June 22, 2001
Neal E. Sullivan
Re: Request for Exemption from Rule 11Ac1-6
Dear Mr. Sullivan and Ms. Marshall-Smith:
In your letter dated June 21, 2001 ("Letter") on behalf of your client, First Union Securities, Inc. ("First Union"), you requested that the Commission grant an exemption from Rule 11Ac1-6 ("Rule") under the Securities Exchange Act of 1934 ("Exchange Act"). Specifically, you request that a broker-dealer not be required to disclose the identity of execution venues that received less than 5% of the firm's non-directed order flow. This letter responds to your request.
Adopted in November 2000,1 the Rule requires all broker-dealers that route orders in equity and option securities to make available quarterly reports that present a general overview of their routing practices. The reports must identify the significant venues to which customer orders were routed for execution during the applicable quarter and disclose the material aspects of the broker-dealer's relationship with such venues. In addition, the Rule requires broker-dealers to disclose, on customer request, the venues to which the customer's individual orders were routed. The compliance date for the Rule is July 2, 2001. Accordingly, the first quarterly reports (for the third quarter of 2001) must be made available to the public by the end of October 2001. In addition, broker-dealers must begin responding to customer requests for individual information on orders that are routed on July 2, 2001 and after.
The Letter states that First Union handles certain types of niche orders that account for a de minimus proportion of its total order flow. These orders include arbitrage and other "spread" orders and orders for preferred securities, which collectively account for less than 2% of First Union's order flow. You indicate that these niche orders require special handling and therefore are not homogenous with the majority of First Union's orders, which are routed on an automated basis to execution venues as determined by First Union's Best Execution Committee. You note the execution venues chosen for niche orders many not be venues that First Union would choose for the rest of its order flow.
Paragraph (b)(1)(ii) of the Rule requires broker-dealers to disclose the identity of the ten venues to which the largest number of total non-directed orders for the section were routed for execution and any venue to which 5% or more of non-directed orders were routed for execution. The Letter notes that First Union typically routes 90% of its order flow to less than ten execution venues. If it were required to report on ten venues instead of only those venues that receive a material amount of order flow, you state that First Union would have the administrative burden of capturing non-automated data on a de minimus amount of its order flow. The cost of this administrative task would outweigh the benefit given that including such data would not materially impact the information First Union will provide on more than 90% of its orders. Accordingly, you request an exemption that would ease a broker-dealer's compliance burden under the Rule with respect to niche orders.
On the basis of your representations and the facts presented, the Commission, by the Division pursuant to delegated authority,2 is exempting broker-dealers from the disclosure requirements of paragraph (b)(1)(ii) of the Rule with respect to execution venues that receive only a small percentage of the non-directed orders. Specifically, a broker-dealer is not required to identify execution venues that received less than 5% of non-directed orders for a section of the broker-dealer's quarterly report, as long as it has identified the top execution venues that in the aggregate received at least 90% of the broker-dealer's total non-directed orders for the relevant section.
The Commission noted in the Adopting Release that "the quarterly reports on order routing are intended to provide a general overview of a broker-dealer's practices that is accessible and useful to individual investors."3 To this end, the Rule requires broker-dealers to disclose only those execution venues to which they routed the most orders for a section - the top ten and any others to which they routed 5% or more of orders. Where, however, a broker-dealer routes the great majority of its orders for a section of the report to only a few venues, it also might route orders to other venues that fall within the top ten, but receive only a small number of orders. The inclusion of these venues in quarterly reports would not provide materially more useful information to investors, yet could impose a significantly higher compliance burden. Consequently, the Commission finds that the exemption for execution venues that receive less than 5% of non-directed orders for a report section is necessary or appropriate in the public interest, and is consistent with the protection of investors. Such exemption, particularly when considered in conjunction with the Division's view that a broker-dealer may use reasonable procedures to estimate order routing percentages within a range that is materially accurate,4 should ease the Rule's compliance burden with respect to niche orders.
The exemption granted in this letter is subject to modification or revocation at any time if the Commission determines that such action is necessary or appropriate in the public interest or otherwise in furtherance of the purposes of the Exchange Act. If you have questions, please do not hesitate to contact me.
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Annette L. Nazareth