More transparency — the mantra which has taken hold regarding Rule 606 reports — needs to make its way to Rule 605 reports, say trade execution experts and buy-side representatives who are hoping the US Securities and Exchange Commission will take action this year.

US broker-dealers which forward orders to trading venues or market makers must better understand the execution quality — or performance– they are receiving. So must retail investors. The current Rule 605 reports are a good start, but don’t go far enough. Adding more information and adjusting other data points won’t be operationally difficult for market centers — trading venues and market-makers– to handle. Now all that is needed is for the SEC to amend Rule 605 just as it updated Rule 606 last year. If only some market centers were to voluntarily change their approach, the results would be far more confusing. Uniformity is required for broker-dealers and investors to make direct comparisons between market centers; therefore, the SEC’s intervention is needed.

Rule 605 and Rule 606 issued by the SEC in 2000, were written to go hand in hand, but there is a key difference. Rule 606 requires executing brokers to disclose where they are routing customer orders. Rule 605 requires market centers to reveal the quality of their executions — in other words, whether investors are getting a good deal relative to broader market conditions. A good deal is all about “price improvement” — receiving a higher price than the National Best Bid and Offer (NBBO) when selling shares or receiving a lower price than the NBBO when buying shares. The NBBO, which serves as the benchmark for the monthly publicly available Rule 605 reports, is based on information gathered by multiple exchanges and consolidated in feeds compiled by two Security Information Processors — one for all New York Stock Exchange markets and the other for Nasdaq. The processors are operated by the exchanges.

Last year, after much industry lobbying, the SEC finally amended Rule 606 reports to require executing brokers to disclose fees paid to and rebates received from trading venues, helping investors understand whether a given executing broker has a vested interest in routing orders to a particular venue. Industry players say the time is now ripe for the regulatory agency to require changes to Rule 605 reports as the regulation is outdated. “The requirements for the Rule 605 reports were suitable at the time the rule was adopted, but the market has changed dramatically since then,” says Ben Calev, chief technology officer for BXS, a New York-based provider of regulatory reporting and trade analytics solutions. “The rise of dark pools and other off-exchange venues, the emergence of high frequency traders as primary liquidity providers, and the proliferation of smart order routing technologies are all factors that have fundamentally altered the landscape.”

Industry players, such as BXS, the securities trade group Financial Information Forum, and the non-profit buy-side coalition Healthy Markets Association, are hopeful the recent controversy involving GameStop shares could finally encourage the SEC to consider mandating the additional information on the Rule 605 reports this year. There have been reinvigorated calls for transparency on trade execution, and by acting on Rule 605 the SEC can demonstrate its commitment to requiring greater disclosure for investors. In late January, popular trading app Robinhood temporarily suspended trading in GameStop and other “hot” stocks, then allowed for “limited buying” and as of February 3, increased the maximum number of shares to be purchased for all of the affected firms. Robinhood, which insisted that its decision was necessary to cover clearing margin requirements, was subsequently hit with a class-action lawsuit for market manipulation and unfair treatment of retail investors. Congressional hearings also followed in February as lawmakers sought to investigate payment for order flow.

Rule 605 reports are woefully short of information on a multitude of trade order types, say skeptics. For starters, orders on odd lot trades — or those under 100 shares are not included. The lowest fill increment on the current Rule 605 reports is 100 to 499 shares, which is larger than many of the trades executed by discount brokers such as Robinhood. “Because orders on odd lot trades are not included on Rule 605 reports, introducing brokers miss out being able to analyze a sizeable percentage of trades,” says Calev. In a February 17 letter to House of Representative lawmakers on the GameStop controversy, Tyler Gellasch, executive director of Healthy Markets Association went into great detail on the pitfalls of the Rule 605 reporting regime when it came to odd lots. Using the current reporting methodology, claims of price improvement made by retail brokers and market makers can easily be flawed, Gellasch argues. Taking the example of shares in GameStop and Amazon, the price improvement cited on January 27 of over US$2 million in off-exchange trading, he says, was double the actual price improvement of US$1 million when factoring in the better-priced odd lots on Nasdaq. “If other exchanges odd-lot quotes were included, the percentage of trades executed at inferior prices would likely rise and price improvement would fall further,” says Gellasch who has also given the SEC a laundry list of other lapses in Rule 605 reports. Among the inclusions Healthy Markets Association advocates are immediate or cancel orders, peg orders, realized liquidity, quoted spread, and average time to execution for all non-marketable limit orders (NMLOs).

Yet another shortcoming of Rule 605 reports, according to Calev, is that they include information on realized spread five minutes after a trade is executed. The timeframe should be far shorter, because a five-minute delay is simply too long to keep pace with the ongoing acceleration of equity markets. Like the Healthy Markets Association, Calev says that the Rule 605 report should also incorporate more granular metrics such as quoted spread, which is captured at the time of order receipt. Although Rule 605 reports allow for trades to be time-stamped, the resulting data is presented in terms of seconds, which is too long an interval, adds Calev, because today’s traders are far more concerned with milliseconds and microseconds than their peers when Rule 605 was first issued. The most glaring omission on the Rule 605 reports, he believes, is the names of the broker-dealers sending the orders to market centers. As a result, there is no way for anyone to compare the price improvements broker-dealers are receiving from particular market centers.

In addition to including orders on odd-lot shares., FIF a New York-based securities trade group representing broker-dealers, market data vendors and exchanges, wants Rule 605 reports to incorporate short sale orders and more info on NMLOs. “The current framework excludes many orders set within a specific price target outside the ten cent threshold [within 10 cents of NBBO],” writes the FIF in a 2019 letter to the SEC’s Division of Trading and Markets. “Adding an additional away from the quote bucket for NMLOs would capture a significantly greater number of self-directed orders from individual investors.” Self-directed orders represent those which the investor executes typically through discount brokers or online platforms without any input from others on what to buy and when. FIF’s letter goes on to ask the SEC to include all NMLOs that can be executed during normal market hours instead of restricting to only orders received after 9:30 AM EST. As the FIF notes, self-directed investors often enter their price target limit orders before the market opens.

Although adding information on executed odd-lot orders appears to be top of the list of market player desires for Rule 605 reports, it will likely be the most difficult to implement. The reason: there is no comparable data on the NBBO reports. Nasdaq, NYSE parent Intercontinental Exchange and CBOE are in litigation with the SEC over what market data should be released and how it should be priced, The SEC has also proposed allowing third-party technology firms to compete with exchanges to becomes SIPs. It is unclear how any data on odd lot shares can be fairly incorporated into Rule 605 reports if the rules aren’t changed to how the NBBO is calculated.

Whether or not the SEC finally takes the plunge and make some changes to Rule 605 is anyone’s guess, but what it certain is that without a regulatory mandate, progress can’t be made. The FIF’s Rule 605 Working Group did come out with a proposed supplement to Rule 605 reports adding various data points, including those cited in its 2019 letter to the SEC, but few market centers used the supplement. “Voluntary initiatives are often difficult to impose,” says Howard Meyerson, managing director of FIF. “The change in the SEC’s leadership combined with the GameStop controversy might just have created have the perfect backdrop for the agency to take action.”

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