On March 6, 2024 the SEC adopted amendments to update the Securities Exchange Commission Rule 605 regarding public disclosure of execution practices. This proposal was the least controversial of four Equity Market Structure proposals launched by the SEC on December 22, 2022.
Evolution of Rule 605
In November 2000, the SEC adopted Rule 11Ac1-5, now referred to as SEC Rule 605 and SEC Rule 606. These rules were designed to provide public disclosure of execution quality and order routing practices. They required qualifying market centers that trade in national market system (NMS) securities to provide monthly detailed reports regarding execution quality information. The goal of these rules was to create transparency, leading to greater competition and better results for retail and institutional investors.
“Customers can use this information to compare execution quality across broker-dealers and select broker-dealers offering better execution quality,” said SEC Commissioner Caroline A. Crenshaw in a Statement on Adoption of Amendments to Rule 605: Disclosure of Order Execution Information.
While SEC Rule 606 has adopted some amendments, these are the first modifications to SEC Rule 605.
Rationale for Amendments
By the time these amendments become effective, a quarter of a century will have passed. In that time Equity markets have seen numerous technological, operational, competitive, and structural changes. The Flash Crash encouraged several regulatory initiatives relating to volatility and market access, including Reg SCI, Limit up/Limit down for individual securities, and minimum quoting standards. Additionally, markets have witnessed the proliferation of ETFs, an explosion of self-directed investing, the introduction of fractional shares, $0 commission trades, Robo advisors, and the Consolidated Audit Trail (CAT), all impacting equity trading and equity market structure.
Unlike the other three SEC proposals from December 2022, the interest in modernizing Rule 605 has relative consensus from industry participants. The industry was concerned that the SEC may choose to implement several or all of the proposals at the same time; instead, the SEC seemed to acknowledge those concerns and move on the Rule 605 proposal, the most logical of the group.
Key Modifications
Most significantly, the amendments dramatically expand the scope of firms required to comply beyond a defined “market center” (essentially market makers, alternative trading systems (ATS) and exchanges), to now include broker-dealers that introduce or house 100,000 or more customer accounts.
Additionally, there are many amendments to required data and format delivery. The amendments:
- expand the definition of “covered orders” to include extended hours trading order, certain “stop” orders, and non-exempt short sale orders;
- modify the existing share based order size buckets to focus on notional dollar value and will consider other orders previously exempt, including odd lots, fractionals, and orders larger than 10,000 shares;
- establish four new order type categories relating to immediate or cancel (IOC) and “stop” orders with “stop” prices;
- replaces three non-marketable limit order types with four new order types, focusing on once the order becomes marketable;
- more granular time to execution buckets measured in milliseconds:
- more detailed time-based realized spread calculations;
- several new statistical measures of execution quality, including spread adjusted effective/quoted and liquidity enhancement (a.k.a. size improvement) statistics; and
- enhanced formatting requires schema for comma separated values (csv) and associated portable document format (PDF).
Compliance Timeline
The amendments will become effective 60 days after the date of publication of the adopting release in the Federal Register. The amendments have a compliance date of 18 months after the effective date.
Implementation Guideline for Firms
This is a highly technical, detailed 586-page amendment. With the Rule’s focus on transparency and reporting, firms should do the following to prepare:
- Determine if the Rule now applies to your broker-dealer. Do you carry or introduce 100,000 or more accounts?
- Review key elements of the Rule (order types, data sets) to determine how it applies to your firm.
- Map out technical specs, roadmaps, and budgeting requests.
- Coordinate with applicable third-party vendors, including your Order Management System (OMS) provider, current Rule 606 and/or Best Execution vendor, clearing firms, and securities processor.
- Prepare your staff. Back-office and client-facing employees will need to be well-versed in the new Rule.
Partnering for Compliance
FINRA and the SEC’s requirements for Best Execution are complex. Oyster Consulting is the partner you need to ensure you are ready for implementation of amendments to Rule 605. Our experienced team of experts will assess your firm’s Best Execution protocols relative to the rule. Our consultants will also review policies and procedures, trading systems and reports, third-party vendors, firm thresholds and all Best Execution related disclosures. Oyster Consulting is the partner you need to help you plan for what needs to be done and ensure that your firm is compliant.
