Rule2024-05556
Disclosure of Order Execution Information
Primary source
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Published
April 15, 2024
Effective
June 14, 2024
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission" or "SEC") is adopting amendments to a rule under the Securities Exchange Act of 1934 ("Exchange Act") that requires disclosures for order executions in national market system ("NMS") stocks. First, the amendments expand the scope of reporting entities subject to the preexisting 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 amendments 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 amendments modify 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. The amendments, as part of the changes to the order size categories, modify the rule to capture execution quality information for fractional share orders, odd-lot orders, and larger-sized orders. Additionally, the amendments 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 amendments modify time-to-execution categories and require average time to execution to be measured in increments of a millisecond or finer and calculated on a share-weighted basis for all orders. The amendments require 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 multiple time intervals. Finally, the amendments enhance the accessibility of the reported execution quality statistics by requiring all reporting entities to make a summary report available.
Full Text
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[Federal Register Volume 89, Number 73 (Monday, April 15, 2024)]
[Rules and Regulations]
[Pages 26428-26617]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-05556]
[[Page 26427]]
Vol. 89
Monday,
No. 73
April 15, 2024
Part III
Securities and Exchange Commission
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17 CFR Parts 240 and 242
Disclosure of Order Execution Information; Final Rule
Federal Register / Vol. 89 , No. 73 / Monday, April 15, 2024 / Rules
and Regulations
[[Page 26428]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-99679; File No. S7-29-22]
RIN 3235-AN22
Disclosure of Order Execution Information
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is adopting amendments to a rule under the Securities Exchange
Act of 1934 (``Exchange Act'') that requires disclosures for order
executions in national market system (``NMS'') stocks. First, the
amendments expand the scope of reporting entities subject to the
preexisting 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 amendments 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 amendments modify 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. The amendments, as part of the changes to the order size
categories, modify the rule to capture execution quality information
for fractional share orders, odd-lot orders, and larger-sized orders.
Additionally, the amendments 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
amendments modify time-to-execution categories and require average time
to execution to be measured in increments of a millisecond or finer and
calculated on a share-weighted basis for all orders. The amendments
require 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 multiple time intervals. Finally, the
amendments enhance the accessibility of the reported execution quality
statistics by requiring all reporting entities to make a summary report
available.
DATES:
Effective date: The final rules are effective June 14, 2024.
Compliance date: See section VII, titled ``Transition Matters,''
for further information on transitioning to the final rules.
FOR FURTHER INFORMATION CONTACT: Kathleen Gross, Senior Special
Counsel, Lauren Yates, Senior Special Counsel, Susie Cho, Special
Counsel, Christopher Chow, Special Counsel, David Michehl, Special
Counsel, or Laura Harper Powell, Special Counsel at (202) 551-5500,
Division of Trading and Markets, Commission, 100 F Street NE,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to 17
CFR 242.600 (``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 (``Rule 605'') as amended, as well as amendments to Rule 605;
and to make conforming amendments to defined terms in 17 CFR 242.602,
242.611, and 242.614; and conforming amendments to defined terms in 17
CFR 240.3a51-1, 240.13h-1, 242.105, 242.201, 242.204, and 242.1000.
Table of Contents
I. Introduction and Background
A. Overview of Need for Rule Modernization
B. Overview of the Proposal and Comments Received
C. Overview of Final Rule 605
II. Modifications to Reporting Entities
A. Larger Broker-Dealers
1. Proposed Approach
2. Final Rule and Discussion
B. Qualified Auction Mechanisms
1. Proposed Approach
2. Final Rule and Discussion
C. NMS Stock ATSs and SDPs
1. Proposed Approach
2. Final Rule and Discussion
III. 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 and Time-to-Execution Statistics
4. Execution Quality Statistics
IV. Summary Execution Quality Report
A. Proposed Approach
B. Final Rule and Discussion
1. Required Information
2. Required Format
3. Investor Testing and Education
V. Requirements for Making Rule 605 Reports Available to the Public
A. Proposed Approach
B. Final Rule and Discussion
1. Accessibility of Rule 605 Reports
2. Alternatives to Rule 605 Proposal
VI. Existing Commission Exemptive Relief and Staff Statements
VII. Transition Matters
VIII. Paperwork Reduction Act
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total PRA Burdens
IX. Economic Analysis
A. Introduction
B. Market Failure
C. Baseline
1. Regulatory Baseline
2. Use of Reports under Rule 605 Prior to Rule Amendments
3. Disclosure Requirements under Preexisting Rule 605
4. Markets for Brokerage and Trading Services for NMS Stocks
under Preexisting Rule 605 Disclosure Requirements
D. Economic Effects
1. Benefits
2. Costs
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
X. Regulatory Flexibility Act Certification
XI. Other Matters
Statutory Authority
I. Introduction and Background
On December 14, 2022, the Commission proposed amendments to Rule
605 under Regulation National Market System (17 CFR 242.600 through
242.614) (``Regulation NMS'') to update the disclosure of order
execution quality statistics in national market system (``NMS'')
stocks.\1\ Rule 605, formerly known as Rule 11Ac1-5, was adopted in
2000 \2\ and requires market centers \3\ to
[[Page 26429]]
make available standardized monthly reports of statistical information
concerning covered orders \4\ in NMS stocks \5\ that they received for
execution.\6\ Prior to these amendments, the Rule 605 report contained
a number of execution quality metrics for covered orders.\7\ The
information was categorized: by (1) individual security, (2) one of
five order types,\8\ and (3) one of four order sizes.\9\ Within each of
the three categories, the Rule 605 report that was required prior to
these amendments included statistics about the total number of orders
submitted, and 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.\10\ For market
and marketable limit orders specifically, the report required by Rule
605 prior to these amendments also included statistics about the (1)
average effective spread; (2) number of shares executed better than the
quote, at the quote, or outside the quote; (3) average time to
execution when executed better than the quote, at the quote, or outside
the quote; and (4) average dollar amount per share that orders were
executed better than the quote or outside the quote.\11\ To calculate
the required statistics, the time of order execution and time of order
receipt were measured to the nearest second.\12\
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\1\ See Securities Exchange Act Release No. 96493 (Dec. 14,
2022), 88 FR 3786 (Jan. 20, 2023) (``Proposing Release'').
\2\ See Securities Exchange Act Release No. 43590 (Nov. 17,
2000), 65 FR 75414 at 75416 (Dec. 1, 2000) (Disclosure of Order
Execution and Routing Practices) (``Rule 11Ac1-5 Adopting
Release''). Along with Rule 11Ac1-5, the Commission also adopted
Rule 11Ac1-6 as part of the Rule 11Ac1-5 Adopting Release. See 17
CFR 242.606 (``Rule 606''). When the Commission later adopted
Regulation NMS in 2005, Rule 11Ac1-5 was re-designated as Rule 605,
and Rule 11Ac1-6 was re-designated as Rule 606. See Securities
Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29,
2005) (``Regulation NMS Adopting Release''). Rule 606 requires the
public disclosure of order routing practices and was amended in
2018. See Securities Exchange Act Release No. 84528 (Nov. 2, 2018),
83 FR 58338 (Nov. 19, 2018) (``2018 Rule 606 Amendments Release'').
\3\ Regulation NMS defines the term ``market center'' to mean
any exchange market maker, over-the-counter (``OTC'') market maker,
alternative trading system (``ATS''), national securities exchange,
or national securities association. See final 17 CFR 242.600(b)(55).
``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 final 17 CFR 242.600(b)(37).
``OTC market makerrdquo; 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 final 17 CFR 242.600(b)(75).
``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 final 17 CFR
242.600(b)(4) (stating that ``alternative trading system'' has the
meaning provided in 17 CFR 242.300(a)). ``National securities
exchange'' means any exchange registered pursuant to section 6 of
the Exchange Act. See final 17 CFR 242.600(b)(63). ``National
securities associationrdquo; means any association of brokers and
dealers registered pursuant to section 15A of the Exchange Act. See
final 17 CFR 242.600(b)(62).
\4\ Prior to these amendments, a ``covered order'' was 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 a national best bid and national best offer
(``NBBO'') is being disseminated, and, if executed, is executed
during regular trading hours, and did not include any orders for
which the customer requests special handling, including, but not
limited to, market on open and market on close orders, stop orders,
all or none orders, and ``not held'' orders. See prior 17 CFR
242.600(b)(22). 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 at
58340, n.19 (Nov. 19, 2018).
\5\ ``NMS stock'' is defined under Regulation NMS as any NMS
security other than an option. See final 17 CFR 242.600(b)(65). An
``NMS security'' is defined as any security or class of securities
for which transaction reports are collected, processed, and made
available pursuant to an effective transaction reporting plan, or an
effective national market system plan for reporting transactions in
listed options. See final 17 CFR 242.600(b)(64).
\6\ See prior 17 CFR 242.605. The procedures for market centers
to make their execution quality data available to the public are set
forth in the National Market System Plan Establishing Procedures
Under Rule 605 of Regulation NMS (``Rule 605 NMS Plan''). See prior
17 CFR 242.605(a)(2) and Securities and Exchange Commission File No.
4-518 (Rule 605 NMS Plan). See also Securities Exchange Act Release
No. 44177 (Apr. 12, 2001), 66 FR 19814 (Apr. 17, 2001) (order
approving the Rule 605 NMS Plan) (``Rule 605 NMS Plan Release'').
\7\ See prior 17 CFR 242.605(a)(1); Rule 11Ac1-5 Adopting
Release, 65 FR 75414 at 75423-25 (Dec. 1, 2000).
\8\ See prior 17 CFR 242.605(a)(1). Prior to these amendments,
``Categorized by order type'' referred to categorization by whether
an order is: (1) a market order, (2) a marketable limit order, (3)
an inside-the-quote limit order, (4) an at-the-quote limit order, or
(5) a near-the-quote limit order. See prior 17 CFR 242.600(b)(14).
\9\ See prior 17 CFR 242.605(a)(1). Prior to these amendments,
the size categories were: 100 to 499 shares; 500 to 1,999 shares;
2000 to 4,999 shares; and 5,000 or greater shares. See prior 17 CFR
242.600(b)(13). On June 22, 2001, the Commission granted exemptive
relief to any order with a size of 10,000 shares or greater (``Large
Order Exemptive Relief''), 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 Group, Inc., dated June
22, 2001 (``Large Order Exemptive Letter'').
\10\ See prior 17 CFR 242.605(a)(1)(i).
\11\ See prior 17 CFR 242.605(a)(1)(ii).
\12\ See prior 17 CFR 242.600(b)(91), (92).
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At the time the Commission adopted Rule 11Ac1-5, there was little
publicly available information to enable investors to compare and
evaluate execution quality among different market centers.\13\ Rule
605, along with Rule 606 of Regulation NMS, was adopted in 2000, and
together these rules required the public disclosure of execution
quality and order routing practices.\14\ The Commission intended Rule
11Ac1-5 to provide awareness 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.\15\ The
Commission reasoned that once investors could evaluate execution
performance provided by various broker-dealers, 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.\16\
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\13\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75416
(Dec. 1, 2000). For clarity, when this release discusses the
adoption of Rule 605, it is referring to the Rule 11Ac1-5 Adopting
Release, supra note 2.
\14\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75416
(Dec. 1, 2000).
\15\ See id. at 75418. 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
Proposing Release, 88 FR 3786 at 3833, n.545-547 (Jan. 20, 2023) and
accompanying text.
\16\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75419
(Dec. 1, 2000). Although it is difficult to isolate the effects of
Rule 605 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 et
al., 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'').
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The information disclosed under Rule 605 has provided significant
insight into execution quality at different market centers.\17\
However, Rule 605 has not been substantively updated since it was
adopted in 2000. In the interim, equity market conditions have changed
due in part to many technological advancements that have altered the
speed and nature of trading. In addition, the participation of
individual investors in the equity markets has increased.\18\
Accordingly, the Commission is adopting amendments to Rule 605 to
update and improve the disclosure of execution quality information by
[[Page 26430]]
expanding the scope of entities subject to Rule 605, modifying the
information required, and making key execution quality metrics more
accessible to investors.
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\17\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594 at 3604, n.55 (Jan. 21, 2010) (``Concept Release
on Equity Market Structure'').
\18\ See Proposing Release, 88 FR 3786 at 3787-88 (Jan. 20,
2023). As used in this release, ``individual investor'' refers to
natural persons that trade relatively infrequently for their own or
closely related accounts.
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A. Overview of Need for Rule Modernization
The U.S. equity markets have evolved significantly in the last
couple of decades. For instance, the equities markets have become
increasingly fragmented, as both the market shares of individual
national securities exchanges have decreased and an increased
percentage of order flow has moved off-exchange. In 2000, there were
nine registered national securities exchanges and one registered
national securities association.\19\ A large proportion of the order
flow in listed equity securities was routed to a few, mostly manual,
trading centers,\20\ and the primary listing exchanges maintained a
high percentage of the order flow for exchange-listed equities.\21\
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\19\ 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>.
\20\ See Securities Exchange Act Release Nos. 78309 (July 13,
2016), 81 FR 49432 at 49436 (July 27, 2016) (``Rule 606 Amendments
Proposing Release''); 42450 (Feb. 23, 2000), 65 FR 10577 at 10579-80
(Feb. 28, 2000) (``Fragmentation Release'').
\21\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75415
(Dec. 1, 2000) (stating that in Sep. 2000, for example, the New York
Stock Exchange Inc. (``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 at
3595 (Jan. 21, 2010) (stating that in Jan. 2005, NYSE executed
approximately 79.1% of the consolidated share volume in its listed
stocks, as compared to 25.1% in Oct. 2009). In addition, NYSE-listed
stocks were traded primarily on the floor of the NYSE in a manual
fashion until Oct. 2006, at which time NYSE began to offer fully
automated access to its displayed quotations. See id. 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 at 10580 (Feb. 28, 2000). See also Proposing
Release, 88 FR 3786 at 3791, n.76 (Jan. 20, 2023).
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In contrast, trading in the U.S. equity markets today is highly
automated and spread even more 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 self-regulatory organization
(``SRO'') trading facilities; \22\ (2) ATSs that trade NMS stocks
(``NMS Stock ATSs''); \23\ (3) exchange market makers; (4) wholesalers;
\24\ and (5) any other broker-dealer that executes orders internally by
trading as principal or crossing orders as agent.\25\ Some OTC market
makers, such as wholesalers, operate single-dealer platforms (``SDPs'')
through which they execute institutional orders in NMS stocks against
their own inventory.\26\ In the first quarter of 2023, NMS stocks were
traded on 16 national securities exchanges, and off-exchange at 33 NMS
Stock ATSs and at over 220 other Financial Industry Regulatory
Authority (``FINRA'') members.\27\Approximately 56% of NMS share volume
was executed on national securities exchanges.\28\ The majority of off-
exchange share volume was executed by wholesalers, who executed over
one quarter of total share volume (26.9%) and about 61% of off-exchange
share volume.\29\
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\22\ See final 17 CFR 242.600(b)(100) (defining ``SRO trading
facility'' as, among other things, a facility operated by a national
securities exchange that executes orders in a security).
\23\ An ``NMS Stock ATS'' as used in this release is an ATS that
has filed an effective Form ATS-N with the Commission.
\24\ 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. 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.
\25\ 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 final 17 CFR
242.600(b)(106) (defining ``trading center''). 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.
\26\ See Proposing Release, 88 FR 3786 at 3860, n.768 (Jan. 20,
2023) and accompanying text.
\27\ See infra Table 6. See also Proposing Release, 88 FR 3786
at 3860, n.766 (Jan. 20, 2023) and accompanying text; and 3861
(Table 7).
\28\ See infra Table 6. See also Proposing Release, 88 FR 3786
at 3860, n.767 (Jan. 20, 2023) and accompanying text; and 3861
(Table 7).
\29\ See infra Table 6. See also Proposing Release, 88 FR 3786
at 3861 (Table 7) (Jan. 20, 2023).
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In addition, developments in trading further point toward the
utility of amending Rule 605. Average stock prices have continued to
increase over time,\30\ and odd-lots \31\ and fractional shares \32\
continue to trade with increasing frequency. In addition, odd-lot
quotes in higher-priced stocks continue to offer prices that are
frequently better than the round lot NBBO for these stocks,\33\ and
this better-
[[Page 26431]]
priced odd-lot liquidity is distributed across multiple price
levels.\34\ In addition, odd-lot rates \35\ have increased among lower
priced stocks.\36\ Because Rule 605 size categories prior to these
amendments excluded orders smaller than 100 shares, a significant
proportion of market activity was excluded.\37\ An analysis of Rule 605
data shows that Rule 605 coverage has declined in the decades since the
initial adoption of Rule 605.\38\ Further, because order size
categories were tied to the number of shares, the categories may have
grouped orders of very different notional values, which might have
complicated comparisons of aggregate execution quality. Finally, the
speed of trading in the market has increased exponentially since
2000,\39\ rendering the 1 second timestamp conventions of preexisting
Rule 605 less informative.
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\30\ See Securities Exchange Act Release No. 90610 (Dec. 9,
2020), 86 FR 18596 at 18606-07 (Apr. 9, 2021) (``Market Data
Infrastructure (``MDI'') Adopting Release'') (citing Securities
Exchange Act Release No. 88216 (Feb. 14, 2020), 85 FR 16726 at 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''). See also Proposing Release,
88 FR 3786 at 3787, n.16 (Jan. 20, 2023).
\31\ See MDI Adopting Release, 86 FR 18596 at 18616 (Apr. 9,
2021) (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);
and Proposing Release, 88 FR 3786 at 3792, n.91 (Jan. 20, 2023)
(describing analysis using the NYSE Trade and Quote database
(obtained via Wharton Research Data Services (``WRDS'')) (``TAQ
data'' or ``NYSE TAQ data'') that found that odd-lots increased from
around 15% of trades in Jan. 2014 to more than 55% of trades in Mar.
2022). An analysis of data from the SEC's Market Information Data
Analytics System (``MIDAS'') analytics tool available at <a href="https://www.sec.gov/marketstructure/datavis.html#">https://www.sec.gov/marketstructure/datavis.html#</a>.YoPskqjMKUk shows that, in
Q1 2023, odd-lots made up 80.5% of on-exchange trades (37.3% of
volume) for stocks in the highest price decile and 18.8% of on-
exchange trades (1.2% 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>. See
also Proposing Release, 88 FR 3786 at 3792, n.91 (Jan. 20, 2023).
\32\ Analysis using Consolidated Audit Trail (``CAT'') data for
executed orders in Aug. 2023 found that an estimated 67.4 million
originating orders with a fractional share component were eventually
executed on- or off-exchange. Orders with a fractional share
component represented approximately 4% of all executed orders and
22% of executed orders from ``individual'' accounts. Generally,
accounts classified as ``individual'' in CAT are attributed to
natural persons. See also Proposing Release, 88 FR 3786 at 3792,
n.92 (Jan. 20, 2023).
\33\ See MDI Adopting Release, 86 FR 18596 at 18729 (Apr. 9,
2021) (describing analysis using data from May 2020 and finding that
approximately 45% of all trades executed on exchange and
approximately 10% of all volume executed on exchange in corporate
stocks and exchange-traded funds (``ETFs'') (6,926 unique symbols)
occurred in odd-lot sizes (i.e., less than 100 shares) and 40% of
those odd-lot transactions (representing approximately 35% of all
odd-lot volume) occurred at a price better than the NBBO). 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
(working paper Feb. 1, 2022), available at SSRN: <a href="https://ssrn.com/abstract=4027099">https://ssrn.com/abstract=4027099</a> (retrieved from SSRN Elsevier database)
(``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 Jan. 2019 to
Jan. 2022). See also Proposing Release, 88 FR 3786 at 3792, n.93
(Jan. 20, 2023).
\34\ See MDI Adopting Release, 86 FR 18596 at 18613 n.202 (Apr.
9, 2021) (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). See also Proposing Release, 88 FR
3786 at 3792, n.94 (Jan. 20, 2023).
\35\ The odd-lot rate is the total number of odd-lot trades
divided by the total number of all trades.
\36\ 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, 2022, and
Sep. 2023 (34%, 34%, 34%) as compared to 2019 and 2020 (23%, 27%).
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, 2022, and Sep.
2023 (26%, 28%, 28%) compared to 2019 and 2020 (19%, 22%). Analysis
has been updated based on MIDAS, available at <a href="https://www.sec.gov/opa/data/market-structure/marketstructuredownloadshtml-by_decile_and_quartile">https://www.sec.gov/opa/data/market-structure/marketstructuredownloadshtml-by_decile_and_quartile</a>. See also Proposing Release, 88 FR 3786 at
3792, n.95 (Jan. 20, 2023).
\37\ See Proposing Release, 88 FR 3786 at 3792, n.91-92 (Jan.
20, 2023). See also id. at 3840, n.619-622 and accompanying text
(estimating, based on analysis of Tick Size Pilot data, coverage of
current Rule 605 reporting requirements).
\38\ See id. at 3841 (Figure 3) (describing analysis comparing
one market center's volume (NYSE) to TAQ data that showed that an
estimated 50% of shares executed during regular market hours were
included in Rule 605 reports as of Feb. 2021, and showed that this
number has been on a slightly downward trend since around mid-2012).
\39\ Analysis of data from the SEC's MIDAS analytics tool shows
that the percent of on-exchange NMLOs that are fully executed within
1 millisecond (as a percentage of all fully executed on-exchange
NMLOs) has increased from 2.1% in Q1 2012 to 11.7% in Q1 2023 for
small cap stocks, and from 5.9% in Q1 2012 to 14.0% in Q1 2023 for
large cap stocks. Further, in Q1 2023 nearly half (48.0%) of NMLOs
executed in less than 1 second in large market capitalization
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 notes 1216-1217 and accompanying text. See also Proposing
Release, 88 FR 3786 at 3792, n.98 (Jan. 20, 2023).
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Moreover, since the adoption of Rule 605, the Commission and its
staff have continually assessed market events and their impact on
market structure, with much of this effort aimed at achieving enhanced
transparency for investors.\40\ In 2010, the Commission issued a
Concept Release on Equity Market Structure seeking public comment on,
among other things, the metrics for assessing the performance of the
current market structure and the effectiveness of tools such as Rule
605 reports to protect investor interests.\41\ In 2015, the Commission
formed the Equity Market Structure Advisory Committee (``EMSAC''),
which considered issues related to Regulation NMS and equity market
structure.\42\ The EMSAC recommended that the Commission amend Rule 605
to modernize it and increase the usefulness of available execution
quality disclosures.\43\ In addition, one broker-dealer petitioned the
Commission to amend Rule 605.\44\
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\40\ For example, since the adoption of Rule 605 in 2000, the
Commission has periodically revised certain of its NMS rules,
including the adoption of Regulation NMS in 2005. See, e.g.,
Regulation NMS Adopting Release, 70 FR 37496 (June 29, 2005); and
MDI Adopting Release, 86 FR 18596 (Apr. 9, 2021).
\41\ See Concept Release on Equity Market Structure, 75 FR 3594
at 3605 (Jan. 21, 2010).
\42\ The archives of these meetings are available at <a href="https://www.sec.gov/spotlight/emsac/emsac-archives.htm">https://www.sec.gov/spotlight/emsac/emsac-archives.htm</a>.
\43\ 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>.
\44\ See Letter from Virtu Financial re Petition for Rulemaking
to Amend SEC Rule 605 (Sept. 20, 2021) (``Virtu Petition''),
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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In 2018, the Commission modified Rule 606, which requires broker-
dealers to disclose the identity of market centers to which they route
orders on behalf of customers.\45\ Rule 606(a)(1), which focuses on
held orders,\46\ requires broker-dealers to produce quarterly public
reports regarding their routing of non-directed orders \47\ in NMS
stocks that are submitted on a held basis and these reports include the
identity of regularly used venues, the percentage of orders routed to
each venue, and information about the broker-dealer's relationship with
each venue.\48\ 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.\49\ 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.\50\ The Commission also adopted Rule 606(b)(3) to
require detailed, customer-specific order handling disclosures that can
be requested by a customer that places, directly or indirectly, one or
more orders in NMS stocks that are submitted on a not held basis.\51\
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\45\ The amendments to Rule 606 in 2018 (``2018 Rule 606
Amendments'') also modified Rule 605 to require that the public
order execution quality reports be kept publicly available for a
period of three years. See 2018 Rule 606 Amendments Release, 83 FR
58338 (Nov. 19, 2018).
\46\ See supra note 4 (discussing held and not held orders).
\47\ A ``non-directed order'' means any order from a customer
other than a directed order. See final 17 CFR 242.600(b)(66). 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 final 17 CFR 242.600(b)(32).
\48\ See 17 CFR 242.606(a)(1). Held orders are typically used by
individual investors. See, e.g., 2018 Rule 606 Amendments Release,
83 FR 58338 at 58372 (Nov. 19, 2018) (stating that retail investors'
orders are typically submitted on a held basis and are typically
smaller in size).
\49\ See 2018 Rule 606 Amendments Release, 83 FR 58338 at 58372
(Nov. 19, 2018).
\50\ See id. at 58373.
\51\ See 17 CFR 242.606(b)(3); 2018 Rule 606 Amendments Release,
83 FR 58338 at 58345 (Nov. 19, 2018) (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).
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At the time of the 2018 Rule 606 Amendments, the Commission
considered suggestions from the EMSAC and other commenters that the
Commission include more or different execution quality statistics in
the required disclosures.\52\ But the Commission stated that the
enhancements to Rule 606(a) that it was adopting were appropriately
designed to enable customers- and retail customers in particular-to
better assess their broker-dealers' order routing performance and, in
particular, potential conflicts of interest that their broker-dealers
face when routing customer orders and how their broker-dealers manage
those potential
[[Page 26432]]
conflicts.\53\ The Commission further stated the limited modifications
being adopted at that time 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.\54\ However, the Commission stated 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.\55\
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\52\ See 2018 Rule 606 Amendments Release, 83 FR 58338 at 58379
(Nov. 19, 2018). See also Proposing Release, 88 FR 3786 at 3790,
n.66 (Jan. 20, 2023) and accompanying text.
\53\ See 2018 Rule 606 Amendments Release, 83 FR 58338 at 58379
(Nov. 19, 2018).
\54\ See id. The Commission further stated that the amendments
to Rule 606 provide an appropriate level of insight into the
widespread financial arrangements between broker-dealers and
execution venues that may affect broker-dealers' order routing
decisions. See id.
\55\ See id.
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Separately, each broker-dealer has a legal duty to seek to obtain
best execution of customer orders.\56\ The duty of best execution
requires broker-dealers to execute customers' trades at the most
favorable terms reasonably available under the circumstances.\57\ When
adopting Rules 605 and 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.\58\ 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.\59\ 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.\60\
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\56\ See, e.g., Regulation NMS Adopting Release, 70 FR 37496 at
37537 (June 29, 2005); 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 has
separately proposed a rule concerning broker-dealers' duty of best
execution. See Securities Exchange Act Release No. 96496 (Dec. 14,
2022), 88 FR 5440 (Jan. 27, 2023) (``Regulation Best Execution
Proposing Release''). See also Proposing Release, 88 FR 3786 at
3790, n.69 (Jan. 20, 2023).
\57\ See Regulation NMS Adopting Release, 70 FR 37496 at 37538
(June 29, 2005) (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. See also
Proposing Release, 88 FR 3786 at 3791, n.70 (Jan. 20, 2023).
\58\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75420
(Dec. 1, 2000).
\59\ See id.
\60\ 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 1097-1098 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.
See also Proposing Release, 88 FR 3786 at 3791 (Jan. 20, 2023).
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B. Overview of the Proposal and Comments Received
In acknowledgment of the myriad changes to the securities markets
since the adoption of Rule 605 more than two decades ago, the proposed
amendments to Rule 605 sought to ensure the continued transparency and
utility of the execution quality statistics required by Rule 605. The
Commission proposed to amend Rule 605 by expanding the scope of
reporting entities to include broker-dealers with a larger number of
customers (``larger broker-dealers'').\61\ The Commission also proposed
to modify the set of required data to capture execution quality
information for more order types and sizes, require time-based
execution statistics to be at a more granular level, and enhance the
utility of the statistics.\62\ The Commission further proposed to
require that reporting entities provide a report of summary execution
quality statistics, in addition to the more detailed reports.\63\
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\61\ See Proposing Release, 88 FR 3786 at 3796-3801 (Jan. 20,
2023). Throughout the release, the term ``larger broker-dealer''
refers to a broker-dealer that meets or exceeds the ``customer
account threshold,'' as defined in final Rule 605(a)(7). See also
infra section II.A.
\62\ See Proposing Release, 88 FR 3786 at 3804-22 (Jan. 20,
2023).
\63\ See id. at 3823-25.
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The Commission received numerous comment letters in response to the
Proposing Release, a large portion of which were from individual
investors.\64\ Many commenters supported updating the disclosures
required by Rule 605.\65\ Several commenters, including industry
groups, broker-dealers, financial services firms,\66\ and investor
advocacy groups, suggested clarifications or changes to the scope of
reporting entities and to certain proposed metrics included in the
detailed report or summary report.\67\ Other commenters broadly
supported the more detailed recommendations of other commenters.\68\
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\64\ The Commission received comments from a wide range of
market participants, including individual investors, broker-dealers,
academics, securities industry groups, national securities
exchanges, and investor advocacy groups. Comments received on the
Proposing Release are available on the Commission's website,
available at <a href="https://www.sec.gov/comments/s7-29-22/s72922.htm">https://www.sec.gov/comments/s7-29-22/s72922.htm</a>.
\65\ See, e.g., letters from: Ellen Greene, Managing Director,
Equity Options Market Structure, SIFMA (Mar. 31, 2023) (``SIFMA
Letter II'') at 2; Stephen John Berger, Managing Director, Global
Head of Government and Regulatory Policy, Citadel Securities (Mar.
31, 2023) (``Rule 605 Citadel Letter'') at 1; Stephen W. Hall, Legal
Director and Securities Specialist, Better Markets, Inc. (Mar. 31,
2023) (``Better Markets Letter'') at 1-2.
\66\ As used in this release, ``financial services firm'' refers
to an entity that includes multiple types of affiliated entities
providing financial services, including broker-dealers, investment
advisers, or banks.
\67\ See, e.g., SIFMA Letter II at 27-28; and letters from:
Howard Meyerson, Managing Director, Financial Information Forum
(Mar. 31, 2023) (``FIF Letter'') at 2-5; Tyler Gellasch, President
and CEO, Healthy Markets Association (Mar. 31, 2023) (``Healthy
Markets Letter'') at 16-18; Douglas A. Cifu, Chief Executive
Officer, Virtu Financial, Inc. (Mar. 30, 2023) (``Virtu Letter II'')
at 10-12. These and other comment letters discussing the scope of
reporting entities and proposed metrics included in the detailed
report or summary report are described infra throughout this
release.
\68\ See, e.g., Rule 605 Citadel Letter at 5; and letters from:
Ryan Kwiatkowski, Chairman of the Board, and James Toes, President &
CEO, Security Traders Association (Apr. 3, 2023) (``STA Letter'') at
4-5; Derrick Chan, Head of Equities, Fidelity Capital Markets (Mar.
31, 2023) (``Fidelity Letter'') at 2, 8; Naureen Hassan, President,
UBS Americas, Robert Karofsky, President, UBS Investment Bank, and
Suni Harford, President, UBS Asset Management, UBS (Mar. 31, 2023)
(``UBS Letter'') at 2; Tim Gately, Managing Director, Head of
Equities Sales, Americas, Citigroup Global Markets Inc. (Mar. 31,
2023) (``CGMI Letter'') at 1-2, 3; Jason Clague, Managing Director,
Head of Operations, The Charles Schwab Corporation (Mar. 31, 2023)
(``Schwab Letter II'') at 2, 30, 33. These and other comment letters
discussing the recommendations of other commenters are described
infra throughout this release. Several individual investors stated
that in Dec. 2022, FINRA and the Commission sent out risk alerts
regarding a lack of compliance with reports pursuant to Rule 606 of
Regulation NMS and that ``one would suspect that brokers will be as
non-compliant with the new 605 reports.'' Letter Type D; Letter Type
E; and Letter Type H at <a href="https://www.sec.gov/comments/s7-29-22/s72922.htm">https://www.sec.gov/comments/s7-29-22/s72922.htm</a>. The Commission will monitor the implementation of the
amendments to Rule 605.
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One industry group recommended that the Commission reissue the
proposed rule after incorporating comments from it and other market
participants ``to ensure that the final rule achieves the Commission's
intended purpose and allow market participants to identify additional
enhancements.'' \69\ A broker-dealer
[[Page 26433]]
stated that the Commission should provide market participants the
opportunity to review and comment on such a revised proposal prior to
finalization.\70\ The Commission does not agree with these commenters.
Delaying the adoption of a final rule, and thereby delaying the
benefits of Rule 605, is not warranted. The Commission has reviewed and
carefully considered the extensive comment file,\71\ which included
input from a broad array of market participants, and as discussed
below, has made certain changes in response to these comments.\72\ For
these reasons, re-proposal of the Rule 605 amendments is not necessary.
---------------------------------------------------------------------------
\69\ Letter from Howard Meyerson, Managing Director, Financial
Information Forum (June 22, 2023) (``FIF Letter II'') at 11. See
also letter from Howard Meyerson, Managing Director, Financial
Information Forum (Feb. 14, 2024) (``FIF Letter III'') at 2, 5.
\70\ See letter from Stephen John Berger, Managing Director,
Global Head of Government & Regulatory Policy, Citadel Securities
(Dec. 5, 2023) (``Equity Market Structure Citadel Letter II'') at 3.
\71\ The Commission voted to issue the Proposing Release on Dec.
14, 2022. The release was posted on the Commission's website that
day, and comment letters were received beginning the same day. The
comment period closed on Mar. 31, 2023. The Commission has
considered comments received since Dec. 14, 2022.
\72\ In addition, as discussed above, the EMSAC and commenters
responding to the Commission's Concept Release on Equity Market
Structure and to the 2018 Rule 606 Amendments recommended that the
Commission update Rule 605 and one broker-dealer petitioned the
Commission to amend the Rule. See supra notes 40-44, 52, and
accompanying text. The Commission considered these suggestions when
proposing amendments to Rule 605. See Proposing Release, 88 FR 3786
at 3792-95 (Jan. 20, 2022).
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Contemporaneously with the proposal to modify Rule 605, the
Commission issued three other proposals related to separate aspects of
equity market structure and Regulation NMS.\73\ A number of commenters
provided comments on all four proposals jointly.\74\ Some commenters
requested that the Commission publicly release anonymized subsets of
CAT data used in connection with the tables and figures in the
proposals' economic analyses.\75\
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\73\ See Regulation Best Execution Proposing Release, 88 FR 5440
(Jan. 27, 2023) (proposing rule that would establish Commission
rule-based best execution standards); and Securities Exchange
Release Nos. 96494 (Dec. 14, 2022), 87 FR 80266 (Dec. 29, 2022)
(``Minimum Pricing Increments Proposing Release'') (proposing
amendments to Regulation NMS to reduce minimum pricing increments,
add a minimum trading increment, reduce access fee caps, improve
transparency of exchange fees and rebates, and enhance the
transparency of market data infrastructure); 96495 (Dec. 14, 2022),
88 FR 128 (Jan. 3, 2023) (``Order Competition Rule Proposing
Release'') (proposing rule that would enhance competition for the
execution of marketable orders of individual investors).
\74\ See, e.g., SIFMA Letter II (Mar. 31, 2023); Equity Market
Structure Citadel Letter II (Dec. 5, 2023); and letters from:
Michael Blaugrund, Chief Operating Officer, NYSE Group, Inc., Jason
Clague, Managing Director, Head of Operations, Charles Schwab & Co.,
and Joseph Mecane, Head of Execution Services, Citadel Securities
(Mar. 6, 2023) (``NYSE, Schwab, and Citadel Letter''); Christopher
A. Iacovella, President & Chief Executive Officer, American
Securities Association (Mar. 31, 2023) (``American Securities
Association Letter II''); Hope Jarkowski, General Counsel, NYSE
Group, Inc. (Mar. 31, 2023) (``NYSE Letter''); Stephen John Berger,
Managing Director, Global Head of Government & Regulatory Policy,
Citadel Securities (Mar. 31, 2023) (``Equity Market Structure
Citadel Letter''); Jason Clague, Managing Director, Head of
Operations, The Charles Schwab Corporation (Mar. 22, 2023) (``Schwab
Letter''); Kirsten Wegner, Chief Executive Officer, Modern Markets
Initiative (Mar. 24, 2023) (``Modern Markets Initiative Letter'');
Joanna Mallers, Secretary, FIA Principal Traders Group (Mar. 31,
2023) (``FIA PTG Letter II''); Peter D. Stutsman, Global Head of
Equity Trading, and Timothy J. Stark, Head of Equity Markets and
Transaction Research, The Capital Group Companies, Inc. (Mar. 31,
2023) (``Capital Group Letter''); Andrew Hartnett, NASAA President
and Deputy Commissioner, Iowa Insurance Division, North American
Securities Administrators Association, Inc. (Mar. 31, 2023) (``NASAA
Letter''); David Howson, Executive Vice President, Global President,
Cboe Global Markets, Nathaniel N. Evarts, Managing Director, Head of
Trading, Americas, State Street Global Advisors, Kimberly Russell,
Market Structure Specialist, Global SPDR Business, State Street
Global Advisors, Mehmet Kinak, Global Head of Equity Trading, T.
Rowe Price, Todd Lopez, Americas Head of Execution Services, UBS
Securities LLC, and Douglas A. Cifu, Chief Executive Officer, Virtu
Financial, Inc. (Mar. 24, 2023) (``Cboe, State Street, et al.,
Letter''); John A. Zecca, Executive Vice President, Global Chief
Legal, Risk & Regulatory Officer, Nasdaq, Inc. (Mar. 30, 2023)
(``Nasdaq Letter''); Jennifer W. Han, Executive Vice President,
Chief Counsel & Head of Global Regulatory Affairs, Managed Funds
Association (Mar. 30, 2023) (``Managed Funds Association Letter'');
Jonathan Kanter, Assistant Attorney General, Antitrust Division,
U.S. Department of Justice (Apr. 11, 2023) (``DOJ Letter'');
Nathanial N. Evarts, Managing Director, Head of Trading, Americas,
and Kimberly Russell, Market Structure Specialist, Global SPDR
Business, State Street Global Advisors (Mar. 30, 2023) (``State
Street Global Advisors Letter''); Michael Markunas, Deputy General
Counsel, Chief Compliance Officer, B. Riley Securities, Inc. (Mar.
31, 2023) (``B. Riley Letter'').
\75\ See, e.g., Virtu Letter at 1; Equity Market Structure
Citadel Letter at 16-17; Schwab Letter II at 3-4 (``there is a
distinct absence of economic data to support many aspects of the
Proposals and to support the Commission's analysis of costs versus
benefits . . . CAT data is not publicly available and thus public
commenters . . . do not have access to the very data on which the
Commission relies''); and letters from: Ellen Greene, Managing
Director, Equity & Options Market Structure, SIFMA (Feb. 8, 2023)
(``SIFMA Letter'') at 3-4; Kristen Malinconico, Director, Center for
Capital Markets Competitiveness, U.S. Chamber of Commerce (Mar. 31,
2023) (``Chamber of Commerce Letter'') at 2-3. Some of these
commenters also requested that the Commission identify the specific
broker-dealers whose Rule 605 and Rule 606 reports, which are
publicly available, were used in the proposals. See, e.g., SIFMA
Letter at 2; Virtu Letter at 1-2.
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The Commission is not releasing anonymized subsets of CAT data used
in connection with the proposals, including CAT data used in connection
with data and figures in the Proposing Release. The CAT database
contains highly sensitive and granular market information.\76\ The
Commission fully described in the Proposing Release and this Release
the CAT data used, the methodology for analysis, and the results of its
analyses. This provides notice of the Commission's use and analysis of
CAT data in support of this rulemaking.\77\
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\76\ See, e.g., Securities Exchange Act Release No. 67457 (July
18, 2012), 77 FR 45722 at 56978 (Aug. 1, 2012) (stating that
maintaining the confidentiality of customer and other information
reported to CAT ``is essential'' and that ``[w]ithout adequate
protections, market participants would risk the exposure of highly-
confidential information about their trading strategies and
positions''); Securities Exchange Act Release No. 84696 (Nov. 15,
2016), 81 FR 84696 (Nov. 23, 2016) (stating that a security breach
involving CAT data could, among other things, ``leak highly-
confidential information about trading strategies or positions,
which could be deleterious for market participants' trading profits
and client relationships'' or ``expose proprietary information about
the existence of a significant business relationship with either a
counterparty or a client, which could reduce business profits'').
\77\ In addition, the Commission declines to provide the
identities of the specific broker-dealers whose Rule 606 reports
were used in connection with the Proposing Release. See supra note
75. The reports themselves are publicly available and interested
parties can analyze these reports using their own selection of
broker-dealers. As with the CAT data, the Commission has fully
described in the Proposing Release the Rule 606 data used, the
methodology for analysis, and the results of its analyses. This
information provides notice of the Commission's use and analysis of
Rule 606 data used in support of this rulemaking.
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Market participants, such as broker-dealers, may analyze their own
order and transaction information as well as commercially available
data and use this analysis to provide meaningful comment on the
Proposing Release from their own perspectives.\78\ The level of
aggregation that would be required to protect market and proprietary
information so that it cannot be used, either itself, or with other
commercially or publicly available information, to reverse engineer or
otherwise reveal market participants' identities, market
[[Page 26434]]
positions, or trading strategies would also mean that the dataset would
be substantially dissimilar from the actual data used in the
Commission's analysis.
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\78\ For example, the SEC's MIDAS analytics tool collects and
processes data from the consolidated tapes as well as from the
separate proprietary feeds made individually available by each
equity exchange. See MIDAS: Market Information Data Analytics
System, SEC, available at <a href="https://www.sec.gov/marketstructure/midas-system">https://www.sec.gov/marketstructure/midas-system</a>. See also letter from John Ramsay, Chief Market Policy
Officer, Investors Exchange LLC (``IEX'') (Oct. 13, 2023) (``IEX
Letter'') at 3 (stating that there are ``myriad sources of
information that . . . market participants draw on to consider how
orders are handled and how markets compete with and compare to each
other,'' including NYSE TAQ data, other exchange proprietary and
consolidated market data, and FINRA's reports on off-exchange
trading). See also, e.g., infra note 330 (FIF Letter) and
accompanying text; notes 113-114 (Professor Christopher Schwarz,
University of California Irvine, Professor Brad Barber, University
of California, Davis, Professor Xing Huang, Washington University in
St. Louis, Professor Philippe Jorion, University of California,
Irvine, Professor Terrance Odean, University of California, Berkeley
(Feb. 7, 2023) (``Professor Schwarz et al. Letter'')) and
accompanying text.
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In addition, several commenters suggested a sequencing of the
equity market structure proposals, such that the Commission would
implement the amendments to Rule 605 and evaluate the execution quality
data from the updated reports, before undertaking further action on the
remaining equity market structure proposals.\79\ One group of members
of Congress recommended that no equity market structure rule ``should
be finalized or implemented'' until the Commission ``[c]onduct[s] a
comprehensive cost-benefit analysis of the aggregate impact of [these
rules] and seek[s] public comment on this analysis[,]'' and proposes
``a reasonable, workable, and staggered schedule for public comment on
the adoption and implementation of the proposals, considering their
overlapping nature, significant compliance and operational burdens, and
if they may be insurmountable for smaller or emerging firms.'' \80\ As
discussed below in the economic analysis, the Commission uses as a
baseline the world as it exists today, including adopted rules but not
proposed rules.\81\ Comments on how the adoption of the Rule 605
amendments should affect the timing or sequence of the other equity
market structure proposals will be considered if and when those rules
are acted on. Similarly, because the effects of the final rule are
measured against the existing regulatory baseline, which does not
include rules that have not been adopted, the Commission does not agree
that an additional analysis of the aggregate impact of the several
equity market structure rules is necessary before the adoption of the
Rule 605 amendments.\82\
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\79\ See, e.g., SIFMA Letter II at 2 (``[o]nce an amended Rule
605 is implemented, the Commission will have the data it needs to
fully assess market quality and consider whether additional
rulemaking is needed and how any such rulemaking should be
designed''); Equity Market Structure Citadel Letter II at 1-3; NYSE,
Schwab and Citadel Letter at 1-2; STA Letter at 4; Modern Markets
Initiative Letter at 2; Cboe, State Street, et al. Letter dated Mar.
24, 2023 at 1-2; Managed Funds Association Letter at 2; T. Rowe
Letter at 3; UBS Letter at 1-2; Virtu Letter II at 2; SIFMA Letter
II at 11; Professor Schwarz et al. Letter at 5; and letters from
Bill Foster, French Hill, Henry Cuellar, Bill Huizenga, Wiley
Nickel, Andy Barr, Ritchie Torres, Ann Wagner, Brittany Pettersen,
Dan Meuser, Josh Gottheimer, Mike Flood, Vicente Gonzalez, Byron
Donalds, Mike Quigley, Michael V. Lawler, David Scott, Andrew R.
Garbarino, Gregory W. Meeks, Monica De La Cruz, Sean Casten, Scott
Fitzgerald, Bradley S. Schneider, Erin Houchin, Jim Himes, Young
Kim, Steven Horsford, Ralph Norman, Gwen Moore, Tom Emmer, Marc
Veasey, and Zach Nunn, United States House of Representatives (Sep.
26, 2023) at 2; Michelle Bryan Oroschakoff, Managing Director and
Chief Legal Officer, LPL Financial (Mar. 31, 2023) (``LPL Financial
Letter'') at 3-4; Chester Spatt, Pamela R. and Kenneth B. Dunn
Professor of Finance, Tepper School, Carnegie Mellon University and
former Chief Economist, U.S. Securities and Exchange Commission
(2004-2007), Thomas Ernst, Assistant Professor of Finance, Smith
School of Business, University of Maryland, Andrey Malenko,
Professor of Finance, Carroll School of Management, Boston College,
Jian Sun, Assistant Professor of Finance, Le Kong Chian School of
Business, Singapore Management University (Nov. 29, 2023)
(``Professor Spatt et al. Letter'') at 5; see also letter from
Patrick McHenry, French Hill, Frank Lucas, Pete Sessions, Bill
Posey, Blaine Luetkemeyer, Bill Huizenga, Ann Wagner, Andy Barr,
Roger Williams, Tom Emmer, Barry Loudermilk, Alexander X. Mooney,
Warren Davidson, John Rose, Bryan Steil, William Timmons, Ralph
Norman, Dan Meuser, Scott Fitzgerald, Andrew R. Garbarino, Young
Kim, Byron Donalds, Mike Flood, Michael V. Lawler, Zach Nunn, Monica
De La Cruz, Erin Houchin, and Andy Ogles, United States House of
Representatives (Sept. 26, 2023) (``McHenry et al. Letter'') at 2.
But see IEX Letter at 5 (``the premise that Rule 605 updates must be
a precondition to any other changes looks more like a calculated
stall than an argument for careful, reasoned decision making'');
letter from Stephen W. Hall, Legal Director and Securities
Specialist, Better Markets, Inc. (Oct. 31, 2023) (``Better Markets
Letter II'') at 5 (``argument that the Commission should first get
more information is a delaying tactic designed to forestall
meaningful reforms that are already clearly necessary and
appropriate'').
\80\ See McHenry et al. Letter at 2. As discussed further below,
Rule 605 as amended imposes reporting requirements only on market
centers and larger broker-dealers that meet the customer account
threshold (i.e., introduce or carry at least 100,000 customer
accounts) and thus does not bring smaller or emerging firms within
scope on the basis of their customer-facing broker-dealer business.
The Commission addresses the impact of its rulemaking on smaller or
emerging firms in its releases, including this release. See infra
section IX.D.1.d)(1). Further, the Regulatory Flexibility Act
(``RFA'') (5 U.S.C. 601 et seq.) requires Federal agencies, in
promulgating rules, to consider the impact of those rules on small
entities. See infra section X for further discussion of the
Commission's consideration of the impact of the amendments on small
entities.
\81\ See infra note 981.
\82\ See id. The Order Competition Rule Proposing Release, the
Regulation Best Execution Proposing Release, and the Minimum Pricing
Increments Proposing Release mentioned by commenters remain at the
proposal stage. To the extent that the Commission takes final action
on any or all of those proposals, the baseline in each of those
subsequent rulemakings will reflect the regulatory landscape that is
current at that time. See also infra section IX.C.1.d).
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The proposed amendments to Rule 605, as well as the costs and
benefits of the proposed amendments, were detailed in the Proposing
Release and received substantial public comment. The proposed
amendments to Rule 605 received broad support from many commenters. The
Commission has considered the comments received, updated its data
analysis where needed, and, in some instances, has modified the
proposal in response to comments received.
C. Overview of Final Rule 605
After reviewing the comments received and considering the
recommendations from commenters,\83\ the Commission has determined to
adopt the proposal with several modifications. In some cases, final
amendments to Rule 605 add new data elements that provide additional
context and information for both the detailed and summary execution
quality reports. In adopting the final amendments to Rule 605, the
Commission aims to provide individual investors, institutional
customers, and broker-dealers with information that they can use to
choose market centers or broker-dealers that align with their
investment and execution objectives. Further, as with Rule 605 reports
prior to these amendments,\84\ the Commission anticipates that third
parties, such as academics and journalists, will also utilize the
reported execution quality data for comparison purposes and analysis of
market conditions.
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\83\ See, e.g., FIF Letter, SIFMA Letter II.
\84\ See, e.g., supra note 16 (discussing studies by Boehmer et
al. and Zhao & Chung).
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As discussed in section II (Modifications to Reporting Entities)
below, the Commission is adopting the amendments to the scope of
reporting entities largely as proposed, with a few modifications. The
Commission is retaining in the adopted amendments to Rule 605 the
proposed requirements that brokers and dealers introducing or carrying
100,000 or more customer accounts prepare Rule 605 reports and that
separate reports be prepared for a firm's broker-dealer activity and
its market center activity. The Commission is also providing additional
explanation of these requirements. The Commission has determined not to
require market centers that operate a proposed qualified auction to
prepare a separate report for covered orders received for execution in
the qualified auction. The Commission is specifying that ATSs must
prepare Rule 605 reports separately from their broker-dealer operators
as proposed and is also retaining the proposed requirement that a
broker-dealer that operates an SDP prepare a separate report for
activity specific to the SDP, but with a modified description of what
constitutes an SDP.
In addition, as discussed in section III (Modifications to Scope of
Orders Covered and Required Information) below, the Commission is
adopting amendments to the information required to be reported in the
detailed report required by Rule 605(a)(1) with modifications from the
proposal. The Commission is adopting amendments to
[[Page 26435]]
the scope of covered orders largely as proposed, with changes to the
coverage of orders with stop prices. The Commission is also revising
the categorization by order size from the proposal to incorporate
notional size buckets and whether an order is for less than a share, is
an odd-lot, or is a round lot. With respect to the categorization by
order type, the Commission is adopting the categorization of executable
NMLOs as proposed, but is modifying the categorization of NMLOs priced
at or better than the midpoint and adding more categories of immediate-
or-cancel orders and more categories related to orders submitted with
stop prices. The Commission is also adopting a timestamp convention of
at least a millisecond as proposed, but eliminating the proposed
statistics for median and 99th percentile time to execution in favor of
utilizing more granular time-to-execution buckets. Further, the
Commission is adopting the other required statistics for inclusion in
the detailed report with several changes from the proposal, including:
(1) adding realized spread statistics for more time intervals; (2)
calculating effective spread and effective spread divided by quoted
spread for marketable order types and NMLOs priced more aggressively
than the midpoint only; (3) utilizing spread-based weighting to
calculate effective spread divided by quoted spread; (4) adding
statistics for average quoted spread, average midpoint, and cumulative
notional size; (5) measuring size improvement at time of order receipt
rather than time of execution, adding an additional size improvement
statistic focused on orders that can receive size improvement, and
calculating these size improvement statistics for marketable order
types and NMLOs priced more aggressively than the midpoint only; and
(6) adding a relative fill rate statistic for NMLOs based on order
executions occurring on national securities exchanges.
Further, as discussed in section IV (Summary Execution Quality
Report) below, the Commission is adopting a requirement for a summary
report pursuant to Rule 605(a)(2), with several changes from the
proposal. The Commission is changing the weighting of certain
statistics and grouping orders into notional size buckets. The
Commission is modifying the required statistics related to average
order size in shares; share-weighted average percentage price
improvement; and effective spread divided by quoted spread. The
Commission is including additional metrics in the summary report for
share-weighted average midpoint; share-weighted average notional size;
average percentage quoted spread; and average percentage realized
spread as calculated at two time horizons. The Commission also is
requiring that the summary report be provided in an alternative format.
Finally, as discussed in section V (Requirements for Making Rule
605 Reports Available to the Public) below, the Commission is adopting
procedures for making the Rule 605 reports publicly available as
proposed.
The Commission endeavors to ensure that investors are provided with
timely and accurate information needed to make informed investment
decisions, and the final amendments to Rule 605 reflect the
Commission's ongoing commitment to enhance transparency for investors.
Facilitating the ability of the public to compare and evaluate
execution quality among different market centers, brokers, and dealers,
is an effective means of reconciling the need to promote both vigorous
price competition and fair competition among market centers and broker-
dealers, to the benefit of individual investors. Section 11A of the
Exchange Act \85\ grants the Commission the authority to promulgate
rules necessary or appropriate to assure the fairness and usefulness of
information on securities transactions \86\ 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.\87\ By requiring the uniform
public disclosure of useful and accessible statistics, amended Rule 605
will 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 objectives of our
national market system.\88\
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\85\ 15 U.S.C. 78k-1.
\86\ 15 U.S.C. 78k-1(c)(1)(B).
\87\ 15 U.S.C. 78k-1(c)(1)(E).
\88\ 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. See 15 U.S.C.
78k-1(a)(1)(C).
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II. Modifications to Reporting Entities
A. Larger Broker-Dealers
1. Proposed Approach
Prior to the adopted amendments, Rule 605 of Regulation NMS
required only market centers, such as national securities exchanges,
OTC market makers, and ATSs, to produce publicly available, monthly
execution quality reports. The Commission proposed to expand the scope
of entities that must prepare Rule 605 reports to include larger
broker-dealers that introduce or carry at least 100,000 customer \89\
accounts. The Commission reasoned that the proposed expansion 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.'' \90\ As discussed further
below, the proposed minimum reporting threshold of 100,000 customers
was intended to balance the benefits of having broker-dealers produce
execution quality statistics with the costs of implementation and
continued reporting.\91\
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\89\ ``Customer'' means any person that is not a broker or
dealer. See final 17 CFR 242.600(b)(28).
\90\ Proposing Release, 88 FR 3786 at 3795 (Jan. 20, 2023).
\91\ See id. at 3797.
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To implement this proposed expansion, the Commission proposed to
insert references to ``brokers'' and ``dealers'' where prior Rule 605
referred to ``market centers.'' \92\ In addition, the Commission
proposed to revise the definition of ``covered order'' in prior Rule
600(b)(22), which referred to any market order or any limit order
(including immediate-or-cancel orders) ``received by a market center,''
\93\ to refer to orders ``received by a market center, broker, or
dealer.'' \94\
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\92\ See id. at 3796 (discussing amendments to Rule 605 in
proposed Rule 605 introductory text, (a) heading, (a)(1)
introductory text, (a)(1)(i)(D), and (a)(3), (4), (5), and (6)).
\93\ Prior 17 CFR 242.600(b)(22).
\94\ See Proposing Release, 88 FR 3786 at 3796 (Jan. 20, 2023);
proposed Rule 605(b)(30). The Commission also proposed 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. See infra section IV for
further discussion of the summary report.
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Proposed Rule 605(a)(7) stated 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'').\95\ As explained in the Proposing Release, the Commission
analyzed available data to determine the proposed customer account
threshold given the additional costs that broad expansion of the rule
to
[[Page 26436]]
broker-dealers would entail.\96\ Utilizing a 100,000 customer account
threshold as proposed 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 fewer customer accounts.\97\
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\95\ See Proposing Release, 88 FR 3786 at 3797 (Jan. 20, 2023).
\96\ See id. at 3797, 3886-87.
\97\ See id. (discussing analysis of the estimated number of
broker-dealers that would be subject to Rule 605 reporting
requirements according to different definitions of the customer
account threshold). See infra note 146 and accompanying text for a
discussion of an updated analysis.
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The proposed customer account threshold also required brokers-
dealers to include in their calculations the public customer accounts
that they introduce, as well as the customer accounts that they
carry.\98\ Because an introducing broker-dealer may use an omnibus
clearing arrangement and not disclose certain information about its
underlying customer accounts to the clearing firm, the Commission
proposed that, 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.\99\
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\98\ See Proposing Release, 88 FR 3786 at 3797 (Jan. 20, 2023).
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 at 56978 (Dec. 2, 1992) (Net Capital Rule).
Alternatively, some broker-dealers utilize an ``omnibus clearing
arrangement,'' where the clearing firm maintains one account for all
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.
\99\ See Proposing Release, 88 FR 3786 at 3797-98 (Jan. 20,
2023); proposed Rule 605(a)(7).
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Proposed Rule 605(a)(7) stated 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.\100\
Further, as proposed a broker-dealer is excluded from Rule 605's
reporting requirements only with respect to its customer-facing broker-
dealer function (as opposed to its market center function, if
applicable) if the number of customer accounts that it introduces or
carries is less than the customer account threshold.\101\ However,
under the proposal, a broker-dealer that meets or exceeds the customer
account threshold for the first time has a grace period of three
calendar months before being required to comply with Rule 605's
reporting requirements.\102\
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\100\ See Proposing Release, 88 FR 3786 at 3798 (Jan. 20, 2023).
\101\ See id. at 3798-99. Proposed Rule 605(a)(7) stated 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'').
See id. at 3799. As proposed, the Reporting Period shall 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 had met or exceeded the customer
account threshold. See id. 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 shall not be
required to produce a report pursuant to this paragraph for the next
calendar month. See id.
\102\ See id. at 3799. The Commission also proposed that after
the three-calendar month grace period, the Reporting Period shall
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 proposed, a broker-dealer that crosses the
customer account threshold for the first time is 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. See id.
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Prior to the amendments, Rule 605 required that reporting entities
calculate certain statistics based on the time of order receipt.\103\
Moreover, Regulation NMS defined ``time of order receipt'' based on the
time an order was received by a market center for execution.\104\ In
conjunction with the proposed expansion of Rule 605 to cover larger
broker-dealers, the Commission proposed 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 center, the time of order receipt
is the time that the order was received by the broker or dealer for
execution.\105\
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\103\ See, e.g., prior 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).
\104\ See prior 17 CFR 242.600(b)(92). See also Rule 11Ac1-5
Adopting Release, 65 FR 75414 at 75423 (Dec. 1, 2000) (``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.'').
\105\ See Proposing Release, 88 FR 3786 at 3799-800 (Jan. 20,
2023); 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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2. Final Rule and Discussion
The Commission is adopting amendments to Rule 605 to include larger
broker-dealers as proposed and addresses certain commenters' questions
below. These amendments will provide enhanced transparency to
investors, allowing them to compare and evaluate execution quality
among different customer-facing larger broker-dealers and promoting
competition among these broker-dealers. As discussed in section
II.A.2.a), the Commission is adopting the customer account threshold as
proposed. In addition, as discussed in section II.A.2.b), the
Commission is adopting as proposed the requirement that larger broker-
dealers that are also market centers produce separate reports
pertaining to each function. Finally, as discussed in section
II.A.2.c), the Commission is adopting as proposed the requirement that
all reporting entities, including larger broker-dealers, measure
certain statistics from the time of order receipt.
The Commission received comments from a variety of market
participants on the proposed expansion to require larger broker-dealers
to provide Rule 605 reports. Certain individual investors supported the
proposed expansion of publicly available Rule 605 reports to include
broker-dealers because this expansion would increase transparency and
encourage competition among broker-dealers.\106\ One such commenter
stated that the proposal would: (1) require broker-dealers to provide
more detailed information about the execution quality of their trades,
including data on execution speeds, price improvements, and order
routing practices, which would help retail investors ``make more
informed decisions about where to route our orders and which broker-
dealers to work with''; (2) provide more data on execution quality that
would ``help level the playing field between individual investors and
large institutional players who currently have an information
advantage''; and (3) ``encourage broker-dealers to compete on the
quality of their executions, which would ultimately benefit all
investors.'' \107\ Two other individual investors supported the
inclusion of broker-dealers and the proposed rule overall, stating that
it would ``provide a more detailed and
[[Page 26437]]
comprehensive standard for broker-dealers to follow, resulting in
consistently robust best execution practices.'' \108\ In addition, an
academic and an individual investor suggested expanding the Rule 605
reporting requirement to include all broker-dealers, rather than just
larger broker-dealers.\109\
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\106\ See, e.g., letters from: Dylan Hodges (Dec. 27, 2022);
Edward Murray (Dec. 26, 2022); Dr. Paul Pritchard (Dec. 27, 2022);
Cody Welch (Mar. 7, 2023) (``Welch Letter''); Abanes (Mar. 3, 2023)
(``Abanes Letter''); Ryan Macarthur (Feb. 24, 2023) (``Macarthur
Letter''); David Genco, Jr. (Feb. 24, 2023) (``Genco Letter'').
\107\ Letter from Caleb C. (Mar. 18, 2023).
\108\ Letters from Justin West (Mar. 19, 2023); Ankit (Mar. 19,
2023).
\109\ See letter from Aswin Joy (Mar. 7, 2023) (``Joy Letter'');
letter from James J. Angel, Georgetown University (Mar. 31, 2023)
(``Angel Letter'') at 2-3. See infra section II.A.2.a) for
additional discussion about the scope of the broker-dealer reporting
requirement.
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For reasons similar to those offered by individual investors,
financial services firms, industry groups, and a group of academics
supported the proposed expansion of Rule 605 reporting requirements to
larger broker-dealers.\110\ One financial services firm stated that the
proposed expansion would ``fill a gap in coverage that currently
obscures the order handling practices of many broker-dealers'' because
many customer-facing broker-dealers do not meet the definition of a
market center and thus do not produce Rule 605 reports.\111\ This
commenter stated that the customers of these broker-dealers are left
without any ``reliable way to evaluate and compare broker-dealer
performance.'' \112\ A group of academics that authored an academic
working paper concerning the execution quality of market orders
received from various broker-dealers \113\ also submitted a comment
letter supporting the proposed expansion and cited the need for
improved public transparency based on their research.\114\ These
commenters stated that, even if retail investors do not pay attention
to broker-level disclosures about execution quality if the dollar cost
to retail investors is low, such disclosures are likely to be
scrutinized by brokers, leading to greater competition and ultimately
better execution for retail investors.\115\ A broker-dealer supported
the proposed expansion to retail brokers, stating that it will make
order execution quality, and the marketplace generally, more
transparent to retail investors.\116\ This commenter also stated that,
given the ``highly competitive state of the current retail brokerage
market,'' it is not certain that the proposed enhancements to Rule 605
would improve execution quality for individual investors because
outcomes for such investors could be ``asymmetric.'' \117\ However,
this commenter stated that to the extent that there are opportunities
to optimize execution quality for individual investors, ``empowering
investors to compare execution quality across retail brokers (and
consequently to switch brokers based on this information) would be the
most efficient and effective way to address these concerns.'' \118\
---------------------------------------------------------------------------
\110\ See Fidelity Letter at 9 (stating that expanding Rule 605
reporting requirements to new entities will provide greater
transparency into execution quality differences and increase the
ability to measure retail order outcomes in a competitive
environment); letter from Gregory Davis, Managing Director and Chief
Investment Officer, and Matthew Benchener, Managing Director,
Personal Investor, The Vanguard Group, Inc. (Mar. 31, 2023)
(``Vanguard Letter'') at 3 (stating that the proposal will increase
transparency by empowering investors to compare execution quality
across broker-dealers and make more informed decisions about their
choice of broker-dealer); Healthy Markets Letter at 16 (stating that
Rule 605 reports should cover large brokers that route orders for
investors); Better Markets Letter at 5 (stating that the proposed
expansion of entities subject to Rule 605 disclosures will help the
public compare and evaluate execution quality among different market
centers and broker-dealers, and thereby increase transparency of
order execution quality, increase information available to both
retail and institutional investors, and help promote competition
among market centers and broker-dealers); Professor Schwarz et al.
Letter at 2; and letter from John L. Thornton, Co-Chair, Hal S.
Scott, President, and R. Glenn Hubbard, Co-Chair, Committee on
Capital Markets Regulation (Mar. 31, 2023) (``CCMR Letter'') at 14
(stating that the proposed expansion ``will allow retail investors
to determine the execution quality of their orders'' and ``would
likely enhance competition among retail broker-dealers based on
price improvement and overall execution quality'').
\111\ See Vanguard Letter at 3.
\112\ Id. at 3-4 (stating that requiring larger broker-dealers
to make Rule 605 disclosures would address this coverage gap and
give their customers a ``direct line of sight into broker-dealer
performance''). See also NASAA Letter at 5-6 (stating that the
proposed expansion of reporting entities would ``provide the public
with a more comprehensive view of order execution quality across the
national market system'' and ``allow brokerage customers to compare
execution quality among different broker-dealers'').
\113\ See Proposing Release, 88 FR 3786 at 3832, n.529 (Jan. 20,
2023) and accompanying text (citing Christopher Schwarz et al., The
`Actual Retail Price' of Equity Trades (Aug. 28, 2022)).
\114\ See Professor Schwarz et al. Letter at 1-2 (strongly
supporting the inclusion of large broker-dealers given their
research study finding that shows economically and statistically
significant price execution variation across brokers; the level of
such differences was previously unknown to retail traders and a
large portion of the financial industry). A group consisting of some
of these academics submitted another comment letter in which they
cited a more recent academic working paper regarding competition
among wholesalers and stated that their results ``emphasize the need
for further price execution disclosure at the broker level.'' Letter
from Xing Huang, Philippe Jorion, and Christopher Schwarz (Dec. 12,
2023) (``Huang et al. Letter'') at 1 (attaching Xing Huang, Philippe
Jorion, Jeongmin Lee & Christopher Schwarz, Who Is Minding the
Store? Order Routing and Competition in Retail Trade Execution (Nov.
19, 2023)).
\115\ See Professor Schwarz et al. Letter at 3. See also Better
Markets Letter at 9-10 (stating that even though some retail
investors may not read Rule 605 reports, these investors will
benefit indirectly by virtue of enhanced disclosure that will
``promote competition, improve regulatory oversight, and facilitate
use by third-party researchers and academics'' to expose problematic
order routing and execution practices).
\116\ See Virtu Letter II at 3.
\117\ See id. at 9. This commenter stated that the proposal
``may lead to changes in the equilibrium mix of customer types at
each broker'' because investors would migrate towards brokers that
have better execution quality statistics. See id. at 9, n.24. This
commenter explained that ``order execution quality tends to be
inversely related to the aggregate cost to provide liquidity to that
broker's customers' orders because market makers are willing to
provide more price improvement to orders that are less expensive to
service.'' Id. This commenter also stated that if the proposal
``induces retail investors with more costly to service orders to
move to brokers that previously had less costly to service orders,
it could cause execution quality to worsen at the broker with
previously less costly to service orders.'' Id.
\118\ Id. at 9.
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Some broker-dealers and financial services firms opposed the
proposed expansion to include larger broker-dealers, citing costs and
the risk of confusion, especially for individual investors.\119\ One
such broker-dealer stated that retail customers are not asking for or
seeking information at the level of granularity required by the
proposed rule, stating that the potential risk of investor confusion
seems disproportionate to the defined transparency benefits it may
provide.\120\ Another commenter opposed the proposed expansion because
the 605 reports are ``overly complicated for the average investor'' and
may give a ``false
[[Page 26438]]
sense of comfort'' about order execution practices and quality.\121\
---------------------------------------------------------------------------
\119\ See Robinhood Letter at 41-42 (stating that adding the
proposed expansion to include larger broker-dealers is not
realistically going to get usable execution quality information in
the hands of individual investors because the voluminous data are in
a format proven not to be particularly useful for them and that the
Commission underestimates the costs for a type of report not
generally prepared by broker-dealers that are not also market
centers); letter from Seth A. Miller, President Advocacy &
Administration, Cambridge Investment Research, Inc. (Mar. 31, 2023)
(``Cambridge Letter'') at 7 (stating in its capacity as a broker-
dealer and investment adviser that the broad scope of the proposed
inclusion of larger retail broker-dealers will impose significant
costs and is ``likely to lead to misaligned, misleading comparisons
between totally different entities''); Schwab Letter II at 35
(stating that differences in certain execution statistics such as E/
Q may be attributable to different business models across firms
rather than actual differences in E/Q among comparable business
models, and thus would create investor confusion rather than provide
useful information); Tastytrade Letter at 4-5 (observing that the
proposal will significantly increase the number of reported data
points per ticker on approximately 10,000 NMS traded products, and
expressing concern about the ability of customers to digest the
additional ``confusing and complicated'' data points in Rule 605
reports).
\120\ See Tastytrade Letter at 4 (``While we agree in general
that greater transparency results in a level playing field for
retail customers, it seems counterproductive to do so in a manner
that risks confusion.'').
\121\ See letter from Kelvin To, Founder and President, Data
Boiler Technologies, LLC (Mar. 31, 2023) (``Data Boiler Letter'') at
27-28.
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After considering the comments, the Commission is adopting the
requirement for broker-dealers that meet the 100,000 customer account
threshold to produce Rule 605 reports, as proposed. To implement this
requirement, the Commission also is adopting the related amendments to
Rules 600 and 605.\122\ The Commission agrees with commenters who
recognized the need for Rule 605 data pertaining to customer-facing
larger broker-dealers. Larger broker-dealer reporting will be useful in
increasing the transparency of larger broker-dealers' order execution
quality so that investors have information available to compare and
evaluate order execution quality and order routing practices among
market centers and larger broker-dealers. As discussed further in
section II.A.2.a) below, by limiting Rule 605 reporting requirements to
larger-broker dealers that meet the customer account threshold only,
Rule 605 will balance the benefits of broker-dealer reporting with the
costs.
---------------------------------------------------------------------------
\122\ See final 17 CFR 242.605(a)(7) (establishing the customer
account threshold for larger broker-dealer reporting requirements,
production of separate reports, and applicable Reporting Period).
See also final 17 CFR 242.605 (inserting references to ``brokers''
and ``dealers'' in introductory text, heading for (a), (a)(1)
introductory text, (a)(1)(i)(E), and (a)(3), (4), (5), and (6)). See
also final 17 CFR 242.600(b)(27) (inserting references to orders
received by a ``broker'' or ``dealer'' in definition of ``covered
order'') and final 17 CFR 242.600(b)(103) (specifying that the
definition of ``time of order receipt,'' in the case of a broker or
dealer that is not acting as a market center, is the time (at a
minimum to the millisecond) that an order was received by the broker
or dealer for execution). For further discussion of these
amendments, see Proposing Release, 88 FR 3786 at 3796, 3798-99 (Jan.
20, 2023).
---------------------------------------------------------------------------
The Commission disagrees with commenters' concerns that larger
broker-dealer reporting will be too confusing or misleading to
investors, or will create a ``false sense of comfort'' about order
execution practices and quality.\123\ Individual investor commenters
expressed interest in receiving access to execution quality statistics
pertaining to larger broker-dealers because this increased transparency
would allow individual investors to make more informed decisions and
encourage competition among larger broker-dealers.\124\ Due to the
expansion of Rule 605 reporting requirements to larger broker-dealers,
customers of these broker-dealers, including individual investors, and
other market participants will no longer need to make inferences about
these broker-dealers' execution quality based on a combination of
broker-dealers' routing information contained in reports required by
Rule 606 and market centers' Rule 605 reports. Instead, customers will
be able to use execution quality information contained in larger
broker-dealers' Rule 605 reports to make comparisons across these
broker-dealers and select those broker-dealers that offer better
execution quality. The availability of information about larger broker-
dealers' execution quality also is expected to increase the extent to
which these broker-dealers compete on the basis of execution quality
when making their order routing decisions. Further, to the extent that
broker-dealers increase the extent to which they route orders to the
market centers offering better execution quality, increased liquidity
at those venues may further improve execution quality, as a result of
promoting the flow of orders to market centers that offer better
execution quality.
---------------------------------------------------------------------------
\123\ See supra notes 119-121 and accompanying text.
\124\ See supra notes 106-108 and accompanying text.
---------------------------------------------------------------------------
The stock-by-stock order execution information that will be
provided in the detailed report will allow market participants,
including individual investors familiar with data analysis, to make
their own determinations about how to group stocks or orders when
comparing execution quality information across broker-dealers. However,
the Commission is mindful that the detailed report will contain a
larger volume of statistical data and many market participants,
including individual investors, may not have the means to directly
analyze the detailed report. As discussed further below, the Commission
is adopting a requirement that every market center, broker, or dealer
produce a summary execution quality report in addition to the more
detailed report required by Rule 605(a)(1).\125\ These summary reports
will make available to market participants and other interested parties
readily accessible, aggregated data that will allow them to compare
some of the more significant aspects of the execution quality provided
by specific market centers and larger broker-dealers. These summary
reports will provide human-readable information that any investor,
including individual investors, can assess without needing technical
expertise or relying on an intermediary.\126\ Moreover, even individual
investors that do not read Rule 605 reports from larger broker-dealers
will benefit from independent analysts, consultants, broker-dealers,
the financial press, or market centers analyzing and producing more
digestible information using Rule 605 data.\127\
---------------------------------------------------------------------------
\125\ See infra section IV.B.
\126\ See infra section IV.B.2. For a discussion of comments
regarding investor education or testing related to the summary
reports, see infra section IV.B.3. As the new Rule 605 requirements,
including the expansion of scope to include larger broker-dealers,
are implemented, the Commission will consider whether there is a
need for additional educational resources to assist investors.
\127\ See infra notes 1075-1077 and accompanying text
(discussing ways in which third parties have used Rule 605 reports
to produce information that is meant for public consumption).
---------------------------------------------------------------------------
One industry group stated that it remains unclear whether broker-
dealers' Rule 605 reports would increase competition.\128\ This
commenter stated its concern that producing Rule 605 statistics without
accounting for different broker-dealer business models could lead
investors to make incorrect decisions regarding broker-dealer
selection.\129\ This commenter further stated that differences in
execution quality could be the result of a myriad of factors, including
``the customers . . . different brokers serve and the equities the
customers trade.'' \130\ In response to this commenter, the Commission
agrees that, as a result of different business models, a particular
broker-dealer's order flow may be made up of a different mixture of
securities, order types, and order sizes, which may impact or constrain
that broker-dealer's overall execution quality level.\131\
[[Page 26439]]
However, under these amendments, larger broker-dealers will be required
to categorize the execution quality information required by Rule 605 by
individual security, different types of orders, and different order
sizes. Giving market participants access to this information in Rule
605 reports will help ensure that they are able to control for these
differences in order flow characteristics and make apples-to-apples
comparisons when assessing and comparing execution quality information
across broker-dealers.\132\
---------------------------------------------------------------------------
\128\ See SIFMA Letter II at 29.
\129\ See id. at 30. This commenter also stated it does not
understand on what basis the Commission believes that differences in
business models are well-known by market participants, and
particularly retail investors, for purposes of evaluating execution
quality statistics. See id. (discussing Proposing Release, 88 FR
3786 at 3800 (Jan. 20, 2023)). However, the Commission's statement
in the Proposing Release was made in specific reference to market
participants' use of Rule 605 reports to compare a market center and
a broker-dealer, rather than use of Rule 605 reports to compare
broker-dealers with one another. The Commission agrees with the
commenter that differences between broker-dealer business models may
not be ex ante well-known to market participants. However, market
participants, including individual investors, will be able to use
the information in Rule 605 detailed reports and the Rule 605
summary reports to account for differences in broker-dealer order
flow, and broker-dealers are not precluded from separately providing
their customers with information that can be used to contextualize
the information in the Rule 605 reports.
\130\ See id. at 30 (stating that when pointing to potential
shifts in order flow from one broker-dealer to another, the
Commission does not account for any potential effects on execution
quality caused by the shifting of the order flow itself or the
potential for order flow to consolidate among a smaller number of
firms, thereby reducing competition and ultimately hurting execution
quality).
\131\ See Proposing Release, 88 FR 3786 at 3831 (Jan. 20, 2023).
See also infra note 984 for an example of how differences in order
flow characteristics may impact inferences about execution quality.
For further discussion, see infra section IX.C.1.a).
\132\ That some of the information contained in the summary
execution quality report will be useful for controlling for
differences across differences in order flow characteristics of
broker-dealer was supported by comment. See, e.g., comments in
support of including average notional order size and average
realized spreads in the summary reports, discussed in infra section
IV.B.1.b).
---------------------------------------------------------------------------
An industry group suggested that the Commission allow firms an
opportunity to provide a statement in their Rule 605 reports explaining
how to contextualize the report based on the nature of the firm's order
flow.\133\ In addition, a broker-dealer suggested that the Commission
permit retail brokers to provide background and contextual information
to explain how their obligations are different from those of
wholesalers or other market centers that currently report under Rule
605.\134\ The Commission is not adopting the suggestion to include a
descriptive statement within the Rule 605 reports because it would be
inconsistent with the structure of these reports, which are designed to
be structured, standardized, machine-readable, quantitative
disclosures.\135\ As the Commission stated in the original adopting
release for Rule 605, Rule 605 is intended to establish a baseline
level of disclosure and facilitate cross-market comparisons of
execution quality.\136\ Similarly, the adopted amendments to Rule 605
provide a baseline level of disclosure that all market centers and
larger broker-dealers must meet. Rule 605 does not preclude larger
broker-dealers from disclosing additional information concerning their
order execution practices that they believe would provide useful
context concerning the quality of their services on their websites or
through other means of communication.\137\
---------------------------------------------------------------------------
\133\ See SIFMA Letter II at 31.
\134\ See Virtu Letter II at 3-4.
\135\ See Rule 605 NMS Plan at 2 (providing that the detailed
report must be in standard, pipe-delimited ASCII format); final 17
CFR 242.605(a)(2) (providing that the summary report must be made
available using the most recent version of the schema for CSV format
and the associated PDF renderer).
\136\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75419
(Dec. 1, 2000).
\137\ Any such statements will be subject to applicable
securities laws and regulations.
---------------------------------------------------------------------------
A broker-dealer recommended that rather than expanding Rule 605 to
include larger broker-dealers, the Commission should update Rule 606,
which already applies to nonmarket center broker-dealers, to require
additional information regarding execution quality.\138\ In response to
the commenter's suggestion, the Commission considers the inclusion of
larger broker-dealers in Rule 605 as adopted to be the preferable
option. Although providing Rule 605 data within an expanded version of
the existing Rule 606 reports could result in lower compliance costs as
a result of broker-dealers' existing experience with preparing and
filing Rule 606 reports, many of the costs associated with the initial
reporting of execution quality statistics would still be incurred by
broker-dealers and therefore broker-dealers would not benefit from a
significant reduction in compliance costs overall. Moreover, the format
and frequency of the Rule 606 reports differs because the data are more
aggregated and the reports are issued quarterly.\139\ In contrast, Rule
605 reports are monthly and provide detailed, symbol-by-symbol data
that will allow market participants and other users of the report to
analyze the data and consider the execution quality that a broker-
dealer provides for orders with specific characteristics. Further,
while Rule 606 covers all brokers or dealers, subject to a de minimis
exception, as described below, the customer account threshold will
focus the Rule 605 reporting requirement on those larger broker-dealers
for which the provision of Rule 605 data will include data for most of
the customer accounts handled by broker-dealers and, therefore, will
balance the benefits of broker-dealer reporting with the costs of
reporting.\140\
---------------------------------------------------------------------------
\138\ See Robinhood Letter at 42 (``Instead of unnecessarily
imposing additional costs on the industry to create new Rule 605
reports that may not have the desired result of empowering investors
to analyze broker-dealers' execution quality, the SEC should require
broker-dealers that already publish Rule 606 reports . . . to add
execution quality statistics to their Rule 606 reports.'').
\139\ See supra notes 45-51 and accompanying text (discussing
Rule 606(a)(1) reports that provide quarterly information about
order routing and payment arrangements).
\140\ See infra section II.A.2.a) (discussing the Commission's
analysis to support the adoption of the customer account threshold,
which indicates that approximately 85 broker-dealers introduce or
carry more than 100,000 customer accounts and these broker-dealers
together handle over 98% of customer accounts). See also infra
section IX.E.5.b) (discussing a reasonable alternative to expand
Rule 606 reporting requirements).
---------------------------------------------------------------------------
(a) Customer Account Threshold
An investor advocacy group and a national securities exchange
specifically supported the proposed customer account threshold that
would include in scope a broker or dealer that introduces or carries
100,000 or more customer accounts.\141\ An academic and an individual
investor suggested that all broker-dealers should be required to submit
Rule 605 reports.\142\ In contrast, a broker-dealer stated that it is
not clear why it is necessary to include such a broad scope of larger
broker-dealers.\143\ According to this commenter, the proposal would
require larger retail broker-dealers to produce execution quality
reporting and metrics that are identical to those required of
securities exchanges and market makers, even if those broker-dealers do
not direct client orders.\144\
---------------------------------------------------------------------------
\141\ See Healthy Markets Letter at 16, n.38; Nasdaq Letter at
43 (stating that the proposed customer account threshold ``appears
to balance the associated implementation costs on those broker-
dealers that may provide the execution quality statistics with the
greatest benefit'').
\142\ See Joy Letter; Angel Letter at 2-3 (stating that all
broker-dealers should be required to show execution quality
information, and that CAT could easily produce Rule 605 reports at
low incremental cost). See also Robinhood Letter at 44-45
(recommending that, if the Commission decides to proceed with the
proposed rule, it should require all broker-dealers to report under
Rule 605, because the number of large broker-dealers is relatively
small (6.7% of all broker-dealers); the limited application of the
rule would create an information gap about execution quality for
investors that use smaller broker-dealers and new retail broker
entrants). With respect to the commenter's suggestion that CAT data
could be used to produce Rule 605 reports, see infra section
V.B.2.b) for a discussion of the potential alternative to generate
order execution quality reports using CAT data.
\143\ See Cambridge Letter at 7 (``such breadth cannot be
justified in light of the likely significant costs to be imposed on
certain participants'').
\144\ See id.
---------------------------------------------------------------------------
After considering the comments, the Commission is adopting the
100,000 customer account threshold, as proposed. The Commission's
analysis of available data on the number of broker-dealers that will
meet the minimum reporting threshold of 100,000 customers confirmed
that such threshold will balance the benefits of having broker-dealers
produce execution quality statistics with the costs of implementation
and continued reporting,\145\ given the smaller amount
[[Page 26440]]
of benefits relative to costs that there would be if the Rule 605
reporting requirements extended to broker-dealers that introduce or
carry a smaller number of customer accounts. Specifically, this
analysis indicates that approximately 85 broker-dealers introduce or
carry more than 100,000 customer accounts and these broker-dealers
together handle over 98% of customer accounts.\146\ The Commission is
not subjecting all broker-dealers to Rule 605 reporting requirements,
as suggested by certain commenters, because of the lower benefits
relative to costs for broker-dealers with a smaller number of customer
accounts.\147\ Conversely, the Commission disagrees with the commenter
that states that the scope of larger broker-dealers that will be
required to provide Rule 605 reports is overbroad.\148\ The relative
market-wide benefit of having a broker-dealer prepare Rule 605 reports
increases when the broker-dealer has more customers.\149\ The
Commission's updated analysis indicates that utilizing a lower customer
account threshold, such as 10,000 customer accounts, would nearly
triple both initial and ongoing costs for non-market center broker-
dealers (which are not otherwise subject to Rule 605's reporting
requirements) and yet would result in capturing only modestly more
customer accounts than the 100,000 customer account threshold.\150\ The
Commission's updated analysis also indicates that utilizing a higher
customer account threshold, such as 250,000 customer accounts, would
lower costs but also decrease coverage of customer accounts and
customer order originations.\151\ Thus, utilizing 100,000 customer
accounts as the adopted minimum reporting threshold will better balance
the benefits of having broker-dealers produce execution quality
statistics with the costs of implementation and reporting.
---------------------------------------------------------------------------
\145\ See infra section IX.D.2.a)(1) for a discussion of the
costs related to expanding the scope of Rule 605 reporting entities.
As discussed further below, broker-dealers that were not previously
required to publish Rule 605 reports will incur initial costs to
prepare and post Rule 605 reports for the first time, which may
include developing any policies and procedures that may be needed to
do so, and all broker-dealers will face ongoing costs to continue to
prepare the reports each month. See also infra section IX.E.1.a) for
a discussion about the estimated costs of utilizing a different
number of customer accounts as the minimum reporting threshold.
\146\ Analysis from the Proposing Release was repeated regarding
the estimated number of broker-dealers that will be subject to Rule
605 reporting requirements according to different definitions of the
customer account threshold. See Proposing Release, 88 FR 3786 at
3886-87 (Jan. 20, 2023). For a description of how this analysis
differs from the analysis in the Proposing Release, see infra note
1747. This updated 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. See
infra Table 13 for a cost-benefit analysis of different customer
account thresholds that could be used to define ``larger broker-
dealer'' and accompanying text for methodology. For example,
approximately 244 broker-dealers introduce or carry more than 10,000
customer accounts and these broker-dealers together handle over 99%
of customer accounts. Further, approximately 1,245 broker-dealers
introduce or carry at least 1 customer account.
\147\ See infra section IX.E.1.a) (reducing the customer account
threshold from 100,000 to 10,000 would almost triple both initial
and ongoing costs); see also infra section IX.E.1.b) (discussing the
alternative of requiring all broker-dealers to prepare Rule 605
reports).
\148\ See supra notes 143-144 and accompanying text. It is
unclear, and the commenter does not explain, why any of the required
execution quality metrics will not be appropriate for reporting by a
larger broker-dealer and the commenter does not suggest any
alternative metrics. It is also unclear, and the commenter does not
explain, how a Rule 605 report prepared by a retail broker will be
less useful if the retail broker did not direct client orders. Even
though the same underlying order may be reflected on multiple Rule
605 reports, the aggregated statistics within each report will
provide different views of execution quality specific to the group
of orders received by each reporting entity. Thus, a Rule 605 report
prepared by a retail broker will allow that retail broker's
customers, as well as other market participants, to view the
execution quality specific to those orders received by the specific
retail broker.
\149\ See Proposing Release, 88 FR 3786 at 3797, n.167 (Jan. 20,
2023) and accompanying text (discussing potential initial and
ongoing costs that broker-dealers would incur as a result of the
proposed amendments to Rule 605).
\150\ See infra section IX.E.1.a) and Table 13 (demonstrating
that, for example, reducing the customer account threshold from
100,000 to 10,000 would increase estimated initial and ongoing
compliance costs from about $3.4 million and $4.4 million,
respectively, to about $9.8 million and $12.6 million, respectively,
while increasing the coverage of customer accounts by 1.4% and the
coverage of customer order originations by 21%). See also infra
notes 1749-1751 (discussing why lowering the customer account
threshold to include these customers might not be particularly
beneficial).
\151\ See Table 13 (demonstrating that raising the customer
account threshold to 250,000 would lower estimated initial and
ongoing compliance costs to about $2.4 million and $3.1 million,
respectively, while decreasing the coverage of customer accounts by
1.1% and the coverage of customer order originations by 55.7%).
---------------------------------------------------------------------------
The customer account threshold will require brokers-dealers to
include in their calculations the customer accounts that they
introduce, as well as the customer accounts that they carry. Rule 605
reports that reflect orders received from customer accounts that a
broker-dealer introduces or carries will provide useful information to
market participants because both introducing and carrying broker-
dealers make decisions about where to route those orders and it will be
helpful for customers to be able to evaluate the execution quality
received as a result of those decisions.
One industry group requested an exception from the Rule 605
reporting requirement for an introducing firm that routes all of its
customer orders to its clearing firm, on a non-directed basis, where
the clearing firm makes all routing decisions and the introducing firm
does not receive payment for order flow (``PFOF'').\152\ This commenter
explained that its request would reduce the reporting burden for
smaller introducing firms.\153\ This commenter stated that, given its
suggested conditions for the exception from reporting requirements that
an introducing broker would be required to examine the clearing firm's
Rule 605 report and not have reason to believe the clearing firm's
report materially misrepresents the introducing broker's order flow,
the quality of the disclosure should not be impacted.\154\ A second
industry group made a similar request for an exception from reporting
for certain introducing broker-dealers, stating that when introducing
broker-dealers send customer orders to a clearing broker that makes the
routing decisions, the introducing broker may not be in the best
position to generate Rule 605 reports.\155\
---------------------------------------------------------------------------
\152\ See FIF Letter at 6.
\153\ See FIF Letter II at 2.
\154\ See id.
\155\ See letter from William C. Thum, Managing Director and
Assistant General Counsel, SIFMA AMG (Mar. 31, 2023) (``SIFMA AMG
Letter'') at 6.
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The Commission considered these commenters' suggestion that Rule
605 provide an exception for certain introducing broker-dealers, but is
not adopting the suggested exception for the following reasons: (1)
Rule 605 reports prepared by larger broker-dealers will provide market
participants and other interested parties with information relevant to
evaluating how relationships among broker-dealers may affect execution
quality, and the payment of PFOF is not the only circumstance that
leads to conflicted relationships between an introducing broker-dealer
and its customers; \156\ (2) an introducing firm would not be able to
determine whether or not its clearing firm's Rule 605 report materially
misrepresents the introducing firm's order flow without independently
calculating its own execution quality statistics, and if the
introducing firm needed to make these calculations to do this
assessment, then any additional burden due to the requirement to
prepare Rule 605 reports will be minimal; (3) different firms
[[Page 26441]]
could have differing interpretations of how much variation there could
be in execution quality statistics between an introducing firm and its
clearing firm before the clearing firm's Rule 605 report would
``materially misrepresent'' the introducing firm's order flow; and (4)
even if an introducing firm determined that it has no reason to believe
that its clearing firm's Rule 605 report materially misrepresents the
introducing firm's order flow, the introducing firm's customers could
consider certain differences between the execution quality statistics
of the introducing firm and its clearing firm to be meaningful.\157\
---------------------------------------------------------------------------
\156\ For instance, retail brokers potentially face conflicts of
interest when making order routing decisions, including whether to
route to a particular wholesaler. See infra section IX.C.4.a)(2). As
an example, broker-dealers 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 their individual investor customers (i.e.,
PFOF). See infra notes 1300-1304 and accompanying text.
\157\ In some instances, the same underlying order may be
reflected on the Rule 605 reports provided by both an introducing
firm and its clearing firm, but the separate reports will provide
different views of execution quality specific to the group of orders
handled by each broker-dealer. See also Proposing Release, 98 FR
3786 at 3798 (Jan. 20, 2023).
---------------------------------------------------------------------------
An industry group asked for clarification regarding how firms would
calculate their number of customer accounts for purposes of the
customer account threshold.\158\ In response, the Commission is
providing the following guidance. First, the introducing broker-dealer
generally should only count the institutional top-level account when an
introducing broker-dealer that is not a clearing broker-dealer
establishes a top-level account for an institutional asset
manager.\159\ The Commission recognizes that in such instances the
introducing broker-dealer often utilizes an omnibus clearing
arrangement and thus does not have specific knowledge of how many
underlying accounts a top-level account may represent.\160\ Second,
broker-dealers generally should count and only count the accounts for
all of their customers that are authorized by their broker-dealers to
trade NMS stocks, including non-U.S. customers. A focus on customers
that are authorized to trade NMS stocks generally should align with the
scope of Rule 605 reports because these reports relate to covered
orders in NMS stocks.\161\ Third, broker-dealers that provide routing
services for other broker-dealers could have customer accounts for that
portion of their business and the routing broker-dealer generally
should consider whether a top-level account pertains to customer orders
and count only those top-level accounts that the routing broker-dealer
introduces or carries that are associated with customer orders. Fourth,
broker-dealers generally should count only active customer accounts.
Broker-dealers generally should consider customer accounts as active in
the same manner as defined and reported in their Financial and
Operational Combined Uniform Single (``FOCUS'') Reports on Form X-17A-
5.\162\ Consistent with their FOCUS reports, larger broker-dealers
reporting under Rule 605 generally should count only active accounts
that have a non-zero cash or securities balance at the end of the
reporting period. Leveraging an existing classification of active
accounts in these FOCUS reports generally should facilitate the
identification of inactive accounts.
---------------------------------------------------------------------------
\158\ See FIF Letter at 5-6 (requesting clarifications on how a
firm would calculate its number of accounts to determine whether it
meets the customer account threshold in the following circumstances:
(1) an introducing firm that is not a clearing firm, where the
introducing firm establishes a top-level trading account for an
institutional asset manager and the asset manager allocates trade
executions to sub-accounts; (2) a firm that has accounts for non-
U.S. customers; (3) a firm that provides routing services for other
broker-dealers; and (4) a firm that has authorized an account to
trade NMS stocks but that account has never traded an NMS stock or
has not traded an NMS stock for an extended period of time).
\159\ In this scenario as presented by the commenter, the asset
manager submits orders using this top-level account and separately
establishes multiple underlying accounts with the clearing broker-
dealer to allocate trades post-execution. See id. at 5-6.
\160\ See supra note 98 and accompanying text (discussing
omnibus clearing arrangements in which the clearing firm does not
know the identity of the customers of the introducing firm). Having
an introducing broker-dealer count the top-level account through
which trading occurs is consistent with the approach for reporting
transactions to the CAT. See FINRA CAT FAQ M4, available at <a href="https://catnmsplan.com/faq">https://catnmsplan.com/faq</a> (stating that in scenarios involving managed
accounts where an order may be placed in a master account with
subaccount allocations made at a later time, the identifier
representing the master/top account should be reported to CAT for
transaction events requiring such identifier).
\161\ See final 17 CFR 242.605(a)(1); final 17 CFR
242.605(a)(7).
\162\ See Instructions to FOCUS Report--Form X-17A-5 at 2.
---------------------------------------------------------------------------
(b) Production of Separate Reports
Two investor advocacy groups expressed their support for the
proposed requirement that larger broker-dealers that are also market
centers produce separate reports for each activity.\163\
---------------------------------------------------------------------------
\163\ See Healthy Markets Letter at 16 (``[B]rokers that are
also market centers (including as OTC market makers) should be
required to separately report their market center functions for all
covered orders (e.g., ATS or SDP operations).''); Better Markets
Letter at 5, n.12.
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After considering the comments, the Commission is adopting the
requirement that larger broker-dealers that are also market centers
produce separate reports pertaining to each function, as proposed. As
explained in the Proposing Release, requiring a firm to produce
separate reports pertaining to its market center function and its
broker-dealer function will 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.\164\
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\164\ See Proposing Release, 88 FR 3786 at 3798 (Jan. 20, 2023).
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An industry group stated that the proposed distinction between
broker-dealer activity and market center activity in Rule 605 reports
requires clarification and asked specific questions to clarify this
distinction for purposes of grouping orders to prepare the separate
reports.\165\ In response, the Commission provides the following
clarifications. First, a firm that is an OTC market maker and
introduces or carries over 100,000 customer accounts (i.e., meets the
customer account threshold for larger broker-dealers) generally should
include in its Rule 605 report pertaining to its broker-dealer function
all covered orders in NMS stocks that the firm's broker-dealer received
for execution as part of its customer-facing line of business. The firm
generally should include in its Rule 605 report pertaining to its
market center function all covered orders in NMS stock that the firm
received for execution that are the type of order for which the firm
serves as an OTC market maker. The set of orders pertaining to a firm's
broker-dealer function may overlap with the set of orders pertaining to
its market center function. The firm generally should include an order
in both of its Rule 605 reports if its broker-dealer received the order
from a customer and the firm also acts as a market center for that type
of order.
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\165\ See SIFMA Letter II at 28 (asking the following questions
as to how a firm should group different transactions for Rule 605
separate reports: (1) ``If a firm is an OTC market maker and
introduces or carries 100,000+ customer accounts, how should the
firm determine which orders to report as broker-dealer trades versus
those executed as a market center?''; (2) ``If a firm engages in a
mixed capacity trade involving both a portion executed as agent and
a portion executed as principal, would this order need to be
bifurcated between the two reports?''; (3) ``If a firm trades in a
riskless principal capacity, but the transaction was part of its
internal broker-dealer business and not its OTC market making
business, should the firm nonetheless attribute the riskless
principal trade to its market center Rule 605 report? The Commission
only discusses a market center engaging in riskless principal
transactions, but it seems possible that a non-market center might
transact on a riskless principal basis as well.'').
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Second, a firm that engages in a mixed capacity trade (i.e., a
trade involving both a portion executed as agent and a portion executed
as principal) generally should include in its Rule 605 report
pertaining to its broker-dealer function the entire covered order that
it received for execution as part of its customer-facing line of
business and subsequently executed in a mixed capacity. Based on
[[Page 26442]]
the firm's execution of a portion of the order as principal, as a
general matter, the firm acts as an OTC market maker for that type of
order and, because an OTC market maker falls within the definition of a
``market center,'' \166\ that portion of the order generally should be
included in its report pertaining to its market center function. The
firm's execution of a portion of the order as agent generally should
not be determinative of whether the firm acts as an OTC market maker
for that type of order. The firm also generally should include in its
Rule 605 report pertaining to its market center function the portion of
the covered order that it executed as agent if it received the order
for execution as an OTC market maker.\167\ Whether the firm received
the entire covered order in its capacity as an OTC market maker (and
thus as market center) or only a portion of the order in its capacity
as an OTC market maker generally will depend on the types of orders for
which it acts as an OTC market maker.\168\
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\166\ See final 17 CFR 242.600(b)(55).
\167\ When a market center, broker, or dealer receives a covered
order for execution, it may execute in part at the receiving market
center, broker, or dealer and in part at an away venue, but the
entire covered order will be included in the firm's Rule 605 report.
See final 17 CFR 242.605(a)(1)(i)(E) (requiring a market center,
broker, or dealer to report the cumulative number of shares of
covered orders executed at the receiving market center, broker, or
dealer, excluding shares executed on a riskless principal basis) and
final 17 CFR 242.605(a)(1)(i)(F) (requiring a market center, broker,
or dealer to report the cumulative number of shares of covered
orders executed at any other venue).
\168\ The Commission agrees with the previous guidance provided
by the staff that the Rule 605 reporting requirement for market
centers generally should apply to broker-dealers insofar as they act
as a market center with respect to orders received from other
persons. See Proposing Release, 88 FR 3786 at 3798, n.180 (Jan. 20,
2023) (citing 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 Commission provides the
following example to illustrate. Assume that Firm A generally acts
as an OTC market maker for XYZ stock. If Firm A receives an order
for 100 shares of XYZ stock, it may choose to execute as principal
50 shares of XYZ stock that it holds in inventory and execute as
agent the 50 shares of XYZ stock necessary to fill the entire order.
Firm A generally would have received the entire 100-share order in
its capacity as an OTC market maker, notwithstanding its execution
of a portion of the order as agent. In contrast, Firm B acts as an
OTC market maker for XYZ stock but not ABC stock. If Firm B receives
an order for 50 shares of XYZ stock and an order for 50 shares of
ABC stock, Firm B generally would have received the order for 50
shares of XYZ stock in its capacity as an OTC market maker,
regardless of whether it executed those shares as principal or as
agent. In this scenario, Firm B generally would not have received
the order for 50 shares of ABC stock in its capacity as an OTC
market maker and therefore generally would have received this order
in connection with its broker-dealer function only.
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Third, a firm that trades in a riskless principal capacity with
respect to a transaction handled by its non-market center, internal
broker-dealer business rather than its OTC market making business
generally should not need to include the transaction in its Rule 605
report pertaining to its market center function because this division
of business lines suggests that the firm is acting in its capacity as a
broker-dealer only. However, the firm generally should evaluate whether
or not it acts as an OTC market maker in connection with its internal
broker-dealer business, in which case that portion of the business may
be a market center and thus be required to be reported as such.
A financial services firm requested clarification of whether a
broker-dealer that principally facilitates the trading of fractional
shares must publish a separate Rule 605 report as a market center.\169\
In response, the Commission clarifies that under the adopted amendments
to Rule 605 a reporting entity must produce a separate Rule 605 report
as a market center if it meets the definition of an ``OTC market
maker'' and receives ``covered orders'' for execution in such
capacity.\170\ As stated in the Proposing Release, as a general matter,
a broker-dealer generally should categorize a customer's submitted
order for an NMS stock, whether it be for a fractional share, whole
shares, or whole shares with a fractional share component, as a
``held'' order (and thus a covered order) if the customer reasonably
expects its broker-dealer to attempt to execute such order
immediately.\171\
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\169\ See Fidelity Letter at 9-10.
\170\ See supra note 3 for the definition of ``OTC market
maker.'' The term ``covered order'' is defined in final 17 CFR
242.600(b)(27). As discussed above, a firm may act as an OTC market
maker for certain types of orders only. For example, Firm C acts as
an OTC market maker for fractional shares only. If Firm C receives
an order for 51.25 shares of XYZ stock, it may execute as principal
0.25 shares of XYZ stock and execute as agent 51 shares of XYZ
stock. Firm B generally would have received only the fractional
share component of the order (i.e., 0.25 shares) in its capacity as
an OTC market maker and therefore only the fractional share
component generally should be included in Firm C's Rule 605 report
pertaining to its market center function.
\171\ See Proposing Release, 88 FR 3786 at 3789, n.36 (Jan. 20,
2023).
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One group of academics suggested that the Commission require
separate disclosures for each account type at each broker-dealer to
reflect the observation that execution quality differs across platforms
with different commission and PFOF structures.\172\ A group consisting
of some of these academics also suggested that the Commission require
separate disclosures of specific ``broker-wholesaler pairs'' consisting
of a broker-dealer and each wholesaler to which the broker-dealer
routes orders from retail investors.\173\ A broker-dealer stated that
execution quality metrics, including the proposed summary reports,
would be more informative if Rule 605 reports differentiated between
retail investors and professional customers because the nature of order
flow and resulting execution quality may be quite different.\174\
Another broker-dealer stated that ``each firm's order flow is unique''
and suggested that the Commission ``consider the balance of this
additional transparency of order flow'' both: (1) ``in the context of
reporting fragmentation for trading venues that have built in
segmentation (i.e., ATS with multiple pools or an exchange that has a
continuous order book and a retail price improvement order book)''; and
(2) ``in the context of retail brokers where experience may be
materially different within a broker-dealer (i.e., a retail broker
chooses to offer retail customers different experiences within the same
broker-dealer).''
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\172\ See Professor Schwarz et al. Letter at 5. See also Better
Markets Letter at 5, n.14 (agreeing with this recommendation).
\173\ See Huang et al. Letter at 1 (``[O]ur results suggest that
disclosures for each broker-wholesaler pair should provide
additional helpful information to monitor broker and wholesaler
performance. This would allow within-broker comparisons of execution
quality that are more meaningful than comparisons solely across
brokers.'').
\174\ See Rule 605 Citadel Letter at 8 (recommending that the
Commission engage with market participants to appropriately define a
retail order, such as by reference to an order or trade threshold
and stating that forty trades per day would be inappropriately
high).
---------------------------------------------------------------------------
The Commission is not adopting these commenters' suggestions that
larger broker-dealers be required to produce multiple reports that
differentiate between account types, business segments, or routing
destinations. Requiring larger broker-dealers to split their orders
amongst multiple Rule 605 reports pertaining to their broker-dealer
function would create additional implementation costs and potentially
undercut the goal of having standardized reports that are comparable
across entities. For instance, differences among how firms structure
different business lines would pose challenges in ensuring that each
firm is capturing order flow with similar characteristics in the same
way, which could impede the comparability of reports.
(c) Time of Order Receipt
One investor advocacy group stated that broker-dealers should be
required to calculate time of order receipt based on when that broker-
dealer received the
[[Page 26443]]
order because, in the commenter's view, the use of the time the order
was received would show if there are order-delays and thereby provide a
useful metric for anyone examining order-routing latency across
brokers.\175\ An industry group and a financial services firm suggested
instead of the proposed rule text that broker-dealers should be
required to calculate time of order receipt based on the time that the
broker-dealer first routes the order.\176\ The industry group
questioned whether execution metrics should be measured before or after
the broker-dealer has applied risk controls and decided whether to
reject the order.\177\ This commenter stated that current order
management systems may not generate a timestamp for when risk controls
have been applied and it would be costly to generate such markers.\178\
For this reason, this commenter suggested permitting a routing firm to
use the time of its first route as the time of order receipt and stated
that the time of first route would be consistent with the Staff
frequently asked questions (FAQs) regarding Rule 606.\179\ The
financial services firm stated that Rule 605 reports for a non-market
center should use the time of order routing, not the time of order
receipt, because broker-dealers perform necessary review activities
following receipt of the order but prior to routing the order.\180\
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\175\ See Healthy Markets at 16-17.
\176\ See FIF Letter at 18-19; Schwab Letter II at 33; letter
from Jason Clague, Managing Director, Head of Operations, The
Charles Schwab Corporation (Sep. 28, 2023) (``Schwab Letter III'')
at 5.
\177\ See FIF Letter at 19.
\178\ See id.
\179\ See id. (citing Rule 606 Staff FAQs, FAQ 11.01). Rule 606
Staff FAQs are available at: <a href="https://www.sec.gov/tm/faq-rule-606-regulation-nms">https://www.sec.gov/tm/faq-rule-606-regulation-nms</a>. Staff reports, Investor Bulletins, and other staff
documents (included 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 documents, they
have no legal force or effect, do not alter or amend the applicable
law, and create no new or additional obligations for any person.
\180\ See Schwab Letter II at 33; Schwab Letter III at 5 (``The
use of order receipt time rather than route time would result in
some execution quality statistics like execution speed not being
fairly represented in the reports due to outliers caused by market
access review activities.'').
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After consideration of comments, the Commission is adopting the
requirement that larger broker-dealers calculate time of order receipt
based on the time that they received the initial order, as
proposed.\181\ Time of order receipt, rather than order route time, is
more relevant to customers of a broker-dealer because it will show how
the broker-dealer handled the order from the time of receipt by the
broker-dealer. Time of order receipt will show any delays in executing
the order, and any resulting consequences on the execution quality the
broker-dealer obtained for that order, because the execution quality
statistics will be measured based on the prevailing market prices at
the time the order was received. In addition, counting time of order
receipt from the time that a broker-dealer initially receives the order
will allow broker-dealers to assign a time of order receipt in a prompt
and uniform manner and thus help to ensure that the time of order
receipt is assigned in a non-manipulatory manner.\182\
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\181\ See final 17 CFR 242.600(b)(103).
\182\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75423
(Dec. 1, 2000) (discussing a commenter's concern that a market
center might attempt to manipulate the time of receipt for its order
flow by, for example, monitoring market movements before and/or
after receipt of any order and assigning the NBBO that is most
favorable to them during that brief option period).
---------------------------------------------------------------------------
A financial services firm that suggested the use of order route
time stated that larger share orders are more likely to be sent to a
review queue and could have a ``disproportionate negative impact'' on
average execution speed.\183\ This commenter further stated that,
``[c]onsequently, using order receipt time could create a perverse
incentive for firms to diminish time spent on necessary reviews in an
effort to improve execution speed statistics.'' \184\ The Commission
disagrees that broker-dealers will be incentivized to circumvent their
risk controls because time-to-execution statistics take into account
the period during which a broker-dealer is performing various reviews
and before the broker-dealer routes an order. Broker-dealers have
multiple reasons to implement risk controls upon the receipt of
customer orders. For example, broker-dealers are subject to other
regulatory requirements, including the Commission's market access rule,
that will continue to apply.\185\ The existence of such requirements
means that broker-dealers will continue to utilize risk controls
necessary to comply with these requirements, including risk controls
implemented to comply with the market access rule, because the
potential consequences of failing to comply with these requirements
likely would counterbalance any perceived benefits of being able to
report faster execution times. Broker-dealers also have reputational
and business concerns that serve as additional incentives to continue
to apply risk controls. Further, to the extent that larger orders
received by broker-dealers may result in slower execution times due to
the application of risk controls, measuring time to execution at the
time of order receipt may motivate broker-dealers to make their risk
controls more efficient. Moreover, time-to-execution statistics are
only one aspect of execution quality statistics and price-based
execution quality statistics will provide a different dimension of the
reporting firms' execution quality.
---------------------------------------------------------------------------
\183\ See Schwab Letter II at 33; Schwab Letter III at 5.
\184\ Schwab Letter II at 33; Schwab Letter III at 5.
\185\ See 17 CFR 240.15c3-5.
---------------------------------------------------------------------------
An industry group requested confirmation that orders rejected based
on the application of risk and compliance controls would not count as
having been received for purposes of Rule 605 reporting.\186\ In
response, the Commission confirms that a broker-dealer generally should
not include orders rejected based on the application of risk and
compliance controls within its Rule 605 reports. Including these
rejected orders in Rule 605 reports would not provide data useful to
understanding the execution quality provided by the reporting broker-
dealer because these orders would not have been received by the firm in
a form where execution was possible. Thus, these rejected orders
generally should not be treated as ``received'' by the broker-dealer
for Rule 605 reporting purposes.
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\186\ See FIF Letter at 19.
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B. Qualified Auction Mechanisms
1. Proposed Approach
In today's equity markets, retail brokers often identify and route
the marketable orders of individual investors in NMS stocks to
wholesalers and the wholesalers often internalize these orders.\187\ At
the same time that the Commission proposed the amendments to Rule 605
discussed herein, the Commission separately proposed 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.\188\ The proposal focused on the treatment of segmented
orders, which the Commission proposed to define as an order for an NMS
stock that
[[Page 26444]]
is for an account that is: (1) of a natural person or an account held
in legal form on behalf of a natural person or group of related family
members; and (2) in which the average daily number of trades executed
in NMS stocks was less than 40 in each of the six preceding calendar
months.\189\ The intent of the proposed definition was to encompass the
marketable orders of individual investors that retail brokers currently
route to wholesalers for handling and execution.\190\ 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 met certain
requirements and was operated by an ``open competition trading
center.'' \191\
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\187\ This practice of separately identifying and routing the
marketable orders of individual investors to wholesalers is a form
of ``segmentation.''
\188\ For a full description and discussion of the order
competition rule proposal, see Order Competition Rule Proposing
Release, 88 FR 128 (Jan. 3, 2023); proposed 17 CFR 242.615 (``Rule
615'').
\189\ See Order Competition Rule Proposing Release, 88 FR 128 at
149 (Jan. 3, 2023); proposed Rule 600(b)(91) (defining ``segmented
order'').
\190\ See Order Competition Rule Proposing Release, 88 FR 128 at
149 (Jan. 3, 2023).
\191\ See id. at 243; proposed Rule 600(b)(87) (defining
``restricted competition trading center''); proposed Rule 615(a)
(describing the order competition requirement). 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. See Order Competition Rule
Proposing Release, 88 FR 128 at 243 (Jan. 3, 2023); proposed Rule
600(b)(64) (defining ``open competition trading center''). A
``qualified auction'' would be an auction operated by an open
competition trading center pursuant to specified requirements that
are designed to achieve competition. See Order Competition Rule
Proposing Release, 88 FR 128 at 243 (Jan. 3, 2023); proposed Rule
600(b)(81) (defining ``qualified auction''); proposed Rule 615(c)
(setting forth requirements for operation of a qualified auction).
---------------------------------------------------------------------------
If the Commission adopts the order competition rule proposal, a
national securities exchange or NMS Stock ATS that serves as an open
competition trading center and is required to prepare execution quality
reports under Rule 605 would be required to include covered orders that
it received for execution in a qualified auction within its blended
execution quality statistics. Because of concerns that differences in
execution quality for orders executed within proposed qualified
auctions as compared to orders executed outside of these qualified
auctions would not be apparent in blended execution quality statistics,
the Commission proposed to amend Rule 605(a)(1) to state that market
centers that operate a qualified auction must prepare a separate report
under Rule 605 pertaining only to covered orders that the market center
receives for execution in a qualified auction.\192\
---------------------------------------------------------------------------
\192\ See Proposing Release, 88 FR 3786 at 3802 (Jan. 20, 2023).
---------------------------------------------------------------------------
2. Final Rule and Discussion
In this release, the Commission is not acting on the proposal to
require separate Rule 605 reports for orders that a market center
receives for execution from a qualified auction. The Commission
received generally supportive comments from a variety of market
participants, including individual investors, on this proposed
amendment.\193\ Some industry commenters suggested that Rule 605
reports should distinguish between segmented and non-segmented orders,
as described in the Order Competition Rule Proposing Release.\194\
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\193\ See, e.g., Joy Letter; Pritchard Letter; and letters from
Julio Cesar (Feb. 24, 2023) (``Cesar Letter''); Nevin Varghese (Dec.
26, 2022) (``Varghese Letter'').
\194\ See FIF Letter at 13 (stating that segmented orders would
likely need to be separate from non-segmented orders); Fidelity
Letter at 9 (recommending that the Commission distinguish Rule 605
data by segmented and non-segmented order flow and display such
orders separately in detailed reports and summary reports); SIFMA
Letter II at 29 (stating that it is unclear why retail broker-
dealers should have to report on segmented orders because execution
quality will depend on the qualified auction rather than actions by
the originating broker, and suggesting instead a single Rule 605
report that evaluates all qualified auctions).
---------------------------------------------------------------------------
The Commission is still considering the order competition rule
proposal and the proposal to require separate Rule 605 reports for
orders that a market center receives for execution in a qualified
auction. Therefore, the qualified auctions contemplated by the Order
Competition Rule Proposing Release do not exist as a place of execution
at this time. Accordingly, in this release, the Commission is not
acting on the proposed separate Rule 605 reporting requirement for
orders a market center receives for execution in a qualified auction.
C. NMS Stock ATSs and SDPs
1. Proposed Approach
Under Rule 605 prior to the amendments, firms that operate two
separate markets must prepare separate Rule 605 reports for each market
center.\195\ This requirement 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. The Commission proposed to specify in Rule 605(a)(1) that an
NMS Stock ATS (as defined in Regulation ATS) \196\ shall prepare
reports separately from their broker-dealer operators to the extent
such entities are required to prepare reports.\197\ The Commission also
proposed 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.\198\ This provision would have
covered an SDP operated by a broker-dealer and required a separate
report pertaining to those orders submitted to the SDP, allowing
customers and other market participants to distinguish SDP activity
from more traditional dealer activity.\199\
---------------------------------------------------------------------------
\195\ See prior 17 CFR 242.605(a)(1) (requiring ``every'' market
center to produce a report). See also Rule 605 NMS Plan at n.1 (``An
entity that acts as a market maker in different trading venues
(e.g., as a specialist on an exchange and as an OTC market maker)
would be considered as a separate market center under the Rule for
each of these 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 Rule 605 NMS Plan, see
infra note 869.
\196\ 17 CFR 242.300(k). ``Regulation ATS'' consists of 17 CFR
242.300 through 242.304 (Rules 300 through 304 under the Exchange
Act).
\197\ See Proposing Release, 88 FR 3786 at 3803 (Jan. 20, 2023).
\198\ See id. 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.
\199\ See id.
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2. Final Rule and Discussion
The Commission is specifying that NMS Stock ATSs must report
separately from their broker-dealer operators, as proposed, and
adopting a separate reporting requirement for SDPs largely as proposed.
In each instance, separate reporting under Rule 605 will bring
transparency to these segments of the OTC equity market.
The Commission received generally supportive comments from a
variety of market participants regarding having firms produce separate
Rule 605 reports for NMS Stock ATSs and for SDPs.\200\ After
considering the comments, and for the reasons discussed in the
Proposing Release, the Commission is specifying
[[Page 26445]]
the separate reporting requirement for NMS Stock ATSs as proposed.
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\200\ See, e.g., Healthy Markets Letter at 16 (``[B]rokers that
are also market centers (including as OTC market makers) should be
required to separately report their market center functions for all
covered orders (e.g., ATS or SDP operations).''); Better Markets
Letter at 5, n.10 (``[R]equiring SDPs and ATSs to produce Rule 605
reports independently from their broker-dealers operations would
increase transparency by allowing market participants to distinguish
such activity from more traditional broker-dealer activity.'');
Varghese Letter (``Expanding the scope of entities subject to Rule
605 to include . . . single dealer platforms will ensure that a
wider range of market participants are held to the same standards of
transparency and accountability.'').
---------------------------------------------------------------------------
Two commenters requested clarification and confirmation that order
and execution management systems (``OEMSs'') will not need to register
as ATSs under the Commission's proposal to amend the definition of
``exchange'' under 17 CFR 240.3b-16 (``Rule 3b-16'') \201\ and thus
need not comply with Rule 605's separate reporting requirement for NMS
Stock ATSs.\202\ The Commission is still considering whether to adopt
the proposed changes to the definition of ``exchange'' discussed in the
2022 Regulation ATS/Definition of Exchange Proposing Release and 2023
Regulation ATS/Definition of Exchange Reopening Release. Any need to
comply with Rule 605's separate reporting requirement under any future
rulemaking is outside the scope of this rulemaking.
---------------------------------------------------------------------------
\201\ Securities Exchange Act Release No. 94062 (Jan. 26, 2022),
87 FR 15496 (Mar. 18, 2022) (``2022 Regulation ATS/Definition of
Exchange Proposing Release''). The comment period was reopened on
May 9, 2022, and ended on June 13, 2022: Securities Exchange Act
Release No. 94868 (May 9, 2022), 87 FR 29059 (May 12, 2022). The
Commission reopened the comment period for the 2022 Regulation ATS/
Definition of Exchange Proposing Release again in the 2023. See
Securities Exchange Act Release No. 97309 (Apr. 14, 2023), 88 FR
29448 (May 5, 2023) (``2023 Regulation ATS/Definition of Exchange
Reopening Release''). The 2023 Regulation ATS/Definition of Exchange
Reopening Release provided supplemental information and economic
analysis regarding trading systems that trade crypto asset
securities that would be newly included in the definition of
``exchange'' under the proposed rules. See id.
\202\ See letter from Hubert De Jesus, Managing Director, Global
Head of Market Structure and Electronic Trading, Samantha DeZur,
Managing Director, Global Public Policy Group, BlackRock, Inc. (Mar.
31, 2023) (``BlackRock Letter'') at 4-5 (``Unlike market centers,
OEMSs only route orders based on explicit order handling direction
provided by a user. . . . OEMSs would not have the necessary data--
and are not structured in a manner--that would allow them to file
Rule 605 reports.''); Managed Funds Association Letter at 5-6
(``[I]t would be inappropriate for [OEMSs] to fall within the
communication protocol systems definition. . . . [OEMSs], which are
essentially software systems that help to facilitate and manage
trade executions, do not have (and should not be required to
develop) the operational capabilities to gather and disseminate
information required by Rule 605 reports . . . due to [their]
limited role.'').
---------------------------------------------------------------------------
An industry group and a broker-dealer requested additional clarity
around what constitutes an SDP.\203\ The broker-dealer suggested that
the Commission avoid an over-inclusive definition of SDPs by focusing
on the order types used by non-retail investors to interact with SDPs,
such as immediate-or-cancel (``IOC'') orders and fill-or-kill orders
(``FOKs''), while also capturing substantially similar trading
activities to ensure a level playing field.\204\ This commenter stated
that ``the Commission should consider whether certain Rule 605 metrics
may be unduly impacted by differences in SDP business models, rather
than execution quality'' (e.g., ``a SDP that sends indications of
interest (``IOIs'') to customers may have materially higher fill rates
than a SDP that solely receives blind IOCs'').\205\ This commenter
further suggested that the Commission ``conduct a more holistic review
of the Rule 605 reports already produced by ATSs in order to determine
whether any additional revisions are warranted in order to accurately
report execution quality for non-retail orders'' (e.g., ``the
definition of a `covered order' may need to be amended in order to
ensure that the Rule 605 reports are sufficiently comprehensive for
non-retail orders'').\206\ Another broker-dealer opposed the separate
reporting requirement for SDPs, stating that it is ``unnecessary to
report these execution quality statistics separately, as users of SDPs
are all sophisticated entities capable of carrying out their own
execution quality measurements,'' and thus the requirement ``imposes an
additional cost on SDPs without any clear benefit.'' \207\
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\203\ See SIFMA Letter II at 28 (noting that the Commission
provides no formal SDP definition); Rule 605 Citadel Letter at 7
(stating its views about the importance of clearly defining what
constitutes an SDP).
\204\ See Rule 605 Citadel Letter at 7 (recommending that the
Commission review FINRA Regulatory Notice 18-28, and the comments
submitted in response, to define ``SDP'' more precisely).
\205\ Id. at 7.
\206\ Id. at 8.
\207\ Virtu Letter II at 12-13.
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After considering the comments, the Commission is adopting separate
reporting for SDPs largely as proposed. The Commission acknowledges
that SDPs have different business models and that SDPs that receive
blind IOCs throughout the trading day (so-called ``blind pinging'')
would likely have execution quality statistics that differ
significantly from the statistics of SDPs that send out IOIs. Although
a commenter raised concerns about potential differential impacts on
Rule 605 metrics for SDPs with different business models,\208\ in the
Commission's experience SDPs largely receive institutional orders and
therefore those market participants that send orders to SDPs generally
are or represent sophisticated market participants that would likely be
aware of and understand these differences in business models; thus
these market participants can contextualize the Rule 605 reports
appropriately. To the extent that OTC market makers operating SDPs
think that additional context would help market participants understand
their Rule 605 reports, these firms generally should consider whether
to provide additional explanation on their websites about the nature of
their order flow and how it affects the particular SDP's execution
quality statistics.
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\208\ See Virtu Letter at 12.
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In response to one commenter's statement that imposing a separate
reporting requirement on SDPs lacks any clear benefit to justify the
additional cost,\209\ these order flow differences highlight the
transparency benefits that justify the costs of requiring OTC market
makers operating SDPs to produce Rule 605 reports separate from their
other trading activity.\210\ Otherwise, commingling 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. Moreover, Rule 605's description
of what constitutes SDP activity for purposes of the separate reporting
requirement will help ensure that the SDP-specific Rule 605 reports
reflect comparable activity.
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\209\ See supra note 207 and accompanying text.
\210\ See section IX.D.2.a)(1) for a discussion of compliance
costs related to expanding the scope of Rule 605 reporting entities.
See also section IX.D.1.a)(2) for a discussion of the benefits of
requiring separate Rule 605 reports for SDPs.
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In response to one commenter's suggestion that the Commission
consider revisions to Rule 605 ``in order to accurately report
execution quality for non-retail orders,'' \211\ no further changes to
Rule 605 are necessary to accommodate reporting by SDPs. Prior to the
amendments, market centers included non-retail orders in their Rule 605
reports, to the extent that such orders were held orders, and therefore
the reporting requirement for SDPs will not represent the first time
that market centers were required to report execution quality for non-
retail orders. It is more appropriate in the context of Rule 605 to
require the same metrics for all reporting entities. As discussed
above, market participants that utilize SDPs generally understand
nuances of different market centers. Further, the Commission is
adopting a requirement that SDPs prepare Rule 605 reports separate from
the Rule 605 reports of their associated broker-dealers so that their
customers and market participants will be able to distinguish SDP
activity from more traditional dealer activity and separately evaluate
reporting firms' execution quality with respect to each type of
activity. It is not necessary for the achievement of this goal to make
adjustments to the scope of Rule 605 to
[[Page 26446]]
include more non-retail orders because the amendments to Rule 605
address this separation of SDPs' execution quality statistics.
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\211\ See supra note 206 and accompanying text.
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The Commission also agrees with the two commenters regarding the
need for additional clarity around the scope of entities that are SDPs
for purposes of Rule 605. After considering commenter suggestions,\212\
the Commission is replacing the proposed description of what type of
broker-dealer activity constitutes SDP activity for purposes of the
separate SDP reporting obligation. In its place, the Commission is
adopting a modified description of SDP activity that states: ``Any OTC
market maker that provides a trading system for only a single dealer
\213\ to solely buy and sell securities against all other persons
entering orders in that system shall produce a separate report
pertaining only to covered orders entered in such trading system.''
\214\ Specifically, the Commission's modified SDP description contains
two substantive changes to the proposed SDP description. First, the
Commission is replacing the term ``market center'' with the term ``OTC
market maker'' because the term ``market center'' would have been
overbroad. ``Market center'' includes an ATS, national securities
exchange, or national securities association, none of which can be a
single dealer.\215\ Second, the Commission is replacing ``separate
routing destination'' with ``trading system'' to focus on the activity
that occurs on SDPs and adding ``only'' before ``a single dealer'' to
clarify that the trading system offered will not be for multiple
dealers and instead will be limited to one dealer.\216\
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\212\ In response to the commenter's suggestion that the
Commission consider FINRA Regulatory Notice 18-28 to define ``SDP''
more precisely (see supra note 204), the Commission observes that
FINRA requested comment on a definition of SDP but did not propose
or adopt a definition. See FINRA Regulatory Notice 18-28.
\213\ A dealer is defined in Exchange Act section 3(a)(5), 15
U.S.C. 78c(a)(5).
\214\ Final 17 CFR 242.605(a)(1). Compare final 17 CFR
242.605(a)(1) with proposed Rule 605(a)(1) (``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.''). SDPs are a type of market
center as defined in Regulation NMS Rule 600(b)(55) because the
description of an SDP in the adopted amendments to Rule 605 includes
the term ``OTC market maker'' and the definition of ``market
center'' lists OTC market maker as one of the included entities. See
final 17 CFR 242.600(b)(55). Therefore, as a general matter, SDPs
are a type of market center and, as such, are within the scope of
Rule 605 reporting entities without reference to the 100,000
customer account threshold.
\215\ See final 17 CFR 242.600(b)(55) (defining ``market
center'' to mean any exchange market maker, OTC market maker, ATS,
national securities exchange, or national securities association).
Compare final 17 CFR 242.600(b)(75) (defining ``OTC market maker''
to mean 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 and continuous basis
otherwise than on a national securities exchange in amounts of less
than a block size).
\216\ Unlike an ATS, on an SDP the broker-dealer operator is the
only counterparty to any trade that occurs on the SDP. See, e.g.,
Where Do Stocks Trade?, <a href="http://FINRA.org">FINRA.org</a> (Sep. 28, 2023), available at
<a href="https://www.finra.org/investors/insights/where-do-stocks-trade#::text=The%20most%20familiar%20type%20of,in%20popularity%20in%20recent%20years">https://www.finra.org/investors/insights/where-do-stocks-trade#::text=The%20most%20familiar%20type%20of,in%20popularity%20in%20recent%20years</a>. In contrast, an ATS meets the criteria of 17 CFR
240.3b-16(a) and ``brings together the orders for securities of
multiple buyers and sellers.''
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A broker-dealer recommended that the Commission clarify: (i) the
circumstances in which an SDP can be considered to be embedded within
an ATS (e.g., by constituting a separate tier within an ATS that can be
specifically targeted by IOC or FOK orders), and (ii) whether SDP
activity includes orders received from both the client (whether a
broker-dealer or not) and from internal smart order routers.\217\
First, executions that occur on or through an NMS Stock ATS are
attributable to that NMS Stock ATS and covered orders received for
execution on or through an ATS must be included in the Rule 605 report
pertaining to the ATS rather than on a separate Rule 605 report.\218\
Therefore Rule 605 reporting requirements are not dependent on whether
``an SDP [could] be considered to be embedded within an ATS.'' The
Commission understands that certain NMS Stock ATSs offer counterparty
selection and segmentation procedures that may allow the orders of a
particular participant to interact with the orders of only a subset of
participants, and in this respect trading activity that occurs on
certain NMS Stock ATSs may resemble trading activity that occurs on
SDPs.\219\ Providing separate Rule 605 reports for SDP-like activity on
ATSs would not be practicable given the lack of uniformity among NMS
Stock ATSs' operations, particularly their counterparty and
segmentation procedures. Another factor that could decrease
comparability across reports if they were divided, as suggested by the
commenter, is that trading activity on an NMS Stock ATS occurs within
the context of regulatory requirements specific to NMS Stock ATSs.\220\
In contrast, SDPs (as defined for purposes of Rule 605) operate as
broker-dealer trading systems that are not ATSs and thus that are not
subject to ATS regulatory requirements. Given the differences in
operations and regulatory requirements between the types of trading
systems, which affect order interaction and execution, the execution
quality statistics for SDP-like trading activity occurring on ATSs
could significantly vary in a manner that differs from the variation in
execution quality statistics among SDPs, thereby reducing the utility
of comparing execution quality statistics for trading activity
occurring on SDPs. Second, SDP activity includes orders received from
both a client (whether or not a broker-dealer) and internal smart order
routers. Orders received from internal smart order routers are included
in Rule 605 reports specific to SDPs because the determination that a
trading system is an SDP for purposes of Rule 605 reporting
requirements depends on the type of trading system that receives the
orders and the single dealer counterparty that interacts with the
orders that the system receives.\221\
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\217\ See Rule 605 Citadel Letter at 7.
\218\ See final 17 CFR 242.605(a)(1).
\219\ NMS Stock ATSs may offer counterparty selection or certain
segmentation profiles that allow a single participant to interact
with one or certain counterparties. Form ATS-N requires public
disclosures about these aspects of an NMS Stock ATS. See Form ATS-N,
Part III, Items 13 and 14. An NMS Stock ATS that permits a
subscriber to use its counterparty selection or segmentation
procedures to trade with only one subscriber or a certain subset of
subscribers can be required, depending on its operations and
arrangement with the subscriber, to disclose additional information
in response to other requirements of the Form ATS-N. These
disclosures can include, among others, Part II, Item 2 (Affiliates
Trading Activities on ATS), Part II, Item 4 (Arrangements with
Trading Centers), Part III, Item 7 (Order Types and Attributes),
Part III, Item 11 (Trading Services, Facilities, and Rules), and
Part III, Item 18 (Fees).
\220\ See, e.g., 17 CFR 242.301(b)(3) (containing requirements
for ATSs pertaining to order display and execution access); 17 CFR
242.301(b)(5) (containing requirements for ATSs that have a
significant percentage of overall trading volume in a security or
category of securities during a certain period of time to comply
with fair access requirements, which include, among other things,
that the ATS establish written standards for granting access to
trading on the ATS and not unreasonably prohibit or limit access by
applying those access standards in an unfair or discriminatory
manner).
\221\ See final 17 CFR 242.605(a)(1) (defining an SDP as a
trading system for only a single dealer to solely buy and sell
securities against ``all other persons entering orders in that
system'').
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An industry group asked specific questions about how to distinguish
between OTC market making and SDP activities in Rule 605 reports.\222\
The
[[Page 26447]]
Commission provides the following responses. First, Rule 605(a), as
adopted, defines the separate Rule 605 reporting obligation as applying
to any OTC market maker that provides a separate trading system that
meets specified criteria; therefore, as it pertains to Rule 605
reporting, any SDP required to prepare Rule 605 reports will be a type
of OTC market maker and therefore a market center.\223\ Second, the
Commission is not changing the definition of ``OTC market maker'' in
Rule 600. Thus, any other rule that refers to an ``OTC market maker''
will utilize the same definition in Rule 600. Third, the Commission is
not assuming that an SDP accepts only IOC orders. As such, an SDP is
not limited to accepting or receiving a particular type of covered
order for execution. Fourth, as described above, although a
subscriber's activity on an NMS Stock ATS may resemble SDP activity,
the trading activity occurs on the ATS and thus is attributable to the
ATS for purposes of Rule 605 reporting requirements. Fifth, as
described above, SDP activity includes orders received from both a
client (whether or not a broker-dealer) and from internal smart order
routers.
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\222\ See SIFMA Letter II at 28 (posing the following
interpretive questions to distinguish between OTC market makers and
SDPs: (1) ``Is the Commission suggesting that an SDP is a type of
OTC market maker and therefore a market center?''; (2) ``Would an
SDP be considered an OTC market maker for purposes of any other
rule?''; (3) ``Is the Commission assuming that an SDP only accepts
IOC orders?''; (4) ``Under what circumstances can an SDP be
considered to be embedded within an ATS (such as when an SDP can be
specifically targeted within an ATS by IOC or FOK orders)?''; (5)
``Would SDP activity include orders received from both a client
(whether or not a broker-dealer) and from internal smart order
routers?'').
\223\ See supra note 214.
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III. Modifications to Scope of Orders Covered and Required Information
The reports required by Rule 605(a)(1) prior to these amendments
grouped orders by both order size and order type and included certain
standardized execution quality metrics for all types of orders, as well
as additional metrics for market orders and marketable limit orders.
For all reporting entities, including larger broker-dealers, the
Commission proposed to: (1) modify the order size and order type
groupings; and (2) make changes to the required information for all
types of orders, market and marketable limit order types, and non-
marketable order types. The Commission is adopting the proposed changes
to Rule 605 largely as proposed, with certain modifications discussed
below. Section III.A. describes the ways in which the Commission is
modifying its proposed definition of ``covered order'' in the adopted
amendments. Section III.B. describes the modifications that the
Commission is making to the information contained in the detailed
execution quality reports required by Rule 605(a)(1), including how
orders are categorized by size and type, the timestamp conventions, and
which execution quality statistics are included.
A. Covered Order
The scope of Rule 605's reporting requirements is limited to
covered orders.\224\ The Commission proposed expanding the definition
of ``covered order'' to include: (1) certain orders received outside of
regular trading hours; and (2) orders submitted with stop prices. The
Commission also addressed whether non-exempt short sale orders would be
covered orders when a price test restriction is in effect for the
security.
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\224\ See prior 17 CFR 242.605(a)(1); final 17 CFR
242.605(a)(1). See supra note 4.
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1. Orders Submitted Pre-Opening/Post-Closing
(a) Proposed Approach
Prior to these amendments, Rule 605 reports were required to
include only orders received during regular trading hours \225\ at a
time when an NBBO is being disseminated. When the Commission adopted
Rule 11Ac1-5, 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.\226\ Similarly, orders for which customers requested special
handling, including orders to be executed at a market opening price,
were excluded from Rule 605 reports because of a concern that their
inclusion would skew the general statistics.\227\
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\225\ ``Regular trading hours'' is defined as the time between
9:30 a.m. and 4 p.m. Eastern Time, or such other time as is set
forth in the procedures established pursuant to 17 CFR
242.605(a)(3). See final 17 CFR 242.600(b)(88).
\226\ See Rule 11Ac1-5 Adopting Release, 65 FR 75414 at 75421
(Dec. 1, 2000).
\227\ See id.
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In the Proposing Release, the Commission proposed to: (1) 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; \228\ (2)
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; \229\ and (3) exclude
from Rule 605 reports market or limit orders received during regular
trading hours at a time when an NBBO is being disseminated but prior to
the dissemination of the primary listing market's first firm, uncrossed
quotations for a trading day (``Opening Exemption''),\230\ thereby
incorporating previously granted exemptive relief into the proposed
definition of ``covered order.'' \231\ The Commission's proposed
definition of ``covered order'' would have excluded market orders and
marketable limit orders submitted prior to open or during a trading
halt; therefore, 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 have been a covered order for purposes of Rule
605.\232\ Additionally, the Commission proposed amending 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.\233\
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\228\ See Proposing Release, 88 FR 3786 at 3804 (Jan. 20, 2023).
The Commission proposed to revise the definition of ``categorized by
order type'' to include executable NMLOs and executable orders
submitted with stop prices. See id. at 3804, n. 227; proposed Rule
600(b)(20). The Commission also proposed to expand the definition of
``covered order'' to cover NMLOs received by a market center or
broker-dealer outside of regular trading hours or when an NBBO is
not being disseminated and, if executed, executed during regular
trading hours. See Proposing Release, 88 FR 3786 at 3804 (Jan. 20,
2023); proposed Rule 600(b)(30).
\229\ See Proposing Release, 88 FR 3786 at 3804 (Jan. 20, 2023).
Specifically, the Commission proposed 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. See id.; proposed Rule 600(b)(57).
\230\ See Proposing Release, 88 FR 3786 at 3804-05 (Jan. 20,
2023); proposed Rule 600(b)(30). The Commission stated that,
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
would have been considered covered orders, provided the NMLOs were
not executed outside of regular trading hours. See Proposing
Release, 88 FR 3786 at 3805 (Jan. 20, 2023).
\231\ 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. The
Commission proposed to rescind the Opening Exemption. See Proposing
Release, 88 FR 3786 at 3805 (Jan. 20, 2023).
\232\ See Proposing Release, 88 FR 3786 at 3804 (Jan. 20, 2023).
\233\ See id. at 3805.
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[[Page 26448]]
(b) Final Rule and Discussion
The Commission is adopting as proposed an expansion to the scope of
Rule 605 reporting to include NMLOs submitted outside of regular
trading hours that become executable after the opening or reopening of
trading during regular trading hours.\234\ The Commission is adopting
the definition of ``covered order'' as it relates to orders submitted
outside of regular trading hours largely as proposed, but with a
modification to accept a commenter's recommendation as discussed below.
The Commission is similarly modifying the proposed definitions of
``executable,'' ``marketable limit order,'' and ``beyond-the-midpoint
limit order'' \235\ to accommodate this modification. Further, the
Commission is adopting as proposed the requirement for a market center,
broker, or dealer to include in its monthly report those covered orders
in NMS stocks that it received for execution in a prior calendar month
but which remained open.\236\
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\234\ See final 17 CFR 242.600(b)(19) (defining ``categorized by
order type'').
\235\ As discussed further below, the Commission is making
additional modifications to this order type category and renaming
the associated definition as ``midpoint-or-better limit order.'' See
infra section III.B.2.b).
\236\ See final 17 CFR 242.605(a)(1).
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Generally, individual investors supported including certain orders
submitted outside of regular trading hours within the scope of covered
orders.\237\ One individual investor who supported the proposed change
stated that after-market and pre-market trades play a greater role
today than ever before, with many of the price changes occurring during
these times rather than during market hours.\238\
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\237\ See, e.g., Pritchard Letter; letter from Dan Liefwalker
(Mar. 7, 2023); Macarthur Letter; Genco Letter; Varghese Letter;
letter from Jeremy B. Beddo (Mar. 30, 2023) (``Beddo Letter'').
\238\ See Joy Letter. However, an individual investor who
opposed the proposal stated that including as covered orders certain
orders submitted outside of regular trading hours (as well as
certain orders submitted with stop prices) ``could make it difficult
for retail investors to place orders at the best possible price''
and ``[t]his could lead to retail investors being left with less
favorable prices and missing out on potential gains in the dark
markets.'' Letter from Jacob Gillmore (Feb. 24, 2023) (``Gillmore
Letter''). It is not clear--and the commenter does not explain--how
including orders submitted outside of regular trading hours in Rule
605 reports could make it difficult for retail investors to place
orders at the best possible price.
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A broker-dealer supported the inclusion of pre-market orders in
Rule 605 reports, stating these orders (along with other included order
types) would provide investors with a more complete picture of order
execution quality across the marketplace.\239\ Another commenter stated
that NMLOs entered outside of ``normal hours'' should not be included
because ``these will likely skew the statistics.'' \240\ Specifically,
this commenter stated that frequently the first quote after opening is
wide and not representative of the quote when the primary exchange
opens, and many orders deemed NMLOs by this benchmark would likely fill
as soon as the primary exchange opens. Therefore, according to this
commenter, ``including these orders will skew the NMLO stats and lead
to difficult comparisons between brokers.'' \241\
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\239\ See Virtu Letter II at 3.
\240\ Schwab Letter II at 32.
\241\ Id.
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A national securities exchange supported inclusion of certain
orders submitted outside of regular trading hours within the definition
of ``covered order.'' \242\ An investor advocacy group recommended that
Rule 605 run from primary market open to primary market close (e.g.,
9:30 a.m. to 4 p.m. eastern standard time).\243\
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\242\ See Nasdaq Letter at 43, text accompanying n.121.
\243\ See Healthy Markets Letter at 17. This commenter's
suggestion of when Rule 605 should be in effect is consistent with
the definition of ``regular trading hours.'' See final 17 CFR
242.600(b)(88) (``Regular trading hours means the time between 9:30
a.m. and 4 p.m. Eastern Time, or such other time as is set forth in
the procedures established pursuant to Sec. 242.605(a)(3).'') This
commenter did not address whether to include certain orders
submitted outside of regular trading hours but executed during
regular trading hours within the scope of Rule 605's reporting
requirements as proposed.
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An industry group stated that the proposed definition of ``covered
order,'' in th
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