This is the fifth article in a series sponsored by S3. 

Discretion is often the better part of valor.

And in a move put forth by the Securities and Exchange Commission and heartily accepted by Wall Street’s myriad broker-dealers, the SEC recently opted to delay implementation of the new Rule 606 regime from a May 20, 2019 compliance date to October 1, 2019. In its wisdom, the regulator responded to comments that additional clarity and guidance was required to promote the consistent implementation of the rule.

Among the issues that market participants wanted clarity on were:

• Ambiguity surrounding the definition of broker-dealer discretion;
• Scope of broker-dealer look-through requirements;
• Challenges involving the capture and reporting of child route information;
• Expectations regarding the reporting of fee/rebate information;
• Options reporting;
• Actionable IOIs;
• Several field specific concerns.

So, in this case the delay was a good thing and should lead to better regulation, said Mark Davies, Chief Executive Officer at S3.

“The delay was absolutely needed.  The data requirements for compliance with this rule are substantial,” Davies said. “The SEC indicated a belief that most of the data was already available, but a lot of it was not, particularly in the case of look-through.”

To recap, on Nov. 2, 2018, the Securities and Exchange Commission amended Rule 606 under Reg NMS to require additional disclosures by broker-dealers to customers regarding the handling of their orders. The intent of these amended rules is to provide more detailed and standardized information to customers—with a focus on institutional customers—thereby allowing a more effective assessment of how broker-dealers are carrying out their best execution obligations and the impact of a broker-dealer’s order routing decisions on the quality of their executions.

As has been well documented here and in the financial media, the onus of Rule 606 compliance falls on the sell-side and they must be able to provide the wider breadth of data the buy-side will be entitled to. The routing-disclosure rule requires the affected brokers to issue the new 606(a)(1) and the 606(b)(3) reports.

Brokers who handle any held customer order flow likely will have to issue 606(a)(1) reports, which are updated versions of the legacy 606 report, according to S3 Chief Executive Officer Mark Davies.

It differs from the previous report, which requires firms to include the trade’s destinations as well as if the orders were market or limit orders, in that the 606(a)(1) must consist of whether the trade was a market, marketable limit, or non-marketable limit order as well as any fees or rebates directly associated with the trade.

Unlike the original 606 reports, which firms could publish in almost any format as long as it included the necessary data, the SEC will require firms to issue reports in XML and PDF formats only.

The 606(b)(3) report is wholly new and requires any firm to report actionable IOIs, further routable information, fill rates, spread sizes, whether the order adds or removes liquidity, net fees or rebates, and the total lifetime of the order within seven days of any client’s request.

Christopher Bok, Director at the Financial Information Forum, agreed with S3’s Davies saying that the extension of the Amended Rule’s compliance date from May 20^th to October 1^st was indeed necessary. First, he explained, it allows time for the SEC to provide the industry with required guidance; Second, it affords the industry members with an opportunity to implement that guidance.

“Third, it provides firms reasonable time to coordinate with their vendors/executing brokers to more effectively consolidate all order execution data in a format that will be readily transferable to 606(a) and 606(b) reports,” Bok said.

Davies, who’s firm S3 provides compliance and regulatory solutions, added the brokers, on whom the burden of this Rule falls on, simply didn’t have the all the data available to comply.

“And they need to get it,” Davies said. And his firm, while ready to provide compliance assistance, itself needs the data too. “The biggest difficulty has been getting the data.  The delay is helping us get the client data so our clients can be compliant.”

Looking Through

Davies told Traders Magazine that getting the fee and rebate data to a specific client has been particularly difficult as it is simply not available today. Secondly, getting the “look through” data – determining where the destinations are routing flow and the fees/rebates paid to those destinations.

“Since brokers are required to show the routes and fees/rebates for their destinations, this drastically increases the complexity of compliance,” he said.

Is four months delay enough?

“I think it helps us in finding the data,” Davies said. “The big concern is that we still don’t have the SEC’s FAQs. So, we still have questions that can substantially affect the outcome.”

Jack Miller, Head of Trading at Baird, said that now that the market has clearly passed the original implementation date and no clarifying guidance has been issued to date and makes the delay seem like the only choice the SEC had. He added brokerages like his are still awaiting guidance, which could come any day.

“Without this, vendors and brokers are put in the position of making a “best guess,” and brokers in particular – who ultimately bear responsibility for compliance – would lack a regulatory mandate to demand certain data or services from vendors or downstream partners,” Miller said. “In my view, industry readiness – and the feasibility of the new October date – depends a lot on the content of the FAQs, including guidance around areas such as the “look through” provision and what should be considered valid “venues” under the rule.  If FINRA were to land on a more detailed interpretation of the rule the implementation date could prove challenging even with the delay given many brokers may not have all the data necessary to provide a full report.”

Miller added the other side of the equation is the buy-side who will be requesting and consuming the reports.  He said there will be a lot of data to process that is not trivial to interpret.  Importantly, this conversation is happening today with clients who are already demanding transparency and have robust analytical capabilities, but there are many who are earlier in that investment cycle.

“So, while the 606 enhancements are an important step forward in the march toward transparency, the evolution of the conversation between brokers and the buyside is something that will progress somewhat independently – albeit in parallel to – the implementation of the rule.”