[Federal Register Volume 81, Number 144 (Wednesday, July 27, 2016)]
[Proposed Rules]
[Pages 49432-49511]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-16967]
[[Page 49431]]
Vol. 81
Wednesday,
No. 144
July 27, 2016
Part III
Securities and Exchange Commission
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17 CFR Parts 240 and 242
Disclosure of Order Handling Information; Proposed Rule
Federal Register / Vol. 81 , No. 144 / Wednesday, July 27, 2016 /
Proposed Rules
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-78309; File No. S7-14-16]
RIN 3235-AL67
Disclosure of Order Handling Information
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing to amend Rules 600 and 606 of Regulation National
Market System (``Regulation NMS'') under the Securities Exchange Act of
1934 (``Exchange Act'') to require additional disclosures by broker-
dealers to customers about the routing of their orders. Specifically,
with respect to institutional orders, the Commission is proposing to
amend Rule 606 of Regulation NMS to require a broker-dealer, upon
request of its customer, to provide specific disclosures related to the
routing and execution of the customer's institutional orders for the
prior six months. The Commission also is proposing to amend Rule 606 of
Regulation NMS to require a broker-dealer to make publicly available
aggregated information with respect to its handling of customers'
institutional orders for each calendar quarter. With respect to retail
orders, the Commission is proposing to make targeted enhancements to
current order routing disclosures under Rule 606 by requiring limit
order information to be broken down into marketable and non-marketable
categories, requiring the disclosure of the net aggregate amount of any
payment for order flow received, payment from any profit-sharing
relationship received, transaction fees paid, and transaction rebates
received by a broker-dealer from certain venues, requiring broker-
dealers to describe any terms of payment for order flow arrangements
and profit-sharing relationships with certain venues that may influence
their order routing decisions, and eliminating the requirement to
divide retail order routing information by listing market. In
connection with these new requirements, the Commission is proposing to
amend Rule 600 of Regulation NMS to include a number of newly defined
terms which are used in the proposed amendments to Rule 606. The
Commission is also proposing to amend Rules 605 and 606 of Regulation
NMS to require that the public order execution and order routing
reports be kept publicly available for a period of three years and to
make conforming changes to Rule 607. Finally, the Commission is
proposing to amend Rule 3a51-1(a) under the Exchange Act; Rule 13h-
1(a)(5) of Regulation 13D-G; Rule 105(b)(1) of Regulation M; Rules
201(a) and 204(g) of Regulation SHO; Rules 600(b), 602(a)(5),
607(a)(1), and 611(c) of Regulation NMS; and Rule 1000 of Regulation
SCI, to update cross-references as a result of this proposed rule.
DATES: Comments should be received on or before September 26, 2016.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an email to [email protected]. Please include
File Number S7-14-16 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street, NE., Washington, DC
20549-1090.
All submissions should refer to File Number S7-14-16. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549-1090 on official business days between the hours of 10:00 a.m.
and 3:00 p.m. All comments received will be posted without change; we
do not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's Web site. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Theodore S. Venuti, Assistant
Director, at (202) 551-5658, Arisa Tinaves Kettig, Senior Special
Counsel, at (202) 551-5676, Steve Kuan, Special Counsel, at (202) 551-
5624, Amir Katz, Special Counsel, at (202) 551-7653, Chris Grobbel,
Special Counsel, at (202) 551-5491, or Andrew Sioson, Attorney-Advisor,
at (202) 551-7186 Division of Trading and Markets, Securities and
Exchange Commission, 100 F Street, NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing: (1) Amendments
to Rules 600 and 606 under the Exchange Act [17 CFR 242.600 and
202.606] to require additional disclosures by broker-dealers to
customers about the routing of their orders; (2) amendments to Rule 605
[17 CFR 242.605] to require that the public order execution and order
routing reports be kept publicly available for a period of three years;
and (3) conforming changes and updating cross-references in Rule 3a51-
1(a) under the Exchange Act [17 CFR 240.3a51-1(a)], Rule 13h-1(a)(5) of
Regulation 13D-G [17 CFR 240.13h-1(a)(5)], Rule 105(b)(1) of Regulation
M [17 CFR 242.105(b)(1)] Rules 201(a) and 204(g) of Regulation SHO [17
CFR 242.201(a) and 242.204(g)], Rules 600(b), 602(a)(5), 605,
607(a)(1), and 611(c) of Regulation NMS [17 CFR 242.600(b),
242.602(a)(5), 242.605, 242.607(a)(1), and 242.611(c)], and Rule 1000
of Regulation SCI [17 CFR 242.1000].
Table of Contents
I. Introduction
II. Current Practices and Regulation and the Need for Enhanced
Disclosures
A. Background on Rule 606
B. Changes in Order Handling Practices
C. Need for Enhanced Disclosures for Institutional Orders
1. Market Complexity
2. Assessing Best Execution
3. Conflicts of Interest
4. Information Leakage
D. Need for Public Reporting of Aggregated Institutional Order
Information
E. Need for Enhanced Disclosures for Retail Orders
F. Comments on Equity Market Structure
1. General Need to Update Rule 606
2. Need for Rule 606 to be Modernized to Maintain Pace with
Technological Advances
3. Requests for Specific Information and Standardized
Disclosures
4. Requests for Specific Disclosures for Institutional Orders
5. Comments on Actionable Indications of Interest
III. Proposed Amendments to Rule 600, Rule 605, Rule 606, and Rule
607
A. Disclosures for Institutional Orders
1. Definition of Institutional Order in Proposed Rule 600(b)(31)
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2. Definition of Actionable Indication of Interest in Proposed
Rule 600(b)(1)
3. Scope and Format of Reports
4. Report Content
5. Public Report for Institutional Orders
B. Disclosures for Retail Orders
1. Marketable Limit Orders and Non-Marketable Limit Orders
2. Net Payment for Order Flow and Transaction Fees and Rebates
by Specified Venue
3. Discussion of Arrangement Terms with a Specified Venue
4. Additional Amendments to Retail Disclosures
5. Amendment to Rule 600(b)(18) to rename ``Customer Order'' to
``Retail Order''
C. Amendment to Disclosure of Order Execution Information
IV. Paperwork Reduction Act
A. Summary of Collection of Information
1. Customer Requests for Information on Institutional Orders
2. Public Aggregated Report on Institutional Orders
3. Requirement to Document Methodologies for Categorizing
Institutional Order Routing Strategies
4. Amendment to Current Disclosures With Respect to Retail
Orders
5. Amendment to Current Disclosures under Rule 605
B. Proposed Use of Information
1. Customer Requests for Information on Institutional Orders
2. Public Aggregated Report on Institutional Orders
3. Requirement to Document Methodologies for Categorizing
Institutional Order Routing Strategies
4. Amendment to Current Disclosures With Respect to Retail
Orders
5. Amendment to Current Disclosures under Rule 605
C. Respondents
D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Customer Requests for Information on Institutional Orders
2. Public Aggregated Report on Institutional Orders
3. Requirement to Document Methodologies for Categorizing
Institutional Order Routing Strategies
4. Amendment to Current Disclosures With Respect to Retail
Orders
5. Amendment to Current Disclosures under Rule 605
E. Collection of Information is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
H. Request for Comments
V. Economic Analysis
A. Introduction
B. Baseline
1. Ad Hoc Reports for Institutional Orders
2. Publication Period for Reports on Retail Orders Required by
Current Rules 605 and 606
3. Available Information on Conflicts of Interest
4. Available Information on Execution Quality for Institutional
and Retail Orders
5. Format of Current Reports for Institutional and Retail Orders
6. Quality of Broker-Dealer Routing Practices for Institutional
Orders
7. Use of Actionable IOIs in Institutional Orders
8. Competition, Efficiency, and Capital Formation
9. Request for Comment
C. Costs and Benefits
1. Disclosures for Institutional Orders
2. Disclosures for Retail Orders
3. Disclosure of Order Execution Information
4. Structured Format of Reports
5. Other Definitions in Proposed Amendments to Rule 600
D. Alternatives Considered
1. Definition of Institutional Order in Proposed Rule 606(b)(31)
2. Limited or No Public Disclosure of Institutional Order
Routing and Execution Quality (Proposed Rule 606(c))
3. More Frequent Public Disclosure of Institutional Order
Routing and Execution Information (Proposed Rule 606(c))
4. Automatic Provision of Customer-Specific Institutional Order
Handling Report (Proposed Rule 606(b)(3))
5. Submission of Institutional Order Handling Reports (Proposed
Rules 606(b)(3) and 606(c))
6. Disaggregate Categories of NMS Stocks for Rule 606(a)
7. Disclosure of Additional Information about Institutional
Order Routing and Execution
8. Institutional Order Handling Reports at the Stock Level
(Proposed Rule 606(b)(3))
9. Alternative to Three-Year Posting Period (Proposed Amendments
to Rules 605(a)(2) and 606(a)(1), and Proposed Rule 606(c))
10. Request for Comment
E. Economic Effects and Effects on Efficiency, Competition, and
Capital Formation
1. Effects of Proposed Amendments on Efficiency and Competition
2. Effects of Proposed Amendments on Capital Formation
3. Request for Comment
VI. Consideration of Impact on the Economy
VII. Regulatory Flexibility Analysis
VIII. Statutory Authority and Text of the Proposed Rule Amendments
I. Introduction
Institutional customers have a compelling interest in the order
handling decisions of their executing brokers as they monitor the
execution quality of their orders, both from the standpoint of the
price received and to evaluate the potential negative effects of
information leakage and conflicts of interest.\1\ This focus on order
handling has intensified in recent years as routing and execution
practices have evolved as markets have become more automated,
dispersed, and complex.\2\ Historically, there was a substantial manual
component involved in the routing and execution of institutional
customers' orders. Today, however, institutional orders tend to be
routed and executed using sophisticated order execution algorithms
developed by broker-dealers or others that break up large institutional
orders into smaller ``child'' orders, and smart order routing systems
to route those child orders to the full range of trading centers in the
national market system, including exchanges, ``dark pool'' alternative
trading systems (``ATSs''), other ATSs, and internalizing broker-
dealers.\3\ These order routing and execution algorithms use a wide
variety of methods, ranging from non-time-sensitive passive strategies
to aggressive liquidity-taking strategies, to achieve the trading goals
of the institutional customer. Although certain advantages flow from
technological advancements and the increase in number of venues, the
Commission preliminarily believes that the complexity of order
execution algorithms and smart order routing systems, and the
multiplicity of venues to which broker-dealers may route orders or send
actionable indications of interest, have made it increasingly difficult
for institutional customers to assess the impact particular order
routing strategies may have on the quality of their executions, or the
risks presented by any resulting information leakage or broker-dealer
conflicts of interest.
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\1\ An institutional customer includes, for example, pension
funds, mutual funds, investment advisers, insurance companies,
investment banks, and hedge funds.
\2\ See Securities Exchange Act Release No. 73639 (November 19,
2014), 79 FR 72252, 72397 (December 5, 2014) (``Regulation SCI
Adopting Release'') (stating that markets have evolved ``to become
significantly more dependent on sophisticated, complex, and
interconnected technology''); see also Securities Exchange Act
Release No. 61358 (January 14, 2010), 75 FR 3594 (January 21, 2010)
(``Concept Release on Equity Market Structure'') (stating that ``the
current market structure can be described as dispersed and complex:
(1) Trading volume is dispersed among many highly automated trading
centers that compete for order flow in the same stocks; and (2)
trading centers offer a wide range of services that are designed to
attract different types of market participants with varying trading
needs'').
\3\ A ``trading center'' means a national securities exchange or
national securities association that operates an SRO trading
facility, an alternative trading system, an exchange market maker,
an OTC market maker, or any other broker or dealer that executes
orders internally by trading as principal or crossing orders as
agent. See 17 CFR 242.600(b)(78).
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Changes to market structure and routing practices have led many
institutional customers to demand more specific and detailed
institutional order handling information from their broker-dealers. The
Commission notes that for
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purposes of this proposing release, the use of ``institution'' or
``institutional'' shall refer to an institutional order, as proposed to
be defined in proposed Rule 600(b)(31),\4\ and the term ``institutional
customer'' shall refer to a sender of an institutional order.
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\4\ See infra Section III.A.1.
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The Commission understands that institutional customer requests
range from detailed information about the handling of specific
institutional orders to more generic data about the order routing
strategies pursued by the broker-dealer for institutional customers and
the venues to which their orders are routed and executed. The level of
detail of the information provided tends to vary by broker-dealer, as
well as the particular institutional customer, some of whom may have
the wherewithal and desire to digest and evaluate voluminous order
handling information and some of whom may not.
The Commission preliminarily believes that market-based efforts to
provide institutional order handling transparency may not be sufficient
insofar as smaller institutional customers may lack the bargaining
power or the resources to demand relevant order handling information
from their broker-dealers. In addition, while many institutional
customers regularly conduct, directly or through a third-party vendor,
transaction cost analysis (``TCA'') of their orders to assess execution
quality against various benchmarks, the Commission preliminarily
believes that the comprehensiveness of such analysis could be enhanced
with more granular order handling information. The Commission also
preliminarily believes that standardizing the baseline information
provided by broker-dealers could help ensure the wide availability of
meaningful order handling information that may be produced in an
efficient and cost-effective manner.\5\
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\5\ There have been recent efforts by representatives of broker-
dealers and institutional customers to develop a template of
baseline order routing disclosure, and these efforts are reflected
in a letter from the Investment Company Institute, the Managed Funds
Association, and the Securities Industry and Financial Markets
Association (collectively, the ``Associations''). See Letter to Mary
Jo White, Chair, Commission, from Dorothy M. Donohue, Deputy General
Counsel, Investment Company Institute, Stuart J. Kaswell, Executive
Vice President & Managing Director, General Counsel, Managed Funds
Association, and Randy Snook, Executive Vice President, Securities
Industry and Financial Markets Association, dated October 23, 2014
(``Associations Letter''), available at http://www.sec.gov/comments/s7-02-10/s70210-428.pdf.
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In light of the foregoing, the Commission preliminarily believes
that standardized baseline institutional order handling information
should be required to be made available to the institutional customer
upon request so that the institutional customer can more effectively
assess the impact of order routing decisions on the quality of their
executions, including the risks of information leakage and potential
conflicts of interest.\6\ Further, the Commission preliminarily
believes that public disclosure of institutional order handling
information, on an aggregated basis, could assist market participants
in comparing the routing services of multiple broker-dealers, and the
relative merits of competing trading centers, and facilitate
institutional customers' ability to make informed decisions when
engaging the services of a broker-dealer. The Commission preliminarily
believes that the proposal would further encourage broker-dealers to
minimize information leakage when executing an institutional order. The
Commission preliminarily believes that the potential benefits of public
disclosure of aggregated institutional order handling information
should justify any potential negative competitive impact such
disclosure may have on broker-dealers.
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\6\ See infra Sections II.C.3. and II.C.4.
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The changes to market structure have impacted the market for
customer order routing and execution services. Currently, a ``customer
order'' means an order to buy or sell an NMS security that is not for
the account of a broker-dealer, but shall not include any order for a
quantity of a security having a market value of at least $50,000 for an
NMS security that is an option contract and a market value of at least
$200,000 for any other NMS security.\7\ As such, the term ``customer
order,'' when used in Regulation NMS, only refers to smaller-sized
orders. As discussed in more detail below, the Commission is proposing
to rename ``customer order'' to ``retail order'' and for purposes of
this proposing release, the term ``retail customer'' shall refer to a
sender of a retail order.
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\7\ See 17 CFR 242.600(b)(18).
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As discussed below, the rise in the number of trading centers and
the introduction of new fee models for execution services have
intensified competition for retail order flow and created new potential
conflicts of interest for broker-dealers. The Commission preliminarily
believes that simplified and enhanced disclosures for retail orders,
particularly with respect to financial inducements from trading
centers, should assist retail customers in evaluating better the order
routing services of their broker-dealers. Additionally, public
transparency of retail orders should drive competition as broker-
dealers seek to compete on the basis of the quality of their order
routing and execution services as well as their ability to manage
conflicts of interest.
The Commission therefore is proposing amendments to Rules 600 \8\
and 606 \9\ of Regulation NMS to require, for the first time,
disclosures by broker-dealers about their handling of institutional
orders, and enhancements to existing disclosures with respect to retail
orders.\10\ Specifically, with respect to institutional orders, the
Commission is proposing to amend Rule 606 of Regulation NMS to require
a broker-dealer, upon request of its customer, to provide specific
disclosures, for the prior six months, broken down by calendar month,
related to: (1) The handling of the customer's institutional orders at
the broker-dealer; (2) the routing of the customer's institutional
orders to various trading centers; (3) the execution of those orders,
and the quality of execution; and (4) the extent to which such orders
provided liquidity or removed liquidity, and the average transaction
rebates received or fees paid by the broker-dealer. This information
would be provided for each venue, and would further be divided into
passive, neutral, and aggressive order routing strategies. In
connection with this new requirement, the Commission is proposing to
amend Rule 600 of Regulation NMS to include definitions of the terms
``institutional order,'' ``actionable indication of interest,''
``orders providing liquidity,'' and ``orders removing liquidity,'' and
to rename the defined term ``customer order'' to ``retail order.'' The
Commission also is proposing to amend Rule 606 of Regulation NMS to
require a broker-dealer to make publicly available the foregoing
information, on an aggregated basis, for all of its customers'
institutional orders, for each calendar quarter, broken down by
calendar month, and keep such reports posted on an Internet Web site
that is free and readily accessible to the public for a period of three
years from the initial date of posting on the Internet Web site.
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\8\ 17 CFR 242.600.
\9\ 17 CFR 242.606.
\10\ The Commission notes that the proposed amendments to Rule
606, if adopted, would not limit any other obligations that the
broker-dealer may have under applicable federal securities laws,
rules, or regulations, including the anti-fraud provisions of the
federal securities laws.
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Further, with respect to retail orders, the Commission
preliminarily believes that the existing Rule 606 disclosures should be
updated to require that more relevant routing information is provided
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to retail customers. Specifically, the Commission is proposing to: (1)
Require limit order information to be split into marketable \11\ and
non-marketable \12\ categories; (2) require more detailed disclosure of
the net aggregate amount of any payments received from or paid to
certain trading centers; (3) require broker-dealers to describe any
terms of payment for order flow arrangements and profit-sharing
relationships with certain venues that may influence its order routing
decisions; (4) require that broker-dealers keep retail order routing
reports posted on an Internet Web site that is free and readily
accessible to the public for a period of three years from the initial
date of posting on the Internet Web site; and (5) eliminate the
requirement to group retail order routing information by listing
market.
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\11\ A ``marketable limit order'' is any buy order with a limit
price equal to or greater than the national best offer at the time
of order receipt, or any sell order with a limit price equal to or
less than the national best bid at the time of order receipt. 17 CFR
242.600(b)(39). ``National best bid and national best offer'' means,
with respect to quotations for an NMS security, the best bid and
best offer for such security that are calculated and disseminated on
a current and continuing basis by a plan processor pursuant to an
effective national market system plan; provided, that in the event
two or more market centers transmit to the plan processor pursuant
to such plan identical bids or offers for an NMS security, the best
bid or best offer (as the case may be) shall be determined by
ranking all such identical bids or offers (as the case may be) first
by size (giving the highest ranking to the bid or offer associated
with the largest size), and then by time (giving the highest ranking
to the bid or offer received first in time). 17 CFR 242.600(b)(42).
\12\ The Commission is proposing in new Rule 600(b)(51) to
define ``non-marketable limit order'' to mean ``any limit order
other than a marketable limit order'', as discussed in more detail
below. See infra Section III.B.1.
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Finally, consistent with the proposed amendments to Rule 606, the
Commission is proposing to amend Rule 605 to require market centers
\13\ to keep execution reports required by the rule posted on an
Internet Web site that is free of charge and readily accessible to the
public for a period of three years from the initial date of posting on
the Internet Web site. With respect to Rule 607, the Commission is
proposing to amend the rule text to reflect the renaming of the defined
term ``customer order'' to ``retail order,'' but is making no
substantive changes to the defined term. As noted above, the Commission
is proposing amendments to other rules to update cross-references as a
result of this proposal.\14\
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\13\ A ``market center'' means any exchange market maker, OTC
market maker, alternative trading system, national securities
exchange, or national securities association. See 17 CFR
242.600(b)(38).
\14\ The Commission is proposing to amend Rule 3a51-1(a) under
the Exchange Act; Rule 13h-1(a)(5) of Regulation 13D-G; Rule
105(b)(1) of Regulation M; Rules 201(a) and 204(g) of Regulation
SHO; Rules 600(b), 602(a)(5), 607(a)(1), and 611(c) of Regulation
NMS; and Rule 1000 of Regulation SCI.
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The release first provides relevant background on Rule 606 and then
discusses the technological advances and regulatory changes that have
prompted the proposal. The release then discusses, in detail, the
proposed amendments to Rules 600, 605, 606, and 607 including the new
institutional order handling disclosures that would be required from
broker-dealers.
II. Current Practices and Regulation and the Need for Enhanced
Disclosures
A. Background on Rule 606
The Commission proposed and adopted Rule 11Ac1-6,\15\ now known as
Rule 606 of Regulation NMS,\16\ in 2000, to improve public disclosure
of order routing practices. Rule 606 arose out of the Commission's
extended inquiry into market fragmentation, defined at the time as the
trading of orders in multiple locations without interaction among those
orders.\17\ In adopting Rule 606, the Commission stated that ``[i]n a
fragmented market structure with many different market centers trading
the same security, the order routing decision is critically important,
both to the individual investor whose order is routed and to the
efficiency of the market structure as a whole. The decision must be
well-informed and fully subject to competitive forces.'' \18\ The
Commission further stated that public disclosure of order routing
practices ``could provoke more vigorous competition on . . . order
routing performance.'' \19\
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\15\ See Securities Exchange Act Release Nos. 43084 (July 28,
2000), 65 FR 48406 (August 8, 2000) (``Rule 606 Predecessor
Proposing Release'') and 43590 (November 17, 2000), 65 FR 75414
(December 1, 2000) (``Rule 606 Predecessor Adopting Release'').
\16\ The Commission re-designated Rule 11Ac1-6 as Rule 606 when
adopting Regulation NMS in 2005. See Securities Exchange Act Release
No. 51808 (June 9, 2005), 70 FR 37496, 37538 (June 29, 2005)
(``Regulation NMS Adopting Release''). For clarity, when this
release discusses the proposal of Rule 606 or the adoption of Rule
606, it is referring to the Rule 606 Predecessor Proposing Release
and Rule 606 Predecessor Adopting Release, supra note 15,
respectively.
\17\ See Securities Exchange Act Release No. 42450 (February 23,
2000), 65 FR 10577 (February 28, 2000) (Commission request for
comment, included in a notice of a proposed self-regulatory
organization (``SRO'') rule change) (``Fragmentation Release'').
\18\ See Rule 606 Predecessor Adopting Release, supra note 15,
at 75415.
\19\ Id. at 75417. Industry participants commenting in response
to the Concept Release on Equity Market Structure, supra note 2,
have expressed the view that increased order routing transparency
has led to increased competition. See, e.g., Letters to Secretary,
Commission, from Joan C. Conley, Senior Vice President and Corporate
Secretary, The NASDAQ OMX Group, Inc., dated April 30, 2010
(``NASDAQ Letter''), at 21 (stating that NASDAQ shares the
Commission's belief that transparency promotes competition); from
Christopher Nagy, Managing Director Order Strategy, Co-Head of
Government Relations, TD Ameritrade and John S. Markle, Deputy
General Counsel, Co-Head of Government Relations, TD Ameritrade,
dated April 21, 2010 (``TD Ameritrade Letter''), at 3-4 (stating
that added transparency has driven brokers to continuously seek
better executions for clients).
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In adopting Rule 606, the Commission limited its scope to smaller
orders.\20\ Larger orders were excluded in recognition of the fact
that, at the time, generalized information for order routing practices
would be more useful for smaller orders, which tended to be handled in
a more homogenous manner.\21\ Because institutional orders required
more individualized, manual handling, they were excluded from Rule 606
in recognition of the fact that, at that time, providing standardized
order handling statistics would be neither practical nor useful in this
context.\22\
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\20\ The Commission limited the scope of Rule 606 to smaller
orders by defining a customer order as an order to buy or sell an
NMS security that is not for the account of a broker or dealer, but
shall not include any order for a quantity of a security having a
market value of at least $50,000 for an NMS security that is an
option contract and a market value of at least $200,000 for any
other NMS security. See 17 CFR 242.600(b)(18).
\21\ See Rule 606 Predecessor Adopting Release, supra note 15,
at 75426.
\22\ See id.
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Thus, in its current form, Rule 606(a) applies only to retail-sized
orders, and requires every broker-dealer to publicly provide a
quarterly report on its routing of non-directed orders \23\ in NMS
securities.\24\ Currently, the report includes the following
information, separated by listing market for NMS stocks,\25\ and in the
aggregate for NMS securities that are option contracts: (1) The
percentage of total retail orders that were non-directed orders, and
the percentages of total non-directed orders that were market orders,
limit orders, and other orders; (2) the identity of the ten venues to
which the largest number of total non-directed orders were routed for
execution and of any venue to which
[[Page 49436]]
five percent or more of such orders were routed (collectively,
``Specified Venues'') and the percentage of total non-directed orders
routed to each Specified Venue, and the percentages of total non-
directed market orders, total non-directed limit orders, and total non-
directed other orders that were routed to each Specified Venue; and (3)
a discussion of the material aspects of the broker-dealer's
relationship with each Specified Venue, including a description of any
payment for order flow \26\ or profit-sharing relationship
arrangements.\27\
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\23\ A ``non-directed order'' means any customer order other
than a directed order. See 17 CFR 242.600(b)(48). A ``directed
order'' means a customer order that the customer specifically
instructed the broker or dealer to route to a particular venue for
execution. See 17 CFR 242.600(b)(19). See also supra note 7 and
accompanying text. The Commission is proposing to rename ``customer
order'' as ``retail order,'' which would carry through to these two
definitions. See infra Section III.B.5.
\24\ An ``NMS security'' is 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 17 CFR 242.600(b)(46).
\25\ An ``NMS stock'' is any NMS security other than an option.
See 17 CFR 242.600(b)(47).
\26\ ``Payment for order flow'' has the meaning provided in 17
CFR 240.10b-10. See 17 CFR 242.600(b)(54). ``Payment for order
flow'' means any monetary payment, service, property, or other
benefit that results in remuneration, compensation, or consideration
to a broker or dealer from any broker or dealer, national securities
exchange, registered securities association, or exchange member in
return for the routing of customer orders by such broker or dealer
to any broker or dealer, national securities exchange, registered
securities association, or exchange member for execution, including
but not limited to: research, clearance, custody, products or
services; reciprocal agreements for the provision of order flow;
adjustment of a broker or dealer's unfavorable trading errors;
offers to participate as underwriter in public offerings; stock
loans or shared interest accrued thereon; discounts, rebates, or any
other reductions of or credits against any fee to, or expense or
other financial obligation of, the broker or dealer routing a
customer order that exceeds that fee, expense or financial
obligation. See 17 CFR 240.10b-10(d)(8).
\27\ A ``profit-sharing relationship'' means any ownership or
other type of affiliation under which the broker or dealer, directly
or indirectly, may share in any profits that may be derived from the
execution of non-directed orders. See 17 CFR 242.600(b)(56).
---------------------------------------------------------------------------
Rule 606(b) currently requires every broker-dealer to provide
customers, upon request, specific information about the routing of
their orders. Specifically, upon request, every broker-dealer shall:
(1) Disclose to its customer the identity of the venue to which the
customer's orders were routed for execution in the six months prior to
the request, whether the orders were directed orders or non-directed
orders, and the time of the transactions, if any, that resulted from
such orders; and (2) notify customers in writing at least annually of
the availability of this information upon request.
B. Changes in Order Handling Practices
U.S. equity market structure has changed significantly since the
adoption of Rule 606. Today it is highly automated, dispersed among
myriad trading centers, and more complex than it was in 2000.\28\ The
primary drivers of this market transformation have been the rapid and
ongoing evolution of technologies for generating, routing, and
executing orders, and the impact of regulatory changes.\29\ In 2000, a
large proportion of order flow in listed equity securities was routed
to a few, mostly manual, trading centers, and it was rare that such
orders would be re-routed to other venues.\30\ In contrast, today,
trading in the U.S. equity markets is spread among a number of highly
automated trading centers: 12 registered exchanges, more than 40
ATSs,\31\ and over 200 over-the-counter (``OTC'') market-makers,\32\
and the routing and re-routing of orders to multiple venues is common.
These venues offer a wide range of services and pricing structures that
are designed to attract different types of market participants with
varying trading needs.\33\
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\28\ See Concept Release on Equity Market Structure, supra note
2, at 3594. See also Regulation SCI Adopting Release, supra note 2,
at 72397.
\29\ See Concept Release on Equity Market Structure, supra note
2, at 3594 (``Changes in market structure also reflect the markets'
response to regulatory actions such as Regulation NMS, adopted in
2005, the Order Handling Rules, adopted in 1996, as well as
enforcement actions, such as those addressing anti-competitive
behavior by market makers in NASDAQ stocks'').
\30\ See Fragmentation Release, supra note 17.
\31\ Data compiled from Forms ATS-R filed with the Commission as
of the end the fourth quarter of 2014.
\32\ More than 200 broker-dealers (excluding ATSs) have
identified themselves to the Financial Industry Regulatory Authority
(``FINRA'') as market centers that must provide monthly reports on
order execution quality under Rule 605 of Regulation NMS (list
available at http://apps.finra.org/datadirectory/1/marketmaker.aspx).
\33\ See Concept Release on Equity Market Structure, supra note
2, at 3594.
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According to a staff report published in 1994, prior to the
emergence and growth of electronic markets, institutional customers
would rely primarily on exchange floor brokers or upstairs block
positioners to execute their large orders.\34\ Typically, exchange
floor brokers or upstairs block positioners would negotiate large
trades off the exchange (often referred to as ``upstairs'') and
subsequently execute or ``print'' on the exchange--subject to auction
market procedures allowing the limit order book or the trading crowd to
participate in the trade and exposing the order to the market.\35\ The
nature of floor trading activity and upstairs block positioning allowed
broker-dealers to manually exercise judgment and expertise to achieve
best execution, and typically involved strategies that were designed to
conceal information about an institutional customer's trading interest
to potential counterparties to minimize price impact.
---------------------------------------------------------------------------
\34\ See Division of Market Regulation, SEC, Market 2000: An
Examination of Current Equity Market Developments, at II-14 (January
1994).
\35\ Id. at II-14-15.
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In today's electronic markets, however, the manual handling of
institutional orders is increasingly rare, and has been replaced by
sophisticated institutional order execution algorithms and smart order
routing systems. These sophisticated algorithms and systems decide the
timing, pricing, and quantity of orders routed to the various trading
centers.\36\ Broker-dealers often use order execution algorithms to
divide a large ``parent'' order of an institutional customer into many
smaller ``child'' orders, and route the child orders over time to
different trading centers in accordance with a particular strategy.\37\
Such algorithms may be ``aggressive,'' and generally seek to take
liquidity quickly at many different trading centers, or they may be
``passive,'' and generally submit resting orders at one or more trading
centers and await executions at favorable prices, or they may be
``neutral,'' and seek to take liquidity or submit resting orders
depending on market conditions.\38\ In addition, some broker-dealers
utilize indications of interest to notify external liquidity providers
of trading interest at that broker-dealer.
---------------------------------------------------------------------------
\36\ See, e.g., Terrence Hendershott, Charles Jones, and Albert
Menkveld, Does Algorithmic Trading Improve Liquidity, 66 Journal of
Finance 1 (February 2011).
\37\ See Concept Release on Equity Market Structure, supra note
2, at 3602.
\38\ See id.
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C. Need for Enhanced Disclosures for Institutional Orders
1. Market Complexity
Institutional customers have long focused on the execution quality
of their large orders, and the potential impacts from information
leakage and conflicts of interest faced by their broker-dealers. While
there is some indication that enhancements to electronic order routing
systems and processes generally have led to improved execution quality
in many cases,\39\ the operation of order routing systems and processes
often is opaque to customers placing institutional orders, who may not
have sufficient information to understand how, where, and why their
orders are routed to specific venues, and whether particular order
routing and execution strategies, whether or not selected by
[[Page 49437]]
the customer, are consistent with the customer's expectations.
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\39\ See, e.g., Letter to Secretary, Commission, from Greg
O'Connor, Compliance Manager, Wolverine Trading, LLC, dated April
21, 2010 (``Wolverine Trading Letter''), at 5 (stating that
technological advancements have led to improved markets and
executions as indicated by tighter spreads, lower trading costs, and
more liquidity). See also Thierry Foucault and Albert J. Menkveld,
Competition for Order Flow and Order Routing Systems, 63 Journal of
Finance 119, 121 (February 2008) (discussing that utilization of
smart order routers reduces the incidence of trade-throughs and may
encourage provision of liquidity).
---------------------------------------------------------------------------
As noted above, at the time of adoption of Rule 606, institutional
orders generally were handled by an exchange floor broker or upstairs
block positioner. The risks of information leakage and broker-dealer
conflicts of interest existed with manual order handling, but because
the execution alternatives were fewer and simpler, less data was
necessary for institutional customers to evaluate those risks and
evaluate broker-dealer performance. Now, however, because of the
complexity of order execution algorithms and smart order routing
systems, and the wide variety of venues to which broker-dealers may
route institutional orders or send actionable indications of interest,
access to data is important for institutional customers to assess the
impact a broker-dealer's order routing strategies may have on the
quality of their executions and the risks presented by any resulting
information leakage or broker-dealer conflicts of interest.
Institutional customers increasingly have been expressing concerns
regarding the difficulty in obtaining and comparing certain information
across broker-dealers and venues, and understanding how their
institutional orders are handled by broker-dealers, and have called for
enhanced order handling disclosures.\40\ Institutional customers have
cited concerns, among other things, about the extent to which broker-
dealer routing decisions are influenced by incentives offered by
trading centers to attract order flow, that inefficiencies in order
execution algorithms and smart order routing systems may lead to
information leakage, and that the complexity and opacity of order
routing practices frustrate the ability to monitor execution quality.
Importantly, a variety of other market participants, including broker-
dealers, also have expressed support for enhanced and consistent
disclosure of institutional order handling information.\41\
---------------------------------------------------------------------------
\40\ See Associations Letter, supra note 5, at 2.
\41\ The Commission received letters addressing these issues in
response to requests for comment on the Concept Release on Equity
Market Structure, supra note 2 (comment letters available at http://www.sec.gov/comments/s7-02-10/s70210.shtml). See Letters to
Secretary, Commission, from Christopher Nagy, CEO, and Dave Lauer,
President, KOR Group LLC, dated September 23, 2014 (``KOR Trading
Letter II''), at 1-2 (stating Rule 606 is severely outdated, has no
coverage of large orders, and should be updated to cover all
orders); from Richie Prager, Managing Director, Head of Trading &
Liquidity Strategies, et al., BlackRock, Inc., dated September 12,
2014 (``BlackRock Letter''), at 3 (stating broker-dealers should be
required to provide periodic standardized reports on order routing
and execution metrics to both retail and institutional investors);
from Christopher Nagy, CEO, and Dave Lauer, President, KOR Trading
LLC, dated April 4, 2014 (``KOR Trading Letter I''), at 2 (stating
Rule 606 has become increasingly outdated as a result of the
increasing complexity of order-types as well as the speed of routing
and routing practices and Rule 606 should be updated to cover 100%
of order flow received, including block transactions); from Kimberly
Unger, Esq., Executive Director, Security Traders Association of New
York, Inc., dated April 30, 2010 (``STA Letter''), at 8 (stating
that since the adoption of Rule 606 in 2000, technological
advancements have made some of the measurements in the Rule less
meaningful and suggesting that 606 metrics be reviewed, amended, and
updated, as needed); NASDAQ Letter, supra note 19, at 20 (stating
Rule 606 has lagged behind technological advances that enhance
market quality, which consequently renders the metrics utilized in
Rule 606 less useful to investors, and further suggesting new
metrics for inclusion on reports and refinements to current
metrics); from Ann Vlcek, Managing Director and Associate General
Counsel, Securities Industry and Financial Markets Association,
dated April 29, 2010 (``SIFMA Letter I''), at 13 (stating that the
Commission should direct broker-dealers to provide institutional
clients with standardized execution venue statistical analysis
reports); from O. Mason Hawkins, Richard W. Hussey, Deborah L.
Craddock, Jeffrey D. Engelberg, and W. Douglas Schrank, Southeastern
Asset Management, Inc., dated April 28, 2010 (``SAM Letter''), at 7
(stating increased complexity in the marketplace has clouded order
handling to the point where even educated customers are not
completely confident as to how or why their orders are routed to
specific venues in a specific way); from Janet M. Kissane, SVP--
Legal & Corporate Secretary, Office of the General Counsel, NYSE
Euronext, dated April 23, 2010 (``NYSE Euronext Letter''), at 12,
Appendix I at 3-4 (stating that U.S. equity market structure has
changed substantially resulting in Rule 606 becoming outdated, and
that Rule 606 reports do not capture information concerning block
transactions and that the rule should be amended to include such
information); Wolverine Trading Letter, supra note 39, at 4 (stating
that the firm believes information currently required by Rule 606
reports is not as meaningful in the context of today's markets and
that Commission staff should determine the types of statistics to
add in order to improve usefulness of the reports); from Dan
Mathisson, Managing Director, Credit Suisse Securities (USA) LLC,
dated April 21, 2010 (``Credit Suisse Letter''), at 9 (stating that
equity markets have changed unequivocally since 2000 when Rule 606
was adopted resulting in a need to update the Rule 606 reports);
from Karrie McMillan, General Counsel, Investment Company Institute,
dated April 21, 2010 (``ICI Letter''), at 8 (stating that currently
institutional investors do not have ready access to complete
information about their orders and the Commission should consider
means to require new disclosures or enhance existing disclosures);
from Michael Gitlin, Head of Global Trading, T. Rowe Price
Associates, Inc.; David Oestreicher, Chief Legal Counsel, T. Rowe
Price Associates, Inc.; and Christopher P. Hayes, Sr. Legal Counsel,
T. Rowe Price Associates, Inc., dated April 21, 2010 (``T. Rowe
Price Letter''), at 3 (supporting interest in revamping Rule 606
reports to provide additional data related to trading volumes and
venues to both large and small investors); from Jennifer S. Choi,
Assistant General Counsel, Investment Adviser Association, dated
April 20, 2010 (``IAA Letter''), at 4 (stating the exclusion of
large orders from Rule 606 reports limits the value of such reports
to institutional investors); from Seth Merrin, Chief Executive
Officer, Liquidnet; Howard Meyerson, General Counsel, Liquidnet; and
Vlad Khandros, Corporate Strategy, Liquidnet, dated March 26, 2010
(``Liquidnet Letter''), at 2 (stating that institutional and retail
investors do not have sufficient information regarding how their
orders are handled, and empowering institutional traders with
appropriate disclosures regarding the handling of large orders will
empower institutions to make the best decisions for their
customers). The Commission also received one letter relevant to this
proposal in response to requests for comment on Securities Exchange
Act Release No. 76474 (November 18, 2015), 80 FR 80997 (December 28,
2015) (File No. S7-23-15) (``NMS Stock ATS Proposing Release'')
(comment letter available at http://www.sec.gov/comments/s7-23-15/s72315.shtml). See Letter to Secretary, Commission, from David M.
Weisberger, Managing Director, Markit, dated April 15, 2016
(``Markit Letter''), at 6-7 (stating order routing statistics
required under Rule 606 should be enhanced to include basic metrics
of execution quality for all categories of executed orders,
separately report on routed and executed orders broken down by
marketability, report on unexecuted routed orders, quantify net fees
paid and rebates received by marketability category, and standardize
the interpretation of ``directed order''). A discussion of the
letters relevant to this proposal is below. See infra Section II.F.
---------------------------------------------------------------------------
In the absence of a Commission rule, some institutional customers
today have taken steps to acquire more information about the nature and
number of venues to which their orders are routed or exposed.\42\ For
example, some institutional customers, using detailed questionnaires,
request and receive information regarding order routing strategies used
by their broker-dealers and the venues to which their broker-dealers
route orders. In addition, more sophisticated institutional customers
often request and receive granular data about the handling of
individual orders.\43\ The level of detail of the information provided
by broker-dealers tends to vary depending on both the broker-dealer and
the particular institutional customer, some of which may have the
ability and desire to digest and evaluate voluminous individual order
handling information and some of which may not. Of concern to the
Commission, however, is the risk that some smaller institutional
customers may not have the bargaining power to demand relevant order
handling information from their broker-dealers. The Commission also
understands that while some broker-dealers are willing and able to
provide order handling information, the non-standardized and non-
transparent nature of the data limits its effectiveness. Moreover, from
the standpoint of the broker-dealers, responding to different
institutional customers could be time-consuming and costly, as the
broker-dealers typically need to prepare custom responses to
[[Page 49438]]
different questions from each institutional customer who requests order
handling information.\44\ Accordingly, the Commission preliminarily
believes that by requiring standardization of such reports, order
handling data could potentially be generated in a more efficient and
cost-effective manner, and provided as a matter of course to the
benefit of all institutional customers.
---------------------------------------------------------------------------
\42\ See Associations Letter, supra note 5, at 2.
\43\ See, e.g., Memorandum from the Division of Trading and
Markets regarding a March 4, 2011, meeting with representatives of
Morgan Stanley with regard to the Concept Release on Equity Market
Structure, dated May 7, 2011 (``TM Memo re Morgan Stanley I'').
\44\ The Commission acknowledges that some institutional
customers, particularly those that are larger and more
sophisticated, may continue to request a customized report, even
with the availability of standardized reports. The Commission
understands that broker-dealers may respond to such requests for
competitive reasons or provide such benefits as a service to its
customers. Accordingly, the potential cost and time savings benefits
of standardized reports would be reduced for these broker-dealers.
---------------------------------------------------------------------------
2. Assessing Best Execution
Broker-dealers have a variety of types of institutional customers
that use their order routing services, including pension funds, mutual
funds, investment advisers, insurance companies, investment banks, and
hedge funds.\45\ Due to the large size in which they trade,
institutional customers generally are focused on ensuring that their
broker-dealers are achieving best execution for their orders. Broker-
dealers are legally required to obtain best execution of all customers'
orders.\46\ FINRA rules specifically require FINRA members to use
reasonable diligence to ascertain the best market for the security, and
to buy or sell in that market so that the resultant price to the
customer is as favorable as possible under prevailing market
conditions.\47\ Under FINRA's rules, some of the factors a FINRA member
must consider in determining whether it has used ``reasonable
diligence'' are: (1) The character of the market for the security, such
as the price, volatility, relative liquidity, and pressure on available
communications; (2) the size and type of transaction; (3) the number of
markets checked; (4) the accessibility of the quotation; and (5) the
terms and conditions of the order which result in the transaction.\48\
---------------------------------------------------------------------------
\45\ See supra note 1.
\46\ A broker-dealer's duty of best execution derives from
common law agency principles and fiduciary obligations, and is
incorporated in self-regulatory organization rules and, through
judicial and SEC decisions, the antifraud provisions of the federal
securities laws. See Regulation NMS Adopting Release, supra note 16,
at 37538. FINRA has codified a duty of best execution into its
rules. See FINRA Rule 5310. Accordingly, violations by a broker of
its duty of best execution expose the broker to potential liability
under the antifraud provisions of the Exchange Act as well as
potential discipline under applicable self-regulatory organization
rules.
\47\ See FINRA Rule 5310(a)(1) (Best Execution and
Interpositioning).
\48\ Id.
---------------------------------------------------------------------------
Some institutional customers have direct relationships with their
broker-dealers, whereas other institutional customers, such as mutual
funds and pension funds, often employ investment advisers to buy and
sell securities on their behalf. Investment advisers are fiduciaries to
their clients (e.g., mutual funds, pension funds) and have an
obligation to act in the best interests of their clients.\49\ Several
obligations flow from an investment adviser's fiduciary duties,
including, among other things, the obligation to seek best execution of
clients' transactions where the investment adviser has the authority to
select broker-dealers to execute client transactions.\50\ As discussed
above, however, the Commission preliminarily believes it has become
more challenging in today's highly automated, complex, and dispersed
markets for institutional customers and their advisers, in the absence
of additional, standardized disclosure, to monitor the extent to which
their broker-dealers are achieving best execution.
---------------------------------------------------------------------------
\49\ See, e.g., Section 206(2) of the Investment Advisers Act of
1940 that prohibits an investment adviser from engaging in any
transaction, practice, or course of business, which operates as a
fraud or deceit upon any client or prospective client. As such,
investment advisers must act in ``utmost good faith,'' provide full
and fair disclosure of all material facts, and employ reasonable
care to avoid misleading clients and prospective clients. SEC v.
Capital Gains Research Bureau, Inc., 375 U.S. 180, 194, 201 (1963).
\50\ See Interpretive Release Concerning the Scope of Section
28(e) of the Securities Exchange Act of 1934 and Related Matters,
Securities Exchange Act Release No. 23170 (April 23, 1986). An
investment adviser must seek to obtain the execution of client
transactions in such a manner that the client's total cost or
proceeds are the most favorable under the circumstances. In
particular, when seeking best execution, an adviser should consider
the full range and quality of a broker's services when selecting
broker-dealers to execute client trades, including, among other
things, the broker's execution capability, commission rate,
financial responsibility, responsiveness to the adviser, and the
value of any research provided. See id. See also Delaware Mgmt. Co.,
43 SEC 392, 396 (1967).
---------------------------------------------------------------------------
Today, broker-dealers are not required by rule to disclose specific
order handling information regarding institutional orders. Instead, as
noted above, the order handling information obtained by institutional
customers is the subject of individualized negotiations with their
broker-dealers, with the result that only a subset of institutional
customers obtain order handling information and the scope of the
information received varies widely. Accordingly, institutional
customers and their advisers today monitor broker-dealers for best
execution with substantially different levels of information, and
potentially with varying degrees of effectiveness. For example, larger
institutional customers may be better able to leverage their market
size and position to obtain more detailed and complete disclosures from
their broker-dealers, whereas smaller institutional customers may lack
sufficient bargaining power to do so.
The Commission preliminarily believes that requiring enhanced order
handling disclosures for all institutional orders would not only place
small institutional customers on a more level playing field with large
institutional customers, but also would create a uniform baseline for
all institutional customers to obtain information on how large orders
are handled. Widespread institutional access to standardized
information could help institutional customers to more effectively
assess the performance of their broker-dealers in handling their
orders. This, in turn, could help improve the quality of broker-dealer
routing practices, by, among other things, introducing more competitive
forces so that broker-dealers are actively competing with each other to
offer routing services that minimize information leakage and mitigate
conflicts of interest.
3. Conflicts of Interest
The Commission has recognized that in a market structure with many
competing trading centers, broker-dealers play a critical role in
deciding where to route a customer's non-directed orders.\51\ The
Commission also has noted that a competitive environment may spur a
trading center to offer economic incentives to broker-dealers to induce
the routing of order flow to that trading center.\52\ The Commission
has recognized that broker-dealer order routing practices can
significantly affect the competition among markets, and in adopting
Rule 606 noted that the purpose of requiring disclosures concerning the
relationships between a broker-dealer and the venues to which it routes
orders was to inform customers to potential conflicts of interest that
may influence the broker-dealer's order routing practices.\53\ The
Commission further explained that providing quantitative data to
customers would provide them a clearer
[[Page 49439]]
understanding of a broker-dealer's order routing practices.\54\ While
these previous statements were made in the context of retail order
routing, the Commission preliminarily believes they are equally
applicable to institutional order routing in today's equity market.
---------------------------------------------------------------------------
\51\ See Fragmentation Release, supra note 17, at 10582.
\52\ Id.
\53\ See Rule 606 Predecessor Adopting Release, supra note 15,
at 75427. The Commission has historically taken a disclosure-based
approach when addressing conflicts of interest that arise from
economic and other incentives provided to broker-dealers to induce
the routing of order flow to a trading center, rather than
prohibiting such incentives. See, e.g., id.
\54\ See id.
---------------------------------------------------------------------------
There are a number of potential conflicts of interest that arise
for broker-dealers in the handling of institutional orders that may
influence their order routing practices. One potential conflict of
interest a broker-dealer may face in the handling of institutional
orders involves the different pricing structures of trading centers. A
prevalent pricing model in the current market structure is the so-
called ``maker-taker'' model, which involves the use of access fees and
rebates.\55\ To incentivize market participants to provide liquidity, a
trading center employing a maker-taker fee structure generally pays a
per-share rebate to its members or participants to encourage them to
display non-marketable liquidity-providing orders on its limit order
book. If an execution occurs, the broker-dealer placing the liquidity-
providing order (the ``maker'') generally receives a rebate. In
contrast, the marketable order that removes liquidity (the ``taker'')
generally is charged a slightly higher fee, to fund the rebate to the
maker and provide a profit for the trading center.\56\
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\55\ See, e.g., Memorandum from the SEC Division of Trading and
Markets to the SEC Equity Market Structure Advisory Committee
(October 20, 2015) (``Maker-Taker Memo''), available at https://www.sec.gov/spotlight/emsac/memo-maker-taker-fees-on-equities-exchanges.pdf. See also Stanislav Dolgopolov, The Maker-Taker
Pricing Model and Its Impact on Securities Market Structure, 8 Va.
L. & Bus. Rev. 231, 232-33 (June 27, 2014) (``Dolgopolov''),
available at http://bit.ly/1mfme9M.
\56\ In contrast to the widespread typical maker-taker model
described above, a few trading venues have adopted an inverted
taker-maker pricing model, in which market participants are assessed
a fee to provide liquidity in securities and provided a rebate to
remove liquidity in securities. See, e.g., NASDAQ OMX BX Fee
Schedule (as of September 2015).
---------------------------------------------------------------------------
Broker-dealers that are members of an exchange or participants of
an ATS with a maker-taker model pay fees to, and receive rebates from,
the venue for each order, including an institutional order, that is
executed on it, but generally do not directly pass those fees or
rebates back to their institutional customers.\57\ In situations where
a broker-dealer can earn a rebate or pay a lesser fee for routing its
customer's orders to a particular venue, a conflict of interest may
exist between the broker-dealer's duty of best execution and its own
direct economic interest.\58\ Understanding how a broker-dealer manages
this conflict of interest to ensure that its own self-interest does not
compromise its best execution obligations is pertinent to institutional
customers in evaluating execution quality.\59\
---------------------------------------------------------------------------
\57\ See, e.g., Robert Battalio, Shane A. Corwin, and Robert
Jennings, Can Brokers Have it All? On the Relation between Make-Take
Fees and Limit Order Execution Quality, at 3 (March 31, 2015)
(``Battalio, Corwin, and Jennings Paper''), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2367462.
\58\ See, e.g., Maker-Taker Memo, supra note 55, at 16. Finance
professors Robert Battalio, Shane Corwin, and Robert Jennings'
analysis of selected market data has suggested that a significant
number of retail firms route non-marketable orders to the venue
offering the highest rebate, and do so in a manner that the authors
felt might not be consistent with the brokers' duty of best
execution. See Battalio, Corwin, and Jennings Paper, supra note 57,
at 31. Payment for order flow, including payments made to retail
brokers from wholesale broker-dealers, presents a similar conflict
of interest. The sale of order flow has been described by some
industry participants as a revenue center that permits firms to
receive payments from market makers for such order flow when they
would otherwise have to pay taker fees. See, e.g., Letter to Joseph
Dear, Chairman, Investor Advisory Committee, SEC from Joseph Saluzzi
and Sal Arnuk, Partners and Co-founders, Themis Trading LLC, dated
January 27, 2014, available at https://www.sec.gov/comments/265-28/26528-55.pdf, at 2.
\59\ See, e.g., Maker-Taker Memo, supra note 55, at 18. This
conflict may present itself despite the obligation of FINRA members
to conduct a regular and rigorous review of their order routing to
evaluate which trading venues offer the most favorable terms of
execution, including execution price, execution speed, and the
likelihood that the trade will be executed. See, e.g., FINRA Rule
5310, Supplementary Material .09(b).
---------------------------------------------------------------------------
For example, with respect to non-marketable orders, the trading
centers that pay the highest rebate for providing liquidity generally
charge the highest fee for removing liquidity.\60\ These venues are
generally lower on the routing table \61\ for broker-dealers seeking to
remove liquidity due to the high take fee.\62\ Thus, if a broker-dealer
places an order seeking to provide liquidity at such a venue, the order
may not receive an execution (or receive an execution only when the
market moves against the order) due to the venue's low position on
routing tables for removing liquidity because of the venue's high take
fee. High rebate venues also are likely to attract a large number of
non-marketable orders, so that the customer queue position, and
likelihood of execution, may be lower than on low rebate venues.
---------------------------------------------------------------------------
\60\ See, e.g., Maker-Taker Memo, supra note 55, at 18.
\61\ Routing table refers to a broker-dealer's automated process
for determining the specific trading venues to which a broker-dealer
routes orders and the sequence in which the orders are routed.
\62\ See, e.g., Battalio, Corwin, and Jennings Paper, supra note
57, at 1; Maker-Taker Memo, supra note 55, at 18.
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A similar conflict of interest may exist for marketable orders.\63\
Broker-dealers may seek to minimize trading costs by first routing
orders to trading centers with the lowest take fees. However, these
venues are likely to offer liquidity providers relatively low rebates
so the available liquidity may be less than at a high rebate venue.
Accordingly, the liquidity available to a marketable order routed to a
low rebate venue may offer less size or fewer opportunities for price
improvement than may be available at high rebate venues. Even where the
broker-dealer ultimately routes a marketable order to other high take
fee venues, prices can move quickly in today's highly automated,
electronic markets, and broker-dealers may miss trading opportunities
for an institutional customer by prioritizing low take fee venues in
their routing tables.
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\63\ See, e.g., Maker-Taker Memo, supra note 55, at 19.
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Another potential conflict of interest may arise when a broker-
dealer internalizes order flow,\64\ routes order flow to affiliated
venues, or routes order flow to venues with which it has payment for
order flow arrangements. While constrained by its best execution
obligation, a broker-dealer still may be incentivized to internalize
customer order flow or route to an affiliated venue so that it can
benefit from the execution by, among other things, capturing the
trading profits or transaction fees. Internalization or execution at
affiliated venues, however, may not offer the most favorable terms of
execution. Likewise, a broker-dealer may be incentivized to first route
customer order flow to venues with which it receives payment for order
flow. Again, execution at such venues may not maximize the best
execution opportunities of institutional orders. Accordingly,
opportunities for internalization, or execution at affiliated venues or
those with which the broker-dealers has payment for order flow
arrangements, create additional potential conflicts of interest between
the broker-dealer's duty of best execution and its own direct economic
interest.\65\
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\64\ Internalization is the process in which a broker-dealer
fills an order to buy a security from its own inventory, or fills an
order to sell by taking a security into its inventory.
\65\ The Commission notes that it recently proposed amendments
to the regulatory requirements in Regulation ATS of the Exchange Act
applicable to certain ATSs that would require detailed public
disclosures about the trading operations of the ATS and the
activities of the broker-dealer that operates the ATS and its
affiliates. See NMS Stock ATS Proposing Release, supra note 41.
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As discussed further below, the Commission preliminarily believes
[[Page 49440]]
these conflicts of interest could be better evaluated if institutional
customers had access to additional information about their broker-
dealers' order handling practices.
4. Information Leakage
The Commission has acknowledged ``the need of investors executing
large size trades to control the information flow concerning their
transactions.'' \66\ Executing a large order in today's complex
electronic markets poses many of the same issues and risks for
institutional customers as existed in the manual markets they replaced,
but also poses new challenges because of the variety of ways in which
information leakage can occur in today's equity market structure. As a
result, it continues to be challenging for institutional customers to
trade in large size while minimizing the risks from information
leakage. As noted above, institutional customers historically would use
exchange floor brokers or upstairs block positioners to execute large
orders.\67\ In today's electronic markets, however, the manual handling
of institutional orders is increasingly rare, and has been replaced by
sophisticated institutional order execution algorithms and smart order
routing systems. At the same time, sophisticated market participants
closely monitor order and execution activity throughout the markets,
looking for patterns that signal the existence of a large institutional
order, so that they can use that information to their trading
advantage.
---------------------------------------------------------------------------
\66\ See Securities Exchange Act Release No. 60997 (November 13,
2009), 74 FR 61208, 61219 (November 23, 2009) (``Regulation of Non-
Public Trading Interest Proposing Release''). For example, Rule
604(b) of Regulation NMS exempts specialists and over-the-counter
market makers from displaying customer block size orders. See 17 CFR
242.604(b)(4). A block size order is an order of at least 10,000
shares or for a quantity of stock having a market value of at least
$200,000. 17 CFR 242.600(b)(9).
\67\ See supra notes 34-35 and accompanying text.
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Each time an order is routed to a venue, and each time an
actionable indication of interest is sent to a market participant,
information is revealed about that order and the potential existence of
a larger institutional order from which it may be derived. Accordingly,
broker-dealers must balance the need to sufficiently expose the
customer's trading interest to achieve execution, with the risk that
such exposure might cause prices to move in a less favorable direction
to the detriment of execution quality. Indeed, institutional customers
have expressed concern that excessive routing \68\ of their orders may
increase the risk of information leakage without a commensurate benefit
to execution quality.\69\ Because information leakage may lead to
higher execution costs for large size orders, the Commission
preliminarily believes that additional disclosure would inform
investors as to whether a broker-dealer's order routing strategy is
potentially resulting in excessive routing and information leakage. As
noted above, the Commission preliminarily believes that institutional
order handling now has become more susceptible to the type of standard
disclosures originally contemplated by Rule 606, and technological
developments have made it easier for broker-dealers to produce it.
Accordingly, standardized order handling disclosures should improve the
ability of institutional customers to assess the potential risk of
information leakage of their orders through a more detailed assessment
of the number and types of venues to which their broker-dealers are
routing their orders or transmitting actionable indications of
interest, and the quality of executions that result therefrom.
---------------------------------------------------------------------------
\68\ In this context, excessive routing occurs when an order is
routed more than may be necessary to obtain full execution of the
order. Each additional route of an order reveals information about
that order.
\69\ See, e.g., Jacob Bunge, A Suspect Emerges in Stock-Trade
Hiccups: Regulation NMS, Wall Street Journal, January 27, 2014
(``Bunge Article''), available at http://www.wsj.com/articles/SB10001424052702303281504579219962494432336 (noting that in order to
purchase 2.5 million shares of a stock, an institutional investor's
brokers had to offer to purchase 750 million shares of the stock).
---------------------------------------------------------------------------
The Commission preliminarily believes that the amendments to Rule
606 it is proposing today would help institutional customers more
efficiently and effectively operate in the current equity market
structure. As discussed in more detail below, the required disclosures
would provide standardized information for institutional customers so
that they can better: (1) Discern where their orders are exposed,
routed, and executed; (2) assess their broker-dealers for best
execution by examining order execution statistics; (3) monitor
conflicts of interest of their broker-dealers with the additional
financial incentives disclosures; and (4) assess information leakage
with the routing of their orders.
D. Need for Public Reporting of Aggregated Institutional Order
Information
As discussed above, there are no legal requirements for a broker-
dealer to disclose institutional order handling information to its
customers, either privately or publicly. The Commission preliminarily
believes that the dearth of public information about each broker-
dealer's institutional order handling practices may make efficient and
effective comparisons about the nature and quality of services offered
by broker-dealers more difficult. Without required public disclosure of
aggregated institutional order handling information, institutional
customers do not have information that could be used to evaluate, among
other things, the venues to which broker-dealers route orders, the
execution quality achieved at such venues, and the overall fees paid
and rebates received for such executions. Public information on a
broker-dealer's institutional order handling practices could both
assist institutional customers in selecting one or more broker-dealers
for order routing services and foster increased competition among
broker-dealers to provide order routing services. Indeed, if
institutional order handling information were publicly available to
review and analyze, the Commission preliminarily believes that
additional competitive forces could be brought to bear on broker-dealer
institutional order routing services, thereby potentially enhancing the
quality of such services.\70\
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\70\ In adopting Rule 606 in 2000, the Commission stated that
public disclosure of order execution and order routing information
could provoke more vigorous competition on execution quality and
order routing performance. See Rule 606 Predecessor Adopting
Release, supra note 15, at 75417.
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E. Need for Enhanced Disclosures for Retail Orders
As discussed above, the U.S. equity markets have evolved in recent
years to become more automated, dispersed, and complex, and the
resulting competition among trading centers has intensified practices
to attract order flow, including retail order flow. Historically,
trading centers have offered payment for order flow or other financial
inducements to broker-dealers based upon whether the retail order flow
is marketable or non-marketable. As a result, broker-dealers generally
handle marketable and non-marketable retail orders differently. Indeed,
whether a retail order is marketable or non-marketable will often
determine where the broker-dealer routes the order. Certain broker-
dealers route a large portion of marketable retail orders to OTC market
makers with whom they have payment for order flow or other
arrangements.\71\ Non-
[[Page 49441]]
marketable retail orders, on the other hand, are more frequently routed
to exchanges with a ``maker-taker'' fee schedule, to capture a rebate
when the non-marketable order is executed.\72\
---------------------------------------------------------------------------
\71\ See Concept Release on Equity Market Structure, supra note
2, at 3606 (noting that Rule 606 statistics reveal that brokers with
significant retail customer accounts send the great majority of non-
directed marketable orders to OTC market makers that internalize
executions, often pursuant to payment for order flow arrangements).
\72\ As an example, during a fiscal quarter one large retail
broker-dealer routed all non-marketable orders to one of two venues
that ``offered the highest rebates available in the market.'' See
Conflicts of Interest, Investor Loss of Confidence, and High Speed
Trading in U.S. Stock Markets: Hearing Before the Permanent
Subcommittee on Investigations of the Committee on Homeland Security
and Governmental Affairs, U.S. Senate, 113th Cong. 48 (2014)
(``Senate PSI Hearing'') (testimony of Steven Quirk, Senior Vice
President, TD Ameritrade). In addition to fee incentives that may
affect routing decisions, another reason non-marketable retail
orders may be routed to exchanges is the requirements of Rule 604 of
Regulation NMS. Rule 604 of Regulation NMS requires, among other
things, exchange specialists and OTC market makers to immediately
display in their bid or offer both the price and the full size of
each customer limit order that would improve their quoted price in a
particular security. See 17 CFR 242.604.
---------------------------------------------------------------------------
Currently, Rule 606(a) does not require broker-dealers to segment
their quarterly disclosures for limit orders between marketable and
non-marketable orders. By only showing aggregated data on retail limit
orders, customers have less visibility into the extent to which broker-
dealers differentiate between marketable and non-marketable limit
orders in their routing practices, and, if so, the potential impact of
such practices. Accordingly, the Commission preliminarily believes that
customers could better evaluate execution quality and potential
conflicts of interest if broker-dealers were required to separately
disclose more comprehensive information about how they route marketable
and non-marketable limit orders to individual trading centers.
In addition, financial inducements to attract order flow from
broker-dealers that handle retail orders have become more prevalent and
for some broker-dealers such inducements may be a significant source of
revenue.\73\ The Commission understands that most broker-dealers that
handle a significant amount of retail orders receive payment for order
flow in connection with the routing of retail orders or are affiliated
with an OTC market maker that executes the orders.\74\ The Commission
preliminarily believes that providing market participants with greater
disclosure regarding the specific financial inducements received by a
broker-dealer from various trading centers would enable market
participants to better assess potential conflicts of interest its
broker-dealers face when routing retail orders.
---------------------------------------------------------------------------
\73\ See, e.g., Bradley Hope and Julie Steinberg, Payments to
Big Brokers Under Fresh Scrutiny, Wall Street Journal, June 13,
2014, available at http://blogs.wsj.com/moneybeat/2014/06/13/payments-to-big-brokers-under-fresh-scrutiny/ (stating that TD
Ameritrade received $236 million in payment for order flow in 2013;
that a spokesman for Charles Schwab Corporation estimated payment
for order flow revenues of $100 million in 2013; and that E*Trade
Financial Corporation stated in a regulatory filing it received
$72.5 million in such revenues in 2013).
\74\ Id.
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Under the quarterly disclosure obligations in current Rule 606(a),
broker-dealers are required to discuss the material aspects of their
relationship with each Specified Venue, including a description of any
arrangement for payment for order flow or profit-sharing relationship.
The current disclosure informs the market participants of a potential
conflict of interest the broker-dealer may face, but the current rule
does not require the broker-dealer to disclose specifics on the
conflict, including financial inducements received from each Specified
Venue, or transaction rebates received from exchanges and other trading
centers.\75\ The lack of detailed disclosure on the specifics of the
financial inducements received from each Specified Venue make it more
difficult for customers to assess a broker-dealer's management of any
conflict of interest and the quality of its broker-dealer's routing and
execution services.
---------------------------------------------------------------------------
\75\ See Rule 606(a); see also Rule 606 Predecessor Adopting
Release, supra note 15, at 75427.
---------------------------------------------------------------------------
Accordingly, the Commission preliminarily believes that requiring
broker-dealers to report more detailed disclosure on the payments
received and fees paid for marketable limit orders, non-marketable
limit orders, and other order types at each Specified Venue would
enable market participants to better assess the extent to which the
broker-dealer is effectively managing the potential conflicts of
interest, as well as the quality of their broker-dealer's retail order
routing and execution services. The Commission also preliminarily
believes that the description of any payment for order flow
arrangements and profit-sharing relationships required to be disclosed
in the quarterly report should be more comprehensive. As such, the
Commission preliminarily believes that it would be appropriate to
require broker-dealers to describe in their quarterly disclosure any
terms of payment for order flow arrangements and profit-sharing
relationships with each Specified Venue that may influence their order
routing decisions.
Separately, in adopting Rule 606, the Commission required that
retail routing reports be divided into three separate sections for NMS
stocks listed on: NYSE, NASDAQ, and American Stock Exchange LLC.\76\
The listing markets are now dominated by electronic trading and the
handling of NMS stocks no longer varies materially based on the primary
listing market.\77\ As such, the Commission preliminarily believes that
the requirement to separate the retail routing reports by primary
listing market is outdated and does not provide useful information to
customers. Accordingly, the Commission preliminarily believes that
requiring retail routing reports to disclose the required information
for NMS stocks as a whole would better inform market participants about
the manner in which retail orders are routed in today's markets and
should simplify the burdens to comply with the rule.
---------------------------------------------------------------------------
\76\ See Rule 606 Predecessor Adopting Release, supra note 15.
The American Stock Exchange is now known as NYSE MKT LLC. In October
2008, the American Stock Exchange LLC was renamed ``NYSE Alternext
US LLC.'' See Securities Exchange Act Release No. 58673 (September
29, 2008), 73 FR 57707 (October 3, 2008) (SR-Amex-2008-62). In March
2009, NYSE Alternext US LLC was renamed ``NYSE Amex LLC.'' See
Securities Exchange Act Release No. 59575 (March 13, 2009), 74 FR
11803 (March 19, 2009) (SR-NYSEALTR-2009-24). In May 2012, NYSE Amex
LLC was renamed ``NYSE MKT LLC.'' See Securities Exchange Act
Release No. 67037 (May 21, 2012), 77 FR 31415 (May 25, 2012) (SR-
NYSEAmex-2012-32).
\77\ See Letter to Secretary, Commission, from Manisha Kimmel,
Managing Director, Financial Information Forum, dated October 22,
2014 (``FIF Letter''), at 3 (noting that with the introduction of
automated trading centers and smart order routing as a result of
Regulation NMS, order routing practices are no longer based on
listing market).
---------------------------------------------------------------------------
F. Comments on Equity Market Structure
The Commission periodically has examined the regulatory regime for
order routing disclosure. The Commission published the Concept Release
on Equity Market Structure in 2010, which requested comment on a wide
range of issues. Among the issues specifically highlighted for comment
were: (1) Whether Rule 606 should be updated and, if so, in what
respects; (2) whether Rule 606 reports continue to provide useful
information for investors and their broker-dealers in assessing the
quality of order execution and routing practices; (3) whether Rule 606
should be updated to address the interests of institutional customers
in efficiently executing large orders and, if so, what metrics would be
useful; (4) whether institutional customers have sufficient information
about the smart order routing services and order execution algorithms
offered by their broker-dealers; and (5) whether a regulatory
initiative to improve disclosure of these broker-dealer services would
be useful
[[Page 49442]]
and, if so, what type of initiative the Commission should pursue.\78\
---------------------------------------------------------------------------
\78\ See Concept Release on Equity Market Structure, supra note
2.
---------------------------------------------------------------------------
The Commission received twenty-eight comment letters \79\ that
directly addressed order routing disclosures. The commenters provided a
wide range of recommendations and many commenters made multiple
recommendations regarding order routing disclosures.
---------------------------------------------------------------------------
\79\ See Letters to Secretary, Commission, from Michael J.
Friedman, General Counsel & Chief Compliance Officer, Trillium,
dated November 7, 2014 (``Trillium Letter''); from Theodore R. Lazo,
Managing Director and Associate General Counsel, SIFMA, dated
October 24, 2014 (``SIFMA Letter II''); Associations Letter, supra
note 5; KOR Trading Letter II, supra note 41; FIF Letter, supra note
77; BlackRock Letter, supra note 41; from Micah Hauptman, Financial
Services Counsel, Consumer Federation of America, dated September 9,
2014 (``CFA Letter''); KOR Trading Letter I, supra note 41; from
Senator Edward E. Kaufman, United States Senate, dated August 5,
2010 (``Kaufman Letter''); from Greg Tusar, Managing Director,
Goldman Sachs Execution & Clearing, L.P and Matthew Lavicka,
Managing Director, Goldman, Sachs & Co., dated June 25, 2010
(``Goldman Sachs Letter II''); from James J. Angel, Ph.D., CFA,
Associate Professor of Finance, Georgetown University, McDonough
School of Business, dated April 30, 2010 (``Angel Letter II''); STA
Letter, supra note 41; NASDAQ Letter, supra note 19; SIFMA Letter I,
supra note 41; SAM Letter, supra note 41; from Eric W. Hess, Esq.,
General Counsel for Direct Edge, dated April 28, 2010 (``Direct Edge
Letter''); NYSE Euronext Letter, supra note 41; from Jonathan D.
Corpina, President, Organization of Independent Floor Brokers;
Jennifer Lee, Vice President, Organization of Independent Floor
Brokers; and Stephen O'Shaughnessy, Director, Organization of
Independent Floor Brokers, dated April 21, 2010 (``IFB Letter'');
Wolverine Trading Letter, supra note 39; Credit Suisse Letter, supra
note 41; ICI Letter, supra note 41; T. Rowe Price Letter, supra note
41; TD Ameritrade Letter, supra note 19; IAA Letter, supra note 41;
from Alan R. Shapiro, President and Chairman, The Transaction
Auditing Group, Inc., dated April 19, 2010 (``TAG Letter'');
Liquidnet Letter, supra note 41; from James J. Angel, Associate
Professor, McDonough School of Business, Georgetown University;
Lawrence E. Harris, Fred V. Keenan Chair in Finance, Professor of
Finance and Business Economics, Marshall School of Business,
University of Southern California; Chester S. Spatt, Pamela R. and
Kenneth B. Dunn Professor of Finance, Director, Center for Financial
Markets, Tepper School of Business, Carnegie Mellon University,
dated February 23, 2010 (``Angel Letter I''). See also TM Memo re
Morgan Stanley I, supra note 43; Memorandum from the Division of
Trading and Markets regarding a May 22, 2013, meeting with
representatives of Morgan Stanley, dated May 22, 2013 (``TM Memo re
Morgan Stanley II''); Memorandum from the Division of Trading and
Markets regarding an October 1, 2015, meeting with representatives
of Morgan Stanley, dated October 1, 2015 (``TM Memo re Morgan
Stanley III''); Memorandum from the Office of Commissioner Walter
regarding a June 30, 2010, meeting with representatives of the
Managed Funds Association, dated July 19, 2010 (``Walter Memo'').
The Commission also received one letter relevant to this proposal in
response to requests for comment on the NMS Stock ATS Proposing
Release, supra note 41. See Markit Letter, supra note 41.
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1. General Need to Update Rule 606
A few commenters referred generally to existing drawbacks in Rule
606 and the need for improvements to Rule 606 without making specific
recommendations. These commenters raised concerns regarding certain
conflicts of interest present in order routing practices and the
sufficiency of current disclosures under Rule 606, and stated that
improvements to Rule 606 would provide more insight to investors and
that the utility of Rule 606 was limited by a lack of disclosure.\80\
Most commenters focused on specific recommendations to update various
aspects of Rule 606.
---------------------------------------------------------------------------
\80\ See IFB Letter, supra note 79, at 2 (questioning the
existing inherent conflicts in the payment for order flow practice
and asking whether disclosure requirements under existing Rule 606
are legally sufficient, and also noting that the required
disclosures under Rule 606 do not shed light on fiduciary duties);
Direct Edge Letter, supra note 79, at 2 (stating that ``improvements
to existing Rules 605 and 606 can be made to provide more detailed
insight to investors''); TAG Letter, supra note 79, at 3 (stating
``utility of the combination of Rules 605 and 606 to the individual
investor is limited since the Rule 606 routing percentages coupled
with the overall execution quality statistics in Rule 605 only give
a general indication as to the results an individual investor can
expect,'' and ``[r]outing information and the associated material
aspects of the relationship concerning the broker's arrangements, if
any, with the various trading centers to which they route does not
provide sufficient data to assess and compare'').
---------------------------------------------------------------------------
2. Need for Rule 606 to be Modernized to Maintain Pace with
Technological Advances
Many commenters cited technological changes in market structure as
the basis for updating Rule 606.\81\ These commenters touched upon the
common theme that the disclosures required by Rule 606 had not kept
pace with the technological advances that had taken place since the
Rule's inception.
---------------------------------------------------------------------------
\81\ See, e.g., NASDAQ Letter, supra note 19, at 20-21 (noting
that Rule 606 has ``never been amended despite changes that have
revolutionized trading and the national market system, including the
advent of decimal trading, the demise of trading floors and other
manual trading, proliferation of private linkages, adoption of
Regulation NMS, refinement of smart routers, modernization of high
frequency trading and automation of dark pools,'' stating that 605
and 606 have ``lagged behind technological advances that enhance
market quality and consequently render the metrics utilized in Rule
605 and 606 less useful to investors,'' and questioning whether Rule
606 continues ``to provide the level of transparency necessary to
exert meaningful pressure on market centers to provide superior
execution quality and routing practices.''); NYSE Euronext Letter,
supra note 41, at 12 (commenting that ``as detailed in the Concept
Release [on Equity Market Structure], the U.S. equity market
structure has changed substantially and, as a result, we believe
[Rule 606 has] become outdated''); see also KOR Trading Letter II,
supra note 41, at 2, 5 (commenting that ``[o]ver time and in
particular with the adoption of Regulation NMS, [Rules 605 and 606]
became increasingly outdated,'' and that Rule 606 has ``eroded due
to the increasing complexity of order-types as well as speed and
routing practices in today's marketplace''); BlackRock Letter, supra
note 41, at 3 (commenting that ``rising complexity in market
structure has made the existing reporting inadequate''); CFA Letter,
supra note 79, at 21 (stating ``it is unreasonable to expect that
given the changes in speed, technology, complexity, and dark trading
in our markets, retail investors would ever utilize them
productively''); KOR Trading Letter I, supra note 41, at 1 (noting
that while outdated, Rule 606 serves as the only current means to
analyze routing behavior); STA Letter, supra note 41, at 8
(commenting that ``technological advances have made some of the
measurements in the rule less meaningful'' and suggesting that Rule
606 metrics be reviewed, amended, and updated, as needed); SIFMA
Letter I, supra note 41, at 16 (commenting that in its current form,
Rule 606 does not provide ``useful and meaningful comparative
information to market participants, particularly individual
investors, or regulators, and that the [rule] should be either
modified or rescinded in light of market developments''); SAM
Letter, supra note 41, at 7 (noting that while order handling used
to be a transparent and simple process, ``transparency has been
sacrificed in the name of technological advancement and the
evolution of market microstructure,'' and stating that the
``enormous complexity introduced by this process has clouded order
handling to the point where even educated customers are never
completely confident how or why their orders are routed to specific
venues in a specific way''); Wolverine Trading Letter, supra note
39, at 4 (noting that ``the information currently required by [Rule
606] reports is not as meaningful in the context of today's
markets'' and that Commission staff should determine the types of
statistics to add in order to improve usefulness of the reports);
Credit Suisse Letter, supra note 41, at 9 (stating with regard to
Rule 606 that ``equity markets have unequivocally changed since 2000
when the rules were adopted, resulting in the need to update the
reports,'' and providing the example that ``the shortest execution
report time category in the reports is 0-9 seconds. In today's
trading, where market centers have begun clocking their executions
in microseconds (millionths of a second) because milliseconds
(thousandths of a second) were too slow, categorizing a 9 second
execution in the top speed category renders the reports less
meaningful than intended''); ICI Letter, supra note 41, at 7 (noting
that ``complexities in the current market structure and the
associated difficulties in assessing market performance for
investors''); TM Memo re Morgan Stanley III, supra note 79 (noting
that ``Order Handling and Execution Disclosure Rules have not been
updated to address technological advances'').
---------------------------------------------------------------------------
3. Requests for Specific Information and Standardized Disclosures
Most commenters identified specific metrics that broker-dealers
should disclose, proposed model templates for disclosure, or called for
disclosures to be made in a standardized fashion. Commenters generally
requested additional information regarding order type usage and fill
rates, marketable and non-marketable limit orders, and the use of
indications of interest (``IOI''). Many commenters also requested more
detailed disclosure of payment for order flow, including fees paid and
rebates received.\82\
---------------------------------------------------------------------------
\82\ See, e.g., Markit Letter, supra note 41, at 6 (Rule 606
statistics should be enhanced to include basic metrics of execution
quality for all categories of executed orders, separately report on
routed and executed orders broken down by marketability, and
quantify net fees paid and rebates received by marketability
category); Associations Letter, supra note 5, at Annex A (attaching
proposed template for enumerated, customer-specific institutional
order routing disclosure); BlackRock Letter, supra note 41, at 3
(stating that revised Rule 605/606 ``disclosures should provide
greater transparency on marketable and non-marketable limit orders,
order fill rates, sub-second execution horizons, pre-/post-trade
price movement, alternative order type usage and total fees/rebates
paid or received'' and that such ``metrics should also be available
in a standardized template for individual customer activity, not
just at an aggregate level by broker-dealer''); KOR Trading Letter
I, supra note 41, at 5 (proposing a list of updates to Rule 606
including, et al., information on marketable limit orders, total
payments or charges to broker-dealers, reporting of the execution
venue of all orders, and require average payments to be reported out
to one one-hundredth of one penny (i.e., four decimal places));
Goldman Sachs Letter II, supra note 79, at 10-11 (proposing
disclosure of order routing information for orders that do not
receive execution); Angel Letter II, supra note 79, at 7-9
(providing sample broker ``report card'' with eight metrics
including percentage of orders executed inside the bid-ask spread);
SAM Letter, supra note 41, at 7 (proposing eight categories of
information that brokers/venues should disclose, including aggregate
broker-level detail regarding specific venue market share based on
both shares routed and shares executed and ``payments, rebates, fees
and fee breakpoints (all costs and payment for order flow
arrangements) related to execution venues (routing broker or routing
venue to venue)''); ICI Letter, supra note 41, at 7 (proposing the
Commission require improved disclosure regarding order routing,
including policies and procedures regarding the dissemination of
information about a customer's order and trade information to
facilitate a trade, including the use of IOIs, ``external venues to
which a broker routes, . . . the percentage of shares executed at
each external venue, any ownership and other affiliations between
the broker and any venues to which the broker routes orders,'' and
``payments and other incentives provided or received (such as
rebates) to direct order flow to particular trading venues''); TD
Ameritrade Letter, supra note 19, at 7-8 (recommending, among other
things, that Rule 606 disclosures include order type categories for
'' ``Opening,'' ``Marketable Limit,'' ``Odd-lot,'' ``Mixed Lot,''
``Stop Orders'' and ``IOC/IOI'' and ``Spreads'' for Options,'' and
``require brokers that internalize order-flow to include additional
disclosure of payments made and overall profitability generated by
the internalizing subsidiary internalizing that order-flow''); see
also Trillium Letter, supra note 79, at 3 (suggesting that ``Rule
606(b) should be enhanced to simply require brokers to disclose the
unabridged order logs of requesting customers''); SIFMA Letter II,
supra note 79, at 13 (suggesting that the Commission should consider
a rule to ``require broker-dealers to publish on their Web sites, on
a monthly basis, a standardized disclosure report that provides an
overview of key macro issues that are of interest to clients,
potentially including: (i) Venues accessed, (ii) order types used on
exchanges, (iii) order types supported on the broker-dealer's ATS
(if applicable), (iv) fill rates (including internalization numbers,
if applicable), (v) location of ATS/co-location footprint, and (vi)
market data structure''); FIF Letter, supra note 77, at 3
(suggesting that market open, market close, stop orders, and odd
lots be removed from the ``other'' category and listed in their own
categories); KOR Trading Letter II, supra note 41, at 2 (suggesting
Rule 606 should be expanded to mandate uniform disclosure); CFA
Letter, supra note 79, at 21 (suggesting the reporting metrics in
Rule 606 ``should be modernized to provide the most relevant
information that will allow market participants, regulators, and
third-party analysts to assess the quality of order execution
practices''); TM Memo re Morgan Stanley II, supra note 79,
PowerPoint at 6 (suggesting Rule 606 should be modified to require
standardized reports providing an ``order life cycle audit trail,
not just ultimate execution or first route venue''); Walter Memo,
supra note 79, at 50-51 (the MFA suggested that Rule 606 could be
updated to require a brokerage firm to ``provide statistics giving
execution times along with the percentages of orders filled at the
quote, better than the quote, and worse than the quote, for
different size buckets including odd lots''); STA Letter, supra note
41, at 8 (suggesting a ``standardized set of metrics which might
include revised speed of execution data, linkages and access to
markets and other measurable data the disclosure of which will
provide investors and traders with adequate information upon which
to make execution and routing decisions''); NYSE Euronext Letter,
supra note 41, at Appendix I (suggesting that the ``percentage of
volume routed and executed internally by a broker-dealer should be
indicated, and the criteria used in order routing decisions should
be identified''); IAA Letter, supra note 41, at 3-4 (noting the
format and the presentation of information in 606 reports make the
information difficult to analyze); Liquidnet Letter, supra note 41,
Annex F, at F-1 to F-3 (suggesting the Commission consider modifying
Rule 606 reports to ``include data on execution quality for orders
received and handled by the routing broker, in particular, data
regarding execution time and price improvement''); Kaufman Letter,
supra note 79, at 6 (suggesting generally that ``brokers should be
required to provide detailed descriptions of their order-routing
procedures, including information on payments and rebates
received''); TM Memo re Morgan Stanley III, supra note 79 (including
a proposed venue analysis template with enumerated, specific
disclosures to be reported).
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[[Page 49443]]
Some commenters expressed concern regarding information leakage and
identified various metrics that could help customers determine whether
a broker-dealer's routing strategy leaves orders vulnerable to
information leakage.\83\ Additionally, several industry commenters
recommended disclosing separately routing statistics for marketable and
non-marketable orders.\84\
---------------------------------------------------------------------------
\83\ See, e.g., ICI Letter, supra note 41, at 8-9 (stating that
broker-dealers should be required to disclose policies and
procedures to control leakage of information regarding a customer's
order and other confidential information and policies and procedures
regarding the dissemination of information about a customer's order
and trade information to facilitate a trade, including the use of
indications of interest); Liquidnet Letter, supra note 41, at 2
(stating that if institutional investors are appropriately informed
as to how broker-dealers route their orders, they will make the best
decisions as to how their large orders should be handled).
\84\ See BlackRock Letter, supra note 41, at 3 (stating that
revised Rule 605/606 disclosures should provide greater transparency
on, among other things, marketable and non-marketable limit orders
and order fill rates); KOR Trading Letter I, supra note 41, at 5
(proposing a list of updates to Rule 606 including requiring
disclosure of statistics on marketable limit orders and greater
transparency around broker-dealer internal order routing practices
and decisions); TD Ameritrade Letter, supra note 19, at 6-7
(proposing to change the order classification in Rule 606
disclosures to include, among other things ``Marketable Limit'').
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4. Requests for Specific Disclosures for Institutional Orders
A number of commenters recommended specific order routing
disclosures for institutional customers or questioned the usefulness of
the current disclosure requirements to retail or institutional
customers given that large orders are excluded from the rule.\85\ Many
commenters called specifically for the disclosure of order routing
information to institutional customers, noting in various ways that the
existing Rule 606 disclosures do not cover large orders and as a result
institutional customers may not receive meaningful information about
how their orders are routed.
---------------------------------------------------------------------------
\85\ See Associations Letter, supra note 5 (calling for
customer-specific order routing disclosures for institutional
investors); SIFMA Letter II, supra note 79, at 13 (stating that the
Commission should require broker-dealers to provide standardized
reports to institutional clients); KOR Trading Letter II, supra note
41, at 1 (stating that the public would be well served by
``expanding Rule 606 to cover all orders and mandating uniform
disclosure''); BlackRock Letter, supra note 41, at 3 (stating that
``[b]roker-dealers should be required to provide periodic
standardized reports on order routing and execution metrics to
retail and institutional investors''); NYSE Euronext Letter, supra
note 41, at 12 (noting that ``Rule 606 reports do not capture
information concerning large block transactions''); ICI Letter,
supra note 41, at 10 (noting that Rule 606 was drafted primarily
with the interests of individual investors in mind and large-sized
orders are excluded from the rule); T. Rowe Price Letter, supra note
41, at 3 (opining that Rule 606 reports are ``rarely used by
institutional investors''); IAA Letter, supra note 41, at 4 (stating
that the ``exclusion of large orders in these [Rule 606] reports
limits the value of these reports to institutional investors'');
Liquidnet Letter, supra note 41, at 2 (stating that
``[i]nstitutional and retail investors do not have sufficient
information regarding how their orders are handled'' and suggesting
Rule 606 be modified to ``[m]andate disclosure of specific order
routing practices by institutional brokers''); TM Memo re Morgan
Stanley III, supra note 79 (suggesting that broker-dealers should be
required to ``[p]rovide institutional clients with mandated
transparency around order handling practices in today's
environment'' including an ``objective and meaningful standardized
venue analysis template'').
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5. Comments on Actionable Indications of Interest
As noted above, some comments on the Concept Release on Equity
Market Structure called for the disclosure of information relating to a
broker-dealer's use of IOIs.\86\ The Commission has considered these
comments, in addition to comments noted above on the Regulation of Non-
Public Trading Interest Proposing Release, and is proposing to define
actionable IOI.\87\
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\86\ See TD Ameritrade Letter, supra note 19, at 6 (stating that
the order classification status should be changed to include IOIs);
ICI Letter, supra note 41, at 8 (suggesting the Commission consider
requiring disclosure of policies and procedures regarding the
dissemination of information about a customer's order and trade
information to facilitate a trade, including the use of
``indications of interest'' or ``IOIs''); KOR Trading Letter II,
supra note 41, at 1 (stating Rule 606 should be expanded to include
information on IOIs on dark pools).
\87\ See infra Section III.A.10.
---------------------------------------------------------------------------
As discussed below, the Commission proposes to define the term
``actionable
[[Page 49444]]
indication of interest'' (``actionable IOI'').\88\ In 2009, the
Commission proposed rules to regulate non-public trading interest,\89\
which described characteristics of actionable IOI.\90\ The Commission
received a number of comment letters that addressed the
characteristics.\91\ Most of these commenters either noted in some form
that the proposal did not expressly define ``actionable IOI'' or
criticized the guidance.\92\ A few of these commenters offered their
own definitions or understanding of an actionable IOI.\93\
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\88\ See proposed Rule 600(b)(1).
\89\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66, at 61219. Among other things, the Commission
proposed to amend the Exchange Act quoting requirements to apply
expressly to actionable IOIs. See id., at 61211.
\90\ ``[A]n IOI would be actionable if it effectively alerted
the recipient that the dark pool currently has trading interest in a
particular symbol, side (buy or sell), size (minimum of a round lot
of trading interest), and price (equal to or better than the
national best bid for buying interest and the national best offer
for selling interest).'' Id., at 61226.
\91\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Senior Vice President--Legal & Corporate Secretary Office of
the General Counsel, NYSE Euronext, dated February 22, 2010 (``NYSE
Euronext IOI Letter''); from John A. McCarthy, General Counsel,
GETCO, LLC, dated February 22, 2010 (``GETCO Letter''); from P. Mats
Goebels, Managing Director and General Counsel, Investment
Technology Group, Inc., dated February 22, 2010 (``ITG Letter'');
from Vivian A. Maese, Esq., General Counsel and Corporate Secretary,
BIDS Trading, LP, New York, New York, dated February 18, 2010
(``BIDS Trading Letter''); from Greg Tusar, Managing Director,
Goldman Sachs Execution & Clearing, L.P. and Matthew Lavicka,
Managing Director, Goldman Sachs & Co., dated February 17, 2010
(``Goldman Sachs Letter''); from Kimberly Unger, Esq., Executive
Director, Security Traders Association of New York, Inc., New York,
New York, dated February 17, 2010 (``STA IOI Letter''); from Patrick
D. Armstrong, Co-President, Alliance of Floor Brokers, New York, New
York, dated January 29, 2010 (``AFB Letter''); from Matthew K.
Samelson, Principal, Woodbine Associates, Stamford, Connecticut,
dated October 23, 2009 (``Woodbine Letter'').
\92\ See NYSE Euronext IOI Letter, supra note 91, at 4 (stating
that the Commission should provide clear guidance as to what
constitutes an actionable IOI, perhaps in the form of a non-
exclusive list of examples); ITG Letter, supra note 91, at 3
(stating that that the Commission should provide a more precise and
predictable definition of ``actionable IOI''); BIDS Trading Letter,
supra note 91, at 2 (noting the uncertainty regarding the definition
of an ``actionable'' IOI); Goldman Sachs Letter, supra note 91, at 2
(expressing concern that an explicit definition of actionable IOIs
will not be sufficiently broad to encompass the evolving range of
messaging and communications that might satisfy the definition of an
actionable IOI); STA IOI Letter, supra note 91, at 2 (stating that
the proposed guidance appears to deem an IOI actionable with
specific mention of price, size, or side, and that such a definition
is too broad); AFB Letter, supra note 91, at 2 (noting that the
Commission's proposal does not specifically define ``actionable
IOI''); Woodbine Letter, supra note 91, at 2-3 (stating that the
Commission's guidance on what constitutes an ``actionable IOI'' is
not clear).
\93\ See GETCO Letter, supra note 91, at 3 (actionable IOIs
explicitly or implicitly convey information that there is actionable
trading interest in a symbol); AFB Letter, supra note 91, at 2 (an
actionable IOI is a bid or offer that can be accessed by one set of
market participants that is not publicly disseminated).
---------------------------------------------------------------------------
The Commission has considered these comments discussed in this
Section II.F., and, for the reasons set forth throughout this release,
is proposing the amendments to Rules 600, 605, 606, and 607 as
described herein. Moreover, as noted earlier, the Commission is
proposing amendments to other rules to update cross-references as a
result of this proposal.\94\
---------------------------------------------------------------------------
\94\ The Commission is proposing to amend Rule 3a51-1(a) under
the Exchange Act; Rule 13h-1(a)(5) of Regulation 13D-G; Rule
105(b)(1) of Regulation M; Rules 201(a) and 204(g) of Regulation
SHO; Rules 600(b), 602(a)(5), 607(a)(1), and 611(c) of Regulation
NMS; and Rule 1000 of Regulation SCI.
---------------------------------------------------------------------------
III. Proposed Amendments to Rule 600, Rule 605, Rule 606, and Rule 607
A. Disclosures for Institutional Orders
The Commission proposes to amend Rule 606 to require a broker-
dealer that receives institutional orders in NMS stocks to, upon
request, provide customer-specific reports regarding the venues to
which the institutional orders are either routed or exposed through an
actionable IOI.\95\ Such disclosures would provide a broad range of
statistical data regarding the broker-dealer's handling of
institutional orders, including order routing and execution information
for those orders at each trading center in the aggregate and by order
routing strategy. The disclosure of such information would provide
customers with standardized information about institutional order
routing and order execution quality and serve as a baseline for further
analysis and comparison of broker-dealers. In addition, the disclosures
would assist customers in reviewing order routing practices, assessing
execution quality, managing potential conflicts of interest, and
handling information leakage. The Commission preliminarily believes
that increased, uniform transparency should assist customers in
determining the quality of their broker-dealer's services.
---------------------------------------------------------------------------
\95\ See proposed Rule 606(b)(3).
---------------------------------------------------------------------------
1. Definition of Institutional Order in Proposed Rule 600(b)(31)
Currently, Rule 606 of Regulation NMS limits the required public
disclosure of a broker-dealer's order routing information to non-
directed orders in NMS securities that are in amounts less than (i)
$200,000 for NMS stocks, and (ii) $50,000 for option contracts.\96\ In
proposing Rule 606, the Commission discussed the thresholds in
connection with its proposed definition of ``customer order'' \97\ and
noted that ``[l]arge orders are excluded in recognition of the fact
that statistics for where orders are routed and general descriptions of
order routing practices are more useful for smaller orders that tend to
be homogenous.'' \98\ Thus, while customers and market participants
have access to publicly-available order execution quality statistics
and order routing information for small orders pursuant to Rule 605 and
606 of Regulation NMS,\99\ institutional customers have observed that
there is a lack of corresponding information for larger orders.
---------------------------------------------------------------------------
\96\ See 17 CFR 242.606. See also supra note 7 and accompanying
text.
\97\ See supra note 7 and accompanying text.
\98\ See Rule 606 Predecessor Proposing Release, supra note 15,
at 48417. The Commission cited the heterogeneity of larger orders,
and the difficulty in effectively reducing that heterogeneous
universe into summary statistics, as the primary reason for
excluding those orders from the coverage of the Rule. See supra
notes 21 and 22 and accompanying text. Today, institutional orders
are still not homogenous; however the manner in which they are
handled has become increasingly systematized, thus making it more
practical to categorize them. The Commission preliminarily believes
that the current market structure and advances in routing and
execution technology, which automatically and electronically record
order routing information, have made statistics for where
institutional orders are routed more useful and disclosure of such
statistics more practicable.
\99\ 17 CFR 242.605-606.
---------------------------------------------------------------------------
To facilitate enhanced transparency around the handling of larger
orders in NMS stocks, the Commission is proposing to amend Rule 600 to
include a definition of ``institutional order.'' \100\ Specifically,
under proposed Rule 600(b)(31) of Regulation NMS, an institutional
order would be defined as an order to buy or sell a quantity of an NMS
stock having a market value of at least $200,000, provided that such
order is not for the account of a broker-dealer.\101\
---------------------------------------------------------------------------
\100\ See proposed Rule 600(b)(31).
\101\ As proposed, the definition of institutional order would
only apply to orders for NMS stocks, and, therefore, would not
include orders in NMS securities that are options contracts. Due to
differences in the current market structure for NMS securities that
are options contracts, in particular the lack of an over-the-counter
market in listed options, the Commission preliminarily believes that
the same market structure complexities do not exist at this time to
warrant the institutional order handling disclosures proposed
herein. See Securities Exchange Act Release No. 61902 (April 14,
2010), 75 FR 20738, 20740 (April 20, 2010) (stating that all orders
in the listed options market are currently executed on registered
national securities exchanges). Specifically, since listed options
are limited to trading on the 14 registered options exchanges, the
number of venues to which listed options could be routed and
executed is significantly less than the over 253 venues for NMS
stocks. See supra notes 31-32 and accompanying text. In addition,
the broker-dealer ownership and affiliation concerns with over-the-
counter venues do not exist in the listed options market. The
Commission preliminarily believes that at this time the current
listed options market structure does not present the same concerns
regarding fiduciary responsibilities, information leakage, and
conflicts of interest as the market structure for NMS stocks.
---------------------------------------------------------------------------
[[Page 49445]]
The proposed definition of ``institutional order'' is intended to
complement the current definition of ``customer order.'' \102\ The
proposed dollar threshold for an institutional order would dovetail
with the definition of ``customer order'' such that all orders in NMS
stocks routed by broker-dealers for their customers, whether retail- or
institutional-sized, would be encompassed by order routing disclosure
rules.\103\ As noted above, institutional orders are generally divided
into smaller orders and routed to various trading centers. The
Commission notes that, as discussed below, the proposed institutional
order handling reports would include the routing of all smaller orders
derived from institutional orders.
---------------------------------------------------------------------------
\102\ See infra Section III.A.1.
\103\ See id. The Commission notes that the proposed definition
of ``institutional order'' was referred to as ``large orders'' in
the Rule 606 Predecessor Proposing Release and Rule 606 Predecessor
Adopting Release. See supra note 15.
---------------------------------------------------------------------------
The Commission preliminarily believes that defining institutional
order in relation to the dollar amount of the order is an appropriate
means to differentiate between small orders that are typically
characterized as orders of $200,000 or less and larger-sized orders
that are generally categorized as orders of $200,000 or more.\104\
Since ``customer order'' is currently defined using $200,000 as an
upper threshold, the Commission preliminarily believes that market
participants are accustomed to considering an order of $200,000 or more
as an institutional order rather than a customer order. In addition,
the Commission preliminarily believes that rather than proposing a new
monetary value to define large-sized orders generally placed by
institutional customers, administration would be more straightforward
for broker-dealers using a defined standard that is commonly recognized
in the industry. Therefore, the Commission preliminarily believes that
the $200,000 threshold continues to be a reasonable threshold to
accommodate such distinction between small orders and large orders,
which are generally handled in a different manner by broker-
dealers.\105\
---------------------------------------------------------------------------
\104\ See, e.g., 17 CFR 242.606 (defining block size with
respect to an order to include an order for a quantity of stock
having a market value of at least $200,000).
\105\ As detailed below, the Commission is proposing new
disclosures in Rule 606 that would apply to institutional orders.
---------------------------------------------------------------------------
The Commission requests comment on the expansion of Rule 606 to
include institutional orders and the definition of ``institutional
order'' in proposed Rule 600(b)(31). In particular, the Commission
solicits comment on the following:
1. Do commenters believe Rule 606 should be expanded to include
institutional orders? Why or why not? Should the Commission consider an
alternative approach? Why or why not?
2. Do commenters believe it is useful or necessary to define an
institutional order? Do commenters believe that the proposed definition
of institutional order should include securities other than NMS stocks?
For example, should NMS securities that are options contracts be
included? Why or why not? Should non-NMS securities, such as securities
traded only in the OTC market, be included? Why or why not? Would
including these types of securities in the definition of institutional
order be useful to institutional customers? If so, how? Please explain
and provide support for your view.
3. Do commenters believe that dollar value is the proper criterion
for defining an institutional order? If so, is $200,000 the appropriate
amount? Why or why not? If not, should it be higher or lower? If so,
what amount? Are there other order characteristics the Commission
should consider to distinguish between retail and institutional orders,
in addition to, or instead of, a dollar threshold? Should the criteria
be different for different types of stocks? For example, would $200,000
capture large-sized orders for liquid or illiquid stocks, high-priced
or low-priced stocks, large capitalization or small capitalization
stocks? Please explain and provide data to support your argument.
4. Should the Commission define an institutional order based on the
number of shares instead of a market value? Why or why not? For
example, would 10,000 shares be an appropriate criterion for defining
an institutional order, regardless of dollar value? Should it be more
or less? Please explain and provide data.
5. Should the Commission require broker-dealers to make the
disclosures proposed in Rule 606(b)-(c) for all orders, irrespective of
dollar amount? Why or why not? Please explain.
6. Should the definition of institutional order reflect a different
threshold, such as order size or market value, for various types of NMS
stocks, such as common stock and exchange-traded products? If so, what
thresholds are appropriate and for which NMS stocks? If possible,
please provide data and analysis to support your view.
7. Should the definition of institutional order incorporate
multiple metrics, such as a certain market value of the order plus a
certain number of shares for the order? If possible, please provide
data and analysis to support your view.
8. Do commenters believe that customers should be able to designate
which orders qualify as an institutional order? For example, should a
customer be able to designate smaller orders sent to a broker-dealer as
an institutional order? If so, how would that be done? Should
institutional order be defined as a combination of customers
designating institutional orders and a threshold, i.e., if either
requirement is satisfied, it would then be defined as an institutional
order? Please provide support for your arguments.
9. Do commenters have alternative definitions for an institutional
order, or modifications to the proposed definition? Please explain and
provide supporting data, if possible.
10. Instead of defining institutional order, do commenters believe
that there are alternative approaches that the Commission should
consider in structuring order handling disclosures for large orders? If
so, please explain the approach in detail, including the benefits and
costs of the approach.
2. Definition of Actionable Indication of Interest in Proposed Rule
600(b)(1)
To further facilitate the institutional order disclosure regime,
the Commission proposes to amend Rule 600 to include a definition of
``actionable indication of interest.'' \106\ As the Commission
indicated in 2009, an actionable IOI is a privately transmitted message
by certain trading centers, such as an ATS or an internalizing broker-
dealer, to selected market participants to attract immediately
executable order flow to such trading centers, and functions in some
respects similarly to a displayed order or a quotation.\107\ As such,
actionable IOIs can be used by: (1) A trading center to generate
trading volume, which in turn could prompt market participants to send
more orders to such venue; (2) market participants that submit orders
to a trading center to receive executions through the use of actionable
IOIs to attract contra side liquidity; and (3) a trading center to
[[Page 49446]]
generate transaction fees from the executions.
---------------------------------------------------------------------------
\106\ See proposed Rule 600(b)(1).
\107\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66, at 61210 (describing actionable IOIs as
privately transmitted messages to selected market participants
intended to ``attract immediately executable order flow'' and
comparing their function to ``displayed quotations'').
---------------------------------------------------------------------------
Under proposed Rule 600(b)(1) of Regulation NMS, an actionable IOI
would be defined as ``any indication of interest that explicitly or
implicitly conveys all of the following information with respect to any
order available at the venue sending the indication of interest: (1)
Symbol; (2) side (buy or sell); (3) a price that is equal to or better
than the national best bid for buy orders and the national best offer
for sell orders; and (4) a size that is at least equal to one round
lot.'' \108\ The Commission preliminarily believes that for an IOI to
be actionable it must contain information sufficient to attract
immediately executable orders to the venue sending the indication of
interest. The Commission preliminarily believes that the four elements
contained in the proposed definition of actionable IOI (symbol, side,
price, and size) are all necessary pieces of information for an
external liquidity provider to respond with an order to execute against
the order at the venue sending the indication of interest. Indeed, if
one of the four elements is not explicitly or implicitly conveyed, an
external liquidity provider would not have sufficient information to
decide whether to respond to the IOI or to ensure the order it sends in
response to the IOI would be immediately executable.\109\ Without the
symbol, an external liquidity provider would not know the security for
which to send an order. Without the side, an external liquidity
provider would not know whether to send a buy order or a sell order.
Without the price, an external liquidity provider would not know where
to price its order to ensure the order is immediately executable.
Without the size, an external liquidity provider would not know the
number of shares it could expect to receive from responding to the IOI.
---------------------------------------------------------------------------
\108\ See proposed Rule 600(b)(1).
\109\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66, at 61210-11 (discussing the four elements of
an actionable IOI and the inferences a trader can make to reasonably
conclude that the order it sends in response to the indication of
interest will result in an execution).
---------------------------------------------------------------------------
A determination of whether an IOI implicitly conveys information--
and thus contains each of the four elements to make such IOI
actionable--involves a consideration of all of the facts and
circumstances, including the course of dealing between the IOI sender
and the recipient. For example, a message that alerts the recipient
that there is trading interest in a particular symbol and side at the
venue sending the IOI generally would be considered ``actionable'' even
though it does not explicitly specify the price and size if, through
the course of dealings, the recipient could expect to respond and
receive an execution equal to or better than the applicable national
best bid or offer for at least one round lot. The Commission notes that
the proposed definition is substantively similar to the Commission's
description of actionable IOIs in the Regulation of Non-Public Trading
Release in 2009.\110\
---------------------------------------------------------------------------
\110\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66. See also supra Section II.F.5. discussing
comments received and discussion relating to actionable IOI.
---------------------------------------------------------------------------
When used in the context of the proposed institutional order
handling report, the proposed definition of actionable IOI would
require a broker-dealer to disclose its activity that communicates to
external liquidity providers to send an order to the broker-dealer in
response to a customer's institutional order. The Commission
preliminarily believes information about a broker-dealer's use of
actionable IOIs in executing institutional orders will be useful to
customers assessing the broker-dealer's order handling decisions,
particularly in regards to analyzing information leakage because, when
``actionable IOIs are intended to attract immediately executable order
flow to the trading venue,'' \111\ actionable IOIs ``function quite
similarly to displayed quotations'' \112\ and thus have the capacity to
communicate information about the existence of an institutional order.
In addition, as discussed in greater detail above,\113\ the Commission
notes that certain commenters on the Concept Release on Equity Market
Structure specifically requested that Rule 606 be expanded to require
the disclosure of information related to the use of actionable
IOIs.\114\ The Commission also notes that some commenters on the
Regulation of Non-Public Trading Interest Release raised concerns about
the Commission's description of an actionable IOI, including whether
the description of an actionable IOI could be clearer and more
precise.\115\ A few commenters also differed on whether the
Commission's description of an actionable IOI was too broad or not
broad enough to encompass all intended messaging activity that could
result in an execution.\116\ The Commission has considered these
comments. The Commission preliminarily believes on balance that, in the
context of the reporting regime proposed in this release, it remains
appropriate to look to the description of actionable IOI contained in
the Regulation of Non-Public Trading Interest Release and preliminarily
believes that description would capture the necessary information to
make an IOI actionable and therefore the functional equivalent of an
order. Accordingly, the Commission is using the description of an
actionable IOI contained in the Regulation of Non-Public Trading
Interest Release as the basis for the proposed definition of actionable
IOI in Rule 600(b)(1) of Regulation NMS. In addition, for the reasons
stated below, the Commission preliminarily believes that the proposed
definition of actionable IOI captures the types of activity that would
be pertinent for customers in evaluating how a broker-dealer handles
its institutional orders.
---------------------------------------------------------------------------
\111\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66, at 61210.
\112\ Id.
\113\ See supra Section II.F.5.
\114\ See supra note 92.
\115\ See id.
\116\ See id.
---------------------------------------------------------------------------
One purpose of the proposed amendments to Rule 606 is to reflect
how large orders are handled and how information is shared and
dispersed among the marketplace. The Commission has previously noted
that because actionable IOIs convey similar information as an order, a
response to an actionable IOI may result in an execution at the venue
of the IOI sender.\117\ As such, the Commission preliminarily believes
that actionable IOIs, as proposed to be defined, function quite
similarly to an order or a displayed quotation.\118\ Given this
similarity, the Commission preliminarily believes that a rule that did
not capture information related to the use of actionable IOIs in this
manner would leave customers without information that could help them
have a more complete understanding of how broker-dealers handle their
institutional orders. If an IOI contains, explicitly or implicitly, the
four criteria of the proposed definition of actionable IOI, then it is
the functional equivalent to an order or a quotation. Because of this,
the Commission preliminarily believes that the proposed definition of
actionable IOI will capture information that could be used by customers
to better understand how broker-dealers handle their institutional
orders, particularly in regards to information leakage, and will be
important to customers in evaluating the order handling and execution
practices of their broker-dealers.
---------------------------------------------------------------------------
\117\ See Regulation of Non-Public Trading Interest Proposing
Release, supra note 66, at 61210-11.
\118\ See id.
---------------------------------------------------------------------------
Separately, the Commission notes that as a result of the Commission
proposing both the definitions of institutional order and actionable
indications of
[[Page 49447]]
interest, the Commission is also proposing to renumber the existing
definitions in Rule 600(b) accordingly, and update other rules to
change cross-references.
The Commission requests comment on the proposed definition of
``actionable indication of interest,'' as well as the other proposed
changes to Rule 600(b) noted above. In particular, the Commission
solicits comment on the following:
11. Do commenters believe that a symbol is a necessary element to
include in the definition of actionable IOI? Is the side (buy or sell)
a necessary element to include in the definition of actionable IOI?
Should price be an element in the definition of actionable IOI or is it
assumed that it would be equal to or better than the applicable
national best bid or offer? Is size a necessary element to define an
actionable IOI? Should an actionable IOI be defined to require only a
subset of these elements, or should any of the proposed elements be
modified? If so, which elements and why? Are there alternative
definitions that would capture the activity of a broker-dealer
communicating to external liquidity providers that should be included
as part of the required disclosure? Are there other elements or factors
that the Commission should consider in the definition of actionable
IOI? Should any of the proposed elements be omitted? Why or why not?
12. Do commenters believe that an IOI can be ``actionable'' even if
a subset of the elements (symbol, side, price, and size) is conveyed
implicitly? Should broker-dealers be required to disclose information
about actionable IOIs where one, some, or all of the elements are
conveyed implicitly? Why or why not? Would broker-dealers be able to
program automated systems to identify as actionable IOIs instances in
which information is being conveyed implicitly, such as through a
course of dealing between a liquidity provider and the broker-dealer?
13. Do commenters believe there are other types of indications of
interest that should be required to be disclosed? If so, what types and
how would they be defined?
14. Do commenters believe actionable IOIs are linked to specific
orders at the broker-dealer, such that when the external liquidity
provider responds to an actionable IOI with a contra-side order, the
broker-dealer will be able to match both sides of the trade?
15. Do commenters believe that there are alternative approaches to
defining an actionable IOI? If so, please explain each approach in
detail, including the benefits and costs of the approach.
3. Scope and Format of Reports
The Commission understands that customers increasingly are
requesting institutional order handling information to better
understand and assess order routing strategies, best execution,
potential conflicts of interest, and the risk of information leakage.
The Commission understands that many broker-dealers currently respond
to such requests by providing reports on their institutional order
handling to customers. However, the Commission understands that these
reports often contain non-standardized terms, and often are not
presented in a uniform manner to allow for effective comparison across
different broker-dealers and trading centers.\119\
---------------------------------------------------------------------------
\119\ See Associations Letter, supra note 5, at 2.
---------------------------------------------------------------------------
The Commission preliminarily believes that requiring broker-dealers
to disclose standardized customer-specific institutional order handling
information to their customers would facilitate the ability for such
customers to assess broker-dealers' order handling practices and how
such practices affect best execution, potential conflicts of interest,
the potential for information leakage, and execution quality generally.
The proposed disclosures described below effectively would set a
baseline for disclosure of customer-specific institutional order
handling information that all customers, regardless of size, could
receive from their broker-dealers upon request. The Commission
preliminarily believes that the proposed disclosures would provide
needed transparency into broker-dealer institutional order handling
practices, and would promote discussions between broker-dealers and
customers regarding the broker-dealer's institutional order handling
practices and the effect such practices have on execution quality. In
addition, the Commission preliminarily believes that the proposed
disclosures would allow customers to better compare institutional order
handling practices across multiple broker-dealers, which should provide
a basis for more informed decision making when customers engage the
order routing services of broker-dealers.
Specifically, the Commission is proposing to amend Rule 606(b) of
Regulation NMS to require that a broker-dealer, on request of a
customer that places, directly or indirectly, an institutional order
with it, disclose to such customer within seven business days of
receiving the request, a report on its handling of institutional orders
for that customer that contains information for the prior six months,
broken down by calendar month.\120\ The Commission preliminarily
believes that requiring broker-dealers to provide the customer-specific
reports within seven business days will ensure that all institutional
customers, regardless of size, receive their order handling information
in a timeframe that would allow them to act in a timely fashion in
response to the information contained in the report. The Commission
also preliminarily believes that broker-dealers will develop technical
processes to produce these reports in an automated manner,\121\ and as
such, requiring a response to an individual customer request within
seven business days would not be unduly burdensome and should provide a
sufficient amount of time for broker-dealers to generate the required
disclosure and respond to customer requests. Separately, the Commission
notes that the proposed requirement to provide customer-specific
institutional order handling information for the prior six months is
consistent with the reporting period currently required for customer-
specific reports on retail order routing.\122\ The Commission
preliminarily believes that a six-month reporting period is also
appropriate for institutional orders, as it would provide individual
customers with the most recent months of institutional order handling
data and would cover the full period contained in the broker-dealer's
last public aggregated institutional order handling report.\123\
---------------------------------------------------------------------------
\120\ See proposed Rule 606(b)(3).
\121\ See infra Section IV.A.1.
\122\ See Rule 606(b)(1).
\123\ See proposed Rule 606(c). See also Rule 606 Predecessor
Adopting Release, supra note 15, at 75430 n.81 (discussing the six-
month reporting period for reports on customer-specific retail order
routing).
---------------------------------------------------------------------------
The proposed report would cover instances where an institutional
order is handled either directly by the broker-dealer or indirectly
through systems provided by the broker-dealer. For example, an
institutional order would have been placed with a broker-dealer if a
broker-dealer receives an institutional order directly from a customer
and works to execute the order itself, as well as if a broker-dealer
receives an institutional order indirectly from a customer, where the
customer self-directs its institutional order by entering it into a
routing system or execution algorithm provided by the broker-dealer.
The Commission notes that the proposal would require a broker-
dealer to provide a report ``on request of a customer that places,
directly or
[[Page 49448]]
indirectly, an institutional order with the broker or dealer . . . .''
\124\ Accordingly, a broker-dealer must provide a report under the
proposed rule to the customer placing the order with the broker-dealer,
who may be acting on behalf of others and thus not be the ultimate
beneficiary of any resulting transactions.\125\ The Commission
preliminarily believes that requiring the reports to be provided to the
customer that places an institutional order with the broker-dealer is
appropriate because it would require the broker-dealer to provide the
report to the person that is responsible for making the routing and
execution decisions for such institutional order. For example, if an
investment adviser, as the customer of a broker-dealer, places
institutional orders with a broker-dealer that represents trading
interest from multiple underlying clients of the investment adviser,
the investment adviser, as the customer of the broker-dealer, would be
the sole entity to whom the broker-dealer is required to provide a
report under the proposed rule; and not the multiple underlying clients
of the investment adviser.
---------------------------------------------------------------------------
\124\ See id.
\125\ The Commission notes that ``customer'' is broadly defined
as ``any person that is not a broker or dealer'' in Rule 600(b)(16).
However, for the purposes of the proposed amendments to Rule 606,
which are to provide detailed information about order routing and
execution quality to the person responsible for assuring the
effectiveness of this function, the Commission preliminarily
believes that it is appropriate to view the customer placing the
order with the broker-dealer, whether the account holder or an
investment adviser or other fiduciary, as the ``customer.''
---------------------------------------------------------------------------
Separately, the Commission notes that while the proposed rule would
allow a customer that places, directly or indirectly, an institutional
order with a broker-dealer to request and receive its institutional
order handling report, it would not limit the number of times a
customer could place a request. The proposed rule also would not
preclude a customer from making a standing request to its broker-
dealer, whereby the customer would automatically receive a recurring
report on an periodic basis without the need to make repeated requests
for its institutional order handling reports. However, the Commission
does not intend for the proposed rule to duplicate information the
broker-dealer has previously provided the customer pursuant to a prior
request under the proposed rule. For example, if a broker-dealer
provides a report to a customer for the prior six months, and that
customer requests an additional report the following month, the broker-
dealer would only need to provide a report for the latest month. In
addition, the Commission acknowledges that broker-dealers may need to
configure their systems to capture the information necessary to produce
the proposed institutional order handling reports and, therefore, may
not have the ability to produce historical reports about the routing of
orders and executions that occurred before such systems are updated.
Accordingly, the Commission would not require broker-dealers to produce
institutional handling reports containing information to cover months
before broker-dealers are required to comply with such rule, if
adopted.
For purposes of the report, the handling of an institutional order
would include the handling of all smaller orders derived from the
institutional orders.\126\ As noted above, institutional orders are
generally divided into smaller orders and routed to various trading
centers. For the disclosure to be meaningful and complete, the
Commission preliminarily believes that the routing of each child order
derived from an institutional parent order should be required to be
included in the report. The Commission understands that current
technologies employed by broker-dealers typically are able to track
child orders and link such child orders back to the parent order,\127\
thus minimizing burdens associated with this component of the proposed
rule.
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\126\ See proposed Rule 606(b)(3). The Commission notes that an
order would only be required to be included in the proposed report
if it met the definition, and thus the size threshold, of an
institutional order when received by the broker-dealer.
\127\ Broker-dealers have developed their own systems allowing
for tracking and linking of child orders to parent orders. Third-
party software enables this, as well. See, e.g., Advanced Orders
Panel, Interactive Brokers, available at https://www.interactivebrokers.com/en/software/tws/usersguidebook/mosaic/advanced_orders_panel.htm; Viewing Child Orders, Trading
Technologies, available at https://www.tradingtechnologies.com/help/xtrader/viewing-child-orders/; Smart Order Routing, StreamBase,
available at http://www.streambase.com/industries/capitalmarkets/smart-order-routing/.
---------------------------------------------------------------------------
The Commission is further proposing to require that the report be
made available using an eXtensible Markup Language (XML) schema and
associated PDF renderer to be published on the Commission's Web
site.\128\ Requiring the report to be provided in XML should result in
the data in the report being provided in a consistent, structured
format. XML is an open standard \129\ that defines, or ``tags,'' data
using standard definitions. The tags establish a consistent structure
of identity and context. This consistent structure can be automatically
recognized and processed by a variety of software applications such as
databases, financial reporting systems, and spreadsheets, and then made
immediately available to the end-user to search, aggregate, compare,
and analyze. In addition, the XML schema could be easily updated to
reflect any changes to the open standard. The Commission preliminarily
believes that requiring the report be provided in in an XML format
would provide the customers and the public (in the case of public
reports) with data about order handling practices in a format that
would facilitate search capabilities, and statistical and comparative
analyses across broker-dealers and date ranges. Absent this
requirement, any customers or members of the public seeking to use the
information would need either to spend time manually collecting the
data and manually entering the data into a format that allows for
analysis, thus increasing the time needed to analyze the data, or incur
the cost of subscribing to a financial service provider that
specializes in this data aggregation and comparison process. Further,
manual entering of data may lead to errors, thereby potentially
reducing data quality and usability. By proposing to require the use of
an XML format so that the information would be more readily available,
customers might be able to better use the information to compare
execution quality of broker-dealers, thereby allowing them to select
broker-dealers that are a better match to their preferences. The
Commission is also proposing that the report be provided in PDF format
using the associated PDF renderer published on the Commission's Web
site so that the report would also be provided in a human-readable
format for those customers who prefer only to review individual reports
and not necessarily aggregate or conduct large-scale analysis on the
data. Like XML, PDF is also an open standard. By using the associated
PDF renderer published on the Commission's Web site, the XML data will
be instantly presentable in a PDF format and consistently presented
across filings.
---------------------------------------------------------------------------
\128\ See proposed Rule 606(b)(3). The Commission's schema is a
set of custom XML tags and XML restrictions designed by the
Commission to reflect the proposed disclosures in Rule 606.
\129\ The term ``open standard'' is generally applied to
technological specifications that are widely available to the
public, royalty-free, at no cost.
---------------------------------------------------------------------------
The Commission seeks comment generally on the report format
proposed in Rule 606(b)(3). In particular, the Commission solicits
comment on the following:
[[Page 49449]]
16. Do commenters believe the proposed scope of the institutional
order handling report is practicable and appropriate? Why or why not?
Please explain and provide data, if possible.
17. Do commenters believe that it is appropriate to view the
customer placing the order with the broker-dealer, whether the account
holder or an investment adviser or other fiduciary, as the ``customer''
for purposes of the proposed amendments to Rule 606? Should entities
other than the customer placing the order with the broker-dealer be
entitled to receive the report? For example, if an investment adviser
represents multiple underlying clients, should each underlying client
be entitled to receive the report? Please explain.
18. Do commenters believe that broker-dealers should be required to
provide the customer-specific report on institutional order handling in
the proposed format? Why or why not? Do commenters believe broker-
dealers should be required to provide the report in a structured XML
format? Would such a format facilitate comparison of the data across
broker-dealers? If not, why not? Do commenters believe broker-dealers
should be required to also provide the report in an instantly readable
PDF format? If not, why not? Are there other formats or alternative
methods to provide the customer-specific reports that the Commission
should consider? If so, please explain and provide data.
19. Do commenters believe that seven business days is a reasonable
amount of time for a broker-dealer to respond to a customer request for
institutional order handling information? If not, what would be a
reasonable amount of time?
20. The Commission notes that Rule 606(b)(2) requires that broker-
dealers notify their customers annually, in writing, of the
availability of a report on the routing of retail orders. Should the
Commission include a similar requirement for a report on the handling
of institutional orders?
21. Do commenters believe that the rule should include a de minimis
exemption for broker-dealers that receive, in the aggregate, less than
a certain threshold number or dollar value of institutional orders? Why
or why not? If so, what would be the appropriate threshold number or
dollar value of institutional orders a broker-dealer should need to
receive from all customers in the aggregate before it would be required
to provide customer-specific order handling disclosures to any
customer? Please explain and provide data, if possible.
22. Do commenters believe that the rule should be applicable, with
respect to disclosures to any particular customer, only if a broker-
dealer receives greater than a certain threshold number or dollar value
of institutional orders from that customer? Why or why not? What would
be the appropriate threshold number or dollar value of institutional
orders from a particular customer before a broker-dealer should be
required to provide customer-specific order handling disclosures to the
particular customer? Please explain and provide data, if possible.
23. Do commenters believe that the required disclosure regarding
the handling of an institutional order should include the handling of
all smaller (child) orders derived from the institutional order? Why or
why not?
24. Do commenters believe that the rule should cover institutional
orders placed both directly and indirectly with a broker-dealer? Should
the rule only cover orders placed directly with a broker-dealer? Why or
why not?
25. Do commenters believe that the rule should specify the number
of times a broker-dealer is required by the rule to respond to a
customer request for a report on the handling of its institutional
orders? Why or why not? If yes, what should the number of times be?
Alternatively, do commenters believe that broker-dealers should be
required to provide customers with institutional orders ongoing access
to order handling reports through a secure portal on their Web sites?
Why or why not? How would this impact broker-dealers' compliance costs,
or the accessibility to customers of order handling reports? Please
explain.
26. As noted above, the proposed rule would not preclude customers
from making standing requests for their broker-dealers to provide them
order handling reports on a specified regular basis. Do commenters
believe broker-dealers should be required to automatically provide
reports to customers with respect to their institutional orders,
without the customer making a specific request? If so, how frequently
should this information be provided (e.g., every month, three months,
six months, annually)? Please explain. To what extent would
automatically providing reports facilitate the dissemination of order
handling information to customers that might not otherwise take the
time to request it? On the other hand, to what extent would
automatically providing reports require order handling information to
be provided to customers that they might not want or use? If order
handling reports are required to be automatically provided, should
customers be permitted to opt out from receiving certain information or
reports in their entirety? Should a requirement to automatically
provide reports exclude customers with only a de minimis number of
institutional orders? If so, what would be an appropriate de minimis
level? How would a requirement to automatically provide customers with
reports rather than provide them upon request change the costs for
broker-dealers? Considering that broker-dealers that handle
institutional orders would need to be prepared to provide reports to
customers on request, and therefore would need to develop the
technology to produce such reports in an automated manner, what would
be the incremental costs for them to run the reports for all customers
on a periodic basis? Would there be any benefits from broker-dealers
running the reports for all customers on a periodic basis? Would the
broker-dealer experience lower costs from manually providing the
reports solely upon request? Would other costs be involved? Please
explain and provide data.
As noted above, the Commission is proposing to require that the
institutional order handling reports be broken down by calendar
month.\130\ The Commission understands that trading centers frequently
change their fee structures, including the amount of fees and rebates,
to attract order flow, and such changes typically occur at the
beginning of a calendar month. The Commission preliminarily believes
these changes in fee structures at trading centers may affect a broker-
dealer's routing decisions. The Commission therefore preliminarily
believes that if customer-specific reports on institutional order
handling reflected data over a longer period of time, the aggregated
information contained in the reports may not be as illustrative or as
useful in informing customers as to how fee structures potentially
affected the broker-dealer's routing behavior.
---------------------------------------------------------------------------
\130\ See id.
---------------------------------------------------------------------------
For example, if a change in a trading center's pricing structure
occurs at the beginning of a calendar month, and the report on a
customer's institutional order handling reflected aggregated data for
the past six months, then any change in broker-dealer routing behavior
as a result of the change in trading center pricing would be harder to
detect as the change in data would be diluted and averaged over a
period of months. The Commission preliminarily believes that by
requiring the reports to be broken down by calendar month would enable
[[Page 49450]]
customers to better assess a broker-dealer's institutional order
handling practices and any changes in routing behavior in response to
internal or external factors. In addition, for those with a fiduciary
responsibility to monitor for best execution, monthly detail would help
facilitate regular and more precise review to evaluate whether their
selected broker-dealers are providing satisfactory execution quality.
As proposed, Rule 606(b)(3) requires that the broker-dealer's
report reflect aggregated information regarding the handling of a
customer's institutional orders for the prior six months, broken down
by calendar month. Additionally, the Commission preliminarily believes
that, if a customer places an institutional order that identifies the
particular account for which the order was submitted, the broker-dealer
would be well-positioned to provide the customer, upon request, a
report broken down by account. The Commission preliminarily believes
that, because the proposed disclosures will aggregate information to be
disclosed to a specific customer across all of the customer's
institutional orders, the risk that such disclosures would reveal
sensitive, proprietary information about broker-dealers' order handling
techniques should be minimal. The Commission is cognizant of the
concerns broker-dealers would have if such disclosures revealed
proprietary order handling techniques, and preliminarily believes that
aggregated customer-specific order handling information would not
enable a customer to reverse-engineer proprietary order handling
techniques.
The Commission requests comment on this proposed requirement. In
particular, the Commission solicits comment on the following:
27. Is six months an appropriate timeframe for the reporting period
for customer-specific order handling information? Would a longer or
shorter time period (e.g., quarterly) be more appropriate? How soon
after month-end should the customer-specific order handling report be
provided (e.g., two-weeks after the end of the preceding month)? Please
explain.
28. Do commenters believe that aggregated information, broken down
by calendar month, is a useful format for the customer? Should the data
be required to be provided in a more granular or broader manner? For
example, would it be more useful for institutional customers to receive
data about the handling of their institutional orders on a stock-by-
stock basis rather than aggregated? Please provide support for your
arguments and describe any costs and benefits associated with an
alternative format.
29. Does aggregating of all of a customer's institutional orders
into a single report adequately prevent sensitive, proprietary
information from being revealed? If not, why not? Could aggregated
institutional order disclosures allow a customer or competitors to
reverse engineer a broker-dealer's order handling techniques?
30. As noted above, the Commission preliminarily believes that, if
a customer places an institutional order that identifies the particular
account for which the order was submitted, the broker-dealer would be
well-positioned to provide the customer, upon request, a report broken
down by account. Do commenters believe that the rule should require a
broker-dealer to provide, upon request, a report broken down by
account, if the customer identifies the particular account for which
the order was submitted? Why or why not? Please discuss the benefits
and costs with such an account-by-account approach.
Finally, to provide a standardized format for the proposed
institutional order handling report, the Commission proposes that the
disclosures regarding institutional orders a broker-dealer executes
internally or routes to other venues be made in chart form with certain
rows and columns of required information.\131\ Specifically, the
Commission proposes to require that each report contain rows that would
be categorized by venue and by order routing strategy category, as
described in more detail below, for each venue.\132\ In addition, the
Commission proposes to require that each report contain certain columns
of information, as described below in more detail, for each of the
required rows.\133\ Thus, each report would be formatted so that a
customer would be readily able to observe their order activity at a
particular venue, as further subdivided by order routing strategy
category for that venue.
---------------------------------------------------------------------------
\131\ See supra note 41. See, e.g., SIFMA Letter II, supra note
79, at 13 (stating that the Commission should direct broker-dealers
to provide institutional clients with standardized execution venue
reports); BlackRock Letter, supra note 41, at 3 (stating broker-
dealers should be required to provide periodic standardized reports
on order routing and execution metrics to both retail and
institutional investors).
\132\ See proposed Rule 606(b)(3).
\133\ See proposed Rule 606(b)(3)(i)-(iv).
---------------------------------------------------------------------------
The Commission preliminarily believes it is important for customers
to understand the venues where their institutional orders are exposed
and executed,\134\ and that segmenting the institutional order handling
report by venue would be useful for customers to understand where their
institutional orders are routed and executed. As proposed, the report
would present the order handling information in a manner that would
allow customers to readily compare venues. For purposes of the
institutional order handling report, a venue would be any trading
center \135\ to which an order is routed or where an order is executed.
---------------------------------------------------------------------------
\134\ See supra note 65.
\135\ See supra note 3.
---------------------------------------------------------------------------
The Commission also proposes to require that the institutional
order handling report be categorized by order routing strategy category
for institutional orders for each venue.\136\ The Commission
preliminarily believes that order routing strategies for institutional
orders can be categorized into three general strategy categories: (1) A
``passive order routing strategy,'' which emphasizes the minimization
of price impact over the speed of execution of the entire institutional
order; (2) a ``neutral order routing strategy,'' which is relatively
neutral between the minimization of price impact and speed of execution
of the entire institutional order; and (3) an ``aggressive order
routing strategy,'' which emphasizes speed of execution of the entire
institutional order over the minimization of price impact.\137\ The
Commission is not aware of any generally accepted definitions or
metrics to define these order routing strategies, and the proposed rule
does not further define these three order routing strategy categories.
Rather, by providing a general description, the Commission would afford
broker-dealers flexibility to determine how to group their various
order routing strategies for institutional orders into the three
categories for reporting purposes, according to the general description
provided in the proposed rule. A broker-dealer would be required to
assign each order routing strategy that it uses for institutional
orders to one of the three categories in a consistent manner for each
report it prepares pursuant to the proposed rule, and would be required
to document the specific methodologies it relies upon for making such
assignments.\138\ The Commission is proposing to require every broker-
dealer to preserve a copy of the methodologies used to assign its order
routing strategies and maintain such copy as part of its books and
records in a manner consistent with Rule 17a-4(b) under the Exchange
[[Page 49451]]
Act.\139\ Once a broker-dealer's strategies are assigned a category,
the broker-dealer shall promptly update such assignments any time an
existing strategy is amended or a new strategy is created that would
change such assignment.\140\
---------------------------------------------------------------------------
\136\ See proposed Rule 606(b)(3).
\137\ See proposed Rule 606(b)(3)(v).
\138\ See id.
\139\ See id.
\140\ See id.
---------------------------------------------------------------------------
The Commission acknowledges that categorization of order routing
strategies for institutional orders would be an internal process for a
broker-dealer, and, therefore, the methodologies for such process would
likely not be entirely consistent across broker-dealers, which could
result in an order routing strategy being placed in a different
category by different broker-dealers. Such inconsistency could make it
difficult for institutional customers to effectively compare
institutional order handling reports across their broker-dealers.
However, the Commission preliminarily believes that the potential
inconsistencies of categorization would only occur at the margins among
order routing strategies, where characteristics of the strategy could
be viewed differently by different broker-dealers. For example, one
broker-dealer might reasonably classify a mixed strategy that mostly
provides liquidity as being ``neutral,'' whereas another broker-dealer
might reasonably categorize the same strategy as ``passive.'' Even if
broker-dealers differ at the margins in their categorization of similar
order routing strategies, the Commission preliminarily believes that
grouping order routing strategies by these three broad categories would
still allow for meaningful comparison of order handling practices
across broker-dealers.
The Commission recognizes that customers may have different
investment strategies and provide specific order handling instructions
that will affect how a broker-dealer handles an institutional order and
utilizes various venues. The Commission preliminarily believes that if
it were to require that the disclosures be categorized only by venue,
the disclosures would contain aggregated order routing strategy data
that might be less useful in analyzing how a broker-dealer implements
the customer's trading decisions. The Commission preliminarily believes
that disclosing the proposed institutional order handling information
by category of order routing strategy should allow customers to better
evaluate a broker-dealer's order handling practices for orders that are
handled using similar strategies.
In addition, a customer's order handling instructions may vary at
particular points in time depending on a number of different factors.
For instance, at certain times a customer may need to quickly liquidate
or acquire a position, in which case an aggressive order routing
strategy may be appropriate. At other times, speed may not be a primary
concern and thus a passive order routing strategy may be appropriate.
Because these types of order routing strategies use different methods
to liquidate or acquire a position, the order routing strategies may
use venues for different purposes. The Commission preliminarily
believes that disclosing the required institutional order handling
information by passive, neutral, and aggressive strategy for each venue
will provide more transparency to customers and a means to understand
better which venues are being used as part of a particular strategy.
Moreover, the Commission preliminarily believes that the three broad
categories should provide a means for customers to ascertain whether a
broker-dealer in the aggregate is handling its institutional orders
pursuant to its instructions. For example, if a customer instructs its
broker-dealer to use mostly passive order routing strategies, the
customer could use the institutional order handling report to monitor
the use of passive, neutral and aggressive order routing strategies
during the reporting period. Finally, the Commission preliminarily
believes that, notwithstanding the limitations on comparisons described
above, categorizing the proposed institutional order handling
information by these three strategies would allow a customer to compare
order routing strategies across its broker-dealers.
The Commission acknowledges that broker-dealers may want to prevent
other market participants from reverse engineering their proprietary
order routing strategies. Thus, the Commission is not proposing to
require broker-dealers to disclose detailed methodologies of their
order routing strategies. Rather, the Commission is proposing to
require broker-dealers to group their various order routing strategies
for institutional orders into three categories \141\--passive, neutral,
aggressive--which it preliminarily believes should provide valuable
transparency to customers while not disclosing proprietary aspects of a
broker-dealer's order routing strategies.
---------------------------------------------------------------------------
\141\ See id.
---------------------------------------------------------------------------
The Commission requests comment on its proposal that the customer-
specific institutional order handling report be categorized by venue
and order routing strategy category. In particular, the Commission
solicits comment on the following:
31. Do commenters believe that disclosure by venues and order
routing strategies would be useful to customers placing institutional
orders? Are there other ways to categorize the disclosures than by
venue and order routing strategies that would be more useful to
institutional customers? If so, please explain. Should the Commission
consider other methods in providing customer-specific institutional
order handling reports? If so, please explain the alternative approach
and provide data, if possible.
32. Do commenters believe that disclosure of order routing
strategies categorized by passive, neutral, and aggressive would be
useful? Should any of these proposed categories be modified or deleted?
Are there other categories of strategies that would be more meaningful?
Please explain and provide data to support your arguments.
33. Are broker-dealers able to classify their order routing
strategies into the three proposed strategy categories? Are there other
strategy categories that should be considered?
34. Do commenters believe that customers would have sufficient
information to meaningfully compare how their institutional orders were
handled by different broker-dealers in light of the fact that each
broker-dealer would establish its own categorization of routing
strategies?
35. Do commenters agree that potential inconsistencies of
categorization will only occur at the margins and grouping order
routing strategies by the three broad categories would still allow for
meaningful comparison of order handling practices across broker-
dealers?
36. Do commenters believe that broker-dealers would be able to
produce their order handling statistics in such a manner to favor one
strategy over another in an effort to enhance the perception of the
services provided? If so, should modifications or additions be made to
address this? Further, please explain and provide data, if possible.
37. Should the Commission further define the three order routing
strategies, and if so, how? Should routing strategies be defined at
all? If not, how should order handling practices be expressed to allow
for an effective comparison? Do commenters believe that there is
benefit in having the strategies listed if there is no common
definition among broker-dealers? Would the report still be useful to
customers placing institutional orders in
[[Page 49452]]
evaluating their broker-dealers, but not comparing broker-dealers?
Please support your arguments.
38. Are there other methodologies that the Commission should
consider that would allow institutional customers to meaningfully
compare order handling practices across broker-dealers? If so, please
explain and provide support, if possible.
39. Would the lack of a more precise definition for the three order
routing strategies affect the ability of broker-dealers to produce
automated reports?
40. Would the lack of a more precise definition impact the ability
of customers to compare order handling practices across broker-dealers?
41. Would disclosing information about the use of the three order
routing strategies potentially reveal broker-dealers' sensitive
proprietary information? Please be specific about what information and
the impact of disclosure.
42. Under the proposal, broker-dealers would be required to
document the specific methodologies they rely upon for making
assignments of institutional orders to the three order routing
strategies. Should these methodologies be made available, in the normal
course or upon request, to customers and/or the public? Would
disclosure of this information be useful to customers? When a broker-
dealer changes its methodology, should it be required to notify its
customers or the public of the change, and/or should it be required to
restate prior reports ``as if'' such new methodology had been in place?
Would such restatements be useful to customers or potential customers?
If so, how? Should such restatements be required for certain material
changes in methodology? If so, for which prior reports should
restatements be made (e.g., the most recently provided report)? Even if
the broker-dealer's methodology is not provided to customers or the
public, should they be notified if and when such methodology changes?
Why or why not? Please explain. Would transparency regarding the
methodologies create risks with respect to sensitive proprietary
information of the broker-dealers? If yes, please identify the specific
information linked to the risk.
43. Do commenters believe that the Commission should specify how
broker-dealers would address a misclassification of a particular order
routing strategy? If so, how should broker-dealers be required to
address the misclassification? For example, do commenters believe that
broker-dealers should be required to promptly provide corrected reports
to customers and the public? Similarly, should the Commission specify
how a broker-dealer would address situations in which it determines
that any data in a previously provided order handling report is
inaccurate? For example, do commenters believe that broker-dealers
should be required to promptly furnish corrected reports to customers
and/or promptly correct any publicly available reports? Why or why not?
Would the dissemination of corrected reports be useful to customers
placing institutional orders, and if so for which prior reports would
it be useful? Separately, do commenters believe that there should be a
materiality threshold for corrections to either the misclassification
of order routing strategies or any other inaccuracy in data provided?
If so, what would be an appropriate threshold? Please explain and
provide data to support your arguments, if possible. As an alternative
to a materiality standard, are there other measures that should
determine whether a misclassification or other inaccuracy would
necessitate a corrected report? For example, if the misclassification
or other inaccuracy could impede trend analysis, should that
necessitate a corrected report? Please explain.
4. Report Content
a. Information on the Customer's Order Flow With the Reporting Broker-
Dealer
The Commission also proposes that the report include information on
the customer's order flow with the broker-dealer. Specifically, the
Commission proposes to require disclosure of: (1) Total number of
shares of institutional orders sent to the broker-dealer by the
customer during the reporting period; (2) total number of shares
executed by the broker-dealer as principal for its own account; (3)
total number of institutional orders exposed by the broker-dealer
through an actionable IOI; and (4) venue or venues to which
institutional orders were exposed by the broker-dealer through an
actionable IOI.\142\ The Commission preliminarily believes that this
information would be useful for customers to evaluate how much order
flow the broker-dealer received from the customer during the reporting
period, the methods the broker-dealer used to achieve executions for
such order flow at the broker-dealer, the management of a broker-
dealer's conflicts of interests, and the risk of information leakage
associated with such methods.
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\142\ See proposed Rule 606(b)(3).
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The Commission preliminarily believes that it is important to
require disclosure of the total number of shares of institutional
orders sent to the broker-dealer by the customer during the reporting
period to allow the customer to more easily compare the number of
shares sent to the broker-dealer versus the number of shares routed by
the broker-dealer. As noted above, a broker-dealer often will route
orders numerous times, such that the aggregate order total may exceed
the total size of the customer's original order flow. Although the
information concerning institutional orders sent by the customer to the
broker-dealer should be known by the customer, providing the customer
with the amount of shares for the customer that the broker-dealer
received over the period covered by the report should put in context
other data provided in the institutional order handling report. Thus,
the Commission preliminarily believes that a broker-dealer should be
required to disclose the total number of shares of institutional orders
sent by the customer to the broker-dealer. Moreover, because many
customers use multiple broker-dealers to execute their institutional
orders, requiring each broker-dealer to disclose the total number of
shares of institutional orders sent by each customer would allow
customers to more readily understand how much of their order flow was
handled by a broker-dealer during the reporting period, which should
help customers in comparing the order handling reports of their various
broker-dealers.
The Commission further proposes that the report disclose the total
number of shares executed by the broker-dealer as principal.\143\ While
customers currently receive disclosure of the number of shares executed
by a broker-dealer as principal for each transaction pursuant to Rule
10b-10,\144\ the Commission preliminarily believes that including the
total number of shares executed by the broker-dealer as principal in
the institutional order handling report, which would be an aggregate
number of every transaction for the reporting period, would be useful
to the customer so that such data would be in the same report as the
other data the Commission is proposing to require for institutional
orders. Such disclosure would allow customers to understand how often a
[[Page 49453]]
broker-dealer trades against its institutional orders, and what order
routing strategies lead to this type of activity. The Commission
preliminarily believes that this data on the volume of institutional
orders interacting with the broker-dealer as principal could be
relevant to customers considering potential conflicts of interest their
broker-dealers face when trading as principal against their orders, and
their broker-dealers' compliance with best execution obligations.
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\143\ See proposed Rule 606(b)(3).
\144\ See 17 CFR 240.10b-10. Further, the Commission
preliminarily believes that it would be more efficient to require
broker-dealers to include this as a line item in the proposed
institutional order handling report than for customers to obtain
information from the proposed reports, obtain information from Rule
10b-10 required disclosures, and combine the two to perform
necessary analysis to evaluate order handling quality.
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The Commission also proposes to require disclosure of the total
number of institutional orders exposed by the broker-dealer through
actionable IOIs as well as the venue or venues to which such orders
were exposed. The Commission preliminarily believes that transparency
into the method of exposing an institutional order through the use of
actionable IOIs would provide useful information to customers. As
discussed above, the Commission understands that broker-dealers may use
actionable IOIs to attract trading interest from external liquidity
providers. For example, before a broker-dealer routes an institutional
order to another trading center, the broker-dealer may send an
actionable IOI to select external liquidity providers to communicate to
such liquidity providers to send orders to the broker-dealer to trade
with the institutional order that is represented by the actionable IOI
at the broker-dealer. While the use of actionable IOIs in this manner
by broker-dealers may be beneficial in executing institutional orders,
actionable IOIs also may reveal information that could be detrimental
to the execution quality of the institutional order. The Commission
preliminarily believes that identifying the total number of
institutional orders exposed by a broker-dealer though actionable IOIs
in the order handling disclosures \145\ should give customers a more
complete view of how their broker-dealers handle their institutional
orders and allow them to better evaluate how their broker-dealer
manages information leakage.
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\145\ See proposed Rule 606(b)(3)(i)(B).
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The Commission also proposes that broker-dealers disclose the venue
or venues that were sent actionable IOIs. Venues that receive the
actionable IOIs, such as external liquidity providers that trade
proprietarily, could, but are not required to, respond to the
actionable IOI by sending an order to the broker-dealer to execute
against the trading interest represented by the actionable IOI. The
Commission preliminarily believes that disclosure of institutional
orders routed to a venue would not, alone, adequately capture a broker-
dealer's order handling practices. As such, the Commission
preliminarily believes that disclosure of the specific venue or venues
that a broker-dealer exposed an institutional order by an actionable
IOI would be useful for the customer to further assess the extent, if
any, of information leakage of their orders and potential conflicts of
interest facing their broker-dealers. Specifically, the Commission
preliminarily believes that such information will enable customers to
assess whether their broker-dealers are exposing their institutional
orders to select market participants with affiliations, business
relationships, or other incentives.
The Commission seeks comment on the disclosure of the reporting
broker-dealer's information. In particular, the Commission solicits
comment on the following:
44. Do commenters believe that disclosing the total number shares
sent to a broker-dealer would be useful to customers placing
institutional orders? Why or why not?
45. Do commenters believe that disclosure of the total number of
shares executed by the broker-dealer as principal would facilitate
understanding the broker-dealer's ability to manage its best execution
obligations? Should additional or different information be required
regarding institutional orders that are executed by the broker-dealer
as principal? Please explain whether and how such additional or
different information would be useful.
46. Do commenters believe that disclosure of the total number of
shares executed by the broker-dealer as principal would be useful to
customers for purposes of evaluating conflicts of interest? Why or why
not?
47. Do commenters believe that the institutional order handling
report should disclose the total number of institutional orders exposed
through an actionable IOI? Is this data useful for customers to
evaluate their broker-dealers' institutional order handling practices?
Why or why not? Would such disclosure guide customers in better
understanding the potential of information leakage of their
institutional orders?
48. Do commenters believe that broker-dealers should disclose the
venues to which it sends actionable IOIs? Would this information help
customers understand how financial incentives or business relationships
might impact their orders? Would this information help customers
evaluate the risk of information leakage?
49. Do commenters believe there are other data points that would be
useful to customers that should be disclosed on institutional order
handling reports? If yes, please explain how such data would be useful
to customers.
b. Information on Order Routing
Within the venue and order routing strategy segmentations described
above, the Commission proposes to require disclosure of information
with respect to order routing.\146\ The Commission preliminarily
believes that information regarding order routing and the size of
orders routed, both the aggregate and average order size, would be
useful for customers to understand where and how their institutional
orders are being routed or exposed to assess the risk of information
leakage and any potential conflicts of interest on the part of their
broker-dealers. The Commission proposes to require, within each venue
and strategy category, disclosure of: (1) Total shares routed; (2)
total shares routed marked immediate or cancel (``IOC''); \147\ (3)
total shares routed that were further routable; and (4) average order
size routed.\148\
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\146\ See proposed Rule 606(b)(3).
\147\ An order marked IOC will execute immediately at a trading
center if liquidity is available at or better than the limit price
of the order or otherwise will be immediately canceled. See Concept
Release on Equity Market Structure, supra note 2, at 3607 n. 69.
\148\ See proposed Rule 606(b)(3)(i).
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Disclosing total shares routed \149\ for each of the required
categories would allow customers to readily compare the total shares
sent to the broker-dealer, as described above, with the total shares
routed by the broker-dealer, which would shed light on the number of
shares needed to be routed to fill the institutional orders as well as
the potential for information leakage. In addition, disclosing the
total shares routed to each venue in total as well as by order routing
strategy would provide a customer with information on which venues were
used in the process of executing its institutional orders, which
strategies were used for each venue, and the extent of such use. The
strategies disclosure, coupled with information on fill rates and fee
models as further described below, would allow customers to determine
whether its broker-dealers are routing orders consistent with the
customer's trading objectives. For example, if a broker-dealer routes a
significant portion of aggressive orders to a venue that pays a rebate
for removing liquidity and the broker-dealer receives a low fill rate
from that venue, the customer could ask the broker-dealer why it routes
orders seeking liquidity to a venue that rarely
[[Page 49454]]
executes those orders and whether doing so is consistent with the
customer's trading objectives.
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\149\ See proposed Rule 606(b)(3)(i)(A).
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The proposed rule would also require disclosure of the total number
of shares routed marked IOC,\150\ and the total number of shares routed
that were further routable.\151\ The Commission preliminarily believes
that requiring disclosure of these two order characteristics would
provide customers a greater understanding of the kind of order flow a
broker-dealer sends to each venue and how a broker-dealer uses a venue.
For example, orders that are marked IOC are orders that seek to access
liquidity at a venue rather than provide liquidity by posting to the
venue's book. If no contra side interest is available at the venue at
the order's limit price, the order will be canceled back to the broker-
dealer. A customer could compare the number of shares routed to a venue
marked as IOC with the total shares routed to a venue to understand
whether the broker-dealer allows its orders to rest on a venue's book
or is primarily seeking to access liquidity at a venue. The Commission
is also proposing to require that the broker-dealer disclose the total
shares routed that are marked IOC by order routing strategy, which
would highlight how the broker-dealer utilizes IOC orders in its
various order routing strategies. For example, a customer could assess
the rate at which a broker-dealer uses IOC orders by order routing
strategy and determine if such rate is consistent with its trading
objectives.
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\150\ See proposed Rule 606(b)(3)(i)(B).
\151\ See proposed Rule 606(b)(3)(i)(C).
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In addition, requiring the total shares routed that were further
routable would allow the customer to understand whether the broker-
dealer allows its orders to be routed by the venue to other venues.
Such ``re-routing'' of orders creates the potential for information
leakage every time an order is routed on to another venue. Moreover,
customers would be able to determine whether their broker-dealers are
in control of the routing of their orders or are relinquishing control
of order routing to another entity. In addition, disclosure by order
routing strategy would highlight how the broker-dealer utilizes
routable orders in its various order routing strategies. For example, a
customer could assess the rate at which a broker-dealer uses routable
orders by order routing strategy and determine if such rate is
consistent with its trading objectives.
Finally, the report would require the disclosure of average order
size routed.\152\ The Commission preliminarily believes that requiring
disclosure of the average order size routed would provide the customer
with information on the nature of a venue, how a venue is being used by
a broker-dealer, and possibly what type of participants use a
venue.\153\ For example, if the average order size routed to a venue is
relatively large, a customer may infer that the venue caters to market
participants that are willing to trade in larger size. In addition, a
customer could compare the average order size routed to a venue to the
average fill size at the venue, as described below, to assess the size
of orders routed relative to the potential execution. If the average
fill size is relatively equivalent to the average order size routed,
the customer may infer that the broker-dealer routed the order in a
manner that minimized information leakage. If the average order size
routed is greater than the average fill size, the customer may infer
that the broker-dealer needed to route the order multiple times to
receive full execution of the order. As noted in Section II.C.4., each
additional route of an order reveals information about that order and
such information leakage might cause prices to move in a less favorable
direction to the detriment of execution quality. In addition,
disclosure of average order size routed by order routing strategy for
each venue would allow a customer to better understand the size of
orders routed by strategy and determine if such size is consistent with
its trading objectives.
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\152\ See proposed Rule 606(b)(3)(i)(D).
\153\ See Laura Tuttle, Division of Economic and Risk Analysis,
SEC, OTC Trading: Description of Non-ATS OTC Trading in National
Market System Stocks, March 2014, available at http://www.sec.gov/marketstructure/research/otc_trading_march_2014.pdf (stating that
order and trade sizes can provide information on how a venue is
being used by traders, and possibly what type of participants use a
venue). The Commission notes that it recently proposed amendments to
regulatory requirements in Regulation ATS that would assist in
enabling customers to obtain further detail on the nature of certain
trading centers. See supra note 65.
---------------------------------------------------------------------------
The Commission requests comment generally on the order routing
information proposed in Rule 606(b)(3)(i). In particular, the
Commission solicits comment on the following:
50. Do commenters believe that disclosure of the four data points
(total shares routed, total shares routed marked immediate or cancel,
total shares routed that were further routable, and average order size
routed) as proposed in Rule 606(b)(3)(i)(A)-(D) by both venue and
strategy is useful? Should the four data points be defined? Are there
other factors or order life cycle audit trail information that should
be included in order routing information? Should some of the proposed
factors be modified or eliminated? If so, which one(s) and why?
51. Do commenters believe it is useful to customers to know the
total shares marked IOC and that were routed? Would the cancellation
rate of orders be useful to customers placing institutional orders? Are
there other order types for which disclosure should be required? If so,
which types and why? Should broker-dealers be required to disclose all
order types used to execute customer orders? Please explain.
52. Do commenters believe that orders that are not only routable,
but are in fact routed on should also be required to be disclosed?
Would such re-routing information be useful to customers in determining
whether their broker-dealers are in control of the routing of their
orders or are relinquishing control of order routing to another entity?
Do commenters believe that such re-rerouting information is retrievable
for broker-dealers? Why or why not?
c. Information on Order Execution
Within the venue and order routing strategy segmentations described
above, the Commission also proposes to require disclosure of
information with respect to order execution.\154\ The Commission
preliminarily believes that information regarding how institutional
orders are executed, including fees paid and rebates received for
executions, is important for customers to better understand and assess
broker-dealer performance. The Commission proposes to require
disclosure of: (1) Total shares executed; (2) fill rate; \155\ (3)
average fill size; \156\ (4) average net execution fee or rebate; \157\
(5) total number of shares executed at the midpoint; (6) percentage of
shares executed at the midpoint; (7) total number of shares executed
that were priced on the side of the spread more favorable to the
institutional order; (8) percentage of total shares executed that were
priced on the side of the spread more favorable to the institutional
order; (9) total number of shares executed that were priced on the side
of the spread less favorable to the institutional order; and (10)
percentage of total shares executed that were priced
[[Page 49455]]
on the side of the spread less favorable to the institutional
order.\158\
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\154\ See proposed Rule 606(b)(3)(ii).
\155\ Fill rate would be calculated by the shares executed
divided by the shares routed.
\156\ Average fill size would be the average size, by number of
shares, of each order executed on the venue.
\157\ The fee and rebate would be measured in cents per 100
shares, specified to four decimal places.
\158\ See proposed Rule 606(b)(3)(ii).
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Disclosing the total shares executed \159\ would provide customers
with the means to understand how much of its order flow was executed at
a particular venue and readily compare such information across venues.
In addition, since the institutional order handling report would also
be categorized by order routing strategy, disclosing the total shares
executed would provide customers with the means to understand how much
of its order flow was executed using passive, neutral, and aggressive
order routing strategies at each venue. Requiring broker-dealers to
disclose the total shares executed pursuant to order routing strategies
could provide customers with more detailed information than they may
currently receive from their TCA provider. Typically, third-party TCA
providers do not have access to routing information and therefore would
not be able to incorporate such information into their TCA offerings.
---------------------------------------------------------------------------
\159\ See proposed Rule 606(b)(3)(ii)(A).
---------------------------------------------------------------------------
The Commission preliminarily believes that disclosure of the fill
rate \160\ would show customers, on a percentage basis, how much of
their order flow was executed compared to how much of their order flow
was routed. While customers could compute the fill rate by dividing the
number of shares executed by the number of shares routed, the
Commission preliminarily believes that it is useful for the fill rate
to be disclosed in a separate column of information to allow customers
to readily compare fill rates without required computations. Such
execution information would provide customers the opportunity to assess
how effective a venue is in filling its institutional orders as well as
how effective particular order routing strategies are at the various
venues. The fill rate is an important piece of execution information
that helps customers in assessing execution quality received at a
trading center, given the customers' strategy. For example, if a
broker-dealer's aggressive order routing strategies routinely route to
a venue with a low fill rate, it could prompt a discussion between the
customer and the broker-dealer to understand the reasons why the
broker-dealer favors such a low fill rate venue when using such
strategies. While the broker-dealer may be able to explain its order
handling practices without the disclosed information, there is
currently very little transparency on the order handling decisions.
---------------------------------------------------------------------------
\160\ See proposed Rule 606(b)(3)(ii)(B).
---------------------------------------------------------------------------
The Commission notes that providing customers' fill rate and
average fill size \161\ at each venue would allow customers to assess
whether their broker-dealers are routing its orders to venues that can
effectively execute the order. This information could be particularly
useful to customers in comparing their fill rate to the average fill
size at each venue across its broker-dealers and across a particular
broker-dealer. For example, if a broker-dealer routinely routes orders
to a venue with low fill rates, the customer could request from its
broker-dealer more details regarding such venue, such as the existence
of any preexisting business relationship or affiliation. Further, if a
broker-dealer regularly routes orders with large average order size to
a venue with a high fill rate but a low average fill size, such
information may indicate to the customer that the broker-dealer might
not be routing the customer's institutional orders in a manner designed
to minimize information leakage, because the broker-dealer would need
to continue to route additional orders to fill the order. Moreover,
requiring the disclosure pursuant to order routing strategies would
result in greater transparency into order handling decisions.
---------------------------------------------------------------------------
\161\ See proposed Rule 606(b)(3)(ii)(C).
---------------------------------------------------------------------------
As proposed, the report would provide data on the average net
execution fee or rebate (cents per 100 shares, specified to four
decimal places).\162\ The average net execution fee or rebate would
disclose to customers potential economic incentives a broker-dealer
faces when handling institutional orders. Providing customers with
details on the economic incentives of broker-dealers at trading centers
would allow customers to more effectively assess any potential
conflicts of interest its broker-dealers face when routing its
institutional orders. For example, with such information, a customer
would be able to compare the average net execution fee or rebate on
particular venues in light of other order handling information at the
venues like the total shares routed and the fill rate. If a broker-
dealer routes a large number of shares to a venue with a low fill rate
but that venue provides a significant rebate for orders executed, a
customer may seek to inquire about the benefits of routing such a large
amount of order flow to that venue.
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\162\ See proposed Rule 606(b)(3)(ii)(D).
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The Commission acknowledges that, depending on the arrangement
between a broker-dealer and its institutional customer, a broker-dealer
may directly pass on execution fees and rebates to its institutional
customer. In such instance, any economic incentives to route orders to
certain trading centers would not present a potential conflict of
interest, as the broker-dealer would not be benefiting from receipt of
fees or rebates. The Commission preliminarily believes that a broker-
dealer that directly passes on execution fees or rebates to its
customers should nonetheless provide the average net execution fee or
rebate in the report so that, among other things, the customer has a
means to verify that no conflict of interest existed between the
broker-dealer and a particular trading center through comparing the
execution fees and rebates it received directly through its broker-
dealer to the average net execution fee or rebate disclosed in the
report.
Moreover, broker-dealers would be required to disclose the average
net execution fee or rebate by order routing strategy. Such disclosure
would allow customers to assess whether there are conflicts of interest
in the broker-dealer's routing decision. For example, if in connection
with an aggressive order routing strategy, the broker-dealer routinely
routes orders that remove liquidity to venues with rebates for removing
liquidity but a low fill rate, it may indicate to the customer that the
broker-dealer may not be acting consistent with the customer's trading
objectives.
The report would further disclose the total number of shares
executed at the midpoint and the percentage of shares executed at the
midpoint.\163\ Many trading centers offer users the ability to post
orders at the midpoint of the NBBO, and incoming marketable orders can
execute against such orders.\164\ Midpoint execution information would
provide a customer with greater information on the execution quality of
the venue and the type of liquidity resting at a venue. For example,
the midpoint is generally considered to be a higher quality execution
than the NBBO because both the buyer and the
[[Page 49456]]
seller receive price improvement over the best displayed price, and an
order at the midpoint generally has less impact on price since the
execution does not remove the best displayed price.\165\ Customers
would be able to examine when they receive midpoint price improvement
and at which venues. Coupled with the other required disclosures such
as the average net execution fee or rebate and fill rate, customers
could further assess the potential for conflicts of interest facing
their broker-dealers that may affect the broker-dealer's institutional
order routing practices. For example, if a broker-dealer routes a large
number of shares to a venue that provides a significant rebate for
orders executed but where the customer receives a low fill rate and a
low percentage of its shares executed at the midpoint, a customer may
seek to question the broker-dealer regarding the benefits of routing
such a large amount of order flow to that venue. As proposed, broker-
dealers would also be required to disclose the total number of shares
executed at the midpoint and the percentage of shares executed at the
midpoint by order routing strategy, which should allow customers
greater insights into which order routing strategies generate midpoint
executions and which venues are providing midpoint executions.
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\163\ See proposed Rule 606(b)(3)(ii)(E)-(F). The midpoint would
be the price halfway between the national best bid and national best
offer.
\164\ See, e.g., Rule 11.9(c)(9) of the Bats BZX Exchange, Inc.
(``Bats BZX'') (defining Midpoint Peg Order); Rule 4702(d) of The
NASDAQ Stock Market LLC (defining Midpoint Pegging); Robert P.
Bartlett, III and Justin McCrary, Dark Trading at the Midpoint:
Pricing Rules, Order Flow and Price Discovery (February 12, 2015)
(``Bartlett and McCrary Paper''), available at http://www.stern.nyu.edu/sites/default/files/assets/documents/2%20Bartlett%20and%20McCrary%20Shall%20We%20Haggle.pdf (describing
midpoint trading on non-exchange venues).
\165\ See, e.g., Bartlett and McCrary Paper, supra note 164
(stating that midpoint of the NBBO is a form of trading that is
generally considered to have significant benefits for institutional
investors).
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The report would also require disclosure of the total number and
percentage of shares executed that were priced on the side of the
spread more favorable to the institutional order and the total number
and percentage of shares executed that were priced on the side of the
spread less favorable to the institutional order.\166\ Information with
respect to which side of the spread orders executed on would help
customers assess the execution quality their institutional orders
received, which in connection with the order routing strategy
disclosures and the fees and rebates disclosures, would allow customers
to better evaluate the performance of its broker-dealers. For example,
if the customer's strategy is to be passive, but its broker-dealer is
frequently routing orders to a venue or venues that are taking
liquidity at the side of the spread less favorable to the institutional
order, then the customer could further inquire about the broker-
dealer's rationale for routing to such venue. The Commission
preliminarily believes that requiring these granular details of how
institutional shares are executed should provide customers with more
information to evaluate the quality of their broker-dealers' order
handling services.
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\166\ See proposed Rule 606(b)(3)(ii)(G)-(J).
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Comment is generally requested on order execution information as
proposed in Rule 606(b)(3)(ii). In particular, the Commission solicits
comment on the following:
53. Should any of the terms in proposed Rule 606(b)(3)(ii) be
defined? Should the information proposed to be required be modified in
any way, should additional information related to order execution be
required, or should any proposed requirement be omitted? Please
explain.
54. Do commenters believe that the required order execution
information would be useful to institutional customers? Please explain
with respect to each of the proposed institutional order disclosure
categories.
55. Do commenters believe that disclosures regarding fill rates and
average fill size would assist institutional customers in understanding
how much of their orders are executed at a venue versus routed on to
another venue? Are there other data that would be useful in analyzing
order execution?
56. Would disclosures related to execution fees and rebates be
useful to institutional customers? Would this information support an
evaluation of a broker-dealer's potential economic incentives and/or
conflicts of interest to route and/or execute orders at a particular
venue? Please provide support for your arguments.
57. Do commenters believe that the total number and percentage of
shares executed at the midpoint indicate higher quality executions?
Would this information be useful to customers interested in examining
their institutional order execution quality? Please explain.
58. Do commenters believe that information on the shares executed
on the side of the spread favorable or less favorable to the
institutional order would be useful to institutional customers in
analyzing their broker-dealer's order handling practices? What other
order execution data, if any, would be useful to customers? Would
information on shares executed against displayed or undisplayed
liquidity be useful? Should any of the proposed requirements be
modified or eliminated? If so, which ones and why? Please provide
support for your arguments.
59. Do commenters believe that the proposed data points outlined
above would provide customers with meaningful information? Would the
proposed disclosures allow customers to better assess the execution
quality of their broker-dealer? Would the report further permit
customers to compare execution quality among multiple broker-dealers
across the market? Would the report, as proposed, allow customers to
more easily monitor for best execution?
d. Information on Orders That Provided Liquidity
In addition to the order routing and execution data detailed above,
the Commission proposes to require disclosure of information on
institutional orders that provided liquidity within the venue and order
routing strategy segmentations described above.\167\ In connection with
this new requirement, the Commission proposes to define the term
``orders providing liquidity'' to mean ``orders that were executed
against after resting at a trading center.'' \168\ Generally, orders
providing liquidity are submitted as non-marketable limit orders and
are kept in a limit order book awaiting execution. The Commission
preliminarily believes that by defining ``orders providing liquidity''
and ``orders removing liquidity'' (described in more detail below),
broker-dealers would be able to classify orders pursuant to a
standardized description for disclosure purposes.
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\167\ See proposed Rule 606(b)(3)(iii).
\168\ See proposed Rule 600(b)(55).
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The Commission preliminarily believes that disclosure of
information on institutional orders that provided liquidity is
important for customers to better understand to which venues the
broker-dealer routes liquidity providing orders, how long it takes to
execute such orders at each venue, and the fees paid to or rebates
received by the broker-dealer at each venue for liquidity providing
orders. The Commission proposes to require disclosure of: (1) Total
number of shares executed of orders providing liquidity; (2) percentage
of shares executed of orders providing liquidity; (3) average time
between order entry and execution or cancellation for orders providing
liquidity (in milliseconds); and (4) the average net execution rebate
or fee for shares of orders providing liquidity (cents per 100 shares,
specified to four decimal places).\169\
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\169\ See proposed Rule 606(b)(3)(iii).
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The information on orders that provided liquidity would include the
total number of shares executed of orders providing liquidity and the
[[Page 49457]]
percentage of shares executed of orders providing liquidity.\170\ The
Commission preliminarily believes that the total number of shares
executed of institutional orders providing liquidity would inform an
institutional customer of how much of its order flow provided liquidity
at each venue and by order routing strategy. Such information is
important for an institutional customer to understand how a broker-
dealer is implementing its order execution and routing strategies and
at what venues. The Commission also preliminarily believes that the
percentage of shares executed of orders providing liquidity would be
useful for an institutional customer to readily assess the amount of
shares that provided liquidity at a venue in comparison to the total
number of shares executed at the venue. Since broker-dealers would also
be required to disclose this information by order routing strategy,
institutional customers would have further data to better understand
and analyze how a broker-dealer routes orders for various strategies
and the potential effect on execution quality.
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\170\ See proposed Rule 606(b)(3)(iii)(A)-(B).
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The institutional order handling report also would require data on
the average time between order entry and execution or cancellation for
orders that provided liquidity prior to execution or cancellation.\171\
The average time between order entry and execution or cancellation for
orders that provided liquidity would be measured in milliseconds,
which, due to the speed of trading in today's equity markets, the
Commission preliminarily believes is an appropriate measure. Disclosing
the average length of time orders rest at venues before they are either
executed or canceled could provide insight into how a broker-dealer
utilized venues when seeking to execute institutional orders,
specifically how long orders rest on order books before receiving an
execution or being canceled and sent back to the broker-dealer for
further handling. The Commission preliminarily believes that depending
on the order routing strategy, the average length of time that orders
are posted to a venue, and thus providing liquidity, could help
indicate empirically whether the broker-dealer is appropriately
implementing a customer's desired order routing strategy. For example,
if a customer wanted its broker-dealer to handle its institutional
order using a neutral order routing strategy, such strategy would
generally seek to provide liquidity and not aggressively cross the
spread, but speed of execution would still be of relative concern. A
venue that pays a significant rebate for shares of orders providing
liquidity would most likely have a deep book as many liquidity
providing orders would post on that venue's book in order to receive
the rebate. Due to the depth of book, the likelihood of receiving an
execution for a liquidity providing order on that venue could be low
and the average time between order entry and execution or cancellation
for orders that provided liquidity could be relatively long. In
combination with the average net execution rebate or fee for shares
that provided liquidity, described below, customers could use the
average time between order entry and execution or cancellation for
orders being posted at that venue to assess how their broker-dealers
are implementing order routing strategies or whether their broker-
dealers may be influenced by the high rebate at such venue, in conflict
with the customer's interests.
---------------------------------------------------------------------------
\171\ See proposed Rule 606(b)(3)(iii)(C).
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The report would also contain the average net execution rebate or
fee for shares of orders providing liquidity.\172\ The Commission
proposes that the average net execution rebate or fee would be
calculated in cents per 100 shares, specified to four decimal places,
to correspond to current industry execution rebate and fee practices
\173\ and to ensure consistency in reporting among broker-dealers.\174\
The Commission preliminarily believes that disclosing the average net
execution rebate or fee for shares of orders providing liquidity at
each venue and by order routing strategy would allow customers to
assess potential conflicts of interest from economic incentives facing
their broker-dealers with regard to the venues to which broker-dealers
route orders and the order routing strategies that use those venues.
For example, if a broker-dealer routes orders that provide liquidity to
the venues with the highest rebate, and orders that remove liquidity to
the venues with the lowest take fee, a customer could then examine the
fill rates at those venues to determine whether there is potential for
conflicts of interest with respect to the broker-dealer's own economic
interest.\175\ The Commission preliminarily believes that this
information will be useful for customers to understand, and assess the
potential effect of, economic incentives on execution quality.
---------------------------------------------------------------------------
\172\ See proposed Rule 606(b)(3)(iii)(D).
\173\ See, e.g., Bats BZX Exchange, Inc. Fee Schedule, available
at http://www.batstrading.com/support/fee_schedule/bzx/; Rule 7018
of The NASDAQ Stock Market LLC, available at http://nasdaq.cchwallstreet.com/NASDAQTools/PlatformViewer.asp?selectednode=chp%5F1%5F1%5F4%5F6&manual=%2Fnasdaq%2Fmain%2Fnasdaq%2Dequityrules%2F (pricing execution fees and rebates
to four decimal places).
\174\ See proposed Rule 606(b)(3)(iii)(D).
\175\ Typically, broker-dealers pay fees and receive rebates
that result from routing orders of retail customers. For orders from
institutional customers, it depends on the arrangement between an
institutional customer and a broker-dealer: the broker-dealer may
pay fees and receive rebates that result from routing orders of the
institutional customer, or the broker-dealer may pass those fees and
rebates through to the institutional customer. In the case where a
broker-dealer passes the fees and rebates through to the customer,
there would not be potential conflicts of interest in the broker-
dealer's order routing decisions with respect to fees and rebates.
---------------------------------------------------------------------------
The Commission requests comment on the disclosure requirements
pertaining to institutional orders that provide liquidity as proposed
in Rule 606(b)(3)(iii). In particular, the Commission solicits comment
on the following:
60. The Commission proposes to define ``orders providing
liquidity.'' Do commenters believe that this term should be defined? Is
the proposed definition useful to broker-dealers in categorizing an
order for reporting purposes? Should it be modified in any way,
including adding additional criteria? Why or why not?
61. Do commenters believe that the total number of shares executed
of orders providing liquidity is the appropriate data to inform
customers how much of its order flow provided liquidity? Are there
other data factors that the Commission should consider?
62. Does the percentage of shares executed of orders providing
liquidity provide information customers could use to evaluate how a
broker-dealer is implementing its order execution and routing
strategies and at what venues? Would this information be useful to
customers in analyzing and potentially modifying their trading
instructions or choosing a broker-dealer for order routing and
execution services?
63. Do commenters believe that the average time between order entry
and execution or cancellation (measured in milliseconds) for orders
providing liquidity will be an appropriate measure of whether the
broker-dealer is implementing a customer's order instructions? If not,
why not? Do commenters believe that the ``average'' is the appropriate
measure to gauge the amount of time an order is resting on the book?
What are alternative data points or measurements that would achieve the
same goal? Separately, is milliseconds an appropriate measure? If not,
what would be more appropriate? Are there other time measures and/or
data that would be useful to institutional customers in evaluating
[[Page 49458]]
whether the broker-dealer is implementing their order instructions? If
so, please explain and provide data to support your argument.
64. Do commenters believe that disclosing the average net execution
rebate or fee for shares of orders providing liquidity at each venue
and by order routing strategy would be useful in assessing potential
conflicts of interest broker-dealers may face with regard to routing
venues and the order routing strategies that use those venues?
65. Do commenters believe that specifying the average net execution
fee or rebate to four decimal places is appropriate? If not, to what
level of precision should the fee or rebate be specified? Please
explain and provide data for your argument.
e. Information on Orders That Removed Liquidity
Similarly to orders that provided liquidity, the Commission
proposes to require the disclosure of information on institutional
orders that removed liquidity within the venue and order routing
strategy segmentations described above.\176\ Related to this new
disclosure, the Commission proposes to define the term ``orders
removing liquidity'' to mean ``orders that executed against resting
trading interest at a trading center.'' \177\ Generally, orders that
remove liquidity are marketable orders that are immediately executable
when routed to a venue and execute against and remove orders that are
resting on a trading center's order book. The Commission preliminarily
believes that the defined term should reduce any potential broker-
dealer confusion when distinguishing orders for reporting purposes and
would allow all broker-dealers to more consistently designate certain
orders as orders removing liquidity.
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\176\ See proposed Rule 606(b)(3)(iv).
\177\ See proposed Rule 600(b)(56).
---------------------------------------------------------------------------
The Commission preliminarily believes that disclosure of
information on institutional orders that removed liquidity will be
useful for customers to understand which venues their broker-dealers
route liquidity removing orders to and the fees paid or rebates
received at each venue for such orders. The Commission proposes to
require disclosure of: (1) Total number of shares executed of orders
removing liquidity; (2) percentage of shares executed of orders
removing liquidity; and (3) average net execution fee or rebate for
shares of orders removing liquidity (cents per 100 shares, specified to
four decimal places).\178\
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\178\ See proposed Rule 606(b)(3)(iv)(A)-(C).
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As proposed, the report would require data on the total number of
shares executed and the percentage of shares executed of orders
removing liquidity.\179\ The Commission preliminarily believes the
number of shares and the percentage of shares executed that removed
liquidity at each venue would allow the customer to understand how much
of its total institutional orders removed liquidity at a particular
venue, as well as by order routing strategy. Coupled with the
information on fill rates, customers could assess the risk of
information leakage and the potential effect of the broker-dealer's
routing practices on execution quality. For example, many market
participants monitor their and other bids and offers for executions.
When an execution occurs on one venue, market participants may adjust
their bids or offers on other venues to take into account that there
may be more trading interest to follow, which could result in prices
moving away from the institutional order and ultimately resulting in
the institutional order receiving a worse overall price for the full
size of the institutional order. Indeed, the risk of information
leakage and its potential negative impact on execution quality may be
significant, if a broker-dealer routinely routes orders removing
liquidity to a venue with insufficient liquidity to fill the orders.
Using the proposed disclosures, customers could assess whether their
broker-dealers routed their institutional orders that removed liquidity
in the most effective manner to reduce the potential that prices move
against the institutional order.
---------------------------------------------------------------------------
\179\ See proposed Rule 606(b)(3)(iv)(A)-(B).
---------------------------------------------------------------------------
The institutional order handling report also would require
disclosure of the average net execution fee or rebate for shares of
orders that removed liquidity. Parallel to the information on orders
providing liquidity, the average net execution fee or rebate for orders
removing liquidity would be calculated in cents per 100 shares,
specified to four decimal places, to correspond to current industry
practice and to ensure consistency in reporting among broker-
dealers.\180\ Additionally, similar to the information on orders
providing liquidity, this information would allow customers to examine
the venues chosen by their broker-dealers, the order routing strategies
used, and the economic interests motivating such choices. If a broker-
dealer routinely routes orders that remove liquidity to a venue that
pays a rebate to the broker-dealer or charges the lowest fee, the
customer could examine whether there is a conflict of interest that
affects how the broker-dealer handles its institutional orders, and if
so, whether that conflict of interest has a negative impact on
execution quality.
---------------------------------------------------------------------------
\180\ See proposed Rule 606(b)(3)(iv)(C).
---------------------------------------------------------------------------
The Commission requests comment on disclosures for institutional
orders that remove liquidity as proposed in Rule 606(b)(3)(iv). In
particular, the Commission solicits comment on the following:
66. The Commission proposes to define ``orders removing
liquidity.'' Do commenters believe that this term should be defined? Is
the proposed definition useful to broker-dealers in categorizing an
order for reporting purposes? Should it be modified in any way,
including adding additional criteria? Why or why not?
67. Do commenters believe that the total number of shares executed
of orders removing liquidity is the appropriate data to inform
customers how much of its order flow removed liquidity? Are there other
data factors that the Commission should consider?
68. Does the percentage of shares executed of orders removing
liquidity provide information customers could use to evaluate how a
broker-dealer is implementing its order execution and routing
strategies and at what venues? Would this information be useful to
customers in analyzing and potentially modifying their order
instructions and/or choosing a broker-dealer for order routing and
execution services?
69. Do commenters believe that the average net execution fee or
rebate for shares of orders removing liquidity at each venue and by
order routing strategy would be useful in assessing potential conflicts
of interest broker-dealers may face with regard to routing venues and
the order routing strategies that use those venues?
70. Do commenters believe that specifying the average net execution
fee or rebate to four decimal places is appropriate? To what level of
precision should the fee or rebate be specified? Please explain and
provide data for your argument.
5. Public Report for Institutional Orders
The institutional order handling disclosures, described above,
would provide detailed information to a requesting customer with regard
to how all of its institutional orders were handled by a broker-dealer,
broken down by calendar month. The Commission preliminarily believes
that a publicly disclosed aggregated report (aggregating all customer
information) could provide additional transparency into the broader
institutional order
[[Page 49459]]
handling practices of broker-dealers, which could, in turn, allow for
more efficient and effective comparisons of the quality of services
offered by broker-dealers. As noted above, in today's complex equity
markets, it may be difficult for customers to assess the order handling
services of multiple broker-dealers without standardized order handling
disclosures, particularly the services of broker-dealers with which
they do not have a relationship.
The Commission preliminarily believes that aggregated public
disclosure of the information contained in the customer-specific
institutional order handling reports, described above, would be useful
to institutional customers and other market participants to determine
whether to engage the services of a broker-dealer as well as the
ability to gauge the adequacy of the services performed by a broker-
dealer. The public disclosure by broker-dealers of aggregated
institutional order handling information should promote competition as
broker-dealers may seek to differentiate their services and expertise
in an effort to retain current customers and attract the business of
prospective customers. Indeed, the Commission preliminarily believes
that public disclosure of institutional order handling information by
each broker-dealer would provide market participants with useful
information and could bring competitive forces to bear on broker-dealer
institutional order handling services. Accordingly, the Commission
preliminarily believes that aggregated public institutional order
handling reports would increase the overall transparency of
institutional order handling practices to the benefit of customers and
the marketplace as a whole.
The Commission proposes to require a broker-dealer that receives
institutional orders to make publicly available \181\ a report that
aggregates the information required for customer-specific institutional
order handling reports, described above, for all institutional orders
it receives.\182\ Broker-dealers would be required to make such report
publicly available for each calendar quarter, broken down by calendar
month, within one month after the end of the quarter.\183\ This public
aggregated institutional order handling report would be mandatory for
all of the institutional orders that a broker-dealer handles within a
calendar quarter regardless of whether any of its customers request
customer-specific institutional order handling reports.
---------------------------------------------------------------------------
\181\ The Commission notes that ``make publicly available'' is
defined in Rule 600(b)(36) of Regulation NMS to mean ``posting on an
Internet Web site that is free and readily accessible to the public,
furnishing a written copy to customers on request without charge,
and notifying customers at least annually in writing that a written
copy will be furnished on request.'' See 17 CFR 242.600(b)(36).
\182\ See proposed Rule 606(c).
\183\ See id.
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Similar to the customer-specific institutional order handling
reports required under proposed Rule 606(b), the public aggregated
institutional order handling report would be made available using an
XML schema and associated PDF renderer to be published on the
Commission's Web site.\184\ The Commission preliminarily believes that
requiring the public aggregated institutional order handling reports be
provided in this format would be useful to customers as it would allow
them to more easily analyze and compare the data provided in both types
of reports, for the reasons discussed above, and would allow market
participants generally to analyze and compare broker-dealer
institutional order handling practices.\185\
---------------------------------------------------------------------------
\184\ See supra Section II.A.3.
\185\ See id.
---------------------------------------------------------------------------
In addition, the Commission proposes to require that broker-dealers
keep such public aggregated institutional order handling reports posted
on an Internet Web site that is free and readily accessible to the
public for a period of three years from the initial date of posting on
the Internet Web site.\186\ The Commission preliminarily believes that
making this historical data available to customers and the public
generally will be useful to those seeking to analyze past order
handling behavior of a broker-dealer or across multiple broker-dealers.
To further support customers' usage of the public aggregated
institutional order handling reports, the Commission notes that it
would be incumbent upon the broker-dealer to maintain accurate order
handling data during the three year period.
---------------------------------------------------------------------------
\186\ The Commission notes that it is proposing similar
reporting format and accessibility requirements for quarterly
reports on retail order routing in Rule 606(a)(1), which is
discussed in more detail in Section III.B.4. below.
---------------------------------------------------------------------------
The Commission recognizes that broker-dealers have proprietary
methods for order handling, and is cognizant of the sensitive nature of
such business practices and intellectual property. The Commission
preliminarily believes that the risk of exposing sensitive proprietary
information on the broker-dealers' order handling techniques would be
minimal due to the structure of the proposed report and by aggregating
the information to be publicly disclosed. Like the proposed customer-
specific institutional order handling reports, the proposed public
aggregated institutional order handling report would aggregate a
broker-dealer's order handling information for all NMS stocks for the
reporting period, and, therefore, the Commission preliminarily believes
other market participants would not be able to ascertain which
particular securities were routed during the reporting period.
Additionally, as routing decisions are generally dependent on the
market for the particular security at the time of routing, the
Commission preliminarily believes that public aggregated institutional
order handling reports for the prior calendar quarter would not provide
other market participants, including a broker-dealer's competitors,
sensitive information about a broker-dealer's order handling
techniques.
Further, while the public aggregated institutional order handling
report would provide information on the venues to which a broker-dealer
routed its institutional order flow as well as the three categories of
order routing strategies used to route those orders, the report would
not provide any information about the manner or sequence in which those
orders were routed to the venues. For example, the report would not
disclose whether the broker-dealer routed orders sequentially or
simultaneously to multiple trading centers in order to fully execute an
institutional order, or the sequence in which such orders were routed
to trading centers. Because such information is essential to
effectively reverse engineer an order routing algorithm, the Commission
preliminarily believes that the proposed public aggregated
institutional order handling information would not provide other market
participants with the information to reverse engineer a broker-dealer's
proprietary order handling techniques, regardless of the number of
orders a broker-dealer routes or the number of institutional customers
for which a broker-dealer routes orders during the reporting period.
Accordingly, the Commission preliminarily believes that information
contained in the proposed public aggregated institutional order
handling report should provide appropriate safeguards for broker-
dealers' current business practices, while, at the same time, providing
meaningful information for customers and others to compare broker-
dealers' order routing services.
The Commission also preliminarily believes that the risk of
exposing sensitive customer-specific information would be minimal due
to the structure of the proposed report and by aggregating the
information to be
[[Page 49460]]
publicly disclosed. As noted above, the proposed public aggregated
institutional order handling report would aggregate order handling
information for all NMS stocks for the reporting period and would not
disclose the customers of the broker-dealer. To the extent a broker-
dealer only had one or a few institutional customers to which it
provided routing services, market participants could presume a
customer's orders were included in the public aggregated institutional
order handling report, but only to the extent the market participants
knew of the routing relationship. However, even if a market participant
is aware of such routing relationship, because the proposed public
aggregated institutional order handling report would not disclose the
specific securities routed and the historical data would reflect only
previous calendar quarters, the Commission preliminarily believes that
public disclosure would not expose sensitive information of the
institutional customers.
The Commission understands that many customers currently request
information about a broker-dealer's order handling practices before
engaging its services.\187\ Generally, these requests are
questionnaires regarding order routing strategies used by the broker-
dealer and the venues to which the broker-dealer routes orders.\188\
The Commission understands that the information requested in the
questionnaires and the responses provided are generally not uniform,
and, therefore, not readily comparable across multiple broker-dealers.
While customers would continue to be able to use their specific
questionnaires, the Commission preliminarily believes that a
standardized report reflecting the order handling information for all
of a broker-dealer's institutional orders for the past calendar quarter
would greatly enhance their ability to understand how the broker-dealer
routes and executes institutional orders and would also allow them to
compare the execution quality of their orders against the execution
quality of all of a broker-dealer's institutional orders. In addition,
the standardized structure of the public aggregated institutional order
handling report would provide all customers, regardless of size or
sophistication, with the means to compare and contrast how broker-
dealers implement passive, neutral, and aggressive order routing
strategies, and the quality of executions received with respect to such
strategies.
---------------------------------------------------------------------------
\187\ See TM Memo re Morgan Stanley I, supra note 43.
\188\ See id.
---------------------------------------------------------------------------
Moreover, the public disclosure of aggregated institutional order
handling information would provide academics and others, including
third-party vendors offering analytical services, access to order
routing and execution information that would not otherwise be
available.
Finally, the Commission notes that the proposed public aggregated
institutional order handling reports differ from the current reports on
retail order routing required pursuant to Rule 606(a).\189\ The
Commission preliminarily believes that such distinction is appropriate
because institutional orders are generally large and may be complex, in
contrast to retail orders that are of smaller size, utilize different
routing strategies, and which typically have less impact on the market.
Specifically, due to the large size of institutional orders, it may be
difficult to fully fill the orders by executing against displayed bids
or offers resting on a trading center. Instead, institutional orders
are often broken up into child orders, routed to multiple trading
centers, and filled at multiple price levels which may result in
potential information leakage \190\ and unfavorable price movement to
the institutional order.\191\ As such, broker-dealers often employ more
complex order routing strategies when handling institutional orders to
reduce the potential information leakage and unfavorable price
movement.\192\ Conversely, marketable retail orders are generally
internalized by broker-dealers at prices at or slightly better than the
NBBO, with very little risk of information leakage and impact on the
market. If not internalized, retail orders, due to their smaller size
are typically routed to a single trading center and fully executed.
While the potential for information leakage of a retail order is low,
even if order information is exposed, there is little influence on the
retail order as it would likely already be fully executed. Due to these
differences, the Commission preliminarily believes that because retail
orders are not subjected to similar risks of potential information
leakage and disadvantageous price impact as with institutional orders,
the use of the proposed aggregated reporting of information for
institutional orders--including order routing and execution and orders
providing and removing liquidity--to among other things, monitor
broker-dealers' management of these risks would not be pertinent for
retail orders.
---------------------------------------------------------------------------
\189\ Rule 606(a) currently requires the reporting of the
percentage of total orders that were non-directed orders, and the
percentages of total non-directed orders that were market orders,
limit orders, and other orders, the percentages of such orders
routed to the Specified Venue, and a discussion of the material
aspects of the broker-dealer's relationship with each Specified
Venue (including a description of any arrangement for payment for
order flow and any profit-sharing relationship). See 17 CFR
242.606(a)(1).
\190\ See Bunge Article, supra note 69.
\191\ See Bartlett and McCrary Paper, supra note 164, at 5
(discussing order size and its relation to price impact).
\192\ See Concept Release on Equity Market Structure, supra note
2, at 3602.
---------------------------------------------------------------------------
The Commission requests comments on information contained in the
public aggregated institutional order handling reports by broker-
dealers. In particular, the Commission solicits comment on the
following:
71. Do commenters believe that aggregated institutional order
handling information being publicly disclosed would be useful to
institutional customers and other market participants? Who would it be
useful to and in what ways?
72. Do commenters believe that the aggregated institutional order
handling information proposed by Rule 606(c) should be disclosed for
both retail and institutional orders, rather than only for
institutional orders as proposed? Why or why not? Please provide
support for your argument.
73. Should the public aggregated institutional order handling
report include all the data points enumerated in proposed Rule
606(b)(3)(i)-(iv)? Why or why not? If not, which data points should be
excluded or modified? Are there other data points the Commission should
consider that would be useful to customers and the public? Please
explain and provide data, if possible.
74. Do commenters believe that broker-dealers should be required to
provide the public aggregated institutional order handling report in
the proposed format? Why or why not? Do commenters believe that
providing the report in a structured XML format will facilitate
comparison of the data across broker-dealers? If not, why not? Do
commenters believe that a structured XML format would be useful to
customers and other market participants, and if so how? What
incremental costs or savings would broker-dealers incur in providing
the report in a structured XML format? Should the Commission consider
alternative formats? If so, please explain the alternative formats and
associated benefits and costs. Do commenters believe that it would be
useful for broker-dealers to also provide the report in an instantly
readable PDF format? If not, why not? Are there other formats
[[Page 49461]]
that would be more appropriate? If so, please explain the alternative
formats and benefits and costs.
75. Do commenters believe that the rule should include a de minimis
exemption for broker-dealers that receive, in the aggregate, less than
a certain threshold number or dollar value of institutional orders? Why
or why not? If so, what would be the appropriate threshold number or
dollar value of institutional orders a broker-dealer should need to
receive from all customers in the aggregate before it would be required
to provide the public order handling reports? Please explain.
Separately, are there alternative approaches to reduce the compliance
costs on broker-dealers with few institutional customers? Please
provide data to support your arguments.
76. Regarding broker-dealers with a small number of institutional
customers, do commenters believe there is a potential risk of exposing
the customer's sensitive, proprietary information in an aggregated
report? Should the Commission make any modifications to the proposed
disclosures or eliminate any or all of the proposed requirements under
certain circumstances? If so, what is the appropriate measure? Please
provide support for your argument.
77. Do commenters believe that a broker-dealer that routes less
than a certain number of orders should be exempt from the public
disclosure requirement? Why or why not? What is an appropriate
threshold for this potential exemption? Separately, are there
alternative approaches to reduce the compliance costs on broker-dealers
who route and execute few institutional orders? Please provide data to
support your arguments. What information, if any, should the broker-
dealer be required to provide to customers and/or the public if it
relies on the potential exemption?
78. Do commenters believe that the public reports would be useful
to customers and the public in comparing the quality of services
offered by broker-dealers? Do commenters believe that public disclosure
of aggregated institutional order handling information will enhance
competition among broker-dealers?
79. Do commenters believe that publicly releasing aggregated
institutional order handling reports on a quarterly basis is
appropriate? Should the report be publicly disclosed at a different
interval, such as monthly? Please explain.
80. Do commenters believe that the requirement that the reports be
broken down by calendar month is useful? Should the report be broken
down with a different interval(s)? Please explain.
81. Do commenters believe that the aggregated institutional order
handling information will be stale if published one month after the end
of the quarter? Should the disclosures be available earlier or later?
Please explain.
82. Will aggregating the information being publicly disclosed
mitigate the risk that the disclosure will reveal sensitive,
proprietary information about the broker-dealer's order handling
practices? Will it mitigate the risk that the disclosure will reveal
sensitive proprietary information about customers' trading strategies?
Why or why not? Are there alternative approaches to protecting such
information while still requiring the public disclosure of meaningful
order handling information? Are there other benefits or risks
associated with publicly disclosing aggregated institutional order
handling information?
83. Should the Commission require that each quarterly report be
publicly available for a designated amount of time? If so, is three
years a reasonable amount of time that the reports should be available?
Would a shorter or longer period be more appropriate? How, if at all,
would a shorter or longer disclosure period impact investors placing
orders or broker-dealers? Please explain.
84. Should the Commission require all broker-dealers to make their
aggregated institutional order handling reports available on one
centralized Web site? For example, should all broker-dealer reports be
available on the SEC's Web site? Alternatively, should the SEC's Web
site have hyperlinks to the Web sites of broker-dealers where they
display their aggregated reports? Why or why not?
85. As proposed, broker-dealers would be required to ``make
publicly available,'' as defined in Rule 600(b)(36) of Regulation NMS,
their aggregated public institutional order handling reports, which
means, among other things, that such reports must be posted on an
Internet Web site that is free and readily accessible to the public. Do
commenters believe that broker-dealers might place restrictions on or
impediments to obtaining the reports from their own Web sites, such as
requiring agreement with certain terms, conditions, or provisions prior
to being provided access to the reports? If so, what would be the costs
and benefits of those restrictions or impediments? Please explain.
86. Should the Commission require that the aggregated institutional
order handling reports be filed with or furnished to the SEC? Should
the Commission require that the individual order handling reports
provided to customers with institutional orders be filed with or
furnished to the SEC? Why or why not?
B. Disclosures for Retail Orders
As noted above, changes to market structure and order routing
practices have led the Commission to analyze the current requirements
for retail orders under Rule 606. Currently, Rule 606 reports allow
customers to assess order routing and execution services of broker-
dealers with respect to retail orders. Additionally, the Rule 606
reports are used by broker-dealers as a means to compare their order
routing and execution services to that of other firms.\193\ Some market
participants have stated that public disclosure of meaningful data in
Rule 606 reports can assist broker-dealers in evaluating their own
trade execution performance relative to other firms.\194\ The
Commission preliminarily believes that Rule 606 reports spur
competition among broker-dealers to provide enhanced order routing
services and better execution quality, which in turn motivates trading
centers to deliver more efficient and innovative execution services as
they compete for order flow. The Commission preliminarily believes that
investors ultimately benefit from such enhanced competition, as broker-
dealers continually seek to enhance their order routing and execution
services to achieve better execution quality for their customers and to
attract business from prospective customers.
---------------------------------------------------------------------------
\193\ See, e.g., NASDAQ Letter, supra note 19, at 20-21 (stating
that, despite the fact that retail investors do not review 606
reports, the disclosure rules have positively impacted retail
customers since the reports facilitate brokers' rigorous review of
execution quality).
\194\ See, e.g., TD Ameritrade Letter, supra note 19, at 3-4
(stating that Rule 606 reports have performed a vital role in adding
transparency to market center execution practices and that retail
investors reap the ultimate benefit of the statistics); and
Scottrade, Quarterly Order Routing Disclosure, available at https://www.scottrade.com/online-brokerage/trade-quality-execution.html
(stating that ``enhanced, meaningful transparency can serve as a
catalyst for driving competition amongst industry participants to
the ultimate benefit of the investing public'').
---------------------------------------------------------------------------
To preserve the benefits of Rule 606 reports and keep pace with
market developments, the Commission preliminarily believes that it is
appropriate to update Rule 606 to provide customers with enhanced
disclosure regarding a broker-dealer's retail order handling practices.
As discussed above in detail, currently, Rule 606 requires, among other
things, broker-dealers that route ``retail'' orders to publicly
disclose, on a quarterly and
[[Page 49462]]
aggregated basis, certain information regarding non-directed orders in
NMS securities by listing market and material aspects of relationships
with Specified Venues.\195\
---------------------------------------------------------------------------
\195\ See supra Section II.A.
---------------------------------------------------------------------------
1. Marketable Limit Orders and Non-Marketable Limit Orders
Currently, with respect to what would be defined as ``retail''
orders by this proposal, Rule 606 distinguishes broadly between
``market orders'' and ``limit orders.'' Limit orders, however, fall
into two categories: (1) Marketable limit orders, which are priced at
or above the lowest offer in the market for a buy order or at or below
the highest bid in the market for a sell order; and (2) non-marketable
limit orders, which are priced to not execute immediately and seek to
provide liquidity.\196\ The distinction between a marketable and non-
marketable limit order often is a significant factor in a broker-
dealer's order routing practices. Broker-dealers have several options
when deciding to route their customers' limit orders--they may (1)
internalize and trade against customer order flow; (2) post the order;
or (3) route the order to a third-party trading center.
---------------------------------------------------------------------------
\196\ See Dolgopolov, supra note 55, at 234-235.
---------------------------------------------------------------------------
The Commission preliminarily believes that, under the current rule,
customers and other market participants cannot fully evaluate a broker-
dealer's limit order routing practice if both marketable and non-
marketable limit orders are combined into a single order category. The
Commission preliminarily believes that classifying limit orders into
marketable and non-marketable limit orders would allow customers and
other market participants to more fully assess a broker-dealer's
routing decisions for both types of orders and the potential impact on
execution quality. The Commission also preliminarily believes that
greater transparency between the routing practices of marketable and
non-marketable limit orders would allow customers and other market
participants to better assess whether broker-dealers are effectively
managing their potential conflicts of interest. For example, the
Commission understands that broker-dealers may be incentivized to route
marketable and non-marketable limit orders to certain venues based on
their fee or rebate schedule to the benefit of the broker-dealer.
Providing greater public transparency between the routing practices of
marketable and non-marketable limit orders could increase competition
among broker-dealers and minimize the potential conflicts of interest
between maximizing revenue and the duty of best execution.\197\
---------------------------------------------------------------------------
\197\ See Battalio, Corwin, and Jennings Paper, supra note 57,
at 3 (finding that fill rates for displayed limit orders are lower
on exchanges with higher take fees).
---------------------------------------------------------------------------
Currently, Rule 606(a)(1)(i) requires every broker-dealer's
quarterly retail order routing report to include the percentage of
total orders that were non-directed orders and the percentages of total
non-directed orders that were market orders, limit orders, and other
orders. In addition, Rule 606(a)(1)(ii) requires every broker-dealer's
quarterly report on retail order routing to include the identity of the
ten venues to which the largest number of non-directed orders were
routed for execution, as well as any venue to which five percent or
more of non-directed orders were routed (i.e., collectively, Specified
Venues). The Commission proposes to amend Rule 606(a)(1)(i) and (ii) to
split limit orders and separately disclose them as marketable and non-
marketable.\198\ In connection with this proposed new requirement, the
Commission is proposing to amend Rule 600 of Regulation NMS to include
the definition of the term ``non-marketable limit order,'' which is
used in the proposed amendments to Rule 606(a). Specifically, the
Commission proposes to define ``non-marketable limit order'' to mean
``any limit order other than a marketable limit order.'' \199\
---------------------------------------------------------------------------
\198\ See proposed Rule 606(a)(1)(i)-(ii).
\199\ See proposed Rule 600(b)(51).
---------------------------------------------------------------------------
The Commission requests comment on the proposed amendments to Rules
600 and 606(a)(1)(i) and (ii). In particular, the Commission solicits
comment on the following:
87. Do commenters believe that broker-dealers use Rule 606 reports
as a means to assess how their order routing and execution services
compare to other firms? Do commenters believe that the reports
encourage competition among broker-dealers? Why or why not? If so, do
investors in turn benefit from such increased competition? Please
provide data to support your arguments.
88. Do commenters believe that Rule 606 quarterly reports continue
to provide useful information for customers placing retail orders in
assessing the quality of order execution and the routing practices of
their broker-dealers? Why or why not? If not, how could the reports be
improved to provide more useful information to retail customers? Please
explain.
89. Do commenters believe that the proposed definition of non-
marketable limit order is appropriate to distinguish the types of limit
orders? Why or why not? Should the proposed definition be modified in
any way? If so, please explain how.
90. Do commenters believe that separately reporting limit orders by
marketable and non-marketable will enable customers placing retail
orders to better understand broker-dealers' routing decisions and
impact on best execution? Are there other ways in which that
information might be useful to customers? Do commenters believe that
the separate disclosure of marketable and non-marketable limit orders
will be useful to broker-dealers, and if so, how? Do commenters believe
it will promote competition among broker-dealers? Please provide data
to support your arguments.
91. Do commenters believe that market orders and marketable limit
orders should be combined in the quarterly retail order routing report?
Would such combination be useful to customers? If so, how? Please
explain and provide support, if possible.
92. Should the Commission require the same disclosures for retail
orders that it is proposing to require for institutional orders? Why or
why not? Would any or all of the disclosures proposed above for
institutional orders be appropriate or useful for evaluating order
routing of retail orders? If so, would the proposed disclosures need to
be modified in any way to be applied to retail orders? Please explain.
93. Are the venues that are required to be included on retail order
routing reports appropriate? Should the requirement cover more or fewer
venues than are currently included (i.e., the ten to which the largest
number of non-directed orders were routed for execution and any to
which five percent or more of non-directed orders were routed)?
2. Net Payment for Order Flow and Transaction Fees and Rebates by
Specified Venue
Currently, Rule 606 requires that a broker-dealer's quarterly
retail order routing report describe the material aspects of the
broker-dealer's relationship with each Specified Venue, including a
description of any arrangement for payment for order flow or profit-
sharing relationship.\200\ The current disclosure requirement is
intended to signal to investors the potential conflicts of interest
that may influence a broker-dealer's order routing decisions.\201\
Generally, the description
[[Page 49463]]
of any payment for order flow arrangement includes the material terms
of the relationship, a description of the amounts per share or per
order that the broker-dealer receives, and any transaction
rebates.\202\ Similarly, a broker-dealer that has entered into a
profit-sharing relationship arrangement with a Specified Venue must
disclose the extent to which it would share in profits derived from the
execution of non-directed orders.\203\
---------------------------------------------------------------------------
\200\ See supra notes 26 and 27 and accompanying text.
\201\ See Rule 606 Predecessor Adopting Release, supra note 15,
at 75427 (stating that ``[t]he purpose of requiring disclosure
concerning the relationships between a broker-dealer and the venues
to which it routes orders is to alert customers to potential
conflicts of interest that may influence the broker-dealer's order
routing practices'').
\202\ See id.
\203\ Id.
---------------------------------------------------------------------------
As noted above, financial inducements to attract order flow have
become more varied and may be a substantial source of revenue.\204\ A
significant percentage of retail orders are routed to OTC market makers
and most broker-dealers that handle retail orders either receive
payment for order flow in connection with the routing of orders or are
affiliated with an OTC market maker that executes the orders.\205\ The
Commission understands that financial inducements to attract order flow
may create conflicts of interest between maximizing revenue and broker-
dealers' duty of best execution to their customers.
---------------------------------------------------------------------------
\204\ See supra notes 71-74 and accompanying text. See also
Battalio, Corwin, and Jennings Paper, supra note 57, at 15-16
(``Nine of the brokers route at least a portion of their orders to
market makers that offer payment for marketable orders . . . Charles
Schwab, Morgan Stanley, Edward Jones, Just2Trade, and LowTrade route
all non-directed market and limit orders to market makers that
purchase order flow (although LowTrade and Just2Trade indicate that
they do not accept payment for order flow, Edward Jones reports `no
material economic relationship' with the market makers, and Morgan
Stanley reveals no payment for order flow)'').
\205\ See id. In a typical payment for order flow arrangement, a
broker-dealer is paid for sending retail orders to another broker-
dealer, which will in turn trade with the retail orders out of its
own inventory or route the order to another venue for execution. The
internalizing broker-dealer is able to capture small profits on
these trades, and is thus able to pay for the order flow which
generates this profit. Moreover, retail order flow is considered to
be less informed about near-term price movements and therefore
particularly attractive to internalizing broker-dealers. See Concept
Release on Equity Market Structure, supra note 2, at 3612.
---------------------------------------------------------------------------
While Rule 606 currently requires public reports on order routing
percentages to Specified Venues and a discussion of the broker-dealer's
relationship with each Specified Venue, it does not require detailed
disclosure of payment for order flow received, payment from any profit-
sharing relationship received, or access fees or transaction rebates.
As a result, the Commission preliminarily believes that customers have
not received as complete a picture of a broker-dealer's activities to
fully evaluate its broker-dealer's management of any potential
conflicts of interest and the quality of their broker-dealers' retail
order routing practices. The Commission further preliminarily believes
that providing such data for specific order types would further enhance
a customer's ability to assess their broker-dealers' retail order
routing practices.
As such, the Commission proposes to amend Rule 606(a)(1) to include
new subparagraph (iii) to require that, for each Specified Venue, the
broker-dealer must report the net aggregate amount of any payment for
order flow received, payment from any profit-sharing relationship
received, transaction fees paid, and transaction rebates received, both
as a total dollar amount and on a per share basis, for each of the
following non-directed order types: (1) Market orders; (2) marketable
limit orders; (3) non-marketable limit orders; and (4) other
orders.\206\
---------------------------------------------------------------------------
\206\ See proposed Rule 606(a)(1)(iii).
---------------------------------------------------------------------------
The Commission preliminarily believes identifying specific payment
information received for each category of order type by Specified Venue
would provide customers with useful information to more completely
evaluate their broker-dealers' services. Specifically, the Commission
preliminarily believes that providing the aggregate amount of payments
and fees received is important to give investors and others a
comprehensive overview of their broker-dealer. Additionally, the
Commission preliminarily believes that payments and fees received in
total dollar amounts per share for each order type would allow
customers to have a stronger grasp on a broker-dealer's motivation to
route to a particular Specified Venue, the management of any potential
conflicts of interest, and provide more insight into their retail order
routing practices. The Commission preliminarily believes that the
greater transparency achieved by such detailed information would be
useful to retail customers when selecting or re-evaluating a broker-
dealer.
The Commission requests comment on the proposed detailed disclosure
of payments received and fees paid for market, marketable limit, non-
marketable limit, and other order types at each Specified Venue. In
particular, the Commission solicits comment on the following:
94. Do commenters believe that requiring broker-dealers to
disclose, for each Specified Venue, payment for order flow received,
payment from any profit-sharing relationship received, transaction fees
paid, and transaction rebates received would enable customers placing
retail orders to better assess their broker-dealers' management of
potential conflicts of interest and quality of routing and execution
services? Should the Commission require such information to be
disclosed? Is there additional information that a customer could use to
better assess their broker-dealer's conflicts of interest and quality
of routing and execution services? Would requiring such disclosure
affect broker-dealers' routing decisions? Please explain and provide
support for your argument.
95. Do commenters believe that the proposal will permit customers
placing retail orders to be able to better assess whether financial
inducements impact their broker-dealer's order routing decisions for
different types of orders and the execution quality of those orders?
Why or why not?
96. Do commenters believe there are other specific categories of
orders in addition to market orders, marketable limit orders, and non-
marketable limit orders that should be included in the disclosure that
would aid investors placing retail orders in assessing the quality of
their order routing? Please provide support for your arguments.
97. Do commenters believe that broker-dealers should disclose the
information required by proposed Rule 606(a)(1)(iii) for all orders,
not just retail orders?
3. Discussion of Arrangement Terms With a Specified Venue
As noted above, Rule 606(a)(1)(iv) currently requires that a
broker-dealer, in its quarterly Rule 606 report, provide a discussion
of the material aspects of its relationship with a Specified Venue,
including a description of any arrangement for payment for order flow
and any profit-sharing relationship. In adopting the rule, the
Commission stated that the description of a payment for order flow
arrangement must include disclosure of the material aspects of the
arrangement.\207\ The Commission noted that material aspects of the
arrangement should include a description of the terms of the
arrangement, such as any amounts per share or per order that the
broker-dealer receives.\208\ While the Commission understands that
certain terms, such as amounts per share or per order received, are
important to a reasonable investor in evaluating a broker-dealer's
routing practices, based
[[Page 49464]]
on market structure changes since the Rule 606 Predecessor Adopting
Release, among other things, the Commission preliminarily believes that
disclosure of any terms, written or oral, that may influence a broker-
dealer's order routing decision would be useful for customers to assess
the potential conflicts of interest facing broker-dealers when
implementing their retail order routing decisions. Accordingly, the
Commission preliminarily believes it should require broker-dealers to
describe any terms, written or oral, of payment for order flow
arrangements or profit-sharing relationships that may influence a
broker-dealer's order routing decision in the discussion of a broker-
dealer's relationship with a Specified Venue.
---------------------------------------------------------------------------
\207\ See Rule 606 Predecessor Adopting Release, supra note 15,
at 75427.
\208\ See id.
---------------------------------------------------------------------------
The Commission acknowledges that payment for order flow
arrangements are intensively fact-based in nature and may vary across
broker-dealers, nevertheless, the Commission preliminarily believes
that disclosing the terms of such arrangements will provide more
complete information for customers to better understand and evaluate a
broker-dealer's retail order routing decision. In this regard, the
Commission preliminarily believes that requiring broker-dealers to
describe the terms of such arrangements with a Specified Venue that may
influence their decision of where to route a retail order should serve
to provide additional clarity to customers in evaluating a broker-
dealer's retail order routing practices. The Commission preliminarily
believes that the following are a non-exclusive list of terms of a
payment for order flow arrangement or profit-sharing relationships that
may influence a broker-dealer's order routing decision and would be
required to be disclosed under the proposal: (1) Incentives for
equaling or exceeding an agreed upon order flow volume threshold, such
as additional payments or a higher rate of payment; (2) disincentives
for failing to meet an agreed upon minimum order flow threshold, such
as lower payments or the requirement to pay a fee; (3) volume-based
tiered payment schedules; and (4) agreements regarding the minimum
amount of order flow that the broker-dealer would send to a venue.\209\
The Commission preliminarily believes that these four types of terms
reflect existing types of arrangements.
---------------------------------------------------------------------------
\209\ See proposed Rule 606(a)(1)(iv).
---------------------------------------------------------------------------
The Commission is proposing to require broker-dealers to disclose
when a Specified Venue provides incentives for equaling or exceeding a
volume threshold by offering additional payments or a higher rate of
payment, or conversely, disincentives for failing to meet an agreed
upon minimum retail order flow threshold, such as a lower payment or
charging a fee. The Commission understands that such arrangements may
vary among venues, as well as for each broker-dealer sending orders to
those venues, and some venues provide higher rebates for meeting or
exceeding order flow quotas or charge financial penalties for failing
to meet order flow quotas. The Commission preliminarily believes that
such incentives and disincentives influence a broker-dealer's decision
to either meet or route additional retail order flow to exceed the
threshold, and should be disclosed to inform customers of their broker-
dealer's conflicts of interest.
Further, the Commission is proposing to require broker-dealers to
disclose any volume-based tiered payment schedules with a Specified
Venue. Venues that offer these payment schedules typically offer
incrementally higher rebates or lower fees to broker-dealers for
additional retail order flow volume. The Commission preliminarily
believes that these payment schedules can encourage a broker-dealer to
route additional retail order flow to such venue in an effort to reap a
financial benefit and should be disclosed. Additionally, the Commission
is proposing to require broker-dealers to disclose agreements regarding
the minimum amount of retail order flow that a broker-dealer would be
required to send to a Specified Venue. These types of agreements
typically specify that a broker-dealer must send a minimum number of
orders or shares to a venue during a particular time period. The
Commission preliminarily believes that such commitments for retail
order flow may present conflicts of interest and should be disclosed.
Finally, the Commission acknowledges that as market structure evolves,
new types of arrangements not specifically listed may come about. The
four arrangements referenced in Rule 606(a)(1)(iv) are not an
exhaustive list of terms of payment for order flow arrangements or
profit-sharing relationships that may influence a broker-dealer's
retail order routing decision that would be required to be disclosed
under the proposed rule. The proposed rule would require disclosure of
any term of such arrangements that may influence a broker-dealer's
retail order routing decision.
As described above, because certain terms of payment for order flow
arrangements or profit-sharing relationships may encourage broker-
dealers to direct their orders to a specific venue in order to achieve
an economic benefit or avoid an economic loss, potential conflicts of
interest may arise. The Commission preliminarily believes that
disclosure of such information would be useful for customers to assess
the extent to which a broker-dealer's payment for order flow
arrangements and profit-sharing relationships may potentially affect or
distort the way in which retail orders are routed. The Commission
further preliminarily believes that providing customers a comprehensive
description of such quantifiable terms of a broker-dealer's
relationship with a Specified Venue would allow them to fully
appreciate the nature and extent of potential conflicts of interest
facing their broker-dealers and assist them in evaluating the broker-
dealers' management of such potential conflicts of interest.
The Commission requests comment on requiring broker-dealers to
describe any terms of payment for order flow arrangements and profit-
sharing relationships with a Specified Venue that may influence their
retail order routing decisions. In particular, the Commission solicits
comment on the following:
98. Do commenters believe that disclosure of any terms of payment
for order flow arrangements and profit-sharing relationships that may
influence order routing decisions is relevant for retail customers to
understand and evaluate a broker-dealer's routing practices and
handling of potential conflicts of interest? If so, do commenters
believe that the Commission should require a description of these terms
to be disclosed in the retail order routing reports? Why or why not?
Please explain. Would requiring such disclosure affect broker-dealers'
routing decisions?
99. Do commenters believe that broker-dealers should disclose the
information required by proposed Rule 606(a)(1)(iv) for all orders, not
just retail orders?
100. Do commenters believe that the four enumerated examples in
proposed Rule 606(a)(1)(iv) reflect the types of payment for order flow
arrangements and other profit-sharing relationships currently in
practice? If not, how should their descriptions be modified and what
other types of arrangements, if any, should be specified in the rule
text?
101. Do commenters believe that there are other identifiable
factors, beyond the four included in the proposed rule, that may
influence a broker-dealer's order routing decisions for retail orders?
If yes, what are the factors and should the rule specify those factors?
[[Page 49465]]
102. Do commenters believe that incentives for equaling or
exceeding an agreed upon order flow volume threshold influence a
broker-dealer's order routing decision for retail orders? Why or why
not? Please explain.
103. Do commenters believe that disincentives for failing to meet
an agreed upon minimum order flow threshold influence a broker-dealer's
order routing decision for retail orders? Why or why not? Please
explain.
104. Do commenters believe that volume-based tiered payment
schedules influence a broker-dealer's order routing decision for retail
orders? Why or why not? Please explain.
105. Do commenters believe that agreements regarding the minimum
amount of order flow that a broker-dealer would send to a venue
influence a broker-dealer's order routing decision for retail orders?
Why or why not? Please explain.
106. Do comments believe that both written and oral terms that may
influence a broker-dealer's order routing decision should be required
to be disclosed? Why or why not? Please explain.
4. Additional Amendments to Retail Disclosures
The Commission is further proposing amendments to remove the
requirement that Rule 606(a)(1) report be divided into three separate
sections for securities listed on the NYSE, securities that are
qualified for inclusion in NASDAQ, and securities listed on the
American Stock Exchange.\210\ First, the Commission notes that the
language is stale, as NASDAQ is currently a national securities
exchange and the American Stock Exchange is now known as NYSE MKT
LLC.\211\ Second, the Commission preliminarily believes that segmenting
retail order routing reports by primary listing market is no longer
necessary or particularly useful to customers placing retail orders
because the handling of NMS stocks no longer varies materially based on
the primary listing market and the primary listing market often is not
the dominant market for the trading of its listed securities.\212\ As
noted earlier, in 2000, when Rule 606 was adopted, the primary listing
markets looked and operated very differently than they do today. For
example, NYSE and the American Stock Exchange were primarily manual
markets with limited electronic trading, while NASDAQ, not yet a
national securities exchange, was a quote-driven dealer market. Today,
with the adoption of Regulation NMS and the advances in technology, the
primary listing markets are all dominated by electronic trading and the
trading characteristics of securities listed on those markets may no
longer warrant separating the routing report by primary listing
market.\213\ Accordingly, the Commission preliminarily believes that
the division of reports by listing market is not particularly useful to
retail customers interested in analyzing their broker-dealers' routing
practices. While the Commission recognizes that eliminating the
division of reports by the three distinct listing markets may
potentially cause some reduction in informational content (as further
discussed below), the Commission preliminarily believes that any
diminution in granular listing market data is appropriate in light of
the proposed new requirement to provide customers with pertinent retail
order routing data that reflects today's multiple trading centers and
practices.
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\210\ See proposed Rule 606(a)(1).
\211\ See supra note 76.
\212\ For example, from February 2005 to February 2014, NYSE's
market share in its listed securities declined from 78.9% to 20.1%.
See Memorandum from the SEC Division of Trading and Markets to the
SEC Market Structure Advisory Committee (April 30, 2015) (``Rule 611
Memo''), available at http://www.sec.gov/spotlight/emsac/memo-rule-611-regulation-nms.pdf.
\213\ See FIF Letter, supra note 77, at 3 (stating that order
routing practices are no longer based on listing market).
---------------------------------------------------------------------------
The Commission is proposing that the public retail order routing
reports required by Rule 606(a)(1) be broken down by calendar
month.\214\ Currently, Rule 606(a)(1) requires broker-dealers to make
retail order routing reports publicly available for each calendar
quarter, and such reports contain aggregate quarterly information on
the routing of retail orders. As noted above, the Commission
understands that trading centers frequently change their fee
structures, including the amount of fees and rebates, in order to
attract order flow, and such changes typically occur at the beginning
of a calendar month. The changes in fee structures at trading centers
may affect a broker-dealer's routing decisions. Disclosing retail order
routing information on an aggregated quarterly basis can mask changes
in routing behavior in response to changes in a trading center's fee
structure. The Commission preliminarily believes that disclosing the
information contained in the public retail order routing reports by
calendar month would allow customers to better assess whether their
broker-dealers' routing decisions are affected by changes in fee
structures and the extent such changes affect execution quality.
Accordingly, similar to the proposed rule to require institutional
order handling reports to be broken down by calendar month,\215\ the
Commission is proposing to amend Rule 606(a)(1) to require that public
retail order routing reports also be broken down by calendar
month.\216\
---------------------------------------------------------------------------
\214\ See proposed Rule 606(a)(1).
\215\ See supra Sections III.A.3. and III.A.4.
\216\ See id.
---------------------------------------------------------------------------
In addition, the Commission is proposing that the public retail
order routing reports required by Rule 606(a)(1) and customer-specific
retail order routing report required by Rule 606(b)(1) be made
available using an XML schema and associated PDF renderer to be
published on the Commission's Web site.\217\ The Commission
preliminarily believes that retail customers would have a similar
interest as institutional customers in receiving the reports in a
format that would allow them to use software applications to
automatically recognize and process the information rather than having
to manually enter the data to perform a comparison across broker-
dealers. The Commission preliminarily believes that requiring both the
public and customer-specific retail order routing reports to be
provided in the proposed format should be useful to customers as it
would allow them to more easily analyze and compare the data provided
in both types of reports across broker-dealers, for the reasons
discussed above.\218\
---------------------------------------------------------------------------
\217\ See proposed Rule 606(a)(1).
\218\ See supra Section III.A.3.
---------------------------------------------------------------------------
The Commission is also proposing to amend Rule 606(a)(1) to require
every broker- dealer to keep the reports required pursuant to Rule
606(a)(1) posted on an Internet Web site that is free of charge and
readily accessible to the public for a period of three years from the
initial date of posting on the Internet Web site. Similar to the
identical requirement proposed for the public aggregated institutional
order handling report under proposed Rule 606(c), the Commission
preliminarily believes that making this historical data available to
customers and the public generally will be useful to those seeking to
analyze past routing behavior of broker-dealers. Should the proposal be
adopted, the requirement to post and maintain reports on an Internet
Web site that is free and readily accessible to the public would begin
at that time and apply going forward. Affected entities would not be
required to post past reports created prior to the proposed Rule's
effectiveness, but such entities would be neither prevented nor
discouraged from posting such reports.
[[Page 49466]]
Finally, the Commission proposes to insert the term ``retail'' in
the heading of Rule 606(a),\219\ to state ``Quarterly report on retail
order routing.'' The Commission preliminarily believes that such
distinction between retail order routing information referred to in
Rule 606(a) and institutional order handling information proposed in
Rule 606(b) will help clarify the requirements of broker-dealers'
reporting obligations under the Rules.
---------------------------------------------------------------------------
\219\ See proposed Rule 606(a).
---------------------------------------------------------------------------
The Commission seeks comment on the proposed amendments to retail
order routing disclosures. In particular, the Commission solicits
comment on the following:
107. Do commenters believe that it continues to be useful for
options to be included in disclosures for retail orders pursuant to
Rule 606, in light of the fact that the proposal with respect to
institutional orders would exclude options?
108. Should the Commission require retail order routing reports,
both customer-specific and public, to be made available using an XML
schema and associated PDF renderer? Why or why not?
109. Do commenters believe that broker-dealers should be required
to provide the customer-specific and aggregated reports on retail order
routing in the proposed format? Why or why not? Do commenters believe
that it is useful to customers for broker-dealers to provide the
reports in a structured XML format that would facilitate comparison of
the data across broker-dealers? If not, why not? Should only the
customer-specific report be provided in a structured XML format? Should
only the aggregated report be provided in a structured XML format? Do
commenters believe that it is useful to customers for broker-dealers to
also provide the reports in an instantly readable PDF format? If not,
why not? Are there other formats that would be more appropriate?
110. Do commenters believe that it is appropriate to remove the
requirement to report retail order routing information by listing
market (NYSE, NASDAQ, and the American Stock Exchange (n/k/a NYSE MKT
LLC))? Why or why not?
111. Do commenters believe that the retail order routing report
divided by the three listing markets continues to be relevant and
useful to customers placing retail orders and/or analyzing their
broker-dealer's routing practices? Why or why not?
112. Do commenters believe that alternative or additional criterion
should be required in reports regarding retail order routing such as
market capitalization or security type (e.g., exchange-traded products
or NMS stocks)? If so, please explain why should such criterion be used
to report retail order routing information? Please provide data to
support your arguments.
113. Do commenters believe that retail order routing information
organized by stocks included in the S&P 500 Index and stocks not
included in the S&P 500 Index versus by listing market or by NMS stocks
would be useful to customers? Why or why not? Please explain.
114. Do commenters believe that it is reasonable and appropriate to
require that the retail order routing reports be broken down by
calendar month? Should the Commission require the retail order routing
reports be produced on a different frequency than quarterly (e.g.,
monthly)? Why or why not? What are the incremental burdens or benefits
of providing reports at a different frequency? Please explain.
115. Do commenters believe that the Commission should require each
retail order routing report be publicly available for a designated
amount of time, as proposed? If so, is three years a reasonable amount
of time that the reports should be available? Would a shorter or longer
disclosure period be useful to investors and/or onerous to broker-
dealers? Please explain.
116. Broker-dealers currently are required to make publicly
available for each calendar quarter their quarterly reports on retail
order routing and retain such reports for a period of not less than
three years. Generally, broker-dealers will remove the previous
quarterly report from their Web site and replace it with their most
recent quarterly report. Since past quarterly reports are already
required to be retained by broker-dealers, should the Commission
require broker-dealers to make publicly available the prior three
years' worth of quarterly reports from the effective date of the rule?
Why or why not?
117. Should the Commission require all broker-dealers to make their
public retail order routing reports available on one centralized Web
site? For example, should all broker-dealer reports be available on the
SEC's or an SRO's Web site? Why or why not?
5. Amendment to Rule 600(b)(18) To Rename ``Customer Order'' to
``Retail Order''
Finally, the Commission proposes to amend Rule 600(b)(18) to rename
the defined term ``customer order'' to ``retail order,'' and to amend
Rules 600(b)(19), 600(b)(23), 600(b)(48), 605, 606, and 607 to reflect
such change. ``Customer order'' is currently defined in Rule 600(b)(18)
to include smaller-sized orders in NMS securities.\220\ As discussed
above, the Commission is proposing to define institutional order to
include larger-sized orders in NMS stocks.\221\ Since ``retail''
generally connotes orders of a smaller size and ``institutional''
generally connotes orders of a larger size, the Commission
preliminarily believes it is appropriate to rename ``customer order''
to ``retail order'' in connection with this proposed rulemaking. The
Commission preliminarily believes that such change would clarify to
market participants that the defined terms are based on the size of the
order.
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\220\ See 17 CFR 242.600(b)(18) and supra note 7 and
accompanying text.
\221\ See proposed Rule 600(b)(31) and supra Section III.A.1.
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The Commission requests comment on the proposal to rename the
defined term ``customer order'' to ``retail order.'' In particular, the
Commission solicits comment on the following:
118. Do commenters believe that the proposed change is appropriate?
Do commenters believe that such change would provide clarity to market
participants? Are there alternative ways to distinguish small and
large-sized orders? Please provide support for your arguments.
C. Amendment to Disclosure of Order Execution Information
The Commission is proposing to amend Rule 605(a)(2) to require
market centers to keep reports required pursuant to Rule 605(a)(1)
posted on an Internet Web site that is free of charge and readily
accessible to the public for a period of three years from the initial
date of posting on the Internet Web site. Similar to the analogous
requirements proposed in Rules 606(a) and 606(c) described above, the
Commission preliminarily believes that making past order execution
information available to customers and the public generally for a
specified period of time will be beneficial to those seeking to analyze
historical order execution information at various market centers.
Should the proposal be adopted, the requirement to post and maintain
reports on an Internet Web site that is free of charge and readily
accessible to the public would begin at that time and apply going
forward. Affected entities would not be required to post reports
covering periods prior to the proposed Rule's effectiveness.
The Commission requests comment on the proposed amendments to the
disclosure of order execution
[[Page 49467]]
information. In particular, the Commission solicits comment on the
following:
119. Do commenters believe that the monthly electronic reports
required by Rule 605(a) should be publicly available for a designated
amount of time? If so, is three years a reasonable amount of time that
the reports should be available? Would a shorter or longer disclosure
period be useful to investors placing institutional orders and/or
onerous to broker-dealers? Please explain.
IV. Paperwork Reduction Act
Certain provisions of these proposed amendments contain
``collection of information requirements'' within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\222\ The Commission is
submitting these collections of information to the Office of Management
and Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d)
and 5 CFR 1320.11. The current collection of information for Rule 606
entitled ``Disclosure of order routing information'' is being modified
in a way that creates new collection of information burden estimates
and modifies existing collection of information burden estimates. The
existing collection of information for Rule 605 entitled ``Disclosure
of order execution information'' is being modified in manner that does
not alter the collection of information burden estimate. An agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless the agency displays a currently valid
control number.
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\222\ 44 U.S.C. 3501 et seq.
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A. Summary of Collection of Information
The proposed amendments to Rule 606 would include a collection of
information within the meaning of the PRA for broker-dealers who
receive and route retail and institutional orders.
1. Customer Requests for Information on Institutional Orders
As detailed above, proposed Rule 606(b)(3) of Regulation NMS would
require a broker-dealer, on request of a customer that places, directly
or indirectly, an institutional order with the broker-dealer, to
electronically disclose to such customer within seven business days of
receiving the request, a report on the broker-dealer's handling of
institutional orders for that customer for the prior six months, broken
down by calendar month. Specifically, the report would contain certain
information on the customer's order flow with the reporting broker-
dealer as well as certain columns of information on institutional
orders handled by the broker-dealer, as described below, categorized by
venue and by order routing strategy category--passive, neutral, and
aggressive--for each venue. The required columns of information include
four groups of information: (1) Information on institutional order
routing; (2) information on institutional order execution; (3)
information on institutional orders that provided liquidity; and (4)
information on institutional orders that removed liquidity.\223\
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\223\ See supra Section III.A.4.
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With regard to information about the customer's order flow with the
reporting broker-dealer, the Commission is proposing to require
disclosure of: (1) Total number of shares of institutional orders sent
to the broker-dealer by the customer during the reporting period; (2)
total number of shares executed by the broker-dealer as principal for
its own account; (3) total number of institutional orders exposed by
the broker-dealer through an actionable indication of interest; and (4)
venue or venues to which institutional orders were exposed by the
broker- dealer through an actionable indication of interest.\224\
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\224\ See proposed Rule 606(b)(3).
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With regard to information on institutional order routing, the
Commission is proposing to require disclosure of: (1) Total shares
routed; (2) total shares routed marked immediate or cancel; (3) total
shares routed that were further routable; (4) average order size
routed.\225\
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\225\ See proposed Rule 606(b)(3)(i)(A)-(D).
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With regard to information on institutional order execution, the
Commission is proposing to require disclosure of: (1) Total shares
executed; (2) fill rate; \226\ (3) average fill size; \227\ (4) average
net execution fee or rebate; \228\ (5) total number of shares executed
at the midpoint; (6) percentage of shares executed at the midpoint; (7)
total number of shares executed that were priced on the side of the
spread more favorable to the institutional order; (8) percentage of
total shares executed that were priced on the side of the spread more
favorable to the institutional order; (9) total number of shares
executed that were priced on the side of the spread less favorable to
the institutional order; and (10) percentage of total shares executed
that were priced on the side of the spread less favorable to the
institutional order.\229\
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\226\ Fill rate would be calculated by the shares executed
divided by the shares routed.
\227\ Average fill size would be the average size, by number of
shares, of each order executed on the venue.
\228\ The fee and rebate would be measured in cents per 100
shares.
\229\ See proposed Rule 606(b)(3)(ii)(A)-(J).
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With regard to information on institutional orders that provided
liquidity, the Commission is proposing to require disclosure of: (1)
Total number of shares executed of orders providing liquidity; (2)
percentage of shares executed of orders providing liquidity; (3)
average time between order entry and execution or cancellation for
orders providing liquidity (in milliseconds); and (4) average net
execution rebate or fee for shares of orders providing liquidity (cents
per 100 shares, specified to four decimal places).\230\
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\230\ See proposed Rule 606(b)(3)(iii)(A)-(D).
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Finally, with regard to information on institutional orders that
removed liquidity, the Commission is proposing to require disclosure
of: (1) Total number of shares executed of orders removing liquidity;
(2) percentage of shares executed of orders removing liquidity; and (3)
average net execution fee or rebate for shares of orders removing
liquidity (cents per 100 shares, specified to four decimal
places).\231\
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\231\ See proposed Rule 606(b)(3)(i)(A)-(C).
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2. Public Aggregated Report on Institutional Orders
Proposed Rule 606(c) of Regulation NMS would require a broker-
dealer that receives institutional orders to make publicly available a
report that aggregates the information required for customer-specific
reports pursuant to proposed Rule 606(b)(3) for all institutional
orders the broker-dealer receives, regardless of whether the
information was requested by a customer and that such report would be
broken down by calendar month. A broker-dealer would be required to
make such report publicly available for each calendar quarter within
one month after the end of the quarter. Broker-dealers would also be
required to keep such reports posted on an Internet Web site that is
free and readily accessible to the public for a period of three years
from the initial date of posting on the Internet Web site.
3. Requirement To Document Methodologies for Categorizing Institutional
Order Routing Strategies
Proposed Rule 606(b)(3)(v) would require broker-dealers to provide
the required information for each venue broken down and classified by
the
[[Page 49468]]
following order routing strategy category: (1) ``Passive order routing
strategy,'' which emphasize the minimization of price impact over the
speed of execution of the entire institutional order; (2) ``neutral
order routing strategy,'' which are relatively neutral between the
minimization of price impact and the speed of execution of the entire
institutional order; and (3) ``aggressive order routing strategy,''
which emphasize the speed of execution of the entire institutional
order over the minimization of price impact. The proposed rule would
require the broker-dealer to assign each order routing strategy that it
uses for institutional orders to one of these three categories in a
consistent manner for each report it prepares, promptly update the
assignments any time an existing strategy is amended or a new strategy
is created that would change such assignments, and to document the
specific methodologies it relies upon for making such assignments. The
Commission is proposing to require every broker-dealer to preserve a
copy of the methodologies used to assign its order routing strategies
and maintain such copy as part of its books and records in a manner
consistent with Rule 17a-4(b) under the Exchange Act.
4. Amendment to Current Disclosures With Respect to Retail Orders
The proposed amendments to Rule 606(a) of Regulation NMS would: (1)
Break down the existing limit order disclosure into separate categories
of marketable limit orders and non-marketable limit orders; (2) require
that for each Specified Venue, the broker-dealer must report the net
aggregate amount of any payment for order flow received, payment from
any profit-sharing relationship received, transaction fees paid, and
transaction rebates received, both as a total dollar amount and on a
per share basis, for each of the following order types: (i) Market
orders; (ii) marketable limit orders; (iii) non-marketable limit
orders; and (iv) other orders; (3) require broker-dealers to describe
specific aspects of any terms of payment for order flow arrangements
and profit-sharing relationships, whether written or oral, with a
Specified Venue that may influence their order routing decisions,
including: (i) Incentives for equaling or exceeding an agreed upon
order flow volume threshold, such as additional payments or a higher
rate of payment; (ii) disincentives for failing to meet an agreed upon
minimum order flow threshold, such as lower payments or the requirement
to pay a fee; (iii) volume-based tiered payment schedules; and (iv)
agreements regarding the minimum amount of order flow that the broker-
dealer would send to a venue; (4) require that such reports be broken
down by calendar month; (5) require that such reports be kept posted on
an Internet Web site that is free and readily accessible to the public
for a period of three years from the initial date of posting on the
Internet Web site; and (6) remove the requirement that the Rule
606(a)(1) report be divided into three separate categories by listing
market. Instead, the information required under Rule 606(a)(1) would be
aggregated for all NMS stocks. The proposed amendments would require
reports produced pursuant to Rules 606(a) and 606(b)(1) to be formatted
in the most recent versions of the XML schema and the associated PDF
renderer as published on the Commission's Web site.
5. Amendment to Current Disclosures Under Rule 605
The Commission is proposing to amend Rule 605(a)(2) to require
market centers to keep reports required pursuant to the Rule 605(a)(1)
posted on an Internet Web site that is free of charge and readily
accessible to the public for a period of three years from the initial
date of posting on the Internet Web site.
B. Proposed Use of Information
Generally, the order routing disclosures required under the
proposed amendments to Rule 606 would provide detailed information to
both institutional and retail customers that would enable them to
evaluate how their orders were routed by their broker-dealers, assess
conflicts of interest facing their broker-dealers in providing order
routing services, and have the ability to engage in informed
discussions with their broker-dealers about the broker-dealer's order
routing practices. The proposed order routing disclosures could inform
future decisions on whether to retain a broker-dealer's order routing
services or engage the order routing services of a new broker-dealer.
In addition, broker-dealers may use the public disclosures to compete
on the basis of order routing services, and academics and others may
use the public disclosures pursuant to Rules 605 and 606 to review and
analyze broker-dealer routing practices and trading center order
executions.
1. Customer Requests for Information on Institutional Orders
The order handling disclosures proposed under Rule 606(b)(3) would
provide detailed order routing and execution information to a customer
regarding its specific institutional orders during the reporting
period. Generally, the five groups of information contained in the
institutional order handling report would enable customers to
understand where and how their institutional orders were routed or
exposed as well as where their orders were executed during the
reporting period. Customers could use the information contained in an
institutional order handling report to assess any considerations a
broker-dealer may have faced when routing its orders to various venues,
whether those considerations may have affected how a broker-dealer
routed its orders, and whether those considerations may have affected
its execution equality.
Specifically, customers would be able to review each venue to which
their institutional orders were routed and identify potential conflicts
of interest, affiliations, or business arrangements between their
broker-dealer and the venue and assess whether large volumes of orders
or certain order types were directed to venues from which the broker-
dealer may receive significant economic benefit. The information
provided in the institutional order handling report could further be
used by customers to assess whether a broker-dealer's order routing
practices may have led to risks of information leakage. In addition,
the information contained in the institutional order handling report
would enable investors to assess, monitor, and generally determine the
overall execution quality received from a broker-dealer. As noted
above, customers could use the proposed order handling disclosures to
inform future decisions on whether to retain a broker-dealer's order
routing services or engage the order routing services of a new broker-
dealer.
2. Public Aggregated Report on Institutional Orders
Proposed Rule 606(c) would require a broker-dealer that receives
institutional orders to make publicly available a report that
aggregates the information enumerated in proposed Rule 606(b)(3), even
if not requested by a customer. The proposed public aggregated
institutional order handling reports would enable customers to use a
standardized set of information to compare how broker-dealers handle
institutional orders and use such information in determining whether to
retain the services of a broker-dealer or engage the services of a new
broker-dealer. Broker-dealers could use the aggregated information to
compare its order handling services against other broker-dealers, which
[[Page 49469]]
could improve competition among broker-dealers on the basis of order
routing and execution quality. In addition, academic researchers and
others could use the public aggregated institutional order handling
information for research and analysis. Further, third-party vendors
offering analytical services may use the information in the public
reports in an attempt to sell customized reporting tools and services.
3. Requirement to Document Methodologies for Categorizing Institutional
Order Routing Strategies
Broker-dealers would assign order routing strategies into passive,
neutral, and aggressive categories, applying consistent classification
of their order routing strategies for purposes of producing customer-
specific and public aggregated institutional order handling reports,
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments. Regulators, including the Commission, could use the
documented methodologies as a reference in determining whether a
broker-dealer is consistently classifying and applying its order
routing strategies for reporting purposes.
4. Amendment to Current Disclosures With Respect to Retail Orders
The proposed amendment to Rule 606(a) to break down the existing
limit order disclosure in the retail order routing reports into
separate categories of marketable limit orders and non-marketable limit
orders could be used by customers to assess the differences in the ways
broker-dealers route these specific order types. Customers could use
the information contained in the retail order routing reports to assess
potential conflicts of interest its broker-dealers face with respect to
routing these distinct order types, particularly with respect to the
economic incentives received from trading centers. Customers could use
this information to determine whether to retain a broker-dealer's
services or engage the services of a new broker-dealer, which could
foster competition among broker-dealers on the basis of quality of
order routing and execution. In addition, academic researchers and
others could use this information for research and analysis.
The proposed requirement that a broker-dealer disclose the net
aggregate amount of any payment for order flow received, payment from
any profit-sharing relationship received, transaction fees paid, and
transaction rebates received, both as a total dollar amount an on a per
share basis, for specified non-directed order types for each Specified
Venue could allow customers to determine how broker-dealers route
different types of orders relative to any economic benefit or
consequence to the broker-dealer. Customers could use this information
to further assess whether their broker-dealers' routing decisions may
be influenced by conflicts of interest. The requirement in proposed
Rule 606(a)(1) that the quarterly reports be broken down by calendar
month could allow customers to determine whether and how their broker-
dealer's routing decisions changed in response to changing fee and
rebate structures in the marketplace, which often change at the
beginning of a calendar month. The proposed requirement that such
reports be kept posted on an Internet Web site for three years could
allow customers and others, such as researchers, to analyze historical
routing behavior of particular broker-dealers. In addition, the
proposed requirement for broker-dealers to describe any terms of
payment for order flow arrangements and profit-sharing relationships
with a Specified Venue that may influence their order routing
decisions, including information relating to specific incentives or
volume minimums, could allow customers to understand how their broker-
dealers route retail orders and whether and how such routing is
influenced by payment for order flow and/or a profit-sharing
relationship.
5. Amendment to Current Disclosures Under Rule 605
The requirement that reports required under Rule 605 be kept posted
on an Internet Web site that is free of charge and readily accessible
to the public for a period of three years from the initial date of
posting on the Internet Web site could allow customers and others, such
as researchers, to analyze historical order execution quality at
various market centers. The three years of data could be useful to
those seeking to analyze how execution quality has changed over time,
in addition to changes in response to regulatory or other developments.
C. Respondents
The respondents to these proposed amendments would be broker-
dealers that route retail or institutional orders and market centers
that create reports pursuant to Rule 605. As of December 2015, the
Commission estimates that there were approximately 4,156 total
registered broker-dealers.\232\ Of these, the Commission estimates 266
are broker-dealers that route retail orders.\233\ The Commission
estimates that 200 broker-dealers are involved in the practice of
routing institutional orders, all of whom also route retail
orders.\234\ The Commission estimates that there are 380 market centers
to which Rule 605 applies.\235\ The Commission requests comment on the
accuracy of these estimated figures.
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\232\ The Commission is basing its estimate off data compiled
from responses to Form BD.
\233\ See id. The Commission estimates that both clearing
brokers and introducing brokers route retail orders. The Commission
notes that the term ``retail order'' refers to ``customer order''
defined in Rule 600 (b)(18) of Regulation NMS. See supra note 7 and
accompanying text.
\234\ See id. Using Form BD data, the Commission estimates that
clearing brokers and some introducing brokers route institutional
orders.
\235\ The Commission derived this estimate based on the
following: 236 OTC market makers (not including market makers
claiming an exemption from the reporting requirements of the Rule),
plus 12 exchanges, 1 securities association, 86 exchange market
makers, and 45 ATSs.
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D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Customer Requests for Information on Institutional Orders
a. Initial Reporting and Recordkeeping Burden
The Commission preliminarily believes that many broker-dealers that
route institutional orders already create and retain the order handling
information required by the proposed changes to Rule 606(b)(3). In such
cases, the initial burden to comply with the requirement would be
significantly lower than for a broker-dealer whose systems do not
already create and retain the required information. In addition, the
Commission preliminarily believes that many broker-dealers who do not
have proprietary systems which create and retain order handling
information use third-party service providers to allow them to create
and retain the information required by the proposed changes to Rule
606(b)(3). For this reason, the Commission is providing two estimates
below, one for broker-dealers that route institutional orders whose
systems do not currently support creating and retaining the information
required by Rule 606(b)(3) who will upgrade their systems either in-
house or via a third-party service provider, and another for broker-
dealers that route institutional orders whose systems currently do
create and retain such information, including those that use a third-
party service provider whose systems currently obtain such information.
The Commission preliminarily believes that most broker-dealers
either have systems that currently obtain the
[[Page 49470]]
information required by the proposed rule, or use third-party service
providers who have systems that obtain such information. The Commission
further preliminarily believes that all broker-dealers have systems in
place that at least capture some of the information required by the
proposed rule. Of the 200 broker-dealers involved in routing
institutional orders, the Commission estimates that 25 broker-dealers
that route institutional orders do not currently have systems that
obtain all of the information required by the proposed amendments.\236\
The Commission estimates that these 25 broker-dealers would be able to
perform the required enhancements in-house, but could also use a third-
party service provider. As discussed further below, the Commission
further estimates that, after required systems enhancements were
performed, all broker-dealers would capture the necessary information
in-house, but some broker-dealers would create the required reports in-
house, while other broker-dealers would engage third parties to create
the reports.
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\236\ This estimate was based on discussions with various
industry participants.
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Based on discussions with industry sources, the Commission
estimates that the average one-time, initial burden for broker-dealers
that route institutional orders that do not currently create and retain
the proposed order handling information to program systems in-house to
implement the requirements of the proposed amendments to Rule 606(b)(3)
in-house would be 200 hours \237\ per broker-dealer. The Commission
estimates the average one-time, initial burden for broker-dealers that
route institutional orders that do not currently create and retain the
proposed order handling information to engage a third-party to program
the broker-dealers' systems to implement the requirements of the
proposed amendments to Rule 606(b)(3) to be 50 hours \238\ and
$35,000.\239\ The Commission estimates that of the 25 broker-dealers
that route institutional orders who do not currently have systems in
place to capture the information required by the rule, 10 such broker-
dealers will perform the necessary programming upgrades in-house, and
15 will engage a third-party to perform the programming upgrades.
Additionally, of the 25 broker-dealers that route institutional orders
who do not currently have systems in place to capture the information
required by the proposed rule, the Commission estimates that 10 such
broker-dealers will need to purchase hardware and software upgrades to
fulfill the requirements of the proposed rule at an average cost of
$15,000 per broker-dealer, and that the remaining 15 broker-dealers
have adequate hardware and software to capture the information proposed
by the rule. Therefore, the total initial burden for broker-dealers
that route institutional orders who do not currently capture order
handling information required by the proposed rule to program their
systems to produce a report to comply with the proposed rule change is
2,750 hours \240\ and $675,000.\241\
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\237\ The Commission estimates the monetized burden for this
requirement to be $60,420. The Commission derived this estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: (Sr. Programmer at $303
per hour for 100 hours) + (Sr. Database Administrator at $312 per
hour for 40 hours) + (Sr. Business Analyst at $251 per hour for 40
hours) + (Attorney at $380 per hour for 20 hours) = 200 hours and
$60,420. This burden hour estimate was based on discussions with
various industry participants.
\238\ The Commission estimates the monetized burden for this
requirement to be $15,125. The Commission derived this estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: (Compliance Manager at
$283 per hour for 20 hours) + (Sr. Business Analyst at $251 per hour
for 15 hours) + (Attorney at $380 per hour for 15 hours) = 200 hours
and $15,125. This burden hour estimate was based on discussions with
various industry participants.
\239\ The Commission estimates that, on average, a third-party
service provider would charge $35,000 to perform the necessary work.
\240\ 200 hours per broker-dealer who routes institutional
orders who does not currently obtain data required by the proposed
rule who will upgrade its own systems x 10 such broker-dealers + 50
hours per broker-dealer who will engage a third-party to perform the
necessary systems upgrades x 15 such broker-dealers = 2,750 hours.
The Commission estimates the total monetized burden for this
requirement to be $831,075 (10 routing broker-dealers who will
perform upgrades in-house x $60,420 = $604,200) + (15 broker-dealers
who will engage a third-party x $15,125 = $226,875) = $831,075). See
supra notes 237 and 238.
\241\ ($35,000 per broker-dealer who will engage a third-party x
15 such broker-dealers) + ($15,000 per broker-dealer who will need
to purchase hardware and software upgrades x 10 such broker-dealers)
= $675.000. See supra note 239.
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A broker-dealer that routes institutional orders whose systems
already capture the data required by the proposed rule would need to
format its systems to produce a report that complies with the proposed
rule. The Commission estimates the average burden for a broker-dealer
who already captures information required by the proposed rule to
format its systems to produce a report to comply with the proposed rule
would be 40 hours.\242\ The Commission estimates that 125 broker-
dealers would format systems to produce the reports in-house. A broker-
dealer that routes institutional orders who uses a third-party service
provider to produce reports using such order handling information would
need to need to work with the vendor to ensure the proper data is
captured in the reports. The Commission estimates 50 broker-dealers
that route institutional orders would use a third-party vendor to
ensure data required by the rule is captured in the reports. The
Commission estimates the average burden for a broker-dealer who uses a
third-party service provider to work with such service provider to
ensure proper reports are produced would be 20 hours \243\ and
$5,000.\244\ The Commission preliminarily believes that broker-dealers
whose systems currently capture and retain information required by the
rule would not need to purchase hardware or software upgrades. Thus,
the total burden for broker-dealers who currently obtain the required
data but need to format their systems, or work with their data
provider, to prepare a report to comply with the proposed rule is 6,000
hours \245\ and $250,000.\246\
[[Page 49471]]
Therefore, the estimated total initial burden to comply with proposed
Rule 606(b)(3) is 8,750 hours \247\ and $925,000.\248\
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\242\ The Commission estimates the monetized burden for this
requirement to be $12,084. The Commission derived this estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: (Sr. Programmer at $303
per hour for 20 hours) + (Sr. Database Administrator at $312 per
hour for 8 hours) + (Sr. Business Analyst at $251 per hour for 8
hours) + (Attorney at $380 per hour for 4 hours) = 40 hours and
$12,084.
\243\ The Commission estimates the monetized burden for this
requirement to be $5,726. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: (Compliance Manager at $283 per
hour for 14 hours) + (Sr. Business Analyst at $251 per hour for 4
hours) + (Attorney at $380 per hour for 2 hours) = 20 hours and
$5,726.
\244\ The Commission estimates a third-party service provider
working with a broker-dealer whose systems currently capture and
retain information required by the rule would, on average, charge
$5,000 to program the systems to create a report that complies with
the rule.
\245\ 40 hours per broker-dealer who needs to format its systems
to prepare a report x 125 broker-dealers who need to format their
systems to prepare a report + 20 hours per broker-dealer who needs
to work with a third-party vendor to ensure a proper report is
produced x 50 broker-dealers who need to work with third-party
vendors = 6,000 hours. The Commission estimates the monetized burden
for this requirement to be $1,796,800 ($12,084 per broker-dealer who
needs to format its systems to prepare a report x 125 such broker-
dealers + $5,726 per broker-dealer who needs to work with a third-
party vendor to ensure a proper report is produced x 50 such broker-
dealers = $1,796,800). See supra notes 242 and 243.
\246\ $5,000 per broker-dealer who works with a third-party
vendor to ensure proper reports are produced x 50 such broker-
dealers = $250,000. See supra note 244.
\247\ 2,750 hours for broker-dealers who need to format their
systems to obtain the information required by the proposed rule and
prepare reports + 6,000 hours for broker-dealers who currently
obtain such information and need to format their systems or work
with their third-party vendor to prepare a report to comply with the
rule = 8,750 hours. The Commission estimates the total monetized
burden for this requirement to be $2,627,875 ($831,075 for broker-
dealers who need to format their systems either on their own or by
using a third-party to obtain the information required by the
proposed rule + $1,796,800 for broker-dealers who currently obtain
such information and need to format their systems or work with their
third-party vendor to prepare a report to comply with the rule =
$2,627,875). See supra notes 240 and 245.
\248\ ($35,000 per broker-dealer who will engage a third-party x
15 such broker-dealers) + ($15,000 per broker-dealer who will need
to purchase hardware and software upgrades x 10 such broker-dealers)
+ ($5,000 per broker-dealer who works with a third-party vendor to
work with such vendor to ensure proper reports are produced x 50
such broker-dealers) = $975,000. See supra notes 241 and 246.
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The Commission requests comment regarding the accuracy of its
estimate as to how many broker-dealers that route institutional orders
are currently able to obtain the information required by the proposed
rules and the estimated burden hours necessary to comply with the
proposal.
b. Annual Reporting and Recordkeeping Burden
Proposed Rule 606(b)(3) requires broker-dealers to respond to
individual customer requests for information on institutional orders.
The Commission estimates that 135 of the 200 broker-dealers that route
institutional orders would respond to proposed Rule 606(b)(3) requests
in-house.\249\ The Commission estimates that an average response to a
Rule 606(b)(3) request for a broker-dealer who responds to such
requests in-house will take approximately 2 hours per response.\250\
The Commission estimates that an average broker-dealer will receive
approximately 200 requests annually.\251\ Therefore, on average, a
broker-dealer who responds to 606(b)(3) requests in-house will incur an
estimated annual burden of 400 hours to prepare, disseminate, and
retain responses to customers required by Rule 606(b)(3).\252\ With an
estimated 135 broker-dealers who route institutional orders who will
respond to 606(b)(3) requests in-house, the estimated total annual
burden for such 135 broker-dealers to comply with the customer response
requirement in proposed Rule 606(b)(3) is 54,000 hours.\253\
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\249\ The Commission estimates that the 125 broker-dealers
estimated already to capture the information that would be required
plus the 10 broker-dealers that would do systems work in-house who
do not currently capture the information that would be required
would respond to Rule 606(b)(3) requests in-house.
\250\ Based on discussions with industry participants, the
Commission estimates that each response will require a Jr. Business
Analyst for 1 hour and a Programmer Analyst for 1 hour. Thus, the
burden estimate is calculated as follows: Jr. Business Analyst at
$160 per hour for 1 hour, and a Programmer Analyst at $220 per hour
for 1 hour, for a total burden of 2 hours and $380 per report. The
Commission derived this estimate based on per hour figures from
SIFMA's Management & Professional Earnings in the Securities
Industry 2013.
\251\ This estimate was based on discussions with various
industry participants.
\252\ 2 hours per request x 200 annual requests = 400 hours. The
Commission estimates the total monetized burden for this requirement
to be $76,000 annually (200 annual requests x $380 per request =
$76,000). See supra note 250.
\253\ 400 hours annually per broker-dealer that routes
institutional orders who will respond to requests in-house x 135
such broker-dealers = 54,000 hours. The Commission estimates the
total monetized burden for this requirement to be $10,260,000
($76,000 per broker-dealer that routes institutional orders that
will respond to requests in-house x 135 such broker-dealers =
$10,260,000). See id.
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For the 65 broker-dealers that route institutional orders who are
anticipated to use a third-party service provider to respond to
requests pursuant to Rule 606(b)(3), the Commission estimates the
burden to be 1 hour \254\ and $100 per response.\255\ With an estimated
200 requests pursuant to Rule 606(b)(3) per year, the Commission
estimates that on average, the annual burden for a broker-dealer who
uses a third-party service provider to respond to requests pursuant to
Rule 606(b)(3) will be 200 hours \256\ and $20,000. With an estimated
65 broker-dealers that route institutional orders who will respond to
Rule 606(b)(3) requests using a third-party-service provider, the
Commission estimates the total annual burden for such 65 broker-dealers
will be 13,000 hours \257\ and $1,300,000.\258\
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\254\ The Commission estimates the monetized burden for this
requirement to be $283. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Compliance Manager at $283 per hour
for 1 hour = $283.
\255\ The Commission estimates a third-party service provider
would charge on average $100 to respond to requests pursuant to the
rule.
\256\ 1 hour per broker-dealer who will use a third-party
service provider per request x 200 requests annually = 200 hours.
The Commission estimates the monetized burden for this requirement
to be $56,600 (200 annual requests x $283 per request = $56,600).
See supra note 254.
\257\ 200 hours annual per broker-dealer who will use a third-
party service provider x 65 such broker-dealers = 13,000 hours. The
Commission estimates the monetized burden for this requirement to be
$3,679,000 ($56,600 annually per broker-dealer who will use a third-
party service provider x 65 such broker-dealers = $3,679,000). See
id.
\258\ $100 per request x 200 requests annually x 65 broker-
dealers who will use a third-party service provider = $1,300,000.
See supra note 255.
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Therefore, the total annual burden for all 200 broker-dealers that
route institutional orders to comply with the customer response
requirement in proposed Rule 606(b)(3) is estimated to be 67,000 hours
\259\ and $1,300,000.\260\
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\259\ 400 hours annually per broker-dealer that routes
institutional orders who will respond to requests in-house x 135
such broker-dealers + 200 hours annually per broker-dealer who
routes institutional orders who will use a third-party to respond to
requests x 65 such broker-dealers = 67,000 hours. The Commission
estimates the total monetized burden for this requirement to be
$13,939,000 ($10,260,000 for broker-dealers that route institutional
orders who will respond to requests in-house + $3,679,000 for
broker-dealers that route institutional orders who will use a third-
party service provider to respond to requests = $13,939,000). See
supra notes 253 and 257.
\260\ See supra note 258.
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2. Public Aggregated Report on Institutional Orders
c. Initial Reporting and Recordkeeping Burden
Once a broker-dealer that routes institutional orders has systems
in place to record and report the information required by proposed Rule
606(b)(3) to individual customers, the broker-dealer creating the
quarterly public aggregated institutional order handling reports in-
house will need to configure its systems to aggregate the information
required by proposed Rule 606(c) or use a third-party service provider
to create such reports. Once the systems to obtain such information are
in place, the Commission estimates that broker-dealers or their third-
party service providers would incur a modest additional burden or cost
to format such data into an aggregated report. The Commission estimates
that some broker-dealers will format these reports themselves in-house
while others will use a third-party service provider to format the
reports. The Commission estimates that a broker-dealer who routes
institutional orders which formats and creates the required reports
itself would incur an initial burden of 20 hours to comply with the
quarterly reporting requirement of proposed Rule 606(c).\261\ The
Commission estimates
[[Page 49472]]
that a broker-dealer who uses a third-party service provide to create
the necessary reports would incur an initial burden of 5 hours \262\
and $2,500.\263\ The Commission estimates that consistent with the
estimates above about reports pursuant to proposed Rule 606(b)(3), 135
broker-dealers who route institutional orders will create the required
reports themselves while 65 broker-dealers will use a third-party
service provider to create the required reports. Therefore, the
estimated total initial burden for broker-dealers that route
institutional orders to produce the quarterly report is 3,025 hours
\264\ and $162,500.\265\
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\261\ The Commission estimates the monetized burden for this
requirement to be $4,990. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Programmer at $248 per hour for 10
hours + Sr. Business Analyst at $251 per hour for 10 hours = 20
hours and $4,990.
\262\ The Commission estimates the monetized burden for this
requirement to be $1,415. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Compliance Manager at $283 per hour
for 5 hours = $1,415.
\263\ The Commission estimates a third-party service provider
would charge on average $2,500 to format a broker-dealer's data to
produce a report to comply with the rule.
\264\ 20 hours per broker-dealer that routes institutional
orders who will create the required reports itself x 135 such
broker-dealers + 5 hours per broker-dealer that routes institutional
orders who uses a third-party service provider to create the
required reports itself x 65 such broker-dealers = 3,025 hours. The
Commission estimates the total monetized burden for this requirement
to be $765,625 ($4,990 per broker-dealer that routes institutional
orders x 135 such broker-dealers + $1,415 per broker-dealer who uses
a third-party service provider to create the required reports x 65
such broker-dealers = $765,625). See supra notes 261 and 262.
\265\ $2,500 per broker-dealer who uses a third-party service
provider to create the required reports x 65 such broker-dealers =
$162,500. See supra note 263.
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d. Annual Reporting and Recordkeeping Burden
The Commission estimates that each broker-dealer that routes
institutional orders who prepares its reports in-house will incur an
average burden of 10 hours \266\ to prepare and make publicly available
a quarterly report in the format required by proposed Rule 606(c), or a
burden of 40 hours per year.\267\ Once a report is posted on an
internet Web site, the Commission does not estimate that there would be
an additional burden to allow the report to remain posted for the
period of time specified in the rule. With an estimated 135 broker-
dealers that route institutional orders that will prepare their own
reports, the total burden per year to comply with the quarterly
reporting requirement in proposed Rule 606(c) is estimated to be 5,400
hours.\268\
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\266\ The monetized cost for this burden requirement was derived
as follows: (Jr. Business Analyst at $160 per hour for 10 hours =
$1,600). The Commission derived this estimate based on per hour
figures from SIFMA's Management & Professional Earnings in the
Securities Industry 2013.
\267\ 10 hours per broker-dealer that routes institutional
orders per quarter x 4 quarters = 40 hours per broker-dealer that
routes institutional orders. The Commission estimates the total
monetized burden for this requirement to be $6,400 ($1,600 per
broker-dealer that routes institutional orders per quarter x 4
quarters = $6,400). See id.
\268\ 40 hours annually per broker-dealer that routes
institutional orders x 135 broker-dealers that route institutional
orders = 5,400 hours. The Commission estimates the total monetized
burden for this requirement to be $864,000 ($6,400 annually per
broker-dealer that routes institutional orders x 135 such broker-
dealers = $864,000). See id.
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The Commission estimates that each broker-dealer that routes
institutional orders that uses a third-party service provider to
prepare the report will incur an average burden of 2 hours \269\ and
$500 \270\ to prepare and make publicly available a quarterly report in
the format required by proposed Rule 606(c), or a burden of 8 hours
\271\ and $2,000 per year.\272\ Once a report is posted on an internet
Web site, the Commission does not estimate that there would be an
additional burden to allow the report to remain posted for the period
of time specified in the rule. With an estimated 65 broker-dealers that
route institutional orders that will use a third-party service provider
to prepare their reports, the total burden per year to comply with the
quarterly reporting requirement in proposed Rule 606(c) is estimated to
be 520 hours \273\ and $130,000.\274\
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\269\ The Commission estimates the monetized burden for this
requirement to be $443. The monetized cost for this burden
requirement was derived as follows: (Jr. Business Analyst at $160
per hour for 1 hour + Compliance Manager at $283 per hour for 1 hour
= $443). The Commission derived this estimate based on per hour
figures from SIFMA's Management & Professional Earnings in the
Securities Industry 2013.
\270\ The Commission estimates a third-party service provider
would charge on average $500 to prepare a report required by the
rule.
\271\ 2 hours per broker-dealer that routes institutional orders
per quarter who uses a third-party servicer provider x 4 quarters =
8 hours per such broker-dealer. The Commission estimates the total
monetized burden for this requirement to be $1,772 ($443 per broker-
dealer that routes institutional orders who uses a third-party
servicer provider per quarter x 4 quarters = $1,772). See supra note
269.
\272\ $500 per report x 4 reports per year = $2,000. See supra
note 270.
\273\ 8 hours annually per broker-dealer that routes
institutional orders who will use a third-party servicer provider to
prepare its reports x 65 such broker-dealers = 520 hours. The
Commission estimates the total monetized burden for this requirement
to be $115,180 ($1,772 annually per broker-dealer that routes
institutional orders x 65 such broker-dealers = $115,180).
\274\ $2000 per broker-dealer who will use a third-party service
provider to prepare its reports x 65 such broker-dealers = $130,000.
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Therefore, the total annual burden for all 200 broker-dealers who
route institutional orders to comply with the quarterly reporting
requirement in proposed Rule 606(c) is estimated to be 5,920 hours
\275\ and $130,000.\276\
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\275\ 40 hours per broker-dealer that routes institutional
orders who will create the required reports x 135 such broker-
dealers + 8 hours per broker-dealer that routes institutional orders
who will use a third-party service provider to create the required
reports itself x 65 such broker-dealers = 5,920 hours. The
Commission estimates the total monetized burden for this requirement
to be $979,180 ($6,400 per broker-dealer that will create the
reports itself x 135 such broker-dealers + $1,772 per broker-dealer
who uses a third-party service provider to create the required
reports x 65 such broker-dealers = $979,180). See supra notes 267
and 271.
\276\ See supra notes 274.
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3. Requirement To Document Methodologies for Categorizing Institutional
Order Routing Strategies
a. Initial Reporting and Recordkeeping Burden
The Commission estimates that broker-dealers that route
institutional orders already have descriptions for their order routing
strategies (or employ third-party vendors who have descriptions for
such strategies) and will need to assign each order routing strategy
for institutional orders to comply with the passive, neutral, and
aggressive categories. Thus, the Commission estimates that the one-
time, initial burden for a broker-dealer that routes institutional
orders to assign its own current strategies and establish and document
its specific methodologies for assigning order routing strategies as
required by Rule 606(b)(3)(v) to be 40 hours.\277\ The Commission
estimates that, consistent with its estimates above, 135 broker-dealers
that route institutional orders would do this in-house. With an
estimated 135 broker-dealers who will assign their strategies and
establish and document its specific methodologies for assigning
institutional order routing strategies as passive, neutral, and
aggressive in-house, the total initial burden for such broker-dealers
is estimated to be 5,400 hours.\278\
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\277\ The Commission estimates the monetized burden for this
requirement to be $12,620. The Commission derived this estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: Sr. Business Analyst at
$251 per hour for 20 hours + Attorney at $380 per hour for 20 hours
= 40 hours and $12,620. This burden hour estimate was based on
discussions with various industry participants.
\278\ 40 hours per broker-dealer that routes institutional
orders x 135 such broker-dealers = 5,400 hours. The Commission
estimates the total monetized burden for this requirement to be
$1,703,700 ($12,620 per broker-dealer that routes institutional
orders x 135 such broker-dealers = $1,703,700). See id.
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[[Page 49473]]
The Commission estimates that the one-time, initial burden for the
65 broker-dealers that route institutional orders who will work with a
third-party service provider to assign each order routing strategy for
institutional orders into passive, neutral, and aggressive categories
and establish and document its specific methodologies for assigning
order routing strategies as required by Rule 606(b)(3)(v) to be 10
hours \279\ and $5,000.\280\ With an estimated 65 broker-dealers that
route institutional orders who will work with a third-party service
provider, the total initial burden for such broker-dealers to assign
their current routing strategies for institutional orders into passive,
neutral, and aggressive strategies is estimated to be 650 hours \281\
and $325,000.\282\
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\279\ The Commission estimates the monetized burden for this
requirement to be $2,896. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Compliance Manager at $283 per hour
for 4 hours + Sr. Business Analyst at $251 per hour for 4 hours +
Attorney at $380 per hour for 2 hours = 10 hours and $2,896. This
burden hour estimate was based on discussions with various industry
participants.
\280\ The Commission estimates a third-party service provider
would charge on average $5,000 to assign into one of the three
categories the current strategies a broker-dealer uses and establish
and document the specific methodologies for assigning order routing
strategies as required by Rule 606(b)(3)(v).
\281\ 10 hours per broker-dealer that routes institutional
orders who will engage a third-party service provider to assign into
one of the three categories its routing strategies and document such
categorizations x 65 such broker-dealers = 650 hours. The Commission
estimates the total monetized burden for this requirement to be
$188,2400 ($2,896 per broker-dealer that routes institutional orders
x 65 such broker-dealers = $188,240). See supra note 279.
\282\ $5,000 per broker-dealer who will use a third-party
service provider to assign into one of the three categories its
routing strategies and document the methodologies for making such
assignments x 65 such broker-dealers = $325,000. See supra note 280.
---------------------------------------------------------------------------
Therefore, the total initial burden for all 200 broker-dealers who
route institutional orders to comply with the requirement to document
the methodologies for categorizing order routing strategies in proposed
Rule 606(b)(3)(v) is estimated to be 6,050 hours \283\ and
$325,000.\284\
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\283\ 5,400 hours for broker-dealers who will assign each order
routing strategy into one of the three categories and document
methodologies for assigning such order routing strategies in-house
plus 650 hours for broker-dealers who will use a third-party service
provider to assign into one of the three categories its routing
strategies, document the methodologies for making such assignments,
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments = 6,050 hours. The Commission estimates the monetized
burden for this requirement to be $1,891,940 ($1,703,700 for broker-
dealers who will assign into one of the three categories its routing
strategies, document the methodologies for making such assignments,
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments in-house plus $188,240 for broker-dealers who will use a
third-party service provider to assign into one of the three
categories its routing strategies, document the methodologies for
making such assignments, and promptly update the assignments any
time an existing strategy is amended or a new strategy is created
that would change such assignments = $1,891,940). See supra notes
278 and 281.
\284\ See supra note 282.
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b. Annual Reporting and Recordkeeping Burden
Once established, broker-dealers that route institutional orders
would be required to maintain the documentation of their order routing
strategies. After a broker-dealer's strategies are initially assigned
to one of the three categories in a consistent manner, the broker-
dealer would be required to promptly update such assignments any time
an existing strategy is amended or a new strategy is created that would
change such assignment. The Commission estimates that the annual burden
for a broker-dealer who will perform the work in-house to assign the
descriptions of order routing strategies and promptly update the
assignments any time an existing strategy is amended or a new strategy
is created that would change such assignments to comply with Rule
606(b)(3)(v) will be 15 hours.\285\ With an estimated 135 broker-
dealers who route institutional orders who will maintain and assign
their own descriptions, the total annual burden for such broker-dealers
to assign the routing strategies for their institutional orders into
passive, neutral, and aggressive strategies is estimated to be 2,025
hours.\286\
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\285\ The Commission estimates the monetized burden for this
requirement to be $3,500. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Jr. Business Analyst at $160 per
hour for 10 hours + Attorney at $380 per hour for 5 hours = 15 hours
and $3,500. This burden hour estimate was based on discussions with
various industry participants.
\286\ 15 hours per broker-dealer that routes institutional
orders who will assign and maintain their own descriptions x 135
such broker-dealers = 2,025 hours. The Commission estimates the
total monetized burden for this requirement to be $472,500 ($3,500
per broker-dealer that routes institutional orders x 135 such
broker-dealers = $472,500). See id.
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The Commission estimates that the annual burden for a broker-dealer
who routes institutional orders who engages a third-party service
provider to comply with Rule 606(b)(3)(v) will be 5 hours \287\ and
$1,000.\288\ With an estimated 65 broker-dealers who route
institutional orders who will engage a third-party to assign each order
routing strategy for institutional orders into one of these three
categories, document the methodologies for making such assignments, and
promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments, the total annual burden for such broker-dealers to work
with a third-party service provider to assign the routing strategies
for their institutional orders into passive, neutral, and aggressive
strategies is estimated to be 325 hours \289\ and $65,000.\290\
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\287\ The Commission estimates the monetized burden for this
requirement to be $1,609. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Compliance Manager at $283 per hour
for 3 hours + Attorney at $380 per hour for 2 hours = 5 hours and
$1,609. This burden hour estimate was based on discussions with
various industry participants.
\288\ The Commission estimates a third-party service provider
would charge $1,000 annually to maintain and keep current strategy
categorizations strategies documentation of specific methodologies
for assigning order routing strategies as required by Rule
606(b)(3)(v).
\289\ 5 hours per broker-dealer that routes institutional orders
who will engage a third-party to assign into one of the three
categories its routing strategies, document the methodologies for
making such assignments, and promptly update the assignments any
time an existing strategy is amended or a new strategy is created
that would change such assignments x 65 such broker-dealers = 325
hours. The Commission estimates the total monetized burden for this
requirement to be $104,585 ($1,609 per broker-dealer that routes
institutional orders who will engage a third-party to assign into
one of the three categories its routing strategies, document the
methodologies for making such assignments, and promptly update the
assignments any time an existing strategy is amended or a new
strategy is created that would change such assignments x 65 such
broker-dealers = $104,585). See supra note 287.
\290\ $1,000 per broker-dealer who will use a third-party
service provider to assign into one of the three categories its
routing strategies, document the methodologies for making such
assignments, and promptly update the assignments any time an
existing strategy is amended or a new strategy is created that would
change such assignments x 65 such broker-dealers = $65,000.
---------------------------------------------------------------------------
Therefore, the total annual burden for all 200 broker-dealers who
route institutional orders to comply with the requirement to document
the
[[Page 49474]]
methodologies for categorizing order routing strategies and maintain
the documentation of such methodologies in proposed Rule 606(b)(3)(v)
is estimated to be 2,350 hours \291\ and $65,000.\292\
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\291\ 2,025 hours for broker-dealers who will assign into one of
the three categories its routing strategies, document the
methodologies for making such assignments, and promptly update the
assignments any time an existing strategy is amended or a new
strategy is created that would change such assignments in-house plus
325 hours for broker-dealers who will use a third-party service
provider to assign into one of the three categories its routing
strategies, document the methodologies for making such assignments,
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments = 2,350 hours. The Commission estimates the monetized
burden for this requirement to be $577,085 ($472,500 for broker-
dealers who will assign into one of the three categories its routing
strategies, document the methodologies for making such assignments,
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments in-house plus $104,585 for broker-dealers who will use a
third-party service provider to assign into one of the three
categories its routing strategies, document the methodologies for
making such assignments, and promptly update the assignments any
time an existing strategy is amended or a new strategy is created
that would change such assignments = $577,085). See supra notes 286
and 291.
\292\ See supra note 290.
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4. Amendment to Current Disclosures With Respect to Retail Orders
a. Initial Reporting and Recordkeeping Burden
Any broker-dealer that routes retail orders is subject to the
collection of information in Rule 606(a) and the proposed amendments
thereto. The Commission notes that there are differences among the
estimated 266 broker-dealers that are subject to retail order routing
disclosure requirements.\293\ Introducing firms typically rely
primarily on clearing brokers to handle their customer accounts, and
the collection of information burden would not apply to introducing
brokers unless they are directly involved in determining where their
customer orders are routed.\294\ The Commission estimates that there
are currently 185 clearing brokers that route retail orders. In
addition to the 185 clearing brokers, there are approximately 81
introducing brokers that receive (but do not hold) funds or securities
from their customers.\295\ Generally, introducing brokers rely on
clearing brokers to clear and execute trades and handle customer funds
and securities.\296\ However, the Commission preliminarily believes
that some introducing brokers which receive funds or securities for
customers may be involved in initiating orders or initially routing
orders on behalf of their customers and may therefore have involvement
in determining where retail orders are routed for execution. Because
such introducing brokers may have involvement in determining where
orders are routed, they have been included, along with clearing
brokers, in estimating the total burden of the proposed amendments for
institutional routing disclosure. The Commission preliminarily believes
that the estimates should be the same for a clearing broker or an
introducing broker that routes retail orders. Therefore, the Commission
estimates that there are 266 broker-dealers to which the proposed
requirements would apply.\297\
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\293\ The Commission has previously noted the differences
between these types of broker-dealers. See, e.g., Rule 606
Predecessor Proposing Release supra note 15, at 48427.
\294\ See Securities Exchange Act Release No. 40122 (June 24,
1998), 63 FR 35508 (June 30, 1998).
\295\ This estimate is based on December 2015 Form Custody data
received by the Commission.
\296\ See Rule 606 Predecessor Proposing Release, supra note 15
at 48427.
\297\ 185 clearing brokers + 81 introducing brokers that receive
funds or securities from customers = 266 broker-dealers that route
retail orders.
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Rule 606(a)(1) currently requires that broker-dealers make publicly
available quarterly reports on retail order routing. While the proposed
rule does not alter this requirement; it does modify the content of the
report. As noted above, broker-dealers will be required to account for
the proportion of non-directed marketable limit and non-marketable
limit orders as a percentage of total retail orders as well as the
percentage of such orders broken down by Specified Venue. In addition,
for each Specified Venue, broker-dealers would be required to provide
information about net payment for order flow received per share,
payment from any profit-sharing relationship received, transaction fees
paid, and transaction rebates received per share and in the aggregate
broken down by order type. The proposed rule would require that such
reports be broken down by calendar month. The proposed rule also
eliminates a requirement that the order routing information contained
in the customer reports be broken down by listing market, which
simplifies presentation of information required under the rule.
To comply with the proposed requirements, broker-dealers who do not
have systems that currently obtain information required by the rule
will have to alter their current systems to obtain, record, and retain
the information required by the proposed changes. The Commission
preliminarily believes that broker-dealers would not encounter capital
expenditures to comply with this requirement. The Commission estimates
that most broker-dealers that route retail orders already obtain the
information required by the proposed rule and that 50 broker-dealers do
not currently obtain such information.\298\ The Commission estimates
that 25 of these 50 broker-dealers would update their systems in-house,
while 25 would use third-party service providers.
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\298\ The Commission estimates that most broker-dealers
currently obtain such information. At the time of routing, for
instance, a broker-dealer should know what type an order is, (i.e.,
market or limit), whether the order is directed or not, and, if the
order is a limit order, whether the limit order is marketable or
not. Additionally, a broker-dealer should know after execution what
types of fees or rebates were received, both on a per share basis
and in the aggregate.
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The Commission estimates that the initial burden for a broker-
dealer that routes retail orders whose systems do not currently capture
all of the information required by the rule to update its systems to
capture the information required by proposed Rule 606(a) and format
that information into a report to comply with the rule will be 80
hours.\299\ Therefore, the Commission estimates the total initial
burden for the 25 broker-dealers who the Commission estimates do not
currently capture information required by the proposed rule that
perform the necessary system updates in-house will be 2,000 hours.\300\
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\299\ The Commission estimates the monetized burden for this
requirement to be $22,648. The Commission derived this cost estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: Sr. Programmer at $303 per
hour for 40 hours) + (Sr. Database Administrator at $312 per hour
for 16 hours) + (Sr. Business Analyst at $251 per hour for 16 hours)
+ (Attorney at $380 per hour for 4 hours) = 80 hours and $22,648.
\300\ 80 hours per broker-dealer that routes retail orders who
will perform necessary system updates in-house x 25 such-broker-
dealers = 2,000 hours. The Commission estimates the total monetized
burden for this requirement to be $566,200 ($22,648 per broker-
dealer that routes institutional orders x 25 such broker-dealers =
$566,200). See id.
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The Commission estimates that the initial burden for a broker-
dealer that routes retail orders to engage a third-party to program the
necessary system updates to comply with proposed Rule 606(a) will be 20
hours \301\ and $10,000.\302\ Therefore, the Commission
[[Page 49475]]
estimates the total initial burden for the 25 broker-dealers who the
Commission estimates do not currently capture information required by
the proposed rule who will engage a third-party service provider to
perform the necessary system updates will be 500 hours \303\ and
$250,000. The Commission notes that this estimate contemplates the
impact of making the reports available using the most recent versions
of the XML schema and the associated PDF renderer, as published on the
Commission's Web site, as required by both proposed Rule 606(a) and
606(b)(1). Therefore, the total initial burden estimate for all 50
broker-dealers who the Commission estimates will need to update their
systems and create a new report is 2,500 hours \304\ and $250,000.\305\
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\301\ The Commission estimates the monetized burden for this
requirement to be $5,985. The Commission derived this cost estimate
based on per hour figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013: Compliance Manager at $283
per hour for 10 hours + Sr. Business Analyst at $251 per hour for 5
hours + Attorney at $380 per hour for 5 hours = 20 hours and $5,985.
\302\ The Commission estimates that a third-party service
provider would charge an average of $10,000 to upgrade a broker-
dealer's systems to comply with proposed Rule 606(a).
\303\ 20 hours per broker-dealer that routes retail orders who
will engage a third-party service provider to perform necessary
system updates x 25 such-broker-dealers = 500 hours. The Commission
estimates the total monetized burden for this requirement to be
$149,625 ($5,985 per broker-dealer that routes institutional orders
x 25 such broker-dealers = $149,625). See supra note 301.
\304\ 2,000 hours for a broker-dealer that routes retail orders
whose systems do not currently capture the required information who
will perform upgrades + 500 hours for a broker-dealer who routes
retail orders whose systems do not currently capture the required
information who will engage a third-party to perform the necessary
upgrades = 2,500 hours. The Commission estimates the total monetized
burden for this requirement to be $715,825 ($566,200 for broker-
dealers that route retail orders whose systems do not currently
capture the required information who will perform necessary upgrades
in-house + $149,625 for broker-dealers that route retail orders
whose systems do not currently capture the required information who
will engage a third-party service provider to perform the system
updates x 25 such broker-dealers) = $715,825. See supra notes 300
and 303.
\305\ $10,000 per broker-dealer who will engage a third-party to
perform necessary updates x 25 such broker-dealers = $250,000.
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For the remaining 216 broker-dealers whom the Commission estimates
currently capture the data required by the proposed modifications to
Rule 606(a), such broker-dealers would need to only format their
reports to incorporate such data. The Commission estimates that 108 of
such broker-dealers currently engage a third-party service provider to
provide reports pursuant to existing Rule 606(a) and such broker-
dealers would continue to use third-party service providers to format
reports to comply with proposed Rule 606(a), as described further
below. The Commission estimates that the remaining 108 broker-dealers
who already capture information required by the proposed rule would
prepare and format a report to comply with the proposed rule in-house.
The Commission estimates for a broker-dealer who already captures such
data, the burden to format that data into its existing reports on its
own would be 20 hours.\306\ Therefore, the total initial burden for
broker-dealers to format already captured data into a report in-house
to comply with proposed Rule 606(a) is estimated to be 2,160
hours.\307\
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\306\ The Commission estimates the monetized burden for this
requirement to be $4,975. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Programmer at $248 per hour for 15
hours + Sr. Business Analyst at $251 per hour for 5 hours = 20 hours
and $4,975.
\307\ 20 hours per broker-dealer who will format reports in-
house x 108 such broker-dealers = 2,160 hours. The Commission
estimates the monetized burden for this requirement to be $537,300
($4,975 per broker-dealer who will format reports in-house x 108
such broker-dealers). See id.
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The Commission estimates the initial burden for the 108 broker-
dealers who engage a third-party service provider to format reports to
comply with proposed Rule 606(a) would be 8 hours \308\ and
$2,000.\309\ Therefore, for the 108 broker-dealers the Commission
estimates route retail orders who will engage a third-party to format
and prepare a report that would comply with the proposed rule, the
estimated total initial burden to comply with proposed Rule 606(a) is
864 hours \310\ and $216,000.\311\ Thus, the total estimate for the 216
broker-dealers for whom the Commission estimates currently capture the
data required by proposed Rule 606(a) to format their reports to
incorporate such data is 3,024 hours \312\ and $216,000.\313\ The
Commission notes that these estimate include the impact of making the
reports available using the most recent versions of the XML schema and
the associated PDF renderer as published on the Commission's Web site,
as required by both proposed Rule 606(a) and 606(b)(1).
---------------------------------------------------------------------------
\308\ The Commission estimates the monetized burden for this
requirement to be $2,555. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: Compliance Manager at $283 per hour
for 5 hours + Attorney at $380 per hour for 3 hours = 8 hours and
$2,555. This burden hour estimate was based on discussions with
various industry participants.
\309\ The Commission estimates a third-party service provider
would charge on average $2,000 to format already captured data into
a report that would comply with proposed Rule 606(a).
\310\ 8 hours per broker-dealer who will perform the necessary
system updates in-house x 108 such broker-dealers = 864 hours. The
Commission estimates the monetized burden for this requirement to be
$275,940 ($2,555 per broker-dealer who will perform the system
updates in-house 108 such broker-dealers). See supra note 308.
\311\ $2,000 per broker-dealer who will use a third-party
service provider to format data and prepare a report x 108 such
broker-dealers = $216,000. See supra note 309.
\312\ 2,160 hours for broker-dealers who currently capture the
information required by proposed Rule 606(a) and will format their
systems to create reports to comply with the proposed rule in-house
+ 864 hours for broker-dealers who currently capture such
information who will hire a third-party service provider to format
their systems to comply with the proposed rule = 3,024 hours. The
Commission estimates the total monetized burden for this requirement
to be $813,240 ($537,500 for broker-dealers who currently capture
the information required by proposed Rule 606(a) and will format
their systems to create reports to comply with the proposed rule in-
house + $275,940 for broker-dealers who currently capture such
information who will hire a third-party service provider to format
their systems to comply with the proposed rule = $813,240). See
supra notes 307 and 310.
\313\ See supra note 311.
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Therefore, the Commission estimates that the total initial burden
to comply with the proposed modifications to Rule 606(a) for all 266
broker-dealers which the Commission estimates route retail orders is
5,524 hours \314\ and $466,000.\315\
---------------------------------------------------------------------------
\314\ 2,500 hours for broker-dealers who need to update their
systems and prepare a report + 3,124 hours for broker-dealers who
currently capture the information required by proposed Rule 606(a)
and need to format their systems to create reports to comply with
the proposed rule = 5,524 hours. The Commission estimates the total
monetized burden for this requirement to be $1,529,065 ($715,850 for
broker-dealers who need to update their systems and prepare a report
+ $813,240 for broker-dealers who currently capture the information
required by proposed Rule 606(a) and need to format their systems to
create reports to comply with the proposed rule = $1,529,065). See
supra notes 304 and 312.
\315\ $250,000 for broker-dealers who will engage a third-party
to perform necessary upgrades + $216,000 for broker-dealers who will
engage a third-party to format reports to comply with the proposed
rule = $466,000. See supra notes 305 and 311.
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Finally, the Commission proposes to amend Rule 606(a)(1)(iv) \316\
to require broker-dealers to describe specific aspects of any terms of
payment for order flow arrangements and profit-sharing relationships,
whether written or oral, with a Specified Venue that may influence
their order routing decisions, including information relating to
specific incentives or volume minimums.\317\ The Commission estimates
that the initial burden for a broker-dealer that routes retail orders
to review, assess, and disclose its payment for order flow arrangements
and profit-sharing relationships would be 10
[[Page 49476]]
hours \318\ and that all 266 broker-dealers who route retail orders
would describe such agreements and arrangements themselves. Therefore,
the total initial burden for all broker-dealers who route retail orders
to review, assess, and disclose its payment for order flow arrangements
and profit-sharing relationships is estimated to be 2,660 hours.\319\
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\316\ Renumbered from Rule 606(a)(1)(iii).
\317\ See proposed Rule 606(a)(1)(iv).
\318\ The Commission estimates the monetized burden for this
requirement to be $3,155. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: (Sr. Business Analyst at $251 per
hour for 5 hours) + (Attorney at $380 per hour for 5 hours) = 10
hours and $3,155.
\319\ 10 hours per broker-dealer that routes retail orders x 266
such broker-dealers = 2,660 hours. The Commission estimates the
total monetized burden for this requirement to be $839,230 ($3,155
per broker-dealer that routes retail orders x 266 such broker-
dealers = $839,230). See id.
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b. Annual Reporting and Recordkeeping Burden
Rule 606(a) currently requires brokers-dealers that route retail
orders to make available reports on the routing of all non-directed
orders. The proposed changes to Rule 606(a)(1) will: (1) Eliminate the
requirement that such reports be divided based on primary listing
market and instead aggregate all NMS stocks into a single section; (2)
add requirements that the reports contain information relating to the
routing of marketable and non-marketable orders, as well as average
payment for order flow for different types of orders; (3) require
broker-dealers to describe any terms of payment for order flow
arrangements and profit-sharing relationships with a Specified Venue
that may influence their order routing decisions; and (4) require that
such reports be made available using the most recent versions of the
XML schema and the associated PDF renderer as published on the
Commission's Web site.\320\ The proposed amendments do alter the
information currently collected under an existing collection of
information requirement. The Commission preliminarily believes that
once the initial burdens, described above, have been incurred to allow
the broker-dealer to obtain the required information, the ongoing
burden to produce a quarterly report would remain the same. However,
broker-dealers would need to monitor payment for order flow and profit-
sharing relationships and potential SRO rule changes that could impact
their order routing decisions and incorporate any new information into
their reports. Thus, the Commission estimates the average annual burden
for a broker-dealer to comply with the proposed amendments to Rule
606(a)(1)(i)-(iii) would be 10 hours.\321\ Thus, the total annual
burden for all broker-dealers to comply with the proposed amendments is
estimated to be 2,660 hours.\322\
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\320\ See supra Section III.B.
\321\ The Commission estimates the monetized burden for this
requirement to be $3,155. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: (Sr. Business Analyst at $251 per
hour for 5 hours) + (Attorney at $380 per hour for 5 hours) = 10
hours and $3,155.
\322\ 10 hours per broker-dealer that routes retail orders x 266
such broker-dealers = 2,660 hours. The Commission estimates the
total monetized burden for this requirement to be $839,230 ($3,155
per broker-dealer that routes retail orders x 266 such broker-
dealers = $839,230). See id.
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Proposed Rule 606(a)(1)(iv) would require broker-dealers to
describe any terms of payment for order flow arrangements and profit-
sharing relationships with a Specified Venue that may influence their
order routing decisions. Current Rule 606(a)(1)(iii), being renumbered
as proposed Rule 606(a)(iv), requires broker-dealers to provide a
discussion of the material aspects of the broker-dealer's relationship
with each Specified Venue, including a description of any arrangement
for payment for order flow and any profit-sharing relationship.
Therefore, the proposed changes would require broker-dealers to
describe any terms of payment for order flow arrangements and profit-
sharing relationships with a Specified Venue that may influence their
order routing decisions, in addition to the material aspects of the
broker-dealer's relationship with each Specified Venue. Additionally,
the costs noted in this section include the impact of posting the
required reports in the specified format to an internet Web site. Once
a report is posted on an internet Web site, the Commission estimates
that there would not be an additional burden to allow the report to
remain posted for the period of time specified in the rule. The
Commission estimates that the average annual burden for a broker-dealer
that handles retail orders to describe and update any terms of payment
for order flow arrangements and profit-sharing relationships with a
Specified Venue that may influence their order routing decisions to be
15 hours.\323\ With 266 broker-dealers involved in retail order routing
practices that would be required to comply with the rule, the
Commission estimates the total annual burden for complying with
proposed Rule 606(a)(1)(iv) to be 3,990 hours.\324\
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\323\ The Commission estimates the monetized burden for this
requirement to be $3,500. The Commission derived this estimate based
on per hour figures from SIFMA's Management & Professional Earnings
in the Securities Industry 2013: (Jr. Business Analyst at $160 per
hour for 10 hours) + (Attorney at $380 per hour for 5 hours) = 15
hours and $3,500.
\324\ 15 hours annually per broker-dealer that routes retail
orders x 266 such broker-dealers = 3,990 hours. The Commission
estimates the total monetized burden for this requirement to be
$931,000 ($3,500 annually per broker-dealer that routes retail
orders x 266 such broker-dealers = $931,000). See id.
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5. Amendment to Current Disclosures Under Rule 605
Currently, Rule 605 requires market centers make available
standardized, monthly reports of statistical information concerning
their order executions. Further, the Rule requires that such reports be
in electronic form and be made available for downloading from an
Internet Web site that is free and readily accessible to the public.
The proposed amendment to Rule 605 would require that such reports be
kept posted on an Internet Web site that is free of charge and readily
accessible to the public for a period of three years from the initial
date of posting on the Internet Web site. Because reports are already
posted to an internet Web site pursuant to current Rule 605, the
Commission estimates the proposed amendment to Rule 605 would not
impose an additional burden. The proposed amendment prescribes a
minimum period of time for which such reports that are already required
to be posted on an Internet Web site shall remain posted.
E. Collection of Information Is Mandatory
All of the collection of information would be mandatory.
F. Confidentiality of Responses to Collection of Information
To the extent that the Commission receives confidential information
pursuant to the collection of information, such information will be
kept confidential, subject to the provisions of applicable law.\325\
Any information required to be disclosed publicly by the proposed Rules
would not be confidential.
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\325\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing
the public availability of information obtained by the Commission).
---------------------------------------------------------------------------
The quarterly order routing reports prepared and disseminated by
broker-dealers pursuant to Rules 606(a) and 606(c), as proposed, would
be available to the public. The individual responses by broker-dealers
to customer requests for order routing information required by Rules
606(b)(1) and (b)(3), as proposed, would be made available the
customer. The Commission, SROs, and
[[Page 49477]]
other regulatory authorities could obtain copies of these reports as
appropriate.
G. Retention Period for Recordkeeping Requirements
Pursuant to proposed Rule 606(a), broker-dealers shall be required
to keep quarterly retail order routing reports posted on an Internet
Web site that is free and readily accessible to the public for a period
of three years from the initial date of posting on the Internet Web
site.
For Rule 606(b), broker-dealers shall be required to preserve all
communications required under these proposed amendments pursuant to
Rule 17a-4, as applicable.\326\ For the categorization of order routing
strategies pursuant to proposed Rule 606(b)(3)(v), broker-dealers shall
be required to preserve such records in a manner consistent with Rule
17a-4(b), specifically for a period of not less than three years, the
first two years in an easily accessible place.
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\326\ 17 CFR 240.17a-4. Registered brokers and dealers are
already subject to existing recordkeeping and retention requirements
under Rule 17a-4.
---------------------------------------------------------------------------
Pursuant to proposed Rule 606(c), broker-dealers shall be required
to keep public aggregated institutional order handling reports posted
on an Internet Web site that is free and readily accessible to the
public for a period of three years from the initial date of posting on
the Internet Web site.
Pursuant to the proposed amendments to Rule 605, market centers
shall be required to keep order execution reports posted on an Internet
Web site that is free and readily accessible to the public for a period
of three years from the initial date of posting on the Internet Web
site.
H. Request for Comments
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
120. Evaluate whether the proposed collections of information are
necessary for the proper performance of the functions of the agency,
including whether the information shall have practical utility;
121. Evaluate the accuracy of our estimates of the burden of the
proposed collection of information;
122. Determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected; and
123. Evaluate whether there are ways to minimize the burden of
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090, with reference to File Number S7-14-16.
Requests for materials submitted to OMB by the Commission with regard
to this collection of information should be in writing, with reference
to File Number S7-14-16 and be submitted to the Securities and Exchange
Commission, Office of FOIA/PA Services, 100 F Street NE., Washington,
DC 20549-2736. As OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication, a
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication.
V. Economic Analysis
The Commission is sensitive to the economic consequences and
effects, including costs and benefits, of its rules. The following
economic analysis identifies and considers the costs and benefits--
including the effects on efficiency, competition, and capital
formation--that may result from the proposed amendments to Rules 600,
605, and 606.\327\ These costs and benefits are discussed below and
have informed the policy choices described throughout this release.
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\327\ The Commission also considered the proposed amendments to
Rule 607 and preliminarily believes that there are no costs and
benefits associated with those proposed amendments. The proposed
amendments to Rule 607 replace ``customer order'' with ``retail
order'' to be consistent with the proposed amendments to Rule
600(b)(19). However, since the definition in proposed Rule
600(b)(19) remains unchanged, there are no cost and benefits to the
proposed amendments to Rule 607. The Commission is also proposing to
amend Rule 3a51-1(a) under the Exchange Act; Rule 13h-1(a)(5) of
Regulation 13D-G; Rule 105(b)(1) of Regulation M; Rules 201(a) and
204(g) of Regulation SHO; Rules 600(b), 602(a)(5), 607(a)(1), and
611(c) of Regulation NMS; and Rule 1000 of Regulation SCI, to update
cross-references as a result of today's proposal, which would not
result in costs or benefits.
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A. Introduction
Among the primary economic considerations for the proposed
amendments to Rule 600, Rule 605, and Rule 606 are transparency for
customers placing institutional orders, enhanced transparency for
customers placing retail orders, and enhanced access to order handling
reports.
The Commission proposes to amend Rule 600 to include a definition
of ``institutional order'' and to amend Rule 606 to require broker-
dealers to (1) disclose standardized customer-specific institutional
order handling information to their customers, including the use of
actionable IOIs in executing institutional orders and (2) make publicly
available for each calendar quarter a report that aggregates the
information required for customer-specific institutional order handling
reports for all institutional orders they receive.
In short, and as discussed earlier, the Commission preliminarily
believes that standardizing customer-specific institutional order
handling disclosures, as would be required by proposed Rule 606(b)(3),
would provide information to customers to enable them to: (1) Assess
the potential for information leakage with the routing of their orders;
(2) assess the conflicts of interest that may influence the broker-
dealer's order handling practices; and (3) compare institutional order
handling practices across multiple broker-dealers. The Commission also
preliminarily believes that requiring broker-dealers to disclose their
use of actionable IOIs in executing institutional orders will be useful
to customers assessing broker-dealers' order handling decisions,
particularly in regards to analyzing information leakage.
In addition, the Commission preliminarily believes that public
disclosure by each broker-dealer of aggregated information about its
institutional order handling, as would be required by proposed Rule
606(c), would, among other things, (1) assist market participants,
including customers, in comparing the order handling services of all
broker-dealers; (2) facilitate customers' ability to make informed
decisions when engaging a broker-dealer's services; (3) provide
academics and other members of the public with access to additional
data for conducting research on institutional order routing and market
execution quality; (4) allow broker-dealers to better compare their own
services against other broker-dealers; and (5) permit trading centers
to better compare their execution statistics against other trading
centers.
The Commission preliminarily believes that the customer-specific as
well as the public aggregated institutional order handling reports may
further incentivize broker-dealers to provide customers with higher-
quality routing services when executing their institutional orders,
thereby mitigating the potential for information leakage,
[[Page 49478]]
and better manage any potential conflicts of interest the broker-
dealers may face. The Commission also preliminarily believes that the
reports will promote competition among broker-dealers to capture
customers' order flow, and among trading centers for order execution.
With respect to retail orders, the Commission proposes to amend
Rule 606(a)(1) to include new subparagraph (iii) to require that, for
each Specified Venue, the broker-dealer must report the net aggregate
amount of any payment for order flow received, payment from any profit-
sharing relationship received, transaction fees paid, and transaction
rebates received, both as a total dollar amount and on a per share
basis, for each of the following non-directed order types: (1) Market
orders; (2) marketable limit orders; (3) non-marketable limit orders;
and (4) other orders.\328\ In addition, proposed amendments to Rule
606(a)(1)(iv) would require disclosure of a description of any terms of
payment for order flow arrangements and profit-sharing relationships,
whether written or oral, with a Specified Venue that may influence a
broker-dealer's order routing decisions, including, but not limited to:
(1) Incentives for equaling or exceeding an agreed upon order flow
volume threshold, such as additional payments or a higher rate of
payment; (2) disincentives for failing to meet an agreed upon minimum
order flow threshold, such as lower payments or the requirement to pay
a fee; (3) volume-based tiered payment schedules; and (4) agreements
regarding the minimum amount of order flow that the broker-dealer would
send to a venue. The Commission preliminarily believes that these
amendments will enhance transparency on the routing of retail orders
and enhance competition among broker-dealers that route retail orders,
to the benefit of investors.
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\328\ See proposed Rule 606(a)(1)(iii).
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In addition, the Commission preliminarily believes that the
proposed amendments would allow customers to better assess the retail
order routing and execution quality offered by their broker-dealers. As
a result, the Commission preliminarily believes that these additional
disclosures may provide broker-dealers further incentives to improve
execution quality for their customers and better manage any potential
for conflicts of interest the broker-dealers may face. In addition, the
ability of customers to better assess routing and execution quality
could also lead to increased competition among broker-dealers with
respect to execution quality, which could, in turn, result in broker-
dealers providing even higher-quality retail order routing and
execution services.
The Commission is further proposing to require that all reports on
institutional order handling and retail order routing be provided in a
consistent, structured format. The Commission preliminarily believes
that requiring the reports be provided in this format would be useful
to customers as it would allow them to more easily analyze and compare
data across broker-dealers.
Finally, the Commission is proposing to amend Rules 605 and 606 of
Regulation NMS to require that the public order execution and order
routing reports be kept publicly available for a period of three years.
The Commission preliminarily believes that this would allow the public
to more efficiently evaluate the services of broker-dealers because it
would be easier for the public to access historic reports and analyze
the data over an extended time period. For example, at a minimum, the
public would have access to three years of historic data and may choose
to download the reports periodically to analyze data over a time period
of more than three years.
The discussion below presents an overview of the current practices
with regards to the reporting and disclosure of order routing and
execution quality for institutional as well as retail orders, a
consideration of the costs and benefits of the proposed new reporting
requirements for institutional orders and of the proposed amendments to
the reporting requirements for retail orders, and a discussion of the
potential effects of the proposed amendments to Rule 606 on efficiency,
competition, and capital formation. This discussion will also describe
the Commission's proposal to amend Rule 605 by requiring market centers
to keep public execution reports posted on an Internet Web site that is
accessible to the public for a period of three years.
B. Baseline
The baseline for considering the economic impact of amending Rule
606 to require reporting for institutional orders consists of: (1)
Information that customers currently receive from their broker-dealers
regarding how their institutional orders are handled; (2) the format in
which such information is currently provided to customers; (3)
conflicts of interest broker-dealers currently face; (4) the current
use of actionable IOIs; and (5) the ability to assess order routing and
execution quality currently provided by different broker-dealers and
execution quality currently provided by different trading centers.
The baseline for considering the economic impact of amending Rule
606 for retail orders and of amending Rule 605 consists of: (1)
Information that customers currently receive under current Rules 605
and 606 or information that customers currently receive from their
broker-dealers that is not required by current Rules 605 and 606; (2)
the format in which information required by current Rule 606 for retail
orders is provided to customers; (3) conflicts of interest broker-
dealers currently face; (4) how long reports required by current Rules
605 and 606 are available to the public; and (5) the ability to assess
order routing and execution quality currently provided by different
broker-dealers and execution quality currently provided by different
trading centers.
Further, the baseline for considering the economic impact of
amending Rule 606 for institutional and retail orders and Rule 605
comprises the current competitive landscape in the markets for
brokerage services and for execution services and any current
limitations on efficiency or capital formation relevant to the proposed
amendments. These various baseline factors are discussed in further
detail below.
1. Ad Hoc Reports for Institutional Orders
Currently, broker-dealers may voluntarily provide some information
on routing and execution quality of institutional orders to individual
customers in response to requests by these customers. Customers may
also use third-party vendors for TCA (e.g., to analyze the execution
prices of orders compared to various benchmarks). However, the
Commission understands that TCA provided by third-party vendors
generally does not encompass an analysis of routing decisions because
the third-party vendors, similar to customers, do not have access to
the order handling information necessary to do so. Therefore, the
completeness of any analysis of institutional orders, including TCA, is
affected by a lack of specific order handling information with regard
to the various venues to which institutional orders are routed. In
addition, while TCA provided by third-party vendors may focus on
measuring and comparing execution quality of orders, TCA does so
typically at the parent order or broker-dealer level, and generally not
at the trading center level, because the third-party vendors, again, do
not have access to the information about institutional order handling
that would be necessary to do so.
[[Page 49479]]
The Commission further understands that reports that institutional
customers currently receive upon request from their broker-dealers may
not provide the consistent and standardized information needed to fully
assess the performance of their broker-dealers. In particular, the
Commission understands that these reports are not prepared or presented
in a uniform manner that allows for easy comparison of institutional
order handling across different broker-dealers, and there is no
uniformity in the current disclosure of execution fees charged or
rebates paid by the trading centers to the broker-dealers. The reports
contain what the broker-dealers provide upon the requests of customers
or what the customers specifically request from the broker-dealers. As
a result, a broker-dealer will often supply reports containing
different information to different customers, and more importantly, a
customer may receive reports containing different information from
different broker-dealers. Further, even if the reports contain the same
data elements, those data elements may not be computed in the same way
or use the same terminology across different broker-dealers or over
time for the same broker-dealer. These differences make it more
difficult for institutional customers to compare broker-dealers or to
examine one broker-dealer's performance over time. In addition, as
these reports are not standardized and vary by broker-dealer or by
customer, the Commission understands that some of these reports group
order routing strategies by their aggressiveness,\329\ while other
reports do not.
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\329\ This grouping could be similar to the grouping into
aggressive, neutral, and passive as proposed in Rule 606(b)(3).
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Even if a broker-dealer voluntarily provides information about
institutional orders upon request, it may not do so with respect to all
customers. Whether a given customer receives a report and how
responsive the report is to the request likely depends on the
customer's current or potential business relationship with the broker-
dealer. A broker-dealer may be more accommodating towards customers
that send, or may send in the near future, substantial order flow. To
the extent that some customers receive reports from broker-dealers
while other customers do not or that some customers receive higher-
quality reports than other customers, the playing field may not be
level with respect to institutional order handling information.
Moreover, the public currently does not have access to information
on the performance of broker-dealers relating to institutional orders.
Under current Rule 606, a broker-dealer is not required to provide
public reports for orders having a market value of $200,000 or more.
While an institutional customer can request ad-hoc reports from broker-
dealers about the handling of its orders, the lack of public reports
relating to institutional orders makes it infeasible for an
institutional customer to compare handling of institutional orders by
broker-dealers that the customer does not have a business relationship
with. For the broker-dealers that the customer does send orders to, the
customer is not able to compare these broker-dealers more generally
based on all orders those broker-dealers handle rather than only the
orders the customer sends to the broker-dealers.\330\ Institutional
customers and the public may use public reports for retail orders
required under current Rule 606 to evaluate broker-dealers, with the
effectiveness of that approach being dependent upon how good a proxy
the order routing for retail orders is for the order routing for
institutional orders. The Commission understands that some customers
use the reports for retail orders required by current Rule 606 to
predict, among other things, the execution quality of institutional
orders.
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\330\ Currently, a customer placing institutional orders can
only compare broker-dealers based on the orders it had sent to the
broker-dealers because only those are contained in the ad-hoc
reports the broker-dealers provide upon request, but cannot compare
how the broker-dealers handle the orders it had sent compared to all
of the institutional orders the broker-dealers had received. In
addition, the ad-hoc reports provided by the broker-dealers upon
request by a customer placing institutional orders may be provided
in different formats and contain different and potentially
inconsistent information, which makes the comparison of the order
routing decisions and execution quality of broker-dealers more
difficult and less useful.
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2. Publication Period for Reports on Retail Orders Required by Current
Rules 605 and 606
Currently, Rule 605 does not specify the minimum length of time
that market centers need to post publicly the order execution reports
and Rule 606 does not specify a minimum length of time that broker-
dealers need to post publicly the order routing reports. The Commission
understands that generally, when reports are posted, market centers and
broker-dealers will remove the previous report from their Web site and
replace it with their most recent report,\331\ though some may make
reports available for a longer period of time that varies.\332\ The
Commission understands that this may make it difficult for the public
to analyze historical data. For example, the public must download the
data regularly to have access to historical data. Alternatively, the
public may rely on third-party vendors who retrieve and aggregate Rule
605 and 606 reports from market centers and broker-dealers,
respectively, to get access to historical data.
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\331\ See, e.g., Morgan Stanley Rules 605 and 606 Disclosures,
available at http://www.morganstanley.com/institutional-sales/sec_rules_605_606; Wells Fargo Legal Disclosures, available at
https://www.wellsfargoadvisors.com/disclosures/legal-disclosures.htm; Charles Schwab Order Routing, available at http://www.schwab.com/public/schwab/nn/legal_compliance/important_notices/order_routing.html; TD Ameritrade Disclosures, available at https://www.tdameritrade.com/disclosure.page; Fidelity Quarterly Reports,
available at https://capitalmarkets.fidelity.com/app/item/RD_13569_21696.html.
\332\ See, e.g., UBS Order Routing Disclosure, available at
https://www.ubs.com/us/en/wealth/misc/orderroutingdisclosure.html.
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3. Available Information on Conflicts of Interest
Current Rule 606 requires for retail orders, among other things, a
description of any arrangement for payment for order flow \333\ and any
profit-sharing relationships. The current required disclosure is
designed to set forth arrangements, including financial relationships,
that could lead to conflicts of interest for a broker-dealer when
routing retail orders.\334\ Broker-dealers have a variety of choices
for order routing and execution, and the venue that a broker-dealer
chooses may have a tangible effect on the execution quality of an
order. Broker-dealers face conflicts of interest when routing orders,
such as affiliations with trading centers, receipt of payment for order
flow or receipt of payment from any profit-sharing relationship, and
liquidity rebates. For example, recent research analyzed the relation
between maker-taker fee schedules and order routing. According to this
study, four out of ten national brokerage firms appear to consistently
route limit orders to the
[[Page 49480]]
exchange(s) paying the highest rebate for those limit orders. In this
research, an analysis of proprietary limit order data and trades from
NYSE's trade and quote (``TAQ'') data showed strong empirical evidence
of a negative relation between take fees and limit order execution
quality.\335\ The Commission preliminarily believes that such financial
incentives have the potential to affect how broker-dealers route retail
orders; however, these conflicts of interest might not only affect
retail orders.
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\333\ In addition, Rule 10b-10 under the Exchange Act requires
broker-dealers, when acting as agent for the customer, to disclose
on the confirmation of a transaction whether payment for order flow
was received and, upon written request of the customer, to furnish
the source and nature of the compensation received. See 17 CFR
240.10b-10(a)(2)(i)(C). Accordingly, Rule 10b-10 provides disclosure
to a specific customer of whether payment for order flow was
received on a particular transaction while Rule 606 provides public
disclosure of any arrangement for payment for order flow and any
profit-sharing relationship by requiring a description of such
arrangements.
\334\ 17 CFR 242.606(a)(1)(iii). See Rule 606 Predecessor
Adopting Release, supra note 15, at 48417 (stating that ``[t]he
purpose of requiring disclosure of any relationships between a
broker-dealer and the venues to which it routes orders is to alert
customers to potential conflicts of interest that may influence the
broker-dealer's order-routing practices.'').
\335\ See Battalio, Corwin, and Jennings Paper, supra note 57.
The authors ``document a strong negative relation between take fees
and several measures of limit order execution quality. Based on this
evidence, [they] conclude that the decision of some national
brokerages to route all nonmarketable limit orders to a single
exchange paying the highest rebate is not consistent with the
broker's responsibility to obtain best execution for customers.''
See id.
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Under the quarterly disclosure obligations in current Rule 606(a),
a broker-dealer is required to discuss the material aspects of the
broker-dealer's relationship with each Specified Venue (which is
determined based on retail order routing), including a description of
any arrangement for payment for order flow, but broker-dealers are not
required to provide information on the net amount of payment for order
flow per share or by order type nor payment received for any profit-
sharing relationship. Further, current Rule 606(a) does not require
broker-dealers to disclose rebates received and access fees paid per
share or by order type nor does it require a description of the terms
of a payment for order flow arrangement or profit-sharing relationship
that may influence a broker-dealer's order routing decision. The
current information required by Rule 606(a) can be used by customers to
assess order routing and execution services of broker-dealers as well
as the potential conflicts of interest faced by broker-dealers in
providing such services and determine whether to retain the services of
broker-dealers or to discontinue the use of such services. In addition,
broker-dealers could use the current information required by Rule
606(a) as a means to evaluate and enhance their order routing and
execution services, compare their order routing and execution services
to that of other firms, and use such comparisons in selling their
services to customers.
Moreover, current Rule 606(a) does not specify a minimum length of
time that reports must be made available from broker-dealers. As a
result, customers placing retail orders may not be able to compare the
order routing decisions of a broker-dealer through time, if past
quarterly reports are not available. Instead, customers may need to
rely on third-party vendors to provide and/or analyze past quarterly
reports.
As noted above, conflicts of interest may affect institutional
orders in ways similar to effects on retail orders. The ad hoc nature
of the current order handling disclosures of institutional orders is
not conducive to providing institutions with information they can use
efficiently to assess conflicts of interest. In particular, a broker-
dealer for which conflicts of interest influence routing decisions may
have the incentive to obscure the conflicts of interest in the ad hoc
reports.
4. Available Information on Execution Quality for Institutional and
Retail Orders
The Commission preliminarily believes that broker-dealers are
incentivized to provide their customers with information about the
quality of services they offer as they may lose business if their
competitors provide reports and they do not. However, as described
above, under current rules, broker-dealers are not required to provide
customers standardized reports about the handling of their
institutional orders and instead customers may receive ad-hoc reports
from broker-dealers upon request. Additionally, a broker-dealer may
have an incentive to structure its reports and provide data in a way
that is advantageous to the broker-dealer. Specifically, broker-dealers
may want to design the ad hoc reports to highlight areas where the
broker-dealer believes it compares well to others and obscure areas
where the broker-dealer may not compare well or where customers are
likely to have concerns. Separately, there are no public reports about
the handling of institutional orders for independent research and
analysis, by academic researchers, the public at large, or third-party
vendors. Due to the limitations noted above, the Commission
preliminarily believes that customers may not be able to compare the
institutional order handling performance of broker-dealers reliably and
as a result, broker-dealers may have less incentive to compete on the
quality of their institutional order handling, which may result in
broker-dealer routing practices that are suboptimal for customers,
e.g., practices that do not avoid excessive information leakage or that
may not provide the execution quality desired by the customer.
For customers placing retail orders, current Rule 606 requires
quarterly public reports on retail order routing and disclosure of
retail order routing information upon request, but the reports do not
require information on payment for order flow received, payment from
any profit-sharing relationship received, or transaction rebates and
access fees, and they are not required to separate limit orders into
marketable and non-marketable limit orders. As a result, it may be
difficult for customers to use the information provided in the reports
to evaluate the quality of their broker-dealers' retail order routing.
Customers may therefore not be well informed as to how their broker-
dealers manage any potential conflicts of interest they may face. The
Commission preliminarily believes providing payment for order flow data
in the quarterly public reports, broken down by calendar month,
separately for marketable and non-marketable limit orders would create
an opportunity for more detailed analysis.\336\
---------------------------------------------------------------------------
\336\ See Battalio, Corwin, and Jennings Paper, supra note 57.
---------------------------------------------------------------------------
As noted above, the current information on retail order routing
required by Rule 606(a) may spur competition between broker-dealers on
the basis of order routing services and execution quality.\337\
Customers may use the information required by Rule 606(a) to evaluate
and retain the services of a broker-dealer or to discontinue the use of
such services. In addition, broker-dealers may use the current
information required by Rule 606(a) as a means to: (1) Evaluate and
enhance their order routing and execution services; (2) compare their
order routing and execution services to that of other firms; and (3)
use such comparison in selling their services to customers.
---------------------------------------------------------------------------
\337\ See supra Section III.B.
---------------------------------------------------------------------------
5. Format of Current Reports for Institutional and Retail Orders
As discussed above, broker-dealers currently may provide some
information on routing and execution quality of institutional orders to
individual customers in response to requests by these customers. The
Commission understands that broker-dealers provide these reports in a
variety of formats and a given broker-dealer may use different formats
for different customers and/or may modify their formats over time. The
formats of these reports vary from unstructured to structured formats,
such as unstructured text and PDF files to structured XML files. The
Commission is soliciting comment on whether broker-dealers currently
provide their reports in a structured or unstructured format, and which
format the broker-dealers use for these reports. For those broker-
dealers that provide their reports
[[Page 49481]]
in a structured format, the Commission is further soliciting comment on
how prevalent or useful the selected structured format is.
Under current Rule 606(a), broker-dealers are required to provide
public quarterly reports on retail order routing. The current Rule
606(a) does not specify a format for these reports. The Commission
understands that broker-dealers currently provide these reports on a
Web site or downloadable as a PDF file. The reports typically are
presented as tables with one line for each listing exchange for NMS
stocks and exchange-listed options, where each row represents metrics
for a particular routing venue, but they are not in a structured
format.
6. Quality of Broker-Dealer Routing Practices for Institutional Orders
The Commission does not have data to gauge the current level of
quality of broker-dealer routing practices for institutional orders, as
current Rule 606 only covers retail orders and not institutional
orders.\338\ As noted, customers of broker-dealers can and do request
ad-hoc reports about the handling of their orders and broker-dealers
may voluntarily provide such reports. Customers can use those reports
to evaluate their broker-dealers' routing practices. This, in turn, may
give broker-dealers additional incentives to provide high execution
quality to their customers. However, as discussed, there are
limitations to the current situation, namely, the ad-hoc reports are
not standardized across broker-dealers and there are no public reports
that would allow customers to evaluate all broker-dealers, independent
of whether they place orders with them or not.
---------------------------------------------------------------------------
\338\ As noted above, including in Section V.B.3., current Rule
606 provides information on the quality of broker-dealer routing
practices for retail orders.
---------------------------------------------------------------------------
7. Use of Actionable IOIs in Institutional Orders
Some broker-dealers use actionable IOIs to communicate to external
liquidity providers to send an order to the broker-dealer in response
to liquidity at the broker-dealer, generally a customer's institutional
order. As noted above, because actionable IOIs convey similar
information as an order, a response to an actionable IOI may result in
an execution at the venue of the IOI sender. Accordingly, a broker-
dealer's use of actionable IOIs creates potential information leakage
similar to the routing of orders. The Commission does not have data to
gauge the current level of use of actionable IOIs by broker-dealers to
attract orders to execute against institutional orders represented by
such actionable IOIs. In addition, current Rule 606 for retail orders
does not require the inclusion of actionable IOIs in the reports.
8. Competition, Efficiency, and Capital Formation
The proposed amendments are likely to affect competition among
broker-dealers that route institutional and retail orders. These
broker-dealers compete in a segment of the market for broker-dealer
services. The market for broker-dealer services is highly competitive,
with most business concentrated among a small set of large broker-
dealers and thousands of small broker-dealers competing for niche or
regional segments of the market.\339\ To limit costs and make business
more viable, small broker-dealers often contract with larger broker-
dealers or service bureaus to handle certain functions, such as
clearing and execution, or to update their technology.\340\ Larger
broker-dealers typically enjoy economies of scale over small broker-
dealers and compete with each other to service the smaller broker-
dealers, who are both their competitors and their customers.\341\ Among
other services, broker-dealers provide execution and strategy services,
distribute shares from initial public offerings, and provide analyst
research on securities. Brokerage commissions typically are charged for
a broker-dealer's premium services, and represent an average, not
marginal, cost of trading.\342\
---------------------------------------------------------------------------
\339\ See Securities Exchange Act Release No. 63241 (November 3,
2010), 75 FR 69791, 69822 (November 15, 2010) (Risk Management
Controls for Brokers or Dealers with Market Access).
\340\ Id.
\341\ Id.
\342\ Brokerage commissions are fixed according to a client
agreement and pay for expected services, such as research, advice,
and execution. However, while the commissions may pay for a variety
of services, broker-dealers charge them only on a per-share basis at
the time of an order's execution. Therefore, the commissions reflect
broker-dealers' expectations of customers' average use of services
and not the cost of servicing each order execution on a per-share
basis. See Michael Goldstein, Paul Irvine, Eugene Kandel, and Zwi
Wiener, Brokerage Commissions and Institutional Trading Patterns, 22
Review of Financial Studies 5175 (December 2009).
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As discussed in Section IV.C., as of December 2015, there were
approximately 4,156 registered broker-dealers.\343\ Of these, the
Commission preliminarily estimates that 266 route retail orders.\344\
The Commission preliminarily estimates that 200 broker-dealers route
institutional orders, all of whom also route retail orders, and that
each broker-dealer who routes institutional orders will receive an
average of 200 requests for reports pursuant to proposed Rule 606(b)(3)
annually.\345\ All of these broker-dealers compete for business from
retail and institutional customers. The Commission also preliminarily
estimates that there are approximately 5,594 customers that may place
institutional orders.\346\
---------------------------------------------------------------------------
\343\ See supra note 232.
\344\ See supra note 233.
\345\ See supra notes 234 and 251.
\346\ The Commission preliminarily estimates the number of
customers that may place institutional orders as the number of 13F
institutions as of December 31, 2015. The Commission recognizes that
not all of these institutions necessarily trade NMS Stocks and not
all necessarily submit orders that would qualify for the definition
of institutional order. Further, some customers that submit
institutional orders may not be 13F institutions. While this
preliminary estimate may not be precise, the Commission
preliminarily believes that it approximates the number of customers
that may be affected by the proposed amendments.
---------------------------------------------------------------------------
Among other factors, broker-dealers may compete for retail and
institutional customers by trying to offer them better terms for
trading, such as better execution quality. The emergence of discount
brokerages has encouraged full-service brokers to compete on price and
led to the unbundling of research from execution services.\347\ In
addition, the fragmentation of NMS stock trading into 12 registered
exchanges, more than 40 ATSs, and over 200 OTC market makers \348\ has
contributed to the need for broker-dealers to focus on venue selection
in executing orders. Broker-dealers may also innovate to attract new
customers by, for example, offering access to algorithms designed to
match trading or investment objectives. However, as noted above, the
information on which broker-dealers offer better terms of trade may be
non-standardized, presented inconsistently over time, or may employ
complex calculations using undisclosed methods.\349\ Further, the
format of the reports may limit the comparison of reports across
broker-dealers.\350\ As a result, customers may not be able to
efficiently identify which broker-dealers provide better execution
quality. This may reduce the incentives for broker-dealers to compete
by offering better execution quality or to innovate on execution
quality. Without the incentive
[[Page 49482]]
to compete by offering better execution quality, broker-dealers may
route customer orders in ways that do not necessarily promote better
execution quality.\351\ Such inefficient routing could have effects on
the market for trading services.
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\347\ See supra note 342.
\348\ See supra Section II.B.
\349\ See generally supra Sections V.B.1., V.B.4., and V.B.5.
\350\ See supra Section V.B.5. for a discussion of current
formats. Broker-dealers provide reports in a variety of formats and
a given broker-dealer may use different structures and formats for
different customers. This makes it difficult to electronically read
reports into a system to compare multiple broker-dealers and conduct
statistical analysis across broker-dealers. Differing formats also
make it difficult to electronically search across broker-dealers for
various data points in the reports.
\351\ See supra Section V.B.3. regarding the conflicts of
interest broker-dealers have when routing customer orders.
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The market for trading services, which is served by trading
centers, relies on competition among these market centers to supply
investors with execution services at efficient prices. These market
centers, which compete to, among other things, match traders with
counterparties, provide a framework for price negotiation, and provide
liquidity to those seeking to trade. As discussed in Section IV.C., the
Commission preliminarily estimates that there are 380 market centers to
which Rule 605 applies.\352\
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\352\ The Commission derived this estimate for purposes of the
PRA based on the following: 236 OTC market makers (not including
market makers claiming an exemption from the reporting requirements
of the Rule), plus 12 exchanges, 1 securities association, 86
exchange market makers, and 45 ATSs.
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These market centers compete with each other for order flow on a
number of dimensions, including execution quality. Their primary
clients are the broker-dealers who route their own or their customers'
orders for execution at the trading center. One way to attract order
flow is to offer payment for order flow. The Commission understands
that a large portion of retail order flow is sent to internalizers who
pay for retail order flow. Trading centers also may innovate to
differentiate themselves from other trading centers to attract more
order flow. For example, several exchanges recently started pilots
intended to provide better execution quality for retail orders to
attract more retail order flow.\353\ Trading centers also may adjust
fees and rebates to incent broker-dealers to route more order flow to
them. To the extent that broker-dealers route orders for reasons other
than execution quality, trading centers may have less of an incentive
to compete and innovate on execution quality. This may limit overall
execution quality and result in higher transaction costs for customers
than would exist with greater competition on execution quality.
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\353\ See, e.g., Securities Exchange Act Release No. 67347 (July
3, 2012), 77 FR 40673 (July 10, 2012) for the NYSE and NYSE MKT
pilot; Securities Exchange Act Release No. 68303 (November 27,
2012), 77 FR 71652 (December 3, 2012) for the Bats BZX pilot;
Securities Exchange Act Release No. 71176 (December 23, 2013), 78 FR
79524 (July 30, 2013) for the NYSE Arca pilot; and Securities
Exchange Act Release No. 73702 (November 28, 2014), 79 FR 72049
(December 4, 2014) for the Nasdaq BX pilot.
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Transaction costs reflect the level of efficiency in the trading
process, with higher transaction costs reflecting less efficiency.\354\
Inefficiency in the trading process creates friction, which limits the
ability for prices to fully reflect a stock's underlying value.\355\
Stoll (2000) defines friction as follows: ``Friction in financial
markets measures the difficulty with which an asset is traded.'' \356\
Stoll follows Demsetz (1968) \357\ to ``view friction as the price paid
for immediacy.'' Thus, higher transaction costs imply higher friction
in the market. Friction makes it more costly to trade and makes
investing less efficient. Further, friction limits the ability for
arbitrageurs or informed customers to push prices to their underlying
values, and thus friction makes prices less efficient.
---------------------------------------------------------------------------
\354\ See Hans R. Stoll, Friction, 55 Journal of Finance 1479
(August 2000).
\355\ See id.
\356\ See id.
\357\ See Harold Demsetz, The Cost of Transacting, 82 Quarterly
Journal of Economics 33 (February 1968).
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As a result of the inefficiencies discussed above, a potential
increase in transaction costs in particular, may cause customers not to
rebalance their portfolios as often as might otherwise be optimal and
security prices may less fully reflect true underlying values. This, in
turn, may limit efficient allocation and capital formation, as those
issuers that have the best ideas may not get the capital needed to fund
them. In particular, the less perfectly efficient prices are, the less
able customers are to identify the issuers with the most profitable
projects and thus the demand for the stock of those issuers may not
fully reflect these opportunities. Less demand could result in a lower
stock price, which would make it harder for these issuers to raise
capital and result in less favorable conditions for the capital they
raise.\358\
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\358\ The Commission also notes that less efficiently allocated
capital could result in too much relative funding available for
unprofitable projects, which erode capital. In other words,
allocative inefficiency could mean that some issuers with
unprofitable projects could raise capital too easily.
---------------------------------------------------------------------------
9. Request for Comment
The Commission requests comments on its baseline analysis. In
particular, the Commission solicits comment on the following:
124. Do customers currently request institutional order handling
reports from their broker-dealers? Are those reports generally provided
and if so, what information do they generally contain? Are there
differences in the responsiveness of broker-dealers to requests from
different customers and/or over time? Are there differences in the
quality or detail of the reports by different broker-dealers? If so,
what impact do the differences have on the costs and benefits of the
reports? If possible, please provide specific estimates and data.
125. Do broker-dealers already have systems in place to produce
order handling reports?
126. Do customers currently receive institutional order handling
reports that are comparable to the public reports as proposed by Rule
606(c)? If so, what information is contained in such reports and how,
if at all, do those reports differ from the proposed public reports?
How do the costs and benefits of those reports compare to the reports
as proposed by Rule 606(c)? Please be specific and, if possible,
provide specific estimates or data.
127. Do commenters believe that the Commission's assessment of the
baseline for the economic analysis is correct? Why or why not? Please
be specific.
128. Do commenters believe that the baseline discussion provides a
fair representation of current practices under Rules 600, 605, and 606?
129. Do commenters believe that the Commission's description of the
competitive landscape for broker-dealers is accurate?
130. Do commenters believe that the market participants identified
by the Commission as being affected by the proposed amendments to Rules
600, 605, and 606 is correct?
131. Do commenters believe that the Commission's description of
what information market participants currently receive is accurate?
132. Do commenters believe that the Commission's description of the
potential conflicts of interest broker-dealers face when routing
institutional or retail orders is accurate? Why or why not? Please be
specific in your response.
133. Do commenters believe that the Commission's description of the
current quality of broker-dealer order routing practices for
institutional orders is accurate? Why or why not? Please be specific in
your response.
134. Do commenters believe that the Commission's description of the
current use of actionable IOIs is accurate? Why or why not? Please be
specific in your response.
135. Do commenters believe that the Commission's description of the
current level of competition, efficiency, and innovation is accurate?
Why or why not? Please be specific in your response.
[[Page 49483]]
C. Costs and Benefits
The Commission preliminarily identified costs and benefits
associated with the proposed amendments to Rules 600, 605, and 606,
which are discussed in this section. Many of these costs and benefits
are difficult to quantify, especially as the practices of market
participants are expected to evolve and may change due to the
information on order routing and execution quality that is required to
be reported under the proposed amendments to Rules 600, 605, and 606.
Therefore, much of the discussion is qualitative in nature but, where
possible, the Commission quantifies the costs.
Many, but not all, of the costs of the proposed amendments to Rules
600, 605, and 606 involve a collection of information, and these costs
and burdens are discussed in the Paperwork Reduction Act Section above,
with those preliminary estimates being used in the economic analysis
below.\359\
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\359\ See supra Section IV.
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1. Disclosures for Institutional Orders
a. Definition of Institutional Order in Rule 600(b)(31)
i. Benefits
Proposed Rule 600(b)(31) defines an institutional order as an order
to buy or sell an NMS stock that is not for the account of a broker-
dealer and is an order for a quantity of an NMS stock having a market
value of at least $200,000. The $200,000 threshold determines the
number of institutional orders included in the proposed reporting
requirements of Rule 606, as orders less than $200,000 in market value
are excluded from Rules 606(b)(3) and (c) for reporting purposes. The
Commission preliminarily estimates that at least 5% of the total
executed volume in NMS securities would meet this threshold.\360\ The
Commission preliminarily believes that the proposed definition is
simple and straightforward, as the same threshold would be applied to
all NMS stocks independent of the liquidity and other characteristics
of the specific stock. In addition, the definition of an institutional
order in proposed Rule 600(b)(31) is the complement to the current
definition of a ``customer order,'' which would be renamed ``retail
order'' under the proposed amendment to Rule 600(b)(18) (renumbered as
600(b)(19)). Specifically, proposed Rule 600(b)(19), as amended,
defines a ``retail order'' for NMS stocks as an order to buy or sell an
NMS stock that is not for the account of a broker-dealer and is an
order for a quantity of an NMS stock having a market value of less than
$200,000. The definition of institutional order would dovetail with the
definition of retail order such that all customers' orders would be
covered by order routing disclosure rules. Moreover, because there
would be no overlap in the definitions of retail and institutional
orders--that is, an order would be classified as either retail or
institutional--there should be no double reporting for any order.\361\
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\360\ Commission staff calculated this estimate using a sample
of institutional orders purchased from Abel Noser Solutions, Ltd., a
provider of TCA. The Commission recognizes that this data may not
include all institutional orders, but cannot predict how incomplete
the data are. The more incomplete this data set is, the more this
statistic underestimates the prevalence of institutional orders.
\361\ Current Rule 600(b)(18) defines a customer order and the
definition is identical to the definition of a retail order in
proposed Rule 600(b)(19). Throughout this proposal, we use the term
``retail order'' rather than ``customer order,'' even if we describe
current rules and practices, because ``retail order'' is the amended
terminology proposed and the definitions are identical.
---------------------------------------------------------------------------
ii. Costs
As noted above, the same threshold would be applied to all NMS
stocks independent of a stock's liquidity. This uniform standard may,
however, result in orders submitted by institutions that are quite
large when considering a stock's activity level not meeting the
definition of institutional order. For example, an order for $200,000
in a small-cap stock that is illiquid is very different from an order
for $200,000 in a large-cap stock that is very liquid.\362\ The
Commission recognizes that orders meeting the $200,000 threshold may
not be as common for illiquid stocks, and institutional customers may
use orders smaller than $200,000, as supported by staff analysis
described below. As a result, the proposed definition may result in
institutional customers who submit such smaller orders in illiquid
stock not obtaining the benefits from the disclosures required in the
proposed amendments to Rule 606, although the existing requirements of
Rule 606 for retail orders would still apply.
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\362\ For example, a $200,000 order in a liquid stock could be
very small relative to the total activity level of that stock
whereas a $150,000 order in an illiquid stock could be half the
typical trading volume of that stock. The execution quality of the
order in the illiquid stock could be much more dependent on the
routing practices of the broker-dealer than the execution quality of
the order in the liquid stock.
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To determine the extent of institutional orders that would not meet
this threshold, the Commission staff examined a set of orders from
institutions and found that 83.2% of the total number of orders are
smaller than $200,000.\363\ However, 92% of total dollar volume from
orders of institutions in the data meets the proposed definition of an
institutional order, i.e., an order to buy or sell a quantity of an NMS
stock having a market value of at least $200,000. The percentage of
orders from institutions that would meet the definition varies by
activity level of the stock, with a higher proportion meeting the
definition in more active stocks. While approximately 20% of orders
from institutions in the group of most active stocks would meet the
proposed definition, less than 3% of orders from institutions in the
group of least active stocks would meet the proposed definition.\364\
Therefore, the proposed definition of institutional order covers a
lower proportion of orders submitted by institutions in less active
stocks than it does in more active stocks.
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\363\ Information on institutional equity trading for the sample
period of 2013-2014 is obtained from Abel Noser Solutions, Ltd.
According to an academic study by Puckett and Yan (2011), the
dataset contains detailed equity trading information for each Abel
Noser client and includes a representative set of institutional
investors including pension plan sponsors (e.g., CalPERS, the
Commonwealth of Virginia, and YMCA retirement fund) and money
managers (e.g., Massachusetts Financial Services (MFS), Putnam
Investments, and Lazard Asset Management). These clients accounted
for at least 10% of the total trading volume from 1999-2005,
according to Puckett and Yan (2011). The Commission assumes for
purposes of this analysis that clients have continued to account for
at least this volume during its sample period. See, e.g., Andy
Puckett and Xuemin (Sterling) Yan, The Interim Trading Skills of
Institutional Investors, 66 Journal of Finance 601 (April 2011).
\364\ A stock is sorted into a decile according to average
monthly dollar volume. The most active stocks are defined as being
those in the 10th decile of the distribution of stocks as measured
by the average monthly dollar volume, and the least active stocks
are defined as being those in the 1st decile of the distribution of
stocks as measured by the average monthly dollar volume.
---------------------------------------------------------------------------
The Commission notes that using any fixed threshold may have
another drawback. For example, market participants may change their
behavior or stock prices may change over time. Fixed thresholds
generally provide an incentive for those affected by the threshold to
alter their actions to control whether the action is above or below the
threshold. With respect to the threshold in the definition of
institutional order, customers may have an incentive to increase their
order sizes to exceed the threshold if they can get better information
about routing and execution quality for orders exceeding the
threshold.\365\ If such changes result in
[[Page 49484]]
an increase in the size of orders submitted by institutional customers,
such that more orders from institutional customers are meeting the
$200,000 threshold to qualify as an ``institutional order,'' the
proposed amendments to Rule 606 would apply to a bigger proportion of
all orders submitted by institutional customers. This would increase
the benefits of the proposed amendments to Rule 606 because
institutional customers and the public would receive order handling
information for a larger proportion of all orders submitted by
institutional customers. However, it would also increase the costs of
the proposed amendments to Rule 606 because the information required by
proposed Rules 606(b)(3) and (c) would have to be disclosed for a
larger proportion of all orders submitted by institutional customers.
The Commission preliminarily believes that the increase in costs would
be negligible because the broker-dealers' systems to generate the
reports would already be in place and the marginal costs of adding one
order in a report is likely to be low as it would use only little
additional computing time. Nonetheless, the Commission preliminarily
believes that these incentives may not significantly alter customer
order sizes. In particular, if a customer is able to obtain the same
level of detail on the routing of all of their orders from broker-
dealers, regardless of whether the orders exceed the threshold to be
institutional orders, that customer may have little benefit in
submitting their orders in larger pieces. Further, an institution that
splits its orders to avoid the risk of leaking information to its
broker-dealer, would incur information leakage costs with larger order
sizes.
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\365\ The Commission understands that customers currently split
large orders across multiple broker-dealers for reasons such as
limiting the information that broker-dealers have about the full
order. On the margin, the proposed threshold could provide the
incentive to avoid splitting orders to pieces of less than $200,000.
---------------------------------------------------------------------------
Conversely, if changes in market participants' behavior or stock
prices resulted in a decrease in the size of orders submitted by
institutional customers, such that fewer orders meet the $200,000
threshold for ``institutional orders,'' then the proposed disclosure
amendments to Rule 606 pertaining to institutional order handling would
apply to a smaller proportion of all orders by institutional customers.
This would lead to the public receiving order handling information for
a smaller proportion of all orders submitted by institutional customers
and therefore would reduce the benefits of the proposed amendments to
Rule 606. Still, a decrease in the size of orders submitted by
institutional customers could also decrease the costs associated with
the institutional order handling disclosure required by the proposed
amendments to Rule 606 (since fewer orders would qualify as
``institutional orders''). The Commission preliminarily believes,
however, that this potential decrease in costs would be negligible
since the marginal cost of providing additional information on
institutional orders once systems were in place to produce such reports
would be negligible. Moreover, under this scenario, the Commission
notes that while there may be a decrease in costs associated with
institutional order handling disclosures, broker-dealers may experience
an increase in the number of orders covered in retail order routing
disclosure reports (because the orders that do not qualify as
``institutional orders'' would nonetheless qualify as ``retail orders''
based on size). However, the Commission preliminarily believes that any
increase in the number of orders in retail order routing reports would
result in minimal costs as retail reports do not require extensive
order routing information, the system to generate the reports would
already be in place, and the marginal costs of adding additional orders
would require little computing time.
iii. Request for Comment
The Commission seeks comment on the definition of institutional
order as proposed in Rule 600(b)(31) and its analysis of the costs and
benefits. In particular, the Commission solicits comment on the
following:
136. Do commenters believe that the Commission's proposed
definition of institutional order is appropriate from a costs and
benefits perspective? If not, please provide alternative definitions
with a detailed discussion of what the advantages and costs of those
alternatives would be. For example, should the threshold be different
for different stocks? If yes, how? Should the threshold be a fixed
dollar amount or should it be variable over time or defined
differently, e.g., relative to the average daily volume of a stock?
Please provide data and analysis to support your view.
b. Customer Requests for Information on Institutional Order Handling
Under Proposed Rule 606(b)(3)
i. Benefits
The proposed amendments to Rule 606 would provide transparency
about order routing and execution quality for institutional orders.
Proposed Rule 606(b)(3) would require standardized reports on
institutional order handling, which would be made available to
customers upon request.
Competition in the market for brokerage services could be further
promoted by more transparent order routing practices and execution
quality. The disclosures proposed in Rule 606(b)(3) would provide
customers who submit institutional orders, including investment fund
managers, standardized information regarding their broker-dealers'
order routing practices and execution quality. To the extent that the
reports required by proposed Rule 606(b)(3) increase the transparency
of institutional order routing and execution quality, broker-dealers
would be better able to compete along the execution quality dimensions
provided in the reports, such as the fill rate, percentage of shares
executed at the midpoint and priced at the near or far side of the
quote, and average time between order entry and execution or
cancellation for orders posted to the limit order book, in addition to
commissions and other considerations that they currently compete on.
The Commission preliminarily believes that broker-dealers would have an
additional incentive to improve their order routing decisions as
customers submitting institutional orders could use the reports
required by the proposed amendments to Rule 606 to compare broker-
dealers, which in turn could lead to better execution quality for
institutional orders.
There could also be an effect on the competition between trading
centers. If broker-dealers improve their order routing decisions for
institutional orders, thereby routing orders to the trading centers
that are more beneficial for their customers, this could further
promote competition between trading centers and spur innovation on
execution quality. To illustrate, if broker-dealers change their
institutional order routing decisions to focus more on execution
quality and route fewer orders to a given trading center, that trading
center would have an incentive to take measures to attract and gain
back order flow by innovating on execution quality.
In addition to comparing broker-dealers based on the reports,
customers may also initiate a dialogue with their broker-dealers, or
broker-dealers they are considering to use, about their institutional
order routing practices to better match the needs of the customers with
the order routing practices of the broker-dealers to whom they send
orders.
As discussed in Section II.C., some customers currently request and
receive reports about order routing and execution quality of their
institutional
[[Page 49485]]
orders from their broker-dealers. However, these reports are not
standardized and as a result, it may be difficult to compare broker-
dealers based on those reports. In addition, the availability, detail,
and quality of such reports likely differ across customers, e.g., it
might be the case that customers placing a greater volume of
institutional orders have easier access to such reports compared to
customers with a smaller volume of institutional orders. Moreover, the
information provided by a broker-dealer may vary over time without any
standardized or required content for the reports. Proposed Rule
606(b)(3) addresses both of these concerns as the reports would be
standardized for all broker-dealers and all institutional customers,
making comparisons easier and analysis more useful. Furthermore, every
institutional customer would be able to receive reports upon request
from their broker-dealer.
However, for customers who already receive reports from their
broker-dealers on the handling of their institutional orders, the
benefits of the reports required by proposed Rule 606(b)(3) may be
modest or even non-existent, depending on the information the customers
currently receive. For example, the reports that customers already
receive may be more detailed and tailored to the particular customer.
The reports also may provide different and potentially more information
than what proposed Rule 606(b)(3) requires. Therefore, the proposed
disclosure's benefits to customers who may continue to receive detailed
tailored reports is preliminarily estimated to be minimal.
Nevertheless, these customers would be able to more readily compare
broker-dealers due to the proposed requirement that the disclosures be
standardized.
Additionally, proposed Rule 606(b)(3) requires that a broker-dealer
assign its order routing strategies to one of three categories and that
the reports contain information grouped by those order routing
strategies: Passive, neutral, and aggressive. Proposed Rule
606(b)(3)(v) defines ``passive order routing strategy'' as ``one that
emphasizes minimization of price impact over the speed of execution'';
``neutral order routing strategy'' as one ``that is relatively neutral
between minimization of price impact and the speed of execution of the
entire institutional order''; and ``aggressive order routing strategy''
as ``one that emphasizes the speed of execution of the entire
institutional order over minimization of price impact.'' The Commission
preliminarily believes that the requirement to group information by
specified order routing strategy categories should make comparisons
among broker-dealers by customers placing institutional orders as well
as by the public possible because it would allow customers to control
for the fact that broker-dealers may get different types of order flow.
For example, to satisfy customer order instructions one broker-dealer
may tend to use an aggressive order routing strategy and another
broker-dealer may tend to use a passive order routing strategy, and
simply comparing these two broker-dealers without considering the order
routing strategy category may lead to incorrect or misleading
conclusions.
Customers preferring passive order routing strategies may be
willing to wait longer for an execution but may want to limit price
impact. Customers preferring aggressive order routing strategies,
however, may endure some price impact to trade quickly. Therefore, a
broker-dealer implementing a passive order routing strategy may,
compared to an aggressive order routing strategy, tend to route to a
dark pool where execution may be less certain, but likely at a better
price.\366\ Similarly, a broker-dealer implementing passive order
routing strategies may be able to place orders providing liquidity more
often, thereby capturing more rebates.\367\ As a result, the routing
statistics of a broker-dealer that implements predominantly passive
order routing strategies should differ from those of a broker-dealer
that implements predominantly aggressive order routing strategies.
Therefore, including the categories of order routing strategies in the
order handling report can facilitate an assessment of how well a
broker-dealer manages its conflicts of interest and provides execution
quality that matches customer preferences because it provides
information on the preferences communicated by that broker-dealers'
customers. It can also assist in comparing broker-dealers that may not
receive the same mix of order instructions from customers.
---------------------------------------------------------------------------
\366\ See, e.g., Albert J. Menkveld, Bart Zhou Yueshen, and
Haoxiang Zhu, Shades of Darkness: A Pecking Order of Trading Venues,
Working Paper (2015). The authors find that there exists a pecking
order of trading venues that puts low-cost-low-immediacy venues on
top and high-cost-high-immediacy venues at the bottom. This suggests
that if an order is a passive order and executed with passive order
routing strategy, the broker-dealer would prefer low-cost-low-
immediacy venues, which the paper identifies as dark pools that
execute at the midpoint.
\367\ Compared to an aggressive order routing strategy, a
passive order routing strategy may reduce transaction costs and
allow the capture of rebates, but immediate execution is not
certain. See Lawrence Harris and Joel Hasbrouck, Market vs. Limit
Orders: The SuperDOT Evidence on Order Submission Strategy, 31
Journal of Financial and Quantitative Analysis 213, 230 (June 1996)
(concluding that passive order routing strategies achieve better
average performance than aggressive order routing strategies in
certain markets). See also Maker-Taker Memo, supra note 55, at 18
(discussing maker-taker fees in U.S. equity markets). A broker-
dealer can be more patient in implementing a passive order routing
strategy and does not have to seek immediate execution.
---------------------------------------------------------------------------
The requirement to differentiate the proposed disclosures into the
three order routing strategy categories should help mitigate the
possibility that the reports could be interpreted incorrectly. However,
there could still be differences among broker-dealers in how they
classify orders into the three strategy categories, which could make
straight comparisons between broker-dealers difficult. Proposed Rule
606(b)(3)(v) requires broker-dealers to ``assign each order routing
strategy that it uses for institutional orders to one of [the] three
categories in a consistent manner for each report it prepares,'' to
``promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments,'' and to ``document the specific methodologies it relies
upon for making such assignments.'' The proposed Rule defines the
general characteristics of the three order routing strategies in terms
of the trade-off between the minimization of price impact and the speed
of execution of the entire institutional order. However, the proposed
Rule does not prescribe how this trade-off should be taken into
consideration. Broker-dealers would have discretion to determine how to
do this when establishing their methodologies to assign categories in a
consistent manner and when applying the methodologies to assign into
categories the routing strategies and, as a result, broker-dealers
might not have the exact same definitions for the three order routing
strategy categories.
Under proposed Rule 606(b)(3), customers can obtain detailed
information on the broker-dealer internalization rate and payment for
order flow received. Currently, broker-dealers may prefer to
internalize uninformed order flow.\368\ Under proposed Rule 606(b)(3),
a customer would have information on whether its order flow is being
internalized and could use this information in its relationships with
its broker-dealers. Similarly, a customer would be able to examine the
payment for order flow to determine if its order flow is sold to a
third-party. In addition, customers may be interested in how maker-
taker fees affect where broker-dealers route their
[[Page 49486]]
institutional orders. If a customer pays a flat-rate commission to its
broker-dealer, and any fraction of the rebate is retained by the
broker-dealer, then the broker-dealer has a financial incentive to
route the order to the trading center offering the highest rebate or
lowest fee.\369\ At present, the brokerage commission, which is known
to the customer, may be lowest when a broker-dealer concentrates order
flow in a high rebate and/or low fee trading center.\370\ Customers
might be concerned if orders routed to a high-rebate destination do not
execute or do so with a delay, as information about the order may leak
into the market, thereby affecting price impact.
---------------------------------------------------------------------------
\368\ See Hitesh Mittal, Are You Playing in a Toxic Dark Pool? A
Guide to Preventing Information Leakage, 3 Journal of Trading 20
(Summer 2008).
\369\ A broker-dealer may take into account rebates when setting
its flat-rate commission by asking for a lower commission. As long
as the rebates are not passed through to the customer, however, the
broker-dealer still has the incentive to maximize rebate capture.
\370\ See Shawn O'Donoghue, The Effect of Maker-Taker Fees on
Investor Order Choice and Execution Quality in U.S. Stock Markets
(January 23, 2015), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2607302.
---------------------------------------------------------------------------
Proposed Rule 606(b)(3) requires the inclusion of actionable IOIs
in institutional order handling disclosures. Proposed Rule 600(b)(1)
defines an actionable IOI as ``any indication of interest that
explicitly or implicitly conveys all of the following information with
respect to any order available at the venue sending the indication of
interest: (1) Symbol; (2) side (buy or sell); (3) a price that is equal
to or better than the national best bid for buy orders and the national
best offer for sell orders; and (4) a size that is at least equal to
one round lot.''
The inclusion of actionable IOIs in the proposed reporting
requirements of broker-dealers should provide customers a more complete
picture of how their institutional orders are handled. Since actionable
IOIs can convey similar information as an order, a response to an
actionable IOI may result in an execution at the venue of the IOI
sender and thus can represent a portion of the liquidity available at a
given price and time. The Commission therefore preliminarily believes
that actionable IOIs should be included in the required disclosure of
how institutional orders are handled. In addition, because an
actionable IOI can convey similar information as an order, the use of
actionable IOIs may contribute to information leakage in a similar way
as the use of orders.\371\ Excluding actionable IOIs therefore would
not provide a complete picture of institutional order routing and
executions and could provide broker-dealers with an incentive to use
actionable IOIs instead of orders to circumvent the proposed disclosure
requirements in Rule 606.
---------------------------------------------------------------------------
\371\ See supra Section II.C.4.
---------------------------------------------------------------------------
The proposed definition of actionable IOI in Rule 600(b)(1),
however, may limit the benefits achieved. Specifically, the proposed
definition is substantively similar to the description of actionable
IOI in the Regulation of Non-Public Trading Interest Release. Comments
received on the Regulation of Non-Public Trading Interest Release
indicated that some commenters are concerned that the discussion of
actionable IOIs in that release was too stringent.\372\ If the proposed
definition of actionable IOIs is, in fact, too stringent, then some
IOIs would not be included in the definition of actionable IOI and
would not be captured by the proposed reports on institutional order
handling. Consequently, it is possible that institutional customers
might find the reports to be less informative on institutional order
handling than if the definition of actionable IOIs was broader. This
suggests that defining actionable IOIs too narrowly may limit the
benefits of the proposed amendments.
---------------------------------------------------------------------------
\372\ Comments on the proposed rule for Regulation of Non-Public
Trading Interest are available at http://www.sec.gov/comments/s7-27-09/s72709.shtml. Comments on actionable IOIs can be found in the
following letters: http://www.sec.gov/comments/s7-27-09/s72709-46.pdf and http://www.sec.gov/comments/s7-27-09/s72709-8.pdf.
---------------------------------------------------------------------------
An additional benefit of having the institutional order handling
information available upon request is that institutional customers
could combine the order handling information with existing TCA or
enhance their TCA. As noted above, institutional customers often work
with independent third-party vendors to perform TCA as a means of
evaluating the cost and quality of brokerage services. Institutional
customers can also conduct their own TCA in-house. TCA, whether
conducted in-house or by a third-party, generally analyzes data on the
parent orders, but typically cannot analyze data on the child orders
because of the lack of standardization of the current ad hoc order
handling information. As a consequence, existing TCA typically does not
incorporate information on how many child orders exist, a broker-
dealer's institutional order routing strategy, nor cost, routing, and
execution quality for individual child orders. The disclosures required
by proposed Rule 606(b)(3) would close this informational gap, so that
customers would have more information on how broker-dealers handle and
execute parent and child institutional orders.
With this additional information, institutional customers or their
third-party vendors could combine the routing information with
execution information to conduct a more thorough TCA than they can
currently. In particular, the information in proposed Rule 606(b)(3)
may be a factor that can explain transaction cost variations and thus,
the reports from the proposed amendments could be combined with TCA to
help explain differences in transaction costs and in performance as
measured by TCA across broker-dealers. For example, TCA often includes
transaction cost measures such as implementation shortfall, but
proposed Rule 606(b)(3) would not.\373\ With TCA alone, a customer may
observe different implementation shortfall across broker-dealers. The
proposed amendments could allow the customers or their third-party
vendors to correlate implementation shortfall with the routing
decisions of the broker-dealers. This could assist the customers in
assessing the execution quality provided by their broker-dealers. In
summary, the Commission preliminarily believes that proposed Rule
606(b)(3) may complement and enhance all customers' evaluations of
institutional order handling quality, including those of customers who
use TCA.
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\373\ For example, proposed Rule 606(b)(3) would not require
reports to contain any information on implementation shortfall costs
of parent orders, which are a key focus for investors placing
institutional orders. In general, the proposed amendments are not
intended to replace TCA and, therefore, do not include many metrics
common to TCA. However, the Commission recognizes that the ability
to use the proposed amendments to enhance TCA may make TCA more
valuable and increase the incentives for customers to use TCA,
either in-house or through a third-party vendor.
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Finally, proposed Rule 606(b)(3) would require reports to be made
available using an XML schema and associated PDF renderer to be
published on the Commission's Web site.\374\ The benefits, as well as
the costs, associated with this requirement are discussed in Section
V.C.4.
---------------------------------------------------------------------------
\374\ See supra Section III.A.3.
---------------------------------------------------------------------------
ii. Costs
As discussed above, some customers currently request reports about
the handling of their institutional orders from their broker-dealers
and those reports may be less or more detailed and provide different
and potentially less or potentially more information than proposed Rule
606(b)(3) would require. If the reports broker-dealers currently
provide to a customer more or different information, proposed Rule
606(b)(3)
[[Page 49487]]
could impose a cost on such a customer to the extent broker-dealers
stop providing the more detailed or additional information and instead
provide only the data required for institutional order handling by
proposed Rule 606(b)(3). The Commission preliminarily believes that
this scenario is not very likely because, even if Rule 606(b)(3) is
adopted, customers could still request additional information or
customized reports from their broker-dealers and broker-dealers are
likely to satisfy such requests, to the extent they currently do, to
retain their customers. As discussed above, the willingness of broker-
dealers to provide such customized reports to customers and how
detailed such a report is might depend on the business relationship
between the broker-dealer and the customer. Customers who send or may
send a large number of orders to a broker-dealer might be able to get
customized reports more easily compared to customers who send fewer
orders, and those reports might be more detailed compared to reports
that customers who send fewer orders receive. While proposed Rule
606(b)(3) mitigates this issue in that every customer would be able to
request the standardized reports required by proposed Rule 606(b)(3),
the Commission recognizes that to the extent large institutional
customers are able to receive customized reports that provide
information not contained in the required reports, those large
institutional customers would continue to have an advantage over
smaller institutional customers who are not able to receive the same
reports.
In addition, the greater transparency provided as a result of the
new reports required under proposed Rule 606(b)(3) might lead broker-
dealers to change how they handle institutional orders. Given that
broker-dealers would be aware of the metrics to be used a priori, they
might route institutional orders in a manner that promotes a positive
reflection on their respective services but which may be suboptimal for
their customers. Any changes to broker-dealers' order routing decisions
due to proposed Rule 606(b)(3) may be intended to benefit customers
placing institutional orders, but if broker-dealers and customers focus
exclusively on the metrics in the reports required by proposed Rule
606(b)(3), the order routing decisions could also be viewed as
suboptimal for some customers.
For example, suppose a broker-dealer routes institutional orders so
that the orders execute at lower cost with a higher fill rate, shorter
duration, and more price improvement than the broker-dealer's
competitors. However, it could be the case that, in order to achieve
these objectives, the broker-dealer routes the majority of non-
marketable limit order shares to the trading center offering the
highest rebate. An institutional customer that reviews the proposed
routing reports might suspect that the broker-dealer acted in its self-
interest by selecting the highest rebate venue in order to maximize
rebates when in fact, the broker-dealer made the decision based on
other variables, which might not be completely reflected in the
proposed reports. Under the proposed amendments to Rule 606, the
broker-dealer may be concerned about the perception of acting on a
conflict of interest, when the broker-dealer is in fact acting in the
customers' interests. As a result, a broker-dealer may be incentivized
to route fewer non-marketable limit order shares to the trading center
offering the highest rebate, even if this imposes additional costs on
the broker-dealer's customers, in an effort to ensure that a customer
does not misconstrue the intent behind the broker-dealer's routing
decisions. Such a potential outcome could reduce the intensity of
competition between broker-dealers on the dimension of execution
quality.
In addition, as noted above, proposed Rule 606(b)(3) requires the
inclusion of actionable IOIs in the reports on institutional order
handling broker-dealers would provide to their customers. The
Commission expects that broker-dealers will incur costs from the
inclusion of actionable IOIs in the reports as a result of having to
process additional data and run additional calculations. The estimated
cost of including actionable IOIs in the proposed reports is included
in the aggregate costs described in the discussion below and in greater
detail in Section IV.D.1.
The disclosure requirements of proposed Rule 606(b)(3) would also
impose a monetary cost, as the required disclosures could entail some
reprogramming by broker-dealers that execute or route institutional
orders. These costs may be low for a given broker-dealer if the broker-
dealer already supplies similar reports on institutional order handling
upon requests by their customers. In addition to reprogramming,
receiving and processing customer requests as well as preparing and
transmitting the data to customers on request would impose costs.
As discussed in Section IV.D.1., the Commission preliminarily
estimates that the one-time, initial burden for a broker-dealer that
routes institutional orders that does not currently retain the proposed
order handling information to program systems in-house to implement the
requirements imposed by the proposed amendments to Rule 606 would be
200 hours resulting in a monetized cost burden of $60,420 per broker-
dealer.\375\ The Commission preliminarily estimates the one-time,
initial burden for a broker-dealer that routes institutional orders
that does not currently create the proposed order handling information
to engage a third-party to program their systems to implement the
requirements of the proposed amendments to Rule 606(b)(3) to be 50
hours resulting in a monetized cost burden of $15,125 per broker-
dealer.\376\ In these cases, the Commission further preliminarily
estimates a fee of $35,000 per broker-dealer to engage the third-party
service provider.\377\ The Commission preliminarily believes that most
broker-dealers either have systems that currently retain the
information required by the proposed rule, or use third-party vendors
who have systems that retain such information. The Commission therefore
preliminarily estimates that 25 broker-dealers that route institutional
orders do not currently have systems that retain the information
required by the proposed amendments or use a third-party vendor to
retain such information.\378\ The Commission preliminarily estimates
that of the 25 broker-dealers that route institutional orders who do
not currently have systems in place to retain the information required
by the proposed rule, 10 such broker-dealers will perform the necessary
programming upgrades in-house, and 15 will engage a third-party to
perform the programming upgrades. Additionally, of the 25 broker-
dealers that route institutional orders who do not currently have
systems in place to retain the information required by the rule, the
Commission preliminarily estimates that 10 such broker-dealers will
need to purchase hardware and software upgrades to fulfill the
requirements of the proposed rule at an average cost of $15,000 per
broker-dealer, and that the remaining 15 broker-dealers have adequate
hardware and software to retain the information proposed by the rule.
Therefore, the total initial burden for all broker-dealers that route
institutional orders who do not currently retain order handling
[[Page 49488]]
information required by the proposed rule to program systems to comply
with the proposed rule change is 2,750 hours resulting in a monetized
cost burden of $831,075, plus an additional fee of $675,000 to engage
the third-party service providers.\379\
---------------------------------------------------------------------------
\375\ See supra note 237.
\376\ See supra note 238.
\377\ See supra note 239.
\378\ See supra note 236.
\379\ See supra note 240.
---------------------------------------------------------------------------
As discussed in Section IV.D.1., the Commission preliminarily
estimates the average cost for a broker-dealer who routes institutional
orders who already retains information required by the proposed rule to
format its systems to produce a report to comply with the proposed rule
to be 40 hours resulting in a monetized cost burden of $12,084.\380\
The Commission preliminarily estimates the average burden for a broker-
dealer who routes institutional orders who uses a third-party service
provider to work with such service provider to ensure proper reports
are produced to be 20 hours resulting in a monetized cost burden of
$5,726.\381\ In these cases, the Commission further preliminarily
estimates a fee of $5,000 per-broker to engage the third-party service
provider.\382\ The Commission preliminarily estimates that, of the 175
broker-dealers who route institutional orders who currently retain the
information required pursuant to the rule and need only format their
systems to produce a report required by the rule, 50 such broker-
dealers will use a third-party vendor to ensure proper reports are
produced and the remaining 125 broker-dealers will perform the
necessary work in-house. Thus, the total cost for all broker-dealers
who route institutional orders who only need to format their systems to
prepare a report to comply with the proposed rule is preliminarily
estimated to be 6,000 hours resulting in a monetized cost burden of
$1,796,800, plus an additional fee of $250,000 to engage the third-
party service providers.\383\ Therefore, the total initial burden for
all broker-dealers to comply with proposed Rule 606(b)(3) is
preliminarily estimated to be 8,750 hours resulting in an estimated
cost of $2,627,875, plus an additional fee of $925,000 to engage the
third-party service providers.\384\
---------------------------------------------------------------------------
\380\ See supra note 242.
\381\ See supra note 243.
\382\ See supra note 244.
\383\ See supra note 245.
\384\ See supra note 247.
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As discussed in Section IV.D.1, the Commission preliminarily
estimates that an average response to a Rule 606(b)(3) request for a
broker-dealer who handles its own responses will take approximately 2
hours per response resulting in a monetized cost burden of $380.\385\
For a broker-dealer that routes institutional orders who will use a
third-party service provider to respond to requests pursuant to Rule
606(b)(3), the Commission preliminarily estimates the burden to be 1
hour per response resulting in a monetized cost burden of $283.\386\ In
these cases, the Commission preliminarily estimates an additional
third-party service provider fee of $100 per response.\387\ The
Commission preliminarily estimates that an average broker-dealer will
receive approximately 200 requests annually.\388\ Therefore, the total
annual burden for all 200 broker-dealers that route institutional
orders to comply with the customer response requirement in proposed
Rule 606(b)(3) is preliminarily estimated to be 67,000 hours, resulting
in a monetized cost burden of $13,939,000, plus an additional fee of
$1,300,000 to compensate third-party service providers for producing
the reports.\389\
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\385\ See supra note 250.
\386\ See supra note 254.
\387\ See supra note 255.
\388\ See supra note 251.
\389\ See supra notes 259 and 260.
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Further, as a result of proposed Rule 606(b)(3), broker-dealers
that route institutional orders would likely re-evaluate their best
execution methodologies to take into account the availability of new
statistics and other information that may be relevant to their decision
making. This may impose a cost only to the extent that broker-dealers
choose to build the proposed statistics into their best execution
methodologies. In addition, they may only choose to do so if the
benefits justify the costs.
Another potential cost of proposed Rule 606(b)(3) is that the
reports could be viewed as a replacement of TCA and therefore have a
negative impact on the market for TCA. Specifying a minimum length of
time for making the Rule 606 reports publicly available may further
impose a cost on third-party vendors that aggregate the time series of
the reports. For example, suppose that a customer chooses to no longer
purchase TCA once reports from proposed Rule 606(b)(3) become
available, because the customer decides that the information contained
in proposed Rule 606(b)(3) reports is sufficient. If fewer customers
purchase TCA, it would have a negative impact on third-party providers
of TCA as well as third-party data vendors, e.g., in terms of less
demand for their services, and the quality of TCA provided by third-
parties may decrease because third-party providers of TCA might have
fewer resources for the development and maintenance of their product
offerings and because fewer customers may also lead to less data the
third-party providers can base their models on.\390\ However, as
discussed in Section V.C.1.b.i, the reports required by proposed Rule
606(b)(3) would provide information that could be complementary to TCA.
As discussed above, in fact, proposed Rule 606(b)(3) could make TCA
more useful and provide incentives to customers to use TCA. As a
result, the Commission preliminarily believes that proposed Rule
606(b)(3) will not replace TCA.
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\390\ Based on staff experience, the Commission understands that
customers of third-party TCA providers typically transmit their
execution data to their TCA providers. The third-party TCA providers
in turn base their models on the data they receive from all their
customers. Having more data to base models on is generally
beneficial and may result in better models.
---------------------------------------------------------------------------
As discussed in Section V.C.1.b.i, proposed Rule 606(b)(3) would
require differentiating order routing strategies for institutional
orders into three types: Passive, neutral, and aggressive order routing
strategies. The Commission preliminarily believes that broker-dealers
would incur costs associated with creating their methodologies,
assigning each order routing strategy for institutional orders into one
of these three categories according to the methodologies, promptly
updating the assignments any time an existing strategy is amended or a
new strategy is created that would change such assignments, and
documenting the specific methodologies it relies upon for making such
assignments. The Commission preliminarily estimates the one-time,
initial burden for a broker-dealer that routes institutional orders to
establish and document in-house its specific methodologies for
assigning order routing strategies as required by proposed Rule
606(b)(3)(v) to be 40 hours resulting in a monetized cost burden of
$12,620.\391\ The Commission preliminarily estimates the one-time,
initial burden for a broker-dealer that routes institutional orders who
will work with a third-party service provider to assign into categories
its current order routing strategies and establish and document its
specific methodologies as required by Rule 606(b)(3)(v) to be 10 hours
resulting in a monetized cost burden of $2,896 plus an additional fee
of $5,000 to the third-party service provider.\392\ These figures are
based on the estimated number of hours to establish and review such
methodologies. As noted above, the
[[Page 49489]]
Commission preliminarily estimates that 135 broker-dealers who route
institutional orders will create the required reports themselves while
65 such broker-dealers will use a third-party service provider to
create the required reports. Therefore, the total initial burden for
all broker-dealers that route institutional orders to assign its
routing strategies into passive, neutral, and aggressive strategies is
preliminarily estimated to be 6,050 hours resulting in a monetized cost
burden of $1,891,940 plus an additional fee of $325,000 to the third-
party service providers.\393\
---------------------------------------------------------------------------
\391\ See supra note 277.
\392\ See supra notes 279 and 280.
\393\ See supra notes 283 and 284.
---------------------------------------------------------------------------
Once the methodologies are established and documented, broker-
dealers that route institutional orders would be required to assign
each order routing strategy for institutional orders into one of these
three categories according to the methodologies in a consistent manner
and promptly update the assignments any time an existing strategy is
amended or a new strategy is created that would change such
assignments.\394\ The Commission preliminarily estimates that the
annual cost for a broker-dealer who will assign its order routing
strategies to one of the three categories and update such assignments
in-house to comply with Rule 606(b)(3)(v) will be 15 hours resulting in
a monetized cost burden of $3,500.\395\ The Commission preliminarily
estimates that the annual burden for a broker-dealer who routes
institutional orders who engages a third-party service provider to
assign the order routing strategies into categories to comply with Rule
606(b)(3)(v) will be 5 hours resulting in a monetized cost burden of
$1,609 plus an additional third-party service provider fee of
$1,000.\396\ As noted above, the Commission preliminarily estimates
that 135 broker-dealers who route institutional orders will create the
required reports themselves while 65 such broker-dealers will use a
third-party service provider to create the required reports. Therefore,
the total annual burden for broker-dealers that route institutional
orders to assign the routing strategies of their institutional orders
into passive, neutral, and aggressive strategies is preliminarily
estimated to be 2,350 hours resulting in a monetized cost burden of
$577,085 plus an additional third-party service provider fee of
$65,000.\397\
---------------------------------------------------------------------------
\394\ For example, a broker-dealer may develop new order routing
strategies, change existing order routing strategies, or change the
descriptions of existing order routing strategies.
\395\ See supra note 285.
\396\ See supra notes 287 and 288.
\397\ See supra notes 291 and 292.
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iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 606(b)(3). In
particular, the Commission solicits comment on the following:
137. Are the assumptions underlying the Commission's estimates for
the costs of implementation and ongoing costs to comply with the
proposal appropriate? Please provide data and analysis to support your
view.
138. Do commenters believe that broker-dealers currently have
systems that contain the data that would be used in the reports? What
data would be incremental to that already maintained by broker-dealers?
What incremental costs would be necessary to modify and maintain
information systems architecture?
139. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
140. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended consequences that have not been discussed that
may result from the proposal?
141. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
The Commission also seeks comment on the analysis of the costs and
benefits for the definition of an actionable IOI in proposed Rule
600(b)(1). In particular, the Commission solicits comment on the
following:
142. Do commenters believe that the Commission's proposed
definition of actionable IOI is appropriate in light of the estimated
costs and benefits? If not, please provide alternative definitions with
a detailed discussion of what the benefits and costs of those
alternatives would be. Please provide data and analysis to support your
view.
c. Public Reports for Institutional Orders Under Proposed Rule 606(c)
i. Benefits
Proposed Rule 606(c) would require public quarterly reports broken
down by calendar month on the order routing and execution quality of
institutional orders by each broker-dealer. As a result, proposed Rule
606(c) would provide the public with standardized information regarding
all broker-dealers' institutional order routing practices and execution
quality aggregated across each broker-dealer's customers.
While these reports would be aggregated across all customers a
broker-dealer serves, the reports would allow current and prospective
customers to compare broker-dealers' institutional order routing
practices and execution quality and ultimately, to inform their choice
of broker-dealers. For example, customers may use the quarterly public
reports broken down by calendar month to decide whether they should
enter into a business relationship with broker-dealers to whom they do
not currently send orders. Additionally, the reports may allow
customers to compare the execution services of their current broker-
dealers with other competitors, who might offer the same execution
quality at lower costs, improved execution quality at the same costs,
or lower cost services and better execution quality.
As discussed in Section V.C.1.b.i, greater transparency about order
routing practices and execution quality may promote competition in the
market for brokerage services and between trading centers. The
Commission preliminarily believes that public aggregated institutional
order handling reports required by proposed Rule 606(c) would increase
the transparency of institutional order routing and execution quality
and provide additional information to customers beyond that provided by
customer-specific reports required by proposed Rule 606(b)(3).
Customers would be able to compare their broker-dealers not just based
on the orders they send to the broker-dealers, but also based on all
institutional orders handled by the broker-dealers. In addition,
customers would be able to evaluate the order routing and execution
quality of broker-dealers they do not send orders to and could
determine whether to send orders to a given broker-dealer based on such
evaluation.
Broker-dealers, in turn, might be able to adjust their business
practices to compete better, specifically along the dimensions of order
routing and execution quality and, through the public aggregated
institutional order handling reports, try to attract orders from
customers with whom they do not yet have a business relationship. The
Commission preliminarily believes that the broker-dealers would have
greater incentive to route institutional orders in a manner beneficial
to a customer in order to attract additional order flow from those
customers who may use the public aggregated institutional order
[[Page 49490]]
handling reports required by proposed Rule 606(c) to compare relative
broker-dealer execution quality. Ultimately, greater transparency may
increase competition in the brokerage services market, thereby
potentially reducing costs to customers in terms of cost of services
and execution quality for institutional orders, of which transaction
costs is one measure.
As discussed in Section V.C.1.b.i, if broker-dealers change their
institutional order routing decisions, it might promote competition
among trading centers. The public aggregated institutional order
handling reports required by proposed Rule 606(c) would allow trading
centers to compare the execution quality of orders on different trading
centers as well as the routing behavior of broker-dealers. The trading
centers would have a further incentive to improve execution quality to
attract order flow and the public aggregated institutional order
handling reports that are broken down by month would allow them to see
the effects of any changes they implement. In addition, this may lead
to innovation by existing trading centers and it may attract new
entrants and the formation of new trading centers.
As discussed for the customer-specific reports required by proposed
Rule 606(b)(3) in Section V.C.1.b.i, customers may also initiate a
dialogue with their broker-dealers, or broker-dealers they are
considering to use, based on the public aggregated institutional order
handling reports required by proposed Rule 606(c). This dialogue may
include discussions about conflicts of interest \398\ and how to match
the needs of customers with the order routing practices of the broker-
dealers to whom they send orders.
---------------------------------------------------------------------------
\398\ As noted above, institutional customers may be able to
utilize the customer-specific reports as required by proposed Rule
606(b)(3) to examine the venues their broker-dealers are routing
orders to and the rebates received and fees paid. The Commission
notes that similar information would be reflected in the public
aggregated institutional order handling reports and could be useful
for institutional customers to discuss order routing practices and
management of conflicts of interest with broker-dealers or
prospective broker-dealers.
---------------------------------------------------------------------------
Further, third-party vendors offering analytical services may use
the information in the public aggregated institutional order handling
reports in an attempt to sell customized reporting tools and services.
These types of consulting services may allow customers and the public
to better identify the potential conflicts of interest that broker-
dealers face with directing order flow to trading centers offering
liquidity rebates and fees.
Greater transparency of institutional order routing and execution
could help shed light on the effect of today's dispersed and complex
market structure on order routing decisions and related execution
quality. The Commission preliminarily believes that the requirement in
proposed Rule 606(c) for quarterly disclosure on order routing, order
execution, and orders that provide and remove liquidity for each venue
broken down by order routing strategy should provide the public with a
better understanding of the operating procedures of broker-dealers and
how their decisions are affected by the current market structure. In
addition, the information on rebates and fees broker-dealers receive or
incur would allow the public to assess how broker-dealers manage
potential conflicts of interest they face when routing institutional
orders.
As discussed for the customer-specific reports required by proposed
Rule 606(b)(3) in Section V.C.1.b.i., the public aggregated
institutional order handling reports broken down by calendar month
required by proposed Rule 606(c) would also give customers information
about broker-dealer internalization rates and the rebates received and
fees paid by broker-dealers. As described above, the public aggregated
institutional order handling reports would require the disclosure of
information by all broker-dealers that receive institutional orders.
Customers would be able to compare internalization rates of their
broker-dealers and rebates received and fees paid by their broker-
dealers to those of broker-dealers they do not send orders to. As such,
the information about broker-dealer internalization rates, rebates, and
fees in the public aggregated institutional order handling reports
required by proposed Rule 606(c) would be complementary to the
customer-specific reports required by proposed Rule 606(b)(3), which
would provide customers only information about their orders rather than
all orders a given broker-dealer receives.
In addition, proposed Rule 606(c) would require the public
aggregated institutional order handling reports to be posted on an
Internet Web site that is free and readily accessible to the public for
a period of three years from the initial date of posting on the
Internet Web site. This requirement would allow customers and the
public to readily access historical data for at least three years
without the need to download the reports frequently, e.g., quarterly,
or purchasing the data from a third-party vendor. Customers and the
public could analyze the historical data and evaluate the order routing
decisions and execution quality provided by broker-dealers based on the
historical data.
Further, the public aggregated institutional order handling reports
required by proposed Rule 606(c) could improve the extent and quality
of information available to the Commission and other regulatory
agencies, thereby assisting in the regulatory oversight of broker-
dealers' operations.
Finally, proposed Rule 606(c) would require the public aggregated
institutional order handling reports be made available using an XML
schema and associated PDF renderer to be published on the Commission's
Web site.\399\ The benefits and costs associated with this requirement
are discussed in Section V.C.4.
---------------------------------------------------------------------------
\399\ See supra Section III.A.3.
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ii. Costs
The Commission considered whether the public aggregated
institutional order handling reports that would be required pursuant to
proposed Rule 606(c) may disclose information about specific
institutional orders that currently is not publicly available, and
preliminarily believes that the possibility of such disclosure and
associated costs are small. First, the reports required by proposed
Rule 606(c) would be quarterly reports broken down by calendar month
made public within one month after the end of the quarter. As a result,
it is very unlikely that the reports would contain any information
about orders that are being worked by broker-dealers at the time of
publication. Second, the reports would be aggregated across all
customers a broker-dealer serves. To the extent that a broker-dealer
serves multiple customers placing institutional orders, it would be
difficult to identify the orders of a particular customer in the
proposed reports. However, it is possible that, for example, a smaller
broker-dealer may have one customer placing institutional orders that
represents the majority of its business and this may be known to other
market participants. In this case, it may be possible to learn from the
reports some information about the order flow of that customer,
particularly the order flow given to the specific broker-dealer. This
information would not be about active orders but could provide
historical information about the general characteristics of the
customer's order flow, e.g., how much of its order flow has been
handled using aggressive or passive order routing strategies. To the
extent that these characteristics apply to future orders, this
information
[[Page 49491]]
may be useful to other market participants. Such a potential outcome
could put smaller broker-dealers (that is, those with a small set of
customers or handling a relatively small number of institutional
orders) at a competitive disadvantage relative to larger broker-
dealers, as customers might avoid using smaller broker-dealers to avoid
possible disclosure that could be traced back to the customer. However,
because the proposed public aggregated institutional order handling
report would not disclose the specific orders and the historical data
would reflect prior calendar quarters, the Commission preliminarily
believes that the potential risks and costs due to this would be small.
Proposed Rule 606(c) would require each broker-dealer to post the
public aggregated institutional order handling report for a period of
three years from the initial date of posting on the Internet Web site.
As noted above, the Commission preliminarily believes that, once the
report is posted, maintaining the report on the Web site will not
impose any additional burden on broker-dealers, and thus any additional
costs to maintain the report on the Web site would be negligible.
The disclosure requirements of proposed Rule 606(c) would impose a
cost, as they would require some reprogramming by broker-dealers that
handle institutional orders. In addition, preparing and disseminating
the data to the public in the form required by proposed Rule 606(c)
would impose costs on such broker-dealers. However, a broker-dealer
could use the infrastructure and processes they put in place for the
customer-specific reports required by proposed Rule 606(b)(3) such that
the additional cost to comply with proposed Rule 606(c) may be low. The
Commission preliminarily estimates that a broker-dealer who handles
institutional orders and formats and creates public aggregated
institutional order handling reports itself will incur an initial
burden of 20 hours resulting in a monetized cost burden of $4,990 to
comply with the quarterly reporting requirement of proposed Rule
606(c).\400\ The Commission preliminarily estimates that a broker-
dealer who uses a third-party service provider to create the public
aggregated institutional order handling reports would incur an initial
burden of 5 hours resulting in a monetized cost burden of $1,415 plus
an additional third-party service provider fee of $2,500.\401\ As noted
above, the Commission preliminarily estimates that 135 broker-dealers
who route institutional orders will create the required reports
themselves while 65 such broker-dealers will use a third-party service
provider to create the required reports. Therefore, the total initial
burden for broker-dealers that route institutional orders to produce
the quarterly report is preliminarily estimated to be 3,025 hours
resulting in a monetized cost burden of $765,625 plus an additional
$162,500 fee to compensate third-party service providers for producing
the reports.\402\
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\400\ See supra note 261.
\401\ See supra notes 262 and 263.
\402\ See supra note 264.
---------------------------------------------------------------------------
Further, the Commission preliminarily estimates that each broker-
dealer that routes institutional orders who prepares its own reports
will incur an average burden of 10 hours resulting in a monetized cost
burden of $1,600 \403\ to prepare, disseminate, and keep for a period
of three years a quarterly report required by proposed Rule 606(c), or
a burden of 40 hours resulting in a monetized cost burden of $6,400 per
year.
---------------------------------------------------------------------------
\403\ See supra note 266.
---------------------------------------------------------------------------
The Commission preliminarily estimates that each broker-dealer that
routes institutional orders that uses a third-party service provider to
prepare the reports required under proposed Rule 606(c) will incur an
average burden of 2 hours resulting in a monetized cost burden of $443
plus an additional third-party service provider fee of $500 \404\ to
prepare and make publicly available a quarterly report, or a burden of
8 hours resulting in a monetized cost burden of $1,772 plus an
additional third-party service provider fee of $2,000 per year.\405\ As
noted above, the Commission preliminarily estimates that 135 broker-
dealers who route institutional orders will create the required reports
themselves while 65 such broker-dealers will use a third-party service
provider to create the required reports. Therefore, the total burden
per year for all broker-dealers who route institutional orders to
comply with the reporting requirement in proposed Rule 606(c) is
preliminarily estimated to be 5,920 hours resulting in a monetized cost
burden of $979,180 plus an additional third-party service provider fee
of $130,000.\406\
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\404\ See supra notes 269 and 270.
\405\ See supra notes 271 and 272.
\406\ See supra notes 275 and 276.
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iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 606(c). In
particular, the Commission solicits comment on the following:
143. Do commenters believe that the assumptions underlying the
Commission's estimates for the costs of implementation and ongoing
costs to comply with the proposal are appropriate? Please provide data
and analysis to support your view.
144. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
145. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended consequences not discussed above that may
result from the proposal?
146. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
2. Disclosures for Retail Orders
Rule 606(a) requires each broker-dealer to make publicly available
quarterly reports on its routing of non-directed orders in NMS
securities. The Commission preliminarily believes that the proposed
amendments to Rule 606(a) would increase the level of transparency
about order routing and execution quality for retail orders through the
enhanced disclosure of data regarding order routing and execution. The
proposed amendments to Rule 606(a) require that the public quarterly
reports be broken down by calendar month and differentiate between
marketable and non-marketable limit orders. The proposed amendments
also would remove the requirement that the quarterly reports be divided
into three separate sections for securities that are listed on the
NYSE, Nasdaq, and Amex. The proposed amendments to Rule 606(a)(1)(iii)
also require that the reports include for Specified Venues the net
aggregate amount of any payment for order flow, payment from any
profit-sharing relationship received, transaction fees paid, and
transaction rebates received, both as a total dollar amount and on a
per share basis, for specified types of orders. The proposed amendment
to Rule 606(a)(1)(iv) would add the requirement that broker-dealers
describe any terms of payment for order flow arrangements and profit-
sharing relationships with Specified Venues that may influence their
order routing decisions, including, among other things: (1) Incentives
for equaling or
[[Page 49492]]
exceeding an agreed upon order flow volume threshold, such as
additional payments or a higher rate of payment; (2) disincentives for
failing to meet an agreed upon minimum order flow threshold, such as
lower payments or the requirement to pay a fee; (3) volume-based tiered
payment schedules; and (4) agreements regarding the minimum amount of
order flow that the broker-dealer would send to a venue.\407\ In
addition, the proposed amendments to Rule 606(a) would require broker-
dealers to keep their reports posted on an Internet Web site that is
free and readily accessible to the public for a period of three years
from the initial date of posting on the Internet Web site, and would
require such reports to be made available using an XML schema and
associated PDF renderer to be published on the Commission's Web site.
---------------------------------------------------------------------------
\407\ See proposed Rule 606(a)(1)(iv).
---------------------------------------------------------------------------
The benefits and costs of each of these proposed amendments are
discussed below. Wherever possible, we quantify cost estimates for a
given amendment. For the remaining amendments concerning retail orders,
we provide total quantitative cost estimates for these amendments in
Section V.C.2.e.
a. Marketable Limit Orders and Non-Marketable Limit Orders
i. Benefits
The proposed amendments to Rule 606(a), which applies to retail
orders, would require broker-dealers to differentiate between
marketable and non-marketable limit orders. Marketable and non-
marketable limit orders generally are handled differently, i.e., non-
marketable limit orders are typically posted to an order book, which
may result in a different fee or rebate compared to a marketable limit
order that may be immediately executed and not posted to the book.
The proposed amendments could allow the public, including customers
placing retail orders, to better understand the potential for conflicts
of interest broker-dealers face when routing retail orders. For
example, if a broker-dealer routes all non-marketable limit orders to
the trading centers that pay the highest rebate for orders providing
liquidity, the broker-dealer may be maximizing its revenue potentially
to the detriment of execution quality. Recent academic research has
identified indications of such routing behavior for retail orders.\408\
On examining the order routing of ten broker-dealers, the researchers
find that four of the broker-dealers sell market orders to market
makers and route limit orders to market makers or exchanges offering
the largest liquidity rebates. In addition, their study indicates that
a negative relation exists between take fees and the likelihood that a
limit order fills and the speed and realized spread of the associated
fill.\409\ The disclosure of order routing data broken down by
marketable and non-marketable limit orders could incentivize broker-
dealers to better manage these and other potential conflicts of
interest, which may result in improved order routing decisions and
execution quality for retail orders. The disclosure could also help
customers and others to assess if and how well broker-dealers manage
the potential conflicts of interest they face when routing retail
orders, and would be a way for broker-dealers to show that they are
indeed managing these potential conflicts of interest.
---------------------------------------------------------------------------
\408\ See Battalio, Corwin, and Jennings Paper, supra note 57.
\409\ See id.
---------------------------------------------------------------------------
In addition, if the additional proposed disclosure results in
broker-dealers improving their order routing for retail orders, which,
in turn, may change which trading centers the broker-dealers route
retail orders to, the proposed disclosure could further promote
competition among trading centers. The new information that would be in
the public reports required by proposed Rule 606(a)(1) would allow
trading centers to compare the order routing decisions of broker-
dealers and the trading centers retail orders are routed to, which
could then inform how the trading centers attempt to attract retail
order flow. The quarterly public reports, which would be broken down by
month, would allow trading centers to see effects of any adjustments
they implement in response to broker-dealers changing their order
routing strategies. In addition, this proposed new disclosure may lead
to innovation by existing trading centers and it may attract new
entrants and the formation of new trading centers.\410\
---------------------------------------------------------------------------
\410\ In particular, a trading center that loses order flow to
venues that offer better execution quality would have the incentive
to innovate to improve its execution quality. Therefore, because the
proposed disclosures may encourage broker-dealers to route for
better execution quality, they may lead to innovation on trading
centers.
---------------------------------------------------------------------------
ii. Costs
The proposed amendments to Rule 606(a) to require broker-dealers to
differentiate between marketable and non-marketable limit orders would
impose costs on broker-dealers. Preliminary estimates for compliance
costs are contained in the estimates for the costs of producing the
reports discussed in Section V.C.2.e.
iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 606(a). In
particular, the Commission solicits comment on the following:
147. Do commenters believe that the assumptions underlying the
Commission's estimates for the costs of implementation and ongoing
costs to comply with the proposal are appropriate? Please provide data
and analysis to support your view.
148. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
149. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended consequences not discussed above that may
result from the proposal?
150. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
b. Net Payment for Order Flow and Transaction Fees and Rebates by
Specified Venue
i. Benefits
Under the proposed amendments to Rule 606(a)(1)(iii), for retail
orders, broker-dealers would be required to publicly report the net
aggregate amount of any payment for order flow, payment from any
profit-sharing relationship received, the transaction fees paid, and
transaction rebates received, both as a total dollar amount and on a
per share basis, for each of the following order types: market orders,
marketable limit orders, non-marketable limit orders, and other orders.
Similarly to differentiating marketable and non-marketable limit
orders discussed in Section V.C.2.a.i, the information required by
proposed Rule 606(a)(1)(iii) could also allow the public, including
customers placing retail orders, to better understand the potential
conflicts of interest broker-dealers face when routing retail
orders.\411\ The proposed disclosure of information could provide
additional
[[Page 49493]]
incentives to broker-dealers to monitor the potential conflicts of
interest, and to review and alter how they route retail orders, which
could result in improved order routing decisions and execution quality
for retail orders. The disclosure could also help the public to assess
better if and how well broker-dealers manage the potential conflicts of
interest they face when routing retail orders.
---------------------------------------------------------------------------
\411\ See supra Section II.C. for an example of routing
decisions being affected by conflicts of interest.
---------------------------------------------------------------------------
Under proposed Rule 606(a)(1)(iii), broker-dealers would be
required to disclose on a quarterly basis more detailed information on
net payment for order flow, payment from any profit-sharing
relationship received, transaction fees paid, and transaction rebates
received per share and in total. Customers and the public could use
this information to gauge whether payments for order flow or maker-
taker fees affect the order routing decisions of broker-dealers. For
example, if a customer pays a flat-rate commission to its broker-
dealer, and any rebate received, or any fraction thereof, is retained
by the broker-dealer, then the broker-dealer may have a financial
incentive to route the retail order to the trading center offering the
highest rebate or lowest fee.\412\ Brokerage commissions, which are
known to the customer, may depend on the rebates and take fees
collected or paid by broker-dealers.\413\ For example, broker-dealers
that collect more in rebates may pass this income on to customers by
charging lower commissions. However, routing solely to maximize rebates
or minimize take fees may result in lower execution quality than other
routing strategies. Without the proposed disclosures customers might
take only brokerage commissions into account and might, therefore,
suboptimally choose the lowest commission broker-dealer, without
considering other relevant costs. Such customers could, in fact, end up
paying higher net costs if the lower commission broker-dealers do not
obtain good execution quality for the retail orders. The information
required by proposed Rule 606(a)(1)(iii), together with the proposed
amendments to Rule 606(a) requiring differentiating of marketable and
non-marketable limit orders, would give customers additional
information to make decisions based on more than the brokerage
commissions.
---------------------------------------------------------------------------
\412\ See, e.g., Battalio, Corwin, and Jennings Paper, supra
note 57.
\413\ The Commission notes that it does not believe that fees
and rebates are the only determinants of brokerage commissions.
---------------------------------------------------------------------------
In addition, as discussed in Section V.C.2.a.i, if broker-dealers
improve their order routing for retail orders, which may result in
changes to which trading centers they route retail orders to, it could
promote competition between trading centers. The trading centers could
gauge, like customers, whether payment for order flow or maker-taker
fees affect the order routing decision of broker-dealers. The trading
centers may change their fees or attempt otherwise to attract retail
order flow and the quarterly public reports that are broken down by
calendar month would allow them to see effects of any changes they
implement. In addition, this may lead to innovation by existing trading
centers and it may attract new entrants and the formation of new
trading centers.
ii. Costs
Proposed Rule 606(a)(1)(iii) would impose initial costs on broker-
dealers in creating a new process to complete the reports and increase
ongoing costs related to incorporating additional information into the
reports. Preliminary estimates for the compliance costs are contained
in the estimates for the costs of producing the reports discussed in
Section V.C.2.e. It is possible that increased transparency about the
net aggregate amount of any payment for order flow, payment from any
profit-sharing relationship, transaction fees paid, and transaction
rebates received, and subsequent scrutiny by retail customers, the
public, academics, regulators, and the financial media, may lead
broker-dealers to decrease the degree to which they internalize orders
and route orders to high rebate or low fee exchanges to avoid the
perception of conflicts of interest. Broker-dealers might do this if
they perceive the potential costs from increased public scrutiny that
would result from the enhanced disclosures to be relatively high
compared to the benefit from sending retail orders to internalizers or
routing retail orders to high rebate and low fee trading centers. If
this were to occur then these retail orders might be more likely to be
routed to trading centers other than internalizers, such as exchanges
or alternative trading systems,\414\ regardless of potential execution
quality differences such as relatively less price improvement, or they
might be more likely to be routed to other lower rebate or higher fee
venues, regardless of the potential execution quality differences. In
addition, if broker-dealers were to reduce the retail order flow sent
to internalizers who pay for it, the broker-dealers would receive less
payment for retail order flow and might pass the lost payments onto
their retail customers by raising brokerage commissions or other fees.
Similarly, if broker-dealers were to route retail orders to trading
centers with lower rebates and higher fees, they might pass the
reduction in rebate revenue and increase in fee costs on to their
retail customers by raising brokerage commissions or other fees.
---------------------------------------------------------------------------
\414\ See supra note 3.
---------------------------------------------------------------------------
It is possible that increased transparency about net payment for
order flow and payments from profit-sharing relationships, and
subsequent scrutiny by retail customers, the public, academics,
regulators, and the financial media, might lead broker-dealers to alter
their payment for order flow or profit-sharing relationships or not
enter such relationships. Broker-dealers might do this if they perceive
the potential costs from increased public scrutiny to be relatively
high compared to a broker-dealer's benefit from such relationships.
This could lead to lower payments received from such relationships. The
affected broker-dealers might offset these lower revenues or higher
costs by increasing brokerage commissions or other fees for retail
customers.
iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 606(a)(1)(iii).
In particular, the Commission solicits comment on the following:
151. Do commenters believe that the assumptions underlying the
Commission's estimates for the costs of implementation and ongoing
costs to comply with the proposal are appropriate? Please provide data
and analysis to support your view.
152. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
153. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended consequences not discussed above that may
result from the proposal?
154. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
c. Discussion of Arrangement Terms With a Specified Venue
i. Benefits
As discussed in Section III.B.3., the proposed amendment to Rule
[[Page 49494]]
606(a)(1)(iv) would require broker-dealers to describe in their
quarterly public report any terms of payment for order flow
arrangements and profit-sharing relationships, whether written or oral,
with a Specified Venue that may influence their order routing
decisions, including, among other things: (1) Incentives for equaling
or exceeding an agreed upon order flow volume threshold, such as
additional payments or a higher rate of payment; (2) disincentives for
failing to meet an agreed upon minimum order flow threshold, such as
lower payments or the requirement to pay a fee; (3) volume-based tiered
payment schedules; and (4) agreements regarding the minimum amount of
order flow that the broker-dealer would send to a venue. The Commission
preliminarily believes that the description provided by proposed Rule
606(a)(1)(iv) would help ensure consistent, accurate, and comprehensive
disclosure of terms of payment for order flow and profit-sharing
relationships that influence broker-dealer order routing decisions.
This would make the public reports required by amended Rule 606(a) more
useful to customers and the public, and the benefits of the description
required by proposed Rule 606(a)(1)(iv) are similar to the benefits of
the disclosures of the net payment for order flow and transaction fees
and rebates by Specified Venue required by proposed Rule 606(a)(1)(iii)
and discussed in Section V.C.2.b.i.
The disclosures required by proposed Rule 606(a)(1)(iv) could allow
the public, including customers placing retail orders, to better
understand the potential conflicts of interest broker-dealers face when
routing retail orders.\415\ Together with the proposed amendments to
Rule 606(a) concerning differentiating marketable and non-marketable
limit orders and with proposed Rule 606(a)(1)(iii), proposed Rule
606(a)(1)(iv) could give customers placing retail orders useful
information about potential conflicts of interest. The disclosures
required by Rule 606(a)(1)(iv) would give customers access to
information on the terms of payment for order flow arrangements and
profit-sharing relationships between broker-dealers and Specified
Venues. Customers could use that information to gauge whether those
arrangements affect the order routing decisions of broker-dealers. The
proposed disclosures could incentivize broker-dealers to monitor their
potential conflicts of interest, and to review and alter how they route
retail orders, which could result in improved order routing decisions
and execution quality for retail orders. The disclosure could also help
the public to assess if and how well broker-dealers manage the
potential conflicts of interest they face when routing retail orders.
---------------------------------------------------------------------------
\415\ See supra Section II.C. for an example of routing
decisions being affected by conflicts of interest.
---------------------------------------------------------------------------
In addition, as discussed in Section V.C.2.a.i, if broker-dealers
improve their order routing for retail orders, which may result in
changes to which trading centers they route retail orders to, it could
promote competition between trading centers. The trading centers could
gauge, like customers, whether payment for order flow arrangements and
profit-sharing relationships between broker-dealers and Specified
Venues affect the order routing decisions of broker-dealers. The
trading centers may change their payment for order flow arrangements
and profit-sharing relationships with broker-dealers or attempt
otherwise to attract retail order flow and the quarterly public reports
that are broken down by calendar month would allow them to see effects
of any changes they implement. In addition, this may lead to innovation
by existing trading centers and it may attract new entrants and the
formation of new trading centers.
ii. Costs
Given that the proposed changes to Rule 606(a)(1)(iv) constitute an
amendment to an existing disclosure, the Commission preliminarily
estimates the initial paperwork burden for a broker-dealer that handles
retail orders to review and assess its payment for order flow
arrangements and profit-sharing relationships, whether written or oral,
with a Specified Venue that may influence their order routing
decisions, and describe terms of such arrangements to be 10 hours
resulting in a monetized cost burden of $3,155.\416\ With 266 broker-
dealers that route retail orders required to comply with the rule, the
Commission preliminarily estimates the total initial paperwork burden
for complying with proposed Rule 606(a)(1)(iv) to be 2,660 hours
resulting in a cost of $839,230.\417\ The Commission preliminarily
estimates the annual paperwork burden for a broker-dealer that handles
retail orders to describe and update any terms of payment for order
flow arrangements and profit-sharing relationships, whether written or
oral, with a Specified Venue that may influence their order routing
decisions to be 15 hours resulting in a monetized cost burden of
$3,500.\418\ With 266 broker-dealers that route retail orders required
to comply with the rule, the Commission preliminarily estimates the
total annual paperwork burden for complying with proposed Rule
606(a)(1)(iv) to be 3,990 hours resulting in a cost of $931,000.\419\
---------------------------------------------------------------------------
\416\ See supra note 318.
\417\ See supra note 319.
\418\ See supra note 323.
\419\ See supra note 324.
---------------------------------------------------------------------------
Increased disclosure about payment for order flow arrangements and
profit-sharing relationships may lead broker-dealers to decrease the
amount of internalization used in the execution of market and
marketable limit orders and to alter such arrangements and
relationships. Section V.C.2.b.ii. discusses this in detail and the
associated costs and other effects.
iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 606(a)(1)(iv). In
particular, the Commission solicits comment on the following:
155. Do commenters believe that the assumptions underlying the
Commission's estimates for the costs of implementation and ongoing
costs to comply with the proposal are appropriate? Please provide data
and analysis to support your view.
156. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
157. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended not discussed above consequences that may
result from the proposal?
158. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
d. Additional Amendments to Retail Disclosures
In addition to the amendments discussed above, the Commission is
proposing to amend disclosures for retail orders by aggregating reports
across listing exchanges, requiring quarterly reports to be broken down
by month, and providing reports in a specific format that are available
for a minimum length of time. The benefits and costs of these
additional amendments are discussed below.
[[Page 49495]]
i. Aggregated Reporting
(a) Benefits
The proposed amendment to Rule 606(a)(1) that requires reports on
retail orders be aggregated across all securities may reduce the
ongoing costs of the Rule 606(a) reports. Current Rule 606(a)(1)
requires that NMS stocks be ``divided into three separate sections for
securities that are listed on the New York Stock Exchange, Inc.,
securities that are qualified for inclusion in The Nasdaq Stock Market,
Inc., and securities that are listed on the American Stock Exchange LLC
or any other national securities exchange.'' To satisfy this
requirement, broker-dealers have to determine the primary listing of
all NMS stocks and incur a cost on an ongoing basis in doing so.
Eliminating this requirement would save broker-dealers this cost. In
addition, new broker-dealers currently have to create the initial
report format for the three groups of NMS stocks, which also imposes a
one-time cost.\420\ Under the proposed amendment, new broker-dealers
would not incur that cost.
---------------------------------------------------------------------------
\420\ NYSE Arca, Inc. (``NYSE Arca'') and Bats BZX are also
listing exchanges but only for exchange traded funds not stocks.
---------------------------------------------------------------------------
(b) Costs
The Commission's proposal to aggregate reports on retail order
routing across listing exchanges would also impose costs, according to
a staff analysis.\421\ In particular, the staff analysis indicates that
the aggregation across listing exchanges would reduce the value of the
606 reports for monitoring execution quality from broker-dealers
because it would make it harder for retail customers to assess the
execution quality provided by their broker-dealers. This section
describes the staff's analysis.
---------------------------------------------------------------------------
\421\ In addition, this proposed amendment would impose an
initial cost for broker-dealers who currently capture the data
required by the proposed modification to Rule 606(a) to change the
process for preparing the reports. These costs are reflected in the
cost estimates discussed in Section V.C.2.e.
---------------------------------------------------------------------------
The staff's analysis focuses on whether customers or others can use
the market-specific routing information to assess the execution quality
they get from their broker-dealers. Specifically, if the order routing
decisions by broker-dealers differ for stocks listed on different
exchanges, e.g., if broker-dealers route orders differently for NYSE-
listed stocks compared to NASDAQ-listed stocks, the proposed aggregated
reports would not provide this information to customers and the
public.\422\ Such information can be useful for customers and the
public as long as order routing decisions determine execution quality
and execution costs. Specifically, Commission staff analyzed execution
costs as measured by effective spreads from Rule 605 reports (``Rule
605 data'') for common stocks with different primary listing exchanges
and on different market centers to determine whether the cost of
executing a market or a marketable limit order for common stock varies
across market centers and primary listing exchange.\423\ The staff's
analysis controls for stock and order characteristics.\424\
Accordingly, the staff's analysis considers whether execution quality
depends on primary listing exchanges, and specifically which market
centers provide better execution, as a means to assess whether the
proposal might reduce the usefulness of the reports.\425\
---------------------------------------------------------------------------
\422\ The Commission notes that there are differences in order
routing decisions depending on primary listing exchange due to
existing rules, regulations, and practices. For example, the NYSE
does not trade NASDAQ- or NYSE MKT-listed stocks. As a result,
orders for a NYSE-listed stock can be routed to the NYSE, NASDAQ,
and other market centers, whereas orders for NASDAQ-listed stocks
can be routed to NASDAQ and other market centers, but not to the
NYSE. This level of information would be lost in aggregated reports.
\423\ The Commission purchased the Rule 605 data from CoreOne
Technologies, a provider of financial data. The data used in this
analysis spans the period from January 1, 2012 through December 31,
2014. The CRSP US Stock Database from Wharton Research Data Services
contains daily and monthly market and corporate action data for
securities, and is used to estimate control variables.
\424\ Specifically, the analysis consists of a regression that
uses dollar volume, market capitalization, and mean variance of
daily returns to control for stock characteristics, and order type
and order size to control for order characteristics.
\425\ Similarly, if any of the information required to be
disclosed by proposed Rules 606(a)(iii) and (iv) differs for stocks
with different listing exchanges, then the proposed aggregation will
reduce the information content of the reports, provided that
information is valuable to institutions as discussion in Section
II.C. For example, it may be the case that payment for order flow
arrangements are different for stocks with different primary listing
exchanges or an exchange may implement different fees and rebates
for stocks with a different primary listing exchange.
---------------------------------------------------------------------------
While the staff's analysis is not a direct test of whether order
routing differs for stocks with different primary listing
exchanges,\426\ it does directly measure one important factor in
whether such routing information would be useful--differences in
execution costs. Information on both execution costs and routing allows
customers (or someone acting on behalf of customers) to assess the
extent to which their broker-dealer routes customer orders to the
market centers with the lowest execution costs. If the execution cost
measures show that listing exchange matters for which market centers
offer better execution quality, then aggregating the routing
information across listing exchanges could reduce the ability for
customers to assess one of the components of best execution. Hence, the
staff's analysis provides some indication of whether aggregated
reporting, as required by the proposed amendment, would deprive
customers and the public of useful information regarding the impact of
routing decisions.
---------------------------------------------------------------------------
\426\ Commission staff was unable to obtain historical quarterly
reports for retail orders required by current Rule 606(a).
Therefore, the Commission staff did not analyze current 606 reports
to see if routing differs by listing exchange of the stock.
Table 1--Association Between Trading Center and Mean Effective Spread for Common Stocks by Listing Exchange
----------------------------------------------------------------------------------------------------------------
Mean effective spread (basis points)
----------------------------------------------------------------------------
(1) (2) (3)
----------------------------------------------------------------------------
NYSE-listed NASDAQ-listed NYSE MKT-listed
----------------------------------------------------------------------------------------------------------------
Intercept.......................... *** 18.02 (227.48) *** 92.01 (412.45) *** 177.29 (122.39)
BATS BYX........................... ***-4.12 (-48.43) ***-35.78 (-141.56) ***-37.58 (-20.35)
BATS BZX........................... ***-7.04 (-77.28) ***-40.70 (-161.74) ***-50.60 (-31.87)
BX................................. ***-1.31 (-14.26) ***-29.21 (-107.52) ***-34.06 (-19.01)
CBSX............................... *** 1.12 (8.76) ***-17.02 (-41.94) *** 14.94 (4.70)
CHX................................ ***-2.27 (-10.93) ***-37.72 (-43.53) ***-21.04 (-2.90)
EDGA............................... ***-4.69 (-55.75) ***-35.49 (-131.77) ***-41.53 (-25.03)
EDGX............................... ***-4.28 (-48.53) ***-27.64 (-96.80) ***-29.09 (-15.71)
[[Page 49496]]
NASDAQ............................. *** 1.63 (17.33) ......................... ** 3.98 (2.53)
NSX................................ ***-2.85 (-28.76) ***-37.17 (-118.44) ***-41.72 (-22.17)
NYSE ARCA.......................... ***-5.75 (-70.19) ***-36.71 (-152.46) ***-48.49 (-30.82)
NYSE MKT........................... ....................... ***-57.02 (-113.92) .......................
Off Exchange....................... ***-3.08 (-43.57) ***-31.85 (-168.35) ***-34.54 (-26.76)
PSX................................ ***-3.10 (-39.77) ***-57.54 (-256.34) ***-81.01 (-54.98)
Marketable limit order............. -0.004 (-.11) *** 2.90 (28.78) ***-10.83 (-15.95)
500-1,999 shares................... *** 0.67 (15.32) ***-2.32 (-21.67) *-1.23 (-1.87)
2,000-4,999 shares................. *** 2.22 (44.37) ***-3.31 (-26.89) ** 1.87 (2.37)
>=5,000 shares..................... *** 3.41 (61.79) ***-4.23 (-28.66) *** 2.98 (3.12)
Dollar volume...................... ***-2.86E-08 (-178.5) *** 2.21E-09 (11.38) -3.04E-08 (-1.49)
Market capitalization.............. *** 8.03E-12 (12.49) ***-3.65E-10 (-121.35) ***-1.96E-08 (-57.69)
Variance of daily return........... *** 334.54 (21.14) *** 438.14 (11.66) *** 877.18 (11.53)
H0: All exchange dummies = 0
Chi-square..................... *** 17,580 *** 75,339 *** 6,346
H0: EDGX = Bats BYX
Chi-square..................... ** 4.13 *** 806.78 *** 18.70
Observations....................... 9,792,105 10,764,324 688,305
Adjusted R\2\...................... 1.02% 1.18% 1.98%
Year fixed effects................. Yes Yes Yes
----------------------------------------------------------------------------------------------------------------
Note: Data are SEC Rule 605 data purchased from CoreOne Technologies and CRSP, and include years 2012-2014. The
mean effective spread is equally-weighted by stock. The variable categories that are dropped are: One trading
center, market orders (for the regressions involving mean effective spreads), inside-the-quote limit orders
(for regressions involving mean realized spreads), order size from 100-499 shares, and the 2012 calendar year.
The Chi-square test is used to test the null hypothesis that all of the exchange coefficients, with the
exception of the intercept coefficient, are jointly zero. The null hypothesis would imply that all exchanges
would not be associated with a mean effective spread different from that associated with NYSE-listed stock
orders executed at NYSE. T-statistics estimated from White standard errors are in parentheses. * indicates
significance of a 2-tailed test at the 10% level; ** at the 5% level; *** at the 1% level.
Table 1 presents the results of the staff's analysis of effective
spreads for common stocks listed on the NYSE, NASDAQ, and NYSE MKT.
Columns 1 through 3 report the results for each of these primary
listing exchanges.\427\ The market center rows in the table report the
basis point difference between the average effective spreads on that
market center and the average effective spreads on the primary listing
exchange. In tests of whether effective spreads of each market center
are the same as the listing exchange, the rows with stars indicate that
the market center effective spreads are statistically significantly
different, with more stars indicating stronger confidence in the
significance. For illustration, the intercept in Column 1 indicates
that the average effective spread for market orders for NYSE-listed
stocks that are executed on the NYSE is 18.02 basis points and the -
4.12 estimate for Bats BYX Exchange, Inc. (``Bats BYX'') indicates that
the effective spreads for NYSE-listed stocks on Bats BYX are 4.12 basis
points lower after controlling for differences due to stock and order
characteristics.\428\
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\427\ The Rule 605 data and, thus, this analysis weight the
effective spread statistics equally by stock. Therefore, these
effective spreads appear larger than if they were weighted by dollar
volume or by share volume.
\428\ For perspective, a one penny effective spread on a $40
stock is 2.5 basis points. A 2.5 basis point cost on a 100 share
trade in a $40 stock would be $1.00. An ordinary least squares
estimate is consistent when the explanatory variables are exogenous,
perfect multicollinearity does not exist, and optimal in the class
of linear unbiased estimators when the errors are homoscedastic and
serially uncorrelated. Under these assumptions, the method of
ordinary least squares provides minimum-variance mean-unbiased
estimates when the errors have finite variances. If any one or more
of these assumptions does not hold then the estimate may not be the
best linear unbiased estimator.
---------------------------------------------------------------------------
Table 1 indicates that the average effective spreads vary
significantly by the market center where the orders were executed.
Table 1 shows that most market center effective spreads are
significantly different than those of the listing exchange. For
example, Column 1 shows that, for NYSE-listed stocks, the average
effective spread on Bats BZX is 7.04 basis points less than on the NYSE
itself, and the average effective spread on NASDAQ is 1.63 basis points
higher than on the NYSE. In addition, some differences in effective
spreads are also economically meaningful. For example, Column 2 reports
that the average effective spread for orders in NASDAQ-listed stocks
that are executed on NASDAQ is 92.01 basis points and the average
effective spread for such orders that are executed on NYSE Arca is
36.71 basis points lower, which corresponds to a 55.3 basis point
difference and represents a reduction of almost 40%.\429\ Differences
of such magnitude may be important to broker-dealers when making order
routing decisions and to customers in monitoring the execution quality
their broker-dealers provide as measured by the current Rule 605
reports.
---------------------------------------------------------------------------
\429\ 36.71/92.01 = 39.9%.
---------------------------------------------------------------------------
Table 1 also indicates that the average effective spreads vary
significantly by listing exchange. The staff's analysis suggests that
NASDAQ-listed stocks tend to have higher average effective spreads than
NYSE-listed stocks because the intercept estimates are much larger in
Column 2 compared to Column 1.\430\ Table 1 also shows that NYSE MKT-
listed stocks tend to have even higher average effective spreads
[[Page 49497]]
than NASDAQ-listed stocks by comparing the results in Column 3 with
those in Column 2. The Commission notes that neither this result alone
nor this result in conjunction with the results in the previous
paragraph directly measure whether the proposed amendment would reduce
the usefulness of the Rule 606 routing information.
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\430\ The Commission recognizes that the staff analysis did not
control for stock and order characteristic differences across the
columns and the staff did not estimate a matched-sample comparison.
These other analysis types would facilitate a more fulsome
comparison of effective spreads in similar stocks by listing
exchange than the staff's analysis in Table 1. However, because the
606 reports do not distinguish individual stocks, the Commission
preliminarily believes that the staff analysis is appropriate for
assessing the costs of the proposed amendments.
---------------------------------------------------------------------------
However, a deeper analysis of Table 1 can inform on these costs.
Specifically, the results in the table suggest that because the
relative ranking of each market center changes depending on the listing
exchange, the proposed amendment to aggregate routing information
across listing exchanges could reduce the usefulness of Rule 606
reports. Commission staff compared the effective spreads across the
various market centers for stocks listed on each of the primary listing
exchanges, as indicated by Table 1.
If the ranking of the effective spreads on each market center were
the same across the three primary listing exchanges, where a stock is
listed would have little or no relationship to whether order routing
information informs on execution quality. Such a result would imply
that aggregating the reports across primary listing exchanges would not
reduce the amount of information in the reports. However, upon
examination, Table 1 shows that the ranking of the market centers by
effective spreads is different depending on the primary listing
exchange. For example, the coefficient estimates in Table 1 suggest
that for NYSE-listed stocks, Bats EDGX Exchange, Inc. (``EDGX'') has
lower execution costs than Bats BYX, but for NASDAQ-listed stocks, EDGX
has higher execution costs than Bats BYX. In Column 1 for NYSE-listed
stocks, the differential cost of trading a stock on EDGX versus Bats
BYX is small, 0.17 basis points, but statistically significant.
However, in Column 2 for NASDAQ-listed stocks, the stocks differ in
cost by a statistically significant 8.14 basis points between the same
two exchanges. This indicates that there seem to be differences between
market centers in terms of effective spreads for stocks with different
primary listings that, together with routing information by listing
exchange, may inform customers in assessing the execution quality their
broker-dealers provide. Therefore, the staff's analysis indicates that
aggregating the reports, as in the proposed amendment, could result in
an informational cost to customers and the public.
As noted above in Section III.B.4., while the Commission recognizes
that eliminating the division of reports by the three distinct listing
markets may potentially cause some reduction in informational content,
as indicated in the analysis above, the Commission preliminarily
believes that any diminution in granular listing market data is
appropriate in light of the proposed requirement to provide retail
customers with pertinent order routing data that reflects today's
multiple trading centers and practices. The Commission solicits comment
on the foregoing.
ii. Other Proposed Amendments to Reporting
The Commission is also proposing to require that the quarterly
public retail order routing reports required by Rule 606(a)(1) be
broken down by calendar month. Current Rule 606(a)(1) requires broker-
dealers to make retail order routing reports publicly available for
each calendar quarter, and such reports contain aggregate quarterly
information on the routing of retail orders. As noted above, the
Commission understands that trading centers frequently change their fee
structures, including the amount of fees and rebates, in order to
attract order flow, and these changes typically occur at the beginning
of a calendar month. The changes in fee structures at trading centers
likely will affect a broker-dealer's routing decisions. Disclosing
retail order routing information on an aggregated quarterly basis can
mask changes in routing behavior in response to changes in a trading
center's fee structure. The Commission preliminarily believes that
disclosing the information contained in the public retail routing
reports by calendar month would allow customers to better assess
whether their broker-dealers' routing decisions are affected by changes
in fee structures and the extent to which such changes affect execution
quality. This proposed amendment would, however, require an initial
cost to change the process for completing the reports. The Commission
preliminarily believes this cost to be small because broker-dealers
typically process data daily and reporting the data broken down by
month would only be a change in the aggregation of the data, from
quarterly to monthly.
In addition, the Commission is proposing that the public retail
order routing report required by Rule 606(a)(1) and customer-specific
order routing report required by Rule 606(b)(1) be made available using
an XML schema and associated PDF renderer to be published on the
Commission's Web site. The benefits and costs associated with this
requirement are discussed in Section V.C.4. The Commission
preliminarily believes that requiring both the public and customer-
specific retail order routing reports to be provided in this format
should be useful to customers as it would allow them to more easily
analyze and compare the data provided in both types of reports across
broker-dealers, for the reasons discussed above.\431\ The proposed
amendments to Rule 606(a)(1) and Rule 606(b)(1) would require an
initial cost to change the process for completing the reports.\432\ The
benefits and costs associated with this requirement are discussed in
further detail in Section V.C.4.
---------------------------------------------------------------------------
\431\ See supra Section III.A.3.
\432\ The benefits and costs associated with this requirement
more generally are discussed in Section V.C.4.
---------------------------------------------------------------------------
Finally, the Commission is proposing to amend Rules 605(a)(2) and
606(a)(1) to require market centers and broker-dealers to keep the
reports posted on an Internet Web site that is free of charge and
readily accessible to the public for a period of three years. Requiring
that data be available to customers and the public for three years
could be useful to those seeking to analyze past execution quality by
market center and routing behavior of broker-dealers. Such analysis may
lead to increased transparency with regards to execution quality and
may lead broker-dealers to compete along this dimension through routing
decisions, resulting in a higher probability of execution and improved
execution in terms of costs. Current Rules 605 and 606 do not specify
the minimum length of time that market centers need to publish the
order execution reports and broker-dealers need to publish the retail
order routing reports, respectively. As a result, the public may not be
able to examine the order execution of a market center and the routing
of retail orders by a broker-dealer through time if past reports are
not currently available or they have to rely on third-party vendors to
supply past reports.
The requirement to make the reports available for three years may
also produce costs. As noted above, however, the Commission
preliminarily believes that, once the report is posted, maintaining the
reports on the Web site will not pose any additional burden on broker-
dealers, and thus any additional costs to maintain the report on the
Web site would be negligible. Any costs of maintaining the report are
included in the Commission's estimates of the costs broker-dealers will
incur to produce the reports, as explained above.\433\ In addition,
third-party vendors that
[[Page 49498]]
aggregate the time series of 605 and 606 reports may find that their
data is less useful, particularly for the three years that the reports
are publicly available.
---------------------------------------------------------------------------
\433\ See infra Section V.C.1.c.ii.
---------------------------------------------------------------------------
iii. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 605(a)(2),
606(a)(1) and 606(b)(1). In particular, the Commission solicits comment
on the following:
159. Do commenters believe that the assumptions underlying the
Commission's estimates for the costs of implementation and ongoing
costs to comply with the proposal are appropriate? Please provide data
and analysis to support your view.
160. Do commenters believe there are additional costs or benefits
that could be quantified or otherwise monetized? If so, please identify
these costs and benefits. Please explain and provide specific data and
estimates.
161. Do commenters believe there are any additional costs or
benefits that may arise from the proposal? Are there costs and benefits
described that would likely not result from the proposed amendments?
Are there any unintended consequences that may result from the
proposal?
162. Do commenters believe that there are methods by which the
Commission could reduce the costs imposed by the proposal, while still
achieving its stated goals? Please explain in detail.
e. Compliance Costs for Retail Order Routing Reports
As discussed in more detail in Section IV.D.4., the Commission
preliminarily estimates the costs to comply with the proposed
amendments to Rule 606(a) that require broker-dealers to distinguish
between marketable and non-marketable limit orders and with proposed
Rule 606(a)(1)(iii) that requires disclosure of net payment for order
flow and transaction fees and rebates by Specified Venue as follows.
The Commission preliminarily estimates that most of the 266 broker-
dealers that route retail orders already obtain the information
required by the proposed rule and that 50 broker-dealers do not
currently obtain such information. The Commission preliminarily
estimates that the initial burden for a broker-dealer who routes retail
orders to update its systems to capture the information required by
proposed Rule 606(a) and format that information into a report to
comply with the rule will be 80 hours resulting in a cost of
$22,648.\434\ The Commission preliminarily estimates that 25 broker-
dealers whose systems do not currently capture all of the information
required by proposed Rule 606(a) will engage a third-party service
provider to perform the necessary upgrades. The Commission
preliminarily estimates that the initial burden for a broker-dealer
that routes retail orders to engage a third-party to perform the
necessary system updates to comply with proposed Rule 606(a) will be 20
hours resulting in a monetized cost burden of $5,985 plus an additional
third-party service provider fee of $10,000.\435\ Therefore, the
Commission preliminarily estimates the total initial burden for all 50
broker-dealers who need to update their systems and create a new report
to be 2,500 hours resulting in a monetized cost burden of $715,825 plus
an additional $250,000 fee to the third-party service providers.\436\
---------------------------------------------------------------------------
\434\ See supra note 299.
\435\ See supra notes 301 and 302.
\436\ See supra notes 304 and 305.
---------------------------------------------------------------------------
For the remaining 216 broker-dealers who the Commission
preliminarily estimates currently capture the data required by the
proposed modifications to Rule 606(a), such broker-dealers would need
only to format their reports to incorporate such data. The Commission
preliminarily estimates for broker-dealers that already capture such
data, 108 would format the reports in-house. The cost to format that
data into its existing reports in-house is preliminarily estimated to
be 20 hours resulting in a monetized cost burden of $4,975.\437\ The
Commission preliminarily estimates that 108 broker-dealers currently
engage a third-party service provider to provide reports pursuant to
existing Rule 606(a) and such broker-dealers would continue to use
third-party service providers to format reports to comply with proposed
Rule 606(a). The Commission preliminarily estimates the initial burden
for a broker-dealer who engages a third-party service provider to
format reports to comply with proposed Rule 606(a) would be 8 hours
resulting in a monetized cost burden of $2,555 plus an additional fee
of $2,000.\438\ As such, the Commission preliminarily estimates that
the total cost for the 216 broker-dealers who the Commission
preliminarily estimates currently capture the data required by proposed
Rule 606(a) to format their reports to incorporate such data to be
3,024 hours resulting in a monetized cost burden of $813,240 plus an
additional $216,000 third-party service provider fee.\439\ Therefore,
the Commission preliminarily estimates that the total initial burden to
comply with Rule 606(a) for all 266 broker-dealers which the Commission
preliminarily estimates route retail orders is 5,524 hours resulting in
a monetized cost burden of $1,529,065 plus an additional fee of
$466,000 to third-party service providers.\440\
---------------------------------------------------------------------------
\437\ See supra note 306.
\438\ See supra notes 308 and 309.
\439\ See supra notes 312 and 313.
\440\ See supra notes 314 and 315.
---------------------------------------------------------------------------
The Commission preliminarily believes that once the initial costs,
described above, have been incurred to allow a broker-dealer to obtain
the required information, the cost to produce a quarterly report would
remain the same compared to a quarterly report required under current
Rule 606(a).\441\ However, broker-dealers would need to monitor payment
for order flow or profit-sharing relationships and potential SRO rule
changes that could impact their order routing decisions and incorporate
any new information into their reports. Thus, the Commission
preliminarily estimates the annual burden for a broker-dealer to comply
with the proposed amendments to Rule 606(a)(1)(i)-(iii) to be 10 hours
resulting in a monetized cost burden of $3,155.\442\ With 266 broker-
dealers that route retail orders required to comply with the proposed
amendments, the Commission preliminarily estimates the total annual
burden to be 2,660 hours resulting in a monetized cost burden of
$839,230.\443\
---------------------------------------------------------------------------
\441\ See supra Section IV.D.4.b.
\442\ See supra note 321.
\443\ See supra note 322.
---------------------------------------------------------------------------
i. Request for Comment
The Commission requests comment on the Commission's discussion of
implementation considerations of the proposed amendments in Rules
606(a)(1) and 606(b)(1). In particular, the Commission solicits comment
on the following:
163. Do commenters agree with the Commission's estimates of the
costs to comply with the proposed amendments in Rules 606(a)(1) and
606(b)(1) for retail orders? Specifically, do commenters agree with the
Commission's estimates for initial costs and for ongoing costs? Please
be specific in your response and provide data to support your response.
3. Disclosure of Order Execution Information
The proposed amendment to Rule 605(a)(2) requires market centers to
keep reports required pursuant to Rule
[[Page 49499]]
605(a)(1) posted on an Internet Web site that is free of charge and
readily accessible to the public for a period of three years from the
initial date of posting on the Internet Web site.
a. Benefits
Similar to the analogous requirements proposed in Rules 606(a) and
606(c) described above, the Commission preliminarily believes that
requiring the previous three years of past order execution information
to be available to customers and the public generally should be useful
to those seeking to analyze historical order execution information at
various market centers. Currently, customers and the public who want to
analyze historical order execution information have to either download
the data every quarter or they have to rely on third-party vendors to
get access to such data. The proposed requirement to make the data
readily accessible to the public for three years would allow customers
and the public to access and analyze historical order execution
information more easily by requiring that historical data are kept
posted by the market centers. The public includes other market
participants. For example, the proposed requirement to make the data
readily accessible to the public for three years would benefit broker-
dealers, market centers, and third-party vendors in that it would allow
them to access and analyze historical order execution information more
easily. This would allow broker-dealers to compare different market
centers more easily, market centers to compare themselves to other
market centers more easily, and third-party vendors to provide their
services based on the data more easily.
b. Costs
The Commission preliminarily believes that the costs to market
centers for making the order execution reports readily accessible to
the public for a period of three years from the date of initial
publication are negligible as it amounts to posting the currently-
required reports for the three-year time period. In addition, some
market centers may already make their reports available to the public
for an extended period of time. The requirement to post and maintain
reports on an Internet Web site that is free of charge and readily
accessible to the public for a period of three years would begin at the
adoption of the proposed amendments to Rule 605(a)(2) and apply going
forward. Affected entities (the market centers) would not be required
to post reports created and posted prior to the proposed Rule's
effectiveness.
The Commission notes that specifying a minimum length of time for
making the Rule 605 reports available may make the data owned by third-
party vendors aggregating the time series of 605 reports less useful
because, for three years, the data would be publicly available and more
easily accessible.
c. Request for Comment
The Commission requests comment on the Commission's analysis of the
costs and benefits of the proposed amendments in Rule 605(a)(2). In
particular, the Commission solicits comment on the following:
164. Do commenters believe that there are benefits to making order
execution reports readily available for three years? If so, please
explain.
165. Do commenters agree with the Commission's analysis that the
costs are negligible? Why or why not?
4. Structured Format of Reports
The Commission is proposing to require that the retail order
routing and institutional order handling reports be made available
using the Commission's XML schema and associated PDF renderer. As
discussed earlier, the Commission preliminarily believes that requiring
the reports to be made available in an XML format will facilitate
enhanced search capabilities, and statistical and comparative analyses
across broker-dealers and date ranges.\444\ In addition, the associated
PDF renderer would provide users with an instantly human-readable
format for those who prefer to review manually individual reports,
while still providing a uniform presentation.
---------------------------------------------------------------------------
\444\ See supra Section III.A.3.
---------------------------------------------------------------------------
The Commission understands that there are varying costs associated
with varying degrees of structuring. Most, if not all, broker-dealers
already have experience applying the XML format to their data. For
example, all FINRA members must use FINRA's Web EFT system, which
requires that all data be submitted in XML.\445\ For the end users,
with the data in the reports structured in XML, they could immediately
download the information directly into databases and analyze it using
various software. This would enhance their ability to conduct large-
scale analysis and immediate comparison of broker-dealers, and across
date ranges. Moreover, as an open standard, XML is widely available to
the public at no cost.
---------------------------------------------------------------------------
\445\ See http://www.finra.org/industry/web-crd/web-eft-schema-documentation-and-schema-files.
---------------------------------------------------------------------------
The Commission also preliminarily believes that if the reports are
provided in a structured format, users could avoid costs associated
with third-party sources who might otherwise extract and structure the
data, and then charge for access to that structured data. Users could
also avoid the additional time it would take for them to manually
review and individually structure the data if they wanted to conduct
large-scale analysis, comparison, or aggregation.
The XML schema would also incorporate certain validations to help
ensure consistent formatting among all reports, in other words, to help
ensure data quality. Validations are restrictions placed on the
formatting for each data element so that comparable data is presented
comparably. However, these validations would not be designed to ensure
the underlying accuracy of the data. Any reports made available by
broker-dealers pursuant to the proposal would have to comply with
validations that are incorporated within the XML schema, otherwise the
reports would not be considered to have been made available using the
most recent version of the Commission's XML schema.
XML is an open standard that is maintained by an organization other
than the Commission and undergoes constant review. As updates to XML or
industry practice develop, the Commission's XML schema may also have to
be updated to reflect the updates in technology. In those cases, the
supported version of the XML schema would be made available on the
Commission's Web site and the outdated version of the schema would be
removed in order to maintain data quality and consistency with the
standard.
The Commission considered alternative formats to XML, such as
comma-separated values (``CSV'') and XBRL. The Commission does not
believe the CSV format is suitable because it does not lend itself to
validations. As a result, the data quality of the reports would likely
be diminished as compared to XML, impairing comparability, aggregation,
and large-scale analysis. While the XBRL format enables users to
capture the rich complexity of financial information presented in
accordance with U.S. Generally Accepted Accounting Principles, XBRL is
not necessary to accurately capture the information for the proposed
reports. The Commission preliminarily believes the simpler
characteristics of the information in the required reports are better
suited for XML.
a. Request for Comment
The Commission requests comment on the Commission's analysis of the
proposed structured format for the
[[Page 49500]]
proposed reports. In particular, the Commission solicits comment on the
following:
166. Should the Commission require a structured format other than
XML? If so, please identify the other format; identify how the other
format could be used for aggregation, comparison, and large-scale
analysis; and identify how the Commission can similarly ensure data
quality.
167. As proposed, the public reports will be made available on each
broker-dealers' Web site. Are there any benefits to the public or to
broker-dealers if the reports were also submitted to the Commission's
EDGAR system? If so, please identify those benefits and any associated
costs.
168. How and in what format do broker-dealers currently provide
their reports for retail orders required by Rule 606(a)(2)?
169. Broker-dealers currently provide reports about order routing
and execution quality to institutional customers upon request on a
voluntary basis. How and in what format do broker-dealers currently
provide those ad-hoc reports?
170. Market centers publish current Rule 605(a) reports in a pipe-
delimited ASCII format. Should the Commission require a different
structured format for the reports required by Rule 605(a)? Why or why
not? If yes, should the Commission require that the reports required by
Rule 605(a) be made available using an XML schema and associated PDF
renderer published on the Commission's Web site? Why or why not? Please
be specific in your response. If commenters believe another format
would be more appropriate, please identify the other format and
identify how the other format can also be used for aggregation,
comparison, and large-scale analysis; and identify how the Commission
can similarly ensure data quality. Please identify any benefits and
associated costs.
5. Other Definitions in Proposed Amendments to Rule 600
a. Definition of Non-Marketable Limit Order in Proposed Rule 600(b)(51)
Proposed Rule 600(b)(51) defines a non-marketable limit order to
mean any limit order other than a marketable limit order. The
Commission preliminarily believes that proposed Rule 600(b)(51) would
ensure consistent and correct interpretation and application of the
proposed amendments to Rule 606(a)(1) for retail orders. The Commission
also preliminarily believes that there are no costs associated with
proposed Rule 600(b)(51) because it is a definition that is widely used
by market participants.
b. Definitions of ``Orders Providing Liquidity'' and ``Orders Removing
Liquidity'' in Proposed Rule 600(b)(55) and (56)
Proposed Rule 600(b)(55) defines ``orders providing liquidity'' to
mean orders that were executed against after resting at a trading
center. Proposed Rule 600(b)(56) defines ``orders removing liquidity''
to mean orders that were executed against resting trading interest at a
trading center. The Commission preliminarily believes that proposed
Rules 600(b)(55) and (56) would ensure consistent and correct
interpretation and application of proposed Rule 606(b)(3) for
institutional orders. The Commission also preliminarily believes that
there are no costs associated with proposed Rules 600(b)(55) and (56)
because the Commission understands that the two definitions are widely
used by market participants.
c. Request for Comment
The Commission requests comment on the Commission's analysis of the
proposed definitions. In particular, the Commission solicits comment on
the following:
171. Do commenters agree with the definitions? If not, please
provide alternative definitions and describe the benefits and costs of
those alternatives as compared to the proposed definitions. Please be
specific.
172. Do commenters agree with benefits and costs of the proposed
definitions as described by the Commission? Please be specific.
173. Do commenters believe that the proposed definitions are widely
used and accepted by market participants? Please be specific.
D. Alternatives Considered
1. Definition of Institutional Order in Proposed Rule 606(b)(31)
The Commission considered one alternative to the proposed
definition of institutional order in Rule 600(b)(31) that would specify
different thresholds for NMS stocks based on trading volume. This
alternative would more finely tailor the definition for different types
of NMS stocks, as described in Section V.C.1.a.ii. However, this
alternative approach would add complexity to the proposed definition,
and analysis of data on orders from institutions does not indicate any
natural breakpoints.\446\ The absence of natural breakpoints makes it
more difficult to draw definitive conclusions about what thresholds, if
any, would be appropriate in a definition.
---------------------------------------------------------------------------
\446\ See Section V.C.1.a.ii. for a discussion of Commission
staff analysis of a set of orders from institutional customers.
---------------------------------------------------------------------------
In addition to the concern that the threshold of a market value of
at least $200,000 may not capture large (measured by shares) orders in
illiquid NMS stocks, Section V.C.1.a.ii. also discusses the incentives
that market participants may have to change their behavior as stock
prices may change over time, which may affect the proportion of orders
that fall under the proposed definition of institutional order.
The Commission considered another alternative to the definition in
proposed Rule 600(b)(31) that would address both concerns. The
alternative would be to have customers identify their orders as
institutional orders subject to Rule 606. This alternative approach
would address the issue of having the same thresholds for all NMS
stocks, independent of the trading volume of the stocks. Since this
approach would require each customer to identify institutional orders,
there would be a risk that customers may apply different criteria in
identifying institutional orders. To the extent broker-dealers receive
institutional orders that take different approaches, the usefulness of
the reports for the purpose of comparing broker-dealers would be lower
than with a consistently applied definition. However, the Commission
notes that the alternative of allowing institutions to identify their
orders as institutional orders would not reduce the usefulness of the
information if the public reports contained specified thresholds as in
the proposal. This alternative may not be significantly more costly for
broker-dealers to implement than the proposal. After identifying the
orders to be included in the calculations, all calculations would be
the same for the alternative as for the proposal. On the other hand, if
the alternative requires a specified threshold for disclosure on public
reports, the public reports would require separate processing because
they would involve calculations on different underlying orders. In this
case, the alternative would be more costly than the proposal.
2. Limited or No Public Disclosure of Institutional Order Routing and
Execution Quality (Proposed Rule 606(c))
The Commission considered requiring broker-dealers to make publicly
available only a subset of the information on institutional order
handling required by proposed Rule 606(c). For instance, order routing
and execution could be disclosed, but not
[[Page 49501]]
information on orders providing liquidity or orders removing liquidity.
Although this alternative would enhance the quality of the disclosure
provided by broker-dealers relative to the disclosure under current
Rule 606, which does not apply to institutional orders, it would shed
less light on how order routing affects execution quality and, thus,
provide less information on the potential for conflicts of interest
relative to proposed Rule 606(c). As such, the benefits that would be
achieved by this alternative are smaller relative to the benefits
proposed Rule 606(c) would offer. Additionally, the Commission
preliminarily believes that the costs to broker-dealers of this
alternative would only be marginally less expensive in than proposed
Rule 606(c), because a process would still be required to create the
report.
The Commission also considered not requiring broker-dealers to make
publicly available any of the information required by proposed Rule
606(c) (but still proposing to require disclosure pursuant to the
amendments to Rule 606(b)(3) regarding customer requests for
institutional order handling information). As for limited public
disclosure just discussed, this alternative would improve the quality
of the disclosure provided by broker-dealers relative to the disclosure
under current Rule 606, but it would shed even less light on how order
routing affects execution quality and thus provide even less
information on the potential for conflicts of interest relative to
proposed Rule 606(c). As such, the benefits that would be achieved by
this alternative would not only be smaller relative to the benefits
proposed Rule 606(c) would offer, but also smaller relative to the
benefits of the alternative of limited public disclosure. The
alternative of no public disclosure would result in cost savings
compared to proposed Rule 606(c) because the process to create the
public report would not be required under this alternative.
3. More Frequent Public Disclosure of Institutional Order Routing and
Execution Information (Proposed Rule 606(c))
The Commission considered requiring broker-dealers to make the
aggregated public disclosure of their institutional order routing and
execution information available on a more frequent basis than in
proposed Rule 606(c) (i.e., monthly rather than quarterly). This
alternative would increase the frequency of order routing and execution
disclosure, but at an additional cost to broker-dealers relative to
proposed Rule 606(c). Specifically, additional costs would accrue from
creating and disseminating the reports more frequently than quarterly.
Monthly public reports as compared to quarterly public reports would
result in having to run the production process to create and
disseminate the reports twelve rather than four times per year.
The Commission preliminarily estimates that each broker-dealer that
routes institutional orders will incur an average burden of 10 hours
resulting in a cost of $1,600 \447\ to prepare and disseminate a
quarterly report required by proposed Rule 606(c).\448\ The Commission
preliminarily believes that the costs for a monthly report would be
similar to the costs of a quarterly report. Hence, the Commission
preliminarily estimates that each broker-dealer that routes
institutional orders would incur an average burden of 120 hours
resulting in a cost of $19,200 per year to prepare and disseminate
monthly reports. This compares to a burden of 40 hours resulting in a
cost of $6,400 per year for quarterly reports as required by proposed
Rule 606(c), that is, the costs for each broker-dealer that routes
institutional orders would be three times higher. The Commission
preliminarily estimates the costs to produce a report would remain the
same each month, as the cost of the report is more related to the act
of producing the report, as opposed to how much data the report
contains (one month vs. three months). The difference in costs for each
broker-dealer to provide monthly reports as compared to quarterly
reports as required by proposed Rule 606(c) is preliminarily estimated
to be $12,800 per year.\449\ With an estimated 200 broker-dealers that
route institutional orders, the total additional burden per year to
comply with a monthly reporting requirement as compared to a quarterly
reporting requirement as in proposed Rule 606(c) is preliminarily
estimated to be 16,000 hours resulting in a cost of $2,560,000.\450\
---------------------------------------------------------------------------
\447\ See supra note 266.
\448\ See supra Section IV.D.2.d.
\449\ $19,200 annually per broker-dealer for monthly reports--
$6,400 annually per broker-dealer for quarterly reports = $12,800
annually per broker-dealer.
\450\ 80 hours more annually per broker-dealer that routes
institutional orders x 200 broker-dealers that route institutional
orders = 16,000 hours. The Commission preliminarily estimates the
total monetized burden for this requirement to be $2,560,000
($12,800 more annually per broker-dealer that routes institutional
orders x 200 broker-dealers that route institutional orders =
$2,560,000).
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More frequent reports compared to the proposed quarterly frequency,
although broken down by month, would have the benefit of providing the
public with information that is more timely. However, the Commission
preliminarily believes that the value of having monthly rather than
quarterly reports is small because the Commission understands that
analysis of order handling data generally is based on data comprising
more than one month. While this may be, at least partially, due to the
fact that current Rule 606 requires quarterly reports, staff experience
suggests that the analysis of order handling data would be based on
more than one month of data even if data were available at a higher
frequency. This is because order handling data are inherently noisy and
a large sample size is necessary to ensure a robust analysis. To that
extent, from staff experience, the Commission understands that data
spanning several months or even years are used in the analysis of order
handling data. The Commission notes that using data spanning several
months or even years does not preclude analyzing the data for trends,
especially recent trends.\451\
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\451\ One way to analyze the data for trends would be to look at
subsamples within the full sample. For example, one could consider
quarters within a full calendar year of data. Another way would be
to employ a rolling window. For example, one could use a twelve-
month rolling window, that is, the analysis would use data
comprising twelve months of data and then replace the oldest data
with more recent data one month at a time.
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In addition, more frequent disclosure could allow sensitive trading
information to be disclosed. For example, as discussed earlier, if a
customer placing large institutional orders primarily engages one
broker-dealer and that broker-dealer has few, if any, other customers
placing significantly sized institutional orders, then other market
participants may be able to decipher the customer's trading interest,
particularly if the customer is building up or selling off a large
position over a longer period of time. The risk of such disclosure of
sensitive trading information is greater for monthly reporting
frequency compared to the proposed quarterly frequency because, by
construction, quarterly reporting provides the data for the first two
months in the quarter with a delay compared to if the data for those
two months were to be released monthly. As a result, it is less likely
that data for those two months contain information about a customer's
current and ongoing trading interests.
4. Automatic Provision of Customer-Specific Institutional Order
Handling Report (Proposed Rule 606(b)(3))
The Commission considered an alternative to proposed Rule 606(b)(3)
[[Page 49502]]
that would not require that customers request customer-specific
standardized reports on institutional order handling, but would instead
require broker-dealers to provide them to customers automatically,
either by sending the reports out or by providing a portal where
customers can view or download the reports. The alternative could
reduce the cost to customers, compared to both the baseline and the
proposal, of acquiring the institutional order handling reports,
because customers would not need to request the reports. At the same
time, it is difficult to determine whether there is any additional
benefit to customers compared to the proposal. It is possible that not
all customers would use the reports provided to them, and under the
proposal, those customers that see enough value in the reports would
incur the cost of requesting them.
With respect to the costs to broker-dealers, the alternative would
impose additional initial costs compared to the baseline, as the
broker-dealers would be required to automatically provide reports to
all customers, not just those that request reports, and would have to
build infrastructure to generate these reports. The Commission
preliminarily believes, however, that the alternative would involve
slight modifications to the systems that produce the institutional
order handling reports and thus preliminarily believes that these
initial costs likely would be minimal.
The effect of this alternative on the costs to broker-dealers,
compared to the proposal, is unclear. On the one hand, the Commission
preliminarily believes the alternative could impose additional, albeit
minimal, initial costs associated with developing systems to
automatically generate the reports compared to the proposal as well as
to the baseline, as described above. On the other hand, the Commission
preliminarily believes the alternative could avoid the initial costs
associated with the proposed rule for those broker-dealers who do not
currently have systems in place to receive and respond to requests
because they would not have to develop and deploy such systems under
this alternative, as they would under the proposal. Any related initial
or ongoing cost savings compared to the proposal may be minimal, as, in
either case, such broker-dealers would need to develop systems to
generate customer-specific reports and broker-dealers could add the
customer requests to a list for individual report generation under the
proposal just as they add customers to a list for automated reports
under the alternative. The alternative may reduce ongoing personnel
costs compared to the proposal because under the proposal, broker-
dealers would have to answer emails, phone calls, or other forms of
requests for ad-hoc reports. However, the brokerage industry is a
relationship business and the Commission understands that broker-
dealers communicate frequently with their customers, especially their
larger customers. Further, the alternative may also result in
additional ongoing personnel costs compared to the proposal if
customers who would not have requested reports contact the broker-
dealers to discuss reports they would receive automatically under the
alternative. In addition, the Commission notes that, even under the
proposal, broker-dealers could choose to provide reports automatically
to their customers if this is more cost effective for them.
5. Submission of Institutional Order Handling Reports (Proposed Rules
606(b)(3) and 606(c))
The Commission considered an alternative to proposed Rules
606(b)(3) and 606(c) that would require the customer-specific
institutional order handling reports and the public aggregated
institutional order handling reports to be submitted to the Commission.
While Commission staff may be able to replicate much of the information
in the reports were the proposed Consolidated Audit Trail to be
approved,\452\ the reports would contain some information not included
as data in the Consolidated Audit Trail (``CAT Data''), such as
information on the use of aggressive and passive order routing
strategies. In addition, the institutional order handling reports would
be already assembled, making access to the reports more efficient than
assembling the analogous information from CAT Data. With direct access
to the reports under this alternative, Commission staff could
potentially use the reports, for example, to investigate best execution
concerns, assist in risk-based examination decisions, and/or conduct
market analyses on order handling to promote data-driven rulemaking.
These activities could, in turn, benefit investors and the market in
the form of enhanced investor protection and better informed
rulemaking. The alternative would also establish a central location for
all reports and could reduce the burden for Commission staff to seek
out and obtain the reports. Notably, under the proposal, the Commission
could acquire the public aggregated institutional order handling
reports as described in Rule 606(c), though not the customer-specific
institutional order handling reports as described in Rule 606(b)(3),
from broker-dealer Web sites. The proposal thus does not preclude the
Commission from obtaining the public aggregated institutional order
handling reports to achieve some of the benefits of this alternative.
---------------------------------------------------------------------------
\452\ See Securities Exchange Act Release No. 77724 (April 27,
2016), 81 FR 30614 (May 17, 2016) (File No. 4-698) (Joint Industry
Plan; Notice of Filing of the National Market System Plan Governing
the Consolidated Audit Trail), available at https://www.sec.gov/rules/sro/nms/2016/34-77724.pdf.
---------------------------------------------------------------------------
While providing some benefits, this alternative would also impose
additional costs to broker-dealers to submit their reports to the
Commission. For example, under this alternative, broker-dealers would
incur additional costs to transmit the reports directly to the
Commission including any initial costs of setting up the connection to
the Commission's repository, though the Commission preliminarily
believes that these costs will not be significant. Further, the
Commission preliminarily believes that acquiring the reports from each
broker-dealer may impose burdens on Commission resources,\453\ though
the magnitude of those burdens is unknown. Receiving customer-specific
institutional order handling reports, which include sensitive
information, e.g., PII or sensitive proprietary information, could
impose further costs to the Commission as the Commission would need to
take steps to safeguard this information, though the Commission may be
able to leverage its experience dealing with the receipt of sensitive
information in other contexts to minimize those costs.
---------------------------------------------------------------------------
\453\ The Commission recognizes that third party vendors could
collect and sell the broker-dealer reports at a price that could
reduce the burdens on Commission resources compared to the burdens
of Commission staff directly collecting the reports from broker-
dealers.
---------------------------------------------------------------------------
6. Disaggregate Categories of NMS Stocks for Rule 606(a)
The Commission considered an alternative to current Rule 606(a)
that would not require reports for retail orders be aggregated across
all NMS stocks, but rather would require that those reports be divided
into categories, e.g., into Exchange-Traded Products (``ETPs'') and all
other NMS stocks, or into groups of stocks with different trading
volume. The Commission considered this alternative in addition to or
instead of the requirement of current Rule 606(a) to divide the reports
by listing markets. This would increase the costs of producing the
reports relative to the proposal, but it also would provide more
information.
For example, one such alternative could require that broker-dealers
[[Page 49503]]
separately report the routing of ETPs and the routing of non-ETP NMS
stocks. The costs of producing the reports under this alternative would
be higher than the costs of the proposal because such an alternative
would require broker-dealers to classify NMS stocks into categories,
e.g., into ETPs and non-ETP stocks. There would be an initial cost for
the classification of all stocks and an ongoing cost to maintain the
classification.
Because some ETPs trade differently than non-ETP NMS stocks,
broker-dealers may route them differently. To the extent that broker-
dealers vary their order routing decisions for ETP and non-ETP stocks,
broker-dealer customers may benefit from the more targeted information
that would be provided for each type of stock under this alternative
compared to the proposed amendments to Rule 606(a). Specifically, the
additional information concerning each type of stock contained in the
divided reports would allow customers, broker-dealers, trading centers,
and the public more generally to better evaluate and compare the order
routing of retail orders for each type stock, whereas under the
proposed rule information on order routing is provided for both ETPs
and non-ETPs in the aggregate. While the consumers of such reports
would benefit from the reports being more informative with respect to
the order routing for each type of stock, broker-dealers would incur
higher costs in processing the additional information provided by the
reports. To use the additional information, customers, broker-dealers,
trading centers, and the public more generally would have to process
the additional information and incorporate it in their analyses and
models when evaluating and comparing the order routing of retail
orders, which could result in higher costs compared to the proposed
amended Rule 606(a).
7. Disclosure of Additional Information About Institutional Order
Routing and Execution
The Commission considered requiring additional information to be
disclosed to customers and the public relating to institutional order
routing and execution quality. The Commission considered requiring
additional measures to be included in proposed Rule 606(b)(3) and
proposed Rule 606(c) reports for institutional orders. For example, the
Commission considered requiring that proposed Rule 606(b)(3) and
proposed Rule 606(c) reports contain time to execution, or
implementation shortfall, which are dimensions of execution quality. In
addition, the Commission considered making the reports more detailed by
requiring segmentation of the data along additional dimensions, not
only on order routing strategy.
In general, transaction costs of institutional orders depend on,
among other factors, stock characteristics, order characteristics, and
market conditions at the time of order arrival and during order
execution. The reports could be segmented by any of these factors.
Examples of stock characteristics are liquidity or volatility of a
stock.\454\ Examples of order characteristics are order size, usually
measured as relative order size in relation to average daily
volume,\455\ or whether an order is generated by a momentum strategy,
where an customer buys a stock while the stock is increasing in price
and sells a stock while the stock is falling in price. Examples of
market conditions are the current liquidity in a stock, e.g., measured
by the most recent volume or bid-ask spread compared to historical
values and the current volatility in a stock, e.g., compared to
historical values. Requiring any of this additional information in
proposed Rule 606(b)(3) and proposed Rule 606(c) reports would increase
the costs of producing the reports as well as the costs of using the
reports relative to proposed Rules 606(b)(3) and 606(c), but it would
also increase the information content and the usefulness of the reports
relative to proposed Rules 606(b)(3) and 606(c).\456\
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\454\ See, e.g., Zhuo Zhong, The Risk Sharing Benefit versus the
Collateral Cost: The Formation of the Inter-Dealer Network in Over-
the-Counter Trading, Working Paper (2014). Zhong argues that broker-
dealers at the center of a dealer network are better able to work
off the inventory risk earned from executing orders containing
volatile stocks, which in turn will determine which broker-dealers
receive orders in volatile stocks. Id.
\455\ Zhong suggests that broker-dealers at the center of the
dealer network are better able to work off the inventory earned from
executing large orders, which in turn will determine which broker-
dealers receive large orders. See id.
\456\ The costs of this alternative would be higher than the
proposed amendments because it would require that broker-dealers
compute additional data items. For purposes of the PRA, the
Commission estimated the costs associated with the rule as proposed.
See supra Sections IV.D.1. and 2. The Commission does not currently
have information on how extensive the programming would be for
broker-dealers to adapt their systems to combine data that they may
not yet combine to calculate these statistics.
---------------------------------------------------------------------------
For some data items, the computation costs would be larger than for
others. For example, computing the implementation shortfall for an
order is more involved than computing the time to execution and thus
would result in larger computational costs. Further, unlike the
proposed amendments, implementation shortfall and time to execution
could involve running calculations on data received on other systems
and from others who handle orders later in their lifecycle. This may
make these fields more computationally costly than those proposed.
However, with the addition of other relevant information, the reports
under this alternative might be more useful than the proposed reports.
In addition, determining categories by metrics such as trading
volume or volatility would add complex definitions to the reports and
the Commission is not aware of any natural breakpoints that would
simplify the identification of appropriate thresholds to classify
stocks into groups of varying trading volume or volatility. Setting
thresholds at levels that do not meaningfully distinguish routing
activity or execution quality would be more costly than the proposed
amendments without providing greater benefits.
The Commission could later evaluate data that would be disclosed
pursuant to proposed Rules 606(b)(3) and 606(c), if adopted, to inform
any decision as to whether additional data items or other changes might
be appropriate.
8. Institutional Order Handling Reports at the Stock Level (Proposed
Rule 606(b)(3))
The Commission also considered requiring the institutional order
handling information required by proposed Rule 606(b)(3) to be reported
at the individual stock level rather than aggregated across stocks.
This alternative would enhance transparency to customers relative to
proposed Rule 606(b)(3) because the reports would be more detailed.
Specifically, order handling information calculated at the stock level
may be more informative than aggregated data because trading centers
may not charge the same maker-taker fee for all stocks. It is possible
for a given trading center to use inverted and non-inverted fees for
different stocks at the same time. If this is the case, the reports as
proposed by Rule 606(b)(3) could potentially mask conflicts of interest
because routing decisions may be different for different stocks on the
same trading center due to differing maker-taker fees across the
stocks, particularly if some stocks have inverted and other stocks have
non-inverted fees on the same trading center.
Because the reports would be more detailed, however, this
alternative would increase the costs of producing the reports as well
as the costs of using the reports relative to proposed Rule 606(b)(3).
The Commission preliminarily believes that any potential
[[Page 49504]]
increase in costs of producing the reports would be negligible because
broker-dealers already process the data order-by-order and to aggregate
orders by stock and venue, rather than only by venue, should not
increase significantly programming costs and processing time. While the
Commission preliminarily believes that the production of these
voluminous reports itself may not result in significantly higher costs
than for the proposed reports, the size of the reports may result in
higher costs to deliver the reports to customers. For example, the
report could be hundreds of pages in hard copy, which would result in
costs to print and deliver the report; likewise, a broker-dealer could
incur higher costs to send a report electronically, depending on the
size of the file that has to be sent to customers.\457\ Moreover, given
the thousands of securities in existence, requiring reporting metrics
be broken down at the stock level would produce voluminous reports that
would be difficult and costly to process for all but the most
sophisticated customers. For these reasons, the Commission is proposing
to have the reports broken down by venue and aggregated across stocks.
---------------------------------------------------------------------------
\457\ For example, there typically are limitation to the size of
files that can be sent through email.
---------------------------------------------------------------------------
9. Alternative to Three-Year Posting Period (Proposed Amendments to
Rules 605(a)(2) and 606(a)(1), and Proposed Rule 606(c))
The Commission considered requiring broker-dealers and market
centers to make both institutional and retail reports available for a
minimum length of time less than three years or more than three years.
If public reports are available for less than three years, then
historical data may not be as readily available to customers and the
public who are seeking to analyze past routing behavior of broker-
dealers or past execution quality of market centers as it would be
under the proposal of a three-year posting period. Customers and the
public would either have to download the data more often or have to
rely on third-party vendors who download and aggregate the data. For
example, if a broker-dealer or market center posted the reports for
only one quarter, customers and the public would have to download the
data every quarter if they wanted access to data that is older than
three months. Third-party vendors also would have to download the data
with sufficient frequency to capture historical data without gaps. This
would have the effect of reducing the transparency of broker-dealer
routing decisions for customers placing both retail and institutional
orders and of the execution quality of market centers compared to the
proposal of a three-year posting period. The benefit of a shorter
minimum length of time would be that any costs broker-dealers incurred
associated with posting reports would be less than under the proposal
of a three-year posting period. However, as discussed above, the
Commission preliminarily believes these incremental costs to be small
and that the cost savings associated with a shorter minimum length of
time would not justify the costs of historical data potentially being
less readily available to customers and the public.
If public reports are available for more than three years, the
historical data would be even more readily available to customers and
the public who are seeking to analyze past routing behavior of broker-
dealers or past execution quality of market centers as it would be
under the proposal of a three-year posting period. Customers and the
public would have to download the data less frequently to have access
to historical data that is older than the minimum length of time
required. However, the Commission preliminarily believes that the
additional benefit of a minimum length of time of more than three years
would be small because three years is a meaningful time period
considering the rapid changes in financial markets and customers and
the public would only need to download data every three years to be
able to access historical data older than three years. The Commission
understands that maintaining public reports for more than three years
may represent a burden and result in an additional cost to broker-
dealers. However, as discussed above, the Commission preliminarily
believes the additional cost to be small. Nevertheless, the Commission
preliminarily believes that a minimum length of time of three years is
appropriate.
10. Request for Comment
The Commission requests comment on the Commission's analysis of
potential alternatives as described above and the costs and benefits
associated with such alternatives. In particular, the Commission
solicits comment on the following:
174. Do commenters believe that the alternatives that the
Commission considered are appropriate? Do commenters believe that the
analysis of the associated costs and benefits of the alternatives is
accurate? If not, please provide alternative costs and benefits,
including any data or statistics that supports those costs and
benefits.
175. Are there other alternatives that the Commission should
consider? If so, please provide additional alternatives and how their
costs and benefits would compare to the proposal.
176. Do commenters believe the reports for retail orders should
contain information required by proposed Rule 606(b)(3) for
institutional orders that is not currently required by Rules 606(a)(1)
and 606(b)(1) for retail orders? Why or why not? If yes, what
additional information should be required? Please be specific in your
response.
177. Do commenters believe the Commission should require that the
reports for institutional orders required by proposed Rule 606(b)(3)
include information about payment for order flow and payment from
profit-sharing relationships as would be required by proposed Rule
606(a)(1)(iii) for retail orders? Why or why not? Similarly, do
commenters believe the Commission should require that the reports for
institutional orders required by proposed Rule 606(b)(3) include a
discussion of the material aspects of the broker-dealer's relationship
with each venue as would be required by amended Rule 606(a)(1)(iv) for
retail orders? Why or why not? Please be specific in your response.
178. Do commenters have information on the costs and benefits of
any of these alternatives? If so, please provide any data or statistics
to support the estimates.
E. Economic Effects and Effects on Efficiency, Competition, and Capital
Formation
Section 23(a)(2) of the Exchange Act requires the Commission, when
making rules under the Exchange Act, to consider the anti-competitive
effects of any rules it adopts.\458\ Specifically, Exchange Act Section
23(a)(2) prohibits the Commission from adopting any rule that would
impose a burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act.\459\ Furthermore,
Section 3(f) of the Exchange Act requires the Commission, whenever it
engages in rulemaking where it is required to consider or determine
whether an action is necessary or appropriate in the public interest,
to consider, in addition to the protection of investors, whether the
action will promote efficiency, competition, and capital
formation.\460\ We consider these effects below.
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\458\ 15 U.S.C. 78c(f).
\459\ Id.
\460\ 15 U.S.C. 78w(a)(2).
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[[Page 49505]]
1. Effects of Proposed Amendments on Efficiency and Competition
a. Proposed Amendments to Disclosures for Retail Orders
As a result of the proposed amendments to Rule 606(a)(1), broker-
dealers that route retail orders would be required to make public
enhanced aggregated reports detailing retail order routing practices
and information regarding marketable and non-marketable limit orders in
addition to information on payment for order flow arrangements, payment
from any profit-sharing relationship received, and transaction fees
paid and rebates received per share and in aggregate for such orders.
In addition, the proposed amendments would require those reports to be
made available using an XML schema and associated PDF renderer on the
Commission's Web site and to be maintained on an Internet Web site that
is free and readily accessible to the public for a period of three
years.\461\ As explained in detail below, the Commission preliminarily
believes that these enhanced disclosures, which require broker-dealers
to describe any terms of payment for order flow arrangements and
profit-sharing relationships with Specified Venues that may influence
their order routing decisions for retail orders, should promote
competition and enhance efficiency.
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\461\ Consistent with the proposed amendments to Rule 606, the
Commission is proposing to amend Rule 605(a)(2) to require market
centers to keep public execution reports required by the rule posted
on an Internet Web site that is free of charge and readily
accessible to the public for a period of three years from the
initial date of posting. The Commission preliminarily believes that
making past order execution information available to customers and
the public generally will be useful to those seeking to analyze
historical order execution information from different market
centers. The proposed requirement to keep public execution reports
required by Rule 605 for a period of three years is expected to make
it easier, and thus more efficient, for the public to collect
historical data for analysis. The Commission preliminarily believes
the proposed requirement could enhance efficiency in the data
collection process of those seeking to retrieve and analyze
historical order execution information from different market
centers.
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First, per the discussion above, the additional information
required by the amendments relative to the information required by
current Rule 606(a)(1) would allow customers to better assess the order
routing and execution quality provided by their broker-dealers,\462\
which, in turn, would enable the customers to more efficiently evaluate
and select broker-dealers.\463\ The proposed amendments to Rule 606(a)
would require broker-dealers, for retail orders, to differentiate
between marketable and non-marketable limit orders and to publicly
report the net aggregate amount of any payment for order flow, payment
from any profit-sharing relationship received, the transaction fees
paid, and transaction rebates received, both as a total dollar amount
and on a per share basis, for each of the following order types: market
orders, marketable limit order, non-marketable limit orders, and other
orders. As discussed in Sections V.C.2.a. and V.C.2.b., the Commission
preliminarily believes that this would allow customers and the public
to better understand the potential conflicts of interest broker-dealers
may face when routing retail orders and to assess if and how well
broker-dealers manage these potential conflicts of interest. This would
enable customers to make a more informed decision as to which broker-
dealers to use for retail orders. The Commission preliminarily believes
that this would enhance the competition for retail order flow between
broker-dealers, which might result in better execution quality for
customers. In addition, if broker-dealers change their routing behavior
in response to the public reports required by proposed Rule 606(a)(1),
the Commission preliminarily believes that competition between trading
centers might be enhanced as trading centers could better compete for
retail order flow, which might result in better execution quality for
retail orders and innovation by existing or new trading centers. As
discussed in Section V.C.1.c.i, one way a trading center can attract
order flow is through innovation thereby differentiating itself from
other trading centers.
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\462\ See supra Section V.C.2.
\463\ The proposed amendments to Rule 606(a)(1) which would no
longer require reports be divided into separate sections for stocks
listed on different exchanges may be an exception to this. As
discussed below, to the extent that order routing decisions may
differ for stocks that are listed on different exchanges, the
reports that aggregate the data as required by the proposed
amendments to Rule 606(a)(1) may provide less information to retail
customers and the public and therefore may reduce the efficiency
with which customers and the public are able to evaluate and select
broker-dealers based on the order routing and execution quality they
provide.
---------------------------------------------------------------------------
Further, to the extent that the proposed amendments to Rule 606(a)
lead to better execution quality provided by broker-dealers and trading
centers, the Commission preliminarily believes that the proposed
amendments would lead to lower transaction costs for customers. Because
transaction costs can be viewed as a measure for efficiency in the
trading process, lower transaction costs would indicate enhanced
efficiency in the trading process. In addition, to the extent that the
proposed amendments to Rule 606(a) make the trading process more
efficient by lowering trading costs, the Commission preliminarily
believes the proposed amendments would reduce market friction and
therefore have a positive effect on the efficiency of prices.
As discussed above, however, the proposed amendments to Rule
606(a)(1) could result in costs that may have an effect on efficiency
and competition. For example, the proposed amendments would impose
certain costs on broker-dealers who currently route retail orders, as
well as on broker-dealers who would like to start routing retail orders
and will also have to comply with the proposed amendments to Rule
606(a)(1). To the extent that the costs for a broker-dealer entering
the market for retail orders are higher under the proposed amended Rule
606(a)(1) than under the current Rule 606(a)(1), these higher costs
could lead to a higher barrier to entry and thereby reduce competition.
However, the Commission preliminarily believes that any difference in
costs under the proposed amended Rule 606(a)(1) and the current Rule
606(a)(1) to be relatively small as to not alone deter broker-dealers
from entering the market for retail brokerage.
Under the proposed amendments to Rule 606, the broker-dealer may be
concerned about the perception of acting on a conflict of interest. As
a result, a broker-dealer may be incentivized to route fewer non-
marketable limit orders to the trading center offering the highest
rebate, even if this affects execution quality, in an effort to ensure
that a customer does not misconstrue the intent behind the broker-
dealer's routing decisions. Such a potential outcome could reduce to
some degree the intensity of competition between broker-dealers on the
dimension of execution quality. However, the Commission preliminarily
believes that such a scenario is not likely as customers are likely to
review the 606 reports in conjunction with execution quality statistics
currently required pursuant to Rule 605 and can discuss with their
broker-dealers the order routing and execution quality the broker-
dealer provides.
b. Proposed Rules for Disclosures for Institutional Orders
For institutional orders, proposed Rules 606(b)(3) and (c) would
require broker-dealers that route institutional orders to provide
detailed reports to customers who submit such orders upon the request
of the customer, and to make public on a quarterly basis broken down by
calendar month, a report that
[[Page 49506]]
aggregates the information. In addition, these proposed rules would
require reports on institutional orders to be made available using an
XML schema and associated PDF renderer to be published on the
Commission's Web site and to be maintained for a period of three years.
As discussed below, the Commission preliminarily believes that these
disclosures of order routing decisions by broker-dealers for
institutional orders could promote competition and enhance efficiency.
First, the disclosures required by the proposal, both on an
individualized and aggregated basis, would inform customers as to the
institutional order routing practices of and the execution quality
provided by a particular broker-dealer, as described in further detail
above. As a result, customers would be able to use that information to
compare the institutional order routing and execution quality of their
broker-dealers based on the institutional orders submitted to those
broker-dealers as reported in the customer-specific reports required by
proposed Rule 606(b)(3). In addition, a customer placing institutional
orders would be able to compare the order routing practices and
execution quality of each broker-dealer based on the public aggregated
institutional order handling reports required under proposed Rule
606(c), independent of whether the customer submits orders to a
specific broker-dealer. Further, a customer would be able to compare
the order routing and execution quality of its institutional orders
submitted to a specific broker-dealer as reflected in the customer-
specific reports required by proposed Rule 606(b)(3) to the order
routing and execution quality of all orders that the broker-dealer
handled contained in the public aggregated institutional order handling
reports required by proposed Rule 606(c).
These enhanced disclosures would better enable customers to analyze
institutional order routing and execution quality provided by broker-
dealers, which would allow customers to more efficiently monitor,
evaluate, and select broker-dealers. In addition, customers and broker-
dealers would be able to evaluate execution quality of institutional
orders on different trading centers more efficiently.\464\ Customers
also would be better informed as to the institutional order routing and
execution quality they received from a particular broker-dealer. If a
customer feels it received poor order routing and execution quality
from a particular broker-dealer, the customer could initiate a dialogue
with the broker-dealer for an explanation, which may lead to better
order routing decisions and execution quality by the broker-dealer. The
customer may also decide to use different broker-dealers in order to
seek better order routing and execution quality. This could enhance
competition between broker-dealers.
---------------------------------------------------------------------------
\464\ See supra Section V.C.1.
---------------------------------------------------------------------------
Further, the Commission preliminarily believes that proposed Rules
606(b)(3) and (c) might enhance competition between trading centers.
First, if broker-dealers change their routing decisions in response to
the reports required by proposed Rules 606(b)(3) and (c), trading
centers would have an additional incentive to compete for institutional
order flow. Second, the reports required by proposed Rules 606(b)(3)
and (c) are structured by trading center, so that the execution quality
at each trading center would be clearly visible. This may lead broker-
dealers to change their routing behavior, but also, more directly,
trading centers could compare the execution quality of all trading
centers, which may again lead to enhanced competition among trading
centers. The Commission preliminarily believes that the enhanced
competition between trading centers could lead to innovation by
existing and new trading centers, resulting in better execution quality
for customers placing institutional orders. As discussed in Section
V.D.1.a if a trading center were to lose order flow to other trading
centers due to lower execution quality it would have the incentive to
innovate to improve its execution quality.
To the extent that proposed Rules 606(b)(3) and (c) lead to better
execution quality being provided by broker-dealers and trading centers,
the Commission preliminarily believes that the proposed amendments
might lead to lower transaction costs for institutional orders. As
discussed above, lower transaction costs indicate enhanced efficiency
in the trading process and the Commission preliminarily believes as a
result, the proposed rules would reduce market friction and therefore
have a positive effect on the efficiency of prices.
In addition, the Commission preliminarily believes that the
requirement of standardized customer-specific and standardized public
aggregated institutional order handling reports in proposed Rules
606(b)(3) and (c) would enhance efficiency for customers and the public
in processing the information contained in the reports, as compared to
the ad-hoc reports customers may currently receive from their broker-
dealers.\465\ Because the data will be presented in a standardized
format, customers and the public would be able to more efficiently
aggregate, compare, and analyze the data, as opposed to reconciling
dissimilar formats, which may not always be possible, before trying to
aggregate, compare, and analyze the data.
---------------------------------------------------------------------------
\465\ See supra Section V.B.1. for a discussion of the ad-hoc
reports and supra Section V.C.4. for a discussion of the
standardization and format for the reports required by proposed
Rules 606(b)(3) and (c).
---------------------------------------------------------------------------
In addition, as discussed above, the Commission understands that
many broker-dealers that handle institutional orders currently
voluntarily provide reports to institutional customers upon request.
However, the Commission understands that how willing a broker-dealer is
to provide such reports and how detailed the reports are might depend
on the size of an institutional customer. To that extent, larger
institutional customers have an advantage over smaller institutional
customers. Proposed Rules 606(b)(3) and (c) would provide access to
reports on institutional order handling to all institutional customers,
regardless of their size.
The Commission notes that, even without the proposed rule
amendments, institutional customers can still request customized
reports from their broker-dealers and broker-dealers would have an
incentive to provide such reports in order to attract institutional
order flow. As is currently the case, broker-dealers might be more
willing to provide such customized reports to larger institutional
customers and the customized reports might provide more detailed
information for larger institutional customers. While the Commission
preliminarily believes that proposed Rules 606(b)(3) and (c) mitigate
the advantage of larger institutional customers in that respect, the
Commission preliminarily believes that larger institutional customers
are likely to continue to have an advantage over smaller institutional
customers to the extent that they are able to obtain customized reports
more easily and that those customized reports contain information not
contained in the reports required by proposed Rules 606(b)(3) and (c).
The Commission preliminarily believes that by reducing the
informational advantage of larger institutional customers over smaller
institutional customers, proposed Rules 606(b)(3) and (c) would improve
fairness between institutional customers. Smaller institutional
customers would be able to evaluate and
[[Page 49507]]
select their broker-dealers with efficiency more similar to larger
institutional customers, thereby increasing the efficiency of their
investment process. The Commission preliminarily believes that this
would provide smaller institutional customers with information to
select the broker-dealers that promote better execution quality, to the
benefit of their investors.
As discussed above, however, proposed Rules 606(b)(3) and (c) could
result in certain costs to broker-dealers who currently route
institutional orders, as well as those who would like to start routing
institutional orders and thus would have to comply with proposed Rules
606(b)(3) and (c). These costs could lead to a higher barrier to entry
and thereby reduce competition. However, the Commission preliminarily
believes that the costs associated with proposed Rules 606(b)(3) and
(c) are not large enough to meaningfully affect the barriers to entry
and the level of competition due to potential new entrants into the
market for institutional orders. In addition, the Commission
preliminarily believes that any negative effect on competition due to
heightened barriers to entry are justified by the expected positive
effect on competition of the disclosures required by proposed Rules
606(b)(3) and (c).
In addition, the proposed amendments may cause broker-dealers to
change how they handle institutional orders. Given that broker-dealers
would be aware of the metrics to be used a priori, they may handle
institutional orders in a manner that promotes a positive reflection on
their respective services but customers could erroneously view a
broker-dealer's handling as suboptimal.\466\ Any changes to broker-
dealers' order routing decisions due to proposed Rule 606(b)(3) may
well be to the benefit of customers placing institutional orders, but
if broker-dealers and customers focus exclusively on the metrics in the
reports required by proposed Rule 606(b)(3), the order routing
decisions could also be viewed as suboptimal for the customers.
Customers' preferences could, therefore, be skewed toward the metrics
as opposed to their true objectives, which could skew broker-dealer
incentives, potentially limiting the efficiency and competition
benefits of the proposed amendments.
---------------------------------------------------------------------------
\466\ The Commission preliminarily believes that the set of
metrics provide customers with the most cost effective view of
broker-dealer order handling practices, but recognizes a risk that
the information from the disclosures may not perfectly align routing
practices and execution quality.
---------------------------------------------------------------------------
For example, suppose a broker-dealer routes institutional orders so
that the orders execute at lower cost with a higher fill rate, shorter
duration, and more price improvement than the broker-dealer's
competitors. However, it could be the case that, in order to achieve
these objectives, the broker-dealer routes the majority of non-
marketable limit order shares to the trading center offering the
highest rebate. An institutional customer that reviews the proposed
order handling reports might suspect that the broker-dealer acted in
its self-interest by selecting the highest rebate venue in order to
maximize rebates when in fact, the broker-dealer made the decision
based on factors that might not be completely reflected in the proposed
reports.\467\
---------------------------------------------------------------------------
\467\ Id.
---------------------------------------------------------------------------
2. Effects of Proposed Amendments on Capital Formation
The Commission preliminarily believes that the proposed amendments
to Rules 600, 605, and 606 might have positive effects on capital
formation, but the Commission notes that predicting the magnitude of
such effects is difficult as the effects likely would be indirect
rather than directly resulting from the proposed amendments.
As discussed, the Commission preliminarily believes the proposed
amendments to Rules 600, 605, and 606 would enhance competition among
broker-dealers and trading centers resulting in better execution
quality for customers that place retail and institutional orders and to
the extent that better execution quality would lead to lower friction
in the trading process, the proposed amendments would increase market
efficiency in both the trading process and asset pricing. This could
lead to more efficient asset allocation because better execution
quality and greater market efficiency leads to more efficient
investment decisions by customers that place retail and institutional
orders.\468\ For example, lower transaction costs could allow customers
to rebalance their portfolios more frequently and more efficiently and
at more efficient prices that better reflect the true underlying value.
More efficient asset allocation could have a positive impact on capital
formation as capital is allocated to firms with the most profitable
projects, which ultimately would allow these firms to raise capital
more easily.\469\
---------------------------------------------------------------------------
\468\ More efficient investment decisions means investing in the
securities with the expected risk and return that better fit the
customer's investment objectives.
\469\ See supra Section V.B.8. for a discussion of how asset
allocation can relate to capital formation.
---------------------------------------------------------------------------
In addition, there is a relation between liquidity of an asset and
the required rate of return for that asset.\470\ The less liquid an
asset is, e.g., the higher transaction costs are to buy or sell it, the
higher rate of return customers could demand as compensation. For
example, lower transaction costs for stocks could result in lower
required rates of return for stocks. This in turn could lead to lower
cost of capital for the firms, which could have a positive impact on
capital formation because it would allow firms to raise capital at more
favorable conditions.
---------------------------------------------------------------------------
\470\ See Yakov Amihud and Haim Mendelson, Asset Pricing and the
Bid-Ask Spread, 17 Journal of Financial Economics 223 (December
1986).
---------------------------------------------------------------------------
3. Request for Comment
In sum, the Commission preliminarily believes that as a result of
the disclosures required by the proposal bringing competitive forces to
bear on the market, the proposed amendments should enhance competition
among broker-dealers as well as trading centers to provide customers
placing both retail and institutional orders with enhanced quality of
execution. The Commission preliminarily believes that this enhanced
quality of execution should promote efficiency in the trading process
as well as pricing, which should also have a positive impact on capital
formation.
The Commission requests comment on its analysis of the proposal's
economic effects and effects on efficiency, competition, and capital
formation. In particular, the Commission solicits comment on the
following:
179. Do commenters believe that the Commission's analysis of the
potential economic effects of the proposal, including potential effects
on efficiency, competition, and capital formation is accurate? Why or
why not? Please provide analysis and empirical data to support your
views.
180. Are there other effects of the proposal that the Commission
should consider? If so, please explain and provide support for your
views.
181. Do commenters believe there are alternative mechanisms for
achieving the Commission's goal of enhancing transparency for order
routing practices while promoting efficiency, competition and capital
formation? If so, what would be the potential impacts on promotion of
efficiency, competition, and capital formation? For example, what would
be the effect of requiring broker-dealers to provide the public reports
for retail orders, on a monthly basis, rather than
[[Page 49508]]
quarterly? What would be the effect of requiring broker-dealers to
provide the public quarterly reports for retail orders, proposed in
Rule 606(a), broken down into exchange-traded products (ETP) and non-
ETP NMS stocks? Would the effects be the same for institutional orders
under proposed Rules 606(b) and 606(c)? Please explain and provide
support for your arguments.
182. Do commenters believe that market participants would change
their behavior in response to the proposal? If so, which market
participants and how? What would be the costs and benefits of these
changes? How would such changes affect efficiency, competition, and
capital formation? Would these changes affect market quality and market
efficiency? Please explain.
VI. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA''),\471\ the Commission requests comment on the
potential effect of the proposed amendments on the United States
economy on an annual basis. The Commission also requests comment on any
potential increases in costs or prices for consumers or individual
industries, and any potential effect on competition, investment, or
innovation. Commenters are requested to provide empirical data and
other factual support for their views to the extent possible.
---------------------------------------------------------------------------
\471\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified
in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
---------------------------------------------------------------------------
VII. Regulatory Flexibility Analysis
The Regulatory Flexibility Act (``RFA'') \472\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) \473\ of the Administrative Procedure
Act,\474\ as amended by the RFA, generally requires the Commission to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
``small entities.'' \475\ Section 605(b) of the RFA states that this
requirement shall not apply to any proposed rule or proposed rule
amendment, which if adopted, would not have significant economic impact
on a substantial number of small entities.
---------------------------------------------------------------------------
\472\ 5 U.S.C. 601 et seq.
\473\ 5 U.S.C. 603(a).
\474\ 5 U.S.C. 551 et seq.
\475\ Although Section 601(b) of the RFA defines the term
``small entity,'' the statute permits agencies to formulate their
own definitions. The Commission has adopted definitions for the term
``small entity'' for purposes of Commission rulemaking in accordance
with the RFA. Those definitions, as relevant to this proposed
rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10. See
Securities Exchange Act Release No. 18451 (January 28, 1982), 47 FR
5215 (February 4, 1982) (File No. AS-305).
---------------------------------------------------------------------------
For purposes of the Commission rulemaking in connection with the
RFA \476\ as it relates to broker-dealers, a small entity includes a
broker-dealer that: (1) Had total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal year
as of which its audited financial statements were prepared pursuant to
Rule 17a-5(d) under the Exchange Act,\477\ or, if not required to file
such statements, a broker-dealer with total capital (net worth plus
subordinated liabilities) of less than $500,000 on the last day of the
preceding fiscal year (or in the time that it has been in business, if
shorter); and (2) is not affiliated with any person (other than a
natural person) that is not a small business or small
organization.\478\
---------------------------------------------------------------------------
\476\ See id.
\477\ 17 CFR 240.17a-5(d).
\478\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------
Based on the Commission's analysis of existing information relating
to broker-dealers that would be subject to the proposed amendments to
Rule 606, the Commission preliminarily believes that such broker-
dealers do not fall within the definition of ``small entity,'' as
defined above.\479\ Further, the proposed amendments to Rule 605 to
require reports to remain posted on an Internet Web site for a
specified period of time will not have a significant impact on small
entities affected by the proposed Rule.\480\ For the foregoing reasons,
the Commission certifies that the proposed amendments to Rules 600,
605, and 606 would not have a significant economic impact on a
substantial number of small entities for the purposes of the RFA.
---------------------------------------------------------------------------
\479\ The Commission considered FOCUS Report data in making this
determination.
\480\ See supra Section IV.D.5.
---------------------------------------------------------------------------
The Commission requests comment regarding this certification. In
particular, the Commission solicits comment on the following:
183. Do commenters agree with the Commission's certification? If
not, please describe the nature of any impact on small entities and
provide empirical data to illustrate the extent of the impact.
VIII. Statutory Authority and Text of the Proposed Rule Amendments
Pursuant to the Exchange Act, and particularly Sections 3(b), 5, 6,
11A, 15, 17, and 23(a) thereof, 15 U.S.C. 78c, 78e, 78f, 78k-1, 78o,
78q, and 78w(a), the Commission proposes to amend Sections 240.3a51-1,
240.13h-1, 242.105, 242.201, 242.204, 242.600, 242.602, 242.605,
242.606, 242.607, 242.611, and 242.1000 of Chapter II of Title 17 of
the Code of Federal Regulations in the manner set forth below.
List of Subjects
17 CFR Part 240
Brokers, Dealers, Registration, Securities.
17 CFR Part 242
Brokers, Reporting and recordkeeping requirements, Securities.
For the reasons stated in the preamble, the Commission is proposing
to amend Title 17, Chapter II of the Code of Federal Regulations as
follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The authority citation for part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78-q1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010); and Pub. L. 112-106,
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
Sec. 240.3a51-1 [Amended]
0
2. Section 240.3a51-1, paragraph (a) introductory text, is amended by
removing the text ``Sec. 242.600(b)(47)'' and adding in its place
``Sec. 242.600(b)(49)''.
Sec. 240.13h-1 [Amended]
0
3. Section 240.13h-1, paragraph (a)(5), is amended by removing the text
``Section 242.600(b)(46)'' and adding in its place ``Sec.
242.600(b)(48)''.
PART 242--REGULATIONS M, SHO, ATS, AC, NMS AND SBSR AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
4. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a23, 80a-29, and
80a-37.
Sec. 240.105 [Amended]
0
5. Section 242.105 is amended by:
[[Page 49509]]
0
a. In paragraph (b)(1)(i)(C), removing the text ``Sec.
242.600(b)(22)'' and adding in its place ``Sec. 242.600(b)(23)''.
0
b. In paragraph (b)(1)(ii), removing the text ``Sec. 242.600(b)(64)''
and adding in its place ``Sec. 242.600(b)(69)''.
Sec. 240.201 [Amended]
0
6. Section 242.201 is amended by:
0
a. In paragraph (a)(1), removing the text ``Sec. 242.600(b)(47)'' and
adding in its place ``Sec. 242.600(b)(49)''.
0
b. In paragraph (a)(2), removing the text ``Sec. 242.600(b)(22)'' and
adding in its place ``Sec. 242.600(b)(23)''.
0
c. In paragraph (a)(4), removing the text ``Sec. 242.600(b)(42)'' and
adding in its place ``Sec. 242.600(b)(44)''.
0
d. In paragraph (a)(5), removing the text ``Sec. 242.600(b)(49)'' and
adding in its place ``Sec. 242.600(b)(52)''.
0
e. In paragraph (a)(6), removing the text ``Sec. 242.600(b)(55)'' and
adding in its place ``Sec. 242.600(b)(60)''.
0
f. In paragraph (a)(7), removing the text ``Sec. 242.600(b)(64)'' and
adding in its place ``Sec. 242.600(b)(69)''.
0
g. In paragraph (a)(9), removing the text ``Sec. 242.600(b)(78)'' and
adding in its place ``Sec. 242.600(b)(83)''.
Sec. 240.204 [Amended]
0
7. Section 242.204, paragraph (g)(2), is amended by removing the text
``Rule 600(b)(64) of Regulation NMS (17 CFR 242.600(b)(64)'' and adding
in its place ``Sec. 600(b)(69) of Regulation NMS (17 CFR
242.600(b)(69)''.
0
8. Section 242.600 is amended by:
0
a. Redesignating paragraphs (b)(52) through (83) as (b)(57) through
(88);
0
b. Adding new paragraphs (b)(55) and (56);
0
c. Redesignating paragraphs (b)(49) through (51) as (b)(52) through
(54);
0
d. Adding new paragraph (b)(51);
0
e. Redesignating paragraphs (b)(30) through (48) as (b)(32) through
(50);
0
f. Amending newly redesignated paragraph (b)(50) by removing the word
``customer'' and adding in its place ``retail'';
0
g. Adding new paragraph (b)(31);
0
h. Redesignating paragraphs (b)(1) through (b)(29) as (b)(2) through
(b)(30);
0
i. Adding new paragraph (b)(1).
0
j. Amending newly redesignated paragraph (b)(19) by removing the word
``Customer'' and adding in its place ``Retail'';
0
k. Amending newly redesignated paragraph (b)(20) by removing the word
``customer'' and adding in its place ``retail'';
0
l. Amending newly redesignated paragraph (b)(24)(ii) by removing the
word ``customer'' and adding in its place ``retail'';
The additions read as follows:
Sec. 242.600 NMS security designation and definitions.
* * * * *
(b) * * *
(1) Actionable indication of interest means any indication of
interest that explicitly or implicitly conveys all of the following
information with respect to any order available at the venue sending
the indication of interest:
(i) Symbol;
(ii) Side (buy or sell);
(iii) A price that is equal to or better than the national best bid
for buy orders and the national best offer for sell orders; and
(iv) A size that is at least equal to one round lot.
* * * * *
(31) Institutional order means an order to buy or sell an NMS stock
that is not for the account of a broker or dealer and is an order for a
quantity of an NMS stock having a market value of at least $200,000.
* * * * *
(51) Non-marketable limit order means any limit order other than a
marketable limit order.
* * * * *
(55) Orders providing liquidity means orders that were executed
against after resting at a trading center.
(56) Orders removing liquidity means orders that executed against
resting trading interest at a trading center.
* * * * *
Sec. 242.602 [Amended]
0
9. Section 242.602 is amended by:
0
a. In paragraph (a)(5)(i) removing the text ``Sec. 242.600(b)(73)''
and adding in its place ``Sec. 242.600(b)(78)''.
0
b. In paragraph (a)(5)(ii) removing the text ``Sec. 242.600(b)(73)''
and adding in its place ``Sec. 242.600(b)(78)''.
0
10. Section 242.605 is amended by:
0
a. Revising the introductory text designated as a Preliminary Note; and
0
b. Adding a sentence at the end of paragraph (a)(2).
The addition reads as follows:
Sec. 242.605 Disclosure of order execution information.
This section requires market centers to make available
standardized, monthly reports of statistical information concerning
their order executions. This information is presented in accordance
with uniform standards that are based on broad assumptions about order
execution and routing practices. The information will provide a
starting point to promote visibility and competition on the part of
market centers and broker-dealers, particularly on the factors of
execution price and speed. The disclosures required by this section do
not encompass all of the factors that may be important to investors in
evaluating the order routing services of a broker-dealer. In addition,
any particular market center's statistics will encompass varying types
of orders routed by different broker-dealers on behalf of customers
with a wide range of objectives. Accordingly, the statistical
information required by this section alone does not create a reliable
basis to address whether any particular broker-dealer failed to obtain
the most favorable terms reasonably available under the circumstances
for retail orders.
(a) * * *
(2) * * * Every market center shall keep such reports posted on an
Internet Web site that is free and readily accessible to the public for
a period of three years from the initial date of posting on the
Internet Web site.
* * * * *
0
11. Section 242.606 is revised to read as follows:
Sec. 242.606 Disclosure of order routing information.
(a) Quarterly report on retail order routing. (1) Every broker or
dealer shall make publicly available for each calendar quarter a report
on its routing of non-directed orders in NMS securities during that
quarter broken down by calendar month and keep such report posted on an
Internet Web site that is free and readily accessible to the public for
a period of three years from the initial date of posting on the
Internet Web site. Such report shall include a section for NMS stocks
and a separate section for NMS securities that are option contracts.
Such report shall be made available using the most recent versions of
the XML schema and the associated PDF renderer as published on the
Commission's Web site for all reports required by this section. Each
section in a report shall include the following information:
(i) The percentage of total retail orders for the section that were
non-directed orders, and the percentages of total non-directed orders
for the section that were market orders, marketable limit orders, non-
marketable limit orders, and other orders;
(ii) The identity of the ten venues to which the largest number of
total non-directed orders for the section were routed for execution and
of any venue to which five percent or more of non-directed orders were
routed for execution, the percentage of total non-directed orders for
the section routed to the venue, and the percentages of total non-
directed market orders, total non-
[[Page 49510]]
directed marketable limit orders, total non-directed non-marketable
limit orders, and total non-directed other orders for the section that
were routed to the venue;
(iii) For each venue identified pursuant to paragraph (a)(1)(ii) of
this section, the net aggregate amount of any payment for order flow
received, payment from any profit-sharing relationship received,
transaction fees paid, and transaction rebates received, both as a
total dollar amount and per share, for each of the following non-
directed order types:
(A) Market orders;
(B) Marketable limit orders;
(C) Non-marketable limit orders; and
(D) Other orders.
(iv) A discussion of the material aspects of the broker's or
dealer's relationship with each venue identified pursuant to paragraph
(a)(1)(ii) of this section, including a description of any arrangement
for payment for order flow and any profit-sharing relationship and a
description of any terms of such arrangements, written or oral, that
may influence a broker's or dealer's order routing decision including,
among other things:
(A) Incentives for equaling or exceeding an agreed upon order flow
volume threshold, such as additional payments or a higher rate of
payment;
(B) Disincentives for failing to meet an agreed upon minimum order
flow threshold, such as lower payments or the requirement to pay a fee;
(C) Volume-based tiered payment schedules; and
(D) Agreements regarding the minimum amount of order flow that the
broker-dealer would send to a venue.
(2) A broker or dealer shall make the report required by paragraph
(a)(1) of this section publicly available within one month after the
end of the quarter addressed in the report.
(b) Customer requests for information on order routing. (1) Every
broker or dealer shall, on request of a customer, disclose to its
customer the identity of the venue to which the customer's retail
orders were routed for execution in the six months prior to the
request, whether the orders were directed orders or non-directed
orders, and the time of the transactions, if any, that resulted from
such orders. Such disclosure shall be made available using the most
recent versions of the XML schema and the associated PDF renderer as
published on the Commission's Web site for all reports required by this
section.
(2) A broker or dealer shall notify customers in writing at least
annually of the availability on request of the information specified in
paragraph (b)(1) of this section.
(3) Every broker or dealer shall, on request of a customer that
places, directly or indirectly, an institutional order with the broker
or dealer, disclose to such customer within seven business days of
receiving the request, a report on its handling of institutional orders
for that customer for the prior six months by calendar month. Such
report shall be made available using the most recent versions of the
XML schema and the associated PDF renderer as published on the
Commission's Web site for all reports required by this section. For
purposes of such report, the handling of an institutional order
includes the handling of all smaller orders derived from the
institutional order. Such report shall include, with respect to the
order flow sent by the customer to the broker or dealer, the total
number of shares of institutional orders sent to the broker or dealer
by the customer during the relevant period; the total number of shares
executed by the broker or dealer as principal for its own account; the
total number of institutional orders exposed by the broker or dealer
through an actionable indication of interest; and the venue or venues
to which institutional orders were exposed by the broker or dealer
through an actionable indication of interest. Such report also shall
include the following columns of information for each venue to which
the broker or dealer routed institutional orders for the customer, in
the aggregate and broken down by passive, neutral, and aggressive order
routing strategies as defined in paragraph (b)(3)(v) of this section:
(i) Information on Order Routing. (A) Total shares routed;
(B) Total shares routed marked immediate or cancel;
(C) Total shares routed that were further routable; and
(D) Average order size routed.
(ii) Information on Order Execution. (A) Total shares executed;
(B) Fill rate (shares executed divided by the shares routed);
(C) Average fill size;
(D) Average net execution fee or rebate (cents per 100 shares,
specified to four decimal places);
(E) Total number of shares executed at the midpoint;
(F) Percentage of shares executed at the midpoint;
(G) Total number of shares executed that were priced on the side of
the spread more favorable to the institutional order;
(H) Percentage of total shares executed that were priced at the
side of the spread more favorable to the institutional order;
(I) Total number of shares executed that were priced on the side of
the spread less favorable to the institutional order; and
(J) Percentage of total shares executed that were priced on the
side of the spread less favorable to the institutional order.
(iii) Information on Orders that Provided Liquidity. (A) Total
number of shares executed of orders providing liquidity;
(B) Percentage of shares executed of orders providing liquidity;
(C) Average time between order entry and execution or cancellation,
for orders providing liquidity (in milliseconds); and
(D) Average net execution rebate or fee for shares of orders
providing liquidity (cents per 100 shares, specified to four decimal
places).
(iv) Information on Orders that Removed Liquidity.(A) Total number
of shares executed of orders removing liquidity;
(B) Percentage of shares executed of orders removing liquidity; and
(C) Average net execution fee or rebate for shares of orders
removing liquidity (cents per 100 shares, specified to four decimal
places).
(v) For the purposes of paragraph (b)(3) of this section:
(A) A passive order routing strategy is one that emphasizes the
minimization of price impact over the speed of execution of the entire
institutional order;
(B) A neutral order routing strategy is one that is relatively
neutral between minimization of price impact and the speed of execution
of the entire institutional order; and
(C) An aggressive order routing strategy is one that emphasizes the
speed of execution of the entire institutional order over minimization
of price impact.
The broker or dealer shall assign each order routing strategy that
it uses for institutional orders to one of these three categories in a
consistent manner for each report it prepares pursuant to paragraph
(b)(3) of this section, promptly update the assignments any time an
existing strategy is amended or a new strategy is created that would
change such assignment, and document the specific methodologies it
relies upon for making such assignments. Every broker or dealer shall
preserve a copy of the methodologies used to assign its order routing
strategies and maintain such copy as part of its books and records in a
manner consistent with Sec. 240.17a-4(b) of this chapter.
[[Page 49511]]
(c) Quarterly report on institutional order handling. A broker or
dealer that receives institutional orders shall make publicly available
a report that aggregates the information required by paragraph (b)(3)
of this section, whether or not requested by a customer, on its
handling of all institutional orders for all customers for each
calendar quarter by calendar month within one month after the end of
the quarter. Such report shall be made available using the most recent
versions of the XML schema and the associated PDF renderer as published
on the Commission's Web site for all reports required by this section.
Every broker or dealer shall keep such report posted on an Internet Web
site that is free and readily accessible to the public for a period of
three years from the initial date of posting on the Internet Web site.
(d) Exemptions. The Commission may, by order upon application,
conditionally or unconditionally exempt any person, security, or
transaction, or any class or classes of persons, securities, or
transactions, from any provision or provisions of this section, if the
Commission determines that such exemption is necessary or appropriate
in the public interest, and is consistent with the protection of
investors.
Sec. 240.607 [Amended]
0
12. Section 242.607 is amended by:
0
a. In paragraph (a)(1) removing the words ``customers' orders'' and add
in its place ``customers' retail orders'' and removing the word
``customer'' and add in its place ``retail''.
0
b. In paragraph (a)(2) removing the word ``customer'' and add in its
place ``retail''.
Sec. 240.611 [Amended]
0
13. Section 242.611, paragraph (c) is amended by removing the text
``Sec. 242.600(b)(30)'' and adding in its place ``Sec.
242.600(b)(32)''.
Sec. 240.1000 [Amended]
0
14. In Section 242.1000 amend the definition of Plan processor by
removing the text ``Sec. 242.600(b)(55)'' and adding in its place
``Sec. 242.600(b)(60)''.
By the Commission.
Dated: July 13, 2016.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-16967 Filed 7-26-16; 8:45 am]
BILLING CODE 8011-01-P