SEC rules have made the United States the gold standard for best execution transparency. Mark Davies, CEO of data firm S3 shares his insights into the rules, how they are changing and potential applications for non-US trading firms.
How do SEC Rules 605 and 606 work in the US and how does it relate to best execution practices?
SEC Rules 605 and 606 each have distinct requirements, but work in tandem to enhance transparency and help investors, regulators, and brokers assess execution quality. Rule 605 provides data to help brokers and investors compare execution quality across venues, while Rule 606 ensures brokers are transparent about how they route orders. Together, these rules encourage competition and efficiency in the marketplace.
How does Rule 605 work?
Rule 605 requires market centres (exchanges, market makers, wholesalers, and ATSs) to publicly report execution quality statistics for covered orders in NMS stocks. “Covered orders” are market orders and limit orders that are immediately executable (marketable orders). 605 reports must include price improvement, effective spread, execution speed, and fill rates, and all of the data must be broken down by trade size. These reports must be publicly published on a monthly basis so that brokers and investors can compare the performance of market centres.
In March of 2024 the SEC approved amendments to modernise Rule 605 by enhancing transparency, adapting to technological advancements, and ensuring that execution quality metrics align with the complexities of modern trading environments. Some of the most significant changes include:
- Broadening the definition of a “covered order” – now includes certain orders submitted outside regular trading hours, orders with stop prices, and non-exempt short sale orders
- Creating new order size categories – instead of share quantity, the report will now show notional dollar value, and will make a distinction between fractional shares, odd-lots, and round lots
- Requiring much more granular reporting metrics – execution times will now be reported using millisecond or finer timestamps (microseconds/nanoseconds), realised spread stats will be calculated using additional time horizons ranging from less than 100 microseconds to 5 minutes after order receipt
- Expanding the scope of who must report – now, in addition to market centres, “large” broker dealers that hold 100,000 or more customer accounts will be required to produce a 605 report
The new requirements will go into effect in December of 2025.
Explain how Rule 606 and the best execution obligation works in the US:
Rule 606 requires broker-dealers to publicly disclose how they route and execute customer orders in NMS stocks and listed options. The best execution obligation requires broker-dealers to seek the most favourable terms reasonably available for customer orders. So, this could mean routing customer orders to an execution venue that has a higher rate of price improvement, or routing large institutional orders to a dark pool or ATS instead of an exchange to avoid moving the market and getting a worse price. In addition to the required disclosures, FINRA-registered firms must regularly review their execution quality, compare venues, monitor payment for order flow, and make adjustments as needed.
This is where S3 comes in. We provide the tools needed to efficiently and effectively perform these best execution reviews. A broker can use S3’s software to perform reviews of their execution partners, and for example, notice a trend of consistently delayed executions leading to poor fill prices during volatile market conditions. That broker can then change its routing practices to send more of their order flow to a more consistently performing partner. S3’s GUI makes it easy to spot trends or exceptions, and track those changes right in the portal. BDs can then adjust their routing behaviour accordingly, while also showing to internal best execution committees or even regulators that they are closely monitoring and optimising execution quality.
We process data for the vast majority of the top market participants in the US – clients use our web-based portal to monitor execution quality and build reports that help to make routing decisions as well as satisfy their regulatory obligations. Regulatory supervision requires the review process to be pre-defined and then documented to show that it’s being followed. The S3 portal features an audit trail function where users can track exceptions and save comments, and then download a file as evidence for regulators. The platform is very intuitive and user-friendly, and simplifies a data-heavy process into something much more manageable.
Why do the changes to 605 matter and why now?
The update to 605 is particularly timely now that retail trading volumes have experienced such a notable surge in recent years, due to several factors. Mobile trading Apps (like Robinhood) have made it easy for people to trade anytime, anywhere. Social media platforms like Reddit and TikTok have become hubs for investment discussions, fostering a community-driven investment culture. The “meme stocks” phenomenon was driven by chatter amongst online communities that made coordinated buying efforts, leading to significant price movements in stocks like GameStop (GME). Many people started exploring stock trading as a new activity after spending so much time at home during pandemic lockdowns. The ability to purchase fractional shares has made investing in high-priced stocks more accessible to retail investors with limited capital. All this combined with zero-commission trading has created an environment where truly anyone can trade.
Rule 606 was last updated in 2018, but Rule 605 hasn’t been changed significantly since its inception in 2000. With the innovations in trading and technology advancements that have occurred in the last 25 years, combined with the recent uptick in retail trading activity, the time has come for the disclosures to catch up.
How is S3’s US best execution reporting software being adapted for non-US clients?
One of our clients, a large US-based bulge bracket bank, asked us to partner with them to develop a best execution product for their global business. They had struggled to find an existing provider of best execution & TCA software that performed as well as the S3 best execution software they use to analyse their US order flow. Because of the profile and global footprint of this client, we realised this approach could be used by other US firms trading globally, as well as UK and European-based firms trading domestically or in the US.
With the elimination of RTS 27 & 28 in the UK, there is an opportunity for firms to pave their own way in terms of how they evaluate execution quality, and to show to regulators (and clients) that they are using a process driven by meaningful data. The increasing globalisation of trading can only mean a need for more transparency and a more streamlined approach to best execution, with more granular execution quality metrics and user-friendly review applications. Increased transparency helps traders make better-informed decisions, resulting in better executions, a reduction in hidden costs, and a more competitive marketplace overall. As the leading provider of best execution analytics and reporting disclosures in the US, S3 is well-positioned to help firms worldwide looking to ensure investor protection in any jurisdiction.
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