and
procedures to post Rule 605 reports for the first time, and all
broker-dealers would face ongoing costs to continue to prepare them
each month. Other potential costs include a potential for less
transparency or lower execution quality, and the costs to update
best execution methodology. See also infra section VII.E.1.(a) for a
discussion about the potential costs of imposing Rule 605's
reporting requirements on broker-dealers with a smaller number of
customer accounts.
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Analysis indicates that approximately 85 broker-dealers (or
approximately 6.7% of customer-carrying broker-dealers) introduce or
carry more than 100,000 customer accounts and these broker-dealers
together handle over 98% of customer accounts.\168\ Utilizing a 100,000
customer account threshold would allow the Rule 605 reporting
requirements to capture those broker-dealers that introduce or carry
the vast majority of customer accounts, while subjecting only a
relatively small percentage of broker-dealers that accept customer
orders for execution to the reporting obligation and excluding those
broker-dealers that introduce or carry a smaller number of customer
accounts. Although utilizing a lower customer account threshold, such
as 10,000 customer accounts, would result in capturing substantially
more transactions, the lower customer account threshold would result in
capturing only marginally more customer accounts. This implies that the
additional customer coverage would result from a small number of
accounts that trade in large volumes. Therefore, the additional
coverage may not be as beneficial because many of the additional
customer accounts that would be included with a lower threshold likely
belong to institutional traders that have access to alternative
execution quality information and also are likely to use not held
orders, which are not included in Rule 605 reports.\169\
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\168\ See infra Table 13 for cost-benefit analysis of different
customer account thresholds defining ``larger broker-dealer'' and
infra note 1008 and accompanying text for methodology. For example,
approximately 45 broker-dealers introduce or carry more than 500,000
customer accounts and these broker-dealers together handle over 96%
of customer accounts. Further, approximately 235 broker-dealers
introduce or carry more than 10,000 customer accounts and these
broker-dealers together handle over 99% of customer accounts. See
infra Table 13.
\169\ See infra note 1011 and accompanying text; Table 13. See
also infra section VII.E.1.(a) for further discussion of alternative
customer account thresholds.
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The Commission considered using the volume of broker-dealers'
customer transactions, rather than the number of their customer
accounts, for purposes of establishing a reporting threshold. Although
establishing a reporting threshold using the number of customer
transactions would likely capture a larger number of customer orders
than the proposed customer account threshold, this approach would
likely exclude broker-dealers that have a larger number of relatively
inactive customer accounts and include broker-dealers that have a small
number of customer accounts associated with large amounts of trading
volume. In each respect, the reporting threshold would be less likely
to capture individual investor orders and more likely to capture
institutional investor orders, and therefore the threshold would be
less likely to target the types of orders that may be most useful for
consumers of Rule 605 reports. In addition, utilizing a threshold based
on the number of customer transactions may result in a less stable set
of broker-dealers that are subject to Rule 605's reporting
requirements, because transaction volume is more likely than customer
account numbers to vary significantly from month to month based on
market conditions. Further, the number of their customer accounts is
likely less costly for broker-dealers to calculate and track as
compared to the volume of transactions associated with their customer
accounts.\170\
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\170\ See infra section VII.E.1.(c) for further discussion about
using a threshold based on the number of customer transactions.
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The Commission also considered EMSAC's recommendation to expand the
scope of Rule 605 to cover all broker-dealers, which contemplated
excluding only broker-dealers with de minimis order flow.\171\ The
Commission is preliminarily concerned that subjecting a significantly
larger number of broker-dealers to Rule 605's reporting requirements
would substantially increase the costs of the proposal and that the
increase in cost that would accompany the use of a de minimis threshold
would not be justified by the corresponding benefit.\172\ This concern
about requiring smaller broker-dealers to prepare Rule 605 reports is
present with any de minimis threshold, whether based on order flow as
the EMSAC suggested or on some other measure such as number of customer
accounts.
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\171\ See supra notes 104-106 and accompanying text.
\172\ See infra note 1011 and accompanying text and Table 13
(showing that, for example, adjusting the customer account threshold
from 100,000 customer accounts to 10,000 customer accounts would
increase the estimated costs from approximately $5 million to
approximately $13.9 million).
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The proposed customer account threshold would require brokers-
dealers to include in their calculations the public customer accounts
that they introduce, as well as the customer accounts that they
carry.\173\ Rule 605 reports that reflect orders received from customer
accounts that a broker-dealer introduces or carries would provide
useful information to market participants because both introducing and
carrying broker-dealers make decisions about where to route those
orders and it would be helpful for customers to be able to evaluate the
execution quality received as a result of those decisions.\174\ An
introducing broker-dealer may choose to utilize an omnibus clearing
arrangement and not disclose certain information about its underlying
customer accounts to the clearing firm.\175\ In such circumstances,
[[Page 3798]]
because the clearing broker may not have access to information about
how many customer accounts a particular omnibus account represents, the
proposal specifies that when an omnibus clearing arrangement is used
the underlying customer accounts would be required to be counted as
accounts carried by the introducing broker-dealer rather than by the
clearing broker. Therefore, for purposes of Rule 605, a broker or
dealer that utilizes an omnibus clearing arrangement for any of its
underlying customer accounts would be considered to carry such
underlying customer accounts when calculating the number of customer
accounts that it introduces or carries.\176\
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\173\ See proposed Rule 605(a)(7).
\174\ An introducing broker-dealer is a broker-dealer that has a
contractual arrangement with another firm, known as the carrying or
clearing firm, under which the clearing/carrying firm agrees to
perform certain services for the introducing firm. Usually, the
introducing firm transmits its customer accounts and customer orders
to the clearing/carrying firm, which executes the orders and carries
the account. See Securities Exchange Act Release No. 31511 (Nov. 24,
1992), 57 FR 56973, 56978 (Dec. 2, 1992) (Net Capital Rule).
\175\ Some broker-dealers utilize an ``omnibus clearing
arrangement,'' where the clearing firm maintains one account for all
of customer transactions of the introducing firm, rather than a
``fully disclosed introducing relationship.'' In an omnibus
arrangement, the clearing firm does not know the identity of the
customers of the introducing firm, whereas in a fully-disclosed
arrangement, the clearing/carrying firm knows the names, addresses,
securities positions, and other relevant data as to each customer.
See id. at 56978 n.16.
\176\ See proposed Rule 605(a)(7). For example, an introducing
broker-dealer that utilizes an omnibus clearing arrangement for
100,000 customer accounts and separately carries 50,000 customer
accounts would be considered, for purposes of proposed Rule 605, to
carry 150,000 customer accounts. In contrast, a broker-dealer who
introduces, on a fully-disclosed basis, 125,000 customer accounts
would be considered, for purposes of proposed Rule 605, to introduce
125,000 customer accounts. In both cases, the introducing broker-
dealers would exceed the proposed customer account threshold.
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Requiring both introducing broker-dealers and carrying broker-
dealers to prepare Rule 605 reports might result, in some instances, in
the same underlying order being reflected on multiple broker-dealers'
Rule 605 reports. However, Rule 605 does not require reports that
reflect execution quality on an order-by-order basis and the separate
reports would provide different views of execution quality specific to
the group of orders handled by each broker-dealer. Moreover, the
current structure of Rule 605 already contemplates that certain orders
may be reflected on more than one report, in the case of orders that
are received by one market center and then routed to another market
center for execution.\177\
---------------------------------------------------------------------------
\177\ See 17 CFR 242.605(a)(1).
---------------------------------------------------------------------------
Proposed Rule 605(a)(7) states that any broker or dealer that meets
or exceeds the customer account threshold and is also a market center
shall produce separate reports pertaining to each function. Therefore,
a broker-dealer that meets or exceeds the customer account threshold
and is also a market center would be required to produce one report
that includes all of the covered orders in NMS stocks that it received
for execution when acting as a market center and a separate report that
includes all of the covered orders in NMS stocks that it received for
execution when acting as a broker-dealer. Requiring a firm to produce
separate reports pertaining to its market center function and its
broker-dealer function would allow market participants and other
interested parties to view the firm's execution quality from the
perspective of how it operates in each of these separate roles.
This aspect of the proposal would not change how a firm should
determine when it is acting as a market center, as that term is defined
in Rule 600(b)(46).\178\ In particular, some firms that are larger
broker-dealers also act as OTC market makers, which are a type of
market center. Currently, to the extent that a dealer holds itself out
as being willing to buy from and sell to its customers, or others, in
the United States, an NMS stock for its own account on a regular or
continuous basis otherwise than on a national securities exchange in
amounts of less than a block size, that dealer is defined as an OTC
market maker.\179\ For example, if a broker-dealer executes certain
types of orders internally (e.g., fractional share orders, small-sized
orders, or orders in particular symbols), that broker-dealer may be
acting as an OTC market maker, and thus a market center, for those
specific types of orders. Moreover, Rule 605 requires that any report
pertaining to a market center include all covered orders that it
received for execution from any person, whether executed at the market
center or at any other venue.\180\ As is the case under Rule 605
currently for market centers that route orders away, under the
proposal, the fact that a larger broker-dealer has routed certain
covered orders away for execution would not alone be the basis on which
to determine that it did not act as a market center with respect to
those orders.\181\
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\178\ See 17 CFR 242.600(b)(46). The Commission is proposing to
renumber the definition of ``market center'' as proposed Rule
600(b)(56).
\179\ See supra note 28. See also Securities Exchange Act
Release No. 37619A (Sept. 6, 1996), 61 FR 48290, 48318-19 (Sept. 12,
1996) (Order Execution Obligations) (stating that dealers that
internalize customer order flow in particular stocks by holding
themselves out to customers as willing to buy and sell on an ongoing
basis would fall within the definition of ``OTC market maker'' as
defined in the predecessor to Rule 602 of Regulation NMS, even
though they may not hold themselves out to all other market
participants, and that dealers that hold themselves out to
particular firms as willing to receive customer order flow, and
execute those orders on a regular or continuous basis, also would
fall within the definition of an OTC market maker); id. at 48319
(stating that broker-dealers will not be considered to be holding
themselves out as regularly or continuously willing to buy or sell a
security if they occasionally execute a trade as principal to
accommodate a customer's request, and that, in response to the
suggestion of some commenters, the Commission has modified the
proposed amendment to the definition of ``OTC market maker'' to make
clear that more than an isolated transaction is necessary before a
dealer is designated an OTC market maker).
\180\ See 17 CFR 242.605(a)(1). We note that the staff has
provided their views on a way that a firm might determine the scope
of covered orders for which it acts as a market center, see Division
of Market Regulation: Staff Legal Bulletin No. 12R (Revised),
Question 4 (June 22, 2001), available at <a href="https://www.sec.gov/interps/legal/slbim12a.htm">https://www.sec.gov/interps/legal/slbim12a.htm</a> (``The Rule applies to broker-dealers
insofar as they act as a `market center' with respect to orders
received from other persons. Consequently, for orders in securities
for which Firm X does not act as an OTC market maker, Firm X would
not be acting as a market center in those securities and therefore
need not report on orders in those securities that it receives as an
agent and routes elsewhere for execution. Conversely, the orders
that Firm X receives from any person in the 500 securities in which
it acts as an OTC market maker (and therefore is a market center)
generally must be included in Firm X's monthly reports, even if Firm
X ultimately routes some of the orders to other market centers for
execution.''). Staff reports, Investor Bulletins, and other staff
documents (including those cited herein) represent the views of
Commission staff and are not a rule, regulation, or statement of the
Commission. The Commission has neither approved nor disapproved the
content of these staff documents and, like all staff statements,
they have no legal force or effect, do not alter or amend applicable
law, and create no new or additional obligations for any person.
\181\ See supra notes 143-144 and accompanying text.
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For a larger broker-dealer that is also a market center, the report
pertaining to its broker-dealer function would cover all orders that
the broker-dealer received for execution as part of its customer-facing
line of business, whether executed internally or routed away. An order
would need to be reflected on both the report regarding the firm's
market center function and the report regarding its broker-dealer
function, if the broker-dealer received the order from a customer and
also acts as a market center for that type of order. Each report would
provide a different view of the firm's execution quality based on a
different aspect of its business, and because reports reflect orders
grouped by symbol, order type, and size, would reflect different
execution quality metrics to the extent that the group of orders
covered by the different reports did not overlap completely.\182\
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\182\ For certain firms regarding certain symbols, order types,
or order sizes, the group of orders for which the firm acts as a
larger broker-dealer may overlap completely with the group of orders
for which the firm acts as a market center. However, broker-dealer
firms are structured in myriad different ways, and the degree of
overlap among reports might not remain stable over time; therefore,
requiring firms to produce reports according to the orders for which
they act as a market center and the orders for which they act as a
broker-dealer would help keep the reports consistent with firms'
lines of business.
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As proposed, pursuant to Rule 605(a)(7), a broker-dealer would be
excluded from Rule 605's reporting requirements only with respect to
its customer-facing broker-dealer function (as opposed to its function
as market center, if applicable) as long as the
[[Page 3799]]
number of customer accounts that it introduces or carries continues to
be less than the customer account threshold. A broker-dealer would no
longer be excluded from Rule 605 once and as long as it meets or
exceeds the customer account threshold; however, a broker-dealer that
meets or exceeds the customer account threshold for the first time
would have a grace period before being required to comply with Rule
605's reporting requirements, as described further below.
Proposed Rule 605(a)(7) states that a broker or dealer that meets
or exceeds the customer account threshold shall be required to produce
reports pursuant to this section for at least three calendar months
(``Reporting Period''). The Reporting Period would begin the first
calendar day of the next calendar month after the broker or dealer met
or exceeded the customer account threshold, unless it is the first time
the broker-dealer has met or exceeded the customer account
threshold.\183\ Any time after a broker or dealer has been required to
produce reports pursuant to this proposed section for at least a
Reporting Period, if a broker or dealer falls below the customer
account threshold, the broker or dealer would not be required to
produce a report pursuant to this paragraph for the next calendar
month.\184\ The Reporting Period would start on the first day of the
next calendar month after the customer account threshold has been
crossed because this timing would align with Rule 605's monthly
reporting period and avoid requiring broker-dealers to produce a report
that covers a partial month, which would be less comparable with the
monthly reports of other broker-dealers. Moreover, brokers-dealers that
may at times fall below the customer account threshold would be
required to produce reports pursuant to Rule 605 for at least three
calendar months, because this minimum reporting period would help
ensure a period of continuity in reporting. If instead a broker-dealer
could fluctuate in and out of being required to comply with the
reporting requirements from month-to-month, it would potentially be
disruptive to the broker-dealer to have to coordinate compliance with
the Rule on some months but not others and could interfere with
customers' or market participants' ability to look at a broker-dealer's
execution quality over time by analyzing historical data.\185\
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\183\ See proposed Rule 605(a)(7).
\184\ See id.
\185\ When discussing the 2018 amendments to Rule 605(a)(2) that
required market centers to keep Rule 605(a) reports posted on a
public website for a period of three years, the Commission stated
that it expected customers and the public to use the historical
information to compare information from the same time period. See
2018 Rule 606 Amendments Release, 83 FR 58338 (Nov. 19, 2018) at
58380 (also stating that, with respect to market centers voluntarily
posting Rule 605(a) reports that were created prior to the amended
rule's effectiveness, making historical data available to customers
and the public could be useful to customers or market participants
seeking to analyze such data).
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The Commission is proposing that, the first time a broker or dealer
has met or exceeded the customer account threshold, there would be a
grace period of three calendar months before the Reporting Period
begins and the broker or dealer must comply with the reporting
requirements of Rule 605.\186\ A limited three-month grace period is
appropriate because it would provide a broker-dealer that crosses the
customer account threshold for the first time with a period of time in
which to come into compliance with Rule 605's reporting requirements.
The three-month grace period would afford a broker-dealer adequate time
to develop the systems and processes and organize the resources
necessary to generate the reports pursuant to Rule 605, while still
requiring the broker-dealer to begin reporting without an overly long
delay. At the same time, should a broker-dealer subsequently fall below
the customer reporting threshold, the Commission preliminarily believes
that the broker-dealer should already have the necessary systems and
processes in place and therefore a grace period would not be necessary
if that broker-dealer again meets or exceeds the customer account
threshold and becomes subject to Rule 605's requirements. The
Commission notes that Rule 606 similarly provides for a three-month
grace period for brokers or dealers subject to Rule 606(b)(3)'s
reporting requirements for the first time only.\187\
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\186\ See proposed Rule 605(a)(7). After the three calendar
month grace period, the Reporting Period would begin on the first
calendar day of the fourth calendar month after the broker or dealer
has met or exceeded the customer account threshold. See id. As
described above, a broker-dealer that meets or exceeds the customer
account threshold would be required to produce Rule 605 reports for
at least a Reporting Period. See supra notes 183-184 and
accompanying text. Therefore, a broker-dealer that crosses the
customer account threshold for the first time would be required to
comply with the reporting requirements of Rule 605 for at least a
Reporting Period, even if that broker-dealer falls below the
customer account threshold during the grace period.
\187\ See 17 CFR 242.606(b)(4).
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Rule 605 requires that reporting entities calculate certain
statistics based on the time of order receipt.\188\ Moreover,
Regulation NMS defines ``time of order receipt'' based on the time an
order was received by a market center for execution.\189\ In
conjunction with the proposed expansion of Rule 605 to cover larger
broker-dealers, it is necessary to modify this definition to specify
how broker-dealers that are not acting as market centers would be
required to calculate ``time of order receipt.'' The Commission has
considered requiring broker-dealers to calculate the ``time of order
receipt'' based on the time that the broker-dealer received the order
or on the time that the broker-dealer transmitted the order to a market
center for execution. Measuring ``time of order receipt'' based on when
a broker-dealer received the order would provide a view of how that
broker-dealer handled that order from the time the order was within its
control, rather than limiting that view to what happened after the
broker-dealer sent the order to a particular market center for
execution. In this way, calculating execution quality statistics based
on the time that a broker-dealer received the order could provide
information about whether a broker-dealer's delay in sending the order
to a market center for execution may have affected the execution
quality obtained for that order, because the execution quality
statistics would be measured based on the prevailing market prices at
that time.\190\ Accordingly, the Commission is proposing to modify the
definition of ``time of order receipt'' to specify that, in the case of
a broker or dealer that is not acting as a market
[[Page 3800]]
center, the time of order receipt is the time that the order was
received by the broker or dealer for execution.\191\
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\188\ See, e.g., 17 CFR 242.605(a)(1)(ii)(D) (measuring, for
shares executed with price improvement, the share-weighted average
period from the time of order receipt to the time of order
execution).
\189\ See 17 CFR 242.600(b)(92). See also Adopting Release, 65
FR 75414 (Dec. 1, 2000) at 75423 (``The definition [of `time of
order receipt'] is intended to identify the time that an order
reaches the control of the market center that is expected, at least
initially, to execute the order.''). The Commission is proposing to
renumber the definition of ``time of order receipt'' as proposed
Rule 600(b)(109).
\190\ When adopting Rule 605, the Commission stated that a
market center will use the time and consolidated BBO at the time it
received the order, rather than the time and consolidated BBO when
the venue to which an order was forwarded received the order, to
calculate the required statistics. See Adopting Release, 65 FR 75414
(Dec. 1, 2000) at 75423. The Commission stated that a market center
should be held accountable for all orders that it receives for
execution and should not be given an opportunity to exclude
difficult orders by routing them to other venues, and that from the
customer's perspective the fact that a market center chooses to
route the order elsewhere does not reduce the customer's interest in
a fast execution that reflects the consolidated BBO as close to the
time of order submission as possible. See id. This same reasoning
applies to orders that a broker-dealer receives and then routes to
another venue for execution, and supports measuring the time of
order receipt from the time that the broker-dealer receives the
order.
\191\ See proposed Rule 600(b)(109). The time that the order is
received by the market center for execution should be the same as
the time that the order is received by the broker-dealer for
execution when the broker-dealer also acts as a market center for
that order.
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The Commission is mindful that some of Rule 605's execution quality
statistics may as a general matter differ for the larger broker-
dealers, as compared to market centers, to the extent that some of
these larger broker-dealers generally or exclusively route orders away.
However, it is appropriate for broker-dealers to report on the same
execution quality statistics as market centers because the reported
statistics can be understood in the context of the specific reporting
entity, and the detailed execution quality statistics would allow
customers and other market participants to parse the differences among
the statistics for each reporting entity. For example, Rule 605
requires statistics for the number of shares executed at the receiving
market center and the number of shares executed at any other
venue.\192\ As discussed above, broker-dealers that generally route the
orders that they receive to other venues for execution, and thereby
would report these shares as being executed at another venue, may
execute certain portions of their order flow internally (e.g.,
fractional shares).\193\ While the Commission considered whether or not
broker-dealers should be required to provide execution quality
statistics for both shares executed at the receiving broker-dealer and
shares executed at any other venue, the Commission decided to propose
to keep both of these statistics in the Rule 605 reporting requirements
for broker-dealers so as to capture all orders that broker-dealers
receive for execution as part of their customer-facing broker-dealer
function.\194\ Further, differences in certain statistics for broker-
dealers as compared to market centers may be more reflective of
differences in business models rather than effectiveness in achieving
execution quality for covered orders because of differences in order
handling practices. The Commission understands that these differences
are well-known and are taken into account by market participants when
evaluating execution quality statistics. For example, broker-dealers
that route customer orders may have consistently longer time to
executions as compared to market centers for similar orders, because of
the time it takes to route these orders, but this difference is well
understood by market participants.
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\192\ See 17 CFR 242.605(a)(1)(i)(D) and (E). As discussed
herein, the Commission is proposing to modify Rule 605(a)(1)(i)(D)
to also cover the number of shares executed at the receiving broker
or dealer. See supra note 155 and accompanying text.
\193\ See supra note 34 and accompanying text.
\194\ If a broker-dealer does not execute any covered orders
internally, then that broker-dealer's Rule 605 report would not
reflect any shares executed at the receiving broker-dealer. For
discussion of what orders broker-dealers that are market centers
would include in their reports pertaining to their market center
function, see supra notes 178-180 and accompanying text.
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The Commission is also mindful that, for orders routed to other
venues for execution, broker-dealers may not have all of the
information needed to calculate the proposed statistics at the time of
order execution. However, these broker-dealers should be able to obtain
the needed information in time to prepare the required reports. Broker-
dealers would need to calculate their execution quality statistics, or
engage a vendor to calculate the statistics on their behalf, on a
monthly basis. At the time that the broker-dealer or its vendor would
need to calculate the execution quality statistics, the broker-dealer
would have received any needed information about the order's execution
from the execution venue and be able to obtain any needed historical
price information from publicly available data sources, such as the
exclusive plan processors (``exclusive SIPs'').\195\ For example, a
broker-dealer that routed an order away for execution would receive
time of order execution and execution price as part of the trade
confirmation provided by the execution venue. The broker-dealer could
then use historical price information available via the exclusive SIPs
to determine the NBBO at the time of order receipt and at the time of
order execution, the number of shares displayed at the NBBO, and the
best available displayed price, if such price is being disseminated,
and use this data to calculate the required execution quality
statistics.\196\
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\195\ See MDI Adopting Release, 86 FR 18596 (Apr. 9, 2021) at
18598-99 (describing that the exclusive SIPS, among other things,
disseminate core data, which currently consists of: (1) the price,
size, and exchange of the last sale; (2) each exchange's current
highest bid and lowest offer and the shares available at those
prices; and (3) the NBBO). A securities information processor
(``SIP'') is defined in section 3(a)(22)(A) of the Exchange Act. See
15 U.S.C. 78c(a)(22)(A). Further, an ``exclusive processor'' (also
known as an exclusive SIP) is defined in section 3(a)(22)(B) of the
Exchange Act. See 15 U.S.C. 78c(a)(22)(B).
\196\ With respect to NMLOs, the broker-dealer could also use
this historical price information available via the exclusive SIPs
to determine when the order became executable, based on when the
NBBO first reached the order's limit price.
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Request for Comment
The Commission seeks comment generally on the proposed expansion of
Rule 605 reporting requirements to include larger broker-dealers that
meet or exceed the customer account threshold, as well as the other
proposed changes to Rule 605 and Rule 600(b) discussed above. In
particular, the Commission solicits comment on the following:
1. Should Rule 605 be expanded to apply to broker-dealers? Why or
why not? Do commenters agree that it would be useful for customers of
certain broker-dealers to be able to access execution quality
statistics that are specific to those broker-dealers, rather than
needing to rely on the execution quality statistics reported by the
market centers to which the broker-dealers route? Do commenters agree
that market centers may provide different execution quality to orders
based on the routing broker-dealer? Please explain and provide data.
2. Do commenters agree that it would be useful for broker-dealers
that are also market centers to produce separate reports pertaining to
each function? Why or why not? Do commenters agree that broker-dealers
that are also market centers should be required to include in the
report pertaining to their market center function all covered orders
for which they act as a market center, including as an OTC market
maker, rather than only those covered orders executed at the market
center? Do commenters agree that broker-dealers that are also market
centers should be required to include in the report pertaining to their
broker-dealer function all of the covered orders in NMS stocks that
they received for execution from any customer, rather than only those
orders that do not pertain to their market center function (i.e., those
orders for which they do not act as a market center)? Would broker-
dealers that are also market centers encounter any specific
difficulties when determining which orders to include in each report?
Please explain.
3. Is a numerical customer account threshold the proper criterion
for determining whether a broker-dealer should be subject to the Rule
605 reporting requirements? If so, is 100,000 or more customer accounts
the appropriate amount? Why or why not? If not, should be it higher or
lower (e.g., 500,000 or more customer accounts or 10,000 or more
customer accounts)? If so, by what amount? Is it appropriate to
consider both the number of customer accounts that the broker-dealer
carries and the number of customer accounts
[[Page 3801]]
that the broker-dealer introduces? Why or why not? Do commenters
believe that it would be more useful to consider the trading volume,
either based on share volume or notional volume, or both, of a broker-
dealer's customers when setting the reporting threshold? Why are why
not? Please explain and provide data to support your argument. Are
there alternative approaches that the Commission should adopt in
expanding Rule 605's reporting requirements to broker-dealers? If so,
please explain the approach in detail, including the benefits and costs
of the approach.
4. Should the Commission require all broker-dealers to report
pursuant to Rule 605 irrespective of the number of customer accounts
that the broker-dealer carries or introduces? Or should such a
requirement be subject to a de minimis exclusion? Why or why not? If
so, what would be an appropriate de minimis exclusion? Please explain
and provide data, if possible.
5. Is three months an appropriate timeframe to use for the
Reporting Period, i.e., the minimum length of time for which a broker-
dealer would need to comply with Rule 605's reporting requirements once
its number of customer accounts meets or exceeds the customer account
threshold? Would a shorter or longer time period (e.g., one, two or six
months) be more appropriate? If so, by what amount? Does whether or not
a broker-dealer uses or could use an outside vendor to prepare reports
pursuant to Rule 605 affect this answer? Please explain.
6. Is three months an appropriate grace period from Rule 605's
reporting requirements for a broker-dealer that has met or exceeded the
customer account threshold for the first time? Would a shorter or
longer time period be more appropriate (e.g., one month, two months, or
six months)? Do commenters agree that a grace period would not be
necessary for broker-dealers that have previously equaled or exceeded
the customer account threshold, but subsequently have fallen below the
threshold and stopped reporting and then need to restart reporting? If
not, what grace period do commenters think would be appropriate? Would
one month be sufficient in this context? Are there any other
circumstances in which a broker-dealer that has met or exceeded the
customer account threshold would need an additional grace period from
Rule 605's reporting requirements? Please explain.
7. Should a broker-dealer that is not a market center be required
to calculate time of order receipt based on when that broker-dealer
received the order? Why or why not? Would it be more useful to
customers or other market participants for a broker-dealer that
generally routes customer orders to calculate time of order receipt
based on when that broker-dealer sent the order to a market center for
execution? Please explain and provide data, if possible.
8. Should broker-dealers be required to produce all of the detailed
execution quality statistics set forth in Rule 605? Why or why not? Do
commenters agree that broker-dealers' customers and other market
participants would be able to interpret differences in these execution
quality statistics among reporting entities that may be attributable to
the context of their different types of business? Do commenters believe
that there are any additional execution quality statistics that would
be useful to require of broker-dealers? Please explain and provide
data, if possible.
9. Would it be difficult for broker-dealers to obtain any of the
information needed to calculate the Rule 605 statistics? Why or why
not? If so, which statistics in particular? Would broker-dealers have
some or all of the information needed to calculate their Rule 605
statistics already, including to meet their obligations to assess
whether they are providing best execution for these orders? Do
commenters agree that broker-dealers would be able to obtain needed
information from the execution venues to which they routed the orders
or publicly available sources? Should the Commission exclude certain
proposed execution quality statistics that are specific to certain
order types, such as executable NMLOs? Why or why not? Please explain.
B. Qualified Auction Mechanisms
Separately, the Commission is proposing rules that generally would
require that individual investor orders be exposed to order-by-order
competition in fair and open auctions designed to obtain the best
prices before such orders could be internalized by wholesalers or any
other type of trading center that restricts order-by-order
competition.\197\ Under those proposed rules, a restricted competition
trading center would not be allowed to execute internally a segmented
order for an NMS stock until after a broker or dealer has exposed such
order to competition at a specified limit price in a qualified auction
that meets certain requirements and is operated by an open competition
trading center.\198\ An ``open competition trading center'' would be a
national securities exchange or NMS Stock ATS that meets certain
requirements, including being transparent and having a substantial
trading volume in NMS stocks independent of qualified auctions.\199\ A
``qualified auction'' would be an auction operated by an open
competition trading center pursuant to specified requirements that are
designed to achieve competition.\200\
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\197\ For a full description and discussion of the order
competition rule proposal, see Securities Exchange Act Release No.
96495 (Dec. 14, 2022) (File No. S7-31-22) (Order Competition Rule)
(``Order Competition Rule Proposal''); proposed Rule 615.
\198\ See Order Competition Rule Proposal; proposed Rule
600(b)(87) (defining ``restricted competition trading center'');
proposed Rule 600(b)(91) (defining ``segmented order''); proposed
Rule 615(a) (describing the order competition requirement).
\199\ See Order Competition Rule Proposal; proposed Rule
600(b)(64) (defining ``open competition trading center'').
\200\ See Order Competition Rule Proposal; proposed Rule
600(b)(81) (defining ``qualified auction''); proposed Rule 615(c)
(setting forth requirements for operation of a qualified auction).
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If the Commission adopts the Order Competition Rule Proposal and a
national securities exchange or NMS Stock ATS that serves as an open
competition trading center is required to prepare execution quality
reports under current Rule 605, that national securities exchange or
NMS Stock ATS would be required to include covered orders that it
received for execution in a qualified auction within its blended
executing quality statistics, which also would include trading activity
outside of the qualified auctions.\201\
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\201\ As discussed further below, the Commission is proposing to
eliminate the separate reporting categories for inside-the-quote
limit orders, at-the-quote limit orders, and near-the-quote limit
orders, and create new reporting categories for executable NMLOs and
beyond-the-midpoint limit orders. See infra sections IV.B.2.(a) and
IV.B.2.(b). While, as proposed, orders submitted to qualified
auctions may in many instances be classified as beyond-the-midpoint
limit orders, this reclassification would not resolve the
Commission's concern about blending execution quality statistics for
orders executed in qualified auctions with orders executed outside
of these auctions.
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The Commission is concerned that there may be differences in
execution quality for orders executed within proposed qualified
auctions, as compared to other orders executed by market centers
outside of these qualified auctions, that would not be apparent in
blended execution quality statistics. For example, orders submitted to
a qualified auction may be more or less likely to receive price
improvement, and may have systematically different fill rates, as
compared to similar orders executed in other trading mechanisms. In
addition, the Order Competition Rule Proposal would propose both a
minimum and maximum time period for
[[Page 3802]]
the qualified auction.\202\ Therefore, the time to execution statistics
for orders submitted to a qualified auction may be systematically
different from the time to execution statistics of other orders
executed at a market center. Further, if a market center receives
covered orders for execution in a qualified auction, then that market
center would not have discretion about whether to submit these orders
into a qualified auction and therefore the distinction between orders
executed by the market center within and outside of a qualified auction
would not reflect any decision-making on the part of the market center.
Thus, it would be more useful for market participants to be able to
review execution quality statistics that are specific to covered orders
submitted to a qualified auction.
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\202\ See Order Competition Rule Proposal; proposed Rule
615(c)(2).
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Accordingly, the Commission is proposing to amend Rule 605(a)(1) to
state that market centers that operate a qualified auction must prepare
a separate report pursuant to Rule 605 pertaining only to covered
orders that the market center receives for execution in a qualified
auction.\203\ This proposed requirement for separate reports is limited
to market centers that operate proposed qualified auctions, and would
not extend to market centers or broker-dealers that route orders away
for execution in a qualified auction. Therefore, a market center or
broker-dealer that routes covered orders to an open competition trading
center for execution within a proposed qualified auction would not be
required to separately report on or otherwise distinguish orders routed
to qualified auctions from other types of orders routed away for
execution in its Rule 605 reports.\204\ In this way, the proposal would
follow current Rule 605's focus on the overall execution quality that
the reporting entity provided to all covered orders that it received
for execution.\205\ Having market centers and broker-dealers report on
the execution quality provided to orders, regardless of where they are
executed, would inform market participants and other observers about
overall execution quality that the market center or broker-dealer is
able to obtain, including when the market center or broker-dealer
decides whether and where to route orders to receive such executions.
Further, distinctions between whether an order was routed to a
qualified auction or not may depend on the characteristics of the
order, such as whether it is a segmented order, rather than the
performance of the market center or broker-dealer that routed the
order. As such, it would be of more limited utility to have a market
center or broker-dealer that routes orders to a qualified auction to
produce a separate Rule 605 report specific to such orders.
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\203\ See proposed Rule 605(a)(1).
\204\ If a larger broker-dealer is also a market center and its
market center operates a qualified auction mechanism, that aspect of
the market center would be subject to the separate reporting
requirement.
\205\ For example, currently Rule 605 does not require market
centers to distinguish among covered orders routed to particular
types of away market centers. Instead, a market center's execution
quality statistics are blended statistics pertaining to all covered
orders that the market center received for execution, with the
limited exception of the statistics for cumulative number of shares
of covered orders executed at the receiving market center and at any
other venue. See 17 CFR 242.605(a)(1).
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Although market centers and broker-dealers would not be required to
produce a separate Rule 605 report pertaining to orders that they route
to a qualified auction, Rule 606 requires routing broker-dealers to
disclose certain regularly-used execution venues to which they route
orders, and a report prepared by a broker-dealer pursuant to Rule 606
would be required to indicate that orders were routed to a particular
qualified auction.\206\ A customer of a broker-dealer could then
analyze whether and to what extent the broker-dealer routes to a
particular market center's qualified auctions (using reports prepared
pursuant to Rule 606), and evaluate the execution quality provided by
that market center's qualified auctions (using reports prepared
pursuant to Rule 605).
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\206\ See 17 CFR 242.606(a)(1). For example, if a broker-dealer
operates an ATS and that ATS has qualified auctions and a continuous
order book, the broker-dealer's Rule 606 report would be required to
disclose information about orders that were routed to the ATS's
qualified auctions separately from orders that were sent directly to
the ATS's continuous order book.
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The Commission considered extending the proposed requirement for
separate Rule 605 reports beyond proposed qualified auctions to include
orders submitted to any trading mechanism that seeks to provide
liquidity to the orders of individual investors. For example, several
national securities exchanges operate retail liquidity programs.\207\
However, in the Order Competition Rule Proposal the Commission is
proposing a prohibition on certain facilities that are limited, in
whole or in part, to the execution of segmented orders and this
prohibition would apply to many of the retail liquidity programs
currently operated by national securities exchanges.\208\
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\207\ Retail liquidity programs are programs for retail orders
seeking liquidity that allow market participants to supply liquidity
to such retail orders by submitting undisplayed orders priced at
least $0.001 better than the exchange's protected best bid or offer.
Each program results from a Commission approval of a proposed rule
change made on Form 19b-4 combined with a conditional exemption,
pursuant to section 36 of the Exchange Act, from 17 CFR 242.612 (the
``Sub-Penny Rule'') to enable the exchange to accept and rank (but
not display) the sub-penny orders. See, e.g., Securities Exchange
Act Release Nos. 85160 (Feb. 15, 2019), 84 FR 5754 (Feb. 22, 2019)
(SR-NYSE-2018-28) (approving the NYSE retail liquidity program on a
permanent basis and granting the exchange a limited exemption from
the Sub-Penny Rule to operate the program); 86194 (June 25, 2019),
84 FR 31385 (July 1, 2019) (SR-BX-2019-011) (approving Nasdaq BX,
Inc.'s retail price improvement program on a permanent basis and
granting the exchange a limited exemption from the Sub-Penny Rule to
operate the program).
\208\ See Order Competition Rule Proposal. The Commission
discusses a number of alternatives in the Order Competition Rule
Proposal. See id. To the extent that any retail liquidity program is
retained, separate execution quality statistics specific to orders
submitted to those programs may be useful to investors.
---------------------------------------------------------------------------
Request for Comment
The Commission seeks comment on the proposal to require a market
center that operates a qualified auction to prepare a separate report
under Rule 605 for covered orders that were submitted to a qualified
auction if the Order Competition Rule Proposal is adopted. In
particular, the Commission solicits comment on the following:
10. Should market centers that operate a proposed qualified auction
be required to prepare a separate Rule 605 report for covered orders
that are submitted to their qualified auctions? Why or why not? Do
commenters agree with limiting this separate reporting requirement to
market centers that operate a proposed qualified auction, and not to
either broker-dealers that are not market centers or market centers
that do not operate a qualified auction? Please explain.
11. Should this separate reporting requirement be limited to a
trading mechanism that meets the proposed requirements for a
``qualified auction''? Would it be more useful if a market center
prepared a separate report for covered orders submitted to any trading
mechanism that seeks to provide liquidity to the orders of individual
investors (e.g., a national securities exchange's retail liquidity
program), whether or not that trading mechanism operates a ``qualified
auction''?
12. Do commenters believe that there are any additional execution
quality statistics that would be useful to require of a market center
that operates a proposed qualified auction to facilitate comparison
among different qualified auctions? For example, would it be useful for
a market center that operates a proposed qualified auction to provide
data on any price improvement provided in the qualified auction as
[[Page 3803]]
measured in relation to any additional price matching offered by the
wholesaler that routed the order to the qualified auction? Please
explain and provide data, if possible.
C. ATSs and Single-Dealer Platforms
Currently under Rule 605, firms that operate two separate markets
must prepare separate reports for each market center.\209\ For example,
for a firm that acts both as an exchange market maker and as an OTC
market maker, each function would be considered a separate market
center and Rule 605 requires the firm to prepare separate reports. The
requirement to produce separate Rule 605 reports for separate markets
allows market participants to assess the execution quality of each
market individually, and prevents differences in the nature of each
market from obscuring information about execution quality.
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\209\ See 17 CFR 242.605(a)(1) (requiring ``every'' market
center to produce a report). See also Plan, at n.1 (``An entity that
acts as a market maker in different trading venues (e.g., as
specialist on an exchange and as an OTC market maker) would be
considered as a separate market center under the Rule for each of
those trading venues. Consequently, the entity should arrange for a
Designated Participant for each market center/trading venue (e.g.,
an exchange for its specialist trading and an association for its
OTC trading).''). For a description of ``Designated Participant'' as
defined in the Plan, see supra note 47.
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Regulation ATS requires each ATS to register as a broker-
dealer.\210\ Many broker-dealers that operate NMS Stock ATSs have
separate lines of business that are distinct from their ATSs, yet also
relate to the trading of NMS stocks.\211\ In addition, one EMSAC
panelist suggested that the Commission require all ATSs and dark pools
(i.e., ATSs that do not publish quotations) to report separately from
their affiliated broker-dealers under Rule 605.\212\ The Commission
believes there is a need to address directly what Rule 605 requires
with respect to reporting by firms that operate ATSs. By specifying
that a broker-dealer that operates an ATS must produce Rule 605 reports
that are specific to the ATS and separate from the broker-dealer
operator's other trading activity, the Commission intends to increase
transparency and regulatory compliance. Accordingly, the Commission
proposes to specify in Rule 605(a)(1) that ATSs (as defined in
Regulation ATS \213\) shall prepare reports separately from their
broker-dealer operators, to the extent such entities are required to
prepare reports.\214\
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\210\ See 17 CFR 242.301(b)(1). 17 CFR 242.301 through 17 CFR
242.304 is generally known as ``Regulation ATS.''
\211\ See, e.g., Securities Exchange Act Release No. 83663 (July
18, 2018), 83 FR 38768, 38771 (Aug. 7, 2018) (Regulation of NMS
Stock Alternative Trading Systems) (stating that ATSs that trade NMS
stocks are increasingly operated by multi-service broker-dealers
that engage in significant brokerage and dealing activities in
addition to operation of their ATS, and that, for instance, the
broker-dealer operator of an NMS Stock ATS may also operate an OTC
market making desk or principal trading desk, or may have other
business units that actively trade NMS stocks on a principal or
agency basis in the ATS or at other trading centers).
\212\ See Healthy Markets II at 2. See also Healthy Markets III
at 4 (recommending that the Commission modernize and mandate Rule
605 disclosure for all NMS ATS operators separate and distinct from
any affiliated broker-dealer). Additionally, a commenter to the
Concept Release on Equity Market Structure recommended that the
Commission require all ATSs and dark pools to report under Rule 605.
See KOR Group I at 3.
\213\ 17 CFR 242.300 et seq.
\214\ See proposed Rule 605(a)(1).
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Some OTC market makers, such as wholesalers, operate SDPs through
which they execute institutional orders in NMS stocks against their own
inventory.\215\ Institutional customers often communicate their trading
interest using immediate-or-cancel orders (``IOCs'') or IOIs on
SDPs.\216\ SDPs account for a nontrivial amount of trading volume
overall (for example, SDPs accounted for approximately 4% of total
trading volume in Q1 2022) and a significant portion of trading volume
executed by wholesalers.\217\ Co-mingling SDP activity with other
market center activity in Rule 605 reports may obscure differences in
execution quality or distort the general execution quality metrics for
the market center.\218\ It would be useful if SDPs reported execution
quality statistics separately from those of their associated broker-
dealer under Rule 605, so that their customers and other market
participants would be able to distinguish SDP activity from more
traditional dealer activity. Separate statistics may be particularly
useful if a dealer provides an SDP (i.e., a separate routing
destination for the execution of orders) for a particular group of
customers or type of orders. Therefore, the Commission is proposing to
require in Rule 605(a)(1) that any market center that provides a
separate routing destination that allows persons to enter orders for
execution against the bids and offers of a single dealer shall produce
a separate report pertaining only to covered orders submitted to such
routing destination.\219\
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\215\ Wholesalers and other OTC market makers either execute
orders themselves or instead further route the orders to other
venues. An SDP always acts as the counterparty to any trade that
occurs on the SDP. See, e.g., Where Do Stocks Trade?, <a href="http://FINRA.org">FINRA.org</a>
(Dec. 3, 2021), available at <a href="https://www.finra.org/investors/insights/where_do_stocks_trade">https://www.finra.org/investors/insights/where_do_stocks_trade</a> for further discussion.
\216\ See infra note 615 and accompanying text.
\217\ See infra notes 618 and 769 and accompanying text.
\218\ For example, IOC orders typically have different execution
profiles than other types of orders, including lower fill rates, and
therefore including orders submitted to a market center's SDP with
its other orders will effect a downwards skew on the market center's
fill rates. See infra note 723 and accompanying text; Table 6.
\219\ See proposed Rule 605(a)(1). To the extent that a
reporting firm produces more than one Rule 605 report, the firm
could label each report with the type of business reflected on the
report. As discussed above, the Commission proposes to expand the
scope of Rule 605 to include larger broker-dealers. See supra
section III.A. It is possible that firms would need to prepare
several Rule 605 reports if they are both a larger broker-dealer and
a market center and need to prepare more than one report as a market
center, pursuant to proposed Rule 605(a)(1).
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Request for Comment
The Commission seeks comment on the proposal to specify that an ATS
must produce reports separately from its broker-dealer operator, and to
require that any market center that provides a separate routing
destination that allows persons to enter orders against the bids and
offers of a single dealer must produce separate reports pertaining to
orders submitted to that routing destination. In particular, the
Commission solicits comment on the following:
13. Is it useful for an ATS to produce reports pursuant to Rule 605
that are specific to covered orders submitted to the ATS and separate
from orders submitted in connection with other trading activity of its
broker-dealer operator? Why or why not?
14. Should a broker-dealer operating an SDP be required to produce
reports pursuant to Rule 605 that are specific to orders sent to that
routing destination and separate from other trading activity by that
dealer, as proposed? Why or why not? Do commenters agree that the
description of ``a market center that provides a separate routing
destination that allows persons to enter orders for execution against
the bids and offers of a single dealer'' accurately describes SDPs? If
not, what is a more accurate description of an SDP? Please explain.
IV. Proposed Modifications to Scope of Orders Covered and Required
Information
Rule 605 reports group orders by both order size and order type,
and require certain standardized information for all types of orders
and additional information for market orders and marketable limit
orders. The Commission is proposing to modify the order size and order
type groupings, and is proposing to make changes to the required
information for: all types of orders; market and marketable limit
[[Page 3804]]
order types; and nonmarketable order types. The modifications described
below would apply to Rule 605 reports produced by all reporting
entities, including larger broker-dealers.
A. Covered Order
The Commission proposes to expand the definition of ``covered
order'' in a number of ways.\220\ The Commission proposes to include
certain orders received outside of regular trading hours and orders
submitted with stop prices. Additionally, the Commission is addressing
whether Rule 605 requires non-exempt short sale orders to be
incorporated into Rule 605 reporting when a price test restriction is
in effect for the security.
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\220\ See proposed Rule 600(b)(30).
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1. Orders Submitted Pre-Opening/Post-Closing
Currently, Rule 605 reports are required to include only orders
received during regular trading hours \221\ at a time when an NBBO is
being disseminated. The Commission excluded orders submitted during the
pre-opening or after the close, among other order types, from the scope
of reporting because nearly all of Rule 605's statistical measures
required the availability of the NBBO at the time of order receipt as a
benchmark.\222\ At the time of adoption, the Commission stated that
there are substantial differences in the nature of the market between
regular trading hours and after-hours, and orders executed at these
times should not be blended together in the same statistics.\223\
Similarly, orders for which customers requested special handling,
including orders to be executed at a market opening price, are excluded
from Rule 605 reports because their inclusion would skew the general
statistics.\224\
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\221\ ``Regular trading hours'' is defined as the time between
9:30 a.m. and 4:00 p.m. Eastern Time, or such other time as is set
forth in the procedures established pursuant to 17 CFR
242.605(a)(2). See 17 CFR 242.600(b)(77). The Commission is
proposing to renumber the definition of ``regular trading hours'' as
proposed Rule 600(b)(91).
\222\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75421.
\223\ See id., text accompanying note 39. Specifically, the
Commission stated that the average quoted spread, average effective
spread, and trade price volatility increased significantly for
certain securities after the close of regular trading hours. See id.
at n.39.
\224\ See id. at 75421.
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Market participants submit limit orders prior to market open, and
these orders are not captured in current Rule 605 reports.\225\
Although NMLOs submitted outside of regular trading hours may represent
a relatively small percentage of NMLO orders overall, pre-open NMLO
submission volume includes a higher concentration of individual
investor orders.\226\ In order to provide increased visibility into
execution quality for individual investor orders, including those
submitted outside of regular trading hours, the Commission proposes to
expand the scope of Rule 605 reporting to include certain NMLOs
submitted outside of regular trading hours if they become executable
after the opening or reopening of trading during regular trading
hours.\227\ The Commission is proposing to expand the definition of
``covered order'' to include any NMLO received by a market center,
broker, or dealer outside of regular trading hours or at a time when a
national best bid and national best offer is not being disseminated
and, if executed, is executed during regular trading hours.\228\ As
discussed below, the Commission is proposing that NMLOs would be
benchmarked from the time they become executable rather than the time
of order receipt.\229\ The executability of limit orders that are
received while an NBBO is not being disseminated would be determined
with reference to the opening or re-opening price of the security. This
would allow market participants to evaluate execution performance for
NMLOs submitted outside of regular trading hours if they become
executable during regular trading hours.
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\225\ See supra notes 123-125 and accompanying text (commenter
to 2018 Rule 606 Amendments and petitioner for rulemaking
recommending inclusion of orders submitted prior to market open).
\226\ Analysis of CAT data found that NMLOs submitted prior to
open and designated as only able to execute during regular hours
make up only a small percentage of order flow when compared to a
sample 10-minute window of NMLOs submitted during regular hours.
However, the analysis shows that individual investor orders are
relatively concentrated in order flow submitted outside of regular
market hours. Specifically, pre-open submission volume contains a
larger percentage of individual investor shares than the sample time
window during regular trading hours, at least for off-exchange
market centers. See infra notes 672-673 and accompanying text.
\227\ See proposed Rule 600(b)(20) (defining ``categorized by
order type'' to include executable NMLOs and executable orders
submitted with stop prices).
\228\ See proposed Rule 600(b)(30).
\229\ See infra section IV.B.2.(a).
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The Commission proposes to amend the definition of ``marketable
limit order'' to specify that the marketability of an order received
when the NBBO is not being disseminated would be determined using the
NBBO that is first disseminated after the time of order receipt.
Specifically, the Commission proposes that an order received at a time
when a national best bid and national best offer is not being
disseminated would be a marketable limit order if it is a buy order
with a limit price equal to or greater than the national best offer at
the time that the national best offer is first disseminated during
regular trading hours after the time of order receipt, or if it is a
sell order with a limit price equal to or less than the national best
bid time at the time that the national best bid is first disseminated
during regular trading hours after the time of order receipt.\230\
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\230\ See proposed Rule 600(b)(57).
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Any limit order received outside of regular trading hours or during
a trading halt that is marketable based on the first disseminated NBBO
during regular trading hours after the time of order receipt would not
be a covered order for purposes of Rule 605.\231\ The Commission's
proposed definition excludes market orders and marketable limit orders
submitted prior to open or during a trading halt because such orders
would generally execute at the opening or re-opening price. Therefore,
their inclusion in general market and marketable limit order statistics
would skew both time to execution statistics and other measures of
execution quality if aggregated with market and marketable limit orders
received during regular trading hours. While including market and
marketable limit orders submitted prior to open or during a trading
halt within the definition of covered order and requiring that the
execution statistics for these types of orders be reported as a
separate order type category would avoid the concern about skewed
statistics, it would add to the complexity of the report.
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\231\ For example, a market or marketable limit order that is
not received by a market center or broker-dealer during regular
trading hours at a time when the NBBO is being disseminated would
not be a covered order under proposed Rule 600(b)(30). In addition,
the covered order definition would continue to exclude any order for
which the customer requests special handling for execution,
including orders to be executed at a market opening price, see
proposed Rule 600(b)(30), and therefore market-on-open (``MOO'')
orders and limit-on-open (``LOO'') orders would be excluded.
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The current definition of covered order includes orders received
during regular trading hours while an NBBO is being disseminated but
before the primary listing market has disseminated its first quotations
in the security. Prior to a primary listing market disseminating its
first quotations in a security, disseminated quotations often reflect
spreads that vary significantly from the norm.\232\ To prevent such
quotations from skewing the execution quality statistics, the
Commission exempted orders from inclusion in Rule
[[Page 3805]]
605 reports that are received prior to the dissemination of the primary
listing market's first firm, uncrossed quotations for a trading day
(``Opening Exemption'').\233\ With respect to orders received during
regular trading hours but before the primary listing market has
disseminated its first firm, uncrossed quotation, the Commission
continues to believe, for the same reasons it granted this exemption,
that including such orders could distort execution quality statistics.
Therefore, the Commission is proposing to incorporate this exemptive
relief into the proposed definition of covered order with respect to
market or limit orders received during regular trading hours at a time
when an NBBO is being disseminated.\234\ However, pursuant to the
proposed amendments to Rule 605, NMLOs (including orders submitted with
stop prices) received outside of regular trading hours or at a time
when an NBBO is not being disseminated could be considered covered
orders, provided the NMLOs were not executed outside of regular trading
hours.\235\ Inclusion of these orders in Rule 605 reports would be
useful to market participants, even though such orders necessarily
would be received before the primary listing market has disseminated
its first firm, uncrossed quotation and thus fall within the scope of
the Opening Exemption. Because the Commission is proposing to
incorporate the exemptive relief reflected in the Opening Exemption
into the Rule with respect to market or limit orders received during
regular trading hours, but believes it would be useful to include the
NMLOs described above in Rule 605 reports, the Commission is also
proposing to rescind the Opening Exemption.\236\
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\232\ See Letter from Annette L. Nazareth, Director, Division of
Market Regulation to Theodore Karn, President, Market Systems, Inc.,
dated June 22, 2001 (``Market Systems Exemptive Letter'') at 2.
\233\ See id. (exemption from reporting under Rule 11Ac1-5, the
predecessor to Rule 605). In addition to the Opening Exemption, the
Market Systems Exemptive Letter included a separate exemption from
the Rule for orders received during a time when the consolidated BBO
reflects a spread that exceeds $1 plus 5% of the midpoint of the
consolidated BBO (``Spread Width Exemption'').
\234\ See proposed Rule 600(b)(30).
\235\ See id.
\236\ Because the Spread Width Exemption is not inconsistent
with the proposed amendments to Rule 605, the Commission would not
rescind the Spread Width Exemption. The Commission continues to
believe that orders received during a time when the consolidated BBO
reflects a spread that exceeds $1 plus 5% of the midpoint of the
consolidated BBO ``could be the result of potentially erroneous
quotes or of abnormal trading conditions'' and their inclusion
``could significantly affect the comparability and reliability of
the execution quality measures in market center monthly reports.''
Market Systems Exemptive Letter at 2. The Commission may adopt an
updated or modified exemption under Rule 605(b) to further refine
the exemption if, for example, additional factors could be
considered reliable indicators of orders that could be the result of
erroneous quotes or abnormal trading conditions. See 17 CFR
242.605(b).
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As a result of the proposed inclusion of limit orders submitted
after closing and the proposed changes to the categorization of NMLOs
described in section IV.B.2, limit orders could be received for
execution and fall within the scope of Rule 605 on a day other than the
day of order receipt. Under current Rule 605(a)(1), a reporter must
prepare a monthly report on the covered orders in NMS stocks that it
received for execution from any person. In order to address this
scenario, the Commission proposes that a covered order would be
required to be included in the report for the month in which it becomes
executable if the day of receipt and the day it initially becomes
executable occur in different calendar months. Therefore, the
Commission proposes to amend Rule 605(a)(1) to require a market center,
broker, or dealer to include in its monthly report, in addition to the
covered orders in NMS stocks that it received for execution from any
person, those covered orders in NMS stocks that it received for
execution in a prior calendar month but which remained open.\237\
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\237\ See proposed Rule 605(a)(1).
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2. Stop Orders
The definition of ``covered order'' excludes orders with special
handling instructions, including orders submitted with stop
prices.\238\ Therefore, orders submitted with stop prices are excluded
from Rule 605 reports.
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\238\ See 17 CFR 242.600(b)(22). Generally, a limit order
submitted with a stop price becomes a market order when the stop
price is reached. A stop order to buy becomes a market order when
the security is bid or trades at or above the specified stop price;
a stop order to sell becomes a market order when the security is
offered or trades at or below the specified stop price.
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The Commission preliminarily understands that market centers and
broker-dealers may differ in how they handle stop orders, and the
current lack of consistent information regarding executions of such
orders may prevent investors from comparing the execution quality of
such orders. Further, stop orders are likely to hit their stop prices,
and are often executed, during periods of price volatility or downwards
market momentum, which may entail less than favorable execution
conditions. Given the potential for variation across market centers and
broker-dealers, as well as the market conditions under which stop
orders may execute, the Commission believes including stop orders
within the scope of the Rule would benefit market participants by
allowing them to analyze these variations in execution quality.
Further, as stated by the petitioner, including stop orders within the
Rule's scope would provide a more complete view of the orders certain
broker-dealers may use when assessing the execution quality market
centers provide.\239\
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\239\ See supra note 123 and accompanying text.
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Orders submitted with stop prices are often submitted well before
their stop prices are reached. In order to provide an ``apples-to-
apples'' comparison of stop orders, the Commission is proposing to
measure the execution quality of orders submitted with stop prices from
the time their stop prices are reached, i.e., when such orders become
executable. As part of the proposed definition of ``executable,'' the
Commission is proposing to specify that executable means, for any buy
order submitted with a stop price, that the stop price is equal to or
greater than the national best bid during regular trading hours, and,
for any sell orders submitted with a stop price, that the stop price is
equal to or less than the national best offer during regular trading
hours.\240\ Incorporation of the ``executable'' concept would have two
effects. First, stop orders would be reported as part of a Rule 605
report only if they become executable.\241\ Second, the point that a
stop order first becomes executable would be used as a benchmark for
several execution quality metrics, including average effective spread,
average effective over quoted spread, average realized spread, and
average time to execution statistics.\242\ The Commission is proposing
to use the time an order becomes executable rather than the time of
order receipt based on the understanding that customers, at least for
purposes of evaluating execution quality of stop orders, would
generally expect such orders to be executed close in time to when their
stop prices are triggered. Including executable orders submitted with
stop prices within the scope of the Rule would help investors compare
the performance of market centers and broker-dealers from a point in
time when such orders could reasonably be expected to execute.
Accordingly, the Commission proposes to rescind the exclusion of orders
submitted with stop prices within the definition of covered
[[Page 3806]]
order.\243\ As proposed, these orders would comprise a separate order
type category to help ensure comparability of execution quality
statistics since, as stated above, stop orders more often may execute
under volatile or downward-trending market conditions.\244\
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\240\ See proposed Rule 600(b)(42). See also infra note 303 and
accompanying text (discussing the definition of ``executable'' as it
relates to other non-marketable order types).
\241\ See proposed Rule 600(b)(20) (defining ``categorized by
order type'' to include a category for ``executable orders submitted
with stop prices'') (emphasis added).
\242\ For further discussion of these metrics, see infra
sections IV.B.3, IV.B.4.(a), IV.B.4.(b), IV.B.4.(d), and IV.B.6.
\243\ See proposed Rule 600(b)(30) (eliminating the express
carve out of orders submitted with stop prices from the definition
of ``covered order'').
\244\ See also infra section IV.B.2.a below for more detailed
description of the changes to categorization by order type,
including a new category for executable orders with stop prices.
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3. Non-Exempt Short Sale Orders
Commission staff has taken the position that staff would view all
short sale orders that are not marked ``short exempt'' (``non-exempt
short sale orders'') as special handling orders and, in the staff's
view, these orders may be excluded from the definition of ``covered
order'' in Rule 600(b)(15).\245\ Non-exempt short sale orders are
subject to a price test under Rule 201 of Regulation SHO (``Rule 201'')
that sets forth a short sale circuit breaker that is triggered in
certain circumstances, after which time a price restriction will apply
to short sale orders in that security for that day and the following
day.\246\ In 2013, Commission staff stated that because in certain
circumstances non-exempt short sale orders are subject to a price test
under Rule 201, and the circumstances could vary for different
securities and different days throughout the month, staff would view
all non-exempt short sale orders as subject to special handling.\247\
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\245\ 17 CFR 242.600(b)(15). See ``Responses to Frequently Asked
Questions Concerning Rule 605 of Regulation NMS'' (Feb. 22, 2013)
(``2013 FAQs'').
\246\ 17 CFR 242.201. Rule 201 generally requires trading
centers to establish, maintain, and enforce written policies and
procedures that are reasonably designed to prevent the execution or
display of a short sale at an impermissible price when a stock has
triggered a circuit breaker by experiencing a price decline of at
least ten percent in one day. Once the circuit breaker in Rule 201
has been triggered, the price test restriction will apply to short
sale orders in that security for the remainder of the day and the
following day, unless an exception applies. See 17 CFR
242.201(b)(1). One exception is for the execution or display of a
short sale order marked ``short exempt.'' See 17 CFR
242.201(b)(1)(iii)(B); 17 CFR 242.201(c).
\247\ See 2013 FAQs.
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The Commission preliminarily believes that for purposes of this
proposal, not all non-exempt short sale orders should be excluded from
the scope of Rule 605 reporting. When a non-exempt short sale order is
subject to a price test restriction under Rule 201 of Regulation SHO, a
trade may only take place at least one tick above the national best
bid.\248\ These tick-sensitive orders could be ``orders to be executed
only on a particular type of tick or bid,'' which is one of the types
of special handling orders specified in the definition of covered
order.\249\ However, excluding all non-exempt short sale orders from
Rule 605 reporting, regardless of whether or not a Rule 201 price test
restriction is in effect, excludes a significant portion of short sale
orders that are not tick-sensitive. Non-exempt short sale orders do not
appear to be tick-sensitive the majority of the time because they are
infrequently subject to a price test restriction. Analysis shows that,
between April 2015 and March 2022, an event that triggered the Rule 201
circuit breaker only occurred on 1.7% of trading days for an average
stock.\250\ The analysis also found that around 18% of trigger events
occurred the day after a previous trigger event, and around 46% of
trigger events occurred within a week after a previous trigger event,
implying that these trigger events tend to be relatively infrequent and
clustered around a small number of isolated events. Moreover, because
non-exempt short sale orders are not tick sensitive when a short sale
price test is not in effect, the inclusion of these orders would not
skew execution quality statistics.\251\
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\248\ See 17 CFR 242.201(b)(1)(i).
\249\ See 17 CFR 242.600(b)(22).
\250\ See infra note 662 and accompanying text.
\251\ In adopting Rule 605, the Commission stated that the
definition of covered order excludes orders (including short sales
that must be executed on a particular tick or bid) for which the
customer requested special handling for execution and that, if not
excluded, would skew general statistical measures of execution
quality. See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75421.
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In addition, including non-exempt short sale orders for which a
price test restriction is not in effect for the security within Rule
605 statistics would lead to a more complete picture of reporting
entities' execution quality, because there is evidence that short sales
compose a large segment of trades, and likely also order flow. Analysis
of short volume data shows that, between August 2009 and February 2021,
short selling constituted an average of 47.3% of trading volume for
non-financial common stocks.\252\ As discussed further below, evidence
suggests that hedge funds make up the majority of the short selling
market, while an academic working paper found that, between January
2010 and December 2016, around 10.92% of retail trading was made up of
short sales.\253\
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\252\ See infra note 820 and accompanying text.
\253\ See infra notes 821-827 and accompanying text. See also
supra note 123 and accompanying text (petitioner recommending
inclusion of short sales in Rule 605).
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Therefore, under the proposal, non-exempt short sale orders would
not be considered special handling orders unless a price test
restriction is in effect for the security. Unless another exclusion
applies, non-exempt short sale orders would fall within the definition
of covered order and thus within the scope of Rule 605 reporting.\254\
Conversely, during a short sale price test, a short sale order not
marked ``exempt'' would be subject to special handling and would be
excluded from the definition of covered order and thus from Rule 605
reporting.
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\254\ If an order is otherwise subject to special handling it
would not be a covered order. See proposed Rule 600(b)(30).
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Request for Comment
The Commission seeks comment generally on the proposed expansion of
Rule 605 reporting requirements to include certain orders received
outside of regular trading hours and orders submitted with stop prices,
as well as the proposal to incorporate non-exempt short sale orders
into Rule 605 unless a price test restriction is in effect for the
security. In particular, the Commission solicits comment on the
following:
15. Should the security's opening or re-opening price be required
to be used as a benchmark to determine whether a limit order submitted
outside of regular trading hours is marketable or non-marketable? If
not, what would be an alternative benchmark? Please explain.
16. Should the definition of ``covered order'' include NMLOs
submitted outside of regular trading hours or when the NBBO is not
being disseminated (i.e., limit orders that are not marketable based on
the security's opening or re-opening price)? Should market orders and
marketable limit orders submitted outside of regular trading hours or
when the NBBO is not being disseminated be included within the
definition of ``covered order''? Why or why not? Should these orders be
grouped with other market or marketable limit orders or as new order
type categories?
17. Do commenters agree that requiring orders submitted with stop
prices to be included in Rule 605 reports, and segregating them into
their own order type category, would avoid distorting execution quality
statistics? If not, why not?
18. Do commenters agree that periods when a short sale price test
is in effect are relatively infrequent and clustered around a small
number of isolated events? Why or why not?
19. Should other types of orders be included within the scope of
covered orders? For example, currently intermarket sweep orders
(``ISOs'') with a limit price inferior to the NBBO may
[[Page 3807]]
be viewed to be subject to special handling and are excluded from Rule
605 reports. Should these or other orders types be included within the
scope of covered orders? If so, please explain any additional
requirements or conditions that would help ensure comparability of
order execution quality statistics across reporting entities. For
example, if a new order type should be within the scope of covered
orders, should it be a new order type category or be added to an
existing or proposed order type category (as described in part IV.B.2
below)?
B. Required Information
The categories in Rule 605 reports are intended to strike a balance
between sufficient aggregation of orders to produce statistics that are
meaningful on the one hand, and sufficient differentiation of orders to
facilitate fair comparisons of execution quality across market centers
on the other hand.\255\ When adopting the Rule, the Commission stated
that its experience with the categories prescribed by the Rule may
indicate ways in which they could be improved in the future.\256\
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\255\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75423.
\256\ See id.
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1. Categorization by Order Size
Rule 600(b)(13) defines ``categorized by order size'' as dividing
orders into separate categories based on the number of shares composing
an order.\257\ For the purposes of Rule 605 reports, the largest size
category has bee
[…truncated; see source link]Indexed from Federal Register on January 20, 2023.
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