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SEC Mulls Rule 605 Reform

U.S. Securities and Exchange Commissioner Elad Roisman stirred the market-structure pot by floating potential reforms to the regulator’s best execution requirement at SIFMA’s annual market structure conference in Midtown Manhattan.

He cited his concerns that brokers are substituting a focus on price, time, and the avoidance of trade-throughs for robust best execution analysis.

“Price is cut and dry, but it is just one factor in best execution analysis when firms make routing decisions and when regulators review those decisions,” said Commissioner Roisman.

One possible approach would be to expand the definition to include subjective factors.

“The SEC has previously cited many other aspects of a brokers’ routing decisions in obtaining best execution of customer orders,” he said. “These include size, availability of information, trading characteristics for a security, transaction costs, and ease of getting a fill. Going beyond the SEC, FINRA cites several other factors surrounding best execution, including price improvement, opportunities, the difference in price dis-improvement, the likelihood of execution of limit orders, customer needs and expectations, and the existence of internalization or payment-for-order-flow arrangements.”

To enable such a change, the Commission could consider adopting a non-prescriptive interpretation of Regulation NMS’ Rule 605 in which brokers would have a baseline requirement that would apply across various market niches and market conditions. Brokers would then be able to differentiate themselves by performing beyond the baseline.

New best execution requirements likely would require the Commission to review or even eliminate its Order Protection Rule as well.

“When adopting NMS 14 years ago, the Commission could not have had predicted 13 active equities exchanges with a 14th recently approved and two more in the works as well as 30 alternative trading systems,” he noted.

The Commissioner raised multiple ways in which the SEC could update the Order Protection Rule, including having exchanges meet a set average daily volume level during a set period, adjusting round lot sizes based on price or order size, or protecting the smaller exchanges.

“I’m not committed to any of these, but are using them to spur the conversation,” said Commissioner Roisman before turning his focus towards order management systems.

He questioned whether the recent consolidation within the OMS market and the opacity of the platform providers’ pricing had raised risks for investors and brokers and if they were diligently overseeing their relationship with the vendors and their services.

“They are performing services that market participants value and have become interwoven in the equities environment,” he said. “I would like to understand this thread that runs through the equities market better.”