On November 2, 2018, the Securities and Exchange Commission (the “Commission”) amended Rules 605 and 606 under Regulation NMS to require additional disclosures by broker-dealers to customers regarding the handling of their orders.1 The Commission stated that the amended rules would provide more detailed 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. The Commission noted its particular concern with regard to information leakage and potential conflicts of interest in order routing decisions.
The effective date of the new rules is two months from publication in the Federal Register, and the compliance date is six months from publication in the Federal Register. With respect to the disclosures required by new Rule 606(b)(3), as further described below, broker-dealers are not required to provide reports for dates prior to the compliance date.
Adoption of Rule 606(b)(3)
The Commission amended Rule 606(b) to require that a broker-dealer, upon request of a customer2 that places, directly or indirectly, one or more not held orders3 with the broker-dealer, provide customer-specific disclosures for the prior six months. In particular, new Rule 606(b)(3) requires disclosures related to:
Broker-dealers are required to provide the report to the customer that places the order with the broker-dealer, regardless of whether the customer is acting on behalf of others and is not the ultimate beneficiary of any resulting transactions. Upon request from the customer, a broker-dealer is required to provide the customer-specific report within seven business days with the report covering the prior six months, broken down by calendar month.4 For subsequent requests, a broker-dealer is not required to provide data for those months already provided.
The Commission adopted two de minimis exceptions to Rule 606(b)(3). First, as a firm-level exception, a broker-dealer is not obligated to provide the new disclosures to any customer if not held NMS stock orders constitute less than 5% of the total shares of NMS stock orders that the broker-dealer receives from its customers over the prior six months. For the first time a broker-dealer crosses this threshold, the broker-dealer has a 3-month grace period until it needs to comply with Rule 606(b)(3)’s disclosure requirements. Additionally, once the threshold is crossed, the broker-dealer must comply with Rule 606(b)(3)’s disclosure requirements for six months (referred to as the “Compliance Period”) regardless of volume during that Compliance Period. After six months pass, the broker-dealer may reassess the firm-level exception on a monthly basis. If a broker-dealer ever meets the de minimis exception—and therefore does not need to comply with Rule 606(b)(3) for the following month—but then crosses the volume threshold in a subsequent month, the six-month Compliance Period would begin again without any applicable grace period.
Second, as a customer-level exception, a broker-dealer would not be obligated to provide Rule 606(b)(3)’s disclosures to a particular customer if that customer trades through the broker-dealer, on average each month for the prior six months, less than $1,000,000 of notional value of not held orders in NMS stocks.
Amendments to Rule 606(a)
In addition to adopting Rule 606(b)(3), the Commission amended Rule 606(a) to require that the order routing disclosures that broker-dealers make on a quarterly basis pertain to NMS stock orders of any dollar value, eliminating the exclusion of orders above $200,000 in market value but maintaining the $50,000 limit on option orders. The Commission also amended Rule 606(a)’s required disclosures by requiring:
Notably, with respect to payment for order flow, a broker-dealer must report any arrangement for payment for order flow and any profit-sharing relationship with each “Specified Venue.”6 The disclosures also include whether the Specified Venue provides any incentives or disincentives for meeting or failing to meet volume threshold.
1 See Securities Exchange Act Release No. 84528 (November 2, 2018). The amendments were first proposed in July 2016. See Securities Exchange Act Release No. 78309, 81 FR 49432 (July 27, 2016).
2 Rule 606(b)(3)’s disclosure requirements do not apply to orders from a broker-dealer.
3 In the adopting release, the Commission defined a “not held” order as an order that provides a broker-dealer with price and time discretion in handling the order.
4 The Commission noted that certain information might not be available within seven business days if the report was requested at the beginning of the month, such as fee/rebate information. In such instances, the broker-dealer would produce reports for the six calendar month period for which the broker-dealer does have complete information.
5 The Commission also amended Rule 606(b)(1) to apply to those orders for which Rule 606(b)(3) does not apply, specifically, held NMS stock orders or for instances when a de minimis exception would except a broker-dealer from providing the Rule 606(b)(3) disclosures.
6 Specified Venues consist of the ten venues to which a broker-dealer routed the largest number of total non-directed orders and any venue to which the broker-dealer routed 5% or more of such orders.