In December 2022, the Securities and Exchange Commission proposed four rules that would reform the structure of U.S. financial markets as part of the regulator’s ongoing effort to enhance protections for investors, especially retail investors.
The proposals included the order competition rule, which would mandate auctions for certain retail orders; moving best execution enforcement from the Financial Industry Regulatory Authority to the SEC (Reg BE); reducing price tick-sizes for tick-constrained stocks; and an update to Rule 605 on order execution and routing quality disclosure.
If finalized, the proposals would seek to increase execution quality for retail investors but could also improve execution quality for institutional investors by turning best execution enforcement over to the SEC and expanding execution quality disclosure.
The update to Rule 605, the most popular of the four changes, would expand execution quality disclosure to include larger broker/dealers and would require “new statistical measures of execution quality” related to price improvement and speed of trade execution. The proposal would also require subject entities to “make a summary report available to the public.”
The Rule 605 proposal has received near-unanimous industry support, and the tick-size reduction has received majority support, provided tick-sizes are reduced to half-penny price increments. The order competition and best execution proposals are widely unpopular in the financial industry.
This divide has prompted some actors to argue that Rule 605 should be finalized first: It is the consensus pick as the best of the four; it would help establish baseline data that would help in evaluating the need for the other three; and it could be used to measure their effectiveness when/if they are adopted.
This argument was advanced by the Securities Investment and Financial Markets Association in a short “video blog” in which the organization noted that Rule 605 is “the one proposal SIFMA supports.”
The SIFMA video argued that “instead of rushing to finalize all four rules at the same time, the SEC should first update Rule 605 to obtain the baseline data needed to accurately assess market quality. Then, after analyzing the new data, determine whether more rulemaking is needed and conduct robust economic analysis to ensure any changes benefit all investors.”
Some policy experts say that argument is advanced in bad faith. John Ramsay, the chief market policy officer for IEX, calls this argument a “calculated stall” from industry actors.
“It’s fair to say that Rule 605 was the one that was least controversial,” Ramsay says, which made it easier to support for those “resistant to any market reform,” because it was the most likely of the four to be finalized. Supporting Rule 605 could also support a strategy of “pause and wait and see” if SEC Chairman Gary Gensler can get around to finalizing the others at all.
Jay Gould, a special counsel at Baker Botts, says many brokers support Rule 605 because it is difficult “to make credible arguments that this information shouldn’t be disclosed” to investors.
When it comes to the order competition rule, Ramsay says putting Rule 605 first “holds some water” because, “if you had more granular detail on price improvement for retail investors,” observers and regulators could better evaluate the effectiveness of mandatory auctions intended to improve pricing for retail investors.
Apart from that, it “goes too far to say that you can’t update other rules at all unless 605 is done first,” because “Rule 605 reports won’t tell you anything about if the other proposals work or not,” Ramsay says.
Gould, on the other hand, thinks finalizing Rule 605 first could help in evaluating the value of reducing tick-sizes, because the SEC could “find out where there are weaknesses in pricing, execution, settlement,” which could help inform the regulator of which stocks are truly tick-constrained.
Despite this, Gould sees little need for a large gap between finalizing Rule 605 and the other three, since the SEC has other data sources, and the tick-size proposal, or Reg NMS, is broadly popular in the financial industry.
Ramsay expects the SEC to finalize Rule 605 and the tick-size proposals by the first quarter of 2024 and Reg BE later in 2024, while the order competition rule has the least clear path to finalization.Tags: broker, broker-dealer, execution, Reg BE, Settlement, spreads