A lot has changed in equities markets since 2000, when the U.S. Securities and Exchange Commission adopted Rule 606 to improve public disclosure of brokers’ order-routing practices.

The NYSE-Nasdaq exchange duopoly is long gone. Electronic trading has evolved from a small corner of the market almost two decades ago, to ubiquitous now. And then-speedy trades measured in milliseconds are glacial today.

So with the old Rule 606 about as relevant today as rules pertaining to 3G mobile-phone technology, the updates the SEC outlined late last year will be substantial.

“By mandating and standardizing broker disclosure of order routing, the newly adopted Rule 606(b)(3) increases transparency and removes potential barriers that investors may face in monitoring broker order handling,” said Stephen Fitzpatrick, Senior Passive Equities Portfolio Manager and Senior Trader at the $48.1 billion Colorado Public Employees’ Retirement Association. “We are hopeful that the rule change will elevate the importance of conflict-free routing with investors, and could even improve routing before it takes effect, as brokers anticipate increased investor scrutiny.”

In a November 2018 release, the SEC highlighted that the rule update will require that broker-dealers provide customers more information on so-called not held orders, or those for which brokers have price and time discretion. The intent is to help investors better understand how brokers handle and route orders and assess the impact of routing decisions on order execution quality. The rule update goes into effect May 20.

Better Comps
Given the risk of ‘information leakage’ compromising order execution, the SEC has stipulated that information about not held orders be shared with customers, but not released publicly.

“Customers will be able to take this granular, standardized data and do a more thorough comparison of routing performance than they were able to do in the previous 606 regime,” said Venu Palaparthi, Chief Compliance Officer and Head of Regulatory Affairs at Dash Financial Technologies. “Previous 606 information was of very limited value to the customer because it was just high-level information on what percentage was non-directed broken down as market, limit or other.”

Palaparthi notes that the Rule 606 update does not cover order flow that is routed from broker-dealer to broker-dealer, “so broker-dealers will have to negotiate what data they want to share among themselves,” he said. “That will result in some information gaps, because the SEC is leaving it to market forces to sort out.”

Palaparthi indicated there may be some complacency on the buy side regarding the upcoming change. “There may be some managers who are assuming that their brokers will be providing this data and this data will contain all the information that it ought to contain,” he said. “But I think what they do not realize is that in many cases, the client-specific report will only say that the order was routed to another broker.”

Palaparthi noted that Dash clients – both on the buy and sell side – have received granular, real-time routing and fee information through the web-based Dash360 since the firm launched in 2011.

The 606 update makes very few improvements for options order handling, and there are some uncertainties with respect to actionable indications of interest (IOIs), for purposes of determining whether to include in the reporting. Palaparthi expects investment managers to ask more questions once they start seeing the first iterations of the data.

Colorado PERA “recognized the importance of monitoring broker routing prior to the rule change, and consequently we have already requested routing data from our brokers, who have been very receptive,” Fitzpatrick said. “As we continue to monitor broker routing, the standardization of disclosure details required under Rule 606(b)(3) may improve comparisons between brokers.”

Overall, the pension plan does not expect issues in brokers meeting the reporting requirements of the rule update. Large brokers should have the necessary infrastructure in place, and Fitzpatrick said in response to queries, smaller brokers “have informed us that implementation will not be too burdensome.”

Limitations

One limitation of the updated Rule 606 is that its public disclosures will be inadequate to use for proper broker evaluation, said Tyler Gellasch, Executive Director of Healthy Markets, an industry trade group.

‘It’s not great as a comparison tool, nor does it help the markets writ large understand the conflicts of interest that the brokers face,” Gellasch said. “The other downside is, it doesn’t apply to anything other than not held orders by institutions. There are a lot of exemptions and exceptions.”

Gellasch also noted that smaller brokers, particularly those that don’t have their own suite of trading algos and instead use ‘white label’ products of larger firms, may face challenges gathering the information they need to deliver to clients.

But overall, the Rule 606 update is a long time coming. “This reform is a very big step for improving best execution,” Gellasch said. “Investors are going to have a much better idea whether a broker is routing for best execution, or whether a broker is routing for the benefit of the broker.”

“Dash has essentially built its business on the premise that complete transparency coupled with full customization capability allows market participants to make data-driven routing decisions that ultimately reduce costs and drive performance,” added Palaparthi. “We think this approach is in the best interest of investors and are happy to see the industry moving in this direction.”