This past week, Reuters featured a piece about “retail brokers avoiding the regulators’ wrath and increasing disclosure”. The announcement came in the midst of current SEC and FINRA investigations into broker dealer conflicts of interest and failure to deliver Best Execution on customer orders. The retail brokers, in conjunction with the Financial Information Forum, have been working to create standard uniform metrics, based largely off of SEC Rule 605, that will allow customers and prospective customers to compare execution metrics “apples to apples,” from one retail provider to the next. As part of the voluntary disclosures, brokers working through the FIF will publish information on their websites that details Enhanced liquidity, Price Improvement and average savings per order from 1-2,000 shares in S&P and non S&P stocks. The program is expected to kick off by mid year. Reform Rules 605 and 606
We applaud the firm’s efforts with some restraint. For the first time, information will be available on a 605 style basis for retail brokers rather than exclusively for internalizing firms such as KCG or Citadel. While any increased transparency is great, this information will provide only a partial view. The program will completely exclude limit orders which today comprise a significant portion of a firm’s order-flow. Additionally, the program will provide information about the most vanilla of orders and will exclude stop orders, orders at the close or open, and the increasingly popular contingent orders.
Worse yet, the information will be based on dated Rule 605 information which is in dire need of modernization and expansion. We’ve been pushing hard through Healthy Markets to modernize Rule 605 and Rule 606. Thus, we were encouraged to see Bats Global markets seeking similar reforms in their market structure petition with the SEC. Modernizing Rule 605 and 606 is low hanging fruit for the SEC. The majority of infrastructure exists today to facilitate this undertaking and there has been little pushback on the matter.
Regulatory pressure can change behavior
The latest SEC 606 statistics for the fourth quarter of 2014 were just released on the 31st and we analyzed the latest metrics among the largest retail brokers. The move to disclose more and increased regulatory pressure is making an impact on Payment for Order-Flow, as it is in our sample universe, where payments for order-flow declined by as much as 22% for some brokers in the fourth quarter of 2014 compared to the previous quarter. This is, no doubt, window dressing to divert payment monies to price improvement instead, which shows regulatory rule-making is not always required to prompt behavioral changes in the market. Imagine how much better execution quality might be if Rules 605 and 606 were modernized with proper regulatory balance.