Yesterday, SEC Chair Gary Gensler announced proposed amendments to Rule 605 of Regulation NMS to modernize and expand disclosure requirements related to order execution quality. Chair Gensler stated that he was “pleased to support this proposal because, if adopted, it would help ensure that brokers have policies and procedures in place to uphold one of their most important obligations: to seek best execution when trading securities, whether equities, fixed income, options, crypto security tokens, or other securities.”

Background

SEC Rule 605, first adopted in 2000 and included as part of Regulation NMS in 2005, requires market centers that trade national market system securities to make monthly reports about the quality of executions on a stock-by-stock basis, including how market orders of various sizes are executed relative to public quotes. The reports must disclose information about the spreads paid by investors whose orders are routed to a particular market center. In addition, market centers must disclose the extent to which they provide executions at prices better than public quotes to investors using limit orders. Notably, Rule 605 has not been substantively updated since its adoption.

The SEC, under Chair Gensler’s leadership, has criticized certain best execution-related practices, chiefly, the practice known as payment for order flow, which it views as opaque and a potential conflict of interest that benefits certain market makers at the expense of retail investors.

Proposed Amendments

The SEC is proposing several amendments to Rule 605 to provide investors with a more complete picture of execution quality that accounts for technological developments in trading and current market speed, helping them compare brokers across the market.

• The proposed amendments would expand the scope of entities subject to Rule 605 to require all broker-dealers with at least 100,000 customer accounts to produce monthly execution quality reports. Single dealer platforms and entities operating proposed qualified auctions would also be included.
• The proposal would modify the definition of “covered order” to include certain orders submitted outside regular trading hours or with stop prices. In addition, non-marketable limit orders would have to be reported from the time they become executable.
• The amendments would change how orders are categorized by order size and type, requiring reporting of execution quality information for fractional share orders, odd-lot orders and larger-sized orders.
• Order receipt and execution times would have to be measured and reported in millisecond increments, with the realized spread calculated at both 15 seconds and 1 minute. New statistical measures of execution quality, including metrics for price improvement and size improvement, would also be required.
• All entities subject to Rule 605 would be required to make available to the public a summary report of their order execution quality statistics.

Gensler further commented that the SEC’s proposals “would heighten the requirements for transactions that involve conflicts of interest with retail investors” and provided an example of how the proposed Rule would enhance investor protection, stating “if brokers receive payment for order flow from a wholesaler, those brokers would be required to have policies and procedures that reflect enhanced diligence in seeking best execution and would be required to document their basis for determining that conflicted transactions comply with the best execution standard.”

The public comment period will remain open until March 31, 2023, or until 60 days after publication of the proposal in the Federal Register, whichever is later.