“Every day, investors turn to broker-dealers in the markets—often through brokerage apps—to build a better financial future. How do you know, however, the quality of the broker’s execution of your order?”
The Securities and Exchange Commission (SEC) has adopted amendments to enhance disclosure requirements under Rule 605 of Regulation NMS, affecting how order execution information is reported for national market system stocks (NMS stocks).
This rule, initially established in 2000, plays a crucial role in enabling public comparison and evaluation of execution quality across different market centers.
Key changes under Rule 605
Key changes introduced by the amendments include a broader range of entities now required to produce monthly execution quality reports, such as broker-dealers managing a significant number of customer accounts and single dealer platforms. The definition of “covered order” has been expanded to encompass orders placed outside regular trading hours, those with stop prices, and certain short sale orders, ensuring a more comprehensive capture of execution quality data for these order types.
Additionally, the amendments revise how orders are classified by size and type, including provisions for fractional share orders, odd-lot orders, and larger-sized orders. They introduce more precise time-to-execution measurement categories, with average times now calculated in milliseconds or finer increments for all orders. New statistical measures of execution quality, including the average effective spread divided by quoted spread and size improvement statistics, have been added to the reporting requirements.
All entities subject to Rule 605 are mandated to make a summary report of execution quality publicly available. The final amendments are accessible on SEC.gov and will be published in the Federal Register. They are set to become effective 60 days following their publication in the Federal Register, with a compliance deadline 18 months post-effectiveness.
“How do you know the quality of the broker’s execution of your order?”
SEC Chair Gary Gensler, stated: “Every day, investors turn to broker-dealers in the markets—often through brokerage apps—to build a better financial future. How do you know, however, the quality of the broker’s execution of your order? You can turn to measures that compare the price you received with what’s called the National Best Bid and Offer at a particular time. This information is measurable, but currently, the brokers whose apps you’re using are not required to disclose execution quality in that way. Rule 605, which the Commission first adopted in 2000, requires monthly disclosures on execution quality from market participants known as market centers. In the 24 years since Rule 605 was adopted, however, our equity markets have been transformed by ever-evolving technologies and business models. Therefore, current Rule 605 disclosures provide investors with a picture of execution quality that could be improved. Thus, I am pleased that these final rules will modernize Rule 605 in a number of ways.
“First, the final rules will require that large broker-dealers—those with more than 100,000 customers—disclose execution quality to the public. Right now, only the so-called market centers, including the wholesalers in the dark markets, must make this disclosure. The Rule 605 requirements will apply to larger broker-dealers that combined handle more than 98 percent of customer accounts and three out of five orders from broker-dealer customers. By requiring large broker-dealers—like those operating the brokerage apps—to disclose execution quality as well, investors will be better able to factor execution quality into their decisions, and you will be able to compare the brokers when you select them. I think that this disclosure also will foster greater competition among brokers, creating additional incentives for brokers to improve execution quality to earn investors’ business and trust.
“Second, we’re proposing to require more types of data to go into these execution quality reports. For example, institutional investors often use percentage-based metrics such as the effective over quoted (E/Q) spread to evaluate execution quality. I think everyday investors would also benefit from easy access to these same metrics. These percentage-based metrics will help investors make apples-to-apples comparisons when evaluating brokers’ execution quality. Further, the disclosure of execution quality will apply to a range of order sizes based on notional dollar value—from $250 to $200,000 or more—with indications that the order is for an odd-lot, a round lot, or a fractional share. The final rules also refine the order type categories to be reported. These amendments will improve execution quality disclosures through capturing a larger range of relevant data.
“Third, today’s amendments will require market centers and broker-dealers to produce summary reports on execution quality that everyday investors can read. The reports for the 24-year-old Rule 605 look like a series of dashes, numbers, and symbols. I kid you not: It’s kind of like the opening credits in “The Matrix.” By coincidence, the Matrix was released in 1999, just one year before the Commission last updated Rule 605. In the years since, the studios have released not one, not two, but three sequels to the Matrix. I think, three Matrix sequels after, it’s about time we developed a “sequel” to current Rule 605 reporting as well, “welcoming” execution quality reports “to the real world” where everyday investors can actually use them.
“The final rules will increase transparency for investors and facilitate their ability to compare brokers. That helps make our markets more efficient, competitive, and fair.”
“A major undertaking for broker-dealers that are not market centers”
SEC Commissioner Hester M. Peirce, commented: “On balance, the Rule 605 amendments we are voting on today are positive. Over the past quarter-century since Rule 605 first mandated the disclosure of certain order-related information, our markets have changed dramatically. Decimalization, the adoption and implementation of Regulation NMS, the increased speed at which orders are communicated and transactions are executed: All of these have combined to refashion the market in ways very different from the market of Y2K.
Rule 605 has not kept up with these changes. The Commission gave hints that it recognized that Rule 605 was out-of-date just a decade after it was adopted. In the 2010 Equity Market Structure Concept Release, the Commission asked whether Rule 605 was fit for purpose in a market that had changed significantly over the preceding decade. The Concept Release also identified issues—such as the granularity of time categories—that are finally being addressed in today’s rule. The Commission also noted that these disclosure requirements “were drafted primarily with the interests of individual investors in mind” but expressed uncertainty whether “individual investors understand and pay attention to [these] statistics,” whether “market participants . . . make decisions based on this data,” and, if so, whether “those decisions [are] beneficial to individual investors.”
The Commission and market participants continued discussing ways to address these deficiencies over the following decade, first in comments on the Concept Release and later in meetings of the Equity Market Structure Advisory Committee (EMSAC) and recommendations that committee issued in November 2016.[6]The conversation continued at a 2018 market data roundtable. For much of this period, trade associations also have repeatedly called for the Commission to improve the quality of these reports.
Given this history, I am happy to see the Commission taking action on these amendments today. Although I have some reservations, the staff has carefully considered the many comments we received in response to this rule and worked to make Rule 605 reports more useful to investors and those who serve investors. I do not agree with every call made, but the final amendments are a necessary response to the evolution of the market. And, if we move forward with the other market structure rules that were proposed in December 2022, which I am not arguing we should do, getting Rule 605 amended and implemented first makes sense.
Now to my reservations. First, as the history I just related shows, the original Rule 605 quickly became outdated given rapid developments in how our markets worked in the first decade of this century. Any additional transparency produced by the changes the Commission is considering today may just as quickly become clouded by market developments. Solving this problem is not easy. The Commission is a large organization that, often out of necessity and prudence, moves slowly.A market solution is preferable, but so far has not succeeded in providing consistent data regarding execution quality across a large number of firms. We should not be complacent about allowing a costly regulatory reporting regime to persist if it is not providing reliable and actionable information to investors. Not only with respect to this rule, but also more broadly, the Commission must stay informed of possible gaps between market developments and our regulatory framework and address them expeditiously. To fail to do so is to neglect our responsibility as a regulator and to risk a loss of relevance to and trust from the investing public.
As the number of firms subject to the reporting agreement increases and the reporting framework becomes more complex—as is happening today—this problem becomes only more acute. For example, for the first time, the final rule requires certain broker-dealers that are not market centers to produce Rule 605 reports and treats broker-dealers that internalize only fractional share orders as market centers. I am not entirely convinced that the reports produced by these broker-dealers will be useful to retail investors, or that their usefulness will be commensurate with the costs of producing them. If the evidence suggests that reports from these firms are not benefitting retail investors, or are becoming less useful over time, we should acknowledge it and take necessary steps to tailor the scope of the rule in response.
Second, the approach the economic analysis takes to analyzing the economic effects of overlapping compliance periods—in particular, between this rule and the yet-to-be implemented market data infrastructure reforms—suggests a higher level of confidence in our prior economic analyses than may be warranted.The economic analysis acknowledges that certain elements of the market data infrastructure rules—particularly the new round lot definition in those rules—mean that the baseline against which the changes to Rule 605 are being assessed incorporates certain assumptions as to the costs and benefits of the market data infrastructure changes that will occur at some future date. The analysis concludes, however, that given that the new round lot definition affects only a limited number of stocks, the market data infrastructure rules are “not expected” to have significant effects on the costs and benefits of the amendments to Rule 605.
Although not ideal, this conclusion in this specific context seems reasonable, but, if taken more broadly, it may raise questions about the reliability of our economic analyses. The relevant changes in the market data infrastructure rule are fairly discrete, as are their interactions with Rule 605. Going forward, however, we need to consider carefully whether there is a point at which it is imprudent to engage in further rulemaking when doing so requires us to perform an economic analysis that depends on multiple layers of assumptions about the expected (but empirically unverified) costs and benefits of closely related rules that we have already adopted but not yet implemented. Although this is a difficult line to draw, at some point, market participants may reasonably raise doubts about the accuracy and usefulness of an economic analysis that incorporates expected-but-unverified costs and benefits of prior rules, whose expected costs and benefits themselves incorporate assumptions about the costs and benefits of yet-to-be-implemented rules.
This concern is heightened with a rule like 605. This rule not only seems likely to affect the baseline of other proposed rules, but itself will produce the data that will help us understand whether these other rules, if adopted, will generate the hoped for benefits. A regulator has a responsibility to confirm that rules it has promulgated produce the intended effects without imposing disproportionate burdens. If the Commission proceeds to adoption of related rules before this rule is implemented and before we have a clearer picture of execution quality under our current rule set, I will be looking closely at how the Commission intends to measure those effects both in any adopting releases and retrospectively, having changed the measuring stick midstream.
I would like to express my thanks to the staff in TM,DERA, and OGC who worked hard on a very technical set of changes to this rule, and for engaging closely with market participants to address their concerns about ensuring that the amended rule generates data that will be useful to the investing public. I do have a few questions.
One of the criticisms of Rule 605 has been that it is not terribly useful to retail investors. I understand the argument that Rule 605 reports generated by market centers are used by broker-dealers and others who route retail investor orders and thus indirectly benefit retail investors even if they do not view the reports themselves. The reports under the amended rule will be, in some ways, considerably more complex, and it seems unlikely that retail investors will pay much attention even to the summary reports. How are retail investors likely to benefit from the Rule 605 reports generated by the broker-dealers who now will have to produce these reports?
What is the case for requiring broker-dealers who are captured by the rule as market centers only because they internalize fractional share orders to produce Rule 605 reports? How many such brokers do you anticipate there are?
Presumably many of the broker-dealers newly captured by this rule will look to third-party vendors to help them get their reporting systems in place.
Do vendors already provide such services, for example, to broker-dealers that are market-centers because they operate ATSs or because they internalize orders?
Do we have any data regarding how much they charge for these services?
Did we use these data in developing our estimates of the costs of compliance that broker-dealers captured under the amended rule are likely to incur?
My understanding is that implementing this rule will be a major undertaking for broker-dealers that are not market centers.
How did we think about implementation difficulties in setting what appears to be too aggressive of a compliance deadline?
What are we planning to do to assist them during implementation?
Commenters have expressed frustration with their inability to examine the CAT data informing our analysis and policy choices in the December 2022 market structure proposals, including the Rule 605 proposal. Why is it appropriate for the Commission to engage in policymaking on the basis of data unavailable to market participants affected by our rules?
In the proposing release, the Commission also relied on analysis of Rule 605 and 606 reports from a select group of broker-dealers.Notwithstanding the fact that these reports are public, the release dismisses a request from some commenters that we provide them with the identity of the broker-dealers whose reports were used in this analysis, given that, as one commenter noted, not providing this information “prevent[s] replication and analysis of the Commission’s use of such data.” The response is quite cavalier: The release notes that“[t]he reports themselves are publicly available and interested parties can analyze these reports using their own selection of broker-dealers,” which makes it look as though we are hiding the ball. Why not just tell them? Are we trying to make it more difficult for the public to check our work?”
