Should SEC’s Rule 605 Come Before Other Market Structure Proposals?

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.”

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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

The earnings recession is over. At least, that’s what a FactSet survey of analysts concluded. After three consecutive quarters of S&P 500 negative earnings per share growth, which gave Wall Street the heebie-jeebies, the third quarter (with slightly more than 80% of the index’s companies reporting) is slated to come in at a 3.7% EPS increase.

True, that isn’t an enormous profit increase, but it is better than we have seen. If so, the stock market, whipsawed since August, could well benefit.

Earlier this year, talk was rife that earnings would be lousy for some time, given escalating interest rates, persistent inflation and international tensions. The first two fears are abating, and thus far the Russia-Ukraine and Israel-Hamas wars have not ignited major conflicts elsewhere.

“It’s clear to us that the earnings recession is over as earnings are set to grow

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for the first time in four quarters,” wrote David Lefkowitz, head of U.S. equities at UBS Global Wealth Management, adding that, “a ‘soft-ish’ landing for the U.S. economy appears achievable and would support our expectations for 9%” EPS growth next year. FactSet’s survey is even more sanguine about 2024, averaging 11.9%; thanks to the bum first half of 2023, it expects this year as a whole to come in at 0.6%.

Increasingly, companies are exceeding projections, generally a positive sign for the future. Of S&P members reporting thus far, 82% showed EPS greater than estimates, higher than the five-year average of 77% and the 10-year average of 74%. If the remaining S&P 500 companies report in line with the results to date, that will be the highest percentage showing of a positive EPS surprise since Q3 2021 (also 82%).

None of this is to say that strategists are expecting a boom anytime soon. FactSet’s November 3 estimate of 11.9% earnings growth next year trails its September 30 estimate of 12.2%. The FactSet 2024 estimate also is lower than the average of the five most recent complete years (2018 through 2022), 18.2%.

As always, down at the individual level, analysts are mixed on what lies ahead. Michael Wilson, the famously bearish chief U.S. equity strategist at Morgan Stanley, is pessimistic about this year and next.

Earnings projections are “too high for the fourth quarter and 2024, even in an economy that’s performing well,” Wilson told Bloomberg. The effects of higher interest rates are continuing to reverberate among companies, to the detriment of their upcoming performance, he opined.

But to UBS’s Lefkowitz, continued strong consumer spending will be the dominant factor in boosting earnings. He wrote that “S&P 500 profits skew more toward goods rather than services, so a rebound in goods activity should support earnings going forward.”