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Amended Disclosure of Order Handling Information

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242 Release No. 34-84528; File No. S7-14-16 RIN 3235-AL67 Disclosure of Order Handling Information

AGENCY: Securities and Exchange Commission.

ACTION:

Final Rule.
SUMMARY: The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to Regulation National Market System (“Regulation NMS”) under the Securities Exchange Act of 1934 (“Exchange Act”) to require additional disclosures by broker-dealers to customers regarding the handling of their orders. The Commission is adding a new disclosure requirement which requires a broker-dealer, upon request of its customer, to provide specific disclosures related to the routing and execution of the customer’s NMS stock orders submitted on a not held basis for the prior six months, subject to two de minimis exceptions. The Commission also is amending the current order routing disclosures that broker-dealers must make publicly available on a quarterly basis to pertain to NMS stock orders submitted on a held basis, and the Commission is making targeted enhancements to these public disclosures. In connection with these new requirements, the Commission is amending Regulation NMS to include certain newly defined and redefined terms that are used in the amendments. The Commission also is amending Regulation NMS to require that the public order execution report be kept publicly available for a period of three years. Finally, the Commission is adopting conforming amendments and updating cross-references as a result of the rule amendments being adopted today.

DATES:

IN THE FEDERAL REGISTER]
Compliance Date:  [INSERT DATE 180 DAYS AFTER DATE OF

Effective Date:  [INSERT DATE 60 DAYS AFTER DATE OF PUBLICATION

PUBLICATION IN THE FEDERAL REGISTER]

FOR FURTHER INFORMATION CONTACT: Theodore S. Venuti, Assistant Director, at

(202) 551-5658, Steve Kuan, Special Counsel, at (202) 551-5624, Sarah Albertson, Special Counsel, at (202) 551-5647, Michael Bradley, Special Counsel, at (202) 551-5594, Amir Katz, Special Counsel, at (202) 551-7653, Emerald Greywoode, Special Counsel, at (202) 551-7965, or Andrew Sherman, Special Counsel, at (202) 551-7255, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is adopting: (1) amendments to 17

CFR 242.600 and 242.606 (respectively, “Rule 600” and “Rule 606” of Regulation NMS) under the Exchange Act to require additional disclosures by broker-dealers to customers about the routing of their orders; (2) amendments to 17 CFR 242.605 (“Rule 605” of Regulation NMS) to require that the public order execution reports be kept publicly available for a period of three years; and (3) conforming changes and updated cross-references in 17 CFR 240.3a51-1(a) (“Rule 3a51-1(a) under the Exchange Act”), 17 CFR 240.13h-1(a)(5) (“Rule 13h-1(a)(5) of Regulation 13D-G”), 17 CFR 242.105(b)(1) (“Rule 105(b)(1) of Regulation M”), 17 CFR 242.201(a) and 242.204(g) (“Rules 201(a) and 204(g) of Regulation SHO”), 17 CFR 242.600(b), 242.602(a)(5) and 242.611(c) ( “Rules 600(b), 602(a)(5), and 611(c) of Regulation NMS”), and 17 CFR 242.1000 (“Rule 1000 of Regulation SCI”).

TABLE OF CONTENTS

2

1. 2. 3. 4.
Applicability of Customer-Specific Disclosures in Rule 606(b)................. 14 Definition of Actionable Indication of Interest............................................ 56 Scope of Broker-Dealer’s Obligation Under Rule 606(b)(3) ...................... 65 Timing and Frequency Requirements for Customer-Specific Order Handling Report........................................................................................... 77

5. 6. 7.
Format of Customer-Specific Order Handling Reports............................... 87 Rule 606(b)(3) Report Content.................................................................... 99 Rule 606(c) Quarterly Aggregated Public Report of Rule 606(b)(3) Information ................................................................................................ 117

1. 2. 3. 4. 5.
Orders Covered By Rule 606(a) Public Disclosures.................................. 126 Marketable Limit Orders and Non-Marketable Limit Orders.................... 131 Payment for Order Flow Disclosures – Rules 606(a)(1)(iii) and (iv)........ 134 Format of Public Order Routing Report .................................................... 145 Division of Rule 606(a) Report’s Section on NMS Stocks by S&P 500 Index and Other NMS Stocks............................................................. 150

6. 7.
Calendar Month Breakdown...................................................................... 153 Execution Metrics...................................................................................... 155
C. Paperwork Reduction Act............................................................................................... 158 A. Summary of Collection of Information............................................................... 159
Amendment to Disclosure of Order Execution Information............................... 156
IV.

1. 2. 3.
Customer-Specific Disclosures Under Rule 606(b)(3).............................. 159 Amendment to Current Public and Customer-Specific Disclosures.......... 160 Amendment to Current Disclosures under Rule 605................................. 161

3

1. 2. 3.
Customer-Specific Disclosures Under Rule 606(b)(3).............................. 162 Amendment to Current Public and Customer-Specific Disclosures.......... 162 Amendment to Current Disclosures under Rule 605................................. 164
C.

D.
Respondents........................................................................................................ 164 1. 2.
Initial Estimate........................................................................................... 164 Estimate for Adopted Rule [Amendments to 605 and 606]....................... 165
Total Initial and Annual Reporting and Recordkeeping Burdens....................... 165 1. 2.
Customer-Specific Disclosures Under Rule 606(b)(3).............................. 166 Proposed Public Aggregated Report on Orders Subject to the Customer-Specific Disclosures Under Rule 606(b) Not Adopted............. 178

Order Routing Strategies Not Adopted...................................................... 178

4. 5. 6.
Amendment to Current Public and Customer-Specific Disclosures.......... 178 Revisions to Compliance Manuals............................................................. 189 Amendment to Disclosures under Rule 605 .............................................. 190
E. F. G.
Collection of Information is Mandatory ............................................................. 190 Confidentiality of Responses to Collection of Information................................ 190 Retention Period for Recordkeeping Requirements ........................................... 191

A. B.
Introduction......................................................................................................... 192 Baseline............................................................................................................... 194 1. 2. 3. 4.
Current $200,000 Threshold...................................................................... 195 Current Reporting for NMS Stock Orders of $200,000 and Above .......... 196 Publication Period for Reports Required by Rules 605 and 606 ............... 197 Available Information on Conflicts of Interest.......................................... 198

4
5. 6. 7.
Available Information on Execution Quality............................................. 199 Format of Current Reports......................................................................... 200 Quality of Broker-Dealer Routing Practices for Not Held NMS Stock Orders......................................................................................................... 200

8. 9.
Use of Actionable IOIs .............................................................................. 200 Competition, Efficiency, and Capital Formation....................................... 201

1. 2. 3. 4. 5.
Customer-Specific Order Handling Disclosures........................................ 206 Public Order Handling Report ................................................................... 246 Disclosure of Order Execution Information .............................................. 283 Structured Format of Reports..................................................................... 284 Other Definitions in Adopted Amendments to Rule 600........................... 287

1. 2. 3.
Alternative Scope for the Customer-Specific Reports............................... 287 Scope of Broker-Dealer’s Obligation Under Rule 606(b)(3) .................... 291 Public Availability of Aggregated Rule 606(b)(3) Order Handling Information ................................................................................................ 293

4.

5.
Automatic Provision of Customer-Specific Not Held Order Handling Report (Adopted Rule 606(b)(3)) .............................................................. 299

Submission to the Commission of Not Held NMS Stock Order Handling Reports (Adopted Rule 606(b)(3))............................................. 300

6. 7.
Categories of NMS Stocks for Rule 606(a)............................................... 301 Disclosure of Additional Information about Not Held NMS Stock Order Routing and Execution .................................................................... 302

8. 9.
Order Handling Reports at the Stock Level (Adopted Rule 606(b)(3))..... 306 Alternative to Three-Year Posting Period (Adopted Amendments to Rules 605(a)(2) and 606(a)(1)).................................................................. 306

5

Formation................................................................................................... 308

1. 2.
Effects of Adopting Amendments on Efficiency and Competition........... 308 Effects of Adopting Amendments on Capital Formation .......................... 319

VII. Statutory Authority and Text of the Proposed Rule Amendments ................................. 322

  • I.
  • Introduction

In July 2016, the Commission proposed to amend Rules 600 and 606 under Regulation
NMS to require additional disclosures by broker-dealers to customers about the handling of their orders, to amend Rules 605 and 607 for consistency with the proposed amendments to Rule 606, and to amend other rules to update cross references as appropriate.1 As discussed below, after careful review and consideration of the comments received, the Commission is adopting these amendments with certain modifications.
Transparency has long been a hallmark of the U.S. securities markets, and the
Commission continuously strives to ensure that investors are provided with timely and accurate information needed to make informed investment decisions. In recent years, the Commission and its staff have undertaken a number of reviews of market structure and market events, and much of this effort has aimed to enhance transparency for investors.2 The amendments being

1

See Securities Exchange Act Release No. 78309, 81 FR 49432 (July 27, 2016) (“Proposing Release” or “Proposal”).

2

The Commission recently adopted amendments to Regulation ATS that enhance the operational transparency of alternative trading systems (“ATSs”) that transact in National Market System (“NMS”) stocks (“NMS Stock ATSs”).” See Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018) (“ATS-N Adopting Release”). In addition, the Commission has proposed a Transaction Fee Pilot for NMS stocks to help inform the Commission, market participants and the public about the effects, if any, that transaction-based fees and rebates may have on order routing behavior, execution quality, and market quality. See Securities Exchange Act Release No. 82873 (March 14, 2018), 83 FR 13008 (March 26, 2018) (“Transaction Fee Pilot Proposing Release”).

6adopted today to Rule 606 of Regulation NMS represent the Commission’s continued commitment to enhance transparency for investors.
Rule 606 encourages competition by enhancing the transparency of broker-dealer order handling and routing practices.3 Rule 606(a) requires broker-dealers to provide a publicly available quarterly report of information regarding routing of non-directed orders.4 Rule 606(b) requires broker-dealers to provide customers, upon request, certain information about the routing of their orders. Prior to the amendments being adopted today, the Rule 606(a) requirements applied to smaller dollar-value orders more typical of retail investors but did not apply to large dollar-value orders more typical of institutional investors.5 As discussed in detail in the Proposing Release, equity market structure, as well as order handling and routing practices, have changed significantly since Rule 606 was adopted in 2000, presenting a need to update the rule such that it provides transparency into broker-dealer order handling and routing practices that continues to be useful in today’s automated and vastly more complex national market system.6
As the Commission noted when it originally adopted Rule 606, in a fragmented market
“the order routing decision is critically important” and “must be well-informed and fully subject

3

See Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594, 3602 (January 21, 2010) (“Concept Release on Equity Market Structure”).

4

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-dealer to route to a particular venue for execution. See 17 CFR 242.600(b)(19). As discussed below, these definitions are being revised in connection with the amendments to Rule 606 so that they no longer only apply to “customer orders,” but otherwise are remaining the same. See infra Section III.A.1.b.vii.

5

The Commission limited the scope of Rule 606(a) to smaller dollar-value orders by defining a “customer order” to which the rule applied as an order to buy or sell an NMS security that is not for the account of a broker-dealer, but not 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).

6

See Proposing Release, supra note 1, at 49433-44 for a detailed description of the history and the market developments leading to the Proposal.

7to competitive forces,”7 and, further, the public disclosure of order routing practices “could provide more vigorous competition on . . . order routing performance.”8 By updating the Rule 606 disclosure regime, the rule as amended will provide disclosures more relevant to today’s marketplace that encourage broker-dealers to provide effective and competitive order handling and routing services, and that improve the ability of their customers to determine the quality of such broker-dealer services.9

  • II.
  • Overview of Adopted Rule Amendments

To facilitate enhanced transparency regarding broker-dealers’ handling and routing of orders in NMS stock, the Commission proposed to amend Rules 600(b) and 606 such that all orders of any dollar value in NMS stock10 submitted by a customer to a broker-dealer would be covered by order handling and routing disclosure rules. Under the proposed amendments, new Rule 606(b)(3) would require broker-dealers to make detailed, customer-specific order handling disclosures for NMS stock orders available to institutional customers in particular, who previously were not entitled to disclosures under the rule for their order flow, or were entitled to disclosures that have become inadequate in today’s highly automated and more complex market.11 The Commission also proposed to require a broker-dealer to make publicly available a report that aggregates the information required for the detailed customer-specific order handling

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    Glossary of useful terms linked to markets in financial instruments IN ALPHABETICAL ORDER Rules governing the decision of an operator of a financial market Access requirements infrastructure, such as a stock exchange or clearing house, to allow third parties to do business on or through their systems. Admission to trading The decision for a financial instrument to be traded in an organised way, notably on the systems of a trading venue. Algorithm An algorithm is a set of defined instructions for making a calculation. They can be used to automate decision making, for instance with regards to trading in financial instruments. Algorithmic trading Algorithmic trading is trading done using computer programmes applying algorithms, which determine various aspects including price and quantity of orders, and most of the time placing them without human intervention. The requirement for a financial firm to take the necessary steps to Appropriateness test ascertain whether a financial product or service is suited to the needs of their client. Approved Publication An Approved Publication Arrangement is a system that requires firms Arrangement (APA) executing transactions to publish trade reports through a body that ensures timely and secure consolidation and publication of such data. See section 4 (on data consolidation) of the Review of the Markets in Financial Instruments Directive. Approved Reporting An approved reporting mechanism is a platform that reports transactions Mechanism (ARM) on behalf of firms. This can also be done via the multi-lateral trading facility or regulated market on which the transaction was performed. Arbitrage strategy An arbitrage strategy is one that exploits differences in price that exist due to market inefficiencies, for example, buying an instrument on one market and simultaneously selling a similar instrument on another 1 market.
  • Do Dark Pools Harm Price Discovery?∗

    Do Dark Pools Harm Price Discovery?∗

    Do Dark Pools Harm Price Discovery?∗ Haoxiang Zhu MIT Sloan School of Management July 2012 Abstract Dark pools are equity trading systems that do not publicly display orders. Orders in dark pools are matched within the exchange bid-ask spread without a guarantee of execution. Informed traders are more likely to cluster on the heavy side of the market and therefore face a lower execution probability in the dark pool, relative to uninformed traders. Consequently, exchanges are more attractive to informed traders, whereas dark pools are more attractive to uninformed traders. Under natural conditions, adding a dark pool alongside an exchange concentrates price-relevant information into the exchange and improves price discovery. Dark pools that operate as nondisplayed limit order books are more attractive to informed traders than dark pools that execute orders at the exchange midpoint. Keywords: dark pools, price discovery, liquidity, fragmentation, equity market structure JEL Classifications: G12, G14, G18 ∗First version: November 2010. For helpful comments, I am very grateful to Darrell Duffie, Sal Arnuk, Jonathan Berk, John Beshears, Bradyn Breon-Drish, Robert Burns, Peter DeMarzo, Thomas George, Steven Grenadier, Frank Hatheway, Dirk Jenter, Ron Kaniel, Arthur Korteweg, Ilan Kremer, Charles Lee, Han Lee, Ian Martin, Jim McLoughlin, Albert Menkveld, Stefan Nagel, Francisco P´erez-Gonz´alez,Paul Pfleiderer, Monika Piazzesi, Michael Ostrovsky, Martin Schneider, Ken Singleton, Jeffrey Smith, Ilya Strebulaev, Ingrid Werner (discussant), Mao Ye (discussant), Ruiling Zeng, and Jeff Zwiebel, as well as seminar participants at Stanford University, Chicago Booth, Princeton University, University of Illinois, MIT Sloan, NYU Stern, Wharton, UT Austin McCombs, Berkeley Haas, UCLA Anderson, Northwestern Kellogg, the Western Finance Association annual meeting, the NBER Market Design Working Group meeting, and the SFS Finance Cavalcade.