U.S. Securities and Exchange Commission Adopts Rules to Enhance Order Handling Information Available to Investors

Background and Impetus for the Proposal

Prior to the amendments, Rule 606 disclosures applied only to small orders, meaning many institutional investors obtained only limited benefit from the rule. While certain large institutional investors may be able to leverage their market size to obtain order routing information from their broker-dealers, smaller institutional investors do not typically possess this bargaining power. Absent rules mandating disclosure, it is sometimes difficult for these smaller institutional investors to obtain order handling information, and for those institutional customers who have received order handling information, the data from broker-dealers does not follow a standardized format.

Because of their larger size, institutional orders tend to be routed and executed using algorithms that break large orders into smaller, “child” orders that are sent to a variety of venues.  Institutional investors worry that the dissemination of these orders may lead to information leakage, in which an institutional investor’s interest in buying or selling a particular security may be revealed to the market before the order can be fully executed. Information leakage can lead to additional costs as other market participants seek to use this information to their advantage. As a result, institutional investors often give their brokers not-held orders so that the broker has discretion in handling them to avoid signaling the rest of the market. Thus, understanding how a broker-dealer routes not-held orders is particularly important to institutional investors.

The above concerns, among others, prompted the Investment Company Institute (ICI) and the Securities Industry and Financial Markets Association (SIFMA) to propose certain enhancements to Rule 606 in a letter to the SEC in 2014.⁶ This letter significantly influenced the framework of the original rule proposal and thus the adopted amendments, which are detailed below.

New Required Customer-Specific Report for Handling of Not-Held Orders Intended to Cover Institutional Customer Order Flow

Subject to certain de minimis exceptions,⁷ new Rule 606(b)(3) requires broker-dealers to provide a customer, upon request, a report on the broker-dealer’s handling of the customer’s NMS stock orders submitted on a not-held basis for the prior six months, divided into separate sections for a customer’s directed and nondirected orders. The report must include the following general information: shares sent to the broker-dealer; shares executed by the broker-dealer as principal for its own account; not-held orders exposed by the broker-dealer through actionable indications of interest;⁸ and the venue or venues to which not-held orders were exposed, provided that the identity of such venue or venues may be anonymized if the venue is a customer of the broker-dealer.

The report will also include the following information for each venue to which the broker-dealer routed not-held orders for the customer, in the aggregate:

• Information on order routing:
  • total shares routed
  • total shares routed marked "immediates" or "cancel"
  • total shares routed that were further routable
  • average order size routed

• Information on order execution:
  • total shares executed
  • fill rate (shares executed divided by the shares routed)
  • average fill size
  • average net execution fee or rebate (cents per 100 shares, specified to four decimal places)
  • total shares executed at the midpoint
  • percentage of shares executed at the midpoint
  • total shares executed that were priced on the side of the spread more favorable to the not-held order
  • percentage of total shares executed that were priced at the side of the spread more favorable to the not-held order
  • total shares executed that were priced on the side of the spread less favorable to the not-held order
  • percentage of total shares executed that were priced on the side of the spread less favorable to the not-held order 

• Information on orders that provided liquidity:
  • total shares executed of orders providing liquidity
  • percentage of shares executed of orders providing liquidity
  • average time between order entry and execution or cancellation, for orders providing liquidity (in milliseconds)
  • average net execution rebate or fee for shares of orders providing liquidity (cents per 100 shares, specified to four decimal places)

• Information on orders that removed liquidity:
  • total shares executed of orders removing liquidity
  • percentage of shares executed of orders removing liquidity
  • average net execution fee or rebate for shares of orders removing liquidity (cents per 100 shares, specified to four decimal places)

Enhanced Disclosures for Held Orders Intended to Cover Noninstitutional or Retail Customer Order Flow

The amendments prescribe the previously required public quarterly reports to now cover NMS stock orders of any size that are submitted on a held basis. These reports must still cover any order, whether held or not held, for an NMS security that is an option contract with a market value less than $50,000. In addition, broker-dealers must report the following:

• separate routing information for marketable limit orders versus nonmarketable limit orders — previously, limit orders were not disaggregated in this manner
• routing information by calendar month instead of quarterly (and no longer categorize NMS stocks by listing market)
• a new category of data detailing separate routing information for NMS stock orders for securities included in the S&P 500 Index versus other NMS stocks
• a new set of information for the 10 venues to which the largest number of total nondirected orders were routed for execution and for any venue to which 5 percent or more of nondirected orders were routed for execution:
  • 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 nondirected market orders, nondirected marketable limit orders, nondirected non-marketable limit orders and other nondirected orders and
• an enhanced discussion of the terms of any payment for order flow and any profit-sharing arrangements that may influence a broker-dealer’s order routing decision, including the following newly-required topics:
  • incentives for equaling or exceeding an agreed-on order flow volume threshold
  • disincentives for failing to meet an agreed-on minimum order flow threshold
  • volume-based tiered payment schedules
  • agreements regarding the minimum amount of order flow that the broker-dealer would send to a venue

Required Format of Rule 606 Reports and Retention of Public Reports Produced Pursuant to Rule 606(a) and Rule 605 Reports

The reports required under new Rule 606 must be made available using an XML schema and associated PDF renderer published on the SEC’s website. In addition, the public quarterly order routing report required by new Rule 606(a) and the public order execution report required by Rule 605 of Regulation NMS must be posted on a website that is free and readily accessible to the public for a period of three years from the initial date of posting on the website.

The enhanced disclosures provide increased transparency both as to broker-dealers’ routing practices and potential conflicts of interest. The added disclosures give investors more complete and consistent data points with which to evaluate and compare the practices of not only their broker-dealer but of competing broker-dealers. This is likely to lead to more innovation and unique arrangements as broker-dealers seek to distinguish their services.

¹ Note that the concept of “customer” excludes broker-dealers, and therefore orders received from broker-dealers are excluded from the reports discussed herein.

² The SEC’s original proposal defined “institutional order” as an order to buy or sell a quantity of a National Market System (NMS) stock having a market value of at least $200,000, provided that such order is not for the account of a broker-dealer.

³ The SEC states that in using the concept of “not held” orders (as opposed to “institutional orders” above $200,000), it intends to capture institutional customer order flow: “[by] using the not held order distinction, Rule 606(b)(3) as adopted will likely result in more Rule 606(b)(3) disclosures for order flow that is typically characteristic of institutional customers — not retail customers — and will likely cover all or nearly all of the institutional order flow.” See Disclosure of Order Handling Information (“Adopting Release”) p. 27, available at https://www.sec.gov/rules/final/2018/34-84528.pdf, Federal Register cite not yet available.

⁴ Note that the SEC describes but does not define the terms “held” and “not held” in the Adopting Release: “Typically, a ‘not held’ order provides the broker-dealer with price and time discretion in handling the order, whereas a broker-dealer must attempt to execute a ‘held’ order immediately.” See Adopting Release p. 10.

⁵ As discussed below, a broker-dealer generally is not obligated to provide the report to any customer if not-held NMS stock orders constitute less than 5 percent of the total shares of NMS stock orders that the broker-dealer receives from its customers over the prior six months.

⁶ Letter to Mary Jo White, Chair, SEC, from Dorothy M. Donohue, Deputy General Counsel, ICI, Stuart J. Kaswell, Executive Vice President and Managing Director, General Counsel, Managed Funds Association, and Randy Snook, Executive Vice President, SIFMA, dated October 23, 2014, available at http://www.sec.gov/comments/s7-02-10/s70210-428.pdf.

⁷ A broker-dealer is not obligated to provide the report to any customer if not-held NMS stock orders constitute less than 5 percent of the total shares of NMS stock orders the broker-dealer receives from its customers over the prior six months (however, the first time a broker-dealer meets or exceeds threshold, there is a grace period of three months before the broker-dealer becomes subject to Rule 606(b)(3)). In addition, a broker-dealer is not obligated to provide the report to a particular customer if that customer trades through the broker-dealer on average each month for the prior six months less than $1 million of notional value of not-held orders in NMS stock.

⁸ The amendments define an “actionable indication of interest” 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: (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.” The SEC is not expanding the scope of existing rules, regulations or guidance related to orders or quotations, other than Rule 606 and guidance related thereto, with regard to actionable indications of interest.