October 5, 2000
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: File No. S7-16-00
Ladies and Gentlemen:
The BRUT ECN, L.L.C. ("BRUT") appreciates the opportunity to provide the Securities and Exchange Commission (the "Commission") with its comments on Exchange Act Release No. 43084 (the "Proposing Release"),1 in which the Commission proposes the adoption of Rules 11Ac1-5 and 11Ac1-6 under the Securities Exchange Act of 1934 (the "Exchange Act"), which would require public reporting by market centers and broker-dealers regarding the routing and execution of certain customer orders. BRUT believes that dialogue regarding how to ensure best execution of customer orders amidst rapid technological change is in the best interest of investors and intermediaries.
Proposed Rules 11Ac1-5 and 11Ac1-6
BRUT concurs in principle with the rationale that, empowered by more information concerning order routing and execution, "investors will be able to make better informed decisions with respect to their orders."2 In executing on that principle the Commission should work with market participants to ensure that the efficacy of required disclosure in achieving the desired objectives is high in relation to the compliance obligations imposed on financial intermediaries. As the operator of an alternative trading system that would be classified as a "market center" under proposed Rule 11Ac1-5, BRUT has performed a preliminary evaluation as to the costs and feasibility of compiling and publishing the requisite information, and believes that compliance with the rule as proposed can be accomplished, although Commission estimates regarding the time and money devoted to compliance with the rule is somewhat low.3 BRUT's operation of an electronic communications network ("ECN") that provides its broker-dealer and
institutional subscribers with comprehensive order-management capabilities would likely mean limited compliance obligations for BRUT under proposed Rule 11Ac1-6, given the lack of "non-directed orders"4 received by BRUT from its subscribers. BRUT's broker-dealer subscribers, however, would be required to make disclosures to the extent that non-directed order flow was directed to BRUT or through for execution. The Commission should seek input from all segments of the financial community to assess the impact of the proposed rules in their totality, in order to judge whether such burden is warranted in light of the benefits that flow from enhancing investor information in this manner.
In addition, the Commission should consider the following issues regarding the proposed rules as drafted that the Commission should resolve before adoption:
Further Action to Improve Competition
The Proposing Release examines several additional regulatory measures that the Commission is considering in an effort to enhance competition among market centers and individual orders. With respect to competition among execution vehicles, BRUT concurs with the Commission's analysis that competition "has proven to be a primary force in improving the operation of the markets."8 As discussed above, BRUT believes that the Commission should focus its efforts on combating fragmentation of information, while allowing the market for trade-execution alternatives to fragment or consolidate as investor needs dictate. A continuation of cooperative efforts to include ECN order prices in the consolidated quotation system for listed securities will improve the quality of price information available to investors. BRUT's agreement, along with other ECNs, to participate in the Nasdaq InterMarket will facilitate this inclusion as well as enhance linkages between markets, allowing for greater interaction between distinct pools of liquidity. The Commission's current approach of encouraging these developments, but allowing "market-based incentives, not government-imposed systems, [to] determine the connections between markets"9 is ideal, given that regulatory attempts to compel the specifics of market-center interaction can have a chilling anti-competitive effect.
Two facets of ECN interaction with more traditional execution vehicles warrant further comment. With respect to ECN access fees, and whether such fees should be included in the price at which ECN orders are displayed to the public, BRUT believes that such an approach would be inaccurate and inefficient. The simple nature of ECN access fees, which are often assessed on a "sliding scale" based on volume levels and often less than a penny per share, would make such inclusion hard to implement even in a decimalized environment. Requiring ECNs to adopt more regimented fee structures to facilitate inclusion of fees in quoted order prices would likely result in higher overall costs to investors and should be avoided absent a compelling regulatory need. In addition, modifying order prices to reflect such fees without similar requirements to include direct or indirect charges assessed by other market centers (e.g., exchange and NASD fees, market maker average realized spreads) would provide investors with an incomplete picture of transaction costs. Suggestions made in the Proposing Release, such as including only fees that are large in relation to the minimum quoting increment10 would not alleviate these difficulties and disparities.
Most importantly, however, this approach would bundle the price of an execution with a cost associated with that execution in a manner that would cloud the nature of both. ECN access fees are typically not directly charged to the investor who receives an execution against a displayed ECN order. Rather, the access fee is treated as part of the cost incurred in executing an order on an agency basis and reflected in the commission charged to the customer.11 The Commission noted the distinction between the cost of accessing a market center and the prices of displayed orders in adopting the Order Handing Rules:
"[I]f an ECN provides an automated link... broker-dealer[s] must take the prices and other relevant costs in that system into account in handling customer orders."12
This prescient statement still rings true today. While the cost of accessing ECN order prices via SelectNet are relevant to a broker-dealer's best-execution analysis in handling customer orders, such costs are separate and apart from order price being displayed by the relevant ECN. To consolidate for public display a priced ECN order along with the trading costs associated with executing against such order would discourage innovative business models and fee structures, create increased opportunities for internalization, and ultimately undermine price competition and investor choice among trade execution alternatives.
How ECNs interact with other market centers when executing transactions in listed securities also requires thoughtful analysis to ensure that investors do not loose order-management flexibility. ECN subscribers retain primary responsibility for their orders' management and execution. Accordingly, ECN executions occasionally occur at prices inferior to quotes in other market centers in instances where an ECN subscriber desires immediacy or anonymity over price improvement, rather than the ECN's desire to trade on a proprietary basis or otherwise internalize customer executions. While recognizing that investors posting superior-priced orders should be rewarded with executions to encourage quote competition, current means for ensuring this in the market for listed securities (e.g., the Intermarket Trading System's "trade-through") are at best inefficient,13 and could serve to undermine the benefits that certain market centers offer. Disclosure by market intermediaries of instances where they by-pass superior quotes in executing non-directed orders may to some extent alleviate best-execution providing another basis of market competition. BRUT is committed to working with the Commission and other market centers to integrate ECN order prices for listed securities into the national market system in a manner that provides greater best-execution opportunities for ECN subscribers and other investors alike.
Diversity and competition for order flow among markets centers has created unique opportunities for best execution and provided a broad range of benefits to investors. Ensuring that information is available to investors to digest these alternatives in a comprehensive and economical fashion is a challenge that, if met, will allow investors to take maximum advantage of the choices at their disposal while allowing the forces of innovation and competition to propel the markets towards further improvements.
BRUT appreciates this opportunity to provide comments to the Commission. If the Commission or its staff would find further discussions or other assistance helpful, do not hesitate to contact me at (917) 637-2560.
Senior Vice President & General Counsel
The BRUT ECN, L.L.C.
cc: The Hon. Arthur Levitt, Chairman
The Hon. Norman S. Johnson, Commissioner
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Paul R. Carey, Commissioner
The Hon. Laura S. Unger, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation
Belinda Blaine, Associate Director, Division of Market Regulation
1 July 28, 2000. 65 Fed. Reg. 48406 (August 8, 2000). File No. S7-16-00.
2 Id., at 48430.
3 See Id., at 48426 (stating that market centers complying with proposed Rule 11Ac1-5 would "spend six hours per month of additional time to collect the data necessary to generate the [required] reports." Preliminary estimates indicate BRUT would need to spend upwards of 100 hours initially to ensure for the efficient generation of required data, although said process would streamline future compliance efforts.
4 Proposed Rule 11Ac1-6(a)(5) would define a non-directed order as any order that is not a directed order, which would be defined as "a customer order that the customer specifically instructed the broker or dealer to route to a particular venue for execution." See proposed Rule 11Ac1-6(a)(3). BRUT subscribers always dictate how their orders will be executed, interacting directly with the orders of other subscribers or with the orders of other market centers displayed in Nasdaq.
5 Proposing Release, supra note 1, at 48419.
6 For example, broker-dealers routing non-directed order flow through Nasdaq's SuperMontage, if approved, would likely have to disclose their membership interest in the NASD (and any shareholder interest in a de-mutualized Nasdaq). Any brokers having an ownership interest in a for-profit exchange would need make similar disclosures, as would brokers with an interest in an ECN (several of which are currently owned in whole or in part by broker-dealers).
7 Exchange Act Release No. 43138 (August 10, 2000), 65 Fed. Reg. 49842 (August 15, 2000) at 49854.
8 Proposing Release at 48418.
9 Id., at 48422.
10 See Id., at 48421.
11 See Letter from Barbara L. N. Roper, Director of Investor Protection, Consumer Federation of America, to Jonathan G. Katz, Secretary, Securities and Exchange Commission, dated September 14, 2000, at 2 (discussing ECN access fees as a function of trading costs that "the [executing] firm, not the investor, typically pays").
12 Exchange Act Release No. 37619 (August 29, 1996), 61 Fed. Reg. 48290, at 48323 (emphasis added).
13 See Proposing Release at 48423 (stating that the rule's "effectiveness in preventing trade-throughs depends in large part on market participants taking steps to seek redress for trade-throughs from another market, which does not always occur.").